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WGL > SEC Filings for WGL > Form 10-Q on 8-Aug-2013All Recent SEC Filings

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Form 10-Q for WGL HOLDINGS INC


8-Aug-2013

Quarterly Report


Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

This Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) analyzes the financial condition, results of operations and cash flows of WGL Holdings and its subsidiaries. It also includes management's analysis of past financial results and potential factors that may affect future results, potential future risks and approaches that may be used to manage them. Except where the content clearly indicates otherwise, "WGL Holdings," "we," "us" or "our" refers to the holding company or the consolidated entity of WGL Holdings and all of its subsidiaries.

Management's Discussion is divided into the following two major sections:

- WGL Holdings-This section describes the financial condition and results of operations of WGL Holdings and its subsidiaries on a consolidated basis. It includes discussions of our regulated operations, including Washington Gas and Hampshire Gas Company (Hampshire), and our non-utility operations.

- Washington Gas Light Company (Washington Gas)-This section describes the financial condition and results of operations of Washington Gas, a wholly owned subsidiary of WGL Holdings, which comprises the majority of the regulated utility segment.

Both sections of Management's Discussion-WGL Holdings and Washington Gas-are designed to provide an understanding of our operations and financial performance and should be read in conjunction with the respective company's financial statements and the combined Notes to Consolidated Financial Statements in this quarterly report as well as our combined Annual Report on Form 10-K for WGL Holdings and Washington Gas for the fiscal year ended September 30, 2012 (2012 Annual Report).

Unless otherwise noted, earnings per share amounts are presented on a diluted basis, and are based on weighted average common and common equivalent shares outstanding. Our operations are seasonal and, accordingly, our operating results for the interim periods presented are not indicative of the results to be expected for the full fiscal year.

EXECUTIVE OVERVIEW

Introduction

WGL Holdings, through its wholly owned subsidiaries, sells and delivers natural gas and provides a variety of energy-related products and services to customers primarily in the District of Columbia and the surrounding metropolitan areas in Maryland and Virginia.

WGL Holdings has four operating segments:

- regulated utility;

- retail energy-marketing;

- commercial energy systems and

- wholesale energy solutions.

Our core subsidiary, Washington Gas, engages in the delivery and sale of natural gas that is regulated by regulatory commissions in the District of Columbia, Maryland and Virginia. Through the wholly owned unregulated subsidiaries of Washington Gas Resources, we offer energy-related products and services. We offer competitively priced natural gas, electricity and energy from renewable sources to customers through WGEServices, our non-utility retail energy-marketing subsidiary. We offer efficient and sustainable commercial energy solutions focused on upgrading energy related systems of large government and commercial facilities as well as own and operate distributed generation assets such as Solar PV systems through WGESystems. Capitol Energy Ventures performs natural gas, pipeline and storage asset optimization activities.


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I-Financial Information

Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Regulated Utility. The regulated utility segment consists of Washington Gas and Hampshire and represents approximately 84% of WGL Holdings' consolidated total assets. Washington Gas, the core of the regulated utility segment, delivers natural gas to retail customers in accordance with tariffs approved by the regulatory commissions that have jurisdiction over Washington Gas' rates and terms of service. These regulatory commissions set the rates in their respective jurisdictions that Washington Gas can charge customers for its rate-regulated services. Washington Gas also sells natural gas to customers who have not elected to purchase natural gas from unregulated third party marketers. Washington Gas recovers the cost of the natural gas purchased to serve firm customers through gas cost recovery mechanisms as approved in jurisdictional tariffs. Any difference between gas costs incurred on behalf of firm customers and the gas costs recovered from those customers is deferred on the balance sheet as an amount to be collected from or refunded to customers in future periods. Therefore, increases or decreases in the cost of gas associated with sales made to firm customers have no direct effect on Washington Gas' net revenues and net income.

Washington Gas' pipeline asset optimization program utilizes Washington Gas' storage and transportation capacity resources when those assets are not fully utilized to serve utility customers. The objective of this program is to derive a profit to be shared with its utility customers (refer to the section entitled "Market Risk" for further discussion of our asset optimization program) by entering into commodity-related physical and financial contracts with third parties. Unless otherwise noted, therm deliveries shown related to Washington Gas or the regulated utility segment do not include therm deliveries related to our asset optimization program.

Hampshire operates and owns full and partial interests in underground natural gas storage facilities, including pipeline delivery facilities located in and around Hampshire County, West Virginia. Washington Gas purchases all of the storage services of Hampshire and includes the cost of these services in the bills sent to its customers. Hampshire operates under a "pass-through" cost of service-based tariff approved by the FERC, and adjusts its billing rates to Washington Gas on a periodic basis to account for changes in its investment in utility plant and associated expenses.

Retail Energy-Marketing. The retail energy-marketing segment consists of the operations of WGEServices. WGEServices competes with regulated utilities and other unregulated third party marketers to sell natural gas and/or electricity directly to residential, commercial and industrial customers in Delaware, the District of Columbia, Maryland, Pennsylvania and Virginia. WGEServices contracts for its supply needs and buys and resells natural gas and electricity with the objective of earning a profit through competitively priced contracts with end-users. These commodities are delivered to retail customers through the distribution systems owned by regulated utilities such as Washington Gas or other unaffiliated natural gas or electric utilities. Washington Gas delivers the majority of natural gas sold by WGEServices, and unaffiliated electric utilities deliver all of the electricity sold. Additionally, WGEServices bills its customers through the billing services of the regulated utilities that deliver its commodities as well as directly through its own billing capabilities.

WGEServices also sells renewable energy credits from wind power and other sources as well as carbon offset products to its customers. WGEServices does not own or operate any other natural gas or electric generation, production, transmission or distribution assets.

Commercial Energy Systems. The commercial energy systems segment consists of the operations of WGESystems and WGSW. WGESystems provides commercial energy efficiency and sustainability solutions to governmental and commercial clients. These solutions include energy efficiency projects and distributed generation assets such as Solar PV systems, combined heat and power plants and fuel cells which we own and operate. WGESystems also focuses on upgrading the mechanical, electrical, water and energy-related infrastructure of large governmental and commercial facilities by implementing both traditional as well as alternative energy technologies, primarily in the District of Columbia, Maryland and Virginia. In addition to these three regions, WGESystems is also expanding its portfolio of Solar PV power generating systems into California, Connecticut, Delaware, Hawaii, Georgia, Massachusetts, New Jersey and New Mexico. WGESystems is also evaluating opportunities in other geographical locations within the United States.

WGSW is a holding company formed to invest in alternative energy assets. WGSW holds a limited partnership in ASD Solar, LP in addition to investments in solar assets through sale leaseback arrangements.

Wholesale Energy Solutions. The Wholesale Energy Solutions segment, which consists of the operations of CEV, engages in acquiring, managing and optimizing natural gas storage and transportation assets. CEV enters into both physical and financial transactions in a manner intended to utilize the most effective energy risk management products available to mitigate risks while maximizing potential profits from the optimization of these assets under its management.

Other Activities.Activities and transactions that are not significant enough on a stand-alone basis to warrant treatment as an operating segment, and that do not fit into one of our other operating segments, are aggregated as "Other Activities" and included as part of non-utility operations as presented below in the operating segment financial information. Administrative and business development activity related costs associated with WGL Holdings and Washington Gas Resources comprise the majority of transactions included in "Other Activities."


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I-Financial Information

Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations (continued)

PRIMARY FACTORS AFFECTING WGL HOLDINGS AND WASHINGTON GAS

The principal business, economic and other factors that affect our operations and/or financial performance include:

weather conditions and weather patterns;

regulatory environment, regulatory decisions and changes in legislation;

availability of natural gas supply and pipeline transportation and storage capacity;

diversity of natural gas supply;

volatility of natural gas and electricity prices;

non-weather related changes in natural gas consumption patterns;

maintaining the safety and reliability of the natural gas distribution system;

competitive environment;

environmental matters;

industry consolidation;

economic conditions and interest rates;

inflation;

use of business process outsourcing;

labor contracts, including labor and benefit costs and

changes in accounting principles.

For further discussion of the factors listed above, refer to Management's Discussion within the 2012 Annual Report. Also, refer to the section entitled "Safe Harbor for Forward-Looking Statements" included in this quarterly report for a listing of forward-looking statements related to factors affecting WGL Holdings and Washington Gas.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements and related disclosures in compliance with GAAP requires the selection and the application of appropriate technical accounting guidance to the relevant facts and circumstances of our operations, as well as our use of estimates to compile the consolidated financial statements. The application of these accounting policies involves judgment regarding estimates and projected outcomes of future events, including the likelihood of success of particular regulatory initiatives, the likelihood of realizing estimates for legal and environmental contingencies and the probability of recovering costs and investments in both the regulated utility and non-utility business segments.

We have identified the following critical accounting policies that require our judgment and estimation, where the resulting estimates may have a material effect on the consolidated financial statements:

accounting for unbilled revenue;

accounting for regulatory operations - regulatory assets and liabilities;

accounting for income taxes;

accounting for contingencies;

accounting for derivative instruments;

accounting for pension and other post-retirement benefit plans and

accounting for stock based compensation.

For a description of these critical accounting policies, refer to Management's Discussion within the 2012 Annual Report. There were no new critical accounting policies or changes to our critical accounting policies during the nine month period ended June 30, 2013.


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I-Financial Information

Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations (continued)

WGL HOLDINGS, INC.

RESULTS OF OPERATIONS

We analyze the operating results using utility net revenues for the regulated utility segment and gross margins for the retail energy-marketing segment. Both utility net revenues and gross margins are calculated as revenues less the associated cost of energy and applicable revenue taxes. We believe utility net revenues is a better measure to analyze profitability than gross operating revenues for our regulated utility segment because the cost of the natural gas commodity and revenue taxes are generally included in the rates that Washington Gas charges to customers as reflected in operating revenues. Accordingly, changes in the cost of gas and revenue taxes associated with sales made to customers generally have no direct effect on utility net revenues, operating income or net income. We consider gross margins to be a better reflection of profitability than gross revenues or gross energy costs for our retail energy-marketing segment because gross margins are a direct measure of the success of our core strategy for the sale of natural gas and electricity.

Neither utility net revenues nor gross margins should be considered as an alternative to, or a more meaningful indicator of our operating performance, than net income. Our measures of utility net revenues and retail energy-marketing gross margins may not be comparable to similarly titled measures of other companies. Refer to the sections entitled "Results of Operations-Regulated Utility Operating Results" and "Results of Operations-Retail Energy-Marketing" for the calculation of utility net revenues and gross margins, respectively, as well as a reconciliation to operating income and net income for both segments.

Summary Results

WGL Holdings reported a net loss of $10.0 million for the three months ended June 30, 2013, compared to $7.5 million reported for the same period of the prior fiscal year. For the twelve month period ended June 30, 2013 and 2012, we earned a return on average common equity of 10.6% and 8.0%, respectively.

The following table summarizes our net income (loss) by operating segment for the three months ended June 30, 2013 and 2012.

                     Net Income (Loss) by Operating Segment

                                                  Three Months Ended
                                                       June 30,               Increase/
 (In millions)                                     2013           2012       (Decrease)
 Regulated Utility                              $     (4.3 )     $ (5.8 )    $       1.5
 Non-utility operations:
 Retail Energy-Marketing                              (4.2 )       19.7            (23.9 )
 Commercial Energy Systems                             0.3          0.7             (0.4 )
 Wholesale Energy Solutions                            1.1         (6.0 )            7.1
 Other Activities                                     (2.9 )       (1.1 )           (1.8 )
 Total non-utility                                    (5.7 )       13.3            (19.0 )
 Net income (loss) applicable to common stock   $    (10.0 )     $  7.5      $     (17.5 )

 EARNINGS PER AVERAGE COMMON SHARE
 Basic                                          $    (0.19 )     $ 0.14      $     (0.33 )
 Diluted                                        $    (0.19 )     $ 0.14      $     (0.33 )


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I-Financial Information

Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Regulated Utility Operating Results

The following table summarizes the Regulated Utility segment's operating results for the three months ended June 30, 2013 and 2012.

                      Regulated Utility Operating Results

                                                          Three Months Ended
                                                               June 30,                Increase/
(In millions)                                            2013            2012          Decrease
Utility net revenues:
Operating revenues                                     $   180.9        $ 164.7       $      16.2
Less: Cost of gas                                           60.1           44.6              15.5
Revenue taxes                                               13.2           12.6               0.6
Total utility net revenues                                 107.6          107.5               0.1
Operation and maintenance                                   71.3           73.1              (1.8 )
Depreciation and amortization                               23.5           24.6              (1.1 )
General taxes and other assessments                         12.7           12.0               0.7
Operating income (loss)                                      0.1           (2.2 )             2.3
Other income (expense) - net, including preferred
stock dividends                                             (0.6 )          0.1              (0.7 )
Interest expense                                             8.8            9.5              (0.7 )
Income tax expense (benefit)                                (5.0 )         (5.8 )             0.8
Net loss applicable to common stock                    $    (4.3 )      $  (5.8 )     $       1.5

The Regulated Utility segment's net loss applicable to common stock was $4.3 million for the three months ended June 30, 2013, compared to a net loss of $5.8 million reported for the same period of the prior fiscal year. The comparison primarily reflects: (i) a $5.0 million impairment loss on property in the prior year; (ii) $2.8 million in higher realized margins associated with our asset optimization program; (iii) $1.7 million in net insurance proceeds related to environmental matters; (iv) $1.1 million in higher net revenues related to the growth of more than 11,300 average active customer meters; (v) $0.7 million of favorable effects of changes in natural gas consumption patterns due to shifts in weather patterns and customer conservation and (vi) $0.7 million in rate recovery related to the accelerated pipeline replacement program in Virginia. Partially offsetting these variances were $7.2 million in lower unrealized margins associated with our asset optimization program and $2.2 million in higher employee benefits due to changes in plan assumptions.

Utility Net Revenues. The following table provides the key factors contributing to the changes in the utility net revenues of the Regulated Utility segment between the three months ended June 30, 2013 and 2012.

                 Composition of Changes in Utility Net Revenues

                                                       Increase/
               (In millions)                          (Decrease)
               Customer growth                        $       1.1
               Estimated weather effects                      0.7
               Natural gas consumption patterns               0.7
               Regulatory recovery programs                   0.7
               Asset optimization:
               Realized margins                               2.8
               Unrealized mark-to-market valuations          (7.2 )
               Lower-of-cost or market adjustment            (0.1 )
               Other                                          1.4
               Total                                  $       0.1

Customer growth - Average active customer meters increased by more than 11,300 for the three months ended June 30, 2013 compared to the same period of the prior fiscal year.


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I-Financial Information

Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Estimated weather effects - Weather, when measured by HDDs, was 0.3% colder and 25.8% warmer than normal for the three months ended June 30, 2013 and 2012, respectively. Washington Gas has a weather protection strategy that is designed to neutralize the estimated financial effects of variations from normal weather on net income (refer to the section entitled "Weather Risk" for further discussion of our weather protection strategy). Washington Gas executed heating degree day derivative contracts to manage its exposure to variations from normal weather in the District of Columbia. Changes in the fair value of these derivatives are reflected in operation and maintenance expenses and offset the benefits reflected above.

Natural gas consumption patterns - The variance in net revenues reflects the changes in natural gas consumption patterns. These changes may be affected by shifts in weather patterns in which customer heating usage may not correlate highly with average historical levels of usage per heating degree days that occur. Natural gas consumption patterns may also be affected by non-weather related factors such as customer conservation.

Regulatory recovery programs - Revenues increased related to the return on investment and recovery of costs associated with an accelerated pipeline replacement program in Virginia and a targeted mechanically coupled pipe replacement and encapsulation program in the District of Columbia.

Asset optimization - We recorded net unrealized losses associated with our energy-related derivatives of $4.6 million for the three months ended June 30, 2013, compared to unrealized gains of $2.6 million reported for the same period of the prior fiscal year. When these derivatives settle, any unrealized amounts will ultimately reverse and Washington Gas will realize margins in combination with related transactions that these derivatives economically hedge. Washington Gas recorded no lower-of-cost or market adjustments related to its storage gas inventory during the three months ended June 30, 2013. Washington Gas recorded a $0.1 million reversal of a prior period lower-of-cost or market write down associated with storage capacity assets during the three months ended June 30, 2012. Refer to the section entitled "Market Risk-Price Risk Related to the Regulated Utility Segment" for further discussion of our asset optimization program.

Operation and Maintenance Expenses. The following table provides the key factors contributing to the changes in operation and maintenance expenses of the Regulated Utility for the three months ended June 30, 2013 and 2012.

          Composition of Changes in Operation and Maintenance Expenses

                                                             Increase/
         (In millions)                                      (Decrease)
         Employee benefits                                  $       2.2
         Operation, engineering, compliance and safety              1.8
         Net insurance proceeds                                    (1.7 )
         Impairment loss on Springfield Operations Center          (5.0 )
         Other operating expenses                                   0.9
         Total                                              $      (1.8 )

Employee benefits - The increase in employee benefits expense reflects higher pension expense, partially offset by lower other post-retirement benefits expense primarily due to changes in the discount rate and other plan assumptions used to measure the benefit obligation.

Operation, engineering, compliance and safety - Washington Gas incurred higher repair costs for the three months ended June 30, 2013 than for the same period in the previous year.

Net insurance proceeds - Washington Gas received proceeds from an environmental insurance policy for past and future claims, partially offset by costs associated with environmental claims and regulatory sharing.

Impairment loss on Springfield Operations Center - On June 30, 2012, Washington Gas incurred a $5.0 million impairment loss on a previous operations facility by reducing the carrying amount of $29.9 million down to its fair value of $24.9 million. There were no impairment indications identified for the three months ended June 30, 2013.

Depreciation and Amortization. The decrease of $1.1 million in depreciation and amortization reflects lower rates in the District of Columbia and a true up of amortization expense.


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I-Financial Information

Item 2-Management's Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Retail Energy-Marketing

The following table depicts the Retail Energy-Marketing segment's operating results along with selected statistical data.

             Retail Energy-Marketing Financial and Statistical Data

                                                Three Months Ended
                                                     June 30,               Increase /
                                               2013           2012          (Decrease)
  Operating Results (In millions)
  Gross margins:
. . .
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