Southwest Gas’ (SWX) CEO John Hester Discusses Q2 2015 Results – Earnings Call Transcript
Southwest Gas Corporation (NYSE: SWX ) Q2 2015 Earnings Conference Call August 6, 2015 13:00 ET Executives Ken Kenny – Vice President, Finance and Treasurer John Hester – President and Chief Executive Officer Roy Centrella – Senior Vice President and Chief Financial Officer Justin Brown – Vice President, Regulation and Public Affairs Analysts Matt Tucker – KeyBanc Capital John Hanson – Praesidis Operator Good day, ladies and gentlemen and welcome to the Southwest Gas 2015 Midyear Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, today’s conference is being recorded. I would like to turn today’s conference call to Mr. Ken Kenny, Vice President of Finance and Treasury. You may begin. Ken Kenny Thank you, Kevin. Welcome to Southwest Gas Corporation’s 2015 midyear conference call. As Kevin 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 website at www.swgas.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 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 June 30, 2015 and an outlook for the remainder of 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 the company’s 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, Page 2 of our presentation, 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 Hester Thanks, Ken. Moving to Slide 3, I would like to summarize some of the highlights of the second quarter. First of all, on the natural gas side of the business, we had 28,000 net new customers in the past year. As we have previously projected, this represents an annualized growth rate of approximately 1.5%. Last month, we commenced construction on our $35 million Paiute Pipeline lateral, which will interconnect with Ruby Pipeline. We expect these facilities to the completed and in service in November of this year. We also submitted a request to the Public Utilities Commission of Nevada for authority to replace $43.5 million of older vintage plastic and steel pipeline next year. All three of these developments are indicative of the positive growth that we are continuing to experience on the regulated utility side of our business. At our unregulated construction services business segment, our effort to fully integrate the Link-Line Group of Companies that we acquired in October of last year continues to progress. We experienced strong revenue growth both organically and from the acquired companies in the past quarter. As we have indicated in previous disclosures over the past year, we continue to believe that we are on pace to reach $950 million to $1 billion in construction services revenues by year end. And with our peak construction season ahead of us, we expect a strong third and fourth quarter that we think will culminate in the construction services group achieving its previously announced 2015 goals. We did increase our loss reserve associated with the Canadian industrial project this quarter by another $2 million and we are currently in negotiations with our customer over change orders. We believe that we are in a very strong position in the ongoing negotiations and that our efforts will result in a substantial mitigation of the current loss reserve. This particular project is essentially complete and we remain very enthusiastic about the construction services segment, including the businesses we acquired this past October. Turning to Slide 4, for today’s call, Roy Centrella will provide an overview on our consolidated earnings as well as separate detail for the regulated natural gas and Centuri Construction Group segments. Justin Brown will provide a recap on the activities that we have been undertaking on the regulatory front and I will wrap up with a report on customer growth, our capital expenditure expectations and an update on our outlook for 2015. With that, I will now turn the call over to Roy. Roy Centrella Thank you, John. As noted, I am going to spend some time reviewing second quarter and 12-month financial results of both the natural gas and construction services segments. I will also highlight some of the key factors impacting the changes between the related periods and potentially influencing full year 2015 results. We will start on Slide 5. Net income for the three months ended June 2015 was $4.9 million, or $0.11 per basic share, down from the $9.6 million, or $0.21 per share earned during last year second quarter. The contribution to net income from both operating segments was down modestly between periods. For the 12-month period ended June, we earned $138 million, or $2.95 per basic share, an improvement from prior period net income of $135 million, or $2.91 per share. Results for the gas segment were markedly better, while the construction segment experienced a slight decline. Let’s turn to second quarter results of the gas segment on Slide 6. A loss of $657,000 was experienced this quarter versus earnings of $1.8 million previously. Operating income declined due mainly to higher operating costs, but was offset by lower interest costs. So other income, which decreased by $2.5 million between periods due mainly to unfavorable returns on company-owned life insurance, or COLI policies, was the primary cause of the decline between periods. Slide 7 provides a breakdown of $4 million operating margin increase, half of which came from customer growth and half from rate relief and other factors. We added 28,000 net customers over the last 12 months consistent with expectations for about 1.5% growth rate. Overall, considering customer growth and rate release, operating margin remains on track to reach our estimated growth forecast of 2% for all of 2015. Moving to Slide 8, you will see that operating expenses increased $5.6 million or 3.5% between quarterly periods. Most of the increase was attributed to higher depreciation and property taxes, resulting from capital expenditures. The reduction in financing cost was attributable to strong cash flows, which allowed us to redeem long-term debt early. I will turn to Slide 9, which summarizes the activity in other income, which declined by $2.5 million between periods. This quarter, we recognized no income on the investments underlying our COLI policies, whereas last year’s earnings amounted to $2.3 million. Next, we will move to Slide 10 and 12-month gas segment results. Net income of nearly $121 million was up about $3.4 million from the $117 million earned in the previous 12-month period. Strong growth in operating margin and flat net operating expenses resulted in a $15 million increase in operating income. A $5.6 million reduction in other income, principally COLI returns, partially offset the improvement in operating income. The next couple of slides further breakdown these components starting with Slide 11 and operating margins. Operating margin grew by $15 million between periods driven by two primary factors. Customer growth contributed $8 million towards the increase, while combined rate relief in California and our Paiute operations kicked in $9 million. Slide 12, total operating expenses. Total operating expenses were flat between periods as increases in depreciation and general taxes were offset by a $14 million decline in O&M expenses. Within O&M, the most significant favorable factors were legal expenses, which fell $5.6 million due to a legal accrual in 2014, which did not recur and a $2 million reduction in rent expense resulting from the company’s purchase of a portion of its headquarters complex, which was previously leased. Slide 13 covers other income and deductions, which declined $11.2 million to $5.6 million. The primary takeaway on this slide is that COLI-related income for the prior period was extremely high due to strong investment returns on assets underlying the policies. On the other hand, in the current period, the $3.4 million return was in the more normal range of $3 million to $5 million. Also, we remind you that in any given period, losses are possible. Next, we will discuss Centuri’s operating results beginning on Slide 14. During the most recent quarter, the construction segment contribution to net income was $5.6 million, down $2.2 million from last year’s $7.8 million. Two factors which influenced this line. First, the loss reserve on the industrial construction project in Canada widened by $2 million. And second, the acquisition of Link-Line made the seasonal aspect of our construction segment more pronounced as it increased a proportionate size of our Northeastern operations and added more fixed cost. This, in no way, dampened our enthusiasm for the business. It’s just a recognition that due to the weather implications, a higher percentage of construction segment earnings are likely to occur during the second half of the year. During the 12-month periods, contribution to net income declined slightly from $17.5 million to $16.9 million. There were several significant factors, which influenced results for both periods, which I will touch on in a minute. Moving to Slide 15, you can see that revenue increased $70 million or 39% between the second quarter of 2014 and 2015. This reflected $32 million of incremental work at NPL and $38 million from the Link-Line acquisition. Construction expenses increased $68 million or 43% between periods with $30 million attributable to NPL and $38 million for the acquired companies. Depreciation expense increased $2.4 million due mainly to equipment purchases to support the higher revenue level, along with $1.4 million of amortizations on acquisition-related intangibles. Now regarding the industrial project, an additional $2 million was incurred beyond our initial reserve estimate to complete the project. The facility is operational and we no longer have employees on-site. We are actively negotiating change orders with the general contractor and believe we will mitigate this loss reserve during the second half of the year. Slide 16 summarizes 12-month construction services results. On the top line, current period revenues totaled $869 million and we are up $207 million between periods with $134 million coming from the acquired companies and $73 million from NPL. Construction expenses increased $189 million with $137 million applicable to the acquired companies and $52 million to the NPL. Depreciation expense increased $9 million, reflecting equipment purchases, Link-Line depreciation of $3.6 million and $4.3 million in amortization of finite live intangibles recognized from the acquisition. The net result of this activity was an increase in operating income of $9.4 million from $28.3 million in the prior periods to $37.7 million in the current 12-month period. Current period operating income reflects a $7.6 million loss reserve on the industrial construction project in Canada as well as $5 million of acquisition costs recorded during the second half of 2014. Prior period operating expenses included $4 million legal settlement recorded in late 2013. As we look ahead to the second half of the year, the construction services segment is well positioned to finish strongly. We are heading into the third quarter construction season peak. There is significant ongoing replacement work in both our U.S. and Canadian service territories. And we are cautiously optimistic that progress will be made on change orders actively being negotiated on the industrial project. I will now turn the time over to Justin Brown for a regulatory update. Justin Brown Thanks Roy. Turning to Slide 17, I would like to focus my comments on the regulatory initiatives that have undergone recent developments since our last earnings call. First, as we have discussed in previous calls, one of our key regulatory initiatives has been to establish infrastructure replacing mechanisms in each of our jurisdictions in order to timely recover capital expenditures associated with projects that enhance the safety, service and reliability to our customers. In Nevada, we recently made our second filing under the recently approved regulations wherein we requested the approval to replace $43.5 million of qualifying projects. These regulations were approved in January 2014 and they authorized Southwest Gas to make annual filings where we will propose the replacement of qualifying projects. We made our first filing in June of last year and subsequently received approval in October 2014 to replace $14.4 million of projects. We anticipate a final commission decision on this year’s application sometime in October. And Nevada regulation, also permit us to make a separate annual filing to implement a surcharge to recover the revenue requirement associated with the previously approved projects. In the fall of 2014, we submitted a rate application and we were authorized to institute a surcharge effective January of this year to collect $2.2 million annually. Similar to last year, we plan to make a proposal on October of this year to update the surcharge to reflect expenditures associated with previously approved projects that have now been completed. In May, the Arizona Corporation Commission approved our requests to update the customer owned yard line or COYL program surcharge to collect annual revenues of $2.5 million, up from the previously approved $1.5 million. The program was approved as part of our last Arizona rate case decision and was most recently expanded in 2014 to include a Phase 2 for the replacement of certain non-Link-Line customer lines. The updated surcharge reflects total capital expenditures of $16 million of which $6.3 million was incurred during 2014 for both Phase 1 and Phase 2. Turning our focus to the two expansion projects, we continue to make progress on the construction of our liquefied natural gas storage facility that was approved by the Arizona Commission. You may recall late last year, we received pre-approval from the Arizona Corporation Commission to construct a $55 million liquefied natural gas storage facility in southern Arizona. We are getting close to completing our due diligence on the land purchase and we recently entered into a contract for the engineering design of the facility. We are looking forward to completing construction of the facility by year end 2017. In Nevada, construction of the Elko County expansion project has officially begun. In June of 2014, our Paiute Pipeline subsidiary made a formal application with the Federal Energy Regulatory Commission requesting approval to build a 35-mile, $35 million lateral to interconnect Paiute with Ruby Pipeline and increase gas supply deliverability to Elko. In May, the FERC issued an order authorizing a certificate of public convenience and necessity to Paiute to construct and operate the project and subsequently provided a formal notice to proceed. Following receipt of the notice to proceed, work began on preparing the 35-mile pipeline corridor for construction. Pipe is also being delivered to the project site and pipeline segments are being welded together and installed. As John mentioned previously, we anticipate construction being completed by year end. Lastly on this slide, you may recall we received approval on California to increase margin by $2.5 million as part of the previously approved annual post test year attrition margin increase of 2.75% per year for calendar years 2015 to 2018. This increase became effective January of 2015. Also consistent with our statements in previous calls, we are still on target for filing an Arizona rate case next year. You may recall, one of the conditions of our last Arizona rate case settlement precludes a filing any sooner than April 30, 2016. Now turning to Slide 18, the purchase gas adjustment or PGA clauses that we have in each of our jurisdictions allow us to adjust rates either monthly or quarterly to timely respond to changing natural gas market conditions and to recover differences between the amount Southwest Gas pays for gas and the cost of gas being recovered from our customers, sometimes resulting in either over or under collections. The benefits of slightly lower and stabilizing natural gas prices combined with having effective PGA clauses in each of our jurisdictions is demonstrated on this slide as we were able to recover approximately $111 million over the first half of this year, moving from an under collected balance at December 31, 2014 to a slightly over collected balance at June 30, 2015. And with that, I will turn it back to John. John Hester Alright. Thanks Justin. Turning to Slide 19, as I mentioned at the outset of our call, Southwest Gas added 28,000 net new customers this past year, continuing the general customer growth trend we have seen across our service territories over the past few years. Moving to Slide 20, indicative data on unemployment rates and employment growth rates in our various service territories are presented in the table shown on this slide. As you can see, unemployment rates in each of our jurisdictions declined year-over-year, reflecting a continuing modest uptrend in general business activity. The trend is less clear, although generally, up in the accompanying employment growth rates displayed. Anecdotal observations seem to confirm a modest continuing upward trend in commerce with major new construction initiatives announced or underway in our major service territories. Moving to Slide 21, we summarized our perspective expectations regarding capital expenditures. We believe that we are on pace to invest $445 million across our service territories by year end. The pie chart on this slide shows a breakout of how those capital dollars will be spent. Looking further into the future, we anticipate that our capital expenditures continue to be in line with our previously disclosed $1.3 billion 3-year capital plan. Turning to our 2015 expectations for the construction services segment on Slide 22, we will continue our ongoing integration efforts to bring the Link-Line Group of Companies into the Centuri Construction Group. We believe we are on track to reach our construction services revenue goal of $950 million to $1 billion by year end. Our operating income for the segment should approximate 6% of revenues depending on the final resolution of our ongoing negotiations related to the Canadian industrial project for which we have recorded a loss reserve. Net interest deductions are expected to be between $7 million and $8 million. Our expectations are before consideration of non-controlling interest and remember that foreign exchange rates and interest rates can impact this segment’s results. Finally, turning to Slide 23 for our outlook for our natural gas utility operations, operating margin is estimated to increase nearly 2% this year. Margin from net new customer growth should be similar to 2014 with the balance of margin growth coming from a variety of rate mechanisms and regulatory decisions. Our operating costs are expected to increase by 3% to 4%. This assumption includes an $8 million pension expense increase to reflect updated actuarial tables. Net interest deductions for this year are expected to be $3 million to $5 million lower than the $68 million recorded in 2014. And finally, as I indicated earlier, our capital expenditures this year should total $445 million. With that, I will turn the call to Ken. Ken Kenny Thanks, John. That concludes our prepared presentation. For those of you who have access to our slides, we have also provided in the appendix with slides that includes other pertinent information about Southwest Gas and can be reviewed at your convenience. Our operator, Kevin, will now explain the process for asking questions. Question-and-Answer Session Operator [Operator Instructions] Our first question comes from Matt Tucker with KeyBanc Capital. Matt Tucker Hey, guys. Thanks for taking my question. First, just wanted to ask at Centuri about the problem project there, could you just give us some sense as to what caused the cost overruns, the nature of the dispute, if you can call it that. Is it more whose it fault or the amount that you are due to recover? And then just kind of what gives you optimism on your position and on the recovery of the cost? Roy Centrella Yes, hi Matt. This is Roy. Well, the project was we talked a little bit about this last time, but it was a relatively short duration project. There is supposed to be 2-month project that crossed over time periods. And when we established the work for this, we are working with the general contractor, there – it was critical that because of that short timeline, the project – the pieces that – the equipment that was needed all come in on a timely basis. And through – really through no fault of our own results, the equipment we needed wasn’t coming in timely and that had, as a result, we had a fair amount of downtime with a good size workforce of about 300 people outside. So, there were – those delays caused revenue – I mean the cost side of the equation to increase. And we finished the project, took probably an extra three days or so to finish and that’s where those extra costs came from. And we initiated negotiations with the general contractor to try to recover those excess cost and that’s where we are today. We believe our position is strong, because we were at the fault of the delay in the equipment coming in. It was a general contractor. And so we are working with them. We would love to settle this without moving to a legal status, but certainly that’s a possibility that we can’t come to the resolution directly. There are legal avenues at what we can pursue. Matt Tucker Thanks. That’s helpful. You kind of preempted part of my next question about kind of the nature of negotiation at this point, but I guess as a follow-up to that, is the general contractor in reasonably good financial condition to your knowledge? Roy Centrella Yes, the best we know. They are a good-sized contractor and have been doing work in the auto industry for a long time. So, we are hopeful that we can make good progress on this leadership. Matt Tucker Got it. Thanks. And then just looking at Centuri’s overall performance in the quarter, if I back out that the project loss, it looks like your operating margin was still about maybe 120 basis points lower year-over-year. If I understand correctly, your view that, that’s primarily attributed to the seasonality in the Link-Line business, is that correct or is there something else that could be going on there? Roy Centrella No, I think that’s the biggest factor. We have some additional fixed cost that come about because of that acquisition, rents and general and administrative costs, things of that nature. And they probably have a bigger summer peak at the Link-Line side of the business than we have at the NPL side. And so as a result of that, we will see more of the earnings shifted to the second part of the year. But right now both sides of the business, the U.S. side and the Canadian side are in their peak operations. Matt Tucker Okay, got it. And then just trying to understand the seasonality a little better, I guess little surprised that the second quarter Link-Line revenues should be lower than the first. Was that unusual, like unusually bad weather this year in the second quarter or is that something you would expect or attributable to something else? Roy Centrella Well, one thing that contract we talked about the industrial project that was all first quarter revenue. And so that’s been – there is no revenues that carried forward from that job into the second quarter. That’s probably the biggest factor. I mean that was $18 million of revenue in the first quarter associated with that job. Matt Tucker Got it. That makes sense. And then just last one, as you are getting further along with the integration of Centuri and getting closer to that $1 billion revenue threshold. You have talked in the past about potentially considering some strategic options for the business when you get there, maybe sometime starting next year? Just wondering if you could update on your current thinking with regard to that? John Hester Hey, Matt, this is John. I think that is our current thinking as we have talked before that we want to make sure that we have the opportunity to continue to grow those businesses and certainly to have a little bit more transparency with the amount of earnings that those businesses will create and I think that they are going to at least need a full calendar year to demonstrate that. And then we will continue to look at our options going forward. We think that certainly, there is a lot of great growth prospects of Centuri. And we think as we talked about a little bit earlier in today’s call that there are a lot of great growth prospects of the utility as well. So, we will continue to try to grow both of those parts of the businesses. And as we continue to go forward, see how the construction services growth rates is going compared to the utility growth rate and continues to look at what options we may have in the future. Matt Tucker Very helpful. Thanks, John. Thanks, Roy. I will back in the queue. John Hester Okay, thank you. Operator Our next question comes from John Hanson with Praesidis. John Hanson Hey, guys. John Hester Hey, John. John Hanson Matt asked most of my questions, but just one kind of follow-up on the construction. What’s your guys view now on more acquisitions in that area? John Hester It’s something that, this is John, John. It’s something that we will continue to look at. One of the things that we have done at Centuri is we have taken a pretty deep dive into what the various business prospects are across the country. We have taken a look at where we have a lot of activity currently being done by the Centuri Group and what kind of markets that we may want to move into. If we see opportunities to move into new markets, we can approach that two ways. We can either start that from the ground up or we can see if there are some smaller tuck-in type companies that may facilitate that growth in markets that we might want to get into. So we will continue to look for those prospects. And if we think it makes sense for our shareholders as an avenue to continue to grow the business profitably we will do that. John Hanson When you talk markets, are you talking more geography or customer type? John Hester Mostly geography, John. John Hanson Good, thank you. Operator [Operator Instructions] And I am not showing any questions at this time. Ken Kenny Okay. Thank you, Kevin. This concludes our conference call and we appreciate your participation and interest in Southwest Gas Corporation. Thank you for being on the call [ph]. Operator Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. 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