<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(MARK ONE)
/ X / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________.
COMMISSION FILE NUMBER 0-21523
VIRGINIA GAS COMPANY
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
DELAWARE 87-0443823
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 EAST MAIN STREET, ABINGDON, VIRGINIA 24210, (540) 676-2380
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
WARRANTS TO PURCHASE COMMON STOCK
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. / X / Yes / / No
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. / /
Revenues for the fiscal year ended December 31, 1998 were $ 9,799,977.
The aggregate market value of the voting Common Stock, par value $.001 per
share, held by nonaffiliates of the Registrant as of March 26, 1999 was
approximately $10,241,563.
As of March 26, 1999, the Registrant had outstanding 5,504,906 shares of Common
Stock, par value $.001.
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-KSB
FOR THE YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM PAGE
NUMBER CAPTION NUMBER
<S> <C> <C>
PART I
1 Business 3
2 Properties 9
3 Legal Proceedings 9
4 Submission of Matters to a Vote of Security Holders 9
PART II
5 Market for Common Equity and Related Stockholder Matters 9
6 Management's Discussion and Analysis 10
7 Financial Statements 16
8 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 35
PART III
9 Directors and Executive Officers of the Company 35
10 Executive Compensation 35
11 Security Ownership of Certain Beneficial Owners and Management 35
12 Certain Relationships and Related Transactions 35
13 Exhibits and Reports on Form 8-K 35
Signatures 39
</TABLE>
2
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ITEM 1. BUSINESS
GENERAL
Virginia Gas Company (the "Company") was organized in 1987 under the
laws of the state of Delaware. The Company, directly or through its subsidiaries
and affiliated companies, is primarily engaged in the storage, marketing,
distribution, gathering, exploration, and production of natural gas, and the
distribution of propane gas. The Company's principal assets are located in the
southwestern counties of the Commonwealth of Virginia.
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 East Tennessee Natural Gas ("ETNG"), CNG Transmission Company
("CNG") and Columbia Gas Transmission Company ("TCO") interstate pipeline
systems, and to the Company's adjacent storage facilities, are being combined 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 to
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 to 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. In 1998, the Company
completed construction of 35 miles of pipeline and began serving two
communities. The Company's third and fourth quarter reflected increased pipeline
revenue. Additionally in 1998, the Company experienced revenue growth in its
propane distribution business. Currently, the Company is continuing to develop
transmission pipeline projects and expanding its storage capacity and expects to
derive future income primarily from natural gas storage, pipeline transportation
fees, and the continued growth of its propane operation.
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.
SUBSIDIARIES AND AFFILIATES
The Company has four consolidated wholly-owned subsidiaries: Virginia
Gas Exploration Company (the "Exploration Company"), Virginia Gas Pipeline
Company (the "Pipeline Company"), Virginia Gas Propane Company (the "Propane
Company") and Virginia Gas Marketing Company (the "Marketing Company").
Affiliates of the Company, Virginia Gas Distribution Company (the "Distribution
Company") and Virginia Gas Storage Company (the
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"Storage Company"), are each owned 50% by the Company and 50% by one individual
investor, who has no affiliation with either the Company, or any executive
officer, director or controlling shareholder of the Company. In January 1999
through a contribution of owner's equity, the Distribution Company became the
parent of the Storage Company. The Distribution Company remains a 50% owned
affiliate of the Company.
The Pipeline Company, the Distribution Company and the Storage Company
are the holders of Certificates of Public Convenience and Necessity ("CPCN")
issued by the Virginia State Corporation Commission ("VSCC") that are required
for such companies to conduct their business. The Pipeline Company's and a
portion of the Storage Company's operations are regulated by both the VSCC and
the Federal Energy Regulatory Commission ("FERC"). In connection with the
financing of the Distribution Company's distribution business, and the Storage
Company and Pipeline Company's storage and related pipeline businesses, the
Company participated in four tax exempt bond issues in 1994, 1995 and 1997 that
provided financing for these various projects. Funds from such financings were
allocated, as needed, to the various subsidiaries and affiliates and each such
entity has provided the Company with interest-bearing promissory notes
evidencing its obligation to repay the funds advanced by the Company. During
1998, the company refinanced the tax exempt bonds through a private debt
placement and the aforementioned promissory notes were replaced by ones
reflecting the lower interest rates.
STORAGE OPERATIONS
The Company has the only two underground natural gas storage facilities
in the Commonwealth of Virginia. One of these facilities is located in Smyth and
Washington counties (the "Saltville Facility"), while the other facility is
located in Scott and Washington counties (the "Early Grove Field"). The Pipeline
company owns the Saltville Facility while the Storage Company owns and operates
the Early Grove Field.
The Pipeline Company developed the Saltville Facility for use as a high
rate, peak usage storage facility. The Saltville Facility uses 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 Pipeline Company filed an application with the VSCC
for a CPCN for the operation of the Saltville Facility. In July 1996 the VSCC
issued an order authorizing the Pipeline Company to begin service on an interim
basis using the rates set forth in the application. The CPCN was issued to the
Pipeline Company in December 1997. In November 1996, the Pipeline Company
received a limited jurisdiction certificate from the FERC authorizing the
Pipeline Company to engage in the sale, transportation (including storage), or
assignment of natural gas that is subject to FERC's jurisdiction under the
Natural Gas Act, and to charge rates for its interstate service equal to the
intrastate rates approved by the VSCC. The Saltville Facility provides 10-day,
60-day and 90-day service and 20-day refill capacity. In August 1996 the
Pipeline Company injected the first working gas into the field. Peak daily
withdrawal rates of 40,000 MMBtu were achieved in January 1997. The Company
began construction of an evaporation facility adjacent to its Saltville Storage
Facility late in 1998. The facility will be used by the Company to create
additional storage space by eliminating brine from the salt cavern.
The Early Grove Field is an underground natural gas storage facility
owned and operated by the Storage Company. The Storage Company has received a
CPCN from the VSCC, authorizing 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 Field includes 29 storage wells and a certificated
area of 2,900 acres. 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
1,835,000 MMBtu for the 1998/1999 heating season. The deliverability of the
Early Grove Field has been increased by reworking existing wells, drilling new
wells, injecting additional base gas, installing
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larger diameter pipe, 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 20,000 MMBtu per day
from 1992 to 1998. Further improvements, including drilling new wells, adding
additional base gas and increasing the maximum operating pressure to up to 2,400
PSI, are being considered. Proposed improvements could increase the field's
capacity to 2,200,000 MMBtu in the future.
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.
PIPELINE OPERATIONS
The Company has completed construction and has begun servicing 35 miles
of intrastate pipeline. The Company is currently acquiring remaining
rights-of-way and permits for the construction of the remaining 36 miles of
pipeline that will make up the Company's P-25 pipeline. The pipeline will
connect the Company's Saltville Facility and transport natural gas to growing
markets in Smyth, Wythe and Pulaski Counties in southwestern Virginia. These
areas currently are served only by ETNG's #3300 interstate pipeline, which
currently has insufficient capacity to meet the area's needs.
The P-25 pipeline has been and will be constructed and maintained
consistent with applicable federal, state and local laws and regulations and
accepted industry practice. The first phase of construction, completed in
October of 1998, consisted of twinning the ETNG line to the town of Wytheville
and opening service to that town and Marion. The remaining phases will extend
the P-25 pipeline from Wytheville to Radford, Virginia. The Company has entered
into a 15-year contract with United Cities Gas Company ("UCG"), the local
distribution company which serves Smyth, Wythe and Pulaski Counties, to provide
pipeline capacity to supply 20,000 MMBtu per day, or 67% of planned pipeline
capacity. Completion of the P-25 pipeline is expected by late 2000. The Company
filed an application for a CPCN with the VSCC in January 1997 for authorization
to develop, construct, own and operate the P-25 pipeline. This CPCN was received
by the Company in December 1997. In early 1999, the Company filed an
application with the VSCC to extend its P-25 pipeline to Roanoke,
Virginia, where it will service a new contract with Roanoke Gas Company.
Substantially all of the operations conducted through the P-25 pipeline
will constitute common carrier pipeline activities. Such common carrier
activities are those under which transportation in the pipeline is available at
tariffs 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. In early
1999, the Company filed an application with the VSCC to extend its P-25
pipeline to Roanoke, VA, where it will service a new contract with Roanoke
Gas Company.
NATURAL GAS AND PROPANE DISTRIBUTION OPERATIONS
The Company, through the Distribution Company, owns and operates 33
miles of distribution pipelines and provides natural gas service to over 250
customers in Russell and Buchanan Counties in Virginia. Construction of a
10-mile pipeline providing service to the town of Lebanon in Russell County was
completed in June 1997. The Distribution Company has a CPCN authorizing it to
provide natural gas service in these counties. In January 1997, the Distribution
Company filed an application with the VSCC to extend its service territory to
include all of Dickenson and Tazewell Counties in Virginia, with the exception
of the service territory in Tazewell County currently certificated to
Commonwealth Public Service Corporation. This application was subsequently
amended to include the town of Saltville, Virginia as part of the
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proposed service territory. In December 1997, the VSCC issued CPCNs to the
Distribution Company authorizing it to provide natural gas service to the
western portion of Tazewell County, excluding the service territory allotted to
Commonwealth Public Service Corporation, all of Dickenson County, and the town
of Saltville. The Distribution Company's tariff rates are approved by the VSCC.
The Distribution Company has a firm transportation service contract for
a ten-year term with East Tennessee Natural Gas for the winter months of
November through March, and an interruptible transportation contract with ETNG
for the remainder of the year.
In 1996, the Company commenced distribution of propane gas in
southwestern Virginia. 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, Inc.'s existing propane
distribution business in Buchanan, Dickenson and Russell Counties and in the
western part of Tazewell County, Virginia in April 1997. The Company is also
expanding its propane distribution operations through an aggressive growth
program. At the end of 1998, the Company was providing propane gas service to
over 3,000 customers in southwestern Virginia.
EXPLORATION, PRODUCTION, GATHERING, AND MARKETING OPERATIONS
DRILLING ACTIVITY. The Company did not drill or complete any natural
gas wells during 1997 or 1998.
SERVICE OPERATIONS. The Company engages in the business of supervising
drilling operations and operating producing wells. As of December 31, 1998 the
Company operated 72 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, 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 Company and the Storage Company operate
various unregulated natural 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 natural gas production to
the ETNG, CNG and TCO interstate pipeline systems as well as to the Distribution
Company's distribution system.
For such natural gas gathering services, the Company and the Storage
Company collect certain transportation allowances from producers (owners of
natural gas). Transportation allowances vary depending upon contractual
arrangements and currently range from $.05 to $.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
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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 Storage Company
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 the Storage Company's natural gas
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.
The Company's non-gathering pipeline operations will also be regulated
by the VSCC. 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 natural gas distribution operations of the Distribution Company 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.
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.
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ENVIRONMENTAL AND SAFETY REGULATION. The 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
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.
TITLE TO PROPERTIES
Substantially all of the properties comprising the Saltville Facility
and the Early Grove Field are situated on land not owned by the Company or the
Storage Company.
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.
The Storage Company's rights to develop and operate the Early Grove
Field are derived from its ownership of mineral leasehold rights and from
surface easements.
The Company's existing pipelines, 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.
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EMPLOYEES
As of December 31, 1998, the Company, its subsidiaries and affiliated
companies employed 60 persons on a full time basis, none of whom is covered by a
collective bargaining agreement.
ITEM 2. PROPERTIES
See Item 1 for a discussion of properties and locations and Note 8 of
Notes to the Consolidated Financial Statements contained in Part II, Item 7 for
a discussion of any liens or encumbrances.
ITEM 3. LEGAL PROCEEDINGS
There is no pending nor, to the knowledge of the Company, any
threatened litigation against the Company or its Subsidiaries or Affiliates
which could have a material adverse effect on their financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
APPROXIMATE NUMBER OF STOCKHOLDERS
<TABLE>
Number of Stockholders
of Record as of
Title of Class December 31, 1998
<S> <C>
Common stock, par value $.001 1,838
Warrants to purchase common stock 52
</TABLE>
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The Common Stock of the Company is traded on the Nasdaq National Market
under the symbol "VGCO." The following table sets forth, for the periods
indicated, the high and low sales prices of the common stock, compiled from
quotations supplied by the Nasdaq Monthly Statistical Report, in addition to
dividends per share declared for the periods indicated:
<TABLE>
<CAPTION>
PRICE RANGE OF COMMON STOCK
--------------------------- DIVIDENDS
HIGH LOW PER SHARE
------------- ----------- -----------
<S> <C> <C> <C>
1997
First Quarter $10 1/2 $ 7 1/4 $0.0150
Second Quarter 10 3/4 8 3/4 0.0175
Third Quarter 10 3/4 8 3/4 0.0175
Fourth Quarter 9 8 0.0175
1998
First Quarter 9 7 5/16 0.0175
Second Quarter 7 3/4 6 0.0175
Third Quarter 6 7/32 4 0.0175
Fourth Quarter 4 1/2 3 0.0175
1999
First Quarter (through March 15) 3 11/16 2 3/16 -
</TABLE>
The Company paid cash dividends on its Common Stock for each of the
years 1992 through 1998. There is no assurance that the Board of Directors of
the Company will authorize the Company to continue to pay cash dividends on its
Common Stock in the future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
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 contained in Part II,
Item 7.
GENERAL
The Company derives revenues from its storage, exploration, production,
gathering, marketing and propane distribution operations. From its 50%
investments in the Storage Company and the Distribution Company, 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.
In its storage business, the Company receives fees for use of its
storage space in addition to injection and withdrawal fees for the use of
compression facilities, collectively referred to as storage revenues. Storage
charges to customers are in accordance with storage rates included in tariffs
approved by the Virginia State Corporation Commission.
In its pipeline business, the Company receives fees for use of its
pipeline space, referred to as pipeline revenues. Pipeline charges to customers
are in accordance with pipeline rates included in tariffs approved by the
Virginia State Corporation Commission.
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In its exploration and production business, the Company receives
revenues from the sale of its 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 natural
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. In its propane distribution business, the Company generates
revenues from the sale of propane to industrial, commercial and residential
customers.
In the Storage Company's unregulated natural gas gathering business,
revenues are generated from its ownership interest in gathering pipelines for
natural gas traveling through its gathering systems. The Storage Company also
provides unregulated winter gas supply services.
In its distribution operations, the Distribution Company's gross
profits are realized by the difference between the prices at which it purchases
and the prices at which it sells natural gas to its industrial, commercial and
residential customers. The prices at which the Distribution Company sells
natural gas to its customers are in accordance with the rate schedules in its
tariff filed with the Virginia State Corporation Commission. The Distribution
Company purchases natural gas under short-term contracts which reflect the
market price of natural gas.
RESULTS OF OPERATIONS
Virginia Gas Company recorded revenues of $9.8 million in
1998 compared to $9.3 in 1997 representing a 5% increase. Revenue growth was
primarily derived from the Company's P-25 pipeline that began service in 1998,
and growth in the Company's propane distribution operation. Lower gas sales
negatively impacted operating revenues as the company had a large one-time sale
of $570,000 in 1997.
<TABLE>
<CAPTION>
PERCENTAGE
REVENUE 1998 1997 CHANGE
----------------------------------- ---------------- -------------- ----------------
<S> <C> <C> <C>
Natural Gas Sales $3,256,000 $ 4,199,000 (23)%
Storage Revenues 2,600,000 2,439,000 7
Pipeline Revenues 447,000 - 100
Propane Gas Sales 1,261,000 643,000 96
Explor. & Prod. Revenues 342,000 361,000 (5)
Management Revenues 260,000 256,000 2
Interest and Other Income 1,634,000 1,446,000 13
---------- ------------- ----
Total Revenue $9,800,000 $ 9,344,000 5%
---------- -------------
---------- -------------
</TABLE>
The Company constructed 35 miles of pipeline from Chilhowie, to
Wytheville, Virginia during 1998. The Company began serving 6,000 MMBtu/day to
Marion, Virginia in July and 4,000 MMBtu/day to Wytheville, Virginia in October,
which generated $ 447,000 in demand charges. The Company's propane operation
experienced significant growth during 1998, as its customer base increased to
3,060 from 1,900 in December of 1997. Revenues nearly doubled from $643,000 in
1997 to $1,261,000 as gallons sold increased to 1,416,000 from 670,000. Virginia
Gas Company sold 1,418,000 MMBtu of gas in 1998 compared to 1,736,000 MMBtu in
1997. The decline is attributable to a one-time sale of 200,000 MMBtu that
occurred in 1997. Revenues from gas sales decreased to $3.3 million compared to
$4.2 million in 1997 as the average price per MMBtu decreased approximately 5%
from $2.42/MMBtu in 1997 to $2.31/MMBtu in 1998. The one-time sale generated
$570,000 in revenue in 1997.
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Cost of natural gas sold declined from $3.8 million in 1997 to $3.0
million in 1998, again due to the one-time sale of gas in 1997. Gross margins on
gas sales declined approximately 4% from 11% in 1997 to 7% in 1998 due entirely
to depressed pricing at the well head. Propane gas expense increased to $574,000
from $328,000 due to higher volume. However, gross margins improved due to
declining wholesale propane prices and steady retail pricing.
The Company experienced significant growth in its infrastructure in
1998 due to the growth of its propane operations and with the construction
and subsequent operation of its P-25 pipeline. As a result, operations and
maintenance expense increased 46% to $1.0 million from $684,000 in 1997 and
general and administrative expense increased 60% to $1.6 in 1998 from $1.0
million in 1997. The propane operations require weighty investments in
infrastructure to service customer demand and the P-25 pipeline project
represents the company's largest single capital expansion in its history.
Depreciation, depletion, and amortization increased to $973,000 from
$806,000 due almost entirely to the Company's addition of the P-25 pipeline.
Production expenses decreased to $161,000 from $216,000 reflecting the continued
maturity and decline of the Company's exploration and production operations.
Interest expense remained flat at $1.5 million for both 1998 and 1997 despite
increases in outstanding debt. This is primarily due to increases in capitalized
interest during construction and a lower cost of capital that resulted from the
refinancing of the Company's industrial revenue bonds, that carried an average
rate of approximately 9.5%, to a lower rate of 8.5%.
The Company resolved a regulatory issue early in 1999 that resulted in
a restatement of first quarter earnings for a charge that related to the
aforementioned refinancing. The Company originally recorded a $233,000
extraordinary loss on extinguishment of debt. That loss related to bond costs of
the Company's industrial revenue bonds that were refinanced. This portion
eliminated the costs on the Company's unregulated subsidiaries. The costs on the
Company's regulated subsidiary were recorded as a regulatory asset pending
resolution of several regulatory matters with the Company's regulatory body, the
Virginia State Corporation Commission. In conjunction with the resolution of
those matters, the Company has restated first quarter 1998 earnings to include
an additional $128,000 in the loss on extinguishment of debt. Accordingly the
total extraordinary loss was $361,000. This resolution also affected the
Company's two affiliates. The Affiliates recorded a combined $943,000 loss on
extinguishment of debt, again as a restatement of first quarter 1998.
The Company recorded a charge of $1.3 million for restructuring and
impairments during 1998. The largest component of that charge related to a $1
million write-down of the Company's exploration and production properties. The
write-down was in response to declining wellhead prices. The Company recognized
that the value of its properties had been impaired by the recent trend of lower
natural gas prices. A much smaller portion of the charge related to severance
paid to former employees and employees that were laid-off in early 1999.
The Company's earnings from affiliated companies declined from
earnings of $217,000 in 1997 to losses (before extraordinary loss discussed
above) of $58,000 in 1998. The Company's affiliate, Virginia Gas Distribution
Company, experienced losses during 1998 that resulted from higher
depreciation and interest. Virginia Gas Distribution Company extended a
13-mile main distribution line into to the town of Lebanon, Virginia in 1997.
The higher interest and depreciation relates to that construction. Currently,
that line is not fully utilized and will remain so until planned expansions
of industrial customers are completed. Until those expansions take place,
Virginia Gas Distribution Company has experienced and will continue to
experience liquidity problems that require assistance from the Company.
12
<PAGE>
OUTLOOK
Virginia Gas Company remains cautiously optimistic about future growth.
The Company has adopted a strategy of slower incremental growth through the
development of its pipeline and storage assets, while continuing the
expansion of its propane operations. With this new focus, the Company's
Tidewater Pipeline Project, which would have extended the Company's P-25
Pipeline approximately 500 miles across the Commonwealth of Virginia, has
been deferred. Demand for this service waned in the wake of unbundling, which
made financing the project, at this current time, unfeasible. Accordingly,
future growth in revenue will be derived from the Company's pipeline and
storage assets, which will require increased demand in our expanded service
area. The Company's optimism was bolstered in February 1999 when a customer
signed a 15-year contract that adds 2.27 million MMBtu's of storage coming on
line in the next 5 years with pipeline service that mirrors the storage
agreement. The Company will be required to extend its P-25 pipeline to
Roanoke, Virginia to service this contract. Also, the Company has been
successfully proliferating the market for storage services in East Tennessee.
Growth is more assured in the Company's propane operations. Over the last two
years the Company has added over 1,200 customers and expects that growth to
continue. The Company's main task is financing and managing that growth.
During 1998, general and administrative and operations and maintenance
expenses rose sharply in support of growth. In response, the Company
instituted a cost reduction plan in late 1998 that resulted in employee
lay-offs and other cost saving measures. Additionally, the Company will
explore opportunities to sell non-strategic assets, which will allow it to
focus on its core business. The first of which was the sale of the gathering
line owned by an affiliate of the Company in February 1999.
FINANCIAL CONDITION
Virginia Gas Company closed two significant financial transactions
during 1998. In March, the Company entered into a $24 million note agreement
with John Hancock Mutual Life Insurance Company that refinanced $19.6 million in
industrial revenue bonds and provided $4.4 million to fund capital expenditures.
The Company entered into an $8 million line of credit in July with Wachovia
National Bank. The Company has drawn $2.5 million of the line of credit to fund
capital expenditures as of December 31, 1998.
Capital expenditures totaled $16.7 million in 1998 compared to $6
million in 1997. In addition to the $6.9 million in incremental financing, the
Company funded capital expenditures through available cash obtained from a
secondary offering of common stock in third quarter of 1997. The Company is
exploring additional financing to support its 1999 capital budget of $18.4
million. Future expansion will be financed through additional debt or equity, as
cash flow from operations is not sufficient to fund growth. However, cash from
operations improved during 1998 to $19,000 from a deficit of $217,000 in 1997.
Additional financing will require the Company to renegotiate current covenants
on its existing debt or refinance that debt. As of December 31, 1998, the
Company was not in compliance with two of its debt covenants. These events of
non-compliance were waived by John Hancock until June 30, 1999.
FORWARD LOOKING STATEMENTS
Certain of the statements contained in this section of the report,
including those under "Outlook" and "Financial Condition" are forward-looking.
While Virginia Gas Company believes that these statements are accurate, the
Company's business is dependent upon general economic conditions and various
conditions specific to its industry, and future trends and these factors could
cause actual results to differ materially from the forward looking statements
that have been made. In particular:
- - The Company's growth plans are contingent on its ability to affordably
finance future capital expenditures through the debt and equity markets. If
the Company is unable to finance capital expenditures, revenue growth will
be impacted.
13
<PAGE>
- - Virginia Gas Company's revenue growth depends on future demand for
pipeline and storage services. Many factors impact that demand. A
continued trend of warmer than normal winters in the Company's service
area could substantially curb the demand for natural gas storage and/or
pipeline service. Potential "unbundling" or deregulation in the natural
gas industry could introduce additional competitors and make the
viability of long-term contracts suspect.
- - Virginia Gas Company derives 67% of its revenues from 4 customers.
Accordingly, the future of the Company is inexorably linked to these
significant customers. If any of these customers experience liquidity
problems or undergo consolidations, it could negatively impact the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective for the fiscal year ended December 31, 1998, the Company has
adopted SFAS No. 130 "Reporting Comprehensive Income" and SFAS No. 131
"Disclosures About Segments of an Enterprise and Related Information." The
adoption of these standards did not have a material impact on the Company's
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES. The Statement establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. The Statement
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. Statement 133 is effective for fiscal years
beginning after June 15, 1999 and may not be applied retroactively. Management
has not yet quantified the impacts of adoption.
YEAR 2000 ISSUE
The Year 2000 ("Y2k") problem concerns the inability of information
and technology-based operating systems to properly recognize and process
date-sensitive information beyond December 31, 1999. This could result in
systems failures and miscalculations, which could cause business disruptions.
Equipment that uses a date, such as computers and operating control systems,
may be affected. This includes equipment used by the Company's customers and
suppliers, as well as by utilities and governmental entities that provide
critical services to us.
The Company has been addressing the Y2k problem since 1997 and has
adopted a 4 phased approach to remediating the problem as it relates to the
Company. Phase I is SYSTEM IDENTIFICATION AND CLASSIFICATION. During this
phase, the Company will methodically identify all systems within the
operations area and classify those systems as potentially vulnerable or not
vulnerable. Phase I is completed. Phase II is SYSTEM COMPLIANCE. During Phase
II, the Company will perform field investigations to collect component level
data for each system identified as potentially vulnerable. That data will be
added to a database, which will be crosschecked with manufacturer compliance
data and vendor contracts. If compliant, a written statement from the
manufacturer will be obtained that provides the language necessary to confirm
that the Y2k issue has been properly addressed. Phase II will be completed by
14
<PAGE>
April 30, 1999. Phase III is entitled REMEDIATION. During the remediation phase
steps will be taken to ensure that non-compliant systems have been properly
readied for the year 2000 and thoroughly tested. The Company expects this phase
to be completed prior to August 1, 1999. Phase IV is PUBLICATION. This phase
will involve communication of the Company's readiness to its business partners
and is expected to be complete by September 30, 1999.
The Company has completed Phase I of the plan to date. Two systems have
been determined to be vulnerable to the Y2k problem. The Company has received
free vendor upgrades that will render the systems Y2k compliant. Accordingly at
this stage in our efforts, the Company does not believe that the Y2k problem or
its remediation will have a material impact on the Company.
15
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
VIRGINIA GAS COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Public Accountants 17
Consolidated Balance Sheets as of December 31, 1998 and 1997 18
Consolidated Statements of Operations for the years ended December 31, 1998 and 1997 19
Consolidated Statements of Changes in Stockholders' Equity for the years ended December
31, 1998 and 1997 20
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1997 21
Notes to Consolidated Financial Statements 22
</TABLE>
16
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Virginia Gas Company:
We have audited the accompanying consolidated balance sheets of Virginia Gas
Company and Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for the years then ended. 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, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Richmond, Virginia
February 18, 1999
17
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
ASSETS
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,763,753 $11,750,899
Accounts receivable 3,469,757 2,681,818
Notes receivable 38,800 120,898
Other current assets 498,707 305,223
----------- -----------
Total current assets 5,771,017 14,858,838
PROPERTY AND EQUIPMENT, net 37,139,538 22,459,289
INVESTMENT IN AFFILIATED COMPANIES 3,930,554 4,459,937
NOTES RECEIVABLE - AFFILIATED COMPANIES 13,000,912 12,900,164
OTHER ASSETS 619,533 1,159,272
----------- -----------
Total assets $60,461,554 $55,837,500
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $2,546,734 $ 218,611
Accounts payable 542,626 1,092,846
Funds held for future distribution 266,806 511,099
Other current liabilities 261,624 46,111
----------- -----------
Total current liabilities 3,617,790 1,868,667
LONG-TERM DEBT 24,254,444 19,728,422
DEFERRED INCOME TAXES 645,674 925,908
----------- -----------
Total liabilities 28,517,908 22,522,997
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock - par value $.001, 100,000,000 and 10,000,000 shares
authorized, 5,504,906 shares issued
and outstanding 5,505 5,505
Additional paid-in capital 31,375,267 31,241,082
Retained earnings 562,874 2,067,916
----------- -----------
Total stockholders' equity 31,943,646 33,314,503
----------- -----------
Total liabilities and stockholders' equity $60,461,554 $55,837,500
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
18
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
REVENUE:
Operating revenue $ 8,165,771 $7,897,394
Interest and other income 1,634,206 1,446,233
----------- -----------
9,799,977 9,343,627
----------- -----------
EXPENSES:
Cost of natural gas sold 3,042,541 3,802,210
Propane gas expense 574,002 328,114
General and administrative 1,646,448 1,003,464
Depreciation, depletion, and amortization 972,891 806,469
Operation and maintenance expense 1,019,449 683,763
Production expenses 160,705 216,290
Restructuring and impairment charges 1,262,110 -
----------- -----------
8,678,146 6,840,310
----------- -----------
Other expense- interest 1,452,677 1,513,964
----------- ------------
INCOME (LOSS) BEFORE EARNINGS OF AFFILIATED COMPANIES, INCOME TAXES,
AND EXTRAORDINARY LOSS (330,846) 989,353
Equity in earnings (losses) of affiliated companies before
extraordinary items
(58,102) 216,917
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY LOSS (388,948) 1,206,270
Provision for (benefit from) income taxes (101,763) 298,663
----------- -----------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (287,185) 907,607
Extraordinary loss on extinguishment of debt net of taxes of $444,000 (832,493) -
----------- -----------
NET INCOME (LOSS) $(1,119,678) $ 907,607
----------- -----------
----------- -----------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $(1,119,678) $ 850,552
----------- -----------
----------- -----------
EARNINGS (LOSS) PER COMMON SHARE, BASIC AND DILUTED:
Net income (loss) before extraordinary item $ (0.13) $ 0.22
----------- -----------
----------- -----------
Extraordinary loss on extinguishment of debt (net of tax) $ (0.07) $ -
----------- -----------
----------- -----------
Net income (loss) per common share $ (0.20) $ 0.22
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
19
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON PAID-IN RETAINED
STOCK STOCK CAPITAL EARNINGS
--------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1996 $1,725,000 $ 3,151 $14,152,137 $1,457,243
Issuance of 54,162 shares of common stock pursuant
to exercise of warrant - 54 - -
Redemption of 2,000 shares of preferred stock (1,725,000) - (275,000) -
Issuance of 2,300,000 shares of common stock - 2,300 17,504,623 -
Payment for cancellation of options - - (140,678) -
Net income - - - 907,607
Preferred stock dividends - - - (57,055)
Common stock dividends - - - (239,879)
---------- ----------- ----------- ----------
BALANCE, December 31, 1997 - 5,505 31,241,082 2,067,916
---------- ----------- ----------- ----------
Repurchase of employee warrants - - (5,015) -
Payment of employee notes receivable for
stock - - 139,200 -
Common stock dividends - - - (385,364)
Net loss - - - (1,119,678)
---------- ----------- ----------- -----------
BALANCE, December 31, 1998 $ - $ 5,505 $31,375,267 $ 562,874
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
20
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,119,678) $ 907,607
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation, depletion, and amortization 972,891 806,469
Undistributed losses (earnings) of affiliated companies 58,102 (216,917)
Extraordinary loss on extinguishment of debt 1,013,394 --
Issuance of note receivable (38,800) --
Deferred income taxes (280,234) 295,994
Impairment charge 1,021,498 --
Increase in accounts receivable (787,939) (1,608,542)
Increase in other current assets (193,484) (170,361)
Decrease (increase) in other assets (47,334) 278,971
Decrease in notes payable -- (250,000)
Decrease in accounts payable (550,220) (104,709)
Decrease in other current liabilities (28,780) (155,974)
------------ ------------
Net cash provided by (used in) operating activities 19,416 (217,462)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (16,748,264) (6,097,356)
Proceeds from sale of assets 89,105 --
Issuance of note receivable -- (3,650,000)
Payments received on notes receivable 159,350 114,556
------------ ------------
Net cash used in investing activities (16,499,809) (9,632,800)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal (19,645,855) (3,330,959)
Proceeds from new loans 26,500,000 9,100,000
Proceeds from issuance of common stock, net -- 17,506,977
Redemption of preferred stock -- (2,000,000)
Purchase of warrants and options (5,015) (140,678)
Payment of debt issuance costs (659,311) (331,333)
Refund (establishment) of financing reserve funds 688,792 (558,750)
Dividends paid (385,364) (296,934)
------------ ------------
Net cash provided by financing activities 6,493,247 19,948,323
------------ ------------
NET INCREASE (DECREASE) IN CASH (9,987,146) 10,098,061
CASH, beginning of year 11,750,899 1,652,838
------------ ------------
CASH, end of year $ 1,763,753 $ 11,750,899
------------ ------------
------------ ------------
SUPPLEMENTAL DISCLOSURE:
Interest paid $ 2,028,874 $ 1,972,624
------------ ------------
------------ ------------
Income taxes paid $ 12,075 $ 22,158
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
21
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1998 AND 1997
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 its subsidiaries and
affiliated companies, is primarily engaged in the storage, marketing,
distribution, gathering, exploration, and production of natural gas, and the
distribution of propane gas, principally in the southwestern counties of the
Commonwealth of Virginia.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements for 1998 and 1997 include the accounts of
all wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of all cash balances and highly liquid
investments which have an original maturity at purchase of three months or less.
INVESTMENT IN AFFILIATED COMPANIES
The Company's investments in affiliated companies are accounted for using the
equity method. Investments carried at equity consist of Virginia Gas Storage
Company and Virginia Gas Distribution Company (the "Affiliates"). Through
December 31, 1998 the Company had a 50 percent interest in each of these
Affiliates. In January 1999 through a contribution of owners equity, VGDC
became the parent of VGSC. VGDC remains a 50% owned affiliate of the Company.
Combined financial information as of December 31, 1998 and 1997, and for the
years then ended, for investments in affiliated companies accounted for by the
equity method is as follows.
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Current assets $ 1,247,549 $ 2,065,089
Property and equipment, net 22,206,543 21,479,467
Other assets 231,757 2,338,307
----------- -----------
$23,685,849 $25,882,863
----------- -----------
----------- -----------
Current liabilities $ 2,754,017 $ 3,395,461
Long-term debt payable to:
Affiliated companies 12,994,969 12,891,488
Third parties 5,943 13,870
Other liabilities 136,281 681,705
Stockholders' equity 7,794,639 8,900,339
----------- -----------
$23,685,849 $25,882,863
----------- -----------
----------- -----------
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31
1998 1997
----------- -----------
<S> <C> <C>
Revenues $ 4,443,782 $ 5,608,166
Income (loss) before income taxes and
extraordinary loss (223,000) 637,794
Net income (loss) (1,105,700) 414,300
</TABLE>
The Company provides certain general and administrative services for Virginia
Gas Storage Company and Virginia Gas Distribution Company. These services
include professional services, insurance coverage and administrative services.
Other transactions include purchases and sales of natural gas, natural gas
storage, and technical services provided for the affiliated companies.
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 assets and liabilities and disclosure of
contingent assets and liabilities (if any) at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes natural gas sales and gathering revenues upon delivery of
natural 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.
Propane gas sales are recognized upon delivery of gas to the customer.
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 $3.1 and $3.6 million for the
year ended December 31, 1998 and 1997 respectively.
INCOME PER COMMON SHARE
Income per common share is computed in accordance with Statement of Financial
Accounting Standard ("SFAS") No. 128, EARNINGS PER SHARE, using the
weighted-average shares of common stock and dilutive common stock equivalents
(options and warrants) outstanding during the respective periods. The number
of weighted-average shares used in calculating income per common share was
5,504,906 and 3,943,274 for the years ended December 31, 1998 and 1997,
respectively.
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
23
<PAGE>
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 recognized an impairment loss of approximately
$1,020,000 in 1998 related to its oil and gas properties. 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 40 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 $578,662 and $328,011 for the years ended December 31, 1998
and 1997, respectively.
OTHER ASSETS
Costs incurred in conjunction with financing transactions are amortized on a
straight-line basis over the terms of the financing transactions.
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 1997 balances to conform to the
1998 presentation.
3. ACCOUNTS RECEIVABLE:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Trade receivables $ 846,025 $ 654,624
Lease operating expenses receivable 120,704 130,294
Joint-interest receivables 12,386 96,320
Due from affiliated companies 2,490,642 1,800,580
---------- ----------
$3,469,757 $2,681,818
---------- ----------
---------- ----------
</TABLE>
24
<PAGE>
The majority of the Company's accounts receivable are due from companies
predominately involved in the marketing and distribution of oil and gas
products.
4. NOTES RECEIVABLE - AFFILIATED COMPANIES:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Note receivable from Virginia Gas Distribution Company; interest
receivable at 8.5%; principal payable in maturities of $845,000 to
$1,056,000 from 2003 to 2012 $ 8,661,172 $ -
Note receivable from Virginia Gas Storage Company; interest receivable
at 8.5%; principal payable in maturities of $423,000 to $529,000
from 2003 to 2012 4,339,740 -
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
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 - 2,504,839
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 - 1,268,288
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 - 1,005,462
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 - 870,562
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
Note receivable from customer; interest receivable at 9% 38,300 --
----------- -----------
13,039,212 13,021,062
Less- Current portion (38,300) (120,898)
----------- -----------
$13,000,912 $12,900,164
----------- -----------
----------- -----------
</TABLE>
5. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Storage properties $15,025,229 $12,971,791
</TABLE>
25
<PAGE>
<TABLE>
<S> <C> <C>
Pipelines 11,540,536 3,127,293
Wells 1,525,247 2,499,105
Propane facilities 2,635,165 1,658,805
Work in progress 7,332,997 3,300,630
Vehicles 430,079 362,889
Building and improvements 860,861 183,650
Office equipment 405,692 278,166
Equipment 96,229 32,093
----------- -----------
39,852,035 24,414,422
Less- Accumulated depreciation, depletion, and amortization (2,712,497) (1,955,133)
----------- -----------
$37,139,538 $22,459,289
----------- -----------
----------- -----------
</TABLE>
6. OTHER ASSETS:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Restricted cash and investments - reserve funds $ - $ 688,792
Deferred financing costs 572,313 455,116
Other 47,220 15,364
----------- -----------
$ 619,533 $ 1,159,272
----------- -----------
----------- -----------
</TABLE>
7. ACCOUNTS PAYABLE:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Trade payables $ 542,626 $ 773,017
Payables to affiliated companies - 319,829
------------ -----------
$ 542,626 $ 1,092,846
------------ -----------
------------ -----------
</TABLE>
8. LONG-TERM DEBT:
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
Notes payable to John Hancock Mutual Life Insurance Company; interest payable
quarterly at 8.5%, beginning in March 1998; principal payable in maturities
of $1,659,000 to $2,073,000 from 2003 to 2012 $ 17,000,000 $ -
Note payable to John Hancock Variable Life Insurance Company; interest payable
quarterly at 8.5%, beginning in March 1998; principal payable in maturities
of $293,000 to $366,000 from 2003 to 2012 3,000,000 -
Notes payable to Mellon Bank, NA; interest payable quarterly at 8.5%, beginning
in March 1998; principal payable in maturities of $390,000 to
$488,000 from 2003 to 2012 4,000,000 -
Line of Credit to Wachovia Bank, N.A.; interest payable monthly at a variable
rate based on the monthly LIBOR rate; payable on January 1, 2000. 2,500,000 -
Note payable to the Industrial Development Authority of Russell
</TABLE>
26
<PAGE>
<TABLE>
<S> <C> <C>
County, Virginia Series 1997; 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 Series 1994; 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
Note payable to the Industrial Development Authority of Buchanan County,
Virginia Series 1995; 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 - 4,009,167
Note payable to the Industrial Development Authority of Russell County, Virginia
Series 1994 A & B; 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 - 2,682,917
Note payable with interest at 8%; payable in monthly installments of principal
and interest of $1,802 through November 2007; secured by an asset with a
book value of $172,335 as of December 31, 1998 136,630 147,688
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 $139,673 as
of December 31, 1998 95,324 101,504
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 - 57,922
Notes payable through 2001 with interest from 9% to 10.75%; secured by assets
with a book value of $72,911 as of December 31, 1998 69,224 97,835
------------ ------------
26,801,178 19,947,033
Less- Current portion (2,546,734) (218,611)
------------ ------------
Long-term debt $24,254,444 $ 19,728,422
------------ ------------
------------ ------------
</TABLE>
In March 1998 the Company closed $24 million in senior notes with John
Hancock Mutual Life Insurance Company ("John Hancock") in the form of four
promissory notes. Subsequently, John Hancock assigned $4.0 million of those
Notes to Mellon Bank. With $19.5 million of the proceeds, the Company
called and retired the Series 1997 Russell County, Virginia Subordinated
Natural Gas Facilities Revenue Bonds, the Series 1995 Buchanan County,
Virginia Senior Subordinated Natural Gas Facilities Revenue Bonds, and the
Series A 1994 Buchanan County, Virginia Natural Gas Revenue Bonds. The
Company also defeased the Series A and B 1994 Russell County, Virginia
Subordinated Natural Gas Facilities Revenue Bonds. The remaining proceeds
were used to develop the Company's pipeline projects. The note agreement
requires the company to maintain certain debt service coverage ratios, a
prescribed consolidated tangible net worth and it limits the company's total
liabilities. As of December 31, 1998, the Company was not in compliance with
two of these covenants. These events of noncompliance were waived by John
Hancock until June 30, 1999.
27
<PAGE>
The Company entered into an $8 million line of credit agreement with Wachovia
Bank, N.A. in July, 1998. The Line of Credit carries an interest rate based
on the monthly LIBOR rate plus a factor, which is contingent on the company's
debt service coverage ratio. The Line's financial covenant requirements are
similar to the one's in the John Hancock Note Agreement. As of December 31,
1998, the Company was not in compliance with two of these covenants. As a
consequence, the Company has classified the balance of the Line as current.
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 used to construct a natural gas distribution
facility in and around the town of Lebanon, Virginia and for related storage
and pipeline facilities. As discussed above, these bonds were called and
retired in March 1998. As of December 31, 1998, principal payments on
long-term debt for the next five years are as follows:
<TABLE>
<S> <C>
1999 $2,546,734
2000 -
2001 -
2002 -
2003 2,342,000
</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, 1998 and 1997, was approximately $27,259,000 and
$20,201,000 respectively.
9. STOCKHOLDERS' EQUITY:
In September 1997, the Company completed a secondary offering of its common
stock. The offering resulted in the issuance of an additional 2,300,000 common
shares of the Company at $8.50 per share.
10. 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.
On October 1, 1998, the Company granted to certain of its officers and
directors options to purchase 290,000 shares of the Company's common stock at
an exercise price of $4.125 in accordance with the 1998 Stock Option Plan.
The options are subject to a three-year vesting period from October 1, 1998
until October 1, 2001. The options expire on October 1, 2008. None of these
options outstanding at December 31, 1998 are currently exercisable.
On July 1, 1997, the Company granted options to purchase 120,000 shares of the
Company's common stock at an exercise price of $10 per share. The options were
subject to a three-year
28
<PAGE>
vesting period from July 1, 1997 until June 30, 2000. These options expire on
June 30, 2002. Of these options, 3,333 are exercisable at December 31, 1998.
Changes in the options outstanding during the years ended December 31, 1998 and
1997, were as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
EXERCISE
PRICE PER
SHARES SHARE
------ -----
<S> <C> <C>
Outstanding, December 31, 1996 84,654 $8.72
Granted 43,266 $8.72
Granted 120,000 $10.00
Canceled (137,920) $8.81
---------
Outstanding, December 31, 1997 110,000 $10.00
Granted 290,000 $4.125
Canceled (100,000) $10.00
---------
Outstanding December 31, 1998 300,000 $4.32
</TABLE>
In 1996, the Company adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, and elected to account for its stock options under APB Opinion
No. 25, under which no compensation cost has been recognized. Had
compensation cost for these stock options been determined in accordance with
SFAS No. 123, the Company's net loss and loss per share would have increased
by approximately $75,000 ($.02 per share) in 1998. Net income and earnings
per share would have been reduced by $28,000 ($.01 per share) in 1997. The
weighted average fair value of options granted during 1998 and 1997 was
approximately $2.52 and $3.80, respectively.
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model. The following weighted average
assumptions were used for grants in 1998 and 1997, respectively: risk-free rate
of return of 4.16% and 6.30%; expected dividend yield of .71% and .71%; expected
life of ten and five years; expected volatility of 50% in both years.
11. 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>
1999 $ 640,008
2000 380,415
2001 366,586
2002 338,001
2003 292,605
Thereafter 2,258,135
</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.
29
<PAGE>
12. SALES TO MAJOR CUSTOMERS:
The Company has four significant customers that accounted for 27%, 18%, 11%, and
11% of 1998 operating revenues and 22%, 16%, 14%, and 13% of 1997 operating
revenues respectively.
13. INCOME TAXES:
The components of the provision for income taxes before extraordinary items
are as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Current:
Federal $ - $ 2,669
State - -
-------- --------
- 2,669
Deferred:
Federal (94,482) 305,082
State (7,281) (9,088)
------- --------
(101,763) 295,994
-------- --------
$(101,763) $298,663
-------- --------
-------- --------
</TABLE>
The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ---------
<S> <C> <C>
Deferred tax assets:
Minimum tax credit carryforwards $ 111,615 $111,615
Net operating loss carryforward 887,461 146,456
---------- --------
Total 999,076 258,071
---------- --------
Deferred tax liabilities:
Capital assets 1,644,750 1,183,979
---------- ---------
Net deferred tax liabilities $ 645,674 $925,908
---------- ---------
---------- ---------
</TABLE>
The Company has no valuation allowances as of December 31, 1998 and 1997.
A reconciliation of the tax provision at the statutory Federal income tax
rate and the Company's actual provision for income tax before extraordinary
items is as follows:
<TABLE>
<CAPTION>
1998 1997
---------- --------
<S> <C> <C>
Tax (benefit) at statutory rate of 34% $(132,242) $ 410,132
Equity in earnings (losses) of affiliated companies 19,755 (73,752)
State income taxes, less Federal benefit (7,281) (5,998)
Statutory depletion in excess of cost depletion (13,874) (27,670)
Other, net 31,879 (4,049)
--------- ---------
$(101,763) $ 298,663
--------- ---------
--------- ---------
</TABLE>
30
<PAGE>
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, 1998, is $111,615.
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 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. The President received a bonus in 1998 of $32,000 based
on 1997 performance and $50,000 in 1997 based on 1996 performance. If the
President is terminated by the Company for any reason other than for cause
during 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 (394,193 shares as of December 31, 1998) 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.
15. RESTRUCTURING AND IMPAIRMENTS CHARGES:
In December 1998, the Company's Board of Directors approved a cost reduction
plan. Consistent with that the plan, the company recorded a $241,000 charge
related to severance payments for former employees and employees that would be
laid-off in January 1999. As discussed in Note 2, the Company also recorded an
impairment charge of approximately $1,020,000 related to its well property. The
charge was in response to lower wellhead prices for natural gas and the
continued decline in significance of the Company's exploration and production
operation. Approximately $833,000 of the impairment related to properties that
are developed but require additional capital to be fully developed or
undeveloped properties. Due to declining natural gas prices, it is not
economically feasible to develop these properties. Additionally, the Company
recognized the impact of declining prices on its producing properties by
estimating the general decline using 1996 as the base year. The Company
determined that the prices have declined 21% since 1996 and recorded an
impairment reserve of $187,000 in response to this decline.
16. EXTRAORDINARY LOSS ON EXTINGUISHMENT OF DEBT AND REGULATORY MATTERS:
In 1998, the Company recorded an extraordinary loss on extinguishment of debt
of approximately $832,000, net of taxes (including its 50% share of the
extraordinary loss recorded by its affiliates). The Company and its Affiliates
had originally capitalized as a regulatory asset a portion of this loss
associated with the refinancing of industrial revenue bonds in March 1998
(see Note 8). An extraordinary loss of approximately $233,000 was reported in
the first quarter. Later in 1998, in connection with the completion of
administrative proceedings with the VSCC, the Company determined that neither
it nor its Affiliates qualify as a regulated entity as defined by FASB
Statement No. 71, ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION.
Accordingly, the Company will restate first quarter earnings to reflect the
entire $832,000 extraordinary loss.
31
<PAGE>
17. SEGMENT INFORMATION:
The Company classifies its business into five fundamental areas: natural gas
storage, production, transportation, propane distribution and parent company
activities. Storage activities include revenues derived from and expenses
incurred in the operation of the Saltville Storage Facility. The production
segment includes gas sales from Company operated wells through its Virginia Gas
Marketing Company and the related expenses. Transportation activities include
revenue derived from the Company's P-25 pipeline system and the expenses
incurred to operate that system. The propane distribution segment includes all
revenues obtained through the retail distribution of propane and the related
expenses. The parent company activities relate solely to activities of Virginia
Gas Company as a holding company. Information as to the operations of the
Company in different business segments is set forth below based on the nature of
the products and services offered.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
------------ ------------
<S> <C> <C>
STORAGE:
Total assets $ 18,453,478 $ 16,190,661
Capital expenditures $ 3,971,187 $ 2,199,674
Operating revenues $ 2,938,746 $ 2,611,442
Interest income 276,041 32,773
Other income 725 --
Operation and maintenance (604,657) (580,090)
Depreciation, depletion, and amortization (374,080) (378,776)
------------ ------------
STORAGE OPERATING INCOME $ 2,236,775 $ 1,685,349
------------ ------------
------------ ------------
PRODUCTION:
Total assets $ 3,849,877 $ 5,768,719
Capital expenditures $ 46,259 $ 360,824
Operating revenues $ 3,646,654 $ 4,726,373
Interest income 42,157 52,638
Other income 7,038 --
Cost of natural gas sold (3,042,541) (3,802,210)
Production expense (160,705) (216,290)
Operations and maintenance (46,534) (780)
Depreciation, depletion, and amortization (244,063) (286,170)
------------ ------------
PRODUCTION OPERATING INCOME $ 202,006 $ 473,561
------------ ------------
------------ ------------
TRANSPORTATION:
Total assets $ 13,693,638 $ 2,251,590
Capital expenditures $ 11,442,048 $ 1,772,379
Operating revenues $ 507,246 $ --
Interest income 48,713 --
Operation and maintenance (106,704) --
Depreciation, depletion, and amortization (135,610) --
------------ ------------
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
TRANSPORTATION OPERATING INCOME $ 313,645 $ --
------------ ------------
------------ ------------
PROPANE DISTRIBUTION:
Total assets $ 3,607,146 $ 2,423,252
Capital expenditures $ 1,226,069 $ 1,665,042
Operating revenue $ 1,321,698 $ 657,234
Interest income 11,081 --
Other income 165,791 82,513
Propane gas expense (574,002) (328,114)
Operation and maintenance (261,554) (102,893)
Depreciation, depletion, and amortization (152,938) (79,817)
------------ ------------
PROPANE DISTRIBUTION OPERATING INCOME $ 510,076 $ 228,923
------------ ------------
------------ ------------
PARENT COMPANY:
Investments in subsidiaries and affiliates $ 28,680,554 $ 34,209,937
Notes receivable from subsidiaries and affiliates $ 21,469,845 $ 16,494,684
Total assets $ 54,776,897 $ 63,944,652
Capital expenditures $ 62,701 $ 99,437
Interest income $ 2,066,314 $ 1,626,644
Other income 2,420 --
Depreciation, depletion, and amortization (66,200) (61,706)
------------ ------------
PARENT COMPANY OPERATING INCOME $ 2,002,534 $ 1,564,938
------------ ------------
------------ ------------
ELIMINATION OF INTERCOMPANY/INTERSEGMENT ACTIVITY:
Total assets $(33,919,482) $(34,741,374)
Operating revenues $ (248,573) $ (97,655)
Interest income $ (986,074) $ (348,335)
VIRGINIA GAS COMPANY CONSOLIDATED:
Total assets $ 60,461,554 $ 55,837,500
Capital expenditures $ 16,748,264 $ 6,097,356
Operating revenues $ 8,165,771 $ 7,897,394
Interest income 1,458,232 1,363,720
Other income 175,974 82,513
Cost of natural gas sold (3,042,541) (3,802,210)
Propane gas expense (574,002) (328,114)
Production expense (160,705) (216,290)
Operations and maintenance (1,019,449) (683,763)
Depreciation, depletion, and amortization (972,891) (806,469)
------------ ------------
VIRGINIA GAS COMPANY CONSOLIDATED OPERATING INCOME $ 4,030,389 $ 3,506,781
------------ ------------
------------ ------------
</TABLE>
33
<PAGE>
18. SUBSEQUENT EVENT:
On January 3, 1999, the Company experienced a fire at its Wytheville gate
station, a part of its P-25 pipeline. Several Company structures were destroyed
in addition to a surrounding house and business. Many area residences and
businesses were without gas service for several days. Currently, the Company,
the Company's insurance company, and other potentially responsible parties are
investigating the incident. Ultimately, the Company does not believe that any
future legal proceedings related to this matter will have a material impact on
the Company.
Virginia Gas Storage Company, a 50% owned affiliate of the Company, sold its
60% interest in the Haysi Gathering System on February 8, 1999 for $2.7
million resulting in a $1.3 million before-tax gain that will be recorded in
the first quarter of 1999. The Company will record the 50% of that gain
through earnings of affiliates during the first quarter of 1999.
34
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1998. The
information provided in the definitive proxy statement is incorporated herein by
reference.
ITEM 10. EXECUTIVE COMPENSATION
Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1998. The
information provided in the definitive proxy statement is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1998. The
information provided in the definitive proxy statement is incorporated herein by
reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1998. The
information provided in the definitive proxy statement is incorporated herein by
reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are included:
EXHIBIT DESCRIPTION OF EXHIBIT
3.1 Amended and Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 to Virginia Gas
Company's Registration Statement, Registration No.
333-5362-NY).
35
<PAGE>
EXHIBIT DESCRIPTION OF EXHIBIT
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to Virginia
Gas Company's Registration Statement, Registration No.
333-5362-NY).
4.1 Specimen Common Stock Certificate (incorporated by reference
to Exhibit 4.1 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
4.2 Loan Agreement between Industrial Development Authority of
Russell County, Virginia and Virginia Gas Company
(incorporated by reference to Exhibit 4.2 to Virginia Gas
Company's Form SB-2 Registration No. 333-32009)
4.3 Promissory Note between Industrial Development Authority of
Russell County, Virginia and Virginia Gas Company
(incorporated by reference to Exhibit 4.3 to Virginia Gas
Company's Form SB-2 Registration No. 333-32009)
4.4 Loan Agreement between Industrial Development Authority of
Buchanan County, Virginia and Virginia Gas Company
(incorporated by reference to Exhibit 4.4 to Virginia Gas
Company's Form SB-2 Registration No. 333-32009)
4.5 Promissory Note between Industrial Development Authority of
Buchanan County, Virginia and Virginia Gas Company
(incorporated by reference to Exhibit 4.5 to Virginia Gas
Company's Form SB-2 Registration No. 333-32009)
9.1 Shareholders' Agreement and Voting Trust (incorporated by
reference to Exhibit 9.1 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
10.1 Series A Preferred Stock Securities Purchase Agreement by
and between Virginia Gas Company and Sirrom Capital
Corporation (incorporated by reference to Exhibit 10.1 to
Virginia Gas Company's Registration Statement, Registration
No. 333-5362-NY).
10.2 Stock Purchase Warrant issued by Virginia Gas Company to
Sirrom Capital Corporation (incorporated by reference to
Exhibit 10.2 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
10.3 Placement Agreement between Virginia Gas Company and
Anderson & Strudwick, Incorporated (incorporated by
reference to Exhibit 10.3 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
10.4 Warrant to Anderson & Strudwick Incorporated (incorporated
by reference to Exhibit 4.2 to Virginia Gas Company's Form
SB-2 Registration No. 333-5362-NY)
10.5 Employment Agreement between Virginia Gas Company and
Michael L. Edwards (incorporated by reference to Exhibit
10.6 to Virginia Gas Company's Registration Statement,
Registration No. 333-5362-NY).
10.6 Lease Agreement between J.D. Morefield, et.al. and Virginia
Gas Company (incorporated by reference to Exhibit 10.7 to
Virginia Gas Company's Registration Statement, Registration
No. 333-5362-NY).
10.7 Firm Gas Storage Agreement between Virginia Gas Storage
Company and Roanoke Gas Company (incorporated by reference
to Exhibit 10.8 to Virginia Gas Company's Form SB-2
Registration No. 333-32009).
10.8 Firm Storage Service Agreement between Virginia Gas Storage
Company and Powell-Clinch Utility District (incorporated by
reference to Exhibit 10.9 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
36
<PAGE>
EXHIBIT DESCRIPTION OF EXHIBIT
10.9 Firm Storage Service Agreement between Virginia Gas Storage
Company and the Public Utility District of Jefferson and
Cocke Counties, Tennessee (incorporated by reference to
Exhibit 10.10 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
10.10 Gas Storage Agreement between Virginia Gas Storage Company
and United Cities Gas Company (incorporated by reference to
Exhibit 10.11 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
10.11 Firm Gas Storage Agreement between Virginia Gas Storage
Company and Knoxville Utilities Board (incorporated by
reference to Exhibit 10.12 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
10.12 Winter Service Firm Natural Gas Sales Agreement between
Virginia Gas Storage Company and Knoxville Utilities Board
(incorporated by reference to Exhibit 10.13 to Virginia Gas
Company's Registration Statement, Registration
No. 333-5362-NY).
10.13 Agreement for Construction, Ownership and Operation of the
Haysi Gathering System between Virginia Gas Storage Company
and Penn Virginia Resources Corporation (incorporated by
reference to Exhibit 10.14 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
10.14 Interruptible Gathering Service Agreement between Columbia
Gas Transmission Corporation and Virginia Gas Storage
Company (incorporated by reference to Exhibit 10.15 to
Virginia Gas Company's Registration Statement, Registration
No. 333-5362-NY).
10.15 Transfer Agreement between Virginia Gas Company and Tenneco
Energy Resources Corporation (incorporated by reference to
Exhibit 10.16 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
10.16 Amendment to Transfer Agreement between Virginia Gas Company
and Tenneco Energy Marketing Company, successor-in-interest
to Tenneco Energy Resources Corporation (incorporated by
reference to Exhibit 10.17 to Virginia Gas Company's Form
10-KSB for the fiscal year ended December 31, 1996)
10.17 Promissory Note in principal amount of $1,725,000 in favor
of Tenneco Energy Resources Corporation (incorporated by
reference to Exhibit 10.17 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
10.18 United Cities Contract (incorporated by reference to Exhibit
10.18 to Virginia Gas Company's Registration Statement,
Registration No. 333-5362-NY).
10.19 Pipeline Balancing Agreement between East Tennessee Natural
Gas Company and Virginia Gas Pipeline Company (incorporated
by reference to Exhibit 10.19 to Virginia Gas Company's
Registration Statement, Registration No. 333-5362-NY).
10.20 Warrant to Shareholders (incorporated by reference to
Exhibit 10.20 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
10.21 Firm Storage Service Agreement between Virginia Gas Storage
Company and Sevier County Utility District (incorporated by
reference to Exhibit 10.22 to Virginia Gas Company's Form
10-KSB for the fiscal year ended December 31, 1996)
10.22 Firm Storage Service Agreement between Virginia Gas Storage
Company and Natural Gas Utility District of Hawkins County
(incorporated by reference to Exhibit 10.23 to Virginia Gas
Company's Form 10-KSB for the fiscal year ended December 31,
1996)
37
<PAGE>
EXHIBIT DESCRIPTION OF EXHIBIT
10.23 Firm Storage Service Agreement between Virginia Gas Pipeline
Company and Citizens Gas Utility District (incorporated by
reference to Exhibit 10.24 to Virginia Gas Company's Form
10-KSB for the fiscal year ended December 31, 1996)
10.24 Firm Gas Storage Agreement between Virginia Gas Pipeline
Company and Knoxville Utilities Board (incorporated by
reference to Exhibit 10.25 to Virginia Gas Company's Form
10-KSB for the fiscal year ended December 31, 1996)
10.25 Underwriting Agreement between Virginia Gas Company and
Anderson & Strudwick, Incorporated (incorporated by
reference to Exhibit 1.1 to Virginia Gas Company's Form
SB-2 Registration No. 333-5362-NY)
10.26 Description of Stock Options issued to named executive
officers (incorporated by reference to Exhibit 10.27 to
Virginia Gas Company's Form SB-2 Registration
No. 333-32009)
10.27 Amendment to the Firm Storage Service Agreement between
Virginia Gas Storage Company and Powell-Clinch Utility
District (incorporated by reference to Exhibit 10.28 to
Virginia Gas Company's Form SB-2 Registration
No. 333-32009)
10.28 Firm Storage Service Contract between Virginia Gas Pipeline
Company and Hawkins County Utility District (incorporated by
reference to Exhibit 10.29 to Virginia Gas Company's Form
SB-2 Registration No. 333-32009)
10.29 Firm Storage Service Contract between Virginia Gas Pipeline
Company and ALCOA (incorporated by reference to Exhibit
10.30 to Virginia Gas Company's Form SB-2 Registration
No. 333-32009)
10.30 Gas Transportation Agreement between Virginia Gas
Distribution Company and East Tennessee Gas Company
(incorporated by reference to Exhibit 10.31 to Virginia Gas
Company's Form SB-2 Registration No. 333-32009)
10.31 Underwriting Agreement between Virginia Gas Company and
Ferris, Baker Watts, Incorporated (incorporated by reference
to Exhibit 1.1 to Virginia Gas Company's Form SB-2
Registration No. 333-32009)
21.1 Subsidiaries and Affiliates of Virginia Gas Company
(incorporated by reference to Exhibit 21.1 to Virginia Gas
Company's Form 10-KSB for the fiscal year ended December 31,
1996)
* 27.1 Financial Data Schedule
99.1 Combined Financial Statements of Virginia Gas Company
Affiliates
* Report of Independent Public Accountants
* Balance Sheets
* Statements of Income
* Statements of Stockholders' Equity
* Statements of Cash Flows
* Notes to Financial Statements
* Statements of Stockholders' Equity
* Statements of Cash Flows
* Notes to Financial Statements
* 99.2 Virginia Gas Company 1998 Stock Option Plan
- ------------
* Filed herewith
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the fourth quarter of 1998.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 24, 1998.
VIRGINIA GAS COMPANY
(Registrant)
By /S/ MICHAEL L. EDWARDS
-------------------------
Michael L. Edwards
President, Chief Executive Officer, and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March , 1999.
/S/ EVERETTE G. ALLEN, JR. Director
- -------------------------------------
Everette G. Allen, Jr.
/S/ KAREN K. EDWARDS Vice President and Director
- -------------------------------------
Karen K. Edwards
/S/ WILLIAM L. CLEAR Vice President and Chief Financial Officer
- -------------------------------------
William L. Clear
39
<PAGE>
<PAGE>
EXHIBIT 21.1
40
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
SUBSIDIARIES AND AFFILIATES OF THE REGISTRANT
SUBSIDIARIES:
STATE OF
NAME INCORPORATION
- ---- -------------
Virginia Gas Exploration Company Virginia
Virginia Gas Pipeline Company Virginia
Virginia Gas Propane Company Virginia
Virginia Gas Marketing Company Virginia
AFFILIATES:
STATE OF
NAME INCORPORATION
- ---- -------------
Virginia Gas Storage Company Virginia
Virginia Gas Distribution Company Virginia
41
<PAGE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,763,753
<SECURITIES> 0
<RECEIVABLES> 3,469,757
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,771,017
<PP&E> 39,852,035
<DEPRECIATION> 2,712,497
<TOTAL-ASSETS> 60,461,554
<CURRENT-LIABILITIES> 3,617,790
<BONDS> 26,754,444
0
0
<COMMON> 5,505
<OTHER-SE> 31,938,141
<TOTAL-LIABILITY-AND-EQUITY> 60,461,554
<SALES> 8,165,771
<TOTAL-REVENUES> 9,799,977
<CGS> 3,616,543
<TOTAL-COSTS> 8,678,146
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,452,677
<INCOME-PRETAX> (388,948)
<INCOME-TAX> 101,763
<INCOME-CONTINUING> (287,185)
<DISCONTINUED> 0
<EXTRAORDINARY> (832,493)
<CHANGES> 0
<NET-INCOME> (1,119,678)
<EPS-PRIMARY> .20
<EPS-DILUTED> .20
</TABLE>
<PAGE>
EXHIBIT 99.1
42
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Boards of Directors and Stockholders of the
Virginia Gas Company Affiliates:
We have audited the accompanying combined balance sheets of the Virginia Gas
Company Affiliates (Virginia Gas Storage Company and Virginia Gas
Distribution Company) as of December 31, 1998 and 1997, and the related
combined statements of operations, changes in stockholders' equity, and cash
flows for the years then ended. 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 the Virginia Gas Company
Affiliates as of December 31, 1998 and 1997, and the combined results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Richmond, Virginia
February 18, 1999
43
<PAGE>
VIRGINIA GAS COMPANY AFFILIATES
COMBINED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
ASSETS
<TABLE>
<CAPTION>
1998 1997
---------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 100,834 $ 421,897
Accounts receivable 945,244 1,399,506
Other current assets 201,471 243,686
------------ ------------
Total current assets 1,247,549 2,065,089
PROPERTY AND EQUIPMENT, net 22,206,543 21,479,467
OTHER ASSETS 231,757 2,338,307
------------ ------------
Total assets $ 23,685,849 $ 25,882,863
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 5,943 $ 129,574
Accounts payable 2,669,668 2,981,401
Other current liabilities 78,406 284,486
------------ -----------
Total current liabilities 2,754,017 3,395,461
LONG-TERM DEBT 13,000,912 12,905,358
DEFERRED INCOME TAXES 136,281 681,705
------------ ------------
Total liabilities 15,891,210 16,982,524
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock
Virginia Gas Storage Company; no par
value, 50,000 shares authorized , 38,200 issued and
outstanding 5,640,000 5,640,000
Virginia Gas Distribution Company; no par value, 100,000 shares authorized,
75,000 shares issued and outstanding 1,500,000 1,500,000
Retained earnings 654,639 1,760,339
------------ ------------
Total stockholders' equity 7,794,639 8,900,339
------------ ------------
Total liabilities and stockholders' equity $ 23,685,849 $ 25,882,863
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these combined balance
sheets.
44
<PAGE>
VIRGINIA GAS COMPANY AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ --------
<S> <C> <C>
REVENUE:
Operating revenue $4,357,423 $5,518,647
Interest and other income 86,359 89,519
------------ --------
4,443,782 5,608,166
------------ --------
EXPENSES:
Purchased gas expense 1,196,498 1,805,700
General and administrative 740,552 858,206
Operation and maintenance expense 647,516 828,606
Depreciation, depletion, and amortization 744,121 675,306
Production expenses 181,833 198,866
------------ --------
3,510,520 4,366,684
------------ --------
Interest expense 1,127,238 597,743
Other 29,024 5,945
------------ --------
INCOME (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY LOSS (223,000) 637,794
Provision (benefit) for income taxes (59,862) 223,494
------------ --------
NET INCOME (LOSS) BEFORE EXTRAORDINARY LOSS (163,138) 414,300
Extraordinary loss on extinguishment of debt, net of taxes of $486,000 (942,562) -
------------ --------
NET INCOME (LOSS) $ (1,105,700) 414,300
------------ --------
------------ --------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
45
<PAGE>
VIRGINIA GAS COMPANY AFFILIATES
COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
COMMON RETAINED
STOCK EARNINGS
----------- ----------
<S> <C> <C>
BALANCE, December 31, 1996 $ 7,140,000 $1,346,039
Net income - 414,300
----------- ----------
BALANCE, December 31, 1997 7,140,000 1,760,339
Net loss - (1,105,700)
----------- ----------
BALANCE, December 31, 1998 $ 7,140,000 $ 654,639
----------- ----------
----------- ----------
The accompanying notes are an integral part of these combined financial
statements.
</TABLE>
46
<PAGE>
VIRGINIA GAS COMPANY AFFILIATES
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,105,700) $ 414,300
Adjustments to reconcile net income to net cash provided by operating
activities:
Extraordinary loss on extinguishment of debt, before taxes 1,428,125 -
Loss on write-off of assets 80,752 -
Depreciation, depletion, and amortization 744,121 675,306
Deferred income taxes (545,424) 132,014
Decrease (increase) in accounts receivable 454,262 (109,861)
Decrease (increase) in other current assets 42,213 (27,098)
Increase in other assets (10,864) (237,929)
Increase (decrease) in accounts payable (311,733) 421,630
Increase (decrease) in other current liabilities (206,080) 165,889
----------- -----------
Net cash provided by operating activities 569,672 1,434,251
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,555,857) (6,042,089)
Payments received on notes receivable - 1,969,714
----------- -----------
Net cash used in investing activities (1,555,857) (4,072,375)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal (28,077) -
Payment of financing costs (689,977) (302,122)
Release (establishment) of reserve funds 1,383,176 (328,500)
Proceeds from new loans - 3,525,858
----------- -----------
Net cash provided by financing activities 665,122 2,895,236
----------- -----------
NET INCREASE (DECREASE) IN CASH (321,063) 257,112
CASH, beginning of year 421,897 164,785
----------- -----------
CASH, end of year $ 100,834 $ 421,897
----------- -----------
----------- -----------
SUPPLEMENTAL DISCLOSURE:
Interest paid $ 613,228 $ 1,129,867
----------- -----------
----------- -----------
Income taxes paid $ 78,000 $ 159,024
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
47
<PAGE>
VIRGINIA GAS COMPANY AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1998 AND 1997
1. DESCRIPTION OF OPERATIONS:
These financial statements contain the combined operations of Virginia Gas
Distribution Company ("VGDC") and Virginia Gas Storage Company ("VGSC") ("the
Companies" or "Virginia Gas Company Affiliates"). Both companies were
organized in 1992 under the laws of the Commonwealth of Virginia. Each
company is 50 percent owned by Virginia Gas Company ("VGC") and 50 percent
owned by a private investor. In January 1999 through a contribution of
Owner's equity VGDC became the parent of VGSC. VGDC remains a 50% owned
affiliate of VGC. The primary business of the VGSC is to develop and operate
natural gas storage and gathering facilities. The primary business of VGDC is
to develop and operate natural gas distribution systems, located in certain
southwestern counties of the Commonwealth of Virginia.
VGDC operates under a Certificate of Public Convenience and Necessity issued by
the Virginia State Corporation Commission ("VSCC"). The Company's gross profits
are realized by the difference between the prices at which it purchases and the
prices at which it sells natural gas to its industrial, commercial and
residential customers. The prices at which the Company sells natural gas to its
customers are in accordance with the rate schedules in its tariff filed with the
Virginia State Corporation Commission. The Company purchases natural gas under
short-term contracts that reflect the market price of natural gas.
VGSC operates under a Certificate of Public Convenience and Necessity issued by
the VSCC and Certificate of Limited Jurisdiction issued by the Federal Energy
Regulatory Commission (FERC). VGSC serves customers in Virginia and Tennessee.
The FERC certificate allows VGSC to charge Tennessee customers rates established
under tariff by the VSCC. Customers in Virginia are charged the same tariff.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF COMBINATION
The combined financial statements for 1998 and 1997 include the accounts of
VGC's two 50% owned affiliates. All significant intercompany balances and
transactions have been eliminated in combination.
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 assets and liabilities and disclosure of
contingent assets and liabilities (if any) at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
48
<PAGE>
REVENUE RECOGNITION
VGSC 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. VGDC 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 Companies provide
for depreciation of property and equipment using the straight-line method
over estimated useful lives ranging from 5 to 30 years.
CAPITALIZED INTEREST
The Companies capitalize interest on expenditures for significant projects while
activities are in progress to bring the assets to their intended use. Interest
capitalized totaled $12,200 and $510,200 for the years ended December 31, 1998
and 1997, respectively.
OTHER ASSETS
Costs incurred in conjunction with financing transactions are amortized on a
straight-line basis over the terms of the financing transactions.
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>
1998 1997
------------- -------------
<S> <C> <C>
Trade receivables $ 823,945 $ 771,259
Receivables from affiliated companies - 319,829
Pipeline operating expenses 49,801 91,415
Joint-interest receivables 71,498 217,003
------------- -------------
$ 945,244 $ 1,399,506
------------- -------------
------------- -------------
4. PROPERTY AND EQUIPMENT:
1998 1997
------------- -------------
Storage properties $15,161,015 $14,320,327
Pipelines 8,304,561 8,269,512
Wells and pipelines in progress 1,111,003 576,570
Vehicles 151,549 108,242
Office equipment 102,664 80,101
Other equipment 23,603 57,089
------------- -------------
</TABLE>
49
<PAGE>
<TABLE>
<S> <C> <C>
24,854,395 23,411,841
Less- Accumulated depreciation, depletion, and amortization (2,647,852) (1,932,374)
------------- -------------
$ 22,206,543 $ 21,479,467
------------- -------------
------------- -------------
</TABLE>
5. OTHER ASSETS:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Restricted cash and investments - reserve funds $ - $ 1,383,176
Deferred debt issuance costs, net 226,488 946,316
Other 5,269 8,815
------------ ------------
$ 231,757 $ 2,338,307
------------ ------------
------------ ------------
</TABLE>
6. ACCOUNTS PAYABLE:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Trade payables $ 179,026 $ 1,180,821
Payable to affiliated companies 2,490,642 1,800,580
------------ ------------
$ 2,669,668 $ 2,981,401
------------ ------------
------------ ------------
</TABLE>
7. OTHER CURRENT LIABILITIES:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Amounts due to affiliated companies $ - $ 16,770
Funds held for future distribution 51,832 243,503
Income taxes payable (49,272) (2,178)
Other 75,846 26,391
------------ ------------
$ 78,406 $ 284,486
------------ ------------
------------ ------------
</TABLE>
8. LONG-TERM DEBT:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Note payable to VGC; interest payable at 8.5%; principal payable in
maturities of $423,000 to $529,000 from 2003 to 2012 $ 4,339,740 --
Note payable to VGC; interest payable at 8.5%; principal payable in
maturities of $845,000 to $1,056,000 from 2003 to 2012 8,661,172 --
Note payable to VGC; interest payable at 8.88%; principal payable in maturities
of $12,000 to $241,000 from 1995 to 2017
-- 2,504,839
Note payable to VGC; interest payable at 7.35%; principal payable in
maturities of $13,000 to $77,000 from 1996 to 2023 -- 1,005,462
Note payable to VGC; interest payable at 9%; principal payable in
maturities of $1,000 to $77,000 from 1999 to 2020 -- 842,697
</TABLE>
50
<PAGE>
<TABLE>
<S> <C> <C>
Note payable to VGC; 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 VGC; interest payable at 9%; principal payable in
maturities of $4,000 to $263,000 from 1999 to 2020 -- 2,879,214
Note payable to VGC; interest payable at 7.35%; principal payable in
maturities of $17,000 to $97,000 from 1996 to 2023 -- 1,268,288
Note payable to VGC; interest payable at 8.88%; principal payable in
maturities of $4,000 to $84,000 from 1995 to 2017 -- 870,562
Note payable through 1999 with interest from 8.0% to 12.75%
5,943 13,870
------------ ------------
13,006,855 13,034,932
Less- Current portion (5,943) (129,574)
------------ ------------
Long-term debt $ 13,000,912 $ 12,905,358
------------ ------------
------------ ------------
</TABLE>
In March 1998, VGC closed $24.0 million in senior notes with John Hancock
Mutual Life Insurance Company. With $19.5 million of the proceeds, Virginia
Gas Company called and retired the Series 1997 Russell County, Virginia
Subordinated Natural Gas Facilities Revenue Bonds, the Series 1995 Buchanan
County, Virginia Senior Subordinated Natural Gas Facilities Revenue Bonds,
and the Series A 1994 Buchanan County, Virginia Natural Gas Revenue Bonds.
Virginia Gas Company also defeased the Series A and B 1994 Russell County,
Virginia Subordinated Natural Gas Facilities Revenue Bonds. This transaction
refinanced VGC's existing debt, of which a portion had been loaned to the
Companies, at a lower rate. Accordingly in March 1998, the Companies'
promissory notes to VGC were canceled in favor of new notes with the lower
rate.
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 $9.1 million. The
bonds are payable from and are secured by a promissory note issued by the
Company to the Russell County Authority. A portion ($3.7 million) of the
proceeds were loaned to the Companies to construct the natural gas
distribution facility in and around the town of Lebanon, Virginia. As
discussed above, these bonds were called and retired in March 1998.
As of December 31, 1998, principal payments on long-term debt for the next five
years are as follows:
<TABLE>
<S> <C>
1999 $ 5,943
2000 -
2001 -
2002 -
2003 1,268,000
</TABLE>
9. SALES TO MAJOR CUSTOMERS:
The Companies have two significant customers that accounted for 58% and 11% of
1998 operating revenues and 54% and 9% of 1997 operating revenues.
51
<PAGE>
10. COMMITMENTS:
Certain of the Companies' leases require the Companies to pay minimum rentals.
The aggregate minimum rental payments on leases for the next five years are as
follows:
<TABLE>
<S> <C>
1999 $ 116,679
2000 108,499
2001 108,499
2002 77,658
2003 74,854
Thereafter 1,497,080
</TABLE>
11. INCOME TAXES:
The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
Current
<S> <C> <C>
Federal $ - $ 91,480
State - -
--------- ---------
- 91,480
--------- ---------
Deferred
Federal (59,862) 132,014
State - -
--------- ---------
(59,862) 132,014
--------- ---------
$ (59,862) $ 223,494
--------- ---------
--------- ---------
</TABLE>
The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
Deferred tax assets:
<S> <C> <C>
Minimum tax credit carryforwards $ 20,648 $ 20,648
Net Operating Loss carryforward 1,067,045 225,620
---------- ----------
Total 1,087,693 246,268
Deferred tax liabilities:
Capital assets 1,223,974 927,973
---------- ----------
Net deferred tax liabilities $ 136,281 $ 681,705
---------- ----------
---------- ----------
</TABLE>
The Company has no valuation allowances as of December 31, 1998 and 1997, and
there were no changes in the valuation allowance during the years then ended.
The Companies' actual provision for income tax as of December 31, 1998 and 1997
approximates the tax provision at the statutory Federal income tax rate.
12. RELATED-PARTY TRANSACTIONS:
With the exception of sales and storage fees charged to outside third parties, a
significant portion of the Companies' transactions are with VGC.
52
<PAGE>
VGC provides certain general and administrative services for the Companies.
These services include professional services, insurance coverage and
administrative services. Other transactions with affiliated companies include
purchases of natural gas, natural gas storage and technical services provided
for and by affiliated companies.
13. EXTRAORDINARY LOSS ON EXTINGUISHMENT OF DEBT AND REGULATORY MATTERS;
The Companies had originally capitalized as a regulatory asset the loss
associated with VGC's refinancing of its industrial revenue bonds in March
1998 (see Note 8). Later in 1998, in connection with the completion of
administrative proceedings with the VSCC, the Companies determined that
they do not qualify as regulated entities as defined by FASB Statement No. 71,
ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION. Accordingly,
the Companies will restate first quarter earnings to reflect approximately
$943,000, net of taxes, as an extraordinary loss on extinguishment of debt.
14. SUBSEQUENT EVENT:
VGSC sold its 60% interest in the Haysi Gathering System on February 8, 1999
for $2.7 million resulting in a $1.3 million before-tax gain that will be
recorded in the first quarter of 1999.
53
