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MDU > SEC Filings for MDU > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for MDU RESOURCES GROUP INC


7-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW
The Company's strategy is to apply its expertise in energy and transportation infrastructure industries to increase market share, increase profitability and enhance shareholder value through:

Organic growth as well as a continued disciplined approach to the acquisition of well-managed companies and properties

The elimination of system-wide cost redundancies through increased focus on integration of operations and standardization and consolidation of various support services and functions across companies within the organization

The development of projects that are accretive to earnings per share and return on invested capital

The Company has capabilities to fund its growth and operations through various sources, including internally generated funds, commercial paper facilities, revolving credit facilities and the issuance from time to time of debt and equity securities. For more information on the Company's net capital expenditures, see Liquidity and Capital Commitments.

The key strategies for each of the Company's business segments and certain related business challenges are summarized below. For a summary of the Company's business segments, see Note 15.

Key Strategies and Challenges
Electric and Natural Gas Distribution
Strategy Provide competitively priced energy and related services to customers. The electric and natural gas distribution segments continually seek opportunities for growth and expansion of their customer base through extensions of existing operations, including building electric generation, transmission extensions, and through selected acquisitions of companies and properties at prices that will provide stable cash flows and an opportunity for the Company to earn a competitive return on investment.

Challenges Both segments are subject to extensive regulation in the state jurisdictions where they conduct operations with respect to costs and permitted returns on investment as well as subject to certain operational and environmental regulations. The ability of these segments to grow through acquisitions is subject to significant competition. In addition, the ability of both segments to grow service territory and customer base is affected by the economic environment of the markets served and competition from other energy providers and fuels. The construction of any new electric generating facilities, transmission lines and other service facilities are subject to increasing cost and lead time, extensive permitting procedures, and federal and state legislative and regulatory initiatives, which will necessitate increases in electric energy prices. Legislative and regulatory initiatives to increase renewable energy resources and reduce GHG emissions could impact the price and demand for electricity and natural gas.

Pipeline and Energy Services
Strategy Utilize the segment's existing expertise in energy infrastructure and related services to increase market share and profitability through optimization of existing operations, internal growth, and acquisitions of energy-related assets and companies. Incremental and new growth opportunities include: access to new energy sources for storage, gathering and transportation services; expansion of existing gathering, transmission and storage facilities; incremental expansion of pipeline capacity; expansion of midstream business to include liquid pipelines and processing activities; and expansion of related energy services.

Challenges Challenges for this segment include: energy price volatility; natural gas basis differentials; environmental and regulatory requirements; recruitment and retention of a skilled workforce; and competition from other pipeline and energy services companies.

Exploration and Production
Strategy Apply technology and utilize existing exploration and production expertise, with a focus on operated properties, to increase production and reserves from existing leaseholds, and to seek additional reserves and production opportunities both in new and existing areas to further expand the segment's asset base. By optimizing existing operations and taking advantage of new and incremental growth opportunities, this segment is focused on balancing the oil and gas commodity mix to maximize profitability with its goal to add value by increasing both reserves and production over the long term so as to generate competitive returns on investment.


Challenges Volatility in natural gas and oil prices; timely receipt of necessary permits and approvals; environmental and regulatory requirements; recruitment and retention of a skilled workforce; availability of drilling rigs, materials, auxiliary equipment and industry-related field services; inflationary pressure on development and operating costs; and competition from other exploration and production companies are ongoing challenges for this segment.

Construction Materials and Contracting
Strategy Focus on high-growth strategic markets located near major transportation corridors and desirable mid-sized metropolitan areas; strengthen long-term, strategic aggregate reserve position through purchase and/or lease opportunities; enhance profitability through cost containment, margin discipline and vertical integration of the segment's operations; and continue growth through organic and acquisition opportunities. Ongoing efforts to increase margin are being pursued through the implementation of a variety of continuous improvement programs, including corporate purchasing of equipment, parts and commodities (liquid asphalt, diesel fuel, cement and other materials), and negotiation of contract price escalation provisions. Vertical integration allows the segment to manage operations from aggregate mining to final lay-down of concrete and asphalt, with control of and access to permitted aggregate reserves being significant. A key element of the Company's long-term strategy for this business is to further expand its market presence in the higher-margin materials business (rock, sand, gravel, liquid asphalt, asphalt concrete, ready-mixed concrete and related products), complementing and expanding on the Company's expertise.

Challenges Volatility in the cost of raw materials such as diesel, gasoline, liquid asphalt, cement and steel, continue to be a concern. This business unit expects to continue cost containment efforts, positioning its operations for the resurgence in the private market, while continuing the emphasis on industrial, energy and public works projects.

Construction Services
Strategy Provide a competitive return on investment while operating in a competitive industry by: building new and strengthening existing customer relationships; effectively controlling costs; retaining, developing and recruiting talented employees; focusing our efforts on projects that will permit higher margins while properly managing risk.

Challenges This segment operates in highly competitive markets with many jobs subject to competitive bidding. Maintenance of effective operational and cost controls, retention of key personnel, managing through downturns in the economy and effective management of working capital are ongoing challenges.

For more information on the risks and challenges the Company faces as it pursues its growth strategies and other factors that should be considered for a better understanding of the Company's financial condition, see Item 1A - Risk Factors, as well as Part I, Item 1A - Risk Factors in the 2011 Annual Report. For more information on each segment's key growth strategies, projections and certain assumptions, see Prospective Information. For information pertinent to various commitments and contingencies, see Notes to Consolidated Financial Statements.


Earnings Overview
The following table summarizes the contribution to consolidated earnings by each
of the Company's businesses.

                                               Three Months Ended             Nine Months Ended
                                                  September 30,                 September 30,
                                                 2012             2011          2012          2011
                                                   (Dollars in millions, where applicable)
Electric                                 $       11.0     $        8.3   $      23.0    $     21.7
Natural gas distribution                         (8.8 )          (11.2 )        10.3          18.2
Pipeline and energy services                      3.3              5.2          21.9          16.9
Exploration and production                      (87.8 )           22.5         (56.9 )        60.1
Construction materials and contracting           41.9             33.1          24.7          16.7
Construction services                             9.9              5.1          30.0          15.8
Other                                              .8               .9           1.9           2.0
Earnings (loss) before discontinued
operations                                      (29.7 )           63.9          54.9         151.4
Income (loss) from discontinued
operations, net of tax                            (.1 )            (.1 )         4.8            .1
Earnings (loss) on common stock          $      (29.8 )   $       63.8   $      59.7    $    151.5
Earnings (loss) per common share -
basic:
Earnings (loss) before discontinued
operations                               $       (.16 )   $        .34   $       .29    $      .80
Discontinued operations, net of tax                 -                -           .03             -
Earnings (loss) per common share - basic $       (.16 )   $        .34   $       .32    $      .80
Earnings (loss) per common share -
diluted:
Earnings (loss) before discontinued
operations                               $       (.16 )   $        .34   $       .29    $      .80
Discontinued operations, net of tax                 -                -           .03             -
Earnings (loss) per common share -
diluted                                  $       (.16 )   $        .34   $       .32    $      .80
Return on average common equity for the
12 months ended                                                                  4.3 %         8.9 %

Three Months Ended September 30, 2012 and 2011 Consolidated earnings for the quarter ended September 30, 2012, decreased $93.6 million from the comparable prior period largely due to a $100.9 million after-tax noncash write-down of oil and natural gas properties at the exploration and production business.

Partially offsetting this decrease were:

Increased construction margins, higher liquid asphalt oil margins and volumes, as well as lower selling, general and administrative expense at the construction materials and contracting business

Higher workloads and margins in the Central and Western regions, higher equipment sales and rental margins, as well as higher margins in the Mountain region, partially offset by higher general and administrative expense at the construction services business

Nine Months Ended September 30, 2012 and 2011 Consolidated earnings for the nine months ended September 30, 2012, decreased $91.8 million from the comparable prior period largely due to:

A $100.9 million after-tax noncash write-down of oil and natural gas properties, lower average realized natural gas prices, as well as decreased natural gas production, partially offset by increased oil production at the exploration and production business

Decreased retail sales volumes at the natural gas distribution business

Partially offsetting these decreases were:

Higher workloads and margins in the Central and Western regions, higher equipment sales and rental margins, as well as higher margins in the Mountain region, partially offset by higher general and administrative expense at the construction services business

Increased construction margins and lower selling, general and administrative expense, partially offset by higher income taxes at the construction materials and contracting business

Lower operation and maintenance expense from existing operations largely related to a $15.0 million net benefit related to the natural gas gathering operations litigation, as discussed in Note 19, partially offset by lower natural gas gathering volumes from existing operations at the pipeline and energy services business


FINANCIAL AND OPERATING DATA
Below are key financial and operating data for each of the Company's businesses.

Electric

                                           Three Months Ended            Nine Months Ended
                                             September 30,                 September 30,
                                              2012         2011          2012              2011
                                                (Dollars in millions, where applicable)
Operating revenues                     $      63.5   $     61.9   $     174.4       $     169.8
Operating expenses:
Fuel and purchased power                      17.6         17.4          51.2              48.8
Operation and maintenance                     17.9         18.1          53.1              52.4
Depreciation, depletion and
amortization                                   8.1          8.1          24.2              24.2
Taxes, other than income                       2.6          2.4           7.9               7.5
                                              46.2         46.0         136.4             132.9
Operating income                              17.3         15.9          38.0              36.9
Earnings                               $      11.0   $      8.3   $      23.0       $      21.7
Retail sales (million kWh)                   753.8        718.8       2,189.8           2,128.1
Sales for resale (million kWh)                 8.9         35.3          11.8              63.9
Average cost of fuel and purchased
power per kWh                          $      .022   $     .022   $      .022       $      .021

Three Months Ended September 30, 2012 and 2011 Electric earnings increased $2.7 million (32 percent) due to:

Higher retail sales volumes of 5 percent, primarily to residential and small commercial and industrial customers, reflecting increased demand due to warmer weather than last year, as well as increased customer growth

Lower operation and maintenance expense of $600,000 (after tax), primarily decreased benefit-related costs, partially offset by increased contract services at certain of the Company's electric generation stations

Higher other income of $500,000 (after tax), largely higher allowance for funds used during construction

Nine Months Ended September 30, 2012 and 2011 Electric earnings increased $1.3 million (6 percent) due to:

Higher retail sales volumes of 3 percent, primarily to small commercial and industrial and residential customers, as previously discussed, offset in part by decreased volumes to large commercial and industrial customers

Lower net interest expense of $800,000 (after tax), including higher capitalized interest

Higher other income of $600,000 (after tax), as previously discussed

Partially offsetting these increases were higher income taxes of $1.2 million, primarily related to the absence of an income tax benefit related to favorable resolution of certain income tax matters in 2011.


Natural Gas Distribution

                                               Three Months Ended            Nine Months Ended
                                                  September 30,                September 30,
                                                 2012             2011          2012         2011
                                                  (Dollars in millions, where applicable)
Operating revenues                       $       80.1     $       92.4   $     504.8   $    627.5
Operating expenses:
Purchased natural gas sold                       38.0             49.3         300.2        408.8
Operation and maintenance                        31.8             34.8         102.9        102.5
Depreciation, depletion and amortization         11.4             11.1          34.0         33.4
Taxes, other than income                          7.0              7.3          33.2         35.7
                                                 88.2            102.5         470.3        580.4
Operating income (loss)                          (8.1 )          (10.1 )        34.5         47.1
Earnings (loss)                          $       (8.8 )   $      (11.2 ) $      10.3   $     18.2
Volumes (MMdk):
Sales                                             8.0              8.4          60.1         69.7
Transportation                                   30.0             28.0          94.7         87.7
Total throughput                                 38.0             36.4         154.8        157.4
Degree days (% of normal)*
Montana-Dakota/Great Plains                        38 %             54 %          75 %        110 %
Cascade                                            91 %             78 %          98 %        104 %
Intermountain                                      51 %             39 %          92 %        110 %
Average cost of natural gas, including
transportation, per dk                   $       4.73     $       5.85   $      4.99   $     5.87


* Degree days are a measure of the daily temperature-related demand for energy for heating.

Three Months Ended September 30, 2012 and 2011 The natural gas distribution business recognized a seasonal loss of $8.8 million compared to a loss of $11.2 million in the third quarter of 2011. The decrease in the seasonal loss is largely due to lower operation and maintenance expense, primarily lower benefit-related costs.

Nine Months Ended September 30, 2012 and 2011 Earnings at the natural gas distribution business decreased $7.9 million (43 percent) due to:

Lower earnings of $7.3 million (after tax) related to decreased retail sales volumes, largely resulting from significantly warmer weather than last year, partially offset by weather normalization adjustments in certain jurisdictions

Higher income taxes of $1.0 million, primarily related to the absence of a reduction of deferred income taxes associated with benefits in 2011

These decreases were partially offset by higher other income of $600,000 (after tax), primarily related to allowance for funds used during construction.


Pipeline and Energy Services

                                                  Three Months Ended                 Nine Months Ended
                                                     September 30,                     September 30,
                                                   2012                  2011          2012           2011
                                                               (Dollars in millions)
Operating revenues                      $          48.3       $          69.1   $     141.6     $    215.5
Operating expenses:
Purchased natural gas sold                         10.8                  31.8          35.4           99.8
Operation and maintenance                          19.2                  16.6          34.8   *       52.8
Depreciation, depletion and
amortization                                        7.3                   6.4          20.4           19.3
Taxes, other than income                            3.5                   3.4          10.5           10.3
                                                   40.8                  58.2         101.1          182.2
Operating income                                    7.5                  10.9          40.5           33.3
Earnings                                $           3.3       $           5.2   $      21.9   * $     16.9
Transportation volumes (MMdk)                      34.1                  29.4         103.0           82.5
Natural gas gathering volumes (MMdk)               10.7                  16.4          36.5           50.8
Customer natural gas storage balance
(MMdk):
Beginning of period                                40.4                  31.7          36.0           58.8
Net injection (withdrawal)                          8.8                   6.8          13.2          (20.3 )
End of period                                      49.2                  38.5          49.2           38.5


* Results reflect a net benefit of $24.1 million ($15.0 million after tax) related to the natural gas gathering operations litigation, largely reflected in operation and maintenance expense, as discussed in Note 19.

Three Months Ended September 30, 2012 and 2011 Pipeline and energy services earnings decreased $1.9 million (37 percent) due to:

Lower natural gas gathering volumes from existing operations, largely resulting from customers experiencing curtailments, normal production declines, deferral of certain natural gas development activity and the Company's divestments

Higher operation and maintenance expense from existing operations of $700,000 (after tax), largely due to higher payroll-related and legal costs

Partially offsetting the earnings decrease was higher storage services revenue of $600,000 (after tax), largely higher average storage balances, as well as higher margins of $600,000 (after tax) from energy efficiency-related services.

Results also reflect lower operating revenues and lower purchased natural gas sold, both related to lower natural gas prices and lower natural gas volumes.

Nine Months Ended September 30, 2012 and 2011 Pipeline and energy services earnings increased $5.0 million due to:

Lower operation and maintenance expense from existing operations largely related to a $15.0 million (after tax) net benefit related to the natural gas gathering operations litigation, as discussed in Note 19, which was partially offset by an impairment of certain natural gas gathering assets of $1.7 million (after tax) due largely to low natural gas prices

Higher transportation volumes of $800,000 (after tax), largely higher volumes transported to storage

Partially offsetting the earnings increase were:

Lower earnings of $7.3 million (after tax) due to lower natural gas gathering volumes from existing operations, as previously discussed

Lower storage services revenue of $1.0 million (after tax), largely lower average storage balances

Results also reflect lower operating revenues and lower purchased natural gas sold, both related to lower natural gas prices and lower natural gas volumes.


Exploration and Production

                                                  Three Months Ended          Nine Months Ended
                                                     September 30,              September 30,
                                                     2012           2011         2012        2011
                                                    (Dollars in millions, where applicable)
Operating revenues:
Oil                                          $       85.0     $     74.9   $    243.6   $   201.9
Natural gas                                          23.5           45.9         70.6       135.6
                                                    108.5          120.8        314.2       337.5
Operating expenses:
Operation and maintenance:
Lease operating costs                                20.7           19.4         58.2        55.8
Gathering and transportation                          4.3            6.9         12.8        18.1
Other                                                 9.6            9.8         28.4        27.3
Depreciation, depletion and amortization             41.4           38.5        112.6       106.0
Taxes, other than income:
Production and property taxes                         9.6           10.0         27.8        30.5
Other                                                  .2            (.7 )         .8         (.1 )
Write-down of oil and natural gas properties        160.1              -        160.1           -
                                                    245.9           83.9        400.7       237.6
Operating income (loss)                            (137.4 )         36.9        (86.5 )      99.9
Earnings (loss)                              $      (87.8 )   $     22.5   $    (56.9 ) $    60.1
Production:
Oil (MBbls)                                         1,123            944        3,165       2,567
Natural gas (MMcf)                                  7,390         11,656       25,676      34,667
Total production (MBOE)                             2,354          2,887        7,444       8,345
Average realized prices (including hedges):
Oil (per Bbl)                                $      75.69     $    79.28   $    76.96   $   78.64
Natural gas (per Mcf)                        $       3.17     $     3.94   $     2.75   $    3.91
Average realized prices (excluding hedges):
Oil (per Bbl)                                $      73.89     $    80.90   $    76.45   $   83.05
Natural gas (per Mcf)                        $       2.25     $     3.44   $     1.88   $    3.44
Average depreciation, depletion and
amortization rate, per BOE                   $      16.85     $    12.72   $    14.44   $   12.09
Production costs, including taxes, per BOE:
Lease operating costs                        $       8.77     $     6.71   $     7.81   $    6.68
Gathering and transportation                         1.84           2.37         1.72        2.17
Production and property taxes                        4.07           3.46         3.74        3.66
                                             $      14.68     $    12.54   $    13.27   $   12.51

Three Months Ended September 30, 2012 and 2011 Exploration and production earnings decreased $110.3 million due to:

A noncash write-down of oil and natural gas properties of $100.9 million (after tax), as discussed in Note 5

Decreased natural gas production of 37 percent, largely related to a decision to curtail production, normal production declines, deferral of certain natural gas development activity and divestment at existing properties

Lower average realized natural gas prices of 20 percent

Lower average realized oil prices of 5 percent

Higher depreciation, depletion and amortization expense of $1.9 million (after tax), due to higher depletion rates, partially offset by lower volumes

Partially offsetting these decreases were:

Increased oil production of 19 percent, largely related to drilling activity in the Bakken area, as well as the Paradox Basin

Lower gathering and transportation expense of $1.6 million (after tax), largely due to lower gathering costs resulting from lower volumes and lower gathering rates in the coalbed area


Nine Months Ended September 30, 2012 and 2011 Exploration and production earnings decreased $117.0 million due to:

A noncash write-down of oil and natural gas properties of $100.9 million (after tax), as discussed in Note 5

Lower average realized natural gas prices of 30 percent

Decreased natural gas production of 26 percent, as previously discussed

Higher depreciation, depletion and amortization expense of $4.2 million (after tax), as previously discussed

Lower average realized oil prices of 2 percent

Increased lease operating expenses of $1.5 million (after tax), largely . . .

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