===============================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 1998
Commission File Number 1-7850
SOUTHWEST GAS CORPORATION
(Exact name of registrant as specified in its charter)
California 88-0085720
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5241 Spring Mountain Road
Post Office Box 98510
Las Vegas, Nevada 89193-8510
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (702) 876-7237
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Common Stock, $1 Par Value, 30,157,678 shares as of August 12, 1998.
===============================================================================
1
PART I - FINANCIAL INFORMATION
------------------------------
ITEM 1. FINANCIAL STATEMENTS
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except par value)
JUNE 30, DECEMBER 31,
1998 1997
------------ ------------
ASSETS (Unaudited)
Utility plant:
Gas plant $ 1,943,129 $ 1,867,824
Less: accumulated depreciation (583,105) (551,083)
Acquisition adjustments 4,070 4,259
Construction work in progress 36,898 39,294
------------ ------------
Net utility plant 1,400,992 1,360,294
------------ ------------
Other property and investments 79,482 64,928
------------ ------------
Current assets:
Cash and cash equivalents 5,590 17,567
Accounts receivable, net of allowances 56,656 78,016
Accrued utility revenue 21,500 54,373
Income tax benefit - 19,425
Deferred purchased gas costs 63,302 86,952
Prepaids and other current assets 27,259 32,211
------------ ------------
Total current assets 174,307 288,544
------------ ------------
Deferred charges and other assets 52,062 55,293
------------ ------------
Total assets $ 1,706,843 $ 1,769,059
============ ============
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $1 par (authorized - 45,000,000 shares; issued
and outstanding - 27,625,315 and 27,387,016 shares) $ 29,255 $ 29,017
Additional paid-in capital 365,077 360,683
Retained earnings (accumulated deficit) 18,396 (3,721)
------------ ------------
Total common equity 412,728 385,979
Redeemable preferred securities of Southwest Gas Capital I 60,000 60,000
Long-term debt, less current maturities 778,951 778,693
------------ ------------
Total capitalization 1,251,679 1,224,672
Current liabilities: ------------ ------------
Current maturities of long-term debt 4,819 5,621
Short-term debt 78,050 142,000
Accounts payable 35,231 62,324
Customer deposits 22,459 21,945
Accrued taxes 25,291 21,125
Accrued interest 13,477 13,007
Deferred taxes 15,981 24,163
Other current liabilities 35,504 34,222
------------ ------------
Total current liabilities 230,812 324,407
Deferred income taxes and other credits: ------------ ------------
Deferred income taxes and investment tax credits 171,545 168,282
Other deferred credits 52,807 51,698
------------ ------------
Total deferred income taxes and other credits 224,352 219,980
------------ ------------
Total capitalization and liabilities $ 1,706,843 $ 1,769,059
============ ============
The accompanying notes are an integral part of these statements.
2
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED TWELVE MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30,
----------------------- ----------------------- -------------------------
1998 1997 1998 1997 1998 1997
--------- --------- --------- --------- ---------- ----------
Operating revenues:
Gas operating revenues $ 165,017 $ 107,740 $ 439,380 $ 319,304 $ 734,741 $ 574,600
Construction revenues 27,880 29,198 46,118 52,865 110,598 129,667
--------- --------- --------- --------- ---------- ----------
Total operating revenues 192,897 136,938 485,498 372,169 845,339 704,267
--------- --------- --------- --------- ---------- ----------
Operating expenses:
Net cost of gas sold 73,768 36,723 194,755 121,322 282,771 193,745
Operations and maintenance 52,181 49,407 103,031 97,855 206,335 200,748
Depreciation and amortization 21,658 20,296 43,042 40,927 86,776 80,035
Taxes other than income taxes 7,845 7,457 15,817 15,111 30,099 28,404
Construction expenses 24,494 27,037 40,400 49,421 96,177 116,021
--------- --------- --------- --------- ---------- ----------
Total operating expenses 179,946 140,920 397,045 324,636 702,158 618,953
--------- --------- --------- --------- ---------- ----------
Operating income (loss) 12,951 (3,982) 88,453 47,533 143,181 85,314
--------- --------- --------- --------- ---------- ----------
Other income and (expenses):
Net interest deductions (15,539) (15,615) (31,819) (30,247) (64,790) (58,731)
Preferred securities distributions (1,369) (1,369) (2,738) (2,738) (5,475) (5,475)
Other income (deductions), net (64) 229 538 (142) (11,560) (676)
--------- --------- --------- --------- ---------- ----------
Total other income and (expenses) (16,972) (16,755) (34,019) (33,127) (81,825) (64,882)
--------- --------- --------- --------- ---------- ----------
Income (loss) before income taxes (4,021) (20,737) 54,434 14,406 61,356 20,432
Income tax expense (benefit) (1,507) (7,989) 20,995 5,586 20,268 7,954
--------- --------- --------- --------- ---------- ----------
Net income (loss) $ (2,514) $ (12,748) $ 33,439 $ 8,820 $ 41,088 $ 12,478
========= ========= ========= ========= ========== ==========
Basic earnings (loss) per share $ (0.09) $ (0.47) $ 1.22 $ 0.33 $ 1.50 $ 0.47
========= ========= ========= ========= ========== ==========
Diluted earnings (loss) per share $ (0.09) $ (0.47) $ 1.21 $ 0.33 $ 1.49 $ 0.46
========= ========= ========= ========= ========== ==========
Dividends paid per share $ 0.205 $ 0.205 $ 0.41 $ 0.41 $ 0.82 $ 0.82
========= ========= ========= ========= ========== ==========
Average number of common shares outstanding 27,570 27,002 27,509 26,910 27,366 26,733
Average shares outstanding (assuming dilution) -- -- 27,691 27,022 27,525 26,839
The accompanying notes are an integral part of these statements.
3
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)
SIX MONTHS ENDED TWELVE MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 33,439 $ 8,820 $ 41,088 $ 12,478
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 43,042 40,927 86,776 80,035
Deferred income taxes (4,919) 27,321 15,236 46,624
Changes in current assets and liabilities:
Accounts receivable, net of allowances 21,360 20,439 (6,992) (8,294)
Accrued utility revenue 32,873 25,959 (959) (577)
Deferred purchased gas costs 23,650 (66,908) (5,826) (103,874)
Accounts payable (27,093) (20,413) 5,693 (3,163)
Accrued taxes 23,591 (14,395) 29,709 (36,579)
Other current assets and liabilities 6,597 7,832 769 12,568
Other 1,062 1,069 13,882 8,502
---------- ---------- ---------- ----------
Net cash provided by operating activities 153,602 30,651 179,376 7,720
---------- ---------- ---------- ----------
CASH FLOW FROM INVESTING ACTIVITIES:
Construction expenditures and property additions (87,543) (81,033) (176,124) (212,690)
Proceeds from bank sale -- -- -- 191,662
Other (7,169) (3,503) (4,974) (22,813)
---------- ---------- ---------- ----------
Net cash used in investing activities (94,712) (84,536) (181,098) (43,841)
---------- ---------- ---------- ----------
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock 4,632 6,166 10,671 12,864
Dividends paid (11,274) (11,020) (22,431) (21,904)
Issuance of long-term debt, net 3,300 92,871 30,750 248,461
Retirement of long-term debt, net (3,576) (3,690) (7,451) (250,702)
Issuance (repayment) of short-term debt (63,950) (32,580) (10,370) 43,244
Other 1 -- 1 (1,270)
---------- ---------- ---------- ----------
Net cash provided by (used in) financing activities (70,867) 51,747 1,170 30,693
---------- ---------- ---------- ----------
Change in cash and temporary cash investments (11,977) (2,138) (552) (5,428)
Cash at beginning of period 17,567 8,280 6,142 11,570
---------- ---------- ---------- ----------
Cash at end of period $ 5,590 $ 6,142 $ 5,590 $ 6,142
========== ========== ========== ==========
Supplemental information:
Interest paid, net of amounts capitalized $ 30,711 $ 29,104 $ 60,378 $ 58,970
========== ========== ========== ==========
Income taxes, net of refunds $ 1,474 $ (2,682) $ (29,798) $ 11,572
========== ========== ========== ==========
The accompanying notes are an integral part of these statements.
4
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. Southwest Gas Corporation (the Company) is comprised
of two segments: natural gas operations (Southwest or the natural gas
operations segment) and construction services. Southwest purchases,
transports, and distributes natural gas to customers in portions of Arizona,
Nevada, and California. Southwest's public utility rates, practices,
facilities, and service territories are subject to regulatory oversight. The
timing and amount of rate relief can materially impact results of operations.
Natural gas sales are seasonal, peaking during the winter months. Variability
in weather from normal temperatures can materially impact results of
operations. Northern Pipeline Construction Co. (Northern or the construction
services segment), a wholly owned subsidiary, is a full-service underground
piping contractor which provides utility companies with trenching and
installation, replacement, and maintenance services for energy distribution
systems.
Basis of Presentation. The consolidated financial statements included
herein have been prepared by the Company, without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. The preparation
of the consolidated financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates. In the
opinion of management, all adjustments, consisting of normal recurring items
and estimates necessary for a fair presentation of the results for the interim
periods, have been made. It is suggested that these consolidated financial
statements be read in conjunction with the financial statements and the notes
thereto included in the Company's 1997 Annual Report to Shareholders, which is
incorporated by reference into the Form 10-K, and the 1998 First Quarter
Report on Form 10-Q.
Intercompany Transactions. The construction services segment recognizes
revenues generated from contracts with Southwest (see Note 2 below). Accounts
receivable for these services were $3.3 million at June 30, 1998 and
$3.6 million at December 31, 1997. The accounts receivable balance, revenues,
and associated profits are included in the consolidated financial statements
of the Company and were not eliminated during consolidation. Statement of
Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of
Certain Types of Regulation," provides that intercompany profits on sales to
regulated affiliates should not be eliminated in consolidation if the sales
price is reasonable and if future revenues approximately equal to the sales
price will result from the rate-making process. Management believes these two
criteria are being met.
NOTE 2 - SEGMENT INFORMATION
The following tables list revenues from external customers, intersegment
revenues, and segment income/loss (thousands of dollars):
Natural Gas Construction
Operations Services Total
----------- ------------ -----------
Six months ended June 30, 1998
Revenues from external customers $ 439,380 $ 28,561 $ 467,941
Intersegment revenues -- 17,557 17,557
----------- ----------- -----------
Total $ 439,380 $ 46,118 $ 485,498
=========== =========== ===========
Segment income $ 32,431 $ 1,008 $ 33,439
=========== =========== ===========
Six months ended June 30, 1997
Revenues from external customers $ 319,304 $ 35,083 $ 354,387
Intersegment revenues -- 17,782 17,782
----------- ----------- -----------
Total $ 319,304 $ 52,865 $ 372,169
=========== =========== ===========
Segment income (loss) $ 9,789 $ (969) $ 8,820
=========== =========== ===========
5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company is principally engaged in the business of purchasing,
transporting, and distributing natural gas. Southwest is the largest
distributor in Arizona, selling and transporting natural gas in most of
southern, central, and northwestern Arizona, including the Phoenix and Tucson
metropolitan areas. Southwest is also the largest distributor and transporter
of natural gas in Nevada, and serves the Las Vegas metropolitan area and
northern Nevada. In addition, Southwest distributes and transports natural
gas in portions of California, including the Lake Tahoe area in northern
California and the high desert and mountain areas in San Bernardino County.
Southwest purchases, transports, and distributes natural gas to approximately
1,171,000 residential, commercial, industrial and other customers, of which
57 percent are located in Arizona, 33 percent are in Nevada, and 10 percent
are in California. During the twelve months ended June 30, 1998, Southwest
earned 57 percent of operating margin in Arizona, 33 percent in Nevada, and 10
percent in California. During this same period, Southwest earned 84 percent
of operating margin from residential and small commercial customers, 4 percent
from other sales customers, and 12 percent from transportation customers.
These patterns are consistent with prior years and are expected to continue.
Northern is a full-service underground piping contractor which provides
utility companies with trenching and installation, replacement, and
maintenance services for energy distribution systems.
CAPITAL RESOURCES AND LIQUIDITY
The capital requirements and resources of the Company generally are determined
independently for the natural gas operations and construction services
segments. Each business activity is generally responsible for securing its
own financing sources. The capital requirements and resources of the
construction services segment are not material to the overall capital
requirements and resources of the Company.
Southwest continues to experience significant population growth throughout its
service territories. This growth has required large amounts of capital to
finance the investment in infrastructure, in the form of new transmission and
distribution plant, to satisfy consumer demand. For the twelve months ended
June 30, 1998, natural gas construction expenditures totaled $166 million.
Approximately 77 percent of these current-period expenditures represented new
construction and the balance represented costs associated with routine
replacement of existing transmission, distribution, and general plant. Cash
flows from operating activities of Southwest (net of dividends) provided $142
million, or 86 percent, of the required capital resources pertaining to these
construction expenditures. The remainder was provided from net external
financing activities. The improvement in operating cash flows from expected
levels was due to higher earnings, and income tax refunds related to timing
differences principally associated with gas purchases and recoveries.
Southwest estimates construction expenditures during the three-year period
ending December 31, 2000 will be approximately $510 million. During the three-
year period, cash flow from operating activities (net of dividends) is
estimated to fund approximately one-half of the gas operations total
construction expenditures. A portion of the construction expenditure funding
will be provided by $26 million of funds held in trust, at December 31, 1997,
from the issuance of industrial development revenue bonds (IDRB). The
remaining cash requirements are expected to be provided by external financing
sources. The timing, types, and amounts of these additional external
financings will be dependent on a number of factors, including conditions in
the capital markets, timing and amounts of rate relief, and growth factors in
Southwest service areas. These external financings may include the issuance
of both debt and equity securities, bank and other short-term borrowings, and
other forms of financing.
In August 1998, the Company completed an offering of 2.5 million primary
shares of common stock. The net proceeds from this offering, before exercise
of underwriter options to purchase up to 375,000 additional shares, are
estimated at $56 million after deducting underwriting discounts and expenses.
The proceeds will be used to finance construction and improvement of pipeline
systems and facilities located in and around the communities served by
Southwest.
6
RESULTS OF CONSOLIDATED OPERATIONS
Quarterly Analysis
- ------------------
Contribution to Net Income (Loss)
Three Months Ended June 30,
---------------------------------
(Thousands of dollars)
1998 1997
--------- ----------
Natural gas operations $ (3,226) $ (12,747)
Construction services 712 (1)
--------- ----------
Net income (loss) $ (2,514) $ (12,748)
========= ==========
Net loss for the second quarter of 1998 was $2.5 million or $0.09 per share.
This was a $10.2 million, or $0.38 per share, improvement from the loss
recorded during the corresponding quarter of the prior year. Natural gas
operations results improved $0.35 per share. See separate discussion at
RESULTS OF NATURAL GAS OPERATIONS for changes as they relate to gas
operations. Construction services contributed per share earnings of $0.03
during the current quarter, a $0.03 per share improvement over the
corresponding quarter of the prior year.
Six-Month Analysis
- ------------------
Contribution to Net Income
Six Months Ended June 30,
--------------------------
(Thousands of dollars)
1998 1997
--------- ----------
Natural gas operations $ 32,431 $ 9,789
Construction services 1,008 (969)
--------- ----------
Net income $ 33,439 $ 8,820
========= ==========
Earnings per share for the six months ended June 30, 1998 were $1.22, an $0.89
increase from per share earnings of $0.33 recorded during the corresponding
six-months of the previous year. Earnings contributed from natural gas
operations during the current six-month period were $1.18 per share, an
increase of $0.82 per share. See separate discussion at RESULTS OF NATURAL
GAS OPERATIONS for changes as they relate to gas operations. Construction
services activities contributed earnings per share of $0.04, a $0.07 per share
improvement over the corresponding period of the prior year. The improvement
resulted from obtaining new work, eliminating less profitable contracts,
implementing cost containment measures, and better-than-expected weather
conditions in several cold-climate operating areas which allowed construction
activities to begin earlier than anticipated during the first quarter of 1998.
7
Twelve-Month Analysis
- ---------------------
Contribution to Net Income
Twelve Months Ended June 30,
---------------------------
(Thousands of dollars)
1998 1997
--------- ---------
Natural gas operations $ 38,467 $ 11,238
Construction services 2,621 1,240
--------- ---------
Net income $ 41,088 $ 12,478
========= =========
Earnings per share for the twelve months ended June 30, 1998 were $1.50, a
$1.03 increase from per share earnings of $0.47 recorded during the prior
twelve-month period. Earnings contributed from natural gas operations
increased $0.99 per share to $1.41 per share. See separate discussion at
RESULTS OF NATURAL GAS OPERATIONS for changes as they relate to gas
operations. Construction services activities contributed per share earnings of
$0.09, a $0.04 per share improvement over the prior twelve-month period. The
improvement is attributed to obtaining new work, eliminating less profitable
contracts, implementing cost containment measures, and better-than-expected
weather conditions in several cold-climate operating areas which allowed
construction activities to begin earlier than normal during the first quarter
of 1998.
The following table sets forth the ratios of earnings to fixed charges for the
Company.
For the Twelve Months Ended
---------------------------
June 30, December 31,
1998 1997
-------- -----------
Ratios of earnings to fixed charges 1.78 1.28
For the purposes of computing the ratios of earnings to fixed charges,
earnings are defined as the sum of pretax income from continuing operations
plus fixed charges. Fixed charges consist of all interest expense including
capitalized interest, one-third of rent expense (which approximates the
interest component of such expense), preferred securities distributions, and
amortized debt costs.
8
RESULTS OF NATURAL GAS OPERATIONS
Quarterly Analysis
- ------------------
Three Months Ended
June 30,
--------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Gas operating revenues $ 165,017 $ 107,740
Net cost of gas sold 73,768 36,723
---------- ----------
Operating margin 91,249 71,017
Operations and maintenance expense 52,181 49,407
Depreciation and amortization 19,674 18,357
Taxes other than income taxes 7,845 7,457
---------- ----------
Operating income (loss) 11,549 (4,204)
Other income (deductions), net (102) (43)
---------- ----------
Income (loss) before interest and income taxes 11,447 (4,247)
Net interest deductions 15,314 15,195
Preferred securities distributions 1,369 1,369
Income tax expense (benefit) (2,010) (8,064)
---------- ----------
Contribution to consolidated net income (loss) $ (3,226) $ (12,747)
========== ==========
Contribution to consolidated net income improved $9.5 million compared to the
second quarter of 1997. The increase was the result of fundamental
improvements in operating margin coupled with favorable weather conditions,
offset somewhat by higher operating expenses.
Operating margin increased $20.2 million, or 28 percent, in the second quarter
of 1998 compared to the same period a year ago. Approximately $10 million was
attributed to cooler temperatures during the current period. Rate relief
contributed an estimated $8 million to the increase, and the remainder of the
improvement in operating margin was due to customer growth as Southwest served
58,000, or five percent, more customers than a year ago.
Operations and maintenance expenses increased $2.8 million, or six percent,
reflecting general increases in labor and maintenance costs.
Depreciation expense and general taxes increased $1.7 million, or
seven percent, as a result of construction activities. Average gas plant in
service increased $131 million, or seven percent, as compared to the second
quarter of 1997. The increase reflects ongoing capital expenditures for the
upgrade of existing operating facilities and the expansion of the system to
accommodate continued customer growth.
Net interest deductions increased $119,000, or less than one percent, as
strong cash flows reduced the amount of net new borrowings and interest rates
on variable-rate facilities were lower than during the prior period.
9
Six-Month Analysis
- ------------------ Six Months Ended
June 30,
--------------------------
(Thousands of dollars)
1998 1997
---------- ----------
Gas operating revenues $ 439,380 $ 319,304
Net cost of gas sold 194,755 121,322
---------- ----------
Operating margin 244,625 197,982
Operations and maintenance expense 103,031 97,855
Depreciation and amortization 38,976 36,315
Taxes other than income taxes 15,817 15,111
---------- ----------
Operating income 86,801 48,701
Other income (expense), net (91) (648)
---------- ----------
Income before interest and income taxes 86,710 48,053
Net interest deductions 31,339 29,456
Preferred securities distributions 2,738 2,738
Income tax expense 20,202 6,070
---------- ----------
Contribution to consolidated net income $ 32,431 $ 9,789
========== ==========
Contribution to consolidated net income increased $22.6 million compared to
the six months ended June 1997. The increase was the result of improvements
in operating margin, offset somewhat by higher operating and financing
expenses.
Operating margin increased $46.6 million, or 24 percent, due to improved
weather conditions, rate relief, and continued customer growth. Differences
in heating demand caused by weather variances between periods resulted in an
increase of $24 million. Approximately $17 million was attributed to colder-
than-normal temperatures in the current six-month period, and the remainder
resulted from the corresponding prior period being warmer than normal. Rate
relief, primarily resulting from a September 1997 $32 million annualized
general rate case settlement in Arizona, contributed $17 million in additional
operating margin to the current period. Customer growth accounted for the
remaining $5.6 million.
Operations and maintenance expenses increased $5.2 million, or five percent,
reflecting increases in labor and maintenance costs along with incremental
operating expenses associated with providing service to the growing Southwest
customer base.
Depreciation expense and general taxes increased $3.4 million, or seven
percent, resulting from an increase in average gas plant in service of
$133 million, or eight percent. This increase reflects capital expenditures
for the upgrade of existing operating facilities and the expansion of the
system to accommodate new customers being added to the system.
Net interest deductions increased $1.9 million, or six percent, during the six
months ended June 1998 over the comparative prior period. The change is
attributed primarily to an increase in average total debt outstanding during
the period to finance construction expenditures and to finance the deferred
purchased gas cost balance. Average interest rates on variable-rate
facilities were lower than during the prior period, partially offsetting the
volume variance.
10
Twelve-Month Analysis
- ---------------------
Twelve Months Ended
June 30,
----------------------------
(Thousands of dollars)
1998 1997
----------- ----------
Gas operating revenues $ 734,741 $ 574,600
Net cost of gas sold 282,771 193,745
----------- ----------
Operating margin 451,970 380,855
Operations and maintenance expense 206,335 200,748
Depreciation and amortization 77,189 70,767
Taxes other than income taxes 30,099 28,404
----------- ----------
Operating income 138,347 80,936
Other income (deductions), net (12,422) (1,133)
----------- ----------
Income before interest and income taxes 125,925 79,803
Net interest deductions 63,634 56,453
Preferred securities distributions 5,475 5,475
Income tax expense 18,349 6,637
----------- ----------
Contribution to consolidated net income $ 38,467 $ 11,238
=========== ==========
Contribution to consolidated net income increased $27.2 million compared to
the corresponding twelve-month period ended June 1997. The increase was the
result of improvements in operating margin, partially offset by higher
operating and financing expenses.
Operating margin increased $71.1 million, or 19 percent, due to improved
weather conditions, rate relief, and continued customer growth. Differences
in heating demand caused by weather variances between periods resulted in an
increase of $33 million. Approximately $22 million pertained to colder-than-
normal temperatures in the current period, and the remainder was attributed to
the prior period being warmer than normal. Rate relief, primarily resulting
from a September 1997 $32 million annualized general rate case settlement in
Arizona, contributed $28 million in additional operating margin to the current
period. Customer growth accounted for the remaining $10.1 million.
Operations and maintenance expenses increased $5.6 million, or three percent,
reflecting general cost increases.
Depreciation expense and general taxes increased $8.1 million, or eight
percent, as a result of additional plant in service. Average gas plant in
service for the current twelve-month period increased $150 million, or
nine percent, compared to the corresponding period a year ago. This was
attributable to the upgrade of existing operating facilities and the expansion
of the system to accommodate new customers being added to the system.
Net interest deductions increased $7.2 million, or 13 percent, during the
twelve months ended June 1998 over the comparative prior period. The change
is attributed primarily to an increase in average total debt outstanding
during the period to finance construction expenditures and to finance the
deferred purchased gas cost balance.
During the fourth quarter of 1997, Southwest recognized nonrecurring charges
to income related to cost overruns on two separate construction projects.
These charges are reflected in Other income (deductions), net. An $8 million
pretax charge resulted from cost overruns experienced during expansion of the
northern California service territory. See RATES AND REGULATORY PROCEEDINGS
herein. A second pretax charge, for $5 million, related to cost overruns on a
nonutility construction project. See Note 11 of the Notes to Consolidated
Financial Statements in the 1997 Annual Report to Shareholders for additional
disclosures related to this charge. Partially offsetting these charges was
the recognition of a $3.4 million income tax benefit related to the successful
settlement in November 1997 of open tax issues dating back as far as 1988.
The combined impact of these three events was a $4.1 million, or $0.15 per
share, after-tax reduction to earnings.
11
RATES AND REGULATORY PROCEEDINGS
California
Northern California Expansion Project. In December 1993, Southwest filed an
application with the California Public Utilities Commission (CPUC) to expand
its northern California service territory and extend service into Truckee,
California. The application included a proposed regulatory mechanism for
recovering the cost of the expansion. In May 1994, rate and cost recovery
issues related to the expansion application were combined by the CPUC with a
January 1994 general rate application Southwest had filed with the CPUC. In
September 1994, a Joint Motion and Stipulation and Settlement Agreement
(Settlement) was presented to the CPUC which resolved the general rate case
and addressed the expansion related cost recovery issues. In December 1994,
the Settlement was approved. In April 1995, Southwest received CPUC approval
for the certificate of public convenience and necessity to serve the expansion
areas.
In its filing, Southwest had indicated that expansion into Truckee would occur
in three phases and result in the conversion of an estimated 9,200 customers
to natural gas service from their existing fuel, primarily propane. The CPUC
established a cost cap of $29.1 million for the project.
In 1995, Southwest completed Phase I of the expansion project, which involved
transmission system reinforcement and distribution system expansion to
accommodate approximately 940 customers. Construction costs of $7.1 million
were on target with the cost estimate approved by the CPUC.
Phase II of the project involved extending the transmission system to Truckee
and distribution system expansion to accommodate an estimated 4,200 customers.
The cost cap apportioned to Phase II was approximately $13.8 million. The
incurred cost of Phase II was $28.6 million. An estimated $9.2 million of the
Phase II cost overrun was due to changes in project scope, such as adjustments
for design changes required by governmental bodies, changes in facilities
necessitated by requirements beyond Southwest's control and costs incurred to
accommodate customer service requests.
Examples of adjustments for changes in project scope included the requirement
to haul excavated soil offsite to be screened whereas normal and anticipated
practice is to screen on site, asphalt repairs which were greater than
expected as a result of increased paving requirements imposed after
construction started, and the installation of more facilities under asphalt
than anticipated. Other unanticipated or externally imposed costs pertained
to extended yard lines, underground boring, environmental studies, right-of-
way acquisitions, and engineering design work.
Due to the Phase II cost overruns and difficult construction environment
experienced, construction of Phase III was postponed to reevaluate the
economics of completing the project.
In July 1997, Southwest filed an application requesting authorization from the
CPUC to modify the terms and conditions of the certificate of public
convenience and necessity granted in 1995. In this application, Southwest
requested that the originally approved cost cap of $29.1 million be increased
to $46.8 million; that the scope of Phase III construction be revised to
include only an estimated 2,900 of the initially estimated 4,200 customers;
and that customer applicants desiring service in the expansion area who were
not identified to receive service during the expansion phases as modified
within the new application be subject to the existing main and service
extension rules. Southwest proposed to recover the incremental costs above
the original cost cap through a surcharge mechanism. Concurrently, the Truckee
town manager, on behalf of the Truckee Town Council, wrote a letter to the
CPUC in support of the application.
In August 1997, the Office of Ratepayer Advocates (ORA) for the CPUC filed a
protest to the Southwest application indicating that the terms of the original
agreement should be adhered to. Southwest responded with written comments in
support of its application. In September 1997, a prehearing conference was
held to discuss the filing, the ORA protest, and Southwest comments. The
administrative law judge (ALJ) made a preliminary ruling in favor of the ORA
protest, but allowed the parties an additional 20 days to supplement their
comments. During this time, Southwest and the ORA, pursuant to direction from
the Commission, began to negotiate a settlement agreement, and the procedural
schedule was adjusted to allow the negotiations to continue beyond the 20 day
period. In January 1998, a settlement involving all parties to the proceeding
was executed and filed with the CPUC which redefined the terms and conditions
12
for completing the project and recovering the additional project costs.
Although CPUC approval of the settlement was still required, management
anticipated approval of the all-party settlement. In February 1998, a
prehearing conference was held before the ALJ and the assigned Commissioner
for the purpose of taking public comment on the settlement agreement. There
was no opposition to the settlement agreement from the Truckee Town Council at
the conference, or in a letter written by the Truckee town manager to the CPUC
subsequent to the conference.
Under the proposed settlement, Southwest agreed, among other things, to absorb
$8 million in cost overruns experienced in Phase II of the project. Southwest
also agreed to an $11 million cost cap (with a maximum of $3,800 per customer)
for Phase III of the project. The Phase III project scope would be modified
as requested in the July 1997 application. In addition, Southwest agreed not
to file its next general rate case until Phase III is complete. Based on the
proposed settlement agreement, Southwest recognized an $8 million pretax
charge in the fourth quarter of 1997.
In May 1998, the ALJ issued an unexpected Proposed Decision (PD) rejecting the
all-party settlement and directing Southwest to complete the project under the
terms and conditions of the 1995 certificate. A PD which ignores an all-party
settlement is rare and inconsistent with CPUC policies and procedures
established in 1992. Subsequent to the PD, the Truckee Town Council took a
formal position in opposition to the settlement, although they were not a
party to the proceeding, and had not previously opposed the settlement.
In July 1998, the CPUC voted to adopt the PD and rejected the all-party
settlement and ordered Southwest to proceed with all deliberate speed to
complete the project under the terms and scope of the 1995 certificate.
Southwest will petition the CPUC for rehearing (Petition) and file a Motion
for Stay (Motion) of order in August 1998. If the CPUC does not act within 60
days, or if the CPUC rejects the Petition, Southwest will petition the Supreme
Court of the State of California for review. Such a petition is discretionary
with the Supreme Court, and if accepted, could take up to two years to be
heard.
Southwest will pursue several alternative regulatory and legal avenues while
seeking the Motion and Petition from the CPUC regarding the July 1998
decision. First, Southwest will petition the CPUC to hold hearings to modify
the original Settlement approved in December 1994. Second, Southwest will
seek to reopen the prior California general rate case and certificate
proceeding to readdress, among other items, the scope and costs of the Truckee
project. Because approval of the settlement agreement was expected, no
evidentiary hearings were conducted. Management strongly believes Southwest
is entitled to an evidentiary hearing before the CPUC, because the recent
proceedings effectively denied Southwest its fundamental due process rights.
Third, Southwest may seek to partially abandon its certificate to serve
certain Phase III geographic locales. Finally, Southwest contemplates
undertaking civil litigation against those parties whose actions materially
contributed to unanticipated changes in project cost and scope.
In the January 1998 all-party settlement agreement, Southwest proposed to
modify Phase III of the project to exclude certain areas from the original
certificate application. The excluded areas are the most distant points from
existing mains and present some of the most challenging geographic conditions
in the expansion area. Extension of mains to serve the estimated 1,300
customers in the excluded areas would be considerably more expensive than the
service areas in Phases I and II. Furthermore, these areas have significantly
lower customer density than the remainder of the expansion project; therefore,
expected revenues would be insufficient to justify the anticipated
construction costs.
Because of the proposed settlement, detailed engineering studies of the
excluded areas have not been performed. However, preliminary estimates
indicate that it could cost an additional $12 million to $14 million to extend
service to these 1,300 potential customers. The cost to extend service to the
remaining 2,900 potential Phase III customers is estimated at $11 million.
13
Based on these forecasts, an additional pretax writeoff of up to $24 million
could be recorded if Southwest is ultimately required to complete the project
under the terms of the 1995 certificate without modification. This estimate
is comprised of approximately $7 million related to costs incurred through
Phase II, and up to $17 million for the forecasted construction costs.
However, Southwest will vigorously prosecute the described regulatory and
legal proceedings with the intent of reversing or mitigating the effects of
the July 1998 CPUC action. Management believes that a reasonable possibility
of modifying the existing CPUC orders pertaining to the expansion project
exists through pursuit of the legal and regulatory remedies which have been
outlined. Management also believes civil litigation offers a reasonable
possibility of recovering certain amounts spent to deal with changes in scope
necessitated by unanticipated third party actions. As a result, Southwest has
not recorded any additional writeoffs beyond the $8 million recognized in the
fourth quarter of 1997.
PGA Filings
Arizona PGA Filing. In March 1998, the Arizona Corporation Commission
approved a purchased gas adjustment (PGA) filing submitted by Southwest in
January 1998 to recover deferred purchased gas costs in Arizona. This filing,
which became effective in April 1998, resulted in an annual increase of $46.9
million, or 14 percent. The increase in rates was designed to recover the
accumulated PGA balance related to Arizona customers, and to eliminate the
refunds currently built into the rate structure. PGA changes impact cash
flows but have no direct impact on profit margin.
Nevada PGA Filing. In January 1997, Southwest submitted an out-of-period PGA
filing in Nevada, in response to a substantial run-up in the commodity cost of
natural gas during November and December of 1996. In September 1997, the
Public Utilities Commission of Nevada (PUCN) approved the filing providing
annual increases of $10.1 million, or 9 percent, in the southern Nevada rate
jurisdiction, and $6 million, or 14 percent, in the northern Nevada rate
jurisdiction.
In June 1997, Southwest submitted its annual PGA filing in compliance with the
Nevada Gas Tariff. The filing covered the period from April 1996 through
March 1997. Southwest requested annual increases of $23.1 million, or
18 percent, in the southern Nevada rate jurisdiction, and $8.4 million, or
17 percent, in the northern Nevada rate jurisdiction.
In an order issued in December 1997, the PUCN found that "Southwest failed to
mitigate the risk inherent in a portfolio of all indexed-priced contracts and
failed to reasonably quantify the costs of any risk mitigation." As a result,
Southwest was ordered to reduce its cost of gas by $3.8 million in southern
Nevada and $1.8 million in northern Nevada. The approved increase, after
consideration of the amounts disallowed, was $17.3 million, or 14 percent in
southern Nevada, and $5.2 million, or 11 percent in northern Nevada.
In December 1997, Southwest filed a Petition for Reconsideration (Petition) of
the decision with the PUCN on the grounds that the findings of fact and
conclusions of law are contrary to binding legislative enactments and judicial
decisions. Specifically, the Petition asserted, among other things, that the
PUCN violated its settled obligation in the previous PGA docket, which
included the same winter period, in finding Southwest to be imprudent.
Effectively, the PUCN allowed a previously settled claim to be relitigated.
In addition, management also believes that the PUCN failed to follow its
previous rules and practices surrounding a PGA proceeding, or changed those
rules effective with the disallowance order and sought to retroactively apply
them, which would have required compliance with formal rulemaking procedures
mandated by Nevada Statutes. In February 1998, the PUCN reaffirmed the
original order.
In March 1998, Southwest filed a petition for judicial review (appeal) of the
final order of the PUCN with the Nevada District Court (NDC). The appeal
alleges the same procedural irregularities as were included in the Petition.
In July 1998, the NDC rejected a PUCN motion to dismiss, which was also filed
in March 1998, and established a procedural schedule. An initial hearing is
scheduled for the third quarter of 1998. Management estimates the NDC appeal
process could take up to six months before a decision is rendered. Subsequent
appeals by either party to the Nevada Supreme Court, if necessary, could take
an additional year.
See Note 8 of the Notes to Consolidated Financial Statements in the 1997
Annual Report to Shareholders for additional background information.
14
Management believes it is probable that the action taken to dispute the
findings of fact and conclusions of law in the order will result in the
successful outcome desired, specifically, that the order to exclude
$5.6 million in gas costs from the PGA balance will be reversed. As a result,
the financial statements do not reflect any charges to effect the
disallowance.
FORWARD-LOOKING STATEMENTS
This report contains statements which constitute "forward-looking statements"
within the meaning of the Securities Litigation Reform Act of 1995 (Reform
Act). All such forward-looking statements are intended to be subject to the
safe harbor protection provided by the Reform Act. A number of important
factors affecting the business and financial results of the Company could
cause actual results to differ materially from those stated in the
forward-looking statements. These factors include, but are not limited to,
the impact of weather variations on customer usage, the effects of regulation,
the outcome of Southwest's challenges to regulatory actions in California and
Nevada, changes in capital requirements and funding, and acquisitions.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132 "Employers'
Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132
standardizes the disclosure requirements for pensions and other postretirement
benefits, requires additional information to facilitate financial analysis,
and eliminates certain previously required disclosures. It does not change
measurement or recognition of amounts related to those plans. This statement
is effective for 1998 reporting. The disclosure requirements of this
statement are not expected to significantly change current reporting practices
of the Company.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. This statement is effective for fiscal years
beginning after June 15, 1999. The disclosure and accounting requirements of
this statement are currently being analyzed by the Company.
15
PART II - OTHER INFORMATION
---------------------------
Items 1-3. None
Item 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders was held on
May 14, 1998. Matters voted upon and the results of the voting
were as follows:
(1) The eleven directors nominated were reelected.
(2) The proposal to ratify the selection of Arthur Andersen LLP as
independent public accountants for the Company was approved.
Shareholders voted 24,239,940 shares in favor, 123,360 opposed,
and 232,728 abstentions.
Item 5. Other Information
Until further notice, any proposal that a shareholder intends to
present at the Company's 1999 Annual Meeting of Shareholders, but
does not intend to submit for inclusion in the proxy statement, must
be received at the principal executive office of the Company before
February 20, 1999, in order to be considered timely under Securities
and Exchange Commission proxy rules.
Item 6. Exhibits and Reports on Form 8-K
(a) The following documents are filed as part of this report on
Form 10-Q:
Exhibit 12 - Computation of Ratios of Earnings to Fixed
Charges and Ratios of Earnings to Combined Fixed
Charges and Preferred Stock Dividends
Exhibit 27 - Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
The Company filed a Form 8-K, dated July 13, 1998, reporting the
CPUC rejection of an all-party settlement agreement related to
an expansion project in northern California.
The Company filed a Form 8-K, dated July 16, 1998, indicating
that operating results for the quarter ended June 30, 1998 would
exceed analysts' estimates.
The Company filed a Form 8-K, dated July 27, 1998, reporting
summary financial information for the quarter ended
June 30, 1998.
The Company filed a Form 8-K, dated August 8, 1998, containing
exhibits related to its common stock offering of up to
2,875,000 shares.
16
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Southwest Gas Corporation
-------------------------
(Registrant)
Date: August 12, 1998
/s/ Edward A. Janov
-------------------------
Edward A. Janov
Vice President/Controller and Chief Accounting Officer
17
EXHIBIT 12
SOUTHWEST GAS CORPORATION
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(Thousands of dollars)
For the Twelve Months Ended
----------------------------------------------------------------------------------
June 30, December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ---------- ----------
Continuing operations
1. Fixed charges:
A) Interest expense $ 64,814 $ 63,247 $ 54,674 $ 52,844 $ 48,688 $ 40,883
B) Amortization 1,180 1,164 1,494 1,569 1,426 1,330
C) Interest portion of rentals 6,877 6,973 6,629 4,435 4,743 4,556
D) Preferred securities distributions 5,475 5,475 5,475 913 - -
---------- ---------- ---------- ---------- ---------- ----------
Total fixed charges $ 78,346 $ 76,859 $ 68,272 $ 59,761 $ 54,857 $ 46,769
========== ========== ========== ========== ========== ==========
2. Earnings (as defined):
E) Pretax income from
continuing operations $ 61,356 $ 21,328 $ 10,448 $ 3,493 $ 38,119 $ 21,959
Fixed Charges (1. above) 78,346 76,859 68,272 59,761 54,857 46,769
---------- ---------- ---------- ---------- ---------- ----------
Total earnings as defined $ 139,702 $ 98,187 $ 78,720 $ 63,254 $ 92,976 $ 68,728
========== ========== ========== ========== ========== ==========
3. Ratio of earnings to fixed charges 1.78 1.28 1.15 1.06 1.69 1.47
========== ========== ========== ========== ========== ==========
For the Twelve Months Ended
----------------------------------------------------------------------------------
June 30, December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ---------- ----------
Adjusted for interest allocated to
discontinued operations
1. Fixed charges:
A) Interest expense $ 64,814 $ 63,247 $ 54,674 $ 52,844 $ 48,688 $ 40,883
B) Amortization 1,180 1,164 1,494 1,569 1,426 1,330
C) Interest portion of rentals 6,877 6,973 6,629 4,435 4,743 4,556
D) Preferred securities distributions 5,475 5,475 5,475 913 - -
E) Allocated interest [1] - - - 9,636 7,874 7,874
---------- ---------- ---------- ---------- ---------- ----------
Total fixed charges $ 78,346 $ 76,859 $ 68,272 $ 69,397 $ 62,731 $ 54,643
========== ========== ========== ========== ========== ==========
2. Earnings (as defined):
F) Pretax income from
continuing operations $ 61,356 $ 21,328 $ 10,448 $ 3,493 $ 38,119 $ 21,959
Fixed Charges (1. above) 78,346 76,859 68,272 69,397 62,731 54,643
---------- ---------- ---------- ---------- ---------- ----------
Total earnings as defined $ 139,702 $ 98,187 $ 78,720 $ 72,890 $ 100,850 $ 76,602
========== ========== ========== ========== ========== ==========
3. Ratio of earnings to fixed charges 1.78 1.28 1.15 1.05 1.61 1.40
========== ========== ========== ========== ========== ==========
[1] Represents allocated interest through the period ended December 31, 1995. Carrying costs for the
period subsequent to year end through the disposition of the discontinued operations were accrued and
recorded as disposal costs.
/TABLE
EXHIBIT 12
SOUTHWEST GAS CORPORATION
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS
(Thousands of dollars)
For the Twelve Months Ended
-------------------------------------------------------------------------------
June 30, December 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- ---------
Continuing operations
1. Combined fixed charges:
A) Total fixed charges $ 78,346 $ 76,859 $ 68,272 $ 59,761 $ 54,857 $ 46,769
B) Preferred dividends [1] - - - 404 826 1,183
--------- --------- --------- --------- --------- ---------
Total fixed charges and
preferred dividends $ 78,346 $ 76,859 $ 68,272 $ 60,165 $ 55,683 $ 47,952
========= ========= ========= ========= ========= =========
2. Earnings $ 139,702 $ 98,187 $ 78,720 $ 63,254 $ 92,976 $ 68,728
========= ========= ========= ========= ========= =========
3. Ratio of earnings to fixed charges
and preferred dividends 1.78 1.28 1.15 1.05 1.67 1.43
========= ========= ========= ========= ========= =========
For the Twelve Months Ended
-------------------------------------------------------------------------------
June 30, December 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- ---------
Adjusted for interest allocated to
discontinued operations
1. Combined fixed charges:
A) Total fixed charges $ 78,369 $ 76,859 $ 68,272 $ 69,397 $ 62,731 $ 54,643
B) Preferred dividends [1] - - - 404 826 1,183
--------- --------- --------- --------- --------- ---------
Total fixed charges and
preferred dividends $ 78,369 $ 76,859 $ 68,272 $ 69,801 $ 63,557 $ 55,826
========= ========= ========= ========= ========= =========
2. Earnings $ 139,702 $ 98,187 $ 78,720 $ 72,890 $ 100,850 $ 76,602
========= ========= ========= ========= ========= =========
3. Ratio of earnings to fixed charges
and preferred dividends 1.78 1.28 1.15 1.04 1.59 1.37
========= ========= ========= ========= ========= =========
[1] Preferred and preference dividends have been adjusted to represent the pretax earnings necessary
to cover such dividend requirements.
/TABLE
UT
1,000
6-MOS
DEC-31-1998
JUN-30-1998
PER-BOOK
1,400,992
79,482
174,307
52,062
0
1,706,843
29,255
365,077
18,396
412,728
0
0
778,951
78,050
0
0
4,819
0
0
0
432,295
1,706,843
485,498
20,995
397,045
397,045
88,453
(2,200)
86,253
31,819
33,439
0
33,439
11,274
0
153,602
1.22
1.21
Includes: trust originated preferred securities of $60,000, current
liabilities, net of current long-term debt maturities and short-term debt, of
$147,943, and deferred income taxes and other credits of $224,352.
Includes distributions related to trust originated preferred securities of $2,738.
