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, 2007.

 

 

OR

 

 

 

o

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

 

EXCHANGE 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, 2007

 

 

Common stock, $1.00 par value

37,759,152 shares

 


TABLE OF CONTENTS

 

 

 

Page

 

 

 

 

Glossary of Terms

3-4

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Income –

 

 

Three and Nine Months Ended September 30, 2007 and 2006

5

 

 

 

 

Condensed Consolidated Balance Sheets –

 

 

September 30, 2007, December 31, 2006 and September 30, 2006

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows –

 

 

Nine Months Ended September 30, 2007 and 2006

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8-30

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and

 

 

Results of Operations

31-56

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

56-59

 

 

 

Item 4.

Controls and Procedures

59

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

60

 

 

 

Item 1A.

Risk Factors

60

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

60

 

 

 

Item 6.

Exhibits

61

 

 

 

 

Signatures

62

 

 

 

 

Exhibit Index

63

 

2

 


GLOSSARY OF TERMS

The following terms and abbreviations appear in the text of this report and have the definitions described below:

AFUDC

Allowance for Funds Used During Construction

Aquila

Aquila, Inc.

Bbl

Barrel

Bcfe

One billion cubic feet equivalent

BHEP

Black Hills Exploration and Production, Inc., a direct, wholly-owned

 

subsidiary of Black Hills Energy, Inc.

BHER

Black Hills Energy Resources, Inc., a direct, wholly-owned subsidiary of Black

 

Hills Energy, Inc.

Black Hills Energy

Black Hills Energy, Inc., a direct, wholly-owned subsidiary of the Company

Black Hills Power

Black Hills Power, Inc., a direct, wholly-owned subsidiary of the Company

Btu

British thermal unit

Cheyenne Light

Cheyenne Light, Fuel & Power Company, a direct, wholly-owned subsidiary

 

of the Company

Cheyenne Light Pension Plan

The Cheyenne Light, Fuel & Power Company Pension Plan

Dth

Dekatherm

Enserco

Enserco Energy Inc., a direct, wholly-owned subsidiary of Black Hills

 

Energy, Inc.

FASB

Financial Accounting Standards Board

FERC

Federal Energy Regulatory Commission

FIN 48

FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes –

 

an Interpretation of FASB Statement 109”

GAAP

Generally Accepted Accounting Principles

GE Capital

General Electric Capital Corporation

Great Plains

Great Plains Energy Incorporated

Indeck

Indeck Capital, Inc.

IPP

Independent power production

LIBOR

London Interbank Offered Rate

LOE

Lease Operating Expense

Las Vegas I

Las Vegas I gas-fired power plant

Las Vegas II

Las Vegas II gas-fired power plant

LVC

Las Vegas Cogeneration Limited Partnership, an indirect, wholly-owned

 

subsidiary of Black Hills Energy, Inc.

Mcfe

One thousand cubic feet equivalent

MMBtu

One million British thermal units

Moody’s

Moody’s Investor Services, Inc.

Mw

Megawatt

Mwh

Megawatt-hour

Nevada Power

Nevada Power Company

PNM

PNM Resources, Inc.

SAB

SEC Staff Accounting Bulletin

SAB 108

SAB 108, “Effects of Prior Year Misstatement on Current Year Financial

 

Statements”

SEC

U. S. Securities and Exchange Commission

SFAS

Statement of Financial Accounting Standards

SFAS 71

SFAS 71, “Accounting for the Effects of Certain Types of Regulation”

SFAS 109

SFAS 109, “Accounting for Income Taxes”

SFAS 133

SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”

 

 

3

 


 

SFAS 144

SFAS 144, “Accounting for the Impairment of Long-lived Assets”

SFAS 157

SFAS 157, “Fair Value Measurements”

SFAS 159

SFAS 159, “The Fair Value Option for Financial Assets and Financial

 

Liabilities”

S&P

Standard & Poor’s Rating Services

Valencia

Valencia Power, LLC, an indirect, wholly-owned subsidiary of Black Hills

 

Energy, Inc.

WPSC

Wyoming Public Service Commission

WRDC

Wyodak Resources Development Corp., a direct, wholly-owned subsidiary of

 

Black Hills Energy, Inc.

 

 

4

 


BLACK HILLS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2007

2006

2007

2006

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

Operating revenues

$

162,354

$

157,608

$

512,830

$

483,312

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

Fuel and purchased power

 

42,840

 

47,740

 

130,726

 

151,150

Operations and maintenance

 

21,942

 

16,490

 

63,220

 

60,566

Administrative and general

 

27,316

 

19,721

 

79,285

 

64,776

Depreciation, depletion and amortization

 

26,630

 

24,141

 

74,712

 

67,407

Taxes, other than income taxes

 

8,347

 

8,570

 

28,337

 

26,667

Impairment of long-lived assets

 

2,721

 

 

2,721

 

 

 

129,796

 

116,662

 

379,001

 

370,566

 

 

 

 

 

 

 

 

 

Operating income

 

32,558

 

40,946

 

133,829

 

112,746

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

Interest expense

 

(9,634)

 

(12,400)

 

(30,720)

 

(37,310)

Interest income

 

990

 

389

 

2,429

 

1,403

Allowance for funds used during

 

 

 

 

 

 

 

 

construction – equity

 

811

 

 

3,851

 

Other income, net

 

67

 

106

 

413

 

517

 

 

(7,766)

 

(11,905)

 

(24,027)

 

(35,390)

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

 

 

 

 

 

 

 

before equity in earnings of

 

 

 

 

 

 

 

 

unconsolidated subsidiaries, minority

 

 

 

 

 

 

 

 

interest and income taxes

 

24,792

 

29,041

 

109,802

 

77,356

Equity in earnings (loss) of unconsolidated

 

 

 

 

 

 

 

 

subsidiaries

 

574

 

615

 

2,092

 

(16)

Minority interest

 

(97)

 

(95)

 

(285)

 

(273)

Income tax expense

 

(7,627)

 

(7,362)

 

(36,235)

 

(23,939)

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

17,642

 

22,199

 

75,374

 

53,128

(Loss) income from discontinued operations,

 

 

 

 

 

 

 

 

net of taxes

 

(178)

 

81

 

(358)

 

7,060

 

 

 

 

 

 

 

 

 

Net income

$

17,464

$

22,280

$

75,016

$

60,188

 

 

 

 

 

 

 

 

 

Weighted average common shares

 

 

 

 

 

 

 

 

outstanding:

 

 

 

 

 

 

 

 

Basic

 

37,643

 

33,187

 

36,810

 

33,157

Diluted

 

38,078

 

33,560

 

37,226

 

33,526

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

Basic–

 

 

 

 

 

 

 

 

Continuing operations

$

0.47

$

0.67

$

2.05

$

1.60

Discontinued operations

 

 

 

(0.01)

 

0.21

Total

$

0.47

$

0.67

$

2.04

$

1.81

 

 

 

 

 

 

 

 

 

Diluted–

 

 

 

 

 

 

 

 

Continuing operations

$

0.46

$

0.66

$

2.03

$

1.59

Discontinued operations

 

 

 

(0.01)

 

0.21

Total

$

0.46

$

0.66

$

2.02

$

1.80

 

 

 

 

 

 

 

 

 

Dividends paid per share of common stock

$

0.34

$

0.33

$

1.02

$

0.99

 

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

 

5

 


BLACK HILLS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

 

September 30,

December 31,

September 30,

 

2007

2006

2006

 

(in thousands, except share amounts)

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

$

81,201 

$

36,939 

$

47,716 

Restricted cash

 

5,394 

 

2,004 

 

— 

Receivables (net of allowance for doubtful accounts of $5,259;

 

 

 

 

 

 

$4,202 and $4,007, respectively)

 

238,662 

 

263,109 

 

195,571 

Materials, supplies and fuel

 

92,625 

 

92,560 

 

91,490 

Derivative assets

 

29,385 

69,244 

 

66,990 

Income tax receivable

 

— 

 

— 

 

11,524 

Other assets

 

11,795 

 

9,221 

 

7,830 

Assets of discontinued operations

 

3,543 

 

1,424 

 

1,043 

 

 

462,605 

 

474,501 

 

422,164 

 

 

 

 

 

 

Investments

 

23,886 

 

23,808 

 

23,709 

 

 

 

 

 

 

Property, plant and equipment

 

2,430,975 

 

2,242,396 

 

2,180,639 

Less accumulated depreciation and depletion

 

(652,701)

 

(596,029)

 

(574,925)

 

 

1,778,274 

 

1,646,367 

 

1,605,714 

Other assets:

 

 

 

 

 

 

Derivative assets

 

3,420 

 

2,871 

 

3,197 

Goodwill

 

30,171 

 

30,563 

 

30,563 

Intangible assets (net of accumulated amortization of

 

 

 

 

 

 

$27,363; $25,852 and $25,072, respectively)

 

21,777 

 

24,429 

 

25,209 

Other

 

44,774 

 

42,137 

 

38,177 

 

 

100,142 

 

100,000 

 

97,146 

 

$

2,364,907 

$

2,244,676 

$

2,148,733 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

$

202,014 

$

224,009 

$

181,255 

Accrued liabilities

 

102,019 

 

95,020 

 

82,098 

Derivative liabilities

 

24,904 

 

24,041 

 

18,937 

Deferred income taxes

 

— 

 

1,215 

 

5,001 

Notes payable

 

96,648 

 

145,500 

 

147,000 

Current maturities of long-term debt

 

143,380 

 

17,106 

 

17,103 

Accrued income taxes

 

17,620 

 

19,561 

 

— 

Liabilities of discontinued operations

 

694 

 

2,526 

 

4,131 

 

 

587,279 

 

528,978 

 

455,525 

 

 

 

 

 

 

 

Long-term debt, net of current maturities

 

466,137 

 

628,340 

 

632,295 

 

 

 

 

 

 

 

Deferred credits and other liabilities:

 

 

 

 

 

 

Deferred income taxes

 

191,451 

 

174,332 

 

170,286 

Derivative liabilities

 

3,615 

 

1,530 

 

2,913 

Other

 

143,786 

 

116,297 

 

101,819 

 

 

338,852 

 

292,159 

 

275,018 

 

 

 

 

 

 

 

Minority interest in subsidiaries

 

5,075 

 

5,158 

 

5,198 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

Common stock equity –

 

 

 

 

 

 

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

 

 

 

 

 

 

Issued 37,802,087; 33,404,902 and 33,330,841 shares,

 

 

 

 

 

 

respectively

 

37,802 

 

33,405 

 

33,331 

Additional paid-in capital

 

558,935 

 

409,826 

 

407,488 

Retained earnings

 

386,869 

 

348,245 

 

338,420 

Treasury stock at cost – 42,935; 35,700 and 34,720

 

 

 

 

 

 

shares, respectively

 

(1,219)

 

(920)

 

(883)

Accumulated other comprehensive (loss) income

 

(14,823)

 

(515)

 

2,341 

 

 

967,564 

 

790,041 

 

780,697 

 

 

 

 

 

 

 

 

$

2,364,907 

$

2,244,676 

$

2,148,733 

 

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

6

 


BLACK HILLS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

Nine Months Ended

 

September 30,

 

2007

2006

 

(in thousands)

Operating activities:

 

 

 

 

Net income

$

75,016

$

60,188

Loss (income) from discontinued operations, net of taxes

 

358

 

(7,060)

 

 

 

 

 

Income from continuing operations

 

75,374

 

53,128

Adjustments to reconcile income from continuing operations

 

 

 

 

to net cash provided by operating activities:

 

 

 

 

Depreciation, depletion and amortization

 

74,712

 

67,407

Net change in derivative assets and liabilities

 

(4,911)

 

2,136

Deferred income taxes

 

10,008

 

32,042

Distributed earnings in associated companies

 

177

 

4,304

Allowance for funds used during construction – equity

 

(3,851)

 

Change in operating assets and liabilities:

 

 

 

 

Materials, supplies and fuel

 

25,011

 

(6,389)

Accounts receivable and other current assets

 

21,099

 

59,005

Accounts payable and other current liabilities

 

4,662

 

(61,878)

Other operating activities

 

6,495

 

26,239

Net cash provided by operating activities of continuing operations

 

208,776

 

175,994

Net cash used in operating activities of discontinued operations

 

(3,045)

 

(1,583)

Net cash provided by operating activities

 

205,731

 

174,411

 

 

 

 

 

Investing activities:

 

 

 

 

Property, plant and equipment additions

 

(159,788)

 

(153,820)

Proceeds from the sale of business operations

 

 

40,735

Payment for acquisition, net of cash acquired

 

 

(75,425)

Other investing activities

 

(3,004)

 

(454)

Net cash used in investing activities of continuing operations

 

(162,792)

 

(188,964)

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

 

2,479

 

(575)

Net cash used in investing activities

 

(160,313)

 

(189,539)

 

 

 

 

 

Financing activities:

 

 

 

 

Dividends paid

 

(37,068)

 

(32,954)

Common stock issued

 

149,860

 

3,560

(Decrease) increase in short-term borrowings, net

 

(78,000)

 

92,000

Long-term debt – issuances

 

 

90,000

Long-term debt – repayments

 

(35,929)

 

(122,566)

Other financing activities

 

(585)

 

(1,171)

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

 

(1,722)

 

28,869

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

 

 

Net cash (used in) provided by financing activities

 

(1,722)

 

28,869

 

 

 

 

 

Increase in cash and cash equivalents

 

43,696

 

13,741

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

Beginning of period

 

37,530(b)

 

34,198(d)

End of period

$

81,226(a)

$

47,939(c)

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

Non-cash investing and financing activities-

 

 

 

 

Property, plant and equipment acquired with accrued liabilities or

 

 

 

 

short-term debt

$

56,274

$

31,481

Cash paid during the period for-

 

 

 

 

Interest (net of amounts capitalized)

$

30,160

$

35,317

Income taxes paid (net of amounts refunded)

$

7,627

$

12,806

_________________________

(a)

Includes insignificant September 30, 2007 cash balances included in assets of discontinued operations.

(b)

Includes approximately $0.6 million at December 31, 2006 of cash included in the assets of discontinued operations.

(c)

Includes approximately $0.2 million at September 30, 2006 of cash included in the assets of discontinued operations.

(d)

Includes approximately $2.4 million at December 31, 2005 of cash included in the assets of discontinued operations.

 

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

7

 


BLACK HILLS CORPORATION

 

Notes to Condensed Consolidated Financial Statements

(unaudited)

(Reference is made to Notes to Consolidated Financial Statements

included in the Company’s 2006 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 SEC. 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 2006 Annual Report on Form 10-K filed with the 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, 2007, December 31, 2006 and September 30, 2006 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 electricity and natural gas is sensitive to seasonal cooling, 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, 2007, 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)

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

 

FIN 48

 

The Company adopted FIN 48 on January 1, 2007 (see Note 8). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 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.

 

8

 


SAB 108  

 

During September 2006, the staff of the SEC released SAB 108. SAB 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 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. Disclosure requirements include 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 108 was effective January 1, 2007. SAB 108 did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

 

(3)

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

SFAS 157

 

During September 2006, the FASB issued SFAS 157, which applies to other accounting pronouncements that require or permit fair value measurements. This Statement defines fair value, establishes a framework for measuring fair value in 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 159

 

During February 2007, the FASB issued SFAS 159, which establishes a fair value option under which entities can elect to report certain financial assets and liabilities at fair value, with changes in fair value recognized in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact SFAS 159 will have on the Company’s consolidated financial statements.

 

9

 


(4)

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

2007

2006

2006

 

 

 

 

 

 

 

Materials and supplies

$

35,562

$

31,946

$

30,160

Fuel

 

7,401

 

9,663

 

9,387

Gas and oil held by Energy

 

 

 

 

 

 

marketing*

 

49,662

 

50,951

 

51,943

 

 

 

 

 

 

 

Total materials, supplies and fuel

$

92,625

$

92,560

$

91,490

___________________________

* As of September 30, 2007, December 31, 2006 and September 30, 2006, market adjustments related to natural gas held by Energy marketing and recorded in inventory were $(6.5) million, $(31.5) million and $(29.8) million, respectively (see Note 13 for further discussion of Energy marketing trading activities).

 

The inventory held by the Company’s Energy marketing subsidiary primarily consists of gas held in storage and gas imbalances held on account with pipelines. Such 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.

 

(5)

LONG-TERM DEBT, NOTES PAYABLE AND GUARANTEES

 

Note Payable

 

During June 2007, the Company entered into a short-term, non-interest bearing, secured promissory note payable to Public Service Company of New Mexico in connection with the purchase of certain equipment and related assets for the Company’s Valencia project in New Mexico. The secured promissory note payable is due December 2007, and is secured by the purchased equipment and related assets. The Company recorded the promissory note payable at the stated amount of the debt of $30.0 million, less interest imputed at a rate of 6 percent totaling $0.9 million, for a net amount of $29.1 million.

 

Long-term Debt

 

On April 30, 2007, the Company called its outstanding debt with GE Capital in the amount of $23.5 million. In conjunction with this, the Company expensed $0.1 million in unamortized deferred financing costs. The associated payment guarantees provided by the Company were also terminated.

 

The Company has classified the $128.3 million Wygen I project debt to current maturities as the debt has a maturity date of June 2008. The Company intends to refinance this debt with other long-term financing prior to its maturity.

 

10

 


Amendments to Revolver

 

On March 13, 2007, the Company entered into a second amendment to its revolving credit facility. The second amendment (i) increased the limit for borrowings or other credit accommodations for the separate credit facility for the Company’s energy marketing subsidiary from $260 million to $300 million, (ii) increased the allowed total commitments under the revolving credit facility without requiring amendment of the facility from $500 million to $600 million, (iii) effective with the acquisition of certain electric and gas utility assets from Aquila, will increase the recourse leverage ratio limit from 0.65 to 1.00 to 0.70 to 1.00 for the first year after completion of the Aquila asset acquisition, reverting to 0.65 to 1.00 thereafter, and (iv) allowed for other modifications to enable the Company to complete the Aquila asset acquisition.

 

Guarantees

 

During the nine months ended September 30, 2007, the Company had the following changes to its guarantees:

 

Extinguished two guarantees totaling $24.2 million at December 31, 2006 related to the payment and performance under the Company’s GE Capital debt obligations. The Company’s outstanding debt obligations with GE Capital were paid on April 30, 2007;

 

 

The $0.3 million guarantee for the payments of Black Hills Power under various transactions with Idaho Power Company expired on March 1, 2007;

 

 

The $3.0 million guarantee for the payments of Cheyenne Light under various transactions with Questar Energy Trading Company expired on March 31, 2007;

 

 

Issued a guarantee for obligations and damages, if any, due by Valencia under a power purchase agreement with Public Service Company of New Mexico for up to $12.0 million and expiring in 2028;

 

 

Issued a guarantee for up to $7.0 million related to the obligations of Enserco under an agency agreement whereby Enserco provides services to structure up to $100.0 million of certain transactions involving the buying, selling, transportation and storage of natural gas on behalf of another energy company and which expires in 2008; and

 

 

Extinguished a $10.0 million guarantee under the Las Vegas I Power Purchase and Sales Agreement on September 25, 2007.

 

 

 

11

 


(6)

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, 2007

Three Months

Nine Months

 

 

Average

 

Average

 

Income

Shares

Income

Shares

 

 

 

 

 

 

 

Income from continuing operations

$

17,642

 

$

75,374

 

 

 

 

 

 

 

 

Basic earnings

 

17,642

37,643 

 

75,374

36,810 

Dilutive effect of:

 

 

 

 

 

 

Stock options

 

111 

 

108 

Estimated contingent shares issuable

 

 

 

 

 

 

for prior acquisition

 

159 

 

159 

Others

 

165 

 

149 

Diluted earnings

$

17,642

38,078 

$

75,374

37,226 

 

 

 

Period ended September 30, 2006

Three Months

Nine Months

 

 

Average

 

Average

 

Income

Shares

Income

Shares

 

 

 

 

 

 

 

Income from continuing operations

$

22,199

 

$

53,128

 

 

 

 

 

 

 

 

Basic earnings

 

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 earnings

$

22,199

33,560 

$

53,128

33,526 

 

 

12

 


(7)

COMPREHENSIVE INCOME

 

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

(in thousands):

 

 

Three Months Ended

 

September 30,

 

2007

2006

 

 

 

 

 

Net income

$

17,464    

$

22,280    

Other comprehensive income (loss),

 

 

 

 

net of tax:

 

 

 

 

Fair value adjustment on derivatives

 

 

 

 

designated as cash flow hedges

 

 

 

 

(net of tax of $3,558 and $(3,998),

 

 

 

 

respectively)

 

(6,749)   

 

7,425    

Reclassification adjustments on cash

 

 

 

 

flow hedges settled and included in

 

 

 

 

net income (net of tax of $1,296

 

 

 

 

and $132, respectively)

 

(2,406)   

 

(246)   

 

 

 

 

 

Comprehensive income

$

8,309    

$

29,459    

 

 

 

Nine Months Ended

 

September 30,

 

2007

2006

 

 

 

 

 

Net income

$

75,016    

$

60,188    

Other comprehensive income (loss),

 

 

 

 

net of tax:

 

 

 

 

Fair value adjustment on derivatives

 

 

 

 

designated as cash flow hedges

 

 

 

 

(net of tax of $3,419 and $(7,318),

 

 

 

 

respectively)

 

(6,521)   

 

12,587    

Reclassification adjustments on cash

 

 

 

 

flow hedges settled and included in

 

 

 

 

net income (net of tax of $4,012

 

 

 

 

and $242, respectively)

 

(7,787)   

 

(416)   

 

 

 

 

 

Comprehensive income

$

60,708    

$

72,359    

 

 

13

 


Balances by classification included within Accumulated other comprehensive (loss) income on the accompanying Condensed Consolidated Balance Sheets are as follows (in thousands):

 

 

Derivatives

Employee

Amount from

 

 

Designated as

Benefit

Equity-method

 

 

Cash Flow Hedges

Plans

Investees

Total

 

 

 

 

 

 

 

 

 

As of September 30, 2007

$

(6,248)           

$

(8,404)

$

(171)

$

(14,823)   

 

 

 

 

 

 

 

 

 

As of December 31, 2006

$

8,119            

$

(8,404)

$

(230)

$

(515)   

 

 

 

 

 

 

 

 

 

As of September 30, 2006

$

5,495            

$

(2,936)

$

(218)

$

2,341    

 

 

(8)

INCOME TAXES

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an approximate $0.7 million benefit from a decrease in the liability for unrecognized tax benefits. This benefit was accounted for as an adjustment to the January 1, 2007 balance of retained earnings.

 

The total gross amount of unrecognized tax benefits at January 1, 2007 was approximately $72.6 million. The total amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate is approximately $2.0 million (net of the federal benefit on state tax items and interest) at the date of adoption.

 

It is the Company’s continuing practice to recognize penalties and/or interest related to income tax matters in income tax expense. The Company had no penalties accrued and approximately $0.4 million for the accrual of interest income at the date of adoption of FIN 48.

 

The Company files income tax returns in the U.S. federal jurisdiction, various state jurisdictions and Canada. The Company recently received notification from the Internal Revenue Service that the 2004 and 2005 tax years will be examined. The Company continues to be under examination by a state taxing authority for tax years 2001 through 2003 and remains subject to examination by Canadian income tax authorities for tax years as early as 1999.

 

The Company does not anticipate that total unrecognized tax benefits will significantly change due to the settlement of any audits or the expiration of statute of limitations prior to September 30, 2008.

 

14

 


Effective Tax Rate

 

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

 

 

Three Months Ended

Nine Months Ended

 

September 30,

September 30,

 

2007

2006

2007

2006

 

 

 

 

 

 

35.0%

35.0%

35.0%

35.0%

State income tax

(0.1)

0.3

0.2

0.5

Percentage depletion in excess

 

 

 

 

of cost

(1.3)

(1.5)

(0.9)

(1.3)

IRS exam tax adjustment*

(7.3)

(2.8)

Tax return true-up

(3.8)

(1.3)

(0.4)

(0.5)

Other

(0.3)

(1.9)

0.2

 

30.0%

24.9%

32.0%

31.1%

_________________________

 

*

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.

 

(9)

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 had 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. As of September 30, 2007, the Company continues to pursue 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.

 

15

 


(10)

COMMON STOCK

 

Other than the following transactions, the Company had no other material changes in its common stock, as reported in Note 9 of the Notes to Consolidated Financial Statements in the Company’s 2006 Annual Report on Form 10-K.

 

Private Placement of Common Stock

 

On February 22, 2007, the Company completed the issuance and sale of approximately 4.17 million shares of common stock at a price of $36.00 per share in a private placement offering. The Company used the approximate $145.6 million of net proceeds from this offering for debt reduction.

 

These shares were not initially registered under the Securities Act of 1933, therefore restricting the purchasers’ ability to offer or sell the shares. The offering agreements required the Company to register the related securities with the SEC within a specified period of time, and the Company has performed this obligation. In addition, the Company must maintain an effective shelf registration statement with the SEC, allowing resale of the restricted shares, until all related shares have been resold or cease to be restricted. If the Company fails to maintain an effective shelf registration statement in accordance with the terms of the offering agreements, it may be required to pay damages to the purchasers at a per thirty-day rate of 1.0 percent of the related share purchase price until the default is cured. The total damage payments under the agreements are limited to 10.0 percent of the related share purchase price. The Company believes the likelihood of making any payments under the damage provisions is remote and accordingly has not recognized any liability within its consolidated financial statements.

 

Equity Compensation Plans

 

Effective January 1, 2007, the Company granted 35,026 target performance shares to certain officers and business unit leaders of the Company for the January 1, 2007 through December 31, 2009 performance period. Performance shares are awarded based on the Company’s total shareholder return over the designated performance period as measured against a selected peer group. In addition, the Company’s stock price must also increase during the performance period.

 

 

 

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 will vary according to the number of shares of common stock that are ultimately granted based upon the actual level of attainment of the performance criteria. The performance awards are paid 50 percent in the form of cash and 50 percent in the form of common stock. The grant date fair value was $34.17 per share.

 

 

The Company issued 33,143 shares of common stock under the short-term incentive compensation plan during the nine months ended September 30, 2007. Pre-tax compensation cost related to the award was approximately $1.2 million, which was accrued for in 2006.

 

 

The Company granted 43,556 restricted common shares during the nine months ended September 30, 2007. The pre-tax compensation cost related to the awards of restricted stock and restricted stock units of approximately $1.6 million will be recognized over the three-year vesting period.

 

 

 

 

16

 


 

156,250 stock options were exercised during the nine months ended September 30, 2007, at a weighted-average exercise price of $29.76 per share providing $4.6 million of proceeds to the Company.

 

 

Total compensation expense recognized for all equity compensation plans for the three months ended September 30, 2007 and 2006 was $1.4 million and $0.1 million, respectively, and for the nine month periods ended September 30, 2007 and 2006 was $4.4 million and $1.8 million, respectively.

 

(11)

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, Black Hills Power, WRDC and BHEP. The other Plan covers employees of the Company’s subsidiary, Cheyenne Light, 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,

 

2007

2006

2007

2006

 

 

 

 

 

 

 

 

 

Service cost

$

687    

$

649     

$

2,061    

$

1,947     

Interest cost

 

1,129    

 

1,041     

 

3,387    

 

3,123     

Expected return on plan assets

 

(1,374)   

 

(1,247)    

 

(4,122)   

 

(3,741)    

Prior service cost

 

38    

 

38     

 

114    

 

114     

Net loss

 

127    

 

227     

 

381    

 

681     

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

$

607    

$

708     

$

1,821    

$

2,124     

 

The Company made a $0.5 million contribution to the Cheyenne Light Pension Plan in the first quarter of 2007; no additional contributions are anticipated to be made to the Plans during the 2007 fiscal year.

 

17

 


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,

 

2007

2006

2007

2006

 

 

 

 

 

 

 

 

 

Service cost

$

103      

$

87      

$

309      

$

261      

Interest cost

 

289      

 

270      

 

867      

 

810      

Prior service cost

 

3      

 

3      

 

9      

 

9      

Net loss

 

178      

 

199      

 

534      

 

597      

 

 

 

 

 

 

 

 

   

Net periodic benefit cost

$

573      

$

559      

$

1,719      

$

1,677      

 

The Company anticipates that it will need to make contributions to the Supplemental Plans for the 2007 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,

 

2007

2006

2007

2006

 

 

 

 

 

 

 

 

 

Service cost

$

135      

$

164      

$

405      

$

492      

Interest cost

 

207      

 

203      

 

621      

 

609      

Net transition obligation

 

15      

 

38      

 

45      

 

114      

Prior service cost

 

—       

 

(6)     

 

—       

 

(18)     

Net gain/loss

 

(4)     

 

—       

 

(12)     

 

—       

 

 

 

 

 

 

 

 

 

Net periodic benefit cost

$

353      

$

399      

$

1,059      

$

1,197      

 

The Company anticipates that it will make contributions to the Healthcare Plans for the 2007 fiscal year of approximately $0.3 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 was approximately $0.1 million for the three month periods ended September 30, 2007 and 2006 and $0.2 million for the nine month periods ended September 30, 2007 and 2006.

 

18

 


(12)

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, 2007, substantially all of the Company’s operations and assets are located within the United States.

 

The Company conducts its operations through the following six reporting segments:

 

 

Retail Services group –

 

Electric utility, which supplies electric utility service to western South Dakota, northeastern Wyoming and southeastern Montana; and

 

 

Electric and gas utility, which supplies electric and gas utility service to Cheyenne, Wyoming and vicinity.

 

Wholesale Energy group –

 

Oil and gas, which produces, explores and operates oil and natural gas interests located in the Rocky Mountain region, Texas, California and other states;

 

 

Power generation, which produces and sells power and capacity to wholesale customers with power plants concentrated in Colorado, Nevada, Wyoming and California;

 

 

Coal mining, which engages in the mining and sale of coal from its mine near Gillette, Wyoming; and

 

 

Energy marketing, which markets natural gas, crude oil and related services primarily in the western and central regions of the United States and Canada.

 

Segment information follows the same accounting policies as described in Note 20 of the Notes to Consolidated Financial Statements in the Company’s 2006 Annual Report on Form 10-K. In accordance with the provisions of SFAS 71, intercompany fuel sales to the electric utility are not eliminated.

 

19

 


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, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail services:

 

 

 

 

 

 

Electric utility

$

51,129    

$

645       

$

5,781         

Electric and gas utility

 

21,146    

 

—       

 

1,408         

Wholesale energy:

 

 

 

   

 

    

Oil and gas

 

24,291    

 

—       

 

1,979         

Power generation

 

42,235    

 

—       

 

5,642         

Coal mining

 

6,818    

 

3,628       

 

1,358         

Energy marketing

 

13,873    

 

—       

 

2,290         

Corporate

 

—    

 

—       

 

(816)        

Inter-segment eliminations

 

—    

 

(1,411)      

 

—         

 

 

 

 

 

 

 

Total

$

159,492    

$

2,862      

$

17,642         

 

 

 

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:

 

 

 

 

 

 

Oil and gas

 

22,969 

 

—  

 

3,006    

Power generation

 

42,700 

 

—  

 

9,839    

Coal mining

 

6,055 

 

3,391  

 

1,908    

Energy marketing

 

6,327 

 

—  

 

2,091    

Corporate

 

11 

 

—  

 

(1,362)   

Inter-segment eliminations

 

— 

 

(1,514) 

 

—    

 

 

 

 

 

 

 

Total

$

155,008 

$

2,600  

$

22,199    

 

 

20

 


 

External

Inter-segment

Income (Loss) from

 

Operating

Operating

Continuing

 

Revenues

Revenues

Operations

Nine Month Period Ended

 

 

 

 

 

 

September 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail services:

 

 

 

 

 

 

Electric utility

$

142,872 

$

1,641 

$

17,361    

Electric and gas utility

 

79,161 

 

— 

 

5,523    

Wholesale energy:

 

 

 

 

 

 

Oil and gas

 

75,948 

 

— 

 

9,945    

Power generation

 

121,763 

 

— 

 

16,055    

Coal mining

 

19,458 

 

10,734 

 

4,353    

Energy marketing

 

65,220 

 

— 

 

23,886    

Corporate

 

— 

 

— 

 

(1,749)   

Inter-segment eliminations

 

— 

 

(3,967)

 

—    

 

 

 

 

 

 

 

Total

$

504,422 

$

8,408 

$

75,374    

 

 

 

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:

 

 

 

 

 

 

Oil and gas

 

69,519   

 

—     

 

10,439      

Power generation

 

114,991   

 

—     

 

14,310      

Coal mining

 

15,905   

 

9,579     

 

4,091      

Energy marketing

 

34,907   

 

—     

 

12,602      

Corporate

 

43   

 

—     

 

(4,627)     

Inter-segment eliminations

 

—   

 

(3,733)    

 

—      

 

 

 

 

 

 

 

Total

$

475,948   

$

7,364     

$

53,128      

 

During 2007, the Company added assets of approximately $43.7 million on the ongoing construction of the Wygen II power plant within the Electric and gas utility segment; approximately $51.8 million on maintenance capital and development drilling within the Oil and gas segment; approximately $9.6 million for development costs related to the Aquila asset acquisition; and approximately $48.6 million on assets related to the Valencia project in the Power generation segment. Other than these significant additions and changes beyond normal operating activities, the Company had no additional material changes in the assets of its reporting segments, as reported in Note 20 of the Notes to Consolidated Financial Statements in the Company’s 2006 Annual Report on Form 10-K.

 

21

 


(13)

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 2006 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 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, 2007

December 31, 2006

September 30, 2006

 

 

Latest

 

Latest

 

Latest

 

Notional

Expiration

Notional

Expiration

Notional

Expiration

 

Amounts

(months)

Amounts

(months)

Amounts

(months)

(in thousands of MMBtus)

 

 

 

 

 

 

 

 

 

Natural gas basis

 

 

 

 

 

 

 

 

 

swaps purchased

 

150,499  

27

 

138,111  

22

 

146,331  

16

Natural gas basis

 

 

 

 

 

 

 

 

 

swaps sold

 

158,349  

27

 

148,720  

22

 

153,530  

18

Natural gas fixed for float

 

 

 

 

 

 

 

 

 

swaps purchased

 

51,958  

25

 

38,239  

16

 

44,600  

18

Natural gas fixed for float

 

 

 

 

 

 

 

 

 

swaps sold

 

70,379  

25

 

59,061  

15

 

58,248  

6

Natural gas physical

 

 

 

 

 

 

 

 

 

purchases

 

95,028  

18

 

87,782  

22

 

66,972  

27

Natural gas physical sales

 

93,008  

30

 

106,500  

34

 

117,135  

39

Natural gas options

 

 

 

 

 

 

 

 

 

purchased

 

31,973  

6

 

22,373  

15

 

18,447  

15

Natural gas options sold

 

31,539  

6

 

22,373  

15

 

18,447  

15

 

 

22

 


 

Outstanding at

Outstanding at

Outstanding at

 

September 30, 2007

December 31, 2006

September 30, 2006

 

 

Latest

 

Latest

 

Latest

 

Notional

Expiration

Notional

Expiration

Notional

Expiration

 

Amounts

(months)

Amounts

(months)

Amounts

(months)

 

 

 

 

 

 

 

 

 

 

(in thousands of Bbls)

 

 

 

 

 

 

 

 

 

Crude oil physical

 

 

 

 

 

 

 

 

 

purchases

 

1,619    

7

 

1,600    

4

 

404(a)  

1

Crude oil physical sales

 

1,370    

5

 

1,367    

7

 

404(a)  

1

Crude oil swaps purchased

 

465    

12

 

240    

12

 

300     

12

Crude oil swaps sold

 

465    

12

 

240    

12

 

300     

12

 

 

 

 

 

 

 

 

 

 

(Dollars, in thousands)

 

 

 

 

 

 

 

 

 

Canadian dollars

 

 

 

 

 

 

 

 

 

purchased

$

29,000    

1

$

44,000    

1

$

23,000     

1

Canadian dollars sold

$

—    

$

—    

$

1,000     

2

_________________________

(a)

The Company began marketing crude oil in the Rocky Mountain region during May 2006.

 

Derivatives and certain natural gas and crude oil marketing activities were marked to fair value on September 30, 2007, December 31, 2006 and September 30, 2006, 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

 

 

 

 

 

 

 

 

 

 

 

September 30, 2007

$

22,183     

$

1,196

$

12,154    

$

1,293

$

9,932

 

 

 

 

 

 

 

 

 

 

 

December 31, 2006

$

53,728     

$

4

$

23,296    

$

377

$

30,059

 

 

 

 

 

 

 

 

 

 

 

September 30, 2006

$

51,528     

$

1,629

$

17,546    

$

1,873

$

33,738

 

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, 2007, December 31, 2006 and September 30, 2006, the market adjustments recorded in inventory were $(6.5) million, $(31.5) million and $(29.8) million, respectively.

 

23

 


Activities Other Than Trading

 

Oil and Gas Exploration and Production

 

On September 30, 2007, December 31, 2006 and September 30, 2006, 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,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps/options

465,000 

1.00

$

490   

$

—    

$

1,995

$

688

$

(2,683)   

$

490  

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

11,180,500 

1.60

 

6,712   

 

872    

 

494

 

1,035

 

6,403    

 

(348) 

 

 

 

$

7,202   

$

872    

$

2,489

$

1,723

$

3,720    

$

142  

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps/options

240,000  

1.00

$

524   

$

—    

$

362

$

$

36    

$

126  

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

10,588,000  

1.25

 

13,485   

 

2,000    

 

309

 

175

 

15,339    

 

(338) 

 

 

 

$

14,009   

$

2,000    

$

671

$

175

$

15,375    

$

(212) 

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

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  

________________________

*crude in Bbls, gas in MMBtus

 

Based on September 30, 2007 market prices, a $4.1 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 gains will likely change during the next twelve months as market prices change.

 

24

 


Fuel in Storage

 

On September 30, 2007, December 31, 2006 and September 30, 2006, the Company had the following swaps and related balances (in thousands):

 

 

 

 

 

 

 

 

Pre-tax

 

 

 

 

 

Non-

 

Non-

Accumulated

 

 

 

Maximum

Current

current

Current

current

Other

 

 

 

Terms in

Derivative

Derivative

Derivative

Derivative

Comprehensive

Unrealized

 

Notional*

Years

Assets

Assets

Liabilities

Liabilities

Income (Loss)

Gain

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

610,000

0.60

$

$

$

172

$

$

(172)

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

380,000

0.25

$

1,220

$

$

$

$

878

$

342

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

525,000

0.50

$

1,634

$

$

$

$

410

$

1,224

________________________

*gas in MMBtus

 

Based on September 30, 2007 market prices, a loss of $0.2 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 losses will likely change during the next twelve months as market prices change.

 

25

 


Financing Activities

 

On September 30, 2007, December 31, 2006 and September 30, 2006, 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

 

Notional

Interest

Terms in

Derivative

Derivative

Derivative

Derivative

Comprehensive

 

Amount

Rate

Years

Assets

Assets

Liabilities

Liabilities

(Loss)/Income

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

$

150,000

5.04%

9.00

$

$

1,352

$

666

$

599

$

87

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

$

150,000

5.04%

9.75

$

287

$

867

$

74

$

978

$

102

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

swaps

$

100,000

5.09%

10.00

$

141

$

452

$

83

$

758

$

(248)

 

Based on September 30, 2007 market interest rates and balances, a loss of approximately $0.7 million would be realized and reported in pre-tax earnings during the next twelve months. Estimated and realized losses will likely change during the next twelve months as market interest rates change.

 

In addition to the interest rate swaps above, during the third quarter of 2007, the Company entered into forward starting interest rate swaps with a total notional amount of $250.0 million to hedge the risk of interest rate movement between the hedge dates and the expected pricing date for a portion of the Company’s anticipated 2008 long-term debt financings. The swaps have a mandatory early termination date of June 30, 2008. As of September 30, 2007, the mark-to-market value was $(3.8) million. These swaps are designated as cash flow hedges and accordingly, any resulting gain or loss will be recorded in “Accumulated other comprehensive loss” on the Condensed Consolidated Balance Sheet and amortized into earnings as additional interest income or expense over the life of the related long-term financing.

 

On July 3, 2007, Cheyenne Light entered into a $110.0 million treasury lock to hedge a $110.0 million First Mortgage Bond offering expected to be completed in November 2007. As of September 30, 2007, the mark-to-market value was $(5.6) million. The treasury lock cash settled on October 15, 2007, the pricing date of the expected offering, and resulted in a $4.3 million payment to the counterparty. The treasury lock was treated as a cash flow hedge and accordingly, the resulting loss is carried in “Accumulated other comprehensive loss” on the Condensed Consolidated Balance Sheet and will be amortized over the life of the related bonds as additional interest expense.

 

26

 


(14)

POWER PLANT PROJECT AND POWER PURCHASE AGEEMENT

 

In April 2007, the Company entered into a power purchase agreement to provide electric power to Public Service Company of New Mexico, a regulated electric and natural gas utility subsidiary of PNM.

 

Under the terms of the agreement, the Company will provide the capacity and energy of a 149 Mw, simple-cycle gas turbine generation facility to be located near Albuquerque, New Mexico. The project is expected to cost approximately $101 million, and has a commercial operation in-service date in June 2008. If the Company would fail to meet the June 2008 in-service date, significant penalties could be incurred under the “delay damage” provisions that are customary within agreements of this nature. The agreement is a customary tolling agreement, where the Company receives variable and fixed fees for the plant’s availability and operation, and Public Service Company of New Mexico will be responsible for providing fuel for the operation. In addition, the agreement affords the Company favorable “change of law” and “government impositions” pass-throughs to Public Service Company of New Mexico. The duration of the power purchase agreement is 20 years. During the term of the agreement, Public Service Company of New Mexico is also provided an option to acquire a 50 percent equity interest in this project for a price equal to the fair market value at the time of the option exercise, with a minimum price equal to book value.

 

On June 20, 2007, the Company purchased certain equipment and assets related to the Valencia project from Public Service Company of New Mexico. The assets included the power plant turbine, permits, land and other auxiliary equipment. The purchase price was approximately $40.6 million, paid through entering into a $30.0 million short-term promissory note, payable to Public Service Company of New Mexico in December 2007, and $10.6 million in cash.

 

(15)

LEGAL PROCEEDINGS

 

The Company is subject to various legal proceedings, claims and litigation as described in Note 18 of the Notes to Consolidated Financial Statements in the Company’s 2006 Annual Report on Form 10-K.

 

Earn-Out Litigation

 

As disclosed in previous filings with the SEC, the Company has ongoing litigation with the former Indeck stockholders. On March 12, 2007, the Court granted, in part, the Company’s Motion to Dismiss the Amended Complaint. The Court dismissed Counts 1 and 5 of the Amended Complaint. Count 1 included all claims of fraud against individual defendants. Those individuals were not named in other counts of the Amended Complaint, so they were dismissed as parties to the lawsuit. Count 5 asserted a claim for breach of the covenant of good faith and fair dealing relating to the alleged destruction of evidence. The Court approved the amendment of the complaint on other theories. The Company expects to file pre-trial motions to dismiss some or all of these claims. To the extent motions to dismiss are denied, a trial of this matter is set to commence on March 31, 2008.

 

The parties retained an arbitrator who will direct the process and decide the Earn-Out issues presently in arbitration, according to the procedure stated in the Merger Agreement. No date for a final decision has been set by the arbitrator.

 

27

 


The outcome of this matter is uncertain, as is the amount of contingent merger consideration that could be awarded following arbitration and/or litigation. If any additional merger consideration is awarded, it would be recorded as additional goodwill, which would be subject to a recoverability analysis under GAAP.

 

Las Vegas Cogeneration/Nevada Power Company Arbitration

 

On March 16, 2007, Nevada Power filed a Demand for Arbitration pursuant to a Power Purchase Agreement dated May 27, 1992, (the “Agreement”) between Nevada Power and LVC. Nevada Power asserts that LVC is in breach of its obligation under the Agreement to maintain a “reliable fuel supply throughout the term of the Power Contract.” On July 5, 2007, Nevada Power served an Amended Demand for Arbitration. The relief Nevada Power requests include: (1) A determination that the Agreement requires LVC to obtain and maintain firm, long-term fuel supply and transportation agreements for the full term of the Agreement; (2) A determination that LVC failed to honor this obligation; (3) A determination that LVC’s failure to obtain and maintain firm fuel supply and transportation agreements constitutes a material breach of the Agreement; and (4) An order of specific performance requiring LVC to enter into long-term fuel supply and transportation agreements to cure the alleged breach.

 

LVC denies all these claims and filed its response to the Demand for Arbitration, asserting the following defenses: (1) That Nevada Power failed to honor its contractual obligation to properly negotiate in good faith before filing the Demand for Arbitration; (2) That LVC has complied with its obligations relating to fuel supply and transportation; and (3) That numerous other affirmative defenses preclude Nevada Power from receiving the relief requested.

 

The arbitration demand was filed with the American Arbitration Association, pursuant to its Commercial Arbitration Rules. The parties selected an arbitrator and expect resolution to the matter by the end of 2007. During October 2007, the parties initiated negotiations for the resolution of this dispute and formally agreed to suspend the arbitration proceeding pending the completion of negotiations. While the Company cannot predict the final outcome of this action, it is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

 

California Price Reporting and Anti-Trust Litigation

 

As disclosed in previous filings with the SEC, the Company’s subsidiary, Enserco, has ongoing litigation in the San Diego Superior Court, in the State of California, under the heading “In re Natural Gas Anti-Trust Cases I, II, III, IV and V.” The lawsuits have been pending against other marketers, traders, transporters and sellers of natural gas since as early as 2004. The plaintiffs allege the defendants, including Enserco, used various practices to manipulate natural gas prices in California in violation of the Cartwright Act and other California state laws. Enserco had filed motions to dismiss, which were pending before the court. On June 2, 2007, Enserco reached a settlement agreement set forth in a Letter of Intent. Final documentation is expected to be completed by the end of 2007. The Company has previously made accruals sufficient to cover the agreed upon settlement payment, the amount of which is not material to the Company’s consolidated financial position, results of operations or cash flows.

 

 

28

 


FERC Compliance Investigation

 

Following an internal investigation of natural gas marketing activities conducted within the Wholesale energy group, the Company identified possible instances of noncompliance with regulatory requirements applicable to those activities. The Company has notified the staff of FERC of its findings. The Company has also evaluated recent public announcements of civil penalties ranging from $0.3 million to $7.0 million that have been levied against other companies for violations of FERC regulatory requirements. We believe we have adequately reserved for the estimated potential penalty that could be levied on the Company. Although the outcome of any legal or regulatory proceedings resulting from these matters cannot be predicted with any certainty, the final resolution of these matters could have a material impact on the consolidated net income of any particular period, but is not expected to have a material impact upon the Company’s overall consolidated financial position.

 

Except as described above, there have been no material developments in any previously reported proceedings or any new material proceedings that have developed or material proceedings that have terminated during the first nine months of 2007.

 

(16)

ACQUISITIONS

 

Aquila

 

On February 7, 2007, the Company entered into a definitive agreement with Aquila for the asset acquisition of Aquila’s regulated electric utility in Colorado and its regulated gas utilities in Colorado, Kansas, Nebraska and Iowa. The purchase price of the assets is $940 million, subject to closing adjustments.

 

The purchase is conditioned on the completion of the acquisition of the outstanding shares of Aquila by Great Plains immediately following the sale of the regulated utilities to the Company. During October 2007, shareholder approvals of the merger were completed. The purchase is also subject to regulatory approvals from the Missouri Public Service Commission, the Kansas Corporation Commission, the Colorado Public Utilities Commission, the Nebraska Public Service Commission, the Iowa Utilit