Southwest Gas Holdings Inc (SWX) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen. And thank you for your patience. You've joined the Southwest Gas Holdings 2017 Year End Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Vice President of Finance and Treasurer, Mr. Ken Kenny. Sir, you may begin.

Thank you, Lateef. Welcome to the Southwest Gas Holdings, Inc. 2017 Earnings Conference Call. As Lateef stated, my name is Ken Kenny, and I am the Vice President, Finance and Treasurer. Our conference call is being broadcast live over the Internet. For those of you who would like to access the webcast, please visit our website at www.swgasholdings.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, Chief Financial Officer; and Mr. Justin L. Brown, Vice President of Regulation and Public Affairs; and other members of senior management to provide a brief overview of 2017 earnings and an outlook for 2018.

Our goal -- 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, our SEC filings and also Slide 3 of the presentation today for a description of factors that may cause actual results to differ from our forward-looking statements.

All forward-looking statements are made as of today, and we assume no obligation to update any such statement. With that said, I'd like to turn the time over to John.

Thanks, Ken. Turning to Slide #4, I'd like to briefly overview some of our 2017 highlights. From a consolidated results perspective, we achieved record earnings of $4.04 a share. And while those results are certainly helped by the tailwind of tax reform, as we will talk about later in the call, even absent the positive impacts of tax reform, our consolidated earnings per share represented a new record.

We also increased our dividend for the 12th straight year with a 5% increase that our Board approved just this past week. Shares of Southwest Gas Holdings will now provide an annualized dividend of $2.08 per share.

Also, at a special shareholder meeting that was convened in October of last year, our shareholders approved a proposal to eliminate cumulative voting and adopt a majority voting policy. We're also able to acquire the 3.4% noncontrolling interest previously held by the owners of Link-Line Group, the predecessor of our NPL Canada construction unit.

Focusing on the natural gas segment, our 2017 operating margin increased by $23 million over the prior year. We added 31,000 net new customers. The total number of utility customers we serve across our 3 service territory reached the 2 million mark in November. And we invested $560 million in capital to serve new customers and increase the safety and reliability of our gas distribution systems.

At our Centuri construction unit, our revenues exceeded $1.2 billion, a new record. We amended our credit and term loan facility to increase our borrowing capabilities to $450 million. We completed our acquisition of New England Utility Constructors, Inc., expanding our footprint into the Northeastern United States. And NPL, the business unit under which most of our U.S. construction operations are conducted, celebrated its 50th anniversary.

Moving to Slide 5. A few weeks ago, we announced the retirement of our esteemed Chief Financial Officer, Roy Centrella, effective April 1.

I very much enjoyed working with Roy for almost 30 years and consider him to be a great strategic partner, especially over the past several years, as well as a friend. He will be succeeded by Greg Peterson, who is our current Chief Accounting Officer and someone who has over 20 years of experience at Southwest Gas. For those of you on the call who will be joining us at our April 4th Analyst Day at the New York Stock Exchange, you will have the opportunity to meet Greg. Greg, in turn, will be succeeded by Lori Colvin as Chief Accounting Officer. Lori has over 25 years of utility and public accounting experience, the past 18 years of which have been at Southwest Gas. While we're sorry to see Roy leave, we're extremely happy to have a solid bench for the management team at Southwest Gas that supports orderly succession planning and that will give our investors the confidence and the quality financial reporting and financial results that they've come to expect at Southwest Gas.

On Slide 6, we show an outline for our call today. For today's call, Roy Centrella will provide his last conference call overview of our consolidated earnings, along with the segment details for both the natural gas and construction services operations. Justin Brown will follow with an update on our various regulatory activities. And then I will close with an update on our customer growth and regional economic conditions, our capital expenditures and rate based growth, our dividend growth and our expectations for 2018. With that, I will turn the call over to Roy.

Thank you, John. Certainly appreciate the kind words and happy to finish my career with such a strong earnings year.

So today, I will provide a high-level review of our 2017 consolidated and business segment operating results, including explanations of significant changes between years. I'm also going to spend a few minutes reviewing the impact of tax reform on our 2017 results as well as expectations for 2018. Let's start with Slide 7.

In 2017, we earned $4.04 per basic share, an improvement of $0.84 over the $3.20 earned in 2016. Net income grew to $194 million from $152 million. Strong operating results were enhanced by $20 million of tax benefits resulting from tax reform as well as strong returns on our investments underlying company-owned life insurance or COLI policies.

Moving to Slide 8. You can see that net income increased $41.8 million between periods, with $37.4 million of the improvement coming from our natural gas operations segment and $5.7 million from construction services.

Before getting into the results by business segment, let's review tax reform impacts beginning on Slide 9.

The Tax Cuts and Jobs Act was signed into law late December. The Act reduces the federal income tax rate from 35% to 21% and for utilities, eliminates bonus depreciation and provides an exemption from limits on interest deductions. For Centuri, we'll have an immediate and ongoing beneficial impact on financial results. For Southwest Gas, we will experience reduced cash flows once lowered tax rates are reflected in customers' bills, but we'll experience higher rate-based growth on future capital expenditures due to lower deferred tax growth.

Slide 10 summarizes specific nonrecurring income statement impact in 2017 due to the reevaluation of net deferred tax liabilities. At Southwest Gas, we recognized an $8 million benefit from a reduction in deferred taxes related to nonplant-related items, while at Centuri the benefit was $12 million related to the overall deferred tax balance.

Other noteworthy items are that Moody's and Standard & Poor's both recently reaffirmed our debt ratings, and 2017 cash flows were not impacted by the passage of tax reform.

Let's now turn to Slide 11 to review 2018 impacts. At Southwest Gas, varying regulatory actions have been initiated by the state, which Justin Brown will review in a few minutes. Our cash flows are not expected to be materially impacted. However, this year, the effective tax rate is difficult to predict until regulatory outcomes and timing become clear. And income statement line item variances may result from regulatory actions without impacting our bottom-line earnings.

At Centuri, we expect our effective tax rate to drop to around 27% or 28%, factoring in Canadian operations and state income taxes. There will be no impact to interest deductibility, and longer-term retention of benefits of lower tax rates is difficult to predict due to the competitive nature of the bidding process.

We'll now move to Slide 12 to review financial results by business segment. This waterfall chart identifies the major line item changes for the gas operations segment income statement. Just want to highlight a couple of items. We had strong growth in operating margin totaling $23 million, mainly due to the addition of 31,000 customers and the impact of rate changes in Arizona and California. Depreciation and amortization and general taxes declined by $26 million due mainly to a reduction of depreciation rates in Arizona that became effective in April 2017.

Other income included COLI income of $10.3 million, which was $2.9 million greater than last year and well above our expected range of $3 million to $5 million. And finally, as noted, tax reform resulted in an $8 million benefit.

Let's turn to Slide 13 and construction services segment. This slide provides the summary waterfall chart reconciling contribution to net income between 2016 and 2017. Revenue growth was quite strong, increasing $107 million or 9% year-over-year. About $30 million of the increase came from a relatively new contract to replace water lines and $17 million from the November 2017 acquisition of Neuco. The remainder was principally from additional work with existing customers.

Construction expenses and depreciation combined for a net increase of $118 million or 11%. Consequently, our operating income was 3.9% of revenue compared to an expectation of nearly 5%. The 2 principal causes of low rate of return were: the temporary work stoppage earlier in the year with one of our larger customers and losses incurred on the water replacement project. Most of our other operating areas -- or major operating areas performed at or above expectations. Regarding the water contract, we remain in negotiations with the customer to get relief in the form of modified terms or additional cost recovery and are hopeful a resolution will be reached soon.

Finally, tax return -- reform was a significant positive factor accounting for 31% of 2017 net income.

Looking ahead to 2018, we expect Neuco to be a significant contributor to our revenue growth and are optimistic of a return to more customary operating profit levels.

With that, let me turn the time over to Justin Brown to provide a regulatory update.

Thanks, Roy. As highlighted on Slide 14, I will be providing an overview of our various regulatory initiatives, including an update on rate case activity, tax reform proceedings, infrastructure tracker programs and several expansion projects.

Let's start with an update on rate case proceeding and planning activities on Slide 15. With the Arizona Corporation Commission's decision last April, our operating income was positively impacted by approximately $45 million in 2017, and we still have 1 quarter of rate relief remaining before we have -- will have realized the full 12-month benefit of Arizona rate case.

As such, following the conclusion of the first quarter of 2018, we should have a better picture of the contributions the Arizona rate cases had on closing the gap between our authorized and earned rates of return.

Turning to Nevada, we're currently preparing our Nevada rate case and plan to make a filing before June of 2018, with new rates expected to become effective by January of 2019.

With respect to California, we're on a 5-year rate case cycle, 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 that we're now targeting September 2019. In the meantime, we will continue to make our annual adjustments to margin through 2020 as part of our annual 2.75% attrition filing. In fact, for 2018, we were authorized to increase revenue by $2.7 million beginning January of this year.

Turning to Slide 16. We wanted to provide an overview of where we stand in terms of working with our regulators 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 within 60 days requesting approval of 1 of 3 things, a Tax Expense Adjustor Mechanism, and attempt to file our rate case within 90 days or some other application to address ratemaking implications of tax reform.

We're currently working with our stakeholders in Arizona and plan to make a filing in response to the Commission's directive later this month. In Nevada, just last week, the Commission opened an investigatory docket and requested utilities file comments by April 4th outlining their respective plans to pass on any savings to customers associated with tax reform. Similar to Arizona, we plan to continue -- we plan to file our written comments in a timely manner and will work collaboratively with our stakeholders.

With respect to California, as I mentioned previously, last year we were granted approval to extend our rate case cycle by 2 years. As part of that approval process, the Commission authorized the establishment of a regulatory accounting treatment in the form of a memorandum account to track impacts associated with future changes in tax law, procedure or policy. As a result, we do not anticipate any regulatory filings in California prior to our currently planned rate case.

And lastly, with respect to our FERC regulated pipeline, Paiute, we have not received any direction from FERC regarding tax reform.

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. In Arizona, we have 2 such programs. First, our COYL replacement program. To date, we've invested approximately $54 million in this program and have been able to make annual filings to recover our cost in a timely manner. You may recall as part of our recent rate case, we moved the previously approved COYL expenditure of $23 million into rate base, and the cost recovery is now incorporated into our base rates. So the current tracker has effectively been reset as of January 1, 2016. Presently, we're collecting margin of $1.8 million based upon 2016 capital expenditures of approximately $12 million.

Yesterday, we filed our annual report with Arizona, 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 in 2017.

Turning to Slide 18. In addition to our COYL program, we were granted approval in our last rate case to start a vintage steel pipe replacement program so we can start chipping away at replacing the approximately 6,000 miles of VSP in Arizona. Similar to COYL, we made our first VSP annual report filing yesterday, requesting to establish a surcharge in the amount of $3.1 million to recover the costs associated with the 40 miles of replacement VSP work that we were able to get started on last year, given the ACC's April decision on our rate case. We also met with the Commission staff last fall to review projects eligible for replacement in 2018 and are currently targeting approximately $100 million of replacement work for completion in 2018 as we start to ramp this program up going forward. We expect decisions on both Arizona filings in time for rates to become effective by June of 2018.

Turning to Nevada, on Slide 19. Since 2014, we have received approval to replace over $180 million of qualifying replacement projects through our GIR program, including the recently approved $66 million worth of projects targeted for replacement this year. We also recently received approval on our 2017 rate application authorizing the increase in surcharge revenue from $4.5 million to $8.7 million, an increase in incremental margin of $4.2 million for 2018. New rates became effective last month and with this approval, we have been authorized to recover over $18 million in margins since the inception of the program.

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 made a filing with the Public Utilities Commission of Nevada requesting to extend our facilities to Mesquite, Nevada, which is currently an unserved area of Southern Nevada. Our proposal includes an approach main and a 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 distribution system by distributing cost recovery for these localized cost among Mesquite customers to help make access more affordable. We held consumer sessions on the filing yesterday. Intervenor testimony is due next week, and hearings are currently scheduled for the first week of April.

We expect a final decision by the end of May or 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 a successful outcome. And with that, I'll turn it back to John.

Thanks, Justin. Turning to Slide 21. You see a table detailing our customer growth over the past few years as well as our expectations for the next several years. As I mentioned at the outset of the call, we added 31,000 net new customers this past year and anticipate continued customer growth in the next few years of approximately 1.6%.

On Slide 22, we see a variety of metrics illustrating robust economic conditions throughout our service territories. Unemployment rates declined across the board year-on-year while job growth continued in an accelerated pace.

Moving to Slide 23. You see that our continued investments in our gas distribution systems to serve growth and increase safety and reliability have resulted in our gas utility plant growing at a 6% compounded annual growth rate over the past several years. Gas utility plant totaled $6.6 billion at year-end.

Turning to Slide 24. We provide a breakdown of our capital expenditures for the next few years. As you can see from the graph, a significant and growing portion of our capital investment is receiving supportive regulatory treatment from our state regulatory bodies through the provision of the infrastructure tracking mechanisms detailed earlier in our call by Justin. Over the coming 3-year period, we expect to invest upwards of $2 billion in our gas distribution business to improve safety, serve growing markets and raise the high bar we have for customer service.

On Slide 25, we show a detailed illustration of how our ongoing capital expenditures impact rate base. Roughly speaking, we anticipate our rate base to grow by over 12% over the next 3 years, reaching $4.5 billion at the end of 2020.

On Slide 26, we provide a graph illustrating the growth in our dividend. Southwest Gas Holdings has realized a 9.5% compounded annual growth rate in its dividend since 2013. And as I mentioned at the outset of our call, just this past week, our Board approved an increase in our annual dividend to $2.08 per share.

Moving to Slide 27. We provide a list of factors that will influence results of our business moving forward into 2018 and beyond. On the utility side of our business, again, we anticipate continued robust customer growth of approximately 1.6% across our service territory. Our growing capital expenditures will require some additional financing activity. We will continue to observe incremental Arizona rate case revenue in 2018, given the April effectiveness date of our last order. Pension expense will rise due to lower year-end interest rates. And our effective tax rate for utility operations will become clearer as we proceed through some of the state regulatory proceedings that Justin referenced.

While on the construction side of the business, our acquisition of Neuco is expected to drive continued revenue growth, as Roy mentioned. Current cost recovery negotiations for our referenced water project had not been factored into our 2018 expectation metrics. And lower tax rates, while generally beneficial, will likely increase the seasonal loss we typically experience in the first quarter of the year.

Turning to Slide 28. Our 2018 expectations for our utility operations include the following observations: capital expenditures for the year are expected to total $670 million; operating margin is expected to increase by 2%; O&M expenses should increase by 2% to 3% plus the previously mentioned $8 million increased pension expense; depreciation and general taxes should be relatively flat; operating income is expected to be comparable to 2017 levels; COLI returns should range between $3 million and $5 million and will, generally, directionally track the volatility observed in the broader equity markets; and net interest deductions are expected to increase by $9 million to $11 million.

And then, finally, on Slide 29. Our 2018 expectations for our Centuri Construction business include revenue growth of 5% to 7% over 2017; operating income that should average 5% to 5.5% of revenues; interest deductions of $11 million to $12 million; and the potential for some foreign currency fluctuation impact due to our Canadian operations.

With that, I'll 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 includes other pertinent information about Southwest Gas Holdings, Inc. and can be reviewed at your convenience. Our operator, Lateef, will now explain the process for asking questions.

(Operator Instructions) Our first question comes from the line of Aga Zmigrodzka of UBS.

I just would like to ask, what return on equity do you expect in 2018?

We don't predict that. There's a slide in the back of our appendix, which is Slide 45, that kind of shows the -- what the historical ROE has been over the last few years. I think with the information that we provided, including equity information there, that's something that could be computed once you calculate out your forecast of our net income.

Okay. And so your utility guidance was flat on operating income basis. But you didn't give the impact of the net income from the lower tax rate. Can you just tell us what you expect of the net income? Do you expect it to be higher? I know you highlighted you don't expect to provide, like, the exact number. But can you directionally help us understand how you think that utility business will move?

You're talking about the utility income tax rate?

Yes, yes.

So because we have these ongoing discussions with our regulators, I think if you were to use the historical average rate of about 36%, you would get the appropriate net income projection for the utility business, given the other line item projections that we provided. And that would only change if we moved -- if we got some different outcomes in those regulatory discussions. So I think the -- I guess the way I would view it is that perhaps there's upside potential, but sort of the worst-case scenario is that we would have an effective tax rate equal to last year's.

(Operator Instructions) Our next question comes from the line of Paul Ridzon of KeyBanc.

Just to clarify that last question, it sounds like any benefit from lower tax rate you're going to book as a reserve until you get direction otherwise from the Commission?

That's correct, yes. I think the effective rate, again, at least with regard to the bottom line projection, the use of 36%, that would be consistent with the other line item projections that we give.

And then cash flow might move around within that, okay. And then any contracts that you signed at Centuri since implementation of tax reform, have you seen any margin pressure with customers looking to -- trying to get some of the benefit of tax reform?

At this point, we haven't signed any new contracts since tax reform has been implemented. Every year, we have master service agreements that on average about 4 to 5 years in duration. And so each year, we probably have 20% to 25% of our contracts come up for renewal. At this point, we have not negotiated any renewal contract.

And I assume none of the legacy contracts have reopeners around tax changes or anything?

That's correct.

So one last question. When do you expect kind of more clarity on the negotiations you're having with the overages on the pipe contract?

Yes, we really are hoping that in the next month or 2 that will happen. There's provisions within the contract that state certain time frames that should occur if you have a contract dispute. And those time tables would point towards something in the late first quarter, early second quarter.

And are these -- is this related to the work stoppage, or is this weather-related? I'm just trying to remember the history here.

No, the work stoppage was with a different customer early in the year. This is the water replacement work that we have going on.

Our next question comes from the line of Jesse Chai of Macquarie.

Hey, this is actually Barry. Can you just -- I just wanted a clarification on a couple things. The last question with regard to the negotiations on the contracts with the construction business, what's this assumption that's put into your guidance directionally for the thing on Slide 29 with regard to the revenues in the operating income? Is there an assumption that anything is done with those contracts? Or that is -- you don't want to take a position at this point?

No. We've just kind of assumed that things would continue the way they have been. We're certainly trying not to accept any more work or very little work until we have resolution. But we didn't try to project in there any kind of recovery level. So again, I guess I would view that as maybe modestly conservative but until we have something, we don't want to try to predict.

Got you. And then on the gas operations. I'm still a little confused because there's a -- it's just a lot going on, and we're trying to get to sort of the bottom line here. So if I just walk through all the components, everything in operating margin could be up or down based on how tax reform is reflected, I assume, because the pass-through of taxes, is that how I should think about it in the future?

Yes. I guess, Barry, we recognize that it's very difficult to predict how each of the line items are going to come out over the course of the year. And so what we try to do is say, "Let's look at the -- each of the line items sort of under 2017-type parameters." And then if you assume the old effective tax rate of 36%, then you'll get the appropriate bottom line. Even over the course of the year, those line items may differ as we start to get regulatory treatment on the taxes. So I think you can use the historical income statement to get a very good estimate of net income from the gas segment. Does that make sense?

Okay. Yes. Can I just -- if I think about it, so when I look at -- so when I -- I guess the top -- until operating income -- it could be plus or minus but the operating income you're saying is flat. So if I look in the appendix section, that's flat. The COLI is the $3 million to $5 million, I add that, I subtract the net interest deductions of the $9 million to $11 million and then that brings me to the pretax amount. And then on that pretax amount, you're saying I tax effect that at the 36% and then I get to net income, or should it be a number -- an effective tax rate below 36% that's closer to the tax reform number?

So let me clarify 2 things. One is that COLI does not have a tax impact because it's recorded without taxes as an insurance item. But other than that, you would compute a pretax income and use the 36% effective tax rate.

Okay. So you're -- so what you're guiding to this year is do that math, tax effected at 36%, and that's your net income, essentially.

Yes, for the gas segment, that's correct. We have a little bit lower tax rate, if you recall, on the Centuri side.

On the Centuri side, okay.

On Centuri, we're -- I don't think -- we may not have made that clear. I think I just mentioned it, but we're estimating a 27% and 28% effective rate over there. So they would benefit immediately from the 21% plus state income taxes brings it up to about 27% or 28% kind of number.

Okay. Then your return, it looks like -- is your return on equity -- then your return on equity is not going up. Is that effectively what you're saying, the return on equity is not going up in 2018 for the construction business? I'm just trying to get a guide. You're trying to give us all the inputs and the output, it's not clear what the output's supposed to be, I guess is what I'm getting at. So I just want to make sure that I'm hearing exactly what you're trying to say.

I don't think we've said anything about return on equity, for starters but particularly at Centuri, we don't really calculate a return on equity there. We calculate a total company return on equity, and we calculate a gas segment-only return on equity.

Okay, I got it then.

At this time, I'd like to turn the call back over to Mr. Kenny for any closing remarks. Sir?

Thank you, Lateef. This concludes our conference call, and we appreciate your participation and interest in the Southwest Gas Holdings. Have a good day, now. Thanks.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.