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.
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.
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The Company's operations involve risks that may result from catastrophic events.
The Company's operations, particularly those related to electric and natural gas 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 have occurred and may recur in the future which 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 current 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. Depressed oil and natural gas prices, however, place pressure on the ability of oil exploration and production companies to meet credit requirements and can 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 products and services, 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 margins realized and demand for construction materials and related contracting services.
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COVID-19 may have a negative impact on the Company's business operations, revenues, results of operations, liquidity and cash flows.
The ongoing COVID-19 pandemic has disrupted national, state and local economies. To the extent the COVID-19 pandemic adversely impacts the Company's businesses, operations, revenues, liquidity or cash flows, it could also have a heightened effect on other risks described in this section. The degree to which COVID-19 will impact the Company depends on future developments, including the resurgence of COVID-19 and its variants, federal and state mandates, actions taken by governmental authorities, effectiveness of vaccines being administered, and the pace and extent to which the economy recovers and remains under relatively normal operating conditions.
The Company's operations have experienced minor disruptions due to shortages of employees or third-party contractors and altered work operations. Government and customer vaccine mandates could leave the Company with a shortage of vaccinated employees or reduce workforce capacity to bid on new projects, which may further exacerbate the already tight labor markets for skilled employees or cause additional wage inflation. The Company could also be impacted by additional costs and lost productivity associated with COVID-19 testing and tracking of employee vaccination records. If a significant percentage of the Company's workforce are unable to work because of illness, quarantine, vaccination requirements 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.
In response to the COVID-19 pandemic, the Company implemented a remote work environment for certain employees of the Company's workforce. As of July 2021, many of these employees returned to their office; however, some employees have transitioned to a permanent remote work environment. The increase in remote work and longevity of the pandemic may create increased vulnerability to cybersecurity incidents affecting the Company’s ability to maintain secure operations.
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 employees and contractors; extended rise in unemployment; public and private sector budget changes and constraints; continued flexible payment plans for utility customers; 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, accounting for the impacts of the COVID-19 pandemic and recovery of invested capital. The economic and market disruptions resulting from COVID-19 could also lead to greater than normal uncertainty with respect to the realization of estimated amounts, including estimates for backlog, revenue recognition, intangible assets, other investments and provisions for credit losses.
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.
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 pipeline, 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.
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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, all of which have occurred and may recur in the future resulting in material costs. 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.
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, among other things. 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.
The Company's participation in joint venture contracts may have a negative impact on its reputation, business operations, revenues, results of operations, liquidity and cash flows.
The Company enters into certain joint venture arrangements typically to bid and execute particular projects. Generally, these agreements are directly with a third-party client; however, services may be performed by the venture, the joint venture partners or a combination thereof. Engaging in joint venture contracts exposes the Company to risks and uncertainties, some of which are outside the Company's control.
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The Company is reliant on joint venture partners to satisfy their contractual obligations, including obligations to commit working capital and equity, and to perform the work as outlined in the agreement. Failure to do so could result in the Company providing additional investments or services to address such performance issues. If the Company is unable to satisfactorily resolve any partner performance issues, the customer could terminate the contract opening the Company to legal liability which could negatively impact the Company's reputation, revenues, results of operations, liquidity and cash flows.
Supply chain disruptions may adversely affect Company operations.
The Company relies on third-party vendors and manufacturers to supply many of the materials necessary for its operations. Disruptions or delays in receiving materials; price increases from suppliers or manufacturers; or inability to source needed materials could adversely affect the Company’s results of operations, financial condition and cash flows.
Environmental and Regulatory Risks
The Company's operations could be adversely impacted by climate change.
Severe weather events, such as tornadoes, hurricanes, rain, drought, 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 and increase maintenance or capital costs to repair facilities and restore customer service. The cost of providing service could increase if 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 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 federal 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 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 result in less competitive terms and conditions.
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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 and disclosure costs and 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 42 percent of Montana-Dakota's owned generating capacity and approximately 69 percent of the electricity it generated in 2021 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 and pipeline 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 or insurance 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 could adversely affect the Company's operations, revenues and cash flows.
The Company's results of operations could 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.
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
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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 businesses 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 and acquisition opportunities 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. Due to the changing workforce demographics and a lack of younger employees who are qualified to replace employees as they retire and remote work opportunities, among other things, competition for these employees is high. 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'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 69 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 28 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 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.
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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.
Technology disruptions or cyberattacks 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 and operation 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 physical and cybersecurity failures or unauthorized access, due to:
•hacking,
•human error,
•theft,
•sabotage,
•malicious software,
•ransomware,
•third-party compromise,
•acts of terrorism,
•acts of war,
•acts of nature or
•other causes.
Although there are manual processes in place, should a compromise or system failure occur, interdependencies to technology may disrupt the Company's ability 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, the Company's electric generation and transmission systems and natural gas pipelines are part of interconnected systems with other operators’ facilities; therefore, 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 and remediation costs that could adversely affect the Company's results of operations and cash flows.
The Company is subject to cybersecurity and privacy laws, regulations and security directives of many government agencies, including TSA, 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, proceedings and regulatory fines or penalties.
The Company, through the ordinary course of business, requires access to sensitive customer, supplier, employee and Company data. While the Company has implemented extensive security measures, including limiting the amount of sensitive information retained, 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 ongoing and often sophisticated cyberattacks by a variety of sources with the apparent aim to breach the Company's cyber-defenses. Although the incidents the Company has experienced to date have not had a material effect on its business, financial condition or results of operations, such incidents could have a material adverse effect in the future as cyberattacks continue to increase in frequency and sophistication. 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. System disruptions, if not anticipated and appropriately mitigated, could adversely affect the Company.
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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.
•Succession planning.
•Inability of 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.
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.
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The Company's common stock is listed on the New York Stock Exchange under the symbol "MDU."
As of December 31, 2021, the Company's common stock was held by approximately 9,900 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 84 consecutive years with an increase in the payout amount for the last 31 consecutive years. The declaration and payment of dividends is at the sole discretion of the board of directors, subject to limitations imposed by agreements governing the Company's indebtedness, 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, 2021 — — — —
(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 and for those directors who elected to receive additional shares of common stock in lieu of a portion of their cash retainer.
(2) Not applicable. The Company does not currently have in place any publicly announced plans or programs to purchase equity securities.
Item 6.
Reserved.
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The Company is Building a Strong America® by providing essential infrastructure 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 America moving with the products and services provided, which include powering, heating and connecting homes, factories, offices and stores; and building roads, highways, data infrastructure and airports.
The Company'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 nearly every state and during peak construction season has employed over 16,000 employees. The Company’s organic investments are strong drivers of high-quality earnings and continue to be an important part of the Company’s growth. Management believes the Company is well positioned in the industries and markets in which it operates.
The Company continues to effectively execute its strategy while managing the ongoing effects of the COVID-19 pandemic. Since early 2020, the Company has maintained its business continuity plans as well as a task force to monitor developments related to the pandemic allowing the Company to continue to provide safe and reliable services. Most of the Company's products and services are considered essential to its country and communities and, as a result, operations have generally continued throughout the pandemic.
Certain of the Company's supply vendors are facing production and staffing challenges as they work to achieve production capacity and lead times consistent with pre-pandemic levels. Coupled with other challenges of the pandemic, these vendors are also experiencing strong demand from the residential construction market, some industrial segments and some utility infrastructure investments. In addition, freight markets continue to have challenges with driver shortages; strong demand for consumer goods; extended lead times; and costs for vehicles, driver retention and recruitment. The Company has implemented measures to proactively order supplies and work with additional suppliers to ensure work continues without delays; however, the Company has experienced some delays on delivery of certain materials as well as cost pressures from supply chain disruptions and commodity price inflation.
The situation surrounding COVID-19 and the potential impacts on the Company and the economy remain fluid. A number of factors could directly impact the Company and the economy, including a widespread resurgence in COVID-19 infections, whether due to the spread of variants of the virus or otherwise; the rate of vaccinations; vaccine mandates; labor constraints; the strength of the global supply chain; and the rate in which governments are re-opening businesses or, in certain jurisdictions, reversing re-opening decisions. Due to the uncertainty of the economic outlook resulting from the COVID-19 pandemic, the Company continues to monitor the situation closely. 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 years ended December 31, 2021 or 2020. The Company will continue to adjust its business in response to the pandemic while positioning for potential opportunities to enhance its competitive position. For more information specific to each of the Company's business segments, see the following discussions in each business segment's Outlook section. 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 .4 (.3) .3
Earnings per share - basic:
Income from continuing operations $ 1.87 $ 1.95 $ 1.69
Discontinued operations, net of tax — — —
Earnings per share - basic $ 1.87 $ 1.95 $ 1.69
Earnings per share - diluted:
Income from continuing operations $ 1.87 $ 1.95 $ 1.69
Discontinued operations, net of tax — — —
Earnings per share - diluted $ 1.87 $ 1.95 $ 1.69
2021 compared to 2020 The Company's consolidated earnings decreased $12.1 million.
Negatively impacting the Company's earnings was a decrease in gross margin across most product lines at the construction materials and contracting business resulting from labor constraints; increased material costs, including asphalt oil and fuel; higher equipment, repair and maintenance costs; and less available paving work in certain regions. The decrease was partially offset by higher AFUDC for the construction of the North Bakken Expansion project and higher earnings due to increased natural gas transportation volumes at the pipeline business. Also positively impacting earnings were higher adjusted gross margins at the electric and natural gas businesses, largely a result of approved rate relief in certain jurisdictions, partially offset by higher operations and maintenance expenses.
2020 compared to 2019 The Company's consolidated earnings increased $54.7 million.
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-mix concrete, as well as most other product lines. The construction services business also experienced an increase in gross margin as a result of higher 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.
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 responsible, 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, climate change initiatives, competitive factors in the energy industry, population growth and economic conditions in the segments' service areas.
The electric and natural gas distribution segments are subject to extensive regulation in the jurisdictions where they conduct operations with respect to costs, timely recovery of investments and permitted returns on investment. The Company is focused on modernizing utility infrastructure to meet the varied energy needs of both its customers and communities while ensuring the delivery of safe, environmentally responsible, reliable and affordable energy. The segments continue to invest in facility upgrades to be in compliance with existing and known future regulations. To assist in the reduction of regulatory lag in obtaining revenue increases to align with increased investments, tracking mechanisms have been implemented in certain jurisdictions, as further discussed in Items 1 and 2 - Business Properties and Item 8 - Note 20.
The segments are also subject to extensive regulation including certain operational and environmental compliance, cybersecurity, permit terms and system integrity. The natural gas segment recently implemented procedure changes issued by PHSMA that were effective July 1, 2021. Both segments are faced with the ongoing need to actively evaluate cybersecurity processes and procedures related to its transmission and distribution systems for opportunities to further strengthen its cybersecurity protections. Implementation of enhancements and additional requirements is ongoing.
To date, many states have enacted and others are considering, mandatory clean energy standards requiring utilities to meet certain thresholds of renewable and/or carbon-free energy supply. The current presidential administration has made climate change a focus, including consideration for legislation on clean energy standards and GHG emission, and the Company expects that to continue. Over the long-term, the Company expects overall electric demand to be positively impacted by increased electrification trends, including electric vehicle adoption, as a means to address economy-wide carbon emission concerns and changing customer conservation patterns. These initiatives could result in increased costs to produce electricity and procure natural gas. To date, the impact of these initiatives on the Company is unknown. The Company will continue to monitor the progress of these initiatives and assess the potential impacts they may have on its stakeholders, business processes, results of operations, cash flows and disclosures.
Revenues are impacted by both customer growth and usage, the latter of which is primarily impacted by weather, as well as impacts associated with commercial and industrial slow-downs, including economic recessions, and energy efficiencies. Very cold winters increase demand for natural gas and to a lesser extent, electricity, while warmer than normal summers increase demand for electricity, especially among residential and commercial customers. Average consumption among both electric and natural gas customers has tended to decline as more efficient appliances and furnaces are installed, and as the Company has implemented conservation programs. Natural gas weather normalization and decoupling mechanisms in certain jurisdictions have been implemented to largely mitigate the effect that would otherwise be caused by variations in volumes sold to these customers due to weather and changing consumption patterns on the Company's distribution margins, as further discussed in Items 1 and 2 - Business Properties.
In February 2021, a prolonged period of unseasonably cold temperatures in the central United States significantly increased the demand for electric and natural gas services and contributed to increased market prices. The Company's transmission settlement process with SPP helped offset the increased energy costs to electric customers during the cold-weather event. Further, in some jurisdictions the Company utilized natural gas in storage to lessen the impact of high natural gas costs. Overall, Montana-Dakota and Great Plains incurred approximately $44.0 million in increased natural gas costs in order to maintain services for its customers. These extraordinary natural gas costs were recorded as regulatory assets as they are expected to be recovered from customers. Montana-Dakota and Great Plains have received approval for the recovery of purchased gas adjustments related to the cold-weather event in all jurisdictions impacted, including out-of-cycle purchased gas adjustment requests in most jurisdictions. The approval in Minnesota is subject to a prudence review by the MNPUC, which is pending, with an order to be issued on or before August 29, 2022. For a discussion of the Company's most recent cases by jurisdiction, see Item 8 - Note 20.
The electric and natural gas distribution segments continue to face increased lead times on delivery of certain raw materials and equipment used in electric transmission and distribution system and natural gas pipeline projects. Long lead times are attributable to increased demand for steel products from pipeline companies as they continue pipeline system safety and integrity replacement projects driven by PHMSA regulations, as well as delays in the manufacturing of electrical equipment as a result of the COVID-19 pandemic, including delays in shipping times and issuance of permits for large and heavy loads. The Company did not experience significant impacts from these delays for the year ended December 31, 2021.
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However, the Company continues to monitor the material lead times and is working with manufacturers to proactively order such materials and working with additional suppliers to help mitigate the risk of any delays.
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 new electric generating facilities, transmission lines and other service facilities is subject to increasing costs and lead times, extensive permitting procedures, and federal and state legislative and regulatory initiatives, which may necessitate increases in electric energy prices.
Earnings overview - The following information summarizes the performance of the electric segment.
(In millions)
Taxes, other than income .8 .6 .6 33.3 % — %
Operating expenses:
Depreciation, depletion and amortization 66.8 63.0 58.7 6.0 % 7.3 %
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.
Operating statistics
Revenues (millions)
Retail sales:
Retail sales (million kWh)
Average cost of electric fuel and purchased power per kWh $ .021 $ .019 $ .023
2021 compared to 2020 Electric earnings decreased $3.7 million as a result of:
•Adjusted gross margin increased $10.2 million attributable to:
◦Higher transmission revenues of $3.3 million.
◦Higher transmission interconnect upgrades of $2.4 million.
◦Higher MISO revenue of $2.0 million.
◦Higher demand revenues of $1.5 million.
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◦Increased retail sales volumes of 2.1 percent, largely as a result of increased industrial and commercial sales volumes, offset in part by lower residential sales volumes, as the impacts of the COVID-19 pandemic began to reverse and businesses reopened.
•Operation and maintenance increased $3.6 million.
◦Primarily the result of:
•Higher planned maintenance outage costs of $2.1 million at Big Stone Station and $800,000 higher maintenance fees at Thunder Spirit.
•Higher other miscellaneous expenses.
◦Partially offset by lower payroll-related costs of $700,000, which includes lower employee incentive accruals, offset in part by higher health care costs.
•Depreciation, depletion and amortization increased $3.8 million largely resulting from:
◦Increased property, plant and equipment balances, primarily related to transmission projects placed in service.
◦Increased amortization of plant retirement and closure costs of $1.7 million recovered in operating revenues, as discussed in Item 8 - Note 6.
•Taxes, other than income was comparable to the same period in the prior year.
•Other income decreased $2.6 million.
◦Primarily due to:
•The absence of an out-of-period adjustment of $2.5 million in 2020 as a result of previously overstated benefit plan expenses.
•Lower returns on certain of the Company's benefit plan investments of $1.3 million.
◦Partially offset by increased interest income associated with higher contributions in aid of construction.
•Interest expense was comparable to the same period in the prior year.
•Income tax benefit decreased $4.0 million largely resulting from:
◦Lower production tax credits of $2.1 million related to the expiration of the 10-year credit-qualifying period on certain facilities and less wind generation.
◦Lower excess deferred tax amortization.
2020 compared to 2019 Electric earnings increased $800,000 as a result of:
•Adjusted gross margin in 2020 was comparable to that of 2019.
◦Positively impacted by higher rates of $2.8 million, including approved rate relief resulting in $2.0 million additional revenue.
◦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 expense decreased $4.4 million.
◦Largely due to:
•Lower generation station expenses of $3.5 million.
•Lower payroll and other employee-related costs of approximately $1.5 million.
◦Partially offset by increased bad debt expense of $500,000 as a result of the COVID-19 pandemic, as discussed later.
•Depreciation, depletion and amortization increased $4.3 million largely from:
◦Increased asset base driven by capital expenditures, which include transmission projects.
◦Higher depreciation rates implemented from a Montana rate case of $1.2 million.
•Taxes, other than income increased $700,000 from higher property taxes in certain jurisdictions.
•Other income increased $3.8 million largely attributable to:
◦An out-of-period adjustment of $2.5 million in the fourth quarter of 2020 as a result of previously overstated benefit plan expenses.
◦The absence of the write-down of a non-utility investment in the second quarter of 2019 for $1.2 million.
◦Lower 2020 pension expense.
•Interest expense increased $1.4 million driven by higher short-term debt balances.
•Income tax benefit decreased $1.0 million, largely due to higher income before income taxes.
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Earnings overview - The following information summarizes the performance of the natural gas distribution segment.
(In millions)
Operating expenses:
Depreciation, depletion and amortization 86.0 84.6 79.6 1.7 % 6.3 %
* NM - not meaningful
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.
Operating statistics
Revenues (millions)
Retail sales:
Volumes (MMdk)
Retail sales:
Transportation sales:
Average cost of natural gas per dk $ 4.70 $ 3.91 $ 3.86
2021 compared to 2020: Natural gas distribution earnings increased $7.6 million as a result of:
•Adjusted gross margin increased $27.5 million.
◦Largely as a result of:
•Approved rate relief in certain jurisdictions of $15.9 million.
•Increased retail sales volumes of 0.7 percent across all customer classes, including the benefit of weather normalization and decoupling mechanisms in certain jurisdictions.
•Increased transportation volumes of 9 percent, primarily to electric generation customers.
•Higher non-regulated project revenues of $1.7 million.
•Increased basic service charges due to customer growth and increased per unit average rates of $1.5 million each.
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•Operation and maintenance increased $8.7 million.
◦Primarily due to:
•Higher payroll-related costs of $4.3 million, largely related to health care costs and straight-time payroll.
•Decreased credits of $2.4 million for costs associated with the installation of meters partially from delaying meter replacements for safety measures implemented as a result of the COVID-19 pandemic.
•Higher expenses for materials, new software, insurance and vehicle fuel.
◦Partially offset by:
•The absence of the write-off of an abandoned project in the third quarter of 2020 for $1.2 million.
•Decreased bad debt expense of $1.0 million as the impacts of the COVID-19 pandemic began to subside.
•Depreciation, depletion and amortization increased $1.4 million.
◦Largely from increased property, plant and equipment balances from growth and replacement projects placed in service.
◦Partially offset by decreased depreciation rates in certain jurisdictions of $4.0 million.
•Taxes, other than income increased $1.3 million resulting from:
◦Higher property taxes in certain jurisdictions of $700,000.
◦Higher payroll taxes driven by increased payroll-related costs.
•Other income decreased $5.4 million primarily related to:
◦The absence of an out-of-period adjustment of $4.4 million in 2020 as a result of previously overstated benefit plan expenses.
◦Decreased interest income related to the recovery of purchased gas cost adjustment balances in certain jurisdictions.
•Interest expense increased $500,000, primarily from lower AFUDC borrowed.
•Income tax expense increased $2.6 million due to higher income before income taxes.
2020 compared to 2019 Natural gas distribution earnings increased $4.5 million as a result of:
•Adjusted gross margin increased $10.4 million.
◦Largely the result of:
•Approved rate recovery of $6.8 million in certain jurisdictions.
•Higher basic service charges of $2.1 million due to customer growth of 2 percent.
•Increased property tax tracker revenue of $1.7 million, which offsets the property tax expense below.
◦Slightly offset by decreased 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, largely offset by weather normalization and decoupling mechanisms in certain jurisdictions.
•Operation and maintenance increased $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.
•Increased software expenses.
◦Partially offset by lower employee-related costs of $1.6 million as a result of the COVID-19 pandemic.
•Depreciation, depletion and amortization increased $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 increased $1.1 million due to:
◦Higher property taxes in certain jurisdictions of $1.7 million.
◦Partially offset by lower payroll taxes.
•Other income increased $6.3 million.
◦Largely driven by:
•An out-of-period adjustment of $4.4 million in the fourth quarter of 2020 as a result of previously overstated benefit plan expenses.
•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.
◦Partially offset by a decrease in interest income of $1.5 million related to the recovery of purchased gas cost adjustment balances.
•Interest expense increased $1.3 million, primarily attributable to increased long-term debt balances, partially offset by lower short-term borrowings.
•Income tax expense increased $4.4 million as a result of:
◦Higher income before income taxes.
◦Permanent tax adjustments.
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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 2020, 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, and continued to adjust and reduce these measures in 2021. In April 2020, the Company waived late payment fees to help customers experiencing financial hardships. As of October 2021, the Company had reinstated disconnects in all states of operation and late payment fees in a majority of states. As a consequence of the suspended disconnects and waived late fees, the Company's cash flows and collection of receivables have been affected but impacts have not been material. The Company 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, which began to transition back to historic levels in 2021. The Company filed requests for the use of deferred accounting for costs related to the COVID-19 pandemic in all of the jurisdictions in which it operates and has since withdrawn its applications in three of those jurisdictions. The Company has deferred an immaterial amount of costs related to the pandemic to date.
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 2021 and 2020, these segments experienced retail customer growth of approximately 1.7 percent and 1.8 percent, respectively, and the Company expects customer growth to continue to average 1 percent to 2 percent per year. This customer growth, along with system upgrades and replacements needed to supply safe and reliable service, will require investments in new and replacement electric and natural gas systems. On July 1, 2021, the Company filed in North Dakota, and provided a courtesy copy to South Dakota, an integrated resource plan for the electric segment, which included the Company's plans for future resources to meet customer demand. This integrated resource plan was filed in Montana on September 15, 2021.
These segments are exposed to energy price volatility and may be impacted by changes in oil and natural gas exploration and production activity. Rate schedules in the jurisdictions in which the Company's natural gas distribution segment operates contain clauses that permit the Company to file for rate adjustments for changes in the cost of purchased 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. During the third and fourth quarters of 2021, the Company experienced increased natural gas prices and expects this trend to continue through the winter due to the increase in demand outpacing the supply. The Company will continue to monitor natural gas prices, as well as oil and natural gas production levels.
In February 2019, the Company announced the retirement of 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 Company ceased operations on March 31, 2021, of Unit 1 at Lewis & Clark Station in Sidney, Montana, and commenced decommissioning in July 2021. Units 1 and 2 at Heskett Station near Mandan, North Dakota, are being retired during the first quarter of 2022. In addition, during the first half of 2022, the Company will begin construction of Heskett Unit 4, an 88-MW simple-cycle natural gas-fired combustion turbine peaking unit at the existing Heskett Station near Mandan, North Dakota.
The Company is one of four owners of Coyote Station and cannot make a unilateral decision on the plant's future; therefore, the Company could be negatively impacted by decisions of the other owners. State implementation of pollution control plans to improve visibility at Class I areas, such as national parks, under the EPA's Regional Haze Rule could require the owners of Coyote Station to incur significant new costs. If the owners decide to incur such costs, the costs could, dependent on determination by state regulatory commissions on approval to recover such costs from customers, negatively impact the Company's results of operations, financial position and cash flows. The NDDEQ submitted a draft state implementation plan to the EPA and federal land managers of the National Park Service, the United States Fish and Wildlife Service and the United States Forest Service for consultation, and the federal land managers have submitted comments back to the NDDEQ for review. North Dakota determined it is not reasonable to require controls during this planning period. The emissions modeling conducted for the combined western state agencies affected by the Regional Haze Rule was delayed and has subsequently delayed the NDDEQ state implementation plan process. Therefore, the NDDEQ's state implementation plan, which was due to the EPA by July 2021, is anticipated to be submitted to EPA in the first half of 2022. Additionally, in September 2021, Otter Tail Power Company filed its 2022 Integrated Resource Plan in Minnesota and North Dakota which included its intent to start the process of withdrawal from its 35 percent ownership interest in Coyote Station with an anticipated exit from the plant by December 31, 2028. The joint owners continue to collaborate in analyzing data and weighing decisions that impact the plant and each company's employees, customers and communities served.
The Company continues to monitor legislation related to clean energy standards that may impact its segments. The current presidential administration is considering changes to the federal Clean Air Act, some of which were amended by the previous presidential administration. The content and impacts of the changes under consideration are uncertain and the Company continues to monitor for potential actions by the EPA. In Oregon, the Climate Protection Program Rule was approved in December 2021, which requires natural gas companies to reduce GHG emissions 50 percent below the baseline by 2035 and 90 percent below the baseline by 2050, which may be achieved through surrendering emissions allowances, investing in additional customer conservation and energy efficiency programs, purchasing community climate investment credits, and purchasing low carbon fuels such as renewable natural gas. The Company expects the compliance costs for these regulations to be recovered through customer rates. In Washington, the Climate Commitment Act signed into law in May 2021 requires natural gas distribution companies to reduce overall GHG emissions 45 percent below 1990 levels by 2030, 70 percent below 1990 levels by 2040 and 95 percent below 1990 levels by 2050, which may be achieved through increased energy efficiency and conservation measures, purchased emission allowances and offsets, and purchases of low carbon fuels. The Washington DOE has begun the Climate Commitment Program rule-making process and is expected to publish a final rule in the
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fall of 2022. The Company has begun reviewing compliance options and expects the compliance costs for these regulations will be recovered through customer rates.
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.
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 following were organic growth projects for the Company in 2021 and 2020:
•The North Bakken Expansion project in western North Dakota, construction began in July of 2021 and was placed in service in February of 2022. The project has capacity to transport 250 MMcf of natural gas per day and can be increased to 625 MMcf per day with additional compression.
•Phase II of the Line Section 22 Expansion project in the Billings, Montana, area was placed in service in September of 2020. The completion of Phase I and II increased capacity by 22.5 MMcf per day.
•The Demicks Lake Expansion project in McKenzie County, North Dakota, was placed in service in February of 2020 and increased capacity by 175 MMcf per day.
In April 2020 and November 2020, the Company completed the sales of its regulated and non-regulated natural gas gathering assets, respectively. With the completion of these sales, the Company has exited the natural gas gathering business.
The segment is exposed to energy price volatility which is impacted by the fluctuations in pricing, production and basis differentials of the energy market's commodities. Legislative and regulatory initiatives on increased pipeline safety regulations and environmental matters such as the reduction of methane emissions could also impact the price and demand for natural gas.
The pipeline segment is also subject to extensive regulation including certain operational and environmental compliance, cybersecurity, permit terms and system integrity. The Company continues to actively evaluate cybersecurity processes and procedures, including changes in the industry's cybersecurity regulations, for opportunities to further strengthen its cybersecurity protections. Implementation of enhancements and additional requirements is ongoing. The pipeline segment recently implemented procedural changes for additional regulations to strengthen the safety of natural gas transmission and storage facilities and hazardous liquid pipelines issued by PHSMA that were 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 natural gas pipelines could also cause negative impacts on the segment with increased costs, potential delays to project completion or cancellation of prospective projects.
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 construction projects potentially causing lost revenues and/or increased costs. Current national supply chain challenges did not have significant impacts to the procurement of raw materials for the year ended December 31, 2021. However, the Company is actively monitoring the situation and working with its manufacturers and suppliers to help mitigate the risk of delays.
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.
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Earnings overview - The following information summarizes the performance of the pipeline segment.
(In millions)
Operating expenses:
Depreciation, depletion and amortization 20.5 21.7 21.2 (5.5) % 2.4 %
Operating statistics
Natural gas gathering volumes (MMdk) — 8.6 13.9
Customer natural gas storage balance (MMdk):
Net injection (withdrawal) (2.5) 9.3 2.3
2021 compared to 2020 Pipeline earnings increased $3.9 million as a result of:
•Revenues decreased $1.3 million.
◦Primarily decreased gathering revenues of $4.9 million due to the sale of the Company's natural gas gathering assets in 2020.
◦Partially offset by:
•Increased transportation volumes and demand revenue of $1.8 million largely from organic growth projects, as previously discussed, and short-term discounted contracts.
•Increased non-regulated project revenues of $1.4 million.
•Operation and maintenance increased $1.4 million due to:
◦The absence of the gain on sale of the Company's natural gas gathering assets of $1.5 million in 2020, offset partially by lower operating expenses related to the natural gas gathering assets.
◦Partially offset by lower payroll-related costs.
•Depreciation, depletion and amortization decreased $1.2 million.
◦Primarily related to lower expense of $1.6 million due to the sale of the Company's natural gas gathering assets in 2020, as previously discussed.
◦Slightly offset by increased property, plant and equipment balances related to organic growth projects.
•Taxes, other than income was comparable to the same period in the prior year.
•Other income increased $6.5 million.
◦Primarily due to:
•Higher AFUDC of $7.3 million for the construction of the North Bakken Expansion project.
•The absence of the write-off of unrecovered gas costs and project expenses of $1.2 million in 2020.
◦Partially offset by:
•The absence of a positive impact of $700,000 related to the sale of the Company's regulated gathering assets in 2020.
•The absence of an out-of-period adjustment of $500,000 in 2020 as a result of previously overstated benefit plan expenses.
•Lower returns on certain of the Company's benefit plan investments.
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•Interest expense decreased $600,000.
◦Primarily due to:
•Higher AFUDC of $1.5 million for the construction of the North Bakken Expansion project.
•Lower average interest rates.
◦Partially offset by higher debt balances.
•Income tax expense increased $1.9 million.
◦Largely a result of:
•Higher income before income taxes.
•The absence of the reversal of excess deferred taxes of $1.5 million associated with the sale of the Company's gas gathering assets in 2020.
◦Partially offset by permanent tax adjustments and an energy efficiency tax benefit.
2020 compared to 2019 Pipeline earnings increased $7.4 million as a result of:
•Revenues increased $3.5 million.
◦Primarily the result of:
•Increased transportation volumes and demand revenue of $6.2 million largely from organic growth projects, as previously discussed.
•Increased storage-related revenues of $4.6 million as a result of stronger demand for storage services.
•Additional revenues of $2.4 million primarily from increased rates effective May 1, 2019, due to the FERC rate case finalized in September 2019.
◦Partially offset by:
•Lower non-regulated project revenues of $5.3 million.
•Lower volumes associated with the sale of the Company's natural gas gathering assets in 2020 and lower gathering rates resulting in a decrease in revenues of $4.3 million.
•Operation and maintenance decreased $3.2 million.
◦Largely driven by:
•Decreased non-regulated project costs of $3.7 million associated with lower non-regulated project revenue.
•A $1.5 million gain on the sale of the Company's non-regulated natural gas gathering assets in 2020.
◦Partially offset by higher payroll-related costs.
•Depreciation, depletion and amortization increased $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.
•Higher depreciation rates effective May 1, 2019, due to the FERC rate case finalized in September 2019.
◦Partially offset by lower expense of $1.5 million due to the sale of the Company's natural gas gathering assets in 2020.
•Taxes, other than income decreased $400,000.
◦Driven by lower expense due to the sale of the Company's natural gas gathering assets in 2020.
◦Partially offset by higher property taxes in certain jurisdictions of $300,000.
•Other income increased $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.
•An out-of-period adjustment of $500,000 in the fourth quarter of 2020 as a result of previously overstated benefit plan expenses.
◦Partially offset by a write-off of unrecovered gas costs and project expenses of $1.2 million.
•Interest expense increased $400,000, primarily from higher debt balances to finance organic growth projects.
•Income tax expense increased $500,000.
◦Directly resulting from higher income before income 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.
OutlookThe Company continues to 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. Overall, the pipeline business has experienced some impacts due to COVID-19 and does not expect significant delays to its regulatory filings or projects due to the pandemic.
In February 2021, the FERC issued a revised notice of inquiry seeking new information and stakeholder perspectives regarding the certification of new interstate natural gas facilities. The FERC issued the original notice of inquiry seeking stakeholder perspectives on this topic in April 2018. The FERC also took a step toward reforming the way in which it analyzes GHG emissions for purposes of natural gas pipeline certificates by including a quantitative analysis of the GHG emissions associated with a pipeline replacement project. At this time, no accepted methodology for a GHG
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significance calculation has been established. A technical conference led by FERC Staff discussing methods natural gas companies may use to mitigate the effects of direct and indirect GHG emissions was held on November 19, 2021. No clear guidance resulted from the conference and comments regarding various questions raised at the conference were due to the FERC on January 7, 2022. On February 18, 2022, the FERC issued two policy statements. The first is an updated certificate policy statement which will apply in pending and future certificate proceedings and is intended to explain how the FERC will consider applications to construct new interstate natural gas transportation facilities to determine whether a project is in the public convenience and necessity. This updated policy statement includes increased focus on the project purpose and need and environmental impacts. This update also focuses on impacts to landowners and environmental justice communities. The second is an interim policy statement which explains how the FERC will assess the impacts of natural gas infrastructure projects on climate change in its reviews under the National Environmental Policy Act and Natural Gas Act. Under the interim version of the policy statement, the FERC will proceed with the preparation of an environmental impact statement if a project may result in emissions of 100,000 metric tons per year of carbon dioxide equivalents or more. Comments are due on the interim policy statement by April 4, 2022. The Company continues to monitor and assess these initiatives and the potential impacts they may have on its business processes, current and future projects, results of operations and disclosures.
The Company has continued to experience the effect of associated natural gas production in the Bakken, which has provided opportunities for organic growth projects and increased demand. The completion of organic growth projects has contributed to the volumes of natural gas the Company transports through its system. Although low oil prices slowed 2020 drilling activities and led to the shut-in of certain wells, the recovery of oil prices has allowed producers to bring wells back online and support new drilling. Associated natural gas production in the Bakken has returned to near pre-pandemic levels and is expected to grow due to new oil wells and increasing gas to oil ratios.
The national record levels of natural gas supply has moderated the 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, the long-term outlook for low natural gas prices continues to provide growth opportunity for industrial supply related projects and seasonal pricing differentials provide opportunities for storage services.
The Company continues to focus on growth and improving existing operations through organic projects in all areas in which it operates, which includes additional organic growth projects with local distribution companies and industrial customers in various stages of development.
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. Long-term take or pay customer contracts support the project at an amended design capacity of 250 MMcf per day, which can be readily expanded to meet forecasted natural gas growth levels and customer needs. In February 2020, the Company filed with the FERC its application for this project. In June 2021, the Company received a FERC order issuing a certificate of public convenience and necessity for the project and in July 2021, the FERC granted the Company a notice to proceed with construction. Construction began in July 2021 and the project was placed into service on February 1, 2022.
In July 2021, the Company announced plans for a natural gas pipeline expansion project in eastern North Dakota. The Wahpeton Expansion project consists of 60 miles of pipe and ancillary facilities and is designed to increase capacity by 20 MMcf per day, which is supported by long-term customer agreements with Montana-Dakota and its utility customers. Construction is expected to begin in early 2024, depending on regulatory approvals, with an anticipated completion date later in 2024. On September 22, 2021, the Company filed with the FERC a request to initiate the pre-filing review process and received FERC approval of the pre-filing request on September 27, 2021.
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 strategic 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, asphalt oil, asphalt concrete, ready-mix 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 1.2 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 it to manage operations from aggregate mining to final lay-down of concrete and asphalt, with control of and access to permitted aggregate reserves being significant. The Company's aggregate reserves are naturally declining and as a result, the Company seeks acquisition opportunities to replace the reserves. In the fourth quarter of 2021, the Company acquired Baker Rock Resources, an aggregates and asphalt supplier located in Beaverton, Oregon. The acquisition included approximately 80 million tons of proven aggregate reserves. In the first quarter of 2021, the Company received the necessary permitting to expand its operation capabilities at its Honey Creek quarry near Austin, Texas. Honey Creek contains an estimated 50 million tons of proven aggregate reserves.
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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, asphalt oil, 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. The Company has and will continue to increase its product pricing to keep pace with rising costs. 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.
The segment also faces challenges in the recruitment and retention of employees. Trends in the labor market include an aging workforce and availability issues. Most of the markets the segment operates in saw an increase in labor shortages in 2021, largely truck drivers, causing increased labor-related costs. The Company continues to monitor the labor markets and expects labor costs to continue to increase based on the increased demand for services and, to a lesser extent, the recent escalated inflationary environment in the United States. If labor costs continue to increase, it could negatively impact gross margin as the segment continues to face increasing pressure to control costs. The increase in labor shortages also impacts the segments ability to recruit and train a skilled workforce to meet the needs of increasing demand and seasonal work. In order to help attract new workers to the construction industry and enhance the skills of its current employees, the Company has completed a training facility in Oregon. The training facility offers hands-on training for heavy equipment operators and truck drivers, as well as leadership and safety training.
Earnings overview - The following information summarizes the performance of the construction materials and contracting segment.
(In millions)
Cost of sales:
Selling, general and administrative expense:
Depreciation, depletion and amortization 4.2 4.8 3.1 (12.5) % 54.8 %
Total selling, general and administrative expense 98.5 99.6 94.0 (1.1) % 6.0 %
Operating statistics Revenues Gross margin
(In millions)
*Other products includes cement, asphalt oil, merchandise, fabric, spreading and other products that individually are not considered to be a major line of business for the segment.
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Sales (thousands):
Average sales price:
2021 compared to 2020 Construction materials and contracting's earnings decreased $17.5 million as a result of:
•Revenues increased $50.9 million.
◦Largely the result of:
•Higher aggregate sales volumes from the recent acquisitions contributed $20.1 million and strong demand for airport, commercial and health care work in Oregon added $16.3 million. Also contributing was an additional $1.6 million due to a few large projects in South Dakota. These increases were partially offset by lower volumes in Texas of $2.0 million driven by lower energy-related sales volumes.
•Higher ready-mix concrete volumes from increased commercial and residential demand in Texas contributed $8.2 million, strong demand in Oregon added $7.8 million and recent acquisitions contributed an additional $4.5 million. Ready-mix concrete revenues also benefited from an increase in average sales price in all regions. These increases were partially offset by decreased sales of $14.8 million due to lower demand in Hawaii as a result of the overall slowdown of the travel industry from COVID-19.
◦Partially offset by:
•Decreased contracting revenues partially due to less available paving work in certain regions of $60.0 million and the absence of a few large jobs in 2020 of $17.5 million. These decreases were offset in part by strong demand for health care, agency and commercial work in Oregon of $28.8 million.
•Decreased asphalt volumes primarily due to less available highway paving work in the public sector of $26.2 million in certain regions was partially offset by strong demand in Oregon.
•Gross margin decreased $24.5 million.
◦Primarily due to:
•Lower margins in other product lines, primarily due to higher asphalt oil material costs of $15.1 million, along with repair and maintenance costs of $2.6 million.
•Higher fuel costs of $13.3 million across all product lines.
•Lower contracting services margins resulting from less available paving work of $8.2 million, as previously discussed, and the absence of a few large jobs for $5.2 million. These margins were also impacted by higher fuel costs, as previously discussed.
•Lower asphalt margins resulting from less available paving work of $5.3 million, as previously discussed.
•Lower aggregates margins resulting from reduced work in Hawaii due to the overall slowdown of the travel industry resulting from COVID-19 of $4.0 million, startup costs of $1.3 million associated with new aggregate sites in Texas and $600,000 higher material costs in Alaska. These decreases were partially offset by higher margins due to strong demand in Oregon of $1.7 million and South Dakota of $1.9 million along with the effects of recent acquisitions.
•Labor constraints, especially truck drivers, which resulted in isolated project delays and staffing inefficiencies across the business.
◦Partially offset by an increase in ready-mix concrete margins of $7.7 million due in part to higher average pricing in all regions and higher volumes in most regions.
•Selling, general and administrative expense decreased $1.1 million.
◦Largely the result of:
•The recovery of prior bad debt expense of $1.6 million.
•Higher gains on asset sales of $900,000.
◦Offset in part by:
•Increased payroll-related costs of $900,000, primarily for higher health care costs.
•Higher acquisition costs of $700,000.
•An increase in miscellaneous taxes, license and governmental fees.
•Other income increased $500,000, primarily resulting from an out-of-period adjustment in 2020 as a result of previously overstated benefit plan expenses.
•Interest expense decreased $1.4 million.
◦Primarily resulting from lower average interest rates of $2.8 million.
◦Offset in part by higher average debt balances.
•Income tax expense decreased $4.0 million as a result of lower income before income taxes.
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2020 compared to 2019Construction materials and contracting's earnings increased $26.9 million as a result of:
•Revenues decreased $12.7 million.
◦Largely from lower contracting revenues partially due to lower materials pricing as a result of decreased energy-related costs.
◦Partially offset 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 increased $40.1 million.
◦Largely resulting from:
•An increase to asphalt and asphalt-related product margins by $21.3 million overall due to lower fuel and material costs.
•Strong pricing for ready-mix concrete in most markets resulting in 1.9 percent higher margins.
•Contracting bid margins positively impacted gross margin partially resulting from lower direct costs associated with having a longer construction season due to favorable weather conditions.
•Lower fuel costs across all product lines.
◦Partially offset by lower gains on asset sales in certain regions of approximately $6.8 million.
•Selling, general and administrative expense increased $5.6 million due to:
◦Higher payroll-related costs of $2.2 million.
◦An increase in amortization of intangible assets associated with the businesses acquired.
•Other income decreased $800,000, largely resulting from an out-of-period adjustment to benefit expense in the fourth quarter of 2020 as a result of previously overstated benefit plan expenses.
•Interest expense decreased $3.2 million driven by lower average debt balances in 2020 along with lower average interest rates.
•Income tax expense increased $10.0 million, directly resulting from higher income before income 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. In 2021, the Company continued to implement safety measures developed in 2020 for its employees that were not able to work from home and experienced some inefficiencies and additional costs in relation to these measures, including delays in the ability to obtain permits from government agencies and, 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 American Rescue Plan Act approved by the United States Congress in the first quarter of 2021 provides $1.9 trillion in COVID-19 relief funding for states, schools and local governments. States are beginning to move forward with allocating these funds based on federal criteria and state needs, and in some cases, funding of infrastructure projects could positively impact the segment. Additionally, the bipartisan infrastructure proposal, known as the Infrastructure Investment and Jobs Act, was approved by the United States Congress in the fourth quarter of 2021. This initiative is providing long-term opportunities by designating $119 billion for the repair and rebuilding of roads and bridges across the Company's footprint. The Company continues to monitor the progress of these legislative items.
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-mix concrete, asphaltic concrete and public and private construction markets. The contracting services and construction materials are sold in connection with street, highway and other public infrastructure projects, as well as private commercial, industrial and residential development projects. The public infrastructure projects have traditionally been more stable markets as public funding is more secure during periods of economic decline. The public projects are, however, dependent on federal and state funding such as appropriations to the Federal Highway Administration. Spending on private development is highly dependent on both local and national economic cycles, providing additional sales during times of strong economic cycles.
During 2021 and 2020, the Company made strategic purchases and completed several acquisitions that support the Company's long-term strategy to expand its market presence. In the second quarter of 2021, the Company acquired Mt. Hood Rock, a construction aggregates business located in Portland, Oregon. In the fourth quarter of 2021, the Company acquired Baker Rock Resources, a construction materials company located in Beaverton, Oregon, and Oregon Mainline Paving, an asphalt paving company located in McMinnville, Oregon. The acquisition of Baker Rock Resources complements the segment's Portland Metro operations and replenishes aggregate reserves in a market with high demand. Oregon Mainline Paving also supports the segment's vertically integrated business model. 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, 2021, at $708 million, as compared to backlog at December 31, 2020, of $673 million. A significant portion of the Company's backlog relates to street and highway construction. Period over period increases or decreases cannot be used as an indicator of future revenues or net income. The Company expects to complete an estimated $665 million of backlog at December 31, 2021, during the next 12 months. Factors noted in Item 1A - Risk Factors can cause revenues to be realized in periods and at levels that are different from originally projected.
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Construction Services
Strategy and challenges The construction services segment provides electrical and mechanical and transmission and distribution specialty contracting services, 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 strategic acquisition opportunities; and focusing efforts on projects that will permit higher margins while properly managing risk. The growth experienced by the segment in recent years is due in part to its ability to support national customers in most of the regions in which it operates.
The construction services segment faces challenges, which are not under direct control of the business, in the 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, 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. Current national supply chain challenges did not have significant impacts to the procurement of project materials for the year ended December 31, 2021. However, the Company is actively monitoring the situation and working with its manufacturers and suppliers to help mitigate the risk of delays and price increases. 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, as well as increasing duration and complexity of customer capital programs. In 2021, the markets the segment operates in saw an increase in labor shortages which caused increased labor-related costs while the segment continues to face increasing pressure to reduce costs and improve reliability. The Company continues to monitor the labor markets and expects labor costs to continue to increase based on the increased demand for services and, to a lesser extent, the recent escalated inflationary environment in the United States. 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 15.8 15.7 15.0 .6 % 4.7 %
Selling, general and administrative expense:
Depreciation, depletion and amortization 4.5 7.8 2.0 (42.3) % NM
Taxes, other than income 4.8 4.8 4.7 — % 2.1 %
* NM - not meaningful
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Operating Statistics
Revenues Gross margin
(In millions)
Electrical & mechanical
Transmission & distribution
Intrasegment eliminations (16.5) (10.1) (21.3) — — —
2021 compared to 2020Construction services earnings decreased $300,000 as a result of:
•Revenues decreased $44.1 million.
◦Largely due to:
•The completion of several large commercial projects in early 2021 and 2020 in the Las Vegas market of $129.0 million.
•Decreased institutional projects of $15.0 million from less available work and the completion of a larger project.
•The completion of a significant industrial project of $43.0 million.
•Decreased demand for electric transportation projects which includes traffic signalization and street lighting.
◦Partially offset by:
•Higher industrial work due to the number of projects awarded and progress on significant projects of $96.0 million.
•Increased service work of $37.0 million related to the repair and maintenance of electrical, mechanical and fire protection systems.
•Strong demand for utility projects including the progress on substations of $21.0 million and power line repair of $3.0 million.
•Gross margin decreased $10.4 million.
◦Largely due to:
•The absence of higher margin utility projects in 2020 negatively impacted gross margin by $15.0 million, which includes storm power line repair and fire hardening work.
•Decreased transportation margins, largely the completion of a higher margin project of $5.1 million.
•Institutional projects, primarily the recognition of reduced margins of $9.4 million from lower margin work in 2021 and the impacts of a job loss of $8.4 million related to change order disputes which resulted in a significant job recognizing higher labor and material costs.
◦Partially offset by:
•Increased industrial margins primarily due to a change order settlement of $10.0 million on a significant project.
•The absence of a job loss in 2020 of $8.9 million related to a large commercial project.
•An increase in the amount of service work awarded and the progress on that work.
•Selling, general and administrative expense decreased $8.5 million.
◦Largely due to:
•Lower bad debt expense of $7.0 million, largely due to changes in estimates related to expected credit losses.
•Lower amortization expense of $3.2 million.
◦Offset in part by:
•Higher office expenses of $1.3 million.
•Increased payroll-related costs.
•Other income increased $600,000, largely related to increased earnings on investments.
•Interest expense decreased $600,000, largely related to decreased debt balances due to lower working capital needs and increased cash collections.
•Income tax expense decreased $400,000 as a result of lower income before income taxes.
2020 compared to 2019 Construction services earnings increased $16.7 million as a result of:
•Revenues increased $246.4 million as a result of:
◦Increased electrical and mechanical workloads, 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. These increases were partially offset by decreased institutional projects.
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◦Increased transmission and distribution workloads as a result of strong demand for utility projects including storm-related power line repair and wildfire restoration work and increased demand for utility transportation projects.
•Gross margin increased $38.2 million.
◦Primarily resulting from a 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 increased $17.0 million, largely resulting from: