WGL Holdings, Inc. (NYSE:WGL)
Q2 2008 Earnings Call Transcript
May 1, 2008 10:30 am ET
Melissa Adams – Director, IR
Vince Ammann – VP and CFO
James DeGraffenreidt – Chairman and CEO
Harry Warren – President of Washington Gas Energy Services
Ted Durbin – Goldman Sachs
Good morning and welcome to the WGL Holdings, Inc. second quarter fiscal year 2008 earnings conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. We will open the conference call for questions and answers after the presentation. The call will be available for rebroadcast today at 1:00 PM Eastern Time running through May 8 at 5:00 PM. You may access the replay by dialing 1-800-642-1687 and entering pin number 44697452. If you do not have a copy of the earnings release, you can obtain one at www.wglholdings.com.
I will now turn the conference over to Melissa Adams, Director of Investor Relations. Please go ahead.
Good morning everyone and thank you for joining our call. This morning's comments will reference the live presentation on our Web site that you can access by going to www.wglholdings.com, clicking on the Investor Relations tab and then choosing Events and webcasts from the dropdown menu.
The slide presentation highlights our second quarter results and the drivers of those results. A reconciliation of our operating earnings with earnings numbers reported in accordance with Generally Accepted Accounting Principles is provided as an attachment to our press release and is also available in the Quarterly Results section of the Investor Relations site at www.wglholdings.com.
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 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, our retail energy marketing business.
Finally, we encourage everyone to review our most recent forms 10-K and 10-Q 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.
And with that, it's my pleasure to turn the call over to Vince Ammann.
Thank you, Melissa, and good morning to everyone. This second consecutive quarter of excellent results demonstrates our progress in implementing a number of strategic objectives that are designed to grow our revenue and reduce our costs. The quarter's success has further raised our expectations for strong fiscal year 2008 earnings growth. I'm pleased to report that we delivered second quarter GAAP net income of $81 million or $1.63 per share, an increase of $17.6 million or $0.34 per share over net income of $63.4 million or $1.29 per share reported for the second quarter of fiscal year 2007. Please note that all per share amounts referenced are on a fully diluted basis.
The current quarter's results include a $0.03 per share loss from unrealized mark-to-market derivatives related to our utility asset optimization program. Last year's second quarter results included a $0.02 per share positive utility benefit from colder than normal weather. Also embedded in last year's results were unrealized derivative losses and gains that cancelled each other out, specifically $0.02 per share related to the unrealized mark-to-market loss at our utility and a $0.02 per share unrealized mark-to-market benefit in our retail energy marketing operation.
Please note that because we've revised our non-GAAP methodology for reporting unrealized mark-to-market adjustments, we did not identify the utility item when we reported last year's second quarter results. As shown on slide three, after adjusting for these items, the current quarter's non-GAAP operating earnings were $1.66 per share, up $0.40 reflecting a 32% improvement over last year's second quarter operating earnings of $1.26 per share. The increase in year-over-year second quarter non-GAAP operating earnings was primarily attributable to a $0.26 per share improvement in utility results and a $0.12 per share improvement in retail energy marketing results. Results from remaining unregulated activities were slightly higher than the previous year.
As shown in slide four, utility operations reported second quarter GAAP earnings per share of $1.57 per share versus $1.33 per share for the same period last year. Corresponding net income was $78.1 million in the current period versus $65.6 million last year.
Slide five shows that after recognizing the significant events mentioned above, the $0.26 improvement in utility non-GAAP operating earnings reflects the positive year-over-year benefit of $0.18 per share from the implementation of new rates and regulatory mechanisms in the District of Columbia, Maryland, and Virginia, $0.08 per share from improved usage factors, $0.03 per share from retained net margins from our enhanced asset optimization program, $0.03 per share from lower O&M expense, and $0.02 from customer growth.
Offsets include a $0.05 per share accrual for estimated earnings sharing in Virginia as a result of our new performance based rate making plan or PBR, and a $0.03 per share net effect of miscellaneous items including higher income tax expense and higher shares outstanding.
I will now provide some detail on these items beginning with the revenue related items. We saw $0.13 per share of direct benefit from the implementation of new rates in the District of Columbia and Maryland. In addition to changes in customer rates, the implementation of other regulatory mechanisms provided additional earnings benefit of $0.05 per share. For example, the application of the GAC or Gas Administrative Charge in the District of Columbia and Virginia increased the recovery of gas cost component bad debt expense compared to the same period last year. Other margin sharing mechanisms also boosted results as did changes in District of Columbia depreciation rates. We also increased operating earnings by $0.03 per share, primarily due to the implementation of a new asset optimization structure in Virginia that enables us to share benefits with shareholders.
On a year-over-year basis, we also benefited by $0.08 per share from an improved pattern of usage among our customers when compared to the same period last year. Even though weather was 13% warmer than last year on a degree day basis, the distribution of that weather, degree day quality, and other factors contributed to higher levels of consumption per customer. The effects of this higher usage boosted net revenues in our District of Columbia and Virginia jurisdictions which do not have a decoupling program like the revenue normalization adjustment mechanism that is in place in our Maryland territory.
We also experienced a $0.02 per share benefit from higher volume and monthly fixed charges from the addition of 8,700 new customers. I'm pleased to report that a reduction in our year-over-year second quarter O&M expense contributed $0.03 to current quarter earnings per share after adjusting the net effect of weather protection products.
The implementation of our Business Process Outsourcing or BPO program and the current period recovery of hexane cost that was allowed in our Virginia and Maryland rate cases, together with other miscellaneous items more than offset minor objects in other expenses. Our overall and collectible expense also held steady with a rate of 0.8%, so there was no effect on quarter-over-quarter earnings.
As a result of these positive second quarter results, we are reducing our fiscal year 2008 GAAP estimate for operating and maintenance expense by $2 million to $247 million. Depreciation levels declined in the current quarter versus the same period last year primarily due to the effects of lower depreciation rates in the District of Columbia. The favorable earnings effect of this change was incorporated in the $0.18 net benefit of new rates that I previously described.
Also please note that the $0.05 accrual for Virginia earnings sharing is based on an estimated annual return on equity calculation, while asset optimization is a driver of improved results, so too are higher than normal usage and other factors including reductions in operating and maintenance expense. Because the sharing mechanism is based on actual annual net earnings, one cannot simply assume that strong asset management optimization revenues or any one component of income will trigger an earnings sharing offset. The net effect of all income items affects the level of sharing.
Turning now to slide six, Washington Gas Energy Services or WGES, our retail energy marketing business, reported net income of nearly $3.6 million or $0.07 per share versus a net loss of $1.6 million or $0.03 per share in the same period last year. There were no non-GAAP adjustments to current period results. Last year's results were positively affected by the unrealized mark-to-market adjustment of $0.02 per share, bringing our non-GAAP operating results to a loss of $0.05 per share.
As a result, retail energy marketing operating results increased by $0.12 per share, rising to $0.07 per share from a loss of $0.05 per share. The $0.12 per share improvement in operating earnings is primarily attributable to significantly higher gross margins on gas sales. While gas sales of 254 million therms in the quarter reflects a 20% decline over the same period last year due to warmer weather and the loss of some large government accounts, margins per therm rose in the current quarter.
The year-over-year quarterly margin improvement benefits from comparisons with last year's negative quarterly margins that were heavily affected by spot market purchases during the periods of cold weather. Natural gas customer accounts remain relatively stable year-over-year with 140,700 customers served at quarter end.
We also sold nearly 872 million kilowatt hours of electricity versus 1 billion kilowatt hours in the same period last year. Total gross margins were lower in the current period, affected by lower sales volumes as well as narrowing unit margins. Higher forecasts for transmission capacity and other load credits through the balance of the fiscal year, however, are expected to provide offsetting support for unit margins which are now expected to range from $7 to $8 per megawatt hour in fiscal year '08, above the forecast range of $6.50 to $7.50 that we provided at our March 12th analyst conference.
Our quarter end customer count of 68,300 remains relatively stable though our customer mix changed so that we are now serving a relatively higher number of residential customers and fewer commercial accounts. Operations and maintenance expense rose slightly due to salaries and benefits. Uncollectible levels remained very low at a rate of less than 0.2%.
Improved results of $0.01 per share at Washington Gas Energy Systems, a provider of design/build energy solutions to government and commercial customers, helped offset a minor uptick in other primarily corporate expenses which had a $0.01 per share loss.
That concludes my discussion of the quarter and I will now turn the call over to James.
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. Regulatory outcomes increased our rates to reflect better alignment 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.
Success in retail energy marketing now contributes a stable and significant share of total net income. I'm pleased also to report that recent new strategic initiatives such as Business Process Outsourcing, a new performance based rate plan in Virginia and new stable rates in the District of Columbia provide us with new opportunities 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 directly to many of these strategic achievements. Therefore, I'm pleased to announce that we are again raising our fiscal year 2008 GAAP earnings guidance to a range of $2.34 to $2.44 and our fiscal year 2008 non-GAAP operating earnings guidance to a range of $2.38 to $2.48 per share, the midpoint of which represents a 22% improvement over last year's non-GAAP operating results of $1.99 per share.
As indicated in slide 16, fiscal year 2008 non-GAAP operating earnings from our utility are expected to range from $2.07 per share to $2.13 per share, the midpoint of which reflects a $0.10 improvement in our February guidance and primarily results from higher than expected customer usage that may be explained by several factors including weather patterns. $0.03 of this improvement is also attributable to lower operating and maintenance expense levels.
As you may recall, we've set a goal limiting the rate of increase in operations and maintenance expense to 1% per year on average over the five year period 2007 to 2012. Our new guidance reflects a $0.39 per share improvement over fiscal year 2007 results. The drivers of this year's utility improvement compared to last fiscal year are outlined on slide 18.
The cumulative effect of rate increases combined with additional favorable regulatory mechanisms are together expected to contribute about $0.36 per share to fiscal year '08 results when compared to the prior year. The second factor reflects 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 sharing threshold which has been set at a 10.5% return on equity for operations in Virginia. Above that threshold, we retain 25% of all earnings for the benefit of shareholders while applying the balance of these earnings as an offset against the gas costs 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 a greater proportion of our assets are expected to generate nearly $11.3 million in fiscal year 2008 revenue, a $9.1 million improvement over the same period last year while at the same time helping to offset the higher wholesale prices for natural gas that our customers face.
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 year 2008 when compared to the prior year. The estimated addition of 13,000 new customers during fiscal year 2008 is projected to contribute $0.08 per share.
We also expect that utility fiscal year 2008 results will be affected by the adoption of performance based rate making in Virginia. Efficient utility operations combined with strong success in managing our asset management programs is expected to generate results that exceed the 10.5% sharing threshold which will enable us to share the economic benefits of improved incremental returns with both customers and shareholders.
Our guidance includes a $0.06 per share effect for earnings sharing with customers. In addition, we are in the process of finalizing rebuttal testimony addressing intervener and staff comments in a Maryland proceeding relating to the adoption of a performance based rate mechanism and associated earnings sharing proposals in that jurisdiction.
Another Maryland rate matter relating to depreciation is also underway with hearings in mid May and 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 a range of $0.31 to $0.35 per share. However, we have reduced our fiscal year 2008 unregulated guidance by $0.07 per share, largely due to recent increases in projected summer natural gas prices that will push margin recognition on fixed price contracts from this summer mainly into next fiscal year.
Recent sharp rises in electricity prices are expected to reduce third quarter customer retention for some smaller customers who may temporarily have cheaper utility supply alternatives. However, we anticipate a larger effect on the number of customer accounts than we expect to see on volumes, margins, or earnings per share. We expect continued strong earnings growth from this business, but as in the past, some of this growth is expected to be uneven.
Despite these tempered expectations, our new unregulated business operating guidance midpoint of $0.33 per share represents a $0.05 per share increase over fiscal year 2007 operating results. Retail energy marketing, the key driver of unregulated results, is currently expected to deliver operating results of $0.35 per share, in line with last year's $0.36 per share. Commercial HVAC is also expected to make a modest contribution to the improved results and we also expect a $0.04 per share improvement in our Other category, with losses related to corporate functions at a rate of $0.05 per share versus $0.09 per share last year.
In summary, the company continues to make excellent progress and is on track to generate a rolling five year average annual earnings per share growth target of 6% to 8% per year. We have increased revenues through the successful resolution of rate cases in all three of our 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 revenue from reduced consumption in Maryland. We've weather normalization protection in Virginia, which constitutes another 40% of net revenue. And we also soon will file a District of Columbia request seeking to expand revenue normalization protection similar to that which we have in Maryland to achieve decoupling in another 20% of our service territory. Newly enacted Virginia legislation is also expected to result in the implementation of full decoupling in 2011.
We are moving forward with the implementation of a major initiative to improve our service quality level and reduce our cost structure and 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 businesses. Washington Gas Energy Services continues to achieve strong margin and sustainable success in markets throughout Delaware, Virginia, Maryland, and the District of Columbia. And Washington Gas Energy Systems has returned to profitability with a backlog of $44 million versus $12 million in the same period last year. About 40% of the backlog is derived from new business and we believe that there are excellent opportunities for growth by providing a diverse array of energy solutions for federal and commercial clients in the greater Washington, DC area.
In fact, our confidence in the sustained strength of our unregulated businesses was a key driver in our decision to increase our targeted growth rate to 6% to 8% per year and raise the annual rate of our dividend increase from $0.02 to $0.05 per year with an annual growth target of 3% to 4%.
That concludes my remarks. We will now be happy to answer your questions.
(Operator instructions) We will take our first question from Ted Durbin with Goldman Sachs.
Ted Durbin – Goldman Sachs
Hey guys, congratulations on a good quarter. I wanted to ask about the retail segment and maybe just a little bit more color on why you brought the guidance down by the $0.07, what are you seeing in terms of trends on the customer count side, on the margin side, et cetera. And I think Vince, you mentioned that actually a negative gross margin in the second quarter last year on the gas side and what you had -- maybe talk about what you had this year.
Okay, this is Harry Warren. I think there's a few questions in there. Let me see if I can get all of them for you and if I miss one, please come back.
Ted Durbin – Goldman Sachs
One issue you brought up was the comment about the $0.07 per share reduction in guidance that had to do with the recognition of gas margins this summer. That one, now that will take a minute here to explain, so bear with me. What happens there is that WGES has allocated the use of utility storage to serve our firm gas customers and we withdraw that storage gas in the winter for those customers and we are also responsible for injecting gas into storage over the summer. So for various reasons, we sell part of that storage at index prices during the summer, the summer that's coming up in front of us. So, when market prices for gas are moving up, the cost of that storage fill and our projections of the cost of that storage fill for the rest of the summer are also going up.
When we compute our margins this summer, we use on the cost side, a weighted average cost of gas that includes all of that storage fill plus all of our other flowing gas supplies for the summer. So, when we see the market prices move up, it sort of compresses our margin recognition during the summer.
Now, we get that back in an offsetting benefit next year because when we are withdrawing the gas from storage next winter, that storage has been put in at that same blended inventory cost this summer so we wind up taking out some cheaper storage gas than we might otherwise next winter. So, that's why we say that we are sort of pushing some margin recognition out into next winter. So really the underlying results of the sales process and our margins haven't really changed. We just shifted some margin recognition.
Ted Durbin – Goldman Sachs
So, if the commodity price doesn't change, then it will reverse or how are you exposed to the commodity prices?
If the commodity prices, if the NYMEX curve stays the same now through the rest of this fiscal year, that $0.07 number won't move around. If prices continue to run up in the coming months, we could see even more margin pushed out into next year. On the other hand, if it inverts and comes back down and we wind up filling storage in July and August at lower prices than we currently expect, some of it would -- the effect would reverse and some would flow back.
I think you also asked a question on customer count outlook for the rest of the year and as was mentioned, this big run up in prices now that's gone on for four months, that really is limiting a lot of our new customer acquisition on the electric side especially. So, whereas we were running along at a pretty good acquisition clip through the first three months of the fiscal year, we are now really at a very low level there. So, we are not expecting to see much customer growth in the electric side during the rest of the year. In fact, we are going through a heavy renewal phase right now and we think that we are starting to see among our residential and smaller commercial customers a higher attrition rate than we are used to because there are some opportunities for people to jump back in certain cases to some cheaper utility rates that are available. So, we are expecting to see some falloff in the number of accounts served during this third quarter. Although as James mentioned, because they are smaller customers, the effect in customer count will be larger than we think it's going to affect us in terms of margins or volumes and profits.
The last thing you mentioned was the comment on negative margins in the gas side from last year. There we were just trying to clarify that year-over-year we saw especially good gas margins over the first six months. Some of that was related to sort of adverse market conditions in the comparative period last year. We had some cold weather late in the year that caused us to buy some additional volumes at some high spot prices. But another thing to keep in mind of course is that when you look at any quarter over the same quarter last year, you know that our pattern of margin recognition over the year changes quite a bit from year to year or can change from year to year. So, it's more important to look at what our full fiscal year projections are for margins rather than look strictly at some quarter-over-quarter comparisons. Did I hit everything there?
Ted Durbin – Goldman Sachs
Yes, I think that's great. Thanks a lot. And if I could just have one more, can you talk about, you lowered on the utility side I think the O&M projection by $2 million and you were down something like $7 million year-over-year at the utility. What's the outlook there, maybe just a little bit more color on what was driving the -- how O&M was down and what you look at going forward?
Yes, we are taking the forecast for O&M expenses down for the full fiscal year and the impact is primarily due to the changes that we see coming up related to the BPO expenses that we are expecting to be lower than what were originally forecasted in the year and then there are some other miscellaneous items. But, all in all, we have got about a $0.03 pick up year-over-year from – excuse me, not year over year, in the forecast. It also happens we have a $0.03 sort of pickup in the quarter year-over-year related to O&M expenses. So, we've just adjusted on a going-forward basis, Ted, what we think we are going to actually see reverse as far as the favorable benefit and then what's going to be realized at the end of the year and we've taken that number down on a GAAP basis by $2 million.
Ted Durbin – Goldman Sachs
(Operator instructions) Again, I would like to remind everyone that you can listen to a rebroadcast of this conference call at 1:00 PM Eastern Time today, running through May 8 at 5:00 PM. You may access the replay by dialing 1-800-642-1687 and entering pin number 44697452.
If there are no further questions, I will turn the call back to Ms. Adams for any additional or closing remarks.
I would like to thank everybody for joining us today. I know it's a busy day with a lot of calls and a lot of earnings, so if you have any follow up questions, please give me a call. You can reach me at 202-624-6410. Thank you.
This concludes our conference call for today. Thank you all 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: email@example.com. Thank you!