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NorthWestern Corp (NYSE:NWE)
Q2 2020 Earnings Call
Jul 29, 2020, 3:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Northwestern Corporation Second Quarter 2020 Financial Results Conference Call and Webcast. [Operator Instructions].

At this time, I would like to turn the conference over to NorthWestern's Investor Relations Officer, Travis Meyer. Please go ahead, sir.

Travis Meyer -- Director of Corporate Finance and Investor Relations Officer

Thank you, Sarah. Good afternoon, and thank you for joining Northwestern Corporation's financial results conference call and webcast for the quarter ending June 30, 2020. NorthWestern's results have been released and the release is available on our website at northwesternenergy.com. We also released our 10-Q premarket this morning. Joining us on the call today are Bob Rowe, President and Chief Executive Officer; Brian Bird, Chief Financial Officer, and we have several other members of the management team in the room with us to address your questions if needed.

Before I turn the call over for us to begin, please note this company's press release, this presentation, comments by presenters and responses to your questions may contain forward-looking statements and non-GAAP financial information. As such, I'll remind you of our safe harbor language. During the course of this presentation, there will be forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often address our expected future business and financial performance and often contain words such as expects, anticipates, intends, plans, believe, seeks or will.

This information in the presentation is based on our current expectations. Our actual future business and financial performance may differ materially and adversely from our expectations expressed in any forward-looking statements. We undertake no obligation to revise or publicly update our forward-looking statements or this presentation for any reason. Although our expectations and beliefs are based upon reasonable assumptions, actual results may differ materially. The factors that may affect our results are listed in certain of our press releases and disclosed in the company's Form 10-K and 10-Q along with other public filings with the SEC.

Today's presentation also includes non-GAAP financial measures. Please refer to the definitions and reconciliations of these measures that are included in our webcast materials. Following the presentation, we'll open up the phone lines to allow those who are dialed into the teleconference to ask questions. The archived replay of today's webcast will be available for one year, beginning at 6:00 p.m. Eastern, and can be found on our website at northwesternenergy.com, under our company investor Relations, Presentations and Webcast link.

With that, I'll hand it over to our President and CEO, Bob Rowe.

Robert Rowe -- President and Chief Executive Officer

Thank you, Travis. Good afternoon, everyone, and thank you very much for joining us. Travis included a photo on the cover of the deck from the Grand Canyon of the Yellowstone. He did that because yesterday we were in the park, meeting with park management. We serve there on a contract basis. It's a privilege, obviously, to serve the nation's oldest and number one national park. The park and gateway communities in Montana are crowded. What's exciting about serving the park is we do it on a contract basis, we design our service to meet the customers' expectations in terms of affordability, environmental sensitivity and sustainability and reliability. And it's a location where we have the opportunity to try some of the exciting new distributed technologies that we're looking at.

So it's a small but important part of who we are in the area we serve. Second quarter highlights. Net income for the second quarter decreased $26.2 million compared to same period last year. This was driven primarily by an income tax benefit received in 2019, by lower gross margin due to impact of COVID-19, as we discussed last quarter, and then by higher depreciation expenses. These were offset in part by a decrease in operating, general and administrative and by some customer growth. Diluted EPS decreased $0.51 as compared to the same period last year. Diluted non-GAAP EPS decreased $0.08 per share after adjusting for income tax benefits noted and the normal weather.

The Board of Directors declared a quarterly dividend of $0.60 per share payable September 30 to shareholders of record as of September 15. I will get a chance to come back and talk about customer engagement and employee health and safety as part of our COVID response in the Q&A. But we continue to be doing very, very well on both those fronts.

And with that, I'll turn it over to Brian.

Brian Bird -- Chief Financial Officer

Thanks, Bob. On page four of the presentation is the summary financial results for the second quarter. As Bob pointed out, our net income is down $26.2 million. As I look at this slide, there are really three themes jump out at main. Gross margin is down $6.7 million on a year-over-year basis. All of that negative variance could be reflected by two 2019 favorable impacts. The second thing I might point out is the reduction in OG&A expenses that we had during the quarter more than offset the increases in property tax, depreciation and interest expense. And the third theme is the $21.5 million negative variance in income taxes, is all attributed to a 2019 favorable impact, of course, on a year-over-year basis.

So taking those things into consideration, we feel we actually had a very good quarter, in line with our expectations from a COVID perspective. And with that, I'll turn you to the following page on gross margin. Gross margin was off $6.7 million or about 3%, as I pointed out, all of that really attributed to our electric business. You look at the primary drivers of the $8.2 million of change in gross margin actually impacts net income. The very first two items, Montana electric supply cost recovery, that item is after some favorable legislation we received. We were able to treat our PCCAM is slightly different, and we made a favorable adjustment in 2019 associated with that. That's $4.4 million. And then this year, our QF gain was $3.3 million less than the QF gain we had in 2019.

Those two items together are eight point excuse me, $7.7 million of the full $8.2 million change in gross margin. I guess the other item that would get you forward to the $8.2 million is lower electric transmission. It really is a result on a year-over-year impacts of the closure of units one and two at Colstrip. So all in all, again, big impact associated with those 2019 favorable items impacting the $8.2 million. Below that, we do show changes in gross margins. That's offset elsewhere within the P&L for a net decrease in gross margin of $6.7 million. Also on page five, to the far right, we do have a red box speaking to COVID. You noticed I didn't say anything about electric or gas retail volumes. The reason being is they were essentially flat.

They were flat. Our customer growth and favorable weather were effectively offset to a great extent, by a $3 million to $4 million negative impact on revenues associated with COVID. As expected, commercial and industrial volumes were down, and residential volumes partially offset that, again, from a margin perspective, relatively flat. Moving forward on weather. It is a shoulder quarter for us. And as expected, didn't have much of a weather impact. We had a $500,000 favorable pre-tax benefit when you compare it to normal and an $800,000 pre-tax benefit compared to Q2 of 2019. If you look at the map on the bottom left side of page six, in April, we did have colder temperatures that helped our heating in our Montana gas business.

In June, we had warmer weather in South Dakota, which helped the South Dakota Electric business. Those two things are the primary drivers for our favorable weather during the quarter. Moving on to operating expenses on page seven. They are down $2.6 million or nearly 2% on a year-over-year basis. The biggest driver, of course, is the OG&A expenses, and I'll speak to that in a minute. Property taxes are up slightly as a result of increased valuation for our Montana property taxes, and depreciation expenses up $3.8 million. Of that $3.8 million increase, $2.3 million is associated with a 2019 favorable impact associated with the settlement of our rate case, where we booked an incremental benefit, the depreciation expense as part of that rate case settlement.

Jumping to the items that are impacting OG&A, the three the biggest of the $9.7 million decrease in OG&A of items impacting net income was a reduction in employee benefits. We had lower medical, we had lower incentive costs. You'll note there, we're also highlighting those costs to reduce that had an impact or increase, had an impact associated with COVID, and I'll speak to that in a minute. So employee benefits decreased to $3.7 million. We had $2.6 million of lower generation maintenance at DGGS in some of our South Dakota generation facilities. We had lower labor costs, some associated with how we changed our work around COVID, some was attributed to allocation of more labor to capital. We had lower hazard trees, and we had anticipated having lower hazard trees based upon the good progress we made in 2019 in that regard.

And then lower travel and training, about $1.2 million to be expected with what's going on with COVID. Those benefits were partially offset by a $3.1 million increase in uncollectible accounts during the quarter, and we had some other impacts as well, totaling $9.7 million of items that impacted net income. Below that, of course, there are some changes in OG&A that are offset elsewhere in the P&L for a net decrease of $9.1 million in OG&A for the quarter. To the far right, again, we show the COVID-related impacts, $3.1 million increase in uncollectible accounts, offset by $2.8 million of lower COVID-related expenses. And you can think of lower medical, lower labor and travel and training for that $2.8 million. We'll give you a full P&L on COVID here later in the presentation. Moving forward, just operating income at the top of the page, off $4 million, on our quarter-over-quarter basis.

Moving down to pre-tax, down about $4.7 million. Primarily, that change is driven by an increase in interest expense, almost all of that attributed to COVID. And we need to have incremental borrowings to improve our liquidity during the quarter. Below pre-tax income, $21.5 million increase in income tax, again, almost all of that really attributed to the $23 million favorable item in 2019 that was taken. That leads us to, again, the $26 million decrease on a quarter-over-quarter basis in net income. And with that, I'm going to stop there for a second and just point out, when you take into consideration this $7.7 million of negative impact this year on margin associated with the 2019 favorable impact items, to take the $2.3 million favorable item associated with depreciation in 2019.

That's $10 million on a pre-tax basis. after-tax, just round numbers, I think $7 million after-tax associated with that. Obviously, $23 million of after-tax benefit in 2019. That's a $30 million swing on an after-tax basis. And so for the quarter, just removing those 2019, all of the 2019 items I discussed, we would have had $4 million favorable on a year-over-year basis. Add to that, we'll show a P&L in a minute, approximately $3 million of an after-tax detriment that we received in 2020 associated with COVID. If you back that out, we would have net been up $7 million for the quarter. So obviously, from a headline perspective, it didn't look like a great quarter. But from our perspective, we feel good knowing what we know regarding COVID and where we're going forward. Moving to page nine on income taxes.

I talked about the $21.5 million increase, again, associated with the recognition of an unrecognized tax benefit in 2019 partially offset by lower pre-tax income and a slightly better flow through repairs on a year-to-date on a quarterly basis. Balance sheet, not much to talk about on page 10. We did have increase in PP&E of the $100 million, increase in short-term debt by $100 million. That's probably the biggest changes since the end of the year 2019. And you can see on a debt-to-capital perspective at the bottom of the page, very little change, around 52% debt to cap. On cash flow on page 11. Cash from operations is approximately $75 million better on a year-over-year basis. Really, three things drove that. We had improvement in collections on supply costs this year. In 2019, we were giving refunds to customers associated with TCJA. We're also giving some transmission interconnection refunds in 2019.

Those three items were partially offset by lower net income this year to, again, approximately $75 million improvement there. Thinking on our adjusted non-GAAP earnings on page 12. You see at the bottom of the page, diluted EPS of $0.43 on a GAAP basis, really taking out a $0.01 for favorable weather this quarter gets $0.42, that compared to a non-GAAP number of $0.50. Last year, we did in that case, we had unfavorable weather of $0.01, and we added back the tax benefit in that was received in 2019. So again, $0.08 detriment on a year-over-year basis. The main thing I'd point out also on this page is pre-tax income on a non-GAAP to non-GAAP basis is down slightly from our GAPP, primarily as a result of the $800,000 swing in favorable weather. And then but I also say the net income improves significantly when we removed the tax benefit, net income there is shown as $4 million less.

And again, it equates to $0.08 on an EPS basis. Moving forward, page 13. Diluted earnings per share, reaffirming our previously revised earnings guidance at $3.30 to $3.45 per diluted share. We do note our assumptions. Obviously, one of the big assumptions we have for the remaining years is our expectations on COVID. And not only an impact on our margins, but also the ability to recover collectibles uncollected account expense from commissions where we made filings, obviously, normal weather and a share count of $50.9 million and a tax range of minus 5% to 0%. Lastly, on this page, I'd point out, we do have a continue to have our 6% to 9% total return. That's on a long-term look from our perspective. And of course, that's going to be derived through a combination of earnings growth and dividend yield.

Moving on to just the change in our bridge associated with revised guidance, in thinking through COVID, you can see at $1.48 for the first two quarters of the year, and we'll need $1.82 to $1.97 to achieve the $3.30 to $3.45 range that we discussed. That means we'll need an improvement on a year-over-year basis of $0.13 to $0.29. And where will that benefit primarily come from? It's going to continue to come from OG&A expense, and it's going to come from tax timing. And one thing I'd point out is we had a $0.14 improvement on OG&A expense in the second quarter alone. And so we do expect, if COVID continues, we'll have a relatively easy time achieving that $0.08 to $0.11, if not better, in that regard. So we're going to work extremely hard to stay on top of that. We also know that we have a tax timing swing and those two things, again, will help us achieve our earnings guidance in Q3 and Q4.

What really changed in the forecast since the second quarter? We did get our final property tax assessment. We have an increase in property taxes, in certainly in the latter half of the year, but we increased the gross margin for property tax recovery associated with that for the second half of the year. Those are the two primary changes since the last time we made this adjustment. Moving on to the next page, on page 15, real quickly, just pointing out that from our perspective, decline in gross margin, of $3 million to $4 million, in line with our expectations. At the top of the page, the far right, we do show what our forecast was for Q2 and how things actually played out a little bit better in industrial and commercial, a little bit worse on residential. But all in all, pretty much where we expected. We do show that we're maintaining our expectations for Q3 and Q4, and we show that at a high level in the upper right and in a more detailed basis for both our electric and gas business.

They are directly below it. Moving forward to expenses on page 16. Again, expenses came in line with our expectations during the second quarter. We do show at the upper right, a full P&L associated with that when you take into consideration of $3 million to $4 million reduction in gross margin I talked about earlier. When you think about expenses, think about a net increase in operating expenses of $300,000 and then add $700,000 of interest expense. So $1 million impact on COVID on the expense side. So that gives us a pre-tax detriment of $4 million to $5 million and an after-tax of $3 million to $3.7 million associated with COVID or $0.06 to $0.07. One other thing I should point out on this page, we mentioned in our press release, capital spending, we still anticipated approximately $400 million. We're seeing very little impacts on the supply chain, very little impacts on staffing levels. We are getting our work done. We've actually spent more capital year-to-date this year than we had all of last year. So we're on great track to keep moving forward there.

And with that, I'll hand it back over to Bob.

Robert Rowe -- President and Chief Executive Officer

Thank you, Brian. Actually, just to reinforce Brian's discussion for the last few minutes in terms of margin and expense, recall that we came out relatively early at the end of the first quarter and certainly relatively early in the new COVID world and the ability to come in really quite closely to where we expected to be at that time with so many unknowns, I think says an awful lot. Turning then to the capital forecast, the health warning, of course, over on the left, we're comfortable with about $1.8 billion of total capital over the next five years, financing with a combination of cash from operations with NOLs available into 2021, first mortgage bonds and equity issuances. And based on what we know now, what we expect now, any additional equity would be late this year or early next year and would be really focused on maintaining current credit ratings.

That said, significant capital beyond what's identified in the ladder to the right would affect those capital projections. The key thing in thinking about our capital forecast, first of all, just exactly, as Brian said, in a crazy year with potential workforce interruptions, potential supply chain interruptions. And with a lot of work really distributed across the company, not just concentrated in one or two big projects. So an awful lot of project management to be done. We're very comfortable that we will be meeting our $400 million expectation for this year. And we're equally comfortable that we'll be continuing over the next five years to invest at, at least that $400 million levels. We talked about it before, what we show on the identified projects to continue to serve our customers as we get more visibility into the out years.

This will change. We're very, very comfortable that we'll continue to invest at the $400 million level. And very importantly, of course, this does not include investment necessary to identify the generation capacity challenges in Montana, and we are unique in being 40 customers are unique, and not in a good way in being exposed to the market of 46% at peak out of Montana. So this is an important investment program to continue to serve our customers, to make growth in our territory, and we're very comfortable with all that's been thrown at us and everyone else this year. We've been able to execute, and we're comfortable we will continue to be able to execute. Looking forward, obviously, always a lot of activity on the regulatory front. The Montana Commission approved the fixed cost recovery mechanism or decoupling.

We talked about this last quarter. Of course, we consider that very, very important over the long term. It's effective was to be effective July one as we discussed last quarter. We did request that, that be the implementation date we deferred until July one of next year for COVID-related concerns. The Commission agreed with that, thought it made sense, delayed implementation by a year. They did request or instruct that we provide kind of a shadow accounting so that the Commission can really understand what the impacts of the FCRM would have been if it had been implemented July of this year. In June, of course, we received an order from the FERC accepting our Montana transmission filing, granting interim rates, setting a procedural schedule, and ultimately, been appointing an administrative law judge. Settlement negotiations continue to be ongoing despite the challenges of COVID. Obviously, our teams are not meeting in person.

And then we would expect a compliance filing with the Montana Commission whenever the FERC rate pace does conclude. As you know concerning our Colstrip application, Talen did assert its right of first refusal. So we are in the process of modifying that application to reflect a 92.5 megawatt acquisition from Puget Sound Energy and then the corresponding purchase power agreement to sell power back to Puget Sound Energy with the net proceeds then proposed to be set aside to cover eventual closing costs for our current ownership at Colstrip. So we think that's a compelling proposition from a customer perspective and also from that company. It's really from an environmental perspective. On the South Dakota front, we're under way, again, despite the COVID challenges with 60 megawatts flexible value that $80 million of flexible capacity located in Huron, South Dakota.

The site will be activated here, really in a matter of days, and that should be online by late 2021. Just a parenthetical, we filed now a new South Dakota IRP, just in the last couple of weeks, for a great feedback from both the staff and the Commission. And we received word from the Commission Chair that our 57 page summary document was the best plan he had ever seen. So we really appreciate that. And that plan is consistent with the plan that we're currently implementing, really focused on renewing our fleet, being able to provide our customers reliability to get the full benefits of participating in the Southwest Power Pool. In Montana, of course, we issued an all-source solicitation for up to 280 megawatts of flexible capacity. That went out in February. We're using a third-party administrator. We are, of course, participating with bids ourself and looking forward to seeing the outcome of that. The projects, of course, at this point are identity blind in terms of who is sponsoring the projects.

So that's about all we can say there. And other than we have participated in the project and look forward to seeing the results. We're also on track to join the western energy imbalance market in April of 2021, and this could certainly provide benefits for our Montana customers and much more efficient utilization of both supply and that transmission assets. But as we've talked about, you have to bring your own toys to the sandbox. We need resources in order to participate. Worth noting there that last week, the Montana Commission had a very great discussion of regional resource adequacy.

Frank Afranji, who is the President of the Northwest Power Pool was the lead presenter, describing the immediate concerns that the entire region has in terms of being able to meet our customers' needs, and the need for coordinated approaches to do that. Then we had our leaders on regional issues, on both the supply and transmission side, speak as well. And again, the region is facing a very, very critical situation. And within the region, being 46% exposed, our customers truly, truly are the most at risk.

So with that, I look forward to questions.

Questions and Answers:

Operator

[Operator Instructions] We'll go ahead and take our first question from Shar Pourreza with Guggenheim partners.

Kody Clark -- Guggenheim partners -- Analyst

Hey, good afternoon. This is actually Kody Clark on for Shar. So you guys guided down at Q1 given weather and the expected impact of COVID-19. And you've had another somewhat challenging quarter with the virus. Obviously, we're still awaiting the approval to defer uncollectible account costs from your commissions. But wondering that you're still confident in the midpoint of guidance, are you tracking more toward the lower end of the range?

Brian Bird -- Chief Financial Officer

Yes. I'd like to we don't ever try to give anybody where we are in the range. I would just say this, we feel good about where we sit today. Obviously, we need to get recovery from the Commission. That's an important part of our range, if you will, as a whole. But actually, Q2 came right in line with our expectations. We do expect that things are going to improve over time in Q3 and Q4 from a COVID-related perspective, that was in our guidance range initially, but we also expected to kind of pull off the gas a little bit on OG&A savings in the second half of the year either.

And if, in fact, things continue to stay difficult because of COVID on the margin side, we'll be that much more attuned to it on the OG&A expense. And so we feel very confident in our earnings guidance as we sit here today.

Kody Clark -- Guggenheim partners -- Analyst

Got it. And second, have you given any more thought on upsizing the current Montana RFP given power on that side of this whole front? I know it's somewhat relies on the intendant valuation, but just wondering your updated thoughts there.

Robert Rowe -- President and Chief Executive Officer

That certainly is something that we will take a look at for exactly the reason that you said. It depends on seeing what comes in. But as I mentioned, we have a pretty big hole to fill on behalf of our customers, and shame on us if we don't do that. So that's certainly a possibility.

Kody Clark -- Guggenheim partners -- Analyst

All right, thanks, that's all I have.

Robert Rowe -- President and Chief Executive Officer

Thanks, Kody.

Operator

We'll take our next question from Michael Weinstein with Credit Suisse.

Michael Weinstein -- Credit Suisse -- Analyst

Hi, good afternoon guys. You said the OG&A expense cuts of $0.08 to $0.11, you're expecting in the second half of the year. That depends on what does that depend on exactly? I think you mentioned COVID continuing, I mean COVID expense cuts continuing? Or things like travel.

Brian Bird -- Chief Financial Officer

What we did is I'm sorry. Mike, as we thought about Q3 and Q4, we expected thanks to, over time, slow reversion to near normal by the end of the year, right? And so if we had an expectation on OG&A cuts for the full year, we would be backing off that a little bit as well. So you noticed, I pointed out earlier, we had $0.14 of improvement on a year-over-year basis on the OG&A line, just in the second quarter alone. And obviously, the range for Q3 and Q4 is less than that. And so if, in fact my point was if, in fact, we don't see the margin improvement in which we do expect that we will get that, that we will need to do more on the OG&A side, but I feel confident that we could.

Michael Weinstein -- Credit Suisse -- Analyst

Got you. And also, could you characterize what the opportunity may be in South Dakota in terms of versus the current capex plan?

Robert Rowe -- President and Chief Executive Officer

It's probably early to say too much beyond the fact that there are additional opportunities. And in the context of our South Dakota operation, those are significant.

Brian Bird -- Chief Financial Officer

And I would share that we had historically shown our over South Dakota what we were going to do over time. And initially, if you think back, if there's a number of units spread across South Dakota. Then we talked about this 60 megawatts in here on and possibly something in Aberdeen in South Dakota. And so I think at that point in time, we talked about a total opportunity of 90 megawatts and being at 60 today. It would be an incremental 30. And hopefully, we can get after that sooner rather than later.

Michael Weinstein -- Credit Suisse -- Analyst

Okay. Fair enough. And regarding the equity issuance, what's the thinking on how the timing might come out? I know you said it could either later this year or maybe early 2021. Is it more likely to be a 2021 timeframe? Or is there some reason why it might be earlier than that?

Brian Bird -- Chief Financial Officer

Mike, I think of it this way. I think it's a 2021 item. We'll continue to have dialogues with rating agencies. If for some reason, concerns are raised there, we could do something sooner than that. But right now, we're planning that as a 2021 item.

Michael Weinstein -- Credit Suisse -- Analyst

Okay, great, thank you very much.

Operator

We'll take our next question from Julien Dumoulin-Smith with Bank of America.

Julien Dumoulin-Smith -- Bank of America -- Analyst

Can you hear me?

Brian Bird -- Chief Financial Officer

Yeah.

Julien Dumoulin-Smith -- Bank of America -- Analyst

Hey, thank you. So first off, let me just start with the numbers here. As you think about the back half of the year, what's driving the $0.11 to $0.17 gross margin uptick in your expectations? And I want to recognize I know you talked through some of the gross margin dynamics already. But perhaps at a high level, what's driving that uptick in the back half here?

And then maybe secondarily, and I know you alluded to this a little bit already, what other levers do you have to call to the extent to which that things don't materialize COVID, etc, from for COVID or otherwise?

Brian Bird -- Chief Financial Officer

Yes. I think if you focus on page 14, in terms of the bridge, one of the biggest reasons for the increase in gross margin in the second half of the year is our property taxes are going up, and we get the recovery of 75% of that 70% of that. So that's the biggest driver from a margin perspective. But we are from our perspective, we're seeing we expect to see better irrigation. We're going to obviously have customer growth. And I mentioned earlier that we expected some in the first quarter, we mentioned some unbilled timing associated in the second half of the year.

So again but looking just at this page, you can see the primary benefit, $0.09 of that gross margin is associated with property taxes. So you really need $0.02 to $0.08 of the remainder, and we feel very good about that. And I think to your question, Julien, on levers. I think I would just focus on my the comment about the $0.14 in Q2. We did better from an expense standpoint. And we do show backing off. I just think that if we continue to stay on top of expenses because of COVID. We can do better than we show there if, in fact, we need to.

Julien Dumoulin-Smith -- Bank of America -- Analyst

Awesome. And then on the RFP in Montana, I know you've alluded to this, it's been more of a net of your pet of then in terms of determining the winners there. Any data points that we should look to in the back half here?

Robert Rowe -- President and Chief Executive Officer

I would say, no.

Brian Bird -- Chief Financial Officer

Bob, one thing I think we shared in the last call is, if, in fact the one thing we did say is if we've ever found out we're not participating or we're not in the final rounds, we're going to let you know that as soon as we can. And if there then if there's some information incrementally that can be shared, we'd share.

Operator

We'll take our next question from Chris Ellinghaus with Siebert Williams Shank.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Thanks guys, I'm not sure if this is for you, Bob, or not but what is it that gives you confidence in the incremental third to fourth quarter improvement? Are you not believers that the possibilities of the flu season being more aggressive than what we're going to see in the second and third quarter relative to what it was like in, say, March or April? What is your sort of general view of the COVID outlook for the fourth quarter?

Robert Rowe -- President and Chief Executive Officer

First, what I would say is, as a company, we take COVID extremely, extremely seriously and adopted measures to keep our employees as safe and healthy as possible, well before the states took action. And we expect that those measures are going to continue in place, certainly, well into the fall. That said, we also know a great, great deal more about safe practices. We know that wearing masks, social distancing are extremely effective and are key on the frontline. The states we serve have three of the lowest unemployment rates in the nation. Nebraska, the lowest; Montana, the sixth lowest; and South Dakota, the 11th lowest. In South Dakota, what's notable is there was never a government order to shut down.

And actually, the virus's reproduction rate in South Dakota, despite that, is really quite, quite low. So the virus certainly continues. We take it as seriously as possible. We have supported the actions that states have taken around masks states and communities and businesses that taken around masks. But we see, consistent with that, a tremendous amount of activity coming back in our service territory. On a daily basis, for example, we're all hearing multiple examples of people from outer state buying property site unseen for at or above the sale price, or in some cases before it's even gone in the market. So there's an awful lot of activity in our service territory, we want all that to be safe, but it certainly is encouraging to see. That doesn't, in any way, minimize the real hardship being faced by the folks who are still out of work, committing to work with them.

But on balance, what we see is a region that is coming back. And arguably, well beyond the end of this year, could end up being much, much stronger as people look around and ask where they want to be.

Brian Bird -- Chief Financial Officer

Bob. I'm kind of just on a lot.Two quick things on top of that two data points. Bob talked about activity being up. We have new connections are up in five of our largest six cities in Montana. People are buying homes in our service territory. So I wouldn't have guessed that. Second thing I'd point out, in our two states, our two largest states, Montana and South Dakota, the total number of COVID cases in those two states combined is about approximately 2,200.

And so our parts of our parts of this country and our service territory are doing extremely well relative to the rest of the country. Yes, do we expect COVID to be tough in the third and fourth quarter? It should be. But our expectations are, we'll be able to manage through that if, in fact, it is through what we've been doing thus far in cost control.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Okay. As far as your offset to the bad debt expense, the labor and the medical costs. Are you starting to see behaviors change a little bit where that benefit has been easing off more of late?

Brian Bird -- Chief Financial Officer

The answer to that is no. Through what we've seen through the second quarter and what I've seen into July, I'd say, no. I'd say it's pretty consistent.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Okay. And should if those behaviors stay similar, would you expect that to continue into the later part of the year as well if the economy is so economies improving locally would not there'd be more customer contact and/or more utilization of medical services that would change that direction a little bit?

Brian Bird -- Chief Financial Officer

Chris, I think that's a possibility. We commonly are using the words levers here. Again, if, in fact, we see COVID being more sustained through this time period, we're going to we're probably going to continue to see medical costs staying low. We're going to probably see our labor costs staying lower as a result, too, lower than we're projecting.

Robert Rowe -- President and Chief Executive Officer

We are going to be so deep in the year that those kinds of changes are really going to be on the margin.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Okay, thanks for the color, guys, I appreciate it.

Operator

We'll take our next question from Brian Russo with Sidoti.

Brian Russo -- Sidoti -- Analyst

Hi, good afternoon. Hey, Brian.

Brian Bird -- Chief Financial Officer

Hey.

Brian Russo -- Sidoti -- Analyst

With the shadow accounting that you're required to do with the delay in the FCRM, now that we're near the end of July, any thoughts on what the avoided impact was of not implementing the FCRM on July 1?

Brian Bird -- Chief Financial Officer

No. No thoughts there.

Brian Russo -- Sidoti -- Analyst

Okay. And in terms of the deferral accounting and the procedural schedule, what's next that we should be looking for? Or what filing testimony, whatever?

Robert Rowe -- President and Chief Executive Officer

Two items. First, in South Dakota, looking for a staff recommendation. And then in Montana, looking to see whether or not parties file testimony. And that could be either consumer counsel or large customer group comments or testimony. If it is filed, it will be due on July 31.

Brian Russo -- Sidoti -- Analyst

Okay. July 31. Got it. And you mentioned a short list in the Montana RFP. When might that be expected?

Robert Rowe -- President and Chief Executive Officer

The analysis is going on now. We'll start to see more information about projects. And again, I would really focus on the first quarter. Brian's qualification to that is a good one. If we're not in the running, we'll let you know.

Brian Russo -- Sidoti -- Analyst

Okay. So if you're in the running, you won't let us know, I guess is the way to think about it as well.

Robert Rowe -- President and Chief Executive Officer

There's a double negative buried in there, but yes.

Brian Russo -- Sidoti -- Analyst

Got it. So just if you don't mind, just a clarification, what was the bad debt or uncollectibles as of June 30? And what might need we expect throughout the year to you ultimately seek recovery of time dollars amount? Just trying to get a sense of what the magnitude of that could possibly be?

Robert Rowe -- President and Chief Executive Officer

Brian?

Brian Bird -- Chief Financial Officer

Yes. I mentioned the increase is $3 million for the quarter. I know what's from what's in rates is approximately $2 million. And so we need to continue anything above what's in rates during the year. That's what we're going to ask to have be put in a reg asset for the year. So we'll see how things play out in Q3 and Q4. And as long as we still have a moratorium on disconnects for nonpayment, we expect to have that bad debt continue to increase.

Brian Russo -- Sidoti -- Analyst

Okay. And just remind me, was this an individual NorthWestern filing with the commission for COVID recovery? Or is it like we've seen in other states where it's more of a generic filing where various in-state peer utilities all filed for the same type of structure and recovery?

Robert Rowe -- President and Chief Executive Officer

It's really yes to both. In South Dakota, there is a filing by Northwestern, MDU, Xcel, MidAm and Otter Tail. Within that filing, various companies are requesting different kinds of relief. We, as you know, we're not requesting a make-whole. We are requesting an accounting order for bad debt. In Montana, it's a stand-alone filing, addressing bad debt and also pension contributions. There is a parallel filing by MDU as well that's broader on the kind of the COVID side.

Brian Bird -- Chief Financial Officer

And Bob, the.

Brian Russo -- Sidoti -- Analyst

And then.

Brian Bird -- Chief Financial Officer

Go ahead. Brian, I do want to point out my fact checkers here pointed something out to me. What's in rates is actually $1.1 million. So the increase thus far in the second quarter is $2 million. I think I said that wrong.

Brian Russo -- Sidoti -- Analyst

The past keep up what. What percentage or the dollar amount of the O&M and SG&A savings this year are sustainable? Obviously, travel, etc, is that should revert back to the norm going forward. But any idea of what level of cost cuts can be sustainable into 2021 and beyond?

Brian Bird -- Chief Financial Officer

Bob, I'll grab that.

Robert Rowe -- President and Chief Executive Officer

Well, yes. Why don't I set up the question and then ladder it over to you. Certainly, there are expenses that are going to change. There will be more travel. There will be more medical expenses. But will travel look like it did before? Probably not. So there are certainly some elements that will be carried forward. But remember, when you benchmark us against any of our peers or even against larger companies on their expense per customer, expense per employee, other than that Montana property taxes, we are already just about as lean as anyone out there.

Brian Bird -- Chief Financial Officer

Bob, that was great. The only thing I'd add to that, it's spot on, is that this budget season is a little bit different. In the sense is that we have to think about COVID, and there are some things that are different in that we would want to capture those benefits, and we're focused on that here right after this earnings call effectively. That's something we have to be focused on. Thinking about how this is going to impact 2021, when we can do to take advantage of COVID to help us going forward.

Brian Russo -- Sidoti -- Analyst

Okay, great, thanks guys.

Operator

We'll take our next question from Jonathan Reeder with Wells Fargo.

Jonathan Reeder -- Wells Fargo -- Analyst

Hey, good afternoon gentlemen. How is everyone doing.

Brian Bird -- Chief Financial Officer

Good.

Jonathan Reeder -- Wells Fargo -- Analyst

Just kind of piggybacking on the last topic. If for some reason, Montana and South Dakota don't grant your request deferral accounting, do you still estimate it's going to be a like a $0.05 EPS hit for the full year if you're already at $2 million thus far?

Brian Bird -- Chief Financial Officer

Yes. We're still impacting $0.05. And I think some of that is we do expect, and hope to expect to have reinstated the ability to disconnect customers before we get into the heating season. And so we're already making having discussions around that in South Dakota very soon, in Montana, a little bit later. But it's something I think it's important that has to get handled. And that should help offset some of the obviously, increases we've seen thus far in the second quarter to kind of slow that rate, if you will.

Jonathan Reeder -- Wells Fargo -- Analyst

Okay. Great. And then, Bob, in your comments regarding being comfortable with deploying $400 million of capex annually going forward. Did you say that would be before adding any potential Montana generation additions? Or like, in other words, Montana generation would be incremental to that $400 million per year?

Robert Rowe -- President and Chief Executive Officer

Yes. No, the capital ladder is built up with projects that are identified and that we are confident about. So as always, the out years are will increase as our specific capital plans to serve our customers become more known.

Jonathan Reeder -- Wells Fargo -- Analyst

Okay. And then the last one, just kind of curious what your thoughts are on the MPSC's comments filed in late June regarding your Montana electric supply form? And how, if at all, that impacts the ongoing generation RFP and winning bid selection criteria?

Robert Rowe -- President and Chief Executive Officer

To my mind, the key thing was that the Commission acknowledges the exposure that our customers face and take it seriously. So we thought that, in fact, the comment was, on balance, very, very positive and probably different in tone than might have been the case just a couple of years ago. And again, the conversations that the Commission had with President of the Northwest Power Pool, just last week, did indicate a real appreciation for the situation that customers in Montana face.

Jonathan Reeder -- Wells Fargo -- Analyst

Okay. So their concerns expressed around, I guess, maybe the inputs or assumptions you could ask for making there and errors that were cited around that? That doesn't overly concern you given the overarching theme that they recognize you're short and everything like that. It just kind of seemed like it took -- and the thought that, I guess, it had to be natural gas to fulfill the need versus the potential that other types of resources to maybe meet the need effectively as well.

Robert Rowe -- President and Chief Executive Officer

The way I look at the plan, the key is the plan identified a need. Subsequently then there were a whole range of scenarios using different resource combinations, and those scenarios were just that. But when we made the decision not to identify a specific "preferred" resource in the plan and then commit to that path to let essentially all resources compete. That's a very different direction. Now a couple of comments that are interesting. First of all, the analyses underlying the South Dakota and Montana plant, it's the same model. It's the same kind of work. The environments in the two states are, in many ways, quite different, obviously, but the same kind of analysis.

And what we received back in South Dakota was just real support for the plan. I certainly think that our planning group in Montana, over time, will continue to address and refine the Montana plan to speak to the concerns that or questions that were raised by the consultant to the Commission, which was really the source for many of the comments. So it's an iterative process plan to plan. But again, the way the RFP is structured in three tiers of opportunities for projects to bid in at 20 hours, 10 hours and five hours, we should see some real diversity and the viability cost-effective viability of various technologies is going to be proven in what's submitted.

Brian Bird -- Chief Financial Officer

Jonathan, one thing I'd like just clarification I think on the capital plan, the capital plan we're showing here on page 17 is our capital plan for the year. And obviously, as we go through the process and go through our budgeting process, in the outer years, they typically tend to be a bit higher than we had originally planned. So there's an expectation, as Bob points out there.

We're going to be close to $400 million. I don't think we should be guaranteeing anybody that they will be $400 million in those outer years. I would say this, though, if, in fact, we're doing any Montana generation, we're likely to be at least $400 million, if not likely higher. If that's helpful clarification.

Operator

There appears to be no further questions at this time.

Robert Rowe -- President and Chief Executive Officer

Okay. Well, thank you for joining us. Thank you for the very good questions and discussion. We look forward to visiting with you, probably online, over the coming months and online or in person, maybe by the end of the year. Take care, everybody.

Operator

[Operator Closing Remarks].

Duration: 58 minutes

Call participants:

Travis Meyer -- Director of Corporate Finance and Investor Relations Officer

Robert Rowe -- President and Chief Executive Officer

Brian Bird -- Chief Financial Officer

Kody Clark -- Guggenheim partners -- Analyst

Michael Weinstein -- Credit Suisse -- Analyst

Julien Dumoulin-Smith -- Bank of America -- Analyst

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Brian Russo -- Sidoti -- Analyst

Jonathan Reeder -- Wells Fargo -- Analyst

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