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WGL > SEC Filings for WGL > Form 10-Q on 6-Feb-2014All Recent SEC Filings

Show all filings for WGL HOLDINGS INC

Form 10-Q for WGL HOLDINGS INC


6-Feb-2014

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 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," "we," "us" or "our" refers to the holding company or the consolidated entity of WGL Holdings, Inc. and all of its subsidiaries.

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

- WGL-This section describes the financial condition and results of operations of WGL Holdings, Inc. 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-This section describes the financial condition and results of operations of Washington Gas, a subsidiary of WGL, which comprises the majority of the regulated utility segment.

Both sections of Management's Discussion-WGL 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 and Washington Gas for the fiscal year ended September 30, 2013 (2013 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, through its 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. In addition to our primary markets, WGL's non-utility subsidiaries own energy assets in 29 states.

WGL has four operating segments:

- regulated utility;

- retail energy-marketing;

- commercial energy systems and

- midstream energy services.

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 Photovoltaic (Solar PV) systems through WGESystems and WGSW. WGL Midstream engages in acquiring, owning and optimizing natural gas storage and transportation assets.

Regulated Utility. The regulated utility segment consists of Washington Gas and Hampshire and represents approximately 84% of WGL's consolidated total assets. Washington Gas is a regulated public utility that sells and delivers natural gas to retail customers in accordance with tariffs approved by the regulatory commissions in the District of Columbia and adjoining areas in Maryland, Virginia and several cities and towns in the northern Shenandoah Valley of Virginia. These regulatory commissions set the rates in their respective jurisdictions that Washington Gas can charge customers for its rate-


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

Hampshire owns full and partial interests in underground natural gas storage facilities, including pipeline delivery facilities located in and around Hampshire County, West Virginia, and operates those facilities to serve Washington Gas, which purchases all of the storage services of Hampshire. Washington Gas 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 buys natural gas and electricity with the objective of earning a profit through competitively priced sales contracts with end-users. These commodities are delivered to retail customers through the distribution systems owned by regulated 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 either independently or through the billing services of the regulated utilities that deliver its commodities.

WGEServices also sells wind and other renewable energy credits and carbon offsets to retail 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, WGSW and the results of operations of affiliate owned commercial solar projects. WGESystems provides energy efficiency and sustainability solutions to governmental and commercial clients. These solutions include energy efficiency projects and distributed generation assets that we own and operate such as Solar PV systems, combined heat and power plants, and fuel cells. 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 Arizona, California, Connecticut, Delaware, Georgia, Hawaii, 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.

Midstream Energy Services. The Midstream Energy Services segment, which consists of the operations of WGL Midstream, engages in developing, acquiring, managing and optimizing natural gas storage and transportation assets. WGL Midstream enters into both physical and financial derivative transactions to mitigate risks while maximizing potential profits from the optimization of these assets under its management. The associated storage and transportation assets are not accounted for as derivative instruments. These derivatives may cause significant period-to-period volatility in earnings as recorded under GAAP; however, this volatility will not change the operating margins that WGL Midstream expects to ultimately realize from sales to customers or counterparties through the use of storage and transportation assets. WGL Midstream's customers and counterparties include producers, utilities, local distribution companies, power generators, wholesale energy suppliers, pipelines and storage facilities. WGL Midstream's risk management policy requires it to closely match its forward physical and financial positions with its asset base, thereby minimizing its price risk exposure. For a discussion of WGL Midstream's


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)

exposure to and management of price risk, refer to the section entitled "Market Risk-Price Risk Related to the Other Non-Utility Segment" in Management's Discussion and Analysis.

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 are included as part of non-utility operations in the operating segment financial information. Administrative and business development activity costs associated with WGL and Washington Gas Resources are included in this segment.

PRIMARY FACTORS AFFECTING WGL 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 2013 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 and Washington Gas.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements and related disclosures in compliance with Generally Accepted Accounting Principles 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;


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)

accounting for contingencies;

accounting for derivative and fair value 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 2013 Annual Report. There were no new critical accounting policies or changes to our critical accounting policies during the three month period ended December 31, 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 reported net income of $18.6 million for the three months ended December 31, 2013, compared to net income of $52.4 million reported for the same period of the prior fiscal year. For the three month period ended December 31, 2013 and 2012, we earned a return on average common equity of 3.4% and 11.2%, respectively.

The following table summarizes our net income (loss) by operating segment for the three months ended December 31, 2013 and 2012.

                         Net Income (Loss) by Operating Segment
                                              Three Months Ended
                                                 December 31,             Increase/
    (In millions)                              2013           2012       (Decrease)
    Regulated Utility                       $     38.7       $ 38.7      $        -
    Non-utility operations:
    Retail Energy-Marketing                        3.3         13.0             (9.7 )
    Commercial Energy Systems                     (0.1 )        1.0             (1.1 )
    Midstream Energy Services                    (21.8 )        1.3            (23.1 )
    Other Activities                              (1.7 )       (1.6 )           (0.1 )
    Total non-utility                            (20.3 )       13.7            (34.0 )
    Intersegment Eliminations               $      0.2       $   -       $       0.2
    Net income applicable to common stock   $     18.6       $ 52.4      $     (33.8 )

    EARNINGS PER AVERAGE COMMON SHARE
    Basic                                   $     0.36       $ 1.01      $     (0.65 )
    Diluted                                 $     0.36       $ 1.01      $     (0.65 )


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 December 31, 2013 and 2012.

                      Regulated Utility Operating Results

                                                               Three Months Ended
                                                                  December 31,              Increase/
(In millions)                                                 2013            2012          Decrease
Utility net revenues:
Operating revenues                                          $   390.4        $ 355.8       $      34.6
Less: Cost of gas                                               190.7          150.4              40.3
Revenue taxes                                                    24.7           24.2               0.5
Total utility net revenues                                      175.0          181.2              (6.2 )
Operation and maintenance                                        71.3           69.7               1.6
Depreciation and amortization                                    25.3           26.8              (1.5 )
General taxes and other assessments                              12.8           12.3               0.5
Operating income                                                 65.6           72.4              (6.8 )
Other expense - net, including preferred stock dividends         (0.5 )         (0.1 )            (0.4 )
Interest expense                                                  8.9            9.1              (0.2 )
Income tax expense                                               17.5           24.5              (7.0 )
Net income applicable to common stock                       $    38.7        $  38.7       $         -

The Regulated Utility segment's net income applicable to common stock was $38.7 million for both the three months ended December 31, 2013 and 2012. The comparison primarily reflects the following:

higher revenues related to growth of more than 11,900 average active customer meters;

higher revenues due to new base rates in the District of Columbia and Maryland;

higher revenues due to accelerated pipe replacement programs;

higher revenues due to favorable effects of natural gas consumption patterns;

higher realized margins associated with our asset optimization program; and a

decrease in the effective tax rate including reinstatement of regulatory assets related to the tax effect of Med D.

Offsetting these favorable variances were:

lower unrealized margins associated with our asset optimization program;

an increase in operating costs;

in higher property taxes; and an

impairment of the old operations center.

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 December 31, 2013 and 2012.


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)

                 Composition of Changes in Utility Net Revenues

                                                       Increase/
              (In millions)                            (Decrease)
              Customer growth                         $        2.0
              Estimated weather effects                        1.3
              Natural gas consumption patterns                 0.9
              Impact of rate cases                             2.7
              Storage carrying costs                           0.8
              Accelerated pipe replacement programs            1.1
              Asset optimization:
              Realized margins                                 2.6
              Unrealized mark-to-market valuations           (17.5 )
              Other                                           (0.1 )
              Total                                   $       (6.2 )

Customer growth - Average active customer meters increased by more than 11,900 for the three months ended December 31, 2013 compared to the same period of the prior fiscal year.

Estimated weather effects- Weather, when measured by HDDs, was 3.7% colder and 2.9% warmer than normal for the three months ended December 31, 2013 and 2012, respectively (refer to the section entitled "Weather Risk" for further discussion of our weather protection strategy).

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. Natural gas consumption patterns may also be affected by non-weather related factors such as customer conservation.

Impact of rate cases - New base rates were approved in the District of Columbia and Maryland effective June 4, 2013 and November 23, 2013, respectively.

Storage carrying costs - Each jurisdiction provides for the recovery of carrying costs based on the cost of capital in each jurisdiction, multiplied by the monthly average balance of storage gas inventory. The three month comparisons reflect higher average storage gas inventory investment balances primarily due to higher weighted average cost of gas in inventory.

Accelerated pipe replacement 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 $26.2 million for the three months ended December 31, 2013, compared to unrealized losses of $8.7 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 December 31, 2013 or 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 December 31, 2013 and 2012.


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)

          Composition of Changes in Operation and Maintenance Expenses

                                                             Increase/
         (In millions)                                      (Decrease)
         Employee benefits                                  $      (1.4 )
         Operation, engineering, compliance and safety              2.0
         Weather-related instruments:
         Loss                                                       0.6
         Impairment loss on Springfield Operations Center           0.8
         Uncollectible accounts                                    (0.6 )
         Other operating expenses                                   0.2
         Total                                              $       1.6

Employee benefits - The decrease in employee benefits expense reflects lower pension, other post-retirement employee benefits and workers' compensation expenses due to changes in plan assumptions used to measure the benefit obligation partially offset by the amortization of the regulatory asset authorized in rates by the District of Columbia. . . .

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