RGC Resources, Inc. — Form 10-Q Summary
Business Context and Reporting Period
RGC Resources is an energy services company primarily engaged in the regulated sale and distribution of natural gas through Roanoke Gas Company in and around Roanoke, Virginia. The filing covers the quarter and six months ended March 31, 2017, corresponding to the company’s fiscal second quarter. Operations are highly seasonal and weather-sensitive; winter periods generally produce greater earnings.
More than 98% of annual revenue is derived from regulated natural gas sales and delivery to approximately 60,800 residential, commercial, and industrial customers. Rates and recovery mechanisms are overseen by the Virginia State Corporation Commission.
Financial Performance and Key Metrics
| Metric | Three Months Ended March 31, 2017 | Three Months Ended March 31, 2016 | Six Months Ended March 31, 2017 | Six Months Ended March 31, 2016 |
|---|---|---|---|---|
| Total operating revenue | $21.9 million | $21.8 million | $40.7 million | $37.8 million |
| Gross margin | $10.8 million | $10.6 million | $20.2 million | $19.4 million |
| Operating income | $5.6 million | $5.4 million | $9.6 million | $8.9 million |
| Net income | $3.2 million | $3.1 million | $5.5 million | $5.0 million |
| Diluted EPS | $0.45 | $0.44 | $0.76 | $0.71 |
| Dividends declared per share | $0.1450 | $0.1350 | $0.2900 | $0.2700 |
- Quarterly revenue increased 1%, gross margin increased 2%, operating income increased 3%, and net income increased $113,752, or 4%.
- Six-month revenue increased 8%, gross margin increased 4%, operating income increased 7%, and net income increased $423,180, or 8%.
- Approximate gross margin was 49.5% for the quarter and 49.7% for the six-month period, compared with 48.9% and 51.3%, respectively, in the prior comparable periods.
- Approximate operating margin was 25.5% for the quarter and 23.5% year to date, compared with 25.0% and 23.7%, respectively, in the prior periods.
- Approximate net margin was 14.7% for the quarter and 13.4% year to date, compared with 14.3% and 13.3%, respectively.
- Heating degree days declined 19% for the quarter and 6% year to date. Total delivered gas volumes declined 14% for the quarter and 3% year to date.
- Warmer weather reduced volumetric margin, but the weather normalization adjustment generated approximately $982,000 of additional revenue and margin in the quarter and $1.605 million year to date.
- SAVE Plan revenue increased to approximately $922,000 in the quarter and $1.803 million year to date, compared with approximately $576,000 and $1.037 million, respectively, in the prior periods.
Cash Flow, Capital Spending, Debt, and Liquidity
| Six-Month Cash Flow | 2017 | 2016 |
|---|---|---|
| Cash provided by operating activities | $11.6 million | $10.9 million |
| Cash used in investing activities | $(12.3) million | $(9.8) million |
| Cash provided by/(used in) financing activities | $0.6 million | $(1.4) million |
| Decrease in cash | $(0.1) million | $(0.3) million |
- Cash and cash equivalents were $546,101 at March 31, 2017, compared with $643,252 at September 30, 2016.
- Capital expenditures for utility plant and nonutility property were $11.4 million year to date, up from $8.2 million. The company expects fiscal 2017 capital spending to exceed $20 million, primarily for SAVE infrastructure projects and automated meter reading deployment.
- Total long-term debt, net of issuance costs, was $50.1 million at March 31, 2017, compared with $33.6 million at September 30, 2016. Debt included $41.9 million of notes payable and $8.5 million drawn under a revolving line of credit.
- The new revolving credit agreement expires March 31, 2019 and provides borrowing capacity ranging from $10 million to $30 million. Borrowings bear interest at 30-day LIBOR plus 1.00%.
- At March 31, 2017, consolidated capitalization was 54% equity and 46% debt.
- Management expects operating cash flow and additional corporate borrowings to fund most capital requirements. The company also uses debt and equity issuances to support seasonal working capital, natural gas inventories, infrastructure investment, the Mountain Valley Pipeline investment, and dividends.
Material Changes, Outlook, Risks, and Unusual Items
- The board approved a three-for-two stock split effective March 1, 2017. Historical share and per-share data were restated retrospectively.
- The company issued a $7.0 million five-year unsecured term note in November 2016 and increased borrowing under its Mountain Valley Pipeline financing facility.
- The company owns a 1% interest in Mountain Valley Pipeline, LLC. Its investment was approximately $5.2 million at March 31, 2017, with an estimated total commitment of approximately $35 million. A capital contribution payable of $883,065 was recorded.
- Mountain Valley Pipeline approval remained subject to FERC review. The company expected a final environmental impact statement in June 2017, construction to begin later in 2017 if approved, and targeted pipeline service by the end of calendar 2018.
- The SCC extended the SAVE Plan through 2021 and approved additional infrastructure projects. Management reported a 2017 SAVE revenue requirement of approximately $4.0 million and was preparing its 2018 filing.
- The automated meter reading project was expected to be completed by the end of fiscal 2017. The project does not qualify for immediate SAVE recovery but is expected to generate future operating cost savings.
- Interest expense increased 13% year over year for both the quarter and six-month period due to higher average debt, although the weighted average effective interest rate declined.
- A 100-basis-point increase in applicable variable interest rates would have increased current-period interest expense by approximately $108,676.
- The company had no outstanding natural gas price derivatives at March 31, 2017. It had an interest rate swap with a recorded fair value of $158,988; the swap is intended to convert the $7.0 million term note to a 2.30% fixed rate beginning November 1, 2017.
- Key operating risks include warmer-than-normal weather, natural gas commodity prices, interest rates, reliance on two primary pipeline supply sources, regulatory decisions, FERC approval and construction of Mountain Valley Pipeline, and the ability to renew or replace credit facilities on comparable terms.
- The current asset management agreement expires in March 2018; management expects to negotiate a replacement agreement before expiration.
- Management stated that the financial results for the first six months are not indicative of full-year results because of seasonality and weather variability.
- The company disclosed no legal proceedings, defaults, or changes to its previously reported risk factors. Disclosure controls were considered effective as of March 31, 2017.
- Management expects the future adoption of the revenue recognition and lease standards not to have a material effect on the financial statements, although revenue-related disclosures could be significant. Management expects the retirement-benefits presentation standard to have a material effect when adopted.
Investor Verification Checklist
- Verify the sustainability of earnings growth excluding weather normalization, SAVE Plan revenue, and other regulatory recovery mechanisms.
- Assess whether projected fiscal 2017 capital spending above $20 million can be funded without materially increasing leverage or dividend risk.
- Monitor Mountain Valley Pipeline FERC approval, construction timing, total project cost, and the company’s remaining approximately $35 million investment obligation.
- Review exposure to variable interest rates, credit facility renewal risk, and debt covenant compliance.
- Evaluate the replacement of the asset management agreement expiring in March 2018.
- Confirm the effect of warmer weather, natural gas prices, storage balances, and PGA/WNA mechanisms on future margins and cash flow.
- Track the regulatory treatment and financial impact of the SAVE Plan, automated meter reading investment, and future accounting standards.