Management's Discussion and Analysis
The Management’s Discussion and Analysis (MD&A) is intended to provide a narrative review of Hydro Ottawa Holding Inc.’s operational performance and financial position, and should be read in conjunction with the audited consolidated financial statements and accompanying notes for the year ended December 31, 2009.
The consolidated financial statements are prepared in accordance
with Canadian generally accepted accounting principles (GAAP),
including accounting principles prescribed by the Ontario Energy Board (OEB) in the Accounting Procedures Handbook, and are
expressed in Canadian dollars.
The MD&A contains forward-looking statements, including, but
not limited to, statements as to future operating results and plans.
These statements reflect management’s expectations as of the
date of release. Risks and uncertainties may cause actual results,
performance or achievements to differ materially from those
projected here.
THE BUSINESS OF HYDRO OTTAWA HOLDING INC.
Hydro Ottawa Holding Inc. (Hydro Ottawa or the Corporation)
is a holding company created in October 2000, wholly owned by the City of Ottawa (the Shareholder), and governed by an independent Board of Directors appointed by the Shareholder. The Corporation and its subsidiaries are incorporated under the Business Corporations Act (Ontario).
The Corporation’s core businesses are electricity distribution, renewable energy generation and related services. In 2009, Hydro Ottawa owned and operated two subsidiary companies, as follows:
Hydro Ottawa Limited: the core and by far the largest business of the Corporation is the distribution of electricity by its largest subsidiary, Hydro Ottawa Limited, which accounts for more than 94 percent of the Corporation’s capital assets and 94 percent of revenues. Hydro Ottawa Limited is a regulated electricity local distribution company (LDC) that owns and operates distribution
infrastructure in the City of Ottawa and the Village of Casselman.
Hydro Ottawa Limited is the largest LDC in eastern Ontario and
the third largest municipally-owned LDC in the Province of Ontario.
Hydro Ottawa Limited delivers safe and reliable electricity to over
296,000 residential and commercial customers across a service
area of 1,104 square kilometres. Hydro Ottawa Limited receives
power from the provincial electricity grid and transports it across
a distribution network comprising 84 distribution stations, 2,700
kilometres of underground cable, 2,700 kilometres of overhead
lines, 40,500 transformers and 48,700 hydro poles. Hydro Ottawa Limited added approximately 4,400 net new customers to its
distribution system in 2009, an increase of 1.5 percent.
Energy Ottawa Inc. (Energy Ottawa): a generator of renewable energy and provider of commercial energy management services, Energy Ottawa is Ottawa’s largest producer of green power. Its run of the river hydro-electric facilities at Chaudière Falls in the city’s core produce more than 125,000-megawatt hours (MWh) of certified green power. In addition, the Trail Road landfill gas-to energy plant, a joint venture 60 percent owned by Energy Ottawa, converts millions of tonnes of previously flared-off methane gas into renewable energy. In combination, Energy Ottawa’s generation plants produced approximately 150,000 MWh of renewable green energy in 2009. This output is enough to meet the annual needs of more than 18,000 homes.
VISION AND STRATEGY
The Corporation’s vision is to be a leading and trusted integrated utility services company. The Corporation will achieve that vision through a strategic direction structured around four key areas of performance:
• Financial Strength
• Customer Value
• Organizational Effectiveness; and
• Corporate Citizenship
In pursuing its strategic direction, Hydro Ottawa intends to preserve and grow its core electricity distribution and renewable generation assets, and capitalize on the opportunities presented in its business environment.
Looking forward, the Corporation’s targeted growth strategy involves three components: expanding the electricity distribution business; expanding hydroelectric and other renewable generation capacity; and building on existing core strengths to diversify business lines, focusing on compatible low risk business opportunities.
REGULATORY ENVIRONMENT
Hydro Ottawa and its subsidiaries operate within the framework of the Electricity Act, 1998 and the Ontario Energy Board Act, 1998 (OEB Act).
Hydro Ottawa Limited, as an electricity distributor, is both licensed and regulated by the OEB, which has a legislated mandate to oversee many aspects of the electricity industry. Hydro Ottawa Holding Inc. and Energy Ottawa also have restrictions on business activities because they are affiliates to a distributor that is owned, directly or indirectly, by a municipal corporation.
The OEB must set or approve all rates charged by Hydro Ottawa Limited and the OEB establishes standards of service and conduct that must be followed as a condition of being licensed to distribute electricity. Energy Ottawa is also licensed by the OEB as an electricity generator. However, the prices charged by Energy Ottawa for the electricity commodity are not subject to regulation.
The permitted business activities of Hydro Ottawa Limited were expanded as a result of the Green Energy and Green Economy Act, 2009 (Green Energy Act), to include the ownership and operation of generation and energy storage facilities under established criteria, in addition to the existing permitted activities of distributing electricity, load management, the promotion of electricity conservation and the efficient use of electricity and cleaner energy sources. In addition, the City of Ottawa’s Shareholder Declaration for Hydro Ottawa states that the Corporation may not, without the prior written approval of its shareholder, engage in the retailing of electricity or gas on a basis which exposes the Corporation or a subsidiary to the risk of fluctuations in the market price of the commodity.
The Green Energy Act requires all distributors to file plans to the OEB on facilitating renewable energy generation and implementing a smart grid. It also amended the mandate of the OEB, expanding its objectives to include promoting conservation and demand management, facilitating the implementation of a smart grid and promoting the use and generation of electricity from renewable energy sources.
Permitted activities for Hydro Ottawa and Energy Ottawa include the same activities as Hydro Ottawa Limited, plus distributing or retailing energy products (e.g. gas) through pipes or wires, activities that enhance the work of a distributor or more effectively use corporate assets, managing or operating public utilities for a municipal corporation and renting or selling hot water heaters.
The Electricity Act establishes the structure of the electricity industry and the roles and responsibilities of parties such as the Independent Electricity System Operator (IESO), Electrical Safety Authority (ESA), Ontario Power Authority (OPA) and the Smart Meter Entity (SME). The Electricity Act further establishes both rights and obligations for distributors. Upon request, distributors are obligated to connect any building that lies along their distribution systems and access to this system must be non-discriminatory. New as a result of the Green Energy Act are mandatory timelines and information requirements for each step of a process established for the connection of generation facilities that will sell electricity through the distribution grid.
The Ontario electricity commodity market is open to competition at both the wholesale and retail levels. At the wholesale level, generators can bid into the electricity market overseen by the IESO or enter into a contract with the OPA. At the retail level, consumers have the choice of purchasing the electricity commodity through a contract with a licenced electricity retailer or from a licenced distributor, such as Hydro Ottawa Limited, as part of a standard supply service (SSS).
Under SSS, the commodity is provided to customers on a pass-through basis such that commodity revenues match the cost. Residential and small commercial customers receive the SSS through a regulated price plan. Under the regulated price plan, the OEB sets the commodity rates for the province twice per year, in May and November, based on a forecast of the commodity costs. Differences between the forecast and actual costs are maintained by the OPA in a variance account until the balance is cleared through future regulated commodity rates. Customers not on the regulated price plan pay for the commodity based on the provincial spot market price or through the terms of a retail contract.
Regardless of whether customers have signed a contract with a retailer, or are supplied through the SSS, Hydro Ottawa continues to be responsible for the delivery of the electricity through its distribution system to all customers within the licenced service area.
Rate Regulation
Electricity bills include charges for the commodity, wholesale market services, transmission services, distribution services, debt retirement, goods and services tax and starting in 2010, harmonized sales tax. Revenues from all of these charges, except distribution services, are collected from customers on a pass-through basis, and any differences between costs and revenues collected are tracked as a regulatory asset or liability to be cleared through rates in a subsequent period. For distribution services, Hydro Ottawa applies to the OEB for approval of distribution rates which include a fixed charge and a variable charge based on electricity consumption or peak demand.
To establish rates for distribution service, the OEB has adopted an incentive regulation mechanism (IRM). Under IRM, a distributor first sets base rates through a cost of service application. This application determines the appropriate revenue requirement to cover the company’s forecasted costs, plus a regulated return. For subsequent years in which no cost of service application is filed, rates are adjusted by an inflation factor less a productivity factor. Further adjustments may be permitted for incremental capital above a prescribed threshold, or for recovery of extraordinary event costs.
Hydro Ottawa Limited last established base rates effective May 1, 2008 using 2008 forecast costs and a rate of return on equity deemed by the OEB at 8.57 percent. For 2009, the OEB approved an adjustment to rates effective May 1, 2009 using the IRM mechanism. Rates were increased by an inflation factor of 2.3 percent determined from the Gross Domestic Product Implicit Price Index on Final Domestic Demand (GDP-IPI FDD) released by Statistics Canada for 2008, less a factor of 1.12 percent established by the OEB to encourage productivity improvements. In October 2009, a further rate application was filed for rates effective May 1, 2010. If approved, rates would once again be adjusted using the same IRM mechanism.
Under the OEB’s IRM, if Hydro Ottawa Limited’s actual rate of return on equity (ROE) is 300 basis points above or below 8.57 percent, the OEB will undertake a review with the possible outcome that a new cost of service application be required. In 2009, the OEB held a proceeding to determine if formulas used for calculating the deemed components of the cost of capital were appropriate. The OEB concluded that the formulas should be amended to ensure that they adequately and appropriately accommodate changing economic and financial conditions. As a result, the deemed ROE will start from 9.75 percent at September 2009 and will then be adjusted based on interest rates going forward. The new formula will be effective at the time of Hydro Ottawa Limited’s next cost of service rate application. Hydro Ottawa Limited is planning to file a cost of service rate application with the OEB in 2010, which would go into effect in 2011.
Capability to Deliver Results
Liquidity and Capital Resources
The table below shows the debt and liquidity profile of the Corporation as at December 31.
| ($000) | 2009 |
2008 |
| Debt: | ||
| Notes payable | 251,705 |
251,481 |
| Letters of credit | 11,931 |
11,931 |
| Liquidity: | ||
| Unused bank facilities | 128,319 | 163,169 |
Sources of Liquidity and Capital Resources
The Corporation’s primary sources of liquidity and capital resources are derived from operating activities, banking facilities and proceeds from bond issuances, as and when required. Liquidity and capital resource requirements are primarily for capital expenditures to maintain the Hydro Ottawa Limited electricity distribution system, cost of power, interest expense and prudential requirements.
On January 16, 2009 the credit facilities in place at December 31, 2008 were replaced with a new credit facility for $140.2 million. The revised facility is more than adequate for current and projected needs, and provides management with additional flexibility. The Corporation may use up to $75 million of the new facility for general operating requirements and annual capital expenditures. In addition, a $50 million five-year revolving credit line has been secured for larger capital expenditures and acquisitions. Capital expenditure requirements, if any, in excess of this will be funded through future bond issuances.
This new credit facility was subsequently renewed on October 7, 2009. As at December 31, 2009, the Corporation had drawn $11.8 million in standby letters of credit against its credit facility. The remaining facility is adequate to support the short-term working capital deficit experienced each month to settle the IESO cost of power invoice in advance of receiving payment from customers.
The Corporation’s joint venture, Powertrail Inc., maintains a separate credit facility with a Canadian Chartered bank. The facility consists of $0.1 million in standby letters of credit. As at December 31, 2009, the joint venture had drawn $0.1 million in standby letters of credit against this credit facility.
Summary of Sources and Uses of Cash
| ($000) | 2009 |
2008 |
| Cash (bank indebtedness), beginning of year | 21,332 | (24,576) |
| Net cash provided by operations | 55,315 | 87,955 |
| Net acquisition of capital assets | (58,900) | (66,486) |
| Dividends paid to the City of Ottawa | (17,200) | (28,375) |
| Streetlight Intelligence Investment | (500) | |
| Other | 3,130 | 228 |
| Net Cash inflow from discontinued operations | 312 | 52,586 |
| Cash, end of year | 3,489 | 21,332 |
Cash Provided by Operating Activities
Cash generated by operating activities provided $32.6 million less cash flow than in 2008. The majority of the decrease arises from less cash flow being generated from working capital as a result of higher accounts receivable and unbilled revenue balances, as year-over-year fourth quarter electricity revenues increased by 10 percent.
Cash Used in Investing Activities
Total investment in property, plant and equipment and intangible assets in 2009 was $84.4 million, offset by contributions in aid of construction and proceeds from the disposition of assets, for net cash impact of $58.9 million. Most of this was invested in Hydro Ottawa Limited’s electricity distribution and general plant initiatives. Capital investments in 2009 included approximately $31.7 million on sustainment capital, to replace aging infrastructure and modify existing distribution system; $15.0 million (net) on demand projects, which include third-party driven growth projects such as new residential or commercial installations, and municipal improvement projects; and $5.8 million on general plant and Conservation and Demand Management (CDM).
Investment in the Hydro Ottawa Limited electricity distribution system continues to be robust. In 2009, 674 new poles, 477 transformers, 87 km of overhead lines and 100 km of underground cable were installed. Over 180 demand capital projects were initiated including the addition of 4,330 new residential and 38 new commercial connections.
Additional capital acquisitions of $0.5 million were invested to maintain or enhance the generation capability of Energy Ottawa facilities.
Cash Used in Financing Activities
Dividends were paid to the Shareholder in 2009 in accordance with the approved dividend policy. 2009 payments totaled $17.2 million, including $15.2 million arising from 2008 continuing operations, $1.1 million from discontinued operations (Telecom Ottawa), and $0.9 million from the gain on sale of Telecom Ottawa. 2008 payments totaled $28.4 million, with $16.4 million arising from 2007 operations, and $12.0 million from the gain on sale of Telecom Ottawa.
Credit Ratings
As at December 31, 2009, the Corporation’s bonds are rated as
follows:
| Rating Agency | Rating |
| Standard & Poor’s Rating Services Inc. | A (stable) |
| Dominion Bond Rating Service Inc. | A (stable) |
On May 1, 2009 the Dominion Bond Rating Service (“DBRS”) upgraded Hydro Ottawa Holdings Inc.’s rating to “A” from “A (low)”, and changed the trend to Stable from Positive. DBRS noted that the rating upgrade reflects the Corporation’s strong financial profile, which has improved over the past five years, conservative financial policies, strong operational performance and low business risk.
The Corporation’s bonds carry covenants normally associated with this type of debt (see Note 16 of the consolidated financial statements for further details). The Corporation is in compliance with these covenants as at December 31, 2009.
Critical Non-Capital Resources
The Corporation employs approximately 600 people. Hydro Ottawa Limited employs over 90 percent of this workforce. The Corporation experiences low attrition rates.
In the next five years, 85 employees in Hydro Ottawa Limited will be eligible for early retirement with an unreduced pension. Over 60 percent are trades or technical employees; the other 40 percent are administrative/clerical and management group employees.
In preparation for these eventual retirements, which are similar to those being experienced by many other utilities in Ontario, Hydro Ottawa Limited has undertaken an extensive in-house apprenticeship program to ensure the continuation of qualified tradespersons. A succession planning and management development program and numerous training and development programs are also in place to ensure that there are known qualified employees in the pipeline for key positions. These initiatives are ongoing.
Internal Processes
Various technology and process initiatives have been introduced to better manage electrical distribution assets and improve customer service, by increasing the reliability of the network through faster repairs, and enhancing its sustainability through new technologies.
The Geographical Information System (GIS) continues to be leveraged to enhance outage management, asset management, system design, and other functions throughout the Corporation. A major enhancement of the Hydro Ottawa Limited Outage Management System (OMS) took place in 2009 providing a connection between the Supervisory Control System (SCADA) and OMS. This enhancement now provides OMS with immediate notification of equipment operation in the field, allowing OMS to diagnose problems faster and more accurately than before. More mobile computing was also added in 2009 that will enhance the ability to electronically dispatch construction work to field crews. Hydro Ottawa Limited will be able to increase the volume of electronically dispatched work orders as more mobile computing technology is deployed.
Hydro Ottawa Limited continues to be actively involved in implementing the province’s Smart Meter Program. As of December 31, 2009, a total of 289,600 smart meters have been installed, representing 99 percent deployment. Hydro Ottawa Limited is in the final testing stages with the provincial Meter Data Management & Repository (MDM/R) system, and plans to transition customers to Time-of-Use (TOU) billing beginning in 2010.
An upgrade to the Corporation’s financial system began in 2009 and will continue into 2010. The main reason for the upgrade is to assist the organization in preparing for its transition to International Financial Reporting Standards (IFRS). A key upgrade or migration to a new Customer Information System (CIS) is also anticipated beginning in 2011.
Hydro Ottawa Limited continues to maintain certification with several international standards, including ISO 9001 Quality Management System, ISO 14001 Environmental Management System and OHSAS 18001 Occupational Health and Safety. Internal and external third-party audits are conducted as required to confirm and maintain certification.
The Corporation also continues to emphasize cost containment and productivity improvement in order to enhance financial strength and operational performance. The OEB sets productivity improvement targets for electricity distributors as part of its incentive regulation mechanism, and the Corporation pursues corporate-wide efficiencies in addition to these targets. In line with these objectives, Hydro Ottawa Limited began a Lean process improvement pilot in 2009, using an established methodology focused on improving the efficiency and effectiveness of core processes. This program will continue in 2010.
Results
The Corporation continued a positive trend of sustained profitability from continuing operations in 2009.
Selected Consolidated Financial Results
The selected consolidated financial results of the Corporation presented below should be viewed in conjunction with the audited consolidated financial statements.
| ($000) | 2009 |
2008 |
Change $ |
Change % |
| Revenues | ||||
| Power recovery | 587,958 |
544,192 |
43,766 |
|
| Distribution and other | 166,774 |
153,568 |
13,206 |
|
754,732 |
697,760 |
56,972 |
||
| Expenses | ||||
| Purchased power | 584,282 |
537,979 |
46,303 |
|
| Operating costs | 71,765 |
68,125 |
3,640 |
|
656,047 |
606,104 |
49,943 |
||
| EBITDA | 98,685 |
91,656 |
7,029 |
7.7% |
| Depreciation and amortization | 41,955 |
40,602 |
1,353 |
|
| Interest | 12,315 |
11,770 |
545 |
|
| Taxes | 13,416 |
13,571 |
(155) |
|
| Other | 1,646 |
423 |
1,223 |
|
| Net income from continuing operations | 29,353 |
25,290 |
4,063 |
16.1% |
| Income from discontinued ops. | 0 |
1,775 |
(1,775) |
|
| Gain on sale of discontinued ops. | 20 |
22,931 |
(22,911) |
|
20 |
24,706 |
(24,686) |
-99.9% |
|
| Net income and comprehensive income | 29,373 |
49,996 |
(20,623) |
-41.2% |
Normalized Net Income
Adjusting for the impact of taxes and extraordinary items, normalized net income increased $4.0 million over 2008.
| ($000) | 2009 |
2008 |
| Net income and comprehensive income | 29,373 | 49,996 |
| Adjusted to reflect income tax at statutory rates | (697) | (183) |
| Net income and comprehensive income using statutory tax rates | 28,676 | 49,813 |
| Adjusted for non-recurring items (net of tax) | ||
| Recovery of regulatory asset write-down | - | (450) |
| Income from discontinued operations | - | (1,775) |
| Gain on disposal of discontinued operations | (20) | (22,931) |
| (20) | (25,156) | |
| Normalized net income | 28,656 | 24,657 |
| Statutory tax rate | 33.0% | 33.5% |
Revenues
Revenue is earned from electricity distribution, sales of generated power, energy management services, the CDM program and sundry revenue.
Hydro Ottawa Limited’s power recovery – a flow-through of purchased power costs to the customer – increased $43.8 million, mainly due to a large increase in the global adjustment rate, offset by small decreases in sales, commodity rates and transmission rates.
Revenue, excluding power recovery, increased $13.2 million (8.6 percent) from 2008. Electricity distribution revenues are reflective of OEB approved distribution rates, and the amount of electricity consumed. Revenue from distribution sales increased due to the impact of the May 1, 2009 rate increase and load growth. Additional revenue was also earned from an expanded CDM program, and increased commercial services revenue was achieved at Energy Ottawa. Energy Ottawa’s generation revenue decreased from the prior year as electricity commodity pricing declined in 2009 and production was higher in 2008 due to more favourable weather conditions.
Expenses
Purchased power costs represent the cost of electricity delivered to customers within Hydro Ottawa Limited’s distribution service territory. These costs consist of the commodity, wholesale market service charges and transmission charges levied by the IESO, net of energy generated by Energy Ottawa and supplied to Hydro Ottawa Limited as an embedded generator within Hydro Ottawa Limited’s service territory. The cost of purchased power increased by $46.3 million, due mainly to the global adjustment rate, which was offset by small decreases in purchases, commodity rates and transmission rates as noted above.
2009 operating costs of $71.8 million increased by $3.6 million over 2008. The most significant increases in operating costs related to Hydro Ottawa Limited’s expanded CDM program and Energy Ottawa’s commercial services. As noted above, these two revenue generating activities experienced increased revenues in 2009. Expenses also increased due to compensation and other inflationary increases.
Other Expenses
Depreciation and amortization expenses rose by $1.4 million primarily due to the Smart Meter program. Smart Meters are depreciated over a 15 year period replacing conventional meters, which were depreciated over 25 years, thereby accelerating depreciation expense. Continued investment in electricity distribution assets also contributes to higher year-over-year depreciation and amortization expenses.
Other expenses increased in 2009 due to an increase in capital taxes and due to a recovery for regulatory asset write-downs, which was received and offset against other expenses in the prior year; there was no similar recovery in the current year.
Payments-in-Lieu of Corporate Taxes (PILs)
The Corporation’s effective income tax rate was 31.37 percent in 2009 compared to 33.03 percent the previous year. The year-over- year decrease results from a reduction in the statutory rate from 33.5 percent to 33.0 percent combined with the recovery of taxes from prior years’ assessment changes.
Total expenses, excluding purchased power, increased 5.3 percent over 2008.
Net Income
Net income from continuing operations was $29.4 million in 2009 compared to $25.3 million in 2008, for a 16.1 percent increase. The increase primarily relates to increased distribution revenue in Hydro Ottawa Limited (due to the increased customer base and the May 1, 2009 rate increase), productivity improvements, and higher commercial services revenue from Energy Ottawa, which more than offset a small decrease in generation revenue.
Net income and comprehensive income of $29.4 million was 41.2 percent lower than in the previous year, due primarily to the fact that 2008 results included an after-tax gain on sale of the Telecom Ottawa subsidiaries.
Balance Sheet Summary
| ($000) | 2009 |
2008 |
Change $ |
Change % |
| Assets | 753,177 | 703,461 | 49,716 | 7.1% |
| Current liabilities | 121,153 |
116,350 |
||
| Non-current liabilities | 302,231 |
269,406 |
||
| Total liabilities | 423,384 |
385,756 | 37,628 | 9.8% |
| Shareholder’s equity | 329,793 |
317,705 | 12,088 | 3.8% |
| Liabilities and shareholder’s equity | 753,177 |
703,461 | 49,716 | 7.1% |
Assets
Total assets increased by $49.7 million from 2008. Cash on hand of $3.5 million is down compared to the prior year as the 2008 cash on hand position of $21.3 million included proceeds from the sale of the Telecom Ottawa subsidiaries. However, the cash decrease is more than offset by a number of significant increases. Property, plant and equipment and intangible assets are up $17.0 million resulting from continued investment in electrical distribution and generation infrastructure, net of contributions in aid of construction, depreciation and amortization. Future income tax assets are up $29.2 million due to the Canadian Institute of Chartered Accountants (CICA) Handbook Section 3465 changes adopted prospectively in 2009. There were also increases in the year-end positions of accounts receivable, which increased $12.2 million over the prior year, and unbilled revenue, which increased $9.8 million. The higher accounts receivable and unbilled revenue balances were the result of a 10 percent increase in year-over-year fourth quarter electricity revenues.
Investment in Streetlight Intelligence Inc.
In 2009, Hydro Ottawa completed a strategic investment of $500,000 in Streetlight Intelligence Inc., (SLI) a publicly listed company based in British Columbia that develops advanced street light optimization systems. This investment supports the Corporation’s strategy to invest in areas with direct application and synergy with its existing core business lines, in this case energy conservation. A second strategic investment of $500,000 in SLI was completed in January 2010. These investments secured options to purchase shares in SLI. A third strategic investment of $500,000 was completed in March 2010, involving the purchase of 4,166,667 common shares in SLI by Hydro Ottawa as well as purchase warrants for additional shares. Hydro Ottawa continues to hold the previously acquired purchase options, and discussions are underway between Hydro Ottawa and SLI regarding a potential distribution agreement for the Province of Ontario.
Beaconhill Station Fire
On March 13, 2009 a fire destroyed a transformer station located in the east end of Ottawa and, as a result, equipment with a net book value of $116,000 has been written‑off. The Corporation has adequate property insurance coverage and recorded insurance proceeds receivable of $116,000 in respect of the damaged equipment. As a result, no gain or loss related to damaged equipment has been reflected in 2009 income. The Corporation has also recorded a receivable of $1,095,000 for the recovery of expenses incurred to clean‑up and restore services at the site. The Corporation has submitted a claim for damages and is in the process of negotiating a settlement with the insurance company. Reconstruction will begin in 2010, at an approximate cost of $6.0 million.
Liabilities
Total liabilities increased by $37.6 million in 2009. This change is largely attributable to the Corporation’s prospective adoption of CICA Handbook Section 3465 changes, which accounts for $29.2 million. There was also an increase in the year-end position of accounts payable and accrued liabilities of $5.9 million. Hydro Ottawa continued to see significantly reduced credit facility borrowing requirements throughout the year due to the cash inflow from the Telecom Ottawa sale in 2008.
Asset Retirement Obligations
The Corporation is subject to environmental regulatory requirements related to the removal and destruction of polychlorinated biphenyls (“PCBs”) in distribution transformers and other clean-up related to PCBs. The Federal PCB Regulatory Framework under the Canadian Environmental Protection Act, 1999 requires that certain equipment containing PCBs be removed from service by December 31, 2009 and December 31, 2025, depending on equipment concentration and physical location. Hydro Ottawa received authorization from Environment Canada to extend the service date beyond December 31, 2009 for 57 distribution vault transformers to December 31, 2011 and for 12 power transformer bushings to December 31, 2014.
Effective December 31, 2009, the Corporation recorded an asset retirement obligation (ARO) of $1,167,000. The ARO was calculated using an estimated undiscounted cash flow over four years totaling $1,255,000, and a discount rate of 5.3 percent. No assets have been legally restricted for settlement of the liability.
An ARO was not previously recorded as it could not be reasonably estimated due to uncertainty around the identification, final removal dates and costs of removal of the related assets.
Net Capital Expenditures
Actual net capital expenditures decreased by $2.4 million in 2009 compared to 2008, primarily due to the installation of fewer smart meters as the installation program was substantially completed in 2009. In 2010, total net capital expenditures are budgeted to increase by $9.6 million from the 2009 actual program. The budgeted increase in Sustainment capital spending is due to aging infrastructure and the Beaconhill Station reconstruction. The budgeted increase in General Plant is primarily for additional customer service and financial system solutions and environmental strategies. Sustainment capital spending on Hydro Ottawa’s distribution and generation systems, in accordance with asset management plans, is expected to be maintained at or above 2008 levels through to 2012.
| ($ millions) | Sustainment | Demand/ Smart Meters | General & CMD | Generating Plant | Total | |
|---|---|---|---|---|---|---|
 |
2010 Budget | 44.3 | 13.1 | 12.4 | 1.0 | 70.8 |
 |
2009 Actual | 38.5 | 14.9 | 7.4 | 0.5 | 61.2 |
 |
2008 Actual | 34.6 | 20.2 | 8.3 | 0.5 | 63.6 |
Significant Accounting Estimates
The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of revenues and expenses during the period, the reported amounts of assets and liabilities, and the disclosure of commitments and contingencies at the date of the financial statements.
These estimates are based on historical experience, current conditions and various other assumptions believed to be reasonable under the circumstances. Because they involve varying degrees of judgment and uncertainty, the amounts currently reported in the financial statements could prove to be inaccurate in the future.
The following accounting estimates require management’s judgments in preparing our financial statements and, as such, are considered to be critical. Most of these are disclosed in the notes to the Corporation’s consolidated financial statements for the year ended December 31, 2009:
• Estimated useful life of major asset categories, Note 2
• Customer deposits, Note 2
• Regulatory asset recovery, Note 8
• Asset retirement obligations, Note 13
• Employee future benefits, Note 14
Allowance for doubtful accounts
The financial statements contain an estimate of bad debt losses arising from uncollectible accounts receivable, calculated based on a combination of reviewing specific accounts and taking a specific percentage of remaining balances over 60 days.
Unbilled revenue
Management establishes unbilled revenue balances based upon an estimate of customer electricity consumption to the end of the financial reporting period. Customer consumption estimates include instances where the meter reading is not scheduled to take place until the next period. This requires management to estimate based on historical usage. Consumption estimates are also necessary when meter readings are not available at the end of a financial reporting period.
Changes in Accounting Policies and Presentation
Accounting for Rate Regulated Entities
As at January 1, 2009, the Corporation prospectively adopted the amendments to the CICA Handbook Section 1100 – “Generally Accepted Accounting Principles” and Handbook Section 3465 – “Income Taxes”.
Effective January 1, 2009, with the removal of the temporary exemption in Section 1100, Hydro Ottawa Limited must now apply Section 1100 to the recognition of assets and liabilities arising from rate regulation. Section 1100 directs Hydro Ottawa Limited to adopt accounting policies that are developed through the exercise of professional judgment and the application of concepts described in the CICA Handbook Section 1000 – “Financial Statement Concepts”. Using professional judgment and guidance issued by bodies authorized to issue accounting standards in other jurisdictions, Hydro Ottawa Limited has determined that its assets and liabilities arising from rate regulated activities qualify for recognition under Canadian GAAP and this recognition is consistent with U.S. Accounting Standards Codification 980 – “Regulated Operations”. As a result, there is no effect on the Corporation’s financial results for the year ended December 31, 2009.
Effective January 1, 2009, with the amendment to Section 3465 the Corporation is required to recognize Hydro Ottawa Limited’s future income tax assets and liabilities and related regulatory liabilities and assets for the amount of future income taxes expected to be refunded to, or recovered from, customers in future electricity rates. Previously, Hydro Ottawa Limited used the taxes payable method to account for PILs where no provision was made for future income taxes as a result of unused tax losses or temporary differences between the tax basis of assets and liabilities and their carrying amounts for accounting purposes as it was expected that they would be collected in future rates. With the adoption of the amended Section 3465, the Corporation has recorded a future income tax asset and a corresponding regulatory liability. The implementation of this standard did not impact the Corporation’s earnings or cash flows in 2009.
Goodwill and Intangible Assets
Effective January 1, 2009, the Corporation adopted CICA Handbook Section 3064 – “Goodwill and Intangible Assets”. In accordance with the transitional provisions of Section 3064, the Corporation has restated its prior period comparative figures and related note disclosures. As a result of the adoption of Section 3064, the Corporation has reclassified land and water rights and computer software from property, plant and equipment to intangible assets (Note 10). Also as a result of the adoption of Section 3064, the Corporation has restated prior year opening retained earnings and other assets by $27,000 as deferred incorporation costs no longer meet the definition of an asset.
Financial Instruments
Effective January 1, 2009, the Corporation adopted a number of amendments to CICA Handbook Section 3855 – “Financial Instruments – Recognition and Measurement”. The amendments relate to revised definitions of certain financial assets, methods of assessing impairments for certain financial assets, reclassifications of financial assets, assessment of embedded derivatives on reclassification of a financial asset out of the held‑for‑trading category and subsequent accounting of impaired financial assets. The amendments had no impact on the financial results of the Corporation.
Effective September 30, 2009, the Corporation prospectively adopted CICA amended Handbook Section 3862 – “Financial Instruments – Disclosure”, which was released in June 2009. The amended section includes additional disclosure requirements about fair value measurement of financial instruments and enhanced liquidity risk disclosures. The amendments have no impact on the financial results of the Corporation.
Credit risk and the fair value of financial assets and financial liabilities
Effective January 1, 2009, the Corporation adopted the CICA Emerging Issues Abstract (EIC) 173 – “Credit Risk and the Fair Value of Financial Assets and Financial Liabilities”. EIC-173 clarifies that the Corporation’s own credit risk and the credit risk of its counterparties be taken into account in determining the fair value of a financial instrument. There was no effect on the Corporation’s financial statements as a result of adopting EIC- 173.
Emerging Accounting Pronouncements
International Financial Reporting Standards
On February 13, 2008, the Accounting Standards Board (AcSB) confirmed that publicly accountable enterprises are required to transition to IFRS effective January 1, 2011. Government Business Enterprises (e.g. municipally owned utilities) are required by the Public Sector Accounting Board to also adopt IFRS on January 1, 2011.
The Corporation launched its IFRS conversion project in 2008, involving a steering committee consisting of senior level management and external advisors. Status updates are provided to the Corporation’s executive team and the Audit Committee of the Board of Directors on a regular basis. A project to upgrade information systems is also underway as part of the IFRS conversion project.
In December 2008, the International Accounting Standards Board (IASB) initiated a project on the application of IFRS to rate regulated activities. In July 2009, the IASB issued an exposure draft on rate-regulated activities which, among other things, allowed the continued recognition of regulatory assets and liabilities on the Balance Sheet as well as the continued capitalization of certain costs to property, plant and equipment that would otherwise not meet the recognition criteria under IFRS, provided these costs were included in the regulated rate base. As part of the IASB comment letter process, the Corporation supported letters from several industry associations that were supportive of the exposure draft. The IASB received approximately 150 letters relating to this exposure draft, many of which were not supportive.
The IASB staff prepared an analysis of all the comment letters and the IASB Board met in February 2010 to review the analysis and the project. The IASB Board has requested that IASB staff prepare a technical analysis on one of the key areas of debate – namely, whether or not regulatory assets and liabilities exist within the definition of assets and liabilities in the IFRS conceptual framework. Prior to this, a rate-regulated standard was expected to be issued in advance of Canada’s adoption date; however, given these recent developments, the issuance of a standard will be delayed and/or possibly cancelled which will most likely affect the Corporation’s IFRS conversion project.
The adoption of IFRS will require the restatement, for comparative purposes, of amounts reported by the Corporation for its year ended December 31, 2010 and the opening balance sheet as at January 1, 2010. The Corporation is currently assessing the impact of the adoption of IFRS on its financial results; however, the financial impact cannot be reasonably estimated at this time due to continuing uncertainty regarding the treatment of rate-regulated activities. The Corporation expects a significant increase in financial statement note disclosure as a result of adopting IFRS.
RISKS AND UNCERTANTIES
The ability to manage and mitigate risk, to maintain flexibility, and to respond effectively to changes in our business environment will be critical to the Corporation’s continued success.
The Corporation’s Enterprise Risk Management (ERM) system establishes the framework to help the Corporation track and respond to risks and opportunities impacting strategic direction and business activities, in a consistent and integrated manner across the enterprise. A three-year Business Planning cycle, with annual updates, enables continuous review of assumptions and the state of the market in which the Corporation operates.
Hydro Ottawa continues to monitor and manage traditional risks and sources of risk that are structural within the industry and the regulated environment. It is possible, nonetheless, that some of these risks could adversely impact Hydro Ottawa’s results and objectives. These include but are not restricted to, the weather, the regulatory and policy environment, the state of the economy and macro-economic trends, government policies relating to the production and procurement of renewable and clean energy as well as carbon emissions and conservation, labour force demographics with a particular emphasis on the renewal of human resources in the trades, and the impact of fiscal policies on customers. In addition, the evolution of the industry presents new and emerging risks that need to be managed effectively.
The emerging as well as the traditional risks are discussed below.
Technology Infrastructure
The Corporation’s business performance is dependent upon complex technology systems, including administrative information technology, customer information systems, advanced metering, and operational technologies such as geographic information systems, system control and outage management systems. Increasing automation, the integration of systems, and extensive use of common technology in facilitating such integration and connectivity present emerging risks that the Corporation must manage effectively. The failure of one or more of these key systems, or a failure of the Corporation to plan effectively for future technology needs or transition effectively to new technology systems, such as the provincial MDM/R, could adversely impact the Corporation’s business operations.
LDCs in Ontario will be required to comply with mandatory reliability standards prescribed by the North American Electric Reliability Corporation (NERC). Considerable investments may need to be made to conform to, and sustain, NERC standards for Critical Infrastructure Protection in respect of IT and physical security, as well as to create mechanisms to monitor and demonstrate compliance.
Cyber Security
An environment marked by increasing automation and higher integration and connectivity between utility control systems could magnify cyber security risks for Hydro Ottawa Limited as well as for other market participants with whom it is integrated. A security breach, data corruption or system failure at the shared resources or common service providers could put at risk Hydro Ottawa Limited’s information systems and information assets.
Time-of-Use Technology
Given the number of devices, systems and web interfaces involved in the Smart Meter – TOU billing process, as well as the number of external and internal service providers engaged, risks arising from the reliability and performance of any single component of this integrated network or of the system as a whole could lead to a disruption of the meter-to-cash cycle. This could present a risk of billing errors and customer dissatisfaction.
Economy
The state of the local and national economy could have a significant impact on the Corporation’s business performance, through factors such as interest rates, inflation, customer credit risk, weakening demand for electricity and/or value-added services, and availability of market capital to fund growth. The economic climate could also have an effect on the stability and performance of some of Hydro Ottawa’s key business partners, notably in pension plans and insurance.
Reduced Demand for Electricity and its Impact
Through the latter half of 2009, energy commodity prices moved consistently downwards, at least in part owing to recessionary conditions, which could persist in the medium term and lead to a reduction in the Corporation’s revenues and net income from energy generation.
Further, as spot market commodity prices slide, the Global Adjustment that the IESO charges to LDCs, to account for the difference between spot market commodity prices and prices paid to OPG for regulated generation assets, could have a significant and adverse impact on Hydro Ottawa’s operating cash flows, mainly owing to timing differences.
Pension Plan Risk
For 2008, the Ontario Municipal Employees Retirement System (OMERS), to which the Corporation and its employees contribute, posted a total rate of return of -15.3 percent and reported a $279 million funding shortfall, which could grow to more than $6 billion over the next few years. For 2009, OMERS posted a total rate of return of 10.6 percent and reported a gain of $4.3 billion in investment income, recovering from an $8 billion loss for 2008. However, OMERS continues to report a plan deficit based on actuarial value of net assets of $1.5 billion. OMERS may choose to eliminate its deficit through higher contribution increases from members and employers, perhaps along with changes (reductions) to benefits.
Policy and Regulatory Environment
Hydro Ottawa’s businesses operate in a regulated environment. Business performance could be adversely affected by significant policy and regulatory changes, including but not limited to changes in rate regulation, policies relating to the production and procurement of renewable and clean energy, carbon emissions, conservation and demand management (CDM), the consolidation of electrical utilities, or restrictions on utility service provisioning.
The OEB approves local electricity distribution rates based on projected load growth and consumption levels. If actual experience varies from the projections, the Corporation’s net income will be affected. CDM programs call for a 5 percent reduction in Ontario’s peak electricity demand by 2010. The OEB has recognized the need to compensate for such lost revenue, but there is no certainty that such compensation will be sufficient to cover all lost revenue.
The ability to maintain and operate the electrical distribution system reliably and safely depends on sufficient funding and the OEB allowing recovery of capital expenditures on distribution infrastructure repair and replacement.
Weather
Severe weather can significantly impact financial results. Storms increase maintenance costs to repair or replace damaged equipment and infrastructure, to ensure the continuing reliability of the electricity distribution system. Weather fluctuations also influence distribution revenues, which tend to increase with severe weather and decrease with moderate weather, and renewable energy production, which depends upon factors such as water flows (hydroelectric), wind, and sun (solar).
Labour Force Demographics
An inability to recruit and retain a sufficient number of skilled employees would negatively impact the Corporation’s ability to deliver on the objectives set out in the strategic plan. Current workforce demographics across the electricity sector present an emerging risk that must be managed, particularly in the trades, as retirements are outpacing new entrants to the workforce. Apprentice training and succession planning programs are underway.
OUTLOOK
Subject to the risks and uncertainties already discussed in this document, Hydro Ottawa will continue to provide efficient, reliable electricity distribution services to customers at a competitive cost, while creating sustainable growth in earnings. The Corporation will achieve this by continuing to invest in core distribution assets, improving productivity and pursuing business growth opportunities that leverage corporate strengths.
The Corporation will pursue positive long-term financial performance through strategies such as stabilizing and protecting revenues, managing net controllable costs, and maximizing operating cash flow and rate-of-return. The Corporation will continue to make prudent investments in maintaining and building its infrastructure, subject to rate-of-return and other financial considerations.
In June 2008, the City of Ottawa endorsed a targeted growth strategy for the Corporation involving three basic components: expanding the electricity distribution business beyond its current service territory, expanding hydroelectric and other renewable generation capacity, and diversification of business lines with a focus on compatible, low-risk opportunities that offer stable long-term returns. The Corporation continues to actively pursue opportunities for expansion in accordance with the endorsed strategy.
Hydro Ottawa is projected to continue the trend of solid financial performance, in line with its 2008 – 2012 Strategic Direction and Financial Outlook.
