Financial Information Table of Contents

Glossary of Key Terms

ACI: American Combustion Industries, Inc. is a subsidiary of Washington Gas Resources Corp. that provides HVAC-related products and services to commercial customers.

Bundled Service: Service in which customers purchase both the natural gas commodity and the distribution or delivery of the commodity from the local regulated utility. When customers purchase bundled service from Washington Gas, no mark-up is applied to the cost of the natural gas commodity that is passed through to customers. The regulated utility has an opportunity to earn a fair rate of return on the delivery of the natural gas.

City Gate: A point or measuring station at which a gas distribution system receives gas from a pipeline or transmission system.

Delivery Service: The regulated distribution, or delivery, of natural gas to retail customers. Washington Gas provides delivery service to retail customers in Washington, DC and parts of Maryland and Virginia.

Firm Customers: Customers whose gas supply will not be disrupted to meet the needs of other customers. Typically, this class of customers comprises residential customers and the vast majority of commercial customers.

HVAC: Heating, ventilating and air conditioning products and services.

Interruptible Customers: Large commercial customers whose service can be temporarily interrupted in order for Washington Gas to meet the needs of firm customers. These customers pay a lower delivery rate than firm customers and they must be able to readily substitute an alternate fuel for natural gas. The effect on net income of any changes in delivered volumes or prices to the interruptible class is minimized by margin sharing arrangements in the company’s tariffs.

Merchant Function: The purchase of the natural gas commodity by the regulated utility on behalf of retail customers.

PSC of DC: Public Service Commission of the District of Columbia, a three-member board that regulates the Washington Gas distribution operations in the District of Columbia.

PSC of MD: Public Service Commission of Maryland, a five-member board that regulates the Washington Gas distribution operations in Maryland.

Regulated Utility: See Utility Operations.

Retail Energy Marketing: Unregulated sales of the natural gas and electricity commodities by company subsidiary, Washington Gas Energy Services, Inc.

SCC of VA: State Corporation Commission of Virginia, a three-member board that regulates the Washington Gas distribution operations in Virginia.

Service Area: The region in which Washington Gas, the regulated utility, operates. The company`s service area includes metropolitan Washington, DC and surrounding regions in Maryland and Virginia.

Tariffs: Documents issued by regulatory commissions in each state jurisdiction that set the prices the regulated distribution company may charge and the practices it must follow when providing service to its customers.

Third-Party Marketer: Unregulated companies that sell natural gas and electricity directly to retail customers. Washington Gas Energy Services, Inc., a subsidiary company, is a third-party marketer.

Therm: A measure of heating value. Washington Gas reports its natural gas sales and deliveries in therms.

Unbundling: The separation of the delivery of natural gas or electricity from the sales of these commodities and related services that, in the past, were provided only by a regulated utility.

Utility Net Revenues: Utility revenues, less the associated cost of gas and applicable revenue taxes.

Utility Operations: The company segment that sells and distributes natural gas primarily to retail customers in Washington, DC, Maryland and Virginia. Utility operations are regulated by state and federal regulatory commissions.

WGEServices: Washington Gas Energy Services, Inc., is a subsidiary of Washington Gas Resources Corp. that markets natural gas and electricity to retail customers.

WGESystems: Washington Gas Energy Systems, Inc., is a subsidiary of Washington Gas Resources Corp. that offers HVAC-related products and services to commercial customers.

WGL Holdings: WGL Holdings, Inc., is a newly formed holding company that, effective November 1, 2000, became the parent company of Washington Gas and its subsidiaries.

Weather Insurance: An insurance policy which provides the utility’s earnings with some protection from the effects of warmer-than-normal winter weather conditions.

Washington Gas Light Company
Selected Financial and Operations Data

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This management’s discussion analyzes the financial condition and results of operations of Washington Gas Light Company (Washington Gas or the company) and its subsidiaries, under the corporate organizational structure that was in place during the three fiscal years ended September 30, 2000. Effective November 1, 2000, the corporation reorganized, such that Washington Gas and its subsidiaries became separate subsidiaries of WGL Holdings, Inc. (WGL Holdings), a newly formed holding company that was established under the Public Utility Holding Company Act of 1935. Note 2 to the Consolidated Financial Statements discusses the new holding company structure. The Glossary of Key Terms on page 16 defines certain terms used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. Bold italics indicate the first reference to a defined term.

     This Annual Report to Shareholders contains “forward-looking statements,” as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements should be read with the cautionary statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations on page 30, under the heading Safe Harbor for Forward-Looking Statements. Forward-looking statements are all statements, other than those of historical fact, including those statements containing words such as, but not limited to, “estimates,” “expects,” “anticipates,” “intends,” “believes,” “plans,” variations of these words and similar expressions. This management’s discussion should be read in conjunction with the company’s Consolidated Financial Statements and Notes thereto.

OVERVIEW

     Established in 1848, Washington Gas and its subsidiaries sell and deliver natural gas and a variety of energy-related products and services to customers in metropolitan Washington, D.C., Maryland, Virginia and beyond. The company’s core business, the distribution and sale of natural gas, is primarily regulated by state regulatory commissions. In response to federal and state changes in regulation, the company has taken the initiative to offer competitively priced gas and electricity to customers. The company also offers energy-related products and services that are closely related to its core business. The majority of these energy-related activities are performed by wholly owned subsidiaries of Washington Gas Resources Corp. (Washington Gas Resources). On November 1, 2000, Washington Gas Resources became a wholly owned subsidiary of WGL Holdings (see Note 2 to the Consolidated Financial Statements for additional details regarding the restructuring).

     During the fiscal years ended September 30, 2000, 1999 and 1998, Washington Gas reported on four major business segments: 1) regulated utility; 2) retail energy marketing; 3) heating, ventilating and air conditioning (HVAC); and 4) consumer financing. These four segments are described below:

     Regulated Utility. With nearly 95 percent of the corporation’s assets, Washington Gas delivers natural gas to retail customers in accordance with tariffs set by state regulatory commissions that have regional jurisdiction over the company’s rates. These rates provide the regulated utility an opportunity to earn a reasonable rate of return for the service on the investment devoted to the delivery of natural gas to customers. Washington Gas also sells the natural gas commodity to customers who either have not yet elected to purchase gas from unregulated third-party marketers or are not yet eligible to make this choice. The regulated utility does not incur a profit or a loss when it sells the natural gas commodity. Instead, Washington Gas charges these utility customers for the natural gas commodity at the same cost it incurs, subject to routine regulatory reviews of the reasonableness of these costs.

     Retail Energy Marketing. Washington Gas Energy Services, Inc. (WGEServices), a wholly owned subsidiary of Washington Gas Resources, competes with other third-party marketers by selling natural gas and electricity directly to residential, commercial and industrial customers, both inside and outside of the regulated utility’s traditional service territory. WGEServices has the opportunity to make a profit or the potential to incur a loss from these sales. While WGEServices sells the natural gas and electricity commodities, regulated utilities deliver these commodities to retail customers.

     HVAC. Two wholly owned subsidiaries, Washington Gas Energy Systems, Inc. (WGESystems) and American Combustion Industries, Inc. (ACI) provide turnkey design-build renovation projects to the commercial and government markets. Through a 50 percent equity investment in Primary Investors, LLC (Primary Investors), the HVAC segment also installs, repairs and maintains HVAC and plumbing equipment in the residential and light commercial markets.

     Consumer Financing. Washington Gas offers financing for consumers to purchase natural gas appliances and other energy-related equipment.

     This Management’s Discussion and Analysis of Financial Condition and Results of Operations describes the company’s financial condition, results of operations and cash flows with specific information on liquidity and capital resources. It also includes management’s interpretation of the company’s past financial results, potential factors that may affect future results, potential risks in the years ahead and approaches used to address these potential risks.

RESULTS OF OPERATIONS

     Net income applicable to common stock was $83.3 million, $67.4 million and $67.3 million for the fiscal years ended September 30, 2000, 1999 and 1998, respectively. The company earned 11.9 percent, 10.4 percent and 11.2 percent, respectively, on average common equity during these three fiscal years.

     Basic and diluted earnings per average common share were $1.79, $1.47 and $1.54 for fiscal years 2000, 1999 and 1998, respectively. A November 1998 public sale of common stock increased the number of shares outstanding, which reduced the earnings per average common share by $0.02 and $0.07 in fiscal years 2000 and 1999, respectively, from the prior years’ results.

     Other factors that affected the company’s earnings included:

     Winter Weather. During each of the last three fiscal years, winter weather that was approximately five percent warmer than normal suppressed the company’s earnings. If normal weather conditions had occurred, Washington Gas estimates that its earnings per average common share during fiscal year 2000 would have been approximately $0.20 higher.

     Utility Customer Base. Despite the impact of warmer-than-normal winter weather, utility net revenues have continued to grow since fiscal year 1998, as Washington Gas continues to expand its customer base at well over twice the national average.

     Operation and Maintenance Expenses. Utility operation and maintenance expenses for fiscal years 2000, 1999 and 1998 were $177.5 million, $201.2 million and $200.8 million, respectively. Reduced pension and postretirement benefit expenses, the absence of Year 2000 and other technology-related costs incurred in fiscal year 1999, the absence of operation and maintenance expenses associated with the company’s former West Virginia utility operations and a decline in the utility’s uncollectible accounts expense generated most of the $23.7 million decline in fiscal year 2000. These reductions were partially offset by increased employee wages. The $0.4 million increase in operation and maintenance expenses in fiscal year 1999 compared with fiscal year 1998 was primarily the result of the previously mentioned technology-related initiative costs incurred in fiscal year 1999, partially offset by a reduction in the utility’s uncollectible accounts expense in fiscal year 1999. During fiscal years 2000 and 1999, the regulated utility’s workforce declined by 5.0 percent and 3.5 percent, respectively, from the preceding years’ levels.

     Depreciation and Amortization Expense. In fiscal years 2000 and 1999, depreciation and amortization expense increased over the prior year by $5.6 million and $5.1 million, respectively. These increases reflect depreciation and amortization associated with the company’s increased investment in property, plant and equipment, including the amortization of a new enterprise-wide software system completed during the second half of fiscal year 1999.

     Non-Utility Operations. The net income contributed by the company’s recurring non-utility operations decreased $1.8 million during fiscal year 2000, or approximately $0.04 per average common share from fiscal year 1999 results. In fiscal year 1999, recurring net income from the company’s non-utility activities increased $3.3 million, or approximately $0.07 per average common share over fiscal year 1998 results. The following table summarizes the changes in net income from recurring operations generated by each of the company’s non-utility segments during fiscal years 2000 and 1999.

COMPOSITION OF CHANGES IN RECURRING NET INCOME FROM NON-UTILITY OPERATIONS

     Nonrecurring Transactions. The company’s earnings for the three reported years include a number of nonrecurring items. The fiscal year 2000 results include a $1.2 million after-tax gain from the sales of two minor non-utility assets. The fiscal year 1999 results include a $1.8 million after-tax gain from a subsidiary’s sale of undeveloped land, offset by a $1.9 million after-tax loss from the sale of natural gas utility assets located in West Virginia. The fiscal year 1998 results include $3.2 million of after-tax gains from non-utility asset sales, partially offset by a $1.0 million after-tax write-off of a regulatory asset. The following table summarizes the net income applicable to common stock and earnings per average common share that were produced by the company’s recurring operations during fiscal years 2000, 1999 and 1998.

NET INCOME APPLICABLE TO COMMON STOCK FROM RECURRING OPERATIONS

     Interest Expense. During fiscal year 2000, interest expense rose by $6.8 million primarily because of an increase in the average balance of total debt outstanding coupled with higher short-term debt costs and a lower allowance for funds used during construction. Additional short-term debt issued during fiscal year 2000 was used to fund non-utility investments, a higher volume and cost of storage gas balances and increased customer accounts receivable as compared with fiscal year 1999.

Regulated Utility Operating Results

     This section describes the detailed results of the company’s consolidated regulated utility operations in the District of Columbia, Maryland, Virginia and West Virginia. During fiscal years 2000, 1999 and 1998, utility operations contributed $1.76, $1.38 and $1.45, respectively, toward basic and diluted earnings per average common share.

Utility Net Revenues

     Utility net revenues increased by $10.9 million or 2.5 percent in fiscal year 2000, and increased by $6.8 million or 1.6 percent in fiscal year 1999. The growth in utility net revenues resulted primarily from increased firm therm deliveries, reflecting a 3.5 percent and a 3.25 percent rise in the number of customer meters during fiscal years 2000 and 1999, respectively.

     The following table provides the factors contributing to the changes in net revenues between years.

COMPOSITION OF UTILITY NET REVENUE CHANGES

     Gas Delivered to Firm Customers. During fiscal years 2000 and 1999, deliveries to the company’s firm customers increased by 23.9 million therms and 9.0 million therms, respectively, over the prior years’ results. These increases include therms identified as “Firm” in the Selected Financial and Operations Data on page 17, under the captions “Gas sold and delivered” and “Gas delivered for others.” These increases primarily reflect increases of 3.5 percent and 3.25 percent in the number of customer meters served by the utility’s operations in fiscal years 2000 and 1999, respectively.

     Winter weather, which typically can cause significant changes in the level of natural gas delivered to firm customers, was nearly identical during fiscal years 2000, 1999 and 1998. As a result, winter weather had little impact on the changes in firm deliveries during these years. However, because winter weather for fiscal years 2000, 1999 and 1998, respectively, was 5.0 percent, 5.2 percent and 5.1 percent warmer than normal, the level of firm therm deliveries was lower than normal in all three years (see Selected Financial and Operations Data on page 17 for a five-year comparison of actual to normal winter weather). The company’s rates are based on normal winter weather temperatures and none of its tariffs include a weather normalization provision. However, Washington Gas does have declining block rates in its Maryland and Virginia jurisdictions that reduce the impact that deviations from normal winter weather have on net revenues.

     Gas Delivered to Interruptible Customers. Deliveries to interruptible customers during fiscal year 2000 decreased by 30.5 million therms or 9.5 percent from the fiscal year 1999 level, which resulted in a $1.9 million decline in net revenues from interruptible customers. The decline by interruptible customers reflects the absence of 8.1 million retail therm sales and deliveries to the company’s former West Virginia operations and a brief planned interruption associated with the changeover to the Year 2000. In addition, a number of interruptible customers have elected to switch to firm service.

     Deliveries to interruptible customers in fiscal year 1999 increased by 4.3 million therms or 1.4 percent over fiscal year 1998. This increase reflects higher customer demand, partially offset by the absence of 1.8 million therms of interruptible retail deliveries to the company’s former West Virginia operations that were made during fiscal year 1998. During fiscal year 1999, net utility revenues associated with therms delivered to interruptible customers increased by $1.4 million over fiscal year 1998.

     Other. The “Other” net revenue category includes: 1) gas deliveries to customers for electric generation; 2) amounts generated from optimizing the value of the company’s contractual assets for transportation and storage of natural gas on the interstate pipelines; 3) wholesale deliveries to the current owner of the company’s former West Virginia utility operations; and 4) miscellaneous other operating revenues that are not associated with the volume of gas sold. Other net revenues increased by $0.8 million during fiscal year 2000 and $0.4 million during fiscal year 1999 over the preceding years’ results.

     The company sells and/or delivers natural gas for use at two electric generation facilities in Maryland, which are each owned by separate companies independent of Washington Gas. Variations in the volumes of deliveries to these two customers have little impact on the company’s net revenues and net income because of a margin-sharing arrangement in Maryland. Under that arrangement, the company calculates the gross margins, less related expenses, and the cost to recover the company’s investment in the facilities constructed to serve these two customers. Most of the remaining gross margins from these customers are used to reduce firm customers’ rates.

     During fiscal years 2000 and 1999, deliveries to electric generation customers increased by 82.2 million therms (63.4 percent) and 36.0 million therms (38.4 percent), respectively, over the prior years’ results. The marked increase in fiscal year 2000 deliveries occurred because an operational problem at one customer’s electric generation facility precluded it from receiving delivery of alternate fossil fuels that it typically includes in its fuel mix. Neither Washington Gas nor the customer can predict how long the operational problem at the affected electric generation facility will continue or how long that facility will continue to use natural gas as its only fuel.

     Cost of Gas. The company’s cost of natural gas includes both fixed and variable components. The company pays the fixed costs or “demand charges” to pipeline companies for system capacity needed to transport and store natural gas. The company pays the variable costs, or the cost of the natural gas commodity itself, to natural gas producers. Variations in the company’s cost of gas expense result from changes in gas sales volumes, the price of the gas purchased and the level of gas costs collected through the operation of firm gas cost recovery mechanisms. Under these regulated recovery mechanisms, the company defers the difference between the firm gas costs it pays and the gas costs recovered from customers. In subsequent periods, the company recovers from, or refunds to, customers any differences. Therefore, increases or decreases in the cost of gas associated with sales made to firm customers have no effect on net revenues and net income.

     The company’s average cost of gas on a per therm basis, excluding the cost and related volumes applicable to sales made outside of the company’s service territory, increased to 42.29¢ in fiscal year 2000 from 36.43¢ in fiscal year 1999. The increase reflects higher commodity gas prices in the current year. The commodity cost of gas invoiced to the company was 31.71¢ and 23.40¢ per therm for fiscal years 2000 and 1999, respectively. This increase reflects the higher market prices incurred during fiscal year 2000.

     The company’s average cost of gas on a per therm basis decreased 2.52¢ per therm in fiscal year 1999 from 38.95¢ in fiscal year 1998. The decrease resulted primarily from lower commodity gas prices during most of fiscal year 1999. The average commodity cost of gas invoiced to the company in fiscal year 1999 also decreased 4.73¢ from 28.13¢ per therm in fiscal year 1998 because of continuing warmer-than-normal winter weather, which resulted in a surplus of natural gas in the marketplace that depressed natural gas commodity prices. In response to the surplus of low-cost gas during fiscal year 1999, a number of natural gas producers curtailed their production, which contributed to a decline in the availability and an increase in the price of natural gas in the marketplace during fiscal year 2000.

Other Utility Operating Expenses

     Operation and maintenance expenses declined $23.7 million or 11.8 percent in fiscal year 2000 and increased $435,000 or 0.2 percent in fiscal year 1999 over the prior years’ results. The reduction in operation and maintenance expenses in fiscal year 2000 improved earnings per average common share by $0.32 over fiscal year 1999 results.

     The following table summarizes the major factors that contributed to the changes in operation and maintenance expenses.

COMPOSITION OF OPERATION AND
MAINTENANCE EXPENSE CHANGES

     Labor and labor-related expenses increased primarily because of an increase in employee wages and performance-based incentive awards that were accrued during fiscal year 2000. No performance-based incentives were accrued or paid applicable to fiscal year 1999. The impact of the fiscal year 2000 increase was lessened somewhat by a 5.0 percent decrease in the utility workforce during fiscal year 2000 to 1,834 utility employees. The successful investment performance of the company’s pension fund in the marketplace, which is reflected in “Pension and Postretirement Medical and Life Insurance Benefit Expenses,” produced a significant decrease in operation and maintenance expenses in fiscal year 2000. This reduced level of benefit expense is likely to continue in the upcoming year. Continuing improvements to the utility’s collection practices in fiscal years 2000 and 1999 generated lower uncollectible accounts expense. In addition, gross revenues in fiscal year 1999 were lower than the gross revenues received in fiscal year 1998, which also contributed to the decline in the uncollectible accounts expense in fiscal year 1999. Expenses for Year 2000-related and other technological initiatives that the company implemented during the second half of fiscal year 1999 did not recur in fiscal year 2000.

     During fiscal year 2000, the company implemented enhanced resource allocation measures that spanned nearly every aspect of the utility’s operations, including the delivery service, advertising and business development functions. These improvements support the utility’s efforts to maintain high-quality safe and reliable service. The $13.3 million decrease in “Operating Unit and Other Expenses (Non-Labor)” reflects those improvements.

     During fiscal years 2000 and 1999, depreciation and amortization rose by $5.6 million (9.3 percent) and $5.1 million (9.2 percent), respectively. The increases reflect additions of $146.7 million and $145.4 million, respectively, to property, plant and equipment that were made to meet continuing customer growth and to upgrade existing facilities and systems. Depreciation and amortization expenses in fiscal years 2000 and 1999 included $4.1 million and $1.4 million, respectively, of amortization related to the company’s new enterprise-wide software system that was completed in the second half of fiscal year 1999. The company amortizes the costs associated with this software system on a straight-line basis over its useful life. The company expects that depreciation and amortization expense will increase less in fiscal year 2001 than it did in fiscal year 2000, because a full year of amortization for the enterprise-wide software system is included in fiscal year 2000 results. The company’s composite depreciation rate was 2.94 percent in fiscal year 2000, compared to 2.93 percent in both fiscal years 1999 and 1998.

     During fiscal year 1999, Shenandoah Gas Company (Shenandoah), a former subsidiary that was merged into Washington Gas in April 2000, sold its utility assets located in West Virginia and recorded a $2.9 million pre-tax loss. The company sold these assets because they were not performing satisfactorily and the proceeds of a sale could be reinvested more effectively elsewhere in the business (see Note 3 to the Consolidated Financial Statements).

     The Consolidated Statements of Income Taxes on page 36 detail the composition of the changes in income tax expense.

Non-Utility Operating Results

     During fiscal years 2000, 1999 and 1998, Washington Gas had three primary unregulated operating segments: 1) retail energy marketing; 2) HVAC; and 3) consumer financing. These activities, plus the impact of other incidental unregulated activities, contributed $0.06, $0.13 and $0.10 per basic and diluted average common share in fiscal years 2000, 1999 and 1998, respectively. These results include $1.2 million, $1.8 million and $3.2 million of nonrecurring after-tax gains from the sales of minor non-utility assets in fiscal years 2000, 1999 and 1998, respectively (see Note 3 to the Consolidated Financial Statements). Excluding the effect of these and other minor items, the primary unregulated activities contributed $0.06, $0.10 and $0.03, of basic and diluted earnings per average common share in fiscal years 2000, 1999 and 1998, respectively.

     The following table shows the composition of the change in revenues for these non-utility operating segments.

COMPOSITION OF NON-UTILITY REVENUE CHANGES

     The following discussion describes the results of operations for each of the three reported non-utility segments.

     Retail Energy Marketing. The company’s retail energy marketing subsidiary, WGEServices, comprises the company’s retail energy marketing segment. Established in 1997, WGEServices sells natural gas on an unregulated competitive basis directly to residential, commercial and industrial customers.

     Revenues for this segment were $166.7 million, $103.9 million and $83.2 million in fiscal years 2000, 1999 and 1998, respectively. The retail energy marketing segment expanded its customer base by over 100 percent in each of the last two fiscal years. Further, WGEServices increased the volume of gas it delivered from 34.3 billion cubic feet (bcf) in fiscal year 1999 to 45.6 bcf in fiscal year 2000—a 33 percent increase. During fiscal year 1999, WGEServices increased its volumes delivered by over 29 percent from fiscal year 1998 levels. WGEServices’ aggressive marketing strategies and the growing participation of customers in various customer choice pilot programs generated the significant growth in WGEServices’ revenues, customer base and volumes delivered.

     Net income from the retail energy marketing segment was $0.5 million in fiscal year 2000, $1.6 million in fiscal year 1999 and $0.3 million in fiscal year 1998. In 1999, declining natural gas prices in the marketplace resulted in higher gross margins and a significant improvement in net income. As natural gas prices rose during fiscal year 2000, WGEServices’ gross margins declined. Thus, despite significant growth in both the number of customers and the volume of sales, the lower gross margins earned in fiscal year 2000, combined with increased selling, general and administrative expenses incurred to prepare for marketing electricity, caused a modest decrease in WGEServices’ net income.

     HVAC. Two subsidiaries, ACI and WGESystems, which offer large-scale HVAC installations and related services to commercial and government customers, are included in the company’s primary HVAC activities. In addition, the company has a 50 percent equity investment in Primary Investors, a company that focuses on investments in companies that provide products and services for residential and light commercial HVAC customers (see Notes 3 and 15 to the Consolidated Financial Statements).

     Revenues from commercial HVAC activities were $47.5 million in fiscal year 2000, reflecting an increase of $16.3 million or 52.1 percent over fiscal year 1999 results. During fiscal year 1999, commercial HVAC revenues increased by $17.4 million from fiscal year 1998, as ACI completed its first full year of operations under company ownership. Net income from commercial HVAC activities, which increased from $1.2 million in fiscal year 1999 to $3.2 million in fiscal year 2000, reflects continued attractive revenue growth combined with controlled costs. The commercial HVAC operations incurred a loss of $0.3 million during fiscal year 1998 because of start-up costs that ACI incurred as it began its first year of operations.

     The company’s 50 percent equity investment in Primary Investors produced a $1.7 million after-tax loss in fiscal year 2000 and a negligible loss in fiscal year 1999. Primary Investors, through its wholly owned subsidiary, Primary Services Group, LLC (PSG), is in the process of acquiring HVAC companies and integrating their operations. To date, PSG has acquired nine companies with annualized revenues of approximately $50 million. The net loss incurred by Primary Investors during fiscal year 2000 resulted from the relatively high level of integration costs, combined with cool summer weather that lowered the demand for HVAC products and services. Excluding net losses incurred to date from its investment, Washington Gas invested $18.3 million in Primary Investors through September 30, 2000.

     Consumer Financing. This business segment offers financing for residential and small commercial customers to purchase gas appliances and other energy-related equipment. The consumer financing segment sells, with recourse, receivables that result from these financing arrangements to financial institutions.

     Revenues from the consumer financing segment decreased 21.6 percent in fiscal year 2000 and net income from this segment dropped from $1.7 million in fiscal year 1999 to $0.8 million in fiscal year 2000. These decreases were attributable to a lower volume of contracts sold by the company to banks, in addition to an increase in interest rates charged by those banks compared to last year. A strengthening of the company’s credit criteria, fewer programs offering interest deferrals, as well as a warmer-than-normal winter and a cooler-than-normal summer (which reduced demand for HVAC products financed by the company) lowered the volume of contracts sold. Revenues from this segment rose 17.9 percent in fiscal year 1999 and net income increased from $1.3 million in fiscal year 1998 to $1.7 million in fiscal year 1999, primarily because of an increase in the volume of contracts sold during fiscal year 1999.

Interest Expense

     Total interest expense increased by $6.8 million or 18.3 percent in fiscal year 2000 and decreased by $0.7 million or 2.0 percent in fiscal year 1999. The following table shows the components of the changes in interest expense between years.

COMPOSITION OF INTEREST EXPENSE CHANGES

     Long-term Debt. The $1.4 million increase in interest expense on long-term debt during fiscal year 2000 primarily resulted from a $20.3 million increase in the average balance of long-term debt outstanding, partially offset by a 0.16 percentage point decline in the weighted-average cost of such debt. The retirement of $43.0 million of First Mortgage Bonds (FMBs) at a weighted-average interest rate of 8.74 percent during fiscal year 1999, partially offset by the issuance of $53.0 million in Medium Term Notes (MTNs) at a weighted-average rate of 7.56 percent during fiscal year 2000, was the primary reason for the decline in the average long-term debt cost during fiscal year 2000. The embedded cost of long-term debt was 6.9 percent, 6.8 percent and 6.9 percent at September 30, 2000, 1999 and 1998, respectively.

     Short-term Debt. The $4.8 million increase in interest expense on short-term debt during fiscal year 2000 resulted from a $70.5 million rise in the average short-term debt balance and a 0.89 percentage point increase in the weighted-average cost of such debt. See “Short-term Cash Requirements and Related Financing” for a discussion of fluctuations in short-term debt balances.

     Other. Other interest expense increased $0.6 million during fiscal year 2000, due primarily to a decrease in the accrual for the allowance for funds used during construction (AFUDC). The decreased accrual for AFUDC reflects a decline in average construction work in progress due to the completion of a number of capital projects during fiscal years 2000 and 1999, including the company’s enterprise-wide software system.

LIQUIDITY AND CAPITAL RESOURCES

     The company has a goal to maintain its common equity ratio in the mid-50 percent range of total capital. In addition, the company has a general policy to reduce short-term debt balances in the spring, because a significant portion of the company’s current assets is converted into cash at the end of the heating season. Accomplishing these objectives and maintaining sufficient cash flow are necessary to preserve the company’s credit ratings and to allow access to capital at relatively low costs. At September 30, 2000, total capitalization, including current maturities of long-term debt, was comprised of 54.7 percent common equity, 2.2 percent preferred stock and 43.1 percent long-term debt.

Short-term Cash Requirements and Related Financing

     The company’s business is weather-sensitive and seasonal. In fiscal year 2000, approximately 75 percent of the total therms delivered in the company’s franchise area (excluding deliveries to two electric generation facilities) were made in the first and second fiscal quarters. This weather sensitivity causes short-term cash requirements to vary significantly during the year. Cash requirements peak in the fall and winter months when accounts receivable, accrued utility revenues and storage gas inventories are at their highest levels. After the winter heating season, these assets convert into cash, which the company generally uses to reduce short-term debt and acquire storage gas for the next heating season.

     Storage gas represents gas purchased from producers and primarily stored in facilities owned by interstate pipelines. The company generally pays for storage gas between heating seasons and withdraws it during the heating season. Significant variations in storage balances at September 30 are usually caused by variations in inventory levels, as well as the price paid to producers and marketers, which is a function of short-term market fluctuations in gas costs. Such costs are a component of the cost of gas recovered from customers.

     Variations in the timing of collections of gas costs under the company’s gas cost recovery mechanisms and the level of refunds from pipeline companies that will be returned to customers can significantly affect short-term cash requirements. At September 30, 2000, the company had a $3.3 million net over-collection of gas costs, compared to a $6.2 million net over-collection at September 30, 1999. The company reflects the amounts under-collected and over-collected in the captions “Gas costs due from customers” and “Gas costs due to customers,” respectively, in the Consolidated Balance Sheets. Most of the current balances will be collected from, or returned to, customers in fiscal year 2001. At September 30, 2000, refunds received from pipelines that are being returned to the company’s customers totaled $0.6 million, compared to $2.2 million at September 30, 1999.

     The company uses short-term debt in the form of commercial paper and unsecured short-term bank loans to fund seasonal requirements. Alternate sources include unsecured lines of credit, some of which are seasonal, and $160 million in a revolving credit agreement maintained with a group of banks. In addition, two subsidiaries each have $5 million of secured lines of credit under revolving credit agreements. The company can activate these financing options to support or replace its commercial paper. Note 4 to the Consolidated Financial Statements includes additional information regarding the company’s short-term borrowing capabilities.

     At September 30, 2000, the company had notes payable outstanding of $161.4 million, compared to $113.1 million outstanding at September 30, 1999. A significantly higher cost of gas in storage due to rising commodity prices, a larger customer accounts receivable balance and a $10.8 million increase in the investment in Primary Investors generated most of the increase in fiscal year 2000. At September 30, 2000, current maturities of long-term debt were $1.7 million.

Long-term Cash Requirements and Related Financing

     The company’s long-term cash requirements primarily depend upon the level of capital expenditures, long-term debt maturity requirements and decisions to refinance long-term debt. The company devotes the majority of its capital expenditures to adding new customers in its existing service area. At September 30, 2000, the company was authorized to issue up to $122 million of long-term debt over approximately two years under an existing shelf registration. Note 5 to the Consolidated Financial Statements further discusses the nature of the company’s long-term debt.

     Cash Flow from Operating Activities. In fiscal year 2000, net cash provided by operating activities was $88.5 million, a decrease of $64.2 million from the fiscal year 1999 level. This decline primarily reflects increased amounts needed to fund higher levels of customer accounts receivable, accrued utility revenues and storage gas inventories. Partially offsetting these uses of cash in fiscal year 2000 was a $16.6 million increase in net income, adjusted for non-cash items, and an increase in the level of accounts payable related primarily to gas cost increases.

     In fiscal year 1999, net cash provided by operating activities was $152.7 million, an improvement of $28.9 million from the fiscal year 1998 level. The improvement was brought about by: 1) lower funds used to support accounts receivable and accrued utility revenues; and 2) increased sources of cash provided by accounts payable resulting from the timing of payments related to gas purchases. Partially offsetting these improvements were: 1) higher funds used to support storage gas balances due to a greater level of gas volumes in storage at higher prices; and 2) lower funds provided by customer deposits and advance payments.

     Cash Flow from Financing Activities. During fiscal year 2000, no cash was either generated through common stock issuances or used to reacquire common stock. Since August 1999, all stock for the Dividend Reinvestment Plan (DRP) and Employee Savings Plans has been acquired from open market purchases. Thus, the DRP and Employee Savings Plans were not a source of funds during fiscal year 2000.

     The company raised $55.7 million during fiscal year 1999 through the sale of 2.3 million shares of common stock. Through its DRP and Employee Savings Plans, the company raised $8.6 million by issuing 342,000 shares of common stock during fiscal year 1999 and raised $5.3 million by issuing 212,000 shares of common stock during fiscal year 1998. During the first quarter of fiscal year 1998, the company paid $2.3 million to repurchase 88,700 shares of common stock for the company’s stock-based compensation plans.

     The following table shows the issuances and retirements of long-term debt that occurred during fiscal years 2000, 1999 and 1998. For additional information regarding these debt issuances, see Note 5 to the Consolidated Financial Statements.

LONG-TERM DEBT ACTIVITY

     The dividends paid by the company during fiscal year 2000 increased by $1.8 million over fiscal year 1999 due primarily to the issuance of 2.3 million shares of common stock in November 1998 (see Note 6 to the Consolidated Financial Statements) and a $0.02 increase per common share paid during the current fiscal year.

     Cash Flow from Investing Activities. Capital expenditures for fiscal years 2000, 1999 and 1998 totaled $124.1 million, $158.7 million and $158.9 million, respectively. Investments in new business construction, which include amounts invested to convert customers from other energy sources, result in additional therm deliveries. During fiscal years 2000, 1999 and 1998, capital expenditures for new business equaled $75.6 million, $83.6 million and $87.4 million, respectively, which represented 60.9 percent, 52.7 percent and 55.0 percent of each year’s respective total capital expenditures.

     Capital expenditures also included $21.1 million and $19.1 million in fiscal years 1999 and 1998, respectively, for the enterprise-wide software system that was implemented in fiscal year 1999. In addition, the company made $10.8 million and $7.5 million of equity investments in Primary Investors during fiscal years 2000 and 1999, respectively.

     During fiscal years 2000 and 1998, the company received $0.7 million and $1.6 million, respectively, from the sales of minor non-utility investments. Also, in fiscal year 1998, the company sold all of its retail propane assets for $4.1 million. In fiscal year 1998, the company bought ACI for $3.0 million in cash and $2.0 million of debt, which was repaid in monthly installments over a two-year period that ended March 2000. Note 3 to the Consolidated Financial Statements more fully discusses the disposition of the retail propane assets and the acquisition of ACI.

     During fiscal year 2000, the sum of net income and non-cash charges, less dividends on common and preferred stock, totaled $97.3 million, representing 72.2 percent of capital expenditures and investments. For fiscal years 1999 and 1998, respectively, the sum of net income and non-cash charges, less dividends on common and preferred stock, totaled $82.5 million and $83.6 million and represented 49.7 percent and 51.0 percent of capital expenditures and investments.

Sales of Accounts Receivable

     During fiscal year 2000, the company augmented cash flow by selling $23.9 million of certain non-utility accounts receivable from its consumer financing segment to commercial banks. Similar sales of non-utility accounts receivable in fiscal years 1999 and 1998 amounted to $28.6 million and $27.2 million, respectively. For further discussion of the company’s sales of non-utility accounts receivable, see Note 13 to the Consolidated Financial Statements.

Long-term Debt Maturities

     Note 5 to the Consolidated Financial Statements describes the maturities on long-term debt for the ensuing five-year period.

Security Ratings

     The table below shows the ratings on the company’s outstanding debt instruments at September 30, 2000.

Capital Expenditures

     The following table shows the company’s actual capital expenditures for fiscal years 1998, 1999 and 2000 and projected capital expenditures for fiscal years 2001 through 2005. This table excludes the company’s investment in Primary Investors of $10.8 million in fiscal year 2000 and $7.5 million in fiscal year 1999, as well as the commitment to invest up to $6.7 million of additional funds in Primary Investors in the future. The company believes that the combination of available internal and external sources of funds will be adequate to meet its requirements.

CAPITAL EXPENDITURES

COMPETITION

Competition with Other Energy Products

     In its core utility business, the company faces competition based on customers’ preferences for natural gas compared to other energy products and the comparative prices of those products. Currently, the most significant product competition occurs between natural gas and electricity in the residential market. The residential market represents a substantial proportion of the company’s net income. In its service territory, the company continues to attract the majority of the new residential construction market. The company believes that consumers’ continuing preference for natural gas allows it to maintain a strong presence.

     Historically, the company has generally maintained a price advantage over electricity in its service area. Recent increases in the price of the natural gas commodity have altered this situation somewhat. However, the company believes natural gas prices are experiencing the effects of a temporary imbalance between supply and demand and should ultimately result in natural gas prices settling at more traditional levels. Furthermore, as discussed below, restructuring in both the natural gas and electric industries is leading to changes in traditional pricing models. As part of the electric industry restructuring effort, certain business segments are moving toward market-based pricing, with third-party marketers of electricity participating in retail markets. Electric restructuring may result in lower comparative pricing for electric service and other alternative energy sources, including natural gas. These changes will result in increased competition for the company.

     In the interruptible market, customers must be capable of using a fuel other than natural gas when demand by the company’s firm customers peaks. Fuel oil is the most significant competing energy alternative to natural gas. The company’s success in this market depends largely on the relationship between gas and oil prices. Because the natural gas marketplace is primarily domestic, the relationship between supply and demand generally has the greatest impact on natural gas prices. Because a large portion of oil comes from foreign sources, political events can have significant influences on oil prices.

Deregulation

     In each of the company’s jurisdictions (Maryland, Virginia and the District of Columbia), regulators and utilities are implementing customer choice pilot programs. These programs provide customers with an opportunity to choose to purchase their natural gas and/or electric commodity from third-party marketers, rather than purchasing these commodities as part of a bundled service from the local utility. When customers choose to purchase their natural gas commodity from a third-party marketer, there is no impact on the regulated utility’s net revenues or net income because Washington Gas passes the cost of gas to customers without any mark-up. However, these customer choice programs provide unregulated third-party marketers, such as WGEServices, with opportunities to profit from the sale of the natural gas commodity in competitive markets through energy sales to an expanding customer base. Participating in this rapidly evolving marketplace also poses new risks and challenges discussed below that must be addressed in the company’s current and future strategies.

The Gas Delivery Function

     The gas delivery function, the company’s core business, continues to be regulated by local regulatory commissions. In developing this core business, the company has invested over $2.2 billion to construct a safe, reliable and economical gas distribution system. Because of the high cost, safety and environmental considerations associated with building and operating a duplicate distribution system, the company believes there will continue to be only one owner and operator of a natural gas distribution system in its franchise area for the foreseeable future. The nature of the company’s customer base and the distance of most customers from interstate pipelines mitigate the threat of bypass of its facilities by other potential delivery service providers.

     The company expects that local regulatory commissions will continue to set the prices and terms for delivery service, which give Washington Gas an opportunity to earn a fair rate of return on the capital invested in its distribution system and to recover reasonable operating expenses. The company plans to continue constructing, operating and maintaining its natural gas distribution system.

     The company does not foresee any near-term changes in the regulated utility’s risk profile. Since the regulated utility passes the cost of the natural gas commodity through to customers, the profitability of its regulated operations is unaffected when customers choose to purchase the natural gas commodity from third-party marketers.

The Merchant Function and Natural Gas Unbundling

     The implementation of customer choice programs for natural gas customers is well underway in Maryland, Virginia and the District of Columbia. Currently, over half of the customers served by Washington Gas are eligible to participate in customer choice programs and the company expects that these programs will gradually encompass all customers in its service territory. Out of the more than 446,000 customers eligible to participate in these programs at September 30, 2000, nearly 165,000 customers purchase their natural gas commodity from unregulated third-party marketers.

     Ultimately, the company expects the regulated utility will play a much smaller role in the merchant function and may eventually exit the merchant function as customers buy natural gas from unregulated marketers. During this transition period, the company continues to have certain obligations under long-term contracts to purchase natural gas from producers and transportation capacity from interstate pipeline companies (see Note 13 to the Consolidated Financial Statements). Accordingly, the company’s strategy focuses on recovering contractual costs and maximizing the value of contractual assets.

     Currently, the regulated utility includes the cost of the natural gas commodity and pipeline services in the purchased gas costs that it includes in firm customers’ rates, subject to regulatory review. The company’s jurisdictional tariffs contain gas cost mechanisms that provide for the recovery of the actual invoice cost of gas applicable to firm customers. The company believes it prudently entered into its gas contracts and that the costs being incurred should be recoverable from customers. If future unbundling or other initiatives remove the current gas cost recovery provisions, the company could suffer adverse impacts to the extent it incurs non-competitive gas costs with no other satisfactory regulatory mechanisms available to recover any costs that may exceed market prices.

     The company currently has recovery mechanisms for such potentially stranded costs in Maryland and the District of Columbia. In fiscal year 2000, the State of Virginia enacted legislation to allow utilities a similar recovery mechanism. Washington Gas submitted a request to the State Corporation Commission of Virginia (SCC of VA) to allow it to include such a recovery mechanism in its tariff provisions. A decision by the SCC of VA on the company’s current request is pending.

     Washington Gas actively manages its supply portfolio to ensure that its sales and supply obligations remain balanced. If the company were to determine that competition or changing regulation would preclude it from recovering these costs in rates, these costs would be charged to expense without any corresponding revenue recovery. If this situation were to occur and depending upon the timing of the occurrence, the impact on the company’s financial position and results of operations would likely be significant. In the event that a regulatory body disallows the recovery of such costs, these costs would be borne by shareholders.

     To minimize its exposure to contracting risks, Washington Gas is not generally renewing expiring long-term gas commodity and pipeline transportation and storage contracts at the present time. As these contracts expire, the company enters into flexible short-term purchasing arrangements to meet demand. This strategy mitigates the company’s exposure to long-term commitments, while ensuring reliable and competitively priced gas for customers that continue to buy the natural gas commodity from the regulated utility. To maximize the value of its contractual assets, the company has entered into contracts with unregulated marketers that make use of the company’s firm storage and transportation rights to meet the company’s city gate delivery needs and to make off-system sales when such storage and transportation rights are underutilized. The company continues to pay the fixed charges associated with the firm storage and transportation contracts used to make sales.

     As the local distribution company’s role in the merchant function decreases over time, opportunities emerge for unregulated natural gas providers. In the deregulated marketplace, third-party marketers have profit-making opportunities, but also assume the risk of loss.

     Recognizing the opportunities presented by competition, the company established WGEServices, an unregulated retail energy marketing subsidiary, in 1997. To date, WGEServices has grown to nearly 125,000 residential, commercial and industrial natural gas customers both inside and outside of the Washington Gas service area. Gross revenues in fiscal year 2000 were $166.7 million and net income was $0.5 million. The company believes that customer choice programs will continue to expand, as well as customers’ selection of WGEServices as a service provider.

     The regulatory process tends to stabilize rates and revenues. However, there can be significant volatility for unregulated third-party marketers, such as WGEServices. Thus, while WGEServices has a significant potential for continued growth, it must carefully manage risks in a volatile commodity market.

     WGEServices competes with other third-party marketers to sell the unregulated natural gas commodity to customers. Marketers of the natural gas commodity compete largely on price and gross margins are relatively small. Furthermore, as with any startup operation, customer acquisition costs are high. Consequently, operating margins for WGEServices are lower than those earned by the regulated utility.

     In addition, WGEServices faces supply-side risks. To minimize its supply-side risks, WGEServices’ strategy is to manage its natural gas contract portfolio in a manner that closely aligns the volumes of gas it purchases with firm commitments from customers to purchase this gas. WGEServices purchases from a number of wholesale suppliers in order to avoid relying on any single provider for its natural gas supply. Similarly, WGEServices’ dependency on any one customer or group of customers is limited.

Electric Unbundling

     Customer choice programs are not unique to the natural gas industry. Choice for electric customers has been legislated or is being considered in each jurisdiction in which the company operates. Similar to the natural gas industry, participants in these programs can choose either to continue purchasing bundled electricity service from their local electric distribution utility or to purchase electricity from a third-party marketer. Since July 2000, customers of three electric utilities in Maryland have been able to choose their electricity supplier. Enrollment in an electric customer choice pilot program for parts of Virginia also began in July 2000 and ten percent of electric customers in the District of Columbia will be able to choose their electricity supplier beginning in January 2001.

     In anticipation of these new opportunities, WGEServices entered into a master purchase and sale agreement in April 2000 with a wholesale energy marketer. Under the agreement, as WGEServices identifies profitable opportunities, it purchases electric energy, capacity and certain ancillary services from the wholesaler for resale to retail electricity customers. As jurisdictions introduce electricity customer choice programs, WGEServices evaluates the associated profit potential and other strategic factors. When advantageous, WGEServices markets electricity and enrolls customers. At September 30, 2000, the company had enrolled 4,000 retail electricity customers in Virginia and Maryland, with service to begin on November 1, 2000. In addition, WGEServices has been awarded a $33.5 million, 18-month contract to begin supplying electricity to Montgomery County, Maryland government agencies beginning on December 1, 2000.

Potential for Further Unbundling

     Currently, the company provides customer services, such as preparing bills, reading meters and responding to customer inquiries, as part of its core utility function. Unregulated third-party marketers have the option to assume responsibility for bill preparation and customer collections. In addition to billing and collecting from customers for the natural gas commodity, third-party marketers’ bills may include natural gas delivery charges due the regulated utility, which they subsequently remit to Washington Gas. Although the company still provides most customer services on a bundled basis, the potential exists for future deregulation initiatives to separate these services from the core utility function. In that case, customers could choose to have unregulated competitors provide these services.

     To maintain its competitive position, the company continues to improve quality and efficiency and to reduce costs with the goal of achieving market-level performance. As the functions become unbundled, the company will continue to review its role in that marketplace.

OTHER FACTORS AFFECTING THE COMPANY

Industry Consolidation

     The energy industry has seen a number of consolidations, combinations, disaggregations and other strategic alliances. These changes are being driven, in part, as energy companies seek to offer a broader range of energy services to compete more effectively in attracting and retaining customers. For example, affiliations with other operating utilities could potentially result in economies and synergies and could provide customers with a wider range of energy services. Consolidation will present combining entities with the challenges of remaining focused on the customer and integrating different organizations. Others in the energy industry are discontinuing operations in certain portions of the energy industry or divesting portions of their business and facilities.

     The company, from time-to-time, performs studies and, in some cases, holds discussions regarding utility and energy-related investments and transactions with other companies. The ultimate impact on the company of any such investments and transactions that may occur cannot be determined at this time.

Regulatory Matters

     The company bases requests for a modification to existing rates on increased investment in plant and equipment, higher operating expenses and the need to earn an adequate return on invested capital. In July 1998, the SCC of VA granted the company’s distribution subsidiary, Shenandoah (now a division of the company), a $1.4 million increase in annual revenues, effective December 28, 1997. The company’s base rates did not change in any of its other major jurisdictions in fiscal year 2000 and have not changed during the past five years. The following table summarizes major rate applications and results.

SUMMARY OF MAJOR RATE APPLICATIONS AND RESULTS

a/ Rates were implemented as a result of a settlement agreement. The return on equity indicated in the order of 11.5 percent was not utilized to establish rates.

b/ Application was settled without stipulating the return on common equity.

Incentive Rate Plan

     On January 6, 2000, the company announced that it filed with the Public Service Commission of Maryland (PSC of MD) a non-unanimous settlement agreement that would freeze Maryland customers’ basic delivery rates at the present levels and insulate them from potential rate increases over the next five years. The only adjustments that would have been allowed under the agreement would have been for material changes in costs due to extraordinary events, such as tax rate changes or new regulatory requirements. The agreement also included the potential to reduce customers’ bills and increase returns to shareholders through the use of an earnings-sharing mechanism. In addition, the agreement included a provision for residential heating customers that would reduce fluctuations in customers’ bills due to the effects of weather deviations from normal levels.

     On October 19, 2000, the PSC of MD issued an order that declined to approve the agreement. On November 6, 2000, Washington Gas filed a request for a rehearing of the PSC of MD’s order.

District of Columbia Regulatory Matters

     On February 17, 2000, the District of Columbia’s Office of the People’s Counsel (OPC) filed a complaint with the Public Service Commission of the District of Columbia (PSC of DC) requesting an investigation into the rates and charges of Washington Gas. The complaint alleges that: 1) Washington Gas earned an actual return on equity that is significantly higher than authorized by the PSC of DC; and 2) the return on equity that the PSC of DC authorizes Washington Gas to earn is higher than is appropriate, given current economic conditions.

     On February 28, 2000, Washington Gas requested the PSC of DC to dismiss the OPC complaint chiefly on the grounds that the OPC’s analysis of the company’s rates was substantively flawed. The PSC of DC is currently reviewing the OPC’s complaint and the company’s response thereto. No specific timeline has been established for the PSC of DC to render its final decision on this matter.

Year 2000

     Washington Gas has continued to operate successfully through the turn of the century and during other key dates associated with the transition to the Year 2000. The company continues to monitor its systems for Year 2000 issues.

     The following table reflects the amounts charged to expense and capitalized early in fiscal year 2000 and during the fiscal years ended September 30, 1999, 1998 and 1997 for business-application systems remediation, embedded systems replacement, end-user applications remediation and replacement, independent verification and validation costs and business continuity initiatives.

Labor Matters

     During fiscal year 2000, Washington Gas successfully negotiated five contracts with bargaining units of the company’s three labor unions. In total, these contracts cover over half of the company’s total workforce. All five contracts include an annual lump-sum payment provision, based upon the company meeting a specified rate of return on common equity and contingent upon the Board of Directors’ approval. Each contract also provides for improved medical, sick leave and disability benefits and a number of other enhancements to employees’ benefits. The following discussion provides additional information regarding the two most significant contract ratifications.

     Office and Professional Employees Union Local 2—On April 6, 2000, approximately 380 members of Local 2 ratified a new three-year labor contract with the company. The contract includes general wage increases of 1.5 percent, 1.0 percent and 2.0 percent in the first, second and third years of the contract, respectively, and a $1,200 lump-sum contract ratification bonus.

     Teamsters Local 96—On June 6, 2000, approximately 725 members of Teamsters Local 96 ratified a new four-year labor contract with the company. The contract includes general wage increases of 3.0 percent, 2.75 percent and 2.25 percent in the first, second and fourth years of the contract, respectively. During the third year of the contract, employees may elect to receive either a lump-sum payment of 2.5 percent of base pay or a 2.0 percent general wage increase.

Environmental Matters

     The company and its subsidiaries are subject to various laws related to environmental matters, as discussed in Note 12 to the Consolidated Financial Statements.

Accounting for Regulatory Matters

     As the industry continues to address competitive market issues, the cost-of-service regulation used to compensate the company for the cost of its regulated operations will continue to evolve. Non-traditional ratemaking initiatives and market-based pricing of products and services could have additional financial implications for the company.

     The company records the results of its regulated activities in accordance with Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS No. 71). In certain circumstances, SFAS No. 71 allows entities whose rates are determined by third-party regulators to defer costs as “regulatory”assets in the balance sheet to the extent that the entity expects to recover these costs in future rates. As deregulation and competitive initiatives increasingly impact the company, however, SFAS No. 71 may no longer apply to all or part of the company’s regulated operations in future years. Such company operations would be subject to the same accounting standards that apply to unregulated entities. In effect, the company could be required to write off certain regulatory assets that had been deferred in prior period Consolidated Balance Sheets and charge these costs to expenses at the time it determines that the provisions of SFAS No. 71 no longer apply. Note 1 to the Consolidated Financial Statements shows the composition of regulatory assets. While the company believes that SFAS No. 71 continues to apply to its regulated operations, the changing nature of the company’s business requires it to assess continually the impact of those changes on its accounting policies.

Weather Insurance Purchase

     On October 30, 2000, Washington Gas announced that it purchased a weather insurance policy in order to reduce its financial exposure to warm weather during the heating season. The policy has a five-year term beginning October 1, 2000.

     The policy covers one-half of the company’s estimated net revenue exposure to variations in heating degree days (HDDs). The insurance policy defines a heating degree day as the greater of (i) 65 degrees Fahrenheit less the average of the daily high and daily low temperatures in degrees Fahrenheit as measured at Washington Reagan National Airport, or (ii) zero. For insurance policy purposes, neither average temperatures nor HDDs are rounded. Income is provided in a predetermined amount for each such HDD below 3,815 per fiscal year up to a maximum of 515 HDDs, subject to certain limitations. The annual premium under the policy is $4.25 million, and the maximum expense impact in any one year is equal to the after tax-effect of that premium. If the weather in any given year is more than 3.5 percent warmer than 3,815 HDDs, the income provided by the policy will exceed the annual premium. Over the five-year term of the policy, the company cannot be paid for more than 1,295 HDDs.

     Additionally, if over the five-year term of the policy the HDDs average less than 4,000 per year, the company will receive a payment of $16.96 million reduced by the effect of certain amounts previously paid on a per HDD basis as described above.

     The company has performed extensive simulation analysis that indicates that the annual net cash outlay for the policy (premiums paid less all benefits received) should average $415,000 after income taxes over the five-year period. Furthermore, the simulation analysis has demonstrated to an extremely high level of confidence that the 1,295 HDD limit is sufficient for the five-year period. Actual year-by-year net cash outlays may vary due to policy design and actual weather conditions.

     When the company reports heating degree days, it computes HDDs in a method different from that used for insurance policy purposes. The company’s method rounds the average of the high and low temperatures to the nearest whole degree prior to subtracting that average from 65 degrees. As a result, for each fiscal year in the five-year policy period, the number of HDDs computed for insurance purposes will almost certainly be greater than the number of HDDs reported by the company. Therefore, the insurance policy computation will indicate colder weather than the company’s computation, and the annual benefit received will be lower than might be expected if the company’s measure of HDDs were used. For example, based on historical analysis, the 3,815 HDD maximum mentioned above would be approximately 3,760 HDDs, or 1.4% warmer than normal, when computed using the company’s method.

     If this policy had been in place during fiscal year 2000, earnings per average common share would have declined by less than $0.01 after taking into consideration the after-tax cost of the premium paid.

Economic Conditions

     The company and its subsidiaries operate in one of the fastest growing regions in the nation. The continued prosperity of this region allowed the company to expand its regulated delivery service customer base at well over twice the national average during the past five years. In addition, this economy provided a robust market for the company’s subsidiaries to market natural gas and other energy-related goods and services. A downturn in the economy of the region in which the company operates, which cannot be predicted with accuracy, would likely adversely affect the company’s ability to grow its regulated utility and other businesses at the same rate they have grown in the past.

Inflation

     From time-to-time, Washington Gas seeks approval for rate increases from regulatory commissions to help it cope with the effects of inflation on its capital investment and returns. The most significant impact of inflation is on the company’s replacement cost of plant and equipment. While the regulatory commissions having jurisdiction over the company’s retail rates allow depreciation only on the basis of historical cost to be recovered in rates, the company anticipates that it will be allowed to recover the increased costs of its investment and earn a return thereon after replacement of the facilities occurs.

Market Risk

Interest Rate Risk Exposure Related to Other Financial Instruments

     At September 30, 2000, the company had fixed-rate MTNs and other long-term debt aggregating $559.6 million in principal amount and having a fair value of $532.8 million. Fair value is defined as the present value of the debt securities’ future cash flows discounted at interest rates that reflect market conditions as of September 30, 2000. While these are fixed-rate instruments and, therefore, do not expose the company to the risk of earnings loss due to changes in market interest rates, they are subject to changes in fair value as market interest rates change. A total of $44.5 million, or approximately 8 percent of the company’s outstanding MTNs, have call options that enable the company to mitigate this market risk through the early redemption of those debt instruments. Likewise, a total of $125 million, or 23 percent of the company’s outstanding MTNs, have put options that allow the holders of debt to mitigate market risk through the early redemption of those debt instruments.

     Using sensitivity analyses to measure this market risk exposure, the company estimates that the fair value of its long-term debt would increase by approximately $23 million if interest rates were to decline by 10 percent. The company also estimates that the fair value of its long-term debt would decrease by approximately $21 million if interest rates were to increase by 10 percent. In general, such an increase or decrease in fair value would impact earnings and cash flows only if the company were to reacquire all or a portion of these instruments in the open market prior to their maturity.

Price Risk Related to Retail Energy Marketing Operations

     The company’s subsidiary, WGEServices, markets both natural gas and electricity. In the course of its business, WGEServices makes fixed-price sales commitments to customers. WGEServices purchases the corresponding physical supplies at fixed prices to lock in margins. WGEServices has exposure to changes in gas prices related to the volumetric differences between purchase commitments and sales commitments. WGEServices manages the risk associated with gas price fluctuations by closely matching purchases from suppliers with sales commitments to customers. At September 30, 2000, WGEServices’ open position was not material to the company’s financial position or results of operations.

SAFE HARBOR FOR FORWARD LOOKING STATEMENTS

     Certain matters discussed in this report, excluding historical information, include forward-looking statements. Certain words, including, but not limited to, “estimates,” “expects,” “anticipates,” “intends,” “believes,” “plans,” variations of these words and similar expressions, identify forward-looking statements that involve uncertainties and risks. These statements are necessarily based upon various assumptions with respect to the future, including:

     1) economic, competitive, political and regulatory conditions and developments;

     2) capital and energy commodity market conditions;

     3) changes in relevant laws and regulations, including tax, environmental and employment laws and regulations;

     4) weather conditions;

     5) legislative, regulatory and judicial mandates and decisions;

     6) timing and success of business and product development efforts;

     7) technological improvements;

     8) the pace of deregulation efforts and the availability of other competitive alternatives; and

     9) other uncertainties.

     Such uncertainties are difficult to predict accurately and are generally beyond the company’s direct control. Accordingly, while it believes that the assumptions are reasonable, the company cannot ensure that all expectations and objectives will be realized. The company urges readers to use care and consider the risks, uncertainties and other factors that could affect the company’s business as described in this Annual Report. All forward-looking statements made in this Annual Report rely upon the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995.

Washington Gas Light Company
Consolidated Statements of Income

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.

Washington Gas LIght Company
Consolidated Balance Sheets

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.

Washington Gas Light Company
Consolidated Statements of Cash Flows

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.

Washington Gas Light Company
Consolidated Statements of Capitalization

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.

Washington Gas Light Company
Consolidated Statements of Common Shareholders’ Equity