INTERIM MANAGEMENT DISCUSSION and ANALYSIS For the Three and Nine Month Periods Ended September 30, 2013

Transcription

1 Third Quarter 2013

2 INTERIM MANAGEMENT DISCUSSION and ANALYSIS For the Three and Nine Month Periods Ended September 30, 2013 Dated November 1, 2013 The following interim Management Discussion and Analysis ( MD&A ) should be read in conjunction with Newfoundland Power Inc. s (the Company or Newfoundland Power ) interim unaudited financial statements and notes thereto for the three and nine month periods ended September 30, 2013 and the MD&A and annual audited financial statements for the year ended December 31, The MD&A has been prepared in accordance with National Instrument Continuous Disclosure Obligations. Financial information herein, all of which is unaudited, reflects Canadian dollars and accounting principles generally accepted in the United States ( U.S. GAAP ), including certain accounting practices unique to rate regulated entities. These accounting practices are disclosed in Notes 2 and 7 to the Company s 2012 annual audited financial statements. Certain information herein is forward-looking within the meaning of applicable securities laws in Canada ( forward-looking information ). The words anticipates, believes, budgets, could, estimates, expects, forecasts, intends, may, might, plans, projects, schedule, should, will, would and similar expressions are often intended to identify forward-looking information, although not all forward-looking information contains these identifying words. The forward-looking information reflects management s current beliefs and is based on information currently available to the Company s management. The forward-looking information in this MD&A includes, but is not limited to, statements regarding: expectations to generate sufficient cash to complete required capital expenditures, and to service interest and sinking fund payments on debt; meeting pension funding requirements; no material adverse credit rating actions expected in the near term; the Company s belief that it does not anticipate any difficulties in issuing bonds on reasonable market terms; and the forecast gross capital expenditures for The forecasts and projections that make up the forward-looking information are based on assumptions, which include, but are not limited to: receipt of applicable regulatory approvals; continued electricity demand; no significant operational disruptions or environmental liability due to severe weather or other acts of nature; no significant decline in capital spending in 2013; sufficient liquidity and capital resources; the continuation of regulator-approved mechanisms that permit recovery of costs; no significant variability in interest rates; no significant changes in government energy plans and environmental laws; the ability to obtain and maintain insurance coverage, licences and permits; the ability to maintain and renew collective bargaining agreements on acceptable terms; and, sufficient human resources to deliver service and execute the capital program. The forward-looking information is subject to risks, uncertainties and other factors that could cause actual results to differ materially from historical results or results anticipated by the forward-looking information. The factors which could cause results or events to differ from current expectations include, but are not limited to: regulation; operating and maintenance investment requirements; economic conditions; defined benefit pension plan performance; capital resources and liquidity; interest rates; electricity prices; purchased power cost; health, safety and environmental regulations; insurance; weather; information technology infrastructure; labour relations; and, human resources. For additional information with respect to these risk factors, reference should be made to the section entitled Business Risk Management in this MD&A. All forward-looking information in this MD&A is qualified in its entirety by this cautionary statement and, except as required by law, the Company undertakes no obligation to revise or update any forward-looking information as a result of new information, future events or otherwise after the date hereof. Additional information, including the Company s interim and annual financial statements and MD&A, annual information form and management information circular, is available on SEDAR at sedar.com. OVERVIEW The Company Newfoundland Power is a regulated electricity utility that owns and operates an integrated generation, transmission and distribution system throughout the island portion of the Province of Newfoundland and Labrador. All the Company s common shares are owned by Fortis Inc. ( Fortis ), which is principally a diversified, international holding company for electricity and gas distribution utilities. Newfoundland Power s primary business is electricity distribution. It generates approximately 7% of its electricity needs and purchases the remainder from Newfoundland and Labrador Hydro ( Hydro ). Newfoundland Power serves over 254,000 customers, approximately 87% of all electricity consumers in the Province. Interim Management Discussion & Analysis 1

3 Newfoundland Power s vision is to be a leader among North American electricity utilities in terms of safety, reliability, customer service and efficiency. The key goals of the Company are to operate sound electricity distribution systems, deliver safe, reliable electricity to customers at the lowest reasonable cost, and conduct business in an environmentally and socially responsible manner. Regulation Newfoundland Power is regulated by the Newfoundland and Labrador Board of Commissioners of Public Utilities (the PUB ). The Company operates under cost of service regulation whereby it is entitled the opportunity to recover, through customer rates, all reasonable and prudent costs incurred in providing electricity service to its customers, including a just and reasonable return on its rate base. The rate base is the value of the net assets required to provide electricity service. On September 14, 2012, the Company filed a 2013/2014 General Rate Application ( GRA ) with the PUB which included a full review of the Company s costs, including the cost of capital. On April 17, 2013, the PUB issued the Order on the GRA ( 2013/2014 Order ) which established the Company s cost of capital for ratemaking purposes for 2013 through The regulated rate of return on common equity ( ROE ) of 8.80% and 45% common equity are consistent with The Company s rate of return on rate base for 2013 is 7.92%, with a range of 7.74% to 8.10%, compared to 8.14%, with a range of 7.96% to 8.32% for The operation of the Automatic Adjustment Formula has been suspended until the next GRA, which the Company is required to file on or before June 1, 2015 to establish customer electricity rates for The 2013/2014 Order also provided for revenue and cost changes as well as the amortization of certain regulatory assets and liabilities and the creation of a conservation and demand management cost deferral. On July 1, 2013, customer electricity rates were adjusted to reflect the implementation of the 2013/2014 Order. See Customer Rates in the Outlook section of this MD&A. As part of the 2013/2014 Order, the PUB approved the deferred recovery of $4.0 million of costs incurred in 2013 but not recovered from customers due to the timing of implementation of customer rates. The Company s interim financial statements for the three and nine month periods ended September 30, 2013 reflect the implementation of the 2013/2014 Order. Financial Highlights Three Months Ended September 30 Nine Months Ended September Change Change Electricity Sales (gigawatt hours, ( GWh )) , , Earnings Applicable to Common Shares $ Millions (1.4) $ Per Share (0.13) Cash Flow from Operating Activities ($millions) Total Assets ($millions) 1, , Reflects normalized electricity sales. Electricity sales for the third quarter of 2013 increased by 9.6 GWh or approximately 1.0% compared to the third quarter of The increase reflects customer growth of 1.7% partially offset by a decrease in average consumption of 0.7%. The decrease in average consumption in the quarter is primarily related to activity associated with the Company s large commercial customers. On a year-to-date basis, electricity sales increased by 66.9 GWh or approximately 1.6%. This increase was composed of (i) an increase of 1.7% due to customer growth; and (ii) an increase of 0.3% in average consumption reflecting higher concentration of electric heat in new home construction as well as economic growth. This was partially offset by a decrease of 0.4% as a result of one less day of electricity sales in 2013 due to 2012 being a leap year. Earnings for the third quarter of 2013 decreased by $1.4 million compared to the third quarter of The decrease in earnings was primarily the result of a $2.5 million income tax recovery recorded in the third quarter of 2012 due to Part VI.1 tax. Part VI.1 tax is not regulated for the purpose of setting customer rates. Excluding the impact of the Part VI.1 tax, earnings were $1.1 million higher compared to This increase was due to the implementation of the 2013/2014 Order, reflecting rate base growth, and lower operating costs, primarily reflecting the impact of Tropical Storm Leslie which affected St. John s and the Avalon areas on September 11, Interim Management Discussion & Analysis 2

4 On a year-to-date basis, earnings increased by $11.4 million compared to the same period last year. The increase in earnings was primarily the result of a $12.8 million income tax recovery recorded in 2013 related to the enactment of corporate income tax rates associated with Part VI.1 tax. Excluding the impact of Part VI.1 tax in both years, earnings were $1.2 million higher than The increase in earnings was primarily due to the implementation of the 2013/2014 Order, reflecting rate base growth, and higher than anticipated margin from electricity sales net of higher demand charges from Hydro. Cash flow from operating activities for the third quarter of 2013 increased by $2.9 million compared to the third quarter of The increase was primarily a result of the rebasing of customer rates effective July 1, 2013 due to the implementation of the 2013/2014 Order and the timing of cash collections. This increase was partially offset by timing of income tax payments and pension funding. Cash from operating activities year-to-date 2013 increased by $14.1 million compared to year-to-date The increase was primarily a result of the rebasing of customer rates effective July 1, 2013 due to the implementation of the 2013/2014 Order, timing of pension funding, and lower income tax payments. Total assets increased by $86.2 million at September 30, 2013 compared to September 30, The increase was due to an increase in regulatory assets, due to the normal operation of various regulatory mechanisms, and continued investment in the electricity system, consistent with the Company s strategy to provide safe, reliable electricity service at the lowest reasonable cost. RESULTS OF OPERATIONS Revenue Three Months Ended September 30 Nine Months Ended September 30 ($millions) Change Change Revenue from Rates Amortization of Regulatory Liabilities and Deferrals (0.4) (1.4) Other Revenue Total Other revenue is composed largely of pole attachment charges to various telecommunication companies, interest revenue associated with customer accounts and other miscellaneous charges. Revenue from rates for the third quarter of 2013 increased by $4.9 million compared to the third quarter of On a year-todate basis, revenue from rates increased $13.1 million compared to the same period last year. This increase reflects higher electricity sales and the rebasing of customer rates effective July 1, 2013 due to the implementation of the 2013/2014 Order. The amortization of regulatory liabilities and deferrals for the third quarter of 2013 and 2012 include the pension expense variance deferral ( PEVDA ) and the other post-employment benefits ( OPEBs ) cost variance deferral. These regulatory liabilities and deferrals are described in Notes 2 and 7 to the Company s 2012 annual audited financial statements. The amounts recorded are in accordance with PUB orders. Other revenue for the third quarter and year-to-date 2013 were comparable to Purchased Power: Purchased power expense for the third quarter of 2013 increased by $0.3 million compared to the third quarter of Year-to-date 2013, purchased power expense was $4.8 million higher compared to the same period last year. The increase resulted from electricity sales growth, partially offset by the amortization of the 2011 balance of the Weather Normalization Account as described in Note 3 to the September 30, 2013 interim financial statements. Operating Expenses: Operating expenses for the third quarter of 2013 were $1.1 million lower than the third quarter of The decrease was primarily due to (i) costs associated with Tropical Storm Leslie in 2012; (ii) lower professional fees; and, (iii) lower customer energy conservation program costs. As part of the 2013/2014 Order, the PUB approved the deferral of customer energy conservation program costs for 2013 and future years to be amortized to operating expenses over the subsequent seven year period. This decrease was partially offset by inflationary increases associated with labor and other operating costs. Year-to-date 2013 operating expenses were $0.7 million lower than the same period last year. The decrease was primarily due to (i) costs associated with Tropical Storm Leslie in 2012; (ii) lower professional fees; and, (iii) lower customer energy conservation program costs due to the deferral of these costs in 2013 as required in the 2013/2014 Order. This decrease was Interim Management Discussion & Analysis 3

5 partially offset by costs associated with restoration efforts following the loss of electricity supply from Hydro on January 11, 2013, as well as inflationary increases associated with labor and other operating costs. Employee Future Benefits: Employee future benefits for the third quarter of 2013 were $0.8 million higher compared to the third quarter of Approximately $0.4 million of the increase was due to an increase in the Company s projected pension obligation with its defined benefit pension plan. The increase was primarily due to a lower discount rate at December 31, 2012, which was used to determine the pension obligation. The remaining increase of $0.4 million relates to higher OPEBs costs, which was also primarily due to a lower discount rate at December 31, Year-to-date 2013 employee future benefits were $2.6 million higher than the same period last year. Approximately $1.4 million was due to an increase in the Company s projected benefit pension obligation with its defined benefit pension plan. The remaining increase of $1.2 million relates to higher OPEBs costs. Depreciation and Amortization: Depreciation and amortization expense for the third quarter of 2013 was $0.9 million higher compared to the third quarter of Year-to-date 2013 was $2.8 million higher compared to the same period last year. The increase was reflective of the Company s capital expenditure program, as well as the implementation of new depreciation rates as approved in the 2013/2014 Order. For 2012 and 2013, depreciation and amortization expense excludes the impact of the income tax deduction associated with the cost of removal of the Company s property, plant and equipment. This is described in Note 4 to the Company s 2012 annual audited financial statements. This change in presentation has no impact on net earnings. Cost Recovery Deferrals: As part of the 2013/2014 Order, the PUB approved the deferred recovery of $4.0 million of costs incurred in 2013 but not recovered from customers due to the timing of implementation of customer rates. The deferral was recorded as an increase in regulatory assets and a decrease in expense of $4.0 million during the second quarter of Amortization of this cost deferral began on July 1, 2013 and will be recorded through December 31, During the three and nine month periods ended September 30, 2013, amortization of $0.4 million was recorded for this deferral. The PUB also ordered the amortization of cost deferrals recorded in 2011 and 2012 over a three year period effective January 1, The amortization recorded for these deferrals for the three and nine month periods ended September 30, 2013 is $0.6 million and $1.8 million respectively. Finance Charges: Finance charges for the third quarter of 2013 were comparable to the third quarter of Finance charges year-to-date 2013 decreased by $0.1 million compared to the same period in The reduction in interest on longterm debt associated with the annual sinking fund payment made in October 2012 was partially offset by additional borrowings under the Company s credit facility. Income Taxes: Income taxes for the third quarter of 2013 were $2.8 million higher than the third quarter of The increase was primarily the result of a $2.5 million income tax recovery recorded in the third quarter of 2012 related to a statute barred reversal of Part VI.1 tax. Excluding the impact of the Part VI.1 tax, income tax expense would have been $0.3 million higher in the third quarter primarily due to higher pre-tax earnings. On a year-to-date basis, income taxes in 2013 were $10.8 million lower compared to the same period last year. The decrease was primarily the result of a $12.8 million income tax recovery recorded in 2013 related to the enactment of corporate income tax rates associated with Part VI.1 tax. Upon adoption of U.S. GAAP in 2012, the Company was required to recognize the impact of the difference between enacted tax rates and substantially enacted tax rates related to the allocation of the Part VI.1 tax deduction from Fortis to Newfoundland Power. On June 26, 2013, the Canadian federal legislation related to proposed corporate income tax rate changes was enacted. This resulted in the Company recording a $12.8 million income tax recovery in Excluding the impact of the Part VI.1 tax in both years, income tax expense would have been $0.6 million lower year-to-date. The decrease reflects a lower effective income tax rate primarily resulting from the increased expense associated with the future cost of removal of the Company s property, plant and equipment, as recorded in depreciation expense and approved in the 2013/2014 Order. Interim Management Discussion & Analysis 4

6 FINANCIAL POSITION Explanations of the primary causes of significant changes in the Company s balance sheets between December 31, 2012 and September 30, 2013 follow: ($millions) Increase (Decrease) Explanation Accounts Receivable (28.1) Decrease due to lower electricity sales in September 2013 compared to December 2012, reflecting the seasonal nature of electricity consumption for heating, and the customer rate decrease effective July 1, The change in accounts receivable also reflects normal timing differences relating to both the operation of the Company s equal payment plan for its customers, and the collection and payment of municipal taxes. Property, Plant and Equipment 26.8 Increase due to investment in electricity system, in accordance with the 2013 capital expenditure program, offset partially by depreciation and customer contributions in aid of construction. Regulatory assets (13.2) Decrease due to the normal operation of various regulatory mechanisms, including new regulatory accounts as approved by the PUB in the 2013/2014 Order. See Note 3 of the Company s interim unaudited financial statements. Accounts Payable and Accrued Charges (33.9) Decrease primarily due to lower purchased power costs related to lower energy consumption in September 2013 compared to December 2012, as well as the decrease in Hydro s Rate Stabilization Plan effective July 1, See Customer Rates in the Outlook section of this MD&A. Interest Payable 3.7 Increase relates to timing of interest payments on long-term debt. Related Party Loan 8.0 Represents a short-term demand loan from Maritime Electric Company, Limited. See Note 11 of the Company s interim unaudited financial statements. Other Liabilities (13.3) Decrease primarily reflects the enactment of proposed corporate income tax rate changes associated with Part VI.1 tax. Regulatory Liabilities 4.5 Increase due to the normal operation of various regulatory mechanisms. See Note 3 of the Company s interim unaudited financial statements. Defined Benefit Pension Plan Liability (10.4) Decrease due to pension funding payments. Long-term Debt, including Current Portion 2.0 Represents additional debt required to finance growth in rate base and ongoing operating activities. Retained Earnings 22.3 Earnings in excess of dividends; retained to finance rate base growth. Interim Management Discussion & Analysis 5

7 LIQUIDITY AND CAPITAL RESOURCES The primary sources of liquidity and capital resources are net funds generated from operations, debt capital markets and bank credit facilities. These sources are used primarily to satisfy capital and intangible asset expenditures, service and repay debt, and pay dividends. A summary of third quarter and year-to-date cash flows and cash position for 2013 and 2012 follows: Three Months Ended Nine Months Ended September ($millions) Change Change Cash, Beginning of Period (0.3) Operating Activities Investing Activities (24.0) (21.5) (2.5) (60.6) (55.7) (4.9) Financing Activities Net Credit Facilities Proceeds (Repayments) (24.0) (21.1) (2.9) (5.5) Net Proceeds from Related Party Loan Dividends and Other (5.9) (0.2) (5.7) (17.5) (5.9) (11.6) (21.9) (21.3) (0.6) (7.2) 1.9 (9.1) Cash, End of Period (0.2) (0.2) Operating Activities Third quarter cash flow from operating activities, for 2013 compared to 2012, increased by $2.9 million. The increase was primarily a result of the rebasing of customer rates effective July 1, 2013 due to the implementation of the 2013/2014 Order and the timing of cash collections. This increase was partially offset by timing of income tax payments and pension funding. Year-to-date cash from operating activities, for 2013 compared to 2012, increased by $14.1 million. The increase was primarily a result of the rebasing of customer rates effective July 1, 2013 due to the implementation of the 2013/2014 Order, timing of pension funding, and lower income tax payments. Investing Activities Third quarter cash flow used in investing activities, for 2013 compared to 2012, increased by $2.5 million. The increase was due to the capital work associated with the Company s 2013 capital plan, partially offset by higher contributions from customers. Year-to-date cash flow used in investing activities increased by $4.9 million compared to The increase was due to the capital work associated with the Company s 2013 capital plan as well as a reduction in contributions from customers. A summary of third quarter and year-to-date 2013 and 2012 capital and intangible asset expenditures follows. Three Months Ended September 30 Nine Months Ended September 30 ($millions) Change Change Electricity System Generation (1.5) (1.5) Transmission (0.5) (0.2) Substations (0.3) Distribution Intangible Assets and Other Capital and Intangible Asset Expenditures The Company s business is capital intensive. Capital investment is required to ensure continued and enhanced performance, reliability and safety of the electricity system and to meet customer growth. All costs considered to be repairs and maintenance are expensed as incurred. Capital investment also arises for information technology systems and for general facilities, equipment and vehicles. Capital expenditures, and property, plant and equipment repairs and maintenance expense, can vary from quarter-to-quarter and year-to-year depending upon both planned system expenditures and unplanned expenditures arising from weather or other unforeseen events. Interim Management Discussion & Analysis 6

8 The Company s annual capital plan requires prior PUB approval. The PUB has approved the Company s 2013 Capital Plan, which provides for capital expenditures of $80.8 million, approximately half of which relate to construction and capital maintenance of the electricity distribution system. Variances between actual and planned expenditures are generally subject to PUB review prior to inclusion in the Company s rate base. The Company s capital expenditures, including unforeseen capital spending, are forecasted to be $85.4 million for Financing Activities Net proceeds from the Company s credit facilities and related party loan increased by $5.1 million compared to the third quarter of 2012 and increased by $2.5 million on a year-to-date basis. The additional cash from financing activities was required to support higher common share dividends and capital expenditures, partially offset by higher cash available from operations. Common share dividends were $11.7 million higher in the current year as the Company suspended common share dividends in the second and third quarters of 2012 to ensure the Company s common share dividend policy was maintained with a capital structure composed of 55% debt and preference equity and 45% common equity. The Company has historically generated sufficient annual cash flows from operating activities to service annual interest and sinking fund payments on debt, to fund pension obligations, to pay dividends and to finance a major portion of its annual capital program. Additional financing to fully fund the annual capital program is primarily obtained through the Company s bank credit facilities and these borrowings are periodically refinanced along with any maturing bonds through the issuance of long-term first mortgage sinking fund bonds. The Company currently does not expect any material changes in these annual cash flow and financing dynamics over the foreseeable future. Debt: The Company s credit facilities are comprised of a $100.0 million committed revolving term credit facility ( Committed Facility ) and a $20.0 million demand facility as detailed below: ($millions) September 30, 2013 December 31, 2012 Total Credit Facilities Borrowing, Committed Facility (44.0) (42.0) Borrowing, Demand Facility (1.0) (0.3) Credit Facilities Available The committed facility matures in August Subject to lenders approval, the Company may request an extension for a further period of up to, but not exceeding, a five year term. Pensions: As at September 30, 2013, the fair value of the Company s primary defined benefit pension plan assets was $308.9 million compared to the fair value of plan assets of $298.4 million as at December 31, The $10.5 million increase in fair value was primarily due to favorable market conditions. Based on the Actuarial Valuation Report as at December 31, 2011, the Company s primary defined benefit pension plan had a solvency deficit of $49.5 million. The deficit was primarily due to lower interest rates as at December 31, The solvency deficit of $49.5 million ($53.4 million inclusive of interest) is expected to be funded over a five-year period, which commenced in The Company will fulfill its 2013 annual solvency deficit funding requirement of $10.7 million by the end of the year. The defined benefit pension funding contributions, including current service and solvency deficit funding amounts, are expected to be $13.6 million in 2013 and $13.7 million in The Company expects to be able to meet future pension funding requirements as it expects the amounts will be financed from a combination of cash generated from operations and amounts available for borrowing under existing credit facilities. Interim Management Discussion & Analysis 7

9 Contractual Obligations: Details, as at September 30, 2013, of all contractual obligations over the subsequent five years and thereafter, follow. Due Within Due in Due in Due After ($millions) Total 1 Year Years 2 & 3 Years 4 & 5 5 Years Related Party Loan (unsecured) Credit Facilities (unsecured) First Mortgage Sinking Fund Bonds Total First mortgage sinking fund bonds are secured by a first fixed and specific charge on property, plant and equipment owned or to be acquired by the Company, by a floating charge on all other assets and carry customary covenants. Credit Ratings and Capital Structure: To ensure continued access to capital at reasonable cost, the Company endeavours to maintain its investment grade credit ratings. Details of the Company s investment grade bond ratings follow. September 30, 2013 December 31, 2012 Rating Agency Rating Outlook Rating Outlook Moody s Investors Service ( Moody s) A2 Stable A2 Stable DBRS A Stable A Stable During the first quarter of 2013, both Moody s and DBRS issued an updated credit rating report confirming the Company s existing investment grade bond rating and rating outlook. The Company s investment grade bond rating and rating outlook remain unchanged from Newfoundland Power manages common share dividends to maintain an average annual capital structure composed of 55% debt and preference equity and 45% common equity. This capital structure is reflected in customer rates and is consistent with the Company s current investment grade credit ratings. The Company s capital structure follows: September 30, 2013 December 31, 2012 $millions % $millions % Total Debt Common Equity Preference Equity Total Includes bank indebtedness, or net of cash, if applicable. The Company expects it will be able to maintain its current investment grade credit ratings in Capital Stock and Dividends: During the third quarter and nine months ended September 30, 2013 and 2012, the weighted average number of common shares outstanding was 10,320,270. Dividends on common shares for 2013 compared to 2012 were $5.7 million higher for the third quarter and $11.7 million higher year-to-date. In 2013, common share dividends increased to $0.55 per share for each of the three quarters compared to $0.52 in the first quarter of The Company did not declare or pay common share dividends during the second or third quarter of 2012 to ensure the Company s common share dividend policy was maintained with a capital structure composed of 55% debt and preference equity and 45% common equity. The Company redeemed 7,400 Series D preference shares outstanding for $74,000 in the third quarter of Interim Management Discussion & Analysis 8

10 RELATED PARTY TRANSACTIONS The Company provides services to, and receives services from, its parent company, Fortis and other subsidiaries of Fortis. The Company also incurs charges from Fortis for the recovery of general corporate expenses incurred by Fortis. These transactions are in the normal course of business and are recorded at their exchange amounts. Related party transactions included in revenue and operating expenses for the third quarter and nine months ended September 30, 2013 and 2012 follow: Three Months Ended September 30 Nine Months Ended September 30 ($millions) Revenue Operating expenses Includes charges for electricity consumed. In July 2013, the Company borrowed $10.0 million from Maritime Electric Company, Limited ( MECL ) as a short-term demand loan, at an interest rate of 1.60%. The full amount was repaid to MECL in September The Company borrowed $8.0 million as a short-term demand loan from MECL in September 2013, at an interest rate of 1.56%. The loan is expected to be repaid in November During the second quarter of 2013, the Company borrowed and repaid a $15.0 million short-term demand loan from MECL, at an interest rate of 1.57%. FINANCIAL INSTRUMENTS The carrying values of financial instruments included in current assets, current liabilities, other assets, and other liabilities approximate their fair value, reflecting their nature, short-term maturity or normal trade credit terms. The fair value of long-term debt is calculated by discounting the future cash flows of each debt instrument at the estimated yieldto-maturity equivalent to benchmark government bonds, with similar terms to maturity, plus a credit risk premium equal to that of issuers of similar credit quality. Since the Company does not intend to settle its debt instruments before maturity, the fair value estimate does not represent the actual liability, and therefore, does not include exchange or settlement costs. The carrying and estimated fair values of the Company s long-term debt, including current portion and committed credit facility, follow: September 30, 2013 December 31, 2012 ($millions) Carrying Value Estimated Fair Value Carrying Value Estimated Fair Value Long-term debt, including current portion and committed credit facility $ $ BUSINESS RISK MANAGEMENT There were no material changes to the Company s business risks during the third quarter of CHANGES IN ACCOUNTING POLICIES Effective January 1, 2013, the Company adopted the amendments to Accounting Standards Codification Topic 210, Balance Sheet Disclosures about Offsetting Assets and Liabilities as outlined in Accounting Standards Updates No and Adoption of the amendments did not impact the Company s interim financial statements for the three and nine month periods ended September 30, Interim Management Discussion & Analysis 9

11 CRITICAL ACCOUNTING ESTIMATES There were no material changes to the Company s critical accounting estimates during the quarter. Interim financial statements, however, tend to employ a greater use of estimates than the annual financial statements. QUARTERLY RESULTS The following table sets forth unaudited quarterly information for each of the eight quarters ended December 31, 2011 through September 30, The quarterly information has been obtained from the Company s interim unaudited financial statements which, in the opinion of management, have been prepared in accordance with U.S. GAAP. These financial results are not necessarily indicative of results for any future period and should not be relied upon to predict future performance. Third Quarter September 30 Second Quarter June 30 First Quarter March 31 Fourth Quarter December 31 (unaudited) Electricity Sales (GWh) , , , , , ,526.6 Revenue ($millions) Net Earnings Applicable to Common Shares ($millions) Earnings per Common Share ($) Basic and fully diluted. 2 The third quarter of 2012 included a $2.5 million income tax recovery related to a statute barred reversal of the unregulated Part VI.1 tax deduction from Fortis to Newfoundland Power. 3 The second quarter of 2013 included a one-time $12.8 million income tax recovery related to the enactment of corporate income tax rates associated with unregulated Part VI.1 tax. Seasonality Sales and Revenue: Interim financial results reflect the seasonality of electricity sales for heating. Sales and revenue are significantly higher in the first quarter and significantly lower in the third quarter compared to the remaining quarters. This reflects the seasonality of electricity consumption for heating. Earnings: Beyond the seasonality of electricity consumption for heating, quarterly earnings are impacted by the purchased power rate structure. The Company pays more, on average, for each kilowatt hour ( kwh ) of purchased power in the winter months and less, on average, for each kwh of purchased power in the summer months. These sales, revenue and cost dynamics are expected to yield lower earnings in the first quarter compared to remaining quarters within any given year. Trending Sales and Revenue: Year-over-year quarterly electricity sales increases primarily reflect modest customer growth. Earnings: Beyond the impact of expected moderate sales growth, future quarterly earnings and earnings per share are expected to trend with the ROE reflected in customer rates and rate base growth. Interim Management Discussion & Analysis 10

12 OUTLOOK The Company s strategy is expected to remain unchanged. Newfoundland Power is regulated under a cost of service regime. Cost of service regulation entitles the Company to an opportunity to recover its reasonable cost of providing service, including its cost of capital, in each year. On April 17, 2013, the PUB issued the 2013/2014 Order, which established the Company s cost of capital for ratemaking purposes for 2013 through The regulated ROE of 8.80% and 45% common equity are consistent with The Company is required to file its next GRA on or before June 1, Newfoundland Power expects to maintain its investment grade credit ratings in Customer Rates: Effective July 1, 2013, there was an overall average decrease in electricity rates charged to customers of approximately 3.1% to reflect the combined impact of the annual operation of the Rate Stabilization Account ( RSA ) and the impact of the Company s 2013/2014 Order. Through the annual operation of Hydro s Rate Stabilization Plan ( Hydro RSP ) and the Company s RSA, variances in Hydro s cost of fuel used to generate electricity are captured in the Hydro RSP and flowed-through to the Company s customers through the operation of the Company s RSA. Electricity rates decreased approximately 7.9% effective July 1 st due to the operation of these regulatory mechanisms. The RSA also captures variances in Newfoundland Power s cost such as energy supply cost variances and employee future benefit cost variances. This adjustment in customer rates has no impact on earnings for Newfoundland Power. The implementation of the 2013/2014 Order had the impact of increasing electricity rates by an overall average of approximately 4.8% effective July 1, Capital Plan: On June 28, 2013, the Company filed an application with the PUB requesting approval for its 2014 capital expenditure plan totalling $84.5 million. The application was approved by the PUB on September 13, Interim Management Discussion & Analysis 11

13 CORPORATE INFORMATION All of the common shares of Newfoundland Power are owned by Fortis. Fortis is the largest investor-owned gas and electric distribution utility in Canada, with total assets exceeding $17 billion and fiscal 2012 revenue totalling approximately $3.7 billion. Its regulated utilities account for 90% of total assets and serve more than 2.4 million customers across Canada and in New York State and the Caribbean. Fortis owns non-regulated hydroelectric generation assets in Canada, Belize and Upstate New York. The Corporation s non-utility investments are comprised of hotels and commercial real estate in Canada and petroleum supply operations in the Mid-Atlantic Region of the United States. Fortis shares are listed on the Toronto Stock Exchange and trade under the symbol FTS. Additional information can be accessed at or For further information, contact: Jocelyn Perry, Vice President, Finance & CFO Newfoundland Power Inc. P.O. Box 8910, St. John s, NL A1B 3P6 Tel: (709) Fax: (709) jperry@newfoundlandpower.com Share Transfer Agent and Registrar: Computershare Trust Company of Canada 1500 University Street, Suite 700 Montreal, QC H3A 3S8 Tel: (514) Fax: (514) Website: Interim Management Discussion & Analysis 12

14 Unaudited Statements of Earnings For the Three and Nine Months Ended September 30 (in thousands of Canadian dollars, except per share amounts) Three Months Ended Nine Months Ended Revenue $ 105,251 $ 100,824 $ 435,666 $ 424,002 Purchased power 54,129 53, , ,361 Gross Margin 51,122 47, , ,641 Operating expenses 11,964 13,034 40,697 41,400 Employee future benefits 6,373 5,525 19,167 16,609 Depreciation and amortization 13,029 12,108 38,038 35,260 Cost recovery deferrals, net of amortization (Note 3) 999 (1,001) (1,764) (3,579) Finance charges (Note 5) 8,949 8,931 26,985 27,074 41,314 38, , ,764 Earnings Before Income Taxes 9,808 8,414 33,416 32,877 Income tax expense (recovery) (Note 6) 2,177 (601) (5,661) 5,143 Net Earnings 7,631 9,015 39,077 27,734 Preference share dividends Net Earnings Applicable to Common Shares $ 7,490 $ 8,874 $ 38,652 $ 27,309 Basic and Diluted Earnings per Common Share $ 0.73 $ 0.86 $ 3.75 $ 2.65 See accompanying notes to financial statements Interim Financial Statements 13

15 Unaudited Statements of Changes in Equity For the Nine Months Ended September 30 (in thousands of Canadian dollars, except per share amounts) Common Shares Preference Shares Retained Earnings Total Equity As at January 1, 2013 $ 70,321 $ 9,081 $ 323,886 $ 403,288 Net earnings ,077 39,077 Allocation of Part VI.1 tax Dividends on common shares ($1.65 per share) - - (17,028) (17,028) Dividends on preference shares - - (425) (425) Redemption of preference shares - (74) - (74) As at September 30, 2013 $ 70,321 $ 9,007 $ 346,201 $ 425,529 As at January 1, 2012 $ 70,321 $ 9,081 $ 298,432 $ 377,834 Net earnings ,734 27,734 Dividends on common shares ($0.52 per share) - - (5,367) (5,367) Dividends on preference shares - - (425) (425) As at September 30, 2012 $ 70,321 $ 9,081 $ 320,374 $ 399,776 See accompanying notes to financial statements Interim Financial Statements 14

16 December 31, 2012 Assets (Note 7) Current assets Accounts receivable $ 48,385 $ 76,461 Income taxes receivable 1,128 1,202 Materials and supplies 1,263 1,155 Prepaid expenses 1,811 1,075 Regulatory assets (Note 3) 32,510 37,421 85, ,314 Property, plant and equipment 899, ,085 Intangible assets 14,689 14,739 Regulatory assets (Note 3) 371, ,752 Other assets 3,923 4,252 $ 1,375,060 $ 1,389,142 Liabilities and Shareholders Equity (Note 13) Current liabilities Bank indebtedness $ - $ 383 Short-term borrowings Accounts payable and accrued charges 41,292 75,212 Interest payable 11,080 7,384 Defined benefit pension plans Other post-employment benefits 3,238 3,035 Regulatory liabilities (Note 3) 2,968 - Related party loan (Note 11) 8,000 - Current instalments of long-term debt (Note 7) 78,153 47,200 Other liabilities (Note 6) - 13,349 Deferred income taxes 5,030 5, , ,008 Regulatory liabilities (Note 3) 135, ,663 Defined benefit pension plans 33,334 43,740 Other post-employment benefits 96,478 94,646 Other liabilities Deferred income taxes 113, ,858 Long-term debt (Note 7) 419, , , ,854 Shareholders equity Common shares, no par value, unlimited authorized shares, 10.3 million shares issued and outstanding 70,321 70,321 Preference shares 9,007 9,081 Retained earnings 346, , , ,288 $ 1,375,060 $ 1,389,142 Commitments (Note 12) See accompanying notes to financial statements. Unaudited Balance Sheets As at (in thousands of Canadian dollars) September 30, 2013 Interim Financial Statements 15

17 Unaudited Statements of Cash Flows For the Three and Nine Months Ended September 30 (in thousands of Canadian dollars) Three Months Ended Nine Months Ended Cash From (Used in) Operating Activities Net earnings $ 7,631 $ 9,015 $ 39,077 $ 27,734 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation of property, plant and equipment 12,416 11,477 36,200 33,363 Amortization of intangible assets and other ,078 2,148 Change in long-term regulatory assets and liabilities 1,710 (3,920) 834 (7,210) Income tax liability - (2,463) (12,814) (2,589) Deferred income taxes (1,189) 178 (882) 2,747 Employee future benefits 96 2,539 (159) (3,252) Equity portion of allowance for funds used during construction (105) (128) (201) (232) Change in non-cash working capital 24,705 25,539 3,738 1,010 45,946 42,954 67,871 53,719 Cash From (Used In) Investing Activities Net adjustment on sale to Bell Aliant (829) Capital expenditures (24,177) (21,597) (60,962) (56,051) Intangible asset expenditures (785) (382) (1,788) (1,947) Contributions from customers 1, ,160 2,955 Other (115) 13 (51) 210 (24,064) (21,458) (60,641) (55,662) Cash From (Used In) Financing Activities Change in bank indebtedness - - (383) - Change in short-term borrowings (3,491) (635) Net proceeds of committed credit facility (20,500) (20,500) 2,000 7,500 Proceeds from related party loan (Note 11 ) 18,000-33,000 - Repayment of related party loan (Note 11 ) (10,000) - (25,000) - Payment of debt financing costs (115) Redemption of preference shares (74) - (74) - Dividends Preference shares (141) (141) (425) (425) Common shares (5,676) - (17,028) (5,367) (21,882) (21,276) (7,230) 1,856 Increase (Decrease) in Cash (87) Cash, Beginning of the Period Cash, End of the Period $ - $ 243 $ - $ 243 See accompanying notes to financial statements Interim Financial Statements 16

18 Unaudited Notes to Interim Financial Statements For the Three and Nine Months Ended September 30, 2013 and 2012 (unless otherwise noted) Tabular amounts are in thousands of Canadian dollars unless otherwise noted. 1. Description of the Business Newfoundland Power Inc. (the Company or Newfoundland Power ) is a regulated electricity utility that operates an integrated generation, transmission, and distribution system throughout the island portion of Newfoundland and Labrador. The Company is regulated by the Newfoundland and Labrador Board of Commissioners of Public Utilities (the PUB ), and operates under cost of service regulation whereby it is entitled the opportunity to recover, through customer rates, all reasonable and prudent costs incurred in providing electricity service to its customers, including a just and reasonable return on its rate base. The rate base is the value of the net assets required to provide electricity service. On September 14, 2012, the Company filed a 2013/2014 General Rate Application ( GRA ) with the PUB which included a full review of the Company s costs, including the cost of capital. On April 17, 2013, the PUB issued the Order on the GRA ( 2013/2014 Order ) which established the Company s cost of capital for ratemaking purposes for 2013 through The regulated ROE of 8.80% and 45% common equity are consistent with The Company s rate of return on rate base for 2013 is 7.92%, with a range of 7.74% to 8.10%, compared to 8.14%, with a range of 7.96% to 8.32% for The implementation of the 2013/2014 Order resulted in an increase to electricity rates by an average of approximately 4.8%. This rate change was combined with the annual operation of the Rate Stabilization Account ( RSA ) for an overall average decrease of 3.1% effective July 1, Basis of Presentation These interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States ( U.S. GAAP ) for interim financial statements and do not include all of the disclosures provided in the audited financial statements. These interim financial statements should be read in conjunction with the Company s 2012 annual audited financial statements. The accounting policies and methods of their application, followed in the preparation of these interim financial statements are the same as those followed in the preparation of the Company s 2012 annual audited financial statements, except for the following: Effective January 1, 2013, the Company adopted the amendments to Accounting Standards Codification Topic 210, Balance Sheet Disclosures about Offsetting Assets and Liabilities as outlined in Accounting Standards Updates No and Adoption of the amendments did not impact the Company s interim financial statements for the three and nine months ended September 30, An evaluation of subsequent events through October 24 th, 2013, the date these interim financial statements were approved by the Audit & Risk Committee of the Board of Directors of the Company and available to be issued, was completed and it was determined there were no circumstances that warranted recognition and disclosure of events or transactions in the interim financial statements as at September 30, Regulatory Assets and Liabilities Regulatory assets and liabilities arise as a result of the rate setting process. Regulatory assets represent future revenues associated with certain costs incurred in the current or prior periods that will be, or are expected to be, recovered from customers in future periods through the rate setting process. Regulatory liabilities represent future reductions or limitations of increases in revenues associated with amounts that will be, or are expected to be, refunded to customers through the rate setting process. The regulatory assets and liabilities, and their eventual settlement through the rate setting process, are prescribed by the PUB and impact the Company s cash flows. The underlying accounting practices, which result in the recognition of regulatory assets and regulatory liabilities, are disclosed in Notes 2 and 7 to the Company s 2012 annual audited financial statements. Notes to Interim Financial Statements 17