UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(mark one)
☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended		September 30, 2020
OR
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to          

Commission File Number: 1-10499

NORTHWESTERN CORP

(Exact name of registrant as specified in its charter)

Delaware			46-0172280
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)
3010 W. 69th Street	Sioux Falls	South Dakota	57108
(Address of principal executive offices)			(Zip Code)

Registrant’s telephone number, including area code: 605-978-2900

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock	NWE	Nasdaq Stock Market LLC

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. Yes x No o

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). Yes x No o

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.

Large Accelerated Filer ☒ Accelerated Filer ☐ Non-accelerated Filer ☐ Smaller Reporting Company ☐ Emerging Growth Company ☐

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. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, Par Value $0.01, 50,581,973 shares outstanding at October 16, 2020

1

NORTHWESTERN CORPORATION

FORM 10-Q

INDEX

		Page
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS		3
PART I. FINANCIAL INFORMATION		4
Item 1.	Financial Statements (Unaudited)	4
	Condensed Consolidated Statements of Income — Three and Nine Months Ended September 30, 2020 and 2019	4
	Condensed Consolidated Statements of Comprehensive Income — Three and Nine Months Ended September 30, 2020 and 2019	5
	Condensed Consolidated Balance Sheets — September 30, 2020 and December 31, 2019	6
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2020 and 2019	7
	Condensed Consolidated Statements of Shareholders’ Equity — Three and Nine Months Ended September 30, 2020 and 2019	8
	Notes to Condensed Consolidated Financial Statements	10
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	53
Item 4.	Controls and Procedures	54
PART II. OTHER INFORMATION		55
Item 1.	Legal Proceedings	55
Item 1A.	Risk Factors	55
Item 6.	Exhibits	64
SIGNATURES		65

2

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

On one or more occasions, we may make statements in this Quarterly Report on Form 10-Q regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events. All statements other than statements of historical facts, included or incorporated by reference in this Quarterly Report, relating to management's current expectations of future financial performance, continued growth, changes in economic conditions or capital markets and changes in customer usage patterns and preferences are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

Words or phrases such as “anticipates,” “may,” “will,” “should,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “targets,” “will likely result,” “will continue” or similar expressions identify forward-looking statements. Forward-looking statements involve risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed. We caution that while we make such statements in good faith and believe such statements are based on reasonable assumptions, including without limitation, management’s examination of historical operating trends, data contained in records and other data available from third parties, we cannot assure you that we will achieve our projections. Factors that may cause such differences include, but are not limited to:

•adverse determinations by regulators, as well as potential adverse federal, state, or local legislation or regulation, including costs of compliance with existing and future environmental requirements, could have a material effect on our liquidity, results of operations and financial condition;

•the impact of extraordinary external events, such as the outbreak of the novel coronavirus (COVID-19) pandemic, on our liquidity, results of operations and financial condition;

•changes in availability of trade credit, creditworthiness of counterparties, usage, commodity prices, fuel supply costs or availability due to higher demand, shortages, weather conditions, transportation problems or other developments, may reduce revenues or may increase operating costs, each of which could adversely affect our liquidity and results of operations;

•unscheduled generation outages or forced reductions in output, maintenance or repairs, which may reduce revenues and increase cost of sales or may require additional capital expenditures or other increased operating costs; and

•adverse changes in general economic and competitive conditions in the U.S. financial markets and in our service territories.

We have attempted to identify, in context, certain of the factors that we believe may cause actual future experience and results to differ materially from our current expectation regarding the relevant matter or subject area. In addition to the items specifically discussed above, our business and results of operations are subject to the uncertainties described under the caption “Risk Factors” which is part of the disclosure included in Part II, Item 1A of this Quarterly Report on Form 10-Q.

From time to time, oral or written forward-looking statements are also included in our reports on Forms 10-K, 10-Q and 8-K, Proxy Statements on Schedule 14A, press releases, analyst and investor conference calls, and other communications released to the public. We believe that at the time made, the expectations reflected in all of these forward-looking statements are and will be reasonable. However, any or all of the forward-looking statements in this Quarterly Report on Form 10-Q, our reports on Forms 10-K and 8-K, our other reports on Form 10-Q, our Proxy Statements on Schedule 14A and any other public statements that are made by us may prove to be incorrect. This may occur as a result of assumptions, which turn out to be inaccurate, or as a consequence of known or unknown risks and uncertainties. Many factors discussed in this Quarterly Report on Form 10-Q, certain of which are beyond our control, will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from forward-looking statements. In light of these and other uncertainties, you should not regard the inclusion of any of our forward-looking statements in this Quarterly Report on Form 10-Q or other public communications as a representation by us that our plans and objectives will be achieved, and you should not place undue reliance on such forward-looking statements.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made on related subjects in our subsequent reports filed with the Securities and Exchange Commission (SEC) on Forms 10-K, 10-Q and 8-K and Proxy Statements on Schedule 14A.

Unless the context requires otherwise, references to “we,” “us,” “our,” “NorthWestern Corporation,” “NorthWestern Energy,” and “NorthWestern” refer specifically to NorthWestern Corporation and its subsidiaries.

3

PART 1. FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS (UNAUDITED)

NORTHWESTERN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(in thousands, except per share amounts)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Revenues
Electric	$	244,155	$	241,237	$	706,718	$	733,933
Gas	36,455		33,599		178,507		195,842
Total Revenues	280,610		274,836		885,225		929,775
Operating Expenses
Cost of sales	68,038		64,227		220,353		235,706
Operating, general and administrative	73,322		76,998		224,042		238,916
Property and other taxes	45,306		44,089		136,786		133,188
Depreciation and depletion	44,289		43,166		134,336		129,766
Total Operating Expenses	230,955		228,480		715,517		737,576
Operating Income	49,655		46,356		169,708		192,199
Interest Expense, net	(23,677)		(23,722)		(72,298)		(71,023)
Other Income (Expense), net	785		(409)		(973)		864
Income Before Income Taxes	26,763		22,225		96,437		122,040
Income Tax Benefit (Expense)	2,703		(555)		5,227		20,098
Net Income	$	29,466	$	21,670	$	101,664	$	142,138
Average Common Shares Outstanding	50,577		50,444		50,551		50,422
Basic Earnings per Average Common Share	$	0.58	$	0.43	$	2.01	$	2.82
Diluted Earnings per Average Common Share	$	0.58	$	0.42	$	2.01	$	2.80
Dividends Declared per Common Share	$	0.60	$	0.575	$	1.80	$	1.725

See Notes to Condensed Consolidated Financial Statements

4

NORTHWESTERN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(in thousands)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Net Income	$	29,466	$	21,670	$	101,664	$	142,138
Other comprehensive income, net of tax:
Foreign currency translation adjustment	(3)		42		90		18
Reclassification of net losses on derivative instruments	113		114		339		339
Total Other Comprehensive Income	110		156		429		357
Comprehensive Income	$	29,576	$	21,826	$	102,093	$	142,495

See Notes to Condensed Consolidated Financial Statements

5

NORTHWESTERN CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share data)

	September 30, 2020		December 31, 2019
ASSETS
Current Assets:
Cash and cash equivalents	$	3,512	$	5,145
Restricted cash	10,497		6,925
Accounts receivable, net	133,115		167,405
Inventories	69,055		53,925
Regulatory assets	47,060		54,432
Other	18,089		13,895
Total current assets	281,328		301,727
Property, plant, and equipment, net	4,860,759		4,700,924
Goodwill	357,586		357,586
Regulatory assets	511,459		484,131
Other noncurrent assets	64,507		66,334
Total Assets	$	6,075,639	$	5,910,702
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of finance leases	$	2,618	$	2,476
Short term borrowings	100,000		—
Accounts payable	74,663		96,690
Accrued expenses	269,722		202,021
Regulatory liabilities	46,513		33,080
Total current liabilities	493,516		334,267
Long-term finance leases	15,463		17,439
Long-term debt	2,188,901		2,233,281
Deferred income taxes	456,735		447,986
Noncurrent regulatory liabilities	468,350		451,483
Other noncurrent liabilities	398,124		387,152
Total Liabilities	4,021,089		3,871,608
Commitments and Contingencies (Note 10)
Shareholders' Equity:
Common stock, par value $0.01; authorized 200,000,000 shares; issued and outstanding 54,144,775 and 50,581,098 shares, respectively; Preferred stock, par value 0.01; authorized 50,000,000 shares; none issued	541		541
Treasury stock at cost	(98,242)		(96,015)
Paid-in capital	1,514,820		1,508,970
Retained earnings	646,650		635,246
Accumulated other comprehensive loss	(9,219)		(9,648)
Total Shareholders' Equity	2,054,550		2,039,094
Total Liabilities and Shareholders' Equity	$	6,075,639	$	5,910,702

See Notes to Condensed Consolidated Financial Statements

6

NORTHWESTERN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

	Nine Months Ended September 30,
	2020		2019
OPERATING ACTIVITIES:
Net income	$	101,664	$	142,138
Items not affecting cash:
Depreciation and depletion	134,336		129,766
Amortization of debt issuance costs, discount and deferred hedge gain	3,604		3,482
Stock-based compensation costs	5,347		4,778
Equity portion of allowance for funds used during construction	(4,503)		(4,118)
Gain on disposition of assets	(26)		(176)
Deferred income taxes	(3,759)		(16,350)
Changes in current assets and liabilities:
Accounts receivable	34,290		36,000
Inventories	(15,130)		(4,353)
Other current assets	(4,194)		(3,332)
Accounts payable	(4,181)		(13,942)
Accrued expenses	67,553		24,945
Regulatory assets	7,372		(17,662)
Regulatory liabilities	13,433		(19,265)
Other noncurrent assets	(6,225)		(5,366)
Other noncurrent liabilities	(7,066)		(2,684)
Cash Provided by Operating Activities	322,515		253,861
INVESTING ACTIVITIES:
Property, plant, and equipment additions	(282,987)		(242,874)
Investment in equity securities	(42)		—
Cash Used in Investing Activities	(283,029)		(242,874)
FINANCING ACTIVITIES:
Treasury stock activity	(1,723)		1,220
Dividends on common stock	(90,260)		(86,343)
Issuance of long-term debt	150,000		150,000
Line of credit repayments, net	(193,000)		(76,000)
Issuance of short-term borrowings	100,000		—
Financing costs	(2,564)		(1,074)
Cash Used in Financing Activities	(37,547)		(12,197)
Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash	1,939		(1,210)
Cash, Cash Equivalents, and Restricted Cash, beginning of period	12,070		15,311
Cash, Cash Equivalents, and Restricted Cash, end of period	$	14,009	$	14,101
Supplemental Cash Flow Information:
Cash paid during the period for:
Income taxes	$	100	$	68
Interest	55,220		55,515
Significant non-cash transactions:
Capital expenditures included in accounts payable	15,986		15,508

See Notes to Condensed Consolidated Financial Statements

7

NORTHWESTERN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

(in thousands, except per share data)

	Three Months Ended September 30,
	Number  of Common Shares	Number of Treasury Shares	Common Stock		Treasury Stock		Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Loss		Total Shareholders' Equity
Balance at June 30, 2019	53,996	3,553	$	540	$	(96,178)	$	1,504,290	$	611,159	$	(9,733)	$	2,010,078
Net income	—	—	—		—		—		21,670		—		21,670
Foreign currency translation adjustment, net of tax	—	—	—		—		—		—		42		42
Reclassification of net losses on derivative instruments from OCI to net income, net of tax	—	—	—		—		—		—		114		114
Stock-based compensation	—	—	—		—		1,169		—		—		1,169
Issuance of shares	—	(3)	—		86		146		—		—		232
Dividends on common stock ($0.575 per share)	—	—	—		—		—		(28,781)		—		(28,781)
Balance at September 30, 2019	53,996	3,550	$	540	$	(96,092)	$	1,505,605	$	604,048	$	(9,577)	$	2,004,524
Balance at June 30, 2020	54,145	3,571	$	541	$	(98,438)	$	1,513,510	$	647,272	$	(9,329)	$	2,053,556
Net income	—	—	—		—		—		29,466		—		29,466
Foreign currency translation adjustment, net of tax	—	—	—		—		—		—		(3)		(3)
Reclassification of net losses on derivative instruments from OCI to net income, net of tax	—	—	—		—		—		—		113		113
Stock-based compensation	—	—	—		—		1,140		—		—		1,140
Issuance of shares	—	(7)	—		196		170		—		—		366
Dividends on common stock ($0.600 per share)	—	—	—		—		—		(30,088)		—		(30,088)
Balance at September 30, 2020	54,145	3,564	$	541	$	(98,242)	$	1,514,820	$	646,650	$	(9,219)	$	2,054,550

8

	Nine Months Ended September 30,
	Number  of Common Shares	Number of Treasury Shares	Common Stock		Treasury Stock		Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Loss		Total Shareholders' Equity
Balance at December 31, 2018	53,889	3,566	$	539	$	(95,546)	$	1,499,070	$	548,253	$	(9,934)	$	1,942,382
Net income	—	—	—		—		—		142,138		—		142,138
Foreign currency translation adjustment, net of tax	—	—	—		—		—		—		18		18
Reclassification of net losses on derivative instruments from OCI to net income, net of tax	—	—	—		—		—		—		339		339
Stock-based compensation	107	25	—		(1,646)		4,744		—		—		3,098
Issuance of shares	—	(41)	1		1,100		1,791		—		—		2,892
Dividends on common stock ($1.725 per share)	—	—	—		—		—		(86,343)		—		(86,343)
Balance at September 30, 2019	53,996	3,550	$	540	$	(96,092)	$	1,505,605	$	604,048	$	(9,577)	$	2,004,524
Balance at December 31, 2019	53,999	3,547	$	541	$	(96,015)	$	1,508,970	$	635,246	$	(9,648)	$	2,039,094
Net income	—	—	—		—		—		101,664		—		101,664
Foreign currency translation adjustment, net of tax	—	—	—		—		—		—		90		90
Reclassification of net losses on derivative instruments from OCI to net income, net of tax	—	—	—		—		—		—		339		339
Stock-based compensation	146	35	—		(2,740)		5,310		—		—		2,570
Issuance of shares	—	(18)	—		513		540		—		—		1,053
Dividends on common stock ($1.80 per share)	—	—	—		—		—		(90,260)		—		(90,260)
Balance at September 30, 2020	54,145	3,564	$	541	$	(98,242)	$	1,514,820	$	646,650	$	(9,219)	$	2,054,550

See Notes to Condensed Consolidated Financial Statements

9

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Reference is made to Notes to Financial Statements included in NorthWestern Corporation’s Annual Report)

(Unaudited)

(1) Nature of Operations and Basis of Consolidation

NorthWestern Corporation, doing business as NorthWestern Energy, provides electricity and/or natural gas to approximately 734,800 customers in Montana, South Dakota and Nebraska.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that may affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period. Actual results could differ from those estimates. The unaudited Condensed Consolidated Financial Statements (Financial Statements) reflect all adjustments (which unless otherwise noted are normal and recurring in nature) that are, in the opinion of management, necessary to fairly present our financial position, results of operations and cash flows. The actual results for the interim periods are not necessarily indicative of the operating results to be expected for a full year or for other interim periods. Events occurring subsequent to September 30, 2020, have been evaluated as to their potential impact to the Financial Statements through the date of issuance.

The Financial Statements included herein have been prepared by NorthWestern, without audit, pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations; however, management believes that the condensed disclosures provided are adequate to make the information presented not misleading. Management recommends that these Financial Statements be read in conjunction with the audited financial statements and related footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2019.

Variable Interest Entities

A reporting company is required to consolidate a variable interest entity (VIE) as its primary beneficiary, which means it has a controlling financial interest, when it has both the power to direct the activities of the VIE that most significantly impact the VIE's economic performance, and the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. An entity is considered to be a VIE when its total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support, or its equity investors, as a group, lack the characteristics of having a controlling financial interest. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.

Certain long-term purchase power and tolling contracts may be considered variable interests. We have various long-term purchase power contracts with other utilities and certain qualifying co-generation facilities and qualifying small power production facilities (QF). We identified one QF contract that may constitute a VIE. We entered into a 40-year power purchase contract in 1984 with this 35 megawatt (MW) coal-fired QF to purchase substantially all of the facility’s capacity and electrical output over a substantial portion of its estimated useful life. We absorb a portion of the facility’s variability through annual changes to the price we pay per megawatt hour (MWH). After making exhaustive efforts, we have been unable to obtain the information from the facility necessary to determine whether the facility is a VIE or whether we are the primary beneficiary of the facility. The contract with the facility contains no provision which legally obligates the facility to release this information. We have accounted for this QF contract as an executory contract. Based on the current contract terms with this QF, as of September 30, 2020 our estimated remaining gross contractual payments aggregate approximately $123.9 million through 2024.

Supplemental Cash Flow Information

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Condensed Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Condensed Consolidated Statements of Cash Flows (in thousands):

10

	September 30,		December 31,		September 30,		December 31,
	2020		2019		2019		2018
Cash and cash equivalents	$	3,512	$	5,145	$	5,046	$	7,860
Restricted cash	10,497		6,925		9,055		7,451
Total cash, cash equivalents, and restricted cash shown in the Condensed Consolidated Statements of Cash Flows	$	14,009	$	12,070	$	14,101	$	15,311

Goodwill

We completed our annual goodwill impairment test as of April 1, 2020 and no impairment was identified. We calculate the fair value of our reporting units by considering various factors, including valuation studies based primarily on a discounted cash flow analysis, with published industry valuations and market data as supporting information. Key assumptions in the determination of fair value include the use of an appropriate discount rate and estimated future cash flows. In estimating cash flows, we incorporate expected long-term growth rates in our service territory, regulatory stability, and commodity prices (where appropriate), as well as other factors that affect our revenue, expense and capital expenditure projections.

(2) Regulatory Matters

COVID-19 Accounting Order Filings

In the second and third quarters of 2020, we experienced lower revenues and an increase in certain operating expenses as a result of the COVID-19 pandemic. In March we voluntarily informed both our retail customers and state regulators that disconnections for non-payment would be temporarily suspended. During August we advised customers that we would resume the disconnection process for customers whose accounts are in arrears.

South Dakota - On May 1, 2020, we submitted a joint filing with four other investor owned utilities to the South Dakota Public Utilities Commission (SDPUC) seeking approval for an accounting order to defer certain costs related to the COVID-19 pandemic as a regulatory asset, subject to future review for recovery from customers. We limited our specific request to uncollectible accounts expense in excess of amounts included in the latest electric and natural gas test periods. In August, the SDPUC issued an order granting deferral of our excess uncollectible accounts expense. As of September 30, 2020 we have deferred $0.4 million of uncollectible accounts expense into a regulatory asset in the Condensed Consolidated Balance Sheet.

Montana - On May 29, 2020, we filed a petition for an accounting order with the Montana Public Service Commission (MPSC) seeking approval of an accounting order to (i) defer uncollectible accounts expense in excess of amounts included in the latest electric and natural gas test periods; and (ii) requesting approval of a proposed pension contribution up to $40 million in 2020 to be recognized over a five-year period. The MPSC held a work session in October 2020 voting to allow tracking of uncollectible accounts expense and amortization of incremental pension contributions. We expect a final order on our request during the fourth quarter of 2020, and cannot determine the impact, if any, of the MPSC's decision until a final order is issued.

Pension costs in Montana are included in expense on a pay as you go (cash funding) basis. We contributed $10.2 million to the Montana pension plan during the nine months ended September 30, 2020. We have not yet determined whether we will contribute incremental amounts during the fourth quarter of 2020.

FERC Filing - Montana Transmission Service Rates

In May 2019, we submitted a filing with the Federal Energy Regulatory Commission (FERC) for our Montana transmission assets. The revenue requirement associated with our Montana FERC assets is reflected in our Montana MPSC-jurisdictional rates as a credit to retail customers. We will submit a compliance filing with the MPSC upon resolution of our Montana FERC case adjusting the proposed credit in our Montana retail rates. In June 2019, the FERC issued an order accepting our filing, granting interim rates (subject to refund) effective July 1, 2019, establishing settlement procedures and terminating our related Tax Cuts and Jobs Act filing. A settlement judge was appointed and settlement negotiations are ongoing.

Cost Recovery Mechanisms - Montana

11

Montana Electric and Natural Gas Supply Cost Trackers - Each year we submit electric and natural gas tracker filings for recovery of supply costs for the 12-month period ended June 30. The MPSC reviews such filings and makes its cost recovery determination based on whether or not our supply procurement activities were prudent.

The MPSC approved a new design for our electric tracker effective July 1, 2017. The revised electric tracker, or Power Costs and Credits Adjustment Mechanism (PCCAM), established a baseline of power supply costs and tracks the differences between the actual costs and associated base rate revenues. Rates are adjusted annually for variances between actual costs and associated revenues with the variances allocated 90% to customers and 10% to shareholders. The initial design of the PCCAM also included a “deadband” which required us to absorb the variances within +/- $4.1 million from the base revenues. In 2019, the Montana legislature made two statutory changes which affected the PCCAM by prohibiting a deadband and allowing 100% recovery of QF purchases. The 90%/10% sharing ratio for other costs remains in place.

In September 2019, we submitted our annual PCCAM filing for the period July 1, 2018 to June 30, 2019, requesting recovery of approximately $23.8 million in electric supply costs. The Montana Consumer Counsel (MCC) and the Montana Environmental Information Center (MEIC) submitted testimony advocating for a disallowance of approximately $6.0 million of replacement power costs incurred during a 2018 third quarter intermittent outage at our Colstrip generating facility necessary to ensure compliance with air permit limits. In addition, the MCC advocated for an application of the deadband and QF cost sharing from July 2018 to the May 2019 statutory change, which would result in an additional under recovery of costs of approximately $4.0 million. The MPSC held a hearing on this matter in June 2020 and we expect a decision in the fourth quarter of 2020. We began collecting costs for the July 2018 - June 2019 tracker period on October 1, 2019, and as of September 30, 2020, the remaining under collection of approximately $2.1 million was reflected in regulatory assets in the Condensed Consolidated Balance Sheets.

Montana QF Power Purchase Cases

Under the Public Utility Regulatory Policies Act (PURPA), electric utilities are required, with certain exceptions, to purchase energy and capacity from independent power producers that are QFs. We track the costs of these purchases through our PCCAM. These purchases are also the subject of proceedings before the MPSC, whose orders are subject to judicial review by Montana state courts.

In May 2016, we filed our biennial update of standard rates for small QFs (3 MW or less). In November 2017, the MPSC approved new, lower rates, reduced the maximum contract term from 25 to 15 years, and ordered that it would apply the same 15-year contract term to our future owned and contracted electric supply resources (Symmetry Finding). We sought judicial review with the Montana State District Court (District Court) of the Symmetry Finding. Cypress Creek Renewables, LLC, Vote Solar, and MEIC, sought judicial review with the District Court of the rates and contract term.

The District Court reversed and modified the MPSC’s decisions on rates, contract term, and the Symmetry Finding. We appealed the District Court’s order regarding rates and contract term to the Montana Supreme Court, which also granted our request to stay the District Court's decision. The MPSC did not appeal the District Court’s Symmetry Finding. On August 24, 2020, the Montana Supreme Court found that the MPSC's order on rates and contract length was arbitrary, left the stay in place, and remanded to the MPSC for consideration when setting rates and contract lengths for small QF's in future regulatory proceedings.

The MPSC adopted the Symmetry Finding in another order when setting the rates and contract term for a large QF - MT Sun, LLC (MTSun). We, as well as MTSun, sought judicial review of the MPSC’s order. The District Court reversed and modified the MPSC’s order regarding rates, contract length, and the Symmetry Finding. We appealed the District Court’s order to the Montana Supreme Court on the issues of rates and contract length, and the MPSC did not appeal the District Court’s reversal of the Symmetry Finding. On September 22, 2020, the Montana Supreme Court found the MPSC's order on rates and contract length was arbitrary and that MTSun is entitled to the rates and contract term determined by the District Court. We are authorized through our PCCAM tariff to recover 100% of our QF purchased power costs.

Montana Community Renewable Energy Projects (CREPs)

We were required to acquire, as of December 31, 2019, approximately 66 MW of CREPs. While we have made progress towards meeting this obligation by acquiring approximately 36 MW of CREPs, we have been unable to acquire the remaining MWs required for various reasons, including the fact that proposed projects fail to qualify as CREPs or do not meet the statutory cost cap. The MPSC granted us waivers for 2012 through 2016. The validity of the MPSC’s action as it related to waivers granted for 2015 and 2016 has been challenged legally and we are waiting on a final decision from the Montana Supreme Court. We expect to file waiver requests for 2017, 2018, and 2019 after resolution of that litigation. If the Montana Supreme Court rules that the 2015 and 2016 waivers were invalid or if the requested waivers for 2017 through 2019 are not

12

granted, we are likely to be liable for penalties. If the MPSC imposes a penalty, the amount of the penalty would depend on how the MPSC calculated the energy that a CREP would have produced. However, we do not believe any such penalty would be material.

(3) Income Taxes

We compute income tax expense for each quarter based on the estimated annual effective tax rate for the year, adjusted for certain discrete items. Our effective tax rate typically differs from the federal statutory tax rate due to the regulatory impact of flowing through the federal and state tax benefit of repairs deductions, state tax benefit of accelerated tax depreciation deductions (including bonus depreciation when applicable) and production tax credits. The regulatory accounting treatment of these deductions requires immediate income recognition for temporary tax differences of this type, which is referred to as the flow-through method. When the flow-through method of accounting for temporary differences is reflected in regulated revenues, we record deferred income taxes and establish related regulatory assets and liabilities.

The following table summarizes the differences between our effective tax rate and the federal statutory rate (in thousands):

	Three Months Ended September 30,
	2020				2019
Income Before Income Taxes	$	26,763			$	22,225
Income tax calculated at federal statutory rate	5,621		21.0	%	4,667		21.0	%
Permanent or flow-through adjustments:
State income tax, net of federal provisions	46		0.2		65		0.3
Flow-through repairs deductions	(4,213)		(15.7)		(2,606)		(11.7)
Production tax credits	(2,205)		(8.2)		(1,414)		(6.3)
Amortization of excess deferred income tax<