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Edited Transcript of CESP6.SA earnings conference call or presentation 8-Aug-19 2:00pm GMT

Q2 2019 CESP Companhia Energetica de Sao Paulo Earnings Call

Sao Paulo Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of CESP Companhia Energetica de Sao Paulo earnings conference call or presentation Thursday, August 8, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Fabio Rogerio Zanfelice

CESP - Companhia Energética de São Paulo - CEO & Member of Management Board

* Mario Antonio Bertoncini

CESP - Companhia Energética de São Paulo - CFO & IR Officer and Member of Management Board

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Conference Call Participants

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* Carolina Carneiro

Crédit Suisse AG, Research Division - Sector Head

* Thiago Silva

Santander Investment Securities Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for standing by. Welcome, everyone, to conference call to discuss second quarter results presenting of CESP, Companhia Energética de São Paulo. This event is being recorded. After CESP's presentation, there will be a Q&A session for analysts and investors. (Operator Instructions) We also have a live webcast with the respective audio track and slide deck, which can be found at the company's RI (sic) [IR] website, www.ri.cesp.com.br. The presentation will also be available for download at the website.

 

The information is also -- the information available is in BRLs as per the Brazilian corporate legislation and accounting practices adopted in Brazil, BR GAAP, already in compliance with international accounting practices, IFRS, except when stated otherwise.

 

Before moving on, we'd like to make that current -- forward-looking statements made during the call concerning the company's business outlook, operating and financial projections and targets are assumptions and beliefs of the company's management and also based on information currently available. Forward-looking statements are no guarantee of performance. They involve risks, uncertainties and assumptions as they refer to future events and depend on circumstances that may or may not materialize. Investors should have in mind that general economic conditions, industry conditions and other operating factors might affect the future performance of the company and thus lead to results that will differ materially from those expressed in these forward-looking statements.

 

Here with us today, we have Mr. Fabio Zanfelice, CEO; and Mr. Mario Bertoncini, CFO and IRO.

 

I'd like to turn the conference over to Mr. Zanfelice, who will start the presentation.

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Fabio Rogerio Zanfelice, CESP - Companhia Energética de São Paulo - CEO & Member of Management Board [2]

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Good morning, ladies and gentlemen. I'd like to, first of all, thank you all for participating in our earnings call for the second quarter of the company for 2019.

 

I'd like to start the presentation on Slide #4, where we have the company's corporate structure, corporate governance and shareholder structure. Once again, the controlling block is made up of VTRM, Votorantim Energia, and [others] hold 40% of the total equity of the company and the free float, amounting to 60%.

 

We also have bits of news about the level of governance that we have today drawing your attention to the fact that the company today has a Board where 40% are independent members, an audit committed (sic) [committee] with 100% of independent members. In our last Board meeting, last Tuesday, we announced the last transition step towards forming a management team for the company, which started with Mr. Bertoncini in February as CFO, then we have [Carlos Dias Costa] for the -- Generation Officer in May [27.] And then last Tuesday, we announced Mario as the new COO of the company, and [Marcello Jesluz], who will take the position of CFO. That transition will be enforced as of August 26, in a few more weeks, 20 more days.

 

Okay. With that, we'll be commenting on it as we move on with the presentation. But that means we have closed the transition period for the company's management, and now we're going to have this new team to manage company's matters.

 

Okay. That being said, let's move on to Slide #5, where we have the company's asset portfolio. At Porto Primavera, 1,655 megawatts, 948 average megawatts for physical guarantee to other plants, Jaguari, Paraibuna. Just to emphasize, we have this commitment because of our concession contract of assessing the feasibility of installing another 4 machines at Porto Primavera. We have already started that assessment process. And we have 24 months starting on the date of the signature of the concession contract to present to the conceding authorities. And we expect that in about 8 months to a year to conclude that assessment process.

 

Okay. On the next slide, Slide #6, we have an overview of our legal contingency liabilities. In this case, we had in March 2019, a total of BRL 11.659 billion (sic) [BRL 11.686 billion] in contingencies. Now we are in June 2019, the second quarter, BRL 12 billion (sic) [BRL 12,015 billion] and core (sic) [escrow] deposits, BRL 554 million (sic) [BRL 544 million] and now BRL 556 million. That may -- that number changed because of monetary correction and adjustment of those deposits. No new deposit was made in other words. An overview of the probable contingencies and liabilities we moved in March from BRL 264 million, (sic) [BRL 2.154 billion,] and in June, BRL 2.122 billion, (sic) [BRL 2.120 billion,] part of that variation due to monetary adjustment and part of it due to settlements that were reached throughout the second quarter.

 

As for the profile of our litigation, they are mainly split between civil lawsuits losses and disappropriation lawsuits as well, [90%,] and a smaller part linked to labor and tax issues. Out of those BRL 12 billion, 45 cases amount for 87% of all cases, reaching a number of around BRL 10 billion. As I had mentioned before, the company does have contingencies of significant amount, but it is concentrated on a relatively small number of cases.

 

On the next slide, as for contingent assets management, basically, the largest contributor to the total is the indemnization for Três Irmãos, the Três Irmãos lawsuit. When the directive was signed, the company was offered BRL 1.7 billion as of June 2012. The company did not accept the first offer. That number went -- that case went to court. Today, we have an expert report, which was made throughout the process that leading to an amount of BRL 4.7 billion. Also, on the same historical basis of June 2012 and that then is broken down as follows: BRL 1.9 billion for the plant; BRL 1 billion floodgates and canal; and BRL 1.8 billion for the lands. Basically, that was what the company was asking for when we contested the first figure presented for indemnification.

 

It was our understanding that number did not encompass all these structures. Parties were notified by the judge to examine the complementary expert report. Then, on April 19, the courts manifested themselves and then we [rebuked] on June. Basically, we have a special appeal happening at the same time. The company is requesting BRL 1.7 billion corrected monetarily, given that, that number has been recognized by the government early on that started back in the day. There was a request for injunction, that request was denied, and the company appealed and then the injunction was accepted at a higher levels. The government also appealed to cancel the payment of that BRL 1.7 billion and the company appealed once again to the Superior Court, and we are now waiting for a ruling.

 

So the discussion has been going on about the expert report. And we have been working to try and receive that amount. Our estimation is to have a first instance decision by the end of this year. I think the case is advancing. So by early 2020, we would have a ruling as a first instance decision.

 

On the next slide, we have an overview of our workforce numbers. The company December '18, when we took on or took over control, had 519 employees. Currently, we have 254 employees. That was driven -- that drop was driven by a voluntary dismissal plan, where we adjusted the workforce with our needs. And we also hired new personnel out in the market. That dismissal plan was broken down in 2 parts. It started in February '19, where we had 327 employees joining. We reissued that plan in June, and then we had another 20 employees joining the plan. So in total, the cost was BRL 124 million for the company and resulted in a drop in payroll of about 50%.

 

The next steps, now as for people management are the [following] we have implemented a target or program, and we now follow-on with a process of performance assessment for everyone. So that will encompass a total overhaul of the people management situation of the company.

 

As for the age group, we have a breakdown of the different age brackets on the right-hand side of the slide. There was a drop in the average age of our employees from 53 years old to 45 years old. And now we understand that we have a healthy level of seniority within the company. We have adjusted with the dismissal plan, and with that, we benefited from the fact that we could bring on younger people or bring that age -- average age down also using as a benchmark what we see out in the market. So we see now that we have a more adequate seniority level among our workforce.

 

Now as for the performance now, on Slide #10, we have public data from the Electrical Energy Chamber, affluent natural energy in June on the top side of the slide and a forecast covering the period until December. And a good piece of information that those 2 charts bring is that despite the chamber being -- projecting a level below the average for the previous 3 months, the reservoir level is higher than what we had at the end of last year, which is reassuring for us. We have a more positive scenario going forward when compared to early on this year.

 

On the next slide, Slide #11, we have once again a breakdown of our energy balance, that's on a monthly basis, as we've been doing for the past announcements. On Chart #1, on the left, gross physical guarantee and the adjusted physical guarantee, which has the GSF effect included. And that shows that we had an impact of [40%] of a reduction of the physical guarantee, 147 average megawatts in relation to the original physical guarantee. On Chart #2, we compare the adjusted guarantee with the company's request or requisite what the company actually sold to market as per the adjusted physical guarantee. On Chart #3, on the right-hand side, we compare the monthly deficits with our energy purchases in average megawatts. And then on number 4, we clearly see a scenario where we do not have major adjustments throughout the year.

 

As I had said before, as soon as the new shareholder took over, adjusting the company's balance was a 0 -- priority #1, if you will. So the idea was not to have any more exposure throughout the year. There was, on the second quarter, a significant variation in the spot price, as you can see, but the company had already made the purchases that we can see on the chart early on in this year. So there were no major variations because of our -- due to market variations of -- or higher volatility.

 

Okay. Moving on to the financial performance in Slide #12, and I give the floor over to our current CFO, Mario Bertoncini.

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Mario Antonio Bertoncini, CESP - Companhia Energética de São Paulo - CFO & IR Officer and Member of Management Board [3]

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Thank you, Fabio. On Slide #12, we have revenue and costs. We closed the second quarter of '19 with a net revenue of BRL 368 million, 6% below what we had in the previous -- the quarter -- second quarter of last year, that was done to some decontracting that took place. One of the ways to adjust a deficit as we had in the end of last year -- one of the main ways to address a deficit, as we saw last year, was the purchase of energy. Another way to do that is through decontracting when there is advantage in doing so. And that's what we did to a smaller part of our energy, [smaller] portion of the energy, and that's what explains somewhat that drop in net revenues.

 

As for costs and expenses, for us to be able to compare numbers, we closed the second quarter of 2019 with costs and operating expenses at BRL 268 million, but a few -- a couple of explanations are necessary here, and that's what we have in the bottom of the slide. For us to be able to compare on equal basis, the second quarter of last year and the second quarter of this year, we made adjustments which can be seen in the bottom part of the slide. On the left-hand side, in the bottom, we see costs and expenses and then we move towards the adjustment. Adjustments based on provision reversals for the second quarter of last year that had to do with the agreement made with the State of Mato Grosso and the 13 municipalities that environmental agreement, which was widely publicized. When we make that adjustment, we reached a cost and expenses adjusted for 2018 at BRL 394 million (sic) [BRL 344 million.] If we do the same thing for the second quarter of this year, we arrive at that number, BRL 242 million. That sort of exposes the adjustment made relative to provisions. So when we compare the second quarter of last year with second quarter of this year, that represents a drop of 29% in operating costs and expenses.

 

The first explanation, the most straightforward one, is, basically, a reduction in energy purchases. That has to do with a lower exposure, a lower volume that was purchased and also lower purchasing prices, but that explains only part of that -- of those numbers. The other part from the net standpoint, which is under the others in that column, is worth mentioning. What lies behind the others column? A reduction of a series of recurring expenses, which were important for the company; personnel, as it was mentioned; payroll, and I'll be talking about percentages comparing quarter-on-quarter, last year and this year, second quarter.

 

In payroll, we had a reduction of 35%. If we except -- if you exclude VDP, our dismissal plan expenses, materials 20%, another 18% of reduction in services, services hired from third parties and 39% in terms of reduction in leases and rents.

 

On the other hand, we had an increase of depreciation expenses, in particular, with the amortization of the new grant paid by Porto Primavera and other requisites. I'd like to call your attention to the fact, even though the net number is relatively small under others, we can see a significant effort in trying to reduce expenses that are directly linked to the company's cash. Our efforts to reduce expenses are ongoing. This is a very important snapshot for this second quarter, but we are still working on reducing further expenses, and we'll be presenting that as we move on towards the next quarters.

 

Moving on to the next slide, Slide #13, we have a snapshot of our EBITDA and cash flow. The EBITDA, also on adjusted basis, has increased by 114% when we compare second quarter of last year and second quarter of this year. Then on the same bridge, on the right-hand side, we have a breakdown of that evolution about our EBITDA. That increase is driven mainly by this improvement in the costs and expenses profile. Part of it has to do with an increasing price for energy and other factors, as you can see.

 

As we look at the cash flow, especially the operating cash flow, today, we have a cash conversion of 37% in the quarter. What does that mean? The operating cash flow in the first half of the year, 6 months, the first half, accounts for 37% of the EBITDA for that -- for those 6 months. That's what we have in the bottom part of the slide on Page 13.

 

The adjusted EBITDA in the quarter sits at BRL 260 million and a operating cash flow of BRL 96 million. What explains that transition is, expenses with working capital, which has to do with a higher volume of purchased energy and payments for litigations and debt services. And we converge that with a free cash flow, so that we can reconcile that with the company's available cash, no major changes there. So basically debentures, payment -- payout of dividends, which has -- all of those have been widely announced, publicized as of recent.

 

Moving on to Page 14, we have our capital structure. No major big news here. Not much different from what we saw last quarter. We closed this quarter with a leverage level of 4x, net debt adjusted EBITDA ratio. That's a leverage level which we expect to see a significant conversion downwards by December because of the growth in EBITDA, which is expected for the company. Debt is that 7-year debt with amortization for the past 4 years, as we can see on the amortization schedule, on the right, with an average term slightly below 5 years.

 

More recently, as of last month, the S&P reemphasized our rating or repeated our rating. There was no change compared to the previous status. BB minus today rating, even though we have metrics for investment rate. So it is capped by the republic rate. And in the local rating, we have AAA rating, as we had previously.

 

I will move now to the -- I'll now give the floor back over to Fabio Zanfelice to close this first part of the presentation.

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Fabio Rogerio Zanfelice, CESP - Companhia Energética de São Paulo - CEO & Member of Management Board [4]

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Well, thank you, Mario. Now on the last slide, Slide #16, we'll be talking about key initiatives for 2019. As for our power plants, it is widely known that CESP has manifested no interest in the Jaguari plant, driven mainly by the fact that when we participated in the process of share divestment, there was an item in the bidding process saying that the State would be interested in requesting that concession at the end of the original concession. Given that fact, we understood that there would be a conflict if, for example, the company planned for renewal at the end of the period. So that's because -- that's why we expressed a -- our waiving of that plant. So no renewal for Jaguari was the bottom-line decision.

 

We have also advanced in our cost and expenses for maintenance and operation. A good portion has been executed in terms of cost reduction, and that can be seen in our drop in expenses, as it was seen in the slide before. We still have work to do. We are focused on reaching an [excellent] level in terms of asset management and in adjusting our expenses. It's an ongoing process, and it's part of our continued improvement policy.

 

In terms of operational efficiency, we have progress in our SAP system implementation. So in the third quarter, we hope to have that concluded. And we have also reorganized and monetized our nonoperating properties. We have several nonoperating properties today, which generate expenses for the company. So we need to manage our [asset] portfolio. So the company has focused effort in addressing that process, so that we can monetize those properties and reduce maintenance costs related to those assets.

 

As for personnel, we have approved our long-term incentive policy plan for the management -- for the senior management. And also, as I had mentioned, we have established performance criteria, results criteria and value-generation criteria to assess the whole team. We have also concluded a volunteer dismissal plan, as I mentioned. The last one was just in July. And as I said, we had 20 employees joining. For this last VDP, the expenses amounted to BRL 6 million, which will impact the third quarter of '19.

 

As for energy trading, when we took over the company, we requested the Board of Directors to authorize CESP and Votorantim to share better practices throughout the period, which would be deemed necessary to change and implement new processes for the company. That process has been concluded. Today, the company already has a energy trading policy in place. We have hired a General Manager for trading. We have all procedures well advanced, so that CESP will count on standards and procedures for trading, which are benchmark in the market.

 

As for the creation of a trading company, we have advanced on that front as well. We have a big avenue for value creation along those lines. So the [idea is] to add value as we trade energy.

 

And lastly, the 2019 hydrological risk has been addressed. The focus of the company now is on the exposures that will be having for the next 3 years. We have made some adjustments to those exposures. Of course, as I mentioned before, this is a process which is done gradually, every decision made in terms of energy purchase is taken carefully, needs to be the best possible strategy. So the company has been carefully assessing ways to mitigate that exposure for the coming 3 years. We have observed the market a drop in prices when compared to what we had in the first quarter. And that's, of course, part of the company's strategy to try and lock those positions for the next 3 years at the best possible price and that has been done.

 

Okay. I'd like now to close this part of our call and now open up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Thiago Silva from Santander.

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Thiago Silva, Santander Investment Securities Inc., Research Division - Research Analyst [2]

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I have 2 questions, actually. The first one has to do with indemnization relative to the plants, which have not been renewed, where we have court cases and so on. I'd like you to give us some more color, if I may, in terms of timing, when is this expected to take place, the first trial at the superior court? Is it expected for the first half of next year, or when? And what does the company expect? Is the company optimistic? Is the company bullish? Are you expecting to reach some kind of settlement? Are there settlement avenues?

 

And the second question has to do with the liabilities. If you could give us a bit more details, out of those 45 cases you mentioned, which account for most -- for the bulk of the cases, if we have a third-party law firm working on it, do we have a success fee involved to expedite those cases and also a deadline, a timing, for that in terms of bringing those or writing off those liabilities from our balance sheet?

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Unidentified Company Representative, [3]

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Okay, Thiago. Thank you for your questions. Number one, as for Três Irmãos, the most relevant of our indemnification cases, we expect the first trial, the court trial to be judged in the first quarter of next year at most. So it's a good estimate. As for the company's optimism level, we see that from a very positive light because Três Irmãos unlike other concessions, it does have a specificity, which are the lock gates and the channels which had not been included in the reversal process. So it's a different case, it's a different process from those where we had basically the plants. We had no navigation structure, no lock gates. That has been recognized by the authorities. They already recognized that this should be included in the reversal process. So we do have a concrete fact that there was a change and that there was another estimate early on as they estimated the asset. Because of that, we look at it from a very positive standpoint.

 

Realistic speaking, there is a good chance of us winning that case. Of course, we'll need to wait and see for possible negotiations. And negotiations will only take place when we have a first court decision. So we need to see how the case will progress in the coming months, so that we can take a stand for a possible negotiation. All avenues are open and -- which one to take will be decided as the process, as the case matures.

 

As for liabilities, out of those 45 cases, they're all linked to top of the line law firms. The company is not taking care of any of those. Of course, the company oversees all of that, but the company has hired top law firms to take care of those 45. We are coordinating, of course, moves and supervising, but we have chosen to choose experienced law firms in liabilities and litigations. And we believe that's the best way, the best path for the company to emerge successful at the end of the day.

 

Those 2 quarters of this year were make up -- made up the moment for us to study the in depth those cases, so that we could decide on the best strategy to go about them. And there might be cases where we should -- we'll need to negotiate. And for those cases, we have to stop and think and see what to do. The company might find itself in a place where we need to negotiate, but the company's focus, the bottom line, is to win all cases, right? Whenever we see a possibility of winning, we'll go for it. We'll place all energy, all efforts that we can to lead to a successful ending. We are quite engaged in taking that to a good term.

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Thiago Silva, Santander Investment Securities Inc., Research Division - Research Analyst [4]

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Just as a follow-up, if I may. If any of those cases -- do any of those cases -- or does any of those cases limit the company's growth because of greenfield auctions or M&As, provided a window of opportunity might emerge?

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Unidentified Company Representative, [5]

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Well, it does not limit or block, but we need to have as an assumption the following. I have mentioned before, we have to work with -- have to work around growing the company, of course. But with that level of litigation is an issue, we need to pay attention to. We might need -- we might have the resources, but those resources might be better invested in solving those [liabilities.] So our assumption is the following. Every monetary unit that we have will provide returns that will be invested in solving those issues in the short run. So we believe that the company once we solve those contingency issues, only then we'll be in a good position, be prepared to focus on growth.

 

So we're going to be going through a period now in the short run, working around those contingencies, but once that phase is past, the company will be able to do other things to grow, to expand. Not that contingencies represent a limitation or constraint is more a -- it's rather a matter of having energy, having the necessary focus to work on growing. Today, we feel that if we do both things at the same time, then management might not be making the best possible decisions either for growth, either for solving contingencies. So that's why we have focused all energy, all efforts on addressing the contingency issues.

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Operator [6]

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Our next question comes from Maria Carneiro from Crédit Suisse.

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Carolina Carneiro, Crédit Suisse AG, Research Division - Sector Head [7]

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I have a question -- one question. If you could give us some more detail about the new people management measures, which you have mentioned in the press release and also in the presentation. So you mentioned the voluntary dismissal plan. I also read that you have implemented a long-term incentive plan. If you could give us some more detail about the people management front, I'd appreciate it?

 

And also a second question, if I may, about the management of the energy balance. This year, we have -- you have shown us a breakdown of the balance between purchases and exposure and allocation. But in the long run, what would be the company's intention, if you already have a plan for that to manage the portfolio? This year has been atypical year. What can we expect going forward in terms of improvement, given what we've seen in the past previous quarters in terms of energy balance at CESP?

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Unidentified Company Representative, [8]

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Thank you, Maria. As for the dismissal plan, we have concluded the dismissal plan. We have reduced the company's head count by half. We consider the process to have been successful. And we have no plans around dismissal -- voluntary dismissal. That is done and over with. That cycle has been closed. That being said, the company now needs to work towards improving the team, improving performance based on procedures, based on processes that will work towards forming a high performance team. So targets establishment, performance assessment, all those initiatives which any top company has, we plan to do as well.

 

The incentive -- the long-term incentive plan was approved 2 Board meetings ago. This incentive plan, in the long run, has a vesting period of 5 years, and that was based in the company's [GSI.] So we have defined the expected return for 5 years, and the management -- the senior management will be assessed or will be entitled to that incentive provided that expectation is met, expectation of return on equity.

 

As for the energy balance, this year, it was atypical, as you said, and we recognize that. And I think the market, as a whole, was caught by surprise by the recession we had in January of this year. 2018, we started really well in terms of rainfall. There was a drop in January this year that brought the price down. The company addressed that in December. We arrived at the company on December 13. On December 14, we promoted an auction to settle half of the company's exposure, then we worked on seasonalization. And then we closed the position because we understood that to be one of the company's vulnerabilities for 2019. And we did that throughout December and then early in the year, January and February. We did it in a very fast expedited way because we had no time in our hands.

 

So we decided to close the balance, to announce that to market, so that we would be showing the company's best interests in solving that issue. And that was done, and you have been receiving information whenever we announced our results. In any event, that's not the best possible practice to do something throughout the year. The best practice would be to anticipate that, to close and lock positions in the year before, buying energy in installments, very few companies buy energy cash. Few of them get it right.

 

So what we have been doing for next year for 2020 and then throughout 2022, which is the period where we still have some [best.] We have already hired some energy for the coming -- for those years. We have been contracting more energy, so that we can close that position. We have not announced the volumes to be contracted to 2020, 2022, basically because there is a seasonality process that takes place in December. Whatever profile we might be able to convey now for the next months -- next years will be subject to the seasonality of the physical guarantee and also to the change of market prices. So we need to first define that seasonality profile, right? So that we are behaving a bit more conservative and holding back those numbers because of volatility issues, which are implicit to this process.

 

And the idea, the bottom-line idea is to reduce the exposure. Of course, throughout next year, 2020, we intend to put in practice the same process we've be doing 2019. In other words, announce on a monthly basis, what our forecast is, right.

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Operator [9]

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(Operator Instructions) Once again, I'd like to give the floor back over to the company's management for their final remarks.

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Fabio Rogerio Zanfelice, CESP - Companhia Energética de São Paulo - CEO & Member of Management Board [10]

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Well, we are now closing our earnings call for this quarter, the second quarter. I'd like to thank everyone for participating. This is my last participation as the company's CEO. I'd like to thank, everyone, for their collaboration in this transition process and the company. All market analysts have been very helpful for the company. As for what is expected from the company, as to what we really need to do to take this company back to a growing prosperous path. I wish Bertoncini, [Marcello,] all the success in the world in this new moment for the company. I am quite sure we put together a top team that will bring, but good news to the market and make this company shine in the short run. Okay. Thank you very much. Have a nice day.

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Operator [11]

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CESP earnings call is now over. Thank you all for participating. Have a nice day, everyone.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]