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WGL Holdings – Company View


To Our Shareholders:
2006 was a solid year for WGL Holdings, Inc. We continued to rely on our proven strategy for producing lasting results and positioning the company for growth. At the same time, we introduced several initiatives to deliver continued corporate progress and successes. As we discuss our fiscal year highlights, we urge you to read the report with the following, familiar words in mind: WGL Holdings works continuously to be the retail energy company of choice by achieving excellence for customers, investors and employees.

Each year, we discuss the steps that we have taken over the preceding 12 months to deliver on our vision.This year, we offer a look not only at where we have been, but also share what we have done to leverage our enduring strength and to reinforce our stable foundation as we look toward the future.

As we begin this discussion, please note that we have taken a new and different approach to annual reporting this year. This document, our 2006 Corporate Financial Report, presents an overview of this year’s results and our outlook for the year ahead. Also included in this publication is our Annual Report on Form 10-K as filed with the Securities and Exchange Commission and a summary supplement of key financial and operating statistics.

Separately, we are introducing a new publication—the 2006 Corporate Performance Report. We are taking the opportunity to improve upon our already transparent look into how we work and how we benefit our various constituents. The 2006 Corporate Performance Report is available online at wglholdings.com.

Producing Results: Our vision is to be the retail energy company of choice by achieving excellence for customers, investors and employees.

Fiscal Year 2006 in Summary Our financial results for the 2006 fiscal year reflect our efforts to achieve stable earnings growth and to remove the volatility in earnings that results from fluctuations in customer usage and weather conditions. Our weather protection products allowed us to neutralize the impact of a warmer-than-normal winter in the District of Columbia and Virginia. We even had a slight benefit due to a period of cold weather that preceded the coverage period. In addition, we neutralized the impact of weather and price-induced conservation in Maryland by implementing a new regulatory mechanism at the beginning of the fiscal year.

These positive steps helped ease the downward tug on earnings associated with higher customer conservation and, to a lesser extent, increasing overhead costs. Although we expect softening natural gas prices to mitigate some of the price-related customer conservation, we expect that the pressures on our expenses will remain with us into 2007. We have adopted several initiatives, also discussed below, to lessen the influence of these factors on the business.

In keeping with our objective to grow profitable energyrelated businesses, we made the strategic decision to sell American Combustion Industries (ACI), one of WGL Holdings’ two commercial heating, ventilating and air conditioning businesses.

For our continuing operations, 2006 fiscal year’s results reflected:

  • Income totaling $94.7 million, or $1.94 per share, for the year. Although our results declined compared with 2005, several indicators suggest strong positioning for future growth.
  • Increased normalized utility earnings compared with last year. We added $0.10 per share, a performance driven in part by the addition of 19,811 new customers, timely recovery of carrying costs on higher storage gas inventory balances, and the introduction of a revenue normalization adjustment (RNA) in Maryland that allows us to protect 40% of our revenues when customers conserve energy, causing usage to decline from normalized levels. The mechanism also protects our Maryland customers when usage increases above normalized levels. The phrase “normalized utility earnings” refers to a non-GAAP attribute. See page 4 of this report for a discussion of our non-GAAP measures.
  • Lower customer usage in the District of Columbia and Virginia, which decreased earnings by $0.14 per share.
  • Reduced reported earnings to $0.27 per share from our retail energy-marketing business. The underlying strong performance of this business unit was tempered somewhat by mark-to-market valuations and unusual items. For a complete discussion of our financial results, see Management’s Discussion and Analysis contained in the Annual Report on Form 10-K, which begins on page 7.

The Year Ahead
During our 2007 fiscal year, we will take several steps to produce long-term success and continue meeting the needs of our customers, investors and employees. We expect to see continued benefit from robust economic growth and new home construction and anticipate adding new customers at a rate that exceeds industry averages. This year, we will enhance our utility growth strategy by focusing greater attention on residential conversions.

We also will work closely with regulators in all of our jurisdictions as we invite them to rethink the way that customers pay for the gas they use. Virginia regulators currently are considering our proposal to implement a new rate-making formula for our customers in the jurisdiction. This will help us achieve full and timely recovery of the cost to deliver natural gas safely and reliably. Our rate increase application included an RNA proposal designed to deliver benefits similar to those currently in effect in Maryland. We also proposed a performance-based rate structure that will provide a regulatory mechanism to encourage continuing performance improvements and share these benefits in a timely manner between customers and investors. We are evaluating the need to file similar plans in the District of Columbia and will propose a rate-making formula in Maryland this spring that would deliver these desired outcomes.

Our education and outreach efforts continue as we encourage customers to use energy more efficiently. Natural gas supply and demand remain in a tight balance, and this approach represents sound, responsible energy policy. Our RNA proposal appropriately aligns advocacy for energy efficiency with providing a reasonable opportunity to earn timely recovery of and return on our costs of serving utility customers. This balanced approach clearly benefits customers and investors.

We also are uniquely positioned to move this agenda forward through our leadership roles with national policy organizations, such as the American Gas Association and the Alliance to Save Energy.

The Quest for Excellence
WGL Holdings continues to pursue operational excellence by improving processes, reducing operating and maintenance costs and maintaining or improving service delivery. We are considering the potential benefits of outsourcing as a means of meeting these objectives. For more than a decade, outsourcing has driven dramatic reductions in our costs to add new customers. We also have seen significant process improvements in targeted areas of our operations. In hopes of achieving similar efficiencies in other portions of our business, we are evaluating proposals to provide business process outsourcing services in information technology, human resources, customer service and certain financial functions.We expect to complete our review and determine an appropriate course of action by the spring of 2007.

In addition to our work to enhance internal processes and service delivery, we continue our efforts to foster a high-performance culture—a workplace that rewards and inspires excellence by offering challenge, support and growth. The most recent employee opinion survey confirmed that we have achieved a level of workforce engagement that compares favorably with national norms.

Successful Results—Ten Years and Counting
2006 marked a major milestone for Washington Gas Energy Services (WGES), our energy-marketing arm, which celebrated a decade of service in July. WGES, a substantive contributor to net income, is well positioned to win customers in new electric markets.Through a timely promotion to customers in the District, Maryland and Delaware last summer, WGES increased its electricity patronage by 75%. We will report on the financial benefits from adding these new customers in future periods as their consumption becomes more significant.

System Integrity, Supply Diversity
As our multiyear replacement and rehabilitation project continued in Prince George’s County, Md., our operations leaders developed a remediation approach based on the root cause of the initial problem. We launched this project in 2005 to stem an unusual pattern of leaks caused by the introduction of gas from the Cove Point liquefied natural gas (LNG) terminal in southern Maryland. This gas has a different chemical composition than what traditionally flows through most of our pipes and has been identified by research as the principal cause of premature failure of certain pipe couplings.

Based on the results of scientific testing, we constructed and are operating a facility that conditions gas from Cove Point to make it compatible with the composition of gas that has normally flowed through our system. Results to date are promising, and we continue monitoring our progress. With continued success, we may be able to modify the scope and cost of the repair and rehabilitation project and achieve our goals for maintaining the safety and integrity of our system.

We continue to pursue authorization to construct an LNG storage facility on company property, which previously housed natural gas storage tanks. Upon its construction, the LNG storage facility would serve customers on the coldest days and give our company greater ability to manage the costs of natural gas delivery. Our single storage tank facility will cost roughly $148.6 million to construct and would be ready for the winter of 2011–2012.

Building for the Long-Term
We see challenge, promise and opportunity in the year ahead. With our new fiscal year underway, we expect to build on our well-established foundation. We will advance national energy policy and state regulatory proposals that benefit customers and investors.We will continue long-term, large-scale projects that will allow us to serve the region’s natural gas customers safely and reliably and at a reasonable cost. We will work to continue strong growth by adding newly constructed homes and by converting more existing homes to natural gas. And, we will continue to build on our opportunities for growth in our non-utility subsidiaries.

Of course, the knowledge, support and dedication of the men and women of WGL Holdings drive our ability to realize our goals, and again, we extend our gratitude for all that they do in support of the company and our customers.