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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 001-34585
GAS NATURAL INC.
(Exact name of registrant as specified in its charter)
     
Ohio   27-3003768
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
1 First Avenue South    
Great Falls, Montana   59401
(Address of principal executive office)   (Zip Code)
Registrant’s telephone number, including area code: (800) 570-5688
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files. Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller Reporting Company þ
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
The number of shares outstanding of the registrant’s common stock as of May 5, 2011 was 8,151,301 shares.
As used in this Form 10-Q, the terms “Company,” “Gas Natural,” “Registrant,” “we,” “us” and “our” mean Gas Natural Inc. and its consolidated subsidiaries as a whole, unless the context indicates otherwise. Except as otherwise stated, the information is this Form 10-Q is as of March 31, 2011.
 
 

 


 

GAS NATURAL INC.
INDEX TO FORM 10-Q
         
    Page No.  
       
 
       
       
 
       
    F-1  
 
       
    F-3  
 
       
    F-4  
 
       
    F-5  
 
       
    F-7  
 
       
    1  
 
       
    12  
 
       
    12  
 
       
       
 
       
    12  
 
       
    13  
 
       
       
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

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PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS.
GAS NATURAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
                 
    March 31,     December 31,  
    2011     2010  
ASSETS
               
Current Assets:
               
Cash and cash equivalents
  $ 13,104,237     $ 13,026,585  
Marketable securities
    304,875       274,950  
Accounts receivable
               
Trade, less allowance for doubtful accounts of $326,534 and $354,719, respectively
    9,477,385       9,593,840  
Related parties
    479,255       559,384  
Unbilled gas
    4,031,852       5,724,346  
Note receivable — related parties — current portion
    9,733       9,565  
Inventory
               
Natural gas and propane
    1,102,216       5,876,710  
Materials and supplies
    1,693,767       1,414,367  
Prepaid income taxes
          1,601,798  
Prepayments and other
    706,587       912,959  
Recoverable cost of gas purchases
    1,020,653       2,628,824  
Deferred tax asset
    103,203       114,362  
 
           
Total current assets
    32,033,763       41,737,690  
 
               
Property, Plant and Equipment, Net
    77,856,138       76,134,401  
 
               
Other Assets
               
Note receivable — related parties, less current portion
    43,167       45,665  
Deferred tax assets — less current portion
    1,804,264       1,804,264  
Regulatory assets
               
Property taxes
    802,513       873,197  
Income taxes
    452,645       452,645  
Rate case costs
    79,107       64,271  
Debt issuance costs
    474,199       485,244  
Goodwill
    14,607,952       14,607,952  
Customer relationships
    656,458       662,167  
Investment in unconsolidated affiliate
    748,859       640,216  
Other assets
    218,399       220,224  
 
           
Total other assets
    19,887,563       19,855,845  
 
           
 
               
TOTAL ASSETS
  $ 129,777,464     $ 137,727,936  
 
           
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GAS NATURAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED (Unaudited)
                 
    March 31,     December 31,  
    2011     2010  
LIABILITIES AND CAPITALIZATION
               
Current Liabilities:
               
Checks in excess of amounts on deposit
  $ 401,287     $ 532,145  
Line of credit
    11,000,000       18,149,999  
Accounts payable
               
Trade
    7,864,061       9,200,297  
Related parties
    213,488       417,543  
Notes payable, current portion
    878,996       910,917  
Notes payable — related parties, current portion
    49,361       49,361  
Accrued liabilities
               
Income taxes
    884,811        
Taxes other than income
    2,541,294       2,961,853  
Deferred payments from levelized billing
    1,521,137       2,916,408  
Property tax settlement — current portion
    242,120       242,120  
Related parties
    391,599       413,399  
Other current liabilities
    1,612,730       1,919,231  
Overrecovered gas purchases
    412,977       1,203,191  
 
           
Total current liabilities
    28,013,861       38,916,464  
 
           
 
               
Long Term Liabilities:
               
Deferred investment tax credits
    192,176       197,441  
Asset retirement obligation
    1,581,477       1,546,867  
Customer advances for construction
    938,517       949,434  
Regulatory liability for income taxes
    83,161       83,161  
Regulatory liability for gas costs
    76,514       131,443  
Property tax settlement, less current portion
    243,008       243,008  
 
           
Total
    3,114,853       3,151,354  
 
           
 
               
Notes Payable, Less Current Portion
    21,737,708       21,958,616  
 
               
Commitments and Contingencies (see note 11)
           
 
               
Stockholders’ Equity:
               
Preferred stock; $.15 par value, 1,500,000 shares authorized, no shares outstanding
           
Common stock; $.15 par value, 15,000,000 shares authorized, 8,150,926 and 8,149,801 shares outstanding at March 31, 2011, and December 31, 2010, respectively
    1,222,639       1,222,470  
Capital in excess of par value
    41,926,227       41,910,067  
Accumulated other comprehensive income
    65,356       46,590  
Retained earnings
    33,696,820       30,522,375  
 
           
Total stockholders’ equity
    76,911,042       73,701,502  
 
           
 
               
TOTAL CAPITALIZATION
    98,648,750       95,660,118  
 
           
 
               
TOTAL LIABILITIES AND CAPITALIZATION
  $ 129,777,464     $ 137,727,936  
 
           
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GAS NATURAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
REVENUES:
               
Natural gas operations
  $ 38,219,583     $ 31,506,160  
Marketing and production
    1,825,502       3,118,323  
Pipeline operations
    106,324       108,602  
 
           
Total revenues
    40,151,409       34,733,085  
 
           
COST OF SALES:
               
Gas purchased
    24,716,908       19,620,814  
Marketing and production
    1,399,407       2,591,411  
 
           
Total cost of sales
    26,116,315       22,212,225  
 
           
 
               
GROSS MARGIN
    14,035,094       12,520,860  
 
           
 
               
OPERATING EXPENSES
               
Distribution, general, and administrative
    4,657,320       3,904,909  
Maintenance
    285,227       291,329  
Depreciation and amortization
    1,035,077       949,462  
Accretion
    34,610       29,100  
Taxes other than income
    853,965       1,006,283  
 
           
Total operating expenses
    6,866,199       6,181,083  
 
           
 
               
OPERATING INCOME
    7,168,895       6,339,777  
 
               
LOSS FROM UNCONSOLIDATED AFFILIATE
    (62,957 )     (20,014 )
OTHER INCOME (EXPENSE)
    115,680       (231,401 )
INTEREST EXPENSE
    (413,179 )     (592,784 )
 
           
 
               
INCOME FROM OPERATIONS BEFORE INCOME TAXES
    6,808,439       5,495,578  
 
               
INCOME TAX EXPENSE
    (2,533,685 )     (1,832,636 )
 
           
 
               
NET INCOME
  $ 4,274,754     $ 3,662,942  
 
           
 
               
EARNINGS PER SHARE — BASIC
  $ 0.52     $ 0.61  
 
               
EARNINGS PER SHARE — DILUTED
  $ 0.52     $ 0.61  
 
               
WEIGHTED AVERAGE DIVIDENDS DECLARED PER COMMON SHARE
  $ 0.14     $ 0.14  
 
               
WEIGHTED AVERAGE SHARES OUTSTANDING — BASIC
    8,150,239       5,973,851  
 
               
WEIGHTED AVERAGE SHARES OUTSTANDING — DILUTED
    8,158,079       5,980,627  
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GAS NATURAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER’S EQUITY AND COMPREHENSIVE INCOME (Unaudited)
                                                         
                    Capital In     Other     Non-              
    Common     Excess Of     Comprehensive     Controlling     Retained        
    Shares     Stock     Par Value     Income (Loss)     Interest     Earnings     Total  
BALANCE AT DECEMBER 31, 2009
    4,361,869     $ 654,280     $ 6,514,851     $ 146,701     $ 100,989     $ 28,270,987     $ 35,687,808  
 
                                                       
Net income
                                  3,662,942       3,662,942  
Net unrealized losses on available for sale securities
                      (167,047 )                 (167,047 )
Stock based compensation
    1,726       259       21,915                         22,174  
Acquisition of Ohio Companies
    1,707,308       256,096       16,816,988                         17,073,084  
Purchase of remaining shares in Cut Bank Gas Company
                            (100,989 )           (100,989 )
Dividends declared
                                  (819,491 )     (819,491 )
 
                                         
 
                                                       
BALANCE AT MARCH 31, 2010
    6,070,903     $ 910,635     $ 23,353,754     $ (20,346 )   $     $ 31,114,438     $ 55,358,481  
 
                                         
 
                                                       
BALANCE AT DECEMBER 31, 2010
    8,149,801     $ 1,222,470     $ 41,910,067     $ 46,590     $     $ 30,522,375     $ 73,701,502  
 
                                                       
Net income
                                  4,274,754       4,274,754  
Net unrealized gains on available for sale securities
                      18,766                   18,766  
Stock based compensation
    1,125       169       16,160                         16,329  
Dividends declared
                                  (1,100,309 )     (1,100,309 )
 
                                         
 
                                                       
BALANCE AT MARCH 31, 2011
    8,150,926     $ 1,222,639     $ 41,926,227     $ 65,356     $     $ 33,696,820     $ 76,911,042  
 
                                         
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GAS NATURAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Net income
  $ 4,274,754     $ 3,662,942  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    1,035,077       949,462  
Accretion expense
    34,610       29,100  
Stock-based compensation
    16,329       22,174  
Gain on sale of marketable securities
          (26,609 )
Loss on sale of fixed assets
    6,948        
Loss from unconsolidated affiliate
    62,957       20,014  
Investment tax credit
    (5,265 )     (5,265 )
Deferred income taxes
          1,510,504  
Changes in assets and liabilities:
               
Accounts receivable, including related parties
    196,584       5,932,813  
Unbilled gas
    1,692,493       (339,831 )
Natural gas and propane inventories
    4,774,494       4,653,044  
Accounts payable, including related parties
    (1,639,066 )     (2,681,235 )
Recoverable/refundable cost of gas purchases
    817,957       (2,701,968 )
Prepayments and other
    206,372       105,608  
Other assets
    1,384,764       (5,482 )
Other liabilities
    (1,314,320 )     (1,240,797 )
 
           
Net cash provided by operating activities
    11,544,688       9,884,474  
 
           
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Construction expenditures
    (2,811,832 )     (1,133,127 )
Proceeds from sale of marketable securities
          301,897  
Proceeds from sale of fixed assets
    4,000        
Proceeds from related party note
    2,329       2,329  
Purchase of Cut Bank shares
          (97,667 )
Cash acquired in acquisitions
          144,203  
Investment in unconsolidated affiliate
    (132,000 )     (52,500 )
Other investments
    (10,183 )      
Customer advances for construction
    (10,917 )     56,899  
Contributions in aid of construction
    (5,362 )     24,813  
 
           
Net cash used in investing activities
    (2,963,965 )     (753,153 )
 
           
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from lines of credit
    2,500,000       3,700,000  
Repayments of lines of credit
    (9,650,000 )     (10,752,098 )
Repayments of long-term debt
    (252,796 )     (234,229 )
Repayments of other short-term borrowings
          (444,808 )
Dividends paid
    (1,100,275 )     (819,444 )
 
           
Net cash used in financing activities
    (8,503,071 )     (8,550,579 )
 
           
 
               
NET INCREASE IN CASH AND CASH EQUIVALENTS
    77,652       580,742  
 
               
CASH AND CASH EQUIVALENTS:
               
Beginning of period
    13,026,585       2,752,168  
 
           
End of period
  $ 13,104,237     $ 3,332,910  
 
           
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GAS NATURAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid for interest
  $ 275,200     $ 174,188  
 
           
Cash paid for income taxes
  $ 52,303     $ 50,000  
 
           
 
               
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
               
Shares issued to purchase Ohio Companies
  $     $ 17,073,084  
 
           
Construction expenditures included in accounts payable
  $ 119,778     $ 200,286  
 
           
Capitalized interest
  $ 1,423     $ 1,777  
 
           
Accrued dividends
  $ 366,775     $ 273,191  
 
           
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GAS NATURAL INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 — Summary of Business and Significant Accounting Policies
Nature of Business
Gas Natural Inc. is the parent company of Energy West, Incorporated (“Energy West”), Lightning Pipeline Company, Inc. (“Lightning Pipeline”), Great Plains Natural Gas Company (“Great Plains”), Brainard Gas Corp. (“Brainard”), and Gas Natural Service Company, LLC (the “Service Company”). Energy West is a natural gas utility with operations in Montana, Wyoming, North Carolina and Maine. Lightning Pipeline is a natural gas utility with operations in Ohio and Pennsylvania. Great Plains and Brainard are natural gas utilities with operations in Ohio. The Service Company manages gas procurement, transportation and storage for Brainard and subsidiaries of Lightning Pipeline and Great Plains. The Company was originally incorporated in Montana in 1909. The Company currently has four reporting segments:
             
 
    Natural Gas Operations   Annually distribute approximately 30 billion cubic feet of natural gas to approximately 63,500 customers through regulated utilities operating in Montana, Wyoming, Maine, North Carolina, Ohio and Pennsylvania. The Maine and North Carolina operations were acquired in 2007, while Cut Bank Gas in Montana was added in November 2009 and the Ohio and Pennsylvania operations were acquired in January 2010.
 
           
 
    Marketing and Production Operations   Annually market approximately 1.3 billion cubic feet of natural gas to commercial and industrial customers in Montana and Wyoming and manage midstream supply and production assets for transportation customers and utilities through the subsidiary, Energy West Resources, Inc. (“EWR”). EWR owns an average 48% gross working interest (an average 42% net revenue interest) in 160 natural gas producing wells and gas gathering assets. The production holds approximately 20,000 acres of lease rights on state lands in Montana.
 
           
 
    Pipeline Operations   The Shoshone interstate and Glacier gathering natural gas pipelines located in Montana and Wyoming are owned through the subsidiary Energy West Development, Inc. (“EWD”). Certain natural gas producing wells owned by EWD are being managed and reported under the marketing and production operations.
 
           
 
    Corporate and Other   Corporate and other encompasses the results of corporate acquisitions and other equity transactions. Included in corporate and other are costs associated with business development and acquisitions, dividend income and recognized gains from the sale of marketable securities.
Basis of Presentation
The accompanying condensed balance sheet as of December 31, 2010, which has been derived from audited financial statements, and the unaudited interim condensed financial statements of Gas Natural Inc. and its subsidiaries (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal and recurring nature.
The Company follows accounting standards set by the Financial Accounting Standards Board (“FASB”). The FASB sets generally accepted accounting principles (“GAAP”) to ensure the consistent reporting of the Company’s financial condition, results of operations and cash flows. Over the years, the FASB and other designated GAAP-setting bodies, have issued standards in the form of FASB Statements, Interpretations, FASB Staff Positions, EITF consensuses, AICPA Statements of Position, etc. References to GAAP

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issued by the FASB in these footnotes are to the FASB Accounting Standards Codification, sometimes referred to as the Codification or ASC.
Operating results for the three month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for future fiscal periods. Events occurring subsequent to March 31, 2011 have been evaluated as to their potential impact to the financial statements through the date of issuance. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the period ended December 31, 2010.
Effects of Regulation
The Company follows the provisions of ASC 980, Regulated Operations, and the accompanying financial statements reflect the effects of the different rate-making principles followed by the various jurisdictions regulating the Company. The economic effects of regulation can result in regulated companies recording costs that have been or are expected to be allowed in the rate-making process in a period different from the period in which the costs would be charged to expense by an unregulated enterprise. When this occurs, costs are deferred as assets in the balance sheet (regulatory assets) and recorded as expenses in the periods when those same amounts are reflected in rates. Additionally, regulators can impose liabilities upon a regulated company for amounts previously collected from customers and for amounts that are expected to be refunded to customers which are recorded as liabilities in the balance sheet (regulatory liabilities).
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
The Company has used estimates in measuring certain deferred charges and deferred credits related to items subject to approval of the various public service commissions’ with jurisdiction over the Company. Estimates are also used in the development of discount rates and trend rates related to the measurement of postretirement benefit obligations and accrual amounts, allowances for doubtful accounts, asset retirement obligations, and in the determination of depreciable lives of utility plant. The deferred tax asset and valuation allowance require a significant amount of judgment and are significant estimates. The estimates are based on projected future tax deductions, future taxable income, estimated limitations under the Internal Revenue Code, an estimated valuation allowance, and other assumptions.
Such estimates could change in the near term and could significantly impact the Company’s results of operations and financial position.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less, at the date of acquisition, to be cash equivalents. The Company maintains, at various financial institutions, cash and equivalents which may exceed federally insurable limits and which may, at times, significantly exceed balance sheet amounts.
Receivables
The accounts receivable are generated from sales and delivery of natural gas as measured by inputs from meter reading devices. Trade accounts receivable are carried at the expected net realizable value. There is risk associated with the collection of these receivables. As such, a provision is recorded for the receivables considered to be uncollectible. The provision is based on management’s assessment of the collectability of specific customer accounts, the aging of the accounts receivable and historical write-off amounts. The underlying assumptions used for the provision can change from period to period and the provision could potentially cause a negative material impact to the income statement and working capital.
Two of the Company’s utilities in Ohio, Orwell Natural Gas Company (“Orwell”) and Northeast Ohio Natural Gas Corp. (“NEO”) collect from their customers through rates an amount per Mcf billed to provide an allowance for doubtful accounts. As accounts are identified as uncollectible, they are written off against this allowance for doubtful accounts with no income statement impact. In effect, all bad debt expense is funded by the customer base. The total amount collected from customers and the amounts written off are reviewed annually by the Public Utility Commission of Ohio (“PUCO”) and the rate per Mcf is adjusted as necessary.
The Company’s bad debt expense for the three months ended March 31, 2011 and 2010 was $44,983 and $44,252, respectively.

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Recoverable/Refundable Costs of Gas Purchases
The Company accounts for purchased gas costs in accordance with procedures authorized by the Montana Public Service Commission (“MPSC”), the Wyoming Public Service Commission (“WPSC”), the North Carolina Utilities Commission (“NCUC”), the Maine Public Utilities Commission (“MPUC”), the PUCO and the Pennsylvania Public Utility Commission (“PaPUC”). Purchased gas costs that are different from those provided for in present rates, and approved by the respective commission, are accumulated and recovered or credited through future rate changes. The gas cost recoveries are monitored closely by the regulatory commissions in all of the states in which the Company operates and are subject to periodic audits or other review processes.
During the year ended December 31, 2010, the PUCO conducted audits of NEO and Orwell of the rates as filed from September 2007 through August 2009 and January 2008 through June 2010, respectively. As of March 31, 2011, the PUCO had not completed the audits of NEO and Orwell. The PUCO did provide the preliminary audit findings noting NEO had not included approximately $1,050,000 of costs and Orwell included an excess of approximately $1,100,000 of costs in the filings under audit.
In accordance with ASC 980, Regulated Operations, the Company recorded an adjustment of $1,050,000 and ($1,100,000) during the year ended December 31, 2010 for NEO and Orwell, respectively. When the PUCO concludes each audit, if the amounts are different than initially recorded, the Company will record an additional adjustment.
Regulatory Assets
The regulatory asset for property tax is recovered in rates over a ten-year period starting January 1, 2004. The income taxes earn a return equal to that of the Company’s rate base. The rate case costs do not earn a return. Regulatory assets will be recovered over a period of approximately three to twenty years.
Debt Issuance Costs
Debt issuance costs are fees and other direct incremental costs incurred by the Company in obtaining debt financing and are recognized as assets and are amortized using straight-line amortization as interest expense over the term of the related debt. The unamortized balance of debt issuance costs was $474,199 and $485,244 as of March 31, 2011 and December 31, 2010, respectively, including the costs related to refinancing the debt in Ohio. The amortization expense was $11,046 and $13,863 for the three months ended March 31, 2011 and 2010, respectively.
Asset Retirement Obligations
The Company records the fair value of a liability for an asset retirement obligation (“ARO”) in the period in which it was incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The increase in carrying value of a property associated with the capitalization of an asset retirement cost is included in “Property, plant and equipment, net” in the accompanying balance sheets. The Company amortizes the amount added to property, plant, and equipment, net. The accretion of the asset retirement liability is allocated to operating expense using a systematic and rational method. As of March 31, 2011 and December 31, 2010, the Company has recorded a net asset of $162,503 and $172,909, and a related liability of $1,581,477 and $1,546,867, respectively.
The Company, excluding Orwell and Brainard, has identified but not recognized ARO liabilities related to gas transmission and distribution assets resulting from easements over property not owned by the Company. These easements are generally perpetual and only require retirement action upon abandonment or cessation of use of the property for the specified purpose. The ARO liability is not estimable for such easements as the Company intends to utilize these properties indefinitely. In the event the Company decides to abandon or cease the use of a particular easement, an ARO liability would be recorded at that time.
As a result of regulatory action by the PUCO related to prior audits, Orwell and Brainard accrue towards an estimated liability for removing gas mains, meter and regulator station equipment and service lines at the end of their useful lives. The liability is to be equal to a percent of the asset cost according to the following table:

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    Percent of Asset Cost  
    Orwell     Brainard  
Mains
    15 %     20 %
Meter/regulator stations
    10 %     10 %
Service lines
    75 %     75 %
The Company has no assets legally restricted for purposes of settling its asset retirement obligations. The schedule below is a reconciliation of the Company’s liability for the three months ended March 31:
                 
    2011     2010  
Balance, beginning of period
  $ 1,546,867     $ 787,233  
Liabilities incurred or acquired
          487,445  
Liabilities settled
           
Accretion expense
    34,610       29,100  
 
           
 
               
Balance, end of period
  $ 1,581,477     $ 1,303,778  
 
           
Revenue Recognition
Revenues are recognized in the period that services are provided or products are delivered. The Company records gas distribution revenues for gas delivered to residential and commercial customers but not billed at the end of the accounting period. The Company periodically collects revenues subject to possible refunds pending final orders from regulatory agencies. When this occurs, appropriate reserves for such revenues collected subject to refund are established.
Comprehensive Income
Comprehensive income includes net income and other comprehensive income, which is primarily comprised of unrealized holding gains or losses on our available-for-sale securities that are excluded from the statement of income in computing net income and reported separately in stockholders’ equity. Comprehensive income and its components are as follows:
                 
    Three Months Ended  
    March 31,  
    2011     2010  
Net income
  $ 4,274,754     $ 3,662,942  
Other comprehensive income
               
Change in unrealized gain on available-for-sale securities, net of tax
    18,766       (167,047 )
 
           
Comprehensive income
  $ 4,293,520     $ 3,495,895  
 
           
Other comprehensive income is reported net of tax of $11,159 and ($104,439) as of March 31, 2011 and 2010, respectively.
Earnings Per Share
Net income per common share is computed by both the basic method, which uses the weighted average number of common shares outstanding, and the diluted method, which includes the dilutive common shares from stock options and other dilutive securities, as calculated using the treasury stock method.

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    Three months ended March 31,  
    2011     2010  
Weighted average number of common shares outstanding used in the basic earnings per common share calculations
    8,150,239       5,973,851  
Dilutive effect of stock options
    7,840       6,776  
 
           
Weighted average number of common shares outstanding adjusted for the effect of dilutive options
    8,158,079       5,980,627  
 
           
Reclassifications
Certain reclassifications of prior year reported amounts have been made for comparative purposes. Such reclassifications had no effect on income.
Recently Adopted Accounting Pronouncements
ASU No. 2010-28, “Intangibles — Goodwill and Other (Topic 350) When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”
On January 1, 2011, the Company adopted new authoritative guidance under this ASU, which modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The adoption of this guidance did not have a material impact on the accompanying financial statements.
ASU No. 2010-29, “Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations”
On January 1, 2011, the Company adopted new authoritative guidance under this ASU, which provides clarification regarding the acquisition date that should be used for reporting pro forma financial information disclosures required by Topic 805 when comparative financial statements are presented. This ASU also requires entities to provide a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination. The adoption of this guidance did not have a material impact on the accompanying financial statements.
Recently Issued Accounting Pronouncements
ASU No. 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20”
In January 2011, the FASB issued ASU 2011-01, which temporarily delays the effective date of the disclosures about troubled debt restructurings in ASU 2010-20. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. This ASU is not expected to have a material impact on the accompanying financial statements.
Note 2 — Acquisitions
On January 5, 2010, the Company completed the acquisition of Lightning Pipeline, Great Plains, Brainard and Great Plains Land Development Co., LTD. (“GPL”) and collectively with Lightning Pipeline, Great Plains and Brainard, the “Ohio Companies” and each an “Ohio Company”. Lightning Pipeline is the parent company of Orwell and Great Plains is the parent company of NEO. Orwell, NEO and Brainard are natural gas distribution companies that serve approximately 24,000 customers in Northeastern Ohio and Western Pennsylvania. The acquisition increased the Company’s customers by more than 50%. GPL is a real estate holding company whose primary asset is real estate that is leased to NEO.

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Merger Consideration-Issuance of Shares
The final aggregate purchase price for the Ohio Companies was $37.9 million, which consisted of approximately $20.8 million in debt of the Ohio Companies with the remainder of the purchase price paid in unregistered shares of common stock of the Company. In accordance with the Merger Agreements, on January 5, 2010, the shares of common stock of Lightning Pipeline, Great Plains and Brainard and the membership units of GPL were converted into the right to receive unregistered shares of common stock of the Company (the “Shares”) in accordance with the following calculation:
The total number of Shares the Shareholders received equaled the total of $34,304,000 plus $3,565,339, which was the number of additional active customers of the Ohio Companies in excess of 20,900 at closing (23,131 — 20,900 = 2,231 multiplied by $1,598.09), less $20,796,254 (which was the debt of the Ohio Companies at closing), divided by $10.
Based on this calculation, the Company issued 1,707,308 Shares in the aggregate. The Company issued Richard M. Osborne (“Mr. Osborne”), as trustee, 1,565,701 Shares, Thomas J. Smith (“Mr. Smith”) 73,244 Shares and Rebecca Howell (“Ms. Howell”) 19,532 Shares. Mr. Osborne is chairman of the board and chief executive officer, Mr. Smith is a director and the chief financial officer, and Ms. Howell is the corporate secretary of the Company. After the closing of the Merger Transaction on January 5, 2010, Mr. Osborne owned 2,487,972 Shares, or 41.0% of the Company, Mr. Smith owned 86,744 Shares, or 1.4% of the Company and Ms. Howell owned 19,532 Shares, or less than 1% of the Company.
The acquisition of the Ohio Companies was accounted for under the purchase method of accounting. Under the purchase method of accounting, the purchase price is allocated to the assets acquired and liabilities assumed based on their estimated fair values. The estimated fair value of the assets acquired and liabilities assumed is reflected in the following table at the date of acquisition.
                                 
    Total                      
    Ohio             Lightning        
    Companies     Great Plains     Pipeline     Brainard  
Current assets
  $ 11,475,899     $ 7,343,431     $ 4,012,843     $ 119,625  
Property and equipment
    29,530,636       18,290,612       10,818,923       421,101  
Deferred tax assets
    76,772             11,535       65,237  
Other noncurrent assets
    152,585       1,000       140,002       11,583  
Customer relationships
    685,000       640,000       45,000        
Goodwill
    13,551,181       9,112,901       4,312,007       126,273  
 
                       
 
                               
Total assets acquired
    55,472,073       35,387,944       19,340,310       743,819  
 
                       
 
                               
Current liabilities
    13,836,123       7,589,554       5,842,518       404,051  
Asset retirement obligation
    487,447             477,939       9,508  
Deferred tax liability
    3,279,164       1,483,525       1,651,769       143,870  
 
                       
 
                               
Total liabilities assumed
    17,602,734       9,073,079       7,972,226       557,429  
 
                       
 
                               
Net assets acquired:
  $ 37,869,339     $ 26,314,865     $ 11,368,084     $ 186,390  
 
                       
Approximately $13.6 million of the total purchase price was allocated to goodwill. None of the goodwill is expected to be deductible for tax purposes. Transaction costs related to the mergers totaled $125,368 for the three months ended March 31, 2010, and are recorded in the accompanying statements of income within the other income (expense).
The results of operations for the Ohio Companies for the period from January 1, 2010 to January 4, 2010 were not material.
Note 3 — Marketable Securities
Securities investments that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and recorded at amortized cost. Securities investments bought expressly for the purpose of selling in the near term are classified as trading securities and are measured at fair value with unrealized gains and losses reported in earnings. Securities investments not classified as either held-to-maturity or trading securities are classified as available-for-sale securities. Available-for-

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sale securities are recorded at fair value in marketable securities in the accompanying balance sheets, with the change in fair value during the period excluded from earnings and recorded net of tax as a component of other comprehensive income. Realized gains and losses, and declines in value judged to be other than temporary, are in the accompanying statements of income. The Company did not hold any held-to-maturity or trading securities as of March 31, 2011 or December 31, 2010.
The following is a summary of available-for-sale securities at:
                         
    March 31, 2011  
    Investment     Unrealized     Estimated  
    at cost     Gains     Fair Value  
Common Stock
  $ 199,500     $ 105,375     $ 304,875  
 
                 
                         
    December 31, 2010  
    Investment     Unrealized     Estimated  
    at cost     Gains     Fair Value  
Common Stock
  $ 199,500     $ 75,450     $ 274,950  
 
                 
Unrealized gain on available-for-sale securities of $65,356, and $46,590 (net of $40,019 and $28,860 in taxes), was included in accumulated other comprehensive income in the accompanying unaudited balance sheets at March 31, 2011, and December 31, 2010, respectively.
The gross realized gains are summarized below:
                         
                    Gross  
Three Months Ended   Sales             Realized  
         March 31,   Proceeds     Cost     Gains  
2011
  $     $     $  
2010
  $ 301,897     $ 275,288     $ 26,609  
As of March 31, 2011 and December 31, 2010, the Company did not hold any securities in an unrealized loss position.
The fair value of cash and cash equivalents, notes and accounts receivable and notes and accounts payable are not materially different from their carrying amounts. The fair values of marketable securities are estimated based on closing share price on the quoted market price for those investments. The fair value of long-term debt is estimated based on the quoted market prices for the same or similar issues, or the current rates for debt of the same remaining maturities and credit quality. Cost basis is determined by specific identification of securities sold.
Note 4 — Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., an exit price). Measuring fair value requires the use of market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, corroborated by market data, or generally unobservable. Valuation techniques are required to maximize the use of observable inputs and minimize the use of unobservable inputs.
Valuation Hierarchy
A fair value hierarchy that prioritizes the inputs used to measure fair value, and requires fair value measurements to be categorized based on the observability of those inputs has been established by the applicable accounting guidance. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).

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The following tables represent the Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of:
                                 
    March 31, 2011  
    Level 1     Level 2     Level 3     TOTAL  
Available-for-sale securities
  $ 304,875                 $ 304,875  
 
                       
                                 
    December 31, 2010  
    Level 1     Level 2     Level 3     TOTAL  
Available-for-sale securities
  $ 274,950                 $ 274,950  
 
                       
Note 5 — Credit Facilities and Long-Term Debt
Bank of America
Energy West has a $20,000,000 revolving credit facility that includes an annual commitment fee equal to 0.20% of the unused portion of the facility and interest on amounts outstanding at the monthly London Interbank Offered Rate (LIBOR) plus 120 to 145 basis points for interest periods selected by Energy West. For the three months ended March 31, 2011 and 2010, the weighted average interest rate on the facility was 1.64% and 3.20%, respectively, resulting in $56,780 and $83,354 of interest expense, respectively. The balance on the revolving credit facility was $11,000,000 and $18,149,999 at March 31, 2011 and December 31, 2010, respectively.
Senior Unsecured Notes
On June 29, 2007, Energy West authorized the sale of $13,000,000 aggregate principal amount of its 6.16% Senior Unsecured Notes, due June 29, 2017. The proceeds of these notes were used to refinance existing notes. Approximately $463,000 was incurred related to the debt issuance which was capitalized and are being amortized over the life of the note using the effective interest method.
Interest expense was $200,200 for the three months ended March 31, 2011 and 2010.
Citizens Bank
In connection with the acquisition of the Ohio Companies, NEO, Great Plains and GPL each entered modifications/amendments to its credit facility with Citizens Bank (the “Citizens Credit Facility”). The Citizens Credit Facility consisted of a revolving line of credit and term loan to NEO, and two other term loans to Great Plains and GPL respectively. Each amendment/modification was initially effective as of December 1, 2009, but was later modified to be effective as of January 5, 2010. Gas Natural Inc. guarantees each loan. Mr. Osborne guarantees each loan both individually and as trustee of the RMO Trust, and Great Plains guarantees NEO’s revolving line of credit and term loan as well as GPL’s term note.
NEO’s, Great Plains’ and GPL’s term loans with Citizens Bank were in the amounts of $7.8 million, $2.65 million and $892,000 respectively. Each term note had a maturity date of July 1, 2013 and bore interest at an annual rate of 30-day LIBOR plus 400 basis points with an interest rate floor of 5.00% per annum. For the three months ended March 31, 2011 and 2010, the weighted average interest rate on the term loans was 5% and 4.17%, respectively, resulting in $118,727 and $103,029 of interest expense, respectively. These loans were paid off on May 3, 2011.
NEO’s revolving credit line with Citizens Bank matured on November 29, 2010 and was repaid and extinguished at that time. For the three months ended March 31, 2010, the weighted average interest rate on the revolving credit line was 5%, resulting in $26,403 of interest expense.
At March 31, 2011 and December 31, 2010, $6.4 million and $6.6 million had been borrowed under the NEO term loan, $2.2 million and $2.2 million under the Great Plains term loan, and $738,000 and $753,000 under the GPL term loan, respectively.

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Huntington Bank
On December 31, 2009, Orwell entered into an amended and restated short-term credit facility with The Huntington National Bank, N.A. (the “Huntington Credit Facility”). The Huntington Credit Facility amended and restated the previous credit facility that matured on November 30, 2009. The loan was secured by all of the assets of Orwell. The Huntington Credit Facility was guaranteed by Gas Natural Inc., Lightning Pipeline, Mr. Osborne individually and as Trustee of the RMO Trust, and certain entities owned and controlled by Mr. Osborne. The Huntington Credit Facility was also secured by a pledge of $3.0 million in market value of Gas Natural Inc. stock by the RMO Trust.
The Huntington Line of Credit and Term Loan both had a maturity date of November 28, 2010. Orwell repaid and extinguished these debt obligations at that time.
For the three months ended March 31, 2010, the weighted average interest rate on the term note was 4%, resulting in $45,568 of interest expense. The weighted average interest rate on the credit line was 4%, resulting in $16,115 of interest expense.
Combined Term Loans and Credit Facilities
The $11.0 million of borrowings at March 31, 2011, leaves the borrowing capacity on our line of credit at $9.0 million.
The total amount outstanding under the Energy West long term debt obligations was approximately $13.0 million at March 31, 2011, with none being due within one year. Including the amounts related to the Ohio Companies, the total amount is approximately $22.6 million, with approximately $879,000 due within one year.
Debt Covenants
The Company’s 6.16% Senior Unsecured Note and Bank of America credit facility agreements contain various covenants, which include, among others, limitations on total dividends and distributions made in the immediately preceding 60-month period to 75% of aggregate consolidated net income for such period, restrictions on certain indebtedness, limitations on asset sales, and maintenance of certain debt-to-capital and interest coverage ratios.
The Citizens Credit Facility, which was paid off on May 3, 2011 required a minimum debt service coverage ratio of at least 1.25 to 1.0 measured quarterly on a rolling four quarter basis. The Citizens Credit Facility also required a minimum tangible net worth equal to the sum of $1,815,000 plus 100% of net income less the pro-rata share of any dividend paid to Gas Natural, measured on a quarterly basis beginning with the quarter ended December 31, 2009. The Citizens Credit Facility allowed the payment of dividends to Gas Natural Inc. if the net worth (as defined in the Citizens loan documents) after payment of any dividends was not less than $1,815,000 as positively increased by 100% of net income as of the end of each fiscal quarter and fiscal year.
The Company believes it was in compliance with the financial covenants under its debt agreements.
Notes payable consists of the following:
                 
    March 31,     December 31,  
    2011     2010  
Bank of America — Senior unsecured notes
  $ 13,000,000     $ 13,000,000  
Auto and equipment loans — various lenders
    256,993       320,079  
Citizens’ Bank Term Loan — Great Plains Land Development
    737,956       752,917  
Citizens’ Bank Term Loan — Great Plains Natural Gas
    2,187,490       2,231,835  
Citizens’ Bank Term Loan — Northeast Ohio
    6,434,265       6,564,702  
Less: Current portion
    (878,996 )     (910,917 )
 
           
 
               
Total
  $ 21,737,708     $ 21,958,616  
 
           
The following table shows the future minimum payments on the credit facilities and long-term debt for the years ended March 31:

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2012
  $ 878,996  
2013
    867,811  
2014
    7,861,132  
2015
    5,425  
2016
    3,340  
Thereafter
    13,000,000  
 
     
 
       
Total
  $ 22,616,704  
 
     
On May 3, 2011, the Company and its Ohio subsidiaries, NEO, Orwell and Brainard, (together “the Issuers”), issued $15.334 million of 5.38% Senior Secured Guaranteed Fixed Rate Notes due June 1, 2017. Additionally, Great Plains issued $3.0 million of 4.12% Senior Secured Guaranteed Floating Rate Notes due May 3, 2014. Both notes were placed with SunLife Assurance Company of Canada.
The first note, in the amount of $15.334 million, is a joint obligation of the Issuers, and is being guaranteed by the Company, Lightning Pipeline, and Great Plains (together with the Issuers, “the Fixed Rate Obligors”). This note received approval from the PUCO on March 30, 2011. The note is governed by a Note Purchase Agreement (“NPA”) as filed with the SEC on Form 8-K on November 2, 2010. Concurrent with the funding and closing of this transaction, which occurred on May 3, 2011, the Fixed Rate Obligors signed an amended Note Purchase Agreement that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is subject to a 50 basis point make- whole premium.
The second note in the amount of $3.0 million, is an obligation of Great Plains and is guaranteed by the Company (together, “the Floating Rate Obligors”). The note is priced at a fixed spread of 385 basis points over three month Libor. Pricing for this note will reset on a quarterly basis to the then current yield of three month Libor. The note is governed by a Note Purchase Agreement as filed with the Securities and Exchange Commission (“SEC”) Form on 8-K on November 2, 2010. Concurrent with the funding of this transaction, which occurred on May 3, 2011, the Floating Rate Obligors signed an amended Note Purchase Agreement that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is at par.
Payments for both notes prior to maturity are interest-only.
The notes carry a 60% debt-to-capitalization financial covenant on a consolidated basis for Ohio, as well as, a 2.0x Interest Coverage test based on a trailing twelve-month basis. Additional covenants customary for asset sales and purchases, additional indebtedness, dividends, change of control and other matters are also included.
The use of proceeds for both notes are to repay and extinguish existing amortizing bank debt and other existing indebtedness, fund $3.4 million for the 2011 capital program for Orwell and NEO, establish two debt service reserve accounts, replenish the Company’s treasuries for the previously announced repayment of maturing bank debt, and transaction expenses.
Note 6 — Stockholders’ Equity
2002 Stock Option Plan
The Energy West Incorporated 2002 Stock Option Plan (the “Option Plan”) provides for the issuance of up to 300,000 options to purchase the Company’s common stock to be issued to certain key employees. As of March 31, 2011 and December 31, 2010, there were 35,000 and 39,500 options outstanding, respectively. The maximum number of shares available for future grants under this plan is 58,000 shares. Under the Option Plan, the option price may not be less than 100% of the common stock fair market value on the date of grant (in the event of incentive stock options, 110% of the fair market value if the employee owns more than 10% of the Company’s outstanding common stock). Pursuant to the Option Plan, the options vest over four to five years and are exercisable over a five to ten-year period from date of issuance.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

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A summary of the status of the stock option plans as follows:
                         
            Weighted     Aggregate  
    Number of     Average     Intrinsic  
    Shares     Exercise Price     Value  
Outstanding December 31, 2009
    44,500     $ 8.52          
Granted
        $          
Exercised
        $          
Expired
    (15,000 )   $ 9.93          
 
                 
 
                       
Outstanding March 31, 2010
    29,500     $ 7.81     $ 69,755  
 
                 
                         
Exerciseable March 31, 2010
    8,750     $ 7.79     $ 20,812  
 
                 
                         
            Weighted     Aggregate  
    Number of     Average     Intrinsic  
    Shares     Exercise Price     Value  
Outstanding December 31, 2010
    39,500     $ 8.40          
Granted
        $          
Exercised
        $          
Expired
    (4,500 )   $ 6.34          
 
                 
 
                       
Outstanding March 31, 2011
    35,000     $ 8.66     $ 61,300  
 
                 
 
                       
Exerciseable March 31, 2011
    17,500     $ 8.22     $ 107,350  
 
                 
As of March 31, 2011 and December 31, 2010, there was $35,653 and $31,824 of total unrecognized compensation cost related to stock-based compensation, respectively. That cost is expected to be recognized over a period of three years.
The following information applies to options outstanding at March 31, 2011:
                                                 
                            Weighted                
                            Average                
                    Weighted     Remaining             Weighted  
                    Average     Contractual             Average  
Grant   Exercise     Number     Exercise     Life     Number     Exercise  
Date   Price     Outstanding     Price     (Years)     Exercisable     Price  
12/1/2008
  $ 7.10       10,000     $ 7.10       7.67       7,500     $ 7.10  
6/3/2009
  $ 8.44       5,000     $ 8.44       3.18       2,500     $ 8.44  
12/1/2009
  $ 8.85       10,000     $ 8.85       8.67       5,000     $ 8.85  
12/1/2010
  $ 10.15       10,000     $ 10.15       9.67       2,500     $ 10.15  
 
                                           
 
            35,000                       17,500          
 
                                           
During the three months ended March 31, 2011 and 2010, the Company recorded $3,916 and $4,703, respectively ($2,894 and $2,456, respectively, net of related tax effects), of compensation expense for stock options granted after July 1, 2005, and for the unvested portion of previously granted stock options that remained outstanding as of July 1, 2005.

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Note 7 — Employee Benefit Plans
The Company has a defined contribution plan (the “401k Plan”) which covers substantially all of its employees. The plan provides for an annual contribution of 3% of salaries, with a discretionary contribution of up to an additional 3%. The expense related to the 401k Plan during the three months ended March 31, 2011 and 2010 was $111,333 and $67,350, respectively.
The Company makes matching contributions in the form of Company common stock equal to 10% of each participant’s elective deferrals in the 401k Plan. The Company contributed shares of common stock valued at $11,957 and $6,120 for the three months ended March 31, 2011 and 2010, respectively. In addition, a portion of the 401k Plan consists of an Employee Stock Ownership Plan (“ESOP”) that covers most employees. The ESOP receives contributions of common stock from the Company each year as determined by the Board of Directors. The contribution is recorded based on the current market price of the Company’s common stock. The Company made no contributions for the three months ended March 31, 2011 and 2010.
The Company has sponsored a defined postretirement health benefit plan (the “Retiree Health Plan”) providing health and life insurance benefits to eligible retirees. The Plan pays eligible retirees (post-65 years of age) up to $125 per month in lieu of contracting for health and life insurance benefits. The amount of this payment is fixed and will not increase with medical trends or inflation. In addition, the Retiree Health Plan allows retirees between the ages of 60 and 65 and their spouses to remain on the same medical plan as active employees by contributing 125% of the current COBRA rate to retain this coverage. The amounts paid in excess of the current COBRA rate is held in a VEBA trust account, and benefits for this plan are paid from assets held in the VEBA Trust account. The Company discontinued contributions in 2006 and is no longer required to fund the Retiree Health Plan. As of March 31, 2011 and December 31, 2010, the value of plan assets was $208,937 and $212,678, respectively. The assets remaining in the trust will be used to fund the plan until these assets are exhausted.
Note 8 — Income Taxes
Income tax expense (benefit) differs from the amount computed by applying the federal statutory rate to pre-tax income or loss as demonstrated in the following table:
                 
    Three Months Ended  
    March 31,  
    2011     2010  
Income tax from continuing operations:
               
Tax expense at statutory rate of 34%
  $ 2,314,869     $ 1,868,497  
State income tax expense, net of federal tax expense
    223,954       76,640  
Amortization of deferred investment tax credits
    (5,265 )     (5,265 )
Other
    127       (107,236 )
 
           
 
               
Total income tax expense
  $ 2,533,685     $ 1,832,636  
 
           
The Company recognizes interest accrued related to unrecognized tax positions in interest expense and penalties in operating expense. No interest and penalties related to unrecognized tax positions were accrued at March 31, 2011 and December 31, 2010.
The tax years 2006 and later remain open to examination by the major taxing jurisdictions in which the Company operates, although no material changes to unrecognized tax positions are expected within the next twelve months.
Note 9 — Related Party Transactions
The Company is party to certain agreements and transactions with Mr. Osborne, or companies owned or controlled by Mr. Osborne.
Notes Payable
The Company had two notes payable to Mr. Osborne. The first note was payable on demand and bore interest at a rate equal to the prime rate as published by Key Bank. On December 1, 2010, the Company repaid the first note in full, including all interest accrued to date. The second note has a maturity date of January 3, 2014 and bears interest at 6.0% annually. As of March 31, 2011 and December 31, 2010, the second note had a balance of $52,975 and $52,578, which included $3,614 and $3,217 of accrued interest,

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respectively. Interest expense incurred related to both loans was $397 and $47,645, respectively, for the three months ended March 31, 2011 and 2010. On May 3, 2011, the Company repaid the second note in full, including all interest accrued to date.
Note Receivable
The Company has a note receivable from John D. Oil and Gas Marketing, a company controlled by Mr. Osborne, with a maturity date of December 31, 2016 and an annual interest rate of 7.0% relating to funds loaned to John D. Oil and Gas Marketing to finance the acquisition of a gas pipeline. The balance due from John D. Oil and Gas Marketing was $52,900 and $55,230 (of which, $9,733 and $9,565 is due within one year) as of March 31, 2011 and December 31, 2010, respectively. The Company has a corresponding agreement to lease the pipeline from John D. Oil and Gas Marketing through December 31, 2016. Lease expense resulting from this agreement was $3,300 for the three months ended March 31, 2011 and 2010, which is included in the Natural Gas Purchased column below. There was no balance due at March 31, 2011 and December 31, 2010 to John D. Oil and Gas Marketing related to these lease payments.
Accounts Payable
The table below details amounts due to related parties, including companies owned or controlled by Mr. Osborne, at March 31, 2011 and transactions with the related parties for the three months ended March 31, 2011:
                                 
                            Rent, Supplies,  
    Accounts     Natural Gas     Pipeline and     Consulting, and  
    Payable     Purchased     Construction Supplies     Other Services  
John D. Oil and Gas Marketing
  $ 89,080     $ 1,472,102     $     $ 127  
Cobra Pipeline
    15,990       179,603              
Orwell Trumbell Pipeline
    56,929       220,517             49,080  
Great Plains Exploration
    150       19,143       85,680       150  
Big Oats Pipeline Supply
    11,739             166,782       138,872  
Kykuit Resources
    39,600                   39,600  
Other
                      55,616  
The Company also accrued a liability of $391,599 and $413,399, respectively, due to companies controlled by Mr. Osborne for natural gas used through March 31, 2011 and December 31, 2010 that is not yet invoiced. The related expense is included in the gas purchased line item in the accompanying statements of income. These amounts will be trued up to the actual invoices when received in future periods.
Accounts Receivable
The table below details amounts due from related parties, including companies owned or controlled by Mr. Osborne, at March 31, 2011 and transactions with the related parties for the three months ended March 31, 2011:
                         
    Accounts     Natural Gas     Management and  
    Receivable     Sold     Other Services  
John D. Oil and Gas Marketing
  $ 1,094     $     $ 3,282  
Cobra Pipeline
                128  
Orwell Trumbell Pipeline
    125,978       1,370       4,715  
Great Plains Exploration
    123,195       3,538       8,981  
Big Oats Pipeline Supply
    1,191       2,173        
Kykuit Resources
    97,154              
Sleepy Hollow
    106,845             6,205  
Other
    23,798       41,240       1,749  
Note 10 — Segments of Operations
The following tables set forth summarized financial information for the Company’s natural gas, marketing and production, pipeline,

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and corporate and other operations. The Company classifies its segments to provide investors with a view of the business through management’s eyes. The Company primarily separates its state regulated utility businesses from the non-regulated marketing and production business and from the federally regulated pipeline business. The Company has regulated utility businesses in the states of Montana, Wyoming, North Carolina, Maine, Ohio, and Pennsylvania and these businesses are aggregated together to form the natural gas operations. Transactions between reportable segments are accounted for on the accrual basis, and eliminated prior to external financial reporting. Inter-company eliminations between segments consist primarily of gas sales from the marketing and production operations to the natural gas operations, inter-company accounts receivable, accounts payable, equity, and subsidiary investment:
Three Months Ended March 31, 2011
                                                 
            Marketing                          
    Natural Gas     and     Pipeline     Corporate              
    Operations     Production     Operations     and Other     Eliminations     Consolidated  
OPERATING REVENUES:
                                               
Natural gas operations
  $ 38,309,893     $     $     $     $ (90,310 )   $ 38,219,583  
Marketing and Production
          4,340,252                   (2,514,750 )     1,825,502  
Pipeline operations
                106,324                   106,324  
 
                                   
Total operating revenue
    38,309,893       4,340,252       106,324             (2,605,060 )     40,151,409  
 
                                   
COST OF SALES:
                                               
Gas purchased
    24,807,218                         (90,310 )     24,716,908  
Marketing and production
          3,914,157                   (2,514,750 )     1,399,407  
 
                                   
Total Cost of Sales
    24,807,218       3,914,157                   (2,605,060 )     26,116,315  
 
                                   
GROSS MARGIN
  $ 13,502,675     $ 426,095     $ 106,324     $     $     $ 14,035,094  
 
                                   
 
                                               
OPERATING INCOME:
  $ 6,886,867     $ 226,598     $ 64,000     $ (8,570 )   $     $ 7,168,895  
 
                                   
 
                                               
NET INCOME
  $ 4,259,125     $ 85,782     $ 36,802     $ (106,955 )   $     $ 4,274,754  
 
                                   
 
                                               
Total Assets
    110,806,862       5,238,233       721,458       77,360,028       (64,349,117 )   $ 129,777,464  
Goodwill
    14,607,952                             $ 14,607,952  
Three Months Ended March 31, 2010
                                                 
            Marketing                          
    Natural Gas     and     Pipeline     Corporate              
    Operations     Production     Operations     and Other     Eliminations     Consolidated  
OPERATING REVENUES:
                                               
Natural gas operations
  $ 31,584,769     $     $     $     $ (78,609 )   $ 31,506,160  
Marketing and Production
          5,483,312                   (2,364,989 )     3,118,323  
Pipeline operations
                108,602                   108,602  
 
                                   
Total operating revenue
    31,584,769       5,483,312       108,602             (2,443,598 )     34,733,085  
 
                                   
COST OF SALES:
                                               
Gas purchased
    19,699,423                         (78,609 )     19,620,814  
Marketing and production
          4,956,400                   (2,364,989 )     2,591,411  
 
                                   
Total Cost of Sales
    19,699,423       4,956,400                   (2,443,598 )     22,212,225  
 
                                   
GROSS MARGIN
  $ 11,885,346     $ 526,912     $ 108,602     $     $     $ 12,520,860  
 
                                   
 
                                               
OPERATING INCOME:
  $ 5,928,490     $ 350,156     $ 63,652     $ (2,521 )   $     $ 6,339,777  
 
                                   
 
                                               
NET INCOME
  $ 3,731,295     $ (78,950 )   $ 36,235     $ (25,638 )   $     $ 3,662,942  
 
                                   
 
                                               
Total Assets
    107,073,699       5,527,569       749,855       63,249,099       (58,543,369 )   $ 118,056,853  
Goodwill
    13,813,626                             $ 13,813,626  

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Note 11 — Commitments and Contingencies
Legal Proceedings
From time to time, the Company is involved in certain lawsuits that have arisen in the ordinary course of business. The Company is contesting each of these lawsuits vigorously and believes it has defenses to the allegations that have been made.
Note 12 — Financial Instruments and Risk Management
Management of Risks Related to Fixed Contracts
The Company and its subsidiaries are subject to certain risks related to changes in certain commodity prices and risks of counterparty performance. The Company has established policies and procedures to manage such risks. The Company has a Risk Management Committee comprised of Company officers and management to oversee our risk management program as defined in its risk management policy. The purpose of the risk management program is to minimize adverse impacts on earnings resulting from volatility of energy prices, counterparty credit risks, and other risks related to the energy commodity business.
In order to mitigate the risk of natural gas market price volatility related to firm commitments to purchase or sell natural gas, from time to time the Company and its subsidiaries have entered into fixed contracts. Such arrangements may be used to protect profit margins on future obligations to deliver gas at a fixed price, or to protect against adverse effects of potential market price declines on future obligations to purchase gas at fixed prices.
The Company accounts for these contracts in accordance with ASC 815, Derivatives and Hedging. In accordance with ASC 815, such contracts are reflected in the balance sheet as assets or liabilities and valued at “fair value,” determined as of the balance sheet date. Fair value accounting treatment is also referred to as “mark-to-market” accounting. Mark-to-market accounting results in disparities between reported earnings and realized cash flow. The changes in the derivative values are reported in the income statement as an increase or (decrease) in revenues without regard to whether any cash payments have been made between the parties to the contract. ASC 815 specifies that contracts for purchase or sale at fixed prices and volumes must be valued at fair value (under mark-to-market accounting) unless the contracts qualify for treatment as a “normal purchase or normal sale.”
For the three months ended March 31, 2011 and 2010, all of the Company’s fixed contracts for purchase or sale at fixed prices and volumes qualified for treatment as a “normal purchase or normal sale.”
Note 13 — Subsequent Events
Acquisition of Spelman Pipeline
On April 8, 2011 the Company’s indirect subsidiary, Spelman Pipeline Holdings, LLC (“Spelman”), a subsidiary of Lightning Pipeline, completed the acquisition of dormant refined products pipeline assets from Marathon Petroleum Company LP. The cash purchase price for the assets was $3.34 million.
The acquired assets include pipelines and rights-of-way located in Ohio and Kentucky. In Ohio, the assets include more than 140 miles of pipeline spanning almost a third of the state from Marion to Youngstown. Other Ohio assets are located in metropolitan and south suburban Cleveland. The Kentucky assets include more than 60 miles of right-of-way in the area surrounding and to the south of Louisville.
Spelman intends to recondition and convert the Ohio pipelines to transport natural gas to new markets where natural gas service is currently not available, as well as to connect to markets served by the Company’s Ohio utilities. The Company expects to fund $2.4 million of capital expenditures in 2011 to convert the existing facilities to natural gas. The expenditures include reestablishment and clearing of rights-of-way, “pigging” and pressure test of the line, replacement of some existing pipe, connect to supply sources and establishment of interconnections to customers. The current assets are cathodically protected and reside in a protective nitrogen bath.
Spelman expects to file an application known as a “First Filing” to establish intrastate transportation rates with the PUCO. Should the Commission find that the rates proposed by the Company are not unjust and unreasonable, it may approve the rates without a hearing. Spelman expects to begin delivering gas during the fourth quarter of 2011.
Future plans include extending the lines to participate in the transportation of Utica and Marcellus Shale production. The Company’s plans for the Kentucky assets are uncertain.

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This quarterly report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which represent our expectations or beliefs concerning future events. Forward-looking statements generally include words such as “anticipates,” “believes,” “expects,” “planned,” “scheduled” or similar expressions and statements concerning our operating capital requirements, utilization of tax benefits, recovery of property tax payments, our environmental remediation plans, and similar statements that are not historical are forward-looking statements that involve risks and uncertainties. Although we believe these forward-looking statements are based on reasonable assumptions, statements made regarding future results are subject to a number of assumptions, uncertainties and risks that could cause future results to be materially different from the results stated or implied in this document.
Such forward-looking statements, as well as other oral and written forward-looking statements made by or on behalf of us from time to time, including statements contained in filings with the SEC and our reports to shareholders, involve known and unknown risks and other factors that may cause our company’s actual results in future periods to differ materially from those expressed in any forward-looking statements. See “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the SEC. Any such forward looking statement is qualified by reference to these risk factors. We caution that these risk factors are not exclusive. We do not undertake to update any forward looking statements that may be made from time to time by or on behalf of us except as required by law.
OVERVIEW
Gas Natural is a natural gas company, primarily operating local distribution companies in six states and serving approximately 63,500 customers. Our natural gas utility subsidiaries are Energy West, Incorporated (Montana and Wyoming), Cut Bank Gas Company (Montana), Northeast Ohio Natural Gas Corporation (Ohio), Brainard Gas Corp. (Ohio), Orwell Natural Gas Company (Ohio and Pennsylvania), Bangor Gas Company (Maine) and Frontier Natural Gas (North Carolina). Our operations also include production and marketing of natural gas and gas pipeline transmission and gathering. Approximately 95% of our revenues in the three months ended March 31, 2011 were derived from our utility operations.
Increased sales volumes in our natural gas segment driven by continued customer growth magnified by colder weather in the majority of our service areas lead to our results for the three months ended March 31, 2011. Our earnings increased to $4.3 million from net income of $3.7 million in the three months ended March 31, 2010, an increase of $600,000 or 16%.
In our marketing and production segment, lower sales volumes in our Wyoming market and lower volumes produced from our gas production operation caused lower gross margin in the first quarter of 2011 than in the first quarter of 2010. Offsetting this is the expense included in the first quarter of 2010 related to the conclusion of the lawsuit with Shelby Gas Association of $441,000. The net result is an increase in net income of $165,000 to net income of $86,000 in the three months ended March 31, 2011 from a net loss of $79,000 in the three months ended March 31, 2010.
Our pipeline operations segment returned net income of $37,000 for the three months ended March 31, 2011 compared to $36,000 for 2010. Our Corporate and other operations incurred a net loss of $107,000 for the three months ended March 31, 2011 compared to a net loss of $26,000 for the same period in 2010.
Company Structure
On July 9, 2010, we reincorporated from Montana to Ohio. The reincorporation effected a change in the legal domicile of the Company and other changes of a legal nature, but did not result in any change in our business, our management personnel, our operations or the location of our facilities. The effect of the reincorporation is described in greater detail in our proxy statement for the June 30, 2010 annual meeting of shareholders. As part of the reincorporation, we changed our name to “Gas Natural Inc.”
QUARTERLY RESULTS OF CONSOLIDATED OPERATIONS
Quarter Ended March 31, 2011 Compared with Quarter Ended March 31, 2010
The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this report and our Annual Report on Form 10-K for the period ended December 31, 2010. The following gives effect to the unaudited Consolidated

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Financial Statements as of March 31, 2011 and for the three month period ended March 31, 2011. Results of operations for interim periods are not necessarily indicative of results to be attained for any future period.
     Net Income — Our net income for the three months ended March 31, 2011 was $4.3 million or $0.52 per diluted share, compared to net income of approximately $3.7 million or $0.61 per diluted share for the three months ended March 31, 2010, an increase of $600,000. Our secondary public offering in November 2010 resulted in 2.075 million additional shares outstanding and leads to the dilutive effect on the per share amounts in 2011 compared to 2010. Net income from our natural gas operations increased by $600,000, due primarily to customer growth and colder weather in most of our service territories, which led to increased revenues and gross margin. Our gas marketing and production operation returned net income of $86,000 in the three months ended March 31, 2011, an increase of $165,000 from the loss of $79,000 for the same period in 2010. Offsetting these improvements is the net loss from our corporate and other segment of $107,000 compared to a net loss of $26,000 in 2010, a difference of $81,000.
     Revenues — Our revenues for the three months ended March 31, 2011were approximately $40.2 million compared to $34.7 million for the three months ended March 31, 2010. This $5.5 million increase was primarily attributable to: (1) a natural gas revenue increase of $6.7 million due to colder weather and increased sales volumes in the majority of the markets we serve, partly offset by (2) a decrease in our marketing and production operation’s revenue of $1.3 million due primarily to lower sales volumes in our Wyoming market and lower volumes produced from our production operation.
     Gross Margin — Gross margin was approximately $14.0 million in the three months ended March 31, 2011 compared to approximately $12.5 million in the three months ended March 31, 2010, an increase of $1.5 million. Our natural gas operation’s margins increased $1.6 million, due to the cold weather and increased sales volumes. Gross margin from our marketing and production operations decreased $101,000, due to lower volumes produced and lower prices received.
     Operating Expenses — Expenses other than cost of sales increased by $685,000 to approximately $6.9 million in the three months ended March 31, 2011 from approximately $6.2 million in the three months ended March 31, 2010. The increase is due to increases in administrative expenses including salaries and professional services, and increases in depreciation due to the increases in capital expenditures, offset partially by a decrease in taxes other than income.
     Other Income (Expense) , including Loss From Unconsolidated Affiliate — Other income increased by $304,000 to income of $53,000 in the three months ended March 31, 2011 from expense of $251,000 in the three months ended March 31, 2010 as a result of the following: (1) other income from natural gas operations increased by $22,000; (2) the 2010 period included $441,000 of expenses from the conclusion of the lawsuit with Shelby Gas Association; (3) the loss from investment in unconsolidated affiliate, which is our investment in Kyuit, increased by $43,000 and (4) our Corporate and Other segment posted other expense of $80,000 in 2011 compared to other income in 2010 of $36,000, resulting in an increase in costs of $116,000.
     Interest Expense — Interest expense decreased by $180,000 to $413,000 in the three months ended March 31, 2011 from $593,000 in the three months ended March 31, 2010. The Ohio Companies had less debt outstanding in the three months ended March 31, 2011 because of the debt that was repaid in November 2010, resulting in lower interest expense.
     Income Tax Expense — Income tax expense increased by approximately $700,000 to approximately $2.5 million in the three months ended March 31, 2011 from $1.8 million in the three months ended March 31, 2010. The three months ended March 31, 2010 included an income tax benefit of $190,000 from an adjustment to true up the deferred tax balances for a change in the effective tax rate for 2010. The remaining increase is due primarily to the increase in pre-tax income in 2011 compared to 2010.

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Net Income by Segment and Service Area
The components of net income for 2011 and 2010 are:
                 
    Three Months Ended March 31,  
($ in thousands)   2011     2010  
Natural Gas Operations
               
Energy West Montana (MT)
  $ 864     $ 932  
Energy West Wyoming (WY)
    315       258  
Frontier Natural Gas (NC)
    663       644  
Bangor Gas (ME)
    868       491  
Ohio Companies (OH)
    1,549       1,407  
 
           
Total Natural Gas Operations
  $ 4,259     $ 3,732  
Marketing & Production Operations
    86       (79 )
Pipeline Operations
    37       36  
 
           
 
    4,382       3,689  
Corporate & Other
    (107 )     (26 )
 
           
 
               
Consolidated Net Income
  $ 4,275     $ 3,663  
 
           
The following highlights our results by operating segments:
NATURAL GAS OPERATIONS
Income Statement
                 
    Three Months Ended March 31,  
($ in thousands)   2011     2010  
Natural Gas Operations
               
Operating revenues
  $ 38,220     $ 31,506  
Gas Purchased
    24,717       19,621  
 
           
Gross Margin
    13,503       11,885  
Operating expenses
    6,616       5,957  
 
           
Operating income
    6,887       5,928  
Other income
    195       173  
 
           
Income before interest and taxes
    7,082       6,101  
Interest (expense)
    (387 )     (568 )
 
           
 
               
Income before income taxes
    6,695       5,533  
Income tax (expense)
    (2,436 )     (1,801 )
 
           
Net Income
  $ 4,259     $ 3,732  
 
           

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Operating Revenues
                 
    Three Months Ended March 31,  
($ in thousands)   2011     2010  
Full Service Distribution Revenues
               
Residential
  $ 18,603     $ 15,612  
Commercial
    16,062       12,549  
Industrial
    224       205  
Other
    36       128  
 
           
Total full service distribution
    34,925       28,494  
 
               
Transportation
    3,007       2,724  
Bucksport
    288       288  
 
           
 
               
Total operating revenues
  $ 38,220     $ 31,506  
 
           
Utility Throughput
                 
    Three Months Ended March 31,  
(in million cubic feet (MMcf))   2011     2010  
Full Service Distribution
               
Residential
    2,164       1,837  
Commercial
    1,950       1,599  
Industrial
    40       45  
 
           
Total full service
    4,154       3,481  
 
               
Transportation
    2,684       2,046  
Bucksport
    3,801       3,749  
 
           
 
               
Total Volumes
    10,639       9,276  
 
           
Degree Days
                                         
            Three Months Ended     Percent (Warmer) Colder  
            March 31,     2011 Compared to  
    Normal     2011     2010     Normal     2010  
Great Falls, MT
    3,224       3,662       2,921       13.59 %     25.37 %
Cody, WY
    3,030       3,277       3,079       8.15 %     6.43 %
Bangor, ME
    3,735       3,808       3,101       1.95 %     22.80 %
Elkin, NC
    2,117       2,096       2,113       (0.99 %)     (0.80 %)
Youngstown, OH
    3,259       3,308       2,971       1.50 %     11.34 %
Quarter Ended March 31, 2011 Compared with Quarter Ended March 31, 2010
Revenues and Gross Margin
Operating revenues for the three months ended March 31, 2011 increased to approximately $38.2 million from approximately $31.5 million in the three months ended March 31, 2010. This $6.7 million increase is the result of three factors :

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  1)   Revenue from our Montana and Wyoming markets increased $2.6 million on a volume increase of 386 MMcf in the three months ended March 31, 2011 compared to the three months ended March 31, 2010, due to colder than normal weather throughout the three months.
 
  2)   Revenue from our Maine and North Carolina markets increased by approximately $1.5 million on a volume increase of 294 MMcf in 2011 compared to 2010, due primarily to increased customer count and colder weather in our Maine market in the 2011 period.
 
  3)   Revenues from the Ohio Companies increased $2.6 million on a volume increase of 682 MMcf, due to colder weather in 2011 than in 2010 and increases in sales volumes to a customer whose rates are not based on volumes.
Gas purchases in natural gas operations increased to approximately $24.7 million for the three months ended March 31, 2011 from approximately $19.6 million for the three months ended March 31, 2010. The increase of $5.1 million is due primarily to the increase in sales volumes discussed above. Our gas costs are passed on dollar for dollar to our customers under tariffs regulated by the Public Utility Commissions in the jurisdictions in which we operate. Our gas costs are subject to periodic audits and prudency review in all of these jurisdictions.
Gross margin increased to approximately $13.5 million for the three months ended March 31, 2011 from approximately $11.9 million for the three months ended March 31, 2010, an increase of $1.6 million. The cold weather and increased sales discussed above are the primary drivers of the increase. Montana and Wyoming accounted for $371,000 of the increase, Maine and North Carolina $760,000 and the Ohio Companies $487,000.
Earnings
The Natural Gas Operations segment’s earnings for the three months ended March 31, 2011 were $4.3 million, or $0.52 per diluted share, compared to earnings of $3.7 million or $0.62 per diluted share for the three months ended March 31, 2010.
Operating expenses increased by $659,000 to approximately $6.6 million for the three months ended March 31, 2011 from approximately $6.0 million for the three months ended March 31, 2010. The increase is due to increases in administrative expenses including salaries and professional services, and increases in depreciation due to the increases in capital expenditures, offset partially by a decrease in taxes other than income.
Other Income increased by $22,000 to $195,000 for the three months ended March 31, 2011 from $173,000 for the three months ended March 31, 2010.
Interest expense decreased by $181,000 to $387,000 for the three months ended March 31, 2011 from $568,000 for the three months ended March 31, 2010. The Ohio Companies had less debt outstanding in the three months ended March 31, 2011 because of the debt that was repaid in November 2010, resulting in lower interest expense.
Income tax expense increased by $634,000 to approximately $2.4 million in the three months ended March 31, 2011 compared with approximately $1.8 million in the three months ended March 31, 2010. The three months ended March 31, 2010 included an income tax benefit of $190,000 from an adjustment to true up the deferred tax balances for a change in the effective tax rate for 2010. The remaining increase is due primarily to the increase in pre-tax income in 2011 compared to 2010.

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MARKETING AND PRODUCTION OPERATIONS (EWR)
Income Statement
                 
    Three Months Ended,  
($ in thousands)   2011     2010  
Energy West Resources
               
Operating revenues
  $ 1,825     $ 3,118  
Gas Purchased
    1,399       2,591  
 
           
Gross Margin
    426       527  
Operating expenses
    199       177  
 
           
Operating income
    227       350  
Other expense
    (63 )     (460 )
 
           
Income before interest and taxes
    164       (110 )
Interest (expense)
    (23 )     (20 )
 
           
Income before income taxes
    141       (130 )
Income tax (expense) benefit
    (55 )     51  
 
           
Net Income
  $ 86     $ (79 )
 
           
Quarter Ended March 31, 2011 Compared with Quarter Ended March 31, 2010
Revenues and Gross Margin
Revenues decreased approximately $1.3 million to $1.8 million for the three months ended March 31, 2011 from approximately $3.1 million for the three months ended March 31, 2010. $1.2 million of this decrease is due primarily to lower sales volumes in our Wyoming market and a lower overall price for volumes sold. Production revenues decreased by $100,000 due to lower volumes produced and a lower price received for these volumes.
Gross margin decreased $101,000 to approximately $426,000 in the three months ended March 31, 2011 from approximately $527,000 in the three months ended March 31, 2010. Gross margin from retail gas decreased by $27,000 due to the lower sales volumes and gross margin from gas production decreased by $74,000.
Earnings
The Marketing and Production segment’s earnings in the three months ended March 31, 2011 were $86,000 or $0.01 per diluted share, up from the loss of $79,000 or ($0.01) per diluted share in the three months ended March 31, 2010.
Our operating expenses increased approximately $22,000, to $199,000 in the three months ended March 31, 2011 from $177,000 in the three months ended March 31, 2010, due primarily to increased salaries and professional services expenses in the three months ended March 31, 2011.
Other expense totaled $63,000 in the three months ended March 31, 2011, and is directly related to the loss incurred on our equity investment in Kykuit. This compares to expense of $460,000 in the three months ended March 31, 2010, which is caused by expense related to the conclusion of the lawsuit with Shelby Gas Association of $441,000 and a loss on our equity investment in Kykuit of $194,000.
Income tax expense increased approximately $106,000 to an expense of $55,000 in the three months ended March 31, 2011 from a benefit of $51,000 in the three months ended March 31, 2010. The increase is due to the change to pre-tax income of $141,000 in 2011 from the pre-tax loss of $130,000 in 2010.

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PIPELINE OPERATIONS
Income Statement
                 
    Three Months Ended March 31,  
($ in thousands)   2011     2010  
Pipeline Operations
               
Operating revenues
  $ 106     $ 109  
Gas Purchased
           
 
           
Gross Margin
    106       109  
 
           
Operating expenses
    42       45  
 
           
Operating income
    64       64  
Other income
           
 
           
Income before interest and taxes
    64       64  
Interest (expense)
    (3 )     (5 )
 
           
Income before income taxes
    61       59  
Income tax (expense)
    (24 )     (23 )
 
           
Net Income
  $ 37     $ 36  
 
           
Quarter Ended March 31, 2011 Compared with Quarter Ended March 31, 2010
     Net income stayed flat at approximately $37,000 in the three months ended March 31, 2011 compared to approximately $36,000 in the three months ended March 31, 2010. The overall impact of the results of our pipeline operations was not material to our results of consolidated operations.
CORPORATE AND OTHER OPERATIONS
Income Statement
                 
    Three Months Ended March 31,  
($ in thousands)   2011     2010  
Corporate and Other
               
Operating revenues
  $     $  
Gas Purchased
             
 
           
Gross Margin
           
Operating expenses
    9       3  
 
           
Operating loss
    (9 )     (3 )
Other (expense) income
    (80 )     36  
 
           
(Loss) Income before interest and taxes
    (89 )     33  
Interest expense
           
 
           
(Loss) Income before income taxes
    (89 )     33  
Income tax benefit (expense)
    (18 )     (59 )
 
           
Net Loss
  $ (107 )   $ (26 )
 
           
Quarter Ended March 31, 2011 Compared with Quarter Ended March 31, 2010
Our Corporate and Other reporting segment is intended primarily to encompass the results of corporate acquisitions and other equity transactions, as well as certain other income and expense items associated with Gas Natural’s holding company functions. Therefore, it does not have standard revenues, gas purchase costs, or gross margin.

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Results of corporate and other operations for the three months ended March 31, 2011 include administrative costs of $9,000, costs related to acquisition activities of $83,000,and income tax expense of $18,000, offset by interest income of approximately $3,000, for a net loss of approximately $107,000.
Results of corporate and other operations for the three months ended March 31, 2010 include dividends from marketable securities of approximately $81,000, offset by administrative costs of $2,500, costs related to acquisition activities of $46,000, and the related income taxes expense of $59,000, for a net loss of approximately $26,000.
Sources and Uses of Cash
Operating activities provide our primary source of cash. Cash provided by operating activities consists of net income (loss) adjusted for non-cash items, including depreciation, depletion, amortization, deferred income taxes, and changes in working capital.
Our ability to maintain liquidity depends upon our $20.0 million credit facility with Bank of America, shown as line of credit on the accompanying balance sheets. Our use of the Bank of America revolving line of credit was $11.0 million and $18.1 million at March 31, 2011 and December 31, 2010, respectively. This change in our cash position is due to the withdrawal of our gas storage inventory to furnish a portion of our gas supply needs and the seasonal increase in cash inflow from the winter heating season, causing cash to be available to pay down the line of credit.
We made capital expenditures for continuing operations of $2.8 million and $1.1 million for the quarters ended March 31, 2011 and 2010, respectively. We finance our capital expenditures on an interim basis by the use of our operating cash flow and use of the Bank of America revolving line of credit.
We periodically repay our short-term borrowings under the Bank of America revolving line of credit by using the net proceeds from the sale of long-term debt and equity securities. Long-term debt was $22.6 million and $22.9 million at March 31, 2011 and December 31, 2010, respectively.
Cash increased slightly to $13.1 million at March 31, 2011, compared with $13.0 million at December 31, 2010.
                 
    For the Quarter Ended March 31,  
    2011     2010  
Cash provided by operating activities
  $ 11,545,000     $ 9,884,000  
Cash used in investing activities
    (2,964,000 )     (753,000 )
Cash used in financing activities
    (8,503,000 )     (8,550,000 )
 
           
(Decrease) Increase in cash
  $ 78,000     $ 581,000  
 
           
OPERATING CASH FLOW
For the quarter ended March 31, 2011, cash provided by operating activities increased $1.7 million as compared to the quarter ended March 31, 2010. Items affecting the use of cash included a decrease in accounts receivable collections of $5.7 million, a $3.5 million increase in collections of recoverable costs of gas, a $2.0 million decrease in unbilled revenue, a $1.5 million increase in net deferred tax assets, and decreased amounts paid for other assets and liabilities of $1.3 million. Other changes to cash resulted from a decrease in amounts paid on accounts payable of $1.0 million, an increase in net income of $600,000, a decrease in amounts paid for gas supply of $100,000, a $100,000 increase in depreciation expense, and a $100,000 decrease in prepayments.
INVESTING CASH FLOW
For the quarter ended March 31, 2011, cash used in investing activities increased by $2.2 million as compared to the quarter ended March 31, 2010, primarily due to increased construction expenditures of $1.7 million. Other changes include a $302,000 decrease in proceeds from the sale of marketable securities, a $144,000 decrease in cash acquired in acquisitions, a $98,000 decrease in purchases of noncontrolling interests, an $80,000 increase in investments in our unconsolidated affiliate, and a $68,000 decrease in customer advances for construction.

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Capital Expenditures
Our capital expenditures for continuing operations totaled $2.8 million and $1.1 million for the quarters ended March 31, 2011 and 2010, respectively. We finance our capital expenditures on an interim basis by the use of our operating cash flow and use of the Bank of America revolving line of credit.
The majority of our capital spending is focused on the growth of our Natural Gas Operations segment. We conduct ongoing construction activities in all of our utility service areas in order to support expansion, maintenance, and enhancement of our gas pipeline systems. We are actively expanding our systems in North Carolina and Maine to meet the high customer interest in natural gas service in those two service areas.
Estimated Capital Expenditures
The table below details our capital expenditures for the three months ended March 31, 2011 and 2010 and provides an estimate of future cash requirements for capital expenditures:
                         
                    Estimated Future  
    Quarter ended March 31,     Cash Requirements  
($ in thousands)   2011     2010     2011  
Natural Gas Operations
  $ 2,807     $ 1,133     $ 12,123  
Marketing and Production
                 
Pipeline Operations
                114  
Corporate and Other
    5             88  
 
                 
 
Total Capital Expenditures
  $ 2,812     $ 1,133     $ 12,325  
 
                 
FINANCING CASH FLOW
For the quarter ended March 31, 2011, cash used in financing activities decreased by $47,000 as compared with the quarter ended March 31, 2010. The primary reason for this is a decrease in repayments of other short-term borrowings of $445,000, partially offset by a $281,000 increase in dividends paid as a result of the secondary offering in November 2010. Additionally, net line of credit proceeds decreased by $98,000, while payments on long-term debt increased by $19,000.
We fund our operating cash needs, as well as dividend payments and capital expenditures, primarily through cash flow from operating activities and short-term borrowing. Historically, to the extent cash flow has not been sufficient to fund these expenditures, we have used our working capital line of credit. We have greater need for short-term borrowing during periods when internally generated funds are not sufficient to cover all capital and operating requirements, including costs of gas purchased and capital expenditures. In general, our short-term borrowing needs for purchases of gas inventory and capital expenditures are greatest during the summer and fall months and our short-term borrowing needs for financing customer accounts receivable are greatest during the winter months. Our ability to maintain liquidity depends upon our $20.0 million credit facility with Bank of America, shown as line of credit on the accompanying balance sheets. Our use of the Bank of America revolving line of credit was $11.0 million and $18.1 million at March 31, 2011 and December 31, 2010, respectively. In addition to cash flow from operations, we periodically repay our short-term borrowings under the Bank of America revolving line of credit by using the net proceeds from the sale of long-term debt and equity securities. Long-term debt was $22.6 and $22.9 million at March 31, 2011, and December 31, 2010, respectively.
Secondary Public Offering
In November 2010, Gas Natural completed a 2.415 million share secondary public offering. Of these shares, 340,000 were selling shareholder shares and 2.075 million were primary shares. The primary shares sold by Gas Natural include a full exercise of the over-allotment option. Gas Natural did not receive any of the proceeds from the selling shareholder shares. Net proceeds to Gas Natural were approximately $19.0 million after sales concessions, underwriting expenses, and deal expenses. The primary uses of proceeds are for investment in utility operations as we continue to expand our organic footprint. Additionally, proceeds were used to repay debt of the Ohio utilities.
In December 2010, NEO repaid upon maturity the Citizens Bank Line of Credit in the amount of $2.1 million and Orwell repaid upon maturity the, Huntington Bank Line of Credit in the amount of $1.5 million and the Huntington Bank Term Loan in the amount of $4.1 million. These notes were secured by all assets of the Ohio utilities, as well as a personal guarantee from our chairman and CEO. These three instruments matured at the end of November 2010. These notes were repaid and extinguished with no ability to redraw at this time. In addition to these notes that had a pending maturity date, a related party demand note was also repaid in December 2010.

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Lightning Pipeline Company, the intermediate holding company for Orwell, had a $2.0 million unsecured demand note payable with our chairman, which was repaid in December of 2010, including accrued interest.
SunLife Senior Secured Notes
On May 3, 2011, the Company and its Ohio subsidiaries, NEO, Orwell and Brainard, (together “the Issuers”), issued $15.334 million of 5.38% Senior Secured Guaranteed Fixed Rate Notes due June 1, 2017. Additionally, Great Plains issued $3.0 million of 4.12% Senior Secured Guaranteed Floating Rate Notes due May 3, 2014. Both notes were placed with SunLife Assurance Company of Canada.
The first note, in the amount of $15.334 million, is a joint obligation of the Issuers, and is guaranteed by the Company, Lightning Pipeline, and Great Plains (together with the Issuers, the “Fixed Rate Obligors”). This note received approval from the PUCO on March 30, 2011. The note is governed by a Note Purchase Agreement (“NPA”) as filed with the SEC on Form 8-K on November 2, 2010. Concurrent with the funding and closing of this transaction, which occurred on May 3, 2011, the Fixed Rate Obligors signed an amended Note Purchase Agreement that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is subject to a 50 basis point make- whole premium.
The second note in the amount of $3.0 million, is an obligation of Great Plains and is guaranteed by the Company (together, the “Floating Rate Obligors”). The note is priced at a fixed spread of 385 basis points over three month London Interbank Offered Rate (“LIBOR”). Pricing for this note will reset on a quarterly basis to the then current yield of three month Libor. The note is governed by a Note Purchase Agreement as filed with the SEC Form on 8-K on November 2, 2010. Concurrent with the funding of this transaction, which occurred on May 3, 2011, the Floating Rate Obligors signed an amended Note Purchase Agreement that is substantially the same as the NPA released on November 2, 2010. Prepayment of this note prior to maturity is at par.
Payments for both notes prior to maturity are interest-only.
The notes carry a 60% debt-to-capitalization financial covenant on a consolidated basis for Ohio, as well as, a 2.0x interest coverage test based on a trailing twelve-month basis. Additional covenants customary for asset sales and purchases, additional indebtedness, dividends, change of control and other matters are also included.
The use of proceeds for both notes are to repay and extinguish existing amortizing bank debt and other existing indebtedness, fund $3.4 million for the 2011 capital program for Orwell and NEO, establish two debt service reserve accounts, replenish the Company’s treasuries for the previously announced repayment of maturing bank debt, and transaction expenses.
The following discussion describes our credit facilities as of March 31, 2011, prior to the repayment of the Citizens debt and completion of the SunLife financing.
Bank of America
On June 29, 2007, Energy West established a new five-year unsecured credit facility with Bank of America for $20.0 million which replaced a previous one-year facility with Bank of America for the same amount. The current credit facility includes an annual commitment fee equal to 0.20% of the unused portion of the facility and interest on amounts outstanding at LIBOR, plus 120 to 145 basis points, for interest periods selected by us.
The following table represents borrowings under the Bank of America revolving line of credit for each of the quarters ended March 31, 2011 and 2010.
         
Quarter Ended March 31, 2011
       
Minimum borrowing
  $ 9,700,000  
Maximum borrowing
  $ 18,150,000  
Average borrowing
  $ 13,852,000  
 
       
Quarter Ended March 31, 2010
       
Minimum borrowing
  $ 7,298,000  
Maximum borrowing
  $ 14,650,000  
Average borrowing
  $ 10,218,000  
Senior Unsecured Notes
On June 29, 2007, Energy West issued $13.0 million aggregate principal amount of our 6.16% Senior Unsecured Notes, due June 29, 2017. The proceeds of these notes were used to refinance our existing notes. With this refinancing, we expensed the remaining debt

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issue costs of $991,000 in fiscal 2007, and incurred approximately $463,000 in new debt issue costs to be amortized over the life of the new note. Our 6.16% Senior Unsecured Note and Bank of America credit facility agreements contain various covenants, which include, among others, limitations on total dividends and distributions made in the immediately preceding 60-month period to 75% of aggregate consolidated net income for such period, restrictions on certain indebtedness, limitations on asset sales, and maintenance of certain debt-to-capital and interest coverage ratios.
At March 31, 2011 and December 31, 2010, we had $11.0 million and $18.1 million of borrowings under the $20.0 million Bank of America revolving line of credit. Our short-term borrowings under our line of credit during the years ended March 31, 2011 and 2010 had a daily weighted average interest rate of 1.64% and 3.20% per annum, respectively.
Our 6.16% Senior Unsecured Note and Bank of America credit facility agreements contain various covenants, which include, among others, limitations on total dividends and distributions made in the immediately preceding 60-month period to 75% of aggregate consolidated net income for such period, restrictions on certain indebtedness, limitations on asset sales, and maintenance of certain debt-to-capital and interest coverage ratios.
Citizens Bank Credit Facility and Term Loans
In connection with our acquisition of our Ohio operations, NEO, Great Plains and GPL each entered modifications/amendments to its credit facility with Citizens Bank (the Citizens Credit Facility). The Citizens Credit Facility consists of a revolving line of credit and term loan to NEO, and two other term loans to Great Plains and GPL respectively. Each amendment/modification was initially effective as of December 1, 2009, but was later modified to be effective as of January 5, 2010. Gas Natural guaranteed each loan. Our chairman and chief executive officer, Richard M. Osborne, guaranteed each loan both individually and as trustee of the RMO Trust, and Great Plains guarantees NEO’s revolving line of credit and term loan as well as GPL’s term note. The line of credit was repaid in December 2010.
Long-term Debt — $10.3 million 5.00% Senior Secured Notes — NEO’s, Great Plains’ and GPL’s term loans with Citizens Bank are in the amounts of $7.8 million, $2.65 million and $892,000 respectively. Each term note has a maturity date of July 1, 2013 and bears interest at an annual rate of 30-day LIBOR (Eurodollar) plus 400 basis points with an interest rate floor of 5.00% per annum. At March 31, 2011, the interest rate was 5.00% per annum. The term notes require monthly payments of approximately $63,000 in the aggregate.
The Citizens Credit Facility requires Great Plains, GPL and NEO to maintain a debt service coverage ratio of at least 1.25 to 1.0 measured quarterly on a rolling four quarter basis. The Citizens Credit Facility also requires NEO, Great Plains and GPL to maintain a minimum net worth, on a combined basis, equal to the sum of $1,815,000 plus 100% of net income less the pro-rata share of any dividend paid to Gas Natural Inc., measured on a quarterly basis beginning with the quarter ended December 31, 2009. The Citizens Credit Facility allows NEO, Great Plains and GPL to pay dividends to Gas Natural Inc. If those entities’ combined net worth (as defined in the Citizens loan documents) after payment of any dividends would not be less than $1,815,000 on a consolidated basis as positively increased by 100% of net income as of the end of each fiscal quarter and fiscal year.
At March 31, 2011 and December 31, 2010, $6.4 million and $6.6 million had been borrowed under the NEO term loan, $2.2 million and $2.2 million under the Great Plains term loan, and $738,000 and $753,000 under the GPL term loan, respectively.
Combined Term Loans and Credit Facilities
The $11.0 million of borrowings at March 31, 2011, leaves our borrowing capacity at $9.0 million. Including the amounts related to the Ohio Companies, we had $11.0 million of borrowings and borrowing capacity of $9.0 million. As discussed above, this level of borrowings is due primarily to increases in our capital expenditures due to expansion in our North Carolina and Maine markets, and the acquisition of the Ohio Companies.
The cash flow from our business is seasonal and the line of credit balance in December normally represents the high point of borrowings in our annual cash flow cycle. Our cash flow increases and our borrowings decrease, beginning in January, as monthly heating bills are paid and the gas we paid for and placed in storage in the summer months is used to supply our customers. The total amount outstanding under all of our long term debt obligations was approximately $22.6 million at March 31, 2011, with approximately $879,000 due within one year.
We believe we are in compliance with the financial covenants under our debt agreements or have received waivers for any defaults.

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OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance-sheet arrangements, other than those currently disclosed that have or are reasonably likely to have a current or future effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to certain market risks, including commodity price risk (i.e., natural gas prices) and interest rate risk. The adverse effects of potential changes in these market risks are discussed below. The sensitivity analyses presented do not consider the effects that such adverse changes may have on overall economic activity nor do they consider additional actions management may take to mitigate our exposure to such changes. Actual results may differ. See the Notes to our Consolidated Financial Statements for a description of our accounting policies and other information related to these financial instruments.
Commodity Price Risk
We seek to protect ourself against natural gas price fluctuations by limiting the aggregate level of net open positions that are exposed to market price changes. We manage such open positions with policies that are designed to limit the exposure to market risk, with regular reporting to management of potential financial exposure. Our risk management committee has limited the types of contracts we will consider to those related to physical natural gas deliveries. Therefore, management believes that although revenues and cost of sales are impacted by changes in natural gas prices, our margin is not significantly impacted by these changes.
Credit Risk
Credit risk relates to the risk of loss that we would incur as a result of non-performance by counterparties of their contractual obligations under the various instruments with us. Credit risk may be concentrated to the extent that one or more groups of counterparties have similar economic, industry or other characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in market or other conditions. In addition, credit risk includes not only the risk that a counter-party may default due to circumstances relating directly to it, but also the risk that a counterparty may default due to circumstances that relate to other market participants that have a direct or indirect relationship with such counterparty. We seek to mitigate credit risk by evaluating the financial strength of potential counterparties. However, despite mitigation efforts, defaults by counterparties may occur from time to time. To date, no such default has occurred.
ITEM 4 -CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of March 31, 2011, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. The evaluation was carried out under the supervision of and with the participation of our management, including our principal executive officer and principal financial officer. Based upon this evaluation, our chief executive officer and chief financial officer each concluded that our disclosure controls and procedures were effective as of March 31, 2011.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1 — LEGAL PROCEEDINGS
From time to time, we are involved in lawsuits that have arisen in the ordinary course of business. We are contesting each of these lawsuits vigorously and believe we have defenses to the allegations that have been made.

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ITEM 6 — EXHIBITS
     
Exhibit Number   Description
31.1*
  Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2*
  Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1*
  Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
   
32.2*
  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
*   Filed or furnished herewith.

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SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  Gas Natural Inc.
 
 
  /s/ Thomas J. Smith    
  Thomas J. Smith   
May 11, 2011  Chief Financial Officer
(principal financial officer
and principal accounting officer) 
 
 

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