Southwest Gas Holdings, Inc. (SWX) Q1 2019 Earnings Call Transcript
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Southwest Gas Holdings, Inc. (NYSE: SWX)
Q1 2019 Earnings Call
May. 9, 2019, 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 2019 First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Mr. Ken Kenny, Vice President of Finance and Treasurer. Mr. Kenny, you may begin.
Kenneth J. Kenny -- Vice President, Finance, Treasurer
Thank you, Josh. Welcome to Southwest Gas Holdings Inc's 2019 first quarter earnings conference call. As Josh 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 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, Chief Financial Officer; 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 operation and earnings ended March 31st, 2019 and reaffirm earnings per share guidance for 2019. Also, the Company will address certain 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, and may or may not come true and 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 statements.
With that said, I would like to turn the time over to John.
John P. Hester -- President and Chief Executive Officer
Thanks, Ken.
Turning to Slide 4, we review some of our 2019 highlights of Southwest Gas Holdings. From a consolidated entity perspective, we had first quarter diluted earnings of $1.77 per share. We were able to increase our annual dividend for the 13th straight year to $2.18 per share and we are reaffirming the 2019 earnings per share guidance we provided earlier this year.
At the Natural Gas segment, we continue to experience robust regional economic conditions, having added 32,000 customers over the past year, an annualized customer growth rate of 1.6%. We also recently announced the filing of a new Arizona general rate case, just last week. Also, please note that our financial results were favorably impacted by Company-owned life insurance returns in the first quarter. And then at our Centuri Utility Infrastructure Services segment, we saw revenues increased, largely from our acquisition of Linetec Services and saw Centuri's seasonal quarterly net loss improve by $3 million.
Moving on to Slide 5, we present our outline for today's call. First, Greg will review our first quarter consolidated earnings with segment detail for both our utility and infrastructure services businesses. Justin will overview our various regulatory activities, including detail on the Arizona rate case filing I just referenced. And then I'll close with a review on customer growth and regional economic conditions, our planned capital expenditures and our 2019 earnings per share guidance.
I'll now turn the call over to Greg.
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Thanks, John. Let's begin with a summary of total Company operating results on Slide 6. For the first quarter of 2019, consolidated net income was $94.8 million or $1.77 per diluted share, an increase of $15.7 million or $0.14 per share, compared to the first quarter of 2018. For the 12 months ended March 31, 2019, net income was $198 million or $3.91 a share compared to net income in the prior-year period of nearly $204 million or $4.23 per share, which included a one-time tax reform benefit of approximately $20 million or $0.42 per share. Slide 7 depicts the relative contributions by our two business segments during the 12 months ended March 31, 2019. As you can see, natural gas operations provided about three-fourth of consolidated net income, while Centuri's Utility Infrastructure Services group provided about one-fourth.
Let's move to Slide 8, and look at each segment's impact to the consolidated change between 12-month period. Slide 8 depicts the components of this $5.6 million decline in earnings between 12-month period. Contribution from the Natural Gas segment declined $18.3 million, while contribution from utility infrastructure services increased $13.2 million.
Slide 9 shows the relative improvement between quarters of our two segments. Natural gas operations provided a $13 million increase to quarterly earnings and utility infrastructure services results improved by $3 million per -- between quarters.
Next, we'll take a deeper dive into each segment, starting with the quarterly comparison of Natural Gas Operations on Slide 10. Overall, Natural Gas Operations' net income increased $13 million between quarters. The $19.5 million increase in operating margin, includes $4 million from customer growth, as John mentioned, 32,000 net new customers were added over the past 12 months. A combined $4 million from California attrition and Nevada rate relief, and $4 million from changes in reserves for tax reform. The remaining margin increase reflects higher surcharge recoveries, which also impact amortization expense as well as miscellaneous revenues.
The $3.4 million or 3% increase in O&M expenses reflects general cost increases. Higher pipeline integrity management and damage prevention program costs were offset by lower pension and employee medical costs. The $8.6 million increase in depreciation, amortization and general taxes, includes an incremental $5 million in regulatory amortization, which was also reflected in operating margin. A $527 million or 8% growth in average gas plant in service, as we continue to expand and reinforce our distribution system, also contributed to the depreciation increase.
The $10.5 million increase in other income reflects favorable market fluctuations on the cash surrender values of company-owned life insurance or COLI policies. COLI value surged $7.6 million this quarter versus the $700,000 decline in the prior year quarter. In addition, a $1.5 million reduction in non-service pension related cost is reflected in this category.
Lastly, the $3.8 million uptick in interest expense reflects higher debt outstanding, including $300 million of senior notes issued in March 2018 to facilitate Southwest's ongoing capital expenditure program. Higher interest on PGA payable balances in Arizona also impacted interest expense.
Slide 11 depicts the components of an $18.3 million decline in natural gas operation results between 12 month periods. The $17.7 million improvement in operating margin includes $11 million from solid customer growth and $5 million in combined rate relief in Nevada, and California. The remaining increase in operating margin includes incremental recoveries of regulatory assets and miscellaneous revenues net of reserve and related regulatory adjustments associated with tax reform. The $18.5 million increase in O&M includes $3.5 million of incremental damage prevention or call before you dig costs associated with utility and construction related activities throughout our service territories. In addition to general cost increases, pension service costs also widened by $3 million.
The $11.2 million or 4.5% increase in depreciation, amortization and general taxes, reflects the impact of the $487 million or 8% increase in average gas plant in service, partially offset by $1 million decline in regulatory amortization.
The $3.1 million increase in other income includes $2.6 million in additional interest income and a $2.5 million increase in the equity component of AFUDC, or allowance for funds used during construction. COLI cash surrender values declined $1.7 million between periods. The $13.8 million increase in interest expense is due to higher outstanding debt balances on Southwest credit facility, as well as $300 million of debt issued in March 2018, as we continue to finance capital expenditures to expand and fortify our distribution system.
Next, we'll discuss the components of the quarterly change in our utility infrastructure services segment, beginning on slide 12. Results for Centuri improved $3 million in the first quarter of 2019 versus the first quarter of 2018. Losses during the first quarter are typical due to the impacts of winter weather on operations. Of the $52.8 million increase in revenues, $47.6 million was attributable to Linetec operation, which we acquired in November 2018.
Infrastructure expenses increased $41.5 million between quarters, including $37.9 million from the Linetec operations. Unfavorable weather conditions, including some heavy rains and storms, hampered efficient construction activities in a few areas. The $7.4 million increase in depreciation and amortization was primarily due to $5.7 million of incremental depreciation and amortization associated with the Linetec acquisition. The remaining increase was due to additional equipment needed for expanded operations.
Slide 13 shows the components of the $13.2 million increase in Centuri net income between 12-month periods. Revenues increased $261 million, including $62 million of new revenues from Linetec and $124 million of incremental revenue from New England Utility Constructors, or Neuco, that we acquired in November of 2017.
Utility Infrastructure revenues also grew with existing customers due primarily to additional pipe replacement work across the US and Canada. Infrastructure expenses were $213 million higher than the prior year period and included greater operating expenses to support increased growth as well as incremental amounts for Linetec and Neuco operations.
Depreciation and amortization increased $14.5 million due to depreciation on incremental equipment purchases and incremental amortization of intangible assets associated with the Linetec and Neuco acquisition. The other category includes a $5 million increase in interest expense due to higher debt outstanding, including amounts associated with the acquisitions.
The $14 million change in income taxes primarily reflects the impact of a one-time $12 million benefit recognized in December of 2017 due to the remeasurement of deferred tax liability associated with tax reforms.
For the 12 months ended March 31, 2019, Centuri operations contributed $47.9 million in net income toward our consolidated results. Based on the quarterly results for both segments, we reaffirm our full-year 2019 EPS guidance of $3.75 to $4 per share.
I'll now turn the call over to Justin Brown to give an update on regulatory matters.
Justin L. Brown -- Senior Vice President, General Counsel
Thanks, Greg. As highlighted on Slide 14, my comments today will focus on upcoming rate case activity, namely our Arizona rate case that was filed last week, as well as an update on our infrastructure tracker program and our expansion projects.
Let's start on Page 15. With the expiration of a rate case moratorium that we agreed to as part of our last Arizona general rate case, we were able to file a new rate case last week. Our application requests an increase in revenue of $57 million or 8% over existing revenues. One of the primary drivers of this case is to fully reflect the impact of tax reform in base rates, and the proposed $57 million increase in revenues is net of any offset from tax reform, including our proposed amortization of approximately $21 million associated with excess deferred income taxes.
In addition to tax reform, another driver for the case is to update rates to reflect the significant capital investments that have been made in Arizona to serve our customers. As a result, we are requesting increased rate base by approximately $670 million. Lastly, we simply need to update rates to reflect changes in customer volumes, margin and other changes to our cost of service since 2015.
Our proposed revenue increase is based upon a proposal to increase our authorized return on common equity to 10.3%, relative to an equity ratio of 51%. We are also requesting approval of a new infrastructure recovery mechanism to help monitor, assess and potentially replace certain plastic pipes. We've also requested approval of a renewable natural gas program, whereby we would target specific percentages of RNG to include in our gas supply portfolio. We hope to receive a procedural schedule sometime next month, but presently, we would anticipate a final decision by approximately April of 2020.
Turning to Slide 16. With respect to California, we are targeting to file our next California general rate case before September 1. The rate case will use the calendar year 2021 test period with new rates becoming effective in January of 2021. 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 2019, we're authorized to increase revenues by $2.8 million beginning January of this year.
As part of Paiute last general rate case in 2014, Paiute agreed to file a new rate case no later than the end of May 2019. As such, we're currently working on preparing a rate case that will be filed by the end of this month, within our rates being put in place by December 1, 2019, and a final decision in the second half of 2020. We are also commencing work on a significant modernization initiative with respect to our customer service and gas transaction information systems. Combined, these two projects will cost approximately $174 million span the course of the next couple of years.
Turning to Slide 17. A key component of executing on these projects is to seek constructive regulatory support for these initiatives through the establishment of regulatory assets in Arizona and Nevada to defer the cost of the project so that we may seek recovery of the cost in the future rate case proceedings.
In California, we filed an application requesting approval of the project and to establish a 2-way balancing account to track and recover the actual cost of the project. We anticipate decisions later this year for Arizona and Nevada and sometime in early 2020 for California.
Turning to Slide 18. Slides 18 and 19 highlights the 2 filings we currently have pending with the Arizona Corporation Commission to increase our surcharge revenue from $3.5 million to $6.7 million for COYL and as indicated on Slide 19, from $2.4 million to $11.9 million for our VSP program. We currently expect decisions on both Arizona filings in time for rates to become effective during the third quarter.
Turning to Nevada on Slide 20. Last year we received approval to replace $35 million worth of projects targeted for replacement in 2019. We also received approval to increase our GIR surcharge revenue by $6 million from $8.7 million to $14.7 million for 2019.
Turning to Slide 21, and our expansion projects. Construction of our $80 million LNG facility in Southern Arizona remains in line with our expectations, as we expect to see the completion of this project later this year. We've also included the cost of this facility in our rate case as part of our post-test year plan adjustment.
In Nevada, last year, we received approval for $28 million expansion as part of our first-ever SB 151 filing authorizing us to extend facilities to Mesquite, Nevada. Earlier this year, we officially welcomed our first Mesquite customer and plan to continue hooking up customers throughout the remainder of the year using a temporary virtual pipeline and compressed natural gas, while we continue to work on the design and construction of the permanent gas supply over the next 18 to 24 months.
And with that, I'll turn it back to John.
John P. Hester -- President and Chief Executive Officer
Thanks, Justin. On Slide 22, we detailed some metrics on our regulated utility service territory growth and economic conditions. As shown, we anticipate continuing population growth in each of our three states that is expected to significantly outpace national growth rates over the coming five years. Similarly, we continue to see low unemployment rates and positive job growth.
Turning to Slide 23, we illustrate the strong trends in customer growth that we expect to observe in the coming years. We expect to add over 100,000 new customers to the Southwest Gas family over the coming three year period.
Moving to slide 24. Continued strong growth, service territory expansions and aggressive safety oriented pipe replacement activity require a significant commitment to investment in our gas distribution systems. Over the coming three year period, Southwest expects to invest over $2 billion in capital to serve our customer's needs. The bar chart on this slide shows how those capital expenditures match up nicely with strong local growth and partnerships with the regulators to recover our cost of service through a variety of infrastructure tracking mechanisms. Approximately 45% to 50% of our capital expenditure financing needs will be met by internal cash flows with the balance satisfied by a combination of debt and equity issuances.
On Slide 25, we show how our planned expenditures for capital translate into significant rate base growth. We anticipate regulated rate base to grow from $3.5 billion at year-end 2018 to $4.8 billion by the end of 2021. This rate base growth represents a compounded annual growth rate of 11% over the coming three year period.
Turning to Slide 26. We show and reaffirm our 2019 earnings guidance. We expect year-end earnings to be between $3.75 and $4.00 per share.
Moving to Slide 27. We detailed some of the underlying factors supporting our year-end earnings per share guidance. On the regulated utility side of the business, we expect a number of the factors that we've discussed today to result in operating margin growing by 4% to 5%. We expect operating income to increase modestly and anticipate investing $710 million in our gas delivery systems in support of customer growth and safety-oriented pipe replacement activity.
At our unregulated utility infrastructure services business, we believe our diversified base of regulated utility customers like Southwest Gas will continue to reinvest in their gas and electric utility systems. And with the positive impacts of our Linetec Services acquisition, 2019 Centuri revenues are expected to increase by 15% to 20% year-on-year. Operating income is expected to be 6% to 6.5% of revenues. Please note that Southwest Gas Holdings results are net of non-controlling interest and that due to our Canadian operations, fluctuations in Canadian exchange rates can influence results.
And finally, wrapping up on Slide 28. We believe we offer a compelling value proposition to both our customers and investors. Both sides of our business expect strong growth in the years to come. At the regulated utility, we anticipate continuing annualized growth of 35,000 customers for the coming three year period, capital investments of over $2 billion over that same period, significant compounded annual growth in rate base and partnerships with our regulators to facilitate the timely recovery of our cost of service through constructive rate mechanisms.
Likewise, at our Centuri utility infrastructure services business, we will continue to leverage our position as one of the largest utility specialty contractors in North America to create value for customers and shareholders alike. Our Centuri group's focus on safety and quality has allowed us to successfully partner with utilities in 28 different markets across the U.S. and Canada as they seek to reinvest in their energy distribution systems to deliver safe and reliable service to their millions of utility end-use customers.
With that, I will turn the call to Ken.
Kenneth J. Kenny -- Vice President, Finance, Treasurer
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, Josh, will now explain the process for asking questions.
Questions and Answers:
Operator
Thank you. (Operator Instructions) Our first question comes from Dennis Coleman of Bank of America. You may proceed with your question.
Jasmine -- Bank of America -- Analyst
Hi. This is Jasmine (ph) for Dennis. Thanks for taking my question. To start off, can you provide some additional background on CDMI, how did the program come about and how will Southwest recover the cost?
Justin L. Brown -- Senior Vice President, General Counsel
Hey Jasmine, it's Justin Brown. They're both kind of legacy system, so the CSS system is a 30-year-old system. So, just one of those things that you upgrade over time in terms of your different information systems, same with the gas transaction system. It's a system that was developed in-house, nearly 20 years ago. So it's just something that as we go through and we look at our different information systems and we look at serving our customers and the capability of those systems and the need to either continue to adjusted to them or just replace them, that's how it really came about as ultimately a decision to replace the system.
In terms of the cost recoveries, I mentioned in California, we actually have a process where we can file for approval of the project and then implement a balancing account to recover and track the costs associated with that project. In Arizona and Nevada, we filed a request to establish regulatory assets, so that, that way we can track the cost and then once the projects are completed and when we file a future rate case in either jurisdiction, we would request to include those costs as part of a rate case at that time.
Jasmine -- Bank of America -- Analyst
Got it. And on guidance for 2019 was a strong first quarter and then the COLI contribution, is it right to think that now we're looking at the higher end of the guidance for the year?
John P. Hester -- President and Chief Executive Officer
I still -- this is John. I still think it's early in the year and we really aren't ready to point to a certain area of that range. I think that at this point, we're very comfortable continuing with the guidance that we issued earlier this year.
Jasmine -- Bank of America -- Analyst
Okay, thanks. That's it for me.
Operator
Thank you. And our next question comes from Phil Covello of ExodusPoint. You may proceed with your question.
Phil Covello -- ExodusPoint -- Analyst
Good morning, guys.
John P. Hester -- President and Chief Executive Officer
Good morning.
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Good morning.
Phil Covello -- ExodusPoint -- Analyst
Thanks for taking my question. My first one is just on the financing. The ATM program announced for roughly up to $300 million or so, if that -- is that your expectation that it will cover the totality of the equity you expect to need toward the, I guess, the $2.1 billion over the next three years?
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Yeah. Phil, this is Greg. Certainly, we launched that $300 million ATM filing yesterday, and it's designed to be a multiyear process that we will use. As we mentioned, about 45% to 50% of that CapEx need will come from internal cash flows and we'll do a balance of debt and equity over the course of that three year period, with a desire to maintain our cap structure at the 50-50 area that it's out right now. So that is a multiyear usage of that $300 million ATM.
Phil Covello -- ExodusPoint -- Analyst
Got it. And the rest of that, absent the cash from ops, as you said, you'd be looking at like $700 million or so of utility-level debt, in that ballpark?
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Well, I won't say anything about the amount. Certainly, we will be issuing debt over the course of time as well to maintaining the equilibrium in our cap structure.
Phil Covello -- ExodusPoint -- Analyst
Got you. And just one more thing on this piece, assuming you execute on the full CapEx plan, do you see an opportunity to perhaps not utilize the full authorization there? Like could you just talk about maybe puts and takes as to how much of that $300 million is utilized?
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Yes, this is Greg again. I don't think we'll get into any details. Again, the ATM shelf that we just registered is to give us flexibility over multiple years to issue common stock as it's needed for our CapEx programs and other needs. So again, I think the reason for authorizing that amount is it is a multiyear amount and we will be using it over the course of the next 2 to 3 years.
Phil Covello -- ExodusPoint -- Analyst
Fair enough. Okay. My last question. It's really more of an observation, I guess. It looks like through Q1, you added about 11,000 customers, your full year expectation is for 35,000. So it seems like you're tracking ahead. Is that right? And do you expect to continue to track ahead or is this just seasonality?
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Yes, to your point, Phil, this is Greg again. Seasonality is a big portion of that. I think that's why when we talk about customer growth, we do a year-over-year comparison. So the year-over-year is 32,000. As you mentioned, the first quarter is good and we remain on track to meet our expectation of 35,000 customers for calendar 2019.
Phil Covello -- ExodusPoint -- Analyst
Okay, that's all I had. Thank you, guys.
Operator
Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Ken Kenny for any further remarks.
Kenneth J. Kenny -- Vice President, Finance, Treasurer
Thank you, Josh. This concludes our conference call and we appreciate your participation and interest in Southwest Gas Holdings Inc. Have a great day. Thank you.
Operator
Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a wonderful day.
Duration: 31 minutes
Call participants:
Kenneth J. Kenny -- Vice President, Finance, Treasurer
John P. Hester -- President and Chief Executive Officer
Gregory J. Peterson -- Senior Vice President, Chief Financial Officer
Justin L. Brown -- Senior Vice President, General Counsel
Jasmine -- Bank of America -- Analyst
Phil Covello -- ExodusPoint -- Analyst
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