Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Rebecca MacDonald - Co-Founder and Executive Chairman

Kenneth M. Hartwick - Chief Executive Officer, President and Director

Analysts

Nelson Ng - RBC Capital Markets, LLC, Research Division

Kevin Chiang - CIBC World Markets Inc., Research Division

Trevor Johnson - National Bank Financial, Inc., Research Division

Damir Gunja - TD Securities Equity Research

Just Energy Group (JE) Q3 2013 Earnings Call February 8, 2013 8:30 AM ET

Operator

Hello, and welcome to the Just Energy Third Quarter Fiscal 2013 Results. [Operator Instructions] And now to begin our call, I introduce Rebecca McDonald, Executive Chair. Please go ahead.

Rebecca MacDonald

Good morning, everyone. Thank you for joining us for our third quarter conference call. With me this morning are Ken Hartwick, our CEO; and Beth Summers, our CFO. Ken and I will make a short presentation and then we'll open up the call to questions. Before we get going, let me preface the call by you telling you that our earnings release and potentially our answers to your questions will contain forward-looking financial information. This information may eventually prove to be inaccurate, so please read the disclaimer regarding such information at the bottom of our press releases.

Our third quarter results are highlighted by 2 things: First, we had another solid quarter with both customer growth and embedded margin growth in double digits; second, we have announced that we are changing our dividend policy.

Let me move immediately to our to our Board decision to set the fiscal 2014 dividend at $0.84, down from current $1.24. The first payment at the new level will be the April 2013 dividend. As you are aware, our Board considers the advice of management on dividend policy on an annual basis. After careful and thorough evaluation, it was concluded that the reduction of the current dividend would provide the company with the necessary financial flexibility and stability to forecast on 3 priorities. In order, they are: Number one, further investing growth opportunities in our customer base and particularly the sale of products such as Smart thermostats, which deepen our customer relationship; number two, continue paying a substantial dividend to our loyal shareholders and number three, preserve excess cash to provide us the option of reducing our overall debt level.

As discussed in our prior quarters, with our fiscal 2013 dividend rate of $1.24, our payout ratio of funds from operation will exceed 100% for this year and based on current forecast, will exceed 100% in the fiscal 2014 as well. This reflects a period of very high growth with double-digit increases in our customer base and future embedded margins.

The newly approved fiscal 2014 dividend level should drop this payout ratio of funds from operation below 100% next year and management believes it will reach a target range of 60% to 65% by the end of fiscal 2015. We believe this target range is prudent for high-return business like ours that has shown an ability to grow rapidly.

Management believes that there needs to be focus on this profitable growth and debt reduction as well as dividends. Historically, high levels of growth investments have been funded by raising capital. While we were, again, able to pass the debt market raising $105 million in debentures privately placed with the CPPIB in December, the need for continued cost-effective financing exist and the expense -- as we expand our business. An improved balance sheet will aid this process.

The fiscal 2014 dividends level will allow the funding of necessary growth capital expenditure and the cash repayment of the entire fiscal 2015 $90 million convertible debenture issues, if necessary. In addition, the new level of dividend will allow Just Energy to build a cash reserve to deal with future refinancing and growth needs. While we will lower dividend, we will continue to have one of the highest dividend yields on TSX 300 and in New York Stock Exchange. Furthermore, it's management's belief that our recent share price reflects unexpected fashion [ph] of a dividend reduction and is discounted accordingly. Management believes that Just Energy's core business growth, combined with a stabilized capital structure will allow our company to return to being provider of both business growth and income growth to our shareholders.

Let me turn it over to Ken to discuss the quarterly results.

Kenneth M. Hartwick

Thanks, Rebecca. Just Energy's third quarter was another strong quarter for long-term growth. We were able to build our customer base and future embedded margin despite a challenging commodity environment, heightened commercial competition and weak economics for our ethanol business. When we first talk about growth, something that is often forgotten with a focus on payout ratios and debt levels.

In the past year, we have grown our total customer base by 11%, and our embedded margin to $2.2 billion, up 14% from a year earlier. At the end of the quarter, our embedded future margin per share was $15.19, a solid underpinning to our equity and evidence of the long-term financial strength necessary to execute our growth strategy.

Customer additions in the third quarter were 341,000, up 10% from fiscal 2012 and the second highest total registered in Just Energy's history. New additions were solid in all segments of the business led by 150,000 new residential customers, up 34% from the 112,000 added in the third quarter of fiscal 2012. Commercial additions totaled 191,000, down slightly from the company record 198,000 added in the prior fiscal year.

National Home Services saw 44% year-over-year growth in total installations, reaching 222,000 customers. We see all of our marketing channels making headway towards our continued success and remain committed to making the necessary investments to strengthen these channels. Just Energy intends to be a growth company for the years to come.

Growth expenditures in our U.K. operation and our Smart Thermostat business are essential to the expansion plans, and we will continue to invest in both of these areas as well. Management believes that the broadening of the customer relationship is the next step in the evolution of Just Energy. While the funding platform for NHS supports this growth in Canada, there is a need to provide the capital to expand the business in the U.S. This step will contribute to an increasingly profitable customer relationship less impacted by natural gas prices.

While we saw significant customer growth during the quarter, our margin growth lagged our customer growth falling 3% versus Q3 of fiscal 2012. There were 3 main reasons. The ethanol plant was and remains a problem division. This nonstrategic plant saw its gross margin fall to $2.2 million, down from $6.5 million a year ago. Management cannot forecast when this performance will improve, and we expect no improvement in Q4.

The second area of margin shortfall was weather derivatives. In the last 2 years, the company's hedged this weather exposure through weather derivative options. Based on warm weather, these options payout during the third and fourth quarters of the year, while the true adverse cash impact of the warm weather is generally not seen until the following Q1 and Q2 results, which contain the utility reconciliations.

The record warm weather in fiscal 2012 resulted in a $9 million payout on these options last year, while in Q3 this year, the payout was less than $1 million. In this case much of the shortfall should be recovered in Q1 and 2 next year, while improved utility reconciliations versus last winter.

Finally, on average, the U.S. dollar fell against the Canadian dollar year-over-year. This reduced margin by $3.2 million. Based on today's dollar, this margin loss would have disappeared. Overall, these factors caused gross margin to be 3% lower in Q3 despite an 11% increase in our customer base. This customer growth shows that Just Energy remains a benefactor of this unique growth industry. Deregulated energy is a fast-growing market, and we are striving to generate both net customer growth and higher profits.

Adding customers is very important to this end, but retaining them is vital as well. We continue to see a low stable commodity price environment, which makes renewals more difficult and attrition a challenge. In Q3, both these measures were solid. Attrition was essentially flat year-over-year at 13%, down from 14%. Renewals were strong at 69%, up from 62% a year earlier. Our ability to fine [ph] or retain customers at these rates that have consistently improved supports our belief that we are achieving great customer value out of each relationship.

Our administration costs were up $34 per customer from $32 a year ago. And as we continue to build a base for future expansion, much of the higher cost was building the Momentis base and the establishment of the U.K. office. We believe that our base is now in place and expect administrative expenses to fall to the $30 per customer range going forward.

Aggregation costs per residential customer was down 22% to $158 from $203 a year prior. Commercial customer aggregation costs run average down slightly. This continued positive trend has been driven by the use of multiple sales channels and the economic of scale as fixed marketing costs were spread across more customers.

Bad debt remains at our target range, averaging 2.1%, down from 2.5% a year earlier. As a percentage of our revenue exposed to bad debt grows, management is carefully monitoring to ensure that losses are held within the range of 2% to 3%.

National Home Services had another solid quarter, cracking its growth and its total base year-over-year. Gross margin and EBITDA are up 32% and 21%, respectively. NHS has recently launched in Québec and we'll look for further expansion opportunities. Gaining a stronger and stronger foothold in the customer base [ph] is a key theme you will hear repeated on these calls in quarters to come.

We've begun to see the benefits of getting multiple products into our customers' house, whether it is our commodity contracts with NHS products or our Smart Thermostats, each customer relationship is improving in economic value, and we believe a more stable customer relationship will follow.

Regarding our outlook, previously issued guidance called for 10% to 12% gross margin growth and 8% to 10% adjusted EBITDA growth for fiscal 2013. All over -- overall margin is up 9% year-to-date. Management does not expect it to reach 10% to 12% target range for the fiscal year. Continued weak results from TGF and delays in the positive cash impact of colder winter temperatures causes management to currently estimate no more than 8% margin growth for the fiscal year.

Our forecast for roughly flat fourth quarter margins would have result in adjusted EBITDA being down -- being in the current range of down 6% compared to the year, again, target growth of 8% to 10%. The administrative and sales and marketing expenses are growing more quickly than margin as they track the number of customers in our base.

Looking ahead, our efforts in expenditures to broaden our sales channels and geographic footprint have resulted in renewed growth in customers and future embedded margin. Each of our sales channels is performing well. Our customer base is becoming more stable, both through improved churn performance and a deep pick-up [ph] customer relationship. We continue to see a very soft natural gas and electricity wholesale market, which put some pressure on our business. While these conditions persist, our customer growth and resulting growth of our embedded margin indicate that Just Energy's future is bright.

As in the past, we have adjusted our business model to changing market realities and are working to ensure that customer and margin growth lead to bottom line results. Strategic investment today will lead to a stronger balance sheet and higher returns in coming years.

Let me finish on this note. I want to be clear that we do not see any fundamental problems in our core business. Our customer additions are strong as they have ever been. Our cost of signing each high-margin residential customer is down 22% year-over-year. Our attrition rates and renewal rates are improved and are at the best levels in the last 5 years. People will note margins appear weak. This is not due to our core business.

Year-to-date, our electricity margin is 18%, the same as fiscal 2012 and up 1% from fiscal 2011. Our natural gas customer margins percentage is 16%, the same as fiscal 2012 and up 1% from fiscal 2011.

The quarter saw our overall margin down $5 million year-over-year. To be in an our annual guidance of 10% after quarter, we would have had to be up $1.5 million in margin. Why were we not at guidance for the quarter? As I noted early -- earlier, this weakness can be clearly attributed to 4 either noncore or nonrecurring areas: First, our ethanol plant, where margin was down $4.3 million. This is a noncore asset for us and it only has nonrecourse debt associated with it. To the extent that the ethanol industry does not recovery in the near-term, the plant will no longer be able to service its debt. It is our intention to not provide any supplementary refinancing to the plant. In other words, in the worst case closing the plant, we would remove $64 million of debt from our balance sheet at the cost of $3.1 million of EBITDA in the last 9 months.

The second area of margin weakness, the nonrecurring $8 million timing difference on our weather hedges. This is the nature of weather options and will result in less volatile -- volatility going forward as the relative size of our gas book continues to shrink. We do not anticipate another record warm winter, but there will always be some weather variance in our book.

Third, we had a $3 million swing in U.S. currency exchange year-over-year. This adversely impacts margins, but we have no real losses. We have never repatriated any of these dollars. All were spent on U.S. marketing expense and G&A. Had we done the calculation at today's exchange rate, this margin loss would disappear.

Finally, we made a decision to limit the number of new Momentis agents in the quarter, feeling we have reached critical mass. This meant that fewer chip sales to these agents reduced what we call other margin by $2 million versus the comparative quarter. These noncore or nonrecurring issues reduced reported margin by $17 million, which added back -- brings us within our guidance. The shortfall is entirely in noncore segments of our business. Our core business was right in line with our expectations.

The driver of long-term value is growth in our customer base and relative growth in embedded margin. Both are double-digits year-over-year. The real question is, is Just Energy creating value? The simplest measure creating -- created value is future embedded margin, which the undiscounted margin locked into our current customer contracts. At the end of 2010, our embedded margin was $10.08 per share. At the end of fiscal '11, it was $12.34 per share, up 22%. A year ago, it was $13.56 per share, up 10%. And today, it is $15.19, up 14%. This is steady creation of real value by Just Energy.

Let us look at what we are saying about our future with our target payout ratios. Our funds from operations for the last 12 months was $103 million. Our new dividend is $121 million. To bring our payout ratio to a target of less than 100% next year, we would have to grow FFO by 19% in one year. This is substantial growth reflecting the growth in embedded margin I just spoke about. We also see reaching our payout ratio of 60% to 65% by fiscal 2016. That would require us to increase FFO by 82% over the next 3 years. Combine this with what we -- what will be an 8-percent-plus dividend and you have a high gross stock with a very high yield by any measure. To say that 2 quarters of slow results from noncore businesses somehow offsets our embedded margin growth over 5 years and our substantial growth inherent in our book for the coming year is, in our view, very shortsighted.

This is a message we want to leave you with. We steadily increase the long-term cash flow of our business and intend to continue to do so. With a more sustainable capital structure, we will assure that we have the funds to support this continued growth and the result we'll return to shareholders. The future is bright for Just Energy.

And we will now open for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Nelson Ng with RBC Capital Markets.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Just in terms of the dividend and payout ratio, let me just summarize. So for fiscal 2014, it will be less than 100%, and fiscal 2016, it will be about 60% to 65%. Is that right?

Kenneth M. Hartwick

That's correct.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay. In terms of the other kind of cash flow items for like below the FFO line, such as like contracted, sort of capitalized commissions and things like amortizing debt repayments, will those items like pressure your cash flows? Like I'm just kind of trying to -- I'm trying to figure out whether the cut is large enough?

Kenneth M. Hartwick

Yes, I think it is. If you're referring to really, what else is going to be below FFO with regards to CapEx-related expenditures, then I don't think there's going to be a material difference in the 2 as again, outside of the NHS, National Home Services type of products, which again, we have a financing vehicle in place through Home Trust in Canada. We don't have a lot of other cash-related items go below that FFO line.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay. In terms of the trip participation, what's -- -- can you let me know what the current participation level is?

Rebecca MacDonald

Yes. It roughly worth as to $10 million a quarter. That's what we've been seeing, Nelson.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay. Then my next question, just moving on in terms of a water heater acquisition, I think you did a small acquisition and the average life for those water heaters was about 7 years. Are those customers locked into, let's say, an original 15-year contract, or could they leave at any time?

Kenneth M. Hartwick

No. Their contract life is almost identical to ours, the ones that we sign up organically.[ph] So they do have, I think, it actually is -- actually 15-year contract life.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay, got it. And just one more question before I get back in the queue. Regarding the weather hedges, like how is the winter shaping up this year? I noticed that only about $0.9 million of the potential weather derivatives is, I think, a $20 million payout was received, so that implies that the winter has been okay, or how is Q4 looking?

Kenneth M. Hartwick

Right. So the way the weather hedge works and this is across each of quarters is we will always retain the first $3 million of weather exposure, and then the weather hedge protects us above that up to the cap of $45 million which is what we have in place. So Q3 was slightly warmer than normal, which is why you have the $3 million, plus the roughly $1 million of the weather hedge that we utilize. January was between 7% and 10% warmer across markets. February is looking very good so far. If you look out your window, right now, it's, for most people anyway, it's -- it is looking like a very normal, if not a little bit colder February than historic norms.

Operator

[Operator Instructions] And we have a question from Kevin Chiang with CIBC.

Kevin Chiang - CIBC World Markets Inc., Research Division

I just had a quick question on NHS. I'm trying to get a sense of the cash flow profile here. If I'm not mistaken, and correct me if I'm wrong, I believe currently, you're not generating any cash flow based on how your agreement with Home Trust Company is currently set up, given it's a relatively new venture. But when I kind of just -- when I look at your gross margin on a trailing 12-month basis and I back out selling expense, G&A, interest expense, it's such a good business that's not -- from my perspective, not generating any operating cash flow. But can you just reconcile that for me? I'm just trying to get a sense of, I guess, what the operating cash flow could look like for this division given it's a huge growth profile for you guys?

Kenneth M. Hartwick

Right. So if we start with the Canadian for -- under the Home Trust capital structure, the financing, we actually -- for every water heater we install, we get back around 120% of the cash that we have put out to install the water heater under the financing arrangement. And then in return, we pay that back over, I think, on average around 7, 6.5 years to pay back the cash flow. So each one we install, we actually get the funding back of more than what it costs us to put that in. So that's what you see in the cash flow and then it gets amortized back through for accounting purposes, the cash payments relative to the margin we're going to receive from the customer against that cash flow. So it's a very efficient cash usage model for us because we are constantly getting the funding to then install the next water heater under the program. And as I referenced in my comments, as we look to build the asset part of our business into the U.S. to integrate with our other customers, I think we'll go through a period of time where we will do the funding of that rather than Home Trust into the U.S. until we get something similar financing in place in the U.S.

Rebecca MacDonald

And I would just like to add one more thing that any incremental increases on the rental basis year-over-year are repaid by us. They don't go to Home Trust.

Kevin Chiang - CIBC World Markets Inc., Research Division

That's good to know. And so what I'm trying to, I guess, get a sense of as you look over this business longer term, it seems like right now, on an accounting basis, at least the way I see it in your MD&A, it looks like it's effectively a business that's just breaking even, i.e., if I take the gross margin and then back out your selling expense, G&A and interest line and maybe the amortization, it looks like you essentially get to a number close to 0. When I think of the longer term, it sounds like I should, or I guess you guys are modeling a situation where gross margin growth will outpace the line item, the expected [ph] lines below that?

Kenneth M. Hartwick

Right, yes. And I think, Kevin, the other thing, because of the nature of the asset intents [ph] versus our commodity business, is we've always said the payback period for that business is going to be 4 years. So yes, I think if you look at it and say technically, you don't get your money back until you are 5 from an all-in cash standpoint in absence looking at the financing.

Kevin Chiang - CIBC World Markets Inc., Research Division

Okay. And then -- just quickly on your customer growth on the core energy business, you guys have obviously done a good job here over a number of quarters in terms of adding to that customer base. How big can this grow? I mean, I know you're moving to the U.K. Given the challenging weather environment, given, I guess, what's been a relatively tough renewal environment, given the disconnect between spot price and some of your contract pricing, when does this eventually flatline? And especially the risk related to that when you consider, at least internally here, we're not assuming any type of real pickup in commodity pricing. Can you kind of comment around those various variables and the risk to that operation?

Kenneth M. Hartwick

Yes. It's actually what, I think, we are most proud of the organization, which is why a lot of -- both Rebecca and my comments were around the core part of our business is we've had a low commodity price environment for -- since 2008 or 2009 or late '08, early 2009. And we've been able to adapt our products to customers, adapt our sales organization to have strong growth and accelerated growth the last couple of years across each one of our sales channels. So and on the point on the customer retention side, I think this is something we spoke to a couple of years ago is when we first had renewal issues, particularly on our gas book, we said at the time that we saw that once our entire book of customers that repriced onto more, call it, current market prices that we would begin to see renewal rates go up and they have. We would begin to see attrition rates come down and they have. So the actual customer churn retention part of our book has steadily improved. And again, creates that value and embedded margin and we don't see that doing anything but improving going forward. And with respect to customer additions, how much more could we add if we're sort of consistently now in that 340,000, 320,000 range as far as gross customer additions. We feel confident that we can grow that pace maybe mid-high single digits going forward for the foreseeable future.

Rebecca MacDonald

And just to add. If you look at our organization historically, and if you even look at just the last couple of years, I know it's always difficult for you guys because there are no direct comparisons to us in the marketplace. One of biggest strengths we have is our sales organization and our ability to market the product whatever the product is and that's not going away. As a matter of fact, I think we should have been able to fine-tune, expand and find even different ways of selling the product and what, in my opinion, you can look forward in the next 2, 3 years is management desire and willingness to expand different sales channels even more. And as it happens, we will be announcing it. So I don't think that we expect any weakness there.

Kevin Chiang - CIBC World Markets Inc., Research Division

Okay. And maybe just lastly for me, given the announcement on the dividend cut. I guess, as you sit here today, maybe you can prioritize for me how you view your use of cash flow, i.e., from paying a dividend, buying back shares, funding growth and deleveraging the balance sheet. Is there a way to prioritize that when you look at, I guess, finite resource in your cash flow?

Rebecca MacDonald

Well, I would say -- first of all, we have been paying this -- I mean, we have been paying dividends for 12 years, so we take this very seriously. This was not a decision that was made overnight. Analysis were taken and our priority for the cash that will be -- excess cash that will be generated really is around our growth. That's number one. Number two, as I said when I opened up this call, we wanted to set a dividend policy that's sustainable over long period of time. And number three, is everything else that you mentioned: buying back shares, as well we wanted to get into below 100% FFO, and basically wanted to get in a much stronger balance sheet position. So those are our priorities. Company of our size needs cash to grow and we want a clean balance sheet on going-forward basis. So I know that nobody likes a cut. I am the one that probably likes it the least because I haven't sold the shares for over 10 years. And I know that my personal income is going to drop, but I am very confident that it is definitely a right decision for the longevity of the business and the growth that we want to experience in the future.

Kevin Chiang - CIBC World Markets Inc., Research Division

What gas price do you assume when you kind of look at your -- when you make that comment that the dividend is sustainable through a cycle. Do you presume that gas prices stay where they are or commodity prices stay where they are today? Or do you assume some sort of improvement in the commodity price environment? I mean, how much does commodity price play into that forecast?

Kenneth M. Hartwick

No. We assume that gas -- which we've done for the last 4 years, we assume that gas prices will stay where they are now and no change. We've built the business around that, our cost structure, our product offerings. And to a large degree, although electricity is more volatile than gas, it does sort of reflect it a little bit and we assume the same thing on power prices. So no, there's no built-in assumption of commodity prices changing from where they are.

Rebecca MacDonald

I can assure you that the board looked at a very, very conservative assumptions and the board looked at many different variables before they concluded that this was the right thing to do.

Operator

Okay. Next up we have Trevor Johnson with National Bank.

Trevor Johnson - National Bank Financial, Inc., Research Division

Just with regards to your U.K. fran. Can you just speak about your U.K. franchise and how you see that business evolving with regards to maybe customer aggregation being the first point and if you can share that? And then I guess, secondly, is the potential to maybe expand into other geographies in and around the U.K.?

Kenneth M. Hartwick

Sure, Trevor, I'll start off with the U.K. We launched operationally there in July of last year of 2012, and commercial-only to start. And our intention was to build on a good foundation of an employee management base, as well as a good understanding of the market from a commercial standpoint and we are very, very happy with the results. It's a well-established market, very similar to Texas. And we -- and probably from a customer standpoint, is the same size as Texas and New York combined. So we see a lot of potential. We are very happy with the early results. But we said we're going to go very slow there because we want to make sure that we are learning the market, building the customer relationships and broker relationships on the commercial side that we want to be able to do. I think at some point in the next 6 months, we will probably begin to open the residential side of that business and begin to add that into our customer offerings there. And again, that's really premised on the team that's on the ground there, continuing to build that team out. So we do that as just another really big, solid and well-regulated market for us to grow both parts of our business in. With respect to other geographic expansion, I don't think beyond the U.K. for the next couple of years we will not go anywhere else geographically. It's something where we would want to be in the U.K. for probably 2 or 3 years before we would ever look at another market. We're in no big rush. You would look across the North American marketplace and say we probably have 4% or 5% of market share so we can have significant growth in North America and the U.K. for the next number of years before going to another market. I think more of our focus, as Rebecca has mentioned, is on other products into the house in North America and that's where we want to devote our time. Because we think it does 2 things, improves the economics of the relationship with the customer, related products like what we do with NHS and Smart thermostats. And we also think it has a very meaningful impact on customer churn. So you'll see us talk more about that as opposed to the next country that we might go to.

Rebecca MacDonald

And I would just like to emphasize, more and more and more over the next 5 years you're going to be hearing the same line from us. We want to own customer basement and we want to own the basement of the customers that we have presently on our book. And we want to expand, obviously, in the jurisdictions we operate. But the key will be owning that basement and having numerous products going in there. That's definitely the focus of the management for the future.

Trevor Johnson - National Bank Financial, Inc., Research Division

Excellent. And then I guess, with regards to just going back to the U.K. for a second, are the economics and the nature of your wholesale partnership with Shell Energy Europe, is that consistent with what we see with your North American partners? Or is there any nuances or any differences that maybe we should be made aware of?

Kenneth M. Hartwick

No, I think we were delighted with the announcement that we put out on Monday with Shell. They were -- when Rebecca founded Just Energy back in 1997, Shell was the anchor partner that we grew the business off of. The relationship with them has been great over 15 years that we have been in operation, and they were just a natural partner for us to want to build our U.K. presence with. And again, they took a very long-term strategic view as well. They recognize that we want to build out our U.K. business for the next 2 or 3 years. And -- but they also have aspirations to be with us to grow in other countries in Europe. So we -- the terms of the supply are -- the only difference is really the market specifics around them. But otherwise, the structure of it, the no need to post collateral, all those types of arrangements are identical to what we have in North America. And like I said, we are -- that has given us now the platform to take and grow the U.K. business in, and as I said, longer-term, other places into Europe as they become relevant for us.

Rebecca MacDonald

And I've got tell you from board perspective, our board is incredibly pleased that we were able to finalize this agreement with Shell because it's just the last piece that we wanted for future growth in Europe. So it's a wonderful arrangement that we have in place.

Kenneth M. Hartwick

And Trevor, your question on margins. In the commercial business, I think what we're seeing so far, although it's relatively small, is actually a higher margin profile than what we see in North America. So -- and we have some insight into what residential margins look like and we would be very satisfied with the residential margin potential in the U.K. when we open up that market.

Operator

Okay. Next up, we have Mr. Robert [indiscernible] Claris Wealth Management.

Unknown Analyst

How many shares owned by management and the board participate in the DRIP program?

Rebecca MacDonald

I know how many I own. I own 6.7 million shares.

Unknown Analyst

And do you participate in DRIP program?

Rebecca MacDonald

I don't participate in a DRIP program. I do not.

Kenneth M. Hartwick

I just got to say, I don't think we know which of our employees and/or management participate in the DRIP program. We have an employee share ownership program, which we also run, which the company and manage -- if your Manager can contribute 2% towards. And I would say all of the senior management participate in the share ownership plan.

Unknown Analyst

With respect to your decision to cut the dividend, are you making any assumptions with respect to the DRIP participation changing going forward?

Kenneth M. Hartwick

No, I think when we set up -- looked at sort of the variation on that, I think we're comfortable that DRIP were to, I think more relevant if the DRIP were to decline slightly or decline. So we looked at it, and we think we have flexibility within the change to the $0.84 to reflect that perhaps -- again, if it were to decline from its current level that we're still very comfortable with what we set it at. Obviously, you said, the DRIP level increases for a period of time, then the cash impact of that is the other direction. So yes, we did look at it and yes, we're very comfortable with the level we set.

Unknown Analyst

In terms of the decision to cut the dividend, was it a unanimous decision at the board level?

Rebecca MacDonald

Well, we have a very interesting board, a very strong board. There was a lot of discussion that has taken place around this over the last 3 months. And when the vote was taken after 3 months discussion, it was unanimous decision.

Kenneth M. Hartwick

Yes, and I think to add to that, the real unanimous part of our board and the entire management team is the belief in what we're doing for our customer and segment part of what the company has moved to. And including the belief that we need to expand the product lines we are offering in order to continue to grow the company in these segments that we're in. And that part is extremely [indiscernible] across-the-board to continue to evolve the company.

Rebecca MacDonald

And you know what, I think the fair addition to our answer would be as well. The board has been looking at analysts reports over the last couple of quarters and our board members take their job to heart, and they looked at concerns over assets above 100 payout ratios. That was one of the things that they have definitely looked at and they looked at the balance sheet issues. So they -- when they combined those, with growth, that made it a unanimous and easy decision for the board.

Operator

Okay. Next up, we have Mr. Nelson Ng with RBC Capital Markets.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Just in terms of annual gross margins per customer, I think that the trend, in general, has been that the additional -- the gross margins for the additional customers has been kind of lower than the gross margins for customers that are at a loss during the period. Are they -- like, at some point, when do you expect them to generally be equal in terms of the margins, the margins for customers coming in equal into the margins of the customers leaving?

Kenneth M. Hartwick

Yes, Nelson, I think if you go back to my earlier comment that when we have customers coming off of very high commodity prices that have come through the renewal process, of which we would have perhaps another years' worth of customers coming out, those customers inherently had higher margins on them. And so I think on the residential side of our business, that's something where we're getting pretty much to a normalized basis within the next year or so, that you should start to see that customers added on the residential side would be very close to the customers peeling off out of that nonrenewal bucket. On the commercial side of the business, again, it's more competitive by its nature and that we've seen some pull back on the margins there. But that's part of the business. We built the cost structure of that business to be very advantageous at the levels it's at and again, we'll work to improve those over time as well.

Rebecca MacDonald

And I think that over time, we have told everybody that as our commercial book of commercial business grows and commercial customer number grows with the lower commercial margin, overall margin will be pulled down just because of the percent between commercial and residential business. And numbers are very clear. Our commercial book is growing very rapidly and that's just nature of the book, two different types of customers that you're dealing with.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay, got it. In terms of the commercial customers you mentioned that there is more kind of competition. From a high-level or industry perspective, is the higher competition due to like additional entrants coming into the market? Or is it just due to the dynamics of the low volatility of energy prices? Or like what are some of the contributors to increased competition?

Kenneth M. Hartwick

Well, I think it's really -- the primary factor is as we've grown our commercial business with the acquisition of Hudson and then with what the team has done on commercial, we've always had a strong basis we've set through that small, medium commercial, where the margins are better. But again, as we've grown, we've also said, we're going to move upscale on those commercial customers. Again, within segments that we like. So we don't like industrial, the big manufacturing, that's not a business we're in. But to move into bigger customers like a school board that might be the equivalent of 5,000 or 6,000 RCEs. We're now able to move into that segment. Margins are lower on it, which drags the average down on the surface but the cost to serve that customer is incredibly efficient. And that's really some of what you'll see within our commercial businesses is both as we grow and become a bigger market participant, we are going to bump into those higher, more competitive bids. But on -- like I'd say, on our cost to serve are very effective for us. And that's in part why you see the commercial margins coming down. Now definitely, it's a competitive marketplace. And as we move into that segment that I just referred to, we do run into the bigger players like Constellation, like Suez, who will be more competitive, but again, we like the economics of it and we're going to continue to go there.

Rebecca MacDonald

And we said to the market time and time again, that our belief is that in the future, North American markets will be served by 5, 6 large players. Of course, we are one of them, but as Ken pointed out, Constellation and SUEZ and NRG are very reputable, good players and we welcome good competitors. It's very, very healthy for the marketplace.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay. So what I'm hearing is like if you stay within the small or midsized commercial then competition is -- hasn't really necessarily increased. It's more about you targeting larger customers whereas in those areas there is more competition?

Kenneth M. Hartwick

Sure. Yes, absolutely. And like I said, the commercial business gets bigger, stronger, more effective. We just figured out that's a natural place for us to continue to go. Let's say the economics of a $40 margin on a 5,000 RCE school board is very, very good for us as a business.

Nelson Ng - RBC Capital Markets, LLC, Research Division

Okay. Just kind of switching gears a bit. In terms of the Fulcrum acquisition in 2011, there was -- there is -- I think, you're expected to earn or pay about I think $4 million earnouts out of a potential $18 million earnout. Does that imply that the acquisition or the performance of Fulcrum is not doing as well as expected? Or how do -- can you give me a bit of color on that?

Kenneth M. Hartwick

Sure. When we acquired Fulcrum, it was for 2 specific purposes: One was the affinity side of the business that they are -- they had in place; and the second was around the specific access into the Asian part of what we do or part of the segment of the business. We put that earnout in there for a very specific reason, that we said how fast did the group at Fulcrum expect to be able to expand that business outside of North America because it's Texas-centric at the time. And again, from an acquirer's standpoint, we said if the excess performance could be achieved, that's great, we're willing to pay for it. And if it didn't, that's fine as well. But the effective amount that we would pay out under that earnout, combined with the purchase price we did pay, we're very pleased with the acquisition. We see very strong inroads into the affinity side of our business. We have a series of affinity partnerships that have now been struck nationwide, predominantly in the U.S. that we are very, very excited about and aligning ourselves with other brands and other companies. And again, it has outperformed in Texas, which is -- was its' biggest market. And the underperformance side really has come from the speed of us being able to use their -- the sort of an Asian part of their marketing process into the Northeast. That's why we put the earnout in place where we did the acquisition. So on balance, we're very happy with what we'll end up paying for the company and what it's done and very excited about the expansion of the affinity program which again, is one of the sales channels that will contribute towards the growth that we have.

Nelson Ng - RBC Capital Markets, LLC, Research Division

And just one last question. You guys mentioned that you want to own the basement and focus -- or put more focus on smart meters. How many smart meters have been deployed to date?

Rebecca MacDonald

Are you referring to smart thermostat, not smart meter?

Nelson Ng - RBC Capital Markets, LLC, Research Division

Yes. Sorry. Smart thermostat. I'm sorry.

Kenneth M. Hartwick

So we've installed, probably as of today, around 2,500 in Texas and Ontario, which is the 2 markets that we are -- wanted to run the process initially, both have different dynamics. In Texas, we bill and Ontario, we bill through the utilities. And like I said, why we're excited about the program and we'll expand it very rapidly really across every jurisdiction that we operate in over the coming years, is that we see a couple of things: It is definitely prodding the relationship with the customer and changing the discussion with the customer, which is what we want to do. And we've always been a company that said, we will come in and fix your price or give you price certainty in some manner. Increasingly, we see customer behavior also saying, "Can you just help me use less?" So help me use less or use it in a different period or help me participate in the case of Texas, in demand response programs where there's significant upside for the customer and us to help the customer use energy in a different time during the day. So like I say, we're early stages in this but we are convinced that this is a material change for the company that will have a significant long-term impact. And we're just going to, like we've done with every other part of our business as we build it out in Texas and Ontario, and get sort of all the underpinnings of our customer information system in place to support it, then we'll go into the next state, the next province, and the next state after that. And 3 years from now, it will be a staple in every state and every province that we operate in.

Operator

Okay. Next up, we have Damir Gunja with TD Securities.

Damir Gunja - TD Securities Equity Research

Just follow up on the commercial margins. I guess, you refer to them stabilizing around the $64 per C level. Is there a scenario where, I guess, if you continue to pursue maybe some of these larger customers you alluded to that, that number could possibly drift further lower?

Kenneth M. Hartwick

No. We don't actually think so. But actually, sort of we think it stabilize in and around the $70, $75 range, is what we would expect. So for the next quarter, whether we're within that range, within a few dollars is fine. But -- and as again, as that segment of our business continues to perform as strongly as they are, you'll see us also then capturing that smaller, higher-margin segment. And again, I want to make sure everyone is clear on my comments. We have no intention of going upscale further into industrial, into manufacturing type of business. It is not our core customer, but it is those customers that have a very low cost to serve and a very low credit profile -- or high credit profile from a business standpoint. But Damir, I think long-term, we would say $70, $75 is a very comfortable range for us over the next number of years.

Damir Gunja - TD Securities Equity Research

Okay, well, that's encouraging. And I guess, maybe part of that is maybe competition easing up at some point or?

Rebecca MacDonald

Well, Damir, where there is money to be made, I don't think you're going to see easing of competition. I don't think we are counting on that. I think they have -- we've seen a lot of consolidations in the last couple of years and I would say that competitors that we have right now, most of them are still going to be around. We can't see that they will be exiting because it's a profitable business and companies like making money. Market is -- Damir, market is very big and it cannot be served by one company, so that's just nature of the beast. I would be very concerned if we were the only player in that segment. That definitely would concern me but the fact that people like NRG or Constellation as well, very much interested in what -- in the segment that we are playing in is good for everyone.

Damir Gunja - TD Securities Equity Research

Actually, that ties into something I was going to ask you guys. I guess, you've adopted the rights plan maybe somewhat related to that. Can you guys just talk about the overall industry dynamic? Are there utilities now looking at moving downstream or maybe producers that are looking at moving downstream? Have there been any assets that have traded in the market or any sort of big macro movements that you could touch on?

Kenneth M. Hartwick

Yes, Damir, I don't think so. I think what we are seeing is really the consolidation of activities around a handful of very big participants. And as Rebecca said, it's NRG, Direct Energy, Constellation, which is part of Exelon and someone like FirstEnergy. So we don't really see a lot of others stepping into the marketplace. There's always going to be smaller participants, whether they're private or -- that sort of, are regional in nature. But those guys, we don't see them having a long shelf life in part and I think for the industry as a whole and this is at a very macro level. I think if you are not able to evolve into managing the volume side of the customer, so control of that basement, then I think longer-term, I don't think the smaller retailers are really going to be relevant to the industry.

Rebecca MacDonald

And what I would just add to it, the only caveat is it's always possible for foreign company to make a decision to -- or step into the retail sector in North America, and that's speculation on my part. But you have mainland Chinese people that are constantly looking what other business they could get in, in North America. And in the next 2, 3, 4 years, it's possible that they will step in. But from a producer's point of view, I don't think most of them want to be there. And I think that you just look at Shell. At one point of time, Shell had SESCO and they walked away from it. So I don't think we're going to see much change.

Damir Gunja - TD Securities Equity Research

Okay. Just a couple final ones for me. What, if any, competition do you have on these smart thermostat business line?

Kenneth M. Hartwick

Yes, it's the -- I'd say from a retail sector standpoint, Direct Energy and NRG are both active with it, I'd say it on a relevant basis. And then I'd say our other level of competition on smart thermostats is really from places like Best Buy, where our consumer can go in and decide to get one. Why I think that is a far distant and less relevant competitor is, unless the customer is given the ability to participate in demand-response type of programs, they're really not going to achieve some of the benefits that they are able to achieve. So I think this is going to be a product that needs to be pushed and explained versus one that's on store shelf and people realize they should go get one.

Damir Gunja - TD Securities Equity Research

Are the incumbent utilities, I guess, potentially competitors there?

Kenneth M. Hartwick

They might install a smart thermostat, which I think in Ontario, for instance, they've been running a program where you get a rebate from the Ontario Power Authority. I think if you talk to incumbency utilities, nobody has really done it. But again, if you go to a consumer and say, I can help you manage your energy properly and I can give you a benefit if you participate in the demand-response side of it, which the utilities do not do, then that becomes a value proposition to the customer. And that's what I'm saying, the value needs to be pushed, not put on a brochure or on a store shelf.

Rebecca MacDonald

Damir, you have to appreciate, it's really targeting customers that are willing to change their behavior around their energy use, right? It's not me. I will never change my behavior. I'm terrible like that. But is it going to be my son? Absolutely. So I would say that there's a large segment of North American population that's very willing to change their behavior around energy management, and we want to be there.

Damir Gunja - TD Securities Equity Research

Okay. And just a final one. I guess you've kind of implied some forward guidance with your -- with the payout ratios you're sort of referencing. With the year-end or the Q1, will you be providing a sort of a 2014 growth view?

Kenneth M. Hartwick

Damir, we've not decided what we're going to do on guidance for the year-end. So you'll need to -- we thought sort of giving the range of the payout ratios of what we expect to get to should give people enough of a path forward and that combined with the fact that the dividend we will continue to pay will place us among the highest, if not the highest yield on the TSX, should be enough to bridge people through until the year-end.

Operator

Okay. Ladies and gentlemen, our time has expired for this webcast. I will turn it back to management for closing remarks.

Rebecca MacDonald

Thank you very much for joining us on this call. If by any chance, any of you have additional questions, Ken, Beth and myself are available, so feel free to call us at any time. Look forward talking to you at our next quarter. Bye-bye.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Just Energy Group Management Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts