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Southwest Gas Corp  (NYSE:SWX)
Q3 2018 Earnings Conference Call
Nov. 08, 2018, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day ladies and gentlemen and welcome to the Southwest Gas Holdings 2018 Third Quarter 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 be given at that time. (Operator Instructions). As a reminder, this call is being recorded. It is now my pleasure to introduce Vice President, Finance and Treasurer, Mr. Ken Kenny. Please go ahead, sir.

Kenneth Kenny -- Vice President of Finance and Treasurer

Thank you, Andrew. Welcome to the Southwest Gas Holdings Inc., 2018 Third Quarter Earnings Conference Call. As Andrew has stated, my name is Ken Kenny and I'm the Vice President of 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.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, Southwest's President and Chief Executive Officer; Mr. Gregory J. Peterson, Senior Vice President, Chief Financial Officer; and Mr. Justin L. Brown, Senior Vice President, General Counsel; and other members of senior management to provide a brief overview of the company's operations and earnings ended September 30th, 2018 and an outlook for the remainder of 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 in the press release, Slide 3 of our presentation, and also SEC filings for a description of the factors that may cause actual results to differ from the 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.

John Hester -- President and Chief Executive Officer

Thanks Ken. Turning to Slide 4, looking to some of our 2018 highlights, first from a consolidated results perspective, we had earnings per share for the 12 months ended September of $4.30. We experienced a return on equity of 11.3% over that same period and our financial results for the historic 12-month period were generally favorably impacted by tax reform.

For the natural gas segment, we added 33,000 new customers over the past 12 months. We are nearing the end of our Nevada rate case regulatory process. We received approval from the Public Utilities Commission of Nevada to replace over $35 million of older pipe in 2019; and we are working to expand service in Mesquite, Nevada pursuant to the regulatory approval we previously received.

Then, for the infrastructure services segment, we experienced record quarterly earnings of $26.8 million. We had net income for the 12 months ended September of $57.7 million. The New England Utility Constructors Group we acquired late last year continues to perform extremely well, and we are quite enthusiastic about the segment's anticipated 2018 full year performance.

Moving to Slide 5. Our outline for today's call is as follows: our CFO, Greg Peterson will provide an overview of our financial performance from a consolidated entity perspective with a detail for both the natural gas operations and infrastructure services segments; Justin Brown will provide an overview of our regulatory activities; and I will finish with a report on customer growth, regional economic conditions, our planned capital expenditures and our end of year expectations and focus for the future.

With that, I will now turn the call over to Greg.

Gregory Peterson -- Senior Vice President and Chief Financial Officer

Thank you, John. I'll begin with total company operating results on Slide 6. For the third quarter of 2018, consolidated net income was $12.3 million or $0.25 per share, an increase of $2.1 million or $0.04 per share compared to the third quarter of 2017.

For the 12 months ended September 2018, net income was $209 million or $4.30 per share, a sizable increase from net income of $163 million or $3.42 per basic share recorded in the prior year 12-month period.

It should be noted that the current 12-month period includes a one-time tax reform benefit of approximately $20 million or about $0.41 per share recorded in December 2017. Moving to the Slide 7, this depicts the composition of the $2.1 million net improvements between quarters.

Quarterly results for the national gas operation segment declined nearly $9.7 million while results for the infrastructure services segment were up about $12.5 million between quarters. I'll provide some additional details surrounding the changes in each segment in the following slides.

Slide eight depicts the composition of the $46.9 million increase in earnings between 12-month periods. Contribution from the natural gas operations segment increased $19.4 million and contribution from infrastructure services increased $28.7 million.

So now we'll get a little more granular into the driver for each segment's results starting with the quarterly comparison of natural gas operations on Slide 9. This waterfall chart depicts the components of the $9.7 million decrease in natural gas operations results between the third quarters of 2018 and 2017.

Due to the seasonality of our business, utility losses during the third quarter were not unusual. Operating margin includes $2 million from 33,000 net new customers added during the past 12 months, a 1.6% growth rate, and another 1 million in attrition rate relief in California in miscellaneous revenues.

These improvements were offset by a $3 million decrease in operating margin due to the impact of tax reform, reflected in customer's bills resulting in essentially flat operating margin when you compare it to last year's third quarter.

The $639,000 improved tax benefit reflected on the chart is due to a greater pre-tax loss during the current quarter. The lower corporate tax rates under the The Tax Cuts and Jobs Act enacted in December of 2017 actually provided a reduced benefit during periods when seasonal losses are encountered.

Thus tax reform had a negative impact on the third quarter stand-alone results for utility operations. The $7.3 million increase in operations and maintenance or O&M expense includes approximately $2 million of higher pension costs associated with the lower discount rate or the interest rate used to measure pension liabilities at December 2017.

O&M expenses were also impacted by incremental integrity management and damage prevention program costs including a $1.2 million increase in line locating or call before you dig costs due to population growth and the associated increase in commercial and residential construction activities throughout our service territories.

Higher informational technology maintenance and software licensing costs and general inflationary increases also impacted O&M during the current quarter. We expect that O&M costs for full year 2018 will be about 3% higher than 2017, plus the impact of the full year $8 million increase in pension costs.

Despite a $480 million or 8% increase in average gas plant at service, depreciation, amortization and general taxes only increased $2.7 million or about 4.5%. The reduction in amortization associated with reduced regulatory surcharge recoveries mitigated that increase.

The $2.6 million improvement in other income primarily reflects incremental increases between quarters and the cash surrender values of company owned life insurance or COLI policies and the associated net debt benefits.

That $3 million increase in interest expense reflects higher outstanding debt balances, including $300 million of senior notes issued in March 2018 to facilitate Southwest's ongoing capital expenditures program.

Slide 10 reflects the components of the $19.4 million increase between 12-month periods for the natural gas operation segment. Operating margin reflects a combined $11 million of rate relief in Arizona and California and $10 million from continuing customer growth partially offset by a $6 million reduction in miscellaneous revenues.

This net $15 million increase was offset by a $15 million operating margin reduction associated with tax reform. Income taxes declined $20 million due to tax reform including the $8 million recognized in December of 2017 upon the enactment of The Tax Cuts and Jobs Act.

O&M expenses increased $10.9 million or 3% between periods reflecting general cost increases and higher pension and pipeline damage prevention program expenses. The $15.5 million reduction in depreciation and property taxes reflects lower depreciation rates associated with the Arizona rate case settlement in April of 2017 partially offset by depreciation associated with the $430 million or 7% increase in average gas plant at service.

The $2.8 million improvement in other income and deductions is primarily due to higher interest income related to the Gas Infrastructure Replacement mechanism in Nevada. Income associated with increases in cash surrender values of COLI policies and related net debt benefit was $9.5 million in the current 12-month period and $8.8 million in the prior 12-month period, both of which were higher than our longer-term expected range of $3 million to $5 million annually.

The $8.5 million increase in interest expense is primarily due to higher outstanding debt balances between periods including the $300 million senior notes I previously mentioned. Southwest's ongoing capital expenditures were being financed with the combination of debt and equity issuances to supplement cash flows from operation.

We'll now review Centuri third quarter results starting with Slide 11 which reflects the net income increase of $12.5 million compared to the third quarter of 2017.

Revenues for the third quarter of 2018 increased nearly $71 million compared to the prior year quarter. The increase includes $50 million in revenue from operations of New England Utility Constructors or Neuco which we acquired in November 2017 as well as additional pipe replacement work performed for existing customers.

On a year-to-date basis, we've recognized revenue increases for 16 of our top 20 customers. Construction expenses increased approximately $53 million between quarters primarily due to cost directly associated with the additional pipe replacement work performed including nearly $35 million from Neuco operations.

Incremental general and administrative costs were also incurred to provide support for the overall growth in operations.

The $1.9 million increase in depreciation and amortization was due to incremental amortization, associated with the Neuco acquisition and depreciation on additional equipment purchases partially offset by an extension of estimated useful lives of certain equipment that was implemented in the first quarter of 2018.

Interest expense which is included in the category labeled as other on this slide increased $2 million due to higher outstanding debt, including the amounts used to finance the Neuco acquisition.

Despite a $13.7 million increase in pre-tax income, income tax expense only increased $1.4 million between quarters due to the benefits of lower rates associated with the tax reform. Slide 12 shows the components of the $28.7 million increase in infrastructure services net income between 12-month periods.

Construction revenues increased $306 million due primarily to additional pipe replacement work with existing customers across the U.S. and Canada.

Neuco operations have provided nearly $116 million of revenues since we acquired them in November 2017 exceeding our expectations. Construction expenses were $277 million higher than the prior year period including $95 million associated with the Neuco operations.

Depreciation and amortization increased $6.2 million due to amortization of intangible assets associated with the Neuco acquisition and depreciation on incremental equipment purchases to support growing operations, partially offsetting these with the $6.4 million reduction in depreciation associated with extensions of estimated useful lives of certain depreciable equipment.

The category labeled as other on this slide includes a $6.5 million increase in interest expense due to higher debt outstanding, including amounts associated with the Neuco acquisition in November 2017. And wrapping this up, income taxes reflected a one-timer $12 million benefit recognized in December 2017 associated with the tax reform.

I'll now turn the call over to Justin Brown for a regulatory update.

Justin Brown -- Senior Vice President and General Counsel

Thanks Greg. As highlighted on Slide 13, my comments today will focus on pending and upcoming rate case activity, progress on our various infrastructure tracker programs and an update on several expansion projects.

Starting with our Nevada rate case on Slide 14, we recently completed hearings on our $29.7 million rate case. The proposed rate adjustment is premised on a increase to rate base of $311 million and a return on common equity capital of 10.3% relative to an equity ratio of 49.3%.

In addition to the almost $30 million rate increase, we're also requesting to increase the GIR surcharge revenue by $6 million which is something I'll discuss in more detail later in my comments when I'm talking about our tracker programs. We are still anticipating a decision before the end of the year with new rates to become effective by January 1st, 2019.

Turning to Slide 15 in California, we're still targeting a September 2019 filing date for our next California general rate case. We're also preparing our annual attrition filing that was approved as part of our most recent rate case, you may recall we are currently collecting an incremental $2.7 million for 2018.

We will make our 2019 filing at the end of this month which following approval will allow us to adjust margin by 2.75% beginning in January of 2019. Turning to Arizona, the first quarter of 2018 saw the tail end of our rate relief from our most recent rate case decision that became effective in April of 2017. We are now focusing on our next Arizona rate case which we're currently anticipating filing by May of 2019.

Lastly, most of this year has been focused on working collaboratively with our regulators to flow back the benefits from tax reform to our customers.

We recently received approval in Arizona on a plan to adjust rates to refund approximately $20 million to customers during 2018. In Nevada, the commission recently issued a decision confirming that our pending Nevada rate case is the appropriate venue for addressing tax reform on a go-forward basis; and that our rate case proposal includes the effective tax reform as part of the proposed adjustment to rates.

As such we anticipate no further adjustments in 2018 to reflect tax reform changes. With respect to California, we have a decision from the commission directing us to use a tax memorandum account to track ratemaking impacts for attrition years 2019 and 2020 that was approved as part of our proposal to extend our rate case cycle. As a result we do not anticipate any additional regularity filings prior to our currently planned rate case in September 2019.

And lastly with respect to pipeline, we will be filing our Form 501 G later this year in compliance with the FERC's decision directing pipelines to file this form to calculate the impact of tax reform on its current cost of service.

Turning to Slide 16 and an update on our various capital tracker programs. In Arizona, we recently received approval to increase the COYL surcharge by $1.7 million bringing our current surcharge revenue up to $3.5 million based upon cumulative capital expenditures during 2016 and 2017 of $30.9 million. We are currently targeting an additional $21 million in capital expenditures for 2018 which will result in an estimated surcharge revenue of $6 million or $6.1 million or an incremental $2.6 million.

We plan to make that request in February of 2019 with rates becoming effective in June 2019.

Turning to Slide 17, we also received approval to implement surcharge revenue of $2.4 million based upon capital expenditures of $27 million for our recently approved Vintage Steel Pipe replacement program. We are currently targeting a $100 million of replacement work for completion during calendar year 2018 which will result in estimated surcharge revenue of nearly $12 million or an incremental $9.3 million.

Similar to COYL, we'll make our filing in February to update surcharge revenue with the idea that it will become effective in June of 2019. Turning to Slide 18, in Nevada, we recently received approval to continue our early Vintage plastic pipe customer-owned yard line and Vintage Steel Pipe replacement programs in Nevada for calendar year 2019.

You may recall we had requested approval of a 3-year program but ultimately the commission expressed the preference to review these projects annually, resulting in approval of our 2019 project totals of $35 million that John referenced earlier.

The decision also extended the timeframe for replacing early Vintage plastic pipe by one year, resulting in a slightly lower level of accelerated replacements for 2019 than what we've experienced in prior years, but that was just a shaping to extend it out by another year into 2021.

We are currently recovering surcharge revenue of $8.7 million that was approved late last year, we currently have pending before the commission a proposal to increase the surcharge revenue by $6 million. As mentioned earlier in my comments this request was included as part of our rate case filing and is in addition to the $29.7 million rate relief that is associated with our rate case.

If approved, this incremental GIR surcharge revenue would become effective in January 2019, the same time as new rates would become effective from our rate case. And turning to Slide 19 and an update on our expansion projects, our $80 million LNG facility in Southern Arizona remains on track and in line with our expectations for completion in the second half of next year.

In Nevada, we received approval for a $28 million expansion as part of our first ever SB 151 filing which authorizes us to extend our facilities to Mesquite, Nevada.

We have begun the planning and design stages of the project and we are currently targeting service to our first Mesquite customers in the first quarter of 2019. Lastly, we received approval from FERC to proceed with our 2018 pipeline expansion project. This $22 million project is currently wrapping up and should be completely in service before the end of this month.

And with that I'll turn it back to John.

John Hester -- President and Chief Executive Officer

Thanks Justin. Turning to Slide 20, as I mentioned at the outset of the call, we added 33,000 new customers over the past year. We expect that trend to continue for the foreseeable future representing a 1.6% customer growth rate for our regulated utility operations.

Moving to Slide 21, regional economic conditions across our 3 state utility service territory continue to be strong. We expect higher than the national average population growth in Arizona, California and Nevada over the next five years.

Furthermore, regional unemployment rates continue to be quite low and we continue to experience positive job growth year-on-year. On Slide 21, we provide detail on our planned capital expenditures. We plan to invest approximately $2 billion in capital over the 3-year period ending 2020.

As Justin referenced previously, a significant portion of these investments are accompanied by infrastructure tracking mechanisms. We expect to fund 50% to 60% of those investments through internal cash flows and fund the remaining amounts through the balance of debt and equity.

Turning to Slide 23, our continued investments in our gas utility distribution systems translate into growing rate base. Over the 3-year period ending December 2020, we anticipate a 12% compounded annual growth rate in rate base moving from $3.2 billion to $4.5 billion.

On Slide 24, we provide 2018 line item guidance for our natural gas operations. Operating margin should increase by 2% plus approximately $20 million due to tax reform. Operations and maintenance expense should increase by 3% plus an $8 million pension expense.

Depreciation and general taxes are expected to decline slightly due to last year's Arizona rate case rate adjustments. Operating income should be flat to up again impacted by the effects of tax reform. Net interest deductions are expected to increase by $10 million to $12 million. We expect normal COLI returns of $3 million to $5 million. Income taxes should average 23% to 24%, and our 2018 capital expenditures should total $670 million or more.

Moving to Slide 25, we detail line item guidance for our Centuri Infrastructure Services group. Revenues should be up by 12% to 16%.

Operating income should average between 5% and 5.5% of revenues. Net interest deductions are expected between $13 million and $14 million. Foreign exchange rates can influence results due to our Canadian operations and income taxes should average 27% to 28%.

And finally on Slide 26, we provide an overview of the value drivers for our business. For the natural gas operations, we expect continued annual growth rate of 33,000 customers or more.

We will invest $2 billion over the 3-year period ended 2020 to serve new growth and enhance the safety and reliability of our gas utility distribution systems. Our capital investments ultimately translate into additional rate base which should grow by 12% annually.

And we will continue to partner with our regulators to ensure timely recovery of our cost through the use of infrastructure tracking mechanisms. And for our Centuri Infrastructure Services group, their role as one of the largest in growing underground pipeline contractors in North America will continue to create shareholder value.

The diversity of that business is underscored by its operations in 25 different markets across the U.S. and Canada. Centuri strides for long-lasting customer relationships averaging over 20 years with our top 20 customers. And we believe Centuri's focus on safety and quality, positions them well to partner with regulated utilities across North America for years to come.

I'll now turn the call to Ken.

Kenneth Kenny -- Vice President of Finance and Treasurer

Thanks John. That concludes our prepared presentation. For those of you who have access to our slides, we have also provided an appendix with slides that includes other pertinent information about Southwest Gas Holdings Inc. and its subsidiaries and can be reviewed at your convenience.

Our operator Andrew will now explain the process for asking questions.

Questions and Answers:

Operator

(Operator Instructions). And our first question comes from the line of Aga Zmigrodzka with UBS. Your line is now open.

Aga Zmigrodzka -- UBS -- Analyst

Hello everyone. My first question is on customer growth. It has been trending above your prior guidance of 32,000 customers year-over-year growth. Do you see a potential upside to your customer growth forecast for 2019 and 2020? Thank you.

John Hester -- President and Chief Executive Officer

I think the growth numbers that we have in there should pretty accurately reflect to our expectations, Aga. I think that economic conditions again, when you look at Las Vegas, Central Arizona, et cetera a lot of exciting new projects going on and a lot of that work on the projects as well as the workers that are having to complete that work are creating new customer opportunities for us.

So I think we think the economy is pretty robust as it is now, and that the expectations that we have on that slide 20 should pretty much accurately reflect that at this time.

Aga Zmigrodzka -- UBS -- Analyst

Thank you for that. And you reported strong revenues from the infrastructure segment. Could you please provide more color on the regional trends and your confidence in 2019 growth?

John Hester -- President and Chief Executive Officer

In terms of regional trends, I think that what we're seeing basically across the business is the same kind of activity that we see here at Southwest Gas utility. We see a lot of utilities continuing to invest in aging infrastructure, as we've talked before Aga we've got on our utility side one of the probably newer distribution systems in the country, but yeah, we've got a pretty robust capital expenditure plan.

And I think when you go to the Midwest to the Northeast and some of the much older infrastructure that you see there, I think that you're going to see those utilities continue to ramp up those capital replacement projects for years to come. So I think we're pretty bullish on the prospects of the business.

Aga Zmigrodzka -- UBS -- Analyst

Thank you for the color, and that's it from my end.

John Hester -- President and Chief Executive Officer

Thank you.

Operator

Thank you. (Operator Instructions) And our next question comes from the line of Paul Ridzon with KeyBanc. Your line is now open.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

Good afternoon. Good morning, there, I guess.

John Hester -- President and Chief Executive Officer

Good morning Paul.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

Just turning to Slide 12, income tax benefit was about $12 million which was kind of the onetime benefit you saw in the fourth quarter of last year. Is that actually bigger, but just being masked by the fact that pre-tax income is higher?

Gregory Peterson -- Senior Vice President and Chief Financial Officer

Yes, that's certainly the case, Paul. This is Greg. It's -- we had a higher pre-tax net income, but that tax benefit is the main driver of the income tax decline.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

And then just on your drivers at the construction business, between the mid-year deck and this deck, the revenue expectations for Centuri has gone up pretty markedly. What -- is that a timing issue or is that fundamental?

Gregory Peterson -- Senior Vice President and Chief Financial Officer

There are certainly two -- both of those components are there, we've had some opportunities with some of our customers, some one-time work, specialty work that we've had, and so that has provided some incremental increase that we recognized in Q3, but as John mentioned earlier, we're certainly seeing a continued ramp-up from our customers as well as the rest of the utility industry in doing infrastructure replacement.

So there is a component to each of those in this increase in guidance.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

Do you do any work in Massachusetts?

John Hester -- President and Chief Executive Officer

Yes, we do, do work in Massachusetts, Paul.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

And so I would assume some of this might be in Lawrence incident?

John Hester -- President and Chief Executive Officer

We do have some of our crews that are doing work for NiSource. We also as an aside did have some of our Southwest Gas utility crews go out to assist in that effort pursuant to the mutual assistance agreements that we have through the American Gas Association.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

And then on your gas business drivers, I think you're pointing to a 23% to 24% tax rate. That should go higher in '19 correct? As you don't share -- to retain the benefit of lower taxes?

Gregory Peterson -- Senior Vice President and Chief Financial Officer

That tax benefit just reflects, Paul this is Greg, just reflects the 21% federal rate plus some state rates. So we don't anticipate that that rate will go up in 2019 and in fact to the extent that we start as in Nevada amortization of the deferred amount, the ARAP (ph) amount that we have on our books that actually will have the impact of pushing rates even lower.

But they will be to your point, they will correspond to a reduction in revenues pretty much on our one-for-one basis.

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

Okay. So we'll see that in the revenue line, OK. Thank you very much.

John Hester -- President and Chief Executive Officer

Thank you, Paul.

Operator

Thank you. And I'm showing no further questions at this time. So with that, I'd like to turn the call back over to Ken Kenny for closing remarks.

Kenneth Kenny -- Vice President of Finance and Treasurer

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

Operator

Ladies and gentlemen thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone have a wonderful day.

Duration: 34 minutes

Call participants:

Kenneth Kenny -- Vice President of Finance and Treasurer

John Hester -- President and Chief Executive Officer

Gregory Peterson -- Senior Vice President and Chief Financial Officer

Justin Brown -- Senior Vice President and General Counsel

Aga Zmigrodzka -- UBS -- Analyst

Paul Ridzon -- KeyBanc Capital Markets -- Analyst

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