UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006.

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934

For the transition period from __________ to __________.

 

Commission File Number 001-31303

 

Black Hills Corporation

Incorporated in South Dakota

IRS Identification Number 46-0458824

625 Ninth Street

Rapid City, South Dakota 57701

 

 

Registrant’s telephone number (605) 721-1700

 

 

Former name, former address, and former fiscal year if changed since last report

NONE

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


 

Yes

x

No

o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

 

Large accelerated filer

x

Accelerated filer

o

Non-accelerated filer

o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


 

Yes

o

No

x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.


Class

Outstanding at October 31, 2006

 

 

Common stock, $1.00 par value

33,313,142 shares

 

 

 

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Income –

 

 

Three and Nine Months Ended September 30, 2006 and 2005

3

 

 

 

 

Condensed Consolidated Balance Sheets –

 

 

September 30, 2006, December 31, 2005 and September 30, 2005

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows –

 

 

Nine Months Ended September 30, 2006 and 2005

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6-36

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and

 

 

Results of Operations

37-59

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

60-62

 

 

 

Item 4.

Controls and Procedures

62

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

63

 

 

 

Item 1A.

Risk Factors

63

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

63

 

 

 

Item 6.

Exhibits

64

 

 

 

 

Signatures

65

 

 

 

 

Exhibit Index

66

 

 

2

 

 

 

BLACK HILLS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2006

2005

2006

2005

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

Operating revenues

$

157,608

$

149,008

$

483,312

$

433,813

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

Fuel and purchased power

 

47,740

 

49,758

 

151,150

 

134,849

Operations and maintenance

 

16,490

 

18,014

 

60,566

 

55,071

Administrative and general

 

19,721

 

21,669

 

64,776

 

60,403

Depreciation, depletion and amortization

 

24,141

 

22,039

 

67,407

 

62,362

Taxes, other than income taxes

 

8,570

 

8,869

 

26,667

 

25,483

Project development cost write - off

 

 

8,931

 

 

9,495

Impairment of long-lived assets

 

 

50,279

 

 

50,279

 

 

116,662

 

179,559

 

370,566

 

397,942

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

40,946

 

(30,551)

 

112,746

 

35,871

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

Interest expense

 

(12,400)

 

(11,089)

 

(37,310)

 

(36,421)

Interest income

 

389

 

331

 

1,403

 

1,294

Other income, net

 

106

 

139

 

517

 

819

 

 

(11,905)

 

(10,619)

 

(35,390)

 

(34,308)

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

 

 

 

 

 

 

before equity in earnings of

 

 

 

 

 

 

 

 

unconsolidated subsidiaries, minority

 

 

 

 

 

 

 

 

interest and income taxes

 

29,041

 

(41,170)

 

77,356

 

1,563

Equity in earnings of unconsolidated

 

 

 

 

 

 

 

 

subsidiaries

 

615

 

3,434

 

(16)

 

7,788

Minority interest

 

(95)

 

(74)

 

(273)

 

(199)

Income tax (expense) benefit

 

(7,362)

 

14,026

 

(23,939)

 

(2,367)

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

22,199

 

(23,784)

 

53,128

 

6,785

Income (loss) from discontinued operations,

 

 

 

 

 

 

 

 

net of taxes

 

81

 

(119)

 

7,060

 

22

 

 

 

 

 

 

 

 

 

Net income (loss)

 

22,280

 

(23,903)

 

60,188

 

6,807

Preferred stock dividends

 

 

 

 

(159)

Net income (loss) available for

 

 

 

 

 

 

 

 

common stock

$

22,280

$

(23,903)

$

60,188

$

6,648

 

 

 

 

 

 

 

 

 

Weighted average common shares

 

 

 

 

 

 

 

 

outstanding:

 

 

 

 

 

 

 

 

Basic

 

33,187

 

32,967

 

33,157

 

32,660

Diluted

 

33,560

 

32,967

 

33,526

 

33,100

 

 

 

 

 

 

 

 

 

Earnings (loss) per share:

 

 

 

 

 

 

 

 

Basic–

 

 

 

 

 

 

 

 

Continuing operations

$

0.67

$

(0.73)

$

1.60

$

0.20

Discontinued operations

 

 

 

0.21

 

Total

$

0.67

$

(0.73)

$

1.81

$

0.20

 

 

 

 

 

 

 

 

 

Diluted–

 

 

 

 

 

 

 

 

Continuing operations

$

0.66

$

(0.73)

$

1.59

$

0.20

Discontinued operations

 

 

 

0.21

 

Total

$

0.66

$

(0.73)

$

1.80

$

0.20

 

 

 

 

 

 

 

 

 

Dividends paid per share of common stock

$

0.33

$

0.32

$

0.99

$

0.96

 

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed consolidated financial statements.

 

3

 

 

 

BLACK HILLS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

 

September 30,

December 31,

September 30,

 

2006

2005

2005

 

(in thousands, except share amounts)

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

$

47,716

$

31,817

$

46,060

Restricted cash

 

 

 

700

Receivables (net of allowance for doubtful accounts of $4,007;

 

 

 

 

 

 

$4,685 and $4,317, respectively)

 

195,571

 

264,695

 

240,110

Materials, supplies and fuel

 

91,490

 

122,521

 

179,387

Derivative assets

 

66,990

 

20,681

 

33,184

Income tax receivable

 

11,524

 

 

Deferred income taxes

 

 

 

6,803

Other assets

 

7,830

 

7,842

 

6,666

Assets of discontinued operations

 

1,043

 

122,158

 

119,019

 

 

422,164

 

569,714

 

631,929

 

 

 

 

 

 

 

Investments

 

23,709

 

27,558

 

24,906

 

 

 

 

 

 

 

Property, plant and equipment

 

2,180,639

 

1,928,559

 

1,898,313

Less accumulated depreciation and depletion

 

(574,925)

 

(518,525)

 

(510,401)

 

 

1,605,714

 

1,410,034

 

1,387,912

Other assets:

 

 

 

 

 

 

Derivative assets

 

3,197

 

1,898

 

4,722

Goodwill

 

30,563

 

29,847

 

28,455

Intangible assets (net of accumulated amortization of

 

 

 

 

 

 

$25,072; $22,734 and $21,954, respectively)

 

25,209

 

27,548

 

28,328

Other

 

38,177

 

53,646

 

47,391

 

 

97,146

 

112,939

 

108,896

 

$

2,148,733

$

2,120,245

$

2,153,643

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

$

181,255

$

202,639

$

192,202

Accrued liabilities

 

82,098

 

72,514

 

71,610

Derivative liabilities

 

18,937

 

26,141

 

114,941

Deferred income taxes

 

5,001

 

1,443

 

Notes payable

 

147,000

 

55,000

 

42,000

Current maturities of long-term debt

 

17,103

 

11,771

 

11,690

Accrued income taxes

 

 

11,650

 

16,022

Liabilities of discontinued operations

 

4,131

 

92,818

 

86,720

 

 

455,525

 

473,976

 

535,185

 

 

 

 

 

 

 

Long-term debt, net of current maturities

 

632,295

 

670,193

 

672,770

 

 

 

 

 

 

 

Deferred credits and other liabilities:

 

 

 

 

 

 

Deferred income taxes

 

170,286

 

134,533

 

128,798

Derivative liabilities

 

2,913

 

2,623

 

6,096

Other

 

101,819

 

95,116

 

90,853

 

 

275,018

 

232,272

 

225,747

 

 

 

 

 

 

 

Minority interest in subsidiaries

 

5,198

 

4,925

 

5,034

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

Common stock equity –

 

 

 

 

 

 

Common stock $1 par value; 100,000,000 shares authorized;

 

 

 

 

 

 

Issued 33,330,841; 33,222,522 and 33,200,699 shares,

 

 

 

 

 

 

respectively

 

33,331

 

33,223

 

33,201

Additional paid-in capital

 

407,488

 

404,035

 

403,822

Retained earnings

 

338,420

 

313,217

 

297,204

Treasury stock at cost – 34,720; 66,938 and 73,805

 

 

 

 

 

 

shares, respectively

 

(883)

 

(1,766)

 

(1,909)

Accumulated other comprehensive income (loss)

 

2,341

 

(9,830)

 

(17,411)

 

 

780,697

 

738,879

 

714,907

 

 

 

 

 

 

 

 

$

2,148,733

$

2,120,245

$

2,153,643

 

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed consolidated financial statements.

 

4

 

BLACK HILLS CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

 

Nine Months Ended

 

September 30,

 

2006

2005

 

(in thousands)

Operating activities:

 

 

 

 

Income from continuing operations

$

53,128

$

6,785

Adjustments to reconcile income from continuing operations

 

 

 

 

to net cash provided by operating activities:

 

 

 

 

Depreciation, depletion and amortization

 

67,407

 

62,362

Impairment of long-lived assets

 

 

50,279

Net change in derivative assets and liabilities

 

2,136

 

2,894

Deferred income taxes

 

32,042

 

(17,617)

Distributed earnings in associated companies

 

4,304

 

1,954

Change in operating assets and liabilities, net of acquisition-

 

 

 

 

Materials, supplies and fuel

 

(6,389)

 

(19,058)

Accounts receivable and other current assets

 

59,005

 

(14,068)

Accounts payable and other current liabilities

 

(61,878)

 

39,932

Other operating activities

 

26,239

 

15,489

Net cash provided by operating activities of continuing operations

 

175,994

 

128,952

Net cash (used in) provided by operating activities of discontinued operations

 

(1,583)

 

5,276

Net cash provided by operating activities

 

174,411

 

134,228

 

 

 

 

 

Investing activities:

 

 

 

 

Property, plant and equipment additions

 

(153,820)

 

(86,897)

Proceeds from sale of assets

 

 

103,010

Payment for acquisition, net of cash acquired

 

(75,425)

 

(67,331)

Other investing activities

 

(454)

 

5,615

Net cash used in investing activities of continuing operations

 

(229,699)

 

(45,603)

Net cash provided by (used in) investing activities of discontinued operations

 

40,160

 

(6,966)

Net cash used in investing activities

 

(189,539)

 

(52,569)

 

 

 

 

 

Financing activities:

 

 

 

 

Dividends paid

 

(32,954)

 

(31,612)

Common stock issued

 

3,560

 

12,822

Increase in short-term borrowings, net

 

92,000

 

18,000

Long-term debt – issuances

 

90,000

 

Long-term debt – repayments

 

(122,566)

 

(91,675)

Other financing activities

 

(1,171)

 

(730)

Net cash provided by (used in) financing activities of continuing operations

 

28,869

 

(93,195)

Net cash used in financing activities of discontinued operations

 

 

Net cash provided by (used in) financing activities

 

28,869

 

(93,195)

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

13,741

 

(11,536)

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

Beginning of period

 

34,198*

 

64,507**

End of period

$

47,939*

$

52,971**

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

Non-cash investing and financing activities-

 

 

 

 

Property, plant and equipment acquired with accrued liabilities

$

31,481

$

9,711

Cash paid during the period for-

 

 

 

 

Interest

$

35,317

$

31,551

Net income taxes paid

$

12,806

$

2,403

_________________________

   *Includes approximately $0.2 million at September 30, 2006 and $2.4 million at December 31, 2005 of cash included in discontinued operations.

**Includes approximately $6.9 million at September 30, 2005 and $8.6 million at December 31, 2004 of cash included in discontinued operations.

 

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed consolidated financial statements.

5

 

 

 

BLACK HILLS CORPORATION

 

Notes to Condensed Consolidated Financial Statements

(unaudited)

(Reference is made to Notes to Consolidated Financial Statements

included in the Company’s 2005 Annual Report on Form 10-K)

 

(1)

MANAGEMENT’S STATEMENT

 

The financial statements included herein have been prepared by Black Hills Corporation (the Company) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations; however, the Company believes that the footnotes adequately disclose the information presented. These financial statements should be read in conjunction with the financial statements and the notes thereto, included in the Company’s 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).

 

Accounting methods historically employed require certain estimates as of interim dates. The information furnished in the accompanying financial statements reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the September 30, 2006, December 31, 2005 and September 30, 2005 financial information and are of a normal recurring nature. Some of the Company’s operations are highly seasonal and revenues from, and certain expenses for, such operations may fluctuate significantly among quarterly periods. Demand for natural gas is sensitive to seasonal heating and industrial load requirements, as well as changes in market price. The results of operations for the three and nine months ended September 30, 2006, are not necessarily indicative of the results to be expected for the full year. All earnings per share amounts discussed refer to diluted earnings per share unless otherwise noted.

 

(2)

RECLASSIFICATIONS

 

Certain 2005 amounts in the financial statements have been reclassified to conform to the 2006 presentation. These reclassifications include reflecting a net presentation for derivative assets and liabilities that are subject to master netting agreements which provide for the legal right of offset of amounts due to and due from the same counterparty under the agreement. At September 30, 2005, current derivative assets and current derivative liabilities on the accompanying Condensed Consolidated Balance Sheet have been reduced by approximately $133.5 million and non-current derivative assets and non-current derivative liabilities have been reduced by approximately $1.7 million to reflect the legal right of offset and conform to the December 31, 2005 and September 30, 2006 presentation. These reclassifications did not have an effect on the Company’s total stockholders’ equity or net income available for common stock as previously reported.

 

 

6

 

 

 

(3)

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

 

SFAS No. 123 (Revised 2004)

 

On December 16, 2004, the Financial Accounting Standards Board, or FASB, issued FASB Statement No. 123 (Revised 2004) “Share-Based Payment,” or SFAS 123(R), which is a revision of SFAS Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.

 

The Company previously accounted for its employee equity compensation stock option plans under the provisions of APB No. 25 and no stock-based employee compensation cost is reflected in net income for the three and nine month periods ended September 30, 2005 for stock options.

 

As of January 1, 2006, the Company applied the provisions of SFAS 123(R) using the modified prospective method, recognizing compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that were outstanding at the date of adoption. Adoption of SFAS 123(R) did not have a significant effect on the Company’s consolidated financial position, results of operations or cash flows. See Note 11, Common Stock, for further discussion of stock-based compensation plans.

 

EITF Issue No. 04-6

 

On March 17, 2005, the Emerging Issues Task Force (EITF) issued EITF Issue No. 04-6, “Accounting for Stripping Costs Incurred during Production in the Mining Industry” (EITF 04-6). EITF 04-6 provides that stripping costs incurred during the production phase of a mine are variable production costs that should be included in the costs of the inventory produced during the period that the stripping costs are incurred. EITF 04-6 is effective for the first reporting period in fiscal years beginning after December 15, 2005. Upon adoption of EITF 04-6 on January 1, 2006, the Company recorded a $2.0 million cumulative effect adjustment to write-off previously recorded deferred charges, with the offset decreasing retained earnings. Additionally, since January 1, 2006, stripping costs are expensed at the time incurred.

 

EITF Issue No. 04-13

 

On September 28, 2005 the FASB ratified the consensus reached under EITF Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty,” (EITF 04-13) which determines if such transactions should be reported on a gross basis or a net basis.

 

EITF 04-13 is effective for new arrangements entered into, and modifications or renewals of existing arrangements, in reporting periods beginning after March 16, 2006. The adoption did not have a significant effect on the Company’s consolidated financial position, results of operations or cash flows.

 

 

7

 

 

 

(4)

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

SFAS No. 157

 

During September 2006 the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157) and applies under other accounting pronouncements that require or permit fair value measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Management is currently evaluating the impact SFAS 157 will have on the Company’s consolidated financial statements.

 

SFAS No. 158

 

During September 2006 the FASB issued Statement of Financial Accounting Standards No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS 158). This Statement requires the recognition of the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability in the statement of financial position, recognition of changes in the funded status in comprehensive income, measurement of the funded status of a plan as of the date of the year-end statement of financial position, and provides for related disclosures. SFAS 158 is effective for the recognition of the funded status as an asset or liability in the statement of financial position, recognition of changes in the funded status in comprehensive income, and the related disclosures in financial statements issued for fiscal years ending after December 15, 2006. Effective for fiscal years ending after December 15, 2008, SFAS 158 will require the measurement of the funded status of the plan to coincide with the date of the year end statement of financial position. Management is currently evaluating the impact SFAS 158 will have on the Company’s consolidated financial statements.

 

FIN 48

 

During June 2006 the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109 “Accounting for Income Taxes” (FAS 109) and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006 with the impact of adoption to be reported as a cumulative effect of an accounting change. Management is currently evaluating the impact FIN 48 will have on the Company’s consolidated financial statements.

 

 

8

 

 

 

SAB No. 108 – Effects of Prior Year Misstatements on Current Year Financial Statements  

 

During September 2006 the staff of the SEC released SAB No. 108 on Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides guidance on how the effects of the carryover or reversal of prior year financial statement misstatements should be considered in quantifying a current year misstatement. Prior practice allowed the evaluation of materiality on the basis of (1) the error quantified as the amount by which the current year income statement was misstated (rollover method) or (2) the cumulative error quantified as the cumulative amount by which the current year balance sheet was misstated (iron curtain method). Reliance on either method in prior years could have resulted in misstatement of the financial statements. The guidance provided in SAB No. 108 requires both methods to be used in evaluating materiality. Immaterial prior year errors may be corrected with the first filing of prior year financial statements after adoption. The cumulative effect of the correction can either be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year, and the offsetting adjustment made to the opening balance of retained earnings for that year, or by restating prior periods. Appropriate disclosure of the nature and amount of each individual error being corrected in the cumulative adjustment, as well as a disclosure of when and how each error being corrected arose and the fact that the errors had previously been considered immaterial. SAB No. 108 is effective January 1, 2007. Management is currently evaluating the impact this bulletin might have on the Company’s consolidated financial statements.

 

(5)

MATERIALS, SUPPLIES AND FUEL

 

The amounts of materials, supplies and fuel included on the accompanying Condensed Consolidated Balance Sheets, by major classification, are provided as follows (in thousands):

 

 

September 30,

December 31,

September 30,

Major Classification

2006

2005

2005

 

 

 

 

 

 

 

Materials and supplies

$

30,160

$

24,567

$

24,435

Fuel

 

9,387

 

7,544

 

8,745

Gas held by energy marketing*

 

51,943

 

90,410

 

146,207

 

 

 

 

 

 

 

Total materials, supplies and fuel

$

91,490

$

122,521

$

179,387

___________________________

* As of September 30, 2006, December 31, 2005 and September 30, 2005, market adjustments related to natural gas held by energy marketing and recorded in inventory were $(29.8) million, $6.6 million and $61.0 million, respectively.

 

The gas inventory held by the Company’s energy marketing subsidiary is held under various contractual storage arrangements. The gas is being held in inventory to capture the price differential between the time at which it was purchased and a sales date in the future. A substantial majority of the gas was economically hedged at the time of purchase either through a fixed price physical or financial forward sale.

 

 

9

 

 

 

(6)

LONG-TERM DEBT AND GUARANTEES

 

On July 12, 2006 the Company’s subsidiary, Black Hills Colorado, LLC, entered into a Second Amended and Restated Credit Agreement to refinance the floating rate project debt for the Valmont and Arapahoe plants in the amount of $90.0 million. The maturity date of the amortizing borrowings is July 2013. In conjunction with the refinancing, the Company made a payment in the amount of $21.3 million on the $111.3 million principal outstanding at June 30, 2006 and expensed approximately $0.7 million of unamortized deferred finance costs associated with the First Amended and Restated Credit Agreement. In addition, as of July 12, 2006, the Company has guaranteed during the term of the debt the payment obligations of Black Hills Colorado, LLC, to the Bank of Nova Scotia, as administrative agent under the Credit Agreement, for up to $30 million. The cost of borrowings under the facility is determined based upon the Company’s corporate credit ratings; at the current ratings levels, the facility has a borrowing spread on Eurodollar loans of 87.5 basis points over LIBOR (which equates to a 6.25 percent, three-month borrowing rate as of September 30, 2006).

 

On May 24, 2006 the Company entered into an Amended and Restated Credit Agreement for the project financing floating rate debt for Wygen I. The agreement extended the maturity date of the $111.1 million tranche of the financing from June 2006 to June 2008 to coincide with the maturity date of the remaining $17.2 million tranche. The cost of borrowings under the financing is determined based upon the Company’s corporate credit ratings; at the Company’s current ratings levels, the financing has a borrowing spread on Eurodollar loans of 62.5 basis points over LIBOR (which equates to a 5.95 percent, one-month borrowing rate as of September 30, 2006). In conjunction with the Amended and Restated Credit Agreement, the Company entered into an Amended and Restated Guarantee in favor of Wygen Funding, Limited Partnership, which continues the Company’s guarantee obligations under the Wygen I plant lease.

 

In addition to the guarantees discussed above, during the nine months ended September 30, 2006 the Company had the following changes to its guarantees:

 

•     Issued and amended a Guarantee for payment under various transactions by Cheyenne Light with Tenaska Marketing Ventures for $2.0 million, expiring in 2007.

 

•     Extinguished a guarantee of up to $3.0 million of Enserco Energy Inc.’s obligations to Fortis Capital Corp. and other lenders under its credit facility.

 

•     Expiration of a guarantee of an interest rate swap transaction with Union Bank of California.

 

At September 30, 2006, we had guarantees totaling $187.9 million in place.

 

 

10

 

 

 

(7)

EARNINGS PER SHARE

 

Basic earnings per share from continuing operations is computed by dividing income from continuing operations by the weighted-average number of common shares outstanding during the period. Diluted earnings per share from continuing operations gives effect to all dilutive common shares potentially outstanding during a period. A reconciliation of “Income from continuing operations” and basic and diluted share amounts is as follows (in thousands):

 

Period ended September 30, 2006

Three Months

Nine Months

 

 

   Average

 

Average

 

Income

Shares

Income

Shares

 

 

 

 

 

 

 

Income from continuing operations

$

22,199

 

$

53,128

 

 

 

 

 

 

 

 

Basic – available for common shareholders

 

22,199

33,187

 

53,128

33,157

Dilutive effect of:

 

 

 

 

 

 

Stock options

 

91

 

85

Estimated contingent shares issuable

 

 

 

 

 

 

for prior acquisition

 

158

 

158

Others

 

124

 

126

Diluted – available for common shareholders

$

22,199

33,560

$

53,128

33,526

 

 

 

Period ended September 30, 2005

Three Months

Nine Months

 

 

   Average

 

Average

 

Income

Shares

Income

Shares

 

 

 

 

 

 

 

Income (loss) from continuing operations

$

(23,784)

 

$

6,785

 

Less: preferred stock dividends

 

 

 

(159)

 

 

 

 

 

 

 

 

Basic – available for common shareholders

 

(23,784)

32,967

 

6,626

32,660

Dilutive effect of:

 

 

 

 

 

 

Stock options

 

 

164

Estimated contingent shares issuable

 

 

 

 

 

 

for prior acquisition

 

 

158

Others

 

 

118

Diluted – available for common shareholders

$

(23,784)

32,967

$

6,626

33,100

 

 

11

 

 

 

(8)

COMPREHENSIVE INCOME

 

The following table presents the components of the Company’s comprehensive income (loss)

(in thousands):

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2006

2005

2006

2005

 

 

 

 

 

 

 

 

 

Net income (loss)

$

22,280

$

(23,903)

$

60,188

$

6,807

Other comprehensive income (loss),

 

 

 

 

 

 

 

 

net of tax:

 

 

 

 

 

 

 

 

Fair value adjustment on derivatives

 

 

 

 

 

 

 

 

designated as cash flow hedges

 

7,425

 

(11,095)

 

12,587

 

(15,260)

Reclassification adjustments on cash flow

 

 

 

 

 

 

 

 

hedges settled and included in net

 

 

 

 

 

 

 

 

income

 

(246)

 

3,262

 

(416)

 

5,441

Unrealized gain on available-for-sale

 

 

 

 

 

 

 

 

securities

 

 

 

 

15

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

$

29,459

$

(31,736)

$

72,359

$

(2,997)

 

(9)

INCOME TAXES

 

The Company’s effective tax rates differ from the federal statutory rate as follows:

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2006

2005

2006

2005

 

 

 

 

 

 

35.0%

35.0%

35.0%

35.0%

State income tax

0.3

1.1

0.5

(2.1)

Percentage depletion in excess of cost

(1.5)

0.7

(1.3)

(6.0)

IRS exam tax adjustment*

(7.3)

(2.8)

Tax return true-up

(1.3)

1.5

(0.5)

(4.5)

Other

(0.3)

(1.2)

0.2

3.5

 

24.9%

37.1%

31.1%

25.9%

________________________

 

*

As a result of the settlement of an Internal Revenue Service (IRS) exam of the tax years

 

 

 2001-2003 with respect to certain tax positions taken by the Company, a reduction to income

 

 tax expense of approximately $2.2 million was recorded in the third quarter of 2006.

 

 

 

12

 

 

 

(10)

PROCEEDS RECEIVED ON INSURANCE CLAIMS

 

In late 2005 and the first half of 2006, the Company’s Las Vegas II power plant experienced unplanned outages due to damage to three of its gas turbines and two of its steam turbines. The outages lasted approximately six months as repairs were made to the turbines. The Company has filed insurance claims for reimbursement of repair expenditures and business interruption losses in the amount of approximately $11.1 million. At September 30, 2006, the Company has provided for the receipt of insurance proceeds of approximately $4.3 million. Approximately $0.4 million was applied to reduce capitalized repair costs included in Property, plant and equipment on the accompanying Condensed Consolidated Balance Sheet and $2.2 million for repair costs and $1.7 million for business interruption were applied as a reduction to Operations and maintenance expense on the accompanying Condensed Consolidated Statement of Income. While the Company is pursuing additional reimbursement from the insurance carrier, the carrier asserts that certain deductibles, exclusions and limitations apply preventing any future claims reimbursements. There can be no assurance that the Company will obtain any additional recovery from the insurance carrier.

 

(11)

COMMON STOCK

 

Equity Compensation Plans

 

The Company has several employee equity compensation plans, which allow for the granting of stock, restricted stock, restricted stock units, stock options and performance shares. The Company has 1,082,894 shares available to grant at September 30, 2006.

 

At September 30, 2006, the Company had one stock-based employee compensation plan under which it can grant stock options to its employees and three prior plans with stock options outstanding. Prior to January 1, 2006, the Company accounted for these plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees (APB 25),” and related interpretations. Prior to 2006, no stock-based compensation expense related to stock options was reflected in net income as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. However, the Company did recognize stock-based compensation expense for other non-vested share awards including restricted stock and restricted stock units, performance shares and directors’ phantom shares.

 

 

13

 

 

 

The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share amounts):

 

 

Three Months Ended

Nine Months Ended

 

September 30, 2005

September 30, 2005

 

 

 

 

 

Net (loss) income available for common stock, as reported

$

(23,903)

$

6,648

Deduct: Total stock-based employee compensation expense

 

 

 

 

determined under fair value based method for all awards,

 

 

 

 

net of related tax effects

 

(126)

 

(389)

Pro forma net income available for common stock

$

(24,029)

$

6,259

 

 

 

 

 

Earnings (loss) per share:

 

 

 

 

Basic–as reported

 

 

 

 

Continuing operations

$

(0.73)

$

0.20

Discontinued operations

 

 

Total

$

(0.73)

$

0.20

Diluted–as reported

 

 

 

 

Continuing operations

$

(0.73)

$

0.20

Discontinued operations

 

 

Total

$

(0.73)

$

0.20

 

 

 

 

 

Basic–pro-forma

 

 

 

 

Continuing operations

$

(0.73)

$

0.19

Discontinued operations

 

 

Total

$

(0.73)

$

0.19

Diluted–pro-forma

 

 

 

 

Continuing operations

$

(0.73)

$

0.19

Discontinued operations

 

 

Total

$

(0.73)

$

0.19

 

On January 1, 2006 the Company adopted the fair value recognition provisions of SFAS 123(R) requiring the recognition of expense related to the fair value of stock-based compensation awards. The Company elected the modified prospective transition method. Under this method, compensation expense is recognized for all stock-based awards granted prior to, but not yet vested as of January 1, 2006 and all stock-based awards granted subsequent to January 1, 2006. Adoption of SFAS 123(R) did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows. Compensation expense is determined using the grant date fair value estimated in accordance with the provisions of SFAS 123(R) and is recognized over the vesting periods of the individual plans. Total stock-based compensation expense for the three months ended September 30, 2006 and 2005 was $0.1 million ($0.1 million, after tax) and $1.1 million ($0.7 million, after tax), respectively, and for the nine months ended September 30, 2006 and 2005 was $1.8 million ($1.2 million, after tax) and $3.1 million ($2.0 million, after tax), respectively, and is included in administrative and general expense on the accompanying Condensed Consolidated Statements of Income. In accordance with the modified prospective transition method of SFAS 123(R), financial results for prior periods have not been restated. As of September 30, 2006, total unrecognized compensation expense related to stock options and other non-vested stock awards is $3.5 million and is expected to be recognized over a weighted-average period of 1.8 years.

 

 

14

 

 

 

In November 2005, the FASB issued FASB Staff Position (FSP) No. FAS 123 (R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” FSP 123(R)-3 provides an alternative method of calculating the excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS 123(R). The calculation of excess tax benefits reported as an operating cash outflow and a financing inflow in the Consolidated Statements of Cash Flows required by FSP No. 123(R)-3 differs from that required by SFAS 123(R). The Company has until January 1, 2007 to make a one-time election to adopt the transition method described in FSP No. 123 (R)-3. The Company is currently evaluating FSP No. FAS 123 (R)-3; however, the one-time election is not expected to affect the Company’s results of operations.

 

Stock Options

 

The Company has granted options with an option exercise price equal to the fair market value of the stock on the day of the grant. The options granted vest one-third each year for three years and expire after ten years from the grant date.

 

A summary of the status of the stock option plans at September 30, 2006 is as follows:

 

 

 

 

Weighted-

 

 

 

Weighted-

Average

 

 

 

Average

Remaining

Aggregate

 

 

Exercise

Contractual

Intrinsic

 

Shares

Price

Term

Value

 

(in thousands)

 

(in years)

(in thousands)

 

 

 

 

 

Balance at January 1, 2006

854

$

29.56

 

 

 

Granted

15

 

33.17

 

 

 

Forfeited/cancelled

(18)

 

33.53

 

 

 

Expired

 

 

 

 

Exercised

(71)

 

27.99

 

 

 

Balance at September 30, 2006

780

$

29.68

5.5

$

3,066

 

 

 

 

 

 

 

Exercisable at September 30, 2006

680

$

29.58

5.1

$

2,739

 

The weighted-average grant-date fair value of options granted during the nine months ended September 30, 2006 and 2005 was $3.79 and $6.93, respectively. The total intrinsic value of options (the amount by which the market price of the stock on the date of exercise exceeded the exercise price of the option) exercised during the nine months ended September 30, 2006 and 2005 was $0.5 million and $5.1 million, respectively. The total fair value of shares vested during each of the nine months ended September 30, 2006 and 2005 was $0.4 million and $0.7 million, respectively.

 

 

15

 

 

 

The fair value of share-based awards is estimated on the date of grant using the Black-Scholes option pricing model. The fair value is affected by the Company’s stock price as well as a number of assumptions. The assumptions used to estimate the fair value of share-based awards are as follows:

 

 

Nine Months Ended

Nine Months Ended

Valuations Assumptions1

September 30, 2006

September 30, 2005

 

 

 

Weighted average risk-free interest rate2

4.94%

3.90%

Weighted average expected price volatility3

21.54%

42.27%

Weighted average expected dividend yield4

3.98%

4.17%

Expected life in years5

7

7

_____________________________

 

 

1

Forfeitures are estimated using historical experience and employee turnover.

   

 

2

Based on treasury interest rates with terms consistent with the expected life of the options.

   

 

3

Based on a blended historical and implied volatility of the Company’s stock price in 2006 and historical volatility only in 2005.

   

 

4

Based on the Company’s historical and expectation of future dividend payouts and may be subject to substantial change in the future.

   

 

5

Based upon historical experience.

 

Net cash received from the exercise of options for the nine months ended September 30, 2006 and 2005 was $2.0 million and $10.0 million, respectively. The tax benefit realized from the exercise of shares granted for the nine months ended September 30, 2006 and 2005 was $0.2 million and $1.8 million, respectively, and was recorded as an increase to equity.

 

As of September 30, 2006, there was $0.3 million of unrecognized compensation expense related to stock options that is expected to be recognized over a weighted-average period of 0.9 years.

 

Restricted Stock and Restricted Stock Units

 

The fair value of restricted stock and restricted stock unit awards equals the market price of the Company’s stock on the date of grant.

 

The shares carry a restriction on the ability to sell the shares until the shares vest. The shares substantially vest one-third per year over three years, contingent on continued employment. Compensation cost related to the awards is recognized over the vesting period.

 

A summary of the status of the restricted stock and non-vested restricted stock units at September 30, 2006 is as follows:

 

 

 

Weighted

 

Stock

Average

 

And

Grant Date

 

Stock Units

Fair Value

 

(in thousands)

 

 

 

 

Balance at January 1, 2006

90

$

30.71

Granted

42

 

35.20

Vested

(37)

 

29.33

Forfeited

(2)

 

32.12

Balance at September 30, 2006

93

$

33.25

 

 

16

 

 

 

The weighted-average grant-date fair value of restricted stock and restricted stock units granted in the nine months ended September 30, 2006 and 2005 was $35.20 and $30.03, per share, respectively. The total fair value of shares vested during the nine months ended September 30, 2006 and 2005 was $1.3 million and $1.2 million, respectively.

 

As of September 30, 2006, there was $2.0 million of unrecognized compensation expense related to non-vested restricted stock and non-vested restricted stock units that is expected to be recognized over a weighted-average period of 1.9 years.

 

Performance Share Plan

 

Certain officers of the Company and its subsidiaries are participants in a performance share award plan, a market-based plan. Performance shares are awarded based on the Company’s total shareholder return over designated performance periods as measured against a selected peer group. In addition, the Company’s stock price must also increase during the performance periods.

 

Participants may earn additional performance shares if the Company’s total shareholder return exceeds the 50th percentile of the selected peer group. The final value of the performance shares may vary according to the number of shares of common stock that are ultimately granted based upon the performance criteria.

 

Outstanding Performance Periods at September 30, 2006 are as follows:

 

Grant Date

Performance Period

Target Grant of Shares

 

 

(in thousands)

 

 

 

March 1, 2004

March 1, 2004 – December 31, 2006

23

January 1, 2005

January 1, 2005 – December 31, 2007

39

January 1, 2006

January 1, 2006 – December 31, 2008

34

 

The performance awards are paid 50 percent in cash and 50 percent in common stock. The cash portion accrued is classified as a liability and the stock portion is classified as temporary equity. In the event of a change-in-control performance awards are paid 100 percent in cash. If it is ever determined that a change-in-control is probable, the equity portion will be reclassified as a liability. At September 30, 2006, the Company had $0.6 million of temporary equity.

 

 

17

 

 

 

A summary of the status of the Performance Share Plan at September 30, 2006 and changes during the nine-month period ended September 30, 2006, is as follows:

 

 

Equity Portion

Liability Portion

 

 

 

 

 

 

 

 

 

Weighted-

 

 

Weighted-

 

Average

 

 

Average

 

September 30,

 

 

Grant Date

 

2006

 

Shares

Fair Value

Shares

Fair Value

 

(in thousands)

 

(in thousands)

 

 

 

 

 

 

Balance at January 1, 2006

38

$

29.95

38

 

 

Granted

17

 

32.06

17

 

 

Forfeited

(1)

 

29.95

(1)

 

 

Vested

(6)

 

29.92

(6)

 

 

Balance at September 30, 2006

48

$

30.70

48

$

23.61

 

The weighted-average grant-date fair value of performance share awards granted in the nine months ended September 30, 2006 and 2005 was $32.06 and $29.97, per share, respectively. The grant date fair value for the performance shares granted in 2006 was determined by Monte Carlo simulation using a blended volatility of 21 percent comprised of 50 percent historical volatility and 50 percent implied volatility and the average risk-free interest rate of the three-year U.S. Treasury security rate in effect as of the grant date. The grant date fair value for the performance shares issued in 2005 was equal to the market value of the common stock on the grant date.

 

During the nine months ended September 30, 2006, the Company issued 11,667 shares of common stock and paid $0.4 million for the Performance Period of March 1, 2004 to December 31, 2005, for a total intrinsic value of $0.8 million. The payout was fully accrued at December 31, 2005.

 

As of September 30, 2006, there was $1.2 million of unrecognized compensation expense related to outstanding performance share plans that is expected to be recognized over a weighted-average period of 1.8 years.

 

Other Plans

 

The Company issued 36,685 shares of common stock with an intrinsic value of $910,000 in the nine months ended September 30, 2006 to certain key employees under the Short-term Annual Incentive Plan, a performance-based plan. The payout was fully accrued at December 31, 2005.

 

 

18

 

 

 

(12)

EMPLOYEE BENEFIT PLANS

 

Defined Benefit Pension Plan

 

The Company has two non-contributory defined benefit pension plans (Plans). One Plan covers employees of the Company and the following subsidiaries who meet certain eligibility requirements: Black Hills Service Company, LLC, Black Hills Power, Inc., Wyodak Resources Development Corp., and Black Hills Exploration and Production, Inc. The other Plan covers employees of the Company’s subsidiary, Cheyenne Light, Fuel and Power Company, who meet certain eligibility requirements.

 

The components of net periodic benefit cost for the two Plans are as follows (in thousands):

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2006

2005

2006

2005

 

 

 

 

 

 

 

 

 

Service cost

$

649

$

576

$

1,947

$

1,728

Interest cost

 

1,041

 

995

 

3,123

 

2,985

Expected return on plan assets

 

(1,247)

 

(1,157)

 

(3,741)

 

(3,471)

Amortization of prior service cost

 

38

 

54

 

114

 

162

Amortization of net loss

 

227

 

296

 

681

 

888

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

$

708

$

764

$

2,124

$

2,292

 

The Company made a $1.2 million contribution to the Cheyenne Light Pension Plan in the first quarter of 2006; no additional contributions are anticipated to be made to the Plans during the 2006 fiscal year.

 

Supplemental Non-qualified Defined Benefit Plans

 

The Company has various supplemental retirement plans for key executives of the Company (Supplemental Plans). The Supplemental Plans are non-qualified defined benefit plans.

 

The components of net periodic benefit cost for the Supplemental Plans are as follows (in thousands):

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2006

2005

2006

2005

 

 

 

 

 

 

 

 

 

Service cost

$

87

$

86

$

261

$

258

Interest cost

 

270

 

252

 

810

 

756

Amortization of prior service cost

 

3

 

2

 

9

 

6

Amortization of net loss

 

199

 

157

 

597

 

471

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

$

559

$

497

$

1,677

$

1,491

 

 

19

 

 

 

The Company anticipates that it will need to make contributions to the Supplemental Plans for the 2006 fiscal year of approximately $0.7 million. The contributions are expected to be made in the form of benefit payments.

 

Non-pension Defined Benefit Postretirement Healthcare Plans

 

Employees who are participants in the Company’s Postretirement Healthcare Plans (Healthcare Plans) and who meet certain eligibility requirements are entitled to postretirement healthcare benefits.

 

The components of net periodic benefit cost for the Healthcare Plans are as follows (in thousands):

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2006

2005

2006

2005

 

 

 

 

 

 

 

 

 

Service cost

$

164

$

185

$

492

$

555

Interest cost

 

203

 

232

 

609

 

696

Amortization of net transition

 

 

 

 

 

 

 

 

obligation

 

38

 

37

 

114

 

111

Amortization of prior service cost

 

(6)

 

(6)

 

(18)

 

(18)

Amortization of net loss

 

 

25

 

 

75

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

$

399

$

473

$

1,197

$

1,419

 

The Company anticipates that it will make contributions to the Healthcare Plans for the 2006 fiscal year of approximately $0.2 million. The contributions are expected to be made in the form of benefits payments.

 

It has been determined that the Company’s post-65 retiree prescription drug plans are actuarially equivalent and qualify for the Medicare Part D subsidy. The decrease in net periodic postretirement benefit cost due to the subsidy is as follows (in thousands):

 

 

Three Months

Nine Months

 

Ended

Ended

 

September 30, 2006

September 30, 2006

 

 

 

 

 

Service cost

$

(25)

$

(75)

Interest cost

 

(28)

 

(84)

Amortization of net loss

 

(18)

 

(54)

 

 

 

 

 

Total decrease to net periodic

 

 

 

 

postretirement benefit cost

$

(71)

$

(213)

 

 

20

 

 

 

(13)

IMPAIRMENT TESTING OF OIL AND NATURAL GAS PROPERTIES

 

The Company’s oil and gas segment follows the full cost method of accounting for its oil and gas properties. Under the full cost method, costs related to acquisition, exploration and development drilling activities are capitalized. The net capitalized costs are subject to a “ceiling test” that limits these costs to the estimated present value of future net revenues from proved reserves based on a single day’s spot market prices, and the lower of cost or fair value of unproved properties. Rules mandated by the Securities and Exchange Commission require that future net revenues be based on end-of-period spot market prices, with consideration for alternate prices only to the extent provided for by contractual arrangements, and discounted at a 10 percent interest rate. If the net capitalized costs exceed the full cost “ceiling” at period end, a permanent non-cash write-down would be required to be charged to earnings in that period unless subsequent market price changes eliminate or reduce the indicated write-down.

 

In accordance with the Company’s full cost method of accounting for its oil and gas properties, we conducted our quarterly “ceiling test” as of September 30, 2006. Spot market prices for natural gas, particularly in the Rocky Mountain region where a predominant portion of the Company’s reserves are located, experienced a drastic and brief decline at the end of the period ended September 30, 2006. If the spot market prices on September 28, 2006, the market trading date for September 30, 2006 natural gas deliveries, were used the “ceiling” limitation would have exceeded the Company’s net capitalized costs and accordingly no ceiling test write-down would have been indicated. Average wellhead adjusted natural gas and crude oil prices on this date were $3.16 per Mcf and $55.39 per barrel, respectively. When using the spot market prices on September 29, 2006, the last market trading day of the period, the calculation resulted in an indicated $15.5 million pre-tax impairment of the Company’s oil and gas properties at September 30, 2006. Average wellhead adjusted natural gas and crude oil spot prices used on this date in the “ceiling test” calculation were $2.79 per Mcf and $55.39 per barrel, respectively. The Company does not believe this short-term decline in natural gas prices impacts the long-term economic value of its oil and gas properties as its average reserve life is approximately 15 years with individual well lives ranging up to 40 years.

 

Subsequent to September 30, 2006 natural gas prices both nationwide and in the Rocky Mountain region increased significantly. In accordance with the full cost accounting rules the Company recalculated its full cost "ceiling" using November 2, 2006 average wellhead adjusted spot prices of $5.88 per Mcf and $48.69 per barrel, respectively. These prices resulted in a "ceiling" limit significantly in excess of the Company's net capitalized costs, thereby eliminating the need to take a charge to earnings and write-down the carrying value of the Company's oil and gas properties.

 

 

21

 

 

 

(14)

IMPAIRMENT OF LONG-LIVED ASSETS AND CAPITALIZED DEVELOPMENT COSTS

 

Due to a significant increase in the long-term forecasts for natural gas prices during the third quarter of 2005, the operation of the Company’s Las Vegas I gas-fired power plant (Las Vegas I) became uneconomic. Accordingly, the Company assessed the recoverability of the carrying value of Las Vegas I in accordance with the provisions of SFAS No. 144 “Accounting for the Impairment of Long-lived Assets” (SFAS 144).

 

Las Vegas I is a 53 megawatt, natural gas-fired, combined-cycle turbine operating under a contract as a qualifying facility as defined by the Public Utility Regulatory Policies Act of 1978. Under the contract, which extends through 2024, the Company sells capacity and energy to Nevada Power Company and accepts price risk associated with the plant’s fuel requirements. While the Company’s oil and gas exploration and production operation produces gas sufficient to cover the plant’s fuel requirements thus providing an internal hedge, SFAS 144 requires the determination of asset impairment at each asset group which has separately identifiable cash flows.

 

The carrying value of the assets tested for impairment was $60.3 million. The assessment resulted in an impairment charge in September, 2005 of $50.3 million to write down the related Property, plant and equipment by $44.7 million, net of accumulated depreciation of $11.1 million, and intangible assets by $5.6 million, net of accumulated amortization of $1.5 million. This charge reflects the amount by which the carrying value of the facility exceeded its estimated fair value determined by its estimated future discounted cash flows. This charge is included as a component of “Operating expenses” on the accompanying Condensed Consolidated Statements of Income. Operating results from Las Vegas I are included in the Power Generation Segment.

 

In addition, during the three-month period ended September 30, 2005, the Company recorded an $8.9 million pre-tax charge for the write-off and expensing of certain capitalized costs for various energy development projects determined less likely to advance, and costs related to unsuccessfully bid projects during the third quarter of 2005. The Company determined these projects were less likely to advance, due to reduced economic feasibility of gas-fired power generation in the expected sustained high-priced natural gas environment, increased expectations of reliance on renewable or coal-fired generation, and a perceived preference of utilities in certain regions to acquire existing merchant generation at significant discounts as an alternative to entering into contracts for capacity and energy from new generation. These costs had been capitalized as management believed it was probable that such costs would ultimately result in acquisition or construction of the projects. This charge is included as a component of “Operating expenses” on the accompanying Condensed Consolidated Statements of Income. For segment reporting the development costs are included in Corporate results.

 

 

22

 

 

 

(15)

SUMMARY OF INFORMATION RELATING TO SEGMENTS OF THE COMPANY’S BUSINESS

 

The Company’s reportable segments are those that are based on the Company’s method of internal reporting, which generally segregates the strategic business groups due to differences in products, services and regulation. As of September 30, 2006, substantially all of the Company’s operations and assets are located within the United States. On March 1, 2006, the Company completed the sale of the operating assets of Black Hills Energy Resources, Inc. and related subsidiaries, the Company’s crude oil marketing and pipeline transportation business which for segment reporting was classified in the Energy marketing and transportation segment; and on June 30, 2005 the Company completed the sale of its subsidiary, Black Hills FiberSystems, Inc., which operated as the Company’s Communications segment (see Note 19). The financial information of the related crude oil marketing and pipeline transportation business and communications segment has been reclassified into Discontinued operations on the accompanying condensed consolidated financial statements.

 

The Company conducts its operations through the following six reporting segments: Retail Services group consisting of the following segments: Electric utility, which supplies electric utility service to western South Dakota, northeastern Wyoming and southeastern Montana; and Electric and gas utility, acquired January 21, 2005, which supplies electric and gas utility service to Cheyenne, Wyoming and vicinity; and Wholesale Energy group, consisting of the following segments: Coal mining, which engages in the mining and sale of coal from its mine near Gillette, Wyoming; Oil and gas, which explores for and produces oil and gas primarily in the Rocky Mountain region, with non-operated interests in Texas, California, Oklahoma and other states; Energy marketing, which markets natural gas, crude oil and related services to customers in the Midwest, Southwest, Rocky Mountain, West Coast and Northwest regions; and Power generation, which produces and sells power and capacity to wholesale customers with plants concentrated in Colorado, Nevada, Wyoming and California.

 

Segment information follows the same accounting policies as described in Note 22 of the Company’s 2005 Annual Report on Form 10-K. In accordance with the provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation” (SFAS 71), intercompany fuel sales to the electric utility are not eliminated.

 

 

23

 

 

 

Segment information included in the accompanying Condensed Consolidated Statements of Income is as follows (in thousands):

 

 

External

Inter-segment

Income (Loss) from

 

Operating

Operating

Continuing

 

Revenues

Revenues

Operations

Three Month Period Ended

 

 

 

 

 

 

September 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail services:

 

 

 

 

 

 

Electric utility

$

52,467

$

723

$

5,764

Electric and gas utility

 

24,479

 

 

953

Wholesale energy:

 

 

 

 

 

 

Coal mining

 

6,055

 

3,391

 

1,908

Oil and gas

 

22,969

 

 

3,006

Energy marketing

 

6,327

 

 

2,378

Power generation

 

42,700

 

 

9,839

Corporate

 

11

 

 

(1,649)

Inter-segment eliminations

 

 

(1,514)

 

 

 

 

 

 

 

 

Total

$

155,008

$

2,600

$

22,199

 

 

 

External

Inter-segment

Income (Loss) from

 

Operating

Operating

Continuing

 

Revenues

Revenues

Operations

Three Month Period Ended

 

 

 

 

 

 

September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail services:

 

 

 

 

 

 

Electric utility

$

48,336

$

938

$

1,888

Electric and gas utility

 

23,501

 

 

(127)

Wholesale energy:

 

 

 

 

 

 

Coal mining

 

5,537

 

2,945

 

1,643

Oil and gas

 

22,800

 

7

 

5,109

Energy marketing

 

3,398

 

 

(1,206)

Power generation

 

43,076

 

 

(24,587)*

Corporate

 

93

 

 

(6,504)**

Inter-segment eliminations

 

 

(1,623)

 

 

 

 

 

 

 

 

Total

$

146,741

$

2,267

$

(23,784)

________________________

 

*

Loss from continuing operations includes $32.7 million after-tax impairment charge for Las Vegas I.

 

**

Loss from continuing operations includes $5.8 million after-tax for the write-off and expensing of certain capitalized project development costs.

 

24

 

 

 

 

External

Inter-segment

Income (Loss) from

 

Operating

Operating

Continuing

 

Revenues

Revenues

Operations

Nine Month Period Ended

 

 

 

 

 

 

September 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail services:

 

 

 

 

 

 

Electric utility

$

142,676

$

1,518

$

13,099

Electric and gas utility

 

97,907

 

 

3,214

Wholesale energy:

 

 

 

 

 

 

Coal mining

 

15,905

 

9,579

 

4,091

Oil and gas

 

69,519

 

 

10,439

Energy marketing

 

34,907

 

 

13,249

Power generation

 

114,991

 

 

14,310

Corporate

 

43

 

 

(5,274)

Inter-segment eliminations

 

 

(3,733)

 

 

 

 

 

 

 

 

Total

$

475,948

$

7,364

$

53,128

 

 

External

Inter-segment

Income (Loss) from

 

Operating

Operating

Continuing

 

Revenues

Revenues

Operations

Nine Month Period Ended

 

 

 

 

 

 

September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail services:

 

 

 

 

 

 

Electric utility

$

133,295

$

1,387

$

9,619

Electric and gas utility

 

78,034

 

 

1,028

Wholesale energy:

 

 

 

 

 

 

Coal mining

 

15,717

 

9,144

 

4,860

Oil and gas

 

61,504

 

7

 

14,346

Energy marketing

 

16,193

 

 

2,187

Power generation

 

121,366

 

 

(14,601)*

Corporate

 

647

 

 

(10,654)**

Inter-segment eliminations

 

 

(3,481)

 

 

 

 

 

 

 

 

Total

$

426,756

$

7,057

$

6,785

_________________________

 

*

Loss from continuing operations includes $32.7 million after-tax impairment charge for Las Vegas I.

 

**

Loss from continuing operations includes $6.2 million after-tax for the write-off and expensing of certain capitalized project development costs.

 

Other than the sale of the assets of the crude oil marketing and transportation business and its reclassification to Discontinued operations, and the acquisition of certain oil and gas assets in the Piceance Basin in Colorado, the Company had no material changes in the assets of its reporting segments, as reported in Note 22 of the Notes to Consolidated Financial Statements in the Company’s 2005 Annual Report on Form 10-K, beyond changes resulting from normal operating activities.

 

25

 

 

 

 

(16)

RISK MANAGEMENT ACTIVITIES

 

The Company actively manages its exposure to certain market risks as described in Note 2 of the Notes to Consolidated Financial Statements in the Company’s 2005 Annual Report on Form 10-K. Details of derivative and hedging activities included in the accompanying Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Income are as follows:

 

Trading Activities

 

Natural Gas and Crude Oil Marketing

 

The Company’s natural gas and crude oil marketing subsidiary, Enserco Energy Inc. (Enserco), recently began marketing crude oil in the Rocky Mountain region out of the Company’s Golden, Colorado offices. Our primary strategy involves executing physical crude oil purchase contracts with producers, and reselling into various markets. These transactions are primarily entered into as back-to-back purchases and sales, effectively locking in a marketing fee equal to the difference between the sales price and the purchase price, less transportation costs. Under FAS 133, mark-to-market accounting for the related commodity contracts in the Company’s back-to-back strategy results in an acceleration of marketing margins locked in for the term of the contracts. These are generally short-term contracts with automatic renewals (typically monthly) if there is no notice of cancellation. The realized and unrealized gains and losses from the oil marketing activities are shown net on the accompanying Condensed Consolidated Income Statement within “Operating revenues”.

 

The contract or notional amounts and terms of the Company’s natural gas and crude oil marketing activities and derivative commodity instruments are as follows:

 

 

Outstanding at

Outstanding at

Outstanding at

 

September 30, 2006

December 31, 2005

September 30, 2005

 

 

 

Latest

 

 

Latest

 

 

Latest

 

 

Notional

Expiration

 

Notional

Expiration

 

Notional

Expiration

 

 

Amounts

(months)

 

Amounts

(months)

 

Amounts

(months)

(in thousands of MMbtus)

 

 

 

 

 

 

 

 

 

Natural gas basis

 

 

 

 

 

 

 

 

 

swaps purchased

 

146,331

16

 

43,507

22

 

51,155

18

Natural gas basis

 

 

 

 

 

 

 

 

 

swaps sold

 

153,530

18

 

53,665

22

 

60,522

18

Natural gas fixed - for - float

 

 

 

 

 

 

 

 

 

swaps purchased

 

44,600

18

 

17,083

23

 

19,979

26

Natural gas fixed - for - float

 

 

 

 

 

 

 

 

 

swaps sold

 

58,248

6

 

24,871

23

 

29,576

26

Natural gas physical

 

 

 

 

 

 

 

 

 

purchases

 

66,972

27

 

59,855

34

 

62,020

37

Natural gas physical sales

 

117,135

39

 

88,302

46

 

110,341

49

Natural gas options

 

 

 

 

 

 

 

 

 

purchased

 

18,447

15

 

6,176

21

 

12,725

24

Natural gas options sold

 

18,447

15

 

6,176

21

 

12,725

24

 

 

26

 

 

 

 

Outstanding at

Outstanding at

Outstanding at

 

September 30, 2006

December 31, 2005

September 30, 2005

 

 

 

Latest

 

 

Latest

 

 

Latest

 

 

Notional

Expiration

 

Notional

Expiration

 

Notional

Expiration

 

 

Amounts

(months)

 

Amounts

(months)

 

Amounts

(months)

 

 

 

 

 

 

 

 

 

 

(in thousands of barrels)

 

 

 

 

 

 

 

 

 

Crude oil physical

 

 

 

 

 

 

 

 

 

purchases

 

404

1

 

 

 

 

Crude oil physical sales

 

404

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars, in thousands)

 

 

 

 

 

 

 

 

 

Canadian dollars

 

 

 

 

 

 

 

 

 

purchased

$

23,000

1

$

88,000

2

$

29,700

1

Canadian dollars sold

$

1,000

2

$

29,000

5

$

37,600

8

 

Derivatives and certain natural gas and crude oil marketing activities were marked to fair value on September 30, 2006, December 31, 2005 and September 30, 2005, and the related gains and/or losses recognized in earnings. The amounts included in the accompanying Condensed Consolidated Balance Sheets and Statements of Income are as follows (in thousands):

 

 

Current

Non-current

Current

Non-current

 

 

Derivative

Derivative

Derivative

Derivative

Unrealized

 

Assets

Assets

Liabilities

Liabilities

Gain (Loss)

 

 

 

 

 

 

 

 

 

 

 

September 30, 2006

$

51,528

$

1,629

$

17,546

$

1,873

$

33,738

 

 

 

 

 

 

 

 

 

 

 

December 31, 2005

$

20,326

$

1,747

$

20,751

$

2,086

$

(764)

 

 

 

 

 

 

 

 

 

 

 

September 30, 2005

$

33,112

$

4,722

$

97,215

$

4,541

$

(63,922)

 

In addition, certain volumes of natural gas inventory have been designated as the underlying hedged item in a “fair value” hedge transaction. These volumes are stated at market value using published spot industry quotations. Market adjustments are recorded in inventory on the Condensed Consolidated Balance Sheets and the related unrealized gain/loss on the Condensed Consolidated Statements of Income, effectively offsetting the earnings impact of the unrealized gain/loss recognized on the associated derivative asset or liability described above. As of September 30, 2006, December 31, 2005 and September 30, 2005, the market adjustments recorded in inventory were $(29.8) million, $6.6 million and $61.0 million, respectively.

 

 

27

 

 

 

Activities Other Than Trading

 

Oil and Gas Exploration and Production

 

On September 30, 2006, December 31, 2005 and September 30, 2005, the Company had the following derivatives and related balances (in thousands):

 

 

 

 

 

 

 

 

Pre-tax

 

 

 

Maximum

 

Non-

 

Non-

Accumulated

 

 

 

Terms

Current

current

Current

current

Other

Pre-tax

 

 

in

Derivative

Derivative

Derivative

Derivative

Comprehensive

Income

 

Notional*

Years

Assets

Assets

Liabilities

Liabilities

Income (Loss)

(Loss)

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps/options

300,000

1.00

$

456

$

$

1,308

$

282

$

(1,441)

$

307

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

6,765,000

1.50

 

13,231

 

1,116

 

 

 

14,347

 

 

 

 

$

13,687

$

1,116

$

1,308

$

282

$

12,906

$

307

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps/options

300,000

1.00

$

150

$

$

2,535

$

307

$

(2,842)

$

150

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

2,950,000

0.60

 

 

151

 

2,560

 

 

(2,409)

 

 

 

 

$

150

$

151

$

5,095

$

307

$

(5,251)

$

150

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

300,000

1.00

$

$

$

4,448

$

1,177

$

(5,607)

$

(18)

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

2,502,500

0.50

 

 

 

11,829

 

378

 

(12,207)

 

 

 

 

$

$

$

16,277

$

1,555

$

(17,814)

$

(18)

________________________

*crude in barrels, gas in MMbtu’s

 

Based on September 30, 2006 market prices, an $11.6 million gain would be realized and reported in pre-tax earnings during the next twelve months related to hedges of production. Estimated and actual realized losses will likely change during the next twelve months as market prices change.

 

Fuel in Storage

 

The Company holds natural gas in storage for use as fuel for generating electricity with certain of its gas-fired combustion turbines. To minimize associated price risk and seasonal storage level requirements, the Company utilizes various derivative instruments in managing these risks.

 

28

 

 

 

On September 30, 2006, December 31, 2005 and September 30, 2005, the Company had the following swaps and related balances (in thousands):

 

 

 

 

 

 

 

 

Pre-tax

 

 

 

 

 

Non-

 

Non-

Accumulated

 

 

 

Maximum

Current

current

Current

current

Other

Unrealized

 

 

Terms in

Derivative

Derivative

Derivative

Derivative

Comprehensive

Gain

 

Notional*

Years

Assets

Assets

Liabilities

Liabilities

(Loss)

(Loss)

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

525,000

0.5

$

1,634

$

$

$

$

410

$

1,224

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

275,000

0.25

$

192

$

$

219

$

$

(219)

$

192

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

425,000

0.50

$

$

$

1,246

$

$

(759)

$

(487)

________________________

*gas in MMbtu’s

 

Based on September 30, 2006 market prices, a gain of $0.4 million would be realized and reported in pre-tax earnings during the next twelve months related to the cash flow hedge. Estimated and actual realized gains will likely change during the next twelve months as market prices change.

 

In addition, certain volumes of natural gas inventory were designated as the underlying hedged item in “fair value” hedge transactions. These volumes are stated at market value using published spot industry quotations. Market adjustments are recorded in inventory on the Balance Sheet and the related unrealized gain/loss on the Statement of Income. As of September 30, 2006, December 31, 2005 and September 30, 2005, the market adjustments recorded in inventory were $(1.2) million, $(0.2) million and $0.5 million, respectively.

 

29

 

 

 

Financing Activities

 

On September 30, 2006, December 31, 2005 and September 30, 2005, the Company’s interest rate swaps and related balances were as follows (in thousands):

 

 

 

Weighted

 

 

 

 

 

Pre-tax

 

 

 

Average

 

 

Non-

 

Non-

Accumulated

 

 

Current

Fixed

Maximum

Current

current

Current

current

Other

Pre-tax

 

Notional

Interest

Terms in

Derivative

Derivative

Derivative

Derivative

Comprehensive

Income

 

Amount

Rate

Years

Assets

Assets

Liabilities

Liabilities

Income (Loss)

(Loss)

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

$

100,000

5.09%

10.00

$

141

$

452

$

83

$

758

$

(248)

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005