Note 1 – Nature of Operations and Basis of Presentation

Nature of Operations. Southwest Gas Holdings, Inc., is a holding company, owning all of the shares of common stock of Southwest Gas Corporation and, prior to August 2017, 96.6% of the shares of common stock of Centuri Construction Group, Inc. (“Centuri” or the “construction services” segment). During August 2017, Southwest Gas Holdings, Inc. acquired the remaining 3.4% equity interest in Centuri that was held by the previous owners.

Southwest Gas Corporation (“Southwest” or the “natural gas operations segment”) is engaged in the business of purchasing, distributing, and transporting natural gas for customers in portions of Arizona, Nevada, and California. Public utility rates, practices, facilities, and service territories of Southwest are subject to regulatory oversight. The timing and amount of rate relief can materially impact results of operations. Natural gas purchases and the timing of related recoveries can materially impact liquidity. Results for the natural gas operations segment are higher during winter periods due to the seasonality incorporated in its regulatory rate structures. Centuri is a comprehensive construction services enterprise dedicated to meeting the growing demands of North American utilities, energy, and industrial markets. Centuri derives revenue from installation, replacement, repair, and maintenance of energy distribution systems, and developing industrial construction solutions. Centuri operations are generally conducted under the business names of NPL Construction Co. (“NPL”), Canyon Pipeline Construction, Inc. (“Canyon”), NPL Canada Ltd. (“NPL Canada”), W.S. Nicholls Construction, Inc. (“W.S. Nicholls”), and Canyon Special Projects, Inc. (“Special Projects,” formerly Brigadier Pipelines Inc.). Typically, Centuri revenues are lowest during the first quarter of the year due to unfavorable winter weather conditions. Operating revenues typically improve as more favorable weather conditions occur during the summer and fall months. Centuri acquired New England Utility Constructors, Inc. (“Neuco”) in November 2017, thereby expanding its core services in the Northeast region of the United States. See Note 11 – Acquisition of Construction Services Business for more information.

Basis of Presentation. The condensed consolidated financial statements for Southwest Gas Holdings, Inc. and subsidiaries (the “Company”) and Southwest included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. In connection with a holding company reorganization in January 2017, Centuri ceased to be a subsidiary of Southwest and became a subsidiary of Southwest Gas Holdings, Inc. To give effect to this change, the separate condensed consolidated financial statements related to Southwest Gas Corporation, which are included in this Form 10-Q, depict Centuri-related amounts for periods prior to January 1, 2017 as discontinued operations.

No substantive change has occurred with regard to the Company’s business segments on the whole, or in the primary businesses comprising those segments as a result of the foregoing organizational changes, or due to the acquisition of Neuco. Following the organizational changes, Centuri operations continue to be part of continuing operations and included in the consolidated financial statements of Southwest Gas Holdings, Inc.

The preparation of the condensed 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 revenues 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 statement of results for the interim periods, have been made. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the 2017 Annual Report to Shareholders, which is incorporated by reference into the 2017 Form 10-K.

Early Adoption of Accounting Standards Update (“ASU”) No. 2018-02. In January 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-02 “Income Statement—Reporting Comprehensive Income (Topic 220)—Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” Early adoption of the amendments in this update is permitted, including adoption in any interim period. Therefore, the Company and Southwest chose to adopt the update early, as permitted, as of January 1, 2018. The adoption of this update is considered a change in accounting principle. The update addresses issues resulting from the December 22, 2017 enactment of the Tax Cuts and Jobs Act (“TCJA”). Stakeholders raised a narrow-scope financial reporting issue that arose as a consequence of the TCJA related to the fact that when deferred tax balances were remeasured in December 2017, those deferred tax balances were to be reduced, but related amounts historically accumulated in Accumulated other comprehensive income (“AOCI”) prior to the enactment of the TCJA, were required to be recognized as income tax expense rather than being relieved from AOCI. The amendments in this update allow a reclassification from AOCI to retained earnings for those otherwise “stranded” tax effects in AOCI following enactment of the TCJA. Accordingly, approximately $9.3 million of previously stranded tax effects resulting from the TCJA were reclassified to retained earnings from AOCI on the Condensed Consolidated Balance Sheets of Southwest and the Company effective with the early adoption date. Also in association with the adoption, the Company and Southwest elected an accounting policy for releasing income tax effects from AOCI, such that the release of any income tax effects from AOCI will occur as individual items in AOCI are sold or liquidated, to the extent that the related income tax effects are material. See Note 9 – Equity, Other Comprehensive Income, and Accumulated Other Comprehensive Income for more information.

Prepaids and other current assets. Prepaids and other current assets includes gas pipe materials and operating supplies of $55 million at June 30, 2018 and $33 million at December 31, 2017 (carried at weighted average cost), as well as $69 million at June 30, 2018 and $40 million at December 31, 2017 related to a regulatory asset associated with the Arizona decoupling mechanism (an alternative revenue program). In May 2018, El Paso Natural Gas, L.L.C. (“EPNG”), was ordered to refund approximately $49 million to Southwest related to transmission services with EPNG. The refund (which was received by Southwest in July 2018) relates to rates authorized by the Federal Energy Regulatory Commission (“FERC”) to be in effect subject to refund provisions from EPNG’s 2010 rate case. Southwest will dispense the funds received through rate adjustments associated with its purchased gas adjustment (“PGA”) mechanisms. As the refund was outstanding at June 30, 2018, it did not impact cash flows; however, it is reflected in Prepaids and other current assets and a corresponding amount is reflected in a regulatory liability included within Other current liabilities in the balance sheets of both Southwest and the Company as of that date.

Income Taxes. On December 22, 2017, the TCJA legislation was enacted. Substantially all of the provisions of the TCJA are effective for taxable years beginning after December 31, 2017. The TCJA includes extensive changes which significantly impact the taxation of business entities, including specific provisions related to regulated public utilities. The more significant change that impacts the Company includes the reduction in the corporate federal income tax rate from 35% to 21%. The tax rate reduction created excess deferred taxes, resulting in the required remeasurement of deferred tax balances, which when remeasured during the fourth quarter of 2017, reduced income tax expense. The regulated operations of Southwest experienced other impacts due to its rate-regulation and the accounting treatment prescribed by U.S. GAAP to reflect the economics of that regulation. The remeasurement for Southwest reduced the net deferred income tax liability and caused the creation of a regulatory liability with appropriate tax gross-up. Both deferred tax liabilities and excess deferred tax liabilities (included within regulatory liabilities) reduce utility rate base. The TCJA includes provisions that stipulate how these excess deferred taxes are to be passed back to customers, and ultimate facilitation will occur in conjunction with appropriate regulatory commissions. During the six months ended June 30, 2018, tax expense for the Company and Southwest reflects the lower U.S. federal income tax rate now in effect (as applicable to earnings in 2018). Amounts recorded by the Company and Southwest associated with the measurement and accounting for the effects of the TCJA are provisional reasonable estimates. Management is continuing to evaluate and finalize all provisional items during the measurement period permitted by the SEC and the FASB, which is not to exceed one year from the enactment date.

In the first quarter of 2018, management recorded a regulatory liability and reduced utility revenues by approximately $14 million for potential regulatory rate reductions to customers resulting from the reduced cost-of-service levels during the period. Based on regulatory activity in the second quarter of 2018, management has updated its estimated reserve to approximately $12.5 million.

In July 2018, the Arizona Corporation Commission (“ACC”) staff issued a recommended opinion and order that would require Southwest to return to customers amounts related to excess cost-of-service rates as a result of customer rates having been authorized prior to the reduction in federal tax expense from tax reform. Also in July, the ACC issued a decision (the “Decision”) based on the staff recommendation. The Decision provides for bill credits for excess amounts experienced through July 2018. Additionally, starting in August 2018, surcredits applied to volumes would be implemented in consideration of lower tax rates impacting tax expense on an ongoing basis. Based on these recent actions of the ACC, the $12.5 million reserve is reflected in Other current liabilities. During the first quarter of 2018, related amounts were included in Other deferred credits and other long-term liabilities pending resolution of regulatory outcome and timing.

Other current liabilities. Other current liabilities for both Southwest and the Company include the $49 million regulatory liability associated with the EPNG refund (noted previously) and the $12.5 million reserve associated with tax reform noted above. This caption on Southwest’s Condensed Consolidated Balance Sheets also includes $22 million of dividends declared by Southwest Gas Corporation, but not yet paid to Southwest Gas Holdings, Inc. at June 30, 2018.

Cash and Cash Equivalents. For purposes of reporting consolidated cash flows, cash and cash equivalents include cash on hand and financial instruments with a purchase-date maturity of three months or less. In general, cash and cash equivalents fall within Level 1 (quoted prices for identical financial instruments) of the three-level fair value hierarchy that ranks the inputs, used to measure fair value, by their reliability. However, cash and cash equivalents for Southwest and the Company also includes money market fund investments totaling approximately $1.9 million and $13.2 million, respectively, which fall within Level 2 (significant other observable inputs) of the fair value hierarchy, due to the asset valuation methods used by money market funds.

Significant non-cash investing and financing activities included the following: Upon contract expiration, customer advances of approximately $512,000 and $1.6 million, during the first six months of 2018 and 2017, respectively, were applied as contributions toward utility construction activity and represent non-cash investing activity.

Goodwill. Goodwill is assessed as of October 1^st each year for impairment, or otherwise, if circumstances indicate an impairment to the carrying value of goodwill may have occurred. In consideration of the holding company reorganization, management of the Company considered its reporting units and segments and determined that historic judgments regarding its segments and reporting units continue to apply, and that no change was necessary with regard to the level at which goodwill is assessed for impairment. No impairment was deemed to have occurred in the first six months of 2018.

Goodwill:


(Thousands of dollars)	Natural Gas Operations		Construction Services			Consolidated
December 31, 2017	$	10,095	$	169,219		$	179,314
Additional goodwill from Neuco acquisition		—		182			182
Foreign currency translation adjustment		—		(5,263	)		(5,263	)

June 30, 2018	$	10,095	$	164,138		$	174,233

Intercompany Transactions. Centuri recognizes revenues generated from contracts with Southwest (see Note 4 - Segment Information). Centuri’s accounts receivable for these services are presented in the table below (thousands of dollars):


	June 30, 2018		December 31, 2017
Centuri accounts receivable for services provided to Southwest	$	13,899	$	12,987

The accounts receivable balance, revenues, and associated profits are included in the condensed consolidated financial statements of the Company and were not eliminated during consolidation in accordance with accounting treatment for rate-regulated entities.

Other Property and Investments. Other property and investments on the Condensed Consolidated Balance Sheets includes (thousands of dollars):


	June 30, 2018			December 31, 2017
Southwest Gas Corporation:
Net cash surrender value of COLI policies	$	118,733		$	117,341
Other property		1,743			1,773

Total Southwest Gas Corporation		120,476			119,114
Centuri property, equipment, and intangibles		606,750			554,730
Centuri accumulated depreciation/amortization		(278,209	)		(258,906	)
Other property		13,219			13,242

Total Southwest Gas Holdings, Inc.	$	462,236		$	428,180

Other Income (Deductions). The following table provides the composition of significant items included in Other income (deductions) in the Condensed Consolidated Statements of Income (thousands of dollars):


	Three Months Ended						Six Months Ended						Twelve Months Ended
	June 30,						June 30,						June 30,
	2018			2017			2018			2017			2018			2017
Southwest Gas Corporation - natural gas operations segment:
Change in COLI policies	$	2,000		$	1,900		$	1,300		$	4,700		$	6,900		$	9,000
Interest income		1,377			614			2,795			1,178			4,401			2,269
Equity AFUDC		357			633			586			1,109			1,773			2,116
Other components of net periodic benefit cost		(5,264	)		(4,857	)		(10,529	)		(9,712	)		(20,241	)		(19,591	)
Miscellaneous income and (expense)		(564	)		(1,095	)		(849	)		(1,324	)		(1,869	)		(3,637	)

Southwest Gas Corporation - total other income (deductions)		(2,094	)		(2,805	)		(6,697	)		(4,049	)		(9,036	)		(9,843	)

Construction services segment:
Interest income		1			1			2			1			4			1
Foreign transaction gain (loss)		202			(197	)		349			(198	)		(207	)		(201	)
Miscellaneous income and (expense)		(835	)		190			(720	)		445			(69	)		1,641

Centuri - total other income (deductions)		(632	)		(6	)		(369	)		248			(272	)		1,441

Corporate and administrative		20			1			26			1			38			1

Consolidated Southwest Gas Holdings, Inc. - total other income (deductions)	$	(2,706	)	$	(2,810	)	$	(7,040	)	$	(3,800	)	$	(9,270	)	$	(8,401	)

Included in the table above is the change in cash surrender values of company-owned life insurance (“COLI”) policies (including net death benefits recognized). These life insurance policies on members of management and other key employees are used by Southwest to indemnify itself against the loss of talent, expertise, and knowledge, as well as to provide indirect funding for certain nonqualified benefit plans. Current tax regulations provide for tax-free treatment of life insurance (death benefit) proceeds. Therefore, changes in the cash surrender values of COLI policies, as they progress towards the ultimate death benefits, are also recorded without tax consequences. Refer also to Note 2 – Components of Net Periodic Benefit Cost.

Recently Issued Accounting Standards Updates.

In February 2016, the FASB issued the update “Leases (Topic 842).” Under the update, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:

•

A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and

•

A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, “Revenue from Contracts with Customers.” Though companies have historically been required to make disclosures regarding leases and of associated contractual obligations, leases with terms longer than a year will no longer exist off-balance sheet. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. Early application is permitted. Management currently plans to adopt the update at the required adoption date, which is for interim and annual reporting periods commencing January 1, 2019. Existing leases have been historically documented under traditional leasing arrangements by both segments. Management is in the process of evaluating other types of arrangements that have the potential to meet the definition of a lease under the new standard. The FASB recently issued guidance that will allow the election of a practical expedient to not apply the new standard to existing easement contracts that were not previously assessed as leases under historic guidance. However, the Company and Southwest would still be required to evaluate any new easements entered into after the effective date of the standard to determine if the arrangements should be accounted for as leases. In July 2018, the FASB issued narrow-scope improvements to the standard, which include, among other things, guidance on lease classification reassessments, that reference index changes, and on their own, do not constitute resolution of a contingency requiring remeasurement of lease payments, and clarification that lessor-controlled options to terminate a lease are considered in the lease term. Management is currently in the process of implementing a new software system to comply with Topic 842 including amendments thereto, and continues to evaluate the guidance in light of its customary leasing arrangements (and other arrangements in association with the new guidance) to determine the effect the new standard, and its amendments, will have on its financial position, results of operations, cash flows, and business processes.

In June 2016, the FASB issued the update “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The update amends guidance on reporting credit losses for financial assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, the update eliminates the “probable” threshold for initial recognition of credit losses in current U.S. GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current U.S. GAAP; however, the update will require that credit losses be presented as an allowance rather than as a write-down. This update affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The update affects loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in this update earlier as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Management is evaluating what impact, if any, this update might have on its consolidated financial statements and disclosures.