Black Hills Corp (BKH) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Black Hills Corp. quarterly earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given to you at that time. (OPERATOR INSTRUCTIONS). As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Mr. Dale Jahr. Please go ahead.

Good morning, everyone, and I would like to add my welcome. Thank you for joining us. We are conducting this conference call a little differently this morning. Mr. David Emery, our Chairman, President and CEO, will be joining us from Cheyenne, Wyoming, where our Board of Directors held its quarterly meeting. Of course, Cheyenne is home to our utility, Cheyenne Light, Fuel and Power. I am in our Rapid City headquarters handling the logistics of this call and other matters related to our earnings release of yesterday. Our CFO, Mark Thies, could not join us in the call this morning.

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.

Again, this discussion will be led by Mr. David Emery, and Dave would like to start off with a review of recent results before we open the call to your questions. Dave?

Thank you, Dale, and I will reiterate my welcome to everybody. Thanks for being on the call today. We appreciate it.

2007 continues to be a good year for Black Hills Corporation, and in the third quarter, which we are here to talk about today, we posted some pretty good operating results in a quarter that historically is the weaker quarter for us, primarily due to seasonality of some of the energy markets. We also during this quarter made significant progress on some of our key strategic initiatives, and I will talk about that more later.

First, yesterday, our Board approved an increase in our quarterly dividend to $0.35 a share. That is up a penny, which would equate to $1.40 in an annual dividend. 2007 represents the 37th consecutive year of dividend increases, and this will be the 38th year, after we go through another year here with this penny increase.

We typically do this dividend increase after the results and in conjunction with our year-end results disclosures. This year, as I think is a sign of confidence in our confidence in the future, the Board accelerated the increase to this quarter instead, which I think bodes well for the future for Black Hills.

Looking at third-quarter results, the net income for the third quarter was $17.5 million or about $0.46 a share versus $22.3 million or $0.66 a share last year. One thing I will note is that we did in February issue about 4.17 million shares, which was roughly an 11% dilution in our outstanding shares of stock.

If you look at continuing operations in the third quarter, the number was $17.6 million or $0.46, again, compared to $22.2 million or $0.66 in 2006. If you look at the year-over-year comparison, there is a couple of onetime issues that impacted each year. First, in 2007, a couple items, and I'll talk about them both more a little later, but we had a $1.9 million impairment of our Ontario, California, qualifying facility power plant. We also had a couple cents in expenses, $0.02 in expenses, related to our Aquila transaction, which we are ongoing and progressing towards closing.

In 2006, we had a couple positive items. One was a $2 million, just under $0.06 beneficial tax adjustment and a $1.9 million insurance proceed that we received due to our Las Vegas plant outage. So if you take out those items, quarter over quarter, we are relatively comparable, slightly down, but fairly consistent quarterly performance.

Switching to the business units and operations, in almost all of our business units, with the exception of one, and I'll talk about that, we had either normal or a little better than normal operations in the business units. Our utilities performed well. Black Hills Power was essentially flat, nominally greater than last year in the same quarter, significantly higher numbers as far as just our native load. We had a good native load year, as well as the impacts of the rate case that went into effect January 1.

Those were offset by much lower margins from off-system sales in this quarter. The quarter was just really weak from a market perspective, and in addition, our native load use was higher, which meant we had less of our low-cost resources to sell into the market.

Cheyenne Light, good performance continuing there, more aggressive, particularly related to in operating expense reductions and more aggressive on some of our collections activity and less bad debt expense as a result of that. Our power plant availability and our regulated fleet was very good, a little bit of maintenance outage at some of our coal facilities, but other than that, availability was very, very high.

In the wholesale energy side, Energy Marketing is continuing a great year. Year over year, this is a $200,000 gain in net income, $2.3 million versus $2.1 million last year. Stronger realized margins were offset by higher expenses, particularly related to compensation, and then also marked-to-market losses as well.

On the bright side, good, positive increases in volumes marketed for both gas and crude oil, continuing that slow, steady growth trend we have in Enserco. They have just had a great year because of all the gas price volatility, primarily basis differentials between Rockies and some of the other parts of the country.

Power generation was a relatively normal year, a normal quarter, with the exception of an impairment on our Ontario, California, plant. We have disclosed in some of our prior 10-Ks and Qs that we had a mismatch between the contract for our steam host and our actual power sales contract. And because of that, and because we're not getting real strong indications of either an ability to recontract the steam host or recontract the power itself, we elected to impair that facility this quarter. That was a $1.8 million after-tax charge. Other than that, in our generation fleet, our availabilities remained very strong, good operating results, pretty normal operations.

Again, on comparing quarter over quarter to last year, the two onetime issues I brought up were related to our generation for last year, so we had a $2 million and a $1.9 million benefit last year that made that quarter look stronger, relatively speaking.

Oil and gas, our income was $2 million versus $3 million last year, even though we had much stronger production. Now, year over year, the production increase looks very positive, but we had a quite a weak third quarter in 2006, so it makes the number look artificially better for this year, when it's a 13% number.

Prices were clearly down, even with hedging, this year over last. Our depletion increased as a result of several things, continued cost increases in our drilling and rework activity, as well as the impact that those cost increases have on future development costs for our proved undeveloped reserves. Those things, combined with the revisions we had last year at the end of the year, have just kind of continued to push our depletion number up.

We are revising this year our production growth down, a little bit more than we had before, primarily just because of the activity that we have, the trend in costs and just our overall attitude that I think we're trying to be much more prudent in the way we're spending those dollars and not just pushing for a production goal. When you've got relatively weak and very weak prices in the Rockies in the third quarter, combined with continued increasing capital costs, it makes better sense, in our opinion, to back off a little on pushing for production growth and spend our capital wisely instead of just to achieve a production goal.

Coal mining down slightly, despite a little bit higher volumes. Most of that is just purely related to operating expenses and increased royalties. The majority of that is the result of increasing overburden. We've been talking about for a year or two now that our overburden was going to increase as we mined into a different part of our pit, and that is indeed happening. So nothing unusual there, but it will be a higher overburden ratio than we've historically had for quite a while into the future.

Shifting gears to corporate, not a lot to talk about there except for the $900,000 or a couple cents in Aquila-related expenses recognized in the third quarter. We said in last quarter's release we would have $0.05 to $0.10 in expenses recognized in 2007 related to the Aquila transaction. This is a couple pennies of that number. We expect more, obviously, in the fourth quarter. We're also capitalizing costs associated with Aquila, but this is just expense share.

Shifting gears to 2008 guidance, we're putting out guidance for our existing operations only, essentially under the assumption that everything stays status quo from a business perspective. We're making the assumption that Aquila closes, which means we won't have to write off any of our capitalized costs for Aquila in '08, but we're not including any of the results of Aquila. We're not exactly sure when it's going to close, although we expect it to be in the first quarter, and not comfortable putting out specific numbers for Aquila yet. We plan to do that after we close on the transaction.

So looking at guidance, then, for next year, net income from continuing operations for 2008 will be in the range of $235 million to $255 million. That does not include a forecast of Aquila-related expenses in the $0.10 to $0.20 a share.

Some of the key issues related to our guidance -- we expect an increase in Cheyenne Light, Fuel and Power, our electric and gas utility, because of the Wygen II power plant that is scheduled to be online January 1, 2008, and the rate case associated with that, which is expected to take effect on the same date. Our electric utility will be relatively flat from an earnings perspective. We had a rate case there that took effect January 1 of '07, and so their operations will be relatively stable. Oil and gas production, again for next year, we're assuming a 2% to 4% production growth rate rather than the 4% to 6% number we had out there before, primarily due to the same reasons that I talked about for 2007 just a minute ago.

Our oil and gas prices that are disclosed, they are based on NYMEX and the hedges that we have in place today, so you can see what oil and gas price assumptions we're operating under.

We do forecast a decrease in earnings from Energy Marketing, not due to anything really negative in the business, it's just we've had a phenomenal year there. The basis differentials between Rockies and other parts of the country have been very, very good. We've had excellent volatility there, which helped tremendously in our earnings, and it's just very difficult for us to just say that will continue. We know there's going to be another pipeline, Rockies Express, coming on out of the Rockies here around year end that should narrow some of the basis differentials and other things. We believe a lot in that business. It's done very well for us. But it's hard to predict another year just like this year, hard to be sure we can have the volatility in the basis differentials that we have this year.

We predict a decrease in earnings at our coal mine, despite more production associated with Wygen II, primarily related, again, to the O&M costs associated with higher overburden ratios and a little bit higher royalties due to price improvements there.

No significant outages at our power plants. Another key item is we're assuming midyear 2008, June 2008, commercial operations at our Valencia power plant in Mexico, which is currently under construction.

A negative item for next year that we talked about in some of our previous public releases is that we have a termination payment associated with an old contract on our Harbor facility in California. That termination payment will end about two-thirds of the way through 2008, which is about a $3.6 million decrease in revenue compared to 2007. And then certainly in the rest of '08 and '09, that payment will no longer be in place. And we have been speaking to that for a while, so it shouldn't be a surprise for anyone.

Normal operations at our nonregulated fleet, the successful completion of Aquila, which I talked about, and then really no other material change in the Company's business mix. As you are aware, we put out a public release that says we are conducting a strategic review of some of our IPP assets in particular, and until we know the results of that review and make any decisions related to asset divestitures, we have to maintain a status quo as far as giving earnings guidance goes.

Moving on to some of our key strategic objectives, we're making excellent progress on a lot of fronts. We've got a lot of exciting activity going on. I talked about Wygen II already. That plant is well under construction and definitely in line for a January 1, 2008, commercial operation date. Just in the last couple weeks, we have completed test firing that at full load on coal, and the facility will be up and down here in the next couple months as we continue to test and train crews and some of those things. But we're very, very pleased with our progress on the plant to date.

The rate case related to that in Cheyenne Light in general, both gas and electric rate cases are proceeding. Our hearings were held within the last couple of weeks here in Cheyenne, and we hope to have an order, a favorable order, prior to year end.

I mentioned before that construction at our Valencia site in New Mexico is on schedule. That 140 million megawatt plant will be on in June of 2008, and it's already under contract on a 20-year power purchase agreement to Public Service in New Mexico. That's a tolling agreement where they take the fuel risk. We're excited about our progress there. Things are going very well. We've had great construction weather, and it's on schedule as well.

Wygen III, will be the twin to our Wygen II plant at our Wyodak mine in Gillette, is also progressing. We disclosed last year that we received in early 2007 -- this year, I guess -- in early 2007 our air permit. We recently filed our industrial siting permit and hope here in the next month or so to file our certificate of public convenience and necessity in Wyoming and South Dakota for that plant. Our goal is to start construction late first quarter of 2008, assuming we get the necessary regulatory approvals.

Finally, strategic initiatives, our largest one is our pending acquisition of five separate utility properties from Aquila. It's still on track for a first-quarter 2008 close. We announced that deal in February, and have been very, very busy on a couple of different fronts. One is all the integration planning and transition planning and hiring and recruiting that comes along with the acquisition. That is all going very well, a lot of work going on there, but we're very pleased with where we stand in our preparedness to take over these utilities. We still have a lot of work to do, but we're where we want to be at this stage.

Regulatory approval-wise, we have essentially obtained four of the seven necessary approvals that we need for the transaction. We've obtained state utility commission or equivalent body approvals in Iowa and Nebraska. We've had our hearing in Colorado and expect an order prior to year end in Colorado. We are still working on State of Kansas approval, just really gearing up there real heavily into the discovery phase of that one. So that will be an early next year process. We have received our federal approvals on Hart-Scott-Rodino antitrust clearance and also approval from the Federal Energy Regulatory Commission on our acquisition of the Colorado electric utility.

As all of you are aware, our deal is cross-contingent on the Aquila-Great Plains merger, which will occur simultaneous with our asset purchase. They're making great progress as well and have their regulatory proceedings underway in both Missouri and Kansas, and they have had two successful shareholder votes at each organization in the last month where the shareholders approved that merger. So things are going very, very well on all fronts from our strategic objectives perspective. We're very excited about our long-term prospects related to those projects, as well as continuing our performance in 2007, which we are very happy about.

With that, I would entertain any questions.

(OPERATOR INSTRUCTIONS). Neil Stein, Levin Capital.

A few questions. First, in your '08 guidance, could you say how much lower the trading and marketing contribution is relative to '07, if it's possible to --

We have not specifically identified that, Neil. I'm sure you'd like to know it, but we have not specifically identified that number.

Is it possible you could say roughly what the percentage contribution is or a range or maybe even talk generally speaking about how you go about forecasting earnings from that segment? Because from the outside looking in, it's very difficult to analyze the various moving parts and come up with a precise estimate.

It's very difficult to forecast in general, and that's why we don't give the segment disclosures, because as you know, that unit depends tremendously on gas price volatility, seasonal spreads for our storage and basis differentials between the Rockies and other parts of the country. Those are very, very difficult to forecast. So for that reason, we don't give the specific disclosures there. And I understand the frustration with that, but it is very, very difficult to forecast for us as well as you. So sympathetic there, but it is a challenge.

Those are the three parts of our business, and we have talked about that a lot, related to our dependencies on, in addition to our producer services, which is a fee-based business, and we depend on our storage, which is the seasonal spreads, and certainly just the overall volatility in gas prices for our proprietary trading and then the basis differentials for our transport. And so relatively speaking, it's hard to predict what those are going to do next year.

Moving on to the Aquila acquisition, from the various public filings, we have come up with a rate base total of about $450 million to $500 million. Is it possible if you could comment, are we in the right range there?

I don't specifically off the top of my head know what that number is, Neil. I think you are in the ballpark, but I'd hate to say definitively. All of that information, though, is available, and I know we have referred people before, to Aquila's Form 1s on some of those properties. (technical difficulty) previously about looking at EBITDA numbers and things related to those last year's FERC Form 1s. But they would give you real accurate information about us. I don't want to give you a number that I'm not confident of off the top of my head.

And again, the purchase price is about $950 million?

Yes, the actual purchase price itself is $940 million, and then we will have some other onetime fees and other associated costs.

How do you, from a valuation perspective and you're looking at acquisitions like this, how do you justify paying two times rate base for a set of assets where you kind of know what the return profile is going to be?

Essentially, it comes down to looking at the value and what we think the value is and what it can be under our ownership. We have talked about that before, that one of the benefits that we think we bring to the transaction is a much different G&A cost structure than what Aquila has. Aquila was quite a bit larger and has been contracting and selling utility assets. And as they have done so, their G&A hasn't reduced proportionately. So if you look at our situation, it's completely different, where because we're buying assets only, we don't get any of the associated G&A functions or assets and liabilities with our part of the purchase. So we can build up our G&A structure from scratch, essentially, on top of what we already have, but add onto that and specifically design it to serve these additional five utilities, which allows us to really right-size it right from the start.

So that's where we see one of the advantages. And certainly some of the advantages, upside opportunities we see there is Aquila's Colorado electric property does not have much of its own generation. They were out actively seeking requests for proposals at the time the acquisition was announced. That process has been put on hold to allow us to jointly look with Aquila at some self-built options we might pursue there as well. So those are some of the rationale behind the deal.

On the G&A savings, I could see where that would be good for customers, but what gives you confidence us shareholders would benefit?

I think we're pretty comfortable with the way that they would occur. Essentially, we would be able to retain some of those benefits for shareholders. Certainly customers will receive some as well. So truly it's going to be good for both shareholders and customers, from our perspective. And that's just -- essentially, it boils down to successfully negotiating the regulatory process in order to make that happen. That's one of the things we believe we're pretty good at as far as regulatory relationships and our ability to work on a deal that's truly a win-win for shareholders and customers.

(OPERATOR INSTRUCTIONS). Gordon Howald, Calyon.

You talked about native load being higher here in the quarter. Was this higher due to weather, or is this something that we -- kind of a recurring issue that we should be thinking about as we go through 2008 and beyond? I mean, is excess wholesale capacity just continuously getting degraded, or is it just weather-related here?

Well, we have talked about a lot, for a long time, we have very slow, steady load growth in Black Hills Power. But it's that 1%, 2% a year number, and it has been for years, and it's been very, very steady. So there is some erosion of our excess low-cost coal-fired generation to sell in the market. It's not a radical erosion, but it's a slow, steady one, and it's been going on since we built our last plant.

The other one is this third quarter was particularly hot for us, and so our native sales were up some 4%, I believe, in megawatt-hour sales related to just our native load. So related to that, we had less off-system sales. We also had increased purchase power and fuel for peaking generation costs as well.

If I could have one or two more, and Neil touched on this earlier, trading margins were up $5.7 million in the quarter. You mentioned some offsets, marked to market being about $0.9 million, compensation, bad debt. Could you give us a little more granularity on what these offsets were? You only identified one specifically, and obviously some of the other ones appear to be pretty significant.

Yes, the only thing we have out publicly is just specifically what's in the press release as far as the off-system or the gross trading margin number and then the marked to market. The others are related -- primarily, when you have high current gross margins, your compensation expense goes up, even though you may have marked to market or something that offsets that trading margin from an actual net income perspective. So your compensation expense is up regardless of the marked-to-market issue.

Yes, that makes some sense. Which of these costs have been recurring? How should we think about the recurring nature of some of the offsets? Does that make any sense?

Yes.

It's a significant number. That's why I'm trying to dig in a little bit.

Right. Yes, I don't know if I could add whole lot of color to that, Gordon, frankly, at least not now. I think there will be a little bit more information in there when we put out our 10-Q next week, but not a whole lot.

Okay, and I will look through there. And if I could, just one more and I will let other people ask. The rationale for the IPP sales, I know you've talked about in the past -- are you looking at market conditions and that's prompting you to possibly sell or looking to sell some of those assets? Is it really just to raise cash for the Aquila acquisition? And lastly, and I'm sure you have talked about this, what kind of timing do you have on these asset sales, or potential?

What we are doing, obviously, is conducting that review. And what prompted the need to do the review on our part is obviously we are in a financing mode here with the Aquila transaction, but that in and of itself really isn't the trigger. The trigger is we have some great assets in some excellent locations, some of which may be more valuable to others than to us long term, and market conditions are very, very favorable. So it seemed like a good time for us, if we were considering trying to high-grade our IPP portfolio, if you will, now is a good time to look at doing just that. So we are out conducting that process to try to value those assets and then make our strategic decisions appropriately. Certainly the timing is good relative to the Aquila transaction, but that's not the primary driver.

That's probably [agreed].

As far as the timing part -- I didn't answer that of your question, but we would anticipate the timing to be within the next couple of quarters, we would work our way through that process and make decisions one way or the other, not any different than a typical process like this takes. It takes several months to work your way through it. And we would anticipate at least similar timeframes as far as reaching the point where we would make a decision, whatever that decision may be.

It sounds like a smart strategic move on your part. I appreciate it. Thanks, guys.

Ella Faynzilberg, RBC Capital Markets.

I have a couple of questions about your oil and gas production. You stated that you plan to slow production to a rate of about 2% to 4% versus prior guidance of 4% to 6% for next year. Is there an estimated exit rate for fourth quarter?

We haven't disclosed that, no.

Okay, and also, you cited as drivers for that, one of them being the pricing environment. If prices were to turn next year, would you be in a position or think about accelerating drilling to increase the growth rate back up to above 4% or 6%?

We have talked for quite a while about the amount of undeveloped reserves we have, and even probable and possible reserves. And so we do have the ability to do that, assuming we can get permits and rigs and things like that. And if economic conditions warrant, it probably makes sense to do so. It's hard to make that decision without sitting in the circumstance where conditions merit being more aggressive, but we have the properties in our existing inventory to do just that. So certainly, if price conditions warrant, we could react relatively quickly, assuming we have all the permits we need. And we are trying to stay ahead of the game on permits, so we could do that.

Now, a little bit of color back on your first question. We haven't put out an exit rate, but we have said that our '07 production will be a 2% to 4% growth rate as well. So you can at least infer an exit rate from those numbers.

Thank you very much. I also, to follow up on that, wanted to understand if there's any impact to your E&P assets due to the Rockies Express or Spectra's new proposed Bronco pipeline?

Anything that helps prices out of the Northern Rockies is a net positive for us. Now, a lot of our gas reserves that are producing today are in the San Juan Basin, but we do have a lot of property in the Rockies, and our Piceance Basin properties that we bought last year, a lot of those are undrilled, proved undeveloped reserves. So the Piceance Basin, the Powder River Basin, our Montana properties, those would all be positively impacted by any pipeline project or anything else, frankly, that would narrow the basis differentials between Northern Rockies and the NYMEX or Midcontinent prices.

It's hard to specifically state how much they would be impacted, but it certainly is a net positive, anything we can do to reduce that basis differential, because the Rockies prices are very, very low. Particularly in the third quarter, intraday spot prices were under $1 in parts of the Rockies, Southwest Wyoming and other places.

Finally, along these same lines, are there any plans to do a strategic review of your oil and gas assets?

Don't have any plans at this time.

(OPERATOR INSTRUCTIONS). Neil Stein, Levin Capital.

With respect to the review of the generation business, do you have any sort of point of view on whether or not the equity markets are properly valuing those assets relative to what the private market might be willing to pay?

I don't know if I do have an opinion on that one, Neil. I think that certainly the people who follow us, I believe, look pretty carefully at our IPP portfolio. And we disclose all of our plants and contract provisions and things for those. So I guess I don't have any reason to believe that they're not fairly valued. Certainly, some players who are willing to put a lot of debt on some of those assets and just more aggressive as far as overall general return criteria may value them higher. We have seen some of that in the market, and so that's really what prompted the timing for the review, is if you've got these conditions combined with some of the other things we have going on, it's probably a good time to take a look.

What's your view on potential tax leakage from a sale? And would there be any way to pursue some sort of lifetime exchange treatment in connection with the Aquila acquisition?

We certainly haven't looked -- well, we have looked, but we haven't stated anything related to any tax leakage. It really depends on what, if anything, we decide to sell and win. We are doing a lot of things related to construction and otherwise, so clearly pursuing strategies to minimize tax leakage is something that we would pursue. Now, how successful we would be in that, it's hard to say until you know specifics of which assets you might sell and what the specific tax conditions related to that asset are, so really difficult to say at this time.

At this time, I'm showing no further questions. Please continue.

All right, well, thank you, everyone, for attending the call today. Thanks for your interest in Black Hills. We're very excited about what we have going on. We're very excited about the future, with all of the construction we have going on, growth in our existing business units, as well as really looking forward to the closing date of Aquila, hopefully, in the first quarter of 2008, and allow us to add those into our Company and continue to pursue growth in those areas as well.

So thanks for your attention. Thanks for your interest in Black Hills. Have a good day.

And ladies and gentlemen, today's conference call will be available for replay after 12.30PM today until midnight, November 9. You may access the AT&T teleconference replay system by dialing 800-475-6701 and enter the access code of 892112. International participants, dial 320-365-3844. (OPERATOR INSTRUCTIONS).

That does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.