Southwest Gas 10-K 2006
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File Number 1-7850
SOUTHWEST GAS CORPORATION
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (702) 876-7237
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Aggregate market value of the voting and non-voting common stock held by nonaffiliates of the registrant:
$976,113,313 as of June 30, 2005
The number of shares outstanding of common stock:
Common Stock, $1 Par Value, 39,557,464 shares as of March 1, 2006
DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
Item 1. BUSINESS
Southwest Gas Corporation (the Company) was incorporated in March 1931 under the laws of the state of California. The Company is composed of two business segments: natural gas operations (Southwest or the natural gas operations segment) and construction services.
Southwest is engaged in the business of purchasing, transporting, and distributing natural gas in portions of Arizona, Nevada, and California. Southwest is the largest distributor of natural gas in Arizona, selling and transporting natural gas in most of central and southern Arizona, including the Phoenix and Tucson metropolitan areas. Southwest is also the largest distributor and transporter of natural gas in Nevada, serving the Las Vegas metropolitan area and northern Nevada. In addition, Southwest distributes and transports natural gas in portions of California, including the Lake Tahoe area and the high desert and mountain areas in San Bernardino County.
Northern Pipeline Construction Co. (NPL or the construction services segment), a wholly owned subsidiary, is a full-service underground piping contractor that provides utility companies with trenching and installation, replacement, and maintenance services for energy distribution systems.
Financial information concerning the Companys business segments is included in Note 11 of the Notes to Consolidated Financial Statements, which is included in the 2005 Annual Report to Shareholders and is incorporated herein by reference.
The Company maintains a website (www.swgas.com) for the benefit of shareholders, investors, customers, and other interested parties. The Company makes its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports available, free of charge, through its website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). The Companys Corporate Governance Guidelines, Code of Business Conduct and Ethics, and charters of the nominating and corporate governance, audit, and compensation committees of the board of directors are also available on the website and are available in print by request.
Southwest is subject to regulation by the Arizona Corporation Commission (ACC), the Public Utilities Commission of Nevada (PUCN), and the California Public Utilities Commission (CPUC). These commissions regulate public utility rates, practices, facilities, and service territories in their respective states. The CPUC also regulates the issuance of all securities by the Company, with the exception of short-term borrowings. Certain accounting practices, transmission facilities, and rates are subject to regulation by the Federal Energy Regulatory Commission (FERC). NPL is not regulated by the state utilities commissions in any of its operating areas.
As of December 31, 2005, Southwest purchased, transported, and distributed natural gas to 1,713,000 residential, commercial, and industrial customers in geographically diverse portions of Arizona, Nevada, and California. There were 100,000 customers added to the system during 2005 (including 19,000 customers associated with the purchase of the South Lake Tahoe natural gas distribution properties of Avista Corporation (Avista) in April 2005).
The table below lists the percentage of operating margin (operating revenues less net cost of gas) by major customer class for the years indicated:
Southwest is not dependent on any one or a few customers such that the loss of any one or several would have a significant adverse impact on earnings or cash flows.
Transportation of customer-secured gas to end-users accounted for 51 percent of total system throughput in 2005. Customers who utilized this service transported 127 million dekatherms in 2005, 126 million dekatherms in 2004, and 134 million dekatherms in 2003. Although these volumes were significant, these customers provide a much smaller proportionate share of operating margin.
The demand for natural gas is seasonal. Variability in weather from normal temperatures can materially impact results of operations. It is the opinion of management that comparisons of earnings for interim periods do not reliably reflect overall trends and changes in operations. Also, earnings for interim periods can be significantly affected by the timing of general rate relief.
Rates and Regulation
Rates that Southwest is authorized to charge its distribution system customers are determined by the ACC, PUCN, and CPUC in general rate cases and are derived using rate base, cost of service, and cost of capital experienced in an historical test year, as adjusted in Arizona and Nevada, and projected for a future test year in California. The FERC regulates the northern Nevada transmission and liquefied natural gas (LNG) storage facilities of Paiute Pipeline Company (Paiute), a wholly owned subsidiary, and the rates it charges for transportation of gas directly to certain end-users and to various local distribution companies (LDCs). The LDCs transporting on the Paiute system are: Sierra Pacific Power Company (serving Reno and Sparks, Nevada) and Southwest Gas Corporation (serving Truckee, South Lake Tahoe and North Lake Tahoe, California and various locations throughout northern Nevada). In April 2005, Southwest purchased the Avista natural gas distribution properties in South Lake Tahoe. Prior to this acquisition, Avista also was an LDC transporting on the Paiute system.
Rates charged to customers vary according to customer class and rate jurisdiction and are set at levels that are intended to allow for the recovery of all prudently incurred costs, including a return on rate base sufficient to pay interest on debt, preferred securities distributions, and a reasonable return on common equity. Rate base consists generally of the original cost of utility plant in service, plus certain other assets such as working capital and inventories, less accumulated depreciation on utility plant in service, net deferred income tax liabilities, and certain other deductions. Rate schedules in Southwests service territories, with the exception of Nevada, contain purchased gas adjustment (PGA) clauses, which allow Southwest to file for rate adjustments as the cost of purchased gas changes. In Nevada, effective November 2005, Southwest began operating under the deferred energy regulations as established by the Nevada Administrative Code, which governs the recovery of energy costs in the state. These provisions result in little difference in the method used to account for or report purchased gas costs, including the ability of the Company to defer over or under-collections of gas costs to balancing accounts. Previously, the Nevada Administrative Code required at least an annual filing to adjust for changes in purchased gas costs. Nevada Senate Bill No. 238, effective October 2005, provides for quarterly gas cost adjustments, calculated on a twelve-month rolling average. These adjustments will be made effective immediately upon filing each quarter, but are subject to an annual prudence review and audit of the natural gas costs incurred. The Company anticipates filing its first quarterly adjustment in mid-2006. Deferred energy and purchased gas adjustment (collectively PGA) rate changes affect cash flows but have no direct impact on profit margin. Filings to change rates in accordance with PGA clauses are subject to audit by the appropriate state regulatory commission staff. Information with respect to recent general rate cases and PGA and deferred energy filings is included in the Rates and Regulatory Proceedings section of Managements Discussion and Analysis (MD&A) in the 2005 Annual Report to Shareholders.
The table below lists the docketed general rate filings last initiated and the status of such filing within each ratemaking area:
Demand for Natural Gas
Deliveries of natural gas by Southwest are made under a priority system established by state regulatory commissions. The priority system is intended to ensure that the gas requirements of higher-priority customers, primarily residential customers and other customers who use 500 therms or less of gas per day, are fully satisfied on a daily basis before lower-priority customers, primarily electric utility and large industrial customers able to use alternative fuels, are provided any quantity of gas or capacity.
Demand for natural gas is greatly affected by temperature. On cold days, use of gas by residential and commercial customers may be as much as six times greater than on warm days because of increased use of gas for space heating. To fully satisfy this increased high-priority demand, gas is withdrawn from storage in certain service areas, or peaking supplies are purchased from suppliers. If necessary, service to interruptible lower-priority customers may be curtailed to provide the needed delivery system capacity. No curtailment occurred during the latest peak heating season. Southwest maintains no significant backlog on its orders for gas service.
Natural Gas Supply
Southwest is responsible for acquiring (purchasing) and arranging delivery of (transporting via interstate pipelines) natural gas to its system for all sales customers.
The primary objective of Southwest in acquiring gas supply is to ensure that adequate supplies of natural gas are available from reliable sources at the best cost. Gas is acquired from a wide variety of sources and a mix of purchase provisions, including spot market purchases and firm supplies with a variety of terms. During 2005, Southwest acquired gas supplies from 53 suppliers. Southwest constantly monitors the number of suppliers, their quality and their relative contribution to the overall customer supply portfolio. New suppliers are contracted whenever possible, and solicitations for supplies are extended to the largest possible list of suppliers. Competitive pricing, flexibility in meeting Southwest requirements, and aggressive participation by suppliers who have demonstrated reliability of service are key to their inclusion in the annual portfolio mix. The goal of this practice is to mitigate the risk of nonperformance by any one supplier and insure competitive prices for customer supplies.
Balancing reliable supply assurances with the associated costs results in a continually changing mix of purchase provisions within the supply portfolios. To address the unique requirements of its various market areas, Southwest assembles and administers a separate natural gas supply portfolio for each of its jurisdictional areas. Firm and spot market natural gas purchases are made in a competitive bid environment. Southwest has experienced price volatility over the past five years, as the weighted average delivered cost of natural gas has ranged from a low of 38 cents per therm in 2002 to a high of 71 cents per therm in 2005. During 2005, prices increased to record levels, particularly following the occurrences of Hurricanes Katrina and Rita during the third quarter, which caused supply interruptions and damaged natural gas production facilities in the U.S. Gulf of Mexico. Increased demand from recently constructed natural gas-fueled electric generating plants has also affected the price of natural gas. Prices are generally expected to remain high through 2006. To mitigate customer exposure to market price volatility, Southwest continues to purchase a significant percentage of its forecasted annual normal weather requirements under firm, fixed-price arrangements that are secured periodically throughout the year. About half of Southwests normal weather supply needs for the 2005/2006 heating season were secured using short duration contracts (generally less than one year) which were put in place in 2004 and 2005 at fixed prices ranging from $5 to $9 per dekatherm. Natural gas purchases not covered by fixed-price contracts are made under variable-price contracts with firm quantities and on the spot market. At the end of 2005, prices for these supplies were generally higher than those in the Companys existing fixed-price contracts.
The firm, fixed-price arrangements are structured such that a stated volume of gas is required to be scheduled by Southwest and delivered by the supplier. If the gas is not needed by Southwest or cannot be procured by the supplier, the contract provides for fixed or market-based penalties to be paid by the non-performing party.
In managing its gas supply portfolios, Southwest uses the fixed-price arrangements noted above, but does not currently utilize other stand-alone derivative financial instruments for speculative purposes or for hedging. A hedging program utilizing stand-alone derivative instruments to mitigate price volatility is planned starting in 2006. The costs of such derivative financial instruments would be pursued as part of the PGA mechanisms upon approval by Southwests regulatory commissions for recovery from customers in each jurisdiction. None of the Companys long-term financial instruments or other contracts are derivatives that are marked to market or contain embedded derivatives with significant mark-to-market value.
Storage availability can influence the average annual price of gas, as storage allows a company to purchase natural gas in larger quantities during the off-peak season and store it for use in high demand periods when prices may be greater or supplies/capacity tighter. Southwest currently has no storage availability in its Arizona or southern Nevada rate jurisdictions. Limited storage availability exists in southern and northern California and northern Nevada. A contract with Southern California Gas Company is intended for delivery only within Southwests southern California rate jurisdiction. In addition, a contract with Paiute for its LNG facility allows for peaking capability only in northern Nevada and northern California. Gas is purchased for injection during the off-peak period for use in the high demand months, but is limited in its impact on the overall price.
Gas supplies for the southern system of Southwest (Arizona, southern Nevada, and southern California properties) are primarily obtained from producing regions in Colorado and New Mexico (San Juan basin), Texas (Permian basin), and Rocky Mountain areas. For its northern system (northern Nevada and northern California properties), Southwest primarily obtains gas from Rocky Mountain producing areas and from Canada.
Southwest arranges for transportation of gas to its Arizona, Nevada, and California service territories through the pipeline systems of El Paso Natural Gas Company (El Paso), Kern River Gas Transmission Company (Kern River), Transwestern Pipeline Company (Transwestern), Northwest Pipeline Corporation, Tuscarora Gas Pipeline Company (Tuscarora), Southern California Gas Company, and Paiute. Supply and pipeline capacity availability on both short- and long-term bases is continually monitored by Southwest to ensure the reliability of service to its customers. Southwest currently receives firm transportation service, both on a short- and long-term basis, for all of its service territories on the pipeline systems noted above and also has interruptible contracts in place that allow additional capacity to be acquired should an unforeseen need arise.
Southwest is dependent upon the El Paso pipeline system for the transportation of gas to virtually all of its Arizona service territories and a portion of its southern Nevada service territory. During 2005, Southwest entered into negotiations with alternative transportation service providers to evaluate capacity options for its southern Nevada service territory. After evaluating several proposals, Transwestern was chosen to replace the capacity previously provided by El Paso for southern Nevada, effective September 2006. The new five-year contract with Transwestern will extend capacity during winter months and provide greater flexibility in meeting monthly requirements. Rates under the new contract are not expected to differ significantly from those currently paid.
The Company believes that the current level of contracted firm interstate capacity is sufficient to serve each of its service territories. As the need arises to acquire additional capacity on one of the interstate pipeline transmission systems, primarily due to customer growth, Southwest will continue to consider available options to obtain that capacity, either through the use of firm contracts with a pipeline company or by purchasing capacity on the open market.
Electric utilities are the principal competitors of Southwest for the residential and small commercial markets throughout its service areas. Competition for space heating, general household, and small commercial energy needs generally occurs at the initial installation phase when the customer/builder typically makes the decision as to which type of equipment to install and operate. The customer will generally continue to use the chosen energy source for the life of the equipment. As a result of its success in these markets, Southwest has experienced consistent growth among the residential and small commercial customer classes.
Unlike residential and small commercial customers, certain large commercial, industrial, and electric generation customers have the capability to switch to alternative energy sources. To date, Southwest has been successful in retaining most of these customers by setting rates at levels competitive with alternative energy sources such as electricity, fuel oils, and coal. However, high natural gas prices may impact Southwests ability to retain some of these customers. Overall, management does not anticipate any material adverse impact on operating margin from fuel switching.
Southwest competes with interstate transmission pipeline companies, such as El Paso, Kern River, and Tuscarora, to provide service to certain large end-users. End-use customers located in proximity to these interstate pipelines pose a potential bypass threat. Southwest attempts to closely monitor each customer situation and provide competitive service in order to retain the customer. Southwest has remained competitive through the use of negotiated transportation contract rates, special long-term contracts with electric generation and cogeneration customers, and other tariff programs. These competitive response initiatives have mitigated the loss of margin earned from large customers.
Federal, state, and local laws and regulations governing the discharge of materials into the environment have had little direct impact upon Southwest. Environmental efforts, with respect to matters such as protection of endangered species and archeological finds, have increased the complexity and time required to obtain pipeline rights-of-way and construction permits. However, increased environmental legislation and regulation are also beneficial to the natural gas industry. Because natural gas is one of the most environmentally safe fossil fuels currently available, its use can help energy users to comply with stricter environmental standards.
At December 31, 2005, the natural gas operations segment had 2,590 regular full-time equivalent employees. In March 2005, non-exempt employees in the Central Arizona Division of the Company voted to no longer be represented by any labor organization. On March 21, 2005, the Company received notification that the United States of America National Labor Relations Board had certified the voting results. As a result, none of the employees in the Companys natural gas operations segment are now represented by a union. Southwest believes it has a good relationship with its employees and that compensation, benefits, and working conditions afforded its employees are comparable to those generally found in the utility industry.
NPL is a full-service underground piping contractor that provides utility companies with trenching and installation, replacement, and maintenance services for energy distribution systems. NPL contracts primarily with LDCs to install, repair, and maintain energy distribution systems from the town border station to the end-user. The primary focus of business operations is main and service replacement as well as new business installations. Construction work varies from relatively small projects to the piping of entire communities. Construction activity is seasonal in most areas. Peak construction periods are the summer and fall months in colder climate areas, such as the midwest. In the warmer climate areas, such as the southwestern United States, construction continues year round. Construction activity is also cyclical and can be significantly impacted by changes in general and local economic conditions, including interest rates, employment levels, job growth and local and federal tax rates.
NPL business activities are often concentrated in utility service territories where existing energy lines are scheduled for replacement. An LDC will typically contract with NPL to provide pipe replacement services and new line installations. Contract terms generally specify unit-price or fixed-price arrangements. Unit-price contracts establish prices for all of the various services to be performed during the contract period. These contracts often have annual pricing reviews. During 2005, approximately 92 percent of revenue was earned under unit-price contracts. As of December 31, 2005, no significant backlog existed with respect to outstanding construction contracts.
Materials used by NPL in its pipeline construction activities are typically specified, purchased, and supplied by NPLs customers. Construction contracts also contain provisions which make customers generally liable for remediating environmental hazards encountered during the construction process. Such hazards might include digging in an area that was contaminated prior to construction, finding endangered animals, digging in historically significant sites, etc. Otherwise, NPLs operations have minimal environmental impact (dust control, normal waste disposal, handling harmful materials, etc.).
Competition within the industry has traditionally been limited to several regional competitors in what has been a largely fragmented industry. Several national competitors also exist within the industry. NPL currently operates in approximately 16 major markets nationwide. Its customers are the primary LDCs in those markets. During 2005, NPL served 46 major customers, with Southwest accounting for approximately 28 percent of NPL revenues. With the exception of two other customers that in total accounted for approximately 25 percent of revenue, no other customer had a relatively significant contribution to NPL revenues.
Employment fluctuates between seasonal construction periods, which are normally heaviest in the summer and fall months. At December 31, 2005, NPL had 2,350 regular full-time equivalent employees. Employment peaked in November 2005 when there were 2,489 employees. Most employees are represented by unions and are covered by collective bargaining agreements, which is typical of the utility construction industry.
Operations are conducted from 17 field locations with corporate headquarters located in Phoenix, Arizona. Buildings are normally leased from third parties. The lease terms are typically five years or less. Field location facilities consist of a small building for repairs and land to store equipment.
NPL is not directly affected by regulations promulgated by the ACC, PUCN, CPUC, or FERC in its construction services. NPL is an unregulated construction subsidiary of Southwest Gas Corporation. However, because NPL performs work for the regulated natural gas segment of the Company, its construction costs are subject indirectly to prudency reviews just as any other capital work that is performed by third parties or directly by Southwest. However, such prudency reviews would not bring NPL under the regulatory jurisdiction of any of the commissions noted above.
Item 1A. RISK FACTORS
Although the Company is not able to predict all factors that may affect future results, described below and in Item 7A. Quantitative and Qualitative Disclosures about Market Risk of this report, are some of the risk factors identified by the Company that may have a negative impact on our future financial performance or affect whether we achieve the goals or expectations expressed or implied in any forward-looking statements contained herein. Unless indicated otherwise, references below to we, us and our should be read to refer to Southwest Gas Corporation and its subsidiaries.
Our liquidity, and in certain circumstances our earnings, may be reduced during periods in which natural gas prices are rising significantly or are more volatile.
Increases in the cost of natural gas may arise from a variety of factors, including weather, changes in demand, the level of production and availability of natural gas, transportation constraints, transportation capacity cost increases, federal and state energy and environmental regulation and legislation, the degree of market liquidity, natural disasters, wars and other catastrophic events, national and worldwide economic and political conditions, the price and availability of alternative fuels, and the success of our strategies in managing price risk.
Rate schedules in each of our service territories contain purchased gas adjustment clauses which permit us to file for rate adjustments to recover increases in the cost of purchased gas. Increases in the cost of purchased gas have no direct impact on our profit margins, but do affect cash flows and can therefore impact the amount of our capital resources. We have used short-term borrowings in the past to temporarily finance increases in purchased gas costs, and we expect to do so during 2006, if the need again arises.
We may file requests for rate increases to cover the rise in the costs of purchased gas. Due to the nature of the regulatory process, there is a risk of a disallowance of full recovery of these costs during any period in which there has been a substantial run-up of these costs or our costs are more volatile. Any disallowance of purchased gas costs may reduce cash flow and earnings.
Governmental policies and regulatory actions can reduce our earnings.
Governmental policies and regulatory actions, including those of the ACC, the CPUC, the FERC, and the PUCN relating to allowed rates of return, rate structure, purchased gas and investment recovery, operation and construction of facilities, present or prospective wholesale and retail competition, changes in tax laws and policies, and changes in and compliance with environmental and safety laws and policies, can reduce our earnings. Risks and uncertainties relating to delays in obtaining regulatory approvals, conditions imposed in regulatory approvals, or determinations in regulatory investigations can also impact financial performance. In particular, the timing and amount of rate relief can materially impact results of operation.
We are unable to predict what types of conditions might be imposed on Southwest or what types of determinations might be made in pending or future regulatory proceedings or investigations. We nevertheless believe that it is not uncommon for conditions to be imposed in regulatory proceedings, for Southwest to agree to conditions as part of a settlement of a regulatory proceeding, or for determinations to be made in regulatory investigations that will reduce our earnings and liquidity. For example, we may request recovery of a particular operating expense in a general rate case filing that a regulator disallows, negatively impacting our earnings.
Significant customer growth in Arizona and Nevada could strain our capital resources.
We continue to experience significant population and customer growth throughout our service territories. During 2005, we added 81,000 customers (excluding 19,000 customers associated with the acquisition of the South Lake Tahoe gas distribution properties of Avista in April 2005), a five percent growth rate. Over the past ten years, customer growth has averaged five percent per year. This growth has required large amounts of capital to finance the investment in new transmission and distribution plant. In 2005, our natural gas construction expenditures totaled $259 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 (net of dividends) have been inadequate, and are expected to continue to be inadequate, to fund all necessary capital expenditures. We have funded this shortfall through the issuance of additional debt and equity securities, and expect to continue to do so. However, our ability to issue additional securities is dependent upon, among other things, conditions in the capital markets, regulatory authorizations, our credit rating and our level of earnings.
Significant customer growth in Arizona and Nevada could also impact earnings.
Our ability to earn the rates of return authorized by the ACC and the PUCN is also more difficult because of significant customer growth. The rates we charge our distribution customers in Arizona and Nevada are derived using rate base, cost of service, and cost of capital experienced in an historical test year, as adjusted. This results in regulatory lag which delays our recovery of some of the costs of capital improvements and operating costs from customers in Arizona and Nevada.
Our earnings are greatly affected by variations in temperature during the winter heating season.
The demand for natural gas is seasonal and is greatly affected by temperature. Variability in weather from normal temperatures can materially impact results of operations. On cold days, use of gas by residential and commercial customers may be as much as six times greater than on warm days because of the increased use of gas for space heating. Weather has been and will continue to be one of the dominant factors in our financial performance.
Uncertain economic conditions may affect our ability to finance capital expenditures.
Our ability to finance capital expenditures and other matters will depend upon general economic conditions in the capital markets. The direction of interest rates is uncertain. Declining interest rates are generally believed to be favorable to utilities while rising interest rates are believed to be unfavorable because of the high capital costs of utilities. In addition, our authorized rate of return is based upon certain assumptions regarding interest rates. If interest rates are lower than assumed rates, our authorized rate of return in the future could be reduced. If interest rates are higher than assumed rates, it will be more difficult for us to earn our currently authorized rate of return.
The nature of our operations presents inherent risks of loss that could adversely affect our results of operations.
Our operations are subject to inherent hazards and risks such as gas leaks, fires, natural disasters, explosions, pipeline ruptures, and other hazards and risks that may cause unforeseen interruptions, personal injury, or property damage. Additionally, our facilities, machinery, and equipment, including our pipelines, are subject to third party damage from construction activities and vandalism. Any of these events could cause environmental pollution, personal injury or death claims, damage to our properties or the properties of others, or loss of revenue by us or others.
We maintain liability insurance for some, but not all, risks associated with the operation of our natural gas pipelines and facilities. In connection with these liability insurance policies, we have been responsible for an initial deductible or self-insured retention amount per incident, after which the insurance carriers would be responsible for amounts up to the policy limits. For the policy year August 2004 to July 2005, the self-insured retention amount associated with general liability claims increased from $1 million per incident to $1 million per incident plus payment of the first $10 million in aggregate claims above $1 million in the policy year. For the policy year August 2005 to July 2006, we entered into insurance contracts that limit our self-insured retention to $1 million per incident plus payment of the first $5 million in aggregate claims above $1 million. We cannot predict the likelihood that any future event will occur which will result in a claim exceeding $1 million; however, a large claim for which we were deemed liable would reduce our earnings. See Item 3. Legal Proceedings in this report for information on an existing claim.
A significant reduction in our credit ratings could materially and adversely affect our business, financial condition and results of operations.
We cannot be certain that any of our current ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances in the future so warrant. Any downgrade could increase our borrowing costs, which would diminish our financial results. We would likely be required to pay a higher interest rate in future financings, and our potential pool of investors and funding sources could decrease. A downgrade could require additional support in the form of letters of credit or cash or other collateral and otherwise adversely affect our business, financial condition and results of operations.
Item 2. PROPERTIES
The plant investment of Southwest consists primarily of transmission and distribution mains, compressor stations, peak shaving/storage plants, service lines, meters, and regulators, which comprise the pipeline systems and facilities located in and around the communities served. Southwest also includes other properties such as land, buildings, furnishings, work equipment, vehicles, and software systems in plant investment. The northern Nevada and northern California properties of Southwest are referred to as the northern system; the Arizona, southern Nevada, and southern California properties are referred to as the southern system. Several properties are leased by Southwest, including a portion of the corporate headquarters office complex located in Las Vegas, Nevada and the administrative offices in Phoenix, Arizona. Total gas plant, exclusive of leased property, at December 31, 2005 was $3.6 billion, including construction work in progress. It is the opinion of management that the properties of Southwest are suitable and adequate for its purposes.
Substantially all gas main and service lines are constructed across property owned by others under right-of-way grants obtained from the record owners thereof, on the streets and grounds of municipalities under authority conferred by franchises or otherwise, or on public highways or public lands under authority of various federal and state statutes. None of the numerous county and municipal franchises are exclusive, and some are of limited duration. These franchises are renewed regularly as they expire, and Southwest anticipates no serious difficulties in obtaining future renewals.
With respect to the right-of-way grants, Southwest has had continuous and uninterrupted possession and use of all such rights-of-way, and the associated gas mains and service lines, commencing with the initial stages of the construction of such facilities. Permits have been obtained from public authorities and other governmental entities in certain instances to cross or to lay facilities along roads and highways. These permits typically are revocable at the election of the grantor and Southwest occasionally must relocate its facilities when requested to do so by the grantor. Permits have also been obtained from railroad companies to cross over or under railroad lands or rights-of-way, which in some instances require annual or other periodic payments and are revocable at the election of the grantors.
Southwest operates two primary pipeline transmission systems:
Southwest provides natural gas service in parts of Arizona, Nevada, and California. Service areas in Arizona include most of the central and southern areas of the state including Phoenix, Tucson, Yuma, and surrounding communities. Service areas in northern Nevada include Carson City, Yerington, Fallon, Lovelock, Winnemucca, and Elko. Service areas in southern Nevada include the Las Vegas valley (including Henderson and Boulder City) and Laughlin. Service areas in southern California include Barstow, Big Bear, Needles, and Victorville. Service areas in northern California include the Lake Tahoe area and Truckee.
Information on properties of NPL can be found on page 5 of this Form 10-K under Construction Services.
Item 3. LEGAL PROCEEDINGS
In May 2005, a leaking natural gas line was involved in a fire in a residence in Tucson, Arizona. An individual was severely injured. The leak is believed to have been caused by a rock impinging upon a natural gas line that was installed for Southwest Gas and that is owned and operated by the Company. A lawsuit was filed against the Company in December 2005 in the Superior Court for the State of Arizona, in and for the County of Pima (Case No. C20057063), in which $3.4 million in medical bills are claimed, $12 million in future medical expenses are claimed, and unspecified claims are made for general damages and punitive damages. Plaintiffs have claimed relief under theories of negligence, negligence per se, strict liability and loss of consortium and punitive damages. The Company has answered the complaint and denied liability. The complaint was amended in February 2006 to identify the parties to the litigation as Arnold Valenzuela, a single man, and Arturo and Julia Valenzuela, husband and wife, plaintiffs, and the Company as the sole defendant. If the Company was deemed fully or partially responsible, the Company estimates its exposure could be as much as $11 million (the maximum self-insured retention amount under its insurance policies). As of December 31, 2005, the Company has recorded an $11 million liability related to this incident.
The Company is named as a defendant in various other legal proceedings. The ultimate dispositions of these proceedings are not presently determinable; however, it is the opinion of management that none of this litigation individually or in the aggregate will have a material adverse impact on the Companys financial position or future results of operations.
Item 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The listing of the executive officers of the Company is set forth under Part III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT, which by this reference is incorporated herein.
Item 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The principal market on which the common stock of the Company is traded is the New York Stock Exchange. At March 1, 2006, there were 23,049 holders of record of common stock, and the market price of the common stock was $28.77. The quarterly market price of, and dividends on, Company common stock required by this item are included in the 2005 Annual Report to Shareholders filed as an exhibit hereto and incorporated herein by reference.
The Companys common stock dividend policy states that common stock dividends will be paid at a prudent level within the normal dividend payout range for its respective businesses, and that dividends will be established at a level considered sustainable in order to minimize business risk and maintain a strong capital structure throughout all economic cycles. The quarterly common stock dividend was 20.5 cents per share throughout 2004 and 2005. The dividend of 20.5 cents per share has been paid quarterly since September 1994.
Item 6. SELECTED FINANCIAL DATA
Information required by this item is included in the 2005 Annual Report to Shareholders and is incorporated herein by reference.
Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information required by this item is included in the 2005 Annual Report to Shareholders and is incorporated herein by reference.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various forms of market risk, including commodity price risk, weather risk, and interest rate risk. The following describes the Companys exposure to these risks.
Commodity Price Risk
About half of Southwests normal weather gas supply needs for the 2005/2006 heating season were secured using short duration fixed-price term contracts designed to mitigate price volatility. Fixed-price contracts for the 2005/2006 heating season range in price from approximately $5 to $9 per dekatherm. Natural gas purchases not covered by fixed-price contracts are made under variable-price contracts with firm quantities and on the spot market, which are subject to market fluctuations. At the end of 2005, prices for these supplies were generally higher than those in the Companys existing fixed-price contracts. The PGA mechanism allows Southwest to file to change the gas cost component of the rates charged to its customers to reflect increases or decreases in the price expected to be paid to its suppliers and companies providing interstate pipeline transportation service. Filings to change rates in accordance with PGA clauses are subject to audit by state regulatory commission staffs.
The Company does not currently utilize stand-alone derivative financial instruments, other than fixed-price term contracts, for speculative purposes or for hedging. A hedging program utilizing stand-alone derivative instruments to mitigate price volatility is planned starting in 2006. The Company intends to pursue the recovery of such costs as part of the PGA mechanisms upon approval by Southwests regulatory commissions in each jurisdiction.
A significant portion of the Companys operating margin is volume driven with current rates based on an assumption of normal weather. Demand for natural gas is greatly affected by temperature. On cold days, use of gas by residential
and commercial customers may be as much as six times greater than on warm days because of increased use of gas for space heating. Space heating-related volumes are the primary component of billings for these customer classes and are concentrated in the months of November to April. Variances in temperatures from normal levels, especially during these months, have a significant impact on the margin and associated net income of the Company. This impact is most pronounced in Arizona, where 54 percent of Southwests customers are located and where rates are highly leveraged.
The Company continues to pursue mechanisms in each of its service territories intended to stabilize the recovery of the Companys fixed costs and reduce fluctuations in customers bills due to colder or warmer than average weather. In California, the CPUC authorized a margin tracker balancing account in April 2004 that mitigates margin volatility due to weather and other usage variations. In Nevada, the PUCN approved certain rate design improvements in September 2004 to mitigate weather variations, including an increase in the monthly basic service charge and the use of declining block rates. In addition, Southwest filed an application in March 2005 requesting the PUCN to approve a weather normalization adjustment provision. In Arizona, Southwests requests for weather mitigation provisions in its recent general rate case were rejected in the ACCs final order approved in February 2006. The ACC did however encourage Southwest to work with the ACC Staff and other interested parties prospectively to seek rate design alternatives that will provide benefits to all affected stakeholders.
Interest Rate Risk
Interest rate risk is the risk that changes in interest rates could adversely affect earnings or cash flows. Specific interest rate risks for the Company include the risk of increasing interest rates on variable rate obligations. Interest rate risk sensitivity analysis is used to measure interest rate risk by computing estimated changes in cash flows as a result of assumed changes in market interest rates. In Nevada, fluctuations in interest rates on variable rate IDRBs are tracked and recovered from ratepayers through an interest balancing account. As of December 31, 2005 and 2004, the Company had $224 million and $250 million, respectively, in variable rate debt outstanding, excluding Nevada variable-rate IDRBs. Assuming a constant outstanding balance in variable rate debt for the next twelve months, a hypothetical one percent change in interest rates would increase or decrease interest expense for the next twelve months by approximately $2.2 million.
Other risk information is included in Item 1A. Risk Factors of this report.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Southwest Gas Corporation and Notes thereto, together with the report of PricewaterhouseCoopers LLP, are included in the 2005 Annual Report to Shareholders and are incorporated herein by reference.
Item 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company has established disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, communicated to management, and reported within the time periods specified in the SECs rules and forms. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and benefits of controls must be considered relative to their costs. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or management override of the control. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
Based on the most recent evaluation, as of December 31, 2005, management of the Company, including the Chief Executive Officer and Chief Financial Officer, believe the Companys disclosure controls and procedures are effective at attaining the level of reasonable assurance noted above.
Internal Control Over Financial Reporting
The report of management of the Company required to be reported herein is incorporated by reference to the information reported in the 2005 Annual Report to Shareholders under the caption Managements Report on Internal Control Over Financial Reporting on page 60.
The Attestation Report of the Registered Public Accounting Firm required to be reported herein is incorporated by reference to the information reported in the 2005 Annual Report to Shareholders under the caption Report of Independent Registered Public Accounting Firm on page 61.
There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors. Information with respect to Directors is set forth under the heading Election of Directors in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
(b) Identification of Executive Officers. The name, age, position, and period position held during the last five years for each of the Executive Officers of the Company as of December 31, 2005 are as follows:
(c) Identification of Certain Significant Employees. None.
(d) Family Relationships. No Directors or Executive Officers are related either by blood, marriage, or adoption.
(e) Business Experience. Information with respect to Directors is set forth under the heading Election of Directors in the definitive 2006 Proxy Statement, which by this reference is incorporated herein. All Executive Officers have held responsible positions with the Company for at least five years as described in (b) above.
(f) Involvement in Certain Legal Proceedings. None.
(g) Promoters and Control Persons. None.
(h) Audit Committee Financial Expert. Information with respect to the financial expert of the Board of Directors audit committee is set forth under the heading Committees of the Board in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
(i) Identification of the Audit Committee. Information with respect to the composition of the Board of Directors audit committee is set forth under the heading Committees of the Board in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
(j) Material Changes in Director Nomination Procedures for Security Holders. None.
Section 16(a) Beneficial Ownership Reporting Compliance. The Company has adopted procedures to assist its directors and executive officers in complying with Section 16(a) of the Exchange Act, as amended, which includes assisting in the preparation of forms for filing. For 2005, all but five reports were timely filed. Purchases of Company common stock by Terrence L. Wright, Director, consisting of 2,750 shares on December 22, 2005, were reported on January 6, 2006. The exercise of options and subsequent sale of Company common stock by Christina A. Palacios, Senior Vice President/Central Arizona Division, consisting of 1,300 options/shares on July 6, 2004 and 8,700 options/shares on July 7, 2004, were reported on March 22, 2005.
Code of Business Conduct and Ethics. The Company has adopted a code of business conduct and ethics for its employees, including its chief executive officer, chief financial officer, chief accounting officer, and non-employee directors. A code of ethics is defined as written standards that are reasonably designed to deter wrongdoing and to promote: 1) honest and ethical conduct; 2) full, fair, accurate, timely, and understandable disclosure in reports and documents that a registrant files; 3) compliance with applicable governmental laws, rules, and regulations; 4) the prompt internal reporting of violations of the code to an appropriate person or persons identified in the code; and 5) accountability for adherence to the code. The Companys Code of Business Conduct & Ethics can be viewed on the Companys website (www.swgas.com). If any substantive amendments to the Code of Business Conduct & Ethics are made or any waivers are granted, including any implicit waiver, from a provision of the Code of Business Conduct & Ethics, to the Companys chief executive officer, chief financial officer and chief accounting officer, the Company will disclose the nature of such amendment or waiver on the Companys website, www.swgas.com.
Item 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is set forth under the heading Executive Compensation and Benefits in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
(a) Security Ownership of Certain Beneficial Owners. Information with respect to security ownership of certain beneficial owners is set forth under the heading Securities Ownership by Directors, Director Nominees, Executive Officers, and Certain Beneficial Owners in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
(b) Security Ownership of Management. Information with respect to security ownership of management is set forth under the heading Securities Ownership by Directors, Director Nominees, Executive Officers, and Certain Beneficial Owners in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
(c) Changes in Control. None.
(d) Securities Authorized for Issuance Under Equity Compensation Plans.
At December 31, 2005, the Company had two stock-based compensation plans. With respect to the first plan, the Company may grant options to purchase shares of common stock to key employees and outside directors.
Pursuant to the terms of the management incentive 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.
Additional information regarding the two equity compensation plans is included in Note 9 of the Notes to Consolidated Financial Statements in the 2005 Annual Report to Shareholders.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information with respect to accounting fees and services associated with PricewaterhouseCoopers LLP is set forth under the heading Selection of Independent Accountants in the definitive 2006 Proxy Statement, which by this reference is incorporated herein.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report on Form 10-K:
(b) See LIST OF EXHIBITS.
LIST OF EXHIBITS
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.