SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended March 31, 2003
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Commission File Number 000-26591
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RGC Resources, Inc.
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(Exact name of Registrant as Specified in its Charter)
VIRGINIA 54-1909697
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
519 Kimball Ave., N.E., Roanoke, VA 24016
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(Address of Principal Executive Offices) (Zip Code)
(540) 777-4427
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(Registrant's Telephone Number, Including Area Code)
None
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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 X No
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the close of the period covered by this report.
Class Outstanding at March 31, 2003
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Common Stock, $5 Par Value 1,982,389
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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UNAUDITED
March 31, September 30,
ASSETS 2003 2002
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Current Assets:
Cash and cash equivalents $ 495,255 $ 288,030
Accounts receivable - (less allowance for
uncollectibles of $1,115,770 and
and $155,062, respectively) 17,123,901 4,460,867
Inventories 1,716,021 2,172,808
Prepaid gas service 55,899 9,372,493
Prepaid income taxes - 1,189,154
Deferred income taxes 2,443,788 2,579,879
Under-recovery of gas costs 281,941 -
Unrealized gains on marked to market transactions - 1,779,891
Other 625,365 453,804
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Total current assets 22,742,170 22,296,926
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Property, Plant And Equipment:
Utility plant in service 91,184,363 89,504,217
Accumulated depreciation and amortization (35,896,718) (34,386,639)
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Utility plant in service, net 55,287,645 55,117,578
Construction work in progress 2,489,302 1,810,520
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Utility Plant, Net 57,776,947 56,928,098
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Nonutility property 20,814,492 19,869,186
Accumulated depreciation and amortization (8,315,341) (7,659,087)
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Nonutility property, net 12,499,151 12,210,099
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Total property, plant and equipment 70,276,098 69,138,197
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Other Assets:
Intangible assets, net of accumulated amortization 298,314 298,314
Other assets 935,797 668,018
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Total other assets 1,234,111 966,332
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Total Assets $ 94,252,379 $ 92,401,455
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See notes to condensed consolidated financial statements.
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2
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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UNAUDITED
March 31, September 30,
LIABILITIES AND STOCKHOLDERS' EQUITY 2003 2002
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Current Liabilities:
Current maturities of long-term debt $ 2,181,229 $ 105,127
Borrowings under lines of credit 4,034,000 8,991,000
Dividends payable 565,539 559,069
Accounts payable 8,482,383 7,897,084
Income taxes payable 2,575,686 -
Customer deposits 567,189 543,891
Accrued expenses 4,572,458 3,961,174
Refunds from suppliers - due customers 19,364 51,889
Overrecovery of gas costs 1,818,454 1,742,905
Unrealized losses on marked to market transactions 242,955 -
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Total current liabilities 25,059,257 23,852,139
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Long-term Debt, Excluding Current Maturities 28,236,463 30,377,358
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Deferred Credits:
Deferred income taxes 4,928,200 5,802,417
Deferred investment tax credits 283,924 300,544
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Total deferred credits 5,212,124 6,102,961
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Stockholders' Equity:
Common stock, $5 par value; authorized,
10,000,000 shares; issued and outstanding
1,982,389 and 1,960,418 shares, respectively 9,911,945 9,802,090
Preferred stock, no par, authorized, 5,000,000
shares; 0 shares issued and outstanding in
both 2003 and 2002 - -
Capital in excess of par value 11,673,715 11,374,173
Retained earnings 14,309,604 10,758,491
Accumulated comprehensive income (loss) (150,729) 134,243
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Total stockholders' equity 35,744,535 32,068,997
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Total Liabilities and Stockholders' Equity $ 94,252,379 $ 92,401,455
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3
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED MARCH 31, 2003 AND 2002
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UNAUDITED
Three Months Ended Six Months Ended
March 31, March 31,
2003 2002 2003 2002
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Operating Revenues:
Gas utilities $ 30,192,554 $ 23,565,404 $ 51,285,821 $ 40,147,818
Propane operations 7,502,674 4,946,231 11,952,450 7,866,939
Energy marketing 3,288,209 3,105,813 6,004,771 6,230,851
Other 239,133 126,933 435,655 353,380
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Total operating revenues 41,222,570 31,744,381 69,678,697 54,598,988
------------------ --------------- --------------- ---------------
Cost of Sales:
Gas utilities 22,562,747 16,765,229 37,494,240 27,939,767
Propane operations 3,594,521 2,562,987 5,699,044 3,992,765
Energy marketing 3,216,684 2,978,367 5,860,315 6,038,691
Other 137,646 50,372 248,329 186,428
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Total cost of sales 29,511,598 22,356,955 49,301,928 38,157,651
------------------ --------------- --------------- ---------------
Operating Margin 11,710,972 9,387,426 20,376,769 16,441,337
------------------ --------------- --------------- ---------------
Other Operating Expenses:
Operations 3,756,994 2,775,507 7,167,896 5,793,936
Maintenance 408,581 320,569 769,487 683,461
General taxes 497,746 442,920 956,822 842,521
Depreciation and amortization 1,316,132 1,313,368 2,651,661 2,626,739
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Total other operating expenses 5,979,453 4,852,364 11,545,866 9,946,657
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Operating Income 5,731,519 4,535,062 8,830,903 6,494,680
Other Expenses, net 68,742 21,060 108,051 52,345
Interest Expense 551,284 511,953 1,105,860 1,075,471
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Income Before Income Taxes 5,111,493 4,002,049 7,616,992 5,366,864
Income Tax Expense 1,970,540 1,531,603 2,937,902 2,055,643
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Net Income $ 3,140,953 $ 2,470,446 $ 4,679,090 $ 3,311,221
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Basic and Diluted Earnings Per Common Share $ 1.59 $ 1.28 $ 2.37 $ 1.72
================== =============== =============== ===============
See notes to condensed consolidated financial statements.
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4
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED MARCH 31, 2003 AND 2002
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UNAUDITED
Three Months Ended Six Months Ended
March 31, March 31,
2003 2002 2003 2002
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Net Income $ 3,140,953 $ 2,470,446 $ 4,679,090 $ 3,311,221
Reclassification of loss (income) transferred to
net income (190,640) 67,308 (264,412) 111,154
Unrealized gain (loss) on derivative financial
instruments 62,478 145,705 (20,560) 70,562
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Other comprehensive income (loss), net of tax (128,162) 213,013 (284,972) 181,716
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Comprehensive Income $ 3,012,791 $ 2,683,459 $ 4,394,118 $ 3,492,937
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5
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE-MONTH AND SIX-MONTH
PERIODS ENDED MARCH 31, 2003 AND 2002
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UNAUDITED
Three Months Ended Six Months Ended
March 31, March 31,
2003 2002 2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,140,953 $ 2,470,446 $ 4,679,090 $ 3,311,221
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 1,372,122 1,349,389 2,763,638 2,699,683
Impairment loss
Gain on disposal of property (29,494) (1,022) (32,961) (2,635)
Loss on sale of other assets - -
Deferred taxes and investment tax credits (1,104,982) (22,705) (754,746) (543,320)
Changes in assets and liabilities which provided
cash, exclusive of changes and noncash
transactions shown separately 10,782,038 8,169,288 3,154,686 9,102,545
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Net cash provided by operating activities 14,160,637 11,965,396 9,809,707 14,567,494
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to utility plant and nonutility property (2,279,777) (1,766,946) (4,171,626) (4,387,991)
Cost of removal of utility plant, net (11,469) (7,703) (10,054) (24,048)
Proceeds from disposal of equipment 302,241 11,162 313,102 28,888
Proceeds from sale of other assets - - - -
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Net cash used in investing activities (1,989,005) (1,763,487) (3,868,578) (4,383,151)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt - - 8,000,000 -
Retirement of long-term debt and capital leases (32,463) (56,945) (64,793) (763,767)
Net (repayments) under lines of credit (11,561,000) (10,865,000) (12,957,000) (9,384,000)
Cash dividends paid (562,438) (548,376) (1,121,508) (1,084,761)
Proceeds from issuance of stock 194,327 238,741 409,397 389,067
Capital stock expense - - - -
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Net cash (used in) financing activities (11,961,574) (11,231,580) (5,733,904) (10,843,461)
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NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 210,058 (1,029,671) 207,225 (659,118)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 285,197 1,256,231 288,030 885,678
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CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 495,255 $ 226,560 $ 495,255 $ 226,560
================= ============== ============== ==============
SUPPLEMENTAL INFORMATION:
Interest paid $ 195,793 $ 180,131 $ 1,118,733 $ 1,128,975
Income taxes paid (refunded), net $ 575,000 $ 371,551 $ (250,067) $ 369,119
See notes to condensed consolidated financial statements.
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6
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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UNAUDITED
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1. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly RGC Resources, Inc.'s financial position as of March 31,
2003 and the results of its operations and its cash flows for the three
months and six months ended March 31, 2003 and 2002. Because of seasonal
and other factors, the results of operations for the six months ended March
31, 2003 are not indicative of the results to be expected for the fiscal
year ending September 30, 2003.
2. The condensed consolidated financial statements and condensed notes are
presented as permitted by Form 10-Q and do not contain certain information
included in the Company's annual consolidated financial statements and
notes thereto.
3. Quarterly earnings are affected by the highly seasonal nature of the
business as variations in weather conditions generally result in greater
earnings during the winter months.
4. On January 27, 2003, a break occurred on a natural gas main located in the
Company's Bluefield, WV service territory due to a ground shift
attributable to much colder than normal temperatures. As a result of the
leak and its subsequent repair, service to approximately 4,300 customers
was interrupted for periods ranging from several hours to 4 days. The
Company was able to restore service due to assistance provided from by five
other natural gas distribution companies. Over 75 service technicians
worked extended shifts around the clock. Although not all of the charges
have been received for the technician assistance, the Company has provided
for a total of $280,000 related to the repair of the gas line and the
reestablishing of service to its customers.
The Company has received authorization from the staff of the West Virginia
Public Service Commission (PSC) to defer the costs associated with the West
Virginia portion of the outage as a regulatory asset and apply for the
recovery of these costs through future rate filings. The Company has
applied Statement of Financial Accounting Standards No. 71, "Accounting for
the Effects of Certain Types of Regulation," in recording a regulatory
asset in the amount of $219,127. The Company currently has a rate filing
pending and anticipates placing new billing rates into effect beginning in
December 2003 to recover these costs over future periods. However, there is
no guarantee that the final rate order received from the PSC will allow
full or partial recovery of these costs.
The costs attributable to the Virginia portion of the gas outage were
expensed during the quarter. Due to the dollar amount, the Company elected
not to file for special rate relief on these costs. The total expense
allocated to the Virginia operations was $60,873.
5. Effective April 1, 2003, the Company and Wachovia Bank agreed to extend the
current terms of the Company's line of credit agreements to allow
sufficient time to complete the paperwork for the renewals. On April 21,
2003, the Company completed its renewals of the line of credit agreements
with Wachovia Bank. The new agreements maintained the same variable
interest rates based upon 30 day LIBOR; however, the Company agreed to
establish a three-tier level for borrowing limits. Due to the seasonal
borrowing demands of the Company, the variation in the level of borrowing
differs throughout the year. Generally, the Company's borrowing needs are
at their lowest in Spring, increase during the Summer and Fall due to gas
prepayments and construction and reach their maximum levels in Winter. The
three-tier approach will keep the Company's borrowing costs to a minimum by
improving the level of utilization on
7
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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UNAUDITED
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its line of credit agreements. Effective with the date of renewals, the
Company's total available lines of credit will range from $10,500,000 to
$28,000,000. The line of credit agreements will expire on March 31, 2004,
unless extended.
6. On October 1, 2000, the Company adopted the provisions of SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended
and interpreted. SFAS No. 133 requires the recognition of all derivative
instruments as assets or liabilities in the Company's balance sheet and
measurement of those instruments at fair value. The adoption of the
standard did not have a material impact on the results of operations or
other comprehensive income.
The Company's risk management policy allows management to enter into
derivatives for the purpose of managing commodity and financial market
risks of its business operations. The key market risks that RGC Resources,
Inc. would seek to hedge include the price of natural gas and propane gas
and the cost of borrowed funds.
The Company had entered into futures and swaps for the purpose of hedging
the price of propane in order to provide price stability during the winter
months. The Company's hedging activities are in accordance with established
risk management policies. The hedges qualify as cash flow hedges;
therefore, changes in the fair value are reported in Other Comprehensive
Income. No portion of the hedges were ineffective during the three months
and six months ended March 31, 2003 and 2002.
The Company also had entered into swap arrangements for the purchase of
natural gas for the purpose of providing price stability during the winter
months. The fair value of these instruments is recorded in the balance
sheet with the offsetting entry to under-recovery of gas costs. Net income
and other comprehensive income are not affected by the change in market
value as any cost incurred or benefit received from these instruments is
recoverable or refunded through the regulated natural gas purchased gas
adjustment (PGA) mechanism. Both the Virginia State Corporation Commission
(SCC) and the West Virginia Public Service Commission (PSC) currently allow
for full recovery of prudent costs associated with natural gas purchases,
and any additional costs or benefits associated with the settlement of
these instruments will be passed through to customers when realized.
The Company also entered into an interest rate swap related to the
$8,000,000 note issued in November 2002. The swap essentially converted the
three-year floating rate note into fixed rate debt with a 4.18 percent
interest rate. The swap qualifies as a cash flow hedge with changes in fair
value reported in Other Comprehensive Income.
8
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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UNAUDITED
- ---------
A summary of the derivative and financial instrument activity is provided
below:
THREE MONTHS ENDED MARCH 31, 2003 Propane Interest Rate Natural Gas
Derivatives Swap Derivative Total
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Unrealized gains/(losses) on derivatives $ 169,835 $ (66,420) $ - $ 103,415
Income tax (expense)/benefit (66,150) 25,213 - (40,937)
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Net unrealized gains/(losses) 103,685 (41,207) - 62,478
Transfer of realized losses/(gains) to income (349,385) 36,525 - (312,860)
Income tax benefit/expense 136,085 (13,865) - 122,220
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Net transfer of realized losses/(gains) to income (213,300) 22,660 - (190,640)
Net other comprehensive income/(loss) $ (109,615) $ (18,547) $ - $ (128,162)
THREE MONTHS ENDED MARCH 31, 2002 Propane Interest Rate Natural Gas
Derivatives Swap Derivative Total
----------------- --------------- ------------- ------------
Unrealized gains/(losses) on derivatives $ 238,665 $ - $ - $ 238,665
Income tax (expense)/benefit (92,960) - - (92,960)
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Net unrealized gains/(losses) 145,705 - - 145,705
Transfer of realized losses/(gains) to income 110,250 - - 110,250
Income tax benefit/expense (42,942) - - (42,942)
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Net transfer of realized losses/(gains) to income 67,308 - - 67,308
Net other comprehensive income/(loss) $ 213,013 $ - $ - $ 213,013
9
SIX MONTHS ENDED MARCH 31, 2003 Propane Interest Rate Natural Gas
Derivatives Swap Derivative Total
----------------- --------------- ------------- ------------
Unrealized gains/(losses) on derivatives $ 250,334 $ (279,480) $ - $ (29,146)
Income tax (expense)/benefit (97,505) 106,091 - 8,586
----------------- --------------- ------------- ------------
Net unrealized gains/(losses) 152,829 (173,389) - (20,560)
Transfer of realized losses/(gains) to income (470,225) 36,525 - (433,700)
Income tax benefit/expense 183,153 (13,865) - 169,288
----------------- --------------- ------------- ------------
Net transfer of realized losses/(gains) to income (287,072) 22,660 - (264,412)
Net other comprehensive income/(loss) $ (134,243) $ (150,729) $ - $ (284,972)
Unrealized gain on marked to market transactions - $ (242,955) - $ (242,955)
Accumulated comprehensive income/(loss) - $ (150,729) - $ (150,729)
SIX MONTHS ENDED MARCH 31, 2002 Propane Interest Rate Natural Gas
Derivatives Swap Derivative Total
----------------- --------------- ------------- ------------
Unrealized gains/(losses) on derivatives $ 115,580 $ - $ - $ 115,580
Income tax (expense)/benefit (45,018) - - (45,018)
----------------- --------------- ------------- ------------
Net unrealized gains/(losses) 70,562 - - 70,562
Transfer of realized losses/(gains) to income 182,070 - - 182,070
Income tax benefit/expense (70,916) - - (70,916)
----------------- --------------- ------------- ------------
Net transfer of realized losses/(gains) to income 111,154 - - 111,154
Net other comprehensive income/(loss) $ 181,716 $ - $ - $ 181,716
Unrealized gain on marked to market transactions $ 175,039 - $ 1,348,125 $ 1,523,164
Accumulated comprehensive income/(loss) $ 106,861 - - $ 106,861
10
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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UNAUDITED
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7. Basic earnings per common share are based on the weighted average number of
shares outstanding during each period. The weighted average number of
shares outstanding for the three-month and six-month periods ended March
31, 2003 were 1,978,541 and 1,973,028 compared to 1,929,088 and 1,924,336
for the same periods last year. The weighted average number of shares
outstanding assuming dilution were 1,981,605 and 1,974,852 for the
three-month and six-month periods ended March 31, 2003 compared to
1,932,979 and 1,928,376 for the same periods last year. The difference
between the weighted average number of shares for the calculation of basic
and diluted earnings per share relates to the dilutive effect associated
with the assumed issuance of stock options as calculated using the Treasury
Stock method.
8. RGC Resources, Inc.'s reportable segments are included in the following
table. The segments are comprised of natural gas, propane, energy marketing
and other. The other segment is composed of the heating and air
conditioning business, mapping services, information system services and
certain corporate eliminations.
Energy
Natural Gas Propane Marketing Other Total
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FOR THE THREE MONTHS ENDED MARCH 31, 2003
Operating revenues 30,192,554 7,502,674 3,288,209 239,133 41,222,570
Operating margin 7,629,807 3,908,153 71,525 101,487 11,710,972
Income before income taxes 2,771,784 2,184,209 58,608 96,892 5,111,493
FOR THE THREE MONTHS ENDED MARCH 31, 2002
Operating revenues 23,565,404 4,946,231 3,105,813 126,933 31,744,381
Operating margin 6,800,175 2,383,244 127,446 76,561 9,387,426
Income before income taxes 2,696,160 899,897 118,847 (29,821) 3,685,083
Energy
Natural Gas Propane Marketing Other Total
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FOR THE SIX MONTHS ENDED MARCH 31, 2003
Operating revenues 51,285,821 11,952,450 6,004,771 435,655 69,678,697
Operating margin 13,791,581 6,253,406 144,456 187,326 20,376,769
Income before income taxes 4,354,298 2,959,491 121,641 181,562 7,616,992
As of March 31, 2003:
Total assets 75,780,895 15,916,118 2,012,405 542,961 94,252,379
FOR THE SIX MONTHS ENDED MARCH 31, 2002
Operating revenues 40,147,818 7,866,939 6,230,851 353,380 54,598,988
Operating margin 12,208,051 3,874,174 192,160 166,952 16,441,337
Income before income taxes 4,322,896 970,512 175,731 (102,275) 5,366,864
As of March 31, 2002:
Total assets 69,657,627 14,474,728 1,610,705 996,880 86,739,940
11
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------
UNAUDITED
- ---------
9. The Company has a Key Employee Stock Option Plan (the "Plan"), which is
intended to provide the Company's executive officers with long-term
(ten-year) incentives and rewards tied to the price of the Company's common
stock. The Company applies the recognition and measurement principles of
APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related
Interpretations in accounting for this Plan. No stock-based employee
compensation expense is reflected in net income as all options granted
under the Plan had an exercise price equal to the market value of the
underlying common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of FASB Statement No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION, to the options granted under
the Plan.
3 Months Ended 6 Months Ended
March 31 March 31
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- -------------- --------------- ---------------
Net income, as reported $ 3,140,953 $ 2,470,446 $ 4,679,090 $ 3,311,221
Deduct: Total stock-based employee
compensation expense determined
under fair value method for all awards,
net of tax (15,221) (17,481) (15,221) (17,481)
--------------- --------------- -------------- ---------------
Pro forma net income $ 3,125,732 $ 2,452,965 $ 4,663,869 $ 3,293,740
============== ============== ============== ==============
Earnings per share:
Basic and diluted - as reported $ 1.59 $ 1.28 $ 2.37 $ 1.72
=============== ============== =============== ===============
Basic and diluted - pro forma $ 1.58 $ 1.27 $ 2.36 $ 1.71
=============== ============== =============== ===============
Diluted - as reported $ 1.59 $ 1.28 $ 2.37 $ 1.72
=============== ============== =============== ===============
Diluted - pro forma $ 1.58 $ 1.27 $ 2.36 $ 1.71
=============== ============== =============== ===============
10. Both Roanoke Gas Company and Bluefield Gas Company, subsidiaries of RGC
Resources, Inc., operated manufactured gas plants (MGPs) as a source of
fuel for lighting and heating until the early 1950's. A by- product of
operating MGPs was coal tar, and the potential exists for on-site tar waste
contaminants at the former plant sites. The extent of contaminants at these
sites, if any, is unknown at this time. An analysis at the Bluefield Gas
Company site indicates some soil contamination. The Company, with
concurrence of legal counsel, does not believe any events have occurred
requiring regulatory reporting. Further, the Company has not received any
notices of violation or liabilities associated with environmental
regulations related to the MGP sites and is not aware of any off-site
contamination or pollution as a result of prior operations. Therefore, the
Company has no plans for subsurface remediation at the MGP sites. Should
the Company eventually be required to remediate either site, the Company
will pursue all prudent and reasonable means to recover any related costs,
including insurance claims and regulatory approval for rate
12
RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------
UNAUDITED
- ---------
case recognition of expenses associated with any work required. A
stipulated rate case agreement between the Company and the West Virginia
Public Service Commission recognized the Company's right to defer MGP
clean-up costs, should any be incurred, and to seek rate relief for such
costs. If the Company eventually incurs costs associated with a required
clean-up of either MGP site, the Company anticipates recording a regulatory
asset for such clean-up costs to be recovered in future rates. Based on
anticipated regulatory actions and current practices, management believes
that any costs incurred related to this matter will not have a material
effect on the Company's financial condition or results of operations.
11. The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, GOODWILL AND OTHER INTANGIBLE ASSETS, on October 1, 2002. SFAS No.
142 requires that goodwill no longer be amortized over an estimated useful
life. Instead, goodwill balances will be subject to an annual fair-value-
based impairment assessment. The Company completed its evaluation of the
new standard and determined that no impairment existed as of the date of
adoption. The following table reflects the impact of removing the goodwill
amortization on prior year net income.
Three Months Ended Six Months Ended
March 31 March 31
2003 2002 2003 2002
--------------- ------------- ------------ ------------
Net Income $ 3,140,953 $ 2,470,446 $ 4,679,090 $ 3,311,221
Add: Goodwill amortization,
net of tax 0 2,763 0 5,525
--------------- ------------- ------------ ------------
Adjusted Net Income $ 3,140,953 $ 2,473,209 $ 4,679,090 $ 3,316,746
=============== ============= ============ ============
Basic and diluted earnings $ 1.59 $ 1.28 $ 2.37 $ 1.72
per share
Goodwill amortization 0 0 0 0
--------------- ------------- ------------ ------------
Adjusted basic and diluted earnings
per share $ 1.59 $ 1.28 $ 2.37 $ 1.72
=============== ============= ============ ============
The Company also adopted SFAS No. 143, ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS, on October 1, 2002. SFAS No. 143 requires the reporting at
fair value of a legal obligation associated with the retirement of tangible
long-lived assets that result from acquisition, construction or
development. Management has determined that the Company has no material
legal obligations for the retirement of its assets. However, the Company
provides a provision, as part of its depreciation expense, for the ultimate
cost of asset retirements and removal. Removal costs are not a legal
obligation as defined by SFAS No. 143 but rather the result of cost-based
regulation and therefore accounted for under the provisions of SFAS No. 71,
ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION. The accumulated
depreciation amount reflected on the Company's Balance Sheet at March 31,
2003 contains approximately $5 million of accumulated provisions for
retirement costs.
13
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
GENERAL
RGC Resources, Inc. 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
Bluefield, Virginia and West Virginia and the surrounding areas through its
Roanoke Gas Company and Bluefield Gas Company subsidiaries. Natural gas service
is provided at rates and for the terms and conditions set forth by the State
Corporation Commission in Virginia and the Public Service Commission in West
Virginia.
RGC Resources, Inc. also provides unregulated energy products through
Diversified Energy Company, which operates as Highland Propane Company and
Highland Energy Company. Highland Propane sells and distributes propane to
approximately 18,800 customers in western Virginia and southern West Virginia.
Highland Energy brokers natural gas to several industrial transportation
customers of Roanoke Gas Company and Bluefield Gas Company. Propane sales have
become a more significant portion of the consolidated operation with an annual
growth rate that far exceeds the growth in natural gas customers.
RGC Resources, Inc. also provides information system services to software
providers in the utility industry through RGC Ventures, Inc. of Virginia, which
operates as Application Resources.
Management views warm winter weather, energy conservation due to high prices and
competition from alternative fuels each as a factor that could have a
significant impact on the Company's earnings.
For the quarter ended March 31, 2003, colder weather and rising energy prices
significantly increased revenues over the same period last year. The Company's
propane business contributed a substantial portion of the increase in net
income.
RESULTS OF OPERATIONS
Consolidated net income for the three-month period and six-month period ended
March 31, 2003 were $3,140,953 and $4,679,090, respectively, compared to
$2,470,446 and $3,311,221 for the same period last year.
Total operating revenues for the three months ended March 31, 2003 increased by
nearly 30 percent compared to the same period last year due to increasing gas
costs and higher sales volumes attributable to colder weather. The total number
of heating-degree days (an industry measure by which the average daily
temperature falls below 65 degrees Fahrenheit) increased by more than 19 percent
over the same period last year and by nearly 4 percent above the 30 year normal.
Total regulated natural gas deliveries increased by nearly 15 percent with non-
transporting volumes reflecting a 19 percent increase in dekatherms sold.
Propane gallons delivered rose by 22 percent. Energy marketing volumes declined
by nearly 8 percent due in part to the economy and to certain transporting
customers opting to purchase their gas supply directly from the Company's
regulated natural gas operations. Other revenues increased by 88 percent due to
the sale of nearly 400 propane tanks to propane customers. The sale of tanks
resulted from the Company's efforts to improve profitability on its under
performing accounts by implementing additional tank rent or selling the propane
tank to the customer. This process has resulted in the loss of some customers;
however, as these customers were not profitable, their departure should not have
a negative impact on the overall performance of the propane operations. For the
affected customers that remain customers, management expects profitability to
improve.
14
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
Total operating margin increased by $2,323,546, or 25 percent, for the quarter
ended March 31, 2003 over the same period last year. Regulated natural gas
margins increased by $829,632, or 12 percent, on a total delivered volume
(tariff and transporting) increase of 626,911 dekatherms, or 15 percent, due to
the effect of colder weather and the implementation of increased billing rates
in December 2002. The regulated natural gas margins are composed of two
components: volumetric sales and base charge. The increase in volumetric margin
was nearly 14 percent, which correlates with the 15 percent increase in volumes.
The base charge, which is a flat monthly fee billed to each natural gas
customer, increased by 8 percent due to the implementation of increased base
charge rates placed into effect in December 2002 and to customer growth. Propane
margins increased by $1,524,909, or 64 percent, on a 863,091, or 22 percent,
gallon increase in deliveries over the same period last year. The increase in
propane margin derived from four factors. The first factor pertains to increased
sales volume due to colder weather. Second, the colder weather served to
increase the average margin realized per gallon of propane as the sales mix
skewed more to the higher margin residential volumes that rely on propane for
heating versus the lower margin commercial and production loads that are not as
sensitive to the weather. Third, the Company realized the benefits of financial
propane price hedges during the quarter. For the three month period ended March
31, 2003, the Company received $349,385 in proceeds from propane derivative swap
arrangements compared to a net payout of $110,250 on similar derivative
instruments during the same period last year. And fourth, the Company benefited
significantly from fixed price contracts on purchased propane that mitigated the
effect of rising wholesale propane prices. Management considers the improvement
in margin attributable to the derivative instruments and fixed price contracts
to be one-time events that are unlikely to be replicated in the near future. The
energy marketing division margin decreased by $55,921, or nearly 44 percent, as
total sales volume declined by 51,403 dekatherms, or 9 percent. The prior year
margin included a one-time gain of $78,600 related to the sale of a fixed price
purchase contract of 120,000 dekatherms of gas. Other margins increased by
$24,916, or 33 percent, due to the sale of propane tanks as discussed above.
The table below reflects volume activity and heating degree-days.
Quarter Quarter
Ended Ended Increase/
Delivered Volumes 3/31/03 3/31/02 (Decrease) Percentage
--------------- -------------- -------------- ---------------
Regulated Natural Gas (DTH)
Tariff Sales 4,168,623 3,515,430 653,193 19%
Transportation 741,115 767,397 (26,282) -3%
--------------- -------------- --------------
Total 4,909,738 4,282,827 626,911 15%
Propane (Gallons) 4,734,066 3,870,975 863,091 22%
Highland Energy (DTH) 534,738 586,141 (51,403) -9%
Heating Degree Days 2,260 1,894 366 19%
(Unofficial)
15
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
Operations expenses increased by $981,487, or 35 percent, for the three-month
period ended March 31, 2003 compared to the same period last year. The increase
related to increases in bad debt expense, employee benefit costs, corporate
insurance and higher operating costs as a result of the colder weather. Bad debt
expense increased by $152,980, or 56 percent, as total revenues increased by 30
percent. The rate of increase in bad debt expense is attributable to the
combined effect of colder weather and higher energy prices potentially causing
more customers to become unable to pay their gas bill. As a result, management
expects bad debt expense to be higher than last year's level for the remainder
of the year. Furthermore, in March 2002, the Company established a regulatory
asset in the amount of $316,966 that provided for the deferral of a portion of
incurred bad debt expense. The Company applied Statement of Financial Accounting
Standards No. 71, ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION, in
recording the regulatory asset. Beginning December 2002, the Company began
amortizing the regulatory asset in conjunction with the implementation of new
rates approved by the State Corporation Commission of Virginia, which included a
provision for recovery of the amortized expense. Total amortization of the
regulatory asset amounted to $26,413 during the current quarter. The Company
also experienced increases of $170,864 in employee benefit costs. Health
insurance claims activity has been above normal and prior year levels. In
addition, both the defined benefit pension plan and post-retirement medical plan
provided by the Company have experienced higher level of expense due to the
actuarial impact of reductions in interest rates and performance of plan assets
during the recent stock market decline. Much of the remaining increase in
operations expenses related to higher labor and other costs associated with
system operations during the colder weather. Maintenance expenses increased by
$88,012, or 27 percent, as the Company began focusing on repairing pipeline
leaks and performing general facility maintenance during the warmer weather in
March. General taxes increased $54,826, or 12 percent, for the three-month
period ended March 31, 2003 compared to the same period last year primarily due
to increased business and occupation (B&O) taxes, a revenue sensitive tax,
related to the West Virginia natural gas operations, higher payroll taxes
related to increases in operations and maintenance labor and increased property
taxes associated with increases in the taxable property.
Interest charges increased by $39,331, or nearly 8 percent, as the Company's
average total debt position during the current quarter increased by more than 7
percent over the same period last year. The increase in average total debt for
the quarter was attributable to capital expenditures and the funding of higher
accounts receivable balances related to the colder weather and higher energy
prices. The overall average interest rate on total debt increased from 5.489
percent to 5.524 percent even though the Company's average short-term rates fell
by 34 basis points. The increase in average rate relates to the $8,000,000
intermediate term note issued in November 2002 to refinance a portion of the
line-of-credit balance resulting in an increase in the average interest rate
over the corresponding rate under the line-of-credit.
Income tax expense increased by $438,937, or 29 percent, as pre-tax income
increased by 28 percent.
For the six-month period ended March 31, 2003, total operating margin increased
$3,935,432, or 24 percent, over the same period last year. Regulated natural gas
margin increased $1,583,530, or 13 percent, as total natural gas deliveries rose
by 1,250,032 DTH, or 17 percent, over the same period last year, on weather that
had 26 percent more heating degree days. The components of the regulated natural
gas margin, base charge and volumetric margin, increased by 4 percent and 17
percent, respectively. The increase in base charge was primarily attributed to
the increased base charge rates placed into effect in December 2002, and the
increase in volumetric margin relates to the increase in volumes delivered due
to the colder weather. Propane margins increased $2,379,232, or 61 percent, as
total gallons delivered grew by 31 percent. As discussed above, several factors
contributed to the increase in propane margins. Colder weather generated the
increase in gallons delivered and provided for higher unit margins due to the
impact that weather had on the sales mix between heating (higher margin) and
production (lower margin.) The remainder of the increase is attributed to the
benefits realized on propane derivative contracts
16
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
and fixed price contracts. The propane derivative contracts contributed $470,225
in additional margin during the current period as compared to a $182,070
reduction in the prior period margin due to realized losses under derivative
contracts. Management considers the improvement in margin attributable to the
derivative instruments and fixed price contracts to be one-time events that are
unlikely to be replicated in the near future. Energy marketing margins declined
$47,704, or 25 percent, on an 8 percent reduction in volumes as prior year
results reflect the one-time benefit from the sale of fixed price purchase
contract for $78,600. Other margins increased by $20,374, or 12 percent, due to
the gains associated with the sale of propane tanks.
The table below reflects volume activity and heating degree-days.
Y-T-D Y-T-D Increase/
Delivered Volumes 3/31/03 3/31/02 (Decrease) Percentage
---------------- --------------- -------------- --------------
Regulated Natural Gas (DTH)
Tariff Sales 7,129,555 5,870,535 1,259,020 21%
Transportation 1,493,522 1,502,510 (8,988) -1%
---------------- --------------- --------------
Total 8,623,077 7,373,045 1,250,032 17%
Propane (Gallons) 8,083,552 6,183,265 1,900,287 31%
Highland Energy (DTH) 1,118,603 1,221,323 (102,720) -8%
Heating Degree Days 3,934 3,124 810 26%
(Unofficial)
Other operations expenses increased by $1,373,960 or 24 percent for the
six-month period ended March 31, 2003 compared to the same period last year.
Most of the increase is associated with bad debt expense, employee benefit costs
and labor costs. Accrued bad debt expense increased $169,756, or 38 percent, due
to the 30 percent increase in total revenues. As discussed above, the prior year
results reflect an expense reduction of $316,966 related to the deferral of
incurred bad debt expense. Employee benefit costs increased $438,867 primarily
due to much higher claims experience under the Company's medical plan and, to a
lesser extent, higher pension and post-retirement medical expenses attributable
to changes in actuarial assumptions and performance of plan assets. Labor costs
associated with operations increased $199,387 due to the increased demands that
colder weather places on operation of the natural gas system and increased
levels of propane delivery. Maintenance expense increased $86,026, or 13
percent, as the warm weather in the month of March provided the Company with the
opportunity to focus on repairing system leaks on the natural gas pipeline and
conduct facility maintenance.
General taxes increased $114,301, or 14 percent, for the six-month period ended
March 31, 2003 compared to the same period last year as a result higher West
Virginia B&O taxes, greater payroll taxes and increased level of property taxes.
Depreciation increased $24,922, or 1 percent, on increased investment in utility
property partially offset by reduced levels of capital spending in propane
operations.
17
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
Interest charges increased by $30,389, or 3 percent, as a result of an increase
of more than 5 percent in the average borrowing levels during the period. The
average overall interest rate declined from 5.380 percent to 5.294 percent from
the same period last year due to reductions in the interest rates under the
Company's line-of-credit agreements. Income tax expense increased $882,259, or
43 percent, due to a 42 percent increase in pretax income.
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, 2003. The total revenues and margins during the first
six months reflect higher billings due to the weather sensitive nature of the
gas business. Due to the seasonal nature of the Company's energy business, the
final two quarters of the fiscal year tend to generate losses. Any improvement
or decline in earnings depends primarily on weather in the months of April and
May and the level of operating and maintenance costs during the remaining
months.
GAS LINE BREAK
On January 27, 2003, a break occurred on a natural gas main located in the
Company's Bluefield, WV service territory due to a ground shift attributed to
much colder than normal temperatures. As a result of the leak and its subsequent
repair, service to approximately 4,300 customers was interrupted for periods
ranging from several hours to 4 days. The Company was able to restore service
due to assistance provided by five other natural gas distribution companies.
Over 75 service technicians worked extended shifts around the clock. Although
not all of the charges have been received for the technician assistance, the
Company has provided for a total of $280,000 related to the repair of the gas
line and the reestablishing of service to its customers.
The Company has received authorization from the staff of the West Virginia
Public Service Commission (PSC) to defer the costs associated with the West
Virginia portion of the outage as a regulatory asset and apply for recovery of
these costs through future rate filings. The Company has applied Statement of
Financial Accounting Standards No. 71, ACCOUNTING FOR THE EFFECTS OF CERTAIN
TYPES OF REGULATION, in recording a regulatory asset in the amount of $219,127.
The Company currently has a rate filing pending and anticipates placing new
billing rates into effect beginning in December 2003 to recover these costs over
future periods. However, there is no guarantee that the final rate order
received from PSC will allow full or partial recovery of these costs.
The costs attributable to the Virginia portion of the gas outage were expensed
during the quarter. Due to the dollar amount, the Company elected not to file
for special rate relief on these costs. The total expense allocated to the
Virginia operations was $60,873.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of RGC Resources, Inc. 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 estimates and judgments 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 could differ from the
estimates, which would affect the related amounts reported in the Company's
financial statements. Although, estimates and judgments are applied in arriving
at many of the reported amounts in the financial statements including provisions
for employee medical insurance, projected useful lives of capital assets and
goodwill valuation, the following items may involve a greater degree of
judgment.
18
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
Revenue recognition - The Company bills natural gas customers on a monthly cycle
basis; however, the billing cycle periods for most customers do not coincide
with the accounting periods used for financial reporting. The Company accrues
estimated revenue for natural gas delivered to customers not yet billed during
the accounting period. Determination of unbilled revenue relies on the use of
estimates, current and historical data.
Bad debt reserves - The Company evaluates the collectibility of its accounts
receivable balances based upon a variety of factors including loss history,
level of delinquent account balances and general economic climate.
Retirement plans - The Company offers a defined benefit pension plan and a
post-retirement medical plan to eligible employees. The expenses and liabilities
associated with these plans are determined through actuarial means requiring the
estimation of certain assumptions and factors. In regard to the pension plan,
these factors include assumptions regarding discount rate, expected long-term
rate of return on plan assets, compensation increases and life expectancies
among others. Similarly, the post-retirement medical plan also requires the
estimation of many of the same factors as the pension plan in addition to
assumptions regarding rate of medical inflation and medicare availability.
Actual results may differ materially from the results expected from the
actuarial assumptions due to changing economic conditions, volitility in
interest rates and changes in life expectancy to name a few. Such differences
may result in a material impact on the amount of expense recorded in future
periods or the value of the obligations on the balance sheet.
Derivatives - As discussed in the "Item 3 - Qualitative and Quantitative
Disclosures about Market Risk" section below, the Company hedges certain risks
incurred in the normal operation of business through the use of derivative
instruments. The Company applies the requirements of Statement of Financial
Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, which requires the recognition of all derivative instruments as
assets or liabilities in the Company's balance sheet at fair value. In most
instances, fair value is based upon quoted futures prices for the commodities of
propane and natural gas. Changes in the commodity and futures markets will
impact the estimates of fair value in the future. Furthermore, the actual market
value at the point of realization of the derivative may be significantly
different from the futures value used in determining fair value in prior
financial statements.
Regulatory accounting - The Company's regulated operations follow the accounting
and reporting requirements of Statement of Financial Accounting Standards No.
71, ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION. The economic
effects of regulation can result in a regulated company deferring costs that
have been or are expected to be recovered from customers in a period different
from the period in which the costs would be charged to expense by an unregulated
enterprise. When this results, costs are deferred as assets in the consolidated
balance sheet (regulatory assets) and recorded as expenses when such amounts are
reflected in rates. Additionally, regulators can impose liabilities upon a
regulated company for the amounts previously collected from customers and for
current collection in rates of costs that are expected to be incurred in the
future (regulatory liabilities).
19
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
ASSET MANAGEMENT
Effective November 1, 2001, Roanoke Gas Company and Bluefield Gas Company (the
Companies) entered into a contract with a third party, Duke Energy Trading and
Marketing (Duke Energy), to provide future gas supply needs. Duke Energy has
also assumed the management and financial obligation of the Companies' firm
transportation and storage agreements. In connection with the agreement, the
Companies exchanged gas in storage at November 1, 2001 for the right to receive
an equal amount of gas in the future as provided by the agreement. As a result
of this arrangement, natural gas inventories on the balance sheet are replaced
with a new classification called "prepaid gas service." This contract expires on
October 31, 2004.
ENERGY COSTS
The wholesale cost of energy has risen significantly over the past year. Based
upon the average NYMEX (New York Mercantile Exchange - an industry standard for
measuring gas prices) contract settlements during the quarter ended March 31,
2003, natural gas prices surged to nearly three times last year's spot market
prices. Energy analysts cite decreasing exploration and production caused by
previously low prices and warm weather in the prior year as a primary reason for
the surge in prices. Furthermore, natural gas and propane storage volumes are
below the normal levels for this time of year due to the cold winter over much
of the United States. The Energy Information Administration, a government
agency, projects natural gas and propane prices will continue to remain at a
higher level.
To lessen the impact of price volatility, Roanoke Gas Company, Bluefield Gas
Company and Highland Propane Company use a variety of hedging mechanisms. Summer
storage injections, financial instruments and fixed price contacts were utilized
during the current period and provided the Company with much lower fuel costs
than would have been incurred through spot market purchases alone.
Natural gas costs are fully recoverable under the present regulatory Purchased
Gas Adjustment (PGA) mechanisms, and increases and decreases in the cost of gas
are passed through to the Company's customers. The unregulated propane and
energy marketing operations are able to more rapidly adjust pricing structures
to compensate for increasing costs. However, due to the competitive nature of
these unregulated markets, there can be no assurance that the Company can adjust
its pricing to sufficiently recover cost increases without negatively affecting
sales and competitive position.
Although rising energy prices are recoverable through the PGA mechanism for the
regulated operations, high energy prices may have a negative impact on earnings
through increases in bad debt expense and higher interest costs because the
delay in recovering higher gas costs requires borrowing to temporarily fund
receivables from customers, LNG (liquefied natural gas) and prepaid gas service
levels. As discussed below, the implementation of a new rate structure will
provide the Company a level of protection against the impact that rising energy
prices may have on bad debts and carrying costs on LNG storage and prepaid gas
service by allowing for immediate recovery of these costs. However, the new rate
structure will not protect the Company from increased rate of bad debts or
increases in interest rates.
20
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
REGULATORY AFFAIRS
Bluefield Gas Company has filed an application requesting a general rate
increase with the West Virginia Public Service Commission (PSC). The application
reflects an additional revenue requirement of $318,000 primarily for increased
operating expenses including employee benefits, corporate property and liability
insurances and recovery of costs associated with the recent gas main break. The
PSC staff is currently performing an on-site audit. Roanoke Gas Company intends
to file an application for a rate increase with the State Corporation Commission
of Virginia in the Company's fourth quarter.
In late December 2002, the Virginia State Corporation Commission approved a
joint stipulation filed by all parties associated with the Roanoke Gas Company
rate case. This final order approved a weather normalization adjustment
mechanism, to begin next winter, which will help stabilize the Company's
earnings from significant variations in weather. The weather normalization
adjustment mechanism would not have impacted the current year's financial
results as the mechanism is only triggered when weather is outside the band of 6
percent warmer or colder than the 30 year normal. For the six-month period ended
March 31, 2003, the weather was approximately 4.5 percent colder than the 30
year normal. The order also provided for a change in the definition of gas cost
to include the gas cost component of bad debts and the carrying cost of prepaid
gas service and LNG storage. These provisions, which went into effect on April
1, 2003, will reduce the earnings impact of rising gas costs on bad debts,
prepaid gas service and LNG storage.
As discussed above, the Company has received authorization from the staff of the
West Virginia Public Service Commission to defer costs associated with the West
Virginia portion of the gas outage as a regulatory asset and apply for recovery
of these costs in future rate filings. A total of $219,127 in expenses have been
deferred as a result on this notification.
ENVIRONMENTAL ISSUES
Both Roanoke Gas Company and Bluefield Gas Company, subsidiaries of RGC
Resources, Inc., operated manufactured gas plants (MGPs) as a source of fuel for
lighting and heating until the early 1950's. A by-product of operating MGPs was
coal tar, and the potential exists for on-site tar waste contaminants at the
former plant sites. The extent of contaminants at these sites, if any, is
unknown at this time. An analysis at the Bluefield Gas Company site indicates
some soil contamination. The Company, with concurrence of legal counsel, does
not believe any events have occurred requiring regulatory reporting. Further,
the Company has not received any notices of violation or liabilities associated
with environmental regulations related to the MGP sites and is not aware of any
off-site contamination or pollution as a result of prior operations. Therefore,
the Company has no plans for subsurface remediation at the MGP sites. Should the
Company eventually be required to remediate either site, the Company will pursue
all prudent and reasonable means to recover any related costs, including
insurance claims and regulatory approval for rate case recognition of expenses
associated with any work required. A stipulated rate case agreement between the
Company and the West Virginia Public Service Commission recognized the Company's
right to defer MGP clean-up costs, should any be incurred, and to seek rate
relief for such costs. If the Company eventually incurs costs associated with a
required clean-up of either MGP site, the Company anticipates recording a
regulatory asset for such clean-up costs to be recovered in future rates. Based
on anticipated regulatory actions and current practices, management believes
that any costs incurred related to this matter will not have a material effect
on the Company's financial condition or results of operations.
21
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
CAPITAL RESOURCES AND LIQUIDITY
The Company's primary capital needs are for the funding of its continuing
construction program and the seasonal funding of its accounts receivable, gas
prepayment requirements and LNG storage under the asset management contract. The
Company's construction program is comprised of a combination of replacing old
bare steel and cast iron pipe with new plastic or coated steel pipe and
expansion of natural gas and propane service to new customers. Total capital
expenditures were $2,279,777 and $4,171,626 for the three-month and six-month
periods ended March 31, 2003, respectively, compared to $1,766,946 and
$4,387,991 for the same periods last year.
The Company also funds seasonal levels of gas prepayments, LNG storage and
accounts receivables. From April through October, the Company prepays its asset
manager for the right to receive additional natural gas in the colder winter
months. This gas prepayment replaces the old underground natural gas storage
that was used prior to the asset management contract. A majority of the
Company's sales and billings occur during the winter. As a result, accounts
receivable balances increase during these months and decrease during the summer
months. Due to the much colder weather and higher energy costs, accounts
receivable balances at March 31, 2003 were well above the levels at March 31,
2002.
The level of borrowing under the Company's line of credit agreements can
fluctuate significantly due to changes in the wholesale price of energy and
weather outside the normal temperature ranges. As the wholesale price of natural
gas increases, short-term debt generally increases because the payment to the
Company's energy suppliers is due before the Company can recover its costs
through the monthly billing of its customers. In addition, colder weather
requires the Company to purchase greater volumes of natural gas, the cost of
which is recovered from customers on a delayed basis.
Effective April 1, 2003, the Company and Wachovia Bank agreed to extend the
current terms of the Company's line-of-credit agreements to allow sufficient
time to complete the paperwork for the renewals. On April 21, 2003, the Company
completed its renewal of the line-of-credit agreements with Wachovia Bank. The
new agreements maintained the same variable interest rates based upon 30 day
LIBOR; however, the Company agreed to establish a three-tier level for borrowing
limits to accommodate its seasonal borrowing demands. Generally, the Company's
borrowing needs are at their lowest in Spring, increase during the Summer and
Fall due to gas prepayments and construction and reach their maximum levels in
Winter. The three-tier approach will keep the Company's borrowing costs to a
minimum by improving the level of utilization on its line of credit agreements
and providing increased credit availability as borrowing requirements increase.
Effective April 21, 2003, the Company's total available lines of credit were set
at $10,500,000. On June 16, 2003, the total available lines of credit increase
to $16,000,000. And on September 16, 2003, the total available lines of credit
increase to $28,000,000. The line-of- credit agreements will expire March 31,
2004, unless extended. The Company anticipates being able to extend or replace
the credit lines upon expiration.
Short-term borrowings, together with internally generated funds and the sale of
Common Stock through the Company's Dividend Reinvestment and Stock Purchase
Plan, have been used to finance construction costs, debt service, dividend
payments and inventories. Total outstanding balances on the Company's
lines-of-credit at March 31, 2003 were $4,034,000 compared to $8,323,000 for the
same period last year.
At March 31, 2003, the Company's capitalization consisted of 46 percent in
long-term debt and 54 percent in common equity.
22
RGC RESOURCES, INC. AND SUBSIDIARIES
ITEM 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
FORWARD-LOOKING STATEMENTS
From time to time, 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. 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 the following: (i) failure to earn on a consistent basis an adequate
return on invested capital; (ii) increasing expenses and labor costs and labor
availability; (iii) price competition from alternative fuels; (iv) volatility in
the price and availability of natural gas and propane; (v) uncertainty in the
projected rate of growth of natural gas and propane requirements in the
Company's service area; (vi) general economic conditions both locally and
nationally; (vii) increases in interest rates; (viii) increased customer
delinquencies and conservation efforts resulting from high fuel costs and/or
colder weather; (ix) developments in electricity and natural gas deregulation
and associated industry restructuring; (x) significant variations in winter
heating degree-days from normal; (xi) changes in environmental requirements and
cost of compliance; (xii) impact of potential increased governmental oversight
due to the financial collapse of Enron; (xiii) cost and availability of property
and liability insurance in the wake of terrorism concerns and corporate
failures; (xiv) ability to raise debt or equity capital in the wake of recent
corporate financial irregularities; (xv) impact of war with Iraq and related
uncertainties in the Middle East, and (xvi) new accounting standards issued by
the Financial Accounting Standards Board, which could change the accounting
treatment for certain transactions. 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" or similar
words or future or conditional verbs such as "will," "would," "should," "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. We assume no duty to update these statements should
expectations change or actual results differ from current expectations.
23
RGC RESOURCES, INC. AND SUBSIDIARIES
- ------------------------------------
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks associated with interest rates and
commodity prices. Interest rate risk is related to the Company's
outstanding long-term and short-term debt. Commodity price risk is
experienced by the Company's regulated natural gas operations, propane
operations and energy marketing business. The Company uses derivative
commodity instruments to hedge price exposures for these operations. The
Company's risk management policy, as authorized by the Company's Board of
Directors, allows management to enter into derivatives for the purpose of
managing commodity and financial market risks of its business operations.
The Company is exposed to market risk related to changes in interest rates
associated with its borrowing activities. As of March 31, 2003, the Company
had $4,034,000 outstanding under its lines of credit and $2,500,000
outstanding on an intermediate-term variable rate note. A hypothetical 10
percent increase in market interest rates applicable to the Company's
variable rate debt outstanding at March 31, 2003 would have resulted in a
decrease in quarterly earnings of approximately $2,400.
The Company manages the price risk associated with purchases of natural gas
and propane by using a combination of fixed price contracts, prepaid gas
service payments and derivative commodity instruments including futures,
swaps and collars. As of March 31, 2003, all propane derivative contracts
had been settled.
With respect to the Company's hedging activities for the price of natural
gas, the Company had entered into swap arrangements for the purchase of
natural gas for November 2002 through March 2003. Any cost incurred or
benefit received from the derivative arrangement is recoverable or refunded
through the regulated natural gas purchased gas adjustment (PGA) mechanism.
Both the Virginia State Corporation Commission and the West Virginia Public
Service Commission currently allow for full recovery of prudent costs
associated with natural gas purchases, and any additional costs or benefits
associated with the settlement of the derivative contract will be passed
through to customers when realized. As of March 31, 2003, all natural gas
derivative contracts had been settled.
ITEM 4 - CONTROLS AND PROCEDURES
Based on their evaluation of the Company's disclosure controls and
procedures (as defined by Rule 13a-14 (c) under the Securities Exchange Act
of 1934) as of a date within 90 days of the filing date of this quarterly
report, the Company's Chief Executive Officer and Chief Financial Officer
have concluded that these disclosure controls and procedures are effective.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to
the date of their evaluation.
24
Part II - Other Information
ITEM 2 - CHANGES IN SECURITIES.
Pursuant to the RGC Resources Restricted Stock Plan for Outside Directors
(the "Restricted Stock Plan"), 40% of the monthly retainer fee of each
non-employee director of the Company is paid in shares of unregistered
common stock and is subject to vesting and transferability restrictions
("restricted stock"). A participant can, subject to approval of Directors
of the Company (the "Board"), elect to receive up to 100% of his retainer
fee in restricted stock. The number of shares of restricted stock is
calculated each month based on the closing sales price of the Company's
common stock on the Nasdaq-NMS on the first day of the month. The shares of
restricted stock are issued in reliance on section 3(a)(11) and section
4(2) exemptions under the Securities Act of 1993 (the "Act") and will vest
only in the case of the participant's death, disability, retirement or in
the event of a change in control of the Company. Shares of restricted stock
will be forfeited to the Company upon (i) the participant's voluntary
resignation during his term on the Board or (ii) removal for cause. During
the quarter ended March 31, 2003, the Company issued a total of 708.534
shares of restricted stock pursuant to the Restricted Stock Plan as
follows:
INVESTMENT DATE PRICE NUMBER OF SHARES
1/2/2003 $17.860 214.447
2/3/2003 $19.520 245.963
3/3/2003 $19.350 248.124
On March 3, 2003, the Company issued a total of 187.584 shares of its
common stock as bonuses to certain employees and management personnel as
rewards for performance and service. The 187.584 shares were not issued in
a transaction constituting a "sale" within the meaning of section 2(3) of
the Act.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On January 27, 2003, the Company held its Annual Meeting of Shareholders to
elect three directors and to ratify the selection of independent auditors.
Shareholders elected all nominees for Class C directors as listed below to
serve a three year term expiring at the Annual Meeting of Shareholders to
be held in 2006.
Shares Shares Shares
Director For Withheld Not Voted
Frank T. Ellett 1,580,082 45,834 343,172
George W. Logan 1,610,653 15,263 343,172
Maryellen F. Goodlatte 1,597,536 28,380 343,172
Abney S. Boxley, III, S. Frank Smith and John B. Williamson, III continue
to serve as Class A directors until the Annual Meeting of Shareholders to
be held in 2004. Lynn D. Avis, J. Allen Layman and Thomas L. Robertson
continue to serve as Class B directors until the Annual Meeting of
Shareholders to be held in 2005.
Shareholders approved the selection by the Board of Directors of the firm
Deloitte & Touche LLP as independent auditors for the fiscal year ending
September 30, 2003, by the following vote.
Shares Shares Shares Shares
For Against Abstaining Not Voted
1,603,172 7,670 6,396 343,172
25
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Number Description
10 (p)(p)(p) Unconditional Guaranty by and between Bluefield Gas Company, RGC
Resources, Inc. and Wachovia Bank, National Association, dated April 21,
2003
10 (q)(q)(q) Promissory Note by and between Bluefield Gas Company and Wachovia Bank,
National Association in the amount of $4,500,000, dated April 21, 2003
10 (r)(r)(r) Unconditional Guaranty by and between Diversified Energy Company, RGC
Resources, Inc. and Wachovia Bank, National Association, dated April 21,
2003
10 (s)(s)(s) Promissory Note by and between Diversified Energy Company and Wachovia
Bank, National Association in the amount of $4,500,000, dated April 21, 2003
10 (t)(t)(t) Unconditional Guaranty by and between Roanoke Gas Company, RGC
Resources, Inc. and Wachovia Bank, National Association, dated April 21,
2003
10 (u)(u)(u) Promissory Note by and between Roanoke Gas Company and Wachovia Bank,
National Association in the amount of $18,000,000, dated April 21, 2003
10 (v)(v)(v) Promissory Note by and between RGC Resources, Inc. and Wachovia Bank,
National Association in the amount of $1,000,000, dated April 21, 2003
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, of John B. Williamson, III,
dated May 15, 2003.
99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, of Howard T. Lyon, dated May
15, 2003.
(b) Reports on Form 8-K
On April 30, 2003, the Company filed a current report on Form
8-K, dated April 30, 2003, furnishing under Items 9 and 12
thereof a press release announcing the financial results of the
second quarter of fiscal year 2003, including the applicable
financial statements.
26
SIGNATURES
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.
RGC Resources, Inc.
Date: May 15, 2003 By: s/Howard T. Lyon
Howard T. Lyon
Controller and Treasurer
Principal Financial Officer
27
CERTIFICATION
I, Howard T. Lyon, certify that:
1. I have reviewed this Form 10-Q of RGC Resources, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report; and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the audit
committee of the board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
s/Howard T. Lyon
Vice-President, Treasurer
and Controller
(Principal Financial Officer)
CERTIFICATION
I, John B. Williamson, III, certify that:
1. I have reviewed this Form 10-Q of RGC Resources, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report; and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the audit
committee of the board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
s/John B. Williamson, III
Chairman of the Board,
President and Chief Executive Officer
EXHIBIT INDEX
NUMBER DESCRIPTION
10 (p)(p)(p) Unconditional Guaranty by and between Bluefield Gas Company, RGC Resources, Inc.
and Wachovia Bank, National Association, dated April 21, 2003
10 (q)(q)(q) Promissory Note by and between Bluefield Gas Company and Wachovia Bank, National
Association in the amount of $4,500,000, dated April 21, 2003
10 (r)(r)(r) Unconditional Guaranty by and between Diversified Energy Company, RGC Resources,
Inc. and Wachovia Bank, National Association, dated April 21, 2003
10 (s)(s)(s) Promissory Note by and between Diversified Energy Company and Wachovia Bank,
National Association in the amount of $4,500,000, dated April 21, 2003
10 (t)(t)(t) Unconditional Guaranty by and between Roanoke Gas Company, RGC Resources, Inc.
and Wachovia Bank, National Association, dated April 21, 2003
10 (u)(u)(u) Promissory Note by and between Roanoke Gas Company and Wachovia Bank, National
Association in the amount of $18,000,000, dated April 21, 2003
10 (v)(v)(v) Promissory Note by and between RGC Resources, Inc. and Wachovia Bank, National
Association in the amount of $1,000,000, dated April 21, 2003
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, of John B. Williamson, III, dated May 15, 2003.
99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, of Howard T. Lyon, dated May 15, 2003.