XASE:EGAS Gas Natural Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

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 March 31, 2012

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.)
1 First Avenue South   
Great Falls, Montana    59401
(Address of principal executive office)    (Zip Code)

Registrant’s telephone number, including area code: (800) 570-5688

 

 

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.    Yes   x    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).    Yes  x     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 filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock as of May 10, 2012 was 8,155,801 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 is this Form 10-Q is as of March 31, 2012.

 

 

 


Table of Contents

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, natural gas marketing and natural gas pipeline operations and that are used in this Form 10-Q.

AECO. Alberta Energy Company Limited (used in reference to the AECO natural gas price index).

ASC. FASB Accounting Standards Certification, standards issued by FASB with respect to GAAP.

Bangor Gas Company. Bangor Gas Company, LLC.

Brainard. Brainard Gas Corp.

Bcf. One billion cubic feet, used in reference to natural gas.

CIG. Colorado Interstate Gas (used in reference to the Colorado Interstate Gas Index).

Citizens. Citizens Bank of Michigan.

Clarion River. Clarion River Gas Company.

Cut Bank Gas. Cut Bank Gas Company.

Dekatherm. One million British thermal units, used in reference to natural gas. Abbreviated as Dkt.

EPA. The United States Environmental Protection Agency.

EWR. Energy West Resources, Inc.

Energy West. Energy West, Incorporated.

Energy West Development. Energy West Development, 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.

GAAP. Generally accepted accounting principles in the United States of America.

GNES. Gas Natural Energy Solutions, 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. John D. Oil and Gas Marketing Co. LLC.

KPSC. Kentucky Public Service Commission.

Kykuit. Kykuit Resources, LLC.

Lightning Pipeline. Lightning Pipeline Company, Inc.

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.

NGA. The Natural Gas Act.

Orwell. Orwell Natural Gas Company.

Osborne Trust. The Richard M. Osborne Trust, dated January 1, 1995.

PaPUC. The Pennsylvania Public Utility Commission.


Table of Contents

PGC. Public Gas Company, Inc.

PUCO. The Public Utilities Commission of Ohio.

Penobscot Natural Gas. Penobscot Natural Gas Company, Inc.

SEC. The United States Securities and Exchange Commission.

Spelman. Spelman Pipeline Holdings, LLC.

SunLife. SunLife Assurance Company of Canada.

Walker Gas. Walker Gas & Oil Company, Inc.

WPSC. The Wyoming Public Service Commission.


Table of Contents

GAS NATURAL INC.

INDEX TO FORM 10-Q

 

     Page No.  

Part I - Financial Information

  

Item 1 – Financial Statements

  

Condensed Consolidated Balance Sheets March 31, 2012 and December 31, 2011 (Unaudited)

     F-1   

Condensed Consolidated Statements of Income and Comprehensive Income Three months ended March  31, 2012 and 2011 (Unaudited)

     F-3   

Condensed Consolidated Statements of Changes in Stockholders’ Equity Three months ended March  31, 2012 and 2011 (Unaudited)

     F-4   

Condensed Consolidated Statements of Cash Flows Three months ended March 31, 2012 and 2011 (Unaudited)

     F-5   

Notes to Unaudited Condensed Consolidated Financial Statements

     F-7   

Item  2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     3   

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

     13   

Item 4 – Controls and Procedures

     13   

Part II – Other Information

  

Item 1 – Legal Proceedings

     13   

Item 6 – Exhibits

     15   

Signatures

  

 

2


Table of Contents

Gas Natural Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

March 31, 2012 and December 31, 2011 (Unaudited)

 

     March 31,
2012
     December 31,
2011
 
ASSETS      

CURRENT ASSETS

     

Cash and cash equivalents

   $ 7,880,046       $ 10,504,845   

Marketable securities

     382,500         367,875   

Accounts receivable

     

Trade, less allowance for doubtful accounts of $807,433 and $630,632, respectively

     8,527,414         9,381,625   

Related parties

     555,626         519,084   

Unbilled gas

     2,653,169         4,232,854   

Note receivable—related parties, current portion

     10,437         10,256   

Inventory

     

Natural gas and propane

     1,821,005         6,967,739   

Materials and supplies

     2,053,111         1,958,858   

Prepaid income taxes

     72,920         1,584,869   

Prepayments and other

     605,425         741,101   

Recoverable cost of gas purchases

     3,231,242         2,627,416   

Deferred tax asset

     1,137,100         1,061,314   
  

 

 

    

 

 

 

Total current assets

     28,929,995         39,957,836   

PROPERTY, PLANT AND EQUIPMENT, net

     100,021,399         97,612,257   

OTHER ASSETS

     

Notes receivable—related parties, less current portion

     32,731         35,408   

Regulatory assets

     

Property taxes

     519,781         590,464   

Income taxes

     452,645         452,645   

Rate case costs

     204,192         205,714   

Debt issuance costs, net

     909,150         869,593   

Goodwill

     14,607,952         14,607,952   

Customer relationships

     633,625         639,333   

Investment in unconsolidated affiliate

     327,610         330,351   

Restricted cash

     958,647         949,907   

Other assets

     114,751         159,954   
  

 

 

    

 

 

 

Total other assets

     18,761,084         18,841,321   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 147,712,478       $ 156,411,414   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-1


Table of Contents

Gas Natural Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

March 31, 2012 and December 31, 2011 (Unaudited)

 

Condensed Consolidated Balance Sheets
     March 31,
2012
     December 31,
2011
 
LIABILITIES AND CAPITALIZATION      

CURRENT LIABILITIES

     

Checks in excess of amounts on deposit

   $ 407,656       $ 1,027,376   

Lines of credit

     17,651,000         23,160,000   

Accounts payable

     

Trade

     5,817,447         8,755,623   

Related parties

     98,712         191,763   

Notes payable, current portion

     8,109         7,885   

Accrued liabilities

     

Taxes other than income

     2,531,315         3,018,964   

Vacation

     134,420         115,940   

Employee benefit plans

     214,885         140,149   

Interest

     307,079         30,688   

Deferred payments received from levelized billing

     2,053,060         2,948,188   

Customer deposits

     672,594         707,062   

Property tax settlement, current portion

     242,128         242,128   

Related parties

     448,455         635,192   

Other current liabilities

     1,303,687         1,280,670   

Overrecovered gas purchases

     1,362,448         2,237,827   
  

 

 

    

 

 

 

Total current liabilities

     33,252,995         44,499,455   

LONG-TERM LIABILITIES

     

Deferred investment tax credits

     171,114         176,379   

Deferred tax liability

     3,200,808         2,908,167   

Asset retirement obligation

     1,727,161         1,689,081   

Customer advances for construction

     916,349         880,851   

Regulatory liability for income taxes

     83,161         83,161   

Regulatory liability for gas costs

     40,217         57,570   
  

 

 

    

 

 

 

Total long-term liabilities

     6,138,810         5,795,209   

NOTES PAYABLE, less current portion

     31,342,594         31,344,723   

COMMITMENTS AND CONTINGENCIES (see Note 11)

     

STOCKHOLDERS’ EQUITY

     

Preferred stock; $0.15 par value, 1,500,000 shares authorized, no shares issued or outstanding

     —           —     

Common stock; $0.15 par value, 15,000,000 shares authorized, 8,155,426 and 8,154,301 shares issued and outstanding, respectively

     1,223,314         1,223,145   

Capital in excess of par value

     41,993,623         41,978,799   

Accumulated other comprehensive income

     89,551         80,405   

Retained earnings

     33,671,591         31,489,678   
  

 

 

    

 

 

 

Total stockholders’ equity

     76,978,079         74,772,027   
  

 

 

    

 

 

 

TOTAL CAPITALIZATION

     108,320,673         106,116,750   
  

 

 

    

 

 

 

TOTAL LIABILITIES AND CAPITALIZATION

   $ 147,712,478       $ 156,411,414   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-2


Table of Contents

Gas Natural Inc. and Subsidiaries

Condensed Consolidated Statements of Income and Comprehensive Income

For the Three Months Ended March 31, 2012 and 2011 (Unaudited)

 

Condensed Consolidated Statements of Income
     Three Months Ended  
     March 31,  
     2012     2011  

REVENUES

    

Natural gas operations

   $ 29,848,085      $ 38,219,583   

Marketing and production

     1,907,094        1,825,502   

Pipeline operations

     107,784        106,324   

Propane operations

     1,909,158        —     
  

 

 

   

 

 

 

Total revenues

     33,772,121        40,151,409   

COST OF SALES

    

Natural gas purchased

     17,236,894        24,716,908   

Marketing and production

     1,395,416        1,399,407   

Propane purchased

     1,431,269        —     
  

 

 

   

 

 

 

Total cost of sales

     20,063,579        26,116,315   
  

 

 

   

 

 

 

GROSS MARGIN

     13,708,542        14,035,094   

OPERATING EXPENSES

    

Distribution, general, and administrative

     5,212,920        4,657,320   

Maintenance

     296,235        285,227   

Depreciation and amortization

     1,243,344        1,035,077   

Accretion

     38,080        34,610   

Taxes other than income

     937,490        853,965   
  

 

 

   

 

 

 

Total operating expenses

     7,728,069        6,866,199   
  

 

 

   

 

 

 

OPERATING INCOME

     5,980,473        7,168,895   

LOSS FROM UNCONSOLIDATED AFFILIATE

     (2,741     (62,957

OTHER INCOME (EXPENSE), net

     (72,053     115,680   

INTEREST EXPENSE

     (664,069     (413,179
  

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     5,241,610        6,808,439   

INCOME TAX EXPENSE

     (1,958,763     (2,533,685
  

 

 

   

 

 

 

NET INCOME

     3,282,847        4,274,754   

OTHER COMPREHENSIVE INCOME

    

Unrealized gain on available for sale securities, net of tax

     9,146        18,766   
  

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 3,291,993      $ 4,293,520   
  

 

 

   

 

 

 

EARNINGS PER SHARE—BASIC AND DILUTED

   $ 0.40      $ 0.52   

WEIGHTED AVERAGE DIVIDENDS DECLARED PER COMMON SHARE

   $ 0.135      $ 0.135   

WEIGHTED AVERAGE SHARES OUTSTANDING—BASIC

     8,154,734        8,150,239   

WEIGHTED AVERAGE SHARES OUTSTANDING—DILUTED

     8,162,957        8,158,079   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-3


Table of Contents

Gas Natural Inc. and Subsidiaries

Condensed Consolidated Statements of Changes in Stockholders’ Equity

For the Three Months Ended March 31, 2012 and 2011 (Unaudited)

 

                          Accumulated               
                   Capital In      Other               
     Common      Common      Excess Of      Comprehensive      Retained        
     Shares      Stock      Par Value      Income      Earnings     Total  

BALANCE AT DECEMBER 31, 2010

     8,149,801       $ 1,222,470       $ 41,910,067       $ 46,590       $ 30,522,375      $ 73,701,502   

Net income

     —           —           —           —           4,274,754        4,274,754   

Net unrealized gain on available for sale securities

     —           —           —           18,766         —          18,766   

Stock issued for services

     1,125         169         12,244         —           —          12,413   

Stock option expense

     —           —           3,916         —           —          3,916   

Dividends declared

     —           —           —           —           (1,100,309     (1,100,309
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

BALANCE AT MARCH 31, 2011

     8,150,926       $ 1,222,639       $ 41,926,227       $ 65,356       $ 33,696,820      $ 76,911,042   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

BALANCE AT DECEMBER 31, 2011

     8,154,301       $ 1,223,145       $ 41,978,799       $ 80,405       $ 31,489,678      $ 74,772,027   

Net income

     —           —           —           —           3,282,847        3,282,847   

Net unrealized gain on available for sale securities

     —           —           —           9,146         —          9,146   

Stock issued for services

     1,125         169         12,473         —           —          12,642   

Stock option expense

     —           —           2,351         —           —          2,351   

Dividends declared

     —           —           —           —           (1,100,934     (1,100,934
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

BALANCE AT MARCH 31, 2012

     8,155,426       $ 1,223,314       $ 41,993,623       $ 89,551       $ 33,671,591      $ 76,978,079   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-4


Table of Contents

Gas Natural Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended March 31, 2012 and 2011 (Unaudited)

 

     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 3,282,847      $ 4,274,754   

Adjustments to reconcile net income to net cash provided by operating activities

    

Depreciation and amortization

     1,243,344        1,035,077   

Accretion

     38,080        34,610   

Amortization of debt issuance costs

     77,022        11,046   

Stock based compensation

     14,993        16,329   

Loss on sale of assets

     7,747        6,948   

Loss from unconsolidated affiliate

     2,741        62,957   

Investment tax credit

     (5,265     (5,265

Deferred income taxes

     211,376        —     

Changes in assets and liabilities

    

Accounts receivable, including related parties

     817,669        196,584   

Unbilled gas

     1,579,685        1,692,493   

Natural gas and propane inventory

     5,146,734        4,774,494   

Accounts payable, including related parties

     (2,982,618     (1,639,066

Recoverable/refundable cost of gas purchases

     (1,479,205     817,957   

Prepayments and other

     135,676        206,372   

Other assets

     1,442,540        1,363,535   

Other liabilities

     (1,158,078     (1,314,320
  

 

 

   

 

 

 

Net cash provided by operating activities

     8,375,288        11,534,505   

CASH FLOWS FROM INVESTING ACTIVITIES

    

Capital expenditures

     (4,366,485     (2,811,832

Proceeds from sale of fixed assets

     17,302        4,000   

Proceeds from related party note receivable

     2,496        2,329   

Investment in unconsolidated affiliate

     —          (132,000

Customer advances for construction

     35,498        (10,917

Contributions in aid of construction

     48,210        (5,362
  

 

 

   

 

 

 

Net cash used in investing activities

     (4,262,979     (2,953,782

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from lines of credit

     2,551,000        2,500,000   

Repayment on lines of credit

     (8,060,000     (9,650,000

Repayments of notes payable

     (1,905     (252,796

Debt issuance costs

     (116,579     —     

Restricted cash

     (8,740     —     

Dividends paid

     (1,100,884     (1,100,275
  

 

 

   

 

 

 

Net cash used in financing activities

     (6,737,108     (8,503,071
  

 

 

   

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (2,624,799     77,652   

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     10,504,845        13,026,585   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 7,880,046      $ 13,104,237   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-5


Table of Contents

Gas Natural Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended March 31, 2012 and 2011 (Unaudited)

 

Condensed Consolidated Statements of Cash Flows
     2012      2011  

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

     

Cash paid for interest

   $ 387,678       $ 275,200   

Cash paid for income taxes

     50,000         52,303   

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES

     

Capital expenditures included in accounts payable

   $ 549,135       $ 119,778   

Capitalized interest

     1,693         1,423   

Accrued dividends

     366,994         366,775   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F-6


Table of Contents

GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Business and Significant Accounting Policies

Nature of Business

Gas Natural Inc. is the parent company of Brainard, Energy West, GNES, GNSC, Great Plains, Independence and Lightning Pipeline Company. Brainard is a natural gas utility company with operations in Ohio. Energy West is the parent company of multiple entities that are natural gas utility companies with regulated operations in Maine, Montana, North Carolina and Wyoming as well as non-regulated operations in Montana and Wyoming. GNSC manages gas procurement, transportation, and storage for Brainard and subsidiaries of Lightning Pipeline and Great Plains. Great Plains is the parent company of an entity that is a regulated natural gas utility company with operations in Ohio. Independence is a non-regulated subsidiary that delivers liquid propane, heating oil, and kerosene to customers in North Carolina and Virginia. Lightning Pipeline is the parent company of multiple entities that are regulated natural gas utility companies with operations in Ohio and Pennsylvania. On April 1, 2012, the Company acquired PGC, which is a regulated natural gas distribution company in Kentucky. The Company was originally incorporated in Montana in 1909. The Company currently has five reporting segments:

 

•    Natural Gas Operations

   Annually distribute approximately 32 billion cubic feet of natural gas to approximately 70,000 customers through regulated utilities operating in Maine, Montana, North Carolina, Ohio, Pennsylvania and Wyoming.

•    Marketing and Production Operations

   Annually market approximately 1.2 billion cubic feet of natural gas to commercial and industrial customers in Montana and Wyoming and manage midstream supply and production assets for transportation customers and utilities through the subsidiary, EWR. EWR owns an average 51% gross working interest (an average 43% net revenue interest) in 160 natural gas producing wells and gas gathering assets in Glacier and Toole Counties in Montana.

•    Pipeline Operations

   The Shoshone interstate and Glacier gathering natural gas pipelines located in Montana and Wyoming are owned through the subsidiary, EWD. Certain natural gas producing wells owned by EWD are being managed and reported under the marketing and production operations.

•    Propane Operations

   Delivers liquid propane, heating oil and kerosene to approximately 4,300 residential, commercial and agricultural customers in North Carolina and Virginia through the subsidiary, Independence. The operations were acquired in August 2011.

•    Corporate and Other

   Corporate and other encompasses the results of corporate acquisitions and other equity transactions. Included in corporate and other are costs associated with business development and acquisitions, dividend income and recognized gains from the sale of marketable securities.

Basis of Presentation

The accompanying condensed balance sheet as of December 31, 2011, which has been derived from audited financial statements, and the unaudited interim condensed financial statements of Gas Natural Inc. and its subsidiaries (collectively, the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal and recurring nature.

The historical financial statements reflect the following reportable business segments: Natural Gas Operations, Marketing and Production Operations, Pipeline Operations, Propane Operations and Corporate and Other.

 

F-7


Table of Contents

GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The Company follows accounting standards set by the FASB. The FASB sets GAAP to ensure the consistent reporting of the Company’s financial condition, results of operations and cash flows. Over the years, the FASB and other designated GAAP-setting bodies, have issued standards in the form of FASB Statements, Interpretations, FASB Staff Positions, EITF consensuses, AICPA Statements of Position, etc. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification, sometimes referred to as the Codification or ASC.

Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for future fiscal periods. Events occurring subsequent to March 31, 2012 have been evaluated as to their potential impact to the financial statements through the date of issuance. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the period ended December 31, 2011.

Effects of Regulation

The Company follows the provisions of ASC 980, Regulated Operations, and the accompanying financial statements reflect the effects of the different rate-making principles followed by the various jurisdictions regulating the Company. The economic effects of regulation can result in regulated companies recording costs that have been, or are expected to be, allowed in the rate-making process in a period different from the period in which the costs would be charged to expense by an unregulated enterprise. When this occurs, costs are deferred as assets in the balance sheet (regulatory assets) and recorded as expenses in the periods when those same amounts are reflected in rates. Additionally, regulators can impose liabilities upon a regulated company for amounts previously collected from customers and for amounts that are expected to be refunded to customers which are recorded as liabilities in the balance sheet (regulatory liabilities).

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 development of the allowances for doubtful accounts, unbilled gas, asset retirement obligations, 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.

Such estimates could change in the near term and could significantly impact the Company’s results of operations and financial position.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less, at the date of acquisition, to be cash equivalents. The Company maintains, at various financial institutions, cash and cash equivalents which may exceed federally insurable limits and which may, at times, significantly exceed balance sheet amounts.

Receivables

The accounts receivable are generated from sales and delivery of natural gas and propane as measured by inputs from meter reading devices. Trade accounts receivable are carried at the expected net realizable value. There is credit risk associated with the collection of these receivables. As such, a provision is recorded for the receivables considered to be uncollectible. The provision is based on management’s assessment of the collectability of specific customer accounts, the aging of the accounts receivable and historical write-off amounts. The underlying assumptions used for the provision can change from period to period and the provision could potentially cause a negative material impact to the income statement and working capital.

Two of the Company’s utilities in Ohio, Orwell and NEO collect from their customers, through rates, an amount to provide an allowance for doubtful accounts. As accounts are identified as uncollectible, they are written off against this allowance for doubtful accounts with no income statement impact. In effect, all bad debt expense is funded by the customer base. The total amount collected from customers and the amounts written off are reviewed annually by the PUCO and the rate per Mcf is adjusted as necessary.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The Company’s bad debt expense for the three months ended March 31, 2012 was $157,983. Bad debt expense for the three months ended March 31, 2011 was $44,983.

Recoverable/Refundable Costs of Gas Purchases

The Company accounts for purchased gas costs in accordance with procedures authorized by the MPUC, the MPSC, the NCUC the PUCO, the PaPUC and the WPSC. Purchased gas costs that are different from those provided for in present rates, and approved by the respective commission, are accumulated and recovered or credited through future rate changes. The gas cost recoveries 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.

During the year ended December 31, 2010, the PUCO conducted audits of NEO and Orwell’s rates as filed from September 2007 through August 2009 and January 2008 through June 2010, respectively. The PUCO provided the primary audit findings during the fourth quarter of 2010, taking the position that NEO had not included approximately $1,050,000 of costs and Orwell included an excess of approximately $1,100,000 of costs in the filings under audit. On October 26, 2011, the PUCO adopted and approved a Joint Stipulation that finalizes the adjustments for NEO and Orwell to approximately $1,100,000 and ($964,000), respectively. However, the Joint Stipulation modified the refund period for Orwell to one year as compared to two years as originally identified. The Company considered the modification to be material and sought rehearing. On December 22, 2011, the PUCO affirmed its Finding and Order requiring Orwell’s refund to be completed over twelve months.

During the year ended December 31, 2011, the PUCO conducted an audit of Brainard’s rates as filed from July 2009 through June 2011. The Staff of the PUCO recommended a finding that Brainard collected excess gas costs of approximately $104,000. The Company agreed that excess gas costs were collected, but only in the amount of approximately $48,000. An evidentiary hearing was convened on November 3, 2011, resumed on March 27, 2012 and concluded on April 12, 2012. The Company and the PUCO are currently preparing closing arguments that are due May 18, 2012.

Regulatory Assets and Liabilities

The regulatory asset for property tax is recovered in rates over a ten-year period starting January 1, 2004. The income taxes earn a return equal to that of the Company’s rate base. The rate case costs do not earn a return. Regulatory assets will be recovered over a period of approximately three to twenty years. Regulatory liabilities will be refunded over a period of approximately five to twenty years.

Debt Issuance Costs

Debt issuance costs are fees and other direct incremental costs incurred by the Company in obtaining debt financing and are recognized as assets and are amortized as interest expense over the term of the related debt. Amortization expense was $77,022 for the three months ended March 31, 2012. Amortization expense was $11,046 for the three months ended March 31, 2011.

Asset Retirement Obligations

The Company records the fair value of a liability for an asset retirement obligation ("ARO") in the period in which it was incurred or acquired. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The increase in carrying value of a property associated with the capitalization of an asset retirement cost is included in “Property, plant and equipment, net” in the accompanying balance sheets. The Company amortizes the amount added to property, plant, and equipment, net. The accretion of the asset retirement liability is allocated to operating expense using a systematic and rational method. As of March 31, 2012 and December 31, 2011, the Company has recorded a net asset of $209,616 and $227,216, and a related liability of $1,727,161 and $1,689,081, respectively.

The Company, excluding Orwell and Brainard, has identified but not recognized ARO liabilities related to gas transmission and distribution assets resulting from easements over property not owned by the Company. These easements are generally perpetual and only require retirement action upon abandonment or cessation of use of the property for the specified purpose. The ARO liability is not estimable for such easements as the Company intends to utilize these properties indefinitely. In the event the Company decides to abandon or cease the use of a particular easement, an ARO liability would be recorded at that time.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

As a result of regulatory action by the PUCO related to prior audits, Orwell and Brainard accrue an estimated liability for removing gas mains, meter and regulator station equipment and service lines at the end of their useful lives. The liability is equal to a percent of the asset cost according to the following table:

 

     Percent of Asset Cost  
     Orwell     Brainard  

Mains

     15     20

Meter/regulator stations

     10     10

Service lines

     75     75

The Company has no assets legally restricted for purposes of settling its asset retirement obligations. The schedule below is a reconciliation of the Company’s liability for the three months ended March 31:

 

     2012      2011  

Balance, beginning of period

   $ 1,689,081       $ 1,546,867   

Accretion expense

     38,080         34,610   
  

 

 

    

 

 

 

Balance, end of period

   $ 1,727,161       $ 1,581,477   
  

 

 

    

 

 

 

Revenue Recognition

Revenues are recognized in the period that services are provided or products are delivered. The Company records gas distribution revenues for gas delivered to residential and commercial customers but not billed at the end of the accounting period. The Company periodically collects revenues subject to possible refunds pending final orders from regulatory agencies. When this occurs, appropriate liabilities for such revenues collected subject to refund are established.

Comprehensive Income

Comprehensive income includes net income and other comprehensive income, which for the Company is primarily comprised of unrealized holding gains or losses on available-for-sale securities that are excluded from the statement of operations in computing net income and reported separately in shareholders’ equity.

Other comprehensive income for the three months ended March 31, 2012 is reported net of tax of $5,479. Other comprehensive income for the three months ended March 31, 2011 is reported net of tax of $11,159.

Earnings Per Share

Earnings per common share is computed by both the basic method, which uses the weighted average number of common shares outstanding, and the diluted method, which includes the dilutive common shares from stock options and other dilutive securities, as calculated using the treasury stock method.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

     Three Months Ended March 31,  
     2012      2011  

Numerator:

     

Net income

   $ 3,282,847       $ 4,274,754   
  

 

 

    

 

 

 

Denominator:

     

Basic weighted average common shares outstanding

     8,154,734         8,150,239   

Dilutive effect of stock options

     8,223         7,840   
  

 

 

    

 

 

 

Diluted weighted average common shares outstanding

     8,162,957         8,158,079   
  

 

 

    

 

 

 

Reclassifications

Certain reclassifications of prior year reported amounts have been made for comparative purposes. Such reclassifications had no effect on income (loss).

Recently Adopted Accounting Pronouncements

ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in US GAAP and IFRSs”

In May 2011, the FASB issued ASU 2011-04, which changes the wording used to describe many of the requirements in US GAAP for measuring fair value and for disclosing information about fair value measurements. The adoption of this guidance did not have a material impact on the accompanying financial statements.

ASU No. 2011-05, “Presentation of Comprehensive Income”

In June 2011, the FASB issued ASU 2011-05, which is intended to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of GAAP and IFRS, the FASB eliminated the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The ASU requires all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU changed the presentation of other comprehensive income in the accompanying financial statements. However, this ASU did not change the calculation of the other comprehensive income. The adoption of this guidance did not have a material impact on the accompanying financial statements.

Note 2 – Acquisitions

Acquisition of Spelman Pipeline

On April 8, 2011 the Company’s indirect subsidiary, Spelman Pipeline Holdings, LLC (“Spelman”), a subsidiary of Lightning Pipeline, completed the acquisition of dormant refined products pipeline assets from Marathon Petroleum Company LP. The cash purchase price for the assets was $3.34 million.

The acquired assets include pipelines and rights-of-way located in Ohio and Kentucky. In Ohio, the assets include more than 140 miles of pipeline spanning almost a third of the state from Marion to Youngstown. Other Ohio assets are located in metropolitan and south suburban Cleveland. The Kentucky assets include more than 60 miles of right-of-way to the south of Louisville.

Spelman intends to recondition and convert the Ohio pipelines to transport natural gas to new markets where natural gas service is currently not available, as well as to connect to markets served by the Ohio subsidiaries.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Future plans include extending the lines to participate in the transportation of Utica and Marcellus Shale production. The Company does not currently have definitive plans for the Kentucky assets.

Spelman has filed an application known as a “First Filing” to establish intrastate transportation rates with the PUCO. Should the Commission find that the rates proposed by the Company are not unjust and unreasonable, it may approve the rates without a hearing. On October 12, 2011, the PUCO authorized Spelman to commence operations as an intrastate pipeline company and approving its proposed tariff including its proposed transportation rates and charges.

Acquisition of Independence Oil & LP Gas, Inc.

On August 1, 2011 the Company purchased certain assets and assumed certain liabilities of Independence Oil & LP Gas, Inc. for the original price of $1.6 million, of which $200,000 was held back for 90 days. Independence Oil & LP Gas, Inc. delivered liquid propane, heating oil, and kerosene to approximately 4,500 customers from its offices in West Jefferson, North Carolina and Independence, Virginia. The Company created a new subsidiary named Independence Oil, LLC and is continuing to service the current customers with the intention to expand to other customers in each of the regions. The costs related to the transaction were $13,526 and were expensed during the year ended December 31, 2011.

In accordance with GAAP, the Company determined the purchase of the assets acquired and liabilities assumed to be a business combination. Therefore, the Company applied the acquisition method and valued each of the assets acquired (cash, accounts receivable, inventory, and property, plant and equipment) and liabilities assumed (accounts payable) at fair value as of the acquisition date. The cash, accounts receivable and accounts payable were deemed to be at fair value as of the acquisition date. The Company valued the fair value of inventory and property, plant and equipment by performing fair value research of the items acquired. This process resulted in the fair value of the assets acquired, reduced by the liabilities assumed, to be greater than the purchase price. The difference is a gain from bargain purchase and is included as a separate line item in the statements of income for the year ended December 31, 2011. The Company completed the transaction as it provided the opportunity to strengthen its presence in North Carolina, while extending into Virginia, two markets with favorable competitive conditions targeted for growth.

The estimated fair value of the assets acquired and liabilities assumed is reflected in the following table at the date of acquisition.

 

Current assets

   $ 429,576   

Property and equipment

     1,958,717   
  

 

 

 

Total assets acquired

     2,388,293   
  

 

 

 

Current liabilities

     57,777   
  

 

 

 

Total liabilities assumed

     57,777   
  

 

 

 

Net assets acquired

   $ 2,330,516   
  

 

 

 

The asset purchase agreement included a settlement date 90 days after the acquisition date, determined to be October 31, 2011 by both parties. As a result of this settlement, the Company paid $125,000 of the $200,000 that was held back at the acquisition date on November 1, 2011. The remaining $75,000 was held back to complete an environmental remediation project that was agreed upon at the time of closing. The environmental remediation was completed in December 2011 and the $75,000 was paid for the remediation project and therefore no funds were remaining to provide to the seller. In addition, there was approximately $50,000 of net working capital adjustments made during this settlement. The effects of this settlement were recorded during December 2011 and are reflected in the accompanying condensed consolidated financial statements.

Acquisition of Public Gas Company, Inc.

On April 1, 2012 the Company purchased the stock of PGC from Kentucky Energy Development, LLC for the original price of $1.6 million, of which $48,522 was held back and a portion is to be settled up 45 days from closing and the remainder is to be settled up 135 days from closing. PGC is a regulated natural gas distribution company serving approximately 1,600 customers in the State of Kentucky in the counties of Breathitt, Jackson, Johnson, Lawrence, Lee, Magoffin, Morgan and Wolf. Due to the timing of the transaction, the Company has not completed all the work necessary to provide the disclosures under ASC 805.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3 – Marketable Securities

Securities investments that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and recorded at amortized cost. Securities investments bought expressly for the purpose of selling in the near term are classified as trading securities and are measured at fair value with unrealized gains and losses reported in earnings. Securities investments not classified as either held-to-maturity or trading securities are classified as available-for-sale securities. Available-for-sale securities are recorded at fair value in marketable securities in the accompanying balance sheets, with the change in fair value during the period excluded from earnings and recorded net of tax as a component of other comprehensive income. Realized gains and losses, and declines in value judged to be other than temporary, are in the accompanying statements of income. The Company did not hold any held-to-maturity or trading securities as of March 31, 2012 or December 31, 2011.

The following is a summary of available-for-sale securities at:

 

     March 31, 2012  
     Investment      Unrealized      Estimated  
     at cost      Gains      Fair Value  

Common stock

   $ 238,504       $ 143,996       $ 382,500   
  

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Investment      Unrealized      Estimated  
     at cost      Gains      Fair Value  

Common stock

   $ 238,504       $ 129,371       $ 367,875   
  

 

 

    

 

 

    

 

 

 

Unrealized gains on available-for-sale securities of $89,551 and $80,405, respectively (net of $54,718 and $48,966 in taxes) was included in accumulated other comprehensive income in the accompanying balance sheets at March 31, 2012 and December 31, 2011, respectively.

The Company did not sell any available-for-sale securities during the three months ended March 31, 2012 and 2011.

As of March 31, 2012 and December 31, 2011, the Company did not hold any securities in an unrealized loss position.

Note 4 – Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., an exit price). Measuring fair value requires the use of market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, corroborated by market data, or generally unobservable. Valuation techniques are required to maximize the use of observable inputs and minimize the use of unobservable inputs.

Valuation Hierarchy

A fair value hierarchy that prioritizes the inputs used to measure fair value, and requires fair value measurements to be categorized based on the observability of those inputs has been established by the applicable accounting guidance. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables represent the Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of:

 

     March 31, 2012  
     Level 1      Level 2      Level 3      TOTAL  

Available-for-sale securities

   $ 382,500         —           —         $ 382,500   
  

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Level 1      Level 2      Level 3      TOTAL  

Available-for-sale securities

   $ 367,875         —           —         $ 367,875   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 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.

Note 5 – Credit Facilities and Long-Term Debt

Bank of America

At March 31, 2012, Energy West had an unsecured $30 million revolving credit facility with the Bank of America. On November 2, 2011, the Company exercised the $10 million accordion feature on the revolving credit facility with Bank of America to increase the capacity from $20 million to $30 million. The expanded credit facility changes the annual commitment fee from 0.20% to a range of 0.25% to 0.45% of the unused portion of the facility. The interest on amounts outstanding changes from the monthly London Interbank Offered Rate (“LIBOR”) plus 120 to 145 basis points for interest periods selected by Energy West (the “Bank of America Credit Facility”) to the monthly LIBOR plus 175 to 225 basis points. The other terms of the agreement remain the same, including the expiration of the facility on June 29, 2012.

For the three months ended March 31, 2012 and 2011, the weighted average interest rate on the facility was 3.30% and 1.64%, respectively, resulting in $125,672 and $56,780 of interest expense, respectively. The balance on the revolving credit facility was $17,651,000 and $23,160,000 at March 31, 2012 and December 31, 2011, respectively. The $17.7 million of borrowings as of March 31, 2012, leaves the remaining borrowing capacity on the line of credit at $12.3 million

Senior Unsecured Notes

On June 29, 2007, Energy West authorized the sale of $13,000,000 aggregate principal amount of its 6.16% Senior Unsecured Notes, due June 29, 2017 (the “Senior Unsecured Notes”). The proceeds of these notes were used to refinance existing notes. Approximately $463,000 was incurred related to the debt issuance which was capitalized and is being amortized over the life of the notes.

Interest expense was $200,200 for the three months ended March 31, 2012 and 2011, respectively.

Citizens Bank

In connection with the acquisition of the Ohio subsidiaries, NEO and Great Plains each entered modifications/amendments to its credit facility with Citizens Bank (the “Citizens Credit Facility”). The Citizens Credit Facility consisted of a revolving line of credit and term loan to NEO, and two other term loans to Great Plains respectively. Each amendment/modification was initially effective as of December 1, 2009, but was later modified to be effective as of January 5, 2010. Gas Natural guaranteed each loan. Mr. Osborne guaranteed each loan both individually and as trustee of the Richard M. Osborne Trust, and Great Plains guaranteed NEO’s revolving line of credit and term loans.

The Ohio subsidiaries had term loans with Citizens Bank in the aggregate amount of $11.3 million. Each term note had a maturity date of July 1, 2013 and bore interest at an annual rate of 30-day LIBOR plus 400 basis points with an interest rate floor of 5.00% per annum. For the three months ended March 31, 2011, the weighted average interest rate on the term loans was 5.00%, resulting in $118,727 of interest expense. The term loans were paid off on May 3, 2011.

SunLife Assurance Company of Canada

On May 2, 2011, the Company and its Ohio subsidiaries, NEO, Orwell and Brainard (together “the Issuers”), issued $15.3 million of 5.38% Senior Secured Guaranteed Fixed Rate Notes due June 1, 2017 (“Fixed Rate Note”). Additionally, Great Plains issued $3.0 million of Senior Secured Guaranteed Floating Rate Notes due May 3, 2014 (“Floating Rate Note”). Both notes were placed with SunLife. Approximately $615,000 was incurred related to the debt issuance which was capitalized and is being amortized over the life of the notes.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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”). This note received approval from the PUCO on March 30, 2011. The note is governed by a Note Purchase Agreement (“NPA”). Concurrent with the funding and closing of this transaction, which occurred on May 3, 2011, the Fixed Rate Obligors signed an amended NPA that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is subject to a 50 basis point make-whole premium.

The Floating Rate Note, in the amount of $3.0 million, is an obligation of Great Plains and is guaranteed by the Company (together, “the Floating Rate Obligors”). The note is priced at a fixed spread of 385 basis points over three month Libor. Pricing for this note will reset on a quarterly basis to the then current yield of three month Libor. The note is governed by a NPA. Concurrent with the funding of this transaction, which occurred on May 3, 2011, the Floating Rate Obligors signed an amended NPA that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is at par.

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 for 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 year ended December 31, 2011, the Company breached a financial covenant under the Fixed Rate Note and Floating Rate Note when the Ohio subsidiaries made restricted payments in the form of dividends to the holding company in excess of the amounts permissible. In addition, the Company did not timely notify Sun Life of certain newly-formed subsidiaries which were required to be obligors under the Fixed Rate Note and Floating Rate Note. The failure to timely notify Sun Life constituted a breach of the Fixed Rate Note and Floating Rate Note. The Company requested that Sun Life waive these breaches and amend the financial covenants.

On April 9, 2012, the Company entered into a waiver and amendment of the Fixed Rate Note and Floating Rate Note. Pursuant to the amendments, Sun Life waived its rights and remedies of the breaches of the covenants described above. The amendments also provide that any cash dividends, distributions, redemptions or repurchases of common stock may be made by the Ohio subsidiaries 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 Ohio subsidiaries 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. Currently, the Company does not expect the Ohio subsidiaries to be able to pay a dividend to holding company until the fourth quarter of 2012. The inability of the Ohio subsidiaries to pay a dividend to the holding company may impact the Company’s ability to pay a dividend to shareholders. In addition, the Company has agreed to deliver an irrevocable standby letter of credit to Sun Life in the amount of $750,000 to be drawn upon by Sun Life if and when any event of default has occurred and is continuing.

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, determined in accordance with GAAP. The interest coverage ratio is measured with respect to the Ohio subsidiaries 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 Ohio subsidiaries, and again on a consolidated basis with respect to the Company and all of its subsidiaries.

Payments for both notes prior to maturity are interest-only.

For the three months ended March 31, 2012, the weighted average interest rate on the Fixed Rate Note was 5.38%, resulting in $206,242 of interest expense. For the three months ended March 31, 2012, the weighted average interest rate on the Floating Rate Note was 4.36% resulting in $32,725 of interest expense.

Yadkin Valley Bank

On February 13, 2012, Independence Oil entered into a one year, $500,000 revolving credit facility with Yadkin Valley Bank with an interest rate of 4.5% per annum. For the three months ended March 31, 2012, the weighted average interest rate on the facility was 4.50%, resulting in $8 of interest expense. The balance on the facility was $1,000 at March 31, 2012. The $1,000 of borrowings as of March 31, 2012, leaves the remaining borrowing capacity on the line of credit at $499,000.

Debt Covenants

The Company’s Bank of America Credit Facility and the Senior Unsecured Notes contain various covenants, which include, among others, limitations on total dividends and distributions made in the immediately preceding 60-month period to 75% of aggregate consolidated net income for such period, restrictions on certain indebtedness, limitations on asset sales, and maintenance of certain debt-to-capital and interest coverage ratios.

The Fixed Rate Note and the Floating Rate Note carry a 60% debt-to-capitalization financial covenant on a consolidated basis for Ohio, as well as, a 2.0x interest coverage test based on a trailing twelve-month basis. Additional covenants customary for asset sales and purchases, additional indebtedness, dividends, change of control and other matters are also included.

The Company believes it is in compliance with the financial covenants under its debt agreements or has received waivers for any defaults.

The following table shows the future minimum payments on the credit facilities and long-term debt for the years ended March 31:

 

2013

   $ 8,109   

2014

     8,594   

2015

     3,000,000   

2016

     —     

2017

     —     

Thereafter

     28,334,000   
  

 

 

 

Total

   $ 31,350,703   
  

 

 

 

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6 – Stockholders’ Equity

2002 Stock Option Plan

The Energy West Incorporated 2002 Stock Option Plan (the “Option Plan”) provides for the issuance of up to 300,000 options to purchase the Company’s common stock to be issued to certain key employees. As of March 31, 2012 and December 31, 2011, there are 35,000 and 39,500 options outstanding, respectively. The maximum number of shares available for future grants under this plan is 58,000 shares. Under the Option Plan, the option price may not be less than 100% of the common stock fair market value on the date of grant (in the event of incentive stock options, 110% of the fair market value if the employee owns more than 10% of the outstanding common stock). Pursuant to the Option Plan, the options vest over four to five years and are exercisable over a five to ten-year period from date of issuance.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

A summary of the status of the stock option plans as follows:

 

     Number of
Shares
    Weighted
Average
Exercise Price
     Aggregate
Intrinsic
Value
 

Outstanding December 31, 2010

     39,500      $ 8.40      

Granted

     —        $ —        

Exercised

     —        $ —        

Expired

     (4,500   $ 6.34      
  

 

 

   

 

 

    

Outstanding March 31, 2011

     35,000      $ 8.66       $ 61,300   
  

 

 

   

 

 

    

 

 

 

Exerciseable March 31, 2011

     17,500      $ 8.22       $ 107,350   
  

 

 

   

 

 

    

 

 

 
     Number of
Shares
    Weighted
Average
Exercise Price
     Aggregate
Intrinsic
Value
 

Outstanding December 31, 2011

     35,000      $ 8.66      

Granted

     —        $ —        

Exercised

     —        $ —        

Expired

     —        $ —        
  

 

 

   

 

 

    

Outstanding March 31, 2012

     35,000      $ 8.66       $ 104,900   
  

 

 

   

 

 

    

 

 

 

Exerciseable March 31, 2012

     26,250      $ 8.37       $ 86,300   
  

 

 

   

 

 

    

 

 

 

As of March 31, 2012 and December 31, 2011, there was $10,286 and $12,637 of total unrecognized compensation cost related to stock-based compensation, respectively. That cost is expected to be recognized over a period of three years.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following information applies to options outstanding at March 31, 2012:

 

Grant

Date

   Exercise
Price
     Number
Outstanding
     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Life
(Years)
     Number
Exercisable
     Weighted
Average
Exercise
Price
 
                 
                 
                 
                 
                 

12/1/2008

   $ 7.10         10,000       $ 7.10         6.67         10,000       $ 7.10   

6/3/2009

   $ 8.44         5,000       $ 8.44         2.17         3,750       $ 8.44   

12/1/2009

   $ 8.85         10,000       $ 8.85         7.67         7,500       $ 8.85   

12/1/2010

   $ 10.15         10,000       $ 10.15         8.67         5,000       $ 10.15   
     

 

 

          

 

 

    
        35,000               26,250      
     

 

 

          

 

 

    

During the three months ended March 31, 2012, the Company recorded $2,351 ($1,458, respectively, net of related tax effects), of compensation expense for stock options granted after July 1, 2005, and for the unvested portion of previously granted stock options that remained outstanding as of July 1, 2005. During the three months ended March 31, 2011, the Company recorded $3,916 ($2,894, respectively, net of related tax effects), of compensation expense for stock options granted after July 1, 2005, and for the unvested portion of previously granted stock options that remained outstanding as of July 1, 2005.

Note 7 – Employee Benefit Plans

The Company has a defined contribution plan (the "401k Plan") which covers substantially all of its employees. The plan provides for an annual contribution of 3% of salaries, with a discretionary contribution of up to an additional 3%. The expense related to the 401k Plan for the three months ended March 31, 2012, was $121,670. The expense related to the 401k Plan for the three months ended March 31, 2011, was $111,333.

The Company makes matching contributions in the form of Company common stock equal to 10% of each participant’s elective deferrals in the 401k Plan. The Company contributed shares of common stock valued at $9,185 for the three months ended March 31, 2012. The Company contributed shares of common stock valued at $11,957 for the three months ended March 31, 2011. In addition, a portion of the 401k Plan consists of an Employee Stock Ownership Plan (“ESOP”) that covers most employees. The ESOP receives contributions of common stock from the Company each year as determined by the Board of Directors. The contribution is recorded based on the current market price of the Company’s common stock. The Company made no contributions for the three months ended March 31, 2012 and 2011.

The Company has sponsored a defined postretirement health benefit plan (the “Retiree Health Plan”) providing health and life insurance benefits to eligible retirees. The Plan pays eligible retirees (post-65 years of age) up to $125 per month in lieu of contracting for health and life insurance benefits. The amount of this payment is fixed and will not increase with medical trends or inflation. In addition, the Retiree Health Plan allows retirees between the ages of 60 and 65 and their spouses to remain on the same medical plan as active employees by contributing 125% of the current COBRA rate to retain this coverage. The amounts paid in excess of the current COBRA rate is 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 March 31, 2012 and December 31, 2011, the value of plan assets was $183,575 and $182,931, respectively. The assets remaining in the trust will be used to fund the plan until these assets are exhausted.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 8 – 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 March 31,  
     2012     2011  

Income tax from continuing operations:

    

Tax expense at statutory rate of 34%

   $ 1,782,147      $ 2,314,869   

State income tax, net of federal tax expense

     183,713        223,954   

Amortization of deferred investment tax credits

     (5,265     (5,265

Other

     (1,832     127   
  

 

 

   

 

 

 

Total income tax expense

   $ 1,958,763      $ 2,533,685   
  

 

 

   

 

 

 

The Company recognizes interest accrued related to unrecognized tax positions in interest expense and penalties in operating expense. No interest and penalties related to unrecognized tax positions were accrued at March 31, 2012 and December 31, 2011.

The tax years after 2007 remain open to examination by the major taxing jurisdictions in which the Company operates, although no material changes to unrecognized tax positions are expected within the next twelve months.

Note 9 – Related Party Transactions

The Company is party to certain agreements and transactions with Mr. Osborne, or companies owned or controlled by Mr. Osborne.

Notes Payable

The Company had two notes payable to Mr. Osborne. The first note was payable on demand and bore interest at a rate equal to the prime rate as published by Key Bank. On December 1, 2010, the Company repaid the first note in full, including all interest accrued to date. The second note had a maturity date of January 3, 2014 and bore interest at 6.0% annually. On May 3, 2011, the Company repaid the second note in full, including all interest accrued to date, using the SunLife proceeds. Interest expense incurred related to both loans was $397 for the three months ended March 31, 2011.

Note Receivable

The Company has a note receivable from John D. Oil and Gas Marketing, a company controlled by Mr. Osborne, with a maturity date of December 31, 2016 and an annual interest rate of 7.0% relating to funds loaned to John D. Oil and Gas Marketing to finance the acquisition of a gas pipeline. The balance due from John D. Oil and Gas Marketing was $43,168 and $45,664 (of which, $10,437 and $10,256 is due within one year) as of March 31, 2012 and December 31, 2011, respectively. The Company has a corresponding agreement to lease the pipeline from John D. Oil and Gas Marketing through December 31, 2016. Lease expense resulting from this agreement was $3,300 for the three months ended March 31, 2012 which is included in the Natural Gas Purchased column below. Lease expense resulting from this agreement was $3,300 for the three months ended March 31, 2011 which is included in the Natural Gas Purchased column below. There was no balance due at March 31, 2012 or December 31, 2011 to John D. Oil and Gas Marketing related to these lease payments.

 

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GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Accounts Receivable and Accounts Payable

The table below details amounts due from and due to related parties, including companies owned or controlled by Mr. Osborne, at March 31, 2012 and December 31, 2011, respectively:

 

     Accounts Receivable      Accounts Payable  
     March 31, 2012      December 31, 2011      March 31, 2012      December 31, 2011  

John D. Oil and Gas Marketing

   $ 3,282       $ 3,282       $ 42,481       $ 126,051   

Cobra Pipeline

     448         448         714         1,312   

Orwell Trumbell Pipeline

     128,362         128,012         747         1,043   

Great Plains Exploration

     160,040         133,928         —           9   

Big Oats Pipeline Supply

     742         432         54,770         53,348   

Kykuit Resources

     98,037         98,037         —           —     

Sleepy Hollow

     142,397         138,611         —           —     

Other

     22,318         16,334         —           10,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 555,626       $ 519,084       $ 98,712       $ 191,763   
  

 

 

    

 

 

    

 

 

    

 

 

 

The table below details transactions with related parties, including companies owned or controlled by Mr. Osborne, for the three months ended March 31, 2012:

 

     Three Months Ended March 31, 2012  
     Natural Gas
Purchases
     Pipeline and
Construction
Purchases
     Rent, Supplies,
Consulting,  and
Other Purchases
     Natural Gas
Sales
     Management
and Other
Sales
 
              
              

John D. Oil and Gas Marketing

   $ 1,006,934       $ 9,870       $ —         $ —         $ 3,282   

Cobra Pipeline

     201,360         890         —           —           —     

Orwell Trumbell Pipeline

     211,465         —           —           715         151   

Great Plains Exploration

     196,924         —           —           4,051         5,253   

Big Oats Pipeline Supply

     —           163,482         90,401         1,247         —     

Sleepy Hollow

     —           —           —           —           3,787   

Other

     374,002         —           40,771         18,115         671   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,990,685       $ 174,242       $ 131,172       $ 24,128       $ 13,144   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The table below details transactions with related parties, including companies owned or controlled by Mr. Osborne, for the three months ended March 31, 2011:

 

     Three Months Ended March 31, 2011  
     Natural Gas
Purchases
     Pipeline and
Construction
Purchases
     Rent, Supplies,
Consulting, and
Other Purchases
     Natural Gas
Sales
     Management
and Other
Sales
 
              
              

John D. Oil and Gas Marketing

   $ 1,472,102       $ —         $ 127       $ —         $ 3,282   

Cobra Pipeline

     179,603         —           —           —           128   

Orwell Trumbell Pipeline

     220,517         —           49,080         1,370         4,715   

Great Plains Exploration

     19,143         85,680         150         3,538         8,981   

Big Oats Pipeline Supply

     —           166,782         138,872         2,173         —     

Kykuit Resources

     —           —           39,600         —           —     

Sleepy Hollow

     —           —           —           —           6,205   

Other

     —           —           55,616         41,240         1,749   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,891,365       $ 252,462       $ 283,445       $ 48,321       $ 25,060   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The Company also accrued a liability of $448,455 and $635,192, respectively, due to companies controlled by Mr. Osborne for natural gas used through March 31, 2012 and December 31, 2011 that is not yet invoiced. The related expense is included in the gas purchased line item in the accompanying statements of income and comprehensive income. These amounts will be trued up to the actual invoices when received in future periods.

On December 20, 2011, the Company consummated a real estate transaction with Black Bear, an Ohio limited liability company owned and controlled by Mr. Osborne, whereby Black Bear sold to the Company approximately 9.24 acres of real estate Black Bear owned in Violet Township, Fairfield County, Ohio for $600,000.

Note 10 – Segments of Operations

The following tables set forth summarized financial information for the Company’s natural gas, marketing and production, pipeline, propane, and corporate and other operations. The Company classifies its segments to provide investors with a view of the business through management’s eyes. The Company primarily separates its state regulated utility businesses from the non-regulated marketing and production business, propane business and from the federally regulated pipeline business. The Company has regulated utility businesses in the states of Maine, Montana, North Carolina, Ohio, Pennsylvania and Wyoming and these businesses are aggregated together to form the natural gas operations. 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, accounts payable, equity, and subsidiary investment:

Three Months Ended March 31, 2012

 

     Natural Gas
Operations
    Marketing
and
Production
    Pipeline
Operations
     Propane
Operations
    Corporate  and
Other
    Consolidated  
             
             

OPERATING REVENUES

   $ 29,933,151      $ 3,625,788      $ 107,784       $ 1,909,158      $ —        $ 35,575,881   

Intersegment eliminations

     (85,065     (1,718,695     —           —          —          (1,803,760
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total operating revenue

     29,848,086        1,907,093        107,784         1,909,158        —          33,772,121   

COST OF SALES

     17,321,959        3,114,111        —           1,431,269        —          21,867,339   

Intersegment eliminations

     (85,065     (1,718,695     —           —          —          (1,803,760
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total cost of sales

     17,236,894        1,395,416        —           1,431,269        —          20,063,579   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

GROSS MARGIN

   $ 12,611,192      $ 511,677      $ 107,784       $ 477,889      $ —        $ 13,708,542   

OPERATING EXPENSES

     6,729,273        331,084        38,506         566,413        62,793        7,728,069   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

OPERATING INCOME (LOSS)

   $ 5,881,919      $ 180,593      $ 69,278       $ (88,524   $ (62,793   $ 5,980,473   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 3,352,534      $ 95,315      $ 38,223       $ (94,841   $ (108,384   $ 3,282,847   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

As of March 31, 2012

             

Goodwill

   $ 14,607,952      $ —        $ —         $ —        $ —        $ 14,607,952   

Investment in unconsolidated affiliate

   $ —        $ 327,610      $ —         $ —        $ —        $ 327,610   

Total assets

   $ 133,685,618      $ 5,365,659      $ 811,489       $ 3,332,796      $ 64,887,107      $ 208,082,669   

Intersegment eliminations

     (48,284,824     (1,229,052     13,406         (2,212,617     (8,657,104     (60,370,191
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total assets

   $ 85,400,794      $ 4,136,607      $ 824,895       $ 1,120,179      $ 56,230,003      $ 147,712,478   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Three Months Ended March 31, 2011

 

     Natural Gas
Operations
    Marketing
and
Production
    Pipeline
Operations
    Propane
Operations
     Corporate  and
Other
    Consolidated  
             
             

OPERATING REVENUES

   $ 38,309,893      $ 4,340,252      $ 106,324      $ —         $ —        $ 42,756,469   

Intersegment eliminations

     (90,310     (2,514,750     —          —           —          (2,605,060
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total operating revenue

     38,219,583        1,825,502        106,324        —           —          40,151,409   

COST OF SALES

     24,807,218        3,914,157        —          —           —          28,721,375   

Intersegment eliminations

     (90,310     (2,514,750     —          —           —          (2,605,060
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total cost of sales

     24,716,908        1,399,407        —          —           —          26,116,315   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

GROSS MARGIN

   $ 13,502,675      $ 426,095      $ 106,324      $ —         $ —        $ 14,035,094   

OPERATING EXPENSES

     6,615,808        199,497        42,324        —           8,570        6,866,199   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

OPERATING INCOME (LOSS)

   $ 6,886,867      $ 226,598      $ 64,000      $ —         $ (8,570   $ 7,168,895   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 4,259,125      $ 85,782      $ 36,802      $ —         $ (106,955   $ 4,274,754   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

As of March 31, 2011

             

Goodwill

   $ 14,607,952      $ —        $ —        $ —         $ —        $ 14,607,952   

Investment in unconsolidated affiliate

   $ —        $ 748,859      $ —        $ —         $ —        $ 748,859   

Total assets

   $ 105,779,527      $ 5,238,233      $ 721,458      $ —         $ 76,953,664      $ 188,692,882   

Intersegment eliminations

     (45,389,522     (2,825,763     (54,123     —           (10,646,010     (58,915,418
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 60,390,005      $ 2,412,470      $ 667,335      $ —         $ 66,307,654      $ 129,777,464   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Note 11 – Commitments and Contingencies

Legal Proceedings

In 2010, Bangor Gas Company, the Company’s Maine utility, asserted a claim against H.Q. Energy Services (US), Inc. (“HQ”) for a breach of a firm gas transportation service agreement between the parties. HQ filed a counterclaim against the Company for reimbursement of certain transportation charges that HQ paid to a third party. The parties agreed to arbitration and on September 1, 2011, the arbitrators awarded HQ the sum of approximately $280,000 for past transportation charges that HQ paid to the Company. The arbitrators also ordered the Company to pay future transportation charges that will be incurred during the remaining term of the agreement while HQ was ordered to pay the Company for future fuel reimbursements for the remaining term of the agreement. On September 23, 2011, the arbitrators clarified their initial order to require HQ to reimburse the Company for the past transportation charges awarded by the arbitrators if the FERC determined that our payment of the transportation charges was not consistent with FERC policy. On November 10, 2011, the FERC’s Office of General Counsel issued a no-action letter indicating that the FERC staff could not assure the Company that the FERC would not recommend enforcement action if the Company made the payments to HQ required by the arbitration award. As a result, on November 30, 2011, the Company filed an action in the United States District Court, District of Maine against HQ seeking to vacate the arbitration award against the Company and confirm that portion of the award requiring HQ to return the transportation payments to the Company and obtain an award of past fuel reimbursements in addition to the prospective award made by the arbitrators. On March 1, 2012, the court issued an order confirming the arbitration award against the Company, rejecting the Company’s claim for past fuel costs, and denying the Company’s claim for reimbursement of transportation charges on the grounds that the FERC no-action letter was not a final, binding finding by the FERC of the consistency of the payments with FERC policy. On March 30, 2012, the Company filed an action with the United States Court of Appeals for the First Circuit appealing the district court’s decision in its entirety. The Company intends to vigorously pursue the claim against HQ.

On April 15, 2011, the Company and Richard M. Osborne, Chairman and CEO, filed a lawsuit captioned “Richard M. Osborne and Gas Natural Inc. v. Michael I. German, Henry B. Cook, Ted W. Gibson, George J. Welch and Corning Natural Gas Corporation,” Case No. 1:11-CV-744 which was filed in the U.S. District Court for the Northern District of Ohio. The lawsuit claims that Messrs. German, Cook, Gibson and Welch, as directors of Corning Natural Gas Corporation (“Corning”), breached their fiduciary duties to shareholders of Corning by (i) failing to maximize shareholder value in connection with the Company’s offers to acquire all of Corning’s outstanding shares of common stock and (ii) instituting a rights offering to dilute Mr. Osborne and the Company’s ownership of Corning. Alternatively, the lawsuit provides for a derivative claim against the directors of Corning for the same conduct. The Company and Mr. Osborne seek to rescind the rights offering. Corning and the directors of Corning filed a motion to dismiss the lawsuit. The court granted the motion to dismiss on March 23, 2012.

 

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Table of Contents

GAS NATURAL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

In a related proceeding, on August 11, 2011, the Company filed a lawsuit against Corning in the Supreme Court of the State of New York, County of Steuben, to inspect the corporate books and records of Corning concerning the rights offering. On February 16, 2012, the court granted in part the petition of the Company to inspect the corporate books and records of Corning.

In the Company’s opinion, the outcome of these legal actions will not have a material adverse effect on the financial condition, cash flows or results of operations of the Company.

The Company reached agreement with the Montana Department of Revenue (“DOR”) to settle personal property tax claims for the years 1997-2002. The settlement amount is being paid in ten annual installments of $243,000 each, beginning November 30, 2003. The Company has obtained rate relief that includes full recovery of the property tax associated with the DOR settlement. The last payment under this settlement is November 2012.

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.

Note 12 – Financial Instruments and Risk Management

Management of Risks Related to Fixed Contracts

The Company and its subsidiaries are subject to certain risks related to changes in certain commodity prices and risks of counterparty performance. The Company has established policies and procedures to manage such risks. The Company has a Risk Management Committee comprised of Company officers and management to oversee the risk management program as defined in its risk management policy. The purpose of the risk management program is to minimize adverse impacts on earnings resulting from volatility of energy prices, counterparty credit risks, and other risks related to the energy commodity business.

In order to mitigate the risk of natural gas market price volatility related to firm commitments to purchase or sell natural gas, from time to time the Company and its subsidiaries have entered into fixed contracts. Such arrangements may be used to protect profit margins on future obligations to deliver gas at a fixed price, or to protect against adverse effects of potential market price declines on future obligations to purchase gas at fixed prices.

The Company accounts for these contracts in accordance with ASC 815, Derivatives and Hedging. In accordance with ASC 815, such contracts are reflected in the balance sheet as assets or liabilities and valued at “fair value,” determined as of the balance sheet date. Fair value accounting treatment is also referred to as “mark-to-market” accounting. Mark-to-market accounting results in disparities between reported earnings and realized cash flow. The changes in the derivative values are reported in the income statement as an increase or (decrease) in revenues without regard to whether any cash payments have been made between the parties to the contract. ASC 815 specifies that contracts for purchase or sale at fixed prices and volumes must be valued at fair value (under mark-to-market accounting) unless the contracts qualify for treatment as a “normal purchase or normal sale.”

At March 31, 2012 and December 31, 2011, all of the Company’s fixed contracts for purchase or sale at fixed prices and volumes qualified for treatment as a “normal purchase or normal sale.”

Note 13 – Subsequent Events

The Company declared a dividend of $0.045 per share on March 28, 2012 that is payable to shareholders of record on April 13, 2012. There were 8,155,426 shares outstanding on April 13, 2012 resulting in a total dividend of $366,994 which was paid to shareholders on April 30, 2012.

 

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ITEM 2. MANAGEMENTS 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 ended December 31, 2011 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 70,000 customers. Our natural gas utility subsidiaries are Bangor Gas Company (Maine), Brainard Gas Corp. (Ohio), Cut Bank Gas Company (Montana), Energy West, Incorporated (Montana and Wyoming), Frontier Natural Gas (North Carolina), Northeast Ohio Natural Gas Corporation (Ohio) and Orwell Natural Gas Company (Ohio and Pennsylvania). Our operations also include production and marketing of natural gas, gas pipeline transmission and gathering and propane operations. Approximately 87% of our revenues in the three months ended March 31, 2012 were derived from our natural gas utility operations.

The following summarizes the critical events that impacted our results of operations during the three months ended March 31, 2012:

 

   

Warm weather in all service territories caused gross margin and net income from natural gas operations to decrease as compared to the prior year.

 

   

Our recently acquired propane operations returned gross margin of $478,000 and a net loss of $95,000.

 

   

Our interest expense increased primarily the result of our Ohio subsidiaries refinancing their debt in May 2011. There were loans paid off in preparation of the refinancing in 2011 and therefore a lower amount of debt was outstanding. In addition, the average balance on our Bank of America line of credit was higher during the current period.

Our historical financial statements reflect the following reportable business segments: Natural Gas Operations, Marketing and Production Operations, Pipeline Operations and Corporate and Other. In addition, the financial statements now reflect a new segment for Propane Operations as a result of the new subsidiary, Independence Oil, LLC, in connection with the 2011 acquisition.

RESULTS OF CONSOLIDATED OPERATIONS

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, 2011. The following gives effect to the unaudited Condensed Consolidated Financial Statements as of March 31, 2012 and for the three month period ended March 31, 2012. Results of operations for interim periods are not necessarily indicative of results to be attained for any future period.

Three Months Ended March 31, 2012 Compared with Three Months Ended March 31, 2011

Net Income — Net income for the three months ended March 31, 2012 was $3,283,000, or $0.40 per diluted share, compared to a net income of $4,275,000, or $0.52 per diluted share for the three months ended March 31, 2011, a decrease of $992,000. Net income from our natural gas operations decreased by $906,000, due primarily to warm weather in all of our service territories. Net income from our gas marketing and production operations increased by $9,000. Net income from our pipeline operations increased by $1,000. Our recently acquired propane operations returned a net loss of $95,000.

 

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Revenues — Revenues decreased by $6,379,000 to $33,772,000 for the three months ended March 31, 2012 compared to $40,151,000 for the same period in 2011. The decrease was primarily attributable to a natural gas revenue decrease of $8,372,000 due to warm weather in all of our service territories, offset by revenue from our recently acquired propane operations segment of $1,909,000 and an increase of $82,000 in the revenue from our marketing and production operation due to increased customers.

Gross Margin — Gross margin decreased by $326,000 to $13,709,000 for the three months ended March 31, 2012 compared to $14,035,000 for the same period in 2011. Our natural gas operation’s margins decreased $892,000, due to the warm weather and offset somewhat by increased margin from customer growth in our Maine and North Carolina markets. Gross margin from our propane operations returned gross margin of $478,000 and our marketing and production operations increased $86,000.

Operating Expenses — Operating expenses, other than cost of sales, increased by $862,000 to $7,728,000 for the three months ended March 31, 2012 compared to $6,866,000 for the same period in 2011. The newly formed propane operations segment contributed $567,000 while the remainder is primarily the result of increases in uncollectible accounts expense and increases in depreciation due to the additional capital expenditures.

Other Income (Expense), net — Other income decreased by $188,000 to a loss of $72,000 for the three months ended March 31, 2012 compared to income of $116,000 for the same period in 2011. The decrease is a result of the following: (1) other income from our natural gas operations decreased by $81,000 due to decreased rental income; (2) our recently acquired propane operations contributed other expense of $71,000 and (3) our corporate and other segment increased $36,000.

Interest Expense — Interest expense increased by $251,000 to $664,000 for the three months ended March 31, 2012 compared to $413,000 for the same period in 2011. The increase is primarily the result of our Ohio subsidiaries refinancing their debt in May 2011. There were loans paid off in preparation of the refinancing and therefore a lower amount of debt was outstanding during the three months ended March 31, 2011. In addition, the balance on our Bank of America line of credit averaged $20,363,000 during the three months ended March 31, 2012, compared to $13,852,000 during the 2011 period, causing additional interest expense.

Income Tax Expense — Income tax expense decreased by $575,000 to $1,959,000 for the three months ended March 31, 2012 compared to $2,534,000 for the same period in 2011. The decrease is primarily due to the reduction in pre-tax income.

 

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Net Income by Segment and Service Area

The components of net income (loss) for the three months ended March 31, 2012 and 2011 are:

 

     Three Months
Ended March 31,
 
($ in thousands)    2012     2011  

Natural Gas Operations

    

Energy West Montana (MT)

   $ 681      $ 864   

Energy West Wyoming (WY)

     238        315   

Frontier Natural Gas (NC)

     575        663   

Bangor Gas (ME)

     865        868   

Ohio Companies (OH)

     995        1,549   

Gas Natural Energy Solutions

     (1     0   
  

 

 

   

 

 

 

Total Natural Gas Operations

   $ 3,353      $ 4,259   

Marketing & Production Operations

     95        86   

Pipeline Operations

     38        37   

Propane Operations

     (95     —     
  

 

 

   

 

 

 
     3,391        4,382   

Corporate & Other

     (108     (107
  

 

 

   

 

 

 

Consolidated Net Income

   $ 3,283      $ 4,275   
  

 

 

   

 

 

 

The following highlights our results by operating segments:

NATURAL GAS OPERATIONS

Income Statement

 

     Three Months
Ended March 31,
 
($ in thousands)    2012     2011  

Natural Gas Operations

    

Operating revenues

   $ 29,848      $ 38,220   

Gas Purchased

     17,237        24,717   
  

 

 

   

 

 

 

Gross Margin

     12,611        13,503   

Operating expenses

     6,729        6,616   
  

 

 

   

 

 

 

Operating income

     5,882        6,887   

Other income

     114        195   
  

 

 

   

 

 

 

Income before interest and taxes

     5,996        7,082   

Interest expense

     (637     (387
  

 

 

   

 

 

 

Income before income taxes

     5,359        6,695   

Income tax expense

     (2,006     (2,436
  

 

 

   

 

 

 

Net Income

   $ 3,353      $ 4,259   
  

 

 

   

 

 

 

 

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Operating Revenues

 

     Three Months
Ended March 31,
 
($ in thousands)    2012      2011  

Full Service Distribution Revenues

     

Residential

   $ 13,746       $ 18,603   

Commercial

     12,579         16,062   

Industrial

     262         224   

Other

     23         36   
  

 

 

    

 

 

 

Total full service distribution

     26,610         34,925   

Transportation

     2,950         3,007   

Bucksport

     288         288   
  

 

 

    

 

 

 

Total operating revenues

   $ 29,848       $ 38,220   
  

 

 

    

 

 

 

Utility Throughput

 

     Three Months
Ended March 31,
 
(in million cubic feet (MMcf))    2012      2011  

Full Service Distribution

     

Residential

     1,811         2,164   

Commercial

     1,638         1,950   

Industrial

     53         40   
  

 

 

    

 

 

 

Total full service

     3,502         4,154   

Transportation

     2,954         2,684   

Bucksport

     3,662         3,801   
  

 

 

    

 

 

 

Total Volumes

     10,118         10,639   
  

 

 

    

 

 

 

Heating Degree Days

A heating degree day is a measure of coldness of the weather experienced, based on the extent to which the daily average temperature falls below a reference temperature, usually 65 degrees Fahrenheit.

 

            Three Months Ended
March 31,
     Percent (Warmer) Colder
2012 Compared to
 
     Normal      2012      2011      Normal     2011  

Great Falls, MT

     3,180         2,914         3,662         (8.36 %)      (20.43 %) 

Cody, WY

     3,030         2,738         3,277         (9.64 %)      (16.45 %) 

Bangor, ME

     3,735         3,273         3,808         (12.37 %)      (14.05 %) 

Elkin, NC

     2,117         1,616         2,096         (23.67 %)      (22.90 %) 

Youngstown, OH

     3,118         2,413         3,308         (22.61 %)      (27.06 %) 

Three Months Ended March 31, 2012 Compared with Three Months Ended March 31, 2011

Revenues and Gross Margin

Revenues decreased by $8,372,000 to $29,848,000 for the three months ended March 31, 2012 compared to $38,220,000 for the same period in 2011. This decrease is the result of the following factors:

 

  1) Revenue from our Montana and Wyoming markets decreased $3,270,000 on a volume decrease of 395 MMcf in the three months ended March 31, 2012 compared to the three months ended March 31, 2011.

 

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  2) Revenue from our Maine and North Carolina markets increased by $32,000 on a volume increase from full service and transportation customers of 115 MMcf in the three months ended March 31, 2012 compared to the three months ended March 31, 2011.

 

  3) Revenues from our Ohio market decreased $5,134,000 on a volume decrease of 102 MMcf to full service and transportation customers in the three months ended March 31, 2012 compared to the three months ended March 31, 2011.

Gas purchased decreased by $7,480,000 to $17,237,000 for the three months ended March 31, 2012 compared to $24,717,000 for the same period in 2011. The decrease is due primarily to the decrease in sales volumes. 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 $892,000 to $12,611,000 for the three months ended March 31, 2012 compared to $13,503,000 for the same period in 2011. Warmer weather in 2012, both compared to normal and compared to 2011, is the primary driver of the decrease in gross margin. The decrease is offset somewhat by increased gross margin due to customer growth in our Maine and North Carolina markets. Our Ohio market accounted for $772,000 of the decrease, and Montana and Wyoming for $429,000, offset by an increase in Maine and North Carolina of $309,000.

Earnings

The Natural Gas Operations segment’s income for the three months ended March 31, 2012 was $3,353,000, or $0.41 per diluted share, compared to $4,259,000, or $0.52 per diluted share for the three months ended March 31, 2011.

Operating expenses increased by $113,000 to $6,729,000 for the three months ended March 31, 2012 compared to $6,616,000 for the same period in 2011. The increase is primarily caused by the increase in depreciation due to the increased capital expenditures.

Other income decreased by $81,000 to $114,000 for the three months ended March 31, 2012 compared to $195,000 for the same period in 2011. The decrease is primarily due to the reduction in rental income.

Interest expense increased by $250,000 to $637,000 for the three months ended March 31, 2012 compared to $387,000 for the same period in 2011. The increase is primarily the result of our Ohio subsidiaries refinancing their debt in May 2011. There were loans paid off in preparation of the refinancing and therefore a lower amount of debt was outstanding during the three months ended March 31, 2011. In addition, the balance on our Bank of America line of credit averaged $20,363,000 during the three months ended March 31, 2012, compared to $13,852,000 during the 2011 period, causing additional interest expense.

Income tax expense decreased by $430,000 to $2,006,000 for the three months ended March 31, 2012 compared to $2,436,000 for the same period in 2011. The decrease is primarily due to the reduction in pre-tax income.

MARKETING AND PRODUCTION OPERATIONS

Income Statement

 

     Three Months
Ended March 31,
 
($ in thousands)    2012     2011  

Marketing and Production Operations

    

Operating revenues

   $ 1,907      $ 1,825   

Gas Purchased

     1,395        1,399   
  

 

 

   

 

 

 

Gross Margin

     512        426   

Operating expenses

     331        199   
  

 

 

   

 

 

 

Operating income

     181        227   

Other expense

     (2     (63
  

 

 

   

 

 

 

Income before interest and taxes

     179        164   

Interest expense

     (21     (23
  

 

 

   

 

 

 

Income before income taxes

     158        141   

Income tax expense

     (63     (55
  

 

 

   

 

 

 

Net Income

   $ 95      $ 86   
  

 

 

   

 

 

 

 

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Three Months Ended March 31, 2012 Compared with Three Months Ended March 31, 2011

Revenues and Gross Margin

Revenues increased by approximately $82,000 to $1,907,000 for the three months ended March 31, 2012 compared to $1,825,000 for the same period in 2011. $130,000 of this increase is due to increased customers in our marketing operation, leading to higher sales volumes and revenue, offset by a decrease in production revenues of $48,000 due to lower prices received for volumes produced.

Gross margin increased by $86,000 to $512,000 for the three months ended March 31, 2012 compared to $426,000 for the same period in 2011. Gross margin from gas marketing increased by $106,000, offset by a decrease from our production operation of $20,000.

Earnings

The Marketing and Production segment’s earnings for the three months ended March 31, 2012 were $95,000, or $0.01 per diluted share, compared to earnings of $86,000, or $0.01 per diluted share for the three months ended March 31, 2011.

Operating expenses increased by $132,000 to $331,000 for the three months ended March 31, 2012 compared to $199,000 for the same period in 2011. The increase is primarily due to the additional estimate for uncollectible accounts.

Other expense decreased by $61,000 to $2,000 for the three months ended March 31, 2012 compared to $63,000 for the same period in 2011. The decrease is primarily due to the reduction in the loss from unconsolidated affiliate of $60,000.

Income tax expense increased by $8,000 to $63,000 for the three months ended March 31, 2012 compared to $55,000 for the same period in 2011. The increase is primarily due to the additional pre-tax income.

PIPELINE OPERATIONS

Income Statement

 

     Three Months
Ended March 31,
 
($ in thousands)    2012     2011  

Pipeline Operations

    

Operating revenues

   $ 108      $ 106   

Gas Purchased

     —          —     
  

 

 

   

 

 

 

Gross Margin

     108        106   

Operating expenses

     39        42   
  

 

 

   

 

 

 

Operating income

     69        64   

Other expense

     —          —     
  

 

 

   

 

 

 

Income before interest and taxes

     69        64   

Interest expense

     (6     (3
  

 

 

   

 

 

 

Income before income taxes

     63        61   

Income tax expense

     (25     (24
  

 

 

   

 

 

 

Net Income

   $ 38      $ 37   
  

 

 

   

 

 

 

Three Months Ended March 31, 2012 Compared with Three Months Ended March 31, 2011

Net income increased by $1,000 to $38,000 for the three months ended March 31, 2012 compared to $37,000 for the same period in 2011. The overall impact of the results of our pipeline operations was not material to our results of consolidated operations.

 

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PROPANE OPERATIONS

Income Statement

 

0000000 0000000
     Three Months
Ended March 31,
 
($ in thousands)    2012     2011  

Propane Operations

    

Operating revenues

   $ 1,909      $ —     

Gas Purchased

     1,431        —     
  

 

 

   

 

 

 

Gross Margin

     478        —     

Operating expenses

     567        —     
  

 

 

   

 

 

 

Operating income

     (89     —     

Other expense

     (71     —     
  

 

 

   

 

 

 

Income before interest and taxes

     (160     —     

Interest expense

     —          —     
  

 

 

   

 

 

 

Income before income taxes

     (160     —     

Income tax benefit

     65        —     
  

 

 

   

 

 

 

Net Loss

   $ (95   $ —     
  

 

 

   

 

 

 

Three Months Ended March 31, 2012 Compared with Three Months Ended March 31, 2011

Net loss is $95,000, or $0.01 per diluted share for the three months ended March 31, 2012. The propane operations were acquired on August 1, 2011 and there are no comparative amounts for 2011.

CORPORATE AND 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. Therefore, it does not have standard revenues, gas purchase costs, or gross margin.

Income Statement

 

     Three Months
Ended March 31,
 
($ in thousands)    2012     2011  

Corporate and Other Operations

    

Operating revenues

   $ —        $ —     

Gas Purchased

     —          —     
  

 

 

   

 

 

 

Gross Margin

     —          —     

Operating expenses

     63        9   
  

 

 

   

 

 

 

Operating income

     (63     (9

Other expense

     (116     (80
  

 

 

   

 

 

 

Income before interest and taxes

     (179     (89

Interest expense

     —          —     
  

 

 

   

 

 

 

Income before income taxes

     (179     (89

Income tax benefit (expense)

     71        (18
  

 

 

   

 

 

 

Net Loss

   $ (108   $ (107
  

 

 

   

 

 

 

Three Months Ended March 31, 2012 Compared with Three Months Ended March 31, 2011

Results of corporate and other operations for the three months ended March 31, 2012 include costs related to acquisition activities of $119,000, administrative costs of $63,000, offset by income tax benefits of $71,000 and interest income of $3,000, for a net loss of $108,000.

 

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Results of corporate and other operations for the three months ended March 31, 2011 include administrative costs of $9,000, costs related to acquisition activities of $83,000, and income tax expense of $18,000, offset interest income of $3,000, for a net loss of $107,000.

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 depreciations, depletion, amortization, deferred income taxes, and changes in working capital.

Our ability to maintain liquidity depends upon our credit facility with Bank of America, shown as line of credit on the accompanying balance sheets. Our use of the Bank of America revolving line of credit was $17.7 million and $23.2 million at March 31, 2012 and December 31, 2011, respectively.

We made capital expenditures for continuing operations of $4.4 million and $2.8 million for the three months ended March 31, 2012 and 2011, 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 line of credit.

We periodically repay our short-term borrowings under the Bank of America revolving line of credit by using the net proceeds from the sale of long-term debt and equity securities. Long-term debt was $31.4 million at March 31, 2012 and December 31, 2011, including the amount due within one year.

Cash, excluding restricted cash, decreased to $7.9 million at March 31, 2012, compared to $10.5 million at December 31, 2011.

 

     Three Months
Ended March 31,
 
     2012     2011  

Cash provided by operating activities

   $ 8,375,000      $ 11,535,000   

Cash used in investing activities

     (4,263,000     (2,954,000

Cash used in financing activities

     (6,737,000     (8,503,000
  

 

 

   

 

 

 

Increase (decrease) in cash

   $ (2,625,000   $ 78,000   
  

 

 

   

 

 

 

OPERATING CASH FLOW

For the three months ended March 31, 2012, cash provided by operating activities decreased by $3.2 million as compared to the three months ended March 31, 2011. Major items affecting operating cash included a $2.3 million decrease in collections of recoverable costs of gas, a $985,000 decrease in payments on accounts payable, a $621,000 increase in accounts receivable collections, a $211,000 decrease in net deferred tax assets, and a $113,000 decrease in unbilled revenue.

INVESTING CASH FLOW

For the three months ended March 31, 2012, cash used in investing activities increased by $1.3 million as compared to the three months ended March 31, 2011, primarily due to increased construction expenditures of $1.5 million offset by the reduction in investment to unconsolidated affiliate of $132,000.

Capital Expenditures

Our capital expenditures for continuing operations totaled $4.4 million and $2.8 million for the three months ended March 31, 2012 and 2011, 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 line 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 two service areas.

 

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Estimated Capital Expenditures

The table below details our capital expenditures for the three months ended March 31, 2012 and 2011 and provides an estimate of future cash requirements for capital expenditures:

 

00000 00000 00000
     Three Months ended      Remaining Cash  
     March 31,      Requirements through  
($ in thousands)    2012      2011      December 31, 2012  

Natural Gas Operations

   $ 3,342       $ 2,807       $ 11,700   

Marketing and Production Operations

     —           —           —     

Pipeline Operations

     6         —           63   

Propane Operations

     80         —           870   

Corporate and Other Operations

     938         5         476   
  

 

 

    

 

 

    

 

 

 

Total Capital Expenditures

   $ 4,366       $ 2,812       $ 13,109   
  

 

 

    

 

 

    

 

 

 

FINANCING CASH FLOW

For the three months ended March 31, 2012, cash provided by financing activities decreased by $1.8 million as compared with the three months ended March 31, 2011. The primary decrease is due to the reduction in the net line of credit proceeds of $1.6 million. In addition, there was a reduction of $117,000 in debt issuance costs.

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 working capital 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. Our ability to maintain liquidity depends upon our credit facility with Bank of America, shown as line of credit on the accompanying balance sheets. Our use of the Bank of America revolving line of credit was $17.7 million and $23.2 million at March 31, 2012 and December 31, 2011, respectively. We periodically repay our short-term borrowings under the Bank of America revolving line of credit by using the net proceeds from the sale of long-term debt and equity securities. Long-term debt was $31.4 million at March 31, 2012, and December 31, 2011, including the amount due within one year.

Citizens Bank Term Loans

In connection with the acquisition of the Ohio subsidiaries, NEO and Great Plains each entered modifications/amendments to its credit facility with Citizens Bank (the “Citizens Credit Facility”). The Citizens Credit Facility consisted of a revolving line of credit and term loan to NEO, and two other term loans to Great Plains respectively. Each amendment/modification was initially effective as of December 1, 2009, but was later modified to be effective as of January 5, 2010. Gas Natural guaranteed each loan. Mr. Osborne guaranteed each loan both individually and as trustee of the Richard M. Osborne Trust, and Great Plains guaranteed NEO’s revolving line of credit and term loans.

The Ohio subsidiaries had term loans with Citizens Bank in the aggregate amount of $11.3 million. Each term note had a maturity date of July 1, 2013 and bore interest at an annual rate of 30-day LIBOR plus 400 basis points with an interest rate floor of 5.00% per annum. For the three months ended March 31, 2011, the weighted average interest rate on the term loans was 5.00%, resulting in $118,727 of interest expense. The term loans were paid off on May 3, 2011.

The following discussion describes our credit facilities as of March 31, 2012.

SunLife Assurance Company of Canada

On May 2, 2011, the Company and its Ohio subsidiaries, NEO, Orwell and Brainard (together “the Issuers”), issued $15.3 million of 5.38% Senior Secured Guaranteed Fixed Rate Notes due June 1, 2017 (“Fixed Rate Note”). Additionally, Great Plains issued $3.0 million of Senior Secured Guaranteed Floating Rate Notes due May 3, 2014 (“Floating Rate Note”). Both notes were placed with SunLife Assurance Company of Canada (“SunLife”). Approximately $615,000 was incurred related to the debt issuance which was capitalized and are being amortized over the life of the notes.

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”). This note received approval from the PUCO on March 30, 2011. The note is governed by a Note Purchase Agreement (“NPA”). Concurrent with the funding and closing of this transaction, which occurred on May 3, 2011, the Fixed Rate Obligors signed an amended NPA that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is subject to a 50 basis point make-whole premium.

 

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The Floating Rate Note, in the amount of $3.0 million, is an obligation of Great Plains and is guaranteed by the Company (together, “the Floating Rate Obligors”). The note is priced at a fixed spread of 385 basis points over three month Libor. Pricing for this note will reset on a quarterly basis to the then current yield of three month Libor. The note is governed by a NPA. Concurrent with the funding of this transaction, which occurred on May 3, 2011, the Floating Rate Obligors signed an amended NPA that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is at par.

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 in the amount of $950,000, and replenished the Company’s treasuries for the previously announced 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 year ended December 31, 2011, the Company breached a financial covenant under the Fixed Rate Note and Floating Rate Note when the Ohio subsidiaries made restricted payments in the form of dividends to the holding company in excess of the amounts permissible. In addition, the Company did not timely notify Sun Life of certain newly-formed subsidiaries which were required to be obligors under the Fixed Rate Note and Floating Rate Note. The failure to timely notify Sun Life constituted a breach of the Fixed Rate Note and Floating Rate Note. The Company requested that Sun Life waive these breaches and amend the financial covenants.

On April 9, 2012, the Company entered into a waiver and amendment of the Fixed Rate Note and Floating Rate Note. Pursuant to the amendments, Sun Life waived its rights and remedies of the breaches of the covenants described above. The amendments also provide that any cash dividends, distributions, redemptions or repurchases of common stock may be made by the Ohio subsidiaries 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 Ohio subsidiaries 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. Currently, the Company does not expect the Ohio subsidiaries to be able to pay a dividend to holding company until the fourth quarter of 2012. The inability of the Ohio subsidiaries to pay a dividend to the holding company may impact the Company’s ability to pay a dividend to shareholders. In addition, the Company has agreed to deliver an irrevocable standby letter of credit to Sun Life in the amount of $750,000 to be drawn upon by Sun Life if and when any event of default has occurred and is continuing.

Payments for both notes prior to maturity are interest-only.

For the three months ended March 31, 2012, the weighted average interest rate on the Fixed Rate Note was 5.38%, resulting in $206,242 of interest expense. For the three months ended March 31, 2012, the weighted average interest rate on the Floating Rate Note was 4.36% resulting in $32,725 of interest expense.

The notes require that we maintain, 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, determined in accordance with GAAP. The interest coverage ratio is measured with respect to our Ohio subsidiaries on a consolidated basis and also with respect to Gas Natural and all of our subsidiaries on a consolidated basis. The notes also require that we do 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 our Ohio subsidiaries and again on a consolidated basis with respect to Gas Natural and all of our subsidiaries.

Additionally, cash dividends, distributions, redemptions or repurchases of our common stock may be made by our Ohio subsidiaries to their respective parent companies 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 our Ohio subsidiaries (determined on a consolidated basis and in accordance with GAAP) and (ii) there exists no other event of default at the time the dividend, distribution, redemption or repurchase is made.

We 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.

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.

Bank of America

At March 31, 2012, Energy West had an unsecured $30 million revolving credit facility with the Bank of America. On November 2, 2011, the Company exercised the $10 million accordion feature on the revolving credit facility with Bank of America to increase the capacity from $20 million to $30 million. The expanded credit facility changes the annual commitment fee from 0.20% to a range of 0.25% to 0.45% of the unused portion of the facility. The interest on amounts outstanding changes from the monthly London Interbank Offered Rate (“LIBOR”) plus 120 to 145 basis points for interest periods selected by Energy West (the “Bank of America Credit Facility”) to the monthly LIBOR plus 175 to 225 basis points. The other terms of the agreement remain the same, including the expiration of the facility on June 29, 2012. There are currently on-going discussions with Bank of America and the respective public service commissions to renew the credit facility.

For the three months ended March 31, 2012 and 2011, the weighted average interest rate on the facility was 3.30% and 1.64%, respectively, resulting in $125,672 and $56,780 of interest expense, respectively. The balance on the revolving credit facility was $17,651,000 and $23,160,000 at March 31, 2012 and December 31, 2011, respectively. The $17.7 million of borrowings as of March 31, 2012, leaves the remaining borrowing capacity on the line of credit at $12.3 million.

The following tables represent borrowings under the Bank of America revolving line of credit for each of the three months ended March 31, 2012 and 2011.

 

     Three Months Ended March 31,  
     2012      2011  

Minimum borrowing

   $ 16,800,000       $ 9,700,000   

Maximum borrowing

   $ 23,610,000       $ 18,150,000   

Average borrowing

   $ 20,363,000       $ 13,852,000   

At March 31, 2012 and December 31, 2011, we had $17.7 million and $23.2 million of borrowings under the Bank of America revolving line of credit. For the three months ended March 31, 2012 and 2011, the weighted average interest rate on the facility was 3.30% and 1.64%, respectively, resulting in $125,672 and $56,780 of interest expense, respectively.

The credit facility requires 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 .65-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 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 credit facility also restricts Energy West’s ability to pay dividends and make distributions, redemptions and repurchases of stock during any 60-month period to 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. 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.

Senior Unsecured Notes

On June 29, 2007, Energy West authorized the sale of $13,000,000 aggregate principal amount of its 6.16% Senior Unsecured Notes, due June 29, 2017 (the “Senior Unsecured Notes”). The proceeds of these notes were used to refinance existing notes. Approximately $463,000 was incurred related to the debt issuance which was capitalized and are being amortized over the life of the notes.

The notes contain various covenants, including a limitation on Energy West’s total dividends and distributions made in the immediately preceding 60-month period to 75% of aggregate consolidated net income for such period. The notes restrict Energy West from incurring additional senior indebtedness in excess of 60% of capitalization at any time and require Energy West to maintain an interest coverage ratio of not 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.

Yadkin Valley Bank

On February 13, 2012, Independence Oil entered into a one year, $500,000 revolving credit facility with Yadkin Valley Bank with an interest rate based on the prime rate, with a floor of 4.5% and a max of 16%. For the three months ended March 31, 2012, the weighted average interest rate on the facility was 4.50%, resulting in $8 of interest expense. The balance on the facility was $1,000 at March 31, 2012. The $1,000 of borrowings as of March 31, 2012, leaves the remaining borrowing capacity on the line of credit at $499,000.

 

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The cash flow from our business is seasonal and the line of credit balance in December normally represents the high point of borrowings in our annual cash flow cycle. Our cash flow increases and our borrowings decrease, beginning in January, as monthly heating bills are paid and the gas we paid for and placed in storage in the summer months is used to supply our customers. The total amount outstanding under all of our long term debt obligations was approximately $31.4 million at March 31, 2012, with $8,100 being due within one year.

The provisions in our debt agreements limit the amount of indebtedness we can obtain or issue, which could impact our ability to finance our operations and fund growth.

We believe we are in compliance with the financial covenants under our debt agreements or have received waivers for any defaults

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance-sheet arrangements, other than those currently disclosed that have or are reasonably likely to have a current or future effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are subject to certain market risks, including commodity price risk (i.e., natural gas prices) and interest rate risk. The adverse effects of potential changes in these market risks are discussed below. The sensitivity analyses presented do not consider the effects that such adverse changes may have on overall economic activity nor do they consider additional actions management may take to mitigate our exposure to such changes. Actual results may differ. See the Notes to our Condensed Consolidated Financial Statements for a description of our accounting policies and other information related to these financial instruments.

Commodity Price Risk

We seek to protect against natural gas price fluctuations by limiting the aggregate level of net open positions that are exposed to market price changes. We manage such open positions with policies that are designed to limit the exposure to market risk, with regular reporting to management of potential financial exposure. Our risk management committee has limited the types of contracts we will consider to those related to physical natural gas deliveries. Therefore, management believes that although revenues and cost of sales are impacted by changes in natural gas prices, our margin is not significantly impacted by these changes.

Credit Risk

Credit risk relates to the risk of loss that we would incur as a result of non-performance by counterparties of their contractual obligations under the various instruments with us. Credit risk may be concentrated to the extent that one or more groups of counterparties have similar economic, industry or other characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in market or other conditions. In addition, credit risk includes not only the risk that a counter-party may default due to circumstances relating directly to it, but also the risk that a counterparty may default due to circumstances that relate to other market participants that have a direct or indirect relationship with such counterparty. We seek to mitigate credit risk by evaluating the financial strength of potential counterparties. However, despite mitigation efforts, defaults by counterparties may occur from time to time. To date, no such default has occurred.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of March 31, 2012, 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 March 31, 2012.

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.

 

13


Table of Contents

In 2010, Bangor Gas Company, our Maine utility, asserted a claim against H.Q. Energy Services (US), Inc. (“HQ”) for a breach of a firm gas transportation service agreement between the parties. HQ filed a counterclaim against us for reimbursement of certain transportation charges that HQ paid to a third party. The Parties agreed to arbitration and on September 1, 2011, the arbitrators awarded HQ the sum of approximately $280,000 for past transportation charges that HQ paid to us. The arbitrators also ordered us to pay future transportation charges that will be incurred during the remaining term of the agreement while HQ was ordered to pay us for future fuel reimbursements for the remaining term of the agreement. On September 23, 2011, the arbitrators clarified their initial order to require HQ to reimburse us for the past transportation charges awarded by the arbitrators if the FERC determined that our payment of the transportation charges was not consistent with FERC policy. On November 10, 2011, the FERC’s Office of General Counsel issued a no-action letter indicating that the FERC staff could not assure us that the FERC would not recommend enforcement action if we made the payments to HQ required by the arbitration award. As a result, on November 30, 2011, we filed an action in the United States District Court, District of Maine against HQ seeking to vacate the arbitration award against us and confirm that portion of the award requiring HQ to return the transportation payments to us and obtain an award of past fuel reimbursements in addition to the prospective award made by the arbitrators. On March 1, 2012, the court issued an order confirming the arbitration award against us, rejecting our claim for past fuel costs, and denying our claim for reimbursement of transportation charges on the grounds that the FERC no-action letter was not a final, binding finding by the FERC of the consistency of the payments with FERC policy. On March 30, 2012, we filed an action with the United States Court of Appeals for the First Circuit appealing the district court’s decision in its entirety. We intend to vigorously pursue our claim against HQ.

On April 15, 2011, Gas Natural and Richard M. Osborne, our Chairman and CEO, filed a lawsuit captioned “Richard M. Osborne and Gas Natural Inc. v. Michael I. German, Henry B. Cook, Ted W. Gibson, George J. Welch and Corning Natural Gas Corporation,” Case No. 1:11-CV-744 which was filed in the U.S. District Court for the Northern District of Ohio. The lawsuit claims that Messrs. German, Cook, Gibson and Welch, as directors of Corning Natural Gas Corporation (“Corning”), breached their fiduciary duties to shareholders of Corning by (i) failing to maximize shareholder value in connection with our offers to acquire all of Corning’s outstanding shares of common stock and (ii) instituting a rights offering to dilute Mr. Osborne and our ownership of Corning. Alternatively, the lawsuit provides for a derivative claim against the directors of Corning for the same conduct. We and Mr. Osborne sought to rescind the rights offering. Corning and the directors of Corning filed a motion to dismiss the lawsuit. The court granted the motion to dismiss on March 23, 2012.

In a related proceeding, on August 11, 2011, we filed a lawsuit against Corning in the Supreme Court of the State of New York, County of Steuben, to inspect the corporate books and records of Corning concerning the rights offering. On February 16, 2012, the court granted in part the petition of us to inspect the corporate books and records of Corning.

In our opinion, the outcome of these legal actions will not have a material adverse effect on our financial condition, cash flows or results of operations.

 

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ITEM 6. EXHIBITS

 

Exhibit     

Number

  

Description

10.1*    Base Contract for Sale and Purchase of Natural Gas, dated April 1, 2011, between Great Plains Exploration Ltd. and Gas Natural Service Company, LLC, as amended by the Intrastate Natural Gas Sales Contract, dated April 1, 2011.
10.2*    Base Contract for Sale and Purchase of Natural Gas, dated November 25, 2011, between OsAir, Inc., and Gas Natural Service Company, LLC, as amended by the Intrastate Natural Gas Sales Contract, dated November 25, 2011.
10.3*    Base Contract for Sale and Purchase of Natural Gas, dated November 25, 2011, between John D. Resources, LLC, and Gas Natural Service Company, LLC, as amended by the Intrastate Natural Gas Sales Contract, dated November 25, 2011.
10.4*    Base Contract for Sale and Purchase of Natural Gas, dated December 28, 2011, between Mentor Energy and Resources Company and Gas Natural Service Company, LLC, as amended by the Intrastate Natural Gas Sales Contract, dated December 28, 2011.
10.5*    Base Contract for Sale and Purchase of Natural Gas, dated November 25, 2011, between John D. Oil and Gas Company and Gas Natural Service Company, LLC, as amended by the Intrastate Natural Gas Sales Contract, dated November 25, 2011.
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.

 

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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.
     

/s/ Thomas J. Smith

      Thomas J. Smith

May 14, 2012

     

Chief Financial Officer

(principal financial officer

      and principal accounting officer)

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