Gas Natural Inc. (NYSEMKT: EGAS ) Q4 2014 Results Earnings Conference Call March 13, 2015, 10:00 AM ET Executives Karen Howard – Kei Advisors LLC Gregory Osborne – President and CEO Jim Sprague – VP and CFO Kevin Degenstein – COO and CCO Analysts Jay Dobson – Wunderlich Securities George Walsh – Gilford Securities Operator Greetings and welcome to the Gas Natural Fourth Quarter and Full Year 2014 Financial Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Ms. Karen Howard, Investor Relations for Gas Natural. Thank you, you may begin. Karen Howard Thank you, Christine, and good morning everyone. Welcome to our fourth quarter 2014 earnings teleconference call. We appreciate your interest in 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 fourth quarter and 2014 result and also give an update on the company’s outlook and strategic progress. You should have a copy of the financial results that were released yesterday evening and if not you can access it at the company’s website at www.egas.net. Before Gregory and Jim get started, I want to bring to your attention to our Safe Harbor statement, which is shown on page three of our release. As 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 in today’s call. 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 be found on the company’s website or at www.sec.gov. And with that let me turn it over to you, Gregory. Gregory Osborne Thanks, Karen and good morning everyone. I appreciate your time today and your interest in Gas Natural. I can certainly say we remain encouraged by our by our progress and excited about our future. The excitement of the changes will affect in the organization, the direction we’re heading, and the opportunities in front of us are permitting throughout the company. Our whole team is onboard with our strategic plan and direction. First let me review our operational results for the quarter and year end. Then I’ll hand it over to Jim to review the detailed results. Note that we’re reporting continuing operations which excludes our Wyoming operations that are in the process of being sold to Blackhills. The sale is progressing and we expect to close on that transaction by late in the second quarter. Just a little refresher, the agreement to sell the operation for approximately $17 million, we believe there is opportunity as well to monetize other assets that are less critical to our strategy. I should also point out that there are some noise in our financials with unusual or non-recurring cost this quarter that we have identified for your convenience. We think our two operating performance is better understood by isolating those costs. For the fourth quarter of 2014 on an adjusted basis, income from continuing operations was $3 million or $0.28 per share. For the year on an adjusted basis, income from continuing operations was $5.7 million or $0.55 per share. We believe we’re making solid progress as we advance Gas Natural to the issue this management team inherited last year we also continue to demonstrate growth. In 2014, we once grew our customer base by nearly 5% to approximately 68,000 customers driven by emerging markets of Maine, North Carolina and are still growing Ohio market. In fact, since 2009 we’ve had 65,000 customers. We have grown the customer count by comp on annual growth rate of almost 4.5%. The growth has been driven by the investments we’ve made in expanding our distribution systems. We believe our target of 4% to 5% customer growth per year remains achievable. Companywide we increased our full service distribution throughput by over 12% during 2014. As noted in the release, our key milestone this year was activation of Phase 1 of our Loring Pipeline in Lincoln Maine and the initiation of service to Lincoln Paper and Tissue our industrial customer. The first phase represents 60 miles of the 189 mile pipeline and we’re currently working on Phase 2 which comprises the next 30 miles. We made progress as well on the governance front. We added a new independent Director in 2014 and another just last month. I’m confident that Mike Winter and Michael Bender will be viable contributors to the Board offering strategic insight, industry experience, and direction to help guide us forward. Those additions as well as the voluntary resignation of three other Directors, our Board now consists of seven Directors, six of whom are independent a measurable improvement in independents. We’ve also carefully examined all our business deals to make sure we have the right people on the right position to make changes where necessary. Through the year we reduced our overall employee count by approximately 12%. At December 31, we had 229 employees, which we believe is about the right level for the business as we currently stand. As expected, we will see the results and the investigate audit required by Public Utility Commission of Ohio or PUCO in January of 2015 known as the ramming report. The audit which was conducted throughout 2014 revealed many opportunities for improvement of historical practices and record keeping. During the course of the audit we were closely with the commission and at staff to make significant changes to our past practices and procedures and we continue to do so. Some of the key actions we have taken before during and since completion on the audit includes the following; we engage Freed Maxick CPAs to assist with designing and implementing a complete system of total controls and procedures. As a result, we established a solid and documented system to better ensure effective and consistent processing of transactions and controls and to improve decision making. We eliminated related party transactions other than those where we had contractual obligations. We have established transfer and relationship throughout the regulatory bodies and all of our jurisdictions. This includes increased communications with PUCO staff to ensure compliance with gas cost recover filings. We segregated our corporate offices from our utility offices as required by the PUCO to maintain proper segregation of duties. We are in the early stages of establishing in internal audit department that will report directly to the audit community of our board. Also in December, our Board approved a change or dividend payment schedule to a more typical quarterly payment beginning in the first quarter of 2015. Many investors have suggested this and it also reduced the costs. For 2015, we will continue to advance our strategic initiatives, as changes we’ve made last year should be demonstrated. We have a new culture here on focused on driving transparency, individual responsibility, safety and reliability and faster decision making. And we continue to remain focused on building a value driven transparent and growing natural gas utility. With that, I will 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. Our 2014 results are an early demonstration of our focus on cost discipline, the effects of strategic investment to drive shareholder growth, and overall strengthening of our natural gas utility operations. There were a number of unusual items that impacted our results for the quarter and the year so we will speak to both GAAP and adjusted non-GAAP results. Let me start by talking through the quarter. Revenue grew modestly to approximately $40 million up about 2%. Revenue from our natural gas operation segment improved $2.3 million or 7% due to growth in our customer base, increased natural gas prices and higher sales volumes. As you may know, increases in our cost of natural gas are a direct pass-through to our customers without offering opportunity for margin expansion. Consolidated gross margin was $12 million in the quarter down from $13.5 million in 2013 fourth quarter. Warmer than average temperatures in our markets during the 2014 quarter compared with the year ago was a primary reason for the decline. Our operating expenses for the fourth quarter grew by $500,000 or about 6% over the prior year quarter to $8.9 million. Higher expenses were mostly the result of a couple of factors that totaled about $2.9 million. These were as follows; first, professional and legal fees related to increase regulatory and legal proceedings of which $2.5 million is non-recurring in nature. And also, a business combination adjustment of $400,000 which we also consider non-recurring. Operating income for the fourth quarter was $3.1 million down $2 million from the prior period. Let me now turn to adjusted EBITDA and bottom line GAAP and adjusted results. We feel that when used in conjunction with GAAP measures, adjusted income from continuing operations and adjusted EBITDA or earnings before interest taxes, depreciation, amortization and accretion, and non-recurring charges, allow investors to view our operating performance in a manner similar to the methods we use and provide additional insight into the company’s operating result. Reconciliations of GAAP to adjusted non-GAAP numbers can be found in the tables in our press release. For the quarter, adjusted EBITDA increased 20% to $7.1 million. Adjusted income from continuing operations, a non-GAAP measure was $3 million improved 20% over the prior year period. Adjusted income on a per share diluted basis, adjusted income from operations was up $0.04 to $0.28 a share, a 16% improvement. On a per share basis, the non-recurring professional and legal fees amounted to approximately $0.15 per share and business combination adjustments were $0.02. On a GAAP basis income from continuing operations was $1.2 million or $0.11 per share. Let’s look briefly as well at the full year. 2014 revenue grew by $23.2 million or 21% to $132.6 million, mostly as a result of customer growth, further magnified by colder weather and higher prices for natural gas. These increases were offset by a reduction from the loss of our LNG customer to pipeline competition. On a full year basis, gross margin grew $1.5 million to $44.9 million. The full year margin benefited from a larger customer base and colder than normal temperatures in all markets, although it was somewhat offset by the loss of our LNG customer as I mentioned previously and higher cost of natural gas used to supply of fixed price contracts. Over the year, operating expenses grew by $6.1 million to $37.8 million. Of that increase, $1.1 million was for higher depreciation, amortization and accretion. There was also $5.2 million of non-recurring costs. These included the following. First, there were non-recurring legal and professional and other expenses of $3.7 million. Second, 2014 was impacted by a specific $1.1 million non-recurring bad debt charge that was incurred in the second quarter. Third, we wrote off 300,000 relating to a software conversion project that was terminated. And finally, we also recorded a net unrealized holding loss, a $100,000 related to the earn-out provision in the JDOG marketing purchase compared to a net unrealized holding gain of nearly $1.6 million in 2013. With these unusual costs, 2014 operating income was down about $4.7 million to $7.1 million. For the year, adjusted EBITDA was up about $400,000 or 2% to $19.1 million. Adjusted income from continuing operations in 2014 was $5.7 million or $0.55 per share compared with $6.5 million or $0.70 per share in 2013. On a per share basis, the non-recurring professional and legal fees amounted to approximately $0.21, the bad debt charge amounted to $0.06 and business combination adjustments were $0.02. GAAP income from continuing operations for the year was $2.7 million or $0.26 per share. Turning to the balance sheet and looking at our capital requirements, at year end we had $1.6 million of cash and cash equivalent. We have several initiatives going on with regard to our capital structure. We are investigating bridge financing until we realize the cash from our Wyoming divestiture. Even though our existing debt is not due until 2017, we are also looking at recapitalization of our debt at the parent company level. Revolution of outstanding regulatory issues in Ohio and Montano are critical to execution of the recapitalization. Finally, this is one of our strongest cash flow quarters especially strong this year with the cold weather we have been realizing in the majority of our markets. Our notes payable at December 31 2104 amounted to $40.3 million or 42% of equity compared with the ratio of 45% at the end of 2013. Capital expenditures in 2014 were $21.6 million, down slightly from $23.5 million in 2013. For 2015, we expect full year CapEx to be approximately $8 million to $9 million. We have done a great deal analysis on the projects we have in our pipeline and have weeded out a great number whose return is not reach our expectation. In addition, we will be filing in Maine where needed in order to systematically expand our systems in our various territories. We will have a greater amount of discipline in our project selection and management, focusing our resources where we can execute effectively to drive earnings. As a result of this review, our 2015 CapEx is lower than recent years. We continue to be focused on the growth of our natural gas operation segments in markets that we consider to be underserved. Safety remains our number one priority, so maintenance CapEx requires for reinforcing the infrastructure in all of our utility service areas as critical to our planning. And with that summary, let me turn the call back to Gregory. Gregory Osborne Thank you, Jim. We’re continuing to execute our strategy of transforming Gas Natural into a more transparent organization based on trust and credibility with employees, regulators and shareholders as well as continuing strategic involvement in our key markets. Now let’s open it up for line of questions. Question-and-Answer Session Operator [Operator Instructions] Our first question comes from the line of Jay Dobson with Wunderlich Securities. Please proceed with your question. Jay Dobson Greg, its Jay Dobson. How are you? Gregory Osborne Hey how are you? Jay Dobson Very well thanks. Hey I am very sorry, I joined late in the middle, I’ve been multitasking here a little bit, but I was hoping if you can give us some insight into sort of where we are. I know you got an order out of the Ohio Commission and sort of where you stand in sort of correcting the number of items identified in the management audit. I know you talked a little bit about this, but I was wondering if you could elaborate as to specifically where we are? Gregory Osborne Absolutely. I am going to shoot that over to Jim and Jim go ahead. Jim Sprague Good morning, Jay. How are you? Jay Dobson Great, thanks Jim. Jim Sprague As far as the progress where we’re at with the Raymond report, the report as you know has been filed and we’re in the process now of working with the PUCO the staff and the Ohio Consumers Counsel to come up with a stipulation that would follow the recommendations that are embedded in the report and recognizing that we’ve already implemented or in the process of implementing another — a number of the initiatives that are in there. We’re looking to just cement that down and we’re hoping that we have resolution of that in short order. But at this point, we’re pleased with the progress we’ve been making and conversations we’ve had with them and expect resolution and short order. Jay Dobson And then as far as process goes on that, as you have these discussions, how does the process or proceeding play out from here? Will you have to commit to doing certain things and then the proceeding will be closed or will it remain open for a period of time as they watch your actions? Jim Sprague Well the process hasn’t been completed yet Jay, but the reaction is going as is going to be one that we enter into a stipulation to work hand in hand with the Commission to make sure that we’re implementing the recommendations and then there will be a monitoring of those on a going forward basis. Ultimately the resolution will be based on a final agreement between all the parties, but we’re confident that the focus of the attention will be more on management and the utilities progress going forward as opposed to going backwards? Jay Dobson Got you and then lastly on that same element, I know just given some of the cost and the like you had taken reserves, do you feel as though you’re adequately reserved for cost that will come out of this given that as you said the proceeding is still ongoing? Jim Sprague We are. Jay Dobson Great. Thank you so very much. Really appreciated. Looking forward to speaking soon. Jim Sprague You’re welcome Jay. Take care. Operator Our next question comes from the line of [John Bear] [ph] Ascend Wealth Management. Please proceed with your question. Unidentified Analyst Good morning, Greg. How are you doing today? Gregory Osborne Good. How are you? Unidentified Analyst Good. Got just a general question and looking to very good capital expenditures look like you’re going to be down pretty significantly this year from somewhere in the $20 million down to $8 million to $9 million and hopefully that with the regulatory issues getting behind you, assuming that those costs will come down and then with selling your properties, should be a fairly dramatic change in capital demands. Am I interpreting that correctly? Gregory Osborne Yes, correct. Unidentified Analyst And so with that being said then what — with that improved cash flow and capital requirements, what’s the next step? What will you do with that, hopefully that will make life a lot easier on you to expand the business? What are you looking at doing from that point? Jim Sprague John, this is Jim Sprague. How are you this morning. Unidentified Analyst Good, very good. Thank you. Jim Sprague Yes, as I mentioned in my comments John, we’re looking to recapitalize our debt structure at the G&I level currently at a subsidiary holding company. To achieve that is going to require us to as we alluded to earlier, bring a resolution to the Ohio regulatory issues that we currently have in front of us and also to work with the Montana regulators, which I’ll defer to Kevin Degenstein to give you more detail on that. But getting those two matters concluded or at least resolved to the point that we can then proceed forward with the recapitalization. Then at that point everything is about timing at this point John. So when the Wyoming sale closes, we’re looking at a convergence of events then that would allow us to relook at our capital budgets and provide some additional direction to our General Managers as far as budgetary requirements. As we were discussing our budgets for 2015, we took a conservative approach to make sure that we prioritized our projects such that we kept our initiatives of growth moving forward without being overly aggressive until we knew the resolution of some of these events. So there is — it is a bit of a fluid situation, but we thought taking a conservative approach allows us to be nimble and flexible enough to be able to execute where we can and then be able to make revisions once we do get some resolution on these certain regulatory issues as well as our financing recap. Unidentified Analyst Okay. And which areas would you expect to focus on expansion once you got that all behind you recently into North Carolina? Is that a primary focus as opposed to Maine so much or is Maine so pretty much on — and Ohio of course your focus areas. Gregory Osborne Kevin, do you want to speak to the CapEx moving forward in some of the emerging markets? Kevin Degenstein Yes absolutely. Hi, how are you doing John? Unidentified Analyst Great. Kevin Degenstein Good. Yeah, ready to go, thank you. I appreciate that. To Greg’s point earlier when he was speaking, we really stepped back and looked at staffing adjustments and rightsizing the organization based on the environment today. We spend significant capital in previous years and we have a significant amount of infrastructure that’s been put in the ground. We’re at a point where we’re looking and stepping back and saying, the low hanging fruit is really to step away from expanding and filling in behind where we already have and so we looked and said, we’ve got a great opportunity to reduce cost, fill in behind where we’ve already got being front of the companies — customers, excuse me and take advantage of our previous investments. And then also right size in a market where pricing of propane and oil has changed a little bit, we don’t expect that to be long term, but it’s an opportunity for us to step back when maybe our competitors have pricing that is not as easy to compete with, that we still can compete — we still can convert, but we don’t have as great of an advantage. So, I think the timing worked out well. The lessons we have we could take advantage of. And then, from a regulatory front, I think to Jim’s point, putting this behind us is important. We look at the Wyoming use of proceeds and getting that close, and then look at our short-term bridge loan and dealing with the staff in Montana here puts us in a position to get back to the point where we are depending from EWI. So, we’ve got things in place that we are doing to get those things put in place. Any year we’re going to take a conservative approach to expansion. And we’ll fill-in where we already got main thing. Unidentified Analyst Yes. I’ll get back. Go ahead. Gregory Osborne No. I just think to add to that — this is Gregory — is you know, there’s new management we got together for 2015 and we’ve got with our heads of utility is in the past it was always grow, grow, grow. We realized we did — we could monetize a lot of these past investments with fill-in. So, we obviously put corporate governance and regulatory relations and things of that nature at the forefront and spend a lot of time on those. So, it’s been a transformational year; and like Kevin and Jim have mentioned, we’re focusing on some of those paths and just want to monetizing those with lot of the fill-in work, so it’s been good. Unidentified Analyst Thanks. Good luck. Gregory Osborne Thank you. Kevin Degenstein Thank you, John. Unidentified Analyst Keep going. Okay. Operator Our next question comes from the line of George Walsh with Gilford Securities. Please proceed with your question. George Walsh Thank you. Just to clarify what you’re saying on the CapEx. $8 million to $9 million seems to be the minimum and pending these transactions in Wyoming and other issues, you’re looking at a possible increase, but are we looking at something that should be back up to the $20 million in CapEx to your — you feel because of what you said that it’s going to be less than that. You don’t need to spend that much. So we’re looking at something you make it upto $15 million or something like that. Kevin Degenstein Yeah. This is Kevin. I can answer that. I think through this year looking at fill-ins and competitive projects and getting the rate of return we want, we will not hit the $20 million mark. $8 million to $9 million is our target. If we adjust it may be by $1 million or $2 million, I don’t anticipate we would be at $15 million. I think this is the good year to step back and take advantage of previous investments. And then, we’ll watch the competitive market, specifically in Maine in North Carolina, and we’ll continue to grow in Ohio. But no, I do not anticipate we would be significantly above $8 million, $9 million. George Walsh Okay. That’s good. The — could you just speak to with the changes on the Board, who we have on the audit committee right now? Well, well beyond the audit committee? Gregory Osborne Currently we have Rich Greaves. Kevin Degenstein Chairman. Gregory Osborne As a Chairman, we have Michael Winner who is a new Board member, former Price Waterhouse… Kevin Degenstein Partner. Gregory Osborne Partner. And lastly we have Wade Brooksby. George Walsh Okay. But not Michael Bender. Gregory Osborne Currently, Michael Bender is on the nominating committee. George Walsh Got it. Okay. Jim Sprague Corporate governance. George Walsh And could you speak a little bit more to that appointment that was the — they’ve taken the significant interest in the company, and they’ve taken the speed on the Board. And it seems to be a stabilizing influence of somebody within InterTech Group coming in there. And just if you could give us a little more detail about the relationship there and the role they seek to play. Gregory Osborne Absolutely. Throughout this past year, the Board, myself as we’ve continue to evaluate the structural requirements of the Board, and I’ve always wanted to evolve the Board. So I think by bringing Michel Winner and Michael Bender we’ve done just that. So — and speaking to InterTech, as you know, or as you may now that they have investments and a lot of our peers in Delta and Corning, Chesapeake, other utilities. So to understand the utility business they have Board representation on Corning Natural Gas. So we felt by them owning a large percentage in our company, they support management by bringing them on with their industry experience, their network in the finance community. It’s a great benefit to Gas Natural and its shareholders moving forward. So, I couldn’t be more excited about both Michael Winner and Michael Bender and their new involvement with Gas Natural. So what role they played, they’ll just do what they can to better Gas Natural, and we’re excited about it. And they both bring different aspects from their past carriers or current carries. So, again it’s really excited to have them on board and we’re excited about things to come. George Walsh Okay. Great. That sounds good. It sounds like given what we’re looking at if these non-recurring items are less recurring. Well, could you just speak to that? How you see the non-recurring items that have been recurring the last couple of years. What your best guess is that how those will speak in 2015? Gregory Osborne Yeah. I might have Jim speak to that please, Jim? Jim Sprague Yeah, George. The issues that we have, clearly from the regulatory front, we had quite a bit of increased cost as a result of issues in Maine and North Carolina, basically all are jurisdictions. And we’ve stabilized relationships in both Maine and North Carolina. We would expect those cost to get more to normal levels. There is always going to be relative compliance, but not at the level that we needed in those jurisdictions. Ohio and Montana, as we’ve alluded to in several instances during this call, we’re looking for resolution of those. I would hope we could get the Ohio issues resolved by the end of Q2 of 2015. Montana, Kevin could give you a little bit more on the timing and more specifics, but I believe we’re looking at resolution of that and about the same timeframe as well. Again, a lot of these events are converging that we have coming up here in 2015. But we would see a lot of those regulatory costs to be ramping down back to more normal levels at the very latest by the second quarter of ’15. On the legal front from a legal cost standpoint, non-regulatory issues are ongoing. There were certain aspects that require more involvement in the early phases. So, while those issues continue, we wouldn’t anticipate those to be at the levels that they had been historically or at least in the year 2014. So, we do see a lot of these particular issues I don’t want to say winding down, but not being at the levels that they were in ’14 for this current year. George Walsh And are they more about regulatory operational compliance with procedures as oppose to any — you’re still be dealing with bonds, or I don’t know if there’s customer rebate involved something like that. Jim Sprague No. We’re not dealing with those at this point in time. I mean, we clearly have gas cost recovery, audits that take place on an ongoing basis that would result in upward or downward adjustments, but nothing that would be considered out of the ordinary. George Walsh Okay. Okay. That’s it for me. Thank you. Gregory Osborne Thank you. Operator Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments. Gregory Osborne Thank you, Christine. At close, I’d like to thank you all for joining us this morning on our 2014 fourth quarter earnings teleconference. This is exciting time for Gas Natural as we continue to execute our strategy of investing in key growth markets. Despite several challenges this quarter, we continue to execute our strategy and we remain excited for the future. Thank you for joining us today. We look forward to sharing 2015 progress with our first quarter results in May. Have a great day. Operator Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.