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WGL Holdings (NYSE:WGL)

Q2 2013 Earnings Call

May 02, 2013 10:30 am ET

Executives

Douglas Bonawitz - Head of Investor Relations

Terry D. McCallister - Chairman, Chief Executive Officer, Chairman of Executive Committee, Chairman of Washington Gas Light Company and Chief Executive Officer of Washington Gas Light Company

Vincent L. Ammann - Chief Financial Officer, Vice President, Chief Financial Officer of Washington Gas Light Co and Vice President of Washington Gas Light Co

Adrian P. Chapman - President, Chief Operating Officer, President of Washington Gas Light Co and Chief Operating Officer of Washington Gas Light Co

Harry A. Warren - President

Analysts

Mark Barnett - Morningstar Inc., Research Division

Spencer E. Joyce - Hilliard Lyons, Research Division

Operator

Good morning, and welcome to the WGL Holdings Inc. Second Quarter Fiscal Year 2013 Earnings Conference Call. At this time, I'd like to inform you that this conference is being recorded. [Operator Instructions] We'll open the conference call for questions and answers after the presentation. The call will be available for rebroadcast today at 1:00 p.m. Eastern time, running through May 9, 2013. You may access the replay by dialing 1 (855) 859-2056 and entering pin number 52734968. 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 Doug Bonawitz. Please go ahead.

Douglas Bonawitz

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, clicking on the Investor Relations tab and then choosing Events and Webcast from the drop-down menu. The slide presentation highlights the results for our second quarter of fiscal year 2013 and the drivers of those results. A reconciliation of the operating earnings with results reported in accordance with Generally Accepted Accounting Principles, is provided as an attachment to our press release and is available in the quarterly results section of our website.

This morning, Terry McCallister, our Chairman and Chief Executive Officer, will provide some opening comments and a brief recap of our second quarter fiscal year 2013 consolidated results. Following that, Vince Ammann, Vice President and Chief Financial Officer, will review the major items that led to the second quarter results. Also on this morning's call is Adrian Chapman, President and Chief Operating Officer, who will discuss key issues affecting our business and the status of some of our initiatives. In addition, Harry Warren, President of Washington Gas Energy Services; and Gautam Chandra, Vice President of Strategy and Business Development, are with us this morning and available to answer your questions.

Finally, we encourage everyone to review our most recent Form 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 made this morning.

And with that, I would like to turn the call over to Terry McCallister.

Terry D. McCallister

Thank you, Doug, and good morning, everyone. I'm happy to discuss with you today our second quarter operating earnings. Our non-GAAP operating earnings for the second quarter shown on Slide 3 of our presentation were $90.7 million or $1.75 per share, up from $81.3 million or $1.58 per share in the second quarter of 2012.

On a non-GAAP basis, consolidated operating earnings for the first 6 months were $149.6 million or $2.89 per share. This compares to $139.4 million in the prior year or $2.70 per share. Non-GAAP operating earnings for the regulated utility segment were higher this quarter compared to the prior year as shown on Slide 3.

Our utility customer base continues to grow and average active customer meters increased by over 10,400 meters year-over-year. Our region has seen impacts some impact from the federal sequestration, we're also seeing indications that the new housing market is strengthening, particularly in the multisegment -- multifamily segment, where we're focusing our marketing efforts.

On the regulatory front, our decision in the -- our District of Columbia rate case should be issued soon. I am optimistic that this will lead to recovery of deferred cost from the District and an expansion of our accelerated replacement program. We also recently filed a new rate case in Maryland and our STRIDE legislation, which was passed by the Maryland legislature and is awaiting the governor's signature. Adrian will talk more about these developments shortly.

We also continue to expand our non-utility businesses. Our Commercial Energy Systems business added new solar energy project to its portfolio, including a recent agreement to build our first commercial solar project in the state of California. Our Retail business also announced a 5-year secured supply arrangement with Shell Energy North America with a goal of reducing cash flow volatility for that segment. Vince will discuss this development in more detail in a few minutes.

I remain confident in our ability not just to achieve but to exceed our goals in 2013. With second quarter financial performance coming in better than our internal targets, we are raising our consolidated earnings outlook.

I'm now going to turn the call over to Vince, who will review our second quarter results by segment, as well as our updated guidance for 2013.

Vincent L. Ammann

Thank you, Terry. I would first like to mention that reconciliations of our GAAP net income to non-GAAP operating earnings can be found in the earnings release that is available on our website. As it is our standard practice, I will be referencing non-GAAP operating earnings in my comments.

Turning first to our Utility segment. Operating earnings for the second quarter of fiscal year 2013 were $1.57 per share, $0.08 above the same period last year. The drivers of this change are detailed on Slide 5.

As Terry mentioned, we continued to add new meters. The addition of over 10,400 average active customer meters improved operating earnings by $0.01 per share. Changes in natural gas consumption patterns this spring added $0.02 to earnings. And a lower effective tax rate and other miscellaneous items increased earnings by $0.07 per share.

Offsetting these items, higher depreciation expense due to increased investment in utility plant reduced earnings by $0.01 per share. Also operating earnings were lower by $0.01 per share due to reduced revenues related to the recovery of gas inventory carrying costs, driven by lower average cost of gas and inventory.

Turning to the Retail Energy Marketing segment. Second quarter 2013 non-GAAP operating earnings were $0.22 per share, up $0.12 per share from the year earlier. The primary drivers of the increase are detailed on Slide 6, and they were higher natural gas and electric gross margins.

In the natural gas business, unit margins and sales volumes were higher. The increase in natural gas sales margins for the quarter was primary attributable to a more favorable pattern of margin recognition in the current quarter due to higher levels of storage withdrawals at favorable spreads. In addition, gas margins increased due to higher retail sales volumes resulting from colder weather and higher margins on portfolio optimization activities. Natural gas sales volumes increased 28% in the second quarter versus the same quarter last year, primarily due to colder weather in March.

Partially offsetting these favorable impacts was a decrease in customer accounts. The retail energy marketing business served 8,000 fewer natural gas customers compared to the first quarter of fiscal year 2012, a 4% decrease with the account losses primarily among residential customers.

In the Electric business, unit margins and sales volumes were also higher. Higher electric unit margins were primarily due to favorable price conditions and a more favorable pattern of margin recognition in the current quarter versus the same quarter of the prior year. Note, however, that we do not or we do expect margin recognition patterns to be less favorable in the second half of the year.

Electric volumes increased 5% in the second quarter versus the same quarter last year driven primarily by colder weather in March. Partially offsetting this favorable impact was a decrease in customer accounts. At the end of the second quarter, the Retail Energy Marketing business served 183,000 electric accounts compared to 197,000 a year earlier representing a 7% decrease. As in our Gas business, the account losses were primarily among residential customers.

As we've discussed in the past, the pattern of quarterly margin recognition varies from year-to-year for both gas and electricity, and it is important to consider annual margins in evaluating the performance of the business. Operating expenses declined due to lower customer acquisition expenses in the current quarter compared to the same quarter of the prior year. I'd also like to note a significant development related to our Retail business that occurred during the second quarter.

As we discussed in our Analyst Conference in February, Washington Gas Energy Services entered into a 5-year secured supply arrangement with Shell Energy North America. Under this arrangement, Washington Gas Energy Services will have the ability to purchase the majority of its power, natural gas and related products through Shell Energy in a structure that reduces cash flow volatility from collateral posting requirements. This innovative arrangement will allow the business to grow while reducing capital reserve to cover contingent collateral needs. Washington Gas Energy Services began to utilize this supply agreement in early April.

Next I'll move to the Commercial Energy Systems segment. For the second quarter, Commercial Energy business -- Systems business had earnings of $0.01 per share, unchanged compared to last year. Earnings in this segment were driven by higher revenues from commercial solar projects and high returns on investments from alternative energy assets, partially offset by less project work for government and federal customers.

The Commercial Energy Systems segment continues to add new solar energy projects to its portfolio. As of March 31, we have over 15.5 megawatt hours installed solar capacity. During the second quarter, Washington Gas Energy Systems was awarded an additional project totaling $11.6 million in capital investment and representing nearly 4 megawatts of incremental solar capacity.

When this new project and other projects currently underway are complete, we will have 34 megawatts of installed capacity, representing $116 million in capital investment and a robust pipeline of future projects. During the second quarter, our commercial solar assets generated 4,411 megawatt hours of clean solar electricity.

Our alternative energy investments such as American Solar Direct, Skyline Innovations and Echo are also reported within the Commercial Energy Systems. These investments now represent $49 million in capital investment since inception.

Finally, I'll move to the Wholesale Energy Solutions segment. After adjustments to reflect storage inventory valued at current market prices, the Wholesale Energy Solutions business had a non-GAAP operating loss of $0.04 compared to a loss of $0.02 per share for the same period for the prior year. The decrease reflects compressed transportation and storage spreads.

Finally, I'll provide fiscal year 2013 earnings guidance where we are increasing our consolidated non-GAAP operating earnings estimate. As shown on Slide 8, we are forecasting non-GAAP earnings in a range of $2.42 to $2.54 per share. We now expect earnings to in the Utilities segment to be between $1.79 and $1.85 per share for the year, an increase of $0.09 from prior guidance.

Our increased expectations for this segment primarily reflect higher asset optimization, revenue and lower operations and maintenance expense. We expect operating earnings for the non-utility businesses for fiscal year 2013 to be between $0.63 and $0.69 per share for the year, a decrease of $0.04 from prior guidance. This change is largely driven by the impact of transportation and storage spreads on the earnings of our Wholesale Energy Solutions business, partially offset by higher earnings from our Retail Energy Marketing business.

I will now turn the call over to Adrian for his comments.

Adrian P. Chapman

Thank you, Vince, and good morning, everyone. I'm pleased to provide you with an update on our utility operations and regulatory initiatives, and I will start with our rate cases. In the District of Columbia, you may recall that in November 2011, the Public Service Commission initiated an investigation into the reasonableness of our rates.

In February 2012, we filed an application to increase our rates by approximately $29 million, of which $26.5 million relates to current and previously deferred pension and OPEB costs. We now expect a decision in this case in early May.

Turning to Maryland, on April 26, we filed an application with the Public Service Commission to increase our rates. We requested in this filing an increase in annual revenue of $30.7 million, based on a proposed return on equity of 10.7%, which represents approximately $7 million of the increase. This case will also provide us with the return of and on the first year of our investment in our accelerated pipe replacement program in Maryland, net of depreciation, under a plan authorized in our 2011 rate case. We've also included a request for the recovery of expenses consistent with our pending requests for reconsideration associated with amounts not approved by the commission in that same 2011 rate case.

This case was filed using a partially forecasted test period, which will be reconciled with actual results during the proceeding to minimize regulatory lag. The successful conclusion of this case in Maryland, which represents over 40% of the customer base of our regulated utility, will realign revenues with our expenses and investments.

We expect that the new rates resulting from this case will be effective in November 2013. I'm also pleased to report that the 2013 Maryland General Assembly approved the STRIDE legislation that will put in place the process for revenue recovery associated with additional infrastructure investments through a surcharge. The bill currently awaits the governor's signature and we expect that, that will happen this afternoon. The bill will be effective on June 1, 2013.

Turning to Virginia, in December, Washington Gas filed an application to amend its conservation and rate-making efficiency plan or care plan. On April 2, the commission issued an order approving an amended care plan effective for a 3-year period beginning on May 1, 2013, and applicable to both residential and small commercial and industrial customer classes. We now have full decoupling in place for virtually all our customers in Virginia. The impact of this order is an expansion of conservation programs available to our customers in Virginia and an increase in revenues associated with any ongoing nonresidential customer conservation in Virginia since the 2010 rate case.

Finally, I will now provide an update on the status of our proposed LNG storage facility in Chillum, Maryland. You may recall that in 2011, we pushed back the plant in-service date until the 2019, 2020 heating season, outside of our 5-year planning horizon, due to ongoing legal proceedings related to the proposed facility.

On March 25, 2013, the U.S. District Court of Appeals for the Fourth Circuit upheld the lower court's previous denial of our motion for summary judgment. As a result of this decision, we have decided to not proceed with any additional legal challenges related to the Chillum facility, and we have no plans to build the facility at this time.

As stated previously, we have always planned for alternative sources of supply to meet our customers' peak day requirements. These plans include capital expenditures related to infrastructure improvements. Please note that costs associated with the planning for the Chillum facility are included in the Maryland rate case filed last week.

I would like to now turn the call back to Terry for his closing comments.

Terry D. McCallister

Thanks, Adrian. I am encouraged by our business performance so far this year. We continue the sound day-to-day operation of our businesses and have maintained our focus on safety, customer service and reliability. We've also continued the steady execution of our longer-term plans, as we explore new business opportunities and add to our solar portfolio. As Adrian outlined, our regulatory initiatives are designed to deliver earnings increases for our shareholders. I look forward to giving you further updates as the year progresses.

I would now like to highlight a few other developments that occurred during the second quarter. I am pleased and excited to welcome a new member to the WGL Holdings Board of Directors, Linda Gooden, the appointment was effective April 1. The experience, knowledge and leadership that Ms. Gooden brings to the board will make us that much better as we pursue our vision. I would encourage any of you on the webcast who would like to learn more about the background of Ms. Gooden to review the press release posted our website.

As mentioned earlier, we continue to add to our portfolio of solar assets. In April, Washington Gas Energy Systems under contract with the town of Bellingham, Massachusetts, to build, own and operate a 3.8-megawatt solar array. Washington Gas Energy Systems will own and operate the $11.6 million project under a 20-year purchase power agreement. Bellingham's schools will save nearly $6 million in energy costs over the 20-year life of the project. Construction has begun on this solar facility with commercial operations expected to commence in June.

In April, we also signed an agreement to build our first commercial solar project in California. This will be our first commercial solar project where the economics of the project do not rely on state incentives. $3.2 million project is located near Bakersfield, California and is expected to be in service by December.

This concludes our prepared remarks. We will now be happy to answer your questions. We also look forward to seeing many of you at the AGA financial forum next week.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Mark Barnett with Morningstar.

Mark Barnett - Morningstar Inc., Research Division

Two quick regulatory items. I heard you say that there's some Chillum expenses in the Maryland filing. Is there some risks that, that will be a controversial item given your decision not to continue? Or maybe some detail on that?

Adrian P. Chapman

This is Adrian. We don't expect that to be controversial. We've been very transparent in our filings with the commission as we've gone through this process. They understood that this was an appropriate plant to pursue at the time, and they've been very aware of how we've addressed this. So I think, at least from a commission history perspective, if there's going to be any question, it's really whether such expenditures would earn a return on the investment. I don't think there's any question about getting a return of those expenditures.

Mark Barnett - Morningstar Inc., Research Division

Okay. And then given the signing of that STRIDE law that you expect today, what's the process, since you just filed this month, what's the process for incorporating that mechanism into your rates?

Adrian P. Chapman

We will most likely have to update the plan that we did get authorized in our prior case, that was a 5-year plan. We will update that plan and extend it out, so that it will now include the next 5 years. We'll update the expenditures that we anticipate to include in that plan, and we'll include the explicit request for a surcharge. And in coordination with the amounts that we've included in this rate case, we should have an ability to collect the first year of our expenditure in the plan through the rate case and then the ongoing expenditures through that surcharge. So the plan will look similar to what we had authorized and was very well received by the commission's engineering staff and the commission. And we certainly expect the surcharge to fit under the parameters of the legislation. And so we think that should provide for a reasonably streamlined approval process and an uninterrupted importunity for us to both make the investment, upgrade our facilities and be able to collect on the investment that we've made.

Operator

[Operator Instructions] Your next question comes from the line of Spencer Joyce with Hilliard Lyons.

Spencer E. Joyce - Hilliard Lyons, Research Division

Just one quick item here. You guys gave a pretty good breakout about what drove the changes in the guidance on Slides 10 and 12. I'm just wondering, is any of those or are any of those weather-related? Or is all that's really sort of tied to either underlying strengths in the business or maybe just good execution on your guys’ part?

Vincent L. Ammann

I'll speak to the utility changes first on Slide 10. Spencer, this is Vince. The asset optimization revenues that are exceeding our plan, sort of due to weather, that's primarily due to some opportunities to make some off-system sales to power generation that was driven by colder unexpected weather and the gas prices being where they were able to dispatch the plant. So I guess it's indirectly related to weather. The operations and maintenance expenses is -- that's an improvement. Majority of that $0.05 is a reduction in our expected uncollectibles expense. So that's not weather-related other than I guess the colder weather, we probably will be recording a slightly higher expense. So it would have been -- probably been greater if we've had the warm weather we had last year, but it's certainly more driven by the cost of gas and improving economics of the economy than it is anything else. So that's a little more flavor on the change in guidance on the regulated side. On the nonregulated side, I'm speaking to Slide 12 now. I'll speak to the wholesale energy solutions, reduction of $0.06, and then I'll ask Terry to talk about the retail energy marketing changes, but on wholesale energy solutions business, we did take guidance down $0.06. Most of that is related to when the degree days for the year occurred. While we had some colder weather in March and we had some improving conditions, that business tends to do much better when the cold weather occurs early in the season, early in the heating season, and we did not have much of that this year. And so as a consequence, the storage spreads were pretty narrow and didn't allow us an opportunity to make the kind of money we typically would expect to make in an average year on that business. So I think that's probably the majority of the weather impacts on wholesale energy solutions. So Terry, do you want to talk a bit about retail?

Harry A. Warren

Sure, Vince. On the retail side, generally, I would say there's not a lot out of sensitivity to weather. As we talk about pretty consistently, our hedging strategy really looks to protect us on the upside and the downside against weather in both directions. And actually with this year coming out on a seasonal basis, pretty close to normal weather over the course of the winter. We didn't see any big excursions. A little bit of the natural gas gross margin uptick was kind of as been said, there's a little bit of maybe ancillary improvement there. We had a little bit of what we call asset optimization there, where during some particular short periods of unusually cold or warm weather, we can move some gas supplies around between delivery points and get a little bit of extra margin there. When March came in very cold, as a very cold month, we wound up taking a little bit more gas out of storage than we would have by the -- typically over the course of winter, since that cold weather piled up at the end. And there were some bigger margin spreads on the storage withdrawals. But by and large, I would say, kind of as Vince, I think, indicated on utility side, it's more around the edges, our weather sensitivity, we've gotten that down pretty well.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Yes, that's fantastic color. So it sounds like maybe a little weather upside on a couple of small pieces but even that was potentially offset by wholesale. So it sounds like a pretty clean race to me. That's actually the only question I have. Looking forward to catching up with you guys at AGA.

Operator

And your next question comes from the line of Mark Barnett with Morningstar.

Mark Barnett - Morningstar Inc., Research Division

I just had one more quick follow-up. On the O&M out-performance that you have versus the plan, how much of that would you say is kind of an ongoing thing beyond this year?

Vincent L. Ammann

Mark, I guess it depends on the economy. But I would say to the extent that we were able to lower O&M expenses, we did not make a adjustment to our reserve for collectibles. We just -- we reduced the ongoing accrual rate. So we're going to be accruing less on an ongoing basis, that's what that reflects. So I would say, right now, it's pretty much a reflection of where we think the ongoing level of O&M expenses would need to be, in order to recover our appropriate amount for bad debt expense. So that would be about $0.04 of the $0.05. And then the rest is just some miscellaneous savings that we had in labor and unit cost, so it's not that significant. So it's probably on the order of magnitude of what we would expect to be able to continue on as it relates to those specific items.

Operator

Again, I would like to remind everyone that you can listen to the rebroadcast of today's call running through May 9, 2013. You may access the replay by dialing 1 (855) 859-2056 and entering pin number, 52734968.

Next, there are no further questions, I will turn the call back to Mr. Bonawitz for any additional or closing remarks.

Douglas Bonawitz

Thank you, everyone, for joining us this morning. If you do have any further questions, please don't hesitate to call me at (202) 624-6129. Thanks and have a great day.

Operator

This concludes our conference call for today. Thank you for participating. All parties may disconnect now.

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