Earnings Call Transcript - NWE Q2 2020

Operator, Operator

Good day, and welcome to the NorthWestern Corporation's Second Quarter 2020 Financial Results Conference Call and Webcast. Today's event is being recorded. At this time, I would like to turn the conference over to NorthWestern's Investor Relations Officer, Travis Meyer. Please go ahead, sir.

Travis Meyer, Investor Relations Officer

Thank you, Sarah. Good afternoon, and thank you for joining NorthWestern Corporation's financial results conference call and webcast for the quarter ending June 30, 2020. 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. Joining us on the call today are Bob Rowe, President and Chief Executive Officer; Brian Bird, Chief Financial Officer, and we have several other members of the management team in the room with us to address your questions if needed. Before I turn the call over for us to begin, please note that the Company's press release, this presentation, comments made by presenters and responses to your questions may contain forward-looking statements and non-GAAP financial information. As such, I will remind you of our Safe Harbor language. During the course of this presentation, there will be forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often address our expected future business and financial performance and often contain words such as expects, anticipates, intends, plans, believes, seeks or will. The information in the presentation is based upon our current expectations. Our actual future business and financial performance may differ materially and adversely from our expectations expressed in any forward-looking statements. We undertake no obligation to revise or publicly update our forward-looking statements or this presentation for any reason. Although our expectations and beliefs are based upon reasonable assumptions, actual results may differ materially. The factors that may affect our results are listed in certain of our press releases and disclosed in the Company's Form 10-K and 10-Q, along with other public filings with the SEC. Today's presentation also includes non-GAAP financial measures. Please refer to the definitions and reconciliations of these measures that are included in our webcast materials. Following the presentation, we'll open the phone lines to allow those who are dialed into the teleconference to ask questions. The archived replay of today's webcast will be available for one year beginning at 6:00 p.m. Eastern Time today and can be found at our website at northwesternenergy.com under the Our Company, Investor Relations, Presentations and Webcast link. With that, I'll hand it over to our President and CEO, Bob Rowe.

Bob Rowe, President and CEO

Thank you, Travis. Good afternoon everyone and thank you very much for joining. Travis included a total on the cover of the deck from the Grand Canyon of Yellowstone. He did that because yesterday we were in the park meeting with FERC management. We serve there on a contract basis. It’s a privilege obviously to serve the nation’s oldest and number one national park. The park and the gateway communities in Montana are crowded. What’s exciting about serving the park is, we do it on a contract basis. We design our service to meet the customers’ expectations in terms of affordability, environmental sensitivity, sustainability, and reliability at their location, where we have the opportunity to try some of the exciting new distributed technologies that we are looking at. So it’s a small, but important part of who we are and the area we serve. Second quarter highlights. Net income for the second quarter decreased $26.2 million compared to the same period last year. This was driven primarily by an income tax benefit received in 2019, lower gross margin due to impacts of COVID-19 as we discussed last quarter, and higher depreciation expenses. These are offset in part by a decrease in operating general administrative costs and some customer growth. Diluted EPS decreased $0.51 as compared to the same period last year. Diluted non-GAAP EPS decreased $0.08 per share after adjusting for income tax benefits noted in the normal weather. The Board declared a quarterly dividend of $0.60 per share payable September 30 to shareholders of record as of September 15. I will get a chance to come back and talk about customer engagement and employee health and safety as part of our COVID response in the Q&A. But we continue to be doing very, very well on both of those fronts. And with that, I’ll turn it over to Brian.

Brian Bird, Chief Financial Officer

Thanks, Bob. On Page 4 of the presentation is the summary financial results for the second quarter. As Bob pointed out, our net income is down $26.2 million. As I look at this slide, there are really three themes that jump out. Gross margin is down $6.7 million on a year-over-year basis. All of that negative variance could be attributed to two favorable impacts in 2019. The second theme I would point out is that the reduction in operating general and administrative expenses we had during the quarter more than offset the increases in property tax, depreciation, and interest expense. And the third theme is the $21.5 million negative variance in income taxes is all attributed to the 2019 favorable impact. So, taking these considerations into account, we feel we actually had a very good quarter in line with our expectations from a COVID perspective. And with that, I will turn you to the following page on gross margin. Gross margin was off $6.7 million or about 3% as I pointed out. All of that was really attributed to our electric business. If you look at the primary drivers of the $8.2 million of change in gross margin, they actually impact net income; the very first two items, Montana electric supply cost recovery, that item is after some favorable legislation we received. We were able to treat our PCAM slightly differently and we had a favorable adjustment in 2019 associated with that, that’s $4.4 million. And then, this year our QF gain was $3.3 million less than the QF gain we had in 2019. Those two items together are 7.7 of the full 8.2 change in gross margin. The other item that contributes fully to the 8.2 is lower electric transmission, which is really a result on a year-over-year impact due to the closure of Units 1 and 2 at Colstrip. So, all in all, again, a big impact associated with the 2019 favorable items impacting the $8.2 million. Below that, we do show changes in gross margins that are offset elsewhere within the P&L for a net decrease in gross margin of $6.7 million. Also on Page 5, to the far right, we do have a red box speaking to COVID. You notice I didn’t say anything about electric or gas retail volumes. The reason being is, they were essentially flat. Our customer growth and favorable weather were effectively offset to a great extent by a $3 million to $4 million negative impact on revenues associated with COVID. As expected, commercial and industrial volumes were down, and residential volumes partially offset that, again from a margin perspective, relatively flat. Moving forward on weather, it was a colder quarter for us and as expected didn’t have much of a weather impact. We had a $500,000 favorable pre-tax benefit when compared to normal and an $800,000 pre-tax benefit compared to Q2 of 2019. If you look at the map on the bottom left side of Page 6, in April, we did have colder temperatures that helped our heating in our Montana gas business. In June, we had warmer weather in South Dakota which benefited the South Dakota Electric business. Those two things are the primary drivers for our favorable weather during the quarter. Moving on to operating expenses on Page 7. They are down $2.6 million or nearly 2% on a year-over-year basis. The biggest driver of course is OG&A expenses and I’ll speak to that in a minute. Property taxes are up slightly due to increased valuation for our Montana property taxes. Depreciation expenses were up $3.8 million, of that $3.8 million increase, $2.3 million is associated with a 2019 favorable impact associated with the settlement of our rate case where we booked an incremental benefit, the depreciation expense part of that rate case settlement. Jumping to the items impacting OG&A, the three biggest contributors to the $9.7 million decrease in OG&A impacting net income were a reduction in employee benefits. We had lower medical expenses. We had lower incentive costs. It’s important to note that those costs reduced were impacted by COVID, and I’ll speak to that in a minute. Employee benefits decreased to $3.7 million. We had $2.6 million of lower generation maintenance at DDGS in some of our South Dakota generation facilities. We had lower labor costs, some associated with how we changed work around COVID, and some attributed to the allocation of more labor to capital. We had lower hazard trees and anticipated having lower hazard trees based upon the good progress we made in 2019 in that regard. Finally, we had lower travel and training expenses, about $1.2 million to be expected with what’s going on with COVID. Those benefits were partially offset by a $3.1 million increase in uncollectible accounts during the quarter, bringing the total to $9.7 million of items impacting net income. Below that, there are also some items changed in OG&A that are offset elsewhere in the P&L for a net decrease of $9.1 million in OG&A for the quarter. To the far right, again, we show the COVID-related impacts, a $3.1 million increase in uncollectible accounts offset by $2.8 million of lower COVID-related expenses, such as lower medical, lower labor, and less travel and training for that $2.8 million. We’ll give you a full P&L on COVID here later in the presentation. Moving forward just, operating income at the top of the page is up $4 million on a quarter-over-quarter basis. Moving down to pre-tax income, it is down about $4.7 million, primarily that change is driven by an increase in interest expense. Almost all of that is attributed to COVID and the need to have incremental borrowings to improve our liquidity during the quarter. Below pre-tax income, we saw a $21.5 million increase in income taxes, again, almost all of that really attributed to the $23 million favorable item in 2019 that was taken. That leads us to, again, the $26 million decrease on a quarter-over-quarter basis in net income. I want to stop for a second and just point out that when you take into consideration this $7.7 million of negative impact this year on margin associated with the 2019 favorable impact items, along with a $2.3 million favorable item associated with depreciation in 2019, that’s a $10 million swing on a pre-tax basis, after tax just round numbers, $7 million after tax associated with that. Obviously, $23 million of after-tax benefit in 2019, that’s a $30 million swing on an after-tax basis. And so, for the quarter, just removing those 2019 items I discussed, we would have had $4 million favorable on a year-over-year basis. Adding to that, we will show the P&L in a minute. Approximately $3 million of an after-tax detriment that we received in 2020 associated with COVID. If you back that out, we would have netted roughly $7 million for the quarter. So, obviously, from a headline perspective, it didn’t look like a great quarter. But from our perspective, we feel good knowing what we know with COVID and where we are going forward. Moving to Page 9 on income taxes. I talked about the $21.5 million increase, again associated with the recognition of an unrecognized tax benefit in 2019, partially offset by lower pretax income and slightly better flow-through repairs on a year-to-date and on a quarterly basis. Balance sheet, not much to talk about on Page 10. We had an increase in PP&E with a $100 million increase in short-term debt, which is probably the biggest change since the end of the year 2019, and you can see on a debt-to-capital perspective at the bottom of the page, very little change around 52% debt-to-cap. On cash flow, on Page 11, cash from operations is approximately $75 million better on a year-over-year basis. Really three things drove that improvement in collections on supply cost this year. In 2019, we were giving refunds to customers associated with TCJA. We were also issuing some transmission interconnection refunds in 2019. Those three items were partially offset by lower net income this year to arrive at approximately $75 million improvement. Thinking of our adjusted non-GAAP earnings on Page 12, we see at the bottom on the page, diluted EPS of $0.43 on a GAAP basis, really taking out a penny for favorable weather this quarter, resulting in $0.42. That compares to a non-GAAP number of $0.50 last year. We did have, in that case, unfavorable weather of a penny and added back the tax benefit that was received in 2019. So again, an $0.08 detriment on a year-over-year basis. The main thing I’d point out on this page is that pretax income on a non-GAAP to non-GAAP basis is down slightly from our GAAP, primarily due to the $800,000 swing in favorable weather. But I would also say the net income improved significantly when you remove the tax benefit, now net income there is shown as $4 million less. That again equates to $0.08 on an EPS basis. Moving forward, Page 13, diluted earnings per share reaffirming our previously revised earnings guidance at $3.30 to $3.45 per diluted share. We do know our assumptions. One of the big assumptions we have in the remaining years is our expectations on COVID and not only the impact on our margins but also the ability to recover collectibles, uncollectible account expenses from commissions where we made filings, obviously normal weather and a share count of 50.9 million and a tax range of minus 5% to 0%. Lastly, on this page, I’d point out, we continue to expect a 6% to 9% total return as a long-term outlook from our perspective, and, of course, that’s going to be derived through a combination of earnings growth and dividend yield. Moving on just to the change in our bridge associated with the revised guidance and thinking through COVID. We can save $1.48 for the first two quarters of the year, and we’ll need $1.82 to $1.97 to achieve the $3.30 to $3.45 range that we discussed. That means we’ll need an improvement on a year-over-year basis of $0.13 to $0.29 and where will that benefit primarily come from? It’s going to continue to come from OG&A expense and it’s going to come from tax timing. One thing I’d point out is we had a $0.14 improvement on OG&A expense in the second quarter alone. We expect if COVID continues, we will have a relatively easy time achieving that $0.08 to $0.11, if not better in that regard. We are going to work extremely hard to stay on top of that. We also know that we have a tax timing swing. Those two things again will help us achieve our earnings guidance in Q3 and Q4. What really changed in the forecast, since the second quarter, we did get our final property tax assessment. We have an increase in property taxes certainly in the latter half of the year, but we increased the gross margin for a property tax recovery associated with that for the second half of the year. Those are the two primary changes since the last time we made this adjustment. Moving on to Page 15, I want to quickly point out that, from our perspective, the decline in gross margin is projected at $3 million to $4 million in line with our expectations. At the top of the page, to the far right, we do show what our forecast plus the Q2 and how things actually played out. We saw a little bit better in industrial and commercial, a little bit worse on residential, and all in all, pretty much where we expected. We show that we are maintaining our expectations for Q3 and Q4. We provide that at a high level in the upper-right and in more detail for both our Electric and Gas businesses directly below it. Moving forward to expenses on Page 16, again, expenses came in line with our expectations during the second quarter. At the upper-right is our full P&L associated with that. If you consider the $3 million to $4 million reduction in gross margin I talked about earlier and think about expenses, you can see a net increase in operating expenses of $300,000, and then add $700,000 of interest expense. So a $1 million impact on COVID on the expense side. That gives us a pretax detriment of $4 million to $5 million and an after-tax of $3 million to $3.7 million associated with COVID or $0.06 to $0.07. One other thing I should point out on this page is that we mentioned in our press release capital spending; we still anticipate approximately $400 million, and we are seeing very little impacts in the supply chain. Very little impacts on staffing levels, and we are getting our work done. We’ve spent more capital year-to-date this year than we had all of last year. So we are on a great track and continuing to move forward there. And with that, I’ll hand it back over to Bob.

Bob Rowe, President and CEO

Thank you, Brian. I just want to reinforce Brian’s discussion for the last three minutes in terms of margin and expense. Recall that we managed to come in really quite closely to where we expected to be at that time with so many unknowns on expense and a lot turning into the capital forecast. We are comfortable with about $1.8 billion of total capital over the next five years, financing with a combination of cash from operations with net operating losses available into 2021, first mortgage bonds, and equity issuances. Based on what we know now, we expect that any additional equity would be raised this year or early next year and it would be focused on maintaining current credit ratings. That said, significant capital beyond what’s identified would put us at those capital projections. Importantly, this does not include investment necessary to identify the generation capacity challenges in Montana. Our customers are unique in that sense, being exposed to the market 46% at peak out of Montana. This is an important investment program to be shared by customers in the growth of our territory, and we are confident in our execution and ability to deliver on this. Looking forward, there is obviously a lot of regulatory activity. The Montana Commission approved the fixed cost recovery mechanism or decoupling. We talked about this last quarter, and we think it’s very important over the long-term. It’s effective on July 1. As we discussed last quarter, we requested that the implementation date be deferred until July 1 of next year for COVID-related concerns. Definition agreed with that, we thought that made sense - delayed the implementation by a year, but didn’t request it. We are providing kind of a shadow accounting for the Commission to really understand what the impacts of the FCRM would have been if it had been implemented this July. In June, we were ordered from the FERC accepting our Montana transmission filing, guiding interim rates, and setting a procedural schedule. Ultimately, we are appointing an administration law judge, and settlement negotiations continue, despite the challenges of COVID and not meeting in person. We expect a compliance filing with the Montana Commission once an early FERC rate case concludes. Additionally, concerning our post application, Talen did assert its right of first refusal. We are modifying that application to reflect a 92.5 megawatt acquisition from Puget Sound Energy and then the corresponding purchase power agreement to sell power back to Puget Sound Energy within that proceeds to cover eventual closing costs for our current ownership goals. That’s a compelling proposition from both a customer perspective and from an environmental perspective. On the South Dakota front, we are underway again, despite the COVID challenges, with a 60-megawatt flexible value with $80 million of flexible capacity located in Iran. This site will be activated here within a matter of days and should be online by late 2021. In addition, we’ve filed a new South Dakota higher feed in the last couple of weeks. We have received very positive feedback from both the staff and the Commission. The Commission Chair remarked that our 57-page summary document was the best plan they had ever seen. We really appreciate that feedback, and our plan is consistent with what we are currently implementing, focused on maintaining reliability for our customers to gain full benefits and participate in the Southwest power pool. In Montana, we issued an all-source solicitation for up to 280 megawatts of flexible capacity. That went out in February. We are using a third-party administrator. We, of course, are participating with ourselves, and we look forward to seeing the outcome of that. The projects at this point are identity blind in terms of who sponsors them, so that’s about all we can say there. Again, we have participated in the project and look forward to the results. We are also on track to join the Western Energy imbalance market in April of 2021, and this could certainly provide benefits for our Montana customers through more efficient utilization of both supply and transmission assets. But as we discussed, you have to bring your own toys to the sandbox. We need resources in order to participate. Worth noting that last week, the Montana Commission had a great discussion of regional resource adequacy. Frank Afranji, who was the President of the Northwest Power Pool, was the lead presenter describing the immediate concerns of the entire region in terms of being able to meet our customers’ needs. So, with that, I look forward to questions.

Operator, Operator

And we’ll go ahead and take our first question from Shar Pourreza with Guggenheim Partners.

Unidentified Analyst, Analyst

Hey. Good afternoon. This is actually Cody on for Shar. Thanks for taking the question.

Bob Rowe, President and CEO

Hey, Cody.

Unidentified Analyst, Analyst

Hey, so, you guys got it down to weather and the expected impact of COVID-19, and you’ve had another somewhat challenging quarter with the virus. Obviously, so in the approval to defer on collectible costs and your commission, I was wondering if you are still confident in the midpoint of guidance or are you tracking more towards the lower-end of the range?

Brian Bird, Chief Financial Officer

Yes, I would like to say that we don’t ever try to give anybody where we are in the range. I would just say this, we feel good about where we sit today. Obviously, we need to get recovery from the commission; that’s an important part of our range if you will as a whole. But actually Q2 came really in line with our expectations. We do expect that things are going to improve over time and Q3 and Q4 from a COVID-related perspective that was included in our guidance range initially. But we also expected to kind of pull off the gas a little bit on OG&A savings in the second half of the year either, and if in fact things continue to stay difficult with COVID on the margins side, we will be that much attuned to it on the OG&A expense. And so, we feel very confident in our earnings guidance as we sit here today.

Unidentified Analyst, Analyst

Got it. Thank you. And stuck in – can you give us any more thoughts on outsizing the current Montana RFP given Talen's situation? I know it somewhat relies on the internal valuation, but just wondering your updated thoughts there.

Bob Rowe, President and CEO

That’s certainly something that we will take a look at for exactly the reason that you said. It depends on seeing what comes in. But as I mentioned, we have a pretty big hole to fill on behalf of our customers. I think we don’t do that. So that certainly is a possibility.

Unidentified Analyst, Analyst

All right. Thanks. That’s all I have. Stay safe.

Brian Bird, Chief Financial Officer

Thanks, Cody.

Operator, Operator

We’ll take our next question from Michael Weinstein with Credit Suisse.

Michael Weinstein, Analyst

Hi. Good afternoon, guys.

Brian Bird, Chief Financial Officer

Hi, Mike.

Michael Weinstein, Analyst

You said that the OG&A expense cuts of $0.08 to $0.11 you are expecting in the second half of the year depend on what? I think you mentioned COVID continuing and COVID expense cuts continuing or maybe the travel...

Brian Bird, Chief Financial Officer

What we did is – I am sorry Mike. As we thought about Q3 and Q4, we expected things to over time slow the version to near normal by the end of the year, right. And so, if we had expectation on OG&A cuts for the full year, we would be backing off that a little bit as well. You noticed that quite early, we had $0.14 of improvement on the OG&A line just in the second quarter alone. Obviously, the range for Q3 and Q4 is less than that. If in fact, my point was, if in fact we don’t see the margin improvement in which we do expect that we will get that. We will need to do more on the OG&A side, but feel confident that we could.

Michael Weinstein, Analyst

Got you. And also, could you characterize what the opportunity may be in South Dakota in terms of – versus the current CapEx plan?

Bob Rowe, President and CEO

It’s probably early to say too much beyond the fact that there are additional opportunities. In the context of our South Dakota operation, there is significance.

Brian Bird, Chief Financial Officer

Bob, I would share that we had historically shown our South Dakota opportunities over time, and initially if you think back, there is a number of units spread across South Dakota. We mentioned this 60 megawatts in Huron and possibly something at Aberdeen in South Dakota. We talked about our total opportunity of 90 megawatts. Being at 60 today would give us an incremental 30, and we hope to get after that sooner rather than later.

Michael Weinstein, Analyst

Okay. Fair enough. And regarding the equity issuance, what’s the thinking on how the timing might come out? I know you said later this year or maybe early 2021. Is it more likely to be a 2021 timeframe? Or is there some reason why you will not be earlier than that?

Brian Bird, Chief Financial Officer

Mike, I think this way; I think it’s a 2021 item. We’ll continue the dialogues with the rating agencies. If some reasons concerns are raised there, we could do something sooner than that. But right now, we are planning that as a 2021 item.

Michael Weinstein, Analyst

Okay. Great. Thank you very much.

Operator, Operator

We’ll take our next question from Julien Dumoulin-Smith with Bank of America.

Julien Dumoulin-Smith, Analyst

Hey. Can you hear me?

Brian Bird, Chief Financial Officer

Yes.

Julien Dumoulin-Smith, Analyst

Excellent. Hey, thank you. So, first off, let me start with the numbers here. As we think about the back half of the year, what’s driving the $0.11 to $0.17 gross margin uptick in your expectations? I recognize, I know you talked through some of the gross margin dynamics already. But perhaps at a high level, what’s driving that uptick in the back half here? And then, can you maybe secondarily and I know you alluded this a little bit already, what other levers you have to go to the extent you wish that things don’t materialize – COVID or otherwise?

Brian Bird, Chief Financial Officer

Yes, I think if you focus on Page 14 in terms of the bridge, one of the biggest reasons for the increase in gross margin in the second half of the year is our property taxes are going up and we have recovery of 75% of that, or 70% of that. So, that’s the biggest driver from a margin perspective. But, we are seeing in our expectations, we’ll of course expect better irrigation. We are going to have customer growth, and I mentioned earlier that we expected some unbilled timing associated in the second half of the year. So, again – but, in looking just at this page, you can see that the primary benefit, $0.09 of that gross margin is associated with property tax. So, you really need $0.02 to $0.08 of the remainder, and we feel very good about that. And I think, to your question Julia on levers, I would just focus on our $0.14 improvement on OG&A expense in Q2. We did better from an expense standpoint, and we show backing off. I just think that we continue to stay on top of expenses because of COVID, we can do better than we show there if we need to.

Julien Dumoulin-Smith, Analyst

Awesome. Thank you. On the RFP in Montana, I know you’ve alluded to this – any data points that we should look for in the back half here?

Bob Rowe, President and CEO

I would say no.

Julien Dumoulin-Smith, Analyst

Okay. Alright. Fair enough. That’s – I’ll leave it there, guys.

Bob Rowe, President and CEO

Thank you.

Brian Bird, Chief Financial Officer

Hey, Bob, one thing I think we shared in the last call is, if we found that we are not participating or not in the final rounds, we will let you know that as soon as we can. If there’s some information incrementally that can be shared, we will share it.

Operator, Operator

We’ll take our next question from Chris Ellinghaus with Siebert Williams Shank.

Chris Ellinghaus, Analyst

Sorry, guys. I forgot to unmute. How are you guys?

Brian Bird, Chief Financial Officer

Hey, Chris.

Chris Ellinghaus, Analyst

I am not sure if this is for you, Bob, or not, but what is it that gives you confidence in incremental third to fourth quarter improvement? Are you not believers in the possibilities of the flu season being more aggressive than what we are going to see in the second and third quarter relative to what it was like in say March or April? What is your sort of general view of the COVID outlook for the fourth quarter?

Bob Rowe, President and CEO

First of all, I would say, is this is a company we take COVID extremely seriously and adopted measures to keep our employees safe and healthy as possible well before the states took action. We expect that those measures are going to continue in place certainly well into the fall. That said, we also know a great deal more about safe practices. We know that wearing masks and social distancing are extremely effective and key on the front line. The states we serve have three of the lowest unemployment rates in the nation. Nebraska has the lowest, Montana the sixth lowest, and South Dakota, the 11th lowest. In South Dakota, what’s notable is there was never a government order to shut down, and actually the virus reproduction rate in South Dakota, despite that, is really quite low. If the virus continues, we take it as seriously as possible. We support the actions that states have taken around masks, and we see consistent with that, a tremendous amount of activity coming back in our service territory. On a daily basis, for example, we are seeing multiple indications of people from out of state buying property and sites for at or above the sale price or in some cases even before it’s listed. So, there is an awful lot of activity in our service territory. We want all that to be safe, but it’s certainly encouraging to see. That doesn’t minimize the real hardship being faced by those who are still out of work, and we need to work with them. But, on balance, what we see is a region that is coming back and arguably, we could end up much stronger as people look around and choose where they want to be.

Brian Bird, Chief Financial Officer

Hey, Bob, just two last quick things to add. Bob talked about activity being up; we have new connections that are up in five of our largest six cities in Montana. People are buying homes in our service territory. I wouldn’t have guessed that. The second thing I’d point out is that in our two largest states, Montana and South Dakota, the total number of COVID cases in those two states combined is approximately 2200. Our parts of this country and other service territories are doing extremely well relative to the rest of the country. Yes, do we expect COVID to be a challenge in the third and fourth quarter? It should be. But our expectations are we will be able to manage through that, if in fact it is, through what we’ve been doing so far in cost control.

Chris Ellinghaus, Analyst

Okay. As far as your offsets to the bad debt expense, did the labor and medical costs, are you starting to see behaviors change a little bit where those benefits are easing off more of late?

Brian Bird, Chief Financial Officer

That’s sort of what we have seen through the second quarter and from what I have seen into July, I’d say no. It’s pretty consistent.

Chris Ellinghaus, Analyst

Okay. And if those behaviors stay similar, would you expect that to continue into the later part of the year as well? If the economy is improving locally would there be more customer contact and/or more utilization of medical services that could change that direction a little bit?

Brian Bird, Chief Financial Officer

Chris, I think that’s a possibility. We commonly are using the words 'levers' here. Again, if we see COVID being sustained through this time period, we are probably going to continue to see medical costs staying low. We are going to probably see our labor costs staying lower as a result of being lower than we are projecting.

Robert Rowe, President and CEO

We are glad to be here and those kinds of changes are really going to be on the margin.

Chris Ellinghaus, Analyst

Okay. Thanks for the color, guys. Appreciate it.

Operator, Operator

We’ll take our next question from Brian Russo with Sidoti.

Brian Russo, Analyst

Hi, good afternoon.

Brian Bird, Chief Financial Officer

Hey, Brian.

Brian Russo, Analyst

With the shadow accounting that you are required to do regarding the FCRM in your slide, any thoughts on what the avoided impact was of not implementing the FCRM on July 1?

Brian Bird, Chief Financial Officer

No thoughts there.

Brian Russo, Analyst

Okay. And in terms of the deferral accounting and the procedural schedule, what’s next that we should be looking for or what filing testament, whatever?

Bob Rowe, President and CEO

Two items. First, in South Dakota, we are looking for a staff recommendation. In Montana, we are looking to see whether or not parties file testimony, and that could be either consumer counsel or large customer group comments or testimony, which we did file on July 31.

Brian Russo, Analyst

Okay, July 31. Got it. And you mentioned a short list in the Montana RFP. When might that be expected?

Bob Rowe, President and CEO

The analysis is ongoing now, and we’ll start to see more information about projects. I would really focus on the first quarter. Brian’s qualification to that is a good one; if we are in the running, we’ll let you know.

Brian Russo, Analyst

Okay. So, if you are in the running, you will let us know. My guess is that way we can get that as well.

Bob Rowe, President and CEO

There is a double negative there, even there. But yes.

Brian Russo, Analyst

Got it. So, just if you don’t mind, just a clarification, what was the bad debt or uncollectibles as of June 30? And what might we expect throughout the year to ultimately seek recovery of X dollars amount? Just trying to get a sense of the magnitude of that possibly.

Robert Rowe, President and CEO

Brian?

Brian Bird, Chief Financial Officer

Yes. I mentioned the increase is $3 million for the quarter. What’s included in rates is approximately $2 million. We need to continue anything above what’s in rates during the year. That’s what we are going to have to have put in the regulatory asset for the year. So, we’ll see how things play out for Q3 and Q4. As long as we still have a moratorium on disconnects for non-payment, we expect to have that bad debt continue to increase.

Brian Russo, Analyst

Okay. And just remind me, was this an individual NorthWestern filing with the Commission for COVID recovery? Or is this likely seen in other states where it’s more of a generic filing where various in-state pure utilities all file for the same type of structure and recovery?

Robert Rowe, President and CEO

It’s really yes to both. In South Dakota, there is a filing by NorthWestern, and within that filing, various companies are requesting different kinds of relief. We are not requesting a make-whole; we are requesting an accounting order for bad debt. In Montana, it’s a standalone filing addressing bad debts and also pension contributions. There is a parallel filing by MDU as well addressing COVID.

Brian Bird, Chief Financial Officer

Hey, Bob. I do want to point out my fact checkers here pointed something out to me. What’s in rates is actually $1.1 million. So, the increase thus far in the second quarter is $2 million. I think I said that wrong.

Brian Russo, Analyst

Okay. And what percentage of our dollar amount of the O&M and SG&A savings this year are sustainable? Obviously, travel, et cetera, that should revert back to the norm going forward. But any idea of what level of cost cuts can be sustainable into 2021 and beyond?

Brian Bird, Chief Financial Officer

Bob, I’ll grab that. Well, there are expenses that are going to change. There will be more travel, there will be more medical expenses. But will travel look like it did before? Probably not. So there is certainly some element that will be carried forward, but remember, when you benchmark us against any of our peers or even against larger companies, our expenses per customer and expense per employee, particularly Montana property taxes, we are already just about as low as anyone out there.

Bob Rowe, President and CEO

That was great. I only had to add that you’re spot on; this budget season is a little bit different in a sense that we have to think about COVID. There are things that are different that we want to capture those benefits, and we are focused on that here right after this earnings call. Effectively, that's something we have to think about in regard to how this is going to impact 2021 and what we can do to take advantage of COVID to help us going forward.

Brian Russo, Analyst

Okay. Great. Thanks, guys.

Operator, Operator

We’ll take our next question from Jonathan Reeder with Wells Fargo.

Jonathan Reeder, Analyst

Hey, good afternoon, gentlemen. How is everyone doing?

Brian Bird, Chief Financial Officer

Good, thanks.

Jonathan Reeder, Analyst

Good. Just kind of piggybacking on the last topic. If for some reason Montana or South Dakota don’t grant your request to pro-accounting, do you still estimate that it’s going to be like a $0.05 EPS hit for the full year, if you are already at $2 million thus far?

Brian Bird, Chief Financial Officer

Yes, we are still anticipating $0.05. Some of that is we do expect and we hope to have reinstated ability to disconnect customers before we get into the heating season. We are having discussions around that in South Dakota very soon, in Montana, a little bit later. It’s an important task at hand, but that should help offset some of the increases we’ve seen thus far in the second quarter to help slow that rate, if you will.

Jonathan Reeder, Analyst

Okay, great. And then, Bob, in your comments regarding being comfortable with the point, $400 million of CapEx annually going forward. Did you say that would be before adding any potential Montana generation additions? In other words, Montana generation would be incremental to that $400 million per year?

Robert Rowe, President and CEO

Yes, the capital ladder is built up with projects that are identified. We are confident about, so as always the out years will increase as our specific capital plans to serve our customers become more known.

Jonathan Reeder, Analyst

Okay. Thanks for clarifying that. And then the last one, just curious about your thoughts on the MPSC’s comments filed in late June regarding your Montana Electric Supplies brand and how if at all that impacts beyond going generation RFP and whether you did a selection criteria?

Robert Rowe, President and CEO

To my mind, the key thing was that the commission acknowledges the exposure that our customers face and takes it seriously. We thought that the comments were on balance, very positive and probably deferential, which might have been the case just a couple of years ago. Again, the conversations with the commission in last week has shown a real appreciation for the situation that customers in Montana face.

Jonathan Reeder, Analyst

Okay. So, their concerns regarding the inputs or assumptions you guys are making, does that not overly concern you given the overarching belief that they recognize the short and everything? Just kind of feel like the thought, I guess, it had to be natural gas to fulfill the person potential to other types of resources to maybe meet the need effectively as well.

Robert Rowe, President and CEO

The way I see it is the key is the plan identified a need. Subsequently, there were a whole range of scenarios using different resource combinations, and those scenarios were just that. We made the decision not to identify a specific preferred resource in the plan and commit to the path to let essentially all resources compete. That’s a very different direction. A couple of interesting comments I'd make. First of all, the analyses underlying the South Dakota and Montana plan is the same model and the same kind of work. The environments in the two states are in many ways quite different, obviously, but the same kind of analysis and what we’ve received back in South Dakota was real support for the plan. I would certainly think that our plan in Montana over time will continue to address the concerns raised by the consultants to the commission, which is really the source for many of the comments. It’s a significant process plan to plan, but again, the RFP is structured in three tiers of opportunities for projects to bid at 20 hours, 10 hours, and 5 hours. We should see some real diversity and viability, as well as cost-effective viability in the technology submitted.

Jonathan Reeder, Analyst

Okay. Great. Thanks for that clarity.

Brian Bird, Chief Financial Officer

Jonathan, I wanted to add just a clarification. I think the capital plan we are showing on Page 17 is our capital plan for the year. Obviously, as we go through the budgeting process, the outer years typically tend to be higher than originally planned. If there is an expectation, as Bob points out, that we are going to be close to that $400 million, I think we shouldn’t guarantee anybody that there will be $400 million out there. If we are doing any Montana generation, we are likely to be at least at $400 million if not likely higher. If that’s helpful clarification.

Jonathan Reeder, Analyst

No, it is. Thank you.

Operator, Operator

There appears to be no further questions at this time.

Bob Rowe, President and CEO

Okay. Well, thank you for joining us. Thank you for the great questions and discussion. I look forward to visiting with you probably online over the coming months and hopefully in person maybe by the end of the year. Take care, everybody.

Operator, Operator

This does conclude today's conference. Thank you for your participation. You may now disconnect.