UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2015
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission file number 001-34585
GAS NATURAL INC.
(Exact name of registrant as specified in its charter)
| Ohio | | 27-3003768 |
| (State or other jurisdiction of | | (I.R.S. Employer |
| incorporation or organization) | | Identification No.) |
| | | |
| 1375 East 9th St, Suite 3100 | | |
| Cleveland, Ohio | | 44114 |
| (Address of principal executive office) | | (Zip Code) |
Registrant’s telephone number, including area code: (440) 701-5100
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer¨ | Accelerated filerx |
| Non-accelerated filer¨ (Do not check if a smaller reporting company) | Smaller Reporting Company¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes¨ Nox
The number of shares outstanding of the registrant’s common stock as of November 3, 2015 was 10,504,734 shares.
As used in this Form 10-Q, the terms “Company,” “Gas Natural,” “Registrant,” “we,” “us” and “our” mean Gas Natural Inc. and its consolidated subsidiaries as a whole, unless the context indicates otherwise. Except as otherwise stated, the information in this Form 10-Q is as of September 30, 2015
GLOSSARY OF TERMS
Unless otherwise stated or the context requires otherwise, references to “we,” “us,” the “Company” and “Gas Natural” refer to Gas Natural Inc. and its consolidated subsidiaries. In addition, this glossary contains terms and acronyms that are relevant to natural gas distribution and natural gas marketing that are used in this Form 10-Q.
8500 Station Street. 8500 Station Street, LLC.
AECO. Alberta Energy Company Limited (used in reference to the AECO natural gas price index).
ASC. Accounting Standard Codification, standards issued by FASB with respect to U.S. GAAP.
ASU. Accounting Standards Update.
Bangor Gas Company. Bangor Gas Company, LLC.
Bcf. One billion cubic feet, used in reference to natural gas.
Brainard. Brainard Gas Corp.
CIG. Colorado Interstate Gas (used in reference to the Colorado Interstate Gas Index).
Clarion River. Clarion River Gas Company.
CNG. Compressed Natural Gas.
Cut Bank Gas. Cut Bank Gas Company.
Dth. Abbreviation of dekatherm. One million British thermal units, used in reference to natural gas.
EBITDA. Earnings before interest, taxes, depreciation, and amortization.
Energy West Development. Energy West Development, Inc.
Energy West Montana. Energy West Montana, Inc.
Energy West Wyoming. Energy West Wyoming, Inc.
Energy West. Energy West, Incorporated.
EPA. The United States Environmental Protection Agency.
ERP. Enterprise Resource Planning.
EWR. Energy West Resources, Inc.
Exchange Act. The Securities Exchange Act of 1934, as amended.
FASB. Financial Accounting Standards Board.
FERC. The Federal Energy Regulatory Commission.
Frontier Natural Gas. Frontier Natural Gas, LLC.
Frontier Utilities. Frontier Utilities of North Carolina, Inc.
Gas Natural. Gas Natural Inc.
GCR. Gas cost recovery.
GNR. Gas Natural Resources, LLC.
GNSC. Gas Natural Service Company, LLC.
GPL. Great Plains Land Development Co., Ltd.
Great Plains. Great Plains Natural Gas Company.
Independence. Independence Oil, LLC.
JDOG Marketing. John D. Oil and Gas Marketing Company, LLC.
KPSC. Kentucky Public Service Commission.
Kykuit. Kykuit Resources, LLC.
Lake County Title. Lake County Title LLC.
Lake Shore Gas. Lake Shore Gas Storage, Inc.
LIBOR. London Interbank Offered Rate (1 Month)
Lightning Pipeline. Lightning Pipeline Company, Inc.
LNG. Liquefied Natural Gas.
Lone Wolfe. Lone Wolfe Insurance, LLC.
Loring. Loring Pipeline (a leased pipeline owned by Bangor Gas Company)
MMcf. One million cubic feet, used in reference to natural gas.
MPSC. The Montana Public Service Commission.
MPUC. The Maine Public Utilities Commission.
NCUC. The North Carolina Utilities Commission.
NEO. Northeast Ohio Natural Gas Corp.
NIL Funding. NIL Funding Corporation
Orwell. Orwell Natural Gas Company.
Osborne Trust. The Richard M. Osborne Trust, dated February 24, 2012.
PaPUC. The Pennsylvania Public Utility Commission.
Penobscot Natural Gas. Penobscot Natural Gas Company, Inc.
PGC. Public Gas Company, Inc.
PUCO. The Public Utilities Commission of Ohio.
SEC. The United States Securities and Exchange Commission.
Spelman. Spelman Pipeline Holdings, LLC.
Sun Life. Sun Life Assurance Company of Canada
U.S. GAAP. Generally accepted accounting principles in the United States of America.
USPF. United States Power Fund, L.P.
Walker Gas. Walker Gas & Oil Company, Inc.
WPSC. The Wyoming Public Service Commission.
GAS NATURAL INC.
INDEX TO FORM 10-Q
Gas Natural Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
| | | September 30, | | | December 31, | |
| | | 2015 | | | 2014 | |
| | | (unaudited) | | | | |
| ASSETS | | | | | | | | |
| CURRENT ASSETS | | | | | | | | |
| Cash and cash equivalents | | $ | 3,904,154 | | | $ | 1,585,926 | |
| Accounts receivable | | | | | | | | |
| Trade, less allowance for doubtful accounts of $272,367 and $370,909, respectively | | | 4,403,443 | | | | 12,095,535 | |
| Related parties | | | 164,302 | | | | 250,101 | |
| Unbilled gas | | | 2,260,541 | | | | 7,630,852 | |
| Note receivable, current portion | | | 726 | | | | 2,070 | |
| Inventory | | | | | | | | |
| Natural gas | | | 5,733,778 | | | | 5,301,895 | |
| Materials and supplies | | | 2,324,890 | | | | 2,300,990 | |
| Prepaid income taxes | | | 434,100 | | | | 431,681 | |
| Regulatory assets, current | | | 2,713,255 | | | | 4,097,822 | |
| Deferred tax asset | | | 578,033 | | | | 635,195 | |
| Prepayments and other | | | 2,064,654 | | | | 986,941 | |
| Assets held for sale | | | 3,647,248 | | | | 802,436 | |
| Discontinued operations | | | - | | | | 11,653,934 | |
| Total current assets | | | 28,229,124 | | | | 47,775,378 | |
| | | | | | | | | |
| PROPERTY, PLANT AND EQUIPMENT | | | | | | | | |
| Property, plant and equipment | | | 192,675,626 | | | | 187,566,638 | |
| Less accumulated depreciation, depletion and amortization | | | (48,637,868 | ) | | | (45,555,553 | ) |
| PROPERTY, PLANT, & EQUIPMENT, NET | | | 144,037,758 | | | | 142,011,085 | |
| | | | | | | | | |
| OTHER ASSETS | | | | | | | | |
| Notes receivable, less current portion | | | 32,502 | | | | 90,345 | |
| Regulatory assets, non-current | | | 1,653,750 | | | | 2,055,404 | |
| Debt issuance costs, net of amortization | | | 713,198 | | | | 1,079,447 | |
| Goodwill | | | 15,872,247 | | | | 16,155,672 | |
| Customer relationships, net of amortization | | | 2,707,486 | | | | 2,927,500 | |
| Restricted cash | | | 1,897,672 | | | | 1,897,677 | |
| Other assets | | | 14,360 | | | | 11,404 | |
| Total other assets | | | 22,891,215 | | | | 24,217,449 | |
| TOTAL ASSETS | | $ | 195,158,097 | | | $ | 214,003,912 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
Gas Natural Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
| | | September 30, | | | December 31, | |
| | | 2015 | | | 2014 | |
| | | (unaudited) | | | | |
| LIABILITIES AND CAPITALIZATION | | | | | | | | |
| CURRENT LIABILITIES | | | | | | | | |
| Checks in excess of amounts on deposit | | $ | 34,504 | | | $ | 194,524 | |
| Line of credit | | | 15,750,000 | | | | 28,760,799 | |
| Accounts payable | | | | | | | | |
| Trade | | | 6,174,579 | | | | 14,115,367 | |
| Related parties | | | 62,943 | | | | 170,319 | |
| Notes payable, current portion | | | 521,321 | | | | 542,201 | |
| Contingent consideration, current | | | 671,638 | | | | 671,638 | |
| Derivative instruments | | | 31,290 | | | | 3,023,271 | |
| Accrued liabilities | | | 4,920,853 | | | | 4,860,663 | |
| Accrued liabilities - related parties | | | 99,150 | | | | 111,133 | |
| Customer deposits, current | | | 400,522 | | | | 634,090 | |
| Obligation under capital lease, current | | | 199,517 | | | | 188,224 | |
| Regulatory liability, current | | | 1,065,596 | | | | 925,175 | |
| Build-to-suit liability | | | 7,408,163 | | | | 5,597,287 | |
| Other current liabilities | | | 959,695 | | | | 940,643 | |
| Liabilities held for sale | | | 262,513 | | | | 61,416 | |
| Discontinued operations | | | 20,139 | | | | 544,432 | |
| Total current liabilities | | | 38,582,423 | | | | 61,341,182 | |
| | | | | | | | | |
| LONG-TERM LIABILITIES | | | | | | | | |
| Deferred investment tax credits | | | 97,396 | | | | 113,193 | |
| Deferred tax liability | | | 13,166,934 | | | | 10,538,394 | |
| Asset retirement obligation | | | 1,217,595 | | | | 1,196,518 | |
| Customer advances for construction | | | 1,026,700 | | | | 993,681 | |
| Regulatory liability, non-current | | | 1,210,816 | | | | 1,089,850 | |
| Customer deposits | | | 949,540 | | | | 949,540 | |
| Obligation under capital lease, less current | | | 1,475,197 | | | | 1,674,714 | |
| Contingent consideration, less current | | | - | | | | 75,362 | |
| Total long-term liabilities | | | 19,144,178 | | | | 16,631,252 | |
| | | | | | | | | |
| NOTES PAYABLE, less current portion | | | 39,335,068 | | | | 39,720,860 | |
| | | | | | | | | |
| COMMITMENTS AND CONTINGENCIES (see Note 14) | | | | | | | | |
| | | | | | | | | |
| STOCKHOLDERS’ EQUITY | | | | | | | | |
| Preferred stock; $0.15 par value; 1,500,000 shares authorized, no shares issued or outstanding | | | - | | | | - | |
| Common stock; $0.15 par value; Authorized: 30,000,000 and 30,000,000 shares, respectively; Issued: 10,501,263 and 10,487,511 shares, respectively; Outstanding: 10,501,263 and 10,487,511 shares, respectively | | | 1,574,690 | | | | 1,573,127 | |
| Capital in excess of par value | | | 63,958,752 | | | | 63,826,341 | |
| Retained earnings | | | 32,562,986 | | | | 30,911,150 | |
| Total stockholders’ equity | | | 98,096,428 | | | | 96,310,618 | |
| TOTAL CAPITALIZATION | | | 137,431,496 | | | | 136,031,478 | |
| TOTAL LIABILITIES AND CAPITALIZATION | | $ | 195,158,097 | | | $ | 214,003,912 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
Gas Natural Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| REVENUES | | | | | | | | | | | | | | | | |
| Natural gas operations | | $ | 11,355,099 | | | $ | 12,542,698 | | | $ | 77,402,612 | | | $ | 88,327,066 | |
| Marketing and production | | | 1,728,716 | | | | 1,072,273 | | | | 5,460,246 | | | | 7,284,543 | |
| Total revenues | | | 13,083,815 | | | | 13,614,971 | | | | 82,862,858 | | | | 95,611,609 | |
| | | | | | | | | | | | | | | | | |
| COST OF SALES | | | | | | | | | | | | | | | | |
| Natural gas purchased | | | 4,583,203 | | | | 5,739,430 | | | | 45,918,641 | | | | 56,257,668 | |
| Marketing and production | | | 1,639,912 | | | | 860,900 | | | | 5,018,370 | | | | 6,538,023 | |
| Total cost of sales | | | 6,223,115 | | | | 6,600,330 | | | | 50,937,011 | | | | 62,795,691 | |
| | | | | | | | | | | | | | | | | |
| GROSS MARGIN | | | 6,860,700 | | | | 7,014,641 | | | | 31,925,847 | | | | 32,815,918 | |
| | | | | | | | | | | | | | | | | |
| OPERATING EXPENSES | | | | | | | | | | | | | | | | |
| Distribution, general, and administrative | | | 6,806,138 | | | | 6,321,270 | | | | 19,792,959 | | | | 19,018,069 | |
| Maintenance | | | 256,483 | | | | 295,762 | | | | 871,714 | | | | 920,308 | |
| Depreciation and amortization | | | 1,790,111 | | | | 1,830,287 | | | | 5,327,327 | | | | 5,178,270 | |
| Accretion | | | - | | | | 9,255 | | | | 21,077 | | | | 36,533 | |
| Provision for doubtful accounts | | | 34,713 | | | | 7,626 | | | | 133,041 | | | | 829,814 | |
| Taxes other than income | | | 1,014,908 | | | | 901,329 | | | | 3,023,365 | | | | 2,861,724 | |
| Total operating expenses | | | 9,902,353 | | | | 9,365,529 | | | | 29,169,483 | | | | 28,844,718 | |
| | | | | | | | | | | | | | | | | |
| OPERATING INCOME (LOSS) | | | (3,041,653 | ) | | | (2,350,888 | ) | | | 2,756,364 | | | | 3,971,200 | |
| | | | | | | | | | | | | | | | | |
| Loss from unconsolidated affiliate | | | - | | | | - | | | | - | | | | (977 | ) |
| Other income, net | | | 277,402 | | | | 408,821 | | | | 593,429 | | | | 617,656 | |
| Gain on sale of marketable securities | | | - | | | | 183,371 | | | | - | | | | 183,371 | |
| Acquisition expense | | | - | | | | - | | | | - | | | | (7,197 | ) |
| Interest expense | | | (811,765 | ) | | | (764,367 | ) | | | (2,566,886 | ) | | | (2,334,435 | ) |
| Income (loss) before income taxes | | | (3,576,016 | ) | | | (2,523,063 | ) | | | 782,907 | | | | 2,429,618 | |
| | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | | 1,312,049 | | | | 1,008,494 | | | | (342,191 | ) | | | (901,141 | ) |
| | | | | | | | | | | | | | | | | |
| INCOME (LOSS) FROM CONTINUING OPERATIONS | | | (2,263,967 | ) | | | (1,514,569 | ) | | | 440,716 | | | | 1,528,477 | |
| | | | | | | | | | | | | | | | | |
| Discontinued operations, net of tax | | | 3,394,981 | | | | 34,825 | | | | 4,044,776 | | | | 581,652 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | 1,131,014 | | | $ | (1,479,744 | ) | | $ | 4,485,492 | | | $ | 2,110,129 | |
| | | | | | | | | | | | | | | | | |
| Basic weighted shares outstanding | | | 10,494,130 | | | | 10,487,511 | | | | 10,490,736 | | | | 10,475,213 | |
| Dilutive effect of stock options | | | 1,134 | | | | - | | | | 1,173 | | | | - | |
| Diluted weighted shares outstanding | | | 10,495,264 | | | | 10,487,511 | | | | 10,491,909 | | | | 10,475,213 | |
| | | | | | | | | | | | | | | | | |
| BASIC AND DILUTED EARNINGS (LOSS) PER SHARE: | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (0.22 | ) | | $ | (0.14 | ) | | $ | 0.04 | | | $ | 0.15 | |
| Discontinued operations | | | 0.32 | | | | - | | | | 0.39 | | | | 0.05 | |
| Net income (loss) per share | | $ | 0.10 | | | $ | (0.14 | ) | | $ | 0.43 | | | $ | 0.20 | |
| | | | | | | | | | | | | | | | | |
| Dividends declared per common share (see Note 15) | | $ | 0.135 | | | $ | 0.135 | | | $ | 0.270 | | | $ | 0.405 | |
| | | | | | | | | | | | | | | | | |
| COMPREHENSIVE INCOME (LOSS): | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | 1,131,014 | | | $ | (1,479,744 | ) | | $ | 4,485,492 | | | $ | 2,110,129 | |
| OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX | | | | | | | | | | | | | | | | |
| Unrealized gain/(loss) on available-for-sale securities, net of tax of $0, $6,066, $0, and $7,689, respectively | | | - | | | | 10,584 | | | | - | | | | 14,811 | |
| Unrealized gain on available-for-sale securities transferred to earnings, net of tax of $0, $63,651, $0 and $63,651, respectively | | | - | | | | (119,720 | ) | | | - | | | | (119,720 | ) |
| Other comprehensive income, net of tax | | | - | | | | (109,136 | ) | | | - | | | | (104,909 | ) |
| | | | | | | | | | | | | | | | | |
| COMPREHENSIVE INCOME (LOSS) | | $ | 1,131,014 | | | $ | (1,588,880 | ) | | $ | 4,485,492 | | | $ | 2,005,220 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
Gas Natural Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| | | Nine months ended September 30, | |
| | | 2015 | | | 2014 | |
| CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | | |
| Net income | | $ | 4,485,492 | | | $ | 2,110,129 | |
| Less income from discontinued operations | | | 4,044,776 | | | | 581,652 | |
| Incomefrom continuing operations | | | 440,716 | | | | 1,528,477 | |
| | | | | | | | | |
| Adjustments to reconcile incomefrom continuing operations to net cash provided by operating activities: | | | | | | | | |
| Depreciation and amortization | | | 5,327,327 | | | | 5,178,270 | |
| Accretion | | | 21,077 | | | | 36,533 | |
| Amortization of debt issuance costs | | | 517,379 | | | | 304,177 | |
| Provision for doubtful accounts | | | 133,041 | | | | 829,814 | |
| Stock based compensation | | | 133,974 | | | | 312,100 | |
| Loss on goodwill and asset impairments | | | 803,518 | | | | - | |
| Gain on sale of marketable securities | | | - | | | | (183,371 | ) |
| Loss (gain) on sale of assets | | | (34,812 | ) | | | 10,635 | |
| Loss from unconsolidated affiliate | | | - | | | | 977 | |
| Unrealized holding (gain) loss on contingent consideration | | | (75,362 | ) | | | (3,000 | ) |
| Change in fair value of derivative financial instruments | | | (119,596 | ) | | | (8,419 | ) |
| Investment tax credit | | | (15,797 | ) | | | (15,797 | ) |
| Deferred income taxes | | | 2,685,702 | | | | 1,243,512 | |
| Changes in assets and liabilities | | | | | | | | |
| Accounts receivable, including related parties | | | 7,532,912 | | | | 5,467,686 | |
| Unbilled gas | | | 5,360,535 | | | | 5,011,695 | |
| Natural gas inventory | | | (431,883 | ) | | | (3,048,511 | ) |
| Accounts payable, including related parties | | | (7,572,247 | ) | | | (3,425,347 | ) |
| Recoverable/refundable cost of gas purchases | | | (1,147,233 | ) | | | (624,880 | ) |
| Regulatory assets & liabilities | | | 186,122 | | | | (2,401,250 | ) |
| Prepayments and other | | | (1,101,642 | ) | | | (560,351 | ) |
| Other assets | | | (453,379 | ) | | | (141,418 | ) |
| Other liabilities | | | 57,390 | | | | (912,571 | ) |
| Net cash provided by operating activities of continuing operations | | | 12,247,742 | | | | 8,598,961 | |
| | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES | | | | | | | | |
| Capital expenditures | | | (8,325,234 | ) | | | (16,276,508 | ) |
| Proceeds from sale of fixed assets | | | 65,660 | | | | 33,234 | |
| Proceeds from sale of marketable securities | | | - | | | | 421,875 | |
| Proceeds from note receivable | | | 59,187 | | | | 2,752 | |
| Restricted cash – capital expenditures fund | | | - | | | | 57,441 | |
| Customer advances for construction | | | 33,335 | | | | 15,303 | |
| Contributions in aid of construction | | | 605,785 | | | | 1,942,695 | |
| Net cash used in investing activities of continuing operations | | | (7,561,267 | ) | | | (13,803,208 | ) |
| | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | | | | | | | |
| Proceeds from line of credit | | | 13,750,000 | | | | 16,450,000 | |
| Repayments of line of credit | | | (26,760,799 | ) | | | (16,919,000 | ) |
| Repayments of notes payable, including related parties | | | (5,406,672 | ) | | | (3,429,702 | ) |
| Proceeds from notes payable, including related parties | | | 5,000,000 | | | | 102,000 | |
| Repayments of build-to-suit | | | (1,371,434 | ) | | | - | |
| Payments of capital lease obligations | | | (188,224 | ) | | | (177,570 | ) |
| Debt issuance costs | | | (151,130 | ) | | | (9,298 | ) |
| Restricted cash – debt service fund | | | 5 | | | | 131,840 | |
| Exercise of stock options | | | - | | | | 45,761 | |
| Dividends paid | | | (2,833,656 | ) | | | (4,242,608 | ) |
| Net cash used in financing activities of continuing operations | | | (17,961,910 | ) | | | (8,048,577 | ) |
| | | | | | | | | |
| DISCONTINUED OPERATIONS | | | | | | | | |
| Operating cash flows | | | 1,288,242 | | | | 1,907,389 | |
| Investing cash flows | | | 14,305,421 | | | | (346,220 | ) |
| Financing cash flows | | | - | | | | 53,892 | |
| Net cash provided by discontinued operations | | | 15,593,663 | | | | 1,615,061 | |
| | | | | | | | | |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | 2,318,228 | | | | (11,637,763 | ) |
| Cash and cash equivalents, beginning of period | | | 1,585,926 | | | | 12,741,197 | |
| | | | | | | | | |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | | $ | 3,904,154 | | | $ | 1,103,434 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
Gas Natural Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| | | Nine months ended September 30, | |
| | | 2015 | | | 2014 | |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | | | | | | | | |
| Cash paid for interest | | $ | 2,085,083 | | | $ | 1,842,202 | |
| Cash refunded for income taxes, net | | | - | | | | 6,025 | |
| | | | | | | | | |
| NONCASH INVESTING AND FINANCING ACTIVITIES | | | | | | | | |
| Assets acquired under build-to-suit agreement | | $ | 3,182,310 | | | $ | 4,148,469 | |
| Capital expenditures included in accounts payable | | | 425,857 | | | | 848,371 | |
| Capitalized interest | | | 323,764 | | | | 16,742 | |
| Restricted cash received from customer as security deposit | | | - | | | | 949,540 | |
| Accrued dividends | | | - | | | | 472,163 | |
| Capital assets acquired through trade-in | | | - | | | | 85,068 | |
| Capital assets acquired through debt | | | - | | | | 25,543 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
Note 1 – Summary of Business and Basis of Presentation
Nature of Business
Gas Natural Inc. (the “Company”) is a natural gas company with operations in six states. The Company’s primary operations are natural gas utility companies located throughout these states. The Company’s operations also include marketing and production of natural gas, and along with its corporate level operations, these areas of operation represent the Company’s three operating and reportable segments and are described below.
| · | Natural Gas Operations | | Annually distributes approximately 26 Bcf of natural gas to approximately 69,000 customers. The Company’s natural gas utility subsidiaries are Public Gas Company (Kentucky), Bangor Gas (Maine), Cut Bank Gas Company (Montana), Energy West Montana (Montana), Frontier Natural Gas (North Carolina), Brainard Gas Corp. (Ohio), Northeast Ohio Natural Gas Corporation (Ohio), and Orwell Natural Gas Company (Ohio and Pennsylvania). |
| | | | |
| · | Marketing & Production Operations | | Annually markets approximately 1.3 Bcf of natural gas to commercial and industrial customers in Montana, Wyoming, Ohio, and Pennsylvania through the Company’s EWR and GNR subsidiaries. The EWR subsidiary also manages midstream supply and production assets for transportation customers and utilities. EWR owns an average 55% gross working interest (average 46% net revenue interest) in 160 natural gas producing wells and gas gathering assets located in Glacier and Toole Counties in Montana. |
| | | | |
| · | Corporate & Other | | Encompasses costs associated with business development and acquisitions, dispositions of subsidiary entities and results of discontinued operations, dividend income, recognized gains or losses from the sale of marketable securities, and activity from Lone Wolfe which serves as an insurance agent for the Company and other businesses in the energy industry. |
Energy West was originally incorporated in Montana in 1909 and was reorganized as a holding company in 2009 to facilitate future acquisitions and corporate-level financing to support the Company’s growth strategy. On July 9, 2010, the Company changed its name to Gas Natural Inc. and reincorporated from Montana to Ohio. Moving the incorporation to Ohio enhanced the Company’s flexibility and provided a more efficient platform from which to operate and grow.
Basis of Presentation
The accompanying Condensed Consolidated Balance Sheet as of December 31, 2014, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements of Gas Natural Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all disclosures required by generally accepted accounting principles. In the opinion of the Company, all normal recurring adjustments have been made that are necessary to fairly present the results of operations for the interim periods. Certain reclassifications have been made to prior period amounts to conform to current period presentation. Such reclassifications have no effect on net income as previously reported.
Operating results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. A majority of the Company’s revenues are derived from its natural gas utility operations, making its revenue seasonal in nature. Therefore, the largest portion of the Company’s operating revenue is generated during the colder months when its sales volume increases considerably. Reference should be made to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
The Company has used estimates in measuring certain deferred charges and deferred credits related to items subject to approval of the various public service commissions with jurisdiction over the Company. Estimates are also used in determining amounts for the Company’s allowances for doubtful accounts, unbilled gas, asset retirement obligations, contingent consideration liability, loss contingencies, and determination of depreciable lives of utility plant. The deferred tax asset and valuation allowance require a significant amount of judgment and are significant estimates. The estimates are based on projected future tax deductions, future taxable income, estimated limitations under the Internal Revenue Code, and other assumptions.
The Company makes acquisitions which involve combining the assets and liabilities of the acquired company with our Company. The assets and liabilities acquired are reported at their fair value at the date of acquisition. Measuring this fair value may require the use of estimates. Such estimates could change in the near term and could significantly impact the Company’s results of operations and financial position.
There have been no material changes in the Company’s significant accounting policies during the nine months ended September 30, 2015 as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.
Recent Accounting Pronouncements
In September 2015, the FASB issuedASU 2015-16, Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments, which requires acquirers to recognize adjustments to provisional amounts identified during the reporting period in which adjustments to business combination accounting are determined. Acquirers should record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Application of the standard, which should be applied prospectively, is required for the annual and interim periods beginning after December 15, 2015. Early adoption is permitted. The new standard may have an impact on the Company’s condensed consolidated financial statements in the event of a business combination.
In July 2015, the FASB issuedASU 2015-11, Simplifying the Measurement of Inventory, which is intended to simplify the subsequent measurement of inventories by replacing the current lower of cost or market test with a lower of cost and net realizable value test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out and the retail inventory method. Application of the standard, which should be applied prospectively, is required for the annual and interim periods beginning after December 15, 2016. Early adoption is permitted. The Company expects that the adoption of this standard will not have a material impact on its condensed consolidated financial statements.
In April 2015, the FASB issuedASU 2015-3, Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheet as a reduction of the associated debt liability. This update is effective for interim and annual reporting periods beginning after December 15, 2015, and requires retrospective application. The adoption of this update is not expected to cause any material changes to the Company’s consolidated financial statements other than the reclassification of debt issuance costs from assets to a reduction of liabilities in our consolidated balance sheets.
In May 2014, the FASB issuedASU 2014-09 Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. This pronouncement is effective for annual reporting periods beginning after December 15, 2016 and is to be applied using one of two retrospective application methods, with early application not permitted. The Company is currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements.
Note 2 – Discontinued Operations
The following table reconciles the carrying amounts of the major classes of assets and liabilities to the Company’s discontinued operations as presented on its Condensed Consolidated Balance Sheet.
| | | September 30, 2015 | | | December 31, 2014 | |
| | | EWW/Pipelines | | | Independence | | | Total | | | EWW/Pipelines | | | Independence | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Current Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | | $ | - | | | $ | - | | | $ | 257,358 | | | $ | - | | | $ | 257,358 | |
| Accounts receivable, net | | | - | | | | - | | | | - | | | | 1,002,763 | | | | 155 | | | | 1,002,918 | |
| Unbilled gas | | | - | | | | - | | | | - | | | | 735,122 | | | | - | | | | 735,122 | |
| Inventory | | | - | | | | - | | | | - | | | | 181,197 | | | | - | | | | 181,197 | |
| Prepayments and other | | | - | | | | - | | | | - | | | | 71,101 | | | | - | | | | 71,101 | |
| Regulatory assets, current | | | - | | | | - | | | | - | | | | 250,031 | | | | - | | | | 250,031 | |
| Total current assets | | | - | | | | - | | | | - | | | | 2,497,572 | | | | 155 | | | | 2,497,727 | |
| Non-Current Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Property, plant & equipment, net | | | - | | | | - | | | | - | | | | 8,966,965 | | | | - | | | | 8,966,965 | |
| Regulatory assets, non-current | | | - | | | | - | | | | - | | | | 155,826 | | | | - | | | | 155,826 | |
| Other assets | | | - | | | | - | | | | - | | | | 33,416 | | | | - | | | | 33,416 | |
| Total non-current assets | | | - | | | | - | | | | - | | | | 9,156,207 | | | | - | | | | 9,156,207 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total discontinued assets | | $ | - | | | $ | - | | | $ | - | | | $ | 11,653,779 | | | $ | 155 | | | $ | 11,653,934 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Current Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Accounts payable | | $ | - | | | $ | 20,139 | | | $ | 20,139 | | | $ | 28,578 | | | $ | 1,079 | | | $ | 29,657 | |
| Accrued liabilities | | | - | | | | - | | | | - | | | | 334,664 | | | | - | | | | 334,664 | |
| Other current liabilities | | | - | | | | - | | | | - | | | | 123,318 | | | | 16,000 | | | | 139,318 | |
| Total current liabilities | | | - | | | | 20,139 | | | | 20,139 | | | | 486,560 | | | | 17,079 | | | | 503,639 | |
| Non-Current Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Customer advances for construction | | | - | | | | - | | | | - | | | | 40,793 | | | | - | | | | 40,793 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total discontinued liabilities | | $ | - | | | $ | 20,139 | | | $ | 20,139 | | | $ | 527,353 | | | $ | 17,079 | | | $ | 544,432 | |
The following table reconciles the carrying amounts of the major line items constituting the pretax profit of discontinued operations to the after-tax profit or loss of discontinued operations that are presented on the Condensed Consolidated Statements of Comprehensive Income.
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| EWW/Pipeline assets | | | | | | | | | | | | | | | | |
| Revenues | | $ | - | | | $ | 1,741,491 | | | $ | 4,608,504 | | | $ | 7,185,277 | |
| Cost of sales | | | - | | | | (1,047,877 | ) | | | (2,533,836 | ) | | | (4,204,071 | ) |
| Distribution, general & administrative | | | - | | | | (345,758 | ) | | | (779,610 | ) | | | (1,129,945 | ) |
| Maintenance | | | - | | | | (42,372 | ) | | | (80,708 | ) | | | (130,788 | ) |
| Depreciation & amortization | | | - | | | | (178,554 | ) | | | - | | | | (541,777 | ) |
| Taxes other than income | | | - | | | | (62,236 | ) | | | (168,588 | ) | | | (233,612 | ) |
| Other income | | | - | | | | 6,307 | | | | 7,263 | | | | 22,571 | |
| Interest expense | | | 1,598 | | | | 971 | | | | 634 | | | | (281 | ) |
| Pretax income from discontinued operations | | | 1,598 | | | | 71,972 | | | | 1,053,659 | | | | 967,374 | |
| Gain on the sale of EWW/Pipeline Assets | | | 5,366,271 | | | | - | | | | 5,366,271 | | | | - | |
| Income tax expense | | | (1,960,882 | ) | | | (20,465 | ) | | | (2,345,201 | ) | | | (346,660 | ) |
| Income from discontinued operations of EWW/Pipeline assets | | $ | 3,406,987 | | | $ | 51,507 | | | $ | 4,074,729 | | | $ | 620,714 | |
| | | | | | | | | | | | | | | | | |
| Independence | | | | | | | | | | | | | | | | |
| (Loss) from discontinued operations of Independence | | | (12,006 | ) | | | (16,682 | ) | | | (29,953 | ) | | | (39,062 | ) |
| | | | | | | | | | | | | | | | | |
| Discontinued operations, net of tax | | $ | 3,394,981 | | | $ | 34,825 | | | $ | 4,044,776 | | | $ | 581,652 | |
Energy West Wyoming and the Glacier & Shoshone Pipelines
On October 10, 2014, the Company executed a stock purchase agreement for the sale of all of the stock of its wholly-owned subsidiary, Energy West Wyoming, Inc. (“EWW”), to Cheyenne Light, Fuel and Power Company (“Cheyenne”). EWW has historically been included in the Company’s Natural Gas Operations segment. In conjunction with this sale, the Company’s Energy West Development, Inc. subsidiary entered into an asset purchase agreement for the sale of the transmission pipeline system known as the Shoshone Pipeline and the gathering pipeline system known as the Glacier Pipeline and certain other assets directly used in the operation of the pipelines (together the “Pipeline Assets”) to Black Hills Exploration and Production, Inc. (“Black Hills”), an affiliate of Cheyenne. The Pipeline Assets have historically comprised the entirety of the Company’s Pipeline segment. As a result of EWW and the Pipeline Asset’s classification as discontinued operations, their results have been included in Corporate & Other segment for all periods presented. On July 1, 2015, the transaction was completed and the Company received $14.6 million for the sale of EWW and $1.2 million for the sale of the Pipeline Assets.
The Company’s subsidiary, EWR, continues to conduct some business with both EWW and Black Hills relating to the Pipeline Assets. EWW continues to purchase natural gas from EWR under an established gas purchase agreement through the first quarter of 2017. Concurrently, EWR continues to use EWW’s transmission system under a standing transportation agreement through the first quarter of 2017. Finally, EWR continues to use the Pipeline Assets’ transmission systems under a standing transportation agreement through October 2017. These transactions are a continuation of transactions that were conducted prior to the sales of EWW and the Pipeline Assets and have been eliminated through the consolidation process.
Independence
On November 6, 2013, the Company closed on the sale of Independence to Blue Ridge Energies, LLC (“Blue Ridge”) for a total of $2.3 million. The Company recorded a loss on sale of $7,915 in the fourth quarter of 2013. The results of operations and financial position for Independence have been reclassified to the discontinued operations sections of the Company’s consolidated financial statements. Independence was the Company’s only subsidiary included in its Propane segment. As a result of its classification as discontinued operations, its results have been included in Corporate & Other segment for all periods presented. The Company has no material continuing cash flows or other contractual obligations associated with this sales transaction.
Note 3 – Held for Sale
On January 14, 2015, the Company entered into an asset purchase agreement with Utility Pipeline, LTD to sell nearly all of the assets and liabilities of its Clarion and Walker Pennsylvania utility divisions. The Company will receive $0.9 million under the transaction. The agreement contains customary representations, warranties, covenants and indemnification provisions. The consummation of the transaction is dependent upon the satisfaction or waiver of a number of customary closing conditions, the receipt of regulatory approvals and the consent of certain lenders of the Company. The Company expects this transaction to be finalized in the fourth quarter of 2015.
Clarion and Walker have historically been reported as a component of the Company’s Natural Gas Operations segment and collectively contributed $(185,000) and $87,000 to the Company’s pre-tax income from continuing operations for the three months ended September 30, 2015 and 2014, respectively, and $(80,000) and $189,000 to the Company’s pre-tax income from continuing operations for the nine months ended September 30, 2015 and 2014, respectively. The Company does not believe that the sale of Clarion and Walker constitutes a strategic shift that will have a major effect on its operations or financial results and as such, neither of the divisions have been classified as discontinued operations in the Company’s financial statements, but instead have been classified as assets and liabilities held for sale at September 30, 2015 and December 31, 2014.
On August 5, 2015, the Company executed an asset purchase agreement with Kentucky Frontier Gas, LLC, to sell nearly all the assets and liabilities of its subsidiary PGC in Kentucky. The Company will receive approximately $1.9 million under the transaction. The asset purchase agreement contains customary representations, warranties, covenants and indemnification provisions. The consummation of this transaction depends upon the satisfaction or waiver of a number of customary closing conditions and the receipt of regulatory approvals.
Goodwill associated with the original acquisition of the operating assets of PGC in the amount of $283,425 is impaired as a result of the pending sale and has been included in the Distribution, general and administrative line item in the accompanying Consolidated Statements of Comprehensive Income for the nine months ended September 30, 2015. As a result of this transaction, the Company will recognize an asset impairment loss of $109,682 based on the carrying amount of assets sold totaling $1,939,682 and the estimated cost to sell of $70,000. This loss has been recorded in the Distribution, general and administrative line item in the accompanying Consolidated Statement of Comprehensive Income for the nine months ended September 30, 2015.
PGC has historically been reported as a component of the Company’s Natural Gas Operations segment and excluding the effects of the impairments discussed above, accounted for losses of $131,000 and $43,000 to the Company’s pre-tax income from continuing operations for the three months ended September 30, 2015 and 2014, respectively, and losses of $195,000 and $126,000 to the Company’s pre-tax income from continuing operations for the nine months ended September 30, 2015 and 2014, respectively. The Company does not believe that the sale of PGC constitutes a strategic shift that will have a major effect on its operations or financial results and as such, PGC has not been classified as discontinued operations in the Company’s financial statements, but instead has been classified as assets and liabilities held for sale at September 30, 2015.
On August 10, 2015, the Company entered into an asset purchase agreement with Marc Wertenberger to sell the land, building and improvements of the “Matchworks” building located at 8500 Station Street, Mentor Oh, 44060. This represents substantially all of the assets of the Company’s 8500 Station Street, LLC subsidiary. The Company received $1.4 million less closing costs under the transaction which closed on October 15, 2015. As a result of this transaction, the Company will recognize an asset impairment loss of $410,411 based on the carrying amount of assets sold totaling $1,760,411. This loss has been recorded in the distribution, general and administrative line item in the accompanying Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015.
8500 Station Street has historically been reported as a component of the Company’s Natural Gas Operations segment and excluding the effects of the impairment discussed above contributed $7,000 and $35,000 to the Company’s pre-tax income from continuing operations for the three months ended September 30, 2015 and 2014, respectively, and $21,000 and $82,000 to the Company’s pre-tax income from continuing operations for the nine months ended September 30, 2015 and 2014, respectively. The Company does not believe that the sale of the assets of 8500 Station Street constitutes a strategic shift that will have a major effect on its operations or financial results and as such, 8500 has not been classified as discontinued operations in the Company’s financial statements, but instead has been classified as assets and liabilities held for sale at September 30, 2015.
The following table summarizes the major classes of assets and liabilities classified as held for sale at September 30, 2015 and December 31, 2014.
| | | September 30, | | | December 31, | |
| | | 2015 | | | 2014 | |
| | | | | | | |
| Current Assets: | | | | | | | | |
| Accounts receivable, net | | $ | 161,007 | | | $ | 49,069 | |
| Unbilled gas | | | 31,928 | | | | 22,151 | |
| Inventory | | | 42,216 | | | | 3,622 | |
| Prepayments and other | | | 27,469 | | | | 5,401 | |
| Regulatory assets, current | | | 3,077 | | | | 203,241 | |
| Total current assets | | | 265,697 | | | | 283,484 | |
| Non-Current Assets: | | | | | | | | |
| Property, plant & equipment, net | | | 3,267,908 | | | | 407,247 | |
| Goodwill | | | 111,706 | | | | 111,705 | |
| Other assets | | | 1,937 | | | | - | |
| Total non-current assets | | | 3,381,551 | | | | 518,952 | |
| | | | | | | | | |
| Total assets held for sale | | $ | 3,647,248 | | | $ | 802,436 | |
| | | | | | | | | |
| Current Liabilities: | | | | | | | | |
| Accounts payable | | $ | 56,247 | | | $ | 36,184 | |
| Accrued liabilities | | | 65,318 | | | | 21,632 | |
| Customer deposits | | | 111,475 | | | | - | |
| Other current liabilities | | | 29,473 | | | | 3,600 | |
| Total liabilities held for sale | | $ | 262,513 | | | $ | 61,416 | |
Note 4 – Goodwill
On August 5, 2015, the Company executed an asset purchase agreement with Kentucky Frontier Gas, LLC, to sell nearly all the assets and liabilities of its subsidiary PGC in Kentucky. Goodwill associated with the original acquisition of the operating assets of PGC in the amount of $283,425 is impaired as a result of the pending sale and has been included in the distribution, general and administrative line item in the accompanying Consolidated Statements of Comprehensive Income. SeeNote 3 – Held for Sale for further information regarding the PGC asset sale. The schedule below presents the changes in carrying amount of goodwill for the three and nine months ended September 30, 2015.
| | | Three Months | | | Nine Months | |
| | | Ended | | | Ended | |
| | | September 30, 2015 | | | September 30, 2015 | |
| | | | | | | |
| Beginning balance | | $ | 15,872,247 | | | $ | 16,155,672 | |
| PGC Impairment Loss | | | - | | | | (283,425 | ) |
| Ending balance | | $ | 15,872,247 | | | $ | 15,872,247 | |
Note 5 – Fair Value Measurements
The Company follows a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to measurements involving unobservable inputs (Level 3). The three levels of the fair value hierarchy are as follows:
| Level 1 inputs - | observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. |
| | |
| Level 2 inputs - | other inputs that are directly or indirectly observable in the marketplace. |
| | |
| Level 3 inputs - | unobservable inputs which are supported by little or no market activity. |
The level in the fair value hierarchy within which a fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
The following table presents the placement in the fair value hierarchy of the Company’s assets and liabilities measured at fair value on a recurring basis:
| | | September 30, 2015 | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | | | | | | | | | | | | |
| LIABILITIES: | | | | | | | | | | | | | | | | |
| Contingent consideration | | $ | - | | | $ | - | | | $ | 671,638 | | | $ | 671,638 | |
| | | | | | | | | | | | | | | | | |
| Commodity swap contracts | | $ | - | | | $ | 31,290 | | | $ | - | | | $ | 31,290 | |
| | | December 31, 2014 | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | | | | | | | | | | | | |
| LIABILITIES: | | | | | | | | | | | | | | | | |
| Contingent consideration | | $ | - | | | $ | - | | | $ | 747,000 | | | $ | 747,000 | |
| | | | | | | | | | | | | | | | | |
| Commodity swap contracts | | $ | - | | | $ | 3,023,271 | | | $ | - | | | $ | 3,023,271 | |
The fair value of financial instruments including cash and cash equivalents, notes and accounts receivable and notes and accounts payable are not materially different from their carrying amounts. The fair values of marketable securities are estimated based on the closing share price on the quoted market price for those investments. Cost basis is determined by specific identification of securities sold. Under the fair value hierarchy, the fair value of cash and cash equivalents is classified as a Level 1 measurement and the fair value of notes payable are classified as Level 2 measurements.
Commodity Swaps Contracts
The commodity swap contracts, categorized in level 2 of the fair value hierarchy, are valued by comparing the futures price at the measurement date of the natural gas commodity specified in the contract to the fixed price to be paid by the Company. SeeNote 6 – Derivative Financial Instrumentsfor more information regarding the commodity swap contracts.
Contingent Consideration Liability
The contingent consideration liability categorized in level 3 of the fair value hierarchy arose as a result of the JDOG Marketing acquisition in June 2013. The purchase agreement for the transaction provided for contingent “earn-out” payments in the form of validly issued, fully paid and non-assessable shares of the Company’s common stock for a period of five years after the closing of the transaction if the acquired business achieved a minimum annual EBITDA target of $810,432. This amount was JDOG Marketing’s EBITDA for the year ended December 31, 2011. If the acquired business’s actual EBITDA for a given year is less than the target EBITDA, then no earn-out payment is due and payable for that period. If the acquired business’s actual EBITDA for a given year meets or exceeds the target EBITDA, then an earn-out payment in an amount equal to actual EBITDA divided by target EBITDA multiplied by $575,000 will have been earned for that year. Due to the earn-out structure, the maximum amount that could be earned over the five year period is indeterminate.
Valuation of the contingent consideration liability for financial statement purposes was conducted by an independent third-party valuation firm. Inputs and assumptions used in the valuation were reviewed for reasonableness by the Company in the course of the valuation process and have been updated to reflect changes in the Company’s business environment.
The Company calculated a first year earn-out payment of $671,638 as its best estimate for financial reporting purposes and this amount is included as a component of the valuation. The Company does not believe an earn-out payment is due to JDOG Marketing as a result of payments made by the Ohio utilities to JDOG Marketing during 2013 that were disallowed by the PUCO. Richard M. Osborne, father of the Company’s chief executive officer and the Company’s former chairman and chief executive officer believes that JDOG Marketing is entitled to the earn-out. Mr. Osborne and JDOG Marketing have filed a suit against the Company for the earn-out payment for 2013. In addition, the acquired business did not achieve the minimum annual EBITDA target in 2014 and, as a result, the Company has notified Mr. Osborne that no earn-out payment is due for 2014. SeeNote 14 – Commitments and Contingencies for more information.
The following table reconciles the beginning and ending balances of the contingent consideration liability categorized under level 3 of the fair value hierarchy.
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
| | | Contingent
Consideration Liability | |
| | | | |
| Opening balance December 31, 2014 | | $ | 747,000 | |
| | | | | |
| Transfers into level 3 | | | - | |
| Transfers out of level 3 | | | - | |
| Total (gains) losses for period: | | | | |
| Included in net income | | | (75,362 | ) |
| Included in other comprehensive income | | | - | |
| Purchases | | | - | |
| Sales | | | - | |
| Settlements | | | - | |
| Issuances | | | - | |
| | | | | |
| Closing balance September 30, 2015 | | $ | 671,638 | |
The following table summarizes quantitative information used in determining the fair value of the Company’s liabilities categorized in level 3 of the fair value hierarchy.
Quantitative Information about Level 3 Fair Value Measures
| | | Fair Value at
September 30,
2015 | | | Valuation
Techniques | | Unobservable Input | | Range |
| | | | | | | | | | |
| Contingent Consideration | | $ | 671,638 | | | Monte Carlo analysis | | Forecasted annual EBITDA | | $0.5 - $0.7 million |
| | | | | | | | | Weighted avg cost of capital | | 14.0% - 14.0% |
| | | | | | | | | U.S. Treasury yields | | 0.0% - 0.7% |
| | | | | | | | | | | |
| | | | | | | Discounted cash flow | | U.S. Treasury yields | | 0.0% - 0.7% |
| | | | | | | | | Credit spread | | 2.1% - 3.0% |
The significant unobservable inputs used in the fair value measure of the Company’s contingent consideration liability are its weighted average cost of capital, various U.S. Treasury yields, and the Company’s credit spread above the risk free rate. Significant increases (decreases) in any of these inputs in isolation would result in a significantly lower (higher) fair value measure. An additional significant unobservable input for this fair value measure is the Company’s forecasted annual EBITDA related to its GNR subsidiary. A significant increase (decrease) in this input would result in a significant increase (decrease) in the fair value measure.
Note 6 – Derivative Financial Instruments
The Company has entered into commodity swap contracts in order to reduce the commodity price risk related to natural gas prices. These commodity swap contracts set a fixed price that the Company will ultimately pay for quantities of natural gas specified in the contracts. The Company has not designated any of these commodity swaps contracts as hedging instruments.
The following table summarizes the commodity swap contracts entered into by the Company as of September 30, 2015. The Company will pay the fixed price listed for the volumes denoted in the table below. In exchange it will receive from a counterparty a variable payment based on the market price for the natural gas product listed for these volumes. These payments are settled monthly.
| Product | | Type | | Contract Period | | Volume | | Price per MMBtu | |
| | | | | | | | | | |
| AECO Canada - CGPR 7A Natural Gas | | Swap | | 4/1/15 - 3/31/16 | | 500 MMBtu/Day | | $ | 2.420 | |
| AECO Canada - CGPR 7A Natural Gas | | Swap | | 11/1/15 - 3/31/16 | | 500 MMBtu/Day | | $ | 2.260 | |
Included in the cost of sales line item in the accompanying Consolidated Statements of Comprehensive Income is $316,000 and $0 of realized losses on commodity swap agreements not designated as hedging instruments for the three months ended September 30, 2015 and 2014, respectively and $3,061,000 and $0 for the nine months ended September 30, 2015 and 2014, respectively.
Unrealized (gains)/losses on commodity swap agreements not designated as hedging instruments for non-regulated subsidiaries were $16,000 and $0 for the three months ended September 30, 2015 and 2014, respectively and ($120,000) and $0 for the nine months ended September 30, 2015 and 2014, respectively.
The table below shows the line item in the Company’s Condensed Consolidated Balance Sheets where the fair value of the commodity swap contracts is included.
Fair Value of Derivative Instruments
| | | Liabilities |
| | | | | September 30, | | | December 31, | |
| | | Balance Sheet Location | | 2015 | | | 2014 | |
| Derivatives not designated as hedging instruments | | | | | | | | | | |
| | | | | | | | | | | |
| Commodity swap contracts | | Derivative instruments | | $ | 31,290 | | | $ | 3,023,271 | |
Note 7 -Regulatory Assets and Liabilities
The following table summarizes the components of the Company’s regulatory asset and liability balances at September 30, 2015 and December 31, 2014.
| | | September 30, 2015 | | | December 31, 2014 | |
| | | Current | | | Long-term | | | Current | | | Long-term | |
| | | | | | | | | | | | | |
| REGULATORY ASSETS | | | | | | | | | | | | | | | | |
| Recoverable cost of gas purchases | | $ | 2,179,935 | | | $ | - | | | $ | 692,117 | | | $ | - | |
| Deferred costs | | | 489,996 | | | | 1,347,509 | | | | 489,996 | | | | 1,715,006 | |
| Deferred loss on commodity swaps | | | - | | | | - | | | | 2,872,385 | | | | - | |
| Income taxes | | | - | | | | 296,819 | | | | - | | | | 296,819 | |
| Rate case costs | | | 43,324 | | | | 9,422 | | | | 43,324 | | | | 43,579 | |
| Total regulatory assets | | $ | 2,713,255 | | | $ | 1,653,750 | | | $ | 4,097,822 | | | $ | 2,055,404 | |
| | | | | | | | | | | | | | | | | |
| REGULATORY LIABILITIES | | | | | | | | | | | | | | | | |
| Over-recovered gas purchases | | $ | 1,065,596 | | | $ | - | | | $ | 925,175 | | | $ | - | |
| Income taxes | | | - | | | | 83,161 | | | | - | | | | 83,161 | |
| Asset retirement costs | | | - | | | | 1,127,655 | | | | - | | | | 1,006,689 | |
| Total regulatory liabilities | | $ | 1,065,596 | | | $ | 1,210,816 | | | $ | 925,175 | | | $ | 1,089,850 | |
Recoverable Cost of Gas Purchases/Over-recovered Gas Purchases
The Company accounts for purchased gas costs in accordance with procedures authorized by the utility commissions in the states in which it operates. Purchased gas costs that are different from those provided for in present rates, and approved by the respective commission, are accumulated and recovered (recoverable cost of gas purchases) or credited through future rate changes (over-recovered gas purchases). These amounts are generally recovered or credited through rates within one year. The gas cost recovery mechanisms are monitored closely by the regulatory commissions in all of the states in which the Company operates and are subject to periodic audits or other review processes.
Deferred Costs
On June 27, 2014, the Company’s Frontier Natural Gas subsidiary entered into a stipulation with the Public Staff of the North Carolina Utilities Commission (Docket No G-40, Sub 124), in which the subsidiary agreed, among other items, to reclassify $2.5 million from its recoverable cost of gas purchases asset account to a deferred gas cost asset account. This amount represents a portion of deferred expenses related to the subsidiary’s January and February 2014 gas purchases on which it will not earn return. The stipulation calls for amortization of this amount as operating expense over a five year period beginning July 1, 2014. Under the stipulation, the Public Staff agreed to not request a change in Frontier Natural Gas’s base margin rates, exclusive of cost of gas, for the same five-year period.
Deferred Loss on Commodity Swaps
The Company’s regulated subsidiaries defer recognition of unrealized losses and gains on its commodity swap derivative instruments as regulatory assets and liabilities, respectively. Deferred losses and gains are recognized as a component of cost of sales – natural gas purchased on the Company’s Consolidated Statements of Comprehensive Income during the period in which they are settled and recovered through rates. This regulatory asset was recovered in the third quarter of 2015.
Income Taxes
The regulatory asset related to income taxes earns a return equal to that of the Company’s rate base and will be recovered through rates. The regulatory liability related to income taxes will be credited to our customers.
Asset Retirement Costs
As a result of regulatory action by the PUCO, Orwell and Brainard accrue an estimated liability for removing certain classes of utility plant long-lived assets at the end of their useful lives. The liability is equal to a set percentage of the asset’s historic cost. These liabilities are accrued over the useful lives of the assets with the corresponding expense included as a portion of depreciation expense. Upon retirement of any assets included in these asset classes, any costs incurred to retire the asset will be recorded against this regulatory liability. Any costs in excess of the liability will be expensed as incurred and any residual liability in excess of incurred costs to retire the asset will act to reduce Orwell and Brainard’s future rates. As of September 30, 2015, none of the assets included in these asset classes have been retired.
Rate Case Costs
Rate case costs do not earn a return and will be amortized over a period of 2 to 3 years.
Note 8 – Credit Facilities and Long-Term Debt
Line of Credit
The Company has a revolving credit facility with the Bank of America with a maximum borrowing capacity of $30.0 million due April 1, 2017. On November 26, 2014, the Company entered into an amendment temporarily increasing the borrowing capacity by $10.0 million to a maximum of $40.0 million. In an order approving this temporary increase in borrowing capacity, the MPSC stated that any amounts borrowed under this increase in excess of $5.0 million would first require the approval of the MPSC. Amounts borrowed under this temporary increase had a maturity date of July 1, 2015 and were repaid to Bank of America prior to that date. This revolving credit facility includes an annual commitment fee ranging from 25 to 45 basis points of the unused portion of the facility and interest on the amounts outstanding at LIBOR plus 175 to 225 basis points. The Company had outstanding borrowings under this facility of $15.8 million and $28.8 million at September 30, 2015 and December 31, 2014, respectively. For the three months ended September 30, 2015 and 2014, interest expense related to the line of credit was $110,000 and $146,000, respectively. For the nine months ended September 30, 2015 and 2014, interest expense related to the line of credit was $423,000 and $421,000, respectively. The weighted average interest rate for the revolving credit facility was 2.32% and 2.50% for the three months ended September 30, 2015 and 2014, respectively. The weighted average interest rate for the revolving credit facility was 2.39% and 2.42%, for the nine months ended September 30, 2015 and 2014, respectively.
Notes Payable
The following table details the Company’s outstanding long-term debt balances at September 30, 2015 and December 31, 2014.
| | | September 30, | | | December 31, | |
| | | 2015 | | | 2014 | |
| | | | | | | |
| LIBOR plus 1.75 to 2.25%, Bank of America amortizing term loan, due April 1, 2017 | | $ | 8,500,000 | | | $ | 8,875,000 | |
| 6.16%, Allstate/CUNA Senior unsecured note, due June 29, 2017 | | | 13,000,000 | | | | 13,000,000 | |
| 5.38%, Sun Life fixed rate note, due June 1, 2017 | | | 15,334,000 | | | | 15,334,000 | |
| 4.15%, Sun Life senior secured guaranteed note, due June 1, 2017 | | | 2,989,552 | | | | 2,989,552 | |
| Vehicle and equipment financing loans | | | 32,837 | | | | 64,509 | |
| Total notes payable | | | 39,856,389 | | | | 40,263,061 | |
| Less: current portion | | | 521,321 | | | | 542,201 | |
| Notes payable, long-term portion | | $ | 39,335,068 | | | $ | 39,720,860 | |
Short Term Loan Agreement with NIL Funding Corporation
On April 6, 2015, the Company entered into a loan agreement and promissory note with NIL Funding Corporation (“NIL Funding”). Pursuant to the note and loan agreement, NIL Funding loaned Gas Natural $5.0 million, bearing an annual interest rate of 7.5%, and a maturity date of October 3, 2015. NIL Funding Corporation is considered a related party. SeeNote 12 – Related Party Transactions for further details. On July 27, 2015, the NIL Funding credit facility was paid off and extinguished.
The Company used proceeds from this loan, in part, to repay an intercompany payable owed to Energy West. On November 24, 2014, the MPSC issued an order directing, in part, that Energy West require Gas Natural to repay an intercompany payable to Energy West by December 24, 2014. In addition, the MPSC order restricted Energy West and its Montana, Maine, and North Carolina operating subsidiaries from paying dividends to Gas Natural until persuasive evidence could be presented that Energy West was on a sound financial footing and that effect had been given to the MPSC’s ring-fencing conditions; the strongest indication being the absence of ongoing balances owed to Energy West by Gas Natural. On April 9, 2015, Energy West filed a request to reinstate Energy West and its Montana, Maine, and North Carolina operating subsidiaries ability to pay dividends to Gas Natural. On July 22, 2015, the MPSC issued an order allowing for the reinstatement of the dividends. They also approved a special dividend to be declared from the proceeds from the sale of Energy West’s subsidiaries Energy West Wyoming and the Shoshone and Glacier pipeline assets.
Debt Covenants
Bank of America
The Bank of America revolving credit agreement and term loan contain various covenants, which require that Energy West and its subsidiaries maintain compliance with a number of financial covenants, including a limitation on investments in another entity by acquisition of any debt or equity securities or assets or by making loans or advances to such entity. In addition, Energy West must maintain a total debt to total capital ratio of not more than .55-to-1.00 and an interest coverage ratio of no less than 2.0-to-1.0. The credit facility restricts Energy West’s ability to create, incur or assume indebtedness except (i) indebtedness under the credit facility (ii) indebtedness incurred under certain capitalized leases including the capital lease related to the Loring pipeline, and purchase money obligations not to exceed $500,000, (iii) certain indebtedness of Energy West’s subsidiaries, (iv) certain subordinated indebtedness, (v) certain hedging obligations and (vi) other indebtedness not to exceed $1.0 million.
In addition, the Bank of America revolving credit agreement and term loan also restricts Energy West’s ability to pay dividends and make distributions, redemptions and repurchases of stock during any 60-month period to 80% of its net income over that period. In addition, no event of default may exist at the time such dividend, distribution, redemption or repurchase is made. Energy West is also prohibited from consummating a merger or consolidation or selling all or substantially all of its assets or stock except for (i) any merger consolidation or sale by or with certain of its subsidiaries, (ii) any such purchase or other acquisition by Energy West or certain of its subsidiaries and (iii) sales and dispositions of assets for at least fair market value so long as the net book value of all assets sold or otherwise disposed of in any fiscal year does not exceed 5% of the net book value of Energy West’s assets as of the last day of the preceding fiscal year.
Allstate/CUNA
The Allstate/CUNA senior unsecured notes contain various covenants, including a limitation on Energy West’s total dividends and distributions made in the immediately preceding 60-month period to 100% of aggregate consolidated net income for such period. The notes restrict Energy West from incurring additional senior indebtedness in excess of 65% of capitalization at any time and require Energy West to maintain an interest coverage ratio of more than 150% of the pro forma annual interest charges on a consolidated basis in two of the three preceding fiscal years.
Sun Life
The Sun Life covenants restrict certain cash balances and require two main types of debt service reserve accounts to be maintained to cover approximately one year of interest payments. The total balance in the debt service reserve accounts was $0.9 million and $0.9 million at September 30, 2015 and December 31, 2014, respectively, and is included in restricted cash on the Company’s Condensed Consolidated Balance Sheets. The debt service reserve accounts cannot be used for operating cash needs.
The covenants also provide that any cash dividends, distributions, redemptions or repurchases of common stock may be made by the obligors to the holding company only if (i) the aggregate amount of all such dividends, distributions, redemptions and repurchases for the fiscal year do not exceed 70% of net income of the obligors for the four fiscal quarters then ending determined as of the end of each fiscal quarter, and (ii) there exists no other event of default at the time the dividend, distribution, redemption or repurchase is made. The inability of the obligors to pay a dividend to the holding company may impact the Company’s ability to pay a dividend to shareholders.
The obligors (NEO, Orwell, Brainard, and the Company’s unregulated Ohio subsidiaries) are also prohibited from creating, assuming or incurring additional indebtedness except for (i) obligations under certain financing agreements, (ii) indebtedness incurred under certain capitalized leases and purchase money obligations not to exceed $500,000 at any one time outstanding, (iii) indebtedness outstanding as of March 31, 2011, (iv) certain unsecured intercompany indebtedness and (v) certain other indebtedness permitted under the notes.
On May 31, 2014, the Company loaned $3.1 million to Great Plains, one of the obligors under the note purchase agreements. The loan was not evidenced by a promissory note and pledged to Sun Life as required by certain covenants in the note purchase agreement. On July 8, 2015, Great Plains executed a $3.1 million revolving note payable to the Company, which was pledged to Sun Life. Concurrently, the Company entered into a limited waiver to the note purchase agreement with Sun Life curing the breach of the covenants.
The covenants require, on a consolidated basis, an interest coverage ratio of at least 2.0 to 1.0, measured quarterly on a trailing four quarter basis. The notes generally define the interest coverage ratio as the ratio of EBITDA to gross interest expense. The note defines EBITDA as net income plus the sum of interest expense, any provision for federal, state, and local taxes, depreciation, and amortization determined on a consolidated basis in accordance with GAAP, but excluding any extraordinary non-operating income or loss and any gain or loss from non-operating transactions. The interest coverage ratio is measured with respect to the obligors on a consolidated basis and also with respect to the Company and all of its subsidiaries on a consolidated basis. The notes also require that the Company does not permit indebtedness to exceed 60% of capitalization at any time. Like the interest coverage ratio, the ratio of debt to capitalization is measured on a consolidated basis for the Obligors and again on a consolidated basis with respect to the Company and all of its subsidiaries.
The notes prohibit the Company from selling or otherwise transferring assets except in the ordinary course of business and to the extent such sales or transfers, in the aggregate, over each rolling twelve month period, do not exceed 1% of total assets. Generally, the Company may consummate a merger or consolidation if there is no event of default and the provisions of the notes are assumed by the surviving or continuing corporation. The Company is also generally limited in making acquisitions in excess of 10% of total assets.
An event of default, if not cured or waived, would require the Company to immediately pay the outstanding principal balance of the notes as well as any and all interest and other payments due. An event of default would also entitle Sun Life to exercise certain rights with respect to any collateral that secures the indebtedness incurred under the notes.
NIL Funding Corporation
The NIL Funding short term loan contains various covenants, including a restriction on any future indebtedness by Gas Natural. Gas Natural is also prohibited from consummating a merger or consolidation or selling all or substantially all of its assets or stock except for (i) any merger consolidation or sale by or with certain of its subsidiaries and (ii) sales and dispositions of assets for at least fair market value so long as the net book value of all assets sold or otherwise disposed of in any fiscal year does not exceed $2 million.
In an event of default, as defined under the loan agreement, NIL Funding may, at its option, require the Company to immediately pay the outstanding principal balance of the note as well as any and all interest and other payments due or convert any part of the amounts due and unpaid to shares of the Company’s common stock at a conversion price of 95% of the previous day’s closing price on the NYSE MKT.
The Company believes it is in compliance with the financial covenants under its debt agreements or has received waivers as described above.
Note 9 – Stock Compensation
2012 Incentive and Equity Award Plan
The 2012 Incentive and Equity Award Plan provides for the grant of options, restricted stock, performance awards, other stock-based awards and cash awards to certain eligible employees and directors. There are 500,000 shares authorized for issuance under the plan.
The Company recognized $102,948 in expense for the three and nine months ended September 30, 2015, related to the grant of 3,471 and 12,305, respectively, of the Company’s common stock to the then current directors of Gas Natural under the 2012 Incentive and Equity Award Plan. The awards were not conditional on any future performance or event and as such, were fully expensed on the grant date.
The Company recognized $0.3 million in expense for the three and nine months ended September 30, 2014, related to the grant of 30,833 of the Company’s common stock to the then current directors of Gas Natural under the 2012 Incentive and Equity Award Plan. The awards were not conditional on any future performance or event and as such, were fully expensed on the grant date.
The 2012 Non-Employee Director Stock Award Plan allows each non-employee director to receive his or her fees in shares of the Company’s common stock by providing written notice to the Company. There are 250,000 shares authorized for issuance under the plan. As of September 30, 2015, no awards had been granted under the plan.
Note 10 – Employee Benefit Plans
The Company has a 401(k) defined contribution plan which covers substantially all of its employees. The plan provides for an annual contribution of 3% of all employees’ salaries, with an additional contribution of 10% of each participant’s elective deferral, which is invested in shares of the Company’s common stock under the 401(k) plan. The expense related to the 401(k) plan for the three months ended September 30, 2015 and 2014 was $114,000 and $123,000, respectively. The expense related to the 401(k) Plan for the nine months ended September 30, 2015 and 2014 was $352,000 and $391,000, respectively.
The Company has sponsored a defined postretirement health plan (the "Retiree Health Plan") providing Medicare supplement benefits to eligible retirees. The Retiree Health Plan pays eligible retirees (post-65 years of age) up to $125 per month toward eligible Medicare supplement payments. The amount of this payment is fixed and will not increase with medical trends or inflation. The amounts available for retirement supplement payments are currently held in a VEBA trust account, and benefits for this plan are paid from assets held in the VEBA Trust account. The Company discontinued contributions in 2006 and is no longer required to fund the Retiree Health Plan. As of September 30, 2015 and December 31, 2014, the value of plan assets was $100,460 and $133,000, respectively. The assets remaining in the trust will be used to fund the plan until the assets are exhausted.
Note 11 – Income Taxes
Income tax position differs from the amount computed by applying the federal statutory rate to pre-tax income or loss as demonstrated in the table below:
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Tax (benefit) expense at statutory rate of 34% | | $ | 602,682 | | | $ | (834,880 | ) | | $ | 2,432,626 | | | $ | 1,140,627 | |
| State income tax (benefit), net of Federal tax benefit (expense) | | | 42,864 | | | | (82,641 | ) | | | 267,173 | | | | 112,905 | |
| Amortization of deferred investment tax credits | | | (5,265 | ) | | | (5,265 | ) | | | (15,794 | ) | | | (15,794 | ) |
| Adjustment to tax return filed | | | - | | | | (70,734 | ) | | | - | | | | (29,820 | ) |
| Other | | | 1,296 | | | | 17,183 | | | | (14,715 | ) | | | 36,187 | |
| | | | | | | | | | | | | | | | | |
| Total income tax (benefit) expense | | | 641,577 | | | | (976,337 | ) | | | 2,669,290 | | | | 1,244,105 | |
| Less: income tax from discontinued operations | | | 1,953,626 | | | | 32,157 | | | | 2,327,099 | | | | 342,964 | |
| | | | | | | | | | | | | | | | | |
| Income tax (benefit) expense from continuing operations | | $ | (1,312,049 | ) | | $ | (1,008,494 | ) | | $ | 342,191 | | | $ | 901,141 | |
The “Adjustment to tax return filed” line above for the nine months ended September 30, 2014 includes an income tax adjustment of $40,914 related to the correction of income tax items related to 2012 recorded during the nine months ended September 30, 2014.
The Company files its income tax returns on a consolidated basis. Rate-regulated operations record cumulative increases in deferred taxes as income taxes recoverable from customers. The Company uses the deferral method to account for investment tax credits as required by regulatory commissions. Deferred income taxes are determined using the asset and liability method, under which deferred tax assets and liabilities are measured based upon the temporary differences between the financial statement and income tax basis of assets and liabilities, using current tax rates.
Tax positions must meet a more-likely-than-not recognition threshold to be recognized. The Company has no unrecognized tax benefits that would have a material impact to the Company’s financial statements for any open tax years. No adjustments were recognized for uncertain tax positions for the three and nine months ended September 30, 2015 and 2014.
The Company recognizes interest and penalties related to unrecognized tax benefits in operating expense. As of September 30, 2015 and December 31, 2014, there were no unrecognized tax benefits nor interest or penalties accrued related to unrecognized tax benefits. For the three and nine months ended September 30, 2015 and 2014, the Company did not recognize any interest or penalties related to unrecognized tax benefits.
The Company, or one or more of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The tax years after 2011 for federal and state returns remain open to examination by the major taxing jurisdictions in which the Company operates.
Note 12 – Related Party Transactions
Accounts Receivable and Accounts Payable
The table below details amounts due from and due to related parties, including companies owned or controlled by Richard M. Osborne, father of the Company’s chief executive officer and the Company’s former chairman and chief executive officer, at September 30, 2015 and December 31, 2014. These amounts are presented on the balance sheet as Related parties under Accounts receivable and Accounts payable. During the three months and nine months ended September 30, 2015, the Company wrote-off $0 and $9,000, respectively, of related party receivables as uncollectable.
| | | Accounts Receivable | | | Accounts Payable | |
| | | September 30, | | | December 31, | | | September 30, | | | December 31, | |
| | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Cobra Pipeline | | $ | 93,093 | | | $ | 178,596 | | | $ | 1,145 | | | $ | 67,982 | |
| Orwell Trumbell Pipeline | | | 100 | | | | - | | | | 12,437 | | | | 102,231 | |
| Great Plains Exploration | | | 452 | | | | 959 | | | | 4,839 | | | | 9 | |
| Big Oats Oil Field Supply | | | 30 | | | | 4,752 | | | | - | | | | - | |
| John D. Oil and Gas Company | | | 6,864 | | | | 6,854 | | | | 44,522 | | | | - | |
| OsAir | | | 41,271 | | | | 35,329 | | | | - | | | | 97 | |
| Lake County Title | | | 18,413 | | | | 15,491 | | | | - | | | | - | |
| Other | | | 4,079 | | | | 8,120 | | | | - | | | | - | |
| Total related party balances | | $ | 164,302 | | | $ | 250,101 | | | $ | 62,943 | | | $ | 170,319 | |
The tables below detail transactions with related parties, including companies owned or controlled by Richard M. Osborne, father of the Company’s chief executive officer and the Company’s former chairman and chief executive officer, for the three months ended September 30, 2015 and 2014.
| | | Three Months Ended September 30, 2015 | |
| | | Natural Gas
Purchases &
Transportation | | | Rent, Supplies,
Consulting and
Other Purchases | | | Natural Gas Sales | | | Rental Income
and Other Sales | |
| | | | | | | | | | | | | |
| Cobra Pipeline | | $ | 195,131 | | | $ | 6,000 | | | $ | - | | | $ | - | |
| Orwell Trumbell Pipeline | | | 48,423 | | | | - | | | | 57 | | | | - | |
| Great Plains Exploration | | | 15,232 | | | | - | | | | 20 | | | | - | |
| Big Oats Oil Field Supply | | | - | | | | - | | | | 19 | | | | - | |
| John D. Oil and Gas Company | | | 132,407 | | | | - | | | | 157 | | | | - | |
| OsAir | | | - | | | | - | | | | 265 | | | | - | |
| Other | | | - | | | | - | | | | 758 | | | | - | |
| Total | | $ | 391,193 | | | $ | 6,000 | | | $ | 1,276 | | | $ | - | |
| | | Three Months Ended September 30, 2014 | |
| | | Natural Gas
Purchases &
Transportation | | | Rent, Supplies,
Consulting and
Other Purchases | | | Natural Gas Sales | | | Rental Income
and Other Sales | |
| | | | | | | | | | | | | |
| Cobra Pipeline | | $ | 154,871 | | | $ | 6,000 | | | $ | - | | | $ | - | |
| Orwell Trumbell Pipeline | | | 46,125 | | | | - | | | | 140 | | | | 35,549 | |
| Great Plains Exploration | | | 120,707 | | | | - | | | | 599 | | | | 1,700 | |
| Big Oats Oil Field Supply | | | - | | | | - | | | | 29 | | | | - | |
| John D. Oil and Gas Company | | | 135,237 | | | | - | | | | 144 | | | | 6,323 | |
| OsAir | | | 32,984 | | | | - | | | | 44 | | | | 17,079 | |
| Other | | | 13,839 | | | | - | | | | 2,839 | | | | 100 | |
| Total | | $ | 503,763 | | | $ | 6,000 | | | $ | 3,795 | | | $ | 60,751 | |
The tables below detail transactions with related parties, including companies owned or controlled by Richard M. Osborne, father of the Company’s chief executive officer and the Company’s former chairman and chief executive officer, for the nine months ended September 30, 2015 and 2014.
| | | Nine Months Ended September 30, 2015 | |
| | | Natural Gas
Purchases &
Transportation | | | Rent, Supplies,
Consulting and
Other Purchases | | | Natural Gas Sales | | | Rental Income
and Other Sales | |
| | | | | | | | | | | | | |
| Cobra Pipeline | | $ | 838,154 | | | $ | 20,000 | | | $ | - | | | $ | - | |
| Orwell Trumbell Pipeline | | | 646,529 | | | | - | | | | 1,028 | | | | 100 | |
| Great Plains Exploration | | | 338,304 | | | | - | | | | 275 | | | | (500 | ) |
| Big Oats Oil Field Supply | | | - | | | | - | | | | 2,378 | | | | 850 | |
| John D. Oil and Gas Company | | | - | | | | - | | | | 474 | | | | - | |
| OsAir | | | - | | | | - | | | | 6,650 | | | | - | |
| Lake County Title | | | - | | | | - | | | | - | | | | 7,241 | |
| Other | | | - | | | | - | | | | 9,816 | | | | - | |
| Total | | $ | 1,822,987 | | | $ | 20,000 | | | $ | 20,621 | | | $ | 7,691 | |
| | | Nine Months Ended September 30, 2014 | |
| | | Natural Gas
Purchases &
Transportation | | | Pipeline
Construction
Purchases | | | Rent, Supplies,
Consulting and
Other Purchases | | | Natural Gas Sales | | | Rental Income
and Other Sales | |
| | | | | | | | | | | | | | | | |
| Cobra Pipeline | | $ | 864,118 | | | $ | - | | | $ | 14,000 | | | $ | 104,623 | | | $ | 13,400 | |
| Orwell Trumbell Pipeline | | | 562,728 | | | | - | | | | - | | | | 1,595 | | | | 37,124 | |
| Great Plains Exploration | | | 611,187 | | | | - | | | | - | | | | 12,735 | | | | 4,700 | |
| Big Oats Oil Field Supply | | | - | | | | 254,752 | | | | 93,741 | | | | 4,482 | | | | 850 | |
| John D. Oil and Gas Company | | | 737,522 | | | | - | | | | - | | | | 431 | | | | 35,473 | |
| OsAir | | | 176,116 | | | | - | | | | 6,001 | | | | 2,889 | | | | 39,945 | |
| Lake Shore Gas | | | 162,360 | | | | - | | | | - | | | | - | | | | - | |
| Other | | | 76,281 | | | | - | | | | 22,808 | | | | 21,065 | | | | 1,676 | |
| Total | | $ | 3,190,312 | | | $ | 254,752 | | | $ | 136,550 | | | $ | 147,820 | | | $ | 133,168 | |
In addition, the Company accrued a liability of approximately $99,150 and $69,253 payable to companies controlled by Richard M. Osborne, father of the Company’s chief executive officer and the Company’s former chairman and chief executive officer, for natural gas and natural gas transportation services used through September 30, 2015 and 2014, respectively, which had not yet been invoiced. The related expenses are included in the gas purchased line item in the accompanying Condensed Consolidated Statements of Comprehensive Income.
The Company had related party natural gas imbalances of $27,088 and $98,000 at September 30, 2015 and December 31, 2014, respectively, which were included in the Company’s natural gas inventory balance. These amounts represent quantities of natural gas due to the Company from natural gas transportation companies controlled by Richard M. Osborne, father of the Company’s chief executive officer and the Company’s former chairman and chief executive officer.
On April 6, 2015, the Company entered into a loan agreement and promissory note with NIL Funding Corporation (“NIL Funding”). Pursuant to the note and loan agreement, NIL Funding loaned Gas Natural $5.0 million, bearing an annual interest rate of 7.5%, and a maturity date of October 3, 2015. SeeNote 8 – Credit Facilities and Long-Term Debtfor further detail regarding this loan. On July 27, 2015, the NIL Funding credit facility was paid off and extinguished.
NIL Funding is an affiliate of The InterTech Group, Inc. (“InterTech”). The Chairperson and Chief Executive Officer of InterTech is Anita G. Zucker. Ms. Zucker, as trustee of the Article 6 Marital Trust, under the First Amended and Restated Jerry Zucker Revocable Trust dated April 2, 2007, beneficially owns 940,000 shares, or 8.96%, of the Company’s outstanding common stock, as of February 9, 2015. Two members of Gas Natural’s Board of Directors, Robert Johnston and Michael Bender, also currently serve as Executive Vice President and Chief Strategy Officer and Director, Corporate Secretary and Corporate Counsel, respectively, of InterTech.
Note 13 – Operating Segments
The Company’s reportable segments are based on the Company’s method of internal reporting, which generally segregates the strategic business units due to differences in services and regulation. The internal reporting of these operating segments is defined based on the reporting and review process used by the Company’s chief operating officer. The Company primarily separates its state regulated utility businesses from the non-regulated marketing and production business. Transactions between reportable segments are accounted for on the accrual basis, and eliminated prior to external financial reporting. Inter-company eliminations between segments consist primarily of gas sales from the marketing and production operations to the natural gas operations, inter-company accounts receivable and payable, equity, and subsidiary investments.
The following tables set forth summarized financial information for the Company’s natural gas, marketing and production, and corporate and other operations.
| Three Months Ended September 30, 2015 |
| | | | | | | | | | | | | |
| | | Natural Gas | | | Marketing & | | | Corporate & | | | | |
| | | Operations | | | Production | | | Other | | | Consolidated | |
| | | | | | | | | | | | | |
| OPERATING REVENUES | | $ | 11,356,319 | | | $ | 1,885,718 | | | $ | - | | | $ | 13,242,037 | |
| Intersegment elimination | | | (1,220 | ) | | | (157,002 | ) | | | - | | | | (158,222 | ) |
| Total operating revenue | | | 11,355,099 | | | | 1,728,716 | | | | - | | | | 13,083,815 | |
| | | | | | | | | | | | | | | | | |
| COST OF SALES | | | 4,584,423 | | | | 1,796,914 | | | | - | | | | 6,381,337 | |
| Intersegment elimination | | | (1,220 | ) | | | (157,002 | ) | | | - | | | | (158,222 | ) |
| Total cost of sales | | | 4,583,203 | | | | 1,639,912 | | | | - | | | | 6,223,115 | |
| | | | | | | | | | | | | | | | | |
| GROSS MARGIN | | $ | 6,771,896 | | | $ | 88,804 | | | $ | - | | | $ | 6,860,700 | |
| | | | | | | | | | | | | | | | | |
| OPERATING EXPENSES | | | 9,335,060 | | | | 141,801 | | | | 450,737 | | | | 9,927,598 | |
| Intersegment elimination | | | (25,245 | ) | | | - | | | | - | | | | (25,245 | ) |
| Total operating expenses | | | 9,309,815 | | | | 141,801 | | | | 450,737 | | | | 9,902,353 | |
| | | | | | | | | | | | | | | | | |
| OPERATING INCOME (LOSS) | | $ | (2,537,919 | ) | | $ | (52,997 | ) | | $ | (450,737 | ) | | $ | (3,041,653 | ) |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) FROM CONTINUING OPERATIONS | | $ | (1,902,628 | ) | | $ | (65,648 | ) | | $ | (295,691 | ) | | $ | (2,263,967 | ) |
| | | | | | | | | | | | | | | | | |
| DISCONTINUED OPERATIONS | | $ | - | | | $ | - | | | $ | 3,394,981 | | | $ | 3,394,981 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | (1,902,628 | ) | | $ | (65,648 | ) | | $ | 3,099,290 | | | $ | 1,131,014 | |
| Three Months Ended September 30, 2014 |
| | | | | | | | | | | | | |
| | | Natural Gas | | | Marketing & | | | Corporate & | | | | |
| | | Operations | | | Production | | | Other | | | Consolidated | |
| | | | | | | | | | | | | |
| OPERATING REVENUES | | $ | 12,619,151 | | | $ | 2,134,914 | | | $ | - | | | $ | 14,754,065 | |
| Intersegment elimination | | | (76,453 | ) | | | (1,062,641 | ) | | | - | | | | (1,139,094 | ) |
| Total operating revenue | | | 12,542,698 | | | | 1,072,273 | | | | - | | | | 13,614,971 | |
| | | | | | | | | | | | | | | | | |
| COST OF SALES | | | 5,815,883 | | | | 1,923,541 | | | | - | | | | 7,739,424 | |
| Intersegment elimination | | | (76,453 | ) | | | (1,062,641 | ) | | | - | | | | (1,139,094 | ) |
| Total cost of sales | | | 5,739,430 | | | | 860,900 | | | | - | | | | 6,600,330 | |
| | | | | | | | | | | | | | | | | |
| GROSS MARGIN | | $ | 6,803,268 | | | $ | 211,373 | | | $ | - | | | $ | 7,014,641 | |
| | | | | | | | | | | | | | | | | |
| OPERATING EXPENSES | | | 8,146,216 | | | | 372,682 | | | | 873,202 | | | | 9,392,100 | |
| Intersegment elimination | | | (26,571 | ) | | | - | | | | - | | | | (26,571 | ) |
| Total operating expenses | | | 8,119,645 | | | | 372,682 | | | | 873,202 | | | | 9,365,529 | |
| | | | | | | | | | | | | | | | | |
| OPERATING INCOME (LOSS) | | $ | (1,316,377 | ) | | $ | (161,309 | ) | | $ | (873,202 | ) | | $ | (2,350,888 | ) |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) FROM CONTINUING OPERATIONS | | $ | (879,952 | ) | | $ | (108,248 | ) | | $ | (526,369 | ) | | $ | (1,514,569 | ) |
| | | | | | | | | | | | | | | | | |
| DISCONTINUED OPERATIONS | | $ | - | | | $ | - | | | $ | 34,825 | | | $ | 34,825 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | (879,952 | ) | | $ | (108,248 | ) | | $ | (491,544 | ) | | $ | (1,479,744 | ) |
| Nine Months Ended September 30, 2015 |
| | | | | | | | | | | | | |
| | | Natural Gas | | | Marketing & | | | Corporate & | | | | |
| | | Operations | | | Production | | | Other | | | Consolidated | |
| | | | | | | | | | | | | |
| OPERATING REVENUES | | $ | 77,419,693 | | | $ | 8,916,218 | | | $ | - | | | $ | 86,335,911 | |
| Intersegment elimination | | | (17,081 | ) | | | (3,455,972 | ) | | | - | | | | (3,473,053 | ) |
| Total operating revenue | | | 77,402,612 | | | | 5,460,246 | | | | - | | | | 82,862,858 | |
| | | | | | | | | | | | | | | | | |
| COST OF SALES | | | 45,935,722 | | | | 8,474,342 | | | | - | | | | 54,410,064 | |
| Intersegment elimination | | | (17,081 | ) | | | (3,455,972 | ) | | | - | | | | (3,473,053 | ) |
| Total cost of sales | | | 45,918,641 | | | | 5,018,370 | | | | - | | | | 50,937,011 | |
| | | | | | | | | | | | | | | | | |
| GROSS MARGIN | | $ | 31,483,971 | | | $ | 441,876 | | | $ | - | | | $ | 31,925,847 | |
| | | | | | | | | | | | | | | | | |
| OPERATING EXPENSES | | | 26,381,246 | | | | 596,698 | | | | 2,278,814 | | | | 29,256,758 | |
| Intersegment elimination | | | (87,275 | ) | | | - | | | | - | | | | (87,275 | ) |
| Total operating expenses | | | 26,293,971 | | | | 596,698 | | | | 2,278,814 | | | | 29,169,483 | |
| | | | | | | | | | | | | | | | | |
| OPERATING INCOME (LOSS) | | $ | 5,190,000 | | | $ | (154,822 | ) | | $ | (2,278,814 | ) | | $ | 2,756,364 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) FROM CONTINUING OPERATIONS | | $ | 2,342,145 | | | $ | (83,643 | ) | | $ | (1,817,786 | ) | | $ | 440,716 | |
| | | | | | | | | | | | | | | | | |
| DISCONTINUED OPERATIONS | | $ | - | | | $ | - | | | $ | 4,044,776 | | | $ | 4,044,776 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | 2,342,145 | | | $ | (83,643 | ) | | $ | 2,226,990 | | | $ | 4,485,492 | |
| Nine Months Ended September 30, 2014 |
| | | | | | | | | | | | | |
| | | Natural Gas | | | Marketing & | | | Corporate & | | | | |
| | | Operations | | | Production | | | Other | | | Consolidated | |
| | | | | | | | | | | | | |
| OPERATING REVENUES | | $ | 88,568,864 | | | $ | 13,136,479 | | | $ | - | | | $ | 101,705,343 | |
| Intersegment elimination | | | (241,798 | ) | | | (5,851,936 | ) | | | - | | | | (6,093,734 | ) |
| Total operating revenue | | | 88,327,066 | | | | 7,284,543 | | | | - | | | | 95,611,609 | |
| | | | | | | | | | | | | | | | | |
| COST OF SALES | | | 56,499,466 | | | | 12,389,959 | | | | - | | | | 68,889,425 | |
| Intersegment elimination | | | (241,798 | ) | | | (5,851,936 | ) | | | - | | | | (6,093,734 | ) |
| Total cost of sales | | | 56,257,668 | | | | 6,538,023 | | | | - | | | | 62,795,691 | |
| | | | | | | | | | | | | | | | | |
| GROSS MARGIN | | $ | 32,069,398 | | | $ | 746,520 | | | $ | - | | | $ | 32,815,918 | |
| | | | | | | | | | | | | | | | | |
| OPERATING EXPENSES | | | 24,301,048 | | | | 2,156,684 | | | | 2,464,547 | | | | 28,922,279 | |
| Intersegment elimination | | | (77,561 | ) | | | - | | | | - | | | | (77,561 | ) |
| Total operating expenses | | | 24,223,487 | | | | 2,156,684 | | | | 2,464,547 | | | | 28,844,718 | |
| | | | | | | | | | | | | | | | | |
| OPERATING INCOME (LOSS) | | $ | 7,845,911 | | | $ | (1,410,164 | ) | | $ | (2,464,547 | ) | | $ | 3,971,200 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) FROM CONTINUING OPERATIONS | | $ | 4,189,646 | | | $ | (936,885 | ) | | $ | (1,724,284 | ) | | $ | 1,528,477 | |
| | | | | | | | | | | | | | | | | |
| DISCONTINUED OPERATIONS | | $ | - | | | $ | - | | | $ | 581,652 | | | $ | 581,652 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | 4,189,646 | | | $ | (936,885 | ) | | $ | (1,142,632 | ) | | $ | 2,110,129 | |
The following table presents the Company’s assets by reportable segments:
| | | Natural Gas
Operations | | | Marketing &
Production
Operations | | | Corporate &
Other
Operations | | | Consolidated | |
| September 30, 2015 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Goodwill | | $ | 14,496,247 | | | $ | 1,376,000 | | | $ | - | | | $ | 15,872,247 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 207,865,565 | | | $ | 8,234,003 | | | $ | 91,209,698 | | | $ | 307,309,266 | |
| Intersegment eliminations | | | (24,460,173 | ) | | | (220,953 | ) | | | (87,470,043 | ) | | | (112,151,169 | ) |
| Total assets | | $ | 183,405,392 | | | $ | 8,013,050 | | | $ | 3,739,655 | | | $ | 195,158,097 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2014 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Goodwill | | $ | 14,779,672 | | | $ | 1,376,000 | | | $ | - | | | $ | 16,155,672 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 214,030,368 | | | $ | 9,192,830 | | | $ | 100,781,302 | | | $ | 324,004,500 | |
| Intersegment eliminations | | | (68,714,744 | ) | | | (2,714,405 | ) | | | (38,571,439 | ) | | | (110,000,588 | ) |
| Total assets | | $ | 145,315,624 | | | $ | 6,478,425 | | | $ | 62,209,863 | | | $ | 214,003,912 | |
Note 14 – Commitments and Contingencies
Legal Proceedings
From time to time, the Company is involved in lawsuits that have arisen in the ordinary course of business. The Company is contesting each of these lawsuits vigorously and believes it has defenses to the allegations that have been made. In our opinion, the outcome to these legal actions will not have a material adverse effect on the financial condition, cash flows or results of operations of the Company.
Richard M. Osborne Suits
On June 13, 2014, Richard M. Osborne, father of our chief executive officer and our former chairman and chief executive officer, filed a lawsuit against us and our corporate secretary captioned, “Richard M. Osborne and Richard M. Osborne Trust, Under Restated and Amended Trust Agreement of February 24, 2012 v. Gas Natural, Inc. et al.,” Case No. 14CV001210 which was filed in the Court of Common Pleas in Lake County, Ohio. In this lawsuit, Mr. Osborne sought an order requiring us to provide him with “the minutes and any corporate resolutions for the past five years.” We had provided Mr. Osborne with all the board minutes he requested that had been approved by the board. On October 29, 2014, Mr. Osborne filed an amended complaint in this matter demanding minutes of the committees of the board of directors and additional board minutes which he claimed he was entitled to receive. On November 17, 2014, the defendants moved to dismiss Mr. Osborne’s amended complaint for failure to state a claim upon which relief can be granted, and for summary judgment. On February 11, 2015, the Court granted defendants’ motion, dismissing the case except for one allegation in one paragraph of Mr. Osborne’s amended complaint: that we failed to produce minutes of any board meeting that occurred between June 1, 2014 and June 13, 2014. The Court held in abeyance its ruling on this issue, to give Mr. Osborne 30 days to conduct discovery limited to determining whether any board meetings occurred during that two-week period. On February 13, 2015, Mr. Osborne voluntarily dismissed his Complaint, without prejudice. On April 28, 2015, Mr. Osborne refiled this lawsuit in a different court, the Cuyahoga County Court of Common Pleas, captioned “Richard M. Osborne and Richard M. Osborne Trust, Under Restated and Amended Trust Agreement of January 13, 1995 v. Gas Natural Inc., et al.,” Case No. 15CV844836. Mr. Osborne is again seeking the board minutes at issue in the previously dismissed lawsuit and minutes that have been prepared subsequently. We believe the lawsuit, like its prior iteration, is wholly without merit and will vigorously contest it. In addition, we have filed a counterclaim against Mr. Osborne seeking to have him declared a vexatious litigator. If successful, Mr. Osborne will only be able to initiate new litigation against the Company after receiving permission from the court in which the case would be pending.
On June 26, 2014, Mr. Osborne filed a lawsuit against us and our board of directors captioned “Richard M. Osborne, Richard M. Osborne Trust, Under Restated and Amended Trust Agreement of February 24, 2012 and John D. Oil and Gas Marketing Company, LLC v. Gas Natural, Inc. et al.,” Case No. 14CV001290, filed in the Court of Common Pleas in Lake County, Ohio. In this lawsuit, among other things, Mr. Osborne (1) demanded payment of an earn-out associated with our purchase of assets from John D. Marketing, (2) alleged that the board of directors breached its fiduciary duties, primarily by removing Mr. Osborne as chairman of the board and chief executive officer, (3) sought injunctive relief to restrain our board members from “taking any actions on behalf of Gas Natural until they are in compliance with the law and the documents governing corporate governance,” and (4) asked the Court to enjoin the 2014 annual meeting that was scheduled to take place on July 30, 2014, and to delay it until such time that the board of directors would be “in compliance with the law and corporate governance.”
Mr. Osborne dismissed the above lawsuit on July 15, 2014, without prejudice, as the parties started to engage in settlement negotiations in an attempt to resolve the dispute. After settlement negotiations broke down, Mr. Osborne refiled the lawsuit on July 28, 2014, Case No. 14CV1512, against us and our board members. In the re-filed lawsuit, among other things, Mr. Osborne (1) demands payment of an earn-out amount associated with our purchase of assets from John D. Marketing, (2) alleges that the board of directors breached its fiduciary duties by removing Mr. Osborne as chairman and chief executive officer, (3) seeks to enforce a July 15, 2014 term sheet, where the parties memorialized certain discussions they had in connection with their efforts to resolve the dispute arising out of the lawsuit, which included a severance payment of $1.0 million, and (4) seeks to invalidate the results of the July 30, 2014 shareholder meeting and asks the court to order us to hold a new meeting at a later date. Mr. Osborne is also seeking compensatory and punitive damages. The parties have each filed motions for summary judgment which are awaiting the ruling of the court. We believe that Mr. Osborne’s claims in this lawsuit are wholly without merit and will vigorously defend this case on all grounds.
On March 12, 2015, Cobra Pipeline Co., Ltd (“Cobra”) filed a lawsuit against the Company in the United States District Court for the Northern District of Ohio captioned “Cobra Pipeline Co., Ltd. v. Gas Natural Inc., et al.,” Case No. 1:15-CV-00481. Mr. Osborne owns and controls Cobra. Cobra’s complaint alleged that it uses a service to track the locations of its vehicles via GPS monitoring. Cobra alleged that defendants, including the Company, accessed and intercepted vehicle tracking data, after Gas Natural knew or should have known that its authority to do so had ended. The complaint alleged claims under the Stored Communications Act, the Wiretap Act, and various state-law claims. On September 17, 2015, the court granted defendants’ motion for summary judgment and dismissed Cobra’s complaint in its entirety. On October 19, Cobra filed its Notice of Appeal to the Sixth Circuit Court of Appeals.
Shareholders Suit
Beginning on December 10, 2013, five putative shareholder derivative lawsuits were filed by five different individuals, in their capacity as our shareholders, in the United States District Court for the Northern District of Ohio, purportedly on behalf of us and naming certain of our current and former executive officers and directors as individual defendants. These five shareholder lawsuits are captioned as follows: (1) Richard J. Wickham v. Richard M. Osborne, et al., (Case No. 1:13-cv-02718-LW); (2) John Durgerian v. Richard M. Osborne, et al., (Case No. 1:13-cv-02805-LW); (3) Joseph Ferrigno v. Richard M. Osborne, et al., (Case No. 1:13-cv-02822-LW); (4) Kyle Warner v. Richard M. Osborne, et al., (Case No. 1:14-cv-00007-LW) and (5) Gary F. Peters v. Richard M. Osborne, (Case No. 1:14-cv-0026-CAB). On February 6, 2014, the five lawsuits were consolidated solely for purposes of conducting limited pretrial discovery, and on February 21, 2014, the Court appointed lead counsel for all five lawsuits. No formal discovery has been conducted to date.
The consolidated action contains claims against various of our current or former directors or officers alleging, among other things, violations of federal securities laws, breaches of fiduciary duty, waste of corporate assets and unjust enrichment arising primarily out of our acquisition of the Ohio utilities, services provided by JDOG Marketing and the acquisition of JDOG Marketing, and the sale of our common stock by Richard M. Osborne, our former chairman and chief executive officer, and Thomas J. Smith, our former chief financial officer. The suit, in which we are named as a nominal defendant, seeks the recovery of unspecified damages allegedly sustained by us, corporate reforms, disgorgement, restitution, the recovery of plaintiffs’ attorney’s fees and other relief.
We, along with the other defendants, filed a motion to dismiss the consolidated action in its entirety on May 8, 2014. The motion to dismiss was based on, among other things, the failure of the plaintiffs to make demand on our board of directors to address the alleged wrongdoing prior to filing their lawsuits and the failure to state viable claims against various individual defendants. Richard Osborne, individually, is now represented by counsel independent of all other defendants in the case and submitted a filing in support of the motion to dismiss on his own behalf.
On September 24, 2014, the magistrate judge assigned to the case issued a report and recommendation in response to the motion to dismiss. The magistrate judge recommended that the plaintiffs’ claims against the individual defendants with respect to the “unjust enrichment” allegation in the complaint be dismissed. The magistrate judge recommended that all other portions of the motion to dismiss be denied. The report and recommendation, the objections filed by the defendants, and the responses from the plaintiffs will all be reviewed by the trial judge assigned to the case who will then either adopt the report and recommendation in full, reject it in full, or adopt in part and modify in part. The parties engaged in settlement mediation on February 25, 2015. The parties failed to reach a settlement, but discussions are ongoing.
At this time we are unable to provide an estimate of any possible future losses that the Company may incur in connection to this suit. We carry insurance that we believe will cover any negative outcome associated with this action. This insurance carries a $250,000 deductible, which we have reached. Although we believe these insurance proceeds are available, we may incur costs and expenses related to this suit that are not covered by insurance which may be substantial. Any unfavorable outcome of this suit could adversely impact our business and results of operations.
Harrington Employment Suit
On February 25, 2013, one of our former officers, Jonathan Harrington, filed a lawsuit captioned “Jonathan Harrington v. Energy West, Inc. and Does 1-4,” Case No. DDV-13-159 in the Montana Eighth Judicial District Court, Cascade County. Mr. Harrington claims he was terminated in violation of a Montana statute requiring just cause for termination. In addition, he alleges claims for negligent infliction of emotional distress and negligent slander. Mr. Harrington is seeking relief for economic loss, including lost wages and fringe benefits for a period of at least four years from the date of discharge, together with interest. Mr. Harrington is an Ohio resident and was employed in our Ohio corporate offices. On March 20, 2013, we filed a motion to dismiss the lawsuit on the basis that Mr. Harrington was an Ohio employee, not a Montana employee, and therefore the statute does not apply. On July 1, 2014, the court conducted a hearing, made extensive findings on the record, and issued an Order finding in our favor and dismissing all of Mr. Harrington’s claims. On July 21, 2014, Mr. Harrington appealed the dismissal to the Montana Supreme Court. On August 11, 2015, the Montana Supreme Court agreed with us that Mr. Harrington’s employment was governed by Ohio law, and as such he could not take advantage of Montana’s Wrongful Discharge from Employment Act. However, the Montana Supreme Court also held the trial court erred in determining it lacked jurisdiction over the case, finding the trial court should have retained jurisdiction and applied Ohio law to Mr. Harrington’s claims. As Ohio is an “at will” state, we believe there are no claims under Ohio law and the case will ultimately be dismissed by the trial court on remand. On September 28, 2015, Mr. Harrington filed a Motion to Amend Complaint to assert new causes of action not previously alleged including claims for misrepresentation, constructive fraud based on alleged representations, slander, and mental pain and suffering. We continue to believe Mr. Harrington’s claims under both Montana and Ohio law are without merit, and we will oppose Mr. Harrington’s recent motion and will continue to vigorously defend this case on all grounds.
Special Committee of the Board Investigation
On March 26, 2014, the board of directors formed a special committee comprised of three independent directors to investigate the allegations contained in a letter received from one of our shareholders. The letter demands that the board take legal action to remedy alleged breaches of fiduciary duties by the board and certain of our executive officers in connection with the Order and Opinion issued by the PUCO on November 13, 2013. The special committee has the power to retain any advisors, including legal counsel and accounting, financial and regulatory advisors, that the committee determines to be appropriate to carry out its responsibilities in connection with its investigation. The special committee has prepared a report with the assistance of legal counsel and financial and regulatory advisors evaluating the allegations and the board is in the process of determining the position Gas Natural will take with respect to the letter. Although the Company believes that insurance proceeds are available for a portion of the cost of the investigation, the Company has incurred substantial costs and expenses related to the investigation that are not covered by insurance.
SEC Investigation
The Company received a letter from the Chicago Regional Office of the SEC dated March 3, 2015 stating that the staff of the SEC is conducting an investigation regarding (i) audits by the PUCO and Rehmann Corporate Investigative Services, (ii) the determination and calculation of the GCR, (iii) the Company’s financial statements and internal controls and (iv) various entities affiliated with our former CEO, Richard M. Osborne. The SEC has requested we preserve all documents relating to these matters. The Company received a subpoena to produce documents from the staff of the SEC dated May 29, 2015 in connection with this matter. The Company is complying with these requests and intends to cooperate fully with the SEC. Although the Company believes that insurance proceeds will be available for a portion of the cost of the investigation, the Company has incurred substantial costs and expenses related to the investigation that are not covered by insurance.
Note 15 – Subsequent Events
Dividends
On October 8, 2015, the Company declared a dividend of $0.135 per share that is payable to shareholders of record on October 22, 2015. There were 10,504,734 shares outstanding on October 22, 2015 resulting in a total dividend of $1,418,139 which was paid to shareholders on October 29, 2015.
Loan agreement with NIL Funding
On October 23, 2015, the Company entered into a loan agreement and promissory note with NIL Funding Pursuant to the note and loan agreement, NIL Funding loaned Gas Natural $3.0 million, bearing an annual interest rate of 6.95%, and a maturity date of April 20, 2016. The note and loan agreement are subject to other customary loan covenants and default provisions. In an event of default, as defined under the loan agreement, NIL Funding may, at its option, require the Company to immediately pay the outstanding principal balance of the note as well as any and all interest and other payments due or convert any part of the amounts due and unpaid to shares of the Company’s common stock at a conversion price of 95% of the previous day’s closing price on the NYSE MKT. NIL Funding is considered a related party. SeeNote 12 – Related Party Transactions for further details.
Sale of Assets of 8500 Station Street
On August 5, 2015, the Company entered into an asset purchase agreement with Marc Wertenberger to sell the land, building and improvements of the “Matchworks” building located at 8500 Station Street, Mentor Oh, 44060. This represents substantially all of the assets of the Company’s 8500 Station Street, LLC subsidiary. The Company received $1.4 million less closing costs under the transaction which closed on October 15, 2015. As a result of this transaction, the Company will recognize an asset impairment loss of $410,411 based on the carrying amount of assets sold totaling $1,760,411. This loss has been recorded in the distribution, general and administrative line item in the accompanying Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This quarterly report on Form 10-Q contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which represent our expectations or beliefs concerning future events. Forward-looking statements generally include words such as "anticipates," "believes," "expects," "planned," "scheduled" or similar expressions and statements concerning our operating capital requirements, utilization of tax benefits, recovery of property tax payments, our environmental remediation plans, and similar statements that are not historical are forward-looking statements that involve risks and uncertainties. Although we believe these forward-looking statements are based on reasonable assumptions, statements made regarding future results are subject to a number of assumptions, uncertainties and risks that could cause future results to be materially different from the results stated or implied in this document.
Such forward-looking statements, as well as other oral and written forward-looking statements made by or on behalf of us from time to time, including statements contained in filings with the Securities and Exchange Commission ("SEC") and our reports to shareholders, involve known and unknown risks and other factors that may cause our company's actual results in future periods to differ materially from those expressed in any forward-looking statements. See “Risk Factors” in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2014 filed with the SEC. Any such forward looking statement is qualified by reference to these risk factors. We caution that these risk factors are not exclusive. We do not undertake to update any forward looking statements that may be made from time to time by or on behalf of us except as required by law.
OVERVIEW
Gas Natural is a natural gas company, primarily operating local distribution companies in six states and serving approximately 68,000 customers. Our natural gas utility subsidiaries are Bangor Gas (Maine), Brainard Gas Corp. (Ohio), Cut Bank Gas Company (Montana), Energy West Montana (Montana), Frontier Natural Gas (North Carolina), Northeast Ohio Natural Gas Corporation (Ohio), Orwell Natural Gas Company (Ohio and Pennsylvania) and Public Gas Company (Kentucky). Our operations also include production and marketing of natural gas. Approximately 95% of our revenues for the three and nine months ended September 30, 2015 were derived from our natural gas utility operations. Our revenue is seasonal in nature; therefore, the largest portion of our operating revenue is generated during the colder months when our sales volumes increase considerably. The interim results on the accompanying condensed consolidated statements of comprehensive income are not indicative of the estimated results for a full fiscal year.
The following summarizes the critical events that impacted our results of operations during the three and nine months ended September 30, 2015:
Revenues decreased due to:
| · | Lower prices for gas passed on to our customers in our Ohio, North Carolina and Montana markets. |
| · | Offsetting increase in revenue from the Loring Pipeline and increased sales volumes in Maine. |
| · | Offsetting increase in revenue from our customer Energy West Wyoming in our marketing and production operation. Energy West Wyoming was sold to Cheyenne Light Fuel and Power in July 2015. EWR continues to sell Energy West Wyoming natural gas and the revenues are no longer eliminated in consolidation. SeeItem 1 – Financial Statements - Note 2 – Discontinued Operationsfor further detail on the EWW sale. |
| · | Lower sales volumes due to warmer weather in our Montana market contributed to lower revenues in the nine months ended September 30, 2015, compared to the same period in 2014. |
| · | A decrease of $534,000 related to a downward adjustment to volumes used to calculate unbilled revenue in our North Carolina market in the nine months ended September 30, 2015. |
Gross margin decreased due to:
| · | An adjustment to deferred gas costs in our Clarion River and Walker Gas divisions in Ohio lowered gross margin in the three months ended September 30, 2015 by $184,000. |
| · | In the second quarter of 2015, the executed stipulation with the PUCO Staff related to the most recent gas cost recovery audits in Ohio specified a disallowance of gas costs of $693,000 over amounts previously accrued. |
| · | The lower sales volumes in our Montana market caused lower gross margin in the nine months ended September 30, 2015. |
| · | $234,000 related to the downward adjustment to the volumes used in the unbilled revenue calculation in our North Carolina market in the nine months ended September 30, 2015. |
| · | A partially offsetting increase in gross margin in our Maine market due to the activation of the Loring Pipeline and the higher sales volumes in the nine months ended September 30, 2015. |
Operating expenses increased because of the following:
| · | A $410,000 asset impairment charge in the three months ended September 30, 2015 related to the pending sale of the assets of 8500 Station Street. SeeItem 1 – Financial Statements - Note 3 – Held for Salefor further detail on the 8500 Station Street sale. |
| · | The nine months ended September 30, 2015 included expense of $393,000 from the impairment of goodwill and assets related to the pending sale of the assets of PGC. SeeItem 1 – Financial Statements - Note 3 – Held for Salefor further detail on the PGC sale. |
| · | Both the three and nine months ended September 30, 2015 include increased costs related to depreciation, property taxes and a decrease in capitalized labor. |
| · | Offsetting these increases, in the nine months ended September 30, 2015, the provision for doubtful accounts decreased by $697,000. The comparable 2014 period included the write-off of uncollectible accounts of $1,056,000 related to the unfavorable ruling in a large industrial customer’s Chapter 11 bankruptcy proceeding. |
In addition, included in discontinued operations for the third quarter of 2015 is the net gain recorded for the sale of Energy West Wyoming of $3,089,000 and the net gain for the sale of the Pipeline Assets of $499,000.
Our financial statements reflect the following reportable business segments: Natural Gas Operations, Marketing & Production Operations, and Corporate & Other.
RESULTS OF CONSOLIDATED OPERATIONS
| | | | | | | | | Amount Change | | | | | | | | | Amount Change | |
| | | Three Months Ended September 30, | | | Favorable | | | Nine Months Ended September 30, | | | Favorable | |
| ($ in thousands) | | 2015 | | | 2014 | | | (Unfavorable) | | | 2015 | | | 2014 | | | (Unfavorable) | |
| | | | | | | | | | | | | | | | | | | |
| Revenue | | $ | 13,084 | | | $ | 13,615 | | | $ | (531 | ) | | $ | 82,863 | | | $ | 95,612 | | | $ | (12,749 | ) |
| Cost of sales | | | 6,223 | | | | 6,600 | | | | 377 | | | | 50,937 | | | | 62,796 | | | | 11,859 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross margin | | | 6,861 | | | | 7,015 | | | | (154 | ) | | | 31,926 | | | | 32,816 | | | | (890 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating expenses | | | | | | | | | | | | | | | | | | | | | | | | |
| Distribution, general & administrative | | | 6,806 | | | | 6,321 | | | | (485 | ) | | | 19,793 | | | | 19,018 | | | | (775 | ) |
| Maintenance | | | 256 | | | | 296 | | | | 40 | | | | 872 | | | | 920 | | | | 48 | |
| Depreciation amortization & accretion | | | 1,790 | | | | 1,830 | | | | 40 | | | | 5,328 | | | | 5,178 | | | | (150 | ) |
| Accretion | | | - | | | | 9 | | | | 9 | | | | 21 | | | | 37 | | | | 16 | |
| Taxes other than income | | | 1,015 | | | | 901 | | | | (114 | ) | | | 3,023 | | | | 2,862 | | | | (161 | ) |
| Provision for doubtful accounts | | | 35 | | | | 8 | | | | (27 | ) | | | 133 | | | | 830 | | | | 697 | |
| Total operating expense | | | 9,902 | | | | 9,365 | | | | (537 | ) | | | 29,170 | | | | 28,845 | | | | (325 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | | (3,041 | ) | | | (2,350 | ) | | | (691 | ) | | | 2,756 | | | | 3,971 | | | | (1,215 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Loss from unconsolidated affiliate | | | - | | | | - | | | | - | | | | - | | | | (1 | ) | | | 1 | |
| Other income | | | 277 | | | | 408 | | | | (131 | ) | | | 593 | | | | 618 | | | | (25 | ) |
| Gain (loss) on sale of marketable securities | | | - | | | | 183 | | | | (183 | ) | | | - | | | | 183 | | | | (183 | ) |
| Acquisition expense | | | - | | | | - | | | | - | | | | - | | | | (7 | ) | | | 7 | |
| Interest expense | | | (812 | ) | | | (764 | ) | | | (48 | ) | | | (2,567 | ) | | | (2,334 | ) | | | (233 | ) |
| Income (loss) before income taxes | | | (3,576 | ) | | | (2,523 | ) | | | (1,053 | ) | | | 782 | | | | 2,430 | | | | (1,648 | ) |
| Income tax benefit (expense) | | | 1,312 | | | | 1,008 | | | | 304 | | | | (342 | ) | | | (901 | ) | | | 559 | |
| Income (loss) from continuing operations | | | (2,264 | ) | | | (1,515 | ) | | | (749 | ) | | | 440 | | | | 1,529 | | | | (1,089 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Discontinued operations, net of tax | | | 3,395 | | | | 35 | | | | 3,360 | | | | 4,045 | | | | 581 | | | | 3,464 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | 1,131 | | | $ | (1,480 | ) | | $ | 2,611 | | | $ | 4,485 | | | $ | 2,110 | | | $ | 2,375 | |
The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this report and our Annual Report on Form 10-K for the period ended December 31, 2014. The following gives effect to the unaudited Condensed Consolidated Financial Statements as of September 30, 2015 and for the three and nine month periods ended September 30, 2015. Results of operations for interim periods are not necessarily indicative of results to be attained for any future period.
Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014
Income (Loss) from Discontinued Operations — The 2015 and 2014 results of our Propane Operations segment have been classified as discontinued operations as a result of the sale of the assets of Independence in November 2013. SeeNote 4 – Discontinued Operations to the notes of our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the SEC for more information regarding the sale of Independence. In addition, the 2015 and 2014 results of our Energy West Wyoming subsidiary, historically included in the Natural Gas Operations segment, and the results of our pipeline operations segment have also been classified as discontinued operations as a result of a sale agreement executed on October 10, 2014. SeeItem 1 – Financial Statements - Note 2 – Discontinued Operationsfor further detail. The Company’s income from discontinued operations for the three months ended September 30, 2015 was $3,395,000 or $0.32 per diluted share, compared to $35,000 or $0.00 per diluted share for the three months ended September 30, 2014. The income from discontinued operations of EWW and Energy West Development increased $3,355,000 to $3,407,000 for the three month period ended September 30, 2015 compared to $1,000 for the same period in 2014. The net gain recorded for the sale of EWW was $3,089,000 and the net gain for the sale of the Pipeline Assets was $499,000. The loss from discontinued operations of Independence decreased $5,000 to a loss of $12,000 for the three month period ended September 30, 2015 compared to a loss of $17,000 the same period in 2014.
Loss from Continuing Operations — Loss for the three months ended September 30, 2015 was $2,264,000, or $0.22 per diluted share, compared to a loss of $1,515,000 or $0.14 per diluted share for the three months ended September 30, 2014. Loss from our natural gas operations increased by $1,023,000 due primarily to: 1) the $410,000 impairment charge in the 2015 period related to the pending sale of the assets of 8500 Station Street; 2) increases in corporate cost allocations of $325,000; and 3)increased taxes other than income of $114,000. Loss from our gas marketing & production operations decreased by $42,000. Loss from our corporate and other segment decreased by $231,000 due primarily to lower administrative costs in the three months ended September 30, 2015.
Revenues — Revenues decreased by $531,000 to $13,084,000 for the three months ended September 30, 2015 compared to $13,615,000 for the same period in 2014. Revenue from natural gas operations decreased by $1,188,000 due to 1) a decrease in the price of natural gas passed through to our customers in our Ohio, North Carolina and Montana markets; and 2) partially offset by an increase of $194,000 from the operation of our Loring Pipeline and increased sales volumes in our Maine market. Revenue from our marketing and production operations increased by $657,000 primarily due to the inclusion of gas sales to EWW, which was sold to Cheyenne Light Fuel and Power Company in July 2015. These revenues were previously eliminated as intercompany revenue for consolidation purposes.
Gross Margin — Gross margin decreased by $154,000 to $6,861,000 for the three months ended September 30, 2015 compared to $7,015,000 for the same period in 2014. Our natural gas operation’s margins decreased $32,000, due primarily to: 1) an adjustment to deferred gas costs in our Clarion River and Walker Gas divisions in Ohio of $184,000; and 2) decreases totaling $66,000 in our Montana, North Carolina and Kentucky markets. These decreases were partially offset by the revenue from the Loring Pipeline. Gross margin from our marketing & production operations decreased $122,000 primarily due to significantly lower prices for volumes produced in our production operation.
Operating Expenses — Operating expenses, other than cost of sales, increased by $537,000 to $9,902,000 for the three months ended September 30, 2015 compared to $9,365,000 for the same period in 2014. Distribution, general and administrative expenses increased by $485,000 primarily due to: 1) a $410,000 asset impairment charge in the 2015 period related to the pending sale of the assets of 8500 Station Street; 2) increases in allocated corporate costs of $328,000; 3) increases in payroll expense due to less labor being capitalized of $56,000 and partially offset by 4) decreases in corporate costs not allocated to operating entities of $422,000 Depreciation and amortization expense decreased $40,000 due to decreased capital expenditures. Taxes other than income expenses increased by $114,000 due to property tax increases.
Other Income, net — Other income, net decreased by $131,000 to $277,000 for the three months ended September 30, 2015 compared to $408,000 for the same period in 2014. This decrease is primarily due to a decrease in interest income. The 2014 period included $82,000 of interest income in our North Carolina Market which was earned on the deferred gas cost balances.
Gain on Sale of Marketable Securities — Gain on sale of marketable securities decreased by $183,000 in 2015 due to the sale of all of our shares of Corning Natural Gas Corporation stock in August of 2014.
Interest Expense — Interest expense decreased by $48,000 to $812,000 for the three months ended September 30, 2015 compared to $764,000 in 2014.
Income Tax Benefit — Income tax benefit increased by $304,000 to $1,312,000 for the three months ended September 30, 2015 compared to $1,008,000 for the same period in 2014 due primarily to increased pre-tax loss in the current year.
Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014
Income (Loss) from Discontinued Operations — The 2015 and 2014 results of our Propane Operations segment have been classified as discontinued operations as a result of the sale of the assets of Independence in November 2013. SeeNote 4 – Discontinued Operations to the notes of our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the SEC for more information regarding the sale of Independence. In addition, the 2015 and 2014 results of our Energy West Wyoming subsidiary, historically included in the Natural Gas Operations segment, and the results of our pipeline operations segment have also been classified as discontinued operations as a result of a sale agreement executed on October 10, 2014. SeeItem 1 – Financial Statements - Note 2 – Discontinued Operationsfor further detail. The Company’s income from discontinued operations for the nine months ended September 30, 2015 was $4,045,000 or $0.39 per diluted share, compared to $581,000 or $0.06 per diluted share for the nine months ended September 30, 2014. The income from discontinued operations of Energy West Wyoming and Energy West Development increased $3,454,000 to $4,075,000 for the nine month period ended September 30, 2015 compared to $621,000 for the same period in 2014. The net gain recorded for the sale of Energy West Wyoming was $3,089,000 and the net gain for the sale of the Pipeline Assets was $499,000. The loss from discontinued operations of Independence decreased $9,000 to a loss of $30,000 for the nine month period ended September 30, 2015 compared to a loss of $39,000 for the same period in 2014.
Income from Continuing Operations — Income for the nine months ended September 30, 2015 was $440,000, or $0.04 per diluted share, compared to a net income of $1,529,000 or $0.15 per diluted share for the nine months ended September 30, 2014. Income from our natural gas operations decreased by $1,848,000 due primarily to: 1) the charge in the second quarter of 2015 for additional disallowed gas cost beyond amounts accrued from the stipulation with the PUCO Staff in the most recent gas cost recovery audit in Ohio; 2) the impairment expense related to the pending sale of PGC and 8500 Station Street and; 4) an offsetting increase from the Loring Pipeline, customer growth and colder weather in our Maine market. Loss from our gas marketing & production operations decreased by $853,000. The 2014 period included an expense of $1,056,000 for uncollectible accounts resulting from an unfavorable ruling in a large industrial customer’s Chapter 11 bankruptcy proceedings. Loss from our corporate and other segment increased by $93,000.
Revenues — Revenues decreased by $12,749,000 to $82,863,000 for the nine months ended September 30, 2015 compared to $95,612,000 for the same period in 2014. Revenue from natural gas operations decreased by $10,924,000 due primarily to: 1) a decrease in the price of natural gas passed through to our customers in our Ohio, North Carolina and Montana markets; 2) decreased sales volumes due to warmer weather in our Montana market; and partially offset by 3) an increase of $579,000 from the operation of our Loring Pipeline and increased sales volumes from customer growth and colder weather in Maine. Revenue from our marketing and production operation decreased by $1,825,000 due to the loss of our LNG customer to pipeline competition and significantly lower prices for volumes produced in our production operation.
Gross Margin — Gross margin decreased by $890,000 to $31,926,000 for the nine months ended September 30, 2015 compared to $32,816,000 for the same period in 2014. Our natural gas operation’s margins decreased $585,000, due primarily to: 1) the charge recorded in the second quarter of 2015 for additional disallowed gas cost beyond amounts accrued from the PUCO Staff stipulation in the gas cost recovery audit in Ohio; 2) lower sales in our Montana market due to warmer weather; and partially offset by 3) increased margin from the Loring Pipeline and customer growth and colder weather in our Maine market. Gross margin from our marketing & production operations decreased $305,000, primarily due to the loss of our LNG customer to pipeline competition and the lower prices for volumes produced in our production operation.
Operating Expenses — Operating expenses, other than cost of sales, increased by $325,000 to $29,170,000 for the nine months ended September 30, 2015 compared to $28,845,000 for the same period in 2014. Distribution, general and administrative expenses increased $775,000 primarily due to goodwill and asset impairment expenses totaling $804,000 related to the pending sales of the assets of PGC and 8500 Station Street. Depreciation and amortization expense increased by $150,000 primarily due to amortization expense related to the regulatory asset in Frontier of $367,000 in the current year, compared to $122,000 in the prior period, partially offset by decreased depreciation expenses due to decreased capital expenditures. Taxes other than income increased by $161,000 due to property tax increases. Provision for doubtful accounts decreased $697,000 during the first nine months of 2015 because during the comparable 2014 period, our marketing operation in Montana wrote-off $1,056,000 of uncollectible receivables resulting from an unfavorable ruling in a large industrial customer’s Chapter 11 bankruptcy proceedings.
Other Income, net — Other income, net decreased by $25,000 to $593,000 for the nine months ended September 30, 2015 compared to $618,000 for the same period in 2014.
Interest Expense — Interest expense increased by $233,000 to $2,567,000 for the nine months ended September 30, 2015 compared to $2,334,000 in 2014 due primarily to the interest expense and amortized debt issue costs related to the new short-term loan agreement, which contributed $217,000 to the increased interest cost.
Income Tax Expense — Income tax expense decreased by $559,000 to $342,000 for the nine months ended September 30, 2015 compared to $901,000 for the same period in 2014. The decrease is primarily due to a decrease in pre-tax income. The Company’s effective tax rate increased to 37.73% for the nine months ended September 30, 2015 compared to 37.35% in the 2014 period.
Net Income (Loss) by Segment and Service Area
The components of net income for the three and nine months ended September 30, 2015 and 2014 are:
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Natural Gas Operations | | | | | | | | | | | | | | | | |
| Energy West Montana (MT) | | $ | (279 | ) | | $ | (132 | ) | | $ | 353 | | | $ | 884 | |
| Frontier Natural Gas (NC) | | | 63 | | | | 94 | | | | 1,135 | | | | 1,403 | |
| Bangor Gas (ME) | | | (72 | ) | | | (90 | ) | | | 1,712 | | | | 1,297 | |
| Ohio & Pennsylvania Companies (OH/PA) | | | (1,535 | ) | | | (677 | ) | | | (500 | ) | | | 732 | |
| Public Gas (KY) | | | (80 | ) | | | (75 | ) | | | (358 | ) | | | (126 | ) |
| Total Natural Gas Operations | | | (1,903 | ) | | | (880 | ) | | | 2,342 | | | | 4,190 | |
| Marketing & Production Operations | | | (66 | ) | | | (108 | ) | | | (84 | ) | | | (937 | ) |
| Corporate & Other | | | (295 | ) | | | (526 | ) | | | (1,818 | ) | | | (1,725 | ) |
| | | | | | | | | | | | | | | | | |
| Income (loss) from Continuing Operations | | | (2,264 | ) | | | (1,514 | ) | | | 440 | | | | 1,528 | |
| | | | | | | | | | | | | | | | | |
| Discontinued Operations | | | | | | | | | | | | | | | | |
| Energy West Wyoming (WY) | | | 3,090 | | | | 10 | | | | 3,672 | | | | 499 | |
| Pipeline operations | | | 317 | | | | 42 | | | | 403 | | | | 122 | |
| Propane Operations | | | (12 | ) | | | (17 | ) | | | (30 | ) | | | (39 | ) |
| Income from discontinued operations | | | 3,395 | | | | 35 | | | | 4,045 | | | | 582 | |
| | | | | | | | | | | | | | | | | |
| Consolidated Net Income (Loss) | | $ | 1,131 | | | $ | (1,479 | ) | | $ | 4,485 | | | $ | 2,110 | |
The following highlights our results by operating segments:
NATURAL GAS OPERATIONS
| Income Statement | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Natural Gas Operations | | | | | | | | | | | | | | | | |
| Operating revenues | | $ | 11,355 | | | $ | 12,543 | | | $ | 77,403 | | | $ | 88,327 | |
| Gas Purchased | | | 4,583 | | | | 5,739 | | | | 45,919 | | | | 56,258 | |
| Gross Margin | | | 6,772 | | | | 6,804 | | | | 31,484 | | | | 32,069 | |
| Operating expenses | | | 9,310 | | | | 8,120 | | | | 26,294 | | | | 24,223 | |
| Operating income (loss) | | | (2,538 | ) | | | (1,316 | ) | | | 5,190 | | | | 7,846 | |
| Other income | | | 151 | | | | 369 | | | | 493 | | | | 620 | |
| Income (loss) before interest and taxes | | | (2,387 | ) | | | (947 | ) | | | 5,683 | | | | 8,466 | |
| Interest expense | | | (621 | ) | | | (586 | ) | | | (1,912 | ) | | | (1,895 | ) |
| Income (loss) before income taxes | | | (3,008 | ) | | | (1,533 | ) | | | 3,771 | | | | 6,571 | |
| Income tax benefit (expense) | | | 1,105 | | | | 653 | | | | (1,429 | ) | | | (2,381 | ) |
| | | | | | | | | | | | | | | | | |
| Net Income (Loss) | | $ | (1,903 | ) | | $ | (880 | ) | | $ | 2,342 | | | $ | 4,190 | |
| Operating Revenues | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Full Service Distribution Revenues | | | | | | | | | | | | | | | | |
| Residential | | $ | 3,693 | | | $ | 4,149 | | | $ | 33,294 | | | $ | 37,552 | |
| Commercial | | | 4,555 | | | | 5,783 | | | | 33,314 | | | | 40,960 | |
| Other | | | 49 | | | | 16 | | | | 110 | | | | 56 | |
| Total full service distribution | | | 8,297 | | | | 9,948 | | | | 66,718 | | | | 78,568 | |
| | | | | | | | | | | | | | | | | |
| Transportation | | | 2,770 | | | | 2,307 | | | | 9,822 | | | | 8,896 | |
| Bucksport | | | 288 | | | | 288 | | | | 863 | | | | 863 | |
| | | | | | | | | | | | | | | | | |
| Total operating revenues | | $ | 11,355 | | | $ | 12,543 | | | $ | 77,403 | | | $ | 88,327 | |
| Utility Throughput | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| (in million cubic feet (MMcf)) | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Full Service Distribution | | | | | | | | | | | | | | | | |
| Residential | | | 345 | | | | 355 | | | | 3,459 | | | | 3,662 | |
| Commercial | | | 472 | | | | 565 | | | | 3,186 | | | | 3,572 | |
| Total full service | | | 817 | | | | 920 | | | | 6,645 | | | | 7,234 | |
| | | | | | | | | | | | | | | | | |
| Transportation | | | 2,342 | | | | 1,871 | | | | 8,106 | | | | 7,865 | |
| Bucksport | | | 124 | | | | 2,018 | | | | 537 | | | | 4,778 | |
| | | | | | | | | | | | | | | | | |
| Total Volumes | | | 3,283 | | | | 4,809 | | | | 15,288 | | | | 19,877 | |
Heating Degree Days
A heating degree day is a measure designed to reflect the demand for energy needed for heating, based on the extent to which the daily average temperature falls below a reference temperature which no heating is required, usually 65 degrees Fahrenheit.
| | | | | | Three Months Ended | | | Percent Colder (Warmer) | |
| | | | | | September 30, | | | 2015 Compared to | |
| | | Normal | | | 2015 | | | 2014 | | | Normal | | | 2014 | |
| | | | | | | | | | | | | | | | |
| Great Falls, MT | | | 354 | | | | 319 | | | | 325 | | | | (9.89 | )% | | | (1.85 | )% |
| Bangor, ME | | | 152 | | | | 134 | | | | 235 | | | | (11.84 | )% | | | (42.98 | )% |
| Elkin, NC | | | 30 | | | | 48 | | | | 63 | | | | 60.00 | % | | | (23.81 | )% |
| Lancaster, OH | | | 90 | | | | 44 | | | | 128 | | | | (51.11 | )% | | | (65.63 | )% |
| Jackson, KY | | | 84 | | | | 67 | | | | 97 | | | | (20.24 | )% | | | (30.93 | )% |
| | | | | | Nine Months Ended | | | Percent Colder (Warmer) | |
| | | | | | September 30, | | | 2015 Compared to | |
| | | Normal | | | 2015 | | | 2014 | | | Normal | | | 2014 | |
| | | | | | | | | | | | | | | | |
| Great Falls, MT | | | 4,780 | | | | 4,233 | | | | 5,188 | | | | (11.44 | )% | | | (18.41 | )% |
| Bangor, ME | | | 4,706 | | | | 5,737 | | | | 5,352 | | | | 21.91 | % | | | 7.19 | % |
| Elkin, NC | | | 2,484 | | | | 2,657 | | | | 2,856 | | | | 6.96 | % | | | (6.97 | )% |
| Lancaster, OH | | | 3,487 | | | | 3,819 | | | | 4,050 | | | | 9.52 | % | | | (5.70 | )% |
| Jackson, KY | | | 2,756 | | | | 3,042 | | | | 3,178 | | | | 10.38 | % | | | (4.28 | )% |
Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014
Revenues and Gross Margin
Revenues decreased by $1,118,000 to $11,355,000 for the three months ended September 30, 2015 compared to $12,543,000 for the same period in 2014. This decrease is the result of the following factors:
| 1) | Revenue from our Montana market decreased $765,000 primarily due primarily to lower gas prices passed on to customers. Sales volumes decreased 20 MMcf during the 2015 quarter compared to the same period in 2014. |
| 2) | Revenue from our North Carolina market decreased by $602,000 due primarily to lower gas costs passed on to customers in the three months ended September 30, 2015 compared to the 2014 period. Sales volumes increased 7 MMcf. |
| 3) | Revenues from our Ohio market decreased $248,000. Revenue to full service customers decreased $243,000, primarily due to lower prices paid for natural gas passed on to our customers. Sales volumes increased 7 MMcf in the three months ended September 30, 2015 compared to the 2014 period. |
| 4) | Revenue from our Kentucky market decreased $88,000 during the 2015 quarter compared to the same period in 2014. |
| 5) | Revenue from our Maine market increased $365,000. The Loring pipeline in Maine, which started transport services in September 2014, contributed $194,000 of this increase. In addition, volumes from full service and transportation customers increased by 258 MMcf in the three months ended September 30, 2015 compared to the 2014 period. |
Gas purchases decreased by $1,156,000 to $4,583,000 for the three months ended September 30, 2015 compared to $5,739,000 for the same period in 2014. This decrease is primarily due to decreases in the price paid for natural gas passed on to our customers, partially offset by an adjustment to deferred gas costs of $184,000 in our Clarion River and Walker Gas divisions. Our gas costs are passed on dollar for dollar to our customers under tariffs regulated by the various commissions in the jurisdictions in which we operate. Our gas costs are subject to periodic audits and prudency reviews in all of these jurisdictions.
Gross margin decreased by $32,000 to $6,772,000 for the three months ended September 30, 2015 compared to $6,804,000 for the same period in 2014. Gross margin in our Ohio market decreased by $206,000 primarily due to the Clarion River and Walker Gas gas cost adjustments. Gross margin in our North Carolina market increased by $23,000. Gross margin in our Montana market decreased by $26,000, and Kentucky gross margin decreased by $17,000. Partially offsetting these, gross margin in our Maine market increased by $194,000 due primarily to the startup of the Loring Pipeline and the increased sales volumes.
Earnings
The Natural Gas Operations segment’s net loss for the three months ended September 30, 2015 was $1,903,000 or $0.18 per diluted share, compared to a loss of $880,000, or $0.08 per diluted share for the three months ended September 30, 2014.
Operating expenses increased by $1,190,000 to $9,310,000 for the three months ended September 30, 2015 compared to $8,120,000 for the same period in 2014. Distribution, general and administrative expenses increased by $1,196,000 due to 1) a $410,000 asset impairment charge in the 2015 period related to the pending sale of the assets of 8500 Station Street; 2) increases in corporate cost allocations of $325,000; and 3) increases in payroll expense due to less labor being capitalized of $82,000. Depreciation and amortization expense decreased by $31,000 primarily due to decreased capital expenditures. Taxes other than income increased by $114,000 due primarily to property tax increases.
Other income decreased by $218,000 to $151,000 for the three months ended September 30, 2015 compared to $369,000 for the same period in 2014.
Interest expense increased by $35,000 to $621,000 for the three months ended September 30, 2015 compared to $586,000 for the same period in 2014.
Income tax benefit increased by $452,000 to $1,105,000 for the three months ended September 30, 2015 compared to $653,000 for the same period in 2014 primarily due to the larger pre-tax loss in 2015 compared to the 2014 period.
Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014
Revenues and Gross Margin
Revenues decreased by $10,924,000 to $77,403,000 for the nine months ended September 30, 2015 compared to $88,327,000 for the same period in 2014. This decrease is the result of the following factors:
| 1) | Revenues from our Ohio market decreased $5,581,000. Revenue to full service customers decreased $5,685,000, primarily due to lower prices paid for natural gas passed on to our customers, along with a decrease of volumes sold to full service customers of 54 MMcf due to warmer weather. |
| 2) | Revenue from our Montana market decreased $4,819,000 primarily caused by a volume decrease of 410 MMcf during the 2015 period compared to the same period in 2014, due to much warmer weather in 2015. A decrease in prices paid for natural gas passed on to our customers also contributed to the decreased revenue. |
| 3) | Revenue from our North Carolina market decreased by $2,069,000 due to 1) the $534,000 decrease from the adjustment to sales volumes used in our unbilled revenue calculation in the second quarter of 2015; 2) lower prices paid for natural gas passed through to customers; and 3) a decrease in sales volumes of 76 MMcf due to warmer weather. |
| 4) | Revenue from our Kentucky market decreased $164,000 during the 2015 quarter compared to the same period in 2014. |
| 5) | Revenue from our Maine market increased $1,559,000. The Loring pipeline in Maine, which started transport services in September 2014, contributed $579,000 of the increase. The remainder is due to a volume increase from full service and transportation customers of 443 MMcf caused by continued customer growth magnified by colder weather. |
Gas purchases decreased by $10,339,000 to $45,919,000 for the nine months ended September 30, 2015 compared to $56,258,000 for the same period in 2014. This decrease is primarily due to lower gas costs passed through to customers in our Ohio, North Carolina and Montana markets as well as decreases in sales volumes in our Montana markets. Partially offsetting these decreases are 1) the amount of $693,000 recorded in the second quarter of 2015 for additional disallowed gas costs over amounts previously accrued from the PUCO Staff stipulation in the gas cost recovery audit in Ohio and 2) the $184,000 to gas costs in our Clarion River and Walker Gas divisions in the three months ended September 30, 2015. Our gas costs are passed on dollar for dollar to our customers under tariffs regulated by the various commissions in the jurisdictions in which we operate. Our gas costs are subject to periodic audits and prudency reviews in all of these jurisdictions.
Gross margin decreased by $585,000 to $31,484,000 for the nine months ended September 30, 2015 compared to $32,069,000 for the same period in 2014. Gross margin in our Ohio market decreased by $717,000 primarily due to the adjustment of additional disallowed gas cost in the second quarter of 2015. Gross margin in our Montana markets decreased by $469,000 due to lower sales volumes caused by warmer weather. Gross margin in our North Carolina market decreased by $69,000 due to the $234,000 adjustment in the second quarter of 2015 to decrease the lower volumes used in the unbilled revenue calculation, offset by a change in the sales volume mix toward higher margin customers. Kentucky decreased gross margin by $32,000. Partially offsetting these, gross margin in our Maine market increased by $702,000 due to the startup of the Loring Pipeline and the increased sales volumes.
Earnings
The Natural Gas Operations segment’s net income for the nine months ended September 30, 2015 was $2,342,000 or $0.22 per diluted share, compared to earnings of $4,190,000, or $0.40 per diluted share for the nine months ended September 30, 2014.
Operating expenses increased by $2,071,000 to $26,294,000 for the nine months ended September 30, 2015 compared to $24,223,000 for the same period in 2014. Distribution, general and administrative expenses increased by $1,759,000 due to: 1) a total of $804,000 from the impairment of goodwill and assets related to the pending sales of the assets of PGC and 8500 Station Street, 2) increases in corporate cost allocations of $361,000; and 3) increases in payroll expense due to $415,000 less labor being capitalized as part of construction projects. Depreciation and amortization expense increased by $190,000 primarily due to amortization expense related to the regulatory asset in Frontier of $367,000 in the current year, compared to $122,000 in the prior year period. Taxes other than income increased by $169,000 due to increased property taxes
Other income decreased by $127,000 to $493,000 for the nine months ended September 30, 2015 compared to $620,000 for the same period in 2014. Interest income decreased $151,000 due to interest income allowed on deferred gas costs in our North Carolina market in 2014.
Interest expense increased by $17,000 to $1,912,000 for the nine months ended September 30, 2015 compared to $1,895,000 for the same period in 2014.
Income tax expense decreased by $952,000 to $1,429,000 for the nine months ended September 30, 2015 compared to $2,381,000 for the same period in 2014 primarily due to the decrease in pre-tax income in 2015 compared to the 2014 period.
MARKETING and PRODUCTION OPERATIONS
| Income Statement | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Marketing and Production Operations | | | | | | | | | | | | | | | | |
| Operating revenues | | $ | 1,729 | | | $ | 1,072 | | | $ | 5,460 | | | $ | 7,285 | |
| Gas Purchased | | | 1,640 | | | | 861 | | | | 5,018 | | | | 6,538 | |
| Gross Margin | | | 89 | | | | 211 | | | | 442 | | | | 747 | |
| Operating expenses | | | 142 | | | | 372 | | | | 597 | | | | 2,157 | |
| Operating loss | | | (53 | ) | | | (161 | ) | | | (155 | ) | | | (1,410 | ) |
| Other income (expense) | | | (16 | ) | | | 8 | | | | 120 | | | | 8 | |
| Income (loss) before interest and taxes | | | (69 | ) | | | (153 | ) | | | (35 | ) | | | (1,402 | ) |
| Interest expense | | | (35 | ) | | | (34 | ) | | | (97 | ) | | | (89 | ) |
| Loss before income taxes | | | (104 | ) | | | (187 | ) | | | (132 | ) | | | (1,491 | ) |
| Income tax benefit | | | 38 | | | | 79 | | | | 48 | | | | 554 | |
| | | | | | | | | | | | | | | | | |
| Net Loss | | $ | (66 | ) | | $ | (108 | ) | | $ | (84 | ) | | $ | (937 | ) |
Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014
Revenues and Gross Margin
Revenues increased by $657,000 to $1,729,000 for the three months ended September 30, 2015 compared to $1,072,000 for the same period in 2014. Revenue increased from our EWR marketing operations by $885,000 to $1,039,000 in the 2015 period. We continue to supply natural gas to Energy West Wyoming which was sold to Cheyenne Light Fuel and Power in July 2015. This revenue is no longer eliminated in consolidation. Our GNR subsidiary contributed revenue of $547,000, which is a decrease of $77,000 from the 2014 quarter due primarily to lower prices charged to customers. Revenue from our production operation decreased by $152,000 to $140,000 due to much lower prices for volumes produced.
Gross margin decreased by $122,000 to $89,000 for the three months ended September 30, 2015 compared to $211,000 for the same period in 2014. GNR’s margin decreased by $62,000 to $28,000 for the three months ended September 30, 2015 from $90,000 in the 2014 period. Gross margin from our production operation decreased by $95,000 due to the lower prices for volumes produced. Partially offsetting these was an increase to gross margin from our EWR marketing operations of $34,000 due primarily to higher margins per unit on volumes sold.
Earnings
The Marketing and Production segment’s loss for the three months ended September 30, 2015 was $66,000, or $0.01 per diluted share, compared to a loss of $108,000, or $0.01 per diluted share for the three months ended September 30, 2014.
Operating expenses decreased by $230,000 to $142,000 for the three months ended September 30, 2015 compared to $372,000 for the same period in 2014. The three months ended September 30, 2015 included an unrealized holding gain on the contingent consideration liability of $75,000. The 2014 period included costs for removing the LNG equipment from the site of our former LNG customer.
Other income (expense) decreased by $24,000 to expense of $16,000 for the three months ended September 30, 2015 from income of $8,000 for the same period in 2014, due to a market-to-market gain on derivative liabilities.
Income tax benefit decreased by $41,000 to $38,000 for the three months ended September 30, 2015 compared to $79,000 for the same period in 2014 primarily due to the decrease in the pre-tax loss in 2015 compared to the 2014 period.
Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014
Revenues and Gross Margin
Revenues decreased by $1,825,000 to $5,460,000 for the nine months ended September 30, 2015 compared to $7,285,000 for the same period in 2014. Revenue from our LNG business decreased by $1,390,000 due to the loss of our LNG customer to pipeline competition in 2014. Our GNR subsidiary contributed revenue of $2,472,000, which is a decrease of $580,000 from the 2014 quarter due primarily to lower prices charged to customers. Revenue from our production operation decreased by $397,000 due to significantly lower prices for volumes produced. Offsetting these is an increase in revenue from our EWR marketing operation by $542,000 due primarily to the switch of Energy West Wyoming to an outside customer with the sale to Cheyenne Light Fuel and Power.
Gross margin decreased by $305,000 to $442,000 for the nine months ended September 30, 2015 compared to $747,000 for the same period in 2014. Gross margin from our LNG business decreased by $213,000. Gross margin from our EWR production operation decreased by $163,000 due the lower prices on volumes produced. GNR’s margin increased $17,000 to $274,000 for the nine months ended September 30, 2015 from $257,000 in the 2014 period. Gross margin on EWR marketing operations increased by $55,000 due to higher margins per unit on volumes sold.
Earnings
The Marketing & Production segment’s loss for the nine months ended September 30, 2015 was $84,000, or $0.01 per diluted share, compared to a loss of $937,000, or $0.09 per diluted share for the nine months ended September 30, 2014.
Operating expenses decreased by $1,560,000 to $597,000 for the nine months ended September 30, 2015 compared to $2,157,000 for the same period in 2014. The 2014 period included $1,056,000 in uncollectible accounts expense resulting from an unfavorable ruling in a large industrial customer’s Chapter 11 bankruptcy proceedings.
Other income (expense) increased by $112,000 to income of $120,000 for the nine months ended September 30, 2015 compared to income of $8,000 for the same period in 2014, due to a $120,000 market-to-market gain on derivative liabilities.
Income tax benefit decreased by $506,000 to $48,000 for the nine months ended September 30, 2015 compared to $554,000 for the same period in 2014 primarily due to the decrease in pre-tax income in 2015 compared to the 2014 period.
CORPORATE & OTHER OPERATIONS
Our Corporate and Other reporting segment is intended primarily to encompass the results of corporate acquisitions and other equity transactions, as well as certain other income and expense items associated with Gas Natural’s holding company functions. It also includes the results of our insurance business. Therefore, it does not have standard revenues, gas purchase costs, or gross margin.
Income Statement
| Income Statement | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | | | 2015 | | | 2014 | |
| | | | | | | | | | | | | |
| Corporate and Other | | | | | | | | | | | | | | | | |
| Operating revenues | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Gas Purchased | | | - | | | | - | | | | - | | | | - | |
| Gross Margin | | | - | | | | - | | | | - | | | | - | |
| Operating expenses | | | 451 | | | | 873 | | | | 2,279 | | | | 2,465 | |
| Operating loss | | | (451 | ) | | | (873 | ) | | | (2,279 | ) | | | (2,465 | ) |
| Other income (expense) | | | 142 | | | | 215 | | | | (19 | ) | | | 165 | |
| Loss before interest and taxes | | | (309 | ) | | | (658 | ) | | | (2,298 | ) | | | (2,300 | ) |
| Interest expense | | | (155 | ) | | | (144 | ) | | | (558 | ) | | | (351 | ) |
| Loss before income taxes | | | (464 | ) | | | (802 | ) | | | (2,856 | ) | | | (2,651 | ) |
| Income tax benefit | | | 169 | | | | 276 | | | | 1,038 | | | | 926 | |
| Net loss from continuing operations | | | (295 | ) | | | (526 | ) | | | (1,818 | ) | | | (1,725 | ) |
| Discontinued operations | | | 3,395 | | | | 34 | | | | 4,045 | | | | 582 | |
| | | | | | | | | | | | | | | | | |
| Net Income (Loss) | | $ | 3,100 | | | $ | (492 | ) | | $ | 2,227 | | | $ | (1,143 | ) |
Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014
Results of corporate and other operations for the three months ended September 30, 2015 include administrative costs of $451,000, corporate income of $142,000, which includes income from our insurance operations, interest expense of $155,000, offset by an income tax benefit of $169,000, for a net loss from continuing operations of $295,000.
Results of corporate and other operations for the three months ended September 30, 2014 include administrative costs of $873,000, a gain on marketable securities of $183,000, corporate expenses of $28,000, interest expense of $144,000, offset by an income tax benefit of $276,000, and interest income of $3,000, for a net loss from continuing operations of $526,000.
Loss from discontinued operations
Discontinued operations of the prior and current periods represent the results of operations related to the sale of the Independence assets, our Energy West Wyoming subsidiary, and the Shoshone & Glacier pipeline assets. SeeNote 4 – Discontinued Operationsto the notes of our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for more information regarding the sale of Independence. SeeNote 2 – Discontinued Operations to the notes of our consolidated financial statements in this 10-Q for more information regarding the sale of Energy West Wyoming and the Shoshone & Glacier pipeline assets. Net income from discontinued operations increased by $3,361,000 to income of $3,395,000 for the three months ended September 30, 2015 as compared to income of $34,000 for the same period in 2014.
Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014
Results of corporate and other operations for the nine months ended September 30, 2015 include administrative costs of $2,279,000, corporate expenses of $19,000, interest expense of $558,000, offset by an income tax benefit of $1,038,000, for a net loss from continuing operations of $1,818,000.
Results of corporate and other operations for the nine months ended September 30, 2014 include administrative costs of $2,465,000, acquisition related costs of $8,000, a gain on marketable securities of $183,000, corporate expenses of $20,000, interest expense of $351,000, offset by an income tax benefit of $926,000, and interest income of $10,000, for a net loss from continuing operations of $1,725,000. Included in administrative costs is expense related to director stock compensation awards of $308,000, and the write-off of $197,000 of construction work in progress related to a software conversion project that has been terminated.
Loss from discontinued operations
Discontinued operations of the prior and current periods represent the results of operations related to the sale of the Independence assets, our Energy West Wyoming subsidiary, and the Shoshone & Glacier pipeline assets. SeeNote 4 – Discontinued Operationsto the notes of our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for more information regarding the sale of Independence. SeeNote 2 – Discontinued Operations to the notes of our consolidated financial statements in this 10-Q for more information regarding the sale of Energy West Wyoming and the Shoshone & Glacier pipeline assets. Net income from discontinued operations increased by $3,463,000 to income of $4,045,000 for the nine months ended September 30, 2015 as compared to income of $582,000 for the same period in 2014.
Sources and Uses of Cash
Operating activities provide our primary source of cash. Cash provided by operating activities consists of net income adjusted for non-cash items, including depreciation, depletion, amortization, deferred income taxes, and changes in working capital.
Cash provided by discontinued operations is presented separately from cash flows from continuing operations in the Consolidated Statements of Cash Flows. The disposition of Energy West Wyoming and the Shoshone & Glacier pipeline assets is not expected to have a material negative impact on the Company’s liquidity.
Our ability to maintain liquidity depends upon our credit facility with Bank of America, shown as line of credit on the accompanying Condensed Consolidated Balance Sheets. We periodically repay our short-term borrowings under the revolving line of credit by using the net proceeds from the sale of long-term debt and equity securities.
Cash, excluding restricted cash, increased to $3.9 million at September 30, 2015, compared to $1.6 million at December 31, 2014.
| | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | |
| | | | | | | |
| Cash Flows from Continuing Operations | | | | | | | | |
| Cash provided by operating activities | | $ | 12,248 | | | $ | 8,599 | |
| Cash used in investing activities | | | (7,561 | ) | | | (13,803 | ) |
| Cash used in financing activities | | | (17,962 | ) | | | (8,049 | ) |
| Decrease in cash | | $ | (13,275 | ) | | $ | (13,253 | ) |
| | | | | | | | | |
| Cash Flows from Discontinued Operations | | | | | | | | |
| Cash provided by operating activities | | $ | 1,288 | | | $ | 1,907 | |
| Cash used in investing activities | | | 14,305 | | | | (346 | ) |
| Cash provided by (used in) financing activities | | | - | | | | 54 | |
| Increase in cash | | $ | 15,593 | | | $ | 1,615 | |
Operating Cash Flow
For the nine months ended September 30, 2015, cash provided by operating activities increased by $3.6 million as compared to the nine months ended September 30, 2014. Major items affecting operating cash included a $1.1 million decrease in net income from continuing operations, a $4.1 million increase in accounts payable payments, a $2.6 million decrease in inventory purchases, a $2.6 million increase in collections of recoverable costs of gas, a $2.0 million increase in accounts receivable receipts, a $1.0 million decrease in other current liabilities, a $0.5 million increase in prepayments, a $0.4 million increase in unbilled revenue, and a $0.3 million increase in other current assets.
Investing Cash Flow
For the nine months ended September 30, 2015, cash used in investing activities decreased by $6.2 million as compared to the nine months ended September 30, 2014. The decrease is primarily attributable to a decrease of $8.0 million in cash paid for capital expenditures, offset by a decrease of $1.4 million decrease in contributions in aid of construction and a $0.4 decrease in proceeds from the sale of marketable securities.
Capital Expenditures
Our capital expenditures for continuing operations totaled $8.3 million and $16.3 million for the nine months ended September 30, 2015 and 2014, respectively. We finance our capital expenditures on an interim basis by the use of our operating cash flow and use of the Bank of America revolving lines of credit.
The majority of our capital spending is focused on the growth of our Natural Gas Operations segment. We conduct ongoing construction activities in all of our utility service areas in order to support expansion, maintenance, and enhancement of our gas pipeline systems. We are actively expanding our systems in North Carolina and Maine to meet the high customer interest in natural gas service in those areas.
Estimated Capital Expenditures
The table below details our capital expenditures for the nine months ended September 30, 2015 and 2014 and provides an estimate of future cash requirements for capital expenditures:
| | | Nine Months Ended September 30, | |
| ($ in thousands) | | 2015 | | | 2014 | |
| | | | | | | |
| Natural Gas Operations | | $ | 8,204 | | | $ | 15,680 | |
| Marketing and Production Operations | | | 78 | | | | 60 | |
| Corporate and Other Operations | | | 43 | | | | 536 | |
| | | | | | | | | |
| Total Capital Expenditures | | $ | 8,325 | | | $ | 16,276 | |
We anticipate our remaining cash requirements for capital expenditures through December 31, 2015 to be approximately $1.4 million, which we expect to fund from cash provided by operating activities.
Financing Cash Flow
For the nine months ended September 30, 2015, cash used in financing activities increased by $9.9 million as compared with the nine months ended September 30, 2014. The change is due to $12.5 million in additional net payments on our line of credit, $3.0 million in net proceeds from short-term loans, a $1.4 million decrease in dividends paid, and increase in payments on the build to suit liability in 2015 of $1.4 million.
We fund our operating cash needs, as well as dividend payments and capital expenditures, primarily through cash flow from operating activities and short-term borrowing. Historically, to the extent cash flow has not been sufficient to fund these expenditures, we have used our line of credit. We have greater need for short-term borrowing during periods when internally generated funds are not sufficient to cover all capital and operating requirements, including costs of gas purchased and capital expenditures. In general, our short-term borrowing needs for purchases of gas inventory and capital expenditures are greatest during the summer and fall months and our short-term borrowing needs for financing customer accounts receivable are greatest during the winter months. We use our credit facility with Bank of America, shown as line of credit on the accompanying Condensed Consolidated Balance Sheets, to maintain liquidity. Our use of the revolving line of credit was $15.8 million and $28.8 million at September 30, 2015 and December 31, 2014, respectively. We periodically repay our short-term borrowings under the revolving line of credit by using the net proceeds from the sale of long-term debt and equity securities. Long-term debt was $39.9 million and $40.3 million at September 30, 2015 and December 31, 2014, respectively, including the amount due within one year.
The following discussion describes our credit facilities as of September 30, 2015.
Bank of America Credit Agreement and Line of Credit
On September 20, 2012, the Company’s subsidiary, Energy West, entered into an Amended and Restated Credit Agreement (the "Credit Agreement"), with the Bank of America, N.A. ("Bank of America") which modifies the original credit agreement entered into on June 29, 2007, as amended from time to time. The Credit Agreement renewed the $30.0 million revolving credit facility available to Energy West and provides for a maturity date of April 1, 2017. On November 26, 2014, the Company entered into an amendment temporarily increasing the borrowing capacity by $10.0 million to a maximum of $40.0 million. In an order approving this temporary increase in borrowing capacity, the MPSC stated that any amounts borrowed under this increase in excess of $5.0 million would first require the approval of the MPSC. Amounts borrowed under this temporary increase had a maturity date of July 1, 2015 and were repaid to Bank of America prior to that date.
The Credit Agreement includes an annual commitment fee ranging from 25 to 45 basis points of the unused portion of the facility and interest on the amounts outstanding at LIBOR plus 175 to 225 basis points. The Company had outstanding borrowings under this facility of $15.8 million and $39.9 million at September 30, 2015 and December 31, 2014, respectively. For the three months ended September 30, 2015 and 2014, interest expense related to the line of credit was $110,000 and $146,000, respectively. The weighted average interest rate for the revolving credit facility was 2.32% and 2.50%, for the three months ended September 30, 2015 and 2014, respectively. For the nine months ended September 30, 2015 and 2014, interest expense related to the line of credit was $423,000 and $421,000, respectively. The weighted average interest rate for the revolving credit facility was 2.39% and 2.42%, for the nine months ended September 30, 2015 and 2014, respectively.
Bank of America Term Loan
Energy West entered into a $10.0 million term loan with Bank of America with a maturity date of April 1, 2017 (the "Term Loan"). The Term Loan portion of the Bank of America credit agreement has an interest rate of LIBOR plus 175 to 225 basis points with an interest rate swap provision that allows for the interest rate to be fixed in the future. The Term Loan is amortized at a rate of $125,000 per quarter. As of September 30, 2015, the Company had not exercised the interest rate swap provision for the fixed interest rate.
For the three months ended September 30, 2015 and 2014, the weighted average interest rate was 2.19% and 2.15%, respectively, resulting in interest expense of $48,000 and $50,000, respectively. For the nine months ended September 30, 2015 and 2014, the weighted average interest rate was 2.18% and 2.15%, respectively, resulting in interest expense of $144,800 and $151,000, respectively. The balance outstanding on the Term Loan at September 30, 2015 and December 31, 2014 was $8,500,000 and $8,875,000, respectively.
Senior Unsecured Notes of Energy West
On June 29, 2007, Energy West authorized the sale of $13,000,000 aggregate principal amount of its 6.16% Senior Unsecured Notes to Allstate/CUNA, due June 29, 2017 (the “Senior Unsecured Notes”). The proceeds of these notes were used to refinance existing notes. Interest expense was $200,200 for the three and nine months ended September 30, 2015 and 2014.
Sun Life Assurance Company of Canada
On May 2, 2011, the Company and its Ohio subsidiaries, NEO, Orwell and Brainard (together the “Issuers"), issued a $15.3 million, 5.38% Senior Secured Guaranteed Fixed Rate Note due June 1, 2017 ("Fixed Rate Note"). The Fixed Rate Note is governed by a Note Purchase Agreement (“NPA”). Concurrent with the funding and closing of the note, which occurred on May 3, 2011, the parties executed amended note purchase agreements that are substantially the same as the note purchase agreements executed on November 2, 2010. On April 9, 2012, the Company entered into a waiver and amendment of the Fixed Rate Note to cure certain breaches of covenants.
The Fixed Rate Note, in the amount of $15.3 million, is a joint obligation of the Issuers, and is guaranteed by the Company, Lightning Pipeline and Great Plains (together with the Issuers, the “Fixed Rate Obligors"). Prepayment of this note prior to maturity is subject to a 50 basis point make-whole premium.
The use of proceeds for both notes extinguished existing amortizing bank debt and other existing indebtedness, funded $3.4 million for the 2011 capital program for Orwell and NEO, established two debt service reserve accounts, and replenished the Company’s treasuries prior repayment of maturing bank debt and transaction expenses. The capital program funds and debt service reserve accounts are in interest bearing accounts and included in restricted cash.
For the three and nine months ended September 30, 2015 and 2014, the weighted average interest rate on the Fixed Rate Note was 5.38%. Interest expense related to the Fixed Rate Note was $206,000 and $619,000 for the three and nine months ended September 30, 2015 and 2014, respectively. Payments for the Fixed Rate Note prior to maturity are interest-only.
On October 24, 2012, Orwell, NEO, and Brainard issued a Senior Secured Guaranteed Note in the amount of $2.989 million. The Senior Note was placed with Sun Life, pursuant to a third amendment to the original NPA dated as of November 1, 2010, by and among Orwell, NEO, and Brainard, and Great Plains, Lightning Pipeline, Gas Natural and Sun Life. The Senior Note bears an interest rate of 4.15%, compounded semi-annually, and it matures on June 1, 2017. The Senior Note is a joint obligation of the Ohio subsidiaries and is guaranteed by Gas Natural’s non-regulated Ohio subsidiaries. For the three and nine months ended September 30, 2015 and 2014, the interest expense related to the Senior Note was $31,000 and $92,000, respectively.
Short Term Loan Agreement with NIL Funding Corporation
On April 6, 2015, the Company entered into a loan agreement and promissory note with NIL Funding Corporation (“NIL Funding”). Pursuant to the note and loan agreement, NIL Funding loaned Gas Natural $5.0 million, bearing an annual interest rate of 7.5%, and a maturity date of October 3, 2015. The note and loan agreement are subject to other customary loan covenants and default provisions. For the three and nine months ended September 30, 2015, the interest expense related to the short term loan was $129,000 and $217,000, respectively. On July 27, 2015, the NIL Funding credit facility was paid off and extinguished.
The Company used proceeds from this loan, in part, to repay an intercompany payable owed to Energy West. On November 24, 2014, the MPSC issued an order directing, in part, that Energy West require Gas Natural to repay an intercompany payable to Energy West by December 24, 2014. In addition, the MPSC order restricted Energy West and its Montana, Maine, and North Carolina operating subsidiaries from paying dividends to Gas Natural until persuasive evidence could be presented that Energy West was on a sound financial footing and that effect had been given to the MPSC’s ring-fencing conditions; the strongest indication being the absence of ongoing balances owed to Energy West by Gas Natural. On April 9, 2015, Energy West filed a request to reinstate Energy West and its Montana, Maine, and North Carolina operating subsidiaries ability to pay dividends to Gas Natural. On July 22, 2015, the MPSC issued an order allowing for the reinstatement of the dividends. They also approved a special dividend to be declared from the proceeds from the sale of Energy West’s subsidiaries Energy West Wyoming and the Shoshone and Glacier pipeline assets.
NIL Funding is an affiliate of The InterTech Group, Inc. (“InterTech”). The Chairperson and Chief Executive Officer of InterTech is Anita G. Zucker. Ms. Zucker, as trustee of the Article 6 Marital Trust, under the First Amended and Restated Jerry Zucker Revocable Trust dated April 2, 2007, beneficially owns 940,000 shares, or 8.96%, of the Company’s outstanding common stock, as of February 9, 2015. Two members of Gas Natural’s Board of Directors, Robert Johnston and Michael Bender, also currently serve as Executive Vice President and Chief Strategy Officer and Director, Corporate Secretary and Corporate Counsel, respectively, of InterTech.
Debt Covenants
The Bank of America revolving credit agreement and term loan contain various covenants, which include limitations on total dividends and distributions, limitations on investments in other entities, maintenance of certain debt-to-capital and interest coverage ratios, and restrictions on certain indebtedness as outlined below.
The credit facility restricts Energy West’s ability to pay dividends and make distributions, redemptions and repurchases of stock during any 60-month period to 80% (previously 75%) of its net income over that period. In addition, no event of default may exist at the time such dividend, distribution, redemption or repurchase is made.
The amended credit facility limits investments in another entity by acquisition of any debt or equity securities or assets or by making loans or advances to such entity. Energy West is also prohibited from consummating a merger or consolidation or selling all or substantially all of its assets or stock except for (i) any merger consolidation or sale by or with certain of its subsidiaries, (ii) any such purchase or other acquisition by Energy West or certain of its subsidiaries and (iii) sales and dispositions of assets for at least fair market value so long as the net book value of all assets sold or otherwise disposed of in any fiscal year does not exceed 5% of the net book value of Energy West’s assets as of the last day of the preceding fiscal year.
Energy West must maintain a total debt- to-capital ratio of not more than .55-to-1.00 and an interest coverage ratio of no less than 2.0-to-1.0. The credit facility restricts Energy West’s ability to create, incur or assume indebtedness except (i) indebtedness under the credit facility (ii) indebtedness incurred under certain capitalized leases including the capital lease related to the Loring pipeline, and purchase money obligations not to exceed $500,000, (iii) certain indebtedness of Energy West’s subsidiaries, (iv) certain subordinated indebtedness, (v) certain hedging obligations and (vi) other indebtedness not to exceed $1.0 million.
The Senior Unsecured Notes contain various covenants, which include limitations on Energy West’s total dividends and distributions, restrictions on certain indebtedness as outlined below, maintenance of certain interest coverage ratios, and limitations on asset sales as outlined below.
The credit facility limits Energy West’s total dividends and distributions made in the immediately preceding 60-month period to 100% of aggregate consolidated net income for such period.
The notes restrict Energy West from incurring additional senior indebtedness in excess of 65% of capitalization at any time.
The credit facility also requires Energy West to maintain an interest coverage ratio of more than 150% of the pro forma annual interest charges on a consolidated basis in two of the three preceding fiscal years.
Energy West is prohibited from selling or otherwise disposing of any of its property or assets except (i) in the ordinary course of business, (ii) property or assets that are no longer usable in its business or (iii) property or assets transferred between Energy West and its subsidiaries if the aggregate net book value of all properties and assets so disposed of during the twelve month period next preceding the date of such sale or disposition would constitute more than 15% of the aggregate book value of all Energy West’s tangible assets. In addition, Energy West may only consummate a merger or consolidation, dissolve or otherwise dispose of all or substantially all of its assets (i) if there is no event of default, (ii) the provisions of the notes are assumed by the surviving or continuing corporation and such entity further agrees that it will continue to operate its facilities as part of a system comprising a public utility regulated by the Public Service Commission of Montana or another federal or state agency or authority and (iii) the surviving or continuing corporation has a net worth immediately subsequent to such acquisition, consolidation or merger equal to or greater than $10 million.
The Sun Life Fixed Rate Note, Floating Rate Note, and Senior Note contain various covenants, which include, among others, limitations on total dividends and distributions, restrictions on certain indebtedness, limitations on asset sales, and maintenance of certain debt-to-capital and interest coverage ratios as outlined below.
The amendments provide that any cash dividends, distributions, redemptions or repurchases of common stock may be made by the obligors to the holding company only if (i) the aggregate amount of all such dividends, distributions, redemptions and repurchases for the fiscal year do not exceed 70% of net income of the obligors for the four fiscal quarters then ending determined as of the end of each fiscal quarter for the four fiscal quarters then ending, and (ii) there exists no other event of default at the time the dividend, distribution, redemption or repurchase is made. Due to the covenants, the Obligors are may be unable to pay a dividend to the holding company, which may impact the Company’s ability to pay a dividend to shareholders.
The Ohio subsidiaries and PGC are prohibited from creating, assuming or incurring additional indebtedness except for (i) obligations under certain financing agreements, (ii) indebtedness incurred under certain capitalized leases and purchase money obligations not to exceed $500,000 at any one time outstanding, (iii) indebtedness outstanding as of March 31, 2011, (iv) certain unsecured intercompany indebtedness and (v) certain other indebtedness permitted under the notes.
On May 31, 2014, the Company loaned $3.1 million to Great Plains, one of the obligors under the note purchase agreements. The loan was not evidenced by a promissory note and pledged to Sun Life as required by certain covenants in the note purchase agreement. On July 8, 2015, Great Plains executed a $3.1 million revolving note payable to the Company, which was pledged to Sun Life. Concurrently, the Company entered into a limited waiver to the note purchase agreement with Sun Life curing the breach of the covenants.
The notes prohibit us from selling or otherwise transferring assets except in the ordinary course of business and to the extent such sales or transfers, in the aggregate, over each rolling twelve month period, do not exceed 1% of our total assets. Generally, we may consummate a merger or consolidation if there is no event of default and the provisions of the notes are assumed by the surviving or continuing corporation. We are also generally limited in making acquisitions in excess of 10% of our total assets. An event of default, if not cured, would require us to immediately pay the outstanding principal balance of the notes as well as any and all interest and other payments due. An event of default would also entitle Sun Life to exercise certain rights with respect to the collateral that secures the indebtedness incurred under the notes.
The Fixed Rate Note and Floating Rate Note require, on a consolidated basis, an interest coverage ratio of at least 2.0 to 1.0, measured quarterly on a trailing four quarter basis. The notes generally define the interest coverage ratio as the ratio of EBITDA to gross interest expense. The note defines EBITDA as net income plus the sum of interest expense, any provision for federal, state, and local taxes, depreciation, and amortization determined on a consolidated basis in accordance with GAAP, but excluding any extraordinary non-operating income or loss and any gain or loss from non-operating transactions. The interest coverage ratio is measured with respect to the Obligors on a consolidated basis and also with respect to the Company and all of its subsidiaries, on a consolidated basis. The notes also require that the Company does not permit indebtedness to exceed 60% of capitalization at any time. Like the interest coverage ratio, the ratio of debt to capitalization is measured on a consolidated basis for the Obligors, and again on a consolidated basis with respect to the Company and all of its subsidiaries.
Additionally, Sun Life restricted certain cash balances and required two main types of debt service reserve accounts to be created to cover approximately one year of interest payments. The balance in both debt service reserve accounts was $0.9 million and $0.9 million at September 30, 2015 and December 31, 2014, respectively, and is included in restricted cash. The debt service reserve accounts cannot be used for operating cash needs.
The Senior Note is a joint obligation of the Ohio subsidiaries and is guaranteed by Gas Natural’s non-regulated Ohio subsidiaries. The Senior Note is subject to other customary loan covenants and default provisions.
The NIL Funding Corporation short term loan contains various covenants, including a restriction on any future indebtedness by Gas Natural. Gas Natural is also prohibited from consummating a merger or consolidation or selling all or substantially all of its assets or stock except for (i) any merger consolidation or sale by or with certain of its subsidiaries and (ii) sales and dispositions of assets for at least fair market value so long as the net book value of all assets sold or otherwise disposed of in any fiscal year does not exceed $2 million.
In an event of default, as defined under the loan agreement, NIL Funding may, at its option, require the Company to immediately pay the outstanding principal balance of the note as well as any and all interest and other payments due or convert any part of the amounts due and unpaid to shares of the Company’s common stock at a conversion price of 95% of the previous day’s closing price on the NYSE MKT.
The Company believes it is in compliance with the financial covenants under its debt agreements or has received waivers as described above.
Ring Fencing Restrictions
In addition to the financial covenants under our credit facilities, the ring fencing provisions required by our regulatory commissions impose additional limitations on our liquidity. Specifically, usage of the Bank of America line of credit is regulated by ring fencing provisions from the MPSC, MPUC, NCUC and WPSC. One of the ring fencing provisions issued by the MPSC requires that of the $30.0 million line of credit available, $11.2 million must be used or available to be used exclusively by Energy West Montana. The remaining $18.8 million balance of the line of credit is available for use by Energy West and its other Montana, North Carolina and Maine subsidiaries.
In 2014, our maximum borrowing capacity under the revolving line of credit was temporarily increased by $10.0 million to a maximum borrowing capacity of $40.0 million. The MPSC restricted borrowing on this increased borrowing capacity to $5.0 million unless Energy West receives express permission from the commission. In addition, the uncommitted $5.0 million of borrowing capacity increase does not count toward the $11.2 million requirement which must be used or available for Energy West Montana.
We continue to monitor our compliance under these ring fencing provisions on a monthly basis. The amount available to be drawn on the Bank of America line of credit after giving effect to the $11.2 million allocation to Energy West Montana was $8.7 million at September 30, 2015. We believe we are currently in compliance with all ring fencing provisions.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off-balance-sheet arrangements.
Item 3. Quantitative And Qualitative Disclosure About Market Risk
There have been no material changes in market risk at September 30, 2015 from that reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.
Item 4. Controls And Procedures
Evaluation of Disclosure Controls and Procedures
As of September 30, 2015, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. The evaluation was carried out under the supervision of and with the participation of our management, including our principal executive officer and principal financial officer. Based upon this evaluation, our chief executive officer and chief financial officer each concluded that our disclosure controls and procedures were effective as of September 30, 2015.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we are involved in lawsuits that have arisen in the ordinary course of business. We are contesting each of these lawsuits vigorously and believe we have defenses to the allegations that have been made. . In our opinion, the outcome to these legal actions will not have a material adverse effect on the financial condition, cash flows or results of operations of the Company.
Beginning on December 10, 2013, five putative shareholder derivative lawsuits were filed by five different individuals, in their capacity as our shareholders, in the United States District Court for the Northern District of Ohio, purportedly on behalf of us and naming certain of our current and former executive officers and directors as individual defendants. These five shareholder lawsuits are captioned as follows: (1) Richard J. Wickham v. Richard M. Osborne, et al., (Case No. 1:13-cv-02718-LW); (2) John Durgerian v. Richard M. Osborne, et al., (Case No. 1:13-cv-02805-LW); (3) Joseph Ferrigno v. Richard M. Osborne, et al., (Case No. 1:13-cv-02822-LW); (4) Kyle Warner v. Richard M. Osborne, et al., (Case No. 1:14-cv-00007-LW) and (5) Gary F. Peters v. Richard M. Osborne, (Case No. 1:14-cv-0026-CAB). On February 6, 2014, the five lawsuits were consolidated solely for purposes of conducting limited pretrial discovery, and on February 21, 2014, the Court appointed lead counsel for all five lawsuits. No formal discovery has been conducted to date.
The consolidated action contains claims against various of our current or former directors or officers alleging, among other things, violations of federal securities laws, breaches of fiduciary duty, waste of corporate assets and unjust enrichment arising primarily out of our acquisition of the Ohio utilities, services provided by JDOG Marketing and the acquisition of JDOG Marketing, and the sale of our common stock by Richard M. Osborne, our former chairman and chief executive officer, and Thomas J. Smith, our former chief financial officer. The suit, in which we are named as a nominal defendant, seeks the recovery of unspecified damages allegedly sustained by us, corporate reforms, disgorgement, restitution, the recovery of plaintiffs’ attorney’s fees and other relief.
We, along with the other defendants, filed a motion to dismiss the consolidated action in its entirety on May 8, 2014. The motion to dismiss was based on, among other things, the failure of the plaintiffs to make demand on our board of directors to address the alleged wrongdoing prior to filing their lawsuits and the failure to state viable claims against various individual defendants. Richard Osborne, individually, is now represented by counsel independent of all other defendants in the case and submitted a filing in support of the motion to dismiss on his own behalf.
On September 24, 2014, the magistrate judge assigned to the case issued a report and recommendation in response to the motion to dismiss. The magistrate judge recommended that the plaintiffs’ claims against the individual defendants with respect to the “unjust enrichment” allegation in the complaint be dismissed. The magistrate judge recommended that all other portions of the motion to dismiss be denied. The report and recommendation, the objections filed by the defendants, and the responses from the plaintiffs will all be reviewed by the trial judge assigned to the case who will then either adopt the report and recommendation in full, reject it in full, or adopt in part and modify in part. The parties engaged in settlement mediation on February 25, 2015. The parties failed to reach a settlement, but discussions are ongoing.
At this time we are unable to provide an estimate of any possible future losses that the Company may incur in connection to this suit. We carry insurance that we believe will cover any negative outcome associated with this action. This insurance carries a $250,000 deductible, which we have reached. Although we believe these insurance proceeds are available, we may incur costs and expenses related to this suit that are not covered by insurance which may be substantial. Any unfavorable outcome could adversely impact our business and results of operations.
On February 25, 2013, one of our former officers, Jonathan Harrington, filed a lawsuit captioned “Jonathan Harrington v. Energy West, Inc. and Does 1-4,” Case No. DDV-13-159 in the Montana Eighth Judicial District Court, Cascade County. Mr. Harrington claims he was terminated in violation of a Montana statute requiring just cause for termination. In addition, he alleges claims for negligent infliction of emotional distress and negligent slander. Mr. Harrington is seeking relief for economic loss, including lost wages and fringe benefits for a period of at least four years from the date of discharge, together with interest. Mr. Harrington is an Ohio resident and was employed in our Ohio corporate offices. On March 20, 2013, we filed a motion to dismiss the lawsuit on the basis that Mr. Harrington was an Ohio employee, not a Montana employee, and therefore the statute does not apply. On July 1, 2014, the court conducted a hearing, made extensive findings on the record, and issued an Order finding in our favor and dismissing all of Mr. Harrington’s claims. On July 21, 2014, Mr. Harrington appealed the dismissal to the Montana Supreme Court. On August 11, 2015, the Montana Supreme Court agreed with us that Mr. Harrington’s employment was governed by Ohio law, and as such he could not take advantage of Montana’s Wrongful Discharge from Employment Act. However, the Montana Supreme Court also held the trial court erred in determining it lacked jurisdiction over the case, finding the trial court should have retained jurisdiction and applied Ohio law to Mr. Harrington’s claims. As Ohio is an “at will” state, we believe there are no claims under Ohio law and the case will ultimately be dismissed by the trial court on remand. On September 28, 2015, Mr. Harrington filed a Motion to Amend Complaint to assert new causes of action not previously alleged including claims for misrepresentation, constructive fraud based on alleged representations, slander, and mental pain and suffering. We continue to believe Mr. Harrington’s claims under both Montana and Ohio law are without merit, and we will oppose Mr. Harrington’s recent motion and will continue to vigorously defend this case on all grounds.
On June 13, 2014, Richard M. Osborne, father of our chief executive officer and our former chairman and chief executive officer, filed a lawsuit against us and our corporate secretary captioned, “Richard M. Osborne and Richard M. Osborne Trust, Under Restated and Amended Trust Agreement of February 24, 2012 v. Gas Natural, Inc. et al.,” Case No. 14CV001210 which was filed in the Court of Common Pleas in Lake County, Ohio. In this lawsuit, Mr. Osborne sought an order requiring us to provide him with “the minutes and any corporate resolutions for the past five years.” We had provided Mr. Osborne with all the board minutes he requested that had been approved by the board. On October 29, 2014, Mr. Osborne filed an amended complaint in this matter demanding minutes of the committees of the board of directors and additional board minutes which he claimed he was entitled to receive. On November 17, 2014, the defendants moved to dismiss Mr. Osborne’s amended complaint for failure to state a claim upon which relief can be granted, and for summary judgment. On February 11, 2015, the Court granted defendants’ motion, dismissing the case except for one allegation in one paragraph of Mr. Osborne’s amended complaint: that we failed to produce minutes of any board meeting that occurred between June 1, 2014 and June 13, 2014. The Court held in abeyance its ruling on this issue, to give Mr. Osborne 30 days to conduct discovery limited to determining whether any board meetings occurred during that two-week period. On February 13, 2015, Mr. Osborne voluntarily dismissed his Complaint, without prejudice. On April 28, 2015, Mr. Osborne refiled this lawsuit in a different court, the Cuyahoga County Court of Common Pleas, captioned “Richard M. Osborne and Richard M. Osborne Trust, Under Restated and Amended Trust Agreement of January 13, 1995 v. Gas Natural Inc., et al.,” Case No. 15CV844836. Mr. Osborne is again seeking the board minutes at issue in the previously dismissed lawsuit and minutes that have been prepared subsequently. We believe the lawsuit, like its prior iteration, is wholly without merit and will vigorously contest it. In addition, we have filed a counterclaim against Mr. Osborne seeking to have him declared a vexatious litigator. If successful, Mr. Osborne will only be able to initiate new litigation against the Company after receiving permission from the court in which the case would be pending.
On June 26, 2014, Mr. Osborne filed a lawsuit against us and our board of directors captioned “Richard M. Osborne, Richard M. Osborne Trust, Under Restated and Amended Trust Agreement of February 24, 2012 and John D. Oil and Gas Marketing Company, LLC v. Gas Natural, Inc. et al.,” Case No. 14CV001290, filed in the Court of Common Pleas in Lake County, Ohio. In this lawsuit, among other things, Mr. Osborne (1) demanded payment of an earn-out associated with our purchase of assets from John D. Marketing, (2) alleged that the board of directors breached its fiduciary duties, primarily by removing Mr. Osborne as chairman of the board and chief executive officer, (3) sought injunctive relief to restrain our board members from “taking any actions on behalf of Gas Natural until they are in compliance with the law and the documents governing corporate governance,” and (4) asked the Court to enjoin the 2014 annual meeting that was scheduled to take place on July 30, 2014, and to delay it until such time that the board of directors would be “in compliance with the law and corporate governance.”
Mr. Osborne dismissed the above lawsuit on July 15, 2014, without prejudice, as the parties started to engage in settlement negotiations in an attempt to resolve the dispute. After settlement negotiations broke down, Mr. Osborne refiled the lawsuit on July 28, 2014, Case No. 14CV1512, against us and our board members. In the re-filed lawsuit, among other things, Mr. Osborne (1) demands payment of an earn-out amount associated with our purchase of assets from John D. Marketing, (2) alleges that the board of directors breached its fiduciary duties by removing Mr. Osborne as chairman and chief executive officer, (3) seeks to enforce a July 15, 2014 term sheet, where the parties memorialized certain discussions they had in connection with their efforts to resolve the dispute arising out of the lawsuit, which included a severance payment of $1.0 million, and (4) seeks to invalidate the results of the July 30, 2014 shareholder meeting and asks the court to order us to hold a new meeting at a later date. Mr. Osborne is also seeking compensatory and punitive damages. The parties have each filed motions for summary judgement which are awaiting the ruling of the court. We believe that Mr. Osborne’s claims in this lawsuit are wholly without merit and will vigorously defend this case on all grounds.
As disclosed above, on June 26, 2014, Mr. Osborne filed a lawsuit against us in the Court of Common Pleas in Lake County, Ohio. In the lawsuit, Mr. Osborne sought injunctive relief delaying the 2014 annual meeting scheduled to take place on July 30, 2014. While that suit was pending, on July 9, 2014, Mr. Osborne mailed the first of several letters to our shareholders, criticizing our board and seeking the shareholders’ support in replacing them. On July 15, 2014, Mr. Osborne dismissed without prejudice his Lake County lawsuit, but he refiled it on July 28, 2014. He did not again seek to enjoin the annual shareholder meeting, which occurred as scheduled two days later. Instead, he requests in his complaint that the Lake County court void the election of directors at the July 30, 2014 meeting and order us to conduct another shareholder meeting for the purpose of electing directors no later than February 2015, which the Court did not do. Mr. Osborne’s refiled lawsuit remains pending. Mr. Osborne wrote two additional letters, dated August 12, 2014, and September 9, 2014, which he mailed to our shareholders in mid-September. In the letters Mr. Osborne continued to criticize our board and management.
Mr. Osborne did not file these letters with the Securities and Exchange Commission and we believe that his letters violated Section 14(a) of the Securities Exchange Act and related regulations that require shareholder solicitations to be filed with the SEC. On October 2, 2014, we filed a suit against Mr. Osborne captioned “Gas Natural Inc. v. Richard M. Osborne” in the United States District Court Northern District of Ohio (Case No. 1:14-cv-2181). In this case we sought to enjoin Mr. Osborne from sending additional letters to our shareholders without complying with applicable Federal securities laws. The court held a hearing on October 8, 2014, and the judge granted the injunction, requiring Mr. Osborne to file with the SEC any letters he writes to shareholders so long as his action in Lake County seeking to invalidate the July 30, 2014 meeting is pending. Mr. Osborne appealed the ruling to the Sixth Circuit Court of Appeals which issued an order vacating the injunction and remanding the case to the District Court. On September 3, 2015, the District Court Judge held a teleconference at which the parties agreed that the Court should issue an order dissolving the injunction which should result in the termination of the case. On September 4, 2015, the District Court issued an order dissolving the injunction and terminating the case as final.
On March 12, 2015, Cobra Pipeline Co., Ltd (“Cobra”) filed a lawsuit against the Company in the United States District Court for the Northern District of Ohio captioned “Cobra Pipeline Co., Ltd. v. Gas Natural Inc., et al.,” Case No. 1:15-CV-00481. Mr. Osborne owns and controls Cobra. Cobra’s complaint alleged that it uses a service to track the locations of its vehicles via GPS monitoring. Cobra alleged that defendants, including the Company, accessed and intercepted vehicle tracking data, after Gas Natural knew or should have known that its authority to do so had ended. The complaint alleged claims under the Stored Communications Act, the Wiretap Act, and various state-law claims. On September 17, 2015, the court granted defendants’ motion for summary judgment and dismissed Cobra’s complaint in its entirety. On October 19, Cobra filed its Notice of Appeal to the Sixth Circuit Court of Appeals.
Item 5. Other Information
Special Committee of the Board Investigation
On March 26, 2014, the board of directors formed a special committee comprised of three independent directors to investigate the allegations contained in a letter received from one of our shareholders. The letter demands that the board take legal action to remedy alleged breaches of fiduciary duties by the board and certain of our executive officers in connection with the Order and Opinion issued by the PUCO on November 13, 2013. The special committee has the power to retain any advisors, including legal counsel and accounting, financial and regulatory advisors, that the committee determines to be appropriate to carry out its responsibilities in connection with its investigation. The special committee has prepared a report with the assistance of legal counsel and financial and regulatory advisors evaluating the allegations and the board is in the process of determining the position Gas Natural will take with respect to the letter. Although the Company believes that insurance proceeds are available for a portion of the cost of the investigation, the Company has incurred substantial costs and expenses related to the investigation that are not covered by insurance.
SEC Investigation
The Company received a letter from the Chicago Regional Office of the SEC dated March 3, 2015 stating that the staff of the SEC is conducting an investigation regarding (i) audits by the PUCO and Rehmann Corporate Investigative Services, (ii) the determination and calculation of the GCR, (iii) the Company’s financial statements and internal controls and (iv) various entities affiliated with our former CEO, Richard M. Osborne. The SEC has requested we preserve all documents relating to these matters. The Company received a subpoena to produce documents from the staff of the SEC dated May 29, 2015 in connection with this matter. The Company is complying with these requests and intends to cooperate fully with the SEC.
Item 6. Exhibits
Exhibit Number | | Description |
| | | |
| 31.1 | | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32* | | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 101.INS | | XBRL Instance Document |
| 101.SCH | | XBRL Taxonomy Extension Schema |
| 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase |
| 101.LAB | | XBRL Taxonomy Extension Label Linkbase |
| 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase |
| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase |
*Furnished herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | Gas Natural Inc. | |
| | | | |
| November 9, 2015 | | /s/James E. Sprague | |
| | | James E. Sprague, Chief Financial Officer | |
| | | (principal financial officer) | |
