Southwest Gas Corporation and its subsidiaries (the "Company") consist 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, distributing, and transporting natural gas for customers in portions of Arizona, Nevada, and California. Southwest is the largest distributor in Arizona, selling and transporting natural gas in most of central and southern Arizona, including the Phoenix and Tucson metropolitan areas. Southwest is also the largest distributor of natural gas in Nevada, serving the Las Vegas metropolitan area and northern Nevada. In addition, Southwest distributes and transports natural gas for customers in portions of California, including the Lake Tahoe area and the high desert and mountain areas in San Bernardino County.

On a seasonally adjusted basis as of September 30, 2012, Southwest had 1,858,000 residential, commercial, industrial, and other natural gas customers, of which 998,000 customers were located in Arizona, 676,000 in Nevada, and 184,000 in California. Residential and commercial customers represented over 99% of the total customer base. During the twelve months ended September 30, 2012, 56% of operating margin was earned in Arizona, 34% in Nevada, and 10% in California. During this same period, Southwest earned 85% of its operating margin from residential and small commercial customers, 4% from other sales customers, and 11% from transportation customers. These general patterns are expected to remain materially consistent for the foreseeable future.

Southwest recognizes operating revenues from the distribution and transportation of natural gas (and related services) to customers. Operating margin is the measure of gas operating revenues less the net cost of gas sold. Management uses operating margin as a main benchmark in comparing operating results from period to period. The principal factors affecting operating margin changes are general rate relief, weather, conservation and efficiencies, and customer growth. Weather has traditionally been the primary reason for volatility in margin, which continued throughout 2011 with respect to Southwest's Arizona service territories. In January 2012, however, a full revenue decoupling mechanism, which includes a monthly weather adjuster, was implemented in the Arizona service territories. With this change, all of Southwest's service territories now have decoupled rate structures, which are designed to mitigate the impacts of weather variability and conservation on margin and allow the Company to aggressively pursue energy efficiency initiatives.

NPL Construction Co. ("NPL" or the "construction services" segment), a wholly owned subsidiary, is a full-service underground piping contractor that primarily provides utility companies with trenching and installation, replacement, and maintenance services for energy distribution systems. NPL operates in 18 major markets nationwide. Construction activity is cyclical and can be significantly impacted by changes in weather, general and local economic conditions (including the housing market), interest rates, employment levels, job growth, the equipment resale market, pipe replacement programs of utilities, and local and federal regulation (including tax rates and incentives). During the past few years, utilities have implemented pipeline integrity management programs to enhance safety pursuant to federal and state mandates. These programs, coupled with bonus depreciation tax deduction incentives, have resulted in a significant increase in multi-year pipeline replacement projects throughout the country. Generally, revenues are lowest during the first quarter of the year due to less favorable winter weather conditions. Revenues typically improve as more favorable weather conditions occur during the summer and fall months. In certain circumstances, such as with large, longer duration bid contracts, results may be impacted by differences between costs incurred and those anticipated when the work was originally bid.

This Management's Discussion and Analysis ("MD&A") of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and the notes thereto, as well as the MD&A, included in the 2011 Annual Report to Shareholders, which is incorporated by reference into the 2011 Form 10-K, and the first and second quarter 2012 reports on Form 10-Q.

The items discussed in this Executive Summary are intended to provide an overview of the results of the Company's operations. As needed, certain items are covered in greater detail in later sections of management's discussion and analysis. As reflected in the table below, the natural gas operations segment accounted for an average of 85% of twelve-month-to-date consolidated net income over the past two years. As such, management's discussion and analysis is primarily focused on that segment. Natural gas sales are seasonal, peaking during the winter months; therefore, results of operations for interim periods are not necessarily indicative of the results for a full year.

Summary Operating Results



                                                                Period Ended September 30,
                                           Three Months                  Nine Months                Twelve Months
                                       2012           2011           2012          2011          2012          2011
                                                          (In thousands, except per share amounts)
Contribution to net income (loss)
Natural gas operations               $ (11,389 )    $ (25,566 )    $  64,609     $  42,648     $ 113,381     $  81,627
Construction services                    7,084          9,925          6,329        14,315        12,881        20,321

Net income (loss)                    $  (4,305 )    $ (15,641 )    $  70,938     $  56,963     $ 126,262     $ 101,948


Average number of common shares
outstanding                             46,134         45,881         46,106        45,837        46,059        45,766


Basic earnings (loss) per share
Consolidated                         $   (0.09 )    $   (0.34 )    $    1.54     $    1.24     $    2.74     $    2.23


Natural Gas Operations
Operating margin                     $ 142,296      $ 128,482      $ 594,220     $ 554,888     $ 829,209     $ 778,243

3rd Quarter 2012 Overview

Natural gas operations highlights include the following:

• Operating margin increased approximately $14 million compared to the prior-year quarter

• Operating expenses increased $4.7 million, or 3%, compared to the prior-year quarter

• Other income increased $9.7 million between quarters

• Decision reached in the Nevada general rate case

• Redemption of the $14.3 million 1999 5.95% Series C fixed-rate IDRBs
(originally due in 2038)

Construction services highlights include the following:

• Revenues increased $19.3 million, or 12%, compared to the prior-year quarter

• Construction expenses increased $20.1 million, or 15%, compared to the prior-year quarter

Weather and Conservation. Weather has traditionally been the primary reason for volatility in margin, which continued throughout 2011 with respect to Southwest's Arizona service territories. In January 2012, however, a full revenue decoupling mechanism, which includes a winter-period monthly weather adjuster, was implemented in the Arizona service territories. With this change, all of Southwest's service territories now have decoupled rate structures, which are designed to mitigate the impacts of weather variability and conservation on margin and allow the Company to aggressively pursue energy efficiency initiatives.

Customer Growth. Southwest completed 16,000 first-time meter sets, but realized 22,000 net new customers over the last twelve months. The incremental additions reflect a return to service of customer meters on previously vacant homes. Southwest estimates the number of excess inactive meters is approximately 36,000 at September 30, 2012. Southwest projects customer growth associated with new meter sets of 1% or less for 2012, along with the gradual return of customers associated with previously vacant homes.

Company-Owned Life Insurance ("COLI"). Southwest has life insurance policies on members of management and other key employees to indemnify itself against the loss of talent, expertise, and knowledge, as well as to provide indirect funding for certain nonqualified benefit plans. The COLI policies have a combined net death benefit value of approximately $229 million at September 30, 2012. The net cash surrender value of these policies (which is the cash amount that would be received if Southwest voluntarily terminated the policies) is approximately $79 million at September 30, 2012 and is included in the caption "Other property and investments" on the balance sheet. Cash surrender values are directly influenced by the investment portfolio underlying the insurance policies. This portfolio includes both equity and fixed income (mutual fund) investments. As a result, generally the cash surrender value (but not the net death benefit) moves up and down consistent with movements in the broader stock and bond markets. As indicated in Note 1, cash surrender values of COLI policies increased $2.2 million in the third quarter of 2012. In the same period of 2011, cash surrender values of COLI policies (net of recognized death benefits) decreased $6.7 million. Management currently expects average returns of $2 million to $4 million annually on the COLI policies, excluding any net death benefits recognized. Based on the current investment mix, both positive and negative deviations from expected levels are likely to continue.

Liquidity. Southwest believes its liquidity position is solid. Southwest has a $300 million credit facility maturing in March 2017. The facility is provided through a consortium of eight major banking institutions. Historically, usage of the credit facility has been low and concentrated in the first half of the winter heating period when gas purchases require temporary financing. The credit facility borrowings outstanding at December 31, 2011 along with borrowings after that date were repaid during the first quarter of 2012, and no borrowing took place under the facility during the second quarter, primarily due to existing cash reserves and natural gas prices that were relatively stable. The maximum amount outstanding on the credit facility during the third quarter was $40 million at September 30, 2012, leaving $110 million available for long-term borrowing and $150 million available for working capital needs. The effective interest rate on the long-term portion of the credit facility was 2.08% at September 30, 2012. Southwest has no significant debt maturities prior to 2017.

NPL has another contract in the same geographical area, the fixed-price component of which is approximately $28 million. Work began in the middle of 2012 and will continue into 2013. Based on the progress to date and review of estimated costs to complete, management expects this contract to be marginally profitable overall. Other operating areas are expected to continue to remain profitable.

Results of Natural Gas Operations

Quarterly Analysis



                                                          Three Months Ended
                                                            September 30,
                                                       2012               2011
                                                        (Thousands of dollars)
  Gas operating revenues                           $     195,573      $     195,647
  Net cost of gas sold                                    53,277             67,165

  Operating margin                                       142,296            128,482
  Operations and maintenance expense                      90,627             89,087
  Depreciation and amortization                           46,763             43,640
  Taxes other than income taxes                           10,600             10,585

  Operating income (loss)                                 (5,694 )          (14,830 )
  Other income (deductions)                                1,631             (8,093 )
  Net interest deductions                                 16,074             17,116

  Income (loss) before income taxes                      (20,137 )          (40,039 )
  Income tax expense (benefit)                            (8,748 )          (14,473 )

  Contribution to consolidated net income (loss)   $     (11,389 )    $     (25,566 )

Contribution to consolidated net income from natural gas operations improved by $14.2 million in the third quarter of 2012 compared to the same period a year ago. The improvement was primarily due to increases in operating margin and other income, partially offset by higher operating expenses.

Operating margin increased $14 million in the third quarter of 2012 compared to the third quarter of 2011. Rate relief in Arizona provided $9 million of the increase in operating margin. New customers contributed an incremental $1 million in operating margin during the third quarter of 2012, as approximately 22,000 net new customers were added during the last twelve months. In addition, a $4 million out-of-period adjustment (related to a regulatory deferral mechanism) that decreased operating margin was included in the prior-year quarter.

Operations and maintenance expense increased $1.5 million, or 2%, between quarters primarily due to higher general costs and employee-related costs including pension expense.

Depreciation expense increased $3.1 million, or 7%, as a result of additional plant in service. Average gas plant in service for the current quarter increased $260 million, or 6%, compared to the corresponding quarter a year ago. This was attributable to pipeline capacity reinforcement work, franchise requirements, scheduled and accelerated pipe replacement activities, and new business.

Other income, which principally includes returns on COLI policies (including recognized net death benefits) and non-utility expenses, increased $9.7 million between quarters. In the current quarter, cash surrender values of COLI policies increased $2.2 million, while the prior-year quarter included a net $6.7 million decrease in other income associated with COLI cash surrender value changes (net of death benefits recognized).

Net interest deductions decreased $1 million between quarters primarily due to cost savings from refinancing, partially offset by additional interest on higher deferred PGA balances.

Nine-Month Analysis



                                                       Nine Months Ended
                                                         September 30,
                                                   2012               2011
                                                    (Thousands of dollars)
     Gas operating revenues                    $     982,203     $     1,022,914
     Net cost of gas sold                            387,983             468,026

     Operating margin                                594,220             554,888
     Operations and maintenance expense              278,361             268,745
     Depreciation and amortization                   139,428             130,997
     Taxes other than income taxes                    31,065              30,750

     Operating income                                145,366             124,396
     Other income (deductions)                         4,317              (6,804 )
     Net interest deductions                          51,077              52,097

     Income before income taxes                       98,606              65,495
     Income tax expense                               33,997              22,847

     Contribution to consolidated net income   $      64,609     $        42,648

Contribution to consolidated net income from natural gas operations increased by $22 million in the first nine months of 2012 compared to the same period a year ago. The improvement was primarily due to increases in operating margin and other income, partially offset by higher operating expenses.

Operating margin increased $39 million between periods. Rate relief in Arizona provided an approximate $35 million increase in operating margin. New customers contributed an incremental $4 million in operating margin during the first nine months of 2012. Offsetting these increases was a reduction of $4 million in operating margin between periods primarily due to moderately cold weather experienced in Arizona in the first half of 2011. With a new rate decoupling mechanism in Arizona, effective January 2012, weather is not expected to be a significant factor in operating margin overall. The remaining $4 million of the increase was due to an out-of-period adjustment that decreased operating margin in the prior-year period.

Operations and maintenance expense increased $9.6 million, or 4%, between periods primarily due to higher general costs and employee-related costs including pension expense.

Depreciation expense increased $8.4 million, or 6%, as a result of additional plant in service. Average gas plant in service for the current period increased $251 million, or 5%, compared to the corresponding period a year ago. This was attributable to pipeline capacity reinforcement work, franchise requirements, scheduled and accelerated pipe replacement activities, and new business.

Other income increased $11.1 million between the nine-month periods of 2012 and 2011. Cash surrender values of COLI policies increased $5.5 million in the current-year period, while values of COLI policies (net of recognized death benefits) decreased $1.9 million during the nine-month period of 2011. In addition, Arizona non-recoverable pipe replacement and other non-utility costs were lower in 2012, especially during the first quarter, as compared to 2011. This pipe replacement activity is expected to be substantially complete by the end of 2012.

Net interest deductions decreased $1 million between periods primarily due to cost savings from refinancing, partially offset by a temporary increase in debt outstanding for approximately two months associated with the issuance of $250 million 3.875% Senior Notes in March 2012 to repay $200 million 7.625% Senior Notes that matured in May 2012.

Twelve-Month Analysis



                                                      Twelve Months Ended
                                                         September 30,
                                                     2012            2011
                                                    (Thousands of dollars)
        Gas operating revenues                    $ 1,362,655     $ 1,401,150
        Net cost of gas sold                          533,446         622,907

        Operating margin                              829,209         778,243
        Operations and maintenance expense            368,114         363,302
        Depreciation and amortization                 183,684         174,037
        Taxes other than income taxes                  41,264          40,231

        Operating income                              236,147         200,673
        Other income (deductions)                       5,717          (3,785 )
        Net interest deductions                        67,757          71,209

        Income before income taxes                    174,107         125,679
        Income tax expense                             60,726          44,052

        Contribution to consolidated net income   $   113,381     $    81,627

The contribution to consolidated net income from natural gas operations increased $31.8 million between the twelve-month periods of 2012 and 2011. The improvement was primarily due to increases in operating margin and other income, partially offset by higher operating expenses.

Operating margin increased $51 million between periods primarily due to $36 million of rate relief in Arizona. Differences in heating demand, caused primarily by weather variations, accounted for $6 million of the increase. With a new rate decoupling mechanism in Arizona, effective January 2012, weather is not expected to be a significant factor in operating margin overall. Customer growth contributed $5 million toward the increase. The remaining $4 million of the increase was due to an out-of-period adjustment that decreased operating margin in the prior-year period.

Operations and maintenance expense increased $4.8 million, or 1%, between periods primarily due to higher general costs and employee-related costs including pension expense. These cost increases were partially offset by favorable claims experience under Southwest's self-insured medical plan during the fourth quarter of 2011.

Depreciation expense increased $9.6 million, or 6%, as a result of additional plant in service. Average gas plant in service for the current period increased $230 million, or 5%, as compared to the prior-year period. This was attributable to pipeline capacity reinforcement work, franchise requirements, scheduled and accelerated pipe replacement activities, and new business.

Taxes other than income taxes increased $1 million primarily due to higher property taxes in Arizona.

Other income increased $9.5 million between the twelve-month periods of 2012 and 2011. The current period reflects an $8.1 million increase in COLI policy cash surrender values and recognized death benefits, while the prior twelve-month period reflected a net COLI-related increase (including recognized death benefits) of $2.3 million.

Net interest deductions decreased $3.5 million between the twelve-month periods of 2012 and 2011 primarily due to cost savings from debt refinancing.

Operating margin for 2012 is expected to increase primarily due to the additional revenue authorized in the Arizona rate case effective January 2012. However, the incremental margin in 2012 compared to 2011 is expected to be about 10% lower than the $52.6 million approved because the average usage and margin per Arizona customer in 2011 were higher than the amounts used in calculating the deficiency when the rate case was filed in 2010. In April 2012, Southwest filed a general rate case in Nevada requesting a $27 million increase in revenue. In October, a decision was received from the PUCN which approved a $7 million annualized increase in rates effective November 2012. The margin projection above does not reflect any incremental margin associated with the Nevada rate case.

Operating expenses for full-year 2012 compared to 2011 will continue to be impacted by inflation, general cost increases, and depreciation expense on plant additions. Incremental costs, including a $7.5 million increase in pension expense for 2012 and additional depreciation on accelerated pipe replacement activities, are expected to result in a higher level of expense increase (approximately 4%) than has been experienced over the past two calendar years.

Southwest expects to realize approximately $5 million in interest savings on an annualized basis due to debt refinancings and redemptions. These savings relate to the March 2012 issuance of $250 million in 3.875% Senior Notes and the repayment of the $200 million of 7.625% debt that occurred in May 2012, as well as the January 2012 redemption of the $12.4 million 1999 6.1% Series A IDRBs and the August 2012 redemption of the $14.3 million 1999 5.95% Series C IDRBs. A portion of these savings will not be realized until 2013.

Results of Construction Services

Results of Construction Services



                                       Three Months Ended            Nine Months Ended            Twelve Months Ended
                                         September 30,                 September 30,                 September 30,
                                      2012           2011           2012           2011           2012           2011
(Thousands of dollars)
Construction revenues               $ 176,226      $ 156,945      $ 457,009      $ 346,623      $ 594,208      $ 436,499
Operating expenses:
Construction expenses                 154,267        134,161        419,072        305,242        537,533        380,240
Depreciation and amortization           9,955          6,701         26,990         17,621         34,585         22,606

Operating income                       12,004         16,083         10,947         23,760         22,090         33,653
Other income (deductions)                   5              6            257            (10 )          259           (217 )
Net interest deductions                   336            191            744            524          1,045            645

Income before income taxes             11,673         15,898         10,460         23,226         21,304         32,791
Income tax expense                      4,698          6,079          4,536          9,254          9,009         12,848

Net income                              6,975          9,819          5,924         13,972         12,295         19,943
Net income (loss) attributable to
noncontrolling interest                  (109 )         (106 )         (405 )         (343 )         (586 )         (378 )

Contribution to consolidated net
income attributable to NPL          $   7,084      $   9,925      $   6,329      $  14,315      $  12,881      $  20,321

Quarterly Analysis. Contribution to consolidated net income from construction . . .