Southwest Gas Holdings, Inc. (SWX) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Southwest Gas 2015 Year-End Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. As a reminder, the conference call maybe recorded. I would now like to turn the conference over to Ken Kenny, Vice President of Finance and Treasurer. You may begin.

Thank you, Nicole. Welcome to Southwest Gas Corporation 2015 Earnings Conference Call. As Nicole stated, my name is Ken Kenny, and I am Vice President, Finance and Treasurer. Our conference call is being broadcast live over the Internet. For those of you who would like to access the webcast, please visit our website at www.swgas.com, and click on the conference call link. We will have slides on the Internet, which can be accessed to follow our presentation. Today, we have Mr. John P. Hester, President and Chief Executive Officer; Mr. Roy R. Centrella, Senior Vice President and Chief Financial Officer; Mr. Justin L. Brown, Vice President Regulation and Public Affairs and other members of senior management to provide a brief overview of 2015 earnings and an outlook for 2016. Our general practice is not to provide earnings projections. Therefore, no attempt will be made to project earnings for 2016. Rather, the company will address those factors that may impact this coming year's earnings. Further, our lawyers have asked me to remind you that some of the information that will be discussed contains forward-looking statements. These statements are based on management's assumptions, which may or may not come true, and you should refer to the language in the press release, our SEC filings and also Slide number 2 presented today for a description of the factors that may cause actual results to differ from our forward-looking statements. All forward-looking statements are made as of today, and we assume no obligation to update any such statement. With that said, I'd like to turn the time over to John.

Thanks, Ken. Turning to slide three and our highlights for 2015. From a consolidated perspective first, earlier this week, our Board approved an increase in our annual dividend of $0.18 to a $1.80 per share. This is an increase of over 11% and the 10th straight year at Southwest has increased dividend shareholders. For 2015, we realized earnings per share of $2.94, slightly better than 2014 as we normalized COLI results, which Roy will talk about in a few minutes. We also submitted applications to establish a holding company structure in each of our state jurisdictions and have recently received approval on the application, we submitted in California. In the natural gas segment in particular, we saw record operating margin of $891 million at 26,000 customers during the past year, invested $438 million to serve growing customer demands and increase safety and reliability of our gas delivery infrastructure and we’re voted in top five company and brand trust for utilities. We also saw our sales moving ever closer to the end of our Arizona rate case moratorium. On the unregulated construction services side, we realized record revenues and net income of over $1 billion and $26.7 million respectively. We also completed the first full calendar year of integrated operations with the Link-Line Group of Companies that we acquired in October 2014. In addition, we reached a resolution on a previously contested Canadian industrial project that has been pending for the past few quarters. Moving to slide four, our outline for today’s call will be as follows: Roy Centrella will provide an overview of our 2015 consolidated earnings, including detail for both the natural gas operations in Centuri Construction Group. Justin Brown will follow with the review of our various regulatory activities, and I will finish with some observations on customer growth, the regional economic picture, our capital expenditure plan, growth in our dividend and expectations for 2016. With that, I will turn the call over to Roy.

Thank you, John. I’ve planned to provide a summary of our 2015 operating results and recap the primary factors impacting the change from 2014. And also comment on some expectations around 2016, so let’s move to the slides. Consolidated net income for 2015 came in at a $138 million or $2.94 per basic share that compared to $141 million or $3.04 in 2014. Our Construction Services segment showed strong improvement between years, while our gas segment results declined. Operationally, the gas segment declined was fairly modest. However, returns on investments underlying company-owned life insurance or COLI policy fell by $5.8 million between years and was the primary reason for both the overall gas segment and consolidated earnings decline. Taking that into account, 2015 compares favorably to 2014. Let’s move to slide six in the natural gas segment highlights. In addition to the items, John mentioned earlier, highlights included operating margin growth, reduced financing costs of $4.2 million between years and successes we’ve had on the regulatory front, which Justin will discuss later on. Slide seven, this slide summarizes in the gas segment. Operating margin increased by $14 million between 2014 and 2015, all operating expenses increased by $21 million or 3.3%. As a result, operating income declined by $7 million between three. Net interest deductions favorably offset the operating income decline by $4.2 million. But other income was substantially lower than last year, when COLI returns were quite favorable. That result was a decrease in the gas segment contribution to net income from $117 million in 2014, to $112 million in 2015. Now slide eight summarizes the change in operating margin between years. Customer growth contributed $8 million as the company increases customer account by 26,000 over the last 12 months. Combining rate release in California and from pipeline provided $5 million in operating margin. For 2016, we expect an overall operating margin increase of about 3% from customer growth, California rate release, margins from our infrastructure tracking mechanisms and the Elko expansion project. We also expect another $11 million to recover deferred conservation cost in Nevada, for which there will be a direct offset in amortization expense. On slide nine and 10 relates to our operating expenses. Operating expenses increased $20.9 million or 3.3% between 2014 and 2015, which was on the lower end of our initial forecast range of 3% to 4%. There were several main factors influencing operating expenses in 2015. O&M expenses were up 2.5%, nearly all of which was driven by a higher pension costs, resulting from a new mortality table adopted last year. Our other O&M cost on a net basis were pretty well flat. Depreciation expense increased 5% and general taxes 5% as a result of the 5% growth in gas plant. During 2015, the company invested $438 million of gas system, up from $350 million in 2014 and our highest single year capital expenditure level in history. Looking ahead to 2016, relatively flat O&M costs coupled with higher depreciations and general taxes from continued investment in our distribution system are expected to result in an overall operating expense increase in the range of 2% to 3% plus the $11 million amortization described previously. Slide 10 please. Other income declined from $7.2 million to $2.3 million between years, as 2015 returns on investments underlying our COLI policies were slightly negative, while 2014 returns were strong at $5.3 million. Investments underlying COLI policies include a blend of debt and equity mutual funds; whose combined returns were relative flat consistent with the broader investment market landscape. As a reminder, we think annual average COLI returns in the range of $3 million to $5 million will represent a normal level, but these returns are influenced by market forces and therefore subject to volatility. On the next slide, we'll look at financing activity. Net financing costs decreased by $4.2 million between years. This primarily resulted from the early redemption of $116 million of industrial development revenue bonds since November 2014 that was driven by healthy cash flows particularly those related to gas cost recoveries. For 2016, we anticipate some incremental financing later in the year to support our capital expenditure program. Consequently, interest expense is expected to increase over 2015 levels. Next, we'll turn our attention to the Construction Services segment starting at slide 12. Our Construction Services segment had another very good year in 2015. Revenue exceeded $1 billion for the first time and net income reached a new high watermark at $26.7 million. Favorable weather through most of the fourth quarter allowed us to extend the construction season on the East Coast, Midwest and in Canada helping drive the revenue milestone. And also as John mentioned, we reached the final settlement on the industrial project in Canada, reducing our previously accrued pretax loss from $7.7 million to $3.4 million. Revenues in construction costs associated with the project are included on the slide. Slide 13 provides a snapshot of the Centuri income statement over the last three years. The trend line for all significant line items is very favorable to reflect solid organic growth as well as full year results from the companies acquired in October 2014. The next we'll walk through the line item changes, starting with revenues on slide 14. Construction revenues increased from $740 million in 2014 to $1 billion in 2015, an improvement of $269 million or 36%. Acquired company’s revenue accounted for $124 million of the revenue increased, while growth of replacement work from existing NPL customers was responsible for the remaining $145 million. For 2016, we estimate an operating revenue growth in the range of 3% to 7%, assuming a return to more normal weather conditions and returning to the 7% and 10% range thereafter. Operating income as a percentage of revenue is expected to be between 5.5% or 6%. Moving to slide 15, construction expense increased by $251 million or 39%. Acquired company construction cost accounted for $115 million of the increase and cost associated with additional pipe replacement work at legacy NPL accounted for the remaining $136 million. Also contained within the construction expense increase were 9 million of higher G&A costs. Nearly all of which was attributable to having a full year of operations of the acquired companies. And finally, depreciation expense increased $8 million between years and included an incremental 3 million related to the amortization of finite-lived intangible assets recognized in the acquisition and 4 million of incremental depreciation at the acquired companies. With that, let me turn the time over to Justin Brown.

Thanks Roy. Slide 16 summarizes four areas to highlight our key regulatory initiatives. I will discuss each of these areas starting with an update on a general rate case activity, infrastructure recovery mechanisms, expansion projects and a couple of other recent regulatory filings and outcomes. Turning to slide 17, you may recall that our most recent California general rate case authorized post-test year attrition increases of 2.75% per year for calendar years 2015 through 2018. We made a filing in November requesting an annual increase in operating margin of $2.5 million and this request was approved in December and rates became effective January 2016. Also in California as part of the pipeline safety implementation plan docket where gas utilities were directed to modernize the transmission systems. We received approval to replace 7.1 miles of transmission pipeline and install remote control shut off valve. As part of that same docket, we also received approval to include the revenue requirement associated with that work in a future filing. Since the work was completed in 2015, we made a filing in November requesting to recover approximately $1.7 million of incremental operating margin. That filing was approved in December and new rates became effective January 2016. Moving to slide 18, we are currently in the planning and preparation stages for the next Arizona general rate case. You may recall that some of the conditions of our last rate case settlement preclude a filing in each center in April 30, 2016 and prohibit new rates from becoming effective any sooner than May 2017, as part of our next general rate case we anticipate requesting approval to continue our decoupled rate design, expand our currently approved infrastructure recovery program and update our depreciation rates as well as update our overall cost of service, including an estimated increase in rate base of approximately 22% to 24% to reflect the various investments we've made during the five year rate case mark line. We remain on track to make the filing shortly after the exploration of the stay out period. Turning to slide 19, as we've discussed in previous calls, one of our key regulatory initiatives has been to establish infrastructure recovering mechanisms in each of our jurisdictions. In Arizona, we are currently collecting $2.5 million in annualized operating margin associated with the customer-owned yard line or COYL program. The program was approved as part of our last Arizona rate case decision and began in 2012. In 2014, the commission granted its authority to expand the program to include a phase II for the replacement of certain non-leaking customer lines. The $2.5 million currently being collected in rates is based upon accumulative capital expenditures of $60 million, of which $6.3 million was incurred during 2014 for both phase I and phase II work. We will be making a filing before the end of this month to update these numbers to reflect capital expenditures that were made during calendar year 2015 and requesting the new rates going to affect in June of 2016. Turning to slide 20, in Nevada, we proposed the development infrastructure recovery mechanism as part of our last Nevada rate case in 2012 and ensuring the commission to open rulemaking, to develop regulations for gas infrastructure replacement recovery. These regulations were finalized in January 2014 and since that time we've received approval to replace $58 million of qualifying replacement projects. $14.4 million was approved in 2014 for replacement of early vintage plastic pipe during calendar year 2015 and in October 2015, we received approval to replace up to $43.5 million during calendar year 2016. The 2016 work will consist of replacement of both early vintage plastic pipe and vintage steel pipes. In Nevada GIR regulations also permit us to make a separate annual filing to implement a surcharge to recover the deferred revenue requirement associated with previously approved projects. We've made filings in both 2014 and 2015 and we are currently collecting annualized operating margin of approximately $4 million as a result of the rate application that was approved late last year. The new rates became effective January 2016. Turning our focus to expansion and reliability projects on slide 21. We continue to make progress on the development and construction of our $55 million Liquefied Natural Gas Storage facility that was approved by the Arizona Corporation Commission in December 2014. We recently completed the purchase of the site for the LNG facility and we are completing the frontend engineering design work and preparing construction requirement's bid package for potential contractor. We expect to have a construction contract in place by the second half of this year and we anticipate construction taking up to three years to complete. In Nevada, construction of the Elko expansion project is complete in the latter, it was placed into service in January of 2016. In June of 2014, our Paiute Pipeline subsidiary made a formal application with the Federal Energy Regulatory Commission requesting approval to build the 35-mile, $35 million lateral to interconnect Paiute with Ruby Pipeline and increased gas supply deliverability to Elko Nevada. In May 2015, the FERC issued an order authorizing a certificate of public convenience and necessity to Paiute to construct and operate the project and subsequently provide a formal notice proceed. Following the receipt of that notice to proceed, construction began last summer on the 35-mile pipeline project. The new rates that went into effect with the placement this project in the service are estimated to yield annualized incremental operating margin of approximately $6 million throughout 2016. During last year, Nevada Legislative Session SP151 was introduced and passed unanimously by both houses and signing the wall by the governor in May 2015. SP151 directs the Public Utilities Commission in Nevada to implement regulations authorizing natural gas utilities to expand their infrastructure consistent with the program of economic development. This can include providing natural gas service to unserved and underserved areas in Nevada, as well as attracting and retaining residential and business utility customers and accommodating the expansion of existing business customers. The regulations have been developed and approved by the Nevada Commission and we're currently working with various stakeholders and reviewing potential qualifying projects. Moving to slide 22, we wanted to provide you an update on a couple of other regulatory proceedings. First, in Nevada, as Roy mentioned earlier, each year would file an annual rate adjustment filing to adjust rates to click various deferred costs. This year's filing included the proposed recovery of both deferred and projected energy efficiency and conservation development implementation costs associated with our commission approved programs. The commission approved the filing in December and we received approval to adjust rates by approximately $11 million to recover these energy efficiency program costs. However, as Roy mentioned, there is no impact to net income as the amount also be reflected as amortization expense. And on slide 23, as John mentioned previously, we made filings in October of last year with each of our three state regulatory commissions, requesting approval of a plan to reorganize into a holding company structure. The proposed reorganization is designed to provide further legal and financial separation between the regulated and unregulated businesses. The proposed reorganization is subject to approval of each of our state commissions consensus from various third parties and final board approval. However, as John mentioned we have received approval from the California commission in January of the 2016 and we expect to receive the decisions from Nevada and Arizona sometimes in the first half of this year. And with that, I'll turn it back to John.

Thanks, Justin. Slide 24 provides a breakdown of our customer growth over the past few years. As I previously mentioned, surplus gas added 26,000 customers in 2015. 23,000 of those customers were new meter sets with the balance generally coming from previously unoccupied homes. We now serve 1.956 million customers and anticipate continuing to experience approximately 1.5% customer growth for the foreseeable future. On slide 25, you can see a graph illustrating the decline in the unemployment rate that we’ve seen in the states in which we operate over the past several years. And then on slide 26, you see a table detailing the job creation observed across states we serve as a regional economy continues to improve. Turning to slide 27. As we continue to invest in facilities to serve customer growth and increase the safety and reliability of gas delivery systems, our gas utility plant has grown at a rate of 5.6% over the past few years. Moving to slide 28, the growth in our gas utility plant is the result of continuing to invest in infrastructure to serve our customers. This past year, we invested $438 million to serve our customers and we expect to invest an additional $460 million in 2016. Over the coming three-year period, our capital expenditures should range from between $1.4 billion and $1.6 billion, the exact magnitude of Southwest's prospective capital expenditures will impart the function of our continuing collaborative discussions with our regulators regarding accelerated type replacement activity. Slide 29 provides additional detail in how we see our 2016 capital expenditures breaking down between growth and other categories. As we’ve indicated in previous conference calls, we continue to expect to see the portion of our capital expenditures associated with tracking mechanisms to grow overtime. Turning to slide 30, as I mentioned at the outset of the call earlier this week our Board of Directors approved an increase in our annual dividend to a $1.80 per share. This increase continues a trend of double-digit increases in our dividend over the past several years. Moving to slide 31 and some expectations for 2016 for our natural gas operations, we expect margin to grow by about 3% this year as a result of customer growth, our infrastructure recovery mechanisms, expansion projects in California attrition revenue. Operations and maintenance expense should be relatively flat with higher general and incremental cost to offset by a pension cost decrease. Depreciation and general taxes should increase consistent with growth in gas plant. As Roy and Justin previously mentioned, we expect about $11 million in margin associated with the cost recovery of Nevada conservation programs. This revenue again will be offset by similar amortization expense. Overall operating income should increase by 4% to 5%. We also expect normalized annual COLI returns of $3 million to $5 million recognizing that these returns tend to fluctuate with returns observed in the broader equity markets. Net interest deductions for 2016 are expected to increase by $5 million to $7 million due to our previously discussed capital expenditure plan. Moving to slide 32, in the Construction Services segment, we expect 2016 revenues to grow by 3% to 7% over 2015 levels. This growth is driven by demands of our diverse based utility clients, many of which are in the midst of multi-year type replacement programs. We believe our Construction Services Group is well poised to continue capitalizing on the growing needs for utility infrastructure nationwide and of Canada. That said, we expect operating income to grow by approximately 5.5% to 6% of revenues and we expect net interest deductions of between $6.5 million to $7.5 million based on current interest rate levels. Our collective expectations exclude consideration of earnings attributable to non-controlling interest and finally changes in foreign exchange rates can impact our results. Finally, turning to slide 33, recapping our strategic focus for our company moving forward. We remain focused on the core elements of our business. We’re focused on maximizing safety and customer satisfaction. We will work collaboratively with our regulators. We will retain a skilled and motivated workforce. We will strive to control our cost and increase our productivity and we will encourage growth across our business segments. We will also look to continue our successful track record of executing on our strategic initiatives and we will manage our business with a long-term view of success. With that, I will return the call to Ken.

Thanks John. That concludes our prepared presentation for those of you who have access to our slides, we have also provided an appendix of slides which includes other important information about Southwest Gas it can be reviewed at your convenience. Our operator Nicole will now explain the process for asking questions.

Thank you. [Operator Instructions]. Our first question comes from the line of Matt Tucker of KeyBank Capital Markets. Your line is now open.

Hey guys, congrats on a nice quarter.

Thanks Matt.

First, I just want to ask about the Centuri guidance, the 3% to 7% revenue growth. I guess I mean first, growth of any kinds obviously a good thing in this environment, it is about slower than the growth that you saw in '15. I think even on an organic basis. Is that largely because of just how strong the fourth quarter was with the weather being unusually favorable. Or any other reasons why you couldn't see similar growth next year.

Your observation is correct. That weather at year end especially the month of December, the warmest December on record from the whole eastern half of the United States and we have a lot of business in the Midwest and in the Eastern areas, where we were able to extend our season. If you look at sort of the guidance we have put out in the third quarter, it was higher but I was assumed off of a lower base. And I think you will see that this current guidance now with the higher base of revenues. It's pretty consistent with where we think we were going to be at following the end of the third quarter.

Okay, thanks. And then a couple of questions on the upcoming Arizona rate case. You mentioned, you're likely to request an expansion of infrastructure tracking mechanism. Is that - would that be an expansion the company-owned yard line program or are you looking to expand beyond that?

Yeah Matt, it's Justin. It's actually both, so currently the COYL program provides if you recall under phase I to replace lines that are leaking after leak survey that was expanded to phase II to replace the lines that are not leaking under certain situations. And so I think there is kind of a natural next phase which would be kind of more of a targeted approach. So we're going to look at doing something like that as well as consistent with what we've done in Nevada looking to expand it to include other kind of ageing infrastructure vintage still pipe or plastic pipe where would the case maybe.

Got it. Thanks, Justin. And then you've mentioned you'll be requesting a 20% plus rate based increase I guess not too surprising given the duration of the rate freeze you've been. But I guess could you comment on potential customer build impacts, I think in the past you'd said with the deprecation study rates there may come down and kind of offset what you'd be requesting in terms of rate increase. Is that still the case?

Yes, it is.

Perfect. And then just last question, the expected increase - the expected debt financing and increasing in interest expense. Does that factor in the extension of bonus deprecation?

Yes, it does even with the bonus depreciation we're projecting roughly 60% to 70% of CapEx to be covered by internally generated funds over the three-year cycle. and so we will need some external financing, I might recall we have an existing equity shale programs that still has about $65 million left on it which we can draw on in addition to raising going out into the debt capital market.

Great. Thanks guys.

Okay. Thank you Matt.

Thank you. And I am showing no further questions at this time. I'd like to hand the call back to management for any closing remarks.

All right. Thank you Nicole. This concludes our conference call. And we appreciate your participation and interest in Southwest Gas Corporation. Thank you all.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone.