Black Hills Corp (BKH) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Black Hills Corporation 2010 second quarter earnings conference call. I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session.

(Operator Instructions)

In order to get as many questions answered as possible, we ask that participants re-enter the queue after asking one initial question and one follow-up question.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Jason Ketchum, Director of Investor Relations of Black Hills Corporation. Please proceed, sir.

Thank you, Latasha. Good morning, everyone and welcome to the Black Hills second quarter 2010 earnings call. With me today are Dave Emery, Chairman and CEO and Tony Cleberg, CFO. Before I turn the call over, I need to remind you that during the course of this call, some of the comments we make may contain forward-looking statements as defined by the Securities and Exchange Commission and there are a number of uncertainties inherent in such comments. Although we believe that our expectations and beliefs are based on reasonable assumptions, actual results may differ materially. We direct you to our earnings release, slide two of the investor presentation on our website and our most recent Form 10-K and Form 10-Q, filed with the Securities and Exchange Commission, for a list of some of the factors that could cause future results to differ materially from our expectations. I will now turn the call over to Dave Emery.

Alright, thank you, Jason. Good morning, everyone. Thanks for joining us. Before we discuss the quarter, I'd like to first take a minute or two and explain some of the formatting changes we've made to our quarterly earnings press release. For the past several years, as all of you are aware, we've been extremely busy at Black Hills and, as a result, we've had a lot of, we'll call it, special activities. So, buying, selling, major construction projects, ceilings tests, impairments, integration activities, and alike. We've received a lot of feedback from you, our investors, stating that all of those special or unique one time, nonrecurring type activities make it very hard to determine the actual performance of our ongoing operating businesses. Last year, Tony in his financial portion of the presentation started including a reconciliation of those special items. And we've received a lot of positive feedback on that reconciliation that we'd included in the webcast presentation portion of our materials. So, you may have noticed that yesterday in the press release we made a change for the second quarter and that's one that we intend to continue going forward in our quarterly earnings releases.

We will present the adjusted earnings numbers first. They are a non-GAAP measure, but we do believe they give a more meaningful representation of the ongoing earnings potential of the Business. Then we'll also, of course, provide the GAAP numbers and, in addition, we'll provide a table with the specific reconciliation of the GAAP to non-GAAP or adjusted numbers. That way you can see the details of all the special items and their related impact on earnings. Obviously, the intent of this change in format is to make our earnings numbers more transparent and easily understood. As usual, we'd love to have feedback on our materials, so if you have any feedback on the change, please let Jason Ketchum know if you have any feedback or additional suggestions. Now I'll move on to the presentation itself and for those of you that have a copy of the webcast presentation, we'll try to refer to page numbers as we go through and make it a little easier to follow along.

Starting on slide five, 2010 second quarter was a very good quarter for us. From an earnings perspective, particularly looking at the as adjusted earnings, slightly better than last year and certainly in line with our expectations, despite a couple of negatives. Notably, some extended plant outages at our Neil Simpson II and Wygen power plants and combined with continued challenges in energy marketing and oil and gas. If you look at the quarter from a highlights or key accomplishments perspective, it really was a fantastic quarter. We made significant progress on a lot of our strategic initiatives, both during the quarter and a few subsequent to quarter end. Moving on to utility highlights on slide six, on the electric side our Wygen III plant began commercial operation April 1, 2010, which we talked about on the last call. That project was ahead of schedule and under budget.

We have also completed two rate cases related to the plant addition, one in Wyoming and one in South Dakota and those were very successful. On July 14, in mid-July we closed on the sale of a 23% ownership in that plant to the City of Gillette, Wyoming and received $62 million in proceeds from that sale. In Colorado, we have two power plant projects ongoing there. One is an electric utility project, the other is an IPP or nonregulated power plant to serve our electric utility there. In July, on the 22nd, we received our air permit and have commenced full scale construction on that project. I'll talk about some of the details on that one a little bit more here later. Literally effective today, the Colorado PUC approved a $17.9 million rate case settlement that we'd reached with the interveners in that case that takes effect today. A very good accomplishment there as well. During July, we've set two new peak loads at both Colorado Electric and Cheyenne Light, Fuel & Power. So, at least the third quarter, from a weather perspective's off to a good start.

On the gas side of the utility business, Nebraska we're still awaiting a decision from the Nebraska Public Utilities Commission on a pending rate case there and during June we filed a $4.7 million rate case for our Iowa Gas Utility.

Nonregulated energy highlights on slide seven. I've already mentioned the progress update on our IPP plant in Colorado. Enserco, during May, completed a new $250 million, two-year stand alone credit facility, replacing our prior one-year facility That facility also has $100 million accordion feature, which will allow us to expand as necessary in the future. We also improved the covenants in that facility and Tony will elaborate on the positive impacts of that change a little bit later during the discussion.

On June 1, our energy marketing company, Enserco, acquired a small coal marketing business who are primarily dealing with Powder River Basin Coal for about $2.25 million. Subsequent to that date, there's been a significant positive improvement in the coal price and, at the time of the acquisition, that company had a relatively long coal position. So, we benefited from the mark to market gain on that position. Now, in general, we don't plan on leaving a position that large open. It's not real large, just a couple million tons. But, we are in the process of selling a lot of that coal, but the profitability has been very positive there.

E&P spending continues to be low relative to some of our prior years, primarily driven by low natural gas prices. We've talked about that before.

On the coal mining front, we had a nice improvement in earnings, primarily driven by the approval from the State of Wyoming of a new post mining topography plan. In a nut shell, what it means is that we can move some of our overburden one-time and it ends up being in its final location and we don't have to move it again and that has a significant impact on costs for future reclamation. Been a very positive impact on the mine's profitability. Also, obviously the increase in production to serve Wygen III beginning in April also helped out the coal mining results.

On the corporate side, slide eight, several of these things you've heard about, but they occurred during the quarter. We did complete a new $500 million corporate revolving credit facility. Another facility that has an accordion feature, which allows some flexibility for the future. In the middle of July, we completed a $200 million senior unsecured debt offering with a 5.875% interest rate. We were very pleased with that rate. Very positive rate for shareholders, 10% cost there. We had, as we have in several prior quarters, $16.2 million noncash unrealized mark to market loss from the interest rate swaps that we de-designated last year. In July and August, in early August, we've completed the conversion of several different systems and process changes that we've been working on here since the acquisition of the Aquila properties or our Black Hills Energy properties in 2008. That project involved a total of seven major systems.

Now, with the completion of a couple of those, our human resources and financial system, mapping and work management systems, we're down to five out of the seven major projects are completed. And we expect the remaining two to be completed by year end. With that, I'll turn it over to Tony to talk about the financials for the quarter. Tony?

Thank you, Dave. Good morning. Since our last quarterly call, we've been focused on a number of initiatives and more importantly we've accomplished a number of key milestones that position us for continued earnings growth. From an earnings standpoint, the second quarter had the large mark to market decline in our interest rate swaps, which overshadows the 19% improvement that we saw in operating income. In addition, the extended outage at Wygen I cost us more in repair expenses and reduced our expected coal sales. So, even though coal sales went up, they didn't go up quite as much as what we would have liked them to. Moving to slide ten, I have included a quarterly EPS analysis and this is consistent with past quarters. We've adjusted our income from continuing operations to display the impact of special items recorded during each quarter. This slide displays five quarters, with the second quarter amounts designated for 2009 and 2010 in the two outside boxed columns.

The only adjustment to the second quarter of 2010 was a $0.41 addition for an unrealized loss on the interest rate swaps. So, income from continuing operations as adjusted was $0.19, which compares to $0.18 in 2009. Last year, we included a $0.53 subtraction for an unrealized gain on the same interest rate swaps and a $0.07 addition for a couple of non-routine costs. The trailing four quarters now adds to $1.65. Moving to slide 11, here we display our income statement for the second quarter of 2010 and 2009. Highlights include 19% increase in operating income year-over-year and this was driven by an improved performance of $5.2 million in the electric utilities. The gas utilities and non-regulated businesses were generally flat year-over-year, but there were some fluctuations among the segments that I'll describe later. Moving down the income statement, interest expense decreased $700,000 from 2009. As you may recall, 2009 included a $2.9 million of a write-off for bank fees related to the acquisition facility that was extinguished in the second quarter. So, our run rate for interest expense actually increased by $2.2 million, which reflects the higher interest rate on long term debt compared to short term debt.

We've made significant progress over the last year to move our short term debt into long term debt.

Continuing down the income statement, the mark-to-market interest rate swaps had a $31.7 million gain in 2009 versus a $24.9 million loss in 2010. These are pretax numbers. The interest rate swaps relate to the $250 million of debt swaps, which were put in place in 2007 for an expected 2008 financing. The financings were pushed out due to market meltdown in 2008. Consequently, these swaps were de-designated and any mark-to-market changes are recorded in the income statement. At the same time, because of the situation that we were in, we put debt out that probably would have been longer term. We had planned for longer term debt, but instead we put out a five-year debt in 2009. So, these hedges are longer than that. And we chose to leave these swaps in place because we have the expected future need for financings of capital projects and future maturities of debt in the 2013 and 2014 time frame.

Continuing down the income statement, the income tax rate for second quarter was 37% in 2010 compared to 36% in 2009. No real significant change there. The resulting 2010 GAAP income from continuing ops for the quarter was a loss of $8.7 million compared to income of $24.6 million, primarily driven by the change in the impact of the interest rate swaps. Moving to slide 12 and drilling down into the income statement, this displays our 2010 second quarter segment roll up of revenue and operating income compared to 2009. The electric utilities segment operating income increased by $5.2 million year-over-year. Megawatts sold increased 2% and was almost all attributable to the off-system sales and supported by the new Wygen III power plant. The operating income increase was driven by about 80% rate case settlements and about 20% of off-system sales margins.

The gas utilities segment sold had solid performance in this shoulder quarter. Decatherms sold in 2010 to 2009 declined 6.6% because of milder weather. The operating income improved, reflecting the impact of the rate cases.

Moving to oil and gas performance, during the quarter we saw our average hedge prices improve, while our production volumes declined. Average hedge prices received for oil improved by 54% and for natural gas by 10%. Production volumes year-over-year decreased by 12% for oil and 11% for natural gas. That combination, along with a $1.2 million charge to true-up some revisionary ownership interests, contributed to lower operating income of $300,000. Moving to the next segment, power generation saw a $2.7 million decline during the quarter compared to 2009. The decline was driven by the outage at Wygen I. Operating income was impacted by a combination of lost revenue, power purchases, and repair costs.

Moving to the next segment, coal mining, revenue increased 11% as a result of 7% increase in tons sold and a 4% improvement in prices received. The higher coal volume resulted from Wygen III sales increases offset by lower volumes on Wygen I. The operating income improved $3.7 million, reflecting increased sales and lower reclamation costs.

The next segment, energy marketing, operating income declined year-over-year by $900,000. The realized margins declined by $13.9 million, but the unrealized mark to market gain increased by $15 million year-over-year. The tight basis spreads and low natural gas prices continue to challenge our financial performance in this segment. The addition of coal marketing contributed almost all of the operating income during the quarter.

At the corporate level, year-over-year was flat.

Moving to slide 13, I want to mention several transactions that strengthened our capital structure. One transaction was completing the sale of 23% of Wygen III in July, which generated $62 million in cash. Another transaction was issuing $200 million of ten-year notes at par with a 5.875% coupon. Another transaction was completing a two-year standalone facility at Enserco, with improved covenants that allowed us to free up $40 million in cash. The last transaction was completing a three-year, $500 million corporate credit facility. The corporate credit facility includes a $100 million accordion feature, which allows us to increase the size if needed. Also in July, we received an upgrade on Black Hills Power secured - senior secured debt rating to BBB plus from a BBB. So, we feel good about the continued progress on liquidity and about freeing up over $100 million worth of cash.

Slide 14 shows our capital structure. In the right column, you can see our current debt to equity. The bottom line is that the debt capitalization remains conservative at 53%. Our net debt capitalization increased to 52% at the end of the quarter. However, the sale of the 23% of Wygen III in July has us already back at the 50% net debt to capitalization. So, we feel we're well positioned for the remainder of the year. We will continue to take actions to minimize cash expenditures and other parts of the Company in order to help fund our construction in Colorado. But, we expect to issue equity later this year or next to keep our debt to capital ratios at 55% or less. As we have said before, our strategy for equity is as little as possible as late as possible. As you saw in the press release, we did reaffirm our 2010 guidance, excluding special items, in the range of $1.80 to $2.05.

Since guidance last October, we've seen various ups and downs, including declines in natural gas prices, rate case settlements, extended outages, colder weather in the first quarter, followed by very mild weather in the second quarter, and other items. So, considering those variables in our performance through the second quarter, we still believe we can achieve the earnings guidance range. I'm sure some of you would prefer that we narrow the range, but at this time, considering the variable of commodity prices, the variable of Enserco market conditions, and the variable of weather, we do not feel it's prudent to narrow the range.

So, with those comments on quarterly financial performance, I'll turn it back to Dave.

Alright. Thank you, Tony. Moving on to slide 16, as Tony mentioned, we've got a very solid balance sheet, very strong cash flows, demonstrated access to the capital markets and, on top of that, excellent growth plans. With a 2010 capital budget forecast of about $477 million, we're making a lot of investments that will provide future growth for us in the future.

Slide 17 is something we've been showing you for a couple of years now. And this gives you an idea of our growth capital investments, not including routine things like new customer hookups or maintenance or overhauls, things like that. Between 2008 and 2011, we're forecasting almost $1.1 billion in growth capital spending, very large number, very positive impact for the future. The only change of significance on this slide from previous quarters is the Black Hills Energy Colorado Electric generation facility. We've narrowed that range from $240 million to $260 million down to $250 million to $260 million, as we've continued making progress on executing procurement contracts and construction contracts and taking more of the uncertainty out of that project.

The next slide, number 18, is just a timeline of events. Notable changes there just include a few items that have been completed or we've reached significant milestones on a few projects in the last quarter, as we've discussed already.

On slide 19 is an update on the Colorado Electric generation. This will be the utility plant, 180 megawatt facility that we intend to rate base in our Colorado Electric utility. Had significant progress on that project, as I mentioned at the beginning of the call. After receiving our air permit, we immediately started construction. Prior to receiving the air permit, we did as much work essentially outside the fence as we could -- access roads, site grading, things like that, anything that we could actually commence without an air permit in hand. Upon receipt of the air permit, we immediately commenced construction, literally the same day, driving foundation piles and are making very good progress there.

Hope to commence even pouring foundations maybe as early as next week or the week after. With the $250 million to $260 million budget for the project, we've already spent nearly $90 million. We've awarded 100% of our procurement contracts for that facility, a little less than half of the construction contracts have been awarded and only 5% of the construction has been completed to date. We have also awarded our gas and water line contracts to supply the facility with both gas and water and at least the gas line is well under construction as well.

Slide 20 related to the IPP facility, 200 megawatt combined cycle facility that will be co-located with the power plant for the regulated utility. This project, if you recall, started several months later than the utility project, just due to the approval and bidding process for this project. So, we're not quite as far along on this one. But have spent $61 million to date, almost 80% done on procurement, and a little less than 40% done on construction.

The piles were driven for the utility plant first, but they're quickly catching up on this one. So, making excellent progress on the construction and we intend to be on schedule and on budget, with both facilities in service prior to January 1, 2012.

Slide 21 is a regulatory update. Other than the successful completion of rate cases in Colorado, South Dakota, and Wyoming, no other updates to provide at this time.

Slide 22 is a topic that we've had some questions from investors on over the last few months related to legislative changes in the State of Colorado. During the 2010 session in the State of Colorado, a couple notable changes were made that impact us as an investor owned utilities serving the state. One of those was a change in the renewable energy standard from 20% by 2020 to now 30% by 2020. A significant increase in renewable requirement for the State of Colorado.

The second bill, which they call their Clean Air - Clean Jobs Act, essentially provides an incentive for the investor owned utilities in the state to retire their coal burning plants. The incentive, then, is allowing the utility to replace those plants with new rate based resources rather than having to go through a full competitive bidding process to replace those resources.

The changes in legislation represent a significant opportunity for both renewable investment and either the replacement or conversion to biomass of our WN Clark facility in Canyon City. That's a relatively small 42 megawatt coal plant, literally almost 60 years old now. So, we're actively evaluating our compliance alternatives for these and our investment opportunities for shareholders and, as we make decisions along the way, we'll make sure to keep you informed about our progress in that regard.

During our first quarter earnings call, we discussed the leadership change we'd made in our oil and gas subsidiary in early May and during that discussed we also noted that, throughout the year, we would gradually expand some of the disclosures related to our oil and gas drilling and production activity.

In the last couple of years, we've received a lot of questions from your regarding our involvement in the Bakken oil shale play in the Williston Basin in North Dakota and Montana. And so in that light, we've presented a summary of our Bakken activity on slide 23.

To summarize, we have a little less than a 10% non-operated working interest and approximately 38,000 gross acres of Bakken leasehold, primarily located in McKenzie County, North Dakota, with less than half of that acreage currently developed. Our partner group has one drilling rig running continuously and plan to continue running that rig throughout the remainder of the year. Our current net production from the Bakken only represents about 4% of our total production. So, it's not a huge impact on us from a financial perspective. We are, however, actively leasing in the Bakken play and pursuing opportunities to economically expand our position in that play.

Some of you who follow drilling permit activity are aware that last year we dissembled a relatively large acreage position and operated acreage position in the Bakken play in Montana. We'd acquired approximately 90,000 gross acres in Roosevelt County and drilled and operated test well on that project, which was remote to the main Bakken play. We had a 40% working interest in the prospect. That prospect, because it was remote to the main play and we were able to acquire the acreage cheaply, provided an enormous upside opportunity for us with a very relatively small up front investment. That particular test well produced oil, but also significantly more water than we had hoped for and we do not currently have any plans to drill additional wells on that prospect.

Slide 24 is our strategy scorecard updated for activities of the quarter and subsequent to the end of the quarter. This is something we've been showing you for a couple of years, where we lay our key initiatives and let you know when they are completed and we will continue to update that as we continue to make progress on our strategic initiatives.

In summary, on slide 25, the second quarter was a strong quarter for us. Our adjusted EPS and operating income, as Tony alluded to, was greater than last year, despite some significant challenges. We made great progress on many of our key goals and objectives. Power plant construction, utility rate cases, key systems upgrades and conversions, and a lot of other things. So, pretty excited about our performance in the quarter. Does a lot to set us up well for future earnings growth and other opportunities for stockholders, as we complete some of the projects that are currently ongoing.

That concludes our prepared remarks. We'd be happy to entertain any questions if people have those.

Ladies and gentlemen, we are ready to open the line up for your questions.

(Operator Instructions)

As a reminder, in order to get as many questions answered as possible, we ask that participants re-enter the queue after asking one initial question and one follow-up question. Please stand by for your first question. And your first question comes from the line of Gordon Howald with East Shore Partners. Please proceed.

Good morning, all.

Hi. Good morning, Gordon.

At Enserco debut, you have the new coal team and you noted that you had a long position, which was additive in the quarter and that you now are in the process of monetizing. You stated you typically don't keep an open position like that. What was the VAR limits at Enserco and what are they now with this new team? Where were you relative to your VAR, I guess is really the question, during the second quarter? And lastly, we've seen strong coal pricing of late. And I believe that includes PRB. How should we think about the impact of stronger coal prices on that coal position in the third quarter?

Our VAR, Gordon, we have not changed the overall VAR limit at Enserco and in a relatively low VAR limit there. So, we have not anticipated a change in the VAR with the addition of the coal marketing business. So, we don't expect to carry significant long positions there. It was just essentially related to the timing of when the business was bought and sold, where prior owner had accumulated some positions and then essentially stopped doing business, not completely stopped, but slowed way down right prior to closing. And so they'd acquired some coal and had not been bidding that coal into utilities and other customers. So, essentially, it provided an open position right at closing and coal prices moved up substantially during June. We don't anticipate that that business is going to have a huge impact on Enserco in the short run. I mean, we've said when we acquired it that it'll gradually have an increased impact to earnings. A very characteristic and similar, I guess, in characteristics to how our producer services part of that business, will operate more fee based, not really trading in market speculation. It's buy the coal and resell it.

We do provide some logistical services there for of the smaller customers, where they may buy coal and want someone to deal with rail shipment, particularly if they don't have a whole unit train for themselves. So, we provide that service for a fee. But, don't really expect, at least this year and into next year, a real meaningful positive impact to the income statement on a cash and actual realized income basis. This particular quarter was very unique with the open position and the mark to market gain on that position, which, of course, we will close out at a profit. But, don't really anticipate that type of business being part of the ongoing activity there.

Got you. Okay. I appreciate the answer. Thank you.

Your next question comes from the line of Ella Vuernick with RBC Capital Markets. Please proceed.

Good morning. Appreciate some greater clarity and insight into the oil and gas business. You had mentioned in the press release that the volumes were down largely due to some natural declines because of the current CapEx levels. But, you also mentioned that you're looking to opportunistically grow your position, if I understand correctly, in the Bakken. So, can we infer from that that you have, perhaps, an updated outlook in terms of your view on commodity prices and their impact for CapEx in oil and gas?

Yes, I wouldn't infer that we've changed our outlook, Ella. I think the -- if you look at the product prices, oil prices are relatively strong and they support drilling in certain areas, like the Bakken and Powder River Basin and other areas. So, to the extent we have holdings or are involved in those plays, they're the ones that essentially rise to the top as far as the ones that you can justify today economically because oil prices are relatively positive compared to natural gas. The activity that we have is expanded, but it's on a relative basis. If you look at last year, we spent about $20 million in E&P and that's what's impacting our production for this year. The wells that would have been drilled and completed last year are the ones that would have started producing late last year and early this year. So, that's the majority of the impact of decline is related to very little drilling activity last year. This year, our disclosed budget is a little under $40 million for E&P, so, although it's double last year, still a relatively modest level of investment. So, I wouldn't say we're signaling any change over what we have in prior quarters.

Thanks for that clarification. Also, just to clarify, at coal mining, the change in the overburden process, is that a permanent change? Is that something that we can -- in other words, should we be expecting a decrease in the run rate for O&M at that business on an ongoing basis due to this new procedure?

There will be a slight change in expense going forward because it affects the post mining topography plan. So, all of our ongoing activity there will be some impact -- positive impact, related to that change. Probably not quite as dramatic as the first one.

So, this quarter was higher than -- the impact of that change was higher this quarter than in future quarters this year?

Probably a little bit more, yes.

Okay, great. That's all my questions. Thanks very much.

Thank you.

(Operator Instructions )

Alright. Doesn't sound like we have any additional questions. Thank you for attending the call this morning. And, as always, we appreciate your support of Black Hills. Have a good day. Thank you.

This concludes the presentation. You may all now disconnect. Good day.