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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, 1998
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 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, 30,316,387 shares as of November 3, 1998.
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1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except par value)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
ASSETS (Unaudited)
Utility plant:
Gas plant $ 1,983,373 $ 1,867,824
Less: accumulated depreciation (599,751) (551,083)
Acquisition adjustments 3,976 4,259
Construction work in progress 37,833 39,294
------------ ------------
Net utility plant 1,425,431 1,360,294
------------ ------------
Other property and investments 75,204 64,928
Current assets: ------------ ------------
Cash and cash equivalents 7,018 17,567
Accounts receivable, net of allowances 52,724 78,016
Accrued utility revenue 22,500 54,373
Income tax benefit -- 19,425
Deferred purchased gas costs 59,740 86,952
Prepaids and other current assets 41,669 32,211
------------ ------------
Total current assets 183,651 288,544
------------ ------------
Deferred charges and other assets 51,355 55,293
------------ ------------
Total assets $ 1,735,641 $ 1,769,059
============ ============
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $1 par (authorized - 45,000,000 shares; issued
and outstanding - 30,285,129 and 27,387,016 shares) $ 31,915 $ 29,017
Additional paid-in capital 421,631 360,683
Retained earnings (accumulated deficit) 720 (3,721)
------------ ------------
Total common equity 454,266 385,979
Redeemable preferred securities of Southwest Gas Capital I 60,000 60,000
Long-term debt, less current maturities 808,807 778,693
------------ ------------
Total capitalization 1,323,073 1,224,672
Current liabilities: ------------ ------------
Current maturities of long-term debt 5,128 5,621
Short-term debt 33,325 142,000
Accounts payable 36,878 62,324
Customer deposits 22,918 21,945
Accrued taxes 23,923 21,125
Accrued interest 13,494 13,007
Deferred taxes 10,626 24,163
Other current liabilities 41,621 34,222
------------ ------------
Total current liabilities 187,913 324,407
Deferred income taxes and other credits: ------------ ------------
Deferred income taxes and investment tax credits 172,275 168,282
Other deferred credits 52,380 51,698
------------ ------------
Total deferred income taxes and other credits 224,655 219,980
------------ ------------
Total capitalization and liabilities $ 1,735,641 $ 1,769,059
============ ============
The accompanying notes are an integral part of these statements.
2
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED TWELVE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------ -----------------------
1998 1997 1998 1997 1998 1997
--------- --------- --------- --------- --------- ---------
Operating revenues:
Gas operating revenues $ 128,229 $ 95,009 $ 567,609 $ 414,313 $ 767,961 $ 584,075
Construction revenues 34,279 33,689 80,397 86,554 111,188 123,635
--------- --------- --------- --------- --------- ---------
Total operating revenues 162,508 128,698 648,006 500,867 879,149 707,710
--------- --------- --------- --------- --------- ---------
Operating expenses:
Net cost of gas sold 51,499 28,508 246,254 149,830 305,762 198,226
Operations and maintenance 50,765 50,310 153,796 148,165 206,790 201,972
Depreciation and amortization 22,780 21,636 65,822 62,563 87,920 82,216
Taxes other than income taxes 7,699 7,371 23,516 22,482 30,427 28,410
Construction expenses 30,294 28,121 70,694 77,542 98,350 110,416
--------- --------- --------- --------- --------- ---------
Total operating expenses 163,037 135,946 560,082 460,582 729,249 621,240
--------- --------- --------- --------- --------- ---------
Operating income (loss) (529) (7,248) 87,924 40,285 149,900 86,470
--------- --------- --------- --------- --------- ---------
Other income and (expenses):
Net interest deductions (15,760) (16,115) (47,579) (46,362) (64,435) (60,830)
Preferred securities distributions (1,368) (1,368) (4,106) (4,106) (5,475) (5,475)
Other income (deductions), net (304) (467) 234 (609) (11,397) (1,132)
--------- --------- --------- --------- --------- ---------
Total other income and (expenses) (17,432) (17,950) (51,451) (51,077) (81,307) (67,437)
--------- --------- --------- --------- --------- ---------
Income (loss) before income taxes (17,961) (25,198) 36,473 (10,792) 68,593 19,033
Income tax expense (benefit) (7,016) (9,512) 13,979 (3,926) 22,764 7,603
Net income (loss) $ (10,945) $ (15,686) $ 22,494 $ (6,866) $ 45,829 $ 11,430
--------- --------- --------- --------- --------- ---------
Basic earnings (loss) per share $ (0.38) $ (0.58) $ 0.80 $ (0.25) $ 1.65 $ 0.42
========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share $ (0.38) $ (0.58) $ 0.80 $ (0.25) $ 1.64 $ 0.42
========= ========= ========= ========= ========= =========
Dividends paid per share $ 0.205 $ 0.205 $ 0.615 $ 0.615 $ 0.82 $ 0.82
========= ========= ========= ========= ========= =========
Average number of common shares outstanding 29,050 27,149 28,028 26,990 27,846 26,902
Average shares outstanding (assuming dilution) -- -- 28,216 -- 28,022 27,021
The accompanying notes are an integral part of these statements.
3
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)
NINE MONTHS ENDED TWELVE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss) $ 22,494 $ (6,866) $ 45,829 $ 11,430
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 65,822 62,563 87,920 82,216
Deferred income taxes (9,544) 28,984 8,948 45,155
Changes in current assets and liabilities:
Accounts receivable, net of allowances 25,292 23,199 (5,820) (3,140)
Accrued utility revenue 31,873 24,775 (775) (1,438)
Deferred purchased gas costs 27,212 (74,237) 5,065 (104,357)
Accounts payable (25,446) (16,519) 3,446 4,431
Accrued taxes 22,223 (19,814) 33,760 (31,300)
Other current assets and liabilities (3,503) 13,742 (15,241) 15,760
Other 1,136 530 14,495 9,595
--------- --------- --------- ---------
Net cash provided by operating activities 157,559 36,357 177,627 28,352
--------- --------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES:
Construction expenditures and property additions (136,647) (120,449) (185,812) (197,336)
Other 902 (4,974) 4,568 2,077
--------- --------- --------- ---------
Net cash used in investing activities (135,745) (125,423) (181,244) (195,259)
--------- --------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock, net 63,846 8,762 67,289 12,507
Dividends paid (17,460) (16,583) (23,054) (22,042)
Issuance of long-term debt, net 34,572 118,992 35,901 124,382
Retirement of long-term debt, net (4,646) (5,475) (6,736) (6,986)
Issuance (repayment) of short-term debt (108,675) (12,000) (75,675) 67,575
--------- --------- --------- ---------
Net cash provided by (used in) financing activities (32,363) 93,696 (2,275) 175,436
--------- --------- --------- ---------
Change in cash and temporary cash investments (10,549) 4,630 (5,892) 8,529
Cash at beginning of period 17,567 8,280 12,910 4,381
--------- --------- --------- ---------
Cash at end of period $ 7,018 $ 12,910 $ 7,018 $ 12,910
========= ========= ========= =========
Supplemental information:
Interest paid, net of amounts capitalized $ 46,108 $ 44,126 $ 60,753 $ 56,416
========= ========= ========= =========
Income taxes paid (received), net $ 6,666 $ (2,694) $ (24,594) $ (2,623)
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
4
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS. Southwest Gas Corporation (the Company) is comprised
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. Southwest's public utility rates, practices,
facilities, and service territories 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. Northern Pipeline Construction Co. (Northern or the construction
services segment), a wholly owned subsidiary, is a full-service underground
piping contractor which provides utility companies with trenching and
installation, replacement, and maintenance services for energy distribution
systems.
BASIS OF PRESENTATION. The 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. 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 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 consolidated financial
statements be read in conjunction with the financial statements and the notes
thereto included in the Company's 1997 Annual Report to Shareholders, which is
incorporated by reference into the Form 10-K, and 1998 quarterly reports on
Form 10-Q.
INTERCOMPANY TRANSACTIONS. The construction services segment recognizes
revenues generated from contracts with Southwest (see Note 2 below). Accounts
receivable for these services were $4.2 million at September 30, 1998 and
$3.6 million at December 31, 1997. The accounts receivable balance, revenues,
and associated profits are included in the consolidated financial statements
of the Company and were not eliminated during consolidation. Statement of
Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of
Certain Types of Regulation," provides that intercompany profits on sales to
regulated affiliates should not be eliminated in consolidation if the sales
price is reasonable and if future revenues approximately equal to the sales
price will result from the rate-making process. Management believes these two
criteria are being met.
NOTE 2 - SEGMENT INFORMATION
The following tables list revenues from external customers, intersegment
revenues, and segment income/loss (thousands of dollars):
NATURAL GAS CONSTRUCTION
OPERATIONS SERVICES TOTAL
----------- ------------ ----------
NINE MONTHS ENDED SEPTEMBER 30, 1998
Revenues from external customers $ 567,609 $ 53,946 $ 621,555
Intersegment revenues -- 26,451 26,451
----------- ------------ ---------
Total $ 567,609 $ 80,397 $ 648,006
=========== ============ =========
Segment income $ 20,637 $ 1,857 $ 22,494
=========== ============ =========
NINE MONTHS ENDED SEPTEMBER 30, 1997
Revenues from external customers $ 414,313 $ 60,165 $ 474,478
Intersegment revenues -- 26,389 26,389
----------- ------------ ---------
Total $ 414,313 $ 86,554 $ 500,867
=========== ============ =========
Segment income (loss) $ (6,982) $ 116 $ (6,866)
=========== ============ =========
5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company is principally engaged in the business of purchasing,
transporting, and distributing natural gas. Southwest is the largest
distributor in Arizona, selling and transporting natural gas in most of
southern, central, and northwestern Arizona, including the Phoenix and Tucson
metropolitan areas. Southwest is also the largest distributor and transporter
of natural gas in Nevada, and serves 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 in northern
California and the high desert and mountain areas in San Bernardino County.
Southwest purchases, transports, and distributes natural gas to approximately
1,182,000 residential, commercial, industrial and other customers, of which
57 percent are located in Arizona, 33 percent are in Nevada, and 10 percent
are in California. During the twelve months ended September 30, 1998,
Southwest earned 57 percent of operating margin in Arizona, 33 percent in
Nevada, and 10 percent in California. During this same period, Southwest
earned 84 percent of operating margin from residential and small commercial
customers, 5 percent from other sales customers, and 11 percent from
transportation customers. These patterns are consistent with prior years and
are expected to continue.
Northern is a full-service underground piping contractor, which provides
utility companies with trenching and installation, replacement, and
maintenance services for energy distribution systems.
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 population growth throughout its
service territories. This growth has required large amounts of capital to
finance the investment in infrastructure, in the form of new transmission and
distribution plant, to satisfy consumer demand. For the twelve months ended
September 30, 1998, natural gas construction expenditures totaled $173
million. 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
$144 million, or 83 percent, of the required capital resources pertaining to
these construction expenditures. The remainder was provided from net external
financing activities. The improvement in operating cash flows from expected
levels was due to higher earnings, and income tax refunds related to timing
differences principally associated with gas purchases and recoveries.
Southwest estimates construction expenditures during the three-year period
ending December 31, 2000 will be approximately $510 million. During the three-
year period, cash flow from operating activities (net of dividends) is
estimated to fund approximately one-half of the gas operations total
construction expenditures. A portion of the construction expenditure funding
will be provided by $26 million of funds held in trust, at December 31, 1997,
from the issuance of industrial development revenue bonds (IDRB). 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, and
growth factors in Southwest service areas. These external financings may
include the issuance of both debt and equity securities, bank and other
short-term borrowings, and other forms of financing.
In August 1998, the Company completed an offering of 2.5 million primary
shares of common stock. The net proceeds from this offering were $56 million
after deducting underwriting discounts and expenses. In September 1998, the
Company issued $25 million in medium-term notes, due 2008, bearing interest at
6
6.27 percent. The proceeds from these issuances will be used to finance
construction and improvement of pipeline systems and facilities located in and
around the communities served by Southwest.
RESULTS OF CONSOLIDATED OPERATIONS
Quarterly Analysis
- ------------------
Contribution to Net Income (Loss)
Three Months Ended September 30,
--------------------------------
(Thousands of dollars)
1998 1997
--------- ---------
Natural gas operations $ (11,794) $ (16,771)
Construction services 849 1,085
--------- ---------
Net income (loss) $ (10,945) $ (15,686)
========= =========
Loss per share for the quarter ended September 30, 1998 was $0.38, compared to
a $0.58 loss per share recorded during the corresponding quarter of the prior
year. Natural gas operations results improved $0.21 per share. See separate
discussion at RESULTS OF NATURAL GAS OPERATIONS for changes as they relate to
gas operations. Construction services contributed per share earnings of $0.03
during the current quarter, a $0.01 per share decrease from the corresponding
quarter of the prior year. Average shares outstanding increased 1.9 million
shares between periods primarily due to a 2.5 million issuance of primary
shares in August 1998, and continuing issuances under the Dividend
Reinvestment and Stock Purchase Plan.
Nine-Month Analysis
- -------------------
Contribution to Net Income (Loss)
Nine Months Ended September 30,
--------------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Natural gas operations $ 20,637 $ (6,982)
Construction services 1,857 116
---------- ----------
Net income (loss) $ 22,494 $ (6,866)
========== ==========
Earnings per share for the nine months ended September 30, 1998 were $0.80, a
$1.05 improvement from a per share loss of $0.25 recorded during the
corresponding nine months of the previous year. Natural gas operations
results improved $1.00 per share. See separate discussion at RESULTS OF
NATURAL GAS OPERATIONS for changes as they relate to gas operations.
Construction services activities contributed per share earnings of $0.06
during the current period, a $0.05 per share improvement over the
corresponding period of the prior year. The improvement resulted from
obtaining new work, eliminating less profitable contracts, implementing cost
containment measures, and better-than-expected weather conditions in several
cold-climate operating areas which allowed construction activities to begin
earlier than anticipated during the first quarter of 1998. Average shares
outstanding increased 1 million shares between periods primarily due to a 2.5
million issuance of primary shares in August 1998, and continuing issuances
under the Dividend Reinvestment and Stock Purchase Plan.
7
Twelve-Month Analysis
- ---------------------
Contribution to Net Income
Twelve Months Ended September 30,
--------------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Natural gas operations $ 43,444 $ 10,723
Construction services 2,385 707
---------- ----------
Net income $ 45,829 $ 11,430
========== ==========
Earnings per share for the twelve months ended September 30, 1998 were $1.65,
a $1.23 increase from per share earnings of $0.42 recorded during the prior
twelve-month period. Earnings contributed from natural gas operations
increased $1.16 per share. See separate discussion at RESULTS OF NATURAL GAS
OPERATIONS for changes as they relate to gas operations. Construction
services activities contributed per share earnings of $0.09, a $0.07 per share
improvement over the prior twelve-month period. The improvement is attributed
to obtaining new work, eliminating less profitable contracts, implementing
cost containment measures, and better-than-expected weather conditions in
several cold-climate operating areas which allowed construction activities to
begin earlier than normal during the first quarter of 1998. Average shares
outstanding increased 944,000 shares between periods primarily due to a 2.5
million issuance of primary shares in August 1998, and continuing issuances
under the Dividend Reinvestment and Stock Purchase Plan.
The following table sets forth the ratios of earnings to fixed charges for the
Company:
For the Twelve Months Ended
------------------------------
September 30, December 31,
1998 1997
------------ ------------
Ratios of earnings to fixed charges 1.88 1.28
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.
8
RESULTS OF NATURAL GAS OPERATIONS
Quarterly Analysis
- ------------------
Three Months Ended
September 30,
----------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Gas operating revenues $ 128,229 $ 95,009
Net cost of gas sold 51,499 28,508
---------- ----------
Operating margin 76,730 66,501
Operations and maintenance expense 50,765 50,310
Depreciation and amortization 20,563 18,873
Taxes other than income taxes 7,699 7,371
---------- ----------
Operating loss (2,297) (10,053)
Other income (expense), net (341) (2)
---------- ----------
Loss before interest and income taxes (2,638) (10,055)
Net interest deductions 15,467 15,736
Preferred securities distributions 1,368 1,368
Income tax expense (benefit) (7,679) (10,388)
---------- ----------
Contribution to consolidated net loss $ (11,794) $ (16,771)
========== ==========
Contribution from natural gas operations improved approximately $5 million
compared to the third quarter of 1997. The improvement was primarily due to
growth in operating margin, offset somewhat by higher operating expenses.
Operating margin increased $10.2 million, or 15 percent, in the third quarter
of 1998 when compared to the same period a year ago. Approximately $6 million
was due to rate relief. The remainder was due to customer growth as Southwest
served 58,000, or five percent, more customers than a year ago.
Operations and maintenance expenses increased $455,000, or one percent,
although increases in labor costs between periods were six percent.
Operations and maintenance expenses overall are expected to trend higher for
the calendar year, consistent with the year-to-date results.
Depreciation expense and general taxes increased $2 million, or eight percent,
as a result of construction activities. Average gas plant in service increased
$134 million, or seven percent, as compared to the third quarter of 1997. The
increase reflects ongoing capital expenditures for the upgrade of existing
operating facilities and the expansion of the system to accommodate continued
customer growth.
Net interest deductions decreased $269,000, or two percent. Strong cash flows
coupled with a common stock offering reduced the net amount of debt
outstanding and interest rates on variable-rate facilities were lower than
during the prior period.
9
Nine-Month Analysis
- -------------------
Nine Months Ended
September 30,
--------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Gas operating revenues $ 567,609 $ 414,313
Net cost of gas sold 246,254 149,830
---------- ----------
Operating margin 321,355 264,483
Operations and maintenance expense 153,796 148,165
Depreciation and amortization 59,539 55,188
Taxes other than income taxes 23,516 22,482
---------- ----------
Operating income 84,504 38,648
Other income (expense), net (432) (650)
---------- ----------
Income before interest and income taxes 84,072 37,998
Net interest deductions 46,806 45,192
Preferred securities distributions 4,106 4,106
Income tax expense (benefit) 12,523 (4,318)
---------- ----------
Contribution to consolidated net income (loss) $ 20,637 $ (6,982)
========== ==========
Contribution to consolidated net income improved $27.6 million compared to the
nine months ended September 1997. The improvement was the result of increases
in operating margin, offset somewhat by higher operating and financing
expenses.
Operating margin increased $56.9 million, or 22 percent, due to improved
weather conditions, rate relief, and continued customer growth. Differences
in heating demand caused by weather variances between periods resulted in an
increase of $24 million. Approximately $17 million was attributable to colder-
than-normal temperatures in the current nine-month period, and the remainder
resulted from the corresponding prior period being warmer than normal. Rate
relief, primarily resulting from a September 1997 $32 million annualized
general rate case settlement in Arizona, contributed $23 million in additional
operating margin to the current period. Customer growth accounted for the
remaining $9.9 million.
Operations and maintenance expenses increased $5.6 million, or four percent,
reflecting increases in labor costs along with incremental operating expenses
associated with providing service to the growing Southwest customer base.
Depreciation expense and general taxes increased $5.4 million, or seven
percent, resulting from an increase in average gas plant in service of
$153 million, or nine percent. This increase reflects capital expenditures
for the upgrade of existing operating facilities and the expansion of the
system to accommodate new customers being added to the system.
Net interest deductions increased $1.6 million, or four percent, during the
nine months ended September 1998 over the comparative prior period. The
change is attributed primarily to an increase in average total debt
outstanding during the period to finance construction expenditures and to
finance the deferred purchased gas cost balance. Average interest rates on
variable-rate facilities were lower than during the prior period, partially
offsetting the volume variance.
10
Twelve-Month Analysis
- ---------------------
Twelve Months Ended
September 30,
--------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Gas operating revenues $ 767,961 $ 584,075
Net cost of gas sold 305,762 198,226
---------- ----------
Operating margin 462,199 385,849
Operations and maintenance expense 206,790 201,972
Depreciation and amortization 78,879 72,628
Taxes other than income taxes 30,427 28,410
---------- ----------
Operating income 146,103 82,839
Other income (expense), net (12,761) (1,112)
---------- ----------
Income before interest and income taxes 133,342 81,727
Net interest deductions 63,365 58,871
Preferred securities distributions 5,475 5,475
Income tax expense 21,058 6,658
---------- ----------
Contribution to consolidated net income $ 43,444 $ 10,723
========== ==========
Contribution to consolidated net income increased $32.7 million compared to
the corresponding twelve-month period ended September 1997. The increase was
the result of improvements in operating margin, partially offset by higher
operating and financing expenses.
Operating margin increased $76.4 million, or 20 percent, due to improved
weather conditions, rate relief, and continued customer growth. Differences
in heating demand caused by weather variations between periods resulted in an
increase of $33 million. Approximately $22 million was attributable to colder-
than-normal temperatures in the current period, and the remainder was
attributed to the prior period being warmer than normal. Rate relief,
primarily resulting from a September 1997 general rate case settlement in
Arizona, contributed $32 million in additional operating margin to the current
period. Customer growth accounted for the remaining $11.4 million.
Operations and maintenance expenses increased $4.8 million, or two percent,
primarily reflecting increases in labor costs between periods.
Depreciation expense and general taxes increased $8.3 million, or eight
percent, as a result of additional plant in service. Average gas plant in
service for the current twelve-month period increased $140 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 new customers being added to the system.
Net interest deductions increased $4.5 million, or eight percent, during the
twelve months ended September 1998 over the comparative prior period. The
change is attributed primarily to an increase in average total debt
outstanding during the period to finance construction expenditures and to
finance the deferred purchased gas cost balance.
During the fourth quarter of 1997, Southwest recognized nonrecurring charges
to income related to cost overruns on two separate construction projects.
These charges are reflected in Other income (deductions), net. An $8 million
pretax charge resulted from cost overruns experienced during expansion of the
northern California service territory. See RATES AND REGULATORY PROCEEDINGS
herein. A second pretax charge, for $5 million, related to cost overruns on a
nonutility construction project. See Note 11 of the Notes to Consolidated
Financial Statements in the 1997 Annual Report to Shareholders for additional
disclosures related to this charge. Partially offsetting these charges was
the recognition of a $3.4 million income tax benefit related to the successful
settlement in November 1997 of open tax issues dating back as far as 1988.
The combined impact of these three events was a $4.1 million, or $0.15 per
share, after-tax reduction to earnings.
11
RATES AND REGULATORY PROCEEDINGS
CALIFORNIA
NORTHERN CALIFORNIA EXPANSION PROJECT. In December 1993, Southwest filed an
application with the California Public Utilities Commission (CPUC) to expand
its northern California service territory and extend service into Truckee,
California. The application included a proposed regulatory mechanism for
recovering the cost of the expansion. In May 1994, rate and cost recovery
issues related to the expansion application were combined by the CPUC with a
January 1994 general rate application Southwest had filed with the CPUC. In
September 1994, a Joint Motion and Stipulation and Settlement Agreement
(Settlement) was presented to the CPUC which resolved the general rate case
and addressed the expansion related cost recovery issues. In December 1994,
the Settlement was approved. In April 1995, Southwest received CPUC approval
for the certificate of public convenience and necessity to serve the expansion
areas.
In its filing, Southwest had indicated that expansion into Truckee would occur
in three phases and result in the conversion of an estimated 9,200 customers
to natural gas service from their existing fuel, primarily propane. The CPUC
established a cost cap of $29.1 million for the project.
In 1995, Southwest completed Phase I of the expansion project, which involved
transmission system reinforcement and distribution system expansion to
accommodate approximately 940 customers. Construction costs of $7.1 million
were on target with the cost estimate approved by the CPUC.
Phase II of the project involved extending the transmission system to Truckee
and distribution system expansion to accommodate an estimated 4,200 customers.
The cost cap apportioned to Phase II was approximately $13.8 million. The
incurred cost of Phase II was $28.6 million. An estimated $9.2 million of the
Phase II cost overrun was due to changes in project scope, such as adjustments
for design changes required by governmental bodies, changes in facilities
necessitated by requirements beyond Southwest's control and costs incurred to
accommodate customer service requests.
Examples of adjustments for changes in project scope included the requirement
to haul excavated soil offsite to be screened whereas normal and anticipated
practice is to screen on site, asphalt repairs which were greater than
expected as a result of increased paving requirements imposed after
construction started, and the installation of more facilities under asphalt
than anticipated. Other unanticipated or externally imposed costs pertained
to extended yard lines, underground boring, environmental studies, right-of-
way acquisitions, and engineering design work.
Due to the Phase II cost overruns and difficult construction environment
experienced, construction of Phase III was postponed to reevaluate the
economics of completing the project.
In July 1997, Southwest filed an application requesting authorization from the
CPUC to modify the terms and conditions of the certificate of public
convenience and necessity granted in 1995. In this application, Southwest
requested that the originally approved cost cap of $29.1 million be increased
to $46.8 million; that the scope of Phase III construction be revised to
include only an estimated 2,900 of the initially estimated 4,200 customers;
and that customer applicants desiring service in the expansion area who were
not identified to receive service during the expansion phases as modified
within the new application be subject to the existing main and service
extension rules. Southwest proposed to recover the incremental costs above
the original cost cap through a surcharge mechanism. Concurrently, the Truckee
town manager, on behalf of the Truckee Town Council, wrote a letter to the
CPUC in support of the application.
In August 1997, the Office of Ratepayer Advocates (ORA) for the CPUC filed a
protest to the Southwest application indicating that the terms of the original
agreement should be adhered to. Southwest responded with written comments in
support of its application. In September 1997, a prehearing conference was
held to discuss the filing, the ORA protest, and Southwest comments. The
administrative law judge (ALJ) made a preliminary ruling in favor of the ORA
protest, but allowed the parties an additional 20 days to supplement their
comments. During this time, Southwest and the ORA, pursuant to direction from
the Commission, began to negotiate a settlement agreement, and the procedural
schedule was adjusted to allow the negotiations to continue beyond the 20 day
period. In January 1998, a settlement involving all parties to the proceeding
was executed and filed with the CPUC which redefined the terms and conditions
for completing the project and recovering the additional project costs.
Although CPUC approval of the settlement was still required, management
anticipated approval of the all-party settlement. In February 1998, a
prehearing conference was held before the ALJ and the assigned Commissioner
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for the purpose of taking public comment on the settlement agreement. There
was no opposition to the settlement agreement from the Truckee Town Council at
the conference, or in a letter written by the Truckee town manager to the CPUC
subsequent to the conference.
Under the proposed settlement, Southwest agreed, among other things, to absorb
$8 million in cost overruns experienced in Phase II of the project. Southwest
also agreed to an $11 million cost cap (with a maximum of $3,800 per customer)
for Phase III of the project. The Phase III project scope would be modified
as requested in the July 1997 application. In addition, Southwest agreed not
to file its next general rate case until Phase III is complete. Based on the
proposed settlement agreement, Southwest recognized an $8 million pretax
charge in the fourth quarter of 1997.
In May 1998, the ALJ issued an unexpected Proposed Decision (PD) rejecting the
all-party settlement and directing Southwest to complete the project under the
terms and conditions of the 1995 certificate. A PD which ignores an all-party
settlement is rare and inconsistent with CPUC policies and procedures
established in 1992. Subsequent to the PD, the Truckee Town Council took a
formal position in opposition to the settlement, although they were not a
party to the proceeding, and had not previously opposed the settlement.
In July 1998, the CPUC voted to adopt the PD and reject the all-party
settlement and ordered Southwest to proceed with all deliberate speed to
complete the project under the terms and scope of the 1995 certificate.
Southwest filed a Motion for Stay (Motion) of order and petitioned the CPUC
for rehearing (Petition) in August 1998. The CPUC in its order stated that
Southwest was required to show extraordinary circumstances to readjudicate the
original settlement. Management did not have the opportunity to demonstrate
that such extraordinary circumstances exist; however, it believes that such
extraordinary circumstances do exist. In September 1998, the CPUC denied the
Motion. However, no action has been taken on the Petition. As a result,
Southwest has the right to petition the Supreme Court of the State of
California for review. Such a petition is discretionary with the Supreme
Court, and if accepted, could take up to two years to be heard. The Supreme
Court filing has not been made pending action by the CPUC on the Petition and
pending the outcome of other contemplated and active proceedings.
Southwest will pursue several alternative regulatory and legal avenues while
seeking the Petition from the CPUC regarding the July 1998 decision. First,
Southwest will petition the CPUC to hold hearings to modify the original
Settlement approved in December 1994. Second, Southwest will seek to reopen
the prior California general rate case and certificate proceeding to
readdress, among other items, the scope and costs of the Truckee project.
Because approval of the settlement agreement was expected, no evidentiary
hearings were conducted. Management strongly believes Southwest is entitled
to an evidentiary hearing before the CPUC, because the recent proceedings
effectively denied Southwest its fundamental due process rights. Third,
Southwest may seek to partially abandon its certificate to serve certain Phase
III geographic locales. Finally, Southwest will undertake civil litigation
against other parties whose actions materially contributed to unanticipated
changes in project cost and scope. The first such action occurred in
September 1998, when Southwest filed a civil lawsuit in U.S. Federal District
Court naming the town of Truckee as a defendant for an indeterminate amount of
damages.
In the January 1998 all-party settlement agreement, Southwest proposed to
modify Phase III of the project to exclude certain areas from the original
certificate application. The excluded areas are the most distant points from
existing mains and present some of the most challenging geographic conditions
in the expansion area. Extension of mains to serve the estimated 1,300
customers in the excluded areas would be considerably more expensive than the
service areas in Phases I and II. Furthermore, these areas have significantly
lower customer density than the remainder of the expansion project; therefore,
expected revenues would be insufficient to justify the anticipated
construction costs.
13
Because of the proposed settlement, and ongoing proceedings, new studies to
extend service into the excluded areas have not been performed. However,
preliminary estimates indicate that it could cost an additional $12 million to
$14 million to extend service to these 1,300 potential customers. The cost to
extend service to the remaining 2,900 potential Phase III customers is
estimated at $11 million.
Based on these forecasts, an additional pretax writeoff of up to $24 million
could be recorded if Southwest is ultimately required to complete the project
under the terms of the 1995 certificate without modification. This estimate
is comprised of approximately $7 million related to costs incurred through
Phase II, and up to $17 million for the forecasted construction costs.
However, Southwest will vigorously prosecute the described regulatory and
legal proceedings with the intent of reversing or mitigating the effects of
the July 1998 CPUC action. Management believes that a reasonable possibility
of modifying the existing CPUC orders pertaining to the expansion project
exists through pursuit of the legal and regulatory remedies which have been
outlined, although there can be no assurance of a favorable outcome.
Management also believes civil litigation offers a reasonable possibility of
recovering certain amounts spent to deal with changes in scope necessitated by
unanticipated third party actions. As a result, Southwest has not recorded any
additional writeoffs beyond the $8 million recognized in the fourth quarter of
1997.
PGA FILINGS
ARIZONA PGA FILING. In March 1998, the Arizona Corporation Commission
approved a purchased gas adjustment (PGA) filing submitted by Southwest in
January 1998 to recover deferred purchased gas costs in Arizona. This filing,
which became effective in April 1998, resulted in an annual revenue increase
of $46.9 million, or 14 percent. The increase in rates was designed to
recover the accumulated PGA balance related to Arizona customers, and to
eliminate the refunds previously built into the rate structure. PGA changes
impact cash flows but have no direct impact on profit margin.
NEVADA PGA FILING. In January 1997, Southwest submitted an out-of-period PGA
filing in Nevada, in response to a substantial run-up in the commodity cost of
natural gas during November and December of 1996. In September 1997, the
Public Utilities Commission of Nevada (PUCN) approved the filing providing
annual revenue increases of $10.1 million, or 9 percent, in the southern
Nevada rate jurisdiction, and $6 million, or 14 percent, in the northern
Nevada rate jurisdiction.
In June 1997, Southwest submitted its annual PGA filing in compliance with the
Nevada Gas Tariff. The filing covered the period from April 1996 through
March 1997. Southwest requested annual revenue increases of $23.1 million, or
18 percent, in the southern Nevada rate jurisdiction, and $8.4 million, or
17 percent, in the northern Nevada rate jurisdiction.
In an order issued in December 1997, the PUCN found that "Southwest failed to
mitigate the risk inherent in a portfolio of all indexed-priced contracts and
failed to reasonably quantify the costs of any risk mitigation." As a result,
gas costs of $3.8 million in southern Nevada and $1.8 million in northern
Nevada were disallowed. The approved annualized revenue increase, after
consideration of the amounts disallowed, was $17.3 million, or 14 percent in
southern Nevada, and $5.2 million, or 11 percent in northern Nevada.
In December 1997, Southwest filed a Petition for Reconsideration (Petition) of
the decision with the PUCN on the grounds that the findings of fact and
conclusions of law are contrary to binding legislative enactments and judicial
decisions. Specifically, the Petition asserted, among other things, that the
PUCN violated its settled obligation in the previous PGA docket, which
included the same winter period, in finding Southwest to be imprudent.
Effectively, the PUCN allowed a previously settled claim to be relitigated.
In addition, management also believes that the PUCN failed to follow its
previous rules and practices surrounding a PGA proceeding, or changed those
rules effective with the disallowance order and sought to retroactively apply
them, which would have required compliance with formal rulemaking procedures
mandated by Nevada Statutes. In February 1998, the PUCN reaffirmed the
original order.
In March 1998, Southwest filed a petition for judicial review (appeal) of the
final order of the PUCN with the Nevada District Court (NDC). The appeal
alleges the same procedural irregularities as were included in the Petition.
In July 1998, the NDC rejected a PUCN motion to dismiss, which was also filed
in March 1998, and established a procedural schedule related to the appeal.
14
An initial hearing is scheduled for the fourth quarter of 1998. Management
estimates the NDC appeal process could take up to six months before a decision
is rendered. Subsequent appeals by either party to the Nevada Supreme Court,
if necessary, could take an additional year.
Management believes it is probable that the action taken to dispute the
findings of fact and conclusions of law in the order will result in the
successful outcome desired, specifically, that the order to exclude
$5.6 million in gas costs from the PGA balance will be reversed. As a result,
the financial statements do not reflect any charges to effect the
disallowance.
In June 1998, Southwest submitted its annual PGA filing in compliance with the
Nevada Gas Tariff. Effective November 1998, new rates were approved by the
PUCN. No gas cost disallowances were ordered and no prudency issues were
raised. The new rates, reflecting a lower cost of gas, resulted in annualized
revenue decreases of $3 million, or two percent in the southern Nevada rate
jurisdiction, and $782,000, or one percent in the northern Nevada rate
jurisdiction. These PGA changes impact cash flows but have no direct impact on
profit margin.
YEAR 2000 RELATED ISSUES
Most companies have computer systems that use two digits to identify a year in
the date field (e.g. "98" for 1998). These systems must be modified to handle
turn-of-the-century calculations. If not corrected, system failures or
miscalculations could occur, potentially causing disruptions of operations,
including, among other things the inability to process transactions, send
invoices, or engage in other normal business activities. The Year 2000 issue
also threatens disruptions in government services, telecommunications, and
other essential industries. This creates potential risk for all companies,
even if their own computer systems are Year 2000 compliant.
In 1994, the Company initiated a comprehensive review of its computer systems
to identify processes that could be adversely affected by Year 2000 issues. By
early 1995, the Company identified computer application systems that required
modification or replacement. Since that time, the Company has focused on
converting all business-critical systems to be Year 2000 compliant.
In addition to the evaluation and remediation of computer application systems
and components, the Company has also developed a comprehensive Year 2000
compliance plan. As part of this plan, the Company has formed a Year 2000
project team with the mission of ensuring that all critical systems,
facilities, and processes are identified and analyzed for Year 2000
compliance. The project team consists of representatives from several
strategic departments of the Company.
The Year 2000 plan includes specific timetables for categories of tasks for
each department as follows:
(1) Assess Year 2000 issues - complete;
(2) Analyze, prioritize, and catalog Year 2000 issues - substantially
complete;
(3) Create action plans - in process and due by the first quarter of 1999;
(4) Implement plans and validate compliance - in process and due by the third
quarter of 1999.
15
The Company's top priority is to ensure that natural gas can be received from
suppliers and delivered to customers. To accomplish this, the Company has
sent inquiries to its five major providers of interstate natural gas
transportation service. All of these providers have responded to the inquiries
indicating that they intend to be Year 2000 compliant before the end of 1999.
The Company has also evaluated its gas pipeline delivery systems, which are
the systems used to distribute natural gas from the interstate pipelines to
the customer. These systems utilize nearly 1,000 hardware and software
components that schedule, regulate, measure, or otherwise facilitate the flow
of natural gas. Of these components, approximately 75 percent are Year 2000
compliant, 5 percent of the components are not compliant and will be remedied,
and 20 percent of the components are being evaluated for compliance. The
Company plans to complete this evaluation by the end of 1998, and intends to
remedy those components determined to be noncompliant during the first quarter
of 1999.
Many of the Company's business-critical computer systems are Year 2000
compliant. For example, the customer service system which supports customer
billing, accounts receivable, and other customer service functions is Year
2000 compliant. The general ledger accounting system of the Company is also
Year 2000 compliant. Year 2000 compliance work on other systems, such as
accounts payable, purchasing, human resources, and payroll, is in process. In
total, over 70 percent (including work-in-progress) of the Company's computer
applications are currently Year 2000 compliant. The Company has also assessed
its other computer components, such as computer equipment and software, and
determined that nearly 90 percent of these components are Year 2000 compliant.
The Company projects that both the computer application systems and the other
computer components will be Year 2000 compliant by the third quarter of 1999.
The Company has initiated communications with suppliers and vendors to
determine the extent to which those companies are addressing Year 2000
compliance issues. The Company is requiring business-critical suppliers and
vendors to certify compliance in order to continue doing business with the
Company. In addition, the Company is identifying and contacting alternate
suppliers and vendors as part of a Year 2000 contingency plan. The majority
of the companies contacted have responded and indicated in their responses
that efforts are underway to become compliant.
The Company is also assessing and remediating Year 2000 issues related to
embedded system devices (such as microcontrollers used in equipment and
machinery), data exchange functions, networks, telecommunications, security
access and building control systems, forms, reports, and other business
processes and activities. The Company expects these areas to be Year 2000
compliant by the third quarter of 1999.
The Company is establishing Year 2000 contingency plans. These plans include
such steps as identifying alternative vendors and suppliers (as noted above),
establishing alternative power supplies, and determining personnel and
staffing requirements to react to potential Year 2000 problems. As part of
this process, the Company will assess and prepare for the most reasonably
likely worst case Year 2000 scenario, which will consider potential power
interruptions, telecommunications disruptions, and upstream pipeline delivery
issues. The timeframe for completing and documenting contingency plans has
not been finalized.
The Company estimates that the cost of remediation will be less than $2
million. Expenditures of $900,000 have already been incurred in connection
with systems that have been converted. The remediation costs include internal
labor costs, as well as fees and expenses paid to outside contractors
specifically associated with reprogramming or replacing noncompliant
components. At the present time, the Company does not expect that such
expenditures will have a material impact on results of operations or financial
condition.
The Company's Year 2000 plans, including costs and completion schedules, are
based on management's best estimates. These estimates were derived using
numerous assumptions of future events including, but not limited to third
party modification plans, availability of qualified personnel, support of
software vendors, and other factors. The Company is also relying on the
representations made by significant third party suppliers and vendors.
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FORWARD-LOOKING STATEMENTS
This report contains statements which constitute "forward-looking statements"
within the meaning of the Securities Litigation Reform Act of 1995 (Reform
Act). All such 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, the effects of regulation,
the outcome of Southwest's challenges to regulatory actions in California and
Nevada, changes in capital requirements and funding, Year 2000 remediation
efforts, and acquisitions.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132 "Employers'
Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132
standardizes the disclosure requirements for pensions and other postretirement
benefits, requires additional information to facilitate financial analysis,
and eliminates certain previously required disclosures. It does not change
measurement or recognition of amounts related to those plans. This statement
is effective for 1998 reporting. The disclosure requirements of this
statement are not expected to significantly change current reporting practices
of the Company.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. This statement is effective for fiscal years
beginning after June 15, 1999. The disclosure and accounting requirements of
this statement are currently being analyzed by the Company.
In August 1998, the Securities and Exchange Commission (SEC) issued Release
No. 33-7558 "Statement of the Commission Regarding Disclosure of Year 2000
Issues and Consequences by Public Companies, Investment Advisers, Investment
Companies, and Municipal Securities Issuers," (the Release). The Release
provides guidance regarding specific matters for companies to address in SEC
filings. Required disclosures must cover four areas: state of readiness,
costs to address Year 2000 issues, risks of Year 2000 issues, and contingency
plans. Companies are required to apply the interpretive guidance contained in
the Release for reporting periods ending after August 4, 1998. The Company
applied the interpretive guidance provided by the Release to prepare the Year
2000 Related Issues disclosure shown on pages 15 and 16.
17
PART II - OTHER INFORMATION
ITEMS 1-5. None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report on
Form 10-Q:
Exhibit 10.1 - Form of Employment Agreement with Company
Officers.
Exhibit 10.2 - Form of Change in Control Agreement with
Company Officers.
Exhibit 12.1 - Computation of Ratios of Earnings to Fixed
Charges and Ratios of Earnings to Combined Fixed Charges and
Preferred Stock Dividends.
Exhibit 27.1 - Financial Data Schedule (filed electronically
only).
(b) Reports on Form 8-K
The Company filed a Form 8-K, dated September 14, 1998,
containing amended bylaws disclosing the adoption of notice
procedures for shareholder proposals intended for
consideration at an annual meeting.
The Company filed a Form 8-K, dated October 29, 1998,
reporting summary financial information for the quarter ended
September 30, 1998.
18
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 13, 1998
/s/ Edward A. Janov
------------------------------------------------------
Edward A. Janov
Vice President/Controller and Chief Accounting Officer
19