10-Q 1 a10q-20170630xq3.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended June 30, 2017
Commission File Number 000-26591
 
RGC Resources, Inc.(Exact name of Registrant as Specified in its Charter)
 
 
 
VIRGINIA
 
54-1909697
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
519 Kimball Ave., N.E., Roanoke, VA
 
24016
(Address of Principal Executive Offices)
 
(Zip Code)
(540) 777-4427
(Registrant’s Telephone Number, Including Area Code)
None
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 ____________________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated-filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
¨
  
Accelerated filer
 
ý
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at July 31, 2017
Common Stock, $5 Par Value
 
7,232,482


RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS



 
 
Unaudited
 
 
 
June 30,
2017
 
September 30,
2016
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
763,816

 
$
643,252

Accounts receivable (less allowance for uncollectibles of $282,829 and $76,934, respectively)
4,659,087

 
3,478,983

Materials and supplies
983,899

 
824,139

Gas in storage
5,445,275

 
7,436,785

Prepaid income taxes

 
1,550,836

Other
1,273,224

 
1,548,329

Total current assets
13,125,301

 
15,482,324

UTILITY PROPERTY:
 
 
 
In service
199,152,544

 
185,577,286

Accumulated depreciation and amortization
(58,895,489
)
 
(56,156,287
)
In service, net
140,257,055

 
129,420,999

Construction work in progress
4,709,968

 
2,707,139

Utility plant, net
144,967,023

 
132,128,138

OTHER ASSETS:
 
 
 
Regulatory assets
14,504,029

 
14,332,451

Investment in unconsolidated affiliate
5,704,091

 
3,496,404

Fair value of marked-to-market transactions
118,606

 

Other
115,707

 
113,532

          Total other assets
20,442,433

 
17,942,387

TOTAL ASSETS
$
178,534,757

 
$
165,552,849




1

RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS


 
Unaudited
 
 
 
June 30,
2017
 
September 30,
2016
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Line-of-credit
$

 
$
14,556,785

Dividends payable
1,048,710

 
970,244

Accounts payable
5,730,734

 
5,345,575

Capital contributions payable
402,589

 
287,794

Customer credit balances
715,139

 
1,605,608

Income taxes payable
552,148

 

Customer deposits
1,532,074

 
1,627,105

Accrued expenses
2,485,160

 
3,194,255

Over-recovery of gas costs
3,258,221

 
909,687

Total current liabilities
15,724,775

 
28,497,053

LONG-TERM DEBT:
 
 
 
Notes payable
42,820,200

 
33,896,200

Line-of-credit
10,516,426

 

Less unamortized debt issuance costs
(252,117
)
 
(260,149
)
                 Long-term debt net of unamortized debt issuance costs
53,084,509

 
33,636,051

DEFERRED CREDITS AND OTHER LIABILITIES:
 
 
 
Asset retirement obligations
5,867,216

 
5,682,556

Regulatory cost of retirement obligations
10,014,380

 
9,348,443

Benefit plan liabilities
13,557,156

 
13,763,820

Deferred income taxes
20,615,021

 
18,957,854

          Total deferred credits and other liabilities
50,053,773

 
47,752,673

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock, $5 par value; authorized 10,000,000 shares; issued and outstanding 7,231,535 and 7,182,434, respectively
36,157,675

 
23,941,445

Preferred stock, no par, authorized 5,000,000 shares; no shares issued and outstanding

 

Capital in excess of par value
182,031

 
9,509,548

Retained earnings
25,636,416

 
24,713,310

Accumulated other comprehensive loss
(2,304,422
)
 
(2,497,231
)
Total stockholders’ equity
59,671,700

 
55,667,072

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
178,534,757

 
$
165,552,849

See notes to condensed consolidated financial statements.


2

RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016
UNAUDITED


 
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
OPERATING REVENUES:
 
 
 
 
 
 
 
Gas utilities
$
11,171,499

 
$
11,017,281

 
$
51,346,456

 
$
48,372,615

Other
264,325

 
277,916

 
777,966

 
710,411

Total operating revenues
11,435,824

 
11,295,197

 
52,124,422

 
49,083,026

COST OF SALES:
 
 
 
 
 
 
 
Gas utilities
4,679,047

 
4,833,604

 
24,862,147

 
23,037,896

Other
122,375

 
149,253

 
407,238

 
345,405

Total cost of sales
4,801,422

 
4,982,857

 
25,269,385

 
23,383,301

GROSS MARGIN
6,634,402

 
6,312,340

 
26,855,037

 
25,699,725

OTHER OPERATING EXPENSES:
 
 
 
 
 
 
 
Operations and maintenance
3,294,939

 
3,060,435

 
9,880,293

 
9,868,164

General taxes
450,528

 
413,711

 
1,372,870

 
1,281,312

Depreciation and amortization
1,560,728

 
1,384,844

 
4,702,185

 
4,154,533

Total other operating expenses
5,306,195

 
4,858,990

 
15,955,348

 
15,304,009

OPERATING INCOME
1,328,207

 
1,453,350

 
10,899,689

 
10,395,716

Equity in earnings of unconsolidated affiliate
111,626

 
40,562

 
289,791

 
95,945

Other expense, net
8,738

 
39,151

 
23,020

 
71,460

Interest expense
472,300

 
396,304

 
1,400,301

 
1,220,600

INCOME BEFORE INCOME TAXES
958,795

 
1,058,457

 
9,766,159

 
9,199,601

INCOME TAX EXPENSE
343,233

 
431,389

 
3,693,180

 
3,538,296

NET INCOME
$
615,562

 
$
627,068

 
$
6,072,979

 
$
5,661,305

BASIC EARNINGS PER COMMON SHARE
$
0.09

 
$
0.09

 
$
0.84

 
$
0.79

DILUTED EARNINGS PER COMMON SHARE
$
0.08

 
$
0.09

 
$
0.84

 
$
0.79

DIVIDENDS DECLARED PER COMMON SHARE
$
0.1450

 
$
0.1350

 
$
0.4350

 
$
0.4050

See notes to condensed consolidated financial statements.

3

RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016
UNAUDITED


 
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
NET INCOME
$
615,562

 
$
627,068

 
$
6,072,979

 
$
5,661,305

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Interest rate swap
(25,053
)
 

 
73,583

 

Defined benefit plans
39,742

 
34,289

 
119,226

 
102,867

OTHER COMPREHENSIVE INCOME, NET OF TAX
14,689

 
34,289

 
192,809

 
102,867

COMPREHENSIVE INCOME
$
630,251

 
$
661,357

 
$
6,265,788

 
$
5,764,172

See notes to condensed consolidated financial statements.

4

RGC RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE-MONTH PERIODS
ENDED JUNE 30, 2017 AND 2016
UNAUDITED

 
 
Nine Months Ended June 30,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
6,072,979

 
$
5,661,305

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
4,793,270

 
4,245,223

Cost of removal of utility plant, net
(236,292
)
 
(291,620
)
Stock option grants
73,780

 
64,640

Equity in earnings of unconsolidated affiliate
(289,791
)
 
(95,945
)
Changes in assets and liabilities which used cash, exclusive of changes and noncash transactions shown separately
5,337,120

 
5,951,846

Net cash provided by operating activities
15,751,066

 
15,535,449

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Additions to utility plant and nonutility property
(16,451,865
)
 
(12,558,509
)
Investment in unconsolidated affiliate
(1,803,100
)
 
(2,272,576
)
Proceeds from disposal of equipment
13,971

 
543

Net cash used in investing activities
(18,240,994
)
 
(14,830,542
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of notes payable
8,924,000

 
2,596,200

Borrowings under line-of-credit agreement
31,170,307

 
26,452,983

Repayments under line-of-credit agreement
(35,210,666
)
 
(27,666,149
)
Debt issuance expenses
(16,675
)
 
(101,619
)
Proceeds from issuance of stock (49,101 and 54,255 shares, respectively)
810,689

 
774,175

Cash dividends paid
(3,067,163
)
 
(2,840,898
)
Net cash provided by (used in) financing activities
2,610,492

 
(785,308
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
120,564

 
(80,401
)
BEGINNING CASH AND CASH EQUIVALENTS
643,252

 
985,234

ENDING CASH AND CASH EQUIVALENTS
$
763,816

 
$
904,833

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
Interest paid
$
1,598,629

 
$
1,435,553

Income taxes paid
51,000

 
181,000

 
 
 
 
 
 
 
 
 
 
 
 
See notes to condensed consolidated financial statements.

5

RGC RESOURCES, INC. AND SUBSIDIARIES


CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

1.
Basis of Presentation

RGC Resources, Inc. is an energy services company primarily engaged in the sale and distribution of natural gas. The consolidated financial statements include the accounts of RGC Resources, Inc. ("Resources" or the "Company") and its wholly owned subsidiaries: Roanoke Gas Company; Diversified Energy Company; and RGC Midstream, LLC.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly Resources financial position as of June 30, 2017 and the results of its operations, cash flows and comprehensive income for the three months and nine months ended June 30, 2017 and 2016. The results of operations for the three months and nine months ended June 30, 2017 are not indicative of the results to be expected for the fiscal year ending September 30, 2017 as quarterly earnings are affected by the highly seasonal nature of the business and weather conditions generally result in greater earnings during the winter months.

The unaudited condensed consolidated interim financial statements and condensed notes are presented as permitted under the rules and regulations of the Securities and Exchange Commission. Pursuant to those rules, certain information and note disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted, although the Company believes that the disclosures made are adequate to make the information not misleading. Therefore, the condensed consolidated financial statements and condensed notes should be read in conjunction with the financial statements and notes contained in the Company’s Form 10-K for the year ended September 30, 2016. The September 30, 2016 balance sheet was included in the Company’s audited financial statements included in Form 10-K.

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.

The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements in Form 10-K for the year ended September 30, 2016. Newly adopted and newly issued accounting standards are discussed below.
Recently Issued or Adopted Accounting Standards

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) that affects any entity that enters into contracts with customers for the transfer of goods or services or transfer of non-financial assets. This guidance supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (1) identify the contract with the customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when, or as, the entity satisfies the performance obligation. In August 2015, the FASB issued ASU 2015-14 that deferred the effective date of this guidance by one year making the standard effective for the Company's annual reporting period ending September 30, 2019 and interim periods within that annual period.

As of June 30, 2017, the Company is identifying sources of revenue and evaluating the effect that the revenue guidance will have on financial results and disclosures. The FASB continues to issue subsequent guidance under ASC No. 606 to provide further clarification of the original ASU. In addition, the Company is also monitoring the activity of the Power and Utilities Task Force. The Task Force was formed by the American Institute of Certified Public Accountants ("AICPA") in an effort to provide industry-specific guidance. Implementation issues identified by the Task Force include accounting for contributions in aid of construction and assessing collectability of customer accounts when regulated mechanisms exist to allow recovery of uncollected accounts from ratepayers. The Company will consider all current and future guidance in before determining how best to implement the new revenue recognition standard.


6



Although Management has not completed its evaluation of all the issued guidance under ASC No. 606, currently the Company does not expect it to have a material effect on its financial position, results of operations or cash flows. However, the disclosure requirements under ASU 2014-09 could be significant to the Company.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU enhances the reporting model for financial instruments to provide users of the financial statements with more useful information through several provisions, including the following: (1) requires equity investments, excluding investments accounted for under the equity method, be measured at fair value with changes in fair value recognized in net income, (2) simplifies the impairment assessment of equity investments without readily determinable fair values, (3) eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (4) requires entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, and (5) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The new guidance is effective for the Company for the annual reporting period ending September 30, 2019 and interim periods within that annual period. Management has not completed its evaluation of the new guidance. However, the Company does not currently expect the new guidance to have a material effect on its financial position, results of operations or cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases. The ASU leaves the accounting for leases mostly unchanged for lessors, with the exception of targeted improvements for consistency; however, the new guidance requires lessees to recognize assets and liabilities for leases with terms of more than 12 months. The ASU also revises the definition of a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. Consistent with current GAAP, the presentation and cash flows arising from a lease by a lessee will primarily depend on its classification as a finance or operating lease. In contrast, the new ASU requires both types of leases to be recognized on the balance sheet. In addition, the new guidance includes quantitative and qualitative disclosure requirements to aid financial statement users in better understanding the amount, timing and uncertainty of cash flows arising from leases. The new guidance is effective for the Company for the annual reporting period ending September 30, 2020 and interim periods within that annual period. Early adoption is permitted. Management is in the process of compiling an inventory of all leases that fall under the requirements of ASU 2016-02. The Company has very few agreements that fall under the prior definition of leases; however, management is reviewing other agreements that may fall within the scope of ASU 2016-02. The Company does not currently expect the new guidance to have a material effect on its financial position, results of operations or cash flows.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting. The guidance simplifies several aspects of the accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The new guidance is effective for the Company for the annual reporting period ending September 30, 2018 and interim periods within that annual period. Early adoption is permitted. The Company adopted this ASU during the quarter ended September 30, 2016. This ASU had no effect on the financial statements at the time of adoption; however, as the application of the APIC pool is eliminated, the Company will recognize all excess tax benefits and deficiencies associated with the exercise of stock options in income tax expense rather than as an offset to additional paid in capital.

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections and Investments - Equity Method and Joint Ventures. This update adds the text of the SEC Staff Announcement, Disclosure of the Impact That Recently Issued Accounting Standards Will Have on the Financial Statements of a Registrant When Such Standards Are Adopted in a Future Period (in accordance with Staff Accounting Bulletin Topic 11.M) as paragraph 250-10-S99-6. Related specifically to ASU 2014-09, ASU 2016-02 and ASU 2016-13, an SEC registrant should evaluate ASUs that have not yet been adopted to determine and include appropriate financial disclosures and MD&A discussions, including consideration of additional qualitative disclosures, to assist financial statement readers in assessing the significance of impact on adoption. The new guidance is effective immediately. The nature of this guidance relates to the effectiveness and quality of disclosures related to ASUs not yet adopted; however, there is no effect on the Company's financial position, results of operations or cash flows.

In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits. The primary objective of this guidance is to improve the financial statement presentation of net periodic pension and postretirement benefit costs; however, it also changes which cost components are eligible for capitalization. The amendments in the ASU require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and, if presented, outside of income from operations. In addition, the ASU allows only the service cost component of periodic benefit cost to be eligible for capitalization when applicable. This change to

7



capitalization eligibility differs from the treatment currently applied by the Company and from allowed regulatory accounting. The new guidance is effective for the Company for the annual reporting period ending September 30, 2019 and interim periods within that annual period. Early adoption is permitted. Management is in the process of evaluating the new guidance from this ASU. The regulatory body in the Company's service jurisdiction requires the capitalization of all cost components included in net benefit costs. As a result, the Company may have to establish regulatory assets for those costs now excluded from capitalization under this ASU. The Company has begun discussions with its regulatory body, the State Corporation Commission of Virginia, regarding the expected treatment of those costs. Although the ultimate disposition of these other components of net periodic benefit costs has not been determined, management expects the new guidance may have a material effect on the Company's consolidated financial statements when adopted.

Other accounting standards that have been issued by the FASB or other standard-setting bodies are not currently applicable to the Company or are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

2.
Stock Split

On January 17, 2017, Resources Board of Directors approved a three-for-two stock split of the Company's issued and outstanding common stock. The stock split was effected in the form of a 50% stock dividend entitling each shareholder to receive one additional share of common stock for every two shares owned. The stock dividend was payable March 1, 2017 to shareholders of record on February 15, 2017. As the par value of the common stock remained at $5 per share, the Company reclassified $10,025,546 from "Capital in excess of par value" and $2,004,244 from "Retained earnings" to "Common stock" associated with the issuance of 2,405,958 shares. Corresponding prior period amounts, including share and per share data, have been restated retrospectively to reflect the 50% stock dividend.

3.
Rates and Regulatory Matters

The State Corporation Commission of Virginia (“SCC”) exercises regulatory authority over the natural gas operations of Roanoke Gas. Such regulation encompasses terms, conditions, and rates to be charged to customers for natural gas service; safety standards; extension of service; and accounting and depreciation.

On June 30, 2017, the Company filed with the SCC its SAVE (Steps to Advance Virginia's Energy) Plan and Rider application. The SAVE Plan provides a mechanism for the Company to recover the related depreciation and expenses and a return on rate base of the additional capital investment related to the modernization of aging natural gas infrastructure without the filing of a formal application for an increase in non-gas base rates. Under the current application, the Company submitted its report for collecting the shortfall in SAVE revenues collected under the 2016 SAVE Plan and proposed new 2018 SAVE rates to be implemented for the ongoing investment in SAVE Plan projects. The Company anticipates the SCC to complete its review of the application over the next few months. The Company continues to bill its customers for SAVE revenues associated with its 2017 SAVE Plan.

4.
Other Investments

In October 2015, the Company, through its wholly-owned subsidiary, RGC Midstream, LLC ("Midstream"), acquired a 1% equity interest in the Mountain Valley Pipeline, LLC (the “LLC”).

The LLC was established to construct and operate a natural gas pipeline originating in northern West Virginia and extending through south central Virginia. The proposed pipeline will have the capacity to transport approximately 2 million decatherms of natural gas per day. Subject to approval by the Federal Energy Regulatory Commission, the pipeline is targeted to be in service by late 2018.

The total project cost is estimated to be approximately $3.5 billion. The Company's 1% equity interest in the LLC will require a total estimated cash investment of approximately $35 million, by periodic capital contributions throughout the design and construction phases of the project. Midstream held an approximate $5.7 million equity method investment in the LLC at June 30, 2017. On a quarterly basis, the LLC issues a capital call notice, which specifies the capital contributions to be paid over the subsequent 3 months. As of June 30, 2017, the Company had $402,589 remaining to be paid under the most recent notice. The capital contribution payable has been reflected on the Company's balance sheet as of June 30, 2017, with a corresponding increase to Investment in Unconsolidated Affiliate. Related to capital contributions payable, there was a non-cash $114,795 increase in the Investment in Unconsolidated Affiliate in the nine months ended

8

RGC RESOURCES, INC. AND SUBSIDIARIES


June 30, 2017. Initial funding for Midstream's investment in the LLC is provided through two unsecured promissory notes, each with a 5-year term.

The Company is participating in the earnings of the LLC in proportion to its level of investment. The Company is utilizing the equity method to account for the transactions and activity of the investment.

The financial statement locations of the investment in the LLC are as follows:

Balance Sheet Location of Other Investments:
June 30, 2017
 
September 30, 2016
Other Assets:
 
 
 
     Investment in unconsolidated affiliate
$
5,704,091

 
$
3,496,404

Current Liabilities:
 
 
 
     Capital contributions payable
$
402,589

 
$
287,794


 
Three Months Ended
 
Nine Months Ended
Income Statement Location of Other Investments:
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
    Equity in earnings of unconsolidated affiliate
$
111,626

 
$
40,562

 
$
289,791

 
$
95,945


5.
Derivatives and Hedging

The Company’s risk management policy allows management to enter into derivatives for the purpose of managing the commodity and financial market 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 the Company seeks to hedge include the price of natural gas and the cost of borrowed funds.

The Company has one interest rate swap associated with its $7,000,000 term note with Branch Banking & Trust as discussed in Note 6. Effective November 1, 2017, the swap agreement converts the floating rate note based on LIBOR into a fixed rate debt with a 2.30% effective interest rate. The swap qualifies as a cash flow hedge with changes in fair value reported in other comprehensive income. No portion of the swap was deemed ineffective during the periods presented.

The table below reflects the fair values of the derivative instrument and its corresponding classification in the condensed consolidated balance sheets under the caption of "Fair value of marked-to-market transactions":

 
June 30, 2017
 
September 30, 2016
Derivative designated as hedging instrument:
 
 
 
Interest rate swap
$118,606
 



The table in Note 7 reflects the effect on income and other comprehensive income of the Company's cash flow hedge.

6.
Long-Term Debt

On March 27, 2017, Roanoke Gas entered into a new unsecured line-of-credit agreement. This new line-of-credit agreement replaced the agreement which expired on March 31, 2017. The expired agreement was for a term of one year and all amounts drawn against that agreement were considered to be current liabilities. The new line-of-credit agreement is for a two-year term expiring March 31, 2019. Amounts drawn against the new agreement are considered to be non-current as the balance under the line-of-credit is not subject to repayment within the next 12-month period.

Except for the two-year term, the new agreement maintains the same variable interest rate based on 30-day LIBOR plus 100 basis points and availability fee of 15 basis points as the expired agreement. The new agreement also maintains the multi-tiered borrowing limits to accommodate seasonal borrowing demands and minimize borrowing costs. The

9



Company's total available borrowing limits during the term of the new agreement range from $10,000,000 to $30,000,000. The Company anticipates being able to extend or replace the line-of-credit upon expiration.

On November 1, 2016, Roanoke Gas entered into a 5-year unsecured note with Branch Banking & Trust in the principal amount of $7,000,000. The note is variable rate with interest based on 30-day LIBOR plus 90 basis points. In addition, Roanoke Gas also entered into a swap agreement to convert the variable rate debt into a fixed-rate instrument with an annual interest rate of 2.30%. The swap agreement is not effective until November 1, 2017, with the monthly interest rate on the note floating until the swap period begins. The proceeds from the note were used to convert a portion of the Company's line-of-credit balance into longer-term financing.

Midstream has two unsecured Promissory Notes ("Notes") which provide up to a total of $25 million in borrowing limits over a period of 5 years, with an interest rate of 30-day LIBOR plus 160 basis points. Midstream issued the Notes in December 2015 to provide financing for capital contributions in respect of its 1% interest in the LLC. In accordance with the terms of the Agreement, at such point in time as Midstream has borrowed $17.5 million under the Notes, Midstream is required to provide the next $5 million towards its capital contributions to the LLC. Once Midstream has completed its $5 million in contributions, it may resume borrowing under the Notes up to the $25 million limit.

All of the debt agreements set forth certain representations, warranties and covenants to which the Company is subject, including financial covenants that limit Consolidated Long Term Indebtedness to not more than 65% of Consolidated Total Capitalization and Priority Indebtedness to not more than 15% of Consolidated Total Assets.

Long-term debt consists of the following:

 
June 30, 2017
 
September 30, 2016
 
Principal
 
Unamortized Debt Issuance Costs
 
Principal
 
Unamortized Debt Issuance Costs
Roanoke Gas Company:
 
 
 
 
 
 
 
Unsecured senior notes payable, at 4.26% due on September 18, 2034
$
30,500,000

 
$
166,533

 
$
30,500,000

 
$
173,773

Unsecured term note payable, at 30-day LIBOR plus 0.90%, due November 1, 2021
7,000,000

 
14,451

 

 

RGC Midstream, LLC:
 
 
 
 
 
 
 
Unsecured term notes payable, at 30-day LIBOR plus 1.60%, due December 29, 2020
5,320,200

 
71,133

 
3,396,200

 
86,376

Total notes payable
$
42,820,200

 
$
252,117

 
$
33,896,200

 
$
260,149

Line-of-credit, at 30-day LIBOR plus 1.00%, due March 31, 2019
$
10,516,426

 
$

 
$

 
$

Total long-term debt
$
53,336,626

 
$
252,117

 
$
33,896,200

 
$
260,149



7.
Other Comprehensive Income
A summary of other comprehensive income and loss is provided below:
 

10

RGC RESOURCES, INC. AND SUBSIDIARIES


 
Before-Tax
Amount
 
Tax
(Expense)
or Benefit
 
Net-of-Tax
Amount
Three Months Ended June 30, 2017
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
Unrealized losses
$
(40,382
)
 
$
15,329

 
$
(25,053
)
Defined benefit plans:
 
 
 
 
 
Amortization of actuarial losses
64,058

 
(24,316
)
 
39,742

Other comprehensive income
$
23,676

 
$
(8,987
)
 
$
14,689

Three Months Ended June 30, 2016
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
Unrealized losses
$

 
$

 
$

Defined benefit plans:
 
 
 
 
 
Amortization of actuarial losses
55,268

 
(20,979
)
 
34,289

Other comprehensive income
$
55,268

 
$
(20,979
)
 
$
34,289

 
 
 
 
 
 
 
Before-Tax
Amount
 
Tax
(Expense)
or Benefit
 
Net-of-Tax
Amount
Nine Months Ended June 30, 2017
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
Unrealized gains
$
118,606

 
$
(45,023
)
 
$
73,583

Defined benefit plans:
 
 
 
 
 
Amortization of actuarial losses
192,174

 
(72,948
)
 
119,226

Other comprehensive income
$
310,780

 
$
(117,971
)
 
$
192,809

Nine Months Ended June 30, 2016
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
Unrealized losses
$

 
$

 
$

Defined benefit plans:
 
 
 
 
 
Amortization of actuarial losses
165,804

 
(62,937
)
 
102,867

Other comprehensive income
$
165,804

 
$
(62,937
)
 
$
102,867


The amortization of actuarial losses is included as a component of net periodic pension and postretirement benefit cost in operations and maintenance expense. 

Reconciliation of Other Accumulated Comprehensive Income (Loss)
 
 
Accumulated
Other
Comprehensive
Income (Loss)
Balance at September 30, 2016
$
(2,497,231
)
Other comprehensive income
192,809

Balance at June 30, 2017
$
(2,304,422
)

8.
Commitments and Contingencies

On June 28, 2017, the Company announced that effective July 21, 2017, all customer support services functions would be outsourced resulting in a reduction of 18 employees. The Company recorded approximately $135,000 in severance-related expenses for the impacted employees.

Roanoke Gas currently holds the only franchises and/or certificates of public convenience and necessity to distribute natural gas in its service area. The current franchise agreements expire December 31, 2035. The Company's certificates of public convenience and necessity are exclusive and are intended for perpetual duration. 


11



Due to the nature of the natural gas distribution business, the Company has entered into agreements with both suppliers and pipelines for natural gas commodity purchases, storage capacity and pipeline delivery capacity. The Company obtains most of its regulated natural gas supply through an asset manager. The Company utilizes an asset manager to assist in optimizing the use of its transportation, storage rights, and gas supply in order to provide a secure and reliable source of natural gas to its customers. The Company also has storage and pipeline capacity contracts to store and deliver natural gas to the Company’s distribution system. Roanoke Gas is served directly by two primary pipelines. These two pipelines deliver all of the natural gas supplied to the Company’s distribution system. Depending on weather conditions and the level of customer demand, failure of one or both of these transmission pipelines could have a major adverse impact on the Company's ability to deliver natural gas to its customers and its results of operations.
 
9.
Earnings Per Share

Basic earnings per common share for the three months and nine months ended June 30, 2017 and 2016 were calculated by dividing net income by the weighted average common shares outstanding during the period. Diluted earnings per common share were calculated by dividing net income by the weighted average common shares outstanding during the period plus potential dilutive common shares. A reconciliation of basic and diluted earnings per share is presented below:
 
 
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
Net Income
$
615,562

 
$
627,068

 
$
6,072,979

 
$
5,661,305

 
Weighted average common shares
7,227,171

 
7,160,650

 
7,212,289

 
7,140,914

 
Effect of dilutive securities:
 
 
 
 
 
 
 
 
Options to purchase common stock
46,669

 
12,062

 
32,275

 
7,951

 
Diluted average common shares
7,273,840

 
7,172,712

 
7,244,564

 
7,148,865

 
Earnings Per Share of Common Stock:
 
 
 
 
 
 
 
 
Basic
$
0.09

 
$
0.09

 
$
0.84

 
$
0.79

 
Diluted
$
0.08

 
$
0.09

 
$
0.84

 
$
0.79

 
10.
Employee Benefit Plans

The Company has both a defined benefit pension plan (the “pension plan”) and a postretirement benefit plan (the “postretirement plan”). The pension plan covers substantially all of the Company’s employees and provides retirement income based on years of service and employee compensation. The postretirement plan provides certain health care and supplemental life insurance benefits to retired employees who meet specific age and service requirements. Net pension plan and postretirement plan expense recorded by the Company is detailed as follows:
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
June 30,
 
June 30,
 
 
2017
 
2016
 
2017
 
2016
 
Components of net periodic pension cost:
 
 
 
 
 
 
 
 
Service cost
$
176,669

 
$
173,594

 
$
530,007

 
$
520,782

 
Interest cost
248,900

 
283,194

 
746,700

 
849,582

 
Expected return on plan assets
(404,103
)
 
(373,060
)
 
(1,212,309
)
 
(1,119,180
)
 
Recognized loss
165,545

 
125,420

 
496,635

 
376,260

 
Net periodic pension cost
$
187,011

 
$
209,148

 
$
561,033

 
$
627,444

 

12

RGC RESOURCES, INC. AND SUBSIDIARIES


 
 
Three Months Ended
 
Nine Months Ended
 
 
June 30,
 
June 30,
 
 
2017
 
2016
 
2017
 
2016
 
Components of postretirement benefit cost:
 
 
 
 
 
 
 
 
Service cost
$
45,817

 
$
37,005

 
$
137,451

 
$
111,015

 
Interest cost
156,706

 
156,145

 
470,118

 
468,435

 
Expected return on plan assets
(142,878
)
 
(126,965
)
 
(428,634
)
 
(380,895
)
 
Recognized loss
107,440

 
62,543

 
322,320

 
187,629

 
Net postretirement benefit cost
$
167,085

 
$
128,728

 
$
501,255

 
$
386,184


The table below reflects the Company's actual contributions made fiscal year-to-date and the expected contributions to be made during the balance of the current fiscal year.
 
 
 
Fiscal Year-to-Date Contributions
 
Remaining Fiscal Year Contributions
 
Defined benefit pension plan
$
450,000

 
$
300,000

 
Postretirement medical plan

 
1,000,000

 
Total
$
450,000

 
$
1,300,000


11.
Fair Value Measurements
FASB ASC No. 820, Fair Value Measurements and Disclosures, established a fair value hierarchy that prioritizes each input to the valuation method used to measure fair value of financial and nonfinancial assets and liabilities that are measured and reported on a fair value basis into one of the following three broad levels:

Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 – Inputs other than quoted prices in Level 1 that are either for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 – Unobservable inputs for the asset or liability where there is little, if any, market activity for the asset or liability at the measurement date.

The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3).
 
The following table summarizes the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as required by existing guidance and the fair value measurements by level within the fair value hierarchy as of June 30, 2017 and September 30, 2016:
 

13

RGC RESOURCES, INC. AND SUBSIDIARIES


 
 
 
Fair Value Measurements - June 30, 2017
 
Fair
Value
 
Quoted
Prices
in Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Interest rate swap
$
118,606

 
$

 
$
118,606

 
$

Total
$
118,606

 
$

 
$
118,606

 
$

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Natural gas purchases
$
1,880,645

 
$

 
$
1,880,645

 
$

Total
$
1,880,645

 
$

 
$
1,880,645

 
$

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements - September 30, 2016
 
Fair
Value
 
Quoted
Prices
in Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Liabilities:
 
 
 
 
 
 
 
Natural gas purchases
$
1,052,930

 
$

 
$
1,052,930

 
$

Total
$
1,052,930

 
$

 
$
1,052,930

 
$


The fair value of the interest rate swap included in the line item "Fair value of marked-to-market transactions", is determined by using the counterparty's proprietary models and certain assumptions regarding past, present and future market conditions.

Under the asset management contract, a timing difference can exist between the payment for natural gas purchases and the actual receipt of such purchases. Payments are made based on a predetermined monthly volume with the price based on weighted average first of the month index prices corresponding to the month of the scheduled payment. At June 30, 2017 and September 30, 2016, the Company had recorded in accounts payable the estimated fair value of the liability valued at the corresponding first of month index prices for which the liability is expected to be settled.

The Company’s nonfinancial assets and liabilities measured at fair value on a nonrecurring basis consist of its asset retirement obligations. The asset retirement obligations are measured at fair value at initial recognition based on expected future cash flows required to settle the obligation. 

The carrying value of cash and cash equivalents, accounts receivable, accounts payable (with the exception of the timing difference under the asset management contract), customer credit balances and customer deposits is a reasonable estimate of fair value due to the short-term nature of these financial instruments. In addition, the carrying amount of the variable rate line-of-credit is a reasonable approximation of its fair value. The following table summarizes the fair value of the Company’s financial assets and liabilities that are not adjusted to fair value in the financial statements as of June 30, 2017 and September 30, 2016:
 

14

RGC RESOURCES, INC. AND SUBSIDIARIES


 
 
 
Fair Value Measurements - June 30, 2017
 
Carrying
Value
 
Quoted
Prices
in Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Liabilities:
 
 
 
 
 
 
 
Long-term debt - notes payable
$
42,820,200

 
$

 
$

 
$
44,295,661

Total
$
42,820,200

 
$

 
$

 
$
44,295,661

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements - September 30, 2016
 
Carrying
Value
 
Quoted
Prices
in Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Liabilities:
 
 
 
 
 
 
 
Long-term debt - notes payable
$
33,896,200

 
$

 
$

 
$
36,163,523

Total
$
33,896,200

 
$

 
$

 
$
36,163,523

 
The fair value of long-term debt is estimated by discounting the future cash flows of the debt based on current market rates and corresponding interest rate spread.

FASB ASC 825, Financial Instruments, requires disclosures regarding concentrations of credit risk from financial instruments. Cash equivalents are investments in high-grade, short-term securities (original maturity less than three months), placed with financially sound institutions. Accounts receivable are from a diverse group of customers including individuals and small and large companies in various industries. As of June 30, 2017 and September 30, 2016, no single customer accounted for more than 5% of the total accounts receivable balance. The Company maintains certain credit standards with its customers and requires a customer deposit if such evaluation warrants.
 
12.
Stock Options

On December 8, 2016, the Board of Directors granted 25,500 options to certain officers of the Company. In accordance with the Key Employee Stock Option Plan, the grant price of $16.37 was the closing price of the Company's stock on the grant date. The options become exercisable six months from the grant date and expire after ten years from the date of issuance.

Fair value at the grant date was $2.89 per option as calculated using the Black-Scholes option pricing model. Compensation expense is recognized over the vesting period. Total compensation expense recognized through June 30, 2017 was $73,780. The number of options granted, grant price and option value have been adjusted for the stock split effective March 1, 2017.

13.
Subsequent Events

The Company has evaluated subsequent events through the date the financial statements were issued. There were no items not otherwise disclosed which would have materially impacted the Company’s condensed consolidated financial statements. 

15

RGC RESOURCES, INC. AND SUBSIDIARIES


ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-Looking Statements
This report contains forward-looking statements that relate to future transactions, events or expectations. In addition, RGC Resources, Inc. (“Resources” or the “Company”) may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. These statements are based on management’s current expectations and information available at the time of such statements and are believed to be reasonable and are made in good faith. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company’s business include, but are not limited to those set forth in the following discussion and within Item 1A “Risk Factors” in the Company’s 2016 Annual Report on Form 10-K. All of these factors are difficult to predict and many are beyond the Company’s control. Accordingly, while the Company believes its forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. When used in the Company’s documents or news releases, the words, “anticipate,” “believe,” “intend,” “plan,” “estimate,” “expect,” “objective,” “projection,” “forecast,” “budget,” “assume,” “indicate” or similar words or future or conditional verbs such as “will,” “would,” “should,” “can,” “could” or “may” are intended to identify forward-looking statements.
Forward-looking statements reflect the Company’s current expectations only as of the date they are made. The Company assumes no duty to update these statements should expectations change or actual results differ from current expectations except as required by applicable laws and regulations.
The three-month and nine-month earnings presented herein should not be considered as reflective of the Company’s consolidated financial results for the fiscal year ending September 30, 2017. The total revenues and margins realized during the first nine months reflect higher billings due to the weather sensitive nature of the gas business.
Overview
Resources is an energy services company primarily engaged in the regulated sale and distribution of natural gas to approximately 60,000 residential, commercial and industrial customers in Roanoke, Virginia and the surrounding localities through its Roanoke Gas Company (“Roanoke Gas”) subsidiary. Natural gas service is provided at rates and for terms and conditions set by the Virginia State Corporation Commission (“SCC”).
Resources also provides certain unregulated services through Roanoke Gas and its other subsidiaries. Such unregulated operations represent less than 2% of total revenues and margin of Resources on an annual basis.
The Company’s utility operations are regulated by the SCC, which oversees the terms, conditions, and rates to be charged to customers for natural gas service, safety standards, extension of service, accounting and depreciation. The Company is also subject to federal regulation from the Department of Transportation in regard to the construction, operation, maintenance, safety and integrity of its transmission and distribution pipelines. The Federal Energy Regulatory Commission ("FERC") regulates the prices for the transportation and delivery of natural gas to the Company’s distribution system and underground storage services. The Company is also subject to other regulations which are not necessarily industry specific.

Over 98% of the Company’s annual revenues are derived from the sale and delivery of natural gas to Roanoke Gas customers. The SCC authorizes the rates and fees the Company charges its customers for these services. These rates are designed to provide the Company with the opportunity to recover its gas and non-gas expenses and to earn a reasonable rate of return for shareholders based on normal weather. Normal weather refers to the average number of heating degree days (an industry measure by which the average daily temperature falls below 65 degrees Fahrenheit) over the previous 30-year period.

As the Company’s business is seasonal in nature, volatility in winter weather and the commodity price of natural gas can impact the effectiveness of the Company’s rates in recovering its costs and providing a reasonable return for its shareholders. In order to mitigate the effect of variations in weather and the cost of natural gas, the Company has certain approved rate mechanisms in place that help provide stability in earnings, adjust for volatility in the price of natural gas and provide a return on increased infrastructure investment. These mechanisms include a purchased gas adjustment factor ("PGA"), weather normalization adjustment factor ("WNA"), inventory carrying cost revenue ("ICC") and a Steps to Advance Virginia Energy ("SAVE") adjustment rider.

16

RGC RESOURCES, INC. AND SUBSIDIARIES


The Company's approved billing rates include a component designed to allow for the recovery of the cost of natural gas used by its customers. The cost of natural gas is considered a pass-through cost and is independent of the non-gas rates of the Company. This rate component, referred to as the PGA, allows the Company to pass along to its customers increases and decreases in natural gas costs incurred by its regulated operations. On a quarterly basis, the Company files a PGA rate adjustment request with the SCC to adjust the gas cost component of its rates up or down depending on projected price and activity. Once administrative approval is received, the Company adjusts the gas cost component of its rates to reflect the approved amount. As actual costs will differ from the projections used in establishing the PGA rate, the Company will either over-recover or under-recover its actual gas costs during the period. The difference between actual costs incurred and costs recovered through the application of the PGA is recorded as a regulatory asset or liability. At the end of the annual deferral period, the balance is amortized over an ensuing 12-month period as amounts are reflected in customer billings.

The WNA model reduces earnings volatility, related to weather variability in the heating season, by providing the Company a level of earnings protection when weather is warmer than normal and providing customers price protection when the weather is colder than normal. The WNA is based on a weather measurement band around the most recent 30-year temperature average. Under the WNA, the Company recovers from its customers the lost margin (excluding gas costs) for the impact of weather that is warmer than normal or refunds the excess margin earned for weather that is colder than normal. The WNA mechanism used by the Company is based on a linear regression model that determines the value of a single heating degree day. For the three months ended June 30, 2017 and 2016, the Company accrued approximately $255,000 and $42,000 in additional revenue and margin for weather that was warmer than normal during each of the periods, respectively. For the nine months ended June 30, 2017 and 2016, the Company accrued approximately $1,860,000 and $1,223,000 in additional revenue and margin for weather that had nearly 19% and 12% fewer heating degree days than normal.
The Company also has an approved rate structure in place that mitigates the impact of financing costs associated with its natural gas inventory. Under this rate structure, Roanoke Gas recognizes revenue for the financing costs, or “carrying costs,” of its investment in natural gas inventory. This ICC factor applied to the cost of inventory is based on the Company’s weighted-average cost of capital including interest rates on short-term and long-term debt and the Company’s authorized return on equity. During times of rising gas costs and rising inventory levels, the Company recognizes ICC revenues to offset higher financing costs associated with higher inventory balances. Conversely, during times of decreasing gas costs and lower inventory balances, the Company recognizes less carrying cost revenue as financing costs are lower. In addition, ICC revenues are impacted by the changes in the weighting of the components that are used to determine the weighted-average cost of capital. The average unit price of gas in storage during the first nine months of the current fiscal year was $0.21 per decatherm, or 7%, lower than the same period last year, as the Company benefited from lower natural gas commodity prices during the summer storage refill period in calendar 2016. With the beginning of the current year summer storage refill in April, natural gas prices purchased for the storage delivery were higher than for the same period last year, which combined with higher average volumes of gas in storage has increased the average total cost of natural gas in storage during the quarter by nearly 18%. However, the ratio of debt to equity has increased from last year, leading to a reduction in the ICC factor applied to inventory balances. The result is a smaller increase in ICC revenues for the quarter compared to last year and a decrease for the nine-month period. Natural gas futures are currently higher than the average price of gas in storage, which may result in higher average cost and ICC revenues as storage balances are replenished during the summer months.
The Company’s non-gas rates provide for the recovery of non-gas related expenses and a reasonable return to shareholders. These rates are determined based on the filing of a formal rate application with the SCC utilizing historical information, including investment in natural gas facilities. Generally, investments related to extending service to new customers are recovered through the non-gas rates currently in place. The investment in replacing and upgrading existing infrastructure is not recoverable until a formal rate application is filed and approved to include the additional investment in new non-gas rates. The SAVE Plan, however, provides the Company with the ability to recover costs related to investments in qualified infrastructure projects on a prospective basis rather than on a historical basis. The SAVE Plan provides a mechanism through which the Company may recover the related depreciation and expenses and provide a return on rate base for the additional capital investments related to improving the Company's infrastructure until such time that a formal rate application is filed to incorporate this investment in the Company's non-gas rates. As the Company did not file for an increase in the non-gas rates during the prior three years and the level of capital investment continues to grow, SAVE Plan revenues have continued to increase. The Company recognized approximately $965,000 and $2,768,000 in SAVE Plan revenues for the three-month and nine-month periods ended June 30, 2017, compared to $664,000 and $1,701,000 for the same periods last year. These SAVE Plan revenues will be included as part of the new non-gas base rates the next time the Company files for a non-gas rate increase.




17

RGC RESOURCES, INC. AND SUBSIDIARIES


Results of Operations
Three Months Ended June 30, 2017:
Net income declined by $11,506 for the three months ended June 30, 2017, compared to the same period last year. Increases in SAVE Plan revenues nearly offset a reduction in capitalized overheads and severance costs related to the outsourcing of the customer support services function.
The tables below reflect operating revenues, volume activity and heating degree-days.
 
 
Three Months Ended June 30,
 
 
 
 
 
2017
 
2016
 
Increase / (Decrease)
 
Percentage
Operating Revenues
 
 
 
 
 
 
 
Gas Utilities
$
11,171,499

 
$
11,017,281

 
$
154,218

 
1
 %
Other
264,325

 
277,916

 
(13,591
)
 
(5
)%
Total Operating Revenues
$
11,435,824

 
$
11,295,197

 
$
140,627

 
1
 %
Delivered Volumes
 
 
 
 
 
 
 
Regulated Natural Gas (DTH)
 
 
 
 
 
 
 
Residential and Commercial
769,795

 
865,471

 
(95,676
)
 
(11
)%
Transportation and Interruptible
631,297

 
658,869

 
(27,572
)
 
(4
)%
Total Delivered Volumes
1,401,092

 
1,524,340

 
(123,248
)
 
(8
)%
Heating Degree Days (Unofficial)
245

 
332

 
(87
)
 
(26
)%
Total operating revenues for the three months ended June 30, 2017, compared to the same period last year, increased primarily due to higher SAVE Plan revenues and natural gas commodity prices, partially offset by lower customer volume deliveries. As discussed above, SAVE Plan revenues continue to grow as the Company continues to invest in its SAVE related infrastructure replacement program allowing for recovery of the cost and a return on investment in the new facilities. In addition, the commodity price of natural gas increased by more than 10% per decatherm over the same period last year. The Company is able to recover the higher commodity price through its PGA factor. Due to the warmer weather during the quarter, primarily in April, weather sensitive residential and commercial sales volumes declined by 11% with total natural gas deliveries declining by 8%. The Company was able to recover most of the lost margin attributable to warmer weather through the WNA mechanism. Transportation and industrial volumes declined by 4% due in part to warmer weather.

 
Three Months Ended June 30,
 
 
 
 
 
2017
 
2016
 
Increase
 
Percentage
Gross Margin
 
 
 
 
 
 
 
Gas Utilities
$
6,492,452

 
$
6,183,677

 
$
308,775

 
5
%
Other
141,950

 
128,663

 
13,287

 
10
%
Total Gross Margin
$
6,634,402

 
$
6,312,340

 
$
322,062

 
5
%
Regulated natural gas margins from utility operations increased from the same period last year primarily as a result of higher SAVE Plan revenues. SAVE revenues increased by $300,209 due to the continuing investment in SAVE related projects. Total volumetric margin, net of the WNA adjustment, decreased slightly by $11,660, or less than 1.0%, due to reductions in transportation and interruptible deliveries. The residential and commercial volumes as adjusted for WNA reflected an increase of more than 1% in volumes. The remaining margin increase was attributable to increases in customer base charge from customer growth, higher ICC revenues due to higher average inventory balances for the quarter and other gas revenues. Other margins reflected a small increase over last year.
The components of and the change in gas utility margin are summarized below:

18

RGC RESOURCES, INC. AND SUBSIDIARIES


 
Three Months Ended June 30,
 
 
 
2017
 
2016
 
Increase / (Decrease)
Customer Base Charge
$
3,112,654

 
$
3,104,082

 
$
8,572

Carrying Cost
107,051

 
100,179

 
6,872

SAVE Plan
964,697

 
664,488

 
300,209

Volumetric
2,025,593

 
2,250,298

 
(224,705
)
WNA
255,163

 
42,118

 
213,045

Other Gas Revenues
27,294

 
22,512

 
4,782

Total
$
6,492,452

 
$
6,183,677

 
$
308,775

Operation and maintenance expenses increased by $234,504, or 8%, from the same period last year. Severance costs related to the outsourcing of the customer support services functions, lower capitalized overheads and increases in employee benefit costs more than offset reductions in corporate property and liability insurance premiums and other costs. The Company accrued $135,000 in severance related payroll and benefit costs for the 18 employees who were displaced due to the changes in the customer service area. These costs will be paid in the next quarter. Total capital expenditures subject to general and administrative overheads declined by nearly 5% for the quarter. This reduction in eligible expenditures combined with a lower overhead factor resulted in $120,000 less overhead capitalization. The reduction in capital expenditures was due to the level and timing expenditures between the quarters. Total capital expenditures for the year remain well above last year's levels. Employee benefit costs increased by $73,000 due to increased health insurance premiums and higher actuarial determined retirement plan costs. The Company continues to benefit from the reduction in corporate property and liability insurance cost due to favorable policy renewals. Premium expense declined by $46,000 for the quarter. The remaining differences were related to various minor fluctuations in other expenses.
General taxes increased by $36,817, or 9%, due to higher property taxes associated with increases in utility property.
 
Depreciation expense increased by $175,884, or 13%, on a corresponding increase in utility plant investment.
Equity in earnings of unconsolidated affiliate increased by $71,064, or 175%, due to the increasing investment in the Mountain Valley Pipeline ("MVP") project. This project began in the first quarter of fiscal 2016 and the corresponding earnings are primarily composed of allowance for funds used during construction ("AFUDC"). The equity in earnings amount will continue to increase as the investment in the MVP project continues. Additional information about the Company's investment in the MVP can be found under the Equity Investment in Mountain Valley Pipeline section below.
Other expense, net decreased by $30,413 primarily due to lower pipeline assessments.
Interest expense increased by $75,996, or 19%, due to increased borrowing to finance the Company's capital budget and the Company's investment in MVP. Total average debt outstanding during the quarter increased by 31% over the same period last year, while the weighted-average effective interest rate declined from 4.05% to 3.69% due to the additional borrowing on lower interest rate debt.
Income tax expense declined by $88,156, or 20%. The effective tax rate was 36% and 41% for the three months ended June 30, 2017 and 2016, respectively. The difference in the effective tax rate was due to the exercise of stock options during the quarter, which resulted in additional tax deductions above the amount recorded at grant due to the significant appreciation in stock price. During the prior year, the effective tax rate was higher than the statutory rate due to higher non-deductible expenses and the expiration of unexercised stock options.

Nine Months Ended June 30, 2017:
Net income increased by $411,674 for the nine months ended June 30, 2017, compared to the same period last year. Increases in SAVE Plan revenues, earnings from the investment in the MVP project and higher capitalized overheads were the primary reasons for the growth in net income.
The tables below reflect operating revenues, volume activity and heating degree-days.
 

19

RGC RESOURCES, INC. AND SUBSIDIARIES


 
Nine Months Ended 
 June 30,
 
 
 
 
 
2017
 
2016
 
Increase / (Decrease)
 
Percentage
Operating Revenues
 
 
 
 
 
 
 
Gas Utilities
$
51,346,456

 
$
48,372,615

 
$
2,973,841

 
6
 %
Other
777,966

 
710,411

 
67,555

 
10
 %
Total Operating Revenues
$
52,124,422

 
$
49,083,026

 
$
3,041,396

 
6
 %
Delivered Volumes
 
 
 
 
 
 
 
Regulated Natural Gas (DTH)
 
 
 
 
 
 
 
Residential and Commercial
5,305,263

 
5,567,255

 
(261,992
)
 
(5
)%
Transportation and Interruptible
2,115,333

 
2,158,032

 
(42,699
)
 
(2
)%
Total Delivered Volumes
7,420,596

 
7,725,287

 
(304,691
)
 
(4
)%
Heating Degree Days (Unofficial)
3,213

 
3,484

 
(271
)
 
(8
)%
Total operating revenues for the nine months ended June 30, 2017, compared to the same period last year, increased due to the increase in SAVE Plan revenues and higher natural gas commodity prices partially offset by lower delivered volumes. SAVE Plan revenues increased by $1,066,320 as investments in SAVE related projects continued. The commodity price for natural gas increased by 17% per decatherm. As the cost of natural gas is a pass-through to the Company's customers, revenues were increased through the PGA factor to recover the corresponding higher costs. Total natural gas deliveries decreased by 4% due to warmer weather, as evidenced by the 8% reduction in heating degree days. Residential and commercial volumes decreased by 5% due to warmer weather, while transportation and industrial volumes decreased slightly from the same period last year.

 
Nine Months Ended 
 June 30,
 
 
 
 
 
2017
 
2016
 
Increase
 
Percentage
Gross Margin
 
 
 
 
 
 
 
Gas Utilities
$
26,484,309

 
$
25,334,719

 
$
1,149,590

 
5
%
Other
370,728

 
365,006

 
5,722

 
2
%
Total Gross Margin
$
26,855,037

 
$
25,699,725

 
$
1,155,312

 
4
%
Utility margins increased from the same period last year primarily as a result of higher SAVE Plan revenues and customer growth. SAVE revenues increased by $1,066,320 due to the increasing investment in SAVE related projects. Volumetric margin, net of the WNA adjustment, increased by $99,072 as a result of a 1% increase in WNA adjusted volumes. The increase in net volumetric margin and customer base charges are attributable to customer growth, while lower average gas storage balances during the nine month period reduced carrying cost revenues. Other margins experienced a small increase on higher revenues.
The components of and the change in gas utility margin are summarized below:
 
Nine Months Ended 
 June 30,
 
 
 
2017
 
2016
 
Increase / (Decrease)
Customer Base Charge
$
9,330,860

 
$
9,288,474

 
$
42,386

Carrying Cost
406,838

 
464,883

 
(58,045
)
SAVE Plan
2,767,636

 
1,701,316

 
1,066,320

Volumetric
12,033,663

 
12,571,627

 
(537,964
)
WNA
1,860,497

 
1,223,461

 
637,036

Other Gas Revenues
84,815

 
84,958

 
(143
)
Total
$
26,484,309

 
$
25,334,719

 
$
1,149,590

Operation and maintenance expenses were nearly unchanged from the same period last year with an increase of $12,129. Increased capitalized overheads and lower corporate property and liability insurance premiums offset severance costs and higher employee benefit expenses. Although capitalized expenses were down for the quarter, expenditures subject to the

20

RGC RESOURCES, INC. AND SUBSIDIARIES


overheads increased by 35% for the nine-month period. As a result, capitalized construction overheads increased by more than $193,000. The combination of the ongoing pipeline renewal program and the automated meter reading system project accounted for the increased capital spending during the year. Corporate property and liability insurance premiums declined by $148,000 due to improvements in the insurance market. These expense reductions were offset by $134,000 in accrued payroll and benefit costs associated with the severance package offered to employees impacted by the outsourcing of the customer service function and $188,000 in higher employee benefit costs related to increased health insurance premiums and higher actuarial determined retirement plan costs. The remaining differences were related to various minor fluctuations in other expenses.
General taxes increased by $91,558, or 7%, due to higher property taxes associated with increases in utility property.
 
Depreciation expense increased by $547,652, or 13%, on higher utility plant investment.
Equity in earnings of unconsolidated affiliate increased by $193,846, or 202%, as the investment in the MVP project continues to grow.
Other expense, net decreased by $48,440 primarily due to lower pipeline assessments and timing of charitable giving.
Interest expense increased by $179,701, or 15%, due to the Company's increased borrowing to finance its capital investment in infrastructure and the MVP. Total average debt outstanding during the current period increased by 17% over the same period last year, while the weighted average effective interest rate declined slightly from 3.76% to 3.71%.
Income tax expense increased by $154,884, or 4%, which corresponds to an increase in pre-tax income for the period. The effective tax rate was 38% for both periods.
Critical Accounting Policies and Estimates
The consolidated financial statements of Resources are prepared in accordance with accounting principles generally accepted in the United States of America. The amounts of assets, liabilities, revenues and expenses reported in the Company’s financial statements are affected by accounting policies, estimates and assumptions that are necessary to comply with generally accepted accounting principles. Estimates used in the financial statements are derived from prior experience, statistical analysis and management judgments. Actual results may differ significantly from these estimates and assumptions.
The Company considers an estimate to be critical if it is material to the financial statements and it requires assumptions to be made that were uncertain at the time the estimate was made and changes in the estimate are reasonably likely to occur from period to period. There have been no changes to the critical accounting policies as reflected in the Company’s Annual Report on Form 10-K for the year ended September 30, 2016.
Asset Management
Roanoke Gas uses a third-party asset manager to manage its pipeline transportation, storage rights and gas supply inventories and deliveries. In return for being able to utilize the excess capacities of the transportation and storage rights, the asset manager pays Roanoke Gas a monthly utilization fee, which is used to reduce the cost of gas for customers. The current agreement expires in March 2018. The Company will begin the process to solicit bids for a new asset management agreement prior to fiscal year end and expects to complete the bidding process, select a provider and negotiate a new asset management agreement by the expiration date of the current agreement.
Equity Investment in Mountain Valley Pipeline
On October 1, 2015, the Company through its wholly-owned subsidiary, RGC Midstream, LLC ("Midstream"), entered into an agreement to become a 1% member in Mountain Valley Pipeline, LLC (the "LLC"). The purpose of the LLC is to construct and operate the MVP, a natural gas pipeline connecting an existing gathering and transmission system in northern West Virginia to another interstate pipeline in south central Virginia. This project falls under the jurisdiction of FERC and is subject to its approval prior to beginning construction. In October 2015, the LLC filed the application with FERC to construct the pipeline. On June 28, 2016, FERC issued the Notice of Schedule for Environmental Review ("NOS"); on September 16, 2016, FERC issued its draft environmental impact statement ("EIS") regarding the MVP; and on June 23, 2017, FERC issued the Final EIS for the MVP. The Final EIS noted that "... approval of the projects would result in some adverse environmental impacts, but the majority of these impacts would be reduced to less-than-significant levels." The MVP project will now be sent to the FERC Commissioners for approval. Upon receiving FERC approval, the LLC will commence construction of the pipeline and is targeting an in-service date by the end of calendar 2018.


21

RGC RESOURCES, INC. AND SUBSIDIARIES


Management believes the investment in the LLC will be beneficial for the Company, its shareholders and southwest Virginia. In addition to the potential returns from the investment in the LLC, Roanoke Gas will benefit from access to an additional source of natural gas to its distribution system. Currently, Roanoke Gas is served by two pipelines and a liquefied natural gas storage facility. Damage to or interruption in supply from any of these sources, especially during the winter heating season, could have a significant impact on the Company's ability to serve its customers. A third pipeline would reduce the impact from such an event. In addition, the proposed pipeline path would provide the Company with a more economically feasible opportunity to provide natural gas service to previously unserved areas in southwest Virginia.

The total project cost is anticipated to be approximately $3.5 billion. As a 1% member in the LLC, Midstream's cash contribution is expected to be approximately $35 million. The agreement provides for a schedule of cash draws to fund the project. The initial payments are for the acquisition of land and materials related to the construction of the pipeline and other pre-construction costs. Once approved and construction begins, more significant cash draws will be required. Initial funding for the investment in the LLC is provided through the Midstream credit facility under which Midstream may borrow up to a total of $25 million, over a period of 5 years, with the balance coming from equity capital. The Company expects to fund the equity capital portion from the issuance of additional common stock. The number of shares issued and the amount raised will be determined after an assessment of the overall capital needs of the Company and will depend on capital market conditions.

A majority of the earnings from the investment in MVP relates to AFUDC income generated by the deployment of capital in the design, engineering, materials procurement, project management and ultimately construction of the pipeline. AFUDC is an accounting method whereby the costs of debt and equity funds used to finance facility infrastructure are credited to income and charged to the cost of the project. The level of investment in the MVP will continue to grow at a steady pace until such time FERC issues their decision on the project. If approved, construction on the pipeline should begin in earnest and both the investment in the MVP and the AFUDC will increase at a much greater rate until the pipeline is placed in service. Earnings after the pipeline becomes operational would be derived from the fees charged for transporting natural gas through the pipeline.
Regulatory
The Company continues to recover the costs of its infrastructure replacement program through its SAVE Plan. On June 30, 2017, the Company filed its 2018 SAVE Plan application with the SCC. The original SAVE Plan was approved by the SCC through an order issued on August 29, 2012 and has been modified amended or updated each year since. The original SAVE Plan was designed to facilitate the accelerated replacement of the remaining bare steel and cast iron natural gas pipe by providing a mechanism for the Company to recover the related depreciation and expenses and return on rate base of the additional capital investment without the filing of a formal application for an increase in non-gas base rates. The projects included under the SAVE Plan will enhance the safety and reliability of the Company’s gas distribution system and reduce greenhouse emissions. The amendments in 2013 and 2014 added projects related to the replacement of bare steel and cast iron natural gas pipe in addition to two other major projects and the investment for related meter and regulator installations located on customer premises. In 2015, the SCC approved the Company's request to expand the authorized annual spending variance from 10% to 20% and set a 5% cumulative SAVE spending variance. This allows the Company to recover its investment up to the new variance limits. The 2016 and 2017 applications included provisions to continue the ongoing pipeline renewal project with a focus on pre-1973 plastic pipe, replacement of natural gas custody transfer stations and the replacement of coated steel tubing services and related meter installations. In the 2018 SAVE Plan application, the revenue requirement is approximately $5,000,000, representing an increase of almost $1,000,000 over the estimated 2017 SAVE Plan year. The 2018 SAVE Plan continues the focus on the replacement of the pre-1973 plastic pipe and the replacement of one custody transfer station. The Company anticipates the SCC will complete its review of the application over the next few months and will implement the approved rates beginning in January 2018. If approved, the additional SAVE Plan revenue generated by the SAVE Plan rider will allow the Company to forgo a formal non-gas rate increase application at this time.
The Company's WNA year runs from April through March. At the end of the WNA year ended March 31, 2017, the Company had more than $1.7 million in WNA revenues accrued for weather that was nearly 18% warmer than the 30-year normal. In April, the Company submitted to the SCC its proposed WNA billing factors designed to recover the revenue shortfall attributable to the warmer weather. The SCC approved the billing factors to be used for a three-month period. Beginning in May 2017, the Company began billing customers for the WNA revenue. As of June 30, 2017, $572,000 of WNA was in the accounts receivable balance to be billed to customers in the July billing cycle.



22

RGC RESOURCES, INC. AND SUBSIDIARIES


Capital Resources and Liquidity
Due to the capital intensive nature of the utility business, as well as the related weather sensitivity, the Company’s primary capital needs are the funding of its utility plant capital projects, investment in the MVP, the seasonal funding of its natural gas inventories and accounts receivable and the payment of dividends. To meet these needs, the Company relies on its operating cash flows, line-of-credit agreement, long-term debt and capital raised through the Company’s stock plans.
Cash and cash equivalents increased by $120,564 for the nine-month period ended June 30, 2017, compared to a $80,401 decrease for the same period last year. The following table summarizes the sources and uses of cash:
 
 
Nine Months Ended 
 June 30,
 
2017
 
2016
Cash Flow Summary Nine Months Ended
 
 
 
Net cash provided by operating activities
$
15,751,066

 
$
15,535,449

Net cash used in investing activities
(18,240,994
)
 
(14,830,542
)
Net cash provided by (used in) financing activities
2,610,492

 
(785,308
)
Increase (decrease) in cash and cash equivalents
$
120,564

 
$
(80,401
)
The seasonal nature of the natural gas business causes operating cash flows to fluctuate significantly during the year as well as from year to year. Factors including weather, energy prices, natural gas storage levels and customer collections contribute to working capital levels and the related cash flows. Generally, operating cash flows are positive during the second and third quarters as a combination of earnings, declining storage gas levels and collections on customer accounts all contribute to higher cash levels. During the first and fourth quarters, operating cash flows generally decrease due to increases in natural gas storage levels, rising customer receivable balances and construction activity.
Cash flow provided by operations is primarily driven by net income, depreciation and reductions in natural gas storage inventory during the first nine months of the fiscal year. Cash flow provided by operations increased from the same period last year by $215,617, primarily due to a greater increase in net income, depreciation and over-collection of gas costs. The increase in cash provided by over-collection of gas costs is attributable to actual gas cost increases being less than the projected costs included in the PGA billing rate. Any over-collection remaining at the end of the current PGA period will be refunded to customers next year. Much of the increase in cash provided by net income, depreciation and over-collection of gas costs was offset by a decline in cash generated from reductions in gas storage. Higher natural gas commodity prices for deliveries of gas into storage during the current year combined with higher storage levels due to a warmer winter heating season resulted in a much smaller reduction in storage gas levels for the period. A summary of the cash provided by operations is listed below:
 
Nine Months Ended 
 June 3
0,
 
 
Cash Flow From Operating Activities:
2017
 
2016
 
Increase / (Decrease)
Net income
$
6,072,979

 
$
5,661,305

 
$
411,674

Depreciation
4,793,270

 
4,245,223

 
548,047

Increase in over-collections
2,348,534

 
767,194

 
1,581,340

Decrease in gas in storage
1,991,510

 
3,856,242

 
(1,864,732
)
Increase in accounts receivable
(1,385,998
)
 
(1,077,678
)
 
(308,320
)
Increase (decrease) in accounts payable
277,786

 
(68,557
)
 
346,343

Other
1,652,985

 
2,151,720

 
(498,735
)
Net Cash Provided by Operations
$
15,751,066

 
$
15,535,449

 
$
215,617

Investing activities are generally composed of expenditures related to investment in the Company's utility plant projects, which includes replacing aging natural gas pipe with new plastic or coated steel pipe, improvements to the LNG plant and distribution system facilities, expanding its natural gas system to meet the demands of customer growth, as well as the continued investment in the MVP. The Company completed the replacement of its bare steel and cast iron pipe during the first quarter and is now focused on continued SAVE infrastructure replacement projects including the replacement of approximately 45 miles of pre-1973 first generation plastic pipe and upgrades to three natural gas transfer stations. Total capital expenditures for additions to property during the first nine months of the year were $16.5 million, which represented a $3.9 million increase

23

RGC RESOURCES, INC. AND SUBSIDIARIES


over the same period last year. The increase is attributable to the Company's expenditures for installing an automated meter reading system ("AMR"). The AMR project, which involves the retrofitting of all customer meters with transmitters to allow consumption data to be collected remotely, is projected to be completed by the end of the current fiscal year. The AMR project does not qualify as a SAVE project subject to immediate recovery of the related investment costs and expenses; however, the Company expects future cost savings through reduced meter reading and billing costs. The combination of the AMR and SAVE related projects have resulted in a projected fiscal 2017 capital budget of more than $20 million. Operating cash flows and additional corporate borrowings are expected to provide the majority of the funding for these projects.
Investing cash flows also reflect the Company's continued funding of its participation in the MVP, with a total cash investment of $1,803,100 for the nine months ended June 30, 2017. The level of investment in the MVP has moderated pending FERC approval If approved by FERC, the Company expects to invest an estimated total of $35 million in the project. Initial funding for the investment in the LLC is provided through the Midstream credit facility, as discussed above and in Note 6 of the Condensed Consolidated Financial Statements. The Company expects that a portion of the funding will come from the issuance of its common stock. Management is currently evaluating the capital needs related to the investment in MVP as well as the funding requirements for the Company's ongoing pipeline renewal and infrastructure improvements. Based on the results of this assessment and capital market conditions, the Company plans to determine the level and timing of any equity financing.
Financing activities generally consist of long-term and line-of-credit borrowings and repayments, issuance of stock and the payment of dividends. As discussed above, the Company uses its line-of-credit arrangement to fund seasonal working capital needs as well as provide temporary financing for capital projects. Cash flows provided by financing activities were $2,610,492 for the current period compared to a use of $785,308 for the same period last year. The $3.3 million swing is attributable to the additional borrowing required to support the increased capital expenditures noted above. The primary difference in financing activities between the two periods relates to the issuance of a 5-year unsecured note in the principal amount of $7,000,000 on November 1, 2016. The proceeds from this note were used to convert a portion of the line-of-credit balance supporting Roanoke Gas' capital expenditures into a longer-term financing instrument. As a result, the line-of-credit balance increased by $2.4 million from last June while the total principal amount of long-term notes payable for Roanoke Gas increased by $7,000,000 reflecting the issuance of the new note. The remaining $1,924,000 increase in long-term notes payable is attributable to the borrowing under Midstream's credit facility to finance investment in the MVP. The Company will continue to use the line-of-credit for bridge financing for its capital expenditures and will evaluate the need and timing to convert additional portions of this debt to more permanent financing. The Company will also continue to draw against the Midstream credit facility and issue additional common stock to finance the MVP project.
On May 18, 2017, Roanoke Gas entered into an Agreement with Prudential Investment Management to issue notes in the aggregate principal amount of $8,000,000. These notes are scheduled to be issued on October 2, 2017. The notes will have a 10-year term, from the date of issue, with a 3.58% fixed rate of interest. The Company will use the proceeds from these notes to refinance a portion of its borrowings under its variable rate line-of-credit.
On March 27, 2017, Roanoke Gas entered into a new revolving line-of-credit note agreement. The new line-of-credit agreement is for a two-year term expiring March 31, 2019, replacing the prior one-year agreement that expired on March 31, 2017. As the new agreement is for a two-year term, amounts drawn against the new agreement are considered to be non-current as the balance outstanding under the line-of-credit will not be subject to repayment within the next 12-month period. Therefore, the balance sheet at June 30, 2017 reflects the line-of-credit balance as part of long-term debt while the outstanding balance of the line-of-credit at September 30, 2016 is classified as a current liability. Except for the two-year term, the new agreement maintains the same variable interest rate based on 30-day LIBOR plus 100 basis points and availability fee of 15 basis points applied to the unused balance on the note. The new agreement also maintains the multi-tiered borrowing limits to accommodate seasonal borrowing demands and minimize borrowing costs. The total available borrowing limits during the term of the new agreement range from $10,000,000 to $30,000,000. The Company anticipates being able to extend or replace the line-of-credit agreement on or prior to expiration; however, there is no guarantee that the line-of-credit agreement will be extended or replaced on terms comparable to those currently in place.
At June 30, 2017, the Company’s consolidated long-term capitalization including the line-of-credit was 53% equity and 47% debt.
 

24

RGC RESOURCES, INC. AND SUBSIDIARIES


ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks associated with interest rates and commodity prices. Interest rate risk is related to the Company’s outstanding variable rate debt including Roanoke Gas' line-of-credit and the Midstream credit facility. Commodity price risk is experienced by the Company’s regulated natural gas operations. The Company’s risk management policy, as authorized by the Company’s Board of Directors, allows management to enter into derivatives for the purpose of managing commodity and financial market risks of its business operations.
Interest Rate Risk
The Company is exposed to market risk related to changes in interest rates associated with its borrowing activities. At June 30, 2017, the Company had $10,516,426 outstanding under its variable rate line-of-credit with an average balance outstanding during the nine-month period of $10,387,806. The Company also had $7,000,000 outstanding under a 5-year variable rate term loan and $5,320,200 outstanding under a 5-year variable rate term credit facility. A hypothetical 100 basis point increase in market interest rates applicable to the Company’s variable-rate debt outstanding during the period would have resulted in an increase in interest expense for the current year of approximately $158,500. The Company's other long-term debt is at fixed rates.
Commodity Price Risk
The Company manages the price risk associated with purchases of natural gas by using a combination of liquefied natural gas (LNG) storage, underground storage gas, fixed price contracts, spot market purchases and derivative commodity instruments including futures, price caps, swaps and collars.
At June 30, 2017, the Company had no outstanding derivative instruments to hedge the price of natural gas. The Company had 1,711,610 decatherms of gas in storage, including LNG, at an average price of $3.18 per decatherm, compared to 1,552,126 decatherms at an average price of $2.77 per decatherm last year. The SCC currently allows for full recovery of prudent costs associated with natural gas purchases, as any additional costs or benefits associated with the settlement of derivative contracts and other price hedging techniques are passed through to customers when realized through the PGA mechanism.
 

25

RGC RESOURCES, INC. AND SUBSIDIARIES


ITEM 4 – CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to be effective in providing reasonable assurance that information required to be disclosed in reports under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to management to allow for timely decisions regarding required disclosure.
As of June 30, 2017, the Company completed an evaluation, under the supervision and with the participation of management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of June 30, 2017.
Management routinely reviews the Company’s internal control over financial reporting and makes changes, as necessary, to enhance the effectiveness of the internal controls over financial reporting. There were no changes in the internal controls over financial reporting during the fiscal quarter ended June 30, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 

26

RGC RESOURCES, INC. AND SUBSIDIARIES


Part II – Other Information
ITEM 1 – LEGAL PROCEEDINGS
None.
ITEM 1A – RISK FACTORS
No changes.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5 – OTHER INFORMATION
None.
ITEM 6 – EXHIBITS
 
Number
  
Description
10.1
 
Private Shelf Agreement by and between Roanoke Gas Company and Prudential Investment Management, Inc. for the pre-authorization to issue notes up to $29,500,000 in total during the term of the agreement following proper notice and compliance with the provisions of the Agreement.
10.2
 
Agreement by and between Roanoke Gas Company and Prudential Investment Management for the issuance of $8,000,000 in notes in October 2017 (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed on May 23, 2017)
31.1
 
Rule 13a–14(a)/15d–14(a) Certification of Principal Executive Officer.
31.2
 
Rule 13a–14(a)/15d–14(a) Certification of Principal Financial Officer.
32.1*
 
Section 1350 Certification of Principal Executive Officer.
32.2*
 
Section 1350 Certification of Principal Financial Officer.
101
 
The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at June 30, 2017 and September 30, 2016, (ii) Condensed Consolidated Statements of Income for the three months and six months ended June 30, 2017 and 2016; (iii) Condensed Consolidated Statements of Comprehensive Income for the three months and nine months ended June 30, 2017 and 2016; (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2017 and 2016, and (v) Condensed Notes to Condensed Consolidated Financial Statements.
 
*
These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of the Registrant, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
 

27

RGC RESOURCES, INC. AND SUBSIDIARIES


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
RGC Resources, Inc.
 
 
 
 
Date: August 4, 2017
 
 
 
By:
 
/s/ Paul W. Nester
 
 
 
 
 
 
Paul W. Nester
 
 
 
 
 
 
Vice President, Secretary, Treasurer and CFO

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