UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2005

 

 

Commission File Number 1-7850

 

 

SOUTHWEST GAS CORPORATION

 

(Exact name of registrant as specified in its charter)

 

 

 

 

California

88-0085720

 

 

(State or other jurisdiction of

(I.R.S. Employer

 

incorporation or organization)

Identification No.)

 

 

5241 Spring Mountain Road

 

 

Post Office Box 98510

 

 

Las Vegas, Nevada

89193-8510

(Address of principal executive offices)

(Zip Code)

 

 

 

Registrant’s telephone number, including area code: (702) 876-7237

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  X 

No      

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  X 

No      

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes      

 No  X 

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Common Stock, $1 Par Value, 39,124,126 shares as of November 1, 2005.

 

 

 

 


 

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except par value)
(Unaudited)

SEPTEMBER 30,
2005

DECEMBER 31,
2004

                                      ASSETS            
Utility plant:    
    Gas plant   $ 3,451,372   $ 3,287,591  
    Less: accumulated depreciation    (1,073,660 )  (985,919 )
    Acquisition adjustments, net    2,218    2,353  
    Construction work in progress    52,146    31,967  


        Net utility plant    2,432,076    2,335,992  


Other property and investments    113,274    99,879  


Current assets:  
    Cash and cash equivalents    16,932    13,641  
    Accounts receivable, net of allowances    107,431    176,090  
    Accrued utility revenue    31,500    68,200  
    Deferred purchased gas costs    60,480    82,076  
    Prepaids and other current assets    81,687    91,986  


        Total current assets    298,030    431,993  


Deferred charges and other assets    78,173    70,252  


Total assets   $ 2,921,553   $ 2,938,116  


                          CAPITALIZATION AND LIABILITIES  
Capitalization:  
    Common stock, $1 par (authorized - 45,000,000 shares; issued  
        and outstanding - 39,027,923 and 36,794,343 shares)   $ 40,658   $ 38,424  
    Additional paid-in capital    620,231    566,646  
    Accumulated other comprehensive income (loss), net    (10,892 )  (10,892 )
    Retained earnings    101,412    111,498  


        Total equity    751,409    705,676  
    Subordinated debentures due to Southwest Gas Capital II    100,000    100,000  
    Long-term debt, less current maturities    1,149,190    1,162,936  


        Total capitalization    2,000,599    1,968,612  


Current liabilities:  
    Current maturities of long-term debt    81,031    29,821  
    Short-term debt    29,000    100,000  
    Accounts payable    97,571    165,872  
    Customer deposits    55,717    50,194  
    Accrued general taxes    43,023    38,189  
    Accrued interest    18,942    22,425  
    Deferred income taxes    11,285    26,676  
    Other current liabilities    53,739    49,854  


        Total current liabilities    390,308    483,031  


Deferred income taxes and other credits:  
    Deferred income taxes and investment tax credits    288,514    281,743  
    Taxes payable    14,503    3,965  
    Accumulated removal costs    99,000    84,000  
    Other deferred credits    128,629    116,765  


        Total deferred income taxes and other credits    530,646    486,473  


Total capitalization and liabilities   $ 2,921,553   $ 2,938,116  


The accompanying notes are an integral part of these statements.

 

2

 

                                                                                                        

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)

THREE MONTHS ENDED
SEPTEMBER 30,

NINE MONTHS ENDED
SEPTEMBER 30,

TWELVE MONTHS ENDED
SEPTEMBER 30,

2005
2004
2005
2004
2005
2004
Operating revenues:                            
    Gas operating revenues   $ 239,318   $ 206,459   $ 1,032,349   $ 866,999   $ 1,427,402   $ 1,168,160  
    Construction revenues    73,960    58,008    184,939    149,565    250,382    200,109  






        Total operating revenues    313,278    264,467    1,217,288    1,016,564    1,677,784    1,368,269  






Operating expenses:  
    Net cost of gas sold    128,745    102,978    599,697    450,690    794,773    574,285  
    Operations and maintenance    77,445    74,289    226,678    214,957    302,521    285,317  
    Depreciation and amortization    39,387    36,725    116,449    108,867    153,600    144,123  
    Taxes other than income taxes    9,888    9,528    30,277    29,026    38,920    37,406  
    Construction expenses    63,272    49,964    161,862    130,285    218,617    175,112  






        Total operating expenses    318,737    273,484    1,134,963    933,825    1,508,431    1,216,243  






Operating income (loss)    (5,459 )  (9,017 )  82,325    82,739    169,353    152,026  






Other income and (expenses):  
    Net interest deductions    (20,602 )  (20,079 )  (60,880 )  (57,622 )  (82,040 )  (76,019 )
    Net interest deductions on subordinated debentures    (1,931 )  (1,930 )  (5,792 )  (5,791 )  (7,725 )  (7,721 )
    Other income (deductions)    1,038    2,076    4,694    3,252    5,193    4,922  






        Total other income and (expenses)    (21,495 )  (19,933 )  (61,978 )  (60,161 )  (84,572 )  (78,818 )






Income (loss) before income taxes    (26,954 )  (28,950 )  20,347    22,578    84,781    73,208  
Income tax expense (benefit)    (10,510 )  (12,597 )  6,779    6,249    30,767    22,405  






Net income (loss)   $ (16,444 ) $ (16,353 ) $ 13,568   $ 16,329   $ 54,014   $ 50,803  






Basic earnings (loss) per share   $ (0.43 ) $ (0.46 ) $ 0.36   $ 0.47   $ 1.44   $ 1.47  






Diluted earnings (loss) per share   $ (0.43 ) $ (0.46 ) $ 0.36   $ 0.47   $ 1.43   $ 1.45  






Dividends paid per share   $ 0.205   $ 0.205   $ 0.615   $ 0.615   $ 0.82   $ 0.82  






Average number of common shares outstanding    38,528    35,412    37,780    34,857    37,392    34,661  
Average shares outstanding (assuming dilution)    --    --    38,101    35,116    37,722    34,942  

The accompanying notes are an integral part of these statements.

 

3

 

                                                                                                

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)

NINE MONTHS ENDED
SEPTEMBER 30,

TWELVE MONTHS ENDED
SEPTEMBER 30,

2005
2004
2005
2004
CASH FLOW FROM OPERATING ACTIVITIES:                    
     Net income   $ 13,568   $ 16,329   $ 54,014   $ 50,803  
     Adjustments to reconcile net income to net  
       cash provided by operating activities:  
         Depreciation and amortization    116,449    108,867    153,600    144,123  
         Deferred income taxes    (8,620 )  8,263    21,118    36,102  
         Changes in current assets and liabilities:  
           Accounts receivable, net of allowances    70,434    39,477    (18,350 )  (14,052 )
           Accrued utility revenue    37,882    37,000    (618 )  (1,700 )
           Deferred purchased gas costs    23,070    (45,273 )  (4,582 )  (76,966 )
           Accounts payable    (69,884 )  (42,734 )  28,608    13,044  
           Accrued taxes    15,165    3,074    15,118    13,670  
           Other current assets and liabilities    15,533    (3,749 )  (6,124 )  (2,142 )
         Other    (4,609 )  (4,880 )  1,321    (6,154 )




         Net cash provided by operating activities    208,988    116,374    244,105    156,728  




CASH FLOW FROM INVESTING ACTIVITIES:  
     Construction expenditures and property additions    (200,260 )  (195,360 )  (307,588 )  (272,132 )
     Other    (3,185 )  3,336    (415 )  (18,564 )




         Net cash used in investing activities    (203,445 )  (192,024 )  (308,003 )  (290,696 )




CASH FLOW FROM FINANCING ACTIVITIES:  
     Issuance of common stock, net    55,819    36,633    77,873    44,248  
     Dividends paid    (23,196 )  (21,420 )  (30,612 )  (28,407 )
     Issuance of subordinated debentures, net    --    --    --    (81 )
     Issuance of long-term debt, net    65,803    72,759    140,179    71,548  
     Retirement of long-term debt, net    (29,678 )  (5,326 )  (107,789 )  (7,763 )
     Temporary changes in long-term debt    --    --    --    19,814  
     Change in short-term debt    (71,000 )  (14,000 )  (9,000 )  38,000  




         Net cash provided by (used in) financing activities    (2,252 )  68,646    70,651    137,359  




     Change in cash and cash equivalents    3,291    (7,004 )  6,753    3,391  
     Cash at beginning of period    13,641    17,183    10,179    6,788  




     Cash at end of period   $ 16,932   $ 10,179   $ 16,932   $ 10,179  




     Supplemental information:  
     Interest paid, net of amounts capitalized   $ 67,340   $ 60,497   $ 87,276   $ 79,598  
     Income taxes paid (received), net    3,491    179    (9,328 )  (25,598 )

The accompanying notes are an integral part of these statements.

 

 

4

 

                                                                                                

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Note 1 - Summary of Significant Accounting Policies

 

Nature of Operations. Southwest Gas Corporation (the "Company") is composed of two segments: natural gas operations ("Southwest" or the "natural gas operations" segment) and construction services. Southwest purchases, transports, and distributes natural gas to customers in portions of Arizona, Nevada, and California. The public utility rates, practices, facilities, and service territories of Southwest are subject to regulatory oversight. The timing and amount of rate relief can materially impact results of operations. Natural gas sales are seasonal, peaking during the winter months. Variability in weather from normal temperatures can materially impact results of operations. Natural gas purchases and the timing of related recoveries can materially impact liquidity. Northern Pipeline Construction Co. ("NPL" or the "construction services" segment), a wholly owned subsidiary, is a full-service underground piping contractor that provides utility companies with trenching and installation, replacement, and maintenance services for energy distribution systems.

 

Basis of Presentation. The condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The preparation of the condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments, consisting of normal recurring items and estimates necessary for a fair presentation of the results for the interim periods, have been made. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the 2004 Annual Report to Shareholders, which is incorporated by reference into the 2004 Form 10-K, and the first and second quarter 2005 Form 10-Qs.

 

Intercompany Transactions. NPL recognizes revenues generated from contracts with Southwest (see Note 2 below). Accounts receivable for these services were $10.3 million at September 30, 2005 and $8.3 million at December 31, 2004. The accounts receivable balance, revenues, and associated profits are included in the condensed consolidated financial statements of the Company and were not eliminated during consolidation in accordance with Statement of Financial Accounting Standards ("SFAS") No. 71, “Accounting for the Effects of Certain Types of Regulation.”

 

Recently Issued Accounting Pronouncements. In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, “Inventory Costs.” SFAS No. 151 is an amendment of Accounting Research Bulletin (“ARB”) No. 43, “Restatement and Revision of Accounting Research Bulletins.” SFAS No. 151 addresses the accounting for abnormal amounts of idle facility expense, freight handling costs and spoilage and will no longer allow companies to capitalize such inventory costs on their balance sheets when the production defect rate varies significantly from the expected rate. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of the standard is not expected to have a material impact on the financial position or results of operations of the Company.

 

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” SFAS No. 153 is an amendment of Accounting Principles Board Opinion (“APB”) No. 29, “Accounting for Nonmonetary Transactions.” SFAS No. 153 addresses the accounting for exchanges of similar productive assets and eliminates the exception to the fair-value principle for such exchanges, which previously had been accounted for based on the book value of the asset surrendered with no gain recognition. Under SFAS No. 153, using certain criteria, the gain would be recognized currently and not deferred. The provisions of SFAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company adopted this standard on July 1, 2005. The adoption did not have a material impact on the financial position or results of operations of the Company.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 is a replacement of APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle, and requires retrospective application for voluntary changes in accounting principle unless it is

 

5

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

impracticable to do so. The provisions of SFAS No. 154 are effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of the standard is not expected to have a material impact on the financial position or results of operations of the Company.

 

In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations.” FIN 47 is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN 47 clarifies that the term conditional asset retirement obligation as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing or method of settlement. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN 47 is designed to clarify when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation.

 

Upon adoption of SFAS No. 143 in January 2003, Southwest concluded it could not reasonably estimate its conditional asset retirement obligation. At the time of adoption, Southwest determined that it had limited legal obligations related to retirement costs for portions of its system that are subject to limited-duration easements and rights-of-way agreements. However, Southwest has traditionally been able to renew its easements and rights-of-way without having to retire, abandon, or remove facilities, and anticipates no serious difficulties in obtaining future renewals. In addition, certain franchises and provisions of federal and state statutes for abandonment of facilities impose removal obligations under certain circumstances. Southwest has the intent and the ability to operate such facilities indefinitely. As a result, the probability and the length of time until settlement of the asset retirement obligation is unknown. The Company will adopt the provisions of FIN 47 on December 31, 2005. Management is evaluating the criteria under FIN 47 to determine what, if any, impact the new standard may have on the financial position or results of operations of the Company.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” SFAS No. 123 (revised 2004) is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123 (revised 2004) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement eliminates the alternative to use APB No. 25 and the intrinsic value method of accounting. SFAS No. 123 (revised 2004) requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). The provisions of the statement (as amended by the SEC) are effective for the Company beginning January 2006. In 2006, compensation expense will increase due to the adoption of SFAS No. 123 (revised 2004) since no compensation expense is currently recorded for the Company's Stock Incentive Plan. The table below illustrates the effect SFAS No. 123 would have had on historical net income and earnings per share.

 

 

 

6

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Stock-Based Compensation. The Company has two stock-based compensation plans, which are described more fully in Note 9 - Employee Benefits in the 2004 Annual Report to Shareholders. These plans are currently accounted for in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision of SFAS No. 123, "Accounting for Stock-Based Compensation" to its stock-based employee compensation (thousands of dollars, except per share amounts):

 

Period Ended September 30,
Three Months
Nine Months
Twelve Months
2005
2004
2005
2004
2005
2004
Net income (loss), as reported     $ (16,444 ) $ (16,353 ) $ 13,568   $ 16,329   $ 54,014   $ 50,803  
Add:  
   Stock-based employee  
   compensation expense included  
   in reported net income (loss),  
   net of related tax benefits    431    365    1,331    1,253    1,903    2,337  
Deduct:  
   Total stock-based employee  
   compensation expense  
   determined under fair value  
   based method for all awards,  
   net of related tax benefits    (546 )  (445 )  (1,632 )  (1,651 )  (1,939 )  (2,849 )






Pro forma net income (loss)   $ (16,559 ) $ (16,433 ) $ 13,267   $ 15,931   $ 53,978   $ 50,291  






Earnings (loss) per share:                            
   Basic - as reported     $ (0.43 ) $ (0.46 ) $ 0.36   $ 0.47   $ 1.44   $ 1.47  
   Basic - pro forma       (0.43 )   (0.46 )   0.35     0.46     1.44     1.45  
           
   Diluted - as reported       (0.43 )   (0.46 )   0.36     0.47     1.43     1.45  
   Diluted - pro forma       (0.43 )   (0.46 )   0.35     0.45     1.43     1.44  

 

7

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Components of Net Periodic Benefit Cost. Southwest has a noncontributory qualified retirement plan with defined benefits covering substantially all employees. Southwest also provides postretirement benefits other than pensions ("PBOP") to its qualified retirees for health care, dental, and life insurance benefits.

 

Components of Net Periodic Benefit Cost

 

Qualified Retirement Plan
Period Ended September 30,
Three Months
Nine Months
Twelve Months
2005
2004
2005
2004
2005
2004
Service cost     $ 3,947   $ 3,448   $ 11,841   $ 10,343   $ 15,288   $ 13,409  
Interest cost    6,332    5,915    18,996    17,745    24,910    23,055  
Expected return on plan assets    (7,388 )  (7,017 )  (22,164 )  (21,051 )  (29,180 )  (27,854 )
Amortization of prior service costs    (3 )  13    (9 )  40    5    55  
Amortization of unrecognized  
   transition obligation    --    --    --    --    --    198  
Amortization of net (gain) loss    613    --    1,839    --    1,839    --  






Net periodic benefit cost   $ 3,501   $ 2,359   $ 10,503   $ 7,077   $ 12,862   $ 8,863  







PBOP
Period Ended September 30,
Three Months
Nine Months
Twelve Months
2005
2004
2005
2004
2005
2004
Service cost     $ 209   $ 181   $ 627   $ 542   $ 807   $ 710  
Interest cost    529    545    1,587    1,636    2,131    2,160  
Expected return on plan assets    (419 )  (357 )  (1,257 )  (1,071 )  (1,612 )  (1,372 )
Amortization of prior service costs    --    --    --    --    --    --  
Amortization of unrecognized  
   transition obligation    217    217    651    651    867    867  
Amortization of net (gain) loss    34    53    102    159    156    224  






Net periodic benefit cost   $ 570   $ 639   $ 1,710   $ 1,917   $ 2,349   $ 2,589  






 

 

8

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Note 2 – Segment Information

 

The following tables list revenues from external customers, intersegment revenues, and segment net income (thousands of dollars):

 

Natural Gas
Operations

Construction
Services

Total
Three months ended September 30, 2005                
Revenues from external customers   $ 239,318   $ 53,538   $ 292,856  
Intersegment revenues    --    20,422    20,422  



     Total   $ 239,318   $ 73,960   $ 313,278  



Segment net income (loss)   $ (20,023 ) $ 3,579   $ (16,444 )



Three months ended September 30, 2004  
Revenues from external customers   $ 206,459   $ 43,423   $ 249,882  
Intersegment revenues    --    14,585    14,585  



     Total   $ 206,459   $ 58,008   $ 264,467  



Segment net income (loss)   $ (18,954 ) $ 2,601   $ (16,353 )




Natural Gas
Operations

Construction
Services

Total
Nine months ended September 30, 2005                
Revenues from external customers   $ 1,032,349   $ 133,024   $ 1,165,373  
Intersegment revenues    --    51,915    51,915  



     Total   $ 1,032,349   $ 184,939   $ 1,217,288  



Segment net income   $ 7,001   $ 6,567   $ 13,568  



Nine months ended September 30, 2004  
Revenues from external customers   $ 866,999   $ 106,445   $ 973,444  
Intersegment revenues    --    43,120    43,120  



     Total   $ 866,999   $ 149,565   $ 1,016,564  



Segment net income   $ 10,992   $ 5,337   $ 16,329  




Natural Gas
Operations

Construction
Services

Total
Twelve months ended September 30, 2005                
Revenues from external customers   $ 1,427,402   $ 179,971   $ 1,607,373  
Intersegment revenues    --    70,411    70,411  



     Total   $ 1,427,402   $ 250,382   $ 1,677,784  



Segment net income   $ 44,363   $ 9,651   $ 54,014  



Twelve months ended September 30, 2004  
Revenues from external customers   $ 1,168,160   $ 140,696   $ 1,308,856  
Intersegment revenues    --    59,413    59,413  



     Total   $ 1,168,160   $ 200,109   $ 1,368,269  



Segment net income   $ 44,212   $ 6,591   $ 50,803  



 

9

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Note 3 – Comprehensive Income (Loss)

 

Three Months Ended
September 30,

Nine Months Ended
September 30,

Twelve Months Ended
September 30,

2005
2004
2005
2004
2005
2004
Net income (loss)     $ (16,444 ) $ (16,353 ) $ 13,568   $ 16,329   $ 54,014   $ 50,803  
Additional minimum pension  
  liability adjustment, net of  
  $6.5 million tax benefit    --    --    --    --    (10,892 )  --  






Comprehensive income (loss)   $ (16,444 ) $ (16,353 ) $ 13,568   $ 16,329   $ 43,122   $ 50,803  






The additional minimum pension liability adjustment noted above resulted from the measurement of pension obligations at December 31, 2004. Adjustments, if any, are only made at each annual measurement date.

Note 4 – Debt Instruments

 

In April 2005, the Company replaced its $250 million credit facility, scheduled to expire in May 2007, with a $300 million facility that expires in April 2010. Of the $300 million, $150 million will be available for working capital purposes and $150 million will be designated long-term debt. Interest rates for the facility are calculated at either the London Interbank Offering Rate plus an applicable margin, or the greater of the prime rate or one-half of one percent plus the Federal Funds rate. The applicable margin on the new credit facility is lower than the applicable margin of the previous facility. At September 30, 2005, $150 million and $29 million were outstanding on the long-term and short-term portions of the credit facility, respectively.

 

In June 2005, a $50.1 million letter of credit, which supports the Clark County, Nevada $50 million Industrial Development Revenue Bonds ("IDRBs") Series 2003A, due 2038, was renewed for a five-year period expiring in June 2010.

 

In June 2005, a $55.3 million letter of credit, which supports the City of Big Bear $50 million tax-exempt Series A IDRBs, due 2028, was renewed for a five-year period expiring in June 2010.

 

In July 2005, the Company amended its Financing Agreement dated March 1, 2003 with Clark County, Nevada associated with $50 million in Series 2003B IDRBs. The Company has chosen to secure payment of the principal of the Series 2003B IDRBs using an insurance policy with Ambac Assurance Corporation. Previously, payment of the principal was secured with a letter of credit. The amendment was executed in connection with the use of insurance to secure payment in the remarketing of the Series 2003B IDRBs.

 

Note 5 – Common Stock

 

During the nine months ended September 30, 2005, the Company issued approximately 2.2 million shares of common stock through its Equity Shelf Program, Dividend Reinvestment and Stock Purchase Plan ("DRSPP"), Employees’ Investment Plan, Management Incentive Plan, and Stock Incentive Plan. Of this activity, approximately 1 million shares were issued in at-the-market offerings through the Equity Shelf Program (at an average price of $25.53 per share). As of September 30, 2005, the $60 million Equity Shelf Program is fully issued.

 

In July 2005, the Company registered 750,000 additional shares of common stock with the SEC for issuance under the Employees' Investment Plan.

 

10

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Note 6 – Asset Purchase

 

In April 2005, the Company purchased the natural gas distribution properties of Avista Corporation (“Avista”) in South Lake Tahoe, California, which included approximately 19,000 customers. The cash purchase price for the properties was $15.2 million, net of post-closing adjustments. The assets acquired and the liabilities assumed at the acquisition date were as follows (thousands of dollars):

 

   Gas plant     $ 20,951  
   Less: accumulated depreciation       (13,158 )

     Net utility plant    7,793  
   Accounts receivable, net of allowances    1,775  
   Accrued utility revenue    1,182  
   Deferred purchased gas costs    1,474  
   Prepaids and other current assets    276  
   Deferred charges and other assets    4,670  

     Total assets acquired    17,170  

   Accounts payable    1,583  
   Customer deposits    169  
   Accrued general taxes    207  
   Accrued interest    2  

     Total liabilities assumed    1,961  

   Cash acquisition price   $ 15,209  

 

Note 7 – Contingency

 

The Company maintains liability insurance for various risks associated with the operation of its natural gas pipelines and facilities. In connection with these liability insurance policies, the Company has been responsible for an initial deductible or self-insured retention amount per incident, after which the insurance carriers would be responsible for amounts up to the policy limits. For the policy year August 2004 to July 2005, the self-insured retention amount associated with general liability claims increased from $1 million per incident to $1 million per incident plus payment of the first $10 million in aggregate claims above $1 million in the policy year. In May 2005, a leaking natural gas line was involved in a fire that injured an individual. The injuries are severe and life threatening. The cause of the leak is under investigation. Claims are expected to be filed against the Company. If the Company was deemed fully or partially responsible, the Company estimates its exposure could be from $1 million to $11 million (the maximum noted above) depending on a number of factors currently under investigation. Accordingly, the Company has recorded a $1 million liability related to this incident. Future results of operations would be impacted to the extent that the Company was deemed responsible for amounts in excess of $1 million. However, the Company believes that the range of possible losses would not materially affect the financial position of the Company.

 

Note 8 – Subsequent Event

 

In October 2005, the Company issued $100 million in Clark County, Nevada, 4.85% Series 2005A IDRBs. The IDRBs were issued at a discount of 0.75% and are due October 2035. The proceeds from the IDRBs will be used by Southwest to expand and upgrade facilities in Clark County, Nevada.

 

 

11

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

ITEM 2.            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Executive Summary

 

The following discussion of Southwest Gas Corporation and subsidiaries (the “Company”) includes information related to regulated natural gas transmission and distribution activities and non-regulated activities.

 

The Company is composed of two business segments: natural gas operations (“Southwest” or the “natural gas operations” segment) and construction services. Southwest is engaged in the business of purchasing, transporting, and distributing natural gas in portions of Arizona, Nevada, and California. Southwest is the largest distributor in Arizona, selling and transporting natural gas in most of central and southern Arizona, including the Phoenix and Tucson metropolitan areas. Southwest is also the largest distributor and transporter of natural gas in Nevada, serving the Las Vegas metropolitan area and northern Nevada. In addition, Southwest distributes and transports natural gas in portions of California, including the Lake Tahoe area and the high desert and mountain areas in San Bernardino County.

 

Southwest purchases, transports, and distributes natural gas to approximately 1,677,000 residential, commercial, industrial, and other customers, of which 54 percent are located in Arizona, 36 percent are in Nevada, and 10 percent are in California. During the twelve months ended September 30, 2005, Southwest earned 53 percent of operating margin in Arizona, 37 percent in Nevada, and 10 percent in California. During this same period, Southwest earned 86 percent of operating margin from residential and small commercial customers, 5 percent from other sales customers, and 9 percent from transportation customers. These general patterns are expected to continue.

 

Northern Pipeline Construction Co. (“NPL” or the "construction services" segment), a wholly owned subsidiary, is a full-service underground piping contractor that provides utility companies with trenching and installation, replacement, and maintenance services for energy distribution systems.

Results of Consolidated Operations

Period Ended September 30,
Three Months
Nine Months
Twelve Months
2005
2004
2005
2004
2005
2004
Contribution to net income (loss)                            
  (Thousands of dollars)  
Natural gas operations   $ (20,023 ) $ (18,954 ) $ 7,001   $ 10,992   $ 44,363   $ 44,212  
Construction services    3,579    2,601    6,567    5,337    9,651    6,591  






Net income (loss)   $ (16,444 ) $ (16,353 ) $ 13,568   $ 16,329   $ 54,014   $ 50,803  






Basic earnings (loss) per share  
Natural gas operations   $ (0.52 ) $ (0.53 ) $ 0.19   $ 0.32   $ 1.18   $ 1.28  
Construction services       0.09     0.07     0.17     0.15     0.26     0.19  






Consolidated     $ (0.43 ) $ (0.46 ) $ 0.36   $ 0.47   $ 1.44   $ 1.47  






 

See separate discussions at Results of Natural Gas Operations and Results of Construction Services. Average shares outstanding increased by 3.1 million between the third quarter of 2005 and 2004, 2.9 million between the year-to-date periods, and 2.7 million in the current twelve-month period compared to the same period a year ago, primarily resulting from at-the-market offerings through the Equity Shelf Program and continuing issuances under the Company's various stock plans. The Equity Shelf Program was fully issued as of September 30, 2005.

 

As reflected in the table above, the natural gas operations segment accounted for an average of 85 percent of twelve-month-to-date consolidated net income over the past two years. Accordingly, management’s main focus of discussion in this document is on that segment.

 

 

12

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Southwest’s operating revenues are recognized from the distribution and transportation of natural gas (and related services) billed to customers. An estimate of the amount of natural gas distributed, but not yet billed, to residential and commercial customers from the latest meter reading date to the end of the reporting period is also recognized in revenues.

 

Operating margin is the measure of utility revenues less the net cost of gas sold. Management uses operating margin as a main benchmark in comparing operating results from period to period. The principal factors affecting operating margin are general rate relief, weather/conservation, and customer growth. Weather is primarily a factor during the first and fourth quarters of the year.

 

Rates are intended to provide for recovery of all prudently incurred costs and provide 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. The Company currently has a rate case on file in Arizona seeking $70.8 million to cover increased costs and provide a reasonable return on plant investment. The filing also proposes a revised rate structure to reduce the amount of rate recovery subject to volumetric fluctuations. Hearings were held in October 2005. See the section on Rates and Regulatory Proceedings for additional information.

 

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 costs of providing service (including the cost of natural gas purchased) change and as additional investments in new or replacement pipeline and related facilities are made. General rate relief in California and Nevada provided $15 million in incremental operating margin during the twelve months ended September 30, 2005. Of equal importance, improvements in rate design have mitigated the impacts of weather and conservation on margin volatility for nearly half of Southwest's business. See the section on Rates and Regulatory Proceedings for additional information.

 

Customer growth, excluding acquisitions, has averaged five percent in recent years. Southwest served 98,000 more customers (including approximately 19,000 customers associated with the purchase of the South Lake Tahoe natural gas distribution properties of Avista Corporation (“Avista”) described below) in the third quarter of 2005 than in the third quarter of 2004. Incremental margin has accompanied this customer growth, but the costs associated with creating and maintaining the infrastructure needed to accommodate these customers also are increasing. The timing of including these costs in rates is often delayed (regulatory lag) and results in a reduction of current-period earnings. Management has attempted to mitigate the regulatory lag by being judicious in its staffing levels through the effective use of technology. However, growth, coupled with external factors, is causing operating expenses to increase. See Results of Natural Gas Operations for additional information.

 

The results of the natural gas operations segment and the overall results of the Company are heavily dependent upon the components noted previously (general rate relief, weather/conservation, and customer growth). Significant changes in these components (primarily weather) have contributed to somewhat volatile earnings. Management continues to work with its regulatory commissions in designing rate structures that strive to provide affordable and reliable service to its customers while mitigating the volatility in prices to customers and stabilizing returns to investors.

 

In April 2005, the Company purchased the natural gas distribution properties of Avista in South Lake Tahoe, California, which included approximately 19,000 customers. The cash purchase price for the properties was $15.2 million, net of post-closing adjustments. See Capital Resources and Liquidity for further discussion.

 

 

13

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Results of Natural Gas Operations

 

Quarterly Analysis

Three Months Ended
September 30,

2005
2004
(Thousands of dollars)
Gas operating revenues     $ 239,318   $ 206,459  
Net cost of gas sold    128,745    102,978  


  Operating margin    110,573    103,481  
Operations and maintenance expense    77,445    74,289  
Depreciation and amortization    34,611    32,844  
Taxes other than income taxes    9,888    9,528  


  Operating income (loss)    (11,371 )  (13,180 )
Other income (expense)    767    1,566  
Net interest deductions    20,323    19,814  
Net interest deductions on subordinated debentures    1,931    1,930  


  Income (loss) before income taxes    (32,858 )  (33,358 )
Income tax expense (benefit)    (12,835 )  (14,404 )


  Contribution to consolidated net income (loss)   $ (20,023 ) $ (18,954 )


 

Contribution from natural gas operations decreased $1.1 million in the third quarter of 2005 compared to the same period a year ago. A $1.6 million nonrecurring income tax benefit recognized in the third quarter of 2004 was the primary reason for the change between quarters.

 

Operating margin increased approximately $7 million, or seven percent, in the third quarter of 2005 compared to the third quarter of 2004. During the last twelve months, the Company added 79,000 customers (excluding 19,000 customers associated with the acquisition of the South Lake Tahoe service territory of Avista Corporation), an increase of five percent. Customer growth contributed an incremental $4 million in operating margin during the quarter. Incremental rate relief in Nevada and California added $3 million in margin compared to the prior year.

 

Operations and maintenance expense increased $3.2 million, or four percent, primarily due to the impact of general cost increases and incremental costs associated with providing service to a growing customer base.

 

Depreciation expense and general taxes increased $2.1 million, or five percent, as a result of construction activities. Average gas plant in service increased $253 million, or eight percent, as compared to the third quarter of 2004. The increase reflects ongoing capital expenditures for the upgrade of existing operating facilities, the expansion of the system to accommodate continued customer growth, and the purchase of the South Lake Tahoe properties.

 

Income taxes in the prior-year quarter included a $1.6 million benefit which resulted from completion of general rate cases and the closure of federal tax year 2000.

 

14

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Nine-Month Analysis

Nine Months Ended
September 30,

2005
2004
(Thousands of dollars)
Gas operating revenues     $ 1,032,349   $ 866,999  
Net cost of gas sold    599,697    450,690  


   Operating margin    432,652    416,309  
Operations and maintenance expense    226,678    214,957  
Depreciation and amortization    103,068    97,396  
Taxes other than income taxes    30,277    29,026  


   Operating income    72,629    74,930  
Other income (expense)    2,853    1,627  
Net interest deductions    60,244    57,122  
Net interest deductions on subordinated debentures    5,792    5,791  


   Income before income taxes    9,446    13,644  
Income tax expense    2,445    2,652  


   Contribution to consolidated net income   $ 7,001   $ 10,992  


 

Contribution to consolidated net income from natural gas operations decreased $4 million in the first nine months of 2005 compared to the same period a year ago. The decrease was principally attributed to higher operating expenses and financing costs, partially offset by improved, but lower than expected, operating margin.

 

Operating margin increased approximately $16 million, or four percent, in the first nine months of 2005 compared to the first nine months of 2004. During the current period, customer growth contributed an incremental $14 million in operating margin. Rate relief in Nevada and California added $8 million in margin. Differences in heating demand primarily caused by weather variations between periods resulted in a $6 million margin decrease as warmer-than-normal temperatures were experienced during both periods. During the current period, operating margin was negatively impacted by $12 million, while the negative impact in the prior-year period was $6 million.

 

Operations and maintenance expense increased $11.7 million, or five percent, principally due to the impact of general cost increases and incremental costs associated with providing service to a growing customer base. Additional factors include higher insurance premiums, uncollectible expenses, employee-related expenses, and compliance costs.

 

Other income rose $1.2 million between periods. The current period includes a $636,000 increase in interest income primarily associated with the unrecovered balance of deferred purchased gas costs.

 

Depreciation expense and general taxes increased $6.9 million, or five percent, as a result of construction activities. Average gas plant in service increased $250 million, or eight percent, as compared to the first nine months of 2004. The increase reflects ongoing capital expenditures for the upgrade of existing operating facilities, the expansion of the system to accommodate continued customer growth, and the purchase of the South Lake Tahoe properties.

 

Net financing costs increased $3.1 million, or five percent, between periods primarily due to an increase in average debt outstanding and higher rates on variable-rate debt.

 

Income tax expense in the prior period included a $1.6 million benefit which resulted from completion of general rate cases and the closure of federal tax year 2000.

 

 

15

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Twelve-Month Analysis

Twelve Months Ended
September 30,

2005
2004
(Thousands of dollars)
Gas operating revenues     $ 1,427,402   $ 1,168,160  
Net cost of gas sold    794,773    574,285  


   Operating margin    632,629    593,875  
Operations and maintenance expense    302,521    285,317  
Depreciation and amortization    136,187    128,815  
Taxes other than income taxes    38,920    37,406  


   Operating income    155,001    142,337  
Other income (expense)    2,837    3,073  
Net interest deductions    81,259    75,382  
Net interest deductions on subordinated debentures    7,725    7,721  


   Income before income taxes    68,854    62,307  
Income tax expense    24,491    18,095  


   Contribution to consolidated net income   $ 44,363   $ 44,212  


 

Contribution to consolidated net income from natural gas operations increased $151,000 in the current twelve-month period compared to the same period a year ago. The improvement in contribution was primarily caused by higher operating margin, partially offset by increased operating expenses and financing costs. Prior-period results included $3.6 million of nonrecurring income tax benefits.

 

Operating margin increased approximately $39 million, or seven percent, between periods. Continuing customer growth contributed an incremental $20 million. Rate relief in California and Nevada added $15 million. Differences in heating demand caused by weather variations between periods, net of lower usage due to conservation and energy efficiencies, resulted in a net $4 million margin increase. Warmer-than-normal temperatures were experienced during both periods. The unfavorable impacts of these factors were approximately $10 million in the current twelve-month period and $14 million in the prior period.

 

Operations and maintenance expense increased $17.2 million, or six percent, between periods reflecting general increases in operations and maintenance costs and incremental operating costs associated with serving additional customers. Additional factors included increases in insurance premiums, uncollectible expenses, employee-related expenses, and compliance costs.

 

Depreciation expense and general taxes increased $8.9 million, or five percent, as a result of additional plant in service. Average gas plant in service for the current twelve-month period increased $247 million, or eight percent, compared to the corresponding period a year ago. This was attributable to the upgrade of existing operating facilities and the expansion of the system to accommodate continued customer growth.

 

Net financing costs increased $5.9 million, or seven percent, primarily due to an increase in average debt outstanding to help finance growth and higher rates on variable-rate debt.

 

Income tax expense in the prior period included a $1.6 million benefit, recognized in the third quarter of 2004, which resulted from completion of general rate cases and the closure of federal tax year 2000. In addition, the prior period also included $2 million of income tax benefits, recognized in the fourth quarter of 2003, associated with plant-related items.

 

 

16

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Results of Construction Services

 

For the three, nine and twelve months ended September 30, 2005, construction revenues and construction expenses increased 27, 24, and 25 percent, respectively, when compared to the corresponding periods in 2004. These increases reflect a greater amount of work in several of NPL’s operating areas. Contribution to consolidated net income for the three, nine, and twelve months ended September 30, 2005 increased $978,000, $1.2, and $3.1 million, respectively, when compared to the corresponding periods in 2004. These increases were primarily due to revenue growth, an improvement in the number of profitable bid jobs, an advantageous mix of work, and a favorable equipment resale market in the current period.

 

Rates and Regulatory Proceedings

 

Arizona General Rate Case. In December 2004, Southwest filed a general rate application with the Arizona Corporation Commission (“ACC”) for its Arizona rate jurisdiction. The application seeks authorization to increase operating revenues by $70.8 million. The request is a result of increases in fixed operating costs and investment in infrastructure to serve new customers, coupled with a rate structure that has hindered Southwest’s ability to earn the return authorized by the ACC. The Company is asking the ACC to approve a balancing account mechanism to decouple residential margin from sales volumes in order to mitigate margin volatility due to weather and other usage variations. Southwest is also seeking changes in residential rate design that will shift a greater portion of the recovery of its fixed operating costs away from cold weather consumption. In July 2005, the two primary intervening parties in the case, the ACC Staff and the Residential Utility Consumer Office, filed testimony in the case. Both parties are separately advocating revenue increases which approximate two-thirds of the filed for amount, although their positions on a number of matters differ. In addition, neither party supports all of Southwest's proposed rate design changes or the balancing account mechanism, both of which Southwest deems critical components of its rate filing if greater margin stability (for both Southwest and its customers) is to be achieved. The hearing process was completed in October 2005, with an order expected in the first quarter of 2006. Management cannot predict the amount of rate relief or the rate design ultimately granted. The last general rate increase received in Arizona was November 2001.

 

California General Rate Case. In November 2004, Southwest made its annual attrition filing, which was approved by the California Public Utilities Commission ("CPUC") effective January 2005. The combined effect of the filing, which also adjusted various other balancing account surcharges, was an increase in annual margin of $2.8 million in southern California and $600,000 in northern California. An annual attrition filing will be made in the fourth quarter of 2005 for 2006. As a result of the Company’s acquisition of Avista's natural gas distribution properties in South Lake Tahoe, California (see Capital Resources and Liquidity section for further discussion), the CPUC agreed to extend the general rate case cycle for two additional years, which will include annual attrition adjustments through 2008 (excluding the acquired properties). Accordingly, the Company expects to file a general rate case in the fourth quarter of 2007 for rates to be effective in January 2009.

 

Nevada Weather Normalization Adjustment Provision. In March 2005, Southwest filed an application requesting the Public Utilities Commission of Nevada ("PUCN") to approve a weather normalization adjustment provision in advance of the Company's next general rate case. This filing requested that winter season billing volumes for weather sensitive customers be adjusted to reflect consumption variations that can be attributed to departures from normal weather. In the second quarter of 2005, the PUCN opened an investigation/rulemaking docket to address the issue of weather normalization. Southwest expects the PUCN to issue guidelines in the fourth quarter of 2005 regarding the methodology to be used in any future mechanisms. Southwest would then file under these guidelines in its next general rate filing.

 

FERC Jurisdiction. In January 2005, Paiute (an interstate pipeline subsidiary of Southwest Gas) filed a general rate case with the Federal Energy Regulatory Commission (“FERC”). The application seeks authorization to increase annual revenues by $1.7 million. The filing was a result of a FERC order issued in December 2004, whereby the Company entered into settlement agreements related to the purchase of a previously leased liquefied natural gas ("LNG") peaking facility. New storage and transportation rates were implemented in March and August 2005, respectively (subject to refund until a final FERC decision is received). In October 2005, Paiute filed an Offer of Settlement with the FERC,

 

17

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

which, if approved, would resolve all rate case related issues. Final FERC action is not expected until the first quarter of 2006. The last general rate increase received by Paiute was in January 1997.

 

PGA Filings

 

All of Southwest's state regulatory commissions have regulations that permit the Company to track and recover its actual costs of purchased gas. Deferred energy provisions and purchased gas adjustment clauses are collectively referred to as "PGA" clauses. PGA filings are subject to audit by state regulatory commission staffs. PGA rate changes impact cash flows but have no direct impact on profit margin. As of September 30, 2005 and December 31, 2004, Southwest had the following outstanding PGA balances receivable (millions of dollars):

 

September 30, 2005
December 31, 2004
          Arizona     $ 30.5   $ 15.3  
          Northern Nevada       3.8     13.1  
          Southern Nevada       22.1     41.9  
          California       4.1     11.8  


      $ 60.5   $ 82.1  


 

California Gas Cost Incentive Mechanism. As part of the CPUC's decision in the Company's last general rate case, Southwest was encouraged to propose a Gas Cost Incentive Mechanism ("GCIM"). A GCIM is designed to provide greater incentive to reduce gas costs than exists under traditional regulation, encourage reasonable risk taking, and reduce administrative burden.

 

In November 2004, the Company filed for a GCIM using attributes similar to those used by other California utilities. The plan provides for savings or penalties for gas cost incurred as compared to a predetermined range surrounding an established benchmark. Any savings or penalties outside the range, neither of which are expected to be significant, would then be shared on an annual basis by ratepayers and shareholders based upon an authorized percentage. The CPUC approved the GCIM, as proposed, effective May 2005.

 

Nevada Deferred Energy Adjustment Filing. In May 2005, the Company made an annual filing for its southern and northern Nevada rate jurisdictions, pursuant to temporary regulations adopted by the PUCN during the same month. These regulations replaced the PGA provisions in the Company’s Nevada Gas Tariff. The PUCN issued an order in October 2005 approving a $62.3 million annual increase in southern Nevada and a $16 million annual increase in northern Nevada effective November 2005. The increases are based on projected gas costs and will amortize the current under-collected Nevada PGA balances.

 

The temporary regulations above will be affected by another purchased gas related proceeding, prompted by Nevada Senate Bill No. 238. Senate Bill No. 238, which became effective in October 2005, provides for quarterly gas cost adjustments, calculated on a twelve-month rolling average. These adjustments will be made effective immediately upon filing each quarter, but are subject to an annual prudence review and audit of the natural gas costs incurred. The Company anticipates filing its first quarterly adjustment in mid- 2006.

 

El Paso Filing. In June 2005, El Paso Natural Gas Company ("El Paso") filed a general rate case application with the FERC. (Southwest is dependent upon El Paso for the transportation of natural gas for virtually all of its Arizona service territories and part of its southern Nevada service territories.) As part of its application, which is the first since the conversion of full requirements customers like Southwest to contract demand services, El Paso proposed various tariff changes along with new service offerings. It is estimated that the impact of the proposed rate increase will be an annual increase in gas transportation costs to Southwest of as much as $44 million. The new rates will become effective January 2006, subject to refund. It is anticipated that any additional costs to Southwest resulting from El Paso’s filing will be collected from customers through the PGA mechanism.

 

 

18

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Capital Resources and Liquidity

 

The capital requirements and resources of the Company generally are determined independently for the natural gas operations and construction services segments. Each business activity is generally responsible for securing its own financing sources. The capital requirements and resources of the construction services segment are not material to the overall capital requirements and resources of the Company.

 

Southwest continues to experience significant customer growth. This growth has required significant capital outlays for new transmission and distribution plant, to keep up with consumer demand. During the twelve-month period ended September 30, 2005, construction expenditures for the natural gas operations segment were $253 million (excluding the $22 million LNG facility purchase in December 2004 and the South Lake Tahoe acquisition in April 2005). Approximately 78 percent of these current-period expenditures represented new construction and the balance represented costs associated with routine replacement of existing transmission, distribution, and general plant. Cash flows from operating activities of Southwest (net of dividends) provided $191 million of the required capital resources pertaining to these construction expenditures. The remainder was provided from external financing activities. Over the next twelve months, operating cash flows may be negatively impacted by a build up in PGA balances due to higher gas prices expected this winter. See the Liquidity section below.

 

2005 Construction Expenditures and Financing

 

Southwest estimates construction expenditures during the three-year period ending December 31, 2007 will be approximately $700 million. Of this amount, approximately $270 million are expected to be incurred in 2005. During the three-year period, cash flow from operating activities (net of dividends) is estimated to fund approximately 80 percent of the gas operations’ total construction expenditures, assuming timely recovery of currently deferred PGA balances. The Company expects to raise $75 million to $100 million from its various common stock programs. The remaining cash requirements are expected to be provided by other external financing sources. The timing, types, and amounts of these additional external financings will be dependent on a number of factors, including conditions in the capital markets, timing and amounts of rate relief, growth levels in Southwest service areas, and earnings. These external financings may include the issuance of both debt and equity securities, bank and other short-term borrowings, and other forms of financing.

 

During the first nine months of 2005, approximately 1 million shares of common stock were issued in at-the-market offerings through the Equity Shelf Program with gross proceeds of $25.9 million, agent commissions of $258,000, and net proceeds of $25.6 million. Third quarter 2005 activity was 291,000 shares, gross proceeds of $7.8 million, agent commissions of $78,000, and net proceeds of $7.7 million. The Equity Shelf Program was fully issued as of September 30, 2005.

 

In October 2005, the Company issued $100 million in Clark County, Nevada, 4.85% Series 2005A IDRBs. The IDRBs were issued at a discount of 0.75% and are due October 2035. The proceeds from the IDRBs will be used by Southwest to expand and upgrade facilities in Clark County, Nevada.

 

Asset Purchase

 

In April 2005, the Company purchased the natural gas distribution properties of Avista in South Lake Tahoe, California, which included approximately 19,000 customers. The cash purchase price for the properties was $15.2 million, net of post-closing adjustments. The properties were integrated into the northern Nevada operations of Southwest, which include contiguous gas properties in the Lake Tahoe Basin. Southwest assumed the rates in effect at the time of closing the purchase. The purchase price was financed using existing credit facilities.

 

Liquidity

 

Liquidity refers to the ability of an enterprise to generate adequate amounts of cash to meet its cash requirements. Several general factors that could significantly affect capital resources and liquidity in future years include inflation, growth in the

 

19

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

economy, changes in income tax laws, changes in the ratemaking policies of regulatory commissions, interest rates, the variability of natural gas prices, and the level of Company earnings.

 

The price of natural gas has increased steadily over the past several years. Since December 2004, prices have increased to record levels, particularly following the occurrences of Hurricanes Katrina and Rita during the third quarter of 2005 which caused supply interruptions and damaged natural gas production facilities in the U.S. Gulf of Mexico. Increased demand from recently constructed natural gas-fueled electric generating plants has also affected the price of natural gas. Prices are generally expected to remain high through 2006.

 

Southwest periodically enters into fixed-price term contracts to mitigate price volatility. About half of Southwest’s normal weather supply needs for the upcoming 2005/2006 heating season were secured using short duration contracts (generally less than one year) which were put in place in 2004 and 2005 at lower prices than those currently available. Fixed-price contracts currently in place for the 2005/2006 heating season range in price from approximately $5 to $9 per dekatherm. Natural gas purchases not covered by fixed-price contracts are made under variable-price contracts with firm quantities and on the spot market. Prices for these supplies are currently higher than those in the Company’s fixed-price contracts. Southwest continues to pursue all available sources to maintain the balance between price, flexibility, reliability and protection from short term market volatility in the supply of natural gas purchased for its customers.

 

The rate schedules in Southwest's service territories contain PGA clauses which permit adjustments to rates as the cost of purchased gas changes. The PGA mechanism allows Southwest to change the gas cost component of the rates charged to its customers to reflect increases or decreases in the price expected to be paid to its suppliers and companies providing interstate pipeline transportation service. On an interim basis, Southwest generally 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 September 30, 2005, the combined balances in PGA accounts totaled an under-collection of $60.5 million versus an under-collection of $82.1 million at December 31, 2004. See PGA Filings section for more information on recent regulatory filings. Southwest utilizes short-term borrowings to temporarily finance under-collected PGA balances. Based on current and forecasted gas prices, Southwest expects its PGA balances to increase during the winter season as average purchase prices will likely exceed recovery rates. If PGA balances continue to increase, Southwest may have to obtain additional short-term borrowing capacity during the second half of 2006. Management does not anticipate any difficulty obtaining such capacity.

 

In April 2005, the Company replaced its $250 million credit facility, scheduled to expire in May 2007, with a $300 million facility that expires in April 2010. Of the $300 million, $150 million is available for working capital purposes and $150 million is designated long-term debt. Interest rates for the facility are calculated at either the London Interbank Offering Rate plus an applicable margin, or the greater of the prime rate or one-half of one percent plus the Federal Funds rate. The applicable margin on the new credit facility is lower than the applicable margin of the previous facility. At September 30, 2005, $150 million and $29 million were outstanding on the long-term and short-term portions of the credit facility, respectively.

 

The following table sets forth the ratios of earnings to fixed charges for the Company (because of the seasonal nature of the Company’s business, these ratios are computed on a twelve-month basis):

 

For the Twelve Months Ended
September 30,
2005

December 31,
2004

        Ratio of earnings to fixed charges 1.87  1.93 

 

Earnings are defined as the sum of pretax income plus fixed charges. Fixed charges consist of all interest expense including capitalized interest, one-third of rent expense (which approximates the interest component of such expense), preferred securities distributions, and amortized debt costs.

 

 

20

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

Insurance Coverage

 

The Company maintains liability insurance for various risks associated with the operation of its natural gas pipelines and facilities. In connection with these liability insurance policies, the Company has been responsible for an initial deductible or self-insured retention amount per incident, after which the insurance carriers would be responsible for amounts up to the policy limits. For the policy year August 2004 to July 2005, the self-insured retention amount associated with general liability claims increased from $1 million per incident to $1 million per incident plus payment of the first $10 million in aggregate claims above $1 million in the policy year. In May 2005, a leaking natural gas line was involved in a fire that injured an individual. The injuries are severe and life threatening. The cause of the leak is under investigation. Claims are expected to be filed against the Company. If the Company was deemed fully or partially responsible, the Company estimates its exposure could be from $1 million to $11 million (the maximum noted above) depending on a number of factors currently under investigation. Accordingly, the Company has recorded a $1 million liability related to this incident. Future results of operations would be impacted to the extent that the Company was deemed responsible for amounts in excess of $1 million. However, the Company believes that the range of possible losses would not materially affect the financial position of the Company.

 

For the policy year August 2005 to July 2006, the Company entered into insurance contracts that limit the Company’s self-insured retention to $1 million per incident plus payment of the first $5 million in aggregate claims above $1 million.

 

Recently Issued Accounting Pronouncements

 

In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, “Inventory Costs.” SFAS No. 151 is an amendment of Accounting Research Bulletin (“ARB”) No. 43, “Restatement and Revision of Accounting Research Bulletins.” SFAS No. 151 addresses the accounting for abnormal amounts of idle facility expense, freight handling costs and spoilage and will no longer allow companies to capitalize such inventory costs on their balance sheets when the production defect rate varies significantly from the expected rate. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of the standard is not expected to have a material impact on the financial position or results of operations of the Company.

 

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” SFAS No. 153 is an amendment of Accounting Principles Board Opinion (“APB”) No. 29, “Accounting for Nonmonetary Transactions.” SFAS No. 153 addresses the accounting for exchanges of similar productive assets and eliminates the exception to the fair-value principle for such exchanges, which previously had been accounted for based on the book value of the asset surrendered with no gain recognition. Under SFAS No. 153, using certain criteria, the gain would be recognized currently and not deferred. The provisions of SFAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company adopted the standard on July 1, 2005. The adoption did not have a material impact on the financial position or results of operations of the Company.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 is a replacement of APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle, and requires retrospective application for voluntary changes in accounting principle unless it is impracticable to do so. The provisions of SFAS No. 154 are effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of the standard is not expected to have a material impact on the financial position or results of operations of the Company.

 

In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations.” FIN 47 is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN 47 clarifies that the term conditional asset retirement obligation as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing or method of settlement. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably

 

21

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

estimated. FIN 47 is designed to clarify when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation.

 

Upon adoption of SFAS No. 143 in January 2003, Southwest concluded it could not reasonably estimate its conditional asset retirement obligation. At the time of adoption, Southwest determined that it had limited legal obligations related to retirement costs for portions of its system that are subject to limited-duration easements and rights-of-way agreements. However, Southwest has traditionally been able to renew its easements and rights-of-way without having to retire, abandon, or remove facilities, and anticipates no serious difficulties in obtaining future renewals. In addition, certain franchises and provisions of federal and state statutes for abandonment of facilities impose removal obligations under certain conditions. Southwest has the intent and the ability to operate such facilities indefinitely. As a result, the probability and length of time until settlement of the asset retirement obligation is unknown. The Company will adopt the provisions of FIN 47 on December 31, 2005. Management is evaluating the criteria under FIN 47 to determine what, if any, impact the new standard may have on the financial position or results of operations of the Company.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” SFAS No. 123 (revised 2004) is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123 (revised 2004) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement eliminates the alternative to use APB No. 25 and the intrinsic value method of accounting. SFAS No. 123 (revised 2004) requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). The provisions of the statement (as amended by the SEC) are effective for the Company beginning January 2006. In 2006, compensation expense will increase due to the adoption of SFAS No. 123 (revised 2004) since no compensation expense is currently recorded for the Company's Stock Incentive Plan. For more information regarding the effect the original SFAS No. 123 would have had on historical results of operations, see Note 1-Summary of Significant Accounting Policies, Stock-Based Compensation.

 

Forward-Looking Statements

 

This quarterly report contains statements which constitute “forward-looking statements” within the meaning of the 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, projections, strategies, future events or performance, and underlying assumptions. The words “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “continue,” and similar words and expressions are generally used and intended to identify 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, the impact of weather variations on customer usage, customer growth rates, changes in natural gas prices, our ability to recover costs through our PGA mechanism, the effects of regulation/deregulation, the timing and amount of rate relief, changes in rate design, changes in gas procurement practices, changes in capital requirements and funding, the impact of conditions in the capital markets on financing costs, changes in construction expenditures and financing, renewal of franchises, easements and rights-of-way, changes in operations and maintenance expenses, effects of accounting changes, future liability claims, changes in pipeline capacity for the transportation of gas and related costs, acquisitions and management’s plans related thereto, competition and our ability to raise capital in external financings or through our DRSPP. In addition, the Company can provide no assurance that its discussions regarding certain trends relating to its financing, operations and maintenance expenses will continue in future periods. For additional information on the risks associated with the Company’s business, see Item 1. Business-Company Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

 

22

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

All forward-looking statements in this quarterly report are made as of the date hereof, based on information available to the Company as of the date hereof, and the Company assumes 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).

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

See Item 7A. Quantitative and Qualitative Disclosures about Market Risk in the Company’s 2004 Annual Report on Form 10-K filed with the SEC. No material changes have occurred related to the Company’s disclosures about market risk.

 

ITEM 4.

CONTROLS AND PROCEDURES

 

The Company has established disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and benefits of controls must be considered relative to their costs. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or management override of the control. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

Based on the most recent evaluation, as of September 30, 2005, management of the Company, including the Chief Executive Officer and Chief Financial Officer, believe the Company’s disclosure controls and procedures are effective at attaining the level of reasonable assurance noted above.

 

NPL, the Company's construction subsidiary, converted several automated functions (accounts payable, accounts receivable, fixed assets and general ledger) to a new application during the first quarter of 2005, resulting in a material change in internal controls. Pre-implementation testing and post-implementation reviews were conducted by management to ensure that internal controls surrounding the system implementation process, the applications, and manual closing process were properly designed to prevent material financial statement errors. The evaluation of the operating effectiveness of related key controls was completed in the third quarter of 2005. There have been no other changes in the Company’s internal controls over financial reporting during the third quarter of 2005 that have materially affected, or are likely to materially affect, the Company’s internal controls over financial reporting.

 

23

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

PART II - OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

 

The Company is named as a defendant in various legal proceedings. The ultimate dispositions of these proceedings are not presently determinable; however, it is the opinion of management that none of this litigation individually or in the aggregate will have a material adverse impact on the Company’s financial position or results of operations. See Note 7 –Contingency for potential future liability issues.

 

ITEMS 2-5.

None.

 

ITEM 6.

EXHIBITS

 

     The following documents are filed as part of this report on Form 10-Q:

 

 

Exhibit 4.1

-

Indenture for $100 million Clark County IDRBs.

 

Exhibit 10.1

-

Financing Agreement between the Company and Clark County, Nevada, dated as of October 1, 2005.

 

Exhibit 10.2

-

Significant Terms of Employment and Change in Control Agreements by Individual Officer and Director Group.

 

Exhibit 12.1

-

Computation of Ratios of Earnings to Fixed Charges.

 

Exhibit 31.1

-

Section 302 Certifications.

 

Exhibit 32.1

-

Section 906 Certifications.

 

 

24

 



SOUTHWEST GAS CORPORATION

Form 10-Q

September 30, 2005

 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

Southwest Gas Corporation

 

 

(Registrant)

 

 

 

Date: November 8, 2005

 

 

 

 

 

 

 

/s/ Roy R. Centrella

 

 

Roy R. Centrella

 

 

Vice President/Controller and Chief Accounting Officer

 

 

 

25