Southwest Gas Holdings, Inc. (SWX) Q4 2016 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Southwest Gas Holdings 2016 Year-End Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference Mr. Ken Kenny, Vice President of Finance and Treasurer. You may begin.

Thank you, Sandra. Welcome to the Southwest Gas Corporation 2016 earnings conference call. As Sandra stated, my name is Ken Kenny, and I am the Vice President and Treasurer. Our conference call is being broadcast live over the Internet. For those of you who would like to access our 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 2016 earnings and an outlook for 2017. Our general practice is not to provide earnings projections therefore, no attempt will be made to project earnings for 2017. Rather, the company will address factors that may impact those 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 statements. With that said, I’d like to turn the time over to John.

Alright, thanks Ken. Turning to slide 4, 2016 was a very successful and exciting year for Southwest Gas and its shareholders. Our Board of Directors authorized an increase in our dividend for the eleventh straight year. The increase approved by the Board just this last week increases our annual dividend from $1.80 to $1.98 per share. The dividend is an important component of the 42.5% total shareholder return earned by our shareholders this past year. Consolidated earnings reached a record $3.20 per share and our new holding company reorganization was effective at the beginning of this year. On the regulated side of our business we reached a proposed settlement in the Arizona rate case that we filed in May of last year. Justin Brown will provide an update on that resolution later in the call. Operating margin totaled $924 million. We added 28,000 new customers as the regional economies we serve continued to experience growth and we invested $457 million in our gas systems to improve safety and reliability and serve new customers. Finally for 2016 on the construction side of the business, Paul Daily joined our team as the CEO of the Centuri Construction Group. The construction business contributed a record $32.6 million of net income representing the fourth consecutive year of increased earnings. And the construction business is now celebrating its 50th anniversary. Turning to slide 5, as I previously mentioned our new holding company structure took effect at the beginning of the year. The new structure will provide further legal separation between our regulated and non regulated business entities and provide additional future financing flexibility. Moving to slide 6, for today's call Roy Centrella will provide an update on year-end consolidated earnings as well as additional detail on both our utility and construction services subsidiaries. Justin Brown will provide an overview on a variety of regulatory activities that the utility segment has been pursuing and then I'll wrap up the call with the regional economic overview, planned capital expenditures, growth in our dividend, and our expectations for 2017. With that I’ll turn the call over to Roy.

Thank you, John. I’m going to spend a few minutes providing a high level review of 2016 consolidated and business segment operating results including explanations for significant changes between years. I would point out that there's additional detailed information that can be found in the appendix. So let's start with slide 7. In 2016 we earned $3.20 per basic share, an improvement of $0.26 from the $2.94 earned during 2015. Net income grew to $152 million from $138 million and both business segments have improved results. Moving to slide 8, you can see that net income increased $13.7 million between periods and $7.8 million of the improvement came from our natural gas operations segment. While $5.9 million came from construction services. Next we'll look at each business segment starting with gas operations on slide 9. This slide summarizes 2016 and more recent highlights which influence our current year operating results or will impact 2017 and beyond. John touched on several of these earlier so I’ll bring your attention to few others starting with company owned life insurance or COLI income which was very strong at $7.4 million in 2016 versus the small loss in 2015. We completed a $300 million 30 year financing in September of 2016 at a very favorable interest rate of 3.8%. This supported our capital expenditures in the last couple of years and also replaced some higher cost debt that we were able to call at par. And lastly we received approval to spend $57 million on accelerated pipe replacement work in Nevada during 2017 under our gas infrastructure recovery mechanism. Justin will speak more to this later. Turning to slide 10, this waterfall chart identifies a major line item changes for the gas operations segment income statement. We had strong growth in operating margin totaling $33.4 million mainly due to the addition of 28,000 customers during the year and the impact of rate changes including the California attrition, higher general rate release, and infrastructure tracker mechanisms. About one third of the margin increase pertains to demand side management program surcharges in Nevada with a direct offset and amortization expense. Our O&M costs were up about $8.5 million or 2% between years with 2.6 million of the increase attributable to higher pipeline integrity management and damage prevention costs. And depreciation and amortization and general taxes increased $23 million primarily due to our capital expenditures which totaled $457 million last year along with the demand side management amortizations noted previously. Now let's turn to slide 11 and our construction services. Revenue grew, our growth was very strong increasing $130 million or 13% year-over-year. Nearly half of the increase came from several large bid jobs with a new U.S. customer and existing distinct Canadian customer that are not expected to recur in 2017. And the remainder came principally from additional pipe replacement projects. Favorable winter weather conditions were also a tailwind. Slide 12, provides a summary waterfall chart reconciling contribution net income between 2015 and 2016. We estimate the additional revenue contributed $3 million of net income or about half of the net change. Carrying costs pertaining to the 2014 Link-Line acquisition was lower mainly due to expired intangible amortizations and we had a lower effective tax rate as more income was earned in Canada versus United States than in the prior year. So we benefited from the lower relative tax rate. With that let me turn the time over to Justin Brown to provide a regulatory update.

Thanks Roy. Slide 13 highlights several key areas that will be the focus of my comments today starting with rate release namely our Arizona rate case, infrastructure replacement program specifically our Arizona COYL program and our Nevada GIR program, and an update on two expansion projects. Turning to slide 14, just a mere nine months ago we started the process to update rates in Arizona to reflect our current cost providing service. This filing marked the end of our five year rate case moratorium that was agreed to as part of our last general rate case. Since that time we have worked closely with all the parties and have reached a settlement agreement that is currently pending Commission approval. Slide 14 highlights several key outcomes from that proposed settlement agreement including a revenue increase of 16 million and a depreciation expense reduction of 45 million. In addition the settling parties agreed to either continue or implement certain key regulatory mechanisms including full revenue decoupling, expansion of our existing customer owned yard line program which will help us accelerate the replacement of approximately 80,000 COYLs remaining in our system. In addition the parties agreed to implement a new infrastructure replacement program targeting the nearly 6000 miles of pre-1970 vintage steel pipe we have in Arizona service territory and to implement a property tax tracker whereby we will be tracking changes in our property tax expense back to the amount that is embedded in base rates. The difference will be deferred and amortized as part of the future rate case. We're also able to reach agreement with the parties on a cost recovery methodology for our LNG project. I will discuss this in more detail later in the presentation when I provide an update on our project. And lastly the settling parties agreed to a rate case moratorium whereby we agreed not to file a new rate cast before May 1, 2019. Turning to slide 15, this slide illustrates the anticipated impact to operating income for 2017 and 2018 following the implementation of new rates in Arizona resulting from the proposed revenue increase and depreciation expense reduction. This assumes a May 1, 2017 effective date. We did receive a draft order just this week approving the settlement agreement and the matter may be considered by the Commission in either their March open meeting which is currently scheduled for March 14th and 15th or possibly their April open meeting which is currently scheduled for April 5th or 6th. The draft order is currently contemplating its new rates becoming effective April 1, 2017. Turning to slide 16, you may recall that our most recent California rate case authorized post test year attrition increases of 2.75% per year for calendar years 2015 to 2018. We made a filing in November requesting an annual increase in operating margin of $2.8 million and this request was approved in December with rates becoming effective in January. Turning to slide 17, from a California rate case planning perspective or our five year rate case cycle which means we're currently scheduled to file our next rate case later this year. However following discussions with the Office of Ratepayer Advocates we filed a petition at the end of last year requesting to extend the rate case cycle by two years. The petition essentially requests the Commission to extend the rate cycle leaving all other aspects of the previous decision intact including the ability to make post-test year attrition adjustments for an additional two years. The Office of Ratepayer Advocates supports the petition and we have requested a decision by April of this year so that we have time to prepare for a September rate case filing of the petition if for some reason not granted. Turning to slide 18, we continue to focus on establishing and maintaining infrastructure recovery mechanisms in each of our jurisdictions in order to timely recover capital expenditures associated with Commission approved projects and enhanced safety, service, and reliability for our customers. Yesterday we filed our fifth report with the Arizona Corporation Commission requesting to increase our surcharge revenues associated with the customer and the yard line program. We currently are collecting 3.7 million based upon cumulative capital expenditures of $23.1 million. Due to the timing of our Arizona rate case those amounts will move to base rates and it is anticipated that the surcharge will reset in June of this year. Accordingly the proposed surcharge is 1.8 million -- is designed to recover 1.8 million and is based upon 2016 capital expenditures of approximately $12.1 million. Turning to slide 19, our Nevada infrastructure replacement program continues to ramp up as we were work collaboratively with our Nevada regulators to identify replacement projects to be replaced on an accelerated basis. Since 2014 we have received approval to replace over $115 million of qualifying replacement projects. Most recently we received approval to replace 57.3 million of qualifying projects during 2017. As noted on the right hand side of slide 19, as of January we're collecting approximately $4.5 million as a result of the GIR rate application that we filed in October of 2016 and that was subsequently approved in December with rates becoming effective in January. Turning to slide 20, since 2016 marked our third GIR rate application in order for us to continue the GIR program this coming year we are obligated to either file a general rate case to clear out the deferral balances or to file a petition requesting a waiver from that requirement. After discussions with the Commission staff as well as the consumer advocate we chose to file a petition requesting a waiver from the regulations allowing us to proceed with the GIR program for another year. As part of that process we also committed to file a general rate case application some time before June of 2018. The petition was supported by the Commission staff and was approved by the Commission last month. Accordingly we plan to file a GIR advanced application later this year in May and another GIR rate application in October. We will then plan to file our next Nevada rate case in the first half of 2018. Turning our focus to major expansion and reliability projects on slide 21, we recently made a filing with the ACC requesting to modify the pre-approval decision to reflect new not to exceed amount of $80 million for our LNG facility. This reflects the current market pricing to construct a 233,000 dekatherm LNG facility in Southern Arizona. We solicited engineering procurement and construction bids last summer and received those bids in September which provided the basis for the request to increase the estimated cost of the project. The Commission granted our request in December. Accordingly we are proceeding with EPC phase or the engineering procurement and construction phase of the project and we have invested approximately $4 million in capital expenditures primarily associated with the land that was chosen for the site. We anticipate construction being completed by year end 2019. As mentioned previously we reached agreement on a cost recovering methodology for the LNG facilities as part of our rate case settlement. Essentially the parties agreed to extend the deferral accounts such that the revenue requirement associated with all costs incurred before December 31, 2020 will be deferred and recovered in future rate case. Lastly in response to shipper interest for additional transportation service capacity in the Carson City in South Lake Tahoe areas, tight announced plans for an expansion project consisting of 8.4 miles of additional transmission pipeline infrastructure at an approximate cost of $17 million. In October Paiute initiated and received approval to proceed with the pre-filing of review process with the Federal Energy Regulatory Commission for the expansion project. A formal certificate application is expected to be filed by this coming summer. If the process progresses as planned, the additional facilities could be in place by the end of 2018 with new rates in place coincident with the end service dates. And with that I'll turn it back to John.

Thanks Justin. Turning to slide 22, as I mentioned at the outset of the call we added 28,000 customers this past year bringing our total customer count to 1,984,000 customers. We’re really excited about the expectation that we will serve over 2 million customers later this year and expect our growth rate over the next three years to approximate to 1.5%. Moving to slide 23, the regional economic picture continues to improve across our service territories, unemployment rate is down across the board. Employment growth rates are slightly mixed year-on-year with the overall picture being one of continued job growth in the areas to which we provide natural gas service to customers. On slide 24 as we continued to serve our growing customer base and invest in the safety and reliability of our distribution system, we've seen our gas utility plant grow as well. Over the past four years the compounded annual growth rate of our gas utility plant has been approximately 6%. On slide 25, we have a bar chart illustrating the experience and planned capital expenditures for years 2016, 2017, 2018, and 2019. Each year has segmented data to detail how much of our capital is considered general plant, growth related, code required, and the portion covered by tracking mechanisms. Over the coming three year period we anticipate investing upwards of $1.8 billion to serve these varying needs. Moving to slide 26 as I mentioned at the outset of the call, just this past week our Board authorized moving our annual dividend from $1.80 to $1.98 per share, an increase of 10%. We believe we've been one of the leaders in the industry over the past several years with a five year compounded annual growth rate in our dividend of just under 11%. Turning to slide 27, looking forward into 2017 for our expectations with respect to the natural gas segment, we expect operating margin to increase by approximately 2%, capital expenditures should total 570 million as we continue to invest in safety and reliability, and opportunities to serve new growth. Net interest deductions should approximate 2016 levels, normalized company owned life insurance returns are anticipated at $3 million to $5 million, operating income is expected to increase by 10% to 12%, depreciation of general taxes are expected to decrease as a result of depreciation rate decreases included in our proposed Arizona rate case settlement, and O&M expenses are expected to range between 3% and 4% generally tracking inflation and customer growth rates. On slide 28 our construction services expectations for 2017 include expected growth in revenues of 2% to 5%, operating income approximating 5% to 5.5% of revenues, net interest deductions ranging between $6 million and $7 million based on current interest rate levels, collective expectations exclude consideration of earnings attributable to non-controlling interest, and due to our Canadian operation and changes in foreign exchange rates can impact results. Moving to slide 29, while 2016 was a great year we are really excited about the future here itself with gas. We are pursuing numerous initiatives that serve our customers and their shareholders interests. On the utility side we continue to look into the prospect of investments in underground gas storage and gas reserves. We are looking to expand our Nevada service territory into new areas with use of regulations directed by Senate Bill 151. We continue to review the potential replacement of our Southern Nevada transmission lines and we're looking into the future replacement of our customer management system. At Centuri we will look to continue growing the business through organic growth as well as the potential for bolt-on acquisitions, expanded water distribution replacement, and other infrastructure replacement and repair activities. Finally turning to slide 30, we will continue to look for success by following the principles that have guided our historic success including remaining focused on the core elements of our business, fostering growth across our business segments, controlling cost and improving productivity, maximizing safety and customer satisfaction, maintaining trusted relationships with our regulators, retaining a skilled and motivated workforce, successfully executing on our business initiatives, and managing our business with the long-term view of success. With that I will return the call to Ken.

Thanks John. That concludes our prepared presentation. For those who have accessed our slides we have also provided an appendix of slides which include other pertinent information about Southwest Gas Holdings and its two business segments Southwest Gas Utility and Centuri. And this can be reviewed at your convenience. Our operator Sandra will now explain the process for asking questions.

Thank you Sandra. This concludes our conference call and we appreciate your participation and interest in Southwest Gas Corporation. Thank you and have a good day.