WGL Holdings, Inc. (NYSE:WGL)
Q1 2016 Earnings Conference Call
February 08, 2016, 10:30 ET
Doug Bonawitz - IR
Terry McCallister - Chairman & CEO
Vince Ammann - SVP & CFO
Adrian Chapman - President & COO
Gautam Chandra - SVP, Strategy, Business Development & Non-Utility Operations
Sarah Akers - Wells Fargo Securities
Welcome to the WGL Holdings Incorporated First Quarter Fiscal Year 2016 Earnings Conference Call. [Operator Instructions]. I will now turn the conference over to Doug Bonawitz. Please go ahead.
Good morning, everyone and thank you for joining our call. Before we begin, I would like to point out that this conference call will include forward looking statements under the federal securities laws. Forward-looking statements inherently involve risks and uncertainties that could cause our actual results to differ materially from those projected in such forward-looking statements.
The statements made on this conference call should be considered together with cautionary statements and other information contained in our most recent annual report on Form 10-K and other documents we have filed with or furnished to the SEC. Forward-looking statements speak only as of today and we assume no duty to update them.
This morning's comments will reference the slide presentation. Our earnings release and earnings presentation are available on our website. To access these materials, please visit Wglholdings.com. The slide presentation highlights results for our first quarter of fiscal year 2016 and the drivers of those results.
On today's call, we will make reference to certain non-GAAP financial measures including operating earnings of WGL Holdings on a consolidated basis and adjusted EBIT of our operating segments. A reconciliation of these financial measures to the nearest comparable measures reported in accordance with generally accepted accounting principles or GAAP, 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. Following that, Vance Ammann, Senior Vice President and Chief Financial Officer, will review the first quarter results. Adrian Chapman, President and Chief Operating Officer, will discuss key issues affecting our business and the status of some of our principal initiatives. In addition, Gautam Chandra, Senior Vice President of Strategy, Business Development and Nonutility Operations, is also with us this morning to answer questions.
And with that, I would like to turn the call over to Terry McCallister.
Thanks, Doug. Good morning, everyone. Our first quarter results have given us a strong start to fiscal year 2016. Our non-GAAP operating earnings for the first quarter, as shown on slide 3 in our presentation, were $59.2 million or $1.18 per share, compared to $58 million or $1.16 per share, in the first quarter of 2015.
As a utility, earnings were lower year over year primarily due to higher operations in maintenance expenses and fewer asset optimization opportunities. Utility results did continue to benefit from strong customer growth and rate recovery related to our accelerated pipeline replacement program. We added approximately 12,500 average active utility customer meters year over year which represents an annual growth rate of 1.1%.
Commercial energy systems business delivered improved results. We continue to see earnings growth driven by the distributed generation assets that we own across the country as well as more activity locally in our energy efficient e-contracting business. We invested an additional $24 million in commercial solar assets during the quarter as part of our plan to spend $200 million in total on the distributed generation investment this year.
Midstream energy services business delivered significantly higher results compared to the first quarter of 2015, capitalizing on storage optimization opportunities while continuing to invest in the three pipeline projects under development.
Finally, our retail energy marketing business performed largely as expected, with electric margin somewhat lower than the first quarter of last year and natural gas margins slightly higher than last year. We're pleased to see that the changes introduced by PJM over the past few years continues to afford a more stable yet competitive retail energy marketplace. We continue to drive towards return to long term historical levels of earnings in this business, with an increased focus on large commercial and government account relationships.
I remain confident in our ability to achieve our financial plans for 2015. Given our results for the first three months and our earnings outlook for the remainder of the year, we're affirming our consolidated non-GAAP earnings guidance in the range of $3 to $3.20 per share of fiscal year 2016, with an emphasis on the higher end of this range.
Finally, as noted in our earnings release, I am also pleased that the Board of Directors has approved a $0.10 increase in our dividend to an annual rate of $1.95 per share. This slightly higher than 5% increase reflects our confidence in our strategic plans and our commitment to provide sustainable dividend growth for investors. This is the 40th consecutive year that WGL Holdings has increased the dividend on its common stock.
I'm now going to turn the call over to Vince, who will review our first quarter results by segment.
Thank you, Terry. Turning first to our utility segment, adjusted EBIT for the first quarter of fiscal year 2016 was $86.6 million, a decrease of $10 million compared to the same period last year. The drivers of this change are detailed on slide 5. We continue to add new meters with the addition of 12,500 average active customer meters, improved adjusted EBIT by $1.4 million. Higher revenues from our accelerated pipe replacement programs also added $2.5 million in adjusted EBIT. Offsetting these items, lower margins associated with our asset optimization program reduced adjusted EBIT by $3.3 million.
Asset optimization revenues reached a new high last year; therefore, a decrease to more normal levels was expected. However, year to date, we have seen better-than-forecasted results. Reductions in certain natural gas consumption patterns in the District of Columbia decreased adjusted EBIT by $2.2 million.
Reduced revenues associated with the recovery of gas inventory carrying costs due to the lower gas prices decreasing the value of the storage gas balances reduced adjusted EBIT by $1.6 million. Finally, higher O&M expenses driven primarily by higher labor and employee incentive costs as well as system integrity expenses reduced adjusted EBIT by $4.2 million. Other miscellaneous items reduced adjusted EBIT by $2.6 million.
Turning to the retail energy marketing segment, adjusted EBIT for the first quarter of fiscal year 2016 was $5.2 million, a decrease of $2.8 million compared to the same period last year. On slide 6, you'll see the primary driver of the decrease was lower electric gross margins partially offset by higher natural gas margins. Electric margins decreased by $6 million, driven by higher capacity charges from the regional power grid operator, PJM, that impacted the timing of margin recognition. Electric margins also decreased due to the lower unit margins on large commercial sales. In the natural gas business, gross margins were $2.6 million higher, driven by favorable gas supply and pricing opportunities as well as higher price payments related to weather.
As stated previously, our retail energy marketing business has increased its focus on large commercial and government account relationships in both the electric and natural gas markets. As a result, the overall number of electric and natural gas accounts both declined this quarter 14% and 80%, respectively, for electric and gas compared to the prior year.
However, indicative of our revised focus, electric volumes increased 10% prior to the -- versus the prior year and natural gas volumes only decreased 6% versus the prior year despite much warmer weather. An increase in commercial load in both electric and natural gas continues to largely offset the decline in mass-market customers on a volumetric basis. Operating expenses in the first quarter were slightly higher than the prior year.
Next, I will move to the commercial energy systems segment. Adjusted EBIT for the first quarter of fiscal year 2016 was $2.2 million, an increase of $1 million compared to the same period last year. The increase reflects growth in distributed generation assets in service as well as improved margins in the federal contracting business and higher earnings in investment solar businesses. Please note the earnings for this segment are somewhat seasonal in nature, with only 20% of the megawatt hours typically generated in the first quarter. Additional distributed generation projects will also continue to enter service during the year upon completion. While our earnings are modest year to date, we're on track to meet the original adjusted EBIT forecast for this segment.
Turning the first quarter, our commercial distributed generation assets generated over 33,000 megawatt hours of electricity which is sold to customers through power purchase agreements. This represents an 88% increase in megawatt hours compared to the first quarter of last year.
As of December 31, commercial energy systems segment owned $420 million of operating distributed generation assets, while alternative energy investments which include AFV, Megastility [ph] and SunEdison, represent an additional $128 million in capital invested since inception. In total, we now have approximately $550 million invested in distributed generation assets.
Next, I will move to the midstream energy services segment. Adjusted EBIT for the first quarter of fiscal year 2016 was $13.1 million, an increase of $10.5 million over adjusted EBIT of $2.6 million for the same quarter of the prior fiscal year. The increase primarily reflects favorable storage spreads this quarter. These results reflect midstream's ability to capitalize on the storage optimization opportunities created by an abundance of natural gas supply. Our low-cost storage assets are now well-positioned to capitalize on either older or warmer winter scenarios. These assets also provide a natural hedge to business activities in other nonutility segments.
Results for our other nonutility activities reflect an adjusted EBIT loss of $800,000 compared to a loss of $1.5 million for the same period of the prior fiscal year. Interest expense primarily driven by long term debt increased to $12.8 million during the first quarter compared to $12.3 million in the prior period.
As Terry stated earlier, we're affirming our consolidated non-GAAP operating earnings guidance in the range of $3 to $3.20 per share, with a focus on the high end of the range. Our expectations for our regulated utility are essentially unchanged, with higher-than-expected O&M expenses to date offset by higher-than-expected cash and optimization revenues. On the nonutility side, we anticipate that excellent results at the midstream business will drive higher results overall for the full year.
Please note that this earnings guidance includes dilutions in the planned issuance of equity in fiscal year 2016.
I will now turn the call over to Adrian for his comments.
Thank you, Vince and good morning, everyone. I'm pleased to provide you with an update on our operations and regulatory initiatives. In the District of Columbia, the settlement that resulted in the surcharge mechanism to recover accelerated pipe replacement investments included a requirement for the filing of two rate cases, one no later than August 1, 2016 and the second no later than April 30, 2020.
Accordingly, we currently plan to file a rate case during the current fiscal quarter. As a reminder, our last rate case in the district was filed on February 2012, with rates effective in June 2013. As part of this new rate case filing, we will ask for approval of a revenue normalization adjustment or RNA. The District of Columbia is currently the only jurisdiction where we do have -- do not have revenue decoupling in place.
Public service commission in the District of Columbia has no time limitations in which it must make decisions regarding modifications to base rates. Commission targets resolving pending rate cases within three months of the close of the record in each case.
In Virginia, we plan to file a new rate case with the Virginia State Corporation Commission on or before July 31, 2016. The anticipated filing will allow us to rebalance our revenues, expenses and other utility investments in the state of Virginia. Virginia has a 150-day suspension period, therefore placing new rates into effect for the winter 2016/2017, subject to refund. As a reminder, our last rate case in Virginia was filed in January 2011, with rates effective in October 2011. Also in Virginia, Virginia law allows local distribution companies to recover a return of and return on investments in physical gas reserves that benefit customers by reducing costs, price volatility or supply risk.
Washington Gas entered into an agreement with a producer in May of last year to acquire natural gas reserves through non-operating working interest in 25 producing wells in Pennsylvania. On November 6, the SEC of Virginia issued an order denying our gas reserve application by asserting that, due to questions regarding issues such as certainty of volumes delivered and the reasonableness of pricing forecasts we use to establish benefits to customers, the application did not meet the public interest standard.
Under Virginia law, Washington Gas could have filed an amended plan within 60 days of the SEC's decision which in turn would require the SEC to review and approve or deny the amended plan within 60 days. As we disclosed in early January, we chose not to amend the plan. Given the complexities of the long term investment in gas reserves, the criteria for approval under the Virginia law and in consideration of the SEC's observations about our initial plan, we will revise our purchase plan accordingly and then file a new application.
This will have the benefit of providing all the parties with a longer period of time to evaluate a new natural gas reserves purchase plan and the significant benefits we believe it will provide to our customers in Virginia. Washington Gas plans to negotiate a new agreement with a producer, file a new application with the Virginia State Corporation Commission within the next several months.
Finally, a quick update on recent weather-related events. The Washington Gas system performed exceptionally well during the recent historic winter storm, one that had a particularly significant impact on the Washington, DC, region. We were well prepared, encountered no supply issues and continue to provide service to our customers consistent with our 99.7% goal. As always, Washington Gas personnel demonstrated enormous commitment throughout the storm, working through challenging conditions to ensure continuity of business operations to make repairs to promptly restore service in the very few cases where we had interruptions. I'm also pleased to say that we had no injuries or avoidable accidents during the storm, a testament to our strong safety culture.
I would like to now turn the call back to Terry for his closing comments.
Thanks, Adrian. I would now like to highlight a few recent developments to provide an update on the status of our midstream and distributed generation investments. First, an update on WGL Midstream's investment in the Constitution Pipeline project, while we continue to wait with our partners for a permit from the New York State Department of Environmental Conservation, the project received authorization from FERC in late January to commence tree-felling activities in Pennsylvania.
The pipeline has a targeted in-service date of the fourth quarter of 2016. However, this estimate is contingent on the timely issuance of remaining outstanding permits. As of December 31, WGL Midstream has invested approximately $32 million in the Constitution Pipeline project. Based upon updated cost estimates, WGL midstream now expects to invest $83 million in total for its 10% share in the project.
Now I'll turn to our investment in the Central Penn line. The Central Penn line is a greenfield pipeline segment of Transco's Atlantic Sunrise project. The project is on track and development activities are proceeding as expected. Central Penn line has a projected in-service date in the second half of calendar year 2017. WGL midstream will invest approximately $410 million in the project. And as of December 31, WGL midstream has invested approximately $36 million.
Our third pipeline investment involves the Mountain Valley pipeline project. The Mountain Valley pipeline is a proposed 300-mile transmission line through West Virginia and Virginia that is designed to help meet increased demand for natural gas in the mid-Atlantic and Southeast markets. The project is on track and development activities are proceeding as expected. Pending regulatory approval, construction is anticipated to begin in late 2016, with full in-service targeted for the fourth quarter of calendar year 2018.
On January 22, Con Edison Gas Midstream agreed to acquire 12.5% ownership interest in the Mountain Valley pipeline. Consolidated Edison Company of New York will become a chaperone pipeline. WGL Midstream plans to invest $228 million in the project. As of December 31, WGL Midstream has invested approximately $10 million.
Finally, an update on additional opportunity investment infrastructure that we first announced in December 2014. As we have discussed previously, we have an option for a 30% interest in a $400 million gas gathering system in West Virginia. This gathering system will help move gas out of production fields in West Virginia with an interstate pipeline system for transportation to the mid-Atlantic market region. Construction is now complete and substantially within our original cost projections. Therefore, our guidance assumptions continue to include the exercise of this option during the first half of fiscal year 2016.
Turning to our commercial energy systems business, our portfolio of distributed generation assets continues to grow this quarter. As of December 31, we have over 140 megawatts of capacity in service, with an additional 50 megawatts of contracts that are under construction. Our commercial energy systems business is delivering the diverse energy solutions that our customers need.
As an example, WGL Energy Systems was recently awarded the Capital Solar Challenge contract by the General Services Administration. Capital Solar Challenge initiative was launched in 2014 by the White House to identify opportunities to deploy solar renewable energy at federal agencies and military installations across the national capital region. WGL Energy Systems will own, design, install and operate solar facilities at 18 federal locations across Washington, DC. Total generating capacity will exceed 2.8 megawatts and produce over 3,750 megawatt hours of clean, renewable solar power annually. We're proud to partner with the GSA, an organization with requirements that span the full energy spectrum.
Finally, I did want to mention an exciting new opportunity for a solution that we announced last week for our WGL Energy customers. It's an excellent example of the energy answers that we strive to provide. We have expanded the ability of our Energy Management Platform, an innovative online tool that enables commercial government and industrial electricity and natural gas customers to manage their energy budget, calculate carbon emissions, achieve sustainability goals, benchmark against industry standards and obtain custom energy efficiency recommendations. As commercial and government facilities face increasing carbon reduction in energy and reporting requirements, the Energy Management Platform will deliver the advanced planning tools that they will need. We continue to invest in tools like these that provide innovative energy answers for our customers.
All in all, we're off to a good start for the year. We're well-positioned to deliver on the 7% to 10% earnings growth target introduced last year and we look forward to providing additional details during our analyst meeting scheduled for March 15 in New York City.
This concludes our prepared remarks and we will be happy to answer your questions.
[Operator Instructions]. Your first question comes from the line of Sarah Akers from Wells Fargo. Go ahead. Your line is open.
Just a few questions on the midstream segment, first is the strength that you are seeing -- or the strength that you saw in Q1, is that something you expect will sustain throughout 2016 and into 2017? Or were there are some unique opportunities in the market in Q1?
I'll take that. I think a bit of unique opportunities here in 2016 early in the year as a result of the warmer weather that we experienced in the first quarter having an effect on the forward curves that allowed us to capitalize on the assets -- the storage assets that we have.
As I said in my remarks, we do see the ability now as market conditions are evolving with the abundance of natural gas supply to re-create that scenario every time we have a situation where there's warmer weather or other reasons why there is an excess of gas supply in the marketplace. So we see that opportunity for warmer weather and we also see the opportunity when it's colder than normal to actually take gas out of storage and sell it at high prices. So we're -- the business is starting to come together where we see opportunities to make money in a number of different market conditions. I don't know, Gautam, do you have more to add?
Sarah, I would just add to Vince's remarks, I think this really reaffirms the strategy that we had for our storage business which is to get assets that are low price and have them as an option really whenever there is volatility on either side of the curve, we're able to capitalize on it and make money. And I think we're seeing the same thing this year.
And just as a follow-up to that, as you have -- as there's some of these larger pipeline projects with in-service dates over the next few years, do you expect that might reduce some of the optimization opportunities over time relative to your assets?
Yes, Sarah, this is Vince again. Anyone can guess as to where the market conditions are going to evolve. I think the -- what we had seen in the last couple of years before this year is some anomalies in evaluating the storage that was -- which we didn't think was a long term situation where the market really wasn't essentially paying you to own storage the way it had traditionally paid you to own storage. Whereas normally, there is a fairly predictable or at least expected level of margin between winter and summer seasonal spreads that essentially the market reimburses owners of storage for the cost of putting gas in storage. And the effect is that you actually own a valuable asset.
So let's say in the prior year, we didn't see that materialize as much as we thought this year. We do expect that when the pipelines are all completed and built, we will return to them more normal and less -- perhaps a bit less volatile, but more normal seasonal spreads. So where we might not be able to capitalize as much on unique market opportunities on any given day, we think day in, day out or over the whole year, we will still see the reasonable seasonable -- seasonal spreads that will make owning those assets still valuable.
Yes, I think our view still is long term. Even as pipelines get built, it just will promote more use of natural gas. And ultimately, that -- the storage assets will be valuable whether from the demand side or from the supply side as an asset.
And then one more on the midstream side, it looks like there were some shifts in the timing of CapEx including a $56 million reduction in 2016 CapEx. Is that just Constitution getting pushed out further in the calendar year? Or can you comment on what's going on there?
I think you'll see in total the CapEx just is hardly changed. It's just we've moved some -- some capital dollars back and we've moved some other capital dollars forward. It just reflects our partners' best estimates of how the capital costs are going to come in. So, yes, certainly some of the dollars for Constitution have been pushed back as we been waiting for approvals. But we've also seen some acceleration on, I will say, an essential [indiscernible] of where dollars will likely be spent. So that's just a refinement of our overall capital call expectations from our partners.
Okay. And then last question on the utility. Can you just talk about some of the drivers behind the Virginia rate case and whether WGL is currently under-earning in the state?
I would say that what probably distinguishes Virginia compared to our other two jurisdictions is that they have a more forward-looking rate case view in the past that has been a point where you start with a historical test period and then get to update through the process of a rate case. The most recent changes in their regulatory policy has allowed a view to look into the rate effective period and make some more forward-looking adjustments in the presentation of the case. So in one sense, we're looking towards a fiscal year 2017 test period more so than a fiscal year 2015 test period.
[Operator Instructions]. I would like to remind everyone that you can listen to the rebroadcast of this conference call at 1 PM Eastern time today, running through February 15, 2016. You may access the replay by dialing 1-855-859-2056 and entering PIN number 41455179. If there are no further questions, I will now turn the call back to Mr. Bonawitz for any closing remarks.
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 again and have a great day.
This concludes our conference call for today. Thank you for participating. All parties may disconnect now.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!