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Hawaiian Electric Industries (HE) Q4 2014 Results – Earnings Call Transcript

Hawaiian Electric Industries (NYSE: HE ) Q4 2014 Earnings Call February 12, 2015 5:00 pm ET Executives Clifford Chen – Manager of Investor Relations and Strategic Planning Constance Hee Lau – Chief Executive Officer, President, Director, Member of Executive Committee, Chairman of Hawaiian Electric Company Inc and Chairman of American Savings Bank F.S.B. James A. Ajello – Chief Financial Officer, Principal Accounting Officer and Executive Vice President Alan M. Oshima – Executive Vice President of Corporate & Community Advancement, Chief Executive Officer of Hawaiian Electric Company and President of Hawaiian Electric Company Tayne S. Y. Sekimura – Former Chief Financial Officer of Hawaiian Electric Company Inc and Senior Vice President of Hawaiian Electric Company Inc Analysts Paul Patterson – Glenrock Associates LLC Charles J. Fishman – Morningstar Inc., Research Division Nicholas D. Yuelys – G. Research, Inc. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Operator Good day, ladies and gentlemen, and welcome to the Q4 2014 Hawaiian Electric Industries, Inc. Earnings Conference Call. My name is Alex, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the conference over to Clifford Chen, Manager of Investor Relations and Strategic Planning. Please proceed, sir. Clifford Chen Thank you, Alex, and welcome to Hawaiian Electric Industries 2014 Fourth Quarter and Year-End Earnings Conference Call. Joining me this morning are Connie Lau, HEI President and Chief Executive Officer; Jim Ajello, HEI Executive Vice President and Chief Financial Officer; Alan Oshima, Hawaiian Electric Company President and Chief Executive Officer as well as other members of senior management. Connie will provide an overview of the year and recent company updates. Jim will then update you on Hawaii’s economy, our results for the fourth quarter and year-end and will provide 2015 earnings guidance. They will conclude with questions and answers. In today’s presentation, management will be using non-GAAP financial measures to describe the company’s operating performance. Our press release and webcast presentation materials, which are posted on our Investor Relations website, contain additional disclosures regarding these non-GAAP measures, including reconciliations of those measures to the equivalent GAAP measures. Forward-looking statements will also be made on today’s call. Actual results could differ materially from what is described in those statements. Please reference the forward-looking statements disclosure accompanying the webcast slides, which provides additional information on important factors that could cause results to differ. The company undertakes no obligation to publicly update or revise any forward-looking statements, including EPS guidance, whether as a result of new information, future events or otherwise. I’ll now turn the call over to our CEO, Connie Lau. Constance Hee Lau Thank you, Cliff, and aloha to everyone. 2014 was an eventful year for us, as we filed comprehensive energy transformation plans for Hawaii and announced a merger with NextEra energy. Our operating companies delivered solid financial results with earnings in line with our 2014 EPS guidance. Earned ROE was 9.6% on a GAAP basis and 9.8%, excluding merger-related expenses. At the utility, we continue to invest in the modernization and improvement of our electric grid, as we integrated more renewable energy. Even as recent oil price decreases have brought our customers bill relief, we remain focused on further reducing and stabilizing costs for our customers as well as continuing to bring cleaner sources of energy to Hawaii. And similar to Hawaiian Electric’s June abbreviated rate case filing for Oahu, we filed an abbreviated rate case for Maui Electric at the end of December in which we offered to forego the opportunity to request additional base revenue. Our bank delivered solid financial results in 2014 in a challenging regulatory and interest rate environment. We produced strong loan growth of 6.8% while improving credit quality and maintaining healthy capital level. And finally, we are making good progress on our utility merger and bank spinoff. Our pending combination with NextEra Energy brings together 2 industry leaders in clean energy. With NextEra as a partner, we are confident we can accelerate Hawaii’s clean energy transformation. And we are also confident our bank can and will thrive as an independent public company upon spinoff. Hawaiian Electric has, indeed, put Hawaii on the leading edge of clean energy nationally. We continue to make significant progress towards integrating more renewable energy to achieve the state’s clean energy goals to reduce Hawaii’s dependence on oil as quickly as possible. Renewable sources met 21% of our customers’ energy needs in 2014, far outpacing Hawaii’s 2015 required renewable portfolio standard of 15% and more than double the 9.5% achieved in 2010. We continue to lead the nation in the integration of customer-sited solar. 12% of our residential customers have rooftop solar, an estimated 20x the national average. As of December 31, approximately 50,000 of our customers have rooftop solar, an increase of over 10,000 customers compared to 2013. For the year 2014, our use of renewable generation has displaced about 2 million barrels of oil when compared to our oil use in 2008, which would’ve caused our consumers approximately $259 million in imported oil. Let me now update you on further utility development since our third quarter earnings call. First, we have continued our collaboration with other stakeholders in Hawaii’s energy future. In particular, we worked closely with SolarCity, the Electric Power Research Institute and the Department of Energy’s National Renewable Energy Laboratory to test advanced inverters for performance on circuits with high amounts of solar. This work has helped identify mitigation steps that will help integrate more distributed solar to our grid. Using these test results, we collaborated with inverter manufacturers in the solar industry to finalize new inverter settings to expedite approvals for customers to install their PV projects. As another example of such collaboration, Enphase Energy recently announced the remote upgrading of hundreds of thousands of smart microinverters installed in Hawaii. This should allow rooftop solar systems to be more tolerant when a problem occurs on the grid, which, in turns, helps improve the stability of the overall grid. Building on these solutions, we proposed a new program to increase rooftop solar as part of our utilities’ transformation to deliver a more affordable clean energy future for Hawaii. As I mentioned, we’re already the national leader in rooftop solar by far, and it’s very important for us to ensure rooftop solar can continue to grow in a way that is safe, sustainable and fair for all customers. In January, our utilities filed for approval of a new transitional distributed generation program. Under the transitional proposal, new applicants would be credited for their solar kilowatt hours at a rate that more closely approximates the cost to produce that energy instead of the full retail rate received by current NEM customers. However, existing net-energy metering customers and those with pending applications would remain under the current program. Under our utilities’ proposal, the transitional distributed generation program would remain in effect while the PUC works on a permanent program to be developed through a collaborative process involving stakeholders from across the community, including the solar industry. In conjunction with the transitional DG program and with updated inverter settings to help ensure continued safe and reliable service, our utilities will also modify their interconnection policies, more than doubling the solar threshold for neighborhood circuits to 250% of daytime minimum load, up from 120% of daytime minimum load today, and allowing for more than 90% of Oahu circuits to connect without a longer and costly interconnection study in most cases. We’ve requested approval of the new program within 60 days of filing or by March 20, 2015. The Consumer Advocate has requested that the PUC hold our utilities’ motion in abeyance until further review can be conducted. To further support even more customers adding solar on high-penetration circuits, Hawaiian Electric will also be doing several pilot projects for non-export/smart export PV battery systems with local and national PV companies. These projects will provide real-world operational experience on their capacity to increase solar interconnections on high-penetration circuits. The company is also developing a community solar program as another option to help make the benefits of solar available to more customers, including those who may not be able to or want to install rooftop solar such as renters or condo dwellers. In addition, our utilities are seeking to add grid scale renewable projects, and we have submitted for PUC approval a total of 7 renewable projects, aggregating approximately 220 megawatts and at an average price of approximately $0.14 per kilowatt hour, which is lower than the 2014 average avoided energy costs. These solar projects can benefit all utility customers with lower and less volatile prices and help support Hawaiian Electric’s goal to lower and stabilize customer electric bills. Regarding the Schedule B decoupling review proceeding, the parties submitted responses to the PUC’s information request on December 22. The proceeding is currently pending a PUC order, which will delineate for the parties the set of issues to address in the post-hearing opening brief. Post-hearing opening brief would be due 3 weeks from the date of the PUC order, and post-hearing reply brief would be due 2 weeks after the filing of the post-hearing opening brief. On December 30, 2014, we filed with the PUC the abbreviated rate case for Maui Electric for no change in base rates similar to what we did in June for Hawaiian Electric. We are able to do this as our utilities are aggressively focused on managing costs by pursuing operational and financial efficiencies and other steps, such as deactivation of our older oil-fired power plants and refinancing debt at lower rates. And finally, on January 16, 2015, Governor David Ige appointed Randy Iwase to be the PUC Chair, replacing Hermina Morita who resigned on January 12. His appointment is subject to confirmation by our state Senate. Turning to Slide 5. Allow me to update you on the pending merger with NextEra Energy and the spinoff of our bank. The closing of the merger is subject to various conditions including the approval of holders of 75% of the outstanding shares of HEI common stock, the receipt of all required regulatory approvals from, among others, the Federal Energy Regulatory Commission, the Federal Communications Commission and the Hawaii Public Utility Commission. For the bank spin, we are working with the Federal Reserve Board. On January 8, NextEra Energy filed with the SEC a registration statement on Form S-4, which is subject to SEC review. Once the Form S-4 becomes effective, we can seek shareholder approval of the merger, and we anticipate holding a vote this spring. On January 29, Hawaiian Electric and NextEra Energy filed a joint application with the Hawaii Public Utilities Commission, requesting approval of our proposed merger. The Form 10 for the bank spinoff is now being finalized, and we expect to file it by early March. Overall, we are making good progress and targeting to close both the spin and merger by year-end. I’ll now ask Jim to cover Hawaii’s economy and then our financial results and outlook for the economy. James A. Ajello Thanks, Connie. On Hawaii’s economy, 2014 was the third consecutive record year for both visitor arrivals and expenditures, which were up 1.3% and 2.3%, respectively, from 2013 and still robust after many years of strong growth. 2014 arrivals reached 8.3 million, and total spend was at $14.7 billion. Statewide unemployment remained low at 4% in December of ’14 and 3.4% in Honolulu County compared to 4.7% a year ago for the state and significantly below the current national unemployment rate of 5.7% as of January 2015. Hawaii real estate activity remains strong with the median sales price for single-family homes on Oahu increasing 3.8% in 2014 over 2013. However, the number of closed sales was slightly down by 0.9% year-over-year. The December 2014 Oahu median single-family home price was at $690,000. Construction activity reflected by the value of private building permits increased 21.9% in 2014 compared to 2013, driven by the increase in commercial and industrial new projects, additions and alterations. The University of Hawaii Economic Research Organization has estimated that Hawaii will save $1.4 billion over the span of a year from the decline of petroleum prices if recent prices are sustained. Overall, we expect to see continuing growth in Hawaii’s economy in 2015 supported by the construction industry, steady performance of the tourism industry and petroleum prices. As shown on Slide 7, 2014 GAAP earnings per share were $1.64 and in line with our 2014 EPS guidance range of $1.60 to $1.67. Excluding merger-related expenses, core earnings per share were $1.68, up $0.06 on a comparable basis versus $1.62 per share in 2013. Pace of earnings in 2014 can be skewed more towards the first 3 quarters of 2014 with fourth quarter 2014 earnings lower than the prior 3 quarters due to the timing of expenses. As shown on Slide 8, HEI’s 2014 GAAP consolidated ROE was 9.6%. Excluding merger-related expenses, HEI’s 2014 core consolidated ROE was 9.8% versus the comparable 9.7% in 2013. On Slide 9, utility earnings were $138 million in 2014 compared to $123 million in 2013. EPS of $1.34 exceeded our earnings guidance range of $1.30 to $1.33 per share. The detail of variances are shown on the slide, and I’ll highlight just a few. In 2014, on an after-tax basis, the most significant year-over-year net income drivers were: higher net revenues, primarily due to $29 million in higher recovery of additional infrastructure investments and operating costs; $3 million refund to Maui Electric customers in 2013 due to the 2012 final rate case decision and order. This was partially offset by $1 million in lower earnings from lower fuel efficiency performance of our operating units. Higher net revenues were partially offset by higher depreciation, higher interest expense, including lower revenue balancing account interest income, the favorable deferred tax adjustment recorded in 2013 and higher O&M expense. O&M expense was $3 million higher after tax or about 1% higher compared to last year. However, excluding the unanticipated Tropical Storm Iselle expenses, which were $4 million pretax, and the consulting expenses associated with our energy transformation plans, which were $8 million pretax, O&M expenses for 2014 would’ve decreased by approximately $4 million on an after-tax basis, driven by the following pretax items: $8 million for grid modernization programs, cost for smart grid installation; $4 million for the upgrade of our customer information system, partially offset by $9 million of lower customer service expenses; $5 million lower overhead expenses due to the reduced scope of work; and then $5 million in savings from the deactivation of generating units. Overall, we were able to limit our O&M expenses to less than inflationary levels. At the bank, net income for the year was $51 million in 2014 compared to $58 million in the prior year. EPS of $0.50 was firmly in line with our guidance range of $0.47 to $0.52. The most significant drivers of the decline from 2013 after tax were: $3 million in lower interchange fees due to regulatory caps attributable to the Durbin amendment; $3 million in declines of mortgage banking income related to the decline in mortgage refinancing volume; and $3 million in higher provision for loan losses, primarily due to reserves allocated for loan growth. The 2013 provision was low due to the release of reserves associated with the sale of the credit card portfolio, which was partially offset by $3 million in higher net interest income as contributions from loan growth more than offset for lower yields on loans. Now focusing on the utility. Slide 11 shows the utility’s actual ROEs for the year ended 2014. The consolidated utility ROE of 8.4% improved from 8% in 2013, reflecting higher earnings in 2014, topping the guidance range of 8% to 8.3%. The majority of the 2014 increase is driven by higher recovery in infrastructure investments and operating costs. Over the last quarter, we also experienced better-than-expected fuel efficiency in our generating units, enabling us to come in slightly higher than the guidance range. Turning to Slide 12. This slide reflects the cost of oil for Hawaii versus crude oil prices. As you can see from the slide, oil prices in Hawaii have declined starting in December of — September of 2014. With the cost of oil, including purchase power and taxes representing over 70% of customer bills, the average cost per barrel of fuel in the fourth quarter of 2014 declined by about 8% from the third quarter of 2014. From September of 2014 compared to early February of 2015, the average consumer bill on Oahu has declined by approximately 20% from about $219 to $177 per month, a 4-year low. Even with the recent decline in fuel oil prices, we are still firmly committed to LNG as it provides the added benefit of meeting MATS compliance requirements while avoiding costly or alternative solutions. We continue to be focused on replacing oil with renewables as quickly as possible in order to achieve the state’s clean energy goals to reduce Hawaii’s dependence on oil. I’ll now discuss the bank. Turning to American Savings Bank on Slide 14. American continued to deliver solid profitability metrics, which were generally in line with its targets and peers’. We have achieved a competitive return on assets of 95 basis points for 2014. With our ongoing efforts to enhance our products, service and risk management capabilities, we produced strong loan growth of 6.8% in 2014 in line with our mid-single-digit loan growth target and better credit quality. Our net loan charge-off was 1 basis point in 2014, beating our target of 7 basis points, and that is extremely low relative to our peers. Our 2014 net interest margin of 3.62% came in at the high end of our guidance range of 3.5% to 3.6% as loan portfolio repricing due to the low interest rate environment slowed in the latter part of the year, and higher fees and interest were recognized due to the payoff of certain commercial loans. Overall, the bank continues to maintain its low-risk profile, strong balance sheet and straightforward community business banking model. On Slide 15, our net interest margin of 3.65% in the fourth quarter of 2014 was 3 basis points higher than the linked quarter. Our interest-earning asset yield improved by 2 basis points, primarily attributable to interest and fees related to the payoff of certain commercial loans and slower amortization of premiums associated with mortgage-backed securities in our investment portfolio. Our liability cost of 22 basis points was 1 basis point lower than the linked quarter. We anticipate continued net interest margin compression, as new pricing on loans continues to be lower than our portfolio rates, albeit at a smaller — at a slower pace. On Slide 16, we showed the declining trend in noninterest income in 2014, which is primarily driven by lower mortgage banking income related to the decline in mortgage refinancing volume and the gain on sale margin compression and lower fees from other financial services primarily related to the Durbin amendment’s rate cap on interest — on interchange fees. The gain in prior year ended related to the sale of the credit card portfolio. For the full year, the $10.9 million pretax decline compared to 2013 was driven by $5.4 million in lower mortgage banking income, $4.1 million in lower interchange fees driven by $5 million lower rates due to Durbin, partially offset by higher volume and $2.3 million in gain from the sale of credit card portfolio in 2013. These were partially offset by $1.6 million in higher gain sale of securities. As a result of prudent risk management practices and the healthy local economy, credit quality has improved. 2014 net charge-off ratio was a very low 1 basis point compared to 9 basis points in 2013. Provision for loan losses in 2014 was $6.1 million, an increase of $4.6 million compared to 2013, primarily due to reserves allocated for growth in the loan portfolio. The 2013 provision was unusually low due to the $1 million release in reserves in 2013 related to the credit card sale and improvement in loss rates, which has since stabilized. The allowance for loan losses was 1.03% of outstanding loans at $45.6 million at year-end compared to 1% at the end of the linked quarter and 0.97% as of the prior year-end. On Slide 18, American’s nonperforming assets ratio of 0.85% is 3 basis points lower than the end of the third quarter and lower than the 1.2% at the end of the fourth quarter last year and remains better than its high-performing peers. This is consistent with our improved credit quality, effective credit management and strong loan growth. Slide 19 illustrates American’s continued attractive asset and funding mix relative to our peer banks. American’s December 31, 2014, balance sheets stacked against the last complete available data set of our peers, which is at September 2014. 96% of our loan portfolio was funded at low-cost core deposit versus the aggregate of our peers at 90%. In 2014, total deposits increased by $251 million or 5.7%, which helped fund our strong loan growth while maintaining a very low cost of funds of 20 basis points in the fourth quarter of 2014, 15 basis points lower than the median of our peers. American remains well capitalized with a leverage ratio of 8.9% at year-end, tangible common equity of 8.3% and total risk-based capital of 12.3%. In 2014, American paid $36 million in dividends to HEI while maintaining healthy capital levels. Now I’ll address HEI’s outlook for 2015. Utility’s updated 3-year capital expenditures consisting of both foundational and transformational investments is forecast to be between $1.1 billion and $2 billion. Our foundational investments represent the core investments needed to continue to deliver safe, reliable and efficient service to our customers. They include projects to replace aging infrastructure, to improve reliability, connecting or upgrading customer connections and improving our internal infrastructure to be more efficient and effective. Many of our transformational initiatives depend upon external factors, which could impact our ability to execute strategic plans. Our application for approval of the Schofield Generating Station is at the PUC, and we expect to file PUC applications for battery storage, LNG and smart grid in 2015. For 2015, we expect rate base growth in the range of 3% to 5% on our 2014 ending rate base of $2.7 billion. As American prepares for life as an independent publicly traded company, it remains focused on its core banking business, growing loans and deposits and generating fee income by providing an attractive value proposition to customers. In 2015, the bank is targeting mid-single-digit loan growth in order to offset the continued impact of declining yields. The bank expects loan growth generally consistent with current portfolio mix but somewhat faster growth in the consumer and business banking and its — for its asset quality profile to remain strong. Work continues on the bank’s plan to consolidate its personnel and management footprint to its new corporate campus. This will allow the consolidation of teammates from 6 different locations to enhance culture and collaboration. The bank continues to focus on cost management and core operation, as its fund — as it funds critical initiatives for long-term growth, and total noninterest expense will be higher in 2015 due primarily to higher pension costs. Overall, the bank expects to continue to deliver strong profitability metrics. HEI begins 2015 with a strong capital structure with 52% consolidated common equity to total capitalization. Our 2015 holding company financing plans include approximately $50 million settlement of the equity forward, the dividend reinvestment plan remains closed for original issuance throughout 2015, an issuance of $40 million of additional debt for the remainder of the holding company needs is assumed in 2015. On December 4, following our merger announcement with NextEra, Moody’s affirmed its ratings of HEI. Fitch placed HEI on ratings watch positive and noted that it will likely resolve the rating watch upon completion of the transaction and could upgrade HEI by one notch, given its proposed ownership by a higher-rated company. S&P also placed HEI on credit watch with positive implications and issued a subsequent report on January 26, 2015, stating the ratings of HEI and its subsidiaries are on credit watch with positive implications because of the proposed merger and higher-rated — with higher-rated NextEra Energy. There have been no changes to the bank credit ratings or outlooks. Based on our current environment, but excluding any merger-related expenses, we are initiating 2015 earnings guidance in the range of $1.64 to $1.74 per share. We expect utility earnings growth will be 2015 EPS range of $1.30 to $1.35 and bank EPS in the range of $0.50 to $0.54. Based upon the revised CapEx plan and 51% common equity capitalization target, we expect all of our 2015 equity needs to be satisfied through the existing equity forward. At the utility, our guidance assumes no changes to the decoupling model, including Schedule B issues to be addressed and the pending decoupling docket. We assume utility O&M to be up approximately 2% compared to 2014 levels as we continue to execute our strategies, which are not currently recovered in rates and associated with clean energy transformation. We also assume fuel efficiency consistent with rate case levels and related heat rate deadband. However, changes in system demands could cause fuel efficiency to fluctuate outside the deadband. We assume rate base growth of approximately 3% to 5%, and overall, we expect 2015 utility ROE of 8% on a GAAP basis. At the bank, we expect mid-single-digit loan growth, which we expect to be more than offset with the effect of lower yields on net interest income. Net interest margin between 3.45% and 3.55% as we expect yields on our loans to continue to decline, albeit at a slower rate. We expect a slight improvement in noninterest income, a growth in fee income from other financial services. Net charge-offs is expected to remain low at under 0.1%. Provision is expected to be in the range of $5 million to $8 million, slightly higher than 2014 due to additional reserves for loan growth. Overall, we expect return on assets to be about 95 basis points. Connie, I’ll now turn the call back over to you. Constance Hee Lau Thanks, Jim. In summary, our utility is a leader in the industry in integrating renewable and distributed generation. Together with our regulators, policymakers and other stakeholders, we are making Hawaii a leader in clean energy. As we continue to transition to a clean-energy future, our utility continues to be focused on customer choice and affordable and equitable distributed costs for all of our customers. Our bank continues to be a solid performer and will continue to focus on its core banking business, targeting mid-single-digit loan growth and strong credit quality. Overall, HEI’s business model continues to provide our company with the financial resources to invest in the strategic growth of our company while supporting the continued stability of our dividend, which we have paid for over 100 consecutive years. This week, we announced that our board maintained the quarterly dividend of $0.31 per share. Our dividend yield continues to be attractive at 3.7% as of yesterday’s market close. And finally, as our PUC application outlined, joining with NextEra Energy as a partner will help strengthen and accelerate Hawaii’s clean energy transformation. Plus, we are confident that after its related spinoff, American Savings Bank, as a new publicly traded entity, will remain a strong community bank for Hawaii poised to generate shareholder value. And with that, we look forward to hearing your questions. Question-and-Answer Session Operator [Operator Instructions] Your first question comes from the line of Paul Patterson with Glenrock Associates. Paul Patterson – Glenrock Associates LLC A couple of things. I mean, we’ve had some coverage of the governor’s comments. Some legislation’s been introduced regarding municipalization and increased renewable goals and what have you. And there’s a new PUC Chair who’s concerned about, among other things, the number of vacancies and unfunded positions. And there’s also a poll that’s come out that sort of indicates that maybe customers, or at least those who are polled, don’t have a complete view as to the value that’s being provided by the merger. And I’m just wondering, you know, it’s all sort of been in the last month, and I know that it’s been moving. You guys have obviously been filing things, and a lot of stuff has been happening sort of concurrently. But I am just sort of trying to get a sense as to how you feel about sort of the game plan of sort of getting this thing through and making people feel more comfortable with the proposed transaction. And is there a risk that this could drag out longer — this approval process because of the vacancies and just — the review process might take longer because there’s only so many people to do the job kind of thing. I mean, if you could just sort of address that sort of. Constance Hee Lau Sure. Paul, let me just start with the poll that you cited and just give you a little more clarity as to the timing of that, because you really did state it right that the poll was saying that people needed more information about what the combination would bring in terms of advantages for customers. And it’s quite understandable why it came out that way because the poll was actually done before the filing of the application with the Public Utilities Commission that actually outlined the benefits for customers in the form of a 4-year stay-out for increases in base rates and also the foregoing of the increases in O&M that we would normally get through the decoupling mechanism, and that was the quantified savings of about $60 million. So that information was actually not out in the public at the time that the poll was done. And then overall, I think to your question, it’s really in the very, very early stages, and I think most of the statements that have come out from almost everyone, whether it is the governor or our legislators, have been about needing to just make sure that the transaction is really scrutinized carefully to ensure that it is going to be in the interest of the customers here in Hawaii. I’m not sure I can tell you much more than that at this point because I say it is quite early in the process. That application was only filed, what, just a few weeks? James A. Ajello January 29. Constance Hee Lau Yes, January 29, not very long ago at all. And as to the staffing levels at the Public Utilities Commission and its Consumer Advocate, I think unfortunately, in a small state like ours, we always have lived with those shortages of resources. But there have been commitments to try to bump up those resources to deal with all of these issues before our commission. They’ve been pretty stretched for the last few years largely because Hawaii has this very aggressive public policy position to move the state to renewable energy and to get off of oil. Operator The next question comes from the line of Charles Fishman with Morningstar. Charles J. Fishman – Morningstar Inc., Research Division Yes, just a follow-up on Paul’s question. So the Hawaii PUC is still what you expect to be the last approval. Constance Hee Lau The last — yes, we actually have a whole series of approvals. I guess, what I would say, Charles, is that, that’s going to be one of the big approvals that we need to get and, of course, the other one is the shareholder approval. Some of the other so-called approvals like the Federal Reserve Board may not come until just before the bank spin. Charles J. Fishman – Morningstar Inc., Research Division Okay. So I mean — but the PUC is what drags this to year-end. I mean, because obviously, your shareholder vote is in the spring, so you’ll know up or down then. Constance Hee Lau Yes, it is the process that takes the longest period of time. Charles J. Fishman – Morningstar Inc., Research Division Okay. Maybe that was a better way to phrase it. And then just the $0.06 per share difference between core and GAAP, I mean, if I’m reading the last page right and part of the problem here could where the page break was, does the — the entire $0.06 was due to the merger. Correct? Constance Hee Lau Yes, and it is $0.04. Charles J. Fishman – Morningstar Inc., Research Division $0.04 in the fourth quarter but $0.06 for the full year or am I reading that correctly? James A. Ajello Yes. Charles, yes. Jim Ajello. $4.9 million represents the difference all together, and some of the expenses were incurred in the third quarter and some in the fourth quarter. So I cited that there was $1.64 versus $1.68. Some rounding brings you to about $0.05. Charles J. Fishman – Morningstar Inc., Research Division Okay. And then Connie, I was intrigued by your comment about the community solar for apartment buildings. Could you elaborate on that, exactly how that would work? Constance Hee Lau Sure. And actually, since Alan is here, maybe I’ll let him answer that question because as we’ve been going out into the communities there’s been quite a bit of interest in that community solar, and particularly in Hawaii, because we don’t have a whole lot of land. So we do have a lot of condominiums. Not everybody’s got a roof. Alan M. Oshima Yes. So we have, as Connie mentioned, a lot of people in high-rises or apartment dwellers, renters, nonprofits who rent premises are interested in getting some of the benefits of a lower bill but really don’t have a rooftop to install rooftop PV. We’re looking at some solar grid farms that would be offered to the public to purchase designated bill credits as a part of the savings that they could accrue. The bill credits would then follow them from place to place. It wouldn’t be tied to the real estate that they’re currently located at. So this affords more people to get clean renewable energy as a part of their bill reduction. It won’t be 1 for 1 as is with solar, but the upfront investment would not be as great as well. So there’ll still be a good payback, and we’re looking to install the first pilots with PUC approval sometime this year. Charles J. Fishman – Morningstar Inc., Research Division That’s interesting. I sincerely hope you’re new owner continues to treat Hawaiian Electric as a solar laboratory for the world. It’s real interesting. Alan M. Oshima Thank you. Constance Hee Lau Yes. I think they’ve said that’s one of the reasons that they were interested in Hawaiian Electric is because so much is going on here. Operator And your next question from the line of Nick Yuelys with Gabelli & Company. Nicholas D. Yuelys – G. Research, Inc. Congrats, again, on the merger. Just one quick question on the 2016 CapEx, can you just walk us through why it’s about $300 million lower than what you filed in the PSIP? Constance Hee Lau Okay. Tayne is going to answer that. Tayne S. Y. Sekimura Yes. So basically, what we did from — using the PSIP sort of as a baseline, there has been a number of changes, and we had a number of updates to our forecast. And they would include things like looking at battery energy storage and after understanding our needs, re-scoping those types of projects. We looked at probability of executing on our projects, given the schedules, and we’ve flipped some projects out of the 2016 time frame. So those are just sort of general comments about an update from what we filed in August. Operator Your next question comes from the line of Sachin Shah with Albert Fried. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division I just had a couple questions on the regulatory approvals. I just saw the amended S-4 being filed, but I didn’t see any updates on the regulatory approvals, all of them specifically, and if they were filed and when some of the waiting periods may be ending. I know you were talking about the PUC, but just curious to see if there’s an update on that. Constance Hee Lau Sure. So what’s filed — the first document that was filed was the S-4, and so we’ve just received some comments from the SEC the process is that we need to work through those with the SEC, and then they will declare that statement effective. And as we mentioned, we’re expecting that we would be able to work through the comments and obtain the effective dates so that we could go forward sometime this spring with the vote for shareholders. The second document that was filed, and that was just a little less than 2 weeks ago, was the application with the Public Utilities Commission. As you noted, we talked quite a bit about that. There has been no schedule that has been issued around that very recent filing. In addition, we have filed with the Federal Energy Regulatory Commission and also the Federal Reserve Board. And those have, again, just been filed, I guess, within the last week. Jim? James A. Ajello Correct. Constance Hee Lau So they’re pretty new as well, and then Hart-Scott-Rodino is a waiting period that will go now for the next few months. James A. Ajello Yes, HSR — it’s Jim — HSR has a waiting period once filed. And the approval, assuming it comes, has a 12-month shelf life. So you want to stage the filing and hopefully, the approval of that to be fresh enough to complete the transaction once it’s consummated and the PUC approval. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Okay. So as far as the HSR, that has been filed. So if that’s the case, then… James A. Ajello It’s not been filed. HSR has not been filed. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Okay. Any idea when you may be expected to file that, Jim? James A. Ajello We’ll need a little more line of sight on the rest of the filings in the approval process because, as I mentioned, that it has a shelf life associated with it, and so we’ll want to make sure… Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Okay. So you don’t want to do it too early because you want the process to kind of procedurally move forward, and then strategically, you want to file it so you’ll have that window. James A. Ajello That’s correct, and by the way, both partners to the — or parties to the merger file an HSR. Constance Hee Lau And given that the 2 utilities are 5,000 miles away, no, we’re not expecting that Hart-Scott-Rodino would be the critical item in all the approval process. I guess, I should mention one other filing, and that is something called a Form 10 filing, which we also need to make with respect to the bank side of the transaction, and that is the document needed in order to spin the bank. That filing, we would expect to make within the next few weeks. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Okay. So the path to completion, again, it seems with these various filings, have been made or yet to be made is really just the PUC for the most part. Is that — and obviously, the Form 10 for the spinoff, that’s an important part as well. Constance Hee Lau Yes. It’s really the PUC approval and the shareholder approval. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Okay. The shareholder approval, as you mentioned, shareholder vote, we’re potentially looking kind of like a April-May time frame. Constance Hee Lau Yes. Sachin Narendra Shah – Albert Fried & Company, LLC, Research Division Okay. Then it all comes down to kind of procedurally waiting for the PUC later in the year. Constance Hee Lau Yes. Operator And there are no questions at this time. [Operator Instructions] And I show no additional questions in queue at this time. Constance Hee Lau Okay. Well, thank you, all, very much for joining us on the call today. And if you have any follow-up questions, please feel free to contact Cliff. Operator Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

WGL Holdings (WGL) Q1 2015 Results – Earnings Call Transcript

WGL Holdings (NYSE: WGL ) Q1 2015 Earnings Call February 05, 2015 10:30 am ET Executives Douglas Bonawitz – Head of Investor Relations Terry D. McCallister – Chairman, Chief Executive Officer, Chairman of Executive Committee, Chairman of Washington Gas Light Company and Chief Executive Officer of Washington Gas Light Company Vincent L. Ammann – Chief Financial Officer, Senior Vice President, Chief Financial Officer of Washington Gas Light Company and Senior Vice President of Washington Gas Light Company Adrian P. Chapman – President, Chief Operating Officer, President of Washington Gas Light Company and Chief Operating Officer of Washington Gas Light Company Gautam Chandra – Senior Vice President of Strategy, Business Development and Non-Utility Operations Analysts Mark Barnett – Morningstar Inc., Research Division Operator Good morning, and welcome to the WGL Holdings Inc. First Quarter Fiscal Year 2015 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. [Operator Instructions] The call will be available for rebroadcast today at 1:00 p.m. Eastern, running through February 12, 2015. You may access the replay by dialing 1 (855) 859-2056 and entering the pin 70000880. If you do not have a copy of the earnings release, you may obtain one at www.wglholdings.com. I’ll now turn the conference over to Doug Bonawitz. Please go ahead. Douglas Bonawitz Good morning, everyone, and thank you for joining our call. Before we begin, I’d like to point out that this conference will include forward-looking statements under the federal securities laws. Forward-looking statements inherently involve risks and uncertainties that could cause our actual results to vary materially from those predicted in such forward-looking statements. Statements made on this conference call should be considered together with cautionary statements and other information contained in our most recent annual report on Form 10-K and other documents we have filed with or furnished to the SEC. Forward-looking statements speak only as of today and we assume no duty to update them. This morning’s comments will reference a slide presentation on our website, you can access by going to www.wglholdings.com, clicking on the Investor Relations tab, and then, choosing Events and Webcast from the drop down menu. The slide presentation highlights the results for our first quarter of fiscal year 2015 and the drivers of those results. On today’s call, we will make reference to certain non-GAAP financial measures, including operating, earnings of WGL Holdings on a consolidated basis and adjusted EBIT of our operating segments. A reconciliation of these financial measures to the nearest comparable measures reported in accordance with Generally Accepted Accounting Principles or GAAP is provided as an attachment to our press release and is available in the Quarterly Results section of our website. This morning, Terry McCallister, our Chairman and Chief Executive Officer will provide some opening comments. Following that, Vince Ammann, Senior Vice President and Chief Financial Officer will review the major items that led to our first quarter results. Adrian Chapman, President and Chief Operating Officer, will discuss key issues affecting our business and the status of some of our principal initiatives. In addition, Gautam Chandra, Senior Vice President of Strategy, Business Development and Non-utility Operations, is also with us this morning to answer questions. And with that, I would like to turn the call over to Terry McCallister. Terry D. McCallister Thank you, Doug, and good morning everyone. Our first quarter results have given us a strong start to fiscal year 2015. Our non-GAAP operating earnings for the first quarter as shown on Slide 3 in our presentation were $58 million or $1.15 per share, compared to $51.4 million or $0.99 per share in the first quarter of 2014. This 17% increase in consolidated operating earnings per share was driven by strong results in all 4 of our operating segments this quarter compared to the prior year. At the utility, we saw 6% increase in adjusted EBIT over what had been a strong performance in the first quarter of 2014. Our customer base continue to grow as the active — average active customer meters increased by 12,000 meters year-over-year for the first quarter of 2015. Utility results were also driven by accelerated pipeline replacement programs as well as strong asset optimization revenues. The commercial energy systems business also delivered strong results across the board. We continue to see earnings growth driven by the distributed generation in assets that we own across the country. We invested in an additional $43 million in commercial solar assets this quarter, as part of our plan to spend a total of $150 million on the distributed generation investments this year. These investments will continue to build a steady stream of income from the sale of clean power to our customers. Midstream energy services business delivered higher results compared to the first quarter of 2014. Capitalizing on optimization opportunities offered by the winter weather are continuing to invest in the 2 pipeline projects under development. Finally, our retail energy-marketing business performed well, with electric margins significantly higher in the first quarter of — than in the first quarter of last year. Over the past quarter, PJM capacity pricing returned to expected levels. Also, PJM introduced procedural changes that results in lower ancillary cost. The company has also introduced options, that allow our customers to choose a lower price in exchange for sharing the risks associated with potential costs volatility. As discussed in previous quarters, we continue to drive towards a return to historical levels of earnings in this business. These efforts include an increased focus on large commercial and government account relationships. As an example, WGL Energy recently won the General Services Administration contract to serve power to the federal facilities in the District of Columbia and Maryland. Maryland contract extends 2 years, and the District of Columbia contract extends over 18 months. Of course we hope to work further with GFA to explore opportunities to provide distributed power generation to many of these sites, helping these federal organizations meet the mandated 2020 greenhouse gas reduction goals. Retail energy-marketing business continues to be an important component of our ability to provide a comprehensive set of energy answers to customers. I’m confident in our ability to achieve our financial plan for 2015. Given our results for the first 3 months and our earnings outlook for the remainder of the year, we are affirming our consolidated non-GAAP earnings guidance in the range of $2.70 to $2.90 per share for fiscal year 2015, although at this point, we anticipate being in the higher end of the range. Finally, as noted in our earnings release, I’m also pleased the Board of Directors has approved a $0.09 increase in our dividend to an annual rate of $1.85 per share. This 5% increase reflects our confidence in our strategic plan and our commitment to provide sustainable dividend growth for investors. This is the 39th consecutive year that WGL Holdings has increased the dividend on its common stock. I’m now going to turn the call over to Vince, who will review our first quarter segment’s — our results by segment. Vincent L. Ammann Thank you, Terry. First I’d like to remind you that we’ve made a change to our practice of discussing earning results at the segment level. Going forward, we’ll use non-GAAP adjusted earnings before interest and taxes or adjusted EBIT to discuss results at the segment level. This change will provide more clarity by allowing us to discuss the performance of each business unit, prior to the impact of interest expenses, taxes and accretion and dilution. Turning first to our utility segment. Adjusted EBIT for the first quarter of fiscal year 2015 was $96.6 million, an increase of $5.7 million compared to the same period last year. The drivers of this change are detailed on Slide 5. We continue to grow and add new meters. The addition of over 12,000 average active customer meters, improved adjusted EBIT by $1.5 million. Higher asset optimization revenues added $5.8 million. Revenues from the new rates in Maryland added $2.6 million, as new base rates were effective in Maryland on November 23, 2013. Higher revenues from our accelerated pipe replacement program also added $2.3 million in adjusted EBIT. Partially offsetting these items, were higher O&M expense, primarily driven by higher labor and employee incentive costs, which reduced adjusted EBIT by $4.7 million. Higher depreciation expense also reduced adjusted EBIT by $1.6 million, while reflecting growth in our utility investment, our investment utility plan. Turning to the retail energy-marketing segment. Adjusted EBIT for the first quarter of fiscal year 2015 was $9 million, an increase of $7.6 million compared to the same period last year. On Slide 6, you’ll see that the primary driver of the increase was higher electric gross margins, partially offset by lower natural gas margins. Electric margins increased by $8.8 million, driven by lower capacity charges and lower costs for PJM ancillary services, partially offset by lower sales volumes. Electric volumes decreased 6% in the first quarter versus the prior year, primarily, due to a decline in customers and warmer weather. PJM capacity prices for the territories that we serve were on average about 60% of the levels seen in the prior PJM year, which led to more favorable electric margins in this quarter versus the same quarter last year. I would also like to note that ancillary charges in PJM have been well below the levels seen during the polar vortex that occurred last year. While peak demand on the PJM systems this winter has been close to the levels hit during the January of 2014 polar vortex. New PJM procedures that improve generation reliability and cost allocation have resulted in lower energy costs and reduced ancillary service costs this winter. In the natural gas business, gross margins were $1.5 million lower as benefits realized last year related to wholesale portfolio optimization and interruptible spots sales did not recur. Natural gas volumes decreased 5% in the first quarter versus the prior, primarily due to decline in customers and warmer weather. As Terry mentioned, the focus of our sales effort recently as well as going forward, will be on the large commercial and government accounts in both the electric and natural gas margins. We believe this strategy will facilitate the return of earnings to historical levels. Next, I’ll move to the commercial energy systems segment. Adjusted EBIT for first quarter of fiscal year 2015 was $1.2 million, an increase of $1.2 million compared to the same period last year. The increase reflects growth in distributed generation assets in service, as well as improved margins in the federal contracting business and higher earnings in investment solar businesses. Please note the earnings for this segment are somewhat seasonal in nature, and while our earnings are modest year-to-date, we are on track to meet our original adjusted EBIT forecast for the segment. The commercial energy systems segment continue to add new projects to its portfolio. As of December 31, we have over $80 million — over 80 megawatts of installed solar capacity and 3 megawatts of solar fuel cell capacity. We have an additional 20 megawatts of distributed generation, currently under contract or in construction. In total, these projects represent over $330 million of capital investments and we continue to see a robust pipeline of future distributed generation assets. During the first quarter, our commercial distribution generation assets generated over 19,000-megawatt hours of clean electricity, which is sold to customers through all purchase agreements. This is more than double the amount generated during the first quarter of last year. As Terry mentioned earlier, we are on track to invest $150 million in commercial solar, other distribution — distributed generation projects, during the fiscal year 2015. Next, I’ll move to the midstream energy services segment. Adjusted EBIT for the first quarter of fiscal year 2015 was $2.6 million compared to $1.8 million in the same period last year. The increase, primarily reflects favorable storage spreads, partially offset by the development expenses. Results of other non-utility activities reflecting adjusted EBIT loss of $1.5 million compared to a loss of $1.9 million for the same period of the prior year. Please note that in December of 2014, WGL fully impaired it’s equity investment in ASD Holdings Inc. for a charge of $5.6 million. The impairment was recorded as a non-GAAP adjustment. The charge of solar related to revaluation of our equity investment in the development company, and all of our leases, solar residential assets prior to this relationship are performing as expected. I’ll now move to a discussion of interest expense on a consolidated basis for the first quarter. Interest expense primarily driven by long-term debt, increased to $12.3 million during the first quarter compared to $9 million in the prior period. In October, WGL issued $100 million of 5-year notes and $125 million of 30-year notes. In December, WGL sold an additional $25 million of 30-year notes. In total $250 million of long-term debt was issued at the holding company during the first quarter. Proceeds are being used primarily to fund our share repurchase program and non-utility capital investments. In December, Washington Gas also issued $50 million of 30-year notes. We also took advantage of the opportunities to extend our revolving credit facilities to December of 2019. Facilities previously had a maturity date of April, 2017. On August 7, we announced a $150 million share repurchase program authorized by our Board of Directors. The plan authorizes WGL to repurchase shares based on market and other financial conditions. During the quarter ended, December 31, we purchased — we repurchased 1 million shares of common stock for a cost of $42 million. Since the plan’s inception, WGL has invested $98 million to repurchase 2.3 million shares of WGL common stock under the plan at an average price of $43.31. As Terry stated earlier, we are affirming our consolidated non-GAAP operating earnings guidance in a range of $2.70 and $2.90 per share with a focus on the higher end of the range, primarily, due to strong performance at the regulated utility. I’ll now turn the call over to Adrian for his comments. Adrian P. Chapman Thank you, Vince, and good morning, everyone. I’m pleased to provide you with an update on our operations and regulatory initiatives. In addition to Columbia, you may recall that the Public Service Commission issued an order in March of 2014, conditionally approving an expanded accelerated pipeline replacement plan. The plan would increase spending in the District of Columbia to approximately $110 million over a 5-year period. In August, 2014, the commission granted final approval of the revised accelerated pipe replacement plan pending the determination of an appropriate cost recovery mechanism. I’m pleased to report, that the commission recently approved a unanimous settlement agreement that authorizes a surcharge to provide timely recovery of our return on and off pipeline replacement investment, including all replacement activity since June of 2014. As a result, this program will begin to positively impact earnings fiscal year 2015 as expected. In Maryland, the Public Service Commission issued an order in December approving the stride project list for 2015. The project list targets approximately $37 million in accelerated infrastructure replacement capital expenditures and also includes an associated surcharge factor, subject to adjustments made by the staff of the PSC. The calendar year 2015 factor is estimated to collect $3.8 million in revenue. In Virginia, we plan to file by Monday February 9, an application at the SEC of Virginia for approval to amend our current SAVE plan. The Virginia State Act established a regulatory framework for local distribution companies to accelerate infrastructure replacement, and receive current cost recoveries through a surcharge. The commission previously approved and amended SAVE plan in November 2012 that increased our SAVE expenditures to $191 million, over a 5-year period beginning in January, 2013, and ending on December 31, 2017. Based on the company’s experience to date with the implementation of approved SAVE plan program, as well as analysis of our distribution integrity management plan, Washington Gas will propose amendments to the SAVE plan. The amendments in our filing will include both revisions to approve SAVE plan programs, as well as proposals for new eligible infrastructure replacement programs, including the replacement of infrastructure on Washington Gas’ transmission system. The company will request approval for the amended SAVE plan up through December 31, 2017, which is the expiration date for the previously approved SAVE plan. As required by the SAVE Act, the proposed new programs will enhance system safety and reliability by reducing system integrity risks and will also help reduce green house gas emissions. Also in Virginia, legislation was enacted in 2014 that will allow local distribution companies to invest in gas reserves to realize longer-term gas cost to reliability benefits for customers. We initiated a process last year to identify opportunities that would benefit our customers in Virginia. And we are currently evaluating proposals with the goal of presenting a proposal to the commission in the third fiscal quarter of this year. And one final item in Virginia, I’m pleased to report that legislation was recently introduced in the general assembly that supports the expansion of natural gas infrastructure to serve potential customers, located at areas not currently served. Local distribution companies will be able to file a system expansion plans that will address the deferral and recovery of costs, that would be considered uneconomic under utilities new customer economic test and require large upfront contributions in aid of construction from potential customers. A system expansion wider will allow for the recovery of eligible systems expansion infrastructure costs, as a monthly surcharge from effected new customers, as a separate mechanism from the customer rates established in rate case, as well as the deferral of unrecovered eligible system expansion infrastructure costs. To fully support this legislative initiative, that will help bring the benefits of natural gas to more customers in Virginia, including our franchised service territory. I would now like to turn the call back to Terry for his closing comments. Terry D. McCallister Thanks, Adrian. I’d now like to highlight a few of our recent developments. First, an update on our constitution — our investment in the constitution pipeline project. In early December, the FERC issued a certificate of public convenience and necessity for the pipeline. We are still waiting for permitting for the project from the state of New York. Given the permitting delays we now expect in services date sometime in the second half of 2016. While we are disappointed in this delay, we are still confident that the project will move forward to provide an important stream of future earnings. As of December 31, our subsidiary WGL Midstream has invested approximately $24 million in the constitution pipeline project, we expect to invest an additional $55 million through completion. Now turning to our larger investment in the Central Penn Line. The Central Penn Line is greenfield pipeline segment of Transco’s announced Atlantic Sunrise project, WGL Midstream will invest approximately $410 million. This project is on track and development activities are proceeding as expected. The Central Penn Line have a projected in-service date in the second half of 2017. As of December 31, our subsidiary WGL Midstream has invested approximately $10 million in the Central Penn Line project. In late November, WGL Midstream entered into a gas sale and purchase and capacity agreement with GAIL Global USA, a subsidiary of GAIL India. WGL Midstream agreed to sell and deliver a minimum of 340,000 decatherm per day and up to 430,000 decatherms per day of natural gas for a term of 20 years from the in-service date of the Cove Point LNG export facility. WGL Midstream will make deliveries using transportation capacity released by GAIL through an Asset Management arrangement. The majority of the natural gas will be purchased by WGL Midstream through an existing arrangement with Antero Resources, one of the most active operators in the Marcellus and Utica Shale regions. Under these arrangements, WGL Midstream also has an option to acquire a 30% interest in the 70-mile extension of an existing gathering system, pipeline system that will support the Antero’s deliveries to pipeline serving the Mid-Atlantic market. We look forward to a long-term relationship with both GAIL Global and Antero Resources, which capitalize on the growing supply of abundant natural gas from the Marcellus shale region. We continue to evaluate additional midstream opportunities, similar to the projects announced to date, as we continue our strategy to provide infrastructure solutions to move gas from producing areas to the customer market areas. Now turning to our commercial energy systems business. As mentioned earlier, we continue to add to our portfolio of distributed generation assets. In December, Washington Gas Energy systems announced the completion of 20 solar projects, totaling more than 15-megawatts, that will produce renewable energy for Georgia Power. All of its solar arrays will be owned and operated by Washington Gas Energy Systems under our 20-year purchase — power purchasing agreement with Georgia Power. These projects significantly increased renewable energy capacity in the state through the Georgia Power advanced solar initiatives. And we look forward to completing more parts — projects through this partnership. All in all, we are off to a good start for the year. We look forward to providing further information regarding successes and opportunities during our analyst meeting, scheduled for March 18, at the New York Stock Exchange. This concludes our prepared remarks, and we’ll now be happy to answer your questions. Question-and-Answer Session Operator [Operator Instructions] We’ll take our first question from Mark Barnett, Morningstar. Mark Barnett – Morningstar Inc., Research Division Just a couple of quick questions. One, just more broadly, can you talk about how the supply agreement — not the supply, but the financing agreements with Shell has been impacting your operations, and whether that’s something that’s working well for you? Kind of how has the benefits started to show up? Can you maybe discuss that a little bit? Gautam Chandra Mark, this is Gautam. I will take that. Yes, I think the Shell agreement has been performing as we expected. We put that in place, primarily, to reduce short-term capital requirements. Because we’re just leaving a lot of purchases through Shell. And also, just reduction and collateral requirements from the holding company. And I would say, we’ve been achieving that over the last couple of years, where we’ve been operating with Shell and the relationships work very smoothly. So I would say, as expected. Mark Barnett – Morningstar Inc., Research Division Okay. And just shifting to some of the regulatory items you mentioned, the rider proposals for the gas infrastructure in Virginia, I mean, that’s fairly similar to what’s been discussed, I guess, in New England, but there’s been some resistance there. Of course, that’s kind of a multi-state question. I’m wondering what the political climate around that is in Virginia, what you’ve heard, I guess, from stakeholders to-date? Adrian P. Chapman This is Adrian. I’ll address that, Mark. Certainly, there was a some initial perception that this will address to facilitated some of the pipeline activity that’s happening in Virginia, and there was some initial push back, but I think once that was clarified that there’s been certainly generally a wide degree of support due to the economic development benefits of making gas available to currently unserved areas in Virgina. So I think it’s a little premature to predict exactly how the bill will evolve, but it has made good progress through committee and is heading close to the legislative final votes in each chamber of the house. So my expectation is that we’ve been able to clearly articulate the benefits. And what’s been important is it is, there is a signs of cost to those who directly benefit from the development activity that we would do. So those who get access to get service are ones who would directly pay for it. And principally, where we saw that contribution in native construction, sometimes being so large, that it stopped development, now we made that a much more affordable activity for new developers and customers to undertake. Terry D. McCallister Mark, this is Terry. I’d also add to that, this goes through the legislature. We wouldn’t expect — I wouldn’t expect any pushback from the governor, because he clearly drew his support behind the interstate pipeline that’s been proposed to the state earlier this year. So he is a big advocate of natural gas for pipelines for economic development for the state. Mark Barnett – Morningstar Inc., Research Division Okay, okay. And one last question on the regulatory treatment of gas reserves. Could you remind me, would that agreement be directly with an E&P? Terry D. McCallister Yes, it would. Yes, so we are working on a number of arrangements. But ultimately, it would be buying reserves from producer Adrian P. Chapman That’s what the legislation anticipates. Mark Barnett – Morningstar Inc., Research Division Right, I thought so. I just wanted to make sure, because there is obviously a couple of things, you have to work around that, but — okay, it’s great. Operator Again, I would like remind everyone that you can listen the rebroadcast of this conference call at 1 p.m. Eastern today, running through February 12, 2015. You may access the replay by dialing 1 (855) 859-2056 and then entering the pin 70000880. If there are no further questions, I will now turn the call back over to Mr. Bonawitz for any additional or closing remarks. Douglas Bonawitz Well, thank you, all, for joining us this morning. If you do have any further questions, please don’t hesitate to call me at (202) 624-6129. Thanks, again, and have a great day. Operator This concludes our conference call for today. Thank you for participating. And all parties may disconnect now.

Franklin Universal Trust: An Interesting Mix In This CEF

Summary FT’s goal is current income and capital preservation. FT takes a unique approach to that, mixing risky assets with more stable ones. It’s not a fund I’d rush to own, but it could have a place with the right investor. Franklin Universal Trust (NYSE: FT ) is an odd beast in some ways and yet logically built in other ways. At the end of the day, however, if you are buying it as a long-term investor you need to understand that it’s playing in two allocation sectors and that may not fit well within your broader portfolio. What it does Franklin Universal Trust’s primary objective is income and preservation of capital. Its secondary objective is growth of income. That said, it has a funny way of going about reaching these three goals since it invests in a combination of high-yield bonds and utility stocks. The split is around two-thirds bonds and one-third utilities. There are some other things in the mix, like preferred shares and resource stocks, but they are relatively minor positions. FT also makes use of leverage to enhance performance. According to the Closed-End Fund Association , leverage recently stood at around 23% of assets. Essentially, FT is mixing a relatively conservative investment category, utilities, with a riskier one, junk bonds. That’s not an outlandish proposition at all, but it makes this fund something of a difficult fit if you have your own portfolio allocation goals. For example, you’ll need to go down another level, looking at the fund’s portfolio allocations, to truly ensure your portfolio weightings are what you want them to be if you own FT. That wouldn’t be needed for pure-play offerings. There’s not much information available about what the fund actually does to pick its stocks and bonds, except that it uses fundamental research on the bond side and looks for attractive dividend yields and a history of dividend increases in the utility space. That’s not much to work with if you want to really understand what your managers are doing. In fact, it’s utility portfolio is comprised of some of the largest and best-known utilities in the country, a portfolio which you could arguably create yourself if you wanted to. How’s it done? Because of the odd mix of assets, it’s kind of hard to benchmark this fund. That said, it’s 10-year trailing annualized return through January comes in at about 8.5% according to Morningstar (this figure includes dividend reinvestment). That ranks in the top percentile of Morningstar’s “Tactical Allocation” category, but I’m not sure that’s exactly the right place to put this fund-though, to be fair, I have no better suggestion as to where it belongs. For comparison, Vanguard 500 Index Fund (MUTF: VFINX ) turned in a trailing 10 year return of just under 8% annualized. It’s standard deviation over the trailing ten year period was around 13. That’s not much lower than the S&P 500 Index, so FT isn’t exactly a low volatility offering. To bring that point home even more keenly, the standard deviation of Vanguard High-Yield Corporate Fund (MUTF: VWEHX ) over that span was around 9 and Vanguard Utilities Index Fund’s (MUTF: VUIAX ) was about 13. These two funds produced annualized returns of around 6.5% and 9.5%, respectively, over the trailing ten years. So in some ways FT is getting a higher return than you might achieve in other investments, including pure play high-yield funds and an S&P 500 Index fund, but it’s taking on more risk to do it-though not quite as much as an S&P 500 Index fund. And it’s worth noting that the fund’s net asset value, or NAV, fell nearly 37% in 2008. It’s share price fell nearly 41%. Clearly that was a disastrous year for investing, but it’s a real-world reminder that mixing high-yield with utilities isn’t going to save you from market volatility. To be fair, the NAV rose nearly 55% in 2009 (the share price advanced 70%), so what went down hard came back with a vengeance. You just have to be prepared for that kind of price movement should the market get volatile again. And, overall, don’t expect the fund to be a low risk offering. It isn’t. The fund’s distribution, meanwhile, has been fairly steady year in and year out. The current yield is around 6.6%. That’s nothing to write home about but it is an achievable distribution that has allowed for the NAV to increase from $5.85 a share in August of 2010 to a recent figure of around $8.15. And all of its distributions of late have been funded with dividend income, interest, and capital gains. So, as far as it goes, it appears to have lived up to its income objective, though not so much the income growth goal. Expenses are a tad high, but that’s largely related to the fund’s use of leverage. In fact, according to the Closed-End Fund Association, the management fee is less than 1% of assets, which is pretty reasonable. However, total expenses come in at close to 2% and have been as high as 2.6% in recent years. The cost of leverage adds a lot to this relatively small fund’s expenses. You gotta know what you own At the end of the day, FT is an unusual combination of investments, similar in some ways to Cohen & Steers REIT and Preferred Income Fund (NYSE: RNP ) another closed-end fund I’ve reviewed that invests in both real estate investment trusts and preferred shares. If you are trying to build a portfolio based on an asset allocation model, FT and RNP probably aren’t the right fund for you. You’ll have to dig into their portfolios to make sure you don’t over- or under-weight key asset classes. You’d likely be better off just buying pure play funds to keep your life simple That said, if you are looking for a decent fund with a solid yield, RF isn’t a bad option. It’s done reasonably well over time, though not spectacularly, while paying a consistent distribution. That’s hard to argue with, as long as you understand that you’re buying an odd hybrid fund. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.