NorthWestern Energy Group, Inc. Q1 FY2022 Earnings Call

Good afternoon, and thank you for joining NorthWestern Corporation's financial results webcast for the quarter ending March 31, 2022. My name is Travis Meyer. I'm the Director of Corporate Finance and Investor Relations Officer from NorthWestern. Joining us today to walk through the results and provide an overall update are Bob Rowe, Chief Executive Officer; Brian Bird, President and Chief Operating Officer; Crystal Lail, Vice President and Chief Financial Officer; as well as other members of management in the room with us. NorthWestern's results have been released, and this release is available on our website at northwesternenergy.com. We also released our 10-Q premarket this morning. Please note that the company's press release, this presentation, comments by presenters and responses to your questions may contain forward-looking statements. As such, I'll direct you to the disclosures contained within our SEC filings and safe harbor provisions included on the second slide of this presentation. Also note this presentation includes non-GAAP financial measures. Please see the non-GAAP disclosures, definitions and reconciliations also included in the presentation. This webcast is being recorded. The archived replay of the webcast will be available for one year beginning at 6 p.m. Eastern today and can be found in the Financial Results section of our website. With that, I'll hand it over to NorthWestern CEO, Bob Rowe.

Thank you, Travis, and thank you all for joining us. We are meeting this week in Butte, America, where we're having yet another heavy late-season snowstorm, which is very much needed. We're continuing to build up snowpack across Montana, which is great. The Board came in a day early, which provided an opportunity to have them meet with a lot of our employees and visit some key facilities in the Butte area, including our local distribution center, grid control, the new distribution operations center that we've been standing up in stages for several years, and our real-time trading desk, as well as our cybersecurity team. We also had a fantastic community reception. Earlier today, we held an online Annual Shareholders Meeting and received many good questions, which we greatly appreciated. In terms of recent highlights, our financial results are in line with expectations for the quarter. Net income of $59.1 million amounts to $1.08 diluted EPS, while the non-GAAP EPS is $59.5 million or $1.09 diluted EPS. Our expected long-term annual EPS growth rate is in the range of 3% to 6%, and we are reaffirming full-year non-GAAP guidance of $3.20 to $3.40 per diluted share. We have been making significant progress and achieving real results in the whole area of ESG, which has been well received across the board. A significant milestone has been our commitment to net-zero carbon emissions by 2050, a serious plan that we believe we can achieve. This commitment is noteworthy because it is a company-wide commitment covering both Scope 1 and Scope 2 emissions, whereas previously we had focused on our Montana electric supply. We're nearing completion of the 58-megawatt generating station project in South Dakota. This great project will deliver significant value to our customers. Additionally, site work is now underway for the 175-megawatt generating station near Billings, Montana, which arose from an RFP that also identified a hydro-based contract, along with our first investment in supply-level battery technology. We continue our commitment to a sustainable dividend, which will be reflected this year in a dividend of $0.63 per share, payable on June 30 for shareholders as of June 15, 2022. With that, I will turn it over to Crystal, who will then pass it on to Brian.

Thank you, Bob. I'll cover our financial results for the first quarter here, looking at Slide 4 of the deck that you should have available to you. Net income for the quarter was $59.1 million, lower than the prior year first quarter of $63.1 million, with diluted earnings per share at $1.08 compared to $1.24 in the previous period, and on a non-GAAP basis, $1.09. If you take a look at the EPS Bridge, I'll walk you through some key elements of this. We saw favorable performance at the margin line, offset by higher operations, administration, and general expenses, which were expected, and the equity dilution we talked about previously, amounting to a headwind of $0.09. This is laid out in the slide as well. Importantly, these results are in line with our expectations for the quarter. I will provide a little more detail on margin and operational expenses in the next couple of slides. Looking at Slide 6, a few key elements on the margin: this slide details the drivers of improvement. We saw an overall $2.8 million improvement that contributes to the bottom line. There has been strong growth in residential, commercial, and industrial sectors, reporting a 1.6% increase on the electric side and 1.2% on natural gas, though customer usage remains fairly flat compared to the prior year. From a winter weather perspective, it was warmer than normal, but slightly colder than the previous year, which is reflected in the flat performance. Additionally, we observe some incremental improvement in transmission revenue. An overall $2.8 million improvement at the margin contributes to net income. From the operational expense perspective, we anticipate an increase this year amounting to $5.8 million in operating costs impacting the bottom line. This is in line with our guidance for 2022, including significant elements like higher depreciation from infrastructure investments made, and recovering higher uncollectible accounts. I want to remind you that last year's prior number reflected collections that reduced amounts we were taking in from previous periods. We are returning to a more normal level of uncollectible accounts. We continue to invest in technology within the system, leading to higher labor costs and benefits along with some upward pressure on insurance costs, though somewhat offset by lower property taxes. This detail aligns with our expectations for the quarter, amounting to $5.8 million on the operations front. Moving to Slide 8, we present the non-GAAP adjustments. As indicated earlier, our net income stands at $59.1 million, equating to $1.08 on a GAAP basis. The adjustment made on a net income basis accounts for the unfavorable weather add-back of approximately $600,000 for the quarter, resulting in a non-GAAP income of $59.5 million or $1.09. This compares to previous years where, last year, we had an unfavorable weather adjustment of $1.3 million, bringing us to $64.1 million or $1.26 per share. Again, let's not forget the impact of diluted shares from our equity issuance affecting performance on a quarter-over-quarter basis. Slide 9 illustrates cash flow performance, where we have seen significant improvement in operating cash flows and working capital, driven by the collection of costs from previous years. It’s crucial to remember that in Q1 last year, we experienced significant gas costs due to Winter Storm Uri, affecting South Dakota and Nebraska. Those high costs contributed through Q3 and Q4 as well. Therefore, the collection of those costs has resulted in favorable cash flows. Unlike last year, we were not faced with refunds totaling around $30 million, which had a positive impact on our cash flow performance this quarter compared to the prior. Slide 10 reaffirms our guidance for 2022 of $3.20 to $3.40 per share, reflecting first-quarter results in line with our expectations. We've indicated previously that our guidance presents a down year from previous years due to both marginal improvements being offset by higher operating costs and the impact of equity dilution. Hence, we maintain a clear path towards our 2022 guidance with no noted adjustments.

Thanks, Crystal. Moving to Slide 11, we want to discuss our capital investment. On the left side of the page, you can see that our investment of approximately $1.8 million over the last five years has lead to a 12% compound annual growth rate (CAGR). Looking ahead, we are increasing that investment to $2.4 billion over the next five years, which translates to roughly $500 million per year. Two-thirds of this investment will focus primarily on transmission and distribution (T&D). In addition to simply maintaining our system, we are investing in increased capacity, grid modernization, and enhancing customer experience through technologies like AMI meters. This significant investment will yield an annualized rate base growth of approximately 4% to 5% moving forward, financed with a targeted 14% to 15% funds from operations (FFO) to debt. On Slide 12, we highlight hydro conditions and are monitoring these closely. In fact, we tracked this report again this morning, and conditions are looking greener. We received good snow in Butte overnight, and overall conditions are improving. As many of you are aware, Montana has been facing a drought, and this snow will aid both our hydro facilities and our fire management efforts. We feel much better at the end of April than we did at the end of March. Looking ahead, we anticipate concluding testing for the Bob Glanzer 58-megawatt generating station in South Dakota in early May, and we hope to have this online soon to help meet capacity needs in South Dakota. Discussing capacity, as Bob mentioned earlier, our goal has been to avoid adding fossil fuel resources in Montana for over ten years, achieving over 700 megawatts of carbon-free resources during that time. However, it is now time to provide capacity resources to offset intermittent resources. The Yellowstone County plant in Billings will contribute to that. We began construction this April and aim to complete it in the 2023-2024 winter season. Lastly, we plan to file for both electric and natural gas rate reviews this year, primarily to recover substantial investments and costs accrued since the last rate case. We expect to file mid-year 2022 based on a 2021 test year with appropriate adjustments. Regarding net-zero commitments discussed on Page 14, our utilities under NorthWestern Energy have been around for 100 years, and we take pride in our environmental stewardship over the years. We need to commit to achieving net-zero by 2050 for Scope 1 and Scope 2 emissions. Though we may have entered the game a bit later, we aimed to ensure that we can deliver on this promise as a combined electric and gas utility. We need to balance affordability, reliability, and sustainability throughout this transition. Furthermore, we commit to adding no new carbon-emitting generation resources after 2035. The reasoning for the 2035 deadline is that we are closely monitoring technologies that can be non-carbon-emitting, which we expect to become cost-effective by that time. Alongside committing to Scope 1 and 2 emissions on a net-zero basis, we also intend to assist both upstream and downstream Scope 3 emissions with our customers and suppliers moving forward. With that, I'll pass it back over to Mr. Meyer.

Thank you, Brian. We'll take our first question from a Guggenheim representative. Shar or Jamieson, your lines are open.

It's Shar in for the famous Jamieson. It’s good to see you guys are becoming more technological on a Friday afternoon. So just a couple of quick ones here. First, looking ahead to the IRP, you mentioned you plan to file later this year or early next year. How should we think about the timing regarding arbitration efforts around Colstrip? At a high level, where does arbitration progress stand today?

I'll jump in on the arbitration. At one point or another, each of the owners has requested arbitration, but never at the same time or in the same venue. Recently, there was an oral argument in front of a federal magistrate where one of the questions raised was whether the magistrate should advise the federal judge to require arbitration. Technically, all IOU owners at Colstrip are concerned about serving their customers while adhering to state policy and legal requirements, which poses a challenge regarding compliance. I believe Brian would like to address the upcoming IRP. Essentially, we've managed risks for our customers and shareholders well over the next few years with our current setup, creating a strong foundation for whatever outcomes arise from the next planning process. Part of that will certainly involve reacting to any new information we obtain about Colstrip at that time. Overall, we feel we are in a good position, having made substantial progress over the past couple of years. Brian?

Yes, thanks, Bob. First and foremost, we need to finalize an IRP, anticipated in the latter half of '22. This presents pressures on the same individuals working on these plans in late '22 or early '23, as you know from the Montana IRP. To your point, Shar, it would be beneficial if we could clarify the Colstrip situation before we release the IRP. Should we lack clarity by that time, we will need to present sensitivities with or without Colstrip generation.

Got it. Perfect. Now turning to your upcoming rate case filing in June. With rising inflation and supply chain issues, you've mentioned a 2% on the CapEx. Given the regulatory lag pressures associated with large construction projects, you're looking to adjust the test period, among other things. It seems there are many moving pieces. Brian, have you had any preliminary discussions with key stakeholders in anticipation of this filing? Are you concerned about any surprises?

We haven't officially announced a June filing date yet. However, we expect to file in the summer, covering both electric and gas. The internal work done to prepare for this filing is impressive. Our team has made significant progress. Discussions will certainly occur, elucidating what we are filing and why. We have engaged in substantive talks with commission staff regarding major rate filings. At the core, we are focused on recovering our current costs while incorporating the substantial capital investments we've made over the past few years. Additionally, there are valuable specific proposals in consideration. Crystal is deeply involved in that and can perhaps provide more detail.

Yes, Shar. I would like to add that we are operating from a knowledge base of five years in between test periods. You alluded to inflation and discussions with stakeholders. Our primary focus in this rate case will be reflecting the infrastructure investments we've made during that timeframe and recovering those costs. There are observable pricing changes everywhere, and we belong to that category of asking for an increase in prices. We are maintaining open lines of communication with key stakeholders, keeping them informed about our expected rate case actions.

I’ll answer a question you did not ask, which is that had we been able to invest more aggressively in owned generation earlier and if we had a better ability to hedge, I genuinely believe our customers would have been in a much better position and better protected from volatile market costs than they are now. For instance, our hydro system came into the rate base just a few years ago; we have continuously invested in that, and the costs associated with the hydro system for our customers are already beginning to decrease through depreciation. I hope the lessons learned are the right ones.

No, Bob, you answered the question I was about to ask, and I'm grateful for that. Thank you, everyone. Enjoy your weekend.

We'll take our next call from the line of Sophie Karp at KeyBanc. Sophie, your line should be open.

Hi, everyone, can you hear me?

We sure can, Sophie.

Thank you for taking my question. I wanted to ask about the total number of capital investment recovery that you would be discussing in this rate case. While I appreciate that you are digging into the details and planning the filing, should we regard it as more of a statistical view of prior years' CapEx? What would be a suitable approximation for that amount?

There are a couple of points to consider here, and I'm looking to Travis as well. In the appendix, we have Slide 23 that presents an overarching view of an ending rate base figure, which would be a solid approximation for what we would request in recovery. More updates will follow once we officially file regarding the ending rate base figure we will seek. That's where I would recommend pointing you for the most accurate indicator of what we will seek from a revenue requirement perspective.

Got it. So that would not be including the subsidies you're expecting to commission this year, correct? Such as the Bob Glanzer and Yellowstone County projects?

That is correct. The Bob Glanzer project in South Dakota hasn’t had a rate case timing announced yet; regarding Yellowstone, we expect it to be operational by the winter of '23-‘24. Therefore, our approach won't consider those in this year’s test period for the '21 test year without measurable adjustments in '22.

Thank you for that clarification. Now, on a more philosophical note, do you believe there has been any evolution in Montana regarding attitudes toward utility generation ownership? It’s a complex subject.

That's a great question. What I mentioned in response to Shar aligns perfectly. Markets serve their purpose wonderfully when the prices trend favorably, but all those savings can vanish in just a few days. Last July, for instance, we had budgeted around $6 million to $7 million for electric supply in Montana but ended up spending close to $28 million. Under any circumstance, we will participate in the market on behalf of our customers. Recognizing both short-term and long-term strategies provide incredible value over time, including substantial segments of owned generation, is crucial. It has definitely become a more understood concept.

I appreciate your insight. Lastly, now that Talen has filed, are there any implications for that concerning the Colstrip processes that you are aware of?

We have been in touch with Talen and are considering potential implications. To clarify, Talen is an owner of Unit 3, while we own Unit 4. Although there is a reciprocate sharing agreement between both units, we are monitoring how the bankruptcy could affect operations at the plant, given they are the operator. As of now, we do not believe that this will impact our operational activities at the facility.

Thank you. That's everything I had.

Thanks, Sophie. We'll take our next question from Ryan Greenwald at BofA. Ryan, your line is open.

Did that work? It's Ryan and Julien. Good afternoon, everyone.

Hey, Julien. Good afternoon.

To get straight to it, following up on Shar's conversation earlier, how do you view introducing more dialogue around trackers, not just capital trackers in connection with Laurel, but also concerning O&M in a more inflationary environment? Conceivably, there might be more understanding about the necessity, but I’d like to learn about where you are in these discussions with stakeholders.

Julien, I'm aware of stepping into the CFO role at such an inflationary time. Your point about trackers is well-taken. While I wouldn’t classify our PCCAM as a tracker, it doesn’t function like one. We plan to propose a revised design of this mechanism to make it more tracker-like. Pricing may lead to a fresh perspective on generation. We will argue for a mechanism to recover costs more quickly in this climate.

I agree, and I appreciate your insight into PCCAM being more of an anchor than a tracker. It does many things poorly; it is convoluted, and there is an extraordinary lag. It’s asymmetrical and doesn’t give customers the pricing signals they require, resulting in a shocking outcome at some stage. This is an opportunity to learn from our experiences regarding what works and what doesn’t. It falls under the latter category currently.

I understand what you’re saying. Also, could we dig deeper into Laurel briefly? What's your confidence level in securing costs related to that project at this time? Where are we regarding confirming those capital costs?

One reason we proceeded with the Yellowstone project is that we secured a fixed-price contract. While inflationary pressures are possible, we believe they remain manageable due to being locked in with a fixed price.

That makes sense. I hear you. Regarding conversations with stakeholders, how has this been received in terms of reevaluating PCCAM or anything beyond that?

On the PCCAM side, in our filing, as Bob mentioned earlier about the rise in prices, we experienced outsized costs above the base in that filing, highlighting a need for a reset. It appears that conversations with stakeholders and staff indicate a preference for simpler, more formulaic mechanisms. As such, we will advance our proposal for these considerations during the rate case.

Thanks, everyone. I appreciate it. I'll leave it there.

With that, it looks like we've exhausted our questions. I’ll hand it back to Bob for any closing remarks.

Thank you very much for the thoughtful questions and for your support throughout this year. We look forward to seeing many of you in person soon. Have a great weekend, and let's keep the snow coming.