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RGCO > SEC Filings for RGCO > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for RGC RESOURCES INC


10-May-2013

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains forward-looking statements that relate to future transactions, events or expectations. In addition, RGC Resources, Inc. ("Resources" or the "Company") may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. These statements are based on management's current expectations and information available at the time of such statements and are believed to be reasonable and are made in good faith. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company's business include, but are not limited to those set forth in the following discussion and within Item 1A "Risk Factors" of the Company's 2012 Annual Report on Form 10-K. All of these factors are difficult to predict and many are beyond the Company's control. Accordingly, while the Company believes its forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. When used in the Company's documents or news releases, the words, "anticipate," "believe," "intend," "plan," "estimate," "expect," "objective," "projection," "forecast," "budget," "assume," "indicate" or similar words or future or conditional verbs such as "will," "would," "should," "can," "could" or "may" are intended to identify forward-looking 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 and six-month earnings presented herein should not be considered as reflective of the Company's consolidated financial results for the fiscal year ending September 30, 2013. The total revenues and margins realized during the first six months reflect higher billings due to the weather sensitive nature of the gas business. Improvement or decline in earnings for the balance of the fiscal year will depend primarily on weather conditions during the remaining spring months, improvement or deterioration in the local economic environment and the level of operating and maintenance costs during the remainder of the year.

Overview

Resources is an energy services company primarily engaged in the regulated sale and distribution of natural gas to approximately 59,200 residential, commercial and industrial customers in Roanoke, Virginia and the surrounding localities through its Roanoke Gas Company ("Roanoke Gas") subsidiary. Natural gas service is provided at rates and for terms and conditions set by the Virginia State Corporation Commission ("SCC").


RGC RESOURCES, INC. AND SUBSIDIARIES

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 significantly warmer than normal and provides its customers with price protection when the weather is significantly colder than normal. The WNA mechanism provides for a weather band of 3% above and below the 30-year 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. The annual WNA period extends from April to March. The Company had recorded approximately $182,000 in WNA revenues for the quarter ended December 31, 2012 as the weather for the nine-month WNA period ended December 31, 2012 was approximately 8% warmer than normal. Colder than normal weather during the quarter ended March 31, 2013 reduced the heating-degree deficit to within the 3% weather band; consequently, the WNA revenues accrued during the prior quarter were reversed. Weather during the same quarter last year and the prior 12 month WNA period was significantly warmer than normal, and the Company recorded approximately $1,163,000 and $1,740,000 in additional revenues in the corresponding three-month and six-month periods last year to reflect the impact of the WNA for weather that was 22% above the 30-year average. Although the WNA mechanism provides the Company with a method to recover margin not realized for warmer weather above the 3% weather band, the statistical models used in determining the WNA amount do not provide for a precise recovery of lost margin and therefore will vary in their results based not only on the magnitude of weather variation during the total WNA period but also on the variation for each month.


RGC RESOURCES, INC. AND SUBSIDIARIES

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 carrying cost revenue as financing costs are lower. As a result of the lower commodity price of natural gas delivered into storage during last year's summer storage injections, the average cost of gas in storage during the quarter and fiscal year-to-date declined by 24% and 26%, respectively, when compared to the same periods last year. The decline in the average value of inventory resulted in a reduction of $127,000 in carrying cost revenues for the quarter and $244,000 for the six month period compared to the same periods last year.

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.

Results of Operations

Three Months Ended March 31, 2013:

Net income increased by $215,400 for the quarter ended March 31, 2013 compared to the same period last year. Implementation of a non-gas rate increase and colder weather more than offset higher expenses and the absence of a WNA accrual.


RGC RESOURCES, INC. AND SUBSIDIARIES



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



                                            Three Months Ended
                                                March 31,
                                          2013              2012           Increase         Percentage

Operating Revenues
Gas Utilities                         $ 23,776,730      $ 21,021,336      $ 2,755,394                13 %
Other                                      398,908           268,891          130,017                48 %


Total Operating Revenues              $ 24,175,638      $ 21,290,227      $ 2,885,411                14 %


Delivered Volumes
Regulated Natural Gas (DTH)
Residential and Commercial               3,202,757         2,384,602          818,155                34 %
Transportation and Interruptible           815,187           790,395           24,792                 3 %


Total Delivered Volumes                  4,017,944         3,174,997          842,947                27 %


Heating Degree Days (Unofficial)             2,129             1,567              562                36 %

Total operating revenues for the three months ended March 31, 2013, compared to the same period last year, increased primarily due to a 27% increase in total natural gas deliveries associated with a 36% increase in heating degree days, partially offset by lower natural gas commodity prices. The per unit cost of natural gas reflected in the cost of sales decreased by 11% compared to last year.

                                Three Months Ended
                                     March 31,
                               2013            2012         Increase       Percentage

       Gross Margin
       Gas Utilities        $ 9,431,252     $ 8,984,049     $ 447,203                5 %
       Other                    154,475         134,473        20,002               15 %


       Total Gross Margin   $ 9,585,727     $ 9,118,522     $ 467,205                5 %

Regulated natural gas margins from utility operations increased from the same period last year primarily as a result of the implementation of a non-gas rate increase and higher delivered volumes more than offsetting a reduction in inventory carrying cost revenues. The increased natural gas base rates were effective for service rendered on and after November 1, 2012 and were designed to provide $649,639 in additional annual non-gas revenues, split between the customer base charge component and volumetric components, as provided for in the final order issued by the SCC. The additional margin generated by the significant increase in total natural gas deliveries due to much colder weather was mostly offset by last year's accrual of WNA


RGC RESOURCES, INC. AND SUBSIDIARIES

revenues for the quarter. As discussed above, the current WNA period ended March 31, 2013 resulted in weather that was less than 3% warmer than normal, which fell within the 3% weather band, thereby resulting in the reversal of the $182,000 accrual made December 31, 2012. Last year, the WNA period ended March 31, 2012 had weather that was 22% warmer than normal resulting in an accrual of $1,163,000 for the quarter. As a result, WNA revenues declined by $1,345,000 while at the same time total residential and commercial natural gas deliveries increased by 818,155 decatherms, or 34%, due to a 36% increase in the total number of heating degree days for the period. Industrial volumes, which tend to be less weather sensitive than residential and commercial volumes, reflected a 3% increase primarily due to weather.

The components of the gas utility margin increase are summarized below:

Net Margin Increase - Gas Utilities

                       Customer Base Charge   $     48,630
                       WNA                      (1,344,845 )
                       Carrying Cost              (126,790 )
                       Volumetric                1,804,677
                       SAVE Plan                    69,257
                       Other                        (3,726 )


                       Total                  $    447,203

Other margins increased by $20,002 over the same period last year primarily due to work related to a one-time contract that will be completed in the Company's third fiscal quarter. More than half of the revenues and margins included under the caption of "Other" are subject to variations in the level of activity and generally are associated with service contracts that have a limited duration and are subject to renewal on an annual or semi-annual basis. Current service contracts extend through the remainder of the fiscal year; however, any continuation beyond fiscal 2013 is uncertain.

Operation and maintenance expenses were nearly unchanged from the same period last year as higher corporate insurance premiums and labor costs offset increases in capitalized overheads and lower professional services. Corporate property and liability insurance increased by $24,000 due to higher premiums and increased general liability coverage limits. Operation and maintenance labor costs increased $33,000 due to an increase in office personnel levels. Professional services declined by $30,000 primarily due to legal expenses in the prior year related to the propane lawsuit. The remaining differences in operation and maintenance expenses were related to a $23,000 increase in capitalized overheads and various other minor fluctuations in other expenses.

General taxes increased by $35,328, or 10%, primarily due to higher property taxes associated with increases in utility property.


RGC RESOURCES, INC. AND SUBSIDIARIES

Depreciation expense increased by $56,989, or 5%, on a corresponding increase in utility plant investment primarily due to the distribution pipeline replacement program.

Other income (expense), net, moved from an income position to a net expense position due to the payoff of the note receivable from ANGD, LLC on February 1, 2013 as discussed in Note 4.

Interest expense remained virtually unchanged as the Company's total debt position has remained at the $28,000,000 level. The Company briefly accessed its line-of-credit in December and January to meet its cash needs.

Income tax expense increased by $137,799, which corresponds to the increase in pre-tax income for the quarter. The effective tax rate was 38% for the current period and prior period.

Six Months Ended March 31, 2013:

Net income decreased by $65,359 for the six months ended March 31, 2013 compared to the same period last year. Higher operation and maintenance expenses and depreciation more than offset implementation of a non-gas rate increase.

The table below reflects operating revenues, volume activity and heating degree days.

                                             Six Months Ended
                                                March 31,
                                          2013              2012           Increase         Percentage

Operating Revenues
Gas Utilities                         $ 42,235,469      $ 39,194,781      $ 3,040,688                 8 %
Other                                      686,761           594,622           92,139                15 %


Total Operating Revenues              $ 42,922,230      $ 39,789,403      $ 3,132,827                 8 %


Delivered Volumes
Regulated Natural Gas (DTH)
Residential and Commercial               5,209,908         4,189,221        1,020,687                24 %
Transportation and Interruptible         1,551,247         1,530,206           21,041                 1 %

Total Delivered Volumes 6,761,155 5,719,427 1,041,728 18 %

Heating Degree Days (Unofficial) 3,607 2,895 712 25 %

Total operating revenues for the six months ended March 31, 2013 compared to the same period last year increased due to significant increases in delivered volumes partially offset by lower cost of natural gas and the absence of WNA revenues. Total natural gas deliveries rose by 18% due to a 25% increase in heating degree days. In addition, declining natural gas commodity prices resulted in a 9% per unit reduction in the cost of natural gas reflected in cost of sales. Other revenues increased by 15%.


RGC RESOURCES, INC. AND SUBSIDIARIES



                               Six Months Ended
                                   March 31,                Increase/
                             2013             2012          (Decrease)        Percentage

    Gross Margin
    Gas Utilities        $ 17,239,530     $ 16,944,719     $    294,811                 2 %
    Other                     282,680          303,430          (20,750 )              -7 %


    Total Gross Margin   $ 17,522,210     $ 17,248,149     $    274,061                 2 %

Regulated natural gas margins from utility operations increased slightly over the same period last year due to several offsetting factors. Residential and commercial volumes (which tend to be more weather sensitive than transportation and industrial volumes) increased by 24% corresponding to a 25% increase in the number of heating degree days for the period. Industrial volumes were nearly unchanged from the same period last year. The margin increase generated by the higher volume activity, however, was mostly offset by the $1,740,000 WNA accrual last year due to much warmer weather as discussed above. In addition, the margin increase attributable to the implementation of the non-gas rate increase offset the reduction in inventory carrying cost revenues. The components of the regulated margin increase are summarized below:

Net Margin Increase - Gas Utilities



                       Customer Base Charge   $    112,704
                       WNA                      (1,740,151 )
                       Carrying Cost              (243,809 )
                       Volumetric                2,111,370
                       SAVE Plan                    69,257
                       Other                       (14,560 )


                       Total                  $    294,811

Other margins declined by $20,750 primarily due to reductions in the level of other services contract work during the first quarter.

Operation and maintenance expenses increased by $196,392, or 3%, for the six-month period ended March 31, 2013 compared to the same period last year. Higher labor, contracted services, professional services and corporate insurance costs more than offset increases in capitalized overheads. Labor and contracted services increased by $173,000 primarily due to timing of leak surveys, pipeline right-of-way clearing and similar services with most of the work completed during the first quarter. Professional services increased by $27,000 associated mainly with higher costs related to transitioning from smaller reporting company to accelerated filer status and information technology consulting assistance incurred during the first quarter. Corporate


RGC RESOURCES, INC. AND SUBSIDIARIES

property and liability insurance increased by $48,000 due to higher premiums and increased general liability coverage limits. These higher costs were partially offset by greater capitalization of overheads due to higher level of capital expenditures.

General taxes increased $55,983, or 8%, for the six-month period ended March 31, 2013 compared to the same period last year related to higher property taxes associated with increases in utility property.

Depreciation expense increased by $122,363, or 6%, corresponding to the increase in utility plant investment.

Other income (expense), net, was nearly unchanged as decreases in certain expenses offset the reduction in interest income due to the payoff of the ANGD note in February 2013.

Interest expense remained nearly unchanged as borrowing under the Company's line-of-credit was minimal during the period.

Income tax expense declined by $33,615, or 1%, which corresponds to the decrease in pre-tax income. The effective tax rate was 38% for both periods.

Critical Accounting Policies and Estimates

The consolidated financial statements of Resources are prepared in accordance with accounting principles generally accepted in the United States of America. The amounts of assets, liabilities, revenues and expenses reported in the Company's financial statements are affected by accounting policies, estimates and assumptions that are necessary to comply with generally accepted accounting principles. Estimates used in the financial statements are derived from prior experience, statistical analysis and professional judgments. Actual results may differ significantly from these estimates and assumptions.

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, 2012.

Asset Management

Roanoke Gas uses a third party as an asset manager to manage its pipeline transportation and storage rights and gas supply inventories and deliveries. In return for being able to utilize the excess capacities of the transportation and storage rights, the third party pays Roanoke Gas a monthly utilization fee, which is used to reduce the cost of gas for customers. The current agreement expires in October 2013. The Company is currently in process of rebidding the contract.


RGC RESOURCES, INC. AND SUBSIDIARIES

Regulatory

On November 1, 2012, Roanoke Gas Company placed into effect new base rates, subject to refund, that provide for approximately $1,840,000 in additional annual non-gas revenues. On March 21, 2013, the Company reached a stipulated agreement with the SCC staff for a non-gas rate award in the amount of $649,639 in additional annual non-gas revenues. On April 16, 2013, the SCC issued its final order approving the increase in annual non-gas revenues agreed to in the stipulation. The Company has recorded a provision for rate refund, including interest associated with customer billings, for the difference between the rates placed into effect on November 1 and those approved in the final order. Refunds to customers will be made during the Company's May billing cycle.

Beginning in January 2013, the Company started billing a separate rider on customer bills related to its SAVE (Steps to Advance Virginia's Energy) Plan. The SCC approved the Company's SAVE Plan application on July 25, 2012. The SAVE plan is designed to facilitate the accelerated replacement of aging natural gas infrastructure assets by providing the Company with a means to recover depreciation and related expenses and return on rate base of the additional capital investment without the filing of a formal application for an increase in non-gas base rates. The SAVE Plan provides the Company with a more timely mechanism for recovering the cost of its renewal program. Previously, the Company could only recover these expenses and return on rate base on a prospective basis after filing and implementing a non-gas rate increase.

Capital Resources and Liquidity

Due to the capital intensive nature of the utility business, as well as the related weather sensitivity, the Company's primary capital needs are the funding of its continuing construction program, the seasonal funding of its natural gas inventories, accounts receivable and payment of dividends. To meet these needs, the Company relies on its operating cash flows, line-of-credit agreement, long-term debt and capital raised through the Company's Dividend Reinvestment and Stock Purchase Plan ("DRIP").

Cash and cash equivalents increased by $3,271,052 for the six-month period ended March 31, 2013 compared to an $8,101,392 increase for the same period last year. The significant reduction in cash flow was primarily due to the special $1.00 per share dividend paid by the Company on December 17, 2012, and to a lesser extent, to less cash generated by operations and higher capital expenditures related to the Company's pipeline renewal program. The following table summarizes the categories of uses of cash:

                                                      Six Months Ended
                                                         March 31,
                                                   2013              2012

       Cash Flow Summary Six Months Ended:
       Provided by operating activities        $ 12,339,835      $ 13,215,506
       Used in investing activities              (4,438,570 )      (4,021,595 )
       Used in financing activities              (4,630,213 )      (1,092,519 )


       Increase in cash and cash equivalents   $  3,271,052      $  8,101,392


RGC RESOURCES, INC. AND SUBSIDIARIES

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 all 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 . . .

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