BLACK HILLS CORP annual report, FY2012

Business context and reporting period

Black Hills Corporation’s Form 10-K reports the fiscal year ended December 31, 2012; it is an annual filing, not a standalone fourth-quarter report. The diversified U.S. energy company operates regulated electric and gas utilities and non-regulated power generation, coal mining, and oil and gas businesses. Enserco, its energy-marketing segment, was sold on February 29, 2012 and is reported as discontinued operations.

Key financial metrics

Reported operating income was about 20.8% of revenue, versus 14.6% in 2011; the comparison reflects material one-time and accounting items, including the 2012 asset-sale gain and impairment. Utility-group net income was $79.6 million (electric $51.6 million; gas $28.0 million); non-regulated energy net income was $24.7 million. Segment figures do not include all corporate and intercompany effects.

At year-end, notes payable were $277.0 million, current maturities of long-term debt were $104.0 million, and long-term debt was $938.9 million. Total debt on these reported balance-sheet categories was approximately $1.32 billion, down from approximately $1.63 billion in 2011. The $500 million revolving facility, maturing in 2017, had $127.0 million borrowed, $36.3 million of letters of credit, and $336.6 million available. The company reported compliance with debt covenants. Its long-term debt ratio was 43.2%, versus 51.4% in 2011.

Quarterly data in the filing show fourth-quarter 2012 revenue of $318.9 million, income from continuing operations of $30.9 million, net income of $30.8 million, and diluted EPS of $0.70. Fourth-quarter 2011 revenue was $361.2 million, continuing income $18.8 million, net income $25.6 million, and diluted EPS $0.60.

Material changes versus the prior comparable period

• Revenue decreased 7.7% year over year, while continuing income and total net income increased. Lower gas commodity costs and lower gas volumes reduced reported utility revenue; warm winter weather also weighed on gas-utility margins.
• Electric Utilities’ gross margin increased, supported by new rates, the Colorado Electric gas-fired plant entering service, and transmission and environmental recovery mechanisms. Gas Utilities’ gross margin declined $13.9 million, mainly from milder weather and a change in expense classification.
• Power Generation income rose to $21.3 million from $3.0 million, principally because its 200-megawatt Pueblo gas-fired facility began commercial operation under a 20-year contract. Coal Mining income recovered to $5.6 million from a $0.4 million loss, aided by lower costs after a revised mine plan, despite lower sales volumes.
• Oil and Gas reported a $2.2 million continuing-operations loss. A $29.1 million pretax gain on the Williston Basin asset sale was largely offset by a $26.9 million pretax non-cash ceiling-test impairment. Proved reserves fell to 80.7 Bcfe from 133.2 Bcfe, reflecting the asset sale and negative revisions, primarily from lower gas prices and reserve reclassification.
• Operating cash flow increased by $93.3 million. Investing cash flow was a net inflow of $11.2 million, versus a $447.0 million outflow in 2011, largely reflecting asset-sale proceeds and lower capital spending. Financing activities used $371.4 million, including repayment of $225 million of 6.5% notes; the company also paid $65.3 million in common dividends.
• Enserco’s discontinued operations recorded a $7.0 million net loss in 2012, compared with $9.4 million net income in 2011. The company’s share count also increased following a 2011 equity issuance, affecting per-share comparisons.

Outlook, commentary, risks and contingencies

• Management expects continued investment-led growth, with forecast capital expenditures of $460.1 million in 2013, $390.1 million in 2014, and $292.9 million in 2015. The forecast includes Cheyenne Prairie, a 132-MW gas-fired project estimated at $222 million, with commercial operation expected in the fourth quarter of 2014. No consolidated EPS guidance is stated in the provided filing text.
• Cheyenne Prairie construction-financing riders were approved for Wyoming customers; a South Dakota rider had interim approval effective April 2013, subject to refund. Management estimated associated gross-margin increases in 2013 and 2014. Black Hills Power also requested a $13.7 million annual electric revenue increase in South Dakota; a decision was anticipated in the third quarter of 2013. A separate Iowa gas infrastructure adjustment request sought $0.9 million.
• Management cited warm winter weather as a headwind and low natural-gas prices as pressure on oil-and-gas reserve values. Commodity prices, weather, regulatory rate recovery, environmental compliance costs, project execution, and access to capital remain material risks.
• Environmental rules led to suspension or planned retirement of 152.3 MW of older generation, including W.N. Clark and several coal units. Future requirements for emissions, coal ash, water discharges, and greenhouse gases could increase costs or affect plant economics. Estimated environmental compliance capital spending was $6.2 million over 2013–2015, excluding plant closures and new generation.
• The $250 million of 9% notes mature in May 2014; management said it would evaluate refinancing, extending term loans, and long-term financing for Cheyenne Prairie. A $250 million notional amount of undesignated interest-rate swaps had a reported fair-value liability of $88.1 million, net of cash collateral, and could cause earnings volatility or cash-settlement needs.
• The IRS challenged the company’s tax treatment of a 2008 like-kind exchange. The company estimated that up to approximately $125 million of deferred tax could be accelerated in a worst-case outcome, plus estimated interest of about $20 million before tax effects; management disputed the proposed adjustment.
• Claims relating to the 2012 Oil Creek fire were approximately $8.0 million at filing, with additional claims expected. Management said a loss was reasonably possible but could not be reasonably estimated and did not expect an adverse outcome to materially affect the financial statements based on information then available.
• The Enserco buyer disputed post-closing adjustments. Black Hills had paid $1.4 million toward claims; the buyer sought $7.2 million in total and filed a court petition in February 2013 seeking to compel arbitration of disputed claims.
• The board declared a 2013 quarterly dividend of $0.38 per share, or $1.52 annualized. The 2012 dividend payout ratio was 80%. The company reported an unqualified audit opinion and effective internal control over financial reporting; a previously reported income-tax control weakness was remediated.

Important facts for investors to verify

1. Outcomes and timing of the South Dakota rate case and construction-financing rider, and the Iowa infrastructure request.
2. Cheyenne Prairie’s final cost, construction schedule, financing, and recovery of costs through rates.
3. Resolution of the IRS tax challenge and potential tax, interest, and liquidity consequences.
4. Exposure from Oil Creek fire claims and Enserco post-closing disputes.
5. Debt refinancing and repayment plans, available revolver capacity, and any cash settlement or collateral requirements for interest-rate swaps.
6. Whether oil-and-gas prices, reserve revisions, and production support future impairment risk and the planned capital program.
7. Environmental compliance requirements, generation retirements, replacement-resource decisions, and recovery of related costs from customers.