ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Southwest Gas Holdings, Inc. is a holding company that owns all of the shares of common stock of Southwest Gas Corporation (“Southwest” or the “natural gas distribution” segment), all of the shares of common stock of Centuri Group, Inc. (“Centuri,” or the “utility infrastructure services” segment), as well as all of the membership interests in the newly formed MountainWest Pipelines Holding Company (“MountainWest,” or the “pipeline and storage” segment). Southwest Gas Holdings, Inc. and its subsidiaries are collectively referred to as the “Company.”
The Company completed the acquisition of Dominion Energy Questar Pipeline, LLC (“Questar Pipelines”) and related entities in December 2021. Following the acquisition, the Company formed MountainWest which owns all of the membership interests of Questar Pipelines. In April 2022, the Company completed a general rebranding of the Questar Pipelines entities under the MountainWest name. The acquired operations further diversify the Company’s business including an essential Rocky Mountain energy hub with over 2,000 miles of highly contracted, FERC-regulated interstate natural gas pipelines providing transportation and underground storage services in Utah, Wyoming, and Colorado.
In October 2021, our Board of Directors (the “Board”) authorized and declared a dividend of one preferred stock purchase right for each share of common stock outstanding to stockholders of record at the close of business on October 21, 2021.
In March 2022, the Company announced that the Board had determined to separate Centuri from the Company and authorized management to complete the separation within nine to twelve months from the date of such announcement. Management evaluated various alternatives to determine the optimal structure to maximize stockholder value and subsequently announced the separation structure is expected to be a tax-free spin-off in which stockholders of the Company would receive a prorated dividend of Centuri shares in association with the completion. Then, in April 2022, as a result of interest in the Company well in excess of a tender offer by an activist stockholder (Carl Icahn) to other stockholders, the Board authorized the review of a full range of strategic alternatives intended to maximize stockholder value. As part of this process, a strategic review committee of the Board, consisting entirely of independent directors, will evaluate a sale of the Company, as well as a range of alternatives, including, but not limited to, a separate sale of its business units and/or pursuing the spin-off of Centuri. There can be no assurances that the Company will be able to successfully separate Centuri on the anticipated timeline or at all, nor assurances that other strategic alternatives considered will be executed or maximize value as intended. See “Item 1A - Risk Factors” included elsewhere in this Quarterly Report on Form 10-Q.
As described in Note 9 - Subsequent Events, on May 6, 2022, the Company entered into a Cooperation Agreement with Carl C. Icahn and the persons and entities named therein (the “Icahn Group”). In accordance with the Cooperation Agreement, among other things, (i) Karen S. Haller has replaced John C. Hester as the Company’s President and Chief Executive Officer, (ii) the Icahn Group has certain board designation rights, (iii) the Icahn Group has agreed to terminate its previously announced tender offer, and (iv) the Icahn Group caused its affiliates to file a stipulation of dismissal with prejudice dismissing the action filed by them on November 29, 2021, which was entered by the Delaware Court of Chancery on May 9, 2022. See Note 9 - Subsequent Events for more information.
Southwest is engaged in the business of purchasing, distributing, and transporting natural gas for customers in portions of Arizona, Nevada, and California. Southwest is the largest distributor of natural gas in Arizona, selling and transporting natural gas in most of central and southern Arizona, including the Phoenix and Tucson metropolitan areas. In January 2022, Southwest completed the purchase of the Graham County Utilities, Inc. (“GCU”) gas distribution system, located in Graham County, Arizona. Southwest is also the largest distributor of natural gas in Nevada, serving the majority of southern Nevada, including the Las Vegas metropolitan area, and portions of northern Nevada. In addition, Southwest distributes and transports natural gas for customers in portions of California, including the Lake Tahoe area and the high desert and mountain areas in San Bernardino County. Through its subsidiaries, Southwest operates two federally regulated interstate pipelines serving portions of the foregoing northern territories of Nevada and California.
As of March 31, 2022, Southwest had 2,171,000 residential, commercial, industrial, and other natural gas customers, of which 1,161,000 customers were located in Arizona, 806,000 in Nevada, and 204,000 in California. In January 2022, approximately 5,300 customers became part of Southwest’s gas distribution operations that were formerly served by GCU. Over the past twelve months, first-time meter sets were approximately 38,000, compared to 37,000 for the twelve months ended March 2021. Residential and small commercial customers represented over 99% of the total customer base. During the twelve months ended March 31, 2022, 54% of operating margin (Regulated operations revenues less the net cost of gas sold) was earned in Arizona, 34% in Nevada, and 12% in California. During this same period, Southwest earned 85% of its operating margin from residential and small commercial customers, 4% from other sales customers, and 11% from transportation customers. These patterns are expected to remain materially consistent for the foreseeable future.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Southwest recognizes operating revenues from the distribution and transportation of natural gas (and related services) to customers. Operating margin is a financial measure defined by management as Regulated operations revenues less the net cost of gas sold. However, operating margin is not specifically defined in accounting principles generally accepted in the United States (“U.S. GAAP”). Thus, operating margin is considered a non-GAAP measure. Management uses this financial measure because Regulated operations revenues include the net cost of gas sold, which is a tracked cost that is passed through to customers without markup under purchased gas adjustment (“PGA”) mechanisms. Fluctuations in the net cost of gas sold impact revenues on a dollar-for-dollar basis, but do not impact operating margin or operating income. Therefore, management believes operating margin provides investors and other interested parties with useful and relevant information to analyze Southwest’s financial performance in a rate-regulated environment. The principal factors affecting changes in operating margin are general rate relief (including impacts of infrastructure trackers) and customer growth. Commission decisions on the amount and timing of such relief may impact our earnings. Refer to the Summary Operating Results table below for a reconciliation of gross margin to operating margin, and refer to Rates and Regulatory Proceedings in this Management’s Discussion and Analysis, for details of various rate proceedings.
The demand for natural gas is seasonal, with greater demand in the colder winter months and decreased demand in the warmer summer months. All of Southwest’s service territories have decoupled rate structures (alternative revenue programs), which are designed to eliminate the direct link between volumetric sales and revenue, thereby mitigating the impacts of unusual weather variability and conservation on operating margin, allowing Southwest to pursue energy efficiency initiatives.
Centuri is a strategic infrastructure services company that partners with regulated utilities to build and maintain the energy network that powers millions of homes and businesses across the United States (“U.S.”) and Canada. With an unwavering commitment to serve as long-term partners to customers and communities, Centuri’s employees enable regulated utilities to safely and reliably deliver natural gas and electricity, as well as achieve their goals for environmental sustainability. Centuri operates in 70 primary locations across 44 states and provinces in the U.S. and Canada. Centuri operates in the U.S., primarily as NPL, Neuco, Linetec, and Riggs Distler, and in Canada, primarily as NPL Canada.
Utility infrastructure services activity can be impacted by changes in infrastructure replacement programs of utilities, weather, and local and federal regulation (including tax rates and incentives). Utilities continue to implement or modify system integrity management programs to enhance safety pursuant to federal and state mandates. These programs have resulted in multi-year utility system replacement projects throughout the U.S. Generally, Centuri revenues are lowest during the first quarter of the year due to less favorable winter weather conditions. Revenues typically improve as more favorable weather conditions occur during the summer and fall months. In cases of severe weather, such as following a regional storm, Centuri may be engaged to perform restoration activities related to above-ground utility infrastructure, and related results impacts are not solely within the control of management. In addition, in certain circumstances, such as with large bid contracts (especially those of a longer duration), or unit-price contracts with revenue caps, results may be impacted by differences between costs incurred and those anticipated when the work was originally bid. Work awarded, or failing to be awarded, by individual large customers can impact operating results.
MountainWest is an interstate natural gas transmission pipeline company that provides transportation and underground storage services to customers in Utah, Wyoming, and Colorado. A substantial portion of its revenue results from reservation charges, but variable rates are also included as part of its primarily rate-regulated rate structures.
While the novel coronavirus (“COVID-19”) pandemic has been ongoing since the first quarter of 2020, the Company continues to facilitate administration, communication, and all critical functions. To date, there has not been a significant disruption in the Company’s supply chains, transportation network, or ability to serve customers. The extent to which COVID-19 may adversely impact the Company’s business depends on future developments; however, management does not currently expect impacts to be material to the Company’s liquidity or financial position overall.
This Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto, as well as MD&A, included in the 2021 Annual Report to Stockholders, which is incorporated by reference into the 2021 Form 10-K.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Executive Summary
The items discussed in this Executive Summary are intended to provide an overview of the results of the Company’s and Southwest’s operations and are covered in greater detail in later sections of MD&A.
Summary Operating Results
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Period Ended March 31, |
| | Three Months | | | | Twelve Months |
(In thousands, except per share amounts) | | 2022 | | 2021 | | | | | | 2022 | | 2021 |
Contribution to net income | | | | | | | | | | | | |
Natural gas distribution | | $ | 111,795 | | | $ | 118,715 | | | | | | | $ | 180,215 | | | $ | 194,234 | |
Utility infrastructure services | | (23,486) | | | (859) | | | | | | | 17,793 | | | 84,207 | |
Pipeline and storage | | 16,930 | | | — | | | | | | | 16,930 | | | — | |
Corporate and administrative | | (9,061) | | | (563) | | | | | | | (35,274) | | | (1,366) | |
Net income | | $ | 96,178 | | | $ | 117,293 | | | | | | | $ | 179,664 | | | $ | 277,075 | |
| | | | | | | | | | | | |
Weighted average common shares | | 60,737 | | | 57,600 | | | | | | | 59,919 | | | 56,564 | |
Basic earnings per share | | | | | | | | | | | | |
Consolidated | | $ | 1.58 | | | $ | 2.04 | | | | | | | $ | 3.00 | | | $ | 4.90 | |
| | | | | | | | | | | | |
Natural Gas Distribution | | | | | | | | | | | | |
Reconciliation of Gross Margin to Operating Margin (Non-GAAP measure) | | | | | | | | | | | | |
Utility Gross Margin | | $ | 233,882 | | | $ | 233,156 | | | | | | | $ | 571,051 | | | $ | 546,171 | |
Plus: | | | | | | | | | | | | |
Operations and maintenance (excluding Admin. & General) expense | | 73,422 | | | 64,057 | | | | | | | 276,525 | | | 246,214 | |
Depreciation and amortization expense | | 72,114 | | | 68,698 | | | | | | | 256,814 | | | 239,268 | |
Operating margin | | $ | 379,418 | | | $ | 365,911 | | | | | | | $ | 1,104,390 | | | $ | 1,031,653 | |
1st Quarter 2022 Overview
Southwest Gas Holdings highlights include the following:
•Announced the Board’s evaluation of strategic alternatives, including a potential sale of the Company, sale of business segments, and/or spin-off of Centuri
•Issued 6,325,000 shares of common stock, raising $452 million in net proceeds
•Corporate and administrative expenses include impact of interest on $1.6 billion term loan and activism costs
Natural gas distribution highlights include the following:
•38,000 first-time meters sets occurred over the past 12 months
•Operating margin increased $14 million
•Issued $600 million in 4.05% 10-year Notes
•Nevada general rate case finalized with rate relief effective April 2022
Utility infrastructure services highlights include the following:
•Record revenues of $524 million in the first quarter of 2022, an increase of $160 million, or 44%, compared to the first quarter of 2021
•Results impacted by inflationary pressures and incremental interest and amortization associated with Riggs Distler
Pipeline and storage highlights include the following:
•Recognized revenue of $67 million
•Contributed $17 million to consolidated net income, which is net of $8.7 million of one-time stand-up and integration costs
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Results of Natural Gas Distribution
Quarterly Analysis
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
(Thousands of dollars) | | 2022 | | 2021 |
Regulated operations revenues | | $ | 676,539 | | | $ | 521,932 | |
Net cost of gas sold | | 297,121 | | | 156,021 | |
Operating margin | | 379,418 | | | 365,911 | |
Operations and maintenance expense | | 119,636 | | | 106,135 | |
Depreciation and amortization | | 72,114 | | | 68,698 | |
Taxes other than income taxes | | 21,652 | | | 20,687 | |
Operating income | | 166,016 | | | 170,391 | |
Other income (deductions) | | 1,315 | | | 550 | |
Net interest deductions | | 26,610 | | | 22,166 | |
Income before income taxes | | 140,721 | | | 148,775 | |
Income tax expense | | 28,926 | | | 30,060 | |
Contribution to consolidated net income | | $ | 111,795 | | | $ | 118,715 | |
Contribution from natural gas distribution operations decreased $6.9 million between the first quarters of 2022 and 2021. The decline was primarily due to an increase in Operations and maintenance expense, higher Depreciation and amortization, and an increase in Net interest deductions, partially offset by an increase in Operating margin.
Operating margin increased $14 million quarter over quarter. Approximately $7 million of incremental margin was attributable to customer growth including 38,000 first-time meter sets during the last twelve months. Rate relief in California added $1 million of margin. Also contributing to the increase were customer late fees that were $2.8 million greater in the current quarter due to the lifting of the moratorium in 2021 on such fees in Arizona, Nevada, and California. The moratorium was previously in place beginning in March 2020 to provide temporary relief to customers during the COVID-19 pandemic. Amounts collected from and returned to customers associated with regulatory account balances and programs, including $6.2 million in incremental (previously unrecovered) revenue associated with Vintage Steel Pipe (“VSP”) and Customer-Owned Yard Line (“COYL”) programs in Arizona, also contributed to the improvement. Refer to Rates and Regulatory Proceedings below. Other differences in miscellaneous revenue and margin from customers outside the decoupling mechanisms contributed to the remaining net variance between quarters.
Operations and maintenance expense increased $13.5 million between quarters. In addition to general inflationary impacts, other increases occurred in the service-related component of employee pension costs (see $775,000 increase reflected in service cost for the three plans in Note 2 - Components of Net Periodic Benefit Cost) and $3.5 million specifically related to customer service, system support, and billing. Other increases included employee and benefit-related costs ($1.2 million) and increased general business insurance ($800,000). The prior year period expense levels included more modest expense levels overall due to COVID-environment reduced training, travel and related amounts.
Depreciation and amortization expense increased $3.4 million, or 5%, between quarters, primarily due to a $564 million, or 7%, increase in average gas plant in service compared to the corresponding quarter a year ago. Offsetting the increase, amortization related to regulatory account recoveries decreased approximately $700,000 between quarters, which is also reflected in Operating margin above. The increase in plant was attributable to pipeline capacity reinforcement work, franchise requirements, scheduled pipe replacement activities, and new infrastructure.
Other income increased $765,000. The current quarter reflects a $2 million decline in COLI policy cash surrender values, while the prior-year quarter reflected a $2.7 million increase. These fluctuations primarily result from changes in the portion of the cash surrender values that are associated with equity securities, and are directionally consistent with the broader securities markets. This decrease was offset by non-service-related components of employee pension and other postretirement benefit costs, which decreased $3.3 million between quarters. Interest income increased $2.1 million between quarters due to the increased receivable position of the Purchased Gas Adjustment. A gain of $1.5 million was recognized on the sale of non-regulated property in the first quarter of 2022.
Net interest deductions increased $4.4 million in the first quarter of 2022, as compared to the prior-year quarter, primarily related to lower interest in the prior-year quarter, as a carrying amount related to an annual excess accumulated deferred tax
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
(“EADIT”) balance in Arizona was required to be returned to customers, thereby reducing interest when the carrying charge regulatory liability balance was amortized for the return ($1.5 million), and due to higher interest in the current period due to $300 million of Senior Notes issued in August 2021, and to a lesser extent, $600 million of Senior Notes issued in March 2022.
Results of Natural Gas Distribution
Twelve-Month Analysis
| | | | | | | | | | | | | | |
| | Twelve Months Ended March 31, |
(Thousands of dollars) | | 2022 | | 2021 |
Regulated operations revenues | | $ | 1,676,397 | | | $ | 1,369,690 | |
Net cost of gas sold | | 572,007 | | | 338,037 | |
Operating margin | | 1,104,390 | | | 1,031,653 | |
Operations and maintenance expense | | 452,051 | | | 409,429 | |
Depreciation and amortization | | 256,814 | | | 239,268 | |
Taxes other than income taxes | | 81,308 | | | 67,769 | |
Operating income | | 314,217 | | | 315,187 | |
Other income (deductions) | | (3,794) | | | 14,496 | |
Net interest deductions | | 102,004 | | | 98,256 | |
Income before income taxes | | 208,419 | | | 231,427 | |
Income tax expense | | 28,204 | | | 37,193 | |
Contribution to consolidated net income | | $ | 180,215 | | | $ | 194,234 | |
Contribution to consolidated net income from natural gas distribution operations decreased $14 million between the twelve-month periods ended March 2022 and 2021. The decline was due primarily to increases in Operations and maintenance expense, Depreciation and amortization, and Taxes other than income taxes, and a decrease in Other income (deductions), offset by an increase in Operating margin.
Operating margin increased $73 million between periods. Customer growth provided $14 million, and combined rate relief provided $44 million of incremental operating margin. Also contributing to the increase were customer late fees that were $8 million greater in the current period due to lifting the moratorium on such fees in all jurisdictions, which was initially instituted in March 2020 to provide temporary relief to customers during the pandemic. Additionally, regulatory account balance returns and recoveries increased approximately $2.1 million between periods. Incremental (previously unrecovered) VSP and COYL revenue in Arizona ($5.2 million combined, between twelve-month periods) also contributed to the variance between periods.
Operations and maintenance expense increased $43 million, or 10%, between periods. In addition to general inflationary impacts, Southwest also experienced $7 million of higher legal-claim related costs (including a $5 million legal reserve as described in Note 1 – Background, Organization, and Summary of Significant Accounting Policies), higher levels of service-related pension costs ($6.1 million), customer service, system support, and billing costs ($7.9 million), increased expenditures for pipeline damage prevention programs ($4 million) and general business insurance ($2.7 million), as well as increased medical and other employee benefit costs. Prior year expense levels were uncharacteristically low due to COVID-period reduced training/travel and other cost savings.
Depreciation and amortization expense increased $17.5 million, or 7%, between periods primarily due to a $562 million, or 7%, increase in average gas plant in service since the corresponding period in the prior year. The increase in gas plant was attributable to pipeline capacity reinforcement work, franchise requirements, scheduled pipe replacement activities, and new infrastructure, as well as the implementation of a new customer information system placed into production in the second quarter of 2021. Amortization of regulatory account balances impacted expense in both periods, which is offset in Operating margin above.
Taxes other than income taxes increased $13.5 million between periods primarily due to an increase in property taxes in Arizona, and to a lesser extent, in California and Nevada jurisdictions.
Other income decreased $18.3 million between the twelve-month periods of 2022 and 2021, primarily due to current-period income of $4.1 million related to COLI policy cash surrender values and net death benefits recognized, compared to the twelve months ended March 31, 2021 which reflected an exceptionally large increase in values of $27.4 million (including $3.7 million of net death benefits). Additionally, equity AFUDC was lower by $5.6 million, due to the impact short-term borrowings have
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
on AFUDC rates. Offsetting these impacts were non-service cost components of employee pension and other postretirement benefit costs which were $7.8 million lower between periods, and interest income which increased $3.9 million between periods. A gain on sale of non-regulated property in the most recent twelve-month period also impacted the variance between periods.
Net interest deductions increased $3.7 million between periods primarily due to increased interest associated with $300 million of Senior Notes issued in August 2021, and to a lesser extent, $600 million of Senior Notes issued in March 2022.
Income tax expense decreased $9 million between the twelve-month period ended March 31, 2022 and 2021, primarily due to a reduction in pre-tax book income, additional amortization of EADIT ($5 million), and to a lesser extent, changes in Arizona and California state apportionment percentages of $2.8 million. Income tax expense in both periods reflects that COLI results are recognized without tax consequences.
Results of Utility Infrastructure Services
Quarterly Analysis
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
(Thousands of dollars) | | 2022 | | 2021 |
Utility infrastructure services revenues | | $ | 523,877 | | | $ | 363,975 | |
Operating expenses: | | | | |
Utility infrastructure services expenses | | 503,232 | | | 335,614 | |
Depreciation and amortization | | 37,612 | | | 24,744 | |
Operating income (loss) | | (16,967) | | | 3,617 | |
Other income (deductions) | | (486) | | | (102) | |
Net interest deductions | | 11,131 | | | 1,622 | |
Income (loss) before income taxes | | (28,584) | | | 1,893 | |
Income tax expense (benefit) | | (6,170) | | | 1,200 | |
Net income (loss) | | (22,414) | | | 693 | |
Net income attributable to noncontrolling interests | | 1,072 | | | 1,552 | |
Contribution to consolidated results attributable to Centuri | | $ | (23,486) | | | $ | (859) | |
Utility infrastructure services revenues increased $159.9 million, or 44%, in the first quarter of 2022 when compared to the prior-year quarter, including $113.8 million from Riggs Distler. Revenues from electric infrastructure services increased $88 million in the first quarter of 2022 when compared to the prior-year quarter, of which $67.5 million was recorded by Riggs Distler. Included in electric infrastructure services revenues overall was $14 million from emergency restoration services performed by Linetec and Riggs Distler following tornado and other storm damage to customers’ above-ground utility infrastructure in and around the Gulf Coast and eastern regions of the U.S., compared to $9 million in the prior-year quarter. Centuri’s revenues derived from storm-related services vary from period to period due to the unpredictable nature of weather-related events, and when this type of work is performed, it typically generates a higher profit margin than core infrastructure services, due to improved operating efficiencies related to equipment utilization and absorption of fixed costs. The current quarter increase also included approximately $38.8 million in gas infrastructure services revenues, including $13.6 million recorded by Riggs Distler, primarily from increased volumes under master service agreements.
Utility infrastructure services expenses increased $167.6 million in the first quarter of 2022 when compared to the prior-year quarter. The overall increase includes $104.1 million incurred by Riggs Distler, and incremental costs related to the higher volume of infrastructure services provided. Changes in mix of work and inflationary pressures led to higher input costs including fuel and subcontractor expenses, while higher rental and tooling costs were incurred in support of growth in our electric infrastructure business. The incremental impact of fuel costs in the current environment is estimated at $5 million. These impacts are in contrast to the first quarter of 2021, when favorable weather and mix of work provided improved efficiencies and relative favorable results were uncustomary compared to first quarters that typically bring higher losses, given the seasonal nature of the business and winter-weather hampering effects on construction efforts. Also included in total Utility infrastructure services expenses were general and administrative costs, which increased approximately $7.1 million between quarters, including $4 million of general and administrative costs incurred by Riggs Distler. Other administrative costs increased due to the continued growth in the business. Gains on sale of equipment in the first quarter of 2022 and 2021 (reflected as an offset to Utility infrastructure services expenses) were approximately $413,000 and $1.5 million, respectively.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Depreciation and amortization expense increased $12.9 million between quarters, of which $12.3 million was recorded by Riggs Distler. The remaining increase was attributable to equipment and computer systems purchased to support the growing volume of infrastructure work.
The increase in Net interest deductions of $9.5 million was primarily due to incremental interest related to outstanding borrowings under Centuri’s $1.545 billion amended and restated secured revolving credit and term loan facility in conjunction with the acquisition of Riggs Distler.
Results of Utility Infrastructure Services
Twelve-Month Analysis
| | | | | | | | | | | | | | |
| | Twelve Months Ended March 31, |
(Thousands of dollars) | | 2022 | | 2021 |
Utility infrastructure services revenues | | $ | 2,318,563 | | | $ | 1,978,770 | |
Operating expenses: | | | | |
Utility infrastructure services expenses | | 2,123,085 | | | 1,745,729 | |
Depreciation and amortization | | 130,511 | | | 98,548 | |
Operating income | | 64,967 | | | 134,493 | |
Other income (deductions) | | 683 | | | (67) | |
Net interest deductions | | 30,508 | | 7,992 | |
Income before income taxes | | 35,142 | | | 126,434 | |
Income tax expense | | 11,406 | | 34,477 | |
Net income | | 23,736 | | | 91,957 | |
Net income attributable to noncontrolling interests | | 5,943 | | 7,750 | |
Contribution to consolidated net income attributable to Centuri | | $ | 17,793 | | | $ | 84,207 | |
Utility infrastructure services revenues increased $339.8 million, or 17%, in the current twelve-month period compared to the corresponding period of 2021, including $277.7 million recorded by Riggs Distler subsequent to its acquisition on August 27, 2021. Revenues from electric infrastructure services increased $179.7 million in 2022 when compared to the prior year, of which $175.5 million was recorded by Riggs Distler. Included in the incremental electric infrastructure revenues during the twelve-month period of 2022 was $70.5 million from emergency restoration services performed by Linetec and Riggs Distler, following hurricane, tornado, and other storm damage to customers’ above-ground utility infrastructure in and around the Gulf Coast and eastern regions of the U.S., as compared to $90.5 million in similar services during the twelve-month period in 2021. The remaining increase in revenue was attributable to continued growth with existing gas infrastructure customers under master service and bid agreements, partially offset by reduced work with two significant customers during the 2022 twelve-month period (totaling $60.6 million), due to the mix of projects under each customer’s multi-year capital spending programs.
Utility infrastructure services expenses increased $377.4 million, or 22%, between periods (including $14 million of professional fees related to the acquisition of Riggs Distler). The increase overall includes $249 million incurred by Riggs Distler subsequent to the acquisition, as well as incremental costs related to electric infrastructure services work and costs necessary for the completion of additional gas infrastructure work. Higher fuel costs, equipment rental expense, and subcontractor expenses were also incurred in support of growth in our electric infrastructure business. Expenses in relation to revenues, and therefore, profit margins, can be impacted by the mix of work and inefficiencies from equipment and facility utilization and under-absorption of other fixed costs, which occurred due to the reduced work from the two large customers and lower revenues from emergency restoration services as noted above. Also included in total Utility infrastructure services expenses were general and administrative costs, which increased approximately $26.5 million between comparative periods, including the noted $14 million of acquisition-related professional fees and an additional $13.3 million of general and administrative costs incurred by Riggs Distler subsequent to the acquisition. Other administrative costs increased due to the growth in the business. Gains on sale of equipment (reflected as an offset to Utility infrastructure services expenses) were approximately $5.8 million and $3.3 million for the twelve-month periods of 2022 and 2021, respectively.
Depreciation and amortization expense increased $32 million between the current and prior-year twelve-month periods, of which $29.1 million was recorded by Riggs Distler subsequent to the acquisition. The remaining increase was attributable to equipment and computer systems purchased to support the growing volume of infrastructure work.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Net interest deductions increased $22.5 million between periods due to incremental interest related to outstanding borrowings under Centuri’s $1.545 billion amended and restated secured revolving credit and term loan facility in conjunction with the acquisition of Riggs Distler.
Results of Pipeline and Storage
Quarterly Analysis
The first quarter of 2022 was the first reporting period of post-acquisition operating results for the pipeline and storage segment.
| | | | | | | | | | |
| | Three Months Ended March 31, | | |
(Thousands of dollars) | | 2022 | | |
Regulated operations revenues | | $ | 66,993 | | | |
Operating expenses: | | | | |
Net cost of gas sold | | 1,797 | | | |
Operations and maintenance expense | | 24,312 | | | |
Depreciation and amortization | | 12,920 | | | |
Taxes other than income taxes | | 3,164 | | | |
Operating income | | 24,800 | | | |
Other income (deductions) | | 543 | | | |
Net interest deductions | | 4,382 | | | |
Income before income taxes | | 20,961 | | | |
Income tax expense | | 4,031 | | | |
Contribution to consolidated results attributable to MountainWest | | $ | 16,930 | | | |
Current period operating results include rate-regulated transmission and subscription storage revenues of $61.1 million. Operating expenses include $8.7 million of costs associated with integrating MountainWest, including employee retention payments. Additional integration costs will be incurred in future periods until integration efforts are completed.
Rates and Regulatory Proceedings
Southwest is subject to the regulation of the Arizona Corporation Commission (the “ACC”), the Public Utilities Commission of Nevada (the “PUCN”), the California Public Utilities Commission (the “CPUC”), and the Federal Energy Regulatory Commission (the “FERC”). Due to the size of Southwest’s regulated operations and the frequency of rate cases and other procedural activities with its commissions, the following discussion focuses primarily on the proceedings within its natural gas distribution operations.
General Rate Relief and Rate Design
Rates charged to customers vary according to customer class and rate jurisdiction and are set by the individual state and federal regulatory commissions that govern Southwest’s service territories. Southwest makes periodic filings for rate adjustments as the cost of providing service changes (including the cost of natural gas purchased), and as additional investments in new or replacement pipeline and related facilities are made. Rates are intended to provide for recovery of all commission-approved costs and a reasonable return on investment. The mix of fixed and variable components in rates assigned to various customer classes (rate design) can significantly impact the operating margin actually realized by Southwest. Management has worked with its regulatory commissions in designing rate structures that strive to provide affordable and reliable service to its customers while mitigating volatility in prices to customers and stabilizing returns to investors. Such rate structures were in place in all of Southwest’s operating areas during all periods for which results of natural gas distribution operations are disclosed above.
Arizona Jurisdiction
Arizona General Rate Case. In December 2021, Southwest filed a general rate case application proposing a revenue increase of approximately $90.7 million. Although updated rates related to the previous rate case became effective in January 2021, the most significant driver for the new request is the necessity to reflect in rates the substantial capital investments that have been made since the end of the test year in the previous case, including the customer information system implemented in May 2021. The current filing is based on a test year ended August 31, 2021 and proposes a return on common equity of 9.90% relative to a target equity ratio of 51%. Recovery (over three years) of the approximately $12 million related to the outstanding deferral
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
balance associated with the LNG facility (see below) is included in the request, along with the approximately $2.5 million (also over three years) in late payment charges that were suppressed from customer accounts during the COVID-19 pandemic. A request to continue the Delivery Charge Adjustment (“DCA”), Southwest’s full-revenue decoupling mechanism, is also included, while no changes to Southwest’s existing rate design are proposed. A decision is anticipated by the end of 2022, with new rates expected to be effective in the first quarter of 2023.
Delivery Charge Adjustment. The DCA is filed each April, which along with other reporting requirements, contemplates a rate to recover the over- or under-collected margin tracker (decoupling mechanism) amounts based on the balance at the end of the reporting period. An April 2022 filing proposes a rate to return $10.5 million, the over-collected balance existing at the end of the first quarter 2022.
Tax Reform. In the most recently concluded Arizona general rate proceeding, a Tax Expense Adjustor Mechanism (“TEAM”) was approved to timely recognize any future tax rate changes resulting from federal or state tax legislation. In addition, the TEAM tracks and returns/recovers the revenue requirement impact of changes in EADIT amortization compared to the amount authorized in the most recently concluded rate case. In December 2021, Southwest filed its inaugural TEAM rate application for the recovery of approximately $4.3 million associated with the mechanism. The commission staff is expected to issue its report on the filing in the second quarter of 2022 for ACC consideration at a subsequent open meeting.
Liquefied Natural Gas (“LNG”) Facility. In 2014, Southwest sought ACC preapproval to construct, operate, and maintain a 233,000 dekatherm LNG facility in southern Arizona. This facility is intended to enhance service reliability and flexibility related to natural gas deliveries in the southern Arizona area by providing a local storage option, connecting directly to Southwest’s distribution system. Southwest was ultimately granted approval for construction and deferral of costs. The facility was placed in service in December 2019. The capital costs and the operating expenses associated with plant operation were approved and considered as part of Southwest’s previous general rate case. Approximately $12 million in costs, incurred following the in-service date of the facility and after the period considered as part of the previous general rate case, were deferred in the previously authorized regulatory asset account and are included for consideration in the current general rate case application.
Customer-Owned Yard Line (“COYL”) Program. Southwest originally received approval, in connection with its 2010 Arizona general rate case, to implement a program to conduct leak surveys, and if leaks were present, to replace and relocate service lines and meters for Arizona customers whose meters were set off from the customer’s home, representing a non-traditional configuration. A filing in May 2021 proposed the recovery of previously unrecovered surcharge revenue from 2019 and 2020 (collectively, $13.7 million) over a one-year period. In November 2021, the ACC approved full recovery within the proposed timeline, the rate for which was implemented the same month. In a February 2022 filing, Southwest requested to increase its surcharge revenue by $3.4 million to recover the revenue requirement associated with previous investments made since August 2020 and through calendar year 2021, with a proposed rate implementation of June 2022.
Vintage Steel Pipe (“VSP”) Program. Southwest received approval, in connection with its 2016 Arizona general rate case, to implement a VSP replacement program, due to having a substantial amount of pre-1970s vintage steel pipe in Arizona. However, as part of Southwest’s most recent rate case decision in 2020, the ACC ultimately decided to discontinue the accelerated VSP program. A filing in May 2021 proposed the recovery of previously unrecovered surcharge revenue relating to investments during 2019 and 2020, with approximately $60 million to be recovered over a three-year period. In November 2021, the ACC approved full recovery over the proposed three-year timeline, updated rates for which were implemented in March 2022.
Graham County Utilities. In April 2021, Southwest and Graham County Utilities, Inc. (“GCU”) filed a joint application with the ACC for approval to transfer assets of GCU to Southwest and extend Southwest’s Certificate of Public Convenience and Necessity to serve the more than 5,000 associated customers, for a purchase price of $3.5 million. Approval of the application by the ACC was received in December 2021 with final transfer in mid-January 2022. Former GCU customers continue to be served under existing GCU rates until such time as they are rolled into Southwest’s rates, which is proposed to take place in conjunction with the effective date of rates resulting from the currently pending Arizona general rate case.
California Jurisdiction
California General Rate Case. In August 2019, Southwest filed a general rate case based on a 2021 test year, seeking authority to increase rates in its California rate jurisdictions, after being granted earlier permission to extend the rate case cycle by two years and continue its 2.75% previously approved Post-Test Year (“PTY”) attrition adjustments for 2019 and 2020.
Southwest reached an agreement in principle with the Public Advocate’s Office, which was unanimously approved by the CPUC on March 25, 2021, including a $6.4 million total combined revenue increase with a 10% return on common equity, relative to a 52% equity ratio. Approximately $4 million of the original proposed increase was associated with a North Lake
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Tahoe project that would not ultimately be completed by the beginning of 2021; consequently, the parties agreed to provide for recovery of the cost of service impacts of the project through a future surcharge. The rate case decision maintains Southwest’s existing 2.75% annual attrition adjustments and the continuation of the pension balancing account. It also includes cumulative expenditures totaling $119 million over the five-year rate cycle to implement risk-informed proposals, consisting of a school COYL replacement, meter protection, and pipe replacement programs. Although new rates were originally anticipated to be in place by January 1, 2021, in light of an administrative delay, Southwest was granted authority to establish a general rate case memorandum account to track the impacts related to the delay in the implementation of new rates for purposes of later recovery. New rates were ultimately implemented April 1, 2021.
Attrition Filing. Following the 2021 implementation of rates approved as part of the general rate case, Southwest is also authorized to implement annual PTY attrition increases of 2.75%, the first annual adjustment of which began in January 2022.
Customer Data Modernization Initiative (“CDMI”). In April 2019, Southwest filed an application with the CPUC seeking authority to establish a two-way, interest-bearing balancing account to record costs associated with the CDMI to mitigate adverse financial implications associated with this multi-year project (including a new customer information system, ultimately implemented in May 2021). Effective October 2019, the CPUC granted a memorandum account, which allowed Southwest to track costs, including operations and maintenance costs and capital-related costs, such as depreciation, taxes, and return associated with California’s portion of the CDMI (initially estimated at $19 million). The balance tracked in the memorandum account was transferred to the two-way balancing account in July 2020. A rate to begin recovering the balance accumulated through June 30, 2020 was established and made effective September 1, 2020, and updated in January 2021, August 2021, and January 2022. This rate is expected to be updated at least annually.
Carbon Offset Program. In March 2022, Southwest filed an application to seek approval to offer a voluntary program to California customers to purchase carbon offsets in an effort to provide customers additional options to reduce their respective GHG emissions. A request to establish a two-way balancing account to track program-related costs and revenues was included as part of the application. Southwest anticipates a decision in 2023.
Nevada Jurisdiction
Nevada General Rate Case. On August 31, 2021, Southwest filed its most recent general rate case, which was further updated by a certification filing on December 17, 2021. The request proposed a combined revenue increase of approximately $28.7 million (as of certification); the most significant driver for the new request is the necessity to reflect in rates the substantial capital investments that have been made since the end of the test year in the previous case, including the customer information system that was implemented in May 2021. The filing included a proposed return on common equity of 9.90% with a target equity ratio of 51%; recovery over two years of approximately $6.6 million in previously deferred late payment charges related to a regulatory asset associated with COVID-19; and continuation of full revenue decoupling under the General Revenues Adjustment (“GRA”) mechanism. The filing utilized a test year ended May 31, 2021 with certification-period adjustments through November 30, 2021. On February 7, 2022, the parties filed a stipulation with the PUCN, providing for a statewide revenue increase of $14.05 million, a return on common equity of 9.40% relative to a 50% target equity ratio, and continuation of Southwest’s full revenue decoupling mechanism. The stipulation was approved by the commission, and new rates became effective April 1, 2022. The commission’s order did not include recovery of the approximate $6.6 million in previously deferred late payment charges related to a regulatory asset associated with COVID 19 (as noted below).
General Revenues Adjustment. As noted above, the continuation of the GRA was affirmed as part of Southwest’s most recent general rate case with an expansion to include a large customer class (with average monthly throughput requirements greater than 15,000 therms), effective April 2022. Southwest makes Annual Rate Adjustment (“ARA”) filings to update rates to recover or return amounts associated with various regulatory mechanisms, including the GRA. Southwest made its most recent ARA filing in November 2021 related to balances as of September 30, 2021. New rates related to that filing will be effective July 1, 2022. While there is no impact to net income overall from adjustments to recovery rates associated with the related regulatory balances, operating cash flows are impacted by such changes.
COYL Program. In August 2021, Southwest filed a joint petition with the Regulatory Operations Staff of the PUCN proposing a Nevada COYL replacement program to include residential COYLs, public school COYLs, and any other COYLs that are identified to be a safety concern. The petition was approved in January 2022 and provides for capital investments up to $5 million per year for five years and the establishment of a regulatory asset to track the capital-related costs. After five years, the program will be reassessed to determine if it should be continued.
Infrastructure Replacement Mechanism. In 2014, the PUCN approved final rules for the Gas Infrastructure Replacement (“GIR”) mechanism, which provided for the deferral and recovery of certain costs associated with accelerated replacement of qualifying infrastructure that would not otherwise provide incremental revenues between general rate cases. Associated with the replacement of various types of pipe infrastructure under the mechanism (Early Vintage Plastic Pipe, COYL, and VSP), the
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
related regulations provide Southwest with the opportunity to file a GIR “Advance Application” annually to seek preapproval of qualifying replacement projects.
In cases where preapproval of projects is requested and granted, a GIR rate application is separately filed to reset the GIR recovery surcharge rate related to previously approved and completed projects. On September 30, 2021, Southwest filed its latest rate application to reset the recovery surcharge to include cumulative deferrals through August 31, 2021. The updated surcharge rate is expected to result in an annual revenue decrease of approximately $1.4 million in southern Nevada and an annual revenue increase of $66,000 in northern Nevada. The parties reached a stipulation that was approved by the commission and new rates became effective January 1, 2022.
Conservation and Energy Efficiency. The PUCN allows deferral (and later recovery) of approved conservation and energy efficiency costs, recovery rates for which are adjusted in association with ARA filings. In its November 2021 ARA filing, Southwest proposed annualized margin decreases of $574,000 and $434,700 for southern and northern Nevada, respectively, requested to become effective in July 2022. In May 2021, Southwest filed its Conservation and Energy Efficiency plan for the years 2022 – 2024, with a proposed annual budget amount of approximately $3 million. A PUCN decision received in the fourth quarter 2021 authorized the continuation of Southwest’s currently authorized programs and an annual budget of approximately $1.3 million.
Expansion and Economic Development Legislation. In January 2016, final regulations were approved by the PUCN associated with legislation (“SB 151”) previously introduced and signed into law in Nevada. The legislation authorized natural gas utilities to expand their infrastructure to provide service to unserved and underserved areas in Nevada.
In November 2017, Southwest filed for preapproval of a project to extend service to Mesquite, Nevada, in accordance with the SB 151 regulations. Ultimately, the PUCN issued an order approving Southwest’s proposal for the expansion, and Southwest provides periodic updates and adjusts the rates to recover the revenue requirement associated with the investments to serve customers as part of the ARA filings and rate case proceedings. As of March 2022, approximately 40 miles of natural gas infrastructure has been installed throughout the Mesquite expansion area.
In June 2019, Southwest filed for preapproval to construct the infrastructure necessary to expand natural gas service to Spring Creek, near Elko, Nevada, and to implement a cost recovery methodology to recover the associated revenue requirement consistent with the SB 151 regulations. The expansion facilities consist of a high-pressure approach main and associated regulator stations, an interior backbone, and an extension of the distribution system from the interior backbone. The total capital investment was estimated to be $61.9 million. A stipulation was reached with the parties and approved by the PUCN in December 2019, including in regard to the rate recovery allocation amongst northern Nevada, Elko, and Spring Creek expansion customers. Construction began in the third quarter of 2020, and service commenced to the first Spring Creek customers in December 2020. As of March 31, 2022, approximately 28 miles of natural gas infrastructure has been installed throughout the Spring Creek expansion area, and is anticipated to be completed in 2026.
Regulatory Asset Related to COVID-19. The PUCN issued an order directing utilities within the state to establish regulatory asset accounts, effective March 12, 2020, the date the Governor declared a state of emergency related to COVID-19, to track the financial impacts associated with maintaining service for customers affected by COVID-19, including those whose service would have been otherwise terminated/disconnected. These amounts, totaling approximately $6.6 million, were included in Southwest’s recently concluded general rate case request. The commission ultimately decided that the deferred late payment charges that made up the $6.6 million did not qualify as costs of maintaining service and denied recovery. However, this amount was previously fully reserved by management pending the outcome of the ultimate proceeding.
Carbon Offset Program. In June 2021, Southwest filed an application to seek approval to offer a voluntary program to northern and southern Nevada customers to purchase carbon offsets in an effort to provide customers additional options to reduce their respective GHG emissions. A request to establish a regulatory asset to track program-related costs and revenues was included as part of the application. The parties reached a stipulation that was approved by the commission in December 2021 approving Southwest’s proposal. Implementation of the program is expected in the second quarter of 2022.
FERC Jurisdiction
General Rate Case. In 2020, Great Basin Gas Transmission Company (“Great Basin”), a wholly owned subsidiary of Southwest, reached an agreement in principle with the FERC Staff providing that its three largest transportation customers and all storage customers would be required to have primary service agreement terms of at least five years, that term-differentiated rates would continue generally, and included a 9.90% pre-tax rate of return. Interim rates were made effective February 2020. As part of the settlement, Great Basin will not file a rate case later than May 31, 2025.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
PGA Filings
The rate schedules in all of Southwest’s service territories contain provisions that permit adjustment to rates as the cost of purchased gas changes. These deferred energy provisions and purchased gas adjustment clauses are collectively referred to as “PGA” clauses. Differences between gas costs recovered from customers and amounts paid for gas by Southwest result in over- or under-collections. Balances are recovered from or refunded to customers on an ongoing basis with interest. As of March 31, 2022, under-collections in each of Southwest’s service territories resulted in an asset of $368 million on the Company’s and Southwest’s Condensed Consolidated Balance Sheets. The increase in the PGA balance during the first quarter of 2022 includes nearly $400 million in commodity and transmission costs incurred during this period. See also Deferred Purchased Gas Costs in Note 1 – Background, Organization, and Summary of Significant Accounting Policies in this quarterly report on Form 10-Q.
Filings to change rates in accordance with PGA clauses are subject to audit by state regulatory commission staffs. PGA changes impact cash flows but have no direct impact on operating margin. However, gas cost deferrals and recoveries can impact comparisons between periods of individual consolidated income statement components. These include Regulated operations revenues, Net cost of gas sold, Net interest deductions, and Other income (deductions).
The following table presents Southwest’s outstanding PGA balances receivable/(payable):
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(Thousands of dollars) | | March 31, 2022 | | December 31, 2021 | | March 31, 2021 |
Arizona | | $ | 255,472 | | | $ | 214,387 | | | $ | 194,446 | |
Northern Nevada | | 13,700 | | | 12,632 | | | 3,036 | |
Southern Nevada | | 93,153 | | | 55,967 | | | 31,849 | |
California | | 5,629 | | | 8,159 | | | 9,555 | |
| | $ | 367,954 | | | $ | 291,145 | | | $ | 238,886 | |
Not included in the PGA balances table above are $297,000 at March 31, 2022 and $5.7 million at December 31, 2021 in deferred purchased gas cost liabilities for MountainWest.
Capital Resources and Liquidity
Historically, cash on hand and cash flows from operations have provided a substantial portion of cash used in investing activities (primarily for construction expenditures and property additions). In recent years, Southwest has undertaken significant pipe replacement activities to fortify system integrity and reliability, including on an accelerated basis in association with certain gas infrastructure replacement programs. This activity has necessitated the issuance of both debt and equity securities to supplement cash flows from operations. The Company, in executing on its plans to fund the MountainWest acquisition, initially funded the transaction through short-term borrowings, which would be refinanced through a multi-pronged permanent financing plan by the second quarter of 2022, some of which was executed during the first quarter of 2022 as the Company used $452 million in net proceeds from its underwritten offering of common stock to repay a portion of such short-term borrowings. In the interim, its working capital resources are necessarily low compared to its short-term obligations, which will be alleviated once management completes its execution on the remainder of its plan. The Company’s capitalization strategy is to maintain an appropriate balance of equity and debt to preserve investment-grade credit ratings, which help minimize interest costs. Investment-grade credit ratings have been maintained following the acquisition.
The Company’s Cash and cash equivalents as of March 31, 2022 and December 31, 2021 were $625 million and $223 million, respectively. The increase in Cash and cash equivalents between periods is largely attributable to Southwest’s net proceeds received from the $600 million 4.05% Senior Notes issuance in March 2022, which were partially used in March 2022 to pay down amounts then outstanding on the credit facility, and in April 2022, to redeem the $250 million 3.875% Senior Notes then maturing, in addition to funding interest payments on various debt ($23 million), with the remaining cash available for general corporate purposes. Additionally, the Company received a $34 million dividend from MountainWest in March 2022, which was partially used in April 2022 to pay a post-closing payment adjustment to the sellers in connection with the MountainWest acquisition (see Note 8 - Business Acquisitions).
Cash Flows
Southwest Gas Holdings, Inc.:
Operating Cash Flows. Cash flows from consolidated operating activities increased $239 million in the first three months of 2022 as compared to the same period of 2021. The improvement in cash flows primarily resulted from the change in purchased gas costs, including amounts incurred and deferred, as well as when amounts are incorporated in customer bills to recover or return deferred balances. The prior period included a $50 million incremental contribution to the noncontributory qualified
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
retirement plan (reflected as a change in other liabilities and deferred credits). Other impacts include benefits from depreciation and changes in components of working capital overall, including collections of accounts receivable balances in the utility infrastructure services segment.
The corporate and administrative expenses/outflows for Southwest Gas Holdings, Inc. in the three- and twelve-month periods ended March 31, 2022 include expenses incurred related to shareholder activism, in addition to expenses and financing costs for the MountainWest acquisition, as well as expenses for services performed following December 31, 2021, but related to the acquisition.
Investing Cash Flows. Cash used in consolidated investing activities increased $9 million in the first three months of 2022 as compared to the same period of 2021. The change was primarily due to an increase in capital expenditures in the natural gas distribution segment.
Financing Cash Flows. Net cash provided by consolidated financing activities increased $163 million in the first three months of 2022 as compared to the same period of 2021. The change was primarily due to Southwest’s issuance of $600 million in notes, in addition to the Company’s $452 million in net proceeds from the issuance of common stock in an underwritten public offering in the current period. Part of the proceeds of Southwest’s notes issuance was used to pay down the amounts then outstanding under the long-term portion of its credit facility. The Company used the net proceeds from the common stock issuance to repay a portion of its 364-day Term Loan Facility that was funded in December 2021. In February 2022, Southwest also redeemed $25 million 7.78% series Medium-term notes then maturing. By comparison, the prior period included $203 million net proceeds from the short-term portion of Southwest’s credit facility and the Company’s credit facility, all of which is considered short-term.
The capital requirements and resources of the Company generally are determined independently for the individual business segments. Each business segment is generally responsible for securing its own financing sources. However, the holding company may raise funds through stock issuances or other external financing sources in support of each business segment.
Southwest Gas Corporation:
Operating Cash Flows. Cash flows provided by operating activities increased $260 million in the first three months of 2022 as compared to the same period of 2021. The improvement in operating cash flows was primarily attributable to the impacts related to deferred purchased gas costs, as well as to other working capital changes.
Investing Cash Flows. Cash used in investing activities increased $10 million in the first three months of 2022 as compared to the same period of 2021. The change was primarily due to increases in capital expenditures in 2022 as compared to the same period in the prior year. See also Gas Segment Construction Expenditures and Financing below.
Financing Cash Flows. Net cash provided by financing activities increased $179 million in the first three months of 2022 as compared to the same period of 2021. The increase was primarily due to Southwest’s issuance of $600 million in notes in the first quarter of 2022 that was not used until April 2022 to redeem $250 million in maturing notes, but was used to repay the then outstanding amounts on its credit facility. Offsetting this increase was the redemption of $25 million 7.78% series Medium-term notes that matured in February 2022, parent contributions received in the first quarter of 2021 that did not recur in 2022, and proceeds in the prior year from a $250 million Term Loan issued to fund increased gas purchased costs during the 2021 freeze. See Note 5 – Debt.
Gas Segment Construction Expenditures, Debt Maturities, and Financing
During the twelve-month period ended March 31, 2022, construction expenditures for the natural gas distribution segment were $615 million (not including amounts incurred for capital expenditures but not yet paid). The majority of these expenditures represented costs associated with the replacement of existing transmission, distribution, and general plant to fortify system integrity and reliability.
Management estimates natural gas segment construction expenditures during the five-year period ending December 31, 2026 will be approximately $2.5 to $3.5 billion. Of this amount, approximately $650 million to $700 million is scheduled to be incurred in 2022. Southwest plans to continue to request regulatory support to undertake projects, or to accelerate projects as necessary, for the improvement of system flexibility and reliability, or to expand, where relevant, to unserved or underserved areas. Southwest may expand existing, or initiate new, programs. Significant replacement activities are expected to continue well beyond the next few years. See also Rates and Regulatory Proceedings. During the three-year period, cash flows from operating activities of Southwest are expected to provide approximately 69% of the funding for gas operations of Southwest and total construction expenditures and dividend requirements. As of March 31, 2022, Southwest had $250 million, 3.875% notes maturing (repaid in April 2022), and a $250 million Term Loan due in March 2023. Any additional cash requirements, including construction-related, and pay down or refinancing of debt, are expected to be provided by existing credit facilities,
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
equity contributions from the Company, and/or other external financing sources. The timing, types, and amounts of additional external financings will be dependent on a number of factors, including the cost of gas purchases, conditions in the capital markets, timing and amounts of rate relief, timing and amounts of surcharge collections from, or amounts returned to, customers related to other regulatory mechanisms and programs, as well as growth levels in Southwest’s service areas and earnings. External financings may include the issuance of debt securities, bank and other short-term borrowings, and other forms of financing.
Bonus Depreciation
In 2017, with the enactment of U.S. tax reform, the bonus depreciation deduction percentage changed from 50% to 100% for “qualified property” placed in service after September 27, 2017 and before 2023. The bonus depreciation tax deduction phases out starting in 2023, by 20% for each of the five following years. Qualified property excludes public regulated operations property. The Company estimates bonus depreciation will defer the payment of approximately $27 million (which relates to utility infrastructure services operations) of federal income taxes for 2022.
Dividend Policy
Dividends are payable on the Company’s common stock at the discretion of the Board. In setting the dividend rate, the Board currently targets a payout ratio of 55% to 65% of consolidated earnings per share and considers, among other factors, current and expected future earnings levels, our ongoing capital expenditure plans, expected external funding needs, and our ability to maintain strong investment-grade credit ratings and liquidity. The Company has paid dividends on its common stock since 1956 and has increased that dividend each year since 2007. In February 2022, the Board elected to increase the quarterly dividend from $0.595 to $0.62 per share, representing a 4.2% increase, effective with the June 2022 payment.
Liquidity
Liquidity refers to the ability of an enterprise to generate sufficient amounts of cash through its operating activities and external financing to meet its cash requirements. Several factors (some of which are out of the control of the Company) that could significantly affect liquidity in the future include: variability of natural gas prices, changes in ratemaking policies of regulatory commissions, regulatory lag, customer growth in the natural gas distribution segment, the ability to access and obtain capital from external sources, interest rates, changes in income tax laws, pension funding requirements, inflation, and the level of earnings. Natural gas prices and related gas cost recovery rates, as well as plant investment, have historically had the most significant impact on liquidity.
On an interim basis, Southwest defers over- or under-collections of gas costs to PGA balancing accounts. In addition, Southwest uses this mechanism to either refund amounts over-collected or recoup amounts under-collected as compared to the price paid for natural gas during the period since the last PGA rate change went into effect. At March 31, 2022, the combined balance in the PGA accounts totaled an under-collection of $368 million. See PGA Filings for more information.
In March 2022, Southwest amended its $250 million Term Loan, extending the maturity date to March 21, 2023. The proceeds were originally used to fund the increased cost of natural gas supply during the month of February 2021 caused by extreme weather conditions in the central U.S. The Term Loan was extended as a result of the current gas cost environment and management’s funding plans for purchases.
In March 2022, Southwest issued $600 million aggregate principal amount of 4.05% Senior Notes at a discount of 0.65%. The notes will mature in March 2032. Southwest used the net proceeds to redeem $250 million 3.875% notes due in April 2022 and to repay outstanding amounts under its credit facility, with the remaining net proceeds used for general corporate purposes.
Southwest has a credit facility, with a borrowing capacity of $400 million, which expires in April 2025. Southwest designates $150 million of the facility for long-term borrowing needs and the remaining $250 million for working capital purposes. The maximum amount outstanding on the long-term portion of the credit facility (including a commercial paper program) during the first three months of 2022 was $150 million. The maximum amount outstanding on the short-term portion of the credit facility during the first three months of 2022 was $85 million. As of March 31, 2022, no borrowings were outstanding on the short-term or long-term portions of this credit facility. The credit facility can be used as necessary to meet liquidity requirements, including temporarily financing under-collected PGA balances, or meeting the refund needs of over-collected balances. The credit facility has been adequate for Southwest’s working capital needs outside of funds raised through operations and other types of external financing. As indicated, any additional cash requirements would include the existing credit facility, equity contributions from the Company, and/or other external financing sources.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Southwest has a $50 million commercial paper program. Any issuance under the commercial paper program is supported by Southwest’s current revolving credit facility and, therefore, does not represent additional borrowing capacity. Any borrowing under the commercial paper program during 2022 will be designated as long-term debt. Interest rates for the commercial paper program are calculated at the current commercial paper rate during the borrowing term. At March 31, 2022, there were no borrowings outstanding under this program.
Centuri has a senior secured revolving credit and term loan facility. The line of credit portion comprises $400 million; associated amounts borrowed and repaid are available to be re-borrowed. The term loan facility portion provided approximately $1.145 billion. The term loan facility expires on August 27, 2028 and the revolving credit facility expires on August 27, 2026. This multi-currency facility allows the borrower to request loan advances in either Canadian dollars or U.S. dollars. The obligations under the credit agreement are secured by present and future ownership interests in substantially all direct and indirect subsidiaries of Centuri, substantially all of the tangible and intangible personal property of each borrower, certain of their direct and indirect subsidiaries, and all products, profits, and proceeds of the foregoing. Centuri assets securing the facility at March 31, 2022 totaled $2.4 billion. The maximum amount outstanding on the combined facility during the first three months of 2022 was $1.2 billion. As of March 31, 2022, $108 million was outstanding on the revolving credit facility, in addition to $1.01 billion that was outstanding on the term loan portion of the facility. Also at March 31, 2022, there was approximately $239 million, net of letters of credit, available for borrowing under the line of credit.
Southwest Gas Holdings, Inc. has a credit facility with a borrowing capacity of $200 million that expires in December 2026. This facility is intended for short-term financing needs. At March 31, 2022, $69 million was outstanding under this facility.
In November 2021, the Company entered into a $1.6 billion delayed-draw Term Loan Facility that was funded on December 31, 2021 in connection with the acquisition of MountainWest. This term loan matures on December 30, 2022. There was $1.16 billion outstanding under this Term Loan Facility as of March 31, 2022, included in the total of $1.474 billion of total short-term debt and current maturities of $291 million. This contributed to a negative working capital position of $584 million as of March 31, 2022, and the Company does currently not have sufficient liquidity or capital resources to repay this debt at maturity without issuing new debt or equity. In April 2022, the Company used a portion of proceeds from the issuance of $600 million Senior Notes issued in March 2022 to redeem $250 million in Senior Notes then maturing and included in current maturities as of March 31, 2022. In March 2022, the Company used net proceeds from the issuance of a common stock offering (see below) to repay a portion of borrowings under the Term Loan Facility. Management intends to satisfy the remainder of this obligation through the issuance of long-term debt. However, management maintains the discretion to seek alternative sources, and can provide no assurances as to its ability to refinance this obligation with the intended method or on attractive terms.
In March 2022, the Company sold, through a prospectus supplement under its Universal Shelf program, an aggregate of 6,325,000 shares of common stock, with an underwritten public offering price of $74.00 per share, resulting in proceeds to the Company of $452.2 million, net of the underwriters’ discount of $15.8 million. The Company used the net proceeds to repay a portion of the outstanding borrowings under the 364-day term loan credit agreement that was used to initially fund the MountainWest acquisition.
In April 2021, the Company entered into a Sales Agency Agreement between the Company and BNY Mellon Capital Markets, LLC and J.P. Morgan Securities LLC (the “Equity Shelf Program”) for the offer and sale of up to $500 million of common stock from time to time in at-the-market offerings under the related prospectus supplement filed with the Securities and Exchange Commission (the “SEC”) the same month. There was no activity under this multi-year program during the first quarter of 2022. Net proceeds from the sales of shares of common stock under the Equity Shelf Program are intended for general corporate purposes, including the acquisition of property for the construction, completion, extension, or improvement of pipeline systems and facilities located in and around the communities served by Southwest, as well as for repayment or repurchase of indebtedness (including amounts outstanding from time to time under the credit facilities, senior notes, Term Loan or future credit facilities), and to provide for working capital. The Company had approximately $341.8 million available under the program as of March 31, 2022.
During the twelve months ended March 31, 2022, 2,302,407 shares were issued in at-the-market offerings under the foregoing program at an average price of $68.70 per share with gross proceeds of $158.2 million, agent commissions of $1.6 million, and net proceeds of $156.6 million under the equity shelf program noted above. See Note 4 – Common Stock for more information.
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
Interest rates for the Company’s Term Loan Facility and Centuri’s credit facility contain LIBOR-based rates. Certain LIBOR-based rates are scheduled to be discontinued as a benchmark or reference rate after 2021, while other LIBOR-based rates are scheduled to be discontinued after June 2023. As of March 31, 2022, the Company had $2.17 billion billion in aggregate outstanding borrowings under Centuri’s credit facility and the Company’s Term Loan Facility. In order to mitigate the impact of a LIBOR discontinuance on the Company’s financial condition and results of operations, management will monitor developments and work with lenders, where relevant, to determine the appropriate replacement/alternative reference rate for variable rate debt. At this time the Company can provide no assurances as to the impact a LIBOR discontinuance will have on its financial condition or results of operations. Any alternative rate may be less predictable or less attractive than LIBOR.
Forward-Looking Statements
This quarterly report contains statements which constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“Reform Act”). All statements other than statements of historical fact included or incorporated by reference in this quarterly report are forward-looking statements, including, without limitation, statements regarding the Company’s plans, objectives, goals, intentions, projections, strategies, future events or performance, negotiations, and underlying assumptions. The words “may,” “if,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “continue,” “forecast,” “intend,” “endeavor,” “promote,” “seek,” and similar words and expressions are generally used and intended to identify forward-looking statements. For example, statements regarding plans to review a full range of strategic alternatives to maximize stockholder value, refinance near-term maturities, to separate Centuri from the Company, those regarding operating margin patterns, customer growth, the composition of our customer base, price volatility, seasonal patterns, payment of debt, the Company’s COLI strategy, replacement market and new construction market, our intent and ability to complete planned acquisitions and at amounts originally set out, impacts from the COVID-19 pandemic, including on our employees, customers, or otherwise, our financial position, revenue, earnings, cash flows, debt covenants, operations, regulatory recovery, work deployment or resumption and related uncertainties stemming from this pandemic or otherwise, expected impacts of valuation adjustments associated with any redeemable noncontrolling interest, the profitability of storm work, mix of work, or absorption of fixed costs by larger infrastructure services customers including Southwest, the impacts of U.S. tax reform including disposition in any regulatory proceeding and bonus depreciation tax deductions, the impact of recent Pipeline and Hazardous Materials Safety Administration rulemaking, the amounts and timing for completion of estimated future construction expenditures, plans to pursue infrastructure programs or programs under SB 151 legislation, forecasted operating cash flows and results of operations, net earnings impacts or recovery of costs from gas infrastructure replacement and COYL programs and surcharges, funding sources of cash requirements, amounts generally expected to be reflected in future period revenues from regulatory rate proceedings including amounts requested or settled from recent and ongoing general rate cases or other regulatory proceedings, rates and surcharges, PGA administration and recovery, and other rate adjustments, sufficiency of working capital and current credit facilities, bank lending practices, the Company’s views regarding its liquidity position, ability to raise funds and receive external financing capacity and the intent and ability to issue various financing instruments and stock under the existing at-the-market equity program or otherwise, future dividend increases and the Board’s current target dividend payout ratio, pension and postretirement benefits, certain impacts of tax acts, the effect of any other rate changes or regulatory proceedings, contract or construction change order negotiations, impacts of accounting standard updates, statements regarding future gas prices, gas purchase contracts and pipeline imbalance charges or claims related thereto, recoverability of regulatory assets, the impact of certain legal proceedings or claims, and the timing and results of future rate hearings, including any ongoing or future general rate cases and other proceedings, and the final resolution for recovery of the CDMI-related amounts and balances in any jurisdiction, and statements regarding pending approvals are forward-looking statements. All forward-looking statements are intended to be subject to the safe harbor protection provided by the Reform Act.
A number of important factors affecting the business and financial results of the Company could cause actual results to differ materially from those stated in the forward-looking statements. These factors include, but are not limited to, customer growth rates, conditions in the housing market, the impacts of COVID-19 including that which may result from a continued or sustained restriction by government officials or otherwise, including impacts on employment in our territories, the health impacts to our customers and employees due to the persistence of the virus or virus variants or efficacy of vaccines, the ability to collect on customer accounts due to the suspension or lifted moratorium on late fees or service disconnection in any or all jurisdictions, the ability to obtain regulatory recovery of all costs and financial impacts resulting from this pandemic, the ability of the infrastructure services business to resume or continue work with all customers and the impact of a delay or termination of work as a result thereof, the impacts of future restrictions placed on our business by government regulation or otherwise (such as self-imposed restrictions for the safety of employees and customers), including related to personal distancing, investment in personal protective equipment and other protocols, the impact of a resurgence of the virus or its variants, and decisions of Centuri customers (including Southwest) as to whether to pursue capital projects due to economic impacts resulting from the pandemic or otherwise, the ability to recover and timing thereof related to costs associated with the PGA mechanisms or other
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SOUTHWEST GAS HOLDINGS, INC. | | Form 10-Q |
SOUTHWEST GAS CORPORATION | | March 31, 2022 |
regulatory assets or programs, the effects of regulation/deregulation, governmental or regulatory policy regarding pipeline safety, greenhouse gas emissions, natural gas or alternative energy, the regulatory support for ongoing infrastructure programs or expansions, the timing and amount of rate relief, the timing and methods determined by regulators to refund amounts to customers resulting from U.S. tax reform, changes in rate design, variability in volume of gas or transportation service sold to customers, changes in gas procurement practices, changes in capital requirements and funding, the impact of credit rating actions and conditions in the capital markets on financing costs, the impact of variable rate indebtedness with or without a discontinuance of LIBOR including in relation to amounts of indebtedness then outstanding, changes in construction expenditures and financing, levels of or changes in operations and maintenance expenses, or other costs, including fuel costs and other costs impacted by inflation or otherwise, geopolitical influences on the business or its costs, effects of pension or other postretirement benefit expense forecasts or plan modifications, accounting changes and regulatory treatment related thereto, currently unresolved and future liability claims and disputes, changes in pipeline capacity for the transportation of gas and related costs, results of Centuri bid work, the impact of weather on Centuri’s operations, projections about acquired business’ earnings or those planned (including accretion within the first twelve months or other periods) and future acquisition-related costs, the timing and magnitude of costs necessary to integrate and stand up newly acquired operations, administration, and systems, and the ability to complete stand-up for MountainWest prior to the expiration of the transition services agreement, the ability to attract, hire, and maintain necessary staff and management for our collective operations, impacts of changes in value of any redeemable noncontrolling interest if at other than fair value, Centuri utility infrastructure expenses, differences between actual and originally expected outcomes of Centuri bid or other fixed-price construction agreements, outcomes from contract and change order negotiations, ability to successfully procure new work and impacts from work awarded or failing to be awarded from significant customers (collectively, including from Southwest), the mix of work awarded, the amount of work awarded to Centuri following the lifting of work stoppages or reduction, the result of productivity inefficiencies from regulatory requirements or otherwise, delays in commissioning individual projects, acquisitions and management’s plans related thereto, the ability of management to successfully finance, close, and assimilate acquired businesses, the impact on our stock price or our credit ratings due to undertaking or failing to undertake acquisition activity or other strategic endeavors, the impact on our stock price, costs, or businesses from the stock rights program, actions or disruptions of significant shareholders and costs related thereto, competition, our ability to raise capital in external financings, our ability to continue to remain within the ratios and other limits subject to our debt covenants, and ongoing evaluations in regard to goodwill and other intangible assets. In addition, the Company can provide no assurance that its discussions regarding certain trends or plans relating to its financing and operating expenses will continue, proceed as planned, or cease to continue in future periods. For additional information on the risks associated with the Company’s business, see Item 1A. Risk Factors and Item 7A. Quantitative and Qualitative Disclosures About Market Risk in the Annual Report on Form 10-K for the year ended December 31, 2021.
All forward-looking statements in this quarterly report are made as of the date hereof, based on information available to the Company and Southwest as of the date hereof, and the Company and Southwest assume no obligation to update or revise any of its forward-looking statements, even if experience or future changes show that the indicated results or events will not be realized. We caution you not to unduly rely on any forward-looking statement(s).