Gas Natural's (EGAS) CEO Gregory Osborne on Q2 2014 Results - Earnings Call Transcript

| About: Gas Natural (EGAS)

Gas Natural Inc. (NYSEMKT:EGAS)

Q2 2014 Results Earnings Conference Call

August 15, 2014, 10:00 AM ET

Executives

Deborah Pawlowski - Investor Relations

Gregory Osborne - President and CEO

Jim Sprague - VP and CFO

Kevin Degenstein - COO and CCO

Analysts

Mike Bates - Wunderlich Securities, Inc

George Walsh - Gilford Securities

Gregory Macosko - Montrose Advisors

Operator

Greetings and welcome to the Gas Natural Inc. Second Quarter 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Ms. Deborah Pawlowski, Investor Relations for Gas Natural. Thank you, you may begin.

Deborah Pawlowski

Thank you, Melissa, and good morning everyone. We welcome you here to our second quarter 2014 earnings teleconference call for Gas Natural. On the call with me today I have Gregory Osborne, President and Chief Executive Officer; Jim Sprague, Vice President and Chief Financial Officer and Kevin Degenstein, Chief Operating Officer and Chief Compliance Officer. Gregory and Jim will review the second quarter results and also give an update on the company's outlook on strategic progress.

You should have a copy of the financial results that were released yesterday afternoon and if not you can access those at the company's website which is www.ewst.com.

Before Gregory and Jim get started, I want to bring to your attention our Safe Harbor statements, which is available on page three of our press release. If you are aware we may make forward-looking statements during the formal discussion, as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ from what is stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can also be found on the company's website or at sec.gov.

So with that, I'll turn it over to you Gregory to begin.

Gregory Osborne

Thank Deb and good morning everyone. Appreciate you joining us today. It continues to be an exciting time for Gas Natural. We are transforming Gas Natural into a more transparent organization based on trust and credibility with employees, regulators and shareholders.

Joining us today on the call is Kevin Degenstein, who returned to the company in the capacity of Chief Operating Officer and Chief Compliance Officer. We are thrilled to have Kevin back as an integral member of our executive team.

He will be the face to regulators in all of our jurisdictions and unlike the situation was for historically, he will also have the reasonability for the higher operations.

I will let Jim further - go further into the financials, but we grew full-service distribution throughput by 11% and Natural Gas operations gross margin by 18%.

Although we had a net loss of $1.4 million that includes a $700,000 after tax, bad debt expense for large investor customer and bankruptcy located in Montana. We also had higher legal and professional fees for more than the normal amount of regulatory activity.

Our focus is growing in areas where we can get strong returns on our invested capital. During the quarter we installed several miles of pipes and had higher throughput of 1848 million cubic feet for full-service distribution primarily in Maine, North Carolina and Ohio.

There are approximately 73,000 customers at the end of the second quarter up from approximate 72,000 at the end of 2013. Our customers appreciate the benefit of cost effective and clean natural gas. We are actively expanding our systems especially in North China and Maine, to meet the higher customer demand for natural gas service in those two underpenetrated and higher gross market areas. We are also making progress on the regulatory front.

The commissions to deliberation in Maine resulted in alternative rate plan and arrangement with respect to our Bangor Gas subsidiary. This plan incentivizes us to continue to increase our pipeline of services by locking in an alternative rate plan for a period of seven years and importantly eliminated any earnings sharing mechanism.

Also we will work with the staff to implement service related standards, so customers will know what to expect of our gas utility.

You may recall that we're converting our Loring pipeline in that region to natural gas, and completed activation of Phase 1 which spans 60 miles.

We're prepping that section, are on the schedule for going inline the fourth quarter of this year. We are simultaneously working on Phase 2 which involves preparing another three miles of pipe for activation. We expect activation on that section to being complete third quarter of 2015.

We reached stipulation agreement with North Carolina Public Utility staff for our Frontier Natural Gas subsidiary. There we now have locked rates in for five years protecting our returns.

As part of the overall arrangement and to settle our gas cost accounting review we did the sales of $2.45 million regulatory asset, reclassified from our deferred gas account. That new regulatory asset account will be amortized over five year period which began in July. We did retain $1.35 million deferred gas account balance that will be recovered through 2014.

As previously indicated, we expect that ongoing investments such as in these markets will drive our annual customer growth by approximately 4% to 5% per year. While we continue to actively seek and evaluate potential bolt-on acquisitions to complement our organic growth, we also evaluate our assets for rationalization opportunities.

There's been quite a bit of excitement in 2014, some more dramatic than others. We believe we have the leadership team to move beyond that noise and remain focused on delivering results. We are tightening up our internal processes and procedures and increasing our transparency, all while we continue to invest in our utility operations in this field. Clearly we are busy, we are excited and are moving in the right direction.

With that, I'll turn it over to Jim to summarize our financial results. Jim?

Jim Sprague

Thank you, Gregory, and good morning everyone. Thank you for joining us today. As Gregory mentioned, we had a solid quarter aside from some unusual charges.

Our revenue for the second quarter grew by over 9% to $22.4 million with increases realized in all our geographic markets. Revenue from our natural gas operations in Maine, North Carolina and Ohio improved by $1.7 million, due to increased natural gas prices passed on to customers, as well as continued customer growth.

We realized $1.3 million of revenue growth in Montana and Wyoming driven primarily by higher gas prices. As you may know, increases in our cost of natural gas are direct pass-through without offering opportunity for margin expansion.

For the first half of 2014, our revenue grew by over 36% to $87.4 million. In addition to the growth in the second quarter that I just mentioned, you may recall that our first quarter also benefited from customer growth and increased gas pricing as well as colder than our average winter weather in most of our markets.

Our consolidated gross margin grew by nearly 13% to $9.2 million in the second quarter of 2014, compared with $8.2 million in the prior year.

On a year-to-date basis gross margin grew by 13% to $28.1 million. Both period benefited from our increased customer base.

Our operating expenses for the second quarter grew by $2.7 million or about 33% over the prior year quarter to $10.9 million. The increase was driven primarily by a couple of factors. First, a $1.1 million as a bad debt charge for a large industrial customer in Montana, who is in bankruptcy, which we consider unusual.

Energy West Resources was under contract to provide natural gas to an industrial customer in the Great Falls area. The customer ultimately filed bankruptcy. The volumes were billable whether they took deliver or not and were identified as an administrative claim during the bankruptcy procedure.

The receivables under the contracts were booked previously, at the last hour the bankruptcy judge rejected the contract. EWR had to book an uncollectible account expense.

The second factor, increasing expenses by $1 million of higher professional and legal fees related to increased regulatory proceedings and investments in people and processes to improve our controlled end procedures.

And lastly, by $300,000 of higher depreciation expense resulting from increased capital expenditure investment in our utility infrastructure.

For the first half 2014, operating expenses grew by $4.7 million to $20.9 million for the same factors. In addition to the bad debt charge I just noted, professional fees and cost for people and process increased $1.6 million and depreciation expense increased $600,000.

Operating loss for the second quarter was $1.6 million compared with about breakeven operating income in last year's second quarter. On a year-to-date basis, operating income was $7.2 million compared with $8.6 million last year.

Net loss for the quarter was $1.4 million or $0.14 loss per diluted share compared with $300,000 loss last year or $0.04 loss per diluted share.

For the first half of this year net income was $3.6 million or $0.34 per diluted share, compared with $4.5 million or $0.53 per diluted share last year.

It should be noted that the current year period reflects approximately 2 million more shares than last year's periods reflecting our second half 2013 equity issuances. The unusual item add a point - $700,000 or $0.06 per diluted share impact on earnings during the recent quarter.

At the end of the quarter we had $3.2 million in cash and cash equivalents as well as $412,000 of marketable securities. At the end of 2013, we had $13.1 million of cash and $406,000 of marketable securities.

Our notes payable at June 30, 2014 amounted to $40.5 million or 41% of equity compared with our 2013 year end ratio of 45%.

Our first half 2014 CapEx amounted to approximately $10.9 million compared with $9.9 million during the first half of 2013.For the full year, we continued to estimate our CapEx to be between $16 million to $17 million focused on investments and earnings base.

We have construction activities in all of our utility service areas to support expansion, maintenance and enhancement of our gas pipeline systems.

With that, let's open our line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Mike Bates with Wunderlich Securities. Mr. Bates, please ask your question.

Mike Bates - Wunderlich Securities, Inc

Hello Kevin, can you hear me?

Kevin Degenstein

Yes.

Mike Bates - Wunderlich Securities, Inc

Yeah, okay, all right. So the $1.1 million bad debt charge for a customer in Montana, how much revenue or margin did that customer represent historically for you?

Kevin Degenstein

Historically represented nothing because of the fact that they had never fired, so it wasn't in the historical numbers.

Mike Bates - Wunderlich Securities, Inc

All right. Great, great. Okay. And it looks like Bangor Gas swung to a loss in the second quarter and Frontier's earnings dropped by half. I was wondering if you could give us a little bit more color as to what might have happened there, did you view it as unusual?

Jim Sprague

Yeah Mike this is Jim Sprague. As we noted in previous earnings call, there’s been quite a bit of regulatory activity as it relates to the rate case that's been ongoing for the past 18 months.

So, there’s been, as the negotiations were wrapping up there was quite a bit of additional activity there which created some additional expense in that regard.

In addition to that, there were some wrinkles that we are working out with gas cost computations that impacted the earnings as well. So, over a six months period you don’t look at just the quarter but look at the six months period, Bangor is actually ahead of their budget.

Mike Bates - Wunderlich Securities, Inc

Great. All right. And then it looks like marketing and production margins suffered again in the second quarter even setting aside the LNG business. Can you give us a little bit more color as far as what you are seeing there and has there been any change since our last conference call as far as your outlook for that business and whether you see a shift in the fundamentals that might make that segment more profitable for you?

Jim Sprague

Yeah Mike, this is Jim again. What we're seeing as is, with the continued lower price of natural gas at marketplace, it’s making it difficult to maintain the margins that we were when we had higher prices.

So, until we see that dynamic changing, we don't see that to be trending around anytime soon.

Mike Bates - Wunderlich Securities, Inc

All right. Great, great. I appreciate the update. You have said I believe that you expect CapEx at $16 million to $17 million in 2014, is it still too early to talk a little about what your expectations might be for 2015 CapEx?

Jim Sprague

What we are looking at right now Mike is, we have our debt coming due in 2017 and we are looking at going in overall restructure there, ahead of time frame to be proactive. I think at this point it's probably premature to give you too much guidance as it relates to 2015 when we start putting together more formalized budget. So I’ll be answer that question little bit more going.

Mike Bates - Wunderlich Securities, Inc

Great. Thank you very much.

Jim Sprague

You're welcome.

Operator

(Operator Instructions) Our next question comes from the line of George Walsh with Gilford Securities. Please proceed with your question.

George Walsh - Gilford Securities

Just so I could go back to us to clarify that in terms of the charge you said there was no historical, if I understood that correctly, no historical revenues with that client, that customer?

Kevin Degenstein

The client filed bankruptcy before they overall operated. Obviously, the post-petition charges were both and they were taken as an expense but prior to that there was no historical usage of that custom and the customer did not exist.

Deborah Pawlowski

This is Deb, maybe what you could do is just provide a little bit of color surrounding the customer, the pipes, the speed to customer, and that.

Kevin Degenstein

Sure. I can give a little background. The power plant in Great Falls area was built and they built themselves an 18.5 mile 12 inch. They were tied to the Energy West Montana System, and they filed bankruptcy before they ever went live.

It has started to recruit the Energy West Montana there and the bankruptcy process today. If they come out of bankruptcy and operate it in the future, the only real source of gas - natural gas they have is Energy West System as the industrial customer there is no obligation to serve.

So, we are in a good position to negotiate and if they began to operate should be able to negotiate a contract that is good for Energy West soon. We'll help earnings going forward.

If the plant doesn't operate, 18.5 miles of pipe, they are established today, thus serve existing customers, it will continue to serve existing customers that was the part of the negotiation of the initial building of the pipeline that the operator had with customers to gather easements and such.

So as it is, it’s a regulated pipeline today. And it will continue to serve going forward, regardless of how it comes out in bankruptcy.

George Walsh - Gilford Securities

Okay. So what is the charge? Is that cost you guys incurred that you can't collect on in terms of building the pipeline, or --?

Kevin Degenstein

It was essentially a take-or-pay contract. They did not take - the revenues were booked I suppose petitioned under administrative fees. And then at the final hour, I think Jim had pointed to was, the bankruptcy judge had determined that it wasn't correctable. And so it was on the books and had to be reversed but it was post-petition, take-or-pay fees that were put on the receivable side.

George Walsh - Gilford Securities

Okay. I kind of got it. All right, and the other thing just with the growth areas of like Maine and North Carolina. Would the existing customers -- actually the new customers, what is the add there in terms of type? Is it retail customers, bigger commercial customers? How is that developing there?

Kevin Degenstein

Yeah, this is Kevin I can speak to that. It's really a combination, we've had the opportunity in both locations to hook up commercial in Maine. We will be hooking up one large industrial. But we've focused on both commercial and industrial but stepping back and doing fill-ins the existing systems and grabbing residential.

So it’s been a nice blend of all three. I don't have the percentages off the top of my head but I know our focus has been to step-back and also get fill-ins with residential, which wasn't particularly our focus initially, but the opportunity is there now because it’s fill-ins.

George Walsh - Gilford Securities

Okay. And obviously during the quarter Algonquin Power & Utilities made inquiries regarding Gas Natural. So I just wonder if there was any other status update on that?

Gregory Osborne

This is Greg. Currently, there is nothing to inform the market on Algonquin as to speak.

George Walsh - Gilford Securities

Okay. One of the issues I think that comes up in the valuation of the company because there were numbers that were put out in their letter or the ideas that up to one point they were talking about $13 a share, but one of the issues with the company is that you have some understated pipeline assets there where your book value might be something closer to $18 or $19. And I just wanted to -- is that still valid? That is a question, is it still valid? And in various ways this is an undervalued company and that those assets are still yet to be fully exploited.

Jim Sprague

This is Jim. George, yes, as a matter of fact you're absolutely correct. We do have those undervalued assets in Maine and North Carolina that add value as well as our Spelman Pipeline asset in Ohio.

George Walsh - Gilford Securities

Okay. And is there anything where those assets would be -- anything coming up where they would be restated?

Jim Sprague

Not at this time.

George Walsh - Gilford Securities

Okay. And how are things with the -- anything additionally with the banks relative to those assets? I have asked that before but just -- when they look at you on the whole how are they looking at those assets?

Jim Sprague

Yes George. I guess I will back up just to make sure for the benefit of the remaining callers that may or may not have heard from us before or been interested in us. The assets in Maine and North Carolina were purchases part of transaction back in 2007.

The historical cost of those pipeline that had been installed by Sempra Energy were in excess, between Maine and North Carolina in excess of $120 million to $130 million. And we purchased those, both of those utilities for $5 million.

So, due to the accounting rules that happened to be in place at that time, we had to record those assets at historical cost as opposed to, as the way rule of read today with the fairness opinion and recording at fair market value.

So, those two assets, of course were bought in 2007. There's been some level of depreciation since then. But these systems were put in the middle of 90s. So they were very new systems as they relate to natural gas distribution.

And then on the Spelman Pipeline we purchased a pipeline in traverses East to West in the heart of the Utica shale play in Ohio. And we also have continuous right-of-ways that allow pipeline to be installed continuous to ours. And we purchase that for $3 million for marathon and we've improved the pipe, converted it from an old oil pipeline and natural gas.

And right now we are using it somewhat but we are waiting for a lot of the infrastructure to come in to play that would fully utilize and realize the Utica play. So, again we have maybe $5 million to $6 million into that, but with the right-of-way and so forth, we feel the value is well in excess of that. It could be as high as $30 million once the, everything matures in that area.

So, I guess to your question as far as what the banks think about, the banks are clearly cognitive of that. As we look to restructure our gas debt, certainly part of the conversation that we have with those that we're speaking with, it’ll be certainly be factored into the final results.

George Walsh - Gilford Securities

Okay. All right, great. Thanks Jim.

Jim Sprague

You're welcome.

Gregory Osborne

Thank you.

Operator

Thank you. Our next question comes from the line of Gregory Macosko with Montrose Advisors. Please proceed with your question.

Gregory Macosko - Montrose Advisors

Yeah, thank you. Just with respect to your discussion of the expenses. I think those add up to, if I'm not mistaken, $2.4 million. Could you talk about where those are on the P&L, are they all on the expense line?

Jim Sprague

Many of them are in O&M expenses Greg, particularly when we talk about some of the expenses that we’re incurring in relation to some of the people and process, improvements that we're making. As we said in previous calls, we’re revamping our internal control structure within the company. We've added personnel to make sure that we increase our processes as well. So a lot of that cost is in O&M.

Additionally to increase our transparency with the regulators, that is more jurisdictional related. It is not a corporate level expense. So, those expenses are then segmented into each of the utilities.

Gregory Macosko - Montrose Advisors

Could you talk about that total and what portion of that is let's say one-time? I would assume the bad that is. But what about the legal, the pro-illegal and the depreciation? How much of that is ongoing?

Jim Sprague

Well, when we talk about breaking those down, a lot of the increased regulatory cost that we had are, those are recurring cost that are not at the level that we had them on. Particularly in Maine, as we mentioned, we were engaged in a prolong rate case that is being concluded here. So, we don’t anticipate those types of cost to continue at that level.

Again, down in North Carolina in relation to negotiating and executing the stipulation agreement, we had additional regulatory costs that were related to that. Now the debt has been reached where we're comfortable in saying, the total cost should decrease as well.

As far as the people and process cost, we partnered with another firm Freed Maxick out of Buffalo, New York to assist us with the enhancement of our control environment. That is a one-time type expense. Because once it's done, then it’s up to us to maintain.

Clearly there is some costs that are ongoing. We've got some cost related to ongoing legal actions that have been taken that we're managing that process as best as we can. We’re looking to get that resolved as quickly as we could or quickly as we can.

We're also in the midst of the PUCO-mandated investigative audit. We are in the process of managing that process. Once that completed, that won't be a recurring item.

So, of those increased expenses, I would say probably 75% of those would be considered non-recurring.

Gregory Macosko - Montrose Advisors

So if I just went direct to it, at the operating income line does that mean the operating income line would go up by something on the order of $2 million? Does that make sense?

Jim Sprague

No. I don’t think we can make that level of assumption other than as you say the $1.1 million is clearly a non-recurring item. I think what we’re probably looking at is maybe more like a $1.7 million to $1.8 million adjustment for that operating income line and then another $200,000 to $300,000 would be below the line in the other income expense.

Gregory Macosko - Montrose Advisors

Thank you very much.

Operator

Thank you. Our next question is a follow-up from the line of George Walsh with Gilford Securities. Please proceed with your question.

George Walsh - Gilford Securities

Just a follow-up what you spoke about there a bit there, Jim. You've got a lot of changes happened in the last several months and weeks with the management and the Board. One, how settled are you guys right now, number one? And two, what are the any outstanding severance issues that you guys may be facing?

Jim Sprague

From a management structure, we feel very comfortable with our team right now. We feel that reintroducing Kevin back into the Company gives us stability on the operating and regulating side and it's a good compliment to Greg and myself.

As far as…

Gregory Osborne

As far as the Board, this is Greg, again, we are always looking for new independence on the Board, something we re cognizant of and focused on. So, can you elaborate on the severance question?

George Walsh - Gilford Securities

Well, are there any issues left with Richard Osborne? How do you anticipate those being resolved over the next whatever you think it takes, just some type of outlook, potential timing?

Gregory Osborne

He has filed some suits. We will defend those vigorously. Can't really speak to ongoing current litigation but we’ll defend those and update the market as it goes.

George Walsh - Gilford Securities

Okay. All right, thanks.

Gregory Osborne

You're welcome.

Operator

Thank you. We have no further questions at this time. I'd like to turn the floor back to management for closing comments.

Gregory Osborne

Thank you, Melissa. At the close, I’d like to thank you all for joining us this morning on our 2014 second quarter earnings teleconference. I also want to take a minute to thank our Board for their advice, especially during these dynamic times and to thank our team of hardworking individuals for servicing our customers every day, ensuring the deliverability of safe and reliable natural gas and executing on our growth strategy. We have a lot of positive things going on and I hope you share my excitement.

We look forward to updating you on our progress on our third quarter 2014 results in November. Thank you and I hope you have a great day.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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