UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[Missing Graphic Reference]
FORM 10-Q
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x | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended September 30, 2010March 31, 2011 |
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OR |
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¨o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 1-10499
[Missing Graphic Reference]
NORTHWESTERN CORPORATION
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Delaware | | 46-0172280 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
3010 W. 69th Street, Sioux Falls, South Dakota | | 57108 |
(Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code: 605-978-2900 |
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non- accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| 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 o
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
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| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non- accelerated |
filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. |
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Large Accelerated Filer x | Accelerated Filer o | Non-accelerated Filer o Non-accelerated Filer | oSmaller Reporting Company o
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| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange |
Act). Yes o No x
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| Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest |
practicable date: |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock, Par Value $0.01
36,205,29536,257,086 shares outstanding at OctoberApril 22, 20102011
NORTHWESTERN CORPORATION
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
On one or more occasions, we may make statements in this Quarterly Report on Form 10-Q regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events. All statements other than statements of historical facts, included or incorporated by reference in this Quarterly Report, relating to management's current expectations of future financial performance, continued growth, changes in economic conditions or capital markets and changes in customer usage patterns and preferences are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Words or phrases such as “anticipates,”" “may,”" “will,”" “should,”" “believes,”" “estimates,”" “expects,”" “intends,”" “plans,”" “predicts,”" “projects,”" “targets,”" “will likely result,”" “will continue”continue" or similar expressions identify forward-looking statements. Forward-looking statements involve risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed. We caution that while we make such statements in good faith and believe such statements are based on reasonable assumptions, including without limitation, management's examination of historical operating trends, data contained in records and other data available from third parti es,parties, we cannot assure you that we will achieve our projections. Factors that may cause such differences include, but are not limited to:
· | potential adverse federal, state, or local legislation or regulation or local legislation or regulation, including costs of compliance with existing and future environmental requirements, as well as adverse determinations by regulators, could have a material adverse effect on our liquidity, results of operations and financial condition; |
· | changes in availability of trade credit, creditworthiness of counterparties, usage, commodity prices, fuel supply costs or availability due to higher demand, shortages, weather conditions, transportation problems or other developments, may reduce revenues or may increase operating costs, each of which could adversely affectwe have capitalized approximately $17.3 million in preliminary survey and investigative costs related to our proposed Mountain States Transmission Intertie (MSTI) transmission project. If our efforts to complete MSTI are not successful we may have to write-off all or a portion of these costs which could have a material adverse effect on our liquidity and results of operations; |
· | unscheduled generation outages or forced reductions in output, maintenance or repairs, which may reduce revenues and increase cost of sales or may require additional capital expenditures or other increased operating costs; and |
changes in availability of trade credit, creditworthiness of counterparties, usage, commodity prices, fuel supply costs or availability due to higher demand, shortages, weather conditions, transportation problems or other developments, may reduce revenues or may increase operating costs, each of which could adversely affect our liquidity and results of operations;· | adverse changes in general economicunscheduled generation outages or forced reductions in output, maintenance or repairs, which may reduce revenues and increase cost of sales or may require additional capital expenditures or other increased operating costs; and competitive conditions in the U.S. financial markets and in our service territories. |
adverse changes in general economic and competitive conditions in the U.S. financial markets and in our service territories.
We have attempted to identify, in context, certain of the factors that we believe may cause actual future experience and results to differ materially from our current expectation regarding the relevant matter or subject area. In addition to the items specifically discussed above, our business and results of operations are subject to the uncertainties described under the caption “Risk Factors” which is part of the disclosure included in Part II, Item 1A of this Report.
From time to time, oral or written forward-looking statements are also included in our reports on Forms 10-K, 10-Q and 8-K, Proxy Statements on Schedule 14A, press releases, analyst and investor conference calls, and other communications released to the public. We believe that at the time made, the expectations reflected in all of these forward-looking statements are and will be reasonable. However, any or all of the forward-looking statements in this Quarterly Report on Form 10-Q, our reports on Forms 10-K and 8-K, our other reports on Form 10-Q, our Proxy Statements on Schedule 14A and any other public statements that are made by us may prove to be incorrect. This may occur as a result of assumptions, which turn out to be inaccurate, or as a consequence of known or unknown risks and uncertainties. Many factors discussed in this Quarter lyQuarterly Report on Form 10-Q, certain of which are beyond our control, will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from forward-looking statements. In light of these and other uncertainties, you should not regard the inclusion of any of our forward-looking statements in this Quarterly Report on Form 10-Q or other public communications as a representation by us that our plans and objectives will be achieved, and you should not place undue reliance on such forward-looking statements.
We undertake no obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made on related subjects in our subsequent annual and periodic reports filed with the Securities and Exchange Commission (SEC) on Forms 10-K, 10-Q and 8-K and Proxy Statements on Schedule 14A.
Unless the context requires otherwise, references to “we,” “us,” “our,” “NorthWestern Corporation,” “NorthWestern Energy,” and “NorthWestern” refer specifically to NorthWestern Corporation and its subsidiaries.
| PART 1. FINANCIAL INFORMATION |
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ITEM 1. | FINANCIAL STATEMENTS |
NORTHWESTERN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share data)
| | | | | |
| | September 30, 2010 | December 31, 2009 |
ASSETS | | | | | |
Current Assets: | | | | | |
Cash and cash equivalents | | $ | 6,561 | | $ | 4,344 | |
Restricted cash | | 11,367 | | 13,608 | |
Accounts receivable, net | | 98,642 | | 143,759 | |
Inventories | | 64,696 | | 47,305 | |
Regulatory assets | | 61,466 | | 40,509 | |
Deferred income taxes | | 2,996 | | 1,239 | |
Prepaid and other | | 8,050 | | 14,063 | |
Total current assets | | 253,778 | | 264,827 | |
Property, Plant, and Equipment, Net | | 2,075,215 | | 1,964,121 | |
Goodwill | | 355,128 | | 355,128 | |
Regulatory assets | | 179,517 | | 182,382 | |
Other noncurrent assets | | 35,736 | | 28,674 | |
Total assets | | $ | 2,899,374 | | $ | 2,795,132 | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | |
Current Liabilities: | | | | | |
Current maturities of capital leases | | $ | 1,261 | | $ | 1,197 | |
Current maturities of long-term debt | | 6,578 | | 6,123 | |
Accounts payable | | 53,662 | | 92,923 | |
Accrued expenses | | 220,745 | | 165,127 | |
Regulatory liabilities | | 17,071 | | 29,622 | |
Total current liabilities | | 299,317 | | 294,992 | |
Long-term capital leases | | 34,619 | | 35,570 | |
Long-term debt | | 1,017,764 | | 981,296 | |
Deferred income taxes | | 194,158 | | 161,188 | |
Noncurrent regulatory liabilities | | 247,724 | | 238,332 | |
Other noncurrent liabilities | | 295,757 | | 296,730 | |
Total liabilities | | 2,089,339 | | 2,008,108 | |
Commitments and Contingencies (Note 13) | | | | | |
Shareholders' Equity: | | | | | |
Common stock, par value $0.01; authorized 200,000,000 shares; issued and outstanding 39,771,694 and 36,204,715, respectively; Preferred stock, par value $0.01; authorized 50,000,000 shares; none issued | | 398 | | 395 | |
Treasury stock at cost | | (90,360 | ) | (90,228 | ) |
Paid-in capital | | 813,464 | | 807,527 | |
Retained earnings | | 77,665 | | 59,605 | |
Accumulated other comprehensive income | | 8,868 | | 9,725 | |
Total shareholders' equity | | 810,035 | | 787,024 | |
Total liabilities and shareholders' equity | | $ | 2,899,374 | | $ | 2,795,132 | | |
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| March 31, 2011 | | December 31, 2010 |
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ASSETS | | | |
Current Assets: | | | |
Cash and cash equivalents | $ | 7,180 | | | $ | 6,234 | |
Restricted cash | 12,596 | | | 12,862 | |
Accounts receivable, net | 144,725 | | | 143,304 | |
Inventories | 26,853 | | | 50,701 | |
Regulatory assets | 50,771 | | | 59,993 | |
Deferred income taxes | 20,234 | | | 24,052 | |
Other | 8,673 | | | 5,908 | |
Total current assets | 271,032 | | | 303,054 | |
Property, plant, and equipment, net | 2,127,254 | | | 2,117,977 | |
Goodwill | 355,128 | | | 355,128 | |
Regulatory assets | 224,896 | | | 222,341 | |
Other noncurrent assets | 38,129 | | | 39,169 | |
Total assets | $ | 3,016,439 | | | $ | 3,037,669 | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | |
Current Liabilities: | | | |
Current maturities of capital leases | $ | 1,300 | | | $ | 1,276 | |
Current maturities of long-term debt | 6,750 | | | 6,578 | |
Short-term borrowings | 85,989 | | | — | |
Accounts payable | 52,052 | | | 75,042 | |
Accrued expenses | 225,485 | | | 203,900 | |
Regulatory liabilities | 23,187 | | | 17,173 | |
Total current liabilities | 394,763 | | | 303,969 | |
Long-term capital leases | 33,957 | | | 34,288 | |
Long-term debt | 905,003 | | | 1,061,780 | |
Deferred income taxes | 248,487 | | | 232,709 | |
Noncurrent regulatory liabilities | 256,079 | | | 251,133 | |
Other noncurrent liabilities | 337,318 | | | 333,443 | |
Total liabilities | 2,175,607 | | | 2,217,322 | |
Commitments and Contingencies (Note 13) | | | |
Shareholders' Equity: | | | |
Common stock, par value $0.01; authorized 200,000,000 shares; issued and outstanding 39,820,239 and 36,252,743 shares, respectively; Preferred stock, par value $0.01; authorized 50,000,000 shares; none issued | 398 | | | 398 | |
Treasury stock at cost | (90,373 | ) | | (90,427 | ) |
Paid-in capital | 814,955 | | | 813,878 | |
Retained earnings | 107,584 | | | 87,984 | |
Accumulated other comprehensive income | 8,268 | | | 8,514 | |
Total shareholders' equity | 840,832 | | | 820,347 | |
Total liabilities and shareholders' equity | $ | 3,016,439 | | | $ | 3,037,669 | |
See Notes to Condensed Consolidated Financial Statements
NORTHWESTERN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands, except per share amounts)
| | Three Months Ended September 30, | | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | 2010 | | 2009 | |
Revenues | | | | | | | | | | | |
Electric | | $ | 203,585 | | $ | 198,416 | | $ | 592,262 | | $ | 579,277 | |
Gas | | 36,963 | | 34,179 | | 225,882 | | 253,976 | |
Other | | 270 | | 291 | | 906 | | 6,249 | |
Total Revenues | | 240,818 | | 232,886 | | 819,050 | | 839,502 | |
Operating Expenses | | | | | | | | | |
Cost of sales | | 105,922 | | 105,183 | | 390,685 | | 420,033 | |
Operating, general and administrative | | 58,437 | | 57,893 | | 173,871 | | 184,210 | |
Property and other taxes | | 20,535 | | 20,866 | | 68,487 | | 63,401 | |
Depreciation | | 22,825 | | 21,977 | | 68,697 | | 66,959 | |
Total Operating Expenses | | 207,719 | | 205,919 | | 701,740 | | 734,603 | |
Operating Income | | 33,099 | | 26,967 | | 117,310 | | 104,899 | |
Interest Expense, net | | (16,306 | ) | (17,267 | ) | (49,413 | ) | (50,403 | ) |
Other Income | | 2,315 | | 403 | | 4,921 | | 1,192 | |
Income Before Income Taxes | | 19,108 | | 10,103 | | 72,818 | | 55,688 | |
Income Tax (Expense) Benefit | | (4,729 | ) | 8,797 | | (18,030 | ) | (7,877 | ) |
Net Income | | $ | 14,379 | | $ | 18,900 | | $ | 54,788 | | $ | 47,811 | |
Average Common Shares Outstanding | | 36,196 | | 35,968 | | 36,181 | | 35,947 | |
Basic Earnings per Average Common Share | | $ | 0.40 | | $ | 0.53 | | $ | 1.51 | | $ | 1.33 | |
Diluted Earnings per Average Common Share | | $ | 0.40 | | $ | 0.52 | | $ | 1.51 | | $ | 1.32 | |
Dividends Declared per Average Common Share | | $ | 0.340 | | $ | 0.335 | | $ | 1.02 | | $ | 1.01 | |
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| Three Months Ended March 31, | |
| 2011 | | 2010 | |
Revenues | | | | |
Electric | $ | 208,622 | | | $ | 203,839 | | |
Gas | 129,212 | | | 130,019 | | |
Other | 426 | | | 315 | | |
Total Revenues | 338,260 | | | 334,173 | | |
Operating Expenses | | | | |
Cost of sales | 162,071 | | | 172,827 | | |
Operating, general and administrative | 67,383 | | | 58,308 | | |
Property and other taxes | 25,396 | | | 22,968 | | |
Depreciation | 25,315 | | | 22,875 | | |
Total Operating Expenses | 280,165 | | | 276,978 | | |
Operating Income | 58,095 | | | 57,195 | | |
Interest Expense, net | (17,147 | ) | | (17,050 | ) | |
Other Income | 805 | | | 753 | | |
Income Before Income Taxes | 41,753 | | | 40,898 | | |
Income Tax Expense | (9,178 | ) | | (12,180 | ) | |
Net Income | $ | 32,575 | | | $ | 28,718 | | |
Average Common Shares Outstanding | 36,242 | | | 36,169 | | |
Basic Earnings per Average Common Share | $ | 0.90 | | | $ | 0.79 | | |
Diluted Earnings per Average Common Share | $ | 0.89 | | | $ | 0.79 | | |
Dividends Declared per Average Common Share | $ | 0.360 | | | $ | 0.340 | | |
See Notes to Condensed Consolidated Financial Statements
NORTHWESTERN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | |
OPERATING ACTIVITIES: | | | | | |
Net Income | | $ | 54,788 | | $ | 47,811 | |
Items not affecting cash: | | | | | |
Depreciation | | 68,697 | | 66,959 | |
Amortization of debt issue costs, discount and deferred hedge gain | | 1,428 | | 1,640 | |
Amortization of restricted stock | | 1,264 | | 1,631 | |
Equity portion of allowance for funds used during construction | | (4,597 | ) | (828 | ) |
Loss (gain) on sale of assets | | 716 | | (306 | ) |
Deferred income taxes | | 31,213 | | 26,320 | |
Changes in current assets and liabilities: | | | | | |
Restricted cash | | 2,241 | | 1,185 | |
Accounts receivable | | 45,117 | | 65,214 | |
Inventories | | (17,391 | ) | 8,470 | |
Other current assets | | 6,021 | | (950 | ) |
Accounts payable | | (31,371 | ) | (34,478 | ) |
Accrued expenses | | 41,108 | | 12,424 | |
Regulatory assets | | (8,247 | ) | (537 | ) |
Regulatory liabilities | | (12,551 | ) | (12,172 | ) |
Other noncurrent assets | | 10,923 | | 3,000 | |
Other noncurrent liabilities | | (1,049 | ) | (56,072 | ) |
Cash provided by operating activities | | 188,310 | | 129,311 | |
INVESTING ACTIVITIES: | | | | | |
Property, plant, and equipment additions | | (178,147 | ) | (115,855 | ) |
Proceeds from sale of assets | | 69 | | 326 | |
Cash used in investing activities | | (178,078 | ) | (115,529 | ) |
FINANCING ACTIVITIES: | | | | | |
Treasury stock activity | | (127 | ) | (563 | ) |
Dividends on common stock | | (36,728 | ) | (36,134 | ) |
Issuance of long-term debt | | 225,000 | | 249,833 | |
Repayment of long-term debt | | (231,141 | ) | (137,780 | ) |
Line of credit borrowings | | 554,000 | | 275,000 | |
Line of credit repayments | | (511,000 | ) | (359,000 | ) |
Financing costs | | (8,019 | ) | (10,387 | ) |
Cash used in financing activities | | (8,015 | ) | (19,031 | ) |
Increase (decrease) in Cash and Cash Equivalents | | 2,217 | | (5,249 | ) |
Cash and Cash Equivalents, beginning of period | | 4,344 | | 11,292 | |
Cash and Cash Equivalents, end of period | | $ | 6,561 | | $ | 6,043 | |
Supplemental Cash Flow Information: | | | | | |
Cash paid during the period for: | | | | | |
Income Taxes | | 1,000 | | 2 | |
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Significant non-cash transactions: | | | | | |
Capital expenditures included in accounts payable | | 4,416 | | 3,065 | |
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| Three Months Ended March 31, |
| 2011 | | 2010 |
OPERATING ACTIVITIES: | | | |
Net Income | $ | 32,575 | | | $ | 28,718 | |
Items not affecting cash: | | | |
Depreciation | 25,315 | | | 22,875 | |
Amortization of debt issue costs, discount and deferred hedge gain | 398 | | | 531 | |
Amortization of restricted stock | 560 | | | 490 | |
Equity portion of allowance for funds used during construction | (261 | ) | | (848 | ) |
Gain on sale of assets | — | | | (78 | ) |
Deferred income taxes | 19,596 | | | 16,927 | |
Changes in current assets and liabilities: | | | |
Restricted cash | 266 | | | 200 | |
Accounts receivable | (1,421 | ) | | 9,478 | |
Inventories | 23,848 | | | 19,169 | |
Other current assets | (2,765 | ) | | 2,214 | |
Accounts payable | (17,369 | ) | | (17,467 | ) |
Accrued expenses | 26,490 | | | 21,693 | |
Regulatory assets | 6,123 | | | 412 | |
Regulatory liabilities | 6,014 | | | (2,719 | ) |
Other noncurrent assets | (2,751 | ) | | 809 | |
Other noncurrent liabilities | 5,462 | | | 3,866 | |
Cash provided by operating activities | 122,080 | | | 106,270 | |
INVESTING ACTIVITIES: | | | |
Property, plant, and equipment additions | (37,580 | ) | | (57,796 | ) |
Cash used in investing activities | (37,580 | ) | | (57,796 | ) |
FINANCING ACTIVITIES: | | | |
Treasury stock activity | 55 | | | 25 | |
Dividends on common stock | (12,975 | ) | | (12,231 | ) |
Repayments on long-term debt | (3,623 | ) | | (3,396 | ) |
Line of credit borrowings | 80,000 | | | 201,000 | |
Line of credit repayments | (233,000 | ) | | (231,000 | ) |
Issuances of short-term borrowings, net | 85,989 | | | — | |
Financing costs | — | | | (88 | ) |
Cash used in financing activities | (83,554 | ) | | (45,690 | ) |
Increase in Cash and Cash Equivalents | 946 | | | 2,784 | |
Cash and Cash Equivalents, beginning of period | 6,234 | | | 4,344 | |
Cash and Cash Equivalents, end of period | $ | 7,180 | | | $ | 7,128 | |
Supplemental Cash Flow Information: | | | |
Cash paid during the period for: | | | |
Income Taxes | — | | | — | |
Interest | 9,584 | | | 9,529 | |
Significant non-cash transactions: | | | |
Capital expenditures included in accounts payable | 1,695 | | | 5,950 | |
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See Notes to Condensed Consolidated Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Reference is made to Notes to Financial Statements included in NorthWestern Corporation’s Annual Report)
(Unaudited)
(1) Nature of Operations and Basis of Consolidation | |
(1) | Nature of Operations and Basis of Consolidation |
NorthWestern Corporation, doing business as NorthWestern Energy, provides electricity and natural gas to approximately 661,000665,000 customers in Montana, South Dakota and Nebraska. We have generated and distributed electricity in South Dakota and distributed natural gas in South Dakota and Nebraska since 1923 and have generated and distributed electricity and distributed natural gas in Montana since 2002.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that may affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period. Actual results could differ from those estimates. The unaudited Condensed Consolidated Financial Statements (Financial Statements) reflect all adjustments (which unless otherwise noted are normal and recurring adjustmentsin nature) that are, in the opinion of management, necessary to fairly present our financial position, results of operations and cash flows. The actual results for the interim periods are not necessarily indicative of the operating results to be expected for a full year or for other interim periods. Events occurring subsequent to September 30, 2010,March 31, 2011, have been evaluated as to their potential impact to the Financial Statements through the date of issuance.
The Financial Statements included herein have been prepared by NorthWestern, without audit, pursuant to the rules and regulations of the SEC.Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations; however, management believes that the condensed disclosures provided are adequate to make the information presented not misleading. Management recommends that these unaudited Financial Statements be read in conjunction with the audited financial statements and related footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2009.
(2) New Accounting Standards2010.
Accounting Standards IssuedVariable Interest Entities
There have been no new recent accounting pronouncements or changes in accounting pronouncements during the three months ended September 30, 2010, that are of significance, or potential significance,A reporting company is required to us.
Accounting Standards Adopted
In June 2009, the Financial Accounting Standards Board (FASB) amended the accounting forconsolidate a variable interest entities,entity (VIE) as its primary beneficiary, which was effective for us beginning January 1, 2010. This revised guidance changes howmeans it has a company determinescontrolling financial interest, when anit has both the power to direct the activities of the VIE that most significantly impact the VIE's economic performance, and the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. An entity that is insufficiently capitalized orconsidered to be a VIE when its total equity investment at risk is not controlled through voting (or similar) rights should be consolidated.sufficient to permit the entity to finance its activities without additional subordinated financial support, or its equity investors, as a group, lack the characteristics of having a controlling financial interest. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The statement includes the following significant provisions:
· | requires an entity to qualitatively assess the determination of the primary beneficiary of a variable interest entity (VIE) based on whether the entity (1) has the power to direct matters that most significantly impact the activities of the VIE, and (2) has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE, |
· | requires an ongoing reconsideration of the primary beneficiary instead of only upon certain triggering events, |
· | amends the events that trigger a reassessment of whether an entity is a VIE, and |
· | for an entity that is the primary beneficiary of a VIE, requires separate balance sheet presentation of (1) the assets of the consolidated VIE, if they can be used to only settle specific obligations of the consolidated VIE, and (2) the liabilities of a consolidated VIE for which creditors do not have recourse to the general credit of the primary beneficiary. |
We are required to consolidate VIEs if we are the primary beneficiary, which means we have a controlling financial interest. Certain long-term purchase power purchase and tolling contracts may be considered variable interests. We have various long-term purchase power purchase contracts with other utilities and certain qualifying facilityQualifying Facility (QF) plants. We have evaluated our inventory of long-term power purchase and tolling contracts under this guidance. We identified one QF contract that may constitute a VIE. TheWe entered into a power purchase agreement was entered intocontract in 1984 with athis 35 megawattMegawatt (MW) coal-fired QF to purchase substantially all of the plant’sfacility's capacity and electrical output over a substantial portion of its estimated useful life. We absorb a portion of the plant’sfacility's variability through annual changes to the energy payment portion of the contract price we pay per Megawatt Hour (MWH) (energy payment). After making exhaustive efforts, we werehave been unable to obtain the information from the plantfacility necessary to determine whether itthe facility is a VIE or whether we are the primary beneficiary.beneficiary of the facility. The contract with the plantfacility contains no provision which legally obligates the facility to release of this information to us. information. We have continued to accountaccounted for this QF contract as an executory contract. Based on the current contract terms with this QF, our estimated gross contractual payments aggregate approximately $448.7$435.5 million through 2025.2024.
(3) Income Taxes(2) New Accounting Standards
There have been no new accounting pronouncements or changes in accounting pronouncements issued or adopted during the three months ended March 31, 2011 that are of significance, or potential significance, to us.
Our effective tax rate was 24.7%22.0% for the three months ended September 30, 2010.March 31, 2011. The effective tax rate is significantly lower than the statutory rate primarily due to a tax benefit of approximately $2.3$4.0 million recognized for repair costs and $2.6 million related to accelerated tax depreciation based on flow-through regulatory treatment. During September 2009, we received approval of a tax accounting method change for repair costs and recognized approximately $12.4 million of income tax benefit related to repair cost deductions. As we did not receive approval of the tax accounting method change until the third quarter of 2009, we recognized the entire benefit in the third quarter of 2009, and, therefore quarterly income tax expense during 2010 is not comparable with 2009. In addition, our effective tax rate for the third quarter of 2009 reflected the impact of the tax accounting method change for repairs for both 2009 and 2008.
In September 2010, the Small Business Jobs Act of 2010 was signed into law extending bonus depreciation for 2010. We are evaluating the impact of this extension on our estimated taxable income and tax planning strategies for 2010, which may impact the realization of a portion of our state net operating loss (NOL) carryforwards that will expire at the end of 2010.
Uncertain Tax Positions
We have unrecognized tax benefits of approximately $124.3$120.7 million as of September 30, 2010,March 31, 2011, including approximately $85.7$80.2 million that, if recognized, would impact our effective tax rate. We do not anticipate that total unrecognized tax benefits will significantly change due to the settlement of audits or the expiration of statutes of limitations within the next twelve months.
Our policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. During the ninethree months ended September 30, 2010,March 31, 2011, we have not recognized expense for interest or penalties, and do not have any amounts accrued at September 30, 2010March 31, 2011 and December 31, 2009,2010, respectively, for the payment of interest and penalties.
Our federal tax returns from 2000 forward remain subject to examination by the Internal Revenue Service.
(4) Goodwill
There were no changes in our goodwill during the ninethree months ended September 30, 2010.March 31, 2011. Goodwill by segment is as follows for both September 30, 2010March 31, 2011 and December 31, 20092010 (in thousands):
|
| | | |
Electric | $ | 241,100 | |
Natural gas | 114,028 | |
| $ | 355,128 | |
(5) Other Comprehensive Income | |
(5) | Other Comprehensive Income |
The following table displays the components of Accumulated Other Comprehensive Income (AOCI)(OCI), which is included in Shareholders’ Equity on the Condensed Consolidated Balance Sheets (in thousands).
| | Three Months Ended September 30, | | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | 2010 | | 2009 | |
Net income | | $ | 14,379 | | | $ | 18,900 | | | $ | 54,788 | | | $ | 47,811 | | |
Other comprehensive income, net of tax: | | | | | | | | | | | | | | | | | |
Reclassification of net gains on hedging instruments from OCI to net income | | | (297 | ) | | | (297 | ) | | | (891 | ) | | | (891 | ) | |
Foreign currency translation | | | 62 | | | | 155 | | | | 35 | | | | 248 | | |
Comprehensive income | | $ | 14,144 | | | $ | 18,758 | | | $ | 53,932 | | | $ | 47,168 | | |
(6) Risk Management and Hedging Activities |
| | | | | | | | |
| Three Months Ended March 31, | |
| 2011 | | 2010 | |
Net income | $ | 32,575 | | | $ | 28,718 | | |
Other comprehensive income, net of tax: | | | | |
Reclassification of net gains on hedging instruments from OCI to net income | (297 | ) | | (297 | ) | |
Foreign currency translation | 51 | | | 63 | | |
Comprehensive income | $ | 32,329 | | | $ | 28,484 | | |
| |
(6) | Risk Management and Hedging Activities |
Nature of Our Business and Associated Risks
We are exposed to certain risks related to the ongoing operations of our business, including the impact of market fluctuations in the price of electricity and natural gas commodities and changes in interest rates. Commodity price risk is a significant risk due to our minimal ownership of natural gas reserves and our reliance on market purchases to fulfill a portion of our electric supply requirements within the Montana market. Several factors influence price levels and volatility. These factors include, but are not limited to, seasonal changes in demand, weather conditions, available generating assets within regions, transportation availability and reliability within and between regions, fuel availability, market liquidity, and the nature and extent of current and potential federal and state regulations.
Objectives and Strategies for Using Derivatives
To manage our exposure to fluctuations in commodity prices we routinely enter into derivative contracts, such as fixed-price forward purchase and sales contracts. The objective of these transactions is to fix the price for a portion of anticipated energy purchases to supply our customers. These types of contracts are included in our electric and natural gas supply portfolios and are used to manage price volatility risk by taking advantage of seasonal fluctuations in market prices. While we may incur gains or losses on individual contracts, the overall portfolio approach is intended to provide price stability for consumers; therefore, these commodity costs are included in our cost tracking mechanisms. We do not maintain a trading portfolio, and our derivative transactions are only used for risk management purposes. In addition, we may use interest rate swaps to manage our interest rate exposures associated with new debt issuances or to manage our exposure to fluctuations in interest rates on variable rate debt.
Accounting for Derivative Instruments
We evaluate new and existing transactions and agreements to determine whether they are derivatives. The permitted accounting treatments include: normal purchase normal sale; cash flow hedge; fair value hedge; and mark-to-market. Mark-to-market accounting is the default accounting treatment for all derivatives unless they qualify, and we specifically designate them, for one of the other accounting treatments. Derivatives designated for any of the elective accounting treatments must meet specific, restrictive criteria both at the time of designation and on an ongoing basis. The changes in the fair value of recognized derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and the type of hedge transaction.
Normal Purchases and Normal Sales
We have applied the normal purchase and normal sale scope exception (NPNS) to most of our contracts involving the physical purchase and sale of gas and electricity at fixed prices in future periods. During our normal course of business, we enter into full-requirement energy contracts, power purchase agreements and physical capacity contracts, which qualify for NPNS. All of these contracts are accounted for using the accrual method of accounting; therefore, there were no amounts recorded in the Financial Statements at September 30, 2010March 31, 2011 and December 31, 2009.2010. Revenues and expenses from these contracts are reported on a gross basis in the appropriate revenue and expense categories as the commodities are received or delivered.
Mark-to-Market Accounting
Certain contracts for the purchase of natural gas associated with our gas utility operations do not qualify for NPNS. These are typically forward purchase contracts for natural gas where we lock in a fixed price; however, the contracts are settled financially and we do not take physical delivery of the natural gas. We use the mark-to-market method of accounting for these derivative contracts as we do not elect hedge accounting. Upon settlement of these contracts, associated proceeds or costs are refunded to or collected from our customers consistent with regulatory requirements; therefore, we record a regulatory asset or liability based on changes in market value.
The following table represents the fair value and location of derivative instruments subject to mark-to-market accounting (in thousands). For more information on the determination of fair value see Note 7.
Mark-to-Market Transactions | | Balance Sheet Location | | September 30, 2010 | | December 31, 2009 | |
| | | | | | | |
Natural gas net derivative liability | | Accrued Expenses | | $ | 36,523 | | $ | 23,661 | |
|
| | | | | | | | |
Mark-to-Market Transactions | Balance Sheet Location | March 31, 2011 | | December 31, 2010 |
| | | | |
Natural gas net derivative liability | Accrued Expenses | $ | 26,622 | | | $ | 29,712 | |
The following table represents the net change in fair value for these derivatives (in thousands):
| | Unrealized (loss) gain recognized in Regulatory Assets | |
| | Three Months Ended | | Nine Months Ended | |
Derivatives Subject to Regulatory Deferral | | September 30, 2010 | | September 30, 2009 | | September 30, 2010 | | September 30, 2009 | |
| | | | | | | | | | |
Natural gas | | $ | (3,161 | ) | $ | 8,377 | | $ | (12,862 | ) | | $ | 5,554 | |
|
| | | | | | | |
| Unrealized gain (loss) recognized in Regulatory Assets |
| Three Months Ended |
Derivatives Subject to Regulatory Deferral | March 31, 2011 | | March 31, 2010 |
| | | |
Natural gas | $ | 3,090 | | | $ | (13,249 | ) |
Credit Risk
We are exposed to credit risk primarily through buying and selling electricity and natural gas to serve customers. Credit risk is the potential loss resulting from counterparty non-performance under an agreement. We manage credit risk with policies and procedures for, among other things, counterparty analysis and exposure measurement, monitoring and mitigation. We may request collateral or other security from our counterparties based on the assessment of creditworthiness and expected credit exposure. It is possible that volatility in commodity prices could cause us to have material credit risk exposures with one or more counterparties.
We enter into commodity master enabling agreements with our counterparties to mitigate credit exposure, as these agreements reduce the risk of default by allowing us or our counterparty the ability to make net payments. The agreements generally are: (1) Western Systems Power Pool agreements – standardized power purchase and sales contracts in the electric industry; (2) International Swaps and Derivatives Association agreements – standardized financial gas and electric contracts; (3) North American Energy Standards Board agreements – standardized physical gas contracts; and (4) Edison Electric Institute Master Purchase and Sale Agreements – standardized power sales contracts in the electric industry.
Many of our forward purchase contracts contain provisions that require us to maintain an investment grade credit rating from each of the major credit rating agencies. If our credit rating were to fall below investment grade, the counterparties could require immediate payment or demand immediate and ongoing full overnight collateralization on contracts in net liability positions.
The following table presents, as of September 30, 2010,March 31, 2011, the aggregate fair value of forward purchase contracts that do not qualify for NPNS that contain credit risk-related contingent features. If the credit risk-related contingent features underlying these agreements were triggered as of September 30, 2010,March 31, 2011, the collateral posting requirements would be as follows (in thousands):
|
| | | | | | | | | | | | |
Contracts with Contingent Feature | | Fair Value Liability | | Posted Collateral | | Contingent Collateral |
| | | | | | |
Credit rating | | $ | 16,447 | | | $ | — | | | $ | 16,447 | |
Contracts with Contingent Feature | | Fair Value Liability | | Posted Collateral | | Contingent Collateral | |
| | | | | | | | |
Credit rating | | $ | 24,978 | | $ | — | | $ | 24,978 | |
Interest Rate Swaps Designated as Cash Flow Hedges
If we enter into contracts to hedge the variability of cash flows related to forecasted transactions that qualify as cash flow hedges, the changes in the fair value of such derivative instruments are reported in other comprehensive income. The relationship between the hedging instrument and the hedged item must be documented to include the risk management objective and strategy and, at inception and on an ongoing basis, the effectiveness of the hedge in offsetting the changes in the cash flows of the item being hedged. Gains or losses accumulated in other comprehensive income are reclassified to earnings in the periods in which earnings are affected by the variability of the cash flows of the related hedged item. Any ineffective portion of all hedges would be recognized in current-period earnings. Cash flows related to these contracts ar eare classified in the same category as the transaction being hedged.
We have used interest rate swaps designated as cash flow hedges to manage our interest rate exposures associated with new debt issuances. These swaps were designated as cash flow hedges with the effective portion of gains and losses, net of associated deferred income tax effects, recorded in AOCI.Accumulated Other Comprehensive Income (AOCI). We reclassify these gains from AOCI into interest expense during the periods in which the hedged interest payments occur. The following table shows the effect of these derivative instruments on the Financial Statements (in thousands):
Cash Flow Hedges | | Amount of Gain Remaining in AOCI as of September 30, 2010 | | Location of Gain Reclassified from AOCI to Income | | Amount of Gain Reclassified from AOCI into Income during the nine months ended September 30, 2010 | |
| | | | | | | |
Interest rate contracts | | $ | 9,573 | | | Interest Expense | | $ | 891 | |
| | | | | | | | | | |
|
| | | | | | |
| | Location of gain reclassified from AOCI to Income | | Three months ended March 31, 2011 and 2010 |
| | | | |
Amount of gain reclassified from AOCI | | Interest Expense | | $ | 297 | |
| | | | |
WeApproximately $9.0 million of the gain on these cash flow hedges is remaining in AOCI as of March 31, 2011, and we expect to reclassify approximately $1.2 million of pre-tax gains on these cash flow hedges from AOCI into interest expense during the next twelve months. These gains relate to swaps previously terminated, and we have no current interest rate swaps outstanding.
| |
(7) | Fair Value Measurements |
(7) Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., an exit price). Measuring fair value requires the use of market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, corroborated by market data, or generally unobservable. Valuation techniques are required to maximize the use of observable inputs and minimize the use of unobservable inputs.
A fair value hierarchy that prioritizes the inputs used to measure fair value, and requires fair value measurements to be categorized based on the observability of those inputs has been established by the applicable accounting guidance. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs). The three levels of the fair value hierarchy are as follows:
· | Level 1 – Unadjusted quoted prices available in active markets at the measurement date for identical assets or liabilities; |
· | Level 2 – Pricing inputs, other than quoted prices included within Level 1, which are either directly or indirectly observable as of the reporting date; and |
· | Level 3 – Significant inputs that are generally not observable from market activity. |
We classify assets and liabilities within the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement of each individual asset and liability taken as a whole. The table below sets forth by level within the fair value hierarchy the gross components of our assets and liabilities measured at fair value on a recurring basis. Normal purchases and sales transactions are not included in the fair values by source table as they are not recorded at fair value. There were no transfers between levels for the periods presented. See Note 6 for further discussion.
September 30, 2010 | | Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Margin Cash Collateral Offset | | Total Net Fair Value | |
| | (in thousands) | |
Restricted cash | | $ | 10,775 | | $ | — | | $ | — | | $ | — | | $ | 10,775 | |
Rabbi trust investments | | | 5,084 | | | — | | | — | | | — | | | 5,084 | |
Derivative asset (1) | | | — | | | 1,895 | | | — | | | — | | | 1,895 | |
Derivative liability (1) | | | — | | | (38,418 | ) | | — | | | — | | | (38,418 | ) |
Net derivative position | | | — | | | (36,523 | ) | | — | | | — | | | (36,523 | ) |
Total | | $ | 15,859 | | $ | (36,523 | ) | $ | — | | $ | — | | $ | (20,664 | ) |
|
| | | | | | | | | | | | | | | | | | | | |
March 31, 2011 | | Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Margin Cash Collateral Offset | | Total Net Fair Value |
| | (in thousands) |
Restricted cash | | $ | 12,057 | | | $ | — | | | $ | — | | | $ | — | | | $ | 12,057 | |
Rabbi trust investments | | 6,295 | | | — | | | — | | | — | | | 6,295 | |
Derivative liability (1) | | — | | | (26,622 | ) | | — | | | — | | | (26,622 | ) |
Total | | $ | 18,352 | | | $ | (26,622 | ) | | $ | — | | | $ | — | | | $ | (8,270 | ) |
| | | | | | | | | | |
December 31, 2010 | | | | | | | | | | |
Restricted Cash | | $ | 12,297 | | | $ | — | | | $ | — | | | $ | — | | | $ | 12,297 | |
Rabbi Trust Investments | | 5,495 | | | — | | | — | | | — | | | 5,495 | |
Derivative asset (1) | | — | | | 1,620 | | | — | | | — | | | 1,620 | |
Derivative liability (1) | | — | | | (31,332 | ) | | — | | | — | | | (31,332 | ) |
Net derivative liability | | — | | | (29,712 | ) | | — | | | — | | | (29,712 | ) |
Total | | $ | 17,792 | | | $ | (29,712 | ) | | $ | — | | | $ | — | | | $ | (11,920 | ) |
_________________________
| |
(1) | The changes in the fair value of these derivatives are deferred as a regulatory asset or liability until the contracts are settled. Upon settlement, associated proceeds or costs are passed through the applicable cost tracking mechanism to customers. |
We present our derivative assets and liabilities on a net basis in the Condensed Consolidated Balance Sheets. The table above disaggregates our net derivative assets and liabilities on a gross contract-by-contract basis as required and classifies each individual asset or liability within the appropriate level in the fair value hierarchy, regardless of whether a particular contract is eligible for netting against other contracts. These gross balances are intended solely to provide information on sources of inputs to fair value and do not represent our actual credit exposure or net economic exposure. Increases and decreases in the gross components presented in each of the levels in this table also do not indicate changes in the level of derivative activities. Rather, the primary factors affecting the gross amounts are commodity prices.
Restricted cash represents amounts held in money market mutual funds. Rabbi trust assets represent assets held for non-qualified deferred compensation plans, which consist of our common stock and actively traded mutual funds with quoted prices in active markets. Fair value for the commodity derivatives was determined using internal models based on quoted forward commodity prices. We consider nonperformance risk in our valuation of derivative instruments by analyzing the credit standing of our counterparties and considering any counterparty credit enhancements (e.g., collateral). The fair value measurement of liabilities also reflects the nonperformance risk of the reporting entity, as applicable. Therefore, we have factored the impact of our credit standing as well as any potential credit enhancements into the fair value measurement of b othboth derivative assets and derivative liabilities. Consideration of our own credit risk did not have a material impact on our fair value measurements.
Financial Instruments
The estimated fair value of financial instruments is summarized as follows (in thousands):
| | September 30, 2010 | | December 31, 2009 | |
| | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value | |
Liabilities: | | | | | | | | | |
Long-term debt (including current portion) | | $ | 1,024,342 | | $ | 1,171,606 | | $ | 987,419 | $ | 1,034,122 | |
|
| | | | | | | | | | | | | | | |
| March 31, 2011 | | December 31, 2010 |
| Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
Liabilities: | | | | | | | |
Long-term debt (including current portion) | $ | 911,753 | | | $ | 992,387 | | | $ | 1,068,358 | | | $ | 1,137,148 | |
The estimated fair value amounts have been determined using available market information and appropriate valuation
methodologies; however, considerable judgment is necessarily required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that we would realize in a current market exchange.
Short-term borrowings includes commercial paper, which is recorded at carrying value as a reasonable estimate of fair value and excluded above. We determined fair values for long-term debt based on interest rates that are currently available to us for issuance of debt with similar terms and remaining maturities, except for publicly traded debt, for which fair value is based on market prices for the same or similar issues or upon the quoted market prices of U.S. treasury issues having a similar term to maturity, adjusted for our bond issuance rating and the present value of future cash flows.
(8) Financing Activities
On May 27, 2010February 8, 2011, we issued $161entered into a commercial paper program under which we may issue unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $250 million aggregate principal amountto provide an alternative financing source for our short-term liquidity needs. The maturities of Montana First Mortgage Bonds at a fixed interest rate of 5.01% maturing in May 1, 2025. At the same time, we also issued $64 million aggregate principal amount of South Dakota First Mortgage Bonds at a fixed interest rate of 5.01% maturing May 1, 2025. The bonds are secured by our electric and natural gas assets in the respective jurisdictions. The bonds were issued in transactions exemptcommercial paper issuances will vary, but may not exceed 270 days from the registration requirementsdate of the Securities Actissue. Commercial paper issuances are supported by available capacity under our $250 million unsecured revolving line of 1933, as amended. We used the proceeds to redeem our 5.875%, $225 million Senior Secured Notes due 2014.credit, which expires in June 2012.
(9) Regulatory Matters
Montana General Rate Case
In October 2009,December 2010, we filedreceived a request withfinal order from the Montana Public Service Commission (MPSC) for an annual electric transmission and distribution revenue increase of $15.5 million, and an annual natural gas transmission, storage and distribution revenue increase of $2.0 million. In September 2010, we and the Montana Consumer Counsel (MCC) filed aapproving our joint Stipulation and Settlement Agreement (Stipulation) with the Montana Consumer Counsel (MCC) regarding the revenue requirement portion of the rate filing. Specific termsKey provisions of the Stipulation include:final order are as follows:
· | An increase in base electric rates of $7.7An increase in base electric rates of $6.4 million; |
· | A decrease in base natural gas rates of approximately $1.0 million; and |
· | An authorized overall rate of return of 7.92%, using an authorized rate of return on equity of 10.25%, cost of long-term debt of 5.76% and a capital structure of 52% debt and 48% equity. |
A hearing was helddecrease in September 2010, and we expect the MPSC to issue a final order during the fourth quarter of 2010. The MPSC approved interimbase natural gas rates subject to refund, beginning July 8, 2010. During the three months ended September 30, 2010, we recognized revenues of approximately $1.6 million (subject to refund), which is consistent with the rate increase included in the proposed Stipulation.$1.0 million; and
Montana ElectricAn authorized return on equity of 10.0% and Natural Gas Supply Trackers
Rates10.25% for our Montanabase electric and natural gas rates, respectively.
The overall authorized rates of return are based on the equity percentages above, long-term debt cost of 5.76% and a capital structure of 52% debt and 48% equity.
The order included an additional MPSC requirement to implement a modified lost revenue adjustment mechanism (previously proposed as a decoupling mechanism), an inclining block rate structure for electric energy supply are set bycustomers, and a reduction to the MPSC. authorized return on equity in the Stipulation for base electric rates from 10.25% to 10.0%. The change in return on equity reduced the electric revenue requirement increase from $7.7 million to $6.4 million. We have recognized revenue and implemented rates consistent with the MPSC's final order; however, we appealed the MPSC's decision to the Montana district court due to the required implementation of a modified lost revenue adjustment mechanism and the related reduction in return on equity and the block rate design. We exchanged counter offers with the MPSC to settle this matter. In April 2011, the MPSC accepted our district court counter offer, which removes the modified lost revenue adjustment mechanism, inclining block rate structure, and reinstates a 10.25% return on equity, previously contained in the Stipulation. In addition, to settle the district court case we agreed to a $0.7 million reduction of electric rates as compared to the original Stipulation.
Montana Electric Supply Tracker
Each year we submit electric and natural gas tracker filings for recovery of supply costs for the 12-month period ended June 30 and for the projected supply costs for the next 12-month period. The MPSC reviews such filings and makes its cost recovery determination based on whether or not our electric and natural gas energy supply procurement activities were prudent. IfDuring April 2011, the MPSC subsequently determinesfound that a procurement activity was imprudent, then it may disallow such costs.
In June 2010, we filed our 2010 annual electric supply tracker, and received an interim order fromcosts through the MPSC approving recovery of costs pending review. A hearing is scheduled for January 2011.
Our 2009 andperiod ended June 30, 2010 annual natural gas cost tracker filings are currently pending review by the MPSC. The MPSC issued interim orders for each cost tracking period, approving recovery of our projected gas costs pending its review. The procedural schedule has been suspended pending ongoing settlement discussions between the MCC and us related to future natural gas procurement strategies.
were prudently incurred.
Dave Gates Generating Station at Mill Creek (formerly Mill Creek Generating StationStation) (DGGS)
In August 2008,On December 31, 2010, we filed a request with the MPSC for advanced approval to constructcompleted construction of DGGS, a 150 megawatt (MW)MW natural gas fired facility.facility and began commercial operations on January 1, 2011. The Mill Creek Generating Station, estimated to cost approximately $202 million, will providefacility provides regulating resources (in place of previously contracted costs for ancillary services) to balance our transmission system in Montana to maintain reliability and enable wind power to be integrated onto the network to meet renewable energy portfolio needs. In May 2009,Total project costs through March 31, 2011 were approximately $183
million.
Approximately 80% of our revenues related to the facility are subject to jurisdiction of the MPSC issued an order granting approvaland approximately 20% are subject to construct the facility, authorizing a return on equity of 10.25% and a preliminary cost of debt of 6.5%, with a capital structure of 50% equity and 50% debt. In addition, the MPSC determined the $81 million cost for the turbines is prudent, with the remainderjurisdiction of the project costs to be submitted to the MPSC for review and approval once construction of the facilit y is complete. Construction began in June 2009, and the plant is scheduled to be operational by January 1, 2011. We filed a request for interim rates with the MPSC in October 2010 based on the estimated Mill Creek Generating Station construction costs. These rates are expected to be effective beginning January 1, 2011, and would replace the current contracted costs for ancillary services. As of September 30, 2010, we have capitalized approximately $161.3 million in construction work in process related to this project.
Our Federal Energy Regulatory Commission (FERC) Open Access Transmission Tariff (OATT) allows for pass-through. In October 2010, the FERC approved interim rates to reflect the estimated cost of ancillary costs to our customers, including the regulating reserve service described above to be provided by the Mill Creek Generating Station under Schedule 3 (Regulation and Frequency Response) of the Open Access Transmission Tariff (OATT). We submitted a filing toIn November 2010, the FERC related to this project in April 2010 and have requested anMPSC approved interim rates based on the originally estimated construction costs of $202 million. The interim rates under both orders became effective date for the change in rates of January 1, 2011 in order to reflect the cost of service for the Mill Creek Generating Station under the OATT in Schedule 3. On October 15, 2010 FERC issued an order accepting our filing and postponing our requested rate increase untilbeginning January 1, 2011. On that date theThe respective interim rates will go into effect,are subject to refund plus interest pending final resolution in both jurisdictions.
On March 31, 2011, we made a compliance filing with the MPSC that will be used to conduct a final cost review and establish final rates. As a result of the lower than estimated construction costs and estimated impact of the flow-through of accelerated tax depreciation, we also reduced our interim rate request, which the MPSC authorized to take effect beginning May 1, 2011. We anticipate this review process will take approximately nine months; however a procedural schedule has not been established.
During March 2011, we began settlement discussions with FERC hearing process.Staff and large customers receiving service under Schedule 3 of the OATT. We anticipate the settlement discussions will take approximately nine months.
Transmission Investment Projects
We are conducting open season processes forhave recognized revenues associated with DGGS based on our current best estimate of final resolution before the proposed MPSC and the FERC. There is significant uncertainty related to the ultimate resolution of cost allocations between the two jurisdictions, which could result in an inability to fully recover our costs, as well as requiring us to refund more interim revenues than our current estimate.
Mountain States Transmission Intertie (MSTI) and Collector Project to identify potential interest for new transmission capacity on these paths due to the changing nature of generation projects. The open seasons were initiated with an informational meeting for prospective bidders
We have been involved in March 2010. Thean open season process is designed to provide for our proposed MSTI line . Under our original timeline, we anticipated completing the open season process by the end of 2010. During 2010, a staged level of commitment by prospective users. Assuming sufficient interest, we would expect to make filings with FERC early in 2011. A lawsuit has beenwas filed against the Montana Department of Environmental Quality (MDEQ) by Jefferson County, Montana, regarding the County’sCounty's ability to be more involved in the siting and routing of MSTI. On September 8, 2010, the Montana District Court agreed with Jefferson County and (i) required the MDEQ to consult with Jefferson County in the preparation of the environmental impact statement (EIS) concerning the project and (ii) enjoined the MDEQ from releasing the draft EIS until that consultation occurs. The delayIn January 2011, MDEQ appealed the decision to the Montana Supreme Court. In February 2011, we also appealed the decision to the Montana Supreme Court. In addition to this lawsuit, due to general economic conditions, lack of clarity around federal legislation on renewables and uncertainty in the release of the draft EIS will delay the timing and completion ofCalifornia renewable standards we have extended the open season process.process for the proposed MSTI line until December 31, 2011. We have capitalized approximately $15.5$17.3 million of preliminary survey and investigative costs associated with the MSTI transmission project. If our efforts to complete MSTI are not successful we may have to write-off all or a portion of these proposed transmission projects.costs, which could have a material adverse effect on our results of operations.
Distribution System Infrastructure Project
In March 2011, the MPSC approved a request for an accounting order to defer and amortize certain incremental operating and maintenance costs up to $16.9 million for 2011 and 2012 over a five-year period beginning in 2013 associated with the phase-in portion of the Montana Distribution System Infrastructure Project (DSIP). The order does not specify the future regulatory treatment of the costs. We discuss these transmission investment opportunities furtherhave not deferred any costs to date. We expect incremental costs related to the DSIP project to be approximately $7.2 million and $9.7 million, respectively in 2011 and 2012. In addition, we are currently projecting capital expenditures under the “Overview” sectionDSIP to be approximately $287 million over a seven-year time span beginning in 2011. We are evaluating both the form and timing of Management’s Discussion and Analysisour next DSIP related filing with the MPSC. Filing alternatives could consist of Financial Condition and Results of Operations in our Annual Report on Form 10-K(i) a formal advanced approval for the year ended December 31, 2009.DSIP or (ii) an informational filing followed by more frequent general rate cases. Based on current circumstances, along with the MPSC's recent approval of the accounting order, we anticipate the latter.
(10) Segment Information
Our reportable business segments are primarily engaged in the electric and natural gas business. The remainder of our operations are presented as other. While it is not considered a business unit, other primarily consists of a remaining unregulated natural gas capacity contract, the wind down of our captive insurance subsidiary and our unallocated corporate costs.
We evaluate the performance of these segments based on gross margin. The accounting policies of the operating segments are the same as the parent except that the parent allocates some of its operating expenses to the operating segments
according to a methodology designed by management for internal reporting purposes and involves estimates and assumptions. Financial data for the business segments are as follows (in thousands):
Three Months Ended | | | | | | | | | |
September 30, 2010 | | Electric | | Gas | | Other | | Eliminations | | Total | |
Operating revenues | | $ | 203,585 | | $ | 36,963 | | $ | 270 | | $ | — | | $ | 240,818 | |
Cost of sales | | 92,691 | | 13,231 | | — | | — | | 105,922 | |
Gross margin | | 110,894 | | 23,732 | | 270 | | — | | 134,896 | |
Operating, general and administrative | | 42,331 | | 17,429 | | (1,323 | ) | — | | 58,437 | |
Property and other taxes | | 15,569 | | 5,041 | | (75 | ) | — | | 20,535 | |
Depreciation | | 18,439 | | 4,378 | | 8 | | — | | 22,825 | |
Operating income (loss) | | 34,555 | | (3,116 | ) | 1,660 | | — | | 33,099 | |
Interest expense | | (12,202 | ) | (3,116 | ) | (988 | ) | — | | (16,306 | ) |
Other income | | 2,109 | | 179 | | 27 | | — | | 2,315 | |
Income tax (expense) benefit | | (6,551 | ) | 3,543 | | (1,721 | ) | — | | (4,729 | ) |
Net income (loss) | | $ | 17,911 | | $ | (2,510 | ) | $ | (1,022 | ) | $ | — | | $ | 14,379 | |
Total assets | | $ | 2,040,612 | | $ | 845,116 | | $ | 13,646 | | $ | — | | $ | 2,899,374 | |
Capital expenditures | | $ | 50,552 | | $ | 11,362 | | $ | — | | $ | — | | $ | 61,914 | |
Three Months Ended | | | | | | | | | |
September 30, 2009 | | Electric | | Gas | | Other | | Eliminations | | Total | |
Operating revenues | | $ | 198,689 | | $ | 34,205 | | $ | 291 | | $ | (299 | ) | $ | 232,886 | |
Cost of sales | | 92,592 | | 12,326 | | 265 | | — | | 105,183 | |
Gross margin | | 106,097 | | 21,879 | | 26 | | (299 | ) | 127,703 | |
Operating, general and administrative | | 40,834 | | 17,701 | | (343 | ) | (299 | ) | 57,893 | |
Property and other taxes | | 15,351 | | 5,479 | | 36 | | — | | 20,866 | |
Depreciation | | 17,772 | | 4,197 | | 8 | | — | | 21,977 | |
Operating income (loss) | | 32,140 | | (5,498 | ) | 325 | | — | | 26,967 | |
Interest expense | | (13,056 | ) | (3,243 | ) | (968 | ) | — | | (17,267 | ) |
Other income | | 310 | | 67 | | 26 | | — | | 403 | |
Income tax (expense) benefit | | 789 | | 5,694 | | 2,314 | | — | | 8,797 | |
Net income (loss) | | $ | 20,183 | | $ | (2,980 | ) | $ | 1,697 | | $ | — | | | 18,900 | |
Total assets | | $ | 1,933,877 | | $ | 804,365 | | $ | 16,236 | | $ | — | | $ | 2,754,478 | |
Capital expenditures | | $ | 61,697 | | $ | 7,172 | | $ | — | | $ | — | | $ | 68,869 | |
Nine Months Ended | | | | | | | | | | |
September 30, 2010 | | Electric | | Gas | | Other | | Eliminations | | Total | | |
| | Three Months Ended | | | | | | | | |
March 31, 2011 | | Electric | | Gas | | Other | | Eliminations | | Total |
Operating revenues | | $ | 592,262 | | $ | 225,882 | | $ | 906 | | $ | — | | $ | 819,050 | | $ | 208,622 | | | $ | 129,212 | | | $ | 426 | | | $ | — | | | $ | 338,260 | |
Cost of sales | | 266,052 | | 124,633 | | — | | — | | 390,685 | | 84,446 | | | 77,625 | | | — | | | — | | | 162,071 | |
Gross margin | | 326,210 | | 101,249 | | 906 | | — | | 428,365 | | 124,176 | | | 51,587 | | | 426 | | | — | | | 176,189 | |
Operating, general and administrative | | 124,220 | | 52,455 | | (2,804 | ) | — | | 173,871 | | 45,286 | | | 21,448 | | | 649 | | | — | | | 67,383 | |
Property and other taxes | | 50,625 | | 17,853 | | 9 | | — | | 68,487 | | 18,741 | | | 6,652 | | | 3 | | | — | | | 25,396 | |
Depreciation | | 55,562 | | 13,110 | | 25 | | — | | 68,697 | | 20,354 | | | 4,953 | | | 8 | | | — | | | 25,315 | |
Operating income | | 95,803 | | 17,831 | | 3,676 | | — | | 117,310 | | |
Operating income (loss) | | 39,795 | | | 18,534 | | | (234 | ) | | — | | | 58,095 | |
Interest expense | | (37,309 | ) | (9,717 | ) | (2,387 | ) | — | | (49,413 | ) | (13,527 | ) | | (2,665 | ) | | (955 | ) | | — | | | (17,147 | ) |
Other income | | 4,515 | | 326 | | 80 | | — | | 4,921 | | 615 | | | 164 | | | 26 | | | — | | | 805 | |
Income tax (expense) benefit | | (17,490 | ) | (1,041 | ) | 501 | | — | | (18,030 | ) | |
Net income | | $ | 45,519 | | $ | 7,399 | | $ | 1,870 | | $ | — | | $ | 54,788 | | |
Income tax expense | | (3,921 | ) | | (4,570 | ) | | (687 | ) | | — | | | (9,178 | ) |
Net income (loss) | | $ | 22,962 | | | $ | 11,463 | | | $ | (1,850 | ) | | $ | — | | | $ | 32,575 | |
Total assets | | $ | 2,040,612 | | $ | 845,116 | | $ | 13,646 | | $ | — | | $ | 2,899,374 | | $ | 2,123,470 | | | $ | 880,688 | | | $ | 12,281 | | | $ | — | | | $ | 3,016,439 | |
Capital expenditures | | $ | 150,104 | | $ | 28,043 | | $ | — | | $ | — | | $ | 178,147 | | $ | 26,094 | | | $ | 11,486 | | | $ | — | | | $ | — | | | $ | 37,580 | |
|
| | | | | | | | | | | | | | | | | | | |
Three Months Ended | | | | | | | |
March 31, 2010 | Electric | | Gas | | Other | | Eliminations | | Total |
Operating revenues | $ | 203,839 | | | $ | 130,019 | | | $ | 315 | | | $ | — | | | $ | 334,173 | |
Cost of sales | 91,065 | | | 81,762 | | | — | | | — | | | 172,827 | |
Gross margin | 112,774 | | | 48,257 | | | 315 | | | — | | | 161,346 | |
Operating, general and administrative | 40,016 | | | 17,893 | | | 399 | | | — | | | 58,308 | |
Property and other taxes | 16,773 | | | 6,154 | | | 41 | | | — | | | 22,968 | |
Depreciation | 18,504 | | | 4,363 | | | 8 | | | — | | | 22,875 | |
Operating income (loss) | 37,481 | | | 19,847 | | | (133 | ) | | — | | | 57,195 | |
Interest expense | (13,193 | ) | | (3,145 | ) | | (712 | ) | | — | | | (17,050 | ) |
Other income | 457 | | | 269 | | | 27 | | | — | | | 753 | |
Income tax (expense) benefit | (6,534 | ) | | (5,739 | ) | | 93 | | | — | | | (12,180 | ) |
Net income (loss) | $ | 18,211 | | | $ | 11,232 | | | $ | (725 | ) | | $ | — | | | 28,718 | |
Total assets | $ | 1,975,156 | | | $ | 824,754 | | | $ | 14,727 | | | $ | — | | | $ | 2,814,637 | |
Capital expenditures | $ | 52,248 | | | $ | 5,548 | | | $ | — | | | $ | — | | | $ | 57,796 | |
| | | | | | | | | | |
Nine Months Ended | | | | | | | | | |
September 30, 2009 | | Electric | | Gas | | Other | | Eliminations | | Total | |
Operating revenues | | $ | 580,139 | | $ | 254,338 | | $ | 6,248 | | $ | (1,223 | ) | $ | 839,502 | |
Cost of sales | | 258,964 | | 154,105 | | 6,964 | | — | | 420,033 | |
Gross margin | | 321,175 | | 100,233 | | (716 | ) | (1,223 | ) | 419,469 | |
Operating, general and administrative | | 128,575 | | 58,806 | | (1,948 | ) | (1,223 | ) | 184,210 | |
Property and other taxes | | 46,433 | | 16,857 | | 111 | | — | | 63,401 | |
Depreciation | | 54,113 | | 12,821 | | 25 | | — | | 66,959 | |
Operating income | | 92,054 | | 11,749 | | 1,096 | | — | | 104,899 | |
Interest expense | | (37,963 | ) | (9,629 | ) | (2,811 | ) | — | | (50,403 | ) |
Other income | | 783 | | 322 | | 87 | | — | | 1,192 | |
Income tax (expense) benefit | | (12,066 | ) | 1,571 | | 2,618 | | — | | (7,877 | ) |
Net income | | $ | 42,808 | | $ | 4,013 | | $ | 990 | | $ | — | | $ | 47,811 | |
Total assets | | $ | 1,933,877 | | $ | 804,365 | | $ | 16,236 | | $ | — | | $ | 2,754,478 | |
Capital expenditures | | $ | 100,117 | | $ | 15,738 | | $ | — | | $ | — | | $ | 115,855 | |
(11) Earnings Per Share
Basic earnings per share is computed by dividing earnings applicable to common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of common stock equivalent shares that could occur if all unvested restricted shares were to vest. Common stock equivalent shares are calculated using the treasury stock method, as applicable. The dilutive effect is computed by dividing earnings applicable to common stock by the weighted average number of common shares outstanding plus the effect of the outstanding unvested restricted stock and performance share awards.
Average shares used in computing the basic and diluted earnings per share are as follows:
| | Three Months Ended | |
| | September 30, 2010 | | September 30, 2009 | |
Basic computation | | 36,195,583 | | 35,967,876 | |
Dilutive effect of | | | | | |
Restricted stock and performance share awards (1) | | 116,624 | | 322,110 | |
| | | | | |
Diluted computation | | 36,312,207 | | 36,289,986 | |
| | Nine Months Ended | |
| | September 30, 2010 | | September 30, 2009 | |
Basic computation | | 36,181,238 | | 35,947,378 | |
Dilutive effect of | | | | | |
Restricted stock and performance share awards (1) | | 114,896 | | 322,110 | |
| | | | | |
Diluted computation | | 36,296,134 | | 36,269,488 | |
|
| | | | | |
| Three Months Ended |
| March 31, 2011 | | March 31, 2010 |
Basic computation | 36,241,904 | | | 36,168,703 | |
Dilutive effect of | | | |
Restricted stock and performance share awards (1) | 221,966 | | | 337,371 | |
| | | |
Diluted computation | 36,463,870 | | | 36,506,074 | |
_________________________
(1) Performance share awards are included in diluted weighted average number of shares outstanding based upon what would be issued if the end of the most recent reporting period was the end of the term of the award.
17
(12) Employee Benefit Plans | |
(12) | Employee Benefit Plans |
Net periodic benefit cost (income) for our pension and other postretirement plans consists of the following (in thousands):
| | Pension Benefits | | Other Postretirement Benefits | |
| | Three Months Ended September 30, | |
| | 2010 | | 2009 | | 2010 | | 2009 | |
Components of Net Periodic Benefit Cost | | | | | | | | | |
Service cost | | $ | 2,340 | | $ | 2,068 | | $ | 120 | | $ | 248 | |
Interest cost | | 6,023 | | 5,926 | | 450 | | 787 | |
Expected return on plan assets | | (7,459 | ) | (5,595 | ) | (297 | ) | (249 | ) |
Amortization of prior service cost | | 62 | | 62 | | (488 | ) | — | |
Recognized actuarial loss | | 34 | | 1,019 | | 247 | | 69 | |
Net Periodic Benefit Cost | | $ | 1,000 | | $ | 3,480 | | $ | 32 | | $ | 855 | |
|
| | | | | | | | | | | | | | | |
| Pension Benefits | | Other Postretirement Benefits |
| Three Months Ended March 31, | | Three Months Ended March 31, |
| 2011 | | 2010 | | 2011 | | 2010 |
Components of Net Periodic Benefit Cost (Income) | | | | | | | |
Service cost | $ | 2,782 | | | $ | 2,333 | | | $ | 126 | | | $ | 121 | |
Interest cost | 6,087 | | | 6,019 | | | 327 | | | 391 | |
Expected return on plan assets | (7,535 | ) | | (7,353 | ) | | (296 | ) | | (296 | ) |
Amortization of prior service cost | 62 | | | 61 | | | (488 | ) | | (441 | ) |
Recognized actuarial loss | 592 | | | — | | | 122 | | | 495 | |
Net Periodic Benefit Cost (Income) | $ | 1,988 | | | $ | 1,060 | | | $ | (209 | ) | | $ | 270 | |
| | Pension Benefits | | Other Postretirement Benefits | |
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | 2010 | | 2009 | |
Components of Net Periodic Benefit Cost | | | | | | | | | |
Service cost | | $ | 7,021 | | $ | 6,203 | | $ | 362 | | $ | 745 | |
Interest cost | | 18,068 | | 17,779 | | 1,352 | | 2,362 | |
Expected return on plan assets | | (22,379 | ) | (16,787 | ) | (890 | ) | (746 | ) |
Amortization of prior service cost | | 185 | | 185 | | (1,464 | ) | — | |
Recognized actuarial loss | | 104 | | 3,057 | | 738 | | 208 | |
Net Periodic Benefit Cost | | $ | 2,999 | | $ | 10,437 | | $ | 98 | | $ | 2,569 | |
We experienced plan asset market gains during 2009 in excess of 20%, as compared with plan asset market losses during 2008 in excess of 30%. This volatility in return on plan assets is reflected in the change in net periodic benefit cost above as an actuarial loss dueexpect to the use of asset smoothing. During the nine months ended September 30, 2010 and 2009 we contributedcontribute approximately $10.0$11.7 million and $76.4 million, respectively, to our pension plans. The decrease in other postretirement benefits net periodic benefit cost for the three and nine months ended September 30, 2010 as compared with 2009 is due to a plan amendment.plans during 2011.
(13) Commitments and Contingencies
| |
(13) | Commitments and Contingencies |
ENVIRONMENTAL LIABILITIES AND REGULATION
The operation of electric generating, transmission and distribution facilities, and gas transportation and distribution facilities, along with the development (involving site selection, environmental assessments, and permitting) and construction of these assets, are subject to extensive federal, state, and local environmental and land use laws and regulations. Our activities involve compliance with diverse laws and regulations that address emissions and impacts to air and water, and protection of natural resources. We continuously monitor federal, state, and local environmental initiatives to determine potential impacts on our financial results. As new laws or regulations are promulgated, our policy is to assess their applicability and implement the necessary modifications to our facilities or their operation to maintain ongoing complian ce.compliance.
Our environmental exposure includes a number of components, including remediation expenses related to the cleanup of current or former properties, and costs to comply with changing environmental regulations related to our operations. At present, the majority of our environmental reserve relates to the remediation of former manufactured gas plant sites owned by us. We use a combination of site investigations and monitoring to formulate an estimate of environmental remediation costs for specific sites. Our monitoring procedures and development of actual remediation plans depend not only on site specific information but also on coordination with the different environmental regulatory agencies in our respective jurisdictions; therefore, while remediation exposure exists, it may be many years before costs become fixed and reliably determinabl e.determinable.
Our liability for environmental remediation obligations is estimated to range between $22.4$29.3 million to $44.1$38.9 million. As of September 30, 2010,March 31, 2011, we have a reserve of approximately $31.2$32.4 million. Environmental costs are recorded when it is probable we are liable for the remediation and we can reasonably estimate the liability. Over time, as specific laws are implemented and we gain experience in operating under them, a portion of the costs related to such laws will become determinable, and we may seek authorization to recover such costs in rates or seek insurance reimbursement as applicable; therefore, although we cannot guarantee regulatory recovery, we do not expect these costs to have a material adverse effect on our consolidated financial position or ongoing operations. There can
Manufactured Gas Plants - Approximately $27.8 million of our environmental reserve accrual is related to manufactured gas plants. A formerly operated manufactured gas plant located in Aberdeen, South Dakota, has been identified on the Federal Comprehensive Environmental Response, Compensation, and Liability Information System list as contaminated with coal tar residue. We are currently investigating, characterizing, and initiating remedial actions at the Aberdeen site pursuant to work plans approved by the South Dakota Department of Environment and Natural Resources. Our current reserve for remediation costs at this site is approximately $14.1 million, and we estimate that approximately $8.9 million of this amount will be no assurance,incurred during the next five years.
We also own sites in North Platte, Kearney and Grand Island, Nebraska on which former manufactured gas facilities were located. During 2005, the Nebraska Department of Environmental Quality (NDEQ) conducted Phase II investigations of soil and groundwater at our Kearney and Grand Island sites. During 2006, the NDEQ released to us the Phase II Limited Subsurface Assessments performed by the NDEQ's environmental consulting firm for Kearney and Grand Island. In February 2011, NDEQ completed an Abbreviated Preliminary Assessment and Site Investigation Reports for Grand Island, which recommended additional ground water testing. Our reserve estimate includes assumptions for additional ground water testing. At present, we cannot determine with a reasonable degree of certainty the nature and timing of any risk-based remedial action at our Nebraska locations.
In addition, we own or have responsibility for sites in Butte, Missoula and Helena, Montana on which former manufactured gas plants were located. An investigation conducted at the Missoula site did not require entry into the MDEQ voluntary remediation program, but required preparation of a groundwater monitoring plan. The Butte and Helena sites were placed into the MDEQ's voluntary remediation program for cleanup due to excess regulated pollutants in the groundwater. We have conducted additional groundwater monitoring at the Butte and Missoula sites and, at this time, we believe natural attenuation should address the conditions at these sites; however, additional groundwater monitoring will be necessary. Monitoring of regulatory recovery.groundwater at the Helena site is ongoing and will be necessary for an extended time. At this time, we cannot estimate with a reasonable degree of certainty the nature and timing of risk-based remedial action at the Helena site or if any additional actions beyond monitored natural attenuation will be required.
Global Climate Change
There are national and international efforts to adopt measures related to global climate change and the contribution of emissions of greenhouse gases (GHG) including, most significantly, carbon dioxide. These efforts include legislative proposals and U.S. Environmental Protection Agency (EPA) regulations at the federal level, actions at the state level, as well as litigation relating to GHG emissions.
Specifically, coal-fired plants have come under scrutiny due to their emissions of carbon dioxide. We have a joint ownership interestinterests in four electric generating plants, all of which are coal fired and operated by other companies. We have an undivided interestinterests in these facilities and are responsible for our proportionate share of the capital and operating costs while being entitled to our proportionate share of the power generated. In addition, a significant portion of the electric supply we procure in the market is generated by coal-fired plants.
There is a growing concern nationally and internationally about global climate change and the contribution of emissions of greenhouse gases including, most significantly, carbon dioxide. This concern has led to increased interest in legislation at the federal level, actions at the state level, as well as litigation relating to greenhouse gas emissions.
Specifically, coal-fired plants have come under scrutiny due to their emissions of carbon dioxide, and inIn September 2009, the U.S. Court of Appeals for the Second Circuit reversed a federal district court’s decision and ruled that several states and public interest groups could sue five electric utility companies under federal common law for allegedly causing a public nuisance as a result of their emissions of greenhouse gases. The decision was appealed in the U.S. Supreme Court, which has granted certiorari and is expected to hear the case this year. In October 2009, the U.S. Court of Appeals for the Fifth Circuit reversed a federal district court and ruled that individuals damaged by Hurricane Katrina could sue a variety of companies that emit carbon dioxide, including electric utilities, for allegedly causing a public nuisance that contributed to their damages. In May 2010, due to a lack of quorum, the Court of Appeals for the Fifth Circuit dismissed i tsits decision, which essentially reinstated the district court’scourt's dismissal of the claim. The plaintiffs are seekingU.S. Supreme Court review.has denied the plaintiffs' request to order the Fifth Circuit to hear the appeal. Additional litigation in federal and state courts over these issues is continuing.
Numerous bills have been introduced in Congress that address climate change from different perspectives, including direct regulation of GHG emissions and the establishment of Federal Renewable Portfolio Standards. We cannot predict when or if Congress will pass legislation containing climate change provisions.
In addition to litigation during 2009, the Environmental Protection Agency (EPA)
The EPA issued a finding
during 2009 that
greenhouse gasGHG emissions endanger the public health and welfare. The
EPA’sEPA's finding indicated that the current and projected levels of six
greenhouse gasGHG emissions
–- carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride contribute to climate change. In a related matter, in June 2010, the EPA also adopted rules that would phase in requirements for all new or modified “stationary sources,” such as power plants, that emit 100,000 tons of greenhouse gases per year or modified sources that increase emissions by 75,000 tons per year to obtain permits incorporating the “best available control technology” for such emissions.
These thresholds were effective January 2, 2011, apply for six years and will be reviewed by the U.S. EPA for future applicability thereafter. Under the regulations, new and modified major stationary sources could be required to install best available control technology, to be determined on a case-by-case basis.
In September 2009,Also, in December 2010, the EPA announced the adoption of the first comprehensive national system for reporting emissions of carbon dioxideentered into an agreement to settle litigation brought by states and other greenhouse gases produced by major sources in the United States. The new reporting requirements will apply to suppliers of fossil fuel and industrial chemicals, manufacturers of motor vehicles and engines, as well as large direct emitters of greenhouse gases with emissions equal to or greater than a threshold of 25,000 metric tons per year, which includes certain of our facilities. The effective date for gathering the data is January 2010 with the first mandatory reporting due in March 2011.
National Legislation - In June 2009, the U.S. House of Representatives passed the American Clean Energy and Security Act of 2009, which would regulate greenhouse gas emissions by instituting a cap-and-trade-system. Climate change legislation is currently pending in the U.S. Senate with various proposals under consideration. Meanwhile,environmental groups whereby the EPA is beginningagreed to implement regulatory actions underissue New Source Performance Standards for GHG emissions from certain new and modified
electric generating units and “emissions guidelines” for existing units over the Clean Air Actnext two years. Pursuant to address emission of greenhouse gases. Specifically, thethis settlement agreement, EPA issued aagreed to issue proposed Transport Rule inrules by July 2010 that would require significant reductions in sulfur dioxide (SO2)2011 and nitrogen oxides (NOx) emissions that cross state lines, which could impact our jointly owned plants that serve our South Dakota customers.
International Activities - Other nations have agreed to regulate emissions of greenhouse gases pursuant to the United Nations Framework Convention on Climate Change, also known as the “Kyoto Protocol,” an international treaty pursuant to which participating countries (not including the United States) have agreedRequirements to reduce theirGHG emissions from stationary sources could cause us to incur material costs of greenhouse gases to below 1990 levels by 2012. At the end of 2009, an international conference to develop a successor to the Kyoto Protocol issued a document known as the Copenhagen Accord. Pursuant to the Copenhagen Accord, the United States submitted a greenhouse gas emission reduction target of 17% compared to 2005 levels.
State Activities - The Montana Governor’s office has joined the Western Regional Climate Initiative (WCI) and is expected to participate in any greenhouse gas emission control regulations that are adopted by the WCI. The WCI, which has a goal of reducing carbon dioxide emissions 15% below the 2005 levels by 2020, currently is developing greenhouse gas emission allocations, offsets, and reporting recommendations.
While we cannot predict the impact of any legislation until final, if legislation or regulations are passed at the federal or state levels imposing mandatory reductions of carbon dioxide and other greenhouse gases on generation facilities, the cost to us and/or our customers could be significant. Impacts include future capital expenditures for environmental equipment beyond what is currently planned, financing costs related to additional capital expenditures and the purchase of emission allowances from market sources. Our current capital expenditures projections do not include significant amounts related to environmental projects. We believe the cost of purchasing carbon emissions credits, or alternatively the proceeds from the sale of any excess carbon emissions credits would be included in our supply trackers and passed through to cust omers. We are proactively involved in analyzing the impacts of current legislative efforts on our customers and shareholders and are participating in public policy forums related to these issues.
compliance. In addition, there is a gap between proposed emissions reduction levelsthe possible requirements and the current capabilities of technology,technology. The EPA has indicated that carbon capture and sequestration is not currently feasible as there is no currently available commercial scale technology that would achieve the proposed reduction levels. Such technology may not be available within a timeframe consistent with the implementation of climate change legislation or at all.GHG emission control technology. To the extent that such technology does become available,feasible, we can provide no assurance that it will be suitable or cost-effective for installation at the generation facilities in which we have a joint interest. We believe future legislation and regulations that affect carbon dioxide emissions from power plants are likely, although technology to efficiently capture, remove and sequester carbon dioxide emissions ismay not presentlybe available onwithin a commercial scale.timeframe consistent with the implementation of such requirements.
Interstate Transport - On July 6, 2010, the EPA published its proposed Transport Rule as the replacement to the Clean Air Interstate Rule that had been remanded by a Federal court decision due to a number of legal deficiencies. The proposed Transport Rule is the first of a number of significant regulations that the EPA expects to issue that will impose more stringent requirements relating to air, water and waste controls on electric generating units. Beginning with the proposed Transport Rule, the air requirements are expected to be implemented through a series of increasingly stringent regulations relating to conventional air pollutants (e.g., nitrogen oxide (NOx), sulfur dioxide (SO2) and particulate matter) as well as hazardous air pollutants (HAPs) (e.g., acid gases, mercury and other heavy metals). Under the proposal, the first phase of the NOx and SO2 emissions reductions under the proposed Transport Rule would commence in 2012, with further reductions of SO2 emissions proposed to become effective in 2014. Coal Combustion Residuals (CCRs) -In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs under the Resource Conservation and Recovery Act (RCRA). CCRs include fly ash, bottom ash and scrubber wastes. Under one approach, the EPA would regulate CCRs as a hazardous waste under Subtitle C of RCRA. This approach would have very significant impacts on any coal-fired plant, and would require plants to retrofit their operations to comply with full hazardous waste requirements from the generation of CCRs and associated waste waters through transportation and disposal. This could also have a negative impact on the beneficial use of CCRs and the current markets. The second approach would regulate CCRs as a solid waste under Subtitle D of RCRA. This approach would only affect disposal and most significantly affect any wet disposal operations. Under this approach, many of the current markets for beneficial uses of CCRs would not be affected. Currently, the plant operator of Colstrip Unit 4, a coal-fired generating facility in which we have a 30% interest, expects it could be significantly impacted by either approach. We cannot predict at this time the final requirements of the EPA's Transport Rule or CCR regulations and what impact, if any, they would have on our facilities, but the costs could be significant.
Hazardous Air Pollutant Emission Standards - Citing its authority under the Clean Air Act, in 2005, the EPA issued the Clean Air Act Mercury Regulations (CAMR) affecting coal-fired power plants. Since CAMR was overturned by a 2008 decision by the U.S. Circuit Court, the EPA is now proceeding to develop standards imposing Maximum Achievable Control Technology (MACT) for mercury emissions and other hazardous air pollutants from electric generating units. In order to develop these standards, the EPA has collected information from coal- and oil-fired electric utility steam generating units. In March 2011, EPA proposed emission limits for acid gases, mercury and other hazardous metals. EPA is under a consent decree deadline to issue final MACT standards by November 2011, and compliance is statutorily required three years later. The costs of complying with the final MACT standards are not currently determinable, but could be significant.
Water Intakes - Section 316(b) of the Federal Clean Water Act requires that the location, design, construction and capacity of any cooling water intake structure reflect the “best available technology” for minimizing environmental impacts. Permits required for existing facilities are to be developed by the individual states using their best professional judgment until the EPA takes action to address several court decisions that rejected portions of previous rules and confirmed that EPA has discretion to consider costs relative to benefits in developing cooling water intake structure regulations. In March 2011, EPA proposed rules to address impingement and entrainment of aquatic organisms at existing cooling water intake structures. When final rules are issued and implemented, additional capital and/or increased operating costs may be incurred. The costs of complying with the final water intake standards are not currently determinable, but could be significant.
Regional Haze and Visibility - The Clean Air Visibility Rule was issued by the EPA in June 2005, to address regional haze or regionally-impaired visibility caused by multiple sources over a wide area. The rule requires the use of Best Available Retrofit Technology (BART) for certain electric generating units to achieve emissions reductions from designated sources that are deemed to contribute to visibility impairment in Class I air quality areas. The South Dakota Department of Environment and Natural Resources (DENR) has proposed a draft Regional Haze State Implementation Plan (SIP), which recommends sulfur dioxideSO2 and particulate matter emission control technol ogytechnology and emission rates that generally follow the EPA rules. We have a 23.4%
joint interest in Big Stone, a coal-fired power plant located in northeastern South Dakota, which is potentially subject to these emission reduction requirements. At the request of the DENR, the plant operator submitted an analysis of control technologies that should be considered BART to achieve emissions reductions consistent with both the EPA and DENR rules. In addition to scrubbers that were included in the analysis, the DENR recommended Selective Catalytic Reduction technology for nitrogen oxideNOx emission reduction instead of the plant operator recommended separated over-fire air. We are working with the joint owners to evaluate BART options. Based upon current engineering estimates, capital expenditures for these BART technologies are currently estimated to be approximately $500 - $550 million for Big Stone (our share is 23.4%).
The DENR proposes to require that BART be installed and operating as expeditiously as practicable, but no later than five years from the EPA’sEPA's approval of the South Dakota Regional Haze SIP, which is expected no later thanwas filed in January 15, 2011. We cannot predict the timing of the EPA's approval. We will not incur any costs unless the EPA approves the South Dakota Regional Haze SIP and the plant operator’soperator's plan for emissions reduction technology is accepted. We will seek to recover any such costs through the ratemaking process. The South Dakota Public Utilities Commission (SDPUC)SDPUC has historically allowed timely recovery of the costs of environmental improvements; however, there is no precedent on a project of this size.
In addition, we have been notified by the operator of the Neal 4 Plant,generating facility, of which we have an 8%8.7% ownership, that the plant will require a scrubber similar to the Big Stone project to comply with the Clean Air Act. Capital expenditures are currently estimated to be approximately $220$230 - $240 million (our share is 8%8.7%), and are scheduled to commence in 2011 and be spread over the next three years.
Our incremental capital expenditures projections include amounts related to our share of the BART technologies at Big Stone and Neal 4 based on current estimates. Impacts could include future capital expenditures for environmental equipment beyond what is a coal-fired power plant located in Sioux City, Iowa.
Clean Air Mercury Rule - In March 2005, the EPA issued the Clean Air Mercury Regulations (CAMR) to reduce the emissions of mercury from coal-fired facilities through a market-based cap-and-trade program. Although the U.S. Court of Appeals for the District of Columbia Circuit struck down CAMR, the state of Montana finalized its own mercury emission rules that require, by 2010, every coal-fired generating plant in Montana to achieve reductions more stringent than CAMR's 2018 requirements. Chemical injection technologies were installed at Colstrip during the fourth quarter of 2009 to meet these requirements.
Manufactured Gas Plants
Approximately $26.0 million of our environmental reserve accrual iscurrently planned, financing costs related to manufactured gas plants. A formerly operated manufactured gas plant located in Aberdeen, South Dakota, has been identified onadditional capital expenditures and the Federal Comprehensive Environmental Response, Compensation, and Liability Information System list as contaminated with coal tar residue.purchase of emission allowances from market sources. We are currently investigating, characterizing, and initiating remedial actions atbelieve the Aberdeen site pursuant to work plans approved bycost of purchasing carbon emissions credits, or alternatively the South Dakota DENR. Our current reserve for remediation costs at this site is approximately $12.2 million, and we estimate that approximately $10 million of this amount will be incurred duringproceeds from the next five years.
We also own sites in North Platte, Kearney and Grand Island, Nebraska on which former manufactured gas facilities were located. During 2005, the Nebraska Department of Environmental Quality (NDEQ) conducted Phase II investigations of soil and groundwater at our Kearney and Grand Island sites. In 2006, the NDEQ released to us the Phase II Limited Subsurface Assessment performed by the NDEQ's environmental consulting firm for Kearney and Grand Island. We have conducted limited additional site investigation, assessment and monitoring work at Kearney and Grand Island. At present, we cannot determine with a reasonable degree of certainty the nature and timingsale of any risk-based remedial action atexcess carbon emissions credits would be included in our Nebraska locations.supply trackers and passed through to customers.
In addition, we own or have responsibility for sites in Butte, Missoula and Helena, Montana on which former manufactured gas plants were located. An investigation conducted at the Missoula site did not require entry into the Montana Department of Environmental Quality (MDEQ) voluntary remediation program, but required preparation of a groundwater monitoring plan. The Butte and Helena sites were placed into the MDEQ's voluntary remediation program for cleanup due to excess regulated pollutants in the groundwater. We have conducted additional groundwater monitoring at the Butte and Missoula sites and, at this time, we believe natural attenuation should address the conditions at these sites; however, additional groundwater monitoring will be necessary. In Helena, we continue limited operation of an oxygen delivery system implemented to enha nce natural biodegradation of pollutants in the groundwater and we are currently evaluating limited source area treatment/removal options. Monitoring of groundwater at this site is ongoing and will be necessary for an extended time. At this time, we cannot estimate with a reasonable degree of certainty the nature and timing of risk-based remedial action at the Helena site or if any additional actions beyond monitored natural attenuation will be required.
Other
We continue to manage equipment containing polychlorinated biphenyl (PCB) oil in accordance with the EPA's Toxic Substance Control Act regulations. We will continue to use certain PCB-contaminated equipment for its remaining useful life and will, thereafter, dispose of the equipment according to pertinent regulations that govern the use and disposal of such equipment.
We routinely engage the services of a third-party environmental consulting firm to assist in performing a comprehensive evaluation of our environmental reserve. Based upon information available at this time, we believe that the current environmental reserve properly reflects our remediation exposure for the sites currently and previously owned by us. The portion of our environmental reserve applicable to site remediation may be subject to change as a result of the following uncertainties:
· | We may not know all sites for which we are alleged or will be found to be responsible for remediation; and |
· | Absent performance of certain testing at sites where we have been identified as responsible for remediation, we cannot estimate with a reasonable degree of certainty the total costs of remediation. |
LEGAL PROCEEDINGS
Colstrip Energy Limited Partnership
In December 2006 and June 2007, the MPSC issued orders relating to certain QF long-term rates for the period July 1, 2003, through June 30, 2006. Colstrip Energy Limited Partnership (CELP) is a QF with which we have a power purchase agreement through June 2024. Under the terms of the power purchase agreement with CELP, energy and capacity rates were fixed through June 30, 2004 (with a small portion to be set by the MPSC's determination of rates in the annual avoided cost filing), and beginning July 1, 2004 through the end of the contract, energy and capacity rates are to be determined each year pursuant to a formula, with the rates to be used in that formula derived from the annual MPSC QF rate review. CELP initially appealed the MPSC’sMPSC's orders and then, in July 2007, filed a complaint against NorthWestern and the MPSC in Montana dis trictdistrict court, which contested the MPSC’sMPSC's orders. CELP disputed inputs into the underlying rates used in the formula, which initially are calculated by us and reviewed by the MPSC on an annual basis, to calculate energy and capacity payments for the contract years 2004-2005 and 2005-2006. CELP claimed that NorthWestern breached the power purchase agreement causing damages, which CELP asserted to be approximately $23 million for contract years 2004-2005 and 2005-2006. The parties stipulated that
NorthWestern would not implement the final derived rates resulting from the MPSC orders, pending an ultimate decision on CELP's complaint. The Montana district court, on June 30, 2008, granted both a motion by the MPSC to bifurcate, having the effect of separating the issues between contract/tort claims against us and the administrative appeal of the MPSC’sMPSC's orders and a motion by us to refer the claims against us to arbitration. The order also stayed the appellate decision pending a decision in the arbitrati onarbitration proceedings. Arbitration was held in June 2009 and the arbitration panel entered its interim award in August 2009, holding that although NorthWestern failed to use certain data inputs required by the power purchase agreement, CELP was entitled to neither damages for contract years 2004-2005 or 2005-2006, nor to recalculation of the underlying MPSC filings for those years, effectively finalizing CELP's contract rates for those years. We requested clarification from the arbitration panel as to its intent regarding the applicable rates. On November 2, 2009, we received the final award from the arbitration panelwhich confirmed that the filed rates for 2004-2005 and 2005-2006 are not required to be recalculated. In affirming its interim award, the arbitration panel also denied CELP’sCELP's request for attorney fees, holding that each party would be responsible for its own fees. On June 15, 2010, the Montana district court confirmed the final arbitrati onarbitration panel award and denied CELP’sCELP's motion to vacate, modify or correct the award. CELP has appealed the decision to the Montana Supreme Court (MSC). We participated in a court-ordered mediation with CELP on September 13, 2010, but were unable to resolve the claims. CELP’s opening briefAll appellate briefs have been submitted to the MSC, is duewhich has advised the parties that it will not hold oral argument on the appeal. Thus, we await a decision on the merits by the end ofMSC. On October 2010. We are required to file31, 2010, NorthWestern filed with the MPSC, by October 31, 2010,consistent with the direction of the arbitration panel, for a new determination of the inputs that will be used to calculate contract rates for periods subsequent to June 30, 2006, using data inputs required by the power purchase agreement.2006. Due to the uncertainty around resolution of this matter, we currently are unable to predict its outcome. In addition, settlement discussions concerning these claims are ongoing.
Gonzales
We are a defendant –- along with our predecessor entities the Montana Power Company (MPC) and pre-bankruptcy NorthWestern Corporation (NOR) –- in an action (Gonzales Action) pending in the Montana Second Judicial District Court, Butte-Silver Bow County (Montana State Court), alleging fraud, constructive fraud and violations of the Unfair Claim Settlement Practices Act all arising out of the adjustment of workers’workers' compensation claims. Putnam and Associates, the third party administrator of such workers’workers' compensation claims, also is a defendant.
The Gonzales Action was first filed on December 18, 1999, against MPC (NOR acquired MPC in 2002) and was stayed due to the chapter 11 bankruptcy filing of NOR. On August 10, 2005, the Bankruptcy Court approved a “Bankruptcy Settlement Stipulation” which permitted the Gonzales Action to proceed, assigned to plaintiffs NOR’sNOR's interest in MPC’sMPC's insurance policies (to the extent applicable to the allegations made by plaintiffs), released NOR from any and all obligations to the plaintiffs concerning such claims, and preserved plaintiffs’plaintiffs' right to pursue claims arising after November 1, 2004, relating to the adjustment of workers’workers' compensation claims. To date, no insurance carrier has indicated that coverage is available for any of the claims.
On September 30, 2009, the Montana State Court granted the plaintiffs’ motions to file a sixth amended complaintWe and partially granted the plaintiff’s motion for class certification. The Montana State Court excluded the fraud claims from its class certification. The new complaint seeks to hold us jointlyPutnam and severally liable for the acts of MPC and NOR and alleges that we negligently/intentionally sabotaged plaintiffs’ ability to recover under the MPC insurance policies. Plaintiffs seek compensatory and punitive damages from all defendants. Due to the individual nature of the claims, we believe the class certification was improper under Montana law, and we continue to believe that the new complaint violates the bankruptcy stipulation. We have filed an appeal to the MSC with respect to these issues and intend to continue to defend the lawsuit vigorously. We also believe the sixth amended complaint violates the Bankruptcy Settlement Stipulation and have filed a motion with the Bankruptcy Court seeking enforcement of the Bankruptcy Settlement Stipulation. The motion before the Bankruptcy Court is pending.
The partiesAssociates have agreed to settle the Gonzales Action and have executed a settlement agreement which remains subject to the approval of the Montana State Court. We will paypaid the settlement agreement amount of $2.5 million to the Clerk of the Montana State Court in full satisfaction of all Gonzales Action claims, which amount has been accrued.claims. The Clerk of the Montana State Court will hold these funds pending final Montana State Court approval of the settlement, which could take approximately 12 months.
Maryland Street
On March 16, 2009, Monsignor John F. McCarthy, the duly appointed personal representative for the Estate of his brother, Father James C. McCarthy, filed a wrongful death lawsuit against NorthWestern and one of our employees in the District Court of Butte-Silver Bow County, Montana for injuries that Fr. McCarthy received in an April 2007 natural gas explosion that destroyedat his four-plex residence. The complaint allegeslawsuit alleged negligence and strict liability with respect to the maintenance and operation of the natural gas distribution system that served the residence. Fr. McCarthy died in November 2007, allegedly because of injuries sustained in the explosion. The plaintiff seekssought unspecified compensatory and punitive damages and other equitable relief, costs and attorneys’attorneys' fees. The court has setlawsuit was settled in January 2011 without a trial datematerial impact on our financial position, results of June 6,operations or cash flows. The District Court signed a stipulated motion for dismissal, with prejudice, on March 29, 2011. While we cann ot predict an outcome, we intend to continue vigorously defending against the lawsuit.
Bozeman Explosion
On March 5, 2009, a natural gas explosion occurred in downtown Bozeman, Montana, resulting in one fatality, the destruction of or damage to several buildings and damage to the businesses in them, and damage to other nearby properties and businesses. Twenty-sixThirty-three lawsuits are pendinghave been filed against NorthWestern in the District Court of Gallatin County, Montana, and a number of additional claims not currently in litigation also have been made against us. We have approximately $150 million of
insurance coverage available for known and potential claims arising from the explosion. We have paidtendered our self-insured retention under those policies andto our insurance carriers, havewho accepted the tender and assumed the defense and handling of the existing and potential additional lawsuits and claims arising from the incident. A court-ordered mediation
Settlements were reached in eight cases, including the wrongful death case, during mediations in November 2010, and we subsequently have settled a number of the eleven largestremaining cases and claims. There are currently thirteen remaining property damage and business loss cases pending, laws uits will be held duringthree of which are scheduled for trial in the weekfall of November 8, 2010, and the court has scheduled trial of an unspecified case for June 20, 2011. While we cannot predict an outcome, we intend to continue vigorously defending against the lawsuits.
McGreevey Litigation
We were one An additional number of several defendantsclaims not in a class action lawsuit entitled McGreevey, et al. v. The Montana Power Company, et al., nowlitigation remain pending in U.S. District Court in Montana.
In October 2009, the parties reached a global settlement, which was subject to approvaland are being handled by the U.S. District Court in Montana and the Delaware Bankruptcy Court. On February 23, 2010, the Delaware Bankruptcy Court approved the settlement. On August 4, 2010, the U.S. District Court in Montana entered a final order approving the global settlement. On September 23, 2010, as part of the global settlement, we received $2.0 million from the Touch America bankruptcy estate, which is reflected as a reduction in operating, general and administrative expenses in the Condensed Consolidated Statements of Income, and we have no remaining exposure in the litigation.our primary insurance carrier.
Sierra Club
On June 10, 2008, Sierra Club filed a complaint in the U.S. District Court for the District of South Dakota (Northern Division) (South Dakota Federal District Court) against us and two other co-owners (the Defendants) of Big Stone Generating Station (Big Stone). The complaint alleged certain violations of the (i) Prevention of Significant Deterioration and (ii) New Source Performance Standards (NSPS) provisions of the Clean Air Act and certain violations of the South Dakota State Implementation Plan (South Dakota SIP). The action further alleged that the Defendants modified and operated Big Stone without obtaining the appropriate permits, without meeting certain emissions limits and NSPS requirements and without installing appropriate emission control technology, all allegedly in violation of the Clean Air Act and the South Dakota SIP. S ierra Club alleged that the Defendants’ actions have contributed to air pollution and visibility impairment and have increased the risk of adverse health effects and environmental damage. Sierra Club sought both declaratory and injunctive relief to bring the Defendants into compliance with the Clean Air Act and the South Dakota SIP and to require the Defendants to remedy the alleged violations. Sierra Club also sought unspecified civil penalties, including a beneficial mitigation project. We believe these claims are without merit and that Big Stone was and is being operated in compliance with the Clean Air Act and the South Dakota SIP.
The Defendants filed a Motion to Dismiss the Sierra Club complaint on August 12, 2008, based on certain of the claims being barred by statute of limitations and the remaining claims being an impermissible collateral attack on valid Clean Air Permits issued by the state of South Dakota. On March 31, 2009, the South Dakota Federal District Court entered a Memorandum Opinion and Order granting Defendants’ Motion to Dismiss the Sierra Club Complaint. On July 30, 2009, Sierra Club appealed the South Dakota Federal District Court’s decision to dismiss the complaint to the Eighth Circuit Court of Appeals (Court of Appeals). The United States Department of Justice filed an amicus brief in support of the Sierra Club’s position, and the State of South Dakota filed an amicus brief in support of our position. On August 2 6, 2010, the Court of Appeals affirmed the South Dakota Federal District Court’s decision to dismiss the complaint. The deadline to appeal the decision of the Court of Appeals to the Supreme Court is November 10, 2010. We cannot predict the likelihood of appeal or the outcome of any such appeal at this time.
We are also subject to various other legal proceedings, governmental audits and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these other actions will not materially affect our financial position, results of operations, or cash flows.
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
OVERVIEW
NorthWestern Corporation, doing business as Northwestern Energy, provides electricity and natural gas to approximately 661,000665,000 customers in Montana, South Dakota and Nebraska. For a discussion of NorthWestern’s business strategy, see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2009.2010.
SUMMARY
Significant achievements during the three months ended September 30, 2010March 31, 2011 include:
· | Improvement in income before income taxes of approximately $9.0 million as compared with 2009, due primarily to increased gross margin and the capitalization of allowance for funds used during construction related to the construction of our Mill Creek Generating Station.; |
Improvement in net income of approximately $3.9 million as compared with 2010, due primarily to improved margin and lower income tax expense, offset in part by increased operating expenses;Began commercial operations of the 150 MW Dave Gates Generating Station at Mill Creek on January 1, 2011, with total project costs of approximately $183 million (see additional discussion below);
Received approval from the MPSC of an accounting order to defer and amortize certain incremental operating and maintenance costs up to $16.9 million for 2011 and 2012 associated with our Distribution System Infrastructure Project;
Upgrade of our senior secured and senior unsecured credit ratings by Moody's Investors Service (Moody's); and
Entering into a commercial paper program under which we may issue unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $250 million to provide an alternative financing source to fund short-term liquidity needs.
· | A proposed Stipulation with the MCC, which, if approved by the MPSC, would result in a net annual increase in our Montana electric and natural gas rates of approximately $6.7 million; and |
Supply InvestmentsDave Gates Generating Station at Mill Creek
· | Completing the purchase of a majority interest in the Battle Creek Natural Gas Field on the Sweetgrass Arch in Blaine County, Montana (Battle Creek Field) for approximately $11.4 million. |
On March 19, 2011, our Vice President of Wholesale Operations, David G. Gates, was tragically killed in a private plane crash. On March 26, 2011 our Board of Directors renamed the Mill Creek Generating Station as the Dave Gates Generating Station at Mill Creek (DGGS) to posthumously recognize Gates’ significant contributions to the company. On December 31, 2010, we completed construction of DGGS, a 150 MW natural gas fired facility and began commercial operations on January 1, 2011. The facility provides regulating resources (in place of previously contracted costs for ancillary services) to balance our transmission system in Montana to maintain reliability and enable wind power to be integrated onto the network to meet renewable energy portfolio needs.
Montana General Rate Case
Approximately 80% of our revenues related to the facility are subject to jurisdiction of the MPSC and approximately 20% are subject to jurisdiction of the FERC. In October 2009, we filed a request with2010, the MPSC for an annual electric transmission and distribution revenue increaseFERC approved interim rates to reflect the estimated cost of $15.5 million, and an annual natural gas transmission, storage and distribution revenue increase of $2.0 million. In September 2010, we and the MCC filed a joint Stipulation regarding the revenue requirement portionservice under Schedule 3 of the rate filing. Specific terms ofOATT. In November 2010, the Stipulation include:
· | An increase in base electric rates of $7.7 million; |
· | A decrease in base natural gas rates of approximately $1.0 million; and |
· | An authorized overall rate of return of 7.92%, using an authorized rate of return on equity of 10.25%, cost of long-term debt of 5.76% and a capital structure of 52% debt and 48% equity. |
A hearing was held in September 2010, and we expect the MPSC to issue a final order during the fourth quarter of 2010. The MPSC approved interim rates based on the originally estimated construction costs of $202 million. The interim rates under both orders became effective beginning January 1, 2011. The respective interim rates are subject to refund beginning July 8, 2010. During the three months ended September 30, 2010,plus interest pending final resolution in both jurisdictions.
On March 31, 2011, we recognized revenues of approximately $1.6 million (subject to refund), which is consistentmade a compliance filing with the MPSC that will be used to conduct a final cost review and establish final rates. As a result of the lower than estimated construction costs and estimated impact of the flow-through of accelerated tax depreciation, we also reduced our interim rate increase included inrequest, which the proposed Stipulation. Based onMPSC authorized to take effect beginning May 1, 2011. We anticipate this review process will take approximately nine months; however a procedural schedule has not been established.
During March 2011, we began settlement discussions with FERC Staff and large customers receiving service under Schedule 3 of the proposed Stipulation,OATT. We anticipate the settlement discussions will take approximately nine months.
As compared to the year ended December 31, 2010, we expect the inclusion of DGGS in rate base to positively impact net income by approximately $6 - $8 million in 2011 after considering allowance for funds used during construction (AFUDC) capitalized during 2010, lower than estimated construction costs, lower debt rates and the estimated impact of this rate increasethe flow-through of accelerated tax depreciation. There is significant uncertainty regarding the ultimate resolution of cost allocations between the MPSC and FERC jurisdictions, and we have recognized revenues associated with DGGS based on our current best estimate of final resolution. The ultimate resolution of the allocation of costs between jurisdictions could result in an inability to be approximately $2 – 3 million during the fourth quarter of 2010.
Battle Creek Field
During the 2009 Montana legislative session, changes in state law occurred that allowfully recover our costs, as well as requiring us to acquire natural gas productionrefund more interim revenues than our current estimate and gathering resources and, subject to regulatory approval, include them in rate base. On September 22, 2010, we purchasedhave a majority interest in the Battle Creek Field from a private owner. The purchased assets also include the seller’s interest in the Battle Creek Gas Gathering System Joint Venture. Under the terms of the agreement, we paid the seller $11.4 million for the majority interest in the Battle Creek Field assets including the gathering system. The transaction was funded by drawingmaterial adverse affect on our revolving credit facility. The amountresults of proven reserves purchased are estimated to be approximately 7.6 billion cubic feet (Bcf). Annual net production attributable to the purchase is currently approxim ately 0.5 Bcf or about 2.2% of our current annual consumption in Montana. In 2011, or during our next general natural gas rate case, we plan to seek MPSC approval to include our interest in the Battle Creek Field and the natural gas gathering system into our regulated rate base. In the interim, the cost of service for the natural gas produced, including a return on our investment will be included in our natural gas supply tracker pending completion of the filing with the MPSC.operations.
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25Wind Generation
We had previously announced entering into memoranda of understanding with two wind developers that would have provided approximately 48 MWs. We have decided to move forward with only one of those developers. In April 2011, we executed an agreement to purchase a wind project in Judith Basin County in Montana to be developed and constructed by Spion Kop Wind, LLC, a wholly-owned subsidiary of Compass Wind, LLC (Compass) that would provide approximately 40 MWs of capacity for $77.9 million, with an estimate for the total project of approximately $85 - $90 million. Both the energy and associated renewable energy credits will be placed into the electric supply portfolio and used to meet future renewable portfolio standards obligations.The purchase is conditioned on pre-approval by the MPSC to include the project in regulated rate base as an electric supply resource. We expect to file an application for pre-approval with the MPSC during the second quarter of 2011, which would be followed by a procedural process of up to nine months. If the MPSC fails to grant approval on or before April 1, 2012, then either party may terminate this agreement. Material construction would not commence until we receive a favorable ruling from the MPSC, with commercial operation projected to begin by the end of 2012.
RESULTS OF OPERATIONS
Our consolidated results include the results of our reportable business segments, which are primarily engaged in the electric and natural gas business. The overall consolidated discussion is followed by a detailed discussion of gross margin by segment.
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as another financial measure, Gross Margin, that is considered a “non-GAAP financial measure.” Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position or cash flows that exclude (or include) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. Gross Margin (Revenues less Cost of Sales) is a non-GAAP financial measure due to the exclusion of depreciation from the measure. The presentation of Gross Margin is intended to supplement investors’ understanding of our operating performance. Gross Margin is used by us to determine whether we are collecting the appropriate amount of energy costs from customers to allow recovery of operating costs. Our Gross Margin measure may not be comparable to other companies’ Gross Margin measure. Furthermore, this measure is not intended to replace operating income as determined in accordance with GAAP as an indicator of operating performance.
Outlook
The current weak economic conditions have resulted in weaker customer demand, among other things, and the outlook and timing of economic recovery remains uncertain. We expect to continue to experience relatively stable residential demand as well as reduced commercial and industrial demand during 2010. In addition, the weak economic climate has impacted demand for our transmission capacity as compared with historical levels. In response, we have taken steps to manage our operating, general and administrative expenses and will continue to manage our costs consistent with the impact to our margin.
OVERALL CONSOLIDATED RESULTS
Three Months Ended September 30, 2010March 31, 2011 Compared with the Three Months Ended September 30, 2009March 31, 2010
| | | | Three Months Ended September 30, | | Three Months Ended March 31, |
| | 2010 | | 2009 | | Change | | % Change | | 2011 | | 2010 | | Change | | % Change |
| | (in millions) | | (in millions) |
Operating Revenues | | | | | | | | | | | | | | | | |
Electric | | $ | 203.6 | | $ | 198.7 | | $ | 4.9 | | 2.5 | % | $ | 208.6 | | | $ | 203.8 | | | $ | 4.8 | | | 2.4 | % |
Natural Gas | | 36.9 | | 34.2 | | 2.7 | | 7.9 | | 129.2 | | | 130.0 | | | (0.8 | ) | | (0.6 | ) |
Other | | 0.3 | | 0.3 | | — | | 0.0 | | 0.4 | | | 0.3 | | | 0.1 | | | 33.3 | |
Eliminations | | — | | (0.3 | ) | 0.3 | | 100.0 | | |
| | $ | 240.8 | | $ | 232.9 | | $ | 7.9 | | 3.4 | % | $ | 338.2 | | | $ | 334.1 | | | $ | 4.1 | | | 1.2 | % |
| | Three Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Cost of Sales | | | | | | | | | |
Electric | | $ | 92.7 | | $ | 92.6 | | $ | 0.1 | | 0.1 | % |
Natural Gas | | 13.2 | | 12.3 | | 0.9 | | 7.3 | |
Other | | — | | 0.3 | | (0.3 | ) | (100.0 | ) |
| | $ | 105.9 | | $ | 105.2 | | $ | 0.7 | | 0.7 | % |
|
| | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2011 | | 2010 | | Change | | % Change |
| (in millions) |
Cost of Sales | | | | | | | |
Electric | $ | 84.4 | | | $ | 91.0 | | | $ | (6.6 | ) | | (7.3 | )% |
Natural Gas | 77.6 | | | 81.8 | | | (4.2 | ) | | (5.1 | ) |
| $ | 162.0 | | | $ | 172.8 | | | $ | (10.8 | ) | | (6.3 | )% |
| | Three Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Gross Margin | | | | | | | | | |
Electric | | $ | 110.9 | | $ | 106.1 | | $ | 4.8 | | 4.5 | % |
Natural Gas | | 23.7 | | 21.9 | | 1.8 | | 8.2 | |
Other | | 0.3 | | — | | 0.3 | | 100.0 | |
Eliminations | | — | | (0.3 | ) | 0.3 | | 100.0 | |
| | $ | 134.9 | | $ | 127.7 | | $ | 7.2 | | 5.6 | % |
|
| | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2011 | | 2010 | | Change | | % Change |
| (in millions) |
Gross Margin | | | | | | | |
Electric | $ | 124.2 | | | $ | 112.8 | | | $ | 11.4 | | | 10.1 | % |
Natural Gas | 51.6 | | | 48.2 | | | 3.4 | | | 7.1 | |
Other | 0.4 | | | 0.3 | | | 0.1 | | | 33.3 | |
| $ | 176.2 | | | $ | 161.3 | | | $ | 14.9 | | | 9.2 | % |
Consolidated gross margin was $134.9$176.2 million for the three months ended September 30, 2010,March 31, 2011, an increase of $7.2$14.9 million, or 5.6%9.2%, from gross margin in 2009.2010. Primary components of this change include the following:
| | Gross Margin | |
| | 2010 vs. 2009 | |
| | (in millions) | |
Retail electric and gas volumes | | $ | 3.1 | |
Montana electric interim rate increase (subject to refund) | | 1.6 | |
Transmission capacity | | 1.3 | |
Montana property tax tracker | | 0.2 | |
South Dakota wholesale electric | | (0.5 | ) |
Other | | 1.5 | |
Increase in Consolidated Gross Margin | | $ | 7.2 | |
|
| | | |
| Gross Margin 2011 vs. 2010 |
| (in millions) |
DGGS interim rates (subject to refund) | $ | 7.5 | |
Electric and natural gas retail volumes | 6.2 | |
Montana electric rate increase | 1.9 | |
Expiration of a power sales agreement | 1.5 | |
South Dakota wholesale electric | (0.7 | ) |
Transmission capacity | (0.6 | ) |
Reclamation settlement received during 2010 | (0.5 | ) |
Montana natural gas rate decrease | (0.3 | ) |
Other | (0.1 | ) |
Increase in Consolidated Gross Margin | $ | 14.9 | |
This $7.2$14.9 million increase was primarily duein gross margin includes the following:
DGGS revenues based on our current best estimate of final resolution of applicable rate proceedings as discussed above in the "Summary" section. DGGS rates charged to anMontana retail customers are based on total Montana retail volumes and will fluctuate quarterly based on the cyclical nature of our business;
An increase in electric and natural gas retail volumes relateddue primarily to warmer summer weather in South Dakota, an interimcolder winter weather;
An increase in Montana electric rates (subjecttransmission and distribution rates; and
The expiration in December 2010 of a power sales agreement related to refund), and improvedColstrip Unit 4.
These increases were partly offset by the following:
Lower wholesale electric sales in South Dakota;
Lower transmission capacity revenues. Partially offsetting these increases was lower average wholesale electric pricesrevenues due to decreased demand;
Higher cost of sales due to a settlement in South Dakota.2010 to recover previously incurred reclamation costs associated with the coal supply at Colstrip; and
A decrease in Montana natural gas transmission and distribution rates.
|
| | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2011 | | 2010 | | Change | | % Change |
| (in millions) |
Operating Expenses (excluding cost of sales) | | | | | | | |
Operating, general and administrative | $ | 67.4 | | | $ | 58.3 | | | $ | 9.1 | | | 15.6 | % |
Property and other taxes | 25.4 | | | 23.0 | | | 2.4 | | | 10.4 | |
Depreciation | 25.3 | | | 22.9 | | | 2.4 | | | 10.5 | |
| $ | 118.1 | | | $ | 104.2 | | | $ | 13.9 | | | 13.3 | % |
| | Three Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Operating Expenses (excluding cost of sales) | | | | | | | | | |
Operating, general and administrative | | $ | 58.5 | | $ | 57.9 | | $ | 0.6 | | 1.0 | % |
Property and other taxes | | 20.5 | | 20.8 | | (0.3 | ) | (1.4 | ) |
Depreciation | | 22.8 | | 22.0 | | 0.8 | | 3.6 | |
| | $ | 101.8 | | $ | 100.7 | | $ | 1.1 | | 1.1 | % |
Consolidated operating, general and administrative expenses were $58.5$67.4 million for the three months ended September 30, 2010,March 31, 2011, as compared with $57.9$58.3 million for the three months ended September 30, 2009.March 31, 2010. Primary components of this change include the following:
| | Operating, General & Administrative Expenses | |
| | 2010 vs. 2009 | |
| | (Millions of Dollars) | |
Operating and maintenance | | $ | 2.1 | |
Labor | | 0.8 | |
Jointly owned plant operations | | 0.5 | |
Insurance reserves | | (1.3 | ) |
Postretirement health care | | (1.0 | ) |
Pension | | (1.0 | ) |
Insurance recoveries and settlements | | (0.6 | ) |
Other | | 1.1 | |
Increase in Operating, General & Administrative Expenses | | $ | 0.6 | |
|
| | | |
| Operating, General & Administrative Expenses |
| 2011 vs. 2010 |
| (Millions of Dollars) |
Labor | $ | 3.4 | |
Operating and maintenance | 2.0 | |
Insurance reserves | 1.3 | |
DGGS | 1.3 | |
Pension | 0.4 | |
Other | 0.7 | |
Increase in Operating, General & Administrative Expenses | $ | 9.1 | |
The increase in operating, general and administrative expenses of $0.6$9.1 million was primarily due to the following:
· | Increased operating and maintenance costs; |
Increased labor costs due primarily to compensation increases and more time spent by employees on maintenance projects (which are expensed) rather than capital projects;Increased operating and maintenance costs, primarily due to proactive line maintenance;
Higher insurance reserves due to workers compensation and general liability matters. In addition, results for the three months ended March 31, 2010 included a favorable arbitration decision of $0.8 million;
The operations of DGGS in 2011; and
Higher pension expense, however, based on current assumptions we expect the annual pension expense for 2011 to be comparable with 2010 due to the regulatory treatment of our Montana pension plan.
· | Increased labor costs due primarily to compensation increases offset in part by more time spent by employees on capital projects rather than maintenance projects (which are expensed); and |
27
· | Increased plant operations costs at our Colstrip plant due to chemical injection technologies installed at the plant in 2009. |
These increases were offset in part by:
· | Lower insurance reserves due to higher claims in the prior year; |
· | Lower postretirement health care costs due to a plan amendment during the fourth quarter of 2009. We expect postretirement health care costs to total approximately $1.5 million for the full year 2010 as compared to approximately $5.7 million for the full year 2009; |
· | Lower pension expense, however, based on current assumptions we expect the annual pension expense for 2010 to be comparable with 2009 due to the regulatory treatment of our Montana pension plan; and |
· | Net increase in insurance recoveries and settlements due to $2.0 million received in the third quarter of 2010 related to the McGreevey litigation, as compared with $1.4 million received in the third quarter of 2009 related to previously incurred Montana generation related environmental remediation costs. |
Property and other taxes was $20.5$25.4 million for the three months ended September 30, 2010March 31, 2011 as compared with $20.8$23.0 million in the thirdfirst quarter of 2009, with higher assessed property valuations in Montana offset by2010, due primarily to plant additions, including the capitalizationaddition of an estimated $1.3 million in property taxes related to Mill Creek Generating Station during the construction period.DGGS.
Depreciation expense was $22.8$25.3 million for the three months ended September 30, 2010March 31, 2011 as compared with $22.0$22.9 million in the thirdfirst quarter of 2009.2010. This increase was primarily due to plant additions.additions, including DGGS.
Consolidated operating income for the three months ended September 30, 2010March 31, 2011 was $33.1$58.1 million, as compared with $27.0$57.2 million in the thirdfirst quarter of 2009.2010. This increase was primarily due to an increase in gross margin partially offset by higher operating, general and administrative expenses discussed above.
Consolidated interest expense for the three months ended September 30, 2010 was $16.3 million, a decrease of $1.0 million, or 5.8%, from 2009. This decrease was primarily due to $0.9 million capitalized for the debt portion of allowance for funds used during construction (AFUDC), primarily relatedMarch 31, 2011 remained flat as compared to the Mill Creek Generating Station. We expect to capitalize approximately $1.2 million of additional AFUDC related to the Mill Creek Generating Station through the remainder of the year.
Consolidated other income for the three months ended September 30, same period in 2010 was $2.3 million, as compared, with $0.4 million in the third quarter of 2009. This includes approximately $1.5 million capitalized for the equity portionlower rates on debt outstanding offset by lower capitalization of AFUDC primarily related to the Mill Creek Generating Station. We expect to capitalize approximately $1.9 million of additional AFUDC related to the Mill Creek Generating Station through the remainder of the year.as DGGS began operating in January 2011.
Consolidated income tax expense for the three months ended September 30, 2010March 31, 2011 was $4.7$9.2 million as compared with an $8.8a $12.2 million income tax benefit in the same period of 2009.2010. The effective tax rate in 20102011 was 24.7%22.0% as compared with (87.1)%29.8% for the same period of 2009.2010. The increasedecrease in the effective tax rate was primarily due to lower tax benefits recognized for repair costs. For the three months ended September 30, 2010, we recognized approximately $2.3 millionregulatory flow-through treatment of income tax benefit related to repair coststate accelerated depreciation deductions. During September 2009, we received approval of a tax accounting method change for repair costs and recognized approximately $12.4 million of income tax benefit related to repair cost deductions. As we did not receive approval of the tax accounting method change until the third quarter of 2009, we recognized the entire benefi t in the third quarter of 2009, and , therefore, quarterly income tax expense during 2010 is not comparable with 2009. In addition, our effective tax rate for the third quarter of 2009 reflected the impact of the tax accounting method change for repairs for both 2009 and 2008.
In September 2010, the Small Business Jobs Act of 2010 was signed into law extending bonus depreciation. This Act
provides a bonus tax depreciation deduction ranging from 50% - 100% for 2010.qualified property acquired or constructed and
placed into service during 2010 - 2012. We are evaluatingcontinuing to assess the impact of this extensionAct due to our regulatory tax accounting
method that provides for the flow-through of certain state tax adjustments, including accelerated depreciation. Based on guidance from the Internal Revenue Service, we believe DGGS will qualify for a 50% bonus tax depreciation deduction in 2011. For the three months ended March 31, 2011, we recognized a total bonus depreciation related tax benefit of approximately $2.6 million as compared with no related benefit during the same period in 2010.
We currently expect our estimated taxable income andeffective tax rate to range between 20% - 24% for 2011. We are currently reviewing tax planning strategies for 2010, whichthat may impact the realization of a portion of ourallow us to utilize more state NOL carryforwards that willwere set to expire atin 2010 than our original estimate. This could result in a favorable tax benefit. We anticipate finalizing our review and filing our 2010 Federal tax return during the endsecond quarter of 2010. While we reflect an income tax provision in our Financial Statements, we expect our cash payments for income taxes will be minimal through at least 2014, based on our projected taxable income and anticipated use of consolidated NOL carryforwards.2011.
Consolidated net income for the three months ended September 30, 2010March 31, 2011 was $14.4$32.6 million as compared with $18.9$28.7 million for the thirdfirst quarter of 2009. This decrease was primarily due to higher income tax expense offset in part by higher operating income, lower interest expense, and higher other income as discussed above.
Nine Months Ended September 30, 2010 Compared with the Nine Months Ended September 30, 2009
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Operating Revenues | | | | | | | | | |
Electric | | $ | 592.3 | | $ | 580.1 | | $ | 12.2 | | 2.1 | % |
Natural Gas | | 225.9 | | 254.3 | | (28.4 | ) | (11.2 | ) |
Other | | 0.9 | | 6.3 | | (5.4 | ) | (85.7 | ) |
Eliminations | | — | | (1.2 | ) | 1.2 | | 100.0 | |
| | $ | 819.1 | | $ | 839.5 | | $ | (20.4 | ) | (2.4 | )% |
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Cost of Sales | | | | | | | | | |
Electric | | $ | 266.1 | | $ | 258.9 | | $ | 7.2 | | 2.8 | % |
Natural Gas | | 124.6 | | 154.1 | | (29.5 | ) | (19.1 | ) |
Other | | — | | 7.0 | | (7.0 | ) | (100.0 | ) |
| | $ | 390.7 | | $ | 420.0 | | $ | (29.3 | ) | (7.0 | )% |
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Gross Margin | | | | | | | | | |
Electric | | $ | 326.2 | | $ | 321.2 | | $ | 5.0 | | 1.6 | % |
Natural Gas | | 101.3 | | 100.2 | | 1.1 | | 1.1 | |
Other | | 0.9 | | (0.7 | ) | 1.6 | | 228.6 | |
Eliminations | | — | | (1.2 | ) | 1.2 | | 100.0 | |
| | $ | 428.4 | | $ | 419.5 | | $ | 8.9 | | 2.1 | % |
Consolidated gross margin was $428.4 million for the nine months ended September 30, 2010, an increase of $8.9 million, or 2.1%, from gross margin in 2009. Primary components of this change include the following:
| | Gross Margin | |
| | 2010 vs. 2009 | |
| | (in millions) | |
Retail electric volumes | | $ | 2.0 | |
Montana electric interim rate increase (subject to refund) | | 1.6 | |
Demand-side management (DSM) lost revenues | | 1.6 | |
Loss on capacity contract in 2009 | | 1.5 | |
Transmission capacity | | 1.5 | |
Montana property tax tracker | | 1.3 | |
Reclamation settlement | | 1.0 | |
Operating expenses recovered in supply trackers | | 0.9 | |
QF supply costs | | (3.6 | ) |
South Dakota wholesale electric | | (1.1 | ) |
Other | | 2.2 | |
Increase in Consolidated Gross Margin | | $ | 8.9 | |
This $8.9 million increase includes the following:
· | An increase in retail electric volumes due primarily to warmer summer weather in South Dakota; |
· | An interim increase in Montana electric rates (subject to refund); |
· | An increase in DSM lost revenues recovered through our supply tracker related to efficiency measures implemented by customers; |
· | A loss recorded in our other segment in 2009 on a capacity contract; |
· | Improved transmission capacity revenues; |
· | An increase in Montana property taxes included in a tracker as compared with the same period in 2009; |
· | Decreased cost of sales due to a settlement to recover previously incurred reclamation costs associated with the coal supply at Colstrip; and |
· | Higher revenues for operating expenses recovered in supply trackers, primarily related to customer efficiency programs. |
Partially offsetting these increases were higher QF related supply costs due to higher prices and volumes, and lower average wholesale electric prices in South Dakota.
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Operating Expenses (excluding cost of sales) | | | | | | | | | |
Operating, general and administrative | | $ | 173.9 | | $ | 184.2 | | $ | (10.3 | ) | (5.6 | )% |
Property and other taxes | | 68.5 | | 63.4 | | 5.1 | | 8.0 | |
Depreciation | | 68.7 | | 67.0 | | 1.7 | | 2.5 | |
| | $ | 311.1 | | $ | 314.6 | | $ | (3.5 | ) | (1.1 | )% |
Consolidated operating, general and administrative expenses were $173.9 million for the nine months ended September 30, 2010 as compared with $184.2 million for the nine months ended September 30, 2009. Primary components of this change include the following:
| | Operating, General & Administrative Expenses | |
| | 2010 vs. 2009 | |
| | (Millions of Dollars) | |
Insurance reserves | | $ | (4.1 | ) |
Postretirement health care | | (3.0 | ) |
Pension | | (2.9 | ) |
Labor | | (1.5 | ) |
Jointly owned plant operations | | (0.7 | ) |
Bad debt expense | | (0.7 | ) |
Legal and professional fees | | (0.5 | ) |
Insurance recoveries and settlements | | 1.5 | |
Operating and maintenance | | 1.1 | |
Operating expenses recovered in supply trackers | | 0.9 | |
Other | | (0.4 | ) |
Decrease in Operating, General & Administrative Expenses | | $ | (10.3 | ) |
The decrease in operating, general and administrative expenses of $10.3 million was primarily due to the following:
· | Lower insurance reserves due to claims incurred in the prior year and a favorable arbitration decision in the first quarter of 2010; |
· | Lower postretirement health care costs due to a plan amendment during the fourth quarter of 2009; |
· | Lower pension expense; however, based on current assumptions we expect the annual pension expense for 2010 to be comparable with 2009 due to the regulatory treatment of our Montana pension plan; |
· | Decreased labor costs primarily from a combination of more time spent by employees on capital projects rather than maintenance projects (which are expensed) and lower severance costs, offset in part by compensation increases; |
· | Lower plant operations costs due to scheduled maintenance and an unplanned outage at Colstrip Unit 4 for a rotor repair in 2009, offset in part by increased costs related to chemical injection technologies installed at the Colstrip plant in 2009; |
· | Lower bad debt expense based on lower average customer receivables; and |
· | Decreased legal and professional fees primarily related to outstanding litigation. |
These decreases were offset in part by:
· | A net decrease in insurance recoveries and settlements due to $4.6 million received during the first nine months of 2010 as compared with $6.4 million received during the first nine months of 2009; |
· | Increased operating and maintenance costs; and |
· | Higher operating expenses recovered from customers through supply trackers primarily related to costs incurred for customer efficiency programs, which have no impact on operating income. |
Property and other taxes were $68.5 million for the nine months ended September 30, 2010 as compared with $63.4 million in the same period of 2009. This increase was primarily due to higher assessed property valuations in Montana.
Depreciation expense was $68.7 million for the nine months ended September 30, 2010 as compared with $67.0 million in the same period of 2009. This increase was primarily due to plant additions.
Consolidated operating income for the nine months ended September 30, 2010 was $117.3 million, as compared with $104.9 million in the same period of 2009. The increase was primarily due to the $8.9 million increase in gross margin and the $3.5 million decrease in operating expenses discussed above.
Consolidated interest expense for the nine months ended September 30, 2010 was $49.4 million, a decrease of $1.0 million, or 2.0%, from 2009, with an increase in expense due primarily to increased debt outstanding offset by $2.7 million capitalized for the debt portion of AFUDC, primarily related to the Mill Creek Generating Station.
Consolidated other income for the nine months ended September 30, 2010 was $4.9 million, as compared with $1.2 million in the same period of 2009. This includes an increase of approximately $3.8 million capitalized for the equity portion of AFUDC, primarily related to the Mill Creek Generating Station.
Consolidated income tax expense for the nine months ended September 30, 2010 was $18.0 million as compared with $7.9 million in the same period of 2009. The effective tax rate in 2010 was 24.7% as compared with 14.1% for the same period of 2009, and we expect our effective tax rate for 2010 to be approximately 25%. The reduction in effective tax rate versus the statutory rate in 2010 is primarily due to a tax benefit of $6.9 million recognized for repair costs and the release of valuation allowance of approximately $2.2 million against certain state NOLs.
Consolidated net income for the nine months ended September 30, 2010 was $54.8 million as compared with $47.8 million in the same period of 2009. This increase was primarily due to higher operating income and higher other income, offset in part by higherlower income tax expense as discussed above.
ELECTRIC SEGMENT
Three Months Ended September 30, 2010March 31, 2011 Compared with the Three Months Ended September 30, 2009March 31, 2010
| | Results | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Retail revenue | | $ | 173.0 | | $ | 163.3 | | $ | 9.7 | | 5.9 | % |
Transmission | | 12.5 | | 11.2 | | 1.3 | | 11.6 | |
Wholesale | | 11.5 | | 11.1 | | 0.4 | | 3.6 | |
Regulatory amortization and other | | 6.6 | | 13.1 | | (6.5 | ) | (49.6 | ) |
Total Revenues | | 203.6 | | 198.7 | | 4.9 | | 2.5 | |
Total Cost of Sales | | 92.7 | | 92.6 | | 0.1 | | 0.1 | |
Gross Margin | | $ | 110.9 | | $ | 106.1 | | $ | 4.8 | | 4.5 | % |
| | Revenues | | Megawatt Hours (MWH) | | Avg. Customer Counts | |
| | 2010 | | 2009 | | 2010 | | 2009 | | 2010 | | 2009 | |
| | (in thousands) | | | | | |
Retail Electric | | | | | | | | | | | | | |
Montana | | $ | 51,731 | | $ | 49,248 | | 523 | | 515 | | 269,750 | | 267,382 | |
South Dakota | | 12,441 | | 10,776 | | 149 | | 122 | | 48,464 | | 48,256 | |
Residential | | 64,172 | | 60,024 | | 672 | | 637 | | 318,214 | | 315,638 | |
Montana | | 73,345 | | 70,030 | | 828 | | 828 | | 61,125 | | 60,602 | |
South Dakota | | 17,372 | | 16,539 | | 248 | | 230 | | 11,911 | | 11,792 | |
Commercial | | 90,717 | | 86,569 | | 1,076 | | 1,058 | | 73,036 | | 72,394 | |
Industrial | | 8,612 | | 8,079 | | 694 | | 717 | | 71 | | 71 | |
Other | | 9,462 | | 8,592 | | 80 | | 75 | | 7,607 | | 7,728 | |
Total Retail Electric | | $ | 172,963 | | $ | 163,264 | | 2,522 | | 2,487 | | 398,928 | | 395,831 | |
Wholesale Electric | | | | | | | | | | | | | |
Montana | | $ | 10,524 | | $ | 9,464 | | 205 | | 126 | | N/A | | N/A | |
South Dakota | | 1,040 | | 1,636 | | 53 | | 64 | | N/A | | N/A | |
Total Wholesale Electric | | $ | 11,564 | | $ | 11,100 | | 258 | | 190 | | N/A | | N/A | |
| | 2010 as compared with: | |
Cooling Degree Days | | 2009 | | Historic Average | |
Montana | | 29% cooler | | 25% cooler | |
South Dakota | | 87% warmer | | 17% warmer | |
|
| | | | | | | | | | | | | | |
| Results |
| 2011 | | 2010 | | Change | | % Change |
| (in millions) |
Retail revenue | $ | 196.2 | | | $ | 170.4 | | | $ | 25.8 | | | 15.1 | % |
Transmission | 10.9 | | | 11.5 | | | (0.6 | ) | | (5.2 | ) |
Wholesale | 0.3 | | | 11.0 | | | (10.7 | ) | | (97.3 | ) |
Regulatory amortization and other | 1.2 | | | 10.9 | | | (9.7 | ) | | (89.0 | ) |
Total Revenues | 208.6 | | | 203.8 | | | 4.8 | | | 2.4 | |
Total Cost of Sales | 84.4 | | | 91.0 | | | (6.6 | ) | | (7.3 | ) |
Gross Margin | $ | 124.2 | | | $ | 112.8 | | | $ | 11.4 | | | 10.1 | % |
|
| | | | | | | | | | | | | | | | | | | |
| Revenues | | Megawatt Hours (MWH) | | Avg. Customer Counts |
| 2011 | | 2010 | | 2011 | | 2010 | | 2011 | | 2010 |
| (in thousands) | | | | |
Retail Electric | | | | | | | | | | | |
Montana | $ | 75,663 | | | $ | 63,596 | | | 731 | | | 680 | | | 272,526 | | | 270,923 | |
South Dakota | 13,393 | | | 12,845 | | | 179 | | | 176 | | | 48,705 | | | 48,422 | |
Residential | 89,056 | | | 76,441 | | | 910 | | | 856 | | | 321,231 | | | 319,345 | |
Montana | 77,133 | | | 66,218 | | | 820 | | | 788 | | | 61,459 | | | 60,799 | |
South Dakota | 16,309 | | | 15,808 | | | 238 | | | 238 | | | 11,789 | | | 11,622 | |
Commercial | 93,442 | | | 82,026 | | | 1,058 | | | 1,026 | | | 73,248 | | | 72,421 | |
Industrial | 9,183 | | | 7,767 | | | 692 | | | 676 | | | 72 | | | 71 | |
Other | 4,520 | | | 4,205 | | | 24 | | | 24 | | | 4,620 | | | 4,623 | |
Total Retail Electric | $ | 196,201 | | | $ | 170,439 | | | 2,684 | | | 2,582 | | | 399,171 | | | 396,460 | |
Wholesale Electric | | | | | | | | | | | |
Montana | $ | — | | | $ | 9,934 | | | — | | | 204 | | | N/A | | | N/A | |
South Dakota | 309 | | | 1,078 | | | 31 | | | 39 | | | N/A | | | N/A | |
Total Wholesale Electric | $ | 309 | | | $ | 11,012 | | | 31 | | | 243 | | | — | | | — | |
The following summarizes the components of the changes in electric margin for the three months ended September 30, 2010March 31, 2011 and 2009:2010:
| | Gross Margin | |
| | 2010 vs. 2009 | |
| | (Millions of Dollars) | |
Retail volumes | | $ | 2.7 | |
Montana interim rate increase (subject to refund) | | 1.6 | |
Transmission capacity | | 1.3 | |
Montana property tax tracker | | (1.0 | ) |
South Dakota wholesale | | | (0.5 | ) |
Other | | | 0.7 | |
Increase in Gross Margin | | $ | 4.8 | |
|
| | | |
| Gross Margin 2011 vs. 2010 |
| (Millions of Dollars) |
DGGS interim rates (subject to refund) | $ | 7.5 | |
Retail volumes | 3.1 | |
Montana electric rate increase | 1.9 | |
Expiration of a power sales agreement | 1.5 | |
South Dakota wholesale | (0.7 | ) |
Operating expenses recovered in supply trackers | (0.7 | ) |
Transmission capacity | (0.6 | ) |
Reclamation settlement received during 2010 | (0.5 | ) |
Other | (0.1 | ) |
Increase in Gross Margin | $ | 11.4 | |
The improvement in margin and the change in volumes areis primarily due to DGGS interim rates, as discussed above, an increase in retail volumes due primarily to warmer summercolder weather in South DakotaMontana and to a lesser extent increased average usage in Montana,customer growth, an interim increase in Montana rates, (subject to refund) and an increasethe expiration in transmission capacity revenues due to higher demand to transmit energy for others across our lines. These increases were offset in part byDecember 2010 of a decrease in property taxes included in a tracker as compared with the same period in 2009 and lower average wholesale prices in South Dakota. Revenuespower sales agreement related to property taxes fluctuate depending upon volumes and estimated property tax expense. The decrease in regulatory amortization is due to timing differences between when we incur electric supply costs and when we recover these costs in rates from our customers.
Retail residential and commercial volumes increased from favorable weather and customer growth, while industrial volumes declined in Montana due primarily to the weaker economy. Wholesale volumes increased in Montana due to higher plant availability, while wholesale volumes decreased in South Dakota with lower plant utilization due to market conditions.
Nine Months Ended September 30, 2010 Compared with the Nine Months Ended September 30, 2009
| | Results | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Retail revenue | | $ | 493.1 | | $ | 494.8 | | $ | (1.7 | ) | (0.3 | )% |
Transmission | | 35.0 | | 33.5 | | 1.5 | | 4.5 | |
Wholesale | | 34.5 | | 32.8 | | 1.7 | | 5.2 | |
Regulatory amortization and other | | 29.7 | | 19.0 | | 10.7 | | 56.3 | |
Total Revenues | | 592.3 | | 580.1 | | 12.2 | | 2.1 | |
Total Cost of Sales | | 266.1 | | 258.9 | | 7.2 | | 2.8 | |
Gross Margin | | $ | 326.2 | | $ | 321.2 | | $ | 5.0 | | 1.6 | % |
| | Revenues | | Megawatt Hours (MWH) | | Avg. Customer Counts | |
| | 2010 | | 2009 | | 2010 | | 2009 | | 2010 | | 2009 | |
| | (in thousands) | | | | | |
Retail Electric | | | | | | | | | | | | | |
Montana | | $ | 162,540 | | $ | 162,708 | | 1,698 | | 1,682 | | 270,348 | | 268,337 | |
South Dakota | | 34,775 | | 33,818 | | 435 | | 402 | | 48,435 | | 48,211 | |
Residential | | 197,315 | | 196,526 | | 2,133 | | 2,084 | | 318,783 | | 316,548 | |
Montana | | 203,203 | | 203,324 | | 2,357 | | 2,373 | | 60,900 | | 60,374 | |
South Dakota | | 48,118 | | 47,960 | | 700 | | 660 | | 11,794 | | 11,656 | |
Commercial | | 251,321 | | 251,284 | | 3,057 | | 3,033 | | 72,694 | | 72,030 | |
Industrial | | 24,508 | | 27,292 | | 2,055 | | 2,183 | | 71 | | 72 | |
Other | | 20,002 | | 19,743 | | 145 | | 148 | | 6,011 | | 6,070 | |
Total Retail Electric | | $ | 493,146 | | $ | 494,845 | | 7,390 | | 7,448 | | 397,559 | | 394,720 | |
Wholesale Electric | | | | | | | | | | | | | |
Montana | | $ | 30,689 | | $ | 28,355 | | 597 | | 426 | | N/A | | N/A | |
South Dakota | | 3,796 | | 4,429 | | 182 | | 161 | | N/A | | N/A | |
Total Wholesale Electric | | $ | 34,485 | | $ | 32,784 | | 779 | | 587 | | N/A | | N/A | |
| | 2010 as compared with: | |
Cooling Degree Days | | 2009 | | Historic Average | |
Montana | | 28% cooler | | 27% cooler | |
South Dakota | | 85% warmer | | 15% warmer | |
The following summarizes the components of the changes in electric margin for the nine months ended September 30, 2010 as compared with 2009 as follows:
| | Gross Margin | |
| | 2010 vs. 2009 | |
| | (Millions of Dollars) | |
Retail volumes | | $ | 2.0 | |
Montana interim rate increase (subject to refund) | | 1.6 | |
DSM lost revenues | | 1.6 | |
Transmission capacity | | 1.5 | |
Reclamation settlement | | 1.0 | |
Operating expenses recovered in supply tracker | | 0.9 | |
Montana property tax tracker | | 0.7 | |
QF supply costs | | (3.6 | ) |
South Dakota wholesale | | | (1.1 | ) |
Other | | | 0.4 | |
Increase in Gross Margin | | $ | 5.0 | |
The improvement in margin and the change in volumes are primarily due to:
· | An increase in retail volumes due to warmer summer weather in South Dakota, offset in part by reduced industrial demand in Montana relating to the weak economic climate; |
· | An interim increase in Montana rates (subject to refund); |
· | An increase in DSM lost revenues recovered through our supply tracker related to efficiency measures implemented by customers; |
· | An increase in transmission capacity revenues due to higher demand to transmit energy for others across our lines; |
· | Decreased cost of sales due to a settlement to recover previously incurred reclamation costs associated with the coal supply at Colstrip; |
· | Higher revenues for operating expenses recovered from customers through the supply trackers, primarily related to customer efficiency programs; and |
· | An increase in Montana property taxes included in a tracker as compared with 2009. |
Colstrip Unit 4.
These increases were offset in part by:by lower wholesale sales in South Dakota at lower average prices, lower revenues for operating expenses recovered in supply trackers primarily related to customer efficiency programs, a decline in transmission capacity demand, and the inclusion in the first quarter of 2010 of a settlement to recover previously incurred reclamation costs associated with the coal supply at Colstrip, which reduced cost of sales. Demand for transmission capacity can fluctuate substantially from year to year based on weather and market conditions in states to the South and West. For example, increased availability of local natural gas fired generation due to low natural gas prices and increased generation in the Pacific Northwest due to favorable hydro conditions may make it more economically viable to utilize local generation rather than transmit electricity from Montana over our transmission lines. We expect Pacific Northwest hydro conditions will continue to negatively affect demand for transmission capacity during the second quarter of 2011.
· | Higher QF related supply costs due to higher prices and volumes; and |
Retail volumes increased primarily due to colder weather and customer growth. Wholesale volumes decreased in South Dakota from lower plant utilization due to market conditions. We no longer have Montana wholesale volumes due to the expiration of a remaining wholesale supply contract associated with Colstrip. Beginning January 1, 2011 these volumes are used to supply our retail demand.
· | Lower average wholesale prices in South Dakota. |
NATURAL GAS SEGMENT
Three Months Ended September 30, 2010March 31, 2011 Compared with the Three Months Ended September 30, 2009March 31, 2010
| | Results | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Retail revenue | | $ | 25.4 | | $ | 23.0 | | $ | 2.4 | | 10.4 | % |
Wholesale and other | | 11.5 | | 11.2 | | 0.3 | | 2.7 | |
Total Revenues | | 36.9 | | 34.2 | | 2.7 | | 7.9 | |
Total Cost of Sales | | 13.2 | | 12.3 | | 0.9 | | 7.3 | |
Gross Margin | | $ | 23.7 | | $ | 21.9 | | $ | 1.8 | | 8.2 | % |
|
| | | | | | | | | | | | | | |
| Results |
| 2011 | | 2010 | | Change | | % Change |
| (in millions) |
Retail revenue | $ | 121.0 | | | $ | 118.4 | | | $ | 2.6 | | | 2.2 | % |
Wholesale and other | 8.2 | | | 11.6 | | | (3.4 | ) | | (29.3 | ) |
Total Revenues | 129.2 | | | 130.0 | | | (0.8 | ) | | (0.6 | ) |
Total Cost of Sales | 77.6 | | | 81.8 | | | (4.2 | ) | | (5.1 | ) |
Gross Margin | $ | 51.6 | | | $ | 48.2 | | | $ | 3.4 | | | 7.1 | % |
| | Revenues | | Dekatherms (Dkt) | | Customer Counts | |
| | 2010 | | 2009 | | 2010 | | 2009 | | 2010 | | 2009 | |
| | (in thousands) | | | | | |
Retail Gas | | | | | | | | | | | | | |
Montana | | $ | 11,391 | | $ | 10,259 | | 940 | | 822 | | 156,925 | | 155,546 | |
South Dakota | | 1,714 | | 1,698 | | 120 | | 124 | | 36,844 | | 36,353 | |
Nebraska | | 2,136 | | 1,973 | | 157 | | 164 | | 36,121 | | 36,008 | |
Residential | | 15,241 | | 13,930 | | 1,217 | | 1,110 | | 229,890 | | 227,907 | |
Montana | | 6,476 | | 5,987 | | 582 | | 527 | | 21,920 | | 21,780 | |
South Dakota | | 1,557 | | 1,357 | | 198 | | 212 | | 5,810 | | 5,749 | |
Nebraska | | 1,875 | | 1,560 | | 299 | | 297 | | 4,488 | | 4,408 | |
Commercial | | 9,908 | | 8,904 | | 1,079 | | 1,036 | | 32,218 | | 31,937 | |
Industrial | | 160 | | 134 | | 16 | | 12 | | 282 | | 293 | |
Other | | 61 | | 58 | | 6 | | 5 | | 146 | | 142 | |
Total Retail Gas | | $ | 25,370 | | $ | 23,026 | | 2,318 | | 2,163 | | 262,536 | | 260,279 | |
|
| | | | | | | | | | | | | | | | | | | |
| Revenues | | Dekatherms (Dkt) | | Customer Counts |
| 2011 | | 2010 | | 2011 | | 2010 | | 2011 | | 2010 |
| (in thousands) | | | | |
Retail Gas | | | | | | | | | | | |
Montana | $ | 51,100 | | | $ | 44,620 | | | 5,638 | | | 4,954 | | | 159,029 | | | 158,294 | |
South Dakota | 13,306 | | | 14,551 | | | 1,599 | | | 1,567 | | | 37,712 | | | 37,574 | |
Nebraska | 11,486 | | | 12,833 | | | 1,382 | | | 1,448 | | | 36,949 | | | 36,875 | |
Residential | 75,892 | | | 72,004 | | | 8,619 | | | 7,969 | | | 233,690 | | | 232,743 | |
Montana | 26,438 | | | 22,413 | | | 2,915 | | | 2,484 | | | 22,273 | | | 22,090 | |
South Dakota | 9,302 | | | 13,268 | | | 1,332 | | | 1,732 | | | 5,954 | | | 5,962 | |
Nebraska | 8,242 | | | 9,506 | | | 1,287 | | | 1,355 | | | 4,636 | | | 4,606 | |
Commercial | 43,982 | | | 45,187 | | | 5,534 | | | 5,571 | | | 32,863 | | | 32,658 | |
Industrial | 691 | | | 826 | | | 78 | | | 94 | | | 282 | | | 292 | |
Other | 449 | | | 390 | | | 58 | | | 51 | | | 145 | | | 146 | |
Total Retail Gas | $ | 121,014 | | | $ | 118,407 | | | 14,289 | | | 13,685 | | | 266,980 | | | 265,839 | |
|
| | | | |
| | 20102011 as compared with: | |
Heating Degree-Days | | 20092010 | | Historic Average | |
Montana | | 60% cooler 11% Colder | | 4% cooler | Colder |
South Dakota | | 45% warmer 2% Colder | | 48% warmer | 11% Colder |
Nebraska | | 54% warmer 3% Warmer | | 54% warmer | 5% Colder |
The following summarizes the components of the changes in natural gas margin for the three months ended September 30, 2010March 31, 2011 and 2009:2010:
| | Gross Margin | |
| | 2010 vs. 2009 | |
| | (Millions of Dollars) | |
Montana property tax tracker | | $ | 1.2 | |
Retail volumes | | 0.4 | |
Other | | 0.2 | |
Increase in Gross Margin | | $ | 1.8 | |
|
| | | |
| Gross Margin 2011 vs. 2010 |
| (Millions of Dollars) |
Retail volumes | $ | 3.1 | |
Operating expenses recovered in supply trackers | 0.7 | |
Montana natural gas rate decrease | (0.3 | ) |
Other | (0.1 | ) |
Increase in Gross Margin | $ | 3.4 | |
This increase in margin iswas primarily due to an increasecolder winter weather in Montana property taxes includedand South Dakota and higher revenues for operating expenses recovered in supply trackers primarily related to customer efficiency programs. These increases were offset in part by a tracker as compared with the same period in 2009 and increased retail gas volumesdecrease in Montana due to higher average usage per customer. Revenues related to property taxes fluctuate depending upon volumes and estimated property tax expense. Due to the seasonality of our business, natural gas volumes during the third quarter are impacted to a lesser extent by changes in weather. Heating degree-days for the third quarter reflect activity during the month of September.rates. Our wholesale and other revenues are largely gross margin neutral as they are offset by changes in cost of sales.
Nine Months Ended September 30, 2010 Compared with the Nine Months Ended September 30, 2009
| | Results | |
| | 2010 | | 2009 | | Change | | % Change | |
| | (in millions) | |
Retail revenue | | $ | 189.4 | | $ | 217.9 | | $ | (28.5 | ) | (13.1 | )% |
Wholesale and other | | 36.5 | | 36.4 | | 0.1 | | 0.3 | |
Total Revenues | | 225.9 | | 254.3 | | (28.4 | ) | (11.2 | ) |
Total Cost of Sales | | 124.6 | | 154.1 | | (29.5 | ) | (19.1 | ) |
Gross Margin | | $ | 101.3 | | $ | 100.2 | | $ | 1.1 | | 1.1 | % |
| | Revenues | | Dekatherms (Dkt) | | Customer Counts | |
| | 2010 | | 2009 | | 2010 | | 2009 | | 2010 | | 2009 | |
| | (in thousands) | | | | | |
Retail Gas | | | | | | | | | | | | | |
Montana | | $ | 75,852 | | $ | 86,934 | | 8,198 | | 8,338 | | 157,694 | | 156,662 | |
South Dakota | | 20,778 | | 26,132 | | 2,141 | | 2,251 | | 37,167 | | 36,676 | |
Nebraska | | 19,248 | | 22,432 | | 2,045 | | 1,981 | | 36,457 | | 36,360 | |
Residential | | 115,878 | | 135,498 | | 12,384 | | 12,570 | | 231,318 | | 229,698 | |
Montana | | 38,545 | | 44,401 | | 4,188 | | 4,311 | | 22,029 | | 21,945 | |
South Dakota | | 18,474 | | 19,984 | | 2,438 | | 2,282 | | 5,880 | | 5,810 | |
Nebraska | | 14,617 | | 16,152 | | 2,175 | | 2,094 | | 4,542 | | 4,496 | |
Commercial | | 71,636 | | 80,537 | | 8,801 | | 8,687 | | 32,451 | | 32,251 | |
Industrial | | 1,239 | | 1,149 | | 140 | | 114 | | 287 | | 296 | |
Other | | 625 | | 727 | | 80 | | 79 | | 146 | | 142 | |
Total Retail Gas | | $ | 189,378 | | $ | 217,911 | | 21,405 | | 21,450 | | 264,202 | | 262,387 | |
| | 2010 as compared with: | |
Heating Degree-Days | | 2009 | | Historic Average | |
Montana
| | 3% cooler | | 3% warmer | |
South Dakota
| | 5% warmer | | Remained flat | |
Nebraska
| | 4% cooler | | 2% cooler | |
The following summarizes the components of the changes in natural gas margin for the nine months ended September 30, 2010 and 2009:
| | Gross Margin | |
| | 2010 vs. 2009 | |
| | (Millions of Dollars) | |
Montana property tax tracker | | $ | 0.6 | |
Other | | 0.5 | |
Increase in Gross Margin | | $ | 1.1 | |
This increase in margin is primarily due to an increase in property taxes included in a tracker as compared with the same period in 2009. In addition, average natural gas supply prices decreasedincreased resulting in lowerhigher retail revenues and cost of sales in 20102011 as compared with 2009,2010, with no impact to gross margin.
Retail residential and commercial volumes increased in Montana due to colder weather and customer growth. Retail residential volumes increased in South Dakota due to colder weather, while commercial volumes declined in South Dakota due primarily to higher usage for grain drying requirements during the first quarter of 2010.
LIQUIDITY AND CAPITAL RESOURCES
We utilize short-term borrowings, including our revolver availabilityrevolving credit facility and commercial paper program to manage our cash flows due to the seasonality of our business, and utilize any cash on hand in excess of current operating requirements to invest in our business and reduce borrowings. As of September 30, 2010,March 31, 2011, our total net liquidity was approximately $147.1$170.7 million, including $6.6$7.2 million of cash and $140.5$163.5 million of revolving credit facility availability. RevolverRevolving credit facility availability was $142.5$186.5 million as of OctoberApril 22, 2010.2011.
The following table presents additional information about short term borrowings during the first quarter of 2011 (in millions):
|
| | | |
March 31, 2011 | Short-term Borrowings |
Amount outstanding | $ | 86.0 | |
Weighted average interest rate | 0.42 | % |
Daily average amount outstanding | $ | 103.0 | |
Weighted average interest rate | 2.14 | % |
Maximum amount outstanding | $ | 153.0 | |
Factors Impacting our Liquidity
Supply Costs -Our operations are subject to seasonal fluctuations in cash flow. During the heating season, which is primarily from November through March, cash receipts from natural gas sales and transportation services typically exceed cash requirements. During the summer months, cash on hand, together with the seasonal increase in cash flows and utilization of our existing revolver, are used to purchase natural gas to place in storage, perform maintenance and make capital improvements.
The effect of this seasonality on our liquidity is also impacted by changes in the market prices of our electric and natural gas supply, which is recovered through various monthly cost tracking mechanisms. These energy supply tracking mechanisms are designed to provide stable and timely recovery of supply costs on a monthly basis during the July to June annual tracking period, with an adjustment in the following annual tracking period to correct for any under or over collection in our monthly trackers. Due to the lag between our purchases of electric and natural gas commodities and revenue receipt from customers, cyclical over and under collection situations arise consistent with the seasonal fluctuations discussed above; therefore we usually under collect in the fall and winter and over collect in the spring. Fluctuations in r ecoveriesrecoveries under our cost tracking mechanisms can have a significant effect on cash flow from operations and make year-to-year comparisons difficult.
As of September 30, 2010,March 31, 2011, we are under collected on our current Montana natural gas and electric trackers by approximately $0.7$2.7 million, as compared with an under collection of $19.8$14.1 million as of December 31, 2009,2010, and an under collection of $4.8$4.0 million as of September 30, 2009.March 31, 2010.
Dodd-FrankGrowth Capital Expenditures –In July 2009, we began construction of the Mill Creek Generating Station, a 150 MW natural gas fired facility, estimated to cost $202 million. During the nine months ended September 30, 2010, we capitalized approximately $70.2 million in construction work in process related to this project. We expect to spend an additional $11 million on this project during the remainder of 2010.
Dodd-Frank – On July 21, 2010, President Obama signed into law new federal financial reform legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act. This financial reform legislation includes a provision that requires over-the-counter derivative transactions to be executed through an exchange or centrally cleared. Such clearing requirements would result in a significant change from our current practice of bilateral transactions and negotiated credit terms. An exemption to such clearing requirements is outlined in the legislation, and included in proposed regulations, for end users that enter into hedges to mitigate commercial risk. We expect to qualify under the end user exemption. At the same time, the
legislation includes provisions under which the Commodity Futures Trading Commission (CFTC) may impose collateral requirements for transactions, including those that are used to hedge commercial risk. FinalIn addition, although the CFTC's proposed rules on major provisions in the legislation, like newwould not impose specific margin requirements will be established through rulemakingson end users, the CFTC's proposed regulations would require swap dealers and will not take effect untilmajor swap participants to have credit support arrangements with their end user counterparties. In addition, to the later of July 16, 2011 or at least 60 days following publication ofextent that our counterparties were banking entities, proposed rules issued by banking regulators would require the applicable final rule.banking entities to calculate credit exposure limits for end user counterparties and collect margin when the credit exposure exceeds the limit.
DespiteTherefore, despite the end user exemption, concern remains that counterparties that do not qualify for the exemption will pass along the increased cost and margin requirements through higher prices and reductions in unsecured credit limits. We are unable to assess the impact of the financial reform legislation pending issuance of the final regulations implementing these provisions.
provisions, which will not take effect until the later of July 16, 2011, or at least 60 days following publication of the applicable final rule.
Credit Ratings
Credit ratings impact our ability to obtain short- and long-term financing, the cost of such financing, and vendor payment terms, including collateral requirements. These ratings indicate the agencies’ assessment of our ability to pay interest and principal when due on our debt. Fitch Ratings (Fitch), Moody’s Investors Service (Moody’s) and Standard and Poor’s Rating GroupRatings Service (S&P) are independent credit-rating agencies that rate our debt securities. As of OctoberApril 22, 2010,2011, our current ratings with these agencies are as follows:
|
| | | | | | | |
| Senior Secured Rating | | Senior Unsecured Rating | | Commercial Paper | | Outlook |
Fitch | | A- | | BBB+ | | N/A | | Stable |
Moody’s | A2 | | A3Baa1 | | Baa2Prime-2 | | PositiveStable |
S&P | | A- | | BBB | | Stable |
A-2 | | | | | | Stable |
In general, less favorable credit ratings make debt financing more costly and more difficult to obtain on terms that are favorable to us and impact our trade credit availability. A security rating is not a recommendation to buy, sell or hold securities. Such rating may be subject to revision or withdrawal at any time by the credit rating agency and each rating should be evaluated independently of any other rating.
Cash Flows
The following table summarizes our consolidated cash flows (in millions):
| | Nine Months Ended September 30, | |
| | 2010 | | 2009 | |
Operating Activities | | | | | |
Net income | | $ | 54.8 | | $ | 47.8 | |
Non-cash adjustments to net income | | 98.7 | | 95.4 | |
Changes in working capital | | 24.9 | | 39.2 | |
Other | | 9.9 | | (53.1 | ) |
| | 188.3 | | 129.3 | |
| | | | | |
Investing Activities | | | | | |
Property, plant and equipment additions | | (178.1 | ) | (115.8 | ) |
Sale of assets | | — | | 0.3 | |
| | (178.1 | ) | (115.5 | ) |
| | | | | |
Financing Activities | | | | | |
Net borrowing of debt | | 36.9 | | 28.0 | |
Dividends on common stock | | (36.8 | ) | (36.1 | ) |
Other | | (8.1 | ) | (11.0 | ) |
| | (8.0 | ) | (19.1 | ) |
| | | | | |
Net Increase (Decrease) in Cash and Cash Equivalents | | $ | 2.2 | | $ | (5.3 | ) |
Cash and Cash Equivalents, beginning of period | | $ | 4.3 | | $ | 11.3 | |
Cash and Cash Equivalents, end of period | | $ | 6.5 | | $ | 6.0 | |
|
| | | | | | | |
| Three Months Ended March 31, |
| 2011 | | 2010 |
Operating Activities | | | |
Net income | $ | 32.6 | | | $ | 28.7 | |
Non-cash adjustments to net income | 45.6 | | | 39.9 | |
Changes in working capital | 41.2 | | | 33.0 | |
Other | 2.7 | | | 4.7 | |
| 122.1 | | | 106.3 | |
| | | |
Investing Activities | | | |
Property, plant and equipment additions | (37.6 | ) | | (57.8 | ) |
| (37.6 | ) | | (57.8 | ) |
| | | |
Financing Activities | | | |
Net repayment of debt | (70.6 | ) | | (33.4 | ) |
Dividends on common stock | (13.0 | ) | | (12.2 | ) |
Other | 0.1 | | | (0.1 | ) |
| (83.5 | ) | | (45.7 | ) |
| | | |
Net Increase in Cash and Cash Equivalents | $ | 1.0 | | | $ | 2.8 | |
Cash and Cash Equivalents, beginning of period | $ | 6.2 | | | $ | 4.3 | |
Cash and Cash Equivalents, end of period | $ | 7.2 | | | $ | 7.1 | |
Cash Provided by Operating Activities
As of September 30, 2010,March 31, 2011, cash and cash equivalents were $6.6$7.2 million as compared with $4.3$6.2 million at December 31, 20092010 and $6.0$7.1 million at September 30, 2009.March 31, 2010. Cash provided by operating activities totaled $188.3$122.1 million for the ninethree months ended September 30, 2010March 31, 2011 as compared with $129.3$106.3 million during the ninethree months ended September 30, 2009.March 31, 2010. This increase in operating cash flows is primarily related to a decreaseimprovements in contributions tothe collection of our qualified pension plans of $64.4 million as compared with the same period in 2009supply costs discussed above and an increase in deposits received related to transmission interconnection requests for network upgrades on our existing transmission system of approximately $12.0 million, which were offset in part by a $10.8 million prepayment of a power purchase agreement in 2009.increased net income.
Cash Used in Investing Activities
Cash used in investing activities increaseddecreased by approximately $62.6$20.2 million as compared with the nine months ended September 30, 2009first quarter of 2010 due primarily to increased property, plant and equipment additions related to the Mill Creek Generating StationDGGS project and Battle Creek Field acquisition as discussed above.in the prior year.
Cash Used in Financing Activities
Cash used in financing activities totaled approximately $8.0$83.5 million in the first quarter of 2011 as compared with approximately $45.7 million during the ninethree months ended September 30, 2010 as compared with $19.1 million during the same period in 2009.March 31, 2010. During the nine months ended September 30,first quarter of 2011, net cash used in financing activities consisted of the net revolving credit facility repayments of $153.0 million, net issuance of commercial paper of $86.0 million, the repayment of long-term debt of $3.6 million and the payment of dividends of $13.0 million. During the first quarter of 2010 we made net debt repayments of $6.1 million, received proceeds from net revolver borrowings of $43.0 million, paid deferred financing costs of $8.0$33.4 million and paid dividends on common stock of $36.7 million. During the nine months ended September 30, 2009 we received net proceeds from the issuance of debt of $249.8 million, made net debt repayments of $221.8 million, paid deferred financing costs of $10.4 million and paid dividends on common stock of $36.1$12.2 million.
Financing Activities -On May 27, 2010February 8, 2011, we issued $161entered into a commercial paper program under which we may issue unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $250 million aggregate principal amountto provide an additional financing source for our short-term liquidity needs. The maturities of Montana First Mortgage Bonds at a fixed interest ratethe commercial paper issuances will vary, but may not exceed 270 days from the date of 5.01% maturing May 1, 2025. At the same time, we also issued $64issue. Commercial paper issuances are supported by available capacity under our $250 million aggregate principal amountunsecured revolving line of South Dakota First Mortgage Bonds at a fixed interest rate of 5.01% maturing May 1, 2025. We used the proceeds to redeem our 5.875%, $225 million Senior Secured Notes due 2014.credit, which expires in June 2012.
Sources and Uses of Funds
We require liquidity to support and grow our business and use our liquidity for working capital needs, capital expenditures, investments in or acquisitions of assets, to repay debt and, from time to time, to repurchase common stock. We anticipate that our ongoing liquidity requirements will be satisfied through a combination of operating cash flows, borrowings, and as necessary, the issuance of debt or equity securities, consistent with our objective of maintaining a capital structure that will support a strong investment grade credit rating on a long-term basis. The amount of capital expenditures and dividends are subject to certain factors including the use of existing cash, cash equivalents and the receipt of cash from operations. A material adverse change in operations or available financing could impact our ability to fund our curre ntcurrent liquidity and capital resource requirements, and we may defer capital expenditures as necessary.
Contractual Obligations and Other Commitments
We have a variety of contractual obligations and other commitments that require payment of cash at certain specified periods. The following table summarizes our contractual cash obligations and commitments as of September 30, 2010.March 31, 2011. See our Annual Report on Form 10-K for the year ended December 31, 20092010 for additional discussion.
| | Total | | 2010 | | 2011 | | 2012 | | 2013 | | 2014 | | Thereafter |
| | (in thousands) |
Long-term Debt | | $ | 1,024,342 | | $ | — | | $ | 6,578 | | $ | 112,792 | | $ | — | | $ | — | | $ | 904,972 |
Capital Leases | | 35,880 | | 309 | | 1,282 | | 1,370 | | 1,468 | | 1,582 | | 29,869 |
Future minimum operating lease payments | | 4,563 | | 477 | | 1,719 | | 1,348 | | 425 | | 248 | | 346 |
Estimated Pension and Other Postretirement Obligations (1) | | 38,154 | | 954 | | 13,800 | | 13,800 | | 4,800 | | 4,800 | | N/A |
Qualifying Facilities (2) | | 1,350,151 | | 16,145 | | 65,323 | | 67,111 | | 69,816 | | 72,354 | | 1,059,402 |
Supply and Capacity Contracts (3) | | 1,547,553 | | 90,046 | | 251,562 | | 193,937 | | 175,926 | | 131,945 | | 704,137 |
Other Purchase Obligations (4) | | 11,259 | | 11,259 | | — | | — | | — | | — | | — |
Contractual interest payments on debt (5) | | 594,706 | | 17,624 | | 54,410 | | 52,340 | | 50,566 | | 50,566 | | 369,200 |
Total Commitments (6) | | $ | 4,606,608 | | $ | 136,814 | | $ | 394,674 | | $ | 442,698 | | $ | 303,001 | | $ | 261,495 | | $ | 3,067,926 |
(1) We have only estimated cash obligations related to our pension and other postretirement benefit programs for five years, as it is not practicable to estimate thereafter. These estimates reflect our expected cash contributions, which may be in excess of minimum funding requirements. |
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| Total | | 2011 | | 2012 | | 2013 | | 2014 | | 2015 | | Thereafter |
| (in thousands) |
Long-term Debt | $ | 911,753 | | | $ | 2,958 | | | $ | 3,792 | | | $ | — | | | $ | — | | | $ | — | | | $ | 905,003 | |
Capital Leases | 35,257 | | | 969 | | | 1,370 | | | 1,468 | | | 1,582 | | | 1,705 | | | 28,163 | |
Notes Payable | 85,989 | | | 85,989 | | | — | | | — | | | — | | | — | | | — | |
Future minimum operating lease payments | 4,277 | | | 1,398 | | | 1,569 | | | 638 | | | 291 | | | 142 | | | 239 | |
Estimated Pension and Other Postretirement Obligations (1) | 71,417 | | | 14,617 | | | 15,400 | | | 13,800 | | | 13,800 | | | 13,800 | | | N/A | |
Qualifying Facilities (2) | 1,317,861 | | | 49,178 | | | 67,111 | | | 69,816 | | | 72,354 | | | 74,135 | | | 985,267 | |
Supply and Capacity Contracts (3) | 1,621,924 | | | 255,711 | | | 249,434 | | | 214,933 | | | 136,526 | | | 98,990 | | | 666,330 | |
Contractual interest payments on debt (4) | 559,420 | | | 38,233 | | | 50,861 | | | 50,565 | | | 50,565 | | | 50,565 | | | 318,631 | |
Total Commitments (5) | $ | 4,607,898 | | | $ | 449,053 | | | $ | 389,537 | | | $ | 351,220 | | | $ | 275,118 | | | $ | 239,337 | | | $ | 2,903,633 | |
(2) The QFs require us to purchase minimum amounts of energy at prices ranging from $65 to $167 per MWH through 2029. Our estimated gross contractual obligation related to the QFs is approximately $1.4 billion. A portion of the costs incurred to purchase this energy is recoverable through rates authorized by the MPSC, totaling approximately $1.0 billion._________________________
(3) We have entered into various purchase commitments, largely purchased power, coal and natural gas supply and natural gas transportation contracts. These commitments range from one to 19 years.
(4) This represents contractual purchase obligations related to Mill Creek Generating Station construction project.
(5) Contractual interest payments include our revolving credit facility, which has a variable interest rate. We have assumed an average interest rate of 2.75% on an estimated revolving line of credit balance of $109.0 million through maturity in June 2012.
(6) Potential tax payments related to uncertain tax positions are not practicable to estimate and have been excluded from this table.
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(1) | We have only estimated cash obligations related to our pension and other postretirement benefit programs for five years, as it is not practicable to estimate thereafter. These estimates reflect our expected cash contributions, which may be in excess of minimum funding requirements. |
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(2) | The QFs require us to purchase minimum amounts of energy at prices ranging from $65 to $167 per MWH through 2029. Our estimated gross contractual obligation related to the QFs is approximately $1.3 billion. A portion of the costs incurred to purchase this energy is recoverable through rates authorized by the MPSC, totaling approximately $1.0 billion. |
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(3) | We have entered into various purchase commitments, largely purchased power, coal and natural gas supply and natural gas transportation contracts. These commitments range from one to 19 years. |
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(4) | We have assumed a weighted average interest rate of 0.42% on outstanding short-term borrowing amounts through maturity. |
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(5) | Potential tax payments related to uncertain tax positions are not practicable to estimate and have been excluded from this table. |
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s discussion and analysis of financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and other assumptions that are believed to be proper and reasonable under the circumstances.
As of September 30, 2010,March 31, 2011, there have been no significant changes with regard to the critical accounting policies disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2009.2010. The policies disclosed included the accounting for the following: goodwill and long-lived assets, qualifying facilities liability, revenue recognition, regulatory assets and liabilities, pension and postretirement benefit plans, and income taxes. We continually evaluate the appropriateness of our estimates and assumptions. Actual results could differ from those estimates.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK | |
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK |
We are exposed to market risks, including, but not limited to, interest rates, energy commodity price volatility, and credit exposure. Management has established comprehensive risk management policies and procedures to manage these market risks.
Interest Rate Risk
Interest rate risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financings. We manage our interest rate risk by issuing primarily fixed-rate long-term debt with varying maturities, refinancing certain debt and, at times, hedging the interest rate on anticipated borrowings. All of our debt has fixed interest rates, with the exception of our revolving credit facility. The revolving credit facility bears interest at the lower of prime or available rates tied to the London Interbank Offered Rate (LIBOR) plus a credit spread, ranging from 2.25% to 4.0% over LIBOR. To more cost effectively meet short-term cash requirements, we established a program where we may issue commercial paper; which is supported by our revolving credit facility. Since commercial paper terms are short-term, we are subject to interest rate risk. As of September 30, 2010, the applicable spread was 2.75%, resulting in a borrowing rateMarch 31, 2011, we had approximately $86.0 million of 3.01%. Based upon amountscommercial paper outstanding as of September 30, 2010, aand no borrowings on our revolving credit facility. A 1% increase in the LIBORinterest rates would increase our annual inte restinterest expense by approximately $1.1$0.9 million.
Commodity Price Risk
Commodity price risk is a significant risk due to our minimal ownership of natural gas reserves and our reliance on market purchases to fulfill a large portion of our electric supply requirements within the Montana market. We also participate in the wholesale electric market to balance our supply of power from our own generating resources, primarily in South Dakota. Several factors influence price levels and volatility. These factors include, but are not limited to, seasonal changes in demand, weather conditions, available generating assets within regions, transportation availability and reliability within and between regions, fuel availability, market liquidity, and the nature and extent of current and potential federal and state regulations.
As part of our overall strategy for fulfilling our electric and natural gas supply requirements, we employ the use of market purchases, including forward purchase and sales contracts. These types of contracts are included in our supply portfolios and are used to manage price volatility risk by taking advantage of seasonal fluctuations in market prices. While we may incur gains or losses on individual contracts, the overall portfolio approach is intended to provide price stability for consumers. As a regulated utility, our exposure to market risk caused by changes in commodity prices is substantially mitigated because these commodity costs are included in our cost tracking mechanisms and are recoverable from customers subject to prudence reviews by applicable state regulatory commissions.
Counterparty Credit Risk
We are exposed to counterparty credit risk related to the ability of our counterparties to meet their contractual payment obligations, and the potential non-performance of counterparties to deliver contracted commodities or services at the contracted price. We have risk management policies in place to limit our transactions to high quality counterparties, and continue to monitor closely the status of our counterparties, and will take action, as appropriate, to further manage this risk. This includes, but is not limited to, requiring letters of credit or prepayment terms. There can be no assurance, however, that the management tools we employ will eliminate the risk of loss.
ITEM 4. CONTROLS AND PROCEDURES | |
ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934 areis recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and accumulated and reported to management, including the principal executive officer and principal financial officer to allow timely decisions regarding required disclosure.
We conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the three months ended September 30, 2010March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II.OTHER INFORMATION
PART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGS
See Note 13, Commitments and Contingencies, to the Financial Statements for information about legal proceedings.
You should carefully consider the risk factors described below, as well as all other information available to you, before making an investment in our common stock or other securities.
Economic conditions and instability in the financial markets could negatively impact our business.
Our operations are impacted by local, national and worldwide economic conditions. The consequences of a prolonged recession may include a lower level of economic activity and uncertainty regarding energy prices and the capital and commodity markets. A lower level of economic activity has resulted in a decline in energy consumption and a decrease in customers’ ability to pay their accounts, which may adversely affect our liquidity, results of operations and future growth. While our territories have been less impacted than other parts of the country, we have experienced lower than expected electric and natural gas usage per customer and electric transmission sales, due in part to the recession. In addition, demand for our Montana transmission capacity is impacted by market conditions in states to the South and West of our service ter ritory, which have been more significantly impacted by the economic downturn.
Access to the capital and credit markets, at a reasonable cost, is necessary for us to fund our operations, including capital requirements. We rely on a revolving credit facility for short-term liquidity needs due to the seasonality of our business, and on capital markets to raise capital for growth projects that are not otherwise provided by operating cash flows. Instability in the financial markets may increase the cost of capital, limit our ability to draw on our revolving credit facility and/or raise capital. If we are unable to obtain the liquidity needed to meet our business requirements on favorable terms, we may defer growth projects and/or capital expenditures.
We are subject to extensive and changing governmental laws and regulations that affect our industry and our operations, which could have a material adverse effect on our liquidity and results of operations.
The profitability of our operations is dependent on our ability to recover the costs of providing energy and utility services to our customers and earn a return on our capital investment in our utility operations. We provide service at rates approved by one or more regulatory commissions. These rates are subjectgenerally regulated based on an analysis of our costs incurred in a historical test year. Thus, the rates we are allowed to charge may or may not match our costs at any given time. While rate regulation by federal and state governmental entities, including the FERC, MPSC, SDPUC and Nebraska Public Service Commission. Regulations can affect allowed ratesis premised on providing a reasonable opportunity to earn a reasonable rate of return on invested capital, there can be no assurance that the applicable regulatory commission will judge all of our costs to have been prudently incurred or that the regulatory process in which rates are determined will always result in rates that will produce full recovery of costs and operating requirements. For example, in our 2008 proceeding related to Colstrip, the MPSC approved a 10% return on equity and 6.5% cost of debt for the expected 34-year life of the plant. In addition, existing regulations may be revised or reinterpreted, new laws, regulations, and interpretations thereof may be adopted or become applicable to us and future changes in laws and regulations may have a detrimental effect on our business.
Our rates are approved by our respective commissions and are effective until new rates are approved. The outcome of our Montana electric and natural gas rate case filed in 2009 could have a significant impact on our liquidity and results of operations. The filing is based upon a 2008 test period, and we anticipate a final determination on the filing during the fourth quarter of 2010, which creates a delay between the timing of when such costs are incurred and when the costs are recovered from customers. This lag can adversely impact our cash flows.costs. In addition, supply costs are recovered through adjustment charges that are periodically reset to reflect current and projected costs. Inability to recover costs in rates or adjustment clauses could have a material adverse effect on our liquidity and results of operations.
We are also subject to the jurisdiction of FERC with regard to electric system reliability standards. We must comply with the standards and requirements established, which apply to the North American Electric Reliability Corporation (NERC) functions for which we have registered in both the Midwest Reliability Organization for our South Dakota operations and the Western Electricity Coordination CounselCouncil for our Montana operations. To the extent weThe FERC can now impose penalties for violation of FERC statutes, rules and orders of $1 million per violation per day. In addition, more than 120 electric reliability standards are deemed to not be compliant with these standards, we could bemandatory and subject to finespotential financial penalties by NERC or penalties.FERC for violations. If a serious reliability incident did occur, it could have a material adverse effect on our operations or financial results.
In addition, existing regulations may be revised or reinterpreted, new laws, regulations, and interpretations thereof may be adopted or become applicable to us and future changes in laws and regulations may have a detrimental effect on our business. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which is intended to improve regulation of financial markets was signed into law. Certain provisions of the Act relating to derivatives could result in increased capital and/or collateral requirements. Despite certain exemptions in the law, we will not know if we qualify for the exemptions until the rule making has been completed, and, even if we qualify for the exemptions, concern remains that counterparties that do not qualify for the exemption will pass along the increased cost and margin requirements through higher prices and reductions in unsecured credit limits. We are unable to assess the impact of the financial reform legislation pending issuance of the final regulations implementing these provisions.
We are subject to extensive environmental laws and regulations and potential environmental liabilities, which could result in significant costs and liabilities.
We are subject to extensive laws and regulations imposed by federal, state, and local government authorities in the ordinary course of operations with regard to the environment, including environmental laws and regulations relating to air and water quality, solid waste disposal, coal ash and other environmental considerations. We believe that we are in compliance with environmental regulatory requirements and that maintaining compliance with current requirements will not materially affect our financial position or results of operations; however, possible future developments, including the promulgation of more stringent environmental laws and regulations, and the timing of future enforcement proceedings that may be taken by environmental authorities could affect the costs and the manner in which we conduct our business and could require u sus to make substantial additional capital expenditures.
There is a growing concern nationallyare national and internationally aboutinternational efforts to adopt measures related to global climate change and the contribution of emissions of greenhouse gasesGHGs including, most significantly, carbon dioxide. This concern has led to increased interest in legislationThese efforts include legislative proposals and agency regulations at the federal level, actions at the state level, as well as litigation relating to greenhouseGHG emissions, including a U.S. Supreme Court decision holding that the EPA relied on improper factors in deciding not to regulate carbon dioxide emissions from motor vehicles under
the Clean Air Act and a federal courtdecision by the U.S. Court of appeals has reinstatedAppeals for the Second Circuit reinstating nuisance claims against emitters of carbon dioxide, including several utility companies, alleging that such emissions contribute to global warming. The U.S. Supreme Court has agreed to hear the Second Circuit's decision. Increased pressure for carbon dioxide emissions reduction also is coming from investor organizations. If legislation or regulations are passed at the federal or state levels imposing mandatory reductions of carbon dioxide and other greenhouse gasesGHGs on generation facilities, the cost to us of such reductions could be significant.
Many of these environmental laws and regulations create permit and license requirements and provide for substantial civil and criminal fines which, if imposed, could result in material costs or liabilities. We cannot predict with certainty the occurrence of private tort allegations or government claims for damages associated with specific environmental conditions. We may be required to make significant expenditures in connection with the investigation and remediation of alleged or actual spills, personal injury or property damage claims, and the repair, upgrade or expansion of our facilities to meet future requirements and obligations under environmental laws.
To the extent that our environmental liabilities are greater than our reserves or we are unsuccessful in recovering anticipated insurance proceeds under the relevant policies or recovering a material portion of remediation costs in our rates, our results of operations and financial position could be adversely affected.
Our plans for future expansion through capital improvements to current assets and transmission grid expansion involve substantial risks. Failure to adequately execute and manage significant construction plans, as well as the risk of recovering such costs, could materially impact our results of operations and liquidity.
We have proposed capital investment projects in excess of $1 billion, which includes investment in capital improvements and additions to modernize existing infrastructure, generation investments and transmission capacity expansion. The age of our existing assets may result in them being more costly to maintain and susceptible to outages in spite of diligent efforts by us to properly maintain these assets through inspection, scheduled maintenance and capital investment. The failure of such assets could result in increased expenses which may not be fully recoverable from customers and/or a reduction in revenue.
The completion of generation investments and transmission projects are subject to many construction and development risks, including, but not limited to, risks related to financing, regulatory recovery, escalating costs of materials and labor, meeting construction budgets and schedules, and environmental compliance. Construction of new transmission facilities required to support future growth is subject to certain additional risks, including but not limited to: (i) our ability to obtain necessary approvals and permits from regulatory agencies on a timely basis and on terms that are acceptable to us; (ii) potential changes in federal, state and local statutes and regulations, including environmental requirements, that prevent a project from proceeding or increase the anticipated cost of the project; (iii) inability to acquire rights-of-way or land rights on a timely basis on terms that are acceptable to us; and (iv) insufficient customer throughput commitments. In addition, there are projects proposed by other parties that may result in direct competition to our proposed transmission expansion.
As of March 31, 2011, we have capitalized approximately $17.3 million in preliminary survey and investigative costs related to MSTI. If we are unable to complete the development and ultimate construction of MSTI or decide to delay or cancel construction for any reason, including failure to receive necessary regulatory approvals and/or siting or environmental permits, we may not be able to recover our investment. Even if MSTI is completed, the total costs may be higher than estimated and there is no assurance that we will be able to recover such costs from customers. If our efforts to complete MSTI are not successful we may have to write-off all or a portion these costs, which could have a material adverse effect on our results of operations. See Note 9 - Regulatory Matters to the Condensed Consolidated Financial Statements for further discussion of this project.
Our capital projects will require a significant amount of capital expenditures. We cannot provide certainty that adequate external financing will be available to support these projects. Additionally, borrowings incurred to finance construction may adversely impact our leverage, which could increase our cost of capital. We may pursue joint ventures or similar arrangements with third parties in order to share some of the financing and operational risks associated with these projects, but we cannot be certain we will be able to successfully negotiate any such arrangement. Furthermore, joint ventures or joint ownership arrangements also present risks and uncertainties, including those associated with sharing control over the construction and operation of a facility and reliance on the other party's financial or operational strength.
Our proposed capital investment projects are based on assumptions regarding future growth and resulting power demand that may not be realized. This planning process must look many years into the future in order to accommodate the long lead times associated with the permitting and construction of new generation facilities. Inherent risk exists in predicting demand this far into the future as these future loads are dependent on many uncertain factors, including regional economic conditions,
customer usage patterns, efficiency programs, and customer technology adoption. We may increase our transmission and/or baseload capacity and have excess capacity if anticipated growth levels are not realized. The resulting excess capacity could exceed our obligation to serve retail customers or demand for transmission capacity and, as a result, may not be recoverable from customers.
Our revenues, results of operations and financial condition are impacted by customer growth and usage in our service territories and may fluctuate with current economic conditions. We are also impacted by market conditions outside of our service territories related to demand for transmission capacity and wholesale electric pricing.
Our revenues, results of operations and financial condition are impacted by customer growth and usage, which can be impacted by population growth as well as by economic factors. The consequences of a prolonged recession may include a lower level of economic activity and uncertainty regarding energy prices and the capital and commodity markets. While our service territories have been less impacted than other parts of the country, residential customer consumption patterns may change and our revenues may be negatively impacted. Our commercial and industrial customers have been impacted by the economic downturn, resulting in a decline in their consumption of electricity. Additionally, our customers could voluntarily reduce their consumption of electricity in response to increases in prices, decreases in their disposable income or individual energy conservation efforts. In addition, demand for our Montana transmission capacity and wholesale supply fluctuate with regional demand, fuel prices and contracted capacity and are dependent on market conditions. The timing and extent of the recovery of the economy cannot be predicted.
Our natural gas distribution activities involve numerous risks that may result in accidents and other operating risks and costs.
Inherent in our natural gas distribution activities are a variety of hazards and operating risks, such as leaks, explosions and mechanical problems, which could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution, impairment of our operations and substantial losses to us. In accordance with customary industry practice, we maintain insurance against some, but not all, of these risks and losses. The occurrence of any of these events not fully covered by insurance could have a material adverse effect on our financial position and results of operations. For our distribution lines located near populated areas, including residential areas, commercial business centers, industrial sites and other public gathering areas, the level of damages resulting from these risks is greater.
To the extent our incurred supply costs are deemed imprudent by the applicable state regulatory commissions, we would not recover some of our costs, which could adversely impact our results of operations and liquidity.
Our wholesale costs for electricity and natural gas are recovered through various pass-through cost tracking mechanisms in each of the states we serve. The rates are established based upon projected market prices or contractcontractual obligations. As these variables change, we adjust our rates through our monthly trackers. To the extent our energy supply costs are deemed imprudent by the applicable state regulatory commissions, we would not recover some of our costs, which could adversely impact our results of operations.
We are required tocurrently procure almost all of our natural gas supply and a large portion of our Montana electric supply pursuant to contracts with third-party suppliers. In light of this reliance on third-party suppliers, we are exposed to certain risks in the event a third-party supplier is unable to satisfy its contractual obligation. If this occurred, then we might be required to purchase gas and/or electricity supply requirements in the energy markets, which may not be on commercially reasonable terms, if at all. If prices were higher in the energy markets, it could result in a temporary material under recovery that would reduce our liquidity.
Poor investment performance of plan assets of our defined benefit pension and post-retirement benefit plans, in addition to other factors impacting these costs, could unfavorably impact our results of operations and liquidity.
Our costs for providing defined benefit retirement and postretirement benefit plans are dependent upon a number of factors, including rate offactors. Assumptions related to future costs, return on plan assets, discount rates, other actuarial assumptions,investments and government regulation. Due to the unprecedented volatility in equity markets, we experienced plan asset market gains during 2009 in excess of 20%, as compared with plan asset market losses during 2008 in excess of 30%. In addition, interest rates (and corresponding discount rates) have declined dramatically during 2010.a significant impact on our funding requirements related to these plans. These estimates and assumptions may change based on economic conditions, actual stock market performance and changes in governmental regulations. Without sustained growth in the plan assets over time and depending upon interest rate changes as well as other factors noted above, the costs of such plans reflected in our results of operations and financial position and cash funding obligations may change significantly from projections.
41
Our plans for future expansion through transmission grid expansion, the construction of power generation facilities and capital improvements to current assets involve substantial risks. Failure to adequately execute and manage significant construction plans, as well as the risk of recovering such costs, could materially impact our results of operations and liquidity.
We have proposed capital investment projects in excess of $1 billion. The completion of these projects, which are primarily investments in electric transmission projects and electric generation projects, is subject to many construction and development risks, including, but not limited to, risks related to financing, regulatory recovery, obtaining and complying with terms of permits, escalating costs of materials and labor, meeting construction budgets and schedules, and environmental compliance. In addition, there are projects proposed by other parties that may result in direct competition to our proposed transmission expansion.
Our proposed capital investment projects are based on assumptions regarding future growth and resulting power demand that may not be realized. The timing and extent of the recovery of the economy, and its impact on demand cannot be predicted. Additionally, our customers may undertake further individual energy conservation measures, which could decrease the demand for electricity. We may increase our transmission and/or baseload capacity and have excess capacity if anticipated growth levels are not realized. The resulting excess capacity could exceed our obligation to serve retail customers or demand for transmission capacity and, as a result, may not be recoverable from customers.
The construction of new generation and expansion of our transmission system will require a significant amount of capital expenditures. We cannot provide certainty that adequate external financing will be available to support these projects. Additionally, borrowings incurred to finance construction may adversely impact our leverage, which could increase our cost of capital. We may pursue joint ventures or similar arrangements with third parties in order to share some of the financing and operational risks associated with these projects, but we cannot be certain we will be able to successfully negotiate any such arrangement. Furthermore, joint ventures or joint ownership arrangements also present risks and uncertainties, including those associated with sharing control over the construction and operation of a facility and reliance on the other party’s financial or operational strength.
We have filed for and received advanced approval from the MPSC to construct the Mill Creek Generating Station at an estimated cost of approximately $202 million. The MPSC determined the $81 million cost of the gas turbines included in the estimate to be prudent, with the remainder of the project costs to be submitted for review upon completion of construction. As of September 30, 2010, we have capitalized approximately $161.3 million in construction work in process associated with the Mill Creek Generating Station. A portion of these future costs could potentially be deemed imprudent, which we would not be able to recover from customers.
In addition, as of September 30, 2010, we have capitalized approximately $15.5 million in preliminary survey and investigative costs associated with transmission projects. Should our efforts in these projects be unsuccessful, we could be subject to additional costs, termination payments under committed contracts, and/or the impairment of investments in these projects.
Our obligation to include a minimum annual quantity of power in our Montana electric supply portfolio at an agreed upon price per MWhMWH could expose us to material commodity price risk if certain QFs under contract with us do not perform during a time of high commodity prices, as we are required to supply any quantity deficiency. In addition, we are subject to price escalation risk with one of our largest QF contracts.
As part of a previous stipulation in 2002 with the MPSC and other parties, we agreed to include a minimum annual quantity of power in our Montana electric supply portfolio at an agreed upon price per MWh.MWH. The annual minimum energy requirement is achievable under normal QF operations, including normal periods of planned and forced outages. Furthermore, we will not realize commodity price risk unless any required replacement energy cost is in excess of the total amount recovered under the QF obligation.
However, to the extent the supplied QF power for any year does not reach the minimum quantity set forth in the settlement, we are obligated to secure the quantity deficiency from other sources. The anticipated source for any quantity deficiency is the wholesale market which, in turn, would subject us to commodity price volatility.
In addition, we are subject to price escalation risk with one of our largest QF contracts due to variable contract terms. In estimating our QF liability, we have estimated an annual escalation rate of 1.9% over the term of the contract (through June 2024). To the extent the annual escalation rate exceeds 1.9%, our results of operations and financial position could be adversely affected.
Our owned and jointly owned electric generating facilities are subject to operational risks that could result in unscheduled plant outages, unanticipated operation and maintenance expenses and increased power purchase costs.
Operation of electric generating facilities involves risks, which can adversely affect energy output and efficiency levels. Most of our generating capacity is coal-fired. We rely on a limited number of suppliers of coal for our electric generation, making us vulnerable to increased prices for fuel as existing contracts expire or in the event of unanticipated interruptions in fuel supply. We are a captive rail shipper of the Burlington Northern Santa Fe Railway for shipments of coal to the Big Stone Plant (our largest source of generation in South Dakota), making us vulnerable to railroad capacity and operational issues and/or increased prices for coal transportation from a sole supplier. Operational risks also include facility shutdowns due to breakdown or failure of equipment or processes, labor disputes, operator error, catastrophic ev entsevents such as fires, explosions, floods, and intentional acts of destruction or other similar occurrences affecting the electric generating facilities; and operational changes necessitated by environmental legislation or regulation. The loss of a major electric generating facility would require us to find other sources of supply, if available, and expose us to higher purchased power costs.
Weather and weather patterns, including normal seasonal and quarterly fluctuations of weather, as well as extreme weather events that might be associated with climate change, could adversely affect our results of operations and liquidity.
Our electric and natural gas utility business is seasonal, and weather patterns can have a material impact on our financial performance. Demand for electricity and natural gas is often greater in the summer and winter months associated with cooling and heating. Because natural gas is heavily used for residential and commercial heating, the demand for this product depends heavily upon weather patterns throughout our market areas, and a significant amount of natural gas revenues are recognized in the first and fourth quarters related to the heating season. Accordingly, our operations have historically generated less revenues and income when weather conditions are milder in the winter and cooler in the summer. In the event that we experience unusually mild winters or cool summers in the future, our results of operations and financial positi onposition could be adversely affected. In addition, exceptionally hot summer weather or unusually cold winter weather could add significantly to working capital needs to fund higher than normal supply purchases to meet customer demand for electricity and natural gas.
There is also a concern that the physical risks of climate change could include changes in weather conditions, such as an increase in changes in precipitation and extreme weather events. Climate change and the costs that may be associated with its impacts have the potential to affect our business in many ways, including increasing the cost incurred in providing electricity and natural gas, impacting the demand for and consumption of electricity and natural gas (due to change in both costs and weather patterns), and affecting the economic health of the regions in which we operate. Extreme weather conditions creating high energy demand on our own and/or other systems may raise market prices as we buy short-term energy to serve our own system. Severe weather impacts our service territories, primarily through thunderstorms, tornadoes and sno wsnow or ice storms. To the extent the frequency of extreme weather events increase, this could increase our cost of providing service. Changes in precipitation resulting in droughts or water shortages could adversely affect our ability to provide electricity to customers, as well as increase the price they pay for energy. In addition, extreme weather may exacerbate the risks to physical infrastructure. We may not recover all costs related to mitigating these physical and financial risks.
Our business is dependent on our ability to successfully access capital markets on favorable terms. Limits on our access to capital may adversely impact our ability to execute our business plan or pursue improvements that we would otherwise rely on for future growth.
Our cash requirements are driven by the capital-intensive nature of our business. Access to the capital and credit markets, at a reasonable cost, is necessary for us to fund our operations, including capital requirements. We rely on a revolving credit facility and commercial paper market for short-term liquidity needs due to the seasonality of our business, and on capital markets to raise capital for growth projects that are not otherwise provided by operating cash flows. Instability in the financial markets may increase the cost of capital, limit our ability to draw on our revolving credit facility, access the commercial paper market and/or raise capital. If we are unable to obtain the liquidity needed to meet our business requirements on favorable terms, we may defer growth projects and/or capital expenditures.
We must meet certain credit quality standards. If we are unable to maintain investment grade credit ratings, our liquidity, access to capital and operations could be materially adversely affected.
A downgrade of our credit ratings to less than investment grade could adversely affect our liquidity. Certain of our credit agreements and other credit arrangements with counterparties require us to provide collateral in the form of letters of credit or cash to support our obligations if we fall below investment grade. Also, a downgrade below investment grade could hinder our ability to raise capital on favorable terms, and increaseincluding through the commercial paper markets. Higher interest rates on short-term borrowings with variable interest rates or on incremental commercial paper issuances could also have an adverse effect on our borrowing costs.results of operations.
Our secured credit ratings are also tied to our ability to invest in unregulated ventures due to an existing stipulation with the MPSC and MCC, which establishes diminishing limits for such investment at certain credit rating levels. The stipulation does not limit investment in unregulated ventures so long as we maintain credit ratings on a secured basis of at least BBB+ (S&P)from S&P and Baa1 (Moody’s). For a further discussion of how a lack of liquidity and access to adequate capital could affect our operations, please see the Risk Factor above, “Economic conditions and instability in the financial markets could negatively impact our business.”from Moody's.
(a)Exhibits
Exhibit 10.1—Commercial Paper Dealer Agreement between NorthWestern Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated, dated as of February 3, 2011 (incorporated by reference to Exhibit 10.1 of NorthWestern Corporation's Current Report on Form 8-K, dated February 8, 2011, Commission File No. 1-10499).
Exhibit 10.2—NorthWestern Energy 2011 Annual Incentive Plan (incorporated by reference to Exhibit 99.01 of NorthWestern Corporation's Current Report on Form 8-K, dated February 10, 2011, Commission File No. 1-10499).
Exhibit 10.3—Form of NorthWestern Corporation Long-Term Performance Incentive Restricted Stock Award Agreement (incorporated by reference to Exhibit 99.02 of NorthWestern Corporation's Current Report on Form 8-K, dated February 10, 2011, Commission File No. 1-10499).
Exhibit 10.4—NorthWestern Corporation 2005 Long-Term Incentive Plan, as amended April 8, 2011.
Exhibit 31.1—Certification of chief executive officer.
Exhibit 31.2—Certification of chief financial officer.
Exhibit 32.1—Certification of chief executive officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2—Certification of chief financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 101.INS—XBRL Instance Document
Exhibit 101.SCH—XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL—XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.DEF—XBRL Taxonomy Extension Definition Linkbase Document
Exhibit 101.LAB—XBRL Taxonomy Label Linkbase Document
Exhibit 101.PRE—XBRL Taxonomy Extension Presentation Linkbase Document
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | | |
| | Northwestern Corporation
| Northwestern Corporation |
Date: October 28, 2010 | April 27, 2011 | By: | /s/ BRIAN B. BIRD |
| | | Brian B. Bird |
| | | Chief Financial Officer |
| | | Duly Authorized Officer and Principal Financial Officer |
EXHIBIT INDEX
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| | |
Exhibit Number | | Description |
10.1 | | Commercial Paper Dealer Agreement between NorthWestern Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated, dated as of February 3, 2011 (incorporated by reference to Exhibit 10.1 of NorthWestern Corporation's Current Report on Form 8-K, dated February 8, 2011, Commission File No. 1-10499). |
10.2 | | NorthWestern Energy 2011 Annual Incentive Plan (incorporated by reference to Exhibit 99.01 of NorthWestern Corporation's Current Report on Form 8-K, dated February 10, 2011, Commission File No. 1-10499). |
10.3 | | Form of NorthWestern Corporation Long-Term Performance Incentive Restricted Stock Award Agreement (incorporated by reference to Exhibit 99.02 of NorthWestern Corporation's Current Report on Form 8-K, dated February 10, 2011, Commission File No. 1-10499). |
*10.4 | | NorthWestern Corporation 2005 Long-Term Incentive Plan, as amended April 8, 2011. |
*31.1 | | Certification of chief executive officer. |
*31.2 | | Certification of chief financial officer. |
*32.1 | | Certification of chief executive officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*32.2 | | Certification of chief financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*101.INS | | XBRL Instance Document |
*101.SCH | | XBRL Taxonomy Extension Schema Document |
*101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document |
*101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document |
*101.LAB | | XBRL Taxonomy Label Linkbase Document |
*101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document |
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