-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GXlfG+YJhl1Giq1CL+MdhjZvhEPy7BgXqx5mIjkPMGVYjZhE7eplF1mrqOx3frw5 rId5oM5hNxnix8755H5Rng== 0000068589-98-000004.txt : 19980331 0000068589-98-000004.hdr.sgml : 19980331 ACCESSION NUMBER: 0000068589-98-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUESTAR GAS CO CENTRAL INDEX KEY: 0000068589 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION & DISTRIBUTION [4923] IRS NUMBER: 870407509 STATE OF INCORPORATION: UT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 033-55866 FILM NUMBER: 98579686 BUSINESS ADDRESS: STREET 1: 180 E FIRST SOUTH ST STREET 2: PO BOX 45433 CITY: SALT LAKE CITY STATE: UT ZIP: 84145-0433 BUSINESS PHONE: 8015345555 MAIL ADDRESS: STREET 1: 180 EAST FIRST SOUTH ST STREET 2: P O BOX 11150 CITY: SALT LAKE CITY STATE: UT ZIP: 84147 FORMER COMPANY: FORMER CONFORMED NAME: MOUNTAIN FUEL SUPPLY CO DATE OF NAME CHANGE: 19920703 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 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. 1-935 QUESTAR GAS COMPANY (Exact name of registrant as specified in its charter) State of Utah 87-0155877 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 180 East First South, P.O. Box 45360, Salt Lake City, Utah 84145-360 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (801) 324-5555 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO THE SECURITIES ACT OF 1933: Notes: Medium Term Notes, 6.85% to 8.43%, due 2007 to 2024 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 State the aggregate market value of the voting stock held by nonaffiliates of the registrant as of March 23, 1998: $0. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of March 23, 1998: 9,189,626 shares of Common Stock, $2.50 par value. (All shares are owned by Questar Regulated Services Company.) Registrant meets the conditions set forth in General Instruction (J)(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K Report with the reduced disclosure format. TABLE OF CONTENTS Heading Page PART I Items 1. and 2. BUSINESS AND PROPERTIES............................. 1 General.......................................... 1 Gas Distribution................................. 1 Gas Supply....................................... 3 Competition, Growth and Unbundling............... 4 Regulation....................................... 6 Relationships with Affiliates.................... 8 Employees........................................ 11 Environmental Matters............................ 11 Research and Development......................... 12 Item 3. LEGAL PROCEEDINGS................................... 12 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................... 13 PART II Item 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS..................... 13 Item 6. OMITTED............................................. 13 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION........................................... 14 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................. 18 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................................ 18 PART III Items OMITTED............................................. 18 10-13 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K............................. 18 SIGNATURES.................................................... 36 FORM 10-K ANNUAL REPORT, 1997 PART I ITEMS 1. and 2. BUSINESS AND PROPERTIES General Questar Gas Company (formerly Mountain Fuel Supply Company, referred to as the "Company" or "Questar Gas") distributes natural gas to more than 641,000 sales and transportation customers in Utah, southwestern Wyoming, and a small section in southeastern Idaho. It is part of the Regulated Services segment within Questar Corporation ("Questar"), which is a publicly-owned integrated provider of energy services. The Company, through a predecessor, began distributing natural gas in 1929 when a pipeline was built to transport natural gas from southwestern Wyoming to Salt Lake City, Utah. Between 1929 and the present time, Questar Gas gradually expanded the boundaries of its distribution system to include over 90 percent of Utah's population and to capture a market share of over 90 percent for furnaces and water heaters. The Company has traditionally capitalized on two competitive advantages, owning natural gas reserves and offering a full, range of services to customers at reasonable prices. Questar Gas intends to maintain its competitive position in its traditional service area, even as deregulation and unbundling may open the area to other players, and to take advantage of opportunities to expand its range of activities. Gas Distribution As of December 31, 1997, Questar Gas was serving 641,696 residential, commercial, and industrial customers, a 3.8 percent increase from the 618,231 customers served as of the end of 1996. (Customers are defined in terms of active meters.) The Company distributes gas to customers in the major populated area of Utah, commonly referred to as the Wasatch Front, in which the Salt Lake metropolitan area, Provo, Ogden, and Logan are located. It also serves customers in eastern, central, and southwestern Utah with Price, Roosevelt, Fillmore, Richfield, Cedar City, and St. George as the primary cities. Approximately 96 percent of the Company's customers are in Utah. The Company serves the communities of Rock Springs, Green River, and Evanston in southwestern Wyoming and the community of Preston in southeastern Idaho. Questar Gas has been granted the necessary regulatory approvals by the Public Service Commission of Utah ("PSCU"), the Public Service Commission of Wyoming ("PSCW"), and the Public Utilities Commission of Idaho ("PUCI") to serve these areas. It also has long-term franchises granted by communities and counties within its service area. Questar Gas added 23,465 customers in 1997, which was the fourth consecutive year in which the Company added at least 20,000 customers. Most of the customer growth was attributable to new housing, although the Company continues to add customers in its traditional and new service areas that are converting to natural gas. The population of its service area in Utah continues to grow faster than the national average. The Company expects to add 15,000-20,000 customers each year until at least 2002, when Salt Lake City hosts the Winter Olympics. The Company's sales to residential and commercial customers are seasonal, with a substantial portion of such sales made during the heating season. The typical residential customer in Utah (defined as a customer using 115 decatherms ("Dth") per year) uses more than 75 percent of his total gas requirements in the coldest six months of the year. The Company's revenue forecasts used to set rates are based on normal temperatures. Historically, revenues and resulting net income have been affected by temperature patterns that are below or above normal. As measured in degree days, temperatures in the Company's service area were 6 percent warmer than normal; 1997 was the fourth consecutive year in which temperatures have been warmer than normal. The Company's sensitivity to weather and temperature conditions has been ameliorated by adopting a weather normalization mechanism for its general service customers in Utah and Wyoming. The mechanism, which was in effect for all of 1997, adjusts the non-gas cost portion of a customer's monthly bill as the actual degree days in the billing cycle are warmer or colder than normal. This mechanism reduces the sometimes dramatic fluctuations in any given customer's monthly bill from year to year. During 1997, Questar Gas sold 85.7 million decatherms ("MMDth") of natural gas to residential and commercial customers, compared to 80.8 MMDth in 1996. (A Dth is an amount of heat energy equal to 10 therms or 1 million Btu. In the Company's system, each thousand cubic feet ("Mcf") of gas equals approximately 1.07 Dth.) General service sales to residential and commercial customers were responsible for over 89 percent of the Company's total revenues in 1997. Questar Gas has designed its distribution system and annual gas supply plan to handle design-day demand requirements. The Company periodically updates its design-day demand, which is the volume of gas that firm customers could use during extremely cold weather. For the 1997-98 heating season, the Company used a design-day demand of 958,798 Dth for firm customers. Questar Gas is also obligated to have pipeline capacity, but not gas supply, for firm transportation customers. The Company's management believes that the distribution system is adequate to meet the demands of its firm customers. The Company's total industrial deliveries, including both sales and transportation, increased during 1997, from 58.1 MMDth in 1996 to 60.8 MMDth in 1997. The majority of interruptible sales service customers pay rates based on the Company's weighted average cost of purchased gas, which is periodically lower for some customers than the cost of purchasing volumes directly from producers and paying transportation rates. The Company also has an interruptible sales rate utilizing a dedicated gas portfolio. The Company's tariff permits industrial customers to make annual elections for interruptible sales or transportation service. Questar Gas has been providing transportation service since 1986. The Company's largest transportation customers, as measured by revenue contributions in 1997, are the Geneva Steel plant in Orem, Utah; the Kennecott copper processing operations, located in Salt Lake County; and the mineral extraction operations of Magnesium Corporation of America in Tooele County west of Salt Lake. Questar Gas owns and operates distribution systems throughout its Utah, Wyoming and Idaho service areas and has a total of 19,256 miles of street mains, service lines, and interconnecting pipelines. The Company has consolidated many of its activities in its operations center, warehouse and garage located in Salt Lake City, Utah. Questar Gas continues to own field offices and service center facilities in other parts of its service area. It has fee title to the properties on which its operation and service centers are constructed. The mains and service lines are constructed pursuant to franchise agreements or rights-of-way. Gas Supply Questar Gas owns natural gas producing properties in Wyoming, Utah and Colorado that are operated by Wexpro Company ("Wexpro") and uses the gas produced from these properties for part of its base-load demand. The Company's investment in these properties is included in its utility rate base. Questar Gas has regulatory approval to reserve "cost-of-service" gas for firm sales customers. During 1997, approximately 45 percent of the Company's firm sales requirement was satisfied with cost-of-service gas produced from over 550 wells in more than 30 fields. (As defined, cost-of-service gas includes related royalty gas.) The volumes produced from such properties are transported for the Company by Questar Pipeline. See "Relationships with Affiliates." During 1997, 44.0 MMDth of gas were delivered from such properties, compared to 49.1 MMDth in 1996. The Company estimates that it had reserves of 336.9 billion cubic feet ("Bcf") of natural gas as of year-end 1997 compared to 359.9 Bcf as of year-end 1996. (These reserve numbers do not include gas attributed to royalty interest owners. Reserve numbers are typically reported in volumetric units, such as Bcf, that don't reflect heating values.) The average wellhead cost associated with gas volumes produced from the Company's cost-of-service reserves was $1.32 per Dth in 1997 (compared to $2.26 per Dth of purchased gas). Some of the wells on the Company's producing properties qualify for special tax credits, commonly referred to as "Section 29" or "tight sands" tax credits. During 1997, Questar Gas, as the party with the economic interest in the gas produced from such wells, claimed $2.7 million in Section 29 tax credits. To qualify for the special tax credits, production must flow from wells that meet specified tight sands criteria and that commenced drilling prior to January 1, 1993. Only gas volumes produced prior to January 1, 2003, are eligible for the special tax credit. Questar Gas stores up to 12.5 Bcf of gas at Clay Basin, a base-load storage facility owned and operated by Questar Pipeline. Gas is injected into the Clay Basin storage reservoir during the summer and withdrawn during the heating season. The Company has been directly responsible for all of its gas acquisition activities since September 1, 1993. Questar Gas has a balanced and diversified portfolio of approximately 42 gas supply contracts with more than 21 suppliers located in the Rocky Mountain states of Wyoming, Colorado, and Utah. It purchases gas on the spot market and under contracts, primarily during the heating season. The Company's gas purchase contracts have market-based provisions and are either of short-duration or renewable on an annual basis upon agreement of the parties. The Company's gas acquisition objective is to obtain reliable, diversified sources of gas supply at competitive prices. In the last semi-annual purchased gas cost filing, the Company estimated that its 1998 average wellhead cost of field purchased gas would be $1.83 per Dth. Although Questar Gas has contracts with take-or-pay provisions, it currently has no material take-or-pay liabilities. Competition, Growth, and Unbundling Questar Gas has historically enjoyed a favorable price comparison with all energy sources used by residential and commercial customers except coal and occasionally fuel oil. This historic price advantage, together with the convenience and handling advantages associated with natural gas and with the services provided in conjunction with natural gas, has permitted the Company to retain over 90 percent of the residential space heating and water heating markets in its service area and to distribute more energy, in terms of Btu content, than any other energy supplier to residential and commercial markets in Utah. The Company continues to focus marketing efforts to develop incremental load in existing homes and new construction. Most households in its service area already use natural gas for space heating and water heating. The Company's market share for other secondary appliances, e.g., ranges and dryers, has historically been less than 30 percent, which is significantly lower than its over 90 percent market share for furnaces and water heaters. Questar Gas believes that it must maintain a competitive price advantage in order to retain its residential and commercial customers and to build incremental load by convincing current customers to convert additional secondary appliances to natural gas. During 1997, the Company's rates increased, primarily as a result of higher purchased gas costs. The typical residential customer in Utah would have an annual bill of $594.53, using rates as of January 1, 1998, compared to an annual bill of $512.38, using rates in effect as of the same date a year earlier. (The largest portion of this increase reflects a surcharge to amortize an undercollection in the Company's gas balancing account. The undercollection has been substantially reduced, and the surcharge may be reduced or eliminated in future filings.) The Company's 1998 rates, however, remain lower than they were in 1985. Historically, the Company's competitive position has been strengthened as a result of owning natural gas producing properties and satisfying as much as approximately 40-50 percent of its system requirements with the cost-of-service gas produced from such properties. Questar Gas has developed an annual gas supply plan that provides for a judicious balance between cost-of-service gas and purchased gas. The Company believes that it is important to continue owning gas reserves, producing them in a manner that will serve the best short- and long-term interests of its customers, and satisfying a significant portion of its supply requirements with gas produced from such properties. No other distributor markets natural gas sales service in direct competition with the Company in its service area, but marketing firms are arranging direct purchase contracts between large users in the Company's service area and producers. These customers cannot bypass Questar Gas, but can take advantage of the open-access status of either the pipeline systems owned by Questar Pipeline or Kern River Gas Transmission Company ("Kern River"). The Company's sales rates are competitive when compared to other energy sources, but are periodically higher than the delivered price of spot-market gas volumes transported through its system to large customers. The Kern River pipeline, which was built to transport gas from southwestern Wyoming to Kern County, California, runs through portions of the Company's service area and can provide an alternative delivery source to transportation customers. As of the date of this report, Questar Gas has lost no industrial load as a result of the Kern River line. The existence of the Kern River pipeline, however, coupled with the open-access status of Questar Pipeline's transmission system, has changed the nature of market conditions for the Company. Large industrial customers in Utah's Wasatch Front area could acquire taps on Kern River's system. The Company has a tap on the Kern River line in Salt Lake County that enables it to obtain delivery of additional peak-day supplies to meet increasing demand. The existence and location of the Kern River pipeline system also made it possible for the Company to extend service into new areas in rural Utah and to develop a second source of supply for its central and southern Utah system. As of September 1, 1997, transportation customers are no longer required to pay an additional charge if they don't use the Company's upstream capacity on interstate pipelines. The cessation of this charge, which had been approved by the PSCU for a transitional period, could lead to discounted released capacity revenues and a reduction in the revenues retained by the Company. Questar Gas, for Utah rate-making purposes, currently retains 10 percent of released capacity revenues (reduced from 20 percent effective February 18, 1997) and credits 90 percent of such revenues to its gas balancing account. Questar Gas and all local distribution companies are faced with the challenges and opportunities posed by the unbundling and restructuring of traditional utility services. As a local distribution company, the Company owns and controls the lines through which gas is delivered, supplies natural gas to residential customers, measures the consumption of gas used by its customers, and bills for consumption and related services. The services provided by Questar Gas are packaged and priced as a "bundle." Most "unbundling" discussions focus on commodity unbundling for residential and commercial customers to separate the commodity supply from the transportation service. (Industrial customers have enjoyed the benefit of this supplier choice since 1986.) (See "Regulation" for a discussion of the Company's program to offer supplier choice to its Wyoming general service customers.) Questar Gas has been reviewing the opportunities associated with unbundling. The Company believes that it is well-positioned to succeed in a competitive environment. Questar Gas is an efficient natural gas company, a statement that is supported by such statistics as an operating and maintenance expense of $159 per customer and an overall customer satisfaction rating of 90 percent. Questar Gas intends to maintain its competitive position within its own service area and to take advantage of opportunities in new markets. The Company changed its name from Mountain Fuel to Questar Gas as part of a new branding strategy. The Company's management wanted to avoid confusion concerning the Company's affiliation with other Questar entities. The name change also reflects a recognition that the competitive environment is changing. Regulation Questar Gas and all retail distribution companies have been subject to governmental regulation as a substitute for competition. Other regulated industries, airline, trucking, telecommunication, financial service and interstate pipeline, have been and are being deregulated, and competitive market forces are forcing these industries to place more emphasis on operating efficiency. The substitution of competition for regulation is causing Questar Gas and other distribution companies to review their costs and reexamine their commitment to providing sales service. On November 26, 1997, Questar Gas filed an application with the PSCW requesting permission to offer "supplier choice" to its general service (residential and commercial) customers in Wyoming. The Company's proposal, which has been approved by the PSCW, allows customers the option of selecting, on an annual basis, a different supplier of gas while purchasing transportation and associated services from the Company. Customers can continue purchasing full service (commodity, transportation, and associated services) from the Company. The "open season" during which customers can select a new commodity supplier began March 1, 1998 and runs through April 30, 1998. (Customers, in subsequent years, will have the month of April in which to make an election.) Transportation service for customers choosing an alternate supplier will begin June 1, 1998. The Company has over 21,500 general service customers in Wyoming and expects that a majority of them will continue to purchase full service. (Questar Gas is not aware of any commodity supplier actively soliciting general service customers in Wyoming.) The Wyoming unbundling program should provide Questar Gas with valuable information about customer preference should retail utility services be unbundled in the Utah market. The state of Utah and the PSCU are actively involved in reviewing the restructuring and unbundling of telephone and electric utility services. Questar Gas monitors legislative and regulatory activities focused on the unbundling of other utility services and anticipates that electric utility service will be unbundled before retail gas distribution service. Given its attractive rates and high customer service ratings, the Company does not believe that its residential customers will push for rapid unbundling in Utah. As a public utility, Questar Gas is subject to the jurisdiction of the PSCU and PSCW. (The Company's customers in Idaho are served under the provisions of its Utah tariff. Pursuant to a special contract between the PUCI and the PSCU, the rates for the Company's Idaho customers are regulated by the PSCU.) The Company's natural gas sales and transportation services are provided under rate schedules approved by the two regulatory commissions. Questar Gas has consistently endeavored to balance the costs of adding more than 20,000 customers each year with the cost savings associated with reducing its labor costs and consolidating activities and utilizing new technology. The Company currently does not expect to file a general rate case application with the PSCU or the PSCW in 1998. It is currently authorized to earn a return on rate base of 10.4 percent in Wyoming and 10.22 to 10.34 percent in Utah. Both the PSCU and the PSCW have authorized the Company to use a balancing account procedure for changes in the cost of natural gas, including supplier non-gas costs, and to reflect changes at least as frequently as semi-annually. Questar Gas received regulatory approval from the PSCU and the PSCW to adjust its rates in October of 1997 to reflect unexpected purchased gas cost increases and to address the undercollection in its balancing account. On an aggregate basis, Questar Gas increased its 1997 revenues by $86.8 million in Utah and $3.6 million in Wyoming to reflect gas cost increases. The Company did not change its rates as of January 1, 1998, in either state. The PSCU has not issued an order in a pending case involving the Company's gathering rates paid to Questar Gas Management Company ("QGM"), an affiliate. QGM provides gathering services to Questar Gas under a 1993 agreement that was transferred to it from Questar Pipeline. The agreement specified that contract charges would be redetermined as of September 1, 1997; the redetermination resulted in lower rates on a prospective basis. The Utah Division of Public Utilities (the "Division"), which is a state agency, claims that the reduction in gathering charges should be extended retroactively to March of 1996, when Questar Pipeline transferred the gathering assets and agreement to QGM. The Division's claims involve approximately $7.8 million. The PSCU presided over public hearings to address the Division's claims, and both parties have fully briefed the issues. The Company believes that its gathering costs are reasonable and that it should not be required to retroactively adjust such rates. Responsibility for gas acquisition activities involves inherent risks of regulatory scrutiny. In the past, the Company has been involved in regulatory proceedings in which the prudence of its gas supply activities has been challenged, but has successfully defended its activities and has not incurred any significant disallowance of gas costs. Under Utah law, Questar Gas must report dividends paid on its common stock to the PSCU and must allow at least 30 days between declaring and paying dividends. The PSCU can investigate any dividend declared by the Company to determine if payment of such dividend would impair its capital or service obligations. The PSCW and the PUCI, but not the PSCU, have jurisdiction to review the issuance of long-term securities by the Questar Gas. The Company has significant relationships with its affiliates. The PSCU and PSCW have jurisdiction to examine these relationships and the costs paid by the Company for services rendered by or goods purchased from its affiliates. A settlement agreement involving cost-of-service gas and defining certain contractual obligations between the Company and Wexpro is monitored by the Division and its agents. The PSCU and PSCW have adopted regulations or issued orders that affect the Company's business practices in such areas as main extensions, credit and collection activities, and termination of service standards. Relationships with Affiliates The Company has significant business relationships with affiliated companies, particularly Questar Pipeline, Wexpro, QGM, and Questar InfoComm, Inc. ("Questar InfoComm"). The following diagram shows the corporate structure of the Company and its primary affiliates: Questar Corporation Entrada Industries, Inc. Wexpro Company Universal Resources Corporation Celsius Energy Company Questar Energy Trading Company Questar Gas Management Company Questar Energy Services, Inc. Questar Regulated Services Company Questar Pipeline Company Questar Gas Company Questar InfoComm, Inc. The Company's relationships with its primary affiliates are described below. Questar Pipeline Company. Questar Pipeline owns a two-pronged transmission system running from southwestern Wyoming and western Colorado into the Company's Utah service area. Questar Pipeline's historic function as the Company's supplier ended September 1, 1993, when Questar Pipeline's gas purchase contracts were transferred to Questar Gas and when the Company converted its firm purchase capacity entitlements to firm transportation service. Questar Gas has reserved about 800,000 Dth per day or approximately 70 percent of Questar Pipeline's total transmission capacity. Questar Gas transports both cost-of-service gas and purchased gas on Questar Pipeline's transmission system. (The Company also transports gas volumes on the transmission systems owned by The Williams Companies, Inc. and Colorado Interstate Gas Company. Questar Gas purchases "city gate" gas supplies from transportation customers on Kern River's system.) The Company releases its firm transportation capacity, pursuant to capacity release procedures adopted by the Federal Energy Regulatory Commission ("FERC"), when it does not need such service for its sales customers. Because Questar Gas has sufficient capacity on the system to meet peak-demand periods, it has unused capacity for the balance of the year. During 1997, Questar Pipeline transported 110.3 MMDth of gas for Questar Gas, compared to 100.2 MMDth in 1996. Under Questar Pipeline's "straight fixed-variable" rate schedules, Questar Gas is obligated to pay demand charges for firm capacity, regardless of the volumes actually transported. The Company, in 1997, paid approximately $49.6 million in demand charges to Questar Pipeline for firm transportation capacity and "no notice" transportation. The Company's transportation agreement with Questar Pipeline expires on June 30, 1999. The parties expect that the agreement will be extended, given the Company's design-day requirements and Questar Pipeline's competitive transportation rates. Questar Gas purchases storage capacity at Clay Basin, a large base-load storage facility operated by Questar Pipeline, and also has peaking storage capacity at three additional storage reservoirs owned by Questar Pipeline. The Company paid Questar Pipeline $13.5 million in demand charges during 1997 in connection with storage services. In mid-1996, Questar Pipeline and Questar Gas were placed under the same management team of officers and linked to form the Regulated Services unit of Questar. (Both companies retain separate general managers.) This reorganization was completed as of January 1, 1997, when both entities became subsidiaries of Questar Regulated Services Company ("Regulated Services") and when employees performing specified functions were transferred to Regulated Services. Employees in all three entities share base and incentive compensation plans and are expected to work closely together to improve administrative efficiency and customer service. the Company's administrative costs were lower in 1997 than would otherwise have been experienced as a result of this reorganization. Questar Gas Management Company. On March 1, 1996, Questar Pipeline's gathering facilities were transferred to QGM, which subsequently was moved to the Market Resources segment of Questar. During 1997, QGM gathered 28.5 MMDth of natural gas for Questar Gas, compared to 30.2 MMDth in 1996. During 1997, the Company paid $7.8 million for demand charges in conjunction with gathering services. Under the terms of the gathering agreement between the parties, QGM will gather gas volumes produced from cost-of-service properties for the life of such properties and charge cost-of-service rates. As previously noted, these charges were redetermined as of September 1997. Wexpro Company. Wexpro, another company within Questar's Market Resources segment, operates certain properties owned by Questar Gas. Under the terms of a settlement agreement, which was approved by the PSCU and PSCW and upheld by the Utah Supreme Court, the Company owns gas produced from specified properties that were productive as of August 1, 1981 (the effective date of the settlement agreement). Such gas is reflected in rates at cost-of-service prices based on rates of return established by the settlement agreement. In addition, Wexpro conducts development gas drilling for Questar Gas on specified properties and is reimbursed for its costs plus a current rate of return of 21.69 percent (adjusted annually using a specified formula) on its net investment in such properties, adjusted for working capital and deferred taxes, if the wells are successful. Under the terms of the settlement agreement, the costs of unsuccessful wells are borne by Wexpro. The settlement agreement also permits Questar Gas to share income from hydrocarbon liquids produced from certain properties operated by Wexpro after Wexpro recovers its expenses and a specified rate of return. The income received by Questar Gas from Wexpro is used to reduce natural gas costs to its customers. Wexpro conducts drilling activities in response to the needs of Questar Gas or the demands from other working interest owners. During 1997, Wexpro's drilling activities resulted in additional reserves of 7.4 Bcf. Additional reserves did not replace the 37.5 Bcf of volumes produced from the properties. Other Affiliates. Other significant affiliates of Questar Gas include Questar InfoComm and several additional companies within Market Resources, the second primary business unit within Questar. Questar InfoComm provides data processing and telecommunication services for the Company and other affiliates. It owns and operates a network of microwave facilities, all of which are located in the Company's service area or near Questar Pipeline's transmission system. Services are priced to recover operating expenses and a return on investment. Questar InfoComm personnel are assisting Questar Gas with the development and implementation of new computer systems, including a new customer information system, and the maintenance of existing systems. Questar Gas has a long-term lease for some space in an office building located in Salt Lake City, Utah, that is owned by another affiliate. In addition to QGM and Wexpro, the Market Resources segment of Questar includes Celsius Energy Company ("Celsius"), Questar Energy Trading Company ("Questar Energy Trading"), Questar Energy Services, Inc. ("Questar Energy Services"), and Universal Resources Corporation ("Universal Resources"). All of these companies are owned by Entrada Industries, Inc. ("Entrada"). Celsius conducts oil and gas exploration and related development activities in the Rocky Mountain area and western Canada (through a Canadian subsidiary, Celsius Energy Resources Ltd.) Questar Energy Trading markets gas volumes, including the majority of volumes produced by Celsius, and is responsible for some of the contracts providing gas to the Company's transportation customers. It is also involved in the marketing of oil and other liquid hydrocarbons and electricity. Questar Energy Services provides nonregulated services and products. The Company provides some billing services to Questar Energy Services. Finally, Universal Resources conducts oil and gas exploration and related development activities primarily in the Midcontinent region outside the Company's service area. Entrada is a wholly owned subsidiary of Questar and is the direct parent of all Market Resources entities. While Questar Gas and Entrada are subject to common control by Questar, there is no direct control of Entrada by the Company or of the Company by Entrada. See "Legal Proceedings." Questar, the Company's ultimate parent, provides certain administrative services, e.g., public and government relations, financial, and audit, to the Company and other members of the consolidated group. Questar also sponsors the qualified and welfare plans in which the Company's employees participate. Questar Gas is responsible for a proportionate share of the costs associated with these services and benefit plans. Employees As of December 31, 1997, the Company had 1,037 employees, compared to 1,349 at year-end 1996. (The decrease reflects the transfer of employees to Regulated Services as of January 1, 1998. Regulated Services, the Company's parent, has 474 employees who perform specified services, e.g., legal, accounting, budget, regulatory affairs for Questar Gas and Questar Pipeline.) The Company's employees are nonunion employees who are not represented under collective bargaining agreements. Employee relations are generally deemed to be satisfactory. Environmental Matters The Company is subject to the National Environmental Policy Act and other federal and state legislation regulating the environmental aspects of its operations. Although Questar Gas does not believe that environmental protection laws and regulations will have any material effect on its competitive position, it does believe that such provisions have added and will continue to add to the Company's expenditures and annual maintenance and operating expenses. See "Legal Proceedings" for a discussion of litigation concerning liability for contamination on property owned by Entrada. Questar Gas has an obligation to treat waste water and monitor the effectiveness of an underground slurry wall that was constructed in 1988 at its operations center in Salt Lake City, Utah. The slurry wall was built to contain contaminants from an abandoned coal gasification plant that operated on the site from 1908 to 1929. Questar Gas emphasizes the environmental advantages of natural gas. The Company's marketing campaigns feature the clean-burning characteristics of natural gas fireplaces. Natural gas vehicles are also being encouraged on the basis of environmental considerations. Research and Development The Company conducts studies of gas conversion equipment, gas piping, and engines using natural gas and has funded demonstration projects using such equipment. The total dollar amount spent by the Company on research activities is not material. ITEM 3. LEGAL PROCEEDINGS There are various legal proceedings pending that involve the Company and its affiliates. While it is not feasible to predict or determine the outcome of these proceedings, the Company's management believes that the outcome will not have a material adverse effect on the Company's financial position. Questar Gas, as a result of acquiring Questar Pipeline's gas purchase contracts, is responsible for any judgment rendered against Questar Pipeline resulting from an adverse jury verdict in a case heard in Wyoming's federal district court. The jury, in late 1994, awarded an independent producer compensatory damages of approximately $6,100,000 and punitive damages of $200,000 on his claims involving take-or-pay, tax reimbursement, contract breach, and tortious interference with a contract. The presiding judge has still not issued a decision concerning the competing forms of judgment submitted by the opposing parties. The Company's management believes that any payments arising from the breach of contract claim will be included in the gas balancing account and recovered in its rates for natural gas sales service. This same producer filed a new lawsuit against the Company and its affiliates in 1997. This lawsuit was also filed in Wyoming's federal district court and presents some of the same claims heard in the first case for the time period since the first lawsuit. It also involves new claims of fraud and antitrust violations. As a result of its former ownership of Entrada and Wasatch Chemical Company, Questar Gas has been named as a "potentially responsible party" for contaminants located on property owned by Entrada in Salt Lake City, Utah. Questar and Entrada have also been named as potentially responsible parties. (Prior to October 2, 1984, Questar Gas was the parent of Entrada, which is now a direct, wholly-owned subsidiary of Questar.) The property, known as the Wasatch Chemical property, was the location of chemical operations conducted by Entrada's Wasatch Chemical division, which ceased operation in 1978. A portion of the property is included on the national priorities list, commonly known as the "Superfund" list. In September of 1992, a consent order governing clean-up activities was formally entered by the federal district court judge presiding over the underlying litigation involving the property. This consent order was agreed to by Questar, Entrada, the Company, the Utah Department of Health and the Environmental Protection Agency (the "EPA"). During 1996, Entrada basically completed clean-up activities at the site, but will continue to monitor the situation. Entrada has accounted for all costs spent on the environmental claims and has also accounted for all settlement proceeds, accruals and insurance claims. It has received cash settlements, which together with accruals and insurance receivables, should be sufficient for any future clean-up costs. Questar Gas has consistently maintained that Entrada should be responsible for any liability imposed on the Questar group as a result of actions involving Wasatch Chemical. The Company has not paid any and does not expect to pay any costs associated with the clean-up activities for the property. See "Regulation" for information concerning regulatory proceedings in which Questar Gas is involved. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 1997, Regulated Services, the Company's only stockholder, approved the name change. Part II ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS As of January 1, 1997, the Company's outstanding shares of common stock, $2.50 par value, are owned by Regulated Services. Information concerning the dividends paid on such stock and the ability to pay dividends is reported in the Statements of Common Shareholder's Equity and the Notes to Financial Statements included in Item 8. ITEM 6. SELECTED FINANCIAL DATA The Company, as the wholly owned subsidiary of a reporting person, is entitled to omit the information requested in this Item. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Questar Gas conducts natural-gas distribution operations. Following is a summary of financial results and operating information:
Year Ended December 31, 1997 1996 1995 (Dollars In Thousands) OPERATING INCOME Revenues Residential and commercial sales $399,174 $328,785 $315,458 Industrial sales 24,459 18,357 22,479 Industrial transportation 6,491 5,898 6,127 Other 18,099 18,888 18,705 Total revenues 448,223 371,928 362,769 Natural gas purchases 248,933 182,400 190,606 Revenues less natural gas purchases 199,290 189,528 172,163 Operating expenses Operating and maintenance 101,719 97,110 93,384 Depreciation and amortization 31,160 28,309 25,469 Other taxes 8,174 8,071 9,588 Total expenses 141,053 133,490 128,441 Operating income $58,237 $56,038 $43,722 OPERATING STATISTICS Natural gas volumes (in Mdth) Residential and commercial sales 85,747 80,844 73,950 Industrial deliveries Sales 9,523 8,584 9,210 Transportation 51,313 49,499 59,569 Total industrial 60,836 58,083 68,779 Total deliveries 146,583 138,927 142,729 Natural gas revenue (per dth) Residential and commercial $4.66 $4.07 $4.27 Industrial sales 2.57 2.14 2.44 Transportation for industrial customers 0.13 0.12 0.10 System natural gas cost (per dth) $2.62 $2.44 $2.16 Heating degree days (normal 5,801) 5,465 5,307 5,047 Warmer than normal 6% 9% 13% Number of customers at December 31, 641,696 618,231 592,738
Revenues, net of gas costs, increased $9,762,000 in 1997 when compared with 1996 and increased $17,365,000 in 1996 when compared with 1995. The increasesresulted primarily from higher heating demand caused by colder temperatures and customer additions somewhat offset by lower rates. Temperatures were 3% colder in 1997 when compared with 1996 and 5% colder in 1996 when compared with 1995. However, temperatures were warmer than normal for the three years presented. This warmer-than-normal temperature trend was mitigated in 1997 and 1996 as a result of a weather-normalization adjustment, which was part of a 1995 rate settlement. Virtually all of Questar Gas' residential and commercial volumes were covered under the weather-normalization adjustment in 1997 compared with about 50% in 1996. On February 4, 1997, Questar Gas filed an application with the Public Service Commission of Utah (PSCU) to reduce block rates, eliminate a new-premises fee for multi-family dwellings and reduce capacity-release revenues retained by Questar Gas from 20% to 10%. The PSCU approved the filing effective February 18, 1997. Revenues were $2.1 million lower in 1997 as a result of this reduction. In addition, a revenue surcharge to customers on the southern system, in effect for the past ten years, expired in the last half of 1997. This resulted in an approximate $.6 million decrease in 1997 revenues and an estimated $2.4 million reduction on a yearly basis. The surcharge was added to this area's customer bills to help pay for the system expansion in 1987. Questar Gas added 23,465 customers in 1997 and 25,493 customers in 1996 representing an increase of 3.8% and 4.3%, respectively. Customer additions in 1998 are expected to reach nearly 20,000. Gas deliveries to industrial customers increased 5% in 1997 when compared with 1996 after decreasing 16% in 1996. The increase in 1997 was due to the effects of a healthy regional economy. The 1996 decrease was the result of the availability of cheap electricity from hydropower sources, that reduced the use of gas for electricity generation. Questar Gas' natural gas purchases were higher in 1997 when compared with 1996 due to a higher natural gas cost component allowed in rates and an increase in volumes sold. The gas-cost component in Utah rates was increased in January, July and October of 1997 in an effort to recover sharply increased natural gas purchase costs incurred during the 1996-1997 heating season. The PSCU approved, on an interim basis, gas cost pass through filings in 1997 for a total $86.8 million annualized increase. The Public Service Commission of Wyoming (PSCW) also approved annualized rate increases of $3.6 million to allow recovery of purchased gas costs. In March 1998, the PSCW approved Questar Gas' gas-merchant unbundling proposal that was filed in Wyoming in 1997. Under this plan, a transportation service option is extended to residential and commercial customers as well as industrial customers. Customers choosing transportation service are allowed to secure gas supplies directly from producers and marketers and pay Questar Gas a fee for transportation services. Questar Gas continues to offer a traditional bundled sales service as well. The Company expects that the option of unbundled service in Wyoming will not have a material effect on earnings. Questar Gas will maintain its current structure in Utah. At December 31, 1997, Questar Gas served 21,632 customers in the state of Wyoming representing, 3% of the total number of customers served. Questar Gas' operating and maintenance (O & M) expenses increased 5% in 1997 due primarily to costs of serving an expanding customer base, higher labor costs and modernization of key computer systems. O & M expenses increased 4% in 1996. Questar Gas initiated cost-containment measures intended to slow the increase of operating expenses. In 1997, Questar Gas and Questar Pipeline combined functions common to gas-distribution and gas-transmission operations in order to eliminate duplication. In 1995, Questar Gas closed five service centers, reduced activities at five other service centers and offered an early-retirement program. Depreciation expense was 10% higher in 1997 when compared to 1996 and 11% higher in 1996 when compared to 1995 as a result of Questar Gas' capital expenditures. Settlements of disputed tax assessments with state and local governmental agencies in 1996 resulted in reduced property taxes. Debt expense was 15% higher in 1997 when compared with 1996 primarily because of increased borrowings. Questar Gas borrowed an additional $50 million of medium-term debt between August and October of 1997 with a weighted average coupon rate of 6.88%. Also, short-term debt balances were higher in 1997. The effective income tax rate was 31.7% in 1997 and 1996 and 24.6% in 1995. The effective income tax rate was below the combined federal and state statutory rate of about 38% primarily due to income tax credits received from production of gas from certain properties. These credits amounted to $2,686,000 in 1997, $3,246,000 in 1996 and $4,376,000 in 1995. Year 2000 Costs: Questar Gas has undertaken steps to identify areas of concern and potential remedies, prioritize needs, estimate costs and begin work either to repair or replace data processing software and hardware affected by Year 2000 issues. The expense, associated with addressing Year 2000 related problems, is not expected to be material. However, measurement of the cost has not been completed. The solutions either involve replacement or repair of the affected software or hardware systems. Some replacement or upgrade of systems would take place in the normal course of business. Several systems, key to Questar Gas' operations, have been scheduled to be replaced through vendor supplied systems before 2000. The costs of repairing existing systems is expensed as incurred, while the costs of replacing systems is capitalized and depreciated generally over a three- to five-year period. LIQUIDITY AND CAPITAL RESOURCES Operating Activities Net cash provided from operating activities of $21,504,000 decreased 57% in 1997 when compared to 1996 due primarily to the effects that higher gas costs had on accounts receivable and purchased gas costs adjustments. Net cash provided from operating activities of $50,496,000 in 1996 decreased 26% when compared with 1995 due to higher costs of natural gas. Investing Activities Following is a summary of capital expenditures for 1997 and 1996, and a forecast of 1998 expenditures.
1998 Estimated 1997 1996 (In Thousands) New-customer service $30,800 $30,794 $29,152 Distribution system 9,400 10,507 10,594 Buildings 400 5,388 1,902 Computer software and hardware 16,100 9,083 7,321 General 8,700 9,603 2,688 $65,400 $65,375 $51,657
Expansion of the distribution system in response to the rapid growth in the number of customers was the focus of capital spending. The distribution system was extended by 509 miles of main, feeder and service lines. Financing Activities Questar Gas borrowed $50 million of medium-term notes and increased short-term debt by $23.8 million in 1997. The borrowed funds plus net cash provided from operating activities were used to finance capital expenditures, pay dividends and redeem the remaining balance of preferred stock. Forecasted 1998 capital expenditures of $65.4 million are expected to be financed with net cash provided from operations and borrowings from Questar. Questar makes loans to Questar Gas under a short-term borrowing arrangement. Short-term notes payable to Questar totaled $100,000,000 at December 31, 1997 with an interest rate of 6.02% and $76,200,000 at December 31, 1996 with an interest rate of 5.63%. Questar Gas' capital structure at December 31, 1997 was composed of 50% long-term debt and 50% common equity. Moody's and Standard and Poor's have rated the Company's long-term debt A1 and A+, respectively. Forward Looking Statements This annual report contains some forward looking statements about future operations and expectations of Questar Gas. Management believes they are reasonable representations of Questar Gas' expected performance at this time. Actual results may vary from management's stated expectations and projections. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's financial statements are included in Part IV, Item 14, herein. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Questar Gas has not changed its independent auditors or had any disagreements with them concerning accounting matters and financial statement disclosures within the last 24 months. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Company, as the wholly owned subsidiary of a reporting person, is entitled to omit all information requested in PART III (Items 10-13). PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1)(2) Financial Statements and Financial Statement Schedules. The financial statements identified in the List of Financial Statements are filed as part of this report. (3) Exhibits. The following is a list of exhibits required to be filed as a part of this report in Item 14(c). Exhibit No. Exhibit 3.1.* Restated Consolidated Articles of Incorporation dated August 15, 1980. (Exhibit No. 4(a) to Registration Statement No. 2-70087, filed December 1, 1980.) 3.2.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1982. (Exhibit No. 3(b) to Form 10-K Annual Report for 1982.) 3.3.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 10, 1983. (Included in Exhibit No. 4.1. to Registration Statement No. 2-84713, filed June 23, 1983.) 3.4.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated August 16, 1983. (Exhibit No. 3(a) to Form 8 Report amending the Company's Form 10-Q Report for Quarter Ended September 30, 1983.) 3.5.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated October 26, 1984. (Exhibit No. 3.5. to Form 10-K Annual Report for 1984.) 3.6.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1985. (Exhibit No. 3.1. to Form 10-Q Report for Quarter Ended June 30, 1985.) 3.7.* Articles of Amendment to Restated Consolidated Articles of Incorporation dated February 10, 1988. (Exhibit No. 3.7. to Form 10-K Annual Report for 1987.) 3.8.* Articles of Amendment to Restated Consolidated Articles of Incorporation dated December 31, 1997. (Exhibit No. 3.7. to Form 8-K Current Report for December 31, 1997.) 3.9.* Bylaws (as amended effective August 11, 1992). (Exhibit No. 3.8. to Form 10-K Annual Report for 1992.) 4.* Indenture dated as of May 1, 1992, between the Company and Citibank, as trustee, for the Company's Debt Securities. (Exhibit No. 4. to Form 10-Q Report for Quarter Ended June 30, 1992.) 10.1.* Stipulations and Agreement, dated October 14, 1981, executed by Mountain Fuel Supply Company; Wexpro Company; the Utah Department of Business Regulations, Division of Public Utilities; the Utah Committee of Consumer Services; and the staff of the Public Service Commission of Wyoming. (Exhibit No. 10(a) to Form 10-K Annual Report for 1981.) 10.7.* 1\ Data Processing Services Agreement effective July 1, 1985, between Questar Service Corporation and Mountain Fuel Supply Company. (Exhibit 10.7. to Form 10-K Annual Report for 1988.) 10.8. 2\ Annual Management Incentive Plan adopted by Questar Gas Company, Questar Pipeline Company, and Questar Regulated Services Company. 10.9.* 1,2\ Mountain Fuel Supply Company Window Period Supplemental Executive Retirement Plan effective January 24, 1991. (Exhibit No. 10.9. to Form 10-K Annual Report for 1990.) 10.10.*1,2\ Mountain Fuel Supply Company Deferred Compensation Plan for Directors as amended and restated effective February 13, 1997. (Exhibit No. 10.10. to Form 10-K Annual Report for 1995.) 10.11.*1\ Gas Gathering Agreement between Mountain Fuel Supply Company and Questar Pipeline Company effective September 1, 1993. (This agreement has been transferred to Questar Gas Management Company.) (Exhibit No. 10.11. to Form 10-K Annual Report for 1994.) 10.12. 1\ Amendment to Gas Gathering Agreement between Mountain Fuel Supply Company and Questar Gas Management Company effective September 1, 1997. 12. Ratio of Earnings to Fixed Charges. 23. Consent of Independent Auditors. 24. Power of Attorney. 27. Financial Data Schedule. _______________________ *Exhibits so marked have been filed with the Securities and Exchange Commission as part of the referenced filing and are incorporated herein by reference. 1\This document has not been formally amended to refer to the Company's current name. 2\Exhibit so marked is a management contract or compensation plan or arrangement. (b) Questar Gas Company filed a Form 8-K reporting the name change that was legally effected on December 31, 1997. ANNUAL REPORT ON FORM 10-K ITEM 8, ITEM 14(a) (1) and (2), and (d) LIST OF FINANCIAL STATEMENTS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA YEAR ENDED DECEMBER 31, 1997 QUESTAR GAS COMPANY SALT LAKE CITY, UTAH FORM 10-K -- ITEM 14 (a) (1) AND (2) QUESTAR GAS COMPANY LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES The following financial statements of Questar Gas Company are included in Item 8: Statements of income -- Years ended December 31, 1997, 1996 and 1995 Balance sheets -- December 31, 1997 and 1996 Statements of common shareholder's equity -- Years ended December 31, 1997, 1996 and 1995 Statements of cash flows -- Years ended December 31, 1997, 1996 and 1995 Notes to financial statements Financial statement schedules, for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission, are not required under the related instructions or are inapplicable, and therefore have been omitted. Report of Independent Auditors Board of Directors Questar Gas Company We have audited the accompanying balance sheets of Questar Gas Company as of December 31, 1997 and 1996, and the related statements of income and common shareholder's equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Questar Gas Company at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Salt Lake City, Utah February 9, 1998 QUESTAR GAS COMPANY STATEMENTS OF INCOME
Year Ended December 31, 1997 1996 1995 (In Thousands) REVENUES From unaffiliated customers $445,684 $368,905 $358,758 From affiliated companies - Note 7 2,539 3,023 4,011 448,223 371,928 362,769 OPERATING EXPENSES Natural gas purchases From affiliated companies - Note 7 137,062 128,919 129,781 From unaffiliated parties 111,871 53,481 60,825 Total natural gas purchases 248,933 182,400 190,606 Operating and maintenance - Note 7 101,719 97,110 93,384 Depreciation and amortization 31,160 28,309 25,469 Other taxes 8,174 8,071 9,588 TOTAL OPERATING EXPENSES 389,986 315,890 319,047 OPERATING INCOME 58,237 56,038 43,722 INTEREST AND OTHER INCOME 3,388 3,033 4,232 DEBT EXPENSE (19,119) (16,637) (16,580) INCOME BEFORE INCOME TAXES 42,506 42,434 31,374 INCOME TAXES - Note 4 13,492 13,446 7,706 NET INCOME $29,014 $28,988 $23,668
See notes to financial statements. QUESTAR GAS COMPANY BALANCE SHEETS
ASSETS December 31, 1997 1996 (In Thousands) CURRENT ASSETS Cash and short-term investments $6,747 $1,875 Accounts receivable 46,054 38,141 Unbilled gas accounts receivable 37,302 23,528 Accounts receivable from affiliates 3,131 393 Federal income taxes receivable 1,109 Inventories, at lower of average cost or market Gas stored underground 15,829 11,647 Materials and supplies 4,518 3,648 Total inventories 20,347 15,295 Purchased-gas adjustments 37,251 24,210 Prepaid expenses and deposits 4,356 4,511 TOTAL CURRENT ASSETS 155,188 109,062 PROPERTY, PLANT AND EQUIPMENT Production - Note 8 97,870 97,870 Distribution 641,226 608,571 General 98,974 99,372 Construction in progress 44,866 19,308 882,936 825,121 Less allowances for depreciation and amortization 354,761 325,821 NET PROPERTY, PLANT AND EQUIPMENT 528,175 499,300 OTHER ASSETS Income taxes recoverable from customers 6,371 7,293 Unamortized costs of reacquired debt 9,102 9,596 Other 6,015 5,818 TOTAL OTHER ASSETS 21,488 22,707 $704,851 $631,069
LIABILITIES AND SHAREHOLDER'S EQUITY
December 31, 1997 1996 (In Thousands) CURRENT LIABILITIES Notes payable to Questar - Note 2 $100,000 $76,200 Accounts payable and accrued expenses Accounts payable 32,504 37,075 Accounts payable to affiliates 14,599 17,779 Federal income taxes 3,112 Other taxes 5,304 4,161 Interest 4,548 3,676 Other 4,420 3,867 Total accounts payable and accrued expenses 64,487 66,558 TOTAL CURRENT LIABILITIES 164,487 142,758 LONG-TERM DEBT - Notes 2 and 3 225,000 175,000 OTHER LIABILITIES Unbilled gas revenues 5,180 10,360 Other 809 570 TOTAL OTHER LIABILITIES 5,989 10,930 DEFERRED INVESTMENT TAX CREDITS 6,392 6,774 DEFERRED INCOME TAXES - Note 4 80,717 74,537 COMMITMENTS AND CONTINGENCIES - Note 5 REDEEMABLE CUMULATIVE PREFERRED STOCK $100 stated value, 4,000,000 shares authorized, 48,280 shares outstanding in 1996 4,828 COMMON SHAREHOLDER'S EQUITY Common stock-par value $2.50 per share; authorized 50,000 shares; issued and outstanding 9,189,626 shares 22,974 22,974 Additional paid-in capital 41,875 41,875 Retained earnings 157,417 151,393 TOTAL COMMON SHAREHOLDER'S EQUITY 222,266 216,242 $704,851 $631,069
See notes to financial statements. QUESTAR GAS COMPANY STATEMENTS OF COMMON SHAREHOLDER'S EQUITY
Additional Common Paid-in Retained Stock Capital Earnings (In Thousands) Balances at January 1, 1995 22,974 41,875 140,612 1995 net income 23,668 Payment of dividends Preferred stock (483) Common stock (20,000) Redemption cost (1) Balances at December 31, 1995 22,974 41,875 143,796 1996 net income 28,988 Payment of dividends Preferred stock (391) Common stock (21,000) Balances at December 31, 1996 22,974 41,875 151,393 1997 net income 29,014 Payment of dividends Preferred stock (192) Common stock (22,750) Premium paid on retired preferred stock (48) Balances at December 31, 1997 $22,974 $41,875 $157,417
See notes to financial statements. QUESTAR GAS COMPANY STATEMENTS OF CASH FLOWS
Year Ended December 31, 1997 1996 1995 (In Thousand) OPERATING ACTIVITIES Net income $29,014 $28,988 $23,668 Depreciation and amortization 33,739 31,214 28,295 Deferred income taxes 6,180 13,146 6,366 Deferred investment tax credits (382) (383) (384) 68,551 72,965 57,945 Changes in operating assets and liabilities Accounts receivable (24,425) 1,609 10,549 Inventories (5,052) 5,620 4,026 Prepaid expenses and deposits 155 (668) (722) Accounts payable and accrued expenses (5,183) 4,758 14,379 Federal income taxes 4,221 2,862 (5,620) Purchased-gas adjustments (13,041) (33,392) (7,889) Other (3,722) (3,258) (4,122) NET CASH PROVIDED FROM OPERATING ACTIVITIES 21,504 50,496 68,546 INVESTING ACTIVITIES Capital expenditures (65,375) (51,657) (51,413) Proceeds from disposition of property, plant and equipment 2,761 2,990 1,054 NET CASH USED IN INVESTING ACTIVITIES (62,614) (48,667) (50,359) FINANCING ACTIVITIES Redemption of preferred stock (4,876) (129) (1,367) Issuance of long-term debt 50,000 Change in notes payable to Questar 23,800 20,100 2,600 Payment of dividends (22,942) (21,391) (20,483) NET CASH PROVIDED FROM (USED IN) FINANCING ACTIVITIES 45,982 (1,420) (19,250) Change in cash and short-term investments 4,872 409 (1,063) Beginning cash and short-term investments 1,875 1,466 2,529 ENDING CASH AND SHORT-TERM INVESTMENTS $6,747 $1,875 $1,466
See notes to financial statements. QUESTAR GAS COMPANY NOTES TO FINANCIAL STATEMENTS Note 1 - Summary of Accounting Policies Questar Gas Company (the Company or Questar Gas), formerly Mountain Fuel Supply, is a wholly-owned subsidiary of Questar Regulated Services Company (Regulated Services). Regulated Services is a holding company and wholly-owned subsidiary of Questar Corporation (Questar). Regulated Services was organized in 1996 and provides administrative, accounting and engineering functions for its two subsidiaries, Questar Gas and Questar Pipeline Company (Questar Pipeline). Significant accounting policies are presented below. Business and Regulation: Questar Gas' business consists of natural gas distribution operations for residential, commercial and industrial customers. The Company is regulated by the Public Service Commission of Utah (PSCU) and the Public Service Commission of Wyoming (PSCW). While Questar Gas also serves a small area of southeastern Idaho, the Public Utilities Commission of Idaho has deferred to the PSCU for rate oversight of this area. These regulatory agencies establish rates for the sale and transportation of natural gas. The regulatory agencies also regulate, among other things, the extension and enlargement or abandonment of jurisdictional natural gas facilities. Regulation is intended to permit the recovery, through rates, of the cost of service including a rate of return on investment. The financial statements are presented in accordance with regulatory requirements. Methods of allocating costs to time periods, in order to match revenues and expenses, may differ from those of nonregulated businesses because of cost-allocation methods used in establishing rates. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent liabilities reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue Recognition: Revenues are recognized in the period that services are provided or products are delivered. Questar Gas accrues gas-distribution revenues for gas delivered to residential and commercial customers but not billed at the end of the accounting period. The Company periodically collects revenues subject to possible refund pending final orders from regulatory agencies. In these situations, Questar Gas establishes reserves for revenues collected subject to refund. Purchased-Gas Adjustments: Questar Gas accounts for purchased-gas costs in accordance with procedures authorized by the PSCU and PSCW whereby purchased-gas costs that are different from those provided for in the present rates are accumulated and recovered or credited through future rate changes. Cash and Short-Term Investments: Short-term investments consist principally of repurchase agreements with maturities of three months or less. Property, Plant and Equipment: Property, plant and equipment are stated at cost. The provision for depreciation and amortization is based upon rates which will systematically charge the costs of assets over their estimated useful lives. The costs of natural gas distribution property, plant and equipment, excluding gas wells, are amortized using the straight-line method ranging from 3% to 33% per year and averaging 4.2% in 1997. The costs of gas wells were amortized using the units-of-production method at $.16 per Mcf of natural gas production in 1997. Allowance for Funds Used During Construction: The Company capitalizes the cost of capital during the construction period of plant and equipment using a method required by regulatory authorities. This amounted to $261,000 in 1997, $277,000 in 1996 and $391,000 in 1995. Reacquisition of Debt: Gains and losses on the reacquisition of debt are deferred and amortized as debt expense over the life of the replacement debt in order to match regulatory treatment. Income Taxes: Questar Gas records cumulative increases in deferred taxes as income taxes recoverable from customers. The Company has adopted procedures with its regulatory commissions to include under-provided deferred taxes in customer rates on a systematic basis. Questar Gas uses the deferral method to account for investment-tax credits as required by regulatory commissions. The Company's operations are consolidated with those of Questar and its subsidiaries for income tax purposes. The income tax arrangement between Questar Gas and Questar provides that amounts paid to or received from Questar are substantially the same as would be paid or received by the Company if it filed a separate return. Questar Gas also receives payment for tax benefits used in the consolidated tax return even if such benefits would not have been usable had the Company filed a separate return. Reclassification: Certain reclassifications were made to the 1996 and 1995 financial statements to conform with the 1997 presentation. Note 2 - Debt Questar makes loans to Questar Gas under a short-term borrowing arrangement. Short-term notes payable to Questar totaled $100,000,000 at December 31, 1997 with an interest rate of 6.02% and $76,200,000 at December 31, 1996 with an interest rate of 5.63%. Questar Gas' long-term debt consists of medium-term notes with interest rates ranging from 6.85% to 8.43%, due 2007 to 2024. Questar Gas filed a registration statement with the Securities and Exchange Commission for the issuance of up to $75 million in medium-term notes, which became effective July 23, 1997. The Company issued $50 million of medium-term notes having a weighted average coupon rate of 6.88% and a weighted average maturity of 16.5 years in 1997. There are no maturities of long-term debt for the five years following December 31, 1997 and no long-term debt provisions restricting the payment of dividends. Cash paid for interest was $17,933,000 in 1997, $16,346,000 in 1996 and $16,458,000 in 1995. Note 3 - Financial Instruments and Credit Management Activities The carrying amounts and estimated fair values of the Company's financial instruments were as follows:
December 31, 1997 December 31, 1996 Book Estimated Book Estimated Value Fair Value Value Fair Value (In Thousands) Financial assets Cash and short-term investments $6,747 $6,747 $1,875 $1,875 Financial liabilities Short-term loans 100,000 100,000 76,200 76,200 Long-term debt 225,000 255,615 175,000 190,793 Redeemable cumulative preferred stock 4,828 4,876
The Company used the following methods and assumptions in estimating fair values: (1) Cash and short-term investments, and short-term loans - book value approximates fair value; (2) Long-term debt - the fair value of the medium-term notes is based on the discounted present value of cash flows using the Company's current borrowing rates; Fair value is calculated at a point in time and does not represent what the Company would pay to retire the debt securities. Credit Risk: Questar Gas' primary market area is the Rocky Mountain region of the United States. Exposure to credit risk may be impacted by the concentration of customers in this region due to changes in economic or other conditions. Customers include individuals and numerous industries that may be affected differently by changing conditions. Management believes that its credit-review procedures, loss reserves and customer deposits have adequately provided for usual and customary credit-related losses. Note 4 - Income Taxes The components of income taxes were as follows:
Year Ended December 31, 1997 1996 1995 (In Thousands) Federal Current $5,334 ($678) ($294) Deferred 6,636 12,906 7,099 State Current 1,107 254 302 Deferred 797 1,347 983 Deferred investment tax credits (382) (383) (384) $13,492 $13,446 $7,706
The difference between income tax expense and the tax computed by applying the statutory federal income tax rate of 35% to income before income taxes is explained as follows:
Year Ended December 31, 1997 1996 1995 (In Thousands) Income before income taxes $42,506 $42,434 $31,374 Federal income taxes at statutory rate $14,877 $14,852 $10,981 State income taxes, net of federal income tax benefit 1,155 1,512 1,179 Tight-sands gas production credits (2,686) (3,246) (4,376) Investment-tax credits (382) (383) (384) Reduction in deferred income tax rate (571) Deferred taxes related to regulated assets for which deferred taxes were not provided in prior years 921 921 921 Other (393) (210) (44) Income tax expense $13,492 $13,446 $7,706 Effective income tax rate 31.7% 31.7% 24.6%
Significant components of the Company's deferred tax liabilities and assets were as follows:
December 31, 1997 1996 (In Thousands) Deferred tax liabilities Property, plant and equipment $74,694 $73,979 Purchased-gas adjustments 14,155 9,200 Other 7,135 8,680 Total deferred tax liabilities 95,984 91,859 Deferred tax assets Alternative minimum tax and production credit carryovers 7,866 7,546 Unbilled revenues 1,968 3,937 Other 5,433 5,839 Total deferred tax assets 15,267 17,322 Net deferred tax liabilities $80,717 $74,537
Cash paid for income taxes was $1,516,000 in 1997 and $7,333,000 in 1995. Questar Gas applied an overpayment of 1995 income taxes to more than offset payment of 1996 taxes. Note 5 - Rate Matters, Litigation and Commitments On January 8, 1997, the Utah Division of Public Utilities (Division) filed a motion with the PSCU seeking an investigation into the reasonableness of Questar Gas' rates and requesting an interim rate decrease of $3.5 million. On January 29, 1997, the Division withdrew its petition, and the PSCU accepted that action after Questar Gas agreed to reduce rates and charges by $2.85 million annually. On February 4, 1997, Questar Gas filed an application with the PSCU to reduce block rates, eliminate the new-premises fee for multi-family dwellings, and reduce the capacity-release revenue retained by Questar Gas from 20% to 10%. The PSCU approved the filing effective February 18, 1997. The PSCU approved a purchased gas-cost recovery application on an interim basis, effective January 1, 1996. In connection with the application and pass-through cases filed since then, the Division has raised issues about the reasonableness of gas-gathering costs for field-purchased gas gathered by Market Resources affiliate, Questar Gas Management. Hearings were held January 6, 1998 at which the Division requested that the PSCU disallow gas gathering costs of approximately $7.6 million plus a $.2 million interest charge. Briefs have been filed with the PSCU. The Company's management believes that its gathering costs are reasonable and in compliance with contract terms and applicable laws. The Company cannot predict the resolution of this dispute or any financial impact of such resolution on its balance sheet, income statement, or cash flows at the current time. The PSCW approved Questar Gas' gas-merchant unbundling proposal that was filed in Wyoming in 1997. Under this plan, a transportation service option is extended to residential and commercial customers as well as industrial customers. Customers choosing transportation service are allowed to secure gas supplies directly from producers and marketers and pay Questar Gas a fee for transportation services. Questar Gas continues to offer a traditional bundled sales service as well. Questar Gas expects that the option of unbundled service in Wyoming will not have a material effect on earnings. The Company will maintain its current structure in Utah. At December 31, 1997, Questar Gas served 21,632 customers in the state of Wyoming representing 3% of the total number of customers served. Questar Gas, as a result of acquiring Questar Pipeline's gas-purchase contracts, is responsible for any judgment rendered against Questar Pipeline in a lawsuit that was tried before a jury in 1994. The jury awarded an independent producer compensatory damages of approximately $6.1 million and punitive damages of $200,000 on his claims. The producer's counterclaims originally exceeded $57 million, but were reduced to less than $10 million, when the presiding judge dismissed with prejudice some of the claims prior to the jury trial. The Company's management believes that any payments resulting from this judgment will be included in Questar Gas' gas balancing account and recovered in its rates for natural gas service. This same producer has recently filed additional claims against the Company and its affiliates in the same court and with the same presiding judge. The new lawsuit, which is currently assigned to the same judge presiding over the earlier litigation, updates the claims in the original lawsuit for the period since the trial and adds new claims of fraud and antitrust violations. The Company has informed the producer that it will make any payments for the period subsequent to the date covered by the original trial once the presiding judge enters judgment and rules on pending post-trial motions. The Company's management believes that the producer's new allegations of fraud and antitrust violation are without merit. Questar Gas is involved in an environmental clean-up action on a site that involves numerous other parties. Management believes that the Company's responsibility for remediation will be minor and that any potential liability will not be significant to its results of operations, financial position or liquidity. There are various legal proceedings against the Company. While it is not currently possible to predict or determine the outcome of these proceedings, it is the opinion of management that the outcome will not have a material adverse effect on the Company's results of operations, financial position or liquidity. Each year, Questar Gas purchases significant quantities of natural gas under numerous gas-purchase contracts with varying terms and conditions. Purchases under these agreements totalled $122,106,000 in 1997, $67,249,000 in 1996 and $44,892,000 in 1995. Historically, gas-purchase contracts extended over many years. However, it is now common practice to set contract terms for anywhere from one day up to one year. With this trend toward shorter-term contracts, as of February 1, 1998, substantially all long-term contracts have expired. The remaining long-term contracts are not material. Note 6 - Employee Benefits Pension Plan: Substantially all of Questar Gas' employees are covered by Questar's defined benefit pension plan. Benefits are generally based on years of service and the employee's 36-month period of highest earnings during the 10 years preceding retirement. It is Questar's policy to make contributions to the plan at least sufficient to meet the minimum funding requirements of applicable laws and regulations. Plan assets consist principally of equity securities and corporate and U.S. government debt obligations. Questar Gas transferred employees and related benefit costs to Regulated Services as part of its reorganization of administrative services in 1997. Pension cost was $1,847,000 in 1997, $2,820,000 in 1996 and $3,352,000 in 1995. Questar Gas' portion of plan assets and benefit obligations is not determinable because the plan assets are not segregated or restricted to meet the Company's pension obligations. If the Company were to withdraw from the pension plan, the pension obligation for the Company's employees would be retained by the pension plan. At December 31, 1997, Questar's fair value of plan assets exceeded the accumulated benefit obligation. Postretirement Benefits Other Than Pensions: Questar Gas pays a portion of health-care costs and life insurance costs for employees who retired prior to January 1, 1993. The plan changed for employees hired on or after January 1, 1993, to link the health-care benefits to years of service and to limit Questar's monthly health care contribution per individual to 170% of the 1992 contribution. Employees hired after December 31, 1996, do not qualify for postretirement medical benefits under this plan. The Company's policy is to fund amounts allowable for tax deduction under the Internal Revenue Code. Plan assets consist of equity securities and corporate and U.S. government debt obligations. The Company is amortizing the transition obligation over a 20-year period, which began in 1992. Costs of postretirement benefits other than pensions were $1,993,000 in 1997, $2,424,000 in 1996 and $3,183,000 in 1995. Both the PSCU and the PSCW allowed Questar Gas to recover future costs if the amounts are funded in an external trust. The Company's portion of plan assets and benefit obligations related to postretirement medical and life insurance benefits is not determinable because the plan assets are not segregated or restricted to meet the Company's obligations. Postemployment Benefits: The Company recognizes the net present value of the liability for postemployment benefits, such as long-term disability benefits and health-care and life-insurance costs, when employees become eligible for such benefits. Postemployment benefits are paid to former employees after employment has been terminated but before retirement benefits are paid. The Company accrues both current and future costs. The PSCU and the PSCW have allowed Questar Gas to recover postemployment costs accumulated through December 31, 1994 in future rates. At December 31, 1997, the Company had a $727,000 regulatory asset that it is amortizing over the next seven years. Employee Investment Plan: Questar Gas participates in Questar's Employee Investment Plan (ESOP), which allows eligible employees to purchase Questar common stock or other investments through payroll deduction. The Company makes contributions of Questar common stock to the ESOP of approximately 75% of the employees' purchases and contributes an additional $200 of common stock in the name of each eligible employee. The Company's expense and contribution to the plan was $1,552,000 in 1997, $1,893,000 in 1996, and $1,622,000 in 1995. Note 7 - Related Party Transactions Questar Regulated Services was organized in 1996 and provides services common to its two subsidiaries, Questar Gas and Questar Pipeline. Regulated Services began providing administrative, technical and accounting support in 1997. Employees in these functions from both companies were reassigned to Regulated Services. Regulated Services charged Questar Gas $26,061,000 in 1997. These costs are included in operating and maintenance expenses, primarily, and are allocated based on several methods dictated by the nature of the charges. Management believes that the allocation methods are reasonable. Questar Gas purchased transportation and storage services from Questar Pipeline amounting to $64,924,000 in 1997, $61,078,000 in 1996 and $54,083,000 in 1995. The costs of these services were included in natural gas purchases. Also included in natural gas purchases are amounts paid to Questar Gas Management for gathering of Company-owned gas and purchased gas. These costs amounted to $12,472,000 in 1997, $14,515,000 in 1996 and $15,867,000 in 1995. Questar Gas has reserved transportation capacity on Questar Pipeline's system of approximately 800,000 decatherms per day and paid an annual demand charge of approximately $49.6 million for this reservation. Questar Gas releases excess capacity to its industrial transportation or other customers and receives a credit from Questar Pipeline for the released-capacity revenues and a portion of Questar Pipeline's interruptible-transportation revenues. Wexpro, an affiliated company, operates certain properties owned by Questar Gas under the terms of the Wexpro Settlement Agreement. The Company receives a portion of Wexpro's income from oil operations after recovery of Wexpro's operating expenses and a return on investment. This amount, which is included in revenues, was $2,347,000 in 1997, $2,768,000 in 1996 and $3,400,000 in 1995. Questar Gas paid Wexpro for the operation of gas properties owned by Questar Gas. These costs are included in natural gas purchases and amounted to $49,887,000 in 1997, $53,119,000 in 1996 and $59,831,000 in 1995. In addition in 1997, Questar Gas purchased $568,000 worth of gas from Questar Gas Management and $133,000 from Wexpro. Questar Gas purchased gas from Questar Energy Trading and Questar Gas Management in 1997 and paid $9,078,000 and $559,000, respectively. Questar Gas has a 15-year lease for some space in an office building located in Salt Lake City, Utah, that is owned by affiliated company, Interstate Land. The annual lease payment for the next five years, beginning in 1998, is $1,155,000. Questar InfoComm Inc. is an affiliated company that provides data processing and communication services to Questar Gas. The Company paid Questar InfoComm $19,875,000 in 1997, $16,343,000 in 1996 and $15,781,000 in 1995. Questar charges Questar Gas for certain administrative functions amounting to $5,518,000 in 1997, $5,746,000 in 1996 and $5,283,000 in 1995. These costs are included in operating and maintenance expenses and are allocated based on each affiliated company's proportional share of revenues less gas costs; property, plant and equipment; and labor costs. Management believes that the allocation method is reasonable. Questar Gas incurred debt expense to Questar of $3,575,000 in 1997, $1,906,000 in 1996 and $1,273,000 in 1995 and received interest income from affiliated companies of $126,000 in 1997 and $10,000 in 1995. Note 8 - Oil and Gas Producing Activities (Unaudited) The following information discusses the Company's oil and gas producing activities. All of the properties are cost-of-service properties with the return on investment established by state regulatory agencies. Questar Gas has not incurred any costs for oil and gas producing activities for the three years ended December 31, 1997. Wexpro develops and produces gas reserves owned by the Company. See Note 7 for the amounts paid by Questar Gas to Wexpro. Estimated Quantities of Proved Oil and Gas Reserves: The following estimates were made by Questar's reservoir engineers. Reserve estimates are based on a complex and highly interpretive process which is subject to continuous revision as additional production and development drilling information becomes available. The quantities are based on existing economic and operating conditions using current prices and operating costs. All oil and gas reserves reported are located in the United States. Questar Gas does not have any long-term supply contracts with foreign governments or reserves of equity investees. No estimates are available for proved undeveloped reserves that may exist.
Natural Gas Oil (In Million (In Thousands Cubic Feet) of Barrels) Proved Developed Reserves Balance at January 1, 1995 416,312 707 Revisions of estimates (831) 10 Extensions and discoveries 10,591 2 Production (36,632) (57) Balance at December 31, 1995 389,440 662 Revisions of estimates 4,365 (44) Extensions and discoveries 2,812 2 Production (36,740) (56) Balance at December 31, 1996 359,877 564 Revisions of estimates 7,008 41 Extensions and discoveries 7,439 28 Production (37,454) (24) Balance at December 31, 1997 336,870 609
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on the 27th day of March, 1998. QUESTAR GAS COMPANY (Registrant) By /s/ D. N. Rose D. N. Rose President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. /s/ D. N. Rose President and Chief Executive D. N. Rose Officer; Director (Principal Executive Officer) /s/ S. E. Parks Vice President, Treasurer and Chief S. E. Parks Financial Officer (Principal Financial Officer) /s/ G. H. Robinson Vice President and Controller G. H. Robinson (Principal Accounting Officer) *R. D. Cash Chairman of the Board *W. Whitley Hawkins Director *Robert E. Kadlec Director *Dixie L. Leavitt Director *Gary G. Michael Director *G. L. Nordloh Director *D. N. Rose Director *Harris H. Simmons Director March 27, 1998 *By /s/ D. N. Rose Date D. N. Rose, Attorney in Fact EXHIBIT INDEX Exhibit Number Exhibit 3.1.* Restated Consolidated Articles of Incorporation dated August 15, 1980. (Exhibit No. 4(a) to Registration Statement No. 2-70087, filed December 1, 1980.) 3.2.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1982. (Exhibit No. 3(b) to Form 10-K Annual Report for 1982.) 3.3.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 10, 1983. (Included in Exhibit No. 4.1. to Registration Statement No. 2-84713, filed June 23, 1983.) 3.4.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated August 16, 1983. (Exhibit No. 3(a) to Form 8 Report amending the Company's Form 10-Q Report for Quarter Ended September 30, 1983.) 3.5.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated October 26, 1984. (Exhibit No. 3.5. to Form 10-K Annual Report for 1984.) 3.6.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1985. (Exhibit No. 3.1. to Form 10-Q Report for Quarter Ended June 30, 1985.) 3.7.* Articles of Amendment to Restated Consolidated Articles of Incorporation dated February 10, 1988. (Exhibit No. 3.7. to Form 10-K Annual Report for 1987.) 3.8.* Articles of Amendment to Restated Consolidated Articles of Incorporation dated December 31, 1997. (Exhibit No. 3.7. to Form 8-K Current Report for December 31, 1997.) 3.9.* Bylaws (as amended effective August 11, 1992). (Exhibit No. 3.8. to Form 10-K Annual Report for 1992.) 4.* Indenture dated as of May 1, 1992, between the Company and Citibank, as trustee, for the Company's Debt Securities. (Exhibit No. 4. to Form 10-Q Report for Quarter Ended June 30, 1992.) 10.1.* Stipulations and Agreement, dated October 14, 1981, executed by Mountain Fuel Supply Company; Wexpro Company; the Utah Department of Business Regulations, Division of Public Utilities; the Utah Committee of Consumer Services; and the staff of the Public Service Commission of Wyoming. (Exhibit No. 10(a) to Form 10-K Annual Report for 1981.) 10.7.* 1\ Data Processing Services Agreement effective July 1, 1985, between Questar Service Corporation and Mountain Fuel Supply Company. (Exhibit 10.7. to Form 10-K Annual Report for 1988.) 10.8. 2\ Annual Management Incentive Plan adopted by Questar Gas Company, Questar Pipeline Company, and Questar Regulated Services Company. 10.9.* 1,2\ Mountain Fuel Supply Company Window Period Supplemental Executive Retirement Plan effective January 24, 1991. (Exhibit No. 10.9. to Form 10-K Annual Report for 1990.) 10.10.* 1,2\ Mountain Fuel Supply Company Deferred Compensation Plan for Directors as amended and restated effective February 13, 1997. (Exhibit No. 10.10. to Form 10-K Annual Report for 1995.) 10.11.* 1\ Gas Gathering Agreement between Mountain Fuel Supply Company and Questar Pipeline Company effective September 1, 1993. (This agreement has been transferred to Questar Gas Management Company.) (Exhibit No. 10.11. to Form 10-K Annual Report for 1994.) 10.12. 1\ Amendment to Gas Gathering Agreement between Mountain Fuel Supply Company and Questar Gas Management Company effective September 1, 1997. 12. Ratio of Earnings to Fixed Charges. 23. Consent of Independent Auditors. 24. Power of Attorney. 27. Financial Data Schedule. _______________________ *Exhibits so marked have been filed with the Securities and Exchange Commission as part of the referenced filing and are incorporated herein by reference. 1\This document has not been formally amended to refer to the Company's current name. 2\Exhibit so marked is a management contract or compensation plan or arrangement. (b) Questar Gas Company filed a Form 8-K reporting the name change that was legally effected on December 31, 1997. EX-10.8 2 EXHIBIT NO. 10.8 QUESTAR REGULATED SERVICES COMPANY, QUESTAR GAS COMPANY, AND QUESTAR PIPELINE COMPANY ANNUAL MANAGEMENT INCENTIVE PLAN Paragraph 1. Name. The name of this Plan is the Annual Management Incentive Plan (the Plan) for Questar Regulated Services Company, Questar Gas Company, and Questar Pipeline Company (collectively referred to as Regulated Services). Paragraph 2. Purpose. The purpose of the Plan is to provide an incentive to officers and key employees of Regulated Services for the accomplishment of major organizational and individual objectives designed to further the efficiency, profitability, and growth of Regulated Services. Paragraph 3. Administration. The Management Performance Committee (Committee) of the Board of Directors of Questar Corporation (Questar) shall have full power and authority to interpret and administer the Plan. Such Committee shall consist of no less than three disinterested members of the Board of Directors. Recommendations made by the Committee shall be reviewed by the Boards of Directors of participating employers. Paragraph 4. Participation. Within 60 days after the beginning of each year, the Committee shall nominate Participants from the officers and key employees for such year. The Committee shall also establish a target bonus for the year for each Participant expressed as a percentage of base salary or specified portion of base salary. Participants shall be notified of their selection and their target bonus as soon as practicable. Paragraph 5. Determination of Performance Objectives. Within 60 days after the beginning of each year, the Committee shall establish target, minimum, and maximum performance objectives for Regulated Services and for its affiliates and shall determine the manner in which the target bonus is allocated among the performance objectives. The Committee shall also recommend a dollar maximum for payments to Participants for any Plan year. The Board of Directors shall take action concerning the recommended dollar maximum within 60 days after the beginning of the Plan year. Participants shall be notified of the performance objectives as soon as practicable once such objectives have been established. Paragraph 6. Determination and Distribution of Awards. As soon as practicable, but in no event more than 90 days after the close of each year during which the Plan is in effect, the Committee shall compute incentive awards for eligible participants in such amounts as the members deem fair and equitable, giving consideration to the degree to which the Participant's performance has contributed to the performance of Regulated Services and its affiliated companies and using the target bonuses and performance objectives previously specified. Aggregate awards calculated under the Plan shall not exceed the maximum limits approved by the Board of Directors for the year involved. To be eligible to receive a payment, the Participant must be actively employed by Regulated Services or an affiliate as of the date of distribution except as provided in Paragraph 8. Amounts shall be paid (less appropriate withholding taxes and FICA deductions) according to the following schedule: Award Distribution Schedule Percent of Award Date Initial Award 75% As soon as possible after initial award is (First Year determined of Participation) 25 One year after initial award is determined 100% Subsequent Awards 50% As soon as possible after award is determined 25 One year after award is determined 25 Two years after award is determined 100% Paragraph 7. Restricted Stock in Lieu of Cash. Participants who have a target bonus of $10,000 or higher shall be paid all deferred portions of such bonus with restricted shares of Questar's common stock under Questar's Long-Term Stock Incentive Plan. Such stock shall be granted to the participant when the initial award is determined, but shall vest free of restrictions according to the schedule specified above in Paragraph 6. Paragraph 8. Termination of Employment. (a) In the event a Participant ceases to be an employee during a year by reason of death, disability or approved retirement, an award, if any, determined in accordance with Paragraph 6 for the year of such event, shall be reduced to reflect partial participation by multiplying the award by a fraction equal to the months of participation during the applicable year through the date of termination rounded up to whole months divided by 12. For the purpose of this Plan, approved retirement shall mean any termination of service on or after age 60, or, with approval of the Board of Directors, early retirement under Questar's qualified retirement plan. For the purpose of this Plan, disability shall mean any termination of service that results in payments under Questar's long-term disability plan. The entire amount of any award that is determined after the death of a Participant shall be paid in accordance with the terms of Paragraph 11. In the event of termination of employment due to disability or approved retirement, a Participant shall be paid the undistributed portion of any prior awards in his final paycheck or in accordance with the terms of elections to voluntarily defer receipt of awards earned prior to February 12, 1991, or deferred under the terms of Questar's Deferred Compensation Plan. In the event of termination due to disability or approved retirement, any shares of common stock previously credited to a Participant shall be distributed free of restrictions during the last month of employment. The current market value (defined as the closing price for the stock on the New York Stock Exchange on the date in question) of such shares shall be included in the Participant's final paycheck. Such Participant shall be paid the full amount of any award (adjusted for partial participation) declared subsequent to the date of such termination within 30 days of the date of declaration. Any partial payments shall be made in cash. (b) In the event a Participant ceases to be an employee during a year by reason of a change in control, he shall be entitled to receive all amounts deferred by him prior to February 12, 1991, and all undistributed portions for prior Plan years. He shall also be entitled to an award for the year of such event as if he had been an employee throughout such year. The entire amount of any award for such year shall be paid in a lump sum within 60 days after the end of the year in question. Such amounts shall be paid in cash. For the purpose of this Plan, a "change in control" shall be deemed to have occurred if (i) any "Acquiring Person" (as that term is used in the Rights Agreement dated February 13, 1996, between Questar and Chemical Mellon Shareholder Services, L.L.C. ("Rights Agreement")) is or becomes the beneficial owner (as such term is used in Rule 13d-3 under the Securities Exchange Act of 1934) of securities of Questar representing 15 percent or more of the combined voting power of Questar, or (ii) the stockholders of Questar approve (A) a plan of merger or consolidation of Questar (unless, immediately following consummation of such merger or consolidation, the persons who held Questar's voting securities immediately prior to consummation thereof will hold at least a majority of the total voting power of the surviving or new company), or (B) a sale or disposition of all or substantially all assets of Questar, or (C) a plan of liquidation or dissolution of Questar. A change of control shall also include any act or event that, with the passage of time, would result in a Distribution Date, within the meaning of the Rights Agreement. Paragraph 9. Interest on Previously Deferred Amounts. Amounts voluntarily deferred prior to February 12, 1991, shall be credited with interest from the date the payment was first available in cash to the date of actual payment. Such interest shall be calculated at a monthly rate using the typical rates paid by major banks on new issues of negotiable Certificates of Deposit in the amounts of $1,000,000 or more for one year as quoted in The Wall Street Journal on the first day of the relevant calendar month or the next preceding business day if the first day of the month is a non-business day. Paragraph 10. Coordination with Deferred Compensation Plan. Some Participants are entitled to defer the receipt of their cash bonuses under the terms of Questar's Deferred Compensation Plan, which became effective November 1, 1993. Any cash bonuses deferred pursuant to the Deferred Compensation Plan shall be accounted for and distributed according to the terms of such plan and the choices made by the Participant. Paragraph 11. Death and Beneficiary Designation. In the event of the death of a Participant, any undistributed portions of prior awards shall become payable. Amounts previously deferred by the Participant, together with credited interest to the date of death, shall also become payable. Each Participant shall designate a beneficiary to receive any amounts that become payable after death under this Paragraph or Paragraph 8. In the event that no valid beneficiary designation exists at death, all amounts due shall be paid as a lump sum to the estate of the Participant. Any shares of restricted stock previously credited to the Participant shall be distributed to the Participant's beneficiary or, in the absence of a valid beneficiary designation, to the Participant's estate, at the same time any cash is paid. Paragraph 12. Amendment of Plan. The Boards of Directors for the participating employers, at any time, may amend, modify, suspend, or terminate the Plan, but such action shall not affect the awards and the payment of such awards for any prior years. The Boards of Directors for the participating employers cannot terminate the Plan in any year in which a change of control has occurred without the written consent of the Participants. The Plan shall be deemed suspended for any year for which the Board of Directors has not fixed a maximum dollar amount available for award. Paragraph 13. Nonassignability. No right or interest of any Participant under this Plan shall be assignable or transferable in whole or in part, either directly or by operation of law or otherwise, including, but not by way of limitation, execution, levy, garnishment, attachment, pledge, bankruptcy, or in any other manner, and no right or interest of any Participant under the Plan shall be liable for, or subject to, any obligation or liability of such Participant. Any assignment, transfer, or other act in violation of this provision shall be void. Paragraph 14. Effective Date of the Plan. The Plan shall be effective with respect to the fiscal year beginning January 1, 1997, and shall remain in effect until it is suspended or terminated as provided by Paragraph 12. This Plan replaces the individual plans previously adopted by Questar Gas and Questar Pipeline that became effective January 1, 1984. Plan participants who previously received awards under predecessor plans or any other Annual Management Incentive Plan adopted by an affiliate shall be treated as ongoing participants for purposes of the distribution schedule in Paragraph 6. EX-10.12 3 EXHIBIT NO. 10.12 Amendment to the Gas Gathering Agreement Between Questar Gas Company and Questar Gas Management Company This Amendment is entered into this 6th day of February, 1998, between Questar Gas Company and Questar Gas Management Company. The Parties represent as follows: A. Mountain Fuel Supply Company (MFS) and Questar Pipeline Company entered into a Gas Gathering Agreement on October 11, 1993 (Agreement). B. Questar Gas Management Company (QGM) assumed all of Questar Pipeline Company's interest, rights, duties and obligations under the Agreement in an Assignment dated March 1, 1996 (Assignment). C. Mountain Fuel Supply Company became Questar Gas Company (QGC) on January 1, 1998. The Parties agree as follows: Article III (a)(3) to the Agreement is deleted and the first amended Article III (a)(3) below is inserted in its place. Article III - Gathering Charges, Reimbursements and Credits (3) Effective after August 31, 1997, until the termination of this Agreement, rates will be redetermined each year, to be effective from September 1 through the following August 31, and will be based on: (i) An allocated portion of the annual cost of service for the prior calendar year that is attributable to QGM's gathering function through which any gas dedicated under Section I(d) flows during that year, in accordance with the methodology shown in Appendix B. The allocation for each cost center under this subparagraph shall be the ratio of the November through March volumes dedicated and flowing under Section I(d) to total November through March volumes for each cost center. (ii) An assignment of 60% of the resultant annual gathering cost of service to demand charges and 40% to commodity charges. (iii) Billing determinants. Demand charge: Each month's demand charge is one-twelfth of the total demand allocation. Commodity charge: the actual quantity gathered under this Agreement during the prior calendar year. (iv) Gathering rates will be determined based on Questar Gas' share of the costs for each of QGM's gathering cost centers. 2. Paragraphs 3.(d) (e) (f) and (g) of Appendix B to the Agreement are deleted and first amended paragraphs 3.(d) (e) (f) (g) and (h) of Appendix B to the Agreement below are inserted in their place. (d) Federal and State Income Taxes. Questar Gas' combined federal and state income tax rate shall be applied to the equity portion of the return on rate base. (e) Rate Base. The average rate base shall be determined by taking an average of the beginning and ending months for which data are being used pursuant to paragraph 1 above (adjusted as necessary pursuant to that paragraph) and shall include that portion of the following that are directly related or allocable to the gathering services performed under this Agreement: (i) Gas plant, (ii) Accumulated depreciation and amortization, (iii) Working capital, (iv) Deferred income taxes, and (v) QGM's general and intangible plant (f) Rate of Return. The rate of return on rate base shall be the pre-tax rate of return derived from the overall rate of return allowed by the Utah Public Service Commission for Mountain Fuel effective at the end of the period. (g) All accounting and allowed costs will be consistent with ratemaking policies that have been set by the Utah Public Service Commission, including allowed rate of return and methodologies for calculating rate base, test year and types of costs that are not allowed. (h) The costs of gathering activities determined under this Appendix will be reduced by other operating revenues that are directly related to those costs. 3. Except as expressly amended, the Agreement remains in full force and effect. This Amendment is entered into by the authorized representatives of the Parties whose signatures appear below. Questar Gas Company: Questar Gas Management Company: By: /s/D. N. Rose By: /s/G. L. Nordloh D. N. Rose G. L. Nordloh Name (please type) Name (please type) President & CEO President & CEO Title Title EX-12 4 EXHIBIT NO. 12 Questar Gas Company Ratio of Earnings to Fixed Charges
12 Months Ended December 31, 1996 1997 (Dollars in Thousands) Earnings Income before income taxes $42,434 $42,506 Plus debt expense 16,637 19,119 Plus allowance for borrowed funds used during construction 277 261 Plus interest portion of rental expense 187 193 $59,535 $62,079 Fixed Charges Debt expense $16,637 $19,119 Plus allowance for borrowed funds used during construction 277 261 Plus interest portion of rental expense 187 193 $17,101 $19,573 Ratio of Earnings to Fixed Charges 3.48 3.17
EX-23 5 EXHIBIT NO. 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-27909) of Questar Gas Company and in the related Prospectus of our report dated February 9, 1998, with respect to the consolidated financial statements of Questar Gas Company included in this annual report (Form 10-K) for the year ended December 31, 1997. /s/ Ernst & Young LLP Salt Lake City, Utah March 24, 1998 EX-24 6 EXHIBIT NO. 24 POWER OF ATTORNEY We, the undersigned directors of Mountain Fuel Supply Company, hereby severally constitute D. N. Rose and S. E. Parks, and each of them acting alone, our true and lawful attorneys, with full power to them and each of them to sign for us, and in our names in the capacities indicated below, the Annual Report on Form 10-K for 1997 and any and all amendments to be filed with the Securities and Exchange Commission by Mountain Fuel Supply Company, hereby ratifying and confirming our signatures as they may be signed by the attorneys appointed herein to the Annual Report on Form 10-K for 1997 and any and all amendments to such Report. Witness our hands on the respective dates set forth below. Signature Title Date /s/ R. D. Cash Chairman of the Board 2-10-98 R. D. Cash /s/ D. N. Rose President & Chief 2-10-98 D. N. Rose Executive Officer Director /s/ W. Whitley Hawins Director 2-10-98 W. Whitley Hawkins /s/ Robert E. Kadlec Director 2-10-98 Robert E. Kadlec /s/ Dixie L. Leavitt Director 2-10-98 Dixie L. Leavitt /s/ Gary G. Michael Director 2-10-98 Gary G. Michael /s/ Gary L. Nordloh Director 2-10-98 Gary L. Nordloh /s/ Harris H. Simmons Director 2-10-98 Harris H. Simmons EX-27 7
5 This schedule contains summarized financial information from the Questar Gas Company Statement of Income and Balance Sheet for the year ended December 31, 1997, and is qualified in its entirety by reference to the audited financial statements. 12-MOS DEC-31-1997 DEC-31-1997 6,747 0 86,487 0 20,347 155,188 882,936 354,761 704,851 164,487 225,000 0 0 22,974 199,292 704,851 0 448,223 0 350,652 39,334 0 19,119 42,506 13,492 29,014 0 0 0 29,014 0 0
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