BKH

Business Context and Reporting Period

Company: Black Hills Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: A diversified energy company operating in the United States with two major business groups: Retail Services (electric and gas utilities) and Wholesale Energy (power generation, oil and gas, coal mining, and energy marketing). The company completed the sale of its crude oil marketing and transportation business in March 2006, which is now reported as discontinued operations.

Key Financial Metrics (Nine Months Ended Sept 30, 2006)

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 11% ($49.5 million) year-over-year, driven by higher retail/wholesale sales, rate increases at Cheyenne Light, and higher margins in energy marketing.
• Profitability Surge: Net income from continuing operations increased $46.3 million. This is primarily due to the absence of a $50.3 million impairment charge on the Las Vegas I power plant and an $8.9 million write-off of project development costs that occurred in the prior year (2005).
• Segment Performance:
  • Power Generation: Income increased $28.9 million, largely due to the prior year's impairment charge and lower fuel costs.
  • Energy Marketing: Income increased $11.1 million due to higher realized marketing margins.
  • Oil and Gas: Income decreased $3.9 million due to higher production expenses and depletion costs, despite a 13% revenue increase.
• Discontinued Operations: The company recorded a net income of $7.06 million from discontinued operations, primarily reflecting a $13.7 million pre-tax gain on the sale of crude oil marketing assets in March 2006.

Guidance, Outlook, and Risks

• Capital Expenditures: The company expects full-year 2006 capital expenditures to approximate $302.2 million. Significant projects include the construction of the Wygen II coal-fired power plant (expected commercial operation end of 2007) and oil and gas acquisitions in the Piceance Basin.
• Rate Filings: The electric utility filed for a 9.5% rate increase effective January 1, 2007, which could result in an annual revenue increase of approximately $9.5 million if approved.
• Oil and Gas Ceiling Test: A temporary decline in natural gas prices at period-end indicated a potential $15.5 million impairment. However, subsequent price increases in November 2006 eliminated the need for this write-down.
• Liquidity: The company maintains a $400 million revolving credit facility with $203.3 million available as of September 30, 2006. Credit ratings are Baa3 (Moody's) and BBB- (S&P) with a negative outlook from S&P.
• Legal Proceedings:
  • Forest Fires: Governmental claims regarding the Grizzly Gulch and Hell Canyon fires were settled for approximately $8 million; private claims remain pending but are not expected to be material.
  • Earn-Out Litigation: Ongoing dispute regarding contingent merger consideration from a 2000 acquisition; arbitration is proceeding.
  • Anti-Trust: Enserco Energy Inc. is a defendant in California price reporting lawsuits; outcome is uncertain.

Investor Verification Checklist

• Impairment Volatility: Verify the stability of natural gas prices and the potential for future "ceiling test" write-downs in the Oil and Gas segment.
• Regulatory Approval: Monitor the status of the 9.5% rate increase application filed with the South Dakota Public Utilities Commission.
• Capital Project Execution: Track the progress and cost overruns of the Wygen II power plant construction and Piceance Basin acquisitions.
• Legal Exposure: Review updates on the Earn-Out litigation and California anti-trust cases for potential financial impact.
• Debt Covenants: Confirm continued compliance with the revolving credit facility covenants, specifically the net worth and leverage ratios.