1
CONSOLIDATED SELECTED FINANCIAL STATISTICS
(Thousands of dollars, except per share amounts)
Year Ended December 31, 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------
Operating revenues $ 644,061 $ 563,502 $ 599,553 $ 539,105 $ 534,390
Operating expenses 572,488 505,090 510,863 461,423 448,815
- ---------------------------------------------------------------------------------------------------------
Operating income $ 71,573 $ 58,412 $ 88,690 $ 77,682 $ 85,575
=========================================================================================================
Income from continuing operations $ 6,574 $ 2,654 $ 23,524 $ 13,751 $ 32,214
Income (loss) from discontinued
operations, net of tax (1) -- (17,536) 2,777 1,655 (14,553)
- ---------------------------------------------------------------------------------------------------------
Net income (loss) $ 6,574 $ (14,882) $ 26,301 $ 15,406 $ 17,661
=========================================================================================================
Net income (loss) applicable to
common stock $ 6,574 $ (15,189) $ 25,791 $ 14,665 $ 16,610
=========================================================================================================
Total assets at year end $ 1,560,269 $1,532,527 $ 1,453,582 $1,362,861 $1,265,380
=========================================================================================================
Capitalization at year end
Common equity $ 379,616 $ 356,050 $ 348,556 $ 335,117 $ 329,444
Preferred and preference stocks -- -- 4,000 8,058 15,316
Trust originated preferred
securities 60,000 60,000 -- -- --
Long-term debt 665,221 607,945 678,263 568,600 589,883
- ---------------------------------------------------------------------------------------------------------
$ 1,104,837 $1,023,995 $ 1,030,819 $ 911,775 $ 934,643
=========================================================================================================
Common stock data
Return on average common equity 1.8% (4.1)% 7.6% 4.4% 5.1%
Earnings (loss) per share
Continuing operations $ 0.25 $ 0.10 $ 1.09 $ 0.63 $ 1.51
Discontinued operations -- (0.76) 0.13 0.08 (0.70)
- ---------------------------------------------------------------------------------------------------------
Earnings (loss) per share $ 0.25 $ (0.66) $ 1.22 $ 0.71 $ 0.81
=========================================================================================================
Dividends paid per share $ 0.82 $ 0.82 $ 0.80 $ 0.74 $ 0.70
Payout ratio N/A N/A 66% 104% 86%
Book value per share at year end $ 14.20 $ 14.55 $ 16.38 $ 15.96 $ 15.99
Market value per share at year
end $ 19.25 $ 17.63 $ 14.13 $ 16.00 $ 13.75
Market value per share to book
value per share 136% 121% 86% 100% 86%
Common shares outstanding at year
end (000) 26,733 24,467 21,282 20,997 20,598
Number of common shareholders at
year end 26,371 25,133 20,765 21,851 22,943
Ratio of earnings to fixed charges
Continuing operations 1.10 1.06 1.69 1.47 2.21
Adjusted for interest allocated
to discontinued operations 1.10 1.05 1.61 1.40 2.03
- ------------------------------
(1) Contribution from Financial Services Segment, including 1995 loss on sale of
the Bank.
2
NATURAL GAS OPERATIONS
(Thousands of dollars)
Year Ended December 31, 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------
Sales $ 506,200 $ 524,914 $ 560,207 $ 503,789 $ 506,937
Transportation 40,161 38,588 39,061 34,361 27,190
Other -- -- 285 955 263
- ---------------------------------------------------------------------------------------------------------
Operating revenue 546,361 563,502 599,553 539,105 534,390
Net cost of gas purchased 187,580 227,456 249,922 212,290 214,293
- ---------------------------------------------------------------------------------------------------------
Operating margin 358,781 336,046 349,631 326,815 320,097
Expenses
Operations and maintenance 198,364 187,969 178,310 169,921 159,954
Depreciation and amortization 67,443 62,492 57,284 55,088 52,277
Other 28,156 27,173 25,347 24,124 22,291
- ---------------------------------------------------------------------------------------------------------
Operating income $ 64,818 $ 58,412 $ 88,690 $ 77,682 $ 85,575
=========================================================================================================
Contribution to consolidated net
income (loss) $ 3,919 $ 2,654 $ 23,524 $ 13,751 $ 32,214
=========================================================================================================
Total assets at year end $ 1,498,099 $1,357,034 $1,277,727 $1,194,679 $1,103,794
=========================================================================================================
Net gas plant at year end $ 1,278,457 $1,137,750 $1,035,916 $ 954,488 $ 906,420
=========================================================================================================
Construction expenditures and
property additions $ 210,742 $ 166,183 $ 141,390 $ 113,903 $ 102,517
=========================================================================================================
Cash flow, net
From operating activities $ 47,931 $ 97,754 $ 84,074 $ 50,437 $ 81,457
From investing activities (41,804) (163,718) (141,547) (116,246) (103,065)
From financing activities (11,456) 71,056 61,422 67,488 (7,792)
- ---------------------------------------------------------------------------------------------------------
Net change in cash $ (5,329) $ 5,092 $ 3,949 $ 1,679 $ (29,400)
=========================================================================================================
Total throughput (thousands of
therms)
Sales 818,329 805,884 881,868 850,557 825,521
Transportation 968,208 1,016,011 914,791 725,023 651,141
- ---------------------------------------------------------------------------------------------------------
Total throughput 1,786,537 1,821,895 1,796,659 1,575,580 1,476,662
=========================================================================================================
Weighted average cost of gas
purchased ($/therm) $ 0.27 $ 0.21 $ 0.30 $ 0.29 $ 0.26
Customers at year end 1,092,000 1,029,000 980,000 932,000 897,000
Employees at year end 2,424 2,383 2,359 2,318 2,285
Degree days -- actual (1) 1,896 1,781 2,091 2,097 1,908
Degree days -- ten year average (1) 2,033 2,021 2,068 2,064 2,043
- ------------------------------
(1) Prior years degree days are adjusted to reflect the current year customer
mix by rate jurisdiction.
3
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 its regulated natural gas
transmission and distribution activities and nonregulated activities. Also
discussed is the sale of PriMerit Bank, Federal Savings Bank (the Bank), which
is reported as discontinued operations.
CONTINUING OPERATIONS
The Company is principally engaged in the business of purchasing,
transporting, and distributing natural gas (Southwest or natural gas operations
segment). Southwest is the largest distributor in Arizona, selling and
transporting natural gas in most of southern, central, and northwestern Arizona,
including the Phoenix and Tucson metropolitan areas. Southwest is also the
largest distributor and transporter of natural gas in Nevada, and serves the Las
Vegas metropolitan area and northern Nevada. In addition, Southwest distributes
and transports natural gas in portions of California, including the Lake Tahoe
area in northern California and high desert and mountain areas in San Bernardino
County.
As of December 31, 1996, Southwest had 1,092,000 residential, commercial,
industrial, and other customers, of which 633,000 customers were located in
Arizona, 346,000 in Nevada, and 113,000 in California. Residential and
commercial customers represented over 99 percent of the total customer base.
During 1996, Southwest added 63,000 customers, a six percent increase, of which
28,000 customers were added in Arizona, 29,000 in Nevada, and 6,000 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 five percent in 1997. During 1996, 56 percent of
operating margin was earned in Arizona, 34 percent in Nevada, and 10 percent in
California. These patterns are consistent with prior years and are expected to
continue.
In April 1996, the Company acquired all of the outstanding stock of
Northern Pipeline Construction Co. (Northern or construction services segment)
pursuant to a definitive agreement dated November 1995. The Company issued
approximately 1,439,000 shares of common stock valued at $24 million in
connection with the acquisition. The acquisition was accounted for as a
purchase. Goodwill in the amount of approximately $10 million was recorded by
Northern and is being amortized over a period of approximately 25 years.
Northern provides utility companies with trenching and installation,
replacement, and maintenance services for energy distribution systems.
DISCONTINUED OPERATIONS
In January 1996, the Company signed a definitive agreement to sell the
Bank to Norwest Corporation for $175 million. The original agreement specified a
sale of Bank stock, however, the agreement provided for an alternative
permitting Norwest to purchase assets and assume liabilities. In April 1996,
Norwest elected the asset purchase alternative.
4
The disposition of the Bank resulted in a net loss of $13 million, which
included a pretax book loss of $3.1 million plus income taxes of $9.9 million.
The income taxes resulted because the Company's tax basis in the Bank was lower
than its book basis. The net loss was reported as loss on disposal of a
discontinued segment in the consolidated financial statements.
Shareholders of the Company voted on and approved the principal terms of
the sale at the annual meeting held in July 1996. The sale closed in July 1996.
Net proceeds of $163 million were used to pay down debt.
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 has been and continues to experience unprecedented population
growth throughout its service territories. This growth has required large
amounts of capital to finance the investment in infrastructure, in the form of
new transmission and distribution plant, to satisfy consumer demand. For
example, during the three-year period ended December 31, 1996, total gas plant
increased from $1.3 billion to $1.7 billion, or at an annual rate of nine
percent. More than 80 percent of 1996 construction expenditures represent new
construction and the balance represents costs associated with routine
replacement of existing transmission, distribution, and general plant.
The investment in gas plant has required capital resources in excess of
the amount of cash flow generated from operating activities (net of dividends
paid). During 1996, capital expenditures were $211 million. Cash flow from
operating activities (net of dividends) provided $27 million of the required
capital resources pertaining to these construction expenditures. The remainder
was provided from net external financing activities. Normally, internally
generated funds provide a larger proportionate share of capital resources
required for construction expenditures. However, cash flows from operating
activities were unfavorably impacted in 1996 by warmer than normal weather and
unusually high working capital requirements.
Southwest estimates construction expenditures during the three-year period
ending December 31, 1999 will be approximately $468 million. It is currently
estimated that cash flow from operating activities (net of dividends) will fund
approximately one-half of the gas operations' total construction expenditures
for the three-year period ending December 31, 1999. A portion of the
construction expenditure funding will be provided by $30 million of funds held
in trust at December 31, 1996, from the issuance of industrial development
revenue bonds. 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, and growth
factors in
5
Southwest's service areas. These external financings may include the issuance of
both debt and equity securities, bank and other short-term borrowings, and other
forms of financing. Due to the significant size of the current construction
program, differences between estimated and actual results are expected to occur.
Actual events, and the timing of those events, frequently do not occur as
expected, and can impact, favorably or unfavorably, anticipated cash flows.
In August 1996, the Company issued $75 million of 7 1/2 percent debentures
due 2006 and $75 million of 8 percent debentures due 2026. Net proceeds of $148
million as well as a portion of the $163 million net proceeds from the PriMerit
sale were used to refund or retire $219 million of outstanding callable
debentures and pay down short-term debt. The remaining amount was used for
general corporate purposes, including the acquisition of property for the
construction, completion, extension, and improvement of Southwest's pipeline
systems. The refinancing achieved a 126 basis point reduction in the related
average interest rate.
In October 1996, the Company filed a $250 million shelf registration
statement. In connection with this new registration statement, the Company may
offer, up to the registered amount, any combination of debt securities,
preferred stock, depositary shares, and common stock. This registration
statement includes a carryforward of $60 million remaining from a prior shelf
registration statement declared effective by the Securities and Exchange
Commission in October 1995. The Company filed a prospectus supplement in
December 1996 identifying $150 million of the shelf as medium-term notes. In
January 1997, the Company issued $25 million of 7.59 percent notes due January
2017. In February 1997, the Company issued $25 million of 7.78 percent notes due
February 2022.
Liquidity refers to the ability of an enterprise to generate adequate
amounts of cash to meet its cash requirements. General factors that could
significantly affect capital resources and liquidity in future years include
inflation, growth in the economy, changes in income tax laws, the level of
natural gas prices, interest rates, and changes in the ratemaking policies of
regulatory commissions.
Cash flows from operating activities were significantly affected during
the current year by warm weather and increases in the cost of gas during the
fourth quarter of 1996. In prior periods, operating cash flow was greater due to
a cost of gas which was generally lower than the rate authorized to be
recovered, resulting in an amount payable to ratepayers. However, during the
fourth quarter of 1996, gas costs increased resulting in costs exceeding
authorized recovery rates. See additional discussion regarding the deferred
purchased gas adjustment (PGA) mechanism below. Cash flows used in investing
activities were significantly impacted by increased construction expenditures
and the sale of the Bank. Financing activities include use of proceeds from the
Bank sale to retire debt issued in connection with the Company's investment in
the Bank, as well as the refinancing of a significant portion of long-term debt.
Southwest's rate schedules in all of its service areas contain PGA clauses
which permit adjustments to rates as the cost of purchased gas changes. The PGA
mechanism allows Southwest to
6
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. In addition,
Southwest uses this mechanism to either refund amounts overcollected or recoup
amounts undercollected as compared to the price paid for natural gas during the
period since the last PGA rate change went into effect. Generally, Southwest's
tariffs provide for annual adjustment dates for changes in purchased gas costs.
In addition, Southwest may request to adjust its rates more often than once each
year, if conditions warrant. These changes have no direct impact on profit
margin.
While the changes relating to PGA have no direct net income impact, cash
flows are impacted. At December 31, 1995, Southwest had a purchased gas cost
liability of $32.8 million, reflecting a cumulative overcollection of rates paid
by customers versus payments to suppliers and pipelines. However, as a result of
refunds and gas price increases, particularly in the fourth quarter of 1996, the
overcollection from customers was reduced to $9.4 million at December 31, 1996,
a $23.4 million change during the twelve-month period. The following table shows
the most recent PGA changes authorized by rate jurisdiction (thousands of
dollars):
Annualized
Revenue Effective
Jurisdiction Adjustment Percentage Date
- ---------------------------------------------------------------------------------------------
Arizona:
Central and Southern $(20,900) (17)% August 1995
California:
Northern $ 900 18% October 1993
Southern $ 4,300 9% August 1996
Nevada:
Northern $ (4,000) (9)% July 1996
Southern $(10,100) (8)% July 1996
In October 1996, Southwest submitted an out-of-period PGA filing, in
compliance with its last general rate case order, with the Public Service
Commission of Nevada (PSCN) which would have resulted in an annual revenue
decrease of $700,000 in the southern Nevada rate jurisdiction and an increase of
$500,000 in the northern Nevada rate jurisdiction. However, as a result of the
fourth quarter increases in the amounts paid by Southwest for natural gas
procured on behalf of its sales customers, Southwest filed a revised PGA request
in January 1997. If approved as filed, the proposed revisions would result in
annual increases of $16.4 million, or 16 percent, in the southern Nevada rate
jurisdiction and $6 million, or 15 percent, in the northern Nevada rate
jurisdiction. The change was requested to become effective in the second quarter
of 1997.
In November 1996, in conjunction with the filing of a general rate case,
Southwest filed a PGA change with the Arizona Corporation Commission (ACC) which
would have resulted in an annual
7
revenue decrease of $26.4 million, or eight percent. As a result of the increase
in the amount paid for natural gas in the fourth quarter of 1996, Southwest
alerted the ACC in January 1997 of the circumstances contributing to the
increases.
The Company has established 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 Company's quarterly common stock dividend was 20.5 cents
per share throughout 1996.
Securities ratings issued by nationally recognized ratings agencies
provide a method for determining the credit worthiness of an issuer. The
Company's 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).
In July 1996, Moody's upgraded the Company's unsecured long-term debt
rating from Baa3 to 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).
Also in July 1996, Duff & Phelps Credit Rating Co. upgraded the Company's
unsecured long-term debt rating to BBB from BBB-. Duff & Phelps debt ratings
range from AAA (highest rating possible) to DD (defaulted debt obligation). The
Duff & Phelps rating of BBB indicates that the Company's credit quality is
considered prudent for investment.
The Company's unsecured long-term debt rating from Standard and Poor's
(S&P) is BBB-. S&P debt ratings range from AAA (highest rating possible) to D
(obligation is in default). According to S&P, the BBB- rating indicates the debt
is regarded as having an adequate capacity to pay interest and repay principal.
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 impact of inflation on results of operation has diminished in recent
years. Natural gas, labor, and construction costs are the categories most
significantly impacted by inflation. Changes to Southwest's 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 its 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.
8
CONSOLIDATED RESULTS OF OPERATIONS
Contribution to Net Income
Year Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------
(Thousands of dollars)
Continuing operations:
Natural gas operations $ 3,919 $ 2,654 $23,524
Construction services 2,655 -- --
- ---------------------------------------------------------------------------------------------
6,574 2,654 23,524
Discontinued operations -- financial services -- (17,536) 2,777
- ---------------------------------------------------------------------------------------------
Net income (loss) $ 6,574 $(14,882) $26,301
=============================================================================================
1996 vs. 1995
Earnings per share for the year ended December 31, 1996 were $0.25, a
$0.15 increase from $0.10 per share of earnings from continuing operations
recorded for the year ended December 31, 1995. Current-year earnings were
composed of $0.15 per share from natural gas operations and $0.10 per share from
construction services. Average shares outstanding increased by 2.7 million
shares between years. This increase is the result of a 1.4 million share
issuance in April 1996 to acquire Northern, a public offering in May 1995 and
issuances under the Company's Dividend Reinvestment and Stock Purchase Plan.
1995 vs. 1994
Loss per share for the year ended December 31, 1995 was $0.66, a $1.88
decline from earnings per share of $1.22 recorded for the year ended December
31, 1994. The loss was composed of per share earnings of $0.10 from natural gas
operations and a per share loss of $0.76 from discontinued operations. Average
shares outstanding increased by 2.1 million shares between years primarily
resulting from a 2.1 million share public offering in May 1995. Dividends paid
in 1995 were $0.82 per share reflecting the first full year of the dividend
increase authorized by the Board in 1994.
9
RESULTS OF NATURAL GAS OPERATIONS
Year Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------
(Thousands of dollars)
Gas operating revenues $546,361 $563,502 $599,553
Net cost of gas 187,580 227,456 249,922
- ---------------------------------------------------------------------------------------------
Operating margin 358,781 336,046 349,631
Operations and maintenance expense 198,364 187,969 178,310
Depreciation and amortization 67,443 62,492 57,284
Taxes other than income taxes 28,156 27,173 25,347
- ---------------------------------------------------------------------------------------------
Operating income 64,818 58,412 88,690
Other income (expense), net (760) (652) (1,110)
- ---------------------------------------------------------------------------------------------
Income before interest and income taxes 64,058 57,760 87,580
Net interest deductions 53,971 53,354 49,461
Preferred securities distributions 5,475 913 --
Income tax expense 1,274 839 14,595
- ---------------------------------------------------------------------------------------------
Net income before allocations 3,338 2,654 23,524
Allocation of carrying costs, net of tax 581 -- --
- ---------------------------------------------------------------------------------------------
Contribution to consolidated net income $ 3,919 $ 2,654 $ 23,524
=============================================================================================
1996 vs. 1995
Contribution to consolidated net income increased $1.3 million from 1995.
The increase was due to an increase of operating income, partially offset by an
increase in financing costs between periods.
Weather was the dominant factor affecting the financial performance of the
gas segment in both years. Nevada experienced its second hottest year on record
in 1996 while Arizona experienced one of its hottest years on record. Warm
weather was particularly prevalent in the fourth quarter of 1995 and the first
quarter of 1996. As a result, operating margin was approximately $23 million
less than anticipated during 1996, and $28 million less than anticipated during
1995.
Despite the warm weather, operating margin increased $22.7 million, or
seven percent, in 1996 when compared to 1995. Rate relief and record customer
growth contributed to the improvement between periods. Effective July 1996,
Southwest received a $13.8 million general rate increase applicable to its
Nevada rate jurisdictions, providing $5 million in additional operating margin
in
10
1996. During 1996, Southwest added 63,000 customers, resulting in approximately
$13 million of additional operating margin. This continues a growth trend which
has resulted in nearly 300,000 new customers during the 1990's. Approximately 30
percent of Southwest's current customer base has been added during this period.
Operations and maintenance expenses increased $10.4 million, or six
percent, reflecting increases in labor and maintenance costs, including the
incremental expenses associated with meeting the needs of Southwest's growing
customer base.
Depreciation expense and taxes other than income taxes increased $5.9
million, or seven percent, as a result of additional plant in service. Average
gas plant in service increased $142 million, or nine percent, during the current
period. This is attributable to the upgrade of existing operating facilities and
the expansion of the system to accommodate customer growth.
Financing costs during the current year increased $5.2 million from 1995.
The increase is attributable primarily to the $60 million issuance of preferred
securities in October 1995. The current year reflects the full annual cost of
these securities. Financing activities also included the refunding or retirement
of a significant portion of the Company's outstanding debentures with the
proceeds from the sale of $150 million of debentures and proceeds from the Bank
sale. During 1996, average debt outstanding decreased $18 million and consisted
of an $11 million decrease in long-term debt and a $7 million decrease in
short-term debt. Interest rates were generally lower on variable-rate debt.
1995 vs. 1994
Contribution to consolidated net income decreased $20.9 million from 1994.
The decrease was primarily attributed to a decrease in operating margin between
periods. Increased operating costs and net interest deductions also contributed
to the decrease.
Operating margin decreased $13.6 million, or four percent, during 1995
compared to 1994. Record-breaking warm weather throughout Southwest's service
territories for much of the 1995 heating seasons was the primary factor
influencing the change. Temperatures in the Southwest were significantly above
normal in January, February, November and December, the prime heating months. As
a result, operating margin was approximately $28 million less than would be
expected if normal weather had been experienced. However, record customer growth
and rate relief in southern Arizona and California partially mitigated the
negative impact of warmer weather, contributing an additional $15 million of
operating margin between years. During 1995, 49,000 new customers were added, an
increase of 5 percent.
Operations and maintenance expenses increased $9.7 million, or five
percent, reflecting increases in labor and maintenance costs, including the
incremental expenses associated with meeting the needs of Southwest's growing
customer base.
11
Depreciation expense and taxes other than income taxes increased $7
million, or nine percent, primarily due to an increase in average gas plant in
service of $130 million, or nine percent. This is attributable to capital
expenditures for the upgrade of existing operating facilities and the expansion
of the system to accommodate customer growth.
Net interest deductions increased $3.9 million, or eight percent, in 1995,
after deducting interest costs associated with discontinued operations. The
change is attributed to an overall increase in average debt outstanding during
1995 of six percent, which consisted of a $70 million net increase in average
long-term debt offset by a $27 million decrease in average short-term debt. The
increase in long-term debt is attributed to the draw down of IDRB funds
previously held in trust and replacement of the $165 million term facilities
with a new $200 million term loan facility. The proceeds from the common stock
issuance in May 1995 and the preferred securities issuance in October 1995 are
the primary factors for the decrease in average short-term debt. Higher interest
rates on variable-rate debt also contributed to the increase in net interest
deductions.
RATES AND REGULATORY PROCEEDINGS
California
In January 1994, Southwest filed a general rate application to increase
annual margin by $1.1 million. In December 1994, the California Public Utilities
Commission (CPUC) approved the $1.1 million increase as part of a settlement
agreement, effective January 1995. The settlement, which is in effect through
1998, suspended the supply adjustment mechanism (SAM) previously utilized and
implemented a form of performance-based ratemaking. SAM was a mechanism by which
actual margin was adjusted to the margin authorized in the Southwest tariff.
Although still cost of service based, the settlement allows Southwest to retain
all margin generated from additional volumes sold, but places Southwest at risk
for reductions in margin resulting from lower than projected sales volumes. The
settlement suspends required annual attrition filings for southern California,
but retains attrition adjustments in northern California for certain
safety-related improvements. In addition, no sharing or penalty mechanisms are
required to capture efficiency gains or losses during the settlement period.
Nevada
In December 1995, Southwest filed general rate cases with the PSCN seeking
approval to increase revenues by $15.8 million, or 12 percent, annually for its
southern Nevada rate jurisdiction and $5 million, or 10 percent, annually for
its northern Nevada rate jurisdiction. Southwest was seeking recovery of
increased operating and maintenance costs, construction-related financing, tax,
insurance, and depreciation expenses associated with its expanding customer
base. In April 1996, the PSCN approved a settlement of the general rate cases
providing Southwest with a $10.6 million
12
general rate increase in southern Nevada and a $3.2 million increase in northern
Nevada. The settlement achieved a number of rate design and tariff restructuring
changes resulting in rates that more closely reflect the true costs of serving
the various customer classes. Over 86 percent of annual margin is now
recoverable from core customers classes, those most responsible for the
increased operating costs. The settlement adjusts rate design by equalizing
margins earned from sales and transportation customers, resulting in consistent
margin regardless of the type of service chosen by a customer. The settlement
also specifies a moratorium on future general rate increase requests until April
1999. The new rates became effective July 1, 1996.
Arizona
In November 1996, Southwest filed a general rate application with the ACC
seeking approval to increase revenues by $49.3 million annually for both of its
Arizona rate jurisdictions. Southwest is seeking rate relief for increased
operating costs, changes in financing costs, and improvements and additions to
the distribution system. The rate application also proposes a number of rate
design improvements including consolidation of the southern and central Arizona
rate jurisdictions and better matching of rates with the costs of servicing
various customer classes. The exact amount of rate relief that will ultimately
be authorized is not known. Absent successful negotiation of a settlement, the
hearing process is scheduled to begin in the third quarter of 1997 and no
changes in rates are expected prior to January 1998.
FERC
In July 1996, Paiute Pipeline Company, a wholly owned subsidiary of the
Company, filed a general rate case with the Federal Energy Regulatory Commission
(FERC) seeking approval to increase revenues by $6.9 million annually. Paiute is
seeking rate relief for increased costs associated with transmission system
additions and improvements, higher depreciation rates, operating cost increases
including labor, and an increase in the allowed rate of return. Interim rates
reflecting the increased revenues became effective in January 1997, subject to
refund until a final order is issued. The exact amount of rate relief that will
ultimately be authorized is not known. In the event a settlement can be reached,
a final order could be received by the end of 1997. Under normal procedural
schedules, final rates would become effective by the second or third quarter of
1998.
13
RESULTS OF CONSTRUCTION SERVICES OPERATIONS
For the eight months ended December 31, 1996, the construction services
segment contributed $2.7 million to consolidated net income. This included peak
construction season revenues and profits which are not indicative of results
expected during a twelve-month period. Construction activity is seasonal with
work generally scheduled for the spring through fall months in colder climate
areas, such as the Midwest. In warmer climate areas, such as the southwestern
United States, construction occurs year round. Construction revenues during 1996
were $97.7 million. The related costs of construction were $88.6 million,
resulting in gross profit of $9.1 million. Labor and equipment costs are the
primary components of construction costs. General and administrative expenses
were $2.1 million and interest expense was $942,000. Comparative information is
not included since Northern was acquired in April 1996.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
which establishes consistent accounting and reporting standards as they relate
to transfers and servicing of financial assets and liability extinguishments.
SFAS No. 125 became effective on January 1, 1997. The Company does not
anticipate any material effects to the financial statements as a result of SFAS
No. 125. In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
and SFAS No. 129, "Disclosure of Information about Capital Structure." Both
statements become effective for 1997 year-end financial statements.
COMMON STOCK PRICE AND DIVIDEND INFORMATION
1996 1995 Dividends Paid
----------------- ----------------- -----------------
HIGH LOW High Low 1996 1995
- ------------------------------------------------------------------------------------------------
First Quarter $18 5/8 $15 5/8 $15 1/4 $13 5/8 $0.205 $0.205
Second Quarter 17 3/8 15 3/4 14 7/8 13 5/8 0.205 0.205
Third Quarter 18 3/8 14 7/8 16 3/4 14 0.205 0.205
Fourth Quarter 19 7/8 17 3/8 18 3/8 14 7/8 0.205 0.205
-----------------
$0.820 $0.820
=================
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 14,
1997 there were 26,967 holders of record of common stock. The market price of
the common stock was $18 3/4 as of March 14, 1997.
14
CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except par value)
December 31, 1996 1995
- ----------------------------------------------------------------------------------------------------
ASSETS
Utility plant
Gas plant $1,732,405 $1,579,665
Less: accumulated depreciation (505,984) (474,891)
Acquisition adjustments 5,866 6,298
Construction work in progress 46,170 26,678
- ----------------------------------------------------------------------------------------------------
Net utility plant (Note 2) 1,278,457 1,137,750
- ----------------------------------------------------------------------------------------------------
Other property and investments 71,245 35,128
- ----------------------------------------------------------------------------------------------------
Current assets
Cash and cash equivalents 8,280 11,168
Accounts receivable, net of allowances (Note 3) 69,000 38,186
Accrued utility revenue 46,500 43,900
Deferred tax benefit (Note 10) 8,009 17,089
Prepaids and other current assets 28,029 31,386
Net assets of discontinued operations (Note 14) -- 175,493
- ----------------------------------------------------------------------------------------------------
Total current assets 159,818 317,222
- ----------------------------------------------------------------------------------------------------
Deferred charges and other assets (Note 4) 50,749 42,427
- ----------------------------------------------------------------------------------------------------
Total assets $1,560,269 $1,532,527
====================================================================================================
CAPITALIZATION AND LIABILITIES
Capitalization
Common stock, $1 par (authorized -- 45,000,000 shares; issued and
outstanding -- 26,732,688 and 24,467,499 shares) $ 28,363 $ 26,097
Additional paid-in capital 349,132 312,631
Retained earnings 2,121 17,322
- ----------------------------------------------------------------------------------------------------
Total common equity 379,616 356,050
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) 665,221 607,945
- ----------------------------------------------------------------------------------------------------
Total capitalization 1,104,837 1,023,995
- ----------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 8)
Current liabilities
Current maturities of long-term debt (Note 6) 6,675 120,000
Short-term debt (Note 7) 121,000 37,000
Accounts payable 49,951 41,864
Customer deposits 21,133 21,406
Accrued taxes 9,977 29,116
Accrued interest 9,800 11,107
Deferred purchased gas costs (Note 4) 9,432 32,776
Other current liabilities 33,369 36,942
- ----------------------------------------------------------------------------------------------------
Total current liabilities 261,337 330,211
- ----------------------------------------------------------------------------------------------------
Deferred income taxes and other credits
Deferred income taxes and investment tax credits (Note 10) 152,063 138,893
Other deferred credits (Note 4) 42,032 39,428
- ----------------------------------------------------------------------------------------------------
Total deferred income taxes and other credits 194,095 178,321
- ----------------------------------------------------------------------------------------------------
Total capitalization and liabilities $1,560,269 $1,532,527
====================================================================================================
The accompanying notes are an integral part of these statements.
15
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------------
Operating revenues:
Gas operating revenues $546,361 $563,502 $599,553
Construction revenues 97,700 -- --
- --------------------------------------------------------------------------------------------
Total operating revenues 644,061 563,502 599,553
- --------------------------------------------------------------------------------------------
Operating expenses:
Net cost of gas 187,580 227,456 249,922
Operations and maintenance 198,364 187,969 178,310
Depreciation and amortization 73,699 62,492 57,284
Taxes other than income taxes 28,156 27,173 25,347
Construction expenses 84,689 -- --
- --------------------------------------------------------------------------------------------
Total operating expenses 572,488 505,090 510,863
- --------------------------------------------------------------------------------------------
Operating income 71,573 58,412 88,690
- --------------------------------------------------------------------------------------------
Other income and (expenses):
Net interest deductions (54,913) (53,354) (49,461)
Preferred securities distributions (Note 5) (5,475) (913) --
Other income (deductions), net (737) (652) (1,110)
- --------------------------------------------------------------------------------------------
Total other income and (expenses) (61,125) (54,919) (50,571)
- --------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 10,448 3,493 38,119
Income tax expense (Note 10) 3,874 839 14,595
- --------------------------------------------------------------------------------------------
Net income from continuing operations 6,574 2,654 23,524
- --------------------------------------------------------------------------------------------
Discontinued operations (Note 14):
Income (loss) from discontinued segment, net of tax
expense (benefit) of $0, $(2,306) and $3,127 -- (4,513) 2,777
Loss on disposal of discontinued segment, including
tax expense of $9,900 in 1995 -- (13,023) --
- --------------------------------------------------------------------------------------------
Net income (loss) from discontinued operations -- (17,536) 2,777
- --------------------------------------------------------------------------------------------
Net income (loss) 6,574 (14,882) 26,301
Preferred/preference stock dividend requirements -- 307 510
- --------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 6,574 $(15,189) $ 25,791
============================================================================================
Earnings per share from continuing operations $ 0.25 $ 0.10 $ 1.09
Earnings (loss) per share from discontinued operations -- (0.76) 0.13
- --------------------------------------------------------------------------------------------
Earnings (loss) per share of common stock (Note 13) $ 0.25 $ (0.66) $ 1.22
============================================================================================
Average number of common shares outstanding 25,888 23,167 21,078
============================================================================================
The accompanying notes are an integral part of these statements.
16
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
Year Ended December 31, 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss) $ 6,574 $(14,882) $ 26,301
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 73,699 62,492 57,284
Deferred income taxes 17,453 (15,314) (9,178)
Changes in current assets and liabilities:
Accounts receivable (17,886) 19,719 (6,487)
Accrued utility revenue (2,600) 3,633 (1,300)
Deferred purchased gas costs (23,344) 47,995 9,014
Accounts payable 4,964 (7,101) (2,811)
Accrued taxes (19,139) (13,820) 11,594
Other current assets and liabilities 2,498 3,661 6,681
Other 9,976 (205) 649
Undistributed (income) loss from discontinued operations -- 11,576 (7,673)
- ----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 52,195 97,754 84,074
- ----------------------------------------------------------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES:
Construction expenditures and property additions (218,835) (166,183) (141,390)
Proceeds from bank sale 191,662 -- --
Other (22,112) 2,465 (157)
- ----------------------------------------------------------------------------------------------------
Net cash used in investing activities (49,285) (163,718) (141,547)
- ----------------------------------------------------------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock 18,110 44,844 4,773
Issuance of trust originated preferred securities -- 57,713 --
Reacquisition of preferred/preference stocks -- (4,000) (4,058)
Dividends paid (21,311) (19,575) (17,411)
Issuance of long-term debt 164,876 49,407 73,000
Retirement of long-term debt (248,531) (2,285) (648)
Issuance (repayment) of short-term debt 81,058 (55,000) 6,000
Other -- (48) (234)
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (5,798) 71,056 61,422
- ----------------------------------------------------------------------------------------------------
Change in cash and temporary cash investments (2,888) 5,092 3,949
Cash at beginning of period 11,168 6,076 2,127
- ----------------------------------------------------------------------------------------------------
Cash at end of period $ 8,280 $ 11,168 $ 6,076
====================================================================================================
Supplemental information:
Interest paid, net of amounts capitalized $ 60,008 $ 62,377 $ 55,167
Income taxes paid, net of refunds $ 18,682 $ 20,413 $ 3,574
The accompanying notes are an integral part of these statements.
17
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except per share amounts)
Common Stock Additional
---------------- Paid-in Retained
Shares Amount Capital Earnings Total
- -----------------------------------------------------------------------------------------------
December 31, 1993 20,997 $22,627 $268,725 $ 43,765 $335,117
Common stock issuances 285 285 4,488 4,773
Net income 26,301 26,301
Dividends declared
Preferred: $9.50 per share (437) (437)
Second preference: $3.00 per share (73) (73)
Common: $0.81 per share (17,125) (17,125)
Redemption of second preference stock 4 (4) --
- -----------------------------------------------------------------------------------------------
December 31, 1994 21,282 22,912 273,217 52,427 348,556
Common stock issuances 3,185 3,185 41,659 44,844
Issuance costs, preferred securities (2,287) (2,287)
Net loss (14,882) (14,882)
Dividends declared
Preferred: $9.50 per share (307) (307)
Common: $0.82 per share (19,826) (19,826)
Redemption of preferred stock 42 (90) (48)
- -----------------------------------------------------------------------------------------------
December 31, 1995 24,467 26,097 312,631 17,322 356,050
Common stock issuances 2,266 2,266 36,501 38,767
Net income 6,574 6,574
Dividends declared
Common: $0.82 per share (21,775) (21,775)
- -----------------------------------------------------------------------------------------------
December 31, 1996 26,733* $28,363 $349,132 $ 2,121 $379,616
===============================================================================================
* At December 31, 1996, 1.4 million common shares were registered and available
for issuance under provisions of the Employee Investment Plan and the
Company's Dividend Reinvestment and Stock Purchase Plan.
The accompanying notes are an integral part of these statements.
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. Southwest Gas Corporation and subsidiaries (the
Company) is principally engaged in the business of purchasing, transporting, and
distributing natural gas to customers in portions of Arizona, Nevada, and
California (Southwest or the natural gas operations segment). Southwest's public
utility rates, practices, facilities, and service territories are subject to
regulatory oversight. The timing and amount of rate relief can materially impact
results of operations. Natural gas sales are seasonal, peaking during the winter
months. Variability in weather from normal temperatures can materially impact
results of operations. The Company also provides, through Northern Pipeline
Construction Co. (Northern or the construction services segment), local gas
distribution companies with installation, replacement, and maintenance services
for underground natural gas 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 the 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 revenue 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. Statement of Financial Accounting Standards (SFAS) No.
71, "Accounting for the Effects of Certain Types of Regulation," provides that
intercompany profits on sales to regulated affiliates should not be eliminated
in consolidation if the sales price is reasonable and if future revenues
approximately equal to the sales price will result from the rate-making process.
Management believes these two criteria will be met. The financial services
segment is classified as discontinued operations.
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. Southwest is authorized by the various
regulatory authorities having jurisdiction to adjust its billing rates for
changes in the cost of gas purchased. The difference
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 Northern's 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
cost 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 costs of removal, less salvage, is charged to the accumulated
provision for depreciation. Acquisition adjustments are amortized, as ordered by
regulatory bodies, 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. Nonutility property and equipment are depreciated on a
straight-line method based on the estimated useful lives of the related assets.
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $1.8 million, $1.2 million, and $805,000 of AFUDC related to natural
gas utility operations for each of the years ended December 31, 1996, 1995, and
1994, respectively. 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
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 Common Share. Earnings per common share are calculated by
dividing net income (loss) applicable to common stock by the weighted average
number of shares outstanding during the period. Common stock equivalents (stock
options and performance shares) are immaterial and are not included in the
earnings per share calculation.
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 for industrial
development revenue bonds.
NOTE 2 -- UTILITY PLANT
Net utility plant as of December 31, 1996 and 1995 was as follows
(thousands of dollars):
December 31, 1996 1995
- --------------------------------------------------------------------------------------------
Gas plant:
Storage $ 3,216 $ 14,546
Transmission 150,898 143,989
Distribution 1,360,438 1,206,503
General 179,795 179,378
Other 38,058 35,249
- --------------------------------------------------------------------------------------------
1,732,405 1,579,665
Less: accumulated depreciation (505,984) (474,891)
Acquisition adjustment, net 5,866 6,298
Construction work in progress 46,170 26,678
- --------------------------------------------------------------------------------------------
Net gas utility property $1,278,457 $1,137,750
============================================================================================
Depreciation expense on gas plant was $66.9 million, $62 million, and
$56.5 million during the years ended December 31, 1996, 1995, and 1994,
respectively.
Leases and Rentals. The Company 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
2004, respectively, with optional renewal terms available at the expiration
dates. The rental
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
payments for the LNG facilities are $6.7 annually and $43.3 million in the
aggregate. The rental payments for the corporate headquarters office complex are
$2.4 million in 1997, $1.8 million for each year 1998 through 2001, and $31.9
million thereafter. The rental payments for the Phoenix administrative offices
are $1.3 million in 1997, $1.2 million for each year 1998 through 2000, $1.3
million in 2001, and $3.6 million cumulatively thereafter. These leases are
accounted for as operating leases and are treated as such for regulatory
purposes. Rentals included in operating expenses with respect to these leases
were $11.6 million in 1994, $11.3 million in 1995, and $11.1 million in 1996.
Other operating leases of the Company are immaterial individually and in the
aggregate.
Effective for fiscal years beginning January 1, 1996, SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," requires the review of long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. The adoption of this standard did not have a
material impact on the Company's current financial condition or results of
operations.
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, 1996, gas segment receivables were $46.3 million.
Approximately 58 percent of the gas utility customers were in Arizona, 32
percent in Nevada, and 10 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 certain accounts, some accounts are ultimately not collected.
Provisions for uncollectible accounts are recorded 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):
Allowance for
Uncollectibles
- ---------------------------------------------------------------------------------------------
Balance, December 31, 1993 $ 1,683
Additions charged to expense 1,445
Accounts written off, less recoveries (1,575)
- --------------------------------------------------------------------------------------------
Balance, December 31, 1994 1,553
Additions charged to expense 1,295
Accounts written off, less recoveries (1,621)
- --------------------------------------------------------------------------------------------
Balance, December 31, 1995 1,227
Additions charged to expense 1,285
Accounts written off, less recoveries (1,002)
- --------------------------------------------------------------------------------------------
Balance, December 31, 1996 $ 1,510
============================================================================================
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 -- REGULATORY ASSETS AND LIABILITIES
Natural gas operations are subject to the regulation of the Arizona
Corporation Commission (ACC), the Public Service Commission of Nevada (PSCN),
the California Public Utilities Commission (CPUC), and the Federal Energy
Regulatory Commission (FERC). The Company's accounting policies conform to
generally accepted accounting principles applicable to rate-regulated
enterprises and reflect the effects of the ratemaking process. Such effects
concern mainly the time at which various items enter into the determination of
net income in accordance with the principle of matching costs with related
revenues.
The following table represents existing regulatory assets and liabilities
(thousands of dollars):
December 31, 1996 1995
- --------------------------------------------------------------------------------------------
Regulatory assets:
SFAS No. 109 -- Income taxes, net $11,431 $ 13,211
Unamortized premium on reacquired debt 17,440 10,848
Other 16,601 15,686
- --------------------------------------------------------------------------------------------
45,472 39,745
Regulatory liabilities:
Supplier and other rate refunds due customers (3,828) (4,844)
Deferred purchased gas costs (9,432) (32,776)
Other (2,204) (3,389)
- --------------------------------------------------------------------------------------------
Net regulatory assets (liabilities) $30,008 $ (1,264)
============================================================================================
NOTE 5 -- PREFERRED STOCK AND PREFERRED SECURITIES
In December 1995, the Company redeemed all remaining outstanding $100
Cumulative Preferred Stock, 9.5% Series. Scheduled annual mandatory redemption
requirements were 8,000 shares, or $800,000 per year, through 1999. After the
1995 annual mandatory redemption requirement was satisfied, the Company
exercised its option to redeem an additional 8,000 shares at par. The remaining
24,000 shares were redeemed at $102 per share, plus accrued and unpaid
dividends. The stock was redeemed because other less costly financing options
were available.
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's issuance of the
Preferred Securities and the related purchase by the Company of all of the
Trust's 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
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 are redeemable at the option of the Company on or after
December 31, 2000, 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. The Company's 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 therefor and the indenture governing
the Subordinated Notes, including the Company's 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, 1996, 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 pari passu 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.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 -- LONG-TERM DEBT
December 31, 1996 1995
---------------------- ----------------------
CARRYING MARKET Carrying Market
AMOUNT VALUE Amount Value
(Thousands of dollars)
Debentures:
9% Series A, due 2011 $ -- $ -- $ 26,890 $ 27,663
9% Series B, due 2011 -- -- 31,213 32,110
8 3/4% Series C, due 2011 -- -- 18,353 18,881
9 3/8% Series D, due 2017 -- -- 120,000 126,150
10% Series E, due 2013 -- -- 23,069 23,963
9 3/4% Series F, due 2002 100,000 112,960 100,000 117,600
7 1/2% Series, due 2006 75,000 76,740 -- --
8% Series, due 2026 75,000 78,600 -- --
Unamortized discount (3,137) -- (6,209) --
- ---------------------------------------------------------------------------------------------
246,863 313,316
- ---------------------------------------------------------------------------------------------
Term-loan facilities 184,000 184,000 200,000 200,000
- ---------------------------------------------------------------------------------------------
Industrial development revenue bonds:
Variable-rate bonds
Series due 2028 50,000 50,000 50,000 50,000
Less funds held in trust (30,261) -- (32,942) --
- ---------------------------------------------------------------------------------------------
19,739 17,058
- ---------------------------------------------------------------------------------------------
Fixed-rate bonds
7.30% 1992 Series A, due 2027 30,000 32,029 30,000 31,560
7.50% 1992 Series B, due 2032 100,000 107,232 100,000 106,500
6.50% 1993 Series A, due 2033 75,000 75,241 75,000 75,000
Unamortized discount (3,654) -- (3,757) --
Less funds held in trust -- -- (3,672) --
- ---------------------------------------------------------------------------------------------
201,346 197,571
- ---------------------------------------------------------------------------------------------
Other 19,948 --
- ---------------------------------------------------------------------------------------------
671,896 727,945
Less current maturities (6,675) (120,000)
- ---------------------------------------------------------------------------------------------
$ 665,221 $ 607,945
=============================================================================================
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In August 1996, the Company issued $75 million of 7 1/2 percent debentures
due 2006 and $75 million of 8 percent debentures due 2026. Net proceeds of $148
million as well as a portion of the $163 million net proceeds from the PriMerit
sale were used to refund or retire $219 million of outstanding callable
debentures and pay down short-term debt. The remaining amount was used for
general corporate purposes, including the acquisition of property for the
construction, completion, extension, and improvement of Southwest's pipeline
systems. The refinancing achieved a 126 basis point reduction in the related
average interest rate.
In October 1996, the Company filed a $250 million shelf registration
statement. In connection with this new registration statement, the Company may
offer, up to the registered amount, any combination of debt securities,
preferred stock, depositary shares, and common stock. This registration
statement includes a carryforward of $60 million remaining from a prior shelf
registration statement declared effective by the Securities and Exchange
Commission in October 1995. The Company filed a prospectus supplement in
December 1996 identifying $150 million of the shelf as medium-term notes. In
January 1997, the Company issued $25 million of 7.59 percent notes due January
2017. In February 1997, the Company issued $25 million of 7.78 percent notes due
February 2022.
The $200 million term-loan facility provides for a revolving period
through January 1999 at which time any amounts borrowed under the agreement
become payable on demand. A letter of credit is available to provide credit
support for the issuance of commercial paper. In addition, direct borrowing
options are available which provide for interest at either the London Interbank
Offering Rate (LIBOR) or certificate of deposit rate, plus a margin based on the
Company's credit rating, or the prime rate. The average cost of this facility
was 6.28 percent in 1996 and 6.86 percent in 1995. Amounts outstanding at both
year ends consisted of commercial paper.
The interest rate on the variable-rate industrial development revenue
bonds (IDRB) is established on a weekly basis and averaged 4.16 percent in 1996,
4.80 percent in 1995, and 3.85 percent in 1994. At the option of the Company,
the interest period can be converted from a weekly rate to a daily-term or
variable-term rate.
The fair value of the term-loan facilities approximates carrying value.
Market values for the debentures and fixed-rate IDRB were determined based on
dealer quotes using trading records for December 31, 1996 and 1995, as
applicable, and other secondary sources which are customarily consulted for data
of this kind. The carrying value of the IDRB Series due 2028 was used as the
estimate of fair value based upon the variable interest rate of the bonds.
Estimated maturities of long-term debt for the next five years are
expected to be $6.7 million, $5.9 million, $188 million, $2.9 million, and
$185,000, respectively.
In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." This
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. This statement
became effective January 1, 1997. The Company does not anticipate any material
effect on its financial position or results of operations from this statement.
NOTE 7 -- SHORT-TERM DEBT
The Company has an agreement with several banks for committed credit lines
which aggregate $150 million at December 31, 1996. The agreement provides for
the payment of interest at competitive market rates. The lines of credit also
require the payment of a commitment fee based on the long-term debt rating of
the Company. The committed credit lines have no compensating balance
requirements and expire in July 1997. Short-term borrowings were $121 million
and $37 million at December 31, 1996 and 1995, respectively. The weighted
average interest rates on these borrowings were 6.83 percent at December 31,
1996 and 6.64 percent at December 31, 1995.
NOTE 8 -- COMMITMENTS AND CONTINGENCIES
Legal Proceedings. The Company has been named as defendant in various
legal proceedings. The ultimate dispositions of these proceedings are not
presently determinable; however, it is the opinion of management that no
litigation to which the Company is subject will have a material adverse impact
on its financial position or results of operations.
Northern California Expansion. In 1995, Southwest initiated a multi-year,
three-phase construction project to expand its northern California service
territory and extend service into Truckee, California. The CPUC imposed a $29
million cost cap on the project as a condition of granting Southwest a
certificate of public convenience and necessity to serve the expansion areas.
In 1995, Southwest completed Phase I of the expansion project, which
involved transmission system reinforcement and distribution system expansion to
accommodate 940 additional customers. Construction costs of $7.1 million were on
target with the cost estimate approved by the CPUC.
Phase II of the project involved extending the transmission system to
Truckee, California and distribution system expansion to accommodate 4,200
customers. The cost cap apportioned to Phase II was approximately $13.8 million.
The incurred cost of Phase II through December 1996 was $26.9 million, with
approximately $1.2 million remaining to complete this phase in 1997. An
estimated $9.2 million of the cost overrun was due to changes in project scope,
such as adjustments for design changes required by governmental bodies, changes
in facilities beyond Southwest's control and costs incurred to accommodate
customer service requests.
Examples of adjustments for changes in project scope are: Southwest was
required to haul excavated soil offsite to be screened whereas normal and
anticipated practice is to screen on site; asphalt repairs were greater than
expected as a result of increased paving requirements imposed after construction
started, poor road conditions, and the installation of more facilities under
asphalt
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
than anticipated. Other unanticipated or externally imposed costs pertained to
extended yard lines, underground boring, environmental studies, right-of-way
acquisitions, and engineering design work.
Phase III of the construction project involving distribution system
expansion to add 4,200 customers has a cost cap apportionment of approximately
$8.2 million. Management is currently reexamining construction requirements, and
the scope of this phase in light of the cost overruns and difficult construction
environment experienced in Phase II of the project. As a result, no estimate of
the overall expansion cost or final construction timeline is currently
available.
Management believes that because of the cost overruns which have occurred
in Phase II of the project, an impairment of its expansion assets up to the
amount of the cost overruns could occur in the future if the CPUC either
directly or indirectly denies recovery of the excess costs. An impairment has
not occurred because Southwest is currently on a form of performance-based
ratemaking (PBR) in California (see Rates and Regulatory Proceedings section of
Management's Discussion and Analysis) which effectively provides for recovery of
the northern California expansion assets and an acceptable return on investment.
It is management's intention to request a further extension of the PBR mechanism
in California during 1997. Management believes it is probable that Southwest
will receive the proposed extension, and will continue earning a return on the
northern California expansion assets.
NOTE 9 -- EMPLOYEE BENEFITS
Southwest has a qualified retirement plan covering its employees. The plan
is noncontributory with defined benefits, and covers substantially all
employees. Southwest's policy is to fund the plan at not less than the minimum
required contribution nor more than the tax deductible limit. Plan assets are
held in a master trust whose investments consist of common stock, corporate
bonds, government obligations, real estate, a mutual fund investing in foreign
stocks, an insurance company contract, and cash or cash equivalents.
The plan provides that an employee may earn benefits for a period of up to
30 years and will be vested after 5 years of service. Retirement plan costs were
$7.2 million in 1996, $6.8 million in 1995, and $7.8 million in 1994.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the plan's funded status and amounts
recognized on the Consolidated Balance Sheets and Statements of Income.
December 31, 1996 1995
- -------------------------------------------------------------------------------------------
(Thousands of dollars)
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested benefits of
$(124,156) and $(111,035), respectively $(133,752) $(119,340)
===========================================================================================
Projected benefit obligation for service rendered to date $(187,183) $(167,414)
Market value of plan assets 195,994 169,524
- -------------------------------------------------------------------------------------------
Assets in excess of projected benefit obligation 8,811 2,110
Unrecognized net transition obligation being amortized through
2004 5,816 6,652
Unrecognized net loss (gain) (14,741) (8,669)
Unrecognized prior service cost 409 466
- -------------------------------------------------------------------------------------------
Prepaid retirement plan asset included in the Consolidated Balance
Sheets $ 295 $ 559
===========================================================================================
Assumptions used to develop pension obligations were:
Discount rate 7.00% 7.25%
Long-term rate of return on assets 9.00% 9.00%
Rate of increase in compensation levels 4.75% 4.75%
Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------------
(Thousands of dollars)
Net retirement plan costs include the following
components:
Service cost $ 8,762 $ 7,153 $ 7,805
Interest cost 11,993 11,084 10,164
Actual return on plan assets (23,511) (35,557) 254
Net amortization and deferrals 9,976 24,136 (10,440)
- --------------------------------------------------------------------------------------------
Net periodic retirement plan cost $ 7,220 $ 6,816 $ 7,783
============================================================================================
In addition to the basic retirement plan, Southwest has a separate
unfunded supplemental retirement plan which is limited to certain officers. The
plan is noncontributory with defined benefits. Senior officers who retire with
ten years or more of service with Southwest are eligible to receive benefits.
Other officers who retire with 20 years or more of service with Southwest are
eligible to receive benefits. Plan costs were $1.8 million in 1996, $2 million
in 1995, and $2 million in 1994. The accumulated benefit obligation of the plan
was $15.4 million, including vested
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
benefits of $14.2 million, at December 31, 1996. Southwest also has an unfunded
retirement plan for directors not covered by the employee retirement plan. The
cost and liability for this plan are not significant.
The Employees' Investment Plan provides for purchases of the Company's
common stock or certain other investments by eligible Southwest employees
through deductions of up to 16 percent of base compensation, subject to IRS
limitations. Southwest matches one-half of amounts deferred up to six percent of
an employee's annual compensation. The cost of the plan was $2.6 million in
1996, $2.3 million in 1995, and $2.6 million in 1994. 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. The plan provides the opportunity to defer from a minimum of $2,000
up to 50 percent of annual compensation. Southwest matches one-half of amounts
deferred up to six percent of an officer's annual salary. Payments of
compensation deferred, plus interest, commence upon the participant's retirement
in equal monthly installments over 10, 15, or 20 years, as determined by
Southwest. Deferred compensation earns interest at a rate determined each
January. The interest rate represents 150 percent of Moody's Seasoned Corporate
Bond Index.
Southwest provides postretirement benefits other than pensions (PBOP) to
its qualified retirees for health care, dental, and life insurance. Southwest
accounts for PBOP on an accrual basis. The PSCN, CPUC, and FERC have approved
the use of accrual accounting for ratemaking purposes, subject to certain
conditions, including funding. Southwest did not receive approval to recover
PBOP costs on an accrual basis in its Arizona rate jurisdictions, but was
authorized to continue to recover the pay-as-you-go costs for ratemaking
purposes. Southwest began funding the non-Arizona portion of the PBOP liability
in 1994. Plan assets are combined with the pension plan assets in a master trust
for investment purposes.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the PBOP funded status and amounts
recognized on the Company's Consolidated Balance Sheets and Statements of
Income.
December 31, 1996 1995
- ------------------------------------------------------------------------------------------
(Thousands of dollars)
Accumulated postretirement benefit obligation (APBO)
Retirees $(14,291) $(15,030)
Fully eligible actives (2,322) (1,956)
Other active participants (7,275) (6,182)
- ------------------------------------------------------------------------------------------
Total (23,888) (23,168)
Market value of plan assets 2,408 1,647
- ------------------------------------------------------------------------------------------
APBO in excess of plan assets (21,480) (21,521)
Unrecognized transition obligation 13,871 14,738
Unrecognized prior service cost -- --
Unrecognized loss 2,543 3,003
- ------------------------------------------------------------------------------------------
Accrued postretirement benefit liability $ (5,066) $ (3,780)
==========================================================================================
Assumptions used to develop postretirement benefit
obligations were:
Discount rate 7.00% 7.25%
Medical inflation 8% graded to 5% 9% graded to 5%
Salary increases 4.75% 4.75%
The Company makes fixed contributions, based on age and years of service,
to retiree spending accounts for the medical and dental costs of employees who
retire after 1988. The Company pays up to 100 percent of the medical coverage
costs for employees who retired prior to 1989. The medical inflation assumptions
in the table above apply to the benefit obligations for pre-1989 retirees only.
The inflation assumption at December 31, 1996, was estimated at eight percent
for 1997, and decreases one-half of one percent per year until 2003, at which
time the average annual increase is projected to be five percent. A one percent
increase in these assumptions would change the accumulated postretirement
benefit obligation by approximately $1.2 million at December 31, 1996. Future
annual benefit costs would increase $130,000.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------
(Thousands of dollars)
Net periodic postretirement benefit costs include the following
components:
Service cost $ 521 $ 399 $ 473
Interest cost 1,638 1,562 1,472
Actual return on plan assets (252) (286) --
Net amortization and deferrals 997 1,061 911
- ---------------------------------------------------------------------------------------------
Net periodic postretirement benefit cost $2,904 $2,736 $2,856
=============================================================================================
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This new standard permits the continued use of accounting methods
prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," or use of the fair value based method of accounting
as encouraged by the statement. The following disclosure complies with the
requirements of the new standard.
At December 31, 1996, the Company had two stock-based compensation plans.
These plans are accounted for in accordance with APB Opinion No. 25, "Accounting
for Stock Issued to Employees." In connection with the stock-based compensation
plans, the Company recognized compensation expense of $571,000 in 1996 and
$300,000 in 1995. Had compensation cost been determined based 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):
1996 1995
- --------------------------------------------------------------------------------------------
Net income (loss) As reported $6,574 $(14,882)
Pro forma $6,523 $(14,871)
Primary earnings (loss) per share As reported $ 0.25 $ (0.66)
Pro forma $ 0.25 $ (0.66)
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 10 years. In July 1996, 350,000 options were
granted. 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
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
using the extended binomial option pricing model. The following assumptions were
used in the valuation calculation:
1996
- ------------------------------------------------------------------------------------------
Dividend yield 4.65%
Risk-free interest rate RANGING FROM 5.83 TO 6.42%
Expected volatility RANGING FROM 22 TO 25%
Expected life 1 TO 3 YEARS
As of the grant date, the weighted average fair value of the options
granted was $1.79. At December 31, 1996, the weighted average remaining
contractual life of the options was 9.5 years.
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
over a period of three years and are subject to a final adjustment as determined
by the Board of Directors. The following table summarizes the activity of this
plan:
Year Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------
Nonvested performance shares at beginning of year 41,422 18,001 --
Performance shares granted 63,968 25,363 18,001
Performance shares forfeited -- -- --
Shares vested and issued (12,104) (1,942) --
- ---------------------------------------------------------------------------------------------
Nonvested performance shares at end of year 93,286 41,422 18,001
=============================================================================================
Grant date fair value of award $ 17.75 $15.25 $17.625
=============================================================================================
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- INCOME TAXES
Income tax expense (benefit) consists of the following (thousands of
dollars):
Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------------
Current:
Federal $(15,087) $ 13,588 $16,481
State (1,566) 1,985 2,701
- --------------------------------------------------------------------------------------------
(16,653) 15,573 19,182
- --------------------------------------------------------------------------------------------
Deferred:
Federal 18,832 (13,752) (4,441)
State 1,695 (982) (146)
- --------------------------------------------------------------------------------------------
20,527 (14,734) (4,587)
- --------------------------------------------------------------------------------------------
Total income tax expense $ 3,874 $ 839 $14,595
============================================================================================
Deferred income tax expense (benefit) consists of the following
significant components (thousands of dollars):
Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------------
Deferred federal and state:
Property-related items $11,586 $ 4,921 $ 2,441
Purchased gas cost adjustments 8,437 (16,488) (5,531)
Self insurance (90) (885) 1,161
All other deferred 1,462 (1,414) (1,782)
- --------------------------------------------------------------------------------------------
Total deferred federal and state 21,395 (13,866) (3,711)
Deferred investment tax credit, net (868) (868) (876)
- --------------------------------------------------------------------------------------------
Total deferred income tax expense (benefit) $20,527 $(14,734) $(4,587)
============================================================================================
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The consolidated effective income tax rate for the period ended December
31, 1996 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:
Year Ended December 31, 1996 1995 1994
- ----------------------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
Net state tax liability 5.0 9.0 4.3
Property-related items 8.8 24.1 2.1
Tax credits (8.3) (22.7) (2.3)
Tax exempt interest (3.7) (13.8) --
Corporate-owned life insurance (4.0) (12.5) (1.4)
All other differences 4.3 4.9 0.6
- ----------------------------------------------------------------------------------------------
Consolidated effective income tax rate 37.1% 24.0% 38.3%
==============================================================================================
Deferred tax assets and liabilities consist of the following (thousands of
dollars):
December 31, 1996 1995
- -------------------------------------------------------------------------------------------
Deferred tax assets:
Deferred income taxes for future amortization of ITC $ 12,729 $ 13,256
Employee benefits 6,194 5,306
Regulatory balancing accounts 3,832 12,411
Other 4,415 3,017
Valuation allowance -- --
- -------------------------------------------------------------------------------------------
27,170 33,990
- -------------------------------------------------------------------------------------------
Deferred tax liabilities:
Property-related items, including accelerated depreciation 114,176 101,133
Property-related items previously flowed-through 24,160 26,467
Unamortized ITC 19,006 19,874
Debt-related costs 6,757 4,462
Other 7,125 3,858
- -------------------------------------------------------------------------------------------
171,224 155,794
- -------------------------------------------------------------------------------------------
Net deferred tax liabilities $144,054 $121,804
===========================================================================================
Current $ (8,009) $(17,089)
Noncurrent 152,063 138,893
- -------------------------------------------------------------------------------------------
Net deferred tax liabilities $144,054 $121,804
===========================================================================================
NOTE 11 -- ACQUISITION OF NORTHERN PIPELINE CONSTRUCTION CO.
On April 29, 1996, the Company acquired all of the outstanding stock of
Northern Pipeline Construction Co. (the construction services segment) pursuant
to a definitive agreement dated November 1995. The Company issued approximately
1,439,000 shares of common stock valued at $24 million in connection with the
acquisition. The acquisition was accounted for as a purchase.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill in the amount of approximately $10 million was recorded by the
construction services segment and is being amortized over a period of
approximately 25 years. The construction services segment provides utility
companies with trenching and installation, replacement, and maintenance services
for energy distribution systems.
During the period from the acquisition date through December 31, 1996, the
construction services segment recognized $36 million of revenues generated from
contracts with Southwest. These revenues and associated profits are included in
the consolidated financial statements of the Company and were not eliminated
during consolidation. SFAS No. 71, "Accounting for the Effects of Certain Types
of Regulation," provides that intercompany profits on sales to regulated
affiliates should not be eliminated in consolidation if the sales price is
reasonable and if future revenues approximately equal to the sales price will
result from the rate-making process. Management believes these two criteria will
be met. As of year end, accounts receivable includes $6.4 million which was not
eliminated during consolidation.
The assets acquired and the liabilities assumed at the acquisition date
were as follows (thousands of dollars):
Other property and investments $26,490
Receivables, net 12,928
Prepaids and other current assets 2,545
Deferred charges and other assets 11,340
- -------------------------------------------------------------------------------------------
Total assets acquired 53,303
- -------------------------------------------------------------------------------------------
Long-term debt and capital leases, including current maturities 14,691
Short-term debt 2,942
Accounts payable 3,123
Other current liabilities 6,759
Deferred income taxes 4,737
Other deferred credits 394
- -------------------------------------------------------------------------------------------
Total liabilities assumed 32,646
- -------------------------------------------------------------------------------------------
Net noncash assets acquired 20,657
Cash acquired in acquisition and included in cash flow statement 3,343
- -------------------------------------------------------------------------------------------
Total common equity issued in acquisition $24,000
===========================================================================================
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 -- SEGMENT INFORMATION
The financial information pertaining to the Company's natural gas
operations and construction services segments for each of the three years in the
period ended December 31, 1996, is as follows (thousands of dollars):
1996
------------------------------------------
GAS CONSTRUCTION
OPERATIONS SERVICES TOTAL
- ----------------------------------------------------------------------------------------------
Revenues from unaffiliated customers $ 546,361 $ 61,646 $ 608,007
Intersegment sales -- 36,054 36,054
- ----------------------------------------------------------------------------------------------
Total $ 546,361 $ 97,700 $ 644,061
==============================================================================================
Operating income $ 64,818 $ 6,755 $ 71,573
==============================================================================================
Depreciation, depletion and amortization $ 67,443 $ 6,256 $ 73,699
==============================================================================================
Construction expenditures and property additions $ 210,743 $ 8,092 $ 218,835
==============================================================================================
Indentifiable assets $1,498,099 $ 62,170 $1,560,269
==============================================================================================
1995
------------------------------------------
Gas Construction
Operations Services Total
- -----------------------------------------------------------------------------------------------
Operating revenues $ 563,502 $ -- $ 563,502
===============================================================================================
Operating income $ 58,412 $ -- $ 58,412
===============================================================================================
Depreciation, depletion and amortization $ 62,492 $ -- $ 62,492
===============================================================================================
Construction expenditures and property additions $ 166,183 $ -- $ 166,183
===============================================================================================
Indentifiable assets $1,357,034 $ -- $1,357,034
===============================================================================================
1994
------------------------------------------
Gas Construction
Operations Services Total
- -----------------------------------------------------------------------------------------------
Operating revenues $ 599,553 $ -- $ 599,553
===============================================================================================
Operating income $ 88,690 $ -- $ 88,690
===============================================================================================
Depreciation, depletion and amortization $ 57,284 $ -- $ 57,284
===============================================================================================
Construction expenditures and property additions $ 141,390 $ -- $ 141,390
===============================================================================================
Indentifiable assets $1,277,727 $ -- $1,277,727
===============================================================================================
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter Ended March 31 June 30 September 30 December 31
- -----------------------------------------------------------------------------------------
(Thousands of dollars, except per share amounts)
1996
Operating revenues $188,352 $123,611 $125,255 $206,843
Operating income (loss) 38,539 (4,747) (8,404) 46,185
Net income (loss) 14,859 (11,943) (14,638) 18,296
Net income (loss) applicable to common
stock 14,859 (11,943) (14,638) 18,296
Earnings (loss) per common share* 0.60 (0.46) (0.55) 0.69
1995
Operating revenues $203,521 $122,189 $ 91,433 $146,359
Operating income (loss) 36,829 (2,873) (9,215) 33,671
Income (loss) from continuing
operations 14,449 (9,951) (13,353) 11,509
Income (loss) from discontinued
operations 196 610 522 (18,864)
Net income (loss) 14,645 (9,341) (12,831) (7,355)
Net income (loss) applicable to common
stock 14,550 (9,436) (12,926) (7,377)
Earnings (loss) per share from
continuing operations* 0.67 (0.44) (0.56) 0.47
Earnings (loss) per share from
discontinued operations* 0.01 0.03 0.02 (0.77)
Earnings (loss) per common share* 0.68 (0.41) (0.54) (0.30)
1994
Operating revenues $207,369 $108,407 $ 92,245 $191,532
Operating income (loss) 47,519 (4,251) (8,302) 53,725
Income (loss) from continuing
operations 21,734 (10,735) (11,911) 24,436
Income (loss) from discontinued
operations 976 954 746 101
Net income (loss) 22,710 (9,781) (11,165) 24,537
Net income (loss) applicable to common
stock 22,571 (9,919) (11,303) 24,442
Earnings (loss) per share from
continuing operations* 1.03 (0.52) (0.57) 1.15
Earnings (loss) per share from
discontinued operations* 0.04 0.05 0.03 --
Earnings (loss) per common share* 1.07 (0.47) (0.54) 1.15
- ------------------------------
* 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.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The demand for natural gas is seasonal, and it is management's opinion
that comparisons of earnings for the interim periods do not reliably reflect
overall trends and changes in the Company's operations. 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
the Company's operating results.
NOTE 14 -- DISCONTINUED OPERATIONS -- FINANCIAL SERVICES ACTIVITIES
On July 19, 1996, the Company completed the sale of the assets and
liabilities of PriMerit Bank (the Bank) to Norwest Corporation for $191 million.
Proceeds from the sale were used by the Company to retire debt incurred in
connection with its investment in the Bank. The loss on the sale, recorded
during the fourth quarter of 1995, was $13 million, including taxes. Income tax
expense resulted from the loss due to the Company's investment in the Bank being
lower for tax purposes than book purposes. The results of operations of the Bank
have been included as discontinued operations in the accompanying financial
statements.
39
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders,
Southwest Gas Corporation:
We have audited the accompanying consolidated balance sheets of Southwest
Gas Corporation (a California corporation, hereinafter referred to as the
Company) and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1996. 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 generally accepted auditing
standards. 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 the Company and its
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
February 7, 1997