Exhibit 13.01
Southwest Gas Corporation 29
FINANCIAL REVIEW
Consolidated Selected Financial Statistics Page 30, Natural Gas Operations Page
31, Management's Discussion and Analysis Page 32, Consolidated Balance Sheets
Page 46, Consolidated Statements of Income Page 48, Consolidated Statements of
Cash Flows Page 49, Consolidated Statements of Stockholders' Equity Page 50,
Notes to Consolidated Financial Statements Page 51, Report of Independent Public
Accountants Page 67, Shareholder Information Page 68, Board of Directors and
Officers Page 68
30 Southwest Gas Corporation
CONSOLIDATED SELECTED FINANCIAL STATISTICS
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------
(Thousands of dollars, except per share amounts)
Operating revenues $1,396,688 $1,034,087 $ 936,866 $ 917,309 $ 732,010
Operating expenses 1,262,705 905,457 805,654 763,139 629,749
- -------------------------------------------------------------------------------------------------------------
Operating income $ 133,983 $ 128,630 $ 131,212 $ 154,170 $ 102,261
=============================================================================================================
Net income $ 37,156 $ 38,311 $ 39,310 $ 47,537 $ 16,469
=============================================================================================================
Total assets at year end $2,369,612 $2,232,337 $1,923,442 $1,830,694 $1,769,059
=============================================================================================================
Capitalization at year end:
Common equity $ 561,200 $ 533,467 $ 505,425 $ 476,400 $ 385,979
Trust originated
preferred securities 60,000 60,000 60,000 60,000 60,000
Long-term debt 796,351 896,417 859,291 812,906 778,693
- -------------------------------------------------------------------------------------------------------------
$1,417,551 $1,489,884 $1,424,716 $1,349,306 $1,224,672
=============================================================================================================
Common stock data:
Return on average common equity 6.8% 7.4% 8.0% 11.0% 4.3%
Earnings per share $ 1.16 $ 1.22 $ 1.28 $ 1.66 $ 0.61
Diluted earnings per share $ 1.15 $ 1.21 $ 1.27 $ 1.65 $ 0.61
Dividends paid per share $ 0.82 $ 0.82 $ 0.82 $ 0.82 $ 0.82
Payout ratio 71% 67% 64% 49% N/A
Book value per share at year end $ 17.27 $ 16.82 $ 16.31 $ 15.67 $ 14.09
Market value per share at year
end $ 22.35 $ 21.88 $ 23.00 $ 26.63 $ 18.69
Market value per share to book
value per share 129% 130% 141% 170% 133%
Common shares outstanding at
year end (000) 32,493 31,710 30,985 30,410 27,387
Number of common shareholders at
year end 23,243 24,092 22,989 24,489 25,833
Ratio of earnings to fixed
charges 1.59 1.60 1.78 2.08 1.28
=============================================================================================================
</Table>
Southwest Gas Corporation 31
NATURAL GAS OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Sales $1,149,918 $ 816,358 $ 740,900 $ 753,338 $ 569,542
Transportation 43,184 54,353 50,255 46,259 45,123
- ---------------------------------------------------------------------------------------------------------------
Operating revenue 1,193,102 870,711 791,155 799,597 614,665
Net cost of gas sold 677,547 394,711 330,031 329,849 209,338
- ---------------------------------------------------------------------------------------------------------------
Operating margin 515,555 476,000 461,124 469,748 405,327
Expenses:
Operations and maintenance 253,026 231,175 221,258 209,172 201,159
Depreciation and amortization 104,498 94,689 88,254 80,231 74,528
Taxes other than income taxes 32,780 29,819 27,610 31,646 29,393
- ---------------------------------------------------------------------------------------------------------------
Operating income $ 125,251 $ 120,317 $ 124,002 $ 148,699 $ 100,247
===============================================================================================================
Contribution to consolidated
net income $ 32,626 $ 33,908 $ 35,473 $ 44,830 $ 15,825
===============================================================================================================
Total assets at year end $2,289,111 $2,154,641 $1,855,114 $1,772,418 $1,717,025
===============================================================================================================
Net gas plant at year end $1,825,571 $1,686,082 $1,581,102 $1,459,362 $1,360,294
===============================================================================================================
Construction expenditures and
property additions $ 248,352 $ 205,161 $ 207,773 $ 179,361 $ 164,528
===============================================================================================================
Cash flow, net:
From operating activities $ 103,848 $ 109,872 $ 165,220 $ 189,465 $ 45,923
From investing activities (246,462) (203,325) (207,024) (176,731) (170,455)
From financing activities 154,727 95,481 40,674 (12,632) 132,349
- ---------------------------------------------------------------------------------------------------------------
Net change in cash $ 12,113 $ 2,028 $ (1,130) $ 102 $ 7,817
===============================================================================================================
Total throughput (thousands of
therms)
Sales 1,261,263 1,107,674 1,037,409 1,103,264 914,732
Transportation 1,268,203 1,482,700 1,186,859 1,001,372 1,030,857
- ---------------------------------------------------------------------------------------------------------------
Total throughput 2,529,466 2,590,374 2,224,268 2,104,636 1,945,589
===============================================================================================================
Weighted average cost of gas
purchased ($/therm) $ 0.55 $ 0.42 $ 0.28 $ 0.27 $ 0.35
Customers at year end 1,397,000 1,337,000 1,274,000 1,209,000 1,151,000
Employees at year end 2,507 2,491 2,482 2,429 2,447
Degree days - actual 1,963 1,938 1,928 2,321 1,976
Degree days - ten-year average 1,970 1,991 2,031 2,043 2,022
===============================================================================================================
</Table>
32 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 comprised 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.
As of December 31, 2001 Southwest had 1,397,000 residential, commercial,
industrial, and other customers, of which 785,000 customers were located in
Arizona, 485,000 in Nevada, and 127,000 in California. Residential and
commercial customers represented over 99 percent of the total customer base.
During 2001, Southwest added 60,000 customers, a four percent increase, of which
31,000 customers were added in Arizona, 26,000 in Nevada, and 3,000 in
California. Customer growth over the past three years averaged five percent
annually. These additions are largely attributed to population growth in the
service areas. Based on current commitments from builders, customer growth is
expected to approximate four percent in 2002. During 2001, 58 percent of
operating margin was earned in Arizona, 34 percent in Nevada, and 8 percent in
California. During this same period, Southwest earned 82 percent of operating
margin from residential and small commercial customers, 8 percent from other
sales customers, and 10 percent from transportation customers. In 2000,
Southwest earned 84 percent of operating margin from residential and small
commercial customers, 3 percent from other sales customers and 13 percent from
transportation customers. The difference between years was primarily due to a
number of large commercial and industrial customers moving from transportation
service to sales service.
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.
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. Financing this
growth has required large amounts of capital to pay for new transmission and
distribution plant, to keep up with consumer demand. During the three-year
period ended December 31, 2001, total gas plant increased from $2 billion to
$2.6 billion, or at an annual rate of
Southwest Gas Corporation 33
eight percent. Customer growth was the primary reason for the plant increase as
Southwest added 189,000 net new customers during the three-year period.
Southwest expects to add approximately 60,000 customers in 2002.
During 2001, capital expenditures for the natural gas operations segment were
$248 million. Approximately 74 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
$78 million of the required capital resources pertaining to these construction
expenditures. The remainder was provided from external financing activities.
Normally, internally generated funds provide a larger proportionate share of
capital resources required for construction purposes. However, such cash flows
were unfavorably impacted by unusually high working capital requirements
resulting from gas costs that exceeded the amounts recovered from customers
during much of 2001. This situation is now reversing as recovery rates have been
adjusted and natural gas prices have declined.
In February 2001, the Company issued $200 million in Notes, due 2011, bearing
interest at 8.375%. The net proceeds from the sale of the Notes were used to
finance the construction, completion, extension and improvement of the pipeline
systems and facilities located in and around the communities served by
Southwest. Those capital expenditures were originally funded, in part, with
short-term debt, which was repaid with the net proceeds of the Notes.
In March 2002, the Job Creation and Worker Assistance Act of 2002 (Act) was
signed into law. This Act provides a three-year, 30 percent "bonus" tax
depreciation deduction for businesses. Southwest estimates the bonus
depreciation deduction will reduce federal income taxes paid by approximately
$40 million to $50 million over the next three years (2002-2004).
Southwest estimates construction expenditures during the three-year period
ending December 31, 2004 will be approximately $675 million. Of this amount,
$225 million are expected to be incurred in 2002. 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,
including the impacts of the Act. The remaining cash requirements are expected
to be provided by 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. Southwest has a total of
$400 million in securities registered with the Securities and Exchange
Commission (SEC) which are available for future financing needs.
Current maturities of long-term debt were $308 million at December 31, 2001. In
June 2002, the $350 million revolving credit facility, of which $200 million is
designated as long-term debt, and the $100 million Series F debentures will
mature. The Company intends to refinance the long-term portion of the revolving
credit agreement and the Series F debentures on a long-term basis but no firm
agreements are in place at this time. The timing, types, and amounts of these
external financings will be dependent on conditions in the capital markets. Once
the debt has been refinanced, or long-term agreements have been entered into,
the Current maturities of long-term debt line item should
34 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
return to normal levels. The Company also intends to maintain short-term
borrowing capacity at a level sufficient to cover working capital needs.
All Company debt is recorded on its balance sheets. The Company has long-term
operating leases, which are described in Note 2 "Utility Plant" of the Notes to
Consolidated Financial Statements. No debt instruments have credit triggers or
other clauses that result in default if Company bond ratings are lowered by
rating agencies. Certain Company debt instruments contain customary leverage,
net worth and other covenants, and securities ratings covenants that, if set in
motion, would increase financing costs. To date, the Company has not incurred
any increased financing costs as a result of these covenants.
The Company does not currently utilize stand-alone derivative instruments for
speculative purposes or for hedging and does not have foreign currency exposure.
Southwest has fixed-price gas purchase contracts, which are considered normal
purchases occurring in the ordinary course of business. None of the Company's
long-term financial instruments or other contracts are derivatives, or contain
embedded derivatives.
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 economy, changes in income tax laws, changes in the
ratemaking policies of regulatory commissions, interest rates, the level of
natural gas prices and the level of Company earnings. The most significant
negative factor affecting liquidity in 2001 was the high natural gas prices.
The rate schedules in all of the service territories of Southwest contain
purchased gas adjustment (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. During the second half of 2000 and the first half of 2001,
Southwest experienced high gas purchase prices relative to amounts recovered in
rates for gas purchases. Natural gas prices have declined significantly in
recent months. At December 31, 2001, the combined balances in PGA accounts were
$84 million. At their peak in February 2001, the combined balances were $161
million. The balances should continue to trend downward since recovery rates
have been adjusted, assuming prices paid for gas purchases remain similar to
levels embedded in sales rates. Southwest utilizes short-term borrowings to
temporarily finance PGA balances. Southwest currently has short-term borrowing
capacity of $150 million, which the Company believes is adequate to meet
anticipated needs. Short-term borrowing capacity was $225 million earlier in
2001. A $75 million credit facility expired in November 2001 and was not
renewed.
In Arizona, Southwest adjusts rates monthly for changes in purchased gas costs,
within pre-established limits. In California, a monthly gas cost adjustment
based on forecasted monthly prices is utilized. Monthly adjustments are
Southwest Gas Corporation 35
designed to provide a more timely recovery of gas costs and to send appropriate
pricing signals to customers. In Nevada, tariffs provide for annual adjustment
dates for changes in purchased gas costs. In addition, Southwest may request to
adjust rates more often, if conditions warrant. Filings to change rates in
accordance with PGA clauses are subject to audit by state regulatory commission
staffs. See RATES AND REGULATORY PROCEEDINGS for details of these filings.
PGA changes affect cash flows but have no direct impact on profit margin. In
addition, since Southwest is permitted to accrue interest on PGA balances, the
cost of incremental, PGA-related short-term borrowings will be offset, and there
should be no material negative impact to earnings. However, gas cost deferrals
and recoveries can impact comparisons between periods of individual income
statement captions. These include Gas operating revenues, Net cost of gas sold,
Net interest deductions and Other income (deductions).
Other effects of the reduction in gas costs and adjustments to recovery rates
are visible in Company balance sheets. The Prepaids and other current assets
line item decreased $46 million during 2001 primarily due to the deferral and
collection of gas costs through the PGA accounts. Significantly lower gas costs
during the latter half of 2001 contributed to the $86 million decrease in the
Accounts payable line item.
The Company has a common stock dividend policy which states that common stock
dividends will be paid at a prudent level that is within the normal dividend
payout range for its respective businesses, and that the dividend will be
established at a level considered sustainable in order to minimize business risk
and maintain a strong capital structure throughout all economic cycles. The
quarterly common stock dividend was 20.5 cents per share throughout 2001. The
current dividend of 20.5 cents per share has been paid quarterly since September
1994.
Securities ratings issued by nationally recognized ratings agencies provide a
method for determining the credit worthiness of an issuer. Company debt ratings
are important because long-term debt constitutes a significant portion of total
capitalization. These debt ratings are a factor considered by lenders when
determining the cost of debt for the Company (i.e., the better the rating, the
lower the cost to borrow funds).
Since January 1997, Moody's Investors Service, Inc. (Moody's) has rated Company
unsecured long-term debt at Baa2. Moody's debt ratings range from Aaa (best
quality) to C (lowest quality). Moody's applies a Baa2 rating to obligations
which are considered medium grade obligations (i.e., they are neither highly
protected nor poorly secured).
The Company's unsecured long-term debt rating from Fitch, Inc. (Fitch) is BBB.
Fitch debt ratings range from AAA (highest credit quality) to D (defaulted debt
obligation). The Fitch rating of BBB indicates a credit quality that is
considered prudent for investment.
The Company's unsecured long-term debt rating from Standard and Poor's Ratings
Services (S&P) is BBB-. S&P debt ratings range from AAA (highest rating
possible) to D (obligation is in default). The S&P rating of BBB- indicates the
debt is regarded as having an adequate capacity to pay interest and repay
principal.
36 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
A securities rating is not a recommendation to buy, sell, or hold a security and
is subject to change or withdrawal at any time by the rating agency. The three
securities ratings discussed above are essentially equivalent.
Results of operations are impacted by inflation. Natural gas, labor, and
construction costs are the categories most significantly impacted by inflation.
Changes to Southwest cost of gas are generally recovered through PGA mechanisms
and do not significantly impact net earnings. Labor is a component of the cost
of service, and construction costs are the primary component of rate base. In
order to recover increased costs, and earn a fair return on rate base, general
rate cases are filed by Southwest, when deemed necessary, for review and
approval by regulatory authorities. Regulatory lag, that is, the time between
the date increased costs are incurred and the time such increases are recovered
through the ratemaking process, can impact earnings. See RATES AND REGULATORY
PROCEEDINGS for discussion of recent rate case proceedings.
JANUARY 2002 SALE OF UNDEVELOPED PROPERTY
In January 2002, the Company sold all of its interests in undeveloped property
located in northern Arizona. The property was originally acquired as a potential
site for underground natural gas storage during the gas supply shortages of the
1970s, but was never developed. The sale will result in a one-time pre-tax gain
of $8.9 million, which will be recognized in the first quarter of 2002.
CONSOLIDATED RESULTS OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ---------------------------------------------------------------------------------------------------
(Thousands of dollars)
CONTRIBUTION TO NET INCOME
Natural gas operations $32,626 $33,908 $35,473
Construction services 4,530 4,403 3,837
- ---------------------------------------------------------------------------------------------------
Net income $37,156 $38,311 $39,310
===================================================================================================
EARNINGS PER SHARE
Gas operations $ 1.02 $ 1.08 $ 1.16
Construction services 0.14 0.14 0.12
- ---------------------------------------------------------------------------------------------------
Consolidated $ 1.16 $ 1.22 $ 1.28
===================================================================================================
</Table>
See separate discussions at RESULTS OF NATURAL GAS OPERATIONS and RESULTS OF
CONSTRUCTION SERVICES. Average shares outstanding increased by 751,000 shares
between 2001 and 2000, and 681,000 shares between 2000 and 1999, primarily
resulting from continuing issuances under the Dividend Reinvestment and Stock
Purchase Plan.
Southwest Gas Corporation 37
RESULTS OF NATURAL GAS OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- --------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Gas operating revenues $1,193,102 $870,711 $791,155
Net cost of gas sold 677,547 394,711 330,031
- --------------------------------------------------------------------------------------------------------
Operating margin 515,555 476,000 461,124
Operations and maintenance expense 253,026 231,175 221,258
Depreciation and amortization 104,498 94,689 88,254
Taxes other than income taxes 32,780 29,819 27,610
- --------------------------------------------------------------------------------------------------------
Operating income 125,251 120,317 124,002
Other income (expense) 7,694 (1,765) (2,925)
- --------------------------------------------------------------------------------------------------------
Income before interest and income taxes 132,945 118,552 121,077
Net interest deductions 78,746 68,892 61,597
Preferred securities distributions 5,475 5,475 5,475
Income tax expense 16,098 10,277 18,532
- --------------------------------------------------------------------------------------------------------
Contribution to consolidated net income $ 32,626 $ 33,908 $ 35,473
========================================================================================================
</Table>
2001 VS. 2000
The gas segment contribution to consolidated net income for 2001 decreased $1.3
million from 2000. Growth in operating margin and improvement in other income
(expense) was more than offset by higher operating and financing costs.
Operating margin increased $39.6 million, or eight percent, in 2001 as a result
of customer growth, rate relief, and a return to normal weather. Southwest added
60,000 new customers during the last 12 months. This customer growth, coupled
with increased margin from electric generation and industrial customers,
contributed $30 million in incremental margin. An additional $5.3 million of
incremental margin was realized in 2001 from general rate relief. In Arizona,
annualized rate relief of $21.6 million was granted effective November 2001. The
Company expected the general rate increase in April 2001. This seven-month delay
resulted in unrealized operating margin of approximately $15 million. In Nevada,
annualized rate relief of $19.4 million was granted effective December 2001. The
remainder of the net change in operating margin between periods was due to
weather as average temperatures during 2001 were normal versus moderately
warmer-than-normal average temperatures during 2000.
Operations and maintenance expense increased $21.9 million, or nine percent,
reflecting general increases in labor and maintenance costs, higher
uncollectible expenses, and incremental costs associated with servicing
additional customers. Management believes the increase in uncollectible expenses
is due to high natural gas prices coupled with the downturn of the economy, and
is not a trend that should continue beyond 2002.
Depreciation expense and general taxes increased $12.8 million, or ten percent,
as a result of construction activities. Average gas plant in service increased
$180 million, or eight percent, compared to the prior year. This was attributed
to the continued expansion and upgrading of the gas system to accommodate
customer growth.
38 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Net interest deductions increased $9.9 million, or 14 percent, as the Company
financed both the new construction necessary to keep up with customer growth,
and unrecovered purchased gas costs.
Other income (expense) improved $9.5 million in 2001, primarily as a result of
increased interest income of $5.9 million on PGA balances and a $3 million
pretax gain on the sale of certain assets.
During 2001, Southwest recognized $2.5 million of income tax benefits associated
with the resolution of state income tax issues. During 2000, Southwest
recognized $6 million of income tax benefits associated with the favorable
resolution of certain federal income tax issues and the statutory closure of
open federal tax years. The 2001 effective income tax rate for the gas
operations segment was 33 percent.
2000 VS. 1999
The gas segment contribution to consolidated net income for 2000 decreased $1.6
million from 1999. Growth in operating margin was more than offset by higher
operating and financing costs.
Operating margin increased $14.9 million, or three percent, in 2000. The
increase was primarily due to customer growth as the Company added 63,000, or
five percent, new customers during 2000. Differences in heating demand between
periods partially offset the impact of customer growth, as both periods were
moderately warmer than normal.
Operations and maintenance expense increased $9.9 million, or four percent, as a
result of continued expansion and upgrading of the gas system to accommodate
customer growth.
Depreciation expense and general taxes increased $8.6 million, or seven percent,
as a result of construction activities. Average gas plant in service increased
$173 million, or eight percent, compared to the prior year. This was attributed
to the continued expansion and upgrading of the gas system to accommodate
customer growth.
Net interest deductions increased $7.3 million, or 12 percent, over 1999 due to
the financing of growth-related construction expenditures and higher interest
rates on variable-rate debt instruments.
During 2000, Southwest recognized $6 million of income tax benefits associated
with the favorable resolution of certain federal income tax issues and the
statutory closure of open federal tax years. As a result, the effective income
tax rate for the gas operations segment was 23 percent.
RATES AND REGULATORY PROCEEDINGS
Arizona General Rate Case. In May 2000, Southwest filed a general rate
application with the Arizona Corporation Commission (ACC) seeking approval to
increase revenues by $37.1 million, or nine percent, annually for its Arizona
rate jurisdiction. Southwest sought rate relief for increased operating costs,
changes in financing costs, declining average residential usage, and
improvements and additions to the distribution system. In October 2001, the ACC
authorized Southwest to increase rates by $21.6 million, or five percent,
annually, effective November 2001. The timing of the increase was important to
Southwest because it provided the benefit of having new rates in place at the
Southwest Gas Corporation 39
beginning of the 2001-2002 heating season. The ACC order also approved changes
in rate design that should improve revenue stability in Arizona. For example,
the residential basic service charge was increased by $1.00 per month. In
addition, the base gas cost rate was increased, allowing Southwest to recover
the deferred PGA balance more rapidly.
Nevada General Rate Cases. In July 2001, Southwest filed general rate
applications with the Public Utilities Commission of Nevada (PUCN) seeking
approval to increase annualized revenues by $21.7 million in its southern Nevada
rate jurisdiction and $7.7 million in its northern Nevada rate jurisdiction. In
November 2001, Southwest received approval from the PUCN to increase rates by
$13.5 million, or five percent, annually in southern Nevada and $5.9 million, or
five percent, annually in northern Nevada effective December 2001. In January
2002, the PUCN settled several open issues in the case regarding rate design.
Changes included increasing the residential basic service charge by $2.00 per
month in both jurisdictions, which should improve revenue stability in Nevada.
The changes were effective February 2002 and did not impact the amount of rate
relief granted.
California General Rate Cases. In February 2002, Southwest filed general rate
applications with the California Public Utilities Commission (CPUC) for its
northern and southern California jurisdictions. The application seeks annual
increases over a five-year period beginning January 2003, which cumulatively
amount to $6.3 million in northern California and $17.2 million in southern
California. For 2003, an annualized $2.7 million, or 13 percent, revenue
increase was requested for the northern jurisdiction and an annualized $6.7
million, or eight percent, revenue increase was requested for the southern
jurisdiction. Additional smaller annual revenue increases are proposed in the
subsequent years of the application through 2007. Hearings are expected to begin
in the third quarter of 2002. The last general rate increases received in
California were January 1998 in northern California and January 1995 in southern
California.
FERC Jurisdiction. In July 1996, Paiute Pipeline Company, a wholly owned
subsidiary of the Company, filed its most recent general rate case with the
Federal Energy Regulatory Commission (FERC). The FERC authorized a general rate
increase effective January 1997. Additional rate relief is not yet necessary
and, therefore, no general rate case filing is planned during 2002.
PGA FILINGS
Arizona PGA Filings ($64.9 million unrecovered PGA balance at December 31,
2001). In Arizona, Southwest adjusts rates monthly for changes in purchased gas
costs, within pre-established limits. In January 2002, Southwest filed an advice
letter with the ACC to eliminate a temporary rate adjustment surcharge, which
was otherwise set to expire at the end of the second quarter of 2002. This
action was taken in recognition of moderating gas costs and projections of PGA
balancing account activity. The filing was approved effective February 2002, and
will reduce revenues by $31.9 million annually with no reduction to margin.
Nevada PGA Filings ($10.1 million unrecovered PGA balance at December 31, 2001).
In December 2001, Southwest submitted an out-of-cycle PGA filing to the PUCN for
a $29.2 million decrease for southern Nevada customers. In January 2002, an
additional decrease of $13.9 million was requested. The total of the two
filings, $43.1 million, was
40 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
agreed to in a settlement among all parties and approved by the PUCN to become
effective in February 2002. The filings were made in advance of the scheduled
annual date to allow customers to receive the benefit of decreases experienced
in natural gas costs. PGA changes impact cash flows but have no direct impact on
profit margin.
In October 2001, Southwest submitted an out-of-cycle PGA filing to the PUCN to
reduce rates in both the southern and northern Nevada rate jurisdictions. In
November 2001, rate decreases of $48.6 million, or 17 percent, for southern
Nevada and $15 million, or 14 percent, for northern Nevada were approved by the
PUCN effective December 2001.
In June 2001, the PUCN approved an agreement allowing Southwest to increase
rates by $74.6 million annually to recover higher gas costs. Effective July
2001, rates increased $47.2 million, or 23 percent, in southern Nevada and $27.4
million, or 36 percent in northern Nevada. The agreement followed a thorough
review by the Bureau of Consumer Protection (BCP) and PUCN Staff of the gas
purchasing practices of Southwest. The out-of-cycle PGA filing was submitted by
Southwest in January 2001 to recover gas costs incurred through December 2000.
In October 2000, Southwest submitted an out-of-cycle PGA filing to the PUCN to
recover gas costs incurred through September 2000. A settlement related to this
filing resulted in a gas cost rate increase of $38.5 million, or 24 percent, in
southern Nevada and $16.8 million, or 30 percent, in northern Nevada, effective
January 2001. In a related order issued May 2001, the PUCN directed that
Southwest meet with PUCN staff and the BCP in the third quarter of 2001 to
establish guidelines for Southwest to follow in constructing its Nevada gas
supply portfolio for coming years. The guidelines may include a requirement to
utilize call options to mitigate future price risks. Meetings were held but no
agreement was reached. During the third quarter of 2001, the three parties filed
separate guideline proposals with the PUCN. The PUCN has not yet acted on this
matter.
Effective December 2000, the PUCN approved an annual PGA filing submitted in
June 2000 granting annual increases of $13.9 million, or nine percent, in
southern Nevada and $6 million, or 11 percent, in northern Nevada.
California PGA Filings ($8.5 million unrecovered PGA balance at December 31,
2001). Effective December 2000, the CPUC authorized Southwest to change the cost
of gas included in sales rates each month to reflect the projected cost of gas
for the current month. The treatment of monthly over/under-recoveries of gas
costs varies by magnitude. Small amounts may be included in the following
month's estimated cost of gas for immediate recovery/refund. Large amounts may
be deferred to the PGA account to be amortized over longer periods to avoid
excessive fluctuation in prices. This mechanism allows the most timely recovery
of gas costs within the three-state operating area.
California Order Instituting Investigation (OII). In July 2001, the CPUC ordered
an investigation into the reasonableness of Southwest natural gas procurement
practices and costs from June 1999 through May 2001, and related measures taken
to minimize gas costs beyond May 2001. During the third quarter of 2001,
Southwest filed a detailed report and testimony with the CPUC on these matters
for both its northern and southern California service territories. The OII
resulted from complaints by southern California customers about the size of
monthly PGA rate increases that were necessary due to the unusually high cost of
natural gas during the winter of 2000-2001. In regards to the southern
California jurisdiction, the Office of Ratepayer Advocate and the County of San
Bernardino
Southwest Gas Corporation 41
recommended disallowances of $7.3 million and $11.7 million, respectively. No
issues were raised related to the northern California rate jurisdiction. The
proposed disallowances were based solely on decisions by Southwest not to
purchase gas for storage during the winter of 2000-2001. Hearings were held in
January 2002 with a final decision anticipated in the second quarter of 2002.
Southwest defended its decisions related to storage, based on testimony which
demonstrated that injecting additional volumes of natural gas into storage
during the 2000 injection season (April through September) could not be
economically justified based on market conditions and price forecasts that
existed at the time decisions were made. Management believes it has adequately
defended the prudency of its gas procurement practices and, as a result,
believes there is no legal basis for a disallowance.
RESULTS OF CONSTRUCTION SERVICES
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Construction revenues $203,586 $163,376 $145,711
Cost of construction 189,429 150,678 134,790
- ------------------------------------------------------------------------------------------------------
Gross profit 14,157 12,698 10,921
General and administrative expenses 5,026 3,986 3,312
- ------------------------------------------------------------------------------------------------------
Income from operations 9,131 8,712 7,609
Other income (expense) 871 821 946
- ------------------------------------------------------------------------------------------------------
Income before interest and income taxes 10,002 9,533 8,555
Interest expense 1,985 1,779 1,605
Income tax expense 3,487 3,351 3,113
- ------------------------------------------------------------------------------------------------------
Contribution to consolidated net income $ 4,530 $ 4,403 $ 3,837
======================================================================================================
</Table>
2001 VS. 2000
The 2001 contribution to consolidated net income from construction services
increased $127,000 from the prior year. The increase was principally due to
higher revenues that resulted from obtaining additional work. Revenues increased
25 percent, while the gross profit margin percentage decreased slightly. Gross
profit increased $1.5 million.
General and administrative expenses, as a percent of revenue, remained
relatively constant as did interest expense.
2000 VS. 1999
The 2000 contribution to consolidated net income from construction services
increased $566,000 from the prior year. The increase was principally due to
additional revenues that resulted from obtaining several new contracts and
favorable winter weather conditions. Revenues increased 12 percent, while the
gross profit margin percentage remained relatively constant. Gross profit
increased $1.8 million.
General and administrative expenses, as a percent of revenue, remained
relatively constant as did interest expense.
42 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 is effective for fiscal years beginning after December 15,
2001. In all cases, SFAS No. 142 must be adopted as of the beginning of a fiscal
year. SFAS No. 142 requires that the amortization of goodwill be eliminated and
that existing goodwill be evaluated for impairment. Goodwill will be tested for
impairment at least annually using a two-step process that begins with an
estimation of the fair value of a reporting unit. The first step is a screen for
potential impairment, and the second step measures the amount of impairment, if
any. However, if certain criteria are met, the requirement to test goodwill for
impairment annually can be satisfied without a remeasurement of the fair value
of a reporting unit. The Company has included $7.7 million of goodwill resulting
from the purchase of Northern Pipeline Construction Co. on its consolidated
balance sheet at December 31, 2001. The annual amortization expense associated
with goodwill is $400,000. Management does not anticipate any significant impact
to the financial position or results of operations of the Company as a result of
SFAS No. 142.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. The asset retirement obligations included within the scope of SFAS No.
143 are those that are unavoidable as a result of the acquisition, construction,
development, or normal operation of long-lived assets. The standard requires
that a legal obligation associated with the retirement of tangible long-lived
assets be recognized as a liability when incurred. When a liability for an asset
retirement obligation is initially recorded, the entity capitalizes a cost by
increasing the carrying amount of the related long-lived asset. Over time, the
liability is accreted to its present value each period, and the capitalized cost
is depreciated over the useful life of the related asset. Entities are also
required to recognize period-to-period changes for the liability related to
asset retirement obligations resulting from the passage of time and/or revisions
to either the timing or the amount of the original estimate of undiscounted cash
flows. Upon settlement of the liability, an entity either settles the obligation
for its recorded amount or incurs a gain or loss. Upon initial application of
SFAS No. 143, entities are required to recognize the following items in the
statement of financial position: a liability for any existing asset retirement
obligations adjusted for cumulative accretion to the date of adoption of SFAS
No. 143, an asset retirement cost capitalized as an increase to the carrying
amount of the associated long-lived asset, and accumulated depreciation for the
capitalized cost. SFAS No. 143 is effective for financial statements issued for
fiscal years beginning after June 15, 2002, with early adoption encouraged.
Management has not yet quantified the effects of the new standard on the
financial position or results of operations of the Company.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of." SFAS No. 144 also supercedes the
accounting and reporting provisions of Accounting Principles Board (APB) Opinion
No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business
(as previously defined in that Opinion). Because SFAS No. 121 did not address
Southwest Gas Corporation 43
the accounting for a segment of a business accounted for as a discontinued
operation under APB Opinion No. 30, two accounting models existed for long-lived
assets to be disposed of. The FASB decided to establish a single accounting
model, based on the framework established in SFAS No. 121, for long-lived assets
to be disposed of by sale. The FASB also decided to resolve other implementation
issues related to SFAS No. 121. SFAS No. 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001, with early
adoption encouraged. Management does not anticipate any significant impact to
the financial position or results of operations of the Company as a result of
SFAS No. 144.
MERGER LITIGATION
Litigation is pending in Arizona related to the now terminated acquisition of
the Company by ONEOK Inc. (ONEOK). For additional information, see ITEM 3. LEGAL
PROCEEDINGS, in the 2001 Form 10-K filed by the Company with the SEC.
In January 2002, United States District Court Judge Roslyn O. Silver in Phoenix,
Arizona, issued two orders further addressing the allowable claims and damage
issues in litigation presently pending among Southern Union Company (Southern
Union), ONEOK and the Company.
The first order confirms that Southern Union claims against the Company and
ONEOK are now limited to claims for Southern Union's out-of-pocket expenses,
estimated at approximately $1 million (according to Court filings), and any
punitive damages that it can prove. The second order limits Company claims
against ONEOK to out-of-pocket expenses and any punitive damages that it can
prove. Likewise, the single remaining ONEOK claim against the Company is limited
to out-of-pocket expenses and any punitive damages that it can prove. The second
order also dismisses the claims of the Company and ONEOK against Southern Union.
The Company believes that it will prevail on the remaining Southern Union and
ONEOK claims and that its potential exposure on these claims, including punitive
damages, will not have a material impact on its financial condition.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one which is very important to the portrayal of
the financial condition and results of a company, and requires the most
difficult, subjective or complex judgments of management. The need to make
estimates about the effect of items that are uncertain is what makes these
judgments difficult, subjective and/or complex. Management makes subjective
judgments about the accounting and regulatory treatment of many items. The
following are examples of accounting policies that are critical to the financial
statements of the Company. For more information regarding the significant
accounting policies of the Company, see Note 1 of the Notes to Consolidated
Financial Statements.
- - Natural gas operations are subject to the regulation of the Arizona
Corporation Commission, the Public Utilities Commission of Nevada, the
California Public Utilities Commission, and the Federal Energy Regulatory
Commission. The accounting policies of the Company conform to generally
accepted accounting principles applicable to rate-regulated enterprises and
reflect the effects of the ratemaking process. As such, the Company is allowed
to defer as regulatory assets, costs that otherwise would have been expensed
if it is probable future recovery from customers will occur. If rate recovery
is no longer probable, due to competition or the actions of regulators, the
44 Southwest Gas Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Company would be required to write off the related regulatory asset. Refer to
Note 4 of the Notes to Consolidated Financial Statements for a list of
regulatory assets.
- - The income tax calculations of the Company require estimates due to regulatory
complications, the multiple states in which the Company operates, and future
tax rate changes. The Company uses the asset and liability method of
accounting for income taxes. Under the asset and liability method, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. A change in the regulatory treatment, or
significant changes in tax-related estimates or assumptions, could have a
material impact on the financial position and results of operations of the
Company.
- - Depreciation is computed at composite rates considered sufficient to amortize
costs over the estimated remaining lives of assets, and includes adjustments
for the cost of removal, and salvage value. Depreciation studies are performed
periodically and prospective changes in rates are estimated to make up for
past differences. These studies are reviewed and approved by the appropriate
regulatory agency. Changes in estimates of depreciable lives or changes in
depreciation rates mandated by regulations could effect the results of
operations of the Company in periods subsequent to the change.
Management believes that regulation and the effects of regulatory accounting
have the most significant impact on the financial statements. When Southwest
files rate cases, capital assets, costs and gas purchasing practices are subject
to review, and disallowances could occur. Regulatory disallowances in the past
have not been frequent but have on occasion been significant to the operating
results of the Company.
FORWARD-LOOKING STATEMENTS
This annual 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, customer growth rates, natural gas prices, the
effects of regulation/deregulation, the timing and amount of rate relief,
changes in gas procurement practices, changes in capital requirements and
funding, resolution of pending litigation, acquisitions, and competition.
Southwest Gas Corporation 45
COMMON STOCK PRICE AND DIVIDEND INFORMATION
<Table>
<Caption>
2001 2000 DIVIDENDS PAID
------------------ ------------------ ------------------
HIGH LOW HIGH LOW 2001 2000
- -----------------------------------------------------------------------------------------------------------------
First Quarter $22.60 $19.81 $23.00 $17.06 $0.205 $0.205
Second Quarter 24.29 20.18 20.19 17.50 0.205 0.205
Third Quarter 24.38 18.85 21.25 16.88 0.205 0.205
Fourth Quarter 23.00 20.50 22.50 19.31 0.205 0.205
- -----------------------------------------------------------------------------------------------------------------
$0.820 $0.820
=================================================================================================================
</Table>
The principal markets on which the common stock of the Company is traded are the
New York Stock Exchange and the Pacific Stock Exchange. At March 11, 2002, there
were 23,003 holders of record of common stock and the market price of the common
stock was $23.73.
46 Southwest Gas Corporation
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31 2001 2000
- --------------------------------------------------------------------------------------------
(Thousands of dollars, except par value)
ASSETS
Utility plant:
Gas plant $2,561,937 $2,369,697
Less: accumulated depreciation (789,751) (728,466)
Acquisition adjustments, net 2,894 3,124
Construction work in progress 50,491 41,727
- --------------------------------------------------------------------------------------------
Net utility plant (Note 2) 1,825,571 1,686,082
- --------------------------------------------------------------------------------------------
Other property and investments 92,511 91,685
- --------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents 32,486 19,955
Accounts receivable, net of allowances (Note 3) 155,382 135,609
Accrued utility revenue 63,773 57,873
Taxes receivable, net 26,697 13,394
Deferred purchased gas costs (Note 4) 83,501 92,064
Prepaids and other current assets (Note 4) 38,310 84,334
- --------------------------------------------------------------------------------------------
Total current assets 400,149 403,229
- --------------------------------------------------------------------------------------------
Deferred charges and other assets (Note 4) 51,381 51,341
- --------------------------------------------------------------------------------------------
Total assets $2,369,612 $2,232,337
============================================================================================
</Table>
The accompanying notes are an integral part of these statements.
Southwest Gas Corporation 47
<Table>
<Caption>
DECEMBER 31 2001 2000
- --------------------------------------------------------------------------------------------
(Thousands of dollars, except par value)
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $1 par (authorized - 45,000,000 shares;
issued and outstanding - 32,492,832 and 31,710,004
shares) $ 34,123 $ 33,340
Additional paid-in capital 470,410 454,132
Retained earnings 56,667 45,995
- --------------------------------------------------------------------------------------------
Total common equity 561,200 533,467
Company-obligated mandatorily redeemable preferred
securities of the Company's subsidiary, Southwest Gas
Capital I, holding solely $61.8 million principal amount
of 9.125% subordinated notes of the Company due 2025
(Note 5) 60,000 60,000
Long-term debt, less current maturities (Note 6) 796,351 896,417
- --------------------------------------------------------------------------------------------
Total capitalization 1,417,551 1,489,884
- --------------------------------------------------------------------------------------------
Commitments and contingencies (Note 8)
Current liabilities:
Current maturities of long-term debt (Note 6) 307,641 8,139
Short-term debt (Note 7) 93,000 131,000
Accounts payable 109,167 194,679
Customer deposits 30,288 29,039
Accrued taxes 32,069 -
Accrued interest 20,423 15,702
Deferred income taxes (Note 10) 24,154 48,965
Other current liabilities 36,299 54,006
- --------------------------------------------------------------------------------------------
Total current liabilities 653,041 481,530
- --------------------------------------------------------------------------------------------
Deferred income taxes and other credits:
Deferred income taxes and investment tax credits (Note 10) 217,804 204,168
Other deferred credits (Note 4) 81,216 56,755
- --------------------------------------------------------------------------------------------
Total deferred income taxes and other credits 299,020 260,923
- --------------------------------------------------------------------------------------------
Total capitalization and liabilities $2,369,612 $2,232,337
============================================================================================
</Table>
The accompanying notes are an integral part of these statements.
48 Southwest Gas Corporation
CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
Operating revenues:
Gas operating revenues $1,193,102 $ 870,711 $791,155
Construction revenues 203,586 163,376 145,711
- ----------------------------------------------------------------------------------------------------------
Total operating revenues 1,396,688 1,034,087 936,866
- ----------------------------------------------------------------------------------------------------------
Operating expenses:
Net cost of gas sold 677,547 394,711 330,031
Operations and maintenance 253,026 231,175 221,258
Depreciation and amortization 118,448 106,640 98,525
Taxes other than income taxes 32,780 29,819 27,610
Construction expenses 180,904 143,112 128,230
- ----------------------------------------------------------------------------------------------------------
Total operating expenses 1,262,705 905,457 805,654
- ----------------------------------------------------------------------------------------------------------
Operating income 133,983 128,630 131,212
- ----------------------------------------------------------------------------------------------------------
Other income and (expenses):
Net interest deductions (80,731) (70,671) (63,202)
Preferred securities distributions (Note 5) (5,475) (5,475) (5,475)
Other income (deductions) 8,964 (545) (1,580)
- ----------------------------------------------------------------------------------------------------------
Total other income and (expenses) (77,242) (76,691) (70,257)
- ----------------------------------------------------------------------------------------------------------
Income before income taxes 56,741 51,939 60,955
Income tax expense (Note 10) 19,585 13,628 21,645
- ----------------------------------------------------------------------------------------------------------
Net income $ 37,156 $ 38,311 $ 39,310
==========================================================================================================
Basic earnings per share (Note 12) $ 1.16 $ 1.22 $ 1.28
==========================================================================================================
Diluted earnings per share (Note 12) $ 1.15 $ 1.21 $ 1.27
==========================================================================================================
Average number of common shares outstanding 32,122 31,371 30,690
Average shares outstanding (assuming dilution) 32,398 31,575 30,965
==========================================================================================================
</Table>
The accompanying notes are an integral part of these statements.
Southwest Gas Corporation 49
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------
(Thousands of dollars)
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 37,156 $ 38,311 $ 39,310
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 118,448 106,640 98,525
Deferred income taxes (11,175) 80,836 (19,996)
Changes in current assets and liabilities:
Accounts receivable, net of allowances (19,773) (47,133) (439)
Accrued utility revenue (5,900) (1,500) 500
Deferred purchased gas costs 8,563 (83,013) 48,544
Accounts payable (85,512) 130,432 (48)
Accrued taxes 18,766 (54,005) 7,131
Other current assets and liabilities 34,051 (44,917) 2,737
Other 28,128 (344) 2,296
- ---------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 122,752 125,307 178,560
- ---------------------------------------------------------------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES:
Construction expenditures and property additions (265,580) (223,240) (229,503)
Other 4,318 3,923 3,521
- ---------------------------------------------------------------------------------------------------------
Net cash used in investing activities (261,262) (219,317) (225,982)
- ---------------------------------------------------------------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock, net 17,061 15,595 14,997
Dividends paid (26,323) (25,715) (25,164)
Issuance of long-term debt, net 213,026 45,101 53,348
Retirement of long-term debt, net (14,723) (8,142) (6,168)
Change in short-term debt (38,000) 70,000 9,000
- ---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 151,041 96,839 46,013
- ---------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents 12,531 2,829 (1,409)
Cash at beginning of period 19,955 17,126 18,535
- ---------------------------------------------------------------------------------------------------------
Cash at end of period $ 32,486 $ 19,955 $ 17,126
=========================================================================================================
Supplemental information:
Interest paid, net of amounts capitalized $ 74,032 $ 67,638 $ 61,321
=========================================================================================================
Income taxes paid (received), net $ 13,186 $ (13,417) $ 30,090
=========================================================================================================
</Table>
The accompanying notes are an integral part of these statements.
50 Southwest Gas Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
COMMON STOCK ADDITIONAL
------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
- -----------------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
DECEMBER 31, 1998 30,410 $32,040 $424,840 $ 19,520 $476,400
Common stock issuances 575 575 14,422 14,997
Net income 39,310 39,310
Dividends declared Common: $0.82 per
share.................................... (25,282) (25,282)
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999 30,985 32,615 439,262 33,548 505,425
Common stock issuances 725 725 14,870 15,595
Net income 38,311 38,311
Dividends declared Common: $0.82 per share (25,864) (25,864)
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2000 31,710 33,340 454,132 45,995 533,467
Common stock issuances 783 783 16,278 17,061
Net income 37,156 37,156
Dividends declared Common: $0.82 per share (26,484) (26,484)
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001 32,493* $34,123 $470,410 $ 56,667 $561,200
=================================================================================================================
</Table>
* At December 31, 2001, 1.9 million common shares were registered and available
for issuance under provisions of the Employee Investment Plan, the Stock
Incentive Plan, the Management Incentive Plan, and the Dividend Reinvestment
and Stock Purchase Plan.
The accompanying notes are an integral part of these statements.
Southwest Gas Corporation 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. 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. (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 Company follows generally accepted accounting
principles (GAAP) in accounting for all of its businesses. Accounting for the
natural gas utility operations conforms with GAAP as applied to regulated
companies and as prescribed by federal agencies and the commissions of the
various states in which the utility operates. The preparation of financial
statements in conformity with GAAP 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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Consolidation. The accompanying financial statements are presented on a
consolidated basis and include the accounts of Southwest Gas Corporation and all
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated with the exception of transactions between
Southwest and Northern in accordance with Statement of Financial Accounting
Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of
Regulation."
Net Utility Plant. Net utility plant includes gas plant at original cost, less
the accumulated provision for depreciation and amortization, plus the
unamortized balance of acquisition adjustments. Original cost includes
contracted services, material, payroll and related costs such as taxes and
benefits, general and administrative expenses, and an allowance for funds used
during construction less contributions in aid of construction.
Deferred Purchased Gas Costs. The various regulatory commissions have
established procedures to enable Southwest to adjust its billing rates for
changes in the cost of gas purchased. The difference between the current cost of
gas purchased and the cost of gas recovered in billed rates is deferred.
Generally, these deferred amounts are recovered or refunded within one year.
Income Taxes. The Company uses the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
52 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date.
For regulatory and financial reporting purposes, investment tax credits (ITC)
related to gas utility operations are deferred and amortized over the life of
related fixed assets.
Gas Operating Revenues. Revenues are recorded when customers are billed.
Customer billings are based on monthly meter reads and are calculated in
accordance with applicable tariffs. Southwest also recognizes accrued utility
revenues for the estimated amount of services rendered between the meter-reading
dates in a particular month and the end of such month.
Construction Revenues. The majority of the Northern contracts are performed
under unit price contracts. These contracts state prices per unit of
installation. Revenues are recorded as installations are completed. Fixed-price
contracts use the percentage-of-completion method of accounting and, therefore,
take into account the cost, estimated earnings, and revenue to date on contracts
not yet completed. The amount of revenue recognized is based on costs expended
to date relative to anticipated final contract costs. Revisions in estimates of
costs and earnings during the course of the work are reflected in the accounting
period in which the facts requiring revision become known. If a loss on a
contract becomes known or is anticipated, the entire amount of the estimated
ultimate loss is recognized at that time in the financial statements.
Depreciation and Amortization. Utility plant depreciation is computed on the
straight-line remaining life method at composite rates considered sufficient to
amortize costs over estimated service lives, including components which adjust
for salvage value and removal costs, as approved by the appropriate regulatory
agency. When plant is retired from service, the original cost of plant,
including cost of removal, less salvage, is charged to the accumulated provision
for depreciation. Acquisition adjustments are amortized, as ordered by
regulators, over periods which approximate the remaining estimated life of the
acquired properties. Costs related to refunding utility debt and debt issuance
expenses are deferred and amortized over the weighted-average lives of the new
issues. Other regulatory assets, when appropriate, are amortized over time
periods authorized by regulators. Nonutility property and equipment are
depreciated on a straight-line method based on the estimated useful lives of the
related assets. Goodwill amortization for each of the last three years has been
$400,000. Pursuant to Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets," goodwill amortization will be
eliminated as of January 2002.
Allowance for Funds Used During Construction (AFUDC). AFUDC represents the cost
of both debt and equity funds used to finance utility construction. AFUDC is
capitalized as part of the cost of utility plant. The Company capitalized $2.5
million in 2001, $1.6 million in 2000, and $2.3 million in 1999 of AFUDC related
to natural gas utility operations. The debt portion of AFUDC is reported in the
consolidated statements of income as an offset to net interest deductions and
the equity portion is reported as other income. Utility plant construction
costs, including
Southwest Gas Corporation 53
AFUDC, are recovered in authorized rates through depreciation when completed
projects are placed into operation, and general rate relief is requested and
granted.
Earnings Per Share. Basic earnings per share (EPS) are calculated by dividing
net income by the weighted-average number of shares outstanding during the
period. Diluted EPS includes additional weighted-average common stock
equivalents (stock options and performance shares). Unless otherwise noted, the
term "Earnings Per Share" refers to Basic EPS. A reconciliation of the shares
used in the Basic and Diluted EPS calculations is shown in the following table.
Net income was the same for Basic and Diluted EPS calculations.
<Table>
<Caption>
2001 2000 1999
- ------------------------------------------------------------------------------------------------
(In thousands)
Average basic shares 32,122 31,371 30,690
Effect of dilutive securities
Stock options 122 85 176
Performance shares 154 119 99
- ------------------------------------------------------------------------------------------------
Average diluted shares 32,398 31,575 30,965
- ------------------------------------------------------------------------------------------------
</Table>
Cash Flows. For purposes of reporting consolidated cash flows, cash and cash
equivalents include cash on hand and financial instruments with a maturity of
three months or less, but exclude funds held in trust from the issuance of
industrial development revenue bonds (IDRB).
NOTE 2. UTILITY PLANT
Net utility plant as of December 31, 2001 and 2000 was as follows (thousands of
dollars):
<Table>
<Caption>
DECEMBER 31 2001 2000
- --------------------------------------------------------------------------------------------
Gas plant:
Storage $ 3,992 $ 3,927
Transmission 187,393 183,842
Distribution 2,104,006 1,920,357
General 188,998 188,686
Other 77,548 72,885
- --------------------------------------------------------------------------------------------
2,561,937 2,369,697
Less: accumulated depreciation (789,751) (728,466)
Acquisition adjustments, net 2,894 3,124
Construction work in progress 50,491 41,727
- --------------------------------------------------------------------------------------------
Net utility plant $1,825,571 $1,686,082
============================================================================================
</Table>
Depreciation and amortization expense on gas plant was $102 million in 2001,
$92.4 million in 2000, and $85.6 million in 1999.
54 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Leases and Rentals. Southwest leases the liquefied natural gas (LNG) facilities
on its northern Nevada system, a portion of its corporate headquarters office
complex in Las Vegas, and its administrative offices in Phoenix. The leases
provide for current terms which expire in 2003, 2017, and 2009, respectively,
with optional renewal terms available at the expiration dates. The final rental
payments for the LNG facilities are $6.7 million due in 2002 with the lease
expiring in January 2003. The rental payments for the corporate headquarters
office complex are $1.8 million in 2002, $1.9 million in 2003, $2 million in
each of the years 2004 through 2006, and $22.3 million cumulatively thereafter.
The rental payments for the Phoenix administrative offices are $1.3 million for
each of the years 2002 and 2003, $1.4 million in 2004, $1.5 million for each of
the years 2005 and 2006, and $4 million cumulatively thereafter. In addition to
the above, the Company leases certain office and construction equipment. The
majority of these leases are short-term. These leases are accounted for as
operating leases, and for the gas segment are treated as such for regulatory
purposes. Rentals included in operating expenses for all operating leases were
$28 million in 2001, $25.7 million in 2000, and $24.7 million in 1999. These
amounts include Northern lease expenses of approximately $12.6 million in 2001,
$9.2 million in 2000, and $8.4 million in 1999 for various short-term leases of
equipment and temporary office sites.
The following is a schedule of future minimum lease payments for noncancellable
operating leases (with initial or remaining terms in excess of one year) as of
December 31, 2001 (thousands of dollars):
<Table>
<Caption>
YEAR ENDING DECEMBER 31
- -------------------------------------------------------------------------
2002 $12,101
2003 4,891
2004 4,540
2005 4,265
2006 3,837
Thereafter 26,689
- -------------------------------------------------------------------------
Total minimum lease payments $56,323
=========================================================================
</Table>
NOTE 3. RECEIVABLES AND RELATED ALLOWANCES
Business activity with respect to gas utility operations is conducted with
customers located within the three-state region of Arizona, Nevada, and
California. At December 31, 2001, the gas utility customer accounts receivable
balance was $124 million. Approximately 56 percent of the gas utility customers
were in Arizona, 35 percent in Nevada, and 9 percent in California. Although the
Company seeks to minimize its credit risk related to utility operations by
requiring security deposits from new customers, imposing late fees, and actively
pursuing collection on overdue accounts, some accounts are ultimately not
collected. Provisions for uncollectible accounts are recorded
Southwest Gas Corporation 55
monthly, as needed, and are included in the ratemaking process as a cost of
service. Activity in the allowance for uncollectibles is summarized as follows
(thousands of dollars):
<Table>
<Caption>
ALLOWANCE FOR
UNCOLLECTIBLES
- -----------------------------------------------------------------------------------
Balance, December 31, 1998 $ 1,345
Additions charged to expense 1,897
Accounts written off, less recoveries (1,512)
- -----------------------------------------------------------------------------------
Balance, December 31, 1999 1,730
Additions charged to expense 1,036
Accounts written off, less recoveries (1,202)
- -----------------------------------------------------------------------------------
Balance, December 31, 2000 1,564
Additions charged to expense 3,874
Accounts written off, less recoveries (3,567)
- -----------------------------------------------------------------------------------
Balance, December 31, 2001 $ 1,871
===================================================================================
</Table>
NOTE 4. REGULATORY ASSETS AND LIABILITIES
Natural gas operations are subject to the regulation of the Arizona Corporation
Commission (ACC), the Public Utilities Commission of Nevada (PUCN), the
California Public Utilities Commission (CPUC), and the Federal Energy Regulatory
Commission (FERC). Company accounting policies conform to generally accepted
accounting principles applicable to rate-regulated enterprises, principally SFAS
No. 71, and reflect the effects of the ratemaking process. SFAS No. 71 allows
for the deferral as regulatory assets, costs that otherwise would have been
expensed if it is probable future recovery from customers will occur. If rate
recovery is no longer probable, due to competition or the actions of regulators,
Southwest would be required to write off the related regulatory asset.
The following table represents existing regulatory assets and liabilities
(thousands of dollars):
<Table>
<Caption>
DECEMBER 31 2001 2000
- ----------------------------------------------------------------------------------------
Regulatory assets:
Deferred purchased gas costs $ 83,501 $ 92,064
Accrued purchased gas costs* - 56,400
SFAS No. 109 - Income taxes, net 4,434 5,365
Unamortized premium on reacquired debt 13,607 14,516
Other 29,063 25,169
- ----------------------------------------------------------------------------------------
130,605 193,514
Regulatory liabilities (342) (1,587)
- ----------------------------------------------------------------------------------------
Net regulatory assets $130,263 $191,927
========================================================================================
</Table>
* Included in Prepaids and other current assets on the Consolidated Balance
Sheet.
56 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5. PREFERRED SECURITIES
Preferred Securities of Southwest Gas Capital I. In October 1995, Southwest Gas
Capital I (the Trust), a consolidated wholly owned subsidiary of the Company,
issued $60 million of 9.125% Trust Originated Preferred Securities (the
Preferred Securities). In connection with the Trust issuance of the Preferred
Securities and the related purchase by the Company of all of the Trust common
securities (the Common Securities), the Company issued to the Trust $61.8
million principal amount of its 9.125% Subordinated Deferrable Interest Notes,
due 2025 (the Subordinated Notes). The sole assets of the Trust are and will be
the Subordinated Notes. The interest and other payment dates on the Subordinated
Notes correspond to the distribution and other payment dates on the Preferred
Securities and Common Securities. Under certain circumstances, the Subordinated
Notes may be distributed to the holders of the Preferred Securities and holders
of the Common Securities in liquidation of the Trust. The Subordinated Notes
became redeemable at the option of the Company on December 31, 2000, and may be
redeemed at any time at a redemption price of $25 per Subordinated Note plus
accrued and unpaid interest. In the event that the Subordinated Notes are
repaid, the Preferred Securities and the Common Securities will be redeemed on a
pro rata basis at $25 per Preferred Security and Common Security plus
accumulated and unpaid distributions. Company obligations under the Subordinated
Notes, the Declaration of Trust (the agreement under which the Trust was
formed), the guarantee of payment of certain distributions, redemption payments
and liquidation payments with respect to the Preferred Securities to the extent
the Trust has funds available therefore and the indenture governing the
Subordinated Notes, including the Company agreement pursuant to such indenture
to pay all fees and expenses of the Trust, other than with respect to the
Preferred Securities and Common Securities, taken together, constitute a full
and unconditional guarantee on a subordinated basis by the Company of payments
due on the Preferred Securities. As of December 31, 2001, 2.4 million Preferred
Securities were outstanding.
The Company has the right to defer payments of interest on the Subordinated
Notes by extending the interest payment period at any time for up to 20
consecutive quarters (each, an Extension Period). If interest payments are so
deferred, distributions will also be deferred. During such Extension Period,
distributions will continue to accrue with interest thereon (to the extent
permitted by applicable law) at an annual rate of 9.125% per annum compounded
quarterly. There could be multiple Extension Periods of varying lengths
throughout the term of the Subordinated Notes. If the Company exercises the
right to extend an interest payment period, the Company shall not during such
Extension Period (i) declare or pay dividends on, or make a distribution with
respect to, or redeem, purchase or acquire or make a liquidation payment with
respect to, any of its capital stock, or (ii) make any payment of interest,
principal or premium, if any, on or repay, repurchase, or redeem any debt
securities issued by the Company that rank equal with or junior to the
Subordinated Notes; provided, however, that restriction (i) above does not apply
to any stock dividends paid by the Company where the dividend stock is the same
as that on which the dividend is being paid. The Company has no present
intention of exercising its right to extend the interest payment period.
Southwest Gas Corporation 57
NOTE 6. LONG-TERM DEBT
<Table>
<Caption>
2001 2000
------------------------ ----------------------
CARRYING MARKET CARRYING MARKET
DECEMBER 31 AMOUNT VALUE AMOUNT VALUE
- ------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Debentures:
9 3/4% Series F, due 2002 $ 100,000 $102,868 $100,000 $103,855
7 1/2% Series, due 2006 75,000 79,277 75,000 76,939
8% Series, due 2026 75,000 78,343 75,000 74,139
Notes, 8.375%, due 2011 200,000 218,794 - -
Medium-term notes, 7.59% series, due 2017 25,000 25,555 25,000 24,263
Medium-term notes, 7.75% series, due 2005 25,000 26,812 25,000 25,607
Medium-term notes, 7.78% series, due 2022 25,000 25,124 25,000 23,793
Medium-term notes, 7.92% series, due 2027 25,000 25,327 25,000 23,945
Medium-term notes, 6.89% series, due 2007 17,500 17,973 17,500 17,006
Medium-term notes, 6.76% series, due 2027 7,500 6,813 7,500 6,254
Medium-term notes, 6.27% series, due 2008 25,000 24,865 25,000 23,318
Unamortized discount (5,103) - (2,872) -
- ------------------------------------------------------------------------------------------------------------
594,897 397,128
- ------------------------------------------------------------------------------------------------------------
Revolving credit facility 200,000 200,000 200,000 200,000
- ------------------------------------------------------------------------------------------------------------
Industrial development revenue bonds:
Variable-rate bonds:
Tax-exempt Series A, due 2028 50,000 50,000 50,000 50,000
Taxable Series B, due 2038 - - 8,270 8,270
Less: funds held in trust - - (3,645) -
- ------------------------------------------------------------------------------------------------------------
50,000 54,625
- ------------------------------------------------------------------------------------------------------------
Fixed-rate bonds:
7.30% 1992 Series A, due 2027 30,000 30,900 30,000 31,116
7.50% 1992 Series B, due 2032 100,000 103,000 100,000 103,861
6.50% 1993 Series A, due 2033 75,000 75,000 75,000 73,988
6.10% 1999 Series A, due 2038 12,410 13,310 12,410 13,270
5.95% 1999 Series C, due 2038 14,320 15,287 14,320 14,985
5.55% 1999 Series D, due 2038 8,270 8,311 - -
Unamortized discount (3,276) - (3,384) -
- ------------------------------------------------------------------------------------------------------------
236,724 228,346
- ------------------------------------------------------------------------------------------------------------
Other 22,371 - 24,457 -
- ------------------------------------------------------------------------------------------------------------
1,103,992 904,556
Less: current maturities (307,641) (8,139)
- ------------------------------------------------------------------------------------------------------------
Long-term debt, less current maturities $ 796,351 $896,417
============================================================================================================
</Table>
58 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company has a $350 million revolving credit agreement, which bears interest
at either the London Interbank Offering Rate (LIBOR) plus or minus a competitive
margin, or the greater of the prime rate or one half of one percent plus the
Federal Funds rate. Any amounts borrowed under the revolving credit agreement
become payable in June 2002. The Company has designated $200 million of the
total facility as long-term debt and uses the remaining $150 million for working
capital purposes and has designated the related outstanding amounts as
short-term debt.
The interest rate on the taxable variable-rate IDRBs averaged 5.32 percent in
2001 and 7.01 percent in 2000. The interest rate on the tax-exempt variable-rate
IDRBs averaged 3.81 percent in 2001 and 4.66 percent in 2000. The rates for the
variable-rate IDRBs are established on a weekly basis. The Company has the
option to convert from the current weekly rates to daily rates, term rates, or
variable-term rates.
The fair value of the revolving credit facility approximates carrying value.
Market values for the debentures and fixed-rate IDRBs were determined based on
dealer quotes using trading records for December 31, 2001 and 2000, as
applicable, and other secondary sources which are customarily consulted for data
of this kind. The carrying values of variable-rate IDRBs were used as estimates
of fair value based upon the variable interest rates of the bonds.
In June 2002, the $350 million revolving credit facility, of which $200 million
is designated as long-term debt, and the $100 million Series F debentures will
mature. The Company intends to refinance the long-term portion of the revolving
credit agreement and the Series F debentures on a long-term basis but no firm
agreements are in place at this time. The timing, types, and amounts of these
external financings will be dependent on conditions in the capital markets.
Estimated maturities of long-term debt for the next five years are $308 million,
$6.2 million, $6.2 million, $27.3 million, and $75 million, respectively.
NOTE 7. SHORT-TERM DEBT
As discussed in Note 6, a portion of the $350 million revolving credit facility
is designated as short-term debt. This facility expires in June 2002. Short-term
borrowings were $93 million and $131 million at December 31, 2001 and 2000,
respectively. The weighted-average interest rates on these borrowings were 2.47
percent for 2001 and 7.12 percent for 2000.
In November 2000, the Company obtained another $75 million revolving credit
facility, bearing interest at either the LIBOR plus or minus a competitive
margin, or the greater of the prime rate or one half of one percent plus the
Federal Funds rate. This revolving credit agreement expired in November 2001 and
was not renewed.
NOTE 8. COMMITMENTS AND CONTINGENCIES
Legal and Regulatory Proceedings. In connection with an attempted merger and
subsequent termination, the Company is a party to various legal proceedings. The
Company has also been named as defendant in other miscellaneous legal
proceedings. The Company is a party to various regulatory proceedings. The
ultimate dispositions of these proceedings are not presently determinable;
however, it is the opinion of management that no litigation or regulatory
proceeding to which the Company is subject will have a material adverse impact
on its financial position or results of operations.
Southwest Gas Corporation 59
NOTE 9. EMPLOYEE BENEFITS
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.
The following tables set forth the qualified retirement plan and PBOP funded
status and amounts recognized on the Consolidated Balance Sheets and Statements
of Income.
<Table>
<Caption>
QUALIFIED
RETIREMENT PLAN PBOP
---------------------- ----------------------
2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
CHANGE IN BENEFIT OBLIGATIONS
Benefit obligation for service rendered to date at
beginning of year (PBO/APBO) $262,981 $236,618 $ 26,245 $ 24,882
Service cost 11,057 10,455 591 558
Interest cost 18,805 16,919 1,856 1,762
Actuarial loss (gain) 2,403 5,489 812 193
Benefits paid (7,200) (6,500) (1,300) (1,150)
- -------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year (PBO/APBO) $288,046 $262,981 $ 28,204 $ 26,245
=============================================================================================================
CHANGE IN PLAN ASSETS
Market value of plan assets at beginning of year $281,280 $271,880 $ 10,958 $ 8,946
Actual return on plan assets 23 15,900 218 559
Employer contributions - - 1,226 1,453
Benefits paid (7,200) (6,500) - -
- -------------------------------------------------------------------------------------------------------------
Market value of plan assets at end of year $274,103 $281,280 $ 12,402 $ 10,958
=============================================================================================================
Funded status $(13,943) $ 18,299 $(15,802) $(15,287)
Unrecognized net actuarial loss (gain) (10,698) (39,029) 2,367 513
Unrecognized transition obligation (2004/2012) 1,632 2,469 9,537 10,404
Unrecognized prior service cost 123 180 - -
- -------------------------------------------------------------------------------------------------------------
Prepaid (accrued) benefit cost $(22,886) $(18,081) $ (3,898) $ (4,370)
=============================================================================================================
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31,
Discount rate 7.25% 7.25% 7.25% 7.25%
Expected return on plan assets 9.25% 9.00% 9.25% 9.00%
Rate of compensation increase 4.75% 4.75% 4.75% 4.75%
=============================================================================================================
</Table>
For PBOP measurement purposes, a 5.5 percent annual rate of increase in the per
capita cost of covered health care benefits is assumed for 2002. The rate is
assumed to decrease one-half of one percent in 2003, at which time the average
annual increase is projected to be five percent. The Company makes fixed
contributions for health care benefits of employees who retire after 1988, but
pays up to 100 percent of covered health care costs for employees
60 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
who retired prior to 1989. The assumed annual rate of increase noted above
applies to the benefit obligations of pre-1989 retirees only.
COMPONENTS OF NET PERIODIC BENEFIT COST
<Table>
<Caption>
QUALIFIED
RETIREMENT PLAN PBOP
------------------------------------ -------------------------------
2001 2000 1999 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Service cost $ 11,057 $ 10,455 $ 9,976 $ 591 $ 558 $ 572
Interest cost 18,805 16,919 15,406 1,856 1,762 1,643
Expected return on plan assets (25,383) (22,681) (20,266) (1,073) (858) (664)
Amortization of prior service costs 57 57 58 - - -
Amortization of unrecognized
transition obligation 837 837 837 867 867 867
Amortization of net (gain) loss (568) (694) - - - -
- ------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 4,805 $ 4,893 $ 6,011 $ 2,241 $2,329 $2,418
==================================================================================================================
</Table>
In addition to the qualified retirement plan, Southwest has a separate unfunded
supplemental retirement plan which is limited to officers. The plan is
noncontributory with defined benefits. Plan costs were $2.9 million in 2001,
$2.2 million in 2000, and $2 million in 1999. The accumulated benefit obligation
of the plan was $20.6 million at December 31, 2001.
The Employees' Investment Plan provides for purchases of Company common stock or
certain other investments by eligible Southwest employees through deductions of
a percentage of base compensation, subject to IRS limitations. Southwest matches
one-half of amounts deferred. The maximum Company contribution is three percent
of an employee's annual compensation. The cost of the plan was $3 million in
2001, $3 million in 2000, and $2.8 million in 1999. Northern has a separate
plan, the cost and liability for which are not significant.
Southwest has a deferred compensation plan for all officers and members of the
Board of Directors. The plan provides the opportunity to defer up to 100 percent
of annual cash compensation. Southwest matches one-half of amounts deferred by
officers. The maximum Company contribution is three percent of an officer's
annual salary. Payments of compensation deferred, plus interest, are made in
equal monthly installments over 5, 10, 15, or 20 years, as elected by the
participant. Deferred compensation earns interest at a rate determined each
January. The interest rate equals 150 percent of Moody's Seasoned Corporate Bond
Index.
At December 31, 2001, the Company had two stock-based compensation plans. These
plans are accounted for in accordance with Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees." In connection with
the stock-based compensation plans, the Company recognized compensation expense
of $3.1 million in 2001, $970,000 in 2000, and $2.2 million in 1999. Had
compensation cost been determined based
Southwest Gas Corporation 61
on the fair value of the awards at the grant dates, net income and earnings per
share would have reflected the pro forma amounts indicated below (thousands of
dollars, except per share amounts):
<Table>
<Caption>
2001 2000 1999
- ---------------------------------------------------------------------------------------------------
Net income:
As reported $37,156 $38,311 $39,310
Pro forma 36,813 37,959 38,995
Basic earnings per share:
As reported 1.16 1.22 1.28
Pro forma 1.15 1.21 1.27
- ---------------------------------------------------------------------------------------------------
</Table>
With respect to the first plan, the Company may grant options to purchase shares
of common stock to key employees and outside directors. Each option has an
exercise price equal to the market price of Company common stock on the date of
grant and a maximum term of ten years. The options vest 40 percent at the end of
year one and 30 percent at the end of years two and three. The grant date fair
value of the options was estimated using the extended binomial option pricing
model. The following assumptions were used in the valuation calculation:
<Table>
<Caption>
2001 2000 1999
- --------------------------------------------------------------------------------------------------------------
Dividend yield 3.60% 3.90% 4.62%
Risk-free interest rate range 2.17 to 3.82% 4.74 to 4.86% 4.91 to 5.76%
Expected volatility range 22 to 27% 25 to 30% 22 to 28%
Expected life 1 to 3 years 1 to 3 years 1 to 3 years
- --------------------------------------------------------------------------------------------------------------
</Table>
The following tables summarize Company stock option plan activity and related
information (thousands of options):
<Table>
<Caption>
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF OPTIONS PRICE OF OPTIONS PRICE OF OPTIONS PRICE
- -------------------------------------------------------------------------------------------------------------------------------
Outstanding at the
beginning of the year 990 $ 18.94 704 $ 19.32 587 $ 17.38
Granted during the year 317 23.23 297 17.96 118 28.91
Exercised during the
year (184) 15.07 (7) 15.80 (1) 15.00
Forfeited during the
year - - (4) 17.94 - -
Expired during the year - - - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Outstanding at year end 1,123 $ 20.79 990 $ 18.94 704 $ 19.32
===============================================================================================================================
Exercisable at year end 597 $ 21.00 591 $ 24.18 481 $ 17.77
===============================================================================================================================
</Table>
The weighted-average grant-date fair value of options granted was $2.81 for
2001, $2.51 for 2000, and $4.34 for 1999. The exercise prices for the options
outstanding range from $15.00 to $28.94. On December 31, 2001, the options
outstanding had a weighted-average remaining contractual life of approximately
7.6 years.
62 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
In addition to the option plan, the Company may issue restricted stock in the
form of performance shares to encourage key employees to remain in its
employment to achieve short-term and long-term performance goals. Plan
participants are eligible to receive a cash bonus (i.e., short-term incentive)
and performances shares (i.e., long-term incentive). The performance shares vest
after three years from issuance and are subject to a final adjustment as
determined by the Board of Directors. The following table summarizes the
activity of this plan (thousands of shares):
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ------------------------------------------------------------------------------------------------------
Nonvested performance shares at beginning of year 237 193 172
Performance shares granted 142 111 83
Performance shares forfeited - (6) (1)
Shares vested and issued (65) (61) (61)
- ------------------------------------------------------------------------------------------------------
Nonvested performance shares at end of year 314 237 193
======================================================================================================
Average grant date fair value of award $ 19.91 $ 21.63 $ 26.63
======================================================================================================
</Table>
NOTE 10. INCOME TAXES
Income tax expense (benefit) consists of the following (thousands of dollars):
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ------------------------------------------------------------------------------------------------------
Current:
Federal $ 27,750 $(60,628) $ 33,152
State 2,078 (7,465) 6,736
- ------------------------------------------------------------------------------------------------------
29,828 (68,093) 39,888
- ------------------------------------------------------------------------------------------------------
Deferred:
Federal (9,902) 76,334 (15,126)
State (341) 5,387 (3,117)
- ------------------------------------------------------------------------------------------------------
(10,243) 81,721 (18,243)
- ------------------------------------------------------------------------------------------------------
Total income tax expense $ 19,585 $ 13,628 $ 21,645
======================================================================================================
</Table>
Deferred income tax expense consists of the following significant components
(thousands of dollars):
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- ------------------------------------------------------------------------------------------------------
Deferred federal and state:
Property-related items $ 19,560 $ 28,184 $ 11,405
Purchased gas cost adjustments (26,975) 56,321 (19,201)
Employee benefits (2,121) (3,687) (5,816)
Merger costs - 1,822 (1,822)
All other deferred 161 (51) (1,941)
- ------------------------------------------------------------------------------------------------------
Total deferred federal and state (9,375) 82,589 (17,375)
Deferred ITC, net (868) (868) (868)
- ------------------------------------------------------------------------------------------------------
Total deferred income tax expense $(10,243) $ 81,721 $(18,243)
======================================================================================================
</Table>
Southwest Gas Corporation 63
The consolidated effective income tax rate for the period ended December 31,
2001 and the two prior periods differs from the federal statutory income tax
rate. The sources of these differences and the effect of each are summarized as
follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2001 2000 1999
- -----------------------------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
Net state tax liability 3.2 2.9 3.0
Property-related items 1.5 1.7 1.4
Effect of closed tax years and resolved issues (4.4) (11.6) (1.8)
Tax credits (1.5) (1.7) (1.4)
Tax exempt interest - (0.3) (0.3)
Corporate owned life insurance (0.5) (0.8) (1.0)
All other differences 1.2 1.0 0.6
- -----------------------------------------------------------------------------------------------------
Consolidated effective income tax rate 34.5% 26.2% 35.5%
=====================================================================================================
</Table>
Deferred tax assets and liabilities consist of the following (thousands of
dollars):
<Table>
<Caption>
DECEMBER 31 2001 2000
- ----------------------------------------------------------------------------------------
Deferred tax assets:
Deferred income taxes for future amortization of ITC $ 9,280 $ 9,826
Employee benefits 23,214 21,093
Other 6,601 5,115
Valuation allowance - -
- ----------------------------------------------------------------------------------------
39,095 36,034
- ----------------------------------------------------------------------------------------
Deferred tax liabilities:
Property-related items, including accelerated depreciation 208,285 188,725
Regulatory balancing accounts 33,436 60,411
Property-related items previously flowed through 13,713 15,192
Unamortized ITC 14,668 15,536
Debt-related costs 4,792 5,104
Other 6,159 4,199
- ----------------------------------------------------------------------------------------
281,053 289,167
- ----------------------------------------------------------------------------------------
Net deferred tax liabilities $241,958 $253,133
========================================================================================
Current $ 24,154 $ 48,965
Noncurrent 217,804 204,168
- ----------------------------------------------------------------------------------------
Net deferred tax liabilities $241,958 $253,133
========================================================================================
</Table>
64 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11. SEGMENT INFORMATION
Company operating segments are determined based on the nature of their
activities. The natural gas operations segment is engaged in the business of
purchasing, transporting, and distributing natural gas. Revenues are generated
from the sale and transportation of natural gas. The construction services
segment is engaged in the business of providing utility companies with trenching
and installation, replacement, and maintenance services for energy distribution
systems.
The accounting policies of the reported segments are the same as those described
within Note 1 - Summary of Significant Accounting Policies. Northern accounts
for the services provided to Southwest at contractual (market) prices. At
December 31, 2001 and 2000, consolidated accounts receivable included $4.3
million and $5.2 million, respectively, which were not eliminated during
consolidation.
The financial information pertaining to the natural gas operations and
construction services segments for each of the three years in the period ended
December 31, 2001, is as follows (thousands of dollars):
<Table>
<Caption>
GAS CONSTRUCTION
2001 OPERATIONS SERVICES ADJUSTMENTS TOTAL
- -------------------------------------------------------------------------------------------------------------------
Revenues from unaffiliated customers $1,193,102 $ 135,655 $1,328,757
Intersegment sales - 67,931 67,931
- -------------------------------------------------------------------------------------------------------------------
Total $1,193,102 $ 203,586 $1,396,688
===================================================================================================================
Interest expense $ 78,746 $ 1,985 $ 80,731
===================================================================================================================
Depreciation and amortization $ 104,498 $ 13,950 $ 118,448
===================================================================================================================
Income tax expense $ 16,098 $ 3,487 $ 19,585
===================================================================================================================
Segment income $ 32,626 $ 4,530 $ 37,156
===================================================================================================================
Segment assets $2,289,111 $ 83,228 $ (2,727) $2,369,612
===================================================================================================================
Capital expenditures $ 248,352 $ 17,228 $ 265,580
===================================================================================================================
</Table>
<Table>
<Caption>
GAS CONSTRUCTION
2000 OPERATIONS SERVICES ADJUSTMENTS TOTAL
- -------------------------------------------------------------------------------------------------------------------
Revenues from unaffiliated customers $ 870,711 $ 107,686 $ 978,397
Intersegment sales - 55,690 55,690
- -------------------------------------------------------------------------------------------------------------------
Total $ 870,711 $ 163,376 $1,034,087
===================================================================================================================
Interest expense $ 68,892 $ 1,779 $ 70,671
===================================================================================================================
Depreciation and amortization $ 94,689 $ 11,951 $ 106,640
===================================================================================================================
Income tax expense $ 10,277 $ 3,351 $ 13,628
===================================================================================================================
Segment income $ 33,908 $ 4,403 $ 38,311
===================================================================================================================
Segment assets $2,154,641 $ 79,790 $ (2,094) $2,232,337
===================================================================================================================
Capital expenditures $ 205,161 $ 18,079 $ 223,240
===================================================================================================================
</Table>
Southwest Gas Corporation 65
<Table>
<Caption>
GAS CONSTRUCTION
1999 OPERATIONS SERVICES ADJUSTMENTS TOTAL
- -------------------------------------------------------------------------------------------------------------------
Revenues from unaffiliated customers $ 791,155 $ 95,744 $ 886,899
Intersegment sales - 49,967 49,967
- -------------------------------------------------------------------------------------------------------------------
Total $ 791,155 $ 145,711 $ 936,866
===================================================================================================================
Interest expense $ 61,597 $ 1,605 $ 63,202
===================================================================================================================
Depreciation and amortization $ 88,254 $ 10,271 $ 98,525
===================================================================================================================
Income tax expense $ 18,532 $ 3,113 $ 21,645
===================================================================================================================
Segment income $ 35,473 $ 3,837 $ 39,310
===================================================================================================================
Segment assets $1,855,114 $ 68,630 $ (302) $1,923,442
===================================================================================================================
Capital expenditures $ 207,773 $ 21,730 $ 229,503
===================================================================================================================
</Table>
Construction services segment assets include deferred tax assets of $2.5 million
in 2001, which were netted against gas operations segment deferred tax
liabilities during consolidation. Construction services segment liabilities
include taxes payable of $204,000 in 2001, which were netted against gas
operations segment tax receivable during consolidation. Construction services
segment assets include deferred tax assets of $2.1 million in 2000, which were
netted against gas operations segment deferred tax liabilities during
consolidation. Construction services segment assets include an income tax
receivable of $302,000 in 1999, which was netted against gas operations segment
accrued taxes during consolidation.
66 Southwest Gas Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12. QUARTERLY FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
QUARTER ENDED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- -----------------------------------------------------------------------------------------------------------------
(Thousands of dollars, except per share amounts)
2001
Operating revenues $487,498 $278,960 $ 246,094 $ 384,136
Operating income (loss) 74,106 1,111 (4,597) 63,363
Net income (loss) 33,809 (11,140) (16,488) 30,975
Basic earnings (loss) per common share* 1.06 (0.35) (0.51) 0.96
Diluted earnings (loss) per common share* 1.05 (0.35) (0.51) 0.95
2000
Operating revenues $296,815 $197,634 $ 198,962 $ 340,676
Operating income (loss) 56,619 2,583 (4,197) 73,625
Net income (loss) 25,198 (9,729) (9,680) 32,522
Basic earnings (loss) per common share* 0.81 (0.31) (0.31) 1.03
Diluted earnings (loss) per common share* 0.80 (0.31) (0.31) 1.02
1999
Operating revenues $308,025 $200,292 $ 166,289 $ 262,260
Operating income (loss) 62,725 11,530 (2,904) 59,861
Net income (loss) 28,266 (3,596) (14,188) 28,828
Basic earnings (loss) per common share* 0.93 (0.12) (0.46) 0.93
Diluted earnings (loss) per common share* 0.92 (0.12) (0.46) 0.93
=================================================================================================================
</Table>
* The sum of quarterly earnings (loss) per average common share may not equal
the annual earnings (loss) per share due to the ongoing change in the weighted
average number of common shares outstanding.
The demand for natural gas is seasonal, and it is the opinion of management that
comparisons of earnings for the interim periods do not reliably reflect overall
trends and changes in the operations of the Company. Also, the timing of general
rate relief can have a significant impact on earnings for interim periods. See
Management's Discussion and Analysis for additional discussion of operating
results.
Southwest Gas Corporation 67
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
Southwest Gas Corporation:
We have audited the accompanying consolidated balance sheets of Southwest Gas
Corporation (a California corporation) and its subsidiaries (the Company) as of
December 31, 2001 and 2000, and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Southwest Gas Corporation and
its subsidiaries as of December 31, 2001 and 2000, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
February 8, 2002
68 Southwest Gas Corporation
SHAREHOLDER INFORMATION
STOCK LISTING INFORMATION
Southwest Gas Corporation's common stock is listed on the New York Stock
Exchange under the ticker symbol "SWX." Quotes may be obtained in daily
financial newspapers or some local newspapers where it is listed under
"SoWestGas."
ANNUAL MEETING
The Annual Meeting of Shareholders will be held on May 9, 2002 at 10:00 a.m. at
the Rio Suites Hotel and Casino, I-15 and Flamingo Road, Las Vegas, Nevada.
DIVIDEND REINVESTMENT
AND STOCK PURCHASE PLAN
The Southwest Gas Corporation Dividend Reinvestment and Stock Purchase Plan
(DRSPP) provides common shareholders, customers, employees and residents of
Arizona, California and Nevada with a simple and convenient method of investing
cash dividends in additional shares of Company stock without payment of any
brokerage commission.
The DRSPP features include:
Initial investments of $100, up to $100,000 annually
Automatic investing
No commissions on purchases
Safekeeping for common stock certificates
For more information contact: Shareholder Services, Southwest Gas Corporation,
P. O. Box 98511, Las Vegas, NV 89193-8511 or call (702) 876-7280.
DIVIDENDS
Dividends on common stock are declared quarterly by
the Board of Directors. As a general rule, they are payable
on the first day of March, June, September and December.
INVESTOR RELATIONS
Southwest Gas Corporation is committed to providing relevant and complete
investment information to shareholders, individual investors and members of the
investment community. Additional copies of the Company's 2001 Annual Report on
Form 10-K, without exhibits, as filed with the Securities and Exchange
Commission may be obtained upon request free of charge. Additional financial
information may be obtained by contacting Ken Kenny, Investor Relations,
Southwest Gas Corporation, P. O. Box 98510, Las Vegas, NV 89193-8510 or by
calling (702) 876-7237.
Southwest Gas Corporation information is also available on the Internet at
www.swgas.com. For non-financial information, please call (702) 876-7011.
TRANSFER AGENT
Shareholder Services
Southwest Gas Corporation
P. O. Box 98511
Las Vegas, NV 89193-8511
REGISTRAR
Southwest Gas Corporation
P. O. Box 98510
Las Vegas, NV 89193-8510
AUDITORS
Arthur Andersen LLP
3773 Howard Hughes Pkwy
Suite 500 South
Las Vegas, Nevada 89109