sbsform20f_2013.htm - Generated by SEC Publisher for SEC Filing  

 

 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20‑F

o    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

þ    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013

OR

o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to _______________________

OR

o    SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report__________________________

Commission file number 001‑31317

Companhia de Saneamento Básico do Estado de São Paulo–SABESP
(Exact name of Registrant as specified in its charter)

Basic Sanitation Company of the State of São Paulo‑SABESP
(Translation of the Registrant’s name into English)

Federative Republic of Brazil
(Jurisdiction of incorporation or organization)

Rua Costa Carvalho, 300
05429‑900 São Paulo, SP, Brazil
(Address of principal executive offices)

Rui de Britto Álvares Affonso
raffonso@sabesp.com.br
(+55 11 3388 8247)
Rua Costa Carvalho, 300 05429‑900 São Paulo, SP, Brazil

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class

Name of each exchange on which registered

Common Shares1, without par value

New York Stock Exchange2*

American Depositary Shares, evidenced by American Depositary Receipts, each representing one Common Share

New York Stock Exchange

 
 

 


1 On April 22, 2013, our shareholders approved a stock split, following which each common share represented three new common shares.

2 Until January 23, 2013, each American Depositary Share represented two common shares.  As of January 24, 2013, each American Depositary  Share represents one Common Share.

* Not for trading purposes, but only in connection with the registration of American Depositary Shares pursuant to the requirements of the Securities and Exchange Commission.

 

 

 
 

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:  None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:  None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

683,509,869 Shares of Common Stock

Indicate by check mark if the registrant is a well‑known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes þ No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No þ 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non‑accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b‑2 of the Exchange Act.  (Check one):

Large accelerated filer þ Accelerated filer o Non‑accelerated filer

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP o International Financial Reporting Standards as issued by the International Accounting Standards Board þ Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow

Item 17 o Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).

Yes o No þ 

 

 

 
 

 

TABLE OF CONTENTS

Page

PART I

6

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

6

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

6

ITEM 3.

KEY INFORMATION

6

ITEM 4.

INFORMATION ON THE COMPANY

23

ITEM 4A.

UNRESOLVED STAFF COMMENTS

71

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

71

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

95

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

104

ITEM 8.

FINANCIAL INFORMATION

112

ITEM 9.

THE OFFER AND LISTING

117

ITEM 10.

ADDITIONAL INFORMATION

121

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

134

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

137

PART II

 

138

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

138

ITEM 14.

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

138

ITEM 15.

CONTROLS AND PROCEDURES

138

ITEM 16.

[RESERVED]

140

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

140

ITEM 16B.

CODE OF ETHICS

141

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

141

ITEM 16D.

Exemptions from the Listing Standards for Audit Committees

142

ITEM 16E.

Purchases of Equity Securities by Issuer and Affiliated Purchasers

142

ITEM 16F.

Change in Registrant’s Certifying Accountant

142

ITEM 16g.

CORPORATE GOVERNANCE

143

ITEM 16h.

MinE safety disclosure

145

PART III

 

146

ITEM 17.

FINANCIAL STATEMENTS

146

ITEM 18.

FINANCIAL STATEMENTS

146

ITEM 19.

EXHIBITS

146

SIGNATURES

 

148

 

 

 

i


 
 

 

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

General

We maintain our books and records in reais.  We prepare our financial statements in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or the IASB.  Our financial statements as of December 31, 2013 and 2012 and for the three years ended December 31, 2013 have been audited, as stated in the report appearing herein, and are included in this annual report on Form 20-F.

We restated our financial statements as of and for the years ended December 31, 2012 and 2011 as a result of the adoption, as of January 1, 2013, of two new standards issued by the IASB: IAS 19 (Employee Benefits – as revised in 2011) and IFRS 11 (Joint Arrangements).  These new standards were applied retrospectively to 2012 and 2011 pursuant to IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors) for comparison purposes.  The adoption of these new standards impacted several line items of our financial statements.  One of these impacts relates to the method of accounting for the results of joint-ventures, which are now recognized using the equity method of accounting instead of the proportional consolidation method we used prior to the adoption of the IFRS 11.  See note 4.1 to our financial statements for a description of these standards and their impact on our financial statements.

Convenience Translations

We have translated some of the real amounts contained in this annual report into U.S. dollars.  The rate used to translate such amounts in respect of the year ended December 31, 2013 was R$2.3426 to US$1.00, which was the commercial rate for the purchase of U.S. dollars in effect on December 31, 2013, as reported by the Central Bank.  The U.S. dollar equivalent information presented in this annual report is provided solely for the convenience of the reader and should not be construed as implying that the real amounts represent, or could have been or could be converted into, U.S. dollars at the above rate.  See “Item 3.A. Selected Financial Data—Exchange Rates” for more detailed information regarding the Brazilian foreign exchange system and historical data on the exchange rate of the real against the U.S. dollar.

Rounding

Some percentages and numbers included in this annual report have been subject to rounding adjustments.  Accordingly, figures shown as totals in certain tables may not be an arithmetic aggregation of the figures that precede them.

Other Information

In this annual report, unless the context otherwise requires, references to “we,” “us,” “our,” “Company,” or “SABESP” refer to Companhia de Saneamento Básico do Estado de São Paulo – SABESP.

In addition, references to:

·                     real,” “reais” or “R$” are to the Brazilian real, the official currency of Brazil;

·                     “U.S. dollars” or “US$” are to the United States dollar, the official currency of the United States;

·                     “Brazil” are to the Federative Republic of Brazil;

·                     “State” are to the State of São Paulo, which is also our controlling shareholder;

·                     “federal government” and “Brazilian government” are to the federal government of the Federative Republic of Brazil and “state government” are to the state government of the State of São Paulo;

·                     “São Paulo metropolitan region,” with respect to our operations, are to the area where the Metropolitan executive office operates, comprising 37 municipalities, including the city of São Paulo;

 2


 
 

 

·                     “Regional systems” are to the area where the Regional systems executive office operates, comprising 326 municipalities in the interior and coastline regions of the State of São Paulo;

·                     “water coverage ratio” are to the ratio between the number of residences connected to the water supply network, divided by the number of urban residences in a certain area; and

·                     “sewage coverage ratio” are to the ratio between the number of residences connected to the sewage collection network, divided by the number of urban residences in a certain area.

Information in this annual report related to liters, water and sewage volumes, number of employees, kilometers, water and sewage connections, population served, operating productivity, water production rate, sewage lines (in kilometers), savings achieved and investment in improvement programs has not been audited.

Market Information

We make statements in this annual report about our market share and other information relating to Brazil and the industry in which we operate.  We have made these statements on the basis of information from third‑party sources and publicly available information that we believe is reliable, such as information and reports from the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or IBGE, and the State Data Analysis System Foundation (Fundação Sistema Estadual de Análise de Dados); or SEADE, among others.  We have no reason to believe any of this information is inaccurate in any material respect.

References to urban and total population in this annual report are estimated based on a research prepared by SEADE:  “Projections for the State of São Paulo – Population and Residences until 2025” (Projeções para o Estado de São Paulo – População e Domicílios até 2025). 

Our contracts and the Municipalities We Serve

Throughout this document, we refer to the 363 municipalities we serve and to our 365 water contracts.  This difference results from the fact that we have two partial water contracts with the municipality of Mogi das Cruzes.  These contracts are partial because pursuant to them we serve only two neighborhoods of this municipality and, as a result, do not include Mogi das Cruzes in the total of municipalities we serve.

 3


 
 

 

CAUTIONARY STATEMENTS ABOUT FORWARD‑LOOKING STATEMENTS

This annual report includes forward‑looking statements, mainly in Items 3 through 5.  We have based these forward‑looking statements largely on our current expectations and projections about future events and financial trends affecting our business.  These forward‑looking statements are subject to risks, uncertainties and assumptions, including, among other factors:

·                     general economic, political, demographical and other conditions in Brazil and in other emerging market countries;

·                     changes in applicable laws and regulations, as well as the enactment of new laws and regulations, including those relating to environmental, tax and employment matters in Brazil;

·                     fluctuations in inflation, interest rates and exchange rates in Brazil;

·                     the interests of our controlling shareholder;

·                     our ability to collect amounts owed to us by our controlling shareholder and by municipalities;

·                     our ability to continue to use certain reservoirs under current terms and conditions;

·                     our capital expenditure program and other liquidity and capital resources requirements;

·                     droughts, water shortages, intensive rain and other climatic events;

·                     our exposure to probable increases in the frequency of extreme weather conditions;

·                     power shortages, rationing of energy supply or significant changes in energy tariffs;

·                     the effects of the agreement for provision of water and sewage services in the City of São Paulo, which we executed with the State and the City of São Paulo;

·                     the lack of formal agreements between our company and certain municipalities to which we provide water and sewage services, including cities comprising metropolitan regions, and the fact that the State and municipal governments share competency regarding these services;

·                     the municipalities’ ability to terminate our existing concession agreements prior to their expiration date and our ability to renew such agreements;

·                     our ability to provide water and sewage services in additional municipalities and to maintain the right to provide the services for which we currently have contracts;

·                     the size and growth of our customer base;

·                     our ability to comply with the requirements regarding water and sewage service levels included in our agreements with municipalities;

·                     our level of debt and limitations on our ability to incur additional debt;

·                     our ability to access financing with favorable terms in the future;

·                     the costs we incur in complying with environmental laws and any penalties for failure to comply with these laws;

·                     the outcome of our pending or future legal proceedings;

·                     our management’s expectations and estimates relating to our future financial performance;

 4


 
 

 

·                     the regulations issued by the São Paulo State Sanitation and Energy Regulatory Agency, or ARSESP, regarding several aspects of our business, including limitations on our ability to set and adjust our tariffs;

·                     the impacts on our business of the water consumption reduction incentive program and of any other  measures we may need to take until the level of our reservoirs is normalized and sufficient to supply the customers in the São Paulo metropolitan region;

·                     decisions by the São Paulo State Department of Water and Energy (DAEE) and the National Water Agency (ANA) limiting the volume of water that may be drawn from the Cantareira System, the main water system we use to serve the São Paulo Metropolitan Region, and the measures that we may be required to take to ensure the provision of water to our customers; and

·                     other risk factors as set forth under “Item 3.D. Risk Factors.”

The words “believe,” “may,” “estimate,” “continue,” “anticipate,” “plan,” “intend,” “expect” and similar words are intended to identify forward‑looking statements.  In light of these risks and uncertainties, the forward‑looking events and circumstances discussed in this annual report might not occur.  Our actual results could differ substantially from those anticipated in our forward‑looking statements.  Forward‑looking statements speak only as of the date they were made and we do not undertake any obligation to update or revise any forward‑looking statements, whether as a result of new information, future events or otherwise, unless required by law.  Any such forward‑looking statements are not an indication of future performance and involve risks.

 

 5


 
 

 

PART I

ITEM 1.            IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2.            OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3.            KEY INFORMATION

A.         Selected Financial Data

The following selected financial data should be read in conjunction with our financial statements (including the notes thereto), “Item 5.  Operating and Financial Review and Prospects” and “Presentation of Financial and Other Information.”

The selected financial data as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 have been derived from our financial statements, prepared in accordance with IFRS, and included in this annual report.  As described above and in further detail in note 4.1 to our audited financial statements, our financial data as of and for the years ended December 31, 2012 and 2011 was restated as a result of the retrospective adoption of certain new accounting standards.  The selected financial data as of and for the years ended December 31, 2010 and 2009 have been derived from our financial statements, prepared in accordance with IFRS, which is not included in this annual report.  Because these financial statements, and the financial data derived therefrom, were not restated to reflect the adoption of the new standards described above, they are not comparable to our financial statements, and the financial data derived therefrom, as of and for the years ended December 31, 2013, 2012 and 2011 (see note 4.1 to our audited financial statements).

We have included information with respect to the dividends and/or interest attributable to shareholders’ equity paid to holders of our common shares since January 1, 2009 in reais and in U.S. dollars translated from reais at the commercial market selling rate in effect as of the payment date under the caption “Item 8. Financial Information—Dividends and Dividend Policy—Payment of Dividends.” 

The following tables present our selected financial data as of and for each of the periods indicated.

IFRS Summary Financial Data

Year ended December 31,

 

2013

2013

2012(3)

2011(3)

2010(4)

2009(4)

 

(in millions of U.S. dollars)

(in millions of reais, except per share and per ADS(1) data)

Statement of operations data:

 

 

 

 

 

 

Net operating revenues

4,830.3

11,315.6

10,737.6

9,927.4

9,231.0

8,579.5

Cost of sales and services

(2,909.7)

(6,816.3)

(6,449.9)

(6,018.7)

(5,194.5)

(5,087.3)

Gross profit

1,920.6

4,499.3

4,287.7

3,908.7

4,036.5

3,492.2

Selling expenses

(272.0)

(637.1)

(697.3)

(619.3)

(712.9)

(614.4)

Administrative expenses

(311.2)

(729.1)

(717.4)

(683.6)

(653.2)

(717.1)

Operating profit

1,339.9

3,138.8

2,843.3

2,512.0

2,672.2

2,120.3

Financial income (expenses), net

(206.3)

(483.2)

(295.7)

(633.0)

(379.4)

(10.0)

Net income

821.1

1,923.6

1,911.9

1,380.9

1,630.5

1,507.7

 

 

 

 

 

 

 

Earnings per share – basic and diluted(2)

1.20

2.81

2.80

2.02

2.39

2.21

Earnings per ADS – basic and diluted(*)(2)

1.20

2.81

2.80

2.02

2.39

2.21

 

 

 

 

 

 

 

Dividends and interest on shareholders’ equity per share(2)

0.29

0.67

0.66

0.43

0.57

0.58

Dividends and interest on shareholders’ equity per ADS(*)(2)

0.29

0.67

0.66

0.43

0.57

0.58

Weighted average number of common shares outstanding(2)

 

683,509,869

683,509,869

683,509,869

683,509,869

683,509,869

 

______________

(1)   American Depositary Shares, or ADSs.

(2)   On April 22, 2013, our shareholders approved a stock split, following which each common share represented three new common shares. Therefore, per share information in the selected financial data has been revised to give effect to the stock split retrospective to all periods presented.

(3)   Data for 2012 and 2011 have been restated in application of IAS 19 – Employee Benefits (as revised in 2011) and IFRS 11 – Joint Arrangements, as described in note 4.1 to our financial statements.  With respect to IAS 19 – Employee Benefits, the principal adjustment is the change in the accounting record method of actuarial gains and losses, such that accumulated differences between actuarial estimates and actual obligations are recognized in Other Comprehensive Income when they occur.  With respect to IFRS 11 – Joint Arrangements, the results of the joint-ventures Sesamm – Serviços de Saneamento de Mogi Mirim S/A, Águas de Andradina, Águas de Castilho, Saneaqua Mairinque, Aquapolo Ambiental and Attend Ambiental are recognized using the equity method of accounting in 2013, 2012 and 2011 rather than through proportional consolidation as previously.

(4)   Data for 2010 and 2009 have not been restated in application of IAS 19 – Employee Benefits (as revised in 2011) and IFRS 11 – Joint Arrangements, described in note 4.1 to our financial statements. In particular, data for 2010 and 2009 reflect the results of the joint-ventures Sesamm – Serviços de Saneamento de Mogi Mirim S/A, Águas de Andradina, Águas de Castilho, Saneaqua Mairinque, Aquapolo Ambiental and Attend Ambiental through proportional consolidation in 2010 and 2009, as opposed to the equity method of accounting applicable in 2013, 2012 and 2011.

(*)   On January 10, 2013, the ratio of American Depositary Receipts (“ADRs”) to common shares changed from 1:2 to 1:1.  We have adjusted the earnings per ADS and dividends and interest on shareholders’ equity per ADS for prior years for comparison purposes on the table above.

 6


 
 

 

 

 

As of December 31,

 

2013

2013

2012(3)

2011(3)

2010(4)

2009(4)

 

(in millions of U.S. dollars)

(in millions of reais

Balance sheet data:

 

 

 

 

 

 

Property, plant and equipment

85.2

199.5

196.7

181.6

249.6

190.4

Intangible assets

10,179.4

23,846.2

21,967.5

20,125.7

18,546.8

16,917.5

Total assets

12,069.6

28,274.3

26,476.1

24,983.2

23,350.6

20,243.1

Current portion of long-term loans and financing

273.6

640.9

1,342.6

1,629.2

1,242.1

1,009.9

Long‑term loans and financing

3,760.4

8,809.1

7,532.7

6,794.1

7,022.5

5,548.0

Interest on shareholders’ equity payable

195.1

457.0

414.4

247.5

354.3

365.4

Total liabilities

6,549.8

15,343.5

15,219.4

14,438.3

13,668.8

11,804.5

Equity

5,519.9

12,930.8

11,256.8

10,544.9

9,681.8

8,438.6

Capital stock

2,648.2

6,203.7

6,203.7

6,203.7

6,203.7

6,203.7

 

 

 

 

 

 

 

Other financial information:

 

 

 

 

 

 

Cash generated from operating activities

1,185.5

2,777.2

2,343.2

2,698.6

2,083.0

2,072.5

Cash used in investing activities

(973.9)

(2,281.5)

(1,996.7)

(1,883.2)

(2,091.4)

(1,964.0)

Cash provided by (used in) financing activities

(268.8)

(629.7)

(572.7)

(661.3)

1,226.5

36.9

Purchases of intangible assets and property, plant and equipment as presented in our statement of cash flow

(997.1)

(2,335.8)

(2,026.1)

(2,068.8)

(1,901.5)

(1,982.4)

 

 

Operating Data

 

 

 

 

 

 

As of and for the year ended December 31,

 

2013

2012

2011

2010

2009

Number of water connections (in thousands)

7,888

7,679

7,481

7,295

7,118

Number of sewage connections (in thousands)

6,340

6,128

5,921

5,718

5,520

Percentage of population with water connections (in percentages)

99

99

99

99

99

Percentage of population with sewer connections (in percentages)

84

83

82

81

80

Percentage of treated sewer(5) (in percentages)

78

77

76

75

74

Volume of water billed during period (in millions of cubic meters)

2,149

2,094

2,045

1,992

1,917

Non-revenue water during period (average) (in percentages)(6)

24.4

25.7

25.6

26.0

26.0

Water Loss Index during period (average) (in percentages) (6)

31.2

31.1

32.0

32.3

32.4

Water loss per connection per day (average)(7)

372

393

395

403

402

Number of employees

15,015

15,019

14,896

15,330

15,103

 

______________

(5)   Treated sewage as a percentage of collected sewage.

(6)   Includes both physical and non-physical water loss.  Non-revenue water represents the quotient of (i) the difference between (a) the total amount of water produced by us less (b) the total amount of water invoiced by us to customers minus (c) the volume of water that we exclude from our calculation of water loss (as described in the paragraph below), divided by (ii) the total amount of water produced.  The Water Loss Index represents the quotient of (i) the difference between (a) the total amount of water produced by us less (b) the total amount of water micro-measured by us to customers minus (c) the volume of water set out below that we exclude from our calculation of water loss, divided by (ii) the total amount of water produced.

        We exclude the following from our calculation of water loss:  (i) water discharged for periodic maintenance of water  transmission lines and water storage tanks; (ii) water supplied for municipal uses such as firefighting; (iii) water we consume in our facilities; and (iv) estimated water loss related to the supply of water to favelas (shantytowns).  

(7)   Measured in liters/connection per day, according to the method by which we measure water loss, based on worldwide market practice for the sector.  See “Item 4.B. Business Overview—Description of Our Activities—Water Operations—Water Loss.”

 7


 
 

 

 

Exchange Rates

In the past, the Brazilian National Monetary Council (Conselho Monetário Nacional), or the CMN, has introduced changes to the Brazilian foreign exchange regime, such as unifying the Commercial and Floating Markets and easing the rules governing the ability of Brazilian residents to acquire foreign currency, among others.  On March 24, 2010, the CMN and the Central Bank approved Resolution No. 3,844, which led to a series of measures to consolidate and simplify Brazilian foreign exchange market regulations.

The Brazilian foreign exchange system allows any person or legal entity to purchase or sell foreign currency and make international transfers of reais, regardless of the amount, subject to certain regulatory procedures.

The Brazilian currency has experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies in recent decades.  Between 2003 and mid‑2008, the real appreciated significantly against the U.S. dollar with the exchange rate reaching R$1.634 in August 2008.  Primarily as a result of the global financial crisis, the real depreciated 32.0% against the U.S. dollar during 2008 and closed the year at R$2.337 per US$1.00.  The real  strengthened again by 25.5% in 2009 and 4.3% in 2010, but depreciated against the U.S. dollar by 12.6% in 2011, 8.94% in 2012 and 14.63% in 2013. On December 31, 2013, 2012 and 2011, the real/U.S. dollar exchange rate was R$2.3426, R$2.0435 and R$1.8758 per US$1.00, respectively.

The Central Bank sometimes intervenes in the market to combat instability in foreign exchange rates.  We cannot predict whether the Central Bank or the Brazilian government will continue to let the real float freely or will intervene in the exchange rate through a currency band system or other procedure.  The real may fluctuate against the U.S. dollar substantially in the future.  For further information on this risk, see “Item 3.D. Risk Factors—Risks Relating to Brazil—Exchange rate instability may adversely affect us and the market price of our common shares or ADSs.”

8


 
 

 

Exchange rate fluctuations will affect the U.S. dollar equivalent of the real price of our common shares on the São Paulo Stock Exchange (BM&FBOVESPA S.A. ‑ Bolsa de Valores, Mercadorias e Futuros), or the BM&FBOVESPA, as well as the U.S. dollar equivalent of any distributions we make in reais with respect to our common shares.

The following tables set forth the selling rate, expressed in reais per U.S. dollar (R$/US$), for the periods indicated.

 

R$ per US$1.00

Year ended December 31,

Year end

Average(1)

High

Low

2009

1.7412

1.9935

2.4218

1.7024

2010

1.6662

1.7593

1.8811

1.6554

2011

1.8758

1.6746

1.9016

1.5345

2012

2.0435

1.9550

2.1121

1.7024

2013

2.3426

2.1605

2.4457

1.9528

 

 

 

 

 

 

 

R$ per US$1.00

Month ended

Period end

Average

High

Low

October 31, 2013

2.2026

2.1886

2.2123

2.1611

November 30, 2013

2.3249

2.2954

2.3362

2.2426

December 31, 2013

2.3426

2.3455

2.3817

2.3102

January 31, 2014

2.4263

2.3822

2.4397

2.3335

February 28, 2014

2.3334

2.3837

2.4238

2.3334

March 31, 2014

2.2630

2.3261

2.3649

2.2603

April 16, 2014

2.2342

2.2310

2.2811

2.1974

______________

Source:  Central Bank

(1)   Average of the exchange rates on the last day of each month.

The following tables set forth the selling rate, expressed in reais  per Japanese Yen (R$/¥1.00):  

 

R$ per ¥1.00 

Year ended December 31,

Year end

Average(1)

High

Low

2009

0.0188

0.0213

0.0268

0.0186

2010

0.0205

0.0201

0.0212

0.0183

2011

0.0243

0.0211

0.0249

0.0186

2012

0.0237

0.0245

0.0263

0.0211

2013

0.0223

0.0221

0.0248

0.0196

 

 

R$ per ¥1.00 

Month ended

Period end

Average

High

Low

October 31, 2013

0.0224

0.0224

0.0228

0.0219

November 30, 2013

0.0227

0.0229

0.0235

0.0225

December 31, 2013

0.0223

0.0227

0.0233

0.0223

January 31, 2014

0.0237

0.0229

0.0239

0.0224

February 28, 2014

0.0224

0.0233

0.0238

0.0228

March 31, 2014

0.0219

0.0277

0.0233

0.0219

April 16, 2014

0.0218

0.0217

0.0219

0.0215

 

Source:  Central Bank

(1)   Average of the exchange rates on the last day of each period.

 

 9


 
 

 

B.      Capitalization and Indebtedness

Not applicable.

C.      Reasons for the Offer and Use of Proceeds

Not applicable.

D.      Risk Factors

Risks Relating to Brazil

The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy.  This influence, as well as Brazilian political and economic conditions, could adversely affect us and the market price of our common shares and ADSs.

The Brazilian government frequently intervenes in the Brazilian economy and occasionally makes significant changes in policy and regulations.  The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, changes in interest rates, tax policies, price and tariff controls, currency devaluation or appreciation, capital controls and limits on imports.  Our business, financial condition and results of operations, as well as the market price of our common shares or ADSs, may be adversely affected by changes in public policy at federal, state and municipal levels with respect to public tariffs and exchange controls, as well as other factors, such as:

·                     the regulatory environment related to our business operations and concession agreements;

·                     interest rates;

·                     exchange rates and exchange controls and restrictions on remittances abroad;

·                     currency fluctuations;

·                     inflation; 

·                     liquidity of the Brazilian capital and lending markets;

·                     tax and regulatory policies and laws;

·                     economic and social instability; and

·                     other political, diplomatic, social and economic developments in or affecting Brazil.

For example, the Brazilian government may change its tax policy, such as changing tax rates or imposing temporary taxes.  If overall taxes are increased, we may be unable to immediately recover the difference from our consumers, which may have an adverse effect on our financial condition and results of operations.

Uncertainty over whether the Brazilian government will implement changes in policies or regulations affecting these factors or others may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities market and in securities issued abroad by Brazilian issuers, which could have a material adverse effect on us and on our common shares and ADSs.

Inflation and the Brazilian government’s measures to combat inflation may contribute to economic uncertainty in Brazil, adversely affecting us and the market price of our common shares or ADSs.

Brazil has experienced extremely high rates of inflation in the past.  Inflation and the Brazilian government’s measures to combat inflation have had significant negative effects on the Brazilian economy, contributing to economic uncertainty and heightened volatility in the Brazilian securities market.  The Brazilian government’s measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting the availability of credit and reducing economic growth.  The Special Clearing and Settlement System (Sistema Especial de Liquidação e Custódia), or SELIC, the official overnight interest rate in Brazil, equaled 9.90%, 7.14% and 10.91% at the end of 2013, 2012 and 2011, respectively, in line with the target rate set by the Brazilian Committee on Monetary Policy (Comitê de Política Monetária).   

 10


 
 

 

The Brazilian annual inflation rates, as measured by the General Market Price Index (Índice Geral de Preços—Mercado), or IGP‑M index, were 5.51%, 7.81% and 5.1% during 2013, 2012 and 2011, respectively.  Brazilian governmental actions, including interest rate decreases, intervention in the foreign exchange market and actions to adjust or fix the value of the real, may trigger increases in inflation.  If Brazil experiences high inflation again, our costs and expenses may rise, we may be unable to increase our tariffs to counter the effects of inflation, and our overall financial performance may be adversely affected.  In addition, a substantial increase in inflation may weaken investors’ confidence in Brazil, causing a decrease in the market price of our common shares or ADSs. 

Additionally, in the event of an increase in inflation, the Brazilian government may choose to raise official interest rates.  Increases in interest rates would not only affect our cost of funding, but could also have a material adverse effect on us and may also adversely affect the market price of our common shares or ADSs.

Exchange rate instability may adversely affect us and the market price of our common shares or ADSs.

The Brazilian currency experienced frequent and substantial devaluations in relation to the U.S. dollar and other foreign currencies during the decades leading up to the mid-1990s.  Throughout this period, the Brazilian government implemented various economic plans and exchange rate policies, including sudden devaluations, periodic mini‑devaluations (during which the frequency of adjustments ranged from daily to monthly), floating exchange rate systems, exchange controls and dual exchange rate markets.  From time to time since that period, there have continued to be significant fluctuations in the exchange rate between the Brazilian real and the U.S. dollar and other currencies.  For example, the real appreciated 13.8%, 9.5% and 20.7% against the U.S. dollar in 2005, 2006 and 2007, respectively.  In 2008, primarily as a result of the global financial crisis, the real depreciated 32.0% against the U.S. dollar and closed the year at R$2.337 per US$1.00.  The real  strengthened again by 25.5% in 2009 and 4.3% in 2010, but depreciated against the U.S. dollar by 12.6% in 2011, 8.94% in 2012 and 14.63% in 2013. On December 31, 2013, 2012 and 2011, the real/U.S. dollar exchange rate was R$2.343, R$2.043 and R$1.876 per US$1.00, respectively.  There can be no assurance that the real will not depreciate further against the U.S. dollar.  As of April 16, 2014, the commercial selling rate as reported by the Central Bank was R$2.2342 per US$1.00.

Depreciation of the real against the U.S. dollar could create inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy as a whole and harm our financial condition and results of operations, curtail our access to financial markets and prompt government intervention, including recessionary governmental policies.  Depreciation of the real against the U.S. dollar could also lead to decreased consumer spending, deflationary pressures and reduced growth of the economy as whole.

In the event of a significant devaluation of the real in relation to the U.S. dollar or other currencies, our ability to meet our foreign currency denominated obligations could be adversely affected because our tariff revenue and other sources of income are denominated solely in reais.  In addition, because we have debt denominated in foreign currencies, any significant devaluation of the real will increase our financial expenses as a result of foreign exchange losses that we must record.  We had a total foreign currency denominated debt of R$3,698.6 million as of December 31, 2013 and we anticipate that we may incur additional amounts of foreign currency denominated debt in the future.  In 2013, our results of operations were negatively affected by the 14.64% depreciation of the real against the U.S. dollar, and an appreciation of the real against the yen by 5.91% which led to a R$267.8 million negative impact on our foreign exchange result, net.  We do not currently have any derivative instruments in place to protect us against a devaluation of the real  in relation to any foreign currency.  A devaluation of the real may adversely affect us and the market price of our common shares or ADSs

11


 
 

 

Developments and the perception of risk in other countries, especially in the United States and in emerging market countries, may adversely affect the market price of Brazilian securities, including our common shares and ADSs.

The market price of securities of Brazilian companies is affected to varying degrees by economic and market conditions in other countries, including the United States and other Latin American and emerging market countries.  Although economic conditions in these countries may differ significantly from economic conditions in Brazil, investors’ reactions to developments in these other countries may have an adverse effect on the market price of securities of Brazilian issuers.  Crises in other emerging market countries or economic policies of other countries may diminish investor interest in securities of Brazilian issuers, including ours.  This could adversely affect the market price of our common shares or ADSs, and could also make it more difficult for us to access the capital markets and finance our operations in the future, on acceptable terms or at all.

The global financial crisis has caused significant consequences, including in Brazil, such as stock and credit market volatility, unavailability of credit, higher interest rates, a general slowdown of the world economy, volatile exchange rates, and inflationary pressure, among others, which have and may continue to, directly or indirectly, materially and adversely affect us and the price of securities issued by Brazilian companies, including our common shares and ADSs. 

Risks Relating to Our Control by the State of São Paulo

We are controlled by the State of São Paulo, whose interests may differ from the interests of non-controlling, including holders of ADSs.

As it owns the majority of our common shares, the State of São Paulo is able to determine our operating policies and strategy, control the election of a majority of the members of our board of directors and appoint our senior management.  As of April 16, 2014, the State owned 50.3% of our outstanding common shares.  Both through its control of our board of directors as well as by enacting State decrees, the State has in the past directed our company to engage in business activities and make expenditures that promoted political, economic or social goals but that did not necessarily enhance our business and results of operations.  The State may direct our company to act in this manner again in the future.  These decisions by the State may not be in the interests of our non-controlling, including holders of ADSs.  See “Item 5.A. Operating and Financial Review and Prospects—Certain Transactions with Controlling Shareholder.”

Following the elections for State governor in 2010, the new governor appointed Ms. Dilma Seli Pena as our chief executive officer in 2011 at the meeting of the board of directors held on January 27, 2011.  In late March 2014, Mr. Alberto Goldman temporarily assumed the position of chairman of the board of directors.  The new chairman of the board of directors will be elected for a term of two years at the shareholders’ meeting to be held on April 30, 2014.  Future changes in policy by State government may cause changes in all or some of the members of our management, which may have a material adverse effect on our business and results of operations.

The State and some State entities owe us substantial unpaid debts.  We cannot assure you as to when or whether the State will pay us.

Historically, the State and some State entities have delayed payment of substantial amounts owed to us related to water and sewage services. Additionally, the State also owes us substantial amounts related to reimbursements of State‑mandated special retirement and pension payments that we make to some of our former employees for which the State is required to reimburse us.  As of December 31, 2013, the State owed us R$63.9 million for water and sewage services.  With respect to payment of pensions on behalf of the State, we had a non-contested reimbursement credit in the amount of R$179.1 million as of December 31, 2013 for actuarial liability, and a contested credit amount of R$1,412.5 million as of the same date.  We do not record this contested amount as a reimbursement credit for actuarial liability due to the uncertainty of payment by the State.  In addition, as of December 31, 2013, we had a provision for an actuarial liability in the amount of R$1,780.3 million in respect of future supplemental pension payments the State does not accept responsibility for paying.  The amounts owed to us by the State for water and sewage services and reimbursements for pensions paid may increase in the future.

12


 
 

 

We have entered into agreements with the State to settle the overdue amounts that relate to water and sewage services.  For a detailed discussion of these agreements, see “Item 7.B. Related Party Transactions, Agreements with the State of São Paulo” and Note 9 of our financial statements. 

We cannot assure you when or if the State will pay the remaining overdue amounts it owes us.  Due to the State’s history of not paying us in a timely manner for water and sewage services, and not reimbursing us in a timely manner for the pension benefits we paid on its behalf, we cannot assure you that the amount of account receivables owed to us by the State and some State entities will not significantly increase in the future.

In addition, certain municipalities and other government entities also owe us money.  See “Risks Relating to Our Business—We may face difficulties in collecting overdue amounts owed to us by municipalities to which we provide water on a wholesale basis and municipal government entities.”  

A state controlled company that has a concession to produce energy in the Guarapiranga and Billings reservoirs may require us to pay damages for the use of water from these reservoirs.

Empresa Metropolitana de Águas e Energia S.A., or EMAE, may require us to financially compensate them for our use of water from the Guarapiranga and Billings reservoirs, which they view as a loss of electricity that could otherwise be generated and sold. As such, EMAE has requested compensation from us. In the event water from these reservoirs were no longer made available to us, we would have to bring water in from locations farther away, which would increase the risk of not being able to provide adequate service in the region and increase the costs of water transportation.

The majority shareholder of both EMAE and us, the State of São Paulo, may force a resolution regarding the dispute of water use from the Guarapiranga and Billings reservoirs, which may have an adverse effect on our business. Currently, this matter is under judicial review due to various actions brought by EMAE.  On April 10, 2014, we issued and Announcement to the Market to communicate that we are negotiating with EMAE regarding a potential future agreement.  However, no adjustment has been confirmed and no agreement has been executed by either party as of yet. 

Additionally, in the event we are required to make payments and compensation, our cash position and overall liquidity may be adversely affected.

  

We may be required to pay substantial charges for the use of reservoirs that are not our property.

We use the Billings and Guarapiranga reservoirs in order to provide water services.  We are entitled to withdraw water from these reservoirs under a grant from the State Department of Water and Energy (Departamento de Águas e Energia Elétrica do Estado de São Paulo), or DAEE. We are not currently charged for the use of these reservoirs and are uncertain as to whether we will continue to be able to use the reservoirs without paying charges, or what the likely fee scale would be if one were imposed. 

We may also be required to pay additional maintenance and operational costs for our use of reservoirs.  If we were required to pay substantial charges or additional maintenance or operational costs for our use of these reservoirs, we could be materially and adversely affected.

Risks Relating to Our Business

Current regulatory uncertainty, especially with regard to implementation and interpretation of the Brazilian Basic Sanitation Law, may have an adverse effect on our business.

The Basic Sanitation Law No. 11,445 went into effect in early 2007, and although in 2010 Federal Decree No. 7,217 (as modified by Federal Decree No. 8,211/14) implemented a first series of new principles under the Basic Sanitation Law, the full implementation of a number of its provisions remains subject to regulations that the federal government has not yet published.  As a result, we cannot currently anticipate all the effects that the Basic Sanitation Law and the decree will have on our business and operations, if any.

The Basic Sanitation Law requires states to establish independent regulators with the responsibility of monitoring basic sanitation services and regulating tariffs, and in response São Paulo State established in 2007 the São Paulo State Sanitation and Energy Regulatory Agency (ARSESP), which regulates and supervises the basic sanitation services that we provide in municipalities that have agreed to come under ARSESP’s jurisdiction. 

13


 
 

 

In 2009, ARSESP enacted rules regarding the following: (i) general terms and conditions for water and sewage services; (ii) procedures for communication regarding any failure in our services; (iii) penalties for deficiencies in the provision of basic sanitation services; and (iv) procedures for confidential treatment of our customers’ private information. The implementation of these and other more recent rules will particularly impact our commercial and operations processes, and may adversely affect us in ways we cannot currently predict.  Implementation of these rules started in 2011 and is expected to continue for the next few years. For more information, see “Item 4.B. Business Overview—Government Regulation—ARSESP Rule Enactments”.

In 2011, ARSESP altered the standard contract that we are required to use in our relationships with retail customers.  This alteration requires that invoices be sent to the consumer of the service rather than the owner of the property.  We estimate that this change will affect ongoing legal disputes, particularly those regarding collection procedures, as well as business discussions in general.  However, since this change is still being implemented, we are not currently able to predict its impact on our business.

The Basic Sanitation Law also allows municipalities to create their own regulatory agencies rather than being regulated by ARSESP.  As a result, a number of municipalities have created their own regulatory agencies.  If other municipalities create new agencies or retain regulatory powers, we will be subject to their regulation and to any limitations on our services that such agencies may set.  We are involved in legal proceedings that dispute the authority of these new agencies to regulate us.  We cannot foresee any changes that any such new agencies may implement regarding our business.  If any such changes are unfavorable, they could materially and adversely affect us.

For more information on ARSESP regulations, see “Item 4.B. Business Overview—Tariff Government Regulation—Tariff Regulation in the State of São Paulo” and “ARSESP Rule Enactments—Consumer Relations in the State of São Paulo.”

New joint entities have been, and may continue to be, set up to oversee basic sanitation services in metropolitan regions, including the São Paulo metropolitan region.  We cannot predict how the shared management of these operations will be carried out in the São Paulo metropolitan region and other metropolitan regions we operate or what effect this may have on our business, financial condition or results of operations.

There are some pending cases before the Brazilian Supreme Court regarding whether the right to execute concession and program agreements in metropolitan regions belongs to the State or the municipal government.  On February 28, 2013, the Brazilian Supreme Court decided a pending case on this matter related to the State of Rio de Janeiro.  A majority of the court held that the State of Rio de Janeiro and its municipal governments must set up new joint entities to oversee the planning, regulation and auditing of basic sanitation services in metropolitan regions.  On March 6, 2013, the court ruled that this decision would come into effect after a 24-month period over the State of Rio de Janeiro.  Such decision may be considered a relevant precedent on this matter and therefore similar decisions may be taken on other pending cases as well as on new cases that can be initiated.  The Supreme Court has yet to clarify the effects and extension of its decision. The São Paulo metropolitan region (including the municipalities to which we provide water on a wholesale basis), one of which new decisions on such pending or new cases may apply, accounted for 73.2% of our gross revenue from services in 2013 (excluding revenues relating to the construction of concession infrastructure).  We cannot predict how the shared management of these operations could be carried out in the São Paulo metropolitan region and other municipalities we operate or what effect it may have on our business, financial condition or results of operation.

The terms of our agreement to provide water and sewage services in the City of São Paulo could have a material adverse effect on us.

The provision of water and sewage services in the City of São Paulo accounted for 53.6% of our gross operating revenues (excluding revenues relating to the construction of concession infrastructure) in the year ended December 31, 2013.

 14


 
 

 

On June 23, 2010, the State and the City of São Paulo executed an agreement in the form of a convênio, to which we and ARSESP consented, under which they agreed to manage the planning and investment for the basic sanitation system of the City of São Paulo on a joint basis.  The principal terms of this convênio  were as follows:

·                     The State and the City of São Paulo would execute a separate agreement with us, granting us exclusive rights to provide water and sewage services in the City of São Paulo.

·                     ARSESP would regulate and oversee our activities regarding water and sewage services in the City of São Paulo, including tariffs.

·                     A management committee (Comitê Gestor) would be responsible for planning water and sewage services for the City and for reviewing our investment plans.  The management committee consists of six members appointed for two-year terms.  The State and the City of São Paulo have the right to appoint three members each.  We may participate in management committee meetings but may not vote.

In application of the convênio, we executed a separate contract with the State and the City of São Paulo, also dated June 23, 2010, to regulate the provision of these services for the following 30 years.  The principal terms of this contract are as follows:

·                     The total investment stated in the contract must be equal to 13% of gross revenues from the provision of services to the City of São Paulo, net of the taxes on revenues, which total approximately R$600 million per year.

·                     We must transfer 7.5% of the gross revenues we derive under the convênio, and subtract (i) COFINS and PASEP taxes, and (ii) unpaid bills of publicly owned properties in the city of São Paulo, to the Municipal Fund for Environmental Sanitation and Infrastructure (Fundo Municipal de Saneamento Ambiental e Infraestrutura), established by Municipal Law No. 14,934/2009. 

·                     Our investment plan must be compatible with the sanitation plans of the State, the City of São Paulo and, if necessary, the Metropolitan region.

·                     ARSESP will ensure that the tariffs will adequately compensate us for the services we provide and that tariffs may be adjusted in order to restore the original balance between each party’s obligations and economic gain (equilíbrio econômico‑financeiro).  

We currently have an investment plan in place that reflects these obligations and addresses their compatibility with the sanitation plans for municipalities in which we operate, including the City of São Paulo and the Metropolitan region.  The investment plan is not irrevocable and will be reviewed by our management committee every four years, particularly with respect to the investments to be executed in the subsequent period.

Because we were not previously required to transfer 7.5% to the São Paulo Municipal Sanitation and Infrastructure Fund as described above, our existing tariff and adjustment formulas do not account for this requirement. Nonetheless, ARSESP is required to ensure that the tariffs will adequately compensate us for the services we provide, which includes the pass-through to tariffs.

·                     In April 2013, ARSESP issued Resolution No. 407 authorizing us to pass through to the service bill the 7.5% transfer to the São Paulo Municipal Sanitation and Infrastructure Fund as a legal charge, as defined by municipal legislation.  Pursuant to the Program Contracts and the Sewage and Water Supply Service Contracts, this charge must be considered in the tariff revision.

·                     In April 2013, ARSESP issued Resolution No. 413, which effectively suspended Resolution No. 407 until the tariff revision process is concluded, thereby postponing our authorization to pass the charge through to consumers on the service bill. The postponement of Resolution No. 407 was due to a request from the São Paulo State Government to analyze, among other things, methods of reducing the impact on consumers.  Although Resolution No. 407 establishes the conclusion of the tariff review as the date for the implementation of the pass-through, we cannot be certain when Resolution No. 407 will be implemented.

15


 
 

 

 

·                     In April 2014, ARSESP issued Resolution No. 484, which establishes the conclusion of the tariff revision.  No decision was made in relation to the 7.5% charge to our consumers, and we do not know when a final decision will be reached.  We cannot know when we will be able to pass the 7.5% charge to consumers on the service bill.

Since 2010, we have transferred approximately R$ 1.1 billion to the São Paulo Municipal Sanitation and Infrastructure Fund, as of December 2013.  We cannot assure you when and how we will recover this amount.

We cannot assure you that this charge will eventually be passed through to customers or that the continued delay in passing on the charge to customers will not affect our financial condition.  For further information on ARSESP regulations, see “Item 4.B. Business Overview—Government Regulation—Tariff Regulation in the State of São Paulo” and “Government Regulation—Public Consortia and Cooperation Agreement Law for Joint Management.”

We currently lack formal agreements or concessions with 61 of the municipalities to which we provide service, and 38 of our existing concession agreements will expire between 2014 and 2034.  We may face difficulties in continuing to provide water and sewage services in return for payment in these and other municipalities, and we cannot assure you that they will continue to purchase services from us on the same terms or at all.

As of December 31, 2013, we held formal 30‑year agreements with 265 municipalities (including the City of São Paulo) of the 363 municipalities we serve.  We executed 7 of these agreements during 2013.  The 265 municipalities with which we had formal agreements at year-end accounted for 72.9% of our total revenues for the year ended December 31, 2013, and 64.6% of our intangible assets as of December 31, 2013.  Of the 61 served municipalities for which we lacked formal agreements at year-end, we were in the process of actively renegotiating with all municipalities, including the municipality of Santos.  Together, these 61 municipalities accounted for 16.1% of our total revenues for the year ended December 31, 2013 and 25.1% of our intangible assets as of that same date.  Between 2014 and 2034, 38 of our existing concession agreements will expire.  These 38 concession agreements accounted for 9.0% of our total revenues for the year ended December 31, 2013 and 8.0% of our intangible assets as of that same date.

We may not be able to continue providing service on current terms, or at all, in the municipalities for which we do not have formal agreements, including the 61 for which we are renegotiating expired agreements.  In particular, the lack of formal concessions or contractual rights in these municipalities means that we may not be able to enforce our right to continue to provide services and we may face difficulties in being paid on a timely basis, or at all, for the services that we provide.  If we are successful in renegotiating the expired agreements, or executing formal agreements with the municipalities for which we have never had agreements, those agreements may not contain terms that are as favorable as those under which we currently operate.  We cannot make any such assumption because the Basic Sanitation Law prevents us from planning, regulating and monitoring our services and it requires more stringent control by the municipalities or by ARSESP.  The municipalities for which we do not have formal agreements may choose to start providing water and sewage services directly themselves, or may run public tenders to select another provider.  They may set eligibility requirements for which we do not qualify and, if we do qualify and participate in these tenders, we may not win.  In addition, our ability to continue operating without formal agreements may be modified or cancelled by federal, state or municipal governments, court decisions or other factors.

Any of these events could have a material adverse effect on our business, results of operations and financial condition.  See “Item 4.B. Business Overview—Our Operations” and “Government Regulation—Public Consortia and Cooperation Agreement Law for Joint Management.”

In the municipalities with which we did not have formal agreements by December 31, 2013, we continued operating with municipal approval or with judicial support.

The municipalities may terminate our concessions before they expire in certain circumstances.  The indemnification payments we receive in such cases may be less than the value of the investments we made.

The municipalities have the right to terminate our concessions if we fail to comply with our contractual or legal obligations, or if the municipality determines in expropriation proceedings that early termination of the concession is in the public interest.  If a municipality terminates our concession, we are entitled to be indemnified for the unamortized portion of our investments. 

 16


 
 

 

The Basic Sanitation Law provides that on early termination of a concession, the entity that provides sanitation services should carry out a valuation of the assets that relate to the services we provide, in order to calculate the unamortized portion of our investments.  This valuation uses the criteria defined in the service contract or, in the absence of a contract, is based on customary practice with respect to the services for the preceding 20 years.  The resulting indemnification payment may be less than the remaining value of the investments we made. 

In addition, the São Paulo State constitution permits the municipalities to pay us this compensation in installments over 25 years.  Receiving compensation over this extended period after termination of a significant concession would have a material adverse effect on our financial condition.  The Brazilian Supreme Court suspended this deferred payment mechanism in a 1997 decision, but we cannot assure you that the mechanism will not be reinstated.  This case is still awaiting a final decision, but on March 15, 2004 the Attorney General issued an opinion that this payment method is unconstitutional.  The Basic Sanitation Law reduced the maximum time period for payment of indemnification in such cases to four years.  This provision applies to concession agreements entered into prior to the enactment of the Basic Sanitation Law only to the extent that the concession agreement does not contain a contractual indemnification provision, or we have not otherwise entered into an agreement with the municipality with regard to such early termination.  These provisions have not yet been tested by the courts and we are therefore unable to predict the effect of the Basic Sanitation Law on our rights to indemnification for the early termination of any particular concession.

In 1997, the municipality of Santos enacted a law in order to repossess our water and sewage systems in Santos.  We have adopted the necessary judicial measures to contest this and continue to operate our services in Santos as of December 31, 2013. We filed an ordinary suit against the municipality of Santos, and our operation is still in place. The appellate court issued a decision that is favorable to us, and we consider the risk of loss as remote.

In 1995, the municipality of Diadema terminated its concession agreement with us.  We commenced legal proceedings against the municipality, which were settled in 1996, but the municipality did not comply with the terms of the settlement.  In December 2008, we entered into a memorandum of understanding with the State of São Paulo, the municipality of Diadema and the State Secretariat for Sanitation and Water Resources, previously known as the State Secretariat for Sanitation and Energy (Secretaria de Saneamento e Energia do Estado de São Paulo).  Under this memorandum of understanding the parties agreed to conclude negotiations and settle all outstanding amounts, and we agreed to stay the collection proceedings we had filed against the municipality.  In 2011, we and the municipality of Diadema agreed to develop shared infrastructure for water and sewage services through a mixed capital company to be called Companhia de Água e Esgoto de Diadema, or CAED.  Studies regarding the establishment of CAED have been discontinued, and on March 18, 2014, we executed a contract to resume direct supply of water and sewage services to the municipality of Diadema.  Concurrently, we entered an agreement with Diadema to resolve water supply-related debt and indemnities.  Guarantees are in place if the municipality of Diadema breaches its agreement with us.

Other municipalities may seek to terminate their concession agreements before the contractual expiration date.  If this occurs and we do not receive adequate indemnification for our investments, or the indemnification is paid over an extended period, we may suffer material harm to our financial position.

We may face difficulties in collecting overdue amounts owed to us by municipalities to which we provide water on a wholesale basis and municipal government entities.

As of December 31, 2013, our total accounts receivable was R$4,372.2 million.  Of this amount, certain municipalities to which we provide water on a wholesale basis owed us R$1,917.9 million, and certain municipal government entities owed us R$679.6 million.  Of the total amount owed by municipalities, R$205.2 million was overdue by between 30 and 360 days and R$1,645.3 million was overdue by over 360 days.

The Brazilian courts are entitled to obligate us to continue to supply water to these municipalities, even when we have not received payments due to us.  We have no way of ensuring that negotiations with these municipalities or legal action taken against the municipalities will result in payments being made.  Some entities associated with municipal governments for which we provide services also do not make regular payments.  We cannot guarantee if or when these entities will make payments on a regular basis or pay the amounts owed to us.  If the municipalities and related entities do not pay the amounts owed to us, we may suffer material harm to our financial position. 

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Any failure to obtain new financing may adversely affect our ability to continue our capital expenditure program.

Our capital expenditure program will require resources of approximately R$12.8 billion in the period from 2014 through 2018.  In 2013 we recorded R$2.7 billion in capital expenditures.

We have funded these capital expenditures with cash generated by our operations as well as borrowings in Brazilian reais  and foreign currencies, and we intend to continue to fund our capital expenditures from these sources.  A significant portion of our financing needs has been provided by the Brazilian federal public government banks.  We have obtained long‑term financing at attractive interest rates from multilateral agencies and domestic and international governmental development banks.  If the Brazilian government changes its policies regarding the financing of water and sewage services, or if we fail to obtain long‑term financing at attractive interest rates from domestic and international multilateral agencies and development banks in the future, we may not be able to meet our obligations or finance our capital expenditure program, which could have a material adverse effect on our business and financial condition.

Governmental agencies, institutional lenders and multilateral agencies constitute our main sources of financing in addition to cash generated by our operations and issuances of debt securities in the domestic and international capital markets.  Brazilian financial institutions are legally limited up to a certain percentage of their shareholder’s equity to provide loans to public sector entities, such as us.  These limitations could adversely affect our ability to continue our capital expenditure program.

Our debt includes financial covenants that impose indebtedness limits on us, which could have a material adverse effect on us.  For further information on these covenants, see “Item 5.B. Liquidity and Capital Resources—Capital Sources—Indebtedness Financing—Financial Covenants.”  Our failure to comply with these covenants could seriously impair our ability to finance our capital expenditure program, which could have a material adverse effect on us.

Compliance with environmental laws and environmental liability payments could have a material adverse effect on us.

We are subject to extensive Brazilian federal, state and municipal laws and regulations relating to the protection of human health and the environment.  These laws and regulations set potable water standards and limit or prohibit the discharge or spillage of effluent produced in our operations, particularly raw sewage.  We occasionally suffer accidents such as leakages or breaks in pipes that could lead to liability for damages under environmental law.  We could be subject to various types of criminal, administrative and civil proceedings for non‑compliance with environmental laws and regulations, which could expose us to penalties and criminal sanctions, such as fines, closure orders and significant indemnification obligations.  The scope and enforcement of environmental laws in Brazil are becoming more stringent, and our capital expenditures and environmental compliance costs may increase substantially as a result.  These expenses may lead us to reduce expenditure on strategic investments, which could harm our business.  In addition, Brazilian courts are enforcing environmental laws more stringently than in the past, which may result in fines or liability for damages that are significantly higher than those we currently anticipate.  We are party to various environmental proceedings that could have a material adverse impact on us, including civil processes and investigations relating to the release of untreated sewage into waterways and the disposal of sludge generated by treatment plants.  Any unfavorable judgment in relation to these proceedings, or any material unforeseen environmental liabilities, may have a material adverse effect on us.  For further information on these proceedings, see “Item 8.A. Financial Information – Financial Statements and Other Financial Information – Legal Proceedings.” For further information on investments in environmental programs, see “Item 4.A - Main Projects of our Capital Expenditure Program,” “Item 4.B – Business Overview – Sewage Treatment and Disposal ,” “Item 4.B – Business Overview - Environmental Matters” and “Item 4.B – Business Overview - Environmental Regulation.”

New laws and regulations relating to climate change and changes in existing regulation, as well as the physical Effects of Extreme Weather Events, may result in increased liabilities and increased capital expenditures, which could have a material adverse effect on us.

Current federal, state and municipal laws and regulations on climate change establish global goals, which we intend to meet, concerning greenhouse gas emissions and this may require us to increase our investments in order to comply with these laws. Currently, however, if we increase our capital expenditures for this purpose, we may be required to reduce expenditures on other strategic investments.

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In addition, climate change may lead to increases in extreme weather events such as droughts or torrential rain, which may affect our ability to deliver our services and require us to take action such as:

·                     investing in seeking new water sources located further from major consumer centers;

·                     investing in new technologies;

·                     improvement of water conservation practices and demand management alternatives such as economic mechanisms or educational programs; and

·                     increasing our reserve capacity.

An increase in sea levels could cause additional intrusion of salt water in the river estuaries where we abstract water for treatment, which could generate problems in our water treatment in coastal areas by damaging our collection networks.  Additionally, increases in air temperature could affect demand for water.  Climate change may also reduce water levels in the reservoirs that power hydroelectric plants in Brazil, which may cause energy shortages and increase electricity prices, which may adversely affect our costs and operations.

We cannot predict all of the Effects of Extreme Weather Events, which makes it difficult to predict necessary investments.  We have not provisioned any funds for climate change events as current technology and scientific understandings of climate change make it difficult to predict potential expenses and liabilities. 

We may be required to adopt new norms to improve our energy use efficiency and minimize the release of greenhouse gases when we renew the environmental licenses for the systems already in operation or when we obtain environmental licenses for new enterprises.

We may need to make substantial new expenditures, either to comply with new environmental regulations linked to climate change or to prevent or correct the physical Effects of Extreme Weather Events, any of which could have a material adverse effect on our results of operations.

For more information, see “Item 4.B. Business Overview—Environmental Matters—Climate Change Regulations: Reduction of Greenhouse Gases (GHG).”

We are exposed to risks associated with the provision of water and sewage services.

Our industry is affected by the following additional risks relating to the provision of water and sewage services:

·                     The state and federal government agencies that manage water resources impose substantial charges for the abstraction of water from bodies of water and the discharge of sewage.  We may not be able to pass these charges on to our customers.  See “Item 4.B. Business Overview—Government Regulation—Water Usage.”

·                     The increasing degradation of watershed areas may affect the quantity and quality of water available to meet demand from our customers.  See “Item 4.A. History and Development of the Company—Capital Expenditure Program” and “—Main Projects of Our Capital Expenditure Program.”

·                     In addition to the risks discussed under “—The terms of our new agreement to provide water and sewage services in the City of São Paulo could have a material adverse effect on us,” we may not be able to increase our tariffs on a timely basis, or at all, in order to pass on increases in inflation or operating expenses, including taxes, to our customers.  These constraints may have an adverse effect on our ability to fund our capital expenditure program and financing activities, and to meet our debt service requirements.  See “Item 5.A.  Operating and Financial Review and Prospects—Factors Affecting Our Results of Operations—Effects of Tariff Increases.”

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·                     In addition to the risks discussed under “— New laws and regulations relating to climate change and changes in existing regulation, as well as the physical Effects of Extreme Weather Events, may result in increased liabilities and increased capital expenditures, which could have a material adverse effect on us,” we are exposed to various weather-related risks, since our financial performance is closely linked to climate patterns.  The expected increase in the frequency of extreme weather conditions in the future may adversely affect both the quality and quantity of waters available for abstraction, treatment, and supply.  Droughts could adversely affect the water supply systems, resulting in a decrease in the volume of water distributed and billed as well as in the revenue derived from water supply services.  An increase in heavy rainfall could impact water quality and the regular operation of water sources, including abstraction of waters from our dams, due to increased soil erosion, silting, pollution and eutrophication of aquatic ecosystems.  See “Item 5.A. Operating and Financial Review and Prospects—Factors Affecting Our Results of Operations—Effects of Extreme Weather Events – Drought.”

·                     We are dependent upon energy supplies to conduct our business.  Any shortages or rationing of energy may prevent us from providing water and sewage services, and may also cause material damage to our water and sewage systems when we resume operations.  Also, we may not be able to pass on any significant increases in energy tariffs to our customers.  See “Item 4.B. Business Overview—Energy Consumption.”

·                     We depend on a usage rights grant from ANA and DAEE to extract water in the Cantareira System.  In 2013, the Cantareira system accounted for 47.1% of the water that we supplied to the São Paulo metropolitan region (including the municipalities to which we supplied water on a wholesale basis), which represented 73.2% of our gross operating revenues (excluding revenues relating to the construction of concession infrastructure) for the year.  The Cantareira System usage rights grant was renewed in 2004 and will expire in August 2014.  We are working to renew this grant for a period of 30 years and to maintain the same withdrawal supply rights of 33 m³/s granted in 2004.  Due to current climate conditions, particularly the severe drought, the renewal process is temporarily suspended.  In addition, the current drought may provide a new context for definition of the rules related to the grants for the right to use water and we cannot guarantee that we will be able to renew the grant in accordance with the conditions we requested.

Any of the above may have a material adverse effect on us. 

Droughts, the water consumption reduction program or other measures may result in a significant decrease in the volume of water billed and the revenues from services we provide, which may have a material adverse effect on our company.

 

We experience decreases in our water supply from time to time due to droughts.  Part of the southeastern region of Brazil, particularly the southern region of Minas Gerais State and the Piracicaba river basin (from which we extract the water used in the Cantareira System), and the northern area of the São Paulo metropolitan region experienced below average rainfall in 2012.  The drought worsened in late 2013 and early 2014, with rainfall being significantly below average, which resulted in lower reservoir water levels in the Cantareira System during the rainy season, from October 2013 to March 2014.  This was particularly the case for the Cantareira System, the largest system of the Metropolitan Region of São Paulo.

 

In order to minimize the effects of this drought, in February 2014 we approved a water consumption reduction incentive program based on a bonus system, pursuant to which customers served by the Cantareira System who achieve a 20% reduction in water consumption are entitled to a 30% discount on their service bill.  Initially, this incentive program was scheduled to last seven months from February 1, 2014 or until the water level in the reservoirs is normalized and sufficient to supply the customers in the São Paulo metropolitan region served by the Cantareira System.  However, in April 2014 the incentive program was extended for the entire São Paulo metropolitan region until the end of 2014 or until the water level in the reservoirs is normalized.  As a result of the drought and low water volume in the Cantareira System, the São Paulo State Department of Water and Energy (DAEE) and the National Water Agency (ANA) determined that, as of March 10, 2014, we must temporarily restrict the flow of water from the Cantareira System from 33 m³/s to 27.9 m³/s.  In order to continue to meet consumer demand with a restricted water supply, we are increasing our use of other water systems.  This may lead to an increase in our costs to serve customers in the São Paulo metropolitan region.  If the situation in the reservoirs affected by the drought does not improve, we may be obligated to take more drastic measures. 

 

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As a result of this drought and of the measure imposed by the DAEE and ANA, our volume of water and sewage billed may decrease throughout 2014.  In addition, our operating costs may increase as a result of additional capital expenditures required to mitigate the effects of this drought on our water production systems.  We cannot assure you that the consumption reduction incentive program will be the only mitigating measure we take to address the severe drought.  Although we expect our billing amount to decrease, due to volume decrease and bonus payments, we cannot estimate the impact of this program on our revenues.  In addition, we cannot assure you that any continuous drought in the future will not have any impact on our covenant clauses or any material and adverse effects on our water supply and thus our business and results of operations.

 

Any substantial monetary judgment against us in legal proceedings may have a material adverse effect on us.

We are party to a number of legal proceedings involving significant monetary claims.  These legal proceedings include, among others, civil, tax, labor, corporate and environmental issues.  As of December 31, 2013, the total value of all outstanding claims against us was R$38,604.6 million (net of R$323.4 million in court deposits).  A substantial monetary judgment against us in one or more of these legal proceedings may have a material adverse effect on our financial condition.  We have provisioned a total aggregate amount of R$1,180.4 million (net of court deposits) as of December 31, 2013 to cover probable losses related to legal proceedings.  This provision does not cover all legal proceedings involving monetary claims filed against us and it may be insufficient to cover our liabilities related to these claims.  Any unfavorable judgment in relation to these proceedings may have a material adverse effect on us.  For more information, see “Item 8.A. Financial Information—Financial Statements and Other Financial Information—Legal Proceedings.”

Risks Relating to Our Common Shares and ADSs

We may not always be in a position to pay dividends or interest on shareholders’ equity and ADSs.

Depending on our future results, our shareholders may not receive dividends or interest on own capital if we do not generate a profit.  Despite the requirement to distribute a minimum of 25% of our annual net income to shareholders, our future financial position may not permit us to distribute dividends or pay interest on own capital.

The relative volatility and illiquidity of the Brazilian securities markets may substantially limit your ability to sell our common shares underlying the ADSs at the price and time you desire.

Investing in securities from emerging markets such as Brazil involves greater risk than investing in securities of issuers in major securities markets, and these investments are often considered to be more speculative in nature.  The Brazilian securities market is substantially smaller, less liquid, more concentrated and can be more volatile than major securities markets.  Accordingly, although you are entitled to withdraw the common shares underlying the ADSs from the depositary at any time, your ability to sell the common shares underlying the ADSs at a price and time at which you wish to do so may be substantially limited.  There is also significantly greater concentration in the Brazilian securities market than in major securities markets.  The ten largest companies in terms of market capitalization represented approximately 51.2% of the aggregate market capitalization of the BM&FBOVESPA as of December 31, 2013.  The top ten stocks in terms of trading volume accounted for approximately 41.3%, 43.0% and 47.2% of all shares traded on the BM&FBOVESPA in 2013, 2012 and 2011, respectively.

Investors who exchange ADSs for common shares may lose their ability to remit foreign currency abroad and obtain Brazilian tax advantages.

The Brazilian custodian for the common shares underlying our ADSs must obtain a certificate of registration from the Central Bank in order to be entitled to remit U.S. dollars abroad for payments of dividends and other distributions relating to our common shares or upon sales of our common shares.  If an ADR holder decides to exchange ADSs for the underlying common shares, the holder will be entitled to continue to rely on the custodian’s certificate of registration for five business days from the date of exchange.  After that period, the holder may not be able to obtain and remit U.S. dollars abroad upon sale of our common shares, or distributions relating to our common shares, unless he or she obtains his or her own certificate of registration or registers under Resolution No. 2,689, dated January 26, 2000, of the CMN, which entitles registered foreign investors to buy and sell on a Brazilian stock exchange.  If the holder does not obtain a certificate of registration or register under Resolution No. 2,689, the holder will generally be subject to less favorable tax treatment on gains with respect to our common shares.

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If a holder attempts to obtain his or her own certificate of registration, the holder may incur expenses or suffer delays in the application process, which could delay his or her ability to receive dividends or distributions relating to our common shares or the return of his or her capital in a timely manner.  The custodian’s certificate of registration or any foreign capital registration obtained by a holder may be affected by future legislative changes, and additional restrictions applicable to the holder, the disposition of the underlying common shares or the repatriation of the proceeds of disposition may be imposed in the future.

A holder of common shares or ADSs may face difficulties in protecting his or her interests as a shareholder because we are a Brazilian mixed capital company.

We are a mixed capital company (sociedade de economia mista) organized under the laws of Brazil, and all of our directors and officers and our controlling shareholder reside in Brazil.  All of our assets and those of these other persons are located in Brazil.  As a result, it may not be possible for a holder to effect service of process upon us or these other persons within the United States or other jurisdictions outside Brazil or to enforce against us or these other persons judgments obtained in the United States or other jurisdictions outside Brazil.  Because judgments of U.S. courts for civil liabilities based upon the U.S. federal securities laws may only be enforced in Brazil if certain requirements are met, a holder may face more difficulty in protecting his or her interests in the case of actions by our directors, officers or our controlling shareholder than would shareholders of a corporation incorporated in a state or other jurisdiction of the United States.  In addition, under Brazilian law, none of our assets which are essential to our ability to render public services are subject to seizure or attachment.  Furthermore, the execution of a judgment against our controlling shareholder may be delayed, since the State may only be able to pay a judgment if it is provided for in its budget in a subsequent fiscal year.  None of the public property of our controlling shareholder is available for seizure or attachment, either prior to or after judgment.

Mandatory arbitration provisions in our bylaws may limit the ability of a holder of our ADSs to enforce liability under U.S. securities laws.

Under our bylaws, any disputes among us, our shareholders and our management with respect to the Novo Mercado rules, Law No. 6,404 of December 15, 1976, as amended (“Brazilian Corporate Law”) and Brazilian capital markets regulations will be resolved by arbitration conducted pursuant to the BM&FBOVESPA Arbitration Rules in the Market Arbitration Chamber.  Any disputes among shareholders and ADR holders, and any disputes between us and our shareholders and ADR holders, will also be submitted to arbitration.  As a result, a court in the United States might require that a claim brought by an ADR holder predicated upon the U.S. securities laws be submitted to arbitration in accordance with our bylaws.  In that event, a purchaser of ADSs would be effectively precluded from pursuing remedies under the U.S. securities laws in the U.S. courts.

A holder of our common shares and ADSs might be unable to exercise preemptive rights and tag‑along rights with respect to the common shares.

U.S. holders of common shares and ADSs may not be able to exercise the preemptive rights and tag‑along rights relating to common shares unless a registration statement under the U.S. Securities Act of 1933, as amended, or the Securities Act, is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available.  We are not obligated to file a registration statement with respect to our common shares relating to these rights, and we cannot assure you that we will file any such registration statement.  Unless we file a registration statement or an exemption from registration is available, an ADR holder may receive only the net proceeds from the sale of his or her preemptive rights and tag‑along rights or, if these rights cannot be sold, they will lapse and the ADR holder will receive no value for them.  

Holders of our ADSs do not have the same voting rights as our shareholders.

Holders of our ADSs do not have the same voting rights as holders of our shares. Holders of our ADSs are entitled to the contractual rights set forth for their benefit under the deposit agreements. ADS holders exercise voting rights by providing instructions to the depositary, as opposed to attending shareholders meetings or voting by other means available to shareholders. In practice, the ability of a holder of ADSs to instruct the depositary as to voting will depend on the timing and procedures for providing instructions to the depositary, either directly or through the holder’s custodian and clearing system. The deposit agreement also provides that if the depositary does not receive any instructions from a holder of ADRs, the ADR holder may be deemed to have given a discretionary proxy to a person designated by our company and the underlying shares may be voted by such person.  However, we chose not to designate any person to exercise these deemed proxy rights with respect to the annual general meeting held to approve our financial statements for 2013, and ADSs for which no specific voting instructions were received by the Depositary were therefore not voted at that meeting.

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ITEM 4.            INFORMATION ON THE COMPANY

A.      History and Development of the Company

Overview

Companhia de Saneamento Básico do Estado de São Paulo – SABESP is a mixed capital company (sociedade de economia mista) with limited liability.  We were incorporated on September 6, 1973 under the laws of the Federative Republic of Brazil.  We are registered with the Commercial Registry of the State of São Paulo (Junta Comercial do Estado de São Paulo) under registration number NIRE 35300016831.  Our principal executive offices are located at Rua Costa Carvalho, 300, 05429‑900 São Paulo, SP, Brazil.  Our telephone number is +55 11 3388‑8000.  Our agent for service of process in the United States is CT Corporation System, with offices at 818 West Seventh Street – Team 1, Los Angeles, CA 90017.  We are allowed to operate, in a subsidiary form, in other Brazilian locations and abroad.  See “Item 4.B. Business Overview—Government Regulation—Public Consortia and Cooperation Agreement Law for Joint Management.”

We believe we are one of the largest water and sewage service providers in the world (based on the number of customers in 2012, according to the 14th edition of the Pinsent Masons Water Yearbook 2012-2013).  We operate water and sewage systems in the State of São Paulo, which includes the city of São Paulo, Brazil’s largest city.  According to the IBGE, the State of São Paulo is Brazil’s most populous state and the state with the highest gross domestic product, or GDP, in Brazil.  For the year ended December 31, 2013, we generated net revenue of R$11,315.6 million and net income of R$1,923.6 million.  Our total assets amounted to R$28,274.3 million and our total shareholders’ equity amounted to R$12,930.8 million as of December 31, 2013.

As of December 31, 2013, we provided water and sewage services to a broad range of residential, commercial, industrial and governmental customers in 363 of the 645 municipalities in the State of São Paulo, including the city of São Paulo.  Substantially all of our concessions or program agreements have 30‑year terms.  At year-end 2013 we lacked formal agreements for 61 of the municipalities we serve, each of which we are in the process of actively renegotiating, including in the municipality of Santos.  From January 1, 2014 through 2034, 38 further concessions will expire, and we will seek to replace them with program agreements. In addition to the 363 municipalities we served, we also provided water service to the municipality of Mogi das Cruzes, pursuant to two partial water contracts under which we service only certain neighborhoods of that municipality. See “Presentation of Financial and Other Information—Other Information—Our Contracts and the Municipalities We Serve.”

We also supply water on a wholesale basis to 6 municipalities in the São Paulo metropolitan region in which we do not operate water distribution systems (together covering a total estimated urban population of approximately 3.5 million).  Five of these municipalities also utilize our sewage treatment services.  For the year ended December 31, 2013, the São Paulo metropolitan region (including the municipalities to which we provide water on a wholesale basis) accounted for 73.2% of our gross operating revenue (excluding revenues relating to the construction of concession infrastructure), while the Regional Systems accounted for 26.8%.

As of December 31, 2013, we provided water services through 7.9 million water connections to approximately 24.6 million people, representing approximately 59% of the urban population of the State of São Paulo, and had a water coverage ratio of approximately 99% in respect of all regions.  As of that date, we provided sewage services through 6.3 million sewage connections to approximately 21.5 million people and had an effective sewage coverage ratio of 84%.  As of December 31, 2013, we operated using 69,619 kilometers of water pipes and water transmission lines and 47,103 kilometers of sewer lines.

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We also provide water and/or sewage services to 4 other municipalities through special purpose companies.  In addition, we provide consulting services regarding the rational use of water and commercial and operational management in Panama and Honduras through a partnership with Latin Consult. In addition we set up two new activities in partnership with other companies:  Aquapolo Ambiental S.A., a joint venture with a private sanitation services operator, which commenced operations in the second half of 2012 and operates the largest water recycling facility in the southern hemisphere, with capacity to supply up to 1,000 liters per second to industries in the Capuava petrochemical cluster in the São Paulo metropolitan region; and Attend Ambiental, a joint venture with Estre Ambiental S.A., which is constructing a pre-treatment plant for non-domestic effluent in the São Paulo metropolitan region that is expected to commence operations in the first half of 2014.

The State of São Paulo, our controlling shareholder, is required by law to own at least 50% plus one of our common shares.  As of April 16, 2014, the State owned 50.3% of our outstanding common shares.  As a mixed capital company, we are an integral part of the State governmental structure.  Our strategy and major policy decisions are formulated in conjunction with the State Secretariat for Sanitation and Water Resources as part of the State’s overall strategic planning.  The majority of the members of our board of directors and our board of executive officers are nominated by the State government.

In addition, our capital expenditure budget is subject to approval by the State legislature and is approved in conjunction with the budget of the State Secretariat for Sanitation and Water Resources as a whole.  Our financial statements and accounting records are subject to review by the State Accounts Tribunal (Tribunal de Contas), as are all accounts of the State.

Our Strengths

We believe that our strong business position and future prospects derive from the following strengths:

Well‑established business with significant size, scale and know‑how to operate in complex urban settings.  We believe we are one of the largest water and sewage service providers in the world.  We provide water services directly to approximately 24.6 million people and supply water on a wholesale basis to an additional urban population of approximately 3.5 million people.  As of December 31, 2013, we had an effective water coverage ratio of approximately 99% in respect of all regions in which we operate.  We also provide sewage services directly to approximately 21.5 million people, achieving an effective sewage coverage ratio of 84% in respect of all regions in which we operate as of December 31, 2013.  During the year ended December 31, 2013, our net operating revenues (including revenues relating to the construction of concession infrastructure) increased by 5.4% as compared to 2012.  Our significant size and scale have required us to operate in complex urban settings such as favelas (shantytowns) and environments without urban planning, which has enabled us to develop skill in operating in adverse conditions, well‑trained personnel and a specialized structure that we believe our competitors lack.

Operations in Brazil’s most populous and wealthy state.  The State of São Paulo, which is located in the most developed and economically active region of Brazil, is the most populous state in Brazil, with an estimated total population of 44 million as of December 31, 2013.  The city of São Paulo had an estimated total population of 11 million as of the same date, while the São Paulo metropolitan region had a total population of 21 million.  Based on its GDP, the State of São Paulo is the wealthiest state and largest economy in Brazil. The GDP of the State of São Paulo was approximately R$1.3 trillion in 2011, representing approximately 33% of Brazil’s total GDP.  The State of São Paulo generates more revenue from water and sewage services than any other Brazilian state.

Strong Base of Contracted Business.  Between January 1, 2007 and December 31, 2013, we executed 30‑year agreements with 266 of the 363 municipalities we serve, including an agreement with the City of São Paulo in June 2010.  For the year ended December 31, 2013, income from these 30‑year agreements accounted for 72.9% of our gross operating revenues (including revenues relating to the construction of concession infrastructure).

Access to low‑cost and diverse sources of financing.  Our strong cash flow generation from operations and our role as an essential public service provider places us in a privileged position in our industry to obtain low cost, long‑term financing from Brazilian public banks, and domestic and international multilateral agencies and development banks.  We do not depend on a limited number of sources of financing, but instead have access to various funding alternatives in the Brazilian and international markets to fund our working capital needs and our capital expenditure programs.

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Strong corporate governance practices.  In 2002, we joined the Novo Mercado segment of the BM&FBOVESPA, which is the listing segment in Brazil with the highest corporate governance requirements.  As a result, we are committed to certain corporate governance standards that are not otherwise required by Brazilian law, which provides heightened protection to our shareholders and enhances the quality of information we disclose to the market.  On December 1, 2007, we became part of the BM&FBOVESPA Corporate Sustainability Index, or ISE, which reflects our high degree of commitment to sustainable environmental and social practices. 

High quality operations.  We believe that we adhere to high standards of service and employ the best available technology in the sanitation business to control the quality of the water we abstract, process and distribute.  All of our water quality control laboratories operate in accordance with the ABNT NBR ISO 9001 standard, the highest international water quality standard.  In addition to our central laboratory, 12 of our regional laboratories are accredited by the National Institute of Metrology, Standardization and Industrial Quality, or INMETRO, and comply with the ABNT NBR ISO IEC 17025 standard, thereby assuring the quality and accuracy of our test results.  Moreover, our laboratories and field teams use the latest equipment to detect substances controlled by regulations and have highly trained teams to handle contingencies and customer complaints.  We believe our technology enhances the efficiency and quality of our operations.

Our Strategy

Our mission is to provide water and sewage services, contributing to improvements in quality of life and the environment.  To this end, our strategic objectives are based upon the guiding principles of growth, quality, universalization of sanitation services, social, economic and environmental sustainability, human capital as a competitive strength and innovation, while focusing on reaching excellence in customer service.  Our strategic objectives also focus on our political and institutional relationships as well as on our commitment to the market to increase shareholder value.  We seek to implement these guiding principles through the following strategies:

Continue to seek growth while improving our financial results by reducing operating costs, increasing productivity and profitability and prudently managing our levels of indebtedness.  We aim to apply our principles of financial growth and sustainability to each business unit, assigning goals and setting clear responsibilities to each unit so as to strengthen our financial results.  To achieve this goal, we intend to use our best efforts to reduce operating costs and increase productivity and profitability.  We plan to improve the management of our assets, as well as to continue to reduce our total operating expenses by automating some of our facilities, streamlining operational processes, implementing integrated planning and further investing in internal technological research and development.  We also plan to continue our efforts to improve our collection of overdue accounts receivable from municipalities to which we provide services, from the State and from other governmental entities, including by exploring opportunities to offset these outstanding debts against certain possessory or property rights over utilities relating to water and sewage systems.  We intend to continue to fund our working capital needs and estimated capital expenditure programs with diversified sources of financing, such as domestic and international development banks and multilateral agencies.  We will continue to seek market opportunities for low‑cost financing and restructuring of our indebtedness if and when advantageous and appropriate.

Improve operating efficiency and reduce water loss.  We seek to reduce both physical water loss, which results mainly from leakage; non‑physical water loss, which results primarily from inaccurate water meters installed at customers’ premises and at our water treatment facilities; and clandestine and illegal water use.  In order to achieve more consistent long‑term results, we have developed a comprehensive 12 year program to reduce our water loss rate.  The first four years of the program from 2009 to 2012 were funded by BNDES.  From 2013 to 2017 the program will be funded by a loan granted by the government of Japan through the Japan International Cooperation Agency, or JICA.  The program focuses on renewing our water distribution infrastructure and improving the pressure control and the maintenance and control services as a means of reducing physical water loss.  We are also seeking to reduce physical water loss by creating smaller water supply districts through the construction of district metering areas, which reduce system pressure and pipe bursts, and allow leaks to be detected and repaired more efficiently.  The program also seeks to reduce non‑physical water loss by upgrading and replacing inaccurate water meters and through inspections of non‑authorized water consumption in water service connections.

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Ensure the quality and availability of our services in our existing service area.  Our goal is to maintain an effective water coverage ratio of around 100%, coupled with a high standard of quality and availability, and meet the expected population growth by adding 1.17 million water connections between 2014 and 2020.  We also intend to increase our sewage coverage ratio to 95% by 2020 by adding 1.65 million sewage connections.  In addition, we are also developing short, medium and long‑term marketing strategies, such as client segmentation and tailor‑made solutions for different types of clients, which we believe will help us increase our customer base.  We also seek to improve our customer support strategies by modernizing our telephone and internet‑based customer support and to continuously measure the level of satisfaction of our clients.

Maintain and continue to expand our existing service areas.  We intend to maintain and expand our operating base by executing new agreements.  To this end, we are actively seeking to develop closer relationships with the municipal governments that we currently serve in order to increase customer loyalty and thereby renew all or substantially all our concession agreements as they expire.  In June 2010, we entered into a 30‑year agreement with the State and city of São Paulo for the provision of water and sewage services in the city of São Paulo, which in the year ended December 31, 2013 accounted for 51.8% of our gross operating revenues (excluding revenues relating to the construction of concession infrastructure).  Between January 1, 2007 and December 31, 2013, we entered into agreements with 265 municipalities (including our services agreement with the city of São Paulo), of which seven were entered into in 2013.  These 265 municipalities accounted for 72.9% of our total revenues for the year ended December 31, 2013 and 64.6% of our intangible assets as of the same date.  As of December 31, 2013, 61 of our concessions had expired and are currently being renegotiated.  These 61 municipalities accounted for 16.1% of our total revenues for the year ended December 31, 2013 and 25.1% of our intangible assets as of the same date.  From January 1, 2014 through 2034, 38 concession agreements, accounting for 9.0% of our revenues for the year ended December 31, 2013 and 8.0% of our intangible assets as of the same date, will expire.

Our investment plan will include the investment of R$12.8 billion between 2014 and 2018, designed to improve and expand our water and sewage system and to increase and protect our water sources in order to meet the growing demand for water and sewage services in the State of São Paulo, in order to encourage these customers to continue using our services. We also regularly explore the possibility of executing agreements for the provision of water and sewage services in municipalities in the State of São Paulo in which we currently have no operations or to which we currently supply water and provide sewage treatment solely on a wholesale basis, which together represent a total population of approximately 17 million.  We evaluate possible expansion opportunities in terms of proximity to our existing service areas to maximize return on investment and improve our financial performance.  We also intend to study and take advantage of opportunities in other Brazilian states and in other countries to expand our services and increase our market share.

Expand our water and sewage services.  We had an effective sewage coverage ratio of 84% as of December 31, 2013 and plan to increase this ratio to 95% by 2020 by adding over 1.65 million sewage connections.  In addition, there are municipalities in the State of São Paulo representing a total population of approximately 17 million to which we currently do not provide water or sewage services, or to which we currently supply water solely on a wholesale basis.  Our strong presence in the State and experience in providing water and sewage services places us in a privileged position to expand our sewage services to these additional municipalities in the State of São Paulo, as well as to other Brazilian states and abroad.  Further, we seek to deepen our relationships with strategic clients that consume high volumes of water (more than 500 cubic meters per month) by applying special tariffs to these clients.

Seek selective opportunities to expand our business.  Our activities comprise water supply, sanitary sewage services, urban rainwater management and drainage services, urban cleaning services, solid waste management services.  We are looking into related activities, including the planning, operation, maintenance and commercialization of energy, and the commercialization of services, products, benefits and rights that directly or indirectly arise from our assets, operations and activities.  We are allowed to act, in a subsidiary form, in other Brazilian locations and abroad. Since 2008, we have expanded into activities that complement water and sewage services in which we may leverage our know‑how, size, scale and profitability. For example:

·                     We are planning to install small hydroelectric power plants in our water treatment plants in Guaraú and Cascata in conjunction with the Servitec/Tecniplan consortium.  We expect to start construction of the first two plants, with capacities of 4 and 2 MW, in the second half of 2014.

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·                     We worked with the basic sanitation company of the state of Alagoas to transfer technology for the reduction of water loss in the city of Maceió. Under this type of contract, we are remunerated based on our success rate, or more specifically, we profit based on the reduction of water loss achieved in city of Maceió.

·                     In partnership with the consultancy firm Latin Consult, we are providing consulting services to the Instituto de Acueductos y Alcantarillados Nacionales, the company responsible for water and sewage services in the central provinces of Panama, in the field of sustainable water use and to implement a new model for commercial, financial and operational planning and management.

·                     Also in partnership with Latin Consult, we are providing consulting services to seven municipalities in Honduras to implement a new commercial and operational management model.

·                     We have set up Attend Ambiental, a joint venture with Estre Ambiental S.A., which is constructing a pre‑treatment and processing plant for non-domestic effluent in the São Paulo metropolitan region that is expected to commence operations in the first half of 2014.

·                     We are looking into the production and distribution of bio methane from gas generated in our sewage treatment processes.

Establish efficient and competitive ways of attracting, retaining and motivating our personnel.  We intend to become a reference in human resource management, providing our personnel with growth opportunities and recognition.  We seek to raise workplace satisfaction levels by establishing programs for the professional and personal development of our employees, setting competitive benefit packages and creating a healthy and collaborative work environment.

Streamline internal processes.  We are implementing plans to increase our speed and productivity in responding to regulatory changes; strengthen and streamline our financial, commercial and administrative structure; and increase the efficiency of our operations; while also reducing costs.  To this end, in 2012 we began implementing an enterprise resourcing planning (ERP) system to replace our commercial and management information systems. We contracted through a bidding process the Águas Claras Consortium, which consists of companies Accenture and Engineering and which will provide us with SAP’s ERP system and the Net@suite system. We estimate that the ERP will be implemented in 2014, and the Net@suite in 2015.

We believe that our overall strategy will enable us to meet the demand for high quality water and sewage services in the State of São Paulo, in other Brazilian states and abroad, while strengthening our results of operations and our financial condition and creating shareholder value.

State of São Paulo

The State of São Paulo is one of 26 states that, together with the Federal District of Brasília, constitute the Federative Republic of Brazil.  The State of São Paulo is located in the southeastern region of the country, which also includes the States of Minas Gerais, Espírito Santo and Rio de Janeiro, and which is, according to IBGE, the most developed and economically active region of Brazil.  The State of São Paulo is located on the Atlantic coast of Brazil and is bordered by the States of Rio de Janeiro and Minas Gerais to the north, the State of Paraná to the south and the State of Mato Grosso do Sul to the west.

The State of São Paulo occupies 3.0% of Brazil’s land mass and encompasses an area amounting to approximately 96,000 square miles.  According to the SEADE, the State of São Paulo had an estimated total population of 44 million as of December 31, 2013.  The city of São Paulo, capital of the State of São Paulo, had an estimated total population of 11 million, with a total population of 21 million inhabitants in the São Paulo metropolitan region, as of December 31, 2013.  The São Paulo metropolitan region encompasses 39 municipalities and is the largest metropolitan region in the Americas and the sixth largest metropolitan region in the world, according to the United Nations’ World Urbanization Prospects, 2011 Revision, with approximately 47% of the total population of the State of São Paulo as of December 31, 2013.

According to the IBGE, the GDP of the State of São Paulo was approximately R$1.3 trillion in 2011, representing approximately 33% of Brazil’s total GDP, and making it the largest economy of any state in Brazil based on GDP.  According to the IBGE, the State of São Paulo is also the leading Brazilian state in terms of manufacturing and industrial activity, with a strong position in car manufacturing, pharmaceuticals, computer manufacturing, steel making and plastics, among other activities, as well as a leading position in the banking and financial services industries.  The State of São Paulo is the leading export state in Brazil, according to the Brazilian Ministry of Development, Industry and Foreign Trade (Ministério do Desenvolvimento, Indústria e Comércio Exterior). 

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History

Until the end of the nineteenth century, water and sewage services in the State of São Paulo were generally provided by private companies.  In 1875, the Province of São Paulo granted a concession for the provision of water and sewage services to Companhia Cantareira de Água e Esgotos.  In 1893, the government of the Province of São Paulo assumed responsibility for the provision of water and sewage services from Companhia Cantareira de Água e Esgotos and formed the Office of Water and Sewers (Repartição de Água e Esgotos), a government agency.  Since that time, water and sewage services in the São Paulo metropolitan region have been administered by the State government.  Historically, water and sewage services in substantially all other municipalities of the State were administered directly by the municipalities, either by municipal water and sewage departments or through autarquias of the municipal government.  Autarquias are relatively autonomous public bodies with separate legal standing, assets and revenues, created by law to carry out the administration of public services where the government deems that a decentralized administrative and financial structure would be advantageous.

In 1954, in response to dramatic population growth in the São Paulo metropolitan region, the State government created the Department of Water and Sewers (Departamento de Águas e Esgotos) as an autarquia of the State.  The Department of Water and Sewers provided water and sewage services to various municipalities in the São Paulo metropolitan region.

A major restructuring of the entities providing water and sewage services in the State of São Paulo occurred in 1968, with the creation of the Water Company of the São Paulo metropolitan Region (Companhia Metropolitana de Água de São Paulo), or the COMASP, the purpose of which was to provide potable water on a wholesale basis for public consumption in the various municipalities of the São Paulo metropolitan region.  All assets relating to the production of potable water for the São Paulo metropolitan region previously owned by the Department of Water and Sewers were transferred to COMASP.  In 1970, the State government created the Superintendence of Water and Sewers of the city of São Paulo (Superintendência de Água e Esgoto da Capital), or the SAEC, to distribute water and collect sewage in the city of São Paulo.  All assets relating to water services previously owned by the Department of Water and Sewers were transferred to the SAEC.  Also in 1970, the State created the Basic Sanitation Company of the São Paulo metropolitan Region (Companhia Metropolitana de Saneamento de São Paulo), or the SANESP, to provide sewage treatment services for the São Paulo metropolitan region.  All assets relating to sewage services previously owned by the Department of Water and Sewers were transferred to the SANESP.  The Department of Water and Sewers was subsequently closed.

On June 29, 1973, pursuant to State Law n. 119, COMASP, the SAEC and the SANESP merged to form our Company with the purpose of implementing the directives of the Brazilian government set forth in the National Water Supply and Sanitation Plan (Plano Nacional de Saneamento).  We were incorporated under the laws of Brazil as a limited company (sociedade anônima), for indefinite duration.  The National Water Supply and Sanitation Plan was a program sponsored by the Brazilian government, which financed capital investments in, and assisted in the development of, state‑controlled water and sewage companies.  Since our formation, other State governmental and State‑controlled companies involved in water supply and sewage collection and treatment in the State of São Paulo have been merged into our company.  The State has always been our controlling shareholder, as required by State Law No. 119.  We have therefore been integrated into the State governmental structure and our strategies have been formulated in conjunction with the strategies of the State Department of Water Resources and Sanitation.  Additionally, a majority of the members of our board of directors and our management are appointed by the State Government.

Our capital expenditure budget is subject to approval by the State legislative chamber.  This approval is obtained simultaneously with the approval of the budgets of the Department of Sanitation, of the Department of Energy and of the State of São Paulo.  We are also subject to supervision from the Court of Audit of the State of São Paulo (“Tribunal de Contas do Estado de São Paulo”), with regard to our accounting, financial and budgetary activities and our operating assets.

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We provide water and sewage services directly to a large number of residential, commercial and industrial private consumers, as well as to a variety of public entities, in 363 of the 645 municipalities in the State, including in the city of São Paulo.  We also supply water on a wholesale basis to 6 municipalities in the São Paulo metropolitan region in which we do not operate water distribution systems, and five of these municipalities also utilize our sewage treatment services.  Currently, we are the fifth largest water and sewage service company in the world in terms of number of clients, according to the 14th edition of the Pinsent Masons Water Yearbook (2012‑2013).

In 1994, we were registered with the CVM as a publicly-held company and are therefore subject to the CVM’s rules, including those relating to the periodic disclosure of extraordinary facts or relevant events.  Our common shares have been listed on the BM&FBOVESPA under the ticker “SBSP3” since June 4, 1997.

In 2002, we joined the Novo Mercado segment of the BM&FBOVESPA, which is the listing segment in Brazil with the highest corporate governance requirements.  In the same year, we registered our common shares with the Securities and Exchange Commission, or SEC, and started trading our shares in the form of American Depositary Receipts – level III (“ADRs”) on the New York Stock Exchange, or NYSE.

In 2004, the State of São Paulo carried out a secondary offer of common shares of our company in the Brazilian and international markets.  On December 1, 2007, we became part of the BM&FBOVESPA ISE, which reflects our high degree of commitment to sustainable environmental and social practices.

In December 2007, Law No. 1,025, which provided for the creation of regulatory agencies for the supervision of water and sewage services, created ARSESP, the regulatory agency that regulates and supervises the services we provide.

Corporate Organization

We currently have six management divisions, each of which is supervised by one of our executive officers.

Our board of directors allocates responsibilities to our executive officers following an initial proposal made by our Chief Executive Officer, in accordance with our bylaws.  The Chief Executive Officer is responsible for coordinating all management divisions in accordance with the policies and directives established by our board of directors and board of executive officers, including the coordination, evaluation and control of all functions related to the Chief Executive Officer’s office and staff, integrated planning, business management and corporate organization, communication, audit, ombudsman, and negotiation of concessions.  The Chief Executive Officer represents our company before third parties and certain powers can be granted to attorneys‑in‑fact.  The executive officers described below report to the Chief Executive Officer:

·                     the Corporate Management Officer, who is responsible for marketing (commercial processes), human resources, quality and social responsibility, legal affairs, information technology, asset management, supplies and contracts;

·                     the Chief Financial Officer and Investor Relations Officer, who is responsible for financial planning, costs and tariffs, raising capital and allocating financial resources to divisions of our company, conducting capital markets and other debt incurrence transactions and managing debt levels, financial controls, accounting, corporate governance and investor relations. Moreover, the Chief Financial Officer is part of the committee on regulatory matters and is responsible for implementing the committee’s guidelines with the support of our division responsible for regulatory matters;

·                     the Technology, Enterprises and Environment Officer is responsible for environmental management, technological and operational development, quality control of water and sewage, the development, coordination and execution of special investment programs, projects, research and innovation, and

·                     the Chief Operating Officer for the São Paulo metropolitan region Division and the Chief Operating Officer for the Regional Systems Division, who are responsible for managing the operation, maintenance, execution of planning and works for water and sewage supply systems (including for the services that we provide on a wholesale basis), sales and call center services, and have overall responsibility for the financial and operational performance of their divisions. Moreover, the Chief Operating Officers are part of the committee on regulatory matters and they implement the committee’s guidelines in their respective management team, with the support of our division responsible for regulatory matters. The Chief Operating Officers are also responsible for sanitation advisory services to autonomous municipalities and for mediation and negotiation with communities and local governments, aimed at aligning our interests with the interests of our clients.

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Capital Expenditure Program

Our capital expenditure program is designed to improve and expand our water and sewage system and to increase and protect our water sources in order to meet the growing demand for water and sewage services in the State of São Paulo.  Our capital expenditure program has four specific goals with respect to the municipalities we serve:

(i)    to continue to meet the maximum demand for treated water;

(ii)   to expand the percentage of households connected to our sewage system;

(iii)  to increase the treatment of sewage collected; and

(iv)  to increase operating efficiency and reduce water loss.

Our capital expenditures from 2011 through 2013 totaled R$7.7 billion. We have budgeted investments in the total amount of R$12.8 billion from 2014 through 2018.  We invested R$2.7 billion, R$2.5 billion and R$2.4 billion in 2013, 2012 and 2011, respectively.

The following table sets forth our planned capital expenditures for water and sewage infrastructure for the years indicated.

 

 

Planned Capital Expenditures

 

2014

2015

2016

2017

2018

Total

 

 

 

 

 

 

 

Water

1,139

1,129

1,087

956

974

5,284

Sewage Collection

1,092

1,069

889

893

1,107

5,051

Sewage Treatment

411

478

553

647

339

2,428

Total

2,642

2,676

2,529

2,496

2,420

12,763

 

Our capital expenditure program from 2014 through 2018 will continue to focus on achieving our targets by making regular investments to maintain and expand our infrastructure and to reduce water loss in the 363 municipalities we served as of December 31, 2013.

Main Projects of Our Capital Expenditure Program

The following is a description of the main projects in our capital expenditure program.

Metropolitan Water Program

Demand for our water services has grown steadily over the years in the São Paulo metropolitan region and has at times exceeded the capacity of our water systems.  As a result, prior to September 1998, a portion of our customers in this region received water only on alternate days of the week.  We refer to this as “water rotation.”  In order to remedy this situation, we implemented the (Programa Metropolitano de Água) to improve regular water supply to the entire São Paulo metropolitan region.  This program terminated in 2000 and the water rotation measure was eliminated, but we have maintained our investment plans for the region. 

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The second phase of the Metropolitan Water Program, projected to result in an increase of 13.2 m³/s in water production capacity, started in 2006 and is expected to run through 2014.  Within this phase, there has been an increase of 5.5 m³/s in water production capacity (of which 5 m³/s through the Alto do Tietê Public Private Partnership (PPP) concluded in 2011), and there is a plan to increase another 1 m³/s in 2014.  Total investments made from 2006 to December 31, 2013, amounted to R$1.6 billion, including our own funds and financing from Caixa Econômica Federal and Banco Nacional de Desenvolvimento Econômico e Social (“BNDES”), as well as the investments from the Alto Tietê Public Private Partnership.  In 2013, we invested approximately R$128 million in this program.

In 2013, the goals of the Program were revised, and we initiated the Program’s third phase.  We plan to increase water production capacity by 9.5 m³/s in the São Paulo Metropolitan Region by 2018, including the new São Lourenço System.  This new system alone will increase water production capacity by 4.7 m³/s.  The projected investments in the Program’s third phase may reach R$4.4 billion, including the investments in the São Lourenço PPP.  For information on Public Private Partnerships, see “—Business Overview—Public Private Partnerships.”

Alto Tietê Public Private Partnership

In June 2008 we formed the Alto Tietê PPP with a special purpose company known as Cab Spat, whose main shareholders are Cab Ambiental and Galvão Engenharia S.A.  The Alto Tietê PPP is part of the second phase of the Metropolitan Water Program and aims to improve the reliability, flexibility and availability of the integrated water system that serves the São Paulo metropolitan region.  Through this PPP, Cab Spat carried out certain infrastructure works, which were completed in December 2011, and expanded the Alto Tietê System nominal capacity from 10 cubic meters per second to 15 cubic meters per second. 

Cab Spat has also undertaken to perform maintenance on the Alto Tietê System’s dams on an ongoing basis.  This maintenance work consists of civil engineering, electromechanical and operational services, as well as sludge treatment, water adduction and water supply.

The total estimated cost for this project, including the investments and the System’s maintenance, is R$1.0 billion.  We intend to complete payment for these by 2024. For information on Public Private Partnerships, see “—Business Overview—Public Private Partnerships.”

São Lourenço Project

The metropolitan region suffers from a water shortage, which requires us to obtain water from increasingly distant sources.  In order to remedy this situation, we are currently developing a new supply system called São Lourenço, which will expand our production capacity by 4.7 m3/s and should be able to benefit a population of almost 1.5 million people.  The PPP contract was executed in August 2013 and the works will begin in the first semester of 2014. Sistema Produtor São Lourenço S.A. is a Special Purpose Company (SPC) consisting of the construction companies Camargo Correa and Andrade Gutierrez. The new system is expected to begin operating in 2018. For information on Public Private Partnerships, see “Business Overview—Public Private Partnerships.”

The contract is in the amount of approximately R$6 billion (including the investment in the construction of R$2.2 billion and the system’s operation and maintenance) and it has a 25-year term, four years of which will be dedicated to the construction, while the other 21 years will be dedicated to service delivery. These services include the operation and maintenance of the sludge treatment system of the water treatment station and disposal of the waste thus generated; electromechanic and civil maintenance of the untreated water pumping stations, of the water treatment station and the untreated water pipeline; preservation and cleaning, surveillance and property security.     

Tietê Project

The Tietê river crosses the São Paulo metropolitan region and receives most of the region’s run‑off and wastewater.  The environmental status of the river reached a critical level in 1992.  In an effort to reverse the situation, the State of São Paulo created a recovery program designed to reduce pollution of the Tietê river by installing sewage collection lines along the banks of the Tietê river and its tributaries.  These lines collect raw sewage and deliver it to our sewage treatment facilities.  We carried out the first phase of the program between 1992 and 1998.

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In the first phase of the Tietê Project, we completed the construction of three additional sewage treatment facilities in June 1998.  This involved total investment of US$1.1 billion, of which US$450 million was financed by the Inter‑American Development Bank, or IADB, approximately US$100 million by Caixa Econômica Federal, and approximately US$550 million by us.

The second phase of the project, which was carried out from 2000 through 2008, involved installing 290,000 sewage connections and more than 1,500 kilometers of sewage collection networks, branch collectors and interceptors.  Total investments in this phase amounted to approximately US$500 million, of which US$200 million was financed by the IADB, R$60 million by BNDES directly, and R$180 million by BNDES through another financial institution.

The main objective of the second phase was to continue expanding and optimizing the sewage system in the São Paulo metropolitan region, focusing primarily on improvements to expand the delivery of raw sewage to the sewage treatment facilities that were built in the first phase.  Upon the conclusion of the second phase of the project in 2008, we were able to collect approximately 5,000 liters of raw sewage per second and send it to the five sewage treatment plants in our integrated system for treatment.  As part of the second phase of the Tietê Project, we implemented a geographic information system named SIGNOS.  SIGNOS is a management information system which automates and integrates various business processes, including project management, maintenance, operations and customer service and maps out our entire municipal infrastructure in the São Paulo metropolitan region.

The first and second phases of the Tietê Project contributed to an increase from 70.0% to 84.0% in the sewage collection rate and an increase from 24.0% to 70.0% in the treatment of sewage collected in the São Paulo metropolitan region.  As a result, the sewage collection system covered a total of 15.8 million people (5.1 million more than the number of people served when the Tietê Project was initiated), and the sewage treatment system covered 11.1 million people (8.5 million more than the number of people served when the Tietê Project was initiated).  The five principal sewage treatment facilities in the São Paulo metropolitan region have an aggregate installed capacity of 18 cubic meters of sewage per second and currently treat an aggregate of 16 cubic meters of sewage per second.  We plan to build additional collection lines to direct more raw sewage to our treatment facilities.

The third phase of the Tietê Project, initiated in 2010, aims to remediate the water quality in the Tietê river basin by expanding collection levels to 87.0% and sewage treatment levels to 84.0% in the São Paulo metropolitan region.  The total estimated cost of the third phase is approximately US$2 billion, of which US$600 million will be financed by a loan from the IADB entered into in September 2010 and approximately R$ 1.35 billion by a loan from BNDES entered into in February 2013.  The third phase consists principally of the following items:

·                     improvements to the effluent collection system through collection networks and home connections;

·                     removal and transport of effluent for treatment through branch collectors and interceptors; and

·                     the construction of new sewage treatment plants in the São Paulo metropolitan region. 

Approximately 76% of the work for the third phase is under construction, and a further 7% is in the process of public tender.  Following completion of the third phase of the Tietê Project, the sewage collection system will serve an additional 1.5 million people and the sewage treatment system will serve an additional 3 million people.  We have invested R$1.1 billion in the third phase, R$358 million of which during 2013.

Continuing our efforts to eliminate the disposal of in natura sewage, in the bodies of water of the São Paulo Metropolitan Region, by the areas we serve, we are currently structuring the fourth phase of the Tietê Project, which is expected to begin in 2014 with investments estimated at US$2 billion. We have been seeking financing sources from the Federal Government and international institutions, similarly to what happened in the earlier phases of the program.

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Corporate Program for Reduction of Water Loss

The objective of the Corporate Program for Reduction of Water Loss (Programa Corporativo de Redução de Perdas de Água) is to reduce water loss efficiently by integrating and expanding existing initiatives in our business units.  This program has a 12‑year term that began in 2009.  We have invested R$1.5 billion in this project so far, including R$424 million invested in 2013, and anticipate total investments of approximately R$5.9 billion throughout the term of the program.  Funding for the program will come from our own resources as well as from credit facilities provided by JICA, Caixa Econômica Federal and BNDES.  The program aims to reduce the incidence of water loss from 436 liters per connection per day in December 2008 to 280 liters per connection per day in 2020, which is equivalent to reducing the Non-Revenue Water Index from 27.6% in December 2008 to 18% in 2020.  This is equivalent to reducing the water loss index (based on metered consumption) from 34.1% in December 2008 to 25.7% in 2020.  Since the beginning of the program, we reduced the Non-Revenue Water Index by 3.2%, reaching 24.4% in December 2013.  Regarding the utilization of water sources, the drop in real water loss (water physically lost, which corresponds to about 65% of the Water Loss Index) dropped from 22.2% in December 2008 to 20.3% in December 2013. 

Mananciais/New Life Program

The Mananciais/New Life Program (Programa Vida Nova) consists of various projects that focus on the preservation and improvement of water reserves in the São Paulo metropolitan region, especially in the Guarapiranga and Billings reservoirs.  The resources will be mostly invested in the creation of infrastructure to collect sewage and transport it to treatment plants in order to reduce the discharge of effluent into water sources.  The program also includes the protection of green spaces and the urbanization of favelas (shantytowns) and is expected to directly benefit 58,000 families by 2015.

The State government, local authorities and the federal government are expected to invest approximately R$1.6 billion in this program by the end of 2015.  To implement this program, we estimate we will invest R$335 million.  As of December 31, 2013, the total amount of cumulative investments in this program reached R$117 million, R$48.4 million of which was invested in 2013.    

Clean Stream Program

The Clean Stream Program (Programa Córrego Limpo), a partnership between the State, acting through our company, and the municipality of São Paulo, aims to decontaminate urban streams in the city of São Paulo by eliminating the discharge of sewage into streams and rainwater runoff routes, cleaning streams and banks, and removing and relocating of properties located on the banks of streams.

Total investments made in this program amounted to R$730.3 million as of December 31, 2013, of which we had invested R$130 million.  146 urban streams have been decontaminated since 2007, benefiting approximately 2 million people. In 2013, 30 urban streams have been decontaminated and we had invested R$20 million in this Program. Part of the investment related to the Tietê Program benefit the Clean Stream Program.

In 2013, we began the fourth phase of the Clean Stream Program, and we expect to completely or partially decontaminate more than 20 large streams by the end of 2014, with investments of approximately R$100 million.

Regional Systems Investment Programs

We currently have a number of projects in progress and planned for our Regional Systems.  These relate to the abstraction of water as well as to the collection, removal and disposal of sewage.  We invested approximately R$1.1 billion per year in these projects in 2013, 2012 and 2011, and we have budgeted for additional capital expenditures of approximately R$3.7 billion from 2014 through 2018.

Clean Wave Program

The main goals of the Clean Wave Program (Programa Onda Limpa) are to improve and expand the sewage systems in the municipalities comprising the Baixada Santista metropolitan region, increasing the sewage collection rate to 95%, and treating 100% of the collected sewage, thereby improving bathing water quality at 82 beaches in the region by the end of the decade.  This project is being carried out in two phases, the first of which has started and the second of which is in the planning phase.  The first phase is expected to be completed by 2016, aiming at increasing the sewage collection rate to 88%.  The funds will come from our own resources as well as from loan agreements entered with JICA and from the Government Severance Indemnity Fund for Employees (Fundo de Garantia por Tempo de Serviço), or FGTS.

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As of December 31, 2013, we had invested approximately R$1.9 billion in this program, of which R$75.5  million was invested during 2013.  As a result, sewage collection increased from 53% to 72%, and the treatment of collected sewage rose from 96% to 100%.

After completing the construction of sewage treatment plants and installation of networks, we are prioritizing the connection of customers to the sewage collection system. As of December 31, 2013, we had completed 84 thousand connections.

Additionally, complimentary works of the first phase shall be executed between 2013 and 2016, including an addition of 33 thousand sewage connections, which refer to connections that were not executed in the first phase.  We expect to evaluate the service of sewage collection rate by 88% by the end of this phase. These works have an approximated investment value of R$400 million.

Still in the first stage, we will work until 2017 on the system of oceanic sewage disposal in the city of Praia Grande, which is an important city in the Baixada Santista region, on the coast of São Paulo state. This will involve investments of approximately R$300 million.

The second phase is in planning for the period between 2015 and 2020. We estimate investments in the amount of R$1 billion, in order to enlarge and implement sewage collection and treatment systems and complete 50 thousand new connections. This phase of the Clean Wave Program aims at universalizing sewage services in the Metropolitan Region of Baixada Santista.

Northern Coast Clean Wave Program

The Northern Coast Clean Wave Program (Programa Onda Limpa Litoral Norte) aims at expanding the collection and treatment of sewage on the northern coast of the State of São Paulo, intending to benefit 600 thousand people, including the local population as well as tourists that visit the region each year.  The program aims to increase the sewage collection rate in the region from 36.0% in 2008 to 85.0% in 2016, thereby improving the health and well‑being of the population and stimulating economic development through an increase in tourism.  As of 2013, the sewage collection rate was 56%.

Within this program, in 2013, we implemented collection networks, sewage connections and disposal systems, and built two Sewage Treatment Stations on beaches on the northern coast of São Paulo state.

The funds in the amount of RS510 million that are necessary to conclude this program until 2016 will come from our own resources, as well as from loan agreements entered with BNDES and Caixa Econômica Federal.  As of December 31, 2013, we had invested R$144 million in this program, of which R$18 million was invested during 2013. 

Coastal Water Program

The Coastal Water Program (Programa Água no Litoral) combines various long‑term activities to expand water production capacity in the Baixada Santista metropolitan region and the southern coast of the State of São Paulo.  The program aims to benefit approximately three million people, including both the local population and tourists.  It aims to increase the level of reliability of the local systems, eliminating existing and potential deficiencies and irregularities in the water supply. Through this program we aim to increase the availability of treated water and improve the quality of water available to the population.  The fund will come from our own funds and financing from Caixa Econômica Federal.

During the first phase of this program, we have focused mainly on increasing water production in order to satisfy demand and improve water quality in the Baixada Santista metropolitan region.  In order to reach this goal, we built two water treatment stations, which started operations in 2013: Mambu/Branco, with water treatment capacity of 1.6 m³/s, and Jurubatuba, with water treatment capacity of 2 m³/s.

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As of December 31, 2013, we had invested R$858 million in this program, of which R$100 million was invested during 2013. The total investment estimated in this phase is R$1.1 billion.

The second phase of the program is in planning, with the goal of increasing even further the availability of treated water for the local population and tourists and improving the quality of the water available to the population in the Baixada Santista metropolitan region in the coming years.

New Policies and Programs

Nossa Guarapiranga

In December 2011, we launched the Nossa Guarapiranga project, the main objective of which is to remediate the water quality in the Guarapiranga basin, which is a water source for the São Paulo metropolitan region.  The basin serves one million people directly in the areas near Guarapiranga, and indirectly serves a further two million people who consume the water from the basin.  We installed 11 drains to collect residue from rivers in the Guarapiranga basin, and since July 2012, we have developed diagnosis and control services for the withdrawal of water plants that obstruct water extraction and deposit garbage at the bottom of the basin’s dam. The total amount invested from our own funds was R$12.2 million as of March 2014.  These actions will continue through 2014-2015 during which another R$4.3 million will be invested.  

 

Pró‑Conexão

In December 2011, Municipal Legislative Assembly of the city of São Paulo approved a project to subsidize connections to the sewage system for low‑income families. Initially intended to last 8 years, the project involves capital expenditures of up to R$349.5 million of which 80% will be provided by the State government and 20% by us.  In this period we expect that this program will create 192 thousand new connections benefiting approximately 800 thousand people.  

By December 2013 we completed approximately 15 thousand connections. We believe that this program will increase the efficiency of our sewage collection programs and help improve water quality in the region’s rivers and basins, as well as improving quality of life for low‑income families.

Water is Life

The Water is Life program, established in November 2011, aims to provide water and sewage services to low‑income and isolated communities in the regions of Alto Paranapanema and Vale do Ribeira. In the first phase of the program, we expect to cover 81 communities of 30 municipalities, benefiting approximately 15 thousand people. In this project we are responsible for supplying water, and the municipalities, with financing from the state government, are responsible for installing Individual Sanitary Units (Unidades Sanitárias Individuais), which is a technology designed for low‑income and isolated communities.  Regarding the supply of water, we invested approximately R$6.5 million in well drilling and infrastructure projects (reservoirs, equipment, networks and pipelines).  We expect to invest approximately R$15 million by 2015.

In 2013, we executed almost 64 kilometers of networks and pipelines to serve the program. A large part of these works were executed by our own personnel, which considerably reduced the need for investment. We also started operating 20 new wells and have studies and projects for 18 others. We estimate that by the end of the program we will reach 220 kilometers of network and pipelines and 45 wells.

An amount of approximately R$6 million was estimated for sewage infrastructure construction, to be financed by the State Government. This amount is negotiated between the municipalities and the State Government, and we only indicate the technical solution that is most adequate for each region.

 

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B.      Business Overview

Our Operations

As of December 31, 2013, we provided water and sewage services to 363 municipalities in the State of São Paulo under concession agreements, program agreements, other forms of legal arrangements or without formal agreements.  We also supply treated water on a wholesale basis to six municipalities located in the São Paulo metropolitan region.  Article 2 of our bylaws permits us to carry out the following activities:  provision of water supply and sewage services, urban rain water management and drainage services, urban cleaning services and solid waste management services.  In addition, our bylaws authorize us to carry out other related activities, including the planning, operation and maintenance of production systems, the storage, preservation and trading of energy, and the trading of services, products, benefits and rights that, directly or indirectly, result from our assets, projects and activities, and the right to operate a subsidiary anywhere in Brazil or abroad to provide the services mentioned above.

Following the enactment of the Basic Sanitation Law, which regulates the basic sanitation industry in Brazil, we currently operate under two different contractual environments:  (i) for concession agreements that have expired, we are currently renegotiating or will negotiate new agreements that follow the terms and conditions of the Basic Sanitation Law, known as “program agreements”; and (ii) for concession agreements that have not expired, we will continue to operate under the terms and conditions of the existing concession agreements, except in circumstances where the Basic Sanitation Law applies even though the concession agreement is still in force.  For further information on this topic, see “Government Regulation—Public Consortia and Cooperation Agreement Law for Joint Management.”

As of December 31, 2013, 61 of our agreements or concessions were still in the process of being regularized through formal agreements.  See “3.D. Risk Factors—Risks Relating to Our Business—We currently lack formal agreements or concessions with 61 of the municipalities to which we provide service, and 38 of our existing concession agreements will expire between 2014 and 2034.  We may face difficulties in continuing to provide water and sewage services in return for payment in these and other municipalities, and we cannot assure you that they will continue to purchase services from us on the same terms or at all.”

Regulation of Concessions

Pursuant to the Brazilian Constitution, the authority to develop public water and sewage systems is shared by the states and municipalities, with the municipalities having primary responsibility for providing water and sewage services to their residents.  The Constitution of the State of São Paulo provides that the State shall assure the correct operation, necessary expansion and efficient administration of water and sewage services in the State of São Paulo by a company under its control.

According to the Basic Sanitation Law, existing concessions will remain in effect until payment of indemnification is made based on the valuation of investments.  The Basic Sanitation Law provides that our new concession agreements be planned, supervised and regulated by the municipalities together with the State under a new model of associated management that will allow for better control, supervision, transparency and efficiency in the provision of public services.

As of December 31, 2013, we provided water and sewage services to 363 municipalities.  The majority of these concessions have 30‑year terms.  Due to court orders, we temporarily suspended our services in five other municipalities (Cajobi, Iperó, Álvares Florence, Macatuba and Embaúba) that accounted for less than 0.1% of our gross operating revenues and our intangible assets as of December 31, 2013.  For more information, see “Item 8.A. Financial Information—Financial Statements and Other Financial Information—Legal Proceedings—Concession‑Related Legal Proceedings.”  Between January 1, 2007 and December 31, 2013, we entered into agreements with 265 municipalities (including our services agreement with the city of São Paulo) in accordance with the Basic Sanitation Law, of which seven were entered into in 2013.  As of December 31, 2013, these 265 municipalities accounted for 72.9% of our gross operating revenues (including revenues relating to the construction of concession infrastructure).  In addition to the contracts that have 30‑year terms, the municipalities entered into cooperation contracts with the State of São Paulo, delegating the regulation and monitoring of the provision of services to ARSESP.  As of December 31, 2013, 61 of our agreements or concessions had expired but we continued to provide water and sewage services to these 61 municipalities and were in negotiations with these municipalities to execute program agreements to substitute the expired concessions.  From January 1, 2014 through 2034, 38 concessions will expire.

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Following the increase in the demand for regulatory work, we created a regulatory affairs department, which focuses on regulatory matters and has centralized communication with the regulatory agencies, driving business to the new regulatory regime and proposing matters in which we have an interest to ARSESP.

In April 2011, we created a specific area in our Financial, Economic and Investor Relations Office responsible for costs and tariffs, given the subject’s importance to the continuation of our business.  We also created a statutory Regulatory Affairs Committee.  The committee is composed of our Chief Executive Officer, our Chief Financial Officer and Investor Relations Officer, our Metropolitan Officer and our Regional Systems Officer and is responsible for defining the guidelines, strategies and regulatory recommendations for our Company and coordinating the work of the Regulatory Affairs Department.

The current concessions are based on a standard form of agreement between us and the relevant municipality.  Each agreement received the prior approval of the legislative council of each municipality.  The assets comprising the existing municipal water and sewage systems are transferred from the municipality to us in order for us to provide the contracted services.  Until 1998, we acquired municipal concessions and the existing water and sewage assets in exchange for our common shares issued at book value.  Since 1998, we have acquired concessions and water and sewage assets by paying the municipality an amount equal to the present value of 30 years of estimated cash flows from the date of acquisition of the concession, assuming a discount of at least 12%.  For reference purposes, ARSESP has set the discount rate for concession contracts at 8.06% since 2011.

The main provisions of our existing concession agreements are as follows:

·                  we assume all responsibility for providing water and sewage services in the municipality;

·                  according to the municipal laws authorizing the concession, we are permitted to collect tariffs for our services and tariff readjustments follow the guidelines established by the Basic Sanitation Law and ARSESP;

·                  as a general rule, to date, we are exempt from municipal taxes, and no royalties are payable to the municipality with respect to the concession;

·                  we are granted rights of way on municipal property for the installation of water pipes and water transmission lines, and sewage lines; and

·                  upon termination of the concession, for any reason, we are required to return the assets that comprise the municipality’s water and sewage system to the municipality and the municipality is required to pay us the non‑amortized value of the assets relating to the concession.

        These assets have been considered to be intangible assets since January 2008.  See Note 3.8 to our financial statements.  Under concession agreements executed prior to 1998, the reimbursement for the assets may be through payment of either:

o    the book value of the assets; or

o    the market value of the assets as determined by a third‑party appraiser in accordance with the terms of the specific agreement.

In Brazil, there are three federal legal regimes for contracting water and sewage services:  (i) public concessions, regulated by Law No. 8,987/1995, which require a prior public bidding process; (ii) administration of public services through cooperation agreements between the federal government and local public authorities at State and municipal level without the need for a public bidding process, regulated by the Public Consortia and Cooperation Agreement Law; and (iii) public‑private partnerships, regulated by Law No. 11,079/2004, used to grant concessions to private companies to provide public services and used in relation to construction works associated with the provision of public services.  Until 2005, we had adopted the regime for public concessions.  Following the entry into force of the Public Consortia and Cooperation Agreement Law, we adopted the administration of public services through cooperation agreements, which can be used alongside the other two regimes.

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Since 1998, our contracts with municipalities have been regulated by the Federal Concessions Law No. 8,987/1995.  Generally, these contracts have a 30‑year term, and the total value of the concession is set by the discounted cash flow method.  Under this method, when the expected contractual cash flow is reached, the total value of the concession and assets is amortized to zero on our books and we receive no payment for the assets.  If the concession is terminated prior to the end of the 30‑year term, thereby interrupting the normal contractual cash flow, we are paid an amount equal to the present value of the expected cash flow over the years remaining in the concession, adjusted for inflation.

Federal Law No. 11,107, or the Federal Public Consortia and Cooperation Agreement Law, established the legal basis for the administration of public service contracts, giving greater rights and obligations to municipalities who are responsible for sanitation services and setting out more clearly the provision of services and the responsibilities of the parties.  New agreements entered into following the expiry of concession agreements under the previous law will follow this new model.  See “—Government Regulation—Public Consortia and Cooperation Agreement Law for Joint Management.”

Our new agreement model follows the provisions of the Basic Sanitation Law.  Its main contractual provisions include the joint execution of planning, supervision and regulation of services, the appointment of a regulatory authority for the services, and periodic disclosure of financial statements.

Furthermore, the economic and financial formulas in new agreements must be based on the discounted cash flow methodology and on the revaluation of returnable assets.  Pursuant to the Basic Sanitation Law, the preexisting assets will be returned to the grantor of the concession. We will carry out all new investments and the municipalities will record them as assets.  The municipalities will then transfer possession of these assets to us for our use and management and will also record a credit in the same amount of the assets recorded in our favor.  According to Article 42 of the Basic Sanitation Law and the new agreement model, investments made during the contractual period are the property of the applicable municipality, which in turn generates receivables for us that are to be recovered through the operation of the services.  These receivables may also be used as guarantees in funding operations.

Another important development was that the new agreement model includes exemptions from municipal taxes applicable on our operational areas and the possibility of the revaluation of our assets that existed prior to the execution of the program agreements in cases involving the early resumption of services by the concession authority.

Municipalities have the inherent power under Brazilian law to terminate concessions prior to their contractual expiration dates for reasons of public interest.  The municipalities of Diadema and Mauá, two municipalities we previously served, terminated our concessions in February 1995 and December 1995, respectively.  The municipality of Mauá terminated our concession with our consent.  The municipality of Diadema terminated our concession without our consent after asserting that we did not provide adequate water and sewage services.  In 2011, we and the municipality of Diadema agreed to develop shared infrastructure for water and sewage services through a mixed capital company to be called Companhia de Agua e Esgoto de Diadema, or CAED.  According to the agreement, the amount owed to us by Diadema would be repaid through the issuance of shares in CAED.  Studies regarding the establishment of CAED have been discontinued, and on March 18, 2014, we executed a contract to resume direct supply of water and sewage services to the municipality of Diadema.  Concurrently, we entered an agreement with Diadema to resolve water supply-related debt and indemnities.  Guarantees are in place if the municipality of Diadema breaches its agreement with us.  

The receivables owed to us by Mauá and Diadema total R$85.9 million and R$60.3 million, and have not been recognized in our financial statements due to the uncertainty of our ability to collect them, as of December 31, 2013.  For further information on these matters, see Note 8 to our financial statements included elsewhere in this annual report.  Despite these developments, we currently supply water on a wholesale basis to both Diadema and Mauá.

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We currently do not anticipate that other municipalities will seek to terminate concessions due to our close relationship with municipal governments, recent improvements in the water and sewage services we provide, and the obligation of the municipality to repay us for the return of the concession.  However, we cannot be certain that other municipalities will not seek to terminate their concessions in the future.  See “Item 3.D. Risk Factors—Risks Relating to Our Business—The municipalities may terminate our concessions before they expire in certain circumstances.  The indemnification payments we receive in such cases may be less than the value of the investments we made.”  

In addition, we are currently involved in litigation with respect to municipalities that intend to expropriate our water and sewage systems, or to terminate concession agreements before paying us any indemnification.  For a detailed discussion on these proceedings, see “Item 8.A. Financial Information—Financial Statements and Other Financial Information—Legal Proceedings.”

Operations in the City of São Paulo and Certain Metropolitan Regions

As of December 31, 2013, 61 concessions had expired which jointly accounted for 16.1% of our gross revenues.  We entered into seven agreements in the year ended December 31, 2013, bringing the total number of agreements entered into between 2007 and 2013 to 266.  These seven new agreements accounted for 1.2% of our total revenues and 1.6% of our intangible assets as of December 31, 2013.

On June 23, 2010 the State and the City of São Paulo executed an agreement in the form of a convênio, to which we and ARSESP consented, under which they agreed to manage the planning and investment for the basic sanitation system of the city of São Paulo on a joint basis.  The principal terms of this convênio  were as follows:

·                     The State and the City of São Paulo would execute a separate agreement with us, granting us exclusive rights to provide water and sewage services in the city of São Paulo.

·                     ARSESP would regulate and oversee our activities regarding water and sewage services in the city of São Paulo, including tariffs.

·                     A management committee (Comitê Gestor) would be responsible for planning water and sewage services for the city and for reviewing our investment plans.  The management committee consists of six members appointed for two-year terms.  The State and the City of São Paulo have the right to appoint three members each.  We may participate in management committee meetings but may not vote.

In application of the convênio, we executed a separate contract with the State and the city of São Paulo, also dated June 23, 2010, to regulate the provision of these services for the following 30 years.  The principal terms of this contract are as follows:

·                     The total investment stated in the contract must be equal to 13% of gross revenues from the provision of services to the city of São Paulo, net of the taxes on revenues, which total approximately R$600 million per year. 

·                     We must transfer 7.5% of the gross revenues we derive under the convênio, and subtract (i) COFINS and PASEP taxes, and (ii) unpaid bills of publicly owned properties in the city of São Paulo, to the Municipal Fund for Environmental Sanitation and Infrastructure (Fundo Municipal de Saneamento Ambiental e Infraestrutura),  established by Municipal Law No. 14,934/2009.  In April 2013, ARSESP postponed the application of such municipal charges until the conclusion of the tariff revision process, based on a request from the São Paulo State Government to analyze, among other things, methods to reduce the impact on consumers.

·                     Our investment plan must be compatible with the sanitation plans of the State, the City of São Paulo and, if necessary, the Metropolitan region.

·                     ARSESP will ensure that the tariffs will adequately compensate us for the services we provide and that tariffs may be adjusted in order to restore the original balance between each party’s obligations and economic gain (equilíbrio econômico‑financeiro). 

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We currently have an investment plan in place that reflects these obligations and addresses their compatibility with the sanitation plans for the 363 municipalities in which we operate, that include, the City of São Paulo and, if necessary, the Metropolitan region.  The investment plan is not irrevocable and will be reviewed by our management committee every four years, particularly with respect to the investments to be executed in the subsequent period.

Wholesale Operations

Wholesale Water Services

We provide water services on a wholesale basis to six municipalities located in the São Paulo metropolitan region (Diadema, Mauá, Santo André, São Caetano do Sul, Guarulhos and Mogi das Cruzes).  Agreements to provide water services on a wholesale basis must comply with the Basic Sanitation Law, which designates these services as “interdependent activities” and regulates each stage of the service.  The law requires that the service be supervised by an independent agency, stipulates registration of the cost of the service, and requires assurance of payment among the several service providers in order to continue the provision of the services, in accordance with the rules to be published by ARSESP.  Our agreements currently comply with the provisions of the Basic Sanitation Law.  In 2013, the revenues from wholesale water services were R$208.7 million.  For further information, see “Regulation of Concessions” above.

Wholesale Sewage Services

We provide sewage services on a wholesale basis to the municipalities of Mogi das Cruzes, Santo André, São Caetano, Mauá and Diadema.  Our agreement with Santo André for these services was executed with the intervention of the Public Prosecution Office.  Our agreements with the other municipalities resulted from our environmental efforts and municipal authorities’ awareness of environmental issues.  Through these agreements, in 2013 we treated approximately 38 million cubic meters of sewage from these municipalities.  We believe this illustrates our commitment to social and environmental responsibility.  In 2013, our revenues from wholesale sewage services were R$26.1 million.

In December 2008, we entered into a five‑year agreement for the collection and treatment of 20% of the sewage generated by the city of Guarulhos.  We have not yet started to provide these services, and such services will only commence when the works on linking the Guarulhos sewage to our sewage system are finalized.  These works are the responsibility the Guarulhos sanitation company.

Description of Our Activities

As set forth in Article 2 of our bylaws, we are permitted to render basic sanitation services with the goal of providing basic sanitation services to the entire population in the municipalities where we conduct our activities without harming our long‑term financial sustainability.  Our activities comprise water supply, sanitary sewage services, urban rainwater management and drainage services, urban cleaning services, solid waste management services and related activities, including the planning, operation, maintenance and commercialization of energy, and the commercialization of services, products, benefits and rights that directly or indirectly arise from our assets, operations and activities.  We are allowed to act in a subsidiary form in other Brazilian locations and abroad.  See “—Government Regulation—Public Consortia and Cooperation Agreement Law for Joint Management.”  For a description of our operating segments please see Note 23 to our financial statements as of and for the year ended December 31, 2013.

Operating segments are presented in our annual report in a manner consistent with the internal reporting provided to management, comprised of the board of directors and the board of executive officers, pursuant to IFRS 8.  Under Brazilian GAAP, prior to our conversion to IFRS, the financial information for construction services was not separately presented and construction costs related to concessions were capitalized within property, plant and equipment. As a result, our management did not review the results of this business. Following our conversion to IFRS, our management decided to continue to exclude the construction results from the management reporting of our revenues and expenses, thus not basing his decisions on discrete financial information for that business.  The characteristics described in paragraph 5(b) of IFRS 8 for separate operating segments are thus not fulfilled for this particular business. Nonetheless, after our conversion to IFRS and for IFRS financial statement purposes only, we started to record such results separately as construction revenue and costs under IFRIC 12.  Although such information is available discretely, however, it is not analyzed by our management as such and is not the basis for operational decisions.

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We set forth below a description of our activities.

Water Operations

Our supply of water to our customers generally involves abstraction of water from various sources, subsequent treatment and distribution to our customers’ premises.  In 2013, we produced approximately 3,053 cubic meters of water.  The São Paulo metropolitan region (including the municipalities to which we supply water on a wholesale basis) currently is, and has historically been, our core market, accounting for approximately 66% of water invoiced by volume in 2013.

 

The following table sets forth the volume of water that we produced and invoiced for the periods indicated.

 

Year ended December 31,

 

2013

2012

2011

 

(in millions of cubic meters)

Produced:

 

 

 

São Paulo metropolitan region

2,220.6

2,235.3

2,182.8

Regional systems

832.0

823.5

809.2

Total

3,052.6

3,058.8

2,992.0

 

 

 

 

Invoiced:

 

 

 

São Paulo metropolitan region

1,206.9

1,181.9

1,150.6

Wholesale

299.0

297.5

297.3

Regional systems

628.1

614.0

596.8

Reused water

0.4

0.4

0.3

Effluents

14.7

-

-

Total

2,149.1

2,093.8

2,045.0

 

The difference between the volume of water produced and the volume of water invoiced generally represents both physical and non‑physical water loss.  See “—Water Loss” below.  In addition, we do not invoice:

·                     water discharged for periodic maintenance of water transmission lines and water storage tanks;

·                     water supplied for municipal uses such as firefighting;

·                     water consumed in our own facilities; and

·                     estimated water loss associated with water we supply to favelas (shantytowns). 

Seasonality

Although seasonality does not affect our results in a significant way, in general, higher water demand is observed during the summer and lower water demand during the winter.  The summer coincides with the rainy season, while the winter corresponds to the dry season.  The demand in the coastal region is increased by tourism, with the greatest demand occurring during the Brazilian summer holiday months.

Water Resources

We can abstract water only to the extent permitted by DAEE pursuant to water usage rights granted by it.  Depending on the geographic location of the river basin or if the river crosses more than one state (federal domain), the approval of the National Water Agency (Agência Nacional de Águas), or ANA, a federal agency under the Ministry of the Environment is required.  We currently abstract substantially all of our water supply from rivers and reservoirs, with a small portion being abstracted from groundwater.  Our reservoirs are filled by impounding water from rivers and streams, by diverting the flow from nearby rivers, or by a combination of both methods. For more information on water usage regulation, see “—Water Usage” below.

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In order to supply water to the São Paulo metropolitan region, we rely on 20 reservoirs of non‑treated water and 405 reservoirs of treated water, which are located in the areas under the influence of the eight water producing systems comprising the interconnected water system of the São Paulo metropolitan region.  The capacity of the water sources available for treatment in this area is 72 cubic meters per second.  Total current installed capacity is 73.2 cubic meters per second, which can be treated from the interconnected water system of the São Paulo metropolitan region.  Average verified production during 2013 on the interconnected water system of the São Paulo metropolitan region was 69.1 cubic meters per second.  The Cantareira, Guarapiranga and Alto Tietê systems, as a whole, supplied 84.3% of the water we produced for the São Paulo metropolitan region in 2013.

In 2013, the Cantareira system accounted for 47.1% of the water that we supplied to the São Paulo metropolitan region (including the municipalities to which we supplied water on a wholesale basis), which represented 73.2% of our gross operating revenues (excluding revenues relating to the construction of concession infrastructure) for the year.  The Cantareira System usage rights grant was renewed in 2004 and will expire in August 2014.  We are working to renew this grant for a period of 30 years and to maintain the current withdrawal basin condition which is of 33 m³/s.  Due to current climate conditions, particularly the strong drought, next steps in the renewal process are temporarily suspended.  For further information on droughts see “Item 3.D Risk Factors—Risks Relating to Our Business—Droughts, the water consumption reduction program or other measures may result in a significant decrease in the volume of water billed and the revenues from services we provide, which may have a material adverse effect on our company.”

Water basin committees are authorized to charge both for water usage and the dumping of sewage into water bodies.  We participate in the decentralized and integrated management of water resources established by the National Policy on Water Resources. We are represented by 150 employees on the 21 Committees on State Water Basins, on the four Federal Committees that act in the State of São Paulo and in the National and State Councils on Water Resources. In 2013, the State Committees and part of the Federal Committees renewed their management for the next two years, and we kept our representation.

The following table sets forth the water production systems from which we produce water for the São Paulo metropolitan region:

 

Production Rate(1)

 

2013

2012

2011

Water production system:

(in cubic meters per second)

Cantareira

32.6

32.7

31.5

Guarapiranga

13.6

13.7

12.6

Alto Tietê

12.1

12.4

13.0

Rio Claro

4.8

3.7

4.0

Rio Grande (Billings reservoir)

3.9

4.7

4.6

Alto Cotia

1.2

1.2

1.2

Baixo Cotia

0.8

0.9

0.9

Ribeirão da Estiva

0.1

0.1

0.1

Total

69.1

69.4

67.9

 

______________

(1)   Average of the twelve months ended December 31, 2013, 2012 and 2011.

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We own all of the reservoirs in our production systems other than the Guarapiranga and Billings reservoirs and a portion of some of the reservoirs of the Alto Tietê system, which is owned by other companies controlled by the State.  We currently do not pay any charges with respect to the use of these reservoirs.  In December 2001, we entered into an agreement with the State whereby the State, among other things, agreed to transfer the remaining reservoirs in the Alto Tietê system to us.  We accepted, on a temporary basis, the reservoirs in the Alto Tietê System as part of the payment until the State transfers the property rights with respect to the reservoirs to us.  We are unable to assure you whether and when these reservoirs will be transferred to us because the Public Prosecution Office of the State of São Paulo filed a civil public action alleging that a transfer to us of ownership of the Alto Tietê System reservoirs is illegal.

In January 2009, we began operating, monitoring and maintaining the reservoirs in the Alto Tietê system, formed by the Ponte Nova, Paraitinga, Biritiba, Jundiaí and Taiaçupeba reservoirs.  In the cities of the interior region of São Paulo, our principal source of water consists of surface water from nearby rivers and from wells.  The coastal region is provided with water principally by surface water from rivers and mountain springs.

Statewide, we estimate that we are able to supply nearly all of the demand for water in all of the areas where we operate, subject to droughts and extraordinary climate events.  We were able to meet the demand for water in the São Paulo metropolitan region, primarily as a result of our water conservation program, reductions in water loss, and the installation of new water connections.  We installed 226,421, 212,775 and 207,840 new water connections in 2013, 2012 and 2011, respectively.

The interconnected water system of the São Paulo metropolitan region serves 30 municipalities, of which 24 are operated directly by us under this system.  Through this system, we serve the other six municipalities on a wholesale basis, and the distribution is made by other companies or departments related to each municipality.

In order to reach the final customer, the water is stored and transported through a complex and interconnected system.  This water system requires permanent operational supervision, engineering inspection, maintenance, and quality monitoring and measurement control.

To ensure the continued provision of regular water supply in the São Paulo metropolitan region, we intend to invest R$4.5 billion (including the investment in the São Lourenço PPP) from 2014 to 2018 to increase our water production and distribution capacities as well as to improve the water supply systems.  In 2013, our total investment in water supply systems amounted to R$1.1 billion.

Water Treatment

We treat all water at our water treatment facilities prior to placing it into our water distribution network.  We operate 232 treatment facilities, of which the eight largest, located in the São Paulo metropolitan region, account for approximately 73% of all water we produced in 2013.  The type of treatment used depends on the nature of the source and quality of the untreated water.  Water abstracted from rivers requires extensive treatment, while water drawn from groundwater sources requires less treatment.  All water treated by us also receives fluoridation treatment.

Water Distribution

We distribute water through our own networks of water pipes and water transmission lines, ranging in size from 2.5 meters to 75 millimeters in diameter.  Storage tanks and pumping stations regulate the volume of water flowing through the networks to maintain adequate pressure and continuous water supply.  The following table sets forth the total number of kilometers of water pipes and water transmission lines and the number of connections in our network as of the dates indicated.

 

As of December 31,

 

2013

2012

2011

Water distribution pipes and water transmission lines (in kilometers)

69,619

67,647

66,389

Number of connections (in thousands)

7,888

7,679

7,481

 

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More than 90% of the water pipes in our water distribution network are made of cast iron or polyvinylchloride, or PVC.  Distribution pipes at customers’ residences typically are made from high‑density polyethylene tubing.  Our water transmission lines are mostly made of steel, cast iron or concrete.

As of December 31, 2013, our water distribution pipes and water transmission lines included:  (i) 36,334 kilometers in the São Paulo metropolitan region; and (ii) 33,285 kilometers in the Regional systems.

As of December 31, 2013, we had 405 storage tanks in the São Paulo metropolitan region with a total capacity of 2 million cubic meters, and 1,879 storage tanks in the Regional systems.  As of that date, we had 126 treated water pumping stations in the São Paulo metropolitan region aqueduct system, including stations at treatment facilities, intermediate trunk transfer pumping stations and small booster stations serving local areas.

Water transmission lines that require maintenance are cleaned and their lining is replaced.  We are typically notified of water main fractures or breaks by the public through a toll‑free number maintained by us.  We consider the condition of the water pipes and water transmission lines in the São Paulo metropolitan region to be adequate as of the date of this annual report.  Due to age, external factors such as traffic, the dense population, and commercial and industrial development, water pipes and water transmission lines in the São Paulo metropolitan region are somewhat more susceptible to degradation than those in the Regional systems.  To counter these effects, we have a maintenance program in place for water pipes and water transmission lines that is intended to address anticipated fractures and clogs due to brittleness and encrustation, and to help ensure water quality in the region.  The new customers are responsible for covering part of the costs of connecting to our water distribution network that is related to the connection of customers water pipes that are more than 20 meters away from the water transmission lines.  Thereafter, the customer must cover the costs of connecting to the network from the customer’s premises, including costs of purchasing and installing the water meter and related labor costs.  We perform the installation of the water meter and conduct periodical inspections and measurements.  After completion of installation, the customer is responsible for the water meter.

The following table sets forth projected new water connections for the periods indicated.

 

in thousands

 

2014

2015

2016

2017

2018

2019

2020

2014
‑ 2020

São Paulo metropolitan region

103

99

94

85

84

76

76

617

Regional systems

77

78

78

79

80

82

82

556

Total

180

177

172

164

164

158

158

1,173

 

Water Loss

The difference between the amount of water produced and the amount of water invoiced generally represents both physical and non‑physical water loss.  The Non-Revenue Water Index represents the quotient of (i) the difference between (a) the total amount of water produced by us less (b) the total amount of water invoiced by us to customers minus (c) the volume of water set out below that we exclude from our calculation of water loss, divided by (ii) the total amount of water produced by us. 

We exclude the following from our calculation of water loss:  (i) water discharged for periodic maintenance of water transmission lines and water storage tanks; (ii) water supplied for municipal uses such as firefighting; (iii) water we consume in our facilities; and (iv) estimated water loss associated with water we supply to favelas (shantytowns). 

Among the principal indicators utilized to measure rates of water loss are the following:

·                     Non-Revenue Water (NRW),  in %;

·                     Water Loss Index (based on metered consumption) (WLI); and

·                     Index of total loss per connection, (TLDC) in liters/connection per day.

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These indicators are calculated by applying the following formulas:

Vproduced – (Vbilled + Vused)
NRW  = ______________________________________
                                Vproduced

Vproduced – (Vmicromeasured + Vused)
WLI  = _____________________________________________________
                                             Vproduced

Vproduced – (Vmicromeasured + Vused)
TLDC  = _____________________________________________________
                                Nconnection x  No. of days of a given period

Where:

Vproduced:  corresponds to the volume of water produced at a given period;

Vbilled:  corresponds to the volume of water billed at a given period;

Vmicromeasured:  corresponds to the volume of water micromeasured at a given period;

Vused:  corresponds to the volume of water used for operational, public, private and social needs (supply shantytown areas) at a given period; and

Nconnections:  corresponds to the average number of active water connections.

Since 2005, we have used a method of measuring our water loss based on worldwide market practice for the industry.  According to this measurement method, average water loss is calculated by dividing (i) average annual water loss by (ii) the average number of active water connections multiplied by the number of days of the year The result of this calculation is the number of liters of water lost per connection per day.

Using this calculation method, as of December 31, 2013, we experienced 446 liter/connection per day of water loss in the São Paulo metropolitan region and 261 liter/connection per day in the Regional systems, averaging 372 liter/connection per day.  We plan to reduce total water loss to around 280 liters/connection, Non-Revenue Water to 18% by 2020 and the Water Loss Index to 25.7% by 2020.

Our strategy to reduce water loss has two approaches:

·                     reduction in the level of physical loss, which results mainly from leakage. To this end we are primarily replacing and repairing water transmission lines and pipes, and installing probing and other equipment, including strategically located pressure‑regulating valves; and

·                     reduction of non‑physical loss, which results primarily from the inaccuracy of our water meters installed at our customers’ premises and at our water treatment facilities, and from clandestine and illegal use. To this end we are upgrading and replacing inaccurate water meters and expanding our anti‑fraud personnel.

We are taking measures to decrease physical loss by reducing response time to fix leakages and by better monitoring non‑visible water transmission lines fractures.  Among other initiatives, we have adopted the following measures to reduce physical water loss:

·                     the introduction of technically advanced valves to regulate water pressure throughout our water  transmission lines in order to maintain appropriate water pressure downstream.  These valves are programmed to respond automatically to variations in demand.  During peak usage, the flow of water in the pipes is at its highest point; however, when demand decreases, pressure builds up in the water transmission lines and the resulting stress on the network can cause significant water loss through cracks and an increase in ruptures of the pipes.  The technically advanced valves are equipped with probes programmed to feed data to the valve in order to reduce or increase pressure to the water transmission lines as water usage fluctuates.  As of December 31, 2013, we had installed 1,912 valves at strategic points in the network, with 1,141 valves being installed in the São Paulo metropolitan region and 771 in the Regional systems;

45


 
 

 

·                     the reconfiguration of interconnected water distribution to permit the distribution of water at lower pressure;

·                     the implementation of routine operational leak detection surveys in high water pressure areas to reduce overall water loss;

·                     the monitoring of and improved accounting with respect to water connections, especially for large volume customers;

·                     regular checking on inactive customers and monitoring non‑residential customers that are accounted for as residential customers and, therefore, billed at a lower rate;

·                     preventing fraud with the use of new, more sophisticated water meters that are more accurate and less prone to tampering;

·                     installing water meters where none are present; and

·                     conducting preventive maintenance of existing and newly installed water meters.

Water Quality

We believe that we supply high quality treated water that is consistent with standards set by Brazilian law, which are similar to the standards set in the United States of America and Europe.  Pursuant to the Brazilian Ministry of Health (Ministério da Saúde) regulations, we have significant statutory obligations regarding the quality of treated water.  These laws set certain standards that govern water quality.

In general, the State of São Paulo has excellent water quality from underground or surface water sources.  However, high rates of population growth, increased urbanization and disorganized occupation of some areas of the São Paulo metropolitan region has reduced the quantity and quality of water available to serve the population in the southern area of the São Paulo metropolitan region and in the coastal region.  Currently, we successfully treat this water to make it potable.  We also work to recover the quality of water of water transmission lines and invest in improvements of our treatment systems to ensure the quality and availability of water for the upcoming years.

Water quality is monitored at all stages of the distribution process, including at the water sources, water treatment facilities and on the distribution network.  We have 15 regional laboratories, one central laboratory, and laboratories located in all water treatment facilities that monitor water quality, as required by our standards and those set by statute.  Our laboratories analyze an average of 50,000 samples per month on distributed water, with samples collected from residences.  Our central laboratory located in the city of São Paulo is responsible for organic compound analysis using the chromatographic and spectrometric methods, as well as heavy metals analysis by atomic absorption technique.  All of our laboratories have obtained the ABNT NBR ISO 9001 certification and our central laboratory and 12 of our regional laboratories have obtained the ABNT NBR ISO IEC 17025 accreditation (accreditation for general requirements for the competence of testing and calibration laboratories) awarded by the INMETRO.

All chemical products used for water treatment are analyzed and follow strict specifications set out in recommendations made by the National Health Foundation (Fundação Nacional de Saúde), or NHF, the Brazilian Association of Technical Rules (Associação Brasileira de Normas Técnicas), or the ABNT, and the American Water Works Association, to eliminate toxic substances that are harmful to human health.  From time to time, we face problems with the proliferation of algae, which may cause an unpleasant taste and odor in the water.  In order to mitigate this problem, we work on:  (i) fighting algae growth at the water source and (ii) using advanced treatment processes at the water treatment facilities, which involve the use of powdered activated carbon and oxidation by potassium permanganate.  The algae growth creates significant additional costs for water treatment because of the higher volumes of chemicals used to treat the water.  In 2013, we did not detect significant algae growth.  We participate in Mananciais/New Life, together with other organizations engaged in the promotion of urban development and social inclusion to mitigate the pollution problem in the São Paulo metropolitan region.  In addition, we also participate in the Clean Stream Program to clean up important streams in the city of São Paulo.  Other initiatives also aimed at improving the water quality in our water sources located in the metropolitan region of São Paulo are Nossa Guarapiranga and Pró-Conexão.  See “—Main Projects of Our Capital Expenditure Program—Metropolitan Water Program—Mananciais/New Life Program,” “—Clean Stream Program,” and “—New Policies and Programs—Nossa Guarapiranga.” 

46


 
 

 

We believe that there are no material instances where our standards are not being met.  However, we cannot be certain that future breaches of these standards will not occur.

Fluoridation

As required by Brazilian law, we have adopted a water fluoridation program designed to assist in the prevention of tooth decay among the population.  Fluoridation primarily consists of adding fluorosilicic acid to water at 0.7 parts per million.  We add fluoride to the water at our treatment facilities prior to its distribution into the water supply network.

Sewage Operations

We are responsible for the collection, removal, treatment and final disposal of sewage.  As of December 31, 2013, we collected approximately 87% and 77% of all the sewage produced in the municipalities in which we operate in the São Paulo metropolitan region and in the Regional systems, respectively.  During 2013, we collected approximately 84% of all the sewage produced in the municipalities in which we operated in the State of São Paulo.  We installed 236,647, 240,687 and 246,441 new sewage connections in 2013, 2012 and 2011, respectively.

Sewage System

The purpose of our sewage system is to collect and treat sewage and to adequately dispose of the treated sewage.  As of December 31, 2013, we were responsible for the operation and maintenance of 47,103 kilometers of sewage lines, of which approximately 25,085 kilometers are located in the São Paulo metropolitan region and 22,018 kilometers are located in the Regional systems, respectively.

The following table sets forth the total number of kilometers of sewage lines and the total number of sewage connections in our network for the periods indicated.

 

As of December 31,

 

2013

2012

2011

Sewage lines (in kilometers)

47,103  

45,778

45,073

Sewage connections (in thousands)

6,340

6,128

5,921

 

Our sewage system comprises a number of systems built at different times and constructed primarily from clay pipes and, more recently, PVC tubing.  Sewage lines larger than 0.5 meters in diameter are primarily made of concrete.  Our sewage system is generally designed to operate by gravitational flow, although pumping stations are required in certain parts of the system to ensure the continuous flow of sewage.  Where pumping stations are required, we use sewage lines made of cast iron.

The public sewage system operated by us was structured in order to receive, in addition to household effluents, a portion of non-domestic effluents (such as industrial sewage and sewage from other non‑domestic sources) for treatment together with household effluents.  Non-domestic effluents have characteristics that are qualitatively and quantitatively different from household effluents.  As a result, the discharge of non-domestic effluents into the public sewage system is subject to compliance with specific legal demands with the purpose of protecting the sewage collection and treatment systems, the health and safety of operators and the environment.  The current environmental legislation establishes standards for the discharge of these effluents into the public sewage system and stipulates that such effluents be subject to pre-treatment.  These standards are defined in State Decree No. 8,468 dated September 8, 1976, as amended. 

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Before the discharge is permitted, we carry out acceptance studies that assess the capacity of the public sewage system to receive the discharge as well as the compliance with regulations.  Upon the conclusion of these studies, the technical and commercial conditions for receiving the discharge are established, which are then formalized in a document signed by us and the effluent producer.  Failure to comply with these conditions can lead to the application of penalties by us.  In extreme cases, the environmental protection agency (Companhia Ambiental do Estado de São Paulo), or CETESB, is notified in order for the applicable measures to be taken.  Effluents from our treatment facilities must comply with limitation guidelines for release of effluents into receiving water bodies.  Additionally, the quality of the water in the receiving water body must not be impaired by the release of such effluents, as established by State Decree No. 8,468/76 and Conama Resolutions 357/2005 and 430/2011.

We considered the condition of the sewage lines in the São Paulo metropolitan region to be adequate as of the date of this annual report.  Due to a greater volume of sewage collected, a higher population and more extensive commercial and industrial development, the sewage lines in the São Paulo metropolitan region are more deteriorated than those of the Regional systems.  To counter the effects of deterioration, we maintain an ongoing program for the maintenance of sewage lines intended to address anticipated fractures arising from obstructions caused by system overloads.

Unlike the São Paulo metropolitan region, the interior region of São Paulo State does not generally suffer obstructions caused by sewage system overload.  The coastal region, however, experiences obstructions in its sewage lines primarily due to infiltration of sand, especially during the rainy season in the summer months.  In addition, the sewage coverage ratio in the coastal region is lower than in the other regions served by us, with approximately 60% of all residences in the coastal region currently connected to our sewage network as of December 31, 2013.

New sewage connections are made on substantially the same basis as connections to water lines:  we assume the cost of installation for the first 20 meters of sewage lines from the sewage network to all customers’ sewage connections and the customer is responsible for the remaining costs.

The following table sets forth projected new sewage connections for the periods indicated.

 

2014

2015

2016

2017

2018

2019

2020

2014-2020

São Paulo metropolitan region

124

135

135

125

117

105

121

862

Regional systems

111

111

108

118

118

123

101

790

Total

235

246

243

243

235

228

222

1,652

 

 

Sewage Treatment and Disposal

In 2013, approximately 68% and 95% of the sewage we collected in the São Paulo metropolitan region and the Regional systems, respectively, or 78% of the sewage we collected in the State of São Paulo, was treated at our treatment facilities and afterwards discharged into receiving water bodies such as rivers and the Atlantic Ocean, in accordance with applicable legislation.  Though we have not yet reached universalization of sewage collection and treatment services in the regions were we operate, we are making efforts to reach this goal.

We currently operate 500 sewage treatment facilities and 9 ocean outfalls, of which the five largest, located in the São Paulo metropolitan region, have treatment capacity of approximately 18 cubic meters of sewage per second.

In the São Paulo metropolitan region, the treatment process used by most treatment facilities is the activated sludge process. 

Sewage treatment in the Regional systems will vary according to the particularities of each area. In the interior region of São Paulo State, treatment consists largely of stabilization ponds. There are 407 secondary treatment facilities in the interior region of São Paulo State that have treatment capacity of approximately 14 cubic meters of sewage per second. The majority of sewage collected in the coastal region receives treatment and disinfection and is then discharged into rivers and also into the Atlantic Ocean through our ocean outfalls, in accordance with applicable legislation.  We have 74 sewage treatment facilities in the coastal region.

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 We are a party to a number of legal proceedings related to environmental matters.  See “Item 8.A. Financial Information—Financial Statements and Other Financial Information—Legal Proceedings.”  In addition, our capital expenditure program includes projects to increase the amount of sewage that we treat.  See “Item 4.A. History and Development of the Company—Capital Expenditure Program” and “4.B Business Overview—Government Regulation—Environmental Regulation—Sewage Requirements.”

Sludge Disposal

The creation of sludge is inherent to the sanitation cycle.  The treatment of water and sewage produces residue which needs to be disposed of appropriately to prevent harm to the environment.  Sludge removed from the treatment process typically contains water and a very small proportion of solids.  We use filter presses, belt presses, drying beds and centrifugation machines, among other processes, to abstract the water from the sludge.

Currently, the sludge generated through our activity goes mainly to landfills. In turn, we treat the slurry generated in these landfills.

Current legislation and the population at large demand advances in the search for alternative technologies that minimize the generation of and find beneficial uses for sludge.  In light of these demands, we work on several fronts, seeking innovative approaches to the destination and final disposal of sludge. 

Part of the R$6.4 million invested in research and development in 2013 was used for approached to the disposal and beneficial use of sludge, in order to meet the Principles for Cleaner Production.  Our partnerships with the Brazilian Innovation Agency (FINEP) and the São Paulo State Foundation for Research Support (Fapesp) cover projects to use of sludge to help recover of degraded areas, cover landfills and yield sand for construction works.  

Sludge disposal must comply with State and Federal law requirements, such as Resolution No. 375 of August 29, 2006 of the CONAMA, Federal Law No. 12,305/2010, Federal Decree No. 7,404/2010, State Law No. 12,300/2006 and State Decree No. 54,645/2009.

Principal Markets in Which We Operate

As of December 31, 2013, we operated water and sewage systems in 363 of the 645 municipalities in the State of São Paulo.  In addition, we currently supply water on a wholesale basis to six municipalities located in the São Paulo metropolitan region with an urban population of approximately 3.5 million.

The following table provides a breakdown of gross revenues from water supply and sewage services by geographic market for the periods indicated.

Year ended December 31,

 

2013

2012

2011

 

(in millions of R$)

São Paulo metropolitan region

6,984.4

6,625.0

6,144.7

Regional systems

2,555.7

2,301.7

2,160.4

Total

9,540.1

8,926.7

8,305.1

 

 

The following table provides a breakdown of gross revenues from water supply and sewage services by category of activity for the periods indicated.

 

Year ended December 31,

 

2013

2012

2011

 

(in millions of R$)

Water supply

5,276.1

4,944.2

4,607.2

Sewage services

4,264.0

3,982.5

3,697.9

Total

9,540.1

8,926.7

8,305.1


 
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Competition

In the State of São Paulo, there are approximately 276 municipalities that operate their own water and sewage systems and that collectively have a total population of approximately 13.7 million, or approximately 31% of the population of the State of São Paulo, excluding the population of the municipalities to which we provide water services on a wholesale basis.

The competition for municipal concessions arises mainly from the municipalities, as they may resume the water and sewage services that were granted to us and start providing these services directly to the local population.  In this case, the municipal governments would be required to indemnify us for the unamortized portion of our investment.  See “—Our Operations—Regulation of Concessions.”  In the past, municipal governments have terminated our concessions agreements before the expiration date.  Furthermore, municipal governments have tried to expropriate our assets in an attempt to resume the provision of water and sewage services to local populations.  See “Item 8.A. Financial Information—Financial Statements and Other Financial Information—Legal Proceedings.” We negotiate expired concession agreements and concession agreements close to expiration with the municipalities in an attempt to maintain our existing areas of operations.  In the State of São Paulo we face competition from private and municipal water and sewage service providers.

In recent years, we have also experienced an increasing level of competition in the market of water supply to large customers.  Several large industrial customers located in municipalities served by us use their own wells to supply themselves with water.  In addition, competition for the disposal of non‑residential, commercial and industrial sludge in the São Paulo metropolitan region has increased in recent years as private companies offer stand‑alone solutions inside the facilities of their customers.  We have also established new tariff schedules for commercial and industrial customers in order to assist us in retaining these customers.  For this group of customers, we have a special authorization from ARSESP to establish different tariffs than the ones that agency establishes for regular consumers.

Billing Procedures

The procedure for billing and payment of our water and sewage services is largely the same for all customer categories.  Water and sewage bills are based upon water usage determined by monthly water meter readings.  Larger customers, however, have their meters read every 15 days to avoid non‑physical loss resulting from faulty water meters.  Sewage billing is included as part of the water bill and is based on the water meter reading.

The majority of the bills for water and sewage services are delivered to our customers in person, mainly through one of our employees or through independent contractors who are also responsible for reading water meters.  The remainder, by judicial determination, is sent by mail.  Water and sewage bills can be paid at some banks and other locations in the State of São Paulo.  These funds are paid over to us after deducting average banking fees ranging from R$0.29 to R$1.21 per transaction for collection and remittance of these payments.

Customers must pay their water and sewage bills by the due date if they wish to avoid paying a fine.  We generally charge a penalty fee and interest on late bill payments.  In 2013, 2012 and 2011, we received payment of 95.2%, 94.7% and 94.8%, respectively, of the amount billed to our retail customers, and 95.0%, 95.5% and 94.7%, respectively, of the amount billed to those customers other than State entities, within 30 days after the due date.  In 2013, 2012 and 2011, we received 100.5%, 100.7% and 96.0%, respectively, of the amount billed to the State entities.  Amounts in excess of 100.0% reflect our recovery of amounts billed in prior years.  With respect to wholesale supply, in 2013, 2012 and 2011, we received payment of 45.8%, 50.1% and 54.7%, respectively, of the amount billed within 30 days.

We monitor water meter readings by use of hand‑held computers and transmitters.  The system allows the meter reader to input the gauge levels on the meters into the computer and automatically print the bill for the customer.  The hand‑held computer tracks water consumption usage at each metered location and prepares bills based on actual meter readings.  Part of the water meter monitoring for billing purposes is carried out by our own personnel, trained and supervised by us, and part of it is carried out by third‑party contractors that employ and train their own personnel whose training we supervise.

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Tariffs

Tariff adjustments follow the guidelines established by the Basic Sanitation Law and ARSESP.  The guidelines also establish procedural steps and the terms for the annual adjustments.  The adjustments have to be announced 30 days prior to the effective date of the new tariffs, which used to take effect in September.  Pursuant to the most recent tariff revision, both the base date and future adjustments will now take place in April.

Tariffs have historically been adjusted once a year and for periods of at least 12 months.  See “—Government Regulation—Tariff Regulation in the State of São Paulo” for additional information regarding our tariffs.

With the publication of the Basic Sanitation Law, the regulation of basic sanitation services, including tariff regulation, became the responsibility of an independent regulator.  To exercise this assignment, the State of São Paulo created ARSESP, which regulates and supervises the services we provide to the State and also to the municipalities that have agreed to its jurisdiction through a cooperation agreement.

In regards to municipalities that have not explicitly selected ARSESP as their regulator, the Basic Sanitation Law allows the municipality to create other regulatory agencies of their own.  In 2007, the municipality of Lins decided to create its own regulatory authority, although it revised this decision in 2010, transferring to ARSESP the regulation of the water activities performed in Lins, including for the setting of tariffs.  The municipality of Lins has reserved, however, the power to ultimately approve the tariff set by ARSESP.   

In addition, in 2011 municipalities in which the hydrographic basins of the Piracicaba, Capivari and Jundiaí rivers are located created a consortium (ARES/PCJ) for the regulation and supervision of our activities in those areas. As a result of the creation of the ARES/PCJ, we are currently involved in legal proceedings in which ARES/PCJ is claiming that it has jurisdiction over the regulation and supervision of our activities in two municipalities (Piracicaba and Mombuca). In the municipality of Piracaia, ARSESP is the entity responsible for applying the state tariff policy (Decree 41,446/96) which is in force due to an existing concession agreement. In the municipality of Mombuca, the regulation and supervision of basic sanitation services was delegated to the State of São Paulo, so that ARSESP could exclusively execute these services. We cannot predict the outcome of this case or how it may impact our business.  See” Risk Factor – Risk Relating to Our Business - Current regulatory uncertainty, especially with regard to implementation and interpretation of the Brazilian Basic Sanitation Law, may have an adverse effect on our business.” 

In 2012 and 2011, we readjusted our prices by 5.15% and 6.83% starting on September 11, 2012 and on September 11, 2011, respectively. On April 22, 2013, ARSESP approved a preliminary tariff rate of 2.3509% to be applied equally on all customer tariffs. These adjustments were valid for all municipalities served by us, except for the municipalities of Lins and Magda, which have different rules and readjustment dates.  We adjusted the tariffs in the municipality of São Bernardo do Campo pursuant to a different methodology due to the difference between the tariffs charged in that municipality when we assumed the service and the tariffs we were charging in other metropolitan municipalities we serve.  The adjustments in São Bernardo do Campo were set so that in September 2012 the tariff charged in this municipality and the tariff charged in the other municipalities of the region became the same. Since then, the tariff adjustments in this municipality follow the adjustment calendar of the São Paulo metropolitan region. With respect to the municipality of Lins, we adjust our tariff in January according to the variation of the IPCA for the last twelve‑month period ended November 30.  In Magda, the tariffs will equal the tariffs in the region by July 2014.  In the municipalities of Glicério and Torrinha, the tariffs will equal the tariffs in the region in 2017.

On November 1, 2013, ARSESP issued Resolution No. 435 which authorizes us to implement a tariff adjustment. Initially, this adjustment considered an inflation rate of 6.2707% as measured by the IPCA for the period of August 2012 to July 2013.  From this number, ARSESP deducted the Efficiency Factor (X Factor) of 0.4297% for the period, and this resulted in an adjustment of 5.8410%.  Additionally, ARSESP estimated the gain that we had with a tariff revision of 2.3509% beginning in April 2013, and this resulted in a further discount of 0.9249% in the indicator.  Moreover, ARSESP also estimated our loss of 0.6538% resulting from the delay in the reposition of the IPCA and added that estimated amount. The product of these movements and considerations resulted in a linear increase of 3.1451% in tariffs beginning December 11, 2013.

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Regarding the tariff structure, ARSESP Resolution No. 463, published in January 2014, established April 10, 2014, as a deadline for publication of the timetable for implementation of our new tariff structure.  However, in April 17, 2014, ARSESP issued Resolution No. 484, which maintains the current Tariff Structure and does not set a date for implementation of the new tariff structure. Until the new tariff structure is approved by ARSESP, we will continue to use our current tariff structure.  As such, we currently divide tariffs into two categories:  residential and non‑residential.  The residential category is subdivided into standard residential, residential social and favela (shantytowns).  The residential social tariffs apply to residences of low‑income families, residences of persons unemployed for up to 12 months and collective living residences.  The favela tariffs apply to residences in shantytowns characterized by a lack of urban infrastructure.  The latter two sub‑categories were instituted to assist lower‑income customers by providing lower tariffs for consumption.  The non‑residential category consists of:  (i) commercial, industrial and public customers; (ii) ”not‑for‑profit” entities that pay 50.0% of the prevailing non‑residential tariff;  (iii) government entities that have entered into a water loss reduction agreement with us and pay 75.0% of the prevailing non‑residential tariff; and (iv) public entities that have entered into program agreements, for municipalities with a population of up to 30,000 and with half or more classified according to their degree of social vulnerability by the Social Vulnerability Index of São Paulo (Índice Paulista de Vulnerabilidade Social) 5 and 6, of the SEADE, obtained through the analysis of the 2000 Census figures, and start to receive tariff benefits, in accordance with our normative ruling, for the category of public use, at the municipality level.  The tariffs are equal to those offered to the commercial/entity of social assistance and that corresponds to 50.0% of the public tariffs without contractual provisions referred to in item (iv) above.

We established a new tariff schedule, effective May 2002, for commercial and industrial customers that consume at least 5,000 cubic meters of water per month and that enter into fixed demand agreements (take‑or‑pay) with us for at least one‑year terms.  In October 2007, the minimum volume for entering into these agreements was reduced from 5,000 cubic meters per month to 3,000 cubic meters per month.  We believe this tariff schedule will help prevent our commercial and industrial customers from switching to the use of private wells.  Since 2008, we have been authorized by ARSESP to establish tariffs for non‑residential customers, such as industrial and commercial customers, that consume more than 3,000 cubic meters per month, with a maximum tariff equal to the tariffs applicable to non‑residential customers that consume more than 50 cubic meters per month.  In 2010, ARSESP authorized a reduction in the minimum volume of consumption for customers that enter into demand agreements with us to a minimum of 500 cubic meters per month.  

We establish separate tariff schedules for our services in each of the São Paulo metropolitan regions and each of the interior region of São Paulo State and coastal regions which comprise our Regional systems.  Each tariff schedule incorporates regional cross‑subsidies, taking into account the customers’ type and volume of consumption.  Tariffs paid by customers with high monthly water consumption rates exceed our costs of providing water service.  We use the excess tariff billed to high‑volume customers to compensate for the lower tariffs paid by low‑volume customers.  Similarly, tariffs for non‑residential customers are established at levels that subsidize residential customers.  In addition, the tariffs for the São Paulo metropolitan region generally are higher than tariffs in the interior region of São Paulo State and coastal regions.

Sewage charges in each region are fixed and are based on the same volume of water charged.  In the São Paulo metropolitan region and the coastal region, the sewage tariffs equal the water tariffs.  In the interior São Paulo State region, sewage tariffs are approximately 20.0% lower than water tariffs.  Wholesale water rates are the same for all municipalities served.  We also make available sewage treatment services to those municipalities in line with the applicable contracts and tariffs.  In addition, various industrial customers pay an additional sewage charge, depending on the characteristics of the sewage they produce.

Each category and class of customer pays tariffs according to the volume of water consumed.  The tariff paid by a certain category and class of customer increases progressively according to the increase in the volume of water consumed.  The following table sets forth the water and sewage services tariffs by (i) customer category and class and (ii) volume of water consumed, charged in cubic meters during the years and period stated in the São Paulo metropolitan region.

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Customer Category Consumption

As of December 11, 2013(5)

As of April 22, 2013(4)

As of September 11, 2012(3)

As of September 11, 2011(2)

Residential

 

 

 

 

Standard Residential:

 

 

 

 

0‑10(1)

1.68

1.63

1.59

1.52

11‑20

2.63

2.55

2.49

2.37

21‑50

6.57

6.37

6.22

5.92

Above 50

7.24

7.02

6.86

6.52

Social:

 

 

 

 

0‑10(1)

0.57

0.55

0.54

0.51

11‑20

0.99

0.96

0.94

0.89

21‑30

3.48

3.37

3.29

3.13

31‑50

4.97

4.82

4.71

4.48

Above 50

5.49

5.32

5.20

4.95

Favela (shantytown):

 

 

 

 

0‑10(1)

0.44

0.42

0.41

0.39

11‑20

0.50

0.48

0.47

0.45

21‑30

1.64

1.59

1.55

1.47

31‑50

4.97

4.82

4.71

4.48

Above 50

5.49

5.32

5.20

4.95

Non‑Residential

 

 

 

 

Commercial/Industrial/Governmental:

 

 

 

 

0‑10(1)

3.38

3.28

3.20

3.04

11‑20

6.57

6.37

6.22

5.92

21‑50

12.59

12.21

11.93

11.35

Above 50

13.12

12.72

12.43

11.82

Social Welfare Entities:

 

 

 

 

0‑10(1)

1.69

1.64

1.60

1.52

11‑20

3.29

3.19

3.12

2.97

21‑50

6.32

6.13

5.99

5.70

Above 50

5.56

6.36

6.21

5.91

Government entities that employ the Rational Use of Water Program (Programa de Uso Racional da Água), or PURA, with reduction agreement:

 

 

 

 

0‑10(1)

2.53

2.40

2.28

2.14

11‑20

4.92

4.66

4.43

4.15

21‑50

9.47

8.97

8.53

7.98

Above 50

9.84

9.32

8.86

8.29

 

______________

(1)    The minimum volume charged is for ten cubic meters per month.

(2)    From September 11, 2011 through September 10, 2012.

(3)     From September 11, 2012 through April 21, 2013.

(4)   From April 22, 2013 through December 10, 2013.

(5)   Since December 11, 2013

 

In 2013, 2012 and 2011, the average tariff calculated for the Regional systems was approximately 30% below the average tariff of the São Paulo metropolitan region.

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The Basic Sanitation Law requires states to establish independent regulators with the responsibility of monitoring basic sanitation services and regulating tariffs.  Federal law No. 11,445/07 and São Paulo State Law No. 1,025/07 established the ARSESP, which regulates and supervises the basic sanitation services that we provide in municipalities that have agreed to come under ARSESP’s jurisdiction.  For the municipalities that have not yet agreed to come under ARSESP’s jurisdiction for which we currently provide basic sanitation services, we determine tariffs based on State Decree 41,446/96. ARSESP has proposed or enacted a number of regulatory changes, including the following:

·                     In 2009, ARSESP opened the methodology for tariff revisions for public discussion and hearings. In 2010, ARSESP issued Resolution No. 156.  This resolution established the methodology and general criteria for the valuation of our regulatory asset base to be used for purposes of tariff review processes and auditing. During 2011 and 2012 ARSESP held further public consultations regarding the methodology for tariff revisions, which was finally specified and disclosed in April 2012.  In November 2012, ARSESP published a preliminary technical note for public consultation, proposing a preliminary initial maximum average tariff (P0) and efficiency gains factor (X Factor), based on a preliminary evaluation of assets held by us.  Following further public consultations, in March 2013 ARSESP published two resolutions, Resolution No. 406 and Resolution No. 407.

·                     Resolution No. 406 sets out the following:  (i) an initial maximum average tariff (P0) and a preliminary asset base value to apply until the conclusion of an external audit of our asset base, resulting in a tariff revision of 2.3509%; (ii) authorizes the pass-through to consumers of the regulation and supervision rate of 0.5% immediately after the conclusion of the operational adjustments necessary for the inclusion of this rate in the bills in the municipalities where it will be charged; (iii) ARSESP also establishes an annual tariff adjustment formula, to be implemented during the second tariff cycle, consisting of the IPCA variation (a consumer price index) for the period, adjusted by an efficiency factor designed to transfer a portion of our productivity gains to consumers, which was implemented on November 1, 2013 and further adjusted to reflect changes in service quality to be defined and applied as of the third year of the tariff cycle.  According to ARSESP’s timetable the final maximum average tariff (P0) would be announced in August 2013 after an audit of the asset base value presented by us.  However, it was postponed to April 2014.

·                     A tariff revision of to a rate of 2.3509% was implemented in April 2013 pursuant to Resolution No. 406. Additionally, we will pass an inspection fee of 0.5% to consumers immediately after the conclusion of the operational adjustments necessary for the inclusion of this rate in the bills to municipalities where it will be charged. The adaptation of internal processes to accommodate this charge has not been finalized yet, and it should be finalized in 2014.

·                     In April 2013 ARSESP issued Resolution No. 407 authorizing us to pass through to the service bill the 7.5% transfer to the São Paulo Municipal Sanitation and Infrastructure Fund as a legal charge, as defined by municipal legislation.  Pursuant to the Program Contracts and the Sewage and Water Supply Service Contracts, this charge must be considered in the tariff revision.

·                      In April 2013, ARSESP issued Resolution No. 413, which effectively suspended Resolution No. 407 until the tariff revision process is concluded, thereby postponing our authorization to pass the charge through to consumers on the service bill. The postponement of Resolution No.407 was due to a request from the Government of the State of São Paulo to analyze, among other matters, methods of reducing the impact on consumers.  Although Resolution No.407 establishes the conclusion of the tariff review as the date for the implementation of the pass-through, we cannot be certain when Resolution No. 407 will be implemented.  
In April 2014, ARSESP issued Resolution No. 484, which establishes the conclusion of the tariff revision.  No decision was made in relation to the 7.5% charge to our consumers, and we do not know when a final decision will be reached.  We cannot know when we will be able to pass the 7.5% charge to consumers on the service bill.

·                     In July 2013, ARSESP announced that due to a lack of quorum by its board of directors to deliberate on the tariff revision process, the process would be postponed until a quorum could be formed.  Three directors are necessary so that ARSESP may deliberate on any matter and, at that time, it only had two directors.

  

·                     Resolution No. 427, published by ARSESP on August 1, 2013, maintained suspension of our tariff revision and required that we reevaluate 19 points of our Regulatory Asset Base.  We requested 90 days to assess, clarify and make the adjustments necessary to the Regulatory Asset Base. A revised Regulatory Asset Base was filed in December 2013, in compliance with the schedule.

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·                     In October 2013, ARSESP’s officers fulfilled the minimum requirement quorum necessary to deliberate on subjects related to the tariff adjustment and/or revision that had been paralyzed since August 2013.  On November 1, 2013, ARSESP issued Resolution No. 435, authorizing us to implement a tariff adjustment.  Initially, this adjustment considered an inflation rate of 6.2707% as measured by the IPCA for the period of August 2012 to July 2013.  From this number, ARSESP deducted the Efficiency Factor (X Factor) of 0.4297% for the period, and this resulted in an adjustment of 5.8410%.  Additionally, ARSESP estimated the gain that we had with a tariff revision of 2.3509% beginning in April 2013, and this resulted in a further discount of 0.9249% in the indicator.  Moreover, ARSESP also estimated our loss of 0.6538% resulting from the delay in the reposition of the IPCA and added that estimated amount. The product of these movements and considerations resulted in a linear tariff adjustment of 3.1451% beginning December 11, 2013.

 

·                     ARSESP Resolution No. 463 published in January 2014 established a new timetable for the development of our tariff revision phases and established April 10, 2014, as the date for release of the definitive Initial Maximum Price (P0) and the Efficiency Factor (X Factor) for the tariff cycle initiated on August 10, 2012. The phases of our tariff revision were determined as follows:

          February 11, 2014 – ARSESP released Technical Note RTS 001/2014, which presents its proposals for the definitive Initial Maximum Price (P0) and Efficiency Factor (X Factor) and start of the public consultation and call for a public hearing. With Technical Note RTS 001/2014, ARSESP determined the Final Tariff Level, which consists of: (i) the definition of the Final P0, which refers to December 2012, with the definitive initial Net Regulatory Asset Base, or RAB, (ii) the quantification of the compensatory adjustments for retroactive application to the beginning of the cycle, and (iii) the tariff amounts to be applied on services rendered as from April 11, 2014.

          March 12, 2014 – public hearing and the end of the public consultation;

          April 10, 2014 – release and publication of the results related to the definitive Initial Maximum Price (P0) and Efficiency Factor (X Factor) and the consolidated reports on contributions from the public consultation; and publication of the timetable for implementation of our new tariff structure.  However, on April 10, 2014, ARSESP suspended the publication of this timetable.

          April 17, 2014 – ARSESP issued Resolution No. 484, which, among other things: (i) establishes that, as of May 11, 2014, a tariff repositioning index of 5.4408% in relation to our current tariffs and an annual Efficiency Factor (X Factor) of 0.9386%, which will be deducted in the upcoming annual tariff adjustments, shall be applied to water services bills, (ii) allows us to apply the repositioning index arising from the tariff revision at a more opportune future date, when we shall proceed with a recalculation and monetary adjustment of the applicable amounts, in order to ensure our economic and financial balance, taking into account the atypical situation in our market due to the lack of rainfall and our measures to encourage water savings in order to ensure supply, (iii) establishes that the next annual tariff adjustments will occur on April 11, 2015 and April 11, 2016, with the next tariff revision on April 11, 2017, and (iv) ratifies the readjustment rules set forth on Resolution No. 406 (described above) and updated the X Factor for the tarif cycle from 0.836% to 0.9386%.  The current tariff structure will be kept with respect to our services until the new structure is approved by ARSESP and implemented.  Considering what has been established by Resolution No. 484, we decided to postpone the application of the repositioning index to an opportune date no later than the end of December 2014.

In August 2012, ARSESP issued Resolution No. 346, which established the principle that users should be compensated for any interruptions in water supply.  Implementation of this regulation has been suspended pending further technical discussions.  In 2013, ARSESP held public consultations that resumed technical discussions on the subject, but the new resolution that will replace Resolution No. 346 has not yet been published.

Marketing Channels

As of December 31, 2013, we were the concessionaire for the provision of water supply and collection, treatment and disposal of sewage services directly to end consumers for 363 municipalities of the State of São Paulo.  We also supply water on a wholesale basis to six municipalities located in the São Paulo metropolitan region.  It is the responsibility of these municipalities to then distribute the water to end consumers.  We provide sewage services to five of these municipalities.  Because of our distribution infrastructure, end consumers to whom we offer water services on a wholesale basis cannot alternatively acquire such services directly from us.  For more information on service concessions, see “—Wholesale Operations.”

Energy Consumption

Energy is essential to our operations, and as a result we are one of the largest users of energy in the State of São Paulo.  In the year ended December 31, 2013, we used 1.78% of the total energy consumption in the State of São Paulo.  To date, we have not experienced any major disruptions in energy supply.  Any significant disruption of energy to us could have a material adverse effect on our business, financial condition, results of operations or prospects.  See “Item 3.D. Risk Factors—Risks Relating to Our Business—We are exposed to risks associated with the provision of water and sewage services.”

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Energy prices have a significant impact on our results of operations.  In 2013, 42.6% of our total energy consumption occurred within the “free market,” where we can more efficiently negotiate the supply of energy. In October 2012, we entered into long‑term contracts with AES Tiête (39%) and Tractebel Energia S.A. (61%) to provide these services until 2015.

Insurance

We maintain insurance covering, among other things, fire or other damage to our property and office buildings and third‑party liability.  We also maintain insurance coverage for directors’ and officers’ liability (D&O insurance).  We currently obtain our insurance policies by means of public bids involving major Brazilian and international insurance companies that operate in Brazil.  As of December 31, 2013, we had paid a total aggregate amount of R$5.6 million in premiums.  In addition, we paid R$1.4 million for a D&O insurance policy, covering R$4.1 billion in assets, third‑party liabilities and D&O insurance.  We do not have insurance coverage for business interruption risk because we do not believe that the high premiums for such insurance are justified by the low risk of major interruption of our activities.  In addition, we do not have insurance coverage for liabilities arising from water contamination or other problems involving our water supply to customers and for environmental related liabilities and damages.  We believe that we maintain insurance at levels customary in Brazil for our type of business.

Intellectual Property

Trademarks

We have secured registration of our logo and composite trademark at the Brazilian Institute of Industrial Property (Instituto Nacional da Propriedade Industrial), or INPI. We have registered with the INPI the following trademarks: “Sabesp”, “Sabesp Soluções Ambientais”, “Projeto Tietê”, “Programa Córrego Limpo”, “Programa Onda Limpa”, “Prol – Programa de Reciclagem do Óleo De Fritura”, “Revista DAE”, “Ligação Sabesp”, “Agente da Gente – Sabesp na Comunidade”, “PURA – Programa de Uso Racional da Água”, “Sabesp Inteligência Ambiental”, “Reúso da Água”, “Uso Racional da Água”, “Parque da Integração”, “Clubinho Sabesp”, “Cauã”, “Denis”, “Gabi”, “Gotucho”, “Gota Borralheira”, “Dr. Gastão”, “Iara”, “Ratantan”, “Sayuri”, “Cadu” and “SuperH2O.” Cauã, Denis, Gabi, Gotucho, Gota Borralheira, Dr. Gastão, Iara, Sayuri, Ratantan, Cadu and Super H2O are some of the characters of our children’s club (Clubinho SABESP), which is a tool for environmental education directed to children through our website.

We have also filed applications with the INPI for registration of the following trademarks: “Eu Sou Guardião das Águas Sabesp Eu Não Desperdiço”, “Parque Da Integração”, “Programa de Recuperação Ambiental”, “Signos Sistema De Informação Geográfica No Saneamento”, “Signos Net Sistema De Informação Geográfica No Saneamento”, “Scorpion”, “Sabesp Semana do Meio Ambiente”, “Água de Reúso Sabesp”, “Água Sabesp Aquífero Guarani”, “Água Sabesp Estação Cantareira”, “Contrato de Fidelização Sabesp”, “Esgotos não Domésticos Sabesp”, “Cine Sabesp”, “Ecoposto Sabesp”, “PEA – Programa de Educação Ambiental”, “Projeto Tietê”, “Sabesp Abraço Verde”, “Super H2O”, “Programa Córrego Limpo” and the following character of the Clubinho SABESP: “Cadu”.

Patents

We have a patent granted by the INPI for a constructive device in a building hydraulic simulator used for didactic purposes.  We have also filed patent requests for the following additional devices:

·                     a water consumption measurement unit;

·                     a biofilter odor control unit;

·                     a device for the removal of supernatants in the treatment of sewage;

·                     a mobile device for the calibration of hydrometers;

·                     rotary devices used to clean water reservoirs transported by trucks with high-pressure hydrojetting systems; and

·                     portable metrological test equipment.

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We are currently awaiting responses to our patent requests from the INPI.  While the requests are under consideration, we are granted the exclusive right to use these devices.

Software

We have adopted an internal policy that provides for an active and effective audit and prevention of unauthorized software.  We have acquired the software licenses for all our workstations.

We have also developed certain computer programs for management and control of water and sewage treatment facilities, as well as for third‑party services management, called “CSI– Sistema Comercial, Serviços e Informações,” “AQUALOG (Control Water Treatment Plants),” “SGL (Bid Management System),” “SCORPION (Software to Operational Control),” “Electronic Price Quotation” (Cotação Eletrônica de Preços), “PREGÃO SABESP ONLINE,” “SISDOC – Sistema de Controle de Documentos,” “Sistema de análise do comportamento metrológico de hidrômetros,” “Modelo padronizado de Laudo técnico‑MPLT,” and “SGH” ‑ hydrometry management system (Sistema de Gestão de Hidrometria), “SIA – Sistema de Informações de Auditoria,” “SAN – Sistema de Apoio à Navegação,” online software for managing specific articles published in the DAE magazine, Dashboard and Online Control of Water Losses.  We have also secured registration of these programs at the INPI.

AQUALOG is a Brazilian software designed to monitor water treatment through the employment of artificial intelligence.  In 2001, we completed the first rendering of services based on the AQUALOG software to a third party with the automation of a water treatment plant in the city of Jaguará do Sul, State of Santa Catarina.  We have entered into an agreement to license the software to Sanesul, in the state of Mato Grosso do Sul and to Teuto’s drugs factory, in the city of Anapólis, state of Goiás.  We currently have a temporary license for the AQUALOG software and are awaiting its final registration with the INPI.

SGL is an electronic price quotation system that allows us to view and control all bid and acquisition proceedings in real time.

Domain Names

We own the domain names described below which have been registered with the relevant entity in Brazil, Regristro.br:

·                     www.sabesp.com.br; 

·                     www.corregolimpo.com.br; 

·                     www.projetotiete.com.br; 

·                     www.revistadae.com.br; 

·                     blogdasabesp.com.br; 

·                     blogsabesp.com.br; 

·                     sustentabilidadesabesp.com.br; 

·                     clubinhosabesp.com.br; and

·                     superh2o.com.br. 

Environmental Matters

Our environmental policy establishes environmental management directives that allow us to become a contributing force to environmental sustainability and excellence.  These directives are based on a systematic approach to the environment, which allows us to develop a plan that integrates economic, environmental and social dimensions of our work with sustainable use of natural resources.

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We have the following ongoing environmental management programs:

·         implementation of an Environmental Management System, or EMS, in our water and sewage treatment stations (“WTS” and “STS”).  The EMS is present in 95 stations and we have a plan of progressive extension until 2020. Additionally, we pursue the ISO 14001 certification for our strategic plants.  As of December 31, 2013, we have ISO 14001 certification for 50 STSs;

 

·         participation in the Carbon Disclosure Project since 2006;

 

·         development of the Corporate Greenhouse Gas Management Program (Programa Corporativo de Gestão de Emissões de Gases de Efeito Estufa), in line with the guidelines from the São Paulo State Climate Change Policy (PEMC), including the creation of inventories of greenhouse gases, totaling six inventories concluded since 2007;

·         continuation of the actions set forth in the corporate programs for obtaining and maintaining environmental licenses and grants for the right to use water;

·         the implementation of the Environmental Education Program (PEA SABESP), including over one hundred environmental education actions and projects involving the community and other stakeholders;

 

·         management of our institutional representation in the State and National Systems of Water Resources, including training of company representatives to participate in: (i) the creation of criteria for water usage charges, (ii) the monitoring of water basin plans (Planos de Bacias), (iii) review of water bodies’ classifications,  and (iv) analysis of legislation regarding the protection of water sources;  and

 

·         implementation of the SABESP 3‑Rs Program (Programa SABESP 3Rs) for the reduction, re‑use and recycling of waste of administrative activities, in partnership with the Catadores Cooperatives (Cooperativas de Catadores) and which includes employee training enabling them to act as multipliers in the roll-out of the program.  

In addition to corporate environmental management initiatives, we have several projects and initiatives underway to benefit the environment by engaging the population at large.  In 2013, we invested R$32.5 million in environmental programs and projects.

Climate Change Regulations:  Reduction of Greenhouse Gases (GHG)

We are required to comply with laws and regulations related to climate change, including international agreements and treaties to which Brazil is a signatory.

The São Paulo State Climate Change Policy (Law No. 13,798), enacted on November 9, 2009, aims to reduce global emissions of carbon dioxide by 20.0% by 2020 compared with 2005 levels.  Brazil’s Climate Change Policy (Law No. 12,187), enacted on December 29, 2009, establishes a voluntary national commitment to reduce Brazil’s currently projected GHG emissions for 2020 by a percentage between 36.1% and 38.9%.  Such targets have not been established for the sanitation sector yet.  We are currently developing a Corporate Greenhouse Gas Management Program, aimed at reducing the amount of greenhouse gases released into the atmosphere, including the creation of an inventory to record releases of greenhouse gases.

In 2013, we concluded the corporate inventories of greenhouse gases for 2011 and 2012, thus totaling six inventories since 2007.  We noted that the trend observed in the previous inventories persists, specifically that activities regarding sewage collection and treatment remain our largest sources of greenhouse gas release, representing approximately 91% of CO2 release. Electric energy represents approximately 8% and administrative activities represent approximately 1% of greenhouse gas release. 

We participate in initiatives that may potentially reduce the amount of greenhouse gases we release into the atmosphere, such as installing a small hydroelectric power plant. The use of biogas generated in the treatment of sewage, recycling sewage sludge and covering lagoons, among other actions, are other initiatives related to this matter.

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At this point, it is still not possible to predict if climate change policies will provide opportunities or generate new costs for us.  Reducing our emissions of carbon dioxide will involve costs and expenses related to implementing more stringent control mechanisms, adopting pollution prevention measures and actions to minimize the generation of GHGs.  We may not receive financial incentives to offset all or part of these costs.  In addition, if limitations in GHG emissions affect our supply chain and increase our costs, we may not be able to pass on these costs to our end consumers.  See “—Tariffs.”

Carbon Disclosure Project

·                     Carbon Disclosure Project Investors.  We participate in the Carbon Disclosure Project, a global initiative focused on the financial risks related to climate change.  Through this project, main international institutional investors ask the world’s largest companies to demonstrate that they are managing carbon effectively.  We have received and responded to the project’s questionnaires since 2006. 

Physical Effects of Extreme Weather Events

Since our financial performance is closely linked to climate patterns that influence the availability of water (in terms of quantity and quality of water resources), extreme weather conditions may adversely affect our business and operations.  If long‑term climate change causes significant alterations in environmental conditions, such as an increase in the frequency of extreme weather conditions, this could affect the quality and quantity of water available for abstraction, treatment and supply, which could affect the costs of services and tariffs.

An increase in heavy rainfall can impact water quality and the regular operation of water sources, including abstraction of water from our dams, through increased soil erosion, silting, pollution and eutrophication of aquatic ecosystems.  In addition, increased flows of rainwater into sewage systems may overwhelm the capacity of sewage treatment plants.  We may need to implement new production systems, build larger reservoirs, or increase operational capacity by further automating our existing equipment.  To increase automation, we would need to purchase and operate new equipment to measure dam levels and volumes, river output and the rain in hydrographic basins, create mathematical models for real time operations, and train technicians to operate these systems.

In the case of prolonged periods of drought, for example, reduced water levels in dams can cause an increase in the concentration of plant matter by increasing eutrophication and, consequently, increasing water treatment costs and operational complexity.  In such cases our production costs may increase, affecting our financial margins and the quality of water we produce.  Droughts also lower reservoir levels available for hydroelectric plants, which may lead to power shortages, particularly since hydroelectric power accounts for most of Brazil’s electric power supply.  Lack of electric energy could lead to instability in water supply and sewage collection and treatment services, which could damage our reputation.  In addition, because we are one of the largest consumers of electricity in the State of São Paulo, a potential increase in electricity tariffs due to a shortage of hydroelectric power could have a significant economic impact on us.

We are also the concessionaire for water and sewage services for all the coastal municipalities of the State of São Paulo.  A rise in the sea level could result in increased salinity in the river estuaries where we abstract water, which could affect water treatment in these areas.  Rising sea levels could also cause damage in our sewage collection network.

Extreme climate events may also affect the extraction, production and transportation of the materials necessary for our operations, such as water treatment materials, and may lead to an increase in the cost of these materials.  A rise in air temperature could also increase consumer demand for water, increasing the need to expand both water supply and sewage treatment.

In this context, our strategy calls for identifying mitigating actions, enlarging their coverage and managing possible operational risks related to climate change, as well as identifying opportunities to increase our effectiveness and to implement new technologies. The use of biogas generated in the treatment of sewage is an example of some of our initiatives related to this matter. With regards to the risk of reduced water availability, we are working to adapt to a new scenario of water scarcity due to climate change through initiatives such as the Corporate Programs for Loss Reduction, the Program for Rational Water Usage and the expansion of the planned reutilization of effluents for urban and industrial purposes. 

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See “Item 3.D. Risk Factors—Risks Relating to Our Business—New laws and regulations relating to climate change and changes in existing regulation, as well as the physical Effects of Extreme Weather Events, may result in increased liabilities and increased capital expenditures, which could have a material adverse effect on us.”

Regarding the drought that affected the Cantareira System in late 2013 and early 2014, see “Item 3.D. Risk Factors—Risks Relating to Our Business— Droughts, the water consumption reduction program or other measures may result in a significant decrease in the volume of water billed and the revenues from services we provide, which may have a material adverse effect on our company” and “Item 5.A. Operating and Financial Review and Prospects—Factors Affecting Our Results of Operations—Effects of Extreme Weather Events—Drought.”

Government Regulation

Basic sanitation services in Brazil are subject to an extensive federal, state and local legislation and regulation that, among other matters, regulates:

·                     the granting of concessions to provide water and sewage services;

·                     the development of public private partnerships;

·                     the need of a public bidding process for the appointment of private water and sewage services providers;

·                     the need of setting up an agreement for the appointment of public water and sewage services providers;

·                     the joint management of public services through cooperation, allowing for a program agreement without the need for a public bidding process for the service provider, subject to the condition that the planning, execution and monitoring activities are not executed by the service provider;

·                     minimum requirements for water and sewage services;

·                     water usage;

·                     water quality and environmental protection; and

·                     governmental restrictions on the incurrence of indebtedness applicable to state‑controlled companies.

General

Pursuant to Article 23 of the Brazilian Constitution, water and sewage services are the joint responsibility of the federal government, the states and the municipalities.  Article 216 of the Constitution of the State of São Paulo provides that, by law, the State must provide the conditions for efficient management and adequate expansion of water and sewage services rendered by its agencies and State‑controlled companies or any other concessionaire under its control.  State law authorized our formation to plan, provide and operate water and sewage services in the State and also acknowledged the autonomy of the municipalities.

Pursuant to Article 175 of the Brazilian Constitution, the rendering of public services, such as water and sewage services, is the responsibility of the applicable public authority.  However, any such public authority has the right to render these services directly or through a concession granted to a third party.

In Brazil, there are three federal legal regimes for contracting water and sewage services:  (i) public concessions, regulated by Law No. 8,987/1995, which require a prior public bidding process; (ii) administration of public services through cooperation agreements between the federal government and local public authorities at State and municipal level without the need for a public bidding process, regulated by the Public Consortia and Cooperation Agreement Law; and (iii) public‑private partnerships, regulated by Law No. 11,079/2004, used to grant concessions to private companies to provide public services and used in relation to construction works associated with the provision of public services.  Until 2005, we had adopted the regime for public concessions.  Following the entry into force of the Public Consortia and Cooperation Agreement Law, we adopted the administration of public services through cooperation agreements, which can be used alongside the other two regimes.

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The Public Consortia and Cooperation Agreement Law and the Basic Sanitation Law have caused significant impacts in the development of the state sanitation policy and the regulatory structuring of the industry.

Because we are the legal concessionaire for the State of São Paulo for water and sewage services, serving approximately 59% of the State’s population and providing sanitation services through concession agreements, the Consortium Law affects us on the expiry of our concession agreements entered into in the 1970s when the Brazilian Sanitation Plan (Plano Nacional de Saneamento), or PLANASA, was created.  The Consortium Law has caused important changes in the relationship among municipalities, states and public sanitation service providers, most notably in mixed capital companies, such as us, because of the implementation of the program agreements as a substitute for concession agreements.

In addition, the Basic Sanitation Law in its role as a general guideline for the development of the Brazilian sanitation industry, addresses the conditions for the delegation of water and sewage services, the exercise of ownership by the granting authority and the regulatory conditions for the industry.  The Basic Sanitation Law also provides for a significant amendment to Article 42 of the Concessions Law, which establishes the termination of concessions prior to the expiration date and the reversibility conditions for unamortized assets.  The amendment requires that the service provider be compensated for unamortized assets, prioritizing an agreement between the parties setting out the criteria for calculation and payments of indemnity.

The Basic Sanitation Law

On January 5, 2007, Federal Law No. 11,445, or the Basic Sanitation Law, was enacted, establishing nationwide guidelines for basic sanitation and seeking to create appropriate solutions for the situation of each state and municipality, facilitating the technical cooperation between the state and municipalities.  In addition, the federal government will enact its public policy to facilitate access to financing alternatives that are compatible with the costs and terms of the sanitation industry, in substitution of the PLANASA model.  On June 21, 2010, the federal government enacted Federal Decree No. 7,217 (as amended by Federal Decree No. 8,211/14), regulating the Basic Sanitation Law.  See “Item 3.D. Risk Factors—Risks Relating to our Business—Current regulatory uncertainty, especially with regard to implementation and interpretation of the Brazilian Basic Sanitation Law, may have an adverse effect on our business.”  

The Basic Sanitation Law establishes the following principles for basic sanitation public services:  universalization, integrality, efficiency and economic sustainability, transparency of actions, social control and integration of infrastructure and services with the management of water resources.  It does not define the ownership of the sanitation services, but establishes the minimum liability for the exercise of ownership, such as the development of the sanitation plan, definition of the person responsible for regulation and control and, establishment of the rights and obligations of the users and of the social control mechanisms.  It also defines the regionalized performance of the services (i.e., one single provider serves two or more owners, for which there may be one plan for the combination of services).

Federal Decree No. 7,217, which was enacted on June 21, 2010, (as modified by Federal Decree No. 8,211 of March 21, 2014) and Law 11,445 implemented a first series of new principles under the Basic Sanitation Law, including the following:

·                     for public‑public partnership contracts (or program contracts), public hearings must be held with respect to bid announcements, and technical and economic viability studies must be carried out;

·                      the rights and obligations of customers and service providers, including penalties, are determined by the owner of the public service, not by the regulatory agency (since its function is to ensure full compliance of legislative and contractual conditions);

·                     the regulatory agency’s function is to ensure compliance with the law and with the contractual conditions;

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·                     the technical and financial viability of the provision of water and sewage services should be determined based on (i) capital contributions necessary to offer the services and (ii) expected revenues from the provision of the service; and

·                     when a regulated service is to be provided by different service providers, those providers must execute an agreement regulating their respective activities.

In addition, the Basic Sanitation Law defines the guidelines and objectives of the federal basic sanitation policy to be observed when securing public funds generated or operated by agencies or entities of the federal government, and foresees the possibility of having subsidies as an instrument of social policy to ensure access to basic sanitation services to everyone, particularly the low‑income population.  The subsidies may be granted either directly, through tariffs or indirectly, depending on the characteristics of the beneficiaries and on the source of the funds.

Furthermore, the Basic Sanitation Law also provides that the sanitation services may be interrupted by the service provider, in the event of default of payment of the tariffs by the customer, among other reasons, after written notice, as long as minimum health requirements are met.

The Basic Sanitation Law also establishes the criteria for the reversal of assets at the time of termination of the agreement and with regard to the concessions, such as those that have expired or are effective for an indefinite term, or those that were not formalized by an agreement.  In addition, the Basic Sanitation Law provides the basis for calculating the amount of an indemnity due, which must be calculated by a specialized institution chosen by mutual agreement between the parties.

Pursuant to the Basic Sanitation Law, the parties of the concession may enter into an agreement with respect to the payment of the indemnification due to the concessionaire.  However, in the absence of an agreement, the Basic Sanitation Law establishes that the indemnification must be paid in no more than four equal and successive annual installments, with the first installment payable by the last business day of the fiscal year in which the assets are reversed.

Tariff Regulation in the State of São Paulo

The tariffs for our services are subject to Federal and State regulation.

On December 16, 1996, the governor of the State of São Paulo issued a decree which approved the existing tariff system and allowed us to continue to set our own tariffs.  We used to set our tariffs based on the general objectives of maintaining our financial condition and preserving “social equality” in terms of the provision of water and sewage services to the population while providing a return on investment.  The governor’s decree also directs us to apply the following criteria in determining our tariffs:

·                     category of use;

·                     capacity of the water meter;

·                     characteristics of consumption;

·                     volume consumed;

·                     fixed and floating costs;

·                     seasonal variations of consumption; and

·                     social and economic conditions of residential customers.

With the enactment of the Basic Sanitation Law and Federal Consortium Law, we are prohibited from planning, overseeing and regulating services, which includes determining the tariff policy to be adopted.  Such activities are to be exercised by the owner of the concession.  Other than the responsibility for planning, the remaining activities may not be delegated.

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The current tariff structure maintains different tariff schedules, depending upon whether a customer is located in the São Paulo metropolitan region or the Regional Systems.  There are four levels of volume consumed for each category of customer, except for the residential social and favelas (shantytowns).  The residential social tariffs apply to residences of low income families, residences of persons unemployed for up to 12 months and collective living residences.  The favela tariffs apply to residences in shantytowns characterized by a lack of urban infrastructure.  The latter two sub categories were instituted to assist lower income customers by providing lower tariffs for consumption.  Customers are billed on a monthly basis.  Water and sewage bills are based upon water usage determined by monthly water meter readings.  Larger customers, however, have their meters read every 15 days to avoid nonphysical loss resulting from faulty water meters.  Sewage billing is included as part of the water bill and is based on the water meter reading.  We are also authorized to enter into individual contracts with certain customers, such as municipalities, to supply water or sewage services on a wholesale basis.

Furthermore, since Law No. 11,445 permits municipalities to create their own regulatory agencies rather than being subjected to overview by ARSESP, a number of municipalities created their own regulatory agencies.  The municipality of Lins, which decided in 2007 to create its own regulatory authority, revisited this decision in 2010 and transferred the regulation of water activities, including the setting of tariffs, to ARSESP.  The municipality of Lins has retained, however, the power to ultimately approve the tariff set by ARSESP.

In addition, in 2011 municipalities in which the hydrographic basins of the Piracicaba, Capivari and Jundiaí rivers are located created a consortium (ARES/PCJ) for the regulation and supervision of our activities in those areas. As a result of the creation of the ARES/PCJ, we are currently involved in legal proceedings in which ARES/PCJ is claiming that it has jurisdiction over the regulation and supervision of our activities in two municipalities (Piracicaba and Mombuca). In the municipality of Piracaia, ARSESP is the entity in charge of applying the state tariff policy (Decree 41,446/96) which is in force due to an existing concession agreement. In the municipality of Mombuca, the regulation and supervision of basic sanitation services was delegated to the State of São Paulo, so that ARSESP could exclusively execute these services. We cannot predict the outcome of this case or how it may impact our business.  See” Risk Factor – Risk Relating to Our Business - Current regulatory uncertainty, especially with regard to implementation and interpretation of the Brazilian Basic Sanitation Law, may have an adverse effect on our business”

ARSESP Rule Enactments

In 2009 ARSESP enacted rules regarding the following:

·                     general terms and conditions for water and sewage services;

·                     procedures for communication regarding any failure in our services;

·                     penalties for deficiencies in the provision of basic sanitation services; and

·                     procedures for confidential treatment of our customers’ private information.

Consumer Relations in the State of São Paulo

In 2011 ARSESP altered the standard contract that we are required to use in our relationships with retail customers, requiring that invoices be sent to the consumer of the service rather than the owner of the property.  We estimate that this change will affect ongoing legal disputes, particularly those regarding collection procedures, as well as business discussions in general.  Since this change is still being implemented, we are not currently able to predict its impact on our business.

Regarding changes to the communication process for the reporting of failures, ARSESP has modified the rules and standards for supervision and reporting of incidents.  We have implemented these requested changes.  Currently, part of the reporting of incidents occurs online, through the Incident Reporting System (“Sistema de Comunicação de Incidentes”) established by ARSESP, which introduces greater transparency and control to our operations.

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In 2013, we established procedures for communicating scheduled interruptions in the provision of water services by developing the Communication of Scheduled Interruptions of Basic Sanitation – SISCIP-S.   

We are currently evaluating the enforceability and legality of some of these rules.  Implementation of these rules started during 2011, is currently ongoing, and is expected to continue for the next few years.  The implementation of these rules will impact our commercial and operations processes, and may adversely affect us in ways we cannot currently predict.

We are attentive to these regulatory changes, have been working toward meeting ARSESP’s requirements and recommendations, and have presented technical, legal and factual reasons for any conduct that ARSESP may find irregular.  As a result, we are subject to few regulatory infractions and to limited fines.  See “Risk Factors—Risks Relating to Our Business—“Current regulatory uncertainty, especially with regard to implementation and interpretation of the Brazilian Basic Sanitation Law, may have an adverse effect on our business.”

Regulation of Concessions

Concessions for providing water and sewage services are formalized by agreements executed between the state or municipality, as the case may be, and a concessionaire to which the performance of these services is granted in a given municipality or region.  Our concessions normally have a contractual term of up to 30 years.  However, our concessions in general can be revoked at any time if certain standards of quality and safety are not met, or in the event of default of the terms of the concession agreement.

A municipality that chooses to assume the direct control of its water and sewage services must terminate the current relationship by duly compensating the service provider.  Subsequently, the municipality will be in charge of rendering services or of conducting a public bidding process to grant the concession to potential concessionaires, including agreements with public companies directly.  Although the Constitution of the State of São Paulo determines that the relevant municipality would have to pay us for the unamortized book value of the assets related to any concession and assume any corresponding debt, with the exclusion of any amounts that have been paid to us by the municipality, upon termination or non‑renewal of the concession, the payment for termination may not be effected immediately, and any termination could negatively affect our cash flows, operating results and financial situation.  The Basic Sanitation Law reduced the maximum time period for payment of indemnification in such cases to four years.  See “Item 3.D. Risk Factors—Risks Relating to Our Business—The municipalities may terminate our concessions before they expire in certain circumstances.  The indemnification payments we receive in such cases may be less than the value of the investments we made.”

The Federal Concessions Law No. 8,987/1995 and the State Concessions Law No. 7,835/1992 require that the granting of a concession by the government be preceded by a public bidding process.  However, the Federal Public Bidding Law No. 8,666/1993, which establishes the rules for the public bidding process, provides that a public bidding process can be waived under certain circumstances, including in the case of services to be provided by a public entity created for such specific purpose on a date prior to the effectiveness of this law, provided that the contracted price is compatible with what is practiced in the market.  Furthermore, a provision of the Federal Public Bidding Law, as amended by the Public Consortia and Cooperation Agreement Law, provides that the program contracted can be executed with waiver of a public bidding process.

In the majority of municipalities where we operate, the new contracts have been formalized pursuant to the provisions of the Federal Public Bidding Law that allows the public bidding process to be waived under certain circumstances.  In addition, there are pending cases before the Brazilian Supreme Court regarding whether the right to execute concession and program agreements in the metropolitan regions belongs to the State or the municipal government. On February 28, 2013 the Brazilian Supreme Court decided a pending case on this matter related to the State of Rio de Janeiro.  A majority of the court held that the State and municipal governments must set up new joint entities to oversee the planning, regulation and auditing of basic sanitation services in metropolitan regions.  On March 6, 2013, the court ruled that this decision would come into effect after a 24-month period with respect to the State of Rio de Janeiro. The São Paulo metropolitan region accounted for 73.2% of our gross operating revenue in 2013 (excluding revenues relating to the construction of concession infrastructure).  We cannot predict how the shared management of these operations will be carried out in the São Paulo metropolitan region and other metropolitan regions we operate in or what effect it may have on our business, financial condition or results of operation.  See “Item 3.D. Risk Factors—Risks Relating to Our Business—Current regulatory uncertainty, especially with regard to implementation and interpretation of the Brazilian Basic Sanitation Law, may have an adverse effect on our business.”

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On June 18, 2009, Municipal Law No. 14,934/2009 was enacted and this law revoked Law No. 13,670/2003, which had originally created the discussion on whether the State or the Municipality was the one with the power to grant and monitor formal concessions for water and sewage services in the city of São Paulo.  On June 23, 2010, we entered into a formal agreement with both the State and the city of São Paulo to regulate the provision of water and sewage services in the city of São Paulo for a 30‑year period, which may be extended for an additional 30‑year period. See “Item 3.D. Risk Factors—Risks Relating to Our Business—The terms of our agreement to provide water and sewage services in the City of São Paulo could have a material adverse effect on us.” 

Public Consortia and Cooperation Agreement Law for Joint Management

On April 6, 2005, the federal government enacted Federal Law No. 11,107, or the Federal Public Consortia and Cooperation Agreement Law, which regulates Article 241 of the Brazilian Constitution.  This statute provides general principles to be observed when a public consortia enters into contracts with the Brazilian political divisions and subdivisions (the federal government, states, the Federal District and municipalities) aiming at the joint management of public services of common interests.

Federal Decree No. 6,017/2007 details the conditions of establishment of joint management and the execution of the program agreement regulating the Public Consortia and Cooperation Agreement Law.  This federal legislation introduces significant changes in the relationship among municipalities, states and companies providing public sanitation services, prohibiting the latter from exercising activities of planning, oversight and regulation, including tariff regulation, of the services and creating the program agreement for contracting entities whose share control is held by one of the Brazilian political divisions and subdivisions upon waiver of the public bidding process and compliance with concession legislation, as applicable.

On January 13, 2006, the Governor of the State of São Paulo enacted State Decree No. 50,470, amended by State Decrees No. 52,020, dated July 30, 2007, and No. 53,192, dated July 1, 2008, which provide for the rendering of water and sewage services in the State of São Paulo.  According to these decrees, we may enter into agreements with municipalities in connection with the provision of water and sewage services by means of the so‑called “program agreement without a public bidding process.”  In addition, these decrees establish that we will continue to render services in the areas covered by the concession granted by the State.

Based on these statutes, in January 2007 we executed our first program agreement with the municipality of Lins, located in the State of São Paulo.  Subsequently, we formalized agreements with other municipalities in the State of São Paulo.  These other municipalities transferred the oversight and regulation of our services to the State of São Paulo through a cooperation agreement.

On June 8, 2006, the State of São Paulo enacted Decree No. 50,868 creating the Commission for the Regulation of Sanitation Service of the State of São Paulo (Comissão de Regulação do Serviço de Saneamento do Estado de São Paulo – CORSANPA) to regulate sanitation services.  The Commission for the Regulation of Sanitation Service of the State of São Paulo is directly subordinated to the State Secretariat for Sanitation and Water Resources. On August 5, 2009, the State of São Paulo enacted Decree No. 54,644, which revoked Decree No. 50,868 and regulated the composition, organization and operation of the State Sanitation Council (Conselho Estadual de Saneamento – CONESAN) created by Supplementary Law No. 7,750/92.

The main duty of the Commission for the Regulation of Sanitation Service of the State of São Paulo was conducting studies for the creation of a regulatory agency for the basic sanitation industry and the presentation of legal and regulatory measures.  The completion of such duties resulted in the publication of supplementary Law No. 1,025 of December 7, 2007, which created ARSESP and partially revoked Supplementary Law No. 7,750/92.  Furthermore, Supplementary Law No. 1,025/2007 maintained the State Sanitation Council, as an advisory council to define and implement the state basic sanitation policy, and the State Sanitation Fund (Fundo Estadual de Saneamento – FESAN).  The State Sanitation Fund is connected to the State Secretariat for Sanitation and Water Resources, and collects and manages resources that support State‑approved programs, as well as the development of technology, management and human resources and a sanitation information system, in addition to other support programs.

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ARSESP regulates the basic sanitation services that belong to the State, relating to the federal and municipal jurisdictions and prerogatives, and is responsible for: 

·                     the compliance with and enforcement of state and federal basic sanitation legislation;

·                     the publication of the organizational platform for the services, indicating the types of services provided by the State, as well as the equipment and facilities that compose the system;

·                     the acceptance, where applicable, of the legal attributions of the jurisdictional authority;

·                     the establishment, in accordance with the tariff guidelines defined by Decree No. 41,446/96, of tariffs and other methods that provide compensation for our services, adjustment and review of such tariffs and methods to ensure the financial‑economic balance of services and low‑cost tariffs through mechanisms that increase service efficiency and lead to the distribution of productivity gains to society; and

·                     the approval, oversight and regulation (including tariff issues) of the sewage treatment and wholesale water supply agreements entered into between the state supplier and other suppliers, pursuant to Article 12 of the Basic Sanitation Law.

With respect to municipal basic sanitation, ARSESP oversees and regulates services (including tariff issues) that have been delegated by municipalities to the State as a result of cooperation agreements that authorize program agreements between the municipalities and us for as long as it is convenient to the municipality’s public interest.

For its services, ARSESP charges 0.50% of the annual total invoice from gross operating revenue (excluding revenues relating to the construction of concession infrastructure) of the municipality.  This fee is collected from municipalities that have a signed program agreement with us and the municipalities located in the metropolitan regions.

In connection with the scope of our services, Supplementary Law No. 1,025/2007 expanded the range of services that we can render, with the inclusion of urban rainwater drainage and management, urban cleaning and solid waste management, as well as the operation of power generation, storage, conservation and sales activities, for our own or third‑party use.

In addition, the rules simplified the process for the expansion of our business in Brazil and abroad, authorizing us to:

·                     participate in the controlling block or the capital of other companies;

·                     create subsidiaries, which may become majority or minority shareholders in other companies; and

·                     establish partnerships with national or foreign companies, including other state or municipal basic sanitation companies, in order to expand our activities, share technology and expand investments related to basic sanitation services.

Public‑Private Partnerships

The Public-Private Partnership (PPP) is a form of agreement with the public administration used for the concession of services to private enterprises, as well as for construction works coupled with the provision of services.  PPPs are regulated by the State of São Paulo through Law No. 11,688, which was enacted on May 19, 2004.  PPPs may be used for:  (i) implantation, expansion, improvement, reform, maintenance or management of public infrastructure; (ii) provision of public services; and (iii) exploitation of public assets and non‑material rights belonging to the State.

Payment is conditioned upon performance.  The payment may be collected through:  (i) tariffs paid by users; (ii) use of resources from the budget; (iii) assignment of credits belonging to the State; (iv) transfer of rights related to the commercial exploitation of public assets; (v) transfer of real property and other property of assets; (vi)  public debts securities; and (vii) other revenues.

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In our case, payment is conditional upon performance and is collected through the use of resources from the budget.

Public Bidding Procedures

Pursuant to the Federal Public Bidding Law, the public bid process commences with publication by the granting authority in a federal, state or municipal official newspaper, as the case may be, and another leading Brazilian newspaper.  The publication announces that the granting authority will carry out a public bidding contest pursuant to provisions set forth in an edital (invitation to bid).  The invitation to bid must specify, among other terms:  (i) the purpose, duration and goals of the bid; (ii) the participation of bidders, either individually or forming a consortium; (iii) a description of the qualifications required for adequate performance of the services covered by the bid; (iv) the deadlines for the submission of the bids; (v) the criteria used for the selection of the winning bidder; and (vi) a list of the documents required to establish the bidder’s technical, financial and legal capabilities.

The invitation to bid is binding on the granting authority.  Bidders may submit their proposals either individually or in consortia, as provided for in the invitation to bid.  After receiving proposals, the granting authority will evaluate each proposal according to the following criteria, which must have been set forth in the invitation to bid:

·                     the technical quality of the proposal;

·                     lowest cost or lowest public service tariff offered;

·                     a combination of the criteria above; or

·                     the largest amount offered in consideration for the concession.

The provisions of State Law No. 6,544 of November 2, 1989, as amended, or the State Public Bidding Law, parallel the provisions of the Federal Public Bidding Law.  The Federal and State bidding laws will apply to us in the event that we seek to secure new concessions.  Moreover, these bidding laws currently apply to us with respect to obtaining goods and services from third parties for our business operations or in connection with our capital expenditure program, in each case subject to certain exceptions.

Water Usage

State law establishes the basic principles governing the use of water resources in the State of São Paulo in accordance with the State constitution.  These principles include:

·                     rational utilization of water resources, ensuring that their primary use is to supply water to the population;

·                     optimizing the economic and social benefits resulting from the use of water resources;

·                     protection of water resources against actions which could compromise current and future use;

·                     defense against critical hydrological events which could cause risk to the health and safety of the population or economic and social losses;

·                     development of hydro‑transportation for economic benefit;

·                     development of permanent programs of conservation and protection of underground water against pollution and excessive exploitation; and

·                     prevention of soil erosion in urban and rural areas, with a view to protecting against physical pollution and silting of water resources.

Among other instruments established by this Policy, the competent public authority grants for the right to use water for the implementation of any enterprise that demands the use of surface or underground water resources (for the collection or release of effluents), as well as for the execution of services that alter the regime or quality of such water resources.  In the case of rivers under the federal government’s domain (rivers crossing more than one state), ANA is the public authority which grants the authorization.  With respect to the rivers under a state’s domain, the applicable state authority has jurisdiction to grant the right of use.  In the State of São Paulo, DAEE is the public authority responsible for granting such authorizations. 

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In conducting our principal activities, we have grants for the rights to use water, and there is a corporate program in place to obtain and maintain the rights to use water for the remaining activities.  As of the date of this annual report, we do not own all the required grants for the right to use water in connection with our operations.  However, all of our water-usage activities have filed requests for grants for the right to use water with the competent authority; many of these requests have been granted and others are under analysis by DAEE and ANA. 

State Law No. 12,183, which was enacted on December 29, 2005, established the basis for charging for the use of the water resources under the domain of the State of São Paulo.  To apply such charging, the law provides for, among other provisions, the participation of the Water Basins Committees, the formulation of criteria by such Committees, the creation of basin agencies and the organization of a registered list of water resource users.  The basin committee’s proposals regarding the criteria to calculate the amounts to be charged at each basin must be approved by the State Water Resource Council, and formalized by a decree issued by the State Governor.

According to existing law, the hydrographic basins committees are authorized to charge users, such as us, for the abstraction of water from, or dumping of sewage into, water bodies.

Charging for the use of water is under gradual implementation by the State of São Paulo, where the largest individual contributors are located, and it is a management tool of the Policy on Water Resources to promote the rational use of water and finance programs and actions established by the basin plans.  In 2013, we paid about R$27.0 million for the use of water resources.

Charging for the use of water from rivers of federal domain began in 2003 in the Paraíba do Sul basin, and charging for the use of water from rivers of state domain began in 2007 in the Paraíba do Sul, Piracicaba, Capivari and Jundiaí basins.  Subsequently, charges were implemented for the use of water from the Sorocaba, Middle Tietê and Santos Region basins.  In 2013, charges were implemented for the use of water from the Baixo Tietê basin and, in April 2014, for the use of water from the Alto Tietê Basin.  It is probable that the same will occur in 2014 in the following basins: Tietê/Batalha, Tietê/Jacaré, Baixo Pardo e Grande, Litoral Norte, Mogi-Guacu, Pardo, Pontal do Paranapanema, Sapucaí Mirim/Grande, Serra da Mantiqueira, Ribeira do Iguape/Litoral Sul and Turvo/Grande.  In 2015, charges for the use of water are expected to be implemented for the basins of Alto Paranapanema, Aguapeí/Peixe, Médio Paranapanema and São José dos Dourados.

Water Quality

Administrative Rule No. 2,914/2011, issued by the Ministry of Health of the federal government, provides the standards for potable water for human consumption in Brazil.  This rule is similar to the U.S. Safe Drinking Water Act and the regulations enacted by the U.S. Environmental Protection Agency, which establishes rules for sampling and limits related to substances that are potentially hazardous to human health.

In compliance with Brazilian law, the physical‑chemical, organic and bacteriological analyses carried out for water quality control follow the methodologies of the Standard Methods for Water and Wastewater (21st edition) of the American Water Works Association.

Decree No. 5,440/2005 provides that the quality of water must be disclosed to consumers.  We have been complying with this regulation by publishing the required information in monthly bills and annual reports delivered to all consumers that we serve.

Environmental Regulation

The implementation and operation of water and sewage systems are subject to strict federal, state and municipal laws and regulations on environmental and water‑resource protection.  The National Environmental Council (Conselho Nacional de Meio Ambiental), or the CONAMA, is the federal agency responsible for the regulation of potentially polluting activities.  In the State of São Paulo, the Companhia Ambiental do Estado de São Paulo, or CETESB, is the governmental entity responsible for the control, supervision, monitoring and licensing of polluting activities, pursuant to State Law No. 997 of 1976 and State Law No. 13,542 of 2009. 

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The control and environmental planning instruments are defined by several legal instruments, such as State Law No. 997/1976, which regulates environmental pollution control; CONAMA Resolution No. 05/1988, which requires licensing of sanitation projects that cause significant alterations to the environment; CONAMA Resolution No. 237/1997, which regulates (i) environmental licenses, (ii) federal, state and local jurisdiction over environmental issues, (iii) the list of activities subject to licensing, and (iv) environmental impact studies and reports; State Decree No. 47,400/2002 and related articles from State Law No. 9,509/1997 regarding environmental licensing; State Decree No. 8,468/76, CONAMA Resolution No. 357/2005, and CONAMA Resolution No. 397/08, which establish standards of quality for receiving bodies of water; Decreto Estadual 8,468/76 and CONAMA Resolution No. 430/11 which establish the standards for discharge of effluents; and Portaria Departamento de Águas e Energia Elétrica 717/96, which regulates the concession of grants for the right to use water and rights to interfere in water resources. 

Projects with significant environmental impact are subject to specific studies prepared by multidisciplinary teams that present a series of recommendations focused on minimizing the environmental impact.  These studies are then submitted for analysis and approval by the government authorities.  The licensing process is composed of three stages, including the following licenses:   

·                     preliminary license – granted in the planning stage, approving the location and concept and attesting to the project’s environmental feasibility;

·                     installation license – authorizing the beginning of works for the installation of the project, subject to compliance with approved plans, programs and projects, including environmental control measures and other necessary technical requirements; and

·                     operation license – authorizing the operation of a unit or activity, subject to compliance with the technical requirements contained in the installation license.

We have been implementing a program (Programa Corporativo de Manutenção e Obtenção do Licenciamento Ambiental) since 2010, in order to comply with environmental regulation by 2016.  As of the date of this annual report, we were not in possession of all licenses required in connection with our operations.   

Sewage Requirements

State law sets forth regulations regarding pollution control and environmental preservation in the State of São Paulo.  According to this law, in areas in which there is a public sewage system, all effluents of a “polluting source” must be discharged to such system, as is the case for industrial enterpresises.  It is the responsibility of the polluting source to connect itself to the public sewage system.  All effluents to be discharged are required to meet the standards and conditions established by the applicable environmental law, which allows such effluents to be treated by our treatment facilities and discharged in an environmentally safe manner.  Effluents that do not comply with such criteria are prohibited from being discharged into the public sewage system.  State legislation also establishes that liquid effluents, except those related to basic sanitation, be subjected to pre‑treatment so that they meet the required mandatory levels before being discharged into the public sewage system.  Effluents from our treatment facilities must comply with effluent limitation guidelines and meet the water quality standards of the receiving water bodies established by federal and state legislation.  See “—Sewage Operations—Sewage System”.

The CETESB is authorized under State law to monitor discharges of effluents into the water bodies, among other things.  The CETESB also issues the environmental licenses to the polluting sources, including sewage treatment stations.  For more information, see “Item 4.B. Business Overview—Environmental Matters.”

State and federal water resource legislation establishes the charging of fees for the discharge of treated effluents into water bodies.  This charge is already in force for some water basins, and it is in different implementation stages for the remaining basins.  See “—Government Regulation—Water Usage.”

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Governmental Restrictions on Incurrence of Debt

On June 30, 1998, the CMN issued Resolution No. 2,515/98 amending certain conditions that must be observed with respect to external credit operations (i.e., foreign currency borrowings) of states, the Federal District of Brasilia, municipalities and their respective autarquias (agencies), foundations and non‑financial companies, including us.  This resolution provides, among other things, that, with certain exceptions applicable to the importation of goods and services:

·                     the proceeds of external credit operations must be exclusively used to refinance outstanding financial obligations of the borrower, with preference given to those obligations that have a higher cost and a shorter term, and, until used for such purposes, the proceeds shall remain deposited, as directed by the Central Bank, in a pledged account; and

·                     the total amount of the contractual obligation must be subject to monthly deposits in a pledged account, equal to the total debt service obligation, including principal and interest, divided by the number of months that the obligation is to be outstanding.

The CMN resolution further provides that the requirements described above do not apply to financing transactions involving multilateral or official organizations such as the International Bank for Reconstruction and Development, or IBRD, the IADB or the JICA.  The Central Bank regulation implementing this resolution provides, among other things, that the account referred to in the first bullet point above must be an account opened in a federal financial institution, which is to hold such funds until released for the purpose of refinancing outstanding obligations of the borrower.  The Central Bank regulation further provides that the account described in the second bullet point above must be an escrow account to be opened in a federal financial institution and to secure the payment of principal and interest on the external debt.

Our foreign currency‑denominated transactions are also subject to the approval of the National Secretariat of Treasury (Secretaria do Tesouro Nacional) and the Central Bank.  After reviewing the financial terms and conditions of the transaction, the National Secretariat of Treasury and the Central Bank will issue an approval for the closing of the foreign exchange transaction relating to the entry of the funds into Brazil and, following such entry and at our request, an electronic certificate of registration through which all scheduled payments of principal, interest and expenses will be remitted by us.  The electronic certificate of registration grants the borrower access to the market for foreign exchange.

Lending Limits of Brazilian Financial Institutions

The CMN Resolution No. 2,827 dated as of March 30, 2001, as amended, limits the amount that Brazilian financial institutions may lend to public sector companies, such as us.  Financing of projects which are put up for international bid and any financing in reais provided to the Brazilian counterpart of such international bids are excluded from these limits.

Scope of Business

State Law No. 12,292, dated as of March 2, 2006, and amended State Law No. 119, dated as of June 29, 1973, which created our Company, authorizes us to provide water and sewage services outside São Paulo (in other states of Brazil and other countries).  This law also authorizes us to own interests in other public or private‑public companies and Brazilian or international consortia.  In addition, this law permits us to incorporate subsidiaries and enter into a partnership with or acquire interests in a private company with a corporate purpose related to the sanitation business.

C.      Organizational structure

Not applicable.

 

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D.      Property, Plant, Equipment and Intangible Assets

Our principal property, plant and equipment comprise administrative facilities which are stated at historical costs less depreciation.  The reservoirs, water treatment facilities, water distribution networks consisting of water pipes, water transmission lines, water connections and water meters, sewage treatment facilities, and sewage collection networks consisting of sewer lines and sewage connections are recorded as intangible assets (concession assets).  As of December 31, 2013, we operated through 69,619 kilometers of water pipes and water transmission lines and 47,103 kilometers of sewer lines.  As of that same date, we operated 232 water treatment facilities and 509 sewage treatment facilities (including nine ocean outfalls), as well as 16 water quality control laboratories.

We own our headquarters building and all other major administrative buildings.  We have pledged some of our properties as collateral to the federal government in connection with a long‑term financing transaction we have entered into with the IBRD that was guaranteed by the federal government.  As of December 31, 2013, we held assets in the amount of R$249.0 million pledged as collateral to the Special Program for Payment of Federal and Social Security Related Taxes in Installments (Programa de Parcelamento Especial para Impostos Federais e Previdenciários), or PAES program.  The debt owed to the PAES Program was entirely paid in 120 months, and the last installment was paid on June 28, 2013.

As of December 31, 2013, the total net book value of our property, plant and equipment and intangible assets (including concession assets) was R$24,045.7 million.

All of our material properties are located in the State of São Paulo.

ITEM 4A.             UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 5.            OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our audited financial statements included elsewhere in this annual report.  The financial statements included elsewhere in this annual report have been prepared in accordance with IFRS as issued by the IASB.  This annual report contains forward‑looking statements that involve risks and uncertainties.  Our actual results may differ materially from those discussed in the forward‑looking statements as a result of various factors, including, without limitation, those set forth in “Risk Factors.”

In the following discussion, references to increases or decreases in any period are made by comparison with the corresponding prior period, except as the context otherwise indicates.

A.      Operating and Financial Review and Prospects

Overview

As of December 31, 2013, we operated water and sewage systems in the State of São Paulo, including in the city of São Paulo, Brazil’s largest city, and in 362 municipalities in the State of São Paulo, which represented 56% of all municipalities in the State.  We also provided water services on a wholesale basis to six municipalities located in the São Paulo metropolitan region in which we did not operate water distribution systems. 

The São Paulo metropolitan region, which includes the city of São Paulo, is our most important service region.  With a total population of approximately 21 million, the São Paulo metropolitan region accounted for 73.2%, 74.2% and 74.0% of our gross operating revenue in 2013, 2012 and 2011 (excluding revenues relating to the construction of concession infrastructure), respectively.  As of December 31, 2013, 56.9% of the concession intangible assets reflected on our balance sheet were located in this region.  In an effort to respond to demand in the São Paulo metropolitan region and because the region represents the principal opportunity to increase our net operating revenue, we have concentrated a major portion of our capital expenditure program to expand the water and sewage systems and to increase and protect water sources in this region.  Our capital expenditure program is our most significant liquidity and capital resource requirement.

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Factors Affecting Our Results of Operations

Our results of operations and financial condition are generally affected by our ability to raise tariffs, control costs and improve productivity, general economic conditions in Brazil and abroad and, in some periods, meteorological conditions.

Our results of operations for the 2013, 2012 and 2011 fiscal years were affected by a provision for severance payments in the amount of R$21.3 million for employees who resigned in 2013, R$49.9 million in 2012 and R$47.0 million in 2011.

Effects of Tariff Increases

Our results of operations and financial condition are highly dependent upon our ability to increase tariffs for our water and sewage services.  Since the enactment of the Basic Sanitation Law in 2007, as a general rule, regulatory agencies are responsible for setting, adjusting and reviewing tariffs, taking into consideration, among other factors, the following:

·                     political considerations arising from our status as a State‑controlled company;

·                     anti‑inflation measures enacted by the federal government from time to time; and

·                     when necessary, the readjustment to maintain the original balance between each party’s obligation and economic gain (equilíbrio econômico‑financeiro) under the agreement.

Readjustment of our tariffs continues to be set annually and depend on the parameters established by the Basic Sanitation Law and ARSESP.  The guidelines also establish procedural steps and the terms for annual adjustments.  The annual adjustments must be announced 30 days prior to the effective date of the new tariffs. See “4.B. Business Overview – Tariffs.” 

The following table sets forth, for the periods indicated, the percentage increase of our tariffs, as compared to three inflation indexes:

 

Year ended December 31,

 

2013

2012

2011

Increase in average tariff(1)

5.8410%

5.2%

6.8%

Inflation – IPC – FIPE

3.88%

5.1%

5.8%

Inflation – IPCA

5.91%

5.8%

6.5%

Inflation – IGP‑M

5.51%

7.8%

5.1%

 

______________

(1)   See “Item 4.B. Business Overview—Tariffs” for addition information on tariff increases.

Sources:  Central Bank, Fundação Getulio Vargas, or FGV, and Fundação Instituto de Pesquisas Econômicas

Effects of Brazilian Economic Conditions

As a company with all of its operations in Brazil, our results of operations and financial condition are affected by general economic conditions in Brazil, particularly by the economic activity and the inflation rate.  For example, the general performance of the Brazilian economy may affect our cost of capital and inflation may affect our costs and margins.  The Brazilian economic environment has been characterized by significant variations in economic growth rates.  However, as our product is viewed as essential, our sales revenue has demonstrated high stability over the past three years.

General Economic Conditions

In 2011, Brazilian GDP increased 2.7% in comparison with 2010.  At that same year, Brazil had US$352 billion in currency reserves and its trade surplus was US$29.8 billion.  The average unemployment rate in Brazil’s principal metropolitan regions was 6% in 2011.

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In 2012, Brazilian GDP increased 0.9% in comparison with 2011.  At that same year, Brazil had US$378 billion in currency reserves and its trade surplus was US$19.4 billion.  The average unemployment rate in Brazil’s principal metropolitan regions was 5.5% in 2012, the lowest it has been since March 2002.

In 2013, Brazilian GDP increased 2.3% in comparison with 2012.  Also in 2013, Brazil had US$375 billion in currency reserves and its trade surplus was US$2.6 billion, the worst in 13 years, and its trade balance fell 86% in comparison with 2012.  The average unemployment rate in Brazil’s principal metropolitan regions was 5.4%, the lowest rate in history according to the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or IBGE.

Interest Rates

In 2011, until the month of August, the Central Bank continued increasing the SELIC rate, reaching 12.50% in July.  In the month of August, the Central Bank started decreasing the SELIC, closing 2011 at 11.00%.  This downward trend was maintained in 2012, with the SELIC rate closing the year of 2012 at 7.25%.  In 2013, the SELIC rate was kept at 7.25% until April, after which the Central Bank started to gradually raise it. The SELIC rate at December 31, 2013 was 9.9%.

With respect to our foreign currency-denominated debt, in 2013 we experienced stability in the cost of debt linked to floating interest rates as compared to 2012, but with an upward trend beginning in the second half of 2013. With regards to our fixed-rate foreign currency denominated capital market debt, the reduction in secondary market earnings in 2012 continued during the first half of 2013.  By the beginning of the third quarter, this yield rose, returning to 2010-2011 levels similar to those existing at the time of our 2010 Eurobond issuance.

We have not utilized any derivative financial instruments or any hedging instruments to mitigate interest rate fluctuations. However, we prioritize long term debt in foreign currency alongside multilateral organizations and official foreign government agencies and take advantage of market opportunities to preform “liability management” to reduce cost and anticipate refinancing situations.

Inflation

Inflation affects our financial performance by increasing our costs of services rendered and operating expenses.  Part of our real‑denominated debt is directly indexed to take into account the effects of inflation. Additionally, we are exposed to the mismatch between the inflation adjustment indices of our loans and financing and those of our receivables. Water supply and sewage service tariffs do not necessarily follow the increases in inflation adjustment and interest rates affecting our debt.  We cannot assure you that our tariffs will be increased, in future periods, to offset, in full or in part, the effects of inflation. 

Inflation adjustments derive from collections from or payment to third parties, as contractually required by law or court decision, and are recognized on an accrual basis. Inflation adjustments included in these agreements and decisions are not considered embedded derivatives, since they are deemed as inflation adjustments for us. See Notes 3.20, 4.3.1 and 26 of the Financial Statements for the impacts of inflation adjustments on our financial performance and debt.

Currency Exchange Rates

We had total foreign currency‑denominated indebtedness of R$3,698.6 million as of December 31, 2013, of which R$216.0 million relates to our current portion of our long-term foreign currency‑denominated obligations.  In the event of significant devaluations of the real in relation to the U.S. dollar or other currencies, the cost of servicing our foreign currency‑denominated obligations would increase as measured in reais, particularly as our tariff and other revenue is based solely in reais.  In addition, any significant devaluation of the real will increase our financial expenses as a result of foreign exchange losses that we must record.  In 2011, the 12.6% depreciation of the real against the U.S. dollar and the 18.6% depreciation of the real against the yen, respectively, led to a foreign exchange loss of R$382.3 million.  In 2012, the 8.94% depreciation of the real against the U.S. dollar offset by the 2.4% appreciation of the real against the yen, respectively, led to a foreign exchange loss of R$50.5 million.  In 2013, the 14.64% depreciation of the real  against the U.S. dollar offset by the 5.91% appreciation of the real  against the yen, respectively, led to a foreign exchange loss of R$267.8 million.  However, since most of our debt denominated in foreign currencies is long-term debt with a long amortization schedule, a devaluation of the real would principally impact cash flows regarding the current portion of our long-term debt.

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We manage our indebtedness portfolio closely to decrease the cost of servicing our indebtedness as a whole and our exposure to exchange rate fluctuations.  We do not speculate in foreign currencies, and we do not have any exposure to derivatives tied to foreign currencies.

The following table shows the fluctuation of the real against the U.S. dollar, the period‑end exchange rates and the average exchange rates as of or for the periods indicated:

 

Year ended December 31,

 

2013

2012

2011

Depreciation (appreciation) of the real versus U.S. dollar....

14.6%

8.9%

12.6%

Period‑end exchange rate – US$1.00

R$2.3426

R$2.0435

R$1.8758

Average exchange rate – US$1.00(1)

R$2.1605

R$1.9550

R$1.6746

 

______________

(1)   Represents the average for period indicated.

Source:  Central Bank.

The following table shows the fluctuation of the real against the yen, the period‑end exchange rates and the average exchange rates as of or for the periods indicated:

 

Year ended December 31,

 

2013

2012

2011

Depreciation (appreciation) of the real versus yen....

(5.9)%

(2.4)%

18.6%

Period‑end exchange rate – ¥1.00

R$0.0223

R$0.0237

R$0.0243

Average exchange rate – ¥1.00 (1)

R$0.0221

R$0.0245

R$0.0211

 

______________

(1)   Represents the average for period indicated.

Source:  Central Bank.

From time to time, we may enter into forward exchange transactions to mitigate foreign currency exposure.  In addition, we have monitored, overseen and controlled our foreign currency‑denominated indebtedness, taking advantage of market opportunities to improve the profile of our indebtedness and reduce our costs.  During the years ended December 31, 2013, 2012 and 2011 we had no forward exchange transactions.

Effects of Extreme Weather Events – Drought

We operate in a region of Brazil that has been prone to droughts, although historically droughts have not impacted all of our water supply systems equally.  Brazil experienced a prolonged and severe drought during 2000 and 2001.  As a result, from mid‑June to mid‑September of 2000, we rationed water in the south of the São Paulo metropolitan region, affecting approximately 3.5 million people, or approximately 20% of the total population of this region, which reduced our total water production by approximately 8%.  In March 2004 when our reservoirs were at extremely low levels, we implemented a water usage reduction bonus program.  After returning to normal rainfall levels, which occurred between 2004 and early 2005, the condition of our reservoirs improved.  In 2007 and 2008, rainfall exceeded the levels of previous years, increasing the volume of water held in our reservoirs and thereby providing a cushion to meet demand.   

Part of the Brazil’s Southeastern region, in particular the southern region of Minas Gerais State and the Piracicaba river basin, from which we extract the water used in the Cantareira System, and the northern area of the São Paulo metropolitan region have been experiencing below average rainfall since 2012, which worsened at the end of 2013 and beginning of 2014.  With rainfall significantly below average, there has been a reduction in the level of water stored during the rainy season, from October to March, in the reservoirs of the Cantareira System, which is the largest system of the São Paulo metropolitan region.  In order to minimize the effects of this drought, in February 2014, we approved a program that incentivizes water consumption reduction, based on a bonus system, pursuant to which customers who achieve their consumption reduction goal (20% water consumption reduction) will be entitled to a 30% discount on their service bill.  Initially, this incentive program was scheduled to last seven months from February 1, 2014 or until the water level in the reservoirs is normalized.  However, in April 2014 the incentive program was extended for the entire São Paulo metropolitan region until the end of 2014 or until the water level in the reservoirs is normalized.  For more information on droughts, see “Item 3.D Risk Factors—Risks Relating to Our Business—Droughts, the water consumption reduction program or other measures may result in a significant decrease in the volume of water billed and the revenues from services we provide, which may have a material adverse effect on our company.”

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As of December 31, 2013, the reservoirs in the São Paulo metropolitan region, where our largest market is located, had a utilization rate of 41%, compared to a 50.6% utilization rate as of December 31, 2012.

Critical Accounting Estimates and Judgments

We make estimates and judgments concerning the future.  The resulting accounting estimates will, by definition, seldom equal the related actual results.  The estimates and judgments that have a significant risk of causing material adjustment to the carrying amount of our assets and liabilities within the next financial year are mentioned below.

Allowance for Doubtful Accounts

We record an allowance for doubtful accounts in an amount that our management considers sufficient to cover probable losses, based on an analysis of customer accounts receivable, in accordance with the accounting policy stated in Note 3.4 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011.  Provisions for the allowance for doubtful accounts are included in selling expenses, net of recoveries.  The net charge to this allowance was R$103.9 million, R$192.3 million and R$120.3 million in 2013, 2012 and 2011, respectively.

The methodology for determining the allowance for doubtful accounts requires significant estimates, considering a number of factors, including historical collection experience, current economic trends, estimates of forecast write‑offs, the aging of the accounts receivable portfolio and other factors.  While we believe that the estimates used are reasonable, actual results could differ from those estimates.

Valuation of Long‑Lived Assets

As of December 31, 2013, we had property, plant and equipment and intangible assets of R$199.5 million and R$23,846.2 million, respectively.

Property, plant and equipment, intangibles and other noncurrent assets with definite useful lives, are reviewed annually for impairments or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  The Company does not have assets with indefinite useful lives and concluded that there are no indications of impairment losses.

We recognize intangible assets arising from concession contracts under IFRIC 12.  We estimate the fair value of construction and other work on the infrastructure to recognize the cost of the intangible asset, which is recognized when the infrastructure is built and provided that it will generate future economic benefits.  The great majority of the Company’s contracts for service concession arrangements entered with each grantor is under service concession agreements in which the Company has the right to receive, at the end of the contract, a payment equivalent to the unamortized asset balance of the concession intangible asset, which in this case, is amortized over the useful life of the underlying physical assets; thus at the end of the contract, the remaining value of the intangible would be equal to the residual value of the related physical asset.

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The fair value of construction and other work on the infrastructure is recognized as revenue, at its fair value, when the infrastructure is built, provided that this work is expected to generate future economic benefits.  The accounting policy for the recognition of construction revenue is described in Note 3.3 “Operating Revenue.”

Intangible assets related to concession agreements and program contracts, when there is no right to receive the residual value of the assets at the end of the contract, are amortized on a straight-line basis over the period of the contract or the useful life of the underlying asset, whichever is shorter.

Investments made and not recovered through rendering of services, within the terms of our agreement, must be indemnified by the concession grantor; (1) with cash or cash equivalents or also, in general, (2) with a contract extension.  These investments are amortized over the useful life of the asset.

Law 11445/07 prescribes that, whenever possible, basic sanitation public utilities shall have their economic and financial sustainability ensured through the consideration received from service collection, preferably as tariffs and other public charges, which may be established for each service or both.  Therefore, investments made and not recovered through these services, within the original term of the contract, are recorded as intangible assets and amortized over the useful life of the asset, taking into consideration a solid track record of concession renewal and, therefore, the continuity of services.

The recognition of fair value for the intangible assets arising on concession contracts is subject to assumptions and estimates, and the use of different assumptions could affect the balances recorded.  The amortization of intangible assets and estimated useful lives of the underlying assets also requires significant assumptions and estimates, which different assumptions and estimates, and changes in future circumstances, could affect amortization of intangible assets and remaining useful lives of the underlying assets and can have a significant impact on the results of operations.

Provision

As of December 31, 2013, we were party to judicial and administrative proceedings, relating to civil, environmental and tax matters, amounting to R$1,180.4 million (deducting the amount of R$309.5 million related to escrow deposits) with respect to which we considered the risk of loss as probable.  As of that date, proceedings with respect to which we considered the risk of loss as possible amounted to R$3,244.5 million, and those with respect to which we considered the risk of loss as remote amounted to R$34,179.7 million.

We are a party to a number of legal proceedings involving significant monetary claims.  These legal proceedings include, among other types, disputes with customers and suppliers and tax, labor, civil, environmental and other proceedings.  For a more detailed discussion of these legal proceedings, see Note 18 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011.  We accrue for probable losses resulting from these claims and proceedings when we determine that the likelihood that a loss has occurred is probable and the amount of such loss can be reasonably estimated.  Therefore, we are required to make judgments regarding future events for which we often seek the advice of legal counsel.  As a result of the significant judgment required in assessing and estimating these provisions for risks, actual losses realized in future periods could differ significantly from our estimates and could exceed the amounts which we have provisioned.

Pension Benefits

The present value of the pension obligations depends on a number of factors that are determined on an actuarial basis using a number of assumptions.  The assumptions used in determining the net cost (income) for pensions include a discount rate and a mortality table.  Any changes in these assumptions will impact the carrying amount of pension obligations.

We determine the appropriate discount rates at the end of each year, which is the interest rate that should be used to determine the present value of estimated future cash outflows expected to be required to settle the pension obligations.  The discount rate was increased from 4.0% in 2012 to 6.46% in 2013 under Plan G0 and from 4.1% in 2012 to 6.36% in 2013 under Plan G1 in order to follow the decrease in the rates applicable to the Brazilian Government NTN – B, long term notes, which term is similar to the duration of the pension benefits, as described in Notes 3.19 (a) and 19 (b) to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011.

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Other key assumptions for pension obligations are based in part on current market conditions.  Additional information on the pension plans under Plan G0 and G1is disclosed in Note 19.

Deferred income tax and social contribution

The Company recognizes and settles taxes on income based on the results of operations verified according to the Brazilian Corporate Law, taking into consideration the provisions of the tax laws.  Pursuant to IAS 12, the Company recognizes deferred tax assets and liabilities based on the differences between the accounting balances and the tax bases of assets and liabilities. 

The Company regularly reviews the recoverability of deferred tax assets and recognizes a provision for impairment if it is probable that these assets will not be realized, based on historic taxable income, the projection of future taxable income and the estimated period to reverse temporary differences.  These calculations require the use of estimates and assumptions.  The use of different estimates and assumptions could result in provision for impairment of all or a significant amount of deferred tax assets.

As of December 31, 2013 and 2012, we have recognized R$114.0 million and R$145.3 million, respectively, as deferred income tax assets, net of the deferred tax liabilities, as disclosed in Note 17 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011.

Certain Transactions with Controlling Shareholder

Reimbursement Due from the State

Reimbursement due from the State for pensions paid represent supplementary pensions (Plan G0) that we pay, on behalf of the State, to former employees of State‑owned companies which merged to form our Company.  These amounts must be reimbursed to us by the State, as primary obligor.

In November 2008, we entered into the third amendment to the agreement with the State relating to payments of pension benefits made by us on its behalf.  The State acknowledged that it owed us an outstanding balance of R$915.3 million as of September 30, 2008, relating to payments of pension benefits made by us on its behalf.  We provisionally accepted, but it is not recognized in our books, the reservoirs in the Alto Tietê System as partial payment in the amount of R$696.3 million, subject to the transfer of the property rights of these reservoirs to us.  Since November 2008, the State has been paying the remaining balance in the amount of R$219.0 million in 114 successive monthly installments.  See Note 9 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 and “Item 7.  Major Shareholders and Related Party Transactions.”

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As of December 31, 2013 and 2012, the amounts not recorded related to pension benefits paid on behalf of the State by the Company, totaled R$1,412.5 million and R$1,351.2 million respectively, including the amount of R$696.3 million related to the transfer of the reservoirs in the Alto Tietê system. As a result, the Company also recognized the obligation related to pension benefits, maintained with the beneficiaries and pensioners of Plan G0. As of December 31, 2013 and 2012, the pension benefit obligations of Plan G0 totaled R$1,780.3 million and R$1,987.7 million, respectively. For detailed information on the pension benefit obligations refer to Note 19 of our Financial Statements.

Accounts Receivable from the State for Water and Sewage Services Rendered

Certain of these accounts receivable have been overdue for a long period.  We have entered into agreements with the State with respect to these accounts receivable.  For further information on these agreements, see Note 9 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 and “Item 7. Major Shareholders and Related Party Transactions.”

Use of Certain Assets

Empresa Metropolitana de Águas e Energia S.A. – EMAE plans to receive credit and to obtain financial compensation for the use of water from the Guarapiranga and Billings reservoirs, which we use in our operations, as well as reimbursement of damages related to non-payment in due course.

We understand that no amounts are due for the use of these reservoirs given the grants already made.  Should these reservoirs not be available for our use, there could be a need to collect water in more distant locations and a risk of not being able to properly render services in the region and an increase in water supply cost.

Several lawsuits were filed by EMAE, among them a lawsuit to enforce an arbitration clause related to the Guarapiranga reservoir, a proceeding which has already begun and another lawsuit, pleading for financial compensation due to our water abstraction from the Billings reservoir for public supply.  These two lawsuits allege that this conduct has caused permanent and increasing loss in the capacity of the Henry Borden hydroelectric power plant to generate electricity as well as financial losses.

We understand that the expectation for all cases is of possible losses, and for the time being, it is not feasible to estimate the amounts involved, since they were not determined.

On April 10, 2014, we issued an Announcement to the Market to communicate that we are negotiating with EMAE regarding a potential future agreement.  However, no adjustment has been confirmed, and no agreement has been executed by either party as of yet.

Results of Operations

The following table sets forth, for the periods indicated, certain items in our statement of operations, each expressed as a percentage of net operating revenues:

 

Year ended December 31,

 

2013

2012

2011

 

(in millions of reais, except percentages)

Net operating revenues

11,315.6

100.0%

10,737.6

100.0%

9,927.4

100.0%

Cost of sales and services

(6,816.3)

(60.2)%

(6,449.9)

(60.1)%

(6,018.7)

(60.6%)

Gross profit

4,499.3

39.8%

4,287.7

39.9%

3,908.7

39.4%

Selling expenses

(637.1)

(5.6)%

(697.3)

(6.5)%

(619.3)

(6.2%)

Administrative expenses

(729.1)

(6.4)%

(717.4)

(6.7)%

(683,6)

(6.9%)

Other operating income (expenses), net

5.7

(0.1)%

(29.7)

(0.3)%

(93.8)

(0.9%)

Operating profit

3,138.8

27.7%

2,843.3

26.5%

2,512.0

25.3%

Financial income (expenses), net.

(483.2)

(4.3)%

(295.7)

(2.8)%

(633.0)

(6.4%)

Profit before income tax and social contribution

2,655.6

23.5%

2,547.6

23.7%

1,879.0

18.9%

Income tax and social contribution

(732.0)

(6.5)%

(635.7)

(5.9)%

(498.1)

(5.0%)

Net income for the year

1,923.6

17.0%

1,911.9

17.8%

1,380.9

13.9%

                                                                                                     

 78


 
 

 

 

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

        We restated our financial statements as of and for the years ended December 31, 2012 and 2011 as a result of the adoption, as of January 1, 2013, of two new standards issued by the IASB: IAS 19 (Employee Benefits – as revised in 2011) and IFRS 11 (Joint Arrangements).  These new standards were applied retrospectively to 2012 and 2011 pursuant to IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors) for comparison purposes.  The adoption of these new standards impacted several line items of our financial statements.  One of these impacts relates to the method of accounting for the results of joint-ventures, which are now recognized using the equity method of accounting instead of the proportional consolidation method we used prior to the adoption of the IFRS 11.  See note 4.1 to our financial statements for a description of these standards and their impact on our financial statements.

Net operating revenues

Net operating revenues increased by R$578.0 million, or 5.4%, to R$11,315.6 million in 2013 from R$10,737.6 million in 2012.

Net operating revenues relating to water services increased by R$323.7 million, or 7.1%, to R$4,906.0 million in 2013 from R$4,582.3 million in 2012.  This increase was principally due to:

·                     an average 2.6% increase in the volume of water invoiced in 2013; and

·                     the effect of the 5.15% tariff increase in September 2012, 2.35% tariff adjustment in April 2013 and 3.1% tariff adjustment in December 2013.

Net operating revenues relating to sewage services increased by R$274.0 million, or 7.4%, to R$3,964.9 million in 2013 from R$3,690.9 million in 2012.  This increase was principally due to:

·                     an average 2.9% increase in the volume of sewage services invoiced in 2013; and

·                     the effect of the 5.15% tariff increase in September 2012, 2.35% tariff adjustment in April 2013 and 3.1% tariff adjustment in December 2013.

Gross revenue from construction decreased by R$19.7 million, or 0,8%, to R$2,444.8 million in 2013 from R$2,464.5 million in 2012.  See Note 3.3(b) to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 for a description of the accounting policies applicable to our construction services business.

Cost of Sales and Services

The cost of sales and services increased by R$366.4 million, or 5.7%, to R$6,816.3 million in 2013 from R$6,449.9 million in 2012.  As a percentage of net operating revenues, cost of sales and services increased to 60.2% in 2013 from 60.1% in 2012.

The increase in costs of sales and services was principally due to the following factors:

·                     an increase of R$147.3 million or 11.7%, in salaries and related charges due to the following factors: (i) an increase of 6.17% in salaries since May 2012 and 8.0%  since May 2013 associated to the implementation of the Company’s new job and salary plan, which had an impact of approximately R$109.3 million; and (ii) the increase in the provision for pension plan expenses, amounting to R$22.1 million, due to changes in actuarial assumptions;

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·                     an increase of R$95.2 million in depreciation and amortization, due to the increase in operating intangible assets in 2013, arising mainly from input of the works in operation;

·                     an increase of R$63.2 million or 35.6% in expenses related to water-treatment materials, mainly due to increased consumption and the substitution of water-treatment products in order to meet increased demand while maintaining the same efficiency levels in water treatment;

·                     an increase of R$62.0 million in costs of outsourced services, mainly due to: (i) preventive and corrective sewage system maintenance in the amount of R$17.7 million; (ii) environmental compensation with the beach recovery service in the amount of R$9.4 million; (iii) expenses related to consulting, advisory, and specialized services, which amounted to R$9.3 million; (iv) preventive and corrective maintenance in the water sewage operating systems in the amount of R$9.2 million; and (v) services provided for conservation of property and operating facilities in the amount of R$5.9 million , due to increase in areas being monitored; and

·                     an increase of R$21.2 million payable incurred on expropriations, mainly to honor the commitments assumed with the municipality of Paraguaçu Paulista.

These increases were partially offset by a decrease of R$36.5 million, in the cost of electricity, mainly due to the decrease in the Tariff for the Use of Distribution System (TUSD), as a consequence of Provisional Presidential Decree 579/12 and Law 12,783/13.

Gross Profit

As a result of the factors discussed above, gross profit for the year ended December 31, 2013 increased by R$211.6 million, or 4.9%, from R$4,287.7 million in 2012 to R$4,499.3 in 2013.  As a percentage of net operating revenues, gross profit decreased to 39.8% in 2013 from 39.9% in 2012.

Selling Expenses

Selling expenses decreased by R$60.2 million, or 8.6%, to R$637.1 million in 2013 from R$697.3 million in 2012.  As a percentage of net operating revenues, selling expenses decreased to 5.6% in 2013 from 6.49% in 2012.

The decrease in selling expenses was principally due to the account receivables allowance for losses, due to the higher recovery of amounts in 2013, under installment agreements.

This decrease was partially offset by an increase of R$18.7 million in salaries and related charges, due to the 6.17% in salaries since May 2012 and 8.0%  since May 2013 associated to the implementation of the Company’s new job and salary plan, which had an impact of approximately R$12.5 million.

Administrative Expenses

Administrative expenses increased by R$11.7 million, or 1.6%, to R$729.1 in 2013 from R$717.4 million in 2012.  As a percentage of net operating revenues, administrative expenses decreased to 6.4% in 2013 from 6.7% in 2012.

The increase in administrative expenses was principally due to the following factors:

·                     an increase of R$34.6 million in amortization costs of software in 2013;

·                     an increase of R$22.2 million in salaries and related charges due to the following factors: (i) an increase of 6.17% in salaries since May 2012 and 8.0%  since May 2013 associated with the implementation of the Company’s new job and salary plan, which had an impact of approximately R$7.8 million; and (ii) the increase in the provision for pension plan expenses, amounting to R$13.5 million, due to changes in actuarial assumptions;

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·                     an increase  in tax expenses of R$7.3 million, or 12.0% due to: (i) regulatory tax to ARSESP in the amount of R$4.3 million; and (ii) R$1.0 million in income tax on remittances abroad as a result of the local currency depreciation in 2013.

The increase was partially offset by the following:

·                     a decrease of R$28.9 million, or 19.9% mainly on services provided by third parties relating to advertising campaigns,  in the amount of R$29.4 million;

·                     a decrease of R$25.3 million in general expenses, mainly due to the expenses on judicial proceedings in the amount of R$14.2 million.

Other Operating Income (Expenses), Net

Other operating income (expenses), net, decreased by R$35.4 million, or 119.2%, to R$5.7 million income in 2013 from R$29.7 million expense in 2012.  Other operating expenses showed a decrease of R$37.5, or 40.9%, mainly due to the provision for losses for the indemnification of assets related to the concession for the municipality of Diadema, in the amount of R$60.3 million in 2012.  The decrease was partially offset by the asset write-offs related to asset obsolescence, in the amount of R$17.8 million in 2013.

Financial income (expenses), net

Financial income (expenses), net, consists primarily of interest on our indebtedness and foreign exchange losses (or gains) in respect of our indebtedness, offset partially by interest income on cash and cash equivalents and inflation based indexation accruals, mainly relating to agreements entered into with some customers to settle overdue accounts receivable.

Financial income (expenses), net increased by R$187.5 million, or 63.4%, to a R$483.2 million expense in 2013 from a R$295.7 million expense in 2012.  As a percentage of net operating revenues, financial income (expenses), net increased to 4.3% in 2013 from 2.80% in 2012.

The increase in financial income (expenses), net was principally due to:

·                     an increase in foreign exchange losses related to loans and financing of R$217.3 million as a result of the 14.6% depreciation of the real against the U.S. dollar in 2013, compared to a depreciation of 8.9% of the real against the U.S. dollar in 2012;

·                     an increase of R$38.1 million in expenses with inflation adjustment on loans and internal financings, mainly relating to the seventeenth and eighteenth debentures issued in February and December 2013, respectively.

The increase in financial income (expenses), net was partially offset by:

·                     an increase of R$34.3 million in finance income, mainly due to the investment of interest earned on installment payment plans, and to the interest on the seventeenth and eighteenth debentures issued; and

·                     a decrease of R$10.0 million interest expenses on local loans and financing, mainly due to the repayment of the debt to Banco do Brasil in 2013, in the of R$380.7 million, associated to the change in debt (issue of the seventeenth debenture in February 2013 and anticipation of the amortization of the 11th debenture balance).

Profit before income tax and social contribution

As a result of the factors discussed above, profit before income tax and social contribution increased by 4.2%, to R$2,655.6 million in 2013 from R$2,547.6 million in 2012.  As a percentage of net operating revenues, our profit before income tax and social contribution decreased to 23.5% in 2013 from 23.7% in 2012.

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Income Tax and Social Contribution

Income tax and social contribution increased by R$96.3 million, or 15.1%, to R$732.0 million in 2013 from R$635.7 million in 2012.  This increase was principally due to a higher taxable income in 2013.

Net Income for the year

As a result of the factors discussed above, net income increased to R$1,923.6 million in 2013 from R$1,911.9 million in 2012.  As a percentage of net operating revenues, our net income decreased to 17.0% in 2013 from 17.8% in 2012.

 

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Net operating revenues

Net operating revenues increased by R$810.2 million, or 8.2%, to R$10,737.6 million in 2012 from R$9,927.4 million in 2011.

Net operating revenues relating to water services increased by R$309.2 million, or 7.2%, to R$4,582.3 million in 2012 from R$4,273.1 million in 2011.  This increase was principally due to:

·                     an average 2.4% increase in the volume of water invoiced in 2012; and

·                     the effect of the 6.83% tariff increase in September 2011, and the 5.15% tariff increase in September 2012.

Net operating revenues relating to sewage services increased by R$261.2, or 7.6%, to R$3,690.9 million in 2012 from R$3,429.7 million in 2011.  This increase was principally due to:

·                     an average 3.2% increase in the volume of sewage services invoiced in 2012; and

·                     the effect of the 6.83% tariff increase in September 2011, and the 5.15% tariff increase in September 2012.

Gross revenue from construction increased by R$239.9 million, or 10.8%, to R$2,464.5 million in 2012 from R$2,224.6 million in 2011.  See Note 3.3 (b) to our financial statements as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 for a description of the accounting policies applicable to our construction services business.

Cost of Sales and Services

The cost of sales and services increased by R$431.2 million, or 7.2%, to R$6,449.9 million in 2012 from R$6,018.7 million in 2011.  As a percentage of net operating revenues, cost of sales and services decreased to 60.1% in 2012 from 60.6% in 2011.

The increase in costs of sales and services was principally due to the following factors:

·                     an increase in construction costs of R$237.5 million, or 10.9%, compared with the previous year.  Such change was mainly due to higher investment in 2012;

·                     an increase of R$92.6 million, or 8.2%, in salaries and related charges due to the following factors:  (i) an increase of 6.17% in salaries since May 2012, resulting in an increase of approximately R$88.7 million; and (ii) an increase in the provision we made for termination benefits, in the amount of R$17.2 million, due to a higher number of employees requesting retirement and the adoption of a new law, which increased the required notice from 30 to 90 days in cases of dismissal without cause.  These increases were partially offset by a decrease in the actual cost with respect to the actuarial calculation in 2012 related to our defined contribution plan in the amount of R$12.5 million;

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·                     an increase of R$56.3 million, or 8.4%, in costs of outsourced services, mainly due to:  (i) vehicle rentals in the amount of R$22.9 million;  (ii) the R$17.0 million increase in the Alto Tietê PPP due to the initiation of operations in September 2011; (iii) services of maintenance and repositioning of pavement in the amount of R$13.7 million, as part of intensified efforts to prevent water losses; (iv) expenses related to the security of our assets in the amount of $14.9 million, due to increases in equipment purchases and areas being monitored; and (v) water and sewage systems maintenance, which amounted to R$5.9 million.  The increase in costs of outsourced services was partially offset by a decrease of R$19.7 million related to socio‑environmental programs established pursuant to an agreement with the municipality of São Paulo;

·                     an increase of R$31.5 million, or 8.5%, in general expenses, mainly due to:  (i) the R$22.1 million provision pursuant to our service agreement with the municipality of São Paulo and (ii) beginning in February 2012, charges for water usage in the Baixada Santista reservoir, amounting to R$6.9 million;

·                     an increase of R$22.7 million, or 14.7%, in water-treatment expenses, mainly due to increased consumption and the substitution of water-treatment products in order to meet increased demand while maintaining the same efficiency levels in water treatment;

·                     an increase of R$21.9 million, or 14.9%, in maintenance expenses, mainly due to:  (i) preventive and corrective maintenance of the water and sewage operation systems in the amount of R$8.7 million and (ii) maintenance of water and sewage network connections in the amount of R$7.2 million; and

·                     an increase of R$5.8 million, or 1%, in the cost of electricity due to increased consumption and higher energy tariffs.  This increased consumption and increase in tariffs was partially offset by a discount of 15%, on the fees for usage of distribution systems related to basic sanitation applied since September 2011.

These increases were partially offset by a decrease of R$24.0 million, or 3.2%, in depreciation and amortization expenses, which decreased from R$739.0 million to R$715.1 million, mainly due to the revision in the amortization criteria occurred in 2011 of intangible assets in connection with our service agreement with the municipality of São Paulo.

Gross Profit

As a result of the factors discussed above, gross profit for the year ended December 31, 2012 increased by R$379.0 million, or 9.7%, from R$3,908.7 million in 2011 to R$4,287.7 million in 2012.  As a percentage of net operating revenues, gross profit increased to 39.9% in 2012 from 39.4% in 2011.

Selling Expenses

Selling expenses increased by R$78.0 million, or 12.6%, to R$697.3 million in 2012 from R$619.3 million in 2011.  As a percentage of net operating revenues, selling expenses increased to 6.49% in 2012 from 6.2% in 2011.

The increase in selling expenses was principally due to the following factors:

·                     an increase of R$72.0 million, or 59.9%, from R$120.3 million in 2011 to R$192.2 million in 2012, mainly due to account receivables allowance for losses.  This increase was due mainly to additional provisions of R$14.4 million related to private clients, R$8.8 million related to municipal entities and R$35.1 million related to state entities;

·                     an increase of R$3.5 million or 1.7%, in expenses related to outsourced services mainly due to new billing technology related to the reading of usage, issuance of bills and delivering bills, which cost approximately R$11.3 million, in addition to an increase in the number of connections and inflation adjustments of the contracts in the metropolitan region of São Paulo.  This increase was partially offset by:  a decrease of R$4.5 million resulting from reduced services provided related to the implementation of the Rationed Water Use Program (“Programa de Uso Racional da Água” or “PURA”) in city schools; and

·                     an increase of R$4.0 million, or 2.1%, in personnel salaries and related charges as a result of:  a 6.17% salary readjustments as of May 2011, which had an impact of approximately R$2.7 million.

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Administrative Expenses

Administrative expenses increased by R$33.8 million, or 4.9%, to R$717.4 million in 2012 from R$683.6 million in 2011.  As a percentage of net operating revenues, administrative expenses decreased to 6.7% in 2012 from 6.9% in 2011.

The increase in administrative expenses was principally due to the following factors:

·                     an increase in outsorced service expenses in the amount of R$22.2 million, or 18.0%, mainly on services provided by third parties relating to:  (i) advertising campaigns focused on socio-environmental programs, in the amount of R$16.7 million and (ii) engagement of consultants and specialized service providers, in the amount of R$5.6 million;

·                     an increase in tax expenses in the amount of R$6.8 million, or 11.1%, due to:  (i) R$3.7 million in property taxes and (ii) regulatory tax to ARSESP in the amount of R$3.2 million.

The decrease was partially offset by the following:

·                     a decrease of R$6.7 million, or 30.3%, in amortization costs of software in 2012.

Other Operating Income (Expenses), Net

Other operating income (expenses), net, decreased by R$64.1 million, or 68.3%, to R$29.7 million expense in 2012 from R$93.8 million expense in 2011.  Other operating expenses showed a decrease of R$67.1 million, or 74.3%, mainly due to:  (i) provision for losses related to an indemnificatory liability related to the concession for the municipality of Mauá in the amount of R$85.9 million in 2011, (ii) asset write‑offs in 2011 related to asset obsolescence, in the amount of R$35.3 million, and (iii) write-offs in 2011 relating to studies and projects that were not economically viable in the amount of R$6.1 million.  These decreases were partly offset by the provision for losses for the indemnification of assets related to the concession for the municipality of Diadema, in the amount of R$60.3 million in 2012.

Financial income (expenses), net

Financial income (expenses), net, consists primarily of interest on our indebtedness and foreign exchange losses (or gains) in respect of our indebtedness, offset partially by interest income on cash and cash equivalents and inflation based indexation accruals, mainly relating to agreements entered into with some customers to settle overdue accounts receivable.

Financial income (expenses), net decreased by R$337.3 million, or 53.3%, to a R$295.7 million expense in 2012 from a R$633.0 million expense in 2011.  As a percentage of net revenues from sales and services, financial income (expenses), net decreased to 2.8% in 2012 from 6.4% in 2011.

The decrease in financial income (expenses), net was principally due to:

·                     a decrease in foreign exchange loss related to loans and financing of R$331.8 million as a result of the 8.9% depreciation of the real against the U.S. dollar in 2012, compared to a depreciation of 12.6% of the real against the U.S. dollar in 2011, and the 2.4% appreciation of the real against the Japanese Yen in 2012, compared to a depreciation of 18.6% of the real against the Japanese Yen in 2011; 

·                     a decrease of R$48.7 million in interest expenses mainly due to the amortization of our eighth, ninth and thirteenth debentures in June and October 2011, and February 2012, respectively;

·                     a decrease of R$46.4 million in expenses relating to judicial proceedings mostly involving clients; and

·                     a decrease of R$34.8 million in inflation adjustments, mainly relating to our contracts with municipalities.

The decrease in financial income (expenses), net was partially offset by:

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·                     a decrease in interest rates related to our cash positions, in the amount of R$108.9 million, or 40.1%; and

·                     a decrease of R$22.8 million in the inflation adjustments, mainly due to amounts received as a result of the concession of the exclusive rights concerning the deposit of salaries of our employees in 2011.

Profit before income tax and social contribution

As a result of the factors discussed above, profit before income tax and social contribution increased by 35.6%, to R$2,547.6 million in 2012 from R$1,879.0 million in 2011.  As a percentage of net operating revenues, our profit before income tax and social contribution increased to 23.7% in 2012 from 18.9% in 2011.

Income Tax and Social Contribution

Income taxes increased by R$137.6 million, or 27.6%, to R$635.7 million in 2012 from R$498.1 million in 2011.  This increase was principally due to a higher taxable income in 2012.

Net Income for the year

As a result of the factors discussed above, net income increased to R$1,911.9 million in 2012 from R$1,380.9 million in 2011.  As a percentage of net operating revenues, our net income increased to 17.8% in 2012 from 13.9% in 2011.

B.      Liquidity and Capital Resources

Capital Sources

In order to satisfy our liquidity and capital requirements, we have primarily relied on cash provided by operating activities, long-term borrowings from Brazilian federal governmental financial institutions, and long-term financing from multilateral organizations and from domestic and international development banks, and also from capital markets.  As of December 31, 2013, we had R$1,782.0 million of cash and cash equivalents.  The outstanding current portion of our long-term indebtedness was R$641.0 million as of December 31, 2013, of which R$216.0 million was denominated in foreign currency.  Long‑term indebtedness was R$8,809.1 million as of December 31, 2013, of which R$3,482.6 million consisted of foreign currency-denominated obligations.  We believe that we have sufficient sources of liquidity and capital to meet our liquidity and capital requirements for the next few years, in light of our current financial position and our expected cash generated by operating activities.

Cash Flow

Cash Provided by Operating Activities

Cash provided by operating activities is the single largest source of our liquidity and capital resources, and we anticipate that it will continue to be so in the future.  Our cash generated by operating activities was R$2,777.2 million, R$2,343.2 million and R$2,698.6 million in 2013, 2012 and 2011, respectively.  The main driver of our cash flow from operating activities relates to our strong revenue stream, which is due to the nature of our business and to the fact that we are expanding our infrastructure.

Cash Used in Investing Activities

Our cash used in investing activities was R$2,281.5 million, R$1,996.7 million and R$1,883.2 million in 2013, 2012 and 2011, respectively. The main driver of our cash flow from investing activities relates to the purchases of intangibles assets, as required under our concession and program contracts, which is due to the fact that we are expanding our infrastructure and service coverage.

Cash Used in Financing Activities

Our cash used in financing activities was R$629.7 million, R$572.7 million and R$661.3 million in 2013, 2012 and 2011, respectively. The main driver of our cash flow from financing activities relates to the proceeds and repayments of loans used to finance purchases of intangible assets related to our concession and program contracts, in order to support the expansion of our services and our payment of interest on shareholders’ equity.

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Indebtedness Financing

Our total financial indebtedness increased by 6.5%, from R$ R$8,875.3 million as of December 31, 2012 to R$9,450.1 million as of December 31, 2013.  In addition, during the same period, our total foreign denominated indebtedness recorded increased by 15.0%, from R$3,215.8 million as of December 31, 2012 to R$3,698.6 million as of December 31, 2013. 

As of December 31, 2013, we had R$8,809.1 million in long-term indebtedness outstanding (excluding the current portion of long-term indebtedness), of which R$3,482.6 million consisted of foreign currency-denominated long-term debt.  We had an outstanding current portion of long-term indebtedness of R$640.9 million as of December 31, 2013.  As of December 31, 2013, R$216.0 million of this current portion of long-term indebtedness was denominated in foreign currency.  As of December 1, 2013, our Standard & Poor’s Rating Service domestic rating was brAA+ and our S&P international rating was BB+. Since July 2013 we also started to be covered by Moody’s America Latina Ltda, by whom our national rating was Aa1.br and our global rating was Baa3. 

Various contractual agreements we have entered into, including certain financing agreements with Caixa Econômica Federal and BNDES, provide for liens over a portion of our cash flows from operations.  In addition to Caixa Econômica Federal and BNDES, we have granted liens over a portion of our cash flows deriving from our operations in connection with agreements relating to securitization transactions, the Alto Tietê PPP and arrangements relating to the lease of certain assets.  Pursuant to these agreements, cash received from operations is required to pass through designated accounts.  In the event of a default under the relevant agreement, such cash and future cash flows that are required to be deposited in such accounts become restricted and are subject to security interests in favor of the relevant creditor.  As of December 31, 2013, a substantial portion of our monthly cash flows from operations was subject to these liens.  As of that date, the total amount of our secured debt, including indebtedness benefiting from these liens, was R$2,234.5 million.

The following table sets forth information on our indebtedness outstanding as of December 31, 2013:

 

 

December 31, 2013

 

 

Current

Noncurrent

Total

Final Maturity*

Denominated in local currency

 

 

 

 

Banco do Brasil

100,497

-

100,497

2014 TR + 8.50%

10th issue debentures

37,171

220,109

257,280

2020 TJLP + 1.92% (1st & 3rd series) & IPCA + 9.53% (2nd series)

12th issue debentures

22,727

476,702

499,429

2025 TR + 9.5%

14th issue debentures

20,079

269,862

289,941

2022 TJLP + 1.92% (1st & 3rd series) & IPCA + 9.19% (2nd series)

15th issue debentures

-

820,887

820,887

2019 CDI + 0.99% (1st series) & IPCA + 6.2% (2nd series)

16th issue debentures

-

499,434

499,434

2015 CDI + 0.30% to 0.70%

17th issue debentures

-

1,027,925

1,027,925

2023 CDI + 0.75% (1st series) & IPCA + 4.5% (2nd series) & IPCA + 4.75% (3rd series)

18th issue debentures

-

160,859

160,859

2024 TJLP + 1.92% (1st and 3rd series) & IPCA + 8.25% (2nd series)

Caixa Econômica Federal

83,267

959,853

1,043,120

2013/2032 TR + 6.8% (average)

National Bank for Economic and Social Development (BNDES) Coastal region

16,309

81,546

97,855

2019 2.5% + TJLP

National Bank for Economic and Social Development (BNDES) PAC

9,370

79,644

89,014

2023 2.15% + TJLP

National Bank for Economic and Social Development (BNDES) PAC II 9751

2,308

29,192

31,500

2027 1.72% + TJLP

National Bank for Economic and Social Development (BNDES) PAC II 9752

-

20,400

20,400

2027 1.72% + TJLP

National Bank for Economic and Social Development (BNDES) Onda Limpa

19,230

196,821

216,051

2025 1.92% + TJLP

National Bank for Economic and Social Development (BNDES) Tietê III

-

98,404

98,404

2025 1.66% + TJLP

Financial leasing

-

382,492

382,492

2035 7.73% to 10.12% + IPC

Other

498

2,431

2,929

2018/2025 TR + 12.00%

Interest and others charges

113,504

-

113,504

 

 

 

 

 

Total denominated in local currency

424,960

5,326,561

5,751,521

 

 

 

 

 

 

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Denominated in foreign currency

 

 

 

 

Inter-American Development Bank (IADB) US$475,748,000 (2012 - US$417,295,000)............................

89,378

1,018,693

1,018,071

2016 to 2035 1.14% to 3.00%

International Bank for Reconstruction and Development (IBRD) US$37,335,000 (2012 – US$26,864,000)

-

87,077

87,077

2034 0.45%

Eurobonds - US$ 140,000,000 (2012 - US$ 140,000,000)

-

327,640

327,640

2016 7.50%

Eurobonds - US$ 350,000,000 (2012 – US$ 350,000,000)

-

813,650

813,650

2020 6.25%

JICA 15 - ¥ 18,438,880,000 (2012 - ¥ 19,591,310,000)

25,733

386,007

411,740

2029 1.8% & 2.5%

JICA 18 - ¥ 16,578,560,000 (2012- ¥ 17,614,720,000)

23,137

346,733

369,870

2029 1.8% & 2.5%

JICA 17 - ¥ 450,484,000 (2012 - ¥ 324,213,000)

-

9,704

9,704

2035 1.2% & 0.01%

JICA 19 - ¥ 6,036,325,000 (2012 - ¥ 5,407,000)

-

134,010

134,010

2037 1.7% & 0.01%

IADB 1983AB - US$ 178,173,000 (2012 - US$ 202,115,000)

56,087

359,059

415,146

2023 2.49%to 2.99%

Interest and others charges

21,645

-

21,645

 

 

 

 

 

 

Total denominated in foreign currency

215,980

3,482,573

3,698,553

 

Total loans and financing

640,940

8,809,134

9,450,074

 

 

______________

*          TR was 0,04940% per month as of December 31, 2013; CDI stands for Interbank Deposit Rate (Certificado de Depósitos Interbancários), which was 9,77% per annum as of December 31, 2013; IGP‑M was 5,51% per annum as of December 31, 2013; TJLP stands for Long‑term Interest Rate (Taxa de Juros a Longo Prazo), published quarterly by the Central Bank, which was 5% per annum as of December 31, 2013.

The following table shows the maturity profile of our debt, as of December 31, 2013, for the period indicated (in millions of reais): 

 

2014

2015

2016

2017

2018

After 2019

Total

Loans and financing

640.9

1,019.4

995.8

717.7

836.6

5,239.7

9,450.1

 

Refering to our foreign currency‑denominated indebtedness, the amount of R$2,766.1 million, net of transaction costs, as of December 31, 2013 was denominated in U.S. dollars.  This indebtedness consisted principally of:

·                     R$1,108.1 million (US$475.7 million) in U.S. dollar denominated loans contracted with the Inter-American Development Bank, or the IADB, composed of the following:  (i) two loans to finance the first phase of the Tietê Project in 1992 and one loan to finance the second phase in 2000, under which payments of principal are made in semiannual installments with final maturity in December 2016, December 2017 and July 2025.  The principal amount of this loan is adjusted semiannually for the variation of the U.S. dollar, and accrues interest at a rate varying from 1.14% to 3.00% plus LIBOR; (ii) credit agreement executed in September 2010 with the IADB for the financing of the third phase of the Tietê Project.  This loan matures on September 3, 2035.  Amortizations will be made in semiannual installments after a grace period of six years.  The principal amount accrues interest at USD LIBOR.  We have pledged as collateral part of our receivables from our sales and services up to the amount due;

·                     R$87.1 million (US$37.3 million) in U.S. dollar denominated loans contracted with the International Bank for Reconstruction Development ‑ IBRD which was entered into on October 28, 2009, amounting to US$100.0 million, for the financing of the Water Source Program (Programa Mananciais).  The loan matures in March 2034.  Amortizations will be in semi‑annual installments starting in September 2019.  The principal amount accrues interest at the USD LIBOR plus a variable spread;

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·                     R$415.1 million (US$178.2 million) in U.S. dollar denominated loans from the AB Loan financing contracted with the IADB in May 2008.  Under this loan, payments of principal are made in annual installments with final maturity in May 2023.  The principal amount is adjusted semiannually for the LIBOR plus spread and accrued interest at a rate varying from 2.49% to 2.99%.  This loan was used to repay an outstanding series of debt securities in connection with the implementation of our investment plan;

·                     R$1,141.3 million (US$490.0 million) in U.S. dollar denominated Eurobonds issued in November 2006 (US$140.0 million with an interest rate of 7.5%) and in December 2010 (US$350.0 million with an interest rate of 6.25%).  Under these bonds, the payments of interest are made in semi‑annual installments and principal will be paid at the final maturity in 2016 and 2020, respectively. The proceeds from the offering were used to repay financial commitments throughout 2007 and 2011; and

·                     R$925.3 million (¥41,504.2 million) in Japanese yen denominated loans contracted with the JICA, composed of the following:  (i) ¥21,320.0 million denominated loans contracted in August 2004 for the financing of the environmental recovery program for the Baixada Santista metropolitan region, called the Clean Wave Program (Programa Onda Limpa).  Under these loans, the payments of principal are made in semi‑annual installments with final maturity in August 2029.  The principal amount accrues interest at rates that vary from 1.8% to 2.5% per year; (ii) ¥6,208 million in denominated loans contracted in October 2010 for the financing of the environmental improvement program in the basin of the Billings dam, part of the New Life Program (Programa Vida Nova).  The loan matures in October 2035.  Amortizations will be made in semi‑annual installments after a grace period of seven years, starting in October 2017.  The principal amount accrues interest at a rate varying from 0.01% to 1.2%; (iii) ¥19,169.0 million denominated loans contracted in February 2011 to complement the financing for the first stage of the Clean Wave Program (Programa Onda Limpa), with commercial conditions similar to the loan entered into in August 2004.  These funds will be used for the provision of works and services in the Baixada Santista metropolitan region.  The credit agreement expires in 18 years and interest varies from 1.8% to 2.5% per year; and (iv) ¥33,584 million denominated loan in February 2012 for the financing of the Corporate Program for Water Loss Reduction (Programa corporativo para Redução de Perdas).  The loan matures in February 2037.  Amortizations will be in semi‑annual installments starting in February 2019.  The principal amount accrues interest at a rate varying from 0.01% to 1.7%.  The first disbursement of ¥6 billion connected to the Corporate Program for Water Loss Reduction was in March 2013.

Our borrowings from multilateral institutions and with Government Agency, such as the IADB, IBRD and JICA, have in the past been, and in the future are likely to be, guaranteed by the State or the federal government.  We do not pay fees for these guarantees.  Under some of the loan agreements with the IADB, IBRD and JICA; we have granted a guarantee (contra garantia) to the federal government.  For further information on the terms of these loan agreements, see “Item 7.B. Related Party Transactions – Government Guarantees of Financing.”

Our outstanding domestic debt was R$5,751.5 million as of December 31, 2013 and consisted primarily of real‑denominated loans from federal and state‑owned banks, in particular, Banco do Brasil S.A., Caixa Econômica Federal and BNDES, as well as debentures issued in November 2009, June 2010, February 2011, February 2012, November 2012, January 2013 and October 2013, and financial leasing.

The following summarizes our principal borrowings from federal and State‑owned banks:

·                     in March 1994, we entered into a loan agreement with Banco do Brasil S.A., or Banco do Brasil, in the amount of R$2.3 billion.  Amortizations of the principal amount are made in 240 successive monthly installments, with final maturity in March 2014.  The principal amount accrues interest at the daily government interest rate plus 8.50% per annum and monetary adjustment;

·                     from 1996 to 2013, we have entered into several financing agreements with Caixa Econômica Federal, pursuant to which amortizations of principal are paid in 60, 120, 180 or 240 months in monthly installments commencing 30 days following the applicable grace period, which varies from 14 to 48 months from the date of signature of the line of credit agreement.  The final maturity is 2037.  The principal amount accrues interest from 5.0% to 9.5%.  The lines of credit are collateralized (i) by collections of daily billings of water supply and sewage services up to the total amount of the debt, or (ii) by a monthly plan of billings corresponding to the minimum of three times the monthly charge, depending on the terms of the relevant line of credit agreement;

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·                     in November 2007, we entered into a R$129.9 million financing agreement with BNDES.  Amortizations of the principal amount will be made in 96 successive monthly installments, with final maturity in 2019.  The principal amount accrues interest at the TJLP, but limited to 6.0% per year, plus 2.50% per year.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  The credit agreement is collateralized by part of the billings from the provision of water and sewage services;

·                     in May 2008, we entered into a R$174.0 million financing agreement with BNDES.  Amortizations of the principal amount will be made in 150 successive monthly installments, with final maturity in 2023.  The principal amount accrues interest at the TJLP, but limited to 6.0% per year, plus 2.15% per year.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  The financing agreement is collateralized by part of the billings from the provision of water and sewage services;

·                     in March 2010, we entered into a R$294.3 million financing agreement with BNDES.  Amortizations of the principal amount will be made in 156 successive monthly installments commencing 30 days after the 24‑month grace period, with final maturity in 2025.  The principal amount accrues interest at the TJLP, but limited to 6.0% per year, plus 1.92% per year.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  The financing agreement is collateralized by part of the billings from the provision of water and sewage services;

·                     in March 2012, we entered into a R$180.8 million financing agreement with BNDES.  The amortization of the principal shall be paid in up to 156 successive monthly installments beginning 30 days after the grace period of 36 months, with the final maturity in 2027.  The principal amount accrues interest at the TJLP but it is limited to 6.0% per year plus a yearly 1.72%.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  This credit agreement is guaranteed partly by the earnings of water and sewage services;

·                     in February 2013, we entered into a R$1.3 billion financing agreement with BNDES. The amortization of the principal shall be paid in up to 144 successive monthly installments beginning 30 days after the grace period of 36 months, with the final maturity in 2028. The principal amount accrues interest at the TJLP but is limited to 6.0% per year plus a yearly 1.66%. If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount. The credit agreement is guaranteed partly by the earnings of water and sewage services;

·                     in December 2013, we entered into a R$415.8 million financing agreement with BNDES.  The principal will be amortized in up to 108 successive monthly installments beginning 30 days after the grace period of 36 months, with the final maturity in 2025.  The principal accrues interest at the TJLP but is limited to 6.0% per year plus a yearly 1.66%.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  This credit agreement is guaranteed partly by the earnings of water and sewage services; and

·                     in 2011, we entered into financial leases in the total amount of R$49.6 million with certain contractors for the construction of infrastructure on land we own.  During the construction phase, we recognize an intangible assets and the related liability of the lease at fair value.  Upon the conclusion of the construction, which is estimated to 2014 and 2015, we start to pay the rental of the infrastructure (in 240 installments) and the lease is updated accordingly to the contract.  On August 31, 2013, SES Campo Limpo Paulista and Várzea Paulista started operations, and the corresponding amount as of December 31, 2013 was of R$144,384 million. 

Under BNDES program, in the amount of R$826.1 million, we issued three tranches of debentures.  In November 2009, we issued our tenth debentures in the aggregate principal amount of R$275.4 million.  The debentures are divided in three series:  the first and third series will mature in November 2020 and the second in December 2020.  The debentures of the first and third series, in the aggregate principal amount of R$77.1 million and R$115.7 million, respectively, bear interest at 1.92% per year, plus the TJLP.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  The debentures of the second series, in the aggregate principal amount of R$82.6 million, bear interest at the rate of the IPCA index plus 9.53% per year.  This issuance was entirely subscribed by BNDES.  In February 2011, we issued our fourteenth debentures, the second tranche out of those three, also subscribed exclusively by BNDES.  These debentures are divided in three series:  the first and third series will mature in February 2022 and the second, in March 2022.  The debentures of the first and third series, in the aggregate principal amount of R$77.1 million and R$115.7 million, respectively, bear interest at 1.92% per year, plus the TJLP.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  The debentures of the second series, in the aggregate principal amount of R$82.6 million, bear interest at the rate of the IPCA index plus 9.20% per year.  In October 2013, we concluded our eighteenth issuance of debentures, the third tranche out of those three also subscribed exclusively by BNDES. These debentures are divided in three series:  the first and third series will mature in October 2024 and the second, in November 2024.  The debentures of the first and third series, in the aggregate principal amount of R$77.1 million and R$115.7 million, respectively, bear interest at 1.92% per year, plus the TJLP.  If the TJLP exceeds 6.0% per year, such excess will be added to the principal amount.  The debentures of the second series, in the aggregate principal amount of R$82.6 million, bear interest at the rate of the IPCA index plus 8.26% per year.  In December 2013, BNDES subscribed to the debentures of the first and second series.  BNDES will subscribe to the debentures of the third series in 2015.  We have used the funds raised from the three issuances for investments primarily in the Corporate Program for Water Loss Reduction and on improvements and reforms of the Rio Grande’s water treatment plant, including other projects for water supply and sewage collection systems in the São Paulo Northern Coast, Paraíba Valley and Mantiqueira Regions.

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Additionally, in June 2010, we issued 500,000 debentures to the FGTS, based on the FGTS’s program to finance companies in the sanitation, transport and real estate businesses (our twelfth issuance).  The debentures bear interest based on the TR plus 9.5% per year and will mature in June 2025.  The debentures bear a grace period of four years in respect of payments, and we may redeem the debentures starting in July 2014.  We used the proceeds from the twelfth issuance to fund a portion of our capital expenditure program in the water supply and sewage system.

In August 2011, the joint‑controlled entity “Aquapolo” issued 326,732 debentures, registered as its first issuance of simple debentures, nonconvertible, in a single series amounting to R$326.7 million.  The debentures will mature in August 2029 and bear interest, paid monthly, at the TR plus 8.75% per year.  The proceeds from the first issuance were used to build the Aquapolo plant and infrastructure designed to treat industrial water from this petrochemical industrial center in Mauá municipality.

In February 2012, we issued our fifteenth issuance of debentures in two series in the aggregate principal amount of R$771.0.  The first and second series will mature in February 2017 and 2019, respectively.  The debentures of the first series (in the aggregate principal amount of R$287.3 million) bear interest at a rate of CDI plus 0.99% per year.  The second series (in the aggregate principal amount R$483.7 million) bears interest at a rate of IPCA plus 6.2% per year.  The net proceeds were used to repay financial commitments throughout 2012, including the early redemption of our thirteenth debentures issuance.

In November 2012, we carried out our sixteenth debentures issuance of R$500 million, with a maturity date of November 2015 and bearing interest, each quarter with an interest rate of between 0.30% and 0.7% per year plus the CDI rate.  These proceeds of this issuance were used to pay the Company’s financial commitments for 2012 and 2013.

In January 2013, we carried out our seventeenth debentures issuance of R$1.0 billion in three series, the first for R$424.7 million with maturity date of January 2018 and with an interest rate of 0.75% per year plus the CDI rate, the second for R$395.2 million with a maturity of January 2020 and with the interest rate of 4.50% per year plus IPCA variation and the third for R$180.1 million with a maturity date of January 2023 and with an interest rate of 4.75% per year plus IPCA variation.  The proceeds of these issuances were used to pay our financial commitments for 2013

In March 2013 we made the first and second series amortization payments and the early redemption of the remaining balance of the 1st series of the eleventh debenture issuance.  This issuance was due to mature in March 2015.

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Part of our real‑denominated indebtedness is indexed to take into account the effects of inflation.  This debt provides for inflation‑based increases to the principal amount, determined by reference to the IPCA.

Financial Covenants

We are subject to financial covenants under the agreements evidencing or governing our outstanding indebtedness.

Foreign currency denominated indebtedness

With respect to our indebtedness denominated in U.S. dollars, we are subject to financial covenants, including but not limited to those set forth in the loan agreements entered into with the IADB.  Each of these agreements contains, among other provisions, limitations on our ability to incur debt.  The financial covenants related to loan agreements 713, 896 and 1212 consider - Tariffs must:  (a) produce revenues sufficient to cover the system’s operating expenses, including administrative, operating, maintenance, and depreciation expenses; (b) provide a return on the balance sheet value of property, plant, and equipment not less than 7%; and (c) during project execution, the balances of short‑term loans must not exceed 8.5% of total equity.  These agreements have a cross default clause with IADB.  The financial covenants related to AB Loan agreements (1983AB) consider the Company’s ratio of debt service coverage, which must be higher than or equal to 2.35:1.00; and the total adjusted debt over EBITDA, determined on a consolidated basis, which must be lower than or equal to 3.65:1.00.  This agreement has a cross default clause. See Note 15 of our Financial Statements.

The indentures relating to our US$ 140.0 million 7.5% notes due 2016 and US$ 350.0 million 6.25% notes due 2020 prohibit, subject to some exceptions, the incurrence of additional debt in the event that:  (i) the ratio of Adjusted Total Debt to adjusted EBITDA (as defined in the related indentures) is greater than 3.65:1.00:  or (ii) the Debt Service Coverage Ratio (as defined in the related indentures) is less than 2.35:1.00.  This agreement has a cross default clause, i.e. the early maturity of any debt in connection with our loans or the loans of any of our subsidiaries in a total principal amount of US$25.0 million or more (or the corresponding amount in other currencies) shall imply this agreement’s early maturity.  See Note 15 of our Financial Statements.

We do not believe that these covenants will impose constraints on our ability to finance our capital expenditure program or, more generally, to develop our business and enhance our financial performance.

Local currency denominated indebtedness

With respect to our outstanding indebtedness denominated in reais, we have entered into several credit agreements with the BNDES that require us to maintain (i) adjusted EBITDA/Adjusted net operating revenues equal to or higher than 38%, (ii) adjusted EBITDA/adjusted financial expenses equal to or higher than 2.35:1.00; and (iii) adjusted net debt/adjusted EBITDA equal to or lower than 3.65:1.00.

In addition, all of our financing agreements with the Caixa Econômica Federal and most of our financing agreements with BNDES are subject to a Performance Improvement Agreement (Acordo de Melhoria de Desempenho).  The Performance Improvement Agreement, dated May 28, 2007, as amended in August 2012, was entered into between us and the federal government, and the Caixa Econômica Federal and BNDES as intervening parties.  Pursuant to this agreement, we were required to comply with at least four of eight financial and operating ratios stipulated for the period 2012 to 2016.  If we fail to comply with any of the ratios required by the Caixa Econômica Federal and BNDES, either may suspend our credit lines and we will be prevented from entering into any other financing agreements with those entities.  We have the ability, however, to renegotiate the ratios if needed.  On March 14, 2013, the Ministry of Cities revoked Normative Instruction 05 of 2008, which regulated the Agreement on Performance Improvement (Acordo de Melhoria de Desempenho), or API.  According to the Instruction, the APIs executed by March 14, 2013 will remain valid until their respective expiration dates, and it is not necessary to execute or reschedule APIs for new contracts.

Our financing agreement with the federal government and Banco do Brasil S.A. and our credit agreements with Caixa Econômica Federal do not contain material financial covenants.  The agreement with Caixa Econômica Federal has a cross default clause.  See Note 15 of our Financial Statements.

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With respect to our outstanding debentures, the twelfth issuance requires us to maintain an adjusted current ratio (current assets divided by current liabilities, excluding from current liabilities the current portion of noncurrent debts incurred by the Company that are recorded in current liabilities) higher than 1.0:1.0 and an EBITDA/financial expenses ratio equal to or higher than 1.5:1.0.  This issuance has a cross default clause.  See Note 15 of our Financial Statements.

The tenth, fourteenth and eighteenth issuances require us to maintain (i) Adjusted EBITDA/Adjusted net operating revenues equal to or higher than 38%, (ii) Adjusted EBITDA/Adjusted financial expenses equal to or higher than 2.35:1.0, and (iii) Adjusted net debt/Adjusted EBITDA equal to or lower than 3.65:1.0.  These issuances have a cross default clause.  See Note 15 of our Financial Statements.

The fifteenth, sixteenth and seventeenth issuances require us to maintain (i) an EBITDA/paid financial expenses ratio equal to or higher than 1.5:1.0, and (ii) an adjusted total debt/EBITDA ratio equal to or lower than 3.65:1.0.  These issuances have a cross default clause.  See Note 15 of our Financial Statements.

The table below shows the more restrictive covenants ratios and our financial covenants ratios as of December 31, 2013.

 

 

Restrictive Ratios

Ratio as of December 31, 2013

Adjusted EBITDA/Adjusted net operating revenues

Equal to or higher than 38%

45%

Adjusted EBITDA/Adjusted financial expenses

Equal to or higher than 2.35:1.00

7.51:1.00

Adjusted net debt/Adjusted EBITDA

Equal to or lower than 3.65:1.00

2.32:1.00

Adjusted current ratio

Higher than 1.0:1.0

1.32:1.00

EBITDA/Paid financial expenses

Equal to or higher than 1.5:1.0

6.56:1.00

 

As of December 31, 2013 and 2012, we had met all the requirements set forth by its loan and financing agreements.

Capital Requirements

We have, and expect to continue having, substantial liquidity and capital resource requirements.  These requirements include debt‑service obligations, capital expenditures to maintain, improve and expand our water and sewage systems, and dividend payments and other distributions to our shareholders, including the State.

Capital Expenditures

Historically, we have funded and plan to continue funding our capital expenditures with funds generated by operations and with long‑term financing from international and national multilateral agencies and development banks.  We generally include in our capital expenditure program for the following year the amount of investment that was not realized in the previous year.  In 2013, we recorded R$2.7 billion to improve and expand our water and sewage system and to protect our water source in order to meet the growing demand for water and sewage services in the State of São Paulo. We have budgeted investments in the amount of approximately R$12.8 billion from 2014 through 2018.  See “Item 4.A. History and Development of the Company –Capital Expenditure Program.”

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Dividend Distributions

We are required by our bylaws to make dividend distributions, which can be made as payments of interest on shareholders’ equity to our shareholders in an amount equal to or higher than 25% of the amounts available for distribution.  We declared dividends of R$537.5 million, R$534.3 million and R$578.7 million in 2013, 2012 and 2011, respectively.  See “Item 7.B. Related Party Transactions—Dividends.”

C.      Research and Development, Patents and Licenses, Etc.  

Our policy is to invest continually in the modernization of equipment and in the technology needed to identify, evaluate and improve our provision of basic sanitation services while promoting environmental protection and maintaining our competitiveness and profitability.  Our research and development activity is divided into committees according to strategy and complexity.  In 2013, 2012 and 2011, we invested R$6.4 million, R$6.3 million and R$3.2 million, respectively, in research and development.

In order to further develop our expansion plans, we created a new division for research, technology development and innovation in May 2010.  Among other initiatives, the new division is responsible for:  monitoring technological trends, defining our research projects portfolio, obtaining funding from development agencies, developing an intellectual property protection policy and establishing cooperation agreements for the development of researches that are of interest.  The new division will also enable us to increase the quality of our procedural processes and technology portfolio.

With respect to our partnership with the State of São Paulo Research Foundation (Fundação de Amparo à Pesquisa do Estado de São Paulo) to develop and support research projects involving researchers from graduate schools, the State of São Paulo and our employees.  This partnership provides R$50 million in incentives, to be paid equally by each of the two institutions.  Under this partnership, 12 projects have been approved and nine of them are currently underway.  They are related to:  (i) the development of technology related to the use of filtering membranes in water and sewage treatment, (ii) alternatives for the treatment, mud disposal and use in water and sewage treatment stations, (iii) new technologies for the implementation, operation and maintenance of water distribution and sewage collection systems, (iv) new technologies for improvements in unitary operations processes, (v) water quality monitoring, (vi) energetics efficiency and (vii) sanitary economy. 

In May 2013, we launched a second phase of our agreement with the São Paulo Research Foundation.  In this second phase, the seven lines of research were defined in greater detail in order to precisely contemplate our needs.  In this phase, 37 proposals were submitted, and the São Paulo Research Foundation is currently analyzing these proposals with respect to their scientific and technical merits.

We have been seeking financing for the project “Sabesp – Technological Innovations for the Sanitation Sector” from the Brazilian Agency for Innovation – FINEP. The program “FINEP Innovates Brazil” aims at supporting Brazilian companies’ plans for strategic investment in innovation. These plans must detail a company’s targets and goals for the period during which they will receive financing, pursuant to the Federal Government’s “Greater Brazil Plan – PBM.”  Our project is valued at approximately R$ 90 million. This project consists of five parts as follows: (i) vacuum collection system and sewage removal; (ii) production system for reused water in urban and industrial uses; (iii) biofiltration units for odor control; (iv) sludge dryer based on solar radiation for sewage treatment stations – Franca Sewage Treatment Station; and (v) plasma gasification system for solid waste from sewage treatment plants.

We also started a partnership with Fraunhofer Institute in Germany em 2011, in order to obtain biomethane from the sewage treatment process to be used as fuel for cars.  In the second semester of 2014, it will start to fill up a fleet of 49 cars, instead of gasoline, as a 3-year test.  This project will contribute to reduce pollutant emission into the atmosphere.  We are investing R$900 thousand in this system while our German partner is investing R$5.1 million.

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Seeking energy efficiency in our operations, we projected an equipment to calculate the correct oxygen dosage to be used in air diffusors, which are used in the sewage treatment process.  The project aims also to find the best cleaning period and when these devices have to be replaced.

Additionally, we have developed custom made biofilters to reduce the odor from sewage pumping stations and sewage treatment plants.

D.      Trend Information

Several factors may affect our future results of operations, liquidity and capital resources, including:

·                     the interests of our controlling shareholder;

·                     regulations issued by ARSESP regarding several aspects of our business, with respect to our ability to adjust our tariffs and the competency of state and municipalities to manage their sanitation affairs;

·                     Brazilian economic conditions;

·                     meteorological conditions;

·                     the effects of any continued international financial turmoil that may affect liquidity in the Brazilian capital and lending markets;

·                     the effects that further changes in the Basic Sanitation Law and its interpretation may have on the basic sanitation industry in Brazil and on us;

·                     the effects of inflation in our results of operations;

·                     the effects of fluctuations in the value of the Brazilian real  and in interest rates on our net interest income;

·                     the effects of the tariff revision conducted by ARSESP;

·                     the renewal of our concession agreements;

·                     the impacts on our business of the water consumption reduction incentive program and of any other  measures we may need to take until the level of our reservoirs is normalized and sufficient to supply the customers in the São Paulo metropolitan region;

·                     decisions by the São Paulo State Department of Water and Energy (DAEE) and the National Water Agency (ANA) limiting the volume of water that may be drawn from the Cantareira System, the water system we use to serve the São Paulo Metropolitan Region, and the measures that we may be required to take to ensure the provision of water to our customers; and

·                     the formalization of agreements with certain of the municipalities we serve.

Each of these factors is described in more detail under “5.A. Operating and Financial Review and Prospects.”

In addition, you should read “3.D. Risk Factors” for a discussion of the risks we face in our business operations, which could affect our business, results of operations or financial condition.

E.      Off‑Balance Sheet Arrangements

We had no off‑balance sheet arrangements as of December 31, 2013.

 

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F.       Tabular Disclosure of Contractual Obligations

Our debt obligations and other contractual obligations as of December 31, 2013 were as follows:

 

Less than 1 year

1‑3 years

3‑5 years

More than 5 years

Total

 

(in millions of reais

Loans and financing

640.9

2,015.1

1,554.3

5,239.7

9,450.0

Estimated interest payments(1)

545.9

989.0

757.6

1,620.9

3,913.4

Operating and capital lease obligations(2)

48.6

147.6

238.7

2,301.1

2,736.0

Alto Tietê PPP

93.8

202.2

199.9

534.2

1,030.1

Purchase obligations(3)

2,619.0

2,499.7

175.2

5,971.5

11,265.3

Total

3,948.2

5,853.6

2,925.7

15,667.4

28,394.9

 

______________

(1)   Estimated interest payments on loans and financing were determined considering the interest rates as of December 31, 2013.  However, our loans and financing are subject to variable interest indexation and foreign exchange fluctuations, and these estimated interest payments may differ significantly from payments actually made. The debt agreements have cross default clauses.

(2)   Includes capital lease obligations which are collateralized by part of the billings from the provision of water and sewage services.

(3)   The purchase obligations are the contractual obligations of investments and expenses and consider the estimated inflation adjustments for each year.

We believe that we can meet the maturity schedule through a combination of funds generated by operations, the net proceeds of new issuances of debt securities in the Brazilian and international capital markets and additional borrowings from domestic and foreign lenders.  Our borrowings are not affected by seasonality.  For information concerning the interest rates on our indebtedness outstanding as of December 31, 2013, see Note 15 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31 2013, 2012, 2011 included elsewhere in this annual report.

ITEM 6.            DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A.      Directors and Senior Management

Under our bylaws and Brazilian Corporate Law, we are managed by our board of directors (Conselho de Administração), which currently consists of eight directors, and a board of executive officers (Diretoria), which currently consists of six executive officers.

As our controlling shareholder, the State has the ability to elect the majority of our board of directors and, therefore, our direction and future operations.  Upon the election of a new State governor and any resulting change in the administration of the State, all or some of the members of our board of directors, including our chairman, have historically been replaced by designees of the new administration.  Our board of directors may in turn replace some or all of the executive officers.  See “Item 3.D. Risk Factors—Risks Relating to Our Control by the State of São Paulo—We are controlled by the State of São Paulo, whose interests may differ from ours or from minority shareholders’ interests, including holders of ADSs.”

Board of Directors

Our bylaws provide for a minimum of five and a maximum of 15 directors.  The members of our board of directors are elected at a general shareholders’ meeting to serve a renewable two‑year term.  Pursuant to our bylaws, our employees have the option to elect one member of our board of directors.  Currently, our employees have not elected a director.  In addition, pursuant to Law No. 6,404 of December 15, 1976, as amended (“Brazilian Corporate Law”), at least one member of the board of directors of mixed capital companies, such as us, must be appointed by the minority shareholders.  Finally, according to the Novo Mercado rules, at least 20.0% of the board of directors must be comprised of independent members.

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Six of the current members of our board of directors, Dilma Seli Pena, Walter Tesch, Alberto Goldman, Jerônimo Antunes, Reinaldo Guerreiro and Alexander Bialer were elected at the general shareholders’ meeting held on April 23, 2012.  The directors Claudia Polto da Cunha and Francisco Vidal Luna were elected at the general shareholders’ meeting held on April 22, 2013. The tenure of all the directors will end upon the election of members for the new term at the general shareholders’ meeting to be held on April 30, 2014.  Currently, we have four directors considered independent under the Novo Mercado rules.

Our board of directors ordinarily meets once a month or when called by a majority of the directors or the chairman.  Its responsibilities include the establishment of policy and general orientation of our business, and the appointment and supervision of our executive officers.

The following are the names, ages, positions, dates of election and brief biographical descriptions of the current members of our board of directors: 

Director

Age

Position

Date Elected

Alberto Goldman

76

Chairman

April 23, 2012

Claudia Polto da Cunha

46

Director

April 22, 2013

Dilma Seli Pena

64

Director

April 23, 2012

Walter Tesch

70

Director

April 23, 2012

Jerônimo Antunes

58

Independent Director*

April 23, 2012

Reinaldo Guerreiro

61

Independent Director*

April 23, 2012

Francisco Vidal Luna

67

Independent Director*

April 22, 2013

Alexander Bialer

67

Independent Director*

April 23, 2012

 

______________

*      These directors comply with the independence requirements established by the Novo Mercado rules.

Alberto Goldman.  Mr. Goldman has been the acting chairman of our board of directors since March 27, 2014, when he replaced Edson de Oliveira Giriboni, our chairman from April 2011 to March 2014.  Mr. Goldman has been a member of our board of directors since April 2011.  Mr. Goldman holds a degree in civil engineering from the Escola Politécnica of the Universidade de São Paulo.  Mr. Goldman was vice‑governor of São Paulo from January 2007 to March 2010 and governor of São Paulo from April 2010 to December 2010.  He was a member of our board of directors from April 2009 to March 2010.  He was also the State Secretary of Development (currently, Development, Science and Technology State Department) from January 2007 to February 2009, State Deputy for two terms and Federal Deputy for six terms.  Mr. Goldman was the president of the Budget Mixed Committee in 2000 and rapporteur of the General Telecommunications Law.  He was the Special Secretary of State of the Program Coordination in 1987 and of the Administration Coordination between 1988 and 1990.  Mr. Goldman was the Minister of Transportation from 1992 to 1994.

Claudia Polto da Cunha. Ms. Cunha has been a member of our board of directors since April 2013. She holds a law degree and a master’s degree in Public Law from Faculdade de Direito at Universidade de São Paulo, USP. She has been a state attorney for the State of São Paulo since 2001, acting as the Corporate Matters Officer for Companhia Paulista de Parcerias, and Executive Secretary at State Council for Protection of Capitals of the State (Conselho de Defesa dos Capitais do Estado), since 2006. Ms. Cunha is member of the board of directors at Empresa Metropolitana de Transportes Urbanos, and member of the Fiscal Committee at Companhia de Desenvolvimento Habitacional e Urbano. She was member of the board of directors at Companhia do Metropolitano de São Paulo, member of Fiscal Committee at Rede Ferroviária Federal, as well as member of the board of trustees at Fundação de Proteção e Defesa do Consumidor.

Dilma Seli Pena.  Ms. Pena has been a member of our board of directors since January 2007 and our Chief Executive Officer since January 2011.  She holds a master’s degree in public administration from FGV and a degree in geography from the Universidade de Brasília.  In 1976, she began her career as a public servant working for the Research Institute of Applied Economics (Instituto de Pesquisa Econômica Aplicada), or IPEA.  She was director of the sanitation division of the Urban Policy Secretariat of the Ministry of Planning Office (Secretaria de Política de Saneamento Urbano), director of the strategic investments division of the Ministry of Planning (Investimentos Estratégicos do Ministério de Planejamento) and director of the Brazilian National Water Agency (Agência Nacional de Águas).  She was a deputy secretary of the Economics and Planning Secretariat of the São Paulo state government (Secretaria de Economia e Planejamento do Estado de São Paulo) and an effective member of the Environmental Board of the Industry Federation of the State of São Paulo (Conselho Ambiental da Federação das Indústrias do Estado de São Paulo).  From 2007 to 2011, she was responsible for the State Secretariat of Sanitation and Water Resources (formerly known as the State Secretariat of Sanitation and Energy) and has been the chairperson of the board of directors of EMAE and CESP, companies owned by the State of São Paulo.  She has authored a number of articles, texts and books in the areas of sanitation, water resources and planning.

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Walter Tesch.  Mr. Tesch has been a member of our board of directors since April 2011.  He holds a degree in sociology from the University of Uruguay and a master’s degree in social sciences from the Pontifical Catholic University of Peru.  Mr. Tesch has worked in Peru, Venezuela and several Latin American countries.  Between 2005 and 2008, Mr. Tesch was the head of the administrative district of Parelheiros, a water source region in the city of São Paulo, and until 2010 he was the deputy Executive Secretary of the “Water Defense” (“Defesa das Águas”) operation, an agreement between the São Paulo Municipal and State governments.  Mr. Tesch is also the author of books on cooperativism and water sources in the city of São Paulo.

Jerônimo Antunes. Mr. Antunes has been a member of our board of directors and coordinator of the Audit Committee since April 2008. He holds master’s and Ph.D. degrees in controllership and accounting from the Business, Economics and Accounting School of Universidade de São Paulo - FEA-USP. He holds a bachelor’s degree in business administration and accounting and has been a certified independent accountant and consultant in accountability and corporate finance since 1977. He has been a professor at FEA-USP since 1999, a professor of several MBA courses, promoted at FIPECAFI, since 2000, at FEA-USP, since 2000, and at FIA – Fundação Instituto de Administração since 2006, among other institutions. Mr. Antunes has acted as an independent auditor since 1977, an expert and specialist in accounting examinations since 2005, and president of the Audit Committee of Desenvolve SP since May 2013.   He is a member of IBGC and was an executive officer of IPECAFI, IBRACON and ANEFAC.

 

Reinaldo Guerreiro. Mr. Guerreiro has been a member of our board of directors since January 2007. He holds a Ph.D. in accounting and controllership, a master’s degree in accounting and controllership and a bachelor’s degree in accounting sciences, all of them from the Business, Economics and Accounting School of Universidade de São Paulo - FEA-USP.  Currently, he is both professor and Director at FEA-USP.  He has also authored the books “A meta da empresa, seu alcance sem mistérios,” “Gestão do lucro,” “Estruturação de sistemas de custos para gestão de rentabilidade,” and co-authored “Controladoria uma abordagem de gestão econômica” and “Contabilidade gerencial.”  He is a researcher at CNPQ, author of multiple management accounting books and has published various scientific articles in domestic and international magazines.  He is a specialized consultant in financial management. Mr. Guerreiro has worked on various projects in the areas of financial management, costs, budget and IT in a variety of companies, such as Banco do Brasil, Caixa Econômica Federal, Previ and for the São Paulo Government - GESP.

 

Francisco Vidal Luna. Mr. Luna has been a member of our board of directors since April 2013.  He has a doctorate in Economics from the Business, Economics and Accounting School of Universidade de São Paulo - FEA-USP.  Retired Professor by FEA-USP.  In the public sector, he has served as the Secretary of Planning for the city of São Paulo. He has also worked at the Treasury Department for the State of São Paulo and the Federal Planning Bureau, among other roles. Within the private sector, Mr. Luna was Chairman and President of Banco Inter American Express S.A. At the governmental level, he served as a member of the advisory board of the Superintendency for the Development of the Northeast (Superentendência de Desenvolvimento do Nordeste – Sudene), a member of the board of directors of BNDES; superintendent of the Planning Institute of the Federal Planning Bureau, Special Secretary for Economic Affairs of the Federal Planning Bureau. At the state level, Mr. Luna has also been the Chairman of the Advisory Board for the division of Economic Affairs of the Secretariat of Finance of the State of São Paulo and executive secretary of the Board of Financial Coordination of São Paulo. Currently, Mr. Luna is a member of the board of directors and the audit committee of Desenvolve SP, Chairman of the board of directors of IDBRASIL and the Afro-Brazilian Museum, a member of the board of trustees of Fundação Padre Anchieta and an advisory board member of the Faculty of Medicine Foundation – FFM.

 

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Alexander Bialer. Mr. Bialer has been a member of our board of directors since April 2003, as a representative of the minority shareholders. He holds a degree in mechanical engineering from Instituto Tecnológico da Aeronáutica—ITA and a specialization degree in systems administration from the FGV. He is a member of the board of directors of AVIANCA and Andritz Hydro Inepar. He was on the board of Pacific Rubiales and ROMI. In addition, Mr. Bialer was Director of Business Development of GE in Brazil and Latin America, from which he retired in 2002. He also collaborated with AVON, Máquinas Piratininga and ASEA.

 

Board of Executive Officers

Our board of executive officers is composed of six executive officers appointed by our board of directors for renewable two year terms.  Our executive officers are responsible for all matters concerning our day‑to‑day management and operations.  Members of our board of executive officers have individual responsibilities established by our board of directors and our bylaws.

The following are the names, ages, positions, dates of election and brief biographical descriptions of our board of executive officers:

Executive Officer

Age

Position

Date Elected

Dilma Seli Pena

64

Chief Executive Officer

June 14, 2013

Manuelito Pereira Magalhães Junior

46

Corporate Management Officer

June 14, 2013

Rui de Britto Álvares Affonso

56

Chief Financial Officer and Investor Relations Officer

June 14, 2013

Paulo Massato Yoshimoto

61

Metropolitan Region Officer

June 14, 2013

Luiz Paulo de Almeida Neto

57

Regional Systems Officer

June 14, 2013

Paulo Massato Yoshimoto (cumulatively responsible for this Office)

61

Technology, Enterprises and Environment Officer

June 14, 2013

 

Dilma Seli Pena.  See above “—Board of Directors.”

Manuelito Pereira Magalhães Júnior.  Mr. Magalhães has been our Corporate Management Officer since January 2011.  Mr. Magalhães was a member of our board of directors from January 2007 to February 2011.  He holds a degree in economic sciences and a master’s degree in economic sciences from the Instituto de Economia, Universidade Estadual de CampinasHe was a member of the board of directors of the Companhia de Engenharia de Tráfego de São Paulo, of the COHAB and, of the Empresa de Tecnologia de Informação and Comunicação de São Paulo.  He was a parliamentary advisor in the Federal Senate.  From 1998 to 2002, he was the special advisor of the Minister of Health.  From 2005 to 2006 he was the ombudsman of the National Supplementary Health Agency, or ANS.  From 2005 to 2006, he was the deputy secretary of the Planning Secretariat and the secretary of Planning of the Municipality of São Paulo.  He was also the technical advisor, the secretary of finance and the director of the Department of Advisory, Planning and Management in the municipality of Campinas, State of São Paulo.

Rui de Britto Álvares AffonsoMr. Affonso has been our Chief Financial Officer and Investor Relations Officer since July 2003.  Mr. Affonso holds a Ph.D. and a master’s degree in economics from the Universidade Estadual de Campinas, or UNICAMP, and a degree in economics from the Universidade de São Paulo.  He has been a professor at UNICAMP since 1986, a professor at FEA‑USP from 1983 to 1989, and a director of public economy at Fundação do Desenvolvimento Administrativo from 1994 to 2003.  He also represented Brazil on the board of the Forum of Federations (a non‑governmental entity based in Canada) from 2000 to 2006.  Mr. Affonso has also held several positions at the State government.

Paulo Massato Yoshimoto.  Mr. Yoshimoto has been our metropolitan officer since February 2004.  Since April 2, 2014, Mr. Yashimoto has been cumulatively responsible for the Technology, Enterprises and Environment Office.  He holds a degree in civil engineering from the Escola de Engenharia de Lins.  Mr. Yoshimoto joined us in 1983, and has held the positions of executive assistant to the operations office and head of the water production and maintenance and metropolitan planning departments.  Mr. Yoshimoto has also held the position of senior planning professional at Empresa Metropolitana de Planejamento, from 1975 to 1983.

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Luiz Paulo de Almeida NetoMr. Almeida Neto has been our regional systems officer since January 2011.  He holds a degree in civil engineering from the Escola Politécnica of the Universidade de São Paulo, a business administration degree from Fundação Educacional Votuporanga/SP and a post‑graduate degree in sanitary engineering from Faculdade de Saúde Pública of the Universidade de São Paulo.  Mr. Almeida joined us in 1979 and has worked with us as head of the Baixo Tietê Business Unit responsible for the management of areas located in the hydrographic basins of Baixo Tietê, Tietê‑Batalha, São José dos Dourados and Turvo Grande.  Mr. Almeida Neto has authored several articles.

B.      Compensation 

Pursuant to Brazilian Corporate Law, our shareholders are responsible for establishing the aggregate amount of compensation we pay to the members of our board of directors, members of our fiscal committee and our executive officers.  According to Instruction No. 480 issued by CVM, we have to periodically disclose certain information on the aggregate compensation such as averages and fringe benefits.

In 2013, 2012 and 2011, the aggregate compensation, including benefits in kind granted that we paid to members of our board of directors, board of executive officers and fiscal committee for services in all capacities were R$4.2 million, R$4.1 million and 3.9 million, respectively.

The tables below sets forth the breakdown of the total compensation received by our directors and members of our board of executive officers and fiscal committee and other data related to their compensation for the periods indicated:

 

 

Year ended December 31,

 

2013

2012

2011

Total compensation per administrative body

(in thousands of R$, except where indicated otherwise)

Board of directors

1,026

1,004

1,240

Board of executive officers

2,929

2,878

2,442

Fiscal committee

258

226

217

Total amount of compensation

4,213

4,108

3,899

 

 

 

 

Number of members (in individuals)

 

 

 

Board of directors

9

10

10

Board of executive officers

6

6

6

Fiscal committee

5

4

5

 

 

 

 

Fixed annual compensation

 

 

 

Salary

 

 

 

Board of directors

788

804

853

Board of executive officers

1,673

1,553

1,265

Fiscal committee

198

179

217

Direct and indirect benefits

 

 

 

Board of directors

239

200

Board of executive officers

690

653

495

Fiscal committee

60

47

 

 

 

 

 

Variable compensation

 

 

 

Bonus

 

 

 

Board of directors

-

-

387

Board of executive officers

566

672

681

Fiscal committee

-

-

 

 

 

 

Maximum amount of compensation

 

 

 

Board of directors

157

148

169

Board of executive officers

530

516

444

Fiscal committee

64

56

46

 

 

 

 

Minimum amount of compensation

 

 

 

Board of directors

96

50

81

Board of executive officers

471

335

276

Fiscal committee

17

56

46

 

 

 

 

Average amount of compensation

 

 

 

Board of directors

111

100

128

Board of executive officers

469

480

407

Fiscal committee

57

56

46

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Profit Sharing and Pension Plans

We have established a pension and benefit fund (Fundação SABESP de Seguridade Social), or SABESPREV, to provide our employees with retirement and pension benefits.  This pension plan provides benefit payments to former employees and their families.  Both we and our employees make contributions to the pension plan.  We are also required to pay supplemental pension payments relating to the employment contract of certain employees prior to the creation of SABESPREV.  Our total contributions to the pension plan totaled R$18.4 million, R$7.4 million and R$8.9 million in 2013, 2012 and 2011, respectively.  Based on independent actuarial reports, as of December 31, 2013, our obligation under these plans totaled R$2,327.0 million.  For further information on our pension plans see Note 19 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 included elsewhere in this annual report.

Beginning in 2008, payments under the profit‑sharing plan were based both on general goals that evaluate us as a whole and on other goals that evaluate the performance our different business units.  Payments are proportionally reduced annually if the goals are not completely achieved.

We recorded profit‑sharing expenses of R$68.5 million, R$60.5 million and R$56.6 million in 2013, 2012, and 2011, respectively.  We do not have a stock‑option plan for our employees.

C.      Board Practices

The members of our board of directors are elected at a general shareholders’ meeting to serve a renewable two‑year term.  Our next general shareholders’ meeting will be held on April 30, 2014.  Our board of directors ordinarily meets once a month or when called by a majority of the directors or the chairman.  See “Item 6.A. Directors and Senior Management—Board of Directors.”

Our board of executive officers is composed of six executive officers appointed by our board of directors for a renewable two‑year term.  Meetings of our board of executive officers are held weekly in the case of ordinary meetings or when called by the chief executive officer in the case of special or extraordinary meetings.  See “Item 6.A. Directors and Senior Management—Board of Executive Officers.”

None of our directors and/or executive officers is a party to an employment contract providing for benefits upon termination of employment.  Those directors and officers who are also our employees will remain as our employees after their tenure as directors and/or officers, in this case, maintaining all benefits granted to our employees.

Fiscal Committee (Conselho Fiscal)

Our fiscal committee, which is established on a permanent basis, consists of a minimum of three and a maximum of five members and generally meets once a month.  Our fiscal committee currently consists of four members and four alternates.  Furthermore, each member has its respective alternate.  The current members of our fiscal committee were elected in the shareholders’ meeting held on April 22, 2013.  Their tenure will end on April 30, 2014.  The primary responsibility of the fiscal committee, which is independent from management and from the external auditors appointed by our board of directors, is to review our financial statements and report on them to our shareholders.

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The following are the names, ages, position, date of election and brief biographical descriptions of the current and alternate members of our fiscal committee:

 

Fiscal Committee Members

Age

Position

Date Elected

José Antonio Xavier

53

Member

April 22, 2013

Humberto Macedo Puccinelli

56

Member

April 22, 2013

Horácio José Ferragino

64

Member

April 22, 2013

Massao Fábio Oya

32

Member

April 22, 2013

Tomás Bruginski de Paula

53

Alternate

April 22, 2013

José Rubens Gozzo Pereira

66

Alternate

April 22, 2013

Joaldir Reynaldo Machado

65

Alternate

April 22, 2013

Jorge Michel Lepeltier

66

Alternate

April 22, 2013

 

José Antonio Xavier.  Mr. Xavier has been a member of our fiscal committee since April 2011.  He holds a degree in economics and a post‑graduate degree in governmental controllership from the Pontifícia Universidade Católica de São Paulo (PUC‑SP).  Mr. Xavier was an auditor of the State Treasury from 1993 to 1998 and the Technical Director of the State Treasury since 1998.  He was a member of the Fiscal Committee at BANESCARD, CESP and CDHU.

Humberto Macedo Puccinelli.  Mr. Puccinelli has been a member of our fiscal committee since April 2011.  Mr. Puccinelli holds a degree in economics from the Pontifícia Universidade Católica de São Paulo (PUC‑SP).  He worked at the Department of Planning from 1985 to 1995, at the Health State Department as secretary assistant from 1995 to 1996, at the State Treasury from 1996 to 2002, and at the Planning Department as secretary assistant in 2003.  Since January 2004 he has been the Technical Assistant of the State Treasury.

Horácio José Ferragino.  Mr. Ferragino was elected to our fiscal committee on April 23, 2012.  He holds a degree in accounting from the Faculdades Integradas Santo AntônioFISA‑SP.  He worked in the public sector for the State Fund for School Buildings (FECE – Fundo Estadual de Construções Escolares) from 1970 to 1976, for the School Building Company from 1976 to 1988 (CONESP – Cia de Construções Escolares), for the Educational Development Foundation (FDE – Fundação para o Desenvolvimento da Educação from 1988 to 1995) and Casa Civil e Secretaria de Gestão Pública (1995 – 2012), where he coordinated projects involving public purchase policies.  He currently works in the Counsel for Government Innovation, in the Secretariat of Regional Planning and Development and teaches several courses in the area of public purchases. Mr. Ferragino  has been a Fiscal Councilor for the Official Press of the State of Sao Paulo.

 

Massao Fábio Oya. Mr. Oya has been a member of our fiscal committee since April 2013. He has a degree in accounting and an MBA with a specialization in Financial Management from the University of Anchieta. Mr. Oya is a consultant and advises companies on accounting as well as corporate governance. He also serves on the fiscal committees of several companies, as a sitting member: including COPEL, Wetzel S.A., Banrisul, Sanepar, TIM Participações, Pettenati Indústria Têxtil S.A., Cristal Pigmentos do Brasil S.A. and Bardella S.A. – Indústrias Mecânicas, and as an alternate member: EZ TEC Empreendimentos e Participações S.A., Companhia Providência Indústria e Comércio S.A., M&G Poliester S.A., Companhia de Ferro Ligas da Bahia - Ferbasa and Eucatex S.A.

Tomás Bruginski de Paula.  Mr. de Paula has been an alternate member of our fiscal committee since April 2006.  He holds a degree and a master’s degree in economics from UNICAMP.  He has been a Professor at the Economics Department of Pontifícia Universidade Católica – PUC since 1986.  He has been an executive officer at Companhia Paulista de Parcerias since 2004 and Companhia Paulista de Securitização since 2009.  Mr. de Paula has worked as a consultant for several entities, including the Economic Committee for Latin America (CEPAL), the United Nations Development Program (PNUD), the Brazilian Institute of Municipal Administration (IBAM), the Brazilian School of Public and Business Administration of FGV (EBAPE/FGV), the State System Data Analysis Foundation (SEADE), and the Brazilian Electricity Agency in the infrastructure and public policy financing areas.  He is also a member of the fiscal committee of the Nossa Caixa Desenvolvimento and a member of the Board of Directors of DERSA.  Mr. de Paula was also a member of the fiscal committee of the São Paulo Company of Electric Power Transmission.

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José Rubens Gozzo Pereira.  Mr. Pereira has been an alternate member of our fiscal committee since April 2010.  He holds a degree in economics from Universidade Mackenzie, a graduate degree from FGV and attended international studies extension programs at the Universities of London and Paris.  He has been responsible for the Funding department of the Finance Secretariat since 1989.  Mr. Pereira held positions in the public sector in the DAEE, where he was responsible for the Budget and Financing area; he was an executive officer at Companhia de Engenharia de Tráfego – CET, and in the International Cooperation department of Companhia Energetica de Silo Paulo – CESP.  Mr. Pereira has been the coordinator for the Funding Department of the São Paulo State Government in the Finance Secretariat since 1991.

Joaldir Reinaldo Machado.  Mr. Machado has been an alternate member of our fiscal committee since April 2010.  He holds a degree in economics from Universidade de São Paulo.  Mr. Machado has been an employee of SEADE since 1979.  He has also held several other management positions, including management advisor to Empresa Metropolitana de Planejamento – EMPLASA, financial executive of the Finance Department of our Company, chief of staff of the Environment Secretariat and chief of staff and head of department of the SEADE Foundation.  Mr. Machado is currently the chief of staff of the Economy and Planning Secretariat of the São Paulo State Government.

Jorge Michel Lepeltier. Mr. Lepeltier has been a member of our fiscal committee since April 2013. He has a graduate degree in Capital Markets, Finances and Strategic Planning from New York University. He also has a bachelor’s degree in economics and accounting from Pontifíca Universidade Católica de São Paulo. Mr. Lepeltier has experience with appliance companies, and worked at the Whirlpool Group from May 1978 until August 1993, initially as Treasurer. After two years as serving as CFO and Director of Investor Relations of the Brasmotor Group, Mr. Lepeltier went on to work at Price Waterhouse for twelve years. Currently, Mr. Lepeltier is a partner at Jorge Lepeltier Consultores Associados, which offers consulting services in administration, finance, corporate structure and auditing. He serves on various boards of directors, fiscal committees and auditor committees, and, over the last five years, he has served on the board of directors of the following companies:  AES Tietê S.A., Companhia Paranaense de Energia – Copel and Triunfo Participações e Investimentos S.A., among others. As a fiscal committee member, he has served on the committees of the following companies:  TIM Participações S.A., Cia de Saneamento Básico do Estado de São Paulo – Sabesp and Drogasil S.A., among others.  As an audit committee member, he has served on the audit committees of the following companies:  Triunfo Participações e Investimentos S.A. and Positivo Informática S.A., among others. Currently, he is a fiscal committee member of Alpargatas S.A., Companhia Providência Indústria e Comércio and M&G Poliester S.A., and an audit committee member of Anhanguera Educacional Participações S.A., among others.

Audit Committee

Our bylaws provide for an audit committee to be comprised of three board members, who will cumulatively comply with the requirements of (i) independence, (ii) technical expertise, and (iii) identifying and complying with applicable exemptions in accordance with the United States Securities and Exchange Commission, or the SEC, and New York Stock Exchange, or NYSE, rules.  Our Board of Directors determined that Jerônimo Antunes qualifies as a financial expert under the SEC rules. The members are appointed by the board of directors.

The audit committee is responsible for assisting and advising the board of directors in its responsibilities to ensure the quality, transparency and integrity of our published financial information.  To this end, the audit committee supervises all matters relating to accounting, internal controls and the internal and independent audit functions.  The audit committee and its members have no decision making powers or executive functions.

The minimum availability required from each member of the audit committee is thirty hours per month.  Under our bylaws, the members shall exercise their roles for the same period as their corresponding term of office, or until otherwise resolved by the general shareholders’ meeting or by resolution of the board of directors. All of our Audit Committee members are independent.

The following are the names, positions and dates of election of the members of our audit committee:

Director

Position

Date Elected

Jerônimo Antunes

Coordinator and Financial Expert

April 26, 2012

Reinaldo Guerreiro

Member

April 26, 2012

Francisco Vidal Luna

Member

April 25, 2013

 

 

 

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Regulatory Affairs Committee

Our bylaws provide for a regulatory issues committee to be comprised of our Chief Executive Officer, Chief Financial Officer and Investor Relations Officer, Metropolitan Officer, and Regional System Officer.  The regulatory affairs committee is responsible for defining our regulatory directives, strategies and guidelines and coordinating our regulatory affairs department, under the directives of our board of directors.

The Chief Executive Officer acts as chairman of our regulatory affairs committee and is responsible for proposing its internal regulations to be approved by the committee.  Pursuant to our bylaws, the head of regulation shall be the executive secretary of the committee.

Under our bylaws, the resolutions of our regulatory affairs committee shall be binding and our executive board shall be entitled to implement them in the scope of its jurisdiction.  Meetings of our regulatory affairs committee are held at least once a month, if ordinary, and when extraordinary can be called by any of our committee’s members.

D.      Employees 

As of December 31, 2013, we had 15.015 full‑time employees.  In 2013, we had an average of 924 interns and 491 apprentices (aprendizes), as defined by federal Law No. 10,097, dated December 19, 2000.

The following table sets forth the number of our full‑time employees by main category of activity and geographic location as of the dates indicated:

 

As of December 31,

 

2013

2012

2011

Number of employees by category of activity:

 

 

 

Projects and operations

9,983

9,919

9,782

Administration

2,443

2,474

2,501

Finance

455

454

454

Marketing

2,134

2172

2,159

Number of employees by corporate division:

 

 

 

Head office

1,510

1513

1,475

São Paulo metropolitan region

6,856

6,865

6,861

Regional Systems

6,649

6,641

6,560

Total number of employees

15,015

15,019

14,896

 

The average tenure of our employees is approximately 17 years.  We also outsource certain services such as maintenance, delivery of water and sewage bills, meter reading, catering and security.  We believe that our relations with our employees are generally satisfactory.

Approximately 70% of all our employees are members of unions.  The five main unions that represent our employees are (i) the Union of Workers in Water, Sewage and Environment of São Paulo ‑ SINTAEMA, (ii) workers union of Santos Urban Industries, Baixada Santista region, South Coast and Vale Ribeira ‑ SINTIUS, (iii) the Union of Engineers of the State of São Paulo ‑ SEESP, (iv) the Union of Attorneys of the State of São Paulo ‑ SASP and (v) the Union of Industrial Technicians of the State of São Paulo – SINTEC.  As a result of the 2010 collective bargaining discussions, wages were temporarily increased by 5.05%.  The unions filed a claim with the Labor Court seeking, among other requests, to increase (i) wages by 1.5%, (ii) the salary base over which the annual profit distribution is calculated, (iii) the payment of overtime from 50% to 100% ; and (iv) additional payment of working night hours from 20% to 50%.  The Labor Court decided in favor of the unions, and we appealed the decision. Our appeal resulted in a definitive decision on the matter, issued by the court on August 17, 2012, suspending the unions’ requests, except for the increase in the additional payment of overtime from 20% to 50%. 

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In 2011, we entered into an additional collective bargaining agreement, which:  (i) increased wages by 8.00% (which corresponds to the adjustment for inflation for the period) plus a real gain of 1.51%, (ii) established an employment guarantee for 98% of our employees, (iii) increased meal vouchers by 10.07%, and (iv) increased all other benefits by 8.00%, among other provisions. 

The collective agreement entered into in 2012 resulted in the following: (i) an increase in salaries by 6.17% (which corresponds to the inflation adjustment for the period plus further addition 1.93%), (ii) the establishment of an employment guarantee for 98% of our employees, (iii) an increase in meal vouchers of 10% and a further increase of 8% in all other benefits, and (iv) an end to extra payments to employees who drive company vehicles.

Our last collective bargaining agreement, executed in 2013, resulted in: (i) a salary increase of 8% (which corresponds to the inflation adjustment for the period plus a real gain of 2.5%), (ii) the establishment of an employment guarantee for 98% of our employees, (iii) an increase of 13.6% in meal vouchers (vale refeição), and (iv) an increase of 21.5% in food allowance and an additional of 15% for employees who work on flexible work shifts, among other things.

We have experienced the following strikes in the last seven years, none of which interrupted the essential services that we provide: a four‑day strike in June 2008, a three‑day strike in May 2009, an eight‑day strike in 2010, a one-day strike in 2011 and a two-day strike in 2013.  In 2007 and 2012 there were no strikes.  Under Brazilian law, our non‑administrative employees are considered “essential employees” and, therefore, are limited in their right to strike.

E.      Share Ownership

As of April 16, 2014, the members of the board of directors and the executive officers owned an aggregate of 1,515 common shares.  The members of our board of directors and our executive officers, on an individual basis and as a group, beneficially own less than 0.1% of our common shares.  See “Item 7.A. Major Shareholder” for more information.  As of the same date, none of our directors and executive officers owned any stock option plans.

ITEM 7.            MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A.      Major Shareholder

On April 22, 2013 our shareholders approved a stock split, following which each common share represented three new common shares. Since then, our outstanding capital stock consists of 683,509,869 common shares, without par value. Under our bylaws and the State laws, the State is required to own at least one‑half plus one of our outstanding common shares.  All of our shareholders, including the State, have the same voting rights.

The following table sets forth ownership information for each of our shareholders that beneficially owned 5.0% or more of our common shares and for our officers and directors, individually and as a group, as of April 16, 2014.

 

Common shares

 

Shares

%

State of São Paulo

343,524,258

50.3%

Directors and executive officers of SABESP

1,515

Less than 0.1%

Other

339,984,096

49.7%

Total(1)

683,509,869

100.0%

 

______________

(1)   As of April 16, 2014, 25.6% of our outstanding common shares were held by 5,433 registered shareholders in Brazil.

As of April 16, 2014, 24.1% of our outstanding common shares were held in the United States, in the form of ADSs.  According to the ADS depositary’s records, which contain information regarding the ownership of our ADSs, there were, on March 31, 2014, 36 record holders of ADSs in the United States.

 

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B.      Related Party Transactions

Transactions with the State of São Paulo

We have entered into extensive transactions with the State, which is our controlling shareholder, and we expect to continue to do so.  The State is our largest customer.  It owns some of the facilities that we use in our business, it is one of the governmental entities that regulate our business, and it has assisted us in obtaining financing on favorable terms.

Many of our transactions with the State reflect policies of the State that depend on decisions of elected officials or public servants, and are accordingly subject to change.  Among the practices that could change are those described below concerning the provision of State guarantees, and the terms on which we use State‑owned reservoirs.

Rendering Services

We provide water and sewage services to the federal government, state and municipal governments and government entities in the ordinary course of our business.  Gross revenue from sales to the State, including State entities, totaled R$449.1 million in 2013, R$431.0 million in 2012 and R$405.0 million in 2011.  Our accounts receivable from the State for water supply and sewage services totaled R$63.9 million and R$65.5 million, as of December 31, 2013 and 2012, respectively.  In addition, as required by law, we invest our cash and cash equivalents with government financial institutions.

Payment of Pensions

Pursuant to a law enacted by the State, certain former employees of some State owned companies that provided services to us in the past and later merged to form our Company acquired a legal right to receive supplemental pension benefit payments.  These rights are referred to as “Plan G0.”  These amounts are paid by us, on behalf of the State, and are claimed by us as reimbursements from the State, as primary obligor.  In 2013, 2012 and 2011, we made payments to former employees of R$140.1 million, R$132.7 million and R$124.4 million, respectively, in respect of Plan G0.  The State made reimbursements in 2013, 2012 and 2011 in the amount of R$111.0 million, R$104.4 million and R$89.5 million, respectively.

Agreements with the State

In September 1997, we and the State entered into a memorandum of understanding providing that we would, in effect, apply dividends we declared that were otherwise payable to the State to offset accounts receivable in connection with the provision of water and sewage services to the State and its controlled entities.

On December 11, 2001, we entered into an agreement with the State and the DAEE.  Pursuant to this agreement, the State acknowledged and agreed, subject to an audit by a State‑appointed auditor, to pay us amounts it owed to us in respect of:

·                     water and sewage services we provided to governmental agencies, State‑owned autonomous entities and foundations through December 1, 2001, and that was not offset in accordance with the September 1997 memorandum of understanding, in the total amount of R$358.2 million.  This amount was renegotiated and included in the second amendment to this agreement discussed below; and

·                     supplemental retirement and pension benefits we paid from March 1986 to November 2001 on behalf of the State to former employees of the State‑owned companies which merged to form our Company; as we did not reach an agreement regarding these amounts, a joint inquiry has commenced in order to ensure agreement between us and the State, in the total amount of R$320.6 million.  This amount was renegotiated and included in the third amendment to this agreement discussed below.

The agreement provided that the DAEE would transfer to us ownership of the Taiaçupeba, Jundiaí, Biritiba, Paraitinga and Ponte Nova reservoirs (herein after referred to as “the reservoirs”), which form the Alto Tietê system, and that the fair value of these assets would reduce the amounts owed to us by the State.

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Under the December 2001 agreement, in 2002, a State‑owned construction company (Companhia Paulista de Obras e Serviços), or the CPOS, on behalf of the State, and an independent appraisal firm (Engenharia de Avaliações), or the ENGEVAL, on our behalf, presented their valuation reports relating to the reservoirs.  Under the agreement, the arithmetic average of these appraisals is deemed the fair value of the reservoirs.  The appraisals contained in these reports were in the amounts of R$335.8 million and R$341.2 million, respectively.  Because we had already made investments in these reservoirs by then, the arithmetic average of the appraisals submitted to our board of directors by August 2002, R$300.9 million, was net of a percentage corresponding to these investments.  Our board of directors approved the valuation reports. This amount was updated until September 2008 according to ICPA index and amounted to R$696.3 million.

Under the December 2001 agreement, for amounts due in excess of the fair value of the reservoirs, the State is to make payments in 114 consecutive monthly installments.  The nominal amount owed by the State would not be indexed to inflation or earn interest if there was a delay in concluding the appraisal of fair value.  The installments will be indexed on a monthly basis by the IGP‑M index, plus 6.0% per year, starting on the date the first installment becomes due.

On October 29, 2003, the Public Prosecution Office of the State of São Paulo (Ministério Público do Estado de São Paulo), on behalf of the people of the State, brought a civil public action in a Trial Court of the State of São Paulo (12a Vara da Fazenda Pública do Estado de São Paulo) alleging that a transfer to us of ownership of the Alto Tietê system reservoirs from the DAEE would be illegal.  An injunction against the transfer of ownership of such reservoirs was granted but was later reversed.  However, in October 2004, the court of first instance handed down its judgment on the civil public action and declared the agreement between us, DAEE and State of São Paulo null and void.  This decision was suspended by us, and the State treasury and DAEE appealed the decision.  On August 23, 2010, the appeal was denied.  We have petitioned for clarification of the appeal court’s decision and will seek to take the case to the Supreme Court.  The effects of the appeal court’s decision will be suspended until the end of the legal process.  We have assessed the risk of loss as probable, which would prohibit the transfer of the reservoirs in payment of the accounts receivable due from the State.

The December 2001 agreement also provided that the legal advisors of the State would carry out specific analyses, which have commenced, to ensure agreement among the parties as to the methodology employed in determining the amount of reimbursement for pension benefits owed to us by the State.  The commencement of payments with respect to pension amounts owed to us by the State has been postponed until these analyses are completed, the appraisal report is approved and the credit assignments relating to the transfer of the reservoirs are formalized.  As discussed above, the transfer of these reservoirs is currently being disputed and we are not certain whether the transfer will be legally permitted.  Under the December 2001 agreement, the first payment was to be made in July 2002.

On March 22, 2004, we and the State entered into a first amendment to the December 2001 agreement.  Under this amendment, the State acknowledged that it owed R$581.8 million to us relating to unpaid accounts receivable from the State until February 29, 2004, and we acknowledged that we owed an aggregate amount of R$518.7 million to the State as dividends, in the form of interest on shareholders’ equity.  Accordingly, we and the State agreed to offset each other’s credit up to the limit of R$404.9 million, which was an amount adjusted up to February 2004.  The outstanding balance of R$176.9 million (as of February 29, 2004) of the State’s consolidated debt would be paid in consecutive monthly installments from May 2005 until April 2009.  These installments would be indexed according to the IPCA index, plus an interest rate of 0.5% per month.  Upon the execution of the first amendment, part of the debt that the State owed to us for the use of water and sewage services through February 2004 was offset by the debt that we owed to the State as dividends, in the form of interest on shareholders’ equity.  The outstanding balance of R$113.8 million as dividends in the form of interest on shareholders’ equity that we owed to the State was netted against accounts overdue after February 2004.  The first amendment did not amend the provisions of the December 2001 agreement regarding the supplemental retirement and pension benefits we paid from March 1986 to November 2001 on behalf of the State to former employees of the State‑owned companies.

On December 28, 2007, we and the State entered into a second amendment to the December 2001 agreement, pursuant to which the State agreed to pay (i) the outstanding balance under the first amendment, in the amount of R$133.7 million (as of November 30, 2007), in 60 consecutive monthly installments, beginning on January 2, 2008, and (ii) the amount of R$236.1 million relating to part of the accounts overdue and unpaid from March 2004 through October 2007 regarding the provision of water supply and sewage collection services.  As part of this amendment, we agreed to pay during the period from January through March 2008 the outstanding balance of dividends in the amount of R$400.8 million, in the form of interest on shareholders’ equity, due from March 2004 through December 2006.  We paid these amounts as agreed.  Under the second amendment, dividends payable by us are no longer required to be applied to offset accounts receivable from the State, and as a result, we are currently unable to determine the amount, if any, of the declared dividends that the State will apply to current and future accounts receivable owed to us by the State or its entities.  In addition, pursuant to the second amendment, we and the State agreed on complying with certain mutual obligations relating (i) to the improvement of payment processes and budget management procedures; (ii) the rationalization of the use of water and the amount of water and sewage bills under the responsibility of the State; (iii) the recording of government entities with accounts overdue in a delinquency system or reference file; and (iv) the possibility of interrupting water supply to these entities in case of non‑payment of water and sewage bills.  Finally, this second amendment did not amend the provisions of the December 2001 agreement regarding the supplemental retirement and pension benefits we paid from March 1986 through November 2001 on behalf of the State to former employees of the State‑owned companies that merged to form our Company.

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In 2007, we received payment installments from the State in the amount of R$326.0 million.  As of December 31, 2007, our dividends payable to the State, due from 2004 through 2007, were in the amount of R$552.0 million.  We are currently unable to determine the amount, if any, of the declared dividends that the State will apply to current and future accounts receivable owed to us by the State or its entities.  The second amendment no longer requires that dividends be applied to offset accounts receivable from the State.

On March 26, 2008, we entered into a commitment agreement (termo de compromisso) with the State with the purpose of finding an alternate solution to the deadlock related to the amount owed by the State to us in connection with the supplemental retirement and pension benefits we paid from March 1986 to November 2001 on behalf of the State to former employees of the State‑owned companies which merged to form our Company.  In this agreement, we and State committed to hiring specialized companies to carry out new valuations of the amounts owed to us by the State and of the reservoirs.  An independent consulting firm, FIPECAFI, has been retained to resolve the disagreement and validate the amount we paid from March 1986 through November 2001 on behalf of the State to former employees of the State‑owned companies that merged to form our Company, which the State has not yet agreed to reimburse us hereinafter referred to as the “Disputed Reimbursement Amount.”  In addition, FIPECAFI performed, together with another independent consulting firm, a new evaluation of the reservoirs that might be transferred to us as amortization of the reimbursement payable by the State to us.

On November 17, 2008, we, the State and DAEE entered into a third amendment to the December 2001 agreement, pursuant to which the State recognized a debt balance payable to us totaling R$915.3 million, hereinafter referred to as the “Undisputed Reimbursement Amount,” as adjusted based on the IPCA.  We accepted on a provisional basis the reservoirs as part of the payment of the Undisputed Reimbursement Amount and offered to the State a provisional settlement, recognizing a credit totaling R$696.3 million, corresponding to the value of the reservoirs located in the Alto Tietê region.  We and the State have agreed that the final offset will only be recorded when the effective transfer of the reservoirs is recorded at the Real Estate Registry.  The outstanding balance of Undisputed Reimbursement Amount, amounting to R$219.0 million, is being paid by the State in 114 consecutive monthly installments, as adjusted by the annual IPCA variation, plus interest accruing at the annual rate of 6.0%.  The first installment was paid in November 2008.

In addition to the Undisputed Reimbursement Amount, there is an outstanding balance relating to the Disputed Reimbursement Amount.  As of December 31, 2013, the Disputed Reimbursement Amount, plus the reservoirs mentioned above, amounted to R$1,412.5 million, but due to the uncertainty regarding the recovery of the amount our management decided not to recognize the reimbursements.  See Note 9 to our financial statements as of December 31, 2013 and 2012 and for the year ended December 31, 2013, 2012 and 2011 regarding the Disputed Reimbursement Amount.  We and the State have agreed that the dispute relating to the Disputed Reimbursement Amount will not prevent us from carrying out the commitments made in the December 2001 agreement. 

In addition, the third amendment to the December 2001 agreement provides for the regularization of the monthly flow of benefits.  While we are liable for the monthly flow of benefits to the former employees of the state‑owned companies that merged to form our Company, the State shall reimburse us based on criteria identical to those applied when determining the Undisputed Reimbursement Amount.  Should there be no preventive court decision, the State will assume the flow of monthly payment of benefits portion deemed as undisputed.

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Finally, the third amendment to the December 2001 agreement established that the Public Attorney’s Office of the State of São Paulo, or the Public Attorney’s Office, would issue a revised interpretation of the calculation and eligibility criteria applicable to the Disputed Reimbursement Amount.  At that time, we believed that the Public Attorney’s Office would issue a revised interpretation which would have helped us bring the negotiations with the State to a conclusion.  However, contrary to our expectations, the Public Attorney’s Office interpretation of the calculation and eligibility criteria applicable to the Disputed Reimbursement Amount refuted the reimbursement of the largest portion of this amount.  As of December 31, 2013, we had made a provision of R$1,780.3 million in our pension obligations accounts in respect of the pension benefit obligation of Plan G0.

Even though the negotiations with the State are still progressing, we cannot assure you that we will recover the receivables related to the Disputed Reimbursement Amount.

We will not waive the receivables from the State to which we consider ourselves to be legally entitled.  Accordingly, we will take all possible actions to resolve the issue at all administrative and court levels.  Should this conflict persist, we will take all the necessary actions to protect our interests.  On March 24, 2010, we sent to the controlling shareholder the official letter approved by our executive committee, proposing that the matter be discussed at the BM&FBOVESPA Arbitration Chamber.  In June 2010, we sent a settlement proposal to the Secretary of Treasury, which was denied, and (iii) on November 9, 2010, we filed a civil lawsuit against the State of São Paulo seeking full reimbursement of the amounts paid as benefits granted by Law No. 4,819/58.  Regardless of the civil lawsuit, we will continue to actively seek a settlement with the State government.

Agreement with the State and the city of São Paulo

On June 23, 2010 the State and the city of São Paulo entered into a convention (convênio) with the intermediation and consent of our Company and of ARSESP pursuant to which they agreed to jointly manage the planning of and investment in the basic sanitation system of the city of São Paulo, among other things.  This agreement established that the State and the city of São Paulo would enter into an agreement with us, granting us exclusive rights in the provision of water and sewage services in the city of São Paulo.  In addition, the agreement established the role of ARSESP in regulating and overseeing our activities, and established a management committee that will be responsible for planning the water and sewage services and for reviewing our investment plans.  The management committee is composed of six members appointed for renewable two‑year terms.  The State and the city of São Paulo have the right to appoint three members each.  We are permitted to participate in the meetings of the management committee, but we are not afforded any voting rights.

On June 23, 2010 the State and the City of São Paulo executed an agreement in the form of a convênio, to which we and ARSESP consented, under which they agreed to manage the planning and investment for the basic sanitation system of the city of São Paulo on a joint basis.  The principal terms of this convênio  were as follows:

•      The State and the City of São Paulo would execute a separate agreement with us, granting us exclusive rights to provide water and sewage services in the city of São Paulo.

•      ARSESP would regulate and oversee our activities regarding water and sewage services in the city of São Paulo, including tariffs.

•      A management committee (Comitê Gestor) would be responsible for planning water and sewage services for the city and for reviewing our investment plans.  The management committee consists of six members appointed for two-year terms.  The State and the City of São Paulo have the right to appoint three members each.  We may participate in management committee meetings but may not vote.

In application of the convênio, we executed a separate contract with the State and the city of São Paulo, also dated June 23, 2010, to regulate the provision of these services for the following 30 years.  The principal terms of this contract are as follows:

•      The total investment stated in the contract must be equal to 13% of gross revenues from the provision of services to the city of São Paulo, net of the taxes on revenues, which total approximately R$600 million per year.

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•      We must transfer 7.5% of the gross revenues we derive under the convênio, and subtract (i) COFINS and PASEP taxes, and (ii) unpaid bills of publicly owned properties in the city of São Paulo, to the Municipal Fund for Environmental Sanitation and Infrastructure (Fundo Municipal de Saneamento Ambiental e Infraestrutura),  established by Municipal Law No. 14,934/2009.  In April 2013, ARSESP postponed the application of such municipal charges until the conclusion of the tariff revision process, based on a request from the São Paulo State Government to analyze, among other things, methods to reduce the impact on consumers.

•      Our investment plan must be compatible with the sanitation plans of the State, the City of São Paulo and, if necessary, the Metropolitan region.

•      ARSESP will ensure that the tariffs will adequately compensate us for the services we provide and that tariffs may be adjusted in order to restore the original balance between each party’s obligations and economic gain (equilíbrio econômico financeiro).

We currently have an investment plan in place that reflects these obligations and addresses their compatibility with the sanitation plans of the State, the City of São Paulo and, if necessary, the Metropolitan region.  The investment plan is not irrevocable and will be reviewed by our management committee every four years, particularly with respect to the investments to be executed in the subsequent period.

Dividends

We regularly pay dividends to our shareholders, including the State of São Paulo.  In the past, we have withheld part of the dividends to which the State was entitled in order to offset it against our pending receivables from the State.

In accordance with our agreements with the State, we do not anticipate that we will withhold dividends to which the State was entitled in order to offset it against our pending receivables from the State in the near future.

Government Guarantees of Financing

In some situations, the federal government, the State or government agencies guarantee our performance under debt‑ and project‑related agreements.

Furthermore, the federal government has guaranteed, and the State has provided a counter‑guarantee, in respect of the financial agreements we entered into with the IADB (i) in 1992 and 2000 for the total original aggregate amount of US$650.0 million related to the financing of the first and second phases of the Tietê River recovery project to reduce pollution; and (ii) in 2010 for the aggregate amount of US$600 million related to the financing of the third phase of the Tiête River project.  The federal government has also guaranteed and the State of São Paulo has provided a counter‑guarantee, in respect of the financial agreement we entered with the International Bank for Reconstruction and Development (IBRD) in the amount of US$100 million for the Water Source Program (Programa Mananciais). 

We also entered into credit agreements with the JICA, which were guaranteed by the federal government, with counter‑guarantee from the State of São Paulo, for the financing of (i) the Clean Wave Program for the Baixada Santista metropolitan region, on August 6, 2004, for an aggregate principal amount of ¥21,320 million; (ii) the second phase of the Clean Wave Program, in February 2011, for an aggregate principal amount of ¥19,169 million; (iii) the environmental improvement program in the basin of the Billings dam, as part of the New Life Program (Programa Vida Nova), in October 2010, for an aggregate principal amount of ¥6,208 million; and (iv) the Corporate Program for Water Loss Reduction, in February 2012, for an aggregate principal amount of ¥33,584 million.

The State has also guaranteed a portion of our repayment obligations under loan agreements that we entered into with the federal government in 1994 through its financial agent, Banco do Brasil S.A. which totaled R$100.5 million as of December 31, 2013.

For more information on the aforementioned loans, see “Item 5.B. Liquidity and Capital Resources—Capital Sources—Indebtedness Financing.”

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Use of Reservoirs

We currently use the Guarapiranga and Billings reservoirs, which are also used by another company controlled by the São Paulo State Government, based on a grant issued by the DAEE.  We do not pay any fees with respect to the use of these reservoirs.  We are, however, responsible for maintaining them and funding their operating costs.  The State incurs no operating costs on our behalf.  If these facilities were not available for our use, we would have to obtain water from more distant sources, which would be more costly.

Agreements with Lower Tariffs

We have entered into agreements with public entities, including State entities and municipalities, which manage approximately 8,000 properties.  Under these agreements, these public entities pay a different tariff which is approximately 25.0% lower than the tariff that applies for the public entities that have not entered into these agreements, provided such entities implement our PURA program for the rational use of water, which has a fixed target for reduction or maintenance of water consumption, according to technical evaluations carried out by us. These agreements are valid for a 12‑month term with automatic renewal for equal periods.  Pursuant to the terms of these agreements, if these entities fail to make any payment on a timely basis to us, we have the right to cancel the agreement, thereby revoking the 25.0% tariff reduction.

Personnel Assignment Agreement among Entities Related to the State Government

We have personnel assignment agreements with entities related to the State Government, under which the expenses are fully passed on and monetarily reimbursed.  The expenses related to personnel assigned by us to other state government entities in 2013, 2012 and 2011 amounted to R$12.9 million, R$12.3 million and R$10.9 million, respectively.

The expenses related to personnel assigned by other entities to us totaled R$1.0 million in both 2013 and 2012; in 2011, none of our personnel had been assigned by other offices.

Services Obtained from State Government Entities

As of December 31, 2013, 2012 and 2011, we had an outstanding amount payable of R$2.0 million, R$1.0 million and R$12.1 million, respectively, for services rendered by São Paulo State government entities, including the supply of electric power by CESP.

Non‑operating Assets

We lend land, free of charge, to DAEE.  Such non‑operating assets totaled R$1.0 million, R$1.0 million and R$2.3 million as of December 31, 2013, 2012 and 2011, respectively.

Banco do Brasil

We filed a lawsuit against the Department of Finance of the State São Paulo seeking financial compensation related to the transfer of our exclusive rights in bank services.  On March 27, 2007, the State of São Paulo sold exclusive rights in the provision of banking services administration entities directly and indirectly in favor of Banco Nossa Caixa.  On May 27, 2010, the State of São Paulo sold them in favor of Banco do Brasil.  In this lawsuit, we were pleading financial compensation for the sale of its exclusive rights, requiring a percentage of the values that the State of São Paulo received from each of the financial institutions for the services contract entered into.

On June 28, 2011, we entered into an agreement with the State of São Paulo whereby we received the amount of R$63.4 million upon reduction, as compensation of credit held by the State, corresponding to interests on shareholders’ equity in the fiscal year 2010.

Transactions with SABESPREV Pension Fund

SABESPREV is a pension fund we established to provide our employees with retirement and pension benefits.  The assets of SABESPREV are independently held, but we nominate 50.0% of SABESPREV’s board of directors, including the chairman of the board, who has the deciding vote pursuant to the applicable legislation.  Both we and our employees make contributions to SABESPREV pension plans.  We contributed R$8.4 million, R$7.4 million and R$8.9 million in 2013, 2012 and 2011, respectively.  On May 29, 2001, a federal law was enacted which, among other provisions, limits the amount mixed capital companies, like us, may contribute to their pension plans.  Specifically, the ordinary contributions made by us to our pension plans may not exceed the contributions made by the beneficiaries of these plans.

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Our original pension plan (the Defined Benefit Plan) has an actuarial deficit.  We have commenced studies to manage this deficit and have also created a new, defined contribution plan, SABESPREV Mais.  Our new plan was approved by the Previc in June 2010, after which our old plan stopped accepting new members.  Contributions to the new plan are also shared between plan members and SABESP, and benefits are established based on the balance of the individual member’s account when payment on his or her benefit begins.  This balance consists of contributions and profitability obtained when applying resources.  We intended to have members of the old plan migrate their reserves to the new plan.  This migration was interrupted by a judicial order as a result of proceedings brought by representative entities for our employees and ex‑employees.  In October 2010, the judge presiding over the case pronounced in an interim decision that people and reserves were not allowed to migrate between the plans until a further decision was made.  This decision also prevents the plan from charging contributions to account for the deficit for those who remained covered by the original plan. In September 2012, the judge presiding over the case ordered a financial expert inspection.  An expert was appointed in early 2013 but has not yet begun an inspection.

 

Compensation of Management

The compensation paid by us to the members of our board of directors, board of executive officers and fiscal committee amounted to R$3.6 million, R$3.4 million and R$2.8 million in 2013, 2012 and 2011, respectively, and it refers to salaries and other short‑term benefits management.  An additional R$0.6 million, R$0.7 million and R$1.1 million related to the bonus program was accrued in 2013, 2012 and 2011.

For further information on management compensation, see “Item 6.B. Compensation.”

Loan agreement through credit facility

 

We hold interests in some companies.  Although we do not hold the majority of shares in any of the companies in which we hold interests, we are party to shareholders’ agreements which provide for the power of veto with regard to certain management proposals and decisions.  Due our significant influence on these companies by way of shareholders’ agreements, for accounting purposes, these companies are accounted for by applying the equity method of accounting.

We entered into a loan agreement through credit facility with the Águas de Andradina S.A., Águas de Castilho S.A., and Aquapolo Ambiental S.A. to finance the operations of these companies, until the loans and financing required to banks are cleared.

         The contracts signed on January 19, 2012 with Águas de Andradina and Águas de Castilho were settled in July 2012, according to the agreement’s provisions. On July 18, 2012, new agreements were signed with both companies, pursuant to the terms and conditions in the table below. The agreement signed with Aquapolo Ambiental on March 30, 2012 remains with the same features, according to the table below:

 

 

Companies

Credit limit

Principal disbursed

Interest balance

Total

Interest rate

Maturity

Águas de Andradina

3,467

1,427

297

1,724

SELIC + 3.5% p.a.

(*)

Águas de Castilho

675

403

84

487

SELIC + 3.5% p.a.

(*)

Aquapolo Ambiental

5,629

5,629

1,429

7,058

CDI + 1.2% p.a.

04/30/2016

Aquapolo Ambiental

19,000

19,000

3,789

22,789

CDI + 1.2% p.a.

04/30/2015

Total

28,771

26,459

5,599

32,058

 

 

 

(*) Loan for use agreements with the SPEs Aguas de Andradina and Aguas de Castilho mature when funds from the Brazilian Development Bank (BNDES) long-term contracts are released  at which time the borrower will pay off all the debt arising from the credit facility.

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The amount disbursed is recognized in assets, in “Other receivables” and amounts to R$1,830 for principal and R$381 for interest recognized in current assets and R$24,629 for principal and R$5,218 for interest in noncurrent assets. As of December 31, 2013, the balance of principal and interest of these contracts is R$32,058. In 2013, financial income was impacted by R$3,977.

 

C.      Interests of Experts and Counsel

Not applicable.

ITEM 8.            FINANCIAL INFORMATION

A.      Financial Statements and Other Financial Information

See “Item 3.A. Selected Financial Data” and “Item 18.  Financial Statements.”

Legal Proceedings

We are currently subject to numerous legal proceedings relating to civil, tax, labor, corporate and environmental issues arising in the normal course of our business. Several individual disputes account for a significant part of the total amount of claims against us. Our audited financial statements only include provisions for probable and reasonably estimable losses and expenses we may incur in connection with pending proceedings. Our material legal proceedings are described in Note 18 to our audited financial statements included in this annual report, and that description is incorporated by reference under this Item.

Civil Public Actions Related to Environmental Matters

We are subject to administrative and judicial proceedings, including proceedings initiated by the company of Environmental Sanitation Technology (Companhia de Technologia de Saneamento Ambiental – Cetesb), Public Prosecutor of the State of São Paulo and non-governmental organizations among others.  These result from proceedings alleged environmental damage including proceedings:  (i) seeking that we cease releasing raw sewage into certain local water courses; (ii) in some cases seeking remedies for environmental damages, which have not yet been specified and evaluated by the court’s technical experts; and (iii) seeking to require us to install and operate sewage treatment facilities in the locations referred to in the civil public actions.  In certain case, we are subject to daily fines for non‑compliance.  In our response to these lawsuits we emphasize that the installation and operation of sewage treatment facilities in the locations referred to in the civil public actions is included in our investment plan.  There have already been unfavorable judicial decisions against us.  The effects may include:  (i) investment in works or services not considered by the long‑term investment plan; (ii) early execution of works or services that were   considered for execution in future years in the long‑term investment plan; (iii) payments related to environmental indemnification; and (iv) a negative impact on our image in national and international markets and in public bodies.

Although we are not able to predict the final outcome of these lawsuits, we believe that the outcome, if unfavorable to us, may have a material adverse effect on us. We classify certain of these proceedings as probable loss and possible loss. As of December 31, 2013 we have provisioned R$182.7 million for such matters.

Other Legal Proceedings

The Civil Entity Coordination Committee of Piracicaba filed a civil public action against us, the National Water Agency and the State of São Paulo Treasury Department seeking, among other claims for relief: (i) the termination of use of 31 m3/s of water from one of the municipality’s reservoirs; (ii) the creation of a schedule to regulate water use and withdrawal from the Piracicaba water basin by the Cantareira system to eliminate possible damage to populations downstream and (iii) the development of an environmental impact study on the Cantareira system evaluating the impact of water use and withdrawal on the various basins that constitute the system. This civil public action was decided favorably for us in two lower courts, and the plaintiff’s appeal to a higher court seeking special and extraordinary recourse was denied based on inadmissibility. We are currently awaiting a court decision on the appeal brought by the plaintiff against this decision. The amount involved in this proceeding as of December 31, 2013 is R$19.2 billion. We have assessed the risk of loss as remote, and accordingly have not taken any provisions.

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The Public Prosecutor’s Office of the State of São Paulo filed a civil public action against us seeking: (i) the nullification of the contract we entered with the Municipality of São Paulo on June 23, 2010 regarding the service of water supply and sewage services; (ii) our exclusion from BM&F Bovespa’s Corporate Sustainability Index; and (iii) sewage treatment coverage of the entire Municipality of São Paulo by 2018.  The plaintiff’s request for an injunction was denied, and the courts maintained this decision after we presented our defense.  Separately, we have challenged the amount claimed by the Public Prosecutor’s Office of the State of São Paulo in these proceedings. The amount involved in these proceedings is R$12.3 billion as of December 31, 2013. We have assessed the risk of loss as remote, and accordingly have not taken any provisions.

Dividends and Dividend Policy

Amounts Available for Distribution

At each annual shareholders’ meeting, the board of directors is required to recommend the allocation of net profits for the preceding fiscal year.  For purposes of Brazilian Corporate Law, net profits are defined as net income after income tax and social contribution tax for such fiscal year, net of any accumulated losses from prior fiscal years and any amounts allocated to employees’ and management’s participation in our profits.  In accordance with Brazilian Corporate Law, the amounts available for dividend distribution are the amounts equal to half of the net profit as increased or reduced by:

a)    the amount intended to form the legal reserve; and

b)    the amount intended to form the reserves for contingencies and any written-off amounts of the same reserves formed in previous fiscal years.

We are required to maintain a legal reserve, to which we must allocate 5.0% of net profits for each fiscal year until the amount for such reserve equals 20.0% of our paid‑in capital.  However, we are not required to make any allocations to our legal reserve in respect of any fiscal year in which the aggregate amount of the legal reserve plus our other established capital reserves exceeds 30.0% of our capital.  Net losses, if any, may be offset against the legal reserve.  As of December 31, 2013, 2012 and 2011 the balance of our legal reserve was R$713.0 million, R$616.8 million and R$521.2 million, respectively, which was equal to 11.5%, 9.9% and 8.4%, respectively, of our capital.

Brazilian Corporate Law also provides for two discretionary allocations of net profits that are subject to approval by the shareholders at each annual shareholders’ meeting.  First, a percentage of net profits may be allocated to a contingency reserve for anticipated losses that are deemed probable in future years.  Any amount so allocated in a prior year must be either reversed in the fiscal year in which the loss was anticipated if such loss does not in fact occur, or written off in the event that the anticipated loss occurs.  Second, if the mandatory distributable amount exceeds the sum of realized net profits in any given year, such excess may be allocated to an unrealized revenue reserve.  Under Brazilian Corporate Law, realized net profits is defined as the amount of net profits that exceeds the net positive result of equity adjustments and profits or revenues from operations with financial results after the end of the next succeeding fiscal year.

Under Brazilian Corporate Law, any company may authorize in its bylaws the creation of a discretionary reserve.  Bylaws which authorize the allocation of a percentage of a company’s net income to the discretionary reserve must also indicate the purpose, criteria for allocation and maximum amount of the reserve.  We may also allocate a portion of our net profits for discretionary allocations for plan expansion and other capital investment projects, the amount of which would be based on a capital budget previously presented by management and approved by our shareholders.  Under Law No. 10,303 of October 31, 2001, capital budgets for more than one year must be revised at each annual shareholders’ meeting.  After completion of the relevant capital projects, we may retain the allocation until the shareholders vote to transfer all or a portion of the reserve to capital or retained earnings.  As of December 31, 2013, 2012 and 2011 we had an investment reserve of R$5,980.5 million, R$4,690.6 million and R$3,408.6 million, respectively.

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The amounts available for distribution may be further increased by a reversion of the contingency reserve for anticipated losses constituted in prior years but not realized.  The amounts available for distribution are determined on the basis of our financial statements prepared in accordance with Brazilian GAAP.

The legal reserve is subject to approval by the shareholder vote at our annual shareholders’ meeting and may be transferred to capital but is not available for the payment of dividends in subsequent years.

Mandatory Distribution

Brazilian Corporate Law generally requires that the bylaws of each Brazilian corporation specify a minimum percentage of the amounts available for distribution by such corporation for each fiscal year that must be distributed to shareholders as dividends, also known as the mandatory distributable amount.  Under our bylaws, the mandatory distributable amount has been fixed at an amount equal to not less than 25.0% of the amounts available for distribution, to the extent amounts are available for distribution at the end of each given fiscal year.

The mandatory distribution is based on a percentage of adjusted net income, not lower than 25.0%, rather than a fixed monetary amount per share.  Brazilian Corporate Law, however, permits a publicly held company, such as us, to suspend the mandatory distribution if the board of directors and the fiscal committee report to the shareholders’ meeting that the distribution would be inadvisable in view of the company’s financial condition.  The suspension is subject to the approval of holders of common shares.  In this case, the board of directors must file a justification for such suspension with the CVM.  Profits not distributed by virtue of the suspension mentioned above shall be attributed to a special reserve and, if not absorbed by subsequent losses, must be paid as dividends as soon as the financial condition of such company permits such payments.

Payment of Dividends

We are required by Brazilian Corporate Law and by our bylaws to hold an annual shareholders’ meeting by the fourth month after the end of each fiscal year at which, among other things, the shareholders have to decide on the payment of an annual dividend when profits were accrued.  The decision to distribute annual dividends is based on the financial statements prepared for the relevant fiscal year.  Under Brazilian Corporate Law, dividends generally are required to be paid within 60 days following the date the dividend was declared, unless a shareholders’ resolution sets forth another date for payment, which, in either case, must occur prior to the end of the fiscal year in which the dividend was declared.  A shareholder has a three year period from the dividend payment date to claim dividends (or interest payments on shareholders’ equity as described under “—Record of Dividend Payments and Interest on Shareholders’ Equity”) distributed on his or her shares, after which the amount of the unclaimed dividends reverts to us.  The depositary will set the currency exchange date to be used for payments to ADS holders as soon as practicable upon receipt of those payments from us.

Our bylaws allow us to pay interim dividends from preexisting and accumulated profits related to the current or preceding fiscal year.

In general, shareholders who are not residents of Brazil must register with the Central Bank to have dividends, sales proceeds or other amounts with respect to their shares eligible to be remitted outside of Brazil.  The common shares underlying our ADSs are held in Brazil by Banco Itaú Unibanco S.A., as the custodian and agent for the depositary, which is the registered owner of the common shares underlying the ADSs.  Our current registrar is Banco Itaú Unibanco S.A.  The depositary electronically registers the common shares underlying the ADSs with the Central Bank and, therefore, is able to have dividends, sales proceeds or other amounts with respect to these shares eligible to be remitted outside Brazil.  See “Item 10.D. Exchange Controls.”

Payments of cash dividends and distributions, if any, will be made in Brazilian reais  to the custodian on behalf of the depositary, which will then convert such proceeds into U.S. dollars and will cause such U.S. dollars to be delivered to the depositary for distribution to holders of ADSs.  See “Item 10.D. Exchange Controls.”  Under current Brazilian law, dividends generally paid to shareholders who are not Brazilian residents, including holders of ADSs, will not be subject to Brazilian withholding income tax, except for dividends declared based on profits generated prior to December 31, 1995.  See “Item 10.E. Taxation.”

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Record of Dividend Payments and Interest on Shareholders’ Equity

Brazilian corporations are permitted to distribute dividends in the form of a tax‑deductible notional interest expense on shareholders’ equity in accordance with Law No. 9,249 of December 26, 1995, as amended.  The amount of tax‑deductible interest that may be paid is calculated by applying the daily pro rata variation of the government’s long-term interest rate (TJLP) on the shareholders’ equity during the relevant period and cannot exceed the greater of: 

·                     50.0% of net income (before taking into account such distribution and any deductions for income taxes and after taking into account any deductions for social contributions on net profits) for the period in respect of which the payment is made; or

·                     50.0% of earnings reserves and retained earnings.

Any payment of interest on shareholders’ equity to holders of ADSs or common shares, whether or not they are Brazilian residents, is subject to Brazilian withholding income tax at the rate of 15.0% or 25.0% if the beneficiary is resident in a low tax jurisdiction (tax haven).  See “Item 10.E. Taxation.”  The amount paid to shareholders as interest on shareholders’ equity, net of any withholding tax, may be included as part of the mandatory dividends distributable amount as prescribed in Brazilian Corporate Law.

Dividends and interest on shareholders’ equity over the minimum established in a company’s bylaws are recognized when approved by the shareholders in the general meeting.  Consequently, the amounts recognized as of December 31, 2013 correspond to the minimum established by law of 25.0% of the net income and the difference of R$537.5 million will be recorded in 2014 after the general shareholders’ meeting.

Distributions of dividends

The following table sets forth the distributions of dividends that we made to our shareholders in respect of our 2013, 2012 and 2011 earnings.  All these amounts distributed or to be distributed were or will be in the form of interest on shareholders’ equity.

Year ended December 31,

Aggregate amount distributed

Payment Dates

Payment per share

Payment per ADS

 

(in millions of reais

 

 

(in reais

2013

537.5

(*)

0.79

0.79

2012

534.3

June 21, 2013

0.78

0.78

2011

578.7

June 22, 2012

0.85

0.85

 

______________

(*)   We recorded dividends in the amount of R$456.8 million, which pursuant to our bylaws is our minimum dividend amount.  The dividends will be paid until 60 days after the Ordinary General Meeting, which will occur on April 30, 2014.

Dividend Policy

We intend to declare and pay dividends and/or interest on shareholders’ equity, as required by Brazilian Corporate Law and our bylaws.  Our board of directors may approve the distribution of interest on shareholders’ equity, calculated based on our semiannual or quarterly financial statements.  The declaration of dividends is annual, including dividends in excess of the mandatory distribution, and requires approval by the vote of the majority of the holders of our common shares.  The amount of any distributions will depend on many factors, such as our results of operations, financial condition, cash requirements, prospects and other factors deemed relevant by our board of directors and shareholders.  Within the context of our tax planning, we may in the future continue to determine that it is in our best interest to distribute interest on shareholders’ equity.

 

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B.      Significant Changes

Other than as disclosed in this annual report, no significant change has occurred since the date of the audited financial statements included in this annual report.

 

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ITEM 9.            THE OFFER AND LISTING

A.      Offer and Listing Details

Market Price of Common Shares

Our common shares have been listed on the BM&FBOVESPA under the symbol “SBSP3” since June 4, 1997 and, starting on April 24, 2002, have been included in the Novo Mercado segment of that exchange.  As of December 31, 2013, we had 5,645 registered holders of common shares.

On April 30, 2007, our shareholders approved a reverse stock split of 125 common shares into one common share.  Following a ratio change effected on January 24, 2013, each American Depositary Share currently represents one of our common shares.  On April 22, 2013 our shareholders approved a stock split, following which each common share represented three new common shares.  IFRS requires the retrospective application of earnings‑per‑share computations for stock dividends, stock splits, and reverse splits.

The table below sets forth, for the periods indicated, the reported high and low closing sale prices in reais  for common shares on the BM&FBOVESPA.  The table also sets forth prices per ADS assuming that ADSs had been outstanding on all such dates and translated into U.S. dollars at the commercial market rate for the sale of U.S. dollars for each of the respective dates of such quotations.  In addition, the table sets forth the average daily trading volume for our common shares.

 

Reais per common share

U.S. dollar equivalent per ADS(1)

 

 

Low

High

Low

High

Average daily trading volume

2014

 

 

 

 

 

January

21.78

25.96

8.93

10.83

1,170,873

February

20.84

24.01

8.65

9.97

1,778,260

March

19.61

21.50

8.37

9.31

1,926,905

April 16

19.60

22.05

8.81

9.83

2,075,425

2013

19.55

32.13

8.15

15.95

1,373,958

First quarter

85.00

96.40

41.90

47.87

557,193

Second quarter(2) 

20.40

31.38

9.06

15.66

1,755,594

Third quarter

19.55

23.96

8.15

10.76

1,719,845

Fourth quarter

21.4

26.55

9.70

11.28

1,401,226

2012

50.42

92.48

53.97

91.52

409,457

First quarter

50.42

69.66

53.97

76.46

372,200

Second quarter

68.50

77.32

74.85

74.48

321,627

Third quarter

75.67

92.48

74.51

91.52

417,208

Fourth quarter

80.54

90.50

76.98

89.40

534,115

2011

39.00

52.78

48.75

56.80

258,827

First quarter

40.10

47.00

47.91

57.71

282,548

Second quarter

45.00

49.50

56.39

60.75

267,042

Third quarter

39.00

48.03

48.75

61.43

245,275

Fourth quarter

43.03

52.78

45.75

56.80

241,197

2010

30.27

44.47

32.70

52.56

311,996

First quarter

30.27

34.26

32.70

39.55

323,739

Second quarter

32.36

37.50

35.28

41.63

416,256

Third quarter

33.41

37.90

38.05

44.74

265,725

Fourth quarter

37.59

44.47

44.53

52.56

242,943

2009

21.87

37.19

18.39

43.66

351,874

 

______________

(1)   Following a ratio change effected on January 24, 2013, each ADS represents one common shares.

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 (2)  After April 22, 2013 our common shares are traded considering the stock split.

Market Price of ADSs

Our ADSs, each of which represents one of our common shares, as of the date of this annual report, are listed on the NYSE under the symbol “SBS.”  Prior to June 8, 2007, each ADS represented 250 of our common shares.  From that date through January 23, 2013, each ADS represented two of our common shares.  Following a ratio change effected on January 24, 2013, each American Depositary Share currently represents one of our common shares.  On April 22, 2013 our shareholders approved a stock split, following which each common share represented three new common shares. Our ADSs began trading on the NYSE on May 10, 2002 in connection with the initial offering of our equity securities in the United States.

The table below sets forth, for the periods indicated, the reported high and low closing prices for our ADSs on the NYSE.

 

Price in U.S. dollars per ADS

 

 

Low

High

Average daily trading volume

2014

 

 

 

January

8.91

10.83

2,210,576

February

8.66

10.20

3,006,556

March

8.39

9.33

3,147,725

April 16

8.86

9.84

4,068,361

2013

41.60

48.63

490,280

First quarter(1)

9.33

15.88

1,649,436

Second quarter(2)

8.38

10.82

2,055,875

Third quarter

9.76

11.45

1,725,844

Fourth quarter

41.60

48.63

490,280

2012

56.62

91.48

311,242

First quarter

56.62

76.86

325,938

Second quarter

68.90

80.18

328,410

Third quarter

74.49

91.48

316,824

Fourth quarter

78.16

88.35

321,333

2011

46.35

62.63

263,370

First quarter

48.60

58.74

297,927

Second quarter

56.91

62.63

284,122

Third quarter

46.35

62.07

263,200

Fourth quarter

46.74

56.66

215,152

2010

33.09

53.18

275,432

First quarter

33.09

40.16

262,525

Second quarter

35.33

41.54

337,808

Third quarter

37.97

45.51

266,393

Fourth quarter

45.15

53.18

234,667

2009

18.03

43.40

331,673

2008

16.76

56.35

414,961

2007

29.15

53.57

323,404

 

______________

(1)   After January 23, 2013 our common shares have traded considering the ratio change.  On April 22, 2013 our shareholders approved a stock split, following which each common share represented three new common shares.

(2)   After April 29, 2013 our ADSs are traded considering the stock split.

B.      Plan of Distribution

Not applicable.

 

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C.      Markets 

Trading on the Brazilian Stock Exchange

The preferred shares and common shares are traded on the BM&FBovespa, the only Brazilian stock exchange that trades shares. Trading on the BM&FBovespa is limited to brokerage firms and a limited number of authorized entities. The CVM and BM&FBovespa have discretionary authority to suspend trading in shares of a particular issuer under certain circumstances.

Trading on the BM&FBOVESPA is conducted between 10:00 a.m. and 5:00 p.m. or from 11:00 a.m. to 6:00 p.m. (during daylight savings time in Brazil).  The BM&FBOVESPA also permits trading from 5:30 p.m. to 6:00 p.m. or from 6:30 p.m. to 7:00 p.m. (during daylight savings time in Brazil) during a different trading period called the “after market.”  Trading during aftermarket is subject to regulatory limits on price volatility and on the volume of shares transacted through internet brokers.

In order to maintain better quality control over the fluctuation of its index, BM&FBOVESPA has adopted a “circuit breaker” system pursuant to which trading sessions are suspended (i) for a period of 30 minutes whenever the index of this stock exchange falls more than 10% from the index registered for the previous day; (ii) for one hour if the index of this stock exchange falls 15% or more from the index registered for the previous day, after the reopening of trading; and (iii) for a certain period of time to be defined by the BM&FBovespa, if the index of this stock exchange falls 20% or more from the index registered for the previous day, after the reopening of trading.  The minimum and maximum price is based on a reference price for each asset, which will be the previous session’s closing quote, when considering the asset at the beginning of the day before the first trade, or the price of the day’s first trade. The asset’s reference price will be altered during the session if there is an auction sparked by the intraday limit being breached. In this case the reference price will become whatever results from the auction.

BM&FBOVESPA settles the sale of shares three business days after they have taken place, without monetary adjustment of the purchase price.  The shares are paid for and delivered through a settlement agent affiliated with the BM&FBOVESPA.  The BM&FBOVESPA performs multilateral compensation for both the financial obligations and the delivery of shares.  According to the BM&FBOVESPA’s regulations, financial settlement is carried out by the Central Bank’s reserve transfer system.  The securities are transferred by the BM&FBOVESPA’s custody system.  Both delivery and payment are final and irrevocable.

Trading on the BM&FBOVESPA is significantly less liquid than trading on the NYSE or other major exchanges in the world.  Although any of the outstanding shares of a listed company may trade on the BM&FBOVESPA, in most cases fewer than half of the listed shares are actually available for trading by the public, the remainder being held by a controlling group or by government entities.  As of the end of 2013, the BM&FBOVESPA had a total market capitalization of approximately US$1,030.57 billion (R$2,414.22 billion) and an average daily trading volume of US$3,459.5 million (R$7,417,745 million).  The top ten stocks in terms of 2013 trading volume accounted for approximately 41.31% of all shares traded on the BM&FBOVESPA as of December 31, 2013.  As of December 31, 2013, we accounted for approximately 0.75% of the market capitalization of all listed companies on BM&FBOVESPA.

Trading on the BM&FBOVESPA by a holder not deemed to be domiciled in Brazil for Brazilian tax and regulatory purposes, or a “non‑Brazilian holder,” is subject to certain limitations under Brazilian foreign investment regulations.  With limited exceptions, non‑Brazilian holders may trade on Brazilian stock exchanges in accordance with the requirements of CMN Resolution No. 2,689, which requires that securities held by non‑Brazilian holders be maintained in the custody of financial institutions authorized by the Central Bank and by the CVM or in deposit accounts with financial institutions.  In addition, Resolution No. 2,689 requires non‑Brazilian holders to restrict their securities trading to transactions on the BM&FBOVESPA or qualified over‑the‑counter markets.  With limited exceptions, non‑Brazilian holders may not transfer the ownership of investments made under Resolution No. 2,689 to other non‑Brazilian holders through a private transaction.  See “Item 10.E. Taxation—Brazilian Tax Considerations—Taxation of Gains” for a description of certain tax benefits extended to non‑Brazilian holders who qualify under Resolution No. 2,689.

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The Novo Mercado Segment

Since April 24, 2002, our common shares have been listed on the Novo Mercado segment of the BM&FBOVESPA.  The Novo Mercado is a listing segment designed for the trading of shares issued by companies that voluntarily undertake to abide by some additional corporate governance practices and disclosure requirements in addition to those already required under Brazilian law.  A company in the Novo Mercado must follow good practices of corporate governance.  These rules generally increase shareholders’ rights and enhance the quality of information provided to shareholders.  On April 18, 2002, June 19, 2006, and April 23, 2012, our shareholders approved changes to our bylaws to comply with the Novo Mercado requirements.  In addition, the Novo Mercado provides for the creation of a Market Arbitration Chamber for conflict resolution between investors and companies listed in the Novo Mercado

In addition to the obligations imposed by current Brazilian law, a company listed on the Novo Mercado is obligated to:

·                     maintain only voting shares;

·                     hold public offerings of shares in a manner favoring diversification of the company’s shareholder base and broader access to retail investors;

·                     maintain a minimum free float of at least 25.0% of the outstanding capital stock of the company;

·                     grant tag along rights for all shareholders in connection with a transfer of control of the company;

·                     limit the term of all members of the board of directors to two years;

·                     ensure that at least 20.0% of the members of the board of directors are independent, as defined under the Novo Mercado regulation;

·                     prepare annual financial statements, including cash flow statements, in compliance with U.S. GAAP or IFRS or reconciled from Brazilian GAAP to U.S. GAAP or IFRS;

·                     disclose information on a quarterly basis, including share ownership of certain of our employees and directors and amount of free float of shares;

·                     hold a tender offer by the company’s controlling shareholder (the minimum price of the shares to be offered will be determined by an appraisal process) if it elects to delist from the Novo  Mercado; and

·                     make greater disclosure of related party transactions.

On May 10, 2011, the Novo Mercado rules were revised and currently establish the following additional obligations

·                     the chairman of the board of directors is prohibited from simultaneously holding the position of chief executive officer;

·                     the board of directors must disclose its opinion on takeover proposals within 15 days from the presentation of the proposal; and

·                     the company must have a securities purchase policy and a code of ethics.

Regulation of Brazilian Securities Markets

The Brazilian securities markets are principally governed by Law No. 6,385 of December 7, 1976, and Brazilian Corporate Law, each as amended and supplemented, and by regulations issued by the CVM, which has regulatory authority over the stock exchanges and securities markets generally, by the CMN, and by the Central Bank, which has licensing authority over brokerage firms and regulates foreign investment and foreign exchange transactions.  These laws and regulations, among others, provide for disclosure requirements applicable to issuers of traded securities, protection of minority shareholders and criminal penalties for insider trading and price manipulation.  They also provide for licensing and oversight of brokerage firms and governance of the Brazilian stock exchanges.  Nevertheless, the Brazilian securities markets are not as highly regulated and supervised as the U.S. securities markets.

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Under Brazilian Corporate Law, a company is either public (companhia aberta), such as we are, or closely held (companhia fechada).  All public companies, including us, are registered with the CVM and are subject to reporting requirements.  A company registered with the CVM may have its securities traded on the Brazilian stock exchanges or in the Brazilian over‑the‑counter market.  Our common shares are listed and traded on the BM&FBOVESPA and may be traded privately subject to some limitations.

To be listed on a Brazilian stock exchange a company must apply for registration with the CVM and the stock exchange where the head office of the company is located.

We have the option to ask that trading in our securities on the BM&FBOVESPA be suspended in anticipation of a material announcement.  Trading may also be suspended on the initiative of the BM&FBOVESPA or the CVM, among other reasons, based on or due to a belief that a company has provided inadequate information regarding a material event or has provided inadequate responses to the inquiries by the CVM or the São Paulo Stock Exchange.

The Brazilian over‑the‑counter market consists of direct trades between individuals in which a financial institution registered with the CVM serves as intermediary.  No special application, other than registration with the CVM, is necessary for securities of a public company to be traded in this market.  The CVM requires that it be given notice of all trades carried out in the Brazilian over‑the‑counter market by the respective intermediaries.

Trading on the BM&FBOVESPA by non‑residents of Brazil is subject to limitations under Brazilian foreign investment and tax legislation.  The Brazilian custodian for our common shares underlying the ADSs must, on behalf of the depositary for our ADSs, obtain registration from the Central Bank to remit U.S. dollars abroad for payments of dividends, any other cash distributions, or upon the disposition of the shares and sales proceeds thereto.  In the event that a holder of ADSs exchanges ADSs for common shares, the holder will be entitled to continue to rely on the custodian’s registration for five business days after the exchange.  Thereafter, the holder may not be able to obtain and remit U.S. dollars abroad upon the disposition of our common shares, or distributions relating to our common shares, unless the holder obtains a new registration.  See “Item 10.D. Exchange Controls.”

D.      Selling Shareholders

Not applicable.

E.      Dilution 

Not applicable.

F.       Expenses of the Issue

Not applicable.

 

ITEM 10.         ADDITIONAL INFORMATION

A.      Share Capital

Not applicable.

B.      Memorandum and Articles of Association

The following is a summary of the material terms of our common shares, including related provisions of our bylaws and Brazilian Corporate Law.  This description is qualified by reference to our bylaws and to Brazilian law.

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Corporate Purposes

We are a mixed capital company (sociedade de economia mista) of unlimited duration, incorporated on September 6, 1973, with limited liability, duly organized and operating under Brazilian Corporate Law.  As set forth in Article 2 of our bylaws, our corporate purpose is to render basic sanitation services, aimed at the universalization of basic sanitation in the State of São Paulo without harming our long‑term financial sustainability.  Our activities comprise water supply, sanitary sewage services, urban rainwater management and drainage services, urban cleaning services, solid waste management services and related activities, including the planning, operation, maintenance and commercialization of energy, and the commercialization of services, products, benefits and rights that directly or indirectly arise from our assets, operations and activities.  We are allowed to act, in a subsidiary form, in other Brazilian locations and abroad.

Directors’ Powers

Although our bylaws contain no specific provisions regarding a director or executive officer’s power to vote on a proposal, arrangement or contract in which that director has a material interest, under Brazilian Corporate Law, a director or an executive officer is prohibited from voting in any meeting or with respect to any transaction in which that director or executive officer has a conflict of interest with the company and must disclose the nature and extent of the conflicting interest to be recorded in the minutes of the meeting.  In any case, a director or an executive officer may not transact any business with the company, including any borrowing, except on reasonable or fair terms and conditions that are identical to the terms and conditions prevailing in the market or offered by third parties.

Under our bylaws, our shareholders are responsible for establishing the compensation we pay to the members of our board of directors, members of the fiscal committee and the executive officers.

Pursuant to Brazilian Corporate Law, each member of our board of executive officers must be a resident in Brazil.  Our bylaws do not establish any mandatory retirement age limit.

See also “Item 6.A. Directors and Senior Management.”

Description of Common Shares

General

Each common share entitles the holder thereof to one vote at our annual or special shareholders’ meetings.  Brazilian Corporate Law requires that all our shareholders’ meetings be called by publication of a notice in the Diário Oficial do Estado de São Paulo, the official government publication of the State of São Paulo, and in a newspaper of general circulation in our principal place of business, currently the city of São Paulo, at least fifteen days prior to the meeting.  In addition, the CVM may also require the first call for a shareholders’ meeting to be up to 30 days before such shareholders’ meeting.  The quorum to hold shareholders’ meetings on first call requires the attendance of shareholders, either in person or by proxy, representing at least 25.0% of the shares entitled to vote and, on second call, the meetings can be held with the attendance of shareholders, also either in person or by proxy, representing any number of shares entitled to vote.

Under Brazilian Corporate Law, our common shares are entitled to dividends or other distributions made in respect of our common shares in proportion to their share of the amount available for the dividend or distribution.  See “Item 8.A. Financial Statements and Other Financial Information—Dividends and Dividend Policy” for a more complete description of payment of dividends and other distributions on our common shares.  In addition, upon any liquidation of our Company, our common shares are entitled to our remaining capital after paying our creditors in proportion to their ownership interest in us.

In principle, a change in shareholder rights, such as the reduction of the compulsory minimum dividend, is subject to a favorable vote of the shareholders representing at least one half of our voting shares.  Under some circumstances that may result in a change in the shareholder rights, such as the creation of preferred shares, Brazilian Corporate Law requires the approval of a majority of the shareholders who would be adversely affected by the change attending a special meeting called for such reason.  It should be emphasized, however, that our by‑laws expressly prevents us from issuing preferred shares.  Brazilian Corporate Law specifies other circumstances where a dissenting shareholder may also have appraisal rights.

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According to Brazilian Corporate Law, neither a company’s bylaws nor actions taken at a general meeting of shareholders may deprive a shareholder of certain rights, such as:

·                     the right to participate in the distribution of profits;

·                     the right to participate equally and ratably in any remaining residual assets in the event of liquidation of the company;

·                     the right to supervise the management of the corporate business as specified in Brazilian Corporate Law;

·                     the right to preemptive rights in the event of a subscription of shares, debentures convertible into shares or subscription bonuses (except in some specific circumstances under Brazilian law); and

·                     the right to withdraw from the company in the cases specified in Brazilian Corporate Law.

Pursuant to Brazilian Corporate Law and our bylaws, each of our common shares carries the right to one vote at our shareholders’ meetings.  We may not restrain or deny that right without the consent of the holders of a majority of the shares affected.

Neither Brazilian Corporate Law nor our bylaws expressly addresses:

·                     staggered terms for directors;

·                     cumulative voting, except as described below; or

·                     measures that could prevent a takeover attempt.

However, under the laws of the State of São Paulo, the State is required to own at least a majority of our outstanding common shares.

According to Brazilian Corporate Law and its regulations, shareholders representing at least five per cent of our capital, may request that a multiple voting procedure be adopted to entitle each share to as many votes as there are board members and to give each shareholder the right to vote cumulatively for only one candidate or to distribute their votes among several candidates.  Pursuant to Brazilian Corporate Law, shareholder action must be taken at a shareholders meeting, duly called for and not by written consent.

In addition, shareholders owning at least 15.0% of the capital may request the right to elect, separately a member of the Board of Directors.

Preemptive Rights

Each of our shareholders has a general preemptive right to subscribe for shares or securities convertible into shares in any capital increase, in proportion to his or her ownership interest in us, except in the event of the grant and exercise of any option to acquire shares of our capital stock.  The preemptive rights are valid for a 30‑day period from the publication of the announcement of the capital increase.  Shareholders are also entitled to sell this preemptive right to third parties.  Under Brazilian Corporate Law, we may amend our bylaws to eliminate preemptive rights or to reduce the exercise period in connection with a public offering of shares or an exchange offer made to acquire another company. 

In the event of a capital increase by means of the issuance of new shares, holders of ADSs, or of common shares, would, except under circumstances described above, have preemptive rights to subscribe for any class of our newly issued shares.  However, an ADS holder may not be able to exercise the preemptive rights relating to the common shares underlying his or her ADSs unless a registration statement under the Securities Act is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available.  See “Item 3.D. Risk Factors ‑ Risks Relating to Our Common Shares and ADSs ‑ A holder of our common shares and ADSs might be unable to exercise preemptive rights and tag‑along rights with respect to the common shares.”

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Redemption and Rights of Withdrawal

Brazilian Corporate Law provides that, under limited circumstances, a shareholder has the right to withdraw his or her equity interest from the company and to receive payment for the portion of shareholder’s equity attributable to his or her equity interest.  This right of withdrawal may be exercised by dissenting our shareholders in the event that at least half of all voting shares outstanding authorize us:

·                     to reduce the mandatory distribution of dividends;

·                     to merge into another company or to consolidate with another company, subject to the conditions set forth in Brazilian Corporate Law;

·                     to participate in a centralized group of companies, as defined under Brazilian Corporate Law and subject to the conditions set forth therein;

·                     to change our corporate purpose;

·                     to split up, subject to the conditions set forth in Brazilian Corporate Law;

·                     creating preferred shares or increasing an existing class of preferred shares without maintaining the existing ratio with the remaining class of preferred shares, unless when already set forth in or authorized by the bylaws;

·                     to transform into another type of company;

·                     to transfer all of our shares to another company or to receive shares of another company in order to make the company whose shares are transferred a wholly owned subsidiary of such company, known as incorporação de ações; or

·                     to acquire control of another company at a price which exceeds the limits set forth in Brazilian Corporate Law.

The right of withdrawal lapses 30 days after publication of the minutes of the shareholders’ meeting that approved a corporate action described above.  We would be entitled to reconsider any action giving rise to withdrawal rights within 10 days following the expiration of such rights if the withdrawal of shares of dissenting shareholders would jeopardize our financial condition.  Brazilian Corporate Law allows companies to redeem their shares at their economic value, subject to the provisions of their bylaws and certain other requirements.  Our bylaws currently do not provide that our capital stock will be redeemable at its economic value and, consequently, any redemption pursuant to Brazilian Corporate Law would be made based on the book value per share, determined on the basis of the last balance sheet approved by the shareholders.  However, if a shareholders’ meeting giving rise to redemption rights occurred more than 60 days after the date of the last approved balance sheet, a shareholder would be entitled to demand that his or her shares be valued on the basis of a new balance sheet dated within 60 days of such shareholders’ meeting.

In addition, the rights of withdrawal in the third, fourth and eighth bullet points above may not be exercised by holders of shares if such shares (i) are liquid, defined as being part of the BM&FBOVESPA index or other stock exchange index (as defined by the CVM), and (ii) are widely held, such that the controlling shareholder or companies it controls have less than 50.0% of our shares.  Our common shares are included on the BM&FBOVESPA index.

This right of withdrawal may also be exercised in the event that the entity resulting from a stock merger as described above, consolidation or spin‑off of a listed company fails to become a listed company within 120 days of the shareholders’ meeting at which such transaction was approved.

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We may cancel the right of withdrawal if the payment amount has a material adverse effect on our finances.

Conversion Right

Not applicable because our capital stock is only comprised of common shares.

Special and General Meetings

Unlike the laws governing corporations incorporated under the laws of the State of Delaware, the Brazilian corporate law does not allow shareholders to approve matters by written consent obtained as a response to a consent solicitation procedure.  All matters subject to approval by the shareholders must be approved in a general meeting, duly convened pursuant to the provisions of Brazilian corporate law.  Shareholders may be represented at a shareholders’ meeting by attorneys‑in‑fact who are (i) shareholders of the corporation, (ii) a Brazilian attorney, (iii) a member of management or (iv) a financial institution.

          General shareholders’ meetings shall be called, convened and deliberated under Brazilian Corporate Law to address all matters of interest to the Company. General shareholders’ meetings may be called by publication of a notice in the Diário Oficial do Estado de São Paulo and in a newspaper of general circulation in our principal place of business, and the first call should be made at least 15 days prior to the meeting. In our case, the first call is made 30 days in advance due the issuance of ADRs, as recommended by the CVM. The second call should be made at least 8 days in advance, if quorum is not reached, pursuant to the Brazilian Corporate Law.”

 

At duly called and convened meetings, our shareholders are empowered to take any action regarding our business.  Shareholders have the exclusive right, during our annual shareholders’ meetings required to be hold within 120 days of the end of our fiscal year, to approve our financial statements and to determine the allocation of our net income and the distribution of dividends related to the fiscal year immediately preceding the meeting.  The members of our board of directors are generally elected at annual shareholders’ meetings.  However, according to Brazilian corporate law, they can also be elected at extraordinary shareholders’ meetings.  At the request of shareholders holding a sufficient number of shares, a fiscal committee can be established and its members elected at any shareholders’ meeting.

A special shareholders’ meeting may be held concurrently with the annual shareholders’ meeting and at other times during the year.  Our shareholders may take the following actions, among others, exclusively at shareholders’ meetings:

·                     election and dismissal of the members of our board of directors and our fiscal committee, if the shareholders have requested the setup of the latter;

·                     approval of the aggregate compensation of the members of our board of directors and board of executive officers, as well as the compensation of the members of the fiscal committee, if one has been established;

·                     amendment of our bylaws;

·                     approval of our merger, consolidation or spin‑off;

·                     approval of our dissolution or liquidation, as well as the election and dismissal of liquidators and the approval of their accounts;

·                     granting stock awards and approval of stock splits or reverse stock splits;

·                     approval of stock option plans for our management and employees, as well as for the management and employees of other companies directly or indirectly controlled by us;

·                     approval, in accordance with the proposal submitted by our board of directors, of the distribution of our net income and payment of dividends;

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·                     authorization to delist from the Novo Mercado and to become a private company, except if the cancellation is due to a breach of the Novo Mercado regulations by management, and to retain a specialized firm to prepare a valuation report with respect to the value of our shares, in any such events;

·                     approval of our management accounts and our financial statements;

·                     approval of any primary public offering of our shares or securities convertible into our shares; and

·                     deliberate upon any matter submitted by the board of directors.

Limitations on Rights to Own Securities

There are no limitations under Brazilian law and our bylaws on the rights of non‑residents or foreign shareholders to own securities, including the rights of such non‑resident or foreign shareholders to hold or exercise voting rights.

Equal Treatment Provisions

Pursuant to article 40 of our bylaws and the Novo Mercado regulations, any party that acquires our control must extend a tender offer for the shares held by non‑controlling shareholders at the same conditions and purchase price paid to the controlling shareholder.  In addition, State Law No. 119/73, which created our Company, requires the State to hold the majority of our shares at all times.

Reserves

General

The Brazilian Corporate Law provides that all discretionary allocations of “adjusted income” are subject to shareholder approval and may be added to capital or distributed as dividends in subsequent years.  In the case of our capital reserve and the legal reserve, they are also subject to shareholder approval; however, the use of their respective balances is restricted to being added to capital or absorbed by losses.  They cannot be used as a source for income distribution to shareholders.

Capital Reserve

Our capital reserve is comprised of tax incentives and donations from government agencies and private entities received through December 31, 2007.  As of December 31, 2013, we had a capital reserve of R$124.3 million.

Investment Reserve

Our investment reserve is comprised specifically of internal funds for expansion of water and sewage service systems.  As of December 31, 2013, we had an investment reserve of R$5,980.5 million.

Legal Reserve

Under Brazilian Corporate Law, we are required to record a legal reserve to which we must allocate 5% of the adjusted net income each year until the amount of the reserve equals 20.0% of paid‑in capital.  Any accumulated deficit may be charged against the legal reserve.  As of December 31, 2013, the balance of our legal reserve was R$713.0 million.

Arbitration

In connection with our listing with the Novo Mercado segment of the BM&FBOVESPA, we, our shareholders, directors and officers have undertaken to refer to arbitration any and all disputes or controversies arising out of the Novo Mercado rules or any other corporate matters.  See “Item 9.C. Markets.”  Under our bylaws, any dispute among us, our shareholders and our management with respect to the application of Novo Mercado rules, Brazilian Corporate Law, the application of the rules and regulations regarding Brazilian capital markets, will be resolved by arbitration conducted pursuant to the BM&FBOVESPA Arbitration Rules in the Market Arbitration Chamber.  Any dispute among shareholders, including holders of ADSs, and any dispute between us and shareholders, including holders of ADSs, will also be submitted to arbitration.

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Options

There are currently no outstanding options to purchase any of our common shares.

C.      Material Contracts

For a description of the material contracts entered into by the State and us, see “Item 7.B. Related Party Transactions—Transactions with the State of São Paulo—Agreements with the State.”

D.      Exchange Controls

The right to convert dividend or interest payments and proceeds from the sale of shares into foreign currency and to remit such amounts outside Brazil is subject to restrictions under foreign investment legislation which generally requires, among other things, that the relevant investments have been registered with the Central Bank and the CVM.  Such restrictions on the remittance of foreign capital abroad may hinder or prevent the custodian for our common shares represented by our ADSs or the holders of our common shares from converting dividends, distributions or the proceeds from any sale of these shares into U.S. dollars and remitting the U.S. dollars abroad.  Holders of our ADSs could be adversely affected by delays in, or refusal to grant any, required government approval to convert Brazilian currency payments on the common shares underlying our ADS and to remit the proceeds abroad.

CMN Resolution No. 1,927 of May 18, 1992, of the CMN provides for the issuance of depositary receipts in foreign markets in respect of shares of Brazilian issuers.  The ADS program was approved under the Annex V of CMN Resolution No. 1,289 of March 20, 1987 and the CVM prior to the issuance of the ADSs.  Accordingly, the proceeds from the sale of ADSs by ADR holders outside Brazil are not subject to Brazilian foreign investment controls, and holders of the ADSs are entitled to favorable tax treatment under certain circumstances.  See “Item 3.D. Risk Factors—Risks Relating to Our Common Shares and ADSs—Investors who exchange ADSs for common shares may lose their ability to remit foreign currency abroad and to obtain Brazilian tax advantages” and “Item 10.E. Taxation—Brazilian Tax Considerations.”

E.      Taxation 

This summary contains a description of certain Brazilian and U.S. federal income tax consequences of the purchase, ownership and disposition of common shares or ADSs by a holder.

The summary is based upon the tax laws of Brazil and the federal income tax laws of the United States as in effect on the date of this annual report, which laws are subject to change, possibly with retroactive effect, regarding the U.S. federal income tax, and to differing interpretations.  Holders of common shares or ADSs should consult their own tax advisors as to the Brazilian, U.S. or other tax consequences of the purchase, ownership and disposition of common shares or ADSs, including, in particular, the effect of any non‑Brazilian, non‑U.S., state or local tax laws.

Although there presently is no income tax treaty between Brazil and the United States, the tax authorities of the two countries have had discussions in the past regarding such a treaty.  No assurance can be given, however, as to if or when a treaty will enter into force or how it will affect the U.S. holders of common shares or ADSs.

Brazilian Tax Considerations

The following discussion summarizes the principal Brazilian tax consequences of the acquisition, ownership and disposition of common shares or ADSs by a holder that is not domiciled in Brazil for purposes of Brazilian taxation (a “non‑Brazilian holder”).  It is based on Brazilian laws and regulations as currently in effect, and, therefore, any change in such law may change the consequences described below.  Each non‑Brazilian holder should consult his or her own tax adviser concerning the Brazilian tax consequences of an investment in common shares or ADSs.

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A non‑Brazilian holder of ADSs may withdraw them in exchange for common shares in Brazil.  Pursuant to Brazilian law, the non‑Brazilian holder may invest in the common shares under Resolution 2,689, of January 26, 2000, of the CMN (“2,689 holder”).

Taxation of Dividends

As a result of the tax legislation adopted on December 26, 1995, dividends based on profits generated after January 1, 1996, including dividends paid in kind, payable by us in respect of common shares or ADSs, are exempt from withholding income tax.  Dividends relating to profits generated prior to January 1, 1996 may be subject to Brazilian withholding income tax at varying rates, depending on the year the profits were generated.

For the purposes of calculating the income tax and the social contribution related to 2010 and 2009, we opted to adopt the Transition Tax Regime, or RTT, which allows us to eliminate the accounting effects of Law No. 11,638/07 and Provisional Measure No. 449/08, converted into Law No. 11,941/09, by the records in the fiscal books – LALUR and auxiliary controls, without any modification to bookkeeping.

We have followed the same tax practices since 2008, as RTT became mandatory and will remain in effect until legislation ruling on the tax effect of new accounting methods and seeking tax neutrality comes into effect.

On November 11, 2013, Provisional Measure No. 627 as enacted, altering the federal tax laws on the Corporate Income Tax (IRPJ), Social Contribution on Net Income (CSLL), PIS/PASEP Contribution and Contribution of Social Security Financing (Cofins).  This Provisional Measure revokes RTT, which had been enacted by Law No. 11,941/09, and provides for the taxation of legal entities domiciled in Brazil, referring to the equity addition deriving from the profit sharing earned abroad by subsidiaries and associated companies and profit earned by individuals residing in Brazil by means of foreign subsidiary.  This Provisional Measure allows for the possibility of adopting its effects in the 2014 calendar year.

We prepared a study of potential effects of applying Provisional Measure No. 627/2013 and Normative Ruling 1,397/2013 and concluded that they do not result in relevant effects on our operations and financial statements for the fiscal year ended December 31, 2013, based on the best interpretation of current wording of the Provisional Measure.  The eventual conversion of Provisional Measure No. 627/2013 into law may alter our conclusions if the final text encompasses changes not envisioned by and alters current taxation to which we are subject.  We await the conversion of this Provisional Measure into law, so that we may decide on its early adoption or not, as per final wording to be enacted.

Taxation of Gains

Gains realized on disposition of common shares are subject to income tax in Brazil, regardless of whether the sale or the disposition is made by a non‑Brazilian holder to a resident or person domiciled in Brazil.  This is due to the fact that the common shares can be considered assets located in Brazil for purposes of Law No. 10,833.

Thus, gains, for purposes of taxation of gains earned in a sale or disposition of common shares carried out on a Brazilian stock exchange (which includes transactions carried out on the organized over‑the‑counter market):

·                     are exempt from income tax when assessed on a non‑Brazilian holder that (1) has registered its investment in Brazil with the Central Bank under the rules of CMN Resolution No. 2,689/00, or 2,689 Holder, and (2) is not a resident of or domiciled in a Nil or Low Taxation Jurisdiction; or

·                     in all other cases, including gains realized by a Non-Resident Holder that is not a 2,689 Holder and/or is a resident of or domiciled in a Nil or Low Taxation Jurisdiction, subject to income tax at a 15.0% rate. In these cases, a withholding income tax at a rate of 0.005% will be applied and can later be offset with the eventual income tax due on the capital gain.

Any other gains assessed on the disposition of the common shares that are not carried out on the Brazilian stock exchange are subject to income tax at a rate of 15%, except for Nil or Low Taxation Jurisdiction, which, in this case, would be subject to income tax at a rate of 25%.  In case these gains are related to transactions conducted on the Brazilian non‑organized over‑the‑counter market with intermediation, the withholding income tax of 0.005% shall also be applicable and can be offset with the eventual income tax due on the capital gain.

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For Brazilian purposes, as of January 2009, a Nil or Low Taxation Jurisdiction is considered a regime:  (i) which does not impose income tax or does so at a rate of 20% or lower, or (ii) where applicable local legislation imposes restrictions on the disclosure of the shareholding composition or the ownership of investments, or on the ultimate beneficiary of the income derived from transactions carried out and attributable to a non‑Brazilian holder. See “—Discussion on Low or Nil Taxation Jurisdictions.”

In the case of redemption of securities or capital reduction by a Brazilian corporation, such as ourselves, the positive difference between the amount effectively received by the non‑Brazilian holder and the corresponding acquisition cost is treated, for tax purposes, as capital gain derived from disposition of common shares not carried out on a Brazilian stock exchange market, and is therefore subject to income tax at the rate of 15% or 25%, as the case may be.

Any exercise of preemptive rights relating to the common shares will not be subject to Brazilian income tax.  Any gain on the sale or assignment of preemptive rights relating to the common shares by a non‑Brazilian holder of common shares or ADSs will be subject to Brazilian taxation at the same rate applicable to the sale or disposition of common shares.

There is no assurance that the current preferential treatment for holders of ADSs and non‑Brazilian holders of common shares under Resolution 2,689 will continue in the future or that it will not be changed in the future.  Reductions in the rate of tax provided for by Brazil’s tax treaties do not apply to the tax on gains realized on sales or exchange of common shares.

Sale of ADSs by non-Brazilian holder to another non-Brazilian holder

Gains realized outside Brazil by a non‑Brazilian holder on the disposition of ADSs to another non‑Brazilian holder are not currently subject to Brazilian tax.  However, according to certain interpretations of Law no. 10,833 of December 2003, or Law No. 10,833, the disposition of assets located in Brazil by a non‑Brazilian holder, whether to other non‑Brazilian holder or Brazilian holders, may become subject to taxation in Brazil.  Although we believe that the ADSs do not fall within the definition of assets located in Brazil for the purposes of Law no. 10,833, considering the general and unclear scope of it and the lack of definitive judicial court ruling to act as the leading case in respect thereto, we are unable to predict whether such understanding will ultimately prevail in the courts of Brazil.

In case the argument above does not prevail the gain on disposition of ADSs by a non‑Brazilian holder to a resident in Brazil or even to a non-Brazilian resident may be subject to income tax in Brazil according to the rules described below for ADSs or the tax rules applicable to common shares, as applicable.

Exchange of ADSs for common shares

Although there is no clear regulatory guidance, the withdrawal of ADSs in exchange for common shares is not subject to Brazilian income tax provided that the regulatory rules are appropriately observed in respect to the registration of the investment before the Central Bank of Brazil. 

Upon receipt of the underlying common shares in exchange for ADSs, non-Brazilian holders may also elect to register with the Central Bank the U.S. dollar amount of such preferred shares or common shares as a foreign portfolio investment under Resolution No. 2689/00 or as a foreign direct investment under Law 4,131/62.

Exchange of common shares for ADSs

The deposit of common shares in exchange for ADSs may be subject to Brazilian capital income tax at the rate of 15% or 25%, in case the non‑Brazilian holder is located in a Nil or Low Taxation Jurisdiction, if the acquisition cost of the common shares is lower than (1) the average price per common share on a Brazilian stock exchange on which the greatest number of such shares were sold on the day of deposit, or (2) if no common shares were sold on that day, the average price on the Brazilian stock exchange on which the greatest number of common shares were sold in the fifteen trading sessions immediately preceding such deposit.  In this case, the difference between the acquisition cost and the average price of the common shares, calculated as above, shall be considered a capital gain.

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Discussion on Low or Nil Taxation Jurisdictions

On June 24, 2008, Law No. 11,727 was enacted defining the concept of a “privileged tax regime” in connection with transactions subject to transfer pricing and thin capitalization rules.  In this conception, privileged tax regimes are more comprehensive than tax havens.  A “privileged tax regime” is considered to be a jurisdiction which: (i) does not tax income or taxes income at a maximum rate lower than 20.0%; (ii) grants tax advantages to a non‑resident entity or individual (a) without requiring substantial economic activity in the jurisdiction of such non‑resident entity or individual or (b) to the extent such non‑resident entity or individual does not conduct substantial economic activity in the jurisdiction of such non‑resident entity or individual; (iii) does not tax income generated abroad, or imposes tax on income generated abroad at a maximum rate lower than 20.0%; or (iv) restricts the ownership disclosure of assets and ownership rights or restricts disclosure about economic transactions.

Notwithstanding the fact that the “privileged tax regime” concept was enacted in connection with Brazilian transfer pricing and thin capitalization rules, there is no assurance that Brazilian tax authorities will not attempt to apply the concept of privileged tax regimes to other types of transactions, such as investments in the Brazilian financial and capital markets.  We recommend that prospective investors consult their own tax advisors from time to time to verify any possible tax consequences of Law No. 11,727.

Interest Attributed to Shareholders’ Equity

According to Brazilian laws and our bylaws, we may opt to distribute income as interest attributed to shareholders’ equity as an alternative to the payment of dividends.

Distribution of an interest on equity charge attributed to shareholders’ equity with respect to common shares or ADSs as an alternative form of payment to shareholders, including non‑Brazilian holders of common shares or ADSs, is subject to Brazilian withholding income tax at the rate of 15% or 25%, in case of a Nil or Low  Taxation Jurisdiction holder.  Such payments, subject to certain limitations and requirements, are deductible for Brazilian income tax purposes. This interest is limited to the daily pro rata variation of the Federal Government’s long-term interest rate, as determined by the Central Bank from time to time, and cannot exceed the greater of:

(a)     50% of net income (after the social contribution on net profits and before the provision for corporate income tax, and the amounts attributable to shareholders as interest on net equity) for the period with respect to which the payment is made; or

(b)     50% of the sum of retained earnings and earnings reserves as of the date of the beginning of the period with respect to which the payment is made.

Other Brazilian Taxes

There are no Brazilian inheritance, gift or succession taxes applicable to the ownership, transfer or disposition of common shares or ADSs by a non‑Brazilian holder, except for gift and inheritance taxes, which are levied by some states of Brazil on gifts made or inheritances bestowed by a non‑Brazilian holder to individuals or entities resident or domiciled within such states in Brazil.  There is no Brazilian stamp, issue, registration, or similar taxes or duties payable by a non‑Brazilian holder of common shares or ADSs.

Tax on foreign exchange transactions (“IOF/Exchange”)

 

Pursuant to Decree No. 6,306, dated December 14, 2007, as amended, or Decree No. 6,306/07, the conversion of Brazilian currency into foreign currency (e.g., for purposes of paying dividends and interest) and the conversion of foreign currency into Brazilian currency may be subject to the Tax on Foreign Exchange Transactions or IOF/Exchange. Currently, for most exchange transactions, the rate of IOF/Exchange is 0.38%. Effective as of December 1, 2011, currency exchange transactions carried out for the inflow of funds in Brazil for investments made by a foreign investor (including a Non-Resident Holder, as applicable) are subject to IOF/Exchange at a 0% rate in case of variable income transactions carried out on the Brazilian stock, futures and commodities exchanges, as well as in the acquisitions of shares of Brazilian publicly held companies in public offerings or subscription of shares related to capital contributions, provided that the company has registered its shares for trading on the stock exchange. The IOF/Exchange rate will also be 0% for the outflow of funds from Brazil related to these types of investments, including payments of dividends and interest on shareholders’ equity and the repatriation of funds invested in the Brazilian market.

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The Brazilian government may increase the rate of the IOF/Exchange to a maximum of 25.0% of the amount of the foreign exchange transaction at any time, but such an increase would not apply retroactively.

 

Tax on transactions involving bonds and securities (“IOF/Bonds Tax”)

 

The IOF may also be imposed on any transactions involving bonds and securities, including those carried out on Brazilian futures and commodities stock exchanges.  As a general rule, the rate of this tax for transactions involving common shares or ADSs is currently zero.  The executive branch, also by a Presidential Decree, may increase the IOF rate by up to 1.5% per day, but only with respect to future transactions.

U.S.  Federal Income Tax Considerations

The following discussion is a summary of certain U.S. federal income tax consequences of the acquisition, ownership and disposition of common shares or ADSs as of the date hereof.  This discussion applies only to a beneficial owner of common shares or ADSs that is a “U.S. holder.”  As used herein, the term “U.S. holder” means a beneficial owner of a common share or ADS that, for U.S. federal income tax purposes, is:

·                     an individual who is a citizen or resident of the United States;

·                     a corporation (or other entity treated as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the United States, any state thereof or the District of Columbia;

·                     an estate the income of which is subject to U.S. federal income taxation regardless of its source; or

·                     a trust if it (1) is subject to the primary supervision of a court within the United States and one or more U.S. persons have the authority to control all substantial decisions of the trust or (2) has a valid election in effect under applicable U.S. Treasury Department regulations to be treated as a U.S. person.

If a partnership (or other entity treated as a partnership for U.S. federal income tax purposes) holds common shares or ADSs, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership.  A U.S. holder that is a partner of a partnership holding common shares or ADSs should consult its tax advisors.

Except where noted, this discussion deals only with common shares or ADSs held as capital assets within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended, or the Code, and does not deal with U.S. holders that may be subject to special U.S. federal income tax rules, such as dealers in securities or currencies, traders in securities that elect to use a mark‑to‑market method of accounting for their securities holdings, banks or other financial institutions, tax‑exempt organizations, insurance companies, real estate investment trusts, regulated investment companies, persons holding common shares or ADSs as part of a hedging, integrated, conversion or constructive sale transaction or a straddle, persons liable for alternative minimum tax, pass‑through entities and investors in a pass‑through entity, persons owning 10% or more of our voting stock, or persons whose “functional currency” is not the U.S. dollar.

This discussion is based upon the provisions of the Code, and existing and proposed U.S. Treasury Department regulations, administrative pronouncements of the Internal Revenue Service, or the IRS, and judicial decisions as of the date hereof.  Such authorities may be repealed, revoked or modified so as to result in U.S. federal income tax consequences different from those discussed below, possibly with retroactive effect.  In addition, this discussion is based, in part, upon representations made by the Depositary to us and assumes that the deposit agreement, and all other related agreements, will be performed in accordance with their terms.

Except as specifically described below, this discussion assumes that we are not a passive foreign investment company, or PFIC, for U.S. federal income tax purposes.  Please see the discussion under “—Passive Foreign Investment Company Rules” below.  Further, this discussion does not address the U.S. federal estate and gift, alternative minimum tax, Medicare tax on net investment income, state, local or non‑U.S. tax consequences of acquiring, holding or disposing of common shares or ADSs.

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ADSs

In general, for U.S. federal income tax purposes, U.S. holders of ADSs will be treated as the owners of the underlying common shares that are represented by such ADSs.  Deposits or withdrawals of common shares by U.S. holders for ADSs will not be subject to U.S. federal income tax.  However, the U.S. Treasury Department has expressed concerns that parties involved in transactions wherein depositary shares are pre‑released may be taking actions that are inconsistent with the claiming of foreign tax credits by the holders of ADSs.  Accordingly, the analysis of the creditability of Brazilian income taxes described herein could be affected by future actions that may be taken by the U.S. Treasury Department.

Taxation of Dividends

The gross amount of distributions paid to a U.S. holder (including Brazilian taxes that are withheld, if any, and any payments of interest on shareholders’ equity, as described above under “—Brazilian Tax Considerations”) will be treated as dividend income to the extent paid out of our current or accumulated earnings and profits, as determined under U.S. federal income tax principles.  Such income generally will be includable in a U.S. holder’s gross income as ordinary income when actually or constructively received by the U.S. holder, in the case of common shares, or when actually or constructively received by the Depositary, in the case of ADSs.  Such dividends will not be eligible for the dividends received deduction allowed to corporations under the Code.  To the extent that the amount of any distribution exceeds our current and accumulated earnings and profits for a taxable year, the distribution will first be treated as a tax‑free return of capital to the extent of the U.S. holder’s adjusted tax basis in the common shares or ADS, causing a reduction in such adjusted tax basis (and thereby increasing the amount of gain, or decreasing the amount of loss, to be recognized on a subsequent disposition of our common shares or ADSs), and thereafter as capital gain recognized on a sale or exchange.  Because we do not expect to maintain calculations of earnings and profits in accordance with U.S. federal income tax principles, U.S. holders should expect that a distribution will generally be treated as a dividend for U.S. federal income tax purposes.  Distributions of additional common shares or ADSs to U.S. holders that are part of a pro rata distribution to all of our shareholders generally will not be subject to U.S. federal income tax.

The amount of any dividend paid in reais  will equal the U.S. dollar value of the reais  received calculated by reference to the exchange rate in effect on the date the dividend is received by the U.S. holder, in the case of common shares, or by the Depositary, in the case of ADSs, regardless of whether the reais  are converted into U.S. dollars.  If the reais  received as a dividend are not converted into U.S. dollars on the date of receipt, the U.S. holder will have a tax basis in the reais  equal to their U.S. dollar value on the date of receipt.  Any gain or loss realized on a subsequent conversion or other disposition of the reais  will be foreign currency gain or loss that is treated as U.S. source ordinary income or loss.  If dividends paid in reais  are converted into U.S. dollars on the day they are received by the U.S. holder or the Depositary, as the case may be, U.S. holders generally should not be required to recognize foreign currency gain or loss in respect of the dividend income.  U.S. holders should consult their own tax advisors regarding the treatment of any foreign currency gain or loss if any reais  received by the U.S. holder or the Depositary or its agent are not converted into U.S. dollars on the date of receipt.

Certain dividends received by certain non‑corporate U.S. holders may be eligible for preferential tax rates so long as (1) specified holding period requirements are met, (2) the U.S. holder is not under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (3) the company paying the dividend is a “qualified foreign corporation” and (4) the company is not a PFIC for U.S. federal income tax purposes in the year of distribution or the prior year.  We do not believe that we were classified as a PFIC for our prior taxable year nor do we expect to be classified as a PFIC for the current taxable year.  We generally will be treated as a qualified foreign corporation with respect to our ADSs so long as the ADSs remain listed on the NYSE.  Based on existing guidance, however, it is not entirely clear whether dividends received with respect to the common shares (to the extent not represented by ADSs) will be eligible for this treatment, because the common shares are not themselves listed on a U.S. exchange.  U.S. holders should consult their own tax advisors about the application of this preferential tax rate to dividends paid directly on common shares.

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Subject to certain complex limitations and conditions (including a minimum holding period requirement), Brazilian income taxes withheld on dividends, if any, may be treated as foreign income taxes eligible for credit against a U.S. holder’s U.S. federal income tax liability.  Alternatively, if a U.S. holder does not elect to claim a foreign income tax credit for any foreign taxes paid during the taxable year, all foreign income taxes paid may instead be deducted in computing such U.S. holder’s taxable income.  For purposes of calculating the foreign tax credit, dividends paid on our common shares will be treated as income from sources outside the United States.  For the purposes of the U.S. foreign tax credit limitations, the dividends paid by us should generally constitute “passive category income” for most U.S. holders.  The rules governing the foreign tax credit are complex.  U.S. holders should consult their tax advisors regarding the availability of the foreign tax credit under their particular circumstances.

Taxation of Capital Gains

For U.S. federal income tax purposes, a U.S. holder generally will recognize taxable gain or loss on any sale, exchange or other taxable disposition of a common share or ADS in an amount equal to the difference between the U.S. dollar value of the amount realized for the common share or ADS and the U.S. holder’s adjusted tax basis in the common share or ADS, determined in U.S. dollars.  Such gain or loss will generally be capital gain or loss.  The capital gain or loss will be long‑term capital gain or loss if at the time of sale, exchange or other taxable disposition the U.S. holder has held our common shares or ADSs for more than one year.  Capital gains of individuals derived with respect to capital assets held for more than one year are eligible for reduced rates of taxation.  The deductibility of capital losses is subject to limitations.  Any gain or loss recognized by a U.S. holder will generally be treated as U.S. source gain or loss.  Consequently, a U.S. holder may not be able to use the foreign tax credit arising from Brazilian income tax imposed, if any, on the disposition of a common share or ADS unless such credit can be applied (subject to applicable limitations) against U.S. federal income tax due on other income treated as derived from foreign sources.

Passive Foreign Investment Company Rules

Based upon our current and projected income, assets, activities and business plans, we do not expect the common shares or ADSs to be considered shares of a PFIC for our current fiscal year (although the determination cannot be made until the end of such fiscal year), and we intend to continue our operations in such a manner that we do not expect to be classified as a PFIC in the foreseeable future.  However, because the determination of whether the common shares or ADSs constitute shares of a PFIC will be based upon the composition of our income, assets and the nature of our business, as well as the income, assets and business of entities in which we hold at least a 25% interest, from time to time, and because there are uncertainties in the application of the relevant rules, there can be no assurance that the common shares or ADSs will not be considered shares of a PFIC for any fiscal year.  If the common shares or ADSs were shares of a PFIC for any fiscal year, U.S. holders (including certain indirect U.S. holders) may be subject to adverse tax consequences, including the possible imposition of an interest charge on gains or “excess distributions” allocable to prior years in the U.S. holder’s holding period during which we were determined to be a PFIC.  If we are deemed to be a PFIC for a taxable year, dividends on our ADSs would not be qualified dividend income eligible for preferential rates of U.S. federal income taxation.  In addition, a U.S. holder that owns common shares or ADSs during any taxable year that we are treated as a PFIC would generally be required to file IRS form 8621, including in order to comply with additional annual filing requirements imposed under legislation enacted in 2010.  U.S. holders should consult their own tax advisors regarding the application of the PFIC rules (including any information reporting requirements in connection therewith) to the common shares or ADSs. 

Information Reporting and Backup Withholding

In general, information reporting requirements will apply to dividends in respect of our common shares or ADSs or the proceeds received on the sale, exchange, or redemption of our ADSs, in each case to the extent treated as being paid within the United States (and in certain cases, outside of the United States) to a U.S. holder unless a U.S. holder establishes its status as an exempt recipient, and backup withholding (currently at a rate of 28 percent) may apply to such amounts if the U.S. holder does not establish its status as an exempt recipient or fails to provide a correct taxpayer identification number and certify that such U.S. holder is not subject to backup withholding.  The amount of any backup withholding from a payment to a U.S. holder will be allowed as a refund or credit against such U.S. holder’s U.S. federal income tax liability provided the U.S. holder timely furnishes the required information to the IRS.

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In addition, U.S. holders should be aware that additional reporting requirements apply with respect to the holding of certain foreign financial assets, including stock of foreign issuers which is not held in an account maintained by a financial institution, if the aggregate value of all of such assets exceeds US$50,000.  U.S. holders should consult their own tax advisors regarding the application of the information reporting rules to our common shares and ADSs and the application of these additional reporting requirements for foreign financial assets to their particular situation.

F.       Dividends and Payments Agents

Not applicable.

G.      Statements by Experts

Not applicable.

H.      Documents on Display

We are subject to the periodic reporting and other informational requirements of the U.S. Securities Exchange Act of 1934, as amended and supplemented, or the Exchange Act.  Accordingly, we are required to file reports and other information with the SEC.  You may inspect and copy reports and other information filed by us at the public reference facilities maintained by the SEC at 100 F Street, N.W., Washington D.C. 20549.  Our filings will also be available at the SEC’s website at http://www.sec.gov. Reports and other information may also be inspected and copied at the offices of the NYSE at 20 Broad Street, New York, New York 10005.

 

Our website is located at http://www.sabesp.com.br and our investor relations website is located at http://www.sabesp.com.br/investors. (These URLs are intended to be an inactive textual reference only. They are not intended to be an active hyperlink to our website. The information on our website, which might be accessible through a hyperlink resulting from this URL is not, and shall not be deemed to be, incorporated into this annual report.)     

 

We also furnish to the depositary annual reports in English including audited annual financial statements and unaudited quarterly financial statements in English for each of the first three quarters of the fiscal year.  We also furnish to the depositary English translations or summaries of all notices of shareholders’ meetings and other reports and communications that are made generally available to holders of common shares.

I.        Subsidiary Information

Not applicable.

ITEM 11.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

We are exposed to various market risks, in particular, foreign currency risk and interest rate risk.  We are exposed to foreign currency risk because a substantial portion of our financial indebtedness is denominated in foreign currencies, primarily the U.S. dollar, while we generate all of our net operating revenues in reais.  Similarly, we are subject to interest rate risk based upon changes in interest rates, which affect our net financial expenses.  For further information on our market risks, see Note 4.3 to our financial statements as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 included elsewhere in this annual report.

Exchange Rate Risk

As of December 31, 2013, 2012 and 2011, R$3,698.6 million, R$3,215.8 million and R$3,053.4 million, or 39.1%, 36.2% and 36.2%, respectively, of our debt obligations were denominated in foreign currencies.  As a result, we are exposed to exchange rate risks that may adversely affect our financial condition and results of operations, as well as our ability to meet debt service obligations.

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Exchange Rate Sensitivity

We estimate that the potential loss to us in connection with U.S. dollar and yen-denominated debt that would have resulted as of December 31, 2013, 2012 and 2011 from each hypothetical instantaneous and unfavorable 1% change in the U.S. dollar and yen against the real  would have been approximately R$37.0 million, R$32.3 million and R$30.7 million, respectively.  Consistent with these estimates, a hypothetical instantaneous and unfavorable 10% change in this exchange rate would have resulted in losses of approximately R$369.9 million, R$323.1 million and R$306.7 million as of December 31, 2013, 2012 and 2011, respectively.

The fluctuation of the real in relation to the U.S. dollar and yen for the years ended December 31, 2013, 2012 and 2011 were as follows:

 

Year ended December 31,

 

2013

2012

2011

 

(in percentages)

Depreciation (appreciation) of the real in relation to the U.S. dollar...

14.6

8.9

12.6

Depreciation (appreciation) of the real  in relation to the yen

(5.9)

(2.4)

18.6

 

We have not utilized derivative financial instruments in the years ended December 31, 2013, 2012 and 2011.

As of December 31, 2013, 2012 and 2011, we had no short‑term indebtedness outstanding, other than the current portion of long‑term debt.

Interest Rate Risk

As of December 31, 2013, 2012 and 2011, R$1,653.9 million, or 17.5%, R$2,2029.7 million, or 22.9%, and R$2,364.1 million, or 28.1%, respectively, of our total debt outstanding balance denominated in reais  was based on variable rates of interest based on the UPR, which is equivalent to the TR.  In addition, as of December 31, 2013, 2012 and 2011, R$1,245.9 million, or 13.2%, R$1,835.9 million, or 20.2%, and R$1,882.3 million, or 21.9%, respectively, of our total debt denominated in reais  was subject to interest rates based on the CDI.  As of December 31, 2013, 2012 and 2011, R$1,617.7 million, R$1,319.5 million and R$747.3 million, respectively, of our foreign-currency denominated debt was based on the IADB and the IBRD variable rates of interest, which are determined based on the cost of funding of these multilateral organizations in each period.

As of December 31, 2013, 2012 and 2011, we did not have any derivative contracts outstanding which limited exposure to changes in the UPR or the CDI or in the IADB or IBRD variable rates.  However, we are obliged by law to invest our excess cash with financial institutions controlled by the Brazilian government.  We invest these excess funds, which totaled R$1,529.2 million, R$1,796.6 million and R$2,027.0 million as of December 31, 2013, 2012 and 2011, respectively, mainly in short-term instruments.  As a result, our exposure to Brazilian interest rate risk is partially limited by our real-denominated floating interest time deposits investments, which generally earn interest based on the CDI.  In addition to our exposure with respect to existing indebtedness, we may become exposed to interest rate volatility with respect to indebtedness incurred in the future.

We estimate that we would have suffered a loss over periods of one year, respectively, of up to R$94.5 million, R$88.8 million and R$86.0 million if a hypothetical instantaneous and unfavorable change of 100 basis points in the interest rates applicable to financial liabilities as of December 31, 2013, 2012 and 2011, respectively, had occurred.  Consistent with these estimates, a hypothetical instantaneous and unfavorable 1000 basis points change in these interest rates would have resulted in losses of approximately R$945.0 million, R$887.5 million and R$859.6 million as of December 31, 2013, 2012 and 2011, respectively.  This sensitivity analysis is based on the assumption of an unfavorable 100 basis point movement of the interest rates applicable to each homogeneous category of financial liabilities and sustained over a period of one year, as applicable, and that such movement may or may not affect interest rates applicable to any other homogenous category of financial liabilities.

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A homogeneous category is defined according to the currency in which financial liabilities are denominated and assumes the same interest rate movement within each homogeneous category (i.e., U.S. dollars).  As a result, our interest rate risk sensitivity model may overstate the effect of interest rate fluctuation on these financial instruments, as consistently unfavorable movements of all interest rates are unlikely.

The tables below provide information about our interest rate-sensitive instruments.  For variable interest rate debt, the rate presented is the weighted average rate calculated as of December 31, 2013.  For the foreign currency denominated obligations, these amounts have been converted at the selling rates as of December 31, 2013 and do not represent amounts which may actually be payable with respect to such obligations on the dates indicated.

 

As of December 31, 2013

 

Expected maturity date

 

2014

2015

2016

2017 and after

Total

Average annual interest rate

 

(in millions, except percentages)

Assets

 

 

 

 

 

 

Cash equivalents denominated in reais

1,592.2

-

-

-

1,592.2

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

long‑term debt (current and noncurrent portion)

 

 

 

 

 

 

Floating rate, denominated in reais indexed by TR or UPR

215

108.0

107.8

1,223.2

1,653.9

8.5%

Floating rate, denominated in reais indexed by TJLP

96.1

97.6

105.8

694.3

993.9

1.2%

Floating rate, denominated in reais indexed by IPCA

77.8

25.2

25.2

1,347.1

1,475.3

12.2%

Floating rate, denominated in reais indexed by CDI

36.1

594.3

235.0

380.6

1,245.9

12.0%

Fixed rate, denominated in reais.....  

-

-

-

382.5

382.5

 

Floating rate, denominated in U.S. dollars

88.6

82.9

82.9

927.0

1,181.3

2.2%

Fixed rate, denominated in Yen

56.0

48.9

48.9

778.7

932.5

1.9%

Fixed rate, denominated in U.S. dollars

71.4

62.6

390.2

1,060.5

1,584.8

3.4%

Total long‑term debt

640.9

1,019.4

995.8

6,794.0

9,450.1

6.2%

______________

UPR stands for Standard Reference Unit (Unidade Padrão Referência) and is equal to TR, which  was 0,04940% per month as of December 31, 2013; CDI stands for Interbank Deposit Rate (Certificado de Depósitos Interbancários), which was 9,77% per annum as of December 31, 2013; IGP‑M was 5,51% per annum as of December 31, 2013; TJLP stands for Long‑term Interest Rate (Taxa de Juros a Longo Prazo), published quarterly by the Central Bank, which was 5% per annum as of December 31, 2013.

 

 

The percentage of our indebtedness subject to fixed and floating interest rate is as follows:

 

As of December 31,

 

2013

2012

2011

Floating rate debt:

 

 

 

Denominated in U.S. dollars

16.0%

10.0%

13.6%

Denominated in reais

56.8%

61.3%

63.2%

Fixed rate debt:

 

 

 

Denominated in reais

4.0%

2.4%

0.6%

Denominated in Yen

9.9%

10.1%

11.4%

Denominated in U.S. dollars

13.3%

16.2%

11.2%

Total

100.0%

100.0%

100.0%

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ITEM 12.         DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

A.      Debt Securities

Not applicable.

B.      Warrants and Rights

Not applicable.

C.      Other Securities

Not applicable.

D.      American Depositary Shares

In the United States, our common shares trade in the form of ADS.  Following a ratio change effected on January 24, 2013, each ADS represents one common share of our company.  Following a stock split which took place on April 22, 2013, we issued two new ADSs for each ADS currently trading and distributed them to our holders on April 29, 2013. The ADSs are issued by The Bank of New York Mellon, as Depositary pursuant to a Deposit Agreement.  The ADSs commenced trading on the NYSE on May 10, 2002.

Fees and Expenses

The following table summarizes the fees and expenses payable by holders of ADRs:

Persons depositing common shares or ADR holders must pay:

For:

US$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)

Issuance of ADSs, including issuances resulting from a distribution of common shares or rights or other property

Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates

 

US$0.05 (or less) per ADS or portion thereof (to the extent not prohibited by the rules of any stock exchange on which the ADSs are listed for trading)

Any cash distribution to you

A fee equivalent to the fee that would be payable if securities distributed to you had been common shares and the common shares had been deposited for issuance of ADSs

Distribution of securities distributed to holders of deposited securities which are distributed by the depositary to ADR holders

US$0.05 (or less) per ADS or portion thereof per calendar year (in addition to the cash distribution fee of $0.02 per ADS that the depositary has collected during the year)

Depositary services

Registration or transfer fees

Transfer and registration of common shares on our common share register to or from the name of the depositary or its agent when you deposit or withdraw common shares

Cable, telex and facsimile transmissions expenses (when expressly provided in the deposit agreement)

Expenses of the depositary in converting foreign currency to U.S. dollars

 

Expenses of the depositary

 

Taxes and other governmental charges the depositary or the custodian have to pay on any ADR or common share underlying an ADR, for example, stock transfer taxes, stamp duty or withholding taxes

As necessary

Any charges incurred by the depositary or its agents for servicing the deposited securities

No charges of this type are currently made in the Brazilian market

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Payment of Taxes

The depositary may deduct the amount of any taxes owed from any payments to you.  It may also sell deposited securities, by public or private sale, to pay any taxes owed.  You will remain liable if the proceeds of the sale are not sufficient to pay the taxes.  If the depositary sells deposited securities, it will, if appropriate, reduce the number of ADSs to reflect the sale and pay to you any proceeds, or send to you any property, remaining after it has paid the taxes.

Reimbursement of Fees

The Bank of New York Mellon, as depositary, has agreed to reimburse us for expenses we incur that are related to establishment and maintenance expenses of the ADS program.  The depositary has agreed to reimburse us for our continuing annual stock exchange listing fees.  The depositary has also agreed to pay the standard out‑of‑pocket maintenance costs for the ADRs, which consist of the expenses of postage and envelopes for mailing annual and interim financial reports, printing and distributing dividend checks, electronic filing of United States federal tax information, mailing required tax forms, stationery, postage, facsimile, and telephone calls.  It has also agreed to reimburse us annually for certain investor relationship programs or special investor relations promotional activities.  In certain instances, the depositary has agreed to provide additional payments to us based on any applicable performance indicators relating to the ADR facility.  There are limits on the amount of expenses for which the depositary will reimburse us, but the amount of reimbursement available to the Company is not necessarily tied to the amount of fees the depositary collects from investors.

The depositary collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them.  The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees.  The depositary may collect its annual fee for depositary services by deduction from cash distributions or by directly billing investors or by charging the book‑entry system accounts of participants acting for them.  The depositary may generally refuse to provide fee‑attracting services until its fees for those services are paid.

Reimbursement of Fees Incurred in 2013

From January 1, 2013 to December 31, 2013, we received reimbursements in the amount of US$811,400 for standard out‑of‑pocket maintenance costs for the ADRs, any applicable performance indicators relating to the ADR facility, marketing fees and legal fees.

PART II

ITEM 13.         DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

Not applicable.

ITEM 14.         MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

Not applicable.

ITEM 15.         CONTROLS AND PROCEDURES

a) Disclosure Controls and Procedures.

We carried out an evaluation under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer and Investor Relations Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, including those defined in the United States Exchange Act Rule 13a‑15(e), as of the year ended December 31, 2013.

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As a result of this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were both designed and effective at the reasonable assurance level as of December 31, 2013, that the information required to be disclosed in our filings and submissions under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified by the SEC’s rules and forms, and that this information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer and Investor Relations Officer, as appropriate to allow timely decisions regarding required disclosure.

b) Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal controls over financial reporting.   

Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with applicable generally accepted accounting principles.  Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with applicable generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our CEO and CFO, our management conducted an assessment of our internal control over financial reporting as of December 31, 2013 based on the criteria established in “Internal Control —Integrated Framework” issued by COSO in 1992.

As a result of the assessment described above, our management concluded that as of December 31, 2013, we did maintain effective internal control over financial reporting based on the criteria established in “Internal Control — Integrated Framework” issued by COSO in 1992.

Our independent registered public accounting firm, Deloitte Touche Tohmatsu Auditores Independentes, has issued an audit report on the effectiveness of our internal control over financial reporting.  That report is included below.

c) Attestation Report of the Registered Public Accounting Firm

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUTING FIRM ON INTERNAL
CONTROL OVER FINANCIAL REPORTING 

To the Shareholders, Board of Directors and Management of

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

São Paulo - SP

We have audited the internal control over financial reporting of Companhia de Saneamento Básico do Estado de São Paulo - SABESP (the “Company”) as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on internal control over Financial Reporting.  Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

 

 

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We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board   (IASB). A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements as of and for the year ended December 31, 2013 of the Company and our report dated April 25, 2014, expressed an unqualified opinion on those financial statements and included explanatory paragraph related to the accompanying financial statements that have been retrospectively adjusted as a result of changes in accounting practices related to employee benefits and accounting for joint arrangements.

/s/ Deloitte Touche Tohmatsu Auditores Independentes
April 25, 2014
São Paulo, Brazil.

d) Changes in internal control over financial reporting

There have been no changes in our internal control over financial reporting that occurred during the fiscal year ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 16.         [RESERVED] 

ITEM 16A.           Audit Committee Financial Expert

At our board meeting held on June 26, 2006, we established an audit committee, as defined under section 3(a)(58) of the Exchange Act.  Our board of directors has determined that Jerônimo Antunes qualifies as an “audit committee financial expert” as defined for the purposes of this Item 16A in Item 16 of Form 20‑F.  Jerônimo Antunes is an “independent director” within the meaning of the SEC rules.

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ITEM 16B.           Code of Ethics

We have adopted a code of business conduct and ethics, as defined in Item 16B of Form 20‑F under the Exchange Act.  Our code of business conduct and ethics, called Code of Ethics and Conduct, applies to all of our employees, including our directors, chief executive officer, chief financial officer and head of accounting, as well as our suppliers and third‑party contractors.  To ensure compliance with the Code of Ethics and Conduct, we have an Ethics Committee and an internal Whistle-blowing Channel, as well as a Corporate Accountability Procedure and an Ombudsman Office as well as a Customer Service that receive external complaints.  The internal channel can receive anonymous whistle blowing.  The results of the investigations are forwarded to the Audit Committee.  Cases of recurrence are reported to the Ethics Committee, which urges the related departments to develop preventive actions.  In 2013, 105 whistle blowings were recorded, 62% of which were verified and 38% are under investigation.  Out of the total, 25% refer to misconduct, such as moral harassment, discrimination, persecution and unfair treatment.  During 2013, 25 of our employees or outsourced employees received penalties (5 warnings, 2 suspensions and 18 dismissals).  Our Ethics Committee is also responsible for addressing relevant inquiries and interpreting the norms of the Code of Ethics for all of our employees.  Our Code of Ethics and Conduct is available on our web site at http://www.sabesp.com.br at the following location:  Investors Relations – Corporate Governance.  If we amend the provisions of our Code of Ethics and Conduct, or if we grant any waiver of such provisions, we will disclose the amendment or waiver on our web site at the same address.  You can obtain copies of our Code of Ethics and Conduct, without charge, upon request to sabesp.ri@sabesp.com.br

ITEM 16C.           Principal Accountant Fees and Services

Deloitte Touche Tohmatsu Auditores Independentes served as our independent registered public accounting firm for the years ended December 31, 2013 and 2012.  Deloitte Touche Tohmatsu Auditores Independentes’s activity began with the review of the Quarterly Information (“ITRs”) reporting for the third quarter of 2012.

PricewaterhouseCoopers Auditores Independentes served as our independent registered public accounting firm for the first and second quarter of 2012 and for the year ended December 31, 2011.

The following table presents the aggregate fees for professional services and other services rendered to us by Deloitte Touche Tohmatsu Auditores Independentes and PricewaterhouseCoopers Auditores Independentes in 2013, 2012 and 2011:

 

 

 

Year ended December 31,

 

2013

2012

2011

 

(in millions of reais

Audit Fees(1)

1.4

2.5

3.9

Audit‑Related Fees

-

-

Tax Fees

-

-

All Other Fees

-

-

Total

1.4

2.5

3.9

 

______________

(1)   Audit Fees are the fees billed by our independent auditors for the audit of our annual financial statements, reviews of interim financial statements and attestation services that are provided in connection with statutory and regulatory filings or engagements.

Pre‑approval policies and procedures

Pursuant to Brazilian law, our board of directors is responsible, among other matters, for the selection, dismissal and oversight of our independent registered public accounting firm.  Our management is required to obtain the board of directors’ approval before engaging an independent registered public accounting firm to provide any audit or permitted non‑audit services to us.  The Brazilian Federal and State Public Bidding Laws also apply to us with respect to obtaining services from third parties for our business, including the services provided by our independent registered public accounting firm.  As part of the bidding process, the independent registered public accounting firm is required to submit proposals, and are then selected by us based on certain criteria including technical expertise and cost.

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During 2012 and 2011, PricewaterhouseCoopers Auditores Independentes did not provide non‑audit services to us.  During 2012 and 2013 Deloitte Touche Tohmatsu Auditores Independentes did not provide non-audit services to us.

ITEM 16D.           Exemptions from the Listing Standards for Audit Committees

None.

ITEM 16E.           Purchases of Equity Securities by Issuer and Affiliated Purchasers

Not applicable.

ITEM 16F.           Change in Registrant’s Certifying Accountant

Not applicable.

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item 16g.          Corporate Governance

Significant Differences between our Corporate Governance Practices and NYSE Corporate Governance Standards 

We are subject to the NYSE corporate governance listing standards.  As a foreign private issuer, the standards applicable to us are considerably different than the standards applied to U.S. listed companies.  Under the NYSE rules, we are required only to:  (a) have an audit committee or audit board, pursuant to an applicable exemption available to foreign private issuers, that meets certain requirements, as discussed below, (b) provide prompt certification by our chief executive officer of any material non‑compliance with any corporate governance rules, and (c) provide a brief description of the significant differences between our corporate governance practices and the NYSE corporate governance practice required to be followed by U.S. listed companies.  The discussion of the significant differences between our corporate governance practices and those required of U.S. listed companies follows below.

Majority of Independent Directors

The NYSE rules require that a majority of the board must consist of independent directors.  Independence is defined by various criteria, including the absence of a material relationship between the director and the listed company.  Brazilian law does not have a similar requirement.  Under Brazilian law, neither our board of directors nor our management is required to test the independence of directors before their election to the board.  However, both the Brazilian Corporate Law and the CVM have established rules that require directors to meet certain qualification requirements and that address the compensation and duties and responsibilities of, as well as the restrictions applicable to, a company’s executive officers and directors.  Our board of directors must have a minimum of five members and 20% of the board (even if the board consists of greater than five members) must be independent as defined under Novo Mercado Regulations.  Currently, four of our eight directors are independent, pursuant to the Novo Mercado Listing Regulations.  We believe these rules provide adequate assurances that our directors are independent; however, they do not require that we have a majority of independent directors, as required under the NYSE rules.

Executive Sessions

NYSE rules require that the non‑management directors must meet at regularly scheduled executive sessions without management present.  The Brazilian Corporate Law does not have a similar provision.  According to the Brazilian Corporate Law, up to one‑third of the members of the board of directors can be elected from management.  There is no requirement that non‑management directors meet regularly without management.  Our chairperson and Chief Executive Officer is a member of our board of directors.  All other members of our board of directors meet the NYSE’s definition of “non‑management” directors.  The non‑management directors on our board do not typically meet in executive session.  Our board of directors consists of seven non‑management directors.

Fiscal Committee

Under the Brazilian Corporate Law, the Conselho Fiscal, or fiscal committee, is a corporate body independent of management and a company’s external auditors.  The fiscal committee may be either permanent or non‑permanent, in which case it is appointed by the shareholders to act during a specific fiscal year.  A fiscal committee is not equivalent to, or comparable with, a U.S. audit committee.  The primary responsibility of the fiscal committee is to review management’s activities and a company’s financial statements, and to report its findings to a company’s shareholders.  The Brazilian Corporate Law requires fiscal committee members to receive as remuneration at least 10% of the average annual amount paid to a company’s executive officers.  The Brazilian Corporate Law requires a fiscal committee to be composed of a minimum of three and a maximum of five members and their respective alternates.

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Under the Brazilian Corporate Law, the fiscal committee may not contain members that (i) are on our board of directors, (ii) are on the board of executive officers, (iii) are employed by us or a controlled company, or (iv) are spouses or relatives of any member of our management, up to the third degree.

Our fiscal committee consists of four members and four alternates and the members meet once a month.

Audit Committee

NYSE rules require that listed companies have an audit committee that (i) is composed of a minimum of three independent directors who are all financially literate, (ii) meets the SEC rules regarding audit committees for listed companies, (iii) has at least one member who has accounting or financial management expertise and (iv) is governed by a written charter addressing the committee’s required purpose and detailing its required responsibilities.  However, as a foreign private issuer, we need only to comply with the requirement that the audit committee meet the SEC rules regarding audit committees for listed companies to the extent compatible with Brazilian Corporate Law.  Our audit committee, which is not equivalent to, or comparable with, a U.S. audit committee, provides assistance to our board of directors on matters involving accounting, internal controls, financial reporting and compliance.  The audit committee recommends the appointment of our independent auditors to our board of directors and reviews the compensation of our independent auditors and helps coordinate their activities.  It also evaluates the effectiveness of our internal financial and legal compliance controls.  The audit committee comprises three members elected by the board of directors for a one‑year term with the right to re‑election, all three of which are independent.  The current members of our audit committee are Jerônimo Antunes, Reinaldo Guerreiro and Francisco Vidal Luna.  All members meet the independent membership requirements of the SEC and NYSE as well as other NYSE requirements.  Jerônimo Antunes is the committee’s “financial expert” within the scope of the SEC rules covering the disclosure of financial experts on audit committees in periodic filings pursuant to the U.S. Securities Exchange Act of 1934.

Risks Committee

In 2009, our board of executive officers created the Risks Committee with responsibilities to: i) evaluate the maximum amounts of risk that Management should incur in its operations in order to obtain planned results; ii) evaluate the identification, measurement, treatment and processing of risks in action plans; iii) forward its statements, proposals and evaluations to the audit committee and to the board of executive officers for review, as well as submit such statements, proposals and evaluations to the board of directors for approval.  The Risks Committee is coordinated by a chairman and consists of representatives from the following management divisions: Corporate Management; Technology, Enterprises and Environment; Metropolitan; Economics and Finance and Investor Relations; and Regional Systems.

Nomination/Corporate Governance and Compensation Committees

NYSE rules require that listed companies have a nominating/corporate governance committee and a compensation committee composed entirely of independent directors and governed by a written charter addressing the committee’s required purpose and detailing its required responsibilities.  Required responsibilities for the nominating/corporate governance committee include, among other things, identifying and selecting qualified board member nominees and developing a set of corporate governance principles applicable to the company.  Required responsibilities for the compensation committee include, among other things, reviewing corporate goals relevant to the chief executive officer’s compensation, evaluating the chief executive officer’s performance, approving the chief executive officer’s compensation levels and recommending to the board non‑chief executive officer compensation, incentive‑compensation and equity‑based plans.

We are not required under applicable Brazilian law to have a nomination/corporate governance committee or compensation committee.  Under the Brazilian Corporate Law, the total amount available for compensation of our directors and executive officers and for profit‑sharing payments to our executive officers is established by our shareholders at the annual general meeting.  The board of directors is then responsible for determining the individual compensation and profit‑sharing of each executive officer, as well as the compensation of our board and committee members.  In making such determinations, the board reviews the performance of the executive officers, including the performance of our chief executive officer, who typically excuses himself from discussions regarding his performance and compensation.

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Shareholder Approval of Equity Compensation Plans

NYSE rules require that shareholders be given the opportunity to vote on all equity compensation plans and material revisions thereto, with limited exceptions.  We do not currently have any equity compensation plan.  If such a plan were to be implemented, there is no requirement under Brazilian Corporate Law for the plan to be approved by our shareholders.  However, if the issuance of new shares in connection with any equity compensation plan exceeded the authorized capital under our bylaws, the increase in capital would require shareholder approval.

Corporate Governance Guidelines

NYSE rules require that listed companies adopt and disclose corporate governance guidelines.  We are in compliance with the adoption of corporate governance provisions and guidelines required under the Novo Mercado Regulations.  Additionally, under the CVM’s guidelines, we have established (i) the Policy of Publicizing Acts or Relevant Facts and the Preservation of Confidentiality which requires us to publicly disclose all relevant information and (ii) the Securities Negotiation Policy which requires management to inform the CVM and the BM&FBOVESPA of any purchases or sales of our securities.  We believe the corporate governance guidelines applicable to us under the Novo Mercado Regulations, as well as the CVM, do not conflict with the guidelines established by the NYSE.  Our corporate governance guidelines and practices are available in our website at www.sabesp.com.br and in our annual management report.

Code of Business Conduct and Ethics

NYSE rules require that listed companies adopt and disclose a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers.  Applicable Brazilian law does not have a similar requirement.  We have decided to adopt and disclose a code of ethics and conduct applicable to all our officers, directors and employees.  The adoption and disclosure of a formal code is not required under the Brazilian Corporate Law.  We believe our formal code addresses the matters required to be addressed by the applicable NYSE and SEC rules.

Internal Audit Function

NYSE rules require that listed companies maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control.  Our internal audit department is under the supervision of our Chief Executive Officer and our audit committee and is responsible for our compliance with the requirements of Section 404 of the U.S. Sarbanes Oxley Act of 2002 regarding internal control over financial reporting.  Our internal audit department reports to our chief executive officer and the audit committee.

Citizens’ Access to Information at Sabesp  

The federal law No. 12,527/11 (LAI), regulated by State Decree No. 58.052/12, determines that bodies and entities of the Public Administration must create an unit to make available Citizen Information Services – SIC in order to serve and guide citizens, receive and manage information requests, as well as make available to the citizen information of his/her interest and the requirement to present the motives or reasons of request is forbidden.

In order to comply with LAI, we implemented the Citizen Information Service - SIC, structuring the internal flow of information to serve citizen within the terms provided for by laws and is drafting the Table of documents, data and information, defining restrictive information, protecting business strategic information and pursuing the transparent management. We also made available at our website basic information required by laws and the software to citizen request information, according to the standards of the São Paulo State Government.

These duties are linked to the Risk Management area whose main assumption is the transparency, quality of information and compliance with strategic rules of a listed company.

ITEM 16h.          MINE SAFETY DISCLOSURE

Not applicable.

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PART III

ITEM 17.         FINANCIAL STATEMENTS

We have responded to Item 18 in lieu of responding to this Item.

ITEM 18.         FINANCIAL STATEMENTS

The following financial statements, together with the Report of Independent Registered Public Accounting Firms, are filed as part of this annual report.  See “Index to Financial Statements.”

ITEM 19.         EXHIBITS 

Item

Description

1.1

By‑laws of the Registrant (English translation) (incorporated by reference to the Form 6‑K filed on May, 1 2013).

4.1

Agreement between the Registrant and the State Department of Water and Energy (Departamento de Águas e Energia Elétrica—DAEE), dated April 24, 1997 (English translation) (incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form F‑1 filed on April 8, 2002 (the “April 8, 2002 Form F‑1”).

4.2

Protocol of Understanding between the Registrant and the State of São Paulo, dated September 30, 1997 (English translation) (incorporated by reference to Exhibit 10.2 to the April 8, 2002 Form F‑1).

4.3

Agreement between the Registrant and the State of São Paulo, through the Secretariat of Finance, dated September 10, 2001 (English translation) (incorporated by reference to Exhibit 10.3 to the April 8, 2002 Form F‑1).

4.4

Agreement between the Registrant and the State of São Paulo, through the Secretariat of the Treasury, dated December 11, 2001 (English translation) (incorporated by reference to Exhibit 10.4 to the April 8, 2002 Form F‑1).

4.5

Amendment to the Agreement, dated April 24, 1997, between the Registrant and the DAEE, dated March 16, 2000 (English translation) (incorporated by reference to Exhibit 10.5 to the April 8, 2002 Form F‑1).

4.6

Amendment to the Agreement, dated April 24, 1997, between the Registrant and the DAEE, dated November 21, 2001 (English translation) (incorporated by reference to Exhibit 10.6 to the April 8, 2002 Form F‑1).

4.7

First Amendment to the Agreement, dated December 11, 2001, between the Registrant and the State of São Paulo, dated March 22, 2004. (English Translation) (incorporated by reference to Exhibit 4.7 to the Form 20‑F filed on June 28, 2004).

4.8

Second Amendment to the Agreement, dated December 11, 2001, between the Registrant and the State of São Paulo, dated December 28, 2007. (English Translation) (incorporated by reference to the Form 6‑K filed on February 25, 2008).

4.9

Third Amendment to the Agreement, dated December 11, 2001, between the Registrant and the State of São Paulo, dated November 17, 2008. (English Translation) (incorporated by reference to the Form 6‑K filed on December 23, 2008).

4.10

Commitment Agreement, between the Registrant and the State of São Paulo, dated March 26, 2008. (English Translation) (incorporated by reference to the Form 6‑K filed on April 28, 2008).

4.11

Agreement Executed between the Registrant and the São Paulo City Government, dated November 14, 2007 (English Translation) (incorporated by reference to the Form 6‑K filed on March 12, 2008).

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Item

Description

4.12

Amendment to the Agreement Executed between the Registrant and the São Paulo City government, dated February 10, 2008 (English Translation) (incorporated by reference to the Form 6‑K filed on May 12, 2008).

4.14

The Audit Committee Charter dated February 11, 2010 (English Translation) (incorporated by reference to the Form 6‑K filed on April 20, 2010).

4.15

Convention between the State and the city of São Paulo, dated June 23, 2010, with the intermediation and consent of the Registrant and of ARSESP (English Translation) (incorporated by reference to the Form 6‑K filed on July 13, 2010).

4.16

Contract to provide public water supply and sewage services, among the Registrant, the State and the city of São Paulo, dated June 23, 2010 (English Translation) (incorporated by reference to the Form 6‑K filed on July 13, 2010).

11.1

Code of Ethics and Conduct dated January 26, 2006 (English Translation) (incorporated by reference to the Form 6‑K filed on July 7, 2008).

12.1

Certification of Dilma Seli Pena, Chief Executive Officer, pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

12.2

Certification of Rui de Britto Álvares Affonso, Chief Financial Officer and Investor Relations Officer, pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

13.1

Certification of Dilma Seli Pena, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.

13.2

Certification of Rui de Britto Álvares Affonso, Chief Financial Officer and Investor Relations Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.

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SIGNATURES

The registrant hereby certifies that it meets all of the requirements for filing on Form 20‑F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

COMPANHIA DE SANEAMENTO BÁSICO DO ESTADO DE SÃO PAULO ‑ SABESP

By:     /s/ Dilma Seli Pena                                                 
Name:     Dilma Seli Pena
Title:       Chief Executive Officer

By:     /s/ Rui de Britto Álvares Affonso                        
Name:     Rui de Britto Álvares Affonso
Title:       Chief Financial Officer and Investor
                Relations Officer

Date: April 25, 2014

 


 


  

 

(Convenience Translation into English from the Original Previously Issued in Portuguese)

 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

 

Financial Statements as of

December 31, 2013 and 2012

and for the years ended

December 31, 2013, 2012 and 2011

 

 

 

 

 

 


 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON

FINANCIAL STATEMENTS

To the Shareholders, Board of Directors and Management of

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

São Paulo - SP

We have audited the accompanying statement of financial position of Companhia de Saneamento Básico do Estado de São Paulo - SABESP (the “Company”) as of December 31, 2013 and 2012, and the related statements of income, comprehensive income, changes in equity and cash flows for each of the two years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States) - PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such financial statements present fairly, in all material respects, the financial position of Companhia de Saneamento Básico do Estado de São Paulo - SABESP as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2013, in conformity with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB).

 

As mentioned in Note 4.1, as a result of the changes in accounting practices for the year beginning on January 1, 2013 relating to employee benefits, in compliance with IAS 19(R) – Employee Benefits, and the change in the accounting policy relating to the recording of jointly-owned businesses, in accordance with IFRS 11 - Joint Arrangements, the corresponding amounts recorded in the statement of financial position as of December 31, 2012 and the corresponding statements of income, comprehensive income, changes in equity and cash flows for the years ended December 31, 2012 and 2011, have been retrospectively adjusted in accordance with IAS 8 - Accounting Policies, Changes in Estimates and Correction of Error and IAS 1 - Presentation of Financial Statements.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) - PCAOB, the Company’s internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 25, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

/s/ Deloitte Touche Tohmatsu Auditores Independentes

  

São Paulo, Brazil

April 25, 2014

 

 

F-2


 

 

Report of independent registered

public accounting firm

 

 

To the Board of Directors and Shareholders of

Companhia de Saneamento Básico do
Estado de São Paulo - SABESP

 

In our opinion, the statements of income, of comprehensive income, of shareholders’ equity and of cash flows for the year ended December 31, 2011 present fairly, in all material respects, the results of operations and cash flows of Companhia de Saneamento Básico do Estado de São Paulo - SABESP (the “Company”) for the year ended December 31, 2011 in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board. These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audit.  We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States) and International Standards of Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. 

 

As discussed in Note 4.1 to the financial statements, the Company changed the manner in which it accounted for (i) joint arrangements under IFRS 11 - Joint Arrangements and (ii) employee benefits under IAS 19 - Employee Benefits.

 

 

 

São Paulo - Brazil

May 15, 2013, except for the effects of adopting IFRS 11 - Joint Arrangements and IAS 19- Employee Benefits as discussed in Note 4.1 to the financial statements as to which the date is April 25, 2014.

 

/s/ PricewaterhouseCoopers

PricewaterhouseCoopers

Auditores Independentes

 

 

 

 

 

F-3


 

 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Financial Position as of December 31, 2013, 2012 and January 1, 2012

Amounts in thousands of reais

 

Assets

Note

 

December 31,
2013

 

December 31, 2012

Restated

 

January 1, 2012

Restated

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

6

 

1,782,001

 

1,915,974

 

2,142,079

Trade accounts receivable

8 (a)

 

1,120,053

 

1,038,945

 

1,072,015

Accounts receivable from related parties

9 (a)

 

134,855

 

109,273

 

185,333

Inventories

 

 

58,401

 

53,028

 

44,576

Restricted cash

7

 

10,333

 

64,977

 

99,733

Recoverable taxes

16 (a)

 

87,405

 

118,421

 

117,893

Other accounts receivable

 

 

61,039

 

29,980

 

43,065

Total current assets

 

 

3,254,087

 

3,330,598

 

3,704,694

 

 

 

 

 

 

 

 

Noncurrent assets

 

 

 

 

 

 

 

Trade accounts receivable

8 (a)

 

395,512

 

335,687

 

333,713

Accounts receivable from related parties

9 (a)

 

130,457

 

153,098

 

170,288

Indemnities receivable

 

 

-

 

-

 

60,295

Escrowdeposits

 

 

54,827

 

53,158

 

54,178

Deferred income tax and social contribution

17

 

114,030

 

145,302

 

142,603

Water National Agency – ANA

10

 

107,003

 

108,099

 

100,551

Other accounts receivable

 

 

94,952

 

111,047

 

35,034

 

 

 

 

 

 

 

 

Investments

11

 

23,660

 

20,826

 

21,986

Investment properties

12

 

54,039

 

54,046

 

52,585

Intangible assets

13

 

23,846,231

 

21,967,526

 

20,125,721

Property, plant and equipment

14

 

199,496

 

196,710

 

181,585

Total noncurrent assets

 

 

25,020,207

 

23,145,499

 

21,278,539

Total assets

 

 

28,274,294

 

26,476,097

 

24,983,233

F-4

 

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Financial Position as of December 31, 2013, 2012 and January 1, 2012

Amounts in thousands of reais

 

Liabilities and equity

Note

 

December 31,
2013

 

December 31, 2012

Restated

 

January 1, 2012

Restated

Current liabilities

 

 

 

 

 

 

 

Trade payablesand contractors

 

 

275,051

 

295,392

 

244,658

Current portion of long-term loans and financing

15

 

640,940

 

1,342,594

 

1,629,184

Accrued payroll and related charges

 

 

314,926

 

267,332

 

243,502

Taxes and contributions

16 (b)

 

115,382

 

152,710

 

180,794

Interest on shareholders' equity payable

21 (c)

 

456,975

 

414,355

 

247,486

Provisions

18 (a)

 

631,374

 

565,083

 

764,070

Services payable

20

 

323,208

 

389,091

 

383,116

Public-Private Partnership – PPP

13 (j)

 

20,241

 

24,357

 

12,693

Program Contract Commitments

13 (d) (iv)

 

77,360

 

148,220

 

62,287

Other liabilities

 

 

116,924

 

159,055

 

188,356

Total current liabilities

 

 

2,972,381

 

3,758,189

 

3,956,146

 

 

 

 

 

 

 

 

Noncurrent liabilities

 

 

 

 

 

 

 

Loans and financing

15

 

8,809,134

 

7,532,661

 

6,794,148

Taxes payable

 

 

-

 

-

 

18,363

Deferred Cofins and PASEP

 

 

129,849

 

123,731

 

114,106

Provisions

18 (a)

 

549,008

 

624,071

 

807,759

Pension obligations

19 (b)

 

2,327,016

 

2,592,550

 

2,016,327

Public-Private Partnership – PPP

13 (j)

 

322,267

 

331,960

 

416,105

Program Contract Commitments

13 (d) (iv)

 

88,678

 

87,407

 

130,978

Other liabilities

 

 

145,160

 

168,766

 

184,358

Total noncurrent liabilities

 

 

12,371,112

 

11,461,146

 

10,482,144

 

 

 

 

 

 

 

 

Total liabilities

 

 

15,343,493

 

15,219,335

 

14,438,290

 

 

 

 

 

 

 

 

Equity

21

 

 

 

 

 

 

Capital stock

 

 

6,203,688

 

6,203,688

 

6,203,688

Capital reserve

 

 

124,255

 

124,255

 

124,255

Earnings reserves

 

 

6,736,389

 

5,387,634

 

4,217,953

Other comprehensive income

 

 

(133,531)

 

(458,815)

 

(953)

Total equity

 

 

12,930,801

 

11,256,762

 

10,544,943

Total equity and liabilities

 

 

28,274,294

 

26,476,097

 

24,983,233

The accompanying notes are an integral part of these financial statements.

F-5

                                                                                                                                                                                                                                                     


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Income for the

Years ended December 31, 2013, 2012 and 2011

Amounts in thousands of reais, unless otherwise indicated

 

 

 

Note

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

 

 

Net operating income

24

 

11,315,567

 

10,737,631

 

9,927,445

Operating cost

25

 

(6,816,263)

 

(6,449,951)

 

(6,018,732)

 

 

 

 

 

 

 

 

Gross profit

 

 

4,499,304

 

4,287,680

 

3,908,713

 

 

 

 

 

 

 

 

Selling expenses

25

 

(637,103)

 

(697,252)

 

(619,304)

Administrative expenses

25

 

(729,117)

 

(717,377)

 

(683,550)

Other operating income (expenses), net

27

 

3,296

 

(23,175)

 

(90,253)

Equity results

11

 

2,465

 

(6,532)

 

(3,584)

 

 

 

 

 

 

 

 

Operating profit before financial result

 

 

3,138,845

 

2,843,344

 

2,512,022

 

 

 

 

 

 

 

 

Financial expenses

26

 

(602,910)

 

(578,230)

 

(701,889)

Financial income

26

 

386,110

 

333,129

 

465,753

Foreign exchange result, net

26

 

(266,446)

 

(50,571)

 

(396,882)

 

 

 

 

 

 

 

 

Financing cost, net

 

 

(483,246)

 

(295,672)

 

(633,018)

 

 

 

 

 

 

 

 

Profit before income tax and social contribution

 

 

2,655,599

 

2,547,672

 

1,879,004

Income tax and social contribution

 

 

 

 

 

 

 

Current

17 (d)

 

(742,578)

 

(593,743)

 

(598,024)

Deferred

17 (d)

 

10,538

 

(42,029)

 

99,966

 

 

 

(732,040)

 

(635,772)

 

(498,058)

Profit for the year

  Attributable to the Company’s shareholders

 

 

1,923,559

 

1,911,900

 

1,380,946

 

 

 

 

 

 

 

 

Earnings per share - basic and diluted (in reais)

22

 

2.81

 

2.80

 

2.02

 

 

 

 

 

 

 

 

Earnings per ADS - basic and diluted (in reais)

22

 

2.81

 

2.80

 

2.02

The accompanying notes are an integral part of these financial statements.

F-6

                                          


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Comprehensive Income for the

Years ended December 31, 2013, 2012 and 2011

Amounts in thousands of reais

 

 

 

Note

 

2013

 

2012

Restated

 

2011

Restated

Profit for the year

 

 

1,923,559

 

1,911,900

 

1,380,946

Other comprehensive income

 

 

325,284

 

(457,862)

 

144,642

Items which will not be subsequently reclassified to the statement of income:

 

 

 

 

 

 

 

Actuarial gains and (losses) on defined benefit plans

19 (b)

 

325,284

 

(457,862)

 

144,642

Total comprehensive income for the year

 

 

2,248,843

 

1,454,038

 

1,525,588

 

 

The accompanying notes are an integral part of these financial statements.

F-7

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Changes in Equity for the

Years ended December 31, 2013, 2012 and 2011

Amounts in thousands of reais, unless otherwise indicated

 

                                                                            

 

 

 

 

 

 

 

Earnings Reserves

 

 

 

 

 

 

 

Note

 

Capital
stock

 

Capital Reserve

 

Legal
Reserve

 

Investments
Reserve

 

Additional
proposed
dividend

 

Retained
earnings

 

Other
Comprehensive
income

 

Total

Balances as ofJanuary 1, 2011 - as originally published

 

 

6,203,688

 

124,255

 

460,048

 

2,825,048

 

68,761

 

-

 

-

 

9,681,800

Recognition of actuarial liability IAS 19, net of taxes

 

 

-

 

-

 

-

 

-

 

-

 

-

 

(303,122)

 

(303,122)

Balances as of January 1, 2011 – restated

 

 

6,203,688

 

124,255

 

460,048

 

2,825,048

 

68,761

 

-

 

(303,122)

 

9,378,678

Net income for the year

 

 

-

 

-

 

-

 

-

 

-

 

1,380,946

 

-

 

1,380,946

Actuarial gains (losses)

 

 

-

 

-

 

-

 

-

 

-

 

-

 

144,642

 

144,642

Total comprehensive income for the year

 

 

-

 

-

 

-

 

-

 

-

 

1,380,946

 

144,462

 

1,525,588

Recognition of actuarial liability IAS 19

 

 

-

 

-

 

-

 

-

 

-

 

(157,527)

 

157,527

 

-

Legal reserve

 

 

-

 

-

 

61,171

 

-

 

-

 

(61,171)

 

-

 

-

Interest on shareholders’ equity (R$1.27 per share)

 

 

-

 

-

 

-

 

-

 

-

 

(290,562)

 

-

 

(290,562)

2010 additional dividends, approved (R$0.30 per share)

 

 

-

 

-

 

-

 

-

 

(68,761)

 

-

 

-

 

(68,761)

Additional proposed dividends

 

 

-

 

-

 

-

 

-

 

288,143

 

(288,143)

 

-

 

-

Transfer to investments reserve

 

 

-

 

-

 

-

 

583,543

 

-

 

(583,543)

 

-

 

-

Balances as of December 31, 2011 –restated

 

 

6,203,688

 

124,255

 

521,219

 

3,408,591

 

288,143

 

-

 

(953)

 

10,544,943

Net income for the year

 

 

-

 

-

 

-

 

-

 

-

 

1,911,900

 

-

 

1,911,900

Actuarial gains (losses)

19 (b)

 

-

 

-

 

-

 

-

 

-

 

-

 

(457,862)

 

(457,862)

Total comprehensive income for the year

 

 

-

 

-

 

-

 

-

 

-

 

1,911,900

 

(457,862)

 

1,454,038

Legal reserve

21 (e)

 

-

 

-

 

95,595

 

-

 

-

 

(95,595)

 

-

 

-

Interest on shareholders' equity (R$ 1.99 per share)

21 (c)

 

-

 

-

 

-

 

-

 

-

 

(454,076)

 

-

 

(454,076)

2011 additional dividends, approved (R$ 1.26 per share)

 

 

-

 

-

 

-

 

-

 

(288,143)

 

-

 

-

 

(288,143)

Additional proposed dividends

 

 

-

 

-

 

-

 

-

 

80,201

 

(80,201)

 

-

 

-

Transfer to investments reserve

 

 

-

 

-

 

-

 

1,282,028

 

-

 

(1,282,028)

 

-

 

-

Balances as of December 31, 2012 - restated

 

 

6,203,688

 

124,255

 

616,814

 

4,690,619

 

80,201

 

-

 

(458,815)

 

11,256,762

 

The accompanying notes are an integral part of these financial statements.

F-8

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Changes in Equity for the

Years ended December 31, 2013, 2012 and 2011

Amounts in thousands of reais, unless otherwise indicated

 

                                                                            

Net income for the year

 

 

-

 

-

 

-

 

-

 

-

 

1,923,559

 

-

 

1,923,559

Actuarial gains (losses)

19 (b)

 

-

 

-

 

-

 

-

 

-

 

-

 

325,284

 

325,284

Total comprehensive income for the year

 

 

-

 

-

 

-

 

-

 

-

 

1,923,559

 

325,284

 

2,248,843

Legal reserve

21 (e)

 

-

 

-

 

96,178

 

-

 

-

 

(96,178)

 

-

 

-

Interest on shareholders’ equity (R$0.6684 per share)

21 (c)

 

-

 

-

 

-

 

-

 

-

 

(456,845)

 

-

 

(456,845)

2012 additional dividends, approved(R$ 1.99 per share)

 

 

-

 

-

 

-

 

-

 

(80,201)

 

-

 

-

 

(80,201)

Additional proposed dividends

 

 

-

 

-

 

-

 

-

 

80,620

 

(80,620)

 

-

 

-

Withholding income tax on interest on shareholders’ equity attributed as minimum mandatory dividends

 

 

-

 

-

 

-

 

-

 

(37,758)

 

-

 

-

 

(37,758)

Transfer to investments reserve

 

 

-

 

-

 

-

 

1,289,916

 

-

 

(1,289,916)

 

-

 

-

Balances as of December 31, 2013

 

 

6,203,688

 

124,255

 

712,992

 

5,980,535

 

42,862

 

-

 

(133,531)

 

12,930,801

The accompanying notes are an integral part of these financial statements.

F-9

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Cash Flows for the

Years ended December 31, 2013, 2012 and 2011

Amounts in thousands of reais

 

                                                                                                         

 

 

December 31,
2013

 

December 31, 2012

Restated

 

December 31, 2011

Restated

Cash flow from operating activities

 

 

 

 

 

Profit before income tax and social contribution

2,655,599

 

2,547,672

 

1,879,004

Adjustments for:

 

 

 

 

 

Depreciation and amortization

871,073

 

738,525

 

768,704

Residual value of property, plant and equipment and intangible assets written-off

28,498

 

12,059

 

56,548

Allowance for doubtful accounts

103,864

 

192,236

 

289,589

Provisions and inflation adjustment

202,730

 

201,196

 

310,075

Interest calculated on loans and financing payable

390,039

 

404,196

 

434,315

Inflation adjustment and foreign exchange gains (losses) on loans and financing

340,492

 

85,122

 

442,954

Interest and inflation adjustment losses

18,401

 

24,553

 

31,422

Interest and inflation adjustment gains

(7,671)

 

(12,862)

 

(33,589)

Financial charges from customers

(234,138)

 

(171,481)

 

(169,941)

Margin on intangible assets arising from concession

(50,248)

 

(50,072)

 

(47,588)

Provision for Consent Decree (TAC)

22,518

 

57,332

 

46,991

Indemnities receivable

-

 

60,295

 

85,918

Equity results

(2,465)

 

6,532

 

3,584

Provision from São Paulo agreement

3,168

 

2,466

 

15,386

Provision for defined contribution plan

9,167

 

5,728

 

(8,746)

Pension obligations

260,003

 

213,747

 

100,400

Other adjustments

(33,576)

 

34,772

 

4,832

 

4,577,454

 

4,352,016

 

4,209,858

Changes in assets

 

 

 

 

 

Trade accounts receivable

(11,515)

 

56,003

 

(188,202)

Accounts receivable from related parties

5,586

 

60,450

 

20,455

Inventories

(6,133)

 

(8,858)

 

(8,490)

Recoverable taxes

31,016

 

(29,758)

 

(61,926)

Escrow deposits

(1,669)

 

1,020

 

573

Other accounts receivable

(13,868)

 

(77,613)

 

(41,080)

Changes in liabilities

 

 

 

 

 

Trade payables and contractors

(15,454)

 

(16,898)

 

135,961

Services received

(65,883)

 

5,975

 

87,944

Accrued payroll and related charges

47,594

 

(33,502)

 

(49,814)

Taxes and contributions payable

(146,664)

 

(47,800)

 

(14,416)

Deferred Cofins/Pasep

6,118

 

9,625

 

1,144

Provisions

(211,502)

 

(583,871)

 

(197,521)

Pension obligations

(158,442)

 

(140,115)

 

(11,268)

Other liabilities

(59,211)

 

(53,086)

 

140,220

Cash generated from operations

3,977,427

 

3,493,588

 

4,023,438

Interest paid

(533,362)

 

(589,189)

 

(736,382)

Income tax and social contribution paid

(666,883)

 

(561,158)

 

(588,484)

Net cash generated from operating activities

2,777,182

 

2,343,241

 

2,698,572

Cash flows from investing activities

 

 

 

 

 

Acquisition of intangibles

(2,305,031)

 

(2,008,699)

 

(2,056,756)

Restricted cash

54,644

 

34,752

 

202,841

Investment increase

(369)

 

(5,372)

 

(17,308)

Purchases of tangible assets

(30,743)

 

(17,377)

 

(11,995)

Net cash used in investing activities

(2,281,499)

 

(1,996,696)

 

(1,883,218)

 

 

 

 

 

 

 

 

 

 

           

 

The accompanying notes are an integral part of these financial statements.

F-10

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Statement of Cash Flows for the

Years ended December 31, 2013, 2012 and 2011

Amounts in thousands of reais 

                                                                                                         

 

 

December 31,
2013

 

December 31, 2012

Restated

 

December 31, 2011

Restated

Cash flows from financing activities

 

 

 

 

 

Loans and financing

 

 

 

 

 

Proceeds from loans

1,779,529

 

1,620,852

 

1,685,506

Repayments of loans

(1,780,673)

 

(1,518,240)

 

(1,923,862)

Payment of interest on shareholders' equity

(498,669)

 

(578,705)

 

(422,923)

Public-Private Partnership – PPP

(13,809)

 

(40,285)

 

-

Program Contract Commitments

(116,034)

 

(56,272)

 

-

Net cash used in financing activities

(629,656)

 

(572,650)

 

(661,279)

 

 

 

 

 

 

Decrease in cash and cash equivalents

(133,973)

 

(226,105)

 

154,075

 

 

 

 

 

 

Represented by:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of the year

1,915,974

 

2,142,079

 

1,988,004

Cash and cash equivalents at end of the year

1,782,001

 

1,915,974

 

2,142,079

Decrease in cash and cash equivalents

(133,973)

 

(226,105)

 

154,075

           

The accompanying notes are an integral part of these financial statements.

F-11

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

1              Operational context

 

Companhia de Saneamento Básico do Estado de São Paulo ("SABESP" or the "Company") is a mixed-capital company headquartered in São Paulo, at Rua Costa Carvalho, 300, CEP 05429-900, controlled by the São Paulo State Government. The Company is engaged in the provision of basic and environmental sanitation services in the State of São Paulo, as well as it supplies treated water on a wholesale basis.   

 

In addition to providing basic sanitation services in the State of São Paulo, SABESP may perform these activities in other states and countries, and can operate in drainage, urban cleaning, solid waste handling and energy markets. The objective set in the new vision of SABESP is to be recognized as the company that ensured universal access to water and sewage services in its marketplace in a sustainable and competitive manner, with excellence in customer service.

 

On December 31, 2013, the Company operated water and sewage services in 363 municipalities of the State of São Paulo. Most of these municipalities operations are based on 30-year concession, program and services contracts. The Company has two partial contracts with the municipality of Mogi das Cruzes; however, since most of municipality is serviced by wholesale, it was not included in the 363 municipalities. On December 31, 2013, the Company had 365 contracts.

 

SABESP is not temporarily operating in some municipalities due to judicial orders. The lawsuits in progress refer to Iperó, Cajobi, Álvares Florense, Macatuba and Embaúba, and the carrying amount of these municipalities' intangible assets was R$11,351 as of December 31, 2013 (R$16,516 as of December 31, 2012).

 

As of December 31, 2013, 61 concession agreements had expired and are being negotiated. From  2014 to 2034, 38 concession agreements will expire. Management believes that concession agreements expired and not yet renewed will result in new contracts, disregarding the risk of discontinuity in the provision of municipal water supply and sewage services. By December 31, 2013, 266 program and services contracts were signed (258 contracts on December 31, 2012).

 

As of December 31, 2013, the carrying amount of the underlying assets used in the 61 concessions of the municipalities under negotiation totaled R$5,972,414, accounting for 25.05% of total, and the related revenue for the year then ended totaled R$1,930,348 on December 31, 2013, accounting for 16.11% of total.

 

The Company's operations are concentrated in the municipality of São Paulo, which represents 51.75% of the gross revenues on  December 31, 2013 (51.21% in December 2012 and 51,43% in December 2011) and 42.46% of intangible assets (43.51% in December 2012). 

 

On June 23, 2010, the State of São Paulo, the Municipality of São Paulo, the Company and the regulatory agency “Sanitation and Energy Regulatory Agency – ARSESP” signed an agreement to share the responsibility for water supply and sewage services to the Municipality of São Paulo based on a 30-year concession agreement. This agreement is extendable for another 30 years, pursuant to the law. This agreement sets forth SABESP as the exclusive service provider and designates ARSESP as regulator, establishing prices, controlling and monitoring services

F-12

 


 

 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

Also, on June 23, 2010, the State of São Paulo, the city of São Paulo and SABESP signed the “Public service provision agreement of water supply and sewage services”, a 30-year concession agreement which is extendable for another 30 years. This agreement involves the following activities

 

i. protection of the sources of water in collaboration with other agencies of the State and the City

ii. capture, transport and treat of water

iii. collect, transport, treatment and final dispose of  sanitary sewage; and

iv. adoption of other actions of basic and environmental sanitation

 

In the municipality of Santos, in the Santos coast region, which has a significant population, the Company operates under an authorization by public deed, a situation similar to other municipalities in that region and in the Ribeira valley, where the Company started to operate after the merger of the companies that formed it. As of December 31,   2013 the carrying amount of the municipality of Santos’ intangible assets was R$340,530 (R$328,693 in December 2012) and gross revenue in the year ended December 31, 2013 was R$249,393 (R$202,103 in December 2012 and R$196,831 in December 2011).

 

Article 58 of Law 11,445/07 determines that precarious and expired concessions, as well as those effective for an undetermined period of time, including those that do not have an instrument formalizing them, will be valid until December 31, 2010. However, Article 2 of Law 12,693 of July 24, 2012 allows program agreements to be executed until December 31, 2016.

 

The Company’s Management understands that the concession agreements not yet renewed are valid and are governed by Laws 8,987/95 and 11,445/07, including those municipalities served without an agreement.

 

Public deeds are valid and governed by the Brazilian Civil Code.

 

The Company's shares have been listed in the Novo Mercado (New Market) segment of BM&FBovespa under the ticker symbol SBSP3 since April 2002 and on the New York Stock Exchange (NYSE) as American Depositary Receipts (“ADRs”) Level III, under the SBS code, since May 2002. In 2007, SABESP adhered to the Corporate Sustainability Index, or ISE of BM&FBovespa, which reflects the high level of commitment with sustainable development and social practices.

 

Since 2008, the Company has been setting up partnerships with other companies, which resulted in the following companies: Sesamm, Águas de Andradina, Saneaqua Mairinque, Aquapolo Ambiental, Águas de Castilho and Attend Ambiental. Although SABESP has no majority interest in the capital stock of these companies, the shareholders’ agreements provide for the power of veto and casting vote in certain issues jointly with associates, indicating the shared control in the management of investees.

 

The financial statements were approved by the Management on April 25, 2014.

 

 

F-13

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

2             Basis of preparation and presentation of the financial statements

The financial statements of the Company have been prepared in accordance with the International Financial Reporting Standards ("IFRS"), issued by the International Accounting Standards Board (“IASB”). These policies have been consistently applied to all years presented

The financial statements have been prepared under the historical cost except for certain financial instruments which were measured at fair value according to IFRS

 

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgment in the process of applying the Company's accounting policies. The areas involving a higher degree to judgment or complexity, or areas where assumptions and estimates are significant to the financial statements are described in Note 5.

3             Summary of Significant Accounting Practices

Main accounting policies applied in the preparation of these financial statements are defined below. These policies have been applied consistently in all years presented

 

3.1  Cash and cash equivalents

 

Cash and cash equivalents include cash in hand, bank deposits, other short-term highly liquid investments with original maturities less than three months as of the investment date, with an insignificant risk of changing value, as well as current account overdrafts

 

3.2  Financial instruments

 

Classification

 

The Company classifies its financial assets according to the following categories: measured at fair value through profit or loss, loans and receivables, held-to-maturity and available for sale. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of the financial assets at inception. On December 31, 2013 and 2012, the Company did not have financial assets classified under the fair value through profit or loss, held-to-maturity and available-for-sale financial instruments category

 

Financial assets calculated at fair value through profit or loss

 

These are financial assets held for trading. A financial asset is classified into this category when mainly acquired for sale purposes in the short term. These assets are classified as current assets. Gains or losses arising from changes in the fair value of financial assets measured at fair value through profit or loss are presented in the statement of income in 'Financial income' or 'Financial expenses' in the period they occur, unless the instrument has been contracted in connection to another transaction. In this case, changes are recognized in the same line item of income affected by this transaction.  

 

F-14

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

Loans and receivables

 

These comprise receivables which are non-derivative financial assets with fixed or determinable payments, not quoted in an active market. Loans and receivables are presented in current assets or liabilities, except for those with maturity of more than 12 months after the statement of financial position date (these are classified as noncurrent assets or liabilities). The Company's loans and receivables include cash and cash equivalents, balances of trade accounts receivable, accounts receivable from related parties, other accounts receivables, receivables from the Water National Agency – ANA, contractors and suppliers, loans and financing, services payable, balances payable from public-private partnership (PPP), and program contract commitments. Loans and receivables are recorded at fair value and subsequently at amortized cost, under the effective interest rate method

 

3.3  Operating income

 

(a)              Revenue from water and sewage services

 

Revenue from water supply and sewage collection are recognized as the water is consumed and services are provided. Revenues, including the revenues unbilled, are recognized at the fair value of the consideration received or receivable for the sale of those services. Revenue is shown net of value-added tax, rebates and discounts. Revenues from unbilled represent incurred revenues in which the services were provided, but not yet billed until the end of the each period. Water supply and sewage services are recorded as trade accounts receivable based on monthly estimates of the completed services. Concerning revenues of wholesale municipal governments which do not pay the full invoice, the Company records an allowance for doubtful accounts upon invoicing in revenue reduction account.

 

The Company recognizes revenue when: i) products are delivered or services are rendered; ii) the amount of revenue can be reliably measured, iii) it is probable that future economic benefits will flow to the Company and iv) it is probable that the amounts will be collected. The amount of revenue is not considered to be reliably measurable until all conditions relating to the sale have been satisfied. Amounts in dispute are recognized as revenue when collected

 

F-15

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(b)              Construction revenue

 

Revenue from concession construction contracts is recognized in accordance with IAS 11 (Construction Contracts), using the percentage-of-completion method, provided that the applicable conditions for application are fulfilled. The percentage of completion is calculated from the ratio of the actual costs incurred on the balance sheet date to the planned total costs (cost-to-cost method). Revenue from cost plus contracts is recognized by reference to the construction costs incurred during the period plus a fee earned. The fee represents the additional margin related to the work performed by the Company in relation to such construction contracts and it is added to the construction costs incurred and the total is recognized as construction revenue.

 

3.4  Trade accounts receivable and allowance for doubtful accounts

 

Trade accounts receivable are amounts due from customers for services performed in the ordinary course of business. If collection is expected in one year or less, they are classified as current assets. If not, they are presented as noncurrent assets.  

 

The Company records an allowance for doubtful accounts for receivable balances in an amount that is deemed by management to be sufficient to cover probable losses in accounts receivable, based on the analysis of the history of receipts and current guarantees and it does not expect to incur in additional significant losses

 

3.5  Inventories 

 

Inventories of supplies for consumption and maintenance of the water and sewage systems are stated at the lower of average cost of acquisition or realizable value, and are classified in current assets.  

 

3.6 Investment Properties

 

The investment properties are recorded at the acquisition or construction cost, less accumulated depreciation, calculated by the straight-line method at rates that consider the estimated useful life of assets. Expenditures related to repairs and maintenance are recorded in the statement of income when incurred

                          

The Company also maintains few assets for indeterminate use in the future, i.e., it is not defined if the Company will use the property in the operation or sell the property in the short term during the ordinary course of business

 

3.7  Property, plant and equipment

 

Property, plant and equipment comprise mainly administrative facilities not composing the assets, subject-matter of the concession agreements. Those assets are stated at historical acquisition or construction cost less depreciation, net of impairment charge, when necessary. Interest, other financial charges and inflationary effects deriving from financing effectively applied to construction in progress are recorded as cost of respective property, plant and equipment

 

 

F-16

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

Subsequent costs included in the asset's carrying amount or recognized as a separate asset, as appropriate, only when it is probable that the future economic benefit associated with the item will flow to the Company and the cost of the item can be measured reliably. All other repairs and maintenance are charged to the statement of income during the financial period in which they were incurred

 

Depreciation is calculated using the straight-line method to allocate their cost and is described in Note 14(c). Lands are not depreciated.

 

Residual values and the useful life of assets are revised and adjusted, where applicable, at the end of each year

 

Gain and losses on disposals are determined by the difference between the proceeds with the carrying amount and are recognized within other operating income (expenses) in the statement of income

 

3.8  Intangible assets

 

Intangibles are stated at acquisition cost and/or construction of the underlying assets, including construction margin, interest and other financial charges capitalized during the construction period, in this case, for the qualifying assets. Qualifying assets are assets that, necessarily, take a substantial period to get ready for its intended use or sale. The Company considers that substantial period means a period greater than 12 months. This period was established by considering the completion period of the majority of its constructions which is greater than 12 months, which corresponds to one fiscal year of SABESP. 

 

The intangible has its amortization initiated when the intangible assets are available for use in location and the necessary condition established by the Company.  

 

The amortization of intangible assets reflects the period over the expected future economic benefits generated by the intangible asset are consumed by the Company and can be the period of the contract or the useful life of the asset

 

The amortization of the intangible assets is discontinued when the asset is totally consumed or it is disposed of, whatever occurs first.   

 

Donations in assets to the concession grantor received from third parties and governmental entities to allow the Company to render water and sewage supply services are not recorded in the Company’s financial statements, since these assets are controlled by the concession grantor

 

Financial resources received as donations for the construction of infrastructure are recorded under “Other operating income”

 

F-17

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

(a)              Concession arrangements/programs

 

The Company operates concession agreements including the rendering of basic sanitation, environmental, water supply and sewage collection services signed with the concession grantor. The infrastructure used by SABESP subject to service concession arrangements is considered to be controlled by the concession grantor when

 

(i)        The grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them, and at what price; and

 

(ii)       The grantor controls the infrastructure, i.e., retains the right to take back the infrastructure at the end of the concession

 

SABESP's rights over infrastructure operated under concession arrangements is accounted for as an intangible asset as SABESP has the right to charge for use of the infrastructure assets, and users (consumers) have the primary responsibility to pay SABESP for the services

 

The fair value of construction and other work on the infrastructure is recognized as revenue, as its fair value, when the infrastructure is built, provided that this work is expected to generate future economic benefits. The accounting policy to recognize construction revenue is described in Note 3.3 “Operating income”.

 

Intangible assets related to Concession agreements and Program contracts, when there is no right to receive the residual value of the assets at the end of the contract, are amortized on a straight-line basis over the period of the contract, or the useful life of the underlying asset, whichever occurs first

 

Investments made and not recovered through rendering of services, within the agreement term, must be indemnified by the concession grantor, (1) with cash or cash equivalents or also, in general (2) with the contract extension. These investments are amortized by the useful life of asset.

 

Law 11,445/07 indicates, whenever possible, that basic sanitation public utilities will have the economic and financial sustainability ensured through the remuneration due to service collection, preferably as tariffs and other public prices, which may be established for each service or both jointly. Therefore, investments made and not recovered through services rendered, within original term of the contract, are recorded as intangible assets and amortized by the useful life of the asset, taking into consideration a solid track record of concession renewal and, therefore, the continuity of services.

 

(b)                Software licenses

 

Software licensing is capitalized based on the acquisition costs and other implementation costs. Amortizations are recorded according to the useful lives and the expenses associated with maintaining these are recognized as expenses when incurred.

 

 

F-18

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

3.9  Impairment of non-financial assets

 

Property, plant and equipment, intangibles and other noncurrent assets with definite useful lives, are yearly reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  

 

The Company does not record assets with indefinite useful life and assessed that there are no indications of impairment losses.

 

3.10  Trade accounts payable and contractors

 

Accounts payable to contractors and suppliers are obligations to pay for goods or services purchased from suppliers in the ordinary course of business and are classified as current liabilities if the payment is due in the period up to one year. Otherwise, the accounts payable are presented as noncurrent liabilities and are initially measured at fair value, which generally correspond to the bill and subsequently at amortized cost.

 

3.11  Loans and financing

 

Borrowings are initially recognized at fair value, upon receipt of funds, net of transaction costs. Subsequently, borrowings are stated at amortized cost, as presented in Note 15. Loans and financing are classified as current liabilities unless the Company has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date.  

 

Nonconvertible debentures issued by the Company are recognized in a similar manner to borrowings

 

3.12  Borrowing costs

 

Borrowing costs attributable to acquisition, construction or production of an asset, which, necessarily, requires a substantial time period to be ready for use or sale are capitalized as part of the cost of these assets. Other borrowing costs are recognized as expenses in the period they are incurred. Borrowing costs are interest rates and other charges incurred by the Company related to loans, including exchange variation, as described below

 

The capitalization occurs during the period in which the asset has been built, considering the weighted average rate of loans effective on the capitalization date

 

For foreign currency-denominated loans or financing, the Company analyzes them as if they were contracted in local currency, restricting the capitalization of interest and/or exchange variation by the amount that would be capitalized if these were contracted in the domestic market

 

 

 

F-19

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

3.13  Payroll and related charges

 

Salaries include an accrual for vacations and the 13th salary and additional payments negotiated in collective labor agreements plus related charges and are recorded on the accruals basis

 

3.14  Profit sharing

 

The Company's profit sharing plan for its employees is based on targets of the Company as a whole, and based on the performance of each business unit. The Company recognizes a provision when it is contractually required or when there is a practice in the past that created a constructive obligation. The accrual for profit sharing is recorded on the accrual basis period as operating expenses and operating cost.  

 

3.15  Provisions, legal liabilities, escrow deposits, securities deposits and contingent assets

 

Provisions related to claims are recognized when: i) the Company has a present legal or constructive obligation as a result of past events; ii) it is probable that an outflow of resources will be required to settle the obligation; and iii) the amount can be reliably estimated. Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole.  

 

Provisions are measured at the present value of the disbursements expected to be required to settle the obligation using a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. The increase in the provision due to passage of time is recognized as interest expense

 

For financial statement presentation purposes, the provision is stated net of the related escrow deposits based on the legal right to offset. The bases and the nature of the provisions for civil, tax, labor and environmental risks are described in Note 18.

 

Escrow deposits not linked to related liabilities are recorded in noncurrent assets. Escrow deposits are restated for inflation.

 

Contingent assets are not recognized in the books.

 

3.16  Environmental costs

 

Costs related to ongoing environmental programs are expensed in the income statement, when there is any indication of an event. Ongoing programs are designed to minimize the environmental impact of the operations and to manage the environmental risks inherent to the Company's activities.  

 

3.17  Income taxes – current and deferred

 

Income taxes expenses comprise current and deferred income tax and social contribution

 

 

F-20

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

For information about the Transition Tax Regime (RTT) and Provisional Measure 627/2013, see Note 17 (e) and (f), respectively.

 

Current tax

 

The provision for income tax and social contribution is based on the taxable income for the year. The income tax was accrued at rate 15%, plus 10% surtax on taxable income exceeding R$ 240. The social contribution was accrued at rate 9% over adjusted net income. Taxable income differs from net income (profit presented in the statement of income), because it excludes income and expenses taxable or deductible in other years, and excludes items not permanently taxable or not deductible. Income tax and social contribution are accrued based on legislation in place in the end of the year. Management periodically evaluates and measures the positions taken in the income tax return with respect to situations in which applicable tax regulations are subject to interpretation. It establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities

 

Deferred tax

 

Deferred income tax is recognized, using the liability method, on temporary differences arising between the tax basis of assets and liabilities and their carrying amounts in the financial statements, according to IAS 12. However, the deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction that at the time of the transaction affects neither accounting nor taxable profit nor loss, except for business combinations. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantially enacted by the balance sheet date and are expected to apply when the related deferred income tax asset is realized or the deferred income tax liability is settled

 

Deferred income tax and social contribution assets are recognized only to the extent that it is probable that future taxable profit will be available for which temporary differences can be utilized and tax losses can be carryforward

 

Deferred taxes assets and liabilities are offset when there is a legally enforceable right of offsetting current tax assets against current tax liabilities and when deferred income tax assets and liabilities are related to income taxes levied by same tax authority over the tax entity.  

 

3.18              Taxes on revenues

 

Revenues from water and sewage services are recognized on accrual basis for PASEP and Cofins, calculated at the rates of 1.65% and 7.60%, respectively. Taxes levied on billed amounts to public entities are due when bills are received.

 

As these taxes are calculated by the non-cumulativeness regime and presented net of tax credits, as deductions from gross revenues. Debts measured on “other operating incomeare presented as deductions from the respective operating income or expense

 

F-21

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

3.19  Pension obligations

 

(a)         Defined benefit

 

The Company makes contributions to defined benefit plans on a contractual basis and sponsored thereby, managed by Fundação Sabesp de Seguridade Social – SABESPREV, a supplementary private pension closely-held entity. The regular contributions are recognized in the statement of income for the period

 

Liabilities from defined benefit pension plan obligations correspond to the present value of the defined benefit obligation at balance sheet date, less the fair value of the plan assets. The defined benefit obligation (G1) and (G0) are calculated on an annual basis by independent actuaries, using the projected unit credit method. The estimated future cash outflows is discounted to its present value, using the interest rates of Government bonds with maturities that approximate the maturity of the related liability

 

Referring to actuarial gains and losses deriving from adjustments based on the experience and changes in actuarial assumptions are directly recorded under equity, as other comprehensive income (OCI), so that the plan's net assets or liabilities are recognized in the statement of financial position in order to reflect the full amount of plan’s deficit or surplus.

 

The expenses related to pension plan are recognized in profit and loss of the year as operating cost, selling expenses or administrative expenses, according to employee’s allocation.  

 

In an event where a curtailment relates to only some of the employees covered by a plan, or where only part of an obligation is settled, the gain or loss includes a proportionate share of the past service cost and actuarial gains and losses The proportionate share is determined on the basis of the present value of the obligations before and after the curtailment or settlement

 

(b)         Defined contribution

 

The Company makes contributions to defined contribution plans (Sabesprev Mais) on a contractual basis and sponsored thereby, managed by Fundação Sabesp de Seguridade Social – SABESPREV, a supplementary private pension closely-held entity that provides post-employment benefits to its employees.

 

A defined contribution plan is a pension plan according to which the Company makes fixed contributions to a separate entity. The Company has no obligation of making contributions if the fund has no sufficient funds to pay to all employees the benefits related to employee’s services in current and previous period

 

 

F-22

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

3.20  Financial income and expenses

 

Financial income is primarily comprised of interest, inflation adjustments and exchange variations on escrow deposits and negotiations with customer to pay by installments, using the effective interest rate method.

 

Financial expenses are primarily comprised of interest, inflation adjustments and exchange variations on loans and financing, refinancing, provisions, public-private partnership, program contract commitments and provisions. These financial income and expenses are calculated using the effective interest rate method.  

 

Inflation adjustments and foreign exchange gains and losses derive from the collection or payment to third parties, as contractually required by law or court decision, and recognized on an accrual basis pro rata temporis

 

Inflation adjustments included in the agreements are not considered embedded derivatives, since they are deemed as inflation adjustment rates for the Company’s economic scenario.

 

3.21  Leases 

 

Lease agreements are classified as financial lease when property, risks and rewards inherent to the ownership of asset to the lessee are transferred. Other leases are classified as operational lease, recognized as expenses in the statement of income on a straight-line basis during the lease term

 

Financial lease agreements are measured based on the lower amount between the present value of minimum mandatory payments of the agreement or fair value of asset on the start date the lease agreement. The amounts payable deriving from considerations of financial lease agreements are recognized and allocated between financial expenses and amortization of financial lease payables so that to obtain a constant interest rate. The corresponding lessor’s liability is recorded as current and noncurrent debt

 

 

3.22  Other current and noncurrent assets and liabilities

 

Other assets are stated at cost of acquisition, net of any impairment loss, where applicable. The amounts recognized as other liabilities are stated at known or estimated amounts, including, where applicable, related charges and monetary variations

 

3.23  Dividends and Interest on Shareholders' Equity

 

The Company uses the tax benefits of distributing dividends as interest on shareholders' equity, as permitted by Brazilian Law. This distribution of dividend is accounted for in accordance with Brazilian Law 9249/95 for tax deductibility purposes, limited to the daily pro rata fluctuation of the Long-term Interest Rate (TJLP). The benefit attributed to the shareholders is recognized in the current liability against Equity, based on its by-laws. Dividends and interest on shareholders´ equity over the minimum established in the by-laws are recognized when approved by the shareholders in the general meeting. The tax effects of the interest on shareholders’ equity are recognized in the statement of income of the year, under the same recognition basis.

 

F-23

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

3.24  Present value adjustment

 

Current and noncurrent financial assets and liabilities are adjusted to present value based on discount rate at current market rate as of the transaction date, when the effects are relevant

 

3.25 Segment reporting

 

Operating segments are reported in a manner consistent with the Management internal reporting to make strategic decisions, allocate resources and evaluate the operating segment performance

 

Based on how the Company treats its business and how decision-making of resources allocation is made, two operating segments (water and sewage) were stated for financial reporting purposes. The segment reporting is detailed in Note 23.

 

3.26  Translation into foreign currency

 

(a)         Functional and reporting currency

 

Items included in the financial statements are measured using the currency of the primary economic environment in which the company operates ("the functional currency"). The financial statements are presented in Brazilian reais  (R$), which is also the Company's functional and presentation currency. All financial information presented has been presented in reais, except where indicated

 

 

 

F-24

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(b)      Foreign currency translation

 

Foreign currency-denominated transactions are translated into Brazilian reais  using the exchange rates prevailing at the transaction dates. Balance sheet accounts are translated at the exchange rateprevailing at balance sheet date.  

 

Foreign exchange gains and losses resulting from the settlement of these transactions and the translation of foreign currency-denominated cash assets and liabilities are recognized in foreign exchange result in the statement of income, except for loans and financing referring to property, plant and equipment or intangible assets in progress, where foreign exchange gains and losses are recognized as corresponding entry to the asset while construction is in progress.

 

 

4             Changes in accounting practices and disclosures

 

 

4.1  New standards, amendments and interpretations effective for periods beginning on or after January 1, 2013 

 

New standards and reviews

 

Standard

 

Key requirements

 

Effectiveness date

 

 

 

 

 

Amendments to IFRS 7 – Financial Instruments: Disclosures

 

 

The amendments to IFRS 7 increase the disclosure requirements of transactions involving the financial assets. These amendments aim at providing greater transparency to risk exposures when a financial asset is transferred, but the transferor still retains certain level of exposure on the asset. The amendments also require the disclosure of transfer of financial assets when not equally distributed in the year.

 

 

January 1, 2013

 

IFRS 10 –Consolidated Financial Statements (it replaces parts of IAS 27 and SIC 12)

 

 

Pursuant to IFRS 10, there is only one basis of consolidation for all entities, i.e., the control. This change removes the inconsistency between the previous version of IAS 27 and SIC 12; the former applied the concept of control, while the latter emphasized the concept of risks and benefits.

 

It includes a more detailed definition of control to solve the summarized definition of control from previous version of IAS 27. The definition of control under IFRS 10 includes the following three elements:

i)   power on investee;

ii) exposure, or rights, to variable returns of activities with investee; and

iii) capacity of using the power over investee to affect the value of return on investments.

 

 

January 1, 2013

 

 

 

F-25

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

IFRS 11 – Joint Arrangements (it replaces IAS 31 and SIC 13)

 

 

The definition of joint arrangement according to the new standard is the same of previous one, except for the fact that the new definition emphasizes the investee’s relevant activities instead of only the investee’s operating and financial activities. This new approach is in line with the definition of control under IFRS 10.

 

It discusses how a joint arrangement in which two or more parties own the joint control of an agreement should be classified. There are two types of joint arrangements under IFRS 11: joint arrangements and joint ventures. These two types of joint arrangements are differentiated by the parties’ rights and obligations.

 

 

January 1, 2013

 

IFRS 12 – Disclosure of Interests in Other Entities

 

 

This is a new standard which defines the disclosures to be included in the financial statements when the entities hold interest in subsidiaries, joint arrangements, associated companies or non-consolidated structured entities (similar to special purposes entities under SIC 12).

 

 

January 1, 2013

 

IFRS 13 – Fair Value Measurement

 

 

It presents a new definition of fair value. Pursuant to IFRS 13, the fair value is defined as the price that would be received upon sale of an asset or paid when transferring a liability in a transaction in the main market on the measurement date, according to current market conditions, regardless if this price is directly observable or estimated by means of another valuation technique.

 

 

January 1, 2013

 

 

 

F-26

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

IAS 19 – Employee benefits

 

 

The amendments to IAS 19 change the accounting for defined benefit plans and severance pay. The most relevant change refers to the accounting for changes in defined benefit liabilities and plan assets. The amendments require the recognition of changes in defined benefit liabilities and in the fair value of plan assets as they occur, and therefore, remove the “corridor approach” allowed in the previous version of IAS 19 and speed up the recognition of past cost of services. The amendments require that all actuarial gains and losses are immediately recognized in other comprehensive income, so that the pension plan’s net assets or liabilities are recognized in the statement of financial position in order to reflect the full amount of plan’s deficit or surplus.

 

 

January 1, 2013

 

IAS 27 – Separate Financial Statements

 

 

The reviewed standard only refers to separate financial statements. Most of requirements were maintained in relation to the previous standard.

 

 

January 1, 2013

 

IAS 28 –Investments in Associated Companies and Joint Ventures

 

 

Likewise the previous standard, the new standard gives instructions on how to apply the equity method. However, the scope of reviewed standard was amended in order to treat the investments in joint ventures and due to the fact that IFRS 11 requires that these investments are accounted for by the equity method.

 

 

January 1, 2013

 

 

 

The new rules, amendments or interpretations of the rules which resulted in effects to the Company are as follows:

 

IFRS 11 Joint Ventures andIAS 19Employee Benefits

 

The retrospective adoption of IFRS 11 and IAS 19 for the fiscal year ended December 31, 2012 had the following adjustments:

 

 

 

F-27

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

December 31, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Assets

 

 

 

 

 

 

 

 

Total current assets

 

3,336,865

 

(6,267)

 

-

 

3,330,598

 

 

 

 

 

 

 

 

 

Deferred income tax and social contribution

 

141,356

 

(5,459)

 

9,405

 

145,302

Investments

 

-

 

20,826

 

-

 

20,826

Intangible assets

 

21,991,922

 

(24,396)

 

-

 

21,967,526

Property, plant and equipment

 

383,383

 

(186,673)

 

-

 

196,710

 

 

 

 

 

 

 

 

 

Total noncurrent assets

 

23,338,928

 

(202,834)

 

9,405

 

23,145,499

Total assets

 

26,675,793

 

(209,101)

 

9,405

 

26,476,097

 

 

 

 

December 31, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Liabilities and equity

 

 

 

 

 

 

 

 

Total current liabilities

 

3,797,370

 

(39,181)

 

-

 

3,758,189

 

 

 

 

 

 

 

 

 

Loans and financing

 

7,701,929

 

(169,268)

 

-

 

7,532,661

Pension obligations

 

2,124,330

 

-

 

468,220

 

2,592,550

Total noncurrentliabilities

 

11,162,846

 

(169,920)

 

468,220

 

11,461,146

 

 

 

 

 

 

 

 

 

Total liabilities

 

14,960,216

 

(209,101)

 

468,220

 

15,219,335

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity

 

11,715,577

 

-

 

(458,815)

 

11,256,762

Total liabilities and equity

 

26,675,793

 

(209,101)

 

9,405

 

26,476,097

 

 

 

 

F-28

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

December 31, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Statement of income

 

 

 

 

 

 

 

 

Net operating income

 

10,754,435

 

(16,804)

 

-

 

10,737,631

Operating costs

 

(6,465,398)

 

15,447

 

-

 

(6,449,951)

Selling expenses

 

(697,874)

 

622

 

-

 

(697,252)

Administrative expenses

 

(726,128)

 

8,751

 

-

 

(717,377)

Other operating income (expenses), net

 

(19,775)

 

(3,400)

 

-

 

(23,175)

Equity accounting

 

-

 

(6,532)

 

-

 

(6,532)

 

 

 

 

 

 

 

 

 

Operating profit

 

2,845,260

 

(1,916)

 

-

 

2,843,344

 

 

 

 

 

 

 

 

 

Financial expenses, net

 

(301,356)

 

5,684

 

-

 

(295,672)

 

 

 

 

 

 

 

 

 

Income tax and social contribution

 

(632,004)

 

(3,768)

 

-

 

(635,772)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profit for the year

 

1,911,900

 

-

 

-

 

1,911,900

 

 

 

 

December 31, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Statement of comprehensive income

 

 

 

 

 

 

 

 

Profit for the year

 

1,911,900

 

-

 

-

 

1,911,900

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

-

 

-

 

(457,862)

 

(457,862)

. Items which will not be subsequently reclassified to the statement of income:

 

 

 

 

 

 

 

 

Actuarial gains (losses) on defined benefit plans

 

-

 

-

 

(457,862)

 

(457,862)

 

 

 

 

 

 

 

 

 

Total comprehensive income for the year

 

1,911,900

 

-

 

(457,862)

 

1,454,038

 

 

F-29

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

December 31, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Statement of cash flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash deriving from operating activities

 

2,336,220

 

7,021

 

 

 

2,343,241

Net cash from investing activities

 

(1,998,778)

 

2,082

 

 

 

(1,996,696)

Net cash from financing activities

 

(566,253)

 

(6,397)

 

 

 

(572,650)

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

(228,811)

 

2,706

 

 

 

(226,105)

 

 

 

 

January 1, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Assets

 

 

 

 

 

 

 

 

Total current assets

 

3,725,833

 

(21,139)

 

-

 

3,704,694

 

 

 

 

 

 

 

 

 

Deferred income tax and social contribution

 

179,463

 

(1,537)

 

(35,323)

 

142,603

Other accounts receivable

 

39,933

 

(4,899)

 

-

 

35,034

Investments

 

-

 

21,986

 

-

 

21,986

Intangible assets

 

20,141,677

 

(15,956)

 

-

 

20,125,721

Property, plant and equipment

 

356,468

 

(174,883)

 

-

 

181,585

 

 

 

 

 

 

 

 

 

Total noncurrent assets

 

21,489,151

 

(175,289)

 

(35,323)

 

21,278,539

Total assets

 

25,214,984

 

(196,428)

 

(35,323)

 

24,983,233

 

 

 

 

January 1, 2012

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Liabilities and equity

 

 

 

 

 

 

 

 

Total current liabilities

 

3,968,668

 

(12,522)

 

-

 

3,956,146

 

 

 

 

 

 

 

 

 

Loans and financing

 

6,966,285

 

(172,137)

 

-

 

6,794,148

Deferred Cofins andPasep

 

114,957

 

(851)

 

-

 

114,106

Pension obligations

 

2,050,697

 

-

 

(34,370)

 

2,016,327

Other liabilities

 

742,359

 

(10,918)

 

-

 

731,441

Total noncurrent liabilities

 

10,700,420

 

(183,906)

 

(34,370)

 

10,482,144

 

 

 

 

 

 

 

 

 

Total liabilities

 

14,669,088

 

(196,428)

 

(34,370)

 

14,438,290

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity

 

10,545,896

 

-

 

(953)

 

10,544,943

Total liabilities and equity

 

25,214,984

 

(196,428)

 

(35,323)

 

24,983,233

 

 

F-30

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

 

December 31, 2011

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Statement of income

 

 

 

 

 

 

 

 

Net operating income

 

9,941,637

 

(14,192)

 

-

 

9,927,445

Operating costs

 

(6,030,977)

 

12,245

 

-

 

(6,018,732)

Selling expenses

 

(619,542)

 

238

 

-

 

(619,304)

Administrative expenses

 

(846,593)

 

5,516

 

157,527

 

(683,550)

Other operating income (expenses), net

 

(90,138)

 

(115)

 

-

 

(90,253)

Equity accounting

 

-

 

(3,584)

 

-

 

(3,584)

 

 

 

 

 

 

 

 

 

Operating profit

 

2,354,387

 

(108)

 

157,527

 

2,512,022

 

 

 

 

 

 

 

 

 

Financial expenses, net

 

(633,641)

 

623

 

-

 

(633,018)

 

 

 

 

 

 

 

 

 

Income tax and social contribution

 

(497,327)

 

(731)

 

-

 

(498,058)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profit for the year

 

1,223,419

 

-

 

157,527

 

1,380,946

 

 

 

 

 

F-31

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

December 31, 2011

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Statement of comprehensive income

 

 

 

 

 

 

 

 

Profit for the year

 

1,223,419

 

-

 

157,527

 

1,380,946

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

-

 

-

 

-

 

144,642

. Items which will not be subsequently reclassified to the statement of income:

 

 

 

 

 

 

 

 

Actuarial gains (losses) on defined benefit plans

 

-

 

-

 

-

 

144,642

 

 

 

 

 

 

 

 

 

Total comprehensive income for the year

 

1,223,419

 

-

 

157,527

 

1,525,588

 

 

 

 

 

December 31, 2011

 

 

Original

 

Effects of

IFRS 11 (a)

 

Effects of

IAS 19 (b)

 

Restated

Statement of cash flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profit before income tax and social contribution

 

1,720,746

 

731

 

157,527

 

1,879,004

Pension obligations

 

257,927

 

-

 

(157,527)

 

100,400

Net cash deriving from operating activities

 

2,717,058

 

(18,486)

 

-

 

2,698,572

Net cash from investing activities

 

(2,008,278)

 

125,060

 

-

 

(1,883,218)

Net cash from financing activities

 

(547,970)

 

(113,309)

 

-

 

(661,279)

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

(160,810)

 

(6,735)

 

-

 

154,075

 

 

(a)          Adoption of IFRS 11

 

The joint investees (Note 11) started to be classified as joint venture and are subject to the accounting recognition by the equity method under IAS 28. This amendment implied to change the proportional consolidation to account for investment by the equity method.

 

The adoption of IFRS 11 resulted in changes in the consolidation for investments held by the Company in Sesamm – Serviços de Saneamento de Mogi Mirim S/A, Águas de Andradina S.A., Águas de Castilho, Saneaqua Mairinque S.A., Aquapolo Ambiental S.A. and Attend Ambiental S/A.

 

(b)          Adoption of IAS 19

 

 

F-32

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

The Company’s accounting practice until December 31, 2012 was to account for actuarial gains and losses by the “corridor” approach, where gains and losses deriving from changes in actuarial assumptions were only recognized in profit or loss to the extent they exceed the “corridor” value and amortized over the remaining estimated average life of population which holds the benefits; therefore, the actuarial gains and losses measured in a period were not recognized immediately. As a result of this method, the value recognized in liabilities differed from estimated present value of liabilities by the amount of actuarial gains and losses not yet recognized.

 

With the adoption of the new accounting standard, SABESP started to record in the statement of financial position the total effect of actuarial losses, net of income tax and social contribution, against other comprehensive income; i.e., without carrying through the statement of income. This accounting has been applied during 2013 interim accounting information, with retrospective effect on the Company’s financial statements for the fiscal year ended December 31, 2012 and the opening balance as at January 1, 2012.

 

Deferred income tax and social contribution were accounted for only for G1 plan, since the G0 plan’s expenses are not tax deductible.

 

Below, the reconciliation of new balance sheet balances of actuarial liabilities for the fiscal year ended December 31, 2012 and the opening balance, on January 1, 2012, affected by amendment to the standard:

 

 

 

 

December 31, 2012

 

January 1, 2012

 

 

 

 

 

Balance of actuarial liabilities as per previous accounting practice - G1

 

577,169

 

538,619

Effect of adopting IAS 19

 

27,663

 

(103,892)

Balance of actuarial liabilities after change in the accounting practice

 

604,832

 

434,727

 

 

 

 

 

Balance of actuarial liabilities as per previous accounting practice - G0

 

1,547,161

 

1,512,078

Effect of adopting IAS 19

 

440,557

 

69,522

Balance of actuarial liabilities after change in the accounting practice

 

1,987,718

 

1,581,600

 

 

 

 

 

Total balance of actuarial liabilities after change in the accounting practice

 

2,592,550

 

2,016,327

 

 

F-33

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

Due to the adjustment described above deriving from the adoption of IAS 19, the balances of items “Deferred Taxes” under noncurrent assets, “pension obligations” under noncurrent liabilities and “Other comprehensive income” under equity as of December 31, 2012 and January 1, 2012, related to the previous years compared to this financial statements, were adjusted as follows:

 

 

 

 

December 31, 2012

 

January 1, 2012

 

 

Original

 

 

 

Restated

 

Original

 

 

 

Restated

 

 

balance

 

Adjustment

 

balance

 

balance

 

Adjustment

 

balance

Noncurrent assets

 

 

 

 

 

 

 

 

 

 

 

 

Deferred taxes

 

135,897

 

9,405

 

145,302

 

177,926

 

(35,323)

 

142,603

 

 

 

 

 

 

 

 

 

 

 

 

 

Noncurrent liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Pension obligations

 

2,124,330

 

468,220

 

2,592,550

 

2,050,697

 

(34,370)

 

2,016,327

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

11,715,577

 

(458,815)

 

11,256,762

 

10,545,896

 

(953)

 

10,544,943

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The adoption of IAS 19 did not imply in adjustments to the statements of income and cash flows reported in these financial statements.

 

IFRS 12 Disclosure of interest in other entities

 

It refers to the disclosure of interest in other entities, the purpose of which is to enable that users know the risks, the nature and effects on the financial statements of these entities. The disclosures included in the financial statements for the fiscal year ended December 31, 2013 are in compliance with IFRS 12.

 

F-34

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

IFRS 13 Fair value measurement

 

Applicable when other IFRS pronouncements require or allow measurements or disclosures of fair value (and measurements, such as the fair value less cost of sales, based on fair value or disclosures about referred measurements). The disclosures included in the financial statements for the fiscal year ended December 31, 2013 are in compliance with IFRS 13.

 

4.2 New standards, amendments and interpretations to existing standards that are not yet effective   

 

The Company did not early adopt the new and revised IFRSs below:  

Amendments to IFRS 7

Financial Instruments: Disclosures2

IFRS 9

Financial Instruments2

Amendments to IFRS 10 and 12

Consolidated Financial Statements and Disclosure of Interests in Other Entities – Investment Entities 1

Amendments to IAS 27

Separate Financial Statements – Investment Entities1

Amendments to IAS 32

Offsetting Financial Assets and Financial Liabilities 1

 

1 Effective for annual periods beginning on or after January 1, 2014.  

2 Effective for annual periods beginning on or after January 1,  2015.  

 

4.3 Financial Risk Management

 

4.3.1             Financial risk factors

 

The Company's activities are exposed to Brazilian economic scenario, expositing to market risk, such as exchange rate, interest rate, credit risk and liquidity risk. The Company’s financial risk management is focused on the unpredictability of financial markets and seeks to minimize potential adverse effects on the Company’s financial performance

 

The Company has not utilized derivative instruments in any of the periods reported.

 

(a)        Market risk

 

Foreign currency risk

 

SABESP’s foreign exchange exposure implies market risks associated with Brazilian real  currency fluctuations against the US dollar and yen. SABESP’s foreign currency-denominated liabilities mainly include US dollar and yen-denominated loans.  

 

In case of Brazilian real  depreciation in relation to foreign currency in which the debt is denominated, SABESP will incur in monetary loss in relation to such debt.  

 

 

F-35

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

SABESP’s specific foreign currency risks are related to exposures caused by its current and noncurrent debts denominated in foreign currency.  

 

The management of SABESP’s foreign currency exposure considers several current and projected economic factors, besides market conditions

 

This risk arises from the possibility that the Company may incur losses due to exchange rate fluctuations that would impact liability balances of foreign currency-denominated loans and financing raised in the market and related financial expenses. The Company does not maintain hedge or swap contracts or any financial instrument to hedge against this risk, but conducts an active management of debt, taking advantage of opportunities to swap expensive debts with “cheaper” debts, reducing the cost through early maturity.

 

A significant amount of the Company’s financial debt is indexed to the U.S. dollar and Yen, in the total amount of R$3,715,645 on December 31, 2013 (R$3,231,183 in December 2012). Below, the Company’s exposure to foreign currency risk

 

 

December 31, 2013

 

December 31, 2012

Restated

 

Foreign
currency

 

R$

 

Foreign
currency

 

R$

 

 

 

 

 

 

 

 

Loans and financing– US$

1,181,256

 

2,767,210

 

1,136,274

 

2,321,976

Loans and financing – Yen

41,504,249

 

926,790

 

37,535,650

 

890,346

Interest and charges from loans and financing – US$

 

 

14,512

 

 

 

12,487

Interest and charges from loans and financing– Yen

 

 

7,133

 

 

 

6,374

Total exposure

 

 

3,715,645

 

 

 

3,231,183

Funding cost

 

 

(17,092)

 

 

 

(15,422)

Total foreign currency-denominated loans

 

 

3,698,553

 

 

 

3,215,761

 

 

 

As of December 31, 2013, if the Brazilian real had appreciated or depreciated by 10% against the US dollar and Yen with all other variables remaining constant, effects on results before taxes for the year would have been R$371,564 (R$323,118 in December 2012), lower or higher, mainly as a result of foreign exchange losses or gains on the translation of foreign currency-denominated loans.

 

Scenario I below presents the effect in net income for the next 12 months, considering the projected rates of the U.S. dollar and the Yen. Considering the other variables as remaining constant, the impacts for the next 12 months are shown in scenarios II and III with possible depreciations of 25% and 50%, respectively, in the Brazilian Real.

 

 

F-36

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

Scenario I (Probable)

 

Scenario II (+25%)

 

Scenario III (+50%)

 

 

(*)

 

 

 

 

Net currency exposure on December 31, 2013 (Liabilities) in US$

 

1,181,256

 

1,181,256

 

1,181,256

 

 

 

 

 

 

 

US$ rate on December 31, 2013

 

2.34260

 

2.34260

 

2.34260

Exchange rate estimated according to the scenario

 

2.45000

 

3.06250

 

3.67500

Difference between the rates

 

(0.10740)

 

(0.71990)

 

(1.33240)

 

 

 

 

 

 

 

Effect on net financial result R$ - (loss)  

 

(126,867)

 

(850,386)

 

(1,573,905)

 

 

 

 

 

 

 

Net currency exposure on December 31, 2013 (Liabilities) in Yen

 

41,504,249

 

41,504,249

 

41,504,249

 

 

 

 

 

 

 

Yen rate on December 31, 2013

 

0.02233

 

0.02233

 

0.02233

Exchange rate estimated according to the scenario

 

0.02322

 

0.02903

 

0.03484

Difference between the rates

 

(0.00089)

 

(0.00670)

 

(0.01251)

 

 

 

 

 

 

 

Effect on net financial result in R$ - (loss)  

 

(36,939)

 

(278,078)

 

(519,218)

 

 

 

 

 

 

 

Total effect on net financial result in R$ - (loss)  

 

(163,806)

 

(1,128,464)

 

(2,093,123)

 

 

 

 

 

 

 

(*)The probable scenario inforeign currency (US dollar and Yen) considered the average exchange rate for the 12-month period after December 31, 2013, according to BM&FBovespa.

 

 

 

 

F-37

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

Interest rate risk

 

This risk arises from the possibility that the Company could incur losses due to fluctuations in interest rates, increasing the financial expenses related to loans and financing.

 

The Company has not entered into any derivative contract to hedge against this risk; however continually monitors market interest rates, in order to evaluate the possible need to replace its debt.  

 

The table below provides the Company's loans and financing subject to variable interest rate

 

 

December 31, 2013

 

December 31, 2012

Restated

 

 

 

 

 

TR(i)

 

1,646,546

 

2,019,924

CDI(ii)

 

1,212,010

 

1,799,830

TJLP(iii)

 

990,273

 

845,913

IPCA(iv)

 

1,413,629

 

697,385

LIBOR(v)

 

1,599,815

 

1,243,058

Interest and charges

 

120,839

 

95,475

Total

 

6,983,112

 

6,701,585

 

 

(i) TR – Interest Benchmark Rate

(ii) CDI (Certificado de Depósito Interbancário), an interbank deposit certificate

(iii) TJLP (Taxa de Juros a Longo Prazo), a long-term interest rate index

(iv) IPCA (Índice Nacional de Preços ao Consumidor Amplo), a consumer price index

(v) LIBOR - London Interbank Offered Rate

 

Another risk to which the Company is exposed, is the mismatch between the inflation adjustment indices of its loans and financing with those of its service revenues. Water supply and sewage services tariffs do not necessarily follow the increases in the interest rates affecting the Company's indebtedness

 

As of December 31, 2013, if interest rates on loans and financing denominated in Brazilian reais  had been 1% higher or lower with all other variables held constant, the effects on profit for the year before taxes would have been R$69,831 (R$67,015 in December 2012) lower or higher, mainly as a result of a lower or higher interest expense on floating rate loans and financing.

 

F-38

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(b)      Credit risk

 

Credit risk arises from cash and cash equivalents, deposits in banks and financial institutions, as well as credit exposures to wholesale basis and retail customers, including outstanding accounts receivable, restricted cash, accounts receivable from related parties and indemnities. The Company is required by law to invest its funds with Banco do Brasil (rating AA+(bra)). Credit risk exposure is mitigated by sales to a dispersed customer base.

 

The maximum exposure to credit risk at the reporting date are the carrying amounts of  instruments classified as cash equivalents, deposits in banks and financial institutions, restricted cash, trade accounts receivable and accounts receivable from related parties in the balance sheet date. (See notes 6, 7, 8 and 9).

 

Regarding the financial assets held with financial institutions, the credit quality that is not past due or subject to provision for impairment can be assessed by reference to external credit ratings (if available) or to historical information about counterparty default rates. The credit quality of counterparties which are banks, such as deposits and financial investments, the Company considers the lower rating of the counterparty published by three main international rating agencies (Moody's, Fitch and S&P), according to internal policy of market risk management:

 

 

 

December 31, 2013

 

December 31, 2012

Restated

Cash at bank and short-term bank deposits

 

 

 

AAA(bra)

1,781,327

 

1,913,893

Other (*)

674

 

2,081

 

1,782,001

 

1,915,974

 

 

(*) This category includes current accounts and investment funds in banks which have no credit rating information available.

 

The available credit rating information of the banks in which the Company made transactions during 2013 is as follows:

 

 

 

F-39

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

Banks

Fitch

 

Moody's

 

Standard Poor's

 

 

 

 

 

 

Banco do Brasil S.A.

AAA (bra)

 

Aaa.br

 

-

Banco Santander Brasil S.A.

AAA (bra)

 

Aaa.br

 

brAAA

Brazilian Federal Savings Bank

AAA (bra)

 

Aaa.br

 

-

Banco Bradesco S.A.

AAA (bra)

 

Aaa.br

 

brAAA

Itaú Unibanco Holding S.A.

AAA (bra)

 

Aaa.br

 

brAAA

 

(c)      Liquidity risk

 

The Company's liquidity is primarily reliant upon cash provided by operating activities, loans from Brazilian Federal and State governmental financial institutions, and financing in the domestic and international capital markets. The liquidity risk management considers the assessment of its liquidity requirements to ensure it has sufficient cash to meet operational and capital expenditures needs, as well as the payment of debts.

 

The funds held by the Company are invested in interest-bearing current accounts, time deposits, short-term deposits and securities, selecting instruments with appropriate maturity or liquidity sufficient to provide margin as determined by projections mentioned above

 

The table below analyzes the financial assets and liabilities of the Company, by maturities periods, including the installment of principal and interest to be paid according to the agreement

 

 

 

 

2014

 

2015

 

2016

 

2017

 

2018

 

2019 onwards

 

Total

As of December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans and financing

 

1,186,907

 

1,545,451

 

1,458,618

 

1,125,401

 

1,186,483

 

6,860,587

 

13,363,447

Accounts payable to suppliers and contractors

 

275,051

 

-

 

-

 

-

 

-

 

-

 

275,051

Services payable

 

323,208

 

-

 

-

 

-

 

-

 

-

 

323,208

Public-private partnership (PPP)

 

43,607

 

43,607

 

43,607

 

43,607

 

282,673

 

4,930,579

 

5,387,680

Program contract commitments

 

85,277

 

77,772

 

3,452

 

1,110

 

1,010

 

22,251

 

190,872

 

 

 

 

       

 

 

F-40

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

 

2013

 

2014

 

2015

 

2016

 

2017

 

2018 onwards

 

Total

As of December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans and financing

 

1,743,344

 

1,221,613

 

1,660,890

 

1,100,013

 

779,905

 

5,678,481

 

12,184,246

Accounts payable to suppliers and contractors

 

295,392

 

-

 

-

 

-

 

-

 

-

 

295,392

Services payable

 

389,091

 

-

 

-

 

-

 

-

 

-

 

389,091

Public-private partnership (PPP)

 

41,925

 

41,925

 

41,925

 

41,925

 

41,925

 

305,193

 

514,818

Program contract commitments

 

160,784

 

11,227

 

66,052

 

4,222

 

1,911

 

37,204

 

281,400

 

 

Future interest

 

Future interest was calculated based on the contractual clauses for all agreements. For agreements with floating interest rate, the interest rates used correspond to the base dates above.

 

Cross default

 

The Company has loan agreements including cross default clauses, i.e., the early maturity of any Company’s debt will imply the early maturity of these agreements. The indicators are continuously monitored in order to avoid the execution of this clause.

 

 

4.4 Capital management

 

The Company's objectives when managing capital are ensure its ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders, and to maintain an optimal capital structure to reduce the cost of capital

 

The Company monitors capital based on the leverage ratio. This ratio corresponds to net debt divided by total capital. Net debt corresponds to total loans and financing less cash and cash equivalents. Total capital is calculated as total equity as shown in the statement of financial position plus net debt

 

 

 

 

December 31, 2013

 

December 31, 2012

Restated

 

 

 

 

 

Total loans and financing

 

9,450,074

 

8,875,255

Less: cash and cash equivalents

 

(1,782,001)

 

(1,915,974)

 

 

 

 

 

Net debt

 

7,668,073

 

6,959,281

Total equity

 

12,930,801

 

11,256,762

 

 

 

 

 

Total capital

 

20,598,874

 

18,216,043

 

 

 

 

 

Leverage ratio

 

37%

 

38%

 

 

F-41

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

On December 31, 2013 the leverage ratio fell to 37% versus the 38% recorded on December 31, 2012, due to an increase in equity deriving from profit for the year and other comprehensive income.

 

4.5 Fair value estimates

 

It is assumed that balances from trade accounts receivable (current) and trade payables to suppliers by carrying amount, less impairment approximate fair values, considering their short maturity. Noncurrent trade accounts receivable also approximate their fair values, as they will be adjusted by inflation and/or will bear contractual interest rates over time.

 

 

 

 

F-42

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

4.6 Financial Instruments

 

On December 31, 2013 and December 31, 2012, the Company did not have financial assets classified into the fair value categories through profit or loss, held to maturity and available for sale. The Company’s financial instruments included in the loans and receivables category comprise cash and cash equivalents, restricted cash, trade accounts receivable, accounts receivable from related parties, other accounts receivable, balances receivable from the Water National Agency – ANA, contractors and suppliers, loans and financing, balances payable deriving from the Public Private Partnership-PPP and program contract commitments, which are non-derivative financial assets and liabilities with fixed or determinable payments, not quoted in an active market.

 

The estimated fair values of financial instruments are as follows

 

Financial assets

 

 

December 31, 2013

 

December 31, 2012

Restated

 

Carrying
amount

 

Fair

value

 

Carrying
amount

 

Fair

value

Cash and cash equivalents

1,782,001

 

1,782,001

 

1,915,974

 

1,915,974

Restricted cash

10,333

 

10,333

 

64,977

 

64,977

Trade accounts receivable

1,515,565

 

1,515,565

 

1,374,632

 

1,374,632

Accounts receivable from related parties

265,312

 

265,312

 

262,371

 

262,371

Water National Agency – ANA

107,003

 

107,003

 

108,099

 

108,099

Other accounts receivable

155,991

 

155,991

 

141,027

 

141,027

 

 

Financial liabilities

 

December 31, 2013

 

December 31, 2012

Restated

 

Carrying

amount

 

Fair

value

 

Carrying
amount

 

Fair

value

Loans and financing

9,450,074

 

9,439,094

 

8,875,255

 

9,201,317

Tradepayables and contractors

275,051

 

275,051

 

295,392

 

295,392

Services payable

323,208

 

323,208

 

389,091

 

389,091

Program contract commitments

166,038

 

166,038

 

235,627

 

235,627

Public-private partnership - PPP

342,508

 

342,508

 

356,317

 

356,317

 

 

 

F-43

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

To obtain fair value of loans and financing, the following criteria have been adopted:

 

(i)       Agreements with Banco do Brasil and CEF (Federal Savings Bank) were projected until final maturity, at contractual rates (projected TR + spread) and discounted at present value by TR x DI, both rates were obtained from BM&FBovespa.  

 

(ii)     Debentures were projected up to the final maturity date according to contractual rates (IPCA, DI, TJLP or TR), and discounted to present value considering the future interest rate published by ANBIMA in the secondary market, or by market equivalent rates, or the Company’s share traded in the Brazilian market.  

 

(iii)   BNDES loans are financial instruments valued at carrying amount plus contractual interest rate till mature date, and are indexed by long term interest rate – TJLP.  

 

These loans have specific characteristics and the terms and conditions defined in the loan agreements with BNDES between independent parties, and reflect the conditions for those types of loan. In Brazil, a consolidated market of long-term debts does not exist with the same characteristics of BNDES loans, the offering of credit to the entities in general, with this long-term characteristic, usually is restricted to BNDES.

 

(iv)   Other financing in local currency are valued at its nominal amount plus contractual interest incurred through maturity, discounted to present value considering a future interest rate published by BM&FBovespa.

 

(v)     Agreements with IDB, IBRD, were projected until final maturity in origin currency, applying interest rates contracted, discounted at present value at Libor futures rate, obtained from Bloomberg. Eurobonds were priced at market value through quotes published by Bloomberg. All the amounts obtained were translated into Brazilian reais  at the exchange rate as of December 31, 2013.

 

(vi)   Agreements with JICA, were projected until final maturity in origin currency, using interest rates contracted and discounted at present value, at Tibor futures rate obtained from Bloomberg. The amounts obtained were translated into Brazilian reais at the exchange rate as of December 31, 2013.

 

(vii)   Leases are financial instruments valued at their nominal amount plus contractual interests incurred through maturity date, and are indexed to fixed contractual interest rate, which is a specific rate and cannot be compared to any other rate available in the market. The Company considers the fair value the same amount recognized in the financial statements as of December 31, 2013.

 

Considering the nature of other financial instruments, assets and liabilities of the Company, the balances recognized in the statement of financial position approximate the fair values, taking into account the maturities close to the end of the reporting period, comparison of contractual interest rates with market rates in similar operations at the end of the reporting periods, their nature and maturity terms.

 

 

 

 

F-44

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

5    Main accounting estimates and judgments

 

Estimates and judgments are continually evaluated and are based on historical experience and on other factors, including expectations of future events that are believed to be reasonable under the circumstances

 

The Company makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing material adjustment to the carrying amounts of assets and liabilities within the next financial year are addressed below

 

(a)              Allowance for doubtful accounts

 

The Company records allowance for doubtful accounts in an amount that management considers sufficient to cover probable losses, based on an analysis of trade accounts receivable, in accordance with the accounting policy stated in Note 3.4.

 

The methodology for determining the allowance for doubtful accounts receivable requires significant estimates, considering a number of factors including historical receipt experience, current economic trends, estimates of forecast write-offs, the aging of the accounts receivable portfolio and other factors. While the Company believes that the estimates used are reasonable, actual results could differ from those estimates

 

(b)              Intangible assets arising from concession and program contracts

 

The Company recognizes as intangible assets arising from concession agreements. The Company estimates the fair value of construction and other work on the infrastructure to recognize the cost of the intangible asset, which is recognized when the infrastructure is built and provided that it will generate future economic benefits. The great majority of the Company's contracts for service concession arrangements entered with each grantor is under service concession agreements in which the Company has the right to receive, at the end of the contract, a payment equivalent to the unamortized asset balance of the concession intangible asset, which in this case, are amortized over the useful life of the underlying physical assets, thus at the end of the contract, the remaining value of the intangible would be equal to the residual value of the related fixed asset

 

Concession intangible assets under Concession agreements and Program contracts, in which, at the end of the contract, the Company has no right to receive a payment equivalent to the unamortized asset balance of the concession intangible, are amortized on a straight-line basis over the useful life of asset or contract period, which occurs first. Additional information on the accounting for intangible assets arising from concession agreements is described in Note 3.8.

 

The recognition of fair value for the intangible assets arising on concession agreements is subject to assumptions and estimates, and the use of different assumptions could affect the balances recorded. Different assumptions and estimates and changes in future circumstances, could affect the remaining useful lives of the intangible assets and have a significant impact on the results of operations.  

 

 

 

F-45

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(c)              Provisions 

 

The Company is party to a number of legal proceedings involving significant claims. These legal proceedings include, but are not limited to, tax, labor, civil, environmental, disputes with customers and suppliers and other proceedings. The Company accrues for lawsuits to which it is probable that an outflow will be necessary to settle the liability and the amount of such loss can be reasonably estimated.  Judgments regarding future events, the results of which may differ significantly from actual estimates and could exceed the amounts provisioned. Provisions are revised and adjusted to take into consideration changes in circumstances involved. Additional information of these legal proceedings is disclosed in Note 18.

 

(d)             Pension benefits

 

The Company sponsors the defined benefit plan and the defined contribution plan, as described in Note 19.

 

The liability recognized in the balance sheet in relation to defined benefit pension plans is the present value of defined benefit obligation on the balance sheet date, less the fair value of plan assets. The defined benefit obligation is calculated yearly by independent actuaries, applying the projected credit unit method. The present value of defined benefit obligation is determined by discounting the estimated future cash outflows, using interest rates compatible with the market, which are denominated in currency in which benefits will be paid and with maturity terms close to those of corresponding pension plan obligation

 

 

(e)              Deferred income tax and social contribution

 

The Company recognizes and settles taxes on income based on the results of operations verified according to the Brazilian Corporation Law, taking into consideration the provisions of the tax laws. Pursuant to IAS 12, the Company recognizes deferred tax assets and liabilities based on the differences between the accounting balances and the tax bases of assets and liabilities.

   

The Company regularly reviews the recoverability of deferred tax assets and recognizes a provision for impairment if  it is probable that  these assets will not be realized, based on the historic taxable income, in the projection of future taxable income and the estimated period of reversing temporary differences. These calculations require the use of estimates and assumptions. The use of different estimates and assumptions could result in provision for impairment of all or a significant amount of deferred tax assets.

 

 

 

 

F-46

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

6             Cash and Cash Equivalents

 

 

December 31,2013

 

December 31, 2012

Restated

 

 

 

 

Cash and banks

189,836

 

119,397

Cash equivalents

1,592,165

 

1,796,577

 

1,782,001

 

1,915,974

 

 

Cash and cash equivalents include cash, bank deposits and high-liquidity short-term financial investments, mainly represented by repurchase agreements (accruing CDI interest rates), deposited at Banco do Brasil, whose original maturities are lower than three months, which are convertible into a cash amount and subject to an insignificant risk of change in value

 

The average yield of financial investments corresponds to 100.00% of CDI in December 2013 (100.01% in December 2012). 

 

7             Restricted cash

 

 

On December 31, 2013, the Company’s restricted cash, under current assets, totaled R$10,333, mainly referring to the agreement in the municipality of São Paulo, where the Company transfers 7.5% of the municipality’s revenue to the Municipal Fund (December 2012 – R$64,977).

 

The variation occurred in the period between January and December 2013 when compared to the Financial Statements as at December 31, 2012, mainly refers to the release of restriction of use of funds by the Municipal Government of São Paulo.

 

 

 

F-47

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

8             Trade Accounts Receivable

 

(a)      Balance sheetbalances

 

 

 

December 31,2013

 

December 31, 2012

Restated

Private sector:

 

 

 

 

General and special customers (i) (ii)

 

1,008,335

 

949,800

Agreements (iii)

 

287,662

 

249,470

 

 

 

 

 

 

 

1,295,997

 

1,199,270

Government entities:

 

 

 

 

Municipal

 

511,967

 

610,779

Federal

 

4,292

 

3,150

Agreements (iii)

 

167,642

 

181,271

 

 

 

 

 

 

 

683,901

 

795,200

Wholesale customers – Municipal governments: (iv)

 

 

 

 

Guarulhos

 

661,908

 

578,314

Mauá

 

327,451

 

281,398

Mogi das Cruzes

 

15,430

 

15,202

Santo André

 

700,550

 

620,276

São Caetano do Sul

 

2,114

 

2,072

Diadema

 

210,406

 

180,465

 

 

 

 

 

Total wholesale customers – Municipal governments

 

1,917,859

 

1,677,727

 

 

 

 

 

Unbilled supply

 

474,492

 

425,843

 

 

 

 

 

Subtotal

 

4,372,249

 

4,098,040

Allowance for doubtful accounts

 

(2,856,684)

 

(2,723,408)

 

 

 

 

 

Total

 

1,515,565

 

1,374,632

 

 

 

 

 

Current

 

1,120,053

 

1,038,945

Noncurrent (v)

 

395,512

 

335,687

 

 

 

 

 

 

 

1,515,565

 

1,374,632

 

 

F-48

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

(i)   General customers - residential and small and mid-sized companies

 

(ii)  Special customers - large consumers, commercial, industries, condominiums and special billing consumers (industrial waste, wells, etc.).

 

(iii) Agreements - installment payments of past-due receivables, plus monetary restatement and interest

 

(iv) Wholesale basis customers - municipal governments - This balance refers to the sale of treated water to municipalities, which are responsible for distributing to, billing and charging final customers. Some of these municipalities are questioning in court the tariffs charged by SABESP, which have full allowance for doubtful accounts. Additionally, the overdue amounts are substantially included in the allowance for doubtful account and are classified in noncurrent assets

 

 

December 31, 2013

 

December 31, 2012

Restated

 

 

 

 

Balance at beginning of year

1,677,727

 

1,486,342

Services provided

424,018

 

394,922

Receipts – services in the current year

(160,944)

 

(165,967)

Receipts – services in previous years

(22,942)

 

(37,570)

 

 

 

 

Balance at the end of the year

1,917,859

 

1,677,727

 

 

 

 

Current

35,662

 

33,924

Noncurrent

1,882,197

 

1,643,803

 

 

(v)  The noncurrent portion consists of trade accounts receivable that are past due and renegotiated with customers and amounts past due related to wholesale basis to municipal governments, and the amounts are net of allowance for doubtful account

 

 

 

F-49

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(b)      Aging of trade accounts receivable is as follows:

 

 

 

December 31, 2013

 

December 31, 2012

Restated

 

 

 

 

Current

1,243,156

 

1,091,834

Past-due:

 

 

 

Up to 30 days

191,668

 

197,936

From 31 to 60 days

105,542

 

97,426

From61 to 90 days

60,868

 

61,527

From91 to 120 days

51,932

 

50,729

From121 to 180 days

90,498

 

89,297

From181 to 360 days

149,242

 

139,788

Over 360 days

2,479,343

 

2,369,503

 

 

 

 

Total past-due

3,129,093

 

3,006,206

 

 

 

 

Total

4,372,249

 

4,098,040

 

 

The increase in the balance overdue is mainly due to accounts receivable at wholesale, where the municipalities are challenging in court the tariffs charged by SABESP. These amounts are fully covered by the allowance for doubtful accounts.

 

 

F-50

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(c)      Allowance for doubtful accounts

 

 

December 31, 2013

 

December 31, 2012

Restated

 

December 31, 2011

Restated

 

 

 

 

 

 

Balance at beginning of year

2,723,408

 

2,436,428

 

2,219,420

Private sector/government entities

93,272

 

126,823

 

83,094

Recoveries

(51,654)

 

(49,183)

 

(35,415)

Wholesale customers

218,687

 

209,340

 

169,329

 

 

 

 

 

 

Additions for the year

260,305

 

286,980

 

217,008

 

 

 

 

 

 

Write-offs in the year referring to the bad debt

(127,029)

 

-

 

-

 

 

 

 

 

 

Balance at end of year

2,856,684

 

2,723,408

 

2,436,428

 

 

 

 

 

 

Current

1,182,484

 

1,242,967

 

1,132,638

Noncurrent

1,674,200

 

1,480,441

 

1,303,790

 

 

Reconciliation of provision for losses of income

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

Losses (write-off)

63,102

 

79,454

 

77,905

Provision for state entities (related parties)

(856)

 

35,142

 

-

Provision for private sector/government entities

93,272

 

126,823

 

83,094

Reversal for wholesale customers

-

 

-

 

(5,324)

Recoveries

(51,654)

 

(49,183)

 

(35,415)

 

 

 

 

 

 

Balance

103,864

 

192,236

 

120,260

 

 

The Company does not have customers representing 10% or more of its revenues

 

 

 

F-51

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

9             Related Parties Balances and Transactions

 

The Company is a party to transactions with its controlling shareholder, the State Government, and companies related to it

 

(a) Accounts receivable, interest on shareholders' equity payable, revenue and expenses with the São Paulo State Government

 

December 31, 2013

 

December 31, 2012
Restated

Accounts receivable

 

 

 

Current:

 

 

 

Water and sewage services (i)

110,615

 

113,027

Allowance for losses (i)

(46,674)

 

(47,531)

Reimbursement for pension benefits paid -

 

 

 

Gesp Agreement (ii) and (vi)

39,201

 

35,278

Reimbursement for pension benefits paid -

 

 

 

Monthly flow (ii) and (vi)

9,399

 

8,499

Se Liga na Rede”program (l)

22,314

 

-

 

 

 

 

Total current

134,855

 

109,273

 

 

 

 

Noncurrent:

 

 

 

Reimbursement for pension benefits paid -

 

 

 

GESP Agreement (ii) and (vi)

130,457

 

153,098

 

 

 

 

Total noncurrent

130,457

 

153,098

 

 

 

 

Total receivables from shareholder

265,312

 

262,371

 

 

 

 

Assets:

 

 

 

Water and sewage services

63,941

 

65,496

Reimbursement of additional retirement andpension benefits

179,057

 

196,875

“Se Liga na Rede”program (l)

22,314

 

-

 

 

 

 

Total

265,312

 

262,371

 

 

 

 

Liabilities

 

 

 

Interest on shareholders’ equity payable to related parties

229,605

 

228,214

 

 

F-52

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

2013

 

2012

Restated

 

2011

Restated

Revenue from water and sewage services

 

 

 

 

 

Water supply

239,513

 

228,890

 

216,933

Sewage services

209,585

 

202,094

 

188,059

Payments received from related parties

(453,612)

 

(481,204)

 

(425,129)

 

 

 

 

 

 

Receipt of GESP reimbursement referring to Law 4819/58

110,912

 

104,426

 

89,505

 

 

 

(i)           Water and sewage services

 

The Company provides water supply and sewage collection services to the São Paulo State Government and other companies related to it in accordance with usual market terms and conditions, as considered by management, except for the settlement of credits which can be made according to items (iii), (iv) and (v).  

 

An allowance for losses of amounts past due for more than 360 days has been recorded due to the uncertainty involving these receipts (R$46,674 in 2013 and R$47,531 in 2012).

 

(ii) Reimbursement for pension benefits paid  

 

Refers to amounts of supplementary retirement and pension benefits provided for in State Law 4819/58 ("Benefits") paid by the Company to former employees and pensioners, referred to as Go

 

Under the Agreement referred on item (iii) with the São Paulo State Government ("GESP" or the "State"), GESP recognizes its liability from charges arising from the Benefits, provided that the payment criteria set forth by the State Department of Personnel (DDPE), based on legal guidance of the Legal Consultancy of the Department of Finance and of the State Attorney General's Office (PGE)

 

As discussed on item (vi), during the assessment of the debt due from GESP to the Company there were certain divergences in the calculation and eligibility criteria of the benefits paid by the Company on behalf of GESP

 

See additional information about the Go plan in Note 19 (b) (iii).

 

In January 2004, the payments of supplement retirement and pension benefits were transferred to the Department of Finance and would be made in accordance with the calculation criteria determined by the PGE. As a result of a court decision, the responsibility for making the payments returned to SABESP, as originally established

 

F-53

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(iii)        GESP Agreement

 

On December 11, 2001, the Company, the São Paulo State Government (through the State Department of Finance Affairs, currently Department of Finance) and the Water and Electricity Department (DAEE), with the intermediation of the State Department of Sanitation and Energy (former Department of Water Resources, Sanitation and Construction Works), entered into the Obligations, Payment Commitment and Other Covenants Acknowledgement and Consolidation Agreement ("GESP Agreement") for the settlement of outstanding debts between GESP and the Company related to the provision of water supply and sewage services and to the retirement benefits

 

In view of the strategic importance of the Taiaçupeba, Jundiaí, Biritiba, Paraitinga and Ponte Nova reservoirs for ensuring and maintaining the Alto Tietê water volume, the Company agreed to receive them as partial repayment of the reimbursement related to the Benefits. The DAEE would transfer the reservoirs to the Company, replacing the amount owed by GESP. However, the São Paulo State Public Prosecution Office challenges the legal validity of this agreement, and its main argument is the lack of bidding and the absence of a specific legislative authorization for disposal of DAEE's assets. There is an unfavorable decision to SABESP not yet unappealable. The Company's legal advisors assess the risk of loss in this lawsuit as probable. See additional information in item (vi) below. 

 

(iv)         First Amendment to the GESP Agreement

 

On March 22, 2004, the Company and the São Paulo State Government amended the terms of the original GESP Agreement, (1) consolidating and recognizing the amounts due by the São Paulo State Government for water supply and sewage collection services provided, monetarily adjusted through February 2004; (2) formally authorizing the offset of amounts due by the São Paulo State Government with interest on shareholders' equity declared by the Company and any other debt owed to the São Paulo State Government as of December 31, 2003, monetarily adjusted through February 2004; and (3) defining the payment conditions of the remaining liabilities of the São Paulo State Government for the receipt of the water supply and sewage services

  

(v)          Second Amendment to the GESP Agreement

 

On December 28, 2007, the Company and the São Paulo State Government, represented by the Department of Finance, signed the second amendment to the terms of the original GESP Agreement, agreeing upon the payment in installments of the remaining balance of the First Amendment, amounting to R$133,709 at November 30, 2007, to be paid in 60 monthly and consecutive installments of the same amount, beginning on January 2, 2008. In December 2012 the last installment was paid.

 

The State and SABESP agreed on immediately resuming their compliance with their mutual obligations under new assumptions: (a) implementation of an electronic bill management system to facilitate and speed up the monitoring of payment processes and budget management procedures; (b) structuring of the Rational Water Use Program (PURA) to rationalize the consumption of water and the amount of the water and sewage bills under the responsibility of the State; (c) establishment, by the State, of criteria for budgeting so as to avoid the reallocation of amounts to a specific water and sewage accounts as from 2008; (d) possibility of registering state bodies and entities in a delinquency system or reference file; (e) possibility of interrupting water supply to state bodies and entities in the case of nonpayment of water and sewage bills

 

F-54

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(vi)         Third Amendment to the GESP Agreement

 

On November 17, 2008, GESP, SABESP and DAEE signed the third amendment to the GESP Agreement, through which GESP recognized a debt balance payable to SABESP totaling R$915,251, monetarily adjusted up to September 2008 in accordance with the fluctuation of the IPCA-IBGE, corresponding to the Undisputed Reimbursement, determined by FIPECAFI. SABESP accepted on a provisional basis the reservoirs (see item (iii) above) as part of the payment of the Undisputed Reimbursement and offered to GESP a provisional settlement, recognizing a credit totaling R$ 696,283, corresponding to the value of the reservoirs in the Alto Tietê system. The Company did not recognize the reimbursement receivable of R$696,283 related to the reservoirs, as it is not virtually certain that will be transferred by the State. The final settlement will only be effected with the actual transfer of the property with the proper Registry of Deeds Office. The remaining balance totaling R$218,967 is being paid in 114 monthly, consecutive installments, totaling R$1,920 each, including the annual IPCA-IBGE fluctuation, plus interest of 0.5% p.m., the first of which fell due on November 25, 2008.

 

In addition, the third amendment provides for the regularization of the monthly flow of benefits. While SABESP is liable for the flow of monthly payment of benefits, the State shall reimburse SABESP based on the criteria identical to those applied when determining the Undisputed Reimbursement. Should there be no preventive court decision, the State will assume the flow of monthly payment of benefits portion deemed as undisputed.

 

(vii)       Controversial Amount of Benefits

 

As mentioned before, on November 17, 2008 the Company and the State signed the third amendment to the GESP Agreement, when the reimbursements called disputed and undisputed were quantified. The amendment established the efforts to calculate the so-called Disputed Reimbursement of the Benefits. Under the fourth clause of the amendment, the Disputed Reimbursement represents the difference between the Undisputable Reimbursement and the amount actually paid by the Company as pension benefits and pensioners set out in Law 4,819/58, for which, the Company understands, the State of São Paulo is originally liable, but paid by SABESP under a court order

 

By entering into the third amendment, the State's Legal Representative (PGE) agreed to reassess the differences that gave rise to the disposed reimbursement of benefits set out in Law 4,819/58. At the time, the expectation was based on the willingness of the PGE to reanalyze the issue and the implied right of the Company to the reimbursement, including based on opinions from outside legal advisors

 

However, new opinions issued by the PGE and received on September 4 and 22, 2009 and January 4, 2010, refute the reimbursement of previously defined as controversial amount.  

 

Even though the negotiations with the State are still in progress, it is not possible to assure that the Company will recover the controversial receivables without dispute

 

F-55

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

As part of the actions intended to recover the receivables that management considers due by the State, related to discrepancies in the reimbursement of the pension benefits paid by the Company, the Company: (i) on March 24, 2010, reported to the controlling shareholder the official letter approved by the executive committee, proposing that the matter be discussed at the São Paulo Stock Exchange (BM&FBovespa) Arbitration Chamber; (ii) in June 2010, presented to Department of Finance a proposal to solve the outstanding items, such proposal was not accepted; (iii) on November 9, 2010, filed a judicial action against the State of São Paulo pleading the entire reimbursement related to employee benefits set out in Law 4,819/58 to finalize the discussion between the Company and GESP. Despite the legal action the Company will persist to obtain an agreement with GESP since the management believes that it is the better to the Company and to its shareholders than wait until the end of the judicial action

 

The Company's management decided to not recognize the reimbursements which were not considered virtually certain that will be reimbursed by the State. As of December 31, 2013 and 2012, the amounts not recorded by the Company, related to the pension benefits paid on behalf of the State by the Company, totaled R$1,412,479 and R$1,351,210, respectively, including the amount of R$696,283 related to the transfer of the reservoirs in the Alto Tietê system. As a result, the Company also recognized the obligation related to the pension benefit obligations maintained with the beneficiaries and pensioners of Plan G0. As of December 31, 2013 and 2012, the pension benefit obligations of Plan G0 totaled R$1,780,268 and R$1,987,718, respectively. For detailed information on the pension benefit obligations refer to Note 19 (b) (iii).

 

(b)          Contingent assets - GESP (not recorded)

 

As mentioned above, on December 31, 2013 and December 31, 2012, SABESP had contingent assets with GESP, not recorded in assets referring to the additional retirement and pension paid (Law 4,819/58), as follows:

 

 

December 31, 2013

 

December 31, 2012

Restated

Controversial amounts receivable

716,196

 

654,927

Undisputed amount referring to the transfer to SABESP of reservoirs at Alto Tietê system (original value)

696,283

 

696,283

Total

1,412,479

 

1,351,210

 

 

 

 

F-56

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(c)          Use of reservoirs - EMAE

 

Empresa Metropolitana de Águas e Energia S.A. - EMAE plans to receive for the credit and to obtain financial compensation for the use of water from the Guarapiranga and Billings reservoirs, which SABESP uses in its operations, as well as the reimbursement of damages related to the failure to pay appropriately.

 

The Company understands that no amounts are due for the use of these reservoirs given the grants already made. Should these reservoirs not be available for use to the Company, there could be the need to collect water in more distant places. There is a risk of not properly rendering services in the region, besides increasing water supply cost.

 

Several lawsuits were filed by EMAE, among them a lawsuit to create an arbitration clause related to the Guarapiranga reservoir, a proceeding which had already started and another one, equally pleading for financial compensation due to SABESP’s water collect from Billings reservoir for public supply, these two lawsuits alleging that this conduct has been causing permanent and growing loss in the capacity of generating electricity of Henry Borden hydroelectric power plant with financial losses.

 

SABESP understands that the expectation for all cases is of possible losses, and for the time being, it is not feasible to estimate the amounts involved, since they were not determined.

(d)          Agreements with reduced tariffs with State and Municipal Government Entities that joined the Water Rational Use Program (PURA ).

 

The Company has signed agreements with government entities related to the State Government and municipalities where it operates that benefit from a reduction of 25% in the tariff of water supply and sewage services when they are not in default. These agreements provide for the implementation of the rational water use program, which takes into consideration the reduction in the consumption of water

 

(e)          Guarantees

 

The State Government provides guarantees for some loans and financing of the Company and does not charge any fee with respect to such guarantees

 

(f)           Personnel assignment agreement among entities related to the State Government

 

The Company has personnel assignment agreements with entities related to the State Government, under which the expenses are fully passed on and monetarily reimbursed. In 2013, the expenses related to personnel assigned by SABESP to other state government entities amounted to R$12,879 (R$12,298 in December 2012 and R$10,888 in December 2011). 

 

As of December 31, 2013, expenses related to personnel assigned by other entities to SABESP totaled R$695 (R$689 in December 2012 and no expenses were recorded at December 2011). 

 

(g)          Services obtained from state government entities

 

F-57

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

As of December 31, 2013 and 2012, SABESP had an outstanding amounts payable of R$1,791 and R$958, respectively, for services rendered by São Paulo State Government entities

 

(h)          Non-operating assets

 

As of December 31, 2013, the Company had an amount of R$969 related to free land lent to DAEE (Water and Electricity Department) (R$ 969 in December 2012 and R$2,289 in December 2011).

 

(i)           SABESPREV

 

The Company sponsors a private defined benefit pension plan, which is operated and administered by Fundação Sabesp de Seguridade Social - SABESPREV. The net actuarial liability recognized as of December 31, 2013 amounted to R$546,748 (R$604,832 in December 2012), according to Note 19 (b).

 

(j)           Compensation of Management Key Personnel

 

Compensation:

 

SABESP's compensation policy for the Management and officers is set out according to guidelines of the São Paulo State Government, the CODEC (State Capital protection Board), and are based on performance, market competitiveness, or other indicators related to the Company's business, and is subject to approval by shareholders at an Annual Shareholders' Meeting

 

Officers' compensation is limited to the compensation of the State Governor, and the Board of Directors' compensation is equivalent to 30 percent of the executive committee' overall compensation, contingent on attendance of at least one monthly meeting.

 

The objective of the compensation policy is to set a private sector management paradigm to retain its staff and recruit competent, experienced and motivated professionals, considering the level of management efficiency currently required by the Company

 

In addition to monthly fee, the members of the Board of Directors and the Executive Committee receive

 

Annual reward:  

 

Equivalent to a monthly fee, calculated on a prorated basis in December of each year

 

The purpose of this reward is to correspond to the thirteenth salary paid to Company employees, as officers and directors' relationship with the Company is governed by its bylaws and not the labor code

 

Benefits paid only to statutory officers - meal ticket, basket of food staples, medical care, weekly paid rest typified as a paid leave of 30 calendar days, and payment of a premium equivalent to one third of the monthly fee.  

 

 

F-58

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

Bonuses:

 

SABESP pays bonuses for the purposes of compensating directors and officers, as an incentive policy, providing the company records quarterly, semiannual, and yearly profits, and distributes mandatory dividends to shareholders, even if in the form of interest on shareholders' equity. Annual bonuses cannot exceed six times the monthly compensation of the officers/directors or 10 percent of the interest on shareholders' equity paid by the company.  

 

Expenses related to the compensation to the members of its board of directors and officers amounted to R$3,389, R$3,211 and R$2,614 for the years ended December 31, 2013, 2012 and 2011, respectively, and they refer to short-term benefits. An additional amount of R$566, related to the bonus program, was recorded in 2013 (R$1,074 in December 2012 and R$1,069 in December 2011).

 

(k)          Loan agreement through credit facility

 

The Company holds interest in certain Special Purpose Entities (SPE), not holding the majority interest but with power of veto in some issues. Therefore, these SPEs are considered for accounting purposes as jointly-owned subsidiaries.

 

The Company entered into a loan agreement through credit facility with the SPEs Águas de Andradina S.A., Águas de Castilho S.A. Aquapolo Ambiental S.A. to finance the operations of these companies, until the loans and financing requested with financial institutions is cleared.

 

The contracts signed on January 19, 2012 with Águas de Andradina and Águas de Castilho were settled in July 2012, according to the agreement’s provisions. On July 18, 2012, new agreements were signed with both companies, pursuant to the conditions in the table below. The agreement signed with Aquapolo Ambiental on March 30, 2012 remains with the same characteristics, according to the table below:

 

SPE

 

Credit limit

 

Principal disbursed amount

 

Interest balance

 

Total

 

Interest rate

 

Maturity

Águas de Andradina

 

3,467

 

1,427

 

297

 

1,724

 

SELIC + 3.5 % p.a.

 

(*)

Águas de Castilho

 

675

 

403

 

84

 

487

 

SELIC + 3.5 % p.a.

 

(*)

Aquapolo Ambiental

 

5,629

 

5,629

 

1,429

 

7,058

 

CDI + 1.2% p.a.

 

4/30/2016

Aquapolo Ambiental

 

19,000

 

19,000

 

3,789

 

22,789

 

CDI + 1.2% p.a.

 

4/30/2015

Total

 

28,771

 

26,459

 

5,599

 

32,058

 

 

 

 

 

 

 

F-59

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 (*) The loan agreements with SPEs Águas de Andradina and Águas de Castilho mature when funds deriving from long-term agreement with the Brazilian Development Bank – BNDES are released, when borrower will settle all and any debt deriving from current opening of loan facility.

 

The amount disbursed is recognized in Assets under “Other Receivables” and amounts to R$1,830 for principal and R$381 for interest recognized in Current Assets and R$24,629 for principal and R$5,218 for interest in Noncurrent Assets. As of December 31, 2013, the balance of principal and interest rates of these contracts is R$32,058 (R$28,081 as of December 31, 2012). In 2013, financial income recognized was R$3,977 (R$1,672 as of December 31, 2012).

 

(l)           “Se Liga na Rede” program

 

The State Government enacted the State Law nº 14,687/12, creating the pro-connection program, destined to financially subsidize the execution of household branches necessary to connect to the sewage collecting networks, in low income households which agreed to adhere to the program. The program expenditures, except for indirect costs, construction margin and borrowing costs are financed with 80% of funds deriving from the State Government and the remaining 20% invested by SABESP, which is also liable for the execution of works. On December 31, 2013, the program total amount was R$35,513, R$22,314 recorded in balances receivable from related parties, the amount of R$9,896 recorded in the group of intangible assets and R$3,303 reimbursed by GESP.

 

10           Water National Agency - ANA

 

 

Refers to agreements executed within the scope of the Hydrographic Basin Depollution Program (PRODES), also known as "Treated Sewage Purchase Program".

 

This program does not finance works or equipment, remunerates by results achieved, i.e., by effectively treated sewage. In this program, the Water National Agency (ANA) makes available funds, which are restricted to a specific current account and applied in investment funds at the Caixa Econômica Federal - Federal Savings Banks  (CEF), until the fulfillment of treated sewage volume is evidenced, as well as, the reduction of polluting cargoes of each contract.

 

When resources are made available, liabilities are recorded until funds are released by ANA. After the evidence of targets stipulated in each contract, the revenue deriving from these funds is recognized, but if these targets are not met, funds will return to the National Treasury with the appropriate funds y with duends will return to the National Treasury with dueny records a rearnings. On December 31, 2013, the balances of assets and liabilities were R$107,003 (December 31,2012 – R$108,099), and the liabilities are recorded under "Other liabilities" of noncurrent liabilities.

 

 

11            Investments

 

The Company holds interest in certain Special Purpose Entities (SPE). Although SABESP has no majority shares of its investees, the shareholders’ agreement provides for the power of veto in certain management issues, indicating participating shared control (joint venture – IFRS 11).

 

F-60

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

The Company holds interest valued by the equity accounting in the following investees:

 

Sesamm

 

On August 15, 2008, the Company, together with the companies OHL Médio Ambiente, Inima S.A.U. Unipersonal ("Inima"), Técnicas y Gestión Medioambiental S.A.U. ("TGM") and Estudos Técnicos e Projetos ETEP Ltda. ("ETEP") incorporated the company Serviços de Saneamento de Mogi Mirim S.A. - SESAMM ("SESAMM"), for a period of 30 years from the date the concession agreement with the municipality of Mogi Mirim for the purpose of providing complementary services to the sewage diversion system and implementing and operating sewage treatment system in the municipality of Mogi Mirim, including the disposal of solid waste

 

Sesamm's capital as of December 31, 2013, totaled R$19,532, and was represented by 19,532,409 registered shares without a par value. SABESP holds 36% of its equity interest and Inima holds another 46% of its equity interest.

 

The operations started in June 2012

 

Águas de Andradina

 

On September 15, 2010, the Company, together with the company Companhia de Águas do Brasil – Cab Ambiental incorporated the company Águas de Andradina S.A., with indefinite term, for the purpose of providing water supply and sewage services to the municipality of Andradina

 

On December 31, 2013, the capital of Águas de Andradina totaled R$3,097, divided into 3,096,866 registered shares without a par value. SABESP holds 30% of its equity interest. The amount of R$12 is recorded under investee’s equity, as advance for future capital increase.

 

The operations started in October 2010

 

Águas de Castilho

 

On October 29, 2010, the Company, together with the company Águas do Brasil – Cab Ambiental, incorporated the company Águas de Castilho, for the purpose of providing water supply and sewage services to the municipality of Castilho.  

 

On December 31, 2013, the company’s capital was R$622, and was represented by 622,160 registered share without par value. SABESP holds 30% equity interest.

 

The operations initiated in January 2011.

 

Saneaqua Mairinque

 

 

F-61

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

On June 14, 2010, the Company, together with the company Foz do Brasil S.A. incorporated the company Saneaqua Mairinque S.A., with indefinite term, for the purpose of exploring the public service of water supply and sewage services to the municipality of Mairinque

 

On December 31, 2013, the capital of Saneaqua Mairinque totaled R$2,000, and was represented by 2,000,000 registered shares without a par value. SABESP holds 30% equity interest

 

The operations initiated in October 2010

 

Attend Ambiental

 

On August 23, 2010 Companhia Estre Ambiental S.A, incorporated the company Attend Ambiental S.A, for constructing and operating a pretreatment of non-domestic effluent station, mud transportation and related services in the city of São Paulo as well as implement similar structures in other areas in Brazil and abroad.  

 

On December 31, 2013, the capital totaled R$2,000, and was represented by 2,000,000 registered shares without par value. SABESP holds 45% equity interest. A total of R$11,400 was recorded under the investee’s shareholders’ equity as advance for future capital increase.

 

Attend is at pre-operational phase and startup is scheduled for May 2014.

 

Aquapolo Ambiental S.A.

 

On October 8, 2009, the Company, together with the company Foz do Brasil S.A. incorporated the company Aquapolo Ambiental S.A., for the purpose of producing, providing and commercializing of reused water for Quattor Química S.A., Quattor Petroquímica S.A., Quattor Participações S.A. and other companies comprising the Petrochemical Complex

 

On December 31, 2013, the capital of Aquapolo totaled R$36,412, and was represented by 42,419,045 registered common shares without a par value. SABESP holds 49%of its equity interest

 

The operations initiated in October 2012. 

 

See below a summary of financial information of the joint-controlled entities

 

 

F-62

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

Company

Investments

 

Equity in the earnings of subsidiaries

 

Interest percentage

 

Equity

 

Profit or (loss) for the year

 

  2013

  2012

 

  2013

  2012

  2011

 

  2013

  2012

  2011

 

  2013

  2012

  2011

 

  2013

  2012

  2011

           

 

     

 

     

 

     

 

Sesamm

8,239

5,760

 

2,479

674

(1,176)

 

36%

36%

36%

 

22,884

15,999

14,314

 

6,885

1,871

(3,267)

Águas de Andradina

1,087

751

 

336

(32)

62

 

30%

30%

30%

 

3,622

2,503

2,537

 

1,119

(107)

207

Águas de Castilho

619

474

 

145

155

88

 

30%

30%

30%

 

2,064

1,580

843

 

484

517

293

Saneaqua Mairinque

931

722

 

209

235

(188)

 

30%

30%

30%

 

3,102

2,407

1,563

 

695

783

(627)

Attend Ambiental

2,707

4,379

 

(1,672)

(721)

(932)

 

45%

45%

45%

 

6,016

9,731

(68)

 

(3,715)

(1,602)

(2,071)

Aquapolo Ambiental

9,506

8,538

 

968

(6,843)

(1,438)

 

49%

49%

49%

 

19,400

17,424

31,389

 

1,976

(13,966)

(2,935)

Total

23,089

20,624

 

2,465

(6,532)

(3,584)

 

 

 

 

 

57,088

49,644

50,578

 

7,444

(12,504)

(8,400)

Other investments

571

202

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Overall total

23,660

20,826

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12           Investment properties

 

 

On December 31, 2013, the balances of “Investment properties” are R$54,039 (December/2012 – R$54,046). On December 31, 2013 and 2012, the market value of these properties is R$296,000, approximately.

 

 

 

 

F-63

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

13           Intangible Assets

 

(a)      Balance sheetbalances

 

 

December 31,2013

 

December 31, 2012

Restated

 

 

 

Accumulated

 

 

 

 

 

Accumulated

 

 

 

Cost

 

amortization

 

Net

 

Cost

 

amortization

 

Net

Intangible right arising from:

 

 

 

 

 

 

 

 

 

 

 

Agreements – equity value (i)

8,578,886

 

(1,499,096)

 

7,079,790

 

8,408,007

 

(1,511,813)

 

6,896,194

Concession agreements– economic value (ii)

1,529,096

 

(342,950)

 

1,186,146

 

1,402,854

 

(292,918)

 

1,109,936

Program contracts (iii)

6,473,507

 

(1,804,940)

 

4,668,567

 

5,288,541

 

(1,469,369)

 

3,819,172

Program contracts – commitments (iv)

693,029

 

(79,709)

 

613,320

 

627,989

 

(56,898)

 

571,091

Services contract – São Paulo (v)

11,555,381

 

(1,430,778)

 

10,124,603

 

10,604,942

 

(1,036,455)

 

9,568,487

Software licenses

209,156

 

(35,351)

 

173,805

 

55,615

 

(52,969)

 

2,646

Total

29,039,055

 

(5,192,824)

 

23,846,231

 

26,387,948

 

(4,420,422)

 

21,967,526

 

(b)      Changes

 

 

 

December 31, 2012

Restated

Additions

Contract renewal

Transfer

Write-offs and disposals

Amortization

December 31, 2013

Intangible assets arising from:

 

 

 

 

 

 

 

Agreements – equity value (i)

6,896,194

647,318

(310,844)

(6,690)

(3,458)

(142,730)

7,079,790

Concession agreements– economic value (ii)

1,109,936

126,853

-

82

(86)

(50,639)

1,186,146

Program contracts (iii)

3,819,172

733,796

310,844

4,789

(2,390)

(197,644)

4,668,567

Program contracts – commitments (iv)

571,091

65,040

-

-

-

(22,811)

613,320

Services contract – São Paulo (v)

9,568,487

975,913

-

177

(21,939)

(398,035)

10,124,603

Software licenses

2,646

201,399

-

5,155

-

(35,395)

173,805

Total

21,967,526

2,750,319

-

3,513

(27,873)

(847,254)

23,846,231

 

 

 

 

 

F-64

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

December 31, 2011

Restated

Additions

Contract renewal

Transfer

Write-offs and disposals

Amortization

December 31, 2012

Restated

Intangible assets arising from:

 

 

 

 

 

 

 

Agreements – equity value (i)

6,731,822

976,205

(652,973)

(21,602)

(916)

(136,342)

6,896,194

Concession – economic value (ii)

1,004,988

150,963

-

-

(14)

(46,001)

1,109,936

Program contracts (iii)

2,744,559

483,448

652,973

-

(3,095)

(58,713)

3,819,172

Program contracts – commitments (iv)

434,986

154,662

-

-

-

(18,557)

571,091

Services contract – São Paulo (v)

9,190,573

882,868

-

(49,486)

(5,977)

(449,491)

9,568,487

New businesses (vi)

16,477

-

-

(16,477)

-

-

-

Software licenses

2,316

2,872

-

-

-

(2,542)

2,646

Total

20,125,721

2,651,018

-

(87,565)

(10,002)

(711,646)

21,967,526

 

 

January 1,

 2011

Restated

Additions

Contract renewal

Transfer

Write-offs and disposals

Amortization

December 31, 2011

Restated

Intangible assets arising from:

 

 

 

 

 

 

 

Agreements – equity value (i)

6,328,773

1,114,665

(403,786)

(63,487)

(16,228)

(228,115)

6,731,822

Concession agreements – economic value (ii)

982,973

2,166

-

57,718

(2,780)

(35,089)

1,004,988

Program contracts (iii)

2,134,377

225,510

403,786

(31)

(3,810)

(15,273)

2,744,559

Program contracts – commitments (iv)

311,276

139,385

-

-

-

(15,675)

434,986

Services contract – São Paulo (v)

8,764,958

930,961

-

(36,234)

(32,383)

(436,729)

9,190,573

New businesses (vi)

11,228

9,271

-

-

-

(4,022)

16,477

Software licenses

7,937

3,285

-

-

-

(8,906)

2,316

Total

18,541,522

2,425,243

-

(42,034)

(55,201)

(743,809)

20,125,721

 

 

During 2013, the Company renewed the following program contracts:

 

Quarter

 

Municipalities

 

Term

1st/2013

 

Presidente Prudente e Embu-Guaçu

 

30 years

2nd/2013

 

Ibirá and Glicério

 

30 years

3rd/2013

 

Itatiba and Torrinha

 

30 years

3rd/2013

 

Mogi das Cruzes (*)

 

40 years

4th/2013

 

Ibiúna

 

30 years

 

 

F-65

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

(*) It includes the rendering of sewage collection and treatment services of districts in Mogi das Cruzes boundary to the service already rendered of treated water supply.

 

(c)      Construction services

 

 

 

2013

 

Water supply

 

Sewage services

 

Total

Construction revenue

1,011,412

 

1,433,323

 

2,444,735

Construction costs incurred

988,281

 

1,406,206

 

2,394,487

Margin

23,131

 

27,117

 

50,248

 

 

 

 

2012

Restated

 

Water supply

 

Sewage services

 

Total

Construction revenue

1,053,543

 

1,410,939

 

2,464,482

Construction costs incurred

1,035,171

 

1,379,239

 

2,414,410

Margin

18,372

 

31,700

 

50,072

 

 

 

2011

Restated

 

Water supply

 

Sewage services

 

Total

Construction revenue

1,066,053

 

1,158,580

 

2,224,633

Construction costs incurred

1,043,249

 

1,133,796

 

2,177,045

Margin

22,804

 

24,784

 

47,588

 

 

(d)      Intangible arising from concession agreements

 

The Company operates concession agreements covering the provision of basic and environmental sanitation services, water supply and sewage services. These concession arrangements set out rights and obligations relative to the exploration of assets related to the public service (See Note 3.8 (a)). A general obligation also exists to return the concession infrastructure to the concession grantor in good working condition at the end of the concession.

 

As of December 31, 2013 and 2012, the Company operates in 363 municipalities in the State of São Paulo. In most of these contracts operations are based on 30-year concession period.

 

F-66

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

The services provided by the Company are billed at a price regulated and controlled by the Sanitation and Energy Regulatory Agency of the State of São Paulo (ARSESP).

 

Intangible rights arising on concession agreements include

 

(i)     Service concession agreements – equity value

 

These refer to municipalities assumed until 2006, except for the municipalities assumed by economic value through assets valuation report prepared by independent experts. The amortization of assets is calculated according to the straight-line method, which considers the assets useful life.

 

(ii)                  Concession agreements – economic value

 

From 1999 through 2006, the negotiations for new concessions were conducted on the basis of the economic and financial result of the transaction, determined in a valuation report issued by independent appraisers

 

The amount determined in the related contract, after the transaction is closed with the municipal authorities, realized through the subscription of the Company's shares or in cash, is recorded as "concession agreements" and amortized over the period of the related concession (usually 30 years). As of December 31, 2013 and 2012 there were no amounts pending related to these payments to the municipalities

 

Intangible assets are amortized on a straight line basis over the period of the concession agreements or for the useful lives of the underlying assets, whichever is shorter.  

 

(iii)     Program contracts

 

These refer to the renewal of contracts previously referred to as concession agreements whose purpose is to provide sanitation services. The amortization of the assets acquired until the dates of signatures of the program contracts is calculated according to the straight-line method, which considers the assets’ useful lives. Assets acquired or built after the signature dates of program contracts are amortized during the contracted period (30 years) or during the useful lives of underlying assets, whichever is shorter

 

(iv)     Program contracts - Commitments

 

After the enactment of the regulatory framework in 2007, renewals of concessions started to be made through of program contracts. In some of these program contracts, the Company undertook the commitment to financially participate in social and environmental actions. The assets built and financial commitments assumed within the program contracts are recorded as intangible assets and are amortized by the straight-line method in accordance with the duration of the program contract (mostly, 30 years).

 

On December 31, 2013, amortization expenses related to the commitments of the program contract were R$22,811 (R$18,557 in December 2012 and R$15,675 in 2011).

 

 

F-67

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

The amounts not yet disbursed related to commitments under the program contracts are recorded in “Program Contracts – Commitments” in current liabilities (in the amount of R$77,360 and R$148,220 on December 31, 2013 and 2012, respectively) and noncurrent liabilities (in the amount of R$88,678 and R$87,407 on December 31, 2013 and 2012, respectively). In 2013, the annual rate of 8.06% was applied (WACC) to calculate the present value adjustment of these contracts.

  

(v)     Services agreement with the Municipality of São Paulo

 

On June 23, 2010, the Company entered into an agreement with the State of São Paulo and the Municipality of São Paulo to regulate the provision of water and sewage services in the city of São Paulo for a 30‑year period, which is extendable for an another 30‑year period.  

               

Also on June 23, 2010, an agreement was signed between the state and municipal government, and SABESP and the Sanitation and Energy Regulatory Agency of the State of São Paulo (“ARSESP”) are the consenting and intervening parties, whose main aspects are the following

 

1. The State and the Municipality of São Paulo grant to Sabesp the right to explore the sanitation service in the capital of the State of São Paulo, which consists of the obligation to such provide service and charge the respective tariff for this service

 

2. The State and the Municipality sets forth ARSESP as the agency responsible for regulating the tariff, controlling and monitoring the services

 

3. The evaluation model of the contract was the discounted cash flow which considered the financial and economic sustainability of SABESP’s operations in the metropolitan region of São Paulo

 

4. All operational costs, taxes, investments and the opportunity cost of the investees and the creditors of Sabesp’s were considered in the cash flow analysis

 

5. The agreement provides for investments established in the agreement comply with the minimum of 13% of the gross revenue from the municipality of São Paulo, net of the taxes on revenues. Investment plans referring to Sabesp’s execution shall be compatible with the activities and programs foreseen in the state, municipal sanitation plans, and where applicable, the metropolitan plan. The investment plan is not definite and will be revised by Managing Committee every four years, especially as to investments to be made in the following period

 

6. The payment related to the Municipal Fund of Environmental Sanitation and Infrastructure to be applied in the sanitation service within the municipality must be recovered through the tariffs charges. Such payment represents 7.5% of the total revenue from the municipality of São Paulo, net of the taxes on revenue and delinquency in the period

 

7. The opportunity cost of the investees and the creditors was established by the Weighted Average Cost of Capital (WACC) methodology. The WACC was the interest rate used to discount the cash flow of the operation; and

 

F-68

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

8. The agreement considers the recovery of net assets in operation, preferably evaluated through equity valuation or carrying amount monetarily restated, as defined by ARSESP. In addition, the agreement provides for the remuneration of investments to be made by SABESP, so that there is no residual value at the end of the agreement

 

Referring to the recovery through tariff, mentioned in item 6 above, of transfer to the Municipal Fund of Environmental Sanitation and Infrastructure, ARSESP issued in April 2013, the Resolution no. 413, postponing the application of Resolution no. 407 until the conclusion of the tariff revision process, the transfer to the bill of services of amounts referring to the municipal charges which were stipulated in Resolution no. 407. The postponement to apply Resolution no. 407 was due to a request by the São Paulo State Government to analyze, among other things, methods to reduce the impact on consumers.

 

The agreement represents 51.75% of the total revenue of the Company on December 31, 2013, and ensures the judicial and assets security, adequate return to shareholders and quality services to its customers

 

The municipality of São Paulo and the Company did not conclude an agreement to equalize financial pending issues existing until the signature date of the Agreement related to the rendering of water supply and sewage collection services to the real properties of the municipality, reason that, the Company filed a suit to collect these accounts, which are accrued for losses.

 

(e)         Disposals of concession intangible underlying assets

 

In 2013, the Company wrote-off intangible underlying  assets items totaling R$27,873 (R$10,002 in December 2012 and R$55,201 in December 2011) due to obsolescence, theft, disposals and discontinued works, unproductive wells and projects considered economically unfeasible.

 

(f)          Capitalization of interest and other financial charges

 

In 2013, the Company capitalized interest and inflation adjustment, including related foreign currency exchange effects, in concession intangible assets during the construction period for qualifying assets totaling R$205,012 with an average rate of 4.02% (R$283,016 in December 2012, with an average rate of 5.92% and R$261,886 in December 2011, with an average rate of 5.32%), during the period of the construction.

 

(g)         Construction margin

 

The Company acts as a primary responsible to construct and install the infrastructure related to the concession, using own efforts or hiring outsourcing services, receiving the risks and benefits.

 

Therefore, the Company recognizes revenue from construction service corresponding to the cost of construction increased by margin. Generally, the constructions related to the concessions are performed by third parties, in such case, the margin of the Company is lower, normally, to cover eventual administration costs, and the responsibility of the primary risk. In 2013 and 2012 the margin was 2.3%.

 

F-69

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

Construction margin for 2013 was R$50,248 (R$50,072 in December 2012 and R$47,588 in December 2011).

 

(h)         Expropriations 

 

As a result of the construction of priority projects related to water and sewage systems, the Company was required to expropriate or establish rights of way in third-parties' properties, and the owners of these properties will be compensated either amicably or through courts

 

The assets received as a result of expropriations are recorded as concession intangible assets after the transaction is completed. In 2013, the total amount related to expropriations was R$61,102 (R$34,731 in December 2012 and R$12,167 in December 2011).

 

(i)          Assets pledged as guarantee

 

On December 31, 2012, the Company had underlying physical assets totaling R$249,034 offered as guarantee to the request for the PAES (tax debt refinancing program) (Note 16). Paes-related debt was fully paid in 120 months and the last installment was paid on June 28, 2013.

 

(j)          Public-Private-Partnership (PPP)

 

Alto Tietê Production System

 

The Company and the special purpose entity CAB-Sistema Produtor Alto Tietê S/A, formed by Galvão Engenharia S.A. and Companhia Águas do Brasil – Cab Ambiental, signed in June 2008 the contract of public-private-partnership of Alto Tietê production system

 

The contract last 15 years which purpose is to expand the capacity of treated water of Taiaçupeba from 10 thousand to 15 thousand of liters per second, whose operation began in October 2011

 

As of December 31, 2013 and 2012, the amounts recognized as intangible asset related to PPP were R$415,619 and R$426,791, respectively

 

In relation to the obligations assumed by the Company on December 31, 2013 and 2012, the balances in current liabilities were R$20,241 and R$24,357 and under noncurrent liabilities were R$322,267 and R$331,960, respectively. The annual discount rate of 8.20% was applied in 2013 to calculate the present value adjustment of this contract.

 

São Lourenço Production System

 

SABESP and the special purpose entity CAB-Sistema Produtor São Lourenço S/A composed of Construções e Comércio Camargo Corrêa S/A and Construtora Andrade Gutierrez S/A, in August 2013 signed the Public-Private Partnership agreements of São Lourenço Production System.

 

F-70

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

The services agreement has 25-year term, aiming the rendering of dehydration, drying and sludge final disposal, maintenance services and works of São Lourenço Production System, and the estimated amount of R$6.0 billion, and works are estimated to start in April 2014.

 

(k)         Works in progress

 

The amount of R$6,498 million is recorded as intangible assets as works in progress on December 31, 2013 (R$5,067 million in December 2012), and the major projects are located in the following municipalities:

 

 

December 31, 2013

 

December 31, 2012

São Paulo

3,201

 

2,582

Praia Grande

294

 

279

Peruíbe

267

 

253

Itanhaém

215

 

203

Guarujá

196

 

173

Other

2,325

 

1,577

 

 

 

 

Total

6,498

 

5,067

 

 

(l)          Amortization of intangible assets

 

The amortization average rate totaled 3.9% in 2013, 4.0% in 2012 and 4.3% in 2011.

 

(m)     Software license

 

Software license is capitalized based on the costs incurred to acquire software and make them ready for use. In the first quarter of 2013, the Company started to implement an integrated business management solution (ERP system), where the implementation of administrative/financial module is estimated for July 1, 2014 and the commercial module for March 1, 2015.

 

14           Property, Plant and Equipment

 

(a)         Balance sheet balances

 

 

 

 

F-71

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

 

December 31, 2013

 

December 31, 2012

Restated

 

 

 

Accumulated

 

 

 

 

 

Accumulated

 

 

 

Cost

 

depreciation

 

Net

 

Cost

 

depreciation

 

Net

 

 

 

 

 

 

 

 

 

 

 

 

Land

88,332

 

-

 

88,332

 

88,328

 

-

 

88,328

Buildings

54,187

 

(30,233)

 

23,954

 

56,339

 

(30,778)

 

25,561

Equipment

202,498

 

(130,665)

 

71,833

 

191,202

 

(121,569)

 

69,633

Transportation equipment

13,856

 

(5,961)

 

7,895

 

13,882

 

(7,267)

 

6,615

Furniture and fixtures

17,060

 

(10,239)

 

6,821

 

16,203

 

(10,016)

 

6,187

Other

1,201

 

(540)

 

661

 

1,109

 

(723)

 

386

 

377,134

 

(177,638)

 

199,496

 

367,063

 

(170,353)

 

196,710

 

 

F-72

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

(b)      Changes

 

 

 

December 31, 2012

Restated

 

Additions

 

Transfer

 

Write-offs anddisposals

 

Depreciation

 

December 31, 2013

Land

88,328

 

-

 

4

 

-

 

-

 

88,332

Buildings

25,561

 

-

 

(133)

 

(216)

 

(1,258)

 

23,954

Equipment

69,633

 

24,678

 

(1,358)

 

(350)

 

(20,770)

 

71,833

Transportation equipment

6,615

 

4,096

 

(1,795)

 

-

 

(1,021)

 

7,895

Furniture and fixtures

6,187

 

1,458

 

(5)

 

(59)

 

(760)

 

6,821

Other

386

 

511

 

(226)

 

-

 

(10)

 

661

 

196,710

 

30,743

 

(3,513)

 

(625)

 

(23,819)

 

199,496

 

 

 

 

December 31, 2011

Restated

 

Additions

 

Transfer

 

Write-offs and disposals

 

Depreciation

 

December 31, 2012

Restated

Land

109,303

 

-

 

(20,349)

 

(626)

 

-

 

88,328

Buildings

9,432

 

-

 

18,768

 

(873)

 

(1,766)

 

25,561

Equipment

60,217

 

11,829

 

16,825

 

(510)

 

(18,728)

 

69,633

Transportation equipment

1,491

 

4,572

 

1,427

 

(7)

 

(868)

 

6,615

Furniture and fixtures

97

 

976

 

5,429

 

(41)

 

(274)

 

6,187

Other

1,045

 

-

 

(498)

 

-

 

(161)

 

386

 

181,585

 

17,377

 

21,602

 

(2,057)

 

(21,797)

 

196,710

 

 

 

January 1, 2011

Restated

 

Additions

 

Transfer

 

Write-offs and disposals

 

Depreciation

 

December 31, 2011

Restated

Land

119,567

 

-

 

(10,264)

 

-

 

-

 

109,303

Buildings

12,031

 

-

 

(287)

 

(3)

 

(2,309)

 

9,432

Equipment

71,466

 

9,858

 

-

 

(1,333)

 

(19,774)

 

60,217

Transportation equipment

1,661

 

1,002

 

-

 

(4)

 

(1,168)

 

1,491

Furniture and fixtures

453

 

961

 

-

 

(7)

 

(1,310)

 

97

Other

1,206

 

174

 

-

 

-

 

(335)

 

1,045

 

206,384

 

11,995

 

(10,551)

 

(1,347)

 

(24,896)

 

181,585

 

 

 

F-73

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(c)      Depreciation 

 

The Company reviews the depreciation rates annually, as follows: buildings - 2%; equipment- 10%; transportation equipment - 10% and furniture, fixture and equipment - 6.7%. Lands are not depreciated

 

The depreciation average rate was 11.4%, in 2013, 9.8% in 2012 and 9.9% in 2011.

 

 

 

F-74

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

15           Loans and Financing

 

Loans and financing outstanding balance

 

December 31, 2013

December 31, 2012

Restated

Financial institution

 

Current

 

Noncurrent

 

Total

 

Current

 

Noncurrent

 

Total

LOCALCURRENCY

 

 

 

 

 

 

Banco do Brasil

100,497

-

100,497

380,631

100,306

480,937

10th issue debentures

37,171

220,109

257,280

36,459

252,166

288,625

11th issue debentures

-

-

-

472,500

535,949

1,008,449

12th issue debentures

22,727

476,702

499,429

-

499,511

499,511

14th issue debentures

20,079

269,862

289,941

-

284,649

284,649

15th issue debentures

-

820,887

820,887

-

791,451

791,451

16th issue debentures

-

499,434

499,434

-

499,457

499,457

17 thissue debentures

-

1,027,925

1,027,925

-

-

-

18 th issue debentures

-

160,859

160,859

-

-

-

Brazilian Federal Savings Bank - CEF

83,267

959,853

1,043,120

116,867

918,756

1,035,623

Brazilian Development Bank - BNDES

-

-

-

4,154

-

4,154

Brazilian Development Bank - BNDES BAIXADA SANTISTA

16,309

81,546

97,855

16,309

97,855

114,164

Brazilian Development Bank - BNDES PAC

9,370

79,644

89,014

8,447

80,244

88,691

Brazilian Development Bank - BNDES PAC II 9751

2,308

29,192

31,500

-

6,500

6,500

Brazilian Development Bank - BNDES PAC II 9752

-

20,400

20,400

-

13,000

13,000

Brazilian Development Bank - BNDES ONDA LIMPA

19,230

196,821

216,051

19,230

216,026

235,256

Brazilian Development Bank - BNDES TIETE III

-

98,404

98,404

-

-

-

Leases

-

382,492

382,492

-

215,774

215,774

Others

498

2,431

2,929

763

2,923

3,686

Interest and charges

113,504

-

113,504

89,567

-

89,567

TOTAL IN LOCALCURRENCY

424,960

5,326,561

5,751,521

1,144,927

4,514,567

5,659,494

 

 

 

F-75

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 Loans and financing outstanding balance

 

December 31, 2013

December 31, 2012

Restated

Financial institution

 

Current

 

Noncurrent

 

Total

 

Current

 

Noncurrent

 

Total

FOREIGNCURRENCY

 

 

 

 

 

 

Inter-American Development Bank - IDB713 US$100,391 thousand (US$125,488thousand in December 2012)

58,794

176,382

235,176

51,287

205,149

256,436

Inter-American Development Bank -IDB 896 US$8,333 thousand (US$11,111thousand in December 2012)

6,507

13,014

19,521

5,677

17,029

22,706

Inter-American Development Bank - IDB 1212 US$123,337 thousand (US$133,615thousand in December 2012)

24,077

264,854

288,931

21,003

252,040

273,043

Inter-American Development Bank - IDB 2202 US$243,687 thousand (US$147,080 thousand in December 2012)

-

564,443

564,443

-

296,276

296,276

International Bank for Reconstruction and Development -IBRD –US$37,335 thousand (US$26,864 thousand in December 2012)

-

87,077

87,077

-

54,492

54,492

Eurobonds - US$140,000 thousand (US$140,000 thousand in December 2012)

-

327,640

327,640

-

285,655

285,655

Eurobonds - US$350,000 thousand (US$350,000 thousand in December 2012)

-

813,650

813,650

-

708,076

708,076

JICA 15–¥ 18,438,880 thousand (¥ 19,591,310 thousand in December 2012)

25,733

386,007

411,740

27,335

437,371

464,706

JICA 18 – ¥16,578,560 thousand (¥17,614,720 thousand in December 2012)

23,137

346,733

369,870

24,578

392,894

417,472

JICA 17-¥450,484 thousand (¥ 324,213 thousand in December 2012)

-

9,704

9,704

-

7,524

7,524

JICA 19-¥6,036,325 thousand(¥ 5,407 thousand in December 2012)

-

134,010

134,010

-

1

1

BID 1983AB - US$178,173 thousand (US$202,115 thousand in December 2012)

56,087

359,059

415,146

48,926

361,587

410,513

Interest and charges

21,645

-

21,645

18,861

-

18,861

TOTAL IN FOREIGN CURRENCY

215,980

3,482,573

3,698,553

197,667

3,018,094

3,215,761

TOTAL LOANS AND FINANCING

640,940

8,809,134

9,450,074

1,342,594

7,532,661

8,875,255

 

Exchange rateon December 31, 2013 US$2.34260; ¥0.022330 (US$2.0435; ¥0.023720 on December 31, 2012)

On December 31, 2013, the Company did not record balances of loans and financing raised in 2013 to mature within 12 months.

 

 

 

 

F-76

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

GUARANTEES

MATURITY

ANNUAL INTEREST RATES

FOREIGN EXCHANGE ADJUSTMENT

LOCALCURRENCY

 

 

 

 

Banco do Brasil

SÃO PAULO STATE GOVERNMENT AND OWN FUNDS

2014

8.50%

TR

10th issue debentures

OWN FUNDS

2020

TJLP +1.92% (series 1 and 3) and 9.53% (series 2)

IPCA (series 2)

12th issue debentures

OWN FUNDS

2025

TR + 9.5%

 

14th issue debentures

OWN FUNDS

2022

TJLP +1.92% (series 1 and 3) and 9.19% (series 2)

IPCA (series 2)

15th issue debentures

OWN FUNDS

2019

CDI + 0.99% (series 1) and 6.2% (series 2)

IPCA (series 2)

16th issue debentures

OWN FUNDS

2015

CDI + 0.30% to 0.70%

 

17 th issue debentures

OWN FUNDS

2023

CDI +0.75 (series 1) and 4.5% (series 2) and+4.75% (series 3) 

IPCA (series 2 and 3

18 th issue debentures

OWN FUNDS

2024

TJLP + 1.92 % (series 1 and 3)and 8;25% (series 2

IPCA (series 2)

Brazilian Federal Savings Bank

OWN FUNDS

2013/2032

6.8% (weighted)

TR

Brazilian Development Bank - BNDES BAIXADA SANTISTA

OWN FUNDS

2019

2.5% + TJLP

 

Brazilian Development Bank - BNDES PAC

OWN FUNDS

2023

2.15% + TJLP

 

Brazilian Development Bank - BNDES PAC II 9751

OWN FUNDS

2027

1.72%+TJLP

 

Brazilian Development Bank - BNDES PAC II 9752

OWN FUNDS

2027

1.72%+TJLP

 

Brazilian Development Bank - BNDES ONDA LIMPA

OWN FUNDS

2025

1.92% + TJLP

 

Brazilian Development Bank - BNDES TIETE III

OWN FUNDS

2025

1.66% + TJLP

 

Leases

 

2035

7.73% to 10.12%

IPC

Others

OWN FUNDS

2018/2025

12%

TR

 

 

F-77

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

 

 

 

GUARANTEES

MATURITY

ANNUAL INTEREST RATES

FOREIGN EXCHANGE ADJUSTMENT

FOREIGN CURRENCY

 

 

 

 

Inter-American Development Bank - IDB 713 - US$100,391 thousand

FEDERAL GOVERNMENT

2016

2.30%

US$

Inter-American Development Bank - IDB 896 - US$8,333 thousand

FEDERAL GOVERNMENT

2017

3.00%

US$

Inter-American Development Bank - IDB 1212 - US$123,337 thousand

FEDERAL GOVERNMENT

2025

2.58%

US$

Inter-American Development Bank - IDB 2202 - US$243,687 thousand

FEDERAL GOVERNMENT

2035

1.14%

US$

International Bank for Reconstruction and Development - IBRD US$37,335 thousand

FEDERAL GOVERNMENT

2034

0.45%

US$

Eurobonds – US$140,000 thousand

2016

7.50%

US$

Eurobonds – US$350,000 thousand

2020

6.25%

US$

JICA 15 – ¥18,438,880 thousand

FEDERAL GOVERNMENT

2029

1.8% and 2.5%

Yen

JICA 18– ¥16,578,560 thousand

FEDERAL GOVERNMENT

2029

1.8% and 2.5%

Yen

JICA 17– ¥450,484 thousand

FEDERAL GOVERNMENT

2035

1.2% and 0.01%

Yen

JICA 19– ¥6,036,325 thousand

FEDERAL GOVERNMENT

2037

1.7% and 0.01%

Yen

BID 1983AB – US$178,173 thousand

2023

2.49% to 2.99%

US$

 

 

F-78

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated 

 

 

(i)  Payment schedule – accounting balances

 

 

2014

2015

2016

2017

2018

2019

2020 to 2036

TOTAL

IN LOCALCURRENCY

 

 

 

 

 

 

 

 

Banco do Brasil

100,497

-

-

-

-

-

-

100,497

Debentures

79,977

713,121

355,437

376,069

550,360

613,341

867,450

3,555,755

Brazilian Federal Savings Bank

83,267

61,953

61,721

64,692

68,345

72,450

630,692

1,043,120

BNDES

47,217

49,386

56,018

58,073

58,073

58,074

226,383

553,224

Leasing

-

-

-

-

-

-

382,492

382,492

Other

498

561

632

713

525

-

-

2,929

Interest and other charges

113,504

-

-

-

-

-

-

113,504

TOTAL IN LOCALCURRENCY

424,960

825,021

473,808

499,547

677,303

743,865

2,107,017

5,751,521

IN FOREIGN CURRENCY

 

 

 

 

 

 

 

 

IDB

89,378

89,378

89,378

112,916

54,123

54,123

618,775

1,108,071

IBRD

-

-

-

-

-

2,915

84,162

87,077

Eurobonds

-

-

327,640

-

-

-

813,650

1,141,290

JICA

48,870

48,871

48,871

49,143

49,415

56,701

623,453

925,324

IDB 1983AB

56,087

56,087

56,087

56,087

55,727

41,446

93,625

415,146

Interests and other charges

21,645

-

-

-

-

-

-

21,645

TOTAL IN FOREIGN CURRENCY

215,980

194,336

521,976

218,146

159,265

155,185

2,233,665

3,698,553

TOTAL LOANS AND FINANCING

640,940

1,019,357

995,784

717,693

836,568

899,050

4,340,682

9,450,074

 

 

 

 

 

 

F-79

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

(a)         Debentures

 

Balance is stated net of funding costs in the amount of R$6,402 (2012 – R$8,586), which will be amortized during the same maturity period of each contract.

 

(i)                New loans and financing

 

Debentures (17th issue)

 

On January 15, 2013, the Company conducted the 17th issue of unsecured non-convertible debentures, in three series, for tender offer, pursuant to CVM Rule nº 400/2003, in the total amount of R$1,000,000, amount of 100,000 debentures, in three series, unit value of R$ 10, the characteristics of which are the following:

 

 

 

Number

 

Adjustment

 

Interest rates

 

Payment of interest

 

Amortization

 

Maturity

 

 

 

 

 

 

 

 

 

 

 

 

1st series

42,468

 

-

 

DI+ 0.75% p.a.

 

Semiannual (January and July)

 

Annual (as of January 2016)

 

January/2018

2nd series

39,523

 

IPCA

 

4.50%p.a.

 

Annual (January)

 

Annual (as of January 2019)

 

January/2020

3rd series

18,009

 

IPCA

 

4.75%p.a.

 

Annual (January)

 

Annual (as of January 2021)

 

January/2023

 

Funds deriving from funding by means of the 17th Issue of Debentures were exclusively allocated, as follows: R$500,000 for the settlement of financial commitments falling due in 2013 and R$500,000 for the early redemption of other Company’s debts.

 

Debentures (18th issue)

 

As of October 15, 2013,the Company issued 100 debentures, subscribed exclusively by the Brazilian Development Bank (BNDES). These debentures were distributed in three nonconvertible series, at the unit value of R$2,753.70, totaling R$275,370. BNDES subscribed and settled the 1st and 2nd series, totaling  58 debentures of 100 estimated, on December 16, 2013, in the amount of R$159,715. The 3rd series of 42 debentures shall be subscribed in 2015.

 

The 1st and 3rd series have a total term of 132 months with 36-month grace period and will accrue long-term interest rates (TJLP) + 1.92% p.a. The 2nd series has a total term of 133 months with 37-month grace period, as of October 15, 2014 and will accrue a rate of 8.25% p.a. + IPCA.

 

 

 

 

F-80

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

 

Amount

 

Adjustment

 

Interest

 

Interest payment

 

Amortization

 

Maturity

 

 

 

 

 

 

 

 

 

 

 

 

Series 1

28

 

-

 

TJLP + 1.92% p.a.

 

Quarterly to October 2016 and monthly from then on

 

Monthly (from November 2016)

 

October 2024

Series 2

30

 

IPCA

 

8.25% p.a.

 

Annual

 

Annual (from November 2017)

 

November 2024

Series 3

42

 

-

 

TJLP + 1.92% p.a.

 

Quarterly to October 2016 and monthly from then on

 

Monthly (from November 2016)

 

October 2024

 

 

The funds will reimburse expenditures in water supply and sewage systems, comprising the following projects: ETA Rio Grande, Litoral Norte, Vale do Paraíba and Mantiqueira and Bacia do Piracicaba - Capivari - Jundiaí (PCJ), in addition to supporting part of SABESP’s losses reduction program.  

 

The early amortization, fully or partially, of the subscribed debentures, when authorized by BNDES and/or BNDESPAR, shall always occur jointly, observing the proportionality between the outstanding balances of Series 1, 2 and 3 Debentures of all issues. The agreement does not include a premium due to early amortization.

 

(ii)             Payments 

 

Debentures (11th issue)

 

On March 1, 2013, the Company fully redeemed the 11th issue of debentures, in the amount of R$1,060,428, R$1,012,500 referring to the principal and R$47,928 referring to interest rates and premium.

 

(iii)           Covenants 

 

For the outstanding contracts, the Company has the following restrictive clauses “covenants”:

 

Applicable to the 10th issue, 14th issue and 18th issue:

 

Calculated every quarter, upon the disclosure of interim or annual financial statements:

 

- Adjusted Ebitda / Adjusted net operating income: equal or higher than 38%.

- Adjusted Ebitda / Adjusted financial expenses: equal to or higher than 2.35.

- Adjusted net debt / Adjusted Ebitda: equal to or lower than 3.65

 

For these issues, in the assumption of non-compliance with the levels established in the Financial Commitments, the Company shall within ninety (90) days, as of the debenture holders’ written notice, create additional guarantees, accepted by debenture holders, under the penalty of declaring the early maturity of the agreement.

 

The agreements also have a cross default clause, i.e., the early maturity of any of the Company’s debts, the amount of which may anyhow compromise the settlement of its obligations provided for in the indenture deed shall imply the early maturity of this agreement.

 

F-81

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

Applicable to the 12th issue:

 

Calculated every quarter upon the disclosure of interim or annual financial statements:

 

- Adjusted current ratio (current assets divided by current liabilities, excluding from current liabilities the current portion of noncurrent debts incurred by the Company that are recorded in current liabilities) higher than 1.0

- EBITDA to paid financial expenses ratio equal to or higher than 1.5

 

Noncompliance with these obligations only will be characterized when verified in its interim financial statements, during at least, two consecutive quarters, or also two nonconsecutive quarters within a twelve-month period

 

In case of noncompliance with the covenants, the trustee should call an extraordinary debenture holders' meeting within 48 hours from the acknowledgement of the noncompliance to resolve on the declaration of early maturity of the debentures.

 

The agreements have a cross default clause, i.e. the early maturity of any of the Company’s debts, equal to or exceeding R$50 million, adjusted by IPCA variation as of the issue date, due to contractual default, the amount of which may anyhow compromise the settlement of the Company’s monetary obligations arising from the Issue, shall imply the early maturity of this agreement.

 

Applicable to the 15th issue, 16th issue and 17th issue:

 

Calculated every quarter upon the disclosure of interim or annual financial statements:

 

- Adjusted total Debt/Ebitda: lower than or equal to 3.65; and

- Ebitda/Paid financial expenses: equal to or higher than 1.5.

 

Non-compliance with the covenant clauses, during, at least, two consecutive quarters, or also two nonconsecutive quarters within a twelve-month period shall result in the early maturity of the agreement.

 

The agreements have a cross default clause, i.e., the early maturity of any of the Company’s debts, equal to or exceeding R$90 million adjusted by IPCA variation as of the issue date, due to contractual default, the amount of which may compromise the settlement of the Company’s monetary obligations arising from the Issue.

 

 

F-82

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 (b)     Brazilian Federal Savings Bank - CEF

 

The guarantee of the agreements is the partial binding of the collection deriving from the payment of water and sewage tariffs to the debt total amount. For the agreements executed, a reserve account is also recorded with balance not lower than the amount corresponding to the amortization of principal and debt ancillary payment.

 

(i)     Covenants

 

For the outstanding contracts, the Company has the following restrictive clauses “covenants”:

 

-       AMD – Performance Improvement Agreement (*)

-       Cross default clause, i.e., the early maturity of any of the Company’s debts, due to contractual default, the occurrence of which may anyhow compromise the settlement of its monetary obligations deriving from these contracts shall imply the early maturity.

 

(c)      BNDES

 

Balance is stated net of funding costs in the amount of R$531 (2012 – R$317), which will be amortized during the same maturity period of each contract.

 

(i)                New loans and financing

 

BNDES TIETÊ III

 

Contract 12.2.1381. 1 – Entered into in February 2013, totaling  R$1,350,000, for the purpose of financing part of the Company's contribution to the Tietê River Pollution Abatement Project - Stage III, financed by the Inter-American Development Bank (IDB). The contract aims at implementing collectors, interceptors, collection networks and residential sewer connections, and expand the sewage treatment capacity in the metropolitan region of São Paulo. Total term is 180 months, with 36-month grace period and the first disbursement occurred on December 27, 2013.

 

Interest - TJLP limited to 6% p.a., plus a 3% p.a. spread, paid quarterly during the grace period and monthly in the repayment period. The TJLP portion exceeding 6% p.a. will be added to the debt outstanding balance

 

Loans are collateralized by part of revenues from the provision of water and sewage services 

 

(ii)             Covenants 

 

For the outstanding contracts, the Company has the following restrictive clauses “covenants”:

 

Applicable to Baixada Santista, PAC, Onda Limpa, PAC II 9751, PAC II 9752:

 

-                      AMD – Performance Improvement Agreement (*)

 

 

 

F-83

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

Applicable to Baixada Santista, PAC, Onda Limpa, PAC II 9751, PAC II 9752, Tietê III and PAC 2012/2013:

Calculated every quarter upon the disclosure of interim or annual financial statements:

 

.    Adjusted Ebitda / Adjusted net operating income: equal to or higher than 38%.

.    Adjusted Ebitda / Adjusted financial expenses: equal to or higher than 2.35.

.    Adjusted net debt / Adjusted Ebitda: equal to or lower than 3.65;

 

In the event the levels set out in the Financial Commitments are not met, the Company within ninety (90) days as of the date of BNDES’ written notice, shall create additional guarantees accepted by BNDES, under the penalty of suspending the funds and where applicable, declare the early maturity of the agreement.

 

Onda Limpa agreement has a cross default clause, i.e., the early maturity of any of the Company’s debt, due to contractual default the amount of which may anyhow compromise the settlement of its obligations deriving from this agreement, shall imply the early maturity of this agreement.

 

(*) AMD - Performance Improvement Agreement, calculated on a quarterly basis, upon the disclosure of the interim or annual financial statements;

 

According to the Normative Ruling no. 05 of January 22, 2008, the agreements which are purpose of investment funds, having as source of fund, the Government Severance Indemnity Fund for Employees (“FGTS”) or Worker Support Fund (“FAT”), which go through a selection process of the Ministry of Cities, shall maintain a valid Performance Improvement Agreement (“AMD”) with financial and operational ratios targets, yearly projected for the following 5 years, based on the average of the last two years.

 

The Performance Improvement Agreement, dated May 28, 2007 and amended in August 2012, was signed between SABESP and the federal government and Federal Savings Banks and BNDES as intervening parties. According to this agreement, the Company shall comply with, at least, four of eight operational and financial ratios, stipulated for the period between 2012 and 2016. If we fail to comply with five of these ratios, the Federal Savings Bank and BNDES may suspend the disbursements and we would be prevented from executing any other credit facility agreement with these institutions, until new targets are negotiated. The possibility of renegotiating the targets, if necessary, is foreseen. 

 

On March 14, 2013, through the Normative Ruling no. 06, the Ministry of Cities revoked the Normative Instruction no. 05 of January 22, 2008, which regulates the Performance Improvement Agreement. Pursuant to Article 2 of the Normative Instruction no. 06, the AMDs signed until March 14, 2013 shall remain valid until the expiration date of their related effectiveness period, not being necessary to execute or renegotiate the AMD in new contracts.

 

 

(d)         Leasing

 

The Company has lease agreements signed as Assets Lease. During the construction period, works are capitalized to intangible assets in progress and the lease amount is recorded at the same proportion. Works are estimated to be concluded in 2014 and 2015

 

F-84

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

After startup, the lease payment period starts (240 monthly installments), whose amount is periodically restated by contracted price index

 

On August 31, 2013, the operation of SES Campo Limpo Paulista and Várzea Paulista started and the corresponding amount on December 31, 2013 is R$144,384.

 

(e)  Eurobonds

 

Balance is stated net of funding costs in the amount of R$6,584 (R$7,584 in 2012), which will be amortized during the same maturity period of the contract

 

 

(i)                Covenants 

 

For the outstanding contracts, the Company has the following restrictive clauses “covenants”:

 

Calculated every quarter upon the disclosure of interim or annual financial statements:

 

Restrict the funding of new debts so that:

 

.    adjusted total debt to EBITDA does not exceed 3.65

.    the Company's debt service coverage ratio, determined on the date this debt was incurred, shall not be lower than 2.35

 

Noncompliance with covenants will accelerate the maturity of the contract

 

The agreement has a cross default clause, i.e., the early maturity of any indebtedness in view of the Company’s loans or any of its Subsidiaries with a total principal amount of US$ 25,000,000.00 or more (or its corresponding amount in other currencies) shall imply this agreement’s early maturity.

 

 

(f)          Inter-American Development Bank (IDB)

 

Balance is stated net of funding costs amounting to R$6,418 (R$4,281 in 2012), which will be amortized during the same maturity period of each contract

 

 

(i)                Covenants 

 

For the outstanding contracts, the Company has the following restrictive clauses “covenants”:

 

Calculated every quarter upon the disclosure of interim or annual financial statements:

 

 

 

F-85

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

.    Loan agreements 713, 896 and 1212 - Tariffs must: (a) produce revenues sufficient to cover the system's operating expenses, including administrative, operating, maintenance, and depreciation expenses; (b) provide a return on property, plant, and equipment no less than 7%; and (c) during project execution, the balances of current loans must not exceed 8.5% of total equity

 

Noncompliance with covenants will accelerate the maturity of the contract

 

The agreement has a cross default clause among IDB agreements (same financial bank), i.e., the early maturity will occur in the event of failure to comply with any obligation therewith or any other agreement signed with IDB related to project finance.

 

(g)         Japan International Cooperation Agency - JICA

 

Balance is stated net of funding costs amounting to R$1,466 (R$653 in 2012), which will be amortized during the same maturity period of each contract

 

(h)         AB Loan (IADB 1983AB)

 

The balance stated is net of funding costs amounting to R$2,243 (R$2,509 in 2012), which will be amortized during the same maturity period of each contract

 

(i)                Covenants 

 


The Company has the following restrictive clauses “covenants”:

 

Calculated every quarter upon the disclosure of interim or annual financial statements:

 

- The Company’s ratio of debt service coverage, determined on a consolidated basis, must be higher than or equal to 2.35; and

 

- Total adjusted debt over Ebitda, determined on a consolidated basis, must be lower than or equal to 3.65.

 

The agreement has a cross default clause, i.e., if a Default Event occurs and continues (whether voluntarily or involuntarily, whether resulting from the effect of any applicable laws or according to with due to any act or omission to act by any Authority or another one), the IDB through notification to the Borrower may order the early maturity of loan or part of it as specified in the notice (including accrued interest rates) and all other obligations are overdue and shall be promptly payable.

 

(i)          International Bank for Reconstruction and Development - IBRD

 

Balance is stated net of funding costs amounting to R$384 (R$405 in 2012), which will be amortized during the same maturity period of each contract

 

(j)          Covenants

 

F-86

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

As of December 31, 2013 and 2012, the Company had met the requirements set forth by its loan and financing agreement.

 

(k)      Loans and financing – Credit Limited

 

Brazilian Federal Savings Bank

 

On December 2, 2013 SABESP formalized with the Brazilian Federal Savings Bank the taking out of nine credit facility operations under the PAC (Growth Acceleration Program) modality. The funds derive from the Sanitation for All Program, selection of the Ministry of Cities – PAC 2012/2013. Total investment is R$1.31 billion, R$1.23 billion to be financed by the Brazilian Federal Savings Bank and R$ 80 million with SABESP’s consideration. Funds will be used in the works of Tietê Project and the Metropolitan Water Program. Total term of up to 24 years, with 4-year grace period, depending on the loan operation and financial charges of TR + 7.7% p.a.

 

BNDES PAC 2012/2013

 

Contract 13.2.1060. 1 – On December 5, 2013, SABESP formalized with the Brazilian Development Bank (BNDES) the taking out of a credit facility. Funds derive from FAT – Worker  Support Fund, selection of Ministry of Cities for the 2012 and 2013 fiscal years. Total investments are R$462 million, R$415.8 million to be financed by BNDES and R$46.2 million with SABESP’s consideration. Funds will be used in the works of the Metropolitan Water Program. Total term of 144 months, 36-month grace period and long-term interest rates (TJLP) financial charges + 1.66% p.a.

 

SABESP in order to comply with its investment plan prepares on a fund-raising plan.

 

Financing resources contracted have specific purposes, which have been released for the execution of their respective investments, according to the progress of the works.

 

 

Agent

 

December 31, 2013

 

 

(in millions of reais (*))

Brazilian Federal Savings Bank

 

2,265

Japan International Cooperation Agency – JICA

 

744

Inter-American Development Bank – IDB

 

835

Brazilian Development Bank - BNDES

 

2,020

International Bank for Reconstruction and Development - IBRD

 

147

Others

 

48

TOTAL

 

6,059

 

(*)Exchange rate as of 12/31/2013. (US$1.00 = R$2.3426; ¥ 1.00 = R$0.02233).

 

 

F-87

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

16           Taxes and contributions

 

 

(a)         Current assets

 

 

 

December 31, 2013

 

December 31, 2012

Restated

Recoverable taxes

 

 

 

Income tax and social contribution

79,548

 

100,225

Withholding income tax (IRRF) on financial investments

2,437

 

14,302

Other federal taxes

4,764

 

3,238

Other municipal taxes

656

 

656

Total recoverable taxes

87,405

 

118,421

 

 

The reduction of balance under item “Recoverable Taxes” is mainly due to the lower balance of income tax and social contribution recoverable in 2013 and decrease of IRRF provision on financial investments, due to the concentration of investment funds, where half-yearly (May and November), the taxes on the balance of financial investments shall be collected.

 

 

 

F-88

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(b)         Currentliabilities 

 

 

Taxes and contributions payable

December 31, 2013

 

December 31, 2012

Restated

Cofins and Pasep

21,797

 

46,576

Paes (tax debt refinancing program)

-

 

19,011

INSS (Social Security contribution)

30,822

 

29,401

IRRF (withholding income tax)

39,330

 

41,588

Other

23,433

 

16,134

Total

115,382

 

152,710

 

 

The reduction of taxes payable from current liabilities mainly derives from the recovery of 2012 Cofins and Pasep credit and payment of Paes in the year.

 

The Company applied for enrollment in PAES on July 15, 2003, in accordance with Law No 10,684 of May 30, 2003, and included in its application the debts related to COFINS and PASEP which were involved in a legal action challenging application of Law 9718/98, and the outstanding balance under the Tax Recovery Program (REFIS). The original amount included in PAES was R$316,953

 

The tax debt related to PAES (Special Installment Payment) was fully paid in 120 months, the last installment of which was paid on June 28, 2013. The amounts paid in 2013, 2012 and 2011 were R$19,164, R$37,421 and R$36,091, respectively, and financial expenses of R$153, R$1,353 and 2,761, respectively. There is no outstanding balance as of December 31, 2013. There are no restrictions to the assets offered as guarantee in previous REFIS, totaling R$249,034, which still guaranteed the amounts in the PAES program, pursuant to the Law nº 9532 of December 10, 1997, since tax credits included in referred program were extinguished with the payment of final installment.

 

 

 

 

 

 

F-89

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

17           Deferred Taxes and Contributions

 

 

(a)                Balance sheetbalances

 

 

December 31, 2013

 

December 31, 2012

Restated

Deferred taxesassets

 

 

 

Provisions

506,568

 

512,107

Pension obligations – G0 (1)

85,271

 

85,271

Pension obligations – G1

215,187

 

193,125

Actuarial gain/loss –G1 Plan

(32,405)

 

9,405

Donations of underlying assets on concession agreements

43,901

 

41,312

Allowance for loan losses

172,482

 

162,670

Other

87,266

 

97,425

Total deferred tax assets

1,078,270

 

1,101,315

 

 

 

 

Deferred taxes liabilities

 

 

 

Temporary difference on concession intangible assets

(595,285)

 

(650,093)

Capitalization of borrowing costs

(200,343)

 

(158,298)

Revenue – government entities

(81,711)

 

(77,827)

Other

(86,901)

 

(69,795)

Total deferred tax liabilities

(964,240)

 

(956,013)

 

 

 

 

Deferred tax asset, net

114,030

 

145,302

 

(1)    Refers to the installment of R$250,798 from accounts receivable adjustment (GESP), which was accrued as loss in previous years

 

 

 

 

F-90

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(b)      Realization

 

 

December 31, 2013

 

December 31, 2012

Restated

Deferred taxes assets

 

 

 

to be recovered within 12 months

216,515

 

176,604

to be recovered after one year

861,755

 

924,711

Total deferred tax asset

1,078,270

 

1,101,315

Deferred taxes liabilities

 

 

 

within 12 months

(37,126)

 

(38,267)

after one year

(927,114)

 

(917,746)

Total deferred tax liabilities

(964,240)

 

(956,013)

Deferred tax assets

114,030

 

145,302

 

 

 

(c)   Changes 

 

Deferred taxes assets

December 31, 2012

Restated

 

Net Variation

 

December 31, 2013

Provisions

512,107

 

(5,539)

 

506,568

Pension obligations – G0

85,271

 

-

 

85,271

Pension obligations – G1

193,125

 

22,062

 

215,187

Actuarial gain/loss –G1

9,405

 

(41,810)

 

(32,405)

Donations of underlying assets on concession agreements

41,312

 

2,589

 

43,901

Credit losses

162,670

 

9,812

 

172,482

Other

97,425

 

(10,159)

 

87,266

Total

1,101,315

 

(23,045)

 

1,078,270

 

 

 

 

 

F-91

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

Deferred taxes liabilities

December 31, 2012

Restated

 

Net variation

 

December 31,
2013

Temporary difference on concession intangible assets

(650,093)

 

54,808

 

(595,285)

Capitalization of borrowing costs

(158,298)

 

(42,045)

 

(200,343)

Revenue – government entities

(77,827)

 

(3,884)

 

(81,711)

Other

(69,795)

 

(17,106)

 

(86,901)

Total

(956,013)

 

(8,227)

 

(964,240)

 

 

 

 

 

 

Deferred tax asset, net

145,302

 

(31,272)

 

114,030

 

 

 

 

 

 

 

 

Deferred taxes assets

January 1, 2012

Restated

 

Net variation

 

December 31,
2012

Provisions

575,473

 

(63,366)

 

512,107

Pension obligations – G0

85,271

 

-

 

85,271

Pension obligations - G1

180,018

 

13,107

 

193,125

Actuarial gains(losses)– G1

(35,323)

 

44,728

 

9,405

Donations of underlying assets on concession agreements

38,213

 

3,099

 

41,312

Credit losses

135,223

 

27,447

 

162,670

Other

77,175

 

20,250

 

97,425

Total

1,056,050

 

45,265

 

1,101,315

 

 

 

 

F-92

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

Deferred taxes liabilities

January 1, 2012

Restated

 

Net variation

 

December 31, 2012

Temporary difference on intangible asset concession

(692,210)

 

42,117

 

(650,093)

Capitalization of borrowing costs

(101,507)

 

(56,791)

 

(158,298)

Profit on supply to governmental agencies

(76,773)

 

(1,054)

 

(77,827)

Other

(42,957)

 

(26,838)

 

(69,795)

Total

(913,447)

 

(42,566)

 

(956,013)

 

 

 

 

 

 

Deferred tax assets, net

142,603

 

2,699

 

145,302

 

 

 

December 31, 2013

 

December 31, 2012

Restated

 

December 31, 2011

Restated

Opening balance

145,302

 

142,603

 

68,533

Net changes in the year:

 

 

 

 

 

- corresponding entry in the statement of income

10,538

 

(42,029)

 

99,966

- corresponding entry in other comprehensive income

(41,810)

 

44,728

 

(25,896)

Total change

(31,272)

 

2,699

 

74,070

Closing balance

114,030

 

145,302

 

142,603

 

 

 

(d)              Reconciliation of the effective tax rate

 

The amounts recorded as income and social contribution tax expenses in the financial statements are reconciled to the statutory rates, as shown below

 

 

2013

 

2012

Restated

 

2011

Restated

Profit before income taxes

2,655,599

 

2,547,672

 

1,879,004

Statutory rate

34%

 

34%

 

34%

 

 

 

 

 

 

Estimated expenses at statutory rate

(902,904)

 

(866,208)

 

(638,861)

Tax benefits from interest on shareholders’ equity

182,596

 

252,355

 

122,170

Permanent difference

 

 

 

 

 

Provision Law 4,819/58 (i)

(33,279)

 

(32,514)

 

(33,559)

Donations

(12,218)

 

(11,447)

 

(13,692)

Recovery of tax credits

-

-

37,858

Other differences

33,765

 

22,042

 

28,026

 

 

 

 

 

 

Income tax and social contribution

(732,040)

 

(635,772)

 

(498,058)

 

 

 

 

 

 

Current income tax and social contribution

(742,578)

 

(593,743)

 

(598,024)

Deferred income tax and social contribution

10,538

 

(42,029)

 

99,966

Effective rate

28%

 

25%

 

27%

 

 

F-93

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

(i)           Permanent difference related to the provision for actuarial liability (Note 9 (vii)).

 

(e)      Transition Tax Regime(RTT)

 

For the purposes of calculating the income tax and the social contribution related to 2010 and 2009, the Company opted to adopt the Transition Tax Regime (RTT), which allow eliminate the accounting effects of the Law 11,638/07 and the Provisional Measure 449/08, converted into Law No. 11,941/2009, by the registers in the fiscal books – LALUR and auxiliary controls, without any modification in the bookkeeping

 

The Company has been adopting the same tax practices since 2008, as RTT started to be mandatory and will be effective until the effectiveness of law ruling the tax effects of new accounting methods, seeking the tax neutrality.

 

(f)      Provisional Measure 627/2013

 

On November 11, 2013, the Provisional Measure 627 was issued, altering the federal tax laws on the Corporate Income Tax (IRPJ), Social Contribution on Net Income (CSLL), PIS/PASEP Contribution and Contribution of Social Security Financing (Cofins). This Provisional Measure revokes the Transitory Tax Regime (RTT), enacted by Law 11941/09 and also provides for the taxation of legal entity domiciled in Brazil, referring to the equity addition deriving from the profit sharing earned abroad by subsidiaries and associated companies and profit earned by individual residing in Brazil by means of foreign subsidiary. This provisional measure allows the possibility of adopting its effects in the 2014 calendar year.

 

The Company prepared a study of potential effects of applying the Provisional Measure 627/2013 and the Normative Ruling 1,397/2013 and concluded that they do not result in relevant effects on its operations and its financial statements for the fiscal year ended December 31, 2013, based on the best interpretation of current wording of the Provisional Measure. The eventual conversion of Provisional Measure 627/2013 into Law may result in altering the Company’s conclusion, if the final text results in changes not envisaged in the Provisional Measure and altering current taxation to which the Company is subject. The Company is awaiting the conversion of referred Provisional Measure into Law, so that it may decide on its early adoption or not, as per final wording to be enacted.

 

 

 

 

 

 

F-94

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

18           Provisions

 

(a)   Lawsuits with probable likelihood of loss

 

(i) Balance sheetbalances

 

The Company is party to a number of claims and legal proceedings arising in the normal course of business, including civil, tax, labor and environmental matters. Management, recognized provisions at an amount considered sufficient to cover probable losses. These provisions, net of escrow deposits based on the legal right to offset, are as follows:

 

 

 

Provisions

 

Escrowdeposits

 

December 31, 2013

 

Provisions

 

Escrowdeposits

 

December 31, 2012

Restated

Customer claims (i)

621,999

 

(110,384)

 

511,615

 

652,663

 

(131,408)

 

521,255

Supplier claims (ii)

340,100

 

(183,606)

 

156,494

 

290,593

 

(175,437)

 

115,156

Other civil claims (iii)

129,400

 

(11,965)

 

117,435

 

169,513

 

(4,978)

 

164,535

Tax claims (iv)

59,659

 

(1,956)

 

57,703

 

71,141

 

(3,056)

 

68,085

Labor claims (v)

156,060

 

(1,614)

 

154,446

 

173,227

 

(1,529)

 

171,698

Environmental claims (vi)

182,689

 

-

 

182,689

 

149,061

 

(636)

 

148,425

 

 

 

 

 

 

 

 

 

 

 

 

Total

1,489,907

 

(309,525)

 

1,180,382

 

1,506,198

 

(317,044)

 

1,189,154

 

 

 

 

 

 

 

 

 

 

 

 

Current

631,374

 

-

 

631,374

 

565,083

 

-

 

565,083

Noncurrent

858,533

 

(309,525)

 

549,008

 

941,115

 

(317,044)

 

624,071

 

 

 

 

F-95

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(ii) Changes

 

 

December 31, 2012

Restated

Additional provisions

Interest and inflation adjustment

Use of the accrual

Amounts not used

(reversal)

December 31, 2013

Customer claims (i)

652,663

109,920

106,094

(101,710)

(144,968)

621,999

Supplier claims (ii)

290,593

17,126

45,328

(2,968)

(9,979)

340,100

Other civil claims (iii)

169,513

31,022

26,517

(9,175)

(88,477)

129,400

Tax claims (iv)

71,141

2,506

7,981

(6,320)

(15,649)

59,659

Labor claims (v)

173,227

75,842

22,284

(80,670)

(34,623)

156,060

Environmental claims (vi)

149,061

44,519

10,360

(660)

(20,591)

182,689

Subtotal

1,506,198

280,935

218,564

(201,503)

(314,287)

1,489,907

Escrowdeposits

(317,044)

(34,318)

(17,391)

24,319

34,909

(309,525)

Total

1,189,154

246,617

201,173

(177,184)

(279,378)

1,180,382

 

 

(b)      Lawsuits with possible likelihood of loss

 

The Company is party to lawsuits and administrative proceedings relating to environmental, tax, civil and labor claims, which are assessed by Management whose chances of loss are possible and are not recorded as accruals. Liability contingencies, classified as possible loss, are represented as follows:

 

 

 

 

 

 

December 31, 2013

 

December 31, 2012

Restated

 

 

 

 

 

Customer claims (i)

 

737,800

 

862,100

Supplier claims (ii)

 

1,071,000

 

775,200

Other civil claims (iii)

 

422,400

 

362,000

Tax claims (iv)

 

570,700

 

490,900

Labor claims (v)

 

278,700

 

190,000

Environmental claims (vi)

 

163,900

 

116,300

 

 

 

 

 

Total

 

3,244,500

 

2,796,500

 

 

 

 

F-96

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 (c)      Explanation on the nature of main classes of lawsuits

 

(i)                Customer claims

 

Approximately 1,380 lawsuits were filed by commercial customers, which claim that their tariffs should correspond to other consumer categories, and 720 lawsuits which claim a reduction in the sewage tariff due to losses in the system, consequently requesting the refund of amounts charged by the Company. The Company was granted both favorable and unfavorable final decisions at several court levels and recognized provisions when the chances of losses are probable. The R$9,640 decrease in the lawsuits classified as probable loss (net of escrow deposits) is mainly related to the payments and lawsuits filed during the year and revisions of expectations caused by favorable decisions to the Company in 2013, offset by interest rates, fees and updates of lawsuits in progress. These same revisions of expectations favorable to the Company resulted in a decrease of R$124,300 in the lawsuits with expectation of possible losses.

 

(ii)             Supplier claims

 

Suppliers’ claims include lawsuits filed by some suppliers alleging underpayment of monetary restatements, withholding of amounts related to the understated inflation rates deriving from Real economic plan, and the economic and financial imbalance of the agreements. These lawsuits are in progress at different courts and a provision is recognized when the chances of losses are probable. The R$41,338 increase in lawsuits whose likelihood of loss is considered probable (net of escrow deposits) is mainly related to interest, fees and update of lawsuits in progress. The R$295,800 increase in lawsuits whose likelihood of loss is considered possible is related to an increase in the number of lawsuits filed in 2013, as well as interest rates, fees and update of lawsuits in progress.

 

(iii)           Other civil claims

 

These mainly refer to indemnities for property damage, pain and suffering, and loss of profits allegedly caused to third parties, filed at different court levels, dully accrued when classified as probable losses. The R$47,100 decrease, for lawsuits with probable chances of loss (net of escrow deposits), was due to payments and lawsuits filed occurred in the year and revisions of expectations caused by favorable decisions to the Company during 2013.  The R$60,400 increase in the lawsuits with expectation of possible losses is related to interest rates, fees and update of lawsuits in progress, and an increase in the number of lawsuits filed in 2013.

 

(iv)            Tax claims

 

Tax claims refer mainly to issues related to tax collections challenged due to differences in the interpretation of legislation by the Company's management, accrued when classified as probable loss. The decrease of R$10,382 in lawsuits with expectation of probable losses (net of escrow deposits) was due to payments and lawsuits filed during the year and revisions of expectations due to favorable decisions to the Company during 2013. The R$79,800 increase in lawsuits with chances of possible losses is related to an increase in the number of lawsuits filed in 2013, and mainly to the remeasurement deriving from lawsuits filed by the municipality of São Paulo, as outlined in item “b” below.

 

 

 

 

F-97

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

Main lawsuits are the following:

 

(a) In 2006, the Federal Revenue Service, by means of a tax execution, assessed the Company referring to the tax obligations related to income tax and social contribution for calendar year 2001, and recognized taxes payable adjusted through December 31, 2013 in the amount of R$411,890 (R$389,505 in December 2012). The Company filed a timely objection and will appeal against the tax assessment at administrative level and in courts. Managements considers that the likelihood of loss of this administrative proceeding is approximately 90% considered remote and 10% possible.

 

(b) The municipality of São Paulo through law revoked the services tax exemption which until them the company withheld and thereafter issued tax deficiency notices related to the sewage service and ancillary activities, in the updated amount of R$307,817 (R$264,627 in December 2012), which currently are subject-matter of Tax Foreclosures, classified by the Management as possible losses. SABESP filed a writ of mandamus against this revocation, which was rejected, and currently is under phase of appealability of Special and Extraordinary Appeals filed. Writs of prevention and actions for annulment were also filed, aiming the suspension of enforceability of credits and the annulment of tax deficiency notices, as it understands that notwithstanding the exemption revocation, the sewage activities and ancillary activities are not included in the list of activities subject to taxation by municipality. The Company’s Management assessed the risk as possible losses.

 

(c) The Federal Revenue Service rejected some offset requests made by the Company for the extinction of IRPJ/CSLL payable, using favorable amounts, arising from undue payments of IRPJ/CSLL, which were paid based on monthly estimates. The amount involved was adjusted through December 31, 2013 and is estimated at R$50,065 (R$47,498 in December 2012). Management assessed it as a possible loss.

 

(d) The Company requested an authorization to offset the Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL) of the period of July, August and September 2002 against the amount of IRPJ paid in excess in 1997 and 1998, due to monetary restatement over the financial statements (Law 8.200/91), which was anticipated in 1996 due to an injunction, after excluded by giving up the process and adopted the Provisional Measure 38/02. The Administrative Counsel of Fiscal Resources rejected the credit from 1997. The estimated amount is R$43,689 (R$42,403 in December 2012). The Company’s Management assessed this claim as a possible loss.

 

(e) On June 23, 2010, the Company and the municipality of São Paulo signed an agreement to provide water supply and sewage services. The negotiation of this agreement led to the extinction of some judicial lawsuits, but others were not part of the referred agreement, and lawsuit proceeds as usual.  The remaining judicial lawsuits considered as possible and probable loss are mainly related to taxes and fines. As of December 31, 2013 the amounts of such judicial lawsuits were R$13,696  and R$62,979 (R$23,882 and R$39,063 in December 2012, respectively.)

 

(f) In 2005, the Federal Revenue Service partially rejected the Company´s request of offsetting tax credits related to the Corporate Income Tax (IRPJ) and the Social Contribution on Net Income (CSLL) in the amount of approximately R$56,118, and R$8,659, respectively, which relate to the period from January to April 2003, for which the Company offset prior year IRPJ and CSLL negative balances. The amounts not ratified by the authority of IRPJ and CSLL are R$11,164 and R$698, totaling R$11,862 million. As the Company obtained a partial favorable decision on this matter, the Company´s legal advisors believe likelihood of loss amounts to R$6,999 (R$6,782 in December 2012) and R$1,194 (R$1,157 in December 2012) are possible and probable, respectively.

 

 

 

F-98

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

(g) SABESP filed two writs of mandamus pleading the declaration of unconstitutional municipal law that levies the collection of taxes deriving from the use of public areas in the water and sewage network installation for the rendering of basic sanitation public utilities. The first writ of mandamus was partially granted relief, but will not have any effect because municipal laws were revoked and the second writ of mandamus awaits judgment on the municipality’s appeal, as this writ of mandamus was granted relief suspending the collection for the use of urban soil and tendering of collateral. The Management assessed the risk as possible loss, but it was not possible to estimate the amount involved, as it would be necessary to know the extension of water and sewage networks and other equipment installed in the municipality’s urban soil (public areas), as well as define the amount of related property based on the length applied.

 

(v)                Labor claims

 

The Company is a party to labor lawsuits, involving issues such as overtime, shift schedule, health hazard premium and hazardous duty premium, prior notice, change of function, salary equalization, and other. Part of the amount involved is in provisional or final execution at various court levels, and thus is classified as of probable. The Company recognized a provision for claims which likelihood of loss is considered probable. The R$17,252 decrease in lawsuits with probable chances of losses (net of escrow deposits) is chiefly due to payment and lawsuits filed occurred in 2013. The R$88,700 increase in the lawsuits with possible chances of losses is due to the increased number of suits filed in 2013.

 

(vi)             Environmental claims

 

Environmental claims refer to several administrative proceedings and lawsuits filed by government entities, including Companhia de Tecnologia de Saneamento Ambiental – Cetesb, Public Prosecution Office of the State of São Paulo and others, that aim affirmative and negative covenants and penalty is estimated due to failure to comply in addition to the imposition of indemnity due to environmental damages allegedly caused by the Company. The amounts accrued represent the best estimate of the Company at this moment, however, may differ from the amount to be disbursed as indemnity to alleged damages, in view of the current stage of referred proceedings. The R$34,264 increase in lawsuits with expectation of probable losses (net of escrow deposits) is mainly related to the complementary estimates of lawsuits in progress. The R$47,600 increase in the lawsuits with possible losses is due to the increase in the number of lawsuits filed in 2013 and the complementary estimates of lawsuits in progress.

 

Among the main lawsuits the Company is involved, there are four public civil actions the subject-matters of which are: a) sentence SABESP to restrain itself from discharging or releasing sewage without due treatment; b) invest in the water and sewage treatment system of the municipality, under the penalty of paying a fine; c) payment of indemnity due to environmental damages, amongst others. On December 31, 2013, Management classified part of lawsuits as probable chances of losses, in the amount of R$158,135 (R$127,514 in December 2012) and another part as possible losses in the amount of R$124,880 (R$85,081 in December 2012).

 

 

F-99

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(vii)          Settlements reached in 2013

 

During 2013, the Company settled several legal and administrative proceedings, and most of them totaled R$29,460. Out of this amount, R$28,692 refer to works and R$768 refer to environmental compensations, the later, recorded as “other liabilities”, under the Statement of Financial Position. The accumulated balance on December 31, 2013, referring to these environmental liabilities amounted to R$15,363.

 

(viii)       Other concession-related legal proceedings

 

The Company is party in concessions-related proceedings, cases in which it can lose the right of operating water supply and sewage collection services in few municipalities, among which we point out: a) the municipality of Cajobi filed action to recover possession against SABESP, which was granted relief and maintained the municipality in the possession of water and sewage assets and services, with expected probable losses; b) the municipality of Tarumã filed an ordinary action against SABESP, and the operation is maintained but final decision is pending, with expected possible losses; c) The Company filed an ordinary action against the municipality of Santos, the operation is maintained and there is a final decision at the appellate court favorable to SABESP, with expected remote losses; d) The Company filed a lawsuit to recover possession against the municipality of Álvares Florence, and appellate court decision was unfavorable to SABESP; the operation is not maintained with expected probable losses; e) The Company filed an action to recover possession against the municipality of Macatuba aiming with injunction return to the possession of facilities under concession, the injunction was rejected and the operation is not maintained in the municipality up to this present date, with expected possible losses; f) The Company filed an action to recover possession against the municipality of Iperó, which was deemed groundless at trial  and appellate courts. Currently, the Company awaits the acceptance of appeals, with expectation of probable loss; g) The municipality of Embaúba filed a repossession action against SABESP, pleading for injunction to keep it in the possession; the motion was granted relief and complied with on May 20, 2013. The decision was questioned and Sabesp filed an interlocutory appeal against the injunction decision. Both the repossession lawsuit and the injunction decision are pending judgment, with expectation of possible losses.

 

See information about EMAE lawsuits in Note 9 (c).

 

 

19           Employee Benefits

 

(a)      Health benefit plan

 

The health benefit plan is managed by Fundação SABESP de Seguridade Social - SABESPREV and consists of optional, free choice, health plans sponsored by contributions of SABESP and the active participants, as follows

 

.     Company: 7.3% (December 31, 2012 – 7.8%) on average, of gross payroll

 

.     Participating employees - 3.21% of base salary and premiums, equivalent to 2.2% of payroll, on average.  

 

 

F-100

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(b)      Pension plan benefits

 

 

 

 

December 31, 2013

 

December 31, 2012

Restated

Funded plan – G1 (i)

 

 

 

 

Present value of defined benefit obligations

 

1,988,912

 

2,262,440

Fair value of the plan assets

 

(1,442,164)

 

(1,657,608)

 

 

 

 

 

Net liabilities recognized for defined benefit obligations

 

546,748

 

604,832

 

 

 

 

 

December 31, 2013

 

December 31, 2012

Restated

Unfunded plan – G0 (iii)

 

 

 

 

Present value of defined benefit obligations

 

1,780,268

 

1,987,718

 

 

 

 

 

Net liabilities recognized for defined benefit obligations

 

1,780,268

 

1,987,718

 

 

 

 

 

Liability as per statement of financial position – pension obligations

 

2,327,016

 

2,592,550

 

(*) The decrease of liabilities in 2013 is mainly due to increase in the discount rate from 4.10% and 4.00% in 2012 to 6.36% and 6.46% in 2013, respectively, for G1 and G0 plans.

 

Pursuant to IAS19, the Company recognizes (gains)/losses under equity, as other comprehensive income, as shown below:

 

 

G1 Plan

 

G0 Plan

 

Total

As at December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

Actuarial gain/(loss) on obligations

432,426

 

244,121

 

676,547

 

 

 

 

 

 

Gains/(losses) on financial assets

(312,857)

 

-

 

(312,857)

 

 

 

 

 

 

Other

3,404

 

-

 

3,404

 

 

 

 

 

 

Total gains/(losses)

122,973

 

244,121

 

367,094

 

 

 

 

 

 

Deferred income tax and social contribution – G1 Plan

(41,810)

 

-

 

(41,810)

 

 

 

 

 

 

Other comprehensive income

81,163

 

244,121

 

325,284

 

 

 

F-101

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

 

 

G1 Plan

 

G0 Plan

 

Total

As at December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

Actuarial gains/(losses) on obligations

(488,956)

 

(371,035)

 

(859,991)

 

 

 

 

 

 

Gains/(losses) on financial assets

357,400

 

-

 

357,400

 

 

 

 

 

 

Total gains/(losses)

(131,556)

 

(371,035)

 

(502,591)

 

 

 

 

 

 

Deferred income tax and social contribution – G1 Plan

44,729

 

-

 

44,729

 

 

 

 

 

 

Other comprehensive income

(86,827)

 

(371,035)

 

(457,862)

 

 

 

G1 Plan

 

G0 Plan

 

Total

As at December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

Actuarial gains/(losses) on obligations

57,583

 

94,281

 

151,864

 

 

 

 

 

 

Gains/(losses) on financial assets

18,805

 

-

 

18,805

 

 

 

 

 

 

Other

(131)

 

-

 

(131)

 

 

 

 

 

 

Total gains/(losses)

76,257

 

94,281

 

170,538

 

 

 

 

 

 

Deferred income tax and social contribution – G1 Plan

(25,896)

 

-

 

(25,896)

 

 

 

 

 

 

Other comprehensive income

50,361

 

94,281

 

144,642

 

(i)          Plan G1

 

The Company sponsors a defined benefit pension plan for its employees ("Plan G1"), which is managed by Fundação SABESP de Seguridade Social – SABESPREV, the defined benefit plan is sponsored by similar contributions established in a plan of subsidy of actuarial study of SABESPREV, as follows

 

·         1.16% of the portion of the salary of participation up to 20 salaries; and

·         9.88% of the surplus, if any, of the portion of the salary of participation over 20 salaries.

 

As of December 31, 2013, SABESP had a net actuarial liability of R$546,748 (R$604,832 on December 31, 2012) representing the difference between the present value of the Company's defined benefit obligations to the participating employees, retired employees, and pensioners; the fair value of the related assets

 

 

 

F-102

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

 

2013

 

2012

Restated

Defined benefit obligation, beginning of the year

2,262,440

 

1,638,220

Current service cost

27,947

 

27,764

Interest cost

206,429

 

176,762

Actuarial (gains)/losses recorded as other comprehensive income

(432,426)

 

488,956

Benefits paid

(75,478)

 

(69,262)

 

 

 

 

Defined benefit obligation, end of the year

1,988,912

 

2,262,440

 

Below, the change of fair value of plan assets during the year:

 

 

 

 

F-103

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

2013

 

2012

Restated

Fair value of plan assets, beginning of year

1,657,608

 

1,203,493

Expected return on the plan assets

151,139

 

147,548

Expected Company's contributions

10,876

 

7,411

Expectedparticipants’  contributions

10,876

 

11,018

Benefits paid

(75,478)

 

(69,262)

Financial gain (loss) recorded as other comprehensive income

(312,857)

 

357,400

 

 

 

 

Fair value of plan assets, end of the year

1,442,164

 

1,657,608

 

 

The amounts recognized in the statement of income are as follows:

 

 

2013

 

2012

 

2011

Current service cost

27,947

 

16,746

 

13,462

Interest cost rates

206,429

 

176,762

 

158,069

Expected return on plan assets

(151,139)

 

(147,548)

 

(111,307)

Total recognized in the income statement

83,237

 

45,960

 

60,224

 

 

In 2013, the expenses related to defined pension plan amounting to R$55,781, R$7,977 and R$19,479, were recorded in operating cost, selling expenses and administrative expenses.

 

 

Estimated expenses

 

2014

Current service cost

 

30,072

Interest cost rates

 

54,850

Participants contribution

 

(20,559)

Total additional expense to be recognized

 

64,363

 

 

 

 

F-104

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

Actuarial assumptions:

 

 

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

Discount rate – real (NTN-B)

 

6.36% p.a.

 

4.10% p.a.

 

5.75% p.a.

Inflation rate

 

5.80% p.a.

 

5.00% p.a.

 

5.00% p.a.

Expected rate of return on assets

 

12.53% p.a.

 

9.30% p.a.

 

12.53% p.a.

Future salary increase

 

7.92% p.a.

 

7.10% p.a.

 

7.10% p.a.

Mortality table

 

AT-2000

 

AT-2000

 

AT-2000

 

The number of active participants as of December 31, 2013 was 8,885 (9,283 as of December 31, 2012), and of inactive participants was 6,597 (6,328 as of December 31, 2012).

 

The benefit to be paid of G1 pension plan, expected for 2014 is R$117,491.

 

 

Sensitivity analysis of the defined benefit pension plan as of December 31, 2013 regarding the changes in the main assumptions are

 

 

 Funded plan - G1

 

Change in assumption

 

Impact on present value of the defined benefit obligations

Discount rate

 

Increase of 1.0%

 

Decrease of R$192,978

 

 

Decrease of 1.0%

 

Increase of R$231,785

Wage increase rate

 

Increase of 1.0%

 

Increase of R$62,785

 

 

Decrease of 1.0%

 

Decrease of R$53,478

Life expectation

 

Increase of 1 year

 

Increase of R$34,209

 

 

Decrease of 1 year

 

Decrease of R$37,988

 

 

Plan assets

 

The plan investment policies and strategies are aim at getting consistent returns and reduce the risks associated to the utilization of financial assets available on the Capital Markets through diversification, considering factors, such as the liquidity needs and the long-term nature of the plan liability, types and availability of financial instruments in the local market, general economic conditions and forecasts as well as requirements under the law. The plan's asset allocation management strategies are determined with the support of reports and analysis prepared by SABESPREV and independent financial consultants

 

 

 

 

 

F-105

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

 

 

 

 

December 31, 2013

 

December 31, 2012

Fixed income

 

 

 

 

- NTNB's

 

712,017

 

772,882

- NTNC's

 

132,265

 

214,894

- NTNF's

 

5,858

 

6,835

Government bonds in own portfolio

(a)

850,140

 

994,611

Fixed income fund quotas

(b)

80,931

 

148,005

Private credit investment fund quotas

(c)

78,034

 

79,852

Total fixed income

 

1,009,105

 

1,222,468

 

 

 

 

 

Equities

 

 

 

 

Stocks investment fund quotas

(d)

259,717

 

226,123

Total equities

 

259,717

 

226,123

 

 

 

 

 

Structured investments

 

 

 

 

Equity investment fund quotas

(e)

76,338

 

67,867

Real estate investment fund quotas

(f)

40,220

 

77,876

Multimarket investment fund quotas

(g)

25,806

 

44,590

Total structured investments

 

142,364

 

190,333

 

 

 

 

 

Other

(h)

30,978

 

18,684

 

 

 

 

 

Fair value of plan assets

 

1,442,164

 

1,657,608

 

(a) Fixed income: it is composed of government bonds issued by the National Treasury, between 2017 and 2050. These instruments are indexed by NTN-b indexed by IPCA (Extended Consumer Price Index), NTN-c indexed by IGPM (General Market Price Index) and NTN-f which has a fixed index.

 

(b) Fixed Income Fund Quotas: investment funds that seek return on fixed income assets and shall have at least, 80% of the portfolio in directly related assets, summed up via derivatives to the risk factor.

 

(c) Private Credit Investment Fund Quotas: funds that seek return by means of the acquisition of operations representing corporate debts or disseminated receivables portfolios (rights or bonds), originated and sold by several assignors who anticipate funds and have receivables from several business activities as guarantee.

 

F-106

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(d) Equities: equity fund composed of Brazilian companies’ stocks listed at BM&FBovespa.

 

(e) Equity Investment Fund Quotas: it is composed of a closed-ended investment fund. The assets under its management are destined to the acquisition of stocks, debentures, warrants or other securities convertible or swappable into shares issued by publicly- or closely-held companies.

 

(f) Real Estate Investment Fund Quotas: Funds investing in real estate projects (commercial buildings, shopping centers, hospitals, etc.). The return on capital invested occurs by sharing the Fund’s proceeds or sale of its quotas in the Fund.

 

(g) Multimarket Investment Fund Quotas: they can be classified as Multimercados Referenciados DI or Multimercado Long & Short, they seek a basic return of CDI or share arbitration, respectively.

 

(h) Other: basically composed of loans and real estates.

 

Restrictions with respect to asset portfolio investments, in the case of federal government securities

 

i) papers securitized by the National Treasury will not be permitted

ii) exposure to fluctuations in exchange rates will not be permitted, in the portfolio and derivatives must be used to hedge existing exposure

 

Restrictions with respect to asset portfolio investments, in the case of variable-income securities for internal management, are as follows

 

i) day-trade operations will not be permitted

ii) sale of uncovered share is prohibited

iii) swap operations without guarantee are prohibited

iv) leverage will not be permitted, i.e., operations with derivatives representing leverage of asset or selling short, such operations cannot result in losses higher than invested amounts

 

SABESPREV does not have in its investment portfolio fixed income securities issued by the Company as of December 31, 2013 and 2012. The real estate held in the portfolio is not used by the Company

 

The plan assets had a return of 7.4% in 2013 and 16.7% in 2012. This variation was mainly characterized by difficulties seen in the Brazilian capital market, due to the domestic macroeconomic scenario (combination of low growth and cycle of high basic interest rates) and the foreign macroeconomic scenario (US economy upturn, within a level above expectations and the perception that Eurozone economies are improving), made the prices of assets to have a relevant loss of value.

 

The contributions of the Company and participants of Plan G1 for the fiscal year ended December 31, 2013 was R$18,348 (December 2012 – R$7,411) and R$18,416 (December 2012 – R$8,935), respectively.

 

 

F-107

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

The Company and Sabesprev are in process of negotiation to resolve the actuarial deficit, by continuing changing the Defined Benefit Plan to Sabesprev Mais Plan. Management expects to reduce the actuarial deficit due to the change of the referred plans.

 

(ii)        Private pension plan benefits – Defined contribution

 

On December 31, 2013, Sabesprev Mais plan, based on defined contribution, had 5,627 active and assisted participants.

 

With respect to the Sabesprev Mais plan, the contributions from the sponsor represent 100% over the total basic contribution from the participants

 

Regarding the Sabesprev Mais plan, the commitment to all participants who migrated up to December 31, 2013 amounted to R$10,613 (R$12,441 in December 2012) referred to active participants. The Company has made contributions in the amount of R$8,446 in 2013 (R$7,496 in December 2012). 

 

 (iii)         Plan G0

 

Pursuant to Law 4,819/58, employees who provided services prior to May 1974 and were retired as an employee of the Company acquired a legal right to receive supplemental pension payments, which rights are referred as "Plan G0". The Company pays these supplemental benefits on behalf of the State Government and makes claims for reimbursements from the State Government, which are recorded as accounts receivable from related parties, limited to the amounts considered virtually certain that will be reimbursed by the State Government. As of December 31, 2013, the Company recorded a defined benefit obligation for Plan G0 of R$1,780,268 (R$1,987,718 in December 2012).

 

 

2013

 

2012

Restated

 

 

 

 

Defined benefit obligation, beginning of year

1,987,718

 

1,581,600

Current interest and service costs

176,766

 

167,787

Actuarial gains/(losses) recorded as other comprehensive income

(244,121)

 

371,035

Benefits paid

(140,095)

 

(132,704)

 

 

 

 

Defined benefit liability, end of the year

1,780,268

 

1,987,718

 

 

The amounts recognized in the statement of income are as follows

 

 

2013

 

2012

 

2011

 

 

 

 

 

 

Current service cost

296

 

400

 

548

Interest cost rate

176,470

 

167,387

 

161,718

 

 

 

 

 

 

Total

176,766

 

167,787

 

162,266

 

 

F-108

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

 

In 2013, the expense related to the defined benefit obligation under Plan G0 was recorded in administrative expenses

 

Estimated expenses

2014

 

 

Interest cost rates

224,931

Total additional expenses to be recognized

224,931

 

 

The main actuarial assumptions used

 

 

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

Discount rate – real (NTN-B)

 

6.46% p.a.

 

4.00% p.a.

 

5.75% p.a.

Inflation rate

 

5.80% p.a.

 

5.00% p.a.

 

5.00% p.a.

Future salary increase

 

7.92% p.a.

 

7.10% p.a.

 

7.10% p.a.

Mortality table

 

AT-2000

 

AT-2000

 

AT-2000

 

 

The number of active participants of Plan - Go as of December 31, 2013 was  24 (27 on December 31, 2012). The number of beneficiaries, retirees and survivors as of December 31, 2013 was 2,412 (2,318 on December 31, 2012).

 

The benefit payable from the Go pension plan expected for 2014 is R$149,728.

 

 

The sensitivity analysis of defined benefit pension plan on December 31, 2013 to the changes in the main assumptions is

 

 

 Plan – G0

 

Change in assumption

 

Impact on present value of the defined benefit obligations

Discount rate

 

Increase of 1.0%

 

Decrease of R$145,899

 

 

Decrease of 1.0%

 

Increase of R$170,444

Wages growth rate

 

Increase of 1.0%

 

Increase of R$176,960

 

 

Decrease of 1.0%

 

Decrease of R$152,934

Life expectation

 

Increase of1 year

 

Increase of R$59,817

 

 

Decrease of1 year

 

Decrease of R$62,843

 

 

F-109

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

(c)      Profit sharing

 

The Company has a profit sharing program in accordance with an agreement with labor union and Sabesp. The period covered represents the Company fiscal year, commence in January to December. The limit of the profit sharing is one month salary for each employee, depending on performance goals reached. As of December 31, 2013 the profit sharing accrued amounted to R$68,495 (R$60,479 in December 2012).

 

20          Services payable

 

The services account records the balances payable, mainly from services received from third parties, such as supply of electric power, reading of hydrometers and delivery of water and sewage bills, cleaning, surveillance and security services, collection, legal counsel services, audit, marketing and advertising and consulting services, among others. This account also records the amounts payable from the percentage in the revenues of São Paulo local government (Note 13 (v)). The balances on December 31, 2013 and 2012 were R$323,208 and R$389,091, respectively.

 

21           Equity

 

(a)         Authorized capital

 

The Company is authorized to increase capital by up to R$10,000,000 (R$10,000,000 in December 2012), based on a Board of Directors' resolution, after submission to the Fiscal Council

 

In the event of capital increase, issue of convertible debentures and/or warrants by means of private subscription, shareholders will have preemptive right in the proportion of number of shares held, pursuant to Article 171 of Law 6.404/76.

(b)         Subscribed and paid-in capital

 

Subscribed and paid-in capital is represented by 683,509,869 registered, book-entry common shares without par value as of December 31, 2013 (683,509,869 in December 2012, after the share split described below) held as follows

 

There was a share increase due to the split on April 22, 2013.

 

 

F-110

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

December 31, 2013

 

December 31, 2012

 

Number of shares

 

%

 

Number of shares (**)

 

%

State Department of Finance

343,524,258

 

50.26%

 

343,524,258

 

50.26%

Companhia Brasileira de Liquidação e Custódia

174,076,755

 

25.47%

 

172,570,122

 

25.25%

The Bank Of New York ADR Department (equivalent in shares) (*)

165,291,202

 

24.18%

 

166,806,858

 

24.40%

Other

617,654

 

0.09%

 

608,631

 

0.09%

 

 

 

 

 

 

 

 

 

683,509,869

 

100.00%

 

683,509,869

 

100.00%

 

(*)        Each ADR corresponds to 1 share.

(**)    Amount restated due to split occurred on April 22, 2013.

 

(c)          Distribution of earnings

 

Shareholders are entitled to a minimum mandatory dividend of 25% of the adjusted net income under Brazilian GAAP, calculated according to the Brazilian corporate law. The dividends do not bear interest and the amounts not claimed within three years from the date of the Shareholders' Meeting that approved them mature in favor of the Company

 

 

 

2013

 

2012

 

2011

Profit for the year

1,923,559

 

1,911,900

 

1,380,946

Recognition of actuarial liability IAS 19

-

 

-

 

(157,527)

Net income for the year - as originally published

1,923,559

 

1,911,900

 

1,223,419

(-) Legal reserve - 5%

(96,178)

 

(95,595)

 

(61,171)

 

 

 

 

 

 

 

1,827,381

 

1,816,305

 

1,162,248

 

 

 

 

 

 

 

 

 

 

 

 

Minimum mandatory dividend – 25% (R$0.67, R$0.66 and 0.43 as of December 31, 2013, 2012 and 2011, respectively, per share and per ADS)

456,845

 

454,076

 

290,562

 

 

On April 22, 2013, the Shareholders’ General Meeting approved the distribution of dividends as interest on shareholders’ equity amounting to R$534,277,  for the 2012 fiscal year. Therefore, the amount of R$80,201, related to the surplus minimum mandatory dividends of 25%, set forth in the Bylaws, recorded in the 2012 equity under “Additional proposed dividends” was transferred to current liabilities, and these amounts were paid in 2013. The  R$498,684 interest, net of withholding income tax of R$35,593, totaled R$534,277.

 

 

F-111

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

The Company proposed dividends as interest on shareholders' equity in the amount of R$456,845, corresponding to R$0.6684 per common share net of income tax of R$37,758, to be resolved on the Shareholders’ Meeting to be held on April 30, 2014.

 

The Company declared dividends payable as interest on shareholders’ equity in the amount of R$456,845, which considers the minimum dividend amount set forth in the Bylaws. The amount exceeding the minimum mandatory dividend due in the year of R$80,620 was reclassified in equity to the “Additional proposed dividends” account, this amount includes the withholding income tax of R$37,758.

 

Pursuant to CVM Resolution nº 207/1996, the Company imputed interest on shareholders’ equity to the minimum dividend by its net value of withholding income tax. The amount of R$37,758 referring to the withholding income tax was recognized in current liabilities, in order to comply with tax liabilities related to the credit of interest on shareholders’ equity.

 

The balance payable as of December 31, 2013 was R$456,845, net of withholding income tax.

 

(d)         Capital reserve

 

The capital reserve includes tax incentives and donations received by the company and may only be used for future capital increases

 

(e)          Legal reserve

 

Earnings reserve - legal reserve is a requirement for all Brazilian corporations and represents accrual of 5% of annual net income determined based on Brazilian law, up to 20% of capital. However, we are not required to make any allocations to our legal reserve in a year in which the legal reserve, when added to our other established capital and earnings reserves, exceeds 30% of our capital stock. The amounts allocated to such reserve may only be used to increase our capital stock or to offset losses. Therefore, they are not available for the payment of dividends

 

(f)Investments reserve

 

Earnings reserve - investments reserve is specifically formed by the portion corresponding to own funds assigned to the expansion of the water supply and sewage treatment systems, based on capital budget approved by the Management.

 

As of December 31, 2013, 2012 and 2011, the balance of investment reserve totaled R$5,980,535 , R$4,690,619 and R$3,408,591 , respectively.

 

Pursuant to Paragraph four of Article 28 of the by-laws, the Board of Directors may propose to the Shareholders’ Meeting that the remaining balance of net income for the year, after deducting the legal reserve and minimum mandatory dividends, be allocated to an investment reserve that will comply with the following criteria:  

 

I-                   its balance, jointly with the balance of the other earnings reserves, except for reserves for contingencies and realizable profits, may not exceed the capital stock;                

II-                 the reserve is intended to guarantee the investment plan and its balance may be used:  

  

 

 

F-112

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

a) to absorb losses, whenever necessary;  

b) to distribute dividends, at any moment;  

c) in share redemption, reimbursement or purchase transactions authorized by law;  

d) in incorporation to the capital stock

 

(g)      Allocation of profit for the year

 

 

 

2013

Profit

 

(+)

Profit for the year

1,923,559

(-)

Legal reserve – 5%

96,178

(-)

Minimum mandatory dividends

456,845

(-)

Additional proposed dividends

80,620

Investment reserve recorded in 2013

1,289,916

 

 

The Management will send for approval at the shareholders’ meeting, a proposal to transfer the retained earnings balance, in the amount of R$1,289,916 to the Investment Reserve account, in order to meet the investment needs foreseen in the Capital Budget. In addition, it will send a proposal to increase capital stock with part of earnings reserves, in the amount of R$ 3,672,057, as this reserve exceeds the capital stock amount on December 31, 2013. In addition, it will propose to fully capitalize the capital reserve by increasing capital stock, in the amount of R$124,255.

 

After capitalizing part of the earnings reserve and total capital reserve by increasing capital stock, yet to be approved at the Shareholders’ Meeting, the capital stock will be R$10,000,000.

(h)      Retained earnings (accumulated losses)

 

Retained earnings (accumulated losses): the statutory balance of this account is zero as all retained earnings must be distributed or allocated to an earnings reserve at year end

 

(i)             Other comprehensive income

 

Gains and losses arising from changes in the actuarial assumptions are accounted for as other comprehensive income, net of income tax and social contribution effects. See Note 19 (b), the breakdown of amounts recorded in 2013 and 2012.

 

 

 

 

F-113

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

22           Earnings per Share

 

 

Basic and diluted

 

Basic earnings per share is calculated by dividing the income attributable to the Company’s shareholders by the weighted average number of outstanding common shares during the year. The Company does not have potentially dilutive common shares outstanding or debts convertible into common shares. Accordingly, basic and diluted earnings per share are equal.  

 

 

F-114

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

Income attributable to the Company’s shareholders

1,923,559

 

1,911,900

 

1,380,946

Weighted average number of common shares issued

683,509,869

 

683,509,869

(*)

683,509,869

 

 

 

 

 

 

Basic and diluted earnings per share (reais  per share)

2.81

 

2.80

 

2.02

 

(*) Amount restated due to the split occurred on April, 22, 2013.

 

23          Segment information

 

Management, comprised by the Board of Directors and the Board of Executive Officers, has determined the operating segments used to make strategic decisions, as water supply and sewage services.

 

(i)    Income statement

 

 

 

2013

 

 

Water

 

Sewage

 

Reconciliation

to the financial

statements

 

Balance as per

financial

statements

 

 

 

 

 

 

 

 

 

Gross operating income from external customers

 

5,276,056

 

4,263,965

 

2,444,735

 

11,984,756

 

 

 

 

 

 

 

 

 

Gross sales deductions

 

(370,091)

 

(299,098)

 

-

 

(669,189)

 

 

 

 

 

 

 

 

 

Net operating income from external customers

 

4,905,965

 

3,964,867

 

2,444,735

 

11,315,567

 

 

 

 

 

 

 

 

 

Costs, selling and administrative expenses

 

(3,512,559)

 

(2,275,437)

 

(2,394,487)

 

(8,182,483)

 

 

 

 

 

 

 

 

 

Income from operations before other operating expenses, net and equity accounting

 

1,393,406

 

1,689,430

 

50,248

 

3,133,084

 

 

 

 

 

 

 

 

 

Other operating income (expenses), net

 

 

 

 

 

 

 

3,296

 

 

 

 

 

 

 

 

 

Equity accounting

 

 

 

 

 

 

 

2,465

 

 

 

 

 

 

 

 

 

Financial result, net

 

 

 

 

 

 

 

(483,246)

 

 

 

 

 

 

 

 

 

Income from operations before taxes

 

 

 

 

 

 

 

2,655,599

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

461,426

 

409,647

 

-

 

871,073

 

 

F-115

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

 

 

 

2012

Restated

 

 

Water

 

Sewage

 

Reconciliation

to the financial

statements

 

Balance as per

financial

statements

 

 

 

 

 

 

 

 

 

Gross operating income from external customers

 

4,944,257

 

3,982,480

 

2,464,482

 

11,391,219

 

 

 

 

 

 

 

 

 

Gross sales deductions

 

(362,003)

 

(291,585)

 

-

 

(653,588)

 

 

 

 

 

 

 

 

 

Net operating income from external customers

 

4,582,254

 

3,690,895

 

2,464,482

 

10,737,631

 

 

 

 

 

 

 

 

 

Costs, selling and administrative expenses

 

(3,406,588)

 

(2,043,582)

 

(2,414,410)

 

(7,864,580)

 

 

 

 

 

 

 

 

 

Income from operations before otheroperating income (expenses), net and equity accounting

 

1,175,666

 

1,647,313

 

50,072

 

2,873,051

 

 

 

 

 

 

 

 

 

Other operating expenses, net

 

 

 

 

 

 

 

(23,175)

 

 

 

 

 

 

 

 

 

Equity accounting

 

 

 

 

 

 

 

(6,532)

 

 

 

 

 

 

 

 

 

Financial result, net

 

 

 

 

 

 

 

(295,672)

 

 

 

 

 

 

 

 

 

Income from operations before taxes

 

 

 

 

 

 

 

2,547,672

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

403,980

 

334,545

 

-

 

738,525

 

 

 

2011

Restated

 

 

Water

 

Sewage

 

Reconciliation

to the financial

statements

 

Balance as per

financial

statements

 

 

 

 

 

 

 

 

 

Gross operating income from external customers

 

4,607,160

 

3,697,883

 

2,224,633

 

10,529,676

 

 

 

 

 

 

 

 

 

Gross sales deductions

 

(334,083)

 

(268,148)

 

-

 

(602,231)

 

 

 

 

 

 

 

 

 

Net operating income from external customers

 

4,273,077

 

3,429,735

 

2,224,633

 

9,927,445

 

 

 

 

 

 

 

 

 

Costs, selling and administrative expenses

 

(3,206,338)

 

(1,938,203)

 

(2,177,045)

 

(7,321,586)

 

 

 

 

 

 

 

 

 

Income from operations before other operating income (expenses), net and equity accounting

 

1,066,739

 

1,491,532

 

47,588

 

2,605,859

 

 

 

 

 

 

 

 

 

Other operating expenses, net

 

 

 

 

 

 

 

(90,253)

 

 

 

 

 

 

 

 

 

Equity accounting

 

 

 

 

 

 

 

(3,584)

 

 

 

 

 

 

 

 

 

Financial result, net

 

 

 

 

 

 

 

(633,018)

 

 

 

 

 

 

 

 

 

Income from operations before taxes

 

 

 

 

 

 

 

1,879,004

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

415,028

 

353,676

 

-

 

768,704

 

 

F-116

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

Explanation on the reconciliation items for the Financial Statements: the impacts on gross operating income and in costs are as follows:

 

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

 

Gross revenue from construction recognized under IFRIC 12 (a)

 

2,444,735

 

2,464,482

 

2,224,633

Construction costs recognized under IFRIC 12 (R1) (a)

 

2,394,487

 

2,414,410

 

2,177,045

 

 

 

 

 

 

 

Construction margin

 

50,248

 

50,072

 

47,588

 

 

(a)    Revenue from concession construction contracts is recognized in accordance with IAS 11, Construction Contracts, using the percentage-of-completion method. See Note 13 (c) and (g).

 

(ii)            Intangible assets

 

Reportable segment’s intangible assets are reconciled to total assets as follows:

 

 

 

December 31, 2013

 

December 31, 2012

Restated

Intangible asset:

 

 

 

Water supply

9,741,582

 

9,126,097

Sewage services

12,298,412

 

11,199,727

 

 

 

 

Segment assets for reportable segments

22,039,994

 

20,325,824

 

 

 

 

Other intangible assets

1,806,237

 

1,641,702

 

 

 

 

Total intangible assets

23,846,231

 

21,967,526

 

 

F-117

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

There are no liabilities allocated to the reportable segments

 

 

 

24          Operating Revenue

 

(a)            Revenue from water and sewage services:

 

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

Metropolitan region of São Paulo

6,984,364

 

6,625,041

 

6,144,669

Regional Systems (i)

2,555,657

 

2,301,696

 

2,160,374

Total (ii)

9,540,021

 

8,926,737

 

8,305,043

 

 

(i)  Including the municipalities operated in inland and at the coast of the State of São Paulo.

 

(ii)          Revenue from water and sewage services increased by 6.9% as of December 31, 2013 over 2012. The billed volume was up 2.8% as of December 31, 2013 and the impact of tariff adjustment in 2013 over 2012 was 5.65% .

 

 

(b)     Reconciliation between gross operating income and net operating income:

 

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

Revenue from water and sewage services

9,540,021

 

8,926,737

 

8,305,043

Construction revenue (Nota 13 (c))

2,444,735

 

2,464,482

 

2,224,633

Sales tax

(669,189)

 

(653,588)

 

(602,231)

Net revenues

11,315,567

 

10,737,631

 

9,927,445

 

 

F-118

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

25          Operating Costs and Expenses

 

 

2013

 

2012

Restated

 

2011

Restated

Operating costs

 

 

 

 

 

Salaries and payroll charges

1,348,933

 

1,224,335

 

1,131,774

Pension obligations

59,237

 

36,480

 

49,374

Construction costs (Note 13 (c))

2,394,487

 

2,414,410

 

2,177,045

General supplies

179,771

 

169,096

 

147,268

Treatment supplies

240,730

 

177,453

 

154,748

Outsourced services

786,515

 

724,478

 

668,138

Electricity

551,630

 

588,183

 

582,410

General expenses

444,663

 

400,446

 

368,932

Depreciation and amortization

810,297

 

715,070

 

739,043

 

 

 

 

 

 

 

6,816,263

 

6,449,951

 

6,018,732

 

 

 

 

 

 

Selling expenses

 

 

 

 

 

Salaries and payroll charges

215,083

 

198,762

 

194,747

Pension obligations

8,470

 

6,054

 

7,942

General supplies

6,995

 

8,313

 

7,703

Outsourced services

208,943

 

205,393

 

201,941

Electricity

557

 

629

 

622

General expenses

82,470

 

77,848

 

78,654

Depreciation and amortization

10,721

 

8,017

 

7,435

Allowance for doubtful accounts, net of recoveries (Note 8(c))

103,864

 

192,236

 

120,260

 

 

 

 

 

 

 

637,103

 

697,252

 

619,304

 

 

 

 

 

 

Administrative expenses

 

 

 

 

 

Salaries and payroll charges

176,845

 

168,514

 

157,704

Pension plan

118,600

 

104,717

 

105,070

General supplies

6,700

 

4,374

 

4,142

Outsourced services

116,735

 

145,673

 

123,500

Electricity

694

 

1,175

 

1,047

General expenses

183,874

 

209,191

 

208,365

Depreciation and amortization

50,055

 

15,438

 

22,226

Tax expenses

75,614

 

68,295

 

61,496

 

 

 

 

 

 

 

729,117

 

717,377

 

683,550

 

 

 

 

 

 

Operating costs and expenses

 

 

 

 

 

Salaries and payroll charges

1,740,861

 

1,591,611

 

1,484,225

Pension plan

186,307

 

147,251

 

162,386

Construction costs (Note 13 (c))

2,394,487

 

2,414,410

 

2,177,045

General supplies

193,466

 

181,783

 

159,113

Treatment supplies

240,730

 

177,453

 

154,748

Outsourced services

1,112,193

 

1,075,544

 

993,579

Electricity

552,881

 

589,987

 

584,079

General expenses

711,007

 

687,485

 

655,951

Depreciation and amortization

871,073

 

738,525

 

768,704

Tax expenses

75,614

 

68,295

 

61,496

Allowance for doubtful accounts, net of recoveries (Note 8(c))

103,864

 

192,236

 

120,260

 

8,182,483

 

7,864,580

 

7,321,586

 

 

F-119

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

26          Financial Expenses and Income

 

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

Financial expenses

 

 

 

 

 

Interest and charges on loans and financing – local currency

(294,729)

 

(304,736)

 

(354,813)

Interest and charges on loans and financing – foreign currency

(84,648)

 

(87,800)

 

(79,816)

Other financial expenses (i)

(62,882)

 

(33,860)

 

(21,578)

Income tax over international remittance

(10,662)

 

(11,660)

 

(9,795)

Inflation adjustment on loans and financing (ii)

(72,657)

 

(34,599)

 

(48,879)

Inflation adjustment on Sabesprev Mais deficit (iii)

(1,334)

 

(1,525)

 

(1,794)

Other inflation adjustments (iv)

(5,731)

 

(6,657)

 

(41,449)

Interest and inflation adjustments on provisions

(70,267)

 

(97,393)

 

(143,765)

Total financial expenses

(602,910)

 

(578,230)

 

(701,889)

 

 

 

 

 

 

Financial income

 

 

 

 

 

Inflation adjustment gains (v)

85,245

 

66,497

 

89,351

Income on short-term investments

151,106

 

162,928

 

271,847

Interest and other income (vi)

149,759

 

103,704

 

104,555

Total financial income

386,110

 

333,129

 

465,753

 

 

 

 

 

 

Financial, net before foreign exchange variations

(216,800)

 

(245,101)

 

(236,136)

 

 

 

 

 

 

Net foreign exchange gains (losses)

 

 

 

 

 

Foreign exchange variation on loans and financing (vii)

(267,835)

 

(50,523)

 

(382,305)

Other foreign exchange variations

(6)

 

(43)

 

(96)

Foreign exchange gains

1,395

 

(5)

 

(14,481)

Foreign exchange variations, net

(266,446)

 

(50,571)

 

(396,882)

 

 

 

 

 

 

Financial, net

(483,246)

 

(295,672)

 

(633,018)

 

 

 

 

F-120

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(i)            This variation is mainly due to interest rates of the Public-Private Partnership agreement of Alto Tietê Production System – CAB – Sistema Produtor Alto Tietê S/A, in the amount of R$32,198 in 2013.

 

(ii)          The account variation mainly derives from an increase in debt inventory indexed to IPCA in view of the 17th Issue of Debentures. This inflation adjustment derives from changes in the indexes defined in loan agreements, such as, UPR, IPCA, CDI and TJLP, corresponding to 0.2%, 5.9%, 9.8% and 5.0%, respectively, in 2013. (0.3%, 5.8%, 6.9% and 5.5%, respectively, in 2012 and 1.2%, 6.5%, 10.9% and 6.0%, respectively , in 2011). The exposures to these rates are shown in Note 4.3.1.

 

(iii)        This inflation adjustment derives from the change in the National Consumer Price Index (INPC) rate of 5.6% in 2013 (6.2% in 2012 and 6.1% in 2011), which is used to adjust the balance of SABESP’s commitment in relation to the deficit of the Sabesprev mais pension plan.

 

(iv)         Other expenses related to inflation adjustment mainly arises from the adjustment of liabilities referring to investment commitments required by the public-private partnerships and mainly from program contracts indexed by the IPC and IPCA of 3.9% and 5.9% in 2013 and 5.1% and 5.8% in 2012 and 6.4% and 6.5% in 2011, respectively.

 

(v)           These inflation adjustments  arise from accounts/bills of overdue accounts receivable,  which are restated depending on the payment date, by IPCA (5.9% in 2013, 5.8% in 2012 and 6.5% in 2011) or IPC-FIPE (Consumer Price Index, 3.9% in 2013, 5.1% in 2012 and 5.8% in 2011), and escrow deposits, which are adjusted by the index defined by the Judiciary Branch, which varied between 5.6% in 2013, 6.0% in 2012 and 6,2% in 2011.

 

(vi)         The variation is mainly due to interest rates on agreements and installment payments.

 

(vii)       The increase in foreign exchange variation on loans and financing mainly arises from the 14.6% U.S. dollar appreciation against the Brazilian Real in 2013, when compared to the 8.9% appreciation in 2012 (depreciation of 12.6% of the real against the U.S. dollar in 2011).

 

27           Other Operating Income (expenses), net

 

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

Other net operating income, net

57,382

 

68,364

 

72,386

Other operating expenses (i)

(54,086)

 

(91,539)

 

(162,639)

 

 

 

 

 

 

Other net operating income (expenses)

3,296

 

(23,175)

 

(90,253)

 

 

 

 

F-121

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

 

Other operating income is comprised of sale of property, plant and equipment, sale of contracts awarded in public bids, and indemnities and reimbursement of expenses, fines and collaterals, property leases, reuse water, and PURA projects and services

 

Other operating expenses consist mainly of write-off of property, plant and equipment due to obsolescence, discontinued construction works, unproductive wells, projects considered economically unfeasible, losses on property, plant and equipment

 

(i) Variation mainly refers to the allowance for losses of the municipality of Diadema and recognized in 2012, totaling R$60.295.  In 2013, it refers to the registration of asset write-off, due to replacement of old water and sewage connections by new ones, in the amount of R$17,851.

 

28          Commitments

 

The Company has agreements to manage and maintain its activities, as well as agreements to build new projects aiming at achieving the objectives proposed in its target plan. Below, main committed amounts as of December 31, 2013 are as follows:

 

 

1 year

1-3 year

3-5 year

More than

5 years

Total

Contractual obligations - Expenses

1,211,431

882,827

50,658

3,785,112

5,930,028

Contractual obligations – Investments

1,407,541

1,616,823

124,561

2,186,389

5,335,314

Total

2,618,972

2,499,650

175,219

5,971,501

11,265,342

 

The main commitment refers to São Lourenço PPP, see Note 13 (j).

 

 

 

F-122

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

29          Additional information on cash flows

 

 

 

 

2013

 

2012

Restated

 

2011

Restated

 

 

 

 

 

 

 

Total additions of intangible assets as per Note 13

 

2,750,319

 

2,651,018

 

2,425,243

 

 

 

 

 

 

 

Items not affecting cash (see breakdown below)

 

(445,288)

 

(642,319)

 

(368,487)

 

 

 

 

 

 

 

Total additions to intangible assets as per statement of cash flows

 

2,305,031

 

2,008,699

 

2,056,756

 

 

 

 

 

 

 

Investments and financing operations affecting intangible assets but not cash:

 

 

 

 

 

 

Interest capitalized in the period

 

205,012

 

283,016

 

261,900

Contractors

 

(4,887)

 

67,631

 

(33,936)

Program contract commitments

 

28,197

 

75,434

 

43,325

Leasing

 

166,718

 

166,166

 

49,609

Construction margin

 

50,248

 

50,072

 

47,589

Total

 

445,288

 

642,319

 

368,487

 

 

 

 

 

 

F-123

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

30          Events after the reporting period

 

(a)              Sabesp’s  Incentive Program to Reduce Water Consumption

 

After being approved by ARSESP on an emergency basis through Resolution 469/2014, SABESP adopted an economic incentive to stimulate households of the Greater São Paulo to reduce water consumption. This measure was adopted due to the record heat and the inedited rainless in the Cantareira System, which is in a critical level and which supplies almost 10 million people.

 

The clients who reduced by, at least, 20% the average consumption of a 12-month period: February 2013 to January 2014, will have a 30% discount in their bill. This deduction shall apply over a lower amount, since decrease in consumption will result in cheaper bill to apply the benefit.

 

This measure applies to households, commerce and industries supplied by Cantareira System: the entire north area and São Paulo downtown, part of east and west areas of the capital city, Barueri, Caieiras, Carapicuíba, Francisco Morato, Franco da Rocha, Itapevi, Jandira, Osasco and Santana de Parnaíba. In Guarulhos and São Caetano do Sul, also served by Cantareira System, the distribution is under the local governments’ responsibilities, which buy water from SABESP. The municipal services shall decide about the decision of granting this incentive.

 

This benefit will be valid for the bills in the reference months from February to August and consumers will receive the bill from March to September. In Santana de Parnaíba, this measure shall apply in the reference months from March to August and bill is delivered between April and September.

 

However, in April 2014 the incentive program was extended for the entire São Paulo metropolitan region until the end of 2014 or until the water level in the reservoirs is normalized.  As a result of the drought and low water volume in the Cantareira System, the São Paulo State Department of Water and Energy (DAEE) and the National Water Agency (ANA) determined that, as of March 10, 2014, we must temporarily restrict the flow of water from the Cantareira System from 33 m³/s to 27.9 m³/s.  In order to continue to meet consumer demand with a restricted water supply, we are increasing our use of other water systems.  This may lead to an increase in our costs to serve customers in the São Paulo metropolitan region.  If the situation in the reservoirs affected by the drought does not improve, we may be obligated to take more drastic measures.

 

(b)              ARSESP Tariff Revision

 

ARSESP – Sanitation and Energy Regulatory Agency of the State of São Paulo, by means of its Resolution nº 463 of January 9, 2014, altered the schedule for development of phases D2, D3, D4 and D5 of ARSESP Resolution nº 434 of 10/31/2013, referring to SABESP’s first Tariff Revision and defined as April 10, 2014 as the date to publish the Initial Maximum Price (P0) and the definitive Efficiency Factor (X Factor) for the tariff cycle initiated on August 11, 2012, establishing the following dates for remaining phases:

 

i.             Phase D2 - ARSESP releases the proposals for Initial Maximum Price (P0) and definitive Efficiency Factor (X Factor) and the opening of a public consultation, summoning for public hearing on 2/11/2014;

ii.            Phase D3 – Public hearing was held on 3/12/2014 and closure of Public Consultation postponed for 3/19/2014, as notified at its website;

iii.          Phase D4 – Publication of results related to the Initial Maximum Price (P0) and definitive Efficiency Factor (X Factor) and a substantiated report on contributions to the public consultation on 4/10/2014; and

iv.           Phase D5 – Publication of schedule to define and implement the new Tariff Structure of SABESP on 4/10/2014.

 

On April 17, 2014 – ARSESP issued Resolution No. 484, which, among other things: (i) establishes that, as of May 11, 2014, a tariff repositioning index of 5.4408% in relation to our current tariffs and an annual Efficiency Factor (X Factor) of 0.9386%, which will be deducted in the upcoming annual tariff adjustments, shall be applied to water services bills, (ii) allows us to apply the repositioning index arising from the tariff revision at a more opportune future date, when we shall proceed to recalculate and restate the applicable amounts, in order to ensure our economic and financial balance, taking into account the atypical situation in our market due to the lack of rainfall and our measures to encourage water savings in order to ensure supply, (iii) establishes that the next annual tariff adjustments will occur on April 11, 2015 and April 11, 2016, with the next tariff revision on April 11, 2017, and (iv) ratifies the readjustment rules set forth on Resolution No. 406 (described above) and updated the X Factor for the tarif cycle from 0.836% to 0.9386%. The current tariff structure will be kept with respect to our services until the new structure is approved by ARSESP and implemented. Considering what has been established by Resolution No. 484, we decided to postpone the application of the repositioning index to an opportune date at the end of December 2014, at the latest.

 

 

 

 

F-124

 


 

Companhia de Saneamento Básico do Estado de São Paulo - SABESP

 

Notes to the Financial Statements

Years Ended December 31, 2013 and 2012

Amounts in thousands of reais, unless otherwise indicated

 

(c)                 Signature of services agreement with the municipality of Diadema.

 

On March 18, 2014 were signed (i) judicial settlements in lawsuits filed by Sabesp against the municipality of Diadema and Saned – a municipal company, and (ii) a services agreement for water supply and sewage public utility services in the municipality of Diadema, 30-year effectiveness period as of the agreement’s signature date. This agreement can be extended for another 30 years, upon execution of appropriate amendments, under the terms of law.

 

ARSESP will authorize the tariffs and will ratify the price table proposed by SABESP, as well as it will define the tariff structure, pursuant to the guidelines of Law 11.445/07 and State Decree 41.446/96 of the standards to replace them and related legislation. As of the date of the assumption of services by SABESP scheduled to March 31, 2014, the municipality’s tariffs will be levelled to those practiced by SABESP in the Metropolitan region of São Paulo, through five annual real and consecutive adjustments, starting in a period not less than 12 months as of the agreement's signature.

 

Sabesp shall pay the amount of R$95,000 to the municipality of Diadema to implement actions related to the environmental sanitation in the municipality, necessary to comply with the universalization targets. These amounts will be paid in two installments of R$47,500, the first one 30 days after the agreement’s signature and the final installment, 12 months after the payment of the 1st installment, and this installment shall be adjusted by IPC-IBGE. These amounts will be deposited in a specific account, indicated by municipality, which shall be liable for the execution of these actions, as well as for the regular accountability, and on a half-yearly basis, shall provide a list of actions and related amounts. The amounts, while not used, shall be kept in financial investments and related proceeds only may be used in the execution of the aforementioned actions. These amounts shall be computed by ARSESP for the purposes of determining the agreement’s financial and economic breakeven.

 

The agreement is subject to ARSESP’s regulations, including referring to the economic and financial breakeven.

 

(d)              Program Contracts

 

In 2014, the Company renewed its Program Contract of Water Supply and Sewage Services with the municipalities of Itapevi, Piedade, Rosana, Lucélia, Parapuã, Jaborandi and Registro. These agreements have a 30-year term.

 

 

(e)   Use of reservoirs – EMAE

 

In connection with our lawsuit regards to the compensation for the use of water from the Guarapiranga and Billings reservoirs requested by Empresa Metropolitana de Águas e Energia S.A. (“EMAE”), on April 10, 2014, we issued an Announcement to the Market to communicate that we are negotiating with EMAE regarding a potential future agreement.  However, no adjustment has been confirmed, and no agreement has been executed by either party as of yet.

 

 

 

 

 

 

F-125