WGL Holdings Management Discusses Q3 2013 Results - Earnings Call Transcript

Aug. 8.13 | About: WGL Holdings, (WGL)

WGL Holdings (NYSE:WGL)

Q3 2013 Earnings Call

August 08, 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

Gautam Chandra - Vice President of Strategy, Business Development & Non-Utility Operations

Harry A. Warren - President

Analysts

Mark Barnett - Morningstar Inc., Research Division

James A. Bardowski - Sidoti & Company, LLC

Operator

Good morning and welcome to WGL Holdings Inc.'s Third 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 will open the conference call for questions and answers after the presentation. The call will be available for rebroadcast today at 1 p.m. Eastern Time, running through August 15, 2013. You may access the replay by dialing 1 (855) 859-2056 and entering pin number 26038190. 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 third quarter of fiscal year 2013 and the drivers of those results. A reconciliation of our operating earnings with results reported in accordance with Generally Accepted Accounting Principles is provided as an attachment to our press release, and that 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 third 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 third 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 also 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 third quarter results. I am pleased to be able to report to you that while market dynamics and timing created challenges in a couple of our businesses, the WGL family of companies is still on track to deliver strong results in fiscal year 2013. We have affirmed our earnings outlook for the year, as Vince will discuss in a few minutes.

If you look at Slide 3 of our presentation, you'll see that our non-GAAP operating earnings for the third quarter show a loss of $1.6 million or $0.30 per share compared to operating earnings of $4 million or $0.08 per share in the third quarter of 2012. As most of you know, our utility business results are seasonal in nature and most of our earnings are recorded in the first and second quarter of the fiscal year. On a non-GAAP basis, consolidated operating earnings for the first 9 months were $148 million or $2.86 per share. This compares to $143.4 million in the prior year or $2.78 per share.

Non-GAAP operating earnings for the regulated utility segment were higher this quarter compared to the prior year, shown in Slide 3. Our utility customer base continue to grow, as average active customer meters increased by over 11,000 meters year-over-year. While our region have seen some impact from the federal sequestration, improving job growth continues to support a strengthening housing market. Recent report from the labor department indicated that Washington Metropolitan Area added over 44,000 jobs between June of 2012 and June of this year. On the regulatory front, a decision on our District of Columbia rate case was issued in May and we started seeing the impact of new rates in early June. Our rate case in Maryland is progressing on schedule and hearings begin next week. Adrian will talk more about these developments shortly.

We also continued to expand our non-utility businesses. Our commercial energy systems business added new solar projects to its portfolio, and we now have solar facilities in operations under contract in 13 states, with the addition of California, Connecticut, Hawaii and Georgia in recent months. By the end of the calendar year, we will have over 50 megawatts of commercial solar generation operational in our renewable portfolio.

On the residential side, our partnerships now have over 2,200 rooftop systems in service producing nearly 10 megawatts of clean solar power. In May, we also announced that we committed to a $68 million investment in the Constitution Pipeline through our subsidiary Capital Energy Ventures. Our involvement in the Constitutional Pipeline demonstrates continued execution of our strategy to grow our portfolio of infrastructure assets. I'll discuss the status of this project in more detail later in the call, as well as 2 recent awards that highlighted the success of Washington Gas Energy Services in the areas of customer service and sustainability. I'm now going to turn the call over to Vince who will review our third quarter results by segment, as well as our guidance for 2013.

Vincent L. Ammann

Thank you, Terry. I'd first like to mention the reconciliations of our GAAP net income to non-GAAP operating earnings can be found in the earnings release that's available on our website. As is our standard practice, I'll be referencing non-GAAP operating earnings in my comments. Turning first to our utilities, the segment had an operating loss of $0.06 per share for the third quarter of fiscal 2013, an improvement of $0.02 per share compared to last year. The drivers of this change are detailed on Slide 5. As Terry mentioned, we continue to add new meters. The addition of over 11,000 average active customer meters improved operating earnings by $0.01 per share. Operatings were higher by $0.02 per share due to higher realized margins from our utility asset optimization program. Revenues from our accelerated pipe replacement programs added $0.01 earnings, and other miscellaneous items increased earnings by $0.03 per share.

Offsetting these items, higher operations and maintenance expense reduced earnings by $0.05 per share. These expenses included increased employee pension and post-retirement benefit, medical benefit cost due to changes in plan asset values and valuation assumptions.

Turning to the retail energy-marketing segment, third quarter 2013 non-GAAP operating earnings were $0.12 per share, down $0.05 per share from the year earlier. The primary driver of the decrease, as detailed on Slide 6, was lower electric gross margins. Lower gross margins were due to lower unit margins as we experienced higher PJM costs for load balancing and higher capacity charges that took effect June 1. The changes in capacity charges affect the timing of margin recognition between 2013 and the following years.

In the natural gas business, gross margins were virtually unchanged. Unit margins were slightly lower, offset by slightly higher sales volumes. 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's important to consider annual margins in evaluating the performance of the business.

Operating expenses were slightly higher in the current quarter. Higher customer acquisitions and benefit expenses were partially offset by a decline in bad debt and related purchase of receivable costs. At the end of the third quarter, the retail energy-marketing business served 178,200 electric accounts compared to 202,200 a year earlier, and 168,600 gas accounts compared to 180,900 a year earlier.

While we have experienced a decline in a number of electric accounts served this fiscal year, large commercial electric load adding in Pennsylvania has offset other volume losses. In July, we saw a net growth in the number of residential electric customers for the first time this fiscal year as accelerating sales efforts more than compensated for attrition. Residential attrition continues at higher-than-historical rates, however, and our sales efforts are focused on acquiring customers with the potential for higher retention rates.

The decline in the number of natural gas accounts has followed a similar pattern, with gains in large commercial sales volumes nearly offsetting volume losses among smaller customers, with the exception of a 1 Bcf loss in federal government business this year. Attrition rates among residential gas customers are much lower than among electric customers, but lagging sales have resulted in net customer losses.

Next, I'll move to the commercial energy systems segment. For the third quarter, the commercial energy systems business had earnings of $300,000 compared to $700,000 or $0.01 per share for the same quarter last year. Earnings in this segment were lower compared to the prior year due to lower income from government agency customers and the timing of revenue recognized from the sale of renewable energy credits, partially offset by higher revenue from commercial solar projects. The timing of revenue recognition related to renewable energy credits will have a corresponding positive impact in the fourth quarter.

While earnings were lower this quarter compared to last year due to the timing issue, please note that for the 9 months ended June 30, the commercial energy systems segment has reported higher earnings of $0.04 per share compared to $0.03 per share for the same period for the prior fiscal year. The segment continues to add new solar energy projects to its portfolio. As of June 30, we have 19 megawatts of installed solar capacity.

During the third quarter, Washington Gas Energy Systems was awarded additional projects totaling 8 megawatts of incremental solar capacity. As mentioned, by the end of the calendar year, we expect to have over 50 megawatts of installed solar capacity. These projects will represent $160 million in capital investment, and we continue to see a robust pipeline of future projects.

During the third quarter, our commercial solar assets generated 6,500-megawatt hours of clean solar electricity. Our alternative energy investments such as American Solar Direct, Skyline Innovations and Echo are also reported within commercial energy systems. These investments now represent $67 million in capital investments since inception.

Finally, I'll move to wholesale energy solutions segment. After adjusting -- after adjustments to reflect solar storage inventory valued at current market prices, the wholesale energy solutions business had a non-GAAP operating loss of $0.06 per share compared to a loss of $0.01 per share for the same period of the prior year. The decrease represents compressed transportation and storage spreads, consulting fees related to our investing in the Constitution Pipeline, and higher operations and maintenance expense as a result of these storage arrangements.

Finally, turning to our 2013 non-GAAP earnings guidance, we are affirming our consolidated guidance in the range of $2.42 to $2.54 per share. While we are encouraged by the operating performance of our utility, primarily due to lower operations and maintenance expense, we have lowered our expectations on the nonutility side, principally due to challenges experienced this year in our wholesale energy solutions business. I'll 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 regulatory initiatives and I'll start with our rate cases. In the District of Columbia, on May 15, the Public Service Commission issued an order in our base rate case authorizing an annual revenue increase of $8.4 million compared to our original request of $29 million with a rate of return on common equity of 9.25%. The commission deferred its decision on our request to implement the initial 5-year phase of an accelerated pipe replacement program and surcharge, pending Washington Gas' filing of a report providing additional information on pipeline replacement risk assessment methods and priorities. The report will be filed on August 15th, after which time the commission will rule on our request. The order allowed Washington Gas to continue the surcharge cost recovery for the replacement of mechanical couplings pursuant to a prior order.

On June 14, Washington Gas sought a reconsideration of various rulings in the May decision, including those related to depreciation, return on equity, pension and other post-employment benefits and a repression adjustment. A decision on those requests was issued on July 31, with the PSC denying our request for reconsideration on several issues but confirming that Washington Gas is entitled to recover the pension and other post-employment benefits, track or balances, from December 1, 2012, through June 4, 2013. And clarifying that Washington Gas may seek recovery of these deferred tracker balances in the company's next base rate case.

While we are disappointed that the commission did not support some of our positions in this proceeding, we view the results of this case as supportive of the 5-year plan we presented in February. The commission's decision to modify our approach to normalizing our test year throughput, is in line with similar changes in other jurisdictions. This throughput is the basis for the rates that we will bill our customers to recover our newly authorized revenue requirement. As a result, beginning June 4, 2013, we have the opportunity to collect an additional $12 million in annual revenues versus the rates approved in our last base rate proceeding, including the nominal $8.4 million increase.

We would also note that the commission approved the full recovery of previously deferred pension and postretirement benefit cost. These costs will be recovered over a period of 5 years, as opposed to our original proposal of 3 years. But we will continue to earn a return on the deferred balances during the period of recovery.

Turning to Maryland, you may recall that in April, Washington Gas filed a request with the PSC of Maryland for a $30.7 million annual increase in revenues. The application, partially based on forecasted expenditures, also included the proposed overall rate of return of 8.7% and a return on common equity of 10.7%. On May 31, Washington Gas revised the requested increase in revenues to $28.3 million based on actual test year expenses through March 31. Evidentiary hearings are scheduled to begin on August 16, and we continue to expect that the new rates resulting from this case will be effective in November 2013.

It is important to note that the Maryland case is designed to provide us with a 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. The STRIDE law is now in effect as of June 1. And we expect that our first STRIDE filing under the new law to begin revenue recovery associated with infrastructure investments through a surcharge will occur later this year. We plan to fully recover, either in base rates in the current rate case, or in the surcharge, all accelerated replacement investment in Maryland. I would like to now turn the call back to Terry for his closing comments.

Terry D. McCallister

Thank you, Adrian. I would like to highlight a few other developments that occurred during the third quarter. As I mentioned earlier, our subsidiary, Capital Energy Ventures, announced in late May an equity investment in the Constitution Pipeline. Fully subscribed natural gas pipeline will transport gas from the Marcellus region in Pennsylvania to major North Eastern markets. CEV joins William Partners, Cabot Oil and Gas and Piedmont Natural Gas in the project, and will invest an estimated $68 million. CEV will hold a 10% share in the project. An affiliate of Williams will construct, operate and maintain the 30-inch, 122-mile long pipeline. In June, Constitution Pipeline filed a formal certificate application with the FERC seeking approval to construct the pipeline by spring 2015. FERC approval is expected by February 2014.

When the Constitution Pipeline is operational, we expect that our investment in the project will contribute $0.04 to $0.06 in annual earnings per share going forward.

As I mentioned earlier, we also continue to add to our portfolio of solar investments. Washington Gas Energy Systems recently signed a contract to build our first commercial solar project in Connecticut. Washington Gas Energy Systems will build, own and operate an 818-kilowatt solar array for a large retail facility. These projects will take advantage of State of Connecticut local utility incentives, known as DREC, to pay a fixed renewable credit rate for a period of 15 years. We also signed agreements recently to build our first commercial solar project in Georgia. Washington Gas Energy Systems will own and operate these projects under a 20-year purchase power agreement with a local utility. These projects will total 8 megawatts and are expected to be in service by December. Georgia does not use renewable energy credits as an incentive, and these projects do not rely on SREC to meet our objectives for financial returns.

In July, our retail energy-marketing subsidiary, Washington Gas Energy Services, received recognition on 2 occasions and highlight our ongoing commitment to customer service and sustainability. The J.D. Power Retail Electric Providers Satisfaction Study ranked Washington Gas Energy Services second in customer satisfaction among Maryland competitive electric suppliers. Results also indicated that Maryland customers were among the most satisfied with their electric suppliers across the 8 states included in the study. We are proud of the customer satisfaction ranking we received, and we will use this information of the study to continue to identify opportunities to increase satisfaction among all of our customers. The District of Columbia recognized Washington Gas Energy Services with the 2013 Mayor's Sustainability award. The award is recognition for efforts to help build a more sustainable future for the District of Columbia. Washington Gas Energy Services is one of the largest green energy suppliers in the district with their CleanSteps Windpower and CleanSteps Carbon Offset programs.

I wanted to also note that the secured supply arrangement that our retail business entered into with Shell Energy North America is working as planned. During the third quarter, Washington Gas Energy Services began to purchase power, natural gas and related products through Shell Energy and has structured design to renew to cash flow volatility from collateral posting requirements. Because of the Shell arrangement, Washington Gas Energy Services have been able to reduce its reliance on corporate guarantees by nearly $200 million compared to June of last year.

At the utility, we continue to focus this quarter on updating our utility plants to provide safe and reliable services to our customers through our accelerated pipeline replacement programs. We're on track to spend $75 million on this accelerated replacement in fiscal year 2013. As Adrian mentioned, we will recover these important investments through either base rate cases or surcharges in all 3 of our service territory. These investments also help reduce commission from our delivery system, in line with our previously announced goal with 70% reduction in greenhouse gas emissions from our fleet facility operations by 2020.

We are pleased with our progress against our 5-year plan. As is usual for us, we will give you 2014 guidance during our year-end conference call in November. This concludes our prepared remarks, and we will now be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Mark Barnett, Morningstar Equity.

Mark Barnett - Morningstar Inc., Research Division

Just a quick question from me. When you look at the Constitution Pipeline, obviously, it could be a really nice project for you. But in terms of the size of sort of an infrastructure business and in terms of the balance with the rest of your businesses, is that -- if this thing does end getting built, is that kind of the right size for you, or are you going to be looking for any incremental opportunities. I mean is that kind of a priority still to be looking for those infrastructure returns?

Terry D. McCallister

Mark, this is Terry. I think we made it known out there that we will continue to look for projects like this. 10% interest obviously isn't going to be overwhelming for us and our financial, but if you'll recall at some point, maybe a year or so, we were talking about the Commonwealth Pipeline and roughly $1 billion pipeline and that's made of 1/3 interest dollar in it. So I think we would look at opportunities for larger investments in the pipelines that makes sense for us and meet our criteria. They clearly meet our desire to continue to expand our investment in infrastructure that throw off utility and utility-like returns.

Operator

Your next question comes of the line of James Bardowski of Sidoti.

James A. Bardowski - Sidoti & Company, LLC

Just have a few, which I will make them brief questions. I guess under the commercial segment, it cited that a decline in net earnings results from lower government spending and the timing of recognized renewable credits. With -- assuming no timing, what would the pro forma EPS have been? I'm just trying to get a feel, if you don't mind, shining a little light on how much incremental revenue these renewable credits contribute?

Vincent L. Ammann

Yes, this is Vince. I'll take that. When we try to provide some insight into the fact that this timing difference that we're seeing will probably come back in the fourth quarter. And this really just relates to actually building for the renewable energy credits to the counterparty and completing that building process by the end of the month. So this is -- will essentially, for that purpose, be doubling up on those cells of credits in the fourth quarter. So the best guidance I can give you there is that we're pretty much on plan in this segment. We really don't have any shortfall of either opportunities or deployment of the cash. So plus or minus, we'll really pretty close to the initial guidance we gave you on this, we don't see any real issues in this segment.

Gautam Chandra

This is Gautam Chandra. Just point you back to some guidance that I gave you in our Analyst Call this year, which is for the commercial solar projects, inclusive of the power purchase agreement and the recs for each 6,000-megawatt hours of generation, we add about $0.01 of EPS. So that's still good guidance for looking at this segment.

James A. Bardowski - Sidoti & Company, LLC

Okay, great. That's really helpful. I guess, the next question relates to the net insurance proceeds. I probably overlooked this, but if you don't mind giving a little clarification on what they relate to in regulating utilities?

Terry D. McCallister

You're talking about the items that we've - is part of our non-GAAP adjustment to net favorable? This is just a new item. We've had proceeds proceed from insurance care relative to our environmental exposures. So these would've been expenses accrued in prior years that we're now offsetting, so that's essentially the bulk of that item, James. Since it's a one-time item, we have non-GAAP that I haven't taken credit for that earnings on a non-GAAP -- on a going-forward basis.

James A. Bardowski - Sidoti & Company, LLC

Okay, excellent. Now switching over to the retail segment a bit. Obviously, our customer counts were down roughly 7% on the electric supply side. Did I hear you correct earlier, did you mention that it actually grew in Pennsylvania but some other markets were causing the offset decline?

Harry A. Warren

This is Harry Warren. I'll field that. So I think what Vince pointed out in his comment there was that clearly, we've been seeing some loss of overall customer accounts and you're right, that's coming in the residential markets, in particular. And that's been offset, however, over this fiscal year by actually some gains among commercial customers in terms of adding load in that area, and that has come in Pennsylvania, which is a new territory for us. I think the building on Vince's comments a little bit that he made a few minutes ago, it sort of gives us an opportunity even though the customer losses aren't good news, gives us opportunity to talk about the fact that by selling both electricity and natural gas to residential all the way up through larger commercial customers in a number of jurisdictions, we sort of have this opportunity to offset losses in one area with some opportunities in another area. So across our business right now, we've seen the residential markets as a little more challenging and that's causing some net loss is in customers there. But we've been able to offset a fair bit of that with commercial low growth in some other areas.

James A. Bardowski - Sidoti & Company, LLC

Okay, excellent. And I guess one more final question. It relates to the recent guidance of about $0.04 to $0.06 in incremental EPS that we can expect from the Constitution Pipeline. What kind of utilization are you guys modeling for? And more importantly, what kind of pricing spreads are expected?

Terry D. McCallister

James, you kind of broke up there at the end. You said what kind of what?

James A. Bardowski - Sidoti & Company, LLC

So for the Constitution Pipeline, I don't have it in front of me. I forget the max capacity, but of course, 10% will belong to you. Out of that 10%, given a certain utilization rates, how much, as far as pricing spreads, are you guys modeling for, and yielding the $0.04 to $0.06 guidance?

Vincent L. Ammann

James, what we're modeling for that investment is that there will be the pipeline, which is already fully subscribed, will be received for cost of service rates. So we're not -- we're not having to make a whole lot of assumptions that authority fully subscribed related to the revenue. Does that help? This would be typically a [indiscernible] rate, a straight fixed variable rate design, so you'll be recovering your fixed cost through your demand charges.

Operator

[Operator Instructions] 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 further questions, please don't hesitate to call me at (202) 624-6129. Thanks again and have a good day.

Operator

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

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