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Universal Energy Group Ltd. TSX: UEG 
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Aug 12, 2008 06:00 ET
Universal Energy Group Releases Third Quarter Financial Results and Operational Updates
TORONTO, ONTARIO--(Marketwire - Aug. 12, 2008) - Universal Energy Group Ltd. ("Universal Energy Group") (TSX:UEG) is pleased to announce the release of its financial results for the three and nine month period ended June 30, 2008 of its gas and electricity marketing division, Universal Energy Corporation ("Universal"), its ethanol division, Terra Grain Fuels Inc. ("TGF") and its home services division, National Home Services ("NHS").
Highlights for the third quarter ended June 30, 2008:
- Universal's operational revenue up 75% to $104.0 million; YTD up 73% to $294.6 million.
- Universal's operational margin up 74% to $18.2 million; YTD up 68% to $51.0 million.
- Universal's operational income after customer acquisition costs up 1,393% to $8.9 million; YTD up 112% to $16.9 million.
- Universal's gross customer adds of 20,149 RCEs; Attrition of 22,243 RCEs annualized to 15.2% .
- Universal's YTD net customer additions of 63,811 RCEs; Ending customer base of 427,131 RCEs.
- TGF's Belle Plaine facility commenced production on May 31, 2008.
- NHS introduced a water heater rental program. Its operations are still in the start-up phase.
- Initiation of $0.75 per common share annual dividend, payable quarterly. The first dividend payment will occur on September 30, 2008.
Universal earned revenue for the three and nine months ended June 30, 2008 of $91.5 million and $320.2 million compared to $52.4 million and $178.0 million for the 2007 period. Gross margin for the three and nine months ended June 30, 2008 was $28.2 million and $89.5 million compared to $20.8 million and $61.4 million for the 2007 period. Net income for the three and nine months ended June 30, 2008 was $27.7 million and $60.1 million compared to a loss of $22.0 million and $2.0 million for the 2007 period.
Universal uses the concepts of "operational revenue", "operational margin", "operational income before marketing costs" and "operational income after marketing costs" to adjust for the differences between revenue recognition and delivery/payment that exist in its natural gas business and for the effect of the financial swaps used in its electricity business. Please refer to our management's discussion and analysis ("MD&A") for an explanation of how these non-GAAP measures are calculated and for a reconciliation to the most comparable GAAP measures reported in Universal's financial statements for the three and nine months ended June 30, 2008.
Universal earned operational revenue for the three and nine months ended June 30, 2008 of $104.0 million and $294.6 million compared to $59.6 million and $170.5 million for the 2007 period. Operational margin for the three and nine months ended June 30, 2008 was $18.2 million and $51.0 million compared to $10.4 million and $30.4 million for the 2007 period. Operational income before customer acquisition costs for the three and nine months ended June 30, 2008 was $11.9 million and $32.4 million compared to $6.5 million and $20.4 million for the 2007 period. Operational income after customer acquisition costs for the three and nine months ended June 30, 2008 was $8.9 million and $16.9 million compared to $0.593 million and $7.9 million for the 2007 period. Universal's gross customer additions for the quarter were 20,149 RCEs. Attrition during the quarter was 22,243 RCEs (representing an annualized attrition rate of 15.2% across all markets) for a total customer base at June 30, 2008 of 427,131 RCEs.
TGF's Belle Plaine Facility commenced production on May 31, 2008. Initial production runs of Ethanol and Dried Distillers Grains revealed that a component of the plant's evaporation system was under-designed and requires an upgrade. The expense related to the upgrade is to be covered by the general contractor. Until such time as the component is installed the plant is expected to operate at 80% of design capacity.
NHS is in the start-up phase of its operations. As at June 30, 2008 NHS has installed 2,427 water heaters in residential homes and anticipates earning revenue from its installed base in Q4-2008.
With the Company's ongoing maturation and strong cash flow generation profile a quarterly cash dividend policy was approved on June 11, 2008. On an annual basis, the cash dividend is expected to be $0.75 per common share. The Company's first dividend payment of $0.1875 per common share will be paid on September 30, 2008 to shareholders of record on September 15, 2008.
Universal Energy Group's unaudited interim consolidated financial statements for the three and nine months ended June 30, 2008 and 2007 and MD&A attached hereto are part of this news release. See "Forward-looking information" and "Non-GAAP measures" in the attached MD&A for cautionary information regarding forward-looking statements and discussion of "Non-GAAP measures".
Universal Energy Group's common shares are listed on the Toronto Stock Exchange under the symbol "UEG". Universal Energy Group through its subsidiary Universal Energy Corporation, sells electricity and natural gas in Ontario and natural gas in British Columbia to residential, small to mid-size commercial and small industrial customers. Universal Energy Group through its subsidiary Universal Gas & Electric Corporation, sells natural gas in Michigan to residential, small to mid-size commercial and small industrial customers. Universal Energy Group through its subsidiary National Energy Corporation, operating under the trade name National Home Services, sells long-term water heater rental programs to Ontario residential customers. Universal Energy Group through its subsidiary Terra Grain Fuels Inc. operates an ethanol facility near Belle Plaine, Saskatchewan. Additional information about Universal Energy Group is available on SEDAR (www.sedar.com).
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Aug 12, 2008
The following management's discussion and analysis ("MD&A") of Universal Energy Group Ltd's. (the "Company") financial condition and results of operations for the three and nine months ended June 30, 2008 and 2007 should be read in conjunction with the unaudited interim consolidated financial statements for the three and nine months ended June 30, 2008 and 2007 as well as the Company's audited consolidated financial statements for the year ended September 30, 2007. The financial statements of the Company are prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"), which requires estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the amount of revenue and expenses during the reporting period. Actual results could differ from those estimates as a result of various factors, including those discussed below and elsewhere in this MD&A, particularly under "Forward-looking statements". Certain totals, subtotals and percentages may not reconcile due to rounding. Quarterly reports of, and other information related to, Universal Energy Group Ltd., is available on SEDAR at www.sedar.com.
The Company carries on business through three operating divisions. Universal Energy Corporation ("Universal"), a North American energy marketer, carries on the Company's retail natural gas and electricity marketing business. National Energy Corporation ("NEC"), operating through the trade name National Home Services ("NHS"), provides Ontario residential customers a water heater rental program. Terra Grain Fuels Inc. ("TGF"), an ethanol producer, operates a 150 million litre ethanol facility in Belle Plaine, Saskatchewan.
Forward-looking information
This MD&A contains "forward-looking statements". Statements other than statements of historical fact contained in this MD&A may be forward-looking statements, including, without limitation, management's expectations, intentions and beliefs concerning the retail electricity industry, the retail natural gas industry and the ethanol industry, the competitive landscape in these industries and the general economy, statements regarding the future financial position or results of the Company, business strategies, proposed acquisitions, growth opportunities, budgets, litigation, projected costs and plans and objectives of or involving the Company. Wherever possible, words such as "may", "would", "could", "will", "anticipate", "believe", "plan", "expect", "intend", "estimate", "aim", "endeavour", "project", "continue" and similar expressions have been used to identify these forward-looking statements. These statements reflect management's current beliefs with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, without limitation, those listed in the "Risk Factors" section of this MD&A. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this MD&A. These factors should be considered carefully and undue reliance should not be placed on the forward-looking statements. Although the forward looking statements contained in this MD&A are based upon what management currently believes to be reasonable assumptions, actual results, performance or achievements may not be consistent with these forward-looking statements. The forward-looking statements contained in this MD&A are expressly qualified in their entirety by this cautionary statement. These forward-looking statements are made as of the date of this MD&A and none of the Company, Universal, NEC, TGF, or any other party intends to, or assumes any obligation to, update or revise these forward-looking statements to reflect new events or circumstances.
Non-GAAP measures
This MD&A makes reference to certain non-GAAP measures, namely "Operational Revenue", "Operational Margin" and "Operational Income" to assist in assessing Universal's financial performance. Non-GAAP measures do not have standard meanings prescribed by GAAP and are therefore unlikely to be comparable to similar measures presented by other issuers. Universal recognizes revenue based on customer consumption, but delivers natural gas, and is paid by the local distribution companies ("LDCs") on an equal monthly basis. In addition, Universal uses financial swaps to fix its operating margins in its electricity business. These swap payments are not considered a cost of sales for accounting purposes but Universal treats them as such for business planning purposes. Accordingly, Universal uses the concepts of "Operational Revenue", "Operational Margin" and "Operational Income" to adjust for the differences between revenue recognition and delivery/payment that exist in its natural gas business and for the effect of the financial swaps used in its electricity business. For a reconciliation of Operational Revenue to revenue and Operational Margin to gross margin, see "Reconciliation of Operational Revenue and Operational Margin" in this MD&A. For a discussion of Universal's revenue recognition policies see "Critical Accounting Estimates" in this MD&A.
Selected Financial Highlights and Overall Performance of the Company
The following selected financial information has been derived from the unaudited interim consolidated financial statements of the Company for the three and nine months ended June 30, 2008 and 2007.
Three months ended Nine months ended
------------------------------------------
June 30 June 30 June 30 June 30
2008 2007 2008 2007
Consolidated Statement of Operations
Highlights $ $ $ $
------------------------------------------
(Thousands of dollars except per
share amounts)
GAAP Measures
Revenue 91,483 52,385 320,153 178,041
Gross margin 28,209 20,798 89,518 61,350
Net income/(loss) 10,853 (24,108) 27,519 (6,329)
Basic earnings/(loss) per share 0.30 (0.66) 0.76 (0.24)
Diluted earnings/(loss) per
share 0.29 (0.66) 0.74 (0.24)
Non-GAAP Measures
Operational revenue 104,017 59,607 294,605 170,493
Operational margin 18,168 10,445 51,038 30,357
Operational income before
customer acquisition costs 7,839 6,014 25,046 19,338
Operational income after
customer acquisition costs 4,560 119 9,275 6,844
June 30 September 30
2008 2007
Consolidated Balance Sheet Highlights $ $
--------------------
(Thousands of dollars)
Total assets 414,862 323,380
Long-term liabilities 188,512 111,927
The increase in revenue of 75% (YTD - 80%) and operational revenue of 75% (YTD - 73%) over the comparative quarter and year-to-date period is as a result of the continual increase in the number of gas and electricity customers moving from an enrolled to a flowing state and continued steady aggregation of gas and electricity customers with gross customer additions for this quarter of 20,149. The Ethanol and Home Services divisions are in the start-up phase of operations.
The increase in net income to $10.9 million from a loss of $24.1 million and operational income after marketing costs from $0.119 million to $4.6 million, over the comparative quarter, is the result of continued strong growth in operational margins by maintaining our operational margins per RCE at our long-term target level. In addition to the above, the net income increase is also attributed to the increase in the unrealized gain on commodity contracts.
Total assets increased from $323.4 million to $414.9 million, over the prior quarter, primarily as a result of increased cash holdings from the debenture issue, increases in accounts receivable and inventory, and ongoing fixed asset additions primarily for the ethanol and home services operations. The increase in long-term liabilities results from the debenture issue and the continuing draw down of the debt facilities relating to the construction of the ethanol plant offset by a reduction in the unrealized loss on commodity contracts.
1. Gas & Electricity Marketing Division (Universal) - Management's Discussion and Analysis
(a) Overview
Universal's business currently involves (i) the sale of electricity and natural gas in Ontario to residential, small to mid-size commercial and small industrial customers, (ii) the sale of natural gas in BC to residential, small to mid-size commercial and small industrial customers and (iii) the sale of natural gas in Michigan to residential and small to mid-size commercial and small industrial customers.
Universal's customers purchase electricity and natural gas under long-term, non-terminable (except in limited circumstances) energy contracts, typically for a term of five years. By fixing the price of natural gas under Universal's gas contracts and by obtaining price protection under its electricity contracts for a period of five years, Universal's customers eliminate or reduce their exposure to changes in natural gas and electricity prices.
It is Universal's general policy to match the estimated energy requirements of its customers by purchasing, in the case of natural gas, offsetting volumes of natural gas and, in the case of electricity, entering into offsetting electricity swaps with Sempra Energy Trading Corp. ("Sempra") at fixed prices for the term of its customers' energy contracts. Universal derives its Operational Margin from the difference between the price it pays for electricity swaps and for natural gas supply from Sempra and the price it charges its customers.
(b) Sources of Revenue
Universal earns its revenue primarily from the supply of electricity and natural gas to direct purchase customers. Universal's policy is to purchase in advance an estimate of the commodity supply required for each marketing program (either through physical supply or financial contracts). When it becomes reasonably certain that a marketing program will not exhaust the allotted commodity supply this commodity supply will generally be transferred to other marketing programs.
Universal recognizes revenue for natural gas sales based on customer consumption. Natural gas consumption by customers is typically highest in October through March and lowest in April through September. However, the natural gas delivered monthly by Universal to the LDCs in both Canada and the United States remains fairly constant throughout the year irrespective of customer consumption. As Universal receives payment from the LDCs when the natural gas is delivered, rather than consumed, this results in a reasonably predictable operational margin, unaffected by monthly fluctuations in customer consumption. For electricity, which is consumed by customers upon delivery, Universal recognizes revenue when the customer consumes the electricity and as such operational margins are highest during January through March and July through September when consumption is at its peak and lowest during April through June and October through December.
(c) Selected Consolidated Financial and Operational Data
The following selected financial information has been derived from the unaudited interim consolidated financial statements of Universal for the three and nine months ended June 30, 2008 and 2007:
Gas & Electricity Marketing
Statement of Operations Data (GAAP)
(Thousands of dollars) Three months ended Nine months ended
June 30 June 30
-----------------------------------------
2008 2007 2008 2007
$ $ $ $
-----------------------------------------
Revenue
Canada
Gas 18,530 10,758 64,746 43,897
Electricity 43,141 33,535 129,844 93,462
-----------------------------------------
Total Canada 61,671 44,293 194,590 137,359
United States
Gas 29,812 8,092 125,563 40,682
-----------------------------------------
Total revenue 91,483 52,385 320,153 178,041
-----------------------------------------
Gross Margin
Canada
Gas 3,632 2,053 10,663 8,330
Electricity 20,293 17,641 58,046 45,234
-----------------------------------------
Total Canada 23,925 19,694 68,709 53,564
United States
Gas 4,284 1,104 20,809 7,786
-----------------------------------------
Total Gross Margin 28,209 20,798 89,518 61,350
-----------------------------------------
Customer acquisition costs 3,068 5,895 15,560 12,494
General and administrative 6,244 3,956 18,628 9,920
-----------------------------------------
Total Expenses 9,312 9,851 34,188 22,414
-----------------------------------------
Realized loss on swap contracts (11,786) (11,348) (33,297) (28,094)
Financing charges - - - (51)
Amortization (269) (117) (537) (311)
Gain on sale of supply contracts 3,857 - 3,857 -
Unrealized gain/(loss) on
commodity contracts 30,977 (32,188) 66,259 (12,930)
Other (147) (318) 568 (276)
Income tax (expense)/recovery (13,876) 11,015 (32,053) 712
-----------------------------------------
Net income/(loss) for the period 27,653 (22,009) 60,127 (2,014)
-----------------------------------------
-----------------------------------------
(d) Reconciliation of Operational Revenue, Operational Margin and Operational Income
Universal recognizes natural gas revenue based on customer consumption but delivers natural gas to the LDCs in pre-determined, fixed monthly amounts and is paid for such deliveries monthly rather than upon customer consumption. In addition, Universal uses financial swaps to fix its operating margins in its electricity business. These swap payments are not included in cost of sales for accounting purposes although Universal treats them as such for business planning purposes. Accordingly, Universal uses the concepts of "operational revenue", "operational margin" and "operational income" to adjust for the differences between revenue recognition and delivery/payment that exist in its natural gas business and for the effect of the financial swaps used in its electricity business.
Operational revenue, operational margin and operational income are not earnings measures recognized by GAAP and do not have standardized meanings prescribed by GAAP. Universal's method of calculating operational revenue, operational margin and operational income may differ from the methods used by other issuers and, accordingly, Universal's operational revenue, operational margin and operational income may not be comparable to similar measures presented by other issuers. Investors are cautioned that operational revenue, operational margin and operational income should not be construed as alternatives to revenue, gross margin or net income determined in accordance with GAAP as indicators of Universal's performance or to cash flows from operating activities as measures of Universal's liquidity, cash flows or profitability. Universal believes that these are useful measures as they allow Universal to assess its ongoing business and are indicators of Universal's ability to invest in its businesses and continue operations. Universal calculates operational revenue, operational margin and operational income as follows:
Operational revenue - For natural gas, operational revenue is revenue adjusted upward by the dollar amount of "gas delivered in excess of consumption" (natural gas that has been delivered by Universal to LDCs in excess of customer consumption) and adjusted downward by the dollar amount of "gas under delivered" (natural gas that has been consumed by Universal's customers in excess of that delivered by Universal to the LDCs). For electricity, operational revenue is revenue without adjustment.
Operational margin - For natural gas, operational margin is gross margin adjusted upward for the excess of "deferred revenue" over "gas delivered in excess of consumption" or adjusted downward for the excess of "unbilled revenues" over "gas under delivered". For electricity, operational margin is gross margin adjusted upward for swap receipts (realized gain on swaps contracts) and downward for swap payments (realized loss on swap contracts), which are not included in cost of sales for accounting purposes.
Operational income before customer acquisition costs - Is operational margin reduced by general and administrative expenses but before deduction of customer acquisition costs.
Operational income after customer acquisition costs - Is operational margin reduced by customer acquisition costs and general and administrative expenses.
The effect of making the above operational adjustments to revenue and gross margin is presented below.
Gas & Electricity Marketing
Operational Revenue, Margin &
Income Three months ended Nine months ended
June 30 June 30
------------------------------------------
2008 2007 2008 2007
(Thousands of dollars) $ $ $ $
------------------------------------------
Revenue
Canada
Gas revenue 18,530 10,758 64,746 43,897
Revenue adjustment for gas
over/(under) delivered 3,388 2,616 (8,486) (6,346)
------------------------------------------
Gas operational revenue 21,918 13,374 56,260 37,551
Electricity revenue 43,141 33,535 129,844 93,462
------------------------------------------
Total Canada 65,059 46,909 186,104 131,013
United States
Gas revenue 29,812 8,092 125,563 40,682
Revenue adjustment for gas
over/(under) delivered 9,146 4,606 (17,062) (1,202)
------------------------------------------
Gas operational revenue 38,958 12,698 108,501 39,480
------------------------------------------
Total operational revenue 104,017 59,607 294,605 170,493
------------------------------------------
Operational Margin
Canada
Gas gross margin 3,632 2,053 10,663 8,330
Margin adjustment for gas
over/(under) delivered 535 234 (1,486) (1,476)
------------------------------------------
Gas operational margin 4,167 2,287 9,177 6,854
Electricity gross margin 20,293 17,641 58,046 45,234
Realized loss on swap contracts (11,786) (11,348) (33,297) (28,094)
------------------------------------------
Electricity operational margin 8,507 6,293 24,749 17,140
Total Canada 12,674 8,580 33,926 23,994
United States
Gas gross margin 4,284 1,104 20,809 7,786
Margin adjustment for gas
over/(under) delivered 1,209 760 (3,697) (1,424)
------------------------------------------
Gas operational margin 5,493 1,864 17,112 6,362
------------------------------------------
Total operational margin 18,167 10,444 51,038 30,356
------------------------------------------
Customer acquisition costs 3,068 5,895 15,560 12,494
General and administrative 6,244 3,956 18,628 9,920
------------------------------------------
Operational income after customer
acquisition costs 8,855 593 16,850 7,942
------------------------------------------
------------------------------------------
The following operational data for the three and nine months ended June 30,
2008 and 2007 has been prepared by management based on Universal's records.
Selected Operational Three months ended June 30 Nine months ended June 30
Data ------------------------------------------------------
2008 2007 2008 2007
------------------------------------------------------
Operational margin
per unit (dollars)
Canada - Gas
(Cdn$/m3) 0.0784 0.0704 0.0657 0.0769
Canada - Electricity
(Cdn$/kWh) 0.0180 0.0173 0.0171 0.0168
United States - Gas
(US$/Mcf) 1.4722 1.5656 1.6543 1.7051
United States - Gas
(Cdn$/m3) 0.0531 0.0607 0.0588 0.0682
Operational margin
per RCE (dollars)
Canada - Gas 220.70 198.18 184.95 216.47
Canada - Electricity 180.00 173.00 171.00 168.00
United States - Gas 150.27 159.96 166.45 193.13
Delivered Volume
Canada - Gas (m3) 53,169,517 32,492,494 139,699,959 89,158,643
Canada - Electricity
(kWh) 473,661,631 363,523,505 1,444,508,260 1,018,819,061
United States - Gas
(Mcf) 3,655,494 1,165,327 10,280,583 3,294,225
Consumed Volume
Canada - Gas (m3) 44,648,628 25,887,540 160,172,754 104,374,527
Canada - Electricity
(kWh) 473,661,631 363,523,505 1,444,508,260 1,018,819,061
United States - Gas
(Mcf) 2,798,304 801,488 11,891,515 3,411,676
Note:
"RCE" means a residential customer equivalent, which is a unit of
measurement equivalent to 10,000 kWh of electricity on an annual basis or
2,815 m3 of natural gas on an annual basis, which quantities management
believes to represent the approximate amounts of electricity and natural gas
used annually by a typical residential customer.
(e) Results of Operations
Three and nine months ended June 30, 2008 compared to three and nine months ended June 30, 2007
(i) Revenue and Margin - Canada
Universal continues to experience continued strong growth in revenue and operational margin as the number of flowing customers increase with each successive reporting period. This is clearly demonstrated by the continuing significant increases in the current period financial ratios in comparison to prior periods.
For the three and nine months ended June 30, 2008 Canadian natural gas revenue was $18.5 million and $64.7 million, up 72% and 47.5% from the prior comparable period of $10.8 million and $43.9 million. Canadian natural gas for the quarter accounted for 20.3% of total revenue on customer consumption of 44.6 million m3 of natural gas. Gross margin for the quarter was $3.6 million, an increase of 77% from the prior comparative quarter. Gross margin for the nine months ended June 30, 2008 was $10.7 million, an increase of 28.0% from the prior comparative period.
Gas operational revenue for the three and nine months ended June 30, 2008 was $21.9 million and $56.3 million, up 64% from $13.4 million and 49.8% from $37.6 million in the prior comparable periods on delivered volume of 53.2 million m3 and 139.7 million m3. Gas operational margin for the three and nine months ended June 30, 2008 was $4.2 million and $9.2 million, an increase of 82% and 33.9% from the prior comparable period. This resulted in a unit operational margin for the quarter of $0.0784 or $220.70 per RCE and for the nine months ended June 30, 2008 a unit operational margin of $0.0657 or $184.95 per RCE. The increase in the gas operational margin this quarter compared to the immediately preceding quarter is primarily as a result of time limited discounts offered to gas customers coming to an end and such customers now reverting to the full contracted selling price.
For the three and nine months ended June 30, 2008 Canadian electricity revenue was $43.1 million and $129.8 million, up 28.6% from $33.5 million and 38.9% from $93.5 million in the prior comparable periods. Canadian electricity for the quarter accounted for 47.2% of total revenue on customer consumption of 473.7 million kWh. Gross margin for the three and nine months ended June 30, 2008 was $20.3 million and $58.0 million, an increase of 15.0% from $17.6 million and 28.3% from $45.2 million in the prior comparable periods.
As required by GAAP, the electricity gross margin has not been reduced by swap payments totaling $11.8 million for the quarter and $33.3 million for the nine months ended June 30, 2008. The electricity operational margin, which adjusts for swap payments, for the three and nine months ended June 30, 2008 was $8.5 million and $24.7 million, up 35.2% from $6.3 million and 44.4% from $17.1 million in the prior comparable periods. This resulted in a unit operational margin for the quarter of $0.0180 per kWh or $180.00 per RCE and for the nine months ended June 30, 2008 of $0.0171 per kWh or $171.00 per RCE. The increase in the electricity operational margin this quarter compared to the immediately preceding quarter is primarily as a result of time limited discounts offered to electricity customers coming to an end and such customers now reverting to the full contracted selling price.
(ii) Revenue and Margin - United States
For the three and nine months ended June 30, 2008 U.S. natural gas revenue was $29.8 million and $125.6 million, up 268% from $8.1 million and 209% from $40.7 million in the prior comparable periods. U.S. natural gas for the period accounted for 32.6% of total revenue on customer consumption of 2.8 million Mcf of natural gas. Gross margin for the three and nine months ended June 30, 2008 was $4.3 million and $20.8 million, up 288% from $1.1 million and 167% from $7.8 million in the prior comparable periods.
Gas operational revenue for the three and nine months ended June 30, 2008 was $39.0 million and $108.5 million, up 207% from $12.7 million and 175% from $39.5 million in the prior comparable periods. Operational margin for the three and nine months ended June 30, 2008 was $5.5 million and $17.1 million, up 195% from $1.9 million and 169% from $6.4 million in the prior comparable periods. This resulted in a unit operational margin for the quarter of $1.5029 per Mcf ($0.0531 per m3) or $150.29 per RCE and for the nine months ended June 30, 2008 of $1.6645 per Mcf ($0.0588 per m3) or $166.45 per RCE. This decline in gas margin per RCE is substantially offset by the gain of $3.9 million realized on the sale of excess gas supply previously procured for the Michigan market.
(iii) Revenue and Margin - Combined
On a combined basis (Canada and the United States), Universal's total revenue earned for the three and nine months ended June 30, 2008 was $91.5 million and $320.2 million, up 75% from $52.4 million and 80% from $178.0 million in the prior comparable period. Gross margin for the three and nine months ended June 30, 2008 was $28.2 million and $89.5 million, up 35.6% from $20.8 million and 45.9% from $61.4 million in the prior comparable periods.
Total operational revenue earned for the three and nine months ended June 30, 2008 was $104.0 million and $294.6 million, up 75% from $59.6 million and 73% from $170.5 million in the prior comparable periods. Operational margin for the three and nine months ended June 30, 2008 was $18.2 million and $51.0 million, up 74% from $10.4 million and 68% from $30.4 million in the prior comparable periods.
(iv) Selling, General and Administrative Expenses - Combined
Customer acquisition costs are commissions paid to independent sales agents for enrolling new customers, direct mail marketing costs and other direct selling expenses. For the three and nine months ended June 30, 2008 these costs amounted to $2.7 million and $14.1 million excluding direct mail marketing costs and $3.1 million and $15.6 million including direct mail marketing costs. For the prior comparable period, customer acquisition costs were $5.3 million and $11.6 million excluding direct mail marketing costs and $5.9 million and $12.5 million including direct mail marketing costs. Universal's sales and marketing programs take a North American focus and program costs incurred are for the benefit of both the Canadian and US markets. For the three and nine months ended June 30, 2008 the average acquisition cost excluding direct mail costs was $136 per RCE and $114 per RCE and including direct mail costs was $152 per RCE and $127 per RCE.
General and administrative expense for the three and nine months ended June 30, 2008 amounted to $6.2 million and $18.6 million. The significant components of general and administrative expenses for the three and nine months ended June 30, 2008 are processing charges (principally LDC processing and other third party processing and data entry fees) - $.667 million and $2.1 million, salaries and benefits - $2.7 million and $8.7 million, consulting (principally for management services and systems development) - $0.328 million and $1.1 million and rent - $0.247 million and $0.708 million, together totaling $3.9 million and $12.6 million and accounting for 73% of general and administrative expenses on a year-to-date basis.
(v) Other Income/(Expense)
The realized loss on swap contracts of $11.8 million and $33.3 million are payments made under electricity swap contracts during the three and nine months ended June 30, 2008. The non-cash unrealized gain on commodity contracts of $31.0 million and $66.3 million recognized in income arises from the quarterly marked to market revaluation of the electricity swaps and results from the narrowing of the spread between the fixed and variable electricity swap prices compared to the immediately preceding quarterly revaluation. See "Financial Instruments" in this MD&A. The gain on sale of gas supply of $3.8 million resulted from the sale of excess gas previously procured for the Michigan market.
(f) Customer Aggregation
The following table summarizes Universal's customer aggregation in the Canadian and United States markets for the three and nine months ended June 30, 2008.
Opening Addi- Closing
RCEs tions Addi- Addi- Total RCEs
Sep 30, Q1 tions tions Addi- Attri- Jun 30,
2007 2008 Q2 2008 Q3 2008 tions tion 2008
-------------------------------------------------------------
Canada - Gas 69,774 11,911 11,053 6,664 29,628 (8,598) 90,804
Canada -
Electricity 183,725 19,505 14,497 9,725 43,727 (20,786) 206,666
-------------------------------------------------------------
Total Canada 253,499 31,416 25,550 16,389 73,355 (29,384) 297,470
United
States - Gas 109,821 32,629 13,182 3,760 49,571 (29,731) 129,661
-------------------------------------------------------------
Combined 363,320 64,045 38,732 20,149 122,926 (59,115) 427,131
-------- -----------------
---------------- -----------------
Less:
Attrition (14,731) (22,141) (22,243) (59,115)
-----------------------------------
Net new RCE
additions 49,314 16,591 (2,094) 63,811
-----------------------------------
Cumulative
net RCEs 412,634 429,225 427,131 427,131
-----------------------------------
-----------------------------------
Total additions for the nine months ended June 30, 2008 amounted to 122,926 RCEs. Canadian gas additions accounted for 6,664 RCEs or 33.1% of additions for the quarter. Canadian electricity additions accounted for 9,725
RCEs or 48.3% of additions for the quarter. In total, Canadian additions accounted for 16,389 RCEs or 81% of additions for the quarter. United States gas additions accounted for 3,760 RCEs or 18.7% of additions for the three months ended June 30, 2008.
Combined attrition for all markets over the three months ended June 30, 2008 amounted to 22,243 RCEs or 15.2% on an annualized basis. The Canadian market experienced annualized attrition of 12.2% and the United States market experienced annualized attrition of 21.4% . Largely as the result of negative media coverage, increased customer complaint levels over this winter's heating season have led to a review of UGE's sales and marketing practices by the Michigan Public Service Commission ("MPSC"). US attrition in the past two quarters have exceeded management's forecasts, however, management forecasts that attrition levels will return to usual levels once the effects of the negative media coverage subside. Universal has been able to substantially offset the financial impact of the higher United States attrition by realizing a gain of $3.8 million on the saleback of excess gas previously procured for the Michigan market. In response to both Universal's and the MPSC staff's request, the MPSC ordered a unified contested hearing to review complaints and concerns raised by Universal and MPSC staff. Universal continues to monitor all markets to minimize attrition and follows a policy of diligently enforcing collection of liquidated damages from customers attempting to exit their contracts.
At June 30, 2008 our total customer base amounted to 427,131 RCEs, net of attrition. Geographically, Canada accounts for 69% of total RCEs and the United States accounts for 30.4% of total RCEs. In Canada, residential customers account for 73% of RCEs and commercial customers account for 27.2% of RCEs. In the United States, residential customers account for 69% of RCEs and commercial customers account for 31.3% of RCEs. On a product distribution basis, gas customers account for 52% of total RCEs and electricity customers account for 48.4% of total RCEs.
2. Ethanol Division (TGF) - Management's Discussion and Analysis
(a) Overview
The Belle Plaine Facility commenced production on May 31, 2008, and is now ramping up to performance guarantee levels at which time the contractor group will have completed its onsite activities. Initial production runs of Ethanol and Dried Distillers Grains ("DDG") revealed that a component of the plant's evaporation system was under-designed and requires an upgrade. The expense related to the upgrade is to be covered by the general contractor. Until such time as the component is installed the plant is expected to operate at 80% of design capacity. The plant was successful in producing ethanol that met Canadian industry sales standards as well as DDG during the initial production runs.
(b) Selected Financial Information
(Unaudited - thousands of dollars) Three months Nine months
ended ended
June 30, 2008 June 30, 2008
Investment income $465 $1,242
------------------------------
General and administrative 3,259 5,905
Financing charges 112 424
Amortization of property, plant and equipment 36 97
Realized loss on commodity contracts 2,470 4,313
Unrealized loss on commodity contracts 14,585 26,405
Future taxes (6,104) (10,666)
------------------------------
Net loss $(13,893) $(25,236)
------------------------------
------------------------------
(c) Results of Operations
Total construction costs incurred to June 30, 2008 amounted to $143.8 million, net of investment tax credits. For the three and nine months ended June 30, 2008 TGF realized a net loss of $13.9 million and $25.2 million. For the three and nine months ended June 30, 2008 TGF incurred financing charges of $0.112 million and $0.424 million on wheat growers' loan obligations, and general and administrative expenses of $3.3 million and $5.9 million which relate primarily to compensation and other administration costs. The unrealized loss on commodity contracts arises from the marked to market valuation of the remaining notional volumes of the crude oil hedges and swaps. This represents the estimated amount that TGF would have to pay to settle these commodity contracts in the market if the hedges and swaps were to be terminated at June 30, 2008. See "Financial Instruments" in this MD&A.
3. Home Services Division (NHS)
(a) Overview
In April 2008 the Company entered the home services market through NEC operating under the trade name National Home Services. NHS provides Ontario residential customers a water heater rental program offering conventional and power vented tanks in a variety of sizes. Funding for NHS is currently being provided from the Company's existing cash resources. NHS is in the start-up phase of its operations. As at June 30, 2008 NHS has installed 2,427 water heaters in residential homes and anticipates earning revenue from its installed base in Q4-2008.
(b) Selected Financial Information
Three months Nine months
(Unaudited - thousands of dollars) ended ended
June 30, 2008 June 30, 2008
-------------------------------
Customer acquisition costs 210 210
General and administrative 364 364
Amortization 26 26
Future taxes (195) (195)
-------------------------------
Net loss $(405) $(405)
-------------------------------
-------------------------------
(c) Results of Operations
For the three and nine months ended June 30, 2008 NHS realized a net loss of $0.405 million. The customer acquisition costs relate to sales commissions paid to independent agents. General and administrative expenses relate primarily to staff compensation, advertising and uniforms and interest expense.
4. Summary of Quarterly Results
The following selected financial information has been derived from the interim unaudited consolidated financial statements of the Company for each of the eight most recently completed quarters.
(Thousands of dollars) 2008 2008 2008 2007
Q3 Q2 Q1 Q4
$ $ $ $
------------------------------------------
GAAP Measures
Revenue 91,483 148,568 80,102 49,338
Gross margin 28,209 36,467 24,842 20,783
Net income/(loss) 10,853 18,170 (1,504) (17,915)
Basic earnings/(loss) per share 0.30 0.50 (0.04) (0.49)
Diluted earnings/(loss) per share 0.29 0.49 (0.04) (0.49)
Non-GAAP Measures
Operational revenue 104,017 103,039 87,549 72,805
Operational margin 18,168 17,611 15,260 13,734
Operational income before
marketing costs 7,839 9,301 8,981 7,565
Operational income/(loss) after
marketing costs 4,560 4,497 663 (700)
2007 2007 2007 2006
Q3 Q2 Q1 Q4
GAAP Measures $ $ $ $
------------------------------------------
Revenue 52,385 79,085 46,571 28,248
Gross margin 20,798 22,047 18,505 11,891
Net income/(loss) (24,108) 10,983 6,796 (22,881)
Basic earnings/(loss) per share (0.66) 0.38 0.44 (1.49)
Diluted earnings/(loss) per share (0.66) 0.38 0.44 (1.49)
Non-GAAP Measures
Operational revenue 59,607 58,966 51,920 38,366
Operational margin 10,445 10,246 9,664 7,719
Operational income before
marketing costs 6,014 6,598 6,591 4,670
Operational income/(loss) after
marketing costs 119 3,570 3,138 (480)
The Company's gas and electricity operations are seasonal. Natural gas consumption by customers is typically highest in Q1 (fall) and Q2 (winter) and lowest in Q3 (spring) and Q4 (summer). Electricity consumption is typically highest in Q2 (winter) and Q4 (summer) and is lowest in Q1 (fall) and Q3 (spring). While year over year quarterly comparisons are appropriate, comparison of sequential quarters is affected by seasonality.
Analysis of the Third Quarter - Q3 2008
The increase in revenue of 75% and operational revenue of 75% over the prior comparable quarter is as a result of the continual increase in the number of customers moving from an enrolled to a flowing state. The Ethanol and Home Services divisions are in the start-up phase of operations and no revenues were earned in this quarter.
The increase in net income to $10.9 million from the prior comparable quarter of a loss of $24.1 million and operational income to $4.5 million from the prior comparable quarter of $0.119 million is primarily the result of continued strong growth in operational margins by maintaining our operational margins per RCE at our long-term target level. The net income increase is also the result of the increase in the unrealized gain on commodity contracts.
5. Liquidity and Capital Resources
At June 30, 2008 the Company had cash of $93.0 million of which $8.0 million is restricted cash. Excluding restricted cash, accounts payable to be paid from the proceeds of long-term debt, future taxes and the current portion of the unrealized loss on commodity contracts, the Company had net working capital of $109.4 million. In addition to its cash resources, the Company has credit facilities amounting to $5.0 million available to Universal for trade financing on commodity purchases and approximately $100.0 million available to TGF to be used primarily toward the ethanol plant construction and wheat growers advances. As at June 30, 2008, $79.2 million was drawn against the TGF credit facilities. As the number of Universal customers moving from an enrolled to flowing state continue to increase, Universal will start to receive larger amounts of cash from the underlying margins on these contracts and this will further contribute to the Company's cash resources.
(a) Cash Flows from Operating Activities
Cash provided by operations for the three months ended June 30, 2008 amounted to $10.3 million and used $15.8 million for the nine months ended June 30, 2008 compared to cash provided by operations of $11.6 million and $31.8 million in the prior comparable periods. This is primarily due to an increase in gas under delivered, increases in grain inventory plus normal increases in trade receivables and accounts payable resulting from our increasing customer base.
(b) Cash Flows Used in Investing Activities
Cash used in investing activities for the three and nine months ended June 30, 2008 amounted to $3.9 million and $34.5 million compared to $32.8 million and $155.3 million in the prior period. The investing activities relate to the continuing costs of constructing the ethanol plant.
(c) Cash Flows from Financing Activities
During the nine months ended June 30, 2008 the Company completed a convertible debenture issue for net proceeds of $86.7 million and made further draws on the TGF credit facilities of $34.8 million for the ethanol plant construction.
(d) Long-Term Liabilities
The unrealized loss on commodity contracts of $69.8 million (current portion - $31.2 million) is the estimated amount that Universal and TGF would pay as at June 30, 2008 to dispose of these contracts in the market. These liabilities are marked to market and any changes to the fair value are recorded in other income/(expense). See "Financial Instruments" in this MD&A for further details. The long-term debt of $162.5 million (current portion - $12.7 million) includes $40 million of advances under the TGF debenture facility and $39.2 million of advances under the TGF $50 million credit facility. These funds are specifically used towards the ethanol plant construction. The wheat production financing of $5.1 million relates to advances made by TGF to the wheat growers under contract. Also included in long-term debt is the liability portion of the convertible debenture issue of $78.3 million.
(e) Contractual Obligations
In the normal course of business, the Company is obligated to make future payments under various non-cancellable contracts and other commitments. The payments due by period are set out in the following table.
(Thousands of dollars)
Remainder After
Contractual obligations Total of year 1 1-3 years 4-5 years 5 years
----------------------- ----------------------------------------------
Financing facilities 162,507 4,977 20,920 17,997 118,613
Premises and vehicles under
lease 4,096 380 2,460 1,136 120
Natural gas purchase
commitments 667,521 50,989 358,179 242,946 15,407
EPC and Delta-T contracts 2,508 2,508 - - -
Production contracts 42,647 10,893 31,754 - -
----------------------------------------------
Total 879,279 69,747 413,313 262,079 134,140
----------------------------------------------
For a description of the Company's obligations under electricity swap contracts and other hedging instruments see "Financial Instruments" in this MD&A.
(f) Debenture Offering
On October 2, 2007, the Company issued convertible unsecured subordinated debentures with a face value of $90.0 million. The debentures mature on September 30, 2014 unless converted prior to that date and bear interest at an annual rate of 6% payable semi-annually on March 31 and September 30 of each year. Each $1,000 principal amount of the debentures is convertible at any time prior to maturity or on the date fixed for redemption, at the option of the holder, into approximately 41.67 common shares of the Company representing a conversion price of $24.00 per common share. During the three and nine months ended June 30, 2008 interest expense amounted to $1.3 million and $4.0 million.
The debentures are not redeemable prior to October 1, 2010. On and after October 1, 2010, but prior to September 30, 2012, the debentures are redeemable, in whole or in part, at a price equal to the principal amount thereof, plus accrued and unpaid interest, at the Company's sole option on not more than 60 days and not less than 30 days prior notice, provided that the current market price on the date on which notice of redemption is given is not less than 125% of the conversion price. On and after September 30, 2012, but prior to the maturity date, the debentures are redeemable, in whole or in part, at a price equal to the principal amount thereof, plus accrued and unpaid interest, at the Company's sole option on not more than 60 days and not less than 30 days prior notice.
The conversion feature of the debenture has been accounted for as a separate component of shareholders' equity in the amount of $9.5 million. The remainder of the net proceeds of the debenture of $77.2 million has been recorded as long-term debt, which will be accreted up to the face value of $90.0 million over the term of the debenture. Accretion and interest paid are recorded as finance charges on the consolidated statement of operations. If the debentures are converted into common shares, the value of the conversion feature will be reclassified to share capital along with the principal amount converted.
(Thousands of dollars) $
----------------------------------------------------------------------------
Convertible debentures initially recognized, less issue costs of
$3,304 77,189
Accretion to June 30, 2008 1,063
----------------------------------------------------------------------------
Balance as at June 30, 2008 78,252
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(g) Additional Capital Disclosure
The Company continues to optimize its capital structure with a view to ensuring a strong financial position to support its growth strategies. The capital structure of the Company is as follows:
June 30 September 30
2008 2007 Change
(Thousands of dollars) $ $ %
----------------------------------------------------------------------------
Total shareholders' equity 132,976 92,595 44%
----------------------------------------------------------------------------
Total shareholders' equity as a % of
total capital 45% 65%
Short-term debt 12,650 7,860
Long-term debt 149,857 41,601
----------------------------------------------------------------------------
Total debt 162,507 49,461 229%
----------------------------------------------------------------------------
Total debt as a % of total capital 55% 35%
----------------------------------------------------------------------------
Total capital 295,483 142,056 108%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Equity is defined as share capital, contributed surplus, equity component of convertible debenture and deficit. During the nine months ended June 30, 2008, total equity increased by $40.4 million to $133.0 million. The increase resulted from the equity component of the convertible debenture in the amount of $9.5 million, amortization of stock option and RSU compensation expense of $3.1 million, exercise of stock options in the amount of $0.291 million and a net income for the period of $27.5 million.
Total debt increased during the nine months ended June 30, 2008 by $113.0 million to $162.5 million. The increase resulted from the convertible debenture issue, which had a period end carrying value of $78.3 million, draw downs on the TGF credit facility in the amount of $37.4 million and offset by repayments of the wheat production facility in the amount of $2.6 million.
The Company is not subject to any statutory requirements or any other externally imposed capital requirements. Commitments exist to issue common shares in connection with established stock option and RSU compensation plans with such share issuances to occur from treasury.
6. Related Party Transactions and Balances
During the three and nine months ended June 30, 2008, the Company entered into various transactions with related parties as follows:
(a) Universal has entered into the following agreements with Sempra, a significant shareholder of the Company:
(i) Gas purchase agreements
Universal entered into the natural gas purchase and sale agreement with Sempra on July 14, 2005 (amended and restated February 2, 2007). On February 2, 2007 UGE and Sempra also entered into an agreement pursuant to which Sempra supplies natural gas to UGE in connection with UGE's gas marketing business in Michigan ("Gas Purchase Agreements"). Pursuant to the Gas Purchase Agreements, Universal engaged Sempra to act as Universal's exclusive supplier of natural gas, subject to certain limited circumstances.
Universal's obligations to Sempra under the Gas Purchase Agreements are secured by the grant of a first priority security interest on substantially all of Universal's current and future assets, including all cash and cash equivalents, all accounts receivable and all deposit accounts. In addition, all payments received by Universal from its customers and the LDCs are paid to a specified lockbox or by wire transfer to specified Universal blocked bank accounts under the control of Sempra, from which amounts are first paid to Sempra in satisfaction of payments due to Sempra under the Gas Purchase Agreements, and all excess amounts are then paid to Universal.
If Sempra defaults in its obligations to deliver natural gas to Universal, or if Universal defaults in its obligation to accept delivery of natural gas, subject to force majeure, the Gas Purchase Agreements contain provisions requiring the payment of various amounts by the non-performing party to the performing party.
During the three and nine months ended June 30, 2008, Universal made natural gas purchases under the agreements totaling $51.2 million (2007 - $22.0 million) and $139.1 million (2007 - $63.6 million). Included in accounts payable at June 30, 2008 is an amount owing of $16.1 million.
(ii) Electricity swap agreement
Universal entered into an electricity swap master agreement ("Electricity Swap Agreement") with Sempra on July 14, 2005 (amended and restated February 2, 2007). Pursuant to the Electricity Swap Agreement, Universal engaged Sempra to act as Universal's exclusive supplier of electricity swaps.
Universal's obligations to Sempra under the Electricity Swap Agreement are secured by the grant of a first priority security interest on substantially all of Universal's current and future assets, including all cash and cash equivalents, all accounts receivable and all deposit accounts. In addition, all payments received by Universal from its customers and the LDCs are paid to a specified lockbox or by wire transfer to specified Universal blocked bank accounts under the control of Sempra, from which amounts are first paid to Sempra in satisfaction of payments due to Sempra under the Electricity Swap Agreement, and all excess amounts are then paid to Universal.
Upon the occurrence of a contract termination event, the non-defaulting party has the right to immediately, for so long as the contract termination event is continuing: suspend its performance under electricity swaps then outstanding; or liquidate and terminate the electricity swaps then outstanding and accelerate the payment of any amounts due. Upon any such liquidation and termination, the non-defaulting party must calculate a net settlement amount in accordance with the formula contained in the Electricity Swap Agreement. The party with the net settlement amount payment obligation must pay such amount to the other party within one business day of receipt from the non-defaulting party of notice of such calculation.
During the three and nine months ended June 30, 2008, Universal made net settlement payments under the electricity swap agreements totaling $11.8 million (2007 - $11.3 million) and $33.3 million (2007 - $28.1 million). Included in accounts payable as at June 30, 2008 is an amount owing of $2.5 million.
In addition, the Gas Purchase Agreements and the Electricity Swap Agreement contain financial margin requirements that commence on February 2, 2009 as well as other covenants. These agreements terminate on June 30, 2010. As at June 30, 2008 the balance in the blocked account which is included in restricted cash amounted to $3.0 million.
(b) During the three and nine months ended June 30, 2008, Universal incurred expenses amounting to $0.306 million (2007 - $0.393 million) and $0.782 million (2007 - $0.568 million) for direct mail marketing services to Market Connections Inc. in which certain officers and directors hold an equity interest. Included in accounts payable as at June 30, 2008 is an amount owing of $0.09 million.
(c) TGF has entered into a credit support agreement with Vertex Oil & Gas Ltd., a company controlled by an officer and director, which allows TGF to enter into hedges and swaps to mitigate risk exposure to the volatility of ethanol pricing while the Belle Plaine Facility is under construction. The credit support facility will be phased out shortly after the plant is commissioned and operational. Included in accounts payable as at June 30, 2008 is an amount owing of $2.7 million.
These transactions were conducted in the normal course of business on terms and rates agreed to by the Company and the related parties.
7. Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management of the Company to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. These estimates are based on assumptions and judgments that may be affected by commercial, economic and other factors. Actual results could differ from those estimates. The following assessment of critical accounting estimates is not meant to be exhaustive.
Fair value of derivative financial instruments
Universal enters into contracts with customers to provide electricity at fixed prices. These contracts expose Universal to changes in market prices to supply these commodities. To reduce the exposure to the commodity market price changes, Universal uses derivative financial contracts to secure fixed prices in respect of commodity supply matching its delivery obligations. Universal will hedge the estimated consumption requirements of its customers with offsetting volumes of electricity at fixed prices for terms equal to those of the customer contracts. The valuation of electricity contracts requires judgment and is based on market prices or management's best estimates if there is no market and/or if the market is illiquid.
The fair value of Universal's derivative financial instruments (which is currently limited to electricity swaps) is significantly influenced by the variability of forward spot prices for electricity. Period to period changes in forward spot prices for electricity could cause significant changes in the marked to market valuation of these derivatives. This accounting estimate was first implemented for the year ended September 30, 2006.
TGF has entered into crude oil hedges and swaps to mitigate the risk exposure of the company to the volatility of ethanol pricing while the Belle Plaine Facility is under construction. The fair value of TGF's hedges and swaps is influenced by the variability of forward spot prices for West Texas Intermediate ("WTI") traded on NYMEX. Period to period changes in forward spot prices for WTI could cause significant changes in the marked to market valuation of these derivatives. This accounting estimate was first implemented for the period ended September 30, 2007.
8. Controls and Procedures
(a) Disclosure Controls and Procedures
Management has designed disclosure controls and procedures, as defined by Multilateral Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filing ("MI 52-109"), to provide reasonable assurance that material information relating to the Company, including its consolidated subsidiaries, is made known to the President, Electricity and Gas Marketing, in the capacity of Chief Executive Officer for these purposes ("CEO") and the Chief Financial Officer ("CFO") by others within those entities, particularly during the period in which the interim filings are being prepared.
(b) Internal Control over Financial Reporting
There have been no changes in the Company's internal controls over financial reporting, as defined under MI 52-109, that occurred during the three months ended June 30, 2008, that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
(c) Limitations on the Effectiveness of Disclosure Controls and Internal Control over Financial Reporting
The Company's management, including the CEO and CFO, do not expect that the Company's disclosure controls and procedures and internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. The inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by individual acts of some persons, by collusion of two or more people or by management override of the controls. Due to the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
9. Changes in Accounting Policies and Recent Accounting Pronouncements
Effective October 1, 2007, the Company adopted the recommendations of the CICA Handbook Section 1535, "Capital Disclosures", which requires disclosure of information related to the objectives, policies and processes for managing capital. In addition, the disclosures include whether externally imposed capital requirements have been complied with. The new standard is effective for fiscal years beginning on or after October 1, 2007 and as this standard only addresses disclosure requirements, there is no impact on the Company's operating results.
Effective October 1, 2007, the Company adopted the recommendations of the CICA Handbook Sections 3862, "Financial Instruments Disclosures" and Section 3863, "Financial Instruments - Presentation", which replaces Section 3861 "Financial Instruments - Disclosure and Presentation". The new disclosure standards increase the emphasis on the risks associated with both recognized and unrecognized financial instruments and how those risks are managed. The new presentation standards carry forward the former presentation requirements and are effective for years beginning on or after October 1, 2007. As these standards only address presentation and disclosure requirements, there is no impact on the Company's operating results.
In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. The AcSB has recently confirmed that accounting standards in Canada for public companies are to converge with International Financial Reporting Standards ("IFRS") effective for fiscal periods beginning on or after January 1, 2011. The Company continues to monitor and assess the impact of the convergence of Canadian GAAP and IFRS.
In February 2008, the CICA issued Handbook Section 3064, "Goodwill and Intangible Assets". Section 3064 states that upon their initial identification, intangible assets are to be recognized as assets only if they meet the definition of an intangible asset and the recognition criteria. This section also provides further information on the recognition of internally generated intangible assets (including research and development costs). As for subsequent measurement of intangible assets, goodwill, and disclosure, Section 3064 carries forward the requirements of the old Section 3062, "Goodwill and Other Intangible Assets". The new section will become effective on January 1, 2009. The Company is currently evaluating the effect of the adoption of this new section on the consolidated financial statements.
10. Financial Instruments
(a) Fair value
(i) Universal has entered into contracts with customers to provide electricity at fixed prices ("customer electricity contracts"). The customer electricity contracts expose Universal to changes in market prices of electricity and consumption levels as Universal is obligated to pay the LDCs the floating rate for electricity supplied by the LDCs to Universal's customers. To reduce its exposure to changes in commodity prices arising from the acquisition of electricity at floating or indexed rates, Universal uses electricity derivative financial contracts ("electricity derivative contracts"). These electricity derivative contracts are fixed-for-floating swaps whereby Universal agrees with a counterparty to cash settle the difference between the floating or indexed price and the fixed price on a notional quantity of electricity for a specified time frame. The cash flow from these contracts is expected to be effective in offsetting Universal's electricity price exposure and serves to fix Universal's acquisition cost of electricity to be delivered under the fixed price customer contracts. The fair value of derivative financial instruments is the estimated amount that Universal would pay or receive to settle these supply contracts in the market. Universal has estimated the value of these contracts using a discounted cash flow method which employs market forward curves.
At June 30, 2008, Universal had electricity fixed-for-floating swap contracts to which it has committed with the following terms:
(Thousands of dollars except where indicated)
----------------------------------------------------------------------------
Notional volumes 2.0 to 40.0 MW/h
Total remaining notional volume 6,266,880 MWh
Maturity dates July 1, 2008 to February 28, 2013
Fixed price ($/MWh) $57.94 to $80.50
Fair value $39,713 unfavourable
Remaining notional value $445,918
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(ii) TGF has entered into hedges and swaps to mitigate risk exposure to changes in ethanol pricing while the Belle Plaine Facility is under construction. At June 30 2008, TGF had hedges and swaps to which it had committed with the following terms:
(Thousands of dollars except where indicated)
----------------------------------------------------------------------------
Notional volumes - Owned puts 500 to 1,000 bbl/d
Total remaining notional volume 550,000 bbl
Maturity dates July 1, 2008 to December 31, 2009
Option Strike Price (US$/bbl) $55.00 to $65.00
Fair value $13 favourable
Remaining notional value $34,981
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Notional volumes - Sold calls 500 to 1,000 bbl/d
Total remaining notional volume 550,000 bbl
Maturity dates July 1, 2008 to December 31, 2009
Option Strike Price (US$/bbl) $71.00 to $74.00
Fair value $37,034 unfavourable
Remaining notional value $40,959
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Notional volumes - Swaps 750 bbl/d
Total remaining notional volume 213,750 bbl
Maturity dates July 1, 2008 to December 31, 2008
Fixed price per bbl (US$/bbl) $71.00 to $93.70
Fair value $6,887 favourable
Remaining notional value $12,770
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(iii) The realized loss on Universal's electricity swap contracts and TGF's hedges and swaps during the three and nine months ended June 30, 2008 of $14.3 million (2007 - $11.3 million) and $37.6 million (2007 - $28.1 million) represents the net settlement payments recognized in income on that portion of commodity contracts that matured during the period.
(iv) The current and non-current components of the unrealized loss on commodity contracts are shown below:
June 30 September 30
2008 2007
(Thousands of dollars) $ $
----------------------------------------------------------------------------
Current portion of unrealized loss on commodity
contracts 31,192 39,375
Non-current portion of unrealized loss on commodity
contracts 38,655 70,326
----------------------------------------------------------------------------
Total unrealized loss on commodity contracts 69,847 109,701
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The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their short-term liquidity.
(b) Additional financial instruments disclosure
The following table represents the fair values and carrying amounts of financial assets and liabilities measured at fair value or amortized cost.
(Thousands of dollars) June 30, 2008 September 30, 2007
Carrying Fair Carrying
Fair value amount value amount
Asset/Liability $ $ $ $
--------------- --------------------------------------------
Cash and cash equivalents 84,998 84,998 13,378 13,378
Restricted cash 8,003 8,003 6,972 6,972
Accounts receivable 53,019 53,019 40,155 40,155
Production contract advances 5,259 5,259 7,162 7,162
Accounts payable and accrued
liabilities 47,900 47,900 44,562 44,562
Long-term debt 168,855 162,507 49,461 49,461
The fair values of cash and cash equivalents, restricted cash, accounts receivables, production contract advances, accounts payable and accrued liabilities approximate their carrying amounts due largely to the short-term maturities of these financial instruments. The fair value of the convertible debentures is based on the market price at the balance sheet date. The carrying amount of the convertible debenture does not include the equity component of the convertible debenture in the amount of $9.5 million.
(i) Credit risk
The LDCs provide collection services and assume the risk of any bad debts owing from Universal's customers. Therefore, Universal receives the collection of customer account balances directly from the LDCs. Management believes that the risk of the LDCs failing to deliver payment to Universal is minimal.
TGF entered into agreements with wheat producers to supply suitable grain for ethanol production and provided production advances to the farmers. The default rate from these advances is expected to be in line with that of the industry and an appropriate provision has been recorded.
(ii) Liquidity risk
Universal purchases its natural gas and enters into offsetting electricity swaps with its exclusive supplier Sempra. Universal is reliant upon the ongoing revenues from its customer base to maintain its contractual commitment under these agreements. Management believes that the potential loss of revenue from customer attrition can be managed to ensure that Universal meets its contractual commitments under its commodity supply contracts.
Universal has interest and debt repayment obligations under the convertible debenture issue and TGF has interest and debt repayment obligations under the credit facilities and debentures. Universal and TGF are reliant on the cash flows generated from its operations to fund its debt repayment obligations.
(iii) Market risk
The fair value of Universal's electricity supply contracts are significantly influenced by the variability of forward spot prices for electricity. Period to period changes in forward spot prices for electricity could cause significant changes in the marked to market valuation ("MTM valuation") of these contracts. For example, assuming that all other variables remained constant at June 30, 2008 (i) a 1% increase in forward spot prices for electricity would decrease the MTM valuation by approximately 9.5%, while a 1% decrease in forward spot prices for electricity would increase the MTM valuation by approximately 9.5%; and (ii) a 5% increase in forward spot prices for electricity would decrease the MTM valuation by approximately 47.3%, while a 5% decrease in the forward spot prices for electricity would increase the MTM valuation by approximately 47.3% .
TGF has entered into crude oil hedges to mitigate the risk exposure to the volatility of ethanol pricing while the Belle Plaine Facility is under construction. Market changes in the NYMEX price of West Texas Intermediate ("WTI") could cause significant changes in the MTM valuation of these derivatives. For example, assuming that all other variables remained constant at March 31, 2008 (i) a one dollar increase in WTI spot prices would decrease the MTM valuation by approximately 1.4%, while a one dollar decrease in spot prices for WTI would increase the MTM valuation by approximately 1.4% and (ii) a five dollar increase in WTI spot prices would decrease the MTM valuation by approximately 6.8%, while a five dollar decrease in WTI spot prices would increase the MTM valuation by approximately 6.8%.
(iv) Foreign currency risk
Universal has an exposure to foreign currency exchange rates, as a result of its investment in its United States operations.
(v) Interest rate risk
As at June 30, 2008 the Company has variable rate debt in the amount of $44.3 million and the effect of a 1% change in the interest rate charged on its variable debt will impact interest expense in the amount of $0.443 million per annum.
11. Outstanding Share Data
As at June 30, 2008 and as at August 11, 2008, there were 36,299,228 common shares of the Company outstanding. In addition, as at those dates the Company had outstanding $90.0 million principal amount of 6% convertible unsecured subordinated debentures that are convertible into a total of 3,750,000 common shares and had a total of 2,513,500 common shares reserved for issuance on exercise of outstanding options and restricted share units.
12. Risks and Uncertainties
The Company is subject to a number of risks and uncertainties that could have a material adverse effect on the results of operations, business prospects, financial condition, and the trading price of the Company's securities. A comprehensive discussion of these risks can be found in the Company's most recently filed Annual Information Form which is available from SEDAR through its website at www.sedar.com. There have been no material changes that require an update to the discussion of the applicable risks found in the Company's most recently filed Annual Information Form. These risks include:
(a) risks relating to the Company's retail electricity and natural gas business, including risks relating to: Universal's inability to contract for supply of natural gas and electricity swap agreements; Universal's reliance on Sempra; hedging, balancing and market risks relating to matching the estimated electricity and natural gas requirements of Universal's customers; volatility of commodity prices; the enforcement of Universal's energy supply contracts; the availability of credit; changes in the legislative and regulatory environment; energy trading inherent risks; Universal's dependence on its management information system; Universal's dependence on LDCs; competition; Universal's reliance on its independent contractors; Universal's ability to renew energy supply contracts at the expiration of their terms; customer attrition; customers choosing other energy sources; exposure to fluctuations in currency exchange rates; dependence on key personnel; and Universal's limited operating history;
(b) risks relating to the Company's ethanol business, including risks relating to: the possibility that there are inaccurate assumptions in TGF's business plan; TGF's reliance on the contractor retained to construct the Belle Plaine Facility; defective material, workmanship or process engineering affecting the Belle Plaine Facility; construction or operational delays; the condition of the construction site on which the Belle Plaine Facility is being constructed; TGF's dependence on the Belle Plaine Facility; TGF's reliance on intellectual property rights and proprietary technology; third party claims for infringement in respect of certain proprietary technology to be used by TGF; cost overruns at the Belle Plaine Facility; TGF's limited operating history; TGF's dependence on commodity prices, including the spread between ethanol and wheat prices, TGF's sensitivity to wheat prices and supply, TGF's sensitivity to natural gas prices and supply, TGF's sensitivity to gasoline prices and demand, sensitivity of distillers grains prices to the price of other commodity products and seasonal fluctuations affecting commodity prices; TGF's reliance on third party service providers; TGF's dependence on federal and provincial legislation and regulations; the uncertainty regarding the long term use of ethanol; the existence of excess supplies of ethanol; competition; TGF's inability to execute its expansion strategy; TGF's inability to execute future acquisitions successfully or at all; TGF's use of hedging transactions and other risk management strategies; changes to environmental, health and safety laws and regulations and potential exposure to environmental, health and safety liabilities; disruptions to infrastructure on which TGF relies or to the supply of fuel or natural gas; TGF's dependence on its key personnel; technological advances that may make the Belle Plaine Facility less efficient or obsolete; TGF's use of leverage and obligation to comply with restrictive covenants; TGF's obligation to service its debt and exposure to variations in interest rates; and TGF's exposure to fluctuations in currency exchange rates; and
(c) general risks, including risks relating to: the Company's obligation and potential inability to comply with financial reporting and other continuous disclosure requirements and securities legislation; the Company's inability to secure financing in the future; the existence of conflicts of interest pertaining to the Company's directors and officers; income tax matters; the Company's dependence on its subsidiaries; increases in operating costs; the existence of potential unknown liabilities in connection with the acquisitions pursuant to which it acquired Universal and TGF; the Company's limited operating history as a public company; future sales of common shares by significant shareholders negatively affecting the market price of the common shares; the issuance of common shares from treasury in the future diluting investors' interest in the Company; the limited ability of the Company to recover from the selling shareholders for breaches of the acquisition agreements pursuant to which it acquired Universal and TGF; and the possibility that the market price of the common shares will be unpredictable and volatile.
13. Outlook
(a) Universal
The operational margins which Universal has secured with existing customers over the next five-year period are expected to exceed its projected selling and administrative costs and to generate pretax profits. Operational margins are substantially fixed based on the contracted price in the energy contracts against the price payable under the natural gas supply and electricity swaps arranged by Universal. Universal must manage natural gas balancing arising from the difference between its hedged supply and actual usage and electricity usage in excess of the amounts that it balances under the electricity contracts. Further, it must manage customer attrition to allow it to maintain expected operational margin per RCE. Management believes that balancing and attrition can be managed so as not to materially affect operational margin per RCE. Furthermore, through marketing programs Universal expects to add new customers and accordingly increase its revenues and aggregate operational margins. Universal expects that the funding requirements related to new growth including planned expansion into new markets and acquisitions will firstly be funded by cash flow from operations and working capital and as required by raising funds from the financial markets.
Universal continues to experience continued strong growth in revenue and operational margin as the number of flowing customers increase with each successive reporting period. Canadian attrition continues to be close to our target level of 12% and we expect United States attrition to return to within our target level of 15% as the effects of the negative media coverage in the Michigan market subside. Universal continues to assess growth opportunities by looking at new energy markets and will favour markets that fit with our existing sales, supply and technology infrastructure and provide collection services.
(b) TGF
TGF will operate the Belle Plaine facility at a reduced rate to design capacity fine tuning and stabilizing the plant's various operational, electrical and control systems while it prepares for the plant's performance test which should occur in the fourth quarter of fiscal 2008.
(c) National Home Services
The NHS water heater rental program remains in a start-up phase as we continue to evaluate this new business opportunity.
(d) Capital structure review
The Company conducted an extensive review of its capital structure supported by the analysis of its financial advisors, National Bank Financial, and concluded that the Company's financial position and prospects allows it to implement a quarterly cash dividend policy. On an annual basis, the cash dividend is expected to be $0.75 per common share. The dividend policy underscores the Company's maturation and strong cash flow generation profile while still allowing us to aggressively pursue value creating growth opportunities. The Company's first dividend payment will be paid on September 30, 2008 to shareholders of record on September 15, 2008. While the Board of Directors currently expects to declare dividends quarterly and has determined that this level of dividend is appropriate based on the Company's current financial performance, liquidity and outlook, the declaration and payment of future dividends is subject to the discretion of the Board of Directors after considering the Company's financial results and condition, and other factors it determines to be relevant at the time.
14. Additional Information
Additional information relating to the Company is available on SEDAR (www.sedar.com) and on the Company's website at www.universalenergygroup.ca.
Interim Consolidated Financial Statements
For the three and nine months ended June 30, 2008 and 2007
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UNIVERSAL ENERGY GROUP LTD.
Interim Consolidated Financial Statements
For the three and nine months ended June 30, 2008 and 2007
(Unaudited)
----------------------------------------------------------------------------
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UNIVERSAL ENERGY GROUP LTD.
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----------------------------------------------------------------------------
Consolidated Balance Sheets
(Thousands of dollars)
June 30 September 30
2008 2007
(Unaudited) (Audited)
$ $
ASSETS
Current Assets
Cash 84,998 13,378
Restricted cash Note 9, 15 5,003 3,972
Accounts receivable Note 6 53,019 40,155
Inventory Note 7 12,043 581
Gas over delivered 1,539 21,904
Current portion of production
contract advances 5,217 5,453
Current portion of
future taxes 8,379 15,508
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170,198 100,951
Restricted cash Note 9 3,000 3,000
Property, plant and Note 8
equipment 147,983 116,858
Production contract Note 9
advances 42 1,709
Future taxes 20,493 29,372
Gas contracts 1,656 -
Intangible assets 1,030 1,030
Goodwill Note 3 70,460 70,460
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414,862 323,380
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LIABILITIES
Current Liabilities
Accounts payable and accrued
liabilities 47,900 44,562
Deferred gas revenues 1,302 26,850
Current portion of unrealized loss Note 17
on commodity contracts 31,192 39,375
Current portion of Note 9
long-term debt 12,650 7,860
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93,044 118,647
Unrealized loss on commodity Note 17
contracts 38,655 70,326
Long-term debt Note 9 149,857 41,601
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281,556 230,574
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SHAREHOLDERS' EQUITY
Share capital Note 10 248,204 247,794
Contributed surplus Note 10 5,513 2,568
Equity component of convertible Note 9
debenture 9,507 -
Deficit (130,248) (157,767)
Accumulated other comprehensive
income 330 211
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133,306 92,806
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Commitments Note 16
414,862 323,380
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See accompanying notes to consolidated financial statements.
Approved on behalf of the Board:
(Signed) "Gary J. Drummond" Director (Signed) "Tim J. LaFrance" Director
------------------------------ --------------------------
UNIVERSAL ENERGY GROUP LTD.
Consolidated Statements of Deficit
For the nine months ended June 30
(Unaudited - thousands of dollars)
2008 2007
$ $
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Deficit, beginning of period (157,767) (60,097)
Deemed distribution on Note 3
acquisition of Universal - (73,425)
Net income/(loss) for the
period 27,519 (6,329)
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DEFICIT, END OF PERIOD (130,248) (139,851)
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See accompanying notes to consolidated financial statements.
UNIVERSAL ENERGY GROUP LTD.
Consolidated Statements of Comprehensive Income/(Loss)
and Accumulated Other Comprehensive Income/(Loss)
For the nine months ended June 30
(Unaudited - thousands of dollars)
2008 2007
$ $
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Net income/(loss) for the period 27,519 (6,329)
----------------------------------------------------------------------------
Other comprehensive income:
Unrealized gains and losses on translating financial
statements of self-sustaining foreign operations 119 (73)
----------------------------------------------------------------------------
Other comprehensive income/(loss) 119 (73)
----------------------------------------------------------------------------
Comprehensive income/(loss) 27,638 (6,402)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Accumulated other comprehensive income/(loss),
beginning of period 211 (1)
Other comprehensive income/(loss) 119 (73)
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ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS),
END OF PERIOD 330 (74)
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See accompanying notes to consolidated financial statements.
UNIVERSAL ENERGY GROUP LTD.
Consolidated Statements of Operations
(Unaudited - thousands of dollars except per share amounts)
For the three months For the nine months
ended June 30 ended June 30
2008 2007 2008 2007
$ $ $ $
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REVENUE
Gas 48,342 18,850 190,309 84,579
Electricity 43,141 33,535 129,844 93,462
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91,483 52,385 320,153 178,041
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COST OF SALES
Gas 40,426 15,693 158,837 68,463
Electricity 22,848 15,894 71,798 48,228
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63,274 31,587 230,635 116,691
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GROSS MARGIN 28,209 20,798 89,518 61,350
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EXPENSES
Customer
acquisition costs 3,278 5,895 15,771 12,494
General and
administrative 10,329 4,431 25,992 11,019
Financing
charges 1,819 263 5,510 360
Stock-based Note 11
compensation 1,046 778 3,064 1,574
Amortization Note 12 331 124 660 322
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16,803 11,491 50,997 25,769
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Income before
other income/
(expense) 11,406 9,307 38,521 35,581
OTHER INCOME/
(EXPENSE)
Gain on sale
of supply
contracts 3,857 - 3,857 -
Realized loss Note 17
on commodity
contracts (14,256) (11,348) (37,610) (28,094)
Unrealized Note 17
gain/(loss) on
commodity
contracts 16,392 (33,696) 39,854 (15,735)
Other Note 13 907 (73) 3,973 (166)
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6,900 (45,117) 10,074 (43,995)
----------------------------------------------------------------------------
Income/(loss)
before
income tax 18,306 (35,810) 48,595 (8,414)
Income
tax/(recovery) 7,453 (11,702) 21,076 (2,085)
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NET INCOME/(LOSS)
FOR THE PERIOD 10,853 (24,108) 27,519 (6,329)
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Basic Note 14
earnings/(loss)
per share 0.30 (0.66) 0.76 (0.24)
Diluted Note 14
earnings/(loss)
per share 0.29 (0.66) 0.74 (0.24)
See accompanying notes to consolidated financial statements.
UNIVERSAL ENERGY GROUP LTD.
Consolidated Statements of Cash Flows
(Unaudited - thousands of dollars)
For the three months For the nine months
ended June 30 ended June 30
2008 2007 2008 2007
$ $ $ $
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CASH FLOWS FROM OPERATING
ACTIVITIES
Net income/(loss) for the
period 10,853 (24,108) 27,519 (6,329)
Items not affecting cash:
Amortization 331 124 660 322
Stock-based compensation 1,046 778 3,064 1,574
Financing charges, non-cash
portion 362 - 1,062 -
Unrealized gain on commodity
contracts (16,392) 33,696 (39,854) 15,735
Future taxes 4,319 (12,297) 16,008 (2,594)
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519 (1,807) 8,459 8,708
Changes in non-cash working
capital items:
Accounts receivable 11,113 (2,956) (10,959) 177
Inventory (4,483) - (11,462) -
Gas over/(under) delivered (10,790) (6,228) 20,365 4,647
Deferred/(unbilled) gas
revenues 12,534 7,222 (25,548) (7,548)
Accounts payable and accrued
liabilities 1,408 15,333 3,338 25,811
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Cash provided by/(used in)
operating activities 10,301 11,564 (15,807) 31,795
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CASH FLOWS USED IN INVESTING
ACTIVITIES
Acquisition of TGF, net - - - (32,222)
Acquisition of Universal - - - (73,425)
Acquisition of gas contracts - - (1,779) -
Restricted cash 1,588 (1,050) (1,031) (2,670)
Property, plant and equipment (5,490) (31,717) (31,662) (46,982)
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Cash used in investing
activities (3,902) (32,767) (34,472) (155,299)
----------------------------------------------------------------------------
CASH FLOWS FROM FINANCING
ACTIVITIES
Issuance of common shares 277 (36) 291 (11,630)
Proceeds from initial public
offering, net
of issue costs - - - 143,750
Issuance of convertible
debenture, net of
issue costs - - 86,695 -
Advances under financing
facilities, net 2,898 9,968 34,794 9,968
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Cash provided by financing
activities 3,175 9,932 121,780 142,088
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Unrealized gain/(loss) on
foreign exchange
translation 23 (17) 119 (73)
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NET INCREASE/(DECREASE) IN
CASH 9,597 (11,288) 71,620 18,511
CASH, BEGINNING OF PERIOD 75,401 32,646 13,378 2,847
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CASH, END OF PERIOD 84,998 21,358 84,998 21,358
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Supplemental information:
Property, plant and equipment
in accounts payable 14,432 29,615 14,432 29,615
Interest paid 1,808 263 5,145 315
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See accompanying notes to consolidated financial statements.
UNIVERSAL ENERGY GROUP LTD.
Notes to Interim Consolidated
Financial Statements For the three and nine months ended
June 30, 2008 and 2007
(Unaudited - thousands of dollars except as indicated and per share amounts)
1. Interim financial statements
The unaudited interim consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles applicable to interim consolidated financial statements. These interim financial statements do not include all the note disclosures required for annual financial statements and therefore should be read in conjunction with Universal Energy Group Ltd.'s audited consolidated financial statements for the year ended September 30, 2007.
2. Organization
Universal Energy Group Ltd. (the "Company") is incorporated under the Canada Business Corporations Act. The Company through its subsidiary Universal Energy Corporation ("Universal") operates a retail electricity and natural gas business in Canada, through its subsidiary National Energy Corporation ("NEC") operates a water heater rental program in Ontario under the trade name National Home Services ("NHS") and through its subsidiary Terra Grain Fuels Inc. ("TGF") operates an ethanol business. Universal's wholly owned subsidiary, Universal Gas & Electric Corporation ("UGE"), operates a natural gas marketing business in the United States.
3. Initial public offering and business acquisition
On January 26, 2007, the Company filed a prospectus relating to the initial public offering of its common shares. The closing date of this initial public offering was February 2, 2007 and the Company received gross proceeds from the offering of $143,750 which includes the over allotment proceeds of $18,750 which was exercised on February 7, 2007. The Company incurred issue costs of $11,630 and a future tax benefit in the amount of $3,888 has been recorded on such costs.
On closing, the Company purchased all of the issued and outstanding shares and promissory notes of TGF for cash of $37,825 and 7,889,545 common shares of the Company issued at $11.00 per share. Total aggregate consideration paid for the TGF shares and promissory notes amounted to $124,610.
Also, on closing, the Company purchased all of the issued and outstanding shares of Universal for cash of $73,425 and 15,314,999 common shares of the Company issued at $11.00 per share. Total aggregate consideration paid for the Universal shares amounted to $241,890.
The business combination has been accounted for as a reverse takeover of the Company by Universal and the acquisition of TGF by Universal using the purchase method as follows:
(a) The acquisition of TGF by Universal recorded at the exchange amount of $124,610 which is the fair value of the consideration given to acquire the TGF shares and promissory notes. The purchase price less the cash portion thereof has been added to the capital stock of Universal. In accordance with the purchase method the results of operations in these consolidated financial statements are from the date of acquisition. The allocation of the excess of fair value over net book value has been attributed as follows:
Net assets acquired: $
------------------- ---------
Net working capital (includes cash of $5,603) 12,589
Property, plant and equipment 41,352
Production contract advances 1,185
Intangible assets 1,030
Goodwill 70,460
---------
126,616
Less: Production contract financing (1,322)
Less: Future tax liability (684)
---------
124,610
---------
---------
Consideration:
--------------
Cash 37,825
Issuance of 7,889,545 common shares at $11.00 per share 86,785
---------
124,610
---------
---------
(b) The net equity of the Company was effectively exchanged for equity issued by Universal and accordingly represents an increase to Universal's share capital.
(c) The payment to the then existing Universal shareholders of $73,425 has been recorded as a deemed distribution and charged directly to the deficit.
4. Summary of significant accounting policies
(a) Change in accounting policies and recent accounting pronouncements
Effective October 1, 2007, the Company adopted the recommendations of the CICA Handbook Section 1535, "Capital Disclosures", which requires disclosure of information related to the objectives, policies and processes for managing capital. In addition, the disclosures include whether externally imposed capital requirements have been complied with. The new standard is effective for fiscal years beginning on or after October 1, 2007 and as this standard only addresses disclosure requirements, there is no impact on the Company's operating results.
Effective October 1, 2007, the Company adopted the recommendations of the CICA Handbook Section 3862, "Financial Instruments Disclosures" and Section 3863, "Financial Instruments - Presentation", which replaces Section 3861 "Financial Instruments - Disclosure and Presentation". The new disclosure standards increase the emphasis on the risks associated with both recognized and unrecognized financial instruments and how those risks are managed. The new presentation standards carry forward the former presentation requirements and are effective for years beginning on or after October 1, 2007. As these standards only address presentation and disclosure requirements, there is no impact on the Company's operating results.
In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. The AcSB has recently confirmed that accounting standards in Canada for public companies are to converge with International Financial Reporting Standards ("IFRS") effective for fiscal periods beginning on or after January 1, 2011. The Company continues to monitor and assess the impact of the convergence of Canadian GAAP and IFRS.
In February 2008, the CICA issued Handbook Section 3064, "Goodwill and Intangible Assets". Section 3064 states that upon their initial identification, intangible assets are to be recognized as assets only if they meet the definition of an intangible asset and the recognition criteria. This section also provides further information on the recognition of internally generated intangible assets (including research and development costs). For subsequent measurement of intangible assets, goodwill, and disclosure, Section 3064 carries forward the requirements of the old Section 3062, "Goodwill and Other Intangible Assets". The new section will become effective on January 1, 2009. The Company is currently evaluating the effect of the adoption of this new section on the consolidated financial statements.
(b) Principles of consolidation
The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles and include the accounts of the Company and its subsidiaries, Universal, NEC and TGF. Intercompany balances and transactions are eliminated on consolidation.
(c) Use of estimates
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. In particular, valuation techniques such as those used in the preparation of fair values are significantly affected by the assumptions used and the amount and timing of estimates. The aggregate fair value amounts represent point in time estimates only and should not be interpreted as being realizable in an immediate settlement.
(d) Cash
Cash comprises cash on hand and cash equivalents. Cash investments with an original maturity of three months or less when purchased are considered to be cash equivalents.
(e) Inventory
Ethanol, ethanol in process and grain inventory are valued at the lower of cost and net realizable value with cost being determined on a weighted average basis. Water heaters held for installation are valued at the lower of cost and replacement value, with cost determined on a first in, first out basis.
(f) Gas over delivered/Deferred gas revenues and Unbilled revenues/Gas under delivered
Natural gas is delivered to local distribution companies ("LDCs") in pre-determined fixed monthly amounts. Natural gas delivered to LDCs in excess of consumption by customers (gas over delivered) is stated as an asset at the lower of cost and net realizable value. Collections from LDCs in advance of customer consumption of natural gas result in a liability shown as deferred gas revenues.
Unbilled revenues arise when customers consume more natural gas than has been delivered to LDCs and is stated as an asset at realizable value. Gas