RGC RESOURCES, INC. 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 and Item 1A of this report. 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 endingSeptember 30, 2020 . The total revenues and margins realized during the first nine 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. WhileVirginia is now in Phase 3 of its reopening plan, several of the Company's commercial customers are still temporarily closed and/or have significantly reduced operations. Accordingly, we believe the economic impact of actions taken to limit the spread of the virus will last at least through calendar year end 2020. The Company has seen a decline in natural gas consumption in most categories of its commercial customers; however, other commercial customers have increased gas consumption as a result of specialized business models, more than offsetting the other declines. The Company's volume of gas delivered to residential customers has remained relatively consistent with the prior year. The SCC issued an order inMarch 2020 , which has subsequently been extended toAugust 31, 2020 , that prohibits any utility operating inVirginia from disconnecting utility service to customers for non-payment or applying late payment fees to delinquent accounts. As a result, the Company expects an increase in both customer delinquencies and bad debts. Additionally, inApril 2020 , the SCC issued an order granting potential relief from bad debts and other incremental expenses, directly related to the pandemic. While the Company is tracking these costs and will file for relief with the SCC as appropriate, the full extent of these costs and the impact to the Company's results of operations and financial position remains unpredictable. The full extent to which COVID-19 will impact the Company depends on future developments, which are highly uncertain and cannot be reasonably predicted, including the duration, scope and severity of the pandemic, the increase or reduction in governmental restrictions to businesses and individuals, or the potential for a resurgence of the virus among other factors. The longer COVID-19 continues, the greater the potential negative financial effect on the Company. Due to the nature of its operations, Resources has been deemed an essential entity by virtue of 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 to maintain the safety of the Company's employees for the duration of this pandemic. Additionally during this time, the Company regularly evaluates its pandemic plan for adherence to new rules and regulations issued by theDepartment of Labor and theOccupational Safety and Health Administration regarding workplace safety. 24
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Overview
Resources is an energy services company primarily engaged in the regulated sale and distribution of natural gas to approximately 62,100 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. Historically, 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 with 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 a non-accelerated filer. Furthermore, the non-accelerated filing status extends the deadlines forSEC filings and removes the annual requirement of an independent auditor attestation report on the effectiveness of the Company's internal control over financial reporting. 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$3.8 million to its customers, representing 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 historical and proforma information, including investment in natural gas facilities. Generally, investments related to extending 25
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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. Upon filing 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$508,000 for the nine-month period endedJune 30, 2020 compared to the same period last year; however, SAVE Plan revenues increased by approximately$252,000 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 endedJune 30, 2020 , a$504,000 reduction in revenues was recognized for the effect of weather that was approximately 39% colder than normal. In contrast, during the same period last year, the Company accrued$461,000 in additional revenue related to 46% warmer weather. For the nine-months endedJune 30, 2020 and 2019, weather was 9% and 3% warmer than normal, respectively, resulting in$1.3 million and$350,000 in additional revenue for the corresponding periods. The most recent 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 financial burdens on its customers during the early stages of the COVID-19 pandemic. The Company has since received approval to bill customers over the three-month period of July toSeptember 2020 . See the 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 nine month periods endedJune 30, 2020 declined by approximately 28% and 15%, 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 commodity 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 operational 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 continuously monitors access to these systems and believes it has security measures in place 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 26
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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.
Results of Operations The Company's operations are affected by the cost of natural gas, as reflected in the condensed consolidated income statements under the following 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 or replace 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. The following results of operations analyses will reference gross utility margin. Three Months EndedJune 30, 2020 : Net income increased by$68,023 , or 6%, for the three months endedJune 30, 2020 , compared to the same period last year. Quarterly performance improved due to the earnings on the MVP investment, offset by reduced operating margin as a result of revisions to the estimated non-gas rate refund made during the same period last year. The tables below reflect operating revenues, volume activity and heating degree-days. Three Months Ended June 30, Increase / 2020 2019 (Decrease) Percentage Operating Revenues Gas Utility$ 10,856,453 $ 11,534,948 $ (678,495) (6) % Non utility 215,465 148,002 67,463 46 % Total Operating Revenues$ 11,071,918 $ 11,682,950 $ (611,032) (5) % Delivered VolumesRegulated Natural Gas (DTH) Residential and Commercial 949,845 760,514 189,331 25 % Transportation and Interruptible 1,244,246 667,711 576,535 86 % Total Delivered Volumes 2,194,091 1,428,225 765,866 54 % HDD (Unofficial) 460 185 275 149 % Total operating revenues for the three months endedJune 30, 2020 , compared to the same period last year, declined by 5% as lower natural gas commodity prices and a revision to last year's estimated provision for refund for the non-gas rate increase more than offset a 25% increase in residential and commercial volumes and a 95% increase in transportation volumes. The commodity price of natural gas decreased by 32%, more than offsetting the effect of higher non-transporting sales volumes. The average commodity price of natural gas for the current quarter fell to$1.70 per decatherm for the quarter compared to$2.50 per decatherm for the same period last year. Natural gas prices are expected to remain low due to abundant supplies and depressed demand as a result of the economic effects from COVID-19. Total residential and commercial volumes increased by 25% due to a 149% increase in heating degree days over the same period last year. After adjusting both periods for the WNA, the WNA adjusted volumes reflected a decline from the same period last year. A portion of the decline is related to the nature of the linear regression model to calculate the WNA adjustment, as the model assumes each heating degree day has an equal natural gas volume impact regardless of when the heating degree day occurs. The remainder of the difference reflects the economic effects that COVID-19 had on natural gas sales. Transportation and interruptible volumes increased by 86% related to one multi-fuel use industrial customer that, motivated by low natural gas prices, transitioned to natural gas as its current primary fuel source. Excluding this one customer, total deliveries in this category declined by 66,000 decatherms or 10%. 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 non-gas rate increase to the customer base charge and approximately 20% to volumetric revenues. Based on subsequent discussions with the SCC staff, the Company adjusted its estimated provision for refund of non-gas rates inJune 2019 to reflect non-gas rates that allocated 20% of the rate increase to the customer base charge and 80% to volumetric revenues. As a result, the 2019 fiscal third quarter reflected a larger volumetric revenue component and margin per decatherm when compared to the current quarter, while customer base charge reflects an overall increase over the same period last year due to the revision in the allocation of the non- 27
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gas rate increase. SAVE Plan revenues increased by$251,951 as the rates for the SAVE Plan reset effectiveJanuary 1, 2019 . Non-utility revenue increased due to higher demand for services during the quarter. Three Months Ended June 30, 2020 2019 Decrease Percentage Gross Utility Margin Gas Utility Revenue$ 10,856,453 $ 11,534,948 $ (678,495) (6) % Cost of Gas - Utility 3,680,408 4,132,871 (452,463) (11) % Gross Utility Margin$ 7,176,045 $ 7,402,077 $ (226,032) (3) % Gross utility margins decreased from the same period last year primarily as a result of the revised allocation of the non-gas rate increase in the prior year third quarter, combined with lower WNA adjusted volumes and the economic impact of COVID-19 on natural gas deliveries, more than offsetting the increase in natural gas usage by the one transportation customer discussed above. InJune 2019 , the non-gas rate increase was reallocated to be consistent with the SCC staff, resulting in an increase in volumetric revenues and a decrease in customer base charges during the prior year. As this adjustment took into account the six-month billing period fromJanuary 2019 throughJune 2019 , the allocation of 80% of the increase to volumetric sales resulted in a greater increase in volumetric margin for the quarter than the corresponding reduction in margin related to lower customer base charge rates. The final order issued inJanuary 2020 , reflected an allocation consistent with the revisions made inJune 2019 . The WNA resulted in a reduction in margin of$503,615 during the quarter compared to a$461,315 increase in WNA margin for the same period last year as the weather was 39% colder than normal and 46% warmer than normal, respectively. SAVE Plan margin increased by$251,951 as the level of qualified SAVE infrastructure investment continues to increase since the reset of the SAVE Plan. The components of and the change in gas utility margin are summarized below: Three Months Ended June 30, 2020 2019 Increase / (Decrease) Customer Base Charge$ 3,613,710 $ 2,616,903 $ 996,807 Carrying Cost 50,671 70,485 (19,814) SAVE Plan 348,434 96,483 251,951 Volumetric 3,660,793 4,140,562 (479,769) WNA (503,615) 461,315 (964,930) Other Gas Revenues 6,052 16,329 (10,277) Total$ 7,176,045 $ 7,402,077 $ (226,032) Operations and maintenance expenses were nearly unchanged from the same period last year as higher compensation costs, bad debt expense and professional services were offset by lower regulatory asset amortizations and corporate insurance related costs. Compensation costs increased by$80,000 primarily due to the vesting of officer stock awards and general salary adjustments. Bad debt expense increased by an additional$25,000 for the quarter even though gross billings declined by 20% for the quarter and 22% for the year. The increase in bad debt is in response to management's assessment of the continuing impact of COVID-19 and the SCC's order to suspend disconnection of service to all customers throughAugust 31, 2020 . Accounts receivable balances are continuing to age and past due amounts are currently at a higher level than for the same period last year. With the continuation of the moratorium to disconnect customers for non-payment, bad debt reserve balances are expected to continue to increase and be compounded by the continuing effects of COVID-19 on businesses and individuals. Professional services increased by$55,000 due to a variety of factors, including services related to union contract negotiations, consulting services on benefit plans and support on project evaluations. Regulatory asset amortization decreased by$127,000 related to prior year valuation adjustments. Corporate insurance costs declined$59,000 due to a smaller provision to related insurance deductibles. General taxes increased by$32,460 , or 7%, associated with higher property 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
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Equity in earnings of unconsolidated affiliate increased by$428,381 , or 55%, as the investment in MVP continues to increase. Other income (expense), net increased by$58,523 primarily due to the$41,000 equity portion of AFUDC and the$25,000 decrease 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 related to the two natural gas transfer stations that will interconnectRoanoke Gas' distribution system with MVP, for potential recovery in future rate proceedings rather than providing a return on the investment under the approved non-gas rates. Interest expense increased by$60,505 , or 6%, due to a 28% 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 are partially offset by a 14% 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$62,839 as total average debt outstanding increased by$10,300,000 associated with the issuance of a$10,000,000 unsecured note. The average interest rate decreased from 3.90% to 3.84% between periods. In addition,Roanoke Gas reduced interest expense related to the capitalization of$14,000 for the interest portion of AFUDC. The equity component of AFUDC is included in other income (expense), net. Midstream's interest expense decreased by$2,334 as total average debt outstanding increased by$14,600,000 associated with cash investments in the MVP. However, the decline in the average interest rate from 3.69% to 2.52% related to the reduction in the variable interest rate on Midstream's credit facility more than offset the effect of increased debt balances. Income tax expense increased by$56,982 corresponding to an increase in taxable income. The effective tax rate was 24.9% and 23.2% for the three month periods endedJune 30, 2020 and 2019, respectively. Both periods included the amortization of excess deferred taxes. Nine Months EndedJune 30, 2020 : Net income increased by$2,651,023 , or 32%, for the nine months endedJune 30, 2020 , compared to the same period last year due to the impact of the non-gas rate increase and the earnings on the MVP investment, more than offsetting increases in non-gas expenses. The tables below reflect operating revenues, volume activity and heating degree-days. Nine Months Ended June 30, Increase / 2020 2019 (Decrease) Percentage Operating Revenues Gas Utility$ 52,757,778 $ 57,630,278 $ (4,872,500) (8) % Non utility 537,324 544,378 (7,054) (1) % Total Operating Revenues$ 53,295,102 $ 58,174,656 $ (4,879,554) (8) % Delivered VolumesRegulated Natural Gas (DTH) Residential and Commercial 5,874,218 6,408,144 (533,926) (8) % Transportation and Interruptible 3,030,987 2,217,651 813,336 37 % Total Delivered Volumes 8,905,205 8,625,795 279,410 3 % HDD (Unofficial) 3,561 3,790 (229) (6) % Operating revenues for the nine months endedJune 30, 2020 declined from the same period last year due to a 8% reduction in residential and commercial volumes, lower natural gas commodity prices and reduced SAVE Plan revenue more than offsetting the increase in non-gas rates and higher transportation volumes. The weather sensitive residential and commercial natural gas deliveries declined by 8%, corresponding to a 6% decline in the number of heating degree days during the period. The average commodity price of natural gas delivered for the first nine months of fiscal 2020 was 31% 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$507,974 as the SAVE Rider reset effectiveJanuary 1, 2019 , and all qualifying SAVE Plan investments throughDecember 31, 2018 were included in rate base and used to derive the new non-gas base rates. For the first three months of fiscal 2019, SAVE Plan revenues represented a return on an accumulation of 5 years of SAVE investment. Subsequent toJanuary 1, 2019 , the SAVE Plan investments reset and currently include only 1.5 years of qualifying investments on which to earn a return. As the Company placed into effect new interim non-gas base rates onJanuary 1, 2019 , revenues for the current fiscal year reflect the 29
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non-gas rate increase for the entire period, while the estimated non-gas rate increase was reflected in prior year revenues for the six month period beginningJanuary 1, 2019 . Transportation and industrial volumes increased 37% due to one multi-fuel use industrial customer increasing the use of natural gas in its production activities during the period. The extent and duration of the increased natural gas consumption by this customer is unknown. Nine Months Ended June 30, Increase / 2020 2019 (Decrease) Percentage
Gross Utility Margin
Gas Utility Revenue$ 52,757,778 $ 57,630,278 $ (4,872,500) (8) % Cost of Gas - Utility 20,531,211 28,810,668 (8,279,457) (29) % Gross Utility Margin$ 32,226,567 $ 28,819,610 $ 3,406,957 12 % Gross utility margins increased from the same period last year primarily as a result of the implementation of the non-gas base rate increase and higher WNA revenues, partially offset by a reduction in SAVE revenues. The new non-gas base rates were in effect for the entire fiscal 2020 period, while only in place sinceJanuary 1, 2019 for last year. As a result, customer base charge revenues increased by$738,473 , while volumetric margin increased by$1,720,869 attributable to 80% of the non-gas base rate increase being allocated to volumetric margin, net of the effect of lower residential and commercial volumes due to warmer weather and the effects from COVID-19. WNA margin increased by$963,147 as weather was nearly 9% warmer than normal compared to 3% warmer than normal for the same period last year and a full year implementation of the non-gas base rate increase in the WNA calculation. SAVE Plan revenues declined by$507,974 as all related SAVE investments were incorporated into the new non-gas base rates effectiveJanuary 1, 2019 . The prior year also included a reserve for excess revenues attributable to the reduction in income tax rates, which were refunded to customers. The current year has no such adjustment as the new non-gas rates incorporate the effect of lower federal income tax rates. The components of and the change in gas utility margin are summarized below: Nine Months Ended June 30, 2020 2019 Increase / (Decrease) Customer Base Charge$ 10,805,138 $ 10,066,665 $ 738,473 Carrying Cost 291,712 345,052 (53,340) SAVE Plan 819,046 1,327,020 (507,974) Volumetric 18,898,658 17,177,789 1,720,869 WNA 1,313,540 350,393 963,147 Other Gas Revenues 98,473 76,572 21,901 Excess Revenue Refund - (523,881) 523,881 Total$ 32,226,567 $ 28,819,610 $ 3,406,957 Operations and maintenance expenses increased by$791,050 , or 7%, from the same period last year related to the write-off of a portion of the ESAC regulatory assets and increases in compensation costs, cost of professional services and bad debt expense, partially offset by higher capitalized overheads. 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. The Company recorded the valuation adjustment inDecember 2019 . Compensation costs increased by$294,000 primarily related to the vesting of officer stock awards. Professional services increased by$179,000 due to a variety of factors including legal assistance in the non-gas rate application, services related to union contract negotiations, network systems support, benefit plan consulting and project support activities. Bad debt expense increased by$102,000 related to COVID-19. With the continuation of the moratorium on terminating gas service on delinquent customers, delinquencies and corresponding bad debt expense are expected to continue in an upward trend. Capitalized overheads increased by$110,000 primarily due to timing of LNG production related to facility upgrades at the plant. General taxes increased by$99,345 , 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.
Depreciation expense increased by
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Equity in earnings of unconsolidated affiliate increased by$1,449,836 , or 71%, as a result of AFUDC related to the increased investment in MVP. Other income (expense), net increased by$286,463 primarily due to the$205,000 equity portion of AFUDC income, related to the twoRoanoke Gas transfer stations that will interconnect with the MVP, and a$76,000 decrease in the non-service components of net periodic benefit costs. The Company recorded AFUDC based on activity retro-active toJanuary 1, 2019 , the effective date of the new non-gas rates. Interest expense increased by$474,552 , or 18%, due to a 29% 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$281,941 as total average debt outstanding increased by$9,400,000 associated with debt issuance inDecember 2019 . The average interest rate increased from 3.79% to 3.81% between periods. The increase in interest expense was mitigated by the capitalization of$67,000 for the interest portion of AFUDC as authorized by the SCC in the final order on the non-gas rate increase. Midstream interest expense increased by$192,611 as total average debt outstanding increased by$15,900,000 associated with its investment in the MVP. The average interest rate decreased from 3.71% to 2.98% 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$923,220 , or 37%, on a corresponding increase in taxable income. The effective tax rate was 23.9% and 23.3% for the nine months endedJune 30, 2020 and 2019, respectively. Critical Accounting Policies and Estimates The consolidated financial statements of Resources are prepared in accordance with GAAP. 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, is expected to result in rising customer delinquencies and higher bad debt expense, that could continue through, at least, the remainder of the calendar year. The Company's estimated reserve for bad debts is based on historical activity as well as the evaluation of information currently available, including any relevant trends. 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. The current asset manager contract has been renewed throughMarch 31, 2022 . 31
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On
OnNovember 19, 2019 , the Company's Board of Directors approved a pro-rata increase in its participation in MVP. As a result, Midstream's equity interest will increase to approximately 1.03% by the time the pipeline is placed in service and the Company's total estimated cash investment is expected to range from$57 to$59 million . 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. Total MVP project work is approximately 92% complete. Activity on the MVP has been limited this year to maintaining the infrastructure currently in place and restoration activities. The LLC is working to resolve pending legal and regulatory challenges to or otherwise affecting certain aspects of the project, including actively working with the respective regulatory bodies on the reissuance of water crossing permits that were vacated 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. OnJune 11, 2020 , the LLC announced that it is targeting a full in-service date in early 2021 for the MVP project. In connection with the adjusted targeted in-service date, it is expected that the total costs for the MVP project may potentially increase by approximately 5% over the project's$5.4 billion budget (excluding AFUDC) primarily due to the need to adapt to complex judicial decisions and regulatory changes. Completion of the project in accordance with these targets will require, among other things, timely issuance by theDepartment of the Interior's Fish and Wildlife Service of a new Biological Opinion and Incidental Take Statement for the MVP project (and resolution of related litigation), receipt of authorizations from theBureau of Land Management andU.S. Forest Service and the lifting of the stop work order issued by theFERC , and timely approval of the LLC's pending Nationwide Permit 12 permits or utilization of alternative permitting authority and/or construction methods to cross streams and wetlands in a manner not requiring a Nationwide Permit 12. The delays in completing the project combined with the increased costs has reduced the expected return on investment. 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 will have the financing capacity to meet its MVP funding requirements. If the legal and regulatory challenges are not resolved and/or restrictions are imposed by the government related to COVID-19 that impact future construction, the cost of the MVP and Midstream's capital contributions may increase above current estimates, additional financing may be required, and the in-service date may be extended beyond early 2021. 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 infrastructure construction 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 pipeline utilization capacity charges, per contract. It is expected that these future earnings will be below the level of current AFUDC recognized. In 2018, Midstream became a participant in Southgate, a project to construct a 75-mile pipeline extending from the MVP mainline at theTransco interconnect inVirginia to delivery points inNorth Carolina . TheFERC issued the CPCN for Southgate inJune 2020 . Midstream is a less than 1% investor in the Southgate project and, based on current estimates, will invest approximately$2.1 million in Southgate. Midstream's participation in the Southgate project is for investment purposes only. Subject to approval by theFERC and other regulatory agencies, the Southgate project is targeted to be placed in-service in 2021. 32
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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 its final order onJanuary 24, 2020 . The SCC order awardedRoanoke Gas an annualized non-gas rate increase of$7.25 million with approximately 80% of 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 rates, 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, in the first quarter 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$3.8 million rate refund inMarch 2020 . As noted above, the SCC order excluded a return on investment of the two interconnect stations currently under construction that will connect the MVP pipeline into the Company's distribution system; however, the order did provide for the ability to defer financing costs of these investments for future recovery. After conferring with SCC staff regarding proper treatment, the Company now recognizes AFUDC to capitalize both the equity and debt financing costs incurred during the construction phases. 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 reflected only the amount of AFUDC incurred sinceJanuary 1, 2019 , the rate award's effective date. If the SCC concludes that the AFUDC applies to an earlier period, the Company will reflect it at that time. The condensed consolidated financial statements for the nine-month period endingJune 30, 2020 include$272,000 in AFUDC income, with$205,000 reflected in other income (expense), net and$67,000 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 toAugust 31, 2020 . This order was effective on issuance and also prohibited utilities from assessing late payment fees. Under this order, the Company is unable to disconnect any customer for non-payment of their natural gas service. Therefore, customers that would normally be disconnected for non-payment will continue incurring costs for gas service during the moratorium, resulting in higher potential write-offs. While management expects to experience an increase in bad debts, due to COVID-19-related business closings and higher unemployment, the temporary prohibition to disconnect service will cause bad debts to increase to even higher levels. The Company has increased its provision for bad debts; however, the potential magnitude of the combined impact from the economy and the SCC order on bad debts continues to be uncertain. 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 evaluating this order and the potential application to the Company. For the WNA year endedMarch 31, 2020 , the Company accrued a total of$2.4 million for additional revenues due to warmer weather, of which$1.8 million 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 uncertainty related to COVID-19, management submitted a request to the SCC to delay the customer billing related to the WNA revenues. The Company believed that it was in the best interest of its customers to delay billing at that time. OnApril 14, 2020 , the SCC issued an order granting the Company a waiver of the terms under the WNA rate schedule. As it became apparent that the pandemic would not end before the winter heating season, onJune 15, 2020 , the Company filed a motion with the SCC requesting that it be allowed to collect the WNA revenues beginning inJuly 2020 to ensure the WNA billing would be completed before the winter heating season. OnJune 17, 2020 , the Commission granted the Company's request and the Company began billing the WNA revenues during the three-month period beginningJuly 2020 throughSeptember 2020 . 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 . As Roanoke 33
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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 in Item 1 of this filing. 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 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 its SAVE Plan each year to incorporate various qualifying projects. InMay 2020 , the Company filed its most recent SAVE application with the SCC to further amend its SAVE Plan and for approval of a SAVE Rider for the periodOctober 2020 throughSeptember 2021 . In its application, the Company requested to continue to recover the costs of the replacement of pre-1973 plastic pipe. In addition, the Company requested to include the replacement of certain regulator stations and pre-1971 coated steel pipe as qualifying SAVE projects. The 2021 SAVE Rider is designed to collect approximately$2.3 million , an increase of approximately$1.2 million in annual revenues above the existing SAVE Rider. The Company's SAVE Plan application also seeks to return approximately$73,000 to customers for the over-collection in revenues that occurred in fiscal 2019. The application is currently pending with the SCC. 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 decreased by$430,143 for the nine-month period endedJune 30, 2020 , compared to a$990,934 increase for the same period last year. The following table summarizes the sources and uses of cash: Nine Months Ended June 30, 2020 2019 Cash Flow Summary Net cash provided by operating activities$ 12,826,099 $ 16,586,517 Net cash used in investing activities (23,506,062)
(33,296,103)
Net cash provided by financing activities 10,249,820
17,700,520
Increase (decrease) in cash and cash equivalents
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 fiscal 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 fiscal first and fourth quarters, operating cash flows generally decrease
due to increases in natural gas storage levels, rising customer receivable
balances and construction activity.
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Cash flow from operating activities for the nine months endedJune 30, 2020 decreased by$3,760,418 from the same period in the prior year. The decrease in cash flow provided by operations was primarily driven by changes in regulatory assets and liabilities, net of the effects of net income, accounts receivable and accounts payable. Changes in regulatory assets and regulatory liabilities, specifically the accrued WNA, PGA and rate refund balances, were the primary drivers of the period over period decrease in cash flows provided by operating activities. Though the SCC issued its final order inJanuary 2020 ,Roanoke Gas had been billing its customers using interim billing rates sinceJanuary 2019 ; therefore, during this time the Company accrued an estimated rate refund for the amount due to customers for the difference between total customer billings at interim rates versus total customer billings at projected final rates. Following SCC approval of final non-gas rates,Roanoke Gas issued refunds inMarch 2020 to all customers that had been billed at interim rates sinceJanuary 2019 . During the nine-month period endingJune 30, 2019 , the estimated rate refund increased by$1.5 million thereby providing cash for operations. In contrast, the distribution of the rate refund to customers during the current nine-month period reduced cash available for operations by$3.8 million , resulting in a total net reduction of cash between periods of$5.3 million . As noted in the Regulatory and Tax Reform section above, the Company petitioned the SCC to delay the billing of the$2.4 million WNA receivable atMarch 31, 2020 . The related increase in the WNA receivable balance resulted in a decrease in operating cash of approximately$1.0 million when compared to the same nine-month period in the prior year. The year-over-year change in the PGA resulted in a$3.0 million decrease in cash provided by operations. AtSeptember 30, 2018 , the Company's PGA was in an under-collected, or receivable, position of approximately$0.9 million . Commodity prices continued to decrease throughout the nine-month period endedJune 30, 2019 , outpacing the adjustments to the PGA factor and driving an over-collection, or payable, position of$2.2 million at period end, which resulted in a$3.1 million decrease in operating cash. PGA activity was less volatile during the nine-month period endingJune 30, 2020 , providing an operating cash increase of$0.1 million and netting against the$3.1 million decrease of the prior year. The aforementioned decreases in operating cash were partially offset by increases generated by net income, accounts receivable and accounts payable. Net income, net of equity in earnings and AFUDC, and depreciation contributed more than$1.2 million in cash as compared to the same period last year. This increase was primarily driven by theJanuary 2019 increase in non-gas base rates, as adjusted inJanuary 2020 per the SCC's final order. The timing of when the non-gas base rate increase was implemented results in the current year being impacted for a full nine-months versus only six-months in the prior year. Accounts receivable reflected a$0.1 million decrease during the current year related to lower gas commodity costs, a warmer heating season, the application of the rate refund to customer balances inMarch 2020 and the delay in WNA billings. When compared to the$1.4 million increase in accounts receivable balances during the same period of fiscal 2019, it results in an increase in operating cash flows of$1.5 million . Accounts payable reductions, driven by declining natural gas commodity prices, provided over$1.0 million in operating cash period over period. A summary of the cash provided by operations is provided below:
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