BKH

Business Context and Reporting Period

Company: Black Hills Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2002
Business Overview: A diversified energy holding company operating in the United States. Key segments include an Electric Utility (regulated), Integrated Energy (unregulated power generation, fuel marketing, oil & gas, mining), and Communications. The company serves approximately 59,200 utility customers and operates broadband services in South Dakota.

Key Financial Metrics (Six Months Ended June 30, 2002)

*Note: 2001 debt figure derived from balance sheet comparison; 2002 debt includes significant short-term borrowings to fund acquisitions and construction.

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenues dropped 28% year-over-year, primarily driven by a substantial decrease in wholesale energy commodity prices (natural gas, crude oil, and electricity) compared to the unusually high prices in the first half of 2001.
• Profitability Impact: Net income from continuing operations fell 55% to $29.6 million. The decline is attributed to lower gross margins in fuel marketing and lower wholesale power prices, partially offset by increased production volumes in coal, oil, and gas.
• Discontinued Operations: The company recorded a net loss of $2.6 million from discontinued operations related to the disposal of its coal marketing subsidiary (Black Hills Coal Network), compared to a profit of $1.0 million in the prior year.
• Segment Performance:
  • Power Generation: Net income increased 281% due to additional generating capacity (646 MW in service vs. 327 MW in 2001) and a $1.9 million benefit from collecting previously reserved California receivables.
  • Fuel Marketing: Net income decreased 85% due to lower margins and commodity prices, despite a 16% increase in natural gas marketing volumes.
  • Electric Utility: Net income decreased 57% due to a 75% drop in the average price per megawatt-hour for off-system sales.

Guidance, Outlook, and Risks

Management Commentary and Guidance

• Earnings Outlook: Management expects recurring earnings for 2002 to be in the range of $2.25 to $2.30 per share. Long-term EPS growth targets remain 10-15%, but near-term growth is expected to be 8-10% due to challenging market conditions.
• Communications Segment: Expected to sustain net losses of approximately $6.5 million in calendar year 2002, with profitability projected by 2004.
• Capital Strategy: The company is actively seeking long-term project-level non-recourse financing (approx. $160 million) for the Las Vegas Cogeneration expansion and plans to renew a $200 million credit facility expiring in August 2002.

Risks and Contingencies

• Liquidity Risk: The company faces a potential liquidity deficiency if it fails to secure the Las Vegas project financing or renew its $200 million credit facility by August 27, 2002. Current short-term debt levels are high ($406 million in notes payable).
• Legal Proceedings (Forest Fire): Sagging power lines owned by the company were implicated as the cause of a forest fire in South Dakota that destroyed 20 structures. While no civil action has been initiated, the company could be liable for damages if negligence is proven.
• Counterparty Risk: Credit ratings of key counterparties (e.g., Nevada Power Company) have been downgraded to non-investment grade, increasing the risk of default on power purchase contracts.
• Regulatory Risk: California's efforts to void or reform long-term power purchase contracts could adversely affect the Las Vegas Cogeneration II plant's tolling agreement.

Investor Verification Checklist

• Debt Maturities: Verify the status of the $200 million credit facility renewal and the $160 million Las Vegas project financing, both critical for liquidity post-August 2002.
• Commodity Price Sensitivity: Assess the impact of continued low natural gas and wholesale electricity prices on the Fuel Marketing and Power Generation segments.
• Forest Fire Liability: Monitor the outcome of the investigation into the South Dakota forest fire for potential material claims.
• Communications Write-down Risk: Evaluate the broadband segment's customer acquisition rates against capital investment to determine the risk of future asset write-downs.
• Accounting Changes: Review the impact of the adoption of SFAS 142 (Goodwill) and the upcoming adoption of EITF 02-3 on future earnings presentation.