Gas Natural, Inc. (NYSEMKT: EGAS ) Q4 2015 Earnings Conference Call March 16, 2016, 16:30 ET Executives Deborah Pawlowski – IR Gregory Osborne – President & CEO Jim Sprague – VP & CFO Kevin Degenstein – COO & Chief Compliance Officer Vince Parisi – General Counsel Analysts Jay Dobson – Wunderlich Securities Operator Welcome to Gas Natural Incorporated Fourth Quarter and Full Year 2015 Financial Results Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host Ms. Deb Pawlowski. Thank you, Ms. Pawlowski. You may begin. Deborah Pawlowski Thanks, Chris, and good afternoon everyone. Welcome to our 2015 fourth quarter and full year earnings teleconference call. Joining me on the call today are Gregory Osborne, our President and Chief Executive Officer; Jim Sprague, Vice President and Chief Financial Officer; Kevin Degenstein, our Chief Operating Officer and Chief Compliance Officer as well as Vince Parisi, our General Counsel. Gregory and Jim are going to review the quarter and year and also give an update on our outlook and strategic progress and then we will open it for question-and-answer session. You should have a copy of the financial results were released yesterday after market closed and if not you can access, it’s on our company’s website at www.egas.net. As you’re aware, we may make some forward-looking statements on this call 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 materially from what is stated on 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 sec.gov. So with that, let me turn it over to you Gregory to begin. Gregory? Gregory Osborne Thank you, Deb and good afternoon everyone. I appreciate your time today ad your interest in Gas Natural. While our financial results for the fourth quarter of 2015 do not demonstrate the advances we have made we have in fact made measurable progress. First we completed the sale of a Kentucky and Pennsylvania utilities and our former corporate offices combined with the sale of our Wyoming assets last summer we had a total realization of nearly 20 million in cash from our asset rationalization program in 2015. By even sold these utility assets we can focus our energies and resources on North Carolina and Maine which have higher growth potential while leveraging our scale in Montana and Ohio and factor in the fourth quarter we added approximately a thousand customers. For 2015 we have added a total of 2000 new customers for the full year practically offsetting reduction in customers from the sales Pennsylvania and Kentucky. Secondly, we launched the final phase of our enterprise resource planning or ERP System implementation during the quarter. The system is both costly and challenging to implement but we believe it is necessary to support our growth strategy and facilitate operational efficiency and consistency. Most recently on February 18th we announced a proposal to form a new organizational structure. Subject to regulatory approval that will align our eight regulated utility operation under one fully owned subsidiary further segregating our regulated entities from our non-regulated operations. We believe the structural streamline regulatory processes and create efficiencies with our four regulatory jurisdictions in which we now operate. This two corporate structure will also simplify our financing arrangements and enhance our financial flexibility. In conjunction with this proposal we reached agreement with our lenders to refinance and reconsolidate our debt at the parent company level. The new $99 million debt facilities will replace our existing debt agreements and provide more balance to our capital structure, placing us closer to a 50:50 debt to equity ratio. We also expect the new credit arrangement will provide us much greater flexibility. We have made some new proposed new organizational structure and debt agreements to the appropriate regulatory authorities and anticipate that the review and approval process will be completed in the second half of 2016. Also on the regulatory front most of you know the stipulation or recommendation between the Ohio utilities and our commission staff or the PUCO was filed on October 30th with the commission. The stipulation was related to the 2014 investigative audit of our Ohio utilities because all stipulations are subject to review and final approval by the commission, our recommendation with the staff is still subject to PUCO approval. Turning to our financial results for the quarter, like many natural gas utilities our revenue and gross margin were virtually affected by much warmer than normal weather in 2015. Well typically our geographic diversity works in our favor this year the warmer weather was across all markets we serve. Looking ahead we’ll be evaluating decoupling mechanisms in all of our jurisdictions to reduce the impact of unfavorable weather conditions on our financial performance. During the quarter our operating income was also unfavorably impacted by costs associated with their ERP system implementation. I’ll now turn it over to Jim to more fully review the details. Jim? Jim Sprague Thank you, Gregory and good afternoon everyone. Thank you for joining us today. Our fourth quarter 2015 financial results reflect lower full service distribution throughput primarily due to warmer weather in all of our markets as Gregory managed. Because of a typical expense items that impacted our results for the quarter and year we present both GAAP and adjusted non-GAAP results. Consolidated revenues decreased to 29.5 million down 7.5 million on an 11% decline in full service distribution throughput. I’m going to focus my review on the contributing factors of our results on the natural gas operation segment which currently makes up 90% of our revenue. Revenue from our natural gas operations decreased 8.2 million or 24% to 26.6 million. The primary drivers of the decline were warmer weather and lower gas prices passed on to customers in all of our markets as well as impact of the disposition of our Pennsylvania and Kentucky utilities. Consolidated gross margin was 12.3 million in the quarter almost $300,000 higher than the 2014 fourth quarter. In the natural gas operations segment, gross margin was 12.1 million, an improvement of 227,000 over 2014. 2014 was penalized by an unfavorable GCR adjustment. The gross margin for the 2015 fourth quarter was negatively impacted by lower throughput which was a direct result of an 11% decline in [indiscernible]. Consolidated operating expenses for the fourth quarter of 10.1 million increased by 1.2 million compared with the prior year quarter. 1 million of the increase was related to our ERP System. As Gregory noted we believe the investment in our ERP system is needed to establish the foundational structure to support our future growth. Considering the decline in gross margin from lower throughput and higher operating expense income from continuing operations for the quarter was 700,000 or $0.07 per share down from 1.2 million or $0.11 per share in 2014 fourth quarter. Adjusted EBITDA from continuing operations, a non-GAAP number was 3.8 million compared with 6.5 million in the 2014 fourth quarter. You can find the reconciliation of GAAP to non-GAAP numbers in the news release where we quantified a typical legal and regulatory cost as well as other atypical items. Turning to the full year of 2015 9% lower throughput drove the declines in consolidated revenue to 112.4 million, 20.2 million lower than 2014. Revenue from our natural gas segment declined by 19.1 million or 16% to 104 million with the change largely driven by the same factors as the quarter with warmer weather having the largest impact in the Ohio, Montana and North Carolina market and also a 500,000 reduction in the second quarter for adjustments to sales volumes used in the unbilled revenue calculation. On the positive side we had a 1.8 million volume related increase from customer growth in May including revenue from the Loring pipeline which began service in the September 2014. Gross margin in the natural gas operations segment for the full year decreased by approximately 400,000 to 43.6 million from lower weather related sales volumes. PUCO gas cost adjustments in Ohio, volume adjustments to the unbilled revenue calculation in North Carolina and the impact of the disposed utility. We were able to offset some of these cost increases with the incremental gross margin generated from the startup of a Loring pipeline and more favorable pricing in May. The same factors in the quarter where the primary contributors to a 1.5 million or 4% increase in operating expenses for the year. Income from continuing operations was 1.2 million or $0.11 per share down from 2.7 million or $0.26 per share in 2014. Adjusted EBITDA from continuing operations was 16.4 million down 2.7 million compared with 2014. As I noted earlier please refer to the reconciliations for non-GAAP measures in the press release. Turning to the balance sheet, we had 2.7 million of cash at December 31, 2015 up from 1.6 million at year-end 2014. As Gregory indicated we expect that our proposed reorganization of the company and the related refinancing of our long term debt which does not come due until mid-2017 will provide us with greater financial flexibility. Both are subject to regulatory review and approval. With letter approval secured and our legal and regulatory filings submitted in February this process is well underway and we expect completion in the second half of 2016. Cash provided by operating activities of continuing operations was 9.4 million in 2015 down from 11.1 million in 2014 on lower income. Capital expenditures for 2015 were 9.6 million down measurably from 21.6 in 2014. Investment in 2015 were focused on adding services to install Main that will support customer expansion primarily in our growth market. At this time we have budgeted 4.7 million of investment for 2015. The refinancing coupled with the timing of decline of atypical expenses will determine how much additional cash we will direct to capital expenditures. We are confident that the improvements we have made over the last year and our project selection and management processes will focus our investments and resources in those areas with the highest potential ROI. With that summary let me turn the call back to Gregory. Gregory? Gregory Osborne Thank you, Jim. I would like to take a moment to articulate our strategy which is to number one normalize relations with our regulatory bodies. Number two, rationalize our assets and focus on our core strengths. Number three, internally unify our operations and sell a single operating platform and install a comprehensive set of internal controls and procedures to be followed throughout the entire organization. Number four, undergo a recapitalization of our debt structure at the parent company level with favorable terms for all entities under the corporate umbrella. Number five, reorganize the corporate structure to simplify the command and control functions, provide clarity to our regulators as well as our other stakeholders. Number six, realize efficiencies within each of our operating units through shared services and number seven identify and execute acquisition opportunities that can be assimilated into the reconstructed operations. Underline these initiatives our continued organic growth opportunities within each of our operating units. The strategy also recognizes there are legal matters getting resolution in amidst of our other achievements and we are diligently working to resolve them as expeditiously as possible, but they do take longer than we like. While there’s still work ahead of us we look forward to concentrating our resources and energies in those areas of our business with the best prospects for growth and increased earnings power. And now let’s open the line up for questions. Question-and-Answer Session Operator [Operator Instructions]. And our first question comes from the line of Jay Dobson with Wunderlich Securities. Please proceed with your question, sir. Jay Dobson Jim, help me wrap my head around what would be the sort of weather I guess on I guess earnings but it might be easier to do it on gross margin for the fourth quarter and 2015 and I guess I’m looking at that sort of versus normal I know that’s a bit of a science project but just trying to get at sort of you know the earnings or earnings power of the entity as it stands now. Jim Sprague Well Jay as you see the relationship between then [indiscernible] degree days and throughput you see a real correlation there. Our margins were impacted — the heat degree days were roughly 11% lower than the weighted average from all our jurisdiction and that corresponding throughput was decreased by that as well by a similar percentage. So when you look at that you’re going to see that there is impact that would — and obviously our base rates are different by each jurisdiction. So to give you a specific number we would require some level of computation you know going back to each of our jurisdictions. But it is somewhat proportional that when you look at those divergence from normal you see a proportional in fact to our gross margin. Jay Dobson I absolutely appreciate that, I’m trying to get at sort of what the earnings or earnings power is of the entity on a more whether normal basis because as Greg pointed out you know the results clearly don’t reflect in the fourth quarter for the full year sort of the progress you all have made on sort of restructuring the entity, maybe then turning to costs you know sort of away from the legal and regulatory cost that are probably or certainly are going to be sort of coming down. What do you see is the overall trajectory for costs in 2016? Jim Sprague Well when we put together our budget for 2016 we had in mind several initiatives we were looking to certainly make sure that customers safety and reliability in the system was maintained as well as exceptional customer service. So with that in mind we charged each of our general managers to review their current cost structure and identify areas where there could be some a efficiencies drawn within each of those jurisdictions. We also did that at the corporate level. We looked at our individual cost and we looked at functional areas and made sure that we were running an efficient operation. As Gregory mentioned and his summary we’re also looking more closely at shared services, one of the — what we see is a big benefit of bringing the ERP system on line is to — now that we’re operating on a uniform platform where there are opportunities for us to share cost and understand that the command and control still needs to be locally at utility level but we’ve also got opportunities from a mechanical standpoint to find ways to draw efficiencies there. So you know again I don’t have a quantified number in front of me to be able to tell you what that is but I will say that we’re going to follow up on a management summit that we have last year again this year to explore more opportunities to find those shared services would like to shoot for a cut of probably 10% to 15% operating expenses at least for the current year and then there is respective of the atypical expenses that we had in relation to some of these ongoing matters particularly as it relates to some of the legal matters that still require some effort on our part to bring to a close. Jay Dobson And I think Gregory on the decoupling you alluded to, you know you and I have talked about sort of rate cases and when those occur. Has the thought process around the next sort of round of rate cases changed at all because I think of decoupling as something you’d have to do in the context of a rate case. So anyway just trying to think of that’s something closer in than a couple years off which is when I was thinking rate cases might occur. Gregory Osborne This has been a big topic of discussion obviously with the weather and it’s been on our minds for the last several years. A number of utilities in Ohio for instance have gone this route. So it’s something that we’re paying attention to and focused on. Vince can you speak a little more into detail in regards to Jay’s question? Vince Parisi Yes, there is certainly something we explore and I think you hit right on head you know typically you’re going to see something like decoupling mechanism coupled with a rate case process. Certainly looking at whether there are opportunities to do it outside that context but typically you’re going to see those two kind of follow along with each other. So I think you’re probably right on with respect to time. Jay Dobson And then one last one just on Ohio, you probably don’t want to stay very much but you know we more waiting and hear any hints of when the PUCO might make some decision? Gregory Osborne We really focused at the beginning of this year really I’m getting to financing applications together and filed, it’s really been quiet on that front which I think is a positive obviously we would like to get that one to full inclusion but at this point we’re just waiting for that stuff [indiscernible]. Operator Our next question comes from the line of [indiscernible]. Please proceed with your question. Unidentified Analyst Glad to hear about the ERP system. The 1.3 million I’m assuming that is a large number that has the sort of onetime costs in that, can you give us a sense of on a per quarter or per year basis what the ERP increase will be on an ongoing basis? Gregory Osborne Yes. Greg, when we had been accumulating cost prior to actually our final days of launch. We had been grouping all of our cost into a category called build to suit asset on the balance sheet and when the system went live we did the deep scrub of those cost and reallocated or expense those items that were not capitalized than would have been related to training cost and some of those other period type cost that would not be eligible to capitalize and when we did do this we set up basically say a leaseback transaction on a capital lease which was — we constructed this asset obviously from the license to the form we had it. So there was a component of that that will be written off over a period of the lease term which is 36 months and that number is — we had a component of that in those expenses this year and then the final component of those additional costs then would be actual depreciation of the system itself which we’re amortizing that over a 10 year period and finally then due to the capital lease treatment as we’re making payments to on the financing, and on the lease payment a portion of that lease payment is going to interest expense. So the period caused that we experienced and included in the fourth quarter was a $1 million and the remaining 300,000 both cost from the 1.3 were interest cost that were associated with that. Now on an ongoing basis for the next three year amortization of that what we call the prepaid rent that’s roughly $700,000 a year, we took three months of that. So there’s 33 more months of that expense and then on an annual basis. The depreciation associated with the SAP system is approximately that’s about another $700,000 that we’re taking over the 10 year period. So, that will be amortized on a straight line method so you’ll see that coming in, the 700 on the prepaid rent will expire at the end of ’18. Unidentified Analyst And so is it fair to say that there are obviously you’re looking at those capitalized costs in the ongoing sort of fixed type costs, but in terms of the people and the sort of the variable cost portion of that, is that — has it been reduced because you’re more efficient there or is that the personnel NOL [ph] like? Gregory Osborne Again Greg as I alluded to with the shared services we see that is going to be easy the largest opportunity for us to recognize some cost reductions within the organization. We went live October 1st, there is — and Kevin who is also on the line with us today has assumed some of those coordinator duties with the ERP system that we’ve launched but we’re looking to bring that to what we call a steady state which is you know working out some of the final issues with report rating and some of the other functionality issues and once those are done we’re going to put together we’ve got an RFP out there for us, an application support maintenance agreement going forward and then as I said the shared services then because we’re going to be operating on a single platform throughout the entire organization will provide us with the ability then to review our systems and find some efficiencies that will allow us then to reduce the functionality cost that we have within our jurisdiction and allow some shared services then to provide that. That will be a good topic of our summit next month. Unidentified Analyst With regard to the approval and the restructuring, you’re under four jurisdictions to get the new structure and the decoupling and all that in place do you have to go to the four jurisdictions and say is this all right, is this structure we’re setting up, is this fine, is that how it works? Or is it — will it come sort of piecemeal as you file for new rate cases? Vince Parisi Really the two items will be separate, we’ve already filed the applications with respect to financing those are ongoing. We’re really in the discovery stage with respect to those and we expect to see some resolution there this year sometime towards the second half of this year. the decoupling mechanism really would be probably a broader rate cases and we’re exploring those opportunities. You know we have had recent rate cases some of our jurisdictions and others there are obvious little bit older so where we have those opportunities will certainly explore those but they will be [Technical Difficulty] line. Unidentified Analyst But do you need for separate approvals in the jurisdictions or is that there’s just one? I don’t quite understand the approval process or what’s needed to be approved? Vince Parisi With respect to the decoupling components or the rate cases those will be state specific. So we will need — part of what we’re doing ultimately is something to get the structure in place as well and the financing application, the idea of being clearly bucketing each of the regulatory jurisdictions with respect to those regulated utility. So we would need for example to get approval or on a higher rate case for example with decoupling in Montana. Unidentified Analyst Okay. And then in the text you mentioned the Loring pipeline and the gross margin was incremental there. Could you talk about the gross margin percentage relative to the Loring pipeline and is that going to be a positive on a percentage basis and how is that going to change over time? Kevin Degenstein Yes I think from a percentage basis I don’t have the numbers directly in front of me but ultimately the Loring pipeline does provide a backbone to the Bangor system. It allows for additional industrial customers and commercial customers as you go to Lincoln and as you said head south out of Bangor it gives us the opportunity to pick up some other industrial customers, some other communities and high school [ph]. So incrementally the percentage that it provides will increase and will be a positive to the Bangor gas system. But for an actual incremental percentage I don’t have that on the top of my head. Operator [Operator Instructions]. Our next question comes from the line of John Bear from Assent Wealth Advisors [ph]. Please proceed with your question. Unidentified Analyst I’ve a question on your throughput volumes during the summer period in idea that if you have hotter than normal summer conditions. Do you supply gas directly to the power generators? Kevin Degenstein No we don’t have a summer time load to the power generator, so we’re not affected by warm weather or electrical demand. We just don’t have any of that market captive. Obviously from our perspective construction, money into roads, asphalt [ph] plans and things like that do provide some summertime load but we do not have a captive generation market. Unidentified Analyst Is that something that you could address and work on you know obviously in the summer time or I mean in the winter time you know you like it real cold but just wondering if that’s a possible another outlet for distribution for you. Kevin Degenstein Yes, I think ultimately the answer to that would be yes, if there was power generation built into the geography we serve or in an area by which we could serve and provide services we’d be more than happy to do that but then again it is going to be in the specific utility of geography specific and we would need to have them built in our service territory to provide by the utility. Unidentified Analyst Are you seeing any opportunities in that area? I mean there seems to be a real gravitational wave from coal fired plants in the northeast. Kevin Degenstein Yes not specifically– Unidentified Analyst Just saying, in Ohio you know shut down First Energy shut down, you know a lot of their coal plants. Kevin Degenstein I agree wholeheartedly with you know, we’re not seeing any at this time. But if they would become available within our territory and the market moves that way which I agree it is we would much prefer to fire with natural gas than coal. We would move into that market once it becomes available and we become aware of it. But right now we do not see anything in the immediate future. Operator There are no further questions in queue at this time and I would like to turn the conference back over to Gregory for any closing comments. Gregory Osborne Thank you, Chris. In closing I’d like to thank you all for joining us this afternoon for a 2015 fourth quarter and full year earnings teleconference. And I also would like to thank all of our employees for dedicated, hard work and commitment to Gas Naturals’ long term success. Finally I’d like to thank our board for their ongoing support and advice. This is an exciting time for Gas Natural as we continue to execute our strategy to establish our business as a benchmark gas utility with greater earnings power. Thank you again for joining us. Have a great evening. Operator Ladies and gentlemen this does conclude today’s teleconference. We thank you for your time and participation. 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