Item 1A. Risk Factors
The Company's business and financial results are subject to a number of risks and uncertainties, including those set forth below and in other documents filed with the SEC. The factors and other matters discussed herein are important factors that could cause actual results or outcomes for the Company to differ materially from those discussed in the forward-looking statements included elsewhere in this document. If any of the risks described below actually occur, the Company's business, prospects, financial condition or financial results could be materially harmed. The following are the most material risk factors applicable to the Company and are not necessarily listed in order of importance or probability of occurrence.
Economic Risks
The Company is subject to government regulations that may have a negative impact on its business and its results of operations and cash flows. Statutory and regulatory requirements also may limit another party's ability to acquire the Company or impose conditions on an acquisition of or by the Company.
The Company's electric and natural gas transmission and distribution businesses are subject to comprehensive regulation by federal, state and local regulatory agencies with respect to, among other things, allowed rates of return and recovery of investments and costs, financing, rate structures, customer service, health care coverage and costs, taxes, franchises; recovery of purchased power and purchased natural gas costs; and construction and siting of generation and transmission facilities. These governmental regulations significantly influence the Company's operating environment and may affect its ability to recover costs from its customers. The Company is unable to predict the impact on operating results from future regulatory activities of any of these agencies. Changes in regulations or the imposition of additional regulations could have an adverse impact on the Company's results of operations and cash flows.
There can be no assurance that applicable regulatory commissions will determine that the Company's electric and natural gas transmission and distribution businesses' costs have been prudent, which could result in the disallowance of costs in setting rates for customers. Also, the regulatory process of approving rates for these businesses may not allow for timely and full recovery of the costs of providing services or a return on the Company's invested capital. Changes in regulatory requirements or operating conditions may require early retirement of certain assets. While regulation typically provides rate recovery for these retirements, there is no assurance regulators will allow full recovery of all remaining costs, which could leave stranded asset costs. Rising fuel costs could increase the risk that the utility businesses will not be able to fully recover those fuel costs from customers.
Approval from federal and state regulatory agencies would be needed for acquisition of the Company, as well as for certain acquisitions by the Company. The approval process could be lengthy and the outcome uncertain, which may deter potential acquirers from approaching the Company or impact the Company's ability to pursue acquisitions.
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Economic volatility affects the Company's operations, as well as the demand for its products and services.
Unfavorable economic conditions can negatively affect the level of public and private expenditures on projects and the timing of these projects which, in turn, can negatively affect demand for the Company's products and services, primarily at the Company's construction businesses. The level of demand for construction products and services could be adversely impacted by the economic conditions in the industries the Company serves, as well as in the general economy. State and federal budget issues affect the funding available for infrastructure spending.
Economic conditions and population growth affect the electric and natural gas distribution businesses' growth in service territory, customer base and usage demand. Economic volatility in the markets served, along with economic conditions such as increased unemployment which could impact the ability of the Company's customers to make payments, could adversely affect the Company's results of operations, cash flows and asset values. Further, any material decreases in customers' energy demand, for economic or other reasons, could have an adverse impact on the Company's earnings and results of operations.
The Company's operations involve risks that may result from catastrophic events.
The Company's operations, particularly those related to natural gas and electric transmission and distribution, include a variety of inherent hazards and operating risks, such as product leaks; explosions; mechanical failures; vandalism; fires; pandemics; social or civil unrest; protests and riots; natural disasters; acts of terrorism; and acts of war. These hazards and operating risks could result in loss of human life; personal injury; property damage; environmental pollution; impairment of operations; and substantial financial losses. The Company maintains insurance against some, but not all, of these risks and losses. A significant incident could also increase regulatory scrutiny and result in penalties and higher amounts of capital expenditures and operational costs. Losses not fully covered by insurance could have an adverse effect on the Company’s financial position, results of operations and cash flows.
A disruption of the regional electric transmission grid or interstate natural gas infrastructure could negatively impact the Company's business and reputation. Because the Company's electric and natural gas utility and pipeline systems are part of larger interconnecting systems, a disruption could result in a significant decrease in revenues and system repair costs negatively impacting the Company's financial position, results of operations and cash flows.
The Company is subject to capital market and interest rate risks.
The Company's operations, particularly its electric and natural gas transmission and distribution businesses, require significant capital investment. Consequently, the Company relies on financing sources and capital markets as sources of liquidity for capital requirements not satisfied by cash flows from operations. If the Company is not able to access capital at competitive rates, including through its "at-the-market" offering program, the ability to implement business plans, make capital expenditures or pursue acquisitions the Company would otherwise rely on for future growth may be adversely affected. Market disruptions may increase the cost of borrowing or adversely affect the Company's ability to access one or more financial markets. Such disruptions could include:
•A significant economic downturn.
•The financial distress of unrelated industry leaders in the same line of business.
•Deterioration in capital market conditions.
•Turmoil in the financial services industry.
•Volatility in commodity prices.
•Pandemics, including COVID-19.
•Terrorist attacks.
•Cyberattacks.
The issuance of a substantial amount of the Company's common stock, whether issued in connection with an acquisition or otherwise, or the perception that such an issuance could occur, could have a dilutive effect on shareholders and/or may adversely affect the market price of the Company's common stock. Higher interest rates on borrowings could also have an adverse effect on the Company's operating results.
Financial market changes could impact the Company’s pension and postretirement benefit plans and obligations.
The Company has pension and postretirement defined benefit plans for some of its employees and former employees. Assumptions regarding future costs, returns on investments, interest rates and other actuarial assumptions have a significant impact on the funding requirements and expense recorded relating to these plans. Adverse changes in economic indicators, such as consumer spending, inflation data, interest rate changes, political developments and threats of terrorism, among other things, can create volatility in the financial markets. These changes could impact the assumptions and negatively affect the value of assets held in the Company's pension and other postretirement benefit plans and may increase the amount and accelerate the timing of required funding contributions for those plans.
Significant changes in energy prices could negatively affect the Company's businesses.
Fluctuations in oil and natural gas production, supplies and prices; fluctuations in commodity price basis differentials; political and economic conditions in oil-producing countries; actions of the Organization of Petroleum Exporting Countries; demand for oil due to the economic slowdowns; and other external factors impact the development of oil and natural gas supplies and the expansion and operation of natural gas pipeline systems. The Company has benefited from associated natural gas production in the Bakken, which has provided opportunities for organic growth projects.
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Depressed oil and natural gas prices, however, place pressure on the ability of oil exploration and production companies to meet credit requirements and will continue to be a challenge if prices remain depressed long-term. Prolonged depressed prices for oil and natural gas could negatively affect the growth, results of operations, cash flows and asset values of the Company's electric, natural gas and pipeline businesses.
If oil and natural gas prices increase significantly, customer demand could decline for utility, pipeline and construction materials, which could impact the Company's results of operations and cash flows. While the Company has fuel clause recovery mechanisms for its utility operations in all of the states where it operates, higher utility fuel costs could also significantly impact results of operations if such costs are not recovered. Delays in the collection of utility fuel cost recoveries, as compared to expenditures for fuel purchases, could also negatively impact the Company's cash flows. High oil prices also affect the cost and demand for asphalt products and related contracting services.
COVID-19 may have a negative impact on the Company's business operations, revenues, results of operations, liquidity and cash flows.
To the extent the COVID-19 pandemic adversely affects the Company's business, operations, revenues, liquidity or cash flows, it may also have the effect of heightening many of the other risks described in this section. The degree to which COVID-19 will impact the Company depends on future developments, including severity and duration of the outbreak, actions taken by governmental authorities, timing and effectiveness of vaccines being administered, and timing of when relatively normal economic and operating conditions resume.
The Company's operations have experienced some disruptions due to its employees or third-party employees being diagnosed with COVID-19 or other illnesses and required quarantine periods for those in close contact to COVID-19. Self-quarantine or actual viral health issues may have a negative impact on the Company's employees and the ability to continue its work activities under a normal course of business. Moreover, the diagnosis of COVID-19 or other illnesses could require the Company or its business partners to suspend projects, quarantine employees or institute more aggressive preventive measures including closure of job sites. Mandated healthcare protocols could lead to a shortage of employees or altered operations. If a significant percentage of the Company's workforce are unable to work because of illness, quarantine or government restrictions in connection with the COVID-19 pandemic, the Company's operations may be negatively impacted, potentially adversely affecting its business, operations, revenues, liquidity and cash flows.
A portion of the Company's workforce has been working remotely and the Company has delayed return to work processes for certain office employees due to the rise in local COVID-19 cases in some operating regions. To date, the Company has not experienced any significant delays or information technology disruptions. An increased amount of social engineering and attacks by bad actors taking advantage of the pandemic could affect the Company's ability to maintain secure operations, communications and productivity in the future.
The regulated businesses have been deemed essential service providers and have seen some impacts on their businesses; however, the Company could be materially affected if its businesses were no longer deemed essential service providers. Future actions of its regulatory commissions on accounting for the impacts of the COVID-19 pandemic may also affect the Company's future operating results and cash flows. The Company has experienced some impacts to its commercial and industrial electric and natural gas loads associated with reduced demand from those customers due to the COVID-19 pandemic.
The construction businesses have generally been deemed essential service providers and have experienced some inefficiencies and interruptions on its businesses from the pandemic; however, the Company could be materially impacted if its businesses were no longer deemed essential service providers. These businesses could be further impacted in the future by site closures, government shut-down measures, additional inefficiencies due to compliance with safety and social distancing measures, public and private sector budget changes and constraints, and the impact of overall macro and local economic conditions on future construction projects.
Other factors associated with the COVID-19 pandemic that could impact the Company's businesses and future operating results, revenues and liquidity include impacts related to the health, safety, and availability of its employees and contractors; continued flexible payment plans; counterparty credit; costs and availability of supplies; capital construction and infrastructure operation and maintenance programs; financing plans; pension valuations; travel restrictions; and legal and regulatory matters, including the potential for delayed regulatory filings and recovery of invested capital.
Reductions in the Company's credit ratings could increase financing costs.
There is no assurance the Company's current credit ratings, or those of its subsidiaries, will remain in effect or that a rating will not be lowered or withdrawn by a rating agency. Events affecting the Company's financial results may impact its cash flows and credit metrics, potentially resulting in a change in the Company's credit ratings. The Company's credit ratings may also change as a result of the differing methodologies or changes in the methodologies used by the rating agencies.
Increasing costs associated with health care plans may adversely affect the Company's results of operations.
The Company's self-insured costs of health care benefits for eligible employees continues to increase. Increasing quantities of large individual health care claims and an overall increase in total health care claims could have an adverse impact on operating results, financial position and liquidity. Legislation related to health care could also change the Company's benefit program and costs.
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The Company is exposed to risk of loss resulting from the nonpayment and/or nonperformance by the Company's customers and counterparties.
If the Company's customers or counterparties experience financial difficulties, the Company could experience difficulty in collecting receivables. Nonpayment and/or nonperformance by the Company's customers and counterparties, particularly customers and counterparties of the Company’s construction materials and contracting and construction services businesses for large construction projects, could have a negative impact on the Company's results of operations and cash flows. The Company could also have indirect credit risk from participating in energy markets such as MISO in which credit losses are socialized to all participants.
Changes in tax law may negatively affect the Company's business.
Changes to federal, state and local tax laws have the ability to benefit or adversely affect the Company's earnings and customer costs. Significant changes to corporate tax rates could result in the impairment of deferred tax assets that are established based on existing law at the time of deferral. Changes to the value of various tax credits could change the economics of resources and the resource selection for the electric generation business. Regulation incorporates changes in tax law into the rate-setting process for the regulated energy delivery businesses which could create timing delays before the impact of changes are realized.
The Company's operations could be negatively impacted by import tariffs and/or other government mandates.
The Company operates in or provides services to capital intensive industries in which federal trade policies could significantly impact the availability and cost of materials. Imposed and proposed tariffs could significantly increase the prices and delivery lead times on raw materials and finished products that are critical to the Company and its customers, such as aluminum and steel. Prolonged lead times on the delivery of raw materials and further tariff increases on raw materials and finished products could adversely affect the Company's business, financial condition and results of operations.
Operational Risks
Significant portions of the Company’s natural gas pipelines and power generation and transmission facilities are aging. The aging infrastructure may require significant additional maintenance or replacement that could adversely affect the Company’s results of operations.
The Company’s energy delivery infrastructure is aging, which increases certain risks, including breakdown or failure of equipment, pipeline leaks and fires developing from power lines. Aging infrastructure is more prone to failure which increases maintenance costs, unplanned outages and the need to replace facilities. Even if properly maintained, reliability may ultimately deteriorate and negatively affect the Company’s ability to serve its customers, which could result in increased costs associated with regulatory oversight. The costs associated with maintaining the aging infrastructure and capital expenditures for new or replacement infrastructure could cause rate volatility and/or regulatory lag in some jurisdictions. If, at the end of its life, the investment costs of a facility have not been fully recovered, the Company may be adversely affected if commissions do not allow such costs to be recovered in rates. Such impacts of an aging infrastructure, could adversely affect the Company’s results of operations and cash flows.
Additionally, hazards from aging infrastructure could result in serious injury, loss of human life, significant damage to property, environmental impacts and impairment of operations, which in turn could lead to substantial financial losses. The location of facilities near populated areas, including residential areas, business centers, industrial sites and other public gathering places, could increase the damages resulting from these risks. A major incident involving another natural gas system could lead to additional capital expenditures, increased regulation, and fines and penalties on natural gas utilities. The occurrence of any of these events could adversely affect the Company’s results of operations, financial position and cash flows.
The Company's utility and pipeline operations are subject to planning risks.
Most electric and natural gas utility investments, including natural gas transmission pipeline investments, are made with the intent of being used for decades. In particular, electric transmission and generation resources are planned well in advance of when they are placed into service based upon resource plans using assumptions over the planning horizon including sales growth, commodity prices, equipment and construction costs, regulatory treatment, available technology and public policy. Public policy changes and technology advancements related to areas such as energy efficient appliances and buildings, renewable and distributive electric generation and storage, carbon dioxide emissions, electric vehicle penetration, restrictions on or disallowance of new or existing services, and natural gas availability and cost may significantly impact the planning assumptions. Changes in critical planning assumptions may result in excess generation, transmission and distribution resources creating increased per customer costs and downward pressure on load growth. These changes could also result in a stranded investment if the Company is unable to fully recover the costs of its investments.
The regulatory approval, permitting, construction, startup and/or operation of pipelines, power generation and transmission facilities, and aggregate reserves may involve unanticipated events, delays and unrecoverable costs.
The construction, startup and operation of natural gas pipelines and electric power generation and transmission facilities involve many risks, which may include delays; breakdown or failure of equipment; inability to obtain required governmental permits and approvals; inability to obtain or renew easements; public opposition; inability to complete financing; inability to negotiate acceptable equipment acquisition, construction, fuel supply, off-take, transmission, transportation or other material agreements; changes in markets and market prices for power; cost increases and overruns; the risk of performance below expected levels of output or efficiency; and the inability to obtain full cost recovery in regulated rates. Additionally, in a number of states in which the Company operates, it can be difficult to permit new aggregate sites or expand existing aggregate sites due to community resistance. Such unanticipated events could negatively impact the Company's business, its results of operations and cash flows.
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Operating or other costs required to comply with current or potential pipeline safety regulations and potential new regulations under various agencies could be significant. The regulations require verification of pipeline infrastructure records by pipeline owners and operators to confirm the maximum allowable operating pressure of certain lines. Increased emphasis on pipeline safety and increased regulatory scrutiny may result in penalties and higher costs of operations. If these costs are not fully recoverable from customers, they could have an adverse effect on the Company’s results of operations and cash flows.
The backlogs at the Company's construction materials and contracting and construction services businesses may not accurately represent future revenue.
Backlog consists of the uncompleted portion of services to be performed under job-specific contracts. Contracts are subject to delay, default or cancellation, and contracts in the Company's backlog are subject to changes in the scope of services to be provided, as well as adjustments to the costs relating to the applicable contracts. Backlog may also be affected by project delays or cancellations resulting from weather conditions, external market factors and economic factors beyond the Company's control. Accordingly, there is no assurance that backlog will be realized. The timing of contract awards, duration of large new contracts and the mix of services can significantly affect backlog. Backlog at any given point in time may not accurately represent the revenue or net income that is realized in any period. Also, the backlog as of the end of the year may not be indicative of the revenue and net income expected to be earned in the following year and should not be relied upon as a stand-alone indicator of future revenues or net income.
Environmental and Regulatory Risks
The Company's operations could be adversely impacted by climate change.
Severe weather events, such as tornadoes, hurricanes, rain, ice and snowstorms and high and low temperature extremes, occur in regions in which the Company operates and maintains infrastructure. Climate change could change the frequency and severity of these weather events, which may create physical and financial risks to the Company. Such risks could have an adverse effect on the Company's financial condition, results of operations and cash flows.
Severe weather events may damage or disrupt the Company's electric and natural gas transmission and distribution facilities, which could result in disruption of service and ability to meet customer demand, increased maintenance or capital costs to repair facilities and restore customer service. The cost of providing service could increase to the extent the frequency of severe weather events increases because of climate change or otherwise. The Company may not recover all costs related to mitigating these physical risks.
Increases in severe weather conditions or extreme temperatures may cause infrastructure construction projects to be delayed or canceled and limit resources available for such projects resulting in decreased revenue or increased project costs at the construction materials and contracting and construction services businesses. In addition, drought conditions could restrict the availability of water supplies, inhibiting the ability of the construction businesses to conduct operations.
Utility customers’ energy needs vary with weather conditions, primarily temperature and humidity. For residential customers, heating and cooling represent the largest energy use. To the extent weather conditions are affected by climate change, customers’ energy use could increase or decrease. Increased energy use by its utility customers due to weather may require the Company to invest in additional generating assets, transmission and other infrastructure to serve increased load. Decreased energy use due to weather may result in decreased revenues. Extreme weather conditions, such as uncommonly long periods of high or low ambient temperature, in general require more system backup, adding to costs, and can contribute to increased system stress, including service interruptions. Weather conditions outside of the Company's service territory could also have an impact on revenues. The Company buys and sells electricity that might be generated outside its service territory, depending upon system needs and market opportunities. Extreme temperatures may create high energy demand and raise electricity prices, which could increase the cost of energy provided to customers.
Climate change may impact a region’s economic health, which could impact revenues at all of the Company's businesses. The Company's financial performance is tied to the health of the regional economies served. The Company provides natural gas and electric utility service, as well as construction materials and services, for some states and communities that are economically affected by the agriculture industry. Increases in severe weather events or significant changes in temperature and precipitation patterns could adversely affect the agriculture industry and, correspondingly, the economies of the states and communities affected by that industry.
The insurance industry may be adversely affected by severe weather events which may impact the availability of insurance coverage, insurance premiums and insurance policy terms.
The Company may be subject to litigation related to climate change. Costs of such litigation could be significant, and an adverse outcome could require substantial capital expenditures, changes in operations and possible payment of penalties or damages, which could affect the Company's results of operations and cash flows if the costs are not recoverable in rates.
The price of energy also has an impact on the economic health of communities. The cost of additional regulatory requirements to combat climate change, such as regulation of carbon dioxide emissions under the Clean Air Act, requirements to replace fossil-fuels with renewable energy or credits, or other environmental regulation or taxes could impact the availability of goods and the prices charged by suppliers, which would normally be borne by consumers through higher prices for energy and purchased goods, and could adversely impact economic conditions of areas served by the
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Company. To the extent financial markets view climate change and emissions of GHGs as a financial risk, this could negatively affect the Company's ability to access capital markets or cause less than ideal terms and conditions.
The Company's operations are subject to environmental laws and regulations that may increase costs of operations, impact or limit business plans, or expose the Company to environmental liabilities.
The Company is subject to environmental laws and regulations affecting many aspects of its operations, including air and water quality, wastewater discharge, the generation, transmission and disposal of solid waste and hazardous substances, aggregate permitting and other environmental considerations. These laws and regulations can increase capital, operating and other costs; cause delays as a result of litigation and administrative proceedings; and create compliance, remediation, containment, monitoring and reporting obligations, particularly relating to electric generation, permitting and environmental compliance for construction material facilities, and natural gas transmission and storage operations. Environmental laws and regulations can also require the Company to install pollution control equipment at its facilities, clean up spills and other contamination and correct environmental hazards, including payment of all or part of the cost to remediate sites where the Company's past activities, or the activities of other parties, caused environmental contamination. These laws and regulations generally require the Company to obtain and comply with a variety of environmental licenses, permits, inspections and other approvals and may cause the Company to shut down existing facilities due to difficulties in assuring compliance or where the cost of compliance makes operation of the facilities uneconomical. Although the Company strives to comply with all applicable environmental laws and regulations, public and private entities and private individuals may interpret the Company's legal or regulatory requirements differently and seek injunctive relief or other remedies against the Company. The Company cannot predict the outcome, financial or operational, of any such litigation or administrative proceedings.
Existing environmental laws and regulations may be revised and new laws and regulations seeking to protect the environment may be adopted or become applicable to the Company. These laws and regulations could require the Company to limit the use or output of certain facilities; restrict the use of certain fuels; prohibit or restrict new or existing services; replace certain fuels with renewable fuels; retire and replace certain facilities; install pollution controls; remediate environmental impacts; remove or reduce environmental hazards; or forego or limit the development of resources. Revised or new laws and regulations that increase compliance costs or restrict operations, particularly if costs are not fully recoverable from customers, could adversely affect the Company's results of operations and cash flows.
Initiatives related to global climate change and to reduce GHG emissions could adversely impact the Company's operation, costs of or access to capital and impact or limit business plans.
Concern that GHG emissions contribute to global climate change has led to international, federal, state and local legislative and regulatory proposals to reduce or mitigate the effects of GHG emissions. The Company’s primary GHG emission is carbon dioxide from fossil fuels combustion at Montana-Dakota's electric generating facilities, particularly its coal-fired facilities. Approximately 46 percent of Montana-Dakota's owned generating capacity and approximately 70 percent of the electricity it generated in 2020 was from coal-fired facilities.
Treaties, legislation or regulations to reduce GHG emissions in response to climate change may be adopted that affect the Company's utility operations by requiring additional energy conservation efforts or renewable energy sources, limiting emissions, imposing carbon taxes or other compliance costs; as well as other mandates that could significantly increase capital expenditures and operating costs or reduce demand for the Company's utility services. If the Company’s utility operations do not receive timely and full recovery of GHG emission compliance costs from customers, then such costs could adversely impact the results of operations and cash flows. Significant reductions in demand for the Company's utility services as a result of increased costs or emissions limitations could also adversely impact the results of operations and cash flows.
The Company monitors, analyzes and reports GHG emissions from its other operations as required by applicable laws and regulations. The Company will continue to monitor GHG regulations and their potential impact on operations.
Due to the uncertain availability of technologies to control GHG emissions and the unknown obligations that potential GHG emission legislation or regulations may create, the Company cannot determine the potential financial impact on its operations.
There have also been recent efforts to discourage the investment community from investing in equity and debt securities of companies engaged in fossil fuel related business and pressuring lenders to limit funding to such companies. Additionally, some insurance carriers have indicated an unwillingness to insure assets and operations related to certain fossil fuels. Although the Company has not experienced difficulties in accessing the capital markets or insurance; such efforts, if successfully directed at the Company, could increase the costs of or access to capital and interfere with business operations and ability to make capital expenditures.
Other Risks
The Company's various businesses are seasonal and subject to weather conditions that can adversely affect the Company's operations, revenues and cash flows.
The Company's results of operations can be affected by changes in the weather. Weather conditions influence the demand for electricity and natural gas and affect the price of energy commodities. Utility operations have historically generated lower revenues when weather conditions are cooler than normal in the summer and warmer than normal in the winter particularly in jurisdictions that do not have weather normalization mechanisms in place. Where weather normalization mechanisms are in place, there is no assurance the Company will continue to receive such regulatory protection from adverse weather in future rates.
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Adverse weather conditions, such as heavy or sustained rainfall or snowfall, storms, wind and colder weather may affect the demand for products and the ability to perform services at the construction businesses and affect ongoing operation and maintenance and construction activities for the electric and natural gas transmission and distribution businesses. In addition, severe weather can be destructive, causing outages and property damage, which could require additional remediation costs. The Company could also be impacted by drought conditions, which may restrict the availability of water supplies and inhibit the ability of the construction businesses to conduct operations. As a result, unusual or adverse weather conditions could negatively affect the Company's results of operations, financial position and cash flows.
Competition exists in all of the Company's businesses.
The Company's businesses are subject to competition. Construction services' competition is based primarily on price and reputation for quality, safety and reliability. Construction materials products are marketed under highly competitive conditions and are subject to competitive forces such as price, service, delivery time and proximity to the customer. The electric utility and natural gas industries also experience competitive pressures as a result of consumer demands, technological advances and other factors. The pipeline business competes with several pipelines for access to natural gas supplies and for transportation and storage business. New acquisition opportunities are subject to competitive bidding environments which impact prices the Company must pay to successfully acquire new properties to grow its business. The Company's failure to effectively compete could negatively affect the Company's results of operations, financial position and cash flows.
The Company's operations may be negatively affected if it is unable to obtain, develop and retain key personnel and skilled labor forces.
The Company must attract, develop and retain executive officers and other professional, technical and skilled labor forces with the skills and experience necessary to successfully manage, operate and grow the Company's businesses. Competition for these employees is high, and in some cases competition for these employees is on a regional or national basis. At times of low unemployment or economic downturns, it can be difficult for the Company to attract and retain qualified and affordable personnel. A shortage in the supply of skilled personnel creates competitive hiring markets, increased labor expenses, decreased productivity and potentially lost business opportunities to support the Company's operating and growth strategies. Additionally, if the Company is unable to hire employees with the requisite skills, the Company may be forced to incur significant training expenses. As a result, the Company's ability to maintain productivity, relationships with customers, competitive costs, and quality services is limited by the ability to employ, retain and train the necessary skilled personnel and could negatively affect the Company's results of operations, financial position and cash flows.
The Company's construction materials and contracting and construction services businesses may be exposed to warranty claims.
The Company, particularly its construction businesses, may provide warranties guaranteeing the work performed against defects in workmanship and material. If warranty claims occur, they may require the Company to re-perform the services or to repair or replace the warranted item, at a cost to the Company and could also result in other damages if the Company is not able to adequately satisfy warranty obligations. In addition, the Company may be required under contractual arrangements with customers to warrant any defects or failures in materials the Company purchased from third parties. While the Company generally requires suppliers to provide warranties that are consistent with those the Company provides to customers, if any of the suppliers default on their warranty obligations to the Company, the Company may nonetheless incur costs to repair or replace the defective materials. Costs incurred as a result of warranty claims could adversely affect the Company's results of operations, financial condition and cash flows.
The Company is a holding company and relies on cash from its subsidiaries to pay dividends.
The Company is a holding company as a result of the Holding Company Reorganization in 2019. 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.
Costs related to obligations under MEPPs could have a material negative effect on the Company's results of operations and cash flows.
Various operating subsidiaries of the Company participate in approximately 68 MEPPs for employees represented by certain unions. The Company is required to make contributions to these plans in amounts established under numerous collective bargaining agreements between the operating subsidiaries and those unions.
The Company may be obligated to increase its contributions to underfunded plans that are classified as being in endangered, seriously endangered or critical status as defined by the Pension Protection Act of 2006. Plans classified as being in one of these statuses are required to adopt RPs or FIPs to improve their funded status through increased contributions, reduced benefits or a combination of the two. Based on available information, the Company believes that approximately 31 percent of the MEPPs to which it contributes are currently in endangered, seriously endangered or critical status.
The Company may also be required to increase its contributions to MEPPs if the other participating employers in such plans withdraw from the plans and are not able to contribute amounts sufficient to fund the unfunded liabilities associated with their participation in the plans. The amount and timing of any increase in the Company's required contributions to MEPPs may depend upon one or more factors including the outcome of collective bargaining; actions taken by trustees who manage the plans; actions taken by the plans' other participating employers; the industry for which contributions are made; future determinations that additional plans reach endangered, seriously endangered or critical status; newly-enacted government laws or regulations and the actual return on assets held in the plans; among others. The Company could experience increased operating
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expenses as a result of required contributions to MEPPs, which could have an adverse effect on the Company's results of operations, financial position or cash flows.
In addition, pursuant to ERISA, as amended by MPPAA, the Company could incur a partial or complete withdrawal liability upon withdrawing from a plan, exiting a market in which it does business with a union workforce or upon termination of a plan. The Company could also incur additional withdrawal liability if its withdrawal from a plan is determined by that plan to be part of a mass withdrawal.
Information technology disruptions or cyber-attacks could adversely impact the Company's operations.
The Company uses technology in substantially all aspects of its business operations and requires uninterrupted operation of information technology systems, including disaster recovery and backup systems and network infrastructure. While the Company has policies, procedures and processes in place designed to strengthen and protect these systems, they may be vulnerable to failures or unauthorized access, due to hacking, human error, theft, sabotage, malicious software, acts of terrorism, acts of war, acts of nature or other causes. If these systems fail or become compromised, and they are not recovered in a timely manner, the Company may be unable to fulfill critical business functions. This may include interruption of electric generation, transmission and distribution facilities, natural gas storage and pipeline facilities and facilities for delivery of construction materials or other products and services, any of which could adversely affect the Company's reputation, business, cash flows and results of operations or subject the Company to legal or regulatory liabilities and increased costs. Additionally, because electric generation and transmission systems and natural gas pipelines are part of interconnected systems with other operators’ facilities, a cyber-related disruption in another operator’s system could negatively impact the Company's business.
The Company’s accounting systems and its ability to collect information and invoice customers for products and services could be disrupted. If the Company’s operations are disrupted, it could result in decreased revenues or remediation costs that could adversely affect the Company's results of operations and cash flows.
The Company is subject to cybersecurity and privacy laws and regulations of many government agencies, including FERC and NERC. NERC issues comprehensive regulations and standards surrounding the security of bulk power systems and continually updates these requirements, as well as establishing new requirements with which the utility industry must comply. As these regulations evolve, the Company may experience increased compliance costs and may be at higher risk for violating these standards. Experiencing a cybersecurity incident could cause the Company to be non-compliant with applicable laws and regulations, causing the Company to incur costs related to legal claims or proceedings and regulatory fines or penalties.
The Company, through the ordinary course of business, requires access to sensitive customer, employee and Company data. While the Company has implemented extensive security measures, a breach of its systems could compromise sensitive data and could go unnoticed for some time. Such an event could result in negative publicity and reputational harm, remediation costs, legal claims and fines that could have an adverse effect on the Company's financial results. Third-party service providers that perform critical business functions for the Company or have access to sensitive information within the Company also may be vulnerable to security breaches and information technology risks that could adversely affect the Company.
The Company’s information systems experience on-going and often sophisticated cyber-attacks by a variety of sources with the apparent aim to breach the Company's cyber-defenses. As cyber-attacks continue to increase in frequency and sophistication, the Company may be unable to prevent all such attacks in the future. The Company is continuously reevaluating the need to upgrade and/or replace systems and network infrastructure. These upgrades and/or replacements could adversely impact operations by imposing substantial capital expenditures, creating delays or outages, or experiencing difficulties transitioning to new systems. Systems implementation disruption and any other information technology disruption, if not anticipated and appropriately mitigated, could adversely affect the Company.
General risk factors that could impact the Company's businesses.
The following are additional factors that should be considered for a better understanding of the risks to the Company. These factors may negatively impact the Company's financial results in future periods.
•Acquisition, disposal and impairments of assets or facilities.
•Changes in present or prospective electric generation.
•Population decline and demographic patterns in the Company's areas of service.
•The cyclical nature of large construction projects at certain operations.
•Labor negotiations or disputes.
•Inability of the contract counterparties to meet their contractual obligations.
•The inability to effectively integrate the operations and the internal controls of acquired companies.
Item 1B. Unresolved Staff Comments
The Company has no unresolved comments with the SEC.
MDU Resources Group, Inc. Form 10-K 27
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Item 3. Legal Proceedings
SEC regulations require the Company to disclose certain information about proceedings arising under federal, state or local environmental provisions if the Company reasonably believes that such proceedings may result in monetary sanctions above a stated threshold. Pursuant to SEC regulations, the Company has adopted a threshold of $1.0 million for purposes of determining whether disclosure of any such proceedings is required.
For information regarding legal proceedings required by this item, see Item 8 - Note 21, which is incorporated herein by reference.
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-K, which is incorporated herein by reference.
28 MDU Resources Group, Inc. Form 10-K
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Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company's common stock is listed on the New York Stock Exchange under the symbol "MDU."
As of December 31, 2020, the Company's common stock was held by approximately 10,400 stockholders of record.
The Company depends on earnings and dividends from its subsidiaries to pay dividends on common stock. The Company has paid uninterrupted dividends to stockholders for 83 consecutive years with an increase in the payout amount for the last 30 consecutive years. The declaration and payment of dividends is at the sole discretion of the board of directors, subject to limitations imposed by the Company's credit agreements, federal and state laws, and applicable regulatory limitations. For more information on factors that may limit the Company's ability to pay dividends, see Item 8 - Note 12.
The following table includes information with respect to the Company's purchase of equity securities:
ISSUER PURCHASES OF EQUITY SECURITIES
October 1 through October 31, 2020 — — — —
December 1 through December 31, 2020 — — — —
(1) Represents shares of common stock purchased on the open market in connection with annual stock grants made to the Company's non-employee directors.
(2) Not applicable. The Company does not currently have in place any publicly announced plans or programs to purchase equity securities.
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Item 6. Selected Financial Data
Selected Financial Data
Operating revenues (000's):
Operating income (loss) (000's):
Intersegment eliminations — — — — — (2,942)
Earnings (loss) on common stock (000's):
Common Stock Statistics
Market price ratios:
* Reflects oil and natural gas properties noncash write-downs of $315.3 million (after tax) in 2015 and fair value impairments of assets held for sale of $157.8 million (after tax) and $475.4 million (after tax) in 2016 and 2015, respectively.
**Based on continuing operations.
30 MDU Resources Group, Inc. Form 10-K
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Item 6. Selected Financial Data (continued)
General
Capitalization ratios:
Electric
Natural Gas Distribution
Pipeline
Construction Materials and Contracting
MDU Resources Group, Inc. Form 10-K 31
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company focuses on infrastructure and is Building a Strong America® by providing essential products and services through its regulated energy delivery and construction materials and services businesses. The Company and its employees work hard to keep the economy of the United States moving with the products and services provided, which include powering and connecting homes, factories, offices and stores; and building roads, highways, data infrastructure and airports.
The Company's two-platform business model, regulated energy delivery and construction materials and services, are each comprised of different operating segments. Most of these segments experience seasonality related to the industries in which they operate. The two-platform approach helps balance this seasonality and the risks associated with each type of industry. The Company is authorized to conduct business in 45 states and during peak times has over 15,600 employees. The Company’s organic investments are strong drivers of high-quality earnings growth and continue to be an important part of the Company’s growth story. Management believes the Company is well positioned in the industries and markets in which it operates.
Impact of the COVID-19 pandemic on the Company
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic, and the President of the United States declared the COVID-19 outbreak as a national emergency. Most of the Company's products and services are considered essential to our country and our communities; therefore, operations have generally been permitted to proceed with increased social distancing measures and hygiene practices for its employees. While the Company has experienced some inefficiency impacts, including operation suspensions and interruptions at some locations to carry out preventative measures or in response to instances of positive tests, the impacts have not been material. For more information on specific impacts to each of the Company's business segments, see the following discussions in each business segment's Outlook section.
In March 2020, the President of the United States signed into law the CARES Act in response to the COVID-19 pandemic. The CARES Act provided economic relief and stimulus to support the national economy during the pandemic, including support for individuals and businesses affected by the pandemic and economic downturn. The CARES Act allowed businesses to defer payment of the employer portion of social security taxes incurred through the end of 2020. At December 31, 2020, the Company had deferred approximately $56.7 million in payroll taxes related to this provision. The Company is required to pay 50 percent of the payroll taxes deferred under this provision by the end of 2021 and the remaining balance by the end of 2022.
The Company evaluated its planned capital projects and delayed certain expenditures in 2020 to provide additional financial flexibility and to ensure projects will provide acceptable returns on investment. In addition, the Company established a task force to monitor developments related to the pandemic and implemented procedures to protect employees. Many employees that have the capacity to work from home continue to do so as the Company has delayed return to work processes for certain office employees due to COVID-19 cases in some operating regions. The Company has also enacted additional physical and cybersecurity measures to safeguard systems for remote work locations.
Although there have been logistical and other challenges as a result of COVID-19, there were no material adverse impacts on the Company's results of operations for the year ended December 31, 2020. The Company continues to adjust its business in response to the pandemic while positioning for an economic rebound and potential opportunities to enhance its competitive position. The situation surrounding COVID-19 remains fluid and the potential for a material adverse impact on the Company increases the longer the virus impacts the level of economic activity in the United States. Due to the uncertainty of the economic outlook resulting from the COVID-19 pandemic, the Company continues to monitor the situation closely. For more information on the possible impacts, see Item 1A - Risk Factors.
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Consolidated Earnings Overview
The following table summarizes the contribution to the consolidated income by each of the Company's business segments.
(In millions, except per share amounts)
Income (loss) from discontinued operations, net of tax (.3) .3 2.9
Earnings per share - basic:
Income from continuing operations $ 1.95 $ 1.69 $ 1.38
Discontinued operations, net of tax — — .01
Earnings per share - basic $ 1.95 $ 1.69 $ 1.39
Earnings per share - diluted:
Income from continuing operations $ 1.95 $ 1.69 $ 1.38
Discontinued operations, net of tax — — .01
Earnings per share - diluted $ 1.95 $ 1.69 $ 1.39
2020 compared to 2019 The Company's consolidated earnings increased $54.7 million or 16 percent in 2020 as compared to 2019.
The Company's earnings were positively impacted by increased earnings across all of the Company's businesses in 2020. The construction materials and contracting business experienced an increase in gross margin, primarily resulting from favorable weather conditions and higher realized materials margins on asphalt and asphalt-related products and ready-mixed concrete, as well as most other product lines. The construction services business also experienced an increase in gross margin as a result of higher inside and outside specialty contracting workloads, partially due to the businesses acquired, as well as hospitality projects, high-tech projects and natural disaster recovery work. The pipeline business experienced increased transportation volumes and revenues, largely related to organic growth projects, as well as higher storage-related revenues as a result of stronger demand for storage services. In addition, approved rate recovery positively impacted earnings at the electric and natural gas distribution businesses.
2019 compared to 2018 The Company's consolidated earnings increased $63.2 million or 23 percent in 2019 as compared to 2018.
Positively impacting the Company's earnings was an increase in gross margin at the construction services business, largely resulting from higher inside and outside specialty contracting workloads. Also contributing to the increase in earnings was an increase in gross margin at the construction materials and contracting business as a result of strong economic environments in certain states, as well as contributions from the businesses acquired and an increase in gains recognized on asset sales. The electric business also positively impacted earnings primarily due to approved rate relief in Montana and recovery of the investment in the BSSE project placed into service in the first quarter of 2019. Higher returns on the Company's benefit plan investments also increased earnings across all businesses. At the pipeline business, increased rates and volumes of natural gas being transported through its pipeline were mostly offset by the absence of a $4.2 million income tax benefit recorded in 2018 relating to the reversal of a regulatory liability recorded in 2017 based on a FERC final accounting order and higher depreciation, depletion and amortization expense.
A discussion of key financial data from the Company's business segments follows.
Business Segment Financial and Operating Data
Following are 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. Many of these highlighted points are "forward-looking statements." For more information, see Part I - Forward-Looking Statements. There is no assurance that the Company's projections, including estimates for growth and changes in earnings, will in fact be achieved. Please refer to assumptions contained in this section, as well as the various important factors listed in Item 1A - Risk Factors. Changes in such assumptions and factors could cause actual future results to differ materially from the Company's growth and earnings projections.
For information pertinent to various commitments and contingencies, see Item 8 - Notes to Consolidated Financial Statements. For a summary of the Company's business segments, see Item 8 - Note 17.
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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 Items 1 and 2 - Business Properties. Both segments strive to be top performing utility companies measured by integrity, employee safety and satisfaction, customer service and shareholder return, while providing safe, environmentally friendly, reliable and competitively priced energy and related services to customers. 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, the cost of natural gas, cost of electric fuel and purchased power, weather, 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, as well as certain operational, environmental and system integrity regulations. Legislative and regulatory initiatives to increase renewable energy resources and reduce GHG emissions could impact the price and demand for electricity and natural gas, as well as increase costs to produce electricity and natural gas. The segments continue to invest in facility upgrades to be in compliance with the existing and 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, as further discussed in Items 1 and 2 - Business Properties and Item 8 - Note 20.
In September 2019, the Pipeline and Hazardous Materials Safety Administration issued a rule for additional regulations to strengthen the safety of natural gas transmission and storage facilities and hazardous liquid pipelines. The natural gas segment has implemented procedure changes for the initial requirements and continues to evaluate procedure changes necessary for the additional requirements effective July 1, 2021.
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's state implementation plan is due to be submitted to the EPA by July 2021. The Company expects the NDDEQ to draft a state implementation plan and share its controls selection with federal land managers of the National Park Service and the United States Fish and Wildlife Service in early 2021. Additionally, the Company is one of four owners of Coyote Station and cannot make a unilateral decision on the plant's future. The Company could be negatively impacted by the decisions of the other owners.
The electric and natural gas distribution segments are facing increased lead times on delivery of certain raw materials used in electric transmission and natural gas pipeline projects. Long lead times are attributable to increased demand for steel products from pipeline companies as they respond to the United States Department of Transportation Pipeline System Safety and Integrity Plan, as well as delays in the manufacturing of electrical equipment as a result of the COVID-19 pandemic, including delays in trucking times and issuance of permits for large and heavy loads. The Company continues to monitor the material lead times and is working with manufacturers to proactively order such materials to help mitigate the risk of delays due to extended lead times.
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 and competition from other energy providers and fuels. The construction of any 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 will likely necessitate increases in electric energy prices.
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, as further discussed in Items 1 and 2 - Business Properties.
34 MDU Resources Group, Inc. Form 10-K
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Earnings overview - The following information summarizes the performance of the electric segment.
(Dollars in millions, where applicable)
Taxes, other than income .6 .6 .7 — % (14.3) %
Operating expenses:
Retail sales (million kWh):
Average cost of electric fuel and purchased power per kWh $ .019 $ .023 $ .022
Adjusted gross margin is a non-GAAP financial measure. For additional information and reconciliation of the non-GAAP adjusted gross margin attributable to the electric segment, see the Non-GAAP Financial Measures section later in this Item.
2020 compared to 2019 Electric earnings increased $800,000 as a result of:
Adjusted gross margin: Comparable to the prior year. The adjusted gross margin was positively impacted by higher rates of $2.8 million, including approved rate relief resulting in $2.0 million additional revenue. These increases were offset by lower retail sales volumes of 3.3 percent across all customer classes due to warmer weather and slow-downs as a result of the COVID-19 pandemic.
Operation and maintenance: Decrease of $4.4 million, largely due to lower generation station expenses of $3.5 million and lower payroll and other employee-related costs of approximately $1.5 million. Partially offsetting the decreases were increased bad debt expense of $500,000 as a result of the COVID-19 pandemic, as discussed later.
Depreciation, depletion and amortization: Increase of $4.3 million, largely from an increase in asset base driven by capital expenditures, which include transmission projects, and higher depreciation rates implemented from a Montana rate case of $1.2 million.
Taxes, other than income: Increase of $700,000, from higher property taxes in certain jurisdictions.
Other income: Increase of $3.8 million, largely attributable to an out-of-period adjustment of $2.5 million in the fourth quarter of 2020 related to previously overstated benefit plan expense, as discussed in Item 8 - Note 1, and the absence of the write-down of a non-utility investment in the second quarter of 2019 for $1.2 million, as discussed in Item 8 - Note 8. Lower 2020 pension expense also contributed to the increase in other income.
Interest expense: Increase of $1.4 million driven by higher short-term debt balances.
Income tax benefit: Decrease of $1.0 million, largely due to higher income before income taxes.
2019 compared to 2018Electric earnings increased $7.8 million as a result of:
Adjusted gross margin: Increase of $10.8 million, primarily due to an increase in revenues. The revenue increase was driven by implemented regulatory mechanisms, which include approved Montana interim and final rates and recovery of the investment in the BSSE project placed into service in the first quarter of 2019. Also contributing to the increase was the absence in 2019 of a transmission formula rate adjustment
MDU Resources Group, Inc. Form 10-K 35
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recognized in the third quarter of 2018 for decreased costs on the BSSE project. These increases were partially offset by lower retail sales volumes of 1.2 percent across all major customer classes.
Operation and maintenance: Increase of $2.7 million, primarily resulting from higher payroll-related costs, partially offset by lower material expenses across all locations.
Depreciation, depletion and amortization: Increase of $7.7 million as a result of increased property, plant and equipment balances including the BSSE project, as previously discussed, and other capital projects, as well as a reserve for certain costs related to the retirement of three aging coal-fired electric generating units, as discussed in Item 8 - Note 6, which is offset in income taxes.
Taxes, other than income: Increase of $1.6 million, primarily from higher property taxes in certain jurisdictions.
Other income: Increase of $2.2 million, largely the result of higher returns on the Company's benefit plan investments, partially offset by the write-down of a non-utility investment in the second quarter of 2019, as discussed in Item 8 - Note 8.
Interest expense: Decrease of $600,000 driven by higher AFUDC, which resulted in more interest being capitalized on regulated construction projects.
Income tax benefit: Increase of $6.2 million, largely due to increased production tax credits, as well as increased excess deferred tax amortization.
Earnings overview - The following information summarizes the performance of the natural gas distribution segment.
(Dollars in millions, where applicable)
Operating expenses:
Depreciation, depletion and amortization 84.6 79.6 72.5 6.3 % 9.8 %
* NM - not meaningful
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Volumes (MMdk)
Retail sales:
Transportation sales:
Average cost of natural gas per dk $ 3.91 $ 3.86 $ 4.04
Adjusted gross margin is a non-GAAP financial measure. For additional information and reconciliation of the non-GAAP adjusted gross margin attributable to the natural gas distribution segment, see the Non-GAAP Financial Measures section later in this Item.
2020 compared to 2019 Natural gas distribution earnings increased $4.5 million as a result of:
Adjusted gross margin: Increase of $10.4 million, largely the result of $6.8 million in approved rate recovery in certain jurisdictions, higher basic service charges of $2.1 million due to customer growth of 2 percent and increased property tax tracker revenue of $1.7 million, which offsets the property tax expense below. Slightly offsetting the increases was a decrease in retail sales volumes of 7.4 percent across all customer classes due to warmer weather and slow-downs as a result of the COVID-19 pandemic, which was largely offset by weather normalization and decoupling mechanisms in certain jurisdictions.
Operation and maintenance: Increase of $400,000, primarily related to increased contract services, largely $1.2 million for the write-off of an abandoned project in the third quarter of 2020, and increased software expenses. Partially offsetting the increase was lower employee-related costs of $1.6 million as a result of the COVID-19 pandemic.
Depreciation, depletion and amortization: Increase of $5.0 million, primarily from an increase in asset base driven by capital expenditures, which include system safety and reliability enhancements and other growth projects.
Taxes, other than income: Increase of $1.1 million due to higher property taxes in certain jurisdictions of $1.7 million, partially offset by lower payroll taxes.
Other income: Increase of $6.3 million, largely driven by an out-of-period adjustment of $4.4 million in the fourth quarter of 2020 related to previously overstated benefit plan expenses, as discussed in Item 8 - Note 1, and lower 2020 benefit plan expenses of approximately $2.2 million. The absence of the write-down of a non-utility investment of approximately $800,000 in the second quarter of 2019, as discussed in Item 8 - Note 8, also contributed to the increase in other income. Partially offsetting the increases was a decrease in interest income of $1.5 million related to the recovery of purchased gas cost adjustment balances.
Interest expense: Increase of $1.3 million, primarily attributable to increased long-term debt balances, partially offset by lower short-term borrowings.
Income tax expense: Increase of $4.4 million, as a result of the increase in income before taxes and permanent tax adjustments.
2019 compared to 2018 Natural gas distribution earnings increased $1.8 million as a result of:
Adjusted gross margin: Increase of $17.4 million, primarily driven by an increase in retail sales volumes of 9.9 percent related to all customer classes due to colder weather, partially offset by weather normalization and conservation adjustments in certain jurisdictions, and approved rate recovery in certain jurisdictions. The adjusted gross margin was also positively impacted by higher rate realization due to higher conservation revenue, which offsets the conservation expense in operation and maintenance expense.
Operation and maintenance: Increase of $11.6 million, largely related to higher payroll-related costs, as well as higher conservation expenses being recovered in revenue. The increase was partially offset by lower contract services, which includes the absence of the prior year's recognition of a non-recurring expense related to the approved WUTC general rate case settlement in the second quarter 2018.
Depreciation, depletion and amortization: Increase of $7.1 million, primarily as a result of increased property, plant and equipment balances.
Taxes, other than income: Increase of $1.8 million due to higher property taxes in certain jurisdictions and increased payroll taxes.
Other income: Increase of $7.0 million, largely resulting from higher returns on the Company's benefit plan investments and increased interest income related to higher gas costs to be collected from customers. Partially offsetting these increases was a write-down of a non-utility investment in the second quarter of 2019, as discussed in Item 8 - Note 8.
Interest expense: Increase of $4.8 million, largely resulting from increased debt balances to finance higher gas costs to be collected from customers.
Income tax expense: Decrease of $2.7 million, largely due to increased permanent tax benefits related to the Company's benefit plan investments.
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OutlookThe Company continues to assess the impacts of the COVID-19 pandemic on its operations and is committed to providing safe and reliable service while ensuring the health and safety of its employees, customers and the communities in which it operates. In response to the pandemic, the Company instituted certain measures to help protect its employees from exposure to COVID-19 and to curb potential spread of the virus in customer homes and facilities, including suspension of disconnects due to nonpayment of bills. The Company also waived late payment fees effective April 1, 2020, to help customers experiencing financial hardships. As a consequence of the suspended disconnects and waived late fees, the Company's cash flows and collection of receivables have been affected. The Company reinstated disconnects and late payment fees in five of its eight states effective September 1, 2020, and the Company reinstated disconnects and late payment fees to certain customer classes in another two states effective January 1, 2021. The Company has experienced some impacts to its commercial and industrial electric and natural gas loads associated with reduced economic activity due to the COVID-19 pandemic and oil price impacts, as further discussed below. The Company expects this downward trend on demand to continue throughout the pandemic. The Company temporarily implemented cost containment measures in response to the COVID-19 pandemic, including reduced employee travel and temporary delays in training for employees, as well as delays in filling open positions and contract work. The Company has filed requests for the use of deferred accounting for costs related to the COVID-19 pandemic in most of the jurisdictions in which it operates; the Company has deferred an immaterial amount related to the pandemic to date. The Company's outstanding filings by jurisdiction related to the COVID-19 pandemic are discussed in Item 8 - Note 20.
The Company expects these segments will grow rate base by approximately 5 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 2020 and 2019, these segments experienced retail customer growth of approximately 1.8 percent each year and 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. 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 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. Additionally, the Company has implemented risk mitigation measures to minimize the price volatility associated with natural gas costs through derivative contracts at Cascade. For further discussion on the Company's derivative instruments, see Item 8 - Note 2. Demand for the Company's regulated energy delivery services could be impacted by reduced oil and natural gas exploration and production activity. The Company continues to monitor natural gas prices, as well as the oil and natural gas production levels.
In February 2019, the Company announced that it intends to retire three aging coal-fired electric generating units, resulting from the Company's analysis showing that the plants are no longer expected to be cost competitive for customers. The retirements are expected to be in March 2021 for Unit 1 at Lewis & Clark Station in Sidney, Montana, and in early 2022 for Units 1 and 2 at Heskett Station near Mandan, North Dakota. In addition, the Company announced that it intends to construct Heskett Unit 4, an 88-MW simple-cycle natural gas-fired combustion turbine peaking unit at the existing Heskett Station near Mandan, North Dakota. Heskett Unit 4 production costs coupled with the MISO market purchases are expected to be about half the total cost of continuing to run the coal-fired electric generating units at Heskett and Lewis & Clark stations. Heskett Unit 4 was included in the Company's integrated resource plan submitted to the NDPSC in July 2019. On August 28, 2019, the Company filed for an advanced determination of prudence with the NDPSC for Heskett Unit 4. This request was approved by the NDPSC on August 5, 2020. Heskett Unit 4 is expected to be placed into service in 2023. The Company filed, and the commissions approved, requests with the NDPSC, MTPSC and SDPUC for the usage of deferred accounting for the costs related to the retirement of Unit 1 at Lewis & Clark Station and Units 1 and 2 at Heskett Station.
In December 2020, the governor of Washington outlined a climate policy package that included House Bill 1084, which would eliminate all onsite fossil fuel emissions in new buildings by 2030 and eliminate fossil fuels from existing buildings by 2050, among other things. A public hearing on House Bill 1084 was held February 17, 2021, in the House Committee on Appropriations. The Company is monitoring the status of the proposed legislation.
The Company continues to be focused on the regulatory recovery of its investments by filing for rate adjustments to seek recovery of operating costs and capital investments, as well as reasonable returns as allowed by regulators. The Company's most recent cases by jurisdiction are discussed in Item 8 - Note 20.
38 MDU Resources Group, Inc. Form 10-K
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Pipeline
Strategy and challenges The pipeline segment provides natural gas transportation, underground storage and energy-related services, as discussed in Items 1 and 2 - Business Properties. 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 and placed into service the following organic growth projects in 2020 and 2019:
•In September 2020 and November 2019, Phase II and Phase I, respectively, of the Line Section 22 Expansion project in the Billings, Montana, area. The total project increased capacity by 22.5 MMcf per day.
•In February 2020, the Demicks Lake Expansion project in McKenzie County, North Dakota, increased capacity by 175 MMcf per day.
•In September 2019, the Demicks Lake project in McKenzie County, North Dakota, increased capacity by 175 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 to increase pipeline safety regulations and reduce methane emissions could also impact the price and demand for natural gas.
The segment regularly experiences extended lead times on raw materials that are critical to the segment's construction and maintenance work. Long lead times on materials could delay maintenance work and project construction potentially causing lost revenues and/or increased costs. The Company continues to proactively monitor and plan for the material lead times, as well as work with manufacturers and suppliers to help mitigate the risk of delays due to extended lead times.
The pipeline segment is subject to extensive regulation including certain operational, environmental and system integrity regulations, as well as various permit terms and operational compliance conditions. In September 2019, the Pipeline and Hazardous Materials Safety Administration issued a rule for additional regulations to strengthen the safety of natural gas transmission and storage facilities and hazardous liquid pipelines. The segment has implemented procedure changes for the initial requirements and continues to evaluate procedure changes and implementation of physical modifications to existing facilities necessary for additional requirements effective July 1, 2021. 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. Groups opposing pipelines could also cause negative impacts on the segment with increased costs, potential delays to project completion or cancellation of prospective projects.
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.
(Dollars in millions)
Operating expenses:
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Natural gas gathering volumes (MMdk) 8.6 13.9 14.9
Customer natural gas storage balance (MMdk):
Net injection (withdrawal) 9.3 2.3 (8.5)
2020 compared to 2019 Pipeline earnings increased $7.4 million as a result of:
Revenues: Increase of $3.5 million, largely attributable to increased transportation volumes and demand revenue of $6.2 million largely from organic growth projects, as previously discussed, and increased storage-related revenues of $4.6 million as a result of stronger demand for storage services. Also contributing to the increase was additional revenues of $2.4 million primarily from increased rates effective May 1, 2019, due to the FERC rate case finalized in September 2019. These increases were partially offset by lower non-regulated project revenues of $5.3 million and lower volumes associated with the sale of the Company's natural gas gathering assets in 2020, as discussed later, and lower gathering rates resulting in a decrease in revenues of $4.3 million.
Operation and maintenance: Decrease of $3.2 million, primarily from decreased non-regulated project costs of $3.7 million associated with lower non-regulated project revenue and $1.5 million gain on the sale of the Company's non-regulated natural gas gathering assets in 2020, as discussed later, partially offset by higher payroll-related costs.
Depreciation, depletion and amortization: Increase of $500,000, primarily due to additional expense of $1.3 million associated with increased property, plant and equipment balances as a result of organic growth projects that have been placed into service, and higher depreciation rates effective May 1, 2019, due to the FERC rate case finalized in September 2019. The sale of the Company's natural gas gathering assets in 2020, as discussed later, reduced the increases by $1.5 million.
Taxes, other than income: Decrease of $400,000 driven by the sale of the Company's natural gas gathering assets, partially offset by higher property taxes in certain jurisdictions of $300,000.
Other income: Increase of $1.7 million, as a result of higher AFUDC of $1.1 million, a positive impact of $700,000 related to the sale of the Company's regulated gathering assets and an out-of-period adjustment of $500,000 in the fourth quarter of 2020 related to previously overstated benefit plan expense, as discussed in Item 8 - Note 1. Partially offsetting these increases was the write-off of unrecovered gas costs and project expenses of $1.2 million.
Interest expense: Increase of $400,000, largely resulting from higher debt balances to finance organic growth projects, as previously discussed.
Income tax expense: Increase of $500,000, directly resulting from an increase in income before taxes, largely offset by the reversal of excess deferred taxes of $1.5 million associated with the sale of the Company's regulated natural gas gathering assets.
2019 compared to 2018 Pipeline earnings increased $1.1 million as a result of:
Revenues: Increase of $11.5 million, largely attributable to increased volumes of natural gas transported through its system as a result of organic growth projects, as previously discussed, and increased rates effective May 1, 2019, due to the FERC rate case finalized in September 2019.
Operation and maintenance: Increase of $900,000, primarily from higher payroll-related costs and materials costs.
Depreciation, depletion and amortization: Increase of $3.3 million, primarily due to increased property, plant and equipment balances, largely the result of organic growth projects that have been placed into service, and higher depreciation rates effective May 1, 2019, due to the FERC rate case finalized in September 2019.
Taxes, other than income: Increase of $600,000 driven by higher property taxes in certain jurisdictions.
Other income: Comparable to the prior year.
Interest expense: Increase of $1.3 million, largely resulting from higher debt balances to finance organic growth projects, as previously discussed.
Income tax expense: Increase of $4.5 million, primarily driven by the absence in 2019 of a $4.2 million income tax benefit recorded in 2018 related to the reversal of a regulatory liability recorded in 2017 based on a FERC final accounting order issued.
OutlookThe Company continues to successfully manage the impacts of the COVID-19 pandemic on its operations and is committed to providing safe, reliable and compliant service while ensuring the health and safety of its employees, customers and the communities in which it operates. The Company experienced minor delays on capital and maintenance projects during the first quarter of 2020 but resumed project activities in the second quarter of 2020. Work has progressed on these projects as scheduled through the fourth quarter of 2020. The Company does not expect delays to its regulatory filings due to the pandemic.
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 the increased volumes of natural gas the Company transports through its system. Reduced global oil demand due to the COVID-19 pandemic and disagreements in oil supply levels between the Organization of the Petroleum Exporting Countries and other countries led to record low oil prices during the first quarter of 2020;
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however, oil prices started to recover after the first quarter of 2020 as states and other countries started to reopen. Although low oil prices have slowed drilling activities and led to the shut-in of certain wells, producers continue to bring wells back online and the Company continues to focus on growth and improving existing operations through organic projects in all areas in which it operates. The national record levels of natural gas supply over the last few years have moderated the need for storage services and put downward pressure on natural gas prices and minimized price volatility. While the Company believes there will continue to be varying pressures on natural gas production levels and prices due to these circumstances, low natural gas prices provide growth opportunity for industrial supply related projects and seasonal pricing differentials provide opportunities for storage services.
In January 2019, the Company announced the North Bakken Expansion project, which includes construction of a new pipeline, compression and ancillary facilities to transport natural gas from core Bakken production areas near Tioga, North Dakota, to a new connection with Northern Border Pipeline in McKenzie County, North Dakota. Construction is expected to begin in the second quarter of 2021 with an estimated in-service date late in 2021, which is dependent on regulatory and environmental permitting. On February 14, 2020, the Company filed with the FERC its application for this project. On July 28, 2020, the Company filed an amendment to its application with the FERC reflecting a decrease to the design capacity from 350 MMcf per day to 250 MMcf per day by reducing compression due to delays in forecasted growth levels of natural gas production in the Bakken region. Further, as a result of the forecasted Bakken oil and associated natural gas production delays driven by COVID-19 pandemic-related demand decreases and commodity price impacts, the Company negotiated adjustments to certain long-term customer commitments. A portion of the first-year committed volumes have been delayed one year and, through a combination of rate, volume and term adjustments, the overall project return profile remains unchanged and is expected to be accretive to earnings of the Company. These long-term take or pay customer contracts support the project at a design capacity of 250 MMcf per day, which can be readily expanded when forecasted growth levels rebound. On December 17, 2020, the FERC issued its environment assessment for the project. FERC approval of the project is anticipated in early 2021.
In December 2019, the Company entered into a purchase and sale agreement to divest of the Company's regulated natural gas gathering assets located in Montana and North Dakota, which included approximately 400 miles of natural gas gathering pipelines and associated compression and ancillary facilities. On January 8, 2020, the Company filed an application with the FERC to authorize abandonment by sale of the assets and received FERC approval on April 2, 2020. The sale closed in April 2020 with an effective date of January 1, 2020. Pursuant to the FERC's approval of the abandonment by sale, the proposed accounting treatment was filed with the FERC in October 2020 and approved in November 2020.
In October 2020, the Company entered into a purchase and sale agreement to divest of the Company's non-regulated natural gas gathering assets located in northern Montana, which included approximately 800 miles of natural gas gathering pipelines and associated compression and ancillary facilities. The sale closed in November 2020 with an effective date of December 1, 2020. With the completion of this sale, the Company has exited the natural gas gathering business.
Construction Materials and Contracting
Strategy and challengesThe construction materials and contracting segment provides an integrated set of aggregate-based construction services, as discussed in Items 1 and 2 - Business Properties. The segment focuses on high-growth strategic markets located near major transportation corridors and desirable mid-sized metropolitan areas; strengthening the long-term, strategic aggregate reserve position through available purchase and/or lease opportunities; enhancing profitability through cost containment, margin discipline and vertical integration of the segment's operations; development and recruitment of talented employees; and continued growth through organic and acquisition opportunities.
A key element of the Company's long-term strategy for this business is to further expand its market presence in the higher-margin materials business (rock, sand, gravel, liquid asphalt, asphalt concrete, ready-mixed concrete and related products), complementing and expanding on the segment's expertise. The Company's continued acquisition activity supports this strategy.
As one of the country's largest sand and gravel producers, the segment continues to strategically manage its approximately 1.1 billion tons of aggregate reserves in all its markets, as well as take further advantage of being vertically integrated. The segment's vertical integration allows the segment 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 acquisition opportunities to replace the reserves. In the fourth quarter of 2020, the Company acquired the assets of McMurry Ready-Mix Co., an aggregates and concrete supplier located in Casper, Wyoming. The acquisition included nearly 100 million tons of aggregate reserves. In the first quarter of 2019, the Company purchased additional aggregate deposits in Texas that were estimated to contain a 40-year supply of high-quality aggregates for projected local market needs. Also during 2019, the Company increased aggregate reserves by approximately 40 million tons largely due to strategic asset purchases.
The construction materials and contracting segment faces challenges that are not under the direct control of the business. The segment operates in geographically diverse and highly competitive markets. Competition can put negative pressure on the segment's operating margins. The segment is also subject to volatility in the cost of raw materials such as diesel fuel, gasoline, liquid asphalt, cement and steel. Such volatility can 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. Other variables that can impact the segment's margins include adverse weather conditions, the timing of project starts or completion 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.
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The segment also faces challenges in the recruitment and retention of employees. Trends in the labor market include an aging workforce and availability issues. The segment continues to face increasing pressure to control costs, as well as recruit and train a skilled workforce to meet the needs of increasing demand and seasonal work.
Earnings overview - The following information summarizes the performance of the construction materials and contracting segment.
(Dollars in millions)
Cost of sales:
Selling, general and administrative expense:
Depreciation, depletion and amortization 4.8 3.1 2.2 54.8 % 40.9 %
Total selling, general and administrative expense 99.6 94.0 84.1 6.0 % 11.8 %
2020 compared to 2019 Construction materials and contracting's earnings increased $26.9 million as a result of:
Revenues: Decrease of $12.7 million driven by lower contracting revenues partially due to lower materials pricing as a result of decreased energy-related costs. This decrease was offset in part by higher material sales on most product lines due to an early start to the season, favorable weather conditions in certain regions and additional revenues associated with the businesses acquired.
Gross margin: Increase of $40.1 million, largely resulting from higher material revenues and margins and higher contracting margins. Asphalt and asphalt-related product margins increased $21.3 million overall. Strong pricing for ready-mixed concrete in most markets resulted in 1.9 percent higher margins. Contracting bid margins positively impacted gross margin by $6.5 million partially resulting from lower direct costs associated with having a longer construction season due to favorable weather conditions. The Company also benefited across all product lines from lower fuel costs. Partially offsetting these increases was lower gains on asset sales in certain regions of approximately $6.8 million.
Selling, general and administrative expense: Increase of $5.6 million, primarily related to higher payroll-related costs of $2.2 million and increased amortization of intangible assets associated with the businesses acquired.
Other income: Decrease of $800,000, largely the result of an out-of-period adjustment to benefit expense in the fourth quarter of 2020, as discussed in Item 8 - Note 1.
Interest expense: Decrease of $3.2 million, from lower average debt balances in 2020 along with lower average interest rates.
Income tax expense: Increase of $10.0 million directly resulting from an increase in income before taxes.
2019 compared to 2018Construction materials and contracting's earnings increased $27.8 million as a result of:
Revenues: Increase of $264.8 million driven by higher contracting services and material sales due to strong economic environments in certain states, as well as additional material volumes associated with the businesses acquired.
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Gross margin: Increase of $48.5 million, largely resulting from higher revenues due to strong economic environments in certain states, as previously discussed, higher contracting bid margins and higher realized material prices. Also contributing to the increased gross margin was an increase in gains on asset sales in certain regions of approximately $7.5 million.
Selling, general and administrative expense: Increase of $9.9 million, primarily related to the businesses acquired and higher payroll-related costs.
Other income (expense): Increase of $4.7 million, largely the result of higher returns on the Company's benefit plan investments.
Interest expense: Increase of $6.5 million, largely resulting from higher debt balances as a result of recent acquisitions, capital expenditures and higher average interest rates.
Income tax expense: Increase of $9.0 million directly resulting from an increase in income before taxes.
OutlookThe Company continues to assess the impacts of the COVID-19 pandemic on its operations and is committed to the health and safety of its employees, customers and the communities in which it operates. The Company has implemented safety and social distancing measures for its employees that are not able to work from home and has experienced some inefficiencies and additional costs in relation to these measures but, for the most part, has been able to continue business processes with minimal interruptions. The Company also continues to monitor job progress and service work and at this time has not experienced significant delays, cancellations or disruptions due to the pandemic. The Company will continue to monitor the demand for construction materials and contracting services as such services may be reduced by recessionary impacts of the pandemic as the traditional customers for these services reduce capital expenditures. State and local mandates were issued in response to the COVID-19 pandemic requiring individuals to stay in place, leading to a reduction in fuel consumption in the United States, which directly reduces fuel tax collections. In addition, states, cities and counties across the country are experiencing low sales tax and other revenues as a result of the COVID-19 pandemic. The reduction in tax collections may impact funds available for public infrastructure projects, which in turn could have a material adverse impact on the Company's results of operations, financial position and cash flows. Meanwhile, a comprehensive infrastructure funding program, if adopted, by the United States Congress could positively impact the segment.
The segment's vertically integrated aggregate-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-mixed 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 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.
During 2020 and 2019, the Company made strategic asset purchases and completed several acquisitions that support the Company's long-term strategy to expand its market presence. In the first quarter of 2020, the Company acquired the assets of Oldcastle Infrastructure Spokane, a prestressed-concrete business located in Spokane, Washington. In the fourth quarter of 2020, the Company acquired the assets of McMurry Ready-Mix Co., an aggregates and concrete supplier located in Casper, Wyoming. The Company continues to evaluate additional acquisition opportunities. For more information on the Company's business combinations, see Item 8 - Note 4.
The construction materials and contracting segment's backlog remained strong at December 31, 2020, at $673 million, which was comparable to backlog at December 31, 2019, of $693 million. A significant portion of the Company's backlog relates to street and highway construction. The Company expects to complete a significant amount of backlog at December 31, 2020, during the next 12 months.
Construction Services
Strategy and challenges The construction services segment provides inside and outside specialty contracting, as discussed in Items 1 and 2 - Business Properties. 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 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 its ability to support national customers in most of the regions in which it operates.
The construction services segment faces challenges in the highly competitive markets in which it operates. Competitive pricing environments, project delays, changes in management's estimates of variable consideration and the effects from restrictive regulatory requirements have negatively impacted revenues and margins in the past and could affect revenues and margins in the future. Additionally, margins may be negatively impacted on a quarterly basis due to adverse weather conditions, as well as timing of project starts or completions; disruptions to the supply chain due to transportation delays, travel restrictions, raw material cost increases and shortages and closures of businesses or facilities; declines or delays in new projects due to the cyclical nature of the construction industry; and other factors. These challenges may also impact the risk of loss on certain projects. 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. These trends include an aging workforce and labor availability issues, increasing pressure to reduce costs and improve reliability, and increasing duration
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and complexity of customer capital programs. Due to these and other factors, the Company believes overall customer and competitor demand for labor resources will continue to increase, possibly surpassing the supply of industry resources.
Earnings overview - The following information summarizes the performance of the construction services segment.
(In millions)
Cost of sales:
Depreciation, depletion and amortization 15.7 15.0 14.3 4.7 % 4.9 %
Selling, general and administrative expense:
Depreciation, depletion and amortization 7.8 2.0 1.4 NM 42.9 %
* NM - not meaningful
2020 compared to 2019Construction services earnings increased $16.7 million as a result of:
Revenues: Increase of $246.4 million, primarily resulting from higher inside and outside specialty contracting workloads. Inside workloads contributed $127.2 million, or 10.0 percent more compared to 2019, largely from higher revenues of $71.4 million due to the addition of Perlectric, Inc. and increased customer demand for high-tech, hospitality and industrial projects. Outside workloads contributed $108.0 million, or 18.1 percent more compared to 2019, as a result of strong demand for utility projects including storm-related power line repair and wildfire restoration work.
Gross margin: Increase of $38.2 million, primarily from the higher volume of work resulting in an increase in revenues, as previously discussed, partially offset by an increase in operation and maintenance expense as a direct result of the expenses related to the increased workloads.
Selling, general and administrative expense: Increase of $17.0 million, largely from increased costs of $8.3 million associated with the addition of PerLectric, Inc. operations, allowance for uncollectible accounts of $3.6 million, payroll-related costs of $3.1 million and office expenses.
Other income: Comparable to the prior year.
Interest expense: Decrease of $1.2 million, related to lower debt balances due to lower working capital needs as a result of payroll tax deferrals and increased cash collections.
Income tax expense: Increase of $5.8 million, directly resulting from an increase in income before taxes.
2019 compared to 2018 Construction services earnings increased $28.7 million as a result of:
Revenues: Increase of $477.8 million, largely resulting from higher inside specialty contracting workloads from an increase in customer demand for hospitality, data center and high-tech projects. Also contributing to the increase was higher outside specialty contracting workloads, primarily resulting from increased utility customer demand.
Gross margin: Increase of $55.3 million, primarily due to the higher volume of work resulting in an increase in revenues, as previously discussed, partially offset by an increase in operation and maintenance expense as a direct result of the increased workloads.
Selling, general and administrative expense: Increase of $15.7 million, resulting from increased payroll-related costs, as well as higher office expense and outside professional service costs.
Other income: Increase of $800,000, largely resulting from higher returns on the Company's benefit plan investments.
Interest expense: Increase of $1.7 million, related to higher debt balances as a result of additional working capital needs from the increase in contracting workloads in 2019.
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Income tax expense: Increase of $10.0 million, directly resulting from an increase in income before taxes.
OutlookThe Company continues to assess the impacts of the COVID-19 pandemic on its operations and is committed to the health and safety of its employees, customers and the communities in which it operates. The Company has implemented safety and social distancing measures for its employees that are not able to work from home and has experienced some inefficiencies in relation to these measures but, for the most part, has been able to continue business processes. The Company continues to bid and be awarded work despite the challenging economic environment, as evidenced by the strong backlog for the segment, as further discussed below. The Company also continues to monitor job progress and service work and has experienced some delays, cancellations and disruptions due to the pandemic. The Company will continue to monitor the demand for construction services as such services may be reduced by recessionary impacts of the pandemic as the traditional customers for these services reduce capital expenditures.
The Company continues to have bidding opportunities for both inside and outside specialty contracting work in 2021. Although bidding remains highly competitive in all areas, the Company expects the segment's skilled workforce, quality of service and effective cost management will continue to provide a benefit in securing and executing profitable projects.
The construction services segment's backlog at December 31 was as follows:
(In millions)
Inside specialty contracting $ 1,059 $ 908
Outside specialty contracting 214 236
The increase in backlog at December 31, 2020, as compared to backlog at December 31, 2019, was largely attributable to the new project opportunities that the Company continues to be awarded across its diverse operations, particularly inside specialty electrical and mechanical contracting in the hospitality, high-tech and public industries. The Company's outside power, communications and natural gas specialty contracting also have a high volume of available work. The Company expects to complete a significant amount of the backlog at December 31, 2020, during the next 12 months. Additionally, the Company continues to further evaluate potential acquisition opportunities that would be accretive to earnings of the Company and continue to grow the Company's backlog.
In support of the Company's strategic plan to grow through acquisitions, the Company acquired PerLectric, Inc., an electrical construction company in Fairfax, Virginia, in the first quarter of 2020. For more information on the Company's business combinations, see Item 8 - Note 4.
Other
(In millions)
Operating expenses:
Depreciation, depletion and amortization 2.7 2.1 2.0 28.6 % 5.0 %
Taxes, other than income .1 .1 .1 — % — %
Income tax benefit (.4) (.1) (1.2) NM 91.7 %
Net loss $ (3.1) $ (2.1) $ (.7) (47.6) % NM
* NM - not meaningful
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.
Other was negatively impacted in 2020 as a result of higher insurance claims as compared to 2019, whereas 2019 had higher insurance premiums which increased both operating revenues and operation and maintenance expense.
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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:
(In millions)
Intersegment transactions:
For more information on intersegment eliminations, see Item 8 - Note 17.
Liquidity and Capital Commitments
At December 31, 2020, the Company had cash and cash equivalents of $59.6 million and available borrowing capacity of $736.3 million under the outstanding credit facilities of the Company's subsidiaries. During the first quarter of 2020, short-term capital markets were disrupted as a result of the COVID-19 pandemic. Consequently, the Company temporarily borrowed under its revolving credit agreements in addition to accessing the commercial paper markets and maintained higher than normal cash balances to ensure liquidity during this volatile period. At December 31, 2020, all borrowings under the revolving credit agreements for Montana-Dakota and Centennial had been repaid. The Company expects to meet its obligations for debt maturing within 12 months 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 later in Capital resources; and the issuance of debt and equity securities if necessary.
Cash flows
Operating activities 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 also affected by changes in working capital. Changes in cash flows for discontinued operations are related to the Company's former exploration and production and refining businesses.
Cash flows provided by operating activities in 2020 was $768.4 million compared to $542.3 million in 2019. The increase in cash flows provided by operating activities is reflective of the increased earnings across all businesses. The increase in cash flows provided by operating activities was largely driven by stronger collection of accounts receivable at the construction services business and decreased receivables at the construction materials and contracting business as compared to the prior period as a result of lower contracting revenues. Also contributing to the increase in cash flows provided by operating activities was the decrease in natural gas purchases in 2020 as a result of milder temperatures and lower gas costs and recovery of purchased gas cost adjustment balances at the natural gas distribution business. The Company also benefited from the deferral of payroll taxes related to the CARES Act and the absence of pension contributions at all of its businesses. Partially offsetting these increases was higher cash needs due to decreased bonus depreciation for tax purposes taken on qualified property in 2020 as compared to 2019 and a decrease in deferred taxes as a result of the purchased gas cost adjustment recorded in 2019.
Cash flows provided by operating activities in 2019 were $542.3 million compared to $499.9 million in 2018. The increase in cash flows provided by operating activities was largely driven by increased earnings from higher workloads at the construction businesses, which were partially offset by an increase in accounts receivable as a result of the higher workloads. Lower inventory balances due to higher workloads at the construction materials and contracting business in 2019 as compared to the increase in inventory balances in 2018 due to the activity of acquired businesses also contributed to the increase. Partially offsetting these increases were higher natural gas purchases including the effects of colder weather, higher gas costs and timing of collection of such balances from customers at the natural gas distribution business, as well as higher pension contributions at all of the businesses.
Investing activities Cash flows used in investing activities in 2020 were $630.2 million compared to $603.9 million in 2019. The increase in cash used was primarily related to additional cash needs for acquisition activity in 2020 compared to 2019 at the construction businesses, increased capital expenditures in 2020 at the electric business and lower proceeds on asset sales in 2020 at the construction materials and contracting business. Partially offsetting these increases were decreased capital expenditures in 2020 at the construction materials and contracting business, proceeds on the natural gas gathering asset sales at the pipeline business and higher proceeds on asset sales in 2020 at the construction services businesses.
Cash flows used in investing activities in 2019 was $603.9 million compared to $710.9 million in 2018. The decrease in cash used was primarily related to $112.1 million lower cash used in acquisition activity in 2019 compared to 2018 at the construction materials and contracting business and higher proceeds on asset sales at the construction businesses in 2019.
Financing activitiesCash flows used in financing activities in 2020 was $145.1 million compared to cash flows provided by financing activities of $74.1 million in 2019. The change was largely the result of a decrease in net long-term and short-term debt borrowings in 2020 as compared to
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2019 due to lower working capital needs. In addition, the Company had decreased net proceeds of $103.5 million in 2020 due to the absence of common stock issuance under its "at-the-market" offering and 401(k) plan.
Cash flows provided by financing activities in 2019 were $74.1 million compared to $230.4 million in 2018. The decrease in cash provided by financing activities was largely due to the higher repayment of long-term debt in 2019 on debt issued in 2018 for acquisitions at the construction materials and contracting business. The Company also borrowed and repaid short-term borrowings in 2019. Partially offsetting the decrease in cash provided by financing activities was the receipt of proceeds from the issuance of common stock. The Company issued common stock for net proceeds of $106.8 million under its "at-the-market" offering and 401(k) plan in 2019.
Defined benefit pension plans
The Company has noncontributory qualified defined benefit pension plans for certain employees. Plan assets consist of investments in equity and fixed-income securities. Various actuarial assumptions are used in calculating the benefit expense (income) and liability (asset) related to the pension plans. Actuarial assumptions include assumptions about the discount rate and expected return on plan assets. At December 31, 2020, the pension plans' accumulated benefit obligations exceeded these plans' assets by approximately $53.5 million. Pretax pension income reflected in the Consolidated Statements of Income for the year ended December 31, 2020, was $684,000. Pretax pension expense reflected in the Consolidated Statements of Income for the years ended December 31, 2019 and 2018, was $2.5 million and $843,000, respectively. The Company's pension income is currently projected to be approximately $1.7 million in 2021. Funding for the pension plans is actuarially determined. The Company has no minimum funding requirements for its defined benefit pension plans for 2021 due to an additional contribution of $20.0 million in 2019. There were no minimum required contributions for the year ended December 31, 2020, and the minimum required contributions for the years ended December 31, 2019 and 2018, were approximately $4.9 million and $6.1 million, respectively. For more information on the Company's pension plans, see Item 8 - Note 18.
Capital expenditures
The Company's capital expenditures for 2018 through 2020 and as anticipated for 2021 through 2023 are summarized in the following table.
Actual* Estimated
(In millions)
Capital expenditures:
* Capital expenditures for 2020, 2019 and 2018 include noncash transactions such as the issuance of the Company's equity securities in connection with acquisitions, capital expenditure-related accounts payable, AFUDC and accrual of holdback payments in connection with acquisitions totaling $(15.7) million, $4.8 million and $33.4 million, respectively.
The 2020 capital expenditures include the completed business combinations at the construction materials and contracting and construction services segments, as discussed in Item 8 - Note 4. The 2020 capital expenditures were funded by internal sources and borrowings under credit facilities and issuance of commercial paper of the Company's subsidiaries. The Company has included in the estimated capital expenditures for 2021 through 2023 the North Bakken Expansion project and construction of Heskett Unit 4, as previously discussed in Business Segment Financial and Operating Data.
Estimated capital expenditures for the years 2021 through 2023 include those for:
•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
•Other growth opportunities
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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 estimates in the preceding table. It is anticipated that all of the funds required for capital expenditures for the years 2021 through 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.
Capital resources
Certain debt instruments of the Company's subsidiaries, including those discussed later, 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 December 31, 2020. In the event the subsidiaries do not comply with the applicable covenants and other conditions, alternative sources of funding may need to be pursued. For more information on the covenants, certain other conditions and cross-default provisions, see Item 8 - Note 9.
The following table summarizes the outstanding revolving credit facilities of the Company's subsidiaries at December 31, 2020:
(In millions)
(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). 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 $110.0 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). There were no amounts 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 their 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 58 percent and 56 percent at December 31, 2020 and 2019, respectively. 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. This ratio is an indicator of how the Company is financing its operations, as well as its financial strength. As of December 31, 2020, the Company had investment grade credit ratings at all entities issuing debt.
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. The Distribution Agreement 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 the agreement. Proceeds from the sale of shares of common stock under the 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 did not issue any shares of common stock for the year ended December 31, 2020, pursuant to the “at-the-market” offering. As of December 31, 2020, the Company had capacity to issue up to 6.4 million additional shares of common stock under the "at-the-market" offering program. For more information on the Company's "at-the-market" offering, see Item 8 - Note 12.
Certain of the Company's debt instruments use LIBOR as a benchmark for establishing the applicable interest rate. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform. These reforms and other pressures may cause LIBOR to disappear entirely or to perform differently than in the past. The Company has been proactive to anticipate the reform of LIBOR by replacing it with SOFR in certain of its new debt instruments, as well as those that are being renewed. The Company continues to evaluate the impact the reform will have on its debt instruments and, at this time, does not anticipate a significant impact.
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The following includes information related to the preceding table.
Montana-Dakota On January 1, 2019, the Company's revolving credit agreement and commercial paper program became Montana-Dakota's revolving credit agreement and commercial paper program as a result of the Holding Company Reorganization. The outstanding balance of the revolving credit agreement was also transferred to Montana-Dakota. All of the related terms and covenants of the credit agreements remained the same.
On December 19, 2019, Montana-Dakota amended and restated its revolving credit agreement extending the maturity date to December 19, 2024. Montana-Dakota's revolving credit agreement supports its commercial paper program. Commercial paper borrowings under this agreement are classified as long-term debt as they are intended to be refinanced on a long-term basis through continued commercial paper borrowings. Montana-Dakota's objective is to maintain acceptable credit ratings in order to access the capital markets through the issuance of commercial paper. Historically, downgrades in credit ratings have not limited, nor are currently expected to limit, Montana-Dakota's ability to access the capital markets. If Montana-Dakota were to experience a downgrade of its credit ratings in the future, it may need to borrow under its credit agreement and may experience an increase in overall interest rates with respect to its cost of borrowings. Prior to the maturity of the credit agreement, Montana-Dakota expects that it will negotiate the extension or replacement of this agreement. If Montana-Dakota is unable to successfully negotiate an extension of, or replacement for, the credit agreement, or if the fees on this facility become too expensive, which Montana-Dakota does not currently anticipate, it would seek alternative funding.
On April 8, 2020, Montana-Dakota entered into a $75.0 million term loan agreement with a LIBOR-based variable interest rate and a maturity date of April 7, 2021. At December 31, 2020, Montana-Dakota had $50.0 million outstanding under this agreement. On February 16, 2021, Montana-Dakota repaid the remaining $50.0 million outstanding.
Cascade On June 7, 2019, Cascade amended its revolving credit agreement to increase the borrowing limit to $100.0 million and extend the maturity date to June 7, 2024. Any borrowings under the revolving credit agreement are classified as long-term debt as they are intended to be refinanced on a long-term basis through continued borrowings.
On June 15, 2020, Cascade issued $50.0 million of senior notes under a note purchase agreement with maturity dates ranging from June 15, 2050 to June 15, 2060, at a weighted average interest rate of 3.66 percent.
On October 30, 2020, Cascade issued $25.0 million of senior notes under a note purchase agreement with a maturity date of October 30, 2060, at an interest rate of 3.34 percent.
Intermountain On June 7, 2019, Intermountain amended its revolving credit agreement to extend the maturity date to June 7, 2024. Any borrowings under the revolving credit agreement are classified as long-term debt as they are intended to be refinanced on a long-term basis through continued borrowings.
Centennial On December 19, 2019, Centennial amended and restated its revolving credit agreement to increase the borrowing capacity to $600.0 million and extend the maturity date to December 19, 2024. Centennial's revolving credit agreement supports its commercial paper program. Commercial paper borrowings under this agreement are classified as long-term debt as they are intended to be refinanced on a long-term basis through continued commercial paper borrowings. Centennial's objective is to maintain acceptable credit ratings in order to access the capital markets through the issuance of commercial paper. Historically, downgrades in Centennial's credit ratings have not limited, nor are currently expected to limit, Centennial's ability to access the capital markets. If Centennial were to experience a downgrade of its credit ratings in the future, it may need to borrow under its credit agreement and may experience an increase in overall interest rates with respect to its cost of borrowings. Prior to the maturity of the Centennial credit agreement, Centennial expects that it will negotiate the extension or replacement of this agreement, which provides credit support to access the capital markets. In the event Centennial is unable to successfully negotiate this agreement, or in the event the fees on this facility become too expensive, which Centennial does not currently anticipate, it would seek alternative funding.
WBI Energy Transmission On July 26, 2019, WBI Energy Transmission amended its uncommitted note purchase and private shelf agreement to increase capacity to $300.0 million and extend the issuance period and expiration date to May 16, 2022. On December 16, 2020, WBI Energy Transmission issued $25.0 million of senior notes under the private shelf agreement with a maturity date of December 16, 2035, at an interest rate of 3.26 percent. WBI Energy Transmission had $195.0 million of notes outstanding at December 31, 2020, which reduced the remaining capacity under this uncommitted private shelf agreement to $105.0 million.
Dividend restrictions
For information on the Company's dividends and dividend restrictions, see Item 8 - Note 12.
Off balance sheet arrangements
As of December 31, 2020, the Company had no material off balance sheet arrangements as defined by the rules of the SEC.
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Contractual obligations and commercial commitments
For more information on the Company's contractual obligations on long-term debt, operating leases and purchase commitments, see
Item 8 - Notes 9, 10 and 21. At December 31, 2020, the Company's commitments under these obligations were as follows:
Less than 1 year 1-3 years 3-5 years More than 5 years Total
(In millions)
* Unamortized debt issuance costs and discount are excluded from the table.
** Represents the estimated interest payments associated with the Company's long-term debt outstanding at December 31, 2020, assuming current interest rates and consistent amounts outstanding until their respective maturity dates over the periods indicated in the table above.
At December 31, 2020, the Company had total liabilities of $446.9 million related to asset retirement obligations that are excluded from the table above. Of the total asset retirement obligations, the current portion was $6.6 million at December 31, 2020, and was included in other accrued liabilities on the Consolidated Balance Sheets. Due to the nature of these obligations, the Company cannot determine precisely when the payments will be made to settle these obligations. For more information, see Item 8 - Note 11.
Not reflected in the previous table are $1.3 million in uncertain tax positions at December 31, 2020.
The Company has no minimum funding requirements for its defined benefit pension plans for 2021 due to an additional contribution of $20.0 million in 2019.
The Company's MEPP contributions are based on union employee payroll, which cannot be determined in advance for future periods. The Company may also be required to make additional contributions to its MEPPs as a result of their funded status. For more information, see Item 1A - Risk Factors and Item 8 - Note 18.
New Accounting Standards
For information regarding new accounting standards, see Item 8 - Note 2, which is incorporated herein by reference.
Critical Accounting Estimates
The Company has prepared its financial statements in conformity with GAAP. The preparation of its financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Management reviews these estimates and assumptions based on historical experience, changes in business conditions and other relevant factors believed to be reasonable under the circumstances.
Critical accounting estimates are defined as estimates that require management to make assumptions about matters that are uncertain at the time the estimate was made and changes in the estimates could have a material impact on the Company's financial position or results of operations. The Company's critical accounting estimates are subject to judgments and uncertainties that affect the application of its significant accounting policies discussed in Item 8 - Note 2. As additional information becomes available, or actual amounts are determinable, the recorded estimates are revised. Consequently, the Company's financial position or results of operations may be materially different when reported under different conditions or when using different assumptions in the application of the following critical accounting estimates.
Goodwill
The Company performs its goodwill impairment testing annually in the fourth quarter. In addition, the test is performed on an interim basis whenever events or circumstances indicate that the carrying amount of goodwill may not be recoverable. Examples of such events or circumstances may include a significant adverse change in business climate, weakness in an industry in which the Company's reporting units operate or recent significant cash or operating losses with expectations that those losses will continue.
The Company has determined that the reporting units for its goodwill impairment test are its operating segments, or components of an operating segment, that constitute a business for which discrete financial information is available and for which segment management regularly reviews the operating results. For more information on the Company's operating segments, see Item 8 - Note 17. Goodwill impairment, if any, is measured by comparing the fair value of each reporting unit to its carrying value. If the fair value of a reporting unit exceeds its carrying value, the goodwill of the reporting unit is not impaired. If the carrying value of a reporting unit exceeds its fair value, the Company must record an impairment loss for the
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amount that the carrying value of the reporting unit, including goodwill, exceeds the fair value of the reporting unit. For the years ended December 31, 2020, 2019 and 2018, there were no impairment losses recorded. At October 31, 2020, the fair value substantially exceeded the carrying value at all reporting units.
Determining the fair value of a reporting unit requires judgment and the use of significant estimates which include assumptions about the Company's future revenue, profitability and cash flows, amount and timing of estimated capital expenditures, inflation rates, risk adjusted capital cost, operational plans, and current and future economic conditions, among others. The fair value of each reporting unit is determined using a weighted combination of income and market approaches. The Company uses a discounted cash flow methodology for its income approach. Under the income approach, the discounted cash flow model determines fair value based on the present value of projected cash flows over a specified period and a residual value related to future cash flows beyond the projection period. Both values are discounted using a rate which reflects the best estimate of the risk adjusted capital cost at each reporting unit. Risk adjusted capital cost, which varies by reporting unit and was in the range of 4 percent to 8 percent, was utilized in the goodwill impairment test performed in the fourth quarter of 2020. The goodwill impairment test also utilized a long-term growth rate projection, which varies by reporting unit and was in the range of approximately 1 percent to 3 percent, in the goodwill impairment test performed in the fourth quarter of 2020. Under the market approach, the Company estimates fair value using various multiples derived from enterprise value to EBITDA for comparative peer companies for each respective reporting unit. These multiples are applied to operating data for each reporting unit to arrive at an indication of fair value. In addition, the Company adds a reasonable control premium when calculating the fair value utilizing the peer multiples, which is estimated as the premium that would be received in a sale in an orderly transaction between market participants. The Company believes that the estimates and assumptions used in its impairment assessments are reasonable and based on available market information.
Business combinations
The Company accounts for acquisitions on the Consolidated Financial Statements starting from the date of the acquisition, which is the date that control is obtained. The acquisition method of accounting requires acquired assets and liabilities assumed be recorded at their respective fair values as of the date of the acquisition. The excess of the purchase price over the fair value of the assets acquired and liabilities assumed is recorded as goodwill. The estimation of fair values of acquired assets and liabilities assumed by the Company requires significant judgment and requires various assumptions. Although independent appraisals may be used to assist in the determination of the fair value of certain assets and liabilities, the appraised values may be based on significant estimates provided by management. The amounts and useful lives assigned to depreciable and amortizable assets compared to amounts assigned to goodwill, which is not amortized, can affect the results of operations in the period of and periods subsequent to a business combination.
In determining fair values of acquired assets and liabilities assumed, the Company uses various observable inputs for similar assets or liabilities in active markets and various unobservable inputs, which includes the use of valuation models. Fair values are based on various factors including, but not limited to, age and condition of property, maintenance records, auction values for equipment with similar characteristics, recent sales and listings of comparable properties, data collected from drill holes and other subsurface investigations and geologic data. The Company primarily uses the market and cost approaches in determining the fair value of land and property, plant and equipment. A combination of the market and income approaches are used for aggregate reserves and intangibles, primarily a discounted cash flow model.
There is a measurement period after the acquisition date during which the Company may adjust the amounts recognized for a business combination. Any such adjustments are recorded in the period the adjustment is determined with the corresponding offset to goodwill. These adjustments are typically based on obtaining additional information that existed at the acquisition date regarding the assets acquired and the liabilities assumed. The measurement period ends once the Company has obtained all necessary information that existed as of the acquisition date, but does not extend beyond one year from the date of the acquisition. Once the measurement period has ended, any adjustments to assets acquired or liabilities assumed are recorded in income from continuing operations.
Regulatory accounting
The Company is subject to rate regulation by state public service commissions and/or the FERC. The Company's regulated businesses account for certain income and expense items under the provisions of regulatory accounting, which require these businesses to defer as regulatory assets or liabilities certain items that would have otherwise been reflected as expense or income, respectively, based on the expected regulatory treatment in future rates. Regulatory assets generally represent incurred or accrued costs that have been deferred and are expected to be recovered in rates charged to customers. Regulatory liabilities generally represent amounts that are expected to be refunded to customers in future rates or amounts collected in current rates for future costs.
Management continually assesses the likelihood of recovery in future rates of incurred costs and refunds to customers associated with regulatory assets and liabilities. Decisions made by the various regulatory agencies can directly impact the amount and timing of these items. Therefore, expected recovery or flowback of these deferred items generally is based on specific ratemaking decisions or precedent for each item. If future recovery of costs is no longer probable, the Company would be required to include those costs in the statement of income or accumulated other comprehensive income (loss) in the period in which it is no longer deemed probable. The Company believes that the accounting subject to rate regulation remains appropriate and its regulatory assets are probable of recovery in current rates or in future rate proceedings. At December 31, 2020 and 2019, the Company's regulatory assets were $447.9 million and $417.4 million, respectively, and regulatory liabilities were $459.5 million and $490.3 million, respectively.
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Revenue recognition
Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The recognition of revenue requires the Company to make estimates and assumptions that affect the reported amounts of revenue. The accuracy of revenues reported on the Consolidated Financial Statements depends on, among other things, management's estimates of total costs to complete projects because the Company uses the cost-to-cost measure of progress on construction contracts for revenue recognition.
To determine the proper revenue recognition method for contracts, the Company evaluates whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period. For most contracts, the customer contracts with the Company to provide a significant service of integrating a complex set of tasks and components into a single project. Hence, the Company's contracts are generally accounted for as one performance obligation.
The Company recognizes construction contract revenue over time using an input method based on the cost-to-cost measure of progress for contracts because it best depicts the transfer of assets to the customer which occurs as the Company incurs costs on the contract. Under the cost-to-cost measure of progress, the costs incurred are compared with total estimated costs of a performance obligation. Revenues are recorded proportionately to the costs incurred. This method depends largely on the ability to make reasonably dependable estimates related to the extent of progress toward completion of the contract, contract revenues and contract costs. Inasmuch as contract prices are generally set before the work is performed, the estimates pertaining to every project could contain significant unknown risks such as volatile labor, material and fuel costs, weather delays, adverse project site conditions, unforeseen actions by regulatory agencies, performance by subcontractors, job management and relations with project owners. Changes in estimates could have a material effect on the Company's results of operations, financial position and cash flows. For the years ended December 31, 2020 and 2019, the Company's total construction contract revenue was $3.1 billion and $2.8 billion, respectively.
Several factors are evaluated in determining the bid price for contract work. These include, but are not limited to, the complexities of the job, past history performing similar types of work, seasonal weather patterns, competition and market conditions, job site conditions, work force safety, reputation of the project owner, availability of labor, materials and fuel, project location and project completion dates. As a project commences, estimates are continually monitored and revised as information becomes available and actual costs and conditions surrounding the job become known. If a loss is anticipated on a contract, the loss is immediately recognized.