Southwest Gas Holdings, Inc. (SWX) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Southwest Gas Holdings 2018 First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the call over to Mr. Ken Kenny, Vice President of Finance and Treasurer. Sir, you may begin.

Thank you, Victor. Welcome to Southwest Gas Holdings, Inc.’s 2018 first quarter earnings conference call. As Victor stated, my name is Ken Kenny and I am the Vice President of Finance, 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.swgasholdings.com and click on the Conference Call link. We 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. Gregory J. Peterson, Senior Vice President and Chief Financial Officer; and Mr. Justin L. Brown, Senior Vice President, General Counsel of Southwest Gas Corporation; and other members of senior management to provide a brief overview of the company’s operations and earnings ended March 31, 2018 and a full year outlook for 2018. Our general practice is not to provide earnings projections, therefore, no attempt will be made to project earnings for 2018 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 on Slide 3 in the press release and also our SEC filings 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 would like to turn the time over to John.

Thanks, Ken. Turning to Slide #4, first, I would like to touch on some highlights for the past year ended March 31. From a consolidated results perspective, we had record earnings per share of $4.23 and increased our dividend for the 12th straight year in a row to $2.08 a share. For the natural gas segment, we added 32,000 new customers. Net income increased by $51.5 million. We invested $591 million in capital to serve growth and improve safety and reliability of our gas distribution systems. And we issued $300 million in senior notes to facilitate ongoing capital investment. For the construction services segment, revenues increased by over $67 million. Net income grew to $34.7 million. The acquisition of New England Utility Constructors late last year is performing better than expected and we continue to be enthusiastic about the construction business performance prospects for this calendar year. Moving to Slide #5, the outline for our call today will include a financial report for the consolidated entity with segment detail provided by Greg Peterson; a report on our various regulatory efforts by Justin Brown, recently promoted to Senior Vice President and General Counsel and a wrap up by me covering customer growth and regional economic conditions, our capital expenditure plans and our expectations for 2018. With that, I will turn the call over to Greg.

Thank you, John and thank you all for joining us on today’s call. Let’s start with total company operating results on Slide 6. For the first quarter of 2018, consolidated net income was $79.1 million, or $1.63 per share, an increase of nearly $10 million, or $0.17 a share compared to the first quarter of 2017. For the 12 months ended March 2018, net income was about $204 million, or $4.23 per share, including a one-time tax reform benefit of $20 million or $0.42 a share. This was a significant increase from net income of $146 million, or $3.07 per basic share recorded in the prior year 12 months period. Let’s move to Slide 7 and look at each segment’s impact to the consolidated change in quarterly results. Natural gas operations provided a $13.4 million increase to quarterly earnings, while construction services results were down $3.7 million between the quarters. I will provide some details surrounding the changes in each segment in the following slides. Slide 8 depicts the change in earnings between 12-month periods. Contribution from the natural gas segment increased $51.4 million and contribution from construction services increased $7.3 million. Next, we will take a deeper dive into each segment, starting with the quarterly comparison of natural gas operations on Slide 9. Customer growth amounts from California attrition and the remaining incremental margin from Arizona rate relief that was effective April 2017 had a positive effect on natural gas operating margin in 2018. However, operating margin was reduced by $14 million reserve for corresponding estimated tax reform benefits that are not yet reflected in customer rates. Despite higher pension costs and general cost increases, O&M expenses declined $1.6 million between quarters as the 2017 period included incremental transitional incentive plan grants. The $10.8 million reduction in depreciation, amortization and general taxes reflects the remaining quarter of incremental benefit from lower depreciation rates in Arizona, which more than offset expected increases in depreciation and general taxes associated with a 7% increase in average gas plant in service. The decline in other income reflects market volatility on company-owned life insurance or COLI policies. Lastly, the $2 million uptick in interest expense reflects higher outstanding debt, including $300 million of senior notes issued in 2018 – in March of 2018 to facilitate Southwest’s ongoing capital expenditures program. Slide 10 depicts changes between 12-month periods for natural gas operations. The $11.6 million improvement in operating margin reflects a full 12 months of Arizona rate relief and solid customer growth, but is net of the $14 million of estimated tax reform benefits expected to be returned to customers. The $38 million reduction in depreciation and property taxes includes a full 12 months of lower depreciation rates of about $45 million associated with the Arizona rate case settlements in April 2017 partially offset by depreciation associated with a $359 million or 6% increase in average gas plant in service. The $3.8 million increase in interest expense is due to higher outstanding debt balances. And despite a $45.8 million increase in pretax income, income taxes declined $5.6 million between periods, primarily due to a onetime tax benefit of $8 million associated with tax reform recorded in December 2017. Slide 11 details the components of other income and deductions for the natural gas operations segment for the 12-month periods. While total other income and deductions did not change significantly between periods, there were a few components that I would like to highlight. Income associated with cash surrender values of COLI policies was down $2.5 million between periods, although both periods were higher than our longer term expected range of $3 million to $5 million. Interest income and equity AFUDC totaled $5.7 million in the current 12-month period, an increase of $1.4 million compared to the prior year period. And finally as noted in our first quarter 10-Q effective January 2018, Southwest adopted as required a change in the presentation of pension and other retirement benefit costs. Non-service components of these costs are now included in other deductions instead of in O&M expenses. As required, prior periods have been reclassified to be comparable to the new presentation. The reclassification for the 12 months ended March 2017 increased other deductions and reduced O&M expenses by $19.7 million but had no impact on net income. Turning to Slide 12, we will now review Centuri first quarter results. Revenues for the first quarter of 2018 increased nearly $68 million compared to the prior year quarter, including $14 million from the acquisition of New England Utility Constructors or Neuco in November 2017. Pipe replacement activities continued to increase for most of Centuri’s utility customers. However, construction expenses increased $67 million as unfavorable winter weather working conditions hampered productivity. The $1.2 million increase in depreciation and amortization was due to incremental amortization associated with the Neuco acquisition and depreciation on additional equipment purchases. Income tax benefits declined $2.1 million between quarters due to the impacts of lower rates associated with the tax reform. However, the lower rates will have a positive impact on full year 2018 results. Slide 13 shows the components of the $7.3 million increase in construction services net income between the 12-month periods. Construction revenues increased $189 million due primarily to additional pipe replacement work across the U.S. and Canada. Construction expenses were $193 million higher than the prior year period and include greater operating expenses to support increased growth as well as higher construction costs and an unfavorable mix of work related to a water pipe replacement program. Depreciation and amortization decreased $2.1 million due to a $5.5 million reduction in depreciation associated with the extension of estimated useful lives of certain depreciable equipment, partially offset by depreciation on incremental equipment purchases and amortization of intangible assets associated with the Neuco acquisition. Other includes a $3 million increase in interest expense due to higher debt outstanding, including amounts associated with the Neuco acquisition in November 2017. The income tax benefit is due to the one-time re-measurement of deferred income tax liabilities associated with the tax reform. I will now turn the call over to Justin Brown for a regulatory update.

Thanks, Greg. As highlighted on Slide 14, I will be providing an update on several key regulatory initiatives, including rate case activities and planning, tax reform proceedings, infrastructure tracker programs and several expansion projects. Starting with rate cases on Slide 15, as Greg mentioned earlier, with the conclusion of the first quarter of 2018, we have now experienced the full 12 months of rate relief from our last Arizona rate case. The impact from this case has been a positive contributing factor to our earned return on common equity for the natural gas operations segment over the past 12 months. This is also illustrated in the appendix on Slide 43. We anticipate that this decision, which included $61 million in rate relief and the approval of several important regulatory tools, namely continuation of our fully decoupled rate design, capital tracker programs for both customer-owned yard lines and Vintage Steel Pipe replacement programs as well as approval of a property tax tracker will all continue to have a positive impact on our ability to minimize the difference between our earned and authorized rates return compared to past rate case cycles. Turning to Nevada, we are currently in the final stages of preparing our next Nevada rate case, including finalizing the deficiency that we anticipate filing. We plan to make a filing later this month, with new rates expected to become effective by January of 2019. We intend to utilize a January 2018 test year and we also intend to certify expenses and revenues through July of 2018, which will help ensure that when rates become effective at year end, they will more closely resemble the current cost of providing safe, reliable and affordable service to our customers. With respect to California, we have been on a 5-year rate case cycle historically, which means we were scheduled to file a rate case this past year since our last rate case was filed in 2012. However, the Commission granted a 2-year extension, so we are now targeting a September 2019 filing date. In the meantime, we will continue to make annual adjustments to margins through 2020 as part of our annual 2.75% attrition filing and in fact, for 2018, we were authorized to increase revenue by $2.7 million beginning in January of this year. As part of this rate case decision, the Commission also directed us to use regulatory accounting treatment in the form of a memorandum account to track impacts associated with future changes in tax law procedure or policy, which leads us to the next slide and the topic of tax reform. Turning to Slide 16, we are currently working with our regulators in each of our jurisdictions to ensure a fair and balanced approach to passing tax reform savings back to our customers in a timely manner. With respect to Arizona, the Commission issued an order in February authorizing regulatory accounting treatment to track all impacts resulting from tax reform. The Commission also directed utilities to make a filing requesting approval of one of three things, either a tax expense adjustor mechanism, the filing of a rate case within 90 days, or some other application to address ratemaking implications of tax reform. We chose the third option and made a filing April 2 proposing to refund $12 million to customers based upon the results of a previously approved earnings test where we – that we utilized for our various tracker programs. Alternatively, if the Commission prefers a more traditional approach, we have committed to file a rate case within 120 days of their decision on our pending application. Either approach guarantees that customers will receive the benefit of tax reform through changes in rates. We are currently working with various stakeholders in Arizona. At this point in time, we do not anticipate a decision on our proposal prior to July. In Nevada, the Commission opened an investigatory docket and requested utilities to file written comments outlining their respective plans to pass on savings to customers associated with tax reform. The Commission held a workshop April 26 and we are hopeful to see a decision from the Commission within the next 30 days. Our position in Nevada was that given the timing of our upcoming Nevada rate case that we anticipate making changes reflecting the impact of tax reform as part of our Nevada rate case filing. With respect to California, as I mentioned previously, we have a decision from the Commission directing us to use a tax memorandum account to track ratemaking impacts for attrition years 2019 through 2020 that was approved as part of our proposal to extend our rate case cycle. As a result, we do not anticipate any additional regulatory filings prior to our currently planned rate case in September 2019. And lastly, with respect to FERC – our FERC regulated pipeline, Paiute, FERC issued a draft notice of proposed rule-making, directing pipelines to file a Form 501-G to calculate the impact of tax reform on its current cost of service. And then FERC identified several options for pipelines to adjust their rates, including filing a statement explaining why no change is necessary. Given the expected time line for this proposed rule-making to become final later this year and the timing of Paiute’s next general rate case, we do not anticipate any challenges satisfying the first directive on this particular issue. Turning to Slide 17, we continue to focus on maintaining infrastructure recovery mechanisms in each of our jurisdictions to timely recover capital expenditures associated with Commission approved projects that enhance safety, service and reliability for our customers. We have two such programs in Arizona. First, our COYL replacement program, we filed our most recent annual report with the Arizona Corporation Commission in February requesting to increase our surcharge revenue from $1.8 million to $4.2 million based upon cumulative capital expenditures of $30.9 million, $18.8 million of which was invested during 2017. Turning to Slide 18, in addition to our COYL program, we were also granted approval on our last rate case to start a Vintage Steel Pipe replacement program, so we can start chipping away and replacing the approximately 6,000 miles of Vintage Steel Pipe in Arizona. Similar to COYL, we made our first VSP annual report filing in February requesting to establish an initial surcharge in the amount of $3.1 million to recover the $27 million of costs associated with the 40 miles of replacement activity that were undertaken in 2017. We also met with the Commission staff last fall to review projects eligible for replacement in 2018 and we are currently targeting approximately $100 million of replacement work for completion as we start to ramp this program up. Turning to Nevada on Slide 19, last year, the Commission approved $66 million worth of projects targeted for replacement in 2018. We also recently received approval on our 2017 GIR rate filing authorizing the increase in surcharge revenue from $4.5 million to $8.7 million, which is an increase of incremental margin of $4.2 million for 2018. And lastly, turning to Slide 20, in addition to our 2018 Paiute expansion project and our Southern Arizona LNG facility, both of which continue to make progress in line with our expectations, we recently completed hearings on our first ever SB 151 filing with the Public Utilities Commission of Nevada, where we requested to extend our facilities to Mesquite, which is approximately 80 miles north of Las Vegas. Our proposal includes an approach main and distribution system consisting of approximately 44 miles of pipe and will require an initial capital investment of $30 million. Included in the filing is a proposal to help Mesquite residents access this new system by distributing cost recovery for these localized costs among all the Mesquite customers to help make access more affordable. We expect the final decision later this month or perhaps by early June as the regulations require a Commission decision within 210 days of filing the application. We are looking forward to continuing to work with all stakeholders on this initiative to ensure successful outcome. And with that, I will turn it back to John.

Thanks, Justin. Turning to Slide 21, customer growth continues to be robust across our service territory as we added 32,000 new customers in the past year. We expect this continued growth trend to remain over the balance of this year and into 2019 and 2020. Moving to Slide 22, we present some quantitative detail illustrating growth prospects across our service territory. We expect population growth in Arizona, California and Nevada over the coming several years to exceed the national average and from a job’s perspective, we saw continued low unemployment rates, along with positive employment growth. On Slide 23, we provide our expectations regarding capital expenditures and financings. In 2017, we invested $560 million to serve growth and update our gas distribution systems and look to ramp up these investments over the next few years, spending upwards of $2 billion for the 3-year period ended 2020. The capital expenditures will be funded through a combination of internal cash flows, newly issued debt and equity issuances under our equity shelf program. Turning to Slide 24, we show the growth in our rate base that we expect as a result of our capital expenditure program. Over the 3-year period ended December 2020, we anticipate rate base growing from $3.2 billion to $4.5 billion of compounded annualized growth rate of 12%. Moving to Slide 25, we provide a number of factors that we believe will influence our year end results for 2018. First, in the gas operations segment, as detailed on a prior slide, we expect continued robust customer growth of approximately 1.6%. Also, as previously mentioned, our growing capital expenditures will require incremental financing activity as detailed on Slide 23. As of the conclusion of the first quarter, we have not fully realized the full year rate relief from our last Arizona rate case decision. We expect our pension expense to increase this year by $8 million due to the relatively low interest rate benchmark that was established at the end of 2017. Deferred infrastructure costs and expansion projects will cause interest income and equity AFUDC to rise. And lastly, for the utility, we expect to file a new general rate case application in Nevada later this quarter, with new rates expected to be effective in January of next year. Then for the construction services segment, our Neuco acquisition will be an important contributor to revenue growth this year. And finally, while lower tax rates from tax reform are generally good for the construction business, they do increase the magnitude of our seasonal first quarter loss. Turning to Slide 26, we provide 2018 line item guidance for our natural gas operations segment. As shown on this slide, we expect operating margin to increase by approximately 2%. Operations and maintenance expense should increase by 2% to 3%, not including the previously referenced pension cost increase. Depreciation and general taxes are expected to be flat. Operating income should be flat to modestly up, less the impacts of tax reform. Net interest deductions should increase by $9 million to $11 million. We anticipate company-owned life insurance returns of $3 million to $5 million, along with interest income and AFUDC equity income of $5 million to $6 million. Income taxes are expected to estimate at 23% to 24%. And as previously mentioned capital expenditures should total about $670 million this year. On Slide 27, we show our line item expectations for the construction services business. Revenues are expected to grow by 6% to 8%. Operating income should equate 5.25% to 5.75% of revenues. Net interest deductions are expected to be $11 million to $12 million. Remember that foreign exchange rates can impact results marginally due to our Canadian operations. And we estimate income taxes for this segment in the 27% to 28% range. Finally, moving to Slide 28, we believe that Southwest Gas Holdings continues to offer a compelling value proposition for our shareholders. For our gas utility segment, we expect continued strong customer growth. We have an aggressive capital campaign to serve that growth as well as enhance the safety and reliability of our systems. We anticipate annualized rate base growth of 12% as a result of our capital expenditures. And we continue to see enhanced recovery of our cost as a result of the collaborative relationships we have with our regulators. Similar value drivers on our construction business include its presence as one of the largest underground pipeline contractors in North America, serving 25 different markets across the U.S. and Canada, with long-tenured customer relationships and a positive underlying business prospect for continued replacement of aging infrastructure. I will now 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 with slides that includes other pertinent information about Southwest Gas Holdings and its two business segments. These slides can be reviewed at your convenience. Our operator, Victor, will now explain the process for asking questions.

[Operator Instructions] And our first question comes from the line of Paul Ridzon from KeyBanc. You may begin.

Good afternoon or good morning wherever you are. In California, what’s happening to the tax reform in 2018?

Yes, Paul, this is Justin. The Commission has not opened any proceeding dealing with that particular year. As part of our decision last year, our rate case cycle went out through 2018 as part of the old rate case and so the extension only addressed tax years 2019 and 2020. So we have been currently having informal discussions with the Commission in that regard, but they have yet to open any formal proceeding regarding ‘18.

Are you occurring anything in California?

Yes, we are.

Okay. And then for financing, you talk about a $150 million equity shelf you anticipate that will get you through 2020, if I am reading this properly?

Yes, we certainly have the ability under the equity shelf. We still have $99 million remaining, which we will use to finance any needs.

Okay, thank you. That’s my questions.

[Operator Instructions] Our next question comes from the line of Aga Zmigrodzka.

Hello. This is Aga Zmigrodzka from UBS. Could you please provide more color on the revised higher construction guidance? Thank you.

Certainly, the construction guidance, again, as we have gotten through the first quarter and this is the time when we start to enter into contracts with our customers and they start to distribute the workout to us and so based on that and other factors, we have kind of increased that guidance. As you remember, we increased both the revenue guidance from 5% to 7% to 6% to 8% now as well as the operating income percentage from 5% to 5.5% and now it’s 5.25% to 5.75%. So, it includes all of our expectations based on the information we have now for calendar year 2018.

Perfect. Thank you. My second question is regarding Arizona and the impact from taxes. So when you made a filing proposing to refund approximately $12 million to customers, what’s exactly included in this filing? Does it include other components to bring you closer to your allowed ROE? Thank you.

Yes, again, this is Justin. Essentially, what we did as part of our various tracker programs that we have, we are required to make an earnings test filing each year demonstrating our earned return versus what they have authorized. And so what we did with the tax reform as we essentially use that same earnings test approach and essentially used 2017 as a proxy year estimated the impact of tax reform and then whatever margin exceeded what our authorized return was, that’s how we came to the $12 million proposed refund amount.

Perfect. Thank you. That’s all from my end.

And I am showing no further questions. I would like to turn the call back to Mr. Ken Kenny for closing remarks.

Thank you, Victor. This concludes our conference call and we appreciate your participation and interest in Southwest Gas Holdings Inc. Please have a great day. Thanks.