<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, 1999
[ ] 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
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [ ]
Revenues for the fiscal year ended December 31, 1999 were $ 11,030,088.
The aggregate market value of the voting Common Stock, par value $.001 per
share, held by nonaffiliates of the Registrant as of March 15, 2000 was
approximately $15,011,000 .
As of March 15, 2000, 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, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM PAGE
NUMBER CAPTION NUMBER
<S> <C>
PART I
1 Business 3
2 Properties 10
3 Legal Proceedings 10
4 Submission of Matters to a Vote of Security Holders 10
PART II
5 Market for Common Equity and Related Stockholder Matters 10
6 Management's Discussion and Analysis 11
7 Financial Statements 17
8 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 34
PART III
9 Directors and Executive Officers of the Company 34
10 Executive Compensation 34
11 Security Ownership of Certain Beneficial Owners and Management 34
12 Certain Relationships and Related Transactions 34
13 Exhibits and Reports on Form 8-K 34
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;
(iii) distributing propane and natural gas purchased from third parties or the
Company to local industrial, commercial and residential customers; and (iv)
transporting gas through its pipeline to a local distribution company.
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. The Company's propane
distribution operations have grown steadily since then. In 1998, the Company
completed construction of 35 miles of pipeline and began serving a local
distribution company with transmission services at two delivery points.
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 present
an opportunity for 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
3
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Distribution Company (the "Distribution Company") and Virginia Gas Storage
Company (the "Storage Company"), are each owned 50% by the Company and 50% by
one individual investor, who has no material affiliation with either the
Company, or any executive officer, director or controlling shareholder 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 storage operations of the
Pipeline Company's and 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 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 and operates 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 49,000 MMBtu were achieved during 1999. In 1999, the Company
completed construction of an evaporation facility adjacent to its Saltville
Storage Facility. The facility will be used by the Company to create additional
storage space by eliminating brine from the salt caverns.
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
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MMBtu for the 1999/2000 heating season. The deliverability of the Early Grove
Field has been increased by reworking existing wells, drilling new wells,
injecting additional base gas, installing larger diameter pipe, new compression
equipment, and increasing the maximum operating pressure of the field to 2,000
PSI from 1,400 PSI. Peak field deliverability has been increased from 1,000
MMBtu to over 20,000 MMBtu per day from 1992 to 1999.
PIPELINE OPERATIONS
In 1998, the Company completed construction and began servicing 35
miles of intrastate pipeline under authority granted in an application for a
CPCN with the VSCC filed in January 1997. The Company received the CPCN in
December 1997. The Company has purchased rights-of-way and obtained all
necessary permits for the construction of the remaining 37 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 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. Completion of the P-25
pipeline is expected by late 2000. 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. The Company will provide
17,500 MMBtu per day to Roanoke through an additional 58 miles of pipeline. The
Company received a CPCN to extend its pipeline to Roanoke in December 1999.
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.
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
approximately 300 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
5
<PAGE>
the 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. At the end of 1999, the
Company was providing propane gas service to over 4,400 customers in
southwestern Virginia.
EXPLORATION, PRODUCTION, GATHERING, AND MARKETING OPERATIONS
DRILLING ACTIVITY. The Company did not drill or complete any natural
gas wells during 1998 or 1999.
SERVICE OPERATIONS. The Company engages in the business of supervising
drilling operations and operating producing wells. As of December 31, 1999, 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 operates 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 approximately 67 miles of pipeline. The
gathering systems connect the Company's natural gas production to the ETNG, CNG
and TCO interstate pipeline systems and gathering systems as well as to the
Distribution Company's distribution system.
For such natural gas gathering services, the Company collects certain
transportation allowances from producers (owners of natural gas). Transportation
allowances vary depending upon contractual arrangements and currently range from
$.05 to $.50 per MMBtu.
MARKETING. In 1997 the Company began marketing natural gas. The Company
currently markets and sells natural gas provided from Company-operated wells and
facilities. The Company anticipates that future expansion of its marketing
operations will include purchases of natural gas supplies from third party
sources, storing these supplies in its Saltville Facility and marketing these
supplies to its customers.
6
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COMPETITION AND CUSTOMER BASE
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 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.
The Company has a limited number of customers for its wholesale
pipeline and storage services as the Company's facilities are limited by
their pipeline interconnects. Consequently, access to customers is restricted
to those with interconnects on the pipelines with which the Company's
facilities are connected. As a result, a majority of the Company's revenues
are earned from a small group of customers.
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 transmission pipeline operations are regulated by the
VSCC. Substantially all of the operations conducted through these pipelines
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 Distribution Company
filed for a rate increase late in 1999. The increase was put in place subject to
refund during January 2000. During March 2000, the VSCC approved the Company's
new rate structure.
The Company's gathering facilities, propane distribution operations and
natural gas marketing operations are not subject to service or rate regulation
from the VSCC.
FERC REGULATION. The Company's operations either are not governed by,
or by virtue of limited jurisdiction certificates having been issued by FERC,
are exempt from, further regulation by FERC under the Natural Gas Act.
ENVIRONMENTAL AND SAFETY REGULATION. The 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
7
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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 material 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.
EMPLOYEES
8
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As of December 31, 1999, the Company, its subsidiaries and affiliated
companies employed 55 persons on a full time basis, none of whom is covered by a
collective bargaining agreement.
9
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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 1999.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
APPROXIMATE NUMBER OF STOCKHOLDERS
<TABLE>
<CAPTION>
Number of
Stockholders of Record
Title of Class as of December 31,
1999
<S> <C>
Common stock, par value $.001 1,727
Warrants to purchase common stock 56
</TABLE>
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:
10
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<TABLE>
<CAPTION>
PRICE RANGE OF
COMMON STOCK
------------
DIVIDENDS
HIGH LOW PER SHARE
---- --- ---------
<S> <C> <C> <C>
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 3 5/8 2 5/32 0.0175
Second Quarter 4 3/4 2 1/2 0.0175
Third Quarter 4 3/8 3 3/8 -
Fourth Quarter 4 2 7/8 -
2000
First Quarter 3 3/4 2 17/32 -
(through March 15)
</TABLE>
The Company paid cash dividends on its Common Stock for each of the
years 1992 through 1998. During 1999, the Company's Board of Directors
reexamined the Company's dividend policy and determined that the funds would
be better used in support of capital expansion. Accordingly, at this time,
the Company does not pay cash dividends on its Common Stock. There is no
assurance that the Company will resume dividend payments in the future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion of the financial condition, changes in
financial condition, and results of operations of the Company for 1998 and 1999
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, 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 VSCC.
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 VSCC.
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
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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. 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 VSCC. 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 $11.0 million in 1999
compared to $9.8 in 1998 representing a 13% increase. Revenue growth was
primarily derived from the Company's P-25 pipeline that began service late in
1998, and growth in the Company's propane distribution operations. Lower gas
sales negatively impacted revenues as sales volumes declined 5% due to lower
production from Company wells and lower amounts of third party gas sales. The
trend of lower production will continue due to the maturity of the wells.
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
PERCENTAGE
REVENUE 1999 1998 CHANGE
---------------------------------------------------------------------------------
<S> <C> <C> <C>
Natural Gas Sales $ 2,865,000 $3,256,000 (12)%
---------------------------------------------------------------------------------
Storage Revenues 2,898,000 2,600,000 11
---------------------------------------------------------------------------------
Pipeline Revenues 1,140,000 447,000 155
---------------------------------------------------------------------------------
Propane Gas Sales 1,845,000 1,261,000 46
---------------------------------------------------------------------------------
Explor. & Prod. Revenues 351,000 342,000 3
---------------------------------------------------------------------------------
Management Revenues 304,000 260,000 17
---------------------------------------------------------------------------------
Interest and Other Income 1,627,000 1,634,000 0
--------- ---------
---------------------------------------------------------------------------------
Total Revenue $11,030,000 $ 9,800,000 13%
---------------------------------------------------------------------------------
</TABLE>
The Company operated 35 miles of its newly constructed pipeline for all
of 1999 compared to limited operation in 1998. The pipeline generated $1.1
million in demand charges in 1999 compared to $447,000 in 1998. The pipeline
extends from the Company's Saltville storage facility to Wytheville, Virginia.
The Company has a 15-year contract with Atmos Energy's subsidiary, United Cities
Gas Company, that provides 6,000 MMBtu/day to Marion, Virginia and 4,000
MMBtu/day to Wytheville, Virginia.
The Company's propane operation continued to experience significant
growth during 1999, as its customer base increased to 4,470 from 3,060 in
December 1998. Propane gas revenues increased to $1.8 million from $1.3 million
as gallons sold increased to 2.0 million from 1.4 million. During 1999, the
Company opened a new customer service center in a county adjacent to its
existing territory and doubled its storage capacity to 186,000 gallons from
90,000 gallons in response to customer growth.
Cost of natural gas sold declined from $3.0 million in 1998 to $2.5
million in 1999 due to the aforementioned reduction in gas sale volumes. The
Company sold 1,345,000 MMBtu of gas
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in 1999 compared to 1,418,000 MMBtu in 1998. Gross margins during 1999
improved to 12% from 7% in 1998. The 12% is comparable to the pre-1998
margins. Propane gas expense increased to $848,000 from $574,000 due to
higher volumes, as margins remained steady.
The Company's general and administrative expense increased to $2.3
million in 1999 from $1.6 million in 1998. There are two main reasons for the
increase: more resources were devoted toward administrative efforts and the
Company's ongoing strategic evaluation. The Company constructed 35 miles of
pipeline in 1998. The project required that the Company devote much of its
resources to the capital project. During 1999, the Company's capital projects
did not require the same level of administrative resources. Consequently, with
the same level of infrastructure, the Company capitalized less of its employee
time, which resulted in an additional $560,000 in net overhead. In addition to
less capitalization, the Company's ongoing strategic evaluation required
approximately $200,000 in additional legal costs and investment banking fees.
These increases in costs mitigated the impact of the Company's early 1999
restructuring (See Note 13).
The Company was successful in curbing growth in operations and
maintenance (O&M) expense during 1999. Despite customer growth in its propane
subsidiary of 46%, the Company's O&M expense decreased to $887,000 from
$899,000. A contributing factor to the lower O&M was the purchase of
compressors at the Company's Saltville Storage Facility in February 1999. The
compressors, before the purchase, had been leased for an annual rental of
$252,000.
Depreciation, depletion, and amortization increased to $1.5 million
from $1.0 million due in large part to the Company's addition of the P-25
pipeline that was placed in service late in 1998. Additional depreciation on
propane assets was also a factor as the Company's propane operations
continued to expand. Production expenses decreased to $88,000 from $106,000
reflecting the continued maturity and decline of the Company's exploration
and production operations.
Interest expense was $1.6 million in 1999 compared to $1.5 million in
1998. The Company increased its outstanding balance on its line of credit from
$2.5 million at the beginning of 1999 to $6.0 million at the end of the year to
fund construction of its evaporation facility. Other taxes increased during the
current year to $444,000 from $175,000 in 1998. The main contributor to this
increase was the additional franchise taxes paid by the Company in 1999. Due to
increase in authorized equity that was approved during 1998, the Company's
Delaware franchise taxes increased $130,000 annually. In addition to franchise
taxes, the Company's property taxes increased demonstrating the effect of 1998's
pipeline construction. Revenue earned from the pipeline also contributed to
higher gross receipts taxes paid to the Commonwealth of Virginia.
The Company's earnings from affiliated companies were $413,000 in 1999.
That amount includes the $403,000 (portion attributable to VGC) gain recorded by
Virginia Gas Storage Company related to the sale of its interest in the Haysi
Gathering System during the first quarter of 1999. Factoring out that gain,
earnings from affiliates was $10,000 compared to a loss of $58,000 in 1998.
Improvements occurred at the affiliate level in the form of both lower general
and administrative expenses and lower operations and maintenance expenses.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES (SFAS 133). The Statement establishes
accounting and reporting standards requiring
13
<PAGE>
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. In February 2000, the FASB issued a proposed statement that
would amend SFAS 133 such that contracts to purchase or sell commodities in
volumes deemed to be in a Company's normal course of business would not be
considered derivatives as defined by SFAS 133. Based on this proposed amendment,
management believes that all of its commodities contracts would qualify for this
exemption and would not be considered derivatives under SFAS 133. Therefore,
management does not believe SFAS 133 will have a material impact on the
consolidated financial statements when adopted. Statement No. 133 is effective
for fiscal years beginning after June 15, 2000 and may not be applied
retroactively.
FINANCIAL CONDITION
Capital expenditures during 1999 were $7.5 million compared to $16.7
million in 1998 and were funded by the Company's line of credit with Wachovia
Bank and cash flow from operations. Cash flow from operations improved
dramatically to $3.8 million in 1999 from approximately $19,000 in 1998 as
the Company's affiliates repaid working capital loans.
The Company has classified $24 million of long-term debt as current
due to a technical non-compliance with the Company's debt covenants. The
Company's covenants require it to maintain certain financial ratios (see Note
8). As of December 31, 1999, one covenant requires the Company to maintain
historical EBITDA of one and one-half times current debt service. The
Company's Line of Credit (the "Line") with Wachovia Bank N.A. (the "Bank") is
currently due on July 1, 2000, and as of December 31, 1999, had a balance
outstanding of $6.0 million. The $6.0 million, in its entirety by definition,
must be included in the Company's current debt service and, as a consequence,
causes the technical non-compliance. The Company's senior lenders, John
Hancock and Wachovia, have both provided the Company with a waiver through
March 31, 2000. Furthermore, as of the quarter ending March 31, 2000, the
covenant becomes more stringent, requiring the Company then to maintain
EBITDA of one and three-quarters times current debt service. Due to
construction delays, the Company's revenue has not grown at the expected
pace. Consequently, the Company, with its current debt structure, will have
difficulty in meeting this covenant.
The Company is exploring options to refinance its Line in a manner
that will avoid non-compliance with the covenant. One of those options is a
partial liquidation of assets and a complete repayment of the Line. There can
be no assurance that the Company will be successful in refinancing the Line.
If it is unsuccessful, the Company plans to seek additional waivers or
renegotiate the debt covenants, which will be at the discretion of the
Company's lenders.
The Company projects its capital budget for 2000 to be $20.0 million
if the pipeline and storage assets are expanded in the manner the Company
believes is appropriate and for which it has been securing the necessary
regulatory approvals and future contractual commitments. The Company does not
have internal resources currently to support this budget and has, as
explained below, been seeking financing from outside sources and considering
other strategic alternatives, such as potential asset liquidations, to obtain
it. If resources do not become available in the context of the transactions
described below currently under consideration by the Board of Directors, the
Company will postpone construction.
OUTLOOK
The Company believes the best prospects for its future require the
continued expansion of the pipeline and storage assets. However, the
Company's internal resources are insufficient to support this expansion and,
to date, the Company's external efforts to attract the necessary capital have
been unsuccessful. The Company believes that resources could ultimately be
found but they are likely to be on less favorable terms than those
historically available and than those needed to best realize the benefits of
expansion. The Company could continue to operate in a status quo mode, which
would not require additional financing. However, the Company projects that
flat to declining results would be associated with the adoption of a status
quo approach.
In consideration of the above factors, and as previously disclosed,
the Company has for some time been exploring both sources of additional
external capital and strategic alternatives, which would promote the
expansion strategies that the Board and management believe are in the long
term interest of those invested in the Company's businesses. The efforts
relating to strategic alternatives have intensified in recent months as it
has become clearer that the level of additional financing and/or investment
required is unlikely to be available directly. Given the projected outcome of
a status quo approach, it appears that completion of an appropriate strategic
transaction, if available, would be in the Company's and its stockholders'
best long term interests.
As disclosed, in December 1999, a group of management employees
made an offer to acquire the Company, which was subject to a number of
conditions, including financing. The offer is no longer under active
consideration. Through its financial advisor, CIBC Oppenheimer, the Board has
recently received other indications of interest in a purchase of the
Company's stock or significant portions of its consolidated assets from
several third parties who appear to have the financial resources to
complete the transactions in which they have indicated an interest. These
indications of interest, which have been communicated subject to due
diligence, negotiation of definitive agreements, regulatory approvals,
shareholder approval and other conditions, generally appear to represent
premiums to market value from the standpoint of the Company's recent share
price and are being actively considered by the Board. However, at the present
time, there can be no assurance that any of these transactions will take
place or that if they do take place, they will do so at the prices initially
proposed. It is the intention of the Board in pursuing these matters to seek
the transaction or transactions which will maximize available value for the
Company's shareholders. When and if sufficient progress can be made with
regard to a transaction that appears appropriate for the Board to recommend
to stockholders, further disclosure will be made.
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:
o The Company's growth plans are contingent on its ability to affordably
finance future capital expenditures. If the Company is unable to finance
capital expenditures, revenue growth will be impacted.
o 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. "Unbundling" or deregulation in the natural gas
14
<PAGE>
industry could introduce additional competitors and make the viability of
long-term contracts suspect.
o Virginia Gas Company derives 52% 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.
15
<PAGE>
YEAR 2000 ISSUE
Over the past several years, the Company has developed and
implemented a plan to address the impacts of the Year 2000 ("Y2K") problem on
our information and operations systems. We also surveyed third parties to
determine the status of their Y2K compliance programs. In addition, we
developed contingency plans specifying what the Company would do if we or
important third parties experienced disruptions critical to business
activities as a result of the Y2K problem.
The Company's Y2K plan was completed in all material respects prior
to December 31, 1999. As of March 15, 2000, the Company has not experienced
any material business disruptions or system failures as a result of Y2K
issues, nor is it aware of any Y2K issues that have impacted our customers,
suppliers, or other important third parties to an extent that would be
significant to the Company.
16
<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 18
Consolidated Balance Sheets as of December 31, 1999 and 1998 19
Consolidated Statements of Operations for the years ended December 31, 1999 and 1998 20
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 1999 and 1998 21
Consolidated Statements of Cash Flows for the years ended December 31, 1999 and 1998 22
Notes to Consolidated Financial Statements 23
</TABLE>
17
<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 (a Delaware Corporation) and Subsidiaries as of December 31, 1999 and
1998, 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 consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Virginia
Gas Company and Subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Notes 2 and 8 to
the financial statements, the Company was not in compliance with certain debt
covenants related to $30,000,000 of its debt obligations as of December 31,
1999, which raises substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Richmond, Virginia
March 3, 2000
18
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
ASSETS
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,444,731 $ 1,763,753
Accounts receivable 1,212,685 3,469,757
Notes receivable 40,100 38,800
Other current assets 899,168 498,707
----------- -----------
Total current assets 3,596,684 5,771,017
PROPERTY AND EQUIPMENT, net 43,145,750 37,139,538
INVESTMENT IN AFFILIATED COMPANIES 4,343,460 3,930,554
NOTES RECEIVABLE - AFFILIATED COMPANIES 13,000,912 13,000,912
OTHER ASSETS 639,714 619,533
----------- -----------
Total assets $64,726,520 $60,461,554
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $24,045,144 $ 46,734
Line of credit 6,000,000 2,500,000
Accounts payable 316,666 542,626
Funds held for future distribution 248,136 266,806
Other current liabilities 242,011 261,624
----------- -----------
Total current liabilities 30,851,957 3,617,790
LONG-TERM DEBT 209,709 24,254,444
DEFERRED INCOME TAXES 907,821 645,674
----------- -----------
Total liabilities 31,969,487 28,517,908
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock - par value $.001, 100,000,000 shares
authorized, 5,504,906 shares issued and outstanding 5,505 5,505
Additional paid-in capital 31,375,267 31,375,267
Retained earnings 1,376,261 562,874
----------- -----------
Total stockholders' equity 32,757,033 31,943,646
----------- -----------
Total liabilities and stockholders' equity $64,726,520 $60,461,554
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
19
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
OPERATING REVENUES:
Operating revenues $ 9,402,851 $ 8,165,771
Interest and other income 1,627,237 1,634,206
------------ ------------
11,030,088 9,799,977
------------ ------------
EXPENSES:
Cost of natural gas sold 2,510,885 3,042,541
Propane gas expense 848,217 574,002
General and administrative 2,300,777 1,646,448
Depreciation, depletion, and amortization 1,483,001 972,891
Operation and maintenance expense 887,412 899,030
Production expenses 87,933 106,146
Restructuring and impairment charges - 1,262,110
------------ ------------
8,118,225 8,503,168
------------ ------------
OTHER EXPENSES:
Interest expense 1,645,589 1,452,677
Other taxes 444,342 174,978
------------ ------------
2,089,931 1,627,655
------------ ------------
INCOME (LOSS) BEFORE EARNINGS OF AFFILIATED COMPANIES, INCOME
TAXES, AND EXTRAORDINARY LOSS 821,932 (330,846)
Provision for (benefit from) income taxes 228,793 (101,763)
------------ ------------
INCOME (LOSS) BEFORE EARNINGS OF AFFILIATED COMPANIES AND
EXTRAORDINARY LOSS 593,139 (229,083)
Equity in earnings (losses) of affiliated companies before
extraordinary items 412,920 (58,102)
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM 1,006,059 (287,185)
Extraordinary loss on extinguishment of debt net of taxes of
$ 444,000 -- (832,493)
------------ ------------
NET INCOME (LOSS) $ 1,006,059 $ (1,119,678)
============ ============
WEIGHTED AVERAGE SHARES ISSUED AND OUTSTANDING 5,504,906 5,504,906
============ ============
NET INCOME (LOSS) PER COMMON SHARE, BASIC AND DILUTED:
Net income (loss) before extraordinary item $ 0.18 $ (0.05)
Extraordinary loss on extinguishment of debt (net of tax) -- (0.15)
------------ ------------
Net income (loss) per common share $ 0.18 $ (0.20)
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
20
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN RETAINED
STOCK CAPITAL EARNINGS
------------ ------------ ------------
<S> <C> <C> <C>
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
Common stock dividends -- -- (192,672)
Net income -- -- 1,006,059
------------ ------------ ------------
BALANCE, December 31, 1999 $ 5,505 $ 31,375,267 $ 1,376,261
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
21
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,006,059 $ (1,119,678)
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation, depletion, and amortization 1,483,001 972,891
Gain on sale of fixed assets (15,607) --
Undistributed losses (earnings) of affiliated companies (412,920) 58,102
Extraordinary loss on extinguishment of debt -- 1,013,394
Deferred income taxes 262,147 (280,234)
Impairment charge -- 1,021,498
Decrease (increase) in accounts receivable 2,249,460 (826,739)
Increase in other current assets (400,461) (193,484)
Decrease in other assets (140,480) (47,334)
Decrease in accounts payable (225,960) (550,220)
Decrease in other current liabilities (38,283) (28,780)
------------ ------------
Net cash provided by operating activities 3,766,956 19,416
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (7,489,907) (16,748,264)
Proceeds from sale of assets 142,126 89,105
Payments received on notes receivable 800 159,350
------------ ------------
Net cash used in investing activities (7,346,981) (16,499,809)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal (2,856,325) (19,645,855)
Proceeds from new loans 6,310,000 26,500,000
Purchase of warrants and options -- (5,015)
Payment of debt issuance costs -- (659,311)
Refund of financing reserve funds -- 688,792
Dividends paid (192,672) (385,364)
------------ ------------
Net cash provided by financing activities 3,261,003 6,493,247
------------ ------------
NET DECREASE IN CASH (319,022) (9,987,146)
CASH, beginning of year 1,763,753 11,750,899
------------ ------------
CASH, end of year $ 1,444,731 $ 1,763,753
============ ============
SUPPLEMENTAL DISCLOSURE:
Interest paid $ 2,202,825 $ 2,028,874
============ ============
Income taxes paid $ 300,000 $ 12,075
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
22
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999 AND 1998
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. MANAGEMENT'S PLAN:
The Company has classified $24 million of long-term debt as current due to a
technical non-compliance with the Company's debt covenants. The Company's
covenants require it to maintain certain financial ratios (see Note 8). As of
December 31, 1999, one covenant requires the Company to maintain historical
EBITDA of one and one-half times current debt service. The Company's Line of
Credit (the "Line") with Wachovia Bank N.A. (the "Bank") is currently due on
July 1, 2000, and as of December 31, 1999, had a balance outstanding of $6.0
million. The $6.0 million, in its entirety by definition, must be included in
the Company's current debt service and, as a consequence, causes the
technical non-compliance. The Company's senior lenders, John Hancock and
Wachovia, have both provided the Company with a waiver through March 31,
2000. Furthermore, as of the quarter ending March 31, 2000, the covenant
becomes more stringent, requiring the Company then to maintain EBITDA of one
and three-quarters times current debt service. Due to construction delays,
the Company's revenue has not grown at the expected pace. Consequently, the
Company, with its current debt structure, will have difficulty in meeting
this covenant.
The Company is exploring options to refinance its Line in a manner that will
avoid non-compliance with the covenant. One of those options is a partial
liquidation of assets and a complete repayment of the Line. There can be no
assurance that the Company will be successful in refinancing the Line. If it
is unsuccessful, the Company plans to seek additional waivers or renegotiate
the debt covenants, which will be at the discretion of the Company's lenders.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements for 1999 and 1998 include the accounts of
four wholly owned subsidiaries. These subsidiaries are Virginia Gas Exploration
Company, Virginia Gas Marketing Company, Virginia Gas Pipeline Company, and
Virginia Gas Propane Company. 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 ("VGSC") and Virginia Gas Distribution Company ("VGDC") (the
"Affiliates"). The Company has a 50 percent interest in each of these
Affiliates.
Combined financial information as of December 31, 1999 and 1998, and for the
years then ended, for investments in affiliated companies accounted for by the
equity method is as follows.
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Current assets $ 1,462,597 $ 1,313,989
Property and equipment, net 20,444,918 22,206,543
Other assets 1,967,623 3,637,419
----------- -----------
$23,875,138 $27,157,951
=========== ===========
Current liabilities $ 576,769 $ 2,754,017
Long-term debt 13,916,719 15,916,719
Other liabilities 694,731 626,136
Stockholders' equity 8,686,919 7,861,079
----------- -----------
$23,875,138 $27,157,951
=========== ===========
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31
1999 1998
------------ ------------
<S> <C> <C>
Revenues $ 5,814,707 $ 4,851,762
Income (loss) before income taxes and
extraordinary loss 1,251,273 (176,084)
Net income (loss) 825,840 (1,058,795)
</TABLE>
Virginia Gas Storage Company, a 50% owned affiliate of Virginia Gas Company,
sold its 60% interest in the Haysi gathering System in February 1999 for $2.7
million resulting in a $1.2 million before-tax gain. The Company recorded 50%
of that gain through earnings of affiliates.
The Company provides certain general and administrative services for the
Affiliates. 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 to the
Affiliates.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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.
INCOME PER COMMON SHARE
Income per common share is computed using the weighted-average shares of common
stock and dilutive common stock equivalents (options and warrants) outstanding
during the respective periods. The number of weighted-average shares used in
calculating income per common share was 5,504,906 for the years ended December
31, 1999 and 1998.
PROPERTY AND EQUIPMENT
The Company follows the successful efforts method of accounting for its natural
gas exploration activities. Under this method, geological and geophysical costs
and costs of carrying and retaining undeveloped properties are expensed when
incurred. All direct and certain indirect costs relating to property
acquisition, successful exploratory wells, development costs, and support
equipment and facilities are capitalized as the properties are obtained or the
facilities are placed into service. Costs of exploratory wells are charged to
expense if it is determined that proven reserves are not found.
Unproved gas properties that are individually significant are periodically
assessed for impairment of value, with losses recognized at the time of
impairment. The Company recognized an impairment loss of approximately
$1,020,000 in 1998 related to its oil and gas properties. Property and
equipment is depreciated using the straight-line method over estimated useful
lives,
24
<PAGE>
ranging from 5 to 40 years. Maintenance and repairs are charged to expense as
incurred. Improvements and betterments are capitalized.
LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangible assets (including
goodwill) are reviewed for impairment when circumstances indicate that the
carrying amount of an asset may not be recoverable. VGC periodically evaluates
whether events and circumstances have occurred that indicate whether the
remaining estimated useful lives of long-lived assets should be revised or
whether the remaining balance may not be recoverable. When factors indicate that
a long-lived asset should be evaluated for possible impairment, VGC uses an
estimate of its undiscounted net cash flow over the remaining life of the
long-lived assets in measuring whether the long-lived asset is recoverable.
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 $583,632 and $578,662 for the years ended December 31, 1999
and 1998, respectively.
OTHER ASSETS
Costs incurred in conjunction with financing transactions are amortized on a
straight-line basis, which is not materially different than the effective
interest method 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 1998 balances to conform to the
1999 presentation.
4. ACCOUNTS RECEIVABLE:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Trade receivables $ 864,199 $ 841,256
Due from affiliated companies 209,382 2,490,642
Lease operating expenses receivable 129,199 120,704
Joint-interest receivables 9,905 17,155
------------ ------------
$ 1,212,685 $ 3,469,757
============ ============
</TABLE>
25
<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.
26
<PAGE>
5. NOTES RECEIVABLE - AFFILIATED COMPANIES:
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<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 $ 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 4,339,740
------------ -----------
$13,000,912 $13,000,912
============ ===========
6. PROPERTY AND EQUIPMENT:
1999 1998
------------ -----------
Storage properties $ 15,628,751 $ 15,025,229
Pipelines 12,114,571 11,540,536
Work in progress 11,984,847 7,332,997
Propane facilities 3,877,907 2,635,165
Wells 1,455,086 1,525,247
Building and improvements 1,077,037 860,861
Vehicles 498,926 430,079
Office equipment 490,437 405,692
Equipment 74,269 96,229
------------ -----------
47,201,831 39,852,035
Less- Accumulated depreciation, depletion, and amortization (4,056,081) (2,712,497)
------------ -----------
$ 43,145,750 $ 37,139,538
============ ===========
7. OTHER ASSETS:
1999 1998
------------ -----------
Deferred financing costs $ 243,678 $ 572,313
Interest receivable 222,433 -
Insurance proceeds receivable 119,516 -
Other 48,575 47,220
Note receivable - trade 5,512 -
------------ -----------
$ 639,714 $ 619,533
============ ===========
8. DEBT:
1999 1998
------------ -----------
Notes payable to John Hancock Mutual Life Insurance Company;
interest payable quarterly at 8.5%, principal payable in maturities
of $1,659,000 to $2,073,000 from 2003 to 2012 $ 17,000,000 $ 17,000,000
Note payable to Mellon Bank, NA; interest payable quarterly at
8.5%, principal payable in maturities of $390,000 to $488,000
from 2003 to 2012 4,000,000 4,000,000
Note payable to John Hancock Variable Life Insurance Company;
interest payable quarterly at 8.5%, principal payable in maturities
of $293,000 to $366,000 from 2003 to 2012 3,000,000 3,000,000
27
<PAGE>
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, 1999 125,539 136,630
Note payable with interest at 7.5%; payable in monthly installments of principal
and interest of $1,119; maturing in February 2009, secured by an asset with
a book value of $237,400 as of December 31, 1999 88,802 95,324
Notes payable through 2001 with interest from 8% to 9.3%; secured by assets
with a book value of $47,648 as of December 31, 1999 40,512 69,224
------------ -----------
24,254,853 24,301,178
Less- Current portion (45,144) (46,734)
Amounts classified as current (24,000,000) -
------------ ------------
Long-term debt $ 209,709 $24,254,444
============ ===========
</TABLE>
In March 1998, the Company sold $24 million in senior notes to John Hancock
Mutual Life Insurance Company ("John Hancock") in the form of four promissory
notes. Subsequently, John Hancock assigned $4.0 million of these 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. As a
result of the refinancing, the Company recognized an extraordinary loss on
extinguishment of debt for approximately $832,000. This amount is net of taxes
and includes the Company's 50% share of the extraordinary loss recorded by its
affiliates. 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, 1999 the Company
was not in compliance with these covenants. The Company has obtained waivers
of these covenant violations through March 31, 2000. The notes are quaranteed
by the Company's wholly-owned subsidiaries and the Company has pledged the
stock of its 50 percent owned affiliates as collateral for the notes.
As of December 31, 1999, scheduled principal payments on long-term debt for
the next five years and thereafter are as follows:
<TABLE>
<CAPTION>
<S> <C>
2000 $ 45,144
2001 33,178
2002 23,763
2003 2,365,925
2004 2,367,863
Thereafter 19,418,980
</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, 1999 and 1998, was approximately $23,661,000 and
$27,259,000 respectively.
The Company entered into an $8 million line of credit agreement (the "Line")
with Wachovia Bank, N.A. in July 1998. The Line carries an interest rate
based on the monthly LIBOR rate plus a factor, which is contingent on the
company's debt service coverage ratio. At December 31, 1999 the interest rate
was 8.98%. The Line's financial covenant requirements are similar to the
covenants in the John Hancock Note Agreement discussed above. As of December
31, 1999, the Company was not in compliance with these financial covenants.
The Company has received waivers of these covenant violations through March
31, 2000.
28
<PAGE>
The Company had $6.0 million and $2.5 million outstanding as of December 31,
1999 and 1998. The total amount is due on July 1, 2000.
9. STOCK OPTIONS:
The Company has granted certain management and directors stock options that
allow the individuals 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.
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 are
subject to a three-year vesting period from July 1, 1997 until June 30, 2000.
These options expire on June 30, 2002.
Changes in the options outstanding during the years ended December 31, 1999 and
1998, were as follows:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE
PRICE PER
SHARES SHARE
------- ----------
<S> <C> <C>
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
Canceled (30,000) $4.125
-------
Outstanding, December 31, 1999 270,000 $ 4.34
=======
</TABLE>
At December 31, 1999, options for 103,333 shares are currently exercisable.
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company has 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 income and income per share would have decreased by approximately
$230,000 ($.04 per share) in 1999. Net loss and loss per share would have been
increased by $75,000 ($.02 per share) in 1998. The weighted average fair value
of options granted during 1998 was approximately $2.52.
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: risk-free rate of return of 4.16%;
expected dividend yield of .71%; expected life of ten years; expected volatility
of 50%.
29
<PAGE>
10. COMMITMENTS AND CONTINGENT LIABILITIES:
The Company leases vehicles, equipment, land, and office space. Certain of
these leases require the Company to pay minimum royalties or rentals. The
aggregate minimum royalty and rental payments on leases for the next five
years and thereafter are as follows.
<TABLE>
<S> <C>
2000 $ 198,619
2001 177,270
2002 117,700
2003 68,777
2004 51,857
Thereafter 509,328
</TABLE>
The Company is subject to various Federal, state, and local laws and regulations
relating to the protection of the environment. The Company believes that it is
in compliance with these laws and regulations and does not expect to incur
significant capital expenditures in future years to maintain compliance.
11. SALES TO MAJOR CUSTOMERS:
The Company has four significant customers that accounted for 31%, 9%, 8%, and
4% of 1999 operating revenues and 27%, 18%, 11%, and 11% in 1998 operating
revenues respectively.
12. INCOME TAXES:
The components of the provision (benefit) for income taxes before extraordinary
items are as follows:
<TABLE>
<CAPTION>
1999 1998
----------- ---------
<S> <C> <C>
Current:
Federal $ (30,317) $ 173,834
State (3,037) 4,637
----------- ---------
$ (33,354) 178,471
Deferred:
Federal $ 238,279 $ (272,953)
State 23,868 (7,281)
----------- ---------
262,147 (280,234)
----------- ---------
$ 228,793 $(101,763)
=========== =========
</TABLE>
The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Deferred tax assets:
Minimum tax credit carryforwards $ 111,615 $ 111,615
Net operating loss carryforward 1,264,898 887,461
---------- ----------
Total 1,376,513 999,076
---------- ----------
Deferred tax liabilities:
Capital assets 2,284,334 1,644,750
---------- ----------
Net deferred tax liabilities $ 907,821 $ 645,674
========== ==========
</TABLE>
The Company has no valuation allowances as of December 31, 1999 and 1998.
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:
30
<PAGE>
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Tax (benefit) at statutory rate of 34% $ 419,850 $ (132,242)
Equity in (earnings) losses of affiliated companies (152,780) 19,755
State income taxes, less Federal benefit (36,144) (7,281)
Statutory depletion in excess of cost depletion (6,937) (13,874)
Other, net 4,804 31,879
----------- -----------
$ 228,793 $ (101,763)
----------- -----------
</TABLE>
In addition, the Company has minimum tax credits that can be carried forward
indefinitely to offset future regular tax. The aggregate amount of minimum tax
credits available at December 31, 1999, is approximately $112,000.
13. 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 did not receive a bonus in 1999, however, $28,000 was
accrued for 1999 performance as of December 31, 1999. 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
(404,813 shares as of December 31, 1999) 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.
14. RESTRUCTURING AND IMPAIRMENT CHARGES:
In December 1998, the Company's Board of Directors approved a cost reduction
plan. Consistent with the plan, the Company recorded a $241,000 reserve related
to severance payments for former employees and employees that were laid-off in
January 1999. This reserve had been utilized by December 31, 1999. A total of
eight employees were laid-off. These employees were given payments totaling
$241,000. As discussed in Note 3, 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 had been
developed but require additional capital to be fully developed or are
undeveloped properties. At the end of 1998, it was 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 had declined
21% since 1996 and recorded an impairment reserve of $187,000 in response to
this decline.
15. 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
31
<PAGE>
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
1999 1998
---- ----
<S> <C> <C>
STORAGE:
Total assets $ 23,264,477 $ 18,453,478
Capital expenditures $ 5,331,379 $ 3,971,187
Operating revenues $ 2,924,552 $ 2,938,544
Interest income - 276,041
Other income 2,729 725
Operation and maintenance (466,657) (505,099)
Depreciation, depletion, and amortization (564,987) (374,080)
-------------- --------------
STORAGE OPERATING AND INTEREST INCOME $ 1,895,637 $ 2,336,131
============== ==============
PRODUCTION:
Total assets $ 4,032,109 $ 3,849,877
Capital expenditures $ 39,453 $ 46,259
Operating revenues $ 3,528,617 $ 3,646,654
Interest income 43,545 42,157
Other income 20,666 7,038
Cost of natural gas sold (2,510,885) (3,042,541)
Production expense (87,933) (106,146)
Operations and maintenance (28,453) (77,506)
Depreciation, depletion, and amortization (178,086) (244,063)
-------------- --------------
PRODUCTION OPERATING AND INTEREST INCOME $ 787,471 $ 225,593
============== ==============
TRANSPORTATION:
Total assets $ 14,751,201 $ 13,693,638
Capital expenditures $ 654,904 $ 11,442,048
Operating revenues $ 1,150,349 $ 507,246
Interest income - 48,713
Other income 1,099 -
Operation and maintenance (17,916) (64,103)
Depreciation, depletion, and amortization (267,793) (135,610)
-------------- --------------
</TABLE>
32
<PAGE>
<TABLE>
<S> <C> <C>
TRANSPORTATION OPERATING AND INTEREST INCOME $ 865,739 $ 356,246
============== ==============
PROPANE DISTRIBUTION:
Total assets $ 4,787,296 $ 3,607,146
Capital expenditures $ 1,322,672 $ 1,226,069
Operating revenue $ 1,909,391 $ 1,321,698
Interest income - 11,081
Other income 244,748 165,791
Propane gas expense (848,217) (574,002)
Operation and maintenance (374,386) (252,322)
Depreciation, depletion, and amortization (237,183) (152,938)
-------------- --------------
PROPANE DISTRIBUTION OPERATING AND INTEREST INCOME $ 694,353 $ 519,308
============== ==============
PARENT COMPANY:
Investments in subsidiaries and affiliates $ 29,093,460 $ 28,680,554
Notes receivable from subsidiaries and affiliates $ 23,460,004 $ 21,469,845
Total assets $ 58,022,637 $ 54,776,897
Capital expenditures $ 141,499 $ 62,701
Operating revenue $ 712,036 $ 202
Interest income 2,258,695 2,066,314
Other income 256 2,420
Depreciation, depletion, and amortization (234,952) (66,200)
-------------- --------------
PARENT COMPANY OPERATING AND INTEREST INCOME $ 2,736,035 $ 2,002,736
============== ==============
ELIMINATION OF INTERCOMPANY/INTERSEGMENT ACTIVITY:
Total assets $ (40,131,200) $ (33,919,482)
Operating revenues $ (822,094) $ (248,573)
Interest income $ (944,501) $ (986,074)
VIRGINIA GAS COMPANY CONSOLIDATED:
Total assets $ 64,726,520 $ 60,461,554
Capital expenditures $ 7,489,907 $ 16,748,264
Operating revenues $ 9,402,851 $ 8,165,771
Interest income 1,357,739 1,458,232
Other income 269,498 175,974
Cost of gas sold (2,510,885) (3,042,541)
Production expense (87,933) (106,146)
Propane gas expense (848,217) (574,002)
Operations and maintenance (887,412) (899,030)
Depreciation, depletion, and amortization (1,483,001) (972,891)
-------------- --------------
VIRGINIA GAS COMPANY CONSOLIDATED OPERATING AND
INTEREST INCOME $ 5,212,640 $ 4,205,367
=============== ==============
</TABLE>
33
<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 and will be filed with the Securities and Exchange Commission
("SEC") not later than 120 days after December 31, 1999.
ITEM 10. EXECUTIVE COMPENSATION
Information required by this item is omitted pursuant to Instruction
E of Form 10-KSB and will be filed with the Securities and Exchange Commission
("SEC") not later than 120 days after December 31, 1999.
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 and will be filed with the Securities and Exchange Commission
("SEC") not later than 120 days after December 31, 1999.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is omitted pursuant to Instruction
E of Form 10-KSB and will be filed with the Securities and Exchange Commission
("SEC") not later than 120 days after December 31, 1999.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are included:
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT
------- ----------------------
<S> <C> <C>
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).
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT
------- ----------------------
<S> <C> <C>
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).
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).
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).
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT
------- ----------------------
<S> <C> <C>
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 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).
10.14 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).
10.15 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)
10.16 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).
10.17 United Cities Contract (incorporated by reference to Exhibit
10.18 to Virginia Gas Company's Registration Statement,
Registration No. 333-5362-NY).
10.18 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).
10.19 Warrant to Shareholders (incorporated by reference to
Exhibit 10.20 to Virginia Gas Company's Registration
Statement, Registration No. 333-5362-NY).
10.20 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)
10.21 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)
10.22 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)
</TABLE>
36
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT
------- ----------------------
<S> <C> <C>
10.23 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)
10.24 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)
10.25 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)
10.26 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)
10.27 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)
10.28 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)
10.29 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)
10.30 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
* 23.1 Consent of Arthur Andersen LLP
* 27.1 Financial Data Schedule
* 99.1 Financial Statements of Virginia Gas Storage Company
Report of Independent Public Accountants
Balance Sheets
Statements of Income
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
* 99.2 Financial Statements of Virginia Gas Distribution Company
Report of Independent Public Accountants
Balance Sheets
Statements of Income
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
</TABLE>
- ------------
* Filed herewith
(b) The Company filed the following Current Reports on Form 8-K during the
quarter ended December 31, 1999:
Current Report on Form 8-K as filed with the Securities and Exchange
Commission on December 23, 1999
37
<PAGE>
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 15, 2000
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 15, 2000.
/s/ GLENN B. ROGERS Chairman of the Board of Directors
- -----------------------------
Glenn B. Rogers
/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>
EXHIBIT 21.1
40
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES
SUBSIDIARIES AND AFFILIATES OF THE REGISTRANT
<TABLE>
<CAPTION>
SUBSIDIARIES:
STATE OF
NAME INCORPORATION
---- -------------
<S> <C>
Virginia Gas Exploration Company Virginia
Virginia Gas Pipeline Company Virginia
Virginia Gas Propane Company Virginia
Virginia Gas Marketing Company Virginia
AFFILIATES:
<CAPTION>
STATE OF
NAME INCORPORATION
---- -------------
<S> <C>
Virginia Gas Storage Company Virginia
Virginia Gas Distribution Company Virginia
</TABLE>
41
<PAGE>
EXHIBIT 99.1
42
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Virginia Gas Storage Company:
We have audited the accompanying balance sheets of the Virginia Gas Storage
Company (a Virginia Corporation) as of December 31, 1999 and 1998, and the
related 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform an audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Storage Company as
of December 31, 1999 and 1998, and the results of its operations and its cash
flows for the years then ended, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Richmond, Virginia
March 3, 2000
43
<PAGE>
VIRGINIA GAS STORAGE COMPANY
BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
ASSETS
1999 1998
------------- --------------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 411,520 $ 36,800
Accounts receivable 452,468 740,748
Other current assets 31,378 33,932
------------- --------------
Total current assets 895,366 811,480
PROPERTY AND EQUIPMENT, net 13,687,248 15,420,259
OTHER ASSETS 213,249 132,001
------------- --------------
Total assets $ 14,795,863 $ 16,363,740
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ - $ 5,943
Accounts payable 280,816 1,123,993
Other current liabilities 24,659 57,580
------------- --------------
Total current liabilities 305,475 1,187,516
LONG-TERM DEBT 5,255,547 7,255,547
DEFERRED INCOME TAXES 694,731 626,136
------------- --------------
Total liabilities 6,255,753 9,069,199
------------- --------------
STOCKHOLDERS' EQUITY:
Common stock; no par value, 50,000 shares authorized, 38,200
issued and outstanding 5,640,000 5,640,000
Retained earnings 2,900,110 1,654,541
------------- --------------
Total stockholders' equity 8,540,110 7,294,541
------------- --------------
Total liabilities and stockholders' equity $ 14,795,863 $ 16,363,740
============= ==============
</TABLE>
The accompanying notes are an integral part of these balance sheets.
44
<PAGE>
VIRGINIA GAS STORAGE COMPANY
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
REVENUES:
Operating revenue $ 3,195,776 $ 3,538,976
Gain on sale of Haysi Gathering System 1,215,850 -
Interest and other income 16,955 9,223
----------- -----------
4,428,581 3,548,199
EXPENSES:
Operations and maintenance expense 636,264 631,204
Purchased gas expense 615,781 655,010
Depreciation, depletion, and amortization 422,897 542,991
General and administrative 354,469 459,631
Production expenses 43,099 181,834
----------- -----------
2,072,510 2,470,670
INTEREST EXPENSE 468,845 609,029
----------- -----------
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY LOSS 1,887,226 468,500
Provision for income taxes 641,657 159,291
----------- -----------
INCOME BEFORE EXTRAORDINARY ITEM 1,245,569 309,209
Extraordinary loss on extinguishment of debt net of taxes of
$247,000 - (478,684)
----------- -----------
NET INCOME (LOSS) $ 1,245,569 $ (169,475)
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
45
<PAGE>
VIRGINIA GAS STORAGE COMPANY
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
COMMON RETAINED
STOCK EARNINGS
----------- -----------
<S> <C> <C>
BALANCE, December 31, 1997 $ 5,640,000 $ 1,824,016
Net loss - (169,475)
----------- -----------
BALANCE, December 31, 1998 5,640,000 1,654,541
Net income - 1,245,569
----------- -----------
BALANCE, December 31, 1999 $ 5,640,000 $ 2,900,110
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
46
<PAGE>
VIRGINIA GAS STORAGE COMPANY
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,245,569 $ (169,475)
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation, depletion, and amortization 422,897 542,991
Gain on sale of fixed assets (1,360,499) -
Extraordinary loss on extinguishment
of debt - 725,281
Deferred income taxes 68,595 (87,305)
Loss on write-off of fixed assets - 80,752
Decrease in accounts receivable 288,280 668,652
Decrease (increase) in other current assets 2,554 (2,776)
Increase in other assets (90,300) (225,228)
Decrease in accounts payable (843,177) (1,107,132)
Decrease in other current liabilities (32,921) (211,063)
----------- -----------
Net cash provided by (used in) operating activities (299,002) 214,697
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (105,881) (970,384)
Disposal of fixed assets 81,046 -
Proceeds from sale of assets 2,704,500 -
----------- -----------
Net cash provided by (used in) investing activities 2,679,665 (970,384)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal (2,005,943) (74,722)
Release of reserve funds - 617,982
Payment of financing costs - (126,731)
----------- -----------
Net cash provided by (used in) financing activities (2,005,943) 416,529
----------- -----------
NET INCREASE (DECREASE) IN CASH 374,720 (339,158)
CASH, beginning of year 36,800 375,958
----------- -----------
CASH, end of year $ 411,520 $ 36,800
=========== ===========
SUPPLEMENTAL DISCLOSURE:
Interest paid $ 569,618 $ 201,245
=========== ===========
Income taxes paid $ 555,000 $ 78,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
47
<PAGE>
VIRGINIA GAS STORAGE COMPANY
NOTES TO FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999 AND 1998
1. DESCRIPTION OF OPERATIONS:
Virginia Gas Storage Company (the "Company" or "VGSC") was organized in 1992
under the laws of the Commonwealth of Virginia. The Company is 50 percent owned
by Virginia Gas Company ("VGC") and 50 percent owned by a private investor. The
primary business of the Company is to develop and operate natural gas storage
facilities.
The Company's Early Grove Storage Facility operates under a Certificate of
Public Convenience and Necessity issued by the Virginia State Corporation
Commission ("VSCC") and a Certificate of Limited Jurisdiction issued by the
Federal Energy Regulatory Commission ("FERC"). The Company 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:
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 gas sales 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.
PROPERTY AND EQUIPMENT
All direct and indirect costs relating to property acquisition, development
costs and support equipment and facilities are capitalized as the properties are
obtained or the facilities are placed into service. The Company provides for
depreciation of property and equipment using the straight-line method over
estimated useful lives ranging from 5 to 30 years.
LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangible assets (including
goodwill) are reviewed for impairment when circumstances indicate that the
carrying amount of an asset may not be recoverable. VGSC periodically evaluates
whether events and circumstances have occurred that indicate whether the
remaining balance may not be recoverable. When factors indicate that a
48
<PAGE>
long-lived asset should be evaluated for possible impairment, VGSC uses an
estimate of its undiscounted net cash flow over the remaining life of the
long-lived assets in measuring whether the long-lived asset is recoverable.
CAPITALIZED INTEREST
The Company capitalizes interest on expenditures for significant projects while
activities are in progress to bring the assets to their intended use. The
Company did not capitalize any interest during 1999. Interest capitalized
totaled $12,200 for the year ended December 31, 1998.
OTHER ASSETS
Costs incurred in conjunction with financing transactions are amortized on a
straight-line basis, which is not materially different than the effective
interest rate method, 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.
RECLASSIFICATIONS
Certain reclassifications have been made in the 1998 balances to conform to the
1999 presentation.
3. ACCOUNTS RECEIVABLE:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Trade receivables $ 370,486 $ 619,450
Pipeline operating expenses 33,523 49,800
Joint-interest receivables 28,997 71,498
Receivables from affiliated companies 19,462 -
------------- -------------
$ 452,468 $ 740,748
============= =============
4. PROPERTY AND EQUIPMENT:
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Storage properties $15,169,803 $15,161,015
Vehicles 116,814 126,438
Office equipment 81,241 91,659
Building and improvements 11,414 -
Equipment 1,672 -
Pipelines - 1,987,746
Wells and pipelines in progress - 92,097
----------- -----------
15,380,944 17,458,955
Less- Accumulated depreciation, depletion, and amortization (1,693,696) (2,038,696)
----------- -----------
$13,687,248 $15,420,259
=========== ===========
</TABLE>
49
<PAGE>
5. OTHER ASSETS:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Deferred debt issuance costs, net $ 192,679 $ 126,732
Other 20,570 5,269
------------- -------------
$ 213,249 $ 132,001
============= =============
6. LONG-TERM DEBT:
<CAPTION>
1999 1998
------------- --------------
<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 $ 4,339,740
Note payable to VGDC; interest payable at 8.5%; principal payable in maturities
of $89,300 to $111,700 from 2003 to 2012 915,807 2,915,807
Note payable through 1999 with interest from 8.0% to 12.75% - 5,943
------------- --------------
5,255,547 7,261,490
Less- Current portion - (5,943)
------------- --------------
Long-term debt $ 5,255,547 $ 7,255,547
============= ==============
In March 1998, Virginia Gas Company ("VGC") closed $24 million in senior notes
with John Hancock Mutual Life Insurance Company. With $19.5 million of the
proceeds, VGC 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. VGC also
defeased the Series A and B 1994 Russell County, Virginia Subordinated Natural
Gas Facilities Revenue Bonds. This transaction refinanced the existing debt, of
which a portion had been loaned to the Company, at a lower rate. Accordingly,
the Company's promissory notes were canceled in favor of new notes with the
lower rate. As a result of the refinancing, the Company recognized a loss of
approximately $479,000 as an extraordinary loss on extinguishment of debt.
As of December 31, 1999, principal payments on long-term debt for the next five
years and thereafter are as follows:
<CAPTION>
<S> <C> <C>
2000 $ -
2001 -
2002 -
2003 512,300
</TABLE>
50
<PAGE>
<TABLE>
<S> <C> <C>
2004 512,300
Thereafter 4,230,947
7. SALES TO MAJOR CUSTOMERS:
The Company has three significant customers that accounted for 48%, 19%, and 11%
of 1999 operating revenues and 73%, 15%, and 10% in 1998 operating revenues
respectively.
8. COMMITMENTS:
Certain of the Company's leases require the Company to pay minimum rentals.
The aggregate minimum rental payments on leases for the next five years and
thereafter are as follows:
<CAPTION>
<S> <C> <C>
2000 $ 76,393
2001 76,393
2002 71,777
2003 67,394
2004 65,664
Thereafter $1,247,616
9. INCOME TAXES:
The components of the provision for income taxes are as follows:
<CAPTION>
1999 1998
--------- --------
<S> <C> <C>
Current, Federal $ 573,062 $ 71,986
Deferred, Federal 68,595 87,305
------- -------
$ 641,657 $ 159,291
======= =======
The components of deferred tax assets and liabilities are as follows:
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ - $ 252,104
Minimum tax credit carryforwards 20,648 20,648
----------- -----------
20,648 272,752
----------- -----------
Deferred tax liabilities:
Capital assets 715,379 898,888
----------- -----------
Net deferred tax liabilities $ 694,731 $ 626,136
=========== ===========
</TABLE>
The Company has no valuation allowances as of December 31, 1999 and 1998, and
there were no changes in the valuation allowance during the years then ended.
The Company's actual provision for income tax as of December 31, 1999 and 1998
approximates the tax provision at the statutory Federal income tax rate.
51
<PAGE>
52
<PAGE>
10. RELATED-PARTY TRANSACTIONS:
The Company provided storage services for affiliated companies which fees
approximated $113,000 and $120,000 for the years ended December 31, 1999 and
1998.
VGC provides certain general and administrative services for the Company. 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.
11. SALE OF HAYSI GATHERING SYSTEM
VGSC sold its 60% interest in the Haysi Gathering System in February 1999 for
$2.7 million resulting in a $1.2 million before-tax gain.
53
<PAGE>
EXHIBIT 99.2
54
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Virginia Gas Distribution Company:
We have audited the accompanying balance sheets of Virginia Gas Distribution
Company (a Virginia Corporation) as of December 31, 1999 and 1998, and the
related 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform an audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Distribution
Company as of December 31, 1999 and 1998, and the results of its operations
and its cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Notes 1 and 2 to
the financial statements, the Company has suffered recurring losses from
operations. In addition, Virginia Gas Company, its 50 percent owner and
principal source of financing, was not in compliance with certain debt
covenants related to $30,000,000 of its debt obligations as of December 31,
1999. These matters raise substantial doubt about the company's ability to
continue as a going concern. Management's plans in regard to these matters
are also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Richmond, Virginia
March 3, 2000
55
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
ASSETS
1999 1998
------------- --------------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 287,928 $ 64,034
Accounts receivable 215,826 204,495
Other current assets 63,477 233,980
------------- --------------
Total current assets 567,231 502,509
PROPERTY AND EQUIPMENT, net 6,757,670 6,786,284
NOTES RECEIVABLE 915,807 2,915,807
DEFERRED TAX ASSET 720,979 489,855
DEFERRED DEBT ISSUANCE COSTS, NET 117,588 99,756
------------- --------------
Total assets $ 9,079,275 $ 10,794,211
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 238,261 $ 1,545,674
Other current liabilities 33,033 20,827
------------- --------------
Total current liabilities 271,294 1,566,501
LONG-TERM DEBT 8,661,172 8,661,172
------------- --------------
Total liabilities 8,932,466 10,227,673
------------- --------------
STOCKHOLDERS' EQUITY:
Common stock; no par value, 100,000 shares authorized,
75,000 shares issued and outstanding 1,500,000 1,500,000
Retained earnings (1,353,191) (933,462)
------------- --------------
Total stockholders' equity 146,809 566,538
------------- --------------
Total liabilities and stockholders' equity $ 9,079,275 $ 10,794,211
============= ==============
</TABLE>
The accompanying notes are an integral part of these balance sheets.
56
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
REVENUES:
Operating revenue $ 1,198,376 $ 939,464
Interest and other income 187,750 364,099
------------ -----------
1,386,126 1,303,563
EXPENSES:
Purchased gas expense 730,587 614,756
Depreciation, depletion, and amortization 247,529 201,130
Operations and maintenance expense 188,670 202,986
General and administrative 103,080 130,422
------------ -----------
1,269,866 1,149,294
OTHER EXPENSES:
Interest 736,257 769,829
Other 15,956 29,024
------------ -----------
752,213 798,853
------------ -----------
LOSS BEFORE INCOME TAXES AND EXTRAORDINARY LOSS (635,953) (644,584)
Benefit from income taxes (216,224) (219,141)
------------ -----------
LOSS BEFORE EXTRAORDINARY ITEM (419,729) (425,443)
Extraordinary loss on extinguishment of debt net of tax
benefit of $239,000 - (463,877)
------------ -----------
NET LOSS $ (419,729) $ (889,320)
============ ===========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
57
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
COMMON RETAINED
STOCK DEFICIT
----------- ------------
<S> <C> <C>
BALANCE, December 31, 1997 $ 1,500,000 $ (44,142)
Net loss - (889,320)
----------- ------------
BALANCE, December 31, 1998 1,500,000 (933,462)
Net loss - (419,729)
----------- ------------
BALANCE, December 31, 1999 $ 1,500,000 $ (1,353,191)
=========== ============
</TABLE>
The accompanying notes are an integral part of these
financial statements.
58
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (419,729) $ (889,320)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation, depletion, and amortization 247,529 201,130
Gain on sale of fixed assets (4,500) -
Deferred income taxes (231,124) (458,119)
Extraordinary loss on extinguishment of debt - 702,844
Decrease (increase) in accounts receivable (11,331) 15,894
Decrease in other current assets 170,503 14,082
Decrease (increase) in other assets (25,000) 14,524
Increase (decrease) in accounts payable (1,307,413) 565,114
Increase (decrease) in other current liabilities 12,206 (11,013)
------------ ----------
Net cash provided by (used in) operating activities (1,568,859) 155,136
------------ ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (211,747) (585,456)
Proceeds from sale of fixed assets 4,500 -
Payments received on notes receivable 2,000,000 53,537
------------ ----------
Net cash provided by (used in) investing activities 1,792,753 (531,919)
------------ ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal - (6,892)
Payment of financing costs - (363,424)
Release of reserve funds - 765,194
------------ ----------
Net cash provided by financing activities - 394,878
------------ ----------
NET INCREASE (DECREASE) IN CASH 223,894 18,095
CASH, beginning of year 64,034 45,939
------------ ----------
CASH, end of year $ 287,928 $ 64,034
============ ==========
SUPPLEMENTAL DISCLOSURE:
Interest paid $ 736,256 $ 414,161
============ ==========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
59
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY
NOTES TO FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999 AND 1998
1. DESCRIPTION OF OPERATIONS:
Virginia Gas Distribution Company (the "Company" or "VGDC") was organized in
1992 under the laws of the Commonwealth of Virginia. The Company is 50 percent
owned by Virginia Gas Company ("VGC") and 50 percent owned by a private
investor. The primary business of 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
VSCC. The Company purchases natural gas under short-term contracts that reflect
the market price of natural gas.
In recent years, the Company has had significant losses. The losses have
resulted from large expansions that are at this time underutilized. Until
such time that new customers are added and rate increases are granted by the
VSCC to recover the increased cost of service, the Company will continue to
record losses. The Company has the commitment of VGC to provide sufficient
financial and operating support to enable VGDC to continue to meet its
obligations, however, VGC is technically in default of certain of its debt
covenants. VGC has obtained waivers of these covenant violations through
March 31, 2000.
2. MANAGEMENT'S PLAN:
As discussed in Note 1, VGDC relies upon the support of its 50 percent owner,
VGC, therefore VGC's and VGDC's future plan are inexorably linked. VGC has
classified $24 million of long-term debt as current due to a technical
non-compliance with it's debt covenants. VGC's covenants require it to
maintain certain financial ratios. As of December 31, 1999, one covenant
requires VGC to maintain historical EBITDA of one and one-half times current
debt service. VGC's Line of Credit (the "Line") with Wachovia Bank N.A. (the
"Bank") is currently due on July 1, 2000, and as of December 31, 1999, had a
balance outstanding of $6.0 million. The $6.0 million, in its entirety by
definition, must be included in VCG's current debt service and, as a
consequence, causes the technical non-compliance. VGC's senior lenders, John
Hancock and Wachovia, have both provided VGC with a waiver through March 31,
2000. Furthermore, as of the quarter ended March 31, 2000, the covenant
becomes more stringent, requiring VGC to maintain EBITDA of one and
three-quarters times current debt service. Due to construction delays, VGC's
revenue has not grown at the expected pace. Consequently, VGC, with its
current debt structure, will have difficulty in meeting this covenant.
VGC is exploring options to refinance its Line in a manner that will avoid
non-compliance with the covenant. One of those options is a partial
liquidation of assets and a complete repayment of the Line. There can be no
assurance that VGC will be successful in refinancing the Line. If it is
unsuccessful, VGC plans to seek additional waivers or renegotiate the debt
covenants, which will be at the discretion of VGC's lenders.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 revenue in the period the natural gas is delivered to the
customer.
PROPERTY AND EQUIPMENT
All direct and indirect costs relating to property acquisition, development
costs and support equipment and facilities are capitalized as the properties are
obtained or the facilities are placed into service. The Company provides for
depreciation of property and equipment using the straight-line method over
estimated useful lives ranging from 5 to 30 years.
60
<PAGE>
LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangible assets (including
goodwill) are reviewed for impairment when circumstances indicate that the
carrying amount of an asset may not be recoverable. VGDC periodically evaluates
whether events and circumstances have occurred that indicate whether the
remaining balance may not be recoverable. When factors indicate that a
long-lived asset should be evaluated for possible impairment, VGDC uses an
estimate of its undiscounted net cash flow over the remaining life of the
long-lived assets in measuring whether the long-lived asset is recoverable.
OTHER ASSETS
Costs incurred in conjunction with financing transactions are amortized on a
straight-line basis, which is not materially different than the effective
interest rate method, 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.
RECLASSIFICATIONS
Certain reclassifications have been made in the 1998 balances to conform to the
1999 presentation.
4. NOTES RECEIVABLE - AFFILIATED COMPANIES:
<TABLE>
<CAPTION>
1999 1998
------------- ------------
<S> <C> <C>
Note receivable from Virginia Gas Storage Company; interest
receivable at 8.5%; principal due in maturities of $89,300 to
$111,700 from 2003 to 2012 $ 915,807 $ 2,915,807
============= ============
5. PROPERTY AND EQUIPMENT:
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Pipelines $ 7,080,359 $ 6,316,815
Project and construction in progress 457,458 920,725
Other property and equipment 48,520 157,900
------------ ------------
7,586,337 7,395,440
Less- Accumulated depreciation, depletion, and amortization (828,667) (609,156)
------------ ------------
$ 6,757,670 $ 6,786,284
============ ============
6. LONG-TERM DEBT:
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Note payable to Virginia Gas Company; interest payable at
8.5%: principal payable in maturities of $845,000 to
$1,056,000 from 2003 to 2012 $ 8,661,172 $ 8,661,172
============ ============
</TABLE>
61
<PAGE>
In March 1998, VGC closed $24 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 the existing debt, of
which a portion had been loaned to VGDC, at a lower rate. Accordingly in March
1998, the Company's promissory notes were canceled in favor of new notes with
the lower rate. As a result of the refinancing, the Company recognized an
extraordinary loss on extinguishment of debt of approximately $464,000.
As of December 31, 1999, principal payments on long-term debt for the next five
years and thereafter are as follows:
<TABLE>
<S> <C> <C>
2000 $ -
2001 -
2002 -
2003 845,000
2004 845,000
Thereafter 6,971,172
7. SALES TO MAJOR CUSTOMERS:
The Company has four significant customers that accounted for 33%, 23%, 11%, and
9% of 1999 operating revenues and 30%, 20%, 13%, and 12% of 1998 operating
revenues, respectively.
8. INCOME TAXES:
The components of the benefit from income taxes are as follows:
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Current, Federal $ 14,900 $ 238,978
Deferred, Federal (231,124) (458,119)
---------- ----------
$(216,244) $(219,141)
========== ==========
The components of deferred tax assets and liabilities are as follows:
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $1,143,984 $ 786,907
Deferred tax liabilities:
Capital assets (423,005) (297,052)
---------- ----------
Net deferred tax assets $ 720,979 $ 489,855
=========== ==========
</TABLE>
The Company has no valuation allowances as of December 31, 1999 and 1998. The
Company believes that the net operating losses will be utilized through the
future earnings of the Company. Currently, the Company's assets are
underutilized due to a large expansion project in 1997. Over time the Company
will experience customer growth in addition to rate increases, the
62
<PAGE>
first of which was obtained in early 2000, that will provide taxable income to
offset the net operating loss carryforward.
The Company's actual provision for income tax as of December 31, 1999 and 1998
approximates the tax provision at the statutory Federal income tax rate.
9. RELATED-PARTY TRANSACTIONS:
With the exception of sales to outside third parties, a significant portion of
the Company's transactions are with VGC and affiliated companies.
VGC provides certain general and administrative services for the Company. These
services include professional services, insurance coverage and administrative
services. Other transactions with affiliated companies include purchases of
natural gas, natural gas storage and technical services provided for and by
affiliated companies.
10. SUBSEQUENT EVENT:
The Company filed a rate case with the VSCC in August 1999. The Company
requested a significant rate increase to cover cost of service. The Company's
new tariff schedule, the subject of the rate case, was approved by the VSCC in
March 2000 and placed in effect retroactively to January 23, 2000.
63
<PAGE>
Exhibit 23.1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10KSB into the Company's previously filed
Registration Statement File No.333-88641.
ARTHUR ANDERSEN LLP
Richmond, Virginia
April 11, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF VIRGINIA GAS COMPANY AND SUBSIDIARIES AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,444,731
<SECURITIES> 0
<RECEIVABLES> 1,212,685
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 3,596,684
<PP&E> 47,201,831
<DEPRECIATION> 4,056,081
<TOTAL-ASSETS> 64,726,520
<CURRENT-LIABILITIES> 30,857,957
<BONDS> 0
0
0
<COMMON> 5,505
<OTHER-SE> 32,751,528
<TOTAL-LIABILITY-AND-EQUITY> 64,726,520
<SALES> 9,402,851
<TOTAL-REVENUES> 11,030,088
<CGS> 8,118,225
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 444,342
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,645,589
<INCOME-PRETAX> 1,234,852
<INCOME-TAX> 228,793
<INCOME-CONTINUING> 1,006,059
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,006,059
<EPS-BASIC> 0.18
<EPS-DILUTED> 0.18
</TABLE>
