Black Hills Corp (BKH) 2005 Q2 法說會逐字稿

Ladies and gentlemen thank you very much for standing by. We do appreciate your patience today and good morning. Welcome to the Black Hills Corporation second quarter 2005 earnings conference call. Now at this point we do have all of your phone lines in a listen-only mode. However, after the executive team's presentation today there will be opportunities for your questions and those instructions will be given at that time. Just as a note, if you should require any assistance during the earnings call you may reach an AT&T operate by pressing star then zero on your phone keypad. As a reminder, today's call is being recorded for replay purposes and that information will be announced at the conclusion of our call. So with that being said, let's get right to the second quarter agenda and here with our opening remarks is Black Hills Corporation Director of Investor Relations, Mr. Dale Jahr. Please, go ahead, sir.

Thank you and thank you for joining us and welcome to our conference call. I remind the audience 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. Mark Thies, our CFO and Executive Vice President, will start off with a few comments and then we will open up to questions. Mark.

Thank you, Dale. Good morning, everyone. And if you hear a loud rumble in the background, in the Black Hills we now have the Sturgis Motorcycle Rally going on. So we have a half a million Harley bikers traveling in and about the hills and that may provide some background music for you different than what you were just listening to on your call. We are here to report our second quarter earnings and recent developments. We had a very good second quarter with net income of $14.9 million or $0.45 a share, compared to 11.4 million or $0.35 a share in the same period last year. Year-to-date we have income -- net income of 30.6 million or $0.93 a share, compared to 21 million or $0.65 a share. From continuing operations we had 16 million in net income or $0.48 a share in the second quarter of 2005, compared to 9.7 million or $0.30 a share for the same period last year.

And year-to-date from continuing operations we have 32.8 million or $0.99 a share, compared to 21.5 million or $0.66 a share in the prior period. Major items affecting our earnings improvement, primarily oil and gas earnings both on an increased production, we increased production 17% and 15% on an Mcf equivalent basis for the quarter and year-to-date respectively, and we have continued strong product prices in the marketplace for our oil and natural gas commodities. Those prices were $5.58 for natural gas for the quarter compared to $4.23 in the prior year and year-to-date for -- or quarter date for oil we were also -- we were at 32.87 versus 23. So strong product prices. Partially offsetting what you may expect from product prices for the oil side, we do have approximately 60% of our oil hedged. And that is included in those net product prices.

We put those hedges on over a over a year ago and we have that impact. But going forward we expect in 2006 and 2007 strong product prices and we do have increased prices hedged out for those periods. In addition, Black Hills Power increased 1.6 million or $0.05 a share in their earnings. Recalling last year we had some unplanned outages in our power plants that affected second quarter -- negatively affected second quarter results and we had a return to normal operations in our electric utility Black Hills Power. With respect to power plant outages, we also have confirmed our guidance for 2005 at $1.90 to $2.05 a share. And this includes the impact of an unplanned outage we incurred in late July of this year at our Neil Simpson Unit ll plant. That plant had operational problems and had to be taken down and is expected to be down through the month of August. We expect it to be back on line September 1st and we expect $2.5 to $3 million of cost or $0.05 to $0.06 a share.

The largest component of that cost is replacement power. We went out and covered our expected loss of capacity in energy in the marketplace and that's included in the $2.5 to $3 million cost estimate and is also included in our guidance going forward. During the second half of 2005 we do expect continued strong production from our oil and gas operations, as we -- as I mentioned earlier, we have increased our production 17% and 15% on a quarter-to-date and year-to-date basis. Our targeted goal for production on an annualized basis is a 10% increase, so we appear on track to meet that -- to meet that goal. In 2005 in the second quarter we also accomplished the sale of our communications business segment. We sold Black Hills FiberCom for approximately $103 million and then used the proceeds of that to retire some project debt at our Fountain Valley facility and paid down $81 million of debt.

That moved our debt to total capitalization ratio to 48% and we believe we are well positioned to continue to deploy capital and grow our business with a strong balance sheet. Given that, we are also expecting in the third quarter -- or late third quarter or early fourth quarter to begin construction on the Wygen ll facility, as we are calling it, which is a 90 megawatt power plant that we expect to be a rate-based asset to serve the customers of Cheyenne. That construction is expected to be completed early in 2008 and recall our power purchase agreement with Xcel Energy expires December 31, 2007. So we expect to be able to begin construction on that plant and serve the customers of Cheyenne. We are going through the regulatory process and we appear to be on track with that project as we move forward. I would now like to turn the call over to questions.

Indeed, and thank you very much, sir. And ladies and gentlemen, then as you just heard if you do have any questions or comments, please feel free to queue up at this point simply by pressing star, one on your phone keypad. You do hear a tone indicating you have been placed in queue. And if you would like to remove yourself from the queue simply press the pound key. So once again, ladies and gentlemen, to queue up for question, please press star, one on your touch tone phone. And representing Zimmer Lucas Partners, our first question we go to the line of Mike Weinstein. Plead go ahead.

Hi, guys. My question is about the utility. Wondering if you could breakout the effects of weather and maybe increased wholesale power sales at the utility in terms of its affect on net income.

What we did include in the -- in the 10-Q, that we just filed yesterday as well, was a breakdown of the electric revenue by customer class and customer base. And generally with residential and commercial customers, it is primarily, and our contract wholesale, it is primarily weather related to our customer base. And we increased our commercial and residential electric revenues and megawatt hours by 6% and 9% for the revenue side and 5% and 6% -- or 9% for the megawatt hours. Our industrial base increased slightly on the revenue side and then our contract wholesale, which is to serve the cities of Gillette and Sheridan, Wyoming, increased on the revenue side 12% and 5 -- 9% on the megawatt hour side.

That's again primarily weather related or related to the -- the weather on the residential side. Our industrial customers and wholesale off-system sales are more market driven and our revenues were up in wholesale -- contract wholesale off system, but our actual total megawatt hours were down because of the revenues being up or the prices -- our costs are tied more to what the market prices are for the wholesale. You can see in the resource side of that, Mike, that we did have additional coal megawatt hours generated. We also put in what our megawatt hours generated by the various sources, coal, gas and purchase power. And because of last year we had some unplanned outages in our fleet and this year we did not, so our over all megawatt hours generated by coal, which is our lowest cost resource, were up and our purchase power was down. So that contributed to an improvement in our utility earnings.

Is there any -- it sounds like higher coal costs that are effecting the west right now would not apply to you then at all? And I'm thinking that because -- .

No our -- our plants sit either on our coal mine -- we own a coal mine and they are mine and mouth generation with contracted coal prices. Or we have some that we truck just regionally to Rapid City and to Osage, Wyoming. But those are all contracts with our own coal mines. So no, we have not had any problems with delivery of coal.

And you are not seeing a benefit from higher coal prices either in the PacifiCorp contract, are you?

No, that's a contracted price that remains in accordance with that contract. It's not market driven.

Okay. Thank you very much.

Thank you, Mike.

And thank you very much, sir. And our next question we go to the line of Michael Worms representing Harris Nesbitt. Please go ahead.

Good morning, Mark and Dale. How are you? Good morning, Mike, good. Are you ready to hit the holly after the conference call. No comment, huh?

Well, that would be a good thing.

Okay. Anyway, a couple of questions for you. One, with regard to the Wygen ll. In the queue it mentions it would be a regulatory asset. In the filing have you filed that in such a way that this would be a regulatory asset? Or is there still an option for the Wyoming Commission to just allow Cheyenne to enter into a purchase power agreement?

We are -- we are making our regulatory filings as if this will be a regulated asset. And probably the biggest filing is the certificate of public needs and necessity, or public convenience, that we have filed that and we are in process with that regulatory filing. We expect to have a ruling based on that sometime in the third quarter. And then we would expect, assuming that that ruling meets the certificate of needs and public convenience, we would be able to have that as a regulated asset. If not, we do have the opportunity to also work with the commission to have that as a contracted asset. But we believe, based on just internal discussions, that the regulators in Wyoming, as well as the consumer advocate, would like to see rate-based generation and assets dedicated to serve the customers of Cheyenne. And that's how we have filed all of our -- all of our information with the -- with the public utility --Public Service Commission of Wyoming.

Can you just remind us of the timing of when the decision on that will be made and when the Wyoming Commission is scheduled to make a decision on the rate increase.

There's two separate decisions. They are two different things, Mike. The timing, we expect in the third quarter to get a decision on Wygen ll. Whether that will be a regulated asset and if there is a decision different than that we would have to work with them whether that would be a non-regulated asset and a contract. But we believe, and we are moving forward with it, it would be a regulated asset. The timing on the rate increase or the proposed rate increase that we have filed, which is $5.1 million, to increase revenues for Cheyenne was filed in March. And they have until, I believe, February of 2006 to be required to act. We believe that that will be done by the end of the year and in place for rates 1/1/06. And we are regulatorily precluded from changing rates until 1/1/06, so that timing appears to be on schedule.

Just separately then, on the power generation side, can you just explain the mark-to-market gain that you mentioned in your release.

Well -- and we have had -- we've had these from time to time. We own partnership interests in certain plants, a fund that owns plants, and when they sell an asset, we record our share of the earnings related to that. And they did -- they did have a transaction occur where they sold an asset, and we -- we recorded our share of the earnings there. And winding down, though, they still have certain assets remaining, but as that goes, that becomes a smaller and smaller portion of our business. But they are winding down the fund and we take our equity share of earnings from that. And we had that occur in the second quarter.

And lastly, can you just explain why the realized margins on your gas and oil marketing business declined?

Well, that was on a per unit basis primarily. We increased significantly our volumes. Our volumes went up nearly 50% in the second quarter and are up 30%, but that's albeit at lower margins.

All righty. Thank you very much.

Thank you, Mike.

Thank you, sir. Next we go to the line of Gordon Howald with Natexis Bleichroeder. Please go ahead.

Great, thank you.

Good morning, Gordon.

Good morning. I guess one of the biggest concerns that we have always had was the rate freeze at Black Hills Power and the possibility of an unplanned outage. It seems you guys were able to handle this will one pretty easily. Could you talk a little bit more about the Neil Simpson outage. What kind of problems there were? Why you have confidence that the timing will be limited to August? And, you know, maybe where the replacement power had come from? Because it didn't seem like there was much of an issue here. Obviously there was one, but certainly not as bad as we had been concerned in a worst case scenario.

Well, a number of questions in that, I'll try to answer all of them, Gordon. We just took that plant down last year for a major overhaul. We brought it back on line. It had been operating. It has had a tremendous history in it's 10-year history. It was placed in the service in '95. And when we did the outage we just did normal major overhaul last year and it had a seal, and I'm not an engineer, but a seal break and caused it to shutdown and damage the turbine. So we went in immediately and evaluated the damage, came out -- talked with representatives from GE and determined what a time frame for repair and how long it would be down. And that we expect to be the month of August. It was late July when it occurred.

We then went and immediately went to the market and purchased replacement power from the market to cover our expected load. And we forecast that load, you know, based on what we see for the load and we purchased replacement power. We feel -- we feel very confident that we'll be able to get the plant back into service by September 1st and are working very hard to do that. So the impacts of $2.5 to $3 million, I don't view as minor, I view that as a negative impact. It's $0.05 to $0.06 a share, but it is -- you know, it does happen. Outages can occur and you just have to -- to react very quickly and that's what we have done. And we -- we covered our position so we are not open and we believe that makes a lot of sense.

And our doomsday scenario was certainly worse, so this was, I guess, a manageable issue. Great quarter. Great, thank you very much.

Thank you. If -- are there any other questions?

I beg your pardon, Mr. Howald, did you have any follow-up question.

No, we're good. Thank you.

You're very welcome. Thank you, sir. We do have three left in queue. Let's go to Jeff Gildersleeve now with Millennium Partners. Please go ahead.

Hi, Mark.

Good morning, Jeff.

Just a few questions. I missed the mark-to-market gain that had to do with a partnership, could you explain that again?

We call it mark-to-market. It's the accounting for -- one of our partnerships owns power plants. Energy investors Fund and they own interests in power plants. We own a small percentage interest and as they sell assets, we -- they mark their portfolio to market and we record our share. And they are in wind -- one of the funds is in wind-down mode and selling assets. So as they accomplish that and have a value, we record our share of earnings. We call it mark-to-market because that's a technical accounting that the fund follows and we just follow the funds accounting.

Okay. So even on liquidation it's still trade as mark-to-market?

Yes.

And these are private equity investments?

It was a fund investment made -- made many years ago. It came over actually with the acquisition of Indeck Capital in 2000. And those investments were made prior to that.

Was there a booked value at the end of the year?

Yes, but off the top of my head I don't recall the specific book value of the funds.

Okay. Is it material?

No, it's not significant to our total assets.

Okay. Next question. You talk -- obviously, the balance sheet has improved a lot, telecom sale helped a lot as well, and your comment about future opportunities to expand your energy presence. You know, can you elaborate on that? What you mean by energy presence?

Well, we are -- you know, with the sale of the communications we are -- we are back to, you know, an energy Company with regulated utilities as well as oil and gas, coal, you know, midstream assets, marketing, and independent power production. So our focus has always been energy and we have stated it as an energy presence in the west as our core focus. You know, most specifically the -- the activity that we look going forward immediately is the Wygen power plant. We're going to build another -- we expect to build another 90 megawatt coal fired facility which helps our coal as well as electric generation. In this case, we believe it to be a regulated asset in Cheyenne Light, Fuel, & Power, to serve that. But that's one deployment. And that power plant is expected to be a total cost of approximately $160 million over the remainder of this year through 2006 and 2007, being placed in service early in 2008 is -- is the current schedule.

We continue to look at other opportunities to deploy capital, and -- and until we have a, you know, a definitive agreement or a signed agreement, we don't announce those activities. But we're looking to, you know, expand the existing sites we have in power generation in both California, Colorado and Nevada. We have existing assets there in sites and we look to expand on those and work with the utilities in those areas and they need power. Those are growing areas in the market. On the midstream asset side we continue to look to have opportunities to expand that to market around those assets. And oil and gas we continue to look for opportunities to expand our oil and gas business. Our primarily focus in oil and gas currently is drilling. We have our opportunity in New Mexico that we have been continuing to drill and we expect to do that for the next few years. So we'll continue to grow the production from our oil and gas Company through the drill bit. But we are always looking at opportunities to acquire assets that make sense for us in oil and gas as well.

Okay. And then finally, I just want to be reminded, the Wyodak outage was supposed to be this year and then PacifiCorp delayed it to, what, second quarter next year?

Spring. I would expect it to be second quarter, yes.

Okay. And that was -- that was in guidance at the beginning of the year?

Yes, and that's -- we changed our guidance up $0.05 on -- from $1.85 to $2 we moved that after the first quarter announcement to $1.90 to $2.05, which is our current guidance. And that was primarily due to the move of the Wyodak plant outage and just continuing to look at other factors impacting our business.

Okay. But that was before the Neil Simpson issue?

Yes.

Okay. Great, thanks a lot, Mark.

Thank you, Jeff.

And thank you very much. And next we go to the line of James Bellessa with DA Davidson. Please go ahead.

Good morning, Mark and Dale. On the mark-to-market gains, you have one for these partnership investments and then also for energy marketing. Right?

Correct. Correct. We have -- and in energy marketing, we -- we typically try to have hedge positions, but certain positions do not receive hedge accounting treatment, so we have to mark that to market. In the first quarter we actually had a mark-to-market loss impacting us and that turned around to a mark-to-market gain to effectively we're largely flat for the year.

Do you know what the EPS contribution was from these mark-to-market gains?

For which --

For the most recent quarter.

Well, we had -- we had $3.4 million of a mark-to-market gain in the second quarter on a pre-tax basis. So -- you know, you can do the math at a -- at a -- it's about $0.06, $0.07. $0.06 to $0.07.

And the biggest portion of that mark-to-market was that with the partnership investment?

No, I'm sorry, that was just the marketing component.

Just the marketing?

Just the marketing component. On the generation side I don't believe we specifically said the amount of the mark-to-market gain on the -- on the partnerships.

Would the energy marketing side be larger than the other side?

Again, I don't think we disclosed -- I'll -- I'll see, but it was -- it was a -- the gain from the generation side, the -- I don't have that right in front of me, Jim.

Okay. Have you given advice for 2006?

No, we have not. We -- we typically give the current year guidance, continue with that, and then towards the end of the year provide guidance for the next year on an annual basis and we just give annual guidance.

Had this Neil Simpson ll power outage not occurred would your guidance have gone up this -- this call? I -- the Neil Simpson outage did occur. So I -- I can't say. We'll stick with our guidance that -- our guidance includes the effects of $0.05 to $0.06 of the Neil Simpson outage. I mean, it occurred, I can't speculate of what would have happened had that not happened.

And I see in your materials you have heating and cooling degree day information. Is that throughout your territory an average? Or is that for Rapid City temperatures? That would be the impacts to our system of heating and cooling degree days. So it would be for Black Hills Power service territory, what impacts our system.

Thank you very much.

Thank you, Jim.

And next we'll go to the line of John Hanson representing Imperium. Please go ahead.

Good morning.

Good morning, John.

All of my questions are answered except for one minor one. In the corporate section you talk about development costs and project development costs that were as part of the item in that area. What kind of project development costs might those be?

Well, as I mentioned earlier, we do look at opportunities to expand existing sites that we have on the generation side and look for potential new sites to continue to grow our business. And not every item that you look at becomes successful in that. So when those -- when those costs are -- are determined not to be part of a project that we can complete and be successful, then we have to expense those costs. And that's what occurred in the second quarter. We analyze on a quarterly basis all of our development costs and certain of those that we don't believe will result in projects are expensed. And that occurred in the second quarter.

Okay. Thanks a lot. And enjoy your visitors you have in town for the weekend.

Thank you.

Good-bye.

Okay. We have a question now from the line of Jim Harmon representing Lehman Brothers. Please go ahead.

Good morning.

Good morning, Jim.

How are you?

Good.

Two quick questions. The first is you indicated that you felt comfortable with production growing at 10% this year. Would that be sustainable over the next two to three years with what you have in inventory?

Yes, we expect to grow production 10% annually. That's our long-term goal. We have been able to demonstrate that and we expect to continue to do that.

Okay. The second question is, it's an observation and a question, is that it appear that Moody's took a little bit more of a relaxed stance around your Company this -- last quarter. And I'm just curious if the other rating agencies -- have you had a chance to go in and talk with them and what they may be inclined to -- or how they are inclined to view your ratings going forward?

Well that's -- that's -- you know, we were -- we were pleased that -- that we had for the first time in a while a positive movement on our ratings. And we have continued -- we don't control what the -- what the rating agencies do, we run our business and try to do it prudently and conservatively. We talk with them on a regular basis to identify activities at the Company. Probably the largest one that occurred in the second quarter was the sale of Black Hills FiberCom, in which we sold that business. Got $103 million, reduced debt and our debt to capitalization is now 48%. So, we will continue to have discussions with the -- with the rating agencies and continue to demonstrate, you know, the -- the investment grade characteristics that we've -- we believe we have always demonstrated and work to improve our ratings. But part of the issue with the ratings that occurs is to -- to some extent, and they have said this in their -- in their filings, is a risk profile because a larger percentage of our earnings are coming out of oil and gas operations.

We feel very strongly that we can consistently, you know, grow that business and product prices look very strong, as we go forward. So we feel very comfortable that we are running our business prudently and generating good cash flow and really looking at good solid projects to grow our business. So, you know, what the rating agencies do I don't control, all we can do is manage our business as we see prudently fit for not only the debt but also our equity shareholders.

Okay, thank you.

Thank you, Jim.

We do have a follow-up question. Let's go back to Jeff Gildersleeve with Millennium Partners. Please go ahead.

Hi, real quick, on the guidance paragraph, just from an industry perspective, you talked about improved natural gas margins on -- on the marketing side. What -- what is driving that?

Well, as you get into peak season for electricity, a number of utilities increase their gas usage in the summer. And then it continues. The winter quarter of the fourth quarter and the first quarter are typically our better quarters, historically, in our energy marketing business on a margin basis. And the second quarter is typically one of the weaker quarters, as it's the shoulder. With an increased move in the west to have natural gas facilities, and I believe someone earlier mentioned some difficulties with coal shipments in the west, that has caused increased pressure on natural gas in the summer months to generate electricity. So we believe that we'll have an opportunity to improve the margins that we had in the second quarter in the third and fourth quarter.

Do you see evidence of that currently?

Well you can see that natural gas prices have moved up and there's still consistent usage in the marketplace. We'll report those -- the impacts of that when we report our third quarter.

It's just sometimes pricing goes up and the margins don't. Also, I wanted to ask you, you know, if, you know, the spread between where you are and west coast power prices, you have benefited in the past from having off-system sales that have gone to the west coast. What -- what sort of dynamic is currently out there? Has it been very hot in the third quarter where you are? Or have you seen this, you know, core temperatures in your territory with stronger demand out west.

I don't know that I would say that it's been cooler. I don't know the specific degree days. We have had a reasonable summer. But, again, our Black Hills historic impacts we -- we are a summer peak and we have benefited in the past from -- from opportunities on the off-systems side to sell our coal. But in the summer, in the third quarter when we peak, we generally have less off-systems sales because we're serving -- you know, our primary responsibility is our native load. And we serve that. So historically, we have seen in the third quarter lower off-systems sales. With the outage of the Neil Simpson Unit ll that will even more so impact the availability of low cost coal resources. So, I would expect -- and that's built into -- some of that impact into $2.5 to $3 million on the negative side for that outage. So I would not expect significant improvement in the third quarter and then the fourth quarter it's just hard to tell right now.

Got it. Okay, thanks a lot, Mark.

Thank you.

Okay and thank you very much for that, Mr Gildersleeve. And with that, Mr Thies, Mr Jahr, I'll turn the call back to you. There are no further questions.

Well, I would like to thank everybody for their interest in Black Hills and have a good day.

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