RGC Resources - 10-Q quarterly report FY2015 Q1

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Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

Forward-looking statements reflect the Company’s current expectations only as of the date they are made. The Company assumes no duty to update these statements should expectations change or actual results differ from current expectations except as required by applicable laws and regulations.

The three-month earnings presented herein should not be considered as reflective of the Company’s consolidated financial results for the fiscal year ending September 30, 2015. The total revenues and margins realized during the first three months reflect higher billings due to the weather sensitive nature of the gas business.

Resources also provides certain unregulated services through Roanoke Gas and its other subsidiaries. Such unregulated operations represent less than 3% of total revenues and margin of Resources on an annual basis.

The Company’s utility operations are regulated by the SCC, which oversees the terms, conditions, and rates to be charged to customers for natural gas service, safety standards, extension of service, accounting and depreciation. The Company is also subject to federal regulation from the Department of Transportation in regard to the construction, operation, maintenance, safety and integrity of its transmission and distribution pipelines. The Federal Energy Regulatory Commission regulates the prices for the transportation and delivery of natural gas to the Company’s distribution system and underground storage services. The Company is also subject to other regulations which are not necessarily industry specific.

The SCC authorizes the rates and fees that the Company charges its customers for regulated natural gas service. The Company has in place certain approved rate mechanisms that reduce some of the volatility in earnings associated with variations in winter weather and the cost of natural gas.

Roanoke Gas has in place a weather normalization adjustment mechanism (“WNA”) based on a weather measurement band around the most recent 30-year temperature average (“normal"). Because the SCC authorizes billing rates for the utility operations of Roanoke Gas based on normal weather, warmer than normal weather may result in the Company failing to earn its authorized rate of return. Therefore, the WNA provides the Company with a level of earnings protection when weather is warmer than normal and provides its customers with a level of price protection when the weather is colder than normal. Prior to April 2014, the WNA provided for a weather band of 3% above and below normal, whereby the Company would bill its customers for the lost margin (excluding gas costs) for the impact of weather that was more than 3% warmer than normal or refund customers the excess margin earned for weather that was more than 3% colder than normal. No adjustment was made for weather that fell within the 3% weather band. Effective with the WNA period that began April 1, 2014, the SCC removed the 3% weather band from the WNA mechanism. This change will now result in either a recovery or refund of revenues due to

any weather variations from normal. For the quarter ended December 31, 2014, weather was nearly 3% colder than normal, which based on the WNA mechanism resulted in the billing of more than 50,000 additional decatherms above what would have been expected based on normal. These additional volumes generated approximately $109,000 in margin. As a result, the Company recorded a reserve during the quarter for the excess revenues billed. For the current WNA year that began April 1, 2014, weather has been approximately 1% warmer than normal, resulting in a net accrual of approximately $35,000 in additional margin for the nine-month period. For the quarter ended December 31, 2013, weather was approximately 1% colder than normal. As the Company was still under the provisions of the 3% weather band at that time, the Company did not record a WNA adjustment for that period. The WNA mechanism significantly reduces the impact to the Company for the effect of weather that is different from normal.

The Company also has an approved rate structure in place that mitigates the impact of financing costs of its natural gas inventory. Under this rate structure, Roanoke Gas recognizes revenue for the financing costs, or “carrying costs,” of its investment in natural gas inventory. The carrying cost revenue factor applied to the cost of inventory is based on the Company’s weighted-average cost of capital including interest rates on short-term and long-term debt and the Company’s authorized return on equity. During times of rising gas costs and rising inventory levels, the Company recognizes revenues to offset higher financing costs associated with higher inventory balances. Conversely, during times of decreasing gas costs and lower inventory balances, the Company recognizes less inventory carrying cost ("ICC") revenue as financing costs are lower. In addition, ICC revenues are impacted by the changes in the weighting of the components that are used to determine the weighted average cost of capital. Although the average unit price of gas in storage during the first three months of the current fiscal year was $0.60, or 15%, per decatherm higher than for the same period last year, and average inventory levels were more than 4% higher, ICC revenues increased by less than $20,000 as the weighted-average cost of capital declined due to the refinancing of the Company's long-term debt in September and the effect of higher levels of low interest rate short-term borrowings under the Company's line-of-credit.

Generally, as investment in natural gas inventory increases so does the level of borrowing under the Company’s line-of-credit. However, as the carrying cost factor used in determining carrying cost revenues is based on the Company’s weighted-average cost of capital, carrying cost revenues do not directly correspond with incremental short-term financing costs. Therefore, when investment in inventory declines due to a reduction in commodity prices, net income will be negatively affected as carrying cost revenues decrease by a greater amount than short-term financing costs decrease. The inverse occurs when inventory costs increase.

The tables below reflect operating revenues, volume activity and heating degree-days.

Regulated natural gas margins from utility operations increased from the same period last year primarily as a result of SAVE Plan revenues, higher customer base charges and volumetric margins on customer growth partially offset by the WNA adjustment. SAVE Plan revenues increased by approximately $219,000 related to the infrastructure upgrades to the Company's distribution pipelines and liquified natural gas ("LNG") plant in the absence of a non-gas rate increase. In addition, residential and commercial volumes increased by 4% on 2% colder weather. The WNA adjustment, as discussed above, effectively reduced the margin on about 50,000 decatherms, or $109,000, of the higher sales. The remaining increase is related to customer growth and one large commercial customer that began operations in 2014. Customer base charges, a flat monthly fee billed to each natural gas customer, also increased due to the related customer growth.

The components of the change in gas utility margin are summarized below:

Other margins increased by $24,460 from the same period last year primarily due to improved margins under the Company's non-gas contracts. Much of the other revenues and margins are subject to variations in the level of activity and generally are associated with service contracts that have a limited duration or are subject to renewal on an annual or semi-annual basis. Any continuation of these contracts beyond their current expiration dates is uncertain.

Operation and maintenance expenses increased by $81,302, or 2%, as higher labor, contracted services and benefit costs more than offset higher capitalization of overheads. Total labor and contracted services increased by $55,000 related to slightly higher employee count. Benefit costs increased by $170,000 primarily due to higher health insurance premiums and increased

pension and postretirement medical costs related to the amortization of higher actuarial losses. The higher operating costs were partially mitigated by the capitalization of $138,000 more in corporate and benefit overheads related to the Company's pipeline renewal program and enhancements to the LNG plant during the quarter. The remaining differences were related to various minor fluctuations in other expenses.

General taxes increased by $17,313, or 4%, primarily due to higher property taxes associated with increases in utility property and higher payroll taxes.

Other expense, net, decreased by $19,256 primarily due to timing of charitable contributions.

Interest declined by $67,386, or 15%, due to the refinancing of the Company's debt in September 2014 at a lower average interest rate, which more than offset the interest on increased line-of-credit utilization.

Income tax expense increased by $126,760, which corresponds to the increase in pre-tax income for the quarter. The effective tax rate was 38% for the three months ended December 31, 2014 and 2013, respectively.

The Company considers an estimate to be critical if it is material to the financial statements and it requires assumptions to be made that were uncertain at the time the estimate was made and changes in the estimate are reasonably likely to occur from period to period. There have been no changes to the critical accounting policies as reflected in the Company’s Annual Report on Form 10-K for the year ended September 30, 2014.

Cash and cash equivalents decreased by $149,818 for the three-month period ended December 31, 2014 compared to a $2,349,305 decrease for the same period last year. The following table summarizes the sources and uses of cash:

The seasonal nature of the natural gas business causes operating cash flows to fluctuate significantly during the year as well as from year to year. Factors including weather, energy prices, natural gas storage levels and customer collections contribute to working capital levels and the related cash flows. Generally, operating cash flows are positive during the second and third quarters as a combination of earnings, declining storage gas levels and collections on customer accounts all contribute to higher cash levels. During the first and fourth quarters, operating cash flows generally decrease due to increases in natural gas storage levels, rising customer receivable balances and construction activity.

For the three months ended December 31, 2014, cash flow used in operations was $1,415,018 compared to $1,269,372 for the same period last year. As mentioned above, the primary reason for operating activities being in a use of cash position during the first quarter is due to the significant increase in accounts receivable associated with the much higher billings during the winter months. In addition, the Company began drawing down its storage gas balances to meet winter demand which provided cash from operations. The Company also had a significant change between deferred and current taxes during the current quarter. In December 2014, the President signed into law a tax extenders bill, which provided for the continuation of bonus depreciation that had expired December 31, 2013. The tax provision for the Company's fiscal year ended September 30, 2014 did not include consideration of bonus depreciation since Congress had not acted and the President had not signed the bill into law until after the release of the financial statements. As a result, the Company increased its deferred tax liability by more than $1.5 million and prepaid income taxes by the same amount to reflect the impact of bonus depreciation on fiscal 2014. This change had no effect on income tax expense or net income. Investing activities are generally composed of expenditures under the Company’s construction program, which primarily involves replacing aging bare steel and cast iron pipe with new plastic or coated steel pipe, improvements to the LNG plant, and expanding its natural gas system to meet the demands of customer growth. Cash flows used in investing activities increased by $295,466 as capital expenditures continued at high levels. In addition to the ongoing pipeline replacement program, the Company also completed the replacement of the LNG boil off compressor and focused on extending service to new customers. The Company currently expects to finish replacing the remaining bare steel and cast iron pipe within its natural gas distribution system in 2016 and then will shift efforts to replacing pre-1973 first generation plastic pipe with current polyethylene pipe. In addition, the Company is planning to upgrade its gate stations. As a result, capital expenditures are expected to remain at elevated levels over the next few years. Operating cash flows and corporate borrowing are expected to provide the funding for completing these projects.

Financing activities generally consist of long-term and short-term borrowings and repayments, issuance of stock and the payment of dividends. As discussed above, the Company uses its line-of-credit arrangement to fund seasonal working capital needs as well as provide temporary financing for capital projects. Cash flows provided by financing activities increased by $2,640,599 primarily due to the increased borrowing under the Company's line-of-credit agreement to fund the Company's capital expenditures. Due to the ongoing increased level of capital projects, corporate borrowing will continue to increase. The Company will use the line-of-credit for bridge financing and will evaluate the need and timing to convert some of the debt to more permanent financing.

The Company's line-of-credit agreement will expire on March 31, 2015, unless extended. The Company anticipates being able to extend or replace its current line-of-credit agreement upon expiration; however, there is no guarantee that the line-of-credit will be extended or replaced on terms comparable to those currently in place.

At December 31, 2014, the Company’s consolidated long-term capitalization was 64% equity and 36% debt. The Company's total consolidated capitalization including the line-of-credit was 54% equity and 46% debt.

At December 31, 2014, the Company had no outstanding derivative instruments to hedge the price of natural gas. The Company had 1,962,945 decatherms of gas in storage, including LNG, at an average price of $4.72 per decatherm compared to 1,839,592 decatherms at an average price of $4.13 per decatherm last year. The SCC currently allows for full recovery of prudent costs associated with natural gas purchases, as any additional costs or benefits associated with the settlement of derivative contracts and other price hedging techniques are passed through to customers when realized through the PGA mechanism.

As of December 31, 2014, the Company completed an evaluation, under the supervision and with the participation of management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2014.

Management routinely reviews the Company’s internal control over financial reporting and makes changes, as necessary, to enhance the effectiveness of the internal controls over financial reporting. There were no changes in the internal controls over financial reporting during the fiscal quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 1 – LEGAL PROCEEDINGS

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.