Business context and reporting period
Black Hills Corporation’s Form 10-K covers the fiscal year ended December 31, 2016. The company operates regulated electric and gas utilities alongside power generation, coal mining, and oil and gas businesses. It serves approximately 208,500 electric customers and 1.03 million gas customers.
The major structural change was the February 12, 2016 acquisition of SourceGas for approximately $1.89 billion, including $760 million of assumed debt. SourceGas contributed $348 million of revenue and $15 million of net income from acquisition through year-end. Comparisons with 2015 are therefore affected by partial-year consolidation and the acquisition.
Financial performance and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Operating revenue | $1.573 billion | $1.305 billion |
| Operating income | $222.6 million | $29.8 million |
| Net income (loss) available to common shareholders | $73.0 million | $(32.1) million |
| Diluted earnings (loss) per share | $1.37 | $(0.71) |
| Cash from operating activities | $320.5 million | $424.3 million |
| Capital expenditures | $467.1 million | $458.8 million |
Revenue rose about 21%, largely reflecting SourceGas. Operating income and earnings improved substantially, but the comparison also reflects lower oil and gas impairments: 2016 included $107 million pretax of long-lived asset impairments, versus $250 million in 2015. The oil and gas segment remained loss-making, with a $71.1 million loss available to common shareholders in 2016.
Reported gross margin, a non-GAAP measure, was $415.9 million in Electric Utilities, up from $410.4 million, and $486.2 million in Gas Utilities, up from $251.7 million. The gas increase primarily reflects SourceGas and other acquired utility operations; milder weather reduced gas margin by about $2 million.
Cash from operations declined by $103.8 million year over year, while cash used in investing increased to $1.589 billion, primarily because of the acquisition. Financing activities provided $841.0 million. Year-end cash was $13.6 million, down from $440.9 million.
At year-end, long-term debt was $3.211 billion, notes payable were $96.6 million, and current maturities of long-term debt were $5.7 million. The company reported a 67% total debt capitalization ratio in its financial-position summary; its separate credit-facility covenant ratio was 62%, versus a 70% limit for 2016. The $750 million revolving facility had $617 million of available capacity after $97 million of borrowings and $36 million of letters of credit. The company reported covenant compliance.
Total assets were $6.515 billion, including $1.299 billion of goodwill, which increased substantially with SourceGas. Stockholders’ equity was $1.615 billion. Dividends paid were $1.68 per share for 2016; the board declared a 2017 quarterly dividend of $0.445 per share, or $1.78 annualized.
Material changes versus the prior comparable period
- SourceGas expanded the regulated gas business and increased consolidated scale, assets, debt, and goodwill. Gas customers increased to about 1.03 million from 591,000 at year-end 2015.
- Electric Utilities net income available to common shareholders increased to $85.8 million from $77.6 million; Gas Utilities increased to $59.6 million from $39.3 million, with acquired businesses a major factor.
- Oil and Gas losses narrowed to $71.1 million from $180.0 million, primarily due to lower impairment charges, despite lower production and realized commodity prices.
- Operating cash flow fell despite the return to positive earnings, in part because of working-capital and regulatory-account movements, acquisition-related effects, and the $28.8 million cash settlement of interest-rate swaps.
- Debt increased sharply to fund the acquisition. The company issued $550 million of notes in January and $700 million in August, refinanced the debt assumed with SourceGas, and raised $119 million net through an at-the-market equity program. It also sold a 49.9% interest in Black Hills Colorado IPP for $216 million.
- Retail electric sales volume grew, including industrial load growth in Wyoming and Colorado, while off-system wholesale sales declined amid weaker market conditions.
Outlook, management commentary, risks and unusual items
Management expects growth from the SourceGas acquisition, utility capital investment, operating efficiencies, and potential cost-of-service gas initiatives. Forecast capital expenditures are $324 million in 2017, $305 million in 2018, and $365 million in 2019. The forecast excludes cost-of-service gas investment because regulatory timing and program details remain uncertain. The filing provides no clear consolidated earnings or EPS guidance for 2017.
The company completed the $109 million, 60 MW Peak View wind project and a 40 MW Colorado gas turbine in 2016. A Colorado renewable-energy settlement provides for 60 MW of additional renewable resources to be in service by 2019. A $54 million transmission project was underway, with its remaining segment expected in the first half of 2017.
Cost-of-service gas proposals encountered regulatory setbacks: applications in Iowa, Kansas, South Dakota, and Wyoming were withdrawn, while earlier Colorado and Nebraska proceedings did not establish adequate customer-benefit support. Management is reconsidering its approval strategy. Colorado Electric also sought reconsideration of a regulator’s decision that approved a $1.2 million annual revenue increase, versus the $8.9 million requested.
Key risks include elevated leverage and financing needs after the acquisition; execution of integration and anticipated savings; weather sensitivity; energy price volatility; oil and gas reserve and impairment risk; regulatory recovery of costs and capital investment; environmental rules affecting coal and emissions; and operational, pipeline-safety, cyber, and severe-weather risks. The Clean Power Plan was stayed pending litigation, leaving potential compliance obligations uncertain. Fitch maintained a BBB+ rating with a negative outlook; S&P rated the company BBB stable and Moody’s Baa2 stable.
Unusual items include the $107 million pretax oil and gas impairment, $30 million of after-tax SourceGas acquisition and transition costs, the $29 million interest-rate-swap settlement (with most of the loss deferred in AOCI and amortized over the related debt term), and tax benefits tied to depletion deductions and an IRS Appeals agreement. SourceGas represented about 20% of year-end assets and 22% of annual sales, but was excluded from management’s and the auditor’s internal-control assessment for 2016 under the permitted acquisition transition relief. The company and auditor reported effective controls for the assessed operations; the financial-statement audit opinion was unqualified.
Most important facts for investors to verify
- How SourceGas performs on a full-year basis, whether expected efficiencies materialize, and whether integration costs or regulatory conditions constrain benefits.
- Debt repayment capacity, covenant headroom, refinancing requirements, and credit-rating developments following the acquisition-driven increase in leverage.
- Whether utility regulators allow adequate recovery on requested rates and investments, including the Colorado rate reconsideration and future SourceGas rate filings.
- Further oil and gas impairments, reserve revisions, asset-sale proceeds, and the viability and regulatory prospects of the cost-of-service gas strategy.
- Cash generation and dividend coverage: 2016 dividends exceeded reported common earnings, although management stated dividends were paid from operating cash flows.
- Integration of SourceGas into company-wide financial controls, since its operations were excluded from the 2016 internal-control assessment.