EX-99.2 3 exhibit992q22018fs.htm EXHIBIT 99.2 Exhibit

Exhibit 99.2
 
 
 












FORTIS INC.

Condensed Consolidated Interim Financial Statements
For the three and six months ended June 30, 2018 and 2017
(Unaudited)

 
F - 1
 

Fortis Inc.
Condensed Consolidated Interim Balance Sheets (Unaudited)
As at
(in millions of Canadian dollars)
 
June 30,
 
December 31,
 
2018
 
2017
 
 
 
 
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
197

 
$
327

Accounts receivable and other current assets (Note 6)
1,133

 
1,131

Prepaid expenses
62

 
79

Inventories
346

 
367

Regulatory assets (Note 7)
331

 
303

Total current assets
2,069

 
2,207

Other assets
526

 
480

Regulatory assets (Note 7)
2,780

 
2,742

Property, plant and equipment, net
31,559

 
29,668

Intangible assets, net
1,165

 
1,081

Goodwill
12,150

 
11,644

Total assets
$
50,249

 
$
47,822

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities
 
 
 
Short-term borrowings (Note 8)
$
69

 
$
209

Accounts payable and other current liabilities
1,769

 
2,053

Regulatory liabilities (Note 7)
587

 
490

Current installments of long-term debt (Note 8)
1,037

 
705

Current installments of capital lease and finance obligations
46

 
47

Total current liabilities
3,508

 
3,504

Other liabilities
1,234

 
1,210

Regulatory liabilities (Note 7)
2,990

 
2,956

Deferred income taxes
2,465

 
2,298

Long-term debt (Note 8)
21,572

 
20,691

Capital lease and finance obligations (Note 15)
616

 
414

Total liabilities
32,385

 
31,073

Commitments and Contingencies (Note 15)

 

Equity
 
 
 
Common shares (1) 
11,731

 
11,582

Preference shares
1,623

 
1,623

Additional paid-in capital
10

 
10

Accumulated other comprehensive income
540

 
61

Retained earnings
2,110

 
1,727

Shareholders' equity
16,014

 
15,003

Non-controlling interests
1,850

 
1,746

Total equity
17,864

 
16,749

Total liabilities and equity
$
50,249

 
$
47,822

 
 
 
 
(1) No par value. Unlimited authorized shares; 424.8 million and 421.1 million issued and outstanding as at June 30, 2018 and December 31, 2017, respectively
 
 
 
 
See accompanying Notes to Condensed Consolidated Interim Financial Statements

 
F - 2
 

Fortis Inc.
Condensed Consolidated Interim Statements of Earnings (Unaudited)
For the periods ended June 30
(in millions of Canadian dollars, except per share amounts)
 
 
 
 
 
 
 
 
 
 
 
Quarter Ended
 
Year-to-Date
 
 
2018

2017

2018

2017
 
 
 
 
 
 
 
 
 
Revenue (Note 6)
$
1,947

 
$
2,015

 
$
4,144

 
$
4,289

 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
Energy supply costs
507

 
524

 
1,236

 
1,278

 
Operating expenses
553

 
567

 
1,106

 
1,146

 
Depreciation and amortization
309

 
298

 
611

 
595

Total expenses
1,369

 
1,389

 
2,953

 
3,019

Operating income
578

 
626

 
1,191

 
1,270

Other income, net (Note 10)
18

 
20

 
27

 
48

Finance charges
243

 
232

 
479

 
461

Earnings before income taxes
353

 
414

 
739

 
857

Income tax expense
61

 
102

 
83

 
208

Net earnings
$
292

 
$
312

 
$
656

 
$
649

 
 
 
 
 
 
 
 
 
Net earnings attributable to:
 
 
 
 
 
 
 
 
Non-controlling interests
$
35

 
$
38

 
$
60

 
$
65

 
Preference equity shareholders
17

 
17

 
33

 
33

 
Common equity shareholders
240

 
257

 
563

 
551

 
 
$
292

 
$
312

 
$
656

 
$
649

 
 
 
 
 
 
 
 
 
Earnings per common share (Note 12)
 
 
 
 
 
 
 
 
Basic
$
0.57

 
$
0.62

 
$
1.33

 
$
1.34

 
Diluted
$
0.57

 
$
0.62

 
$
1.33

 
$
1.34

 
 
 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Interim Financial Statements
Fortis Inc.
Condensed Consolidated Interim Statements of Comprehensive Income (Unaudited)
For the periods ended June 30
(in millions of Canadian dollars)
 
 
Quarter Ended
 
Year-to-Date
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Net earnings
$
292

 
$
312

 
$
656

 
$
649

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
Unrealized foreign currency translation gains (losses), net of hedging activities and tax
244

 
(244
)
 
550

 
(336
)
Other, net of tax
1

 
(2
)
 
1

 
(2
)
 
245

 
(246
)
 
551

 
(338
)
Comprehensive income
$
537

 
$
66

 
$
1,207

 
$
311

Comprehensive income attributable to:
 
 
 
 
 
 
 
 
Non-controlling interests
$
68

 
$
38

 
$
132

 
$
65

 
Preference equity shareholders
17

 
17

 
33

 
33

 
Common equity shareholders
452

 
11

 
1,042

 
213

 
$
537

 
$
66

 
$
1,207

 
$
311

 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Interim Financial Statements

 
F - 3
 

Fortis Inc.
Condensed Consolidated Interim Statements of Cash Flows (Unaudited)
For the periods ended June 30
(in millions of Canadian dollars)
 
 
 
 
 
 
 
 
 
Quarter Ended
 
Year-to-Date
 
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
 
Operating activities
 
 
 
 
 
 
 
Net earnings
$
292

 
$
312

 
$
656

 
$
649

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
 
 
 
 
 
 
Depreciation - property, plant and equipment
276

 
267

 
545

 
533

 
 
Amortization - intangible assets
25

 
24

 
51

 
48

 
 
Amortization - other
8

 
7

 
15

 
14

 
 
Deferred income tax expense
76

 
102

 
61

 
174

 
 
Accrued employee future benefits
7

 
9

 
3

 
10

 
 
Equity component of allowance for funds used during construction (Note 10)
(15
)
 
(19
)
 
(30
)
 
(36
)
 
 
Other
41

 
(33
)
 
59

 
(11
)
Change in long-term regulatory assets and liabilities
(38
)
 
(2
)
 
2

 
(9
)
Change in working capital (Note 13)
10

 
(18
)
 
(91
)
 
(182
)
Cash from operating activities
682

 
649

 
1,271

 
1,190

Investing activities
 
 
 
 
 
 
 
Capital expenditures - property, plant and equipment
(724
)
 
(654
)
 
(1,379
)
 
(1,323
)
Capital expenditures - intangible assets
(68
)
 
(65
)
 
(98
)
 
(105
)
Contributions in aid of construction
33

 
24

 
60

 
37

Other
(33
)
 
(46
)
 
(53
)
 
(69
)
Cash used in investing activities
(792
)
 
(741
)
 
(1,470
)
 
(1,460
)
Financing activities
 
 
 
 
 
 
 
Proceeds from long-term debt, net of issuance costs
32

 
368

 
352

 
756

Repayments of long-term debt and capital lease and finance obligations
(85
)
 
(19
)
 
(231
)
 
(35
)
Borrowings under committed credit facilities (Note 16)
1,196

 
1,658

 
2,362

 
3,624

Repayments under committed credit facilities (Note 16)
(1,079
)
 
(1,881
)
 
(2,185
)
 
(4,397
)
Net change in short-term borrowings (Note 16)
25

 
8

 
23

 
10

Issue of common shares, net of costs, and dividends reinvested
5

 
30

 
20

 
544

Dividends
 
 
 
 
 
 
 
 
 
Common shares, net of dividends reinvested
(114
)
 
(104
)
 
(230
)
 
(202
)
 
 
Preference shares
(17
)
 
(17
)
 
(33
)
 
(33
)
 
 
Subsidiary dividends paid to non-controlling interests
(16
)
 
(22
)
 
(40
)
 
(39
)
Other
22

 
6

 
20

 
7

Cash (used in) from financing activities
(31
)
 
27

 
58

 
235

Effect of exchange rate changes on cash and cash equivalents
5

 
(2
)
 
11

 
(3
)
Change in cash and cash equivalents
(136
)
 
(67
)
 
(130
)
 
(38
)
Cash and cash equivalents, beginning of period
333

 
298

 
327

 
269

Cash and cash equivalents, end of period
$
197

 
$
231

 
$
197

 
$
231

 
 
 
 
 
 
 
 
 
 
Supplementary Information to Condensed Consolidated Interim Statements of Cash Flows (Note 13)
 
 
 
 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Interim Financial Statements

 
F - 4
 

Fortis Inc.
Condensed Consolidated Interim Statements of Changes in Equity (Unaudited)
For the periods ended June 30
(in millions of Canadian dollars)
 
Common Shares
Common Shares
 
Preference Shares
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Non-Controlling Interests
 
Total Equity
 
(# millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As at December 31, 2017
421.1

$
11,582

 
$
1,623

 
$
10

 
$
61

 
$
1,727

 
$
1,746

 
$
16,749

Net earnings
—

—

 
—

 
—

 
—

 
596

 
60

 
656

Other comprehensive income
—

—

 
—

 
—

 
479

 
—

 
72

 
551

Common shares issued
3.7

149

 
—

 
(1
)
 
—

 
—

 
—

 
148

Subsidiary dividends paid to non-controlling interests
—

—

 
—

 
—

 
—

 
—

 
(40
)
 
(40
)
Dividends declared on common shares ($0.425 per share)
—

—

 
—

 
—

 
—

 
(180
)
 
—

 
(180
)
Dividends declared on preference shares
—

—

 
—

 
—

 
—

 
(33
)
 
—

 
(33
)
Other
—

—

 
—

 
1

 
—

 
—

 
12

 
13

As at June 30, 2018
424.8

$
11,731

 
$
1,623

 
$
10

 
$
540

 
$
2,110

 
$
1,850

 
$
17,864

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As at December 31, 2016
401.5

$
10,762

 
$
1,623

 
$
12

 
$
745

 
$
1,455

 
$
1,853

 
$
16,450

Net earnings
—

—

 
—

 
—

 
—

 
584

 
65

 
649

Other comprehensive loss
—

—

 
—

 
—

 
(338
)
 
—

 
—

 
(338
)
Common shares issued
16.4

673

 
—

 
(4
)
 
—

 
—

 
—

 
669

Foreign currency translation impacts
—

—

 
—

 
—

 
—

 
—

 
(52
)
 
(52
)
Subsidiary dividends paid to non-controlling interests
—

—

 
—

 
—

 
—

 
—

 
(39
)
 
(39
)
Dividends declared on common shares ($0.40 per share)
—

—

 
—

 
—

 
—

 
(166
)
 
—

 
(166
)
Dividends declared on preference shares
—

—

 
—

 
—

 
—

 
(33
)
 
—

 
(33
)
Other
—

—

 
—

 
1

 
—

 
—

 
3

 
4

As at June 30, 2017
417.9

$
11,435

 
$
1,623

 
$
9

 
$
407

 
$
1,840

 
$
1,830

 
$
17,144

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying Notes to Condensed Consolidated Interim Financial Statements
 
 
 
 
 
 
 


 
F - 5

 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

1. DESCRIPTION OF BUSINESS

Nature of Operations

Fortis Inc. ("Fortis" or the "Corporation") is principally an international electric and gas utility holding company.

Earnings for interim periods may not be indicative of annual results due to the impact of seasonal weather conditions on customer demand and market pricing and the timing and recognition of regulatory decisions. Most of the annual earnings of the gas utilities are realized in the first and fourth quarters due to space-heating requirements. Earnings for the electric distribution utilities in the United States are generally highest in the second and third quarters due to the use of air conditioning and other cooling equipment.

Each entity within the reporting segments that follow operates with substantial autonomy.

Regulated Utilities

ITC: Comprised of ITC Holdings Corp. and the electric transmission operations of its regulated operating subsidiaries, which include International Transmission Company, Michigan Electric Transmission Company, LLC, ITC Midwest LLC and ITC Great Plains, LLC, all operating in the United States. Fortis owns 80.1% of ITC and an affiliate of GIC Private Limited owns 19.9% minority interest.

UNS Energy: Comprised of UNS Energy Corporation, which primarily includes Tucson Electric Power Company ("TEP"), UNS Electric, Inc. and UNS Gas, Inc., all operating in the United States.

Central Hudson: Represents Central Hudson Gas & Electric Corporation, operating in the United States.

FortisBC Energy: Represents FortisBC Energy Inc., operating in Canada.

FortisAlberta: Represents FortisAlberta Inc., operating in Canada.

FortisBC Electric: Represents FortisBC Inc., operating in Canada.

Other Electric: Comprised of utilities in Eastern Canada and the Caribbean as follows: Newfoundland Power Inc. ("Newfoundland Power"); Maritime Electric Company, Limited ("Maritime Electric"); FortisOntario Inc. ("FortisOntario"); the Corporation's 49% equity investment in Wataynikaneyap Power Limited Partnership; Caribbean Utilities Company, Ltd. ("Caribbean Utilities"), in which Fortis holds an approximate 60% controlling interest; FortisTCI Limited and Turks and Caicos Utilities Limited (collectively "FortisTCI"); and a 33% equity investment in Belize Electricity Limited ("BEL").

Non-Regulated

Energy Infrastructure: Primarily comprised of long-term contracted generation assets in British Columbia and Belize, and the Aitken Creek natural gas storage facility ("Aitken Creek") in British Columbia.

Corporate and Other: Captures expenses and revenues not specifically related to any reportable segment and those business operations that are below the required threshold for segmented reporting, including net expenses of Fortis and non-regulated holding companies.


 
F - 6
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

2. REGULATORY MATTERS

Regulation of the Corporation's utilities is generally consistent with that disclosed in its 2017 annual audited consolidated financial statements. A summary of significant regulatory developments in the first six months of 2018 follows.

U.S. Tax Reform

The Corporation's U.S. utilities are working with their respective regulators to return to customers the net income tax savings resulting from U.S. tax reform.

ITC: In April 2018 ITC reposted formula rates charged to customers of its Midcontinent Independent System Operator ("MISO") regulated subsidiaries retroactive to January 1, 2018, as approved by the Federal Energy Regulatory Commission ("FERC"). As at June 30, 2018, the amounts owing had been substantially returned to customers.

UNS Energy: In April 2018 the Arizona Corporation Commission ("ACC") approved TEP's application to return ongoing income tax savings through a combination of customer bill credits and regulatory liabilities. Customer bill credits became effective in May 2018. As at June 30, 2018, a regulatory liability of $10 million (US$8 million) was recognized for amounts to be returned to customers in the remainder of 2018. In 2019 and beyond, TEP will continue to return savings to customers using the same approach. Regulatory liabilities will be returned to customers as part of TEP's next rate case.

In March 2018 FERC issued an order directing TEP to either: (i) submit proposed revisions to its transmission rates or transmission revenue requirement to reflect the reduction in the federal corporate income tax rate; or (ii) show why a rate adjustment is not required. In May 2018 TEP proposed an overall customer rate reduction, to be effective March 2018, reflecting the lower federal corporate income tax rate. The proposal is currently being reviewed by FERC.

Central Hudson: In June 2018, as part of its approval of a joint proposal, discussed below, the New York Public Service Commission ("PSC") also approved Central Hudson's recommendation to reflect the recovery of lower federal corporate income tax in customer rates effective July 1, 2018. As at June 30, 2018, a regulatory liability of $14 million (US$10 million) was recognized related to the income tax savings realized in the first six months of 2018. As approved by the PSC, the refund of this regulatory liability to customers will be determined as part of a future regulatory proceeding.

ITC

In April 2018 a third-party complaint was filed with FERC challenging independence incentive adders that are included in transmission rates charged by ITC's MISO-regulated operating subsidiaries. Independence incentive adders were established to encourage transmission investment and recognize that ITC's operating subsidiaries are independent, dedicated transmission-only operations, with no affiliation to market participants in their regions. The adder allows 0.50% or 1.00% to be added to the authorized return on equity ("ROE"), subject to any ROE cap established by FERC. The outcome of this matter cannot be predicted at this time; however, ITC believes it has a strong position in respect of this complaint.

Central Hudson

In June 2018 the PSC issued an order approving a three-year rate plan, or joint proposal, that had been filed by Central Hudson along with multiple stakeholders and intervenors, pursuant to the July 2017 general rate application. The order included an allowed ROE of 8.8% and common equity ratios of 48%, 49% and 50% in rate years one, two and three, respectively, and is effective July 1, 2018 through June 30, 2021. Also included is an earnings sharing mechanism whereby the Company and customers share equally earnings between 50 and 100 basis points above the allowed ROE. Earnings beyond this are primarily returned to customers.


 
F - 7
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

FortisAlberta

Generic Cost of Capital Proceeding: Oral hearings to determine the ROE and capital structure for 2018, 2019 and 2020 were completed in March 2018. The ROE and capital structure approved for 2017 will remain in effect on an interim basis pending a final decision by the Alberta Utilities Commission ("AUC"), which is expected in the third quarter of 2018.

Next Generation Performance-Based Rate Setting Proceeding: In March 2018 the AUC approved the Company’s 2018 distribution rates, on an interim basis, until true-up amounts are finalized. New rates are effective January 1, 2018 with collection from customers effective April 1, 2018. Key provisions included an increase of approximately 5.5% in the distribution component of rates.

FortisAlberta is pursuing options to appeal certain elements of the rate-setting design for the second term of performance-based rate setting ("PBR").


3. ACCOUNTING POLICIES

These condensed consolidated interim financial statements ("Interim Financial Statements") have been prepared in accordance with accounting principles generally accepted in the United States of America and are in Canadian dollars unless otherwise noted.

These Interim Financial Statements are comprised of the accounts of Fortis and its wholly owned subsidiaries and controlling ownership interests. All inter-company balances and transactions have been eliminated on consolidation, except as disclosed in Note 5.

These Interim Financial Statements do not include all of the disclosures required in the annual financial statements and should be read in conjunction with the Corporation's 2017 annual audited consolidated financial statements. In management's opinion, these Interim Financial Statements include all adjustments that are of a normal recurring nature, necessary for fair presentation.

The preparation of the Interim Financial Statements requires management to make estimates and judgments, including those related to regulatory decisions, that affect the reported amounts of, and disclosures related to, assets, liabilities, revenues and expenses. Actual results could differ from estimates.

The accounting policies applied herein are consistent with those outlined in the Corporation's 2017 annual audited consolidated financial statements, except as described below.

New Accounting Policies

Revenue
Effective January 1, 2018, Fortis adopted Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers, which clarifies the principles for recognizing revenue and requires additional disclosures. Fortis adopted the new standard using the modified retrospective approach, under which comparative periods are not restated and the cumulative impact is recognized at the date of adoption supplemented by additional disclosures (Note 6). Upon adoption, there were no adjustments to the opening balance of retained earnings.

Most of the Corporation's revenue is derived from energy sales and the provision of transmission services to customers based on regulator-approved tariff rates. Most contracts have a single performance obligation, being the delivery of energy or the provision of transmission services. Revenue is generally measured in kilowatt hours, gigajoules, or transmission load delivered. The billing of energy sales is based on customer meter readings, which occur systematically throughout each month. The billing of transmission services at ITC is based on peak monthly load.


 
F - 8
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

FortisAlberta is a distribution company and is required by its regulator to arrange and pay for transmission services with the Alberta Electric System Operator. These services include the collection of transmission revenue from its customers, which is achieved through invoicing the customers' retailers through the transmission component of its regulator-approved rates. FortisAlberta reports revenue and expenses related to transmission services on a net basis.

Electricity, gas and transmission service revenue includes an unbilled revenue estimate for energy consumed or services provided since the last meter reading that have not been billed at the end of the accounting period. Sales estimates generally reflect an analysis of historical consumption in relation to key inputs, such as current energy prices, population growth, economic activity, weather conditions and system losses. Unbilled revenue accruals are adjusted in the periods actual consumption becomes known.

Generation revenue from non-regulated operations is recognized on delivery at contracted rates.

The Corporation estimates variable consideration at the most likely amount and reassesses its estimate at each reporting date until the amount is known. Variable consideration, including amounts subject to a future regulatory decision, is recognized as a refund liability until the Corporation is certain that it will be entitled to the consideration.

The Corporation's revenue excludes sales and municipal taxes collected from customers. Prior to the adoption of ASC Topic 606, Central Hudson recognized sales tax and FortisAlberta recognized municipal tax on a gross basis, in both revenue and expense. Effective January 1, 2018, the exclusion of these taxes from revenue resulted in a decrease in revenue of $12 million and $26 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017.

The Corporation has elected not to assess or account for any significant financing components associated with revenue billed in accordance with equal payment plans as the period between the transfer of energy to customers and the customers' payment will be less than one year.

The Corporation disaggregates revenue by regulatory status, service territory and substantially autonomous utility operations (Note 5). This represents the level of disaggregation used by the Corporation's President and Chief Executive Officer ("CEO") in allocating resources and evaluating performance.

Financial Instruments
Effective January 1, 2018, the Corporation adopted Accounting Standards Update ("ASU") No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. Principally, it requires: (i) equity investments in unconsolidated entities not accounted for using the equity method to be measured at fair value through earnings; however, entities may elect to record equity investments without readily determinable fair values at cost, less impairment, and plus or minus subsequent adjustments for observable price changes; and (ii) financial assets and liabilities to be presented separately in these financial statement notes, grouped by measurement category and form. Adoption of this ASU did not impact the Interim Financial Statements.

Pension and Postretirement Benefit Costs
Effective January 1, 2018, the Corporation adopted ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires current service costs to be disaggregated and grouped in the statement of earnings with other employee compensation costs arising from services rendered. The other components of net periodic benefit costs must be presented separately and outside of operating income. Additionally, only the service cost component is eligible for capitalization. On adoption, the Corporation applied the presentation guidance retrospectively and the capitalization guidance prospectively. This resulted in a retrospective $4 million and $7 million reclassification from Operating Expenses to Other Income, Net for the three and six months ended June 30, 2017, respectively, in these Interim Financial Statements.


 
F - 9
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

4. FUTURE ACCOUNTING PRONOUNCEMENTS

Leases
ASU No. 2016-02, Leases (ASC Topic 842), was issued in February 2016, is effective for Fortis January 1, 2019 with earlier adoption permitted, and is to be applied using a modified retrospective approach with implementation options, referred to as practical expedients. Principally, it requires balance sheet recognition of a right-of-use asset and a lease liability by lessees for those leases that are classified as operating leases along with additional disclosures. Based on Fortis' assessment to date, leasing activities accounted for as operating leases primarily relate to office facilities and utility plant and equipment.

Fortis expects to elect a package of practical expedients that will allow it to not reassess whether any expired or existing contract is a lease or contains a lease, the lease classification of any expired or existing leases, and the initial direct costs for any existing leases. Fortis also expects to elect an additional practical expedient that permits entities to not evaluate existing land easements that were not previously accounted for as leases.

Fortis continues to assess the impact of adoption and monitor standard-setting activities that may affect transition requirements.

Hedging
ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities, was issued in August 2017, is effective for Fortis January 1, 2019 with earlier adoption permitted and is to be applied as of the beginning of the fiscal year of adoption. Principally, it better aligns risk management activities and financial reporting for hedging relationships through changes to designation, measurement, presentation and disclosure guidance. For cash flow and net investment hedges existing at the date of adoption, the amendments should be applied as a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness to accumulated other comprehensive income with a corresponding adjustment to opening retained earnings. Amended presentation and disclosure guidance is to be applied prospectively. Fortis is assessing the impact of adoption.

Financial Instruments
ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, was issued in June 2016, is effective for Fortis January 1, 2020 and is to be applied on a modified retrospective basis. Principally, it requires entities to use an expected credit loss methodology and to consider a broader range of reasonable and supportable information to estimate credit losses. Fortis is assessing the impact of adoption.


5. SEGMENTED INFORMATION

Fortis segments its business based on regulatory status, service territory and substantially autonomous utility operations. This represents the information used by the Corporation's President and CEO in deciding how to allocate resources and evaluate performance. Segment performance is evaluated based on net earnings attributable to common equity shareholders.

Effective January 1, 2018 the former Eastern Canadian and Caribbean segments are aggregated as Other Electric as they individually do not meet the quantitative threshold for separate reporting.


 
F - 10
 

FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)


 
REGULATED
 
NON-REGULATED
 
 
Quarter Ended
 
 
 
 
 
 
Energy
 
Inter-
 
June 30, 2018
 
UNS
Central
 
FortisBC
Fortis
FortisBC
Other
Sub
 
Infra-
Corporate
segment
 
($ millions)
ITC
Energy
Hudson
 
Energy
Alberta
Electric
Electric
Total
 
structure
and Other
eliminations
Total
Revenue
374

530

201

 
226

143

89

336

1,899

 
49

—

(1
)
1,947

Energy supply costs
—

186

63

 
50

—

19

189

507

 
—

—

—

507

Operating expenses
109

157

97

 
75

39

24

43

544

 
6

4

(1
)
553

Depreciation and amortization
57

67

18

 
55

48

15

40

300

 
8

1

—

309

Operating income
208

120

23

 
46

56

31

64

548


35

(5
)
—

578

Other income, net
11

4

3

 
1

—

—

1

20

 
—

(2
)
—

18

Finance charges
70

25

11

 
34

24

10

19

193

 
2

48

—

243

Income tax expense
45

18

3

 
6

—

6

7

85

 
—

(24
)
—

61

Net earnings
104

81

12

 
7

32

15

39

290


33

(31
)
—

292

Non-controlling interests
18

—

—

 
—

—

—

4

22

 
13

—

—

35

Preference share dividends
—

—

—

 
—

—

—

—

—

 
—

17

—

17

Net earnings attributable to common equity shareholders
86

81

12

 
7

32

15

35

268


20

(48
)
—

240

Goodwill
8,082

1,819

594

 
913

227

235

253

12,123

 
27

—

—

12,150

Total assets
18,786

9,451

3,376

 
6,347

4,550

2,210

3,930

48,650


1,566

84

(51
)
50,249

Capital expenditures 
245

144

59

 
114

104

25

72

763

 
29

—

—

792

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter Ended
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ millions)
 
 
 
 
 
 
 
 
 
 
 
 
 


Revenue
408

552

206

 
227

148

85

331

1,957

 
59

1

(2
)
2,015

Energy supply costs
—

175

64

 
72

—

21

193

525

 
—

—

(1
)
524

Operating expenses
114

150

99

 
73

48

21

44

549

 
10

9

(1
)
567

Depreciation and amortization
56

67

17

 
50

46

15

38

289

 
8

1

—

298

Operating income
238

160

26

 
32

54

28

56

594


41

(9
)
—

626

Other income, net
10

3

1

 
6

1

—

(1
)
20

 
—

1

(1
)
20

Finance charges
67

26

11

 
29

24

9

19

185

 
1

47

(1
)
232

Income tax expense
67

48

6

 
3

—

3

5

132

 
2

(32
)
—

102

Net earnings
114

89

10

 
6

31

16

31

297


38

(23
)
—

312

Non-controlling interests
21

—

—

 
—

—

—

4

25

 
13

—

—

38

Preference share dividends
—

—

—

 
—

—

—

—

—

 
—

17

—

17

Net earnings attributable to common equity shareholders
93

89

10

 
6

31

16

27

272


25

(40
)
—

257

Goodwill
7,960

1,793

585

 
913

227

235

251

11,964

 
27

—

—

11,991

Total assets
17,885

8,696

3,089

 
6,175

4,241

2,155

3,731

45,972


1,581

93

(65
)
47,581

Capital expenditures
244

121

53

 
103

102

25

68

716

 
3

—

—

719


 
F - 11

 

FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)



 
REGULATED
 
NON-REGULATED
 
 
Year-to-Date
 
 
 
 
 
 
Energy
 
Inter-
 
June 30, 2018
 
UNS
Central
 
FortisBC
Fortis
FortisBC
Other
Sub
 
Infra-
Corporate
segment
 
($ millions)
ITC
Energy
Hudson
 
Energy
Alberta
Electric
Electric
Total
 
structure
and Other
eliminations
Total
Revenue
728

974

476

 
655

284

201

733

4,051

 
97

—

(4
)
4,144

Energy supply costs
—

348

182

 
184

—

62

459

1,235

 
1

—

—

1,236

Operating expenses
212

296

202

 
151

81

50

88

1,080

 
19

11

(4
)
1,106

Depreciation and amortization
113

132

35

 
110

95

30

79

594

 
16

1

—

611

Operating income
403

198

57

 
210

108

59

107

1,142

 
61

(12
)
—

1,191

Other income, net
21

6

5

 
2

—

1

—

35

 
—

(8
)
—

27

Finance charges
138

50

21

 
67

49

20

38

383

 
3

93

—

479

Income tax expense
77

23

8

 
40

—

9

11

168

 
2

(87
)
—

83

Net earnings
209

131

33

 
105

59

31

58

626

 
56

(26
)
—

656

Non-controlling interests
37

—

—

 
—

—

—

5

42

 
18

—

—

60

Preference share dividends
—

—

—

 
—

—

—

—

—

 
—

33

—

33

Net earnings attributable to common equity shareholders
172

131

33

 
105

59

31

53

584

 
38

(59
)
—

563

Goodwill
8,082

1,819

594

 
913

227

235

253

12,123

 
27

—

—

12,150

Total assets
18,786

9,451

3,376

 
6,347

4,550

2,210

3,930

48,650

 
1,566

84

(51
)
50,249

Capital expenditures 
468

269

107

 
200

223

54

125

1,446

 
31

—

—

1,477

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year-to-Date
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
803

1,010

464

 
676

295

198

733

4,179

 
115

1

(6
)
4,289

Energy supply costs
—

346

149

 
254

—

67

462

1,278

 
1

—

(1
)
1,278

Operating expenses
226

297

208

 
145

100

44

87

1,107

 
23

21

(5
)
1,146

Depreciation and amortization
110

133

34

 
100

95

31

75

578

 
16

1

—

595

Operating income
467

234

73

 
177

100

56

109

1,216

 
75

(21
)
—

1,270

Other income, net
20

15

2

 
10

2

—

(1
)
48

 
—

1

(1
)
48

Finance charges
130

52

21

 
58

46

18

38

363

 
2

97

(1
)
461

Income tax expense
132

67

21

 
26

—

7

11

264

 
7

(63
)
—

208

Net earnings
225

130

33

 
103

56

31

59

637

 
66

(54
)
—

649

Non-controlling interests
41

—

—

 
—

—

—

6

47

 
18

—

—

65

Preference share dividends
—

—

—

 
—

—

—

—

—

 
—

33

—

33

Net earnings attributable to common equity shareholders
184

130

33

 
103

56

31

53

590

 
48

(87
)
—

551

Goodwill
7,960

1,793

585

 
913

227

235

251

11,964

 
27

—

—

11,991

Total assets
17,885

8,696

3,089

 
6,175

4,241

2,155

3,731

45,972

 
1,581

93

(65
)
47,581

Capital expenditures
512

248

103

 
197

195

46

120

1,421

 
7

—

—

1,428



 
F - 12

 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Related-Party and Inter-Company Transactions

Related-party transactions are in the normal course of operations and are measured at the amount of consideration agreed to by the related parties. There were no material related-party transactions for the three and six months ended June 30, 2018 and 2017.

Inter-company balances, transactions and profit are eliminated on consolidation, except for certain inter-company transactions between non-regulated and regulated entities in accordance with accounting standards for rate-regulated entities. Inter-company transactions are summarized below.
 
Quarter Ended
Year-to-Date
 
June 30
June 30
($ millions)
2018

2017

2018

2017

Sale of capacity from Waneta Expansion to FortisBC Electric
4

3

19

19

Sale of energy from Belize Electric Company Limited to BEL
9

7

18

14

Lease of gas storage capacity and gas sales from Aitken Creek to FortisBC Energy
6

5

13

13


As at June 30, 2018 accounts receivable included approximately $10 million due from BEL (December 31, 2017 - $20 million).

The Corporation periodically provides short-term financing to subsidiaries to support capital expenditure programs, acquisitions and seasonal working capital requirements. There were no inter-segment loans outstanding as at June 30, 2018 and December 31, 2017.


6. REVENUE
 
Quarter Ended
Year-to-Date
June 30
June 30
($ millions)
2018

2017

2018

2017

Electric and gas revenue
 
 
 
 
United States
 
 
 
 
ITC
400

411

741

775

UNS Energy
475

502

862

907

Central Hudson
208

186

496

422

Canada
 
 
 
 
FortisBC Energy
204

231

634

718

FortisAlberta
139

149

276

293

FortisBC Electric
80

74

180

173

Newfoundland Power
147

154

367

381

Maritime Electric
48

47

102

98

FortisOntario
48

50

97

101

Caribbean
 
 
 
 
Caribbean Utilities
62

57

114

107

FortisTCI
20

20

37

38

Total electric and gas revenue
1,831

1,881

3,906

4,013

Other services revenue (1)
111

106

209

199

Revenue from contracts with customers
1,942

1,987

4,115

4,212

Alternative revenue
(9
)
(6
)
3

(2
)
Other revenue
14

34

26

79

Total revenue
1,947

2,015

4,144

4,289

(1) 
Includes $57 million and $109 million from regulated operations for the three and six months ended June 30, 2018, respectively ($53 million and $100 million for the three and six months ended June 30, 2017, respectively).

 
F - 13
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Revenue from Contracts with Customers
Electric and gas revenue includes revenue from the sale and/or delivery of electricity and gas, transmission revenue, and wholesale electric revenue, all based on regulator-approved tariff rates.

Other services revenue includes: (i) the sale of energy from non-regulated generation operations; (ii) management fee revenue at UNS Energy for the operation of Springerville Units 3 and 4; (iii) revenue from storage optimization activities at Aitken Creek; and (iv) revenue from other services that reflect the ordinary business activities of Fortis' utilities.

Alternative Revenue
Alternative revenue programs allow utilities to adjust future rates in response to past activities or completed events, if certain criteria are met. Alternative revenue is recognized on an accrual basis with a corresponding regulatory asset or liability until the revenue is settled. Upon settlement, revenue is not recognized as revenue from contracts with customers but rather as settlement of the regulatory asset or liability on the balance sheet. The Corporation's significant alternative revenue programs are summarized below.

ITC's formula rates include an annual true-up mechanism that compares actual revenue requirements to billed revenue and any over- or under-collections are accrued and reflected in future rates within a two-year period. The formula rates do not require annual regulatory approvals, although inputs remain subject to legal challenge.

UNS Energy has a lost fixed-cost recovery mechanism ("LFCR") surcharge that provides for the recovery of lost fixed costs, as measured by a reduction in non-fuel revenue, associated with energy efficiency savings and distributed generation that is authorized by the ACC and determined to have occurred. For recovery of the LFCR regulatory asset, UNS Energy is required to file an annual LFCR adjustment request with the ACC for the LFCR revenue recognized in the prior year. The recovery is subject to a year-over-year cap of 1% of total retail revenue. UNS Energy also has a demand side management surcharge that is approved by the ACC annually, which is effective June 1 of each year, to compensate UNS Energy for the costs to design and implement cost-effective energy efficiency and demand response programs until such costs are reflected in UNS Energy's non-fuel base rates as well as a performance incentive.

At FortisBC Energy and FortisBC Electric, an earnings sharing mechanism that allows for a 50/50 sharing of variances from operating and maintenance expenses and capital expenditures was approved as part of the annual revenue requirements. This mechanism is in place until the expiry of the current PBR plan in 2019. Additionally, variances in the forecast versus actual customer-use rate are captured throughout the year in a revenue stabilization adjustment mechanism and a flow-through deferral account, which are either refunded to or recovered from customers in rates within two years.

Other Revenue
Other revenue primarily includes gains/losses on energy contract derivatives and lease revenue.


 
F - 14
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Accounts Receivable and Other Current Assets
The timing of revenue recognition, billings, and cash collections results in trade accounts receivable and unbilled accounts receivable. Accounts receivable are summarized below.
 
As at
 
June 30,

December 31,

($ millions)
2018

2017

Trade accounts receivable
488

460

Unbilled accounts receivable
493

562

Allowance for doubtful accounts
(34
)
(31
)
Total accounts receivable
947

991

Income tax receivable
32

8

Other
154

132

 
1,133

1,131



7. REGULATORY ASSETS AND LIABILITIES

Detailed information about the Corporation's regulatory assets and liabilities is provided in Note 8 to the Corporation's 2017 annual audited consolidated financial statements. A summary follows.
 
As at
 
June 30,

December 31,

($ millions)
2018

2017

Regulatory assets
 
 
Deferred income taxes
1,417

1,403

Employee future benefits
492

510

Deferred energy management costs
213

200

Deferred lease costs
107

104

Generation early retirement costs
103

105

Deferred operating overhead costs
97

91

Derivative instruments
89

87

Rate stabilization accounts
81

95

Manufactured gas plant site remediation deferral
77

75

Other regulatory assets
435

375

Total regulatory assets
3,111

3,045

Less: current portion
(331
)
(303
)
Long-term regulatory assets
2,780

2,742


 
F - 15
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

 
As at
 
June 30,

December 31,

($ millions)
2018

2017

Regulatory liabilities
 
 
Deferred income taxes
1,522

1,484

Asset removal cost provision
1,135

1,095

Rate stabilization accounts
272

254

Return on equity refund liability
194

182

Renewable energy surcharge
76

66

Energy efficiency liability
67

82

Electric and gas moderator account
62

58

Employee future benefits
42

47

Other regulatory liabilities (1)
207

178

Total regulatory liabilities
3,577

3,446

Less: current portion
(587
)
(490
)
Long-term regulatory liabilities
2,990

2,956

(1) 
Includes a $29 million provision reflecting income tax savings, as a result of U.S. tax reform.


8. LONG-TERM DEBT
 
 
As at
 
 
June 30,

December 31,

($ millions)
2018

2017

Long-term debt
21,696

20,864

Credit facility borrowings
1,051

671

Total long-term debt
22,747

21,535

Less: Deferred financing costs and debt discounts
(138
)
(139
)
Less: Current installments of long-term debt
(1,037
)
(705
)
 
21,572

20,691


In March 2018 ITC issued 35-year US$225 million first mortgage bonds at 4.00%. The net proceeds were used to repay maturing long-term debt, repay credit facility borrowings, finance capital expenditures and for general corporate purposes.

In February 2018 FortisTCI issued 5-year US$25 million unsecured notes at a floating interest rate of a one‑month LIBOR plus a spread of 1.75%. The net proceeds were used to repay a hurricane-related emergency standby loan.

In June 2018 Central Hudson issued 30-year US$25 million unsecured notes at 4.27%. The net proceeds were used for general corporate purposes.

Credit Facilities

As at June 30, 2018, the Corporation and its subsidiaries had consolidated credit facilities of approximately $5.1 billion, of which approximately $3.8 billion was unused, including $1.1 billion unused under the Corporation's committed revolving corporate credit facility. The credit facilities are syndicated mostly with large banks in Canada and the United States, with no one bank holding more than 20% of these facilities. Approximately $4.8 billion of the total credit facilities are committed facilities with maturities ranging from 2019 through 2023.

 
F - 16
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Credit facilities are summarized below.
 
 
 
As at
 
Regulated

Corporate

June 30,

December 31,

($ millions)
Utilities

and Other

2018

2017

Total credit facilities
3,706

1,385

5,091

4,952

Credit facilities utilized:








Short-term borrowings (1)
(69
)
—

(69
)
(209
)
Long-term debt (including current portion) (2)
(803
)
(248
)
(1,051
)
(671
)
Letters of credit outstanding
(69
)
(59
)
(128
)
(129
)
Credit facilities unutilized
2,765

1,078

3,843

3,943

(1) 
The weighted average interest rate was approximately 3.0% (December 31, 2017 - 1.8%).
(2) 
The current portion was $601 million (December 31, 2017 - $312 million). The weighted average interest rate was approximately 2.9% (December 31, 2017 - 2.5%).

Borrowings under long-term committed credit facilities were classified as long-term debt. It is management's intention to refinance these borrowings with long-term permanent financing during future periods. There were no material changes in credit facilities from that disclosed in the Corporation's 2017 annual audited consolidated financial statements.


9. EMPLOYEE FUTURE BENEFITS

The Corporation and its subsidiaries each maintain one or a combination of defined benefit pension plans and defined contribution pension plans, including group Registered Retirement Savings Plans and group 401(k) plans, for employees. The Corporation and certain subsidiaries also offer other post‑employment benefit ("OPEB") plans for qualifying employees. The net benefit cost is detailed below.
 
Defined Benefit
Pension Plans
OPEB Plans
($ millions)
2018

2017

2018

2017

Quarter ended June 30
 
 
 
 
Components of net benefit cost:
 
 
 
 
Service costs
20

20

7

7

Interest costs
28

29

6

7

Expected return on plan assets
(40
)
(38
)
(4
)
(4
)
Amortization of actuarial losses
12

12

—

1

Amortization of past service credits/plan amendments
—

—

(2
)
(3
)
Regulatory adjustments
—

—

2

1

Net benefit cost
20

23

9

9

 
 
 
 
 
Year-to-date June 30
 
 
 
 
Components of net benefit cost:
 
 
 
 
Service costs
41

39

15

14

Interest costs
56

58

12

13

Expected return on plan assets
(80
)
(76
)
(8
)
(7
)
Amortization of actuarial losses
24

23

—

1

Amortization of past service credits/plan amendments
—

—

(5
)
(6
)
Regulatory adjustments
—

—

3

2

Net benefit cost
41

44

17

17


 
F - 17
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

For the three and six months ended June 30, 2018, the Corporation expensed $9 million and $20 million, respectively, ($9 million and $20 million for the three and six months ended June 30, 2017, respectively) related to defined contribution pension plans.


10. OTHER INCOME, NET

Other income, net of expenses, includes the equity component of allowance for funds used during construction of $15 million and $30 million for the three and six months ended June 30, 2018, respectively ($19 million and $36 million for the three and six months ended June 30, 2017, respectively).


11. INCOME TAXES

For the three months ended June 30, 2018 and 2017, the Corporation’s effective tax rates were 17% and 25%, respectively. For the six months ended June 30, 2018 and 2017, the Corporation's effective tax rates were 11% and 24%, respectively. The decrease in the effective tax rate was primarily driven by the reduction in the U.S. federal corporate tax rate from 35% to 21%, effective January 1, 2018. On a year-to-date basis, the decrease was also due to a one-time $30 million remeasurement of the Corporation's deferred income tax liabilities, which resulted from an election to file a consolidated state income tax return.


12. EARNINGS PER COMMON SHARE

Earnings per common share ("EPS") is based on the weighted average number of common shares outstanding. Diluted EPS reflects the treasury stock method for options and the "if-converted" method for convertible securities.
 
2018
2017
 
Net Earnings

Weighted

 
Net Earnings

Weighted

 
 
to Common

Average

 
to Common

Average

 
 
Shareholders

Shares

 
Shareholders

Shares

 
 
($ millions)

(# millions)

EPS

($ millions)

(# millions)

EPS

Quarter Ended June 30
 
 
 
 
 
 
Basic EPS
240

423.8

$
0.57

257

416.8

$
0.62

Potential dilutive effect of stock options
—

0.5

 
—

0.6

 
Diluted EPS
240

424.3

$
0.57

257

417.4

$
0.62

Year-to-Date June 30
 
 
 
 
 
 
Basic EPS
563

422.9

$
1.33

551

411.5

$
1.34

Potential dilutive effect of stock options
—

0.5

 
—

0.6

 
Diluted EPS
563

423.4

$
1.33

551

412.1

$
1.34




 
F - 18
 



FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

13. SUPPLEMENTARY CASH FLOW INFORMATION
 
Quarter Ended
Year-to-Date
 
June 30
June 30
($ millions)
2018

2017

2018

2017

Change in working capital:
 
 
 
 
Accounts receivable and other current assets
48

19

32

6

Prepaid expenses
17

10

20

11

Inventories
(19
)
(40
)
33

11

Regulatory assets - current portion
(33
)
10

(23
)
(13
)
Accounts payable and other current liabilities
(58
)
(15
)
(165
)
(21
)
Regulatory liabilities - current portion
55

(2
)
12

(176
)
 
10

(18
)
(91
)
(182
)
 
 
 
 
 
Non-cash investing and financing activities:
 
 
 
 
Accrued capital expenditures
294

309

294

309

Gila River generating station Unit 2 capital lease
217

—

217

—

Common share dividends reinvested
66

63

129

125

Contributions in aid of construction
13

15

13

15

Exercise of stock options into common shares
—

3

1

4



14. FAIR VALUE OF FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

Derivative Instruments

The Corporation generally limits the use of derivative instruments to those that qualify as accounting, economic or cash flow hedges, or those that are approved for regulatory recovery.

The Corporation records all derivative instruments at fair value, with certain exceptions including those derivatives that qualify for the normal purchase and normal sale exception. Fair values reflect estimates based on current market information about the instruments as at the balance sheet dates. The estimates cannot be determined with precision as they involve uncertainties and matters of judgment and, therefore, may not be relevant in predicting the Corporation's future consolidated earnings or cash flows.

Cash flows associated with the settlement of all derivative instruments are included in operating activities on the consolidated statements of cash flows.

Energy Contracts Subject to Regulatory Deferral
UNS Energy holds electricity power purchase contracts and gas swap contracts to reduce its exposure to energy price risk. Fair values were measured primarily under the market approach using independent third-party information, where possible. When published prices are not available, adjustments are applied based on historical price curve relationships, transmission costs and line losses.

Central Hudson holds swap contracts for electricity and natural gas to minimize price volatility by fixing the effective purchase price. Fair values were measured using forward pricing provided by independent third parties.

FortisBC Energy holds gas supply contracts and financial commodity swaps to fix the effective purchase price of natural gas. Fair values reflect the present value of future cash flows based on published market prices and forward natural gas curves.


 
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FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Unrealized gains or losses associated with changes in the fair value of these energy contracts are deferred as a regulatory asset or liability for recovery from, or refund to, customers in future rates, as permitted by the regulators. As at June 30, 2018, unrealized losses of $89 million (December 31, 2017 - $87 million) were recognized as regulatory assets and unrealized gains of $6 million (December 31, 2017 - $2 million) were recognized as regulatory liabilities.

Energy Contracts Not Subject to Regulatory Deferral
UNS Energy holds wholesale trading contracts that qualify as derivative instruments to fix power prices and realize potential margin, of which 10% of any realized gains are shared with customers through rate stabilization accounts. Fair values were measured using a market approach using independent third-party information, where possible.

Aitken Creek holds gas swap contracts to manage its exposure to changes in natural gas prices, to capture natural gas price spreads, and to manage the financial risk posed by physical transactions. Fair values were measured using forward pricing from published market sources.

Unrealized gains or losses associated with changes in the fair value of these energy contracts are recognized in earnings. During the three and six months ended June 30, 2018, unrealized losses of $15 million and $21 million, respectively, (three and six months ended June 30, 2017 - unrealized gains of $1 million and $8 million, respectively) were recognized in earnings.

Foreign exchange contracts
The Corporation holds US dollar foreign exchange contracts to help mitigate exposure to volatility of foreign exchange rates. The contracts expire in 2018 and 2019, and have a combined notional amount of $160 million. Fair value was measured using independent third-party information.

Unrealized gains and losses associated with changes in fair value are recognized in earnings. During the three and six months ended June 30, 2018, unrealized losses of $3 million and $7 million, respectively, (three and six months ended June 30, 2017 - nil) were recognized in earnings.

Interest rate and total return swaps
UNS Energy holds an interest rate swap to mitigate exposure to volatility in variable interest rates on capital lease obligations. The swap agreement expires in 2020 and has a notional amount of $16 million. Fair value was measured using an income valuation approach based on six month LIBOR rates.

Unrealized gains and losses associated with changes in the fair value of this interest rate swap, which was designated as cash flow hedge, are recognized in other comprehensive income and reclassified to earnings through interest expense over the life of the hedged debt. The loss expected to be reclassified to earnings within the next twelve months is estimated to be approximately $3 million, net of tax.

The Corporation holds three total return swaps to manage the cash flow risk associated with forecasted future cash settlements of certain stock-based compensation obligations. The swaps have a combined notional amount of $41 million and terms ranging from one to three years expiring in January 2019, 2020 and 2021. Fair value was measured using an income valuation approach based on forward pricing curves.

Unrealized gains and losses associated with changes in the fair value of the total return swaps are recognized in earnings. During the three and six months ended June 30, 2018, unrealized losses of $1 million and $3 million, respectively, (three and six months ended June 30, 2017 - nil) were recognized in earnings.

Other investments
ITC and Central Hudson hold investments in trust associated with supplemental retirement benefit plans for selected employees. These investments consist of mutual funds and money market accounts, which are recorded at fair value based on quoted market prices in active markets. Gains and losses on these funds are recognized in earnings. During the three and six months ended June 30, 2018, unrealized losses of less than $1 million (three and six months ended June 30, 2017 - unrealized gains of less than $1 million) were recognized in earnings.


 
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FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Recurring Fair Value Measures
The following table presents the fair value of the Corporation's assets and liabilities that are accounted for at fair value on a recurring basis.
($ millions)
Level 1 (1)
Level 2 (1)

Level 3 (1)

Total

As at June 30, 2018
 
 
 
 
Assets
 
 
 
 
Energy contracts subject to regulatory deferral (2) (3)
—

23

6

29

Energy contracts not subject to regulatory deferral (2)
—

11

7

18

Other investments (4)
86

—

—

86

 
86

34

13

133

 
 
 
 
 
Liabilities
 
 
 
 
Energy contracts subject to regulatory deferral (3) (5)
—

(109
)
(3
)
(112
)
Energy contracts not subject to regulatory deferral (5)
—

(5
)
(1
)
(6
)
Foreign exchange contracts, interest rate and total return swaps (6)
(6
)
(1
)
—

(7
)
 
(6
)
(115
)
(4
)
(125
)
As at December 31, 2017
 
 
 
 
Assets
 
 
 
 
Energy contracts subject to regulatory deferral (2) (3)
—

19

2

21

Energy contracts not subject to regulatory deferral (2)
—

26

4

30

Foreign exchange contracts (6)
3

—

—

3

Other investments (4)
78

—

—

78

 
81

45

6

132

 
 
 
 
 
Liabilities
 
 
 
 
Energy contracts subject to regulatory deferral (3) (5)
(1
)
(103
)
(2
)
(106
)
Energy contracts not subject to regulatory deferral (5)
—

—

(1
)
(1
)
Interest rate and total return swaps (6)
—

(1
)
—

(1
)
 
(1
)
(104
)
(3
)
(108
)
(1) 
Under the hierarchy, fair value is determined using: (i) Level 1 - unadjusted quoted prices in active markets; (ii) Level 2 - other pricing inputs directly or indirectly observable in the marketplace; and (iii) Level 3 - unobservable inputs (used when observable inputs are not available). Classifications reflect the lowest level of input that is significant to the fair value measurement.
(2) 
Included in "accounts receivable and other current assets" or "other assets".
(3) 
Unrealized gains and losses arising from changes in fair value of these contracts are deferred as a regulatory asset or liability for recovery from, or refund to, customers in future rates as permitted by the regulators, with the exception of long-term wholesale trading contracts and certain gas swap contracts.  
(4) 
Included in "other assets".
(5) 
Included in "accounts payable and other current liabilities" or "other liabilities".  
(6) 
Included in "accounts receivable and other current assets", "accounts payable and other current liabilities" or "other liabilities".

Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one hierarchical fair value to another. There were no transfers between levels 2 and 3 during the six months ended June 30, 2018.

For Level 3 measurements, changes in the unobservable inputs could have a significant impact on fair value. Excluding long-term wholesale trading contracts and certain gas swap contracts, impacts of fair value changes are subject to regulatory recovery. The following table reconciles changes in the fair value of Level 3 net assets and liabilities.


 
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FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

 
Quarter Ended
Year-to-Date
 
June 30
June 30
($ millions)
2018

2017

2018

2017

Balance, beginning of period
2

(9
)
3

2

Realized losses
—

(5
)
—

(11
)
Unrealized gains (losses)
8

7

8

(3
)
Settlements
(1
)
3

(2
)
8

Balance, end of period
9

(4
)
9

(4
)

The Corporation has elected gross presentation for its derivative contracts under master netting agreements and collateral positions, which applies only to its energy contracts. The following table presents the potential offset of counterparty netting.
 
Gross Amount Recognized in Balance Sheet

Counterparty Netting of Energy Contracts

Cash Collateral Received/
Posted

Net Amount

($ millions)
As at June 30, 2018
 
 
 
 
Energy contracts
 
 
 
 
Derivative assets
47

19

6

22

Derivative liabilities
(118
)
(19
)
—

(99
)
As at December 31, 2017
 
 
 
 
Energy contracts
 
 
 
 
Derivative assets
51

17

7

27

Derivative liabilities
(107
)
(17
)
—

(90
)

Volume of Derivative Activity

As at June 30, 2018, the Corporation had a variety of energy contracts that will settle on various dates through 2029. The volumes related to electricity and natural gas derivatives are outlined below.
 
As at
 
June 30,

December 31,

 
2018

2017

Energy contracts subject to regulatory deferral (1)
 
 
Electricity swap contracts (GWh)
1,100

1,291

Electricity power purchase contracts (GWh)
961

761

Gas swap contracts (PJ)
242

216

Gas supply contract premiums (PJ)
225

219

Energy contracts not subject to regulatory deferral (1)




Wholesale trading contracts (GWh)
2,849

2,387

Gas swap contracts (PJ)
32

36

(1) 
GWh means gigawatt hours and PJ means petajoules.


 
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FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

Credit Risk

For cash equivalents, accounts receivable and other current assets, and long-term other receivables, credit risk is generally limited to the carrying value on the consolidated balance sheets. The Corporation's subsidiaries generally have a large and diversified customer base, which minimizes the concentration of credit risk. Various policies are in place to minimize credit risk, which include requiring deposits, prepayments and/or credit checks for certain customers and performing disconnections and/or using third-party collection agencies for overdue accounts.

ITC has a concentration of credit risk as approximately 67% of its revenue is derived from three customers. Credit risk is limited as such customers have investment-grade credit ratings. ITC further reduces credit risk by requiring a letter of credit or cash deposit equal to the credit exposure, which is determined by a credit-scoring model and other factors.

FortisAlberta has a concentration of credit risk as distribution service billings are to a relatively small group of retailers. The Company reduces its exposure by obtaining from the retailers either a cash deposit, bond, letter of credit, an investment-grade credit rating from a major rating agency, or a financial guarantee from an entity with an investment-grade credit rating.

UNS Energy, Central Hudson, FortisBC Energy, Aitken Creek and the Corporation may be exposed to credit risk in the event of non‑performance by counterparties to derivative instruments. Credit risk is limited by net settling payments when possible and dealing only with counterparties that have investment‑grade credit ratings. At UNS Energy and Central Hudson, certain contractual arrangements require counterparties to post collateral.

The value of derivative instruments in net liability positions under contracts with credit risk-related contingent features that, if triggered, could require the posting of a like amount of collateral was $147 million as of June 30, 2018 (December 31, 2017 - $57 million).

Foreign Exchange Hedge

The reporting currency of ITC, UNS Energy, Central Hudson, Caribbean Utilities, FortisTCI and BECOL is the US dollar. The Corporation's earnings from, and net investments in, foreign subsidiaries are exposed to fluctuations in the US dollar-to-Canadian dollar exchange rate. The Corporation has decreased this exposure by designating US dollar-denominated borrowings at the corporate level as a hedge of its net investment in foreign subsidiaries. The foreign exchange gain or loss on the translation of US dollar-denominated interest expense partially offsets the foreign exchange gain or loss on the translation of US dollar-denominated subsidiary earnings.

As at June 30, 2018, US$3,413 million (December 31, 2017 - US$3,385 million) of net investment in foreign subsidiaries was hedged by the Corporation's corporately issued US dollar-denominated long-term debt and approximately US$7,733 million (December 31, 2017 - US$7,548 million) was unhedged. Exchange rate fluctuations associated with the hedged net investment in foreign subsidiaries and the noted debt are recorded on the consolidated balance sheet in accumulated other comprehensive income.

Financial Instruments Not Carried At Fair Value

Excluding long-term debt, the consolidated carrying value of the Corporation's financial instruments approximates fair value, reflecting their short-term maturity, normal trade credit terms and/or nature.

As at June 30, 2018, the carrying value of long-term debt, including current portion, was $22,747 million (December 31, 2017 - $21,535 million) compared to an estimated fair value of $24,055 million (December 31, 2017 - $23,481 million).

 
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FORTIS INC.
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For the three and six months ended June 30, 2018 and 2017 (unaudited)

The fair value of long-term debt is calculated using quoted market prices or, when unavailable, by either: (i) discounting the future cash flows of the specific debt instrument at an estimated yield to maturity equivalent to benchmark government bonds or treasury bills with similar terms to maturity, plus a credit risk premium equal to that of issuers of similar credit quality; or (ii) obtaining from third parties indicative prices for the same or similarly rated issues of debt of the same remaining maturities, considered Level 2 inputs. Since the Corporation does not intend to settle the long-term debt prior to maturity, the excess of the estimated fair value above the carrying value does not represent an actual liability.


15. COMMITMENTS AND CONTINGENCIES

Commitments
There were no material changes in commitments from that disclosed in the Corporation's 2017 annual audited consolidated financial statements, except as follows.

In March 2018 Maritime Electric extended its power purchase agreement with New Brunswick Power from March 2019 to February 2024, increasing the total commitment under this agreement by approximately $262 million as at June 30, 2018.

In May 2018, following the acquisition of Gila River generating station Units 1 and 2 by a third party with whom UNS Energy has a power purchase agreement, UNS Energy recorded an increase of US$165 million to capital lease obligations to reflect the anticipated exercising of UNS Energy's option to purchase Unit 2 in December 2019.

Contingencies
In April 2013 FortisBC Holdings Inc. ("FHI") and Fortis were named as defendants in an action in the Supreme Court of British Columbia by the Coldwater Indian Band ("Band") regarding interests in a pipeline right of way on reserve lands. The pipeline was transferred by FHI (then Terasen Inc.) to Kinder Morgan Inc. in April 2007. The Band seeks cancellation of the right of way and damages for wrongful interference with the Band's use and enjoyment of reserve lands. In May 2016 the Federal Court dismissed the Band's application for judicial review of the ministerial consent. In September 2017 the Federal Court of Appeal set aside the minister's consent and returned the matter to the minister for redetermination. No amount has been accrued in the Interim Financial Statements as the outcome cannot yet be reasonably determined.


16. COMPARATIVE FIGURES

The Corporation revised a line item within the financing activities section of its statement of cash flows for the three and six months ended June 30, 2017 to correct an immaterial error in the presentation of credit facility borrowings. The error had no impact on the results of operations or financial position and no material impact to cash flows in previously issued financial statements. The correction resulted in $183 million and $245 million for the three and six months ended June 30, 2017, respectively, previously reported within Net Repayments/Borrowings under Committed Credit Facilities, now being reported on a gross basis as Borrowings under Committed Credit Facilities of $324 million and $807 million, respectively, and Repayments under Committed Credit Facilities of $507 million and $1,052 million, respectively.

Effective January 1, 2018, the Corporation elected to present, on the statement of cash flows, borrowings and repayments under committed credit facilities on a gross basis and continue to present borrowings and repayments under uncommitted or demand facilities on a net basis as Net Change in Short-Term Borrowings. Comparative figures were reclassified to conform with the current presentation.

Comparative figures were reclassified to conform with the revised segmentation described in Note 5 and to reflect the retrospective adoption of ASU 2017-07 as described in Note 3.



 
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