Just Energy Group Inc.
Q3 2018 Earnings Call Transcript

Published: 8 Nov 2018

[Operator:]

Good morning, and welcome to the Just Energy Group Fiscal 2019 Second Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Pat McCullough, CEO. Please go ahead.

[Pat McCullough:]

Thank you, Operator. Good morning, everyone, and thank you for joining us fiscal 2019 second quarter conference call. I'm Pat McCullough, Chief Executive Officer of Just Energy. With me today is our Chief Financial Officer, Jim Brown. Jim and I will discuss the results for the quarter, as well as our expectations for the future. We will then open up this call to questions. Let me preface the call by telling you that our earnings release and potentially our answers to your questions will contain forward-looking financial information. This information may eventually prove to be inaccurate, so please read the disclaimer regarding such information at the bottom of our press release. Today, we'll offer some perspective on our results followed by a deeper dive into a few of the key strategic initiatives we're pursuing that will continue to drive performance in the second-half of the year and beyond. In short summary this was quarter full of wins for the business that we're quite excited to talk to you about today. Base EBITDA achieved $37.3 million, surpassing year ago results and our internal projections as referenced in our recent press release. This EBITDA advancement was a result of margin enhancement efforts associated with our differentiated products and service offerings. This overcame headwinds in G&A, bad debt, and higher ERCOT cost in the period. So we're very excited to put a number like this forward despite those headwinds which will not continue in the second-half of this year. Margin expansion led to embedded gross margin of $2.3 billion. This is an all-time high for our Company. As you know, embedded gross margin is our publicly recorded forward earnings projection on gross margin. This is up 45% from $1.6 billion a year ago. So what we're essentially telling the market is our future earnings will be up on the gross margin line by 45% from where we had this book value a year ago. We also noted that in our margin enhancement efforts that we were able to report $333 for RCE on incoming consumer contract signed and renewed. This is higher than $197 a year ago, so significantly up. These are the margin enhancement efforts that we're very proud of and we expect to continue into the third quarter and hopefully beyond. Additionally, we're pleased with our payout ratio, which is falling off of levels near 100% over the last four or five quarters we reported 82% on the trailing 12 month basis. We feel very good about what that means for the sustainability of our dividend. And additionally we had some very large wins in terms of closing the $250 million USD refinancing which solidified our short-term financial needs, as well as giving us capacity for in organic growth. We bought a water filtration company, which puts us severely into the health and well being state and mix up skill like we're very relevant to our customers when you think about devices in homes with our name on it. We closed $225 million insurance wrap which protect the downside on our earnings going forward. This is important because if you think about the earnings challenges that the Company has had in it's recent past, this would cover some of the events that played us in fiscal 2018. Things like the January winter freeze in Texas, things like the weather and hurricane challenges we had second quarter last year. So we're very pleased that this underpins our earnings going forward and along with our margin enhancement, we think that's a very powerful recipe for forward earnings and frankly cash flows for the benefit of our shareholders. Customer contracts grew. So we report on CEs was slightly down but RCEs are subset of what we're selling. That's only the commodity business as depicted within RCEs. And while we're focused on that commodity book, because we feel that it's a greatest short-term upside for financial results in our Company. The customer contract include both commodity contracts and value added product and service contracts. And both recording with and without our water filter acquisition, those numbers are up year-on-year, which we're very pleased and quarter-over-quarter. In summary, the quarter was marked by many wins that are significant and items that our team is very proud. The core business is strong and stable. And we're quite focused on this. We realized with the margin enhancement experience that we've had in the last quarter-and-half that the majority of the short-term earnings and cash upside for the business is on that commodity book, where the value added products and services strategy has really met to address the longer-term customer needs. So you'll see quite a bit emphasis sits on margin enhancement on the electricity and natural gas book that we manage because we gain their strong confidence that there's a lot of course there. The expected impact of these margin enhancements G&A cuts that we'll be talking about more on this call, risk management activities and improvements like the insurance wrap will help drive performance this year, and EBITDA growth for the rest of this fiscal year and fiscal 2020. We're remaining very focused on capital stewardship and cash generation for the support of our dividend and our growth. We're committed to balance sheet discipline of generating superior return on invested capital. We attributed the value added product and service expansion and really setting the stage for predictable prolonged and stable growth. With that, I'd like to turn the call over to Jim Brown, our Chief Financial Officer. Jim?

[Jim Brown:]

Thank you, Pat. As Pat noted, our business is strong with record breaking embedded gross margin of $2.3 billion. Our balance sheet is healthy and we remain committed to the strategy of profitable growth and dividend distributions. First I'd like to cover some highlights of the second quarter, then provide some additional color in certain areas. We are pleased to announce - we've seen significant improvement in our second quarter Base EBITDA, which improved 81% to $37.3 million due to positive contributions from our gross margin initiatives which include contract margin enhancement and new risk management practices to neutralize our commodity cost throughout the year. This was partially offset by higher net debt administrative expenses. As a reminder and as is stated in previous quarters, losses due to change in fair value of derivative instruments including net profit does not reflect of the economic results or cash flow to the Company. Similar to other energy retailers, Just Energy uses Base EBITDA as a preferred measure of operating performance. As you can see our Base EBITDA grew significantly for the quarter. During the quarter realized gross margin increased 22% to $173.3 million, due to expanding new margins in North America and greater sales in the United Kingdom. The Consumer division gross margin increased 17% to $125.2 million as a result of focusing on higher margin customers. While the commercial division or gross acquisitions remained strong, had an increase in gross margin of 36% to $48.1 million. We remain committed to enhancing our risk management activities, including our insurance wrap program, which was finalized in early October and adds an additional layer of protection to the Company's earnings stability. Annual gross margin for RCE per customer ad in renewing the quarter and the September 30, 2018 was $333 for RCE, for the Consumer division, a significant increase from $197 for RCE in the prior year period. In the commercial division design margins increased to $96 for RCE, an increase from $88 for RCE in the prior year. As we noted in our Investor Day, we are keenly focused on securing and retaining higher margin customers, who'll ultimately derive long-term growth rather than customers who are priced sensitive Despite our increase in product business for the first time in five years, our combined attrition remained flat at 13% for the trailing 12 months as compared to the same time last year. Consumer attrition of 20%, decreased three percentage points year-over-year while commercial attrition remained same as a year ago at 5%. Moving back to the income statement. General administrative expenses for the second quarter rose $11.7 million, this increase is largely due to the expansion of our U.K. business and the cost of attracting top down for our organization coupled with an investment in operational efficiencies and automation. As an example, we launched a new cloud based weather forecast in June in the quarter to increase the accuracy and timeliness of position management. While at the same time reducing the IT infrastructure costs associated with this program. Efforts such as this are examples that will ultimately drive greater cost savings as soon as the second-half of fiscal year. Selling and administrative expenses decreased 3% year-over-year to $56.7 million, primarily due to capitalization of upfront commissions along with consolidation of regional sale losses. Now we'll review some of the key financial metrics and balance sheet items. Based on some operations of $26.2 million, increased 241% from a year ago. The increase was largely driven by significant turbulence in our Base EBITDA which came from our gross margin expansion. The payout ratio based on from operation was 85% compared to 279% this time last year. On a trailing 12 month basis the current payout ratio is 82%. As we noted during our Investor Day in September, we are committed to returning our payout ratio to 75% and believe we are taking the appropriate actions for that to recur. Managing our balance sheet continues to be a top priority for the Company. As announced on September 12, 2018, the Company entered into a $250 million USD non-revolving multi-growth senior unsecured term loan facility to secure refinancing of our $150 million USD Euro bond, which matures in July of 2019 in addition to the facility of capital for future acquisitions and general corporate purposes. Net debt to Base EBITDA increased to 3.5% on a trailing 12 months basis, which is higher than 3.2x we reported in the last quarter, primarily due to higher utilization of our credit facility in the second quarter constantly offset by higher Base EBITDA. Turning to our outlook. We've taken several initiatives to attract higher margin customers in conjunction with implementing pricing optimization strategy across the organization. To further drive profitability we have put in place several cost cutting initiatives and particularly the reduction of the administrative expenses to greater automation and consolidation. We believe we have the right strategy and people in place to drive profitability, gross margin and customer growth through our existing channels by correctively promoting high growth products and services while also developing additional strategic alternative channels. These actions will contribute in the third and fourth fiscal quarters. As a result we are reaffirming our fiscal 2019 Base EBITDA guidance in the range $200 million to $220 million. I look forward to updating all of you on our conference next quarter. With that, I'll turn it back to Pat for final remarks.

[Pat McCullough:]

Thanks Jim. We recognize it's early and there's still a lot to be done. But I expect that Q2 results be representative of our new resolve as an organization to execute faster and promote positive change. Operating with urgency and accountability gives sustainable, predictable, and profitable growth is top priority in our commitment. With that, I would like to open the call up for questions. Operator?

[Operator:]

[Operator Instructions] The first question comes from Carter Driscoll of B. Riley FBR. Please go ahead.

[Carson Sippel:]

Hi, this is Carson Sippel on for Carter Driscoll. I just had a couple quick questions. First, for the customer's you're currently signing up, are they signed up with the better pricing the one that provide better margins to you?

[Pat McCullough:]

Can you explain your question Carson? This is Pat. I didn't fully grasp what you're asking.

[Carson Sippel:]

So the customers that you're signing up presently and in the past quarter, are these the customers that have the better pricing? I mean you said you raised your prices so these customers they're currently witnessing the higher pricing that provides better margin to Just Energy?

[Pat McCullough:]

Yes, that's right. So when we report the $333 for RCE, what we're reporting there is our consumer segment, which includes both residential customers and small C&I customers in all markets, so Canada, U.S., and the U.K. and we're showing you what we have signing all new contract and renewed all new contracts ad. So that is the higher population without the commercial business in it on new margin level. So if you think about our book, we have about two-and-half year realized life on a residential account. So we signed one, two, three, four, and five year contract, we have the annual attrition on those contracts, we end realizing two-and-half years but then we renew 75% plus of those contracts. But to rebase your pricing on entire fee book you would need to have that incoming price step up for 10 consecutive quarters. And then you would capture 100% of your book. When we report $333 up from $197 last year, we're essentially telling you that a big part of our book has been repriced at that higher level. We also have that phenomenon on the previous quarter's, and that result being an embedded gross margin calculation being up 45%. That should continue - we can pull these levels in pricing in Q3 and Q4. We're confident that we can. Then you'll see there's 10 case or compound on itself and you'll see the trailing 12 months gross margin RCE results really move forward quickly.

[Carson Sippel:]

And then one more quick question about pricing. Can you comment on if there's any price differences between the regions?

[Pat McCullough:]

Certainly no. So every market is unique in terms of the value propositions that we offer but also the competitive landscape is different. In a market like Texas, where there's not an incumbent utility, we can speak directly to our customers. We hold the entirety of the customer relationship or the customer journey on a one-to-one basis. So we can promote our value depth. So we generally we’ll see higher price, higher margin in a market like Texas. Take New York where we're selling ad as a line item on the bill. We have to work harder to engage with that customer and promote our differentiated value to them. So when you're seeing this $333, it is a blend of Canada, our Midwest markets and Northeast markets, Texas, and the U. K. So the mix of what we sell and which market really does matter to those results.

[Pat McCullough:]

And then one last one from me. So in regards to the filter group acquisition, have you started realizing any of the cross-selling opportunities that you mentioned at the Analysts Day?

[Pat McCullough:]

We haven't in second quarter obviously. We closed the deal on October 1. We are the planning of the integrative phase for a couple of months and then we will be working to cross-sell with existing customers and markets like Texas. But that would be something we'll be talking about in future quarters. Remember what happens for an acquisition to us strategically and for our customers, we talked about $5.5 million first year EBITDA. So it's not going to be material to the bottom line which is why we're really focused on the commodity and what can be done with that in the short-term.

[Operator:]

The next question comes from Endri Leno of National Bank. Please go ahead.

[Endri Leno:]

I'll just start off with a couple. If you can talk a little bit about the retail channel, the kiosk and the Ecobee uptakes in the quarter, please?

[Pat McCullough:]

So, retail continues to develop to be a really important channel for us. It was actually overstated in sales this quarter by our digital channel. So our digital channel and our retail channel are neck-in-neck as our most important residential or consumer channels. We did well in excess of 30,000 sales - converted sales through retail. We remain close to four digits stores at this point and we've expanded to well over 20 brands. So that retail channel is a very important one to us and if you follow our material on Investor Day, we have an authorized Asian channel which is a long lead development we've been working on which could really impact fiscal 2020, which we're excited about. Here I was talking about how we sell through other large enterprises with superior brand recognition brand awareness than Just Energy's.

[Endri Leno:]

The other question, in terms of acquisitions and as you look in this add on and diversification to your earnings and EBITDAs, have you looked at anything if you can provide any guidance in terms of what kind of acquisitions are you looking particularly with increased capacity that you have now?

[Pat McCullough:]

Yes, we're always keeping our eye on market. I think we've said probably a few time that buying commodity books would be interesting to us if volatility returned in a significant way and has multiples on let's say commodity books drop below 3x. That's happened in the past with events like polar vortex. And that's where we would be keen on acquiring books provided they were healthy books. Outside of that, you probably won't see us buying any commodity books that today five plus items EV to EBITDA. If you observe what we've been doing in the last few years, buying small book on capabilities and the value added product and services arena we have well structured deals that really limit the amount of cash that we put upfront. That will remain our strategy. The truth is right now with the acquisition of the water filter business, which is different sale. It's a want sale versus need sale. So if you think about the customer's perspective, we need to digest that acquisition, we need to scale it along with our incomplete product. So we're really going to be focused on what we have right now. Don't expect that they're going to add at least short-term that we're going to have a big inorganic add on. And we see so much opportunity on the core commodity book right now that we're really focused on leveraging at. With regards to Ecobee, we're selling more Ecobees. We sold over 5,000 Ecobees in one month this quarter. So we do believe that Ecobee is a compelling product that we can cross-sell to our customer base. It's obviously provided some extra record turns in business, but it also supports our equity investment in Ecobee, which is 8%-ish. So we're pretty excited about product, that company, and what can be done with it. But yes, we see a lot of opportunity to sell more Ecobees than water filters to the existing commodity book and new customers.

[Endri Leno:]

And one more question before I jump in the queue. If you can talk a little bit about the working capital outflow in the core in the first-half of the year and how do you see that evolve in for the remainder of 2019? Thanks.

[Pat McCullough:]

There's basically three elements to that. One is, greater sales with more upfront commissions. We see gross ads expanding on a trailing 12 month basis. And those all now not to start commercial business like it used to be but the residential business as well, go to our balance sheet first. Secondly, general seasonality. We always have more capital used in the second quarter due to ERCOT summer and injections of natural gas for winner. And the third part is what I alluded in my discussion on gross margin is we are becoming more sophisticated in how we hedge volatility. And by hedging volatility the primary instrument we use is options. And options in many cases require upfront premiums, sometimes really entire year. So we see that trend reversed in for a couple of reasons. One, it allows us strong submitting curve and of reverse as we get the customer cash received as the year goes on. And second, possibility in the second half quarter is obviously expected to be harder than the first-half.

[Operator:]

The next question comes from Mark Jarvi of CIBC Capital Markets. Please go ahead.

[Mark Jarvi:]

Wondering if you could comment in terms of what you're seeing in terms of current pricing whether the step-up you saw in terms of the new additions and the renewals of gross margin proceeds whether or not that can hold flat or still go higher from what you're seeing in terms of the market place right now?

[Pat McCullough:]

We believe it's sustainable. We'll give you a couple facts and then also a little bit of more recent evidence. So number one, we truly have differentiated value propositions in the market. We add things like loyalty rewards which are very material to our customer and to all of our commodity products. There's almost 1 million customers on our loyalty rewards program right now. And we ask things like customer grandfather which is best-in-class where we give our customers more flexibility to manage their account or switch products without cancellation fees. We are attaching Ecobees and soon water filters. So we're creating a stickier relationship. So we do expect to be able to price that at premium to our competition going forward because we feel like we have a better product and service lead. You guys probably have heard that we have won awards for the most trusted brand in Texas recently. We won a reward for most innovative product in Ireland recently, we're really having a lot of external acknowledgment of that differentiated value prop that we're bringing. Secondly, we were bull market. We were not raising our prices over the last five years, as Jim mentioned, despite the fact that our competition was. So they're on a catch up game here where we're getting something that we will probably always do but we're not going after. Another market dynamic that I know you guys think about, ERCOT has higher pricing on forward basis next 12 years than this past obviously which is well up from a year ago August. So that is going to keep our competition in the marketplace thinking about switching prices in our volumes because the costs are going up. And as you're noticing in our results we do not see an attrition spike despite the fact that we started raising prices in a material way for us the beginning of our first quarter. Now I can tell you and I'm looking at October and November, the first few days of November, and I'm seeing that residential gross margin expand from what we just reported. So we just reported $333, if we continue to hold the pricing to the rest of this quarter, and we will caveat on that, we'll push that past $350 next quarter when we report. So we actually do feel that we're going to go on a run near several quarters of expansion on margin due to the differentiation that we're bringing to the market and it's going to continue to drive that gross margin up in short-term gross margin. But really as we replace quarter-in quarter-out big chunks of the book, you'll have 90 year-over-year profit improvement layering effect, which we hope to enjoy for few years.

[Mark Jarvi:]

And can you maybe just elaborate in terms of pricing between new customers and renewals just sort of maybe give us a bit color on how that compares relative to the $333?

[Pat McCullough:]

Yes, it's not something we disclose but I think it's obvious to say that attracting a new customer earning that trust is harder than renewing a customer's that you've already served. So generally the big market expansion can happen on your renewing book but fundamentally we will call customers and move them off prior to renewal, which is a lot of what we've done. The interesting thing I want to point out to you is we're giving you a blended new ads and renewals, and we're also giving you the counts on gross ads. Our gross ads are up significantly year-on-year in all channels and segments, which means despite the margin enhancement that we're talking about and the price increase with it, we're selling at least well above year ago, which means the customers are validating our value in the market.

[Mark Jarvi:]

And then just on RC additions are respectively flat in the quarter. The Investor Day you talked about a target of 10% annually, making us reconcile what you're seeing in terms of the ability to add customers, grow the book, versus the trade off of profitability and how you guys see that evolving over the next year relative to the target of 10%?

[Pat McCullough:]

I think I acknowledged at our Investor Day. We really thought coming end of this year that we have the ability to put $200,000 net RCEs on the board if you think about just the commodity book and don't think about customer contract count. That's obviously going to be pressured by our margin enhancement efforts both on a sale to review and attrition business. So I'm probably going to tell you that I don't know that we want to put a few $100,000 net ad goal ahead of the ultimate embedded gross margin for earnings the extension opportunity that we see. So as we're managing our business every day, every week, and every month, we're thinking about okay we have say a type of customer order planned renewal type of exit be on a customer oil and resale. And we're thinking about the pricing for the full customer lifecycle and the full enterprise value fruition potential. So it might be in order to have to go flat this year on the commodity book, and take price increases like $197 to $333 and then stabilize that and then promote growth and not push the envelope. Once we find that elasticity point where our customers say, okay we love your value more than your competition but we only love it to this amount, that's where you'll see these price increases stop and stabilize. Maybe the strength of that if we've gone too far with attrition result which we haven't seen to this point. And that's when you'll see the growth kind of snap through. So know that from a investor perspective, we're truly focused on enterprise value creation and shareholder return. We're not focused on market share. We've seen a lot of companies do get quite distracted with. So I wouldn't say that $200,000 number that we thought we could do at the beginning of the year is the most important target to extract now. If we can get it we'll get it. We love the customer count addition and increases that we're seeing across all products. So we didn't realize cash growth there but we're really going to be focused on a stable cash flowing commodity book maximize and then return to a big growth sentence. Having said that, there's quite a bit of channel in product expansion. So we still believe strongly there's a bit growth over here. You just may see call that for couple quarters as we take major step toward on profit.

[Mark Jarvi:]

Just on the cost to acquire trends aggregation costs were up pretty substantially quarter-over-quarter, obviously you're getting the benefit of higher margins. Just wondering what it is that's driving the aggregation cost. Is it the channels we're bringing them in or maybe if you could elaborate on how those have moved in parallel sort of the higher margins?.

[Pat McCullough:]

Yes, it's really the concentration of the retail channel now that it's scaled. It's definitely - as I said about the chance, it's door to door. So even if we’re losing its door-to-door emphasis, we're gaining with that. I think I mentioned in Q1 retail overcame digital and became our largest channel in that period. That reversed both our still large and Q2. And it's really the mix of channels sales that drive that as much as anything. Now as you scale you do get a little bit of fixed absorption but it's primarily a variable cost. So it's result of retail channel.

[Operator:]

The next question comes from Raveel Afzaal of Canaccord Genuity. Please go ahead.

[Raveel Afzaal:]

Can you speak about what your book looks like in Texas? How many variable rate customers do you have versus fixed rate customers that's heading into this quarter that you guys just reported?

[Pat McCullough:]

Yes. So we don't have many variable month-to-month customers there in Texas. One of the reason of this, get repriced there. But we're retroactive with our customers. So as we raised spreads in Texas variable month-to-month, we're engaging with our customers that say, hey why don't get back and do a fixed price contract. So as we saw the variable book of trick recently, we did drive two-thirds of those trading customers back into higher margin fixed contracts for long-term. So think about couple of 10,000 of customers that we actually have on variable month-to-month in Texas right now. So it's not driving the big results you're seeing here. It's really fixed price new contract and renewing contracts, that's the main driver behind this. I know that's quite a bit different than a few of our competitors revealed. That does not depend on a high insurance variable book. By the way we don't acquire residential customers on variable contracts.

[Raveel Afzaal:]

Can you speak about the weather volatility that we saw in Texas, what sort of an impact it had on the competitive landscape in that market?

[Pat McCullough:]

Yes, we didn't really saw some choppiness in July. It impacted us as we shared account Investor Day by a few million dollars. So it wasn't a material result to us. But then we had very sophisticated series of hedge influence. And obviously we did not have an insurance wrap done in July. I think we didn't have to rely on that. So we think that was a great result that shows the power of our supply and hedging team endeavor. But we do know that many of the folks in our market that didn't have weather hedges on a book our size, Twitter had $10-s millions of issues if they were properly hedged for weather.

[Raveel Afzaal:]

Make sense. Did you see a lot of your competitors going out of business or at least I mean you guys are very sophisticated but the smaller guys in the market did you guys see those guys going out of business? Like who didn't have the right hedges in place?

[Jim Brown:]

Raveel, I mean we see people going after being consolidated basically one of our larger competitors who was - or not longer competitor, but one of largest small competitors recently acquired by a company and I think it was due to margin compression and maybe taking maybe aggressive stances against the subs Texas summer. But the interesting thing about Texas summer is while volatility went up and former crisis went up, real-time prices still remain very low and if you gamble you could have won. That's a bad gamble - and as a public company we would never do that because we can't risk that or normally we want to. But I think the real issue would if real time price would show up for the non-hedgers that would be a much greater opportunity. We do see pressure though for people who are getting out of the market who can't afford the collateral cost.

[Raveel Afzaal:]

And how's the weather outlook looking for Q4. I know it's just too early to say but I think October was a bit colder than expected. Can you just speak about who you see the outlook for weather variations or any other volatility that you guys expect seeing in this quarter?

[Pat McCullough:]

Yes, we're not worried about it at all. I think we've all talked in the past that Just Energy, how we hedge gas. For this winter we have mild and extreme weather hedges in place in every market we serve of any scale. And we do it at the metropolis area. So for example we'll have a specific colored swap different in New York and Chicago and Dallas. So we're really we'll buttoned up on natural gas in the winter. Of course we've got insurance wrap behind it if we had any funny intra-month volatility. So truly not worried about what weather does this winter because of the robust hedges and insurance wrap behind that. No, we don't go anymore than you do in terms of what to expect at this point.

[Raveel Afzaal:]

And just finally, I'm guessing the bulk of this growth, the pricing improvement came from Texas. But can you speak a little bit about U.K.? Because it looks like pricing over there has also been going higher and just what impact that has had on your margin improvement?

[Pat McCullough:]

Yes, you're right that the impact is worse and frankly the North American market. The U.K. market is a unique one with an exact and highly competitive market. We don't have quite the pricing power there and great deals of value prop enhancements that we've made. We have the U.K. business wind up to receive this year. So you're going to see us be able to differentiate in a meaningful way in the U.K. in the next quarter or two and then probably see more price enhancement there or at least will attempt to premium price for that value there. But no, it's not a large contributor to the $333 you see this quarter and really coming from Canada, the Northeast, Midwest, and Texas.

[Operator:]

The next question comes from Nelson Ng of RBC Capital Markets. Please go ahead.

[Nelson Ng:]

Just a quick clarification on the, I guess, customer counts. You guys mentioned that you lost few years of the customer but then you also gained a large U.K. commercial customer. Were those two items a wash or was it a net negative?

[Pat McCullough:]

So for customer counts, I think you're referring to RCE's and one of our large North American customers that are both we're training from mainly would give themselves in solvency issue. So we were able to mark that risk and get out of it perfect time. So we did fire a customer as a very public in solvency issue. And at the same time as you see in the commercial book, we're most excited about in the commercial book and then really the way we measure success in the commercial state is not around our RCEs or customers but around contract sales term margin, okay. So again, really well aligned to net gross margin and ultimately our enterprise value. And we're imaging the levers of that business just seeing a great deal of progress in the sales term margin in that business and we're very excited about where it's running. The commercial business's contribution to this quarter was well ahead of expectation. So we're talking about consumer biasing and how meaningful that was. But really excited about both new sales coming in recently in commercial book in October which you haven't seen yet but also sales term margin enhancement that's very interesting versus prior years.

[Nelson Ng:]

And then my next question relates to just cost savings and efficiencies. I think Jim mentioned that there's a few initiatives that would be realized in fiscal Q3 and Q4. I think in the Investor Day, you guys talked about realizing at least $20 million of efficiencies or gains and cost savings. Could you just give us like profile in terms of what you think you can achieve, I guess, this fiscal year?

[Jim Brown:]

Sure. So yeah we were talking about run rate savings onset from where we were running. And if you think about our second-half, we expect to be $10 million to $20 million below our first-half G&A spend. And if you include a bit of sales overhead that I would purport in G&A you get to that $20 million run rate that we're talking about. We think we can do another $20 million on top of that next year. So if you got yourself to - I think we said [1.14-ish] if I have the numbers right in H1, we expect to be close to underneath a $100 million in H2, and then we expect to be able to carve the number $20 million of that full year in fiscal 2020 if we deliver all of our cost savings plans that we intend to.

[Nelson Ng:]

And this is on top of, I guess, net of, I guess, additional spending for growth. So you're still, I guess there's additional spending to kind of grow the business but the cost savings would kind of more than offset that incremental investment?

[Jim Brown:]

Yeah there's a couple things to think about. You're right. There's going to be growth investments that always has been, if you think about what we've been doing in our past. The second thing is, we haven't paid the bonus to our employees in the last two years. So we are accruing for a bonus which could be as large as $10 million to $15 million on full year basis. So you're going to have to overcome those year-over-year headwinds. So how are we doing it? We’re doing it through structural cost savings. We're doing it by consolidating the back office and back end of our operation both offices, people, with systems and processes. So you saw a chunk of spend this quarter that was associated with severance and investment into our IT architecture which we are cleaning up and streamlining so we can take the unproductive elements of our processes out and place real money.

[Nelson Ng:]

Got it. Okay. And then just one last question just on the Texas market. So in terms of the outlook for next summer, I believe, the pricing is still high, and I guess the - and it sounds like the competitiveness in the market has somewhat faded in Texas. Like, do you have a sense of whether competition will kind of ramp up over the coming year?

[Pat McCullough:]

We wouldn't expect competition to increase given we see forward peak pricing in August next year being roughly 10% higher than we always realized this year which was several times higher than the previous year. So because we're seeing those values of $300 per megawatt hour at times before the summer next year, that's not an environment that people want to run into because if they collateral requirements and there is liquidity risk for lets say the little Starbuck that might be a price bottoms fear, for lack of a better word. So we don't expect to have any big competition there in the market. The truth is I am not sure if it will impact what we're doing because we are operating off of differentiated value that's understood by our customers. And those guys that come in, they come in with pure and visible price based products. And it's a little bit of different animal these days than what we're doing, so obviously we're taking a major step forward and we're growing everyday and our customer reactions to what we're doing and customer satisfaction and loyalty. So we'll be constantly updating you on the evolving scenarios that we see but we're not expecting any big price pressure to come into the ERCOT market in the next four quarters.

[Nelson Ng:]

Okay. And then you did mention collateral, so I think that the collateral cost increased materially this quarter. Is it very seasonal? So are you expecting collateral costs to come back down and then go back up next summer?

[Jim Brown:]

Yeah, Nelson, that's exactly correct, and maybe some mild increase in the winter too. We're very protective of our balance sheet. And we enter into bilateral agreements to protect ourselves against having the post collateral as well. There's two elements to the Texas collateral. One, is the forward requirement which recently changed; and the second is, [indiscernible] – and both of those are 100% correlated declines. So we figure it's better to have security in place to make sure we are expressive with cash flows and have some incremental financing costs. thanks Jim I’ll leave it there.

[Operator:]

The next question comes from Sameer Joshi of H.C. Wainwright. Please go ahead.

[Sameer Joshi:]

My question focuses on the forecast of $200 million to $220 million Base EBITDA. What are the contributors to that, is cost saving a major contributor or is there any contribution from any of the acquired companies that it gives you that confidence?

[Jim Brown:]

The largest contributor in the second-half uptick in profits is; number one, it is the more profitable part of our book. We make more money on gas contracts than we do on electricity contracts. So you'll see our history Q4 is normally our highest profit quarter and free cash flow quarter, so very important to us. However, given all the contributors overall from the first-half to the second-half or a year ago second-half to a higher outlook this second-half is really is margin expansion first, so since margin enhancement actions that we've taken. Cost reductions are definitely in the forego to the tune of $10 million to $20 million from a half-over-half basis. So you'll see that then improve, you'll see G&A improve dramatically. You'll see a little bit of sales overheads within the selling line improve. And gross margin for us or taxing in short-term is quite easy since we signed multiyear contracts we just taste the billed rate minus our cost which is already locked in with our suppliers multiplied by expected volume and then hedge for variation around that. So it's really primarily driven by gross margin which you're already seeing coming through this quarter, it will continue to improve next quarter then in the fourth quarter.

[Sameer Joshi:]

Okay. And is there any contribution from the acquired companies that is also boosting this?

[Pat McCullough:]

Which companies Sameer?

[Sameer Joshi:]

The filter group and the edge power acquisitions?

[Pat McCullough:]

Yeah, but not material. So we'll see a couple million dollars from each of those in the second-half. But no, that's not going to be a material contributor to the difference. It's really the core commodity book and the margin enhancement efforts we've made.

[Sameer Joshi:]

Okay. And then from U.K. I think last quarter I heard that it was around 9% of your total business. Going forward how big do you expect it to be and then correlated to that is what contributions to the Base EBITDA do you expect from the U.K. business?

[Jim Brown:]

Yeah, so we don't report the U.K. segment that allocates. Not how we run the business frankly, we run the business by product lines. But, no, the U.K. businesses range from 7% to 8% to 15% quarter-in quarter-out. You'll see when we get to the fourth quarter it's a very large contributor to the fourth quarter. Because that is their big gas market quarter and also there's significant growth compounding from last three years when you take it as. So really important business to us. We are definitely investing many of our SG&A dollars both in growing product for [indiscernible] if you think about differentiation in more value added product and services and we're definitely investing in an absolute organic customer growth we're selling. So very important market, do expect that generally if the U.K. ranges to 10% to 15% of our gross margin its relatively similar drop through to the bottom line. Although we have been investing heavily G&A investors list, so this year it will pull the ultra mini guitar back a little bit relative to the North America business. And again it gets back to our bigger North American markets who'll have the big contribution to the second-half, not the U.K.

[Operator:]

The next question comes from David Lieberman of Advisors Capital Management. Please go ahead.

[David Lieberman:]

My question is actually more around some of the fixed assets that you have in the bonds or the preferred's. Some of them, the [AF] for example has sold-off. And yield to worst on it it's probably about 20%. Have you considered from a use of capital standpoint buying it back to lock or buying those assets and some capacity to lock in a 20% return?

[Pat McCullough:]

We don’t recognize any differences between our cost our equity and all forms today and across to debt. And I think if you find out in a surplus cash position which is not that present given the various seasonal cycle we’re going through on the back end of summer. You may see us do interesting things in the market. We’re not committed to do in that right now we’re really committed to dropping through free cash flow and delivering but we exchange your point when you think about the cost of equity on that product and the cheap kick out that we could give after them.

[David Lieberman:]

And just one other question going back to churn a little bit. Do you find that the churn levels are different from marketing type to marketing type digital door-to-door retail and so on. Have you found that the churn levels can be improved for example on a retail store where perhaps there's a bit more of an initial relationship and there might be in some of the other ways?

[Pat McCullough:]

Absolutely it’s interesting because I think some customer no matter what channel they come to us through they want to engage with us and those end up being the stickiest customer. The ones who want to know their offices want to get advices from us those are the guys that stay and maybe come from any channel but you’re right if you have a face to face upfront sale, you have accelerated that process you made it more comfortable for the customer, they are more likely to engage with you with more frequency through the whole customer journey. So a 100% there is a target differences there that’s why we took on retail even though there is a cost to it. We wanted to be there in front of people associated with great brand like Sam's Club as an example and they can handle effect of that. But we’re also selling digitally through some channel partners that had better brand recognition than we do in the marketplace which is super helpful and you can also get city customers through those of type of acquisitions as well.

[Operator:]

This now concludes our question-and-answer session. I would now like to turn the conference back over to Pat McCullough for any closing remarks.

[Pat McCullough:]

Thank you, Operator. Before we conclude today’s call I wanted to pass out my deepest gratitude to our employees. Our employees have done a superb job really rallying around what we’re trying to do with the business for example typical of shareholders. So thanks a lot to our employees in all regions and all parts of the business. Your dedication to building this business through innovation and commitment to customer service is the backbone of our success. It is acknowledged and appreciated. Thank you everyone for participating in the call and for your support of the business. We’ll talk to you next quarter. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.