NorthWestern Reports Third Quarter 2018 Financial Results

BUTTE, Mont. and SIOUX FALLS, S.D., Oct. 23, 2018 /PRNewswire/ -- NorthWestern Corporation d/b/a NorthWestern Energy (NYSE: NWE) reported financial results for the quarter ended September 30, 2018.  Net income for the period decreased 22.6% to $28.2 million, or $0.56 per diluted share, as compared with net income of $36.4 million, or $0.75 per diluted share, for the same period in 2017. This $8.2 million decrease in net income in 2018 is primarily due to unfavorable weather, reduced recovery of Montana electric supply costs and higher operating expenses.  These unfavorable variances were partially offset by lower interest and income tax expense.

Additional information regarding this release can be found in the earnings presentation found at www.northwesternenergy.com/our-company/investor-relations/presentations-and-webcasts.

"Overall mild weather, a decrease in cost recovery resulting from the expected effect of the Montana Public Service Commission's recent vote in the PCCAM docket and timing of some increased expenses all weighed on the financial results this quarter," said Bob Rowe, President and Chief Executive Officer. "However, continued cost controls and efficiencies along with respectable customer growth and strong economic indicators in our service territories allow us to remain committed to our guidance range for the year."

Significant Regulatory Updates

Montana General Electric Rate Case
In September 2018, we filed an electric rate case with the Montana Public Service Commission (MPSC) requesting an annual increase to electric rates of approximately $34.9 million, which represents an approximate 6.6% increase in annual base revenues. Our request is based on a return on equity of 10.65% and an overall rate of return of 7.42%  (except for Colstrip Unit 4 which the MPSC previously set for the life of the facility at a 10% return on equity and an 8.25% rate of return), based on approximately $2.35 billion of Montana electric rate base and a capital structure of 51 percent debt and 49 percent equity.

We also requested that approximately $13.8 million of the rate increase be approved on an interim basis effective November 1, 2018. We expect to receive a decision on our interim request by the end of 2018. If the MPSC does not issue an order within nine months of the filing, new rates may be placed into effect on an interim and refundable basis.

Tax Cuts and Jobs Act
In December 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law, which enacts significant changes to U.S. tax and related laws. The primary impact to us is a reduction of the federal corporate income tax rate from 35% to 21% effective January 1, 2018. Dockets were opened in each of our jurisdictions to investigate the customer benefit of this reduction in the federal corporate income tax rate. During the third quarter of 2018, we received approval of settlement agreements in our South Dakota and Nebraska jurisdictions regarding the customer benefit of the TCJA. As a result, in South Dakota we expect to refund $3.0 million to customers by October 31, 2018, and agreed to a two-year rate moratorium, ensuring customer rates remain static until January 1, 2021. These settlements did not have a material effect on the Consolidated Financial Statements.

In Montana, the MPSC held a hearing during the third quarter of 2018, and we expect a decision in the matter by the end of 2018. We have deferred revenue of approximately $13.3 million associated with the impacts of the TCJA in our Montana jurisdiction as of September 30, 2018. For purposes of the Montana filing, we calculated the customer benefit using two alternate methods based on current and historic test periods. The revenue deferral is based upon our 2018 estimated impact of the TCJA of approximately $18 million to $23 million and is offset by a corresponding reduction in income tax expense. Application of the historic method would result in customer refunds that exceed the reduction in our 2018 taxes, which would be an additional reduction in pretax earnings and cash flows ranging from approximately $5 million to $10 million. We cannot predict how the MPSC may calculate the amount of credits due to customers.

Cost Recovery Mechanisms
Montana House Bill 193 / Electric Tracker - In April 2017, the Montana legislature passed HB 193, amending the statute that provided for mandatory recovery of 100% of our prudently incurred electric supply costs. The revised statute gives the MPSC discretion whether to approve an electric supply cost adjustment mechanism. The MPSC initiated a process to develop a replacement electric supply cost adjustment mechanism, and in response, in July 2017, we filed a proposed electric Power Cost and Credit Adjustment Mechanism (PCCAM).

In September 2018, the MPSC held a work session and voted to approve a PCCAM with the following provisions:

• A baseline of power supply costs, which are consistent with what we proposed;
• A sharing mechanism that includes a +/- $4.1 million deadband around the baseline, with differences beyond the deadband shared by allocating 90% customers and 10% shareholders; and
• Retroactive implementation to the effective date of HB 193 (July 1, 2017).

Based on the MPSC's work session, we recorded an estimate of the impact of the MPSC's decision during the third quarter of 2018, which resulted in an approximate $1.8 million net reduction in revenue to be recovered from customers in the Condensed Consolidated Statements of Income. We expect a final order to be issued during the fourth quarter of 2018.

Significant Earnings Drivers

Gross Margin
Consolidated gross margin for the three months ended September 30, 2018 was $207.7 million compared with $212.4 million for the same period in 2017.  This $4.7 million decrease was a result of a $3.9 million decrease to items that have an impact on net income and $0.8 million decrease to items that are offset in operating expenses, property tax expense and income tax expense with no impact to net income.

Consolidated gross margin for items impacting net income decreased $3.9 million, including:

• $2.8 million net decrease in electric and natural gas retail volumes due primarily to cooler summer weather in our Montana jurisdiction, partially offset by warmer summer weather in our South Dakota jurisdiction and customer growth;
• $1.8 million decrease in Montana supply costs recoverable from customers associated with the application of the expected impact of the PCCAM;
• $0.2 million decrease as a result of a favorable impact in the prior period related to a final order in our Montana natural gas rate case;
• $0.3 million decrease to other miscellaneous gross margin, partially offset by;
• $1.2 million increase from higher demand to transmit energy across our transmission lines due to market conditions and pricing.

The PCCAM adjustment includes an approximately $3.3 million increase in revenues for the PCCAM period 2017/2018 offset by an approximately $5.1 million reduction in revenues for the first three months of the 2018/2019 PCCAM period. The favorable impact for the 2017/2018 PCCAM period was primarily driven by higher generation from our hydroelectric facilities. The unfavorable impact in the first three months of the 2018/2019 PCCAM period was due primarily to higher market prices and lower generation from Colstrip Unit 4 due to an intermittent outage.

The change in consolidated gross margin for items that had no impact on net income represented a $0.8 million decrease primarily due to the following:

• $2.9 million decrease due to the deferral of revenue as a result of the TCJA, offset by a decrease in income tax expense;
• $1.4 million decrease in revenue due to the increase in production tax credit benefits passed through to customers in our tracker mechanisms, which are offset by decreased income tax expense, partially offset by;
• $3.0 million increase in revenues for property taxes included in trackers, offset by increased property tax expense; and
• $0.5 million increase in revenues for operating costs included in trackers, offset by increased operating expense.

Consolidated gross margin for the nine months ended September 30, 2018 was $682.7 million compared with $659.8 million for the same period in 2017.  This $22.9 million increase was a result of a $32.4 million increase to items that have an impact on net income and $9.5 million decrease to items that are offset in operating expenses and income tax expense with no impact to net income.

Operating, General and Administrative Expenses
Consolidated operating, general and administrative expenses for the three months ended September 30, 2018 were $73.8 million compared with $67.7 million for the same period in 2017. This $6.1 million increase was a result of a $1.2 million increase to items that have an impact on net income and $4.9 million increase to items that are offset in gross margin and other income (expense) with no impact to net income.

Consolidated operating, general and administrative expenses for items impacting net income increased $1.2 million, including:

• $1.2 million higher line clearance costs, which includes approximately $0.7 million related to trees outside our electric transmission and distribution lines rights of way in 2018;
• $0.2 million higher maintenance costs at electric generation facilities; and
• $2.3 million other miscellaneous expense increases, partly offset by;
• $1.0 million lower distribution system infrastructure project related expenses due to the conclusion of that project in 2017;
• $1.0 million decrease in employee benefit costs primarily due to lower pension expense; and
• $0.5 million decreased labor costs due primarily to more time being spent by employees on capital rather than maintenance projects (which are expensed).

The change in consolidated operating, general and administrative expenses for items that are offset in other income (expense) and had no impact on net income represented a $4.9 million increase primarily due to the following:

• $2.6 million increase related to the regulatory treatment of non-service cost components of pension and post-retirement benefit expense, offset in other income;
• $1.8 million increase related to the change in value of non-employee directors deferred compensation due to changes in our stock price, offset in other income; and
• $0.5 million higher operating expenses included in trackers recovered through revenue.

Consolidated operating, general and administrative expenses for the nine months ended September 30, 2018 were $222.0 million compared with $218.6 million for the same period in 2017.  This $3.4 million increase was a result of a $4.5 million decrease to items that have an impact on net income and $7.9 million increase to items that are offset in other income (expense) with no impact to net income.

Property and Other Taxes
Property and other taxes were $42.5 million for the three months ended September 30, 2018, as compared with $39.1 million in the same period of 2017. This increase was primarily due to plant additions and higher estimated property valuations in Montana. We estimate property taxes throughout each year, and update based on valuation reports received from the Montana Department of Revenue. Under Montana law, we are allowed to track the increases in the actual level of state and local taxes and fees and adjust our rates to recover the increase between rate cases less the amount allocated to FERC-jurisdictional customers and net of the associated income tax benefit.

Property and other taxes were $128.3 million for the nine months ended September 30, 2018, as compared with $118.5 million in the same period of 2017.

Depreciation and Depletion Expense
Depreciation and depletion expense was $43.6 million for the three months ended September 30, 2018, as compared with $41.5 million in the same period of 2017. This increase was primarily due to plant additions.

Depreciation and depletion expense was $130.9 million for the nine months ended September 30, 2018, as compared with $124.5 million in the same period of 2017.

Operating Income
Consolidated operating income for the three months ended September 30, 2018 was $47.8 million as compared with $64.1 million in the same period of 2017. This decrease was primarily due to lower gross margin and higher operating expenses.

Consolidated operating income for the nine months ended September 30, 2018 was $201.5 million as compared with $198.2 million in the same period of 2017.

Interest Expense
Consolidated interest expense for the three months ended September 30, 2018 was $22.0 million, as compared with $23.1 million in the same period of 2017, with a decrease from the refinancing of debt in 2017 partly offset by rising interest rates.

Consolidated interest expense for the nine months ended September 30, 2018 was $68.2 million, as compared with $70.0 million in the same period of 2017.

Other Income and Expense
Consolidated other income was $2.1 million for the three months ended September 30, 2018 as compared to consolidated other expense of $1.8 million during the same period of 2017. This improvement includes a decrease in other pension expense and an increase in the value of deferred shares held in trust for non-employee directors deferred compensation, both of which are offset in operating, general, and administrative expenses with no impact to net income. These improvements were partly offset by lower capitalization of Allowance for Funds Used During Construction.

Consolidated other income for the nine months ended September 30, 2018, was $1.8 million, as compared with consolidated other expense of $3.4 million in the same period of 2017.

Income Tax
Consolidated income tax benefit for the three months ended September 30, 2018 was $0.4 million as compared with $2.8 million expense in the same period of 2017. Our effective tax rate for the three months ended September 30, 2018 was (1.3)% as compared with 7.1% for the same period of 2017. We expect our full year 2018 effective tax rate to range between 0% - 5%.

The following table summarizes the differences between our effective tax rate and the federal statutory rate for the three and six month periods:

We compute income tax expense for each quarter based on the estimated annual effective tax rate for the year, adjusted for certain discrete items. Our effective tax rate typically differs from the federal statutory tax rate primarily due to the regulatory impact of flowing through federal and state tax benefits of repairs deductions, state tax benefit of accelerated tax depreciation deductions (including bonus depreciation when applicable) and production tax credits.

Net Income
Consolidated net income for the three months ended September 30, 2018 was $28.2 million as compared with $36.4 million for the same period in 2017. This decrease was due to lower gross margin as a result of unfavorable weather and the PCCAM adjustment, and increased operating expenses, partly offset by lower interest and income tax expense.

Consolidated net income for the nine months ended September 30, 2018 was $130.5 million as compared with $114.8 million for the same period in 2017.