NorthWestern Energy Group, Inc. Q3 FY2022 Earnings Call

Good afternoon, and thank you for joining NorthWestern Corporation's Financial Results Webcast for the Quarter Ending September 30, 2022. My name is Travis Meyer. I'm the Director of Corporate Finance and Investor Relations Officer for NorthWestern. Joining us today to walk you through the results and provide an overall update are Bob Rowe, Chief Executive Officer; Brian Bird, President and Chief Operating Officer; and Crystal Lail, Vice President and Chief Financial Officer. All participant lines are currently muted. After the presentation, we have ample time for our Q&A session, and I will provide instructions for asking questions at that time. NorthWestern's results have been released, and the release is available on our website at northwesternenergy.com. We also released our 10-Q pre-market this morning. Please note that this company's press release, this presentation, and comments by presenters and responses to your questions may contain forward-looking statements. I will direct you to the disclosures contained within our SEC filings and the safe harbor provisions included on the second slide of this presentation. Additionally, this presentation includes non-GAAP financial measures, and you can find the non-GAAP disclosures, definitions, and reconciliations also included in the presentation. The webcast is being recorded, and the archived replay of today’s webcast will be available for one year beginning at 6 P.M. Eastern today, which can be found in the Financial Results section of our website. With that, I'll turn it over for one last time to NorthWestern’s CEO, Bob Rowe.

Thank you very much, Travis. We're meeting this week in Sioux Falls, South Dakota. There are some great economic development activities over the weekend, and we're just delighted to be part of one of the most dynamic economies in the country. The highlight of the board meeting was a presentation by PUC Chair, Chris Nelson. Chair Nelson reminded us of our responsibility to focus on the reliability of our system, and he is very clearly focused, as are his colleagues, on reliability and affordability. It's a message that he also delivered very eloquently at the ribbon cutting for the Bob Glanzer Generating Station. So we were really honored and appreciated the team's time for us. I wanted to say a couple of things about the ongoing renewal of our leadership at both the board and executive level. At the board level, as probably most of you know, Kent Larson is a new member of our Board of Directors. Many of you probably know Kent; he was a key leader at Xcel until his retirement and one of the key contributors to Xcel's sustainable growth over a number of years. Kent is already providing great contributions to the Board of Directors. At the executive team, our General Counsel, who also leads our Regulatory Affairs efforts, Heather Grahame, has announced her retirement in early January along with me. Heather will be pursuing her passion for triathlon, where she is world-ranked. Heather has been a great leader for the company, key in all of our legal regulatory compliance work and also a key contributor to our corporate strategy. Because Heather is as good as she is, we will be elevating two people to take her place: Shannon Heim coming in as General Counsel, and Cyndee Fang becoming Vice President for Regulation. In addition, Curt Pohl, our Vice President for Distribution, has already moved into a new position focused on business development, and Jason Merkel has taken over the role of Distribution Vice President. So Brian is going to be leading a great team with veterans and some new faces that are aligned with the direction that Brian, the board and the executive team will be taking the company over the next few years. Turning to financial results, net income for the quarter was $27.4 million, or $0.47 per diluted EPS. Non-GAAP EPS was $24.3 million, or $0.42 diluted EPS. Our expected long-term EPS growth rate is 3% to 6% off a 2020 base. As you know, we filed a Montana rate review on August 8. This was seven months into the year, as opposed to the nine months cadence that we typically follow. Impressively, the Montana Public Service Commission issued an interim order on October 1. Two months after the filing, we received a unanimous order based on a staff recommendation. The order will significantly mitigate that regulatory lag and under-recovery of our purchased power cost, and it will certainly reinforce our credit metrics. It will also provide the retroactive date for a final order. A couple of other notable items in the rate case that Brian's going to come back and discuss in more detail. First of all, some key procedural steps: the Commission has issued a procedural order, and we're past the period during which the application could be deemed inadequate, which could have triggered a refiling or modification to the filing. We're doing some interesting and constructive things in this case, including a very well-attended webinar led by Brian to kick off the filing process, and Cyndee Fang will be leading a series of technical discussions on key points. The case is driven by recovering our substantial investments in capital electric and gas infrastructure since our last filings, cost recovery of flow-through costs, and then a set of about four important policy proposals. Again, Brian is going to be providing more detail on that. We are very pleased to be where we are right now and appreciate the professionalism of the Montana Commission and staff. We filed our South Dakota Integrated Resource Plan on September 6 and look forward to implementation of the actions under that plan. We are on track for our $582 million capital plan for this year, and the board has voted a $0.63 per share dividend payable on December 30 of this year. I will now turn it over to Crystal, who will then hand it off to Brian.

Thank you, Bob. I'll speak to Slide 4 and discuss further details of our financial results and then hand it over to Brian here. For the third quarter of 2022, you'll see net income of $27.4 million, which is $0.47 on a diluted EPS basis, and that compares with a third quarter of 2021, where net income was $35.2 million, or $0.68 on a diluted basis. Slide 5 lays out a bit of the significant drivers of that performance for the quarter with the bridge from the $0.68 for the quarter on a GAAP basis in 2021 to $0.47 on a GAAP basis, or $0.42 on a non-GAAP basis in 2022. The utility margin was impacted by $3.2 million, or $0.05 after tax, which was a detriment given that we had favorable weather. Operating costs are in line with our expectations for the year. When we laid out our guidance for the year, we talked about a sustainable operating cost structure. We are seeing pressures there, but they remain manageable, resulting in a $0.06 impact with $4.1 million on a pretax basis. The next column you'll see is interest rate pressures, which are affecting everyone, leading to a $0.03 impact for the quarter, and of course, dilution from the increased share count from the equity issuance last year, impacting this year's capital investments. The GAAP basis figure of $0.47 is adjusted for a non-GAAP basis decrease of $0.05, driven by weather. The utility margin is detailed on Slide 6, showing that the overall impact from last year fell to $224.1 million of utility margin net income, which was $3.2 million lower than the prior period. Slide 7 details the GAAP to non-GAAP adjustments for Q3, where our only non-GAAP adjustment is weather. Our adjusted net income is $24.3 million on a non-GAAP earnings basis when you consider the $4.2 million adjustment for favorable weather versus normal, compared to $33.6 million in the prior quarter. We saw significantly improved operating cash flows of $87.7 million year-to-date. However, FFO actually decreased by $15.6 million, driven by a lower net income. We also see continued high market electric supply costs and higher natural gas prices impacting cash flows in the near term. With that, I’ll transition to expectations for the full year ‘22 results on Slide 9, and we are narrowing our guidance range to $3.20 to $3.35. While results in the quarter were lower than expected due to high market supply pricing in Montana, the GRC is critical for growth going forward and resetting a reasonable cost structure. I will now turn it over to Brian.

Thanks, Crystal. On Page 10, let's discuss our capital investment. Historically, over the last five years, we invested $1.7 billion, increasing from under $300 million in 2017 to over $400 million in 2021. That represents a compounded annual growth rate of 12%. In 2022, we have an even larger capital plan with $582 million, which remains on track. You may recall that early in the year, we warned of potential delays and rising costs due to the supply chain crisis. We have seen these impacts but overall, our plan remains on track. We are looking to invest $2.4 billion over the next five years, much of which is directed toward our delivery business to modernize the grid and increase capacity. This sustainable level of CapEx is expected to drive an annualized rate base growth of approximately 4% to 5%. The goal is to achieve a 14% to 15% FFO to debt ratio by year-end. Given the time that has passed since our last rate cases for electric and gas in Montana, it has been crucial that we recover our $1 billion investment in infrastructure that we have made since then. Over 49% of the rate case request relates to cost of capital and depreciation, while 42% is driven by flow-through costs, including market power purchases and property taxes. Moving onto Page 12, we received approval on October 1 for interim rates to go into effect, allowing us to collect base electric rates of $29.4 million and to improve our PCCAM perspective. On this, we received approximately 80% of our interim request on the electric side and around 60% on the gas side. Importantly, once final rates are approved, October 1 will be the retroactive date. Our next key procedural date is December 19 for intervenor testimony, followed by rebuttal testimony in early March, leading to the hearing in early April. Regarding our projects, the significant construction in Yellowstone County began in April this year, with about $100 million invested to date in the $275 million project. We are excited about the Bob Glanzer Generating Station, which is dispatching more than we expected and is adding reliable capacity. Lastly, I would like to acknowledge Bob for his incredible leadership over the years. Under his guidance, we have tripled the size of the business and invested over $1 billion in clean energy resources.

Brian, thank you very much. I can't imagine anyone I would have rather worked with than you or this entire group of people, but I will reserve my rebuttal until after we deflect questions. Thank you, Brian.

We will take our first question from Shar Pourreza at Guggenheim. Shar, can you hear us?

Can you hear me, guys?

Yeah. For sure, we can.

I mean, just on as we're thinking about next year. I mean, obviously, you're not issuing ’23 guidance right now, but I think it would be helpful. Maybe just give us a sense on the ’22 headwinds you just highlighted in your prepared remarks as we look to bridge into ‘23, like the lower usage, interest rates, PCCAM recovery. I guess, is the GRC enough to offset sort of these ‘22 impacts as we look into next year or could we see some drag with these items into ‘23? Thanks.

Shar, it's Crystal. A couple of things with that regard. So one, the GRC is a huge driver when you think about the impact of PCCAM on the quarter. As I said, it has multiple impacts in our financial statements. Resetting that base and getting something we can actually work with is critical to how we think about our performance going forward. It has caused under-earning for us in the past and is something we are working with the commission on resetting and moving forward on. So I would say that's certainly a key piece of how the GRC will impact us. And broadly, it's us and everybody else in an inflationary cost environment, and we'll have to manage that. But I would see strong growth overall. We talked about the need to take this year as a reset and to invest for the future in the sense of the equity that we issued, still driving a net income increase this year. Your question, while we continue to grow the business absolutely, the biggest platform for that is certainly getting back to earning our returns from a Montana basis, and the GRC is the most critical piece to that.

Got it. So you don't want to assume that the reset can continue into 2023, depending on how rates play out. That's the key takeaway.

Yeah. Us and everybody else will be dealing with the interest rate pressure. So I don't think that's going to be determinative between us and others, and we'll manage that along with the outcome from the rate review. But certainly, what I would expect to see is what we've talked about from a ‘22 guidance, taking this year to get a solid rate case filed that gives us a sustainable amount of cost captured there and the platform for growth off of that.

Got it. Okay. That's helpful. And then how should we sort of think about potential outcomes of the appeal you have right now that's in front of the Montana Supreme Court regarding the preapproval law? Is there a scenario where they could retroactively apply that to Laurel? Or how would winning the appeal impact your plans going forward?

As you recall, we decided not to use preapproval for the Yellowstone Station because we were concerned about getting the plant in service as quickly as possible, moving ahead with construction before we got caught on the wrong side of the inflationary environment and supply chain challenges. Therefore, the Supreme Court decision, regardless of the outcome, will have no effect on that particular resource. I'll go beyond that and say that we had also identified a 50-megawatt battery project out of the RFP. We had proceeded with a preapproval application for that based on the district court decision validating the statute. Unfortunately, the commission closed that docket, and that project is not going ahead.

Got it. Great. And then just one last one. Just on Colstrip, I mean, obviously, your preference is for fast-ramping generation like the RICE units, but at the same time, we've seen some major cost increases versus the plan, which led to Aberdeen getting canceled last year. If you were to acquire more of Colstrip than is currently planned, how would the cost of that capacity compare to what you're seeing in the market right now for new builds? Thank you.

That's a hypothetical question, and we continue to lean heavily on Colstrip, as it remains a valuable resource for us. Our biggest use for the capacity is on peak demand days, when we're seeing increased demand and higher prices. Thus, acquiring additional capacity would be very helpful.

Got it. Okay. Great. Thanks, guys. I appreciate it.

Thank you.

Thanks, Shar.

We will take our second call from the line that ends in 4377-914 area code. Your microphone should be unmuted.

Yeah.

There you go. We got it.

Is this working? All right. Sweet. There we go. We're figuring it out one day at a time here. Excellent, guys. Thank you very much. I mean, if I could ask just a little bit the inverse of the questions in the last couple. How do you guys think about O&M and your operating budget as we enter ‘23? Is there any way to think about that and put some context to it, given that the rate case won't be a full year in offsetting the headwinds?

Hey, Julien. First of all, you can actually include your name there. We take your question regardless, just your number, just so you know that. But I’m happy to pass it on to Crystal Lail.

So, Julien, regarding operating costs, I'll refer you back to when we laid out our ‘22 bridge. One of the things we stated was that although there were improvements in net income, the impacts of dilution were driving our lower earnings from this year to a sustainable cost structure. There are headwinds, but they are manageable; for the quarter, we saw a $0.06 impact, which is manageable and in line with our expectations. As we enter ‘23, inflationary price impacts may affect us, but we believe the current operating costs can be managed effectively. We have benchmarked well on an O&M basis, which is part of our argument in the GRC that we manage the business efficiently. However, we do not foresee any significantly large cuts needing to be made, and you will see that we did not adjust our operating cost assumptions as we narrowed the guidance range.

Just a footnote to your question. The rates that come out of the case, whether it's up, down, or sideways, the interim rates implemented efficiently by the commission are valuable.

Got it. Excellent. Well, thank you again. Can we talk a little bit about the transmission outcomes? I would have thought that things would have been a little better just given the volumes and the volatility in the quarter in the power markets. What are your expectations for commercial volumes going forward? I saw the commentary in the release on Q3. What does that hold for Q4 versus plan? And then more importantly, as you think about ‘23, if you don't mind discussing both pieces?

Regarding Montana, for example, we have seen growth in new connections overall, including commercial, but many of the commercial sectors seem to not yet be fully staffed. Part of what we're seeing seems to be related to the continued challenges in the labor market.

On the transmission side, your question about the expectations-historical context is valid. Transmission revenues and margins are down due to price and volume effects. This year, we anticipated a $4.7 million lower impact, which was expected. This year, we experienced slightly lower volumes due to variable weather conditions compared to last year. So overall, while we keep close track of market circumstances, we expect strong commercial growth but recognize that one quarter does not establish a trend.

Excellent. Well, thank you, team, and Bob, best of luck. It's been a real pleasure.

Thank you. You as well.

And with that, we've exhausted our queues. So, Bob?

Well, we will get to see many of you in the mosh pit at EEI or possibly in New York in December. As soon as Brian finishes, it’s not unusual after we finish these meetings that we need some tissues. I really appreciate that. Heather will be biking, swimming, and running off into the sunset in January, and I will hopefully pursue several other interests, including spending more time with my wife. Over the last 14.5 years, it has been a great privilege to work with an amazing group of people and become good friends while performing important work in special places. I've been incredibly lucky and enjoyed connecting with many of you to discuss industry trends and answer all your probing questions about our business. Thank you all for your long-term support of our very special company.

Thank you for joining us, and that brings our webcast to a conclusion. Thank you.