SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 MOUNTAIN FUEL SUPPLY 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.) P.O. Box 45360, 180 East 100 South, Salt Lake City, Utah 84145-0360 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (801) 324-5555 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of June 30, 1997 Common Stock, $2.50 par value 9,189,626 shares Registrant meets the conditions set forth in General Instruction H(a)(1) and (b) of Form 10-Q and is filing this Form 10-Q with the reduced disclosure format. PART I FINANCIAL INFORMATION Item 1. Financial Statements MOUNTAIN FUEL SUPPLY COMPANY STATEMENTS OF INCOME (Unaudited) 3 Months Ended 6 Months Ended 12 Months Ended June 30, June 30, June 30, 1997 1996 1997 1996 1997 1996 (In Thousands) REVENUES $63,323 $57,927 $238,636 $202,830 $407,734 $357,488 OPERATING EXPENSES Natural gas purchases 29,669 25,144 126,880 100,609 208,671 175,940 Operating and maintenance 25,802 23,746 53,206 49,167 101,149 93,981 Depreciation 7,369 6,842 15,302 13,943 29,668 26,615 Other taxes 2,546 2,732 5,289 5,851 7,509 9,261 TOTAL OPERATING EXPENSES 65,386 58,464 200,677 169,570 346,997 305,797 OPERATING INCOME (LOSS) (2,063) (537) 37,959 33,260 60,737 51,691 INTEREST AND OTHER INCOME 1,016 1,890 1,739 2,599 2,173 5,111 DEBT EXPENSE (4,465) (3,901) (8,807) (8,173) (17,271) (16,594) INCOME (LOSS) BEFORE INCOME TAXES (5,512) (2,548) 30,891 27,686 45,639 40,208 INCOME TAXES (CREDITS) (2,909) (1,931) 11,185 9,452 15,179 11,519 NET INCOME (LOSS) ($2,603) ($617) $19,706 $18,234 $30,460 $28,689 See notes to financial statements MOUNTAIN FUEL SUPPLY COMPANY CONDENSED BALANCE SHEETS (Unaudited) June 30, December 31, 1997 1996 1996 (In Thousands) ASSETS Current assets Cash and short-term investments $1,875 Accounts receivable $32,626 $34,841 63,171 Inventories 10,745 12,299 15,295 Purchased-gas adjustments 48,866 24,210 Other current assets 2,975 4,124 4,511 Total current assets 95,212 51,264 109,062 Property, plant and equipment 840,247 792,134 825,121 Less allowances for depreciation 339,133 312,921 325,821 Net property, plant and equipment 501,114 479,213 499,300 Other assets 19,514 21,389 22,707 $615,840 $551,866 $631,069 LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities Checks outstanding in excess of cash balances $2,517 $1,638 Notes payable to Questar Corporation 69,900 28,500 $76,200 Accounts payable and accrued expenses 38,625 36,390 66,558 Purchased-gas adjustments 1,559 Total current liabilities 111,042 68,087 142,758 Long-term debt 175,000 175,000 175,000 Other liabilities 11,083 16,056 10,930 Deferred income taxes and investment tax credits 89,901 71,588 81,311 Redeemable cumulative preferred stock 4,808 4,954 4,828 Common shareholder's equity Common stock 22,974 22,974 22,974 Additional paid-in capital 41,875 41,875 41,875 Retained earnings 159,157 151,332 151,393 Total common shareholder's equity 224,006 216,181 216,242 $615,840 $551,866 $631,069 See notes to financial statements MOUNTAIN FUEL SUPPLY COMPANY CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) 6 Months Ended June 30, 1997 1996 (In Thousands) OPERATING ACTIVITIES Net income $19,706 $18,234 Depreciation 16,637 15,312 Deferred income taxes and investment tax credits 8,590 3,040 44,933 36,586 Change in operating assets and liabilities (12,612) 11,289 NET CASH PROVIDED FROM OPERATING ACTIVITIES 32,321 47,875 INVESTING ACTIVITIES Capital expenditures (20,985) (15,969) Proceeds from disposition of property, plant and equipment 2,534 3,291 NET CASH USED IN INVESTING ACTIVITIES (18,451) (12,678) FINANCING ACTIVITIES Decrease in notes payable to Questar Corporation (6,300) (27,600) Checks outstanding in excess of cash balances 2,517 1,638 Redemption of preferred stock (20) (3) Payment of dividends (11,942) (10,698) NET CASH USED IN FINANCING ACTIVITIES (15,745) (36,663) DECREASE IN CASH AND SHORT-TERM INVESTMENTS ($1,875) ($1,466) See notes to financial statements MOUNTAIN FUEL SUPPLY COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS June 30, 1997 (Unaudited) Note 1 - Basis of Presentation The interim financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. All such adjustments are of a normal recurring nature. Due to the seasonal nature of the business, the results of operations for the three- and six-month periods ended June 30, 1997, are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. For further information refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1996. Note 2 - Redemption of Preferred Stock Mountain Fuel redeemed its 8% series of preferred stock July 1, 1997, at a redemption price equal to 101% of the principal amount. The Company had 48,081 shares outstanding with a par value of $4,808,000 at the time of the transaction. Note 3 - Financing Mountain Fuel filed a registration statement with the Securities and Exchange Commission for the issuance of up to $75 million in medium-term notes. The registration statement became effective July 23, 1997. In August, Mountain Fuel issued $25 million of notes maturing August 6, 2012 with an average coupon rate of 6.91%. Mountain Fuel intends to use the net proceeds from the sale of the notes to finance a portion of its capital expenditures and repay a portion of its short-term debt. Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations MOUNTAIN FUEL SUPPLY COMPANY June 30, 1997 (Unaudited) Operating Results Following is a summary of financial and operating information for the Company: 3 Months Ended 6 Months Ended 12 Months Ended June 30, June 30, June 30, 1997 1996 1997 1996 1997 1996 (Dollars In Thousands) FINANCIAL RESULTS Revenues From unaffiliated customers $62,632 $57,064 $236,854 $201,631 $404,128 $354,582 From affiliates 691 863 1,782 1,199 3,606 2,906 Total revenues 63,323 57,927 238,636 202,830 407,734 357,488 Natural gas purchases 29,669 25,144 126,880 100,609 208,671 175,940 Revenues less natural gas purchases $33,654 $32,783 $111,756 $102,221 $199,063 $181,548 Operating income (loss) ($2,063) ($537) $37,959 $33,260 $60,737 $51,691 Net income (loss) ($2,603) ($617) $19,706 $18,234 $30,460 $28,689 OPERATING STATISTICS Natural gas volumes (in thousands of decatherms) Residential and commercial sales 12,157 11,991 48,562 46,408 82,998 76,845 Industrial sales 2,104 1,858 5,006 4,352 9,238 8,309 Transportation for industrial customers 11,625 11,046 24,577 24,775 49,301 52,783 Total deliveries 25,886 24,895 78,145 75,535 141,537 137,937 Natural gas revenue (per decatherm) Residential and commercial $4.31 $3.93 $4.43 $3.93 $4.36 $4.10 Industrial sales 2.30 2.14 2.34 2.14 2.25 2.21 Transportation for industrial customers 0.12 0.13 0.13 0.12 0.12 0.11 Heating degree days Actual 678 617 3,133 3,213 5,227 5,148 Normal 741 741 3,484 3,484 5,801 5,801 Warmer than normal 9% 17% 10% 8% 10% 11% Number of customers at June 30, 621,647 597,143 Mountain Fuel reported a $2,603,000 net loss in the second quarter of 1997, an increase from a $617,000 loss in the second quarter of 1996. The 1996 second quarter loss was reduced by a $1.2 million before-tax gain from the sale of facilities. Mountain Fuel's net income for the first half of 1997 was 8% higher than was reported for the first half of 1996. Revenues, less natural gas purchases, were $871,000 higher in the second quarter of 1997 and $9,535,000 higher in the 6-month period ended June 30, 1997 when compared with the respective periods in 1996. The higher net revenues resulted from an increase in the number of customers served and the effect of a weather-normalization adjustment mechanism. The number of customers served reached 621,647 at June 30, 1997. This represents a 4.1% increase from a year earlier. Temperature adjusted usage per customer was slightly higher in the 12-month period ended June 30, 1997 when compared with the same period a year ago. Temperatures, as measured in degree days, were warmer than normal in the 1997 periods. However, Mountain Fuel's rates include a weather-normalization adjustment that reduces the revenue impact of weather fluctuations. Virtually all of Mountain Fuel's residential and commercial volumes were covered under the weather-normalization adjustment in the first half of 1997 compared with about 50% of these volumes in the first half of 1996. The Company agreed to a negotiated annual rate reduction of $2.85 million of revenues in Utah that went into effect February 18, 1997. The rate reduction decreased block rates, eliminated the new-premises fee for multifamily dwellings and reduced the capacity-release revenues retained by Mountain Fuel from 20% to 10%. In other rate matters, the Company currently intends to file a gas-merchant unbundling proposal in Wyoming during 1997. Under this proposal, a transportation service option would be extended to residential and commercial customers as well as industrial customers. Customers choosing transportation service would be allowed to secure gas supplies directly from producers and marketers and pay the Company a fee for transportation services. Mountain Fuel will continue to offer a traditional bundled service as well. The Company expects that the option of unbundled service in Wyoming, in its anticipated form, will not have a material effect on earnings. Mountain Fuel will maintain its current structure in Utah until competition or opportunities require change. At June 30, 1997, the Company served 21,147 customers in the state of Wyoming representing 3% of the total number of customers served by Mountain Fuel. Volumes delivered to industrial customers increased 6% in the second quarter of 1997 and were 2% higher in the first half of 1997 when compared with the same periods of 1996 due to increased deliveries for electric generation and metals refining. Margins from gas delivered to industrial customers are substantially lower than from gas sold to residential and commercial customers. Mountain Fuel's natural gas purchases were higher in the 3-, 6- and 12-month periods of 1997 when compared with the same periods of 1996 due to the increase in volumes sold and a higher natural gas purchase cost allowed in rates. Mountain Fuel's Utah rates include the recovery of gas cost which amounted to $1.54 per decatherm (dth) in 1997 compared with $1.04 per dth in 1996. The higher gas purchase cost reflects a combination of events. Natural gas prices increased sharply during the 1996-1997 winter heating season and the Company is projecting that less low-cost gas will be supplied from Company-owned reserves in the future. The Public Service Commission of Utah (PSCU) approved on an interim basis a $35.2 million annual increase in Utah natural gas rates to be effective July 1, 1997 to allow recovery of purchased-gas costs. The Public Service Commission of Wyoming approved a $1.8 million annual increase also effective July 1, 1997. The Company has a purchased-gas cost adjustment mechanism whereby purchased-gas costs that are different from those provided for in present rates are accumulated and recovered or credited through future rate changes. The Company routinely files for adjustment of purchased-gas costs with Utah and Wyoming on a semiannual basis. 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 Utah Division of Public Utilities (Division) has raised issues about the reasonableness of gas-gathering costs for field-purchased gas gathered by Questar Gas Management. The Division has not yet formally requested the PSCU to disallow any portion of gas gathering costs, but has advised the Company that the amount in question is approximately $6 million. The Company's management believes that its gathering costs are reasonable and in compliance with contract terms and applicable laws. Mountain Fuel and the Division are engaged in discussions to resolve gathering cost issues. 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 Company's January 1997 application for pass through of gas costs was also approved on an interim basis. Operating and maintenance expenses were higher in the 3-, 6- and 12-month periods ended June 30, 1997 when compared with the same periods in 1996 because of increased costs associated with serving more customers, inflation and write-off obsolete inventory. The Company has experienced a 4% increase in labor costs, which is in line with management's expectations. The escalation of operating costs was somewhat mitigated by cost-containment effects of consolidating certain administrative, marketing, financial, technical and related services under Questar Regulated Services Co., which wholly owns Mountain Fuel. These services were previously staffed and performed separately by Mountain Fuel and its affiliated company, Questar Pipeline. Depreciation expense was higher in the 1997 periods primarily as a result of increased investment in property, plant and equipment. Interest and other income was lower in the 3- and 6-month periods of 1997 when compared with the same periods of 1996 primarily due to a sale of facilities in the second quarter of 1996 that netted a $1.2 million gain before income taxes. The effective income tax rate was 36.2% in the first half of 1997 compared with 34.1% in the first half of 1996. The Company recognized $1,296,000 of tight-sands gas-production credits in the 1997 period down from $1,810,000 in the 1996 period. Liquidity and Capital Resources Operating Activities Net cash provided from operating activities of $32,321,000 was $15,554,000 less than was generated in the same period of 1996. An increase in cash flow from higher earnings and non-cash deferred income tax expense was more than offset by a use of cash flow in operating assets and liabilities. Gas purchase costs were under-collected in the first half of 1997 in contrast to an over-collection in the 1996 period. Timing differences in the withdrawal of gas from storage and the payment of current income taxes accounted for the remainder of the change in cash flow in 1997 compared with 1996. Investing Activities Capital expenditures amounted to $20,985,000 in the first half of 1997 compared with $15,969,000 in the corresponding 1996 period. Capital expenditures for calendar year 1997 are estimated at $61,700,000. Financing Activities The Company has a short-term borrowing arrangement with Questar Corporation. As of June 30, Mountain Fuel had loan balances outstanding of $69,900,000 in 1997 and $28,500,000 in 1996 payable to Questar. Financing activities in the first half of 1997 and 1996 included payment of dividends and a partial repayment of loans from Questar using net cash provided from operations. Capital expenditures for 1997 will be financed with net cash flow provided from operating activities, the issuance of long-term debt and borrowings from Questar. This 10-Q contains forward-looking statements about the future operations and expectations of Mountain Fuel. According to management, these statements are made in good faith and are reasonable representations of the Company's expected performance at the time. Actual results may vary from management's stated expectations and projections due to a variety of factors. PART II OTHER INFORMATION Item 1. Legal Proceedings. a. On June 1, 1997, Mountain Fuel Supply Company (Mountain Fuel or the Company) filed a semi-annual application with the Public Service Commission of Wyoming (the PSCW) under the purchased-gas adjustment provision of its tariff. In its application, the Company requested regulatory permission to reflect annualized gas costs of $8,708,559 in its Wyoming rates for natural gas service, effective July 1, 1997 and to assess and to revise the rate structure for low-load-factor industrial sales customers. The gas costs result in rates that are approximately 9 percent higher for the Company's residential customers. The PSCW authorized the Company to reflect the increased costs in its rates as of July 1, 1997 on an interim basis, but set the matter involving industrial customers for hearing. b. The Company filed a pass-through application with the Public Service Commission of Utah (PSCU) on June 24, 1997. In this application, Mountain Fuel requested authorization to reflect $225,124,508 in its Utah rates, representing an annualized revenue increase of approximately $35,200,000 and resulting in approximately 8 percent higher rates for residential customers. The PSCU issued an interim order on July 8, 1997, authorizing the Company to reflect the requested increase in rates effective July 1, 1997. Item 6. Exhibits and Reports on Form 8-K. a. The following exhibit has been filed as part of this report: Exhibit No.Exhibit 12. Ratio of Earnings to Fixed Charges b. On July 29, 1997, Mountain Fuel filed a Current Report on Form 8-K dated as of July 28, 1997. The report included, as exhibits, a copy of the earnings release issued by Questar Corporation (the Company's parent), a balance sheet and income statement for the periods ending June 30, 1997. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MOUNTAIN FUEL SUPPLY COMPANY (Registrant) August 13, 1997 /s/D. N. Rose (Date) D. N. Rose President and Chief Executive Officer August 13, 1997 /s/S. E. Parks (Date) S. E. Parks Vice President, Treasurer and Chief Financial Officer