UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2004 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from _____________ to ______________ Commission file number 1-3480 MDU Resources Group, Inc. (Exact name of registrant as specified in its charter) Delaware 41-0423660 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Schuchart Building 918 East Divide Avenue P.O. Box 5650 Bismarck, North Dakota 58506-5650 (Address of principal executive offices) (Zip Code) (701) 222-7900 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X. No. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X. No. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of July 30, 2004: 117,492,838 shares. INTRODUCTION This Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are all statements other than statements of historical fact, including without limitation, those statements that are identified by the words "anticipates," "estimates," "expects," "intends," "plans," "predicts" and similar expressions. In addition to the risk factors and cautionary statements included in this Form 10-Q at Item 2 -- Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors and Cautionary Statements that May Affect Future Results, the following are some other factors that should be considered for a better understanding of the financial condition of MDU Resources Group, Inc. (Company). These other factors may impact the Company's financial results in future periods. - Acquisition, disposal and impairment of assets or facilities - Changes in operation, performance and construction of plant facilities or other assets - Changes in present or prospective generation - Changes in anticipated tourism levels - The availability of economic expansion or development opportunities - Population growth rates and demographic patterns - Market demand for, and/or available supplies of, energy products and services - Changes in tax rates or policies - Unanticipated project delays or changes in project costs - Unanticipated changes in operating expenses or capital expenditures - Labor negotiations or disputes - Inflation rates - Inability of the various contract counterparties to meet their contractual obligations - Changes in accounting principles and/or the application of such principles to the Company - Changes in technology - Changes in legal proceedings - The ability to effectively integrate the operations of acquired companies - Fluctuations in natural gas and crude oil prices - Decline in general economic environment - Changes in governmental regulation - Changes in currency exchange rates - Unanticipated increases in competition - Variations in weather The Company is a diversified natural resource company which was incorporated under the laws of the state of Delaware in 1924. Its principal executive offices are at the Schuchart Building, 918 East Divide Avenue, P.O. Box 5650, Bismarck, North Dakota 58506-5650, telephone (701) 222-7900. Montana-Dakota Utilities Co. (Montana-Dakota), a public utility division of the Company, through the electric and natural gas distribution segments, generates, transmits and distributes electricity and distributes natural gas in the northern Great Plains. Great Plains Natural Gas Co. (Great Plains), another public utility division of the Company, distributes natural gas in southeastern North Dakota and western Minnesota. These operations also supply related value-added products and services in the northern Great Plains. The Company, through its wholly owned subsidiary, Centennial Energy Holdings, Inc. (Centennial), owns WBI Holdings, Inc. (WBI Holdings), Knife River Corporation (Knife River), Utility Services, Inc. (Utility Services), Centennial Energy Resources LLC (Centennial Resources) and Centennial Holdings Capital LLC (Centennial Capital). WBI Holdings is comprised of the pipeline and energy services and the natural gas and oil production segments. The pipeline and energy services segment provides natural gas transportation, underground storage and gathering services through regulated and nonregulated pipeline systems primarily in the Rocky Mountain and northern Great Plains regions of the United States. The pipeline and energy services segment also provides energy-related management services, including cable and pipeline magnetization and locating. The natural gas and oil production segment is engaged in natural gas and oil acquisition, exploration, development and production activities, primarily in the Rocky Mountain region of the United States and in and around the Gulf of Mexico. Knife River mines aggregates and markets crushed stone, sand, gravel and related construction materials, including ready-mixed concrete, cement, asphalt and other value-added products, as well as performs integrated construction services, in the central and western United States and in the states of Alaska and Hawaii. Utility Services specializes in electrical line construction, pipeline construction, inside electrical wiring and cabling and the manufacture and distribution of specialty equipment. Centennial Resources owns electric generating facilities in the United States and has investments in electric generating facilities in Brazil and The Republic of Trinidad and Tobago (Trinidad and Tobago). Electric capacity and energy produced at the power plants are sold primarily under long- term contracts to nonaffiliated entities. Centennial Resources also provides analysis, design, construction, refurbishment, and operation and maintenance services to independent power producers. These operations also include investments not directly being pursued by the Company's other businesses. These activities are reflected in this Form 10-Q under independent power production and other. Centennial Capital insures various types of risks as a captive insurer for certain of the Company's subsidiaries. The function of the captive insurer is to fund the deductible layers of the insured companies' general liability and automobile liability coverages. Centennial Capital also owns certain real and personal property and contract rights. These activities are reflected in this Form 10-Q under independent power production and other. On August 14, 2003, the Company's Board of Directors approved a three-for-two common stock split. For more information on the common stock split, see Note 3 of Notes to Consolidated Financial Statements. INDEX Part I -- Financial Information Consolidated Statements of Income -- Three and Six Months Ended June 30, 2004 and 2003 Consolidated Balance Sheets -- June 30, 2004 and 2003, and December 31, 2003 Consolidated Statements of Cash Flows -- Six Months Ended June 30, 2004 and 2003 Notes to Consolidated Financial Statements Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Controls and Procedures Part II -- Other Information Legal Proceedings Changes in Securities and Use of Proceeds Exhibits and Reports on Form 8-K Signatures Exhibit Index Exhibits PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MDU RESOURCES GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 (In thousands, except per share amounts) Operating revenues: Electric, natural gas distribution and pipeline and energy services $159,368 $128,175 $ 391,215 $ 324,045 Utility services, natural gas and oil production, construction materials and mining and other 493,933 420,044 777,545 691,928 653,301 548,219 1,168,760 1,015,973 Operating expenses: Fuel and purchased power 16,370 13,262 33,095 28,669 Purchased natural gas sold 39,534 27,625 134,278 103,731 Operation and maintenance: Electric, natural gas distribution and pipeline and energy services 38,329 34,313 80,530 71,478 Utility services, natural gas and oil production, construction materials and mining and other 397,084 332,003 643,454 554,383 Depreciation, depletion and amortization 51,787 46,911 101,298 90,976 Taxes, other than income 25,466 19,420 47,351 39,103 568,570 473,534 1,040,006 888,340 Operating income 84,731 74,685 128,754 127,633 Other income -- net 9,570 4,949 14,364 8,632 Interest expense 15,653 12,820 29,499 25,679 Income before income taxes 78,648 66,814 113,619 110,586 Income taxes 20,018 23,341 31,410 39,416 Income before cumulative effect of accounting change 58,630 43,473 82,209 71,170 Cumulative effect of accounting change (Note 14) --- --- --- (7,589) Net income 58,630 43,473 82,209 63,581 Dividends on preferred stocks 172 188 342 375 Earnings on common stock $ 58,458 $ 43,285 $ 81,867 $ 63,206 Earnings per common share -- basic: Earnings before cumulative effect of accounting change $ .50 $ .39 $ .71 $ .64 Cumulative effect of accounting change --- --- --- (.07) Earnings per common share -- basic $ .50 $ .39 $ .71 $ .57 Earnings per common share -- diluted: Earnings before cumulative effect of accounting change $ .50 $ .39 $ .70 $ .64 Cumulative effect of accounting change --- --- --- (.07) Earnings per common share -- diluted $ .50 $ .39 $ .70 $ .57 Dividends per common share $ .17 $ .16 $ .34 $ .32 Weighted average common shares outstanding -- basic 116,559 110,602 115,609 110,461 Weighted average common shares outstanding -- diluted 117,567 111,532 116,632 111,283 Pro forma amounts assuming retroactive application of accounting change: Net income $ 58,630 $ 43,473 $ 82,209 $ 71,170 Earnings per common share -- basic $ .50 $ .39 $ .71 $ .64 Earnings per common share -- diluted $ .50 $ .39 $ .70 $ .64 The accompanying notes are an integral part of these consolidated financial statements. MDU RESOURCES GROUP, INC. CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, June 30, December 31, 2004 2003 2003 (In thousands, except shares and per share amounts) ASSETS Current assets: Cash and cash equivalents $ 132,476 $ 66,342 $ 86,341 Receivables, net 421,653 348,209 357,677 Inventories 121,920 97,490 114,051 Deferred income taxes 5,457 7,585 3,104 Prepayments and other current assets 62,304 54,929 52,367 743,810 574,555 613,540 Investments 78,067 42,112 44,975 Property, plant and equipment 3,744,146 3,375,456 3,584,038 Less accumulated depreciation, depletion and amortization 1,267,014 1,111,628 1,187,105 2,477,132 2,263,828 2,396,933 Deferred charges and other assets: Goodwill 200,553 196,394 199,427 Other intangible assets, net 21,105 20,577 18,814 Other 91,941 103,352 106,903 313,599 320,323 325,144 $3,612,608 $3,200,818 $3,380,592 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings $ --- $ 5,500 $ --- Long-term debt and preferred stock due within one year 93,249 17,938 27,646 Accounts payable 183,097 163,033 150,316 Taxes payable 23,031 12,999 15,358 Dividends payable 20,139 18,005 19,442 Other accrued liabilities 132,866 104,667 101,299 452,382 322,142 314,061 Long-term debt 887,721 938,609 939,450 Deferred credits and other liabilities: Deferred income taxes 467,376 379,608 444,779 Other liabilities 232,464 231,624 231,666 699,840 611,232 676,445 Preferred stock subject to mandatory redemption --- 1,200 --- Commitments and contingencies Stockholders' equity: Preferred stocks 15,000 15,000 15,000 Common stockholders' equity: Common stock (Note 3) Shares issued -- $1.00 par value 117,829,664 at June 30, 2004, 74,479,251 at June 30, 2003 and 113,716,632 at December 31, 2003 117,830 74,479 113,717 Other paid-in capital 843,658 755,017 757,787 Retained earnings 617,222 502,403 575,287 Accumulated other comprehensive loss (17,419) (15,638) (7,529) Treasury stock at cost - 359,281 shares at June 30, 2004 and December 31, 2003, and 239,521 shares at June 30, 2003 (3,626) (3,626) (3,626) Total common stockholders' equity 1,557,665 1,312,635 1,435,636 Total stockholders' equity 1,572,665 1,327,635 1,450,636 $3,612,608 $3,200,818 $3,380,592 The accompanying notes are an integral part of these consolidated financial statements. MDU RESOURCES GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, 2004 2003 (In thousands) Operating activities: Net income $ 82,209 $ 63,581 Cumulative effect of accounting change --- 7,589 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization 101,298 90,976 Earnings, net of distributions, from equity method investments (10,455) (943) Deferred income taxes 10,141 11,547 Changes in current assets and liabilities, net of acquisitions: Receivables (45,143) (20,769) Inventories (2,863) (1,399) Other current assets (11,508) (17,284) Accounts payable 24,026 24,399 Other current liabilities 23,814 3,024 Other noncurrent changes 809 3,247 Net cash provided by operating activities 172,328 163,968 Investing activities: Capital expenditures (141,868) (130,780) Acquisitions, net of cash acquired (22,006) (115,246) Net proceeds from sale or disposition of property 10,001 6,984 Investments (22,684) 2,420 Proceeds from notes receivable 22,000 7,812 Net cash used in investing activities (154,557) (228,810) Financing activities: Net change in short-term borrowings --- (14,500) Issuance of long-term debt 55,115 214,084 Repayment of long-term debt (42,202) (100,168) Proceeds from issuance of common stock, net 54,917 188 Dividends paid (39,466) (35,976) Net cash provided by financing activities 28,364 63,628 Increase (decrease) in cash and cash equivalents 46,135 (1,214) Cash and cash equivalents -- beginning of year 86,341 67,556 Cash and cash equivalents -- end of period $132,476 $66,342 The accompanying notes are an integral part of these consolidated financial statements. MDU RESOURCES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 and 2003 (Unaudited) 1. Basis of presentation The accompanying consolidated interim financial statements were prepared in conformity with the basis of presentation reflected in the consolidated financial statements included in the Annual Report to Stockholders for the year ended December 31, 2003 (2003 Annual Report), and the standards of accounting measurement set forth in Accounting Principles Board (APB) Opinion No. 28 and any amendments thereto adopted by the Financial Accounting Standards Board (FASB). Interim financial statements do not include all disclosures provided in annual financial statements and, accordingly, these financial statements should be read in conjunction with those appearing in the Company's 2003 Annual Report. The information is unaudited but includes all adjustments that are, in the opinion of management, necessary for a fair presentation of the accompanying consolidated interim financial statements. 2. Seasonality of operations Some of the Company's operations are highly seasonal and revenues from, and certain expenses for, such operations may fluctuate significantly among quarterly periods. Accordingly, the interim results for particular businesses, and for the Company as a whole, may not be indicative of results for the full fiscal year. 3. Common stock split On August 14, 2003, the Company's Board of Directors approved a three-for-two common stock split to be effected in the form of a 50 percent common stock dividend. The additional shares of common stock were distributed on October 29, 2003, to common stockholders of record on October 10, 2003. Common stock information appearing in the accompanying consolidated financial statements has been restated to give retroactive effect to the stock split. Additionally, preference share purchase rights have been appropriately adjusted to reflect the effects of the split. 4. Allowance for doubtful accounts The Company's allowance for doubtful accounts as of June 30, 2004 and 2003, and December 31, 2003, was $8.0 million, $8.3 million and $8.1 million, respectively. 5. Earnings per common share Basic earnings per common share were computed by dividing earnings on common stock by the weighted average number of shares of common stock outstanding during the applicable period. Diluted earnings per common share were computed by dividing earnings on common stock by the total of the weighted average number of shares of common stock outstanding during the applicable period, plus the effect of outstanding stock options, restricted stock grants and performance share awards. For the three and six months ended June 30, 2004, 205,305 shares, with an average exercise price of $24.54, attributable to the exercise of outstanding stock options, were excluded from the calculation of diluted earnings per share because their effect was antidilutive. For the three and six months ended June 30, 2003, 209,805 shares and 3,500,220 shares, respectively, with an average exercise price of $24.56 and $20.10, respectively, attributable to the exercise of outstanding stock options, were excluded from the calculation of diluted earnings per share because their effect was antidilutive. For the three and six months ended June 30, 2004 and 2003, no adjustments were made to reported earnings in the computation of earnings per share. Common stock outstanding includes issued shares less shares held in treasury. 6. Stock-based compensation The Company has stock option plans for directors, key employees and employees. In the third quarter of 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," and began expensing the fair market value of stock options for all awards granted on or after January 1, 2003. Compensation expense recognized for awards granted on or after January 1, 2003, for the three and six months ended June 30, 2004, was $2,000 and $5,000, respectively (after tax). As permitted by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No. 123," the Company accounts for stock options granted prior to January 1, 2003, under APB Opinion No. 25, "Accounting for Stock Issued to Employees." No compensation expense has been recognized for stock options granted prior to January 1, 2003, as the options granted had an exercise price equal to the market value of the underlying common stock on the date of the grant. Since the Company adopted SFAS No. 123 effective January 1, 2003, for newly granted options only, the following table illustrates the effect on earnings and earnings per common share for the three and six months ended June 30, 2004 and 2003, as if the Company had applied SFAS No. 123 and recognized compensation expense for all outstanding and unvested stock options based on the fair value at the date of grant: Three Months Ended June 30, 2004 2003 (In thousands, except per share amounts) Earnings on common stock, as reported $ 58,458 $ 43,285 Stock-based compensation expense included in reported earnings, net of related tax effects 2 --- Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects (79) (717) Pro forma earnings on common stock $ 58,381 $ 42,568 Earnings per common share -- basic -- as reported $ .50 $ .39 Earnings per common share -- basic -- pro forma $ .50 $ .38 Earnings per common share -- diluted -- as reported $ .50 $ .39 Earnings per common share -- diluted -- pro forma $ .50 $ .38 Six Months Ended June 30, 2004 2003 (In thousands, except per share amounts) Earnings on common stock, as reported $ 81,867 $ 63,206 Stock-based compensation expense included in reported earnings, net of related tax effects 5 --- Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects (172) (1,307) Pro forma earnings on common stock $ 81,700 $ 61,899 Earnings per common share -- basic -- as reported: Earnings before cumulative effect of accounting change $ .71 $ .64 Cumulative effect of accounting change --- (.07) Earnings per common share -- basic $ .71 $ .57 Earnings per common share -- basic -- pro forma: Earnings before cumulative effect of accounting change $ .71 $ .63 Cumulative effect of accounting change --- (.07) Earnings per common share -- basic $ .71 $ .56 Earnings per common share -- diluted -- as reported: Earnings before cumulative effect of accounting change $ .70 $ .64 Cumulative effect of accounting change --- (.07) Earnings per common share -- diluted $ .70 $ .57 Earnings per common share -- diluted -- pro forma: Earnings before cumulative effect of accounting change $ .70 $ .63 Cumulative effect of accounting change --- (.07) Earnings per common share -- diluted $ .70 $ .56 7. Cash flow information Cash expenditures for interest and income taxes were as follows: Six Months Ended June 30, 2004 2003 (In thousands) Interest, net of amount capitalized $26,269 $23,316 Income taxes paid, net $21,295 $31,263 8. Reclassifications Certain reclassifications have been made in the financial statements for the prior year to conform to the current presentation. Such reclassifications had no effect on net income or stockholders' equity as previously reported. 9. New accounting standards In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46 (revised)), which replaced FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 (revised) clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support. An enterprise shall consolidate a variable interest entity if that enterprise is the primary beneficiary. An enterprise is considered the primary beneficiary if it has a variable interest that will absorb a majority of the entity's expected losses, receive a majority of the entity's expected residual returns or both. FIN 46 (revised) shall be applied to all entities subject to FIN 46 (revised) no later than the end of the first reporting period that ends after March 15, 2004. The Company evaluated the provisions of FIN 46 (revised) and determined that the Company does not have any controlling financial interests in any variable interest entities and, therefore, is not required to consolidate any variable interest entities in its financial statements. The adoption of FIN 46 (revised) did not have an effect on the Company's financial position or results of operations. In January 2004, the FASB issued FASB Staff Position No. FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (FSP No. FAS 106-1). FSP No. FAS 106-1 permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (2003 Medicare Act). In May 2004, the FASB issued FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP No. FAS 106-2). FSP No. FAS 106-2 requires (a) that the effects of the federal subsidy be considered an actuarial gain and recognized in the same manner as other actuarial gains and losses and (b) certain disclosures for employers that sponsor postretirement health care plans that provide prescription drug benefits. The Company provides prescription drug benefits to certain eligible employees. The Company elected the one-time deferral of accounting for the effects of the 2003 Medicare Act in the quarter ending March 31, 2004, the first period in which the plan's accounting for the effects of the 2003 Medicare Act normally would have been reflected in the Company's financial statements. During the second quarter of 2004, the Company adopted FSP No. FAS 106-2 retroactive to the beginning of the year. The Company and its actuarial advisors determined that benefits provided to certain participants are expected to be at least actuarially equivalent to Medicare Part D (the federal prescription drug benefit), and, accordingly, the Company expects to be entitled to a federal subsidy. The expected federal subsidy reduced the accumulated postretirement benefit obligation (APBO) at January 1, 2004, by approximately $3.2 million, and net periodic benefit cost for 2004 by approximately $285,000 (as compared with the amount calculated without considering the effects of the subsidy). In addition, the Company expects a reduction in future participation in the postretirement plans, which further reduced the APBO at January 1, 2004, by approximately $12.7 million and net periodic benefit cost for 2004 by approximately $1.3 million. See Note 17 for the components of net periodic benefit cost. The net periodic benefit cost for the three and six months ended June 30, 2004, was reduced by approximately $767,000 to reflect the effects of the 2003 Medicare Act. SFAS No. 142, "Goodwill and Other Intangible Assets," discontinues the practice of amortizing goodwill and indefinite lived intangible assets and initiates an annual review for impairment. Intangible assets with a determinable useful life will continue to be amortized over that period. The amortization provisions apply to goodwill and intangible assets acquired after June 30, 2001. SFAS No. 141, "Business Combinations," and SFAS No. 142 clarify that more assets should be distinguished and classified between tangible and intangible. The Company did not change or reclassify contractual mineral rights included in property, plant and equipment related to its natural gas and oil production business upon adoption of SFAS No. 142. The Company has included such mineral rights as part of property, plant and equipment under the full-cost method of accounting for natural gas and oil properties. An issue has arisen within the natural gas and oil industry as to whether contractual mineral rights under SFAS No. 142 should be classified as intangible rather than as part of property, plant and equipment. Recently, the FASB Staff issued proposed FASB Staff Position No. FAS 142-b, "Application of FASB Statement No. 142, Goodwill and Other Intangible Assets, to Oil- and Gas-Producing Entities," which indicates that the exception in SFAS No. 142 does not change the accounting prescribed in SFAS No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies," including the balance sheet classification of drilling and mineral rights of oil and gas producing entities and, as a result, the contractual mineral rights should continue to be classified as part of property, plant and equipment. The anticipated resolution of this matter is not expected to have an effect on the Company's financial position, results of operations or cash flows. In April 2004, the FASB issued FASB Staff Position Nos. FAS 141- 1 and FAS 142-1, "Interaction of FASB Statements No. 141, 'Business Combinations,' and No. 142, 'Goodwill and Other Intangible Assets,' and EITF Issue No. 04-2, 'Whether Mineral Rights are Tangible or Intangible Assets,'" (FSP Nos. FAS 141-1 and FAS 142-1). FSP Nos. FAS 141-1 and FAS 142-1 amend SFAS No. 141 and SFAS No. 142 to clarify that certain mineral rights held by mining entities that are not within the scope of SFAS No. 19 be classified as tangible assets rather than intangible assets. FSP Nos. FAS 141-1 and FAS 142-1 shall be applied to the first reporting period beginning after April 29, 2004. FSP Nos. FAS 141-1 and FAS 142-1 required reclassification of the Company's leasehold rights at its construction materials and mining operations from other intangible assets, net to property, plant and equipment, as well as changes to Notes to Consolidated Financial Statements. FSP Nos. FAS 141-1 and FAS 142-1 affected the asset classification in the consolidated balance sheet and associated footnote disclosure only, so the reclassifications did not affect the Company's stockholders' equity, cash flows or results of operations. 10. Comprehensive income Comprehensive income is the sum of net income as reported and other comprehensive loss. The Company's other comprehensive loss resulted from losses on derivative instruments qualifying as hedges, minimum pension liability adjustments and foreign currency translation adjustments. Comprehensive income, and the components of other comprehensive loss and related tax effects, was as follows: Three Months Ended June 30, 2004 2003 (In thousands) Net income $ 58,630 $ 43,473 Other comprehensive loss: Net unrealized loss on derivative instruments qualifying as hedges: Net unrealized loss on derivative instruments arising during the period, net of tax of $3,711 and $2,241 in 2004 and 2003, respectively (5,804) (3,587) Less: Reclassification adjustment for loss on derivative instruments included in net income, net of tax of $1,473 and $1,871 in 2004 and 2003, respectively (2,304) (2,926) Net unrealized loss on derivative instruments qualifying as hedges (3,500) (661) Foreign currency translation adjustment (377) (475) (3,877) (1,136) Comprehensive income $ 54,753 $42,337 Six Months Ended June 30, 2004 2003 (In thousands) Net income $ 82,209 $ 63,581 Other comprehensive loss: Net unrealized loss on derivative instruments qualifying as hedges: Net unrealized loss on derivative instruments arising during the period, net of tax of $6,424 and $4,635 in 2004 and 2003, respectively (10,047) (7,331) Less: Reclassification adjustment for loss on derivative instruments included in net income, net of tax of $1,020 and $1,440 in 2004 and 2003, respectively (1,595) (2,252) Net unrealized loss on derivative instruments qualifying as hedges (8,452) (5,079) Foreign currency translation adjustment (1,438) (755) (9,890) (5,834) Comprehensive income $ 72,319 $ 57,747 11. Equity method investments The Company has a number of equity method investments, including MPX Participacoes, Ltda. (MPX) and Carib Power Management LLC (Carib Power). The Company assesses its equity method investments for impairment whenever events or changes in circumstances indicate that such carrying values may not be recoverable. None of the Company's equity method investments have been impaired and, accordingly, no impairment losses have been recorded in the accompanying consolidated financial statements or related equity method investment balances. MPX was formed in August 2001 when MDU Brasil Ltda. (MDU Brasil), an indirect wholly owned Brazilian subsidiary of the Company, entered into a joint venture agreement with a Brazilian firm. MDU Brasil has a 49 percent interest in MPX. MPX, through a wholly owned subsidiary, owns and operates a 220- megawatt natural gas-fired electric generating facility (Brazil Generating Facility) in the Brazilian state of Ceara. Petrobras, the Brazilian state-controlled energy company, has agreed to purchase all of the capacity and market all of the Brazil Generating Facility's energy. The power purchase agreement with Petrobras expires in May 2008. Petrobras also is under contract to supply natural gas to the Brazil Generating Facility during the term of the power purchase agreement. This natural gas supply contract is renewable by a wholly owned subsidiary of MPX for an additional 13 years. The Brazil Generating Facility generates energy based upon economic dispatch and available gas supplies. Under current conditions, including, in particular, existing constraints in the region's gas supply infrastructure, the Company does not expect the facility to generate a significant amount of energy at least through 2006. The functional currency for the Brazil Generating Facility is the Brazilian real. The power purchase agreement with Petrobras contains an embedded derivative, which derives its value from an annual adjustment factor, which largely indexes the contract capacity payments to the U.S. dollar. The Company's 49 percent share of the gain from the change in the fair value of the embedded derivative in the power purchase agreement was $4.1 million (after tax) for the three and six months ended June 30, 2004. The Company's 49 percent share of the loss from the change in the fair value of the embedded derivative in the power purchase agreement was $4.5 million (after tax) and $6.0 million (after tax) for the three and six months ended June 30, 2003, respectively. The Company's 49 percent share of the foreign currency loss resulting from a decrease in value of the Brazilian real versus the U.S. dollar was $1.8 million (after tax) and $2.0 million (after tax) for the three and six months ended June 30, 2004, respectively. The Company's 49 percent share of the foreign currency gains resulting from the increase in value of the Brazilian real versus the U.S. dollar was $2.2 million (after tax) and $3.1 million (after tax) for the three and six months ended June 30, 2003, respectively. In February 2004, Centennial Energy Resources International, Inc. (Centennial International), an indirect wholly owned subsidiary of the Company, acquired 49.9 percent of Carib Power. Carib Power, through a wholly owned subsidiary, owns a 225-megawatt natural gas-fired electric generating facility located in Trinidad and Tobago (Trinidad and Tobago Generating Facility). The functional currency for the Trinidad and Tobago Generating Facility is the U.S. dollar. At June 30, 2004, MPX and Carib Power had total assets of $202.8 million and long-term debt of $158.0 million. The Company's investment in the Brazil and Trinidad and Tobago Generating Facilities was approximately $26.0 million, including undistributed earnings of $14.8 million at June 30, 2004. The Company's investment in the Brazil Generating Facility was approximately $20.6 million at June 30, 2003, and $25.2 million, including undistributed earnings of $4.6 million at December 31, 2003. The Company's share of income from its equity method investments was $7.7 million and $11.1 million for the three and six months ended June 30, 2004, respectively, and was included in other income - net. The Company's share of income from its equity method investments, including MPX, was $1.3 million and $2.3 million for the three and six months ended June 30, 2003, respectively, and was included in other income - net. 12. Goodwill and other intangible assets The changes in the carrying amount of goodwill were as follows: Balance Goodwill Balance as of Acquired as of Six Months January 1, During June 30, Ended June 30, 2004 2004 the Year* 2004 (In thousands) Electric $ --- $ --- $ --- Natural gas distribution --- --- --- Utility services 62,604 28 62,632 Pipeline and energy services 9,494 --- 9,494 Natural gas and oil production --- --- --- Construction materials and mining 120,198 (2,668) 117,530 Independent power production and other 7,131 3,766 10,897 Total $ 199,427 $ 1,126 $ 200,553 __________________ * Includes purchase price adjustments related to acquisitions acquired in a prior period. Balance Goodwill Balance as of Acquired as of Six Months January 1, During June 30, Ended June 30, 2003 2003 the Year* 2003 (In thousands) Electric $ --- $ --- $ --- Natural gas distribution --- --- --- Utility services 62,487 127 62,614 Pipeline and energy services 9,494 --- 9,494 Natural gas and oil production --- --- --- Construction materials and mining 111,887 5,268 117,155 Independent power production and other 7,131 --- 7,131 Total $ 190,999 $ 5,395 $ 196,394 __________________ * Includes purchase price adjustments related to acquisitions acquired in a prior period. Balance Goodwill Balance as of Acquired as of Year Ended January 1, During December 31, December 31, 2003 2003 the Year* 2003 (In thousands) Electric $ --- $ --- $ --- Natural gas distribution --- --- --- Utility services 62,487 117 62,604 Pipeline and energy services 9,494 --- 9,494 Natural gas and oil production --- --- --- Construction materials and mining 111,887 8,311 120,198 Independent power production and other 7,131 --- 7,131 Total $ 190,999 $ 8,428 $ 199,427 __________________ * Includes purchase price adjustments related to acquisitions acquired in a prior period. As discussed in Note 9, the Company reclassified its leasehold rights at its construction materials and mining operations from other intangible assets, net to property, plant and equipment. Other intangible assets were as follows: June 30, June 30, December 31, 2004 2003 2003 (In thousands) Amortizable intangible assets: Noncompete agreements $ 10,275 $ 12,075 $ 12,075 Accumulated amortization (8,024) (9,552) (9,690) 2,251 2,523 2,385 Other 21,292 17,719 17,734 Accumulated amortization (3,398) (1,268) (2,265) 17,894 16,451 15,469 Unamortizable intangible assets 960 1,603 960 Total $ 21,105 $ 20,577 $ 18,814 The unamortizable intangible assets were recognized in accordance with SFAS No. 87, "Employers' Accounting for Pensions," which requires that if an additional minimum liability is recognized an equal amount shall be recognized as an intangible asset, provided that the asset recognized shall not exceed the amount of unrecognized prior service cost. The unamortizable intangible asset will be eliminated or adjusted as necessary upon a new determination of the amount of additional liability. Amortization expense for amortizable intangible assets for the three and six months ended June 30, 2004, was $702,000 and $1.3 million, respectively. Amortization expense for amortizable intangible assets for the three and six months ended June 30, 2003, and for the year ended December 31, 2003, was $630,000, $1.1 million and $2.2 million, respectively. Estimated amortization expense for amortizable intangible assets is $3.0 million in 2004, $2.4 million in 2005, $1.8 million in 2006, $1.7 million in 2007, $1.7 million in 2008 and $10.8 million thereafter. 13. Derivative instruments From time to time, the Company utilizes derivative instruments as part of an overall energy price, foreign currency and interest rate risk management program to efficiently manage and minimize commodity price, foreign currency and interest rate risk. The following information should be read in conjunction with Notes 1 and 5 in the Company's Notes to Consolidated Financial Statements in the 2003 Annual Report. As of June 30, 2004, Fidelity Exploration & Production Company (Fidelity), an indirect wholly owned subsidiary of the Company, held derivative instruments designated as cash flow hedging instruments. Hedging activities Fidelity utilizes natural gas and oil price swap and collar agreements to manage a portion of the market risk associated with fluctuations in the price of natural gas and oil on its forecasted sales of natural gas and oil production. Each of the natural gas and oil price swap and collar agreements was designated as a hedge of the forecasted sale of natural gas and oil production. For the three and six months ended June 30, 2004 and 2003, the amount of hedge ineffectiveness recognized, which was included in operating revenues, was immaterial. For the three and six months ended June 30, 2004 and 2003, Fidelity did not exclude any components of the derivative instruments' gain or loss from the assessment of hedge effectiveness and there were no reclassifications into earnings as a result of the discontinuance of hedges. Gains and losses on derivative instruments that are reclassified from accumulated other comprehensive income (loss) to current-period earnings are included in the line item in which the hedged item is recorded. As of June 30, 2004, the maximum term of Fidelity's swap and collar agreements, in which it is hedging its exposure to the variability in future cash flows for forecasted transactions, is 18 months. Fidelity estimates that over the next 12 months net losses of approximately $9.2 million will be reclassified from accumulated other comprehensive loss into earnings, subject to changes in natural gas and oil market prices, as the hedged transactions affect earnings. 14. Asset retirement obligations The Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations," on January 1, 2003. The Company recorded obligations related to the plugging and abandonment of natural gas and oil wells, decommissioning of certain electric generating facilities, reclamation of certain aggregate properties and certain other obligations associated with leased properties. Removal costs associated with certain natural gas distribution, transmission, storage and gathering facilities have not been recognized as these facilities have been determined to have indeterminate useful lives. Upon adoption of SFAS No. 143, the Company recorded an additional discounted liability of $22.5 million and a regulatory asset of $493,000, increased net property, plant and equipment by $9.6 million and recognized a one-time cumulative effect charge of $7.6 million (net of deferred income tax benefits of $4.8 million). The Company believes that any expenses under SFAS No. 143 as they relate to regulated operations will be recovered in rates over time and accordingly, deferred such expenses as a regulatory asset upon adoption. The Company will continue to defer those SFAS No. 143 expenses that it believes will be recovered in rates over time. In addition to the $22.5 million liability recorded upon the adoption of SFAS No. 143, the Company had previously recorded a $7.5 million liability related to retirement obligations. 15. Business segment data The Company's reportable segments are those that are based on the Company's method of internal reporting, which generally segregates the strategic business units due to differences in products, services and regulation. The Company has six reportable segments consisting of electric, natural gas distribution, utility services, pipeline and energy services, natural gas and oil production, and construction materials and mining. The independent power production and other operations do not individually meet the criteria to be considered a reportable segment. The vast majority of the Company's operations are located within the United States. The Company also has investments in foreign countries, which largely consist of investments in natural gas-fired electric generating facilities in Brazil and Trinidad and Tobago, as discussed in Note 11. The electric segment generates, transmits and distributes electricity, and the natural gas distribution segment distributes natural gas. These operations also supply related value-added products and services in the northern Great Plains. The utility services segment specializes in electrical line construction, pipeline construction, inside electrical wiring and cabling and the manufacture and distribution of specialty equipment. The pipeline and energy services segment provides natural gas transportation, underground storage and gathering services through regulated and nonregulated pipeline systems primarily in the Rocky Mountain and northern Great Plains regions of the United States. The pipeline and energy services segment also provides energy-related management services, including cable and pipeline magnetization and locating. The natural gas and oil production segment is engaged in natural gas and oil acquisition, exploration, development and production activities, primarily in the Rocky Mountain region of the United States and in and around the Gulf of Mexico. The construction materials and mining segment mines aggregates and markets crushed stone, sand, gravel and related construction materials, including ready-mixed concrete, cement, asphalt and other value-added products, as well as performs integrated construction services, in the central and western United States and in the states of Alaska and Hawaii. The independent power production and other operations own electric generating facilities in the United States and have investments in electric generating facilities in Brazil and Trinidad and Tobago. Electric capacity and energy produced at the power plants are sold primarily under long-term contracts to nonaffiliated entities. Centennial Resources also provides analysis, design, construction, refurbishment, and operation and maintenance services to independent power producers. These operations also include investments not directly being pursued by the Company's other businesses. The information below follows the same accounting policies as described in Note 1 of the Company's 2003 Annual Report. Information on the Company's businesses was as follows: Inter- External segment Earnings Operating Operating on Common Revenues Revenues Stock (In thousands) Three Months Ended June 30, 2004 Electric $ 39,834 $ --- $ 735 Natural gas distribution 47,461 --- (1,097) Pipeline and energy services 72,073 13,423 4,434 159,368 13,423 4,072 Utility services 97,226 --- (2,294) Natural gas and oil production 39,038 45,181 26,136 Construction materials and mining 347,026 200 20,345 Independent power production and other 10,643 919 10,199 493,933 46,300 54,386 Intersegment eliminations --- (59,723) --- Total $653,301 $ --- $ 58,458 Inter- External segment Earnings Operating Operating on Common Revenues Revenues Stock (In thousands) Three Months Ended June 30, 2003 Electric $ 38,049 $ --- $ 1,766 Natural gas distribution 42,409 --- (1,291) Pipeline and energy services 47,717 8,508 5,083 128,175 8,508 5,558 Utility services 108,928 --- 1,515 Natural gas and oil production 36,746 27,912 17,866 Construction materials and mining 264,129 --- 12,803 Independent power production and other 10,241 740 5,543 420,044 28,652 37,727 Intersegment eliminations --- (37,160) --- Total $548,219 $ --- $ 43,285 Inter- External segment Earnings Operating Operating on Common Revenues Revenues Stock (In thousands) Six Months Ended June 30, 2004 Electric $ 86,824 $ --- $ 4,143 Natural gas distribution 175,779 --- 1,228 Pipeline and energy services 128,612 41,036 7,117 391,215 41,036 12,488 Utility services 197,477 --- (4,195) Natural gas and oil production 76,544 88,644 51,395 Construction materials and mining 486,473 200 8,464 Independent power production and other 17,051 1,837 13,715 777,545 90,681 69,379 Intersegment eliminations --- (131,717) --- Total $1,168,760 $ --- $ 81,867 Inter- External segment Earnings Operating Operating on Common Revenues Revenues Stock (In thousands) Six Months Ended June 30, 2003 Electric $ 83,720 $ --- $ 6,583 Natural gas distribution 153,397 --- 2,954 Pipeline and energy services 86,928 30,427 9,394 324,045 30,427 18,931 Utility services 212,591 --- 2,625 Natural gas and oil production 77,865 55,816 29,532 Construction materials and mining 384,882 --- 5,363 Independent power production and other 16,590 1,481 6,755 691,928 57,297 44,275 Intersegment eliminations --- (87,724) --- Total $1,015,973 $ --- $ 63,206 Earnings from electric, natural gas distribution and pipeline and energy services are substantially all from regulated operations. Earnings from utility services, natural gas and oil production, construction materials and mining, and independent power production and other are all from nonregulated operations. 16. Acquisitions During the first six months of 2004, the Company acquired a number of businesses, none of which was individually material, including construction materials and mining businesses in Idaho, Iowa and Minnesota and an independent power production operating and development company in Colorado. The total purchase consideration for these businesses and purchase price adjustments with respect to certain other acquisitions acquired prior to 2004, including the Company's common stock and cash, was $54.6 million. The above acquisitions were accounted for under the purchase method of accounting and, accordingly, the acquired assets and liabilities assumed have been preliminarily recorded at their respective fair values as of the date of acquisition. Final fair market values are pending the completion of the review of the relevant assets, liabilities and issues identified as of the acquisition date. The results of operations of the acquired businesses are included in the financial statements since the date of each acquisition. Pro forma financial amounts reflecting the effects of the above acquisitions are not presented, as such acquisitions were not material to the Company's financial position or results of operations. 17. Employee benefit plans The Company has noncontributory defined benefit pension plans and other postretirement benefit plans for certain eligible employees. As discussed in Note 9, the Company recognized the effects of the 2003 Medicare Act during the second quarter of 2004. The net periodic benefit cost (income) for 2004 reflects the effects of the 2003 Medicare Act. Components of net periodic benefit cost (income) for the Company's pension and other postretirement benefit plans were as follows: Other Pension Postretirement Three Months Benefits Benefits Ended June 30 2004 2003 2004 2003 (In thousands) Components of net periodic benefit cost (income): Service cost $ 1,984 $ 1,432 $ 312 $ 442 Interest cost 4,011 3,794 850 1,247 Expected return on assets (5,100) (5,225) (979) (981) Amortization of prior service cost 283 285 72 --- Recognized net actuarial (gain) loss (8) (68) (27) (130) Amortization of net transition obligation (asset) (62) (237) 550 538 Net periodic benefit cost (income) 1,108 (19) 778 1,116 Less amount capitalized 117 (37) 80 128 Net periodic benefit cost (income) $ 991 $ 18 $ 698 $ 988 Other Pension Postretirement Six Months Benefits Benefits Ended June 30 2004 2003 2004 2003 (In thousands) Components of net periodic benefit cost (income): Service cost $ 3,833 $ 2,864 $ 896 $ 884 Interest cost 7,952 7,588 2,173 2,493 Expected return on assets (10,187) (10,450) (1,972) (1,962) Amortization of prior service cost 561 570 72 --- Recognized net actuarial (gain) loss 239 (136) (82) (259) Amortization of net transition obligation (asset) (125) (474) 1,076 1,076 Net periodic benefit cost (income) 2,273 (38) 2,163 2,232 Less amount capitalized 191 (48) 182 208 Net periodic benefit cost (income) $ 2,082 $ 10 $ 1,981 $ 2,024 As of June 30, 2004, approximately $900,000 has been contributed to the defined benefit pension plans and approximately $2.4 million has been contributed to the postretirement benefit plans. The Company presently anticipates contributing an additional $400,000 to its pension plans in 2004 for a total of $1.3 million for the year. The Company presently anticipates contributing an additional $1.3 million to its postretirement benefit plans for a total of $3.7 million for the year. In addition to the qualified plan defined pension benefits reflected in the tables above, the Company also has an unfunded, nonqualified benefit plan for executive officers and certain key management employees that provides for defined benefit payments at age 65 following the employee's retirement or to the beneficiaries upon death for a 15-year period. The Company's net periodic benefit cost for this plan for the three and six months ended June 30, 2004, was $2.3 million and $3.8 million, respectively. The Company's net periodic benefit cost for this plan for the three and six months ended June 30, 2003, was $1.2 million and $2.4 million, respectively. 18. Regulatory matters and revenues subject to refund On June 7, 2004, Montana-Dakota filed an application with the South Dakota Public Utilities Commission (SDPUC) for a natural gas rate increase for the Black Hills service area. Montana- Dakota requested a total of $1.3 million annually or 2.2 percent above current rates. A final order from the SDPUC is due December 7, 2004. On April 1, 2004, Montana-Dakota filed an application with the Montana Public Service Commission (MTPSC) for a natural gas rate increase. Montana-Dakota requested a total of $1.5 million annually or 1.8 percent above current rates. Montana- Dakota requested an interim increase of $500,000 annually to be effective within 30 days of the filing of the natural gas rate increase. A final order from the MTPSC is due January 1, 2005. On March 3, 2004, Montana-Dakota filed an application with the North Dakota Public Service Commission (NDPSC) for a natural gas rate increase. Montana-Dakota requested a total of $3.3 million annually or 2.8 percent above current rates. The natural gas rate increase application included an interim increase of $1.9 million annually to be effective within 60 days of the filing of the natural gas rate increase. On April 26, 2004, Montana-Dakota filed an amendment to its request for interim rate increase requesting an interim increase of $1.7 million annually. On April 27, 2004, the NDPSC issued an Order approving Montana-Dakota's interim rate increase of $1.7 million annually effective for service rendered on or after May 3, 2004. Montana-Dakota began collecting such rates effective May 3, 2004, subject to refund until the NDPSC issues a final order. A final order from the NDPSC is due October 3, 2004. In December 1999, Williston Basin Interstate Pipeline Company (Williston Basin), an indirect wholly owned subsidiary of the Company, filed a general natural gas rate change application with the Federal Energy Regulatory Commission (FERC). Williston Basin began collecting such rates effective June 1, 2000, subject to refund. In May 2001, the Administrative Law Judge (ALJ) issued an Initial Decision on Williston Basin's natural gas rate change application. The Initial Decision addressed numerous issues relating to the rate change application, including matters relating to allowable levels of rate base, return on common equity, and cost of service, as well as volumes established for purposes of cost recovery, and cost allocation and rate design. In July 2003, the FERC issued its Order on Initial Decision. The Order on Initial Decision affirmed the ALJ's Initial Decision on many of the issues including rate base and certain cost of service items as well as volumes to be used for purposes of cost recovery, and cost allocation and rate design. However, there are other issues as to which the FERC differed with the ALJ including return on common equity and the correct level of corporate overhead expense. In August 2003, Williston Basin requested rehearing of a number of issues including determinations associated with cost of service, throughput, and cost allocation and rate design, as discussed in the FERC's Order on Initial Decision. On May 11, 2004, the FERC issued an Order on Rehearing and Compliance and Remanding Certain Issues for Hearing (Order on Rehearing). The Order on Rehearing denied rehearing on all of the issues addressed by Williston Basin in its August 2003 request for rehearing except for the issue of the proper rate to utilize for transmission system negative salvage expenses. In addition, the FERC remanded the issues regarding certain service and annual demand quantity restrictions to an ALJ for resolution. On June 14, 2004, Williston Basin requested clarification of a few of the issues addressed in the May 11, 2004, Order on Rehearing including determinations associated with cost of service and cost allocation, as discussed in the FERC's Order on Rehearing. On June 14, 2004, Williston Basin also made its filing to comply with the requirements of the various FERC orders in this proceeding. Williston Basin is awaiting a decision from the FERC on Williston Basin's compliance filing and clarification request but is unable to predict the timing of the FERC's decision. Reserves have been provided for a portion of the revenues that have been collected subject to refund with respect to Williston Basin's pending regulatory proceeding. Williston Basin believes that such reserves are adequate based on its assessment of the ultimate outcome of the proceeding. 19. Contingencies Litigation In June 1997, Jack J. Grynberg (Grynberg) filed a Federal False Claims Act Suit against Williston Basin and Montana-Dakota and filed over 70 similar suits against natural gas transmission companies and producers, gatherers, and processors of natural gas. Grynberg, acting on behalf of the United States under the Federal False Claims Act, alleged improper measurement of the heating content and volume of natural gas purchased by the defendants resulting in the underpayment of royalties to the United States. In April 1999, the United States Department of Justice decided not to intervene in these cases. In response to a motion filed by Grynberg, the Judicial Panel on Multidistrict Litigation consolidated all of these cases in the Federal District Court of Wyoming. On June 4, 2004, following preliminary discovery, Williston Basin and Montana-Dakota joined with other defendants and filed a Motion to Dismiss on the grounds that the information upon which Grynberg bases his complaint was publicly disclosed prior to the filing of his complaint and further, that he is not the original source of such information. The Motion to Dismiss is additionally based on the grounds that Grynberg disclosed the filing of the complaint prior to the entry of a court order allowing such disclosure. In the event the Motion to Dismiss is not granted, it is expected that further discovery will follow. Williston Basin and Montana-Dakota believe Grynberg will not prevail in the suit or recover damages from Williston Basin and/or Montana- Dakota because insufficient facts exist to support the allegations. Williston Basin and Montana-Dakota believe Grynberg's claims are without merit and intend to vigorously contest this suit. Grynberg has not specified the amount he seeks to recover. Williston Basin and Montana-Dakota are unable to estimate their potential exposure and will be unable to do so until discovery is completed. Fidelity has been named as a defendant in, and/or certain of its operations are the subject of, over a dozen lawsuits filed in connection with its coalbed natural gas development in the Powder River Basin in Montana and Wyoming. These lawsuits were filed in federal and state courts in Montana between June 2000 and May 2004 by a number of environmental organizations, including the Northern Plains Resource Council and the Montana Environmental Information Center as well as the Tongue River Water Users' Association and the Northern Cheyenne Tribe. Portions of two of the lawsuits have been transferred to Federal District Court in Wyoming. The lawsuits involve allegations that Fidelity and/or various government agencies are in violation of state and/or federal law, including the Federal Clean Water Act and the National Environmental Policy Act. The lawsuits seek injunctive relief, invalidation of various permits and unspecified damages. Fidelity is unable to quantify the damages sought in any of these cases, and will be unable to do so until after completion of discovery in the separate cases. Fidelity is vigorously defending all coalbed- related lawsuits in which it is involved. If the plaintiffs are successful in these lawsuits, the ultimate outcome of the actions could have a material effect on Fidelity's existing coalbed natural gas operations and/or the future development of its coalbed natural gas properties. Montana-Dakota has joined with two electric generators in appealing a finding by the North Dakota Department of Health (Department) in September 2003 that the Department may unilaterally revise operating permits previously issued to electric generating plants. Although it is doubtful that any revision of Montana-Dakota's operating permits by the Department would reduce the amount of electricity its plants could generate, the finding, if allowed to stand, could increase costs for sulfur dioxide removal and/or limit Montana- Dakota's ability to modify or expand operations at its North Dakota generation sites. Montana-Dakota and the other electric generators filed their appeal of the order in October 2003, in the Burleigh County District Court in Bismarck, North Dakota. Proceedings have been stayed pending discussions with the United States Environmental Protection Agency (EPA), the Department and the other electric generators. In a related case, the Dakota Resource Council filed an action in Federal District Court in Denver, Colorado, in September 2003, to require the EPA to enforce certain air quality standards in North Dakota. If successful, the action could require the curtailment of discharges of sulfur dioxide into the atmosphere by existing electric generating facilities and could preclude or hinder the construction of future generating facilities in North Dakota. The Company had filed a Motion to Intervene in the lawsuit and had joined in a brief supporting a Motion to Dismiss filed by the EPA. The EPA Motion to Dismiss was granted on April 1, 2004. The Company cannot predict the outcome of the Department or Dakota Resource Council matters or their ultimate impact on its operations. The Company is also involved in other legal actions in the ordinary course of its business. Although the outcomes of any such legal actions cannot be predicted, management believes that the outcomes with respect to these other legal proceedings will not have a material adverse effect upon the Company's financial position or results of operations. Environmental matters In December 2000, Morse Bros., Inc. (MBI), an indirect wholly owned subsidiary of the Company, was named by the EPA as a Potentially Responsible Party in connection with the cleanup of a commercial property site, acquired by MBI in 1999, and part of the Portland, Oregon, Harbor Superfund Site. Sixty-eight other parties were also named in this administrative action. The EPA wants responsible parties to share in the cleanup of sediment contamination in the Willamette River. To date, costs of the overall remedial investigation of the harbor site for both the EPA and the Oregon State Department of Environmental Quality (DEQ) are being recorded, and initially paid, through an administrative consent order by the Lower Willamette Group (LWG), a group of 10 entities which does not include MBI. The LWG estimates the overall remedial investigation and feasibility study will cost approximately $10 million. It is not possible to estimate the cost of a corrective action plan until the remedial investigation and feasibility study has been completed, the EPA has decided on a strategy, and a record of decision has been published. While the remedial investigation and feasibility study for the harbor site has commenced, it is expected to take several years to complete. The development of a proposed plan and record of decision on the harbor site is not anticipated to occur until 2006, after which a cleanup plan will be undertaken. Based upon a review of the Portland Harbor sediment contamination evaluation by the DEQ and other information available, MBI does not believe it is a Responsible Party. In addition, MBI has notified Georgia-Pacific West, Inc., the seller of the commercial property site to MBI, that it intends to seek indemnity for any and all liabilities incurred in relation to the above matters, pursuant to the terms of their sale agreement. The Company believes it is not probable that it will incur any material environmental remediation costs or damages in relation to the above administrative action. Guarantees Centennial has unconditionally guaranteed a portion of certain bank borrowings of MPX in connection with the Company's equity method investment in the Brazil Generating Facility, as discussed in Note 11. The Company, through MDU Brasil, owns 49 percent of MPX. The main business purpose of Centennial extending the guarantee to MPX's creditors is to enable MPX to obtain lower borrowing costs. At June 30, 2004, the aggregate amount of borrowings outstanding subject to these guarantees was $40.1 million and the scheduled repayment of these borrowings is $5.6 million in 2004, $10.7 million in 2005, 2006, and 2007 and $2.4 million in 2008. The individual investor (who through EBX Empreendimentos Ltda. (EBX), a Brazilian company, owns 51 percent of MPX) has also guaranteed these loans. In the event MPX defaults under its obligation, Centennial and the individual investor would be required to make payments under their guarantees, which are joint and several obligations. Centennial and the individual investor have entered into reimbursement agreements under which they have agreed to reimburse each other to the extent they may be required to make any guarantee payments in excess of their proportionate ownership share in MPX. These guarantees are not reflected on the Consolidated Balance Sheets. In addition, WBI Holdings has guaranteed certain of its subsidiary's natural gas and oil price swap and collar agreement obligations. The amount of the subsidiary's obligation at June 30, 2004, was $4.0 million. There is no fixed maximum amount guaranteed in relation to the natural gas and oil price swap and collar agreements, as the amount of the obligation is dependent upon natural gas and oil commodity prices. The amount of hedging activity entered into by the subsidiary is limited by corporate policy. The guarantees of the natural gas and oil price swap and collar agreements at June 30, 2004, expire in 2004 and 2005; however, the subsidiary continues to enter into additional hedging activities and, as a result, WBI Holdings from time to time may issue additional guarantees on these hedging obligations. At June 30, 2004, the amount outstanding was reflected on the Consolidated Balance Sheets. In the event the above subsidiary defaults under its obligations, WBI Holdings would be required to make payments under its guarantees. Certain subsidiaries of the Company have outstanding guarantees to third parties that guarantee the performance of other subsidiaries of the Company. These guarantees are related to natural gas transportation and sales agreements, electric power supply agreements, insurance policies and certain other guarantees. At June 30, 2004, the fixed maximum amounts guaranteed under these agreements aggregated $74.8 million. The amounts of scheduled expiration of the maximum amounts guaranteed under these agreements aggregate $9.6 million in 2004; $31.3 million in 2005; $3.9 million in 2006; $549,000 in 2007; $911,000 in 2009; $13.0 million in 2010; $12.0 million in 2012; $500,000, which is subject to expiration 30 days after the receipt of written notice; and $3.0 million, which has no scheduled maturity date. The amount outstanding by subsidiaries of the Company under the above guarantees was $349,000 and was reflected on the Consolidated Balance Sheets at June 30, 2004. In the event of default under these guarantee obligations, the subsidiary issuing the guarantee for that particular obligation would be required to make payments under its guarantee. Fidelity and WBI Holdings have outstanding guarantees to Williston Basin. These guarantees are related to natural gas transportation and storage agreements that guarantee the performance of Prairielands Energy Marketing, Inc. (Prairielands), an indirect wholly owned subsidiary of the Company. At June 30, 2004, the fixed maximum amounts guaranteed under these agreements aggregated $22.9 million. Scheduled expiration of the maximum amounts guaranteed under these agreements aggregate $2.9 million in 2005 and $20.0 million in 2009. In the event of Prairielands' default in its payment obligations, the entity issuing the guarantee for that particular obligation would be required to make payments under its guarantee. The amount outstanding by Prairielands under the above guarantees was $1.2 million, which was not reflected on the Consolidated Balance Sheets at June 30, 2004, because these intercompany transactions are eliminated in consolidation. In addition, Centennial has issued guarantees to third parties related to the Company's routine purchase of maintenance items for which no fixed maximum amounts have been specified. These guarantees have no scheduled maturity date. In the event a subsidiary of the Company defaults under its obligation in relation to the purchase of certain maintenance items, Centennial would be required to make payments under these guarantees. Any amounts outstanding by subsidiaries of the Company for these maintenance items were reflected on the Consolidated Balance Sheets at June 30, 2004. As of June 30, 2004, Centennial was contingently liable for performance of certain of its subsidiaries under approximately $290 million of surety bonds. These bonds are principally for construction contracts and reclamation obligations of these subsidiaries entered into in the normal course of business. Centennial indemnifies the respective surety bond companies against any exposure under the bonds. The purpose of Centennial's indemnification is to allow the subsidiaries to obtain bonding at competitive rates. In the event a subsidiary of the Company does not fulfill its obligations in relation to its bonded contract or obligation, Centennial may be required to make payments under its indemnification. A large portion of these contingent commitments is expected to expire within the next 12 months; however, Centennial will likely continue to enter into surety bonds for its subsidiaries in the future. The surety bonds were not reflected on the Consolidated Balance Sheets. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview This subsection of Item 2 -- Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion and Analysis) is a brief overview of the important factors that management focuses on in evaluating the Company's businesses, the Company's financial condition and operating performance, the Company's overall business strategy and the earnings of the Company for the period covered by this report. This subsection is not intended to be a substitute for reading the entire Management's Discussion and Analysis section. Reference is made to the various important factors listed under the heading Risk Factors and Cautionary Statements that May Affect Future Results, as well as other factors that are listed in the Introduction in relation to any forward-looking statement. Business and Strategy Overview The Company has six reportable segments consisting of electric, natural gas distribution, utility services, pipeline and energy services, natural gas and oil production, and construction materials and mining. The independent power production and other operations do not individually meet the criteria to be considered a reportable segment. The electric segment includes the electric generation, transmission and distribution operations of Montana-Dakota. The natural gas distribution segment includes the natural gas distribution operations of Montana-Dakota and Great Plains Natural Gas Co. The electric and natural gas distribution segments also supply related value-added products and services in the northern Great Plains. The utility services segment includes all the operations of Utility Services, Inc., which specializes in electrical line construction, pipeline construction, inside electrical wiring and cabling and the manufacture and distribution of specialty equipment. The pipeline and energy services segment includes WBI Holdings' natural gas transportation, underground storage and gathering services through regulated and nonregulated pipeline systems primarily in the Rocky Mountain and northern Great Plains regions of the United States. The pipeline and energy services segment also provides energy- related management services, including cable and pipeline magnetization and locating. The natural gas and oil production segment includes the natural gas and oil acquisition, exploration, development and production operations, primarily in the Rocky Mountain region of the United States and in and around the Gulf of Mexico, of WBI Holdings. The construction materials and mining segment includes the results of Knife River, which mines aggregates and markets crushed stone, sand, gravel and related construction materials, including ready-mixed concrete, cement, asphalt and other value-added products, as well as performs integrated construction services, in the central and western United States and in the states of Alaska and Hawaii. The independent power production and other operations own electric generating facilities in the United States and have investments in electric generating facilities in Brazil and Trinidad and Tobago. Electric capacity and energy produced at the power plants are sold primarily under long-term contracts to nonaffiliated entities. Centennial Resources also provides analysis, design, construction, refurbishment, and operation and maintenance services to independent power producers. These operations also include investments not directly being pursued by the Company's other businesses. Earnings from electric, natural gas distribution, and pipeline and energy services are substantially all from regulated operations. Earnings from utility services, natural gas and oil production, construction materials and mining, and independent power production and other are all from nonregulated operations. On August 14, 2003, the Company's Board of Directors approved a three-for-two common stock split. For more information on the common stock split, see Note 3 of Notes to Consolidated Financial Statements. The Company's strategy is to apply its expertise in energy and transportation infrastructure industries to increase market share through internal growth along with acquisition of well-managed companies and development of projects that enhance shareholder value and are accretive to earnings per share and returns on invested capital. The Company has capabilities to fund its growth and operations through various sources, including internally generated funds, commercial paper credit facilities and through the issuance of long- term debt and the Company's equity securities. Net capital expenditures are estimated to be approximately $450 million for 2004. The Company faces certain challenges and risks as it pursues its growth strategies, including, but not limited to the following: - The natural gas and oil production business experiences fluctuations in average natural gas and oil prices. These prices are volatile and subject to significant change at any time. The Company hedges a portion of its natural gas and oil production in order to mitigate price volatility. - The uncertain economic environment and the depressed telecommunications market have been challenging, particularly for the Company's utility services business, which has been subjected to lower margins and decreased workloads. These economic factors have also negatively affected the Company's energy services business. - Fidelity continues to seek additional reserve and production growth through acquisition, exploration, development and production of natural gas and oil resources, including the development and production of its coalbed natural gas properties. Future growth is dependent upon success in these endeavors. Fidelity has been named as a defendant in, and/or certain of its operations are the subject of, over a dozen lawsuits filed in connection with its coalbed natural gas development in the Powder River Basin in Montana and Wyoming. If the plaintiffs are successful in these lawsuits, the ultimate outcome of the actions could have a material effect on Fidelity's existing coalbed natural gas operations and/or the future development of its coalbed natural gas properties. For further information on certain factors that should be considered for a better understanding of the Company's financial condition, see the various important factors listed under the heading Risk Factors and Cautionary Statements that May Affect Future Results, as well as other factors that are listed in the Introduction. For information pertinent to various commitments and contingencies, see Notes to Consolidated Financial Statements. Earnings Overview The following table (dollars in millions, where applicable) summarizes the contribution to consolidated earnings by each of the Company's businesses. Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Electric $ .7 $ 1.8 $ 4.2 $ 6.6 Natural gas distribution (1.1) (1.3) 1.2 2.9 Utility services (2.3) 1.5 (4.2) 2.6 Pipeline and energy services 4.4 5.1 7.1 9.4 Natural gas and oil production 26.2 17.9 51.4 29.5 Construction materials and mining 20.4 12.8 8.5 5.4 Independent power production and other 10.2 5.5 13.7 6.8 Earnings on common stock $58.5 $ 43.3 $ 81.9 $63.2 Earnings per common share - basic $ .50 $ .39 $ .71 $ .57 Earnings per common share - diluted $ .50 $ .39 $ .70 $ .57 Return on average common equity for the 12 months ended 13.3% 13.0% ________________________________ Three Months Ended June 30, 2004 and 2003 Consolidated earnings for the quarter ended June 30, 2004, increased $15.2 million from the comparable prior period due to higher earnings at the natural gas and oil production, construction materials and mining, independent power production and other, and natural gas distribution businesses. Decreased earnings at the utility services, electric and pipeline and energy services businesses partially offset the earnings increase. In 2004, the Company resolved federal and related state income tax matters for the 1998 through 2000 tax years. The Company reflected the effects of this tax resolution and, in addition, reversed reserves that had previously been provided and were deemed to be no longer required, which resulted in a benefit of $5.9 million (after-tax), including interest, for the three months ended June 30, 2004. Natural gas and oil production earnings increased $8.3 million due to higher average realized natural gas and oil prices, increased natural gas production and a favorable resolution of federal and related state income tax matters, partially offset by higher depreciation, depletion and amortization expense and higher operating expenses. The increase in construction materials and mining earnings of $7.6 million, which was largely from existing operations, reflects higher aggregate, asphalt and ready-mixed concrete volumes and margins, and increased construction activity. A favorable resolution of federal and related state income tax matters and earnings from companies acquired since the comparable prior period also added to the earnings increase. Earnings increased $4.7 million at the independent power production and other businesses due to the increased value of the embedded derivative in the Brazilian electric power purchase agreement, lower financing costs, and acquisitions made since the comparable prior period, partially offset by foreign currency changes. The natural gas distribution business experienced a slightly lower normal seasonal loss of $200,000 as a result of a favorable resolution of federal and related state income tax matters and higher retail sales prices, partially offset by higher operation and maintenance expenses. Utility services experienced a $2.3 million loss compared to $1.5 million of earnings for the comparable prior period due primarily to decreased inside electrical margins, largely due to lower than expected results on certain large jobs that are nearly complete. Electric earnings decreased $1.1 million as a result of lower retail sales margins and higher operation and maintenance expense, partially offset by a favorable resolution of federal and related state income tax matters and higher sales for resale volumes. Earnings decreased $700,000 at the pipeline and energy services business due to higher operating expenses, lower storage revenues and lower revenues from traditional off- system transportation services. Partially offsetting the decrease in earnings were a favorable resolution of federal and related state income tax matters and an increase in natural gas transportation volumes and firm services as a result of the Grasslands Pipeline. Six Months Ended June 30, 2004 and 2003 Consolidated earnings for the six months ended June 30, 2004, increased $18.7 million from the comparable prior period due to higher earnings at the natural gas and oil production, independent power production and other, and construction materials and mining businesses. Decreased earnings at the utility services, electric, pipeline and energy services, and natural gas distribution businesses partially offset the earnings increase. In 2004, the Company resolved federal and related state income tax matters for the 1998 through 2000 tax years. The Company reflected the effects of this tax resolution and, in addition, reversed reserves that had previously been provided and were deemed to be no longer required, which resulted in a benefit of $5.9 million (after-tax), including interest, for the six months ended June 30, 2004. Natural gas and oil production earnings increased $21.9 million due to higher average realized natural gas and oil prices and the absence in 2004 of a $12.7 million ($7.7 million after tax) noncash transition charge in 2003, reflecting the cumulative effect of an accounting change, as discussed in Note 14 of Notes to Consolidated Financial Statements. Higher natural gas production and a favorable resolution of federal and related state income tax matters also contributed to the increase in earnings. Higher depreciation, depletion and amortization expense; higher operation and maintenance expense, largely increased general and administrative costs; and higher interest expense partially offset the earnings increase. Earnings increased $6.9 million at the independent power production and other businesses due to the increased value of the embedded derivative in the Brazilian power purchase agreement and lower financing costs, partially offset by foreign currency changes. Earnings at the construction materials and mining business increased $3.1 million as a result of higher asphalt and ready-mixed concrete volumes and margins, increased construction activity and a favorable resolution of federal and related state income tax matters. Partially offsetting the earnings increase were higher operation and maintenance expense, including increased general and administrative expenses; and lower aggregate volumes at a large harbor- deepening project in southern California compared to the prior period, which project is now substantially complete. Utility services experienced a $4.2 million loss compared to $2.6 million of earnings for the comparable prior period due primarily to decreased inside electrical margins, largely due to lower than expected results on certain large jobs that are nearly complete. Electric earnings decreased $2.4 million as a result of higher operation and maintenance expense, higher fuel and purchased power-related costs and higher interest expense. A favorable resolution of federal and related state income tax matters and higher average sales for resale prices partially offset the decrease in earnings. Earnings decreased $2.3 million at the pipeline and energy services business due to higher operating expenses, lower storage revenues and lower revenues from traditional off- system transportation services. Partially offsetting the decrease in earnings were a favorable resolution of federal and related state income tax matters and an increase in natural gas transportation volumes and firm services as a result of the Grasslands Pipeline. Natural gas distribution earnings decreased $1.7 million due to higher operation and maintenance expense, lower retail sales volumes and decreased service and repair margins. A favorable resolution of federal and related state income tax matters and higher retail sales prices partially offset the decrease in earnings. Financial and operating data The following tables (dollars in millions, where applicable) are key financial and operating statistics for each of the Company's businesses. Electric Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues $ 39.8 $ 38.1 $ 86.8 $ 83.7 Operating expenses: Fuel and purchased power 16.4 13.3 33.1 28.7 Operation and maintenance 14.6 12.9 29.6 26.2 Depreciation, depletion and amortization 5.0 5.0 10.0 9.9 Taxes, other than income 2.0 1.8 4.2 3.9 38.0 33.0 76.9 68.7 Operating income $ 1.8 $ 5.1 $ 9.9 $ 15.0 Retail sales (million kWh) 505.3 529.8 1,126.5 1,129.9 Sales for resale (million kWh) 170.0 122.9 397.2 374.3 Average cost of fuel and purchased power per kWh $ .022 $ .020 $ .020 $ .018 Natural Gas Distribution Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues: Sales $ 46.5 $ 41.4 $ 173.5 $ 151.4 Transportation and other 1.0 1.0 2.3 2.0 47.5 42.4 175.8 153.4 Operating expenses: Purchased natural gas sold 35.4 30.4 141.0 118.5 Operation and maintenance 11.3 10.0 25.1 21.6 Depreciation, depletion and amortization 2.3 2.5 4.7 5.1 Taxes, other than income 1.4 1.3 2.9 2.7 50.4 44.2 173.7 147.9 Operating income (loss) $ (2.9)$ (1.8) $ 2.1 $ 5.5 Volumes (MMdk): Sales 5.4 5.3 21.7 22.8 Transportation 2.6 3.0 6.5 6.1 Total throughput 8.0 8.3 28.2 28.9 Degree days (% of normal)* 98% 91% 96% 100% Average cost of natural gas, including transportation thereon, per dk $ 6.58 $ 5.69 $ 6.49 $ 5.20 _____________________ * Degree days are a measure of the daily temperature-related demand for energy for heating. Utility Services Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues $ 97.2 $ 108.9 $ 197.5 $ 212.6 Operating expenses: Operation and maintenance 93.5 99.8 188.9 194.0 Depreciation, depletion and amortization 2.5 2.7 5.2 5.1 Taxes, other than income 3.7 3.3 8.5 7.7 99.7 105.8 202.6 206.8 Operating income (loss) $ (2.5)$ 3.1 $ (5.1) $ 5.8 Pipeline and Energy Services Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues: Pipeline $ 22.7 $ 25.1 $ 45.7 $ 50.5 Energy services 62.8 31.1 123.9 66.8 85.5 56.2 169.6 117.3 Operating expenses: Purchased natural gas sold 59.2 30.3 116.5 64.8 Operation and maintenance 12.5 11.4 25.9 23.7 Depreciation, depletion and amortization 4.7 3.7 9.2 7.4 Taxes, other than income 1.9 1.4 3.8 2.9 78.3 46.8 155.4 98.8 Operating income $ 7.2 $ 9.4 $ 14.2 $ 18.5 Transportation volumes (MMdk): Montana-Dakota 7.6 8.0 15.9 16.4 Other 20.4 18.1 34.5 30.6 28.0 26.1 50.4 47.0 Gathering volumes (MMdk) 19.8 18.6 39.3 37.5 Natural Gas and Oil Production Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues: Natural gas $ 68.5 $ 52.6 $ 134.9 $ 107.8 Oil 14.9 12.0 29.1 25.8 Other .8 .1 1.2 .1 84.2 64.7 165.2 133.7 Operating expenses: Purchased natural gas sold .7 --- 1.1 .1 Operation and maintenance: Lease operating costs 8.6 6.4 16.8 14.5 Gathering and transportation 2.7 3.7 5.2 7.0 Other 5.9 3.9 11.9 8.9 Depreciation, depletion and amortization 17.9 15.2 34.5 29.4 Taxes, other than income: Production and property taxes 5.7 5.0 10.4 10.6 Other .1 .2 .3 .3 41.6 34.4 80.2 70.8 Operating income $ 42.6 $ 30.3 $ 85.0 $ 62.9 Production: Natural gas (MMcf) 14,796 13,258 29,302 26,897 Oil (000's of barrels) 450 453 907 927 Average realized prices (including hedges): Natural gas (per Mcf) $ 4.63 $ 3.97 $ 4.60 $ 4.01 Oil (per barrel) $ 33.09 $ 26.52 $ 32.12 $ 27.79 Average realized prices (excluding hedges): Natural gas (per Mcf) $ 4.78 $ 4.31 $ 4.73 $ 4.50 Oil (per barrel) $ 35.75 $ 26.98 $ 34.03 $ 29.06 Production costs, including taxes, per net equivalent Mcf: Lease operating costs $ .49 $ .40 $ .48 $ .45 Gathering and transportation .15 .23 .15 .22 Production and property taxes .33 .32 .30 .32 $ .97 $ .95 $ .93 $ .99 Construction Materials and Mining Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues $ 347.2 $ 264.1 $ 486.7 $ 384.9 Operating expenses: Operation and maintenance 286.6 219.2 419.7 330.7 Depreciation, depletion and amortization 17.0 15.6 33.2 30.2 Taxes, other than income 9.6 6.4 16.1 11.0 313.2 241.2 469.0 371.9 Operating income $ 34.0 $ 22.9 $ 17.7 $ 13.0 Sales (000's): Aggregates (tons) 11,187 9,592 15,994 14,619 Asphalt (tons) 2,346 1,701 2,648 1,863 Ready-mixed concrete (cubic yards) 1,239 912 1,813 1,427 Independent Power Production and Other Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues $ 11.6 $ 11.0 $ 18.9 $ 18.1 Operating expenses: Operation and maintenance 3.6 3.1 8.3 7.3 Depreciation, depletion and amortization 2.4 2.2 4.5 3.9 Taxes, other than income 1.1 --- 1.1 --- 7.1 5.3 13.9 11.2 Operating income $ 4.5 $ 5.7 $ 5.0 $ 6.9 Net generation capacity - kW* 279,600 279,600 279,600 279,600 Electricity produced and sold (thousand kWh)* 84,148 89,694 115,503 138,594 _____________________ * Reflects domestic independent power production operations. NOTE: The earnings from the Company's equity method investments in Brazil and Trinidad and Tobago were included in other income - net and, thus, are not reflected in the above table. Amounts presented in the preceding tables for operating revenues, purchased natural gas sold and operation and maintenance expense will not agree with the Consolidated Statements of Income due to the elimination of intersegment transactions. The amounts (dollars in millions) relating to the elimination of intersegment transactions were as follows: Three Months Six Months Ended Ended June 30, June 30, 2004 2003 2004 2003 Operating revenues $ 59.7 $ 37.2 $ 131.7 $ 87.7 Purchased natural gas sold 55.8 33.1 124.3 79.7 Operation and maintenance 3.9 4.1 7.4 8.0 For further information on intersegment eliminations, see Note 15 of Notes to Consolidated Financial Statements. Three Months Ended June 30, 2004 and 2003 Electric Electric earnings decreased $1.1 million as a result of lower retail sales margins, largely due to higher fuel and purchased power- related costs, including higher demand charges resulting from a scheduled outage at an electric supplier's generating station; and a 5 percent decrease in retail sales volumes. Higher operation and maintenance expense, including increased payroll-related costs and company-owned generation facility subcontract expenses, along with increased interest expense, also contributed to the earnings decrease. Partially offsetting the decrease in earnings were a favorable resolution of federal and related state income tax matters and higher sales for resale volumes of 38 percent due to stronger sales for resale markets. Natural Gas Distribution Normal seasonal losses at the natural gas distribution business decreased $200,000 due to a favorable resolution of federal and related state income tax matters and higher retail sales prices primarily due to a rate increase effective in South Dakota, partially offset by higher operation and maintenance expense, including increased payroll-related costs and higher subcontract costs. Utility Services Utility services experienced a $2.3 million loss for the second quarter, compared to $1.5 million in earnings for the comparable prior period. The decrease in earnings was due to lower inside electrical margins, largely due to lower than expected results on certain large jobs that are nearly complete, and higher general and administrative expenses. Increased line construction margins in the Southwest, Central and Rocky Mountain regions partially offset the earnings decrease. Pipeline and Energy Services Earnings at the pipeline and energy services business decreased $700,000 as a result of higher operating expenses, which were partially the result of increased costs associated with last year's expansion of pipeline and gathering operations and higher payroll- related costs. Lower storage service revenues and lower revenues from traditional off-system transportation services also contributed to the earnings decrease. Partially offsetting the decrease in earnings were a favorable resolution of federal and related state income tax matters and an increase in natural gas transportation volumes and firm services as a result of the Grasslands Pipeline, which began providing natural gas transmission service late in 2003. The increase in energy services revenues and the related increase in purchased natural gas sold includes the effect of increases in natural gas prices and volumes since the comparable prior period. Natural Gas and Oil Production Natural gas and oil production earnings increased $8.3 million due to higher average realized natural gas prices of 17 percent due in part to the Company's ability to access higher-priced markets for much of its operated natural gas production through the Grasslands Pipeline, completed late last year; increased natural gas production of 12 percent; and higher average realized oil prices of 25 percent. A favorable resolution of federal and related state income tax matters also contributed to the increase in earnings. Partially offsetting the earnings increase were higher depreciation, depletion and amortization expense due to higher rates and higher natural gas production volumes; higher operation and maintenance expense, primarily higher lease operating expenses and increased general and administrative costs; and higher interest expense. Construction Materials and Mining The increase in construction materials and mining earnings of $7.6 million, which was largely from existing operations, reflects increased aggregate, asphalt and ready-mixed concrete volumes and margins, and increased construction activity. A favorable resolution of federal and related state income tax matters and earnings from companies acquired since the comparable prior period also added to the earnings increase. Partially offsetting the earnings increase were lower aggregate volumes at a large harbor- deepening project in southern California compared to the prior period, which project is now substantially complete and higher operation and maintenance expense, including higher general and administrative expenses. Independent Power Production and Other Earnings for the independent power production and other businesses increased $4.7 million largely due to higher net income of $5.5 million from the Company's share of its equity investment in Brazil. The higher net income was due primarily to the increased value of the embedded derivative in the electric power purchase agreement combined with lower financing costs, largely the result of obtaining low-cost, long-term financing for the operation in mid-2003, partially offset by foreign currency changes. Domestic and international acquisitions made since the comparable prior period also added to the increase in earnings. Lower revenues from existing domestic operations, due in part to lower sales volumes, partially offset the earnings increase. Six Months Ended June 30, 2004 and 2003 Electric Electric earnings decreased $2.4 million as a result of higher operation and maintenance expense, including increased payroll- related costs, pension expense and company-owned generation facility subcontract expenses; higher fuel and purchased power-related costs, as previously discussed; and higher interest expense. Partially offsetting the decrease in earnings were a favorable resolution of federal and related state income tax matters and higher average sales for resale prices of 26 percent. Natural Gas Distribution Earnings at the natural gas distribution business decreased $1.7 million due to higher operation and maintenance expense, including increased payroll-related costs, pension expense and subcontract costs; a 5 percent decrease in retail sales volumes due to weather that was 3 percent warmer than last year; and decreased service and repair margins. Partially offsetting the earnings decrease were a favorable resolution of federal and related state income tax matters and higher retail sales prices, primarily due to a rate increase effective in South Dakota. Utility Services Utility services experienced a $4.2 million loss for the first six months of 2004, compared to $2.6 million in earnings for the comparable prior period. The decrease in earnings was due to lower inside electrical margins, largely due to lower than expected results on certain large jobs that are nearly complete; decreased line construction margins in the Central and Rocky Mountain regions; and higher general and administrative expenses. Increased line construction margins in the Southwest and Northwest regions partially offset the earnings decrease. Pipeline and Energy Services Earnings at the pipeline and energy services business decreased $2.3 million as a result of higher operating expenses, which were partially the result of increased costs associated with last year's expansion of pipeline and gathering operations and higher payroll- related costs. Also contributing to the earnings decrease were lower storage service revenues and lower revenues from traditional off-system transportation services. Partially offsetting the decrease in earnings were a favorable resolution of federal and related state income tax matters and an increase in natural gas transportation volumes and firm services as a result of the Grasslands Pipeline, which began providing natural gas transmission service late in 2003. The increase in energy services revenues and the related increase in purchased natural gas sold includes the effect of increases in natural gas prices and volumes compared to the prior period. Natural Gas and Oil Production Natural gas and oil production earnings increased $21.9 million due to higher average realized natural gas prices of 15 percent due in part to the Company's ability to access higher-priced markets for much of its operated natural gas production through the recently constructed Grasslands Pipeline and the absence in 2004 of a 2003 noncash transition charge, as previously discussed. Higher natural gas production of 9 percent, higher average realized oil prices of 16 percent and a favorable resolution of federal and related state income tax matters also contributed to the increase in earnings. Partially offsetting the earnings increase were higher depreciation, depletion and amortization expense due to higher rates and higher natural gas production volumes; higher operation and maintenance expense, largely increased general and administrative costs; and higher interest expense. Construction Materials and Mining The increase in construction materials and mining earnings of $3.1 million reflects higher asphalt and ready-mixed concrete volumes and margins and increased construction activity, all at existing operations. A favorable resolution of federal and related state income tax matters also added to the earnings increase. Partially offsetting the increase in earnings were higher operation and maintenance expense, including increased general and administrative expenses; and lower aggregate volumes at a large harbor-deepening project in southern California from the prior period, which project is now substantially complete. The increase in revenues and the related increase in operating expense resulted largely from businesses acquired since the comparable prior period. Independent Power Production and Other Earnings for the independent power production and other businesses increased $6.9 million largely due to higher net income of $8.2 million from the Company's share of its equity investment in Brazil. The higher net income was due primarily to the increased value of the embedded derivative in the power purchase agreement combined with lower financing costs, largely the result of obtaining low- cost, long-term financing for the operation in mid-2003, partially offset by foreign currency changes. Domestic and international acquisitions made since the comparable prior period also added to the increase in earnings. Lower revenues from existing domestic operations, due in part to lower sales volumes, partially offset the earnings increase. Risk Factors and Cautionary Statements that May Affect Future Results The Company is including the following factors and cautionary statements in this Form 10-Q to make applicable and to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and underlying assumptions (many of which are based, in turn, upon further assumptions) and other statements that are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature, including statements contained within Prospective Information. All these subsequent forward-looking statements, whether written or oral and whether made by or on behalf of the Company, are also expressly qualified by these factors and cautionary statements. Forward-looking statements involve risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed. The Company's expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including without limitation, management's examination of historical operating trends, data contained in the Company's records and other data available from third parties. Nonetheless, the Company's expectations, beliefs or projections may not be achieved or accomplished. Any forward-looking statement contained in this document speaks only as of the date on which the statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances that occur after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all of the factors, nor can it assess the effect of each factor on the Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Following are some specific factors that should be considered for a better understanding of the Company's financial condition. These factors and the other matters discussed herein are important factors that could cause actual results or outcomes for the Company to differ materially from those discussed in the forward-looking statements included elsewhere in this document. Economic Risks The Company's natural gas and oil production business is dependent on factors, including commodity prices, which cannot be predicted or controlled. These factors include: price fluctuations in natural gas and crude oil prices; availability of economic supplies of natural gas; drilling successes in natural gas and oil operations; the ability to contract for or to secure necessary drilling rig contracts and to retain employees to drill for and develop reserves; the ability to acquire natural gas and oil properties; the timely receipt of necessary permits and approvals; and other risks incidental to the operations of natural gas and oil wells. Significant changes in these factors could negatively affect the results of operations and financial condition of the Company's natural gas and oil production business. The construction and operation of power generation facilities may involve unanticipated changes or delays which could negatively impact the Company's business and its results of operations. The construction and operation of power generation facilities involves many risks, including start-up risks, breakdown or failure of equipment, competition, inability to obtain required governmental permits and approvals, and inability to negotiate acceptable acquisition, construction, fuel supply, off-take, transmission or other material agreements, as well as the risk of performance below expected levels of output or efficiency. Such unanticipated events could negatively impact the Company's business and its results of operations. The uncertain economic environment and depressed telecommunications market may have a general negative impact on the Company's future revenues and may result in a goodwill impairment for Innovatum, Inc. (Innovatum), an indirect wholly owned subsidiary of the Company. In response to the ongoing war against terrorism by the United States and the bankruptcy of several large energy and telecommunications companies and other large enterprises, the financial markets have been volatile. A soft economy could negatively affect the level of public and private expenditures on projects and the timing of these projects which, in turn, would negatively affect the demand for the Company's products and services. Innovatum, which specializes in cable and pipeline magnetization and locating, is subject to the economic conditions within the telecommunications and energy industries. Innovatum has also developed a hand-held locating device that can detect both magnetic and plastic materials. Innovatum could face a future goodwill impairment if there is a continued downturn in the telecommunications and energy industries or if it cannot find a successful market for the hand-held locating device. At June 30, 2004, the goodwill amount at Innovatum was approximately $8.3 million. The determination of whether an impairment will occur is dependent on a number of factors, including the level of spending in the telecommunications and energy industries, the success of the hand-held locating device at Innovatum, rapid changes in technology, competitors and potential new customers. The Company relies on financing sources and capital markets. If the Company is unable to obtain financing in the future, the Company's ability to execute its business plans, make capital expenditures or pursue acquisitions that the Company may otherwise rely on for future growth could be impaired. The Company relies on access to both short-term borrowings, including the issuance of commercial paper, and long-term capital markets as a source of liquidity for capital requirements not satisfied by its cash flow from operations. If the Company is not able to access capital at competitive rates, the ability to implement its business plans may be adversely affected. Market disruptions or a downgrade of the Company's credit ratings may increase the cost of borrowing or adversely affect its ability to access one or more financial markets. Such disruptions could include: - A severe prolonged economic downturn - The bankruptcy of unrelated industry leaders in the same line of business - Capital market conditions generally - Volatility in commodity prices - Terrorist attacks - Global events Environmental and Regulatory Risks Some of the Company's operations are subject to extensive environmental laws and regulations that may increase costs of operations, impact or limit business plans, or expose the Company to environmental liabilities. One of the Company's subsidiaries is subject to litigation in connection with its coalbed natural gas development activities. The Company is subject to extensive environmental laws and regulations affecting many aspects of its present and future operations including air quality, water quality, waste management and other environmental considerations. These laws and regulations can result in increased capital, operating and other costs, and delays as a result of compliance, remediation, containment and monitoring obligations, particularly with regard to laws relating to power plant emissions and coalbed natural gas development. These laws and regulations generally require the Company to obtain and comply with a wide variety of environmental licenses, permits, inspections and other approvals. Public officials and entities, as well as private individuals and organizations, may seek to enforce applicable environmental laws and regulations. The Company cannot predict the outcome (financial or operational) of any related litigation that may arise. Existing environmental regulations may be revised and new regulations seeking to protect the environment may be adopted or become applicable to the Company. Revised or additional regulations, which result in increased compliance costs or additional operating restrictions, particularly if those costs are not fully recoverable from customers, could have a material effect on the Company's results of operations. Fidelity has been named as a defendant in, and/or certain of its operations are the subject of, over a dozen lawsuits filed in connection with its coalbed natural gas development in the Powder River Basin in Montana and Wyoming. If the plaintiffs are successful in these lawsuits, the ultimate outcome of the actions could have a material effect on Fidelity's existing coalbed natural gas operations and/or the future development of its coalbed natural gas properties. The Company is subject to extensive government regulations that may have a negative impact on its business and its results of operations. The Company is subject to regulation by federal, state and local regulatory agencies with respect to, among other things, allowed rates of return, financings, industry rate structures, and recovery of purchased power and purchased gas costs. These governmental regulations significantly influence the Company's operating environment and may affect its ability to recover costs from its customers. The Company is unable to predict the impact on operating results from the future regulatory activities of any of these agencies. Changes in regulations or the imposition of additional regulations could have an adverse impact on the Company's results of operations. Risks Relating to Foreign Operations The value of the Company's investments in foreign operations may diminish due to political, regulatory and economic conditions and changes in currency exchange rates in countries where the Company does business. The Company is subject to political, regulatory and economic conditions and changes in currency exchange rates in foreign countries where the Company does business. Significant changes in the political, regulatory or economic environment in these countries could negatively affect the value of the Company's investments located in these countries. Also, since the Company is unable to predict the fluctuations in the foreign currency exchange rates, these fluctuations may have an adverse impact on the Company's results of operations. The Company's 49 percent equity method investment in a 220-megawatt natural gas-fired electric generation project in Brazil includes a power purchase agreement that contains an embedded derivative. This embedded derivative derives its value from an annual adjustment factor that largely indexes the contract capacity payments to the U.S. dollar. In addition, from time to time, other derivative instruments may be utilized. The valuation of these financial instruments, including the embedded derivative, can involve judgments, uncertainties and the use of estimates. As a result, changes in the underlying assumptions could affect the reported fair value of these instruments. These instruments could recognize financial losses as a result of volatility in the underlying fair values, or if a counterparty fails to perform. Other Risks Competition is increasing in all of the Company's businesses. All of the Company's businesses are subject to increased competition. The independent power industry includes numerous strong and capable competitors, many of which have greater resources and more experience in the operation, acquisition and development of power generation facilities. Utility services' competition is based primarily on price and reputation for quality, safety and reliability. The construction materials products are marketed under highly competitive conditions and are subject to such competitive forces as price, service, delivery time and proximity to the customer. The electric utility and natural gas industries are also experiencing increased competitive pressures as a result of consumer demands, technological advances, deregulation, greater availability of natural gas-fired generation and other factors. Pipeline and energy services competes with several pipelines for access to natural gas supplies and gathering, transportation and storage business. The natural gas and oil production business is subject to competition in the acquisition and development of natural gas and oil properties as well as in the sale of its production output. The increase in competition could negatively affect the Company's results of operations and financial condition. Weather conditions can adversely affect the Company's operations and revenues. The Company's results of operations can be affected by changes in the weather. Weather conditions directly influence the demand for electricity and natural gas, affect the wind-powered operation at the independent power production business, affect the price of energy commodities, affect the ability to perform services at the utility services and construction materials and mining businesses and affect ongoing operation and maintenance and construction and drilling activities for the pipeline and energy services and natural gas and oil production businesses. In addition, severe weather can be destructive, causing outages and/or property damage, which could require additional costs to be incurred. As a result, adverse weather conditions could negatively affect the Company's results of operations and financial condition. Prospective Information The following information includes highlights of the key growth strategies, projections and certain assumptions for the Company and its subsidiaries over the next few years and other matters for each of the Company's businesses. Many of these highlighted points are forward-looking statements. There is no assurance that the Company's projections, including estimates for growth and increases in revenues and earnings, will in fact be achieved. Reference is made to assumptions contained in this section, as well as the various important factors listed under the heading Risk Factors and Cautionary Statements that May Affect Future Results, and other factors that are listed in the Introduction. Changes in such assumptions and factors could cause actual future results to differ materially from targeted growth, revenue and earnings projections. MDU Resources Group, Inc. - - Earnings per common share for 2004, diluted, are projected in the range of $1.75 to $1.90, an increase from prior guidance of $1.60 to $1.75. - - The Company expects the percentage of 2004 earnings per common share, diluted, by quarter to be in the following approximate ranges: - Third quarter - 35 percent to 40 percent - Fourth quarter - 23 percent to 28 percent - - The Company's long-term compound annual growth goals on earnings per share from operations are in the range of 6 percent to 9 percent. - - The Company will consider issuing equity from time to time to keep debt at the nonregulated businesses at no more than 40 percent of total capitalization. Electric - - Montana-Dakota has obtained and holds valid and existing franchises authorizing it to conduct its electric operations in all of the municipalities it serves where such franchises are required. As franchises expire, Montana-Dakota may face increasing competition in its service areas, particularly its service to smaller towns, from rural electric cooperatives. Montana-Dakota intends to protect its service area and seek renewal of all expiring franchises and will continue to take steps to effectively operate in an increasingly competitive environment. - - The expected return for this segment in 2004 is anticipated to be generally consistent with overall authorized levels. - - In mid-May, the Company submitted an air quality permit application to construct a 175-megawatt coal-fired plant at Gascoyne, North Dakota. The air permit application is now under review at the North Dakota Department of Health, and the Company is confident the new facility will provide it with the opportunity to replace capacity associated with expiring contracts and help it meet its growing needs into the future. As an alternative for the capacity needs, this segment is also involved in a coalition with four other utilities to study the feasibility of building a coal- based facility, possibly combined with a wind energy facility, at potential sites in North Dakota, South Dakota and Iowa. The costs of building and/or acquiring the additional generating capacity needed by the utility are expected to be recovered in rates. - - On January 9, 2004, Montana-Dakota entered into a firm capacity contract with a Midwest utility to purchase 5 megawatts of capacity during the period May 1, 2004 to October 31, 2004, 15 megawatts during the period May 1, 2005 to October 31, 2005 and 25 megawatts during the period May 1, 2006 to October 31, 2006. In addition, on January 9, 2004, Montana-Dakota entered into a firm power contract with the same Midwest utility to purchase 70 megawatts of power during the period November 1, 2006 to December 31, 2006, 80 megawatts during the period January 1, 2007 to December 31, 2007, 90 megawatts during the period January 1, 2008 to December 31, 2008 and 100 megawatts during the period January 1, 2009 to December 31, 2010. All capacity and power purchases from these contracts are contingent upon the parties securing transmission service for the delivery of capacity and power to Montana-Dakota's customer load. Transmission service has not yet been secured. On July 15, 2004, Montana-Dakota entered into a firm capacity contract to purchase 15 megawatts of capacity and associated energy for the summer of 2005 and 25 megawatts of capacity and associated energy for the summer of 2006 from a neighboring utility. Natural gas distribution - - Montana-Dakota and Great Plains have obtained and hold valid and existing franchises authorizing them to conduct their natural gas operations in all of the municipalities they serve where such franchises are required. As franchises expire, Montana-Dakota and Great Plains may face increasing competition in their service areas. Montana-Dakota and Great Plains intend to protect their service areas and seek renewal of all expiring franchises and will continue to take steps to effectively operate in an increasingly competitive environment. - - Annual natural gas throughput for 2004 is expected to be approximately 51 million decatherms. - - The Company expects to seek natural gas rate increases from time to time to offset higher expected operating costs. - - Montana-Dakota has filed applications with state regulatory authorities in three states (Montana, North Dakota and South Dakota) seeking increases in natural gas retail rates that are in the range of $1.3 million to $3.3 million annually or 1.8 percent to 2.8 percent above current rates. While Montana-Dakota believes that it should be authorized to increase retail rates in the amounts requested, there is no assurance that the increases ultimately allowed will be for the full amount requested in each jurisdiction. For further information on the natural gas rate increase applications, see Note 18 of Notes to Consolidated Financial Statements. Utility services - - Revenues for this segment are expected to be in the range of $400 million to $450 million in 2004. - - This segment anticipates margins for 2004 to be lower than 2003 levels. However, margins for the second half of 2004 should improve over those experienced in the first half of 2004. - - This segment's work backlog as of June 30, 2004, was approximately $217 million compared to $150 million at June 30, 2003. Pipeline and energy services - - In 2004, total natural gas throughput is expected to increase approximately 15 percent to 20 percent over 2003 levels largely due to the Grasslands Pipeline, which began providing natural gas transmission service on December 23, 2003. - - Firm capacity for the Grasslands Pipeline is currently 90 million cubic feet per day with expansion possible to 200 million cubic feet per day. - - Transportation rates are expected to decline in 2004 from 2003 levels due to the estimated effects of a FERC rate order received in July 2003 and order on rehearing received in May 2004. - - Innovatum could face a future goodwill impairment based on certain economic conditions, as previously discussed in Risk Factors and Cautionary Statements that May Affect Future Results. Innovatum recently developed a hand-held locating device that can detect both magnetic and plastic materials. One of the possible uses for this product would be in the detection of unexploded ordnance. Innovatum is in the preliminary stages of working with and demonstrating the device to a Department of Defense contractor and has met with individuals from the Department of Defense. Natural gas and oil production - - In 2004, the Company believes a combined production increase of approximately 10 percent over 2003 levels remains possible. A portion of this increase is predicated on the timely receipt of various regulatory approvals, which is affecting producers throughout the Rocky Mountain region. The Company is confident that it will receive such permits, but forecasting the timing of such receipt is difficult. Also affecting the forecasted production increase is the timely installation of infrastructure. Currently, this segment's gross operated natural gas production is approximately 140,000 Mcf to 150,000 Mcf per day. - - Natural gas production from operated properties was 73 percent of total natural gas production for the six months ended June 30, 2004. - - This segment expects to drill more than 400 wells in 2004. - - Natural gas prices in the Rocky Mountain region for August through December 2004, reflected in the Company's 2004 earnings guidance, are in the range of $4.50 to $5.00 per Mcf. The Company's estimates for natural gas prices on the NYMEX for August through December 2004, reflected in the Company's 2004 earnings guidance, are in the range of $5.50 to $6.00 per Mcf. During 2003, more than two-thirds of this segment's natural gas production was priced using Rocky Mountain or other non-NYMEX prices. - - NYMEX crude oil prices for July through December 2004, reflected in the Company's 2004 earnings guidance, are in the range of $33 to $37 per barrel. - - The Company has hedged a portion of its 2004 natural gas production. The Company has entered into agreements representing approximately 30 percent to 35 percent of 2004 estimated annual natural gas production. The agreements are at various indices and range from a low CIG index of $3.75 to a high NYMEX index of $6.11 per Mcf. CIG is an index pricing point related to Colorado Interstate Gas Co.'s system. - - This segment has hedged a portion of its 2004 oil production. The Company has entered into agreements at NYMEX prices with a low of $28.84 and a high of $30.28, representing approximately 25 percent to 30 percent of 2004 estimated annual oil production. - - The Company has hedged a portion of its 2005 estimated natural gas production. The Company has entered into agreements representing approximately 15 percent to 20 percent of its 2005 estimated annual natural gas production. The agreements are at a Ventura index with a low of $4.75 and a high of $5.87 per Mcf. Ventura is an index pricing point related to Northern Natural Gas Co.'s system. - - This segment has hedged a portion of its 2005 oil production. The Company has entered into agreements at NYMEX prices with a low of $30.70 and a high of $36.50 representing approximately 20 percent to 25 percent of its 2005 estimated annual oil production. Construction materials and mining - - Aggregate volumes in 2004 are expected to be comparable to 2003 levels. Ready-mixed concrete volumes are expected to increase by 18 percent to 23 percent, while asphalt volumes are expected to increase 10 percent to 15 percent over 2003. - - Revenues in 2004 are expected to increase by approximately 13 percent to 18 percent over 2003 levels. - - The Company is confident that the replacement funding legislation for the Transportation Equity Act for the 21st Century (TEA-21) will be equal to or higher than previous funding levels. - - As of mid-July, this segment had $545 million in work backlog compared to $497 million in mid-July of 2003. - - The four labor contracts that Knife River was negotiating, as reported in Items 1 and 2 -- Business and Properties - General in the Company's 2003 Form 10-K, have been ratified and signed. The Company considers its relations with its employees to be satisfactory. Independent power production and other - - Earnings projections for independent power production and other operations are expected to be in the range of $18 million to $23 million in 2004. - - The Company is constructing a 116-megawatt coal-fired electric generating project near Hardin, Montana. A power sales agreement with Powerex Corp., a subsidiary of BC Hydro, has been secured for the entire output of the plant for a three-year term with an option for a two-year extension. The projected on-line date for this plant is late 2005. - - On July 20, 2004, an indirect wholly owned subsidiary of the Company signed an agreement to acquire a 50 percent ownership interest in a 310-megawatt natural gas-fired electric generating facility in Georgia. The transaction is subject to receipt of certain third-party consents and approval from the FERC. The acquisition is anticipated to close in late third quarter or early fourth quarter 2004. New Accounting Standards In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46 (revised)), which replaced FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 (revised) shall be applied to all entities subject to FIN 46 (revised) no later than the end of the first reporting period that ends after March 15, 2004. The adoption of FIN 46 (revised) did not have an effect on the Company's financial position or results of operations. In January 2004, the FASB issued FASB Staff Position No. FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (FSP No. FAS 106-1). FSP No. FAS 106-1 permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (2003 Medicare Act). In May 2004, the FASB issued FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (FSP No. FAS 106-2). The Company provides prescription drug benefits to certain eligible employees. The Company elected the one-time deferral of accounting for the effects of the 2003 Medicare Act in the quarter ending March 31, 2004, the first period in which the plan's accounting for the effects of the 2003 Medicare Act normally would have been reflected in the Company's financial statements. During the second quarter of 2004, the Company adopted FSP No. FAS 106-2 retroactive to the beginning of the year. The Company and its actuarial advisors determined that benefits provided to certain participants are expected to be at least actuarially equivalent to Medicare Part D (the federal prescription drug benefit), and, accordingly, the Company expects to be entitled to some federal subsidy. The expected federal subsidy reduces the accumulated postretirement benefit obligation (APBO) at January 1, 2004, by approximately $3.2 million, and net periodic benefit cost for 2004 by approximately $285,000 (as compared with the amount calculated without considering the effects of the subsidy). In addition, the Company expects a reduction in future participation in the postretirement plans, which further reduced the APBO at January 1, 2004, by approximately $12.7 million and net periodic benefit cost for 2004 by approximately $1.3 million. SFAS No. 142, "Goodwill and Other Intangible Assets," discontinues the practice of amortizing goodwill and indefinite lived intangible assets and initiates an annual review for impairment. Intangible assets with a determinable useful life will continue to be amortized over that period. The amortization provisions apply to goodwill and intangible assets acquired after June 30, 2001. SFAS No. 141, "Business Combinations," and SFAS No. 142 clarify that more assets should be distinguished and classified between tangible and intangible. An issue has arisen within the natural gas and oil industry as to whether contractual mineral rights under SFAS No. 142 should be classified as intangible rather than as part of property, plant and equipment. The anticipated resolution of this matter is not expected to have an effect on the Company's financial position, results of operations or cash flows. In April 2004, the FASB issued FASB Staff Position Nos. FAS 141-1 and FAS 142-1, "Interaction of FASB Statements No. 141, 'Business Combinations,' and No. 142, 'Goodwill and Other Intangible Assets,' and EITF Issue No. 04-2, 'Whether Mineral Rights are Tangible or Intangible Assets,'" (FSP Nos. FAS 141-1 and FAS 142-1). FSP Nos. FAS 141-1 and FAS 142-1 shall be applied to the first reporting period beginning after April 29, 2004. FSP Nos. FAS 141-1 and FAS 142-1 required reclassification of the Company's leasehold rights at its construction materials and mining operations from other intangible assets, net to property, plant and equipment, as well as changes to Notes to Consolidated Financial Statements. FSP Nos. FAS 141-1 and FAS 142-1 affected the asset classification in the consolidated balance sheet and associated footnote disclosure only, so the reclassifications did not affect the Company's stockholders' equity, cash flows or results of operations. For further information on FIN 46 (revised), FSP Nos. FAS 106-1 and 106-2, SFAS Nos. 142 and 141, and FSP Nos. FAS 141-1 and FAS 142-1, see Note 9 of Notes to Consolidated Financial Statements. Critical Accounting Policies Involving Significant Estimates The Company's critical accounting policies involving significant estimates include impairment testing of long-lived assets and intangibles, impairment testing of natural gas and oil production properties, revenue recognition, purchase accounting, asset retirement obligations, and pension and other postretirement benefits. There were no material changes in the Company's critical accounting policies involving significant estimates from those reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. For more information on critical accounting policies involving significant estimates, see Part II, Item 7 in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Liquidity and Capital Commitments Cash flows Operating activities -- Cash flows provided by operating activities in the first six months of 2004 increased $8.4 million from the comparable 2003 period, the result of an increase in net income of $18.6 million and higher depreciation, depletion and amortization expense of $10.3 million, resulting largely from increased property, plant and equipment balances and higher mineral production rates and volumes. Partially offsetting the increase in cash flows from operating activities were an increase in earnings, net of distributions, from equity method investments of $9.5 million and the absence in 2004 of the 2003 cumulative effect of an accounting change of $7.6 million. Investing activities -- Cash flows used in investing activities in the first six months of 2004 decreased $74.3 million compared to the comparable 2003 period, the result of a decrease in net capital expenditures (capital expenditures; acquisitions, net of cash acquired; and net proceeds from the sale or disposition of property) of $85.2 million and an increase in proceeds from notes receivable of $14.2 million, offset in part by an increase in investments of $25.1 million. Net capital expenditures exclude the noncash transactions related to acquisitions, including the issuance of the Company's equity securities. The noncash transactions were $32.6 million and $4.9 million for the first six months of 2004 and 2003, respectively. Financing activities -- Cash flows provided by financing activities in the first six months of 2004 decreased $35.3 million compared to the comparable 2003 period, primarily the result of a decrease in the issuance of long- term debt of $159.0 million. A decrease in repayment of long-term debt of $58.0 million and an increase in the issuance of common stock of $54.7 million, primarily due to net proceeds received from an underwritten public offering, partially offset the decrease in cash provided by financing activities. Defined benefit pension plans The Company has qualified noncontributory defined benefit pension plans (Pension Plans) for certain employees. Plan assets consist of investments in equity and fixed income securities. Various actuarial assumptions are used in calculating the benefit expense (income) and liability (asset) related to the Pension Plans. Actuarial assumptions include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by the Company within certain guidelines. At December 31, 2003, certain Pension Plans' accumulated benefit obligations exceeded these plans' assets by approximately $4.3 million. Pretax pension expense (income) reflected in the years ended December 31, 2003, 2002 and 2001, was $153,000, ($2.4) million and ($4.4) million, respectively. The Company's pension expense is currently projected to be approximately $4.0 million to $5.0 million in 2004. A reduction in the Company's assumed discount rate for Pension Plans along with declines in the equity markets experienced in 2002 and 2001 have combined to largely produce the increase in these costs. Funding for the Pension Plans is actuarially determined. The minimum required contributions for 2003, 2002 and 2001 were approximately $1.6 million, $1.2 million and $442,000, respectively. For further information on the Company's Pension Plans, see Note 17 of Notes to Consolidated Financial Statements. Capital expenditures Net capital expenditures, including the issuance of the Company's equity securities in connection with acquisitions, for the first six months of 2004 were $186.5 million and are estimated to be approximately $450 million for the year 2004. Estimated capital expenditures include those for: - Completed acquisitions - System upgrades - Routine replacements - Service extensions - Routine equipment maintenance and replacements - Land and building improvements - Pipeline and gathering expansion projects - Further enhancement of natural gas and oil production and reserve growth - Power generation opportunities, including certain construction costs for a 116-megawatt coal-fired development project, as previously discussed - Other growth opportunities Approximately 15 percent of estimated 2004 net capital expenditures are for completed acquisitions. The Company continues to evaluate potential future acquisitions and other growth opportunities; however, they are dependent upon the availability of economic opportunities and, as a result, capital expenditures may vary significantly from the estimated 2004 capital expenditures referred to above. It is anticipated that all of the funds required for capital expenditures will be met from various sources. These sources include internally generated funds; commercial paper credit facilities at Centennial and MDU Resources Group, Inc., as described below; and through the issuance of long-term debt and the Company's equity securities. The estimated 2004 capital expenditures referred to above include completed 2004 acquisitions involving construction materials and mining businesses in Idaho, Iowa and Minnesota and an independent power production operating and development company in Colorado. Pro forma financial amounts reflecting the effects of the above acquisitions are not presented as such acquisitions were not material to the Company's financial position or results of operations. Capital resources Certain debt instruments of the Company and its subsidiaries, including those discussed below, contain restrictive covenants, all of which the Company and its subsidiaries were in compliance with at June 30, 2004. MDU Resources Group, Inc. The Company has a revolving credit agreement with various banks totaling $90 million at June 30, 2004. There were no amounts outstanding under the credit agreement at June 30, 2004. The credit agreement supports the Company's $75 million commercial paper program. There were no amounts outstanding under the Company's commercial paper program at June 30, 2004. The credit agreement expires on July 18, 2006. The Company's goal is to maintain acceptable credit ratings in order to access the capital markets through the issuance of commercial paper. If the Company were to experience a minor downgrade of its credit ratings, it would not anticipate any change in its ability to access the capital markets. However, in such event, the Company would expect a nominal basis point increase in overall interest rates with respect to its cost of borrowings. If the Company were to experience a significant downgrade of its credit ratings, which it does not currently anticipate, it may need to borrow under its credit agreement. To the extent the Company needs to borrow under its credit agreement, it would be expected to incur increased annualized interest expense on its variable rate debt. This was not applicable at June 30, 2004, as there were no variable rate borrowings at such time. Prior to the maturity of the credit agreement, the Company plans to negotiate the extension or replacement of this agreement that provides credit support to access the capital markets. In the event the Company is unable to successfully negotiate the credit agreement, or in the event the fees on this facility became too expensive, which it does not currently anticipate, the Company would seek alternative funding. One source of alternative funding might involve the securitization of certain Company assets. In order to borrow under the Company's credit agreement, the Company must be in compliance with the applicable covenants and certain other conditions. The significant covenants include maximum leverage ratios, minimum interest coverage ratio, limitation on sale of assets and limitation on investments. The Company was in compliance with these covenants and met the required conditions at June 30, 2004. In the event the Company does not comply with the applicable covenants and other conditions, alternative sources of funding may need to be pursued, as previously described. There are no credit facilities that contain cross-default provisions between the Company and any of its subsidiaries. The Company's issuance of first mortgage debt is subject to certain restrictions imposed under the terms and conditions of its Indenture of Mortgage. Generally, those restrictions require the Company to fund $1.43 of unfunded property or use $1.00 of refunded bonds for each dollar of indebtedness incurred under the Indenture and, in some cases, to certify to the trustee that annual earnings (pretax and before interest charges), as defined in the Indenture, equal at least two times its annualized first mortgage bond interest costs. Under the more restrictive of the tests, as of June 30, 2004, the Company could have issued approximately $318 million of additional first mortgage bonds. The Company's coverage of fixed charges including preferred dividends was 4.7 times for the twelve months ended June 30, 2004 and December 31, 2003. Additionally, the Company's first mortgage bond interest coverage was 6.8 times and 7.4 times for the twelve months ended June 30, 2004 and December 31, 2003, respectively. Common stockholders' equity as a percent of total capitalization (net of long-term debt and preferred stock due within one year) was 63 percent and 60 percent at June 30, 2004 and December 31, 2003, respectively. Centennial Energy Holdings, Inc. Centennial has three revolving credit agreements with various banks and institutions that support $300 million of Centennial's $350 million commercial paper program. There were no outstanding borrowings under the Centennial credit agreements at June 30, 2004. Under the Centennial commercial paper program, $85.5 million was outstanding at June 30, 2004. The Centennial commercial paper borrowings are classified as long-term debt as Centennial intends to refinance these borrowings on a long-term basis through continued Centennial commercial paper borrowings and as further supported by the Centennial credit agreements. One of these credit agreements is for $137.5 million and expires on September 3, 2004, and allows for subsequent borrowings up to a term of one year. Another credit agreement is for $137.5 million and expires on September 5, 2006. The other credit agreement is for $25 million and expires on April 30, 2007. Centennial intends to negotiate the extension or replacement of these agreements prior to their maturities. Centennial has an uncommitted long-term master shelf agreement that allows for borrowings of up to $400 million. Under the terms of the master shelf agreement, $384.0 million was outstanding at June 30, 2004. To meet potential future financing needs, Centennial may pursue other financing arrangements, including private and/or public financing. Centennial's goal is to maintain acceptable credit ratings in order to access the capital markets through the issuance of commercial paper. If Centennial were to experience a minor downgrade of its credit ratings, it would not anticipate any change in its ability to access the capital markets. However, in such event, Centennial would expect a nominal basis point increase in overall interest rates with respect to its cost of borrowings. If Centennial were to experience a significant downgrade of its credit ratings, which it does not currently anticipate, it may need to borrow under its committed bank lines. To the extent Centennial needs to borrow under its committed bank lines, it would be expected to incur increased annualized interest expense on its variable rate debt of approximately $128,000 (after tax) based on June 30, 2004, variable rate borrowings. Based on Centennial's overall interest rate exposure at June 30, 2004, this change would not have a material effect on the Company's results of operations or cash flows. Prior to the maturity of the Centennial credit agreements, Centennial plans to negotiate the extension or replacement of these agreements that provide credit support to access the capital markets. In the event Centennial was unable to successfully negotiate these agreements, or in the event the fees on such facilities became too expensive, which Centennial does not currently anticipate, it would seek alternative funding. One source of alternative funding might involve the securitization of certain Centennial assets. In order to borrow under Centennial's credit agreements and the Centennial uncommitted long-term master shelf agreement, Centennial and certain of its subsidiaries must be in compliance with the applicable covenants and certain other conditions. The significant covenants include maximum capitalization ratios, minimum interest coverage ratios, minimum consolidated net worth, limitation on priority debt, limitation on sale of assets and limitation on loans and investments. Centennial and such subsidiaries were in compliance with these covenants and met the required conditions at June 30, 2004. In the event Centennial or such subsidiaries do not comply with the applicable covenants and other conditions, alternative sources of funding may need to be pursued as previously described. Certain of Centennial's financing agreements contain cross- default provisions. These provisions state that if Centennial or any subsidiary of Centennial fails to make any payment with respect to any indebtedness or contingent obligation, in excess of a specified amount, under any agreement that causes such indebtedness to be due prior to its stated maturity or the contingent obligation to become payable, the applicable agreements will be in default. Certain of Centennial's financing agreements and Centennial's practice limit the amount of subsidiary indebtedness. Williston Basin Interstate Pipeline Company Williston Basin has an uncommitted long-term master shelf agreement that allows for borrowings of up to $100 million. Under the terms of the master shelf agreement, $55.0 million was outstanding at June 30, 2004. In order to borrow under Williston Basin's uncommitted long- term master shelf agreement, it must be in compliance with the applicable covenants and certain other conditions. The significant covenants include limitation on consolidated indebtedness, limitation on priority debt, limitation on sale of assets and limitation on investments. Williston Basin was in compliance with these covenants and met the required conditions at June 30, 2004. In the event Williston Basin does not comply with the applicable covenants and other conditions, alternative sources of funding may need to be pursued. Off balance sheet arrangements Centennial has unconditionally guaranteed a portion of certain bank borrowings of MPX in connection with the Company's equity method investment in the Brazil Generating Facility, as discussed in Note 11 of Notes to Consolidated Financial Statements. The Company, through MDU Brasil, owns 49 percent of MPX. The main business purpose of Centennial extending the guarantee to MPX's creditors is to enable MPX to obtain lower borrowing costs. At June 30, 2004, the aggregate amount of borrowings outstanding subject to these guarantees was $40.1 million and the scheduled repayment of these borrowings is $5.6 million in 2004, $10.7 million in 2005, 2006, and 2007 and $2.4 million in 2008. The individual investor (who through EBX, a Brazilian company, owns 51 percent of MPX) has also guaranteed these loans. In the event MPX defaults under its obligation, Centennial and the individual investor would be required to make payments under their guarantees, which are joint and several obligations. Centennial and the individual investor have entered into reimbursement agreements under which they have agreed to reimburse each other to the extent they may be required to make any guarantee payments in excess of their proportionate ownership share in MPX. These guarantees are not reflected on the Consolidated Balance Sheets. As of June 30, 2004, Centennial was contingently liable for performance of certain of its subsidiaries under approximately $290 million of surety bonds. These bonds are principally for construction contracts and reclamation obligations of these subsidiaries entered into in the normal course of business. Centennial indemnifies the respective surety bond companies against any exposure under the bonds. The purpose of Centennial's indemnification is to allow the subsidiaries to obtain bonding at competitive rates. In the event a subsidiary of the Company does not fulfill its obligations in relation to its bonded contract or obligation, Centennial may be required to make payments under its indemnification. A large portion of these contingent commitments is expected to expire within the next 12 months; however, Centennial will likely continue to enter into surety bonds for its subsidiaries in the future. The surety bonds were not reflected on the Consolidated Balance Sheets. Contractual obligations and commercial commitments There are no material changes in the Company's contractual obligations on long-term debt and operating leases from those reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. The Company's contractual obligations on purchase commitments at June 30, 2004, increased $117.6 million or 24 percent from December 31, 2003, primarily due to an increase in commitments for electric generation construction contracts. At June 30, 2004, the Company's contractual obligations on purchase commitments for the twelve months ended June 30, were as follows: 2005 2006 2007 2008 2009 Thereafter Total (In millions) Purchase commitments $257.8 $88.8 $55.0 $36.2 $32.6 $139.9 $610.3 For more information on contractual obligations and commercial commitments, see Part II, Item 7 in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to the impact of market fluctuations associated with commodity prices, interest rates and foreign currency. The Company has policies and procedures to assist in controlling these market risks and utilizes derivatives to manage a portion of its risk. Commodity price risk -- Fidelity utilizes natural gas and oil price swap and collar agreements to manage a portion of the market risk associated with fluctuations in the price of natural gas and oil on its forecasted sales of natural gas and oil production. For more information on commodity price risk, see Part II, Item 7A in the Company's Annual Report on Form 10-K for the year ended December 31, 2003, and Note 13 of Notes to Consolidated Financial Statements. The following table summarizes hedge agreements entered into by Fidelity as of June 30, 2004. These agreements call for Fidelity to receive fixed prices and pay variable prices. (Notional amount and fair value in thousands) Weighted Average Notional Fixed Price Amount (Per MMBtu) (In MMBtu's) Fair Value Natural gas swap agreements maturing in 2004 $ 5.14 5,520 $ (5,008) Natural gas swap agreements maturing in 2005 $ 5.32 7,300 $ (4,164) Weighted Average Floor/Ceiling Notional Price Amount (Per MMBtu) (In MMBtu's) Fair Value Natural gas collar agreements maturing in 2004 $4.62/$5.28 4,878 $ (4,040) Natural gas collar agreement maturing in 2005 $4.92/$5.66 5,475 $ (3,256) Weighted Average Notional Fixed Price Amount (Per barrel) (In barrels) Fair Value Oil swap agreements maturing in 2004 $ 29.59 276 $ (1,977) Oil swap agreement maturing in 2005 $ 30.70 183 $ (757) Weighted Average Floor/Ceiling Notional Price Amount (Per barrel) (In barrels) Fair Value Oil collar agreement maturing in 2005 $32.00/$36.50 164 $ (120) Interest rate risk -- There were no material changes to interest rate risk faced by the Company from those reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. For more information on interest rate risk, see Part II, Item 7A in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Foreign currency risk -- MDU Brasil has a 49 percent equity investment in a 220- megawatt natural gas-fired electric generating facility in Brazil, which has a portion of its borrowings and payables denominated in U.S. dollars. MDU Brasil has exposure to currency exchange risk as a result of fluctuations in currency exchange rates between the U.S. dollar and the Brazilian real. The functional currency for the Brazil Generating Facility is the Brazilian real. For further information on this investment, see Note 11 of Notes to Consolidated Financial Statements. MDU Brasil's equity income from this Brazilian investment is impacted by fluctuations in currency exchange rates on transactions denominated in a currency other than the Brazilian real, including the effects of changes in currency exchange rates with respect to the Brazil Generating Facility's U.S. dollar denominated obligations. At June 30, 2004, these U.S. dollar denominated obligations approximated $80.4 million. If, for example, the value of the Brazilian real decreased in relation to the U.S. dollar by 10 percent, MDU Brasil, with respect to its interest in the Brazil Generating Facility, would record a foreign currency loss in net income of approximately $3.6 million (after tax) based on the above U.S. dollar denominated obligations at June 30, 2004. The investment of Centennial International in the Brazil Generating Facility at June 30, 2004, was approximately $13.8 million. A portion of the Brazil Generating Facility's foreign currency exchange risk is being managed through contractual provisions, which are largely indexed to the U.S. dollar, contained in the Brazil Generating Facility's power purchase agreement with Petrobras. The Brazil Generating Facility has also historically used derivative instruments to manage a portion of its foreign currency risk and may utilize such instruments in the future. ITEM 4. CONTROLS AND PROCEDURES The following information includes the evaluation of disclosure controls and procedures by the Company's chief executive officer and the chief financial officer, along with any significant changes in internal controls of the Company. Evaluation of disclosure controls and procedures The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (Exchange Act). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. The Company's chief executive officer and chief financial officer have evaluated the effectiveness of the Company's disclosure controls and procedures and they have concluded that, as of the end of the period covered by this report, such controls and procedures were effective to accomplish those tasks. Changes in internal control over financial reporting The Company maintains a system of internal accounting controls designed to provide reasonable assurance that the Company's transactions are properly authorized, the Company's assets are safeguarded against unauthorized or improper use, and the Company's transactions are properly recorded and reported to permit preparation of the Company's financial statements in conformity with generally accepted accounting principles in the United States of America. There were no changes in the Company's internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On June 4, 2004, following preliminary discovery, Williston Basin and Montana-Dakota joined with other defendants and filed a Motion to Dismiss in the Grynberg case. For more information on the above legal action, see Note 19 of Notes to Consolidated Financial Statements, which is incorporated by reference. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Between April 1, 2004 and June 30, 2004, the Company issued 663,768 shares of Common Stock, $1.00 par value, and the Preference Share Purchase Rights appurtenant thereto, as part of the consideration paid by the Company for all of the issued and outstanding capital stock with respect to businesses acquired during this period. The Common Stock and Rights issued by the Company in these transactions were issued in a private transaction exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) thereof, Rule 506 promulgated thereunder, or both. The classes of persons to whom these securities were sold were either accredited investors or other persons to whom such securities were permitted to be offered under the applicable exemption. The following table includes information with respect to the Issuer's purchase of equity securities: (a) (b) (c) (d) Maximum Number (or Total Total Number of Approximate Dollar Number of Average Shares (or Units) Value) of Shares (or Shares Price Purchased as Part Units) that May Yet (or Units) Paid of Publicly Be Purchased Under Purchased per Share Announced Plans the Plans or Period (1) (or Unit) or Programs (2) Programs (2) January 1 to January 31, 2004 February 1 to February 29, 2004 29,662 $23.72 March 1 to March 31, 2004 1,863 $23.78 April 1 to April 30, 2004 May 1 to May 31, 2004 June 1 to June 30, 2004 12,333 $22.81 Total 43,858 (1) Represents shares of common stock withheld by the Company at the request of its executive officers and employees to pay taxes pursuant to officer and employee compensation plans. (2) Not applicable. The Company does not currently have in place any publicly announced plans or programs to purchase equity securities. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits 10(a) Change of Control Employment Agreement between the Company and Paul Gatzemeier 10(b) Change of Control Employment Agreement between the Company and Mary B. Hager 10(c) Change of Control Employment Agreement between the Company and Bruce T. Imsdahl 10(d) Change of Control Employment Agreement between the Company and Cindy C. Redding 10(e) Change of Control Employment Agreement between the Company and Paul K. Sandness 10(f) Change of Control Employment Agreement between the Company and Daryl A. Splichal 10(g) Change of Control Employment Agreement between the Company and Floyd E. Wilson 10(h) Non-Employee Director Stock Compensation Plan, as amended 12 Computation of Ratio of Earnings to Fixed Charges and Combined Fixed Charges and Preferred Stock Dividends 31(a) Certification of Chief Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31(b) Certification of Chief Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b) Reports on Form 8-K Form 8-K was filed on April 20, 2004. Under Item 12 -- Results of Operations and Financial Condition, the Company reported the press release issued April 20, 2004, regarding earnings for the quarter ended March 31, 2004. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MDU RESOURCES GROUP, INC. DATE: August 6, 2004 BY: /s/ Warren L. Robinson Warren L. Robinson Executive Vice President and Chief Financial Officer BY: /s/ Vernon A. Raile Vernon A. Raile Senior Vice President and Chief Accounting Officer EXHIBIT INDEX Exhibit No. 10(a) Change of Control Employment Agreement between the Company and Paul Gatzemeier 10(b) Change of Control Employment Agreement between the Company and Mary B. Hager 10(c) Change of Control Employment Agreement between the Company and Bruce T. Imsdahl 10(d) Change of Control Employment Agreement between the Company and Cindy C. Redding 10(e) Change of Control Employment Agreement between the Company and Paul K. Sandness 10(f) Change of Control Employment Agreement between the Company and Daryl A. Splichal 10(g) Change of Control Employment Agreement between the Company and Floyd E. Wilson 10(h) Non-Employee Director Stock Compensation Plan, as amended 12 Computation of Ratio of Earnings to Fixed Charges and Combined Fixed Charges and Preferred Stock Dividends 31(a) Certification of Chief Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31(b) Certification of Chief Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002