Southwest Gas Holdings, Inc.
Q1 2015 Earnings Call Transcript

Published: 9 May 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Southwest Gas 2015 First Quarter Earnings Conference Call. My name is Alex, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Ken Kenny, Vice President of Finance and Treasurer. Please proceed sir.

[Ken Kenny:]

Thank you, Alex. Welcome to Southwest Gas Corporation 2015 First Quarter Earnings Conference Call. As Alex 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 Web site 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 Southwest President and Chief Executive Officer Mr. Roy R. Centrella, Senior Vice President and Chief Financial Officer; and Mr. Justin L. Brown Vice President Regulation and Public Affairs and other members of senior management to provide a brief overview of the Company's operations and earnings ended March 2015 and full year outlook for 2015. Our general practice is not to provide earnings projections. Therefore, no attempt will be made to project earnings for 2015. 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 2 in the press release and also our SEC filings for 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.

[John Hester:]

Thanks Ken. Moving to Slide Number 3 we are pleased to report the consolidated net income for the quarter total approximately $72 million, an increase from that same quarter last year. For our natural gas operations we saw the operating margin for the quarter increase by $4 million to just over $299 million. Our growth in operating margin is partially attributable to our growing customer base, Southwest added 26,000 customers in the past year moving forward we will continue to invest capital to increase safety and liability of our system and look to deploy an increased percentage of that capital in conjunction with regulatory recovery mechanisms. On the construction services side of our business our integration efforts to bring Link-Line into the Centuri Construction Group continue on pace. From a financial perspective overall the construction services group lost $6.9 million in the first quarter while it is not uncommon to see a first quarter loss in this segment of the business year-on-year the loss was greater due impart to a pre-tax loss reserve Southwest made to reflect the lays experienced in a Canadian industrial construction project as is often the case was for such projects change order request for additional revenue have been submitted for the project. We believe the change order request will narrow or reverse the current quarter loss and we will be able to report on the net final result of the project in a future quarter that said we remain very enthusiastic about the construction services business and believe it is on track to contribute over $950 million of revenue this year. Turning to Slide Number 4 for the balance of today's call Roy Centrella will further review first quarter consolidated earnings along with additional detail for the natural gas and constructions services group. After that Justin Brown will report on our regulatory activities and I'll conclude with an overview on our capital expenditures as well as our outlook for 2015. With that I will turn the call over to Roy.

[Roy Centrella:]

Thank you John, I will spend a few minutes reviewing our first quarter and rolling 12 month operating results starting on Slide 5. This slide provides a summary by segment of operating results for the three and 12 month periods and in March 2015 and 2014. Net income for the first quarter improved modestly between periods from $71 million to $72 million while basic earnings per share increased $1.51 to $1.54 and improvement in operating results of the gas segment was largely offset by lower results at the construction services segment. For the 12 month period consolidated net income increased from $135 million to $142 million and basic earnings per share increased from $2.99 to $2.06 with operating segment experiencing improvement. Let's now go through each segment beginning with gas operations on slide 6. Net income was $78.9 million during the first quarter of 2015 versus 72.6 million during last year's first quarter. This improvement was driven by growth in operating margin with $4 million coupled with $3 million net reduction in total operating expenses additionally both other income and that is interest deduction have modest favorable variances between period. Slide 7 breakdowns to change in operating margin between the quarters. The primary cause of the increase is 3 million of incremental margin from the position of 26,000 net new customers since March 2014. This equates to 1.4% customer growth rate we also receive rate relief in our California and Paiute rate jurisdictions. Slide 9 O&M expenses decreased nearly 7% between periods driven mainly by lower legal cost recall that in 2014 we had a $5 million legal accrual there is no similar accrual in 2015. Depreciation expense in property taxes both increase between periods as a result of construction expenditures. Although we are off to a great start we still forecast total operating cost increases of 3% to 4% in 2015 due to the higher pension cost and associated with construction expenses. Next to move to 12 month result on Slide 9 gas segment net income for the current 12 months period $123 million was about $6 million higher than the prior period. The improvement was driven by higher operating margins and relatively flat operating expenses as more fully summarized on Slide 10. Operating income increased $15.2 million between periods operating margin grew by $15 million rate relief in California and Paiute coupled with customer. Total operating expenses were flat between periods as increases in deprecation and general taxes were offset by O&M cost which decline $13 million between periods. The reduction in O&M cost included lower legal expenses and rent on our previously leased headquarters and pension cost in 2014 was lower than 2013. Next we'll move to Slide 11 and Centuri results. During the three month ended March 2015 Centuri experienced a loss to $6.9 million compared to a loss of 1.8 million in the prior year quarter. Now Q1 is traditionally in Centuri is weakest due the number of sizable customers they have in East, Midwest as well as Canada where construction work is largely dictated by weather. That said the results also included a loss reserve for industrial project in Canada which I'll speak about in a minute. Moving to Slide 12 revenue increase $59 million or nearly 50% with 42 million coming from recently acquired companies and 17 million from growth at NPL, however construction expenses increased about $62 million with 49 million of the increase attributable to the acquired entities and 13 million from growth at NPL. Included in this cost was $5.6 million loss reserve for an industrial construction project in Canada. This lost contract in an evolving story with mainly upside potential, this was short duration fixed price contract which started earlier this year and is over 90% complete delays and delivery of critical equipment for the job site resulted in production and efficiencies and increase is estimated total project cost. These delays were not caused by our actions as a result management is actively negotiating change order which may narrow or reverse the loss in future periods. Unfortunately accounting and our polices required in all future cost to complete the project we estimated but potential incremental revenue to cover such cost only be recognized when change orders are finally improving. It is expected to several months to know the final net profit or loss on the job. Slide 13 this slide shows most recent 12 month period, during which Centuri's net income increased from 17.9 million and 18.1 million. Operating income improved by $9 million and was partially offset by higher net interest deductions of $4.1 million resulting from acquisition financing. Turning to Slide 14 you'll see that operating revenues jump $146 million between 12 month period reflecting six month of activity from the acquired companies or $97 million and additional pipe replacement market and deal totaling $49 million. Construction expenses increase to $130 million including 98 million as the acquired entities and $32 million at NPL. In the current period construction expenses reflected the loss reserve discussed previously and $5 million of acquisition cost on prior period results included to $4 million legal settlement recorded in 2013. Lastly on this slide depreciation expense increase $7.5 million and included $2.9 million and the amortization of finite-lived intangible assets recognized in conjunction with the acquisition. Let me now turn the time over to Justin Brown to provide regulatory update.

[Justin Brown:]

Thanks Roy, turning to Slide 15 we have an update on several regulatory activities. First you may recall that we’re on a five year rate cycle in California and as part of our most recent California general rate case we were authorized annual post test year attrition margin increases of 2.75% per year for calendar 2015 through 2018. We made a filing in November of last year requesting a $2.5 million margin increase for 2015. The request was approved by the California commission in December 2014 and new rates become effective at the beginning of this year. One of our key regulatory initiatives has been established infrastructure replacement mechanism in each of our jurisdiction in order to facilitate replacement of qualifying facilities to enhance safety, service and reliability to our customers. In Nevada the public utilities commission approved regulations in January 2014 that authorized Southwest gas to make annual filings was indentified qualifying project that would replaced in the following year. In 2014 the commission approved $14.4 million of early vintage plastic pipe replacement to be performed during calendar year 2015. We look forward to making another filing pursuant to the Nevada regulations within the next month where we will identify qualifying projects for replacement in 2016. The regulations is also authorizes to make a spate annual filing to implement a surcharge to recovery the revenue requirement associated with previously approved projects. You may recall in the fall of 2014 we submitted a gas infrastructure rate applications and we’re authorized the institute of surcharges effective January of this year to collect $2.2 million annually. Similar to last year we plan to make a proposal for an updated recovery surcharge later this year. In Arizona we continue to make progress with our customer-owned yard-line or COYL program. The program was approved as part of our last Arizona rate case decisions and was most recently expanded in 2014 to include a phase 2 for the replacement of certain non linking customer lines. The existing surcharge that was approved last June recovers annualized revenues of $1.5 million and we made a similar filing in February of this year to update that surcharge to 2.5 million. This updated surcharge reflects total capital expenditures to date of $16 million of which 6.3 were incurred during 2014 for both Phase 1 and Phase 2 projects. The currently pending request has been recommended for approval by the ACC staff to become effective June 1 2015. We anticipate a final commission decision within the next week. Lastly in California, the California commission or proposed infrastructure reliability and replacement adjustment mechanism or high or IRRAM in June 2014 as part of our most recent rate case you may recall rate application included a request to establish a COYL program and IRRAM to promote the timely cost recoveries associated with the replacement of offline project. Initially the commission limited there approval to a COYL inspection and week survey program for schools. The IRRAM will facilitate the recovery of the incremental cost associated with this new COYL programs. Turning to our couple expansion related initiatives we continue to make progress towards finalizing land purchase agreement and request for proposals related to the construction of the liquefied natural gas storage facility that was approved by our Arizona commission. You may recall late last year we receive pre-approval from the commission to construct a $55 million liquefied natural gas storage facility in Southern Arizona. The company was also granted authority to differ project cost of the $50 million through November 1 2017 and gas associated with the facilities will be recovered due to current purchase gas adjustment mechanism. Construction facility is still expected to take 24 to 30 months from the date we received approval. In Nevada our Paiute Pipeline subsidiaries expansion Elko remains on track. I made a formal application with the Federal Energy Regulatory Commission in June of 2014 requesting approval to build a $35 million lateral to interconnect pipe with Ruby pipeline increase gas supply deliver ability to Elko. In February of this year we received a preliminary favorable environmental assessment from deferred and we anticipate the final quarter of approving the project anytime now. Which should facilitate a desire in service base of November this year? And lastly closing out our overview of regulation as John mentioned in our last earnings call we are now likely in the historic test year for Arizona general rate case. Recall that our last rate case decision was a settlement to contain several provision governing the timing of our next general rate case. Specifically those conditions required that our next application be submitted earlier than April 30 2016 and is the filing may use a texture ended no sooner than November 30 2015. As this been the case with some of our recent rate case filing we were likely looked to revisit our currently effective depreciation rate. Settlement agreement also provide the rates from the upcoming rate application may be effective no earlier than May 1, 2017 and with that I'll turn it back to John.

[John Hester:]

Thanks Justin. Now turning to Slide 16 we will continue to look for ways to improve the safety and reliability of our natural gas distribution system. For 2015 we expect to make capital expenditures and support of that effort totaling $445 million. In the coming three year period those same capital expenditures are expected to total $1.3 billion. The pie chart on Page 16 shows a breakdown of that capital investment among several categories. Note worthy is the $23 million portion that is associated with the pipe of regulatory tracking mechanism that Justin just described. We expect that portion to grow over the time. We think the tracking mechanism offer a great partnership between regulators, customers, investors and so far as they facilitate the cost recovery of investments made in safety and reliability without acquiring the lumpy increase this in rates that may come as part of traditional rate case filings. Moving to Slide 17 looking forward for the rest of the -- this on our construction services group we will continue our ongoing integration efforts to bring the Link line group of companies into the Centuri Construction Group. We continue to believe that 2015 revenues will range between $950 million and $1 billion with operating income approximating 6% of revenues. Net interest productions are expected to be $6.5 million and $7.5 million. Our expectations are before considering a 3.4% non-controlling interest retailed by Link lines previous owners. Also please keep in mind that results can be influenced by both foreign exchange rates and interest rate. Turning to slide 18 on the natural gas side of the house we expect net customer growth in 2015 to approximate 1.5% 2015 operating margin is expected to increase by 2%. As we have previously indicated operating cost increases should track our growth rate cost inflation which we believe will be in the 3% to 4% range. Our operating cost increase assumption includes a net pension expense increase of $ 8 million as a result of our actuary's updated mortality tables. As for net interest reductions we believe 2015 figures will be equal to a lesser than 2014 results. 2015 COLI returns are expected to fall in the $3 million to $5 million range. And again our 2015 capital expenditures for the year should total about $445 million. With that I will return the call back to Ken.

[Ken Kenny:]

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

[Operator:]

[Operator Instruction] Your first question comes from the line of Matt Tucker with KeyBanc Capital Markets. Please proceed.

[Matt Tucker:]

I just wanted to ask a little bit more about this project loss in Canada and the change orders you're expecting to get. Do you anticipate getting the change orders this year? And would the cost -- or would the recovery be coming from your customer or from a third-party contractor that is responsible for those delays?

[Roy Centrella:]

Yes we're actively those change orders right now that we've submitted several. So we do expect that to play out over the next perhaps led into the third quarter. But certainly clearly our anticipation is ramp up this year and we were sub contractor on this job. So we're negotiating with the primary contractor.

[Matt Tucker:]

And it looks like your operating-income margin guidance for the year is consistent with what you provided on the fourth-quarter call. Was this project loss already reflected in that, or does the intact guidance suggest that you're assuming that you get those change orders this year?

[Roy Centrella:]

No we did not anticipate this occurred was a very short duration project occurred at and we're starting project after the forecast is made. But it does reflect our confidence I guess going forward.

[Matt Tucker:]

And how confident are you that there are no similar projects at Link-Line that could see similar types of issues?

[Roy Centrella:]

This was first of all wasn’t a Link line project and Link line group of companies. The Link Line itself has pipeline replacement where much like NPL this was at some of the other subsidiaries that tend the fabrication work. So they tend to do work on a project basis and we don’t have another project like this in the wings that said Nickels company does do mostly project oriented work and so that add some level or risk or have release a different risk profile than they link line in NPL types of projects.

[Matt Tucker:]

And this project aside, can you just comment on how the performance of the Link-Line group of companies has compared to your expectations over these past two quarters?

[Roy Centrella:]

At this point two quarters in they are meeting our expectations. Certainly the work we had anticipated with Enbridge and Union gas was a bit of two primary customer and coming to fruition. And we're receiving the kinds of margins that we were expect and so we very confident and very positive about what's going to happen over the remaining nine months of year.

[Matt Tucker:]

And just one last one, on your expectations for operating expenses -- the natural gas operations to increase 3% to 4% year over year. It looks like you're down almost 2% in the first quarter. So was that in line with your expectations, or would it be fair to say that you are tracking towards the low end of the expected increase in costs?

[Roy Centrella:]

We had anticipated the first quarter one of the better ones because of last year having that legal accrual in there yes that was a $5 million not – we're hoping we wouldn’t have anything similar this year and that did not. So we did sort of expected the first quarter to be favorable I think at this point we are doing maybe even a little better than we've expected been it as early as it is in the year it's kind of hard to tell which are those year or how much of that is timing and how much is there to savings. I will definitely have a clearer picture after the second quarter.

[Operator:]

Your next question comes from the line of Chris Sighinolfi with Jefferies. Please proceed.

[Chris Sighinolfi:]

Roy, I was curious on the balance sheet side of things, kind of really the science inside understanding that we're getting ready for the rating filing. But I saw the equity distribution rate that was put in place earlier in the year, a little bit shy of $10 million raised in the first quarter. Just wondering if you had any guidance for us how to think about the magnitude of what might be raised this year or sort of a target if we were to think about the balance sheet for the equity component as we come into the rate filing?

[Roy Centrella:]

Yes program is a$100 million equity shelf program has a three year life. We expect and may not be issued rabidly over the three year you might see it little bit more on the front end that first year as we look to make sure our capital is strong as possible heading into the rate case. Ken you want to add something.

[Ken Kenny:]

The whole idea of putting that 200 million out there on the equity show, it is a tool for the financial departments tool box and essences we want to maintain our cash structure that gives us strong credit rating. Those strong credit ratings as you eluted to does certainly help in the situation of the regulatory environment which is that what they look for. But also it also in company and ultimately the shareholders as well and so that really the compliment of this program it's not drove return of shares out on the market. And undercut the existing shareholders but more so, again as a tool to manage the process.

[Chris Sighinolfi:]

If, as it pertains -- staying with the next AG rate case for a moment -- I apologize if it's ignorance, but were you -- just remind me, if that case were to go settlement track as opposed to litigation track, is it possible to have rates effective in any part of 2015? Or is the prior settlement that was entered into -- does that delay any implementation till May of 2017?

[Justin Brown:]

The last settlement agreement we entered into actually specifically provide that rates will not go in sooner than May 1 of 2017. But notwithstanding I would say that there are procedural things that occur if the parties negotiate to have rates going sooner and out of process whereby you would go back and open up the prior case to make modification it's not a possibility but the existing agreement does provides for May 1, 2017 day.

[Chris Sighinolfi:]

Okay, understood. So it's established in the last case but not necessarily set in stone if all parties were in agreement?

[Justin Brown:]

Correct.

[Chris Sighinolfi:]

And then this is somewhat of an unnecessary question, but just wondering -- we are reading so much in the East about California drought conditions. I'm just wondering if that had any -- or is likely to have any impact on your service territory out there or anything within your plan for those northern and southern California jurisdictions.

[John Hester:]

I don’t think that the type of water rationing and restrictions that they're talking about being in place from California I don’t really think that is going to impact our revenues or our expected profitability from those jurisdictions.

[Operator:]

[Operator Instructions] There no additional questions in queue at this time.

[Ken Kenny:]

Thank you, Alex. This concludes our conference call, and we appreciate your participation and interest in Southwest Gas Corporation. Thank you.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.