Good morning and welcome to the WGL Holdings Incorporated fourth quarter fiscal year 2008 earnings conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. We will open the conference call for question-and-answers after the presentation.
The call will be available for rebroadcast today at 1:00pm Easter Time, running through November 21 at 05:00pm. You may access the replay by dialing 1800 642 1687 and entering pin number 71349547. If you do not have a copy of the Earnings Release, you can obtain one at www.wglholdings.com.
I will now turn the conference over to Melissa Adams; please go ahead.
Good morning everyone and thank you for joining our call. This morning’s comments will reference a slide presentation on our website that you can access by going to www.wglholdings.com, and selecting the IR section and clicking on Presentations.
The slide presentation highlights our fourth quarter and full year fiscal year 2008 results and the drivers of those results. For your convenience we’ll also be posting a transcript of the call later on the Investor Relation section of our website.
A reconciliation of our non-GAAP operating results with results reported in accordance with Generally Accepted Accounting Principles is provided as an attachment to our press release and is also available in the finance information section of our Investor Relations site at www.wglholdings.com.
We also encourage everyone to review our most recent forms 10-Q and 10-K filed with the Securities and Exchange Commission for a more complete discussion of the risks and uncertainties that can cause actual results to vary materially from the forward-looking statements that will be made this morning.
This morning, Vince Ammann, Vice President and CFO, will provide a brief recap of the quarter and the year with a focus on the drivers that led to our results. Following that, our Chairman and CEO, James DeGraffenreidt, will discuss key issues affecting fiscal year 2008 and our long-term performance. James will also provide new earnings guidance for fiscal year 2009.
Also joining us on the call this morning and available to answer your questions are Terry McAllister, President and Chief Operating Officer; Adrian Chapman, Vice President of Operations, Regulatory Affairs and Energy Acquisition; Gautam Chandra, Vice President, Business Process Outsourcing and Non Utility Operation; and Harry Warren, President of our Retail Energy Marketing Subsidiary, Washington Gas Energy Services or WGES.
I would also like to introduce a long-time friend and colleague, Bob Dennis, who is the company’s new Director of Investor Relations. I have recently been promoted to a new position in the company, Division Head Sustainability and Business Development in which I will lead our efforts to implement sustainable business practices and position the company to prosper in a carbon constrained future. Bob will be ably assisted by his IR colleagues Dan Foy, Martha Creula and the newest member of our team Kimberly Ellaway. I will be assisting Bob during the transition.
With that, it’s my pleasure to turn the call over to Vince.
Thank you, Melissa and good morning to everyone. I’m delighted to report that due to a number of initiatives that James will discuss in a few minutes, we have delivered record consolidated and utility net income as well as improved fourth quarter results. Before we review full fiscal year results I will summarize fourth quarter results that reflect our typical historical loss which is indicative of a diminished need for gas heating via our utility customers during the summer months.
For the quarter we reported net loss of $11.2 million or $0.22 per average common share versus a loss of $13.5 million or $0.27 per share in the same period last year. As many of you know, in order to give a more transparent look at the ongoing economic results of our operations, we focus our discussion of financial performance on non-GAAP operating results which reflect results after adjusting for unique or significant items. As you look at the schedule to reconcile GAAP results to non-GAAP operating results, you will notice a change in our presentation.
In addition to our customary presentation on unrealized mark-to-market gains and losses for energy derivatives, you will see two new line items that affect our presentation of utility results in connection with storage transactions relating to our asset optimization program.
For purposes of calculating non-GAAP operating results, gains and losses associated with these transactions are included in the reporting period when the gas is delivered to the end use customer and the ultimate profit is realized. This reflects a better matching between the economic costs and the benefits of our optimization strategy.
After considering these items, consolidated operating losses for the fourth quarter of fiscal year ‘08 were $0.23 per share versus $0.31 in the same period last year. This $0.08 per share improvement primarily reflects substantially stronger utility results that were partially offset by weaker unregulated results.
As shown on Slide five, the $0.14 improvement in utility results, a $0.21 seasonal loss this quarter versus a $0.35 seasonal loss in the comparative quarter last year, was primarily attributable to new rates and regulatory mechanisms, higher storage carrying costs reflecting the current quarter’s relatively higher value of storage gas inventory, asset optimization and the favorable effects of customer growth.
A favorable tax adjustment that lowered our effective tax rate added $0.05 to the utility results. The combined $0.18 favorable effect of these items was partially offset by higher depreciation, general taxes, operating and maintenance expense and other items that totaled $0.04 per share.
Our non-utility segment reported an operating loss of $0.02 per share versus $0.04 of operating earnings per share in the same period last year. The reduction is due to lower gross margins at our retail energy marketing business.
I will now switch gears and review the drivers of this year’s record net income of $116.5 million or $2.33 per share. As shown in our GAAP reconciliation tables and our presentation slides, both fiscal year and quarterly periods were affected by unrealized mark-to-market adjustments for energy related derivatives that affected both our retail energy marketing business and our utility. Additional adjustments related to the storage optimization further affected utility results.
After adjusting for these and other non-GAAP items, fiscal year results exceeded FirstCall mean estimates and our previous non-GAAP operating guidance. Our stronger performance relative to the previous guidance was principally due to tax adjustments booked during the fourth quarter.
On a year-over-year basis consolidated fiscal year 2008 operating earnings increased by $0.45 or 23% reflecting operating results of $2.44 per share versus $1.99 per share in the same period last year. Like the quarter, these results reflect sharply improved utility performance that was partially offset by weaker non-regulated results.
Utility operating results rose to $2.23 per share from $1.71 per share in the same period last year. The drivers of this year’s $0.52 or 30% increase are identified on slide 10. With a $0.35 year-over-year effect, the biggest driver of this year’s results were new rates and regulatory mechanisms that went into effect at the beginning of the fiscal year in Virginia and Maryland and in late December in the District of Columbia. Higher usage patterns also contributed $0.13 per share to comparative results.
Even though weather was nearly 13% warmer than last year on a degree day basis, the distribution of that weather, degree day quality and other factors contributed to higher levels of consumption per customer. The effects of this higher usage boosted net revenues in our District of Columbia and Virginia jurisdictions which do not have a decoupling program like our Maryland revenue normalization adjustment mechanism. Because our guidance is based on the historical usage, we are not forecasting this benefit to repeat in the coming year, particularly in view of today’s softer economy.
While we are discussing usage I would also like to update you on our strategy to neutralize the effects of weather on earnings. As some of you know, we are completely decoupled in Maryland, which means that our financial performance is not affected by changes in usage for any reason, either conservation or weather.
In Virginia, operating income has been stabilized due to weather normalization and a declining back rate structure. In the District of Columbia we will re-file for decoupled rates following the resolution of PEPCO’s decoupling application. In the meantime we have purchased a new weather protection product that is designed to totally neutralize the effects of weather. The systematic design of this product removes the potential upside of colder weather and has reduced the weather protection costs by $1.6 million.
Another important driver of our results was the successful expansion of our asset optimization program that contributed $0.13 per share to year-over-year earnings. Customer growth added $0.06 per share to year-over-year operating results. At year end our average customer meter count increased by nearly 10,000 meters.
Storage carrying costs also contributed $0.06 per share. Likewise, a favorable year-end tax adjustment that reduced our effective tax rate resulted in a $0.06 benefit to year-over-year utility income tax expense. These benefits were partially offset by the following items. A $0.14 net increase in operating maintenance expense items that was primarily due to $0.11 per share increase in uncollectible expenses.
Please recall that about half of this increase reflects an adjustment to the accumulated reserve made in the prior fiscal year to reflect better collections. The remaining half of this amount reflects higher uncollectible levels attributable to the negative effects of the slowing economy in the current period. After recognizing these adjustments, our year-to-date utility uncollectible rate remains about 1% of revenue.
The strength of our customer payment statistics reflect the results of a number of actions initiated during the second half of the year. These include an aggressive outbound call campaign that leveraged new capabilities in our BPO contract, as well as expanded field actions to settle bad accounts.
Our proactive steps to keep receivables current and prevent charge-offs is working well. As quarter close, a number of accounts in all aging categories except those over four months were in line with prior year results or prior year levels.
Another offset to fiscal year ‘08 results relate to a $0.06 per share charge that will be credited back to our Virginia customers in connection with our new performance based rates. As you will recall, when our return on equity exceeds the allowed threshold level of 10.5%, we share the economic benefits of improved incremental returns with both customers and shareholders. Depreciation and general taxes also increased by $0.06 per share, primarily due to higher capital expenditure and property taxes.
Turning now to our non-utility results, we generated non-GAAP operating results of $0.21 per share versus $0.28 per share last year. The year-over-year reduction was attributable to lower results at our retail energy marketing business, which had operating earnings of $0.25 per share in the current year versus $0.37 per share last year.
As shown on Slide 12, the $0.12 reduction was primarily due to significantly lower electric margins that were partially offset by higher gas margins. Lower gross margins from the sale of electricity reflect a reduction in unit margins and a 9% decrease in sales volume to 3.6 million-megawatt hours. Lower electric sales reflect milder weather and the loss for certain government and large commercial accounts.
Adjusted unit margins in fiscal year ‘08 were $6.85 per megawatt hour, above the range projected in last quarter’s guidance, but less than last year’s exceptionally strong margins of $9 per megawatt hour. Partially offsetting electricity losses were stronger natural gas gross margins. Despite a reduction in volumes sold, 63.5 Bcf in fiscal year ‘08 versus 72.5 Bcf in fiscal year ’07, primarily due to the loss of certain large government contracts.
Our gross margins improved due to higher adjusted unit margins of $0.42 per decatherm versus $0.32 in the fiscal year 2007. Fiscal year 2008 margins were below our long term target of $0.45 per decatherm, primarily due to certain accounting effects related to storage gas inventory that have deferred approximately $5 million of gas margins into fiscal year 2009 and beyond.
Aggregate, electric and gas customer counts declined from 206,600 to 195,100 accounts, primarily due to the extended run-up in natural gas and electric prices from February through June that caused us to halt mass market customer acquisition efforts. However, as we entered fiscal year ‘09, lower energy prices have allowed us to renew these mass market efforts and begin to rebuild the number of customer accounts.
While we project a net decline in natural gas volumes as the last of a set of lost government accounts roll off of our books, our outlook for electricity sales volume growth is positive. We already have approximately 3.8 million-megawatt hours of normal weather electric volumes under contract for fiscal year ‘09 and are projecting volumes to ultimately grow by 10% over fiscal year ‘08, exceeding 4 million-megawatt hours.
Higher operating expenses reduce results by $0.04 per share, offset by a $0.02 per share improvement from lower interest expense. Half of the increase in operating expense was attributable to higher uncollectible count expenses. Nonetheless, despite this difficult economic climate, our retail energy marketing business experienced very low uncollectible rates of approximately 0.3% in fiscal year ‘08 and is currently projecting a slight decrease to that rate in fiscal year ‘09.
As shown on Slide 8, our design built energy segment continued to show improvement with results of $1.8 million or $0.04 per share versus $367,000 or $0.01 per share in the same period last year.
In our other activities segment, representing mostly corporate related expenses, we saw a $0.02 per share improvement relating to a loss of $3.8 million or $0.08 per share versus $4.8 million or $0.10 per share due to 2007 regulatory audit fees that did not recur this year.
Finally, I would also like to briefly address issues related to liquidity and credit quality which are summarized in our appendix on slides 24 through 26. I’m pleased to report that our strong balance sheet, rigorous risk management and counterparty credit policies, committed credit facilities and solid financial partners have enabled us to navigate safely through this period of great national financial instability and volatility.
While we have not been immune of tightening credit or the revolving credit facilities and bilateral lines of credit for the unit have been provided to us with sufficient resources to fund the business.
On the utility side, short-term investors continue to display confidence in our stability and we continue to have access to the commercial paper market to meet the utility’s cash requirements. To fund the cash requirements of the non-utility business, WGL Holdings had relied more on borrowings under its revolving credit agreement and less on issuing commercial paper. Most recently we have observed increasing liquidity in the credit markets and have been able to issue commercial paper for longer maturities.
Thank you. That concludes my remarks and I will now turn the discussion over to James who will highlight the key initiatives behind this year’s success and our expectations for future success.
Thanks, Vince. Good morning everyone. We have had a good quarter and a great year and we expect the strategies that drove those results will position us for continued success in fiscal year 2009. Throughout the year, we continue to deliver on four key strategic objectives.
First, we dramatically improve the transparency and consistency of our utility earnings by removing the effects of volatility caused by variations in customer usage. Second, we invested in system infrastructure to support the safety and reliability of our system and secured appropriate recovery of and return on that investment.
Third, we successfully implemented transformational initiatives to secure long-term operational excellence, including service enhancements, cost reduction and the promotion of performance based rate making; and fourth, we continued to strengthen and grow our unregulated businesses.
We’ve made great progress in our efforts to improve the stability and transparency of our utility earnings growth by securing a Weather Normalization Adjustment Mechanism or WNA in Virginia. The October 1 implementation of the WNA and our existing declining block rate structure eliminates 90% of the volatility caused by fluctuating gas usage in Virginia, our largest service territory.
Based on the combined effect of the Virginia WNA and the Maryland revenue normalization adjustment or RNA, a full decoupling mechanism, we have you neutralized the revenue effect of variances from normal usage in over 80% of our service territory.
Excellent progress was also made in connection with our second key initiative relating to investment in system infrastructure that support continued reliability, safety and growth, as well as the reasonable recovery of and return on that investment.
At the beginning of the fiscal year, we implemented new rates in Maryland that permit recovery and return on the investment in Prince Georges County rehabilitation project and certain FX and blending facilities. This project involves the replacement of mains and service lines that contain mechanical couplings to a portion of our Prince George of County Merlin service territory that had experienced an unusually high incidence of leaks after the introduction of gas from the Cold Point liquefied natural gas terminal.
In December, we will begin operation of the third and final hexane facility that modifies the chemical composition of gas from Cold Point to resemble more closely that of domestic pipeline natural gas.
The Prince Georges County construction work, the blending facilities and additional limited mechanically coupled main and service replacement projects have helped us manage safely the effect of imported Cold Point LNG on our system. Nevertheless, we remain concerned about the future effects of Cold Point LNG on the safety of our system and will continue to oppose the facility’s expansion until these concerns are satisfactorily addressed.
Last week, we filed a request for rehearing of the Federal Energy Regulatory Commission’s October 7 decision that permits the expansion of the Cold Point facility and receipt of gas in our system at the originally certificated level which far exceeds the amount that Washington Gas has yet received on its system to date.
As you will recall on July 18, the United States Court of Appeals for the District of Columbia circuit vacated FERC’s earlier decision on expansion and remanded the matter until FERC thoroughly reviewed future safety concerns. Our position is that FERC’s subsequent cursory approach to issuing a reauthorization of the expansion does not satisfy the court’s directive and that the FERC decision is legally flawed on a number of counts.
With regard to future capital projects, we remain committed to the construction of a $149 million liquefied natural gas peaking facility in Chiliasm, Maryland that is scheduled to begin service in the winter heating season, 2011, 2012. This project represents the most economic and deficient solution to providing service for our customers during the coldest days of the year. Alternative firm pipeline or storage capacity would cost our customers several times more.
With regard to our third initiative, relating to operational excellence, we have successfully implemented our business process outsourcing program which is on track to deliver significant savings over the 10 year life of the contract while also enhancing service and creating opportunities to generate benefits from performance based rate making. We do not expect the cost savings from this program to generate significant savings until next year. However, we are already seeing key process improvement benefits.
Our customer satisfaction rates of 85% exceed both our company’s historical norms and targeted performance. In fact, J.D. Power and Associates recently ranked Washington Gas number one for customer service among Mid-Atlantic gas companies.
There are also improvements that customers don’t see. For example, I’m also pleased to report that our self service employee benefits program has reduced paper flow and made it possible for most employees to have instantaneous access to important benefit related information; thanks to our outsourcing arrangements.
Our commitment to operational excellence is also reflected in successfully concluded rate cases that implemented regulatory mechanisms that remove volatility from our earnings, while providing us with an opportunity to reduce cost for customers and enhance returns for shareholders. The Virginia rate case approved sharing, the Virginia allocated portion of off-system Asset Management net revenues with customers and shareholders. Before this, shareholders received no benefit.
Through the Virginia rate case, we also secured our first performance based rate mechanism or PBR. The PBR enables us to share with customers and shareholders any earnings generated above a targeted return on equity ratio of 10.5%. The sharing formula directs 75% of these earnings to customers and 25% to shareholders. Based on the strength of this year’s utility results, we directed over $4.8 million back to our Virginia customer.
We also continued to deliver on our initiative to grow earnings from unregulated businesses. Our consistently profitable retail energy marketing business marked its 12 anniversary and delivered $12.4 million or $0.25 per share in non-GAAP operating results. This organically grown business has continued to identify new opportunities for profit and is now exploring the expansion of its renewable energy and energy conservation product and service offering.
I’m also delighted with the progress we have made to turn around our design build energy systems business. This small but grow business contributed $0.04 per share in the current year versus a penny a share last year.
I will now turn to fiscal year 2009 guidance. As shown on Slide 16, we are introducing consolidated fiscal year 2009 non-GAAP operating guidance in a range of $2.27 per share to $2.39 per share. This guidance includes projected full fiscal year 2009 earnings from our utility segment in a range of $1.95 per share to $2.01 per share and projected full fiscal year 2009 non-GAAP operating earnings from our unregulated business segment in a range of $0.32 per share to $0.38 per share.
On Slide 18 we identified the drivers of the variance of the midpoints between gas and actual fiscal year ‘08 non-GAAP utility operating earnings. These include $0.06 per share from the additional 9500 new active customers reflecting encouraging growth despite the weak new construction market.
Also included is $0.05 per share from higher contributions from our expanded Asset Management strategy. Transactions made to date, lock in about $9 million of pretax operating margin or about 1/3 of our expected total of $30 million. While our utility outlook remains strong, certain conditions that generated significant contributions to fiscal year 2008 results are unlikely to repeat this fiscal year.
It appears that many of you have considered these items in developing your estimate as the current void of consensus is very close to our guidance. For example, as shown on slide 18, we are predicting a $0.15 per share effect from lower usage relative to the unusually high usage levels that we observed in fiscal year 2008. Please note that we are not expecting a dip for conservation or other factors, just a return to levels that reflect historical norms.
Another unfavorable item affecting comparative year-over-year results relates to storage carrying costs. As Vince explained, the relatively higher cost of gas in the past fiscal year elevated the value of storage gas inventories and other associated carrying charges. Given current natural gas prices and outlook, we are projecting lower storage gas inventory values and therefore lower carrying costs.
Tax adjustment provides yet another example. One seemingly negative item that I view in a positive light reflects a charge for the return of excess earnings to our Virginia customers. This item underscores our confidence and our ability to earn above the Virginia return on equity threshold for sharing that is set at 10.5%.
We are also expecting a slight up-tick in operation and maintenance expenses which we forecast will rise from $250 million to $256 million due to rising OPEB and pension benefits that have been partially offset by extensive cost containment measures.
On the non-utility side, we are expecting a significant improvement in our retail energy marketing business with operating results increasing by $0.14 to $0.39 per share. The improvement stems from stronger gas gross margins, primarily reflecting higher unit margins and higher electric gross margins that reflect higher sales volume. We are also expecting another good year for our design build energy systems business.
In fiscal year 2009 we expect to increase our capabilities and look forward to future improvement as we leverage our strong reputation for both traditional and alternative energy efficiency solutions that have become increasingly attractive against the backdrop of today’s rising energy costs and environmental concerns. Our business segment labeled other is a forecast to generate loss of $0.08 per share due to miscellaneous corporate related expenses.
In summary, the company continues to make excellent progress and is on the right track to generate sustained competitive long-term results. We are strengthening our infrastructure to meet growing demand and external gas quality challenges.
We have implemented key regulatory proposals that synchronize our approach to removing volatility from variations in usage while building an asset optimization program expected to generate $16.6 million in net revenue or $0.20 per share in the current year.
Software solutions have enabled us to hold the line on operating and maintenance expenses. Outsourcing initiatives are improving service levels and contributing to long-term cost savings and new regulatory mechanism shared benefits between customers and shareholders.
Finally, we are building a foundation to support continued profitable growth in our non-utility business through product offerings and services that help our customers meet their energy cost, efficiency and carbon reduction goals.
As I look to the longer term, our financial outlook is bright and our balance sheet is strong. We remain committed to achieving top core tile performance that includes growing a sustainable dividend that our shareholders can rely on.
Although our nation’s macroeconomic outlook is weakened, negatively affecting new home construction and customer additions, as well as other items such as pension values and costs, our resilient regional economy with the nation’s third highest job growth and lowest unemployment rate, continues to provide a stable platform for growth.
As such, we expect our current business plans to deliver operating earnings growth in a range of 4 to 5%, slightly below the growth goals we shared in March of last year. We will, however, remain vigilant for new opportunities to secure our performance of the top core tile company and I look forward to updating you on our progress during the course of the year.
That concludes my remarks and we’ll now be happy to answer your questions.
Again I would like to remind everyone that you can listen to a rebroadcast of this conference call at 1:00 Eastern Time today, running through November 21 at 5:00 pm. You may access the replay by dialing 1800 6421687 and entering pin number 71349547.
As there are no further questions I will turn the call back to Ms. Adams for any additional or closing remarks.
Thank you for joining us this morning and if you do have any questions, please don’t hesitate to call me or Bob Dennis, Director of Investor Relations, at 202 624 6129. Thank you.
This concludes our conference call for today. Thank you all for participating. All parties may disconnect now.
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