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Oct. 25, 2021, 8:49 a.m. EDT

10-Q: NORTHWESTERN CORP

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(EDGAR Online via COMTEX) -- ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Non-GAAP Financial Measure

The following discussion includes financial information prepared in accordance with GAAP, as well as another financial measure, Gross Margin, that is considered a "non-GAAP financial measure." Generally, a non-GAAP financial measure is a numerical measure of a company's financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. We define Gross Margin as Operating Revenues less Cost of Sales as presented in our Condensed Consolidated Statements of Income. This measure differs from the GAAP definition of Gross Margin due to the exclusion of Depreciation and depletion expenses, which are presented separate from Cost of Sales in our Condensed Consolidated Statements of Income. The following discussion includes a reconciliation of Gross Margin to Operating Revenues, the most directly comparable GAAP measure.

Management believes that Gross Margin provides a useful measure for investors and other financial statement users to analyze our financial performance in that it excludes the effect on total revenues caused by volatility in energy costs and associated regulatory mechanisms. This information is intended to enhance an investor's overall understanding of results. Under our various state regulatory mechanisms, as detailed below, our supply costs are generally collected from customers. In addition, Gross Margin is used by us to determine whether we are collecting the appropriate amount of energy costs from customers to allow for recovery of operating costs, as well as to analyze how changes in loads (due to weather, economic or other conditions), rates and other factors impact our results of operations. Our Gross Margin measure may not be comparable to that of other companies' presentations or more useful than the GAAP information provided elsewhere in this report.

OVERVIEW

NorthWestern Corporation, doing business as NorthWestern Energy, provides electricity and/or natural gas to approximately 743,000 customers in Montana, South Dakota, Nebraska and Yellowstone National Park. For a discussion of NorthWestern's business strategy, see Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2020.

We are working to deliver safe, reliable and innovative energy solutions that create value for customers, communities, employees and investors. This includes bridging our history as a regulated utility safely providing low-cost and reliable service with our future as a globally-aware company offering a broader array of services performed by highly-adaptable and skilled employees. We seek to deliver value to our customers by providing high reliability and customer service, and an environmentally sustainable generation mix at an affordable price. We are focused on delivering long-term shareholder value through:

Infrastructure investment focused on a stronger and smarter grid to improve the customer experience, while enhancing grid reliability and safety. This includes automation in distribution and substations that enables the use of changing technology.

Integrating supply resources that balance reliability, cost, capacity, and sustainability considerations with more predictable long-term commodity prices.

Continually improving our operating efficiency. Financial discipline is essential to earning our authorized return on invested capital and maintaining a strong balance sheet, stable cash flows, and quality credit ratings.

We expect to pursue these investment opportunities and manage our business in a manner that allows us to be flexible in adjusting to changing economic conditions by adjusting the timing and scale of the projects.

As you read this discussion and analysis, refer to our Condensed Consolidated Statements of Income, which present the results of our operations for the three and nine months ended September 30, 2021 and 2020.







                           HOW WE PERFORMED AGAINST OUR THIRD QUARTER 2020 RESULTS
                                                                                     Three Months Ended
                                                                                 September 30, 2021 vs. 2020
                                                                                             Income Tax
                                                                     Income Before           (Expense)
                                                                     Income Taxes             Benefit              Net Income
                                                                                          (in millions)
        Third Quarter 2020                                          $       26.8          $         2.7          $      29.5
        Items increasing (decreasing) net income:
        Higher Montana electric transmission revenue                        10.1                   (2.6)                 7.5
        Higher electric retail volumes                                       8.4                   (2.1)                 6.3
        Higher income tax expense                                              -                   (2.1)                (2.1)
        Higher operating, general, and administrative
        expenses impacting net income                                       (5.0)                   1.3                 (3.7)
        Higher depreciation and depletion                                   (2.8)                   0.7                 (2.1)
        Lower Montana electric supply cost recovery                         (2.1)                   0.5                 (1.6)
        Electric QF liability adjustment                                    (1.3)                   0.3                 (1.0)
        Lower Montana natural gas volumes                                   (0.6)                   0.2                 (0.4)
        Other                                                                4.2                   (1.4)                 2.8
        Third Quarter 2021                                          $       37.7          $        (2.5)         $      35.2
        Change in Net Income                                                                                     $       5.7
        


Consolidated net income for the three months ended September 30, 2021 was $35.2 million as compared with $29.5 million for the same period in 2020. This increase was primarily driven by higher Montana transmission loads and rates and warmer summer weather, partly offset by higher operating costs, lower supply cost recovery, an unfavorable QF liability adjustment compared with the prior period, and higher income tax expense.

SIGNIFICANT TRENDS AND REGULATION

Electric Resource Planning - Montana

We are currently 630 MW short of our peak needs and we cover the shortfall through market purchases. Absent resource additions, we forecast that our portfolio will be 725 MW short by 2025, considering expiring contracts and a modest increase in customer demand. We issued an all-source competitive solicitation request in January 2020 for up to 280 MWs of peaking and flexible capacity to be available for commercial operation in late 2023 or early 2024 (the January 2020 request for proposal (RFP)). Further, we expect to issue additional all-source competitive solicitation requests during 2022.

Initial bids for the January 2020 RFP were received in July 2020. A third-party RFP Administrator evaluated the bids

Laurel Generating Station - the construction of a 175 MW natural gas-fired generation plant near Laurel, Montana, at a cost of approximately $275 million, including Allowance for Funds Used During Construction (AFUDC), which we will own;

On May 19, 2021, we filed an application with the MPSC for advanced approval to acquire the Laurel Generating Station and Beartooth Battery agreement as new capacity resources. These resources, together with the Powerex Transaction, will help address our identified capacity shortage. The Powerex Transaction, was not included in the application for advanced approval filed with the MPSC. Recent upheaval in the construction market and, specifically, timely availability of critical components and escalating labor and construction costs, has necessitated the flexibility to expend capital and make commercial decisions in

advance of the timeline established by the MPSC advanced approval docket. Accordingly, we withdrew our application on September 23, 2021 and intend to seek approval from the MPSC to place the Laurel Generating Station in rate base through a future filing. We currently intend to file a separate application for advanced approval of the Beartooth Battery agreement.

On October 21, 2021 the Montana Environmental Information Center and the Sierra Club filed a lawsuit in Montana State Court, against the Montana Department of Environmental Quality (MTDEQ) and us, alleging the environmental review of our Laurel Generating Station project was unlawful. This lawsuit could delay the Laurel project if the Court were to require a full Environmental Impact Study regarding the project, set aside the air quality permit granted for the Laurel Generating Station, or determine that the underlying environmental statute violates the Montana Constitutional guarantee of a "clean and healthful environment."

Electric Resource Supply - South Dakota

Our energy resource plans identify portfolio requirements including potential investments resulting from a completed competitive solicitation process in South Dakota. Our estimated capital expenditures discussed in our Annual Report on Form 10-K for the year ended December 31, 2020 within the Management's Discussion and Analysis of Financial Condition and Results of Operations section includes approximately $60 million for a 30-40 MW flexible natural gas plant near Aberdeen, South Dakota, which was expected to be in service in early 2024. During the third quarter of 2021, we decided to discontinue our plans to build this project as a result of significant increases in estimated construction cost as a result of global supply chain challenges. As a result of the project discontinuance, we recorded a $1.2 million pre-tax charge in the three months ended September 30, 2021, for the write-off of preliminary construction costs.

Construction continues for a 60 MW reciprocating internal combustion engine project in Huron, South Dakota. The project is expect to be online in early 2022 with total construction costs of approximately $80 million (approximately $40 million invested in 2020).

Regulatory Update

We will not make a general rate case filing in any of our regulatory jurisdictions during 2021. We have recently filed several other regulatory filings, primarily in our Montana jurisdiction, including:

An April 15, 2021 filing of a motion requesting to delay the implementation of our fixed cost recovery mechanism pilot in our Montana jurisdiction for another year until July 2022 or beyond, due to the continued uncertainties created by the COVID-19 pandemic. On June 29, 2021, the MPSC granted our motion and issued a final order denying reconsideration on September 15, 2021; and

We are subject to FERC's jurisdiction and regulations with respect to rates for electric transmission service in interstate commerce and electricity sold at wholesale rates, the issuance of certain securities, and incurrence of certain long-term debt, among other things. The Division of Audits and Accounting in the Office of Enforcement of FERC has initiated a routine audit of NorthWestern Corporation for the period of January 1, 2018 to the present to evaluate our compliance with FERC accounting and financial reporting requirements. We have responded to several sets of data requests as part of the audit process. An audit report has not yet been received from FERC, but is expected within the next six months. Management is unable to predict the outcome or timing of the final resolution of the audit.

February Cold Weather Event

The February 2021 prolonged cold spell resulted in record winter peak demand for electricity and natural gas. The broad reach of this event across the United States and other market factors resulted in an extreme price excursion for purchased power and natural gas. In our South Dakota and Nebraska service territories, natural gas costs for the month of February 2021 exceeded the total cost for all of 2020. Fuel and purchased power costs in these jurisdictions are recovered through fuel adjustment clauses. We've incorporated the liquidity impacts into our overall 2021 financing plans.

The Nebraska Public Service Commission (NPSC) opened a docket on March 2, 2021 to investigate the effect of this cold weather event on natural gas supply. In this docket, we proposed recovery of our costs for February 13, 2021 to February 18,

2021 over a two-year period, which was subsequently approved by the NPSC on May 11, 2021, and a regulatory asset of approximately $26.0 million was recorded for these costs, with a remaining balance of $25.2 million as of September 30, 2021.

The South Dakota Public Utilities Commission issued an order allowing recovery of natural gas costs for the same time period over a one-year period, effective March 2, 2021. A regulatory asset of approximately $22.0 million was recorded for these costs, with a remaining balance of $17.7 million as of September 30, 2021.

COVID-19 Pandemic and Global Economic Recovery

The COVID-19 pandemic has had widespread impacts on people, economies, businesses and financial markets. Beginning in March 2020, the pandemic and resulting economic conditions began impacting our business operations and financial results. Our 2020 financial results were impacted by lower sales volumes, an increase in reserves for uncollectible accounts and an increase in interest expense, partly offset by lower operating, general and administrative expenses. We have experienced improving conditions in our service territories during 2021, that have positively impacted our business as compared to 2020. The ultimate impact of the pandemic on our financial results for 2021 and beyond depends on the evolving landscape of the pandemic and the public health responses to contain it, as well as the substance and pace of the macroeconomic recovery. If health conditions deteriorate or the economic recovery stalls, it could have the result of lower demand for electricity and natural gas, as well as reduced ability of various customers, contractors, suppliers and other business partners to fulfill their obligations or provide the services we seek to support our business operations. These impacts could have a material adverse effect on our results of operations, financial condition and prospects. In addition, the Biden administration is seeking to require large companies like us to have all of our employees vaccinated or undergo weekly COVID testing. Complying with either a vaccine mandate or weekly testing requirements (if there are even enough testing kits available) could be difficult and costly and it is possible that some employees may choose to leave employment over a vaccine or testing requirement.

We place significant reliance on our third-party business partners to supply materials, equipment and labor necessary for us to operate our utility and reliably serve current customers and future customers. As a result of current macroeconomic conditions, both nationally and globally, we have recently experienced issues with our supply chain for materials and components used in our operations and capital project construction activities. Issues include higher prices, scarcities/shortages, longer fulfillment times for orders from our suppliers, workforce availability, and wage increases. Should these economic conditions and issues continue, we could have difficulty completing the operations activities necessary to serve our customers safely and reliably, and/or achieving our capital investment program, which ultimately could result in higher customer utility rates, longer outages, and could have a material adverse impact on our business, financial condition and operations.

Financing Activities

We anticipate financing our ongoing maintenance and capital programs with a combination of cash flows from operations, first mortgage bonds and equity issuances.

In March 2021, we issued and sold $100.0 million aggregate principal amount of Montana First Mortgage Bonds at a fixed interest rate of 1.00% maturing on March 26, 2024. The net proceeds were used to repay in full our outstanding $100.0 million one-year term loan that was due April 2, 2021.

In April 2021, we entered into an Equity Distribution Agreement pursuant to which we may offer and sell shares of our common stock from time to time, having an aggregate gross sales price of up to $200.0 million, through an ATM program, including an equity forward sales component. During the three months ended September 30, 2021, we issued 1,040,085 shares of our common stock at an average price of $63.13, for net proceeds of $64.8 million. During the nine months ended September 30, 2021, we issued 1,919,394 shares of our common stock at an average price of $63.94, for net proceeds of $121.1 million. We expect a total of approximately $200.0 million of equity proceeds during 2021 to support our current capital program and maintain and protect our credit ratings. Financing plans are subject to change, depending on capital expenditures, regulatory outcomes, internal cash generation, market conditions and other factors.

RESULTS OF OPERATIONS

Our consolidated results include the results of our divisions and subsidiaries constituting each of our business segments. The overall consolidated discussion is followed by a detailed discussion of gross margin by segment.

Factors Affecting Results of Operations

Our revenues may fluctuate substantially with changes in supply costs, which are generally collected in rates from customers. In addition, various regulatory agencies approve the prices for electric and natural gas utility service within their respective jurisdictions and regulate our ability to recover costs from customers.

Revenues are also impacted by customer growth and usage, the latter of which is primarily affected by weather. Very cold winters increase demand for natural gas and to a lesser extent, electricity, while warmer than normal summers increase demand for electricity, especially among our residential and commercial customers. We measure this effect using degree-days, which is the difference between the average daily actual temperature and a baseline temperature of 65 degrees. Heating degree-days result when the average daily temperature is less than the baseline. Cooling degree-days result when the average daily temperature is greater than the baseline. The statistical weather information in our regulated segments represents a comparison of this data.

OVERALL CONSOLIDATED RESULTS

Three Months Ended September 30, 2021 Compared with the Three Months Ended September 30, 2020

Consolidated net income for the three months ended September 30, 2021 was $35.2 million as compared with $29.5 million for the same period in 2020. This increase was primarily driven by higher Montana transmission loads and rates and warmer summer weather, partly offset by higher operating costs, higher Montana electric supply costs, an unfavorable QF liability adjustment compared with the prior period, and higher income tax expense.







                                                                 Electric                        Natural Gas                         Total
                                                           2021             2020            2021            2020             2021             2020
                                                                                            (dollars in millions)
        Reconciliation of operating revenue to gross
        margin:
        Operating Revenues                              $ 287.5          $ 244.2          $ 38.5          $ 36.5          $ 326.0          $ 280.7
        Cost of Sales                                      89.4             61.2             9.3             6.9             98.7             68.1
        Gross Margin(1)                                 $ 198.1          $ 183.0          $ 29.2          $ 29.6          $ 227.3          $ 212.6
        


(1) Non-GAAP financial measure. See "Non-GAAP Financial Measure" above.







                                                Three Months Ended September 30,
                                          2021                 2020        Change      % Change
                                                     (dollars in millions)
        Gross Margin
        Electric                $      198.1                 $ 183.0      $ 15.1          8.3  %
        Natural Gas                     29.2                    29.6        (0.4)        (1.4)
        Total Gross Margin(1)   $      227.3                 $ 212.6      $ 14.7          6.9  %
        


(1) Non-GAAP financial measure. See "Non-GAAP Financial Measure" above.

Primary components of the change in gross margin include the following (in millions):







                                                                                   Gross Margin 2021 vs. 2020
        Gross Margin Items Impacting Net Income
        Montana electric transmission revenue                                    $                      10.1
        Electric retail volumes                                                                          8.4
        Montana electric supply cost recovery                                                           (2.1)
        Electric QF liability adjustment                                                                (1.3)
        Natural gas retail volumes                                                                      (0.6)
        Other                                                                                            0.4
        Change in Gross Margin Impacting Net Income                                                     14.9
        Gross Margin Items Offset Within Net Income
        Property taxes recovered in revenue, offset in property tax expense                             (1.3)
        Gas production taxes recovered in revenue, offset in property and other
        taxes                                                                                            0.2
        Operating expenses recovered in revenue, offset in operating expense                             0.3
        Production tax credits reducing revenue, offset in income tax expense                            0.6
        Change in Gross Margin Items Offset Within Net Income                                           (0.2)
        Increase in Consolidated Gross Margin(1)                                 $                      14.7
        (1) Non-GAAP financial measure. See "Non-GAAP Financial Measure" above.
        Consolidated gross margin increased $14.7 million, including a $14.9 million
        increase from items impacting net income and a $0.2 million decrease from items
        offset within net income.
        The change in consolidated gross margin for items impacting net income includes
        the following:
         Higher Montana transmission rates and higher demand to transmit energy across
        our transmission lines due to market conditions and pricing;
         An increase in electric retail revenue due to warmer summer weather, overall
        customer growth, and increased commercial volume as compared to the prior year
        due to the COVID-19 pandemic related shutdowns;
         Higher Montana electric supply costs as compared with the prior period;
         An unfavorable adjustment to our electric QF liability (unrecoverable costs
        associated with Public Utility Regulatory Policies Act of 1978 (PURPA) contracts
        as part of a 2002 stipulation with the MPSC and other parties) associated with a
        one-time clarification in contract term; and
         A decrease in gas volumes due to warmer summer weather, partly offset by
        customer growth.
                                                                                   Three Months Ended September 30,
                                                                 2021                 2020              Change                % Change
                                                                                         (dollars in millions)
        Operating Expenses (excluding cost of sales)
        Operating, general and administrative               $       80.9          $    73.3          $      7.6                     10.4  %
        Property and other taxes                                    43.6               45.3                (1.7)                    (3.8)
        Depreciation and depletion                                  47.1               44.3                 2.8                      6.3
                                                            $      171.6          $   162.9          $      8.7                      5.3  %
        








        Consolidated operating, general and administrative expenses were $80.9 million
        for the three months ended September 30, 2021, as compared with $73.3 million
        for the three months ended September 30, 2020. Primary components of the change
        include the following (in millions):
                                                                                        Operating, General &
                                                                                           Administrative
                                                                                              Expenses
                                                                                           2021 vs. 2020
        Operating, General & Administrative Expenses Impacting Net Income
        Employee benefits                                                               $             3.3
        Technology implementation and maintenance                                                     1.8
        Generation maintenance                                                                        1.3
        Write-off of preliminary construction costs                                                   1.2
        Travel and training                                                                           0.4
        . . .
        


Oct 25, 2021

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