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MDU > SEC Filings for MDU > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for MDU RESOURCES GROUP INC


7-Nov-2013

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 17.

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 to retain, grow and expand their customer base through extensions of existing operations, including building and upgrading electric generation and transmission and natural gas systems, 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, system integrity and environmental regulations. These regulations can require substantial investment to upgrade facilities. 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/refining 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 natural 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; develop and recruit talented employees; and continue growth through organic and acquisition opportunities. 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 Recruitment and retention of key personnel and 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 superior return on investment by: building new and strengthening existing customer relationships; effectively controlling costs; retaining, developing and recruiting talented employees; and 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 2012 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,
                                                 2013             2012          2013          2012
                                                   (Dollars in millions, where applicable)
Electric                                 $       11.4     $       11.0   $      25.7    $     23.0
Natural gas distribution                        (11.2 )           (8.8 )        15.4          10.3
Pipeline and energy services                      5.3              3.3           1.3          21.9
Exploration and production                       17.4            (87.8 )        70.7         (56.9 )
Construction materials and contracting           49.2             41.9          38.6          24.7
Construction services                            12.2              9.9          36.7          30.0
Other                                             1.3               .8           2.1           1.9
Intersegment eliminations                        (1.2 )              -          (3.3 )           -
Earnings (loss) before discontinued
operations                                       84.4            (29.7 )       187.2          54.9
Income (loss) from discontinued
operations, net of tax                            (.1 )            (.1 )         (.2 )         4.8
Earnings (loss) on common stock          $       84.3     $      (29.8 ) $     187.0    $     59.7
Earnings (loss) per common share -
basic:
Earnings (loss) before discontinued
operations                               $        .45     $       (.16 ) $       .99    $      .29
Discontinued operations, net of tax                 -                -             -           .03
Earnings (loss) per common share - basic $        .45     $       (.16 ) $       .99    $      .32
Earnings (loss) per common share -
diluted:
Earnings (loss) before discontinued
operations                               $        .44     $       (.16 ) $       .99    $      .29
Discontinued operations, net of tax                 -                -             -           .03
Earnings (loss) per common share -
diluted                                  $        .44     $       (.16 ) $       .99    $      .32

Three Months Ended September 30, 2013 and 2012 Consolidated earnings for the quarter ended September 30, 2013, increased $114.1 million from the comparable prior period largely due to:

Absence of the write-down of oil and natural gas properties of $100.9 million (after tax), as discussed in Note 5, increased oil production and higher average realized oil prices, partially offset by a loss of $10.5 million (after tax) resulting from a realized commodity derivative loss in 2013 compared to a realized commodity derivative gain in 2012, unrealized commodity derivative loss of $7.9 million (after tax) in 2013 compared to $700,000 (after tax) in 2012, as well as higher depreciation, depletion and amortization expense at the exploration and production business

Higher aggregate, asphalt and other product line margins at the construction materials and contracting business

Nine Months Ended September 30, 2013 and 2012 Consolidated earnings for the nine months ended September 30, 2013, increased $127.3 million from the comparable prior period largely due to:

Absence of the write-down of oil and natural gas properties of $100.9 million (after tax), as discussed in Note 5, increased oil production and higher average realized natural gas and oil prices, partially offset by a loss of $16.1 million (after tax) resulting from a realized commodity derivative loss in 2013 compared to a realized commodity derivative gain in 2012, higher depreciation, depletion and amortization expense, decreased natural gas production, as well as higher production taxes at the exploration and production business

Higher asphalt, aggregate and other product line margins at the construction materials and contracting business

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

Increased retail sales volumes and a gain on the sale of a nonregulated appliance service and repair business, partially offset by higher depreciation, depletion and amortization expense at the natural gas distribution business

Partially offsetting these increases were:

Absence of a 2012 net benefit related to the natural gas gathering operations litigation of $15.0 million (after tax), as discussed in Note 20, as well as an impairment of coalbed natural gas gathering assets of $9.0 million (after tax) in 2013 compared to an impairment of $1.7 million (after tax) in 2012, at the pipeline and energy services business

Loss from discontinued operations of $200,000 (after tax) compared to income from discontinued operations of $4.8 million (after tax) in 2012, as discussed in Note 11


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,
                                              2013         2012          2013              2012
                                                (Dollars in millions, where applicable)
Operating revenues                     $      68.3   $     63.5   $     189.9       $     174.4
Operating expenses:
Fuel and purchased power                      20.0         17.6          59.8              51.2
Operation and maintenance                     19.5         17.9          56.4              53.1
Depreciation, depletion and
amortization                                   8.1          8.1          24.6              24.2
Taxes, other than income                       2.7          2.6           8.4               7.9
                                              50.3         46.2         149.2             136.4
Operating income                              18.0         17.3          40.7              38.0
Earnings                               $      11.4   $     11.0   $      25.7       $      23.0
Retail sales (million kWh)                   795.2        753.8       2,329.4           2,189.8
Sales for resale (million kWh)                 5.4          8.9          21.5              11.8
Average cost of fuel and purchased
power per kWh                          $      .024   $     .022   $      .024       $      .022

Three Months Ended September 30, 2013 and 2012 Electric earnings increased $400,000 (4 percent) due to higher retail sales margins, largely the result of increased retail sales volumes of 5 percent, primarily to large commercial and industrial customers. Largely offsetting this increase was higher operation and maintenance expense of $1.0 million (after tax), largely higher payroll-related costs.

Nine Months Ended September 30, 2013 and 2012 Electric earnings increased $2.7 million (12 percent) due to higher retail sales margins, largely the result of increased retail sales volumes of 6 percent, primarily to residential, small and large commercial and industrial customers due to increased customer growth, as well as weather variances from last year. Largely offsetting this increase was higher operation and maintenance expense, which includes $1.6 million (after tax) largely related to higher payroll-related costs and increased contract services, offset in part by lower benefit-related costs.


Natural Gas Distribution

                                               Three Months Ended            Nine Months Ended
                                                  September 30,                September 30,
                                                 2013             2012          2013         2012
                                                  (Dollars in millions, where applicable)
Operating revenues                       $       77.5     $       80.1   $     536.8   $    504.8
Operating expenses:
Purchased natural gas sold                       36.5             38.0         323.5        300.2
Operation and maintenance                        35.1             31.8         104.9        102.9
Depreciation, depletion and amortization         12.7             11.4          37.3         34.0
Taxes, other than income                          7.3              7.0          32.9         33.2
                                                 91.6             88.2         498.6        470.3
Operating income (loss)                         (14.1 )           (8.1 )        38.2         34.5
Earnings (loss)                          $      (11.2 )   $       (8.8 ) $      15.4   $     10.3
Volumes (MMdk):
Sales                                             7.6              8.0          67.7         60.1
Transportation                                   37.0             30.0         105.6         94.7
Total throughput                                 44.6             38.0         173.3        154.8
Degree days (% of normal)*
Montana-Dakota/Great Plains                        34 %             38 %         101 %         75 %
Cascade                                            74 %             91 %          92 %         98 %
Intermountain                                      89 %             51 %         109 %         92 %
Average cost of natural gas, including
transportation, per dk                   $       4.84     $       4.73   $      4.78   $     4.99


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

Three Months Ended September 30, 2013 and 2012 The natural gas distribution business recognized a seasonal loss of $11.2 million compared to a seasonal loss of $8.8 million a year ago (28 percent decrease). The decline was the result of:

Higher operation and maintenance expense, which includes $1.8 million (after tax) largely related to higher payroll-related and benefit-related costs

Higher depreciation, depletion and amortization expense of $800,000 (after tax), primarily resulting from higher property, plant and equipment balances

Lower margins, which includes $900,000 (after tax) largely related to retail sales and the absence of nonregulated service and repair margins due to the sale of Montana-Dakota's nonregulated appliance service and repair business in March 2013

Partially offsetting these decreases were:

Lower net interest expense, which includes $800,000 (after tax) largely related to lower average interest rates

A favorable resolution of a state income tax matter of $1.0 million (after tax)

Nine Months Ended September 30, 2013 and 2012 Earnings at the natural gas distribution business increased $5.1 million (49 percent) due to:

Increased retail sales volumes of 13 percent, largely resulting from colder weather than last year, partially offset by weather normalization adjustments in certain jurisdictions

A $2.8 million (after tax) gain on the sale of Montana-Dakota's nonregulated appliance service and repair business

Lower net interest expense, which includes $1.9 million (after tax) largely related to lower average interest rates

A favorable resolution of a state income tax matter of $1.0 million (after tax)

Partially offsetting these increases were:

Increased depreciation, depletion and amortization expense of $2.0 million (after tax), as previously discussed

Higher operation and maintenance expense, which includes $1.7 million (after tax) largely related to higher payroll-related costs, offset in part by lower benefit-related costs

Lower other income, which includes $900,000 (after tax) largely lower allowance for funds used during construction


Absence of nonregulated service and repair margins due to the sale of Montana-Dakota's nonregulated appliance service and repair business in March 2013

Pipeline and Energy Services

                                            Three Months Ended               Nine Months Ended
                                               September 30,                   September 30,
                                           2013                2012            2013          2012
                                                          (Dollars in millions)
Operating revenues                    $    51.3        $       48.3      $    148.6     $   141.6
Operating expenses:
Purchased natural gas sold                 14.0                10.8            42.6          35.4
Operation and maintenance                  16.1                19.2            65.3   *      34.8   **
Depreciation, depletion and
amortization                                7.1                 7.3            22.0          20.4
Taxes, other than income                    3.3                 3.5            10.3          10.5
                                           40.5                40.8           140.2         101.1
Operating income                           10.8                 7.5             8.4          40.5
Earnings                              $     5.3        $        3.3      $      1.3   * $    21.9   **
Transportation volumes (MMdk)              52.1                34.1           129.2         103.0
Natural gas gathering volumes (MMdk)       10.6                10.7            30.5          36.5
Customer natural gas storage balance
(MMdk):
Beginning of period                        25.2                40.4            43.7          36.0
Net injection (withdrawal)                 12.9                 8.8            (5.6 )        13.2
End of period                              38.1                49.2            38.1          49.2


* Reflects an impairment of coalbed natural gas gathering assets of $14.5 million ($9.0 million after tax). ** Reflects 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 20, as well as an impairment of coalbed natural gas gathering assets of $2.7 million ($1.7 million after tax).

Three Months Ended September 30, 2013 and 2012 Pipeline and energy services earnings increased $2.0 million (62 percent) due to:

Lower operation and maintenance expense, which includes $1.6 million (after tax) largely related to lower payroll-related costs, contract services and legal

Higher earnings from the Company's interest in the Pronghorn oil and natural gas gathering and processing assets, primarily due to higher volumes

Higher earnings of $600,000 (after tax) due to increased transportation volumes

These increases were partially offset by lower storage services revenue of $1.4 million (after tax), largely due to lower average rates and lower average storage balances.

Nine Months Ended September 30, 2013 and 2012 Pipeline and energy services earnings decreased $20.6 million (94 percent) due to:

Absence of the 2012 net benefit of $15.0 million (after tax) related to the natural gas gathering operations litigation, as discussed in Note 20

An impairment of coalbed natural gas gathering assets of $9.0 million
(after tax) in 2013, compared to an impairment of $1.7 million (after tax) in 2012, largely resulting from low natural gas prices, as discussed in Note 6

Lower earnings of $2.5 million (after tax) resulting from lower natural gas gathering volumes from existing operations, largely resulting from customers experiencing production curtailments, normal declines and deferral of natural gas development activity

Lower storage services revenue of $2.3 million (after tax), largely due to lower average rates

These decreases were partially offset by:

Higher earnings from the Company's interest in the Pronghorn oil and natural gas gathering and processing assets, as previously discussed


Lower operation and maintenance expense (excluding the asset impairments, net benefit related to the natural gas gathering operations litigation and Pronghorn-related expense), which includes $2.6 million (after tax), as previously discussed

Lower depreciation, depletion and amortization expense of $1.0 million (after tax) (excluding depreciation on Pronghorn oil and natural gas gathering and processing assets)

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

Exploration and Production

                                                  Three Months Ended          Nine Months Ended
                                                     September 30,              September 30,
                                                     2013           2012         2013        2012
                                                    (Dollars in millions, where applicable)
Operating revenues:
Oil                                          $      121.4     $     75.1   $    327.3   $   217.4
NGL                                                   7.6            7.9         21.3        24.6
Natural gas                                          20.1           16.7         62.5        48.1
Realized gain (loss) on commodity
derivatives                                          (6.6 )         10.0         (1.0 )      24.6
Unrealized loss on commodity derivatives            (12.6 )         (1.2 )       (5.4 )       (.5 )
                                                    129.9          108.5        404.7       314.2
Operating expenses:
Operation and maintenance:
Lease operating costs                                20.6           20.7         63.4        58.2
Gathering and transportation                          3.5            4.3         12.1        12.8
Other                                                12.5            9.6         32.9        28.4
Depreciation, depletion and amortization             49.6           41.4        137.8       112.6
Taxes, other than income:
Production and property taxes                        13.3            9.6         37.1        27.8
Other                                                  .2             .2           .9          .8
Write-down of oil and natural gas properties            -          160.1            -       160.1
                                                     99.7          245.9        284.2       400.7
Operating income (loss)                              30.2         (137.4 )      120.5       (86.5 )
Earnings (loss)                              $       17.4     $    (87.8 ) $     70.7   $   (56.9 )
Production:
Oil (MBbls)                                         1,252            912        3,571       2,555
NGL (MBbls)                                           196            211          588         610
Natural gas (MMcf)                                  7,302          7,390       21,002      25,676
Total production (MBOE)                             2,664          2,354        7,659       7,444
Average realized prices (excluding realized
and unrealized gain/loss on commodity
derivatives):
Oil (per Bbl)                                $      97.00     $    82.37   $    91.64   $   85.09
NGL (per Bbl)                                $      39.02     $    37.32   $    36.24   $   40.32
Natural gas (per Mcf)                        $       2.75     $     2.25   $     2.98   $    1.88
Average realized prices (including realized
gain/loss on commodity derivatives):
Oil (per Bbl)                                $      91.03     $    85.61   $    91.13   $   85.69
. . .
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