Document/ExhibitDescriptionPagesSize 1: 10-Q Mdu Resources Form 10-Q 03-31-2023 HTML 2.56M
5: EX-95 Mdu Resources Mine Safety Disclosures HTML 123K
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Officer
3: EX-31.B Mdu Resources Certification of Chief Financial HTML 28K
Officer
4: EX-32 Mdu Resources Certification of CEO and CFO HTML 25K
11: R1 Cover page HTML 78K
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losses
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(Exact name of registrant as specified in its charter)
iDelaware
i30-1133956
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
i1200 West Century Avenue
iP.O.
Box 5650
iBismarck, iNorth Dakotai58506-5650
(Address of principal executive offices)
(Zip Code)
(i701) i530-1000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title
of each class
Trading symbol(s)
Name of each exchange on which registered
iCommon Stock, par value $1.00 per share
iMDU
iNew
York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒ No ☐.
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☒ No ☐.
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
iLarge
Accelerated Filer
☒
Accelerated Filer
☐
Non-Accelerated Filer
☐
Smaller Reporting Company
i☐
Emerging
Growth Company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☒.
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of April 27, 2023: i203,638,373
shares.
The
following abbreviations and acronyms used in this Form 10-Q are defined below:
Abbreviation or Acronym
2022 Annual Report
Company's Annual Report on Form 10-K for the year ended December 31, 2022
AFUDC
Allowance for funds used during construction
ASC
FASB Accounting Standards
Codification
ASU
FASB Accounting Standards Update
Big Stone Station
475-MW coal-fired electric generating facility near Big Stone City, South Dakota (22.7 percent ownership)
Cascade
Cascade Natural Gas Corporation, an indirect wholly owned subsidiary of MDU Energy Capital
Centennial
Centennial Energy Holdings, Inc., a direct wholly owned subsidiary of the
Company
Centennial Capital
Centennial Holdings Capital LLC, a direct wholly owned subsidiary of Centennial
Company
MDU Resources Group, Inc.
COVID-19
Coronavirus disease 2019.
Coyote Creek
Coyote Creek Mining Company, LLC, a subsidiary of The North American Coal Corporation
Coyote Station
427-MW coal-fired electric
generating facility near Beulah, North Dakota (25 percent ownership)
dk
Decatherm
Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
EPA
United States Environmental Protection Agency
Exchange Act
Securities Exchange Act of 1934, as amended
FASB
Financial Accounting Standards
Board
FERC
Federal Energy Regulatory Commission
Fidelity
Fidelity Exploration & Production Company, a direct wholly owned subsidiary of WBI Holdings (previously referred to as the Company's exploration and production segment)
GAAP
Accounting principles generally accepted in the United States of America
GHG
Greenhouse gas
Grasslands
Subsystem
A portion of WBI Energy Transmission's natural gas pipeline that runs from western North Dakota to north central Wyoming
Intermountain
Intermountain Gas Company, an indirect wholly owned subsidiary of MDU Energy Capital
IPUC
Idaho Public Utilities Commission
IRA
Inflation Reduction Act of 2022
IRS
Internal Revenue Service
Knife River
Knife
River Corporation, a direct wholly owned subsidiary of Centennial
Knife River Holding Company
A wholly owned subsidiary of the Company that was established in conjunction with the proposed separation of Knife River
kWh
Kilowatt-hour
kV
Kilovolt
LIBOR
London Inter-bank Offered Rate
MDU Construction
Services
MDU Construction Services Group, Inc., a direct wholly owned subsidiary of Centennial
MDU Energy Capital
MDU Energy Capital, LLC, a direct wholly owned subsidiary of the Company
MISO
Midcontinent Independent System Operator, Inc., the organization that provides open-access transmission services and monitors the high-voltage transmission system in the Midwest United States and Manitoba, Canada and a southern United States region which includes much of Arkansas, Mississippi, and Louisiana.
MMcf
Million
cubic feet
MMdk
Million dk
Montana-Dakota
Montana-Dakota Utilities Co., a direct wholly owned subsidiary of MDU Energy Capital
Pipeline
and Hazardous Materials Safety Administration
Regional Haze Rule
The EPA developed the Regional Haze Rule requiring states to develop and implement comprehensive plans to reduce human-caused regional haze in designated areas such as national parks and wilderness areas.
SDPUC
South Dakota Public Utilities Commission
SEC
United States Securities and Exchange Commission
Securities Act
Securities Act of 1933, as amended
SOFR
Secured
Overnight Financing Rate
UA
United Association of Journeyman and Apprentices of the Plumbing and Pipefitting Industry of the United States of America and Canada
VIE
Variable interest entity
Washington DOE
Washington State Department of Ecology
WBI Energy
WBI Energy, Inc., an indirect wholly owned subsidiary of WBI Holdings
WBI Energy Transmission
WBI Energy Transmission,
Inc., an indirect wholly owned subsidiary of WBI Holdings
WBI Holdings
WBI Holdings, Inc., a direct wholly owned subsidiary of Centennial
WUTC
Washington Utilities and Transportation Commission
The
Company's mission is to deliver superior value to stakeholders by providing essential infrastructure and services to America. The Company generates, transmits and distributes electricity and provides natural gas distribution, transportation and storage services that are regulated by state public service commissions and/or the FERC. The Company also provides construction services through its electrical and mechanical and transmission and distribution specialty contracting services, and provides construction materials and associated contracting services through aggregate mining and marketing of related products, such as ready-mix concrete, asphalt and asphalt oil.
Montana-Dakota was incorporated under the state laws of Delaware in 1924. The
Company was incorporated under the state laws of Delaware in 2018. Upon the completion of an internal holding company reorganization, Montana-Dakota became a subsidiary of the Company. Its principal executive offices are located at 1200 West Century Avenue, P.O. Box 5650, Bismarck, North Dakota58506-5650, telephone (701) 530-1000.
As part of the Company's continuous review of its business, the
Company announced strategic initiatives in 2022 that are expected to enhance its value. On August 4, 2022, the Company announced that its board of directors approved a plan to pursue the separation of Knife River, the construction materials and contracting segment, from the Company. The separation will result in two independent, publicly traded companies, MDU Resources Group, Inc. and Knife River Holding Company, and is expected to be completed on May 31, 2023, subject to certain conditions, including the SEC declaring the Registration Statement on Form 10 for Knife River Holding Company to be effective. On May 3, 2023, the
Company's board of directors approved the separation and the distribution of approximately 90 percent of the issued and outstanding shares of Knife River Holding Company to the Company's stockholders. Stockholders of the Company will receive one share of Knife River Holding Company common stock for every four shares of the Company's common stock held on May 22, 2023, the record date for the distribution. The Company will retain approximately 10 percent of Knife River Holding Company's common stock immediately following the separation with the intent to dispose of such shares within twelve
months after the separation. Prior to completing the separation, the Company may adjust the percentage of Knife River Holding Company common stock to be distributed to the Company's stockholders and retained by the Company in response to market and other factors. The separation of Knife River is planned as a tax-free spinoff transaction to the Company’s stockholders for U.S. federal income tax purposes. More information on the separation and distribution can be found within the Form 10, which is not incorporated by reference herein.
The
Company's financial results for the first quarter ended March 31, 2023, include Knife River. Upon completion of the separation, the historical results of Knife River will be presented as discontinued operations in the Company's Consolidated Financial Statements.
On November 3, 2022, the Company announced its intention to create two pure-play publicly traded companies, one focused on regulated energy delivery and the other on construction materials, and that, to achieve this future structure, the Company's board of directors authorized management to commence a strategic review
process of MDU Construction Services. The strategic review is underway and the Company anticipates completing the strategic review during the second quarter of 2023.
The Company is organized into five reportable business segments. These business segments include: electric, natural gas distribution, pipeline, construction materials and contracting, and construction services. The Company's business segments are determined based on the Company's method of internal reporting, which generally segregates the strategic business units due to differences in products, services and regulation. The internal reporting
of these segments is defined based on the reporting and review process used by the Company's chief executive officer.
The Company, through its wholly owned subsidiary, MDU Energy Capital, owns Montana-Dakota, Cascade and Intermountain. The electric segment is comprised of Montana-Dakota while the natural gas distribution segment is comprised of Montana-Dakota, Cascade and Intermountain.
The Company, through its wholly owned subsidiary, Centennial, owns WBI Energy, Knife River, MDU Construction Services and Centennial Capital. WBI Energy is the pipeline segment, Knife River is the construction materials and contracting segment, MDU Construction
Services is the construction services segment and Centennial Capital is reflected in the Other category.
For more information on the Company's business segments, see Note 17 of the Notes to Consolidated Financial Statements.
Reclassification adjustment for loss on derivative instruments included in net income, net of tax of $i11 and $i36
for the three months ended in 2023 and 2022, respectively
i34
i112
Postretirement
liability adjustment:
Amortization of postretirement liability losses included in net periodic benefit credit, net of tax of $i34 and $i164
for the three months ended in 2023 and 2022, respectively
i100
i445
Net
unrealized gain (loss) on available-for-sale investments:
Net unrealized gain (loss) on available-for-sale investments arising during the period, net of tax of $i19 and $(i85)
for the three months ended in 2023 and 2022, respectively
i70
(i320)
Reclassification
adjustment for loss on available-for-sale investments included in net income, net of tax of $i3 and $i8
for the three months ended in 2023 and 2022, respectively
i13
i32
Net
unrealized gain (loss) on available-for-sale investments
i83
(i288)
Other
comprehensive income
i217
i269
Comprehensive
income attributable to common stockholders
$
i38,570
$
i32,032
The
accompanying notes are an integral part of these consolidated financial statements.
iThe accompanying consolidated interim financial statements were prepared
in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Interim financial statements do not include all disclosures provided in annual financial statements and, accordingly, these financial statements should be read in conjunction with those appearing in the 2022 Annual Report. The information is unaudited but includes all adjustments that are, in the opinion of management, necessary for a fair presentation of the accompanying consolidated interim financial statements and are of a normal recurring nature. Depreciation, depletion and amortization expense is reported separately on the Consolidated Statements of Income and therefore is excluded from the other line items within operating expenses.
As part of the Company's continuous review of its business, the
Company announced strategic initiatives in 2022 that are expected to enhance its value. On August 4, 2022, the Company announced that its board of directors approved a plan to pursue the separation of Knife River, the construction materials and contracting segment, from the Company. The separation will result in two independent, publicly traded companies, MDU Resources Group, Inc. and Knife River Holding Company, and is expected to be completed on May 31, 2023, subject to certain conditions, including the SEC declaring the Registration Statement on Form 10 for Knife River Holding Company to be effective. On May 3, 2023, the
Company's board of directors approved the separation and the distribution of approximately 90 percent of the issued and outstanding shares of Knife River Holding Company to the Company's stockholders. Stockholders of the Company will receive one share of Knife River Holding Company common stock for every four shares of the Company's common stock held on May 22, 2023, the record date for the distribution. The Company will retain approximately 10 percent of Knife River Holding Company's common stock immediately following the separation with the intent to dispose of such shares within twelve
months after the separation. Prior to completing the separation, the Company may adjust the percentage of Knife River Holding Company common stock to be distributed to the Company's stockholders and retained by the Company in response to market and other factors. The separation of Knife River is planned as a tax-free spinoff transaction to the Company’s stockholders for U.S. federal income tax purposes.
The Company's financial results for the quarter ended March 31, 2023,
include Knife River. Upon completion of the separation, the historical results of Knife River will be presented as discontinued operations in the Company's Consolidated Financial Statements.
On November 3, 2022, the Company announced its intention to create two pure-play publicly traded companies, one focused on regulated energy delivery and the other on construction materials, and that, to achieve this future structure, the Company's board of directors authorized management to commence a strategic review process of MDU Construction Services. The strategic review is underway and the
Company anticipates completing the strategic review during the second quarter of 2023.
Discontinued operations include the supporting activities of Fidelity and are shown in income from discontinued operations on the Consolidated Statements of Income. Unless otherwise indicated, the amounts presented in the accompanying notes to the consolidated financial statements relate to the Company's continuing operations.
Management has also evaluated the impact of events occurring after March 31, 2023, up to the date of the issuance of these consolidated interim financial statements on May 4, 2023, that would require recognition or disclosure in the Consolidated Financial Statements.
The following table provides a brief description of the accounting pronouncements
applicable to the Company and the potential impact on its Consolidated Financial Statements and/or disclosures:
Standard
Description
Effective date
Impact on financial statements/disclosures
Recently adopted accounting standards
ASU 2020-04 - Reference
Rate Reform
In March 2020, the FASB issued optional guidance to ease the facilitation of the effects of reference rate reform on financial reporting. The guidance applies to certain contract modifications, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Beginning January 1, 2022, LIBOR or other discontinued reference rates cannot be applied to new contracts. New contracts will incorporate a new reference rate, which includes SOFR. LIBOR or other discontinued reference rates cannot be applied to contract
modifications or hedging relationships entered into or evaluated after December 31, 2022. Existing contracts referencing LIBOR or other reference rates expected to be discontinued must identify a replacement rate by June 30, 2023.
For more information, see ASU 2022-06 - Reference Rate Reform: Deferral of Sunset Date in recently issued accounting standards not yet adopted.
Recently issued accounting standards not yet adopted
ASU
2022-06 - Reference Rate Reform: Deferral of Sunset Date
In December 2022, the FASB included a sunset provision within ASC 848 based on expectations of when LIBOR would cease being published. At the time ASU 2020-04 was issued, the UK Financial Conduct Authority had established its intent to cease overnight tenors of LIBOR after December 31, 2021. In March 2021, the UK Financial Conduct Authority announced that the intended cessation date of the overnight tenors of LIBOR would be June 30, 2023 which is beyond the current sunset date of ASC 848. The amendments in this Update defer the sunset date of ASC 848 from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief
in ASC 848.
The Company has updated its credit agreements to include language regarding the successor or alternate rate to LIBOR, and a review of other contracts and agreements is on-going. The Company does not expect the guidance to have a material impact on its results of operations, financial position, cash flows or disclosures.
Note 3 - iSeasonality
of operations
Some of the Company's operations are highly seasonal and revenues from, and certain expenses for, such operations may fluctuate significantly among quarterly periods. Accordingly, the interim results for particular businesses, and for the Company as a whole, may not be indicative of results for the full fiscal year.
Note 4 - iReceivables
and allowance for expected credit losses
iReceivables consist primarily of trade and contracting services contract receivables from the sale of goods and services, which are recorded at the invoiced amount, and contract assets, net of expected credit losses. For more information on contract
assets, see Note 8. The Company's trade receivables are all due in 12 months or less. The total balance of receivables past due 90 days or more was $i53.5 million, $i50.7 million
and $i45.6 million at March 31, 2023 and 2022, and December 31, 2022, respectively.
iThe
Company's expected credit losses are determined through a review using historical credit loss experience; changes in asset specific characteristics; current conditions; and reasonable and supportable future forecasts, among other specific account data, and is performed at least quarterly. The Company develops and documents its methodology to determine its allowance for expected credit losses at each of its reportable business segments. Risk characteristics used by the business segments may include customer mix, knowledge of customers and general economic conditions of the various local economies, among others. Specific account balances are written off when management determines the amounts to be uncollectible. Management has reviewed the balance reserved through the allowance for expected credit losses and believes it is reasonable.
iNatural gas in storage for the Company's regulated operations is generally valued at lower of cost or market using the
last-in, first-out method or lower of cost or net realizable value using the average cost or first-in, first-out method. The majority of all other inventories are valued at the lower of cost or net realizable value using the average cost method. Inventories include production costs incurred as part of the Company's aggregate mining activities. These inventoriable production costs include all mining and processing costs associated with the production of aggregates. Stripping costs incurred during the production phase, which represent costs of removing overburden and waste materials to access mineral deposits, are a component of inventoriable production costs. The portion of the cost of natural gas in storage expected to be used within 12 months was included in inventories. iInventories
on the Consolidated Balance Sheets were as follows:
The
remainder of natural gas in storage, which largely represents the cost of gas required to maintain pressure levels for normal operating purposes, was included in noncurrent assets - other and was $i47.4 million at March 31, 2023 and $ii47.5/
million at both March 31, 2022 and December 31, 2022.
iBasic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the applicable period. Diluted earnings per share is computed by dividing net income by the total of the weighted average number of shares of common stock outstanding during the applicable period, plus the effect of non-vested performance share awards and restricted stock units. Common stock outstanding includes issued shares less shares held in treasury. Net income was the same for both the basic and diluted earnings per share calculations. iA
reconciliation of the weighted average common shares outstanding used in the basic and diluted earnings per share calculations follows:
The
following amounts were reclassified out of accumulated other comprehensive loss into net income. The amounts presented in parenthesis indicate a decrease to net income on the Consolidated Statements of Income. The reclassifications were as follows:
iRevenue is recognized when a performance obligation is satisfied
by transferring control over a product or service to a customer. Revenue is measured based on consideration specified in a contract with a customer and excludes any sales incentives and amounts collected on behalf of third parties. The Company is considered an agent for certain taxes collected from customers. As such, the Company presents revenues net of these taxes at the time of sale to be remitted to governmental authorities, including sales and use taxes.
Disaggregation
i
In
the following tables, revenue is disaggregated by the type of customer or service provided. The Company believes this level of disaggregation best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. The table also includes a reconciliation of the disaggregated revenue by reportable segments. For more information on the Company's business segments, see Note 17.
Presented
in the previous tables are sales of materials to both third parties and internal customers within the construction materials and contracting segment to highlight the focus on vertical integration as this segment sells materials to both third parties and internal customers. Due to consolidation requirements, the internal sales revenues must be eliminated against the construction materials product used in the contracting services to arrive at the external operating revenue total for the segment.
The timing of revenue recognition may differ from the timing of invoicing to customers. The timing of invoicing to customers does not necessarily correlate with the timing of revenues being recognized under the cost-to-cost method of accounting. Contracts
from construction work are billed as work progresses in accordance with agreed upon contractual terms. Generally, billing to the customer occurs contemporaneous to revenue recognition. A variance in timing of the billings may result in a contract asset or a contract liability. A contract asset occurs when revenues are recognized under the cost-to-cost measure of progress, which exceeds amounts billed on uncompleted contracts. Such amounts will be billed as standard contract terms allow, usually based on various measures of performance
or achievement. A contract liability occurs when there are billings in excess of revenues recognized under the cost-to-cost measure of progress on uncompleted contracts. Contract liabilities decrease as revenue is recognized from the satisfaction of the related performance obligation.
i
The changes
in contract assets and liabilities were as follows:
The Company recognized a net increase in revenues of $i21.3
million and $i23.5 million for the three months ended March 31, 2023 and 2022, respectively, from performance obligations satisfied in prior periods.
The remaining performance obligations, also referred to as backlog, at the construction materials and contracting and construction services segments include unrecognized revenues that the Company reasonably expects to be realized. These unrecognized revenues can include: projects that have a written award, a letter of intent, a notice to proceed, an agreed upon work order to perform work on mutually accepted terms and conditions and change orders or claims to the extent management believes additional contract revenues will be earned and are deemed probable of collection. Excluded from remaining performance obligations are potential orders under master service agreements. The majority of the
Company's contracting services contracts have an original duration of less than two years.
The remaining performance obligations at the pipeline segment include firm transportation contracts with fixed pricing and fixed volumes. The Company has applied the practical expedient, which does not require additional disclosures for contracts with an original duration of less than 12 months, to certain firm transportation and non-regulated contracts. The
Company's firm transportation contracts included in the remaining performance obligations have weighted average remaining durations of less than five years.
At March 31, 2023, the Company's remaining performance obligations were $i3.7 billion. The
Company expects to recognize the following revenue amounts in future periods related to these remaining performance obligations: $i2.6 billion within the next i12 months
or less; $i454.5 million within the next i13 to 24 months; and $i592.8
million in i25 months or more.
Note 9 - iBusiness
combinations
iThe following acquisition was accounted for as a business combination in accordance with ASC 805 - Business Combinations. The results of the business combination have been included in the Consolidated Financial Statements beginning on the acquisition date. Pro forma financial amounts reflecting the effects of the business combination are not presented because it was not material to the Company's financial position or results of operations.
Acquisitions
are also subject to customary adjustments based on, among other things, the amount of cash, debt and working capital in the business as of the closing date. The amounts included in the Consolidated Balance Sheets for these adjustments are considered provisional until final settlement has occurred.
The Company had no acquisitions in the three months ended March 31, 2023. In December 2022, the construction materials and contracting segment acquired Allied Concrete and Supply Co., a producer of ready-mixed concrete in California. At March 31, 2023, the purchase price allocation was considered preliminary and will be finalized within 12 months of the acquisition date.
The total purchase price for acquisitions
that occurred in 2022 was $i8.9 million, subject to certain adjustments, with cash acquired totaling $i2.8 million.
The purchase price includes consideration paid of $i1.5 million, a $i70,000
holdback liability, and i273,153 shares of common stock with a market value of $i8.4 million
as of the respective acquisition date. Due to the holding period restriction on the common stock, the share consideration was discounted to a fair value of approximately $i7.3 million. The amounts allocated to the aggregated assets acquired and liabilities assumed during 2022 were as follows: $i1.7 million
to current assets; $i5.9 million to property, plant and equipment; $i200,000
to goodwill; $i100,000 to current liabilities; $i500,000
to noncurrent liabilities - other and $i1.2 million to deferred tax liabilities.
Costs incurred for acquisitions are included in operation and maintenance expense on the Consolidated Statements of Income and were iiimmaterial/
for both the three months ended March 31, 2023 and 2022.
Note 10 - iLeases
The Company's leases primarily include operating leases for equipment, buildings, easements and vehicles. The
Company leases certain equipment to third parties through its utility and construction services segments, which are considered short-term operating leases with terms of less than 12 months.
The Company recognized revenue from operating leases of $i12.2 million and $i11.4
million for the three months ended March 31, 2023 and 2022, respectively. At March 31, 2023, the Company had $i9.1 million of lease receivables with a majority due within 12 months.
The
previous tables include goodwill and intangible assets associated with the business combinations completed during 2022. For more information related to these business combinations, see Note 9.
Amortization expense for amortizable intangible assets for both the three months ended March 31, 2023 and 2022, was $ii1.2/ million.
iEstimated amortization expense for identifiable intangible assets as of March 31, 2023, was:
Natural
gas costs recoverable through rate adjustments
iUp to 1 year
$
i198,166
$
i66,132
$
i141,306
Conservation
programs
iUp to 1 year
i8,599
i7,567
i8,544
Cost
recovery mechanisms
iUp to 1 year
i3,954
i3,432
i4,019
Other
iUp
to 1 year
i5,599
i11,947
i11,223
i216,318
i89,078
i165,092
Noncurrent:
Pension
and postretirement benefits
i**
i143,349
i142,681
i143,349
Cost
recovery mechanisms
iUp to 10 years
i65,732
i67,989
i67,171
Plant
costs/asset retirement obligations
iOver plant lives
i44,131
i63,325
i44,462
Manufactured
gas plant site remediation
i-
i26,605
i26,089
i26,624
Environmental
compliance programs
i-
i21,942
i—
i—
Plant
to be retired
i-
i21,072
i29,452
i21,525
Taxes
recoverable from customers
iOver plant lives
i12,198
i12,492
i12,330
Long-term
debt refinancing costs
iUp to 37 years
i3,041
i3,636
i3,188
Other
iUp
to 16 years
i11,430
i13,564
i11,010
i349,500
i359,228
i329,659
Total
regulatory assets
$
i565,818
$
i448,306
$
i494,751
Regulatory
liabilities:
Current:
Electric fuel and purchased power deferral
iUp to 1 year
i9,630
i—
i4,929
Natural
gas costs refundable through rate adjustments
iUp to 1 year
i6,331
i13,107
i955
Conservation
programs
iUp to 1 year
i3,834
i144
i4,126
Cost
recovery mechanisms
iUp to 1 year
i2,926
i2,550
i1,977
Taxes
refundable to customers
iUp to 1 year
i1,513
i3,470
i3,937
Refundable
fuel and electric costs
iUp to 1 year
i1,179
i316
i3,253
Other
iUp
to 1 year
i18,982
i11,599
i7,263
i44,395
i31,186
i26,440
Noncurrent:
Plant
removal and decommissioning costs
iOver plant lives
i214,467
i171,485
i208,650
Taxes
refundable to customers
iOver plant lives
i200,879
i212,472
i203,222
Cost
recovery mechanisms
iUp to 19 years
i16,313
i9,508
i14,025
Accumulated
deferred investment tax credit
iUp to 19 years
i13,996
i13,352
i13,594
Pension
and postretirement benefits
i**
i7,376
i20,434
i7,376
Other
iUp
to 15 years
i1,638
i6,377
i1,587
i454,669
i433,628
i448,454
Total
regulatory liabilities
$
i499,064
$
i464,814
$
i474,894
Net
regulatory position
$
i66,754
$
(i16,508)
$
i19,857
*Estimated
recovery or refund period for amounts currently being recovered or refunded in rates to customers.
** Recovered as expense is incurred or cash contributions are made.
//
At March 31, 2023 and 2022, and December 31, 2022, approximately $i255.6 million,
$i268.1 million and $i242.5 million,
respectively, of regulatory assets were not earning a rate of return; however, these regulatory assets are expected to be recovered from customers in future rates. These assets are largely comprised of the unfunded portion of pension and postretirement benefits, accelerated depreciation on plant retirement, the estimated future cost of manufactured gas plant site remediation and the costs associated with environmental compliance.
The Company is subject to environmental compliance regulations in certain states which require natural gas distribution companies to reduce overall GHG emissions to certain thresholds as established by each applicable state. Compliance with these standards may be achieved through increased energy efficiency and conservation measures, purchased emission allowances and offsets,
purchases
of community climate investment credits and purchases of low carbon fuels. Emission allowances are allocated by the respective states to the Company at no cost, of which a portion is required to be sold at auction. The Company expects the compliance costs for these regulations and the revenues from the sale of the allocated emissions allowances will be passed through to customers in rates and has, accordingly, deferred the environmental compliance obligation as a regulatory asset.
In the last half of 2021 through 2022, the Company experienced high natural gas costs due to increase in demand outpacing the supply along with the impact of global events. Additionally, in December 2022
and January 2023, natural gas prices significantly increased across the Pacific Northwest from multiple price-pressuring events including wide-spread below-normal temperatures and higher natural gas consumption; reduced natural gas flows due to pipeline constraints, including maintenance in West Texas; and historically low regional natural gas storage levels. This increase in natural gas costs experienced in certain jurisdictions was partially offset by the recovery of prior period natural gas costs being recovered over a period longer than the normal one-year period.
For a discussion of the Company's most recent cases by jurisdiction, see Note 19.
In February 2019, the Company announced the retirement of three aging
coal-fired electric generating units. The Company accelerated the depreciation related to these facilities in property, plant and equipment and recorded the difference between the accelerated depreciation, in accordance with GAAP, and the depreciation approved for rate-making purposes as regulatory assets. Requests were filed with the NDPSC and SDPUC, and subsequently approved, to offset the savings associated with the cessation of operations of these units with the amortization of the deferred regulatory assets. The Company ceased operations of Lewis & Clark Station in March 2021 and Units 1 and 2 at Heskett Station in February 2022. The Company subsequently reclassified the costs being recovered for these facilities
from plant retirement to cost recovery mechanisms in the previous table and began amortizing the associated plant retirement and closure costs in the jurisdictions where requests were filed. The Company expects to recover the regulatory assets related to the plant retirements in future rates.
If, for any reason, the Company's regulated businesses cease to meet the criteria for application of regulatory accounting for all or part of their operations, the regulatory assets and liabilities relating to those portions ceasing to meet such criteria would be written off and included in the statement of income or accumulated other comprehensive loss in the period in which the discontinuance of regulatory accounting occurs.
Note
13 - iEnvironmental allowances and obligations
The Company's natural gas distribution segment acquires environmental allowances as part of its requirement to comply with environmental regulations in certain states. Allowances are allocated by the respective states to the Company at no cost and additional allowances are required to be purchased as needed based on the requirements
in the respective states. The segment records purchased and allocated environmental allowances at weighted average cost under the inventory method of accounting. Environmental allowances are included in noncurrent assets - other on the Consolidated Balance Sheets.
Environmental compliance obligations, which are based on GHG emissions, are measured at the carrying value of environmental allowances held plus the estimated value of additional allowances necessary to satisfy the compliance obligation. Environmental compliance obligations are included in noncurrent liabilities - other on the Consolidated Balance Sheets. At March 31, 2023, the Company accrued $i21.9 million
in compliance obligations.
As environmental allowances are surrendered, the segment reduces the associated environmental compliance assets and liabilities from the Consolidated Balance Sheets. The expenses associated with the Company’s environmental allowances and obligations are deferred as regulatory assets. For more information on the Company’s regulatory assets and liabilities, see Note 12.
Note 14 - iFair
value measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The fair value ASC establishes a hierarchy for grouping assets and liabilities, based on the significance of inputs. The estimated fair values of the Company's assets and liabilities measured on a recurring basis are determined using the market approach.
iThe
Company measures its investments in certain fixed-income and equity securities at fair value with changes in fair value recognized in income.The Company anticipates using these investments, which consist of insurance contracts, to satisfy its obligations under its unfunded, nonqualified defined benefit and defined contribution plans for executive officers and certain key management employees, and invests in these fixed-income and equity securities for the purpose of earning investment returns and capital appreciation. These investments, which totaled $i105.9 million,
$i105.4 million and $i98.0 million, at March 31, 2023 and 2022,
and December 31, 2022, respectively, are classified as investments on the Consolidated Balance Sheets. The net unrealized gain on these investments was $i3.8 million for the three months ended March 31, 2023. The net unrealized loss on these investments was $i5.8 million
for the three months ended March 31, 2022. The change in fair value, which is considered part of the cost of the plan, is classified in other income on the Consolidated Statements of Income.
iThe Company did not elect the fair value option, which records gains and losses in income, for its available-for-sale securities, which include mortgage-backed securities and U.S. Treasury securities. These available-for-sale securities are
recorded at fair value
and are classified as investments on the Consolidated Balance Sheets. Unrealized gains or losses are recorded in accumulated other comprehensive loss. iDetails of available-for-sale securities were as follows:
* The
insurance contracts invest approximately i61 percent in fixed-income investments, i15 percent
in common stock of large-cap companies, i8 percent in common stock of mid-cap companies, i7 percent in target date investments, i6 percent
in common stock of small-cap companies, i2 percent in cash equivalents and i1 percent in international investments.
* The
insurance contracts invest approximately i61 percent in fixed-income investments, i17 percent
in common stock of large-cap companies, i8 percent in common stock of mid-cap companies, i6 percent in common stock of small-cap companies, i6 percent
in target date investments and i2 percent in cash equivalents.
* The
insurance contracts invest approximately i63 percent in fixed-income investments, i15 percent
in common stock of large-cap companies, i8 percent in common stock of mid-cap companies, i6 percent in common stock of small-cap companies, i6 percent
in target date investments and i2 percent in cash equivalents.
The Company's money market funds are valued at the net asset value of shares held at the end of the period, based on published market quotations on active markets, or using other known sources including pricing from outside sources. The estimated
fair value of the Company's mortgage-backed securities and U.S. Treasury securities are based on comparable market transactions, other observable inputs or other sources, including pricing from outside sources. The estimated fair value of the Company's insurance contracts are based on contractual cash surrender values that are determined primarily by investments in managed separate accounts of the insurer. These amounts approximate fair value. The managed separate accounts are valued based on other observable inputs or corroborated market data.
Though the Company believes the methods used to
estimate fair value are consistent with those used by other market participants, the use of other methods or assumptions could result in a different estimate of fair value.
The Company applies the provisions of the fair value measurement standard to its nonrecurring, non-financial measurements, including long-lived asset impairments. These assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. The Company reviews the carrying value of its long-lived assets, excluding goodwill, whenever events or changes in circumstances indicate that such carrying amounts may not be recoverable.
The
Company performed fair value assessments of the assets acquired and liabilities assumed in the business combination that occurred during 2022. The fair value of these assets and liabilities were determined based on Level 2 and Level 3 inputs.
The Company's long-term debt is not measured at fair value on the Consolidated Balance Sheets and the fair value is being provided for disclosure purposes only. The fair value was categorized as Level 2 in the fair value hierarchy and was based on discounted future cash flows using current market interest rates. iThe
estimated fair value of the Company's Level 2 long-term debt was as follows:
The
carrying amounts of the Company's remaining financial instruments included in current assets and current liabilities approximate their fair values.
Note 15 - iDebt
Certain debt instruments of the Company's subsidiaries
contain restrictive and financial covenants and cross-default provisions. In order to borrow under the debt agreements, the subsidiary companies must be in compliance with the applicable covenants and certain other conditions, all of which the subsidiaries, as applicable, were in compliance with at March 31, 2023. In the event the subsidiaries do not comply with the applicable covenants and other conditions, alternative sources of funding may need to be pursued.
Montana-Dakota's and Centennial's respective commercial paper programs are supported by revolving credit agreements. While the amount of commercial paper outstanding does not reduce available capacity under the respective revolving credit agreements,
Montana-Dakota and Centennial do not issue commercial paper in an aggregate amount exceeding the available capacity under the credit agreements. The commercial paper borrowings may vary during the period, largely the result of fluctuations in working capital requirements due to the seasonality of certain operations of the Company's subsidiaries.
Short-term debt
Cascade On January 20, 2023, Cascade entered into a $i150.0 million
term loan agreement with a SOFR-based interest rate and a maturity date of January 19, 2024. The agreement contains customary covenants and provisions, including a covenant of Cascade not to permit, at any time, the ratio of total debt to total capitalization to be greater than i65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Intermountain On January
20, 2023, Intermountain entered into a $i125.0 million term loan agreement with a SOFR-based interest rate and a maturity date of January 19, 2024. In March 2023, Intermountain paid down $i20.0 million
of the outstanding balance. The agreement contains customary covenants and provisions, including a covenant of Intermountain not to permit, at any time, the ratio of total debt to total capitalization to be greater than i65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Centennial On March 18, 2022, Centennial entered into a $i100.0 million
term loan agreement with a SOFR-based variable interest rate and a maturity date of March 17, 2023. On March 17, 2023, Centennial amended this agreement to extend the maturity date to September 15, 2023. The agreement contains customary covenants and provisions, including a covenant of Centennial not to permit, at any time, the ratio of total debt to total capitalization to be greater than i65
percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Other
notes due on dates ranging from January 1, 2024 to January 1, 2061
i1.43
%
i1,561
i2,445
i2,253
Less
unamortized debt issuance costs
i6,453
i6,605
i6,542
Less
discount
i284
i77
i286
Total
long-term debt
i2,847,068
i2,747,763
i2,841,425
Less
current maturities
i78,031
i147,953
i78,031
Net
long-term debt
$
i2,769,037
$
i2,599,810
$
i2,763,394
Schedule
of Debt Maturities iLong-term debt maturities, which excludes unamortized debt issuance costs and discount, at March 31, 2023, were as follows:
Remainder
of
2023
2024
2025
2026
2027
Thereafter
(In thousands)
Long-term debt maturities
$
i78,031
$
i601,846
$
i177,802
$
i140,802
$
i111,452
$
i1,743,872
Note
16 - iCash flow information
i
Cash expenditures for interest and income taxes were as follows:
iThe Company's reportable segments are those that are based on the
Company's method of internal reporting, which generally segregates the strategic business units due to differences in products, services and regulation. The internal reporting of these operating segments is defined based on the reporting and review process used by the Company's chief executive officer.The Company's operations are located within the United States.
The electric segment generates, transmits and distributes electricity in Montana, North Dakota, South Dakota and Wyoming. The natural gas distribution segment distributes natural gas in those states, as well as in Idaho, Minnesota, Oregon and Washington. These operations also supply related value-added services.
The pipeline segment provides natural
gas transportation and underground storage services through a regulated pipeline system primarily in the Rocky Mountain and northern Great Plains regions of the United States. This segment also provides non-regulated cathodic protection services.
The construction materials and contracting segment mines, processes and sells construction aggregates (crushed stone and sand and gravel); produces and sells asphalt; and supplies ready-mix concrete. This segment's aggregate reserves provide the foundation for the vertical integration of its contracting services with its construction materials to support its aggregate-based product lines including heavy-civil construction, asphalt paving, concrete construction and site development and grading. Although not common to all locations, the segment also includes the sale of cement, liquid asphalt modification and distribution, various finished concrete products, merchandise and other building
materials and related contracting services. This segment operates in the central, southern and western United States, including Alaska and Hawaii.
The construction services segment provides a full spectrum of construction services through its electrical and mechanical and transmission and distribution specialty contracting services across the United States. These specialty contracting services are provided to utilities, manufacturing, transportation, commercial, industrial, institutional, renewable and governmental customers. Its electrical and mechanical contracting services include construction and maintenance of electrical and communication wiring and infrastructure, fire suppression systems, and mechanical piping and services. Its transmission and distribution contracting services include construction and maintenance of overhead and underground electrical, gas and communication infrastructure, as well as manufacturing and
distribution of transmission line construction equipment and tools.
The Other category includes the activities of Centennial Capital, which, through its subsidiary InterSource Insurance Company, insures various types of risks as a captive insurer for certain of the Company's subsidiaries. The function of the captive insurer is to fund the self-insured layers of the insured Company's general liability, automobile liability, pollution liability and other coverages. Centennial Capital also owns certain real and personal property. In addition, the Other category includes certain assets, liabilities and tax adjustments of the holding company primarily associated with corporate functions, as well as costs associated with the announced strategic initiatives. Also
included are certain general and administrative costs (reflected in operation and maintenance expense) and interest expense, which were previously allocated to the refining business and Fidelity and do not meet the criteria for income (loss) from discontinued operations.
Discontinued operations include the supporting activities of Fidelity other than certain general and administrative costs and interest expense as described above.
The information below follows the same accounting policies as described in Note 2 of the Notes to Consolidated Financial Statements in the 2022 Annual Report. iInformation
on the Company's segments was as follows:
Net
periodic benefit credit, including amount capitalized
(i1,007)
(i898)
Less
amount capitalized
i24
i31
Net
periodic benefit credit
$
(i1,031)
$
(i929)
/
The
components of net periodic benefit credit, other than the service cost component, are included in other income on the Consolidated Statements of Income. The service cost component is included in operation and maintenance expense on the Consolidated Statements of Income.
Nonqualified defined benefit plans
In addition to the qualified defined benefit pension plans reflected in the table at the beginning of this note, the Company also has unfunded, nonqualified defined benefit plans for executive officers and certain key management employees. The Company's net periodic benefit cost for these plans was $i936,000
and $i773,000 for the three months ended March 31, 2023 and 2022, respectively. The components of net periodic benefit cost for these plans are included in other income on the Consolidated Statements of Income.
Note 19 - iRegulatory
matters
The Company regularly reviews the need for electric and natural gas rate changes in each of the jurisdictions in which service is provided. The Company files for rate adjustments to seek recovery of operating costs and capital investments, as well as reasonable returns as allowed by regulators. Certain regulatory proceedings and cases may also contain recurring mechanisms that can have an annual true-up. Examples of these recurring mechanisms include: infrastructure riders, transmission trackers, renewable resource cost adjustment riders, as well as weather normalization and decoupling mechanisms. The following paragraphs summarize the Company's significant open regulatory proceedings
and cases by jurisdiction including updates to those reported in the 2022 Annual Report and should be read in conjunction with previous filings. The Company is unable to predict the ultimate outcome of these matters, the timing of final decisions of the various regulators and courts, or the effect on the Company's results of operations, financial position or cash flows.
IPUC
Intermountain filed a request with the IPUC for a natural gas general rate increase on December 1, 2022. The request was for an increase of $i11.3 million
annually or i3.2 percent above current rates, which was revised on March 9, 2023, to $i6.8 million
annually or i1.9 percent above current rates. The requested increase is primarily to recover investments made since the last rate case in 2016 and the depreciation, operation and maintenance expenses and taxes associated with the increased investments. A
settlement
in principle has been reached and is expected to be filed with the IPUC no later than May 15, 2023. This matter is pending before the IPUC.
MTPSC
On November 4, 2022, Montana-Dakota filed an application with the MTPSC for an electric general rate increase of approximately $i10.5 million annually or i15.2
percent above current rates, which was revised on March 15, 2023, to $i11.5 million annually or i17.0
percent above current rates to reflect the loss of a large industrial customer. The requested increase is primarily to recover investments made since the last rate case, including Heskett Unit 4, increases in operation and maintenance expenses, and increases in property taxes. On January 24, 2023, the MTPSC approved Montana-Dakota's request for an interim increase of approximately $i1.7 million or i2.7
percent above current rates, subject to refund, effective February 1, 2023. The MTPSC has 9 months to render a final decision on the rate case. The matter is pending before the MTPSC with a hearing scheduled for June 20, 2023.
NDPSC
On May 16, 2022, Montana-Dakota filed an application with the NDPSC for an electric general rate increase of approximately $i25.4 million
annually or i12.3 percent above current rates. The requested increase is primarily to recover investments in production, transmission and distribution facilities and the associated depreciation, operation and maintenance expenses and taxes associated with the increased investment. On July 14, 2022, the NDPSC approved an interim rate increase of approximately $i10.9 million
annually or i5.3 percent above current rates, subject to refund, for service rendered on and after July 15, 2022. The lower interim rate increase is largely due to excluding the recovery of Heskett Unit 4 from interim rates due to not being in service until summer of 2023. On April 26, 2023, the Company filed with the NDPSC an
all-party settlement reflecting an annual revenue increase of $i15.3 million or i7.4 percent
overall. The reduction from the original filing includes a return on equity of i9.75 percent and maintaining depreciation expense at current levels. A hearing was held May 2, 2023. The matter is pending before the NDPSC.
WUTC
On March 24, 2022, Cascade filed a request for tariff revision with the WUTC to rectify an inadvertent IRS normalization violation resulting from its tariff
established in 2018 that passes back to customers the reversal of plant-related excess deferred income taxes through an annual rate adjustment. This request was made in response to the issuances of an IRS private letter ruling to another Washington utility with the same annual rate adjustment tariff, which addressed its normalization violations. The private letter ruling concluded the tariff to refund excess deferred income taxes without corresponding adjustments for other components of rate base or changes in depreciation or income tax expense, is an impermissible methodology under the IRS normalization and consistency rules. Cascade's request proposed a similar remedy through the tariff to recover the excess amounts refunded to customers while this tariff has been in place, and revised the method going forward to reflect excess deferred income taxes in rates in the same manner as other components of rate base from its most recent general rate case. Cascade requested
recovery of the excess refunded to customers of approximately $i3.3 million and elimination of the currently deferred, but not yet refunded balance. A multi-party settlement was filed with the WUTC on October 21, 2022. On January 23, 2023, the WUTC denied recovery of the excess refunded to customers, but approved the tariff revision going forward to rectify the inadvertent normalization violation. On February
1, 2023, Cascade filed a motion for clarification with the WUTC on the currently deferred but not yet refunded balance. A clarifying conference was held on February 27, 2023, resulting in approval to reverse the currently deferred but not yet refunded balance of approximately $i1.1 million. On February 28, 2023, this matter was finalized by the WUTC with rates effective March
1, 2023.
FERC
On January 27, 2023, WBI Energy Transmission filed a general rate case with the FERC for increases in its transportation and storage services rates that also includes a Greenhouse Gas Cost Recovery Mechanism for anticipated future costs. New rates, which are pending FERC approval, will be in effect August 1, 2023.
Note 20 - iContingencies
iThe Company is party to claims and lawsuits arising out of its business and that of its consolidated subsidiaries, which may include, but are not limited to, matters involving property damage, personal injury, and environmental, contractual, statutory and regulatory obligations. The Company accrues a liability for those contingencies
when the incurrence of a loss is probable and the amount can be reasonably estimated. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. The Company does not accrue liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated or when the liability is believed to be only reasonably possible or remote. For contingencies where an unfavorable outcome is probable or reasonably possible and which are material, the Company discloses the nature of the contingency and, in some circumstances, an estimate of the possible loss. Accruals are based on the best information available, but in certain situations management is unable to estimate
an amount or range of a reasonably possible loss including, but not limited to when: (1) the damages are unsubstantiated or indeterminate, (2) the proceedings are in the early stages, (3) numerous parties are involved, or (4) the matter involves novel or unsettled legal theories.
respectively, and regulatory assets of $i20.9 million,
$i20.8 million and $i20.9 million, respectively, related to the accrued liabilities. The accruals are for contingencies resulting from litigation and environmental matters. This includes amounts that have been
accrued for matters discussed in Environmental matters within this note. The Company will continue to monitor each matter and adjust accruals as might be warranted based on new information and further developments. Management believes that the outcomes with respect to probable and reasonably possible losses in excess of the amounts accrued, net of insurance recoveries, while uncertain, either cannot be estimated or will not have a material effect upon the Company's financial position, results of operations or cash flows. Unless otherwise required by GAAP, legal costs are expensed as they are incurred.
Environmental matters
The Company is a party
to claims for the cleanup of environmental contamination at certain manufactured gas plant sites, as well as a superfund site. There were no material changes to the Company's environmental matters that were previously reported in the 2022 Annual Report.
Guarantees
Certain subsidiaries of the Company have outstanding guarantees to third parties that guarantee the performance of other subsidiaries of the Company. These guarantees are related to construction contracts,
insurance deductibles and loss limits, and certain other guarantees. At March 31, 2023, the fixed maximum amounts guaranteed under these agreements aggregate $i350.0 million. Certain of the guarantees also have no fixed maximum amounts specified. At March 31, 2023, the amounts of scheduled expiration of the maximum amounts guaranteed under these agreements aggregate to $i28.3 million
in 2023; $i144.1 million in 2024; $i163.3 million in 2025; $i1.5 million
in 2026; $i1.0 million in 2027; $i300,000 thereafter; and $i11.5 million,
which has no scheduled maturity date. There were ino amounts outstanding under the previously mentioned guarantees at March 31, 2023. In the event of default under these guarantee obligations, the subsidiary issuing the guarantee for that particular obligation would be required to make payments under its guarantee.
Certain subsidiaries have outstanding letters of credit
to third parties related to insurance policies and other agreements, some of which are guaranteed by other subsidiaries of the Company. At March 31, 2023, the fixed maximum amounts guaranteed under these letters of credit aggregated $i26.0 million. At March 31, 2023, the amounts of scheduled expiration of the maximum amounts guaranteed under
these letters of credit aggregate to $i25.6 million in 2023, $i400,000 in 2024. There were ino
amounts outstanding under the previously mentioned letters of credit at March 31, 2023. In the event of default under these letter of credit obligations, the subsidiary guaranteeing the letter of credit would be obligated for reimbursement of payments made under the letter of credit.
In addition, Centennial, Knife River and MDU Construction Services have issued guarantees to third parties related to the routine purchase of maintenance items, materials and lease obligations for which no fixed maximum amounts have been specified. These guarantees have no scheduled maturity date. In the event a subsidiary of the Company defaults under these obligations, Centennial, Knife River or MDU Construction Services would be required to make payments under these guarantees. Any amounts outstanding by subsidiaries
of the Company were reflected on the Consolidated Balance Sheet at March 31, 2023.
In the normal course of business, Centennial has surety bonds related to construction contracts and reclamation obligations of its subsidiaries. In the event a subsidiary of Centennial does not fulfill a bonded obligation, Centennial would be responsible to the surety bond company for completion of the bonded contract or obligation. A large portion of the surety bonds is expected to expire within the next 12 months; however, Centennial will likely
continue to enter into surety bonds for its subsidiaries in the future. At March 31, 2023, approximately $i1.6 billion of surety bonds were outstanding, which were not reflected on the Consolidated Balance Sheet.
iThe Company evaluates its arrangements and contracts with other entities to determine if they are VIEs and if so, if the Company is the primary beneficiary.
Fuel Contract
Coyote Station entered into a coal supply agreement with Coyote Creek that provides for the purchase of coal necessary to supply the coal requirements of the Coyote Station for the period May 2016 through December 2040. Coal purchased under the coal supply agreement is reflected in inventories on the Consolidated Balance Sheets and is recovered from customers as a component of electric fuel and purchased power.
The coal supply agreement creates a variable interest in Coyote Creek due to the transfer of all operating and economic risk to the Coyote Station owners, as the agreement is structured so that the price of the coal will cover all costs of operations, as well as future reclamation costs. The Coyote Station owners are also providing a guarantee of the value of the assets of Coyote Creek as they would be required to buy the assets at book value should they terminate the contract
prior to the end of the contract term and are providing a guarantee of the value of the equity of Coyote Creek in that they are required to buy the entity at the end of the contract term at equity value. Although the Company has determined that Coyote Creek is a VIE, the Company has concluded that it is not the primary beneficiary of Coyote Creek because the authority to direct the activities of the entity is shared by the four unrelated owners of the Coyote Station, with no primary beneficiary existing. As a result, Coyote Creek is not required to be consolidated in the
Company's financial statements.
On April 21, 2023, Intermountain repaid an additional $i30.0 million of the $i125.0
million term loan agreement issued on January 20, 2023. For more information on this debt agreement, see Note 15.
On April 25, 2023, Knife River Holding Company issued $i425.0 million of i7.75
percent senior notes due May 1, 2031, pursuant to an indenture agreement. The proceeds from the issuance of these notes will be held in escrow until the effective date of the Knife River separation or, if the separation does not occur within the time frame specified, released back to the lenders, along with accrued interest.
On May 1, 2023, the Company entered into a $i75.0 million
term loan agreement with a SOFR-based interest rate and a maturity date of November 1, 2023. The agreement contains customary covenants and provisions, including a covenant of the Company not to permit, at any time, the ratio of total debt to total capitalization to be greater than i65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
On
May 3, 2023, the Company's board of directors approved the separation and the distribution of approximately i90 percent of the issued and outstanding shares of Knife River Holding Company to the Company's stockholders. Stockholders of the Company will receive one share
of Knife River Holding Company common stock for every four shares of the Company's common stock held on May 22, 2023, the record date for the distribution. The Company will retain approximately i10 percent of Knife River Holding Company's common stock immediately following the separation with the intent to dispose of such shares within twelve months after
the separation. Prior to completing the separation, the Company may adjust the percentage of Knife River Holding Company common stock to be distributed to the Company's stockholders and retained by the Company in response to market and other factors. The separation is expected to be complete May 31, 2023, subject to certain conditions, including the SEC declaring the registration statement on Form 10 for Knife River Holding Company to be effective.
Item
2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company is Building a Strong America® by providing essential infrastructure and services. The Company and its employees work hard to keep the economy of America moving with the products and services provided, which include powering, heating and connecting homes, factories, offices and stores; and building roads, highways, data infrastructure and airports. The Company is authorized to conduct business in nearly every state in the United States and during peak construction season has employed over 16,800 employees. The
Company's organic investments are strong drivers of high-quality earnings and continue to be an important part of the Company's growth. Management believes the Company is well positioned in the industries and markets in which it operates.
Strategic Initiatives As part of the Company's continuous review of its business, the Company announced strategic initiatives in 2022 that are expected to enhance its value. The Company incurred costs in connection with the announced strategic initiatives
in 2022 and 2023, as noted in the Business Segment Financial and Operating Data section, and expects to continue to incur these costs until the initiatives are completed.
On August 4, 2022, the Company announced that its board of directors approved a plan to pursue the separation of Knife River, the construction materials and contracting segment, from the Company. The separation will result in two independent, publicly traded companies, MDU Resources Group, Inc. and Knife River Holding Company, and is expected to be completed on May 31, 2023, subject to certain conditions, including the SEC declaring the Registration Statement on Form 10 for Knife River Holding Company
to be effective. On May 3, 2023, the Company's board of directors approved the separation and the distribution of approximately 90 percent of the issued and outstanding shares of Knife River Holding Company to the Company's stockholders. Stockholders of the Company will receive one share of Knife River Holding Company common stock for every four shares of the Company's common stock held on May 22, 2023, the record date for the distribution. The Company will retain
approximately 10 percent of Knife River Holding Company's common stock immediately following the separation with the intent to dispose of such shares within twelve months after the separation. Prior to completing the separation, the Company may adjust the percentage of Knife River Holding Company common stock to be distributed to the Company's stockholders and retained by the Company in response to market and other factors. The separation of Knife River is planned as a tax-free spinoff transaction to the Company’s stockholders for U.S. federal income tax purposes. More information on the separation and distribution can be found within the Form
10, which is not incorporated by reference herein.
On November 3, 2022, the Company announced its intention to create two pure-play publicly traded companies, one focused on regulated energy delivery and the other on construction materials, and that, to achieve this future structure, the Company's board of directors authorized management to commence a strategic review process of MDU Construction Services. The strategic review is underway and the Company anticipates completing the strategic review during the second quarter of 2023. For more information on the strategic initiatives,
see Part II, Item IA. Risk Factors in this quarterly report, Part 1, Item 1A. Risk Factors in the 2022 Annual Report and subsequent filings with the SEC.
Market Trends While recent banking and economic issues has created some disruption in the commercial paper market, the Company has not experienced liquidity issues. Further, the Company has the ability to borrow against the revolving credit facilities of Centennial and Montana-Dakota, providing the Company with flexibility in the current commercial paper market. The Company continues to monitor financial services disruptions
but does not have any material exposure to recently distressed financial institutions. Rising interest rates have resulted in and will likely continue to result in higher borrowing costs on new debt, resulting in impacts to the Company's asset valuations and negatively impacting the purchasing power of its customers.
The Company continues to manage the inflationary pressures experienced throughout the United States, including the impact that inflation, rising interest rates, commodity price volatility and supply chain disruptions may have on its business and customers and proactively looks for ways to lessen the impact to its business. The Company has continued to evaluate its businesses
and has increased pricing for its products and services where possible. The ability to raise selling prices to cover higher costs due to inflation are subject to customer demand, industry competition and the availability of materials, among other things.
For more information on possible impacts of these trends to the Company's businesses, see the Outlook for each segment below and Part I, Item 1A. Risk Factors in the 2022 Annual Report.
Forward-Looking Statements
The following sections contain forward-looking statements within the meaning of Section 21E of the Exchange Act. Forward-looking statements are all statements other than statements of historical
fact, including without limitation those statements that are identified by the words "anticipates,""estimates,""expects,""intends,""plans,""predicts" and similar expressions, and include statements concerning plans, trends, objectives, goals, strategies, future events, including the separation of Knife River or the proposed structure of two pure-play publicly traded companies, future events or performance, and underlying assumptions (many of which are based, in turn, upon further assumptions) and other statements that are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature, including statements contained within Business Segment Financial and Operating Data.
Forward-looking
statements involve risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed. The Company's expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including without limitation, management's examination of historical operating trends, data contained in the Company's records and other data available from third parties. Nonetheless, the Company's expectations, beliefs or projections may not be achieved or accomplished and changes in such assumptions and factors could cause actual future results to differ materially.
Any
forward-looking statement contained in this document speaks only as of the date on which the statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances that occur after the date on which the statement is made or to reflect the occurrence of unanticipated events, except as required by law. New factors emerge from time to time, and it is not possible for management to predict all the factors, nor can it assess the effect of each factor on the Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. All forward-looking statements, whether written or oral and whether made by or on behalf of the
Company, are expressly qualified by the risk factors and cautionary statements reported in Part II, Item 1A. Risk Factors in this quarterly report, Part I, Item 1A. Risk Factors in the 2022 Annual Report and subsequent filings with the SEC.
Consolidated Earnings Overview
The following table summarizes the contribution to the consolidated income by each of the Company's business segments.
The Company benefited from increased earnings across the regulated energy delivery and construction services businesses, partially offset by a slightly higher seasonal loss at the construction materials and contracting business. Earnings at the electric business were positively impacted by interim rate relief in certain jurisdictions and lower operating expenses associated with the closure of Units 1 and 2 at Heskett Station. Revenues were higher at the natural gas distribution business due to approved rate relief in Washington and a 4.2 percent increase in retail sales volumes to all customer classes due to colder weather, partially offset by higher operation and maintenance expense. Earnings at the pipeline business increased largely from increased transportation volumes due to a full quarter of
benefit from the North Bakken Expansion project and its increased contracted volume commitments beginning in February 2023. The construction services business saw increased revenues across most sectors, which were partially offset by higher operating costs attributable to inflationary pressures. The construction materials and contracting business reported a higher seasonal loss as a result of unfavorable weather across most regions, particularly in the Pacific region, but was able to increase gross profit largely from increases in average selling prices across its product lines. All of the Company's businesses were impacted by increased interest rates as a result of higher average interest rates, partially offset by higher investment returns of $9.1 million on nonqualified benefit plans. The Company's earnings
were also impacted by costs incurred in 2023 in connection with announced strategic initiatives of $8.3 million, after tax.
A discussion of key financial data from the Company's business segments follows.
The following sections include key financial and operating data for each of the
Company's business segments. Also included are highlights on key growth strategies, projections and certain assumptions for the Company and its subsidiaries and other matters of the Company's business segments.
For information pertinent to various commitments and contingencies, see the Notes to Consolidated Financial Statements. For a summary of the Company's business segments, see Note 17 of the Notes to Consolidated Financial Statements.
Electric
and Natural Gas Distribution
Strategy and challenges The electric and natural gas distribution segments provide electric and natural gas distribution services to customers, as discussed in Note 17. Both segments strive to be top performing utility companies measured by integrity, employee safety and satisfaction, customer service and stockholder return. The segments provide safe, reliable, competitively priced and environmentally responsible energy service to customers while focusing on growth and expansion opportunities within and beyond its existing territories. The Company is focused on cultivating organic growth while managing operating costs and monitoring opportunities for these segments to retain, grow and expand their customer base through extensions of existing operations, including building and upgrading electric generation,
transmission and distribution, and natural gas systems, and through selected acquisitions of companies and properties with similar operating and growth objectives at prices that will provide stable cash flows and an opportunity to earn a competitive return on investment. The continued efforts to create operational improvements and efficiencies across both segments promotes the Company's business integration strategy. The primary factors that impact the results of these segments are the ability to earn authorized rates of return; weather; climate change laws, regulations and initiatives; competitive factors in the energy industry; population growth; and economic conditions in the segments' service areas.
The electric and natural gas distribution segments are subject to extensive regulation in the jurisdictions where they conduct operations with
respect to costs, timely recovery of investments and permitted returns on investment. The Company is focused on modernizing utility infrastructure to meet the varied energy needs of both its customers and communities while ensuring the delivery of safe, reliable, affordable and environmentally responsible energy. The segments continue to invest in facility upgrades to be in compliance with existing and known future regulations. To assist in the reduction of regulatory lag in obtaining revenue increases to align with increased investments, tracking mechanisms have been implemented in certain jurisdictions. The Company also seeks rate adjustments for operating costs and capital investments, as well as reasonable returns on investments, not covered by tracking mechanisms. For more information on the
Company's tracking mechanisms and recent rate cases, see Note 19 and the 2022 Annual Report.
These segments are also subject to extensive regulation related to certain operational and environmental compliance, cybersecurity, permit terms and system integrity. Both segments are faced with the ongoing need to actively evaluate cybersecurity processes and procedures related to its transmission and distribution systems for opportunities to further strengthen its cybersecurity protections. Within the past year, there have been cyber and physical attacks within the energy industry on infrastructure, such as substations, and the Company continues to evaluate the safeguards implemented to protect its electric and natural gas utility systems. Implementation of enhancements and additional requirements to protect the
Company's infrastructure is ongoing.
To date, many states have enacted and others are considering, mandatory clean energy standards requiring utilities to meet certain thresholds of renewable and/or carbon-free energy supply. The current presidential administration has made climate change a focus, as further discussed in the Outlook section. Over the long-term, the Company expects overall electric demand to be positively impacted by increased electrification trends, including electric vehicle adoption, as a means to address economy-wide carbon emission concerns and changing customer conservation patterns. Recently, MISO and NERC announced concerns with reliability of the electric grid due to capacity shortages, which has resulted from rapid expansion of renewables and rapid reduction of baseload resources such as coal, while load growth has
increased faster than expected. MISO received FERC approval of a seasonal resource adequacy construct and accreditation process, versus the previous annual summer peak capacity requirement process. These changes have not had a significant impact on the capacity requirements for Montana-Dakota. The Company will continue to monitor the progress of these changes and assess the potential impacts they may have on its stakeholders, business processes, results of operations, cash flows and disclosures.
Revenues are impacted by both customer growth and usage, the latter of which is primarily impacted by weather, as well as impacts associated with commercial and industrial slow-downs, including economic recessions, and energy efficiencies. 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 residential and commercial customers. Average consumption among both electric and natural gas customers has tended to decline as more efficient appliances and furnaces are installed, and as the Company has implemented conservation programs. Natural gas weather normalization and decoupling mechanisms in certain jurisdictions have been implemented to largely mitigate the effect that would otherwise be caused by variations in volumes sold to these customers due to weather and changing consumption patterns on the Company's distribution margins.
In December 2022 and January 2023, natural gas prices significantly increased across the Pacific Northwest from multiple price-pressuring events including wide-spread below-normal
temperatures and higher natural gas consumption; reduced natural gas flows due to pipeline constraints, including maintenance in West Texas; and historically low regional natural gas storage levels. As of March 2023, natural gas prices have stabilized. The higher natural gas prices in December 2022 and January 2023 impacted both
Intermountain and Cascade, both of which borrowed short-term debt of $125.0 million and $150.0 million, respectively, in January 2023 to finance the increased natural gas costs. To assist in the recovery of the higher natural gas costs, Intermountain filed an out-of-cycle purchased gas adjustment with the IPUC that was effective February
1, 2023. In March and April 2023, Intermountain repaid $20.0 million and $30 million, respectively, of the $125.0 million short-term debt.
The Company continues to proactively monitor and work with its manufacturers to reduce the effects of increased pricing and lead times on delivery of certain raw materials and equipment used in electric generation, transmission and distribution system and natural gas pipeline projects. Long lead times are attributable to increased demand for steel products from pipeline companies as they continue pipeline system safety and integrity replacement projects driven by PHMSA regulations, as well as delays in the manufacturing and shipping of electrical equipment as a result of the lingering effects of the COVID-19 pandemic, staffing shortages across multiple industries and global conflicts. These segments have
experienced delays and inflationary pressures, including increased costs related to purchased natural gas and capital expenditures. The Company has been able to minimize the effects by working closely with suppliers or obtaining additional suppliers, as well as modifying project plans to accommodate extended lead times and increased costs. The Company expects these delays and inflationary pressures to continue.
The ability to grow through acquisitions is subject to significant competition and acquisition premiums. In addition, the ability of the segments to grow their service territory and customer base is affected by regulatory constraints, the economic environment of the markets served, population changes and competition from other energy providers and fuels.
The construction of new electric generating facilities, transmission lines and other service facilities is subject to increasing costs and lead times, extensive permitting procedures, and federal and state legislative and regulatory initiatives, which may necessitate increases in electric energy prices. As the industry continues to expand the use of renewable energy sources, the need for additional transmission infrastructure is growing. As part of MISO's long range transmission plan, in August 2022, the Company announced its intent to develop, construct and co-own an approximately 95 mile 345-kV transmission line with Otter Tail Power Company in central North Dakota.
Earnings overview - The following information summarizes the performance of the electric segment.
Average
cost of electric fuel and purchased power per kWh
$
.025
$
.027
Three Months Ended March 31, 2023, Compared to Three Months Ended March 31, 2022 Electric earnings increased $5.3 million as a result of:
•Revenue increased $2.0 million.
◦Largely due to:
▪Interim rate relief of $3.1 million in certain jurisdictions.
▪Higher
renewable tracker revenues of $600,000 associated with lower production tax credits offset in expense, as described below.
▪Higher per unit average rates of $500,000, largely related to block rates in certain jurisdictions.
▪Higher retail sales volumes of 3.3 percent attributable to commercial and industrial customers.
◦Partially offset by lower fuel and purchased power costs of $1.9 million recovered in customer rates and offset in expense, as described below.
•Electric fuel and purchased power decreased $1.9 million, largely the result of lower commodity costs, including recovery of fuel clause adjustments, partially offset by higher retail sales volumes.
•Operation
and maintenance decreased $900,000.
◦Largely the result of:
▪Reduced costs of $700,000 for straight time payroll and materials due to the closure of Units 1 and 2 at Heskett Station.
▪Decreased contract services of $500,000, primarily lower transmission expense offset in part by higher Big Stone Station costs.
◦Partially offset by increased costs of $400,000 for vehicles and equipment.
•Depreciation, depletion and amortization decreased $1.3 million.
◦Primarily
due to decreased amortization of plant retirement and closure costs of $1.5 million resulting from an extension to the recovery period for these costs, which are recovered in operating revenues, as discussed in Note 12.
◦Partially offset by increased property, plant and equipment balances, primarily as a result of transmission projects placed in service to improve reliability and update aging infrastructure.
•Taxes, other than income were comparable to the same period in the prior year.
•Other income (expense) increased $1.5 million, primarily resulting from higher returns on the Company's nonqualified benefit plan investments of $1.9 million, as discussed in Note 14, offset in
part by the absence of AFUDC equity due to higher average short-term debt balance.
•Interest expense decreased $300,000 as a result of higher AFUDC debt, largely due to higher rates, partially offset by higher average interest rates and debt balances.
•Income tax benefit decreased $2.5 million, largely due to higher income before income taxes and lower production tax credits of $800,000 driven by lower wind production.
Three Months Ended March 31, 2023, Compared to Three Months Ended March 31, 2022 Natural gas distribution's earnings increased $2.6 million as a result
of:
◦Higher purchased natural gas sold of $104.0 million recovered in customer rates that was offset in expense, as described below, partially offset by $2.0 million of natural gas cost sharing in Oregon.
◦Increased revenue-based taxes recovered in rates of $4.6 million that were offset in expense, as described below.
◦Approved rate relief in Washington of $3.7 million, which includes the excess deferred income tax tariff settlement of $1.1 million, as discussed in Note 19.
◦A 4.2 percent increase in retail sales volumes to all customer classes due to
colder weather, partially offset by weather normalization and decoupling mechanisms of $2.1 million in certain jurisdictions.
•Purchased natural gas sold increased $104.0 million, primarily due to higher natural gas costs of $91.7 million as a result of higher market prices, including the higher recovery of purchased gas adjustments. Purchased natural gas sold was also impacted by higher volumes of natural gas purchased of $12.3 million due to increased retail sales volumes.
•Operation and maintenance increased $3.1 million.
◦Largely
resulting from:
▪Higher payroll-related costs of $2.4 million, primarily higher straight time costs of $1.6 million and higher health care costs.
▪Higher costs of $1.0 million associated with vehicles and equipment.
•Depreciation, depletion and amortization increased $1.0 million, primarily resulting from growth and replacement projects placed in service, partially offset by lower depreciation rates in certain jurisdictions.
•Taxes, other than income increased $4.8 million, largely from higher revenue-based taxes which are recovered in rates.
•Other income (expense) increased $5.3 million driven by higher interest income
of $2.9 million, largely related to higher purchased gas costs, and higher returns on the Company's nonqualified benefit plans of $2.8 million. These increases were offset in part by higher pension and postretirement expense.
•Interest expense increased $4.6 million, primarily from higher short-term and long-term debt balances from debt issued in 2023 and 2022 and higher interest rates, partially offset by higher AFUDC debt of $800,000 due to higher rates.
•Income tax expense was comparable to the same period in the prior year.
Outlook In 2022, the Company experienced rate base growth of 7.8 percent and
expects these segments will grow rate base by approximately 6 percent to 7 percent annually over the next five years on a compound basis. Operations are spread across eight states where the Company expects customer growth to be higher than the national average. In 2022, these segments experienced retail customer growth of approximately 1.6 percent and the Company expects customer growth to continue to average 1 percent to 2 percent per year. This customer growth, along with system upgrades and replacements needed to supply safe and reliable service, will require investments in new and replacement electric and natural gas systems.
These segments are exposed to energy price volatility and may be impacted by changes in oil and natural gas exploration and production
activity. Rate schedules in the jurisdictions in which the Company's natural gas distribution segment operates contain clauses that permit the Company to file for rate adjustments for changes in the cost of purchased natural gas. Although changes in the price of natural gas are passed through to customers and have minimal impact on the Company's earnings, the natural gas distribution segment's customers benefit from lower natural gas prices through the Company's utilization of storage and fixed price contracts. In 2022, the
Company experienced increased natural gas prices across its service areas, and in January 2023, experienced higher natural gas prices in the Pacific Northwest, as previously discussed in Strategy and Challenges. As a result, the Company has filed an out-of-cycle cost of gas adjustment in Idaho to assist in the timely recovery of these costs. The Company will continue to monitor natural gas prices, as well as oil and natural gas production levels.
In May 2022 the Company began construction of Heskett Unit 4, an 88-MW simple-cycle natural gas-fired combustion turbine peaking unit at the existing Heskett Station near Mandan, North Dakota, with an expected in service date in the
summer of 2023.
The Company is one of four owners of Coyote Station and cannot make a unilateral decision on the plant's future; therefore, the Company could be negatively impacted by decisions of the other owners. In September 2021, Otter Tail Power Company filed its 2022 Integrated Resource Plan in Minnesota and North Dakota, which included its intent to start the process of withdrawal from its 35 percent ownership interest in Coyote Station with an anticipated exit from the plant by December 21, 2028. In March 2023, Otter Tail Power Company filed its 2023 Integrated Resource Plan, which differs from the 2022 filing by supporting retention of Coyote Station in its generation portfolio as long as it is not required
to make major capital investments in the plant. Otter Tail Power Company maintains that continuous operation of the facility would be beneficial in meeting MISO's new minimum capacity planning requirements, the Minnesota Clean Energy Law and other statutes and regulations. The joint owners continue to collaborate in analyzing data and weighing decisions that impact the plant and its employees as well as each company's customers and communities served. Further state implementation of pollution control plans to improve visibility at Class I areas, such as national parks, under the EPA's Regional Haze Rule could require the owners of Coyote Station to incur significant new costs. If the owners decide to incur such costs, the costs could, dependent on determination by state regulatory commissions on approval to recover such costs from customers, negatively impact the Company's results of operations,
financial position and cash flows. The NDDEQ submitted its state implementation plan to the EPA in August 2022 and expects a decision on the plan sometime in 2023. The plan, as submitted by the NDDEQ, does not require additional controls for any units in North Dakota, including Coyote Station.
The labor contract at Intermountain with the UA, as reported in Items 1 and 2 - Business Properties - General in the 2022 Annual Report, has been ratified and is effective through March 31, 2027.
Legislation and rulemaking The Company continues to monitor legislation and rulemaking related to clean energy standards that may impact its segments. Below
are some of the specific legislative actions the Company is monitoring.
•The current presidential administration is considering changes to the federal Clean Air Act, some of which were amended by the previous presidential administration. The content and impacts of the changes under consideration are uncertain and the Company continues to monitor for potential actions by the EPA.
•In Oregon, the Climate Protection
Program Rule was approved in December 2021, which requires natural gas companies to reduce GHG emissions 50 percent below the baseline by 2035 and 90 percent below the baseline by 2050. Each year, compliance instruments will be distributed to the Company by the Oregon Department of Environmental Quality at no cost and will decline annually in step with the reductions from baseline. The Company intends to meet its obligations through surrendering no cost emissions allowances and will fill remaining compliance obligations by investing in additional customer conservation and energy efficiency programs, purchasing community climate investment credits, and purchasing low carbon fuels such as renewable natural gas. The Company expects
the compliance costs for these regulations to be recovered through customer rates. Due to timing of regulatory recovery, future compliance obligation purchases could impact the Company's operating cash flow. For more information about this rule and associated compliance costs, see Items 1 and 2 - Business Properties in the 2022 Annual Report. Cascade's draft 2023 Oregon integrated resource plan projects customer bills could increase substantially compared to costs included in customers' current bills as a result of the legislation. Projected customer bill impacts are estimates, subject to change as legislation is implemented and compliance begins, as well as, numerous assumptions used in the complex analysis of integrated resource planning. On September 30, 2022, the
Company filed a request for the use of deferred accounting for costs related to the rule and began deferring those costs. The Company, along with the other two local natural gas distribution companies in Oregon, filed a lawsuit on March 18, 2022, challenging the Climate Protection Program Rule. The lawsuit was filed on behalf of customers as the Company does not believe the rule accomplishes environmental stewardship in the most effective and affordable way possible.
•In Washington, the Climate Commitment Act signed into law in May 2021 requires natural gas distribution companies to reduce overall GHG emissions 45 percent below 1990 levels by 2030, 70 percent below 1990 levels by 2040
and 95 percent below 1990 levels by 2050. As directed by the Climate Commitment Act, in September 2022 the Washington DOE published its final rule on the Climate Commitment Program, which was effective on October 30, 2022, and emissions compliance began on January 1, 2023. The Company must demonstrate that they have met GHG emissions reduction goals through a combination of on-site emissions reductions and the use of approved allowances and offsets. Emissions compliance may be achieved through increased energy efficiency and conservation measures, purchased allowances and offsets, and purchases of low carbon fuels. Emissions allowances are allocated by the Washington DOE to the Company at no cost and additional
allowances are required to be purchased at auction. Auctions for allowances are held quarterly. The Company intends to meet the first compliance period requirements, in part, by purchasing allowances through auction. The Company expects the compliance costs for these regulations will be recovered through customer rates. Due to timing of regulatory recovery, the purchase of allowances could impact the Company's operating cash flow. For more information about this rule and associated compliance costs, see Items 1 and 2 - Business properties in the 2022 Annual Report. Cascade's 2023 Washington integrated resource plan projects customer bills could increase substantially compared to costs included in customers' current bills as
a result of the legislation. Projected customer bill impacts are estimates, subject to change as the legislation is implemented and compliance begins, as well as, numerous assumptions used in the complex analysis of integrated resource planning. On October 14, 2022, the Company filed a request for the use of deferred accounting for costs related to the rule and began deferring those costs. The WUTC approved the deferred accounting order on February 28, 2023.
•On April 22, 2022, the Washington State Building Code Council approved revisions to the state's commercial energy code that will significantly limit the use of natural gas for space and water heating in new and retrofitted
commercial and multifamily buildings and proposed the review of similar restrictions in the future for residential buildings. On November 4, 2022, the Washington State Building Code Council adopted new residential codes requiring gas or electric heat pumps for most new space and water heating installations. The Company continues to assess the impact of these revisions.
•The Company has reviewed the income tax provisions of the IRA signed into law in August 2022, and the Company will continue to evaluate whether any of the new or renewed energy tax credits will provide a benefit.
Strategy and challenges The pipeline segment provides natural gas transportation, underground storage and non-regulated cathodic protection services, as discussed in Note 17. The segment focuses on utilizing its extensive expertise in the design, construction and operation of energy infrastructure and related services to increase market share and profitability through optimization of existing operations, organic growth and investments in energy-related assets within or in close proximity to its current operating areas. The segment focuses on the continual safety and reliability of its systems, which entails building, operating and maintaining safe natural gas pipelines and facilities. The segment continues to evaluate growth opportunities including the expansion of natural gas facilities; incremental pipeline projects; and expansion of energy-related services leveraging on its core competencies. In support of
this strategy, the Company completed the following organic growth projects in 2022:
•In February 2022, the North Bakken Expansion project in western North Dakota was placed in service. The project has capacity to transport 250 MMcf of natural gas per day and can be increased to 625 MMcf per day with additional compression.
•In August 2022, the Line Section 7 Expansion project was placed in service and increased system capacity by 6.7 MMcf per day.
The segment is exposed to energy price volatility which is impacted by the fluctuations in pricing, production and basis differentials of the energy market's commodities. Legislative and regulatory initiatives on increased pipeline safety regulations and environmental
matters such as the reduction of methane emissions could also impact the price and demand for natural gas.
The pipeline segment is subject to extensive regulation related to certain operational and environmental compliance, cybersecurity, permit terms and system integrity. The Company continues to actively evaluate cybersecurity processes and procedures, including changes in the industry's cybersecurity regulations, for opportunities to further strengthen its cybersecurity protections. Implementation of enhancements and additional requirements is ongoing. The segment reviews and secures existing permits and easements, as well as new permits and easements as necessary, to meet current demand and future growth opportunities on an ongoing basis.
The
Company has continued to actively manage the national supply chain challenges being faced by working with its manufacturers and suppliers to help mitigate some of these risks on its business. The segment regularly experiences extended lead times on raw materials that are critical to the segment's construction and maintenance work which could delay maintenance work and construction projects potentially causing lost revenues and/or increased costs. The Company is partially mitigating these challenges by planning for extended lead times further in advance. The segment is also currently experiencing inflationary pressures with increased raw material costs. The Company expects supply chain challenges and inflationary pressures to continue in 2023.
The segment focuses
on the recruitment and retention of a skilled workforce to remain competitive and provide services to its customers. The industry in which it operates relies on a skilled workforce to construct energy infrastructure and operate existing infrastructure in a safe manner. A shortage of skilled personnel can create a competitive labor market which could increase costs incurred by the segment. Competition from other pipeline companies can also have a negative impact on the segment.
Earnings overview - The following information summarizes the performance of the pipeline segment.
Three
Months Ended March 31, 2023, Compared to Three Months Ended March 31, 2022Pipeline earnings increased $1.0 million as a result of:
•Revenues increased $3.7 million, primarily driven by increased transportation volumes, largely due to a full first quarter of benefit from the North Bakken Expansion project that was placed in service in February 2022, as well as increased contracted volume commitments beginning in February 2023. The Company also benefited from slightly higher storage-related revenues, partially offsetting these increases were non-renewal of certain contracts.
•Operation
and maintenance increased $2.1 million.
◦Primarily from:
▪Higher payroll-related costs of $800,000.
▪Higher legal costs of $500,000, largely due to the pending rate case.
▪Higher other costs, including materials and contract services.
•Depreciation, depletion and amortization increased $600,000 due to increased property, plant and equipment balances, largely related to the North Bakken Expansion project in service for the full quarter, as previously discussed.
•Taxes,
other than income were comparable to the same period in the prior year.
•Other income increased $600,000, driven primarily by higher returns of $1.0 million on the Company's nonqualified benefit plan investments, partially offset by lower AFUDC as a result of the completion of the North Bakken Expansion project placed in service in February 2022.
•Interest expense increased $800,000, primarily from higher average interest rates and higher debt balances to fund capital expenditures.
•Income tax expense was comparable to the same period in the prior year.
Outlook The
Company continues to monitor and assess the potential impacts of two FERC draft policy statements issued in the first quarter of 2022. One is the Updated Certificate of Policy Statement, which describes how the FERC will determine whether a new interstate natural gas transportation project is required by public convenience and necessity. It includes increased focus on a project's purpose and need and the environmental impacts; as well as impacts on landowners and environmental justice communities. The second draft policy statement, the Interim GHG Policy Statement, explains how the FERC will assess the impacts of natural gas infrastructure projects on climate change in its reviews under the National Environmental Policy Act and Natural Gas Act.
The Company continues to monitor, evaluate and implement additional GHG emissions reduction strategies,
including increased monitoring frequency and emission source control technologies to minimize potential risk.
The EPA recently proposed additional rules to update, strengthen and expand standards intended to significantly reduce GHG emissions and other air pollutants from the oil and natural gas industries. The standards will apply to natural gas compressors, pneumatic controllers and pumps, fugitive emissions components and super-emitter events. The EPA projects the final rules will be issued in August 2023. Additionally, the EPA anticipates revising the current GHG reporting rules to incorporate provisions in the IRA. These revisions are anticipated to be issued later this year. The Company continues to monitor and assess the proposed rules and the potential impacts they may have on its business processes, current and future projects, results
of operations and disclosures.
The Company has continued to experience the effect of associated natural gas production in the Bakken, which has provided opportunities for organic growth projects and increased demand. The completion of organic growth projects has contributed to higher volumes of natural gas the Company transports through its system. Associated natural gas production in the Bakken fell during the COVID-19 pandemic delaying previously forecasted production growth. Natural gas production has rebounded to pre-pandemic levels and drilling rig activities have increased, and the Company expects continued gradual increases over the next 2 years. The production delay, along
with long-term contractual commitments on the North Bakken Expansion project placed in service in February 2022, has negatively impacted customer renewals of certain contracts. Bakken natural gas production outlook remains positive with continued growth expected due to new oil wells and increasing gas to oil ratios.
Increases in national and global natural gas supply has moderated pressure on natural gas prices and price volatility. While the Company believes there will continue to be varying pressures
on natural gas production levels and prices, the long-term outlook for natural gas prices continues to provide growth opportunity for industrial supply-related projects and seasonal pricing differentials provide opportunities for natural gas storage services.
The Company continues to focus on improving existing operations and growth opportunities through organic projects in all areas in which it operates, which includes additional projects with local distribution companies, Bakken area producers and industrial customers in various stages of development.
In July 2021, the Company announced plans for a natural gas pipeline expansion project in eastern North Dakota. The Wahpeton Expansion project consists of approximately
60 miles of pipe and ancillary facilities and is designed to increase capacity by 20 MMcf per day, which is supported by long-term customer agreements with Montana-Dakota and its utility customers. Construction is expected to begin in early 2024, depending on regulatory approvals, with an anticipated completion date later in 2024. On May 27, 2022, the Company filed with FERC its application for the project and received FERC's final environmental impact statement in April 2023.
On September 19, 2022, the Company filed with the FERC its prior notice application for its 2023 Line Section 27 Expansion project. This project consists of a new compressor station and ancillary
facilities and is designed to increase capacity by 175 MMcf per day, which is supported by a long-term customer agreement. Construction is expected to begin in the second quarter of 2023 with an anticipated completion date in late 2023.
On December 22, 2022, the Company filed with the FERC its prior notice application for its Grasslands South Expansion project. This project consists of approximately 15 miles of pipe in western North Dakota, utilizing existing capacity on its Grasslands Subsystem to a new connection with Big Horn Gas Gathering, LLC in northeastern Wyoming and ancillary facilities in North Dakota and Wyoming. A long-term customer agreement supports a design for incremental capacity of 94 MMcf per day. Construction is expected to begin in the second quarter of 2023 with an anticipated
completion date in late 2023.
On March 6, 2023, the Company filed with the FERC its prior notice application for its Line Section 15 Expansion project. Long-term customer agreements support a design for incremental capacity of 25 MMcf per day. This project consists of additional compression, uprating operational pressure of approximately 23 miles of pipe in western South Dakota and additional ancillary facilities. Construction is expected to begin in the second quarter of 2023, pending regulatory approvals, with an anticipated completion date in late 2023.
See Capital Expenditures within this section for information on the expenditures related to these growth projects.
Construction
Materials and Contracting
Strategy and challenges The segment is a leading aggregates-based construction materials and contracting service provider in the United States, as discussed in Note 17. The segment focuses on continued growth and maximizing its vertical integration, leveraging its core values to be a supplier of choice in all its markets. The segment is also focused on its commitment to its stakeholders by operating with integrity and always striving for excellence; development and recruitment of talented employees; sustainable practices to create value for the communities it serves; being the provider of choice in midsize, high-growth markets; strengthening the long-term, strategic aggregate reserve position through available purchase and/or lease opportunities in existing and new geographies; and enhancing its supply chain to provide reliable, timely and efficient services to its end customers. As previously
discussed, the Company is pursuing a tax-free spinoff of the construction materials and contracting segment, and the separation is expected to be completed in May of 2023.
The segment is one of the leading producers of crushed stone and sand and gravel, and continues to strategically manage its aggregate reserves, as well as take further advantage of being vertically integrated. The segment's vertical integration allows it to manage operations from aggregate mining to final lay-down of concrete and asphalt, with control of and access to permitted aggregate reserves being significant. The Company's aggregate reserves are naturally declining and as a result, the Company seeks permit
expansion and acquisition opportunities to replace the reserves.
The segment's management continually monitors its margins and has been proactive in applying strategies to address the inflationary impacts seen across the United States. The Company has increased its product pricing and continues to implement cost savings initiatives to mitigate these effects on the segment's gross margin. Due to existing contractual provisions, there can be a lag between the announced price increases and the time when they can be fully recognized. The Company will continue to evaluate further price increases on a regular cadence in an attempt to stay ahead of inflationary pressures and enhance stockholder value.
The segment operates in
geographically diverse and competitive markets yet strives to maximize efficiencies, including transportation costs and economies of scale, to maintain strong margins. The segment's margins can experience negative pressure from competition, as well as impacts of the volatility in the cost of raw materials such as fuel, asphalt oil, cement and steel, with fuel and asphalt oil costs having the most significant impact on the segment's results. Such volatility and inflationary pressures may continue to have an impact on the segment's margins, including fixed-price construction contracts that are particularly
vulnerable
to the volatility of energy and material prices. These increases are partially offset by mitigation measures implemented by the Company, including price increases, escalation clauses in contracting services contracts, pre-purchased materials and other cost savings initiatives. While the Company has experienced some supply chain constraints, it continues to have good relationships with its suppliers and has not experienced any material adverse impacts of shortages or delays on materials. Other variables that can impact the segment's margins include adverse weather conditions, the timing of project starts or completions and declines or delays in new and existing projects due to the cyclical nature of the construction
industry and governmental infrastructure spending. Accordingly, operating results in any particular period may not be indicative of the results that can be expected for any other period.
The segment's operations can also be significantly impacted by favorable and unfavorable weather conditions. Unseasonably wet and/or cold weather in the states it operates in can delay the start to construction season or cause temporary delays on specific projects, while unseasonably dry or warm weather in the states it operates in can allow for an early start to the construction season or allow for early completions on specific projects. Either of these conditions can impact both its construction materials sales and contracting services revenues. In early 2023, the western part of the United States had near record levels of precipitation, which impacted the segment's results. Other variables that can impact the segment’s margins include the
timing of project starts or completions, and declines or delays in new and existing projects due to the cyclical nature of the construction industry. Accordingly, operating results in any particular period may not be indicative of the results that can be expected for any other period.
As a people first company, the segment continually takes steps to address the challenge of recruitment and retention of employees. In order to help attract new workers to the construction industry and enhance the skills of its current employees, the Company has constructed and operates a corporate-wide state-of-the-art training facility located in the Pacific Northwest. The training facility offers hands-on training for heavy equipment operators and truck drivers, as well as leadership and safety training. Trends in the labor market include an aging workforce and
labor availability issues, and most of the markets the segment operates in have experienced labor shortages, largely truck drivers, causing increased labor-related costs and delays or inefficiencies on projects. The new training facility is expected to help address some of these challenges. The Company continues to monitor the labor markets and assess additional opportunities to enhance and support its workforce. Despite these efforts, the Company expects labor costs to continue to increase based on the increased demand for services and, to a lesser extent, the recent escalated inflationary environment in the United States.
Earnings overview - The following information summarizes the performance of the construction materials and contracting
segment.
*The Company identified certain costs that were reclassified from cost of sales to selling, general and administrative expense of $16.3 million for the three months ended March, 31, 2022. The reclassification had no impact to net income.
*Other
products includes cement, asphalt oil, merchandise, fabric and spreading and other products that individually are not considered to be a major line of business for the segment.
*Average selling price includes freight and delivery and other revenues.
Three Months Ended March 31, 2023, Compared to Three Months Ended March 31, 2022 Construction materials and contracting's seasonal loss increased $1.3 million as a result of:
•Revenuedecreased $2.1 million.
◦Primarily the result of:
▪Ready-mix sales volumes decreased $29.9 million, largely a result of unfavorable weather across most states of operation.
▪Asphalt sales volumes decreased $10.4 million, largely a result of unfavorable weather in the Pacific and Northwest states as well as the absence of impact projects and less available paving work in certain regions.
▪Aggregates sales volumes decreased $1.8 million, largely a result of unfavorable weather in the Pacific and North Central states, partially offset by higher volumes in certain regions due to demand by data center, commercial and residential customers.
◦Partially
offset by:
▪Higher average selling prices across most product lines of nearly $33.0 million, largely in response to inflationary pressures.
▪Contracting revenues increased slightly due to more available work in certain regions being mostly offset by delays in the Pacific states due to unfavorable weather.
•Gross profit increased $3.0 million, primarily due to higher average selling prices across most product lines as well as cost savings initiatives, partially offset by cement, labor, natural gas and diesel costs which increased year over year on a cost-per-unit basis due to inflation. Gross profit was also impacted by unfavorable weather in certain regions, as previously discussed, resulting in less hours worked.
•Selling,
general and administrative expense increased $3.0 million.
◦Largely the result of:
▪Increased payroll-related costs of $3.9 million higher, largely due to inflationary pressures, offset in part by decreased health care costs of $3.1 million resulting from a change in accounting election.
▪Increased professional services of $900,000, primarily for one-time strategic initiative costs incurred in 2023.
▪Increased expected credit losses of $700,000 associated with an increase in receivable balances over 90 days and absence of bad debt recoveries in 2022.
▪Increased other costs related to corporate costs, insurance
and safety training.
◦Offset in part by higher net gains on asset sales of $1.4 million.
•Other income (expense) increased $2.9 million due to higher returns on the Company's nonqualified benefit plan investments, as discussed in Note 14.
•Interest expense increased $4.3 million the result of higher average interest rates.
•Income tax benefit was comparable
to same period in the prior year.
Outlook In August 2022, the Company announced its intent to separate this segment into a standalone publicly traded company. The separation is expected to result in two independent, publicly traded companies: (1) MDU Resources Group, Inc., the existing company and (2) Knife River, a construction materials and contracting services company. The separation is expected to be completed in May of 2023 and is expected to unlock inherent value within the two companies, which each have unique growth prospects and investment opportunities. The Company may, at any time and for any reason until the proposed transaction is complete, abandon the separation or modify or change its terms. For a complete discussion of all
the conditions to and the risk and uncertainties associated with the separation and distribution, see Part II, Item IA. Risk Factors in this quarterly report and Part I, Item 1A - Risk Factors in the 2022 Annual Report.
Funding for public projects is dependent on federal and state funding, such as appropriations to the Federal Highway Administration. The American Rescue Plan Act enacted in the first quarter of 2021 provides $1.9 trillion in COVID-19 relief funding for states, schools and local governments. States are beginning to move forward with allocating these funds based on federal criteria and state needs, and in some cases, funding of infrastructure projects could positively impact the segment. Additionally, the bipartisan infrastructure proposal, known as the IRA, was enacted in the fourth quarter of 2021 and is providing long-term opportunities by designating $119 billion for the repair and rebuilding of roads and
bridges across the Company's footprint. In addition, the IRA provides $369 billion in new funding for clean energy programs. These programs include new tax incentives for solar, battery storage and hydrogen development along with funding to expand the production of electric vehicles and the build out of infrastructure to support electric vehicles. In addition to federal funding, 11 out of the 14 states in which the Company operates have implemented their own funding mechanisms for public projects, including projects related to highways, airports and other public infrastructure. The Company continues to monitor the progress of these legislative items.
The segment's vertically integrated
aggregates-based business model provides the Company with the ability to capture margin throughout the sales delivery process. The aggregate products are sold internally and externally for use in other products such as ready-mix concrete, asphaltic concrete and public and private construction markets. The contracting services and construction materials are sold in connection with street, highway and other public infrastructure projects, as well as private commercial, industrial and residential development projects. The public infrastructure projects have traditionally been more stable markets as public funding is more secure during periods of economic decline. The public projects are, however, dependent on federal and state funding such as appropriations to the Federal Highway Administration. Spending on private development is highly dependent on both local and national economic cycles,
providing additional sales during times of strong economic cycles and potential for reductions during recessionary periods.
During 2022, the Company completed an acquisition in the higher-margin materials markets. The Company continues to evaluate additional acquisition opportunities. For more information on the Company's business combinations, see Note 9. In 2022, the Company began upgrading its prestress facility located in Spokane, Washington. The state-of-the-art facility is expected to be completed during the first half of 2023. The facility is expected to be a platform for growth through improved
productivity and quality, which will help meet strong market demand for prefabricated concrete solutions.
The segment's backlog remains strong as it begins to enter its peak construction season. Contracting services backlog was $958.5 million at March 31, 2023, compared to contracting services backlog of $778.0 million at March 31, 2022. A significant portion of the Company's backlog at March 31, 2023, relates to publicly funded projects, largely street and highway construction projects, which are primarily driven by public work projects for state departments of transportation. Period over period increases or decreases in backlog cannot be used as an indicator of future revenues or net income. While
the Company believes the current backlog of work remains firm, prolonged delays in the receipt of critical supplies and materials or continued increases to pricing could result in customers seeking to delay or terminate existing or pending agreements. Factors noted in Part I, Item 1A. Risk Factors in the 2022 Annual Report can cause revenues to be realized in periods and at levels that are different from originally projected.
The labor contracts that the construction materials and contracting services segment were negotiating at December 31, 2022, as reported in Items 1 and 2 - Business Properties - General in the 2022 Annual Report, have been ratified.
Construction
Services
Strategy and challenges The construction services segment provides electrical and mechanical and transmission and distribution specialty contracting services, as discussed in Note 17. The construction services segment focuses on safely executing projects; providing a superior return on investment by building new and strengthening existing customer relationships; ensuring quality service; effectively controlling costs; retaining, developing and recruiting talented employees; growing through organic and strategic acquisition opportunities; and focusing efforts on projects that will permit higher margins while properly managing risk. The growth experienced by the segment in recent years is due in part to the project awards in the markets served and the ability to support national customers in most of the regions in which it operates.
The
construction services segment faces challenges, which are not under direct control of the business, in the markets in which it operates, including those described in Part I, Item 1A. Risk Factors in the 2022 Annual Report. These factors, and those noted below, have caused fluctuations in revenues, gross margins and earnings in the past and are likely to cause fluctuations in the future.
•Revenue mix and impact on margins. The mix of revenues based on the types of services the segment provides can impact margins as certain industries and services provide higher margin opportunities. Larger or more complex projects typically result in higher margin opportunities since the segment assumes a higher degree of performance risk and there is greater utilization of the segment's resources for longer construction timelines. However, larger or more complex projects can have a higher risk
of regulatory and seasonal or cyclical delay. Project schedules fluctuate, which can affect the amount of work performed in a given period. Smaller or less complex projects typically have a greater number of companies competing for them, and competitors at times may be more aggressive when pursuing available work. A greater percentage of smaller scale or less complex work in a given period could negatively impact margins due to the inefficiency of transitioning between a greater number of smaller projects versus continuous production on a few larger projects.
•Project variability and performance. Margins for a single project may fluctuate period to period due to changes in the volume or type of work performed, the pricing structure under the project contract or job productivity. Productivity
and performance on a project can vary period to period based on a number of factors, including unexpected project difficulties; unexpected project site conditions; project location, including locations with challenging operating conditions or difficult geographic characteristics; whether the work is on an open or encumbered right of way; inclement weather or severe weather events; environmental restrictions or regulatory delays; political or legal challenges related to a project; and the performance of third parties. In addition, the type of contract can impact the margin on a project. Under fixed-price contracts, which are more common with larger or more complex projects, the segment assumes risk related to project estimates versus execution. Revenues under this type of contract
can vary, sometimes significantly, from original projects due to additional project complexity; timing uncertainty or extended bidding; extended regulatory or permitting processes; and other factors, which can result in a reduction in profit or losses on a project.
•Subcontractor work and provision of materials. Some work under project contracts is subcontracted out to other companies and margins on subcontractor work is generally lower than work performed by the Company. Increased subcontractor work in a given period may therefore result in lower margins. In addition, inflationary or other pressures may increase the cost of materials under fixed-price contracts
and may result in decreased margins on the project. The Company has worked to implement provisions in project contracts to allow for the pass-through of inflationary costs to customers where feasible and will continue to do so to mitigate the impacts.
The segment's management continually monitors its operating margins and has been proactive in attempting to mitigate the inflationary impacts seen across the United States. The segment is currently experiencing continued labor constraints and changing fuel and material costs, as well as impacts from delays in the national supply chain. The segment is working with suppliers and providers of goods and services in advance of construction to secure pricing and reduce delays for goods and services. The inflationary
costs and national supply chain challenges experienced by the segment have increased costs but have not had significant impacts to the procurement of project materials. Such volatility and inflationary pressures may continue to have an impact on the segment's margins, including fixed-price construction contracts that are particularly vulnerable to the volatility of energy and material prices. These increases are partially offset by mitigation measures implemented by the Company, including escalation clauses in contracts, pre-purchased materials and other cost savings initiatives. The segment also continues recruitment and retention efforts to attract and retain employees. The
Company expects these inflationary pressures and national supply chain challenges to continue. Accordingly, operating results in any particular period may not be indicative of the results that can be expected for any other period.
The need to ensure available specialized labor resources for projects also drives strategic relationships with customers and project margins. Challenges faced by the Company to ensure available specialized labor resources, include an aging workforce and labor availability issues, as well as increasing duration and complexity of customer capital programs. Most of the markets the segment operates in have experienced labor shortages which in some cases have caused increased labor-related costs. The Company continues to monitor the labor
markets and expects labor costs to continue to increase based on increases included in the collective bargaining agreements and, to a lesser extent, the recent escalated inflationary environment in the United States. Due to these and other factors, the Company believes overall customer and competitor demand for labor resources will continue to increase.
Three
Months Ended March 31, 2023, Compared to Three Months Ended March 31, 2022Construction services earnings increased $4.8 million as a result of:
•Revenues increased $201.7 million.
◦Largely due to higher electrical and mechanical workloads as a result of:
▪Higher commercial workloads driven largely by a $126.7 million increase in the hospitality sector and a $49.0 million increase in data center work primarily from the progress on large ongoing projects; partially offset by a $13.0 million decrease in general commercial sector workloads.
▪Higher industrial workloads
in the high-tech and government sectors of $29.1 million and $5.2 million, respectively; partially offset by lower maintenance workloads.
▪Higher institutional workloads, primarily in the healthcare sector of $9.5 million and the education sector of $4.6 million.
▪Higher service workloads of $5.6 million from the repair and maintenance for electrical and mechanical projects.
▪Offset partially by lower renewable workloads of $13.0 million due to the completion of renewable projects.
◦Also contributing were higher utility workloads as a result of increases in storm work of $18.6 million, the underground sector of $5.5 million and the substation sector of $3.4 million; offset by
lower workloads in the electrical sector of $21.4 million and the distribution sector of $4.4 million.
◦Largely due to higher gross profit on electrical and mechanical work in the commercial, industrial and institutional sector of $14.1 million due to higher revenues and project mix, offset partially by lower renewable margins from the absence of higher margin work resulting from the timing of project completions and project starts.
◦Partially offset by:
▪Higher
overall operating costs related to inflationary pressures, including increased labor, subcontractor and equipment costs.
▪Losses of $6.5 million on certain industrial and institutional projects.
▪Lower transmission and distribution margins from the absence of higher margin utility projects as a result of the type of customer projects and lower transportation margins, primarily in the street lighting sector.
•Selling, general and administrative expense increased $3.9 million.
◦Primarily due to:
▪Increased payroll-related costs of $2.0 million due to increased support functions for revenue growth, as previously
discussed.
▪Increased reserve for uncollectible accounts of $800,000 due to economic factors and an increase in receivable balances over 90 days.
▪Increased office expenses of $700,000.
•Other income increased $2.7 million, primarily related to the Company's joint ventures.
•Interest expense increased $2.8 million due to higher working capital needs and higher average interest rates.
•Income tax expense increased $800,000 primarily resulting from an increase in income before income taxes.
Outlook
Funding for public projects is highly dependent on federal and state funding, such as appropriations to the Federal Highway Administration. The American Rescue Plan provides $1.9 trillion in COVID-19 relief funding for states, schools and local government including broadband infrastructure. States are beginning to move forward with allocating these funds based on federal criteria and state needs, and in some cases, funding of infrastructure projects could positively impact the segment. Additionally, the Infrastructure Investment and Jobs Act, was enacted in the fourth quarter of 2021 and is providing long-term opportunities by designating funds for investments for upgrades to electric and grid infrastructure, transportation systems, airports and electric vehicle infrastructure, all industries this segment supports. In addition, the IRA provides $369 billion in new funding for clean energy programs. These programs include new tax incentives for
solar, battery storage and hydrogen development along with funding to expand the production of electric vehicles and the build out of infrastructure to support electric vehicles. The Company will continue to monitor the implementation of these legislative items.
The Company continues to have bidding opportunities in the specialty contracting markets in which it operated in during 2023 as evidenced by the segment's backlog. Although bidding remains highly competitive in all areas, the Company expects the segment's relationship with existing customers, skilled workforce, quality of service and effective cost management will continue to provide a benefit in securing and executing profitable
projects in the future. The Company has also seen rapidly growing needs for services across the electric vehicle charging, wind generation and energy storage markets that complement existing renewable projects performed by the Company.
The construction services segment's backlog at March 31, was as follows:
2023
2022
(In
millions)
Electrical & mechanical
$
1,792
$
1,388
Transmission & distribution
306
280
$
2,098
$
1,668
The increase in backlog at March 31,
2023, as compared to backlog at March 31, 2022, was largely attributable to the new project opportunities that the Company continues to be awarded across its diverse operations, particularly within the commercial, industrial, institutional and transportation markets. The increases in backlog have been partially offset by decreases in the renewable and transportation markets due to the timing of project completions. Period over period increases or decreases in backlog cannot be used as an indicator of future revenues or net income. While the Company believes the current backlog of work remains firm, prolonged delays in the receipt of critical supplies and materials could result in customers seeking to delay or terminate existing or pending agreements.
As of March 31, 2023, the Company has not experienced any material impacts related to customer notices indicating that they no longer wish to proceed with planned projects that have been included in backlog. Additionally, the Company continues to further evaluate potential acquisition opportunities that would be accretive to the Company's backlog and continue to grow the segment's revenues and earnings. Factors noted in Part I, Item 1A. Risk Factors in the 2022 Annual Report can cause revenues to be realized in periods and at levels that are different from originally projected.
Other experienced higher operation and maintenance expense related to the Company's strategic initiatives. Income tax expense was lower due to the benefit from deductible
strategic initiative costs and lower income tax adjustments related to the Company's annualized estimated tax rate.
Also included in Other is insurance activity at the Company's captive insurer and general and administrative costs and interest expense previously allocated to the exploration and production and refining businesses that do not meet the criteria for income (loss) from discontinued operations.
Intersegment Transactions
Amounts presented in the preceding tables will not agree with the Consolidated Statements of Income due to the
Company's elimination of intersegment transactions. The amounts related to these items were as follows:
For
more information on intersegment eliminations, see Note 17.
Liquidity and Capital Commitments
At March 31, 2023, the Company had cash and cash equivalents of $93.2 million and available borrowing capacity of $421.1 million under the outstanding credit facilities of the Company's subsidiaries. In anticipation of the separation of Knife River, the Company is evaluating the refinancing of current
debt facilities, as well as other debt facilities for Knife River as discussed in Note 21. The Company also continues to monitor financial services disruptions but does not have any material exposure to the recently distressed financial institutions. The Company has experienced slight disruptions in the commercial paper market, but with access to its revolving credit agreements the Company has not experienced any liquidity issues. The Company expects to meet its obligations for debt maturing within one year and its other operating and capital requirements from various sources, including internally generated funds; credit facilities and commercial
paper of the Company's subsidiaries, as described in Capital resources; and issuance of debt and equity securities if necessary.
Components of net cash provided by (used in) operating activities:
Income from continuing operations
$
38.3
$
31.7
$
6.6
Adjustments to reconcile net income to net cash provided by operating activities
89.0
78.9
10.1
Changes
in current assets and liabilities, net of acquisitions:
Receivables
15.0
(5.7)
20.7
Inventories
(40.9)
(44.1)
3.2
Other current assets
(58.3)
34.5
(92.8)
Accounts
payable
(93.5)
3.0
(96.5)
Other current liabilities
16.7
13.1
3.6
Pension and postretirement benefit plan contributions
(.1)
(.1)
—
Other
noncurrent changes
(9.8)
1.1
(10.9)
Net cash provided by (used in) operating activities
$
(43.6)
$
112.4
$
(156.0)
The
changes in cash flows from operating activities generally follow the results of operations, as discussed in Business Segment Financial and Operating Data, and are affected by changes in working capital. The increase in cash flows used in operating activities in the previous table was primarily driven by the payment of increased natural gas costs and timing of collection from customers at the natural gas distribution business, partially offset by the associated deferred taxes, as well as the purchase of environmental allowances in 2023, as discussed in Note 13. Higher working capital needs resulting from fluctuations in job activity at the construction services business also contributed to the increase. Partially offsetting the increase in cash flows used in operating activities was lower working capital needs due to higher collection of accounts receivable balances at the construction materials and contracting business.
Components of net cash used in investing activities:
Capital expenditures
$
(154.0)
$
(150.3)
$
(3.7)
Acquisitions, net of cash acquired
—
(.5)
.5
Net
proceeds from sale or disposition of property and other
7.2
4.5
2.7
Investments
(4.2)
(4.4)
.2
Net cash used in investing activities
$
(151.0)
$
(150.7)
$
(.3)
The
cash used in investing activities in the previous table remained consistent as compared to 2022. Increased capital expenditures at the natural gas distribution and construction services businesses were offset in part by decreased capital expenditures at the pipeline business related to the North Bakken Expansion project. Net proceeds from the sale or disposition of property at the electric and natural gas distribution businesses increased due to lower costs of removal and higher salvage value on assets.
Components of net cash provided by financing activities:
Issuance
of short-term borrowings
$
275.0
$
100.0
$
175.0
Repayment of short-term borrowings
(20.0)
—
(20.0)
Issuance of long-term debt
175.4
150.0
25.4
Repayment
of long-term debt
(169.9)
(143.6)
(26.3)
Debt issuance costs
(.1)
(.7)
.6
Net proceeds from issuance of common stock
—
(.1)
.1
Dividends
paid
(45.2)
(44.2)
(1.0)
Repurchase of common stock
(4.8)
(7.4)
2.6
Tax withholding on stock-based compensation
(3.1)
(5.0)
1.9
Net
cash provided by financing activities
$
207.3
$
49.0
$
158.3
The increase in cash provided by financing activities in the previous table was primarily due to the issuance of short-term borrowings at the natural gas distribution business to fund higher natural gas costs, as well as increased issuance of long-term debt at the construction services business as a result of higher working capital needs. Partially offsetting these increases were higher commercial paper and short-term debt repayments at the electric and natural gas distribution businesses.
Capital
expenditures
Capital expenditures for the first three months of 2023 and 2022 were $136.7 million and $119.8 million, respectively. Capital expenditures allocated to the Company's business segments are estimated to be approximately $646.4 million for 2023. Capital expenditure estimates have been updated from what was previously reported in the 2022 Annual Report to accommodate project timeline and scope changes made throughout the first quarter of 2023.
The Company has included in the estimated capital expenditures for 2023 multiple organic growth projects at the pipeline business and construction of Heskett Unit 4 at the electric business, as previously discussed in Business Segment Financial and Operating Data, as well as system
upgrades; routine replacements; service extensions; routine equipment maintenance and replacements; buildings, land and building improvements; pipeline and natural gas storage projects; power generation and transmission opportunities, environmental upgrades; and other growth opportunities.
The Company continues to evaluate potential future acquisitions and other growth opportunities that would be incremental to the outlined capital program; however, they are dependent upon the availability of economic opportunities and, as a result, capital expenditures may vary significantly from the estimate previously discussed. The Company continuously monitors its capital expenditures for project delays and changes in economic viability and adjusts as necessary. It is anticipated
that all of the funds required for capital expenditures for 2023 will be funded by various sources, including internally generated funds; credit facilities and commercial paper of the Company's subsidiaries, as described later; and issuance of debt and equity securities if necessary.
The
Company requires significant cash to support and grow its businesses. The primary sources of cash other than cash generated from operating activities are cash from revolving credit facilities, the issuance of long-term debt and the sale of equity securities.
Debt resources
Certain debt instruments of the Company's subsidiaries contain restrictive and financial covenants and cross-default provisions. In order to borrow under the respective debt instruments, the subsidiary companies must be in compliance with the applicable covenants and certain other conditions, all of which the subsidiaries, as applicable, were in compliance with
at March 31, 2023. In the event the subsidiaries do not comply with the applicable covenants and other conditions, alternative sources of funding may need to be pursued. As of March 31, 2023, the Company had investment grade credit ratings at all entities issuing debt. For more information on the covenants, certain other conditions and cross-default provisions, see Part II, Item 8 in the 2022 Annual Report.
(a)The
commercial paper program is supported by a revolving credit agreement with various banks (provisions allow for increased borrowings, at the option of Montana-Dakota on stated conditions, up to a maximum of $225.0 million). At March 31, 2023, there were no amounts outstanding under the revolving credit agreement.
(b)Certain provisions allow for increased borrowings, up to a maximum of $125.0 million.
(c)Outstanding letter(s) of credit reduce the amount available under the credit agreement.
(d)Certain provisions allow for increased borrowings, up to a maximum of $125.0 million.
(e)The commercial paper program is supported by a revolving credit agreement
with various banks (provisions allow for increased borrowings, at the option of Centennial on stated conditions, up to a maximum of $700.0 million). At March 31, 2023, there was $78.4 million outstanding under the revolving credit agreement.
The respective commercial paper programs are supported by revolving credit agreements. While the amount of commercial paper outstanding does not reduce available capacity under the respective revolving credit agreements, Montana-Dakota and Centennial do not issue commercial paper in an aggregate amount exceeding the available capacity under the credit agreements. The commercial paper borrowings may vary during the period, largely the result of fluctuations in working capital
requirements due to the seasonality of certain operations of the Company's subsidiaries.
Total equity as a percent of total capitalization was 52 percent at March 31, 2023 and 54 percent at March 31, 2022 and December 31, 2022. This ratio is calculated as the Company's total equity, divided by the Company's total capital. Total capital is the Company's total debt,
including short-term borrowings and long-term debt due within 12 months, plus total equity. Management believes this ratio is an indicator of how the Company is financing its operations, as well as its financial strength.
MDU Resources Group, Inc. On May 1, 2023, MDU Resources Group, Inc. entered into a $75.0 million term loan agreement with a SOFR-based interest rate and a maturity date of November 1, 2023. The agreement contains customary covenants and provisions, including a covenant of MDU Resources not to permit, at any time, the ratio of total debt to total capitalization to be greater than 65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Cascade
On January 20, 2023, Cascade entered into a $150.0 million term loan agreement with a SOFR-based interest rate and a maturity date of January 19, 2024. The agreement contains customary covenants and provisions, including a covenant of Cascade not to permit, at any time, the ratio of total debt to total capitalization to be greater than 65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Intermountain On January 20, 2023, Intermountain entered into a $125.0 million term loan agreement with a SOFR-based interest rate and a maturity date of January 19, 2024. In March and April 2023, Intermountain repaid $20.0 million and $30
million, respectively, of the outstanding balance. The agreement contains customary covenants and provisions, including a covenant of Intermountain not to permit, at any time, the ratio of total debt to total capitalization to be greater than 65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Centennial On March 18, 2022, Centennial entered into a $100.0 million term loan agreement with a SOFR-based variable interest rate and a maturity date of March 17, 2023. On March
17, 2023, Centennial amended this agreement to extend the maturity date to September 15, 2023. The agreement contains customary covenants and provisions, including a covenant of Centennial not to permit, at any time, the ratio of total debt to total capitalization to be greater than 65 percent. The covenants also include certain restrictions on the sale of certain assets, loans and investments.
Equity Resources
The Company currently has a shelf registration statement on file with the SEC, under which the Company may issue and sell any combination of common stock and debt securities. The
Company may sell such securities if warranted by market conditions and the Company's capital requirements. Any public offer and sale of such securities will be made only by means of a prospectus meeting the requirements of the Securities Act and the rules and regulations thereunder.
In August 2020, the Company amended the Distribution Agreement dated February 22, 2019, with J.P. Morgan Securities LLC and MUFG Securities Americas Inc., as sales agents. This agreement, as amended, allows the offering, issuance and sale of up to 6.4 million shares of the Company's common stock in connection with an "at-the-market" offering.
The common stock may be offered for sale, from time to time, in accordance with the terms and conditions of this agreement. As of March 31, 2023, the Company had capacity to issue up to 3.6 million additional shares of common stock under the "at-the-market" offering program. Proceeds from the sale of shares of common stock under this agreement have been and are expected to be used for general corporate purposes, which may include, among other things, working capital, capital expenditures, debt repayment and the financing of acquisitions.
The Company had no issuances of shares under the "at-the-market" offering program for both the three months ended March 31, 2023
and 2022.
Material cash requirements
There were no material changes in the Company's contractual obligations related to estimated interest payments, purchase commitments, asset retirement obligations and uncertain tax positions for 2023 from those reported in the 2022 Annual Report. For more information on the Company's contractual obligations on long-term debt, operating leases and purchase commitments, see Part II, Item 7 in the 2022 Annual Report.
Material short-term cash requirements of the
Company include repayment of outstanding borrowings and interest payments on those agreements, payments on operating lease agreements, payment of obligations on purchase commitments and asset retirement obligations.
Material long-term cash requirements of the Company include repayment of outstanding borrowings and interest payments on those agreements, payments on operating lease agreements, payment of obligations on purchase commitments and asset retirement obligations.
Defined benefit pension plans
The Company has noncontributory qualified defined benefit pension
plans. Various assumptions are used in calculating the benefit expense (income) and liability (asset) related to these plans, as such costs of providing these benefits bear the risk of changes as they are dependent upon assumptions of future conditions.
There were no other material changes to the Company's qualified noncontributory defined benefit pension plans from those reported in the 2022 Annual Report other than the Company expects to contribute approximately $8.3 million to its pension plans in 2023, largely resulting from an actual decline in asset values decreasing the funded status of the plans. For more information, see Note 18 and Part II, Item 7 in the 2022 Annual Report.
The Company's critical accounting estimates include impairment testing of goodwill; fair values of acquired assets and liabilities under the acquisition method of accounting; regulatory assets expected to be recovered in rates charged to customers; revenue recognized using the cost-to-cost measure of progress for contracts; actuarially determined benefit costs; and tax provisions.
There were no material changes in the Company's critical accounting estimates from those reported in the 2022 Annual Report. For more information on critical accounting estimates, see Part II, Item 7 in the 2022 Annual Report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to the impact of market
fluctuations associated with interest rates and commodity prices. The Company has policies and procedures to assist in controlling these market risks and from time to time has utilized derivatives to manage a portion of its risk.
Interest rate risk
Rising interest rates have resulted in and will likely continue to result in higher borrowing costs on new debt and existing variable interest rate debt. The Company has realized increases in the weighted average interest rates on the commercial paper programs and revolving credit facilities of its subsidiaries of 1.05 percent and 1.73 percent, respectively, from those reported in the 2022 Annual
Report.
There were no material changes to commodity price risk faced by the Company from those reported in the 2022 Annual Report.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act. The Company's disclosure controls and other procedures are designed to provide reasonable assurance that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. The Company's disclosure controls and other procedures are designed to provide reasonable assurance that information required to be disclosed is accumulated and communicated to management, including the Company's chief executive officer and chief financial officer, to allow timely decisions regarding
required disclosure. The Company's management, with the participation of the Company's chief executive officer and chief financial officer, has evaluated the effectiveness of the Company's disclosure controls and other procedures as of the end of the period covered by this report. Based upon that evaluation, the chief executive officer and the chief financial officer have concluded that, as of the end of the period covered by this report, such controls and procedures were effective at a reasonable assurance level.
Changes in internal controls
No change in the Company's
internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended March 31, 2023, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
There were no material changes to the Company's legal proceedings in Part 1, Item 3 - Legal Proceedings in the 2022 Annual Report.
Item 1A. Risk Factors
Please refer to the Company's risk factors that are disclosed in Part I, Item 1A. Risk Factors in the 2022 Annual Report that could be materially harmful to the Company's business, prospects, financial condition or financial results if they occur. At March
31, 2023, there were no material changes to the Company's risk factors provided in Part I, Item 1A. Risk Factors in the 2022 Annual Report other than as set forth below.
The proposed separation of Knife River Holding Company into an independent, publicly traded company is subject to various risks and uncertainties, and may not be completed on the terms or timeline currently contemplated, if at all.
On August 4, 2022, the Company announced its plan to separate Knife River Holding Company, the construction materials and contracting business, from the Company, which would result in two independent,
publicly traded companies, which is expected to occur in May of 2023. The execution of the proposed separation has required and will continue to require significant time and attention from the Company’s senior management and employees, which could disrupt the Company’s ongoing business and adversely affect financial results and results of operations. Further, the Company's employees may be distracted due to the uncertainty regarding their future roles with the Company or Knife River Holding Company pending the consummation of the proposed separation. Additionally, foreseen and unforeseen costs may be incurred in connection with the proposed
separation, including fees such as advisory, accounting, tax, legal, reorganization, debt breakage, restructuring, severance/employee benefit-related, regulatory, SEC filing and other professional services, some of which may be incurred regardless of when the separation occurs. The proposed separation is also complex, and completion of the proposed separation and the timing of its completion will be subject to a number of factors and conditions, including the readiness of the new company to operate as an independent public company and finalization of the capital structure of the new company. Unanticipated developments could delay, prevent or otherwise adversely affect the proposed separation, including, but not limited to, changes in general economic and financial market conditions, material adverse changes in business or industry conditions, unanticipated costs and potential problems or delays in obtaining various regulatory and tax approvals or clearances. In particular,
changes in interest or exchange rates and the effects of inflation could delay or adversely affect the proposed separation, including in connection with any debt financing transactions undertaken in connection with the separation or the terms of any indebtedness incurred in connection therewith. There can be no assurances that the Company will be able to complete the proposed separation on the terms or timeline that was announced, if at all.
The Company's investments
in its subsidiaries comprise the Company's primary assets. The Company depends on earnings, cash flows and dividends from its subsidiaries to pay dividends on its common stock. Regulatory, contractual and legal limitations, as well as their capital requirements, affect the ability of the subsidiaries to pay dividends to the Company and thereby could restrict or influence the Company's
ability or decision to pay dividends on its common stock, which could adversely affect the Company's stock price.
There is no assurance as to the amount, if any, of future dividends to the holding company because the subsidiaries depend on future earnings, capital requirements and financial conditions to fund such dividends. Following the separation of Knife River, the Company's board of directors expects to review its dividend practice with the intent to align payout relative to regulated energy delivery earnings with pure-play peer companies.
(1) Represents
shares of common stock purchased on the open market in connection with the vesting of shares granted pursuant to the Long-Term Performance-Based Incentive Plan.
(2) Not applicable. The Company does not currently have in place any publicly announced plans or programs to purchase equity securities.
Item 4. Mine Safety Disclosures
For information regarding mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Act and Item 104 of Regulation
S-K, see Exhibit 95 to this Form 10-Q, which is incorporated herein by reference.
Item 5. Other Information
None.
Item 6. Exhibits
See the index to exhibits immediately preceding the signature page to this report.
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Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
