Black Hills Corporation — Q2 2016 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2016. Black Hills operates regulated electric and gas utilities, power generation, coal mining, and oil and gas businesses. Results include SourceGas from its February 12, 2016 acquisition; prior-period segment presentations were reclassified for organizational changes.
Financial performance and position
- Revenue: Q2 revenue was $325.4 million, up 19.5% from $272.3 million. First-half revenue was $775.4 million, up 8.6% from $714.2 million. The acquired gas utilities contributed $70 million of Q2 revenue and $145 million for the period since acquisition.
- Profit: Q2 net income available to common shareholders was $0.7 million, or $0.01 per diluted share, versus a $41.8 million loss, or $0.94 loss per share, a year earlier. First-half income was $40.7 million, or $0.78 per diluted share, versus a $8.0 million loss, or $0.18 loss per share.
- Operating income: Q2 operating income was $35.3 million versus an operating loss of $38.9 million; first-half operating income was $108.9 million versus $31.6 million. Lower oil and gas impairment charges were a major factor in the year-over-year improvement.
- Cash flow: First-half operating cash flow was $222.8 million, down from $254.4 million. Investing cash outflow was $1.325 billion, mainly reflecting the $1.124 billion net cash acquisition outlay for SourceGas. Financing cash inflow was $762.2 million. Cash and equivalents fell to $116.8 million from $456.5 million at year-end 2015.
- Debt and liquidity: At June 30, total debt was approximately $3.242 billion, including $3.167 billion of long-term debt and $75 million of revolving-credit borrowings. Cash was $116.8 million; the $500 million revolver had $400 million available after borrowings and letters of credit. Approximately $930.7 million of long-term debt was classified as current, principally maturities in 2017. The company reported compliance with its covenants; its recourse leverage ratio was 69% against a temporary 75% limit.
- Margins and dividends: Utility gross margin, a non-GAAP measure, rose in Gas Utilities to $103.7 million for Q2 and $236.2 million for the first half, substantially reflecting SourceGas. Electric Utilities gross margin was $100.1 million for Q2 and $201.2 million for the first half. Dividends declared were $0.42 per share for Q2; the July 2016 declaration maintained that quarterly rate.
Material changes versus the prior comparable period
- SourceGas expanded the gas utility business and substantially increased assets, debt, goodwill, operating costs, and interest expense. Its contribution to common earnings was a $3.0 million loss for Q2 and $4.6 million income since acquisition.
- Oil and gas impairments fell: pre-tax charges were $25 million for Q2 2016 and $40 million for the first half, compared with $94 million and $117 million, respectively, in 2015. Despite lower charges, oil and gas remained loss-making amid weak commodity prices.
- First-half results included approximately $5.8 million of oil-and-gas percentage-depletion tax benefit and a tax benefit from an IRS Appeals agreement. Acquisition and transition costs were approximately $20 million after tax for the first half.
- Q2 electric utility earnings improved modestly, supported by hotter weather and rider margins. Gas utility Q2 earnings declined year over year, as acquired operations’ costs and interest expense offset their added margin; first-half gas utility earnings increased.
- The company sold a 49.9% noncontrolling interest in its Colorado IPP for $216 million, using proceeds in part to reduce short-term borrowings. It also issued $56 million net through its at-the-market equity program through June 30.
Outlook, commentary, risks and unusual items
- Management said cash on hand, operating cash flow, borrowing capacity, and access to debt and equity markets were expected to support operations, dividends, capital spending, and debt maturities. It intended to refinance approximately $931 million of debt due within the next twelve months.
- Planned capital expenditures were $521 million for 2016, $351 million for 2017, and $331 million for 2018. The company also anticipated continuing its ATM equity program, potentially increasing its revolving facility to $750 million, and implementing commercial paper financing.
- Further oil and gas ceiling-test impairments were considered likely in Q3 if commodity prices remained near then-current levels. The company also identified non-core properties for potential sale as it shifted its oil and gas business toward supporting utility Cost of Service Gas programs.
- Cost of Service Gas applications faced regulatory setbacks: Nebraska denied its application and Colorado dismissed its application; the company subsequently sought withdrawals in Wyoming, Iowa, Kansas, and South Dakota and was considering applications tied to specific reserves. Failure to secure approvals could prompt strategy changes and further impairments.
- SourceGas purchase accounting remained preliminary; $944 million of acquisition goodwill could change materially. Regulatory approvals imposed rate moratoria and customer credits, and disallowed recovery of goodwill and transaction costs. Most costs of terminating an above-market gas supply contract were approved for recovery over five years.
- Credit ratings were BBB from S&P with a stable outlook, Baa1 from Moody’s with a negative outlook, and BBB+ from Fitch with a negative outlook. The filing cites acquisition-related leverage, integration, commodity prices, weather, refinancing access, regulatory decisions, and potential collateral requirements as risks. The company reported effective disclosure controls; acquired SourceGas businesses were excluded from the 2016 internal-control assessment.
Key facts for investors to verify
- Progress and final purchase-price allocation for SourceGas, including the valuation and impairment risk of acquisition goodwill.
- Plans and market access to refinance near-term maturities, and the effect of refinancing terms on interest expense and covenant headroom.
- Regulatory outcomes for Cost of Service Gas proposals and the recoverability and timing of related regulatory assets.
- Whether oil and gas prices, reserves, or strategy changes trigger additional impairments; monitor production, hedges, and potential asset sales.
- Integration costs and operating performance of SourceGas, including whether acquired gas operations’ margins translate into sustained earnings and cash flow.
- Execution, cost, and regulatory recovery of major utility projects, including Peak View Wind and the Colorado gas-fired turbine.