Earnings Call Transcript - NWE Q1 2021

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Good afternoon and thank you for joining NorthWestern Corporation's Financial Results Webcast for the First Quarter of 2021. 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 are Bob Rowe, Chief Executive Officer; Brian Bird, President and Chief Operating Officer; and Crystal Lail, Vice President and Chief Financial Officer. We also have other members of the management team on the line with us to address questions as appropriate. All participants’ lines are currently muted. After the presentation, we have a lot of time for our Q&A session. I will provide instructions for asking questions at that time. However, if you intend to ask a question and are joining us by computer, please set your Zoom identity to your first name, last name and firm name, so we can call you by name to let you know when your line is open. Regarding the results, NorthWestern's results have been released and this release is available on our website. We have 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 in our SEC filings and the safe harbor provisions included on the second slide of this presentation. Please also note this presentation includes non-GAAP financial measures. Please see the non-GAAP disclosures, definitions and reconciliations also included in this presentation today. The webcast is being recorded. The archive of today's webcast will be available for one year beginning at 6:00 p.m. Eastern Time today and can be found on our website at northwesternenergy.com under our company, Investor Relations Presentations and Webcast link. With that, I'll hand the presentation over to NorthWestern CEO, Bob Rowe.

Bob Rowe, CEO

Thank you very much, Travis. Just a couple of quick comments to start. First, happy Earth Day. If you haven't, I really do encourage you to take a look at our environmental stewardship report on our webpage. Today the electric industry has made some good announcements about progress, and do be mindful that from a carbon perspective, our overall company portfolio and particularly our Montana portfolio is in just exceptionally good shape. Brian will come back and discuss ESG, and we'll also talk about steps we've taken to address our substantial and critical capacity shortage in Montana. Second, just very quickly, two tremendous Board members, Board Chair Steve Adik and Governance Committee Chair, Julia Johnson, have stepped down after tremendous 16-year careers. They've led this company effectively on a remarkable journey. They've done a great job too of leaving behind a Board of Directors that is as effective and engaged as possible. Third, this is Crystal Lail's first quarter fully at the helm. Crystal has spent her entire career preparing to take over as Chief Financial Officer and is doing a great job. And then your old friend, Brian Bird, has jumped into a new role as President and Chief Operating Officer. And again he's doing a fantastic job, really helping to focus our entire operations part of the business on the future and really again pulling that whole part of the company together. So congratulations and thanks both to Crystal and to Brian. Now in terms of significant events, net income for the first quarter increased $12.4 million as compared to the same period last year. Diluted EPS increased $0.24 or 24% as compared to last year. After adjusting for weather, non-GAAP adjusted EPS increased $0.20 or about 18.9% as compared to last year. The Board of Directors has declared a quarterly dividend of $0.62 payable on June 30 to shareholders of record as of June 15th. Bid submissions for the January 2020 request for proposals have been evaluated by an independent administrator. After reviewing the independent analysis, the following portfolio project was selected. First, the Laurel Generating Station; this would be a 175-megawatt natural gas-fired generating facility, a very efficient set of RICE units. Second, a five-year agreement with Powerex to purchase capacity for 100 megawatts and that is primarily a hydro-based contract. Third, we have signed, as of today, an agreement with esVolta for a 50-megawatt storage unit. It's a 20-year contract to be located in the Billings area. A little bit of reflection. As we think about NorthWestern, we are a pure electric and gas utility. We are proud to be providers of critical infrastructure and essential service across an extraordinary part of the United States. We're proud of our history as our 100-year operating history, our bills consistently below national averages. We produce the highest ever customer satisfaction scores, best safety record, and one that, as you all know, is particularly important to me, we continue to receive recognition for those strong earnings growth stable and flexible investment-grade balance sheet. We as you may know increased our liquidity, doubled it last year due to the uncertainty we were facing stable growth in our annual dividends; a very disciplined capital investment program of $450 million this year to start; really focused on investments to serve our customers and our part of the country; stable and consistent customer growth. We've seen particularly on the residential side across our service territory, this is where people really do want to be. I mentioned our supply portfolio and the accomplishments there. But again, there is substantial exposure to a market where we really just do not want to be. And with that, Crystal, I'll hand it off to you.

Crystal Lail, CFO

Thank you, Bob. And as Bob mentioned, my first call earnings call as CFO at the helm, and it's not lost on me that it's nice to have my first call be after a solid quarter and also to have important news on our capacity deficit and how we're going to address that. The thing I will say is as Brian is transitioning into his operating role, he seems to be gaining new insights on how to spend dollars. However, certain things will never go away, and I don't think you'll find him buying drinks at the bar, and that his frugal ways will go away anytime soon. But with that on slide five, you'll see the P&L for the quarter and again a solid quarter from that perspective. On a net income basis, Bob mentioned $63.1 million for Q1 2021 compared to $50.7 million in Q1 2020. That's a $12.4 million improvement or 24.5% driven by improvement really at the margin line and some lower operating costs. On a GAAP basis, diluted earnings per share of $1.24 versus $1 in the first quarter of 2020. As we move into slide six to give you a bit more details on the gross margin breakout, really the performance there was driven by colder weather in Q1 2021 as compared to Q1 2020. While that was still a bit warmer than normal, we have seen strong residential usage in the quarter. That's $6.9 million of electric natural gas retail volumes. We also saw an improvement in electric transmission. Those are partially offset by Montana Electric supply costs being a little bit higher. And then you'll also recall in Q1 of 2020 we had some other non-recurring items that were detrimental in that period. Here in Q1 2021, the absence of those leads to improvement. So, when you take out the items that don't fall to the bottom line, that's a $10 million improvement from a gross margin perspective, driving a lot of the performance for the quarter. As we move into slide seven, again, operating income of $80.9 million for the first quarter compared to $75.2 million in 2020, or a $5.7 million or 7.6% increase. We also saw a decrease in interest expense of $0.8 million or 3.3%. That was primarily due to lower interest on our revolving credit facility and higher capitalization of AFUDC, slightly offset by incrementally slightly higher borrowings. Our other income line shows a big increase there. What I would remind you there is some items in there that don't fall to the bottom line. You remove those, and what that shows is an improvement of capitalization of AFUDC after removing those offsets and that's approximately $1.3 million net after those numbers. Also, from an income tax perspective, last year we had an income tax benefit. This year, we're flat for the quarter, so that's a $1.8 million decrease. You'll see as we move into slide 10, that's primarily driven by the increase in net income and improvement in that line. From a deductions perspective, we're right in line with where we would expect to be and you'll see our typical flow-through and other deductions detailed on slide 10.

Brian Bird, President and Chief Operating Officer

Thanks, Bob. I've been known to actually pick up a check now and then, but I'll take that praise you guys provide. By the way, I appreciate Bob setting up. I think everybody on this call understands the capacity issue we've been speaking about for years, particularly during 2020, and into 2021 as we kicked off our RP in Montana in early 2020 and received bids midyear that year; we finally have come to the conclusion of that. We're very pleased to announce a very strong portfolio that will provide great capacity to our customers and effectively help us achieve kind of halfway there, if you will at least to get to the 2025-2026 time period of really putting capacity in place to help us with our capacity shortfall that we've been explaining to investors and other stakeholders for years. That portfolio, first and foremost, we're pleased to announce the Laurel Generation Station, construction of 175 megawatts of flexible reciprocating internal combustion engines. You've heard us speak of RICE units before. Those will be located near Laurel, Montana, and we will own those units in fact if we're able to get proper approval from the Montana Public Service Commission. The cost to construct this plan is expected to be approximately $250 million and should be available for commercial operation in late 2023 or early 2024. The second component of the portfolio is a Powerex transaction, a five-year power purchase agreement for 100 megawatts capacity and energy projects. As Bob pointed out earlier, predominantly from hydroelectric resources. The third and Bob let the cat out of the bag a bit; we did sign contracts today and we're pleased to announce we have signed a 20-year battery energy storage agreement with esVolta on a 50-megawatt facility to be located near Billings and expected to be in operation on October 1, 2023. We expect to request MPSC approval of the Laurel contract and the esVolta energy storage contract and expect to make that filing in May, with the decision anticipated about approximately nine months after filing. So that's the great news out of Montana that I know many of you have been waiting on. The good news out of South Dakota is we continue the construction of the 60-megawatt RICE project and here on South Dakota, the Bob Glanzer Generating Station is expected to be online in late 2021 with a total construction cost of approximately $80 million. An additional 30 to 40 megawatts of flexible generation in Aberdeen, South Dakota is in its planning stages and expected to be online in 2023 with an approximate cost of $60 million. So again, we're taking great steps in these two jurisdictions where we provide electric service to our customers to meet our capacity needs.

Brian Russo, Analyst

Hi. Good afternoon. Just any more details you could provide on the Laurel Generating Station. Is this a new site? Or is it brownfield development or greenfield development? And is there kind of additional space for more units maybe in the next RFP?

Bob Rowe, CEO

Brian, I don't believe we have specifically disclosed the site.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

We haven't Brian, but it is a greenfield site. And we'll disclose that here shortly. Many of the questions associated with Laurel and esVolta will be covered, of course, in our filing that we're going to make in mid-May.

Brian Russo, Analyst

Okay. Understood. Is there any discussion at the commission or the legislature regarding earnings or sort of imputed return on PPAs going forward?

Bob Rowe, CEO

Yes. There has been discussion on both sides of the subject. Commissioners have spoken to it over a number of years favorably. It was a point of debate in the legislature and a number of legislators spoke up against it. As you know, it's something that a number of electric companies are now requesting and receiving, particularly in Michigan and Hawaii.

Brian Russo, Analyst

Okay. Great. Hypothetically, if the Montana Commission pre-approves the filing, what are the possibilities for cost recovery and return on investment? Could it be a one-time filing added to base rates and reflected in customer rates? Or would you need to submit an actual general rate case to include it once it is operational? Also, can you remind me about the treatment of the hydro transaction and the pre-approval?

Bob Rowe, CEO

Actually, we used to include – before our last general rate case, we used to include a table that showed the authorized ROE by asset for assets that came in through the approval process. And so typically, the approval filing is subject to an after-the-fact prudence review just to be sure we did a good job with what we said we were going to do. But it does include an authorized ROE. Typically that will be picked up from whatever the most recent authorized ROE is. Crystal, do you want to add some color to that?

Crystal Lail, CFO

Sure. If you look at how our approval filings have worked in the past, what will happen there is, subject to the commission's approval, when that asset is placed into service, it is added to customer rates at that time. It has its own cap structure and return calculated based off the revenue requirement for that asset. But it does allow for immediate rates in place upon used and useful. And then it's captured in the following rate case and layered into our broader rates. But certainly, it allows for adjustment to regulatory lag there of not experiencing the lag between use and useful and when you do a next rate case.

Brian Russo, Analyst

Okay. Thanks. That's helpful. And then, there wasn't much discussion on Colstrip. Can you just provide us an update there? I think you have a coal supply contract coming due in 2025 around the same time where some of the co-owners are looking to exit. Just curious if there's any update there that you can provide?

Bob Rowe, CEO

What I could say there is that our existing ownership at Colstrip continues to be extremely important to serve our customers. Absent that, the capacity gap would be just that much greater. You're right; we certainly have been talking to Westmoreland about terms of the coal contract and we're focused on price, but also say a contract that is more accommodating to a resource that's being used for capacity.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Thank you, Brian. We'll take our next call from the line of Jonathan Reeder. Jonathan, your line should be open.

Bob Rowe, CEO

And you're on mute, Jonathan. We all need T-shirts with that slogan. That was the motto for the past year. You're on mute.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Star 6, Jonathan, if that helps.

Jonathan Reeder, Analyst

Can you hear me now?

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Now we can.

Bob Rowe, CEO

Good work.

Jonathan Reeder, Analyst

Sorry about that. Maybe I should have raised the hand emoji for you, Bob. Thanks for taking my question. Since we're just on Colstrip, might as well stay there. I saw Senate Bill 379. It's related to potentially acquiring more interest and had passed the Senate earlier this month. I saw it was tabled in the House committee yesterday. Does this mean efforts to potentially acquire more Colstrip interest are definitively dead? I kind of thought it was dead last year after the future deal fell through, but then this kind of somewhat unexpectedly crept up.

Bob Rowe, CEO

Yes. What I would say there to be clear, our interest at Colstrip was always tied to our ability to serve our retail customers and not more. As things stand, as of 1:30 Mountain today, after 379 was tabled, we have no interest in owning an additional share at Colstrip.

Jonathan Reeder, Analyst

Okay. Great. I appreciate you clearing that up. And then could you expand upon your decision not to file a rate case this year in South Dakota? Was it to just be mindful of the customer bill impact given the recovery of the higher February gas costs? I think previously you kind of indicated South Dakota was likely in 2021 in part to incorporate the new gas plant into rates. And then kind of following on that, do you expect to be able to get the new gas plant still into rates when it enters service through alternative standalone recovery filing? Or will it have to wait until the 2022 rate case filing?

Crystal Lail, CFO

Sure. I'll take the South Dakota rate case question. The one thing I would point out about 2020 is certainly, I think Jonathan, you went to the sensitivity around the country that customer bill impacts and where you go from there. The other thing I would say is 2020 isn't the greatest test period for a lot of reasons. One is we certainly had cost control in the South Dakota jurisdiction. The other thing I would say is South Dakota is quite flexible in the sense that we have a couple of options for how we can come in and seek recovery of the capacity investments we're making in the state. So while we're not filing based on a 2020 test period, I'm certain that from a regulatory perspective and with minimal regulatory lag we can bring those assets in when needed.

Jonathan Reeder, Analyst

Okay. I understand that. And then on the $70 million PCCAM request, is that just a standard like kind of annual update that goes every year under the way the PCCAM mechanism process works? Or is this some sort of one-off request that you're trying to update the baseline outside of a rate case?

Bob Rowe, CEO

Crystal, you're on top of that as well.

Crystal Lail, CFO

I can address that. We are definitely in a position to update the PCCAM base. To clarify how this mechanism operates: a base is established, and there are several categories of costs; a portion of these costs is shared above or below the baseline at a 90% to 10% ratio. We reset this for the last time during our previous general rate case. It is possible to file outside of a rate case to reset the base, which is what we are currently pursuing. I should also note that as seen in February and throughout the nation, capacity is becoming more expensive. We are experiencing this issue due to the shutdown of assets in the Pacific Northwest, particularly in Montana, which is shifting from a net exporting state to one that imports energy during peak demand. Consequently, we are facing cost pressures on our PCCAM due to the amount of capacity we need to procure from the market. Therefore, we are making a separate filing to reset that base to address the under-collection and cash flow lag present in the current base.

Jonathan Reeder, Analyst

Okay, that's very helpful. I have one last question for you, Crystal. Can you explain the miscellaneous factors that positively impacted gross margin on both revenue and expense sides during this quarter? I believe you mentioned that it's mainly due to the lack of those miscellaneous challenges we experienced in the same period last year. Is that correct?

Crystal Lail, CFO

Right. If you recall, Jonathan, last year unfortunately, we had to talk about our other. And Brian, as a very experienced CFO covered it well. But we had some items in last year that were non-recurring. They were detrimental in the prior period. So the absence of those in this year provides a middle lift.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

We'll take our next call from the line of Shar Pourreza. Shar, your lines should be open.

Shar Pourreza, Analyst

Hey, guys can you hear me?

Bob Rowe, CEO

Yes. Perfect.

Shar Pourreza, Analyst

Thanks. Travis made this way too technological.

Bob Rowe, CEO

Not at all.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Congrats, you can handle it.

Shar Pourreza, Analyst

And Bob don't worry about it, Brian usually makes me buy him drinks, so we're on the same page.

Bob Rowe, CEO

Good, good, good.

Shar Pourreza, Analyst

So just real quick around just with the Montana generation, the $250 million in CapEx, can you just remind us if you can hit the high-end of your growth rate on it? I think you guys seem to have alluded to that on the fourth quarter call. And then just maybe how you're thinking about financing the $250 million?

Crystal Lail, CFO

Sorry, Bob, were you tossing that one to me?

Bob Rowe, CEO

That's a totally CFO question. Absolutely.

Crystal Lail, CFO

So I think Shar, you said two things. One, where would that put us from an earnings growth rate perspective? The thing that I would remind you of course would be the in-service date would be 1/1/2024. That's the time you would see rates in place. And that's a long-term growth rate on an average. The other thing I would say is certainly there'd be some AFUDC during construction there from that perspective. Of course, that's an important piece to achieve what we've said before is kind of pushing us to the higher past the midpoint of that range is certainly our capacity piece and moving forward on those investments. And I think I forgot the back half of your question, Shar.

Shar Pourreza, Analyst

It's just how to think about financing should we assume sort of a balanced approach?

Crystal Lail, CFO

Financing is definitely on the table. As you might have noticed, we're investing $450 million in capital expenditures this year. We're set to launch an at-the-market equity program in the second quarter. It's important to keep in mind our ongoing capital requirements. We are making significant investments in our system. From a Laurel perspective, pending approval from the Montana Commission, we would likely pursue financing in a typical 50-50 structure.

Sophie Karp, Analyst

Hi, guys. This is Sophie Karp with KeyBanc. Can you hear me?

Bob Rowe, CEO

Yes.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

We can, Sophie.

Sophie Karp, Analyst

Thank you for taking my question. A lot has already been discussed, but could you share some insights on the results of the RFP in Montana? With the addition of these new resources, what is your current position regarding resource adequacy? Also, how do you foresee the timing of future RFPs and resource additions?

Brian Bird, President and Chief Operating Officer

Thanks, Sophie. We're not going to specify what the next RFP will entail just yet. We'll keep evaluating as we proceed. From a rounding perspective, we're about 50% there with this particular RFP. As mentioned in the 10-Q, we expect to release the second RFP late this year or early next year, aiming for something in the 2025 or possibly 2026 timeframe. Additionally, as certain contracts expire and other matters are addressed, our pursuit of capacity won't end in 2025 or 2026. We anticipate looking for more capacity beyond that, particularly around 2028 and into the 2030s.

Sophie Karp, Analyst

And you're assuming that Colstrip will remain available to you throughout this decade? Would that be accurate to say? Or is it still sort of a consideration in future RFPs?

Brian Bird, President and Chief Operating Officer

We certainly are assuming in the next RFP that we released that Colstrip is going to be considered during that time period.

Ryan Greenwald, Analyst

Good afternoon, everyone. It's Ryan Greenwald. Appreciate it. Sorry, I didn’t register my name there.

Brian Bird, President and Chief Operating Officer

No problem.

Ryan Greenwald, Analyst

I appreciate that. Congratulations to you and Crystal again on completing your first quarter in the new roles.

Brian Bird, President and Chief Operating Officer

Thanks, Ryan.

Crystal Lail, CFO

Thank you.

Ryan Greenwald, Analyst

In terms of the three to six and the new generation kind of getting you above the midpoint, is 2020 the right way to think about the base kind of into the outer years here?

Brian Bird, President and Chief Operating Officer

Crystal?

Crystal Lail, CFO

Yes. 2020 is the base.

Ryan Greenwald, Analyst

Awesome. I'm interested in the decoupling efforts and the possibility of delaying it for another year. I'm curious about how you are framing the reasons for this, especially considering that, compared to most of your peers, you seem to be more sensitive to load impacts. Can you elaborate on those efforts?

Bob Rowe, CEO

Yes.

Crystal Lail, CFO

Sure, Ryan. I... The thing I would say is just from a decoupling perspective, this is something we agreed upon our last rate case, and I think as you think about what happened in 2020 we saw certainly a fundamentally different load pattern as we are moving into that initial period. And so, we had the pilot with the shadow accounting. What we've seen from that initial period is something quite different from how that was designed. So think about test period loads when the design was agreed to. As a reminder, that FCRM handles our residential cost and a small slice of our commercial, but not all of our commercial and industrial. And so with that and what we've seen out of that first period, and where we're still seeing fundamentally a different load pattern than we would have seen think pre-pandemic, we've suggested to the commission that they either continue it in pilot form or extend a pilot truly being with just shadow accounting or extend the implementation another year. Again, I would say, it's because we're seeing different load patterns than what we saw in the test loads that that is based on. And of course, as you think of any decoupling mechanism those are typically comparing back to a load period. And with that what we've seen in the initial period of shadow accounting, we've requested the commission to delay impact. Bob, would you add to that?

Brian Bird, President and Chief Operating Officer

That was perfect.

Ryan Greenwald, Analyst

Got you. And then, in terms of legislative items, so with SB 379 getting tabled and I know there was HB 99 looking to remove pre-approval earlier in the year, but anything else that's kind of on your radar at this point?

Bob Rowe, CEO

Yes. Aside from 379, which was not on our initial agenda, it was a busy yet productive legislative session in Montana despite the challenges posed by COVID. Another significant matter was the elimination of the Community Renewable Program, which posed difficulties for us as it was nearly impossible for a resource to balance being both cost-effective and community-focused. There were considerable potential penalties linked to that as well. We put in a lot of effort on compliance, but ultimately it was not feasible. We are therefore pleased to see that requirement eliminated retroactively, which is a major positive. Independently from the legislature's actions, we are advancing a subscription green program, which we believe is a far better way to achieve similar goals by offering customers the chance to subscribe to a resource of their choice. Overall, it was a good and busy session in Montana; Nebraska and South Dakota were quite quiet, as is usually the case, and that was also positive.

Ryan Greenwald, Analyst

Great. I will leave it there. Thank you all for the time.

Bob Rowe, CEO

Thanks, Ryan.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Thanks, Ryan. It looks like Brian Russo has raised his hand one more time. I don't know if Brian has another question or not, Brian?

Brian Russo, Analyst

No. I'm all set. Thank you.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Okay. Thanks, Brian. Let me add one other legislative outcome, which was eliminating what are essentially speculative carbon adders. The concern we have there is effectively our customers could have been put in a position where they have to pay a QF developer for a value that is not received. So just in terms of computing and avoided cost, kind of, non-quantifiable costs may not be added to the avoided cost. So we think that's a good outcome for our customers and for us as well. Thank you, Bob. With that, we've exhausted our question queue. So I'll hand it back to Bob for any closing remarks you might have.

Bob Rowe, CEO

Just as always, we appreciate you being with us this quarter in this new format. And we are very, very eager to get to spend some time with you in person in the coming months.

Travis Meyer, Director of Corporate Finance and Investor Relations Officer

Thanks again for joining us. This brings the webcast to a close. You may now disconnect.