Forward-Looking Statements This report contains forward-looking statements that relate to future transactions, events or expectations. In addition, Resources may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities, operational impacts 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 2019 Annual Report on Form 10-K. All of these factors are difficult to predict and many are beyond the Company's control. Accordingly, while the Company believes its forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. When used in the Company's documents or news releases, the words, "anticipate," "believe," "intend," "plan," "estimate," "expect," "objective," "projection," "forecast," "budget," "assume," "indicate" or similar words or future or conditional verbs such as "will," "would," "should," "can," "could" or "may" are intended to identify forward-looking statements. Forward-looking statements reflect the Company's current expectations only as of the date they are made. The Company assumes no duty to update these statements should expectations change or actual results differ from current expectations except as required by applicable laws and regulations. The three-month and six-month earnings presented herein should not be considered as reflective of the Company's consolidated financial results for the fiscal year endingSeptember 30, 2020 . The total revenues and margins realized during the first six months reflect higher billings due to the weather sensitive nature of the natural gas business. COVID-19 COVID-19 has had and continues to have a significant impact on local, state, national and global economies. The actions taken by governments, as well as businesses and individuals, to limit the spread of the disease has significantly disrupted normal activities throughout the Company's service territory. Numerous businesses have either shut down or are operating on a limited basis, employees have been furloughed or laid off and social distancing has been mandated through stay-in-place orders. The Company expects these actions to have a significant impact on the Company. Reductions in business operations will result in lower demand for the commercial use of natural gas for the next quarter and likely longer. Historically, during the Company's fiscal third and fourth quarters, more than 75% of total natural gas usage is by industrial and larger commercial customers associated primarily with manufacturing activities. The Company is seeing a decline in natural gas consumption as several businesses have temporarily closed or have significantly cut back operations. Furthermore, the current economic environment will likely result in increased financial hardship for both businesses and individuals. With increased levels of unemployment, or a reduction in hours for those still fortunate to continue working, the ability of these customers to remain current on their financial obligations and expenses will become increasingly difficult. Furthermore, the SCC issued an order in March, which extends throughJune 14, 2020 , that prohibits any utility operating inVirginia from disconnecting utility service to customers for non-payment or apply late payment fees to delinquent accounts. As a result, the Company expects to see an increase in both customer delinquencies and bad debts. Due to the nature of its operations, Resources has been deemed an essential entity due to the utility services provided throughRoanoke Gas . Management has updated and implemented its pandemic plan to ensure the continuation of safe and reliable service to customers and maintain the safety of the Company's employees during COVID-19. The full extent of the impact to the Company's results of operations and financial position due to the impact of COVID-19 cannot be currently determined. Management has increased its estimate of bad debt expense in anticipation of an increase in delinquencies. Furthermore, management also expects its financial results over the remainder of the fiscal year to be below the same period last year due to the expected decline in natural gas deliveries, higher bad debt expense and other costs incurred to operate the Company in the current environment. The extent to which COVID-19 will impact the Company will depend on future developments, which are highly uncertain and cannot be reasonably predicted, including the duration of the outbreak, the increase or reduction in governmental restrictions to businesses and individuals, the potential for a resurgence of the virus and other factors. The longer COVID-19 continues, the greater the potential negative financial effect on the Company. 24
--------------------------------------------------------------------------------
Overview
Resources is an energy services company primarily engaged in the regulated sale and distribution of natural gas to approximately 62,200 residential, commercial and industrial customers inRoanoke, Virginia and surrounding localities through itsRoanoke Gas subsidiary. In addition, Resources is a more than 1% investor in the MVP through its Midstream subsidiary and provides certain unregulated services through itsRoanoke Gas subsidiary. The unregulated operations ofRoanoke Gas represent less than 2% of total revenues of Resources on an annual basis. As a public company, Resources operates under the rules and regulations promulgated by theSEC in regards to financial reporting matters. Under the prior rules of theSEC , Resources was considered a smaller reporting company and an accelerated filer under the definitions of Rule 12b-2 under the Securities Exchange Act of 1934 (the "Exchange Act"), as amended. OnMarch 12, 2020 , theSEC adopted amendments to the Exchange Act that revised the definition of an accelerated filer to exclude entities that have a public float of less than$700 million and annual revenues under$100 million . Under the revised definitions, Resources now qualifies as a smaller reporting company and non-accelerated filer. Furthermore, the non-accelerated filing status extends the deadlines forSEC filings and removes the requirement of an auditor attestation report on the Company's internal control over financial reporting in the their Form 10-K. The Company is currently assessing these changes to the reporting requirements and their potential application to Resources. 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 theDepartment of Transportation in regard to the construction, operation, maintenance, safety and integrity of its transmission and distribution pipelines.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, excluding equity in earnings of MVP, are derived from the sale and delivery of natural gas toRoanoke 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. OnOctober 10, 2018 ,Roanoke Gas filed a general rate application requesting an annual increase in customer non-gas base rates.Roanoke Gas implemented the non-gas rates contained in its rate application for natural gas service rendered to customers on or afterJanuary 1, 2019 . OnJanuary 24, 2020 , the SCC issued the final order on the general rate application, grantingRoanoke Gas an annualized increase in non-gas base rates of$7.25 million . The order also directed the Company to write-down$317,000 of ESAC assets that were not subject to recovery under the final order. InMarch 2020 , the Company refunded to its customers the excess revenues collected plus interest for the difference between the final approved rates and the interim rates billed sinceJanuary 1, 2019 . In fiscal 2019, the Company completed its transition to the 21% federal statutory income tax rate as a result of the TCJA that was signed into law inDecember 2017 . Between the enactment of the new tax rates and the Company's implementation of new non-gas rates effectiveJanuary 1, 2019 , the Company was recovering revenues based on a 34% federal income tax rate rather than a 21% federal tax rate. As a result, during this period, the Company recorded a provision for refund related to estimated excess revenues collected from customers for the difference in non-gas rates derived under the lower federal tax rate and the 34% rate in effect. Beginning inJanuary 2019 ,Roanoke Gas incorporated the effect of the 21% federal income tax rate with the implementation of new non-gas base rates, as filed in its general rate application, and began refunding the excess revenues associated with the change in the tax rate. The refund of the excess revenues related to the reduction in the federal income tax rate was completed inDecember 2019 . The Company also recorded a regulatory liability related to the excess deferred income taxes on the regulated operations ofRoanoke Gas . These excess deferred income taxes are being refunded to customers over a 28-year period. Additional information regarding the TCJA and non-gas base rate award is provided under the Regulatory and Tax Reform section below. 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 SAVE, WNA, ICC and PGA.The Company's non-gas base 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 non-gas rate application with the SCC utilizing 25
--------------------------------------------------------------------------------
historical and proforma information, including investment in natural gas facilities. Generally, investments related to extending service to new customers are recovered through the non-gas base rates currently in place, while the investment in replacing and upgrading existing infrastructure is not recoverable until a formal rate application is filed and approved. The SAVE Plan and Rider provides a mechanism through which the Company recovers on a prospective basis the related depreciation and expenses and provides a return on related qualified capital investments until such time that a formal rate application is filed. As the Company has made significant SAVE qualified expenditures since the last non-gas base rate increase in 2013, SAVE Plan revenues have continued to increase each year. With the filing of the 2018 non-gas rate application, the SAVE Rider reset effectiveJanuary 2019 as the prior revenues associated with the qualified SAVE Plan infrastructure investments were incorporated into the new non-gas rates. Accordingly, SAVE Plan revenues declined by approximately$760,000 for the six-month period endedMarch 31, 2020 compared to the same period last year; however, SAVE Plan revenues increased by approximately$267,000 for the corresponding three-month periods. 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 some 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) from 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 and six months endedMarch 31, 2020 , the Company accrued$1,651,000 and$1,817,000 in additional revenues under the WNA model for weather that was approximately 20% and 13% warmer than normal, respectively. For the corresponding periods last year, the Company accrued$46,000 in additional revenues and a$111,000 reduction in revenues for weather that was 1% warmer than normal and 1% colder than normal, respectively. The current WNA year ended onMarch 31, 2020 . The SCC approved the Company's request to delay billing customers for the WNA until later in the year in order to reduce the current financial burdens on its customers as a result of the impact from COVID-19. See Regulatory and Tax Reform section below for more information. 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. Total ICC revenues for the three and six month periods endedMarch 31, 2020 declined by approximately 8% and 12%, respectively, from the same periods last year due to a combination of lower average price of gas in storage balances and a reduction in the ICC factor used in calculating these revenues. 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 a pass-through cost and is independent of the non-gas base 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, or more frequently if necessary, the Company files a PGA rate adjustment request with the SCC to adjust the gas cost component of its tariff rates 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 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 those amounts are reflected in customer billings. Cyber Risk Cyber attacks are a constant threat to businesses and individuals. The Company remains focused on these threats and is committed to safeguarding its information technology systems. These systems contain confidential customer, vendor and employee information as well as important financial data. There is risk associated with unauthorized access of this information with a malicious intent to corrupt data, cause operational disruptions or compromise information. Management believes it has taken reasonable security measures to protect these systems from cyber attacks and similar incidents; however, there can be no guarantee that an incident will not occur. In the event of a cyber incident, the Company will execute its Security Incident Response Plan. The Company maintains cyber insurance to mitigate financial exposure that may result from a cyber incident. 26
--------------------------------------------------------------------------------
Results of Operations Three Months EndedMarch 31, 2020 : Net income increased by$1,010,226 , or 22%, for the three months endedMarch 31, 2020 , compared to the same period last year. Quarterly performance improved significantly due to the impact of the non-gas rate increase and the earnings on the MVP investment, offsetting increases in non-gas expenses. The tables below reflect operating revenues, volume activity and heating degree-days. Three Months Ended March 31, Increase / 2020 2019 (Decrease) Percentage Operating Revenues Gas Utility$ 22,275,719 $ 25,058,749 $ (2,783,030 ) (11 )% Non utility 162,012 216,210 (54,198 ) (25 )% Total Operating Revenues$ 22,437,731 $ 25,274,959 $ (2,837,228 ) (11 )% Delivered VolumesRegulated Natural Gas (DTH) Residential and Commercial 2,675,117 3,281,556 (606,439 ) (18 )% Transportation and Interruptible 917,159 799,875 117,284 15 % Total Delivered Volumes 3,592,276 4,081,431 (489,155 ) (12 )% HDD (Unofficial) 1,661 2,045 (384 ) (19 )% Total operating revenues for the three months endedMarch 31, 2020 , compared to the same period last year, declined due to a 12% reduction in total delivered volumes and a 25% reduction in the commodity price of natural gas more than offsetting the net non-gas rate increase. The average commodity price of natural gas for the current quarter was$2.30 per decatherm compared to$3.06 per decatherm for the same period last year. Natural gas prices are expected to remain at these lower prices due to abundant supplies and depressed demand as a result of the effects of COVID-19. Furthermore, total residential and commercial volumes declined by 18% due to the current quarter having 19% fewer heating degree days than for the same period last year. Transportation and interruptible volumes increased by 15% primarily related to one multi-fuel use industrial customer, which has significantly increased the use of natural gas during the current fiscal year. The Company placed new non-gas base rates into effect for natural gas service rendered on or afterJanuary 1, 2019 , subject to refund. The initial rates implemented in the prior year allocated approximately 80% of the rate increase to the customer base charge and approximately 20% to volumetric revenues. Based on subsequent discussions with the SCC, and ultimately included in the final rate order, the approved increase in non-gas rates were allocated approximately 20% to the customer base charge and 80% to volumetric revenues. As a result, the current quarter reflects a much larger volumetric revenue component and margin per decatherm as compared to the prior year, while customer base charge reflects an overall decrease in comparison. SAVE Plan revenues increased by$266,974 as the rates for the SAVE plan reset effectiveJanuary 1, 2019 . Non-utility revenue declined due to lower demand for services during the quarter. The Company's operations are affected by the cost of natural gas, as reflected in the condensed consolidated income statements under the line item cost of gas - utility. The cost of natural gas is passed through to customers at cost, which includes commodity price, transportation, storage, injection and withdrawal fees with any increase or decrease offset by a correlating change in revenue through the PGA. Accordingly, management believes that gross utility margin, a non-GAAP financial measure defined as utility revenues less cost of gas, is a more useful and relevant measure to analyze financial performance. The term gross utility margin is not intended to represent operating income, the most comparable GAAP financial measure, as an indicator of operating performance and is not necessarily comparable to similarly titled measures reported by other companies. Therefore, the following discussion of financial performance will reference gross utility margin as part of the analysis of the results of operations. 27
--------------------------------------------------------------------------------
Three Months Ended March 31, Increase / 2020 2019 (Decrease) Percentage Gross Utility Margin Gas Utilities Revenue$ 22,275,719 $
25,058,749
Cost of Gas - Utility 8,672,997
12,771,338 (4,098,341 ) (32 )%
Gross Utility Margin$ 13,602,722 $
12,287,411
Gross utility margins increased from the same period last year primarily as a result of the revised allocation of the non-gas rate increase, an adjustment to the WNA pricing model and increases in SAVE Plan revenues. As discussed above, the rate design in the final order resulted in an even greater level of earnings during the weather sensitive heating season due to the increased allocation to the weather sensitive component of non-gas rates and lower earnings in the non-heating season due to lower fixed rate revenues. The current quarter reflects the revenues and margin as approved in the final rate order; however, the quarter endedMarch 31, 2019 reflected the higher allocation to customer base charge. Furthermore, the WNA revenue model, which adjusts the Company's natural gas margin for the variance in weather from normal temperatures, was adjusted by approximately$204,000 during the quarter to reflect the higher allocation of the non-gas rates to the volumetric component for the current WNA year resulting in an increase in the corresponding WNA revenues. SAVE Plan margin increased by$266,974 as the level of qualified SAVE infrastructure investment continues to increase since the reset of the SAVE Plan. COVID-19 had only a minimal impact on the Company's natural gas deliveries during the 2020 second fiscal quarter; however, reductions in sales volumes are expected in future periods. The components of and the change in gas utility margin are summarized below: Three Months Ended March 31, 2020 2019 Increase / (Decrease) Customer Base Charge$ 3,610,679 $ 4,331,767 $ (721,088 ) Carrying Cost 85,134 92,932 (7,798 ) SAVE Plan 289,999 23,025 266,974 Volumetric 7,934,022 7,777,889 156,133 WNA 1,650,558 46,412 1,604,146 Other Gas Revenues 32,330 15,386 16,944 Total$ 13,602,722 $ 12,287,411 $ 1,315,311 Operations and maintenance expenses increased by$396,065 , or 11%, from the same period last year due to higher compensation costs, bad debt expense and professional services. Compensation costs increased by$203,000 primarily due to the vesting of officer restricted stock awards during the quarter. As discussed in the Regulatory and Tax Reform section below, the Company increased its provision for bad debt expense by$83,000 over last year even though gross billings for the quarter declined by 33% due to reductions in natural gas deliveries and the completion of the non-gas rate refund during March. Estimated bad debt reserves increased in anticipation of rising delinquencies on current customer balances and ultimately higher bad debt expense due to customers inability to meet their financial obligations as a result of current economic conditions and government restrictions related to COVID-19. Professional services increased by$64,000 due to a variety of factors including additional regulatory support regarding the non-gas rate increase, network systems support, consulting services on benefit plans and support on project evaluations. The remaining$46,000 relates to a variety of other net increases in expense. General taxes increased by$31,537 , or 6%, associated with higher property and payroll taxes. Property taxes continue to increase corresponding to higher utility property balances related to ongoing infrastructure replacement, system reinforcements and customer growth. Depreciation expense increased by$82,741 , or 4%, on an increase in utility plant investment. Equity in earnings of unconsolidated affiliate increased by$490,418 , or 70%, as the investment in MVP continues to increase. Other income, net increased by$196,183 primarily due to$163,000 in AFUDC related to two natural gas transfer stations that will interconnect with the MVP and a$25,000 increase in the non-service components of net periodic benefit costs. In the final order on the Company's non-gas rate increase, the SCC allowedRoanoke Gas to defer financing costs of these infrastructure 28
--------------------------------------------------------------------------------
projects for potential recovery in future rate proceedings instead of providing a return on the investment under the non-gas rates approved in the final order. The Company recorded the AFUDC based on activity retro-active toJanuary 1, 2019 , the effective date of the new non-gas rates. Interest expense increased by$145,644 , or 16%, due to a 34% increase in total average debt outstanding between quarters. The higher borrowing levels derived from the ongoing investment in MVP and financing expenditures in support ofRoanoke Gas' capital budget, partially offset by a 12% reduction in the weighted average interest rate and capitalization of the interest component of AFUDC related to the two interconnect stations with the MVP.Roanoke Gas interest expense increased by$76,487 as total average debt outstanding increased by$8,500,000 associated with the issuance of two separate debt issuances offset by reductions in the line-of-credit balances. The average interest rate increased from 3.78% to 3.86% between periods. In addition,Roanoke Gas reduced interest expense related to the capitalization of$54,000 for the interest portion of AFUDC. The equity component of AFUDC is included in other income, net. Midstream interest expense increased by$69,157 as total average debt outstanding increased by$14,700,000 associated with cash investments in the MVP. The average interest rate decreased from 3.80% to 3.09% due to the decline in the variable interest rate on Midstream's credit facility and the entry into two separate notes with swap rates at 3.24% and 3.14%. Income tax expense increased by$326,864 corresponding to an increase in taxable income. The effective tax rate was 23.9% and 23.8% for the three month periods endedMarch 31, 2020 and 2019, respectively. Both periods included the amortization of excess deferred taxes. Six Months EndedMarch 31, 2020 : Net income increased by$2,583,000 , or 36%, for the six months endedMarch 31, 2020 , compared to the same period last year due to the impact of the non-gas rate increase and the earnings on the MVP investment, more than offsetting increases in non-gas expenses. The tables below reflect operating revenues, volume activity and heating degree-days. Six Months Ended March 31, Increase / 2020 2019 (Decrease) Percentage Operating Revenues Gas Utilities$ 41,901,325 $ 46,095,330 $ (4,194,005 ) (9 )% Other 321,859 396,376 (74,517 ) (19 )% Total Operating Revenues$ 42,223,184 $ 46,491,706 $ (4,268,522 ) (9 )% Delivered VolumesRegulated Natural Gas (DTH) Residential and Commercial 4,924,373 5,647,630 (723,257 ) (13 )% Transportation and Interruptible 1,786,741 1,549,940 236,801 15 % Total Delivered Volumes 6,711,114 7,197,570 (486,456 ) (7 )% HDD (Unofficial) 3,101 3,605 (504 ) (14 )% Operating revenues for the six months endedMarch 31, 2020 declined from the same period last year due to a 7% reduction in total delivered volumes, lower natural gas commodity prices and reduced SAVE Plan revenue more than offsetting the increase in non-gas rates. The weather sensitive residential and commercial natural gas deliveries declined by 13% corresponding to a 14% decline in the number of heating degree days during the period. Transportation and industrial volumes increased 15% primarily related to one multi-fuel use industrial customer significantly increasing the use of natural gas in its production activities during the period. The extent or expected duration of the increased natural gas consumption by this customer is not currently known and could revert to lower usage patterns in the future. The average commodity price of natural gas delivered for the first six months of fiscal 2020 was approximately 30% per decatherm lower than the same period last year due to available supplies and higher storage levels from a mild winter. SAVE Plan revenues declined by$760,000 as the SAVE Rider reset effectiveJanuary 1, 2019 , and all qualifying SAVE Plan investments were included in rate base used to derive the new non-gas base rates. The fiscal 2019 SAVE Plan revenues represented an accumulation of 5 years of SAVE investment for the first three months of the period. As noted above, the Company placed into effect new interim non-gas base rates onJanuary 1, 2019 . Revenues for the current fiscal year reflect the non-gas rate increase for the entire period, while the estimated non-gas 29
--------------------------------------------------------------------------------
rate increase was reflected in prior year revenues beginningJanuary 1, 2019 . Furthermore, the current year non-gas revenues reflect the findings in the final order specifying that approximately 80% of the non-gas rate increase be reflected in the volumetric portion of rates, while the original rate application reflected non-gas rates that allocated approximately 80% of the non-gas rate increase to customer base charge revenues. Non-utility revenue declined due to lower demand for services during the quarter. Six Months Ended March 31, Increase / 2020 2019 (Decrease) Percentage Gross Utility Margin Gas Utilities Revenue$ 41,901,325 $ 46,095,330
Cost of Gas - Utility 16,850,803 24,677,797
(7,826,994 ) (32 )%
Gross Utility Margin$ 25,050,522 $ 21,417,533
Gross utility margins increased from the same period last year primarily as a result of the implementation of higher non-gas base rates and an adjustment to the WNA pricing model, partially offset by a reduction in SAVE revenues. Customer base charge revenues declined by$258,334 , while volumetric and WNA margin increased by$4,128,715 as a result of the non-gas base rate increase and the re-allocation of the increase from mostly customer base charge to volumetric margin. SAVE Plan revenues declined by$759,925 as all related SAVE investments were incorporated into the new non-gas base rates effectiveJanuary 1, 2019 . WNA margin increased by$1,928,077 as weather moved from colder than normal in the prior year to 13% warmer than normal during the current period In addition, the WNA model was adjusted by$204,000 to reflect the revisions to the non-gas volumetric rates during the WNA year. The prior year included a reserve for excess revenues attributable to the reduction in income tax rates. The current year has no such adjustment as the new non-gas rates incorporate the effect of lower federal income tax rates. The components of and the change in gas utility margin are summarized below: Six Months Ended March 31, 2020 2019 Increase / (Decrease) Customer Base Charge$ 7,191,428 $ 7,449,762 $ (258,334 ) Carrying Cost 241,041 274,567 (33,526 ) SAVE Plan 470,612 1,230,537 (759,925 ) Volumetric 15,237,865 13,037,227 2,200,638 WNA 1,817,155 (110,922 ) 1,928,077 Other Gas Revenues 92,421 60,243 32,178 Excess Revenue Refund - (523,881 ) 523,881 Total$ 25,050,522 $ 21,417,533 $ 3,632,989 Operations and maintenance expenses increased by$791,536 , or 11%, from the same period last year related to the write-off of a portion of the ESAC regulatory assets, amortization of the remaining regulatory assets, and increases in compensation costs, cost of professional services, bad debt expense and corporate insurance, partially offset by higher capitalized overheads. Beginning inJanuary 2019 , concurrent with the implementation of new non-gas rates, the Company began amortizing certain regulatory assets for which recovery was included in the rate application. Total amortization of regulatory assets increased by$129,000 . The final order on the Company's non-gas rate increase directed the Company to write-down$317,000 of ESAC assets that were not subject to recovery. Compensation costs increased by$214,000 primarily related to the vesting of officer restricted stock awards. Professional services increased by$123,000 due to a variety of factors including legal assistance in the non-gas rate application, network systems support, benefit plan consulting and project support activities. Bad debt expense increased by$77,000 related to COVID-19. Corporate insurance expense increased by$78,000 due to higher premiums related to increased liability limits. Capitalized overheads increased by$113,000 primarily due to timing of LNG production related to facility upgrades at the plant during the summer. The remaining difference relates to a variety of small increases and decreases in expenses. General taxes increased by$66,885 , or 6%, primarily associated with higher property taxes on corresponding increases in utility property balances related to ongoing investment in the natural gas distribution facilities. 30
--------------------------------------------------------------------------------
Depreciation expense increased by$165,771 , or 4%, on an increase in utility property balances. Equity in earnings of unconsolidated affiliate increased by$1,021,455 , or 81%, as a result of AFUDC related to the increased construction activity in the MVP investment. Other income, net increased by$227,940 , or 92%, primarily due to the$163,000 in AFUDC income related to the twoRoanoke Gas transfer stations that will interconnect with the MVP and the non-service components of net periodic benefit costs. Interest expense increased by$414,047 , or 24%, due to a 30% increase in total average debt outstanding for the periods related to the ongoing investment inMVP and Roanoke Gas' infrastructure, partially offset by a reduction in the weighted average interest rate during the period.Roanoke Gas interest expense increased by$219,101 as total average debt outstanding increased by$9,000,000 associated with two separate debt issuances offset by reductions in the line-of-credit balances. The average interest rate increased from 3.73% to 3.79% between periods. Midstream interest expense increased by$194,946 as total average debt outstanding increased by$16,600,000 associated with its investment in the MVP. The average interest rate decreased from 3.71% to 3.13% due to the decline in the variable interest rate on Midstream's credit facility and the entry into two separate notes with swap rates at 3.24% and 3.14%. Income tax expense increased by$866,238 , or 40%, on a corresponding increase in taxable income. The effective tax rate was 23.8% and 23.3% for the six month periods endedMarch 31, 2020 and 2019, respectively. Critical Accounting Policies and Estimates The consolidated financial statements of Resources are prepared in accordance with accounting principles generally accepted inthe United States of America . The amounts of assets, liabilities, revenues and expenses reported in the Company's consolidated 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 either quantitatively or qualitatively material to the financial statements and requires assumptions to be made that were uncertain at the time the estimate was derived and changes in the estimate are reasonably likely to occur from period to period. The Company increased it provision for bad debts in anticipation of the economic fallout expected from COVID-19. The anticipated impact on customers from the virus and governmental restrictions combined with the SCC orders prohibiting customer disconnection of utility service will likely result in rising customer delinquencies and higher bad debt expense in the future. The Company's estimated reserve for bad debts is based on historical activity as well as evaluating the limited information currently available. Management will continue to evaluate collectability of its receivables and revise its estimate of bad debts as more information becomes available. The Company adopted 2016-02, Leases, and subsequent guidance and amendments effectiveOctober 1, 2019 . The adoption of the ASU did not have a significant effect on the Company's results of operations, financial position or cash flows as the Company has only one lease, and management determined that the value of the lease obligation was de minimis. The Company does have easements for rights-of-way for its distribution system; however, all related costs associated with these have been paid in advance with no remaining obligation. There have been no other changes to the critical accounting policies as reflected in the Company's Annual Report on Form 10-K for the year endedSeptember 30, 2019 . Asset ManagementRoanoke 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 paysRoanoke Gas a monthly utilization fee. In accordance with an SCC order issued in 2018, a portion of the utilization fee is retained by the Company with the balance passed through to customers through reduced gas costs.
OnOctober 1, 2015 , Midstream entered into an agreement to become a 1% member in the LLC. The purpose of the LLC is to construct and operate the MVP, aFERC -regulated natural gas pipeline connecting Equitran's gathering and transmission system in northernWest Virginia to theTransco interstate pipeline in south centralVirginia . 31
--------------------------------------------------------------------------------
OnNovember 19, 2019 , the Company's Board of Directors approved a pro-rata increase in its participation in MVP, which will result in an estimated additional cash investment of$1.8 million above the current$53 to$55 million estimate. As a result of this increased participation, Midstream's equity interest will increase to approximately 1.03% by the time the pipeline is placed in service. Management believes the investment in the LLC will be beneficial for the Company, its shareholders and southwestVirginia . In addition to Midstream's potential returns from its investment in the LLC,Roanoke Gas will benefit from this additional delivery source. Currently,Roanoke Gas is served by two pipelines and an LNG peak-shaving 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. This additional capacity would reduce the impact from such an event as well as allow the Company to better meet both current and future demands for natural gas. In addition, the proposed pipeline path would provide the Company with a more economically feasible opportunity to provide natural gas service to currently unserved areas within its certificated service territory. The MVP project is currently 90% complete. Activity on the MVP has been limited this year to maintaining the infrastructure currently in place and restoration activities. The LLC is actively working with the respective regulatory bodies on the reissuance of water crossing permits that were rescinded by the Fourth Circuit as well as the permit to cross a section of theJefferson National Forest . Until such time as approval is granted, activity on the pipeline will be limited as most of the pipeline work not encompassed in the revoked permits has been completed. Assuming timely resolution of the permit issues above and no extended restrictions on construction activities due to COVID-19, the LLC projects an in-service date for the MVP in late calendar year 2020. The delays in completing the project combined with the increased costs will reduce the corresponding return on investment, absent a regulatory action that could provide for the recovery of these higher costs by MVP. Midstream entered into the Third Amendment to Credit Agreement and amended the corresponding associated notes to increase the borrowing capacity under the credit facility from$26 million to$41 million and extend the maturity date toDecember 29, 2022 . Under the amended agreement and notes, Midstream should have the needed financing to meet its funding requirements in the MVP. If the rescinded permits are not re-issued and approved in a reasonable time period and/or restrictions imposed by the government related to COVID-19 continue for an extended period, both the cost of the MVP and Midstream's capital contributions will increase above current estimates and the in-service date will likely be extended beyond 2020. The current earnings from the MVP investment are attributable to AFUDC income generated by the deployment of capital in the design, engineering, materials procurement, project management and 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 MVP, as well as the AFUDC, will continue to grow as construction activities continue. When the pipeline is completed and placed into service, AFUDC will cease. Once operational, earnings will be derived from capacity charges for utilizing the pipeline. Continued delays in the project could ultimately result in future earnings from the operation of the pipeline to be below the level of AFUDC recognized. In 2018, Midstream became a participant in Southgate, a project to construct a 74-mile pipeline extending from the MVP mainline at theTransco interconnect inVirginia to delivery points inNorth Carolina . Midstream is a less than 1% investor in the Southgate project and, based on current estimates, will invest approximately$2.5 million in Southgate. Midstream's participation in the Southgate project is for investment purposes only. The Southgate in-service date is currently targeted for 2021.
Regulatory and Tax Reform
OnOctober 10, 2018 ,Roanoke Gas filed a general rate case application requesting an annual increase in customer non-gas base rates. This application incorporated into the non-gas base rates the impact of tax reform, non-SAVE utility plant investment, increased operating costs, recovery of regulatory assets, including all deferred ESAC related costs, and SAVE Plan investments and related costs previously recovered through the SAVE Rider. Approximately$4.7 million of the rate increase was attributable to moving the SAVE Plan related revenues into non-gas base rates. The new non-gas base rates were placed into effect for gas service rendered on or afterJanuary 1, 2019 , subject to refund, pending audit by SCC staff, hearing and final order by the SCC.
Following the completion of the SCC staff audit and the issuance of the hearing
examiner's report, the SCC issued their final order. The SCC order awarded
32
--------------------------------------------------------------------------------
the increase allocated to the volumetric component of rates. The non-gas rate award provided for a 9.44% return on equity but excluded from recovery, at the current time, a return on the investment of two interconnect stations with the MVP. In addition, the final order directed the Company to write-off a portion of ESAC assets that were excluded from recovery under the rate award. As a result, the Company expensed an additional$317,000 of ESAC assets above the normal amortization amount. Management submitted its rate design to reflect the increase of$7.25 million in non-gas rates, which was approved by the SCC at the end ofJanuary 2020 . The Company completed the rate refund duringMarch 2020 by applying a total of$3.8 million in refunds plus interest to the accounts of active customers and mailing checks to former customers. As noted above, the SCC order excluded a return on investment of the two interconnect stations currently under construction that will link the MVP pipeline with the Company's distribution system. However, the order did provide for the ability to defer financing costs of these investments for future recovery, which was done through the application of an AFUDC calculation to capitalize both the equity and debt financing costs during the construction phases. Prior to recording the adjustment, the Company conferred with the SCC regarding the proposed treatment and the calculation of the AFUDC. The specific time period allowed for the recovery of these costs has yet to be determined; therefore, the Company has taken a conservative position and has reflected only the amount of AFUDC sinceJanuary 1, 2019 , the date in which the rate award was effective. If the SCC concludes that the AFUDC applies to an earlier period, the Company will reflect any additional AFUDC at that time. The condensed consolidated financial statements for the current quarter include$217,000 in AFUDC income with$163,000 reflected in other income and$54,000 as an offset to interest expense. OnMarch 16, 2020 , in response to COVID-19, the SCC issued an order applicable to all utilities operating inVirginia to suspend disconnection of service to all customers untilMay 15, 2020 , which was subsequently extended toJune 14, 2020 . This order was effective on issuance and also directed utilities to not assess late payment fees due to the coronavirus public health emergency. Under this order, the Company is unable to disconnect any customer for non-payment of their natural gas service. As a result of COVID-19, management expects to experience an increase in bad debts due to business closings and higher unemployment; however, the prohibition to disconnect service to any customer for a period of 90 days will allow the level of bad debts to increase above the previously expected higher levels. Customers that were not able to pay their bills will now have the potential to owe the Company for an additional three months of service. The Company has increased its provision for bad debts as ofMarch 31, 2020 ; however, the potential magnitude of the combined impact from the economy and this order on bad debts is unknown at this time. The Company supports the decision to suspend service disconnections in light of the current economic situation and will work with its customers in making arrangements to keep or bring their accounts current. OnApril 29, 2020 , the SCC issued an order permitting regulated utilities inVirginia to defer certain incremental prudently incurred costs associated with the COVID-19 pandemic. Management is currently evaluating this order and the potential application to the Company. For the WNA year endedMarch 31, 2020 , the Company accrued at total of$2,387,000 of which$1,817,000 was attributable to the current fiscal year. According to the provisions of the Company's WNA rate schedule, the Company submits its annual filing to the SCC for approval of rates to collect any revenue shortfall or refund any excess revenues, which must then be reflected in customers bills between the months of May and August. However, due to the current issues related to COVID-19, management submitted a request to the SCC to delay the customer billing related to the WNA revenues. The Company believes that it is in the best interest of its customers to delay billing at this time for the additional revenues attributable to the warmer weather. OnApril 14, 2020 , the SCC issued an order granting the Company a waiver of the terms under the WNA rate schedule. The order did not specify when such customer billings will begin; however, the manner and timing of such billings will be determined in consultation with the SCC staff. The general rate case application incorporated the effects of tax reform, which reduced the federal tax rate for the Company from 34% to 21%.Roanoke Gas recorded two regulatory liabilities to account for this change in the federal tax rate. The first regulatory liability related to the excess deferred taxes associated with the regulated operations ofRoanoke Gas . AsRoanoke Gas had a net deferred tax liability, the reduction in the federal tax rate required the revaluation of these excess deferred income taxes to the 21% rate at which the deferred taxes are expected to reverse. The excess net deferred tax liability forRoanoke Gas' regulated operations was transferred to a regulatory liability, while the revaluation of excess deferred taxes on the unregulated operations of the Company were flowed into income tax expense in the first quarter of fiscal 2018. A majority of the regulatory liability for excess deferred taxes was attributable to accelerated tax depreciation related to utility property. In order to comply with theIRS normalization rules, these excess deferred income taxes must be flowed back to customers and through tax expense based on the average remaining life of the corresponding assets, which approximates 28 years. The corresponding balances related to the excess deferred taxes are included in the regulatory liability schedule in Note 14 of the condensed consolidated financial statements. The second regulatory liability relates to the excess revenues collected from customers. The non-gas base rates used since the passage of the TCJA inDecember 2017 throughDecember 2018 were derived from a 34% federal tax rate. As a result, the 33
--------------------------------------------------------------------------------
Company over-recovered from its customers the difference between the federal tax rate at 34% and the 24.3% blended rate in fiscal 2018 and 21% in fiscal 2019. To comply with an SCC directive issued inJanuary 2018 ,Roanoke Gas recorded a refund for the excess revenues collected in fiscal 2018 and the first quarter of fiscal 2019. Starting with the implementation of the new non-gas base rates inJanuary 2019 ,Roanoke Gas began returning the excess revenues to customers over a 12-month period. The refund of the excess revenues was completed inDecember 2019 . The Company continues to recover the costs of its infrastructure replacement program through its SAVE Plan. The original SAVE Plan was designed to facilitate the accelerated replacement of aging natural gas pipe by providing a mechanism for the Company to recover the related depreciation and expenses including a return on qualifying capital investment without the filing of a non-gas base rate application. Since the implementation and approval of the original SAVE Plan in 2012, the Company has modified, amended or updated it each year to incorporate various qualifying projects. InMay 2019 , the Company filed its most recent SAVE Plan and Rider, which continues the focus on the ongoing replacement of pre-1973 plastic pipe and the replacement of a natural gas transfer station. InSeptember 2019 , the SCC approved the updated SAVE Plan and Rider effective with theOctober 2019 billing cycle. The new SAVE Rider is designed to collect approximately$1.1 million in annual revenues, an increase from the approximate$500,000 in annual revenues under the prior SAVE rates. With the inclusion of all previous SAVE investment throughDecember 31, 2018 into the rate application, the current SAVE Plan Rider reflects only the recovery of qualifying SAVE Plan investments made since the beginning ofJanuary 2019 . In addition, the SAVE application includes a refund factor to return approximately$543,000 in SAVE revenue over-collections from 2018, primarily resulting from the effect of the reduction in the federal income tax rate. 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 equity capital. Cash and cash equivalents increased by$2,172,880 and$1,720,152 for the six-month periods endedMarch 31, 2020 and 2019, respectively. The following table summarizes the sources and uses of cash: Six Months EndedMarch 31, 2020 2019
Cash Flow Summary
Net cash provided by operating activities
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 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 from operating activities for the six months endedMarch 31, 2020 increased by$235,008 over the same period in the prior year. The increase in cash flow provided by operations was primarily driven by higher net income, depreciation, reductions in natural gas storage inventory, and increases in accounts receivable, net changes in regulatory assets and liabilities. Net income and accounts receivable primarily contributed to the increase in cash flows provided by operating activities. Net income, net of equity in earnings and AFUDC, and depreciation contributed more than$1.3 million in cash as compared to the same period last year. This increase was primarily driven by theJanuary 2019 implementation of the increase in non-gas base rates, as adjusted inJanuary 2020 per the SCC's final order. Due to a much warmer heating season, delivered volumes for the six-month period endingMarch 31, 2020 were 7% lower than the same period last year. Low commodity prices, combined with lower delivered volumes, resulted in a much smaller increase in accounts receivable balances in the first half of fiscal 2020 compared to the same six month period of fiscal 2019, thereby improving cash flows by$6.3 million . 34
--------------------------------------------------------------------------------
The aforementioned contributions to cash flows provided by operating activities were offset by cash used primarily byRoanoke Gas' rate refund, and WNA and PGA mechanisms. Though the SCC issued its final order inJanuary 2020 ,Roanoke Gas implemented interim billing rates inJanuary 2019 ; therefore, the Company began accruing an estimated rate refund representing the amount due customers for the difference between total customer billings at interim rates versus total customer billings at final rates. Upon SCC approval of final rates,Roanoke Gas issued refunds inMarch 2020 to all customers that were billed at interim rates sinceJanuary 2019 . When compared to the six-month period endingMarch 31, 2019 , the distribution of the rate refund to customers reduced cash available for operations by$4.9 million , which also resulted in a corresponding reduction in accounts receivable. The WNA mechanism contributed to a decrease in cash of approximately$1.7 million when compared to the same six-month period in the prior year. The related receivable increased significantly as the WNA year endedMarch 31, 2020 was 17% warmer than normal, compared to the 1% warmer weather experienced during the WNA year endedMarch 31, 2019 . Continued lower commodity prices combined with a decrease in delivered volumes, attributable to warmer weather, resulted inRoanoke Gas' PGA being in an over-collected position at bothMarch 31, 2020 and 2019. The cash provided by the over-collection for the six-months endedMarch 31, 2020 lagged the cash provided over the same period in the prior year, thereby reducing operating cash by approximately$1.5 million . A summary of the cash provided by operations is provided below:
© Edgar Online, source