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NWE 2019-03-31

Part 1. Financial Information

Item 1. Financial Statements (Unaudited)

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

Part II. Other Information

Item 1. Legal Proceedings

Item 1A. Risk Factors

Item 6. Exhibits -

EX-31.1	ex311certificationq120.htm
EX-31.2	ex312certificationq120.htm
EX-32.1	ex321certificationq120.htm
EX-32.2	ex322certificationq120.htm

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•	adverse determinations by regulators, as well as potential adverse federal, state, or local legislation or regulation, including costs of compliance with existing and future environmental requirements, could have a material 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 affect 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

•	adverse changes in general economic and competitive conditions in the U.S. financial markets and in our service territories.

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ITEM 1.	FINANCIAL STATEMENTS (UNAUDITED)

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NorthWestern Corporation, doing business as NorthWestern Energy, provides electricity and/or natural gas to approximately 726,400 customers in Montana, South Dakota and Nebraska.

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 in 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 March 31, 2019, 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. 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 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, 2018.

Variable Interest Entities

A reporting company is required to consolidate a variable interest entity (VIE) as its primary beneficiary, which means it has a controlling financial interest, when it 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 is considered to be a VIE when its total equity investment at risk is not 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.

Certain long-term purchase power and tolling contracts may be considered variable interests. We have various long-term purchase power contracts with other utilities and certain qualifying co-generation facilities and qualifying small power production facilities (QF). We identified one QF contract that may constitute a VIE. We entered into a 40-year power purchase contract in 1984 with this 35 megawatt (MW) coal-fired QF to purchase substantially all of the facility's capacity and electrical output over a substantial portion of its estimated useful life. We absorb a portion of the facility's variability through annual changes to the price we pay per megawatt hour (MWH). After making exhaustive efforts, we have been unable to obtain the information from the facility necessary to determine whether the facility is a VIE or whether we are the primary beneficiary of the facility. The contract with the facility contains no provision which legally obligates the facility to release this information. We have accounted for this QF contract as an executory contract. Based on the current contract terms with this QF, our estimated gross contractual payments aggregate approximately $164.9 million through 2024.

Accounting Standards Adopted

Leases - In February 2016, the Financial Accounting Standards Board (FASB) issued revised guidance requiring substantially all leases to be recognized on the balance sheet as right-of-use assets and lease liabilities. Leases with a term of 12 months or less may be excluded from the balance sheet and continue to be reflected in the income statement. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease.

We adopted this standard on January 1, 2019, using the modified retrospective method of adoption. Adoption of this standard had minimal impact on our Condensed Consolidated Financial Statements and disclosures. We elected a package of practical expedients that allow us to carry forward historical conclusions related to (1) whether any expired or existing contract is a lease or contains a lease, (2) the lease classification of any expired or existing leases and easements, and (3) the initial direct costs for any existing leases. In addition, as our easements are entered into in perpetuity, they do not meet the definition of a

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lease in accordance with this guidance. We did not restate comparative periods upon adoption. We had one finance lease that was already included on our balance sheets prior to adoption of the lease standard, consistent with previous guidance for capital leases. The initial recognition of right-of-use assets and lease liabilities for operating leases increased our assets and liabilities by approximately $3.3 million and are classified in the Condensed Consolidated Balance Sheets as follows (in thousands):

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	Affected Line Item in the Condensed Consolidated Balance Sheets	March 31, 2019
Operating lease assets	Other noncurrent assets	$	3,262
Operating lease liabilities, current	Accrued expenses and other	1,413
Operating lease liabilities, noncurrent	Other noncurrent liabilities	1,849
Total operating lease liabilities		$	3,262

Supplemental Cash Flow Information

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Condensed Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Condensed Consolidated Statements of Cash Flows (in thousands):

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Montana General Electric Rate Case

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

We also requested that approximately $13.8 million of the proposed rate increase be approved on an interim basis effective November 1, 2018. In March, 2019, the MPSC issued an order approving an increase in rates of approximately $10.5 million on an interim and refundable basis effective April 1, 2019. On April 5, 2019, we filed rebuttal testimony, which responded to intervenor testimony and included certain known and measurable adjustments. This testimony reflects a request for an annual increase of $30.7 million, an approximately $4.2 million reduction from our original request.

A hearing is scheduled to commence on May 13, 2019. Interim rates will remain in effect on a refundable basis until the MPSC issues a final order.

Montana QF Tariff Filing

Under the Public Utility Regulatory Policies Act, electric utilities are required, with certain exceptions, to purchase energy and capacity from independent power producers that are QFs. In May 2016, we filed an application for approval of a revised tariff for standard rates for small QFs (3 MW or less). In November 2017, the MPSC issued an order (QF Order) approving new rates that were substantially lower than the previous rates and reducing the maximum contract term from 25 to 15 years. In the QF Order, the MPSC also ordered that it would apply the same 15-year contract term to our future owned and contracted electric supply resources. We, as well as Cypress Creek Renewables, LLC, Vote Solar, and Montana Environmental Information Center (collectively, Vote Solar), sought judicial review of the QF Order before the Montana State District Court.

On April 2, 2019, the Montana State District Court (Court) reversed the MPSC’s decisions to reduce the contract term to 15 years and apply that term to our supply resources. In addition, the Court found that the MPSC approved rates were too low to reflect avoided cost and ordered the MPSC to provide new calculations to the Court within 20 days. While the Court's decision regarding application of maximum contract length to our future owned and contracted resources is consistent with our initial request for judicial review, we appealed the portion of the Court's decision to increase standard rates to the Montana Supreme Court. In addition, we filed a joint motion along with the MPSC and Montana Consumer Counsel to stay the requirement to provide calculations to the Court. Vote Solar filed a motion to amend the District Court’s decision to address inconsistencies in the order. Our QF purchased power expenses are tracked through the Power Cost and Credits Adjustment Mechanism (PCCAM), so any future increases in rates paid to QFs will be reflected through the application of that mechanism.

Cost Recovery Mechanisms

 

We compute income tax expense for each quarter based on the estimated annual effective tax rate for the year, adjusted for certain discrete items. Our effective tax rate typically differs from the federal statutory tax rate due to the regulatory impact of flowing through the federal and state tax benefit of repairs deductions, state tax benefit of accelerated tax depreciation deductions (including bonus depreciation when applicable) and production tax credits. The regulatory accounting treatment of these deductions requires immediate income recognition for temporary tax differences of this type, which is referred to as the flow-through method. When the flow-through method of accounting for temporary differences is reflected in regulated revenues, we record deferred income taxes and establish related regulatory assets and liabilities.

The following table summarizes the significant differences in income tax expense based on the differences between our effective tax rate and the federal statutory rate (in thousands):

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	Three Months Ended March 31,
	2019							2018
Income Before Income Taxes	$	74,379						$	60,413
Income tax calculated at federal statutory rate	15,620				21.0	%		12,687				21.0	%
Permanent or flow-through adjustments:
State income, net of federal provisions	928				1.2			732				1.2
Flow-through repairs deductions	(7,935		)		(10.7	)		(6,586		)		(10.9	)
Production tax credits	(4,432		)		(6.0	)		(3,888		)		(6.4	)
Plant and depreciation of flow-through items	(1,523		)		(2.0	)		(916		)		(1.6	)
Amortization of excess deferred income tax	(1,376		)		(1.8	)		(384		)		(0.6	)
Share-based compensation	186				0.3			275				0.5
Other, net	105				0.1			(6		)		—
	(14,047		)		(18.9	)		(10,773		)		(17.8	)
Income Tax Expense	$	1,573			2.1	%		$	1,914			3.2	%

Uncertain Tax Positions

We recognize tax positions that meet the more-likely-than-not threshold as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. We have unrecognized tax benefits of approximately $55.7 million as of March 31, 2019, including approximately $47.5 million that, if recognized, would impact our effective tax rate. It is reasonably possible that our unrecognized tax benefits may decrease by up to approximately $20 million in the next 12 months.

Our policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. During the three months ended March 31, 2019, and 2018, we recognized $0.4 million and $0.3 million, respectively, of expense for interest and penalties in the Condensed Consolidated Statements of Income. As of March 31, 2019 and December 31, 2018, we had $3.1 million and $2.7 million, respectively, of interest accrued in the Condensed Consolidated Balance Sheets.

The following tables display the components of Other Comprehensive Income (Loss), after-tax, and the related tax effects (in thousands):

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	Three Months Ended
	March 31, 2019												March 31, 2018
	Before-Tax Amount				Tax Expense				Net-of-Tax Amount				Before-Tax Amount				Tax Expense				Net-of-Tax Amount
Foreign currency translation adjustment	$	63			$	—			$	63			$	95			$	—			$	95
Reclassification of net losses on derivative instruments	153				(41		)		112				153				(40		)		113
Other comprehensive income (loss)	$	216			$	(41	)		$	175			$	248			$	(40	)		$	208

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Balances by classification included within accumulated other comprehensive loss (AOCL) on the Condensed Consolidated Balance Sheets are as follows, net of tax (in thousands):

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	March 31, 2019				December 31, 2018
Foreign currency translation	$	1,511			$	1,448
Derivative instruments designated as cash flow hedges	(11,521		)		(11,633		)
Postretirement medical plans	251				251
Accumulated other comprehensive loss	$	(9,759	)		$	(9,934	)

The following tables display the changes in AOCL by component, net of tax (in thousands):

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			Three Months Ended
			March 31, 2019
	Affected Line Item in the Condensed Consolidated Statements of Income		Interest Rate Derivative Instruments Designated as Cash Flow Hedges				Pension and Postretirement Medical Plans				Foreign Currency Translation				Total
Beginning balance			$	(11,633	)		$	251			$	1,448			$	(9,934	)
Other comprehensive income before reclassifications			—				—				63				63
Amounts reclassified from AOCL	Interest Expense		112				—				—				112
Net current-period other comprehensive income			112				—				63				175
Ending balance			$	(11,521	)		$	251			$	1,511			$	(9,759	)

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			Three Months Ended
			March 31, 2018
	Affected Line Item in the Condensed Consolidated Statements of Income		Interest Rate Derivative Instruments Designated as Cash Flow Hedges				Pension and Postretirement Medical Plans				Foreign Currency Translation				Total
Beginning balance			$	(9,981	)		$	31			$	1,178			$	(8,772	)
Other comprehensive income before reclassifications			—				—				95				95
Amounts reclassified from AOCL	Interest Expense		113				—				—				113
Net current-period other comprehensive income			113				—				95				208
Reclassification of certain tax effects from AOCL			(2,150		)		7				—				(2,143		)
Ending balance			$	(12,018	)		$	38			$	1,273			$	(10,707	)

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Our reportable business segments are primarily engaged in the electric and natural gas business. The remainder of our operations are presented as other, which primarily consists of unallocated corporate costs and unregulated activity.

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):

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Three Months Ended
March 31, 2019	Electric				Gas				Other				Eliminations				Total
Operating revenues	$	273,037			$	111,183			$	—			$	—			$	384,220
Cost of sales	76,994				38,741				—				—				115,735
Gross margin	196,043				72,442				—				—				268,485
Operating, general and administrative	57,783				21,008				2,301				—				81,092
Property and other taxes	35,047				9,740				2				—				44,789
Depreciation and depletion	38,051				7,533				—				—				45,584
Operating income (loss)	65,162				34,161				(2,303		)		—				97,020
Interest expense	(19,535		)		(1,510		)		(2,745		)		—				(23,790		)
Other (expense) income	(561		)		(477		)		2,187				—				1,149
Income tax (expense) benefit	(1,809		)		1,079				(843		)		—				(1,573		)
Net income (loss)	$	43,257			$	33,253			$	(3,704	)		$	—			$	72,806
Total assets	$	4,544,043			$	1,151,929			$	4,683			$	—			$	5,700,655
Capital expenditures	$	52,307			$	13,270			$	—			$	—			$	65,577

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Three Months Ended
March 31, 2018	Electric				Gas				Other				Eliminations				Total
Operating revenues	$	238,342			$	103,160			$	—			$	—			$	341,502
Cost of sales	57,273				38,804				—				—				96,077
Gross margin	181,069				64,356				—				—				245,425
Operating, general and administrative	54,648				21,219				(1,522		)		—				74,345
Property and other taxes	33,493				9,318				2				—				42,813
Depreciation and depletion	36,153				7,594				8				—				43,755
Operating income	56,775				26,225				1,512				—				84,512
Interest expense	(19,520		)		(1,854		)		(1,596		)		—				(22,970		)
Other income (expense)	490				108				(1,727		)		—				(1,129		)
Income tax (expense) benefit	(498		)		(2,226		)		810				—				(1,914		)
Net income (loss)	$	37,247			$	22,253			$	(1,001	)		$	—			$	58,499
Total assets	$	4,319,798			$	1,065,103			$	15,517			$	—			$	5,400,418
Capital expenditures	$	42,898			$	9,107			$	—			$	—			$	52,005

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Nature of Goods and Services

We provide retail electric and natural gas services to three primary customer classes. Our largest customer class consists of residential customers, which include single private dwellings and individual apartments. Our commercial customers consist primarily of main street businesses, and our industrial customers consist primarily of manufacturing and processing businesses that turn raw materials into products.

Electric Segment - Our regulated electric utility business primarily provides generation, transmission, and distribution services to our customers in our Montana and South Dakota jurisdictions. We recognize revenue when electricity is delivered to the customer. Payments on our tariff based sales are generally due in 20-30 days after the billing date.

Natural Gas Segment - Our regulated natural gas utility business primarily provides production, storage, transmission, and distribution services to our customers in our Montana, South Dakota, and Nebraska jurisdictions. We recognize revenue when natural gas is delivered to the customer. Payments on our tariff based sales are generally due in 20-30 days after the billing date.

Disaggregation of Revenue

The following tables disaggregate our revenue by major source and customer class (in millions):