UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934 (Amendment No.   )

Filed by the Registrant  x
Filed by a Party other than the Registrant  o
Check the appropriate box:
o	Preliminary Proxy Statement
o	Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))
x	Definitive Proxy Statement
o	Definitive Additional Materials
o	Soliciting Material Pursuant to §240.14a-12

 

Black Hills Corporation
(Name of Registrant as Specified In Its Charter)
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
x	No fee required.
o	Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
	(1)	Title of each class of securities to which transaction applies:
	(2)	Aggregate number of securities to which transaction applies:
	(3)	Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):
	(4)	Proposed maximum aggregate value of transaction:
	(5)	Total fee paid:
o	Fee paid previously with preliminary materials.
o	Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.
	(1)		Amount Previously Paid:
	(2)		Form, Schedule or Registration Statement No.:
	(3)		Filing Party:
	(4)		Date Filed:

 

Persons who are to respond to the collection of information contained in this form are not required to respond unless the form displays a currently valid OMB control number.

BLACK HILLS CORPORATION

Notice of 2007
Annual Meeting of Shareholders
and Proxy Statement

BLACK HILLS CORPORATION

625 Ninth Street
Rapid City, South Dakota 57701

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
MAY 22, 2007

April 10, 2007

Dear Shareholder:

You are invited to attend the annual meeting of shareholders of Black Hills Corporation to be held on Tuesday, May 22, 2007 at 9:30 a.m., local time, at The Journey Museum, 222 New York Street, Rapid City, South Dakota. The purpose of our annual meeting is to consider and take action on the following:

1.                Election of three directors in Class I:  Jack W. Eugster, Gary L. Pechota and Thomas J. Zeller.

2.                Ratification of Deloitte & Touche LLP to serve as our independent registered public accounting firm for the year 2007.

3.                Any other business that properly comes before the annual meeting.

The enclosed proxy statement discusses the important matters to be considered at this year’s meeting. Our common shareholders of record as of April 3, 2007 can vote at the annual meeting.

Your vote is very important. You may vote your shares by telephone, by the Internet or by returning the enclosed proxy. If you own shares of common stock other than the shares shown on the enclosed proxy, you will receive a proxy in a separate envelope for each such holding. Please vote each proxy received. To make sure that your vote is counted if voting by mail, you should allow enough time for the postal service to deliver your proxy before the meeting.

 

BLACK HILLS CORPORATION

625 Ninth Street
Rapid City, South Dakota 57701

PROXY STATEMENT

A proxy in the accompanying form is solicited by the Board of Directors of Black Hills Corporation, a South Dakota corporation, to be voted at the annual meeting of our shareholders to be held Tuesday, May 22, 2007, and at any adjournment of the annual meeting.

The enclosed form of proxy, when executed and returned, will be voted as set forth therein. Any shareholder signing a proxy has the power to revoke the proxy in writing, addressed to our secretary, or in person at the meeting at any time before the proxy is exercised.

We will bear all costs of the solicitation. In addition to solicitation by mail, our officers and employees may solicit proxies by telephone, fax, or in person. We have retained Georgeson Inc. to assist us in the solicitation of proxies at an anticipated cost of $6,000 plus out-of-pocket expenses. Also, we will, upon request, reimburse brokers or other persons holding stock in their names or in the names of their nominees for reasonable expenses in forwarding proxies and proxy materials to the beneficial owners of stock.

This proxy statement and the accompanying form of proxy are to be first mailed on or about April 10, 2007. Our 2006 annual report to shareholders is being mailed to shareholders with this proxy statement.

VOTING RIGHTS AND PRINCIPAL HOLDERS

Only our shareholders of record at the close of business on April 3, 2007, will be entitled to vote at the meeting. Our outstanding voting stock as of such record date consisted of 37,664,110 shares of our common stock.

Each outstanding share of our common stock is entitled to one vote. Cumulative voting is permitted in the election of our Board of Directors. Each share is entitled to three votes, one each for the election of three directors, and the three votes may be cast for a single person or may be distributed among two or three persons.

TABLE OF CONTENTS

 

COMMONLY ASKED QUESTIONS AND ANSWERS ABOUT THE
ANNUAL MEETING PROCESS

Q:             Who is soliciting my proxy?

A:               The Board of Directors of Black Hills Corporation.

Q:             Where and when is the annual meeting?

A:               9:30 a.m., local time, May 22, 2007 at The Journey Museum, 222 New York Street, Rapid City, South Dakota.

Q:             What am I voting on?

A:               ·  Election of three directors in Class I:  Jack W. Eugster, Gary L. Pechota and Thomas J. Zeller.

·       Ratification of Deloitte & Touche LLP as our independent registered public accounting firm for 2007.

Q:             Who can vote?

A:               Holders of our common stock as of the close of business on the record date, April 3, 2007, can vote at our annual meeting. Each share of our common stock gets one vote. Cumulative voting is permitted in the election of directors. Each share is entitled to three votes, one each for the election of three directors, and the three votes may be cast for a single person or may be distributed among two or three persons.

Q:             How do I vote?

A:               There are three ways to vote by proxy:

·       by calling the toll free telephone number on the enclosed proxy;

·       by using the Internet; or

·       by returning the enclosed proxy in the envelope provided.

You may be able to vote by telephone or the Internet if your shares are held in the name of a bank or broker. If this is the case, you will need to follow their instructions.

If we receive your signed proxy before the annual meeting, we will vote your shares as you direct. You can specify on your proxy whether your shares should be voted for all, some or none of the nominees for directors. You can also specify whether you approve, disapprove or abstain from the other proposal.

If you do not mark any sections, your proxy card will be voted:

·       in favor of the election of the directors named in Item 1; and

·       in favor of Item 2.

You have the right to revoke your proxy any time before the meeting by:

·       entering a new vote by telephone or Internet;

·       notifying our secretary in writing;

·       sending a later dated proxy changing your vote; or

·       attending the meeting in person and revoking your proxy at any time before the proxy is exercised.

1

---

Q:             Who will count the vote?

A:               Representatives of Wells Fargo Bank, N.A. will count the votes and serve as judges of the election.

Q:             What constitutes a quorum?

A:               As of the record date, April 3, 2007, 37,664,110 shares of our common stock were issued and outstanding. In order to conduct the annual meeting, more than one-half of the outstanding shares must be present or be represented by proxy. This is referred to as a “quorum.”  If you submit a properly executed proxy card, you will be considered as part of the quorum. Proxies marked as abstaining and broker non-votes on any proposal to be acted on by shareholders will be treated as present at the annual meeting for purposes of determining a quorum.

Q:             What vote is needed for these proposals to be adopted?

A:               The affirmative vote of a plurality of the votes cast at the meeting is required for the election of directors. This means that the nominees with the largest number of votes “for” will be elected as directors, up to the maximum number of directors to be chosen at the election. A properly executed proxy marked “Withhold authority” with respect to the election of one or more directors will not be voted with respect to the director or directors indicated, although it will be counted for purposes of determining whether there is a quorum.

For the other item, the affirmative vote of the holders of a majority of the shares represented at the meeting and entitled to vote on the item will be required for approval. A properly executed proxy marked “Abstain” with respect to such matter will not be voted, although it will be counted for purposes of determining whether there is a quorum. Accordingly, an abstention will have the effect of a negative, or “no” vote.

If you hold your shares in “street name” through a broker or nominee, your broker or nominee may not be permitted to exercise voting discretion with respect to some of the matters to be acted upon. Thus, if you do not give your broker or nominee specific instructions, your shares may not be voted on those matters and will not be counted in determining the number of shares necessary for approval. Shares represented by such “broker non-votes” will, however, be counted in determining whether there is a quorum.

Q:             Is cumulative voting permitted for the election of directors?

A:               In the election of directors, you may elect to cumulate your vote. Cumulative voting will allow you to allocate among the director nominees, as you see fit, the total number of votes equal to the number of director positions to be filled multiplied by the number of shares you hold. For example, if you own 100 shares of stock, and there are three directors to be elected at the annual meeting, you could allocate 300 “For” votes (three times 100) among as few or as many of the three nominees to be voted on at the annual meeting as you choose.

If you choose to cumulate your votes, you will need to submit a proxy card or a ballot and make an explicit statement of your intent to cumulate your votes, either by indicating in writing on the proxy card or by indicating in writing on your ballot when voting at the annual meeting. If you hold shares beneficially in street name and wish to cumulate votes, you should contact your broker, trustee or nominee.

2

---

Q:             What should I do now?

A:               You should vote your shares by telephone, by the Internet or by returning your signed and dated proxy card in the enclosed envelope as soon as possible so that your shares will be represented at the annual meeting.

Q:             Who conducts the proxy solicitation and how much will it cost?

A:               We are asking for your proxy for the annual meeting and will pay all the cost of asking for shareholder proxies. We have hired Georgeson Inc. to help us send out the proxy materials and ask for proxies. Georgeson Inc.’s fee for these services is anticipated to be $6,000, plus out-of-pocket expenses. We can ask for proxies through the mail or by telephone, fax, or in person. We can use our directors, officers and employees to ask for proxies. These people do not receive additional compensation for these services. We will reimburse brokerage houses and other custodians, nominees and fiduciaries for their reasonable out-of-pocket expenses for forwarding solicitation material to the beneficial owners of our common stock.

Q:             Can I revoke my proxy?

A:               Yes. You can change your vote in one of four ways at any time before your proxy is used. First, you can enter a new vote by telephone or Internet. Second, you can revoke your proxy by written notice. Third, you can send a later dated proxy changing your vote. Fourth, you can attend the meeting and vote in person.

Q:             How will my shares be voted if they are held in a broker’s name?

A:               Your broker may vote shares nominally held in its name, or in what is commonly called “street name,” under some circumstances, only if you provide the broker with written instructions on how to vote.

Q:             What happens if I do not give my broker instructions?

A:               Absent your instructions, under some circumstances, these shares will not be voted. Therefore, we urge you to instruct your broker in writing to vote shares held in street name.

Q:             Who should I call with questions?

A:               If you have questions about the annual meeting, you should call Roxann R. Basham, Vice President—Governance and Corporate Secretary, at (605) 721-1700.

Q:             When are the shareholder proposals for the annual meeting held in 2008 due?

A:               In order to be considered, you must submit proposals for next year’s annual meeting in writing to our Corporate Secretary at our executive offices at 625 Ninth Street, P.O. Box 1400, Rapid City, South Dakota 57709, prior to December 12, 2007.

3

Proposal 1

ELECTION OF DIRECTORS

In accordance with our Bylaws and Article Sixth of our Articles of Incorporation, members of our Board of Directors are elected to three classes of staggered terms consisting of three years each. At this annual meeting of our shareholders, three directors will be elected to Class I of the Board of Directors to hold office for a term of three years until our annual meeting of shareholders in 2010, and until their respective successors shall be duly elected and qualified in accordance with the Company’s Bylaws.

Richard Korpan, director since 2003, informed the Board of Directors that, for personal reasons, he would not seek reelection for an additional term at this annual meeting of shareholders. The Board of Directors expresses its thanks to Richard Korpan for his service on the Board.

Two nominees for directors are presently members of our Board of Directors, and one is not. Gary L. Pechota is standing for election by our shareholders for the first time in connection with this annual meeting. Mr. Pechota was recommended to the Governance Committee by a non-management director. Mr. Pechota is currently retired and previously served as Chief of Staff of the Indian Gaming Commission and in the capacities of Chief Executive Officer, President and Chairman of the Board for companies in the cement industry. The proxy attorneys will vote your stock for the election of the three nominees for directors, unless otherwise instructed. If, at the time of the meeting, any of such nominees shall be unable to serve in the capacity for which they are nominated or for good cause will not serve, an event which the Board of Directors does not anticipate, it is the intention of the persons designated as proxy attorneys to vote, at their discretion, for such nominees as the Governance Committee may recommend and the Board of Directors may propose to replace those who are unable to serve. The affirmative vote of a plurality of the votes cast at the meeting is required for the election of the nominees to the Board of Directors.

The following information, including principal occupation or employment for the past five or more years, is furnished with respect to each of the following persons who are nominated as Class I Directors, each to serve for a term of three years to expire in 2010.

The Board of Directors recommends a vote FOR the election of the following nominees:

Nominees for Election Until
2010 Annual Meeting—Class I

 

4

---

Directors Whose Terms Expire at
2008 Annual Meeting—Class II

 

Directors Whose Terms Expire at
2009 Annual Meeting—Class III

 

5

---

CORPORATE GOVERNANCE

Corporate Governance Guidelines.   Our Board of Directors have adopted corporate governance guidelines titled “Corporate Governance Guidelines of the Board of Directors” which set the tone for operation of our Board and assist the Board in fulfilling its obligations to shareholders and other constituencies. The guidelines lay the foundation for the Board’s responsibilities, operations, leadership, organization and committee matters. The Governance Committee reviews the guidelines annually, and the guidelines may be amended at any time, upon recommendation by the Governance Committee and approval of the Board.

Board Independence.   In accordance with New York Stock Exchange rules, the Board of Directors through its Governance Committee affirmatively determines the independence of each director and director nominee in accordance with guidelines it has adopted, which include all elements of independence set forth in the New York Stock Exchange listing standards. These guidelines are contained in our Policy for Director Independence, which can be found in the “Governance” section of our website (www.blackhillscorp.com/corpgov.htm). Based on these standards, the Governance Committtee determined that each of the following nonemployee directors and director nominee is independent and has no relationship with the Company, except as a director, director nominee, and stockholder of the Company:

 

In addition, based on such standards, the Governance Committee determined that Mr. Emery is not independent because he is our Chairman, President and Chief Executive Officer (the “CEO”).

Presiding Director and Executive Sessions.   The Board has a Presiding Director position that is named annually. John R. Howard held this position through the annual meeting in 2006 and Kay S. Jorgensen was elected to hold this position effective May 24, 2006. The responsibilities of Presiding Director, as provided in the Board’s Governance Guidelines, are to chair executive sessions of the non-management directors and communicate the Board’s annual evaluation of the CEO. The Presiding Director, together with the non-management directors, establishes the agenda for executive sessions, which are held at the end of each regular Board meeting. The Presiding Director serves as a liaison between the non-management members of the Board and the CEO, and discusses, to the extent appropriate, matters discussed by the non-management directors in executive session. The Presiding Director also presides over regular meetings of the Board in the absence of the Chairman.

Consideration of Director Nominees.   The Governance Committee utilizes a variety of methods for identifying and evaluating nominees for director. The Committee regularly assesses the appropriate size of the Board, and whether any vacancies on the Board are expected due to retirement or otherwise. In the event vacancies are anticipated, or otherwise arise, the Committee considers various potential candidates for director. Board candidates are considered based upon various criteria, including diverse business, administrative and professional skills or experiences; an understanding of relevant industries, technologies and markets; financial literacy; independence status; the ability and willingness to contribute time and special competence to Board activities; personal integrity and independent judgment; and a commitment to enhancing shareholder value. The Committee considers these and other factors as it deems appropriate, given the current needs of the Board and the Company. The Committee considers candidates for Board membership suggested by a variety of sources, including current or past Board members, members of management and shareholders. There are no differences in the manner by which the Committee evaluates

6

---

director candidates recommended by shareholders from those recommended by other sources. The Committee has also retained a third-party executive search firm at times to identify candidates.

Nominations from our shareholders for membership on the Board of Directors will be considered by the Governance Committee. A shareholder who wishes to submit names for future consideration for Board membership should do so in writing, with whatever supporting material the shareholder considers appropriate, addressed to Governance Committee, c/o Corporate Secretary, Black Hills Corporation, P.O. Box 1400, Rapid City, South Dakota 57709.

Communications with the Board.   Shareholders and others interested in communicating directly with the Presiding Director, with the non-management directors as a group, or the Board of Directors may do so in writing to the Presiding Director, Black Hills Corporation, P.O. Box 1400, 625 Ninth Street, Rapid City, South Dakota, 57709.

Related Party Transactions.   Our Code of Business Conduct addresses conflicts of interest and related party transactions and applies to all employees, including officers and members of our Board of Directors. Employees are expected to avoid any activity, investment, interest or association that interferes or appears to interfere with their independent exercise of judgment in performing a job responsibility. The Code of Business Conduct specifically states that no employee will engage in any business transaction on behalf of the Company with a family member or with a firm of which that relative is a principal, officer or representative. If a potential conflict of interest or related party transaction arises, the Chief Compliance Officer reviews the facts of each situation to determine if the transaction is allowed under the Code of Business Conduct. The internal audit department conducts an annual audit of the Code of Business Conduct and reports its findings to the Audit Committee.

In addition, on an annual basis, each director and executive officer is obligated to complete a Director and Officer Questionnaire which requires disclosure of any transaction with the Company in which the director or executive officer, or any member of his or her immediate family, have a direct or indirect material interest and confirmation that they have read and understand our Code of Business Conduct. If a related party transaction is disclosed by a director or executive officer it is reported to the Audit Committee.

Corporate Governance Documents.   The charters of the Audit, Compensation, Executive and Governance committees, as well as the Board’s Corporate Governance Guidelines, Policy for Director Independence, Code of Business Conduct and the Code of Ethics that applies to our Chief Executive Officer, Chief Financial Officer, Corporate Controller, and certain other persons performing similar functions can be found in the “Governance” section of our website (www.blackhillscorp.com/corpgov.htm). Copies may also be obtained upon request from our Corporate Secretary. Please note that none of the information contained on our website is incorporated by reference in this proxy statement.

Section 16(a) Beneficial Ownership Reporting Compliance.   Based solely upon a review of our records and copies of reports on Form 3, 4 and 5 furnished to us, we believe that during and with respect to 2006 all persons subject to the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, filed the required reports on a timely basis.

MEETINGS AND COMMITTEES OF THE BOARD

The Board of Directors

Our directors review and approve our strategic plan and oversee management of the Company. Our Board of Directors held 15 meetings during 2006. Directors’ attendance at all Board and Committee meetings averaged 94 percent. During 2006, every director attended at least 75 percent of the combined total of Board meetings and Committee meetings on which the director served. Each regularly scheduled meeting of the Board includes an executive session of only non-management directors. We encourage our

7

---

directors to attend the annual shareholders’ meeting. Seven of our 10 directors were in attendance at the 2006 annual meeting of shareholders.

Committees of the Board

Our Board has four standing committees to facilitate and assist the Board in the execution of its responsibilities. The committees are currently the Audit Committee, the Compensation Committee, the Governance Committee and the Executive Committee. In accordance with the New York Stock Exchange listing standards and our Corporate Governance Guidelines, the Audit, Compensation and Governance Committees are comprised solely of non-employee, independent directors. Each committee operates under a charter which is available on our website at www.blackhillscorp.com/corpgov.htm and is also available in print to any shareholder who requests it.

Members of the Committees are designated by our directors upon recommendation of the Governance Committee. The table below shows current membership for each of the Board committees. Warren Robinson who became a member of our Board of Directors effective April 1, 2007, will be assigned to a committee at the next regularly scheduled Governance Committee meeting.

*                    Committee Chairperson

Audit Committee.   The Audit Committee held six meetings in 2006. The Audit Committee’s responsibilities, discussed in detail in its charter include, among other duties, the responsibility to:

·       assist the Board in fulfilling its responsibility for oversight of the quality and integrity of our accounting, auditing and financial reporting practices;

·       monitor the integrity of our financial reporting process, systems of internal controls and disclosure controls regarding finance, accounting and legal compliance;

·       review areas of potential significant financial risk to the Company;

·       review consolidated financial statements and disclosures;

·       appoint an independent registered public accounting firm for ratification by our shareholders;

·       monitor the independence and performance of our independent registered public accountants and internal auditing department;

·       pre-approve all audit and non-audit services provided by our independent registered public accountants;

·       review the scope and results of the annual audit including reports and recommendations of our independent registered public accountants;

·       review the internal audit plan, results of internal audit work and monitor compliance with our Code of Conduct; and

·       periodically meet with our internal audit group, management, and independent registered public accounting firm.

8

---

In accordance with the rules of the NYSE, all of the members of the Audit Committee are financially literate. The Board determined that Messrs. Eugster, Howard, Vering and Zeller each have the requisite attributes of an “audit committee financial expert” as provided in regulations promulgated by the Securities and Exchange Commission, and that such attributes were acquired through relevant education and/or experience.

Compensation Committee.   The Compensation Committee held four meetings in 2006. The Compensation Committee’s responsibilities, discussed in detail in its charter include, among other duties, the responsibility to:

·       approve and oversee the implementation of the executive and director compensation philosophy, policies and programs;

·       perform functions required by the Board of Directors in the administration of all federal and state statutes relating to employment and compensation;

·       consider and recommend for approval by the Board all executive compensation programs including benefits, stock option plans and stock ownership plans; and

·       promote an executive compensation program that supports the overall objective of enhancing shareholder value.

The Compensation Committee has authority under its charter to retain and terminate compensation consultants, outside counsel and other advisors as the Committee may deem appropriate in its sole discretion. The Committee has sole authority to approve related fees and retention terms. The Committee may delegate any of its responsibilities to subcommittees as the Committee may deem appropriate in its sole discretion. The Committee engaged Hewitt Associates, an independent consulting firm, to conduct an annual review of its total compensation program for executive officers.

The Committee annually evaluates the CEO’s performance in light of established goals and objectives, with input from the other independent directors. Based upon the Committee’s evaluation and recommendation, the independent directors of the Board set the CEO’s annual compensation, including salary, bonus, incentive and equity compensation and perquisites.

The CEO annually reviews the performance of each of our senior officers. He presents a summary of his evaluations of the Chief Operating Officer—Retail (the “COO-Retail,”) the Chief Operating Officer—Wholesale (the “COO-Wholesale”) and the Executive Vice President and Chief Financial Officer (the “CFO”) to the Compensation Committee. Based upon the Committee’s review and recommendation, the Board of Directors sets the annual compensation of the COO-Retail, COO-Wholesale and CFO, including salary, bonus, incentive and equity compensation and perquisites.

The CEO also annually reviews the performance of our other senior officers and provides oversight of management’s evaluations of our other officers. Senior officers assess performance of all officers reporting to them. Based upon these performance reviews, market analysis conducted by Hewitt Associates and discussions with the human resources department, the CEO recommends the compensation of this group of officers to the Committee. The Committee may exercise its discretion in modifying any of the recommended compensation and award levels in its review and approval process.

Compensation Committee Interlocks and Insider Participation.   The Compensation Committee is comprised entirely of independent directors.

Governance Committee.   The Governance Committee held four meetings in 2006. The Governance Committee’s responsibilities, discussed in detail in its charter include, among other duties, the responsibility to:

·       assess the size of the Board and membership needs and qualifications for Board membership;

9

---

·       recruit and recommend prospective directors to the Board to fill vacancies;

·       consider and recommend existing Board members to be renominated at our annual meeting of shareholders;

·       establish and review guidelines for corporate governance;

·       recommend to the Board committee membership and the chairpersons of the committees;

·       nominate an independent director to serve as a Presiding Director;

·       review the independence of each director and director nominee;

·       administer an annual evaluation of the performance of the Board and facilitate an annual assessment of each committee; and

·       review with the CEO the succession plan for corporate officers.

Executive Committee.   The Executive Committee acts upon specific authorization by the Board of Directors in the interval between Board meetings. The Executive Committee did not meet in 2006.

EXECUTIVE COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

Overview of Compensation Program

The Compensation Committee of the Board of Directors (the “Committee,” for purposes of this compensation discussion and analysis) is composed entirely of independent directors and is responsible for approving and overseeing the implementation of our executive compensation philosophy, policies and programs. The Committee has a written executive compensation philosophy which details the objectives of our executive compensation program.

Throughout this proxy statement, the individuals included in the Summary Compensation Table for 2006, are referred to as our “named executive officers.” Our named executive officers, based on 2006 positions and compensation levels, include David R. Emery, our CEO, Mark T. Thies, our CFO, Thomas M. Ohlmacher, our COO-Wholesale, Linden R. Evans, our COO-Retail, and Steven J. Helmers, our Senior Vice President and General Counsel. Our senior officers (the “senior officers”) include the named executive officers plus the Senior Vice President—Corporate Administration and Compliance and the Senior Vice President—Strategic Planning and Development.

Compensation Philosophy.   The Committee seeks to promote an executive compensation program that supports the overall objective of enhancing shareholder value. The executive compensation strategy is based on principles designed to:

·       Attract, retain and encourage the development of highly qualified and motivated executives;

·       Provide compensation that is competitive;

·       Promote the relationship between pay and performance;

·       Promote overall corporate performance that is linked to the interests of our shareholders; and

·       Recognize and reward outstanding performance.

10

The market for our senior executive talent is national in scope and is not focused on any one geographic location, area or region of the country. As such, our executive compensation should be competitive with the national market place for senior executives, and because we operate in a diverse collection of businesses, should also reflect and be competitive with the industry or industries in which each individual executive operates.

Our goal is to provide total direct compensation (the sum of base salary, annual bonus and long-term incentives) at the median of the appropriate market when our operating results approximate average performance in relation to our peers. Our executives’ actual direct compensation should vary significantly based on how actual performance varies from average or target results. For results that are well above average or target performance, our executives should be given the opportunity to earn compensation that is well above the market’s average or median pay level. Conversely, our executives should earn comparatively low levels of total compensation when our performance is well below average or target results or the individual executive’s performance is unsatisfactory.

Our executive compensation is designed to maintain an appropriate and competitive balance between fixed and variable pay elements, short- and long-term compensation, and cash as well as stock-based compensation. Base salaries or fixed compensation should approximate market median levels, place appropriate emphasis on performance-based incentives, and yet be sufficient to attract and retain executive talent. Our target annual bonuses should be capable of producing competitive cash compensation (salary plus bonus), with sufficient upside to enable executives to earn top quartile (75th percentile or higher) salary plus bonus, to promote the achievement of superior annual operating results. On the other hand, no bonus should be paid for results that are well below target to hold executives accountable for unacceptable results. Long-term incentives should be competitive with market median practice and sufficient to provide competitive total direct compensation while tied to the creation of long-term shareholder value.

We believe that the performance basis for determining compensation should differ by each reward element—base salary, annual bonus and long-term incentive compensation. Base salaries should approximate the market median for an individual’s duties, responsibilities, skills, competencies and experience with annual adjustments based on an assessment of the individual’s performance, contributions and development in the prior year. Annual bonuses should recognize and reward the contributions of our executives, foster teamwork and cooperation within the executive officer team, and closely align the executives’ interests with our shareholders. We believe having the annual performance goal for the corporate officers tied to our consolidated earnings per share rewards the executives for their contributions to group performance and leads to overall corporate success. Long-term incentives should tie executive rewards to the value created for shareholders. We believe equity awards most directly support this objective. To the extent stock options are used, they should always be awarded at least at 100 percent of fair market value of the stock on the date of grant and shall not be back-dated or repriced. To the degree other long-term incentives are used, they should focus on sustained long-term results that drive or are based on shareholder value creation. The amount of equity compensation to be awarded based on our total shareholder return should reflect a comparison of our stock performance in relation to the performance of a peer group of entities. Incentive measures (short- and long-term) should emphasize objective, quantitative operating measures, as opposed to subjective, qualitative non-financial measures. The Committee retains the right to positively or negatively adjust incentive payments based on their subjective evaluation of performance, including the materiality of certain extraordinary events. We have a policy that if an accounting restatement occurs after incentive payments have been made, due to the results of misconduct associated with financial reporting, the Committee will request repayment of the incentive compensation from our CEO and CFO and may request repayment of incentive compensation from our other officers and business unit leaders, taking into consideration the individual roles and responsibilities prompting the restatement.

11

---

We believe it is important for our officers to hold Company stock to further link performance to the interests of our shareholders. Consequently, we have stock ownership guidelines in place for all officers and business unit leaders with minimum stock ownership levels that are based upon their level of responsibility. The stock ownership guidelines are disclosed in this Compensation Discussion and Analysis under the heading “Stock Ownership Guidelines.”

It is our philosophy to qualify, to the extent reasonably practicable, our executive officers’ compensation for deductibility under applicable tax law. We reserve the flexibility necessary to provide total cash compensation in line with competitive practice, our compensation philosophy, and the Company’s best interests, and may from time to time pay compensation to our executive officers that may not be deductible for tax purposes. We believe that compensation paid under our executive compensation program generally is fully deductible for federal income tax purposes.

Setting Executive Compensation

Based upon this compensation philosophy, the Committee structures our executive compensation to motivate our officers to achieve specified business goals and to reward them for achieving such goals.

The Committee selected and retained the services of an independent consulting firm, Hewitt Associates, to provide information regarding practices and trends in compensation programs, to review and evaluate our compensation program as compared to compensation practices of other companies with similar characteristics, including size and type of business, and to provide a compensation analysis of 20 executive positions. The Company operates in a diverse collection of businesses; therefore, our comparator groups are comprised of both utility and general industry companies. Hewitt gathered data from its database, as well as from public and private surveys covering the utility and general industries.

The salary surveys used were:

·       Hewitt Associates: Total Compensation Measurement Database—Utility and General Industry;

·       Hewitt Associates: Power Industry Compensation Survey;

·       Hewitt Associates: Energy Marketing & Trading Survey;

·       Towers Perrin: Energy Services Industry, Executive Compensation Database;

·       ECS/Watson Wyatt: Top Management Report; and

·       ECI: Oil and Gas Industry Compensation Survey.

To develop conclusions from the data gathered from these different sources, Hewitt employs a statistical technique called regression analysis to adjust the compensation data for differences in company revenues. The adjusted value is used as the basis of comparison of compensation between Black Hills Corporation’s executive compensation and the survey data.

The Committee annually reviews tally sheets on all components of each executive officer’s compensation, including salary, bonus, equity and other long-term incentive compensation values granted, the actual value realized from stock option exercises and restricted stock and restricted stock units vested, the value of all perquisites and other personal benefits, and the projected annual benefit under the Pension and Pension Equalization Plans.

The Committee seeks to establish a market-based competitive compensation program that is at or near the median of the comparative groups surveyed. Variations from this objective may occur due to the experience level or performance of the officer. Recommendations made by the Committee are based upon the market analysis, company performance, achievement of individual performance objectives, the level and nature of responsibilities, and discussions with the CEO and human resources department. The

12

---

Committee believes that appropriate compensation levels are essential for motivating, retaining and attracting high quality employees.

An important component of the total compensation is derived from incentive compensation as discussed in our compensation philosophy above. The Committee reviews information provided by Hewitt Associates to determine the appropriate level and mix of incentive compensation. Actual income in the form of incentive compensation is realized by the executive as a result of achieving Company goals and overall stock performance. The Committee believes that a significant portion of total target compensation should be comprised of incentive compensation.

Role of the Committee and Board in Setting Executive Compensation.   Each year the Committee evaluates the CEO’s performance in light of established goals and objectives, with input from the other independent directors. Based upon the Committee’s evaluation and recommendation, the independent directors of the Board set the CEO’s annual compensation, including salary, bonus, incentive and equity compensation and perquisites.

The Committee reviews the CEO’s evaluation of the performance of the COO-Retail, COO-Wholesale and the CFO in light of established goals and objectives. Based upon the Committee’s review and recommendation, the Board of Directors sets the annual compensation of the COO-Retail, COO-Wholesale and CFO, including salary, bonus, incentive and equity compensation and perquisites. The Committee also reviews and approves the CEO’s recommendations for compensation of our other senior officers, and oversees management’s compensation decisions relating to other officers and business unit leaders. The Committee is required to approve all decisions regarding equity awards to our officers.

Role of Executive Officers in Compensation Decisions.   The CEO annually reviews the performance of each of our senior officers. He presents a summary of his evaluation of all of our senior officers to the Committee and thoroughly reviews the COO-Retail, COO-Wholesale and CFO evaluations with the Committee.

The CEO also annually reviews the performance of our other senior officers and provides oversight of management’s evaluations of our other officers. Senior officers assess performance of all officers reporting to them. Based upon these performance reviews, market analysis conducted by Hewitt Associates and discussions with our human resources department, the CEO recommends the compensation of this group of officers to the Committee. The Committee may exercise its discretion in modifying any of the recommended compensation and award levels in its review and approval process.

Components of Executive Compensation

The components of our executive compensation program consist of a base salary, an annual incentive plan, and a long-term incentive award program. In addition, we provide income for our officers’ retirement and other benefits. The components of total target compensation in 2006 were as follows:

 

13

---

Base Salary.   Base salaries for all officers are reviewed annually. The base salary component is targeted at the median of the market data provided by Hewitt Associates. The actual base salary of each officer is determined by the executive’s performance, the experience level of the officer, the executive’s current position in a market-based salary range, and internal pay relationships. Evaluation and approval of base salary adjustments normally occurs in December, with the adjustments effective in January of the following year. We also adjust the base salary of our executives at the time of a promotion or change in job responsibility, as appropriate.

Annual Incentive.   Our Short-Term Annual Incentive Compensation Program is designed to recognize and reward the contributions of individual executives as well as the contributions that group performance makes to overall corporate success. Our corporate officer group is eligible to participate in this plan. The program’s goal for our corporate officers is based on an earnings per share target in order to closely align interests with shareholders and to foster teamwork and cooperation within the officer team. The earnings per share target generally equals the budgeted earnings per share from continuing operations. The annual incentive, after applicable tax withholding, is distributed to the officer in the form of 50 percent stock and 50 percent cash, unless the officer has met his or her stock ownership guideline whereby he or she has the option to receive the total award in cash, after applicable tax withholding. Target award levels are established as a percentage of each participant’s base salary considering the appropriate compensation survey data. A target award is comparable to the average annual incentive payout award of the comparator group at the 50th percentile level.

The Committee approves the target level for each officer in December, which is applicable to performance in the following plan year. Target levels vary based upon competitive benchmarks and position. The target levels for our named executive officers applicable to the 2006 and 2007 plans are shown below. The actual amount awarded to corporate officers ranges from zero to two times the target percentage depending on the performance level.

 

The threshold, target and maximum payout levels for our named executive officers under the 2006 Short-Term Annual Incentive Plan are shown in the Grants of Plan Based Awards in 2006 table under the heading “Estimated Possible Payouts Under Non-Equity Incentive Plan Awards.”

In February, the Committee meets to establish the goals for the current plan year, to evaluate actual performance in relation to the prior year’s targets and to approve the actual payment of awards related to the prior plan year. The Committee reserves the discretion to adjust any award, and will review and take into account individual performance, level of contribution, special circumstances and the accomplishment of specific project goals that were initiated throughout the plan year. In February 2007, the Committee approved a payout of 150 percent of target under the 2006 Short-Term Annual Incentive Plan. The Company’s 2006 earnings per share of $2.42 exceeded the target earnings of $2.17 per share. Actual earnings of $2.42 per share were adjusted downward to $2.27 per share by the Board of Directors to exclude the impacts of discontinued operations. The 2006 award, after applicable tax withholding, was distributed in the form of 50 percent stock and 50 percent cash for all of the named executive officers except Mr. Ohlmacher. Mr. Ohlmacher had met his stock ownership guidelines and elected to receive his 2006 award in the form of 100 percent cash. Awards for corporate officers under the Short-Term Annual Incentive Plan have varied over the last three years from the 150 percent payout for the 2006 plan to 100 percent payout for the 2005 plan and no payout for the 2004 plan. Awards made to each of our the named

14

---

executive officers under the Short-Term Annual Incentive Plans for 2006, 2005 and 2004 are shown below. The awards for the 2006 Short-Term Annual Incentive Plan are also included in the Non-Equity Incentive Plan Compensation column of the Summary Compensation Table for 2006.

 

Mr. Evans received an award under the 2004 Short-Term Incentive Plan as a subsidiary officer and not a corporate officer.

Long-Term Incentive.   Long-term incentive compensation is comprised of grants made by the Committee under our 2005 Omnibus Incentive Plan (“Omnibus Incentive Plan”) which was previously approved by our shareholders. Long-term incentive compensation is intended to promote corporate goals by linking the personal interests of participants to those of our shareholders; to provide participants with an incentive for excellence in individual performance; to promote teamwork among participants; and to provide flexibility in our effort to motivate, retain, and attract the services of participants who make significant contributions to our success by allowing participants to share in such success. The Committee oversees the administration of the Omnibus Incentive Plan with full power and authority to determine when and to whom awards will be granted, along with the type, amount and other terms and conditions of each award. The Committee believes that executive compensation tied to stock price appreciation and total shareholder return is an effective way to align the interests of management with those of our shareholders. The long-term incentive compensation component is currently composed of restricted stock (or restricted stock units) and performance shares. None of our named executive officers have received stock option grants since 2003. When stock options have been granted, they were granted with an exercise price equal to the fair market value of the common stock on the date of grant. No stock option back-dating occurred.

The value of long-term incentives awarded is based primarily on competitive market-based data presented by Hewitt Associates to the Committee and internal pay relationships. The Committee approves the target long-term incentive compensation level for each officer in December, which is awarded in January of the following year. Long-term incentive compensation approved in December 2005 and 2006, to be effective for the 2006 and 2007 plan years, respectively, ranged from approximately 50 percent to 115 percent of base salary for our senior officers, and from 30 percent to 45 percent for our other corporate officers. Restricted stock (or restricted stock units) are targeted to deliver 50 percent of the long-term incentive opportunity, with the remaining 50 percent delivered in the form of performance shares.

Restricted Stock and Restricted Stock Units.   Restricted stock and restricted stock units vest one-third each year over a three-year period, and automatically vest in their entirety upon death, disability, retirement or a change in control. Dividends are paid on the restricted shares and dividend equivalents accrue on restricted stock units. Unvested restricted stock or units are forfeited if an officer’s employment is terminated for any reason other than death, disability, retirement or in the event of a change in control. Corporate officers may elect to receive the award in the form of restricted stock, or to defer the payment under the Non-qualified Deferred Compensation Plan, in the form of restricted stock units. Restricted stock award values are normally approved in December with a grant date effective in the first week in January of the following year. Awards of restricted stock granted to plan participants effective January 6, 2006 ranged from 724 shares to 7,396 shares. Awards of restricted stock granted to plan participants effective January 5, 2007 ranged from 728 shares to 8,224 shares. The number of shares and grant date fair

15

---

value awarded in 2006 and 2007 for each of our named executive officers is shown below and the 2006 awards are included in the Grants of Plan Based Awards in 2006 table under the heading “All Other Stock Awards: Number of Shares of Stock or Units” and “Grant Date Fair Value of Stock Awards.”

 

Performance Shares.   Participants are awarded a target number of performance shares based upon the value of the individual performance share component approved by the Committee, divided by the Beginning Stock Price. The Beginning Stock Price, as defined under the Performance Plan, is the average of the closing price of our stock for the 20 trading days immediately preceding the beginning of the plan period. Entitlement to performance shares is based on our total shareholder return over designated performance periods, as measured against our peer group. In addition, in order for any performance shares to be awarded, our stock price must also increase during the performance period from the Beginning Stock Price. The final value of the performance shares is based upon the number of shares of common stock that are ultimately granted, based upon our performance in relation to the performance criteria. At the end of each respective performance period, actual awards may range from 0 percent to 175 percent of the target amounts plus accrued dividends. A 100 percent payout of the target shares occurs if our total shareholder return exceeds the 50th percentile of the peer group. For the performance periods that end in 2006, 2007 and 2008, a zero percent payout occurs if we are below the 30th percentile. For the performance period that ends in 2009, the minimum threshold for a payout was raised from the 30th percentile to the 40th percentile. For all the performance periods outstanding, the maximum payout of 175 percent occurs if we perform at the 80th percentile or above. The performance awards and dividend equivalents, if earned, are paid in 50 percent cash and 50 percent common stock. All payroll deductions and applicable tax withholding related to the award are withheld from the cash portion. Performance share target grant values are normally approved in December for a three-year performance period beginning January 1 of the following year.

Our peer group is comprised of the following 14 companies:  Alliant Energy Corporation, DPL Inc., Duquesne Light Holding Inc., Great Plains Energy Inc., Hawaiian Electrics Inds., Idacorp Inc., Northeast Utilities, NStar, OGE Energy Corporation, Pepco Holdings Inc., PNM Resources Inc., Puget Energy Inc., Wisconsin Energy Corp. and WPS Resources Corp. This peer group was originally identified as the companies in the S&P MidCap Electric Utilities Index; however because of re-categorizing of companies in the index by S&P from time to time, the companies in the peer group must be tracked individually.

Our first performance share plan began in 2004 and was allocated to two different performance periods under a transition plan. One-third of the performance share target grant value was allocated to a March 1, 2004 to December 31, 2005 performance period and two-thirds of the performance share target value was allocated to a March 1, 2004 to December 31, 2006 performance period. Subsequent to 2004, the performance share performance periods have covered a three-year performance period. For the performance period of March 1, 2004 to December 31, 2005, our total shareholder return was 27 percent, which ranked at the 90th percentile of our peer group, resulting in a payout of 175 percent of target levels. For the recently completed performance period, March 1, 2004 to December 31, 2006, our total shareholder return was 35 percent, which ranked at the 37th percentile of our peer group, resulting in a

16

---

payout of 37 percent of target levels. Although our total shareholder return was greater for the performance period ending in 2006 than 2005, our payout was less because of our peer group ranking. The awards were paid in the form of 50 percent cash and 50 percent common stock. Mr. Evans was not a senior officer in March 2004 when the performance periods above began, therefore his award level was at a lower amount than what was awarded for senior officers. The actual shares, cash and total payout value awarded to our named executive officers for the two performance periods was as follows:

March 1, 2004 to December 31, 2006 Performance Period

 

March 1, 2004 to December 31, 2005 Performance Period

 

Current performance periods outstanding and the range of targeted shares authorized to individual plan participants are as follows:

 

17

Target shares for each of our named executive officers for the outstanding performance periods are as follows:

 

Actual payouts, if any, will be determined based upon the total shareholder return for the plan period in comparison to the peer group.

Stock Ownership Guidelines.   The Committee has implemented stock ownership guidelines that apply to all officers and business unit leaders participating in the Long-Term Incentive Plan. We believe it is important for our officers and business unit leaders to hold a significant amount of Company stock to further align their performance with the interest of our shareholders. A “retention ratio” approach to stock ownership is incorporated into the guidelines. This approach requires officers to retain 100 percent of all shares owned, including shares awarded through Company incentive plans (net of share withholding for taxes and in the case of cashless stock option exercises net of the exercise price and withholding for taxes) until specific ownership goals are achieved. Ownership guidelines are denominated in share amounts which approximate a multiple of base pay.

The ownership guidelines for our corporate officers and business unit leaders are shown below along with the current stock ownership of our named executive officers that counts towards the ownership guidelines.

 

Perquisites and Other Personal Benefits.   Other perquisites and benefits provided to our executive officers in 2006 that were not provided to other employees include financial planning services, personal use of a Company vehicle and club dues. The total value of these perquisites in 2006 for our named executive officers ranged from $3,312 to $15,886 and is shown in detail in Note 6 of the Summary Compensation Table for 2006. The perquisites’ value was reported as taxable income to the officers and the officers were required to pay the applicable taxes. The Committee periodically reviews the perquisites and other personal benefits provided to our executive officers. As a result of that evaluation, the Committee discontinued the payment of club dues as a benefit to the executive officers effective January 1, 2007. The value of the club benefit was approximately $1,500 a year. The Committee and the Company believe the current perquisites are reasonable and consistent with our overall compensation program.

18

---

Retirement and Other Benefits.   We currently maintain a variety of employee benefit plans and programs in which our executive officers may participate, including a 401(k) Retirement Savings Plan, the Pension Plan, the Pension Equalization Plan and the Nonqualified Deferred Compensation Plan. We believe it is important to provide post-employment benefits to our executive officers and the benefits we provide approximate retirement benefits paid by other employers to its executives in similar executive positions. The Committee periodically reviews the benefits provided with assistance from its compensation consultant to maintain a market-based benefits package.

The Black Hills Corporation 401(k) Retirement Savings Plan is offered to all eligible employees of the Company and its subsidiaries except for Cheyenne Light, Fuel and Power which has its own 401(k) Plan. All of our named executive officers are participants in the Black Hills Corporation 401(k) Retirement Savings Plan. Participants may elect to invest up to 20 percent of their eligible compensation on a pre-tax basis up to maximum amounts established by the Internal Revenue Service. The Black Hills Corporation Plan provides a matching contribution of 100 percent of the employee’s annual tax-deferred contribution up to a maximum of 3 percent of eligible compensation. Matching contributions vest at 20 percent per year and are fully vested when the participant has five years of service with the Company. Each of our named executive officers received the maximum annual contribution of $6,600 in 2006. The matching contribution is included as “All Other Compensation” in the Summary Compensation Table for 2006.

The Black Hills Corporation Pension Plan covers the employees of Black Hills Corporation and a number of its subsidiary companies. The plan is a qualified defined benefit pension plan that provides benefits at retirement based on length of employment service and certain average compensation levels during the highest five consecutive years of the last ten years of service. Our employees do not contribute to the plan. Each of our named executive officers are participants in the plan and none of our named executive officers have been granted additional years of credited service.

The defined benefit pension plan is limited by the Internal Revenue Code in the amount of annual payments received under the plan ($175,000 in 2006) and in the amount of compensation that can be taken into account in determining contributions and benefits ($220,000 in 2006). Because of these limitations we also have the Pension Equalization Plan. The Pension Equalization Plan is a nonqualified supplemental retirement plan with a pension restoration benefit designed to provide the higher paid executive employee a retirement benefit which, when added to social security benefits and the pension to be received under the defined benefit pension plan, approximate retirement benefits paid by other employers to its employees in similar executive positions. The Board of Directors designates the participants in the Pension Equalization Plan. Each of our named executive officers except Mr. Evans is a participant in the Pension Equalization Plan. The Pension Equalization Plan has been frozen to new participants since 2002. The level of retirement benefits provided by the Pension Plan, Pension Equalization Plan and the Pension Restoration Benefit for each of our named executive officers is reflected in the Pension Benefits for 2006 table and explained in more detail in the accompanying narrative.

19

---

Several of the Company’s current corporate officers became officers after the Pension Equalization Plan was frozen to new participants. During 2006 and early 2007, the Committee, in consultation with Mercer Human Resource Consulting, an independent consultant engaged by the Committee, thoroughly reviewed the need to offer some form of supplemental retirement plan to officers. The Committee concluded that a supplemental retirement plan was needed for corporate officers who were not participants in the existing frozen Pension Equalization Plan in order to provide a benefits package consistent with market practices. In February 2007, the Committee recommended and the Board of Directors approved the 2007 Pension Equalization Plan. The Board of Directors designated the four corporate officers, including Mr. Evans, who were not participants in the existing Pension Equalization Plan as participants in the 2007 Pension Equalization Plan with years of credited service equal to the number of years they served as a corporate officer. The main differences between the original Pension Equalization Plan and the 2007 Pension Equalization Plan are as follows:

Annual Benefit Amount

 

Vesting Schedule

 

 

The nonqualified deferred compensation plan allows our corporate officers to elect to defer up to 50 percent of their base salary and up to 100 percent of their Short-Term Annual Incentive Plan Award, including Company stock, and elect to defer restricted stock grants in the form of restricted stock units. We make no contributions to the plan. None of our named executive officers are currently contributing to the nonqualified deferred compensation plan. The deferred balance in the plan for each of our named executive officers is shown in the Nonqualified Deferred Compensation for 2006 table.

Our named executive officers may also receive severance benefits in the event of a change in control. Change in control agreements are common among our peer group and the Committee and our Board of Directors believe providing these agreements to our corporate officers protect our shareholder interests in the event of a change in control by helping assure management continuity. Our Board of Directors conducted a thorough review of the change in control agreements in 2005. As a result of the review, the Board substantially reduced the number of change in control agreements and entered into new change in

20

---

control agreements with the corporate officers. There are currently 11 change in control agreements in place with a term ending June 1, 2008. In general, our change in control agreements provide a severance payment of up to 2.99 times average compensation for our CEO and up to two times average compensation for our other corporate officers. The change in control agreement for our CEO contains a “modified trigger,” providing benefits in association with a change in control upon (i) termination of employment other than by death, disability or by the Company for cause, (ii) a termination by the CEO for good reason, or (iii) a termination by the CEO for any reason during a 30-day window period immediately following the first anniversary of a change in control. The change in control agreements for our other corporate officers contain a “double trigger,” providing benefits in association with a change in control only upon (i) termination of employment other than by death, disability or by the Company for cause, or (ii) a termination by the employee for good reason. See the Potential Payments Upon Termination or Change in Control table and the accompanying narrative for more information regarding our change in control agreements and estimated payments associated with a change in control.

Impact of Tax Rules.

Deductibility of Executive Compensation.   Section 162(m) of the U.S. Internal Revenue Code of 1986, as amended, limits the tax deductibility by a corporation of compensation in excess of $1 million paid to its CEO and any of its four most highly compensated executive officers. Compensation which qualifies as “performance-based” is excluded from the $1 million limit, if, among other requirements, the compensation is payable only upon attainment of pre-established, objective performance goals under a plan approved by the corporation’s shareholders. We believe the compensation paid to our named executive officers in 2006 is fully deductible.

Nonqualified Deferred Compensation.   On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, changing the tax rules applicable to nonqualified deferred compensation arrangements. Final regulations have not become effective yet, however, we believe we are operating in good faith compliance with the statutory provisions which were effective January 1, 2005. A more detailed discussion of our nonqualified deferred compensation arrangements is provided under the heading “Nonqualified Deferred Compensation for 2006” and the accompanying narrative.

COMPENSATION COMMITTEE REPORT

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Company’s Board of Directors that the Compensation Discussion and Analysis be included in this Proxy Statement.

 

SUMMARY COMPENSATION TABLE FOR 2006

The following table sets forth the total compensation paid or earned by each of our named executive officers for the fiscal year ended December 31, 2006. We have no employment agreements with our named executive officers. Amounts listed under the heading “Non-Equity Incentive Plan Compensation” represent amounts earned under the Short-Term Annual Incentive Plan for 2006. The Compensation

21

---

Committee approved the payout of these awards at its February 1, 2007, meeting and the awards were paid on February 27, 2007.

Based on the fair value of equity awards granted to our named executive officers in 2006 and the base salary of our named executive officers, base salary accounted for 37 percent to 50 percent of the total compensation, short-term annual incentive accounted for 18 percent to 26 percent and long-term incentive accounted for 32 percent to 43 percent of total compensation. Because the table below reflects the value of certain equity awards based on the Statement of Financial Accounting Standards 123(R), “Share-Based Payment,” (“FAS 123(R)”) value rather than the fair value, these percentages cannot be derived using the amounts reflected in the table below.

(1)                Mr. Ohlmacher’s bonus reflects a $32,000 relocation bonus to compensate for additional state income taxes.

(2)                Stock awards represent the 2006 compensation expense related to Restricted Stock, Restricted Stock Units and Performance Shares that have been granted as a component of Long-Term Incentive Compensation. The amount reported is the amount recognized for financial statement reporting purposes for the fiscal year ended December 31, 2006, computed in accordance with FAS 123(R), and therefore includes amounts for awards granted in and prior to 2006.

Mr. Ohlmacher turned age 55 in September 2006 which made him eligible for early retirement. Because our Restricted Stock and Restricted Stock Units fully vest at retirement, the fair value of $190,000 associated with Mr. Ohlmacher’s award granted in 2006 was all recognized in 2006 prior to his turning age 55 in accordance with FAS 123(R), rather than expensing the award over the normal three year vesting period. Assumptions used in the calculation of these amounts are included in Note 9 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2006.

(3)                Option Awards represent the 2006 compensation expense related to Stock Options that have been granted as a component of Long-Term Incentive Compensation in prior years. The amount reported is the amount recognized for financial statement reporting purposes for the year ended December 31, 2006, computed in accordance with FAS 123(R), and therefore includes amounts for awards granted prior to 2006. Assumptions used in the calculation of these amounts are included in Note 9 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2006.

(4)                Non-Equity Incentive Plan Compensation represents amounts earned under the Short-Term Annual Incentive Plan.

(5)                Change in Pension Value and Nonqualified Deferred Compensation Earnings represents the increase in actuarial value of the Defined Benefit Pension Plan (“DB”), Pension Restoration Benefit (“PRB”) and Pension Equalization Plan (“PEP”) for the year. No named executive officer received preferential or above-market earnings on nonqualified deferred compensation. The value attributed from each plan to each named officer is shown in the table below. Mr. Evans was not a participant in the PRB or PEP in 2006.

 

22

---

(6)                All other compensation includes amounts allocated under the 401(k) match, dividends received on restricted stock and unvested restricted stock units, and perquisites as detailed in the table below. Perquisites provided to our named executive officers include personal use of a Company vehicle, financial planning services and club dues. The value attributed to personal use of Company-provided automobiles is calculated in accordance with Internal Revenue Service guidelines. The value of all perquisites and the dividends on restricted stock are included as compensation on the W-2 of the named executive officers who received such benefits. Each such named executive officer is responsible for paying income tax on such amount.

 

GRANTS OF PLAN BASED AWARDS IN 2006(1)

(1)                No stock options were granted to our named executive officers in 2006.

(2)                The columns under “Estimated Possible Payouts Under Non-Equity Incentive Plan Awards” show the range of payouts for 2006 performance under the Short-Term Annual Incentive Compensation Program as described in the Compensation Discussion and Analysis under the section titled “Annual Incentive.” If the performance criteria is met, payouts can range from 30 percent of target at the threshold level to 200 percent of target at the maximum level. The 2007 bonus payment for 2006 performance has been made based on achieving the criteria described in the Compensation Discussion and Analysis, at 150 percent of target, and is shown in the Summary Compensation Table for 2006 in the column titled “Non-Equity Incentive Plan Compensation.”

(3)                The columns under “Estimated Future Payouts Under Equity Incentive Plan Awards” show the range of payouts (in shares of stock) for the January 1, 2006 to December 31, 2008 performance period as described in the Compensation Discussion and Analysis under the section titled “Long-Term Incentive—Performance Shares.” If the performance criteria are met, payouts can range from 1 percent of target to 175 percent of target. If a participant retires, suffers a disability or dies during the performance period, the participant or the participant’s estate is entitled to that portion of the number of performance shares as such participant would have been entitled to had they remained employed, prorated for the number of months served. Performance shares are forfeited if employment is terminated for any other reason. During the performance period, dividends and other distributions paid with respect to the shares of Common Stock shall accrue for the benefit of the participant and are paid out at the end of the performance period.

(4)                The column “All Other Stock Awards” reflects the number of shares of restricted stock granted on January 6, 2006. The restricted stock vests one-third a year over a three-year period, and automatically vests upon death, disability, retirement or a change in control. Unvested restricted stock is forfeited if employment is terminated for any other reason. Dividends are paid on the restricted shares and the dividends that were paid in 2006 are included in the column titled “All Other Compensation” in the Summary Compensation Table for 2006.

(5)                The column “Grant Date Fair Value of Stock Awards” reflects the grant date fair value of each equity award computed in accordance with FAS 123(R). The grant date fair value for the performance shares was $32.06 per share and was calculated using a Monte Carlo simulation model. Assumptions used in the calculation are included in Note 9 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2006. The grant date fair value for the restricted stock was $35.49 per share which was the market value of our common stock on the date of grant as reported on the New York Stock Exchange.

23