Black Hills Corp (BKH) 2007 Q4 法說會逐字稿

Ladies and gentlemen, thank your for standing by and welcome to the Black Hills Corporation quarterly earnings conference call. At this time, all participants 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). As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Mr. Dale Jahr, Director of Investor Relations. Please go ahead.

Good morning, everyone and welcome to our conference call held in conjunction with the release of 2007 fourth-quarter and annual results. 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.

Our discussion of recent results will be led by Mr. David R. Emery, our Chairman, President and CEO. He would like to start out the call with a review of recent results before we open it to your questions. Mr. Chairman.

Thank you, Dale. Welcome, everybody, to our call today. Truly some exciting news to go over. On the earnings front, fourth quarter, our net income was about $23.8 million from continuing operations, $24.8 million or $0.65 share. That is about $0.03 better than the prior year. On the annual basis, which really had some fantastic results overall on the earnings front, we had record net income of $98.8 million, record net income from continuing operations at just over $100 million or $2.68 a share. That is compared to about $74 million or $2.21 in 2006 and also compared to our more recent guidance of $2.35 to $2.55. And I'll also remind you that in February of 2007, we issued an additional 4.17 million shares in a private placement, so we overcame the effects of the stock dilution there as well.

Last week, we announced that our Board declared a dividend on quarterly results, which is equal to the $0.35 a share. That represents or will represent in 2008 the 38th consecutive annual dividend increase for the Company, which is a record we are extremely proud of.

I will go through here 2007 in review and hit on some highlights that I feel are important to our accomplishments for the year, talk a little bit about some of the key projects going on, Aquila and some other things, and then give you a little bit of an outlook on 2008.

For 2007, our retail services or utilities group had an excellent year. Black Hills Power, our electric utility, its earnings were up pretty strongly this year, primarily driven by a new rate increase, their first in about 11 years, which took effect January 1 of '07. Black Hills Power also set a new peak load this summer of 430 megawatts and looking forward, spend a lot of time this year advancing and planning the permitting of our Wygen III power plant. We talked about that in our earnings release and we are down to essentially one final permit needed on that plant -- our certificate of public convenience and necessity from the Wyoming Public Service Commission. We hope to obtain that and commence construction in the spring.

At Cheyenne Light, our electric and gas utility, our earnings were up primarily due to the effects of allowance for funds used during construction related to the plant construction of our Wygen II power plant -- a 95 megawatt mine-mouth plant that was placed into commercial operation on January 1 of 2008. That project was completed on time and on budget and the rate case for Cheyenne Light that includes that plant in rate base was approved and went into effect January 1, 2008 as well.

Wygen II is one of the cleaner coal plants in the country as far as NOx and SOX and other emissions and we believe it is one of the first, if not the first, new plant with Mercury scrubbing technology in service. So we are pretty proud of that fact as well.

On the wholesale energy front, several exciting things going on. Enserco Energy, our energy marketing company, posted record earnings of $34.2 million in 2007. In 2001, our energy marketing earnings were slightly higher than that, $34.6 million, but it included another subsidiary, Black Hills Energy Resources, which we have since divested of. So it was a record year for Enserco. Their average daily physical gas volumes were up almost 9%. Crude oil volumes were down very slightly about 2%, but they were up in the fourth quarter, so we are exiting the year on a high note there as far as expanding our crude oil business. But they set a new record of physical gas moved per day, approximately 1.7 Bcf per day of gas moved through our marketing entity.

On Black Hills Generation, our non-regulated power subsidiary, earnings were up due to lower interest expense from the equity offering we did early in the year, some insurance proceeds related to our 2006 outages at our Las Vegas II plant and certainly increased operations at that plant in comparison year-over-year due to the outage in 2006. Those gains or positives on Black Hills Generation were offset somewhat by the impairment in the third and fourth quarters of three of our small, qualified facility IPP plans.

The Ontario facility we announced in our third-quarter results that we had taken an impairment on that facility. In this year-end release, we announced that a partnership took an impairment on our Rupert and Glenns Ferry facilities in Idaho. All of those essentially are related to uncertainties as to whether the steam hosts of those facilities would continue to take steam and so we triggered an impairment analysis on those facilities as a result of that.

During the year, we signed a 20-year tolling agreement with Public Service Company of New Mexico for the Valencia power plant project south of Albuquerque. That is a 20-year tolling agreement whereby Public Service in New Mexico provides the fuel. We commenced construction of that facility. It is a 149 megawatt, $101 million project and we have all the major plant components on-site and the plant is on schedule for a June 1, 2008 commercial operations date.

At Black Hills Exploration and Production, our oil and gas subsidiary, our earnings were similar to 2006. We did set another record oil and gas production of 14.6 Bcfe equivalent. That is a 1.5% increase over the prior year. 1.5% is less than our revised long-term production growth target of 2% to 4%. We do feel good about that target on a long-term basis going forward, but just didn't achieve that in 2007. On the reserve side though, we have new record reserves at Black Hills Exploration and Production of about 208 Bcf, had a very good reserve study, very minimal revisions to prior estimates, good results there.

On the coal mine, Wyodak Resources, very slight increase in earnings to the prior year, set a new record production at Wyodak as well with a little over 5 million tons in coal production for the year and gearing up to improve that as we go forward with the combination of supplying coal to our Wygen II plant and then a contract extension to serve PacifiCorp's Dave Johnston's station in central Wyoming that will result in some increased tonnages as well.

On the financing front, had a couple of things. I already mentioned the private placement of equity that we did in February raised approximately $150 million with that. This fall, we obtained permanent financing for our Wygen II power plant of Cheyenne Light with a $110 million issuance of first-mortgage bonds. Those bonds were placed at an all-in rate of about 6.91% and they are 30-year bonds.

Other significant activities for 2007, certainly highest on the list of activities is our progress related to our acquisition of Aquila utility assets. We announced last year, yesterday, a year ago yesterday that we were acquiring four gas utility jurisdictions and one electric utility jurisdiction from Aquila for $940 million. Those are in Colorado, Kansas, Iowa and Nebraska. We did put in place, shortly after the announcement, a $1 billion interim financing arrangement that allows us to finance a closing and provide time for us to do permanent financing, which will come in the form of equity, perhaps some mandatory convertible securities, corporate debt and internally-generated cash.

We have made a lot of progress since announcement on the Aquila deal. Out of all the approvals that were necessary, we have obtained quite a few. We have obtained both of our federal approvals -- the antitrust clearance, the FERC approval of the acquisition of the Colorado Electric utility for Aquila. Both Great Plains and Aquila, who were involved in the transaction of a merger after our asset purchase, have obtained the necessary approvals from their shareholders. Black Hills has received state approvals in both Iowa and Nebraska.

With our deal and the deal with Great Plains and Aquila being co-contingent, cross-contingent, we need approvals still in Colorado and Kansas for Black Hills Corporation, in Kansas and Missouri for Great Plains in order to close. We announced in our press release that we have hearings pending in both Colorado and Kansas for Black Hills this month in February and Great Plains is working diligently in Kansas and also in Missouri as well.

As far as a closing date goes, we are all working very diligently to close as soon as possible. Most likely, early in the second quarter, possibly late first quarter, but most likely early in the second quarter. We did announce recently that the parties have agreed to extend the timelines of the formal agreements just to provide additional time for the regulatory process.

While working on obtaining approval, we have been diligently working to be ready in the integration and acquisition planning process really in all the operational areas. A lot of work on IT systems, customer service, establishing a new call center here, a new data center on the computer side, finance and accounting systems reviews, generation planning and even generation resource planning for Aquila's Colorado electric utility. On the HR side, we have been very busy with staffing and assimilation and things like that, so it has been a very busy year.

In October of 2007, we announced that we are conducting a strategic review of alternatives for our non-regulated power generation assets or a portion of those at least. That process is ongoing and then we will take some more time to finish, but we are very encouraged by the level of interest that we have seen from potential bidders on those properties and we are going through the process now of all the detailed diligence and management presentations and things like that.

We have no preconceived notions about what we are going to do relative to that process. We may elect to sell a major portion of those facilities. We may elect to sell none of those facilities or really any combination in between. We will reserve our judgment until we get the offers in, have the opportunity to consider those along with the strategic merits of all of those facilities on a forward basis and then we will make our decision. We would expect to make a decision sometime in the second quarter related to that process.

Looking forward to 2008, several key priorities. Obviously, one of the larger ones is to close and integrate the Aquila asset acquisition, while not losing focus of our existing businesses. We have got a lot of opportunities there as well. We will keep working diligently on our utility business, keep our customer service and reliability standards very high.

As I mentioned before, we plan to increase our coal production between the combination of the new contract extension for the Dave Johnston plant and the Wygen II coal sale. We will continue to focus on growing our oil and gas production and the long-term rate of about 2% to 4% a year.

On the energy marketing front, we will focus on that business as well, maintain our good strict risk controls and continue to try to improve earnings. We have said in our earnings guidance for 2008 that we expect results might be a little bit lower in that segment just because we really had some extraordinary market conditions last year. It is very difficult to predict that those will continue. It is possible, but difficult for us to predict and forecast.

We will finish our Valencia project on time by June 1, 2008 and then hopefully finish our final permitting stage and commence construction of our Wygen III plant in the spring. While doing that, we will continue to look across all of our business line for ways to grow and improve our efficiencies and help drive bottom-line results.

We reaffirmed our 2008 earnings guidance, which we issued in November along with our third-quarter 2007 results. That range was $2.35 to $2.55. The list of assumptions that we gave at that time remain unchanged. The number $2.35 to $2.55 assumes that we close the Aquila transaction, which means we won't be expensing costs that we are currently capitalizing related to that acquisition, but it does not include actual Aquila operating results. It also makes the assumption that we do not divest of any of our IPP assets through the process that we are going through right now. We have estimated that pre-closing will have $0.10 to $0.20 of one-time Aquila expenses. Those are not included in the $2.35 to $2.55 range.

After the Aquila deal is closed and we have completed our review of strategic alternatives for our IPP assets, following that, we would provide updated guidance as things become more clear related to the permanent financing of Aquila, what, if any, assets we may divest on the IPP side and then we can provide some clarity as to what we expect for income from the Aquila operations in conjunction with that.

So in conclusion, truly a fantastic year. We are very proud of what we have accomplished this year. When we announced the deal with Aquila in February of '07, we really emphasized to our employees that we cannot get distracted by the huge transaction that we are going through on Aquila and really despite the fact that we have literally put in tens of thousands of employee hours working on Aquila in regulatory approvals and the transition planning, we had a fantastic year and literally improved results in five of our six business units. The sixth unit had similar results to their prior year, really had a great, great year and our employee team deserves all the credit for that. Despite all the distractions of the Aquila transaction, they really buckled down and provided some great results in our existing business.

2008 marks the 125th anniversary of Black Hills Corporation. We started in 1883 with a company called Black Hills Electric Light Company in Deadwood, South Dakota and have been in business serving utility customers ever since and truly 105 years is an incredible milestone. We plan to celebrate that achievement kind of throughout 2008 really focusing on an even brighter future for our customers, shareholders and employees. And we have got a great legacy of being adept, evolving, changing with the times, being proactive and growing and staying in business for our stockholders. We will continue our commitment to our customers and our communities and continue to focus on growing our earnings for shareholders in the future. With that, I would be happy to entertain any questions.

(OPERATOR INSTRUCTIONS). Lasan Johong, RBC Capital Markets.

Thank you. Good morning. Hi, David. Good results, congratulations. I wanted to ask you a couple of quick questions. On the guidance for '08, $2.35 to $2.55, what I thought I heard you say was that the operating results for the combined entity, including Aquila, is not part of the $2.35 to $2.55, but it assumes the close of Aquila and will reflect -- does not reflect the $0.10 to $0.20 one-time Aquila charges.

Correct. $0.10 to $0.20 of pre-closing expenses related to Aquila. The reason we say we are making the assumption that Aquila closes is essentially says, Lasan, that we won't be expensing any costs that we are capitalizing now related to Aquila.

Okay. And then you will just include that in the rate base and recover it later on is basically what you're saying? Charges that you are currently capitalizing?

Well, it depends on if they are charges that can be included in the rate base, but some of them can, some of them probably cannot.

Okay. That's fair enough. Can you give us an update on what is going on with the CFO search?

Yes, we retained an external recruiting firm, which we announced on the time that we talked about Mark's departure. We are using Spencer Stuart and that process is progressing. It's still probably going to take several months at least from start to finish to get a new CFO, but we are working diligently on the process.

So by like the end of second quarter maybe?

I would hope so. It is hard to say, but typically a senior-level executive search is probably a three to six-month process.

Right, right. Just strategically, it seems like the E&P business is struggling to reach its target of 2% to 4%, which was reduced from 4% to 6% growth. Kind of give me the pros as to why you think you can hold onto it and actually get to your 2% to 4% growth versus the pros of say selling it to somebody who might be able to reap more economies of scale-type benefits from these assets and therefore be able to give you a rate of return better than what you might do on your own.

Yes, one of the things we have said before is that -- and said it in the last quarterly call that we backed off our production growth targets and a large reason for that is because of essentially two trends that we didn't like. One is that capital costs continue to rise. Now they are finally starting to slow a little bit in the E&P business, but they were rising very rapidly and gas prices, particularly in the northern Rockies, have been quite soft through a lot of 2007 and we saw sub $1.00 prices in southwest Wyoming for some days in September. So it doesn't make sense or didn't make sense to us to accelerate the drilling and development of reserves in the ground when your economics aren't as good and it seemed to make more sense rather than just be focused on a production growth target and be a little more focused on economics instead and so we have backed off that target rate.

Now, clearly, if conditions change, we would have the potential to do better than that. We are certainly not saying we are going to do that, but if economic conditions warrant an accelerated drilling schedule and to the extent that equipment is available, we would consider doing some of that.

As far as your question on sales, we have said several times that we have a lot of proved undeveloped reserves, but we also have a significant quantity of probable and possible reserves, which we do not disclose, but we are in basins that have high probability -- what we believe to be high probability probable and possible reserves.

If you look at it from what do we deem the value of that entity to be, we think those reserves are worth a lot of money. If you look at it on any kind of a divestiture scenario or what would someone be willing to pay, typically you have a deep discount on probable and possible reserves and so from a looking-forward perspective, we believe that there truly is more value keeping the business and developing those when it is economically feasible to do so. So that is what we are doing there as far as an overall strategy.

Okay. Then on the impairment at Glenns Ferry, Rupert, etc., Ontario, could you give us what the amount was for that? I don't think it was disclosed.

Well, Ontario was disclosed in the third quarter. I believe it was $1.6 million after tax.

Yes, that was. $1.8 million.

Rupert and Glenns Ferry was impaired at the partnership level, so that would essentially show up in our other income from those investments and the specific amount of the impairment has not been disclosed. There will be a little more color in the 10-K, but in not a whole lot of real specific detail because it was done at the partnership level.

Okay. And then what was the annual mark-to-market unrealized gain?

I don't recall off the top of my head. Let me look here.

Maybe we can follow up with Dale then.

Yes, it's in here, I believe.

I don't think we saw that number, but we will follow up with Dale if we can't find it again. Okay, that's it for me. Thank you.

That will certainly be in the 10-K as well. All right, thank you.

Gordon Howald, Calyon Securities.

Hey, guys. A question for you. Let's see here, obviously, the deal, the Aquila deal is progressing as expected. You are working with these guys pretty closely on integration. Could you discuss the status of Colorado Electric's RFP and what opportunities you see at this point for repowering in the future?

Yes, when we announced the transaction in Colorado, Black Hills and Aquila jointly went to the commission there and ask to suspend their RFP process.

Is that official? Has that been completed?

It was extended and they are required to file an integrated resource plan or a lease cost plan in Colorado by March 31, 2008 and so then we have been working jointly with Aquila during this interim period to work on the integrated resource plan and obviously, our plan looks a little bit different from theirs in that they buy most of their energy from Xcel. Clearly wanted to look at a lot more variations of self-build options in that integrated resource plan and that work is ongoing literally as we speak, Gordon.

Something that is clearly a priority for us is hopefully the ability to add rate-based generation to serve those Colorado Electric customers. We have to do like we have done in Wyoming and South Dakota and prove that rate-based generation is indeed in the best interest of the customers there. We are relatively confident in our ability to do that because we have done it in the other states and we believe pretty strongly that a vertically-integrated model is in the best long-term interests of the customers, provides the benefit of the long-term depreciation of the facilities, more rate stability and other things, but we have to work our way through the process. Our goal is to have the integrated resource plan ready to file immediately after closing and then start that process.

And how would you rate the mood in Colorado? I suspect it is kind of challenging for coal-fired generation even if that generation is actually produced in Wyoming. Would you consider natural gas as an alternative or how are you looking at that at this point?

We made the statement before that we believe that really it is in the customers' best interest to have some good low-cost baseload resource to serve Colorado. Ideally, that would have some coal-fired generation component to it. Gas is clearly an option, a much more expensive one, but it is clearly an option and going through the integrated resource planning process, we are evaluating essentially all of those alternatives and when we look at the coal alternative and we have done this for our Black Hills Power and Cheyenne Light resource plans as well is we look at really a myriad of alternatives related to what might happen on CO2, whether it is CO2 taxes or cap and trade impacts and essentially what the results of that were showing is that coal is still the best choice for customers for a component of baseload energy.

Now in Colorado, you also have a renewable portfolio standard, so regardless of what the economic results of the lease cost plan are, you are mandated to meet wind and solar requirements, which we clearly are working on it incorporating those into our resource planning process as well.

It is hard to say what Colorado's direct impact would be. We have certainly visited with them about our goals of trying to add some long-term rate stability and not have them be being dependent on -- so dependent on purchased power and they seem receptive to that, but until you get a formal resource plan in there that has real specific recommendations on plant types, you are just guessing as to how they might react.

Sure. And maybe kind of going along these lines, maybe a little bit different here, but the market for your IPP asset sales, particularly some of the coal-fired assets, what is the market -- what are you hearing from different types of asset classes? Could you shed some light on details on how the process actually is working, what kind of process you have in place? Is it an auction ultimately or how are you handling that?

Yes, just as far as the markets, the IPP sales that you have seen in the marketplace over the last six months have been quite strong. I am not sure what I think the impact will be of some of the debt market changes. We will see when we get potential offers in what influence that may have, but certainly the reason that we decided to do it now and announced it in October is because that market was real strong and certainly, if there is a thought we may want to divest of some of those assets, the timing would be good relative to doing it when the market was strong and also relative to doing it as we contemplate how to provide permanent financing for Aquila. But until we get final offers in and consider those, it is hard to say what we will end up doing for sure.

As far as the process itself, Gordon, we are essentially running kind of a standard "auction" process. A couple of different phases, go through a lot of diligence and management presentations and on-site visits and things like that. Like I said earlier though, we really don't have any preconceived notions about what we are going to do relative to that. Certainly isn't a fire sale. If we get good strong offers for some of the facilities and we think it is prudent to divest of those, we may choose to do that. We may choose not to.

So until we get those results in and really assess the offers where they are relative to what we think the value of the plants is and not necessarily just book values, but also strategic value, future value, where they are located, expansion capabilities, things like that, we have to feel like we are getting fair value before we would make the decision to divest any of those. But hopefully, we will get our way through the process and sometime in the second quarter have an announcement as to what we are going to do if anything.

I appreciate all the comments. Thanks.

(OPERATOR INSTRUCTIONS). Jim Bellessa, DA Davidson.

Good morning, Dave and Dale. I am going to ask about the Aquila acquisition. You are proceeding there, but let's just assume it gets nixed by regulators and therefore I believe you would have to incur a charge on the capitalized investment that you made. What is the magnitude of that investment to date?

I don't believe we have disclosed that, have we? $19 million has been capitalized to date.

And I see where you've made a significant improvement in results this year, but a lot of that is a result of lower interest rates. Now you don't give out full disclosure of what happened in the fourth quarter yet, but it looks like your interest expense could be down on the order of $10 million or $11 million and that is a good portion of your improvement in results. Not all of it, but a good portion. What is the outlook for interest expense going forward?

Well, I think part of that interest expense impact that you're seeing there is just the payoff of the debt that we did with the private placement we did in February. We raised just shy of $150 million there. And so to the extent there was intercompany debt between some of our entities to corporate, it affected some of those results. Probably the area where you saw it the largest in our '07 results was in the Generation subsidiary. But we haven't provided any specific numbers related to interest costs in '08.

You haven't taken on any new debt of any materiality recently, have you?

Well, the only thing we talked about was the $110 million in first-mortgage bonds for Cheyenne Light, but that replaced short-term debt that had been on our revolver as we built Wygen II and Valencia.

Thank you very much.

I am showing no further questions at this time. Please continue.

All right, well, thank you, everybody. We certainly appreciate your interest in Black Hills and appreciate your time and participating in the call today. We are looking forward to a great 2008. Thanks again.

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