SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001. 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 No. 0-30321 QUESTAR MARKET RESOURCES, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) STATE OF UTAH 87-0287750 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) P.O. Box 45601, 180 East 100 South, Salt Lake City, Utah 84145-0601 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (801) 324-2600 --------------- 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of October 31, 2001 - ----------------------------- ---------------------------------- Common Stock, $1.00 par value 4,309,427 shares Registrant meets the conditions set forth in General Instruction H(a)(1) and (b) of Form 10-Q and is filing this Form 10-Q with the reduced disclosure format. PART I FINANCIAL INFORMATION Item 1. Financial Statements QUESTAR MARKET RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) See notes to consolidated financial statements 2
3 Months Ended 9 Months Ended September 30, September 30, 2001 2000 2001 2000 --------- --------- --------- --------- (In Thousands) REVENUES $ 153,339 $ 187,403 $ 588,927 $ 494,365 OPERATING EXPENSES Cost of natural gas and other products sold 48,976 90,923 268,765 234,606 Operating and maintenance 28,756 25,240 77,890 72,705 Exploration expense 2,606 1,621 8,101 8,228 Depreciation, depletion and amortization 21,952 21,187 64,267 64,008 Other taxes 8,006 9,764 36,993 25,122 Wexpro settlement agreement - oil income sharing 578 1,265 2,603 3,458 --------- --------- --------- --------- TOTAL OPERATING EXPENSES 110,874 150,000 458,619 408,127 --------- --------- --------- --------- OPERATING INCOME 42,465 37,403 130,308 86,238 INTEREST AND OTHER INCOME 59 3,624 12,819 6,777 MINORITY INTEREST 85 (441) 254 (441) INCOME FROM UNCONSOLIDATED AFFILIATES 568 827 796 2,132 DEBT EXPENSE (7,301) (5,900) (16,346) (17,573) --------- --------- --------- --------- INCOME BEFORE INCOME TAXES 35,876 35,513 127,831 77,133 INCOME TAXES 12,825 12,362 45,801 25,463 --------- --------- --------- --------- NET INCOME $ 23,051 $ 23,151 $ 82,030 $ 51,670 ========= ========= ========= ========= QUESTAR MARKET RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) See notes to consolidated financial statements 3
September 30, December 31, 2001 2000 ------------- ----------- (In Thousands) ASSETS Current assets Cash and cash equivalents $ 3,980 Notes receivable from Questar Corp. $ 14,400 Accounts receivable, net 85,916 148,436 Qualifying hedging collateral 48,377 Hedging asset 41,242 Inventories, at lower of average cost or market - Gas and oil storage 7,833 7,618 Materials and supplies 2,113 2,298 Prepaid expenses and other 11,242 4,828 ----------- ----------- Total current assets 162,745 215,537 ----------- ----------- Property, plant and equipment 1,898,361 1,400,159 Less accumulated depreciation and amortization 705,723 662,923 ----------- ----------- Net property, plant and equipment 1,192,638 737,236 ----------- ----------- Investment in unconsolidated affiliates 15,936 15,417 Other assets Goodwill 66,823 Cash held in escrow account 210 5,387 Other 3,729 4,344 ----------- ----------- 70,762 9,731 ----------- ----------- $ 1,442,081 $ 977,921 =========== =========== LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities Checks outstanding in excess of cash balance $ 13,602 Short-term loans 60,000 $ 12,500 Notes payable to Questar Corp. 254,600 51,000 Accounts payable and accrued expenses 118,929 164,330 ----------- ----------- Total current liabilities 447,131 227,830 ----------- ----------- Long-term debt 321,957 244,377 Other liabilities 8,953 13,847 Deferred income taxes 150,631 67,873 Minority interest 7,763 5,483 Common shareholder's equity Common stock 4,309 4,309 Additional paid-in capital 116,027 116,027 Retained earnings 368,475 299,420 Other comprehensive income (loss) 16,835 (1,245) ----------- ----------- Total common shareholder's equity 505,646 418,511 ----------- ----------- $ 1,442,081 $ 977,921 =========== =========== QUESTAR MARKET RESOURCES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) See notes to consolidated financial statements 4
9 Months Ended September 30, 2001 2000 --------- --------- (In Thousands) OPERATING ACTIVITIES Net income $ 82,030 $ 51,670 Depreciation, depletion and amortization 65,092 64,556 Deferred income taxes 13,737 1,116 Income from unconsolidated affiliates, net of cash distributions (649) (1,907) Gain from sale of securities (1,573) Changes in operating assets and liabilities 40,575 (6,731) --------- --------- NET CASH PROVIDED FROM OPERATING ACTIVITIES 200,785 107,131 INVESTING ACTIVITIES Capital expenditures (144,983) (132,166) Acquisition of SEI (402,954) --------- --------- (547,937) (132,166) Proceeds from disposition of property, plant and equipment 21,199 5,481 Proceeds from sales of securities 9,478 --------- --------- NET CASH USED IN INVESTING ACTIVITIES (526,738) (117,207) FINANCING ACTIVITIES Change in notes receivable from Questar Corp. (14,400) 1,400 Change in notes payable to Questar Corp. 203,600 (12,800) Checks outstanding in excess of cash balance 13,602 (1,246) Change in short-term loans 47,500 31,500 Change in cash balance in escrow account 5,177 36,727 Long-term debt issued 321,501 39,793 Long-term debt repaid (241,635) (48,434) Other (264) 1,873 Payment of dividends (12,975) (12,975) --------- --------- NET CASH PROVIDED FROM FINANCING ACTIVITIES 322,106 35,838 Foreign currency translation adjustment (133) (338) --------- --------- Change in cash and cash equivalents (3,980) 25,424 Beginning cash and cash equivalents 3,980 --------- --------- Ending cash and cash equivalents $ -- $ 25,424 ========= ========= QUESTAR MARKET RESOURCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (Unaudited) Note 1 - Basis of Presentation The interim financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three- and nine-month periods ended September 30, are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. For further information refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2000. Note 2 - Change in Method of Accounting for Gas and Oil Properties On July 1, 2001, Questar Market Resources (QMR) elected to change its accounting method for gas and oil properties from the full cost method to the successful efforts method. The change was prompted by the recent acquisition of a company that uses successful efforts. A subsidiary, Wexpro, has always employed the successful efforts method. Management believes that the successful efforts method is preferable and will more accurately present the results of operations of the Company's exploration, development and production activities, minimizes asset write-downs caused by temporary declines in gas and oil prices and reflect impairment of the carrying value of the Company's gas and oil properties only when there has been an other-than-temporary decline in their fair value. As a result of this change in accounting, prior year and interim financial statements have been retroactively restated to reflect this change in accounting method. The effect, net of income taxes, was a reduction of retained earnings recorded retroactively as of December 31, 1995, of $37.6 million. This resulted from a reduction of net property, plant and equipment in the amount of $61.9 million and a reduction of deferred income taxes of $24.3 million. The effect of the change in accounting method on previously reported earnings was an increase in net income of $2.0 million for the six-month period ended June 30, 2001 and a decrease in net income of $4.6 million in the nine-month period ended September 30, 2000. Note 3 - Acquisition QMR acquired 100% of the common stock of Shenandoah Energy, Inc. (SEI) on July 31, 2001 for $403 million in cash including assumed debt. SEI was a privately held Denver-based exploration, production, gathering and drilling company. QMR obtained an estimated 415 billion cubic feet equivalent of proved oil and gas reserves, gas processing capacity of 100 MMcf per day, 90 miles of gathering lines, 114,000 acres of net undeveloped leasehold acreage and four drilling rigs. SEI operations are located primarily in the Uintah Basin of eastern Utah. The transaction was accounted for as a purchase business combination in accordance with accounting principles generally accepted in the United States. The purchase price in excess of the estimated fair value of the assets was assigned to goodwill. The acquisition was financed through bank borrowings. 5 Assets purchased and liabilities assumed were as follows: The following unaudited pro forma consolidated results of operations assume the acquisition occurred on January 1, 2000. The pro forma combined financial information reflects QMR's gas and oil operations restated using the successful efforts method of accounting. In addition, the combined financial information were adjusted for the following factors: Adjust depreciation expense to reflect the new basis of SEI's fixed assets. Adjust interest expense to reflect financing costs of the acquisition. Reduce operating expenses to reflect the resignation of several SEI executives. Allocate a portion of corporate overhead costs to SEI. Exclude results of operations not purchased by QMR. Calculate income tax expense based on pro forma income before income taxes.
(In thousands) Current assets $ 17,332 Property, plant and equipment 401,054 Goodwill 66,823 Other assets 124 Current liabilities (24,328) Other liabilities (8,410) Deferred income taxes (54,364) Other comprehensive loss 4,723 --------- Purchase price, including acquisition costs $ 402,954 ========= Note 4 - Financing QMR borrowed $403 million, including $280 million of bridge loans, to acquire SEI. QMR expects to refinance $200 million of the temporary loans through an offering of long-term notes sometime in the fourth quarter of 2001. On March 6, 2001, QMR, in a public offering, issued $150 million of 7.5% notes due 2011. QMR applied the proceeds of the debt offering to repay a portion of its outstanding floating-rate bank debt. 6
Nine Months Ended September 30, 2001 2000 -------- -------- (In thousands) Revenues $637,085 $516,931 Net income 79,448 $ 55,554 Note 4 - Operations By Line of Business 7
3 Months Ended 9 Months Ended September 30, September 30, 2001 2000 2001 2000 ---------- ---------- ---------- ---------- (In Thousands) REVENUES FROM UNAFFILIATED CUSTOMERS Exploration and production $ 69,446 $ 64,786 $ 212,499 $ 171,709 Cost of service 3,073 4,378 11,115 11,302 Gathering, processing and marketing 58,100 96,999 289,927 246,712 ---------- ---------- ---------- ---------- $ 130,619 $ 166,163 $ 513,541 $ 429,723 ========== ========== ========== ========== REVENUES FROM AFFILIATED COMPANIES Exploration and production $ 1 $ 13 $ 5 $ 13 Cost of service 20,783 17,929 66,849 53,162 Gathering, processing and marketing 1,936 3,298 8,532 11,467 ---------- ---------- ---------- ---------- $ 22,720 $ 21,240 $ 75,386 $ 64,642 ========== ========== ========== ========== DEPRECIATION AND AMORTIZATION EXPENSE Exploration and production $ 16,839 $ 16,242 $ 48,934 $ 49,620 Cost of service 3,663 3,451 11,077 10,355 Gathering, processing and marketing 1,450 1,494 4,256 4,033 ---------- ---------- ---------- ---------- $ 21,952 $ 21,187 $ 64,267 $ 64,008 ========== ========== ========== ========== OPERATING INCOME Exploration and production $ 26,687 $ 24,342 $ 87,450 $ 52,027 Cost of service 11,732 9,680 32,510 28,076 Gathering, processing and marketing 4,046 3,381 10,348 6,135 ---------- ---------- ---------- ---------- $ 42,465 $ 37,403 $ 130,308 $ 86,238 ========== ========== ========== ========== NET INCOME Exploration and production $ 13,106 $ 13,360 $ 54,447 $ 27,638 Cost of service 7,381 6,174 20,452 17,911 Gathering, processing and marketing 2,564 3,617 7,131 6,121 ---------- ---------- ---------- ---------- $ 23,051 $ 23,151 $ 82,030 $ 51,670 ========== ========== ========== ========== FIXED ASSETS - NET, at period end Exploration and production $ 914,633 $ 484,010 Cost of service 186,853 144,981 Gathering, processing and marketing 91,152 75,821 ---------- ---------- $1,192,638 $ 704,812 ========== ========== GEOGRAPHIC INFORMATION REVENUES United States $ 145,092 $ 177,488 $ 556,015 $ 468,697 Canada 8,247 9,915 32,912 25,668 ---------- ---------- ---------- ---------- $ 153,339 $ 187,403 $ 588,927 $ 494,365 ========== ========== ========== ========== FIXED ASSETS - NET, at period end United States $1,114,784 $ 614,657 Canada 77,854 90,155 ---------- ---------- $1,192,638 $ 704,812 ========== ========== Note 6 - New Accounting Standard - "Accounting for Derivative Instruments and Hedging Activities" The Company adopted the accounting provisions of SFAS 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" beginning in January 2001. SFAS 133 addresses the accounting for derivative instruments, including certain derivative instruments embedded in other contracts. Under the standard, entities are required to carry all derivative instruments in the balance sheet at fair value. The accounting for changes in fair value, which result in gains or losses, of a derivative instrument depends on whether such instrument has been designated and qualifies as part of a hedging relationship and, if so, depends on the reason for holding it. If certain conditions are met, entities may elect to designate a derivative instrument as a hedge of exposure to changes in fair value, cash flows or foreign currencies. If the hedged exposure is a fair-value exposure, the gain or loss on the derivative instrument is recognized in earnings in the period of the change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. If the hedged exposure is a cash-flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income in the shareholders' equity section of the balance sheet and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness, as well as the ineffective portion of the gain or loss, is reported in earnings immediately. As of January 1, 2001, the Company structured a majority of its energy derivative instruments as cash flow hedges. As a result of adopting SFAS 133 in January 2001, the Company recorded a $121 million hedging liability for derivative instruments. Measured at September 30, 2001, the results of hedging activities amounted to a $41.2 million current asset. Settlement of contracts accounted for $68 million of the change, while a decrease in prices of gas and oil on futures markets resulted in a $94.2 million change. The offset to the hedging asset, net of income taxes, was a $19.3 million unrealized gain on hedging activities recorded in other comprehensive income in the shareholder's equity section of the balance sheet. The ineffective portion of hedging transactions recognized in earnings was not significant. The fair-value calculation does not consider changes in fair value of the corresponding scheduled equity physical transactions. The contracts at September 30, 2001 had terms extending through December 2003. About 77% of those contracts, representing approximately $24.6 million, settle and will be reclassified from other comprehensive income in the next 12 months. Effective October 2001, the Company hedged $100 million of variable-rate debt by entering into a fixed-rate interest swap for one year. Note 7 - Comprehensive Income Comprehensive income is the sum of net income as reported in the Consolidated Statement of Income and other comprehensive income transactions reported in Shareholder's Equity. Other comprehensive income transactions that currently apply to QMR result from changes in the market value of energy-hedging contracts and changes in holding value resulting from foreign currency translation adjustments. These transactions are not the culmination of the earnings process, but result from periodically adjusting historical balances to market value. Income or loss is realized when the gas or oil underlying the hedging contracts is sold. In 2000, other comprehensive income included mark-to-market adjustments of securities available for sale. QMR sold the balance of these securities late in 2000. 8 Note 8 - Reclassifications Certain reclassifications were made to the 2000 financial statements to conform with the 2001 presentation. 9
3 Months Ended 9 Months Ended September 30, September 30, 2001 2000 2001 2000 --------- --------- --------- --------- (In Thousands) Comprehensive Income: Net income $ 23,051 $ 23,151 $ 82,030 $ 51,670 Other comprehensive income (loss) Unrealized gain on hedging transaction 27,741 30,769 Unrealized gain on securities available for sale 957 6,474 Foreign currency translation adjustments (1,953) (700) (2,391) (2,176) --------- --------- --------- --------- Other comprehensive income before income taxes 25,788 257 28,378 4,298 Income taxes on other comprehensive income 9,421 7 10,298 1,386 --------- --------- --------- --------- Net other comprehensive income 16,367 250 18,080 2,912 --------- --------- --------- --------- Total comprehensive income $ 39,418 $ 23,401 $ 100,110 $ 54,582 ========= ========= ========= ========= Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations QUESTAR MARKET RESOURCES, INC. AND SUBSIDIARIES September 30, 2001 (Unaudited) Operating Results Questar Market Resources (QMR or the Company) through its subsidiaries conducts gas and oil exploration, development and production, gas gathering and processing, and energy marketing operations. Wexpro, a subsidiary of QMR, conducts cost of service development of gas reserves on behalf of affiliated company, Questar Gas. Following is a summary of QMR's financial results and operating information. 10
3 Months Ended 9 Months Ended September 30, September 30, 2001 2000 2001 2000 -------- -------- -------- -------- FINANCIAL RESULTS - (dollars in thousands) Revenues From unaffiliated customers $130,619 $166,163 $513,541 $429,723 From affiliates 22,720 21,240 75,386 64,642 -------- -------- -------- -------- Total revenues $153,339 $187,403 $588,927 $494,365 ======== ======== ======== ======== Operating income $ 42,465 $ 37,403 $130,308 $ 86,238 Net income $ 23,051 $ 23,151 $ 82,030 $ 51,670 OPERATING STATISTICS Production volumes Natural gas (in million cubic feet) 18,451 17,361 50,082 51,985 Oil and natural gas liquids (in thousands of barrels) Questar E & P, SEI 715 562 1,732 1,679 Wexpro 108 126 347 395 Production revenue Natural gas (per thousand cubic feet) $ 2.94 $ 2.98 $ 3.44 $ 2.55 Oil and natural gas liquids (per barrel) Questar E & P, SEI $ 20.24 $ 20.06 $ 20.63 $ 20.48 Wexpro $ 24.08 $ 29.06 $ 26.12 $ 26.63 Wexpro investment base at Sept. 30, net of deferred income taxes (in millions) $ 153 $ 116 Marketing volumes in energy equivalent decatherms (in thousands of decatherms) 20,758 26,943 68,310 79,148 Natural gas gathering volumes (in thousands of decatherms) For unaffiliated customers 21,474 23,205 68,085 68,244 For Questar Gas 8,083 7,500 26,989 26,588 For other affiliated customers 6,382 6,476 19,782 18,154 -------- -------- -------- -------- Total gathering 35,939 37,181 114,856 112,986 ======== ======== ======== ======== Gathering revenue (per decatherm) $ 0.13 $ 0.13 $ 0.13 $ 0.13 Revenues Revenues were 18% lower in the third quarter of 2001 when compared with the third quarter of 2000 due to a 23% reduction of energy marketing volumes and a 26% decrease in energy market prices. Gas production increased 6% over year earlier levels while average selling prices declined 1%. Production of oil and natural gas liquids (NGL) rose 27%, excluding Wexpro. Gas and oil production increases resulted from the acquisition of Shenandoah Energy Inc (SEI) on July 31, 2001. The Company estimates production for the 12 months of 2001 in the range of 83 to 85 billion cubic feet equivalent. In the comparison of the nine month periods, revenues increased 19% in the 2001 period due to higher energy prices for natural gas production and energy marketing transactions. Average realized gas prices were 35% higher. Gas production declined 4% due, in part, to sales of assets in the first quarter and a planned shift in expenditures to cost of service drilling by Wexpro. The Company enters hedging transactions to support the earnings targets and to protect earnings from downward moves in commodity prices. Currently, 62% of projected gas production for the fourth quarter of 2001, including production from SEI properties, is hedged at an average net-to-the-well price of $2.90 per Mcf. For the first half of 2002, about 35% of natural gas production is hedged at a price of $3.51 per Mcf. Approximately, 29% of second half 2002 gas production is hedged at $3.40 per Mcf, net-to-the-well. The Company has hedged 65% of projected fourth quarter 2001 oil production, at an average price of $20.19 per barrel, net-to-the-well. Approximately, 40% of forecast 2002 oil production is hedged at an average price of $24.45 per barrel. The forecast excludes Wexpro production and NGL production. Hedging activities reduced revenues from gas sales by $55.8 million in the first nine months of 2001 and revenues from oil sales by $8.2 million in the first nine months of 2001. Expenses Operating and maintenance expenses were higher in the 2001 periods presented when compared with the corresponding 2000 periods. The expenses of operating producing properties increased $5.1 million in the first nine months primarily due to adding properties. Also, the expenses of operating a gas storage facility that began operations in the third quarter of 2000 resulted in a $600,000 increase in the first nine months of 2001. However, legal costs were $4.9 million lower in the first nine months of 2001 following the settlement of a major lawsuit in the second half of 2000. Exploration expenses were unchanged in the nine month comparison. Depreciation, depletion and amortization expense increased slightly in the comparison of the third quarter and first nine months of 2001 with the prior year periods. The average rate for the nine-month period was $.80 per energy equivalent Mcf (Mcfe) in 2001 compared with $.79 in 2000. Other taxes increased because of higher gas prices and the effect on production-related taxes. Debt expense was lower in the nine month period of 2001 because of lower debt levels in the first half of 2001. However, debt expense was higher in the third quarter of 2001 as a result of borrowings to finance the acquisition of SEI. The effective income tax rate for the first nine months of 2001 was 35.8% compared with 33.0% for the same period of 2000. The effective income tax rate increased because of a higher portion of earnings derived from Canada, where income tax rates are higher. The Company recognized $3.6 million of nonconventional fuel tax credits in the 2001 period and $3.3 million in the 2000 period. Other income Other income includes a $10.4 million pretax gain from selling nonstrategic gas and oil and gathering properties in the first quarter of 2001. Questar Energy Trading recorded $1.9 million of capitalized interest in the third quarter of 2000 and a $1.6 million pretax gain from selling securities in the second and third quarters of 2000. 11 Net income QMR's net income for the first nine months of 2001 improved 59% over the first nine months of 2000. The increase resulted from higher natural gas prices and increased earnings for Wexpro. Wexpro's net income was $2.5 million higher in 2001. Wexpro increased its investment in development-drilling projects resulting in a $37 million increase in the Wexpro investment base since September 30, 2000. Liquidity and Capital Resources Operating Activities Net cash provided from operating activities in the first nine months of 2001 was $93.7 million more than was generated in the first nine months of 2000. The increase in cash flow from operating activities resulted from higher net income, the release of cash deposited as collateral for qualifying hedging contracts and the collection of receivables. Investing Activities Capital expenditures were $547.9 million in the first nine months of 2001 including $403 million in cash paid for SEI. Forecasted capital expenditures for calendar year 2001 are $620 million. Financing Activities Net cash provided from operating activities plus borrowings enabled QMR to repay short-term debt, finance capital expenditures and loan the remaining cash to Questar. In addition, proceeds from the sale of assets in 2001 provided approximately $21.2 million of funds. QMR borrowed $403 million to finance the acquisition of SEI and plans to repay the debt with cash flow from operations and the sale of nonstrategic assets. QMR expects to refinance $200 million of temporary loans from the SEI acquisition through an offering of long-term notes in the fourth quarter of 2001. On March 6, 2001, offering, issued $150 million of 7.5% notes due 2011. QMR applied the proceeds of the debt offering to repay a portion of its outstanding floating-rate debt. QMR expects to finance remaining 2001 capital expenditures with the proceeds of net cash provided from operating activities, bank loans, loans from a private placement and borrowing from Questar. Quantitative and Qualitative Disclosures about Market Risk QMR's primary market-risk exposures arise from commodity-price changes for natural gas, oil and other hydrocarbons and changes in long-term interest rates. The Company has an investment in a foreign operation that subjects it to exchange-rate risk. QMR also has reserved pipeline capacity for which it is obligated to pay $3 million annually for the next several years, regardless of whether it is able to market the capacity to others. HEDGING POLICY The Company has established policies and procedures for managing market risks through the use of commodity-based derivative arrangements. Primary objectives of these hedging transactions are to support the Company's earnings targets and to protect earnings from downward moves in commodity prices. The Company will target between 50 and 75% of the current year's production to be hedged at or above budget levels by the end of March in the current year. The Company will ladder in these hedges, to reach forward beyond the current year when price levels are attractive. The volume of production hedged and the mix of derivative instruments employed are regularly evaluated and adjusted by management in response to changing market conditions and reviewed periodically by the Board of Directors. Additionally, under the terms of the Market Resources' revolving credit facility, not more than 75% of Market Resources' production quantities can be committed to hedging arrangements. The Company does not enter into derivative arrangements for speculative purposes. 12 ENERGY-PRICE RISK MANAGEMENT Oil and natural gas prices fluctuate in response to changes in supply and demand. Market Resources bears a majority of the risk associated with commodity price changes and uses hedge arrangements in the normal course of business to limit the risk of adverse price movements. However, these same arrangements usually limit future gains from favorable price movements. QMR held hedge contracts covering the price exposure for about 69.1 million dth of gas and 1.4 million barrels of oil at September 30, 2001. A year earlier the contracts covered 49.8 million dth of natural gas and 1.3 million barrels of oil. The hedging contracts exist for a significant share of QMR-owned gas and oil production and for a portion of energy-marketing transactions. A portion of the contracts at September 30, 2001 had terms extending through December 2003. About 77% of those contracts, representing approximately $24.6 million, settle and will be reclassified from other comprehensive income in the next 12 months. The undiscounted mark-to-market adjustment of financial gas and oil price-hedging contracts at September 30, 2001 was a positive $33.1 million. A 10% decline in gas and oil prices would add $12.6 million to the mark-to-market calculation; while a 10% increase in prices would deduct $12.7 million. The mark-to-market adjustment of gas and oil price-hedging contracts at September 30, 2000 was a negative $80.8 million. A 10% decline in gas and oil prices at that time would decrease the mark-to-market adjustment by $18.9 million to $61.9 million. Conversely, a 10% increase in prices would have resulted in an $18.8 million negative mark-to-market adjustment to a negative $99.6 million balance at that date. The calculations reflect energy prices posted on the NYMEX, various "into the pipe" postings, and fixed prices on the indicated dates. These sensitivity calculations do not consider changes in the fair value of the corresponding scheduled physical transactions (i.e., the correlation between the index price and the price to be realized for the physical delivery of gas or oil production), which should largely offset the change in value of the hedge contracts. INTEREST-RATE RISK MANAGEMENT As of September 30, 2001, QMR had $172 million of floating-rate long-term debt. The book value approximates fair value. Effective October 2001, the Company hedged $100 million of variable-rate debt by entering a fixed-rate interest swap for one year. FOREIGN CURRENCY RISK MANAGEMENT The Company does not hedge the foreign currency exposure of its foreign operation's net assets and long-term debt. Long-term debt held by the foreign operation, amounting to $35.5 million (U.S.), is expected to be repaid from future operations of the foreign company. Business Development On October 5, 2001, QMR announced an agreement with Western Gas Resources, Inc. to form a joint venture that will provide gas gathering and compression services to the Hoback Basin, including Pinedale Anticline and Jonah Field areas in southwest Wyoming. A subsidiary of Questar Gas Management (QGM) and a subsidiary of Western Gas Resources have formed Rendezvous Gas Services, L.L.C. Each entity will contribute certain assets to the joint venture and Rendezvous will construct and operate gas pipeline and compression facilities with the capacity to transport approximately 275 MMcf per day of gas product from Hoback Basin. In addition, the joint venture will deliver gas for blending and processing services to Granger and Blacks Fork processing plants. QGM is a 50% owner and the operator of the Blacks Fork processing plant. Western Gas Resources owns the Granger plant. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) 141, "Business Combinations," which addresses financial accounting and reporting for business 13 combinations. SFAS 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for under the pooling method initiated before but completed after June 30, 2001. The Company complied with this new accounting pronouncement in recording the SEI acquisition closed in the third quarter of 2001. In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets," which addresses, among other things, the financial accounting and reporting for goodwill subsequent to an acquisition. The new standard eliminates the requirement to amortize acquired goodwill; instead, such goodwill shall be reviewed at least annually for impairment. SFAS 142 is effective for fiscal years beginning after December 15, 2001. In 2001, the Company recorded goodwill acquired subsequent to July 1, 2001, that will not be amortized but will be subject to a yearly impairment test. The Company has not evaluated the impact of the remaining provisions of SFAS 142. In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations," which addresses, among other things, the financial accounting and reporting of the fair value of legal obligations associated with the retirement of tangible long-lived assets. The new standard requires that retirement costs be estimated at fair value, capitalized and depreciated over the life of the assets. The new standard may affect the cost basis of gas and oil assets. SFAS 143 is effective for years beginning after June 15, 2002. The Company has not evaluated the impact of SFAS 143. In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The new standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets, specifically, for a segment of a business accounted for as a discontinued operation. SFAS 144 is effective for years beginning after December 15, 2001. The Company has not evaluated the impact of SFAS 144. Forward-Looking Statements This report includes "forward-looking statements" within the meaning of Section 27(a) of the Securities Act of 1933, as amended, and Section 21(e) of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included or incorporated by reference in this report, including, without limitation, statements regarding the Company's future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations, are forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as "may", "will", "could", "expect", "intend", "project", "estimate", "anticipate", "believe", "forecast", or "continue" or the negative thereof or variations thereon or similar terminology. Although these statements are made in good faith and are reasonable representations of the Company's expected performance at the time, actual results may vary from management's stated expectations and projections due to a variety of factors. Important assumptions and other significant factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements include changes in general economic conditions, gas and oil prices and supplies, competition, rate-regulatory issues, regulation of the Wexpro settlement agreement, availability of gas and oil properties for sale or for exploration and other factors beyond the control of the Company. These other factors include the rate of inflation, assumptions used in business combinations, the weather and other natural phenomena, the effect of accounting policies issued periodically by accounting standard-setting bodies, possible adverse repercussions from terrorist attacks or acts of war, and adverse changes in the business or financial condition of the Company. 14 Part II Other Information ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. a. Questar Market Resources, Inc. ("Questar Market Resources" or the "Company") is filing the following exhibit as part of this report. b. On October 12, 2001, the Company filed a Current Report on Form 8-K with the required financial statements for Shenandoah Energy Inc. ("Shenandoah") and pro forma financial information reflecting the acquisition of Shenandoah, which occurred on July 31, 2001. In its Current Report, Questar Market Resources also disclosed that it was changing its accounting method for gas and oil properties from full cost to successful efforts. 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. QUESTAR MARKET RESOURCES, INC. (Registrant) November 13, 2001 /s/G. L. Nordloh - ------------------ ---------------------------------------- (Date) G. L. Nordloh President and Chief Executive Officer November 13, 2001 /s/S. E. Parks - ------------------ ---------------------------------------- (Date) S. E. Parks Vice President, Treasurer and Chief Financial Officer 15
Exhibit No. Exhibit ----------- ------- 12. Ratio of earnings to fixed charges. EXHIBIT INDEX 16
Exhibit Number Exhibit - ------- ------- 12. Ratio of earnings to fixed charges.
Exhibit No. 12. Questar Market Resources, Inc. and Subsidiaries Ratio of Earnings to Fixed Charges (Unaudited) 1/ For purposes of this presentation, earnings represent income before income taxes and fixed charges. Fixed charges consist of total interest charges, amortization of debt issuance costs, and the interest portion of rental costs estimated at 50%. 2/ Income before income taxes includes QMR's 50% share of pretax earnings of Blacks Fork. 3/ Distributions from less than 50% owned enterprises are included in the calculation, while earnings are excluded. QMR's ownership interest in both Canyon Creek and Roden is about 15%. 4/ Pro forma to reflect the acquisition of Shenandoah Energy Inc as of January 1, 2001.
9 months ended September 30, ----------------------------------------- 2001 2001 (Pro forma) 2000 --------- ---------------- --------- (Dollars in Thousands) EARNINGS Income before income taxes $ 127,831 $ 123,667 $ 77,133 Less income from Canyon Creek (229) (229) (128) Plus distributions from Canyon Creek 174 174 225 Less income from Roden (145) (145) Plus distributions from Roden 228 228 Plus debt expense 16,346 29,132 17,573 Plus interest capitalized during construction 559 559 168 Plus interest portion of rental expense 978 1,680 713 --------- --------- --------- $ 145,742 $ 155,066 $ 95,684 ========= ========= ========= FIXED CHARGES Debt expense $ 16,346 $ 29,132 $ 17,573 Plus interest capitalized during construction 559 559 168 Plus interest portion of rental expense 978 1,680 713 --------- --------- --------- $ 17,883 $ 31,371 $ 18,454 ========= ========= ========= Ratio of Earnings to Fixed Charges 8.15 4.94 5.19