RGC Resources
2002 Annual Report
keepin' life Simple
WHO WE ARE
RGC Resources provides superior customer and shareholder value as a preferred
provider of energy and diversified products and services in its selected market
areas.
PRODUCTS AND MARKETS
Product Division Market Territory
Natural Gas Roanoke Gas Natural gas Virginia
sales & Services
Bluefield Gas Natural gas West Virginia
Propane Highland Propane Propane sales Virginia
& Service & West Virginia
Applications Application Resources Information System National
Services
TABLE OF CONTENTS
Mission Statement.................................................... IFC
Financial Highlights................................................. 1
Shareholders Letter.................................................. 2
Selected Financial Data.............................................. 10
Management Discussion and Analysis................................... 11
Directors and Officers............................................... 24
Corporate Information............................................... IBC
[Image of West Virginia and Virginia]
FINANCIAL HIGHLIGHTS
Years Ended September 30, 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
Operating Revenue - Natural Gas ............... $ 57,647,947 $ 86,195,121 $ 55,685,168
Operating Revenue - Propane........................ $ 10,718,404 $ 14,929,570 $ 11,246,152
Energy Marketing Revenue........................... $ 11,107,532 $ 14,756,066 $ 8,828,492
Other Revenue...................................... $ 751,790 $ 1,562,390 $ 1,990,183
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Net Income......................................... $ 2,486,895 $ 2,306,615 $ 2,873,702
Net Earnings Per Share............................. $ 1.28 $ 1.21* $ 1.54
Dividend Per Share - Cash.......................... $ 1.14 $ 1.12 $ 1.10
Number of Customers - Natural Gas.................. 57,229 56,770 56,067
Number of Customers - Propane...................... 18,156 17,105 15,973
Total Natural Gas Deliveries - DTH................. 10,563,514 11,890,227 11,253,948
Total Propane Sales - Gallons...................... 8,856,086 10,174,329 9,666,772
Total Additions to plant........................... $ 8,614,454 $ 8,029,853 $ 8,398,388
*Reflects $0.32 per share impairment loss.
[Bar graphs appear here depicting Number of Customers - Natural Gas, Number of
Customers-Propane and Dividend Per Share for the years 2002, 2001 and 2000.]
1
[Picture of John B. Williamson, III.]
To Our Shareholders:
I am pleased to report that in spite of a very challenging year for the
Company and the industry, we were able to modestly increase earnings. While I
consider per share earnings of $1.28 well below our potential, we were dealing
with the warmest winter season since 1932 and a recession which reduced energy
demand by industrial and commercial customers. Fiscal year heating degree days
were 19% below last year and 17% fewer than the long-term average. Our sales of
natural gas declined by 1,326,713 decatherms or 11.2% compared to the prior
year, and our propane sales declined by 1,318,243 gallons or 13.0%.
It has been a tumultuous year in the energy sector with the collapse or
near collapse of several of the larger energy trading companies. The combination
of the post-September 11 deepening recession, the bankruptcy of Enron, and the
realization that a number of the large energy trading companies were
artificially inflating revenues clearly shook the public's confidence in the
reliability and value of some sectors of the energy industry. I am pleased to
say that we did not suffer monetary losses or operational disruptions during the
upheaval. Our primary supply contracts are with Duke Energy Trading, a joint
venture of Duke Energy and Exxon Mobil, and they performed well. Our interstate
pipeline capacity contracts are with Columbia Transmission, a subsidiary of
NiSource, Duke Energy and El Paso, all of whom performed to contract and without
incident.
We do not operate as energy traders, but as a utility distributor and
end use retailer. Our fiscal 2002 revenues were 72% regulated utility
distribution sales, 13% unregulated retail propane sales, and 14% unregulated
natural gas sales to large industrial customers. The remaining 1% of revenues
were related to other service offerings in specialized computer application
consulting, heating ventilation and air conditioning equipment, sales and
services (HVAC) and geographic information systems services (GIS).
2
[Caption: "Keepin' Life Simple" - We want our customers to know that we can and
will keep things simple for them in their energy choices and service needs.]
As a result of the effects of the recession, low margins and a competitive
environment that appears to ensure inadequate returns, we are no longer offering
HVAC equipment sales and GIS services. We maintain a capability in computer
applications consulting, but due to the recession and inactivity in the utility
sector for replacing customer information systems, we are not currently involved
in any information system projects other than those supporting our own
operations which recently included upgrading both our customer information
software and our PC local area network.
We focused our efforts in fiscal 2002 on growing our natural gas and
propane markets and on controlling costs to ensure that we would remain
profitable in a dramatically warmer than normal year. In spite of the recession,
we installed over 1,200 new natural gas service lines and over 2,500 new propane
installations as the new home construction market remained reasonably strong due
to low mortgage rates. In addition, we continued to see customers convert from
fuel oil and electric heat pumps, reflecting a continuing customer preference
for the comfort, convenience, reliability and environmental benefits of natural
gas and propane. We also extended natural gas mains into Roanoke County's new
industrial park, Center for Research and Technology, and further extended mains
into the developing sections of Botetourt County's industrial center at
Greenfield.
Net customer growth, however, is not as strong as in previous years.
Record high energy prices in the winter of 2000-2001 led to record customer
service disconnections for non-payment of gas bills. The combination of
accumulated unpaid debt and the recession has resulted in a larger-than-normal
number of customers not restoring their natural gas or propane service. Net
customer growth for natural gas in fiscal year 2002 was 459 and net propane
customer growth was 1,051, reflecting higher than historical
3
[Picture of Lynn D. Avis
Caption:
Board Member
Lynn D. Avis
Chairman of the Board - Avis Construction Company, Inc.]
[Caption: Strong Market]
customer attrition. In addition, we have observed a significant reduction in
propane usage by a segment of our customers who apparently have multiple heating
systems. We are developing a plan to charge these customers a minimum use or
equipment availability fee. The new charges may result in additional customer
attrition, however if that occurs, we will redeploy the propane tanks to new
customers whose usage justifies the equipment investment.
In addition to new customer growth, significant effort went into
infrastructure improvements and system renewal. We replaced eight miles of cast
iron and bare steel mains and 779 bare steel service lines with new plastic
mains and services. We also moved and replaced 350 aging inside meters to the
outside of customer residences, making substantial headway in our enhanced
safety and reliability program. We intend to gradually replace all cast iron and
bare steel mains and services and inside meters in our systems to ensure the
integrity of our distribution plant for the long term.
To ensure adequate supply for growth, we increased our interstate
pipeline and storage capacity by 2,000 decatherms per day in November 2001 and
will add 2,000 more in November 2002. To maximize the new capacity, we have
begun construction of a new interconnect with Duke Energy's Tennessee Gas
Pipeline on the southwest side of the Roanoke Gas Distribution System. The new
capacity and interconnect will add operating flexibility and will increase
supply and pipeline pressure at the point most needed in the Roanoke Gas
distribution system. Our supply contracts, gas inventories, and price hedging
mechanisms for the winter of 2002-2003 are in place and we believe we are well
positioned for the
4
[Picture of Abney S. Boxley, III
Caption:
Board Member
Abney S. Boxley, III
President and Chief Executive Officer -
Boxley Company, Inc. ]
[Picture of Frank T. Ellett
Caption:
Board Member
Frank T. Ellett
President - Virginia Truck Center, Inc.]
[Caption: We focused our efforts in 2002 on growing our natural gas and propane
markets and on controlling costs to ensure that we would remain profitable in a
dramatically warmer than normal year.]
upcoming heating season. I do maintain a degree of apprehension about the
ensuing years because of the slowness of Congress to adopt a much needed
comprehensive energy bill and what that slowness may imply for supply
development and volatility in commodity pricing. Tight credit in the energy
production sector of the industry may also contribute to tightening supply and
price volatility in the near term.
Due to the abnormally warm weather and the resulting decline in sales,
we worked very hard this year to reduce operating costs. Customer bad debt
expense was dramatically reduced on lower prices, lower volume, enhanced
collection efforts, and an agreement we reached with the Regulatory Staff of the
Virginia State Corporation Commission. The regulatory agreement allowed for
deferral and planned future recovery of a portion of the unusually high customer
bad debt experienced in the winter of 2001. The credit for the unusual 2001 bad
debt expense was recognized in the Company's financial results in the spring of
2002 and the incremental rates for recovery of the deferred expense will take
effect December 1, 2002. We were able to further reduce operating expense by
re-focusing company field employees on capital projects, including relocating
inside meters to the outside of customer premises, bare steel and cast iron main
replacement, and reconstruction of over 700 aging farm tap regulators located
along our transmission pipeline. In addition to enhancing the safety and
reliability of the distribution system, the effort reduced current operating
expenses because employee wages and related overhead were capitalized as part of
distribution system construction projects.
5
[Picture of Maryellen F. Goodlatte
Caption:
Board Member
Maryellen F. Goodlatte
Attorney and Principal - Glenn, Feldmann,
Darby & Goodlatte]
[Picture of Frank A. Farmer, Jr.
Caption:
Board Member
Frank A. Farmer, Jr.
Former Chairman of the Board - RGC Resources, Inc.]
[Caption: We are listed on the Nasdaq stock exchange, offer a stable investment,
have paid a consistent dividend, provide easy dividend reinvestment, offer
commission-free stock purchase options, and operate an understandable business
integral to our customers' and our community's needs.]
We also looked for ways to generate additional revenues with Highland
Propane employees in the off-peak season and secured a contract to repair or
replace approximately 2,900 residential meter bars for another natural gas
utility in southwest Virginia and eastern Tennessee. The contract provided us a
means to better balance our winter/summer workload and valuable experience in
Gas Utility Services, a summer revenue niche we hope to further develop.
We are finding cost containment in the current environment particularly
challenging. Medical inflation has clearly returned to employee health care
costs and the broad decline in stock market values has hurt pension fund values,
requiring increased annual pension expense and funding. The September 11 attacks
exacerbated an already hard insurance market and we have seen our insurance
premiums increase by 50% over the last two years, including adding terrorism
coverage for our liquified natural gas storage facility.
To mitigate the impact of these increased operating costs on the
regulated utilities, we filed two rate cases in Virginia and one in West
Virginia. The West Virginia case was settled with an $88,000 increase in base
rates and the Virginia case was settled, subject to Commission approval, with an
increase in base rates of $989,000. The new rates will be put into effect
December 1, 2002, subject to refund, pending a final order from the Virginia
State Corporation Commission. In addition, we filed for, and the pending
settlement in Virginia includes, a weather normalization adjustment mechanism
designed to lessen earnings volatility in periods of significantly warmer than
normal weather. The proposal is symmetrical and would lessen customer bills in
6
[Picture of J. Allen Layman
Caption:
Board Member
J. Allen Layman
Chairman of the Board and President - NTELOS Inc.]
[Caption: Stable Stock]
periods of significantly colder than normal weather. If approved, the program
will first apply to the 2003-2004 winter season.
We also experienced some personnel changes this year and are planning
for more in 2003. Roger Baumgardner retired as Vice President, Treasurer and
Corporate Secretary after 37 years of service. Howard Lyon, our Controller, has
assumed the Treasurer functions and Dale Moore, our Vice President for Finance
and Regulatory Affairs, has assumed the Corporate Secretary functions. Art
Pendleton, President and Chief Operating Officer for the utility companies left
to work for a larger organization in the mid-west. His former duties were
reassigned among John D'Orazio, Vice President of Marketing and Customer
Service, Ed Painter, Director of Operations for Roanoke Gas Company, and Jim
Shockley, Director of Operations for Highland Propane and Bluefield Gas Company.
While we will miss Roger and Art and their years of dedicated service, their
retirement and departure has provided the opportunity for growth and advancement
of aspiring members of a strong management team.
In other important personnel changes, we added Maryellen Goodlatte and
George Logan to our Board of Directors. Maryellen replaces Wilbur Hazlegrove,
who retired from the Board in January 2000, and George is replacing Frank
Farmer, who will retire from the Board in January 2003, after 24 years of
service as a director and 34 years as an employee before his retirement as
President and CEO in February 1998. We deeply appreciate Frank's years of
service and dedication. We also look forward to utilizing the talents, insights
and varied experience that Maryellen and George bring to the Company as
independent directors.
7
[Picture of George W. Logan
Caption:
Board Member
George W. Logan
Chairman of the Board - Valley Financial Corporation
Chairman of the Board - Alliance Logistics Center (Warsaw, Poland)
Principal - Pine Street Partners, LLC
Faculty - University of Virginia Darden Graduate School of Business]
[Caption: Solid Management]
As the cover of this report indicates, we are launching a branding
theme for RGC Resources, "Keepin' Life Simple", beginning in 2003. We plan for
it to be the slogan and theme for customer relations across all of our markets,
services and activities. We want our customers to believe that we can and will
keep things simple for them in their energy choices and service needs. It will
provide a guiding principle for our employees as well. It means making the
natural gas or propane choice simple, whether it be for the end use customer,
the equipment contractor, the home builder, the real estate developer or the
industrial developer. Keeping life simple means making the service offering easy
to understand, making the bill easy to read, and making the work schedule fit
the customer's needs. We think the "Keepin' Life Simple" theme also applies to
our investors. We are listed on the Nasdaq stock exchange, offer a stable
investment, have paid a consistent dividend, provide easy dividend reinvestment,
offer commission free stock purchase options, and operate an understandable
business, integral to our customers and our communities' needs. We are "Keepin'
Life Simple" for our shareholders.
At a time when the motivation of top level managers and the oversight
of board of directors has been called into question in some of the country's
major corporations, I believe we are maintaining a tradition of dedication and
focus. I am proud of our management team and our employees. I believe they
believe "character still matters". I see it in their day-to-day dedication, in
their community involvement, and in the way they support each other and the
Company. I am also proud of our Board of Directors, all of whom are local, and
each of whom has a vested interest in the success of the Company
8
[Picture of Thomas L. Robertson
Caption:
Board Member
Thomas L. Robertson
Chairman of the Board - Carilion Foundation
Chairman of the Board - Carilion Biomedical Institute]
[Picture of S. Frank Smith
Caption:
Board Member
S. Frank Smith
Vice President - Coastal Coal Company, LLC]
[Caption: At a time when the motivation of the top-level managers and the
oversight of board of directors has been called into question in some of the
country's major corporations, I believe we are maintaining a tradition of
dedication and focus.]
and in the vitality of the communities we serve. I believe we have an
exceptionally experienced and qualified Board of Directors. Howard Lyon and I
are certifying to the accuracy of our reported financial statements as required
by the new federal legislation and the Securities and Exchange Commission.
However I have always believed our reputation to be embodied in our public
reports, and no new federal rules were needed to enhance the integrity of our
financial statements.
While the economic news for 2003 continues to be less than optimistic
for industrial and commercial energy usage, we remain optimistic that low
interest rates will continue to support new home construction, and we are
planning for near normal new customer additions and capital investment in 2003.
We believe we will receive reasonable regulatory treatment in our Virginia
natural gas utility rate proceedings. We also continue to expand our propane
operations with one new bulk storage facility established at the end of 2001 and
another planned to be installed early in 2003. As always, energy sales will be
impacted by the weather, commodity prices and the economy; however, I believe
our operating fundamentals are sound and we are positioned for reasonable
customer and earnings growth assuming normal weather and a gradually recovering
economy.
I thank you for your continued investment in our Company and I look
forward to communicating with you about our future operations, growth and
profitability.
Sincerely,
s/John B. Williamson, III
John B. Williamson, III
President, Chairman and Chief Executive Officer
9
SELECTED FINANCIAL DATA
Years Ended September 30, 2002 2001 2000 1999 1998
-----------------------------------------------------------------------------------------------------------------------
Operating Revenues $ 80,225,673 $ 117,443,147 $ 77,749,995 $ 64,202,709 $ 66,507,847
Operating Margin 24,831,089 28,173,186 26,040,519 23,892,521 23,624,462
Operating Income 6,136,417 6,728,633 6,915,177 6,649,827 6,428,919
Net Income 2,486,895 2,306,615* 2,873,702 2,883,407 2,726,879
Net Earnings Per Share 1.28 1.21* 1.54 1.59 1.60
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Cash Dividends Declared Per Share 1.14 1.12 1.10 1.08 1.06
Book Value Per Share 16.36 16.05 15.94 15.36 14.75
Average Shares Outstanding 1,939,511 1,898,697 1,863,275 1,814,864 1,701,048
Total Assets 92,401,455 93,571,129 87,407,494 77,789,982 69,134,920
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Long-Term Debt (Less Current Portion) 30,377,358 22,507,485 23,310,522 23,336,614 20,700,000
Stockholders' Equity 32,068,997 30,725,072 29,985,871 28,154,923 26,464,581
Shares Outstanding at Sept. 30 1,960,418 1,914,603 1,881,733 1,832,771 1,794,416
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*Reflects $0.32 per share impairment loss.
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: inability to obtain authorization for adequate and timely
rate relief from the respective state commissions; failure to earn on a
consistent basis an adequate return on invested capital; increasing expenses and
labor costs and labor availability; price competition from alternative fuels;
volatility in the price and availability of natural gas and propane; uncertainty
in the projected rate of growth of natural gas and propane requirements in the
Company's service area; general economic conditions both locally and nationally;
increases in interest rates; increased customer delinquencies and conservation
efforts resulting from high fuel costs; developments in electricity and natural
gas deregulation and associated industry restructuring; significant variations
in winter heating degree-days from normal; changes in environmental requirements
and cost of compliance; impact of increased governmental regulation and
oversight due to the financial collapse of Enron; cost and availability of
property and liability insurance in the wake of terrorism concerns and corporate
failures; ability to raise debt or equity capital in the wake of recent
corporate financial irregularities; and 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.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
The core business of RGC Resources, Inc. is the sale and distribution
of natural gas to approximately 57,200 customers in Roanoke, Virginia, and
Bluefield, Virginia and West Virginia and the surrounding areas. RGC Resources
also sells and distributes propane to approximately 18,200 customers in western
Virginia and southern West Virginia. 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. The Company is
experiencing customer growth and plans to meet these growth needs by attracting
adequate investment capital and by maintaining adequate rates.
Propane sales are a significant portion of the consolidated operation
with an annual growth rate that far exceeds the growth in natural gas customers.
Energy conservation and competition from alternative fuels could result in a
decline in the Company's earnings.
Roanoke Gas and Bluefield Gas currently hold the only franchises and/or
certificates of public convenience and necessity to distribute natural gas in
its Virginia and West Virginia service areas. These franchises are effective
through January 1, 2016 in Virginia and August 23, 2009 in West Virginia. While
there are no assurances, the Company believes that it will be able to negotiate
acceptable franchises when the current agreements expire. Certificates of public
convenience and necessity are exclusive and are of perpetual duration.
RESULTS OF OPERATIONS
FISCAL YEAR 2002 COMPARED WITH FISCAL YEAR 2001
Operating Revenues - Total operating revenue declined $37,217,474, or 31.7%, for
the year ended September 30, 2002 compared to the same period last year. The
reduction in revenues resulted from a combination of much lower energy costs and
lower sales volume attributable to significantly warmer weather. As the cost of
energy represents well over 50 percent of the average sales price on natural gas
and propane gas, significant changes in the cost of energy have a corresponding
impact on total energy revenues.
Operating Margin - Total operating margin decreased by $3,342,097, or 11.9%, for
the year ended September 30, 2002 compared to the same period last year. The
table below reflects volume activity and heating degree-days.
Volume Summary
Increase/
Year Ended September 30, 2002 2001 (Decrease) Percentage
---------------------------------------------------------------------------------------------------------------
Regulated Natural Gas - DTH:
Residential and Commercial................ 7,499,603 8,863,810 (1,364,207) -15.4%
Interruptible Sales Service............... 156,923 192,659 (35,736) -18.5%
Transported Volumes....................... 2,906,988 2,833,758 73,230 2.6%
------------------------------------------------------------------
Total Delivered Volumes - DTH................ 10,563,514 11,890,227 (1,326,713) -11.2%
Propane - Gallons............................ 8,856,086 10,174,329 (1,318,243) -13.0%
Energy Marketing - DTH....................... 2,437,664 2,431,943 5,721 0.2%
Heating Degree Days.......................... 3,502 4,342 (848) -19.3%
Natural gas margins decreased $1,936,166, or 9.2%, as total delivered
natural gas volumes (firm sales and transportation) declined by 11.2% from last
year's levels. Residential and commercial firm sales volumes decreased by 15.4%
while transportation volumes increased slightly by 2.6%. The decrease in
residential and commercial sales volume relates directly to weather that was
19.3% warmer than last year and 16.8% warmer than the long- term normal. The
increase in transportation volumes related to the
11
resumption of natural gas usage by those industrial customers that switched fuel
during the previous winter months as a result of the high cost on natural gas.
However, during the last few months of fiscal year 2002, transportation volumes
lagged last year's volumes due to the economic slow-down in some of the
industrial sectors.
Propane margins decreased $1,044,253, or 16.7%, as total gallons
delivered declined from last year by 1,318,243 gallons, or 13.0%. The decrease
in gallons delivered corresponds to significantly warmer winter weather. Net
realized losses of $178,870 on derivative contracts during the year compared
with a net realized derivative benefit of $153,168 last year also negatively
affected margins. The Company continues to experience strong competition from
other propane vendors in the Company's service territory; however, customer base
continues to grow with the net addition of more than 1,000 customers during the
year.
Energy marketing margins declined $259,298, or 49.4%, from last year,
as total dekatherms delivered were virtually unchanged from last year. In March
2002, Highland Energy realized a one-time gain of $78,600 related to the sale of
a fixed-price contract for the purchase of 120,000 dekatherms of natural gas. In
2001, however, Highland Energy benefited from another fixed price natural gas
contract that expired in March 2001, which provided a much greater contribution
to margins than the sale of the fixed price contract in 2002. The contract
locked-in the purchase price of natural gas significantly below the high winter
spot-market prices of early 2001. The lower priced gas benefited both the energy
marketing division and its customers during the winter months by allowing the
Company to boost unit margins and provide its customers with energy at below
market prices. Energy-marketing margins are expected to return to normal levels
of approximately $0.05 to $0.07 per dekatherm.
Other margins declined $102,380, or 23.8%, from the same period last
year as a result of minimal activity in the heating and air conditioning
operations and significantly reduced work levels for Application Resources, Inc.
due to the current business environment. Service margins related to work
performed through the natural gas and propane operations showed strong growth
with a 37.3% increase. Most of the increase, however, related to earnings on a
one-time contract that was more than 80% complete as of the end of the fiscal
year.
Other Operating Expenses - Operations and maintenance expenses declined by
$1,569,554, or 11.6%, in fiscal 2002 compared with fiscal 2001. Operations
expenses decreased $1,418,271. Most of this decrease related to reductions in
bad debt expense across all segments of the Company, partially offset by
increases in employee benefits and corporate property and liability insurance
premiums. The reduction in bad debt expense is attributable to significantly
lower gross revenues, improved collection results on prior bad debts and the
recording of a regulatory asset resulting from an agreement with the regulatory
staff of the State Corporation Commission of Virginia (SCC). Warmer winter
weather resulted in lower gross revenues and reduced total sales volumes of both
propane and natural gas and also allowed wholesale energy prices to remain
stable and less volatile compared to the high prices last year. Last year's
high-energy prices and cold weather combined to generate high energy bills for
our customers. These extremely high customer bills, combined with regulatory
restrictions during last year's winter months, which limited the periods when
customers could be disconnected for nonpayment, enabled delinquent balances to
build to high levels last year. During the current year, the warm winter reduced
sales volumes, better enabled customers to pay their bills and provided for a
more timely disconnect process for delinquent customers. Management increased
collection efforts through greater utilization of various legal remedies,
including judgements. In addition to improved delinquencies, the agreement with
the regulatory staff of the SCC provided for the deferral of incurred bad debt
expense in the amount of $316,966 to be amortized over a three-year period
beginning in December 2002, coinciding with the anticipated implementation date
of new rates associated with the Company's pending rate filing. The Company has
applied Statement of Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation," in recording the regulatory asset. The
significant reductions in bad debt expense were partially offset by increases in
employee benefits and corporate property and liability insurance premiums.
Maintenance expenses declined by $151,283, or 10.8%, due to the warmer
winter requiring less maintenance and a shift in the Company's focus from
general maintenance to system renewal and expansion. This change in emphasis
resulted in the
12
capitalization of a greater amount of Company labor and corresponding benefits
compared to the previous year. All critical maintenance continues to be
performed, while certain routine maintenance items have been reduced. Management
expects maintenance expenses to return to prior year levels next year, although
the current focus away from routine maintenance could result in additional
maintenance costs in future periods.
General taxes decreased $838,929, or 35.8%, in fiscal 2002 compared to
2001 primarily as a result of the elimination of state and local gross receipts
tax on Virginia public utilities by the Commonwealth of Virginia beginning
January 1, 2001. Virginia state and local governments switched from a tax based
on gross receipts to a tax based on consumption. The consumption tax is added to
customer bills based on the volume of natural gas consumed. Unlike the gross
receipts tax, the Company does not include the consumption tax in either
operating revenues or general tax expense. This tax is a pass-through from the
customer to the Commonwealth of Virginia and the localities in which the utility
operates within Virginia. Bluefield Gas Company, which operates in the state of
West Virginia, continues to have a gross receipts tax in the form of a business
and occupation tax. The business and occupation tax in West Virginia declined as
a result of reduced revenues upon which the tax is determined.
Capital expenditures for adding new customers to the natural gas and
propane business and replacing older portions of the natural gas distribution
system have resulted in depreciation expense increasing by $286,224, or 5.9%.
The Company recognized an impairment loss of $699,630 for the year
ended September 30, 2001 related to the restructuring of the Company's heating
and air conditioning operations due to losses. The Company decided to
significantly reduce its presence in the heating and air conditioning market. In
connection with this restructuring, the Company adjusted the valuation of
several assets to estimated net realizable value. These adjustments included the
write-off of goodwill and other intangible assets and the write-down of
equipment and other assets. In fiscal 2002, the Company completed the
disposition of those assets written down to net realizable value. The auction of
assets resulted in an additional $72,008 in realized losses.
Interest Expense - Total interest expense for fiscal 2002 decreased $698,096, or
25.4%, from fiscal 2001 on a reduction of 6.9% in total average debt outstanding
during the year.
Debt Summary
Increase/
Year Ended September 30, 2002 2001 (Decrease) Percentage
---------------------------------------------------------------------------------------------------------------
Average Daily Balance:
Long-term Fixed Rate Debt................. 19,729,589 20,457,534 (727,945) -3.6%
Long-term Variable Rate Debt.............. 2,500,000 2,500,000 0 0.0%
Short-term Variable Rate Debt............. 12,751,542 14,598,403 (1,846,861) -12.7%
Total Variable Rate Debt.................. 15,251,542 17,098,403 (1,846,861) -10.8%
Total Debt................................ 34,981,131 37,555,937 (2,574,806) -6.9%
Average Interest Rate:
Long-term Fixed Rate Debt................. 8.10% 8.13% -0.03% -0.4%
Variable Rate Debt........................ 2.59% 5.85% -3.26% -55.7%
Variable rate debt amounted to 43.6% and 45.5% of the total average
debt outstanding during fiscal 2002 and 2001, respectively. Continued declines
in interest rates generated most of the reduction in interest expense as the
interest rates on the Company's variable rate debt fell throughout the year. The
average effective interest rate on the Company's variable rate debt declined
from 5.85% in 2001 to 2.59% in 2002. The decline in total average debt
outstanding resulted from lower energy prices, which reduced the amount of
capital needed to fund accounts receivables and natural gas
inventories/prepayments.
13
Income Taxes - Income tax expense decreased $66,207, or 4.2% from last year.
Although pre-tax income increased by $114,073, last year's earnings included the
amortization and write-down of $508,631 in goodwill related to the heating and
air conditioning operations. The goodwill was not deductible for income tax
purposes resulting in a higher average effective income tax rate for last year.
The lower average effective tax rate for the fiscal year 2002 was partially
offset by the state income tax on regulated Virginia natural gas operations. The
state income tax was in place for the entire year of fiscal 2002; however, it
was only in effect for the last nine months of fiscal 2001. Consequently, from a
tax rate perspective, the average rate on taxable income was effectively higher
in 2002, while the total effective tax rate was lower in 2001, excluding the
nondeductible goodwill.
Net Income and Dividends - Net earnings for fiscal 2002 were $2,486,895 as
compared to fiscal year 2001 earnings of $2,306,615. Earnings improved over last
year despite the warmer winter as a result of a significant reduction in bad
debt expense in the current year and the impairment loss related to the
restructuring of the heating and air conditioning operation recorded in fiscal
2001. Basic earnings per share of common stock were $1.28 in fiscal 2002
compared with $1.21 in fiscal 2001. Dividends per share of common stock were
$1.14 in fiscal 2002 compared with $1.12 in fiscal 2001.
FISCAL YEAR 2001 COMPARED WITH FISCAL YEAR 2000
Operating Revenue - Total operating revenues increased by $39,693,152, or 51.5%,
for year ended September 30, 2001 compared to September 30, 2000. The increase
in revenues resulted from a combination of significantly higher energy costs and
increased sales volume attributable to colder weather. As the cost of energy
represents well over 50 percent of the average sales price of natural gas and
propane gas, significant changes in the cost of energy have a corresponding
impact on total energy revenues.
Operating Margin - Total operating margin increased by $2,132,667, or 8.2%, for
the year ended September 30, 2001 compared to September 30, 2000.
Volume Summary
Increase/
Year Ended September 30, 2001 2000 (Decrease) Percentage
---------------------------------------------------------------------------------------------------------------
Regulated Natural Gas - DTH:
Residential and Commercial................ 8,863,810 7,890,064 973,746 12.3%
Interruptible Sales Service............... 192,659 177,387 15,272 8.6%
Transported Volumes....................... 2,833,758 3,186,497 (352,739) -11.1%
------------------------------------------------------------------
Total Delivered Volumes - DTH................ 11,890,227 11,253,948 636,279 5.7%
Propane - Gallons............................ 10,174,329 9,666,772 507,557 5.3%
Energy Marketing - DTH....................... 2,431,943 2,526,906 (94,963) -3.8%
Heating Degree Days.......................... 4,342 3,721 621 16.7%
Natural gas margins increased $1,115,899 or 5.6%, as total delivered
natural gas volumes (firm sales and transportation) grew by 5.7% over last
year's levels. Residential and commercial sales volumes increased by 12.3% while
transportation volumes declined by 11.1%. The increase in residential and
commercial sales volume related to weather, which was 16.7% colder than the year
ended September 30, 2000. The decline in transportation volumes related to fuel
switching by some customers during the winter months as a result of the high
cost of natural gas.
Propane margins increased $842,278, or 15.6%, as total gallons
delivered increased by 507,557 gallons, or 5.3%. The increase in gallons
delivered corresponded to the colder winter weather. The growth in delivered
gallons was mitigated partially due to energy conservation efforts by customers
and use of alternative energy sources as a result of the high cost of propane.
Propane margins also benefited from greater fixed fees charged during fiscal
2001 including increased tank rental and late payment fees.
14
Energy marketing margins benefited from a fixed-price natural gas
contract the Company entered into during last summer. The contract locked-in the
purchase price of natural gas significantly below the high winter spot-market
prices. The lower priced gas benefited both the energy marketing division and
its customers during the winter months. As a result, energy marketing margins
increased $369,821, or 238%, over the year ended September 30, 2000, even though
total volumes declined by 94,963 dekatherms, or 3.8%, from the same period. The
fixed-price contract expired March 31, 2001.
Other margins declined $195,331, or 31.3%, as the heating and air
conditioning operations under- performed mainly due to increased competition,
the general economic slowdown and lower demand for equipment sales and service.
Other Operating Expenses - Operations and maintenance expenses were up 14.3% in
fiscal 2001 compared with fiscal 2000. Operations expenses were up $1,537,383,
with bad debts being the largest component at $934,054 due to the increase in
homeowner bills associated with the increase in the cost of gas and colder
weather. Additional increases were associated with health insurance, line
locations and increased labor. Maintenance expenses were up 13.5% because of
normal repairs to mains and services.
General taxes decreased 17.8% in fiscal 2001 compared to 2000.
Effective January 1, 2001, Virginia state and local governments switched from a
tax based on gross receipts to a tax based on consumption. The new consumption
tax is added to customer bills based on the volume of natural gas consumed.
Unlike the gross receipts tax, the Company does not include the consumption tax
in either operating revenues or general tax expense. This tax is a pass-through
from the customer to the Commonwealth of Virginia and the localities in which
the utility operates within Virginia.
Depreciation and amortization expenses increased $424,736, or 9.6%, in
fiscal 2001 compared with 2000 due to increases in utility and non-utility
plant.
The Company recognized an impairment loss of $699,630 for the year
ended September 30, 2001 related to the restructuring of the Company's heating
and air conditioning operations due to losses. With the unlikelihood of a timely
improvement in business, the Company decided to significantly reduce its
presence in the heating and air conditioning market. In connection with this
restructuring, the Company adjusted the valuation of several assets to estimated
net realizable value. These adjustments included the write-off of goodwill and
other intangible assets and the write-down of equipment and other assets.
Interest Expense - Total interest expense for fiscal 2001 increased 13.2% over
fiscal 2000 on an increase of 23.1% in average debt outstanding during the year.
Debt Summary
Increase/
Year Ended September 30, 2001 2000 (Decrease) Percentage
---------------------------------------------------------------------------------------------------------------
Average Daily Balance:
Long-term Fixed Rate Debt................. 20,457,534 20,409,837 47,697 0.2%
Long-term Variable Rate Debt.............. 2,500,000 2,500,000 0 0.0%
Short-term Variable Rate Debt............. 14,598,403 7,590,060 7,008,343 92.3%
Total Variable Rate Debt.................. 17,098,403 10,090,060 7,008,343 69.5%
Total Debt................................ 37,555,937 30,499,897 7,056,040 23.1%
Average Interest Rate:
Long-term Fixed Rate Debt................. 8.13% 8.15% -0.02% -0.3%
Variable Rate Debt........................ 5.85% 6.85% -1.00% -14.7%
The increase in total average debt outstanding resulted from the colder winter
weather and the sharp rise in energy costs, both of which required additional
capital to fund higher levels of accounts receivable and inventory. The increase
in debt levels was partially
15
mitigated by declines in the average effective interest rate on the Company's
variable rate debt. The average rate declined 14.7% from 6.85% to 5.85% on the
variable rate debt and 7.8% for all Company borrowings.
Income Taxes - Income taxes for fiscal 2001 increased 3.0% over fiscal 2000.
Even though pretax income was down 11.9%, income taxes increased due to the
non-deductibility of the goodwill written off in conjunction with the
restructuring and the implementation of a state income tax on January 1, 2001
when the Commonwealth of Virginia replaced the gross receipts tax with a
consumption tax and an income tax on the Company's regulated natural gas
operations.
Net Income and Dividends - Net earnings for fiscal 2001 were $2,306,615 as
compared to fiscal year 2000 earnings of $2,873,702. The reduction in earnings
was due to the poor performance of the heating and air conditioning operation
and the impairment loss related to the restructuring of the heating and air
conditioning operation recorded in fiscal 2001. Basic earnings per share of
common stock were $1.21 in fiscal 2001 compared with $1.54 in fiscal 2000.
Dividends per share of common stock were $1.12 in fiscal 2001 compared with
$1.10 in fiscal 2000.
IMPACT OF COST INCREASES
The cost of natural gas represented approximately 74% for fiscal 2002,
81% for fiscal 2001 and 71% for fiscal 2000 of the total operating expenses of
the Company's gas utilities operations, as reflected in the footnotes on
financial information by business segments. However, natural gas costs are fully
recoverable under the present regulatory Purchased Gas Adjustment mechanisms,
and increases and decreases in the cost of gas are passed through to the
Company's customers.
Rising costs affect the Company through increases in non-gas costs such
as property and liability insurance, labor costs, employee benefits and supplies
and services used in operations and maintenance and the replacement cost of
plant and equipment. The rates charged to natural gas customers to cover these
costs may only be increased through the regulatory process via a rate increase
application. In addition to stressing performance improvements and higher gas
sales volumes to offset increasing costs, management must continually review
operations and economic conditions to assess the need for filing and receiving
adequate and timely rate relief from the state commissions.
The unregulated operations of the Company 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 Company can adjust its pricing to sufficiently recover cost increases
without negatively affecting sales and competitive position.
CAPITAL RESOURCES AND LIQUIDITY
Due to the capital intensive nature of RGC Resources' utility and
energy businesses as well as the related weather sensitivity, RGC Resources'
primary capital needs are the funding of its continuing construction program and
the seasonal funding of its inventory and prepaid gas service commitments and
accounts receivables. The Company's capital expenditures for fiscal 2002 were a
combination of replacements and expansions, reflecting the need to replace older
cast iron and bare steel pipe with coated steel or plastic pipe, while
continuing to meet the demands of customer growth in both natural gas and
propane operations. Total capital expenditures for fiscal 2002 were
approximately $8.6 million allocated, as follows: $6.0 million for Roanoke Gas
Company, $0.5 million for Bluefield Gas Company, and $2.1 million for Highland
Propane Company. Depreciation cash flow provided approximately $5.3 million in
support of capital expenditures, or approximately 61% of total investment.
Historically, consolidated capital expenditures were $8.0 million in 2001 and
$8.4 million in 2000. It is anticipated that future capital expenditures will be
funded with the combination of depreciation cash flow, retained earnings, sale
of Company equity securities and issuance of debt.
At September 30, 2002, the Company had available lines of credit for
its short-term borrowing needs totaling $20,500,000, of which $8,991,000 was
outstanding. Effective October 1, 2002, these lines of credit were increased to
$26,500,000 and will
16
expire March 31, 2003, unless extended. The Company anticipates being able to
extend the lines of credit or pursue other options. Interest rates are variable
based upon 30 day LIBOR.
Subsequent to September 30, 2002, the Company executed a three-year $8
million note with Suntrust Bank for the purposes of refinancing a portion of the
short-term line of credit. The note is a variable rate note based upon 30 day
LIBOR rate; however, the Company subsequently entered into an interest rate swap
to effectively convert the note into a fixed rate instrument. Because the
Company had both the intent and ability to execute the note at September 30,
2002, the balance sheet reflects the corresponding reclassification of $8
million from borrowings under lines of credit to long-term debt.
Short-term borrowing, in addition to providing limited capital project
bridge financing, is used to finance seasonal levels of accounts receivables,
inventory and prepaid gas service payments as provided under the Company's asset
management agreement with Duke Energy Trading and Marketing. From April through
October, the Company prepays its asset manager for the right to receive
additional natural gas in the colder winter months. The gas prepayment replaces
the old underground natural gas storage that was used prior to the new asset
management agreement. At September 30, 2002, the Company had $9,372,493 in
prepaid gas service compared to $12,275,530 in inventoried natural gas in the
prior year.
Short-term borrowings, together with internally generated funds,
long-term debt and the sale of common stock through the Company's Dividend
Reinvestment and Stock Purchase Plan (the "Plan"), have been adequate to cover
construction costs, debt service and dividend payments to shareholders. The
terms of short-term borrowings are negotiable, with average rates of 2.46% in
2002, 5.68% in 2001 and 6.67% in 2000. The lines do not require compensating
balances. The Company utilizes a cash management program, which provides for
daily balancing of the Company's temporary investment and short-term borrowing
needs. The program allows the Company to maximize returns on temporary
investments and minimize the cost of short-term borrowings.
Stockholders' equity increased for the period by $1,343,925, reflecting
an increase of $477,213 in retained earnings, net of accumulated comprehensive
income, and proceeds of $866,712 from new common stock purchases through the
Plan and the Restricted Stock Plan For Outside Directors.
At September 30, 2002, the Company's consolidated long-term
capitalization was 51% equity and 49% debt, compared to 57% equity and 43% debt
at September 30, 2001 reflecting the conversion of $8 million of short- term
debt to long-term.
REGULATORY AFFAIRS
Both of the regulated utilities in the RGC Resources family filed
requests for rate increases during the past year. Bluefield Gas Company filed a
base rate case with the West Virginia Public Service Commission on February 4,
2002. The auditors spent several months auditing the schedules and on July 12,
2002, a settlement conference was held in Charleston with the Company and the
Staff. The Company has accepted an $88,000 settlement. The proposed rates are
effective on December 1, 2002.
Roanoke Gas Company filed a base rate case, consolidating Roanoke Gas
Company and Commonwealth Public Service Corporation on June 17, 2002 with the
State Corporation Commission requesting a non-gas rate increase of $1.2 million.
This increase incorporates the three-year benefit of the Distribution System
Renewal Surcharge into non-gas rates. Also included in this application was a
request for a Weather Normalization Adjustment that will serve as a means to
stabilize revenue during periods of extreme weather fluctuations. The Company
also proposed to liberalize the extension of service policy in an attempt to
make natural gas service extensions to more customers in established
neighborhoods. The audit in this case was held during the last week in July
[Bar Graph appears here.]
1998 1999 2000 2001 2002
Number of Shares Issued 1.8 1.8 1.9 1.9 2.0
(in millions)
17
and the first week in August with settlement discussions in mid-November. The
settlement discussions resulted in the filing of joint Stipulation signed by the
company, the Commission Staff, and the Attorney General awarding the Company
approximately $990,000 annual increase in non-gas rates. The Stipulation
accepted the Weather Normalization Adjustment, the liberalization of extension
of service policies, and a shift of bad debt expense associated with gas cost
and the carrying cost of gas inventory and prepaid gas to the gas cost portion
of rates. Settlement rates are effective, subject to refund, on December 1,
2002.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
RGC Resources, Inc.'s contractual obligations as of September 30, 2002
representing cash obligations that are considered to be firm commitments are as
follows.
Payment due within
1 Year 2-3 Years 4-5 Years After 5 Years Total
Lines-of-Credit..................... $ 8,991,000 $ -- $ -- $ -- $ 8,991,000
Long-term Debt...................... 75,000 2,125,000 $ 10,500,000 $ 17,700,000 30,400,000
Capital Leases...................... 30,126 52,359 -- -- 82,485
Natural Gas Commitments............. 2,491,500 -- -- -- 2,491,500
Propane Commitments................. 184,470 -- -- -- 184,470
-----------------------------------------------------------------------------
Total Contractual Obligations....... $ 11,772,096 $ 2,177,359 $ 10,500,000 $ 17,700,000 $ 42,149,455
=============================================================================
The lines of credit have been reduced by $8,000,000 in refinancing that
has been reclassified to long-term debt on the balance sheet. Total available
lines of credit are scheduled to expire on March 31, 2003, at which time the
Company expects to renew the contracts. See Footnote 5 for additional
information.
Long-term debt includes $8,000,000 due in 2005 related to the
refinancing that has been reclassified to long-term debt from lines of credit.
See Footnote 6 for more information.
Natural gas commitments include the fixed price purchase of 664,400
dekatherms (DTH) of natural gas. In addition, the Company has commitments to
purchase natural gas at market price over the next three years in the amount of
3,281,131 DTH, 3,098,631 DTH and 442,660 DTH associated with the prepaid gas
provisions of the Company's asset management agreement with Duke Energy. See
Footnote 12 for more information on commitments.
Propane commitments include the fixed price purchase of 390,000 gallons
of propane. In addition, the Company has commitments to purchase 2,958,225
gallons of propane at market price in 2003. See Footnote 12 for more information
on commitments.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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 statments. Although, estimates and judgments
are applied in arriving at many of the reported amounts in the financial
statements including provisions for pension and post-retirement medical
benefits, provisions for medical self-insurance, valuation of bad debt reserves
on accounts receivable, projected useful lives of capital assets and goodwill
valuation, the following items may involve a greater degree of judgment.
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
18
for natural gas delivered to customers not yet billed during the accounting
period. Determination of unbilled revenue relies on the use of estimates and
historical data.
Derivatives - As discussed in the "Market Risk" section of this report, 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 than the futures value used in
determining fair value in prior financial statements.
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
both physical (fixed priced price and/or fixed quantity supply contracts) and
financial (derivatives contracts) transactions for the purpose of managing
commodity and interest rate risks of its business operations. The policy also
specifies that the combination of all hedging contracts for any 12-month period
shall not exceed a total hedged volume of 90% of projected volumes. Finally, the
policy specifically prohibits the utilization of derivatives for the purposes of
speculation.
The Company is exposed to market risk related to changes in interest
rates associated with its borrowing activities. As of September 30, 2002 and
2001, the Company had outstanding $19,491,000 and $20,207,000 in variable rate
debt, respectively. At September 30, 2002 and 2001, a hypothetical 10 percent
increase in market interest rates applicable to the Company's variable rate debt
outstanding would have resulted in a decrease in annual earnings of
approximately $32,000 and $45,000, respectively.
The Company manages the price risk associated with purchases of natural
gas and propane by using a combination of storage and prepaid gas service, fixed
price contracts, spot market purchases and derivative commodity instruments
including futures, swaps and collars. With respect to propane gas, a
hypothetical 10 percent reduction in market price would result in a decrease in
fair value for the Company's propane gas derivative contracts of approximately
$116,000.
With respect to the Company's hedging activities for the price of
natural gas, during the year ended September 30, 2002, the Company 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
arrangements 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
contracts will be passed through to customers when realized. A hypothetical 10
percent reduction in the market price of natural gas would result in a decrease
in fair value of approximately $555,000 for the Company's natural gas derivative
contracts at September 30, 2002.
[Bar Graph appears here.]
1998 1999 2000 2001 2002
Capitalization Ratios
(in percentages)
Long-term Debt 43.9 45.3 43.8 43.1 48.7
Common Stock 56.1 54.7 56.2 56.9 51.3
19
OPERATIONAL CHANGES
RGC Resources, Inc. completed the integration of GIS Resources, Inc.,
a provider of mapping services, into the Company's natural gas operations.
Management decided to forego third-party sales due to low margins, a very
competitive market and uncertain long-term viability. The Company intends to
focus on internal maintenance of system maps and other related functions.
As a result of the ongoing evaluation of the remaining heating and air
conditioning operations of RGC Ventures, Inc. during 2002, the Company has
decided to discontinue the sales of heating and air conditioning equipment
portion of the business and continue the service portion. As a result, the
Company intends to merge RGC Ventures, Inc. into Diversified Energy Company for
the purposes of combining the service functions of both companies in order to
improve efficiencies and reduce costs. Furthermore, the merger is intended to
preserve the state net operating loss carry-forward recorded on RGC Ventures,
Inc.'s books in order to be utilized by Diversified Energy Company.
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 Company's
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.
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.
IMPACT OF TERRORISM, ECONOMIC DOWNTURN AND OTHER RISKS
Several events or situations have occurred in the recent past that have
created uncertainties and could potentially affect the future results of
operations of the Company.
Terrorism - The terrorist attacks of September 11, 2001 significantly affected
the economic and business climate of this country. Since that tragic day, most
consumer behavior and perceptions have changed in some way, and the ripple
effect moved quickly
20
throughout the world economy. Several industries have been severely impacted
including travel, due to safety concerns, and insurance, due to the tremendous
amount of property damage and loss of life. The losses incurred by the insurance
industry have forced insurers to significantly increase their premiums to
restore needed reserves for future claims; and in some cases, insurers have
eliminated coverage altogether. RGC Resources recently completed renewal of its
corporate property and liability policies for the coming year and successfully
maintained coverage without significant increases in deductibles. However, total
renewal premiums will increase by more than 30% for fiscal year 2003, including
the cost of terrorism specific coverage. Additional increases in subsequent
years may occur depending upon insurance industry losses and the stock market
performance of their assets.
Stock Market Performance - Although RGC Resources, Inc.'s stock has remained
relatively stable, the poor stock market performance over the last two years has
and will affect the Company's performance in other areas. RGC Resources, Inc.
offers both a defined benefit pension plan and post-retirement medical benefits.
The Company funds both of these plans. The poor market performance of stocks has
had a significant negative impact on these plans as total plan assets in the
pension plan have declined by more than 18% in the last two years. The reduction
in plan assets and a change in the expected long-term rate of return will
increase pension expense for fiscal 2003 by $228,000 and require the Company to
increase the amount needed to fund the plan. Post-retirement medical expense
will increase by $156,000 in fiscal 2003 as a result of both market performance
and a higher projected medical inflation rate.
Corporate Accounting Irregularities - As a consequence of the high-profile
irregularities and accounting scandals at a few well-publicized companies,
additional regulation and oversight have been legislated by Congress through the
Sarbanes-Oxley law to be enforced by the SEC. These additional requirements have
resulted in increased compliance and administrative costs to the Company in the
form of legal consultation and internal staff costs, and will likely cause
increased external audit fees.
Economic Downturn - Economic downturns generally lead to reduction in business
operations, increased business failures and higher unemployment. The Company is
currently experiencing a reduction in its transportation volumes for certain
large industrial customers as a result of economic conditions. Although no
single customer accounts for 5% or more of sales, the Company has several
industrial and large commercial customers that could negatively affect operating
results of the Company if more than one went out of business or defaulted on
their energy bills or production activity remained depressed for an extended
period of time. The Company carefully monitors its largest customers for any
issues regarding collectability of amounts billed. Increased unemployment from
an extended weak economic climate could result in greater delinquencies and
non-payment on residential accounts, thereby increasing bad debt expense.
Middle East Unrest - Increased tensions in the Middle East and speculation on
possible interventions in Iraq have recently increased some energy prices.
Higher natural gas and propane prices could encourage customers to switch to
other lower priced energy sources, or lead to greater customer account
delinquencies.
Weather - Perhaps the most significant factor that affects the future results of
the Company is weather. The nature of the Company's business is highly dependent
upon weather - specifically, winter weather. Cold weather increases energy
consumption by customers and therefore increases revenues and margins.
Conversely, warm weather reduces energy consumption and ultimately revenues and
margins. Currently, the Company's authorized billing rates charged to customers
for natural gas service are based
[Bar graph appears here.]
1998 1999 2000 2001 2002
Total Capitalization 47.2 51.5 53.3 54.0 62.6
(in millions)
21
upon normal weather over the last 71 years. Over the past 5 years, the Company
has experienced four winters that were warmer than normal and, as a result, has
not fully earned its authorized rate of return. In its recent rate application
for Roanoke Gas Company, the Company is attempting to reduce the impact that
weather has upon earnings by proposing the use of a weather normalization
adjustment factor, based on a weather occurrence band around the most recent
30-year normal. The weather band would provide a 6 percent range around normal
weather, whereby if the number of heating degree days fell within 6 percent
above or below the 30-year normal, no adjustments would be made. However, if the
number of heating degree-days was more than 6 percent below normal, a surcharge
would be added to customers' bills. Likewise, if the number of heating
degree-days was more than 6 percent above normal, a credit would be applied to
customers' bills. The Company and its customers would be at risk for no more
than a 6 percent swing in heating degree-days above or below the normal.
Implementation of these changes is contingent upon approval by Virginia State
Corporation Commission.
For most of the items described above, the regulated natural gas
operations in Virginia and West Virginia have a means to recover increased costs
through formal rate application filings, as well as the ability to automatically
pass along increases in natural gas cost. However, rate applications are
generally filed based upon historical expenses, which generally results in the
Company lagging in the recovery of rapidly increasing operating expenses.
Moreover, there can be no guarantee that the respective regulatory commissions
in Virginia or West Virginia will allow recovery for all such increased costs
when rate applications are filed. The unregulated propane operations are able to
be more flexible in adjusting rates for increases in costs. However, due to
competition in the propane market, there is no assurance that the Company can
increase prices sufficiently to properly recover all increases without
negatively affecting its future sales and competitive position.
CAPITALIZATION STATISTICS
Years Ended September 30, 2002 2001 2000 1999 1998
Common Stock:
Shares Issued............................ 1,960,418 1,914,603 1,881,733 1,832,771 1,794,416
Basic and Diluted Earnings Per Share..... $ 1.28 $ 1.21* $ 1.54 $ 1.59 $ 1.60
Dividends Paid Per Share (Cash).......... $ 1.14 $ 1.12 $ 1.10 $ 1.08 $ 1.06
Dividends Paid Out Ratio................. 89.1% 92.6% 71.4% 67.9% 66.3%
Capitalization Ratios:
Long-Term Debt, Including
Current Maturities.................... 48.7 43.1 43.8 45.3 43.9
Total Stockholders' Equity............... 51.3 56.9 56.2 54.7 56.1
---------------------------------------------------------------------------
Total............................... 100.0 100.0 100.0 100.0 100.0
---------------------------------------------------------------------------
Long-Term Debt, Including
Current Maturities.................... $ 30,482,485 $ 23,310,522 $ 23,336,614 $ 23,360,896 $ 20,700,000
Total Stockholders' Equity............... 32,068,997 30,725,072 29,985,871 28,154,923 26,464,581
---------------------------------------------------------------------------
Total Capitalization Plus
Current Maturities.................... $ 62,551,482 $ 54,035,594 $ 53,322,485 $ 51,515,819 $ 47,164,581
===========================================================================
*Reflects $0.32 per share impairment loss.
22
SUMMARY OF GAS SALES AND STATISTICS
2002 2001 2000 1999 1998
Years Ended September 30,
-------------------------------------------------------------------------------------------------------------------
Revenues:
Residential Sales..................... $ 33,261,150 $ 50,432,183 $ 32,605,568 $ 28,152,236 $ 30,396,540
Commercial Sales...................... 21,723,467 32,486,778 20,270,890 17,812,922 18,764,195
Interruptible Sales................... 771,439 1,300,369 859,504 646,256 695,279
Transportation Gas Sales.............. 1,686,141 1,609,974 1,784,508 1,776,049 1,715,032
Backup Services....................... 64,287 77,514 10,979 89,061 97,552
Late Payment Charges.................. 100,015 237,579 112,210 108,340 156,634
Miscellaneous Gas Utility Revenue..... 41,448 50,724 41,509 34,279 31,820
Propane............................... 10,718,404 14,929,570 11,246,152 8,469,728 7,530,040
Energy Marketing...................... 11,107,532 14,756,066 8,828,492 5,639,783 6,519,467
Other................................. 751,790 1,562,390 1,990,183 1,474,055 601,288
--------------------------------------------------------------------------
Total............................... $ 80,225,673 $ 117,443,147 $ 77,749,995 $ 64,202,709 $ 66,507,847
Net Income............................... $ 2,486,895 $ 2,306,615 $ 2,873,702 $ 2,883,407 $ 2,726,879
--------------------------------------------------------------------------
DTH Delivered:
Residential........................... 4,230,055 5,121,119 4,572,256 4,528,752 4,861,127
Commercial............................ 3,258,766 3,732,953 3,315,915 3,198,766 3,389,010
Interruptible......................... 156,923 192,659 177,387 164,348 182,110
Transportation Gas.................... 2,906,988 2,833,758 3,186,497 3,021,229 2,967,227
Backup Service........................ 10,782 9,738 1,893 15,376 19,409
--------------------------------------------------------------------------
Total............................... 10,563,514 11,890,227 11,253,948 10,928,471 11,418,883
Gallons Delivered (Propane).............. 8,856,086 10,174,329 9,666,772 8,977,524 7,702,384
Heating Degree Days...................... 3,502 4,342 3,721 3,717 4,054
Number of Customers:
Natural Gas.............................. 51,557 51,198 50,520 49,860 48,265
Residential........................... 5,627 5,529 5,502 5,379 5,272
Commercial............................
Interruptible and Interruptible
Transportation Service............ 45 43 45 44 45
--------------------------------------------------------------------------
Total............................... 57,229 56,770 56,067 55,283 53,582
Propane.................................. 18,156 17,105 15,973 13,832 11,004
--------------------------------------------------------------------------
Total Customers.......................... 75,385 73,875 72,040 69,115 64,586
Gas Account (DTH):
Natural Gas Available................. 10,992,271 12,516,840 11,933,719 11,525,469 11,883,769
Natural Gas Deliveries................ 10,563,514 11,890,227 11,253,948 10,928,471 11,418,883
Storage - LNG......................... 112,692 70,704 123,002 136,338 73,381
Company Use And Miscellaneous......... 62,046 31,480 47,325 62,189 40,127
System Loss........................... 254,019 524,429 509,444 398,471 351,378
--------------------------------------------------------------------------
Total Gas Available................. 10,992,271 12,516,840 11,933,719 11,525,469 11,883,769
Total Assets............................. $ 92,401,455 $ 93,571,129 $ 87,407,494 $ 77,789,982 $ 69,134,920
Long-term Obligations.................... $ 30,377,358 $ 22,507,485 $ 23,310,522 $ 23,336,614 $ 20,700,000
23
CORPORATE DIRECTORY
OFFICERS
John B. Williamson, III
President, Chairman of the Board, and
Chief Executive Officer (1) (2) (3) (4) (5)
J. David Anderson
Assistant Secretary and Assistant
Treasurer (1) (2) (3) (4) (5)
John S. D'Orazio
Vice President Customer Service
and Marketing (2)
Howard T. Lyon
Controller and Treasurer (1) (2) (3) (4) (5)
Dale P. Moore
Vice President and Secretary (1) (2) (3) (4) (5)
Jane N. O'Keeffe
Vice President Human Resources (1)
C. James Shockley, Jr.
Vice President Energy Services Operations (4)
Robert L. Wells
President Applications Operations (4)
BOARD OF DIRECTORS
Lynn D. Avis
Chairman of the Board
Avis Construction Company, Inc.
Director (1) (2)
Abney S. Boxley, III
President and Chief Executive Officer
Boxley Company, Inc.
Director (1) (2)
Frank T. Ellett
President
Virginia Truck Center, Inc.
Director (1) (2) (3) (4)
Frank A. Farmer, Jr.
Former Chairman of the Board
RGC Resources, Inc.
Director (1) (2) (3) (4) (5)
Maryellen F. Goodlatte
Attorney and Principal
Glenn, Feldmann, Darby & Goodlatte
Director (1) (2)
J. Allen Layman
Chairman of the Board and President
NTELOS Inc.
Director(1)
George W. Logan
Chairman of the Board
Valley Financial Corporation
Chairman of the Board
Alliance Logistics Center (Warsaw, Poland)
Principal
Pine Street Partners, LLC
Faculty
University of Virginia Darden Graduate School of Business
Director (2)
Thomas L. Robertson
Chairman of the Board
Carilion Foundation
Chairman of the Board
Carilion Biomedical Institute
Director (1) (2)
S. Frank Smith
Vice President
Coastal Coal Company, LLC
Director(1) (2) (3) (4)
John B. Williamson, III
President, Chairman of the Board, and
Chief Executive Officer
RGC Resources, Inc.
Director(1) (2) (3) (4) (5)
Roger L. Baumgardner
Director (5)
(1) RGC Resources, Inc.
(2) Roanoke Gas Company
(3) Diversified Energy Company
(4) RGC Ventures, Inc.
(5) Bluefield Gas Company
24
CORPORATE INFORMATION
CORPORATE OFFICE
RGC Resources, Inc.
519 Kimball Avenue, N.E.
P.O. Box 13007
Roanoke, VA 24030
(540) 777-4GAS (4427)
Fax (540) 777-2636
AUDITORS
Deloitte & Touche LLP
1100 Carillon
227 West Trade Street
Charlotte, NC 28202-1675
COMMON STOCK TRANSFER AGENT, REGISTRAR,
DIVIDEND DISBURSING AGENT & DIVIDEND
REINVESTMENT AGENT
Wachovia Bank, N.A.
Corporate Trust Group
1525 West W.T. Harris Boulevard - 3C3
Charlotte, NC 28288-1153
COMMON STOCK
RGC Resources' common stock is listed on the Nasdaq National Market under the
trading symbol RGCO.
DIRECT DEPOSIT OF DIVIDENDS & SAFEKEEPING OF STOCK CERTIFICATES
Shareholders can have their cash dividends deposited automatically into
checking, saving or money market accounts. The shareholder's financial
institution must be a member of the Automated Clearing House. Also, RGC
Resources offers safekeeping of stock certificates for shares enrolled in the
dividend reinvestment plan. For more information about these shareholder
services, please contact the Transfer Agent, Wachovia Bank, N.A. of North
Carolina.
10-K REPORT
A copy of RGC Resources, Inc. latest annual report to the Securities & Exchange
Commission on Form 10-K will be provided without charge upon written request to:
RGC Resources, Inc.
Vice President and Secretary
RGC Resources, Inc.
P.O. Box 13007 Roanoke, VA 24030 (540) 777-3846
SHAREHOLDER INQUIRIES
Questions concerning shareholder accounts, stock transfer requirements,
consolidation of accounts, lost stock certificates, safekeeping of stock
certificates, replacement of lost dividend checks, payment of dividends, direct
deposit of dividends, initial cash payments, optimal cash payments and name or
address changes should be directed to the Transfer Agent, Wachovia Bank, N.A.
All other shareholder questions should be directed to:
RGC Resources, Inc.
Vice President and Secretary
RGC Resources, Inc.
P.O. Box 13007
Roanoke, VA 24030
(540) 777-3846
FINANCIAL INQUIRIES
All financial analysts and professional investment managers should direct their
questions and requests for financial information to:
RGC Resources, Inc.
Vice President and Secretary
RGC Resources, Inc.
P.O. Box 13007 Roanoke, VA 24030 (540) 777-3846
Access up-to-date information on RGC Resources and its subsidiaries at
WWW.RGCRESOURCES.COM
MARKET PRICE AND DIVIDEND INFORMATION
RGC Resources' common stock is listed on the Nasdaq National Market under the
trading symbol RGCO. Payment of dividends is within the discretion of the Board
of Directors and will depend on, among other factors, earnings, capital
requirements, and the operating and financial condition of the Company. The
Company's long-term indebtedness contains restrictions on dividends based on
cumulative net earnings and dividends previously paid.
Fiscal Year Ended Range of Bid Prices Cash Dividends
September 30 High Low Declared
---------------------------------------------------------------------------------------------------
2002
First Quarter $ 20.500 $ 18.500 $ 0.285
Second Quarter 20.250 18.800 0.285
Third Quarter 20.750 17.500 0.285
Fourth Quarter 20.010 16.990 0.285
2001
First Quarter $ 20.000 $ 18.250 $ 0.280
Second Quarter 21.250 19.188 0.280
Third Quarter 20.870 18.500 0.280
Fourth Quarter 20.390 18.220 0.280
RGC Resources, Inc. (Image)
519 Kimball Avenue, N.E.
P. O. Box 13007
Roanoke, VA 24030
www.rgcresources.com
Trading on NASDAQ as RGCO
RGC RESOURCES, INC. AND
SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE YEARS ENDED
SEPTEMBER 30, 2002, 2001 AND 2000,
AND INDEPENDENT AUDITORS' REPORT
RGC RESOURCES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
-------------------------------------------------------------------------------
Page
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets 2-3
Consolidated Statements of Income and Comprehensive Income 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6-7
Notes to Consolidated Financial Statements 8-22
DELOITTE
& TOUCHE
Deloitte & Touche
1100 Carilion
227 West Trade Street
Charlotte, North Carolina 28202-1675
Tel: (704) 372-3560
www.us.deloitte.com
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
RGC Resources, Inc.:
We have audited the accompanying consolidated balance sheets of RGC Resources,
Inc. and subsidiaries (the "Company") as of September 30, 2002 and 2001, and the
related consolidated statements of income and comprehensive income,
stockholders' equity and cash flows for each of the three years in the period
ended September 30, 2002. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of September 30,
2002 and 2001, and the results of its operations and its cash flows for each of
the three years in the period ended September 30, 2002 in conformity with
accounting principles generally accepted in the United States of America.
s/Deloitte & Touche LLP
November 1, 2002
Deloitte
Touche
Tohmatsu
1
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND 2001
----------------------------------------------------------------------------------------------------------------
ASSETS 2002 2001
CURRENT ASSETS:
Cash and cash equivalents $ 288,030 $ 885,678
Accounts receivable, less allowance for doubtful accounts of
$155,062 in 2002 and $531,991 in 2001 4,460,867 7,155,930
Inventories 2,172,808 13,473,986
Prepaid gas service 9,372,493 -
Prepaid income taxes 1,189,154 356,020
Deferred income taxes 2,579,879 3,468,168
Under-recovery of gas costs - 1,208,190
Unrealized gains on marked-to-market transactions 1,779,891 -
Other 453,804 428,113
-------------- ----------------
Total current assets 22,296,926 26,976,085
-------------- ----------------
UTILITY PLANT:
In service 89,504,217 83,570,936
Accumulated depreciation and amortization (34,386,639) (31,559,291)
-------------- ----------------
In service, net 55,117,578 52,011,645
-------------- ----------------
Construction work in progress 1,810,520 2,048,565
-------------- ----------------
Utility plant, net 56,928,098 54,060,210
-------------- ----------------
NONUTILITY PROPERTY:
Nonutility property 19,869,186 18,149,109
Accumulated depreciation and amortization (7,659,087) (6,311,673)
-------------- ----------------
Nonutility property, net 12,210,099 11,837,436
-------------- ----------------
OTHER ASSETS:
Goodwill, net of accumulated amortization 298,314 327,429
Other assets 668,018 369,969
-------------- ----------------
Total other assets 966,332 697,398
-------------- ----------------
TOTAL ASSETS $ 92,401,455 $ 93,571,129
============== ================
2
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
SEPTEMBER 30, 2002 AND 2001
-------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 2002 2001
CURRENT LIABILITIES:
Current maturities of long-term debt $ 105,127 $ 803,037
Borrowings under lines of credit 8,991,000 17,707,000
Dividends payable 559,069 536,385
Accounts payable 7,897,084 8,250,618
Customer deposits 543,891 531,288
Accrued expenses 3,961,174 3,776,490
Refunds from suppliers - due customers 51,889 116,758
Overrecovery of gas costs 1,742,905 1,539,782
Unrealized losses on marked-to-market transactions - 1,906,171
-------------- -----------------
Total current liabilities 23,852,139 35,167,529
-------------- -----------------
LONG-TERM DEBT, EXCLUDING CURRENT MATURITIES 30,377,358 22,507,485
-------------- -----------------
DEFERRED CREDITS:
Deferred income taxes 5,802,417 4,836,121
Deferred investment tax credits 300,544 334,922
-------------- -----------------
Total deferred credits 6,102,961 5,171,043
-------------- -----------------
COMMITMENTS AND CONTINGENCIES (Notes 11 and 12)
CAPITALIZATION:
Stockholders' equity:
Common stock, $5 par value; authorized 10,000,000 shares;
issued and outstanding1,960,418 and 1,914,603 shares in
2002 and 2001, respectively 9,802,090 9,573,015
Preferred stock, no par; authorized 5,000,000 shares;
no shares issued and outstanding in 2002 and 2001 - -
Capital in excess of par value 11,374,173 10,736,536
Retained earnings 10,758,491 10,490,375
Accumulated other comprehensive income (loss) 134,243 (74,854)
-------------- -----------------
Total stockholders' equity 32,068,997 30,725,072
-------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 92,401,455 $ 93,571,129
============== =================
See notes to consolidated financial statements.
3
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000
-------------------------------------------------------------------------------------------------------------------
2002 2001 2000
OPERATING REVENUES:
Gas utilities $ 57,647,947 $ 86,195,121 $ 55,685,168
Propane operations 10,718,404 14,929,570 11,246,152
Energy marketing 11,107,532 14,756,066 8,828,492
Other 751,790 1,562,390 1,990,183
-------------- ---------------- -----------------
Total operating revenues 80,225,673 117,443,147 77,749,995
-------------- ---------------- -----------------
COST OF SALES:
Gas utilities 38,616,769 65,227,777 35,833,723
Propane operations 5,511,314 8,678,227 5,837,087
Energy marketing 10,841,871 14,231,107 8,673,354
Other 424,630 1,132,850 1,365,312
-------------- ---------------- -----------------
Total cost of sales 55,394,584 89,269,961 51,709,476
-------------- ---------------- -----------------
OPERATING MARGIN 24,831,089 28,173,186 26,040,519
-------------- ---------------- -----------------
OTHER OPERATING EXPENSES:
Operations 10,758,661 12,176,932 10,639,549
Maintenance 1,245,261 1,396,544 1,230,907
General taxes 1,504,422 2,343,351 2,851,526
Depreciation and amortization 5,114,320 4,828,096 4,403,360
Impairment loss 72,008 699,630 -
-------------- ---------------- -----------------
Total other operating expenses 18,694,672 21,444,553 19,125,342
-------------- ---------------- -----------------
OPERATING INCOME 6,136,417 6,728,633 6,915,177
OTHER EXPENSES, NET 104,956 113,149 98,807
INTEREST EXPENSE 2,050,754 2,748,850 2,428,396
-------------- ---------------- -----------------
INCOME BEFORE INCOME TAXES 3,980,707 3,866,634 4,387,974
INCOME TAX EXPENSE 1,493,812 1,560,019 1,514,272
-------------- ---------------- -----------------
NET INCOME 2,486,895 2,306,615 2,873,702
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF TAX 209,097 (74,854) -
-------------- ---------------- -----------------
COMPREHENSIVE INCOME $ 2,695,992 $ 2,231,761 $ 2,873,702
============== ================ =================
BASIC AND DILUTED EARNINGS PER SHARE $ 1.28 $ 1.21 $ 1.54
============== ================ =================
WEIGHTED-AVERAGE SHARES OUTSTANDING:
Basic 1,939,511 1,898,697 1,863,275
============== ================ =================
Diluted 1,942,058 1,902,293 1,867,138
============== ================ =================
See notes to consolidated financial statements.
4
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000
-------------------------------------------------------------------------------------------------------------------
Accumulated
Capital in Other Total
COMMON Excess of Retained Comprehensive Stockholders'
STOCK Par Value Earnings Income (Loss) Equity
BALANCE, SEPTEMBER 30, 1999
(1,832,771 shares) $ 9,163,855 $ 9,489,551 $ 9,501,517 $ - $ 28,154,923
Net income - - 2,873,702 - 2,873,702
Cash dividends declared
($1.10 per share) - - (2,060,265) - (2,060,265)
Issuance of common stock
(48,962 shares) 244,810 772,701 - - 1,017,511
------------- ------------- ------------ --------------- --------------
BALANCE, SEPTEMBER 30, 2000
(1,881,773 shares) 9,408,665 10,262,252 10,314,954 - 29,985,871
Net income - - 2,306,615 - 2,306,615
Gains (losses) on hedging activities - - - (74,854) (74,854)
Cash dividends declared
($1.12 per share) - - (2,131,194) - (2,131,194)
Issuance of common stock
(32,870 shares) 164,350 474,284 - - 638,634
------------- ------------- ------------ --------------- --------------
BALANCE, SEPTEMBER 30, 2001
(1,914,603 shares) 9,573,015 10,736,536 10,490,375 (74,854) 30,725,072
Net income - - 2,486,895 - 2,486,895
Gains (losses) on hedging activities - - - 209,097 209,097
Cash dividends declared
($1.14 per share) - - (2,218,779) - (2,218,779)
Issuance of common stock
(45,815 shares) 229,075 637,637 - - 866,712
------------- ------------- ------------ --------------- --------------
BALANCE, SEPTEMBER 30, 2002 $ 9,802,090 $ 11,374,173 $ 10,758,491 $ 134,243 $ 32,068,997
============= ============= ============ =============== ==============
See notes to consolidated financial statements.
5
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000
-------------------------------------------------------------------------------------------------------------------
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,486,895 $ 2,306,615 $ 2,873,702
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 5,297,678 4,967,332 4,538,635
Impairment loss 72,008 699,630 -
Loss on asset disposition 1,872 5,944 17,908
Change in over/under recovery of gas costs (1,932,247) 3,003,839 (1,572,842)
Deferred taxes and investment tax credits 1,686,802 (1,218,486) 583,589
Other noncash items, net (296,926) 150,503 (63,140)
Changes in assets and liabilities which provided (used) cash:
Accounts receivable and customer deposits, net 2,707,666 (879,956) 15,067
Inventories and prepaid gas service 1,928,685 (1,052,659) (4,058,128)
Other current assets (858,825) 110,473 108,540
Accounts payable and accrued expenses (168,850) (2,709,804) 925,363
Refunds from suppliers - due customers (64,869) (106,251) 196,947
-------------- -------------- --------------
Net cash provided by operating activities 10,859,889 5,277,180 3,565,641
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to utility plant and nonutility property (8,614,454) (8,029,853) (7,920,163)
Cost of removal of utility plant, net (45,580) (38,618) (51,544)
Proceeds from sales of assets 75,918 43,814 84,886
-------------- -------------- --------------
Net cash used in investing activities (8,584,116) (8,024,657) (7,886,821)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of long-term debt (828,038) (26,092) (530,865)
Net borrowings under lines of credit (716,000) 4,412,000 6,932,000
Proceeds from issuance of common stock 866,712 638,634 539,286
Cash dividends paid (2,196,095) (2,112,636) (2,037,493)
-------------- -------------- --------------
Net cash (used in) provided by financing activities (2,873,421) 2,911,906 4,902,928
-------------- -------------- --------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (597,648) 164,429 581,748
CASH AND CASH EQUIVALENTS:
Beginning of year 885,678 721,249 139,501
-------------- -------------- --------------
End of year $ 288,030 $ 885,678 $ 721,249
============== ============== ==============
6
RGC RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000
-------------------------------------------------------------------------------------------------------------------
2002 2001 2000
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS
INFORMATION:
Cash paid during the year for:
Interest $ 2,086,391 $ 2,537,343 $ 2,566,700
============ ============== ===============
Income taxes, net of refunds $ 640,145 $ 2,670,227 $ 963,990
============ ============== ===============
Noncash transactions:
In January 2000, the assets of a heating and air conditioning company were acquired in exchange
for 22,243 shares of stock valued at $478,225. Subsequent to the acquisition, the Company
retired $506,583 in debt associated with the heating and air conditioning company.
In 2002 and 2001, the Company entered into derivative price swaps, caps, and collar arrangements
for the purpose of hedging the cost of natural gas and propane. In accordance with hedge
accounting requirements, the underlying derivatives were marked to market with the corresponding
non-cash impacts to the balance sheet:
2002 2001
Unrealized gain (loss) on marked-to-market transactions 3,686,062 (1,906,171)
Under (over) recovery of gas costs (3,343,560) 1,783,560
Deferred tax asset (liability) (133,405) 47,757
Subsequent to September 30, 2002 the Company executed an $8,000,000 three-year intermediate term
note to refinance a portion of the line of credit balances. An $8 million reclassification from short-term
to long-term debt was made to the September 30, 2002 balance sheet. (See Note 5.)
See notes to consolidated financial statements.
7
RGC RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000
-------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL - The consolidated financial statements include the accounts of RGC
Resources, Inc. and its wholly owned subsidiaries (the "Company"), Roanoke
Gas Company, Bluefield Gas Company, Diversified Energy Company, operating
as Highland Propane Company and Highland Energy, RGC Ventures, Inc.,
operating as Highland Heating and Cooling, and RGC Ventures, Inc. of
Virginia, operating as GIS Resources and Application Resources. Roanoke Gas
Company and Bluefield Gas Company are gas utilities, which distribute and
sell natural gas to residential, commercial and industrial customers within
their service areas. Highland Propane Company distributes and sells propane
in southwestern Virginia and southern West Virginia. Highland Energy
brokers natural gas to several industrial transportation customers of
Roanoke Gas Company and Bluefield Gas Company. GIS Resources provides
mapping services. Highland Heating and Cooling provides heating and cooling
service and installation in West Virginia. Application Resources provides
information system services to software providers in the utility industry.
The primary business of the Company is the distribution of natural gas to
residential, commercial and industrial customers in Roanoke, Virginia;
Bluefield, Virginia; Bluefield, West Virginia; and the surrounding areas.
The Company distributes natural gas to its customers at rates regulated by
the State Corporation Commission in Virginia ("SCC") and the Public Service
Commission in West Virginia ("PSC").
All significant intercompany transactions have been eliminated in
consolidation.
RATE REGULATED BASIS OF ACCOUNTING - The Company's regulated operations
follow the accounting and reporting requirements of Statement of Financial
Accounting Standards ("SFAS") 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 amounts previously collected from customers and for
current collection in rates of costs that are expected to be incurred in
the future (regulatory liabilities).
The amounts recorded by the Company as regulatory assets and regulatory
liabilities are as follows:
SEPTEMBER 30,
----------------------------------
2002 2001
Regulatory assets:
Rate case costs $ 1,087 $ 10,929
Under-recovery of gas costs - 1,208,190
Bad debt expense deferral 316,966 -
Other 52,103 59,459
------------- ----------------
Total regulatory assets $ 370,156 $ 1,278,578
============= ================
8
SEPTEMBER 30,
----------------------------------
2002 2001
Regulatory liabilities:
Refunds from suppliers - due customers $ 51,889 $ 116,758
Over-recovery of gas costs 1,742,905 1,539,782
------------- ----------------
Total regulatory liabilities $ 1,794,794 $ 1,656,540
============= ================
During 2002, the Company reached an agreement with the regulatory staff of
the SCC that provided for the deferral of $316,966 of bad debt expense to
be amortized over a three-year period beginning in December 2002.
UTILITY PLANT - Utility plant is stated at original cost. The cost of
additions to utility plant includes direct charges and overhead. The cost
of depreciable property retired, plus cost of removal, less salvage, is
charged to accumulated depreciation. Maintenance, repairs, and minor
renewals and betterments of property are charged to operations.
DEPRECIATION AND AMORTIZATION - Provisions for depreciation are computed
principally at composite straight-line rates for financial statement
purposes and at accelerated rates for income tax purposes. Depreciation and
amortization for financial reporting purposes for utility property are
provided on annual composite rates ranging from 2% to 33%. Depreciable
lives for non-utility property range from 5 to 25 years. The annual
composite rates are determined by periodic depreciation studies.
Goodwill is amortized on a straight-line basis over periods ranging from 10
to 15 years.
CASH AND CASH EQUIVALENTS - For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid debt instruments
purchased with an original maturity of three months or less to be cash
equivalents.
INVENTORIES - Inventories consist primarily of natural gas in storage and
propane. Natural gas inventories are recorded at average cost. Propane
inventories are valued at the lower of average cost or market.
UNBILLED REVENUES - The Company bills its natural gas customers on a
monthly cycle basis. The Company records revenue based on service rendered
to the end of the accounting period. The amounts of unbilled revenue
receivable included in accounts receivable on the consolidated balance
sheets at September 30, 2002 and 2001 were $875,316 and $1,145,718,
respectively.
INCOME TAXES - Income taxes are accounted for using the asset and liability
method. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the years in which those temporary differences are expected to
be recovered or settled. A valuation allowance against deferred tax assets
is provided if it is more likely than not the deferred tax asset will not
be realized. The Company and its subsidiaries file a consolidated federal
income tax return. Beginning in January 2001, the Commonwealth of Virginia
implemented a state income tax on regulated utilities.
DEBT EXPENSES - Debt expenses are being amortized over the lives of the
debt instruments.
9
OVER/UNDER RECOVERY OF NATURAL GAS COSTS - Pursuant to the provisions of
the Company's Purchased Gas Adjustment ("PGA") clause, increases or
decreases in natural gas costs incurred by regulated operations, including
gains and losses on derivative hedging instruments, are passed on to
customers. Accordingly, the difference between actual costs incurred and
costs recovered through the application of the PGA is reflected as a
regulatory asset or liability. At the end of the deferral period, the
balance of the net deferred charge or credit is amortized over the next
12-month period as amounts are reflected in customer billings. The Company
is subject to multiple jurisdictions, which may result in both a regulatory
asset and a regulatory liability recorded.
USE OF ESTIMATES - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
DERIVATIVE AND HEDGING ACTIVITIES - Effective 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 interest rate risks
of its business operations. The Company's risk management policy
specifically prohibits the use of derivatives for speculative purposes. The
key market risks that RGC Resources, Inc. would seek to hedge include
natural gas and propane prices, and the cost of borrowed funds.
The Company entered into futures and swaps during 2002 for the purpose of
hedging the price of propane in order to provide price stability during the
2003 winter months. The hedges qualify as cash flow hedges; therefore,
changes in the fair value are reported in other comprehensive income. At
September 30, 2002, approximately $134,000 of gains are included in other
comprehensive income; such amounts are expected to be reclassified into
income within the next year as the hedged transactions settle and will be
included in propane operations' cost of sales on the income statement. No
portion of the hedges was ineffective during the year.
The Company entered into no-cost collar and price-cap arrangements for the
purchase of natural gas for the purpose of providing price stability during
the 2003 winter months. The fair value of these instruments are recorded in
the balance sheet; however, 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 PGA
mechanism. Both the SCC and the PSC currently allow for full recovery of
prudent costs associated with natural gas purchases; therefore, any costs
or benefits associated with the settlement of these instruments will be
passed through to customers when realized. The unrealized gains on
marked-to-market transactions are composed of $1,560,000 of derivative
hedges that are subject to recovery through the PGA mechanism and $219,891
of propane hedges that will flow through income when realized.
All current derivative contracts will expire by March 31, 2003.
10
NEW ACCOUNTING STANDARDS - In June 2001, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS.
SFAS No. 142 is effective for fiscal years beginning after December 15,
2001 and will be adopted by the Company as of October 1, 2002. SFAS No. 142
requires that goodwill no longer be amortized over an estimated useful
life, as previously required. Instead, goodwill amounts will be subject to
a fair-value-based annual impairment assessment. The standard also requires
acquired intangible assets to be recognized separately and amortized as
appropriate. For the years ended September 30, 2002, 2001 and 2000, the
Company's amortization expense was approximately $30,000 (excluding
amortization expense associated with goodwill of the heating and air
conditioning operations, see Note 3 for further discussion). The Company
has completed its evaluation of the new standard and no impairment existed
as of September 30, 2002.
In July 2001, the FASB issued SFAS No. 143, ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS. SFAS No. 143 provides the accounting requirements for
retirement obligations associated with tangible long- lived assets. SFAS
No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company has completed its evaluation of the new standard and determined
that there will be no material impact on the Company's financial position
or results of operations.
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG- LIVED ASSETS. The new rules supersede SFAS No. 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF. The new rules retain many of the fundamental
recognition and measurement provisions, but significantly change the
criteria for classifying an asset as held-for-sale. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The Company
has completed its evaluation of the new standard and determined that there
will be no material impact on the Company's financial position or results
of operation.
2. FINANCIAL INFORMATION BY BUSINESS SEGMENTS
Operating segments are defined as components of an enterprise for which
separate financial information is available and is evaluated regularly by
the chief decision maker in deciding how to allocate resources and assess
performance. The Company uses operating margin to assess segment
performance.
The reportable segments of the Company disclosed herein are as follows:
GAS UTILITIES - The natural gas segment of the Company generates revenue
from its tariff rates, under which it provides distribution energy services
for its residential, commercial and industrial customers.
PROPANE OPERATIONS - The propane gas segment of the Company generates
revenue from the sale and delivery of propane gas and related services to
its residential, commercial and industrial customers located in
southwestern Virginia and southern West Virginia.
ENERGY MARKETING - The energy marketing segment generates revenue through
the sale of natural gas to industrial transportation customers of Roanoke
Gas Company and Bluefield Gas Company.
PARENT AND OTHER - The other segment includes the heating and cooling
operations, mapping services, information system services, and certain
corporate adjustments.
11
Information related to the segments of the Company is detailed below:
Gas Propane Energy Parent Consolidated
Utilities Operations Marketing and Other Total
For the year ended
September 30, 2002:
Operating revenues $ 57,647,947 $ 10,718,404 $ 11,107,532 $ 751,790 $ 80,225,673
Operating margin 19,031,178 5,207,090 265,661 327,160 24,831,089
Operations, maintenance and
general taxes 9,823,575 3,313,645 30,148 340,976 13,508,344
Impairment loss - - - 72,008 72,008
Depreciation and amortization 3,554,814 1,517,463 - 42,043 5,114,320
Interest charges 1,768,853 249,093 - 32,808 2,050,754
Earnings before income taxes 3,789,939 117,037 235,513 (161,782) 3,980,707
As of September 30, 2002:
Total assets $ 76,813,661 $ 13,432,357 $ 1,320,944 $ 834,493 $ 92,401,455
Gross additions to long-lived
assets 6,537,397 2,075,891 - 1,166 8,614,454
For the year ended
September 30, 2001:
Operating revenues $ 86,195,121 $ 14,929,570 $ 14,756,066 $ 1,562,390 $ 117,443,147
Operating margin 20,967,344 6,251,343 524,959 429,540 28,173,186
Operations, maintenance and
general taxes 11,677,941 3,372,455 32,147 834,284 15,916,827
Impairment loss - - - 699,630 699,630
Depreciation and amortization 3,325,814 1,385,236 - 117,046 4,828,096
Interest charges 2,231,918 429,633 - 87,299 2,748,850
Earnings before income taxes 3,643,127 1,051,845 492,812 (1,321,150) 3,866,634
As of September 30, 2001:
Total assets 75,791,015 14,023,168 1,567,179 2,189,767 93,571,129
Gross additions to long-lived
assets 5,981,165 2,037,547 - 11,141 8,029,853
For the year ended
September 30, 2000:
Operating revenues $ 55,685,168 $ 11,246,152 $ 8,828,492 $ 1,990,183 $ 77,749,995
Operating margin 19,851,445 5,409,065 155,138 624,871 26,040,519
Operations, maintenance and
general taxes 11,288,679 2,905,186 11,449 516,668 14,721,982
Depreciation and amortization 3,156,936 1,178,567 - 67,857 4,403,360
Interest charges 1,963,791 443,796 - 20,809 2,428,396
Earnings before income taxes 3,397,456 862,812 143,689 (15,983) 4,387,974
As of September 30, 2000:
Total assets $ 70,970,880 $ 12,660,667 $ 1,161,515 $ 2,614,432 $ 87,407,494
Gross additions to long-lived
assets 5,237,912 2,539,413 - 621,063 8,398,388
During 2002, 2001 and 2000, no single customer accounted for more than 5%
of the Company's sales.No accounts receivable from any customer exceeded 5%
of the Company's total accounts receivable at September 30, 2002 and 2001.
12
3. RESTRUCTURING
In September 2001, the Company decided to restructure the heating and air
conditioning sales and services operations in West Virginia. The decision
to restructure was due to the poor performance of these operations and the
unlikelihood of a timely market recovery. Several factors contributed to
the underperformance of these operations including increasing competition
in the markets served, the general economic slowdown and lower than
expected demand for equipment sales and service, among others. The
restructuring resulted in the reduction of heating and air conditioning
operations.
As a result of the decision to restructure and reduce its heating and air
conditioning operations, the Company adjusted the valuation of several
assets to estimated net realizable value in accordance with the guidance in
SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
LONG-LIVED ASSETS TO BE DISPOSED OF. In connection with the restructuring,
the Company auctioned most of its inventory and fixed assets during 2002.
Such assets were adjusted to reflect the estimated proceeds from auction.
Additionally, goodwill and other intangible assets associated with the
heating and air conditioning operations have been written off, as
management has determined there are no future benefits associated with
these amounts. The following is a summary of the impairment loss recorded
in 2001:
Write-off of goodwill and other intangibles $ 597,949
Write-down of fixed and other assets 101,681
----------------
Total impairment loss $ 699,630
================
In April 2002, the auction of the inventory and fixed assets of the heating
and cooling operations was completed. The results of the auction generated
a loss of $72,008 in excess of the amount provided for at the end of the
previous year. No additional losses on assets are expected as a result of
the restructuring.
As a result of the ongoing evaluation of the remaining heating and air
conditioning operations, during 2002, the Company has decided to
discontinue the sales of heating and air conditioning equipment and
continue the service operations. As a result, the Company intends to merge
RGC Ventures, Inc. into Diversified Energy Company for the purpose of
combining the service functions of both companies in order to improve
efficiencies and reduce costs.
4. ALLOWANCE FOR DOUBTFUL ACCOUNTS
A summary of the changes in the allowance for doubtful accounts follows:
YEARS ENDED SEPTEMBER 30,
----------------------------------------------------------
2002 2001 2000
Balances, beginning of year $ 531,991 $ 314,081 $ 229,238
Provision for doubtful accounts 300,312 1,462,436 528,382
Recoveries of accounts written off 400,283 207,455 160,310
Accounts written off (1,077,524) (1,451,981) (603,849)
--------------- ---------------- -----------------
Balances, end of year $ 155,062 $ 531,991 $ 314,081
=============== ================ =================
13
5. BORROWINGS UNDER LINES OF CREDIT
The Company has available unsecured lines of credit with a bank for
$20,500,000 as of September 30, 2002. From October 1, 2001 to March 31,
2002, the Company had available unsecured lines of credit of $30,000,000.
Effective October 1, 2002, the lines were increased to $26,500,000 and will
expire March 31, 2003. Subsequent to the balance sheet date and prior to
the issuance of the financial statements, the Company executed an
$8,000,000 three-year intermediate term note to refinance a portion of the
line of credit balances. As the Company met the requirements of both the
intent and ability to refinance, an $8,000,000 reclassification was made
from lines of credit to long-term debt on the balance sheet.
A summary of short-term lines of credit follows:
2002 2001 2000
Lines of credit at year-end $ 20,500,000 $ 23,500,000 $ 23,500,000
Outstanding balance at year-end 8,991,000 17,707,000 13,295,000
Highest month-end balances outstanding 21,236,000 23,405,000 13,295,000
Average month-end balances 13,669,000 16,592,000 8,831,000
Average rates of interest during year 2.46% 5.68% 6.67%
Average rates of interest on balances
outstanding at year-end 2.38% 3.54% 7.05%
6. LONG-TERM DEBT
Long-term debt consists of the following:
September 30,
------------------------------
2002 2001
Roanoke Gas Company:
First Mortgage notes payable, at 7.804%, due July 1, 2008 $ 5,000,000 $ 5,000,000
Collateralized term debentures with provision for retirement
in varying annual payments through October 1, 2016, at
interest rates ranging from 6.75% to 9.625% 4,000,000 4,700,000
Unsecured senior notes payable, at 7.66%, with
provision for retirement of $1,600,000 each year
beginning December 1, 2014 through December 1, 2018 8,000,000 8,000,000
Obligations under capital leases, aggregate monthly
payments of $2,924, through April 2005 82,485 110,522
Unsecured note payable, with variable interest rate based
on 30-day LIBOR plus 100 basis point spread, with
provision for retirement on November 21, 2005. 8,000,000 -
Bluefield Gas Company:
Unsecured note payable, at 7.28%, with provision for
retirement of $25,000 quarterly, beginning January 1, 2002
and a final payment of $1,125,000 on October 1, 2003 1,200,000 1,300,000
Highland Propane Company:
Unsecured note payable, with variable interest rate based
on 90-day LIBOR plus 95 basis-point spread, with
provision for retirement on August 26, 2006 2,500,000 2,500,000
Unsecured note payable, at 7%, with provision for
retirement on December 31, 2007 1,700,000 1,700,000
------------- -------------
Total long-term debt 30,482,485 23,310,522
Less current maturities (105,127) (803,037)
------------- -------------
Total long-term debt, excluding current maturities $ 30,377,358 $ 22,507,485
============= =============
14
The above debt obligations contain various provisions, including a minimum
interest charge coverage ratio and limitations on debt as a percentage of
total capitalization. The obligations also contain a provision restricting
the payment of dividends, primarily based on the earnings of the Company
and dividends previously paid. At September 30, 2002, approximately
$6,598,000 of retained earnings were available for dividends.
Long-term debt includes $8,000,000 due in 2005 related to the refinancing
of line-of-credit balances.
The aggregate annual maturities of long-term debt, subsequent to September
30, 2002 are as follows:
Years ending September 30:
2003 $ 105,127
2004 2,157,371
2005 19,987
2006 10,500,000
2007 -
Thereafter 17,700,000
-------------
Total $ 30,482,485
=============
7. INCOME TAXES
The details of income tax expense (benefit) are as follows:
YEARS ENDED SEPTEMBER 30,
---------------------------------------------------------
2002 2001 2000
Current income taxes:
Federal $ (287,947) $ 2,376,081 $ 868,795
State 94,957 405,528 61,888
---------------- --------------- ----------------
Total current income taxes (192,990) 2,781,609 930,683
---------------- --------------- ----------------
Deferred income taxes:
Federal 1,567,525 (916,314) 586,733
State 153,655 (266,142) 36,289
---------------- --------------- ----------------
Total deferred income taxes 1,721,180 (1,182,456) 623,022
---------------- --------------- ----------------
Amortization of investment tax credits (34,378) (39,134) (39,433)
---------------- --------------- ----------------
Total income tax expense $ 1,493,812 $ 1,560,019 $ 1,514,272
================ =============== ================
15
Income tax expense for the years ended September 30, 2002, 2001 and 2000
differed from amounts computed by applying the U.S. federal income tax rate
of 34% to earnings before income taxes as a result of the following:
YEARS ENDED SEPTEMBER 30,
----------------------------------------------------
2002 2001 2000
Income before income taxes $ 3,980,707 $ 3,866,634 $ 4,387,974
============== ================ ================
Income tax expense computed at statutory
rate of 34% $ 1,353,440 $ 1,314,655 $ 1,491,911
Increase (reduction) in income tax expense
resulting from:
State income taxes, net of federal income
tax benefit 164,084 91,995 64,797
Amortization and write-off of nondeductible
goodwill - 172,935 -
Amortization of investment tax credits (34,378) (39,134) (39,433)
Other, net 10,666 19,568 (3,003)
-------------- ---------------- ----------------
Total income tax expense $ 1,493,812 $ 1,560,019 $ 1,514,272
============== ================ ================
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities are as follows:
SEPTEMBER 30,
------------------------------------------
2002 2001
Deferred tax assets:
Allowance for uncollectibles $ 37,736 $ 183,459
Accrued pension and medical benefits 1,490,525 1,408,035
Accrued vacation 168,934 179,012
Over (under) recovery of gas costs 117,724 836,121
Costs on gas held in storage 724,082 578,459
Other 200,839 335,536
---------------- -----------------
Total deferred tax assets 2,739,840 3,520,622
---------------- -----------------
Deferred tax liabilities:
Utility plant basis differences 5,962,378 4,888,575
---------------- -----------------
Total deferred tax liabilities 5,962,378 4,888,575
---------------- -----------------
Net deferred tax liability $ 3,222,538 $ 1,367,953
================ =================
8. EMPLOYEE BENEFIT PLANS
The Company has a defined benefit pension plan (the "Plan") covering
substantially all of its employees. The benefits are based on years of
service and employee compensation. Plan assets are invested principally in
cash equivalents and corporate stocks and bonds. Company contributions are
intended to provide not only for benefits attributed to date but also for
those expected to be earned in the future.
16
The plan assets and obligations were measured as of June 30. The following
sets forth the Plan's funded status and amounts recognized in the
consolidated balance sheet as of September 30, 2002 and 2001:
2002 2001
Change in projected benefit obligation:
Benefit obligation at beginning of year $ 8,068,414 $ 7,732,486
Service cost 228,710 218,310
Interest cost 568,557 563,150
Actuarial (gain) loss 401,810 (22,618)
Benefit payments (432,168) (422,914)
---------------- --------------
Benefit obligation at end of year $ 8,835,323 $ 8,068,414
================ ==============
Change in plan assets:
Fair value of plan assets at beginning of year $ 7,325,329 $ 8,115,593
Actual return (loss) on plan assets (401,151) (556,381)
Employer contributions 19,131 189,031
Benefit payments (432,168) (422,914)
---------------- --------------
Fair value of plan assets at end of year $ 6,511,141 $ 7,325,329
================ ==============
Reconciliation of funded status:
Funded status $ (2,324,182) $ (743,085)
Unrecognized actuarial (gain) loss 1,136,939 (278,898)
Unrecognized transition obligation 1,133 6,064
Unrecognized prior service cost - 7
Contributions made between measurement date and fiscal
year-end 100,000 19,131
---------------- --------------
Net pension liability recognized $ (1,086,110) $ (996,781)
================ ==============
2002 2001 2000
Components of net periodic pension cost:
Service cost $ 228,710 $ 218,310 $ 211,029
Interest cost 568,557 563,150 538,265
Expected return on plan assets (612,876) (680,255) (630,627)
Amortization of unrecognized transition
obligation 4,931 7,586 105,439
Prior service cost recognized 7 18,874 18,874
Recognized gains - (64,985) (51,619)
--------------- ---------------- --------------
Net periodic pension cost $ 189,329 $ 62,680 $ 191,361
=============== ================ ==============
Assumptions used for pension accounting:
Discount rate 7.00% 7.25% 7.50%
Expected rate of compensation increase 5.00% 5.00% 5.00%
Expected long-term rate of return on
plan assets 8.00% 8.50% 8.50%
17
In addition to pension benefits, the Company has a postretirement benefits
plan, which provides certain health care, supplemental retirement and life
insurance benefits to active and retired employees who meet specific age
and service requirements. The plan is contributory. The Company has elected
to fund the plan over future years.
The postretirement medical and life insurance plan assets and obligations
were measured as of June 30. The following sets forth the postretirement
medical and life insurance plans' funded status and amounts recognized in
the consolidated balance sheet as of September 30, 2002 and 2001:
2002 2001
Change in projected benefit obligation:
Benefit obligation at beginning of year $ 7,122,071 $ 7,797,595
Service cost 155,451 155,017
Interest cost 501,320 524,755
Participant contributions 52,501 33,373
Actuarial loss (gain) 730,630 (940,269)
Benefit payments (403,249) (448,400)
---------------- --------------
Benefit obligation at end of year $ 8,158,724 $ 7,122,071
================ ==============
Change in plan assets:
Fair value of plan assets at beginning of year $ 2,255,569 $ 2,219,777
Actual return (loss) on plan assets (195,684) 57,819
Employer contributions 563,000 393,000
Participant contributions 52,501 33,373
Benefit payments (403,249) (448,400)
---------------- --------------
Fair value of plan assets at end of year $ 2,272,137 $ 2,255,569
================ ==============
Reconciliation of funded status:
Funded status $ (5,886,587) $ (4,866,502)
Contribution made between measurement date and year-end 562,000 563,000
Unrecognized actuarial loss 1,704,909 631,283
Unrecognized transition obligation 2,610,300 2,847,600
---------------- --------------
Net postretirement benefit liability $ (1,009,378) $ (824,619)
================ ==============
2002 2001 2000
Components of net periodic postretirement
benefit cost:
Service cost $ 155,451 $ 155,017 $ 122,320
Interest cost 501,320 524,755 471,927
Amortization of unrecognized transition
obligation 237,300 237,300 237,300
Expected return on plan assets (147,312) (164,434) (77,143)
Recognized losses - 10,346 -
---------------- ---------------- --------------
Net periodic benefit cost $ 746,759 $ 762,984 $ 754,404
================ ================ ==============
The weighted-average discount rate used for postretirement benefits
accounting was 7.0%, 7.25% and 7.5% for 2002, 2001 and 2000, respectively.
18
For measurement purposes, 11.0%, 8.5% and 9.0% annual rates of increase in
the per capita cost of covered benefits (i.e., medical trend rate) were
assumed for 2002, 2001 and 2000, respectively; the rates were assumed to
decrease gradually to 5.5% by the year 2009 and remain at that level
thereafter. The medical-trend rate assumption has a significant effect on
the amounts reported. For example, increasing the assumed medical-cost
trend rate by one percentage point each year would increase the accumulated
postretirement benefits obligation as of September 30, 2002 by
approximately $1,051,000 or 13%, and would increase the aggregate of the
service and interest cost components of net postretirement benefits cost by
approximately $108,000, or 16%.
The Company also has a defined contribution plan covering all of its
employees who elect to participate. The Company made annual matching
contributions to the plan in 2002, 2001 and 2000, based on 70% of the net
participants' basic contributions (from 1 to 6% of their total
compensation). The annual cost of the plan was $227,403, $233,756 and
$211,443 for 2002, 2001 and 2000, respectively.
9. COMMON STOCK OPTIONS
During 1996, the Company's stockholders approved the RGC Resources, Inc.
Key Employee Stock Option Plan (the "Plan"). The Plan provides for the
issuance of common stock options to officers and certain other full-time
salaried employees to acquire a maximum of 50,000 shares of the Company's
common stock. In October 1999, the Plan was amended by the Board of
Directors and ratified by the Company's stockholders to authorize an
additional 50,000 shares to be made available under the Plan. The Plan
requires each option's exercise price per share to equal the fair value of
the Company's common stock as of the date of the grant. As of September 30,
2002, the number of shares available for future grants under the Plan is
13,500 shares.
The aggregate number of shares under option pursuant to the RGC Resources,
Inc. Key Employee Stock Option Plan is as follows:
Weighted-
Average Option
Number Exercise Price
of Shares Price Per Share
Options outstanding, September 30, 1999 37,000 $ 18.149 $ 15.500-20.625
Options granted 20,000 20.875
Options exercised -
------------
Options outstanding, September 30, 2000 57,000 $ 19.105 $ 15.500-20.875
Options granted 15,000 19.250
Options exercised -
------------
Options outstanding, September 30, 2001 72,000 $ 19.135 $ 15.500-20.875
Options granted 13,000
Options exercised (13,500)
Options expired (11,500)
------------
Options outstanding, September 30, 2002 60,000 $ 19.319 $ 15.500-20.875
============
Under the terms of the Plan, the options become exercisable six months from
the grant date and expire ten years subsequent to the grant date. All
options outstanding were fully vested and exercisable at September 30, 2002
and 2001.
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The per share weighted-average fair values of stock options granted during
2002, 2001 and 2000 were $2.17, $2.45 and $3.08, respectively, on the dates
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions.
2002 2001 2000
Expected dividend yield 5.89% 5.82% 5.27%
Risk-free interest rate 3.73% 4.65% 5.95%
Expected volatility 22.00% 22.00% 18.00%
Expected life 10 years 10 years 10 years
The Company uses the intrinsic value method for recognizing stock-based
compensation in the consolidated financial statements. Had the Company
determined compensation cost based on the fair value at the grant date for
its stock options, the Company's net earnings and earnings per share would
have been as follows:
2002 2001 2000
Net earnings:
As reported $ 2,486,895 $ 2,306,615 $ 2,873,702
Pro forma $ 2,469,414 $ 2,283,848 $ 2,831,902
Basic and diluted earnings per share
As reported $ 1.28 $ 1.21 $ 1.54
Pro forma $ 1.27 $ 1.20 $ 1.52
10. RELATED-PARTY TRANSACTIONS
Certain of the Company's directors are affiliated with companies that
render services or sell products to the Company. Management believes such
transactions are entered into on terms equivalent to normal business terms.
The Company purchased beeper, internet and telephone services of
approximately $82,857, $92,360 and $67,480 in 2002, 2001 and 2000,
respectively. Management anticipates similar services will be provided to
the Company in 2003.
The significant services relate to legal fees charged to the Company of
approximately $92,000 in 2000. The products sold to the Company include
natural gas and propane purchases of approximately $0, $2,190,000 and
$6,094,000 in 2002, 2001 and 2000, respectively and propane truck purchases
of approximately $210,000 and $292,000 in 2002 and 2001, respectively.
Management does not anticipate that similar services and products will be
provided to the Company in 2003.
11. ENVIRONMENTAL MATTER
Both Roanoke Gas Company and Bluefield Gas Company 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
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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.
12. COMMITMENTS
Effective November 1, 2001, the Company 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 Roanoke Gas Company's and Bluefield Gas Company's
(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 from Duke Energy 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.
Additionally, the Company has short-term contracts with natural gas
suppliers requiring the purchase at fixed and market prices of the
following volumes of gas for the periods specified. Management does not
anticipate that these contracts will have a material impact on the
Company's fiscal year 2003, 2004 or 2005 consolidated results of
operations:
2003 2004 2005
Natural gas contracts - dekatherms 3,281,131 3,098,631 442,660
Propane contracts - Gallons 2,958,225 - -
Fixed price natural gas and propane commitments in 2003 total $2,491,500
and $184,470, respectively.
The Company has also entered into derivative financial contracts for the
purpose of hedging the price on both natural gas and propane gas. These
contracts are financial in nature and do not provide for the physical
delivery of the product. The volume of gas subject to the financial hedges
included 1,250,000 dekatherms of natural gas and 2,352,000 gallons of
propane in 2003.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents and borrowings under lines
of credit are a reasonable estimate of fair value due to their short-term
nature and because the rates of interest paid on borrowings under lines of
credit approximate market rates.
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The fair value of long-term debt is estimated by discounting the future
cash flows of each issuance at rates currently offered to the Company for
similar debt instruments of comparable maturities. The carrying amounts and
approximate fair values for the years ended September 30, 2002 and 2001 are
as follows:
2002 2001
-------------------------------------------------------------------------------
Carrying Approximate Carrying Approximate
Amounts Fair Value Amounts Fair Value
Long-term debt $ 30,482,485 $ 35,215,485 $ 23,310,522 $ 26,493,463
Judgment is required in interpreting market data to develop the estimates
of fair value. Accordingly, the estimates determined as of September 30,
2002 and 2001 are not necessarily indicative of the amounts the Company
could have realized in current market exchanges.
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial data for the years ended September 30, 2002 and 2001 is
summarized as follows:
FIRST Second Third Fourth
2002 Quarter Quarter Quarter Quarter
Operating revenues $ 22,854,607 $ 31,744,381 $ 14,175,352 $ 11,451,333
============== ================= ================ =================
Operating margin $ 7,053,911 $ 9,387,426 $ 4,602,085 $ 3,787,667
============== ================= ================ =================
Operating income (loss) $ 1,959,618 $ 4,535,062 $ 59,709 $ (417,972)
============== ================= ================ =================
Net income (loss) $ 840,775 $ 2,470,446 $ (297,733) $ (526,593)
============== ================= ================ =================
Basic earnings (loss) per
share $ 0.44 $ 1.28 $ (0.15) $ (0.29)
============== ================= ================ =================
2001
Operating revenues $ 41,185,163 $ 46,448,858 $ 17,001,122 $ 12,808,004
============== ================= ================ =================
Operating margin $ 9,623,869 $ 10,171,222 $ 4,491,412 $ 3,886,683
============== ================= ================ =================
Operating income (loss) $ 3,652,837 $ 4,622,415 $ (424,897) $ (1,121,722)
============== ================= ================ =================
Net income (loss) $ 1,816,860 $ 2,346,515 $ (646,601) $ (1,210,159)
============== ================= ================ =================
Basic earnings (loss) per
share $ 0.96 $ 1.24 $ (0.34) $ (0.65)
============== ================= ================ =================
The pattern of quarterly earnings is the result of the highly seasonal
nature of the business, as variations in weather conditions generally
result in greater earnings during the winter months.
******
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