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WGL Holdings Inc.

F1Q08 Earnings Call

February 5, 2008 10:30 am ET

Executives

Melissa E. Adams - Director of Investor Relations

Vincent L. Ammann - Vice President and Chief Financial Officer

James H. DeGraffenreidt - Chairman and Chief Executive Officer

Harry Warren - President of Washington Gas Energy Services

Adrian Chapman - Vice President of Operations, Regulatory Affairs and Energy Acquisitions

Analysts

Ted Durbin - Goldman Sachs

Operator

Welcome to the WGL Holdings Inc first quarter fiscal year 2008 earnings conference call. (Operator Instructions) I will now turn the conference over to Melissa Adams, Director of Investor Relations.

Melissa E. Adams

Good morning, everyone and thank you for joining our call. This morning’s comments will reference the slide presentation on our website that you can access by going to www.WGLHoldings.com, selecting the IR section, clicking on the investor relations tab and then choosing events and webcasts from the dropdown menu.

The slide presentation highlights our first quarter results and the drivers of those results. For your convenience, we’ll also be posting a transcript of this call to the Investor Relations section of our website. This morning, Vince Ammann, Vice President and CFO will provide a brief recap of the quarter with a focus on the drivers that led to our results. Following that, our Chairman and CEO, James DeGraffenreidt, will discuss the items affecting fiscal year 2008 and our long-term performance. James will also provide updated guidance for fiscal year 2008.

Also joining us on the call this morning and available to answer your questions are Terry McCallister, President and Chief Operating Officer; Adrian Chapman, Vice President of Operations, Regulatory Affairs and Energy Acquisitions; and Harry Warren, President of Washington Gas Energy Services.

A reconciliation of our normalized earnings per share with earnings numbers reported in accordance with GAAP is provided as an attachment to our press release and it is also available in the quarterly results section of the investor relations site at www.WGLHoldings.com.

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 that will be made this morning.

With that it’s my pleasure to turn the call over to Vince.

Vincent L. Ammann

Thank you, Melissa and good morning to everyone. This quarter’s strong results underscore our progress in achieving a number of strategic objectives and reinforce our outlook for an excellent year. Despite weather that was 5% warmer than last year and nearly 9% warmer than normal, I am pleased to report that we delivered first quarter GAAP net income of $47.2 million or $0.95 per average common share, which is above last year’s net income from continuing operations of $45.1 million or $0.92 per average common share. Please note that all per share amounts referenced are on a fully diluted basis.

The current quarter’s results include a $0.02 per share benefit for the reversal of costs related to business process outsourcing at our utility, which I will discuss further in a few minutes; and unrealized mark to market losses of $0.05, $0.03 of which related to our utility operations and $0.02 of which are related to retail energy marketing. Also excluded from the current quarter’s results are $0.02 for certain regulatory adjustments related to prior period recovery of hexane in accordance with our Maryland order and an adjustment for interoperable sharing in the District of Columbia.

Last year’s first quarter’s results included a $0.05 per share benefit related to an adjustment to prior period depreciation expense for lower depreciation at our utility and unrealized mark-to-market losses of $0.03 related to retail energy marketing.

As shown on slide 3, after adjusting for these items, the current quarter’s results from non-GAAP operating earnings were $0.96 per share, a $0.06 improvement over the last year’s first quarter operating results of $0.90 per share.

The $0.06 per share increase in year-over-year first quarter non-GAAP operating earnings was primarily attributable to a $0.05 per share improvement in utility results and a $0.01 per share improvement in retail energy marketing results; results from unregulated activities are unchanged. As shown in slide 4, utility operations reported first quarter GAAP net income of $44.2 million or $0.89 per share versus $43 million or $0.88 per share for the same period last year.

Slide 5 shows that after adjusting for significant events identified in our non-GAAP reconciliation tables, non-GAAP utility operating earnings for the first quarter fiscal 2008 were $0.88 per share compared to $0.83 per share in the first quarter of fiscal 2007. This $0.05 improvement in utility non-GAAP operating earnings reflects the positive year-over-year benefit of $0.05 per share from the implementation of new rates in the District of Columbia, Maryland and Virginia; $0.05 per share from our standard asset management program; $0.04 per share from improved usage factors, and $0.05 per share from customer growth and other items. These amounts were partially offset by $0.09 per share increase in operating and maintenance expense, which excludes the accrued benefit of weather protection products.

Other offsets include $0.02 per share of higher growth related utility depreciation and amortization expense, and a $0.02 per share increase in general taxes, and $0.01 per share accrual for estimated earnings share in Virginia as a result of our new performance-based rate making plan or PBR.

I will now provide some details on these items beginning with revenue-related items. The $0.05 per share contribution from the implementation of new rates includes beneficial effect of the early resolution of our District of Columbia rate case which as you may recall from our year end conference call is not scheduled for completion before March 2008.

I’m also pleased to report that we saw a very strong $0.05 per share year-over-year improvement in earnings related to off-system sales from our asset management program. This benefit reflects our success in self-managing a greater portion of our asset portfolio and our ability to retain a higher level of benefits due to a September 2007 order approving our Virginia rate case settlement.

In Virginia, after we generate asset management revenues of $2.4 million we can retain 100% of the benefit until we exceed our 10.5% return on equity earnings sharing threshold. Above that threshold we retained 25% of all earnings for the benefit of shareholders. Our shareholders derive no benefits from asset management activities in Virginia.

On a year-over-year basis we also benefited by $0.04 per share from an improved pattern of usage among our customers when compared to the same period last year. Even though weather was warmer than last year on a degree day basis, the distribution of that weather and degree day quality and perhaps other factors like lower gas cost, contribute to higher levels of consumption for our customers.

Impact of this higher usage boosted net revenue in our District of Colombia and Virginia jurisdiction, which do not have a decoupling program like the revenue normalization adjustment mechanism that is in place Maryland territory.

We also experienced a $0.02 per share benefit from higher volume and system charges from the addition of 12,310 new customers. We had a net benefit of $0.03 from miscellaneous items. Offsets to the $0.18 per share in non-GAAP net revenue related improvements were primarily driven by a $5.3 million pretax or $0.09 per share effect from higher O&M excluding the non-GAAP items discussed previously and about $600,000 or $0.01 per share of net expense related to weather insurance accruals.

About half of the quarter-over-quarter increase related to a pretax $3.5 million or $0.04 per share increase in uncollectible expense. However, as you may recall last year’s experience for this item was unusually low; it included $2.8 million adjustment to the accumulated reserve to reflect better collections. After considering this item’s comparable year-over-year uncollectible rates are relatively flat, reflecting an extraordinarily low uncollectible rate of 0.7%. Even on an unadjusted basis the first quarter fiscal year 2008 uncollectible rates are less than 1% utility revenue.

The remaining $0.05 per share increase in O&M relates to a variety of items including transition cost to implement our business process outsourcing, pipeline integrity costs and miscellaneous items.

Year-over-year earnings were negatively affected by $0.02 from higher depreciation and amortization expense primarily reflecting investments for the continued addition of new customers and other plant approvals. General tax expense also climbed by $1.6 million or $0.02 per share primarily due to higher profit tax assessment rates in Virginia. Income tax expense and interest expense showed little change.

Turning now to slide 6, Washington Gas Energy Services or WGES our retail energy marketing business, reported net income of nearly $3.3 million or $0.07 per share versus $2.7 million or $0.05 per share in the same period last year. After excluding the effects of mark-to-market losses on energy-related derivatives in both periods non-GAAP operating earnings for the first quarter of FY08 were $0.09 per share versus $0.08 per share in the same period last year.

The $0.01 per share improvement in operating earnings is primarily attributable to higher gross margins on gas sales. While gas sales of 196 million tons in the quarter reflects a 4% decline over the same period last year due to warmer weather and the losses in large government accounts, gross margins for them rose in the current quarter. Natural gas customer accounts remained relatively stable year over year with 140,700 customers served at quarter end.

We also sold 900 million kilowatt hours of electricity and served 67,100 customers at quarter’s end with both figures relatively consistent with the same period last year. A $0.01 per share contribution from our HVAC business and a few cent per share loss from other activities were consistent with prior-period results.

That concludes my discussion of the quarter. I will now turn the call over to James.

James H. DeGraffenreidt

Thank you Vince and good morning, everyone. This quarter’s strong results reinforced our outlook for an excellent year and are directly attributable to a number of recent strategic accomplishments. The regulatory outcomes in Virginia, Maryland, and Washington DC increased our rates to better match with the costs we incur to serve our customers. Implementation of revenue stabilization and/or weather normalization in over 80% of our service area combined with weather insurance in the District of Columbia has substantially improved the predictability of our utility operating revenue and our earnings.

The expansion of our asset management program is providing valuable benefits to customers and shareholders. Continued success in retail energy marketing now contributes a stable and significant share of total net income. In addition, recent new strategic initiative such as business process outsourcing and a performance-based rate plan in Virginia provide us with the opportunity to produce valuable benefits for both customers and shareholders over the next several years.

Much like the quarter, forecasted performance for the balance of the year relates to directly to many of these strategic achievements. Therefore I am pleased to announce that we are raising our fiscal year 2008 GAAP earnings guidance to a range of $2.30 a share to $2.40 a share, and our fiscal year 2008 non-GAAP operating earnings guidance to a range of $2.35 to $2.45 per share, the midpoint of which represents a 21% improvement over the last year’s non-GAAP operating results of $1.99 per share.

As indicated in slide 12, fiscal year 2008 non-GAAP non operating earnings from our utility are expected to range between $1.97 per share to $2.03 per share, the midpoint of which reflect a $0.29 per share improvement over fiscal year 2007 result.

As shown on slide 14, drivers of this year utility improvement primarily relates to a few key items. First, the cumulative effect of $26 million in rate increases combined with additional favorable regulatory mechanism are together expected to contribute about $0.36 per share in fiscal year 2008 results when compared to the prior year.

The second factor reflects the expansion of our asset management program and related beneficial rate order. We can now retain 100% of the Virginia share of the benefit after we generate $2.4 million in revenue until the point that we exceed our earnings share threshold which had been set at 10.5% return on equity for operations in Virginia. Above that threshold we retain 25% of all earnings for benefit of shareholder while applying the balance of these earnings as an offset against the gas cost on our customers’ bill.

Asset management revenue generated in our other jurisdictions also allow us to share benefits between customers and shareholders. The successful expansion of the program and our management of greater number of our assets is expected to generate nearly $10 million in fiscal year 2008 revenue and an $8.7 million improvement over the same period last year.

On an earnings per share basis, after sharing the proceeds with our customers, we forecast that this item will contribute an additional $0.11 per share to earnings in fiscal 2008 when compared to the prior year. The addition of 17,500 new customers during the fiscal year 2008 is estimated to contribute $0.09 per share. We also expect that utility fiscal year 2008 results would be affected by the adoption of the performance based ratemaking in Virginia.

Our strong success in efficiently managing our asset management program is likely to generate results that approach or exceed the 10.5% sharing threshold which will enable us to share the economic benefit of improved incremental returns between both customers and shareholders. In addition, we have just begun a phase 2 proceeding relating to our Maryland rate case, which will consider adoption of a performance-based rate mechanism and associated customer/shareholder sharing proposals for that jurisdiction. Another Maryland rate matter related to depreciation is also underway with resolution expected by September.

We expect to continue to deliver strong results from our unregulated businesses which we forecast will deliver non-GAAP operating results in the range of $0.38 to $0.42 per share. The $0.40 midpoint of this range represents a $0.12 increase over fiscal year 2007. Retail energy marketing, the key drivers to unregulated results is currently expected to deliver operating results of $0.41 per share compared with $0.36 per share in fiscal year 2007. The primary drivers of this improvement reflects strong gross margins on natural gas sale.

We also expect that our Commercial HVAC business will make a modest contribution to the improved results. We will experience traditional losses related to corporate functions, but we expect these losses will be $0.05 lower than those affecting prior years result.

In summary, the company continues to make excellent progress and is on track to generate sustained competitive long-term results. We have increased revenues through the successful resolution of rate cases in each of the three jurisdictions and through the expansion of our asset management program. We have successfully neutralized the effect of warmer than normal weather on utility results. We have protected 40% of net revenues from reduced consumption in Maryland and we are encouraged by recent District of Colombia Public Service Commission commentary on the merits of revenue normalization that could provide insights concerning our ability to extend this protection to another 20% of our service territory. The recently introduced legislation may also make future decoupling possible in Virginia.

We are moving forward with the implementation of a major initiative to improve our service levels and reduce our cost structure. We have implemented a regulatory mechanism in Virginia with a similar proposal under consideration in Maryland that will share these potential benefits between customers and shareholders.

Finally, we have built a solid foundation to support continued profitable growth in our non-utility business. Washington Gas Energy Services’ continues to achieve strong margins and sustainable success in markets throughout Delaware, Virginia, Maryland and the District of Colombia. Washington Gas Energy System has returned to profitability with a backlog of $45 million versus $14 million in the same period last year.

I look forward to elaborating further on these accomplishments and their implications for the future during our analyst conference on March 12. At that time, we will introduce new five-year financial objectives that are designed to support reasonably priced safe and reliable service for our customers and dependable competitive returns for our shareholders.

That concludes my remarks and we will now be happy to answer your question.

Question-and-Answer Session

Operator

Your first question comes from Ted Durbin - Goldman Sachs.

Ted Durbin - Goldman Sachs

Retail margins for both electric and gas, you changed your outlook for 2009. Going forward, maybe you can talk a little bit about what’s coming next year?

James H. DeGraffenreidt

Could you repeat the first part of your question? it got cut off.

Ted Durbin - Goldman Sachs

The question is on retail margins, the non-regulated retail margins. What are you expecting for second half of 2008 and going into 2009? What are you seeing in terms of contracts you are signing right now?

Harry Warren

On gas margins, we’re seeing solid margins there. We expanded the range of our guidance assumptions for FY08 and I think that’s basically to the top end of the range we talked about in last year’s analyst conference.

On the electric side, we’re also seeing much stronger unit margins as this year has gone on for FY08; each month our risk management seems to be coming in a little better than our conservative modeling of that. We bake some of that improvement into our projections for the rest of this fiscal year in addition to the results to-date.

As for the implications of all these things for our margins in FY09, we’ll probably talk a little more about that in the analyst meeting that’s coming up in a month right now. Clearly the electric margins are becoming significantly stronger than the numbers in the discussions we had a year ago. So they seem to be continuing strong and again the gas margins are right now at the upper end of the range of the guidance we provided about a year ago.

Ted Durbin - Goldman Sachs

I got a little confused in terms of the impact of weather on the quarter and maybe just someone can run us through because now that you have sort of different rate mechanisms, what was the actual impact of weather on the quarter?

James H. DeGraffenreidt

We’ve had zero impacts of weather on the quarter. The weather has been warmer than normal, same trend that it was last year. What we are trying to describe was, what we referred to the quality of the degree days were better this quarter than the same quarter last year, and what that reflects is that last year we had a large number of degree days occur in the very early part of the season in October and those shoulder months tend to be very difficult times to predict the relationship between degree days and usage. We tend to see some abnormal results from that happen.

So, this year the degree days that we did experience seemed to arise much later in the quarter, in the deeper part of the winter and we had a much better correlation of usage to the degree days. What we refer to as a $0.04 per share improvement quarter over quarter for the impact of that usage, which was primarily driven by the quality of the degree days, not because of the weather normalization factor, because generally our weather normalization, our weather protection products protect us generally from weather changes but not from those type of customer usage pattern differences.

Ted Durbin - Goldman Sachs

You mentioned a little bit of the hit from little bit higher bad debt expense. Do you think that’s a good run rate to go forward? I think you said was 1% of revenues. Are you seeing any kind of economic weakness that might cause that number to be any higher or vice versa?

James H. DeGraffenreidt

We’ve stepped up in this quarter with an increase in our bad debt expense to reflect what we are seeing to date as far as the effect of the economy on our bad debt experience. We have about as accurate a crystal ball as anyone, but I think that what we’ve always seen in our service territory is a very resilient customer base in their ability to pay their gas bills, and we don’t see anything changed in that general pattern.

So yes, the lower level of bad debt expense that we are currently reflecting is slightly less than 1% on a going forward basis. We think that is as good as an indicator that we have right now of what our experience is going to be for the balance of the year.

Ted Durbin - Goldman Sachs

In terms of the Maryland PRB case, what’s your proposed earnings share and what are the interveners or the staff, what are they proposing for that?

Adrian Chapman

What we have just filed as updated testimony begins with a dead band around the associated return on equity that is at 50 basis points and then for the next 100 basis points we proposed 50/50 sharing and then for any basis point of earnings above that it is for the incremental revenues earned it is 75% to shareholders and 25% to the customers.

The other parties have not filed any responsive testimony in this phase of the proceeding yet so we will have the wait to see whether the review on sharing has changed substantively. In the first part of the case, the phase 1 proceeding, the staff of the commission had proposed a 60/40 sharing. 60% for customers and 40% for the company for the first 100 basis points and then they have proposed a reversal of that 60% for the company and 40% for customers for anything above that 100 basis point mark.

Operator

Your next question comes from the line of [inaudible].

Analyst

Your view over the balance sheet and your dividend policy on go-forward basis, clearly a good portion of your CapEx is behind you, there is still some in front of you. Do you feel that the balance sheet is in the right spot at this point? Do you think there is an opportunity to lever it up a little bit and also your general view about the dividend, whether you expect to see growth in dividends more in line with your peers and so forth?

James H. DeGraffenreidt

Our board of directors annually reviews the dividend policy here and makes a decision, so you are asking a question about four weeks early. I’ll just say stay tuned on that. I think our track record shows that we are committed to addressing our shareholders’ interest in a stable, sustainable and growing stream of dividends. I’d say stay tuned on that.

With regard to the balance sheet, typically the opportunity to lever up, I think, yes, we are evaluating how to finance the variety of opportunities that are out there. We do have some capital spending ahead of us. I appreciate you said that a lot of it is behind us. We are still a growing system. We will still be putting price in the ground and we still have on board our plans for an LNG storage facility among other projects. But just in the utility business, there are opportunities for us to spend capital dollars on projects that will be the basis for streams of regulated earnings going forward for many years to come. We’re obviously also evaluating opportunities to invest and grow our existing non-utility businesses and we are exploring other opportunities as well.

Vincent L. Ammann

We have just completed our round of rate cases and in those rate cases, as you know, equity rate percentages our initiative through all these discussions in front of our regulators and we have just finished that process. We have come through it with pretty well retaining a good percentage of our equity ratios that we had proposed. The actual settlements and approved equity ratios range from about 55% to about 51% equity ratio.

So as I had said at the analyst conference last year, we were passing ourselves to get through our rate cases. get an understanding of how successful we were going to be and then look for opportunities that we think are appropriate based on what we learned from that experience.

We certainly acknowledge right now the value of a strong balance sheet for our shareholders and that the opportunities that provides us to explore some of the initiatives that James just referred to. So we’re very cognizant of the balance sheet that we have and we are actually excited by the prospects that it offers us to explore alternatives in the upcoming years to come.

Operator

There are no further questions at this time.

Melissa Adams

I would like to thank everybody for calling. That will conclude the call and again if you do have any subsequent questions please don’t hesitate to call me at 202-624-6410.

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Source: WGL Holdings Inc. F1Q08 (Qtr End 12/31/07) Earnings Call Transcript
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