<PAGE>
PROSPECTUS
2,000,000 SHARES
VIRGINIA GAS COMPANY
COMMON STOCK
------------------
All of the 2,000,000 shares of Common Stock, par value $.001 per share
("Common Stock"), of Virginia Gas Company (the "Company") offered hereby are
being sold by the Company. The Common Stock trades on the Nasdaq National Market
under the symbol "VGCO." On August 26, 1997, the last reported price of the
Common Stock on the Nasdaq National Market was $9.00 bid and $10.00 asked. See
"Common Stock Price Range."
------------------------
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 6 HEREOF.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO DISCOUNTS TO
PUBLIC AND COMMISSIONS(1) COMPANY(2)
<S> <C> <C> <C>
Per Share.............................. $8.50 $0.595 $7.905
Total(3)............................... $17,000,000 $1,190,000 $15,810,000
</TABLE>
(1) The Company has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"). See "Underwriting."
(2) Before deducting expenses payable by the Company, estimated at $150,000.
(3) The Company has granted to the Underwriter a 30-day option to purchase up to
300,000 additional shares of Common Stock on the same terms and conditions
as set forth above solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $19,550,000, $1,368,500 and
$18,181,500, respectively. See "Underwriting."
------------------------
The shares of Common Stock offered by this Prospectus are offered by the
Underwriter subject to prior sale, withdrawal, cancellation or modification of
the offer without notice, to delivery to and acceptance by the Underwriter and
to certain further conditions. It is expected that delivery of the certificates
representing such shares will be made against payment therefor at the offices of
Ferris, Baker Watts, Incorporated, 1720 Eye Street, N.W., Washington, D.C. or
through the facilities of the Depository Trust Company, on or about September 2,
1997.
------------------------
FERRIS, BAKER WATTS
Incorporated
THE DATE OF THIS PROSPECTUS IS AUGUST 26, 1997
<PAGE>
VIRGINIA GAS COMPANY
The map to be included on the inside front cover page of the prospectus
depicts the existing storage facilities operated by the Company and the Early
Grove Affiliate in southwestern Virginia; the existing and proposed pipelines of
the Company and existing interstate pipelines; and natural gas production
fields. The map also depicts other local distribution companies service
territories.
The bottom of the inside front cover page depicts a schematic that
represents the different operations of the Company.
[MAP]
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE MARKET PRICE OF
THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED
AT ANY TIME.
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION, INCLUDING RISK FACTORS, AND FINANCIAL STATEMENTS INCLUDED ELSEWHERE
OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, ALL
INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITER'S OVER-ALLOTMENT
OPTION WILL NOT BE EXERCISED. UNLESS THE CONTEXT OTHERWISE REQUIRES, REFERENCES
TO THE COMPANY ARE TO VIRGINIA GAS COMPANY AND ITS CONSOLIDATED SUBSIDIARIES.
FOR DEFINITIONS OF CERTAIN TERMS USED IN THIS PROSPECTUS, SEE THE GLOSSARY ON
PAGE 39.
THE COMPANY
Virginia Gas Company (the "Company"), directly or through Affiliates, is
primarily engaged in the exploration, production, marketing, gathering, storage,
and distribution of natural gas, and distribution of propane gas. The Company's
principal assets are located in the Commonwealth of Virginia, a region which is
experiencing significant economic growth and increasing demand for natural gas
and has access to three major interstate gas pipeline systems.
The Company's existing and planned assets comprise: (i) interests in 85
natural gas wells with proved developed reserves of approximately 2.6 Bcf; (ii)
gathering systems with over 102 miles of pipeline with a current annual
throughput of over 1.67 Bcf, connected to the interstate pipeline systems of
East Tennessee Gas Company ("ETNG"), CNG Transmission Company ("CNG") and
Columbia Gas Transmission Company ("TCO"); (iii) two underground storage
facilities with current capacity of 2.2 Bcf; and (iv) 120 miles of intrastate
pipeline under development with planned aggregate daily throughput of
approximately 50 MMcf.
The Company's business has developed in response to the growing need for
natural gas storage, pipelines and distribution in its market area, resulting
principally from economic growth and the impact of deregulation. Deregulation
has given natural gas customers more flexibility in negotiating their natural
gas purchases and transportation contracts. The Company's pipeline connections
to the ETNG, CNG, and TCO pipeline systems, and to the Company's adjacent
storage facilities, combine to create a hub which provides opportunities for
more efficient gas distribution, including to local, growing markets. At
present, the Company's business primarily consists of: (i) producing, gathering
and marketing natural gas from wells, in which the Company has an ownership
interest, to municipal distributors, local distribution companies and major oil
and gas companies; (ii) storing natural gas for municipal distributors and local
distribution companies which have supplied their own gas, or purchased gas from
third parties or the Company; and (iii) distributing propane and natural gas
purchased from third parties or the Company to local industrial, commercial and
residential customers.
The Company's principal sources of revenue have varied from time to time
depending on its level of activity in any given segment of natural gas
operations. From 1987 through 1992, substantially all of the Company's income
was derived from exploration, development and production of natural gas and from
fees derived from managing wells. From 1993 through 1996, the Company's income
reflected the growth of its storage operations. Today, the Company is building
transmission pipelines and expanding its storage capacity and expects, beginning
in 1999, to derive income primarily from natural gas storage and transportation
fees.
The Company's objective is to enhance earnings and cash flow by becoming a
leading integrated natural gas company in its market area. The Company's
strategy to achieve this objective is to construct pipeline systems, increase
the utilization of its existing storage facilities and aggressively pursue
end-user customers.
3
<PAGE>
ORGANIZATION AND OFFICES; AFFILIATES
The Company was incorporated in Delaware in March 1987. The Company's
principal executive office is located at 200 East Main Street, Abingdon,
Virginia 24210 and its telephone number is (540) 676-2380. The Company's
underground natural gas storage facility (the "Early Grove Facility") and its
related gathering system are owned and operated through a 50% owned affiliate,
Virginia Gas Storage Company (the "Early Grove Affiliate"). The Company conducts
its natural gas distribution activities through another 50% owned affiliate,
Virginia Gas Distribution Company (the "Distribution Affiliate"). The Early
Grove Affiliate and the Distribution Affiliate are herein collectively referred
to as "Affiliates." See "Risk Factors--Relationship with Affiliates."
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered:...................... 2,000,000 shares of Common Stock
Common Stock to be outstanding after the
Offering:................................ 5,204,906 shares(1)
Use of Proceeds:........................... The development of transmission pipelines;
expansion of a storage facility; and other
general corporate purposes. See "Use of
Proceeds."
Nasdaq National Market Symbol:............. VGCO
</TABLE>
- ------------------------
(1) Excludes 1,191,069 shares of Common Stock issuable upon exercise of
outstanding options and warrants at exercise prices ranging from $8.72 to
$10.00 per share.
4
<PAGE>
SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following summary selected financial information should be read in
conjunction with, and is qualified in its entirety by, the more detailed
financial statements and notes thereto included elsewhere in this Prospectus.
The summary income statement data of the Company for the years ended December
31, 1994, 1995 and 1996 and the summary balance sheet data as of December 31,
1996 have been derived from the Consolidated Financial Statements of the Company
which have been audited by Arthur Andersen LLP, independent public accountants.
This data should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere herein.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31 JUNE 30
------------------------------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1996 1997
--------- --------- --------- ---------- --------- ---------
INCOME STATEMENT DATA:
Operations Data:
Net revenues.................................. $1,236 $1,612 $2,023 $2,770 $ 979 $4,071
Operating income.............................. 310 354 415 549 68 587
Equity in earnings of affiliates.............. 137 193 267 340 208 131
Net income.................................... 302 420 474 608 207 427
Per Share Data:
Earnings per share............................ $ 0.47 $ 0.66 $ 0.62 $ 0.21 $ 0.07 $ 0.12
Weighted average shares outstanding........... 671 640 696 1,638 1,035 3,201
Other Data:
Depreciation, depletion and amortization...... $ 171 $ 191 $ 305 $ 387 $ 129 $ 374
EBITDA........................................ 648 1,019 1,515 2,153 839 1,656
Capital investment............................ 467 1,378 2,331 11,662 4,306 3,150
Interest expense.............................. 120 288 673 1,007 521 717
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1997
----------------------
AS
BALANCE SHEET DATA: 1996 ACTUAL ADJUSTED(1)
--------- --------- -----------
<S> <C> <C> <C>
Net working capital............................................ $ (430) (519) 15,141
Property, plant and equipment, net............................. 16,343 19,163 19,163
Total assets................................................... 33,510 41,416 57,076
Long-term debt................................................. 12,138 21,137 21,137
Stockholders' equity........................................... 17,338 15,494 31,154
</TABLE>
- ------------------------
(1) Adjusted to give effect to the sale by the Company of 2,000,000 shares of
Common Stock at the public offering price of $8.50 per share and the
application of the proceeds therefrom.
<TABLE>
<CAPTION>
AS OF DECEMBER 31
------------------------------------------
SELECTED OPERATING DATA: 1993 1994 1995 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Gas stored (MMBtu)..................... 400,000 520,000 985,500 2,171,500
Gas storage daily maximum
deliverability (MMBtu)............... 3,724 7,846 11,531 55,997
Gas wells in operation (gross)......... 75 87 108 108
Total miles of pipeline................ 95 111 116 128
Distribution customers................. 88 123 145 203
</TABLE>
5
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE COMPANY INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO
THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD
CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS IN EVALUATING AN INVESTMENT IN THE
SHARES OF COMMON STOCK OFFERED HEREBY.
COMPANY INDEBTEDNESS AND RESTRICTIVE COVENANTS. Through its participation
in tax exempt bond offerings of the Industrial Development Authorities of
Russell and Buchanan Counties, Virginia, the Company has incurred significant
long-term indebtedness to develop the exploration, gathering and production
operations, storage facilities and pipelines of the Company and its Affiliates.
A significant portion of the proceeds of such indebtedness was loaned to its
Affiliates. There can be no assurance that revenues from the Company's or the
Affiliates' operations will be sufficient to satisfy the Company's long-term
debt obligations.
The debt instruments contain restrictive covenants which, among other
things, may restrict the Company's ability to incur additional parity debt,
restrict the application of proceeds and require the Company to exercise control
over an Affiliate, which it may be unable to do. See "--Relationship with
Affiliates." In addition, the covenants may limit the development by the Company
or its Affiliates of certain aspects of their business. Failure to comply could
cause acceleration of the debt, could cause the Company's existing long-term
indebtedness to lose its tax exempt status, could require the Company to pay a
higher rate of interest and could preclude the Company from participating in
future tax exempt bond offerings offered by Industrial Development Authorities
of other counties in Virginia.
Should the Company not be permitted to participate in future tax exempt bond
offerings or default on any of its indebtedness, or should any of the Company's
Affiliates be unable to repay the Company as and when required for the portions
of the indebtedness received by them, the Company's assets would be at risk and
its ability to conduct its businesses as presently being, or proposed to be,
conducted would be severely curtailed. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
NEED FOR ADDITIONAL CAPITAL. The Company will require substantial
additional capital to expand and diversify its operations beyond its current
plans. In the event that additional capital or adequate financing is not
available for expenditures to be incurred by the Company, there can be no
assurance that the Company will be able to complete its current projects in the
event of cost overruns, or to continue to expand its operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
COMPLETION OF PIPELINES. In 1996, the Company began the development of an
80-mile intrastate natural gas pipeline (designated "P-25"), by acquiring
certain land easements and other property rights. The Company has also filed an
application with the Virginia State Corporation Commission ("VSCC") for issuance
of a Certificate of Public Convenience and Necessity ("CPCN") which, among other
things, would grant the Company the right of eminent domain over property needed
to construct the pipeline, which may be necessary to obtain all necessary land
rights. At present, the Company is aware of no reason why a CPCN would not be
issued. However, should the issuance of a CPCN, or other necessary governmental
licenses, franchises and permits, be delayed or should such issuances not occur,
the Company could experience a delay in, or could be prevented from,
constructing the P-25 pipeline, or could be required to incur significant costs
to reconfigure the pipeline. Such delays, cost increases, or the inability of
the Company to build the P-25 pipeline would have a material adverse effect on
the financial performance and the prospects of the Company. Comparable
requirements would apply to construction of an additional 40-mile intrastate
pipeline ("designated P-24"). The Company recently initiated development of the
P-24 pipeline. The uncertainties that exist with respect to the P-25 pipeline,
exist with respect to the P-24 pipeline.
6
<PAGE>
In addition, capital intensive projects such as pipeline construction
frequently encounter cost overruns as a result of factors including geography of
the project, timing of construction, and adverse weather conditions. There can
be no assurance that the Company's current cost estimates will prove accurate or
that adequate financing will be available to complete these projects. See
"Business--Regulation" and "Business--Business Activities--Pipeline Operations."
COMPETITION. The natural gas industry is highly competitive. While the
Company currently operates the only underground natural gas storage facilities
in Virginia, it is possible that other companies will engage in similar or
competing activities. The Company's pipeline operation has numerous competitors
in its geographic area of operations, many of which are larger pipeline
companies with more extensive pipeline networks. Many of these competitors,
particularly those affiliated with major integrated oil and interstate and
intrastate pipeline companies, have financial resources substantially greater
than those of the Company and have access to supplies of natural gas
substantially greater than those available to the Company. Although the
Company's plan to expand its pipeline operations is designed to meet presently
growing markets, other competitors may decide to provide pipelines to these
areas. It is also possible that large volume customers or gas suppliers will
attempt to construct gas facilities to connect to an interstate pipeline or
other source of gas supply in order to bypass the Company's systems and/or avoid
use of its storage facilities.
The Company also competes in the areas of exploration, production, marketing
and distribution of propane and natural gas with major oil and gas companies,
other independent oil and gas concerns and individual producers and operators,
and, in the area of utility services, with major utility companies. Many of
these competitors have substantially greater financial and other resources than
the Company. The Company's competition may have a material adverse effect on the
Company's ability to recover its capital costs and repay outstanding
indebtedness. See "Business--Competition."
GOVERNMENTAL REGULATION. The Distribution Affiliate's natural gas
distribution operations are regulated by the VSCC. The VSCC has issued a CPCN
which authorizes the Affiliate to conduct its natural gas distribution business
in designated areas. The VSCC also sets the price of utility services at levels
intended to enable the Distribution Affiliate to recover its cost of service
plus a rate of return.
The VSCC also regulates storage rates. In June 1996 the Company applied for
a CPCN with the VSCC in connection with its high deliverability salt cavern
storage facility in Saltville, Virginia (the "Saltville Facility"). In July 1996
the VSCC issued an order authorizing the Company to begin service on an interim
basis subject to certain rates. A hearing was held in December 1996 on the
Company's application. A final order has not been issued by the VSCC. The VSCC
could deny the Company's application or further limit the rates it may charge
for storage.
In the future, the Company will be required to obtain additional CPCNs to
conduct its proposed pipeline operations. The Company and the Distribution
Affiliate may also periodically petition the VSCC for adjustments to rates to
compensate for changed conditions. In the event the VSCC denies such requests or
fails to give approval of such requests on a timely basis, the Company's and the
Distribution Affiliate's ability to conduct their businesses or to generate
sufficient revenues from such operations could be adversely affected. Further,
any cancellation or revocation of the Company's or the Distribution Affiliate's
CPCN, or denial by the VSCC of the Company's current and future applications,
would result in the Company or the Distribution Affiliate ceasing storage,
pipeline or distribution operations in the affected areas or the inability to
expand such operations. See "Business--Regulation."
Common carriers such as the Company's pipelines are also subject to the
jurisdiction of certain other state and federal agencies with respect to
environmental and safety matters. Changes in regulations or rulings adverse to
the Company's financial interests or failure to comply with such regulations
could have a material adverse effect on the Company's ability to generate
revenue from its storage and pipeline operations and from the Distribution
Affiliate's distribution operations. See "Business--Regulation."
7
<PAGE>
UNCERTAINTY OF PROPANE AND NATURAL GAS PRICES, SUPPLIES AND DEMAND. The
Company's revenues, profitability and future rate of growth substantially depend
upon prevailing prices for propane and natural gas and adequacy of propane and
natural gas supplies, which, in turn, depend upon numerous external factors such
as various economic, political and regulatory developments, weather, and
competition from other sources of energy. The unsettled nature of the energy
markets makes it particularly difficult to estimate future prices of propane,
natural gas and natural gas liquids or the security of propane and natural gas
supplies. The prices of propane, natural gas and natural gas liquids are subject
to wide fluctuations, and there can be no assurance that future decreases in
such prices will not occur. The Company believes that it has developed multiple
sources of propane and natural gas supply. However, there can be no assurance
that these sources will meet the Company's forecasted demand in the future. As a
result of the factors referred to above, there also can be no assurance that the
Company's forecasted demand for its products and services will prove to be
accurate. All of these factors are beyond the control of the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Business--Regulation" and
"Business--Strategy."
UNCERTAINTY OF ESTIMATES OF NATURAL GAS RESERVES AND FUTURE NET
REVENUES. There are numerous uncertainties inherent in estimating quantities of
proved natural gas reserves, including many factors beyond the control of the
Company. This Prospectus contains estimates of proved developed and proved
undeveloped natural gas reserves and future net revenues therefrom based on
studies performed by the Company's engineering staff. The Company has not
engaged the services of an independent petroleum engineering firm to confirm the
Company's estimates. The estimates included in this Prospectus are based on
procedures prescribed by Statement of Financial Accounting Standards No. 69 and
accordingly are based on sales prices, cost rates and statutory income tax rates
in existence at the date of the projections or year end and therefore are an
inherently imprecise indication of future net revenues. Actual future
production, revenues, taxes, development expenditures, operating expenses and
quantities of recoverable natural gas reserves may vary substantially from those
assumed in the estimates. In addition, the Company's reserves valuations may be
subject to downward or upward revision based upon production history, results of
future development, prevailing natural gas prices and other factors. For
example, the value of the Company's reserves as of December 31, 1996, reflects
the prices of natural gas in the winter of 1996, which were approximately 25%
higher than in the prior recent heating seasons as a result of the severity of
weather conditions in the winter of 1995. See "Business--Exploration,
Production, Gathering and Marketing Operations."
RELATIONSHIP WITH AFFILIATES. The Company owns a 50% interest in the Early
Grove Affiliate and the Distribution Affiliate. The remaining 50% interest is
owned by one individual. The Company provides management services to these
Affiliates; however, there are no written management agreements governing the
operation of these Affiliates nor are there any agreements between the Company
and the individual owner relating to corporate governance, buy-sell matters or
"deadlock" issues. The inability of the Company and the other owner of the
Affiliates to agree on matters relating to the management and operation of those
Affiliates could have a material adverse effect on the financial condition of
the Company.
DEPENDENCE ON MAJOR CUSTOMERS. One of the Company's customers, United
Cities Gas Company, accounted for 31% of 1996 consolidated operating revenue and
25% of revenues for the six-month period ended as of June 30, 1997. In addition,
Knoxville Utilities Board and Hope Gas, Inc. accounted for 21% and 15%,
respectively, of revenues for the six-month period ended June 30, 1997. Two of
the Early Grove Affiliate's customers, Roanoke Gas Company and Knoxville
Utilities Board, which contract with the Early Grove Affiliate for natural gas
storage, accounted for 57% and 53% of the Early Grove Affiliate's operating
revenue for 1996 and for the six month period ended June 30, 1997, respectively.
For the six-month period in 1997, White Stone Company, Buchanan General Hospital
and W-L Construction Paving Inc., accounted for 39%, 21% and 12%, respectively,
of the operating revenues for the Distribution Affiliate. The loss of these
customers, or an adverse business or financial development affecting any of
8
<PAGE>
these customers, could have a material adverse financial impact on the Company.
See "Business--Storage Operations."
OPERATING HAZARDS. The Company's storage, pipeline, gathering and
distribution operations are subject to the many hazards inherent in the natural
gas transmission and storage industry and in propane distribution. These include
damage to pipeline and storage facilities, related equipment and surrounding
properties caused by hurricanes, floods, fires and other acts of God,
inadvertent damage from construction and farm equipment, leakage of natural gas
and other hydrocarbons, fires and explosions and other hazards that could also
result in personal injury and loss of life, pollution and suspension of
operations. The Company's exploration and production operations involve a
variety of operating risks, including the risk of fire, explosions, blow-outs,
pipe failure, casing collapse, abnormally pressured formations, and
environmental hazards such as oil spills, gas leaks, ruptures and discharges of
toxic gases, the occurrence of any of which could result in substantial losses
to the Company due to injury and loss of life, severe damage to and destruction
of property, natural resources and equipment, pollution and other environmental
damage, clean-up responsibilities, regulatory investigation and penalties and
suspension of operations.
Any significant problems related to its facilities could adversely affect
the Company's ability to conduct its operations. The Company maintains insurance
against some, but not all, potential risks; however, there can be no assurance
that such insurance will be adequate to cover any losses or exposure for
liability. The occurrence of a significant event not fully insured against could
materially adversely affect the Company's operations and financial condition.
The Company cannot predict whether insurance will continue to be available at
premium levels that justify its purchase or whether insurance will be available
at all. See "Business--Operational Hazards and Insurance."
RELIANCE ON KEY PERSONNEL. The success of the Company will largely be
dependent upon the efforts and active participation of Michael L. Edwards. He is
party to an employment agreement with the Company. The unexpected loss of his
services could have a detrimental effect on the Company. See "Management."
DIVIDEND POLICY. The Company has paid cash dividends in each of the past
five fiscal years and in the current fiscal year. The primary objective of the
Company is to retain its earnings to support the growth of the Company.
Therefore, there can be no assurance that the Board of Directors of the Company
will authorize the Company to pay cash dividends on its Common Stock in the
future. See "Dividend Policy."
ANTI-TAKEOVER PROVISIONS. The Company's Amended and Restated Certificate of
Incorporation provides that the approval of (i) any amendment to the Certificate
or the by-laws, (ii) the merger, dissolution, reorganization (including by share
exchange) or recapitalization of the Company, or (iii) the sale of all or
substantially all of the assets of the Company requires the affirmative vote of
the holders of 75% of the Company's issued and outstanding shares entitled to
vote thereon. This increases the percentage that would otherwise be required
under Delaware law to approve such actions. In addition, the Company's by-laws
provide that members of the Company's Board of Directors are elected to terms
that are staggered. These provisions may make it more difficult to change
control of the Company or replace incumbent management. See "Description of
Securities--Certain Provisions of Certificate of Incorporation and Delaware Law"
and "Management --Executive Officers and Directors."
POSSIBLE VOLATILITY OF STOCK PRICE. The trading price of the Common Stock
could be subject to wide fluctuations in response to quarter-to-quarter
variations in operating results, announcements of unanticipated operating
results by the Company and other events or factors, such as the sale of large
blocks of shares held by existing shareholders. See "--Limited Market for Common
Stock; Shares Eligible for Resale." In addition, the stock market has from time
to time experienced extreme price and volume fluctuations which have
particularly affected the market price for certain companies in a manner often
unrelated to the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock.
9
<PAGE>
LIMITED MARKET FOR COMMON STOCK; SHARES ELIGIBLE FOR RESALE. The Company's
Common Stock is traded on the Nasdaq National Market under the symbol VGCO.
Average daily trading volume for the Common Stock as reported by Nasdaq for the
first half of 1997 was approximately 4,172 shares. Despite the increase in the
number of shares of Common Stock to be publicly held as a result of the
Offering, there can be no assurance that a more active trading market in the
Common Stock will develop. Because there is a small public float in the Common
Stock and it is thinly traded, sales of small amounts of Common Stock in the
public market could materially adversely affect the market price for the Common
Stock. Sales of Common Stock, or the perception that such sales could occur,
could materially adversely affect prevailing market prices for the Common Stock
and may make it more difficult for the Company to sell shares of Common Stock in
the future at times and for prices that it deems appropriate. Upon completion of
the Offering, the Company will have 5,204,906 shares of Common Stock outstanding
(5,504,906 shares if the Underwriter's over-allotment option is exercised in
full) and approximately 247,920 shares issuable upon the exercise of outstanding
employee stock options and, after August 3, 1997, an additional 789,849 shares
and, after October 4, 1997, 153,300 shares issuable upon the exercise of
warrants. The 2,000,000 shares of Common Stock sold in the Offering (2,300,000
shares if the Underwriter's over-allotment option is exercised in full) will be
freely transferable without restriction or registration under the Securities
Act, unless purchased by persons deemed to be affiliates of the Company (as that
term is defined under the Securities Act). Substantially all of the remaining
3,204,906 shares of Common Stock outstanding immediately following the Offering
(and 1,191,069 shares issuable upon exercise of options and warrants, when
exercisable) will be transferable without restriction or registration under the
Securities Act, except for approximately 1,293,188 outstanding shares and an
additional 619,954 shares issuable upon exercise of options and warrants held by
persons deemed to be affiliates of the Company (as that term is defined under
the Securities Act) which will be subject to the volume and other restrictions
under Rule 144. See "Shares Eligible for Future Sale."
ENVIRONMENTAL REGULATIONS. The production, handling, transportation and
disposal of natural gas by-products and propane are subject to regulation under
federal, state and local environmental laws. In most instances, the applicable
regulatory requirements relate to water and air pollution control and solid
waste management measures. Environmental assessments have not been performed on
all of the Company's properties. To date, expenditures for environmental control
facilities and for remediation have not been significant in relation to the
results of operations of the Company. The Company believes, however, that it is
likely that the trend in environmental legislation and regulations will continue
to be towards stricter standards, which could materially adversely affect the
Company's ability to conduct its operations. See "Business--Regulation."
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION. Certain
statements contained in this Prospectus, such as those concerning the Company's
business strategy, acquisition and expansion plans, projected values and
revenues, capital requirements, governmental regulation and other statements
regarding matters that are not historical facts, are forward-looking statements
(as such term is defined in the Securities Act). Because such forward-looking
statements include risks and uncertainties, and are based upon certain
assumptions, actual results may differ materially from those expressed in or
implied by such forward-looking statements. Factors that could cause actual
results to differ materially include, but are not limited to, those discussed
herein under "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business." The Company undertakes no
obligation to publicly release the results of any revision of those
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby (at the public offering price of $8.50 per share) are estimated
to be approximately $15,660,000 ($18,031,500 if the
10
<PAGE>
Underwriter's over-allotment option is exercised in full), after deducting
underwriting discounts and commissions and offering expenses payable by the
Company.
Net proceeds are expected to be used as follows: (i) $14,740,000 for the
development of the P-24 and P-25 pipelines, and (ii) $750,000 for the expansion
of the Saltville Facility. Any remaining amounts will be used for general
corporate purposes, including working capital. Pending the use of the proceeds,
the Company may invest the funds in short-term money market, government and
federal agency obligations, bank certificates of deposit and savings deposits.
COMMON STOCK PRICE RANGE
The Common Stock is traded on the Nasdaq National Market under the symbol
"VGCO." There were approximately 800 stockholders of record and 26 warrant
holders of record as of August 26, 1997. The following table sets forth the high
and low closing prices, as reported by Nasdaq, for the quarters indicated (the
stock began trading on October 4, 1996):
<TABLE>
<CAPTION>
PRICE RANGE OF
COMMON STOCK
----------------
<S> <C> <C>
HIGH LOW
------- -------
1996
Fourth
Quarter......... $ 7 3/4 $ 6 1/2
1997
First Quarter... 10 1/2 7 1/4
Second
Quarter......... 10 3/4 8 3/4
Third Quarter
(through August
26, 1997)....... 10 3/4 9 1/8
</TABLE>
On August 26, 1997, the last reported bid and asked prices of the Common
Stock on the Nasdaq National Market were $9.00 and $10.00, respectively.
11
<PAGE>
CAPITALIZATION
The following table sets forth the actual capitalization of the Company as
of June 30, 1997, and as adjusted to give effect to the sale by the Company of
2,000,000 shares of Common Stock in the Offering (at a price to the public of
$8.50 per share), and the application of the estimated net proceeds therefrom,
as if such transaction had occurred as of June 30, 1997. The table should be
read in conjunction with the Company's Consolidated Financial Statements
included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
----------------------------
ACTUAL AS ADJUSTED
------------- -------------
<S> <C> <C>
Current portion of long-term debt.................................................. $ 748,576 $ 748,576
------------- -------------
Long-term debt..................................................................... 21,136,694 21,136,694
------------- -------------
Stockholders' equity:
Preferred Stock, no par; $1,000 per share liquidation value; zero shares issued
and outstanding as of June 30, 1997............................................ -- --
Common Stock, par value $.001 per share; 10,000,000 shares authorized; 3,204,906
shares issued and outstanding; and 5,204,906 shares as adjusted for the
Offering(1).................................................................... 3,205 5,205
Additional paid-in capital....................................................... 13,751,471 29,409,471
Retained earnings................................................................ 1,739,799 1,739,799
------------- -------------
Total stockholders' equity......................................................... 15,494,475 31,154,475
------------- -------------
Total capitalization............................................................... $ 37,379,745 $ 53,039,745
------------- -------------
------------- -------------
</TABLE>
(1) Excludes 1,191,069 shares of Common Stock issuable upon exercise of
outstanding options and warrants at exercise prices ranging from $8.72 to
$10.00 per share.
DIVIDEND POLICY
The Company has paid cash dividends on its Common Stock in each of the past
five fiscal years. During the past two years dividends were paid to stockholders
of record as follows:
<TABLE>
<CAPTION>
DIVIDEND (PER
RECORD DATE SHARE)
- ------------------------------------------------------------- -------------------
<S> <C>
12/22/95..................................................... $ 0.2900
12/15/96..................................................... 0.0100
1/31/97..................................................... 0.0125
5/15/97..................................................... 0.0150
7/15/97..................................................... 0.0175
</TABLE>
The primary objective of the Company is to retain its earnings to support
the growth of the Company. Therefore, there is no assurance that the Board of
Directors of the Company will authorize the Company to pay cash dividends on its
Common Stock in the future.
12
<PAGE>
SELECTED CONSOLIDATED
FINANCIAL AND OPERATING DATA
The following table presents selected consolidated financial and operating
data of the Company for each of the six month periods ended June 30, 1996 and
1997, and each of the four years in the period ended December 31, 1996. The
annual financial data for 1994, 1995 and 1996 has been derived from the
consolidated financial statements of the Company audited by Arthur Andersen LLP,
independent public accountants. The financial statements, as of December 31,
1996, and for the years ended December 31, 1995 and 1996, and the report of
Arthur Andersen LLP, are included herein under the caption "Financial
Statements." In addition, this data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
SIX MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------------------ --------------------
<S> <C> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- ---------
Revenues:
Gas sales and well operations revenues........... $ 391,084 $ 489,180 $ 603,495 $ 698,645 $ 297,345 $2,077,017
Natural gas gathering and service revenues....... 52,245 104,250 133,794 103,768 51,872 50,883
Natural gas storage revenues..................... -- -- -- 769,025 -- 1,228,297
Management revenues.............................. 753,467 738,583 756,524 320,532 195,928 144,340
Interest income.................................. 30,701 280,182 526,797 877,748 433,763 564,331
Other income..................................... 8,732 -- 2,800 -- -- 6,082
--------- --------- --------- --------- --------- ---------
1,236,229 1,612,195 2,023,410 2,769,718 978,908 4,070,950
--------- --------- --------- --------- --------- ---------
Costs and expenses:
Production expenses.............................. 312,036 361,610 65,029 105,910 43,445 100,665
Purchased gas expense............................ -- -- -- 28,537 -- 66,113
Operations and maintenance expense............... -- -- -- 173,445 -- 229,203
Cost of natural gas sold......................... -- -- -- -- -- 1,635,003
Depreciation and amortization.................... 170,380 190,792 305,216 387,116 129,047 373,590
General and administrative....................... 413,312 425,145 708,191 645,673 303,087 447,430
Other expense.................................... 269 -- 2,752 2,771 1,146 68,039
Interest expense................................. 119,624 288,073 673,251 1,006,800 520,824 717,155
--------- --------- --------- --------- --------- ---------
1,015,621 1,265,620 1,754,439 2,350,252 997,549 3,637,198
--------- --------- --------- --------- --------- ---------
Income (loss) before earnings of affiliated
companies and income taxes....................... 220,608 346,575 268,971 419,466 (18,641) 433,752
Equity in earnings of affiliated companies......... 136,945 193,416 267,484 339,927 207,942 131,201
--------- --------- --------- --------- --------- ---------
357,553 539,991 536,455 759,393 189,301 564,953
Provision (benefit) for income taxes............... 55,426 119,906 62,581 151,827 (17,543) 137,883
--------- --------- --------- --------- --------- ---------
Net income......................................... $ 302,127 $ 420,085 $ 473,874 $ 607,566 $ 206,844 $ 427,070
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Summary of operations-Affiliates:
Early Grove Affiliate
Revenues......................................... $1,118,531 $1,638,233 $2,779,048 $3,985,444 $2,060,751 $2,179,567
Expenses......................................... 782,768 1,260,152 2,293,665 3,309,706 1,660,317 1,954,971
--------- --------- --------- --------- --------- ---------
Net income....................................... $ 335,763 $ 378,081 $ 485,383 $ 675,738 $ 400,434 $ 224,596
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Company's equity share........................... $ 167,882 $ 189,041 $ 242,692 $ 337,869 $ 200,217 $ 112,298
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Distribution Affiliate
Revenues......................................... $ 274,930 $ 455,799 $ 719,188 $1,023,065 $ 496,435 $ 676,012
Expenses......................................... 336,803 447,048 669,603 1,018,950 480,985 638,206
--------- --------- --------- --------- --------- ---------
Net income (loss)................................ $ (61,873) $ 8,751 $ 49,585 $ 4,115 $ 15,450 $ 37,806
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Company's equity share........................... $ (30,937) $ 4,375 $ 24,792 $ 2,058 $ 7,725 $ 18,903
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE HISTORICAL FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS AND RELATED NOTES SET FORTH IN THIS PROSPECTUS. DISCUSSIONS
INVOLVING THE EARLY GROVE AFFILIATE AND THE DISTRIBUTION AFFILIATE SHOULD BE
READ IN CONJUNCTION WITH THE VIRGINIA GAS STORAGE COMPANY FINANCIAL STATEMENTS
AND RELATED NOTES AND THE VIRGINIA GAS DISTRIBUTION COMPANY FINANCIAL STATEMENTS
AND RELATED NOTES SET FORTH IN THIS PROSPECTUS.
GENERAL
The Company derives revenues from its storage, exploration, production,
gathering, marketing and propane distribution operations. From its 50%
investment in the Early Grove Affiliate and the Distribution Affiliate, the
Company derives earnings from the storage, gathering and distribution operations
of these companies. The Company accounts for its investments in these companies
using the equity method.
The Company's growth has been stimulated by deregulation of the natural gas
industry and strong economic and population growth in the main markets in which
the Company competes, specifically eastern Tennessee and western Virginia.
Deregulation has given natural gas customers more flexibility in negotiating
their natural gas purchases and transportation contracts.
Most of the pipeline facilities on major interstate systems such as ETNG,
TCO and CNG are limited by capacity constraints as to the ability to deliver
additional peak-day volumes. The ability of companies to continue to supply
customers from traditional sources such as the Gulf Coast area is limited by the
high capital costs of building new pipelines and compression facilities. The
Company believes that local suppliers of natural gas, such as the Company, the
Early Grove Affiliate and the Distribution Affiliate possess a significant
advantage in delivering these services at a more economical rate due largely to
lower capital costs in developing natural gas delivery facilities.
In its exploration and production business, the Company has revenue
interests in wells which generate revenues from the sale of each well's natural
gas production. The Company also receives revenues from managing the
construction, drilling, development, and operation of natural gas facilities,
including management and operations fees. In its gas gathering business,
revenues are generated from its ownership interest in gathering pipelines for
natural gas traveling through its gathering systems. In its gas marketing
operations, the Company generates revenues from the sale of natural gas. Prices
for the Company's natural gas may vary depending on weather conditions and
demand for natural gas.
In its storage business, the Company receives fees for use of its storage
space in addition to injection and withdrawal fees, collectively referred to as
storage revenues. Storage charges to customers are in accordance with rates
included in tariffs approved by the VSCC.
In its propane distribution business, the Company generates revenues from
the sale of propane to industrial, commercial and residential customers.
With respect to the Early Grove Affiliate's gas gathering business, the
Company records its share of net income from fees received for natural gas
traveling through the Affiliate's gathering system and for storage fees. The
Early Grove Affiliate also sells gas during the heating season.
With respect to the Distribution Affiliate's distribution operations, the
Company records its share of net income from the difference between the prices
at which the Affiliate purchases natural gas and the prices at which it sells
natural gas to its customers. The prices at which the Distribution Affiliate
sells natural gas to its customers are in accordance with the rate schedules in
its tariff filed with the VSCC. The Distribution Affiliate purchases natural gas
under short-term contracts which reflect the market price of natural gas.
14
<PAGE>
FIRST SIX MONTHS OF 1997 AND 1996
OVERVIEW. During the six month period ended June 30, 1997, the Company
recorded net income of $427,000, compared to $207,000 for the same period in
1996, an increase of 106%. The net income per common share available to common
stockholders for the corresponding periods was $0.12 in 1997 compared with $0.07
in 1996. The number of weighted-average shares used in calculating income per
common share was 3,201,350 and 1,034,873 for the six months ended June 30, 1997
and 1996, respectively.
REVENUES. Total revenues increased 316% to $4.1 million for the six months
ended June 30, 1997 compared to $979,000 for the same period in 1996. Gas sales
and well operation revenues totaled $2.1 million for the first six months of
1997 compared to $297,000 for the same period in 1996. The increase primarily
reflects the formation of the Company's marketing operations during the first
quarter of 1997. Sales of natural gas during the first six months of 1997
totaled $1,826,000 on sales volumes of 689,000 MMBtu. Exploration and production
revenues, reflecting the Company's revenue interests in these sales of natural
gas, consisted of natural gas sales of $189,000, and well operation income of
$131,000 compared to $158,000 and $139,000, respectively, for the same period in
1996. Propane sales totaled $118,000 for the six months ended June 30, 1997.
There were no comparable propane sales for the same period in 1996 as these
operations were in the developmental stage.
Natural gas storage revenues totaled $1.2 million for the first six months
of 1997, compared to zero revenue for the same period in 1996. Initial
injections of customer gas into the Saltville Facility began in August 1996.
Contracted storage capacity for the current contract year is comprised of 10-day
(64%), 60-day (9%) and 90-day (27%) service.
Management revenues, interest and other income totaled $715,000 for the six
months ended June 30, 1997, compared with $630,000 for the same period in 1996,
an increase of 14%. The majority of the increase reflects an increase in
interest income of $131,000, offset by a decrease in management revenues of
$52,000.
COSTS AND EXPENSES. Total operating costs and expenses increased $2.4
million to $2.9 million for the six months ended June 30, 1997, compared to
$477,000 for the same period in 1996. Production and purchased gas expenses
increased to $167,000 for the six months ended June 30, 1997 from $43,000 for
the same period in 1996 as a result of increased production expenses in addition
to increased purchased gas expense attributed to the expanding propane
distribution operations.
Operating and maintenance expense totaled $229,000 for the six months ended
June 30, 1997 compared to zero for the same period in 1996, primarily reflecting
operating costs incurred in 1997 related to the Saltville Facility.
Cost of natural gas sold, related to the Company's marketing of natural gas,
totaled $1.6 million for the first six months of 1997 compared to zero for the
same period in 1996, reflecting the initiation of marketing operations and the
corresponding costs.
General and administrative costs were $447,000 for the first six months of
1997, an increase of 48% over the comparable 1996 total of $303,000, reflecting
the growth in Company operations during 1997 and the accompanying growth in
personnel and facilities.
Depreciation, depletion and amortization increased 189% to $374,000 for the
six months ended June 30, 1997 from $129,000 for the same period in 1996. The
increase reflects the recovery of costs for capital projects recently placed
into service, primarily the Saltville Facility.
INTEREST EXPENSE. Interest expense increased 38% to $717,000 during the
first six months of 1997 from $521,000 in the comparable 1996 period, due
primarily to additional tax-exempt bond financing. The Company capitalizes
interest on expenditures for significant projects while activities are in
progress to
15
<PAGE>
bring the assets to their intended use. Capitalized interest for the six month
periods ended June 30, 1997 and 1996 totaled $170,000 and $162,000,
respectively.
EQUITY IN EARNINGS OF AFFILIATES. The Company has a 50% ownership interest
in two Affiliates which provide natural gas storage, gathering and distribution
services. The Company accounts for its investments in these companies using the
equity method. The Company's equity in the earnings of these Affiliates
decreased 37% to $131,000 for the first six months of 1997 from $208,000 for the
same period in 1996. The decrease reflects increased operations expenses related
to natural gas storage operations in addition to higher interest costs. The
increased costs were partially offset by increased usage during the period by
industrial customers of the Distribution Affiliate.
INCOME TAXES. Using the asset-and-liability method, deferred income taxes
reflect the temporary differences between assets and liabilities recognized for
financial reporting purposes and amounts recognized for income tax purposes. The
Company's provision for income taxes as a percentage of income before its equity
in earnings of Affiliates (the Company's equity in earnings of Affiliates is
reflected on a post-income tax basis) was 32% for the six month period ended
June 30, 1997. For the six months ended June 30, 1996, the Company's operations
reflected an income tax benefit.
EQUITY INVESTMENTS
NATURAL GAS STORAGE. Storage revenues from the Early Grove Facility for the
six months ended June 30, 1997 were $1,265,000 compared with storage revenues of
$877,000 for the same period in 1996 due to increased storage capacity at the
Early Grove Facility.
NATURAL GAS GATHERING. Gathering revenues totaled $159,000 for the first
six months of 1997 compared to $207,000 for the same period in 1996, reflecting
a decrease in natural gas throughput due partially to production decline and to
decreased peak winter service sales volume as a result of the milder seasonal
temperatures experienced during the first quarter 1997 as compared to the
corresponding period in 1996. Revenues from winter service sales totaled
$613,000 for the six months ended June 30, 1997, compared to $781,000 for the
same period in 1996. Purchased gas expenses related to these sales totaled
$511,000 and $664,000 for the six months ended June 30, 1997 and 1996,
respectively.
NATURAL GAS DISTRIBUTION. Distribution revenues for the first six months of
1997 were $419,000, an increase of $120,000 over revenues of $299,000 for the
same period in 1996 largely due to increased usage during the period by
industrial customers, which increase was partially offset by decreased
residential customer usage as a result of milder seasonal temperatures.
Purchased gas costs related to these sales totaled $239,000 for the first six
months in 1997 and $147,000 for the same period in 1996.
RESULTS OF OPERATIONS FOR YEARS 1996 AND 1995
OVERVIEW. During the year ended December 31, 1996, the Company recorded net
income of $608,000, compared to $474,000 for 1995. Net income per common share
available to common stockholders for the years was $0.21 in 1996 compared with
$0.62 in 1995. The number of weighted average shares used in calculating income
per common share was 1,637,576 and 695,669 for the years ended December 31, 1996
and 1995, respectively.
REVENUES. Total revenues increased 37% to $2.8 million for the year ended
December 31, 1996 compared to $2.0 million for 1995. Gas sales and well
operation revenues totaled $699,000 in 1996 compared to $603,000 in 1995, an
increase of 16%. This increase primarily reflects an increase in the average
sales price of natural gas to $2.53/Mcf in 1996 from $1.47/Mcf in 1995. Propane
operations, initiated during the second half of 1996, reflected sales totaling
$47,000 for the year ended December 31, 1996.
16
<PAGE>
Natural gas gathering and service revenue decreased 22% to $104,000 for the
year ended December 31, 1996, compared to $134,000 in 1995, primarily as a
result of the Company's 1995 revision of its method of recording certain
gathering revenues. Gathering revenues for 1995 include $35,000 which would not
have been recognized had this revision not been made. See Note 2 of Notes to the
Consolidated Financial Statements.
Natural gas storage revenue totaled $769,000 for the year ended December 31,
1996, compared to zero revenue in 1995. Initial injections of customer natural
gas into the Saltville Facility began in August 1996. Contracted storage
capacity for 1996 contract year totaled 583,000 MMBtu, consisting of 10-day
(59%), 60-day (10%), and 90-day (31%) service.
Management revenues, interest income and other revenue decreased 7% to $1.2
million in 1996, compared to $1.3 million in 1995, primarily as a result of
lower management fees due to the Company's purchase of its partner's interest in
the Saltville Facility.
COSTS AND EXPENSES. Total operating costs and expenses increased 24% to
$1.3 million for the year ended December 31, 1996, compared to $1.1 million for
the same period in 1995. Total production and purchased gas expenses increased
107% to $134,000 in 1996 from $65,000 in 1995 as a result of increased
production expenses and the purchased gas expense related to the 1996
development of propane operations.
Operating and maintenance expense related to the Company's storage
operations was $173,000 in 1996, compared to zero in 1995.
General and administrative expense decreased 9% to $646,000 in 1996 from
$708,000 in 1995. This decrease was due primarily to the shift of certain
personnel and administrative functions from the corporate level to the
individual operating subsidiaries, including the Affiliates.
Depreciation, depletion and amortization increased 27% to $387,000 in 1996
from $305,000 in 1995 reflecting the recovery of costs for capital projects,
primarily the Saltville Facility, then recently placed into service.
INTEREST EXPENSE. Interest expense increased 50% to $1.0 million in 1996
from $673,000 in 1995 due primarily to additional tax-exempt bond financing and
a promissory note issued by the Company to purchase the interest of its joint
venture partner in the development of the Saltville Facility. The Company
capitalizes interest on expenditures for significant projects while activities
are in progress to bring the assets to their intended use. Capitalized interest
totaled $290,000 in 1996 and $93,000 in 1995.
EQUITY IN EARNINGS OF AFFILIATES. The Company's equity in the earnings of
Affiliates increased 27% to $340,000 for 1996 from $267,000 in 1995. The
increase primarily reflects increased storage revenues attributable to an
increase in leased storage capacity.
INCOME TAXES. The Company's provision for income taxes as a percentage of
income before equity in earnings of Affiliates (the Company's equity in earnings
of Affiliates is reflected on a post-income tax basis) was 36% in 1996 and 23%
in 1995.
EQUITY INVESTMENTS
NATURAL GAS STORAGE. Storage revenues from the Early Grove Facility totaled
$2.1 million in 1996, reflecting an increase in revenues of $900,000 over 1995
revenues of $1.2 million, due largely to an increase in leased storage capacity
at the Early Grove Facility.
NATURAL GAS GATHERING. Gathering revenues totaled $378,000 in 1996,
reflecting a decrease of $159,000 from 1995 gathering revenues of $537,000,
partially reflecting a decrease in system throughput during 1996. In addition,
$110,000 of 1995 revenue reflects the revision of the method of recording
certain gathering revenues. See Note 2 of Notes to the Virginia Gas Storage
Company's Financial Statements.
17
<PAGE>
Revenues from winter service sales totaled $1.1 million in 1996 compared to
$888,000 in 1995 due to higher prevailing natural gas sales prices. Purchased
gas expenses related to these sales totaled $974,000 and $681,000 for 1996 and
1995, respectively.
NATURAL GAS DISTRIBUTION. Distribution revenues increased to $629,000 in
1996 from $556,000 in 1995 partially due to an increase in residential and
commercial customers, reflecting 1996 expansions of distribution facilities in
Russell and Buchanan Counties and to an increase in the average sales price for
industrial customers. Purchased gas costs related to these sales totaled
$330,000 and $234,000 in 1996 and 1995, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company anticipates that cash flow from operations, together with
proceeds of this offering and other short-term borrowings, will be sufficient to
meet its foreseeable requirements for working capital, capital expenditures and
other cash requirements of its existing facilities. Material capital expenditure
commitments for planned current projects are expected to include $14.7 million
for the development of the P-24 and P-25 pipelines and $750,000 for continued
development of the Saltville storage facility. The Company will require
substantial additional capital to expand and diversify its operations beyond its
current plans. Because future cash flows are subject to a number of variables,
such as changes in supply and demand, general economic conditions and other
market conditions over which the Company has no control, there can be no
assurance that the Company's capital resources will be sufficient to meet such
requirements.
WORKING CAPITAL
At June 30, 1997, the Company's working capital reflected a $519,000
deficit, a decrease in working capital from the $430,000 deficit at December 31,
1996. The Company's current ratio was .87 at June 30, 1997, consistent with the
ratio at December 31, 1996. The combined working capital of the Early Grove
Affiliate and the Distribution Affiliate increased to a $1.4 million deficit at
June 30, 1997 from the $600,000 deficit at December 31, 1996. The combined
current ratio of these companies was .58 at June 30, 1997.
INVESTING AND FINANCING ACTIVITIES
The Company's cash requirements in the past have been met out of cash
generated from operations, proceeds from the issuance of the Company's common
stock, amounts borrowed in conjunction with tax exempt bonds issued by the
Industrial Development Authorities of Russell and Buchanan Counties, Virginia in
addition to other borrowings. The Company's rapid pace of growth and the timing
of the completion of financing transactions periodically have limited the
Company's short term liquidity. On June 30, 1997, the Company had a cash balance
of $1,526,000 compared to $1,653,000 at December 31, 1996.
Capital investments of $3.2 million for the first six months of 1997 reflect
primarily continued development of the Saltville Facility ($1.7 million),
expansion of the Company's propane distribution operations ($1.1 million) and
development of the P-25 pipeline project ($200,000).
Capital investments of $11.6 million in 1996 reflect primarily the
development of the Saltville Facility ($10.3 million) and the P-25 pipeline
project ($900,000).
Capital investments of $2.3 million in 1995 reflect primarily the
development of the Saltville Facility ($800,000), development of other storage
facilities ($900,000) and development of the P-25 pipeline project ($400,000).
18
<PAGE>
In October 1996, the Company completed an initial public offering of its
common stock. The offering resulted in the issuance of an additional 1,533,000
shares of common stock of the Company at $6 per share. Net proceeds realized
from the offering approximated $8 million.
In July 1996, the Company issued 42,000 shares of its common stock to an
officer of the Company. The net proceeds of the sale of these shares were
$252,000.
In May 1996, the Company issued 800,058 shares of its common stock to one
investor pursuant to a private placement. The net proceeds of the sale of these
shares were $4,401,317.
In September 1995, the Company issued and sold a total of 2,000 shares of
preferred stock in a private placement to a sole investor, Sirrom Capital
Corporation, at a price of $1,000 per share. Proceeds from the sale were used
for working capital, the retirement of debt and general corporate purposes. In
February 1997, the Company redeemed these shares at face value.
During 1995 the Company issued and sold a total of 124,316 shares of common
stock in conjunction with the exercise of stock options. Proceeds from the sales
totaled $496,000.
In February 1997 the Industrial Development Authority of Russell County (the
"Russell County Authority") issued its Subordinated Natural Gas Facilities
Revenue Bonds Series 1997 with principal of $9,100,000 with interest at 9.5% per
annum, repayable from 2002 to 2017. Approximately $3.7 million of the proceeds
was loaned by the Company to the Distribution Affiliate pursuant to an unsecured
note. The proceeds are being used for construction of a natural gas distribution
facility in and around the town of Lebanon, Virginia and for related storage and
pipeline facilities.
In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000
with interest at 9% per annum, repayable from 1999 to 2020. Approximately $3.7
million of the proceeds, received by the Company, was loaned to the Affiliates
pursuant to an unsecured note. Proceeds were used to extend existing natural gas
distribution facilities in and around the town of Grundy, Virginia, and for
related supporting pipeline gathering and storage facilities.
In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000 with interest at an effective
rate of 8.88%, repayable from 1995 to 2017. The bonds were also issued in parity
with the Russell County Bonds discussed above. Approximately $3.6 million of the
proceeds, received by the Company, was loaned to the Affiliates. Proceeds were
used to construct a natural gas distribution facility in and around the town of
Grundy, Virginia, and for related supporting exploration and production,
pipeline, and storage facilities.
In January 1994, the Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000 at an effective
interest rate of 7.35% per annum, repayable from 1996 to 2023. Approximately
$2.6 million of the proceeds, received by the Company, was loaned by the Company
to the Affiliates. Proceeds were used to construct a natural gas distribution
facility in and around the town of Castlewood, Virginia, and for related
supporting exploration and production, pipeline and storage facilities in the
amount of $2,630,000 and to retire $370,000 of long-term debt.
19
<PAGE>
BUSINESS
OVERVIEW
Virginia Gas Company (the "Company"), directly or through Affiliates, is
primarily engaged in the exploration, production, marketing, gathering, storage,
and distribution of natural gas, and distribution of propane gas. The Company's
principal assets are located in the Commonwealth of Virginia, a region which is
experiencing significant economic growth and increasing demand for natural gas
and has access to three major interstate gas pipeline systems.
The Company's existing and planned assets comprise: (i) interests in 85
natural gas wells with proved developed reserves of approximately 2.6 Bcf; (ii)
gathering systems with over 102 miles of pipeline with a current annual
throughput of over 1.67 Bcf, connected to the interstate pipeline systems of
ETNG, CNG and TCO; (iii) two underground storage facilities with current
capacity of 2.2Bcf MMBtu; and (iv) 120 miles of intrastate pipeline under
development with planned aggregate daily throughput of approximately 50 MMcf/d.
The Company's business has developed in response to the growing need for
natural gas storage, pipelines and distribution in its market area, resulting
principally from economic growth and the impact of deregulation. Deregulation
has given natural gas customers more flexibility in negotiating their natural
gas purchases and transportation contracts. The Company's pipeline connections
to the ETNG, CNG, and TCO, and to the Company's adjacent storage facilities,
combine to create a hub which provides opportunities for more efficient gas
distribution, including to local, growing markets. At present, the Company's
business primarily consists of: (i) producing, gathering and marketing natural
gas from wells in which the Company has an ownership interest to municipal
distributors, local distribution companies and major oil and gas companies; (ii)
storing natural gas for municipal distributors and local distribution companies
which have supplied their own gas, or purchased it from third parties or the
Company; and (iii) distributing propane and natural gas purchased from third
parties or the Company to local industrial, commercial and residential
customers.
The Company's principal sources of revenue have varied depending on its
level of activity in any given segment of natural gas operations. From 1987
through 1992, substantially all of the Company's income was derived from
exploration, development and production of natural gas and from fees derived
from managing wells. From 1993 through 1996, the Company's income reflected the
growth of its storage operations. In 1996 and 1997, the Company initiated its
propane distribution and gas marketing operations, respectively. Today, the
Company is building transmission pipelines and expanding its storage capacity
and expects to derive future income primarily from natural gas storage and
transportation fees.
MARKET OVERVIEW
The Company anticipates that its business will benefit from the increasing
economic and natural gas consumption growth in the Commonwealth of Virginia and
surrounding states. The U.S. Department of Energy has forecasted that natural
gas consumption will continue a trend that has seen gas consumption rise 32%
nationwide and 77% in Virginia between 1986 and 1995. Management believes that
current upward trends in the economy, a favorable regulatory environment, the
deregulation of the industry which has resulted in end-users' ability to
purchase gas on a competitive basis from a greater variety of sources, and the
increasing availability of natural gas as a form of energy for residential,
commercial and industrial markets will enable the Company to expand into new
markets and to better develop its current markets. Management believes that it
is well positioned in its market area to capitalize on the opportunities
prevalent in the natural gas industry.
STRATEGY
The Company's objective is to enhance earnings and cash flow by becoming a
leading integrated natural gas company in its market area. The Company's
strategy to achieve this objective is to construct
20
<PAGE>
pipeline systems, increase the utilization of its existing storage facilities,
and aggressively pursue end-user customers. The Company intends to implement
this strategy through the following steps:
CONSTRUCT PIPELINE SYSTEMS. The Company is currently in the process of
acquiring rights-of-way and receiving state approval for the construction of the
P-25 intrastate pipeline which will connect its Saltville Facility to growing
markets in Smyth, Wythe and Pulaski Counties in southwestern Virginia. The
Company also intends to build the P-24 intrastate pipeline which will connect
its Saltville Facility to the CNG interstate pipeline. These pipelines will
allow the Company to develop a transportation business, capture additional peak
storage business, connect to increased supply sources for existing and growing
markets and provide customers with greater flexibility in managing their gas
resources.
INCREASE UTILIZATION OF EXISTING STORAGE FACILITIES. Management believes
that the working gas capacities of the Saltville Facility and the Early Grove
Facility can be increased to 10 Bcf and 2.2 Bcf, respectively, from their
current capacities of 0.6 Bcf and 1.6 Bcf, respectively. By increasing storage
capacity through the opportunities created by the P-24 and P-25 pipelines, the
Company expects to be able to provide additional peak storage service to
existing and new customers and to thereby enhance the profitability of its
storage operations.
PURSUE END-USER CUSTOMERS. As a result of recent regulatory changes,
natural gas customers have more flexibility to negotiate their natural gas
purchases, storage services, and transportation contracts. The Company is
actively pursuing direct sales to these end-users, such as local distribution
companies, industrial plants and municipalities, which are seeking alternative
supplies to meet their energy needs. The Company is distributing propane to
offer alternative energy choices to customers in its service area who may elect
to use propane gas or who may not otherwise be serviced with natural gas.
BUSINESS ACTIVITIES
The Company's principal business activities are as follows:
STORAGE OPERATIONS
The Company has the only two underground natural gas storage facilities in
the Commonwealth of Virginia: The Saltville Facility, located in Smyth and
Washington counties, (owned by the Company) and the Early Grove Facility,
located in Scott and Washington Counties (owned by the Early Grove Affiliate).
Customers contract for storage for annual periods ranging from one to 15 years,
which includes the heating season months of November through March. Contract
storage fees are prorated and paid in equal amounts over a twelve-month period,
with additional payments for injection and withdrawal fees. These contracts are
subject to termination if the storage facility operating company fails to
perform.
The Company is continually assessing the feasibility of developing
additional natural gas storage facilities in its area of operation and is
analyzing available geological and geophysical data and land records related
thereto.
SALTVILLE FACILITY. The Company has developed a high deliverability salt
cavern storage facility in Saltville, Virginia for use as a high rate, peak
usage storage facility. The Saltville Facility utilizes caverns created in
underground salt beds to store natural gas. The Company's engineering staff
believes the ultimate working gas capacity of the Saltville Facility could be up
to 10 Bcf. In June 1996, the Company filed an application with the VSCC for a
CPCN for the operation of the Saltville Facility as a storage facility. In July
1996, the VSCC issued an order authorizing the Company to begin service on an
interim basis using the rates set forth in the application. These interim rates
for 10-day, 60-day and 90-day service are $5.64, $1.86 and $1.50 per MMBtu
stored, respectively, plus $0.05 per MMBtu injected and $0.05 per MMBtu
withdrawn. In August 1996, the Company injected the first working gas into the
field. Peak daily withdrawal rates of 40,000 MMBtu were achieved in January
1997. Current customer commitments total 657,400 MMBtu of capacity, the current
maximum capacity of the Saltville Facility, for the 1997/1998 heating season.
21
<PAGE>
An industry company has an option to jointly develop with the Company other
storage caverns that are not part of the current and proposed Saltville Facility
operations. This company's participation in such development will be on a
50%-50% basis.
The Company currently services contracts for storage with the entities set
forth below (contracted storage is expressed per contract year that includes the
heating season beginning in the year stated; revenues are expressed per calendar
year and include injection and withdrawal fees). In future periods the contracts
with Hawkins County Utility District and Sevier County Utility District may be
serviced by the Early Grove Affiliate.
UNITED CITIES GAS COMPANY. Contracted annual storage is for 300,000 MMBtu
through 2011. The estimated annual revenues expected to be generated from this
contract are $1,722,000.
KNOXVILLE UTILITIES BOARD. Contracted annual storage is for 40,000 MMBtu,
increasing in 1997 to 90,000 MMBtu through 2000. The estimated annual revenues
expected to be generated from this contract are $516,600.
CITIZENS GAS UTILITY DISTRICT. Contracted annual storage is for 3,000 MMBtu
through 2006. The estimated annual revenues expected to be generated from this
contract are $17,220.
CITY OF ETOWAH, TENNESSEE. Contracted annual storage is for 2,000 MMBtu
through 2007. The estimated annual revenues expected to be generated from this
contract are $11,480.
HAWKINS COUNTY UTILITY DISTRICT. Contracted annual storage is for 180,000
MMBtu of 90-day service through 2006 and 5,000 MMBtu of 10-day service through
2007. The estimated annual revenues expected to be generated from these
contracts are $316,700.
SEVIER COUNTY UTILITY DISTRICT. Contracted annual storage is for 60,000
MMBtu through 2006. The estimated annual revenues expected to be generated from
this contract are $117,600.
ALCOA. Contracted annual storage is for 17,400 MMBtu through 2002. The
estimated annual revenues expected to be generated from this contract are
$99,876.
EARLY GROVE FACILITY. The Early Grove Facility is an underground natural
gas storage facility owned and operated by the Early Grove Affiliate. The Early
Grove Affiliate has received a CPCN from the VSCC, which authorizes it to engage
in the sale, transportation (including storage), or assignment of natural gas
and to charge rates approved by the VSCC. The Early Grove Facility has 29
storage wells, a certificated area of 2,900 acres, and has received approval to
charge rates for 60-day, 90-day, 120-day and 150-day service of $1.86, $1.50,
$1.33 and $0.85 per MMBtu stored, respectively, plus $.05 per MMBtu injected and
$.05 per MMBtu withdrawn.
Contracted storage volume for 60-day, 90-day and 150-day service has
increased from 520,000 MMBtu for the 1994/1995 heating season to 1,485,000 MMBtu
for the 1997/1998 heating season. The deliverability of the Early Grove Facility
has been increased by reworking existing wells, drilling new wells, injecting
additional base gas, installing new compression equipment and increasing the
maximum operating pressure of the field to 2,000 PSI from 1,400 PSI. Peak
January deliverability has been increased from 1,000 MMBtu to over 16,000 MMBtu
per day from 1992 to 1997. Further improvements, including drilling new wells,
adding additional base gas and increasing the maximum operating pressure to up
to 2,400 PSI, are planned. Management believes these improvements would increase
the field's capacity to 2,200,000 MMBtu in the future.
The Early Grove Affiliate currently has contracts for storage with the
following entities (contracted storage is expressed per contract year that
includes the heating season beginning in the year stated; revenues are expressed
per calendar year and include injection and withdrawal fees):
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<PAGE>
KNOXVILLE UTILITIES BOARD. Contracted annual storage is for 450,000 MMBtu
for 1997 through 2002. The estimated annual revenues expected to be generated
from this contract are $720,000.
POWELL-CLINCH UTILITY DISTRICT. Contracted annual storage is for 525,000
MMBtu for 1997, increasing an additional 75,000 MMBtu for each subsequent year
up to 975,000 MMBtu for 2003 and remaining at up to 975,000 MMBtu for each year
through 2009. The estimated annual revenues expected to be generated from this
contract are $498,750 per year in 1997, increasing to a maximum of $926,250 in
2004.
ROANOKE GAS COMPANY. Contracted annual storage is for 180,000 MMBtu for
1997 through 2007. The estimated annual revenues expected to be generated from
this contract are $288,000.
UNITED CITIES GAS COMPANY. Contracted annual storage is for 180,000 MMBtu
through the 2000 contract year. The estimated annual revenues expected to be
generated from this contract are $352,800.
PUBLIC UTILITY DISTRICT OF JEFFERSON AND COCKE COUNTIES. Contracted annual
storage is for 150,000 MMBtu from 1997 through 2002. The estimated annual
revenues expected to be generated from this contract are $142,500.
PIPELINE OPERATIONS
In 1996, the Company initiated environmental and feasibility studies for the
construction of the P-25 pipeline which will connect the Company's Saltville
Facility to the ETNG interstate pipeline system and transport natural gas to
growing markets in Smyth, Wythe and Pulaski Counties in southwestern Virginia.
These areas currently are served only by the ETNG pipeline, which has
insufficient capacity to meet the area's needs.
The first phase of construction of the P-25 pipeline consists of 20 miles of
pipe connecting the Company's Saltville Facility to the ETNG interstate pipeline
system and twinning the ETNG line to the town of Marion. The remaining phases
will extend the P-25 pipeline from Marion, Virginia to Radford, Virginia. The
Company has entered into a 15-year contract with United Cities Gas Company, the
local distribution company ("UCGC") which serves Smyth, Wythe and Pulaski
Counties, to provide pipeline capacity to supply 20,000 MMBtu per day, or 67% of
expected pipeline capacity. The Company has filed for a CPCN with the VSCC and
expects a decision by late 1997 or early 1998. At present, the Company is aware
of no reason why a CPCN would not be issued. Tariffs would be set by the VSCC
and charged by the Company for reserved capacity in the pipeline. The Company
expects to complete obtaining land easements and permits and to begin
construction upon obtaining the CPCN. Assuming no unforeseen impediment to its
development, the Company expects the P-25 pipeline to commence operations in
late 1998.
The Company has recently initiated environmental studies and acquisitions of
rights-of-way for permits for the construction of the P-24 pipeline. When
completed, the P-24 pipeline would connect the Company's Saltville Facility to
the CNG interstate pipeline system. The P-24 pipeline is expected to provide a
strategic interconnect between the ETNG and CNG interstate pipeline systems and
would result in additional sources of natural gas supply for the Company's
Saltville Facility.
NATURAL GAS AND PROPANE DISTRIBUTION OPERATIONS
The Company, through the Distribution Affiliate, owns and operates natural
gas distribution systems in Russell and Buchanan Counties in Virginia. The
Distribution Affiliate has a CPCN authorizing it to provide natural gas service
to Russell and Buchanan Counties. The Distribution Affiliate's tariffs to its
customers are set by the VSCC.
The Distribution Affiliate has a firm transportation service contract for a
ten-year term with ETNG for the heating season of November through March, and an
interruptible transportation contract with ETNG for the remainder of the year.
Any disruption accessing ETNG's pipeline could result in the Distribution
Affiliate's inability to serve its customers in the affected areas.
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<PAGE>
The Distribution Affiliate recently completed construction of a 10-mile
pipeline providing service to the town of Lebanon in Russell County. The
Distribution Affiliate has entered into franchise agreements with the towns of
Richlands and Cedar Bluff in Tazewell County which adjoin the Distribution
Affiliate's current service areas and has applied to the VSCC for a CPCN to
provide natural gas service for Tazewell County and Dickenson County.
Restrictions under the Company's debt instruments may inhibit the Affiliate's
ability to develop these areas. See "Risk Factors--Company Indebtedness and
Restrictive Covenants."
The Company recently commenced distribution of propane gas in southwestern
Virginia. The Company believes that its ability to supply propane gas will
satisfy customers' desire for alternative fuel choices and will enable the
Company to expand market share by providing another alternative in areas where
natural gas is not available. Because of shared costs and similarities such as
easily converted appliances, many natural gas utilities provide both products to
their customers. Customers often do not distinguish between the two forms of gas
when used in the home. The Company intends, in part, to develop its propane
distribution business through selective acquisitions. In that regard, the
Company acquired a portion of Blue Grass Oils Incorporated's existing propane
distribution business in Buchanan, Dickenson and Russell Counties and in the
western part of Tazewell County, Virginia in April 1997.
EXPLORATION, PRODUCTION, GATHERING AND MARKETING OPERATIONS
The Company's exploration and production operations consist of acquiring and
developing natural gas properties by acquiring mineral leases from landowners,
drilling and completing wells on the properties and building gas gathering
lines. These activities are typically organized on a joint venture basis with
third parties, with the Company acting as operator of the wells, retaining a
working interest in the project and receiving some promotional consideration.
The Company's net revenue interest in these wells typically averages 10 to 11%.
ACREAGE. The following table sets forth the gross and net acres of
developed and undeveloped natural gas mineral leases held by the Company as of
December 31, 1996. Undeveloped acreage includes leasehold interests which may
already have been classified as containing proved undeveloped reserves.
<TABLE>
<CAPTION>
DEVELOPED ACREAGE(1) UNDEVELOPED ACREAGE
------------------------------ --------------------------------
<S> <C> <C> <C> <C>
GROSS NET GROSS NET
------------- --------------- --------------- ---------------
Virginia.............................................. 11,096 3,537 2,239 2,239
West Virginia......................................... 257 21 -- --
------ ----- ----- -----
Total............................................. 11,353 3,558 2,239 2,239
------ ----- ----- -----
------ ----- ----- -----
</TABLE>
- ------------------------
(1) Developed acreage is acreage assigned to producing wells for the spacing
unit of the producing formation. Developed acreage in certain of the
Company's properties that include multiple formations with different well
spacing requirements may be considered undeveloped for certain formations,
but has only been included as developed acreage in the presentation above.
GAS RESERVES. The Company has conducted an "in-house" estimate of the
Company's proved reserves, projected future production and estimated future net
revenues from production of proved reserves as of December 31, 1996. The
Company's estimates were based upon a review of production histories and other
geologic, economic, ownership and engineering data provided by the Company. In
determining the estimates of reserve quantities that are economically
recoverable, the Company used natural gas prices and estimated development and
production costs as of December 31, 1996. For further information concerning the
present value of future net revenues from the proved reserves, see Note 14 of
Notes to the Consolidated Financial Statements.
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<PAGE>
The following table sets forth gas reserve information estimated as of
December 31, 1996. The present values of estimated future net revenues
(discounted at 10% per annum) shown in the table are not intended to represent
the current market value of the proved reserves owned by the Company.
<TABLE>
<CAPTION>
PROVED RESERVES
---------------------------------------
<S> <C> <C> <C>
DEVELOPED UNDEVELOPED TOTAL
----------- --------------- ---------
Gas (MMcf)................................................................. 2,570 593 3,163
Present value of estimated future net revenues before income taxes (in
thousands)............................................................... $ 4,601 $ 1,194 $ 5,795
Present value of future net cash flow after income taxes (in thousands).... $ 2,848 $ 785 $ 3,633
</TABLE>
There are numerous uncertainties inherent in estimating quantities of proved
reserves and in projecting future rates of production and timing of development
expenditures, including many factors beyond the control of the producer. The
reserve data set forth herein represent only estimates. Reserve engineering is a
subjective process of estimating underground accumulations of oil and gas that
cannot be measured in an exact way, and the accuracy of any reserve estimate is
a function of the quality of available data and of engineering and geological
interpretation and judgment and the existence of development plans. As a result,
estimates of different engineers often vary. In addition, results of drilling,
testing and production subsequent to the date of an estimate may justify
revision of such estimates. Accordingly, reserve estimates are often different
from the quantities of oil and gas that are ultimately recovered. Further, the
estimated future net revenues from proved reserves and the present value thereof
are based upon certain assumptions, including geologic success, prices (which
are higher during the heating season), future production levels and costs, that
may not prove correct over time. Predictions about prices and future production
levels are subject to great uncertainty, and the meaningfulness of such
estimates is highly dependent upon the accuracy of the assumptions upon which
they are based. Oil and gas prices have fluctuated widely in recent years. The
weighted average sales price utilized for the purposes of estimating the
Company's proved reserves and future net revenues therefrom as of December 31,
1996 was $4.23 per Mcf., which was a significantly higher price than present
prices due to seasonal changes and unusually high prices for the 1996/1997
heating season. The Company estimates that, if all other factors (including the
estimated quantities of economically recoverable reserves) were held constant, a
$0.10 per Mcf. decline in gas price from that used in the reserve reports would
reduce such present value by approximately $152,000. See "Risk
Factors--Uncertainty of Propane and Natural Gas Prices, Supplies and Demand."
PRODUCTION. All of the Company's wells produce primarily gas. The following
table sets forth the Company's gas production and sales data during the period
indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
<S> <C> <C>
1996 1995
--------- ---------
Net production:
Gas (Mcf)................................................................................. 161,995 160,798
Average sales price per unit:
Gas (Mcf)................................................................................. $ 2.53 $ 1.47
Average net production cost ($/Mcf)....................................................... $ 0.22 $ 0.20
</TABLE>
The Company owned interests in 85 gross (21 net) natural gas wells as of
December 31, 1996. A well is categorized under state reporting regulations as an
oil well or a gas well based upon the ratio of gas to oil produced when it first
commenced production, and such designation may not be indicative of current
production.
DRILLING ACTIVITY. The Company has not drilled or completed any wells since
1994.
25
<PAGE>
OIL FIELD SERVICE OPERATIONS. The Company engages in the business of
supervising drilling operations and operating producing wells. As of December
31, 1996 the Company operated 80 wells located in Virginia and West Virginia. As
operator of producing wells, the Company is responsible for the maintenance and
verification of all production records, contracting for gas sales, distribution
of production proceeds and information, and compliance with various state and
federal regulations. Generally, the Company provides the routine day-to-day
production operations for producing wells and is paid for such services on a per
well, monthly fee basis.
GAS GATHERING OPERATIONS. The Early Grove Affiliate and the Company operate
various unregulated gas gathering systems located mainly in Dickenson and
Buchanan Counties in Virginia which connect the Company's operated wells to
interstate pipelines. The gathering systems consist of 102.6 miles of pipeline,
two 640 horsepower compressor stations and one 120 horsepower compressor
station. The gathering systems connect the Company's gas production to the ETNG,
CNG and TCO interstate pipeline systems as well as to the Distribution
Affiliate's distribution system. Total 1996 throughput for the Company's
gathering systems was 1.67 Bcf.
For such gas gathering services, the Company collects certain transportation
allowances from producers (owners of natural gas). Transportation allowances
vary depending upon contractual arrangements and currently range from $0.05 to
$0.50 per MMBtu.
MARKETING. In 1997 the Company commenced marketing operations of natural
gas. The Company currently markets and sells natural gas provided from
Company-operated wells and facilities. The Company anticipates that future
expansion of its marketing operations will include purchases of natural gas
supplies from third party sources, storing these supplies in its Saltville
Facility and marketing these supplies to its customers.
COMPETITION
The Company competes with major utility companies and pipeline companies in
the areas of utility services and pipeline operations. The deregulation of the
natural gas industry has provided the Company with marketing and transportation
opportunities; however, other pipeline companies, marketers and brokers with
resources far greater than the Company likewise are the beneficiaries of such
deregulation. While the Company and the Early Grove Affiliate currently own and
operate the only underground natural gas storage facilities in Virginia, it is
possible that other distribution and marketing companies could develop other
underground natural gas storage facilities and companies could rely on other
methods of storage such as above-ground stored liquefied natural gas. The
Company competes in the areas of exploration, production, transportation and
marketing of natural gas and distribution of propane with major oil companies,
other independent oil and gas concerns and individual producers and operators.
Many of the Company's competitors have substantially greater financial and other
resources than the Company.
REGULATION
VSCC REGULATION. The Company's and its Early Grove Affiliate's storage
operations are regulated primarily by the VSCC and the FERC, which has
jurisdiction over interstate sales of storage services. Storage rates are
subject to VSCC approval and are based on the cost of service of the facility,
which provide for an approved rate of return. A facility can apply for revised
rates based on actual costs if they are higher than previously anticipated and
conversely the VSCC may require a reduction in rates if returns are higher than
anticipated. Management believes that the rates currently in effect are adequate
to cover the cost of service and achieve the desired rate of return.
The Company's non-gathering pipeline operations will also be regulated by
the VSCC. In January 1997, the Company filed an application for a CPCN to
operate one of the pipelines. The Company has also filed with the VSCC proposed
transportation rates on the basis of revenues, expenses and investments.
26
<PAGE>
Substantially all of the operations conducted through these pipelines would
constitute common carrier pipeline activities. Such common carrier activities
are those under which transportation in the pipeline is available at tariff
rates published with the VSCC to any shipper of natural gas who requests such
services, provided that each product for which transportation is requested
satisfies the conditions and specifications for transportation.
The distribution operations of the Distribution Affiliate are also regulated
by the VSCC, which regulates the rates which may be charged to end-users,
setting them at levels sufficient to recover the cost of service to its
customers including an approved rate of return. Management believes the rates
currently in effect are adequate to cover the cost of service and achieve the
desired rate of return.
The Company's gathering facilities and propane distribution operations are
not subject to service or rate regulation from the VSCC.
FERC REGULATION. The Company's operations either are not governed by, or by
virtue of limited jurisdiction certificates having been issued by FERC, are
exempt from, further regulation by FERC under the Natural Gas Act.
ENVIRONMENTAL AND SAFETY REGULATION. The pipeline operations of the Company
are subject to various federal, state and local environmental laws. In
particular, operations in Virginia are subject to the Virginia Clean Air Act as
administered by the Virginia Department of Environmental Quality ("VDEQ"). The
Virginia Clean Air Act restricts emissions from wells, pipelines and processing
plants, and the VDEQ may curtail operations not meeting minimum standards. The
design, construction, operation and maintenance of the Company's VSCC
jurisdictional gas pipeline facilities are subject to the safety regulations
established by the United States Department of Transportation pursuant to the
Natural Gas Pipeline Safety Act of 1968, as amended, or by state agency
regulations meeting the requirements thereunder. The Company is also subject to
other federal, state and local laws covering the handling or discharge into the
environment of materials used by the Company, or otherwise relating to
protection of the environment, safety and health.
Expenditures for environmental control facilities and for remediation have
not been significant in relation to the results of operations of the Company.
The Company believes, however, that it is reasonably likely that the trend in
environmental legislation and regulations will continue to be toward stricter
standards. The Company is unaware of future environmental standards that are
reasonably likely to be adopted that will have a material effect on the
Company's results of operations, but there can be no assurance such standards
will not be adopted in the future.
The Company has designated an officer whose responsibility is to monitor
environmental compliance and potential environmental liabilities at its
facilities. No assessment has found any material environmental noncompliance or
cleanup liabilities the cost of which would have, in the aggregate, a material
effect on the Company's results of operations. However, assessments have not
been performed on all of the Company's facilities.
TITLE TO PROPERTIES
Substantially all of the properties comprising the Early Grove Facility and
the Saltville Facility are situated on land not owned by the Early Grove
Affiliate or the Company.
The Early Grove Affiliate's rights to develop and operate the Early Grove
Facility are derived from its ownership of mineral leasehold rights and from
surface easements.
The Company's rights to develop and operate the Saltville Facility are
derived from a deed from the Industrial Development Authority of the town of
Saltville. The deed provides the Company with rights to store gas, rights to use
any facilities and surface area for natural gas storage use and rights to remove
salts to create cavities for natural gas storage. The deed encompasses
approximately 11,000 acres of storage rights in Washington and Smyth Counties,
Virginia.
27
<PAGE>
The Company's existing pipelines, and gathering systems and distribution
systems are situated on land not owned by the Company but as to which the
Company and its Affiliates have easements from the landowners permitting the use
of such land for the construction and operation of pipeline facilities. The
Company has received or intends to receive franchises, easements, licenses,
permits and other authorizations to construct and operate proposed or future
pipelines, gathering systems and distribution systems within the jurisdiction of
various cities, counties and other government agencies and jurisdictions, as
well as along and across waterways and rights-of-way for federal, state, county
and city highways, streets and roads.
Substantially all of the Company's producing property interests are held
pursuant to leases from third parties. The Company has obtained title opinions
on substantially all of its producing properties and believes that it has
satisfactory title to such properties in accordance with standards generally
accepted in the natural gas industry. The Company's producing properties are
subject to customary royalty interests, liens for current taxes and other
burdens which the Company believes do not materially interfere with the use of
or affect the value of such producing properties.
OPERATIONAL HAZARDS AND INSURANCE
The operations of the Company and its Affiliates are subject to the usual
hazards incident to the storage, distribution, exploration for and production of
natural gas and the distribution of propane. These hazards can result in
substantial losses to the Company and its Affiliates due to personal injury and
loss of life, severe damage to and destruction of property and equipment,
pollution or environmental damage or suspension of operations. The Company and
its Affiliates maintain insurance coverage against such risks as are customarily
insured against by other businesses in the industry. For the Company, these
coverages include $2,000,000 ($1,000,000 per occurrence) of general liability
insurance (which insurance is provided in separate policies covering separate
operations), excess liability insurance in the amount of $25,000,000, workers'
compensation insurance and property and automobile insurance. Based on loss
experience, the Company believes that it and its Affiliates currently have
adequate insurance coverage. Their insurance, however, does not cover every
potential risk associated with the storage, distribution, drilling and
production of natural gas and the distribution of propane. In particular,
coverage is not obtainable for certain types of environmental hazards. The
occurrence of a significant adverse event, the risks of which are not fully
covered by insurance, would have a material adverse effect on the results of
operations of the Company. Moreover, no assurance can be given that the Company
and its Affiliates will be able to maintain adequate insurance in the future at
rates it considers reasonable.
LITIGATION
There is no pending nor, to the knowledge of the Company, any contemplated
litigation against the Company or its Affiliates which could have a material
adverse effect on their financial position or which is considered other than
routine litigation incidental to the Company's business.
OFFICE FACILITIES
The Company currently owns its headquarters office building in Abingdon,
Virginia, subject to a mortgage. This building contains 1,927 square feet of
office space. In addition, the Company leases 5,700 square feet of office space
in a building adjacent to its headquarters building.
EMPLOYEES
As of August 26, 1997, the Company employed 44 persons on a full time basis,
none of whom is covered by a collective bargaining agreement. The Company
considers its relations with its employees to be excellent.
28
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------------------- --- --------------------------------------------------------------
<S> <C> <C>
Michael L. Edwards.......................... 44 Chairman of the Board and President
Karen K. Edwards............................ 40 Vice President, Secretary and Director
Frank A. Merendino, Jr...................... 36 Vice President of Operations
John D. Jessee.............................. 36 Vice President, Treasurer and Chief Financial Officer
Mark N. Witt................................ 38 Vice President of Strategic Planning
Allan R. Poole, II.......................... 50 Vice President and Director
Stacey D. Varney............................ 25 Vice President and Assistant Secretary
Peter C. Einselen........................... 57 Director
Charles A. Mills, III....................... 50 Director
</TABLE>
MICHAEL L. EDWARDS. Mr. Edwards has served as President and Chairman of the
Board of the Company since its formation in 1987. His term as a director expires
in 1999. Mr. Edwards also serves as President of each of the Company's
subsidiaries and its Affiliates. From 1983 to 1986 he served as Executive Vice
President and Director of Petroleum Development Corporation. Mr. Edwards is the
husband of Karen K. Edwards.
KAREN K. EDWARDS. Ms. Edwards has served as Vice President, Secretary, and
Director of the Company since its formation in 1987 and until September 1995 she
served as Treasurer. Her term as a director expires in 1998. Ms. Edwards also
serves as Vice President and Secretary of each of the Company's subsidiaries and
its Affiliates. With the exception of Virginia Gas Propane Company she is also
Treasurer of each subsidiary and Affiliate. She is the wife of Michael L.
Edwards.
FRANK A. MERENDINO, JR. Mr. Merendino has served as Vice President of
Operations of the Company since 1991. He was employed by the Company as
Engineering Manager in 1990. Mr. Merendino was employed as a production engineer
by Equitable Resources Exploration from 1986 to 1990. He was employed from 1984
to 1986 as a petroleum engineer by Doran & Associates.
JOHN D. JESSEE. Mr. Jessee has served as Vice President, Treasurer and
Chief Financial Officer of the Company since 1995. He was employed by Eastman
Chemical Company from 1994 to 1995. Mr. Jessee was employed by the Company as
controller from 1992 to 1994. He was employed as controller of the golf division
of The United Company from 1989 to 1992. He was employed by Price Waterhouse
from 1984 to 1989.
MARK N. WITT. Mr. Witt has served as Vice President of Strategic Planning
since 1994. He also served as a Director of the Company from 1994 to May 1996.
From 1984 to 1994 Mr. Witt was employed as financial controller for global gas
for British Petroleum Co., PLC. From 1980 to 1984 he was employed by KPMG Peat
Marwick in Houston, Texas.
ALLAN R. POOLE, II. Mr. Poole has served as Vice President of the Company
since April 1996 and as a Director since September 1996. His term as a director
expires in 1998. Mr. Poole served as Vice President of Penn Virginia Resources
Corporation from 1989 to 1995. From 1978 to 1989 he was employed as regional
manager of Cabot Oil & Gas Corporation. Mr. Poole was employed as a senior
landman by Consolidated Gas Supply Corporation from 1971 to 1978.
STACEY D. VARNEY. Ms. Varney was recently appointed Vice President and has
served as Assistant Secretary of the Company since October 1996. In May 1995 she
joined the Company as Marketing
29
<PAGE>
Manager. Before joining the Company, she graduated from Clinch Valley College of
the University of Virginia and was employed by Penn Virginia Oil and Gas
Corporation in 1994 as an accountant.
PETER C. EINSELEN. Mr. Einselen has served as a director of the Company
since May 1996. His term as director expires in 2000. Mr. Einselen has served as
Senior Vice President of Anderson & Strudwick Incorporated since 1990. From 1983
to 1990, he was employed by Scott & Stringfellow, Incorporated, Richmond,
Virginia.
CHARLES A. MILLS, III. Mr. Mills has served as a Director of the Company
since September 1996 and has been employed by Anderson & Strudwick Incorporated
as a Senior Vice President since 1986. He served as Chairman of the Board of
Anderson & Strudwick Incorporated from 1990 to 1992 and from 1994 to the
present. His term as a director of the Company expires in 2000. He has served as
a director of Humphrey Hospitality Trust, Inc. since 1994.
Directors of the Company receive $2,500 for attending each quarterly Board
of Directors meeting. The executive officers of the Company are elected annually
by the Board of Directors. The executive officers serve terms of one year or
until their resignation or removal.
The by-laws of the Company provide that the Board of Directors shall be
comprised of five persons divided into three classes of directors, with each
class serving staggered three year terms. The by-laws may only be amended with
the approval of holders of 75% of the outstanding shares of stock of the
Company. The classification of the directors makes it more difficult for
shareholders to change the composition of the Board of Directors. The Company
believes, however, that the longer time required to elect a majority of a
classified board of directors will help ensure continuity and stability of the
Company's management and policies.
The classification provisions may also have the effect of discouraging a
third-party from accumulating large blocks of the Common Stock of the Company or
attempting to obtain control of the Company, even though such an attempt might
be beneficial to the Company and its shareholders. Accordingly, shareholders
could be deprived of certain opportunities to sell their shares of Common Stock
at a higher market price than might otherwise be the case. See "Description of
Securities--Certain Provisions of Certificate of Incorporation and Delaware
Law."
Pursuant to a Shareholders' Agreement and Voting Trust entered into on May
31, 1996, between Michael L. Edwards, Karen K. Edwards and Dr. James T. Martin,
these shareholders assigned all of their shares to Michael L. Edwards as trustee
for a period of five years. Mr. Edwards is directed in the agreement to vote
these shares for three nominees for director selected by Mr. Edwards and two
nominees selected by Dr. Martin. Pursuant to this agreement Peter C. Einselen,
Senior Vice President of Anderson & Strudwick Incorporated, was elected as Dr.
Martin's nominee for director. Pursuant to this agreement, the Edwards' nominee,
Allan R. Poole, II, and Dr. Martin's nominee, Charles A. Mills, III, a Senior
Vice President and Chairman of the Board of Anderson & Strudwick Incorporated,
were each elected to serve as directors.
Anderson & Strudwick Incorporated received a fee of $348,028 as a result of
the sale of the Company's Common Stock to Dr. Martin and has underwritten four
tax exempt bond offerings through which the Company has borrowed $20,100,000. A
fee equal to 0.25% of the outstanding principal amount of the bonds is paid to
Anderson & Strudwick Incorporated and one of its senior officers for bondholder
services. Anderson & Strudwick Incorporated received commissions totaling
$610,375 from the two bond offerings which closed during the last two years. In
addition Anderson & Strudwick Incorporated served as underwriter for the
Company's initial public offering of its Common Stock in 1996 for which it
received fees of $735,840 and warrants exercisable for 153,300 shares at an
exercise price of $9.90 per share, which are subject to a shelf registration
statement.
30
<PAGE>
LIMITATION OF LIABILITY AND INDEMNIFICATION
As permitted by the Delaware General Corporation Law, the Company's
Certificate of Incorporation provides that, to the fullest extent permitted by
the Delaware General Corporation Law, no director shall be personally liable to
the Company or its shareholders for monetary damages for the breach of fiduciary
duty in such capacity, except that liability is not eliminated (i) for breach of
the director's duty of loyalty to the Company or its shareholders, (ii) for acts
or omissions by the director not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) for willful or negligent
declaration of an unlawful dividend, stock purchase or redemption, or (iv) for
any transaction from which such director received an improper personal benefit.
In addition, the Company's bylaws provide generally for indemnification by the
Company for all officers, directors, employees or agents to the fullest extent
permitted by Delaware law.
The Company has been advised that insofar as any of the foregoing provisions
may be invoked to disclaim liability for damages arising under the Securities
Act, it is the opinion of the Securities and Exchange Commission that such
provision is against public policy as expressed in the Securities Act and is
therefore unenforceable.
EXECUTIVE COMPENSATION
The following table presents information concerning the annual and long-term
compensation of the executive officers whose salary and bonus were greater than
$100,000 in 1996. This table presents compensation for services rendered in all
capacities to the Company in 1996, 1995 and 1994.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
NAME AND ALL OTHER
PRINCIPAL POSITION YEAR SALARY(1) BONUS(1) COMPENSATION(2)
- ----------------------------------------------------- --------- ---------- --------- -----------------
<S> <C> <C> <C> <C>
Michael L. Edwards................................... 1996 $ 150,000 $ 50,727 $ 2,889
President and Chief Executive Officer 1995 150,000 -- 1,524
1994 102,086 20,661 3,000
Frank A. Merendino, Jr............................... 1996 82,500 26,429 6,496
Vice President of Operations 1995 82,500 16,382 422
1994 75,000 8,728 1,174
John D. Jessee....................................... 1996 82,500 25,628 7,074
Vice President and Chief Financial Officer 1995 31,250 -- --
1994 34,567 7,312 --
</TABLE>
- ------------------------
(1) Amounts include cash compensation earned and received by the named officers
as well as amounts deferred under a 401(k) Savings Plan.
(2) Amounts shown include Company contributions to a 401(k) Savings Plan,
vehicle allowances and directors' fees.
EMPLOYMENT AGREEMENT
On May 23, 1996, the Company entered into a ten-year employment agreement
with Michael L. Edwards which provides for an annual salary of $155,000. Mr.
Edwards will also receive annual bonuses computed on the basis of 10% of the
Company's pre-tax earnings on all amounts from $1,000,000 to $1,999,999 and 15%
of the Company's pre-tax earnings on all amounts in excess of $2,000,000,
provided his bonus for 1996 was $50,000. Payment of this bonus has been
deferred. In the event Mr. Edwards' employment is terminated by the Company for
any reason other than for cause during the term of the
31
<PAGE>
employment agreement, at the election of Mr. Edwards the Company will be
obligated to purchase all or a portion of the shares held by him and/or his wife
at a price equal to 150% of the market value of the Company's shares on the date
of termination. In addition, the Company will be obligated to pay Mr. Edwards in
a lump sum all salary amounts payable to Mr. Edwards through the term of the
employment agreement plus an additional $2,000,000.
EMPLOYEE BENEFIT PLANS
The Company sponsors a qualified tax deferred savings plan in accordance
with the provisions of Section 401(k) of the Internal Revenue Code. Employees
may defer up to 20% of their compensation, subject to certain limitations.
Effective July 1, 1996, the Company matches 100% of permitted employee
contributions.
EMPLOYEE STOCK PURCHASE LOANS
On May 17, 1996, the Board of Directors of the Company approved a plan
whereby the Company made available to certain key employees five year
interest-free loans for the purpose of purchasing a total of 40,000 shares of
the Company's Common Stock at a purchase price of $6.00 per share, which was the
fair market value of the shares on that date. In the event an employee who has
been given a loan pursuant to this plan terminates his employment with the
Company at any time prior to the due date of the loan, the loan is then
immediately due and payable, with interest from the date of the loan at prime
rate plus 2%, compounded monthly. All certificates for shares issued under this
plan to a key employee shall be held by the Company as security until the loan
is paid in full. Pursuant to this plan, on July 31, 1996, the Company made a
loan of $90,000 to Michael L. and Karen K. Edwards to purchase 15,000 shares and
a loan of $90,000 to Allan R. Poole, II, to purchase 15,000 shares.
KEY MAN INSURANCE
The Company maintains a key man life insurance policy in the amount of
$2,000,000 on the life of Michael L. Edwards. The Company is the beneficiary of
this policy.
32
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number and percentage of shares of Common
Stock held beneficially by the owners of more than five percent of the Company's
issued and outstanding Common Stock as of August 26, 1997 or by directors or
officers of the Company:
<TABLE>
<CAPTION>
NAME AND ADDRESS OF AMOUNT OF
BENEFICIAL OWNER OWNERSHIP PERCENT OF CLASS
- ------------------------------------------------------------------------------------- ----------- -----------------
<S> <C> <C>
Dr. James T. Martin.................................................................. 800,058 19.41%
Tupenny House
Tuckerstown, Bermuda
Michael L. and Karen K. Edwards...................................................... 746,226(1) 18.10%
200 East Main Street
Abingdon, Virginia 24210
Michael L. Edwards................................................................... 3,600 0.09%
200 East Main Street
Abingdon, Virginia 24210
Frank A. Merendino, Jr. ............................................................. 38,742(2) 0.94%
135 Douglas Lane
Bristol, Tennessee 37620
Mark N. Witt......................................................................... 136,316(3) 3.31%
288 Clubhouse Drive
Abingdon, Virginia 24211
John D. Jessee....................................................................... 4,200 0.10%
152 Kennedy Drive
Lebanon, Virginia 24266
Allan R. Poole, II................................................................... 57,000 1.38%
1032 Hanover Court
Kingsport, Tennessee 37660
Peter C. Einselen.................................................................... 5,000 0.12%
1 King Street
St. Augustine, Florida 32084
Charles A. Mills, III................................................................ 2,000 0.05%
3 Commercial Place, Suite 100
Norfolk Southern Tower
Norfolk, Virginia 23510
Includes all executive officers and directors as a group............................. 993,084 24.09%
</TABLE>
- ------------------------
(1) Includes 363,663 shares which may be issued to Mr. and Mrs. Edwards upon
exercise of a warrant.
(2) Includes 8,371 shares which may be issued to Mr. Merendino upon exercise of
a warrant.
(3) Includes 127,920 shares which may be issued to Mr. Witt upon exercise of an
option. Mr. Witt's option provides that he is entitled to purchase 2% of the
Company's outstanding Common Stock on a fully diluted basis.
33
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have 5,204,906 shares of
Common Stock outstanding (5,504,906 shares if the Underwriters' over-allotment
option is exercised in full). The 2,000,000 shares sold in this Offering
(2,300,000 shares if the Underwriters' over-allotment option is exercised in
full) will be freely transferable without restriction, unless purchased by
persons deemed to be "affiliates" of the Company (as that term is defined under
the Securities Act). Substantially all of the remaining 3,204,906 shares of
Common Stock outstanding immediately following the Offering will be transferable
without restriction, except for approximately 1,293,188 shares owned by persons
deemed to be affiliates of the Company (as that term is defined under the
Securities Act) which will be subject to certain volume restrictions under Rule
144 under the Securities Act. A total of 943,149 shares are issuable upon
exercise of warrants at an exercise price of $9.90 per share registered pursuant
to a currently effective shelf registration (the "Registered Warrants"). Of the
Registered Warrants, warrants representing 789,849 shares are exercisable
commencing August 3, 1997 and warrants representing 153,300 shares are
exercisable on October 4, 1997. An additional 247,920 shares of Common Stock are
issuable pursuant to the exercise of options, of which options for 127,920
shares are presently exercisable.
In general, under Rule 144, as recently amended, a person (or persons whose
shares are aggregated) including an affiliate, who has beneficially owned his
shares for one year, may sell in the open market within any three-month period a
number of shares that does not exceed the greater of (i) 1% of the then
outstanding shares of the Company's Common Stock (approximately 5,200 shares
immediately after this Offering, or 5,500 if the Underwriters' over-allotment
option is exercised in full) or (ii) the average weekly trading volume in the
Common Stock on the Nasdaq during the four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain limitations on the manner of
sale, notice requirements and availability of current public information about
the Company. A person (or persons whose shares are aggregated) who is deemed not
to have been an "affiliate" of the Company at any time during the 90 days
preceding a sale by such person and who has beneficially owned his shares for at
least two years, will be able to sell such shares in the public market under
Rule 144(k) without regard to the volume limitations, manner of sale provisions,
notice requirements or availability of current information referred to above.
Restricted shares properly sold in reliance upon Rule 144 are thereafter freely
tradable without restrictions or registration under the Securities Act, unless
thereafter held by an "affiliate" of the Company.
The Company's executive officers and directors and certain stockholders of
the Company who collectively own an aggregate of 1,293,188 shares of Common
Stock have agreed that they will not, directly or indirectly, offer, sell,
contract to sell, make a short sale, pledge or otherwise dispose of any shares
of Common Stock (or any securities convertible into or exchangeable or
exercisable for any other rights to purchase or acquire Common Stock) for a
period of 180 days after the date of this Prospectus, without the prior written
consent of Ferris, Baker Watts, Incorporated.
The Company has agreed that for a period of 180 days following the date of
this Prospectus it will not, without the prior written consent of Ferris, Baker
Watts, Incorporated, directly or indirectly, issue, offer, sell, offer to sell,
contract to sell, grant any option to purchase, pledge or otherwise dispose (or
announce any such issuance, offer, sale, offer of sale, contract of sale, grant
of any option to purchase, pledge or other dispostion) any shares of Common
Stock or any other equity securities of the Company except for the shares of
Common Stock offered hereby and shares issued pursuant to the exercise of
options or warrants outstanding on the date hereof.
After the 180-day period, the shares of Common Stock subject to the
restriction will be eligible for sale in the public market.
34
<PAGE>
DESCRIPTION OF SECURITIES
COMMON STOCK
The Company has authorized 10,000,000 shares of Common Stock, par value
$.001 per share. As of August 26, 1997 there were 3,204,906 shares of Common
Stock issued and outstanding. In addition, options and warrants for 1,191,069
shares are currently outstanding. The holders of Common Stock are entitled to
one vote per share and to share ratably on a share for share basis with respect
to any dividends when, as and if declared by the Board of Directors out of
legally available funds. See "Dividend Policy." Upon the liquidation,
dissolution or winding up of the Company, whether voluntary or involuntary,
holders of Common Stock are entitled to share ratably, after payment of
liabilities and the liquidation preference of any then outstanding Preferred
Stock. Holders of Common Stock have no preemptive rights, except those rights
granted to certain option and warrant holders, and no right to convert their
Common Stock into any other securities. There are no redemption or sinking fund
provisions applicable to the Common Stock. All outstanding shares of Common
Stock are, and all shares of Common Stock offered hereby will be, fully paid and
nonassessable.
SHAREHOLDERS' AGREEMENT AND VOTING TRUST
A Shareholders' Agreement and Voting Trust (the "Voting Trust Agreement")
was entered into effective May 31, 1996, by the Company, Michael L. Edwards,
Karen K. Edwards and Dr. James T. Martin. Simultaneous with the execution of his
subscription for 800,058 shares of the Company's Common Stock, Dr. Martin
executed the Voting Trust Agreement providing for the delivery of his shares
along with those of Mr. and Ms. Edwards to Mr. Edwards as trustee for a period
of five years from the date of assignment. The Voting Trust Agreement provides
that Mr. Edwards as trustee must vote the shares at all meetings of the
Company's shareholders in favor of the election of two nominees to the Board of
Directors selected by Dr. Martin and three nominees to the Board of Directors
selected by Mr. Edwards. The withdrawal of the Common Stock pursuant to the
Voting Trust Agreement may only be accomplished by unanimous agreement of the
parties. The beneficial ownership of the shares underlying the Voting Trust
Agreement is assignable. Dividends payable on the underlying shares are
distributable by the trustee to the shareholders. If Dr. Martin decides to sell
to a third party a number of shares of Common Stock of the Company owned by him
which comprises 5% or more of the total outstanding shares of Common Stock of
the Company, Dr. Martin must first give notice to the Company and offer the
Company the right to purchase the shares pursuant to a right of first refusal.
If a purchaser acquires shares of Common Stock of the Company from Dr. Martin
which represent 10% or more of the shares of outstanding Common Stock of the
Company, such purchaser must become a party to the Voting Trust Agreement.
PREFERRED STOCK
The Company has authorized 2,000 shares of Preferred Stock, no par value,
none of which is issued and outstanding.
CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION AND DELAWARE LAW
The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") contains certain provisions that may have the effect of delaying,
deferring or preventing a change of control of the Company. Specifically, the
Certificate provides that to effect: (i) any amendment to the Certificate or the
bylaws; (ii) a merger, dissolution, reorganization (including by share exchange)
or recapitalization of the Company; or (iii) a sale of all or substantially all
of the assets of the Company, the stockholders of the Company must approve the
transaction by an affirmative vote of the holders of 75% of the Company's
capital stock entitled to vote thereon. This increases the percentage that would
otherwise be required under Delaware law to approve such actions, and thus may
make it more difficult to effect a takeover of
35
<PAGE>
the Company. Further, the Company's by laws provides that members of the
Company's Board of Directors are elected to terms that are staggered.
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), which subject to certain exceptions, prohibits a Delaware
corporation from engaging in any business combination with any interested
shareholder for a period of three years after that person became an interested
shareholder, unless: (i) prior to such time, the board of directors of the
corporation approved either the business combination or the transaction which
resulted in the shareholder becoming an interested shareholder; (ii) upon
consummation of the transaction which resulted in the shareholder becoming an
interested shareholder, the interested shareholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding for purposes of determining the number of shares
outstanding those shares owned (x) by persons who are directors and also
officers and (y) by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or (iii) on or subsequent
to such date, the business combination is approved by the board of directors and
authorized at an annual or special meeting of shareholders, and not by written
consent, by the affirmative vote of at least 66 2/3 % of the outstanding voting
stock which is not owned by the interested shareholder.
Section 203 defines business combination to include: (i) any merger or
consolidation involving the corporation and the interested shareholder; (ii) any
sale, transfer, pledge or other disposition involving the interested shareholder
of 10% or more of the assets of the corporation; (iii) subject to certain
exceptions, any transaction which results in the issuance or transfer by the
corporation of any stock of the corporation to the interested shareholder
(except proportionately as a shareholder); (iv) any transaction involving the
corporation which has the effect of materially increasing the proportionate
share of the stock of any class or series of the corporation beneficially owned
by the interested shareholder; or (v) the receipt by the interested shareholder
of the benefit of any loans, advances, guarantees, pledges or other financial
benefits provided by or through the corporation. In general, Section 203 defines
an interested shareholder as any entity or person beneficially owning 15% or
more of the outstanding voting stock of the corporation and any entity or person
affiliated with or controlling or controlled by such entity or person.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is First Union
National Bank of North Carolina, Charlotte, North Carolina.
36
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement,
the form of which is filed as an exhibit to the Registration Statement of which
this Prospectus forms a part (the "Underwriting Agreement"), the Company has
agreed to sell the number of shares of Common Stock to Ferris, Baker Watts,
Incorporated (the "Underwriter"), and the Underwriter has agreed to purchase the
aggregate number of shares of Common Stock set forth opposite its name below.
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
Ferris, Baker Watts, Incorporated.......................................... 2,000,000
-----------------
Total.................................................................... 2,000,000
-----------------
-----------------
</TABLE>
The nature of the Underwriter's obligations under the Underwriting Agreement
is such that all shares of Common Stock offered hereby, excluding shares covered
by the over-allotment option granted to the Underwriter, must be purchased if
any are purchased. The Underwriting Agreement provides that the obligations of
the Underwriter to pay for and accept delivery of the shares of Common Stock
offered hereby are subject to the approval of certain legal matters by counsel
and to certain other conditions.
The Company has been advised by the Underwriter that the Underwriter
proposes to offer the shares of Common Stock to the public at the public
offering price set forth on the cover page of this Prospectus, and to certain
dealers at such public offering price less a selling concession not in excess of
$0.36 per share. The Underwriter may allow, and such dealers may reallow, a
concession not in excess of $0.10 per share to certain other underwriters or to
certain other brokers or dealers.
The Company has granted the Underwriter an option, exercisable within 30
days after the date of this Prospectus, to purchase up to an additional 300,000
shares of Common Stock to cover over-allotments, at the same price per share to
be paid by the Underwriter for the other shares offered hereby. The Underwriter
may purchase such shares only to cover over-allotments, if any, in connection
with the Offering made hereby.
The executive officers, directors and certain stockholders of the Company
have agreed that they will not offer, sell, contract to sell or grant an option
to purchase or otherwise dispose of any shares of Common Stock, options to
acquire shares of Common Stock or any securities exercisable for or convertible
into Common Stock owned by them, in the open market, for a period of 180 days
from the date of this Prospectus, without the prior written consent of the
Underwriter. The Company has agreed not to offer, sell or issue any shares of
Common Stock, options to acquire Common Stock or securities exercisable for or
convertible into shares of Common Stock for a period of 180 days after the date
of this Prospectus, without the prior written consent of the Underwriter, except
that the Company may issue securities upon the exercise of all outstanding stock
options and warrants.
The Company and the Underwriter have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act, which may
arise out of or be based upon any untrue statement or alleged untrue statement
of any material fact made by the indemnifying party and contained in this
Prospectus, the Registration Statement, any supplement or amendment thereto, or
any documents filed with state securities authorities, or any omission or
alleged omission of the indemnifying party to state a material fact required to
be stated in any such document or required to make the statements in any such
document, in light of the circumstances in which they are made, not misleading.
The Underwriter intends to make a market in the securities of the Company,
as permitted by applicable laws and regulations. The Underwriter, however, is
not obligated to make a market in such securities and any such market making may
be discontinued at any time at the sole discretion of the Underwriter.
37
<PAGE>
The Underwriter has informed the Company that it does not intend to confirm
any sales to accounts over which they exercise discretionary authority.
The Company has agreed to pay to the Underwriter a non-accountable expense
allowance equal to one percent of the gross offering proceeds.
LEGAL MATTERS
The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company by Bright & Barnes, a Professional
Corporation, Oklahoma City, Oklahoma. Venable, Baetjer, Howard & Civiletti LLP,
Washington, D.C. has acted as counsel for the Underwriter with respect to
certain legal matters relating to the Common Stock offered hereby.
EXPERTS
The financial statements of the Company, and the financial statements of
Virginia Gas Storage Company and Virginia Gas Distribution Company, as of
December 31, 1996, and for each of the two years in the period then ended,
included in this Prospectus have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.
OTHER MATTERS
In January 1996 the Company retained Arthur Andersen LLP as its independent
public accountants. Another auditor had served in this capacity since 1992.
There were no disagreements with the former auditors on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedures at the time of the change or with respect to the Company's financial
statements which, if not resolved to the former auditors' satisfaction, would
have caused them to make reference to the subject matter of the disagreement in
connection with their reports. The former auditors' reports did not contain an
adverse opinion or disclaimer of opinion and were not modified as to
uncertainty, audit scope or accounting principles. Prior to retaining Arthur
Andersen LLP, the Company had not consulted with Arthur Andersen LLP regarding
accounting principles.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports and other information with the Securities and Exchange
Commission (the "Commission" or "SEC"). Such reports, proxy and other
information filed by the Company may be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Judiciary Plaza, Washington, D.C. 20549, and at the public reference facilities
maintained by the Commission at Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661; and 7 World Trade Center, Suite 1300, New York,
New York 10048. Copies of such materials may also be obtained at prescribed
rates from the Public Reference Section of the Commission at its principal
office at 450 Fifth Street, N.W., Washington, D.C. 20549. The Company's Common
Stock is listed on the Nasdaq National Market. Documents filed by the Company
may also be inspected at the offices of the National Association of Securities
Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.
The Company has filed with the Commission a Registration Statement on Form
SB-2 under the Act, with respect to the securities offered hereby. This
Prospectus does not contain all the information set forth in the Registration
Statement and the exhibits thereto, to which reference is hereby made.
Statements made in this Prospectus as to the contents of any contract, agreement
or other documents referred to are not necessarily complete; with respect to
each such contract, agreement or other document filed as an exhibit to the
Registration Statement, reference is made to the exhibit for a more complete
description of
38
<PAGE>
the matter involved, and each such statement shall be deemed qualified in its
entirety by such reference. A copy of the Registration Statement, and the
exhibits and schedules thereto, may be inspected without charge at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Judiciary Plaza, Washington, D.C. 20549, and at the Public Regional Office of
the Commission at 7 World Trade Center, Suite 1300, New York, New York 10048,
and copies of all or any part of the Registration Statement may be obtained from
such offices or by mail from the Public Reference Section of the Commission at
its principal office upon the payment of the fees prescribed by the Commission.
The Commission also maintains a World Wide Web site (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.
GLOSSARY
BCF. Billion cubic feet.
BLOW-OUT. A sudden, violent expulsion of oil, gas, and mud (and sometimes
water) from a drilling well, followed by an uncontrolled flow from the well. It
occurs when high pressure gas is encountered in the hole and sufficient
precautions have not been taken.
BTU. British thermal unit, which is the heat required to raise the
temperature of a one-pound mass of water from 58.5 to 59.5 degrees Fahrenheit.
CASING. Heavy steel pipe used to seal off fluids from the hole or to keep
the hole from caving in. There may be several strings of casing, one inside the
other, in a single well.
DELIVERABILITY. The amount of natural gas that a pipeline or producer is
able to deliver, limited either by terms of its supply contracts or its own
plant capacity.
DTH. One decatherm. One decatherm is equal to one million British thermal
units (10 therms).
GATHERING SYSTEMS. Pipelines and other equipment, including regulators,
compressors, dehydrators and associated equipment, needed to transport natural
gas from the wells to the transmission pipeline.
GROSS. A Gross number includes all acreage or wells in which the Company
owns an interest.
INJECTION. The introduction of gas under high pressure into a geological
formation.
MMBTU. One million British thermal units.
MBTU. One thousand British thermal units.
MCF. One thousand cubic feet.
MMCF. One million cubic feet.
NET. A Net number is the Gross number multiplied by the percentage interest
which the Company has in acreage or in wells.
PRESENT VALUE. When used with respect to gas reserves, present value means
the estimated future gross revenue to be generated from the production of proved
reserves, net of estimated production and future development costs, using prices
and costs in effect as of December 31, 1996, without giving effect to
non-property related expenses such as general and administrative expenses, debt
service and future income tax expense or to depreciation, depletion and
amortization, discounted using an annual discount rate of 10%.
39
<PAGE>
PROVED DEVELOPED RESERVES. Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.
PROVED RESERVES. The estimated quantities of natural gas and natural gas
liquids which geological and engineering data demonstrate with reasonable
certainty to be recoverable in future years from known reservoirs under existing
economic and operating conditions.
PSI. Pounds per square inch.
SERVICE. The amount of gas necessary to fulfill customer supply contract
quantities for the periods indicated if the customer withdraws all contracted
gas at full contract amounts.
THERM. One hundred thousand British thermal units.
WORKING GAS. The portion of the storage volume that can be removed from a
storage reservoir for deliveries and still maintain pressure sufficient to meet
design deliverability.
WORKING INTEREST. The operating interest which gives the owner the right to
drill, produce and conduct operating activities on the property and a share of
production.
40
<PAGE>
The map on the inside back cover highlights the two counties, Buchanan and
Russell, in southwestern Virginia, in which the Distribution Affiliate is
certificated to provide service by the VSCC and the two adjacent counties,
Tazewell and Dickensen, as to which the Distribution Affiliate has applied for
such certification. The map depicts: (i) the Company's natural gas gathering
systems located in Dickenson and Buchanan counties; (ii) Triangles depict the
Company's natural gas compression facilities located in Dickenson, Buchanan and
Washington counties; (iii) the interstate pipelines located in the Company's
area of operations; (iv) the Company's and its affiliates natural gas storage
facilities; and (v) other companies' pipelines in relation to the Company's.
[MAP]
41
<PAGE>
FINANCIAL STATEMENTS
INDEX
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
Report of Independent Public Accountants................................................................. F-2
Consolidated Balance Sheets.............................................................................. F-3
Consolidated Statements of Income........................................................................ F-4
Consolidated Statements of Changes in Stockholders' Equity............................................... F-5
Consolidated Statements of Cash Flows.................................................................... F-6
Notes to Consolidated Financial Statements............................................................... F-7
VIRGINIA GAS STORAGE COMPANY
Report of Independent Public Accountants................................................................. F-24
Balance Sheets........................................................................................... F-25
Statements of Income..................................................................................... F-26
Statements of Changes in Stockholders' Equity............................................................ F-27
Statements of Cash Flows................................................................................. F-28
Notes to Financial Statements............................................................................ F-29
VIRGINIA GAS DISTRIBUTION COMPANY
Report of Independent Public Accountants................................................................. F-37
Balance Sheets........................................................................................... F-38
Statements of Income..................................................................................... F-39
Statements of Changes in Stockholders' Equity............................................................ F-40
Statements of Cash Flows................................................................................. F-41
Notes to Financial Statements............................................................................ F-42
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Virginia Gas Company:
We have audited the accompanying consolidated balance sheet of Virginia Gas
Company and Subsidiaries as of December 31, 1996, and the related consolidated
statements of income, changes in stockholders' equity, and cash flows for the
years ended December 31, 1996 and 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Company and
Subsidiaries as of December 31, 1996, and the results of their operations and
their cash flows for the years ended December 31, 1996 and 1995, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Richmond, Virginia
March 7, 1997
F-2
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
CURRENT ASSETS:
Cash........................................................................... $ 1,526,050 $ 1,652,838
Accounts receivable............................................................ 1,659,113 1,073,276
Notes receivable............................................................... 118,779 114,556
Other current assets........................................................... 232,689 134,862
------------- -------------
Total current assets................................................... 3,536,631 2,975,532
PROPERTY AND EQUIPMENT, NET........................................................ 19,162,628 16,343,480
INVESTMENT IN AFFILIATED COMPANIES................................................. 4,374,221 4,243,020
NOTES RECEIVABLE--AFFILIATED COMPANIES............................................. 12,956,871 9,371,062
OTHER ASSETS....................................................................... 1,385,805 577,309
------------- -------------
Total assets........................................................... $ 41,416,156 $ 33,510,403
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable.................................................................. $ 1,250,000 $ 250,000
Current portion of long-term debt.............................................. 748,576 1,244,490
Accounts payable............................................................... 1,582,564 1,197,555
Funds held for future distribution............................................. 304,388 544,475
Other current liabilities...................................................... 170,452 168,709
------------- -------------
Total current liabilities.............................................. 4,055,980 3,405,229
LONG-TERM DEBT..................................................................... 21,136,694 12,137,729
DEFERRED INCOME TAXES.............................................................. 729,007 629,914
------------- -------------
Total liabilities...................................................... 25,921,681 16,172,872
------------- -------------
STOCKHOLDERS' EQUITY:
Preferred stock--No par, 2,000 shares authorized, issued and outstanding as of
December 31, 1996............................................................ -- 1,725,000
Common stock--par value $.001, 10,000,000 shares authorized, 3,204,906
(unaudited) and 3,150,744 shares issued and outstanding as of June 30, 1997
and December 31, 1996, respectively.......................................... 3,205 3,151
Additional paid-in capital..................................................... 13,751,471 14,152,137
Retained earnings.............................................................. 1,739,799 1,457,243
------------- -------------
Total stockholders' equity............................................. 15,494,475 17,337,531
------------- -------------
Total liabilities and stockholders' equity............................. $ 41,416,156 $ 33,510,403
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
------------------------ --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ---------- ------------ ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Operating revenue.............................................. $ 3,500,537 $ 545,145 $ 1,772,970 $ 1,493,813
Interest and other income...................................... 570,413 433,763 996,748 529,597
------------ ---------- ------------ ------------
4,070,950 978,908 2,769,718 2,023,410
------------ ---------- ------------ ------------
EXPENSES:
Production expenses............................................ 100,665 43,445 105,910 65,029
Purchased gas expense.......................................... 66,113 -- 28,537 --
Operation and maintenance expense.............................. 229,203 -- 173,445 --
Cost of natural gas sold....................................... 1,635,003 -- -- --
Depreciation, depletion, and amortization...................... 373,590 129,047 387,116 305,216
General and administrative..................................... 447,430 303,087 645,673 708,191
------------ ---------- ------------ ------------
2,852,004 475,579 1,340,681 1,078,436
------------ ---------- ------------ ------------
OTHER EXPENSE:
Interest....................................................... 717,155 520,824 1,006,800 673,251
Other.......................................................... 68,039 1,146 2,771 2,752
------------ ---------- ------------ ------------
785,194 521,970 1,009,571 676,003
------------ ---------- ------------ ------------
INCOME (LOSS) BEFORE EARNINGS OF AFFILIATED COMPANIES AND INCOME
TAXES.......................................................... 433,752 (18,641) 419,466 268,971
EQUITY IN EARNINGS OF AFFILIATED COMPANIES....................... 131,201 207,942 339,927 267,484
------------ ---------- ------------ ------------
INCOME BEFORE INCOME TAXES....................................... 564,953 189,301 759,393 536,455
PROVISION (BENEFIT) FOR INCOME TAXES............................. 137,883 (17,543) 151,827 62,581
------------ ---------- ------------ ------------
NET INCOME....................................................... $ 427,070 $ 206,844 $ 607,566 $ 473,874
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS...................... $ 370,015 $ 76,844 $ 347,566 $ 428,374
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
NET INCOME PER COMMON SHARE...................................... $ 0.12 $ 0.07 $ 0.21 $ 0.62
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED PAID-IN
STOCK COMMON STOCK CAPITAL RETAINED EARNINGS
----------- -------------- -------------- -----------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1994....................... $ -- $ 1,792,741 $ -- $ 925,239
Issuance of 124,316 shares of common stock
pursuant to stock option agreements.......... -- 496,000 -- --
Issuance of 2,000 shares of preferred stock and
warrants covering 54,163 shares of common
stock........................................ 1,725,000 -- 275,000 --
Net income..................................... -- -- -- 473,874
Preferred stock dividends paid................. -- -- -- (45,500)
Common stock dividends paid.................... -- -- -- (212,430)
----------- -------------- -------------- -----------------
BALANCE, December 31, 1995....................... 1,725,000 2,288,741 275,000 1,141,183
Issuance of 800,058 shares of common stock..... -- 4,401,317 -- --
Issuance of 42,000 shares of common stock...... -- 42 251,958 --
Issuance of 40,000 shares of common stock to
officers and employees, net of notes
receivable of $240,000....................... -- 40 -- --
Issuance of 1,533,000 shares of common stock... -- 1,533 7,911,657 --
Payment for cancellation of warrant and
options...................................... -- -- (975,000) --
Net income..................................... -- -- -- 607,566
Preferred stock dividends paid................. -- -- -- (260,000)
Common stock dividends paid.................... -- -- -- (31,506)
Change from no par to $.001 par value of common
stock........................................ -- (6,688,522) 6,688,522 --
----------- -------------- -------------- -----------------
BALANCE, December 31, 1996....................... 1,725,000 3,151 14,152,137 1,457,243
Preferred stock dividends paid (unaudited)..... -- -- -- (57,055)
Common stock dividends paid (unaudited)........ -- -- -- (87,459)
Net income (unaudited)......................... -- -- -- 427,070
Costs related to stock issuance (unaudited).... -- -- (125,666) --
Issuance of 54,162 shares of common stock
pursuant to exercise of warrant
(unaudited).................................. -- 54 -- --
Redemption of 2,000 shares of preferred stock
(unaudited).................................. (1,725,000) -- (275,000) --
----------- -------------- -------------- -----------------
BALANCE, June 30, 1997
(unaudited).................................... $ -- $ 3,205 $ 13,751,471 $ 1,739,799
----------- -------------- -------------- -----------------
----------- -------------- -------------- -----------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ------------ ------------ ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................. $ 427,070 $ 206,844 $ 607,566 $ 473,874
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion, and amortization............ 373,590 129,047 387,116 305,216
Undistributed earnings of affiliated companies....... (131,201) (207,942) (339,927) (267,484)
Deferred income taxes................................ 99,093 (9,450) 141,596 27,693
(Increase) decrease in accounts receivable........... (585,837) 392,754 (180,903) (322,611)
(Increase) decrease in other current assets.......... (97,828) 94,754 66,720 (90,136)
Decrease in other assets............................. 84,342 6,438 20,477 78,359
Increase (decrease) in notes payable................. 1,000,000 (332,212) (332,212) 582,212
Increase (decrease) in accounts payable.............. 385,009 (850,758) (978,177) 1,692,954
(Decrease) increase in current liabilities........... (238,344) 107,108 190,145 (4,119)
------------ ------------ ------------ ------------
Net cash provided by (used in) operating
activities....................................... 1,315,894 (463,417) (417,599) 2,475,958
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................... (3,149,551) (2,581,313) (9,803,768) (1,314,286)
Issuance of notes receivable, net...................... (3,650,000) -- -- (3,721,911)
Payments received on notes receivable.................. 59,968 62,874 128,221 16,838
Investment in joint venture............................ -- -- -- (1,016,682)
------------ ------------ ------------ ------------
Net cash used in investing activities................ (6,739,583) (2,518,439) (9,675,547) (6,036,041)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal.............................. (1,214,222) (2,062,281) (2,731,952) (181,222)
Proceeds from new loans................................ 9,690,632 1,042,732 1,100,000 3,750,000
Redemption of preferred stock.......................... (2,000,000) -- -- --
Proceeds from issuance of common stock, net............ (125,666) 4,401,317 12,566,547 496,000
Proceeds from issuance of preferred stock, net......... -- -- -- 1,220,000
Purchase of warrants and options....................... -- -- (975,000) --
Payment of debt issuance costs......................... (350,579) (174,663) (54,719) (382,399)
Establishment of financing reserve funds............... (558,750) -- -- (46,244)
Dividends paid......................................... (144,514) (130,000) (291,506) (257,930)
------------ ------------ ------------ ------------
Net cash provided by financing activities............ 5,296,901 3,077,105 9,613,370 4,598,205
------------ ------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH.......................... (126,788) 95,249 (479,776) 1,038,122
CASH, beginning of period................................ 1,652,838 2,132,614 2,132,614 1,094,492
------------ ------------ ------------ ------------
CASH, end of period...................................... $ 1,526,050 $ 2,227,863 $ 1,652,838 $ 2,132,614
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
SUPPLEMENTAL DISCLOSURE:
Interest paid.......................................... $ 950,864 $ 684,966 $ 1,282,705 $ 656,833
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Income taxes paid...................................... $ 11,158 $ 8,658 $ 26,158 $ 95,830
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
1. DESCRIPTION OF OPERATIONS:
Virginia Gas Company (the "Company") was organized in 1987 under the laws of
the state of Delaware. The Company, directly or through affiliated companies, is
primarily engaged in the exploration, production, marketing, gathering, storage,
and distribution of natural gas, and distribution of propane gas, principally in
the southwestern counties of the Commonwealth of Virginia.
The Company's operations are subject to certain risks and uncertainties
including, among others, the adequacy of future financing, the need for
additional capital, dependence on major customers, and current and potential
competitors with greater financial and marketing resources.
INTERIM FINANCIAL INFORMATION
The unaudited financial statements as of June 30, 1997, and for the six
months ended June 30, 1997 and 1996, include, in the opinion of management, all
adjustments (that are normal and recurring in nature) necessary to present
fairly the Company's financial position, results of operations, and cash flows.
Operating results for the six months ended June 30, 1997, are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements for 1996 include the accounts of three
wholly owned subsidiaries. The consolidated financial statements for 1995
include the accounts of one wholly owned subsidiary. All significant
intercompany balances and transactions have been eliminated in consolidation.
INVESTMENT IN AFFILIATED COMPANIES
The Company's investments in affiliated companies are accounted for using
the equity method. Investments carried at equity and the percentage interest
owned consist of Virginia Gas Storage Company (50 percent) and Virginia Gas
Distribution Company (50 percent).
F-7
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Combined financial information as of December 31, 1996, and for the years
ended December 31, 1996 and 1995, and as of June 30, 1997, and for the six
months ended June 30, 1997 and 1996 (unaudited), for investments in affiliated
companies accounted for by the equity method is as follows.
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Current assets..................................................................... $ 1,951,459 $ 2,386,057
Property and equipment, net........................................................ 20,327,578 16,079,543
Other assets....................................................................... 6,424,628 4,917,958
------------- -------------
$ 28,703,665 $ 23,383,558
------------- -------------
------------- -------------
Current liabilities................................................................ $ 3,343,700 $ 2,941,557
Long-term debt payable to:
Affiliated companies............................................................. 15,964,990 11,390,406
Third parties.................................................................... 9,617 13,870
Other liabilities.................................................................. 636,917 551,686
Stockholders' equity............................................................... 8,748,441 8,486,039
------------- -------------
$ 28,703,665 $ 23,383,558
------------- -------------
------------- -------------
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
JUNE 30 DECEMBER 31
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ------------ ------------ ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues................................................. $ 2,855,579 $ 2,557,186 $ 5,008,509 $ 3,498,236
Income before income taxes............................... 397,581 630,125 1,030,079 821,876
Net income............................................... 262,402 415,884 679,853 534,968
</TABLE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes natural gas sales and transmission revenues upon
delivery of natural gas to the common pipeline carrier.
In January 1997, the Company's wholly owned subsidiary, Virginia Gas
Marketing Company, began marketing natural gas services. These services include
the marketing of natural gas and are later expected to include natural gas
storage services. The initial source of natural gas supply will be provided by
Company -operated wells and initial future storage services will be provided by
facilities operated by the Company and/or its affiliated companies. Revenues
attributable to the marketing operations totaled $1.8 million for the six months
ended June 30, 1997.
F-8
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
During the year ended December 31, 1995, the Company and Virginia Gas
Storage Company revised their method of recording certain revenue. Prior to
1995, recognition of production and transmission revenues was deferred for three
months after the actual production and transmission of natural gas had occurred,
primarily to match the recognition of revenues with the period these revenues
were distributed to working interest parties and royalty owners. The policy
revision to record revenues on a current basis reflects the companies' ability
to estimate net revenues on a current basis. This change is reflected on a
prospective basis beginning in January 1995 and results in 15 months of
production and transmission revenues being recognized in 1995. The effect of
this change was to increase revenue and net income by $176,000 and $131,000,
respectively, for the year ended December 31, 1995.
INCOME PER COMMON SHARE
Income per common share is computed using the weighted-average shares of
common stock and dilutive common stock equivalents (options and warrants)
outstanding during the respective periods. Net income available to common
stockholders is net income less dividends on preferred stock. The number of
weighted-average shares used in calculating income per common share was
1,637,576 and 695,669 for the years ended December 31, 1996 and 1995, and
3,201,350 (unaudited) and 1,034,873 (unaudited) for the six months ended June
30, 1997 and 1996, respectively, after retroactive effect of 103.1667 per share
stock split, as discussed in Note 9.
PROPERTY AND EQUIPMENT
The Company follows the successful efforts method of accounting for its
natural gas exploration activities. Under this method, geological and
geophysical costs and costs of carrying and retaining undeveloped properties are
expensed when incurred. All direct and certain indirect costs relating to
property acquisition, successful exploratory wells, development costs, and
support equipment and facilities are capitalized as the properties are obtained
or the facilities are placed into service. Costs of exploratory wells are
charged to expense if it is determined that proven reserves are not found.
Unproved gas properties that are individually significant are periodically
assessed for impairment of value, with losses recognized at the time of
impairment. The Company provides for depreciation, depletion, and amortization
of its investment in producing gas properties on a units-of-production method.
The remaining property and equipment is depreciated using the straight-line
method over estimated useful lives, ranging from 5 to 30 years. Maintenance and
repairs are charged to expense as incurred. Improvements and betterments are
capitalized.
CAPITALIZED INTEREST
The Company capitalizes interest on expenditures for significant projects
while activities are in progress to bring the assets to their intended use.
Interest capitalized totaled $290,398 and $92,851 for the years ended December
31, 1996 and 1995, respectively. Interest capitalized totaled $169,862
(unaudited) and $161,711 (unaudited) for the six months ended June 30, 1997 and
1996, respectively.
F-9
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
OTHER ASSETS
In conjunction with the 1997 issuance of the Russell County, the 1995
issuance of the Buchanan County and the 1994 issuance of the Russell County and
Buchanan County, Virginia, Natural Gas Facilities Revenue Bonds by the
Industrial Development Authorities of the respective counties, reserve funds
have been established by the trustee for each issuance. Amounts in the reserve
funds will be used to make payments of principal and interest, whether at
maturity, by acceleration, call for redemption, or otherwise, where trust funds
accumulated by scheduled Company payments are insufficient to satisfy bond
requirements. Such amounts are invested in debt securities issued by the U.S.
Treasury and other U.S. government corporations and agencies. The Company
records these investments at cost and recognizes related interest as earned. The
carrying value of investments approximates market value.
Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.
FUNDS HELD FOR FUTURE DISTRIBUTION
Revenues are collected by the Company as operator and marketer of the gas
sold on behalf of the working interest parties and held for final distribution
to them and to landowners. Until these funds are distributed, they are recorded
as funds held for future distribution.
INCOME TAXES
Income taxes are accounted for using the asset-and-liability method. Under
the asset-and-liability method, deferred income taxes reflect the temporary
differences between assets and liabilities recognized for financial reporting
purposes and amounts recognized for tax purposes.
RECLASSIFICATIONS
Certain reclassifications have been made in the 1995 balances to conform
with the 1996 presentation.
3. ACCOUNTS RECEIVABLE:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Trade receivables................................................ $ 428,182 $ 451,436
Lease operating expenses receivable.............................. 138,089 145,528
Joint-interest receivables....................................... 64,098 64,098
Due from affiliated companies.................................... 1,028,744 412,214
------------ ------------
$ 1,659,113 $1,073,276
------------ ------------
------------ ------------
</TABLE>
The majority of the Company's accounts receivable are due from companies
predominately involved in the marketing and distribution of oil and gas
products.
F-10
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
4. NOTES RECEIVABLE--AFFILIATED COMPANIES:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Note receivable from Virginia Gas Distribution Company; interest receivable at
9.5%; principal payable in maturities of $110,000 to $447,000 from 2002 to
2017............................................................................. $ 3,650,000 $ --
Note receivable from Virginia Gas Distribution Company; interest receivable at 9%;
principal payable in maturities of $4,000 to $263,000 from 1999 to 2020.......... 2,879,214 2,879,214
Note receivable from Virginia Gas Storage Company; interest receivable at 8.88%;
principal payable in maturities of $12,000 to $241,000 from 1995 to 2017......... 2,534,342 2,567,837
Note receivable from Virginia Gas Distribution Company; interest receivable at
7.35%; principal payable in maturities of $17,000 to $97,000 from 1996 to 2023... 1,276,560 1,284,833
Note receivable from Virginia Gas Storage Company; interest receivable at 7.35%;
principal payable in maturities of $13,000 to $77,000 from 1996 to 2023.......... 1,012,021 1,018,580
Note receivable from Virginia Gas Distribution Company; interest receivable at
8.88%; principal payable in maturities of $4,000 to $84,000 from 1995 to 2017.... 880,816 892,457
Note receivable from Virginia Gas Storage Company; interest receivable at 9%;
principal payable in maturities of $1,000 to $77,000 from 1999 to 2020........... 842,697 842,697
------------- -------------
13,075,650 9,485,618
Less--Current portion.............................................................. (118,779) (114,556)
------------- -------------
$ 12,956,871 $ 9,371,062
------------- -------------
------------- -------------
</TABLE>
F-11
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
5. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Storage properties............................................................. $ 12,979,435 $ 9,226,332
Pipelines...................................................................... 1,050,139 1,039,035
Producing properties........................................................... 2,499,105 2,494,370
Propane facilities............................................................. 1,186,300 165,756
Wells, pipelines, and storage properties in progress........................... 2,235,350 3,973,172
Vehicles....................................................................... 282,921 217,955
Building and improvements...................................................... 182,029 150,898
Office equipment............................................................... 250,116 221,685
Well and pipeline equipment.................................................... 32,093 32,093
------------- -------------
20,697,488 17,521,296
Less--Accumulated depreciation, depletion, and amortization.................... (1,534,860) (1,177,816)
------------- -------------
$ 19,162,628 $ 16,343,480
------------- -------------
------------- -------------
</TABLE>
6. OTHER ASSETS:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Deferred financing costs......................................................... $ 700,737 $ 455,350
Restricted cash and investments- reserve funds................................... 670,269 116,809
Other............................................................................ 14,799 5,150
------------ ------------
$ 1,385,805 $ 577,309
------------ ------------
------------ ------------
</TABLE>
F-12
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
7. LONG-TERM DEBT:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Note payable to the Industrial Development Authority of Russell
County, Virginia; interest payable monthly at 9.5%, beginning
in March 1997; principal payable in maturities of $275,000 to
$1,115,000 from 2002 to 2017................................. $ 9,100,000 $ --
Note payable to the Industrial Development Authority of
Buchanan County, Virginia; interest payable monthly at 9%,
beginning in February 1996; principal payable in maturities
of $5,000 to $342,000 from 1999 to 2020...................... 3,750,000 3,750,000
Note payable to the Industrial Development Authority of
Buchanan County, Virginia; interest payable monthly at an
effective rate of 8.88%, beginning in December 1994;
principal payable in maturities of $20,000 to $386,000 from
1995 to 2017................................................. 4,056,389 4,110,000
Note payable to the Industrial Development Authority of Russell
County, Virginia; interest payable monthly at an effective
rate of 7.35%, beginning in February 1994; principal payable
in maturities of $35,000 to $205,000 from 1996 to 2023....... 2,700,417 2,717,917
Note payable to Tenneco Energy Resources Corporation; interest
at Morgan Guaranty prime rate plus 3%; payable in quarterly
installments of principal plus interest through 1997......... -- 975,000
Note payable with interest at 7%; payable in monthly
installments of principal and interest of $1,099; maturing in
February 1999, with a final payment of $95,336 secured by an
asset with a book value of $147,862 as of June 30, 1997...... 104,443 107,283
Note payable with interest at 9%; interest payable in
semiannual installments, maturing October 2024............... -- 100,000
Notes payable with interest at prime plus 2%; payable in
quarterly installments of principal and interest beginning
July 1997.................................................... 590,631 --
Note payable to the Industrial Development Authority of
Washington County, Virginia with interest at 9.25%; payable
in monthly installments of principal and interest of $2,872
through October 1999; secured by an asset with a book value
of $101,142 as of June 30, 1997.............................. 72,093 85,626
Note payable to Virginia Gas Distribution Company;
</TABLE>
F-13
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
7. LONG-TERM DEBT: (CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
(UNAUDITED)
<S> <C> <C>
interest payable at 9%; principal payable in maturities of
$1,000 to $91,000 from 1999 to 2020.......................... 965,000 1,000,000
Note payable to Virginia Gas Distribution Company; interest
payable at 7.35%; principal payable in maturities of $5,000
to $30,000 from 1996 to 2023................................. 392,788 395,333
Note payable to Virginia Gas Storage Company; interest payable
at 8%; balance due December 1997............................. 70,000 70,000
Notes payable through 2001 with interest from 8.95% to 10.75%;
secured by assets with a book value of $96,366 as of June 30,
1997......................................................... 83,509 71,060
------------- -------------
21,885,270 13,382,219
Less--Current portion.......................................... (748,576) (1,244,490)
------------- -------------
Long-term debt................................................. $ 21,136,694 $ 12,137,729
------------- -------------
------------- -------------
</TABLE>
In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with principal of $9,100,000. The bonds are
payable from and are secured by a promissory note issued by the Company to the
Russell County Authority. A portion of the proceeds was loaned to an affiliated
company and is being used to construct a natural gas distribution facility in
and around the town of Lebanon, Virginia, and for related storage and pipeline
facilities.
In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000.
The bonds are payable from and are secured by a promissory note issued by the
Company to the Buchanan County Authority. A portion of the proceeds was loaned
to affiliated companies and are being used to extend existing natural gas
distribution facilities in and around the town of Grundy, Virginia, and for
related supporting pipeline gathering and storage facilities.
In January 1994, the Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000. The bonds are payable
from and are secured by a promissory note issued by the Company to the Russell
County Authority. The proceeds were loaned by the Company to affiliated
companies to construct a natural gas distribution facility in and around the
town of Castlewood, Virginia, and for related supporting exploration and
production, pipeline and storage facilities in the amount of $2,630,000 and to
retire $370,000 of long-term debt.
In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000. The bonds are payable from
and are secured by a promissory note issued by the Company to the Buchanan
County Authority. The bonds were also issued in parity with the Russell County
Bonds discussed above. A portion of the proceeds was loaned to affiliated
companies and are being used to construct a natural gas distribution facility in
an around the town of Grundy, Virginia, and for related supporting exploration
and production, pipeline, and storage facilities.
F-14
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
7. LONG-TERM DEBT: (CONTINUED)
On February 29, 1996, the Company purchased the interest of its joint
venture partner in the development of the Saltville, Virginia, natural gas
storage facility. The purchase price of the interest was $2,225,000, with
consideration consisting of a $500,000 payment in March 1996 and the issuance of
a promissory note for $1,725,000. Interest accrues at the Morgan Guaranty prime
rate plus 3 percent. Quarterly installments of principal and interest were made
during 1996. In December 1996 the Company, in accordance with terms of the
Transfer Agreement and after providing adequate security to the lender, elected
to pay the remaining principal in quarterly installments of principal and
interest through 1997. The former joint venture partner retains the option to
jointly develop with the Company on a 50-50 percent basis any additional storage
caverns on the Saltville property.
As of December 31, 1996, principal payments on long-term debt for the next
five years are as follows:
<TABLE>
<S> <C>
1997............................................................ $1,244,490
1998............................................................ 202,867
1999............................................................ 356,189
2000............................................................ 187,355
2001............................................................ 256,345
</TABLE>
Based upon the borrowing rates currently available to the Company for loans
with similar terms and remaining maturities, the approximate fair value of
long-term debt at December 31, 1996, is approximately $12,972,000 and at June
30, 1997 is approximately $20,932,000 (unaudited).
8. STOCKHOLDERS' EQUITY:
References to the common stock of the Company in these financial statements
and in the accompanying notes reflect retroactive application of an increase in
the number of authorized shares from 20,000 to 10,000,000 and a 103.1667 per
share stock split, effected June 1996, by the shareholders of the Company. In
conjunction with the stock split, the shareholders also implemented a super
majority provision requiring the vote of 75 percent of the issued and
outstanding shares entitled to vote on any matters involving an amendment to the
certificate of incorporation or the bylaws; the merger, dissolution,
reorganization, or recapitalization of the Company; or the sale of all or
substantially all of the assets of the Company.
In October 1996, the Company completed an initial public offering of its
common stock. The offering resulted in the issuance of an additional 1,533,000
common shares of the Company at $6 per share. In connection with the offering,
the Company granted warrants to the underwriter to purchase, on a post-offering
basis, 153,300 shares of the Company's common stock at a purchase price equal to
165 percent of the public offering price, or $9.90 per share.
In September 1995, the Company issued for $2,000,000 cash consideration
2,000 shares of its Series A nonvoting preferred stock and warrants to purchase
common stock equal to 6 percent of the then outstanding common stock of the
Company (increasing 1 percent per year until September 29, 2000, and an
additional 10 percent per year thereafter through September 29, 2003, if the
preferred stock is not redeemed before then) all to one investment corporation.
The Company can redeem the preferred stock at any time with five days' notice to
the holder. The agreement under which the preferred stock and warrants were sold
contains a number of covenants, including requiring the preferred stock
purchaser's consent to certain transactions outside the ordinary course of
business, environmental compliance, and compliance
F-15
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
8. STOCKHOLDERS' EQUITY: (CONTINUED)
with covenants of other loan obligations. Dividends, whether declared or not,
accrue on the preferred stock at 13 percent per annum and are payable monthly.
The liquidation preference of the preferred stock is $2,000,000 plus unpaid
dividends. In February 1997, the Company redeemed the outstanding 2,000 shares
of preferred stock for the liquidation price of $2,000,000 plus unpaid
dividends.
Subordinated indebtedness of the Company in the amount of $780,000 was paid
from the proceeds of the preferred stock issuance during 1995, resulting in net
cash proceeds to the Company of $1,220,000. In conjunction with the issuance of
the subordinated indebtedness in April 1993, the Company issued a warrant
entitling the lender to purchase 76,756 shares of the Company's common stock at
$6.46 per share. The warrant is exercisable upon the earlier of repayment by the
Company of the debenture; the entering into a contract for the sale of all or
substantially all of the assets of the Company or any of its subsidiaries; a
bona fide offer being made by any person for, or the sale in one or more related
transactions of, more than 10 percent of the Company's then outstanding common
stock, or 10 percent of any of its subsidiaries' then outstanding common stock;
on February 28, 1998; the effective date of the first registration statement
filed by the Company covering an underwritten offering of any of its securities
to the general public; or the occurrence of an event of default under the terms
of the financing agreement. The warrant expires on February 28, 2003. Concurrent
with the issuance of the warrant, the Company has issued stock options to the
lender to purchase a number of common shares sufficient for the lender to
maintain 14 percent of the ownership of the Company's common stock on a fully
diluted basis. The options grant the lender the right to purchase the common
stock at 66 percent of issue price of any proposed common stock offerings and
were exercisable subject to the terms described earlier. The options expire on
February 28, 2003. In July 1996, the Company negotiated a release with the
lender and paid $975,000 to the lender in exchange for the cancellation of the
lender's warrant and options.
In May 1996, the Company completed a private placement for 800,058 shares of
the Company's common stock, resulting in net proceeds to the Company of
$4,401,317. All shares were sold to a single investor.
In August 1996, the company sold 42,000 shares of common stock to an officer
of the Company for $252,000 and made loans to eight employees totaling $240,000
related to the purchase of 40,000 shares of the Company's common stock.
In June 1996, the Company issued warrants on a pro rata basis to
shareholders of record of the Company as of May 17, 1996, to purchase an
aggregate of 735,686 shares of the Company's common stock at a purchase price
equal to 165 percent of the planned public offering price per share of $6, or
$9.90 per share. In conjunction with the terms of the agreement under which the
preferred stock and warrants were sold, the Company issued, in June 1996,
warrants to the preferred stockholder to purchase an aggregate of 54,163 shares
of the Company's common stock at a purchase price equal to 165 percent of the
planned public offering price per share of $6, or $9.90 per share.
9. STOCK OPTIONS:
The Company has granted certain management and directors stock options that
allow the individual to purchase previously unissued common shares at a set
price. The exercise prices of options granted approximate the estimated fair
market value, as determined by the Board of Directors, of the Company's common
stock as of the grant date. The Company is also obligated to grant options to a
member of
F-16
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
9. STOCK OPTIONS: (CONTINUED)
management upon issuance of additional shares of the Company's common stock to
ensure that his portion of the Company's common stock will not become diluted.
The Company's obligation is 2 percent of its common shares at December 31, 1996.
The Company applies APB Opinion 25 and related Interpretations in accounting
for its options. Accordingly, no compensation cost has been recognized for its
stock option plans. Had compensation cost for the Company's stock options been
determined based on the fair value at the grant dates for awards, consistent
with the method of FASB Statement No. 123, Accounting for Stock-Based
Compensation, the Company's net income and earnings per share would not be
materially different from amounts reported for the years ended December 31, 1996
and 1995.
The Company estimates the fair value of each option grant on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants: dividend yield of .67 percent and
risk free interest rate of approximately 6 percent for 1996 and 1995, and
expected lives of approximately 3 and 4 years for the options granted in 1996
and 1995, respectively. All options were granted prior to the Company's initial
public offering. Consequently, as permitted by SFAS No. 123, the Company has
excluded volatility from its fair value computations.
Changes in the options outstanding during the years ended December 31, 1996
and 1995, and for the six months ended June 30, 1997, were as follows.
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE PRICE
SHARES PER SHARE
---------- ---------------
<S> <C> <C>
Outstanding, December 31, 1994..................................... 139,894 $ 4.09
Granted.......................................................... 14,650 $ 8.72
Exercised........................................................ (124,316) $ 3.99
Expired.......................................................... (15,578) $ 4.88
----------
Outstanding, December 31, 1995..................................... 14,650 $ 8.72
Granted.......................................................... 70,004 $ 8.72
----------
Outstanding, December 31, 1996..................................... 84,654 $ 8.72
----------
----------
Outstanding, June 30, 1997 (unaudited)............................. 84,654 $ 8.72
----------
----------
</TABLE>
As a result of the excess of exercise price over the share price during
1996, the Black-Scholes option-pricing model indicates that the fair value of
options granted in 1996 is zero. The weighted-average fair value of options
granted during 1995 was $1.95.
As of December 31, 1996, all outstanding options are exercisable, at an
exercise price of $8.72, and expire in 1999.
On July 1, 1997, the Company issued to certain of its officers and employees
options to purchase 120,000 shares of the Company's common stock at an exercise
price of $10 per share.
F-17
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
10. COMMITMENTS AND CONTINGENT LIABILITIES:
Certain of the Company's leases require the Company to pay minimum royalties
or rentals. The aggregate minimum royalty and rental payments on leases for the
next five years are as follows.
<TABLE>
<S> <C>
1997............................................................... $ 31,736
1998............................................................... 31,546
1999............................................................... 30,678
2000............................................................... 29,828
2001............................................................... 29,828
</TABLE>
The Company is subject to various Federal, state, and local laws and
regulations relating to the protection of the environment. The Company believes
that it is in compliance with these laws and regulations and does not expect to
incur significant capital expenditures in future years to maintain compliance.
11. SALES TO MAJOR CUSTOMERS
One of the Company's customers accounted for 31 percent of consolidated
operating revenue for the year ended December 31, 1996. One of the Company's
customers accounted for 25 percent, one customer accounted for 21 percent, while
another customer accounted for 15 percent, respectively, of operating revenue
for the six months ended June 30, 1997.
12. INCOME TAXES:
The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ---------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal...................................... $ 35,564 $ (7,342) $ 10,231 $ 30,996
State........................................ 3,226 (751) -- 3,892
---------- ---------- ---------- ---------
38,790 (8,093) 10,231 34,888
---------- ---------- ---------- ---------
Deferred:
Federal...................................... 82,248 (7,120) 124,985 18,176
State........................................ 16,845 (2,330) 16,611 9,517
---------- ---------- ---------- ---------
99,093 (9,450) 141,596 27,693
---------- ---------- ---------- ---------
$ 137,883 $ (17,543) $ 151,827 $ 62,581
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
</TABLE>
F-18
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
12. INCOME TAXES: (CONTINUED)
The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Deferred tax assets:
Minimum tax credit carryforwards................................ $ 104,609 $ 104,609
Net operating loss carryforward................................. 86,910 86,910
----------- ------------
Total......................................................... 191,519 191,519
----------- ------------
Deferred tax liabilities:
Capital assets.................................................. 920,526 821,433
----------- ------------
Net deferred tax liabilities.................................. $ 729,007 $ 629,914
----------- ------------
----------- ------------
</TABLE>
The Company has no valuation allowances as of December 31, 1996, or as of
June 30, 1997, and there were no changes in the valuation allowance during the
years ended December 31, 1996 or 1995, or during the six months ended June 30,
1997 and 1996.
A reconciliation of the tax provision at the statutory Federal income tax
rate and the Company's actual provision for income tax is as follows.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ----------------------
1997 1996 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
(UNAUDITED)
Tax at statutory rate of 34%..................................... $ 192,084 $ 64,362 $ 258,194 $ 182,395
Equity in earnings of affiliated companies....................... (44,608) (70,700) (115,576) (90,945)
State income taxes, less Federal benefit......................... 11,337 (487) 10,963 7,030
Statutory depletion in excess of cost depletion.................. (13,526) (11,283) (26,693) (19,837)
Other, net....................................................... (7,404) 565 24,939 (16,062)
---------- ---------- ---------- ----------
$ 137,883 $ (17,543) $ 151,827 $ 62,581
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
In addition, the Company has minimum tax credits that can be carried forward
indefinitely to offset future regular tax. The aggregate amount of minimum tax
credits available at December 31, 1996, is $104,609.
13. SUPPLEMENTARY INFORMATION ON NATURAL GAS PRODUCING ACTIVITIES (UNAUDITED):
The following supplementary information regarding the gas producing
activities of the Company is presented in accordance with the requirements of
Statement of Financial Accounting Standards ("SFAS") No. 69. The amounts shown
include the Company's net working and royalty interests in all of its natural
gas operations. The Company has no material investments in unproved properties.
F-19
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
NATURAL GAS RESERVES
Users of this information should be aware that the process of estimating
quantities of proved and proved developed natural gas reserves is complex,
requiring significant subjective decisions in the evaluation of all available
geological, engineering, and economic data for each reservoir. The data for a
given reservoir may also change substantially over time as a result of numerous
factors including, but not limited to, additional development activity, evolving
production history, and continual reassessment of the viability of production
under varying economic conditions. Consequently, material revisions to existing
reserve estimates occur from time to time. Although every reasonable effort is
made to ensure that reserve estimates reported represent the most accurate
assessments possible, the significance of the subjective decisions required and
variances in available data for various reservoirs makes these estimates
generally less precise than other estimates presented in connection with
financial statement disclosures.
Proved reserves represent estimated quantities of natural gas that
geological and engineering data demonstrate, with reasonable certainty, to be
recoverable in future years from known reservoirs under economic and operating
conditions existing at the time the estimates were made.
Proved developed reserves are proved reserves expected to be recovered
through wells and equipment in place and under operating methods being utilized
at the time the estimates were made.
No major discovery or other favorable or adverse event subsequent to
December 31, 1996 is believed to have caused a material change in the estimates
of proved or proved developed reserves as of that date.
CAPITAL COSTS RELATING TO NATURAL GAS PRODUCING ACTIVITIES:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Proved natural gas properties..................................... $ 2,581,634 $ 2,573,132
Support equipment and facilities.................................. 32,093 31,882
------------ ------------
2,613,727 2,605,014
Less--Accumulated depreciation, depletion and amortization........ (668,526) (520,649)
------------ ------------
Net capitalized costs............................................. $ 1,945,201 $ 2,084,365
------------ ------------
------------ ------------
</TABLE>
COSTS INCURRED IN NATURAL GAS ACTIVITIES:
<TABLE>
<CAPTION>
1996 1995
--------- ----------
<S> <C> <C>
Proved property acquisition costs...................................... $ -- $ 320,241
Exploration costs...................................................... 2,688 4,202
Development costs...................................................... 8,502 270,091
--------- ----------
$ 11,190 $ 594,534
--------- ----------
--------- ----------
</TABLE>
RESULTS OF OPERATIONS FOR NATURAL GAS PRODUCING ACTIVITIES
The following table includes results solely from the production and sale of
natural gas and changes for property impairments. It excludes general and
administrative expenses and gains or losses on property
F-20
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
NATURAL GAS RESERVES (CONTINUED)
dispositions. The income tax expense is calculated by applying the statutory tax
rates to the revenues after deducting costs, which include depletion allowances
and giving effect to permanent differences and tax credits.
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Revenues.............................................................. $ 416,201 $ 236,204
Cost of natural gas sold.............................................. (42,349) (26,755)
Exploration costs..................................................... (2,688) (4,202)
Depreciation, depletion and amortization.............................. (168,977) (157,394)
Revenue adjustment (see Note 2)....................................... -- 72,992
---------- ----------
202,187 120,845
Income tax expense.................................................... (43,287) (21,876)
---------- ----------
Results of operations................................................. $ 158,900 $ 98,969
---------- ----------
---------- ----------
</TABLE>
The revenue adjustment for 1995 relates to the Company's revision of its
method of recording certain revenue, as discussed in Note 2.
NATURAL GAS RESERVES (UNAUDITED)
The following table presents the estimated natural gas reserves owned by the
Company. This information includes the Company's royalty and working interest
share of the reserves in southwestern Virginia. These reserves were estimated by
the Company; however, by their nature they are subject to upward and downward
revisions as additional information regarding fields and technology becomes
available. All reserves are located in the United States.
NATURAL GAS
PROVED DEVELOPED AND UNDEVELOPED RESERVES (UNAUDITED):
(THOUSANDS OF CUBIC FEET/MCF)
<TABLE>
<S> <C>
December 31, 1994................................................................ 4,072,782
Revisions of previous estimates................................................ (1,401,793)
Production..................................................................... (160,798)
Purchase of reserves........................................................... 654,025
---------
December 31, 1995................................................................ 3,164,216
Revisions of previous estimates................................................ 160,830
Production..................................................................... (161,995)
Purchase of reserves........................................................... --
---------
December 31, 1996................................................................ 3,163,051
---------
---------
Proved Developed Producing Reserves:
December 31, 1995.............................................................. 2,316,276
---------
---------
December 31, 1996.............................................................. 2,309,325
---------
---------
</TABLE>
F-21
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
NATURAL GAS RESERVES (CONTINUED)
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (UNAUDITED)
The following information relating to proved natural gas reserves has been
developed utilizing procedures prescribed by SFAS No. 69 and based on natural
gas reserve and production volumes estimated by the engineering staff of the
Company. It may be useful for certain comparison purposes but should not be
relied upon solely in evaluating the Company or its performance. Further,
information contained in the following table should not be considered as
representative of realistic assessments of future cash flows, nor should the
Standardized Measure of Discounted Future Net Cash Flows be viewed as
representative of the current value of the Company.
The future cash flows presented below are based on sales prices, cost rates,
and statutory income tax rates in existence as of the date of the projection. It
is expected that material revisions to some estimates of natural gas reserves
may occur in the future, development and production of the reserves may occur in
periods other than those assumed, and actual prices realized and costs incurred
may vary significantly from those used.
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
(UNAUDITED)
Future cash inflows............................................. $ 10,870,114 $ 5,505,812
Future production costs......................................... (1,804,856) (1,680,171)
Future development costs........................................ (196,300) (242,889)
------------- -------------
Future cash inflows before income taxes......................... 8,868,958 3,582,752
Future income tax expense....................................... (2,506,544) (1,057,790)
------------- -------------
Future net cash flows........................................... 6,362,414 2,524,962
10% annual discount for estimated timing of cash flows.......... (3,514,491) (1,416,025)
------------- -------------
Standardized measure of discounted future net cash flows........ $ 2,847,923 $ 1,108,937
------------- -------------
------------- -------------
</TABLE>
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
(UNAUDITED)
Sales of natural gas, net of production costs..................... $ 2,372,780 $ 244,799
Development costs incurred during the period...................... 22,280 (56,189)
Purchase of minerals-in-place..................................... -- 362,994
Net change in income taxes........................................ (656,074) (168,055)
------------ ------------
Net increase (decrease)........................................... 1,738,986 383,549
Beginning of year................................................. 1,108,937 725,388
------------ ------------
End of year....................................................... $ 2,847,923 $ 1,108,937
------------ ------------
------------ ------------
</TABLE>
14. EMPLOYMENT COMMITMENTS:
On May 23, 1996, the Company entered into a ten-year employment contract
with its President and CEO (the "President"), which provides for an annual
salary of $155,000. The contract provides for a bonus
F-22
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
14. EMPLOYMENT COMMITMENTS: (CONTINUED)
to be paid based upon 10 percent of the Company's pretax earnings on all amounts
from $1,000,000 to $1,999,999 and 15 percent of the Company's pretax earnings on
all amounts in excess of $2,000,000. If the President is terminated by the
Company for any reason other than for cause during the term the term of the
employment contract, at the President's election, the Company would be obligated
to purchase all or a portion of the shares held by him and his family (749,826
shares as of June 30, 1997, of which 363,663 shares are issuable upon the
exercise of warrants exercisable at $9.90 per share) at a price equal to 150
percent of the market value of the Company's shares on the date of termination.
In addition, the Company would be obligated to pay the President in a lump sum
all salary amounts owed through the term of the employment agreement plus an
additional $2,000,000.
F-23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Virginia Gas Storage Company:
We have audited the accompanying balance sheet of Virginia Gas Storage Company
as of December 31, 1996, and the related statements of income, changes in
stockholders' equity, and cash flows for the years ended December 31, 1996 and
1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Storage Company as
of December 31, 1996, and the results of its operations and its cash flows for
the years ended December 31, 1996 and 1995, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Richmond, Virginia
March 7, 1997
F-24
<PAGE>
VIRGINIA GAS STORAGE COMPANY
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash........................................................................... $ 189,868 $ 148,619
Accounts receivable............................................................ 1,069,968 1,233,227
Notes receivable............................................................... 70,000 570,000
Other current assets........................................................... 18,348 85,369
------------- -------------
Total current assets................................................... 1,348,184 2,037,215
PROPERTY AND EQUIPMENT, net........................................................ 14,542,439 13,323,883
OTHER ASSETS....................................................................... 965,018 956,099
------------- -------------
Total assets........................................................... $ 16,855,641 $ 16,317,197
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt.............................................. $ 107,861 $ 104,915
Accounts payable............................................................... 1,364,582 2,193,010
Other current liabilities...................................................... 238,540 108,929
------------- -------------
Total current liabilities.............................................. 1,710,983 2,406,854
LONG-TERM DEBT..................................................................... 7,328,182 6,386,212
DEFERRED INCOME TAXES.............................................................. 619,435 551,686
------------- -------------
Total liabilities...................................................... 9,658,600 9,344,752
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock -- no par value, 50,000 shares authorized, 38,200 (unaudited)
shares issued and outstanding as of June 30, 1997; no par value, 50,000
shares authorized, 38,200 issued and outstanding as of December 31, 1996..... 5,640,000 5,640,000
Retained earnings.............................................................. 1,557,041 1,332,445
------------- -------------
Total stockholders' equity............................................. 7,197,041 6,972,445
------------- -------------
Total liabilities and stockholders' equity............................. $ 16,855,641 $ 16,317,197
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-25
<PAGE>
VIRGINIA GAS STORAGE COMPANY
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ------------ ------------ ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Operating revenue.................................... $ 2,149,463 $ 1,952,499 $ 3,831,224 $ 2,696,594
Interest and other income............................ 30,104 108,252 154,220 82,454
------------ ------------ ------------ ------------
2,179,567 2,060,751 3,985,444 2,779,048
------------ ------------ ------------ ------------
EXPENSES:
Production expenses.................................. 110,139 132,654 222,808 277,167
Purchased gas expense................................ 510,502 664,087 974,277 680,857
Operation and maintenance expense.................... 404,381 109,361 374,579 294,249
Depreciation, depletion, and amortization............ 256,332 192,460 416,699 308,039
General and administrative........................... 392,535 278,163 700,296 356,979
------------ ------------ ------------ ------------
1,673,889 1,376,725 2,688,659 1,917,291
------------ ------------ ------------ ------------
OTHER EXPENSE:
Interest............................................. 165,380 77,309 272,941 115,010
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES............................... 340,298 606,717 1,023,844 746,747
PROVISION FOR INCOME TAXES............................... 115,702 206,283 348,106 261,364
------------ ------------ ------------ ------------
NET INCOME............................................... $ 224,596 $ 400,434 $ 675,738 $ 485,383
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
VIRGINIA GAS COMPANY'S EQUITY IN VIRGINIA GAS STORAGE
COMPANY'S EARNINGS..................................... $ 112,298 $ 200,217 $ 337,869 $ 242,692
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
VIRGINIA GAS STORAGE COMPANY
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON RETAINED
STOCK EARNINGS
------------ ------------
<S> <C> <C>
BALANCE, December 31, 1994............................................................ $ 2,000,000 $ 171,324
Issuance of 18,200 shares........................................................... 3,640,000 --
Net income.......................................................................... -- 485,383
------------ ------------
BALANCE, December 31, 1995............................................................ 5,640,000 656,707
Net income.......................................................................... -- 675,738
------------ ------------
BALANCE, December 31, 1996............................................................ 5,640,000 1,332,445
Net income (unaudited).............................................................. -- 224,596
------------ ------------
BALANCE, June 30, 1997 (unaudited).................................................... $ 5,640,000 $ 1,557,041
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
VIRGINIA GAS STORAGE COMPANY
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
------------------------ ------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
----------- ----------- ----------- -----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 224,596 $ 400,434 $ 675,738 $ 485,383
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion, and amortization.............. 256,332 192,460 416,699 308,039
Deferred income taxes.................................. 67,749 120,465 212,476 139,214
Decrease (increase) in accounts receivable............. 163,259 127,407 (304,140) (194,420)
Decrease (increase) in other current assets............ 67,021 (4,386) (22,353) (50,441)
Increase in other assets............................... (36,728) (12,183) (37,981) (31,946)
(Decrease) increase in accounts payable................ (828,428) (746,238) 1,092,591 64,109
Increase (decrease) in other current liabilities....... 129,611 (37,398) (58,690) (27,763)
----------- ----------- ----------- -----------
Net cash provided by operating activities........ 43,412 40,561 1,974,340 692,175
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................... (1,447,079) (1,643,823) (4,225,530) (2,870,185)
Payments received on notes receivable.................. 500,000 1,720,000 1,720,000 100,000
----------- ----------- ----------- -----------
Net cash (used in) provided by investing
activities..................................... (947,079) 76,177 (2,505,530) (2,770,185)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal.............................. (55,084) (57,936) (117,677) (23,006)
Proceeds from new loans................................ 1,000,000 500,000 500,000 1,342,697
Proceeds from issuance of common stock................. -- -- -- 500,000
Payment of financing issuance costs.................... -- -- -- (42,131)
Establishment of financing reserve funds............... -- -- -- (75,843)
----------- ----------- ----------- -----------
Net cash provided by financing activities........ 944,916 442,064 382,323 1,701,717
----------- ----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH............................ 41,249 558,802 (148,867) (376,293)
Cash, beginning of period.................................. 148,619 297,486 297,486 673,779
----------- ----------- ----------- -----------
CASH, end of period........................................ $ 189,868 $ 856,288 $ 148,619 $ 297,486
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE:
Interest paid.......................................... $ 333,254 $ 328,356 $ 606,505 $ 450,501
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Income taxes paid...................................... $ 47,635 $ 79,024 $ 159,024 $ 123,349
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
1. DESCRIPTION OF OPERATIONS:
Virginia Gas Storage Company (the "Company") was organized in 1992 under the
laws of the state of Virginia. The Company is 50 percent owned by Virginia Gas
Company ("VGC") and 50 percent owned by a private investor. The primary business
of the Company is to develop and operate natural gas storage and transmission
facilities.
The Company's operations are subject to certain risks and uncertainties
including, among others, the adequacy of future financing, the need for
additional capital, dependence on major customers, and current and potential
competitors with greater financial and marketing resources.
INTERIM FINANCIAL INFORMATION
The unaudited financial statements as of June 30, 1997, and for the six
months ended June 30, 1997 and 1996, include, in the opinion of management, all
adjustments (that are normal and recurring in nature) necessary to present
fairly the Company's financial position, results of operations, and cash flows.
Operating results for the six months ended June 30, 1997, are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes gas sales and transmission revenues upon delivery of
gas to the common pipeline carrier. Storage revenues are recognized evenly
throughout the contract terms with injection and withdrawal revenues recognized
as natural gas is injected or withdrawn from the storage facility.
During the year ended December 31, 1995, the Company revised its method of
recording certain revenue. Prior to 1995, recognition of transmission revenues
was deferred for three months after the actual transmission of natural gas had
occurred, primarily to match the recognition of revenues with the period these
revenues were distributed to the working interest owners. The policy revision to
record revenues on a current basis reflects the Company's ability to estimate
its net revenues on a current basis. This change is reflected on a prospective
basis beginning in January 1995 and results in 15 months of transmission
revenues being recognized in 1995. The effect of this change was to increase
revenue and net income by $110,000 and $43,000, respectively, for the year ended
December 31, 1995.
PROPERTY AND EQUIPMENT
All direct and indirect costs relating to property acquisition, development
costs and support equipment and facilities are capitalized as the properties are
obtained or the facilities are placed into service. The Company provides for
depreciation of property and equipment using the straight-line method over
estimated useful lives ranging from 5 to 30 years.
F-29
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
CAPITALIZED INTEREST
The Company capitalizes interest on expenditures for significant projects
while activities are in progress to bring the assets to their intended use.
Interest capitalized totaled $283,564 and $317,312 for the years ended December
31, 1996 and 1995, respectively. Interest capitalized totaled $148,176
(unaudited) and $201,047 (unaudited) in the six months ended June 30, 1997 and
1996, respectively.
OTHER ASSETS
In conjunction with the 1997 issuance of the Russell County, the 1995
issuance of the Buchanan County and the 1994 issuance of the Russell County and
Buchanan County, Virginia, Natural Gas Facilities Revenue Bonds by the
Industrial Development Authorities of the respective counties, reserve funds
have been established by the trustee for each issuance. Amounts in the reserve
funds will be used to make payments of principal and interest, whether at
maturity, by acceleration, call for redemption, or otherwise, where trust funds
accumulated by scheduled Company payments are insufficient to satisfy bond
requirements. Such amounts are invested in debt securities issued by the U.S.
Treasury and other U.S. government corporations and agencies. The Company
records these investments at cost and recognizes related interest as earned. The
carrying value of investments approximates market value.
Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.
INCOME TAXES
Income taxes are accounted for using the asset-and-liability method. Under
the asset-and-liability method, deferred income taxes reflect the temporary
differences between assets and liabilities recognized for financial reporting
purposes and amounts recognized for tax purposes.
3. ACCOUNTS RECEIVABLE:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Trade receivables.................................................................... $ 224,622 $ 618,275
Receivables from affiliated companies................................................ 638,741 469,656
Pipeline operating expenses.......................................................... 51,854 54,944
Joint-interest receivables........................................................... 154,648 90,249
Other................................................................................ 103 103
------------ ------------
$ 1,069,968 $1,233,227
------------ ------------
------------ ------------
</TABLE>
F-30
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
4. NOTES RECEIVABLE:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Note receivable from shareholder; interest receivable at 8%; principal received as
consideration for the issuance of common shares. The note receivable from
shareholder was collected in March 1997............................................. $ -- $ 500,000
Note receivable from Virginia Gas Exploration Company; interest receivable at 8%;
principal balance due 1997.......................................................... 70,000 70,000
----------- ------------
70,000 570,000
Less-- Current portion................................................................ (70,000) (570,000)
----------- ------------
$ -- $ --
----------- ------------
----------- ------------
</TABLE>
5. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Storage properties............................................................. $ 13,558,160 $ 12,095,480
Pipelines...................................................................... 2,024,621 2,026,091
Vehicles....................................................................... 108,242 133,742
Office equipment............................................................... 75,242 63,335
Wells and pipelines in progress................................................ 68,294 68,832
------------- -------------
15,834,559 14,387,480
Less-- Accumulated depreciation, depletion, and amortization................... (1,292,120) (1,063,597)
------------- -------------
$ 14,542,439 $ 13,323,883
------------- -------------
------------- -------------
</TABLE>
6. OTHER ASSETS:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Restricted cash and investments-reserve funds......................................... $ 599,653 $ 582,233
Deferred debt issuance costs.......................................................... 357,873 365,707
Other................................................................................. 7,492 8,159
----------- ------------
$ 965,018 $ 956,099
----------- ------------
----------- ------------
</TABLE>
F-31
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
7. ACCOUNTS PAYABLE:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Trade payables....................................................................... $ 623,711 $1,827,867
Payable to affiliated companies...................................................... 740,871 365,143
------------ ------------
$ 1,364,582 $2,193,010
------------ ------------
------------ ------------
</TABLE>
8. OTHER CURRENT LIABILITIES:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Amounts due affiliated companies...................................................... $ 42,519 $ 46,255
Funds held for future distribution.................................................... 144,603 8,120
Income taxes payable.................................................................. 36,047 17,569
Other................................................................................. 15,371 36,985
----------- ------------
$ 238,540 $ 108,929
----------- ------------
----------- ------------
</TABLE>
F-32
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
9. LONG-TERM DEBT:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Note payable to Virginia Gas Company; interest payable at 8.88%; principal payable in
maturities of $12,000 to $241,000 from 1995 to 2017................................ $ 2,534,342 $2,567,837
Note payable to Virginia Gas Company; interest payable at 7.35%; principal payable in
maturities of $13,000 to $77,000 from 1996 to 2023................................. 1,012,021 1,018,579
Notes payable to Virginia Gas Distribution Company; interest payable at 9%; principal
payable in maturities of $1,000 to $91,000 from 1999 to 2020....................... 1,000,000 1,000,000
Notes payable to Virginia Gas Distribution Company; interest payable at 9.5%;
principal payable in maturities of $30,000 to $123,000 from 2002 to 2017........... 1,000,000 --
Note payable to Virginia Gas Company; interest payable at 9%; principal payable in
maturities of $1,000 to $77,000 from 1999 to 2020.................................. 842,697 842,697
Notes payable to Virginia Gas Distribution Company; interest payable at 8.88%;
principal payable in maturities of $3,000 to $53,000 from 1995 to 2017............. 561,141 568,557
Notes payable to Virginia Gas Distribution Company; interest payable at 7.35%;
principal payable in maturities of $6,000 to $36,000 from 1996 to 2023............. 467,767 470,798
Notes payable through 1999 with interest from 8.0% to 12.75%; secured by assets with
a book value of $19,380 as of March 31, 1997....................................... 18,075 22,659
------------ ------------
7,436,043 6,491,127
Less-- Current portion............................................................... (107,861) (104,915)
------------ ------------
Long-term debt....................................................................... $ 7,328,182 $6,386,212
------------ ------------
------------ ------------
</TABLE>
In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with principal of $9,100,000. A portion
($1,000,000) of the proceeds was loaned to the Company by Virginia Gas
Distribution Company.
In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000. A
portion ($842,697) of the proceeds was allocated to the Company by VGC which was
used by the Company to construct natural gas storage facilities to support
natural gas distribution facilities owned by Virginia Gas Distribution Company.
In January 1994, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Natural Gas Revenue Bond
Series A and B with combined principal of $3,000,000. A portion ($1,330,000) of
the proceeds was allocated to the Company by an affiliated company, which was
used by the Company to construct natural gas storage and gathering facilities to
support natural gas distribution facilities owned by Virginia Gas Distribution
Company.
F-33
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
9. LONG-TERM DEBT: (CONTINUED)
In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000. A portion ($2,655,306) of
the proceeds was allocated to the Company by VGC which was used by the Company
to construct natural gas storage and gathering facilities to support natural gas
distribution facilities owned by Virginia Gas Distribution Company.
As of December 31, 1996, principal payments on long-term debt for the next
five years are as follows:
<TABLE>
<S> <C>
1997.............................................................. $ 104,915
1998.............................................................. 109,450
1999.............................................................. 132,363
2000.............................................................. 89,441
2001.............................................................. 143,117
</TABLE>
10. SALES TO MAJOR CUSTOMERS:
One of the Company's customers accounted for 12 percent and 20 percent while
another customer accounted for 45 percent and 29 percent, respectively, of
operating revenue for the years ended December 31, 1996 and 1995. One customer
accounted for 10 percent of 1996 operating revenue while another customer
accounted for 12 percent of 1995 operating revenue. One of the Company's
customers accounted for 44 percent and 53 percent, respectively, of operating
revenue for the six months ended June 30, 1997 and 1996, while another customer
accounted for 12 percent of operating revenue for the six months ended June 30,
1996.
11. COMMITMENTS:
Certain of the Company's leases require the Company to pay minimum rentals.
The aggregate minimum rental payments on leases for the next five years are as
follows:
<TABLE>
<S> <C>
1997............................................................... $ 91,523
1998............................................................... 91,523
1999............................................................... 62,373
2000............................................................... 59,723
2001............................................................... 59,723
</TABLE>
F-34
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
12. INCOME TAXES:
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ----------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal.......................................................... $ 47,953 $ 85,818 $ 135,630 $ 108,482
State............................................................ -- -- -- 13,668
---------- ---------- ---------- ----------
47,953 85,818 135,630 122,150
---------- ---------- ---------- ----------
Deferred:
Federal.......................................................... 67,749 120,465 212,476 139,214
State............................................................ -- -- -- --
---------- ---------- ---------- ----------
67,749 120,465 212,476 139,214
---------- ---------- ---------- ----------
$ 115,702 $ 206,283 $ 348,106 $ 261,364
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Deferred tax assets:
Minimum tax credit carryforwards...................................................... $ 4,656 $ 4,656
----------- ------------
Deferred tax liabilities:
Capital assets........................................................................ 624,091 556,342
----------- ------------
Net deferred tax liabilities.......................................................... $ 619,435 $ 551,686
----------- ------------
----------- ------------
</TABLE>
The Company has no valuation allowances as of December 31, 1996, or as of
June 30, 1997, and there were no changes in the valuation allowance during the
years ended December 31, 1996 and 1995, or during the six months ended June 30,
1997 and 1996.
A reconciliation of the tax provision at the statutory Federal income tax
rate and the Company's actual provision for income tax is as follows.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ----------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Tax at statutory rate............................................ $ 115,702 $ 206,283 $ 348,106 $ 253,894
State income taxes, less Federal benefit......................... -- -- -- 10,961
Other, net....................................................... -- -- -- (3,491)
---------- ---------- ---------- ----------
$ 115,702 $ 206,283 $ 348,106 $ 261,364
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
F-35
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
13. RELATED-PARTY TRANSACTIONS:
With the exception of sales and storage fees charged to outside third
parties, a significant portion of the Company's transactions is with VGC and
affiliated companies.
VGC provides certain general and administrative services for the Company.
These services include professional services, insurance coverage and
administrative services (with associated costs). Accordingly, management fees of
$105,000 and $180,000 have been charged to the Company by VGC for the years
ended December 31, 1996 and 1995, respectively, and zero and $90,000 for the six
months ended June 30, 1997 and 1996. Other transactions with affiliated
companies include purchases of natural gas, natural gas storage and technical
services provided for and by affiliated companies.
F-36
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Virginia Gas Distribution Company:
We have audited the accompanying balance sheet of Virginia Gas Distribution
Company as of December 31, 1996, and the related statements of income, changes
in stockholders' equity, and cash flows for the years ended December 31, 1996
and 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Virginia Gas Distribution
Company as of December 31, 1996, and the results of its operations and its cash
flows for the years ended December 31, 1996 and 1995, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Richmond, Virginia
March 7, 1997
F-37
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash.............................................................................. $ 34,529 $ 16,166
Accounts receivable............................................................... 393,717 151,752
Other current assets.............................................................. 148,783 154,920
Notes receivable.................................................................. 26,246 26,004
------------- ------------
Total current assets............................................................ 603,275 348,842
PROPERTY AND EQUIPMENT, net......................................................... 5,785,139 2,755,660
NOTES RECEIVABLE.................................................................... 4,360,450 3,413,066
DEFERRED TAX ASSET.................................................................. -- 1,995
OTHER ASSETS........................................................................ 1,099,160 546,798
------------- ------------
Total assets.................................................................... $ 11,848,024 $7,066,361
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt................................................. $ 40,376 $ 39,240
Accounts payable.................................................................. 1,563,010 462,095
Other current liabilities......................................................... 29,331 33,368
------------- ------------
Total current liabilities....................................................... 1,632,717 534,703
LONG-TERM DEBT...................................................................... 8,646,425 5,018,064
DEFERRED INCOME TAXES............................................................... 17,482 --
------------- ------------
Total liabilities............................................................... 10,296,624 5,552,767
------------- ------------
STOCKHOLDERS' EQUITY:
Common stock -- no par value, 100,000 shares authorized, 75,000 (unaudited) shares
issued and outstanding as of June 30, 1997; no par value, 75,000 issued and
outstanding as of December 31, 1996............................................. 1,500,000 1,500,000
Retained earnings................................................................. 51,400 13,594
------------- ------------
Total stockholders' equity...................................................... 1,551,400 1,513,594
------------- ------------
Total liabilities and stockholders' equity...................................... $ 11,848,024 $7,066,361
------------- ------------
------------- ------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-38
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
---------------------- ----------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Operating revenue........................................... $ 419,421 $ 299,092 $ 629,280 $ 556,052
Interest income............................................. 211,303 161,284 320,836 129,249
Other income................................................ 45,288 36,059 72,949 33,887
---------- ---------- ---------- ----------
676,012 496,435 1,023,065 719,188
---------- ---------- ---------- ----------
EXPENSES:
Purchased gas expense....................................... 238,996 146,573 330,332 234,297
Operation and maintenance expense........................... 38,386 22,365 55,032 50,563
Depreciation, depletion, and amortization................... 50,751 38,037 78,013 76,162
General and administrative.................................. 73,348 82,440 191,619 125,982
---------- ---------- ---------- ----------
401,481 289,415 654,996 487,004
---------- ---------- ---------- ----------
OTHER EXPENSE:
Interest.................................................... 200,955 170,125 358,158 147,915
Other....................................................... 16,293 13,487 3,676 9,140
---------- ---------- ---------- ----------
217,248 183,612 361,834 157,055
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES...................................... 57,283 23,408 6,235 75,129
PROVISION FOR INCOME TAXES...................................... 19,477 7,958 2,120 25,544
---------- ---------- ---------- ----------
NET INCOME...................................................... $ 37,806 $ 15,450 $ 4,115 $ 49,585
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
VIRGINIA GAS COMPANY'S EQUITY IN VIRGINIA GAS DISTRIBUTION
COMPANY'S EARNINGS............................................ $ 18,903 $ 7,725 $ 2,058 $ 24,792
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-39
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
RETAINED
COMMON EARNINGS
STOCK (DEFICIT)
------------ ----------
<S> <C> <C>
Balance, December 31, 1994.............................................................. $ 1,500,000 $ (40,106)
Net income............................................................................ -- 49,585
------------ ----------
Balance, December 31, 1995.............................................................. 1,500,000 9,479
Net income............................................................................ -- 4,115
------------ ----------
Balance, December 31, 1996.............................................................. 1,500,000 13,594
Net income (unaudited)................................................................ -- 37,806
------------ ----------
Balance, June 30, 1997 (unaudited)...................................................... $ 1,500,000 $ 51,400
------------ ----------
------------ ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-40
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
------------------------ ------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
----------- ----------- ----------- -----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 37,806 $ 15,450 $ 4,115 $ 49,585
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion, and amortization.............. 50,751 38,037 78,013 76,162
Deferred income taxes.................................. 19,477 7,062 2,120 22,197
(Increase) decrease in accounts receivable............. (241,965) (24,680) 52,074 (108,776)
Decrease (increase) in receivable from affiliate....... -- 1,562,500 1,562,500 (1,562,500)
Decrease (increase) in other current assets............ 6,137 21,779 (3,220) (81,914)
Increase in other assets............................... (14,246) (8,648) (25,239) (6,973)
Increase (decrease) in accounts payable................ 1,100,915 (169,198) 227,747 68,609
(Decrease) increase in other current liabilities....... (4,037) (65,645) (70,345) 82,471
----------- ----------- ----------- -----------
Net cash provided by (used in) operating
activities................................... 954,838 1,376,657 1,827,765 (1,461,139)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................... (3,070,452) (180,853) (674,263) (412,178)
Loans made to affiliated companies....................... (1,000,000) (1,500,000) (1,500,000) (500,000)
Payments received on notes receivable.................... 52,374 83,998 98,200 20,741
----------- ----------- ----------- -----------
Net cash used in investing activities.......... (4,018,078) (1,596,855) (2,076,063) (891,437)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal................................ (20,503) (20,392) (42,223) (4,644)
Proceeds from new loans.................................. 3,650,000 -- -- 2,881,314
Payment of financing costs............................... (219,394) -- -- (66,368)
Establishment of financing reserve funds................. (328,500) -- -- (259,129)
----------- ----------- ----------- -----------
Net cash provided by (used in) financing
activities................................... 3,081,603 (20,392) (42,223) 2,551,173
----------- ----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH............................ 18,363 (240,590) (290,521) 198,597
CASH, beginning of period.................................. 16,166 306,687 306,687 108,090
----------- ----------- ----------- -----------
CASH, end of period........................................ $ 34,529 $ 66,097 $ 16,166 $ 306,687
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE:
Interest paid............................................ $ 349,996 $ 316,564 $ 533,085 $ 97,181
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Income taxes paid........................................ $ -- $ -- $ -- $ --
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-41
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
NOTES TO FINANCIAL STATEMENTS
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
1. DESCRIPTION OF OPERATIONS:
Virginia Gas Distribution Company (the "Company") was organized during 1992
under the laws of the state of Virginia. The Company is 50 percent owned by
Virginia Gas Company ("VGC") and 50 percent owned by a private investor. The
primary business of the Company is to develop and operate natural gas
distribution systems, located primarily in the southwestern counties of the
Commonwealth of Virginia.
The Company's operations are subject to certain risks and uncertainties
including, among others, the adequacy of future financing, the need for
additional capital, dependence on major customers, and current and potential
competitors with greater financial and marketing resources.
INTERIM FINANCIAL INFORMATION
The unaudited financial statements as of June 30, 1997, and for the six
months ended June 30, 1997 and 1996, include, in the opinion of management, all
adjustments (that are normal and recurring in nature) necessary to present
fairly the Company's financial position, results of operations, and cash flows.
Operating results for the six months ended June 30, 1997, are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes revenue in the period the natural gas is delivered to
the customer.
PROPERTY AND EQUIPMENT
All direct and indirect costs relating to property acquisition, development
costs, and support equipment and facilities are capitalized as the properties
are obtained or the facilities are placed into service. The Company provides for
depreciation of property and equipment using the straight-line method over
estimated useful lives ranging from 5 to 30 years.
CAPITALIZED INTEREST
The Company capitalizes interest on expenditures for significant projects
while activities are in progress to bring the assets to their intended use.
Interest capitalized totaled $74,927 and $25,930 for the years ended December
31, 1996 and 1995, respectively. Interest capitalized totaled $145,580
(unaudited) and $46,439 (unaudited) for the six months ended June 30, 1997 and
1996, respectively.
F-42
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
OTHER ASSETS
In conjunction with the 1997 issuance of the Russell County, the 1995
issuance of the Buchanan County and the 1994 issuance of the Russell County and
Buchanan County, Virginia, Natural Gas Facilities Revenue Bonds by the
Industrial Development Authorities of the respective counties, reserve funds
have been established by the trustee for each issuance. Amounts in the reserve
funds will be used to make payments of principal and interest, whether at
maturity, by acceleration, call for redemption, or otherwise, where trust funds
accumulated by scheduled Company payments are insufficient to satisfy bond
requirements. Such amounts are invested in debt securities issued by the U.S.
Treasury and other U.S. government corporations and agencies. The Company
records these investments at cost and recognizes related interest as earned. The
carrying value of investments approximates market value.
Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.
INCOME TAXES
Income taxes are accounted for using the asset-and-liability method. Under
the asset-and-liability method, deferred income taxes reflect the temporary
differences between assets and liabilities recognized for financial reporting
purposes and amounts recognized for tax purposes.
3. NOTES RECEIVABLE
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Note receivable from Virginia Gas Storage Company; interest receivable at 8.88%;
principal due in maturities of $3,000 to $53,000 from 1995 to 2017................. $ 561,141 $ 568,557
Notes receivable from Virginia Gas Storage Company; interest receivable at 9%;
principal due in maturities of $1,000 to $91,000 from 1999 to 2020................. 1,000,000 1,000,000
Note receivable from Virginia Gas Pipeline Company; interest receivable at 9%;
principal due in maturities of $1,000 to $91,000 from 1999 to 2020................. 965,000 1,000,000
Note receivable from Virginia Gas Storage Company; interest receivable at 9.5%;
principal due in maturities of $30,000 to $123,000 from 2002 to 2017............... 1,000,000 --
Note receivable from Virginia Gas Storage Company; interest receivable at 7.35%;
principal due in maturities of $6,000 to $36,000 from 1996 to 2023................. 467,767 470,798
Note receivable from Virginia Gas Exploration Company; interest receivable at 7.35%;
principal due in maturities of $5,000 to $30,000 from 1996 to 2023................. 392,788 395,333
Other................................................................................ -- 4,382
------------ ------------
4,386,696 3,439,070
Less--Current portion................................................................ (26,246) (26,004)
------------ ------------
$ 4,360,450 $3,413,066
------------ ------------
------------ ------------
</TABLE>
F-43
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
4. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Pipelines............................................................................ $ 5,447,065 $2,343,856
Project and construction in progress................................................. 570,059 555,232
Other property and equipment......................................................... 56,802 104,386
------------ ------------
6,073,926 3,003,474
Less--Accumulated depreciation and amortization...................................... (288,787) (247,814)
------------ ------------
$ 5,785,139 $2,755,660
------------ ------------
------------ ------------
</TABLE>
5. OTHER ASSETS:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Restricted cash and investments-reserve funds........................................ $ 734,895 $ 396,285
Deferred debt issuance costs......................................................... 361,610 147,191
Other................................................................................ 2,655 3,322
------------ ------------
$ 1,099,160 $ 546,798
------------ ------------
------------ ------------
</TABLE>
6. LONG-TERM DEBT:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Note payable to Virginia Gas Company; interest payable at 9.5%; principal payable in
maturities of $110,000 to $447,000 from 2002 to 2017............................... $ 3,650,000 $ --
Note payable to Virginia Gas Company; interest payable at 9%; principal payable in
maturities of $4,000 to $263,000 from 1999 to 2020................................. 2,879,214 2,879,214
Note payable to Virginia Gas Company; interest payable at 7.35%; principal payable in
maturities of $17,000 to $97,000 from 1996 to 2023................................. 1,276,561 1,284,833
Note payable to Virginia Gas Company; interest payable at 8.88%; principal payable in
maturities of $4,000 to $84,000 from 1995 to 2017.................................. 880,816 892,457
Note payable through 1997 with interest, secured by an asset with a book value of
$1,505............................................................................. 210 800
------------ ------------
8,686,801 5,057,304
Less--Current portion................................................................ (40,376) (39,240)
------------ ------------
Long-term debt....................................................................... $ 8,646,425 $5,018,064
------------ ------------
------------ ------------
</TABLE>
In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with
F-44
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
6. LONG-TERM DEBT: (CONTINUED)
principal of $9,100,000. A portion ($3,650,000) of the proceeds was allocated to
the Company by VGC and is being used to construct a natural gas distribution
facility in and around the town of Lebanon, Virginia.
In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000. A
portion ($2,879,214) of the proceeds was allocated to the Company by VGC which
was used by the Company to extend existing natural gas distribution facilities
in and around the town of Grundy, Virginia.
In January 1994, Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000. A portion
($1,300,000) of the proceeds was allocated to the Company by VGC which was used
by the Company to construct a natural gas distribution facility in and around
the town of Castlewood, Virginia.
In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000. A portion ($922,857) of the
proceeds was allocated to the Company by VGC which was used by the Company to
construct a natural gas distribution facility in and around the town of Grundy,
Virginia.
As of December 31, 1996, principal payments on long-term debt for the next
five years are as follows:
<TABLE>
<S> <C>
1997............................................... $ 39,240
1998............................................... 41,347
1999............................................... 74,435
2000............................................... 81,048
2001............................................... 102,339
</TABLE>
7. SALES TO MAJOR CUSTOMERS:
One of the Company's customers accounted for 35 percent and 35 percent, one
customer accounted for 20 percent and 23 percent, while another customer
accounted for 14 percent and 16 percent, respectively, of operating revenue for
the years ended December 31, 1996 and 1995. One of the Company's customers
accounted for 39 percent and 37 percent, one customer accounted for 12 percent
and 14 percent, while another customer accounted for 21 percent and 22 percent,
respectively, of operating revenue for the six months ended June 30, 1997 and
1996.
F-45
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
8. INCOME TAXES:
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
-------------------- --------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
--------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal........................................... $ -- $ 896 $ -- $ 3,347
State............................................. -- -- -- --
--------- --------- --------- ---------
-- 896 -- 3,347
--------- --------- --------- ---------
Deferred:
Federal........................................... 19,477 7,062 2,120 22,197
State............................................. -- -- -- --
--------- --------- --------- ---------
19,477 7,062 2,120 22,197
--------- --------- --------- ---------
$ 19,477 $ 7,958 $ 2,120 $ 25,544
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The significant components of deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Deferred tax assets:
Net operating loss carryforward................................. $ 128,657 $ 128,657
----------- ------------
Deferred tax liabilities:
Capital assets.................................................. 146,139 126,662
----------- ------------
Net deferred tax (liabilities) assets......................... $ (17,482) $ 1,995
----------- ------------
----------- ------------
</TABLE>
The Company has no valuation allowances as of December 31, 1996, or as of
June 30, 1997, and there were no changes in the valuation allowance during the
years ended December 31, 1996 or 1995, or during the six months ended June 30,
1997 and 1996, respectively.
The Company's actual provision for income tax as of December 31, 1996 and
1995, and for the six months ended June 30, 1997 and 1996, approximates the tax
provision at the statutory Federal income tax rate.
9. RELATED-PARTY TRANSACTIONS:
With the exception of sales to outside third parties, a significant portion
of the Company's transactions is with VGC and affiliated companies.
VGC provides certain general and administrative services for the Company.
These services include professional services, insurance coverage and
administrative services (with associated costs). Accordingly, management fees of
$14,000 and $24,000 have been charged to the Company by VGC for the years ended
December 31, 1996 and 1995, respectively, and zero and $12,000 for the six
months ended June 30, 1997 and 1996. Other transactions with affiliated
companies include purchases of natural gas, natural gas storage and technical
services provided for and by affiliated companies.
F-46
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
WOULD BE UNLAWFUL.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 6
Use of Proceeds........................................................... 10
Common Stock Price Range.................................................. 11
Capitalization............................................................ 12
Dividend Policy........................................................... 12
Selected Consolidated Financial and Operating Data........................ 13
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 14
Business.................................................................. 20
Management................................................................ 29
Shares Eligible for Future Sale........................................... 34
Description of Securities................................................. 35
Underwriting.............................................................. 37
Legal Matters............................................................. 38
Experts................................................................... 38
Other Matters............................................................. 38
Available Information..................................................... 38
Glossary.................................................................. 39
Financial Statements...................................................... F-1
</TABLE>
------------------------
2,000,000 SHARES
VIRGINIA GAS COMPANY
COMMON STOCK
---------------------
PROSPECTUS
---------------------
AUGUST 26, 1997
FERRIS, BAKER WATTS
Incorporated
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
