BKH

Business Context and Reporting Period

Company: Black Hills Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2002
Business Overview: A diversified energy holding company operating in the United States. Key segments include Integrated Energy (Mining, Oil & Gas, Energy Marketing, Power Generation), Electric Utility, and Communications. The company serves approximately 59,600 electric utility customers and over 23,700 communications customers.

Key Financial Metrics (Nine Months Ended Sept 30, 2002)

Note: Debt figures derived from Balance Sheet: Current maturities ($17.3M) + Notes Payable ($383.5M) + Long-term debt ($561.4M).

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenues decreased $53.6 million year-over-year, primarily driven by a substantial decline in wholesale energy commodity prices (natural gas and electricity) compared to the unusual market conditions and shortages experienced in the first half of 2001.
• Profitability Drop: Net income from continuing operations fell significantly due to lower margins in energy marketing and oil/gas production. However, the Power Generation segment saw net income more than triple due to increased capacity and partnership earnings.
• Discontinued Operations: The company disposed of its coal marketing subsidiary (Black Hills Coal Network) in July 2002. This resulted in a net loss of $2.6 million for the nine-month period, compared to a net income of $0.3 million in the prior year.
• Accounting Changes: Adoption of SFAS 142 (Goodwill) eliminated goodwill amortization, providing a nominal earnings benefit. Energy trading contracts are now presented on a net basis in operating revenues.
• Capital Expenditures: Investing cash outflows decreased significantly to $201.8 million from $502.6 million in the prior year, reflecting a slowdown in major project acquisitions compared to 2001.

Guidance, Outlook, and Risks

Management Commentary and Guidance

• 2002 Outlook: Management expects recurring earnings for 2002 to be in the range of $2.25 to $2.30 per share.
• Growth Strategy: The company anticipates annual earnings per share growth of 8% to 10% once market conditions improve. They plan to continue capital deployment to expand integrated energy operations.
• Communications Segment: Expected to sustain net losses of approximately $7.0 million for calendar year 2002, with profitability projected by 2004.
• Acquisition: On October 1, 2002, the company entered a definitive agreement to acquire Mallon Resources Corporation for an estimated $52 million, expected to double proven oil and gas reserves.

Risks and Contingencies

• Forest Fire Liability: A June 2002 forest fire in South Dakota, potentially caused by power line contact, has led to civil actions by the State and potential private claims. Management believes the impact will not be material but cannot predict the outcome.
• Counterparty Credit Risk: Downgrades of key counterparties (e.g., Allegheny Energy, Nevada Power) to non-investment grade status increase the risk of default on power purchase agreements.
• Liquidity and Financing: Financing for the Las Vegas Cogeneration expansion has been delayed due to counterparty credit concerns. The company relies on corporate credit facilities to fund this project until project-level financing is secured.
• Regulatory Environment: A rate freeze with the South Dakota Public Utilities Commission prevents passing on cost increases until 2005, potentially compressing margins if fuel costs rise.

Investor Verification Checklist

• Commodity Price Sensitivity: Verify the correlation between current natural gas and wholesale power prices and the company's projected 2002 earnings guidance ($2.25-$2.30).
• Debt Covenants: Confirm continued compliance with liquidity covenants requiring $30 million in liquid assets and interest coverage ratios, especially given the reliance on short-term credit facilities for the Las Vegas project.
• Counterparty Exposure: Assess the financial stability of Allegheny Energy Supply Company and Nevada Power Company, as their default could impact cash flows from tolling agreements.
• Legal Exposure: Monitor the status of the South Dakota forest fire litigation and any potential insurance recoveries or liability assessments.
• Acquisition Integration: Track the closing and integration of the Mallon Resources acquisition and its impact on oil and gas reserve estimates.