Black Hills Corp (BKH) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Black Hills quarterly earnings call. At this time, all participant lines are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given to you at that time. (OPERATOR INSTRUCTIONS) I would now like to turn the conference over to the Director of Investor Relations, Dale Jahr. Please go ahead.

Yes, I'd like to add my welcome too, and thank you for joining us. I remind the idea that this conference call may include forward-looking statements as defined by the SEC. These statements concern our plans, expectations and objectives for future operations. Such statements are based on what we believe are reasonable assumptions and based on current expectations of industry and economic conditions and other factors. However, risks and uncertainties could cause results to differ materially from those in forward-looking statements. I refer you to the cautionary language published in our press release and other public disclosures. Our discussion of recent events will be led by Mr. Mark Thies, our Executive Vice President and CFO. Mark would like to review the press release before we open this call to questions. Mark.

Thank you, Dale. Good morning everyone and thank you for joining us on our call. Happy Halloween to everybody, and we appreciate your attendance. We believe this is a treat with our release. We had a very solid quarter again, and got a lot accomplished within the quarter as we moved to strengthen our balance sheet. We had a very solid earnings per share -- or earnings of 22.4 million, resulting in 69 cents a share compared to 17.4 million or 64 cents a share in the prior period. This includes a number of events that occurred in the quarter that affect that number.

One of them, and probably the most significant, is the termination of the contract on our Las Vegas Cogeneration II plant with Allegheny, in which we received $114 million in cash. And upon reviewing the remaining revenue stream going forward on a market basis, we determined we needed to have an asset impairment of that plant of approximately $117 million. On a net basis, that resulted in a net charge of 6 cents a share between the two. In addition, we did settle our accounts from the Enron bankruptcy at a slight gain of 1 cent a share. And then also the next large transaction we closed at the very end of the quarter was the sale of the hydroelectric plants in upstate New York. That resulted in a gain on sale of 14 cents a share, and also $186 million in cash, of which we used $91 million to pay down the existing project debt related to those assets and closed out related swaps on that debt.

Commensurate with the sale of the hydroelectric plants in the East, we had one remaining asset in the East which was our 40 megawatt Pepperell power plant in Massachusetts. The company then adopted a plan to sell that asset, and then had to write that asset down to fair value less our estimated cost, which resulted in a 2-cent charge to the company in the quarter. When you add back or take into account the two Las Vegas transactions, the contract termination and the impairment, as well as the Enron, our income from continuing operations was 59 cents a share, which approximates what was out there for First Call for our company.

Our financial results really is very consistent with the past two quarters for Black Hills. Significant improvements in our integrated energy business unit; 28 percent improvement primarily due to improved generation from the additional capacity we have online results from our power generation. Improved oil and natural gas production and prices, primarily resulting from the acquisition of Mallon Resources, which we closed in March of this year. We had a 50 percent improvement in our production -- or 87 percent improvement in production for the quarter and 50 percent year-to-date, and that's primarily due to Mallon Resources.

And we had reduced results -- that is offset partially by reduced results from our marketing business. Our communications business continues its improvement, and we improved our results in the quarter by 29 percent, a 1 million loss compared to $1.5 million loss for the quarter. So we show continued improvement in our communications business, primarily driven by increased customers and reduce cost. And our utility has been down consistently this year, and again was down; had a very strong quarter at $6.8 million, but was down from prior years, primarily due to three things; higher gas costs that we do burn some gas in our operations, increased pension cost, and continued increased interest expense from the bond offering we did in 2002.

Strategically, we have improved our position tremendously with the liquidity and our balance sheet strength with the closing of the Las Vegas and the hydro assets. We also announced our regular quarterly dividend of 30 cents a share, equivalent to $1.20 per share. I would now like to open up the call for any questions.

(OPERATOR INSTRUCTIONS) Michael Worms with Harris Nesbitt.

Good morning, Mark and Dale. Just a couple of questions. First on the coal mining business, earnings were flat. Can you, before we get into it, explain what you mean by lower margin sales through your trainload out facility?

Yes. That's more of a market based sales. Historically most of our sales to Pacific Corp and our own utility are under long-term contracts and they have been very, very stable sales. But as we increase our sales incrementally, and we just announced a contract last year of -- a five year contract for a million tons a year approximately through the trainload out -- those are more a market-based price and we have the same cost of mining or we had some efficiency for increasing the tonnage, but it's largely the same cost of mining and a lower revenue. We still make a margin on those sales, they're just lower then the long-term contracts that we have in place.

And the higher general and administrative costs are -- what would be driving that?

Certain of the administrative costs of the company that we have we allocate to the businesses. And as we've grown over the last several years, we've had additional requirements at the corporate level. And those costs get allocated to the businesses, and given the size of the coal mine we've begun allocating those costs to the coal mine. So relative to prior years they've gotten certain of those costs allocated to them.

On the utility side, some of the pressure is coming from higher purchase power costs. And considering the fact that off system sales were down during the quarter, I guess the question is what was driving purchase power? Why were you out there buying more power?

To some extent, Mike, we look at the -- the purchase power still includes the most efficient delivery to our customers. And given the higher gas cost and certain of our units, peaking units being lower we peak in the third quarter as we had significantly more load, 7 percent increase in firm sales, we do have times when we look at our portfolio and if it is cheaper to purchase power than it is to deliver through our own generation on peaking units we will do that. That is higher than we have had in the past. But it was all in the delivery to our customers.

And in addition, in certain of the instances when we are having our off system sales, again the same analysis is done in which we look at what's the cheapest source of that, and we still make a margin on those sales, albeit smaller. But that may include purchase power or our own generation.

And then finally, can you just kind of give us an update on what the capital expenditure number for the year will be and what the outlook would be for 2004?

We came out previously in July with an expectation on capital expenditures of approximately $110 million which was a reduction of about $160 million, and I didn't have that right in front of me, so if I'm off a little bit we did have that in our July release. We expect to continue on that. We do looking forward, though, expect to have capital expenditures similar to what we had disclosed in our 10-Q, and that includes discretionary capital to grow our businesses.

Thank you.

Paul Debbas from Value Line.

Along those lines, if you do get CAPEX in excess of 300 million as was indicated in your financials, how do you plan to finance that?

Primarily we expect to finance that with strong internal cash flow from our companies. And historically in the Q's you can look at what that has been, and that is the primary driver for the financing of our capital development. In addition, we have significantly reduced our short-term availability and liquidity with cash from the transactions that we've just completed that we believe we will be able to maintain an equity as a component of total capitalization in the 45 to 50 percent range, or conversely debt in the 50 to 55 percent range of capitalization. We believe we will be able to stay within those parameters and deploy the capital to grow our businesses.

If you do hit the targets for CAPEX next year, how much will be generated internally?

Again, we've historically generated around $200 million in operating cash flow. So that would be generated internally. And we have, if there were any other inflows of cash, we would be able to use that, but that's historically what we've generated. And that's what we would use to grow our businesses. We don't really have any significant retirements of debt or other fixed obligations other than the dividend.

So the cash that you receive from the recent transactions, do you plan to just hold on to that for now?

No, we would expect to reduce certain debt. We have some project debt associated with certain of our power plants, we have some corporate bonds and utility bonds and we're looking at what's the most efficient use to reduce debt. We also have obligations for taxes related to the transactions that we've accomplished, and then some cash could be used for future growth.

Thank you.

Fedula Meerty of Zimmer Lucas.

This is Mike Weinstein actually. I just wanted to find out if you guys are still sticking by your original guidance for the remainder of the year being flat with last year?

Yes, from continuing operations for the year we expect to be flat with the prior year.

And that's despite the termination of the Allegheny contract, right?

We expect for the full year that we'll be flat with the prior year, including all factors.

That was it.

Edmund Griffin from Black Rock.

Can you just remind me at your utility, what your allowed ROE and where were you in the quarter, and how do your rates compare in the region?

Can I take the second one -- or the last one and then the first two. Our rates are very competitive in the region relative to other providers. With respect to allowed ROE, we have not had a rate case since 1995, when we entered into our first rate freeze and we extended that in 2000; it goes through 1-1-2005. So we don't really have an allowed rate of return. Historically, it had been around 11 percent, but that was several years ago. We have operated under that rate freeze that has given stability to our customers on their rates, as well as allowed Black Hills to optimize its assets at taking the risk, because we have no purchase power or fuel clause adjustment, but take advantage of wholesale sales. That has worked very well, we believe, for the rate payers as well as for the company. Now, I forget what the second one was.

No, that answered it. So, longer term, the strategy as far as not going back and increasing the rates is just to sell this power on off-system so you can get the differential in between the prices. But given the current levels of pricing, it's weaker right now. So I guess when do you expect the utility to show improvement year-over-year?

Well, that depends a lot on a number of factors; the weather, the pricing between the grids. We have just completed an additional tie. Our utility is uniquely positioned in that it sits between the Eastern and the Western grid, and we are able to arbitrage those prices to maximize the value of our assets. We increase that capacity by completing another D.C. tie, which what that does for people that don't what that does is that transforms electricity between the Eastern and Western grids. It's a 200 megawatt tie, of which we have 70 megawatts of that capacity, and a co-op has the other 130 megawatts. But we believe we will be able to continue to optimize the value of our assets. The comment of not going in for a rate increase, we would have to evaluate that probably sometime next year to evaluate the cost of the utility and its operations relative to its rates. If we determine that it made some sense to go in, we would look at that. But at this point, higher gas cost to the extent they continue, we could look at that, but at this point we don't have any indication that we are going to go in for a rate increase. But that is still an option to us, and we would evaluate that probably mid to late next year as that expires 1-1-05, our current rate freeze.

Thank you.

Dan Eggers from Credit Suisse First Boston.

It's James, actually. I had a question, two questions actually. The first one is on E&P. You had mentioned, I think, that volumes were up 86 percent for the quarter. Is that correct?

Yes, that's in our release.

You had mentioned, I think earlier as a result of the Mallon acquisition, that volumes were expected to be up around 50 percent for the year. Is that still consistent or should we may be looking for a little bit more, given the robust third quarter?

Well, the robust third quarter is we had a good third quarter with production this year. Last year's production was low relative to year to date. So if you look at last year's, it was a slightly lower quarter, and this year was slightly higher, so it improved. We still look at it, and we expect production to be consistent. We had a good production quarter for the third quarter, and we are not changing anything formally quarter over quarter for guidance. We had very strong production. We expect our production to continue to be up 50 percent for the year.

Okay, thanks. On the Dynegy contract, is there any further status you could provide on your work to replace that?

You're mixing your troubled energy with an Allegheny energy (indiscernible).

I'm sorry, Allegheny.

We terminated that. We continue to work with a number of parties on recontracting that plant. That plant is in a great location in Las Vegas. It sits inside the grid. That's a market that needs power, and we would expect to have something to announce relative to the contract by the end of the year.

Thank you very much.

Bill Hyler from H.M. (ph) Capital.

Good morning everybody. Mark, a question for you on the off-system sales. A 36 percent drop in the face of, I think you mentioned modestly higher prices. Is that due to lower plant availability or what would have accounted for that kind of a drop? With prices higher, I would have thought you would have been able to hold those sales?

Well, it's relative to a couple of things, Bill. One, we had increased firm sales for our system. Our first requirement is serve our customers, and we had a 7 percent increase in firm sales. Of the drop of 113,000 megawatt hours, that was 35,000. So approximately a third of it. We had modest -- we saw modest increases in the prices for the power, but we saw much higher increases in the cost of gas. So it made the relative value of those sales lower.

And the coal and the coal plants were needed for the --?

For the baseload.

Was that due to hotter weather on the on-system?

Yes, we had warmer weather than the prior year.

I'm looking at the June 30 balance sheet. I know your September 30 won't be out for a while. But can you fill us in again on what cash proceeds have yet to come in from the asset sales and the Allegheny --?

Those cash proceeds are in. We received approximately $300 million in total; 186 million for the hydro and 114 million relative to the contract termination with Allegheny. We used $91 million specifically to reduce debt.

That was after June 30th?

It was on September 30th.

So it will be reflected in the September 30 balance sheet.

Yes, which comes out in a couple of weeks.

So, basically, total cash proceeds of 300 million roughly, and that 90 million went to pay down long-term debt.

Yes.

And the rest is just going to build your cash position for the short-term.

Given that the big piece of it came right at the end of the quarter, yes, at the quarter we would expect that to be the case.

The Mallon acquisition so far meeting expectations, drilling, development drilling? I know there was hope to build that reserve production base.

Yes, we continue to drill up that property and work through just the normal operations of getting permits and drilling up properties. That appears to be going on track. Our production is on track with our expectations, and pricing has been very favorable so far this year.

Thank you.

James Bellessa from DA Davidson & Co.

Good morning. It's winter in Great Falls. I hope you have a great deep winter. I have a couple follow-up questions from questions already asked, then a new question. First of all, $110 million of CAPEX this year, is that what your expectations remain? Just want to verify that. Then for next year, is it up over 300 million?

Yes. Well, it's consistent with the 10-K.

Next year would be based on some type of project, entering into some type of project or some type of acquisition relative to this year?

Yes, we would expect to continue to grow this year. We focused on a number of activities to strengthen the balance sheet, with the equity offering in April, the bond offering in May, and then the contract termination in the hydro assets that we just announced this quarter. We have strengthened our balance sheet significantly, and we are positioned to grow. We continue to look at opportunities. We have opportunities to expand our existing sites on the generation side, and we look for assets within all of our businesses to grow -- say that sans (ph) communication, we don't expect to grow outside of our area there. But our other businesses, we look for opportunities to continue to grow and deploy capital.

So you didn't have a balance sheet for this most recent quarter yet published, but did you meet your goal? Did you not say that you wanted your equity to -- total cap to be in the 45 to 50 percent range, and was that the case for the end of September?

Well, when you take into account the -- some of the cash came in right at the end of the quarter, so the ability to reduce debt and given that we had short-term debt already paid off with the proceeds or equity in our bond offering, the ability since it came in on the last day to reduce debt, may not have that. But when you take into account those proceeds, I think we will be in good shape to meet our expectations by the end of the year.

Can you give us an update on the Las Vegas project that you're trying to take it from a market position where you're marketing the gas or the electricity yourself and trying to find the toller? Can you give us an update for that?

Again, we just closed that contract termination late in September as we announced. I believe it was the 23rd. I may be off a day there, but it was late in September that we closed the contract termination, and that was dependent on Allegheny closing its position with Jay Air (ph) and (indiscernible) Goldman. So the timing of that was not under our control. Once that occurred, we were able to begin marketing or trying to get a long-term contract of that plant. We've talked with a number of parties and are making progress on that. I can't reiterate enough the location and the value of that plant; we believe it's a terrific location, an area that needs power to serve customers. And we are talking with a number of parties.

We expect to have something to announce by the end of the year on a long-term contract. On an interim basis as that plant is a 7800 heat rate plant to the extent it is able to clear the market relative to gas prices and moving the power, we are on an interim basis marketing that power at current market.

Thank you very much.

Bill Hyler.

A quick follow-up, if I may. The capital budget you mentioned for '04, was that $300 million?

Approximately. I'd have to go back. I don't have the 10-K right in front of me.

How much of that number would be acquisition versus maybe give us a maintenance number and development drilling, and how much of that number is approximately -- would be acquisitions?

With maintenance capital and a normal drilling budget, along with the additional drilling relative to the Mallon acquisition, that we expect to drill out the Mallon acquisition, we would look for our capital budget to be approximately a third maintenance capital, including the drilling for the oil and gas company, which you could argue one way or another as maintenance CAPEX or not, or development capital. But including the oil gas, about a third would be the maintenance capital, including oil and gas, and then two-thirds would be opportunity capital to deploy in our assets, or in new assets.

Given what you said before about how higher gas prices ate into some margin in the June quarter, and with the Las Vegas plant a big user of gas, does it make sense -- do you see additional D&P opportunities, gas reserves, additional gas reserve purchases to maybe complement the power strategy?

We look really in each of the businesses. It can be power generation, it can be oil and gas opportunities. It could be midstream assets. We're primarily focused on the energy businesses, and to the extent that there's an opportunity to get any retail operations as well, that would be something we would look at on the utility side. Again, I will reiterate we're not looking to expand our communications business outside of our service territory. But it does not have to be just power generation. We look at it from -- power generation is an important part of our strategy. Oil and gas is an important part, primarily gas reserves, and then midstream assets as well would be a part. So the components of which we don't have anything announceable at this time, so I can't put out what all each portion of that would be, but we do expect to deploy that capital to continue to grow our businesses.

Thank you, Mark.

John Hanson (ph) from Imperium (ph).

You answered almost all my questions, but I've got one more left here. That is, your release talked about the marketing business and that that might have -- you had increased volumes, but some of the margins or at least the net results of that business were a little bit down. Could you talk about that part of the business and what you see going forward in terms of your outlook for it?

Well, our marketing business has consistently been an integral part of our strategy to really optimize the value of our assets and move -- we have a very conservative strategy. A number of companies have been in the marketing business, significant companies that have exited as they did more paper transactions and were just volumetric move as much as they can. We source gas or aggregate gas from producers and deliver gas to end-users that need that gas in their processes, utilities or industrial customers. And we believe that that strategy and our consistency in that business, we began that in 1996, has shown as we've consistently grown our volumes, but grown very slightly. We're not expecting to be the biggest. We just want to provide good customer service to both sides of the customers when sourcing gas and then also delivering gas. We expect that to continue and continue to be a good part of our strategy.

What about the profitability on that business; how is that doing?

It's historically been profitable. We had one quarter in which we had a fine with expect to the CFTC, and we closed that issue out in the second quarter. But otherwise, it's been consistently profitable and we would expect that to continue.

Very good, thanks.

(OPERATOR INSTRUCTIONS) Peter Hark from Talon Capital.

I'm sorry, I had to step away, so my apologies if you've got to this. One's an easy question; I can't seem to reconcile down from the 69 cent reported to the 54 cent operating or continuing. I backed out the 6 cent gain from the Las Vegas Cogen II, the 1 cent gain on the Enron, the 14 cent gain on hydro plants, and added back the 2 cent adjustment for Pepperell. So I'm missing 8 cents.

Yes, I tried to explain. It goes really the other way. The first three items, the first three bullets, the proceeds of Las Vegas, the $2.09 gain and then the $2.15 loss on the impairment, and that's a 6 cent loss relative to the Allegheny contract. And then you have the 1-cent gain related to the Enron, which is 5 cents. So then you take continuing operations 54 cents and add back that 5 cents, and you get to the 59 cents. The other two items, the hydroelectric plant sale as well as the plan of sale for the Pepperell plant, are really relative to discontinued operations. So they are accounted for and all down and below the line. So they are not in the continuing operations number.

Oh, I see. Your cash is below, I got you. Secondly, I didn't know if you quantified the contribution in the quarter of the Las Vegas Cogen facility ex out the transaction, purely on an operating basis. I don't know if you --

No, we did not separately disclose that.

How about this; do you have, at least for the third quarter, how much it ran in the quarter, that one facility?

Well, it didn't make any difference because it was a capacity contract. We haven't specifically disclosed how much that ran, but we were -- it was a capacity payment and tolling arrangement. So we received our tolling contract revenues up until the point in which we terminated, which was again September 23rd or 22nd. I'm not -- the date I may be off slightly on. But we received our normal revenues with respect to that, and incrementally to the extent the plant ran, we'd get incremental revenues, but it was a capacity contract.

Right. Well, now without the tolling contract, I'm trying to get to what it may contribute in the interim as a merchant facility?

That really depends on the market, and we have not really provided anything. We have run that plant some, but to the extent the contribution, we haven't disclosed any of that.

In the interim, how are you hedging out your gas supply needs?

Generally, we are looking at it on back to back. To the extent the purchaser of the power would like the power, they either bring the gas or we have an ability to make sure we can source the gas on a day ahead basis. We're not marketing that on a long-term. It's more daily or day ahead marketing of electricity. We're sourcing the gas appropriately, or we would use a marketer that could do that and source the gas. So it just depends on what makes sense on a daily basis, and I can't really -- we're not taking significant additional risk, if that's your concern.

Right. Well, to the extent that you can cover your fixed cost by running it and taking into account what spot gas prices are and playing the spread.

And you evaluate that on a daily basis.

Lastly, all the proceeds coming in and kind of fixing the balance sheet, when do you expect the rating agencies to act? I know you're just one notch above junk, so trying to get you going back in the other direction. When will the rating agencies opine?

Well, a couple of things. We have gone in for -- we recently have gone in for our annual review with the rating agencies which we historically do in the fall. We identified all the items in which we strengthen the balance sheet, which a number of what you see in this release today, and we maintain our commitment to a very solid investment grade balance sheet. We discussed all of the activities of the company with the rating agencies, and they historically have taken 60 to 90 days to really come out with anything. And the only thing that I would add is, our discussion with them was we believe that we have taken steps to strengthen our balance sheet and improve our position. If they feel we need to do more, in their opinion, that we would like them to the specific because we believe we've done a good job in strengthening our metrics.

No, that's right. So at least by year-end or early '04, do you think we will have a position from them?

Really, I don't control that. That's really up to the rating agencies. I would expect either later this quarter or in the fourth quarter, we would expect to hear what their position is. But it's up to their internal workings.

Thank you, Mark.

Angela Ho (ph) from Credit Lyonaiss.

I've just got a quick question on the E&P side. I guess in the third quarter while the production is up 87 percent, natural gas prices were up by 14 percent. I'm just kind of wondering why the margin was only up by 1.7 million. I would expect it to kind of increase a little bit higher than that.

Well, the 87 percent versus -- of the increase? That's a significant increase on a relative basis contribution-wise from the oil and gas. And we did have strong prices last year, and the prices this year were comparable to slightly stronger on the oil and gas. That's relative – percentage-wise, I think it's fairly accurate in the contribution of oil and gas. We'll have that more specifically laid out when we file our 10-Q in a couple of weeks.

Great, thanks.

Allen Fleischer (ph), a private investor.

Good morning. On the Las Vegas deal, you have revalued the value of that facility, marked it down.

Yes, correct.

Do you expect when you eventually make a new deal for it that that will -- you'll get a value in excess of what you marked it down?

Well, when you go through the accounting and not to go through the gory details with everybody, but you look at market opportunities on a long-term basis -- that's a long asset -- and what the market values are. And then to the extent that we did that, we did have an impairment of $117 million. But as you go forward and you contract that asset, what that in effect does is reduces your depreciation, but the contribution on that new contract will be what it is. When we are able to -- assuming we are able to have a contract by the end of the year announced, we will be able to announce what we believe the impacts will be going forward from that. But at this point, we don't have anything, and we valued that asset based on a number of factors in the marketplace to take the write-down.

If you make your new deal so that you can reevaluate over your write-down of, will that represent an earning income?

No, you can't write back up. The accounting rules don't allow you to write back up the value of the plant. What we would have is we would have a plant at a value and a contract that would provide us to have earnings over the forward look of that contract higher than we may otherwise have if we had less of a write-down. But again, we valued that plant based on market factors and believe we valued it accordingly. If we get better, the earnings impact, if we are able to contract that at a rate in excess of what we used at the market value, we would just get those earnings over time.

Thank you.

We have no further questions. You may continue.

We appreciate everybody's time, and thank you for your interest in Black Hills.

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