**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

### ** **

### **FORM 10-Q**

 

**(Mark One)**

 

| **ý** | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                 |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                         |
| ** ** | ** ** | **FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006**                                                                                                                                                                             |
|       |       |                                                                                                                                                                                                                         |
|       |       | **OR**                                                                                                                                                                                                                       |
|       |       |                                                                                                                                                                                                                         |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                |
| ** ** | ** ** | ** **                                                                                                                                                                                                                   |
| ** ** | ** ** | **FOR THE TRANSITION PERIOD FROM                     TO             ** |

 

**Commissionfile number 1-10389**

 

**WESTERN GAS RESOURCES, INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Delaware**                                             | ** ** | **84-1127613**       |
|----------------------------------------------------------|------------|----------------------|
| (State or Other  Jurisdiction of                         |       | (I.R.S. Employer     |
| Incorporation or  Organization)                          |       | Identification  No.) |
|                                                     |       |                 |
| **1099  18th Street, Suite 1200, Denver, Colorado**      |       | **80202**            |
| (Address of  Principal Executive Offices)                |       | (Zip Code)           |
|                                                     |       |                 |
| **(303)  452-5603**                                      |
| Registrant’s  Telephone Number, Including Area Code |

 

**NoChanges**

(Former Name,Former Address and Former Fiscal Year, if Changed Since Last Report).

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes   ý   No  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large  Accelerated Filer x |   | Accelerated  Filer o |   | Non-Accelerated  Filer o |
|----------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

 

On August 4, 2006, therewere 76,179,795 shares of the registrant’s common stock outstanding.

 

 

----

 

**Western Gas Resources, Inc.**

 

**Form 10-Q**

 

**Table ofContents**

 
| PART I – Financial Information |
|-------------------------------------|
|                                |   |   |
| Item 1.                             | Consolidated Financial  Statements |   |
|                                |   |   |
|                                | Consolidated Balance Sheet – June 30,  2006 and December 31, 2005 |   |
|                                |   |   |
|                                | Consolidated Statement of  Cash Flows - Six Months Ended June 30, 2006 and 2005 |   |
|                                |   |   |
|                                | Consolidated Statement of  Operations - Three and Six Months Ended June 30, 2006 and 2005 |   |
|                                |   |   |
|                                | Consolidated Statement of  Changes in Stockholders’ Equity - Six Months Ended June 30, 2006 |   |
|                                |   |   |
|                                | Notes to Consolidated  Financial Statements |   |
|                                |   |   |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                |   |   |
| Item 3.                             | Quantitative  and Qualitative Disclosures about Market Risk |   |
|                                |   |   |
| Item 4.                             | Controls and  Procedures |   |
|                                |   |   |
| PART II - Other  Information        |   |
|                                |   |   |
| Item 1.                             | Legal Proceedings |   |
|                                |   |   |
| Item 4.                             | Submission  of Matters to a Vote of Security Holders |   |
|                                |   |   |
| Item 6.                             | Exhibits |   |
|                                |   |   |
| Signatures                          |   |   |

 

2

----

 

**PART I -FINANCIAL INFORMATION**

 

**ITEM1. CONSOLIDATED FINANCIAL STATEMENTS**

** **

WESTERNGAS RESOURCES, INC.

CONSOLIDATEDBALANCE SHEET

(Unaudited)

(Dollars inthousands, except share data)

 
| ** **                                                                                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|------------------|------------|
| ** **                                                                                                            | ** ** | **2006**     | ** ** | **2005**         | ** ** |
| ASSETS                                                                                                                |       |         |       |             |       |
| Current assets:                                                                                                       |       |         |       |             |       |
| Cash and cash  equivalents                                                                                            |       | $            | 3,892      |             | $          | 27,198 |   |
| Trade accounts  receivable, net                                                                                       |       | 286,206      |       | 413,004          |       |
| Margin deposits                                                                                                       |       | 16,744       |       | 31,217           |       |
| Inventory                                                                                                             |       | 115,779      |       | 136,968          |       |
| Assets from  price risk management activities                                                                         |       | 50,253       |       | 48,988           |       |
| Deferred tax  asset                                                                                                   |       | —       |       | 4,808            |       |
| Other                                                                                                                 |       | 20,081       |       | 14,010           |       |
| Total current  assets                                                                                                 |       | 492,955      |       | 676,193          |       |
|                                                                                                                  |       |         |       |             |       |
| Property  and equipment:                                                                                              |       |         |       |             |       |
| Gas gathering,  processing and transportation                                                                         |       | 1,365,944    |       | 1,290,278        |       |
| Oil and gas  properties and equipment (successful efforts method)                                                     |       | 825,305      |       | 666,306          |       |
| Construction in  progress                                                                                             |       | 450,189      |       | 286,641          |       |
|                                                                                                                  |       | 2,641,438    |       | 2,243,225        |       |
| Less:  Accumulated depreciation, depletion and amortization                                                           |       | (751,235     | )          | (684,904         | )          |
|                                                                                                                  |       |         |       |             |       |
| Total property  and equipment, net                                                                                    |       | 1,890,203    |       | 1,558,321        |       |
|                                                                                                                  |       |         |       |             |       |
| Other  assets:                                                                                                        |       |         |       |             |       |
| Gas purchase  contracts (net of accumulated amortization of $43,458 and $42,583,  respectively)                       |       | 30,450       |       | 32,071           |       |
| Assets from  price risk management activities                                                                         |       | 6,787        |       | 5,495            |       |
| Investments in  joint ventures                                                                                        |       | 38,478       |       | 36,791           |       |
| Other                                                                                                                 |       | 28,730       |       | 25,763           |       |
|                                                                                                                  |       |         |       |             |       |
| Total other  assets                                                                                                   |       | 104,445      |       | 100,120          |       |
| TOTAL  ASSETS                                                                                                         |       | $            | 2,487,603  |             | $          | 2,334,634 |   |
|                                                                                                                  |       |         |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                            |       |         |       |             |       |
| Current  liabilities:                                                                                                 |       |         |       |             |       |
| Accounts payable                                                                                                      |       | $            | 350,064    |             | $          | 463,113 |   |
| Accrued expenses                                                                                                      |       | 75,502       |       | 106,542          |       |
| Liabilities from  price risk management activities                                                                    |       | 24,111       |       | 34,343           |       |
| Deferred tax  liability                                                                                               |       | 6,509        |       | —           |       |
| Dividends  payable                                                                                                    |       | 5,699        |       | 5,660            |       |
| Total current  liabilities                                                                                            |       | 461,885      |       | 609,658          |       |
|                                                                                                                  |       |         |       |             |       |
| Long-term  debt                                                                                                       |       | 572,000      |       | 430,000          |       |
| Liabilities from price risk management activities                                                                     |       | 3,080        |       | —           |       |
| Other long-term liabilities                                                                                           |       | 67,682       |       | 66,427           |       |
| Deferred income taxes, net                                                                                            |       | 356,602      |       | 325,090          |       |
| Total  liabilities                                                                                                    |       | 1,461,249    |       | 1,431,175        |       |
|                                                                                                                  |       |         |       |             |       |
| Stockholders’  equity:                                                                                           |       |         |       |             |       |
| Common stock,  par value $0.10; 100,000,000 shares authorized; 76,297,417 and 75,375,134  shares issued, respectively |       | 7,628        |       | 7,565            |       |
| Treasury stock,  at cost; 50,032 common shares in treasury                                                            |       | (788         | )          | (788             | )          |
| Deferred  compensation                                                                                                |       | —       |       | (9,244           | )          |
| Additional  paid-in capital                                                                                           |       | 445,589      |       | 429,007          |       |
| Retained  earnings                                                                                                    |       | 564,699      |       | 471,860          |       |
| Accumulated  other comprehensive income                                                                               |       | 9,226        |       | 5,059            |       |
| Total  stockholders’ equity                                                                                      |       | 1,026,354    |       | 903,459          |       |
|                                                                                                                  |       |         |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                      |       | $            | 2,487,603  |             | $          | 2,334,634 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

3

----

 

WESTERN GAS RESOURCES, INC.

CONSOLIDATED STATEMENT OFCASH FLOWS

(Unaudited)

(Dollars in thousands)

 
| ** **                                                                              | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                       | ** ** | **2005** | ** ** |
|                                                                                    |       |                           |       |   |   |
| Reconciliation of net income to net cash provided by  operating activities:             |       |                           |       |   |   |
| Net income                                                                              |       | $                              | 104,231    |   | $ | 57,335 |   |
| Add income items that do not affect operating cash  flows:                              |       |                           |       |   |   |
| Depreciation,  depletion and amortization                                               |       | 71,286                         |       | 59,877 |   |
| Loss on sale of  assets                                                                 |       | 1,024                          |       | 27 |   |
| Deferred income  taxes                                                                  |       | 44,900                         |       | 19,775 |   |
| Excess tax  benefits from share-based payment awards                                    |       | (2,379                         | )          | — |   |
| Non-cash change  in fair value of derivatives                                           |       | (5,465                         | )          | 17,614 |   |
| Compensation  expense from restricted stock and stock options                           |       | 11,637                         |       | 926 |   |
| Other non-cash  items, net                                                              |       | (587                           | )          | (1,532 | ) |
|                                                                                    |       |                           |       |   |   |
| Adjustments to working capital to arrive at net cash  provided by operating activities: |       |                           |       |   |   |
| Decrease in  trade accounts receivable                                                  |       | 123,555                        |       | 71,601 |   |
| (Increase)  decrease in margin deposits                                                 |       | 3,957                          |       | (8,946 | ) |
| Decrease in  product inventory                                                          |       | 22,457                         |       | 1,933 |   |
| (Increase) in  other current assets                                                     |       | (18,267                        | )          | (11,379 | ) |
| (Increase) in  other assets and liabilities, net                                        |       | (962                           | )          | (565 | ) |
| (Decrease) in  accounts payable                                                         |       | (84,504                        | )          | (57,156 | ) |
| Increase  (decrease) in accrued expenses                                                |       | (5,219                         | )          | 10,592 |   |
|                                                                                    |       |                           |       |   |   |
| Net cash provided by operating activities                                               |       | 265,664                        |       | 160,102 |   |
|                                                                                    |       |                           |       |   |   |
| Cash flows from investing activities:                                                   |       |                           |       |   |   |
|                                                                                    |       |                           |       |   |   |
| Purchases of  property and equipment, including acquisitions                            |       | (399,351                       | )          | (193,112 | ) |
| Distributions  from equity investees                                                    |       | —                         |       | 613 |   |
| Proceeds from  the disposition of property and equipment                                |       | 1,255                          |       | 1,411 |   |
|                                                                                    |       |                           |       |   |   |
| Net cash used in investing activities                                                   |       | (398,096                       | )          | (191,088 | ) |
|                                                                                    |       |                           |       |   |   |
| Cash flows from financing activities:                                                   |       |                           |       |   |   |
|                                                                                    |       |                           |       |   |   |
| Net proceeds  from exercise of common stock options                                     |       | 10,321                         |       | 2,735 |   |
| Excess tax benefits  from share-based payment awards                                    |       | 2,379                          |       | — |   |
| Change in  outstanding checks                                                           |       | (34,207                        | )          | 6,335 |   |
| Borrowings on  revolving credit facility                                                |       | 2,415,700                      |       | 1,789,015 |   |
| Payments on  revolving credit facility                                                  |       | (2,273,700                     | )          | (1,754,015 | ) |
| Borrowings on  long-term debt                                                           |       | —                         |       | 25,000 |   |
| Payments on  long-term debt                                                             |       | —                         |       | (25,000 | ) |
| Debt issue costs  paid                                                                  |       | (14                            | )          | (40 | ) |
| Dividends paid                                                                          |       | (11,353                        | )          | (7,396 | ) |
|                                                                                    |       |                           |       |   |   |
| Net cash provided by financing activities                                               |       | 109,126                        |       | 36,634 |   |
|                                                                                    |       |                           |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                   |       | (23,306                        | )          | 5,648 |   |
|                                                                                    |       |                           |       |   |   |
| Cash  and cash equivalents at beginning of period                                       |       | 27,198                         |       | 390 |   |
|                                                                                    |       |                           |       |   |   |
| Cash  and cash equivalents at end of period                                             |       | $                              | 3,892      |   | $ | 6,038 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

4

----

 

WESTERNGAS RESOURCES, INC.

CONSOLIDATEDSTATEMENT OF OPERATIONS

(Unaudited)

(Dollars inthousands, except share and per share amounts)

 
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                                                |       |                             |       |                           |       |   |   |   |   |
| Sale of gas                                                              |       | $                                | 576,716    |                           | $          | 678,087 |   | $ | 1,348,377 |   | $ | 1,374,306 |   |
| Sale of natural  gas liquids                                             |       | 171,986                          |       | 149,481                        |       | 339,402 |   | 282,450 |   |
| Gathering,  processing and transportation revenue                        |       | 27,573                           |       | 27,823                         |       | 54,273 |   | 51,703 |   |
| Price risk  management activities                                        |       | 9,233                            |       | 11,205                         |       | 30,213 |   | (9,043 | ) |
| Other                                                                    |       | 1,666                            |       | 1,430                          |       | 3,990 |   | 2,717 |   |
| Total revenues                                                           |       | 787,174                          |       | 868,026                        |       | 1,776,255 |   | 1,702,133 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Costs and expenses:                                                      |       |                             |       |                           |       |   |   |   |   |
| Product  purchases                                                       |       | 592,861                          |       | 707,516                        |       | 1,368,993 |   | 1,414,870 |   |
| Plant and  transportation operating expense                              |       | 29,963                           |       | 26,831                         |       | 62,179 |   | 54,530 |   |
| Oil and gas  exploration and production expense                          |       | 35,909                           |       | 24,059                         |       | 64,427 |   | 48,955 |   |
| Depreciation,  depletion and amortization                                |       | 35,924                           |       | 30,799                         |       | 71,286 |   | 59,877 |   |
| Selling and  administrative expense                                      |       | 21,296                           |       | 17,536                         |       | 41,144 |   | 30,096 |   |
| (Earnings) from  equity investments                                      |       | (2,440                           | )          | (2,246                         | )          | (4,814 | ) | (4,380 | ) |
| Interest expense                                                         |       | 5,419                            |       | 4,033                          |       | 8,604 |   | 7,553 |   |
| Total costs and  expenses                                                |       | 718,932                          |       | 808,528                        |       | 1,611,819 |   | 1,611,501 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Income before taxes                                                      |       | 68,242                           |       | 59,498                         |       | 164,436 |   | 90,632 |   |
| Provision for income taxes:                                              |       |                             |       |                           |       |   |   |   |   |
| Current                                                                  |       | 3,018                            |       | 6,172                          |       | 15,305 |   | 13,522 |   |
| Deferred                                                                 |       | 22,855                           |       | 15,697                         |       | 44,900 |   | 19,775 |   |
| Total provision  for income taxes                                        |       | 25,873                           |       | 21,869                         |       | 60,205 |   | 33,297 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Net income                                                               |       | $                                | 42,369     |                           | $          | 37,629 |   | $ | 104,231 |   | $ | 57,335 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Earnings per share of common stock                                       |       | $                                | .56        |                           | $          | .51 |   | $ | 1.38 |   | $ | .77 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average shares of common stock outstanding                      |       | 75,459,422                       |       | 74,234,424                     |       | 75,269,376 |   | 74,191,346 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Income attributable to common stock – assuming  dilution            |       | $                                | 42,369     |                           | $          | 37,629 |   | $ | 104,231 |   | $ | 57,335 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Earnings per share of common  stock – assuming dilution             |       | $                                | .55        |                           | $          | .50 |   | $ | 1.36 |   | $ | .76 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average  shares of common stock outstanding - assuming dilution |       | 76,718,838                       |       | 75,678,389                     |       | 76,509,330 |   | 75,603,310 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

5

----

 

WESTERN GASRESOURCES, INC.

CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(Dollars inthousands, except share amounts)

 
| ** **                                             | ** ** | ** **     | ** ** | ** **      | ** ** | ** ** | ** ** | ** **   | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **        | ** ** |
|--------------------------------------------------------|------------|----------------|------------|-----------------|------------|------------|------------|--------------|------------|------------------|------------|----------------|------------|--------------|------------|-------------------|------------|-------------------|------------|
| ** **                                             | ** ** | ** **     | ** ** | **Shares**      | ** ** | ** ** | ** ** | ** **   | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | **Other**         | ** ** | **Total**         | ** ** |
| ** **                                             | ** ** | **Shares**     | ** ** | **of  Common**  | ** ** | ** ** | ** ** | ** **   | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **   | ** ** | **Comprehensive** | ** ** | **Stock-**        | ** ** |
| ** **                                             | ** ** | **of  Common** | ** ** | **Stock**       | ** ** | **Common** | ** ** | **Treasury** | ** ** | **Deferred**     | ** ** | **Paid-In**    | ** ** | **Retained** | ** ** | **Income**        | ** ** | **holders’** | ** ** |
| ** **                                             | ** ** | **Stock**      | ** ** | **in Treasury** | ** ** | **Stock**  | ** ** | **Stock**    | ** ** | **Compensation** | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Net of  Tax**   | ** ** | **Equity**        | ** ** |
|                                                   |       |           |       |            |       |       |       |         |       |             |       |           |       |         |       |              |       |              |       |
| Balance at  December 31, 2005                          |       | 75,375,134     |       | 50,032          |       | $          | 7,565      |         | $          | (788             | )          | $              | (9,244     | )            | $          | 429,007           |       | $                 | 471,860    |   | $ | 5,059 |   | $ | 903,459 |   |
| Comprehensive  income:                                 |       |           |       |            |       |       |       |         |       |             |       |           |       |         |       |              |       |              |       |
| Net income, first  six months of 2006                  |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | 104,231      |       | —            |       | 104,231           |       |
| Translation  adjustments                               |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | 848               |       | 848               |       |
| Other  comprehensive income                            |       |           |       |            |       |       |       |         |       |             |       |           |       |         |       |              |       |              |       |
| From equity investees                                  |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | 84                |       | 84                |       |
| Reclassification  adjustment for settled contracts     |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | (4,822            | )          | (4,822            | )          |
| Changes in fair  value of outstanding hedge positions  |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | 14,518            |       | 14,518            |       |
| Change in estimated  ineffectiveness                   |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | 320               |       | 320               |       |
| Fair value of new  hedge positions                     |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | (6,781            | )          | (6,781            | )          |
| Change in  accumulated derivative comprehensive income |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | 3,235             |       | 3,235             |       |
| Total comprehensive  income, net of tax                |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | —       |       | —            |       | 108,398           |       |
| Stock options  exercised                               |       | 625,600        |       | —          |       | 63         |       | —       |       | —           |       | 10,258         |       | —       |       | —            |       | 10,321            |       |
| Compensation  expense from common stock options        |       | 296,683        |       | —          |       | —     |       | —       |       | —           |       | 7,853          |       | —       |       | —            |       | 7,853             |       |
| Excess tax  benefit related to stock options exercised |       | —         |       | —          |       | —     |       | —       |       | —           |       | 3,931          |       | —       |       | —            |       | 3,931             |       |
| Effect of change  in accounting principle              |       | —         |       | —          |       | —     |       | —       |       | 9,244            |       | (9,244         | )          | —       |       | —            |       | —            |       |
| Compensation  expense from restricted stock            |       | —         |       | —          |       | —     |       | —       |       |             |       | 3,784          |       | —       |       | —            |       | 3,784             |       |
| Dividends  declared on common stock                    |       | —         |       | —          |       | —     |       | —       |       | —           |       | —         |       | (11,392      | )          | —            |       | (11,392           | )          |
| Balance at June  30, 2006                              |       | 76,297,417     |       | 50,032          |       | $          | 7,628      |         | $          | (788             | )          | $              | —     |         | $          | 445,589           |       | $                 | 564,699    |   | $ | 9,226 |   | $ | 1,026,354 |   |
|                                                        |            |                |            |                 |            |            |            |              |            |                  |            |                |            |              |            |                   |            |                   |            |  |  |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

6

----

 

WESTERNGAS RESOURCES, INC.

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

***NOTE1 – GENERAL***

 

We have prepared theaccompanying unaudited interim consolidated financial statements under therules and regulations of the Securities and Exchange Commission, or SEC. Asprovided by such rules and regulations, we have condensed or omitted certaininformation and notes normally included in annual financial statements preparedin conformity with accounting principles generally accepted in the UnitedStates of America.

 

The interim consolidatedfinancial statements presented herein should be read in conjunction with theConsolidated Financial Statements and Notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2005. Reference is alsomade to our 2005 Form 10-K for definitions of terms used in this quarterlyreport on Form 10-Q. The interim Consolidated Financial Statements as of June30, 2006 and for the three-month and six month periods ended June 30, 2006 and2005 included herein are unaudited but reflect, in the opinion of management,all adjustments (which include only normal recurring adjustments) necessary tofairly state the results for such periods. The results of operations for thethree and six months ended June 30, 2006 are not necessarily indicative of theresults of operations expected for the year ended December 31, 2006.

 

***Proposed Merger of our Company.***On June 23, 2006, we announced that we hadentered into a merger agreement with Anadarko Petroleum Corporation, orAnadarko, whereby it is proposed that we will be merged with a wholly ownedsubsidiary of Anadarko. Our stockholders will receive $61.00 per common sharein cash in the merger. The merger agreement has been approved by each company’sBoard of Directors and was filed with the SEC on Form 8-K. We have scheduled a special meeting of ourstockholders for August 23, 2006 to vote on, adopt the merger agreement andapprove the merger. The merger is also subject to the satisfaction ofcustomary closing conditions, including the receipt of necessary regulatory andgovernmental approvals. The merger will be completed as soon as practicablefollowing satisfaction of these conditions, which could be as early as the endof August 2006. Should the merger be completed, our common stock will bede-listed with the New York Stock Exchange, or NYSE, and we will file a Form 15with the SEC to deregister our common stock. Certain of our directors, officersand other stockholders, who collectively hold approximately 17.3 percent ofWestern’s outstanding shares, have entered into agreements to vote in favor ofthe merger.

 

The closing of ourproposed merger would be an event of default under our revolving creditfacility, which would entitle the lenders to terminate their commitments anddemand payment of all outstanding and unpaid amounts there under.  Further, our master shelf agreement containscross default provisions, which would be triggered by the default under therevolving credit facility.  Therefore, uponthe closing of the merger, the acquirer must renegotiate these agreements orrepay all amounts due under them.  Also,the closing of our proposed merger is also an event of default under some ofour operating leases, which will entitle our counterparties to terminate theircommitments and require a return of the related equipment.  Therefore, on or prior to the closing of themerger, the acquirer must renegotiate these agreements.

 

This Form 10-Q includesdiscussion regarding events that will or may trigger or occur upon completionof the merger. If the merger is not completed these events will not occur. Inaddition, the timing of the completion of the merger will affect the timing ofthese events. See also the first paragraph under Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations for adiscussion of the effect of the proposed merger on certain forward-lookingstatements included in this Form 10-Q.

 

***Earnings Per Share of Common Stock.***Earnings pershare of common stock are computed by dividing net income by the weightedaverage shares of common stock outstanding. Earnings per share of common stock- assuming dilution is computed by dividing net income by the weighted averageshares of common stock outstanding as adjusted for potential common shares.

 

Thefollowing table presents the dividends declared by us on our common stock(dollars in thousands, except per share amounts):

 
| ** **                                   | ** ** | **Quarter  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **2006**                    | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Total dividends declared                     |       | $                           | 5,750      |                           | $          | 3,732 |   | $ | 11,392 |   | $ | 7,425 |   |
| Dividends declared per share of common stock |       | $                           | 0.075      |                           | $          | 0.05 |   | $ | 0.15 |   | $ | 0.10 |   |

 

Common stock options granted are potential common shares. Thefollowing is a reconciliation ofthe weighted average shares of common stock outstanding to the weighted averagecommon shares outstanding – assuming dilution.

 
| ** **                                                               | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **2006**                    | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average shares of common stock outstanding                      |       | 75,459,422                  |       | 74,234,424                     |       | 75,269,376 |   | 74,191,346 |   |
| Potential common shares from common stock options                        |       | 1,259,416                   |       | 1,443,965                      |       | 1,239,954 |   | 1,411,964 |   |
| Weighted average  shares of common stock outstanding - assuming dilution |       | 76,718,838                  |       | 75,678,389                     |       | 76,509,330 |   | 75,603,310 |   |

 

7

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Thecalculation of fully diluted earnings per share reflects potential commonshares, if dilutive.

 

***Accumulated Other Comprehensive Income.***Included in Accumulated other comprehensive income at June 30, 2006 wereunrealized gains of $5.9 million, which is net of $3.4 million of deferredtaxes, from the fair value of derivatives designated as cash flow hedges andunrealized gains of $848,000, which is net of $486,000 of deferred taxes, as aresult of cumulative foreign currency translation adjustments.

 

The gains currentlyreflected in Accumulated other comprehensive income from the fair value ofderivatives designated as cash flow hedges will be reclassified to earnings asthe hedged gas or NGLs are sold. Based on the prices for our products on June30, 2006, approximately $5.9 million of gains in Accumulated othercomprehensive income will be reclassified to earnings, of which $1.4 millionwill be reclassified in the remainder of 2006.

 

##### ***RevenueRecognition.***In the Gas Gathering,Processing and Treating segment, we recognize revenue for our services at thetime the service is performed. We record revenue from our gas and NGL marketingactivities, including sales of our equity production, upon transfer of title. Inaccordance with EITF 03-11, “Reporting Realized Gains and Losses on DerivativeInstruments That are Subject to FASB Statement No. 133, Accounting forDerivative Instruments and Hedging Activities, and Not Held for TradingPurposes as Defined in Issue No. 02-3”, we recordrevenue on our physical gas and NGL marketing activities on a gross basisversus sales net of purchases basis because we obtain title to all the gas andNGLs that we buy including third-party purchases, bear the risk of loss andcredit exposure on these transactions, and it is our intention upon enteringthese contracts to take physical delivery of the product. Gas imbalances on ourproduction are accounted for using the sales method. Gas imbalances on ourproduction at June 30, 2006 and 2005 were immaterial. For our marketingactivities we utilize mark-to-market accounting for our derivatives. In theTransportation segment, we realize revenue on a monthly basis from firmcapacity contracts under which the shipper pays for transport capacity whetheror not the capacity is used and from interruptible contracts where a fee ischarged based upon volumes received into the pipeline.

##### *** ***

Atits September 2005 meeting, the Emerging Issues Task Force, or EITF, of theFASB approved Issue No. 04-13, “*Accountingfor Purchases and Sales of Inventory with the Same Counterparty*.”  This Issue addresses the question of when itis appropriate to measure non-monetary purchases and sales of inventory at fairvalue and record them in cost of sales and revenues and when they should berecorded as an exchange measured at the book value of the item sold. EITF 04-13requires that two or more exchange transactions involving inventory with thesame counterparty that are entered into in contemplation of one another shouldbe combined for the purposes of evaluating the effect of APB Opinion No. 29, “Accountingfor Nonmonetary Transactions”. This EITF is effective for transactions enteredinto or modified in the first interim or annual period beginning after March15, 2006, which for us was the quarter ended June 30, 2006. To the extenttransactions are required to be netted, this results in a reduction of revenuesand costs by an equal amount, but the netting has no impact on net income orcash flows.

 

In order to minimizetransportation costs or make product available at a location of our customer’spreference, from time to time, we will enter into arrangements to buy productfrom a party at one location and arrange to sell a like quantity of product tothis same party at another location. In accordance with EITF 04-13, thesetransactions are required to be reported on a sales net of purchases basis. Forthe quarter and six months ended June 30, 2006, we reduced revenues and productpurchases by $31.2 million for transactions which were entered intoconcurrently and with the intent to buy and sell like quantities with the samecounterparty at different locations and at market prices at those locations.

 

***Supplementary Cash Flow Information*.**Interestpaid was $14.6 million and $11.7 million for the six months ended June 30, 2006and 2005, respectively. A total of $16.5million and $11.0 million was paid in income taxes in the six months ended June30, 2006 and 2005, respectively. Asset retirement obligation assets andliabilities of $3.4 million and $7.7 million were recorded for the six monthsended June 30, 2006 and 2005, respectively. The asset retirement and associatedobligations are non-cash transactions for presentation on the ConsolidatedStatement of Cash Flows.

 

***Property Acquisition.***In March 2006,we acquired certain coal bed methane, or CBM, properties and related gatheringassets in the Big George fairway of the Powder River Basin of Wyoming for anadjusted purchase price of $138.6 million. This acquisition was funded withamounts available under our revolving credit facility. The purchase price included the drilling rights on approximately 40,000gross and net acres and 110 drilled wells. These properties had no productionin the six months ended June 30, 2006 as approximately 70 of the drilled wellsare currently dewatering and the remaining 40 wells are awaiting hookup.

 

8

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***NOTE 2 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES***

 

A netgain was recognized in earnings through Sale of gas and Sale of natural gasliquids during the three and six months ended June 30, 2006 from hedgingactivities of $12.3 million and $20.8 million, respectively. A net loss wasrecognized in earnings through Sale of residue gas and Sale of natural gasliquids during the three and six months ended June 30, 2005 from hedgingactivities of $657,000 and $170,000, respectively.

 

In the second quarter of 2006, in order to properlyalign our hedged volumes of natural gas to our forecasted equity production, wediscontinued hedge treatment on financial instruments for 30 MMcf per day ofnatural gas as the anticipated transaction is no longer probable. As a result,a pre-tax gain of $2.8 million was reclassified into earnings from Accumulatedother comprehensive income.

 

***NOTE 3 – ADOPTION OF SFAS 123(R)***

 

On January 1, 2006, weadopted Statement of Financial Accounting Standards No. 123 (revised 2004),“Share-Based Payment”, or SFAS 123(R), which requires the measurement andrecognition of compensation expense for all share-based payment awards(including stock options) made to employees and directors based on estimatedfair values. SFAS 123(R) supersedes our previous accounting under AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees”, orAPB 25, for periods beginning in fiscal 2006. In March 2005, the SEC issuedStaff Accounting Bulletin No. 107, or SAB 107, relating to SFAS 123(R). Weconsidered the guidance of SAB 107 in our adoption of SFAS 123(R).

 

Weadopted SFAS 123(R) using the modified prospective transition method, whichrequires the application of the accounting standard as of January 1, 2006. Inaccordance with the modified prospective transition method, our ConsolidatedFinancial Statements for prior periods are not restated to reflect, and do notinclude, any impact of SFAS 123(R). We did not modify any outstanding stockoptions in anticipation of the adoption of SFAS 123(R). The effect of thechange in accounting principle resulting from the adoption of SFAS 123(R) wasrecognized in our financial statements through the elimination of previouslyrecognized deferred compensation costs, with offsetting amounts recorded in theAdditional paid-in capital account within Stockholders’ equity.

 

Stock-based compensationexpense recognized under SFAS 123(R) for the three and six months ended June30, 2006 related to employee stock options, including compensation from our2006 grants, is as presented in the following table. 

 
| **(Amounts in thousands, except per share amounts)**                      | ** ** | **Quarter  ended  June 30, 2006** | ** ** | **Six Months   ended  June 30, 2006** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|
| Incremental stock-based compensation expense  recognized through earnings |       | $                                 | 4,058      |                                  | $          | 6,900 |   |
| Related deferred income tax benefit                                       |       | (419                              | )          | (958                                  | )          |
| Decrease in net income                                                    |       | 3,639                             |       | 6,538                                 |       |
| Decrease in earnings per share of common stock                            |       | 0.05                              |       | 0.08                                  |       |
| Decrease in earnings per share of common stock –  assuming dilution  |       | 0.05                              |       | 0.08                                  |       |
| Stock-based compensation expense capitalized                              |       | $                                 | 536        |                                  | $          | 953 |   |

 

SFAS 123(R) requires usto estimate the fair value of stock options on the date of grant using anoption-pricing model. The value of the portion of the award that is ultimatelyexpected to vest is recognized as expense over the requisite service periods inour Consolidated Statement of Operations. Prior to the adoption of SFAS 123(R),we accounted for stock-based awards to employees and directors using theintrinsic value method in accordance with APB 25 as then allowed underStatement of Financial Accounting Standards No. 123, “Accounting forStock-Based Compensation”, or SFAS 123. Under the intrinsic value method, withthe exception of the options granted under the Chief Executive Officer andPresident’s Plan and our restricted stock, no stock-based compensation expensehad been recognized in our Consolidated Statement of Operations, because theexercise price of our stock options granted to employees and directors equaledthe fair market value of the underlying stock at the date of grant.

 

Stock-based compensationexpense to be recognized is based on the fair value of those share-basedpayment awards that are ultimately expected to vest during the period. Stock-basedcompensation expense recognized in our Consolidated Statement of Operations forthe three and six months ended June 30, 2006 includes compensation expense forshare-based payment awards granted in 2006 and granted prior to, but not yetvested, as of January 1, 2006. Compensation expense for the awards grantedprior to January 1, 2006 is based on the grant date fair value estimated inaccordance with the pro forma provisions of SFAS 123. Compensation expense forthe share-based payment awards granted subsequent to December 31, 2005 was basedon the grant date fair value estimated in accordance with the provisions ofSFAS 123(R). In conjunction with the adoption of SFAS 123(R), we continued 

 

9

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our method of attributing the value of stock-based compensation usingthe straight-line single option method. As stock-based compensation expenserecognized in the Consolidated Statement of Operations for the three and sixmonths ended June 30, 2006 is based on awards ultimately expected to vest, itis reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates. At June 30, 2006, thecompensation expense related to non-vested awards to be recognized in futureperiods totaled $23.0 million. The weighted average period over which thisexpense is expected to be recognized is 2.1 years; however, in connection withthe proposed merger of Western with Anadarko, all outstanding options willfully vest and convert to the right to receive a cash payment from the acquirerat the closing of the transaction.

 

In accordance with theadoption of SFAS 123(R), we continue to use the Black-Scholes option pricingmodel for the valuation of share-based awards. Our determination of fair valueof share-based payment awards on the date of grant using the Black-Scholesmodel is affected by our stock price as well as assumptions regardingvariables, including, but not limited to, our expected stock price volatilityover the term of the awards, and actual and projected employee stock optionexercise behaviors. In our estimate of the fair value of the share-basedpayment awards, we utilize historical volatility of our common stock over 250weeks. In our opinion, the historical volatility and the Black-Scholes modelprovide an appropriate measure of the fair value of our employee stock options.

 

On November 10, 2005, theFinancial Accounting Standards Board, issued FASB Staff Position, or FSP, No.123(R)-3, “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards.”  This FSPallows us to take up to one year from the later of our initial adoption of SFAS123(R) or the effective date of the FSP to evaluate the available transitionalternative related to the accounting for the tax effects of share-basedpayment awards that are partially or fully-vested as of the adoption date. Wehave not yet elected which transition method we will utilize.

 

***NOTE 4 – SHARE BASED COMPENSATION***

 

Inthe first six months of 2006, we granted our employees and directors options topurchase approximately 733,000 shares of our common stock at the market (asdefined in the plans) based on the average closing price for the ten days priorto grant, and approximately 297,000 shares of restricted common stock. In thefirst six months of 2005, we granted options to purchase 916,000 shares of ourcommon stock at the market based on the average closing price for the ten daysprior to grant and approximately 362,000 shares of restricted common stock toour employees and directors. In all cases, the grant date was the date on whichthe grants were approved by our board of directors, or the date on which anemployee commenced employment. We realize an income tax benefit from theexercise of non-qualified stock options related to the amount by which themarket price at the date of exercise exceeds the option price and ondisqualifying dispositions of qualified stock options. For the six months endedJune 30, 2006 and 2005, we recognized a tax benefit from our stock options of$3.9 million and $900,000, respectively.

 

Thefollowing is a summary of the options granted topurchase our common stock and the weighted average fair value per share ofthe options granted during the threeand six months ended June 30, 2006 and 2005, respectively.

 
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **2006**                        | ** ** | **2005**                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| 2002 Plan                              |       |                            |       |                          |       |   |   |   |   |
| Options granted                        |       | 10,465                          |       | 54,200                        |       | 16,665 |   | 137,200 |   |
| Weighted average fair value  per share |       | $                               | 15.62      |                          | $          | 14.04 |   | $ | 15.41 |   | $ | 15.01 |   |
| 2005 Plan                              |       |                            |       |                          |       |   |   |   |   |
| Options granted                        |       | —                          |       | 746,726                       |       | 660,026 |   | 746,726 |   |
| Weighted average fair value  per share |       | —                          |       | $                             | 13.25      |   | $ | 19.17 |   | $ | 13.25 |   |
| 2002 Directors Plan                    |       |                            |       |                          |       |   |   |   |   |
| Options granted                        |       | 36,000                          |       | 32,000                        |       | 56,000 |   | 32,000 |   |
| Weighted average fair value  per share |       | $                               | 19.80      |                          | $          | 14.79 |   | $ | 19.68 |   | $ | 14.79 |   |

 

Duringthe six months ended June 30, 2006, the valuesfor the options granted were estimated using the Black-Scholes option-pricingmodel with the following assumptions:

 
| ** **                     | ** ** | **2002 Plan** | ** ** | **2005 Plan** | ** ** | **2002 Directors Plan** | ** ** |
|--------------------------------|------------|---------------|------------|---------------|------------|-------------------------|------------|
| Risk-free interest rate        |       | 5.26          | %          | 5.11          | %          | 5.34                    | %          |
| Expected life (in years)       |       | 4.6           |       | 4.6           |       | 4.6                     |       |
| Expected volatility            |       | 32            | %          | 32            | %          | 32                      | %          |
| Expected dividends (quarterly) |       | $             | 0.075      |          | $          | 0.075                   |       | $ | 0.075 |   |
|                                |            |               |            |               |            |                         |            |  |  |  |

 

Thefollowing table summarizes the number of stock options exercisable andavailable for grant under our benefit plans at June 30, 2006:

 

10

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| ** **               | ** ** | **Per Share  Price Range** | ** ** | **1997  Plan** | ** ** | **1999  Plan** | ** ** | **1999  Directors  Plan** | ** ** | **CEO  Plan** | ** ** | **2002  Plan** | ** ** | **2002   Directors Plan** | ** ** | **2005  Plan** | ** ** |
|--------------------------|------------|----------------------------|------------|----------------|------------|----------------|------------|---------------------------|------------|---------------|------------|----------------|------------|---------------------------|------------|----------------|------------|
| **Exercisable:**         |       |                       |       |           |       |           |       |                      |       |          |       |           |       |                      |       |           |       |
| June 30, 2006            |       | $0.01-5.00                 |       | 1,202          |       | —         |       | 2,600                     |       | —        |       | —         |       | —                    |       | —         |       |
|                     |       | $5.01-10.00                |       | 1,800          |       | —         |       | —                    |       | —        |       | —         |       | —                    |       | —         |       |
|                     |       | $10.01-15.00               |       | —         |       | 6,002          |       | —                    |       | 450,000       |       | —         |       | —                    |       | —         |       |
|                     |       | $15.01-20.00               |       | —         |       | 286,384        |       | —                    |       | —        |       | 441,008        |       | 56,000                    |       | —         |       |
|                     |       | $20.01-25.00               |       | —         |       | —         |       | —                    |       | —        |       | 1,112          |       | —                    |       | —         |       |
|                     |       | $25.01-30.00               |       | —         |       | 30,366         |       | —                    |       | —        |       | 175,587        |       | 18,667                    |       | —         |       |
|                     |       | $30.01-35.00               |       | —         |       | —         |       | —                    |       | —        |       | 44,445         |       | 9,333                     |       | 199,730        |       |
|                     |       | $35.01-40.00               |       | —         |       | —         |       | —                    |       | —        |       | 291            |       | —                    |       | 834            |       |
|                     |       | TOTAL                      |       | 3,002          |       | 322,752        |       | 2,600                     |       | 450,000       |       | 662,443        |       | 84,000                    |       | 200,564        |       |
|                     |       |                       |       |           |       |           |       |                      |       |          |       |           |       |                      |       |           |       |
| **Available for Grant:** |       |                       |       |           |       |           |       |                      |       |          |       |           |       |                      |       |           |       |
| June 30, 2006            |       |                       |       | 745,204        |       | 22,056         |       | —                    |       | —        |       | 65,262         |       | 36,000                    |       | 1,135,608      |       |

 

Thefollowing table summarizes the stock option activity related to optionsoutstanding under our benefit plans during the six months ended June 30, 2006:

 
| ** **                                           |   | **Per Share  Price Range** | ** ** | **1997  Plan** | ** ** | **1999  Plan** | ** ** | **1999  Directors   Plan** | ** ** | **CEO  Plan** | ** ** | **2002  Plan** | ** ** | **2002  Directors  Plan** | ** ** | **2005  Plan** |   |
|------------------------------------------------------|--------|----------------------------|------------|----------------|------------|----------------|------------|----------------------------|------------|---------------|------------|----------------|------------|---------------------------|------------|----------------|--------|
| Balance at 12/31/05                                  |   |                       |       | 6,002          |       | 550,815        |       | 6,600                      |       | 495,000       |       | 1,817,154      |       | 112,000                   |       | 744,726        |   |
| Granted                                              |   | $43.43-48.51               |       | —         |       | —         |       | —                     |       | —        |       | 16,665         |       | 56,000                    |       | 660,026        |   |
| Exercised                                            |   | $2.76-35.71                |       | (3,000         | )          | (138,868       | )          | (4,000                     | )          | (45,000       | )          | (280,614       | )          | —                    |       | (39,765        | )      |
| Forfeited or  expired                                |   | $16.48-50.05               |       | —         |       | (4,968         | )          | —                     |       | —        |       | (51,426        | )          | —                    |       | (40,360        | )      |
| Balance at 6/30/06                                   |   |                       |       | 3,002          |       | 406,979        |       | 2,600                      |       | 450,000       |       | 1,501,779      |       | 168,000                   |       | 1,324,627      |   |
| Weighted-average  remaining contractual life (years) |   |                       |       | 1.6            |       | 4.8            |       | 0.8                        |       | 3.3           |       | 5.0            |       | 5.2                       |       | 6.0            |   |

 

The following table summarizes the weighted averageoption exercise price information under our benefit plans during the six monthsended June 30, 2006:

 
| ** **                   | ** ** | **1997  Plan** | ** ** | **1999  Plan** | ** ** | **1999   Directors   Plan** | ** ** | **CEO  Plan** | ** ** | **2002  Plan** | ** ** | **2002  Directors  Plan** | ** ** | **2005  Plan** | ** ** |
|------------------------------|------------|----------------|------------|----------------|------------|-----------------------------|------------|---------------|------------|----------------|------------|---------------------------|------------|----------------|------------|
| Balance at December 31, 2005 |       | $              | 5.11       |           | $          | 19.32                       |       | $             | 2.76       |           | $          | 12.51                     |       | $              | 24.31      |   | $ | 24.99 |   | $ | 31.86 |   |
| Granted                      |       | —         |       | —         |       | —                      |       | —        |       | 48.38          |       | 49.44                     |       | 43.43          |       |
| Exercised                    |       | (5.82          | )          | (17.19         | )          | (2.76                       | )          | (12.51        | )          | (21.44         | )          | —                    |       | (31.85         | )          |
| Forfeited or  expired        |       | —         |       | (28.35         | )          | —                      |       | —        |       | (26.30         | )          | —                    |       | (36.62         | )          |
| Balance at June 30, 2006     |       | $              | 4.41       |           | $          | 18.13                       |       | $             | 2.76       |           | $          | 12.51                     |       | $              | 25.05      |   | $ | 33.14 |   | $ | 37.48 |   |

 

The total aggregateintrinsic value of options exercised in the first six months of 2006 wasapproximately $15.1 million. The total aggregate intrinsic value of exercisableoptions at June 30, 2006 was approximately $68.8 million and the totalaggregate intrinsic value of outstanding options at June 30, 2006 wasapproximately $124.2 million.

 

The following tablesummarizes the status of the shares of outstanding restricted stock as of June30, 2006 and changes during the six months ended June 30, 2006:

 
| ** **                                                            | ** ** | **2005  Plan** | ** ** |
|-----------------------------------------------------------------------|------------|----------------|------------|
| Balance at 12/31/05                                                   |       | 377,565        |       |
| Granted                                                               |       | 296,683        |       |
| Vested                                                                |       | (114,353       | )          |
| Forfeited or  expired                                                 |       | (28,773        | )          |
| Balance at 6/30/06                                                    |       | 531,122        |       |
| Weighted-average grant date fair value per share of  restricted stock |       | $              | 41.74      |   |
| Weighted-average remaining contractual life (years)                   |       | 1.4            |       |
|                                                                       |            |                |            |  |

 

Asdiscussed in Note 3 above, prior to January 1, 2006, we were not required torecord compensation expense for share-based payment awards.Ifwe had recorded compensation expense in the second quarter and first six monthsof 2005 for grants under our stock-based compensation plans consistent withSFAS 123 (R), our Net income, Earnings per share of common stock and Earningsper share of common stock - assuming dilution would approximate the pro formaamounts below (dollars in thousands, except per share amounts):

 

11

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| ** **                                                                                                                                     | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005**                   | ** ** | **2005**                      | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                     | ** ** | **As Reported**            | ** ** | **Pro Forma**                 | ** ** | **As Reported** | ** ** | **Pro Forma** | ** ** |
| Net income                                                                                                                                     |       | $                          | 37,629     |                          | $          | 35,062 |   | $ | 57,335 |   | $ | 53,089 |   |
| Net income attributable to common stock                                                                                                        |       | 37,629                     |       | 35,062                        |       | 57,335 |   | 53,089 |   |
| Earnings per share of common stock                                                                                                             |       | 0.51                       |       | 0.47                          |       | 0.77 |   | 0.71 |   |
| Earnings per share of common stock - assuming  dilution                                                                                        |       | 0.50                       |       | 0.46                          |       | 0.76 |   | 0.70 |   |
| Stock-based  employee compensation cost, net of related tax effects, included in net  income                                                   |       | 412                        |       | —                        |       | 585 |   | — |   |
| Stock-based  employee compensation cost, net of related tax effects, includable in net  income if the fair value based method had been applied |       | $                          | —     |                          | $          | 2,979 |   | $ | — |   | $ | 4,831 |   |

 

***NOTE5 - SEGMENT REPORTING***

 

Weoperate in four principal business segments, as follows: Gathering, Processingand Treating; Exploration and Production; Marketing; and Transportation. Managementseparately monitors these segments for performance against our internalforecast, and these segments are consistent with our internal financialreporting package. These segments have been identified based upon the differingproducts and services, regulatory environment and the expertise required forthese operations.

 

***Gathering, Processing and Treating.***Inthe Gathering, Processing and Treating segment, which collectively with theMarketing and Transportation segments are referred to as the midstreamoperations, we connect producers’ wells (including those of our Exploration andProduction segment) to our gathering systems for delivery of natural gas to ourprocessing or treating plants, process the natural gas to extract NGLs andtreat the natural gas in order to meet pipeline specifications. In some areas,where no processing is required, we gather and compress producers’ gas anddeliver it to pipelines for further delivery to market. Except for volumestaken in kind by our producers, the Marketing segment sells the gas and NGLsextracted at most of our facilities. In this segment, we recognize revenue forour services at the time the service is performed.

 

Substantially all gasflowing through our gathering, processing and treating facilities is suppliedunder three types of contracts providing for the purchase, gathering, treatingor processing of natural gas for periods ranging from one month to 20 years orin some cases for the life of the oil and gas lease. Approximately 64% of ourplant facilities’ gross margin, or revenues at the plant less productpurchases, or 31% of our plant facilities’ throughput volume for the month ofJune 2006, was under percentage-of-proceeds agreements where we are typicallyresponsible for the marketing of the gas and NGLs. Under these agreements, wepay producers a specified percentage of the net proceeds received from the saleof the gas and the NGLs. Revenue is recognized under these contracts when thegas or NGLs are sold and the related product purchases are recorded as apercentage of the sale of the product.

 

Approximately 25% of ourplant facilities’ gross margin, or 54% of our plant facilities’ throughputvolume, for the month of June 2006 was under contracts that are primarilyfee-based from which we receive a set fee for each Mcf of gas gathered and/orprocessed. This type of contract provides us with a steady revenue stream thatis not dependent on commodity prices, except to the extent that low prices maycause a producer to delay drilling or shut in production. Revenue is recognizedunder these contracts when the related services are rendered.

 

Approximately 11% of ourplant facilities’ gross margin, or 15% of our plant facilities’ throughputvolume, for the month of June 2006 was under contracts with keepwholearrangements or wellhead purchase contracts. Under the keepwhole contracts, weretain the NGLs recovered by the processing facility and keep the producerswhole by returning to the producers at the tailgate of the plant an amount ofgas equal on a Btu basis to the natural gas received at the plant inlet. Thekeepwhole component of the contracts permits us to benefit when the value ofthe NGLs is greater as a liquid than as a portion of the residue gas stream. However,we are adversely affected when the value of the NGLs is lower as a liquid thanas a portion of the residue gas stream. Revenue is recognized under thesecontracts when the product is sold.

 

***Exploration and Production.***Theactivities of the Exploration and Production segment, also referred to asupstream operations, primarily consist of the exploration and development ofgas properties in the Rocky Mountain area, including those where our gatheringand/or processing facilities are located. The Marketing segment sells the 

 

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majority of theproduction from these properties and remits to the Exploration and Productionsegment all of the proceeds from the sales of gas and a proportional share oftransportation charges. Also included in this segment are our Canadianexploration and development operations, which are conducted through our whollyowned subsidiary Western Gas Resources Canada Company and which are immaterialfor separate presentation.

 

Exploratorylease rentals and geological and geophysical costs are charged to expense asincurred. Exploratory drilling costs are capitalized when incurred pending thedetermination of whether a well has found proved reserves. The determination ofwhether a well has found proved reserves is based on a process that relies oninterpretations of available geological, geophysical, and engineering data. Ifan exploratory well is determined to be unsuccessful, the capitalized drillingcosts will be charged to expense in the period the determination is made. If anexploratory well requires a major capital expenditure before production canbegin, the cost of drilling the exploratory well will continue to be carried asan asset pending determination of whether proved reserves have been found onlyas long as: i) the well has found a sufficient quantity of reserves to justifyits completion as a producing well if the required capital expenditure is made,and ii) drilling of additional exploratory wells is under way or firmly plannedfor the near future. If the drilling of additional exploratory wells in thearea is not under way or firmly planned, or if the well has not found acommercially producible quantity of reserves, the exploratory well is assumedto be impaired, and its costs are charged to expense.

 

The following table reflects the net changes incapitalized exploratory well costs during the six months ended June 30, 2006(dollars in thousands).

 
| ** **                                                                                           | ** ** | **Six Months Ended  June 30, 2006** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Beginning balance at December 31, 2005                                                               |       | $                                   | 101,796    |   |
| Additions to capitalized exploratory well costs  pending the determination of proved reserves        |       | 68,216                              |       |
| Reclassifications to wells, facilities, and  equipment based on the determination of proved reserves |       | (5,731                              | )          |
| Capitalized exploratory well costs charged to  expense                                               |       | (342                                | )          |
| Ending balance at June 30, 2006                                                                      |       | $                                   | 163,938    |   |

 

Periodend capitalized exploratory well costs (000s) and number of gross wells at June30, 2006 are as follows:

 
| ** **                                                                | ** ** | **Exploratory   Well Costs** | ** ** | **Number   of wells** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------|------------|
| Exploratory well costs capitalized for a period of  one year or less      |       | $                            | 107,588    |                  | 645        |   |
| Exploratory well costs capitalized for a period of  greater than one year |       | 56,350                       |       | 691                   |       |
| Total exploratory well costs capitalized at June 30,  2006                |       | $                            | 163,938    |                  | 1,336      |   |

 

Substantiallyall of our exploratory wells that have been capitalized for a period greaterthan one year are located in the Powder River Basin. In this basin, we drillwells into various coal seams. After these wells are completed, lease-operatingcosts are incurred. In order to produce gas from the coal seams, a period ofdewatering lasting from a few to thirty-six months, or in some cases longer, isrequired prior to obtaining sufficient gas production to justify capitalexpenditures for compression and gathering, and to classify the reserves asproved. In order to accelerate the dewatering time, we drill additionalexploratory wells in these areas.

 

***Marketing.***OurMarketing segment markets gas and NGLs extracted at our gathering, processingand treating facilities and produced from our Exploration and Productionsegment and buys and sells gas and NGLs in the United States and Canada fromand to a variety of customers. In this segment, revenues for sales of productare recognized at the time the gas or NGLs are delivered to the customer andtitle passes. Revenues in this segment are sensitive to changes in the marketprices of the underlying commodities. The marketing of products purchased fromthird-parties typically results in low operating margins relative to the salesprice. We sell our products under agreements with varying terms and conditionsin order to match seasonal and other changes in demand. Also included in thissegment are our Canadian marketing operations, which are conducted through ourwholly owned subsidiary WGR Canada, Inc. and which are immaterial for separatepresentation.

 

***Transportation.***TheTransportation segment reflects the operations of our MIGC, Inc. and MGTC, Inc.pipelines. The revenue presented in this segment is derived from transportationof gas for our Marketing segment and third parties. In this segment, we realizerevenue on a monthly basis from firm capacity contracts under which the shipperpays for transport capacity whether or not the capacity is used and frominterruptible contracts where a 

 

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fee is charged basedupon volumes received into the pipeline. The Transportation segment’s capacitycontracts range in duration from one month to five years.

 

***Segment Information.*** Thefollowing tables set forth our segment information as of and for the three andsix months ended June 30, 2006 and 2005 (dollars in thousands). Due to ourintegrated operations, the use of allocations in the determination of businesssegment information is necessary. Inter-segment revenues are valued at pricescomparable to those of unaffiliated customers.

 

**Quarter Ended June 30, 2006:**

 
| ** **                                         | ** ** | **Gas  Gathering and   Processing** | ** ** | **Exploration    and   Production** | ** ** | **Marketing** | ** ** | **Transportation** | ** ** | **Corporate** | ** ** | **Eliminating    Entries** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|---------------|------------|--------------------|------------|---------------|------------|----------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers:             |       |                                |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Sale of gas and  NGLs                              |       | $                                   | 710        |                                | $          | 3,232         |       | $                  | 731,995    |          | $          | 460                        |       | $         | —     |   | $ | — |   | $ | 736,397 |   |
| Equity hedges                                      |       | 952                                 |       | 11,353                              |       | —        |       | —             |       | —        |       | —                     |       | 12,305    |       |
| Gathering,  processing and transportation revenue  |       | 25,654                              |       | —                              |       | —        |       | 1,919              |       | —        |       | —                     |       | 27,573    |       |
| Total revenues  from unaffiliated customers        |       | 27,316                              |       | 14,585                              |       | 731,995       |       | 2,379              |       | —        |       | —                     |       | 776,275   |       |
| Inter-segment  revenues                            |       | 284,573                             |       | 85,061                              |       | 15,031        |       | 3,125              |       | 153           |       | (387,943                   | )          | —    |       |
| Price risk  management activities                  |       | (1,630                              | )          | 853                                 |       | 10,010        |       | —             |       | —        |       | —                     |       | 9,233     |       |
| Interest income  and Other, net                    |       | 1,232                               |       | (13                                 | )          | 10            |       | 1                  |       | 20,112        |       | (19,676                    | )          | 1,666     |       |
| Total revenues                                     |       | 311,491                             |       | 100,486                             |       | 757,046       |       | 5,505              |       | 20,265        |       | (407,619                   | )          | 787,174   |       |
|                                               |       |                                |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Product purchases  and operating expenses          |       | 243,231                             |       | 48,680                              |       | 752,794       |       | 1,794              |       | 155           |       | (387,921                   | )          | 658,733   |       |
| (Earnings) from  joint ventures                    |       | (2,440                              | )          | —                              |       | —        |       | —             |       | —        |       | —                     |       | (2,440    | )          |
| Segment operating  profit                          |       | 70,700                              |       | 51,806                              |       | 4,252         |       | 3,711              |       | 20,110        |       | (19,698                    | )          | 130,881   |       |
|                                               |       |                                |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Depreciation,  depletion and amortization          |       | 13,472                              |       | 19,745                              |       | 2             |       | 454                |       | 2,251         |       | —                     |       | 35,924    |       |
| Selling and  administrative expense                |       | (1                                  | )          | (46                                 | )          | —        |       | 27                 |       | 21,325        |       | (9                         | )          | 21,296    |       |
| Interest expense                                   |       | —                              |       | —                              |       | 299           |       | (397               | )          | 25,194        |       | (19,677                    | )          | 5,419     |       |
| Income before  income taxes                        |       | $                                   | 57,229     |                                | $          | 32,107        |       | $                  | 3,951      |          | $          | 3,627                      |       | $         | (28,660    | ) | $ | (12 | ) | $ | 68,242 |   |
|                                               |       |                                |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Identifiable assets:                               |       |                                |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Property and  equipment and other allocated assets |       | $                                   | 917,601    |                                | $          | 903,320       |       | $                  | 215,951    |          | $          | 80,383                     |       | $         | 428,081    |   | $ | (96,211 | ) | $ | 2,449,125 |   |
| Investment in  joint ventures                      |       | 32,073                              |       | —                              |       | —        |       | 1,221              |       | 1,128,509     |       | (1,123,325                 | )          | 38,478    |       |
| Total  identifiable assets                         |       | $                                   | 949,674    |                                | $          | 903,320       |       | $                  | 215,951    |          | $          | 81,604                     |       | $         | 1,556,590  |   | $ | (1,219,536 | ) | $ | 2,487,603 |   |

 

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**Quarter ended June 30, 2005**

 
| ** **                                         | ** ** | **Gas  Gathering   and   Processing** | ** ** | **Exploration    and   Production** | ** ** | **Marketing** | ** ** | **Transportation** | ** ** | **Corporate** | ** ** | **Eliminating    Entries** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|---------------|------------|--------------------|------------|---------------|------------|----------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers              |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Sale of gas and  NGLs                              |       | $                                     | 959        |                                | $          | 3,040         |       | $                  | 823,816    |          | $          | 409                        |       | $         | —     |   | $ | — |   | $ | 828,224 |   |
| Equity hedges                                      |       | (1,035                                | )          | 378                                 |       | —        |       | —             |       | —        |       | —                     |       | (657      | )          |
| Gathering,  processing and transportation revenue  |       | 26,154                                |       | —                              |       | —        |       | 1,669              |       | —        |       | —                     |       | 27,823    |       |
| Total revenues  from unaffiliated customers        |       | 26,078                                |       | 3,418                               |       | 823,816       |       | 2,078              |       | —        |       | —                     |       | 855,390   |       |
| Inter-segment  sales                               |       | 300,326                               |       | 78,376                              |       | 24,940        |       | 3,353              |       | 10            |       | (407,005                   | )          | —    |       |
| Price risk  management activities                  |       | (37                                   | )          | —                              |       | 11,242        |       | —             |       | —        |       | —                     |       | 11,205    |       |
| Interest income  and Other, net                    |       | 1,089                                 |       | 122                                 |       | 21            |       | —             |       | 12,656        |       | (12,457                    | )          | 1,431     |       |
| Total revenues                                     |       | 327,456                               |       | 81,916                              |       | 860,019       |       | 5,431              |       | 12,666        |       | (419,462                   | )          | 868,026   |       |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Product purchases  and operating expenses          |       | 278,758                               |       | 34,403                              |       | 849,780       |       | 2,429              |       | —        |       | (406,964                   | )          | 758,406   |       |
| (Earnings) from  joint ventures                    |       | (2,246                                | )          | —                              |       | —        |       | —             |       | —        |       | —                     |       | (2,246    | )          |
| Segment operating  profit                          |       | 50,944                                |       | 47,513                              |       | 10,239        |       | 3,002              |       | 12,666        |       | (12,498                    | )          | 111,866   |       |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Depreciation,  depletion and amortization          |       | 11,594                                |       | 16,899                              |       | 35            |       | 436                |       | 1,835         |       | —                     |       | 30,799    |       |
| Selling and  administrative expense                |       | (213                                  | )          | 61                                  |       | —        |       | 151                |       | 17,546        |       | (9                         | )          | 17,536    |       |
| Interest expense                                   |       | —                                |       | 3                                   |       | 587           |       | (194               | )          | 16,094        |       | (12,457                    | )          | 4,033     |       |
| Income before  income taxes                        |       | $                                     | 39,563     |                                | $          | 30,550        |       | $                  | 9,617      |          | $          | 2,609                      |       | $         | (22,809    | ) | $ | (32 | ) | $ | 59,498 |   |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Identifiable  assets:                              |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Property and  equipment and other allocated assets |       | $                                     | 763,801    |                                | $          | 553,848       |       | $                  | 150,722    |          | $          | 74,958                     |       | $         | 399,644    |   | $ | (68,763 | ) | $ | 1,874,210 |   |
| Investment in  Joint Ventures                      |       | 32,675                                |       | —                              |       | —        |       | 1,150              |       | 857,160       |       | (854,901                   | )          | 36,084    |       |
| Total  identifiable assets                         |       | $                                     | 796,476    |                                | $          | 553,848       |       | $                  | 150,722    |          | $          | 76,108                     |       | $         | 1,256,804  |   | $ | (923,664 | ) | $ | 1,910,294 |   |

 

**Six months ended June 30, 2006**

 
| ** **                                         | ** ** | **Gas  Gathering   and   Processing** | ** ** | **Exploration    and   Production** | ** ** | **Marketing** | ** ** | **Transportation** | ** ** | **Corporate** | ** ** | **Eliminating    Entries** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|---------------|------------|--------------------|------------|---------------|------------|----------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers:             |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Sale of gas and  NGLs                              |       | $                                     | 1,009      |                                | $          | 6,143         |       | $                  | 1,658,341  |          | $          | 1,462                      |       | $         | —     |   | $ | — |   | $ | 1,666,955 |   |
| Equity hedges                                      |       | 2,053                                 |       | 18,771                              |       | —        |       | —             |       |          |       |                       |       | 20,824    |       |
| Gathering,  processing and transportation revenue  |       | 50,516                                |       | —                              |       | —        |       | 3,757              |       | —        |       | —                     |       | 54,273    |       |
| Total revenues  from unaffiliated customers        |       | 53,578                                |       | 24,914                              |       | 1,658,341     |       | 5,219              |       | —        |       | —                     |       | 1,742,052 |       |
| Inter-segment  sales                               |       | 617,272                               |       | 186,587                             |       | 41,849        |       | 6,467              |       | 268           |       | (852,443                   | )          | —    |       |
| Price risk  management activities                  |       | (1,755                                | )          | (2,604                              | )          | 34,572        |       | —             |       | —        |       | —                     |       | 30,213    |       |
| Interest income  and Other, net                    |       | 2,874                                 |       | 82                                  |       | 13            |       | 1                  |       | 37,770        |       | (36,750                    | )          | 3,990     |       |
| Total revenues                                     |       | 671,969                               |       | 208,979                             |       | 1,734,775     |       | 11,687             |       | 38,038        |       | (889,193                   | )          | 1,776,255 |       |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Product purchases  and operating expense           |       | 549,850                               |       | 89,036                              |       | 1,705,265     |       | 3,930              |       | 273           |       | (852,755                   | )          | 1,495,599 |       |
| (Earnings) from  joint ventures                    |       | (4,814                                | )          | —                              |       | —        |       | —             |       | —        |       | —                     |       | (4,814    | )          |
| Segment operating  profit (loss)                   |       | 126,933                               |       | 119,943                             |       | 29,510        |       | 7,757              |       | 37,765        |       | (36,438                    | )          | 285,470   |       |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Depreciation,  depletion and amortization          |       | 27,076                                |       | 38,881                              |       | 3             |       | 917                |       | 4,409         |       | —                     |       | 71,286    |       |
| Selling and  administrative expense                |       | (4                                    | )          | 740                                 |       | —        |       | 292                |       | 40,133        |       | (17                        | )          | 41,144    |       |
| Interest expense                                   |       | —                                |       | —                              |       | 729           |       | (709               | )          | 45,333        |       | (36,749                    | )          | 8,604     |       |
| Income before  income taxes                        |       | $                                     | 99,861     |                                | $          | 80,322        |       | $                  | 28,778     |          | $          | 7,257                      |       | $         | (52,110    | ) | $ | 328 |   | $ | 164,436 |   |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Identifiable  assets:                              |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Property and  equipment and other allocated assets |       | $                                     | 917,601    |                                | $          | 903,320       |       | $                  | 215,951    |          | $          | 80,383                     |       | $         | 428,081    |   | $ | (96,211 | ) | $ | 2,449,125 |   |
| Investment in  Joint Ventures                      |       | 32,073                                |       | —                              |       | —        |       | 1,221              |       | 1,128,509     |       | (1,123,325                 | )          | 38,478    |       |
| Total  identifiable assets                         |       | $                                     | 949,674    |                                | $          | 903,320       |       | $                  | 215,951    |          | $          | 81,604                     |       | $         | 1,556,590  |   | $ | (1,219,536 | ) | $ | 2,487,603 |   |

 

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**Six months ended June 30, 2005**

 
| ** **                                         | ** ** | **Gas  Gathering   and   Processing** | ** ** | **Exploration    and   Production** | ** ** | **Marketing** | ** ** | **Transportation** | ** ** | **Corporate** | ** ** | **Eliminating    Entries** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|---------------|------------|--------------------|------------|---------------|------------|----------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers:             |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Sale of gas and  NGLs                              |       | $                                     | 781        |                                | $          | 7,075         |       | $                  | 1,647,915  |          | $          | 1,154                      |       | $         | —     |   | $ | — |   | $ | 1,656,925 |   |
| Equity hedges                                      |       | (1,774                                | )          | 1,604                               |       | —        |       | —             |       | —        |       | —                     |       | (170      | )          |
| Gathering,  processing and transportation revenue  |       | 48,446                                |       | (162                                | )          | —        |       | 3,419              |       | —        |       | —                     |       | 51,703    |       |
| Total revenues  from unaffiliated customers        |       | 47,453                                |       | 8,517                               |       | 1,647,915     |       | 4,573              |       | —        |       | —                     |       | 1,708,458 |       |
| Inter-segment  sales                               |       | 576,179                               |       | 147,643                             |       | 42,644        |       | 6,795              |       | 20            |       | (773,281                   | )          | —    |       |
| Price risk  management activities                  |       | (125                                  | )          | —                              |       | (8,918        | )          | —             |       | —        |       | —                     |       | (9,043    | )          |
| Interest income  and Other, net                    |       | 2,194                                 |       | 128                                 |       | 21            |       | —             |       | 22,338        |       | (21,963                    | )          | 2,718     |       |
| Total revenues                                     |       | 625,701                               |       | 156,288                             |       | 1,681,662     |       | 11,368             |       | 22,358        |       | (795,244                   | )          | 1,702,133 |       |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Product purchases  and operating expenses          |       | 526,849                               |       | 69,826                              |       | 1,689,826     |       | 5,098              |       | —        |       | (773,244                   | )          | 1,518,355 |       |
| (Earnings) from  joint ventures                    |       | (4,380                                | )          | —                              |       | —        |       | —             |       | —        |       | —                     |       | (4,380    | )          |
| Segment operating  profit (loss)                   |       | 103,232                               |       | 86,462                              |       | (8,164        | )          | 6,270              |       | 22,358        |       | (22,000                    | )          | 188,158   |       |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Depreciation,  depletion and amortization          |       | 22,872                                |       | 32,528                              |       | 71            |       | 839                |       | 3,567         |       | —                     |       | 59,877    |       |
| Selling and  administrative expense                |       | (182                                  | )          | 61                                  |       | —        |       | 148                |       | 30,089        |       | (20                        | )          | 30,096    |       |
| Interest expense                                   |       | 5                                     |       | 4                                   |       | 589           |       | (348               | )          | 29,266        |       | (21,963                    | )          | 7,553     |       |
| Income before  income taxes                        |       | $                                     | 80,537     |                                | $          | 53,869        |       | $                  | (8,824     | )             | $          | 5,631                      |       | $         | (40,564    | ) | $ | (17 | ) | $ | 90,632 |   |
|                                               |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Identifiable  assets:                              |       |                                  |       |                                |       |          |       |               |       |          |       |                       |       |      |       |
| Property and  equipment and other allocated assets |       | $                                     | 763,801    |                                | $          | 553,848       |       | $                  | 150,722    |          | $          | 74,958                     |       | $         | 399,644    |   | $ | (68,763 | ) | $ | 1,874,210 |   |
| Investment in  Joint Ventures                      |       | 32,675                                |       | —                              |       | —        |       | 1,150              |       | 857,160       |       | (854,901                   | )          | 36,084    |       |
| Total  identifiable assets                         |       | $                                     | 796,476    |                                | $          | 553,848       |       | $                  | 150,722    |          | $          | 76,108                     |       | $         | 1,256,804  |   | $ | (923,664 | ) | $ | 1,910,294 |   |

 

***NOTE 6 - LEGAL******PROCEEDINGS***

 

***Doyle and Margaret M. Hartman, et al. v. Questar Explorationand Production Company et al. In the District Court of Sublette County,Wyoming, Civil Action No. 2006-6843.***On March 31, 2006,the plaintiffs filed a complaint against a group of ten defendants, includingour subsidiary Lance Oil & Gas Company, Inc. The plaintiffs claim that theyhold a five percent net profits interest which they allege was created in 1954and burdened certain oil and gas leases in the original federal Pinedale Unitin the Pinedale Anticline. The relief sought by the plaintiffs includes adeclaration that they hold a valid, continuing net profits interest applicableto certain identified leases, enforcement of the net profits interest,compensatory damages, an accounting of the status of the net profits interest,and interest and penalties under the Wyoming Royalty Payment Act.

 

***UnitedStates of America and ex rel. Jack J. Grynberg v. Western Gas Resources, Inc.,et al., United States District Court, District of Colorado, Civil Action No.97-D-1427.***We, along with over 300 other natural gascompanies, are defendants in litigation filed on September 30, 1997, in 72 separateactions filed by Mr. Grynberg on behalf of the federal government. Theallegations made by Mr. Grynberg are that established gas measurement androyalty calculation practices improperly deprived the federal government ofappropriate natural gas royalties and violate 31U.S.C. 3729(a)(7) of the FalseClaims Act. The cases have been consolidated to the United States DistrictCourt for the District of Wyoming. Discovery on the jurisdictional issues isbeing completed to determine if this matter qualifies as a qui tam, or class,action. The defendants’ joint Motion to Dismiss was argued before a specialmaster on March 17 and 18, 2005 and, as a result thereof, the special masterhas recommended to the court that claims against several of the defendants,including Western, be dismissed. The recommendation is pending before thecourt.

 

***Price,et al. v. Gas Pipelines, Western Gas Resources, Inc., et al., District Court,Stevens County, Kansas, Case No. 99-C-30.***We are adefendant in litigation filed on September 23, 1999, along with numerous othernatural gas companies, in which Mr. Price is claiming an under measurement ofgas and Btu volumes throughout the country. We, along with other natural gascompanies, filed a motion to dismiss for failure to state a claim. The courtdenied these motions to dismiss. The court denied plaintiff’s motion forcertification as a class and, in the third 

 

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quarter of 2003, the plaintiff amended and refiled for certification asa class. On May 12, 2003, Mr. Price filed a further claim, *Will Price et al v. Western Gas Resources, Inc. etal., District Court, Stevens County, Kansas, Case No. 03C23*,relating to certain matters previously removed from the foregoing action.

 

***In re: Western States Wholesale Natural Gas AntitrustLitigation, J.P. Morgan Trust Company, National Association, in its Capacity asTrustee of FLI Liquidating Trust v. The Williams Companies, Inc., et al.,United States District Court, District of Nevada, MDL 1566 CV-S-03-1431-PMP.***OnOctober 17, 2005, the plaintiff, in its capacity as the liquidating trustee ofthe successor in interest to Farmland Industries, Inc., filed an amendedcomplaint, joining us and other defendants to this action, originally filed inthe District Court of Wyandotte County, Kansas. The defendants removed the caseto the U.S. District Court for the District of Kansas, following which theJudicial Panel on Multi District Litigation entered a transfer ordercentralizing the action in the U.S. District Court for the District of Nevadafor coordinated and consolidated pretrial proceedings. On April 21, 2006, theplaintiff’s motion to remand to Kansas state court was denied. The complaintclaims that the defendants violated the Kansas Restraint of Trade Act byreporting allegedly “misleading or knowingly inaccurate reports concerningtrade information” to trade publications that compile and publish indices ofnatural gas prices for natural gas trading hubs throughout the United States. Thecomplaint asserts that these alleged activities had the effect of increasingprices charged by the defendants for natural gas and preventing full and freecompetition. The plaintiff seeks to recover damages in the amount of the fullconsideration of its purchases of natural gas during the time period fromJanuary 1, 2000 through December 31, 2001, together with its costs oflitigation including attorney’s fees.

 

***Learjet, Inc., Cross Oil Refining & Marketing, Inc.Topeka Unified School District 501, on Behalf of Themselves and All OtherSimilarly Situated Direct Purchasers of Natural Gas in the State of Kansas v.Oneok, Inc. et al, In the District Court of Wyandotte County, Kansas, CivilAction No. 05-CV-1500.***On November 4, 2005, theplaintiffs, on behalf of themselves and all others similarly situated, filed anamended Petition for Damages, joining us and other defendants to this action. ThePetition claims that the defendants violated the Kansas Restraint of Trade Actby reporting allegedly “misleading or knowingly inaccurate reports concerningtrade information” to trade publications that compile and publish indices ofnatural gas prices for natural gas trading hubs throughout the United States. Thecomplaint asserts that the allegedly anticompetitive effect of the defendant’sactions was to artificially inflate the prices paid by the plaintiffs fornatural gas. The plaintiffs are bringing the action as a class action on behalfof all persons and entities in Kansas who made direct purchases of natural gas,for their own use and or consumption, during the time period from January 1,2000 through October 31, 2002. The plaintiffs are seeking judgment for the fullconsideration of their purchases of natural gas purchased during such timeperiod, together with costs of litigation including attorney’s fees.

 

***In the Matter of the Notice of Violation, Docket Number 3852-06,Issued to Lance Oil & Gas Company, Inc., Department of EnvironmentalQuality, Water Quality Division, State of Wyoming.***OnJanuary 26, 2006, we received a Notice of Violation issued by the State ofWyoming Department of Environmental Quality, Water Quality Division, for theun-permitted discharge of coal bed methane produced water at our Spotted HorseFacility in Campbell County. We have undertaken remedial steps to address theitems contained in the Notice of Violation and, in May 2006, we paid a settlementin the amount of $100,000.

 

***In the Matter ofthe Notice of Violation, WES-1252-0501, Environment Department, Air QualityBureau, State of New Mexico.***On March 6, 2006, wereceived a Notice of Violation pertaining to operations at our San Juan RiverGas Plant located west of Farmington, New Mexico, containing two allegedviolations. On April 4, 2006,we met with the Environment Department to discuss the notices and any potentialmonetary penalties. This matter is still pending.

 

In addition to the above claims, we are involved invarious other litigation and administrative proceedings arising in the normalcourse of business. While the outcome of claims in litigation is inherentlyuncertain, and it is not possible to predict the ultimate outcome, we intend tovigorously contest the allegations in the previously described matters. In theopinion of our management, any liabilities that may result from these claimswill not, individually or in the aggregate, have a material adverse effect onour results of operations, financial position, or cash flows.

 

***NOTE 7 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS***

 

We continually monitorand revise our accounting policies as new rules are issued. At this time, thereare several new accounting pronouncements that have recently been issued, butnot yet adopted, which will have an impact on our accounting when they becomeeffective.

 

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**SFAS No. 155.**In February 2006, the FASB issued SFAS No. 155, “*Accounting for Certain Hybrid Financial Instruments,an Amendment of SFAS No. 133 and No. 140*”. This statement resolvesissues addressed in SFAS Implementation Issue D1, “*Application of Statement 133 to Beneficial Interests in SecuritizedFinancial Assets*.”  Thisstatement is effective in the annual period commencing after September 15, 2006.We do not believe that the adoption of this statement will have a materialimpact on our results of operation, financial position or cash flows.

 

**EITFNo. 06-3.**At its May 2006 meeting, the Emerging Issues TaskForce, or EITF, of the FASB approved Issue No. 06-3, *“How Taxes Collected from Customers and Remitted to GovernmentalAuthorities Should Be Presented in the Income Statement (That Is, Gross versusNet Presentation).”*  The scopeof this issue includes any tax assessed by a governmental authority that isimposed on a revenue producing transaction between a seller and a customer. ThisEITF is effective for periods beginning after December 15, 2006 and requiresthat the presentation of taxes on either a gross or net basis is an accountingpolicy decision that should be disclosed in the footnotes along with the amountof such taxes. The adoption of this EITFwill not have a material impact on our results of operations, financialposition or cash flows.

 

**FIN No. 48.**In July 2006, the FASBissued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty inIncome Taxes-an interpretation of FASB Statement No. 109.”  This Interpretation provides guidance forrecognizing and measuring uncertain tax positions, as defined in SFASNo. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes athreshold condition that a tax position must meet for any of the benefit of theuncertain tax position to be recognized in the financial statements. Guidance isalso provided regarding derecognition, classification and disclosure of theseuncertain tax positions. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. We do not expect that this Interpretation will have amaterial impact on our financial position, results of operations or cash flows.

 

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**ITEM 2.****  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussionand analysis relates to factors that have affected our consolidated financialcondition and results of operations for the three and six months ended June 30,2006 and 2005. You should also refer to our interim consolidated financialstatements and notes thereto included elsewhere in this document. This section,as well as other sections in this Form 10-Q, contain “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995,which can be identified by the use of forward-looking terminology, such as “may,”“intend,” “will,” “expect,” “anticipate,” “estimate,” or “continue” or thenegative thereof or other variations thereon or comparable terminology. Inaddition to the important factors referred to herein, numerous factorsaffecting the gas processing industry generally and in the specific markets forgas and NGLs in which we operate, could cause actual results to differmaterially from those in such forward-looking statements. In the event that theproposed merger is completed, on and from the date of such merger, these typeof forward-looking statements concerning proposed future activities or plansreferred to in these forward-looking statements may not occur.

 

***BusinessStrategy.***Maximizing the value of our existing coreassets is the focal point of our business strategy. Our core assets are ourfully integrated upstream and midstream assets in the Powder River and GreaterGreen River Basins in Wyoming, the San Juan Basin in New Mexico, the Sand WashBasin in Colorado and our midstream operations in West Texas and Oklahoma. Ourlong-term business plan is to increase stockholder value by: (i) doublingproved natural gas reserves and equity production of natural gas from thelevels achieved in 2001 by the end of 2006; (ii) meeting or exceedingthroughput projections in our midstream operations; and (iii) optimizing annualreturns.

 

***Proposed Merger of our Company.***On June 23, 2006, we announced that we hadentered into a merger agreement with Anadarko Petroleum Corporation, orAnadarko, whereby it is proposed that we will be merged with a wholly ownedsubsidiary of Anadarko. Our stockholders will receive $61.00 per common sharein cash in the merger. The merger agreement has been approved by each company’sBoard of Directors and was filed with the SEC on Form 8-K. We have scheduled a special meeting of ourstockholders for August 23, 2006 to vote on, adopt the merger agreement andapprove the merger. The merger is also subject to the satisfaction ofcustomary closing conditions, including the receipt of necessary regulatory andgovernmental approvals. The merger will be completed as soon as practicablefollowing satisfaction of these conditions, which could be as early as the endof August 2006. Should the merger be completed, our common stock will bede-listed with the New York Stock Exchange, or NYSE, and we will file a Form 15with the SEC to deregister our common stock. Certain of our directors, officersand other stockholders, who collectively hold approximately 17.3 percent ofWestern’s outstanding shares, have entered into agreements to vote in favor ofthe merger.

 

This Form 10-Q includesdiscussion regarding events that will or may trigger or occur upon completionof the merger. If the merger is not completed these events will not occur. Inaddition, the timing of the completion of the merger will affect the timing ofthese events. See also the first paragraph under Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations for adiscussion of the effect of the proposed merger on certain forward-lookingstatements included in this Form 10-Q.

 

***Industry and Company Overview.***InNorth America, our industry has experienced several consecutive years ofdeclining natural gas production. Most of the major gas producing areas, suchas the Gulf of Mexico, are mature and are in production decline. We areconcentrating our efforts in the Rocky Mountain gas producing basins wherethere are estimated to be large quantities of undeveloped gas. The U.S.government largely retains the mineral rights to these undeveloped reserves;accordingly, the development and production of these reserves require permitsfrom several governmental agencies including the Bureau of Land Management, orBLM. We are well positioned for future production growth with a large inventoryof undeveloped drilling locations in the Powder River, the Greater Green Riverand San Juan Basins to meet the growing demand for clean burning natural gas. Inaddition, our experience and technical expertise position us to acquire newopportunities to develop natural gas in the Rocky Mountain region. Ourchallenges will be to accomplish these goals with the difficulties encounteredby the industry in obtaining the necessary permits from the BLM, and stateagencies such as the Wyoming Department of Environmental Quality, or DEQ. Webelieve that our technical expertise in developing environmentally responsiblesolutions to the problems encountered in the development of gas reserves willbe a competitive advantage in overcoming these challenges.

 

Our operations areconducted through the following four business segments:

 

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***Explorationand Production.***We explore for, develop and produce naturalgas reserves independently which also may enhance and support our existinggathering and processing operations. Our producing properties are primarilylocated in the Powder River, Greater Green River, San Juan, and the Sand WashBasins. These plays are relatively low-risk, multi-year development projects. Theseprovide us with the opportunity to steadily increase our production volume overtime at reasonable operating and low finding and development costs. In thesecond quarter of 2006, our average production sold was 197 MMcfe per day,which was a 18.1% increase over the average production volume sold in thesecond quarter of 2005.

 

We continue to seek toadd additional upstream core projects that are focused on Rocky Mountainnatural gas. We will utilize our expertise in exploration and low-riskdevelopment of unconventional gas reservoirs including tight-gas sands, coalbed methane, or CBM, biogenic, and shale gas plays to evaluate acquisitions ofadditional leaseholds, proved and undeveloped reserves or companies withoperations primarily focused on unconventional gas developments. In 2005, weopened an exploration and production office in Calgary, Alberta, Canada toevaluate opportunities in the Western Canadian Sedimentary Basin. In total,through June 30, 2006, we have acquired leases on approximately 1.0 million netacres in areas outside our primary producing areas and continue to activelyacquire additional leasehold positions.

 

In March 2006, weacquired certain CBM, properties and related gathering assets in the Big Georgefairway of the Powder River Basin of Wyoming for an adjusted purchase price ofapproximately $138.6 million. This acquisition was funded with amountsavailable under our revolving credit facility. The purchase price includes the drillingrights on approximately 40,000 gross and net acres and 110 drilled wells. Approximately70 of the drilled wells are currently dewatering, and the remaining 40 wellsare awaiting hookup.

 

***Gathering,Processing and Treating.***Our core operations are inwell-established areas such as the Permian, Anadarko, Powder River, GreaterGreen River, and San Juan Basins. We connect natural gas from gas and oil wellsto our gathering systems for delivery to our processing or treating plantsunder long-term contracts. At our plants we process natural gas to extract NGLsand may treat natural gas in order to meet pipeline specifications. We providethese services to major oil and gas companies, to independent producers ofvarious sizes and for our own production. We believe that our low cost ofoperations, our high on-line time and our safety records are key elements inour ability to compete effectively and provide service to our customers. Ourexpertise in gathering, processing and treating operations can enhance theeconomics of developing new upstream projects.

 

This segment of ouroperations has provided a stream of operating profit that is available forreinvestment into other projects or other segments of our business. Overallthroughput in our facilities during the second quarter of 2006 increased 4.5MMcf per day as compared to the same period in 2005 and averaged a total of1.44 Bcf per day.

 

***Transportation.***In the Powder River Basin, we own one interstatepipeline, MIGC, Inc., and one intrastate pipeline, MGTC, Inc., which transportnatural gas produced by us, natural gas for producers and energy marketersunder fee schedules regulated by state or federal agencies.

 

***Marketing.***Our gas marketing segment is an outgrowth of our gasprocessing and upstream activities and ensures continual flow of our producedproducts. One of the primary goals of our gas marketing operations is thepreservation and enhancement of the value received for our equity volumes ofnatural gas. This goal is achieved through the use of hedges on the productionof our equity natural gas and NGLs and through the use of firm transportationcapacity. Historically, the gas produced in the Rocky Mountain region hastraded at a substantial discount as compared to the Mid-Continent and WestCoast areas, as a result of limited pipeline capacity from the region. We havehistorically used our firm pipeline transportation capacity to access higherpriced Mid-Continent markets and markets further east for both our equityproduction and for gas purchased from third-parties in the Rocky Mountainregion.

 

We also buy and sellnatural gas and NGLs in the wholesale market in the United States and Canada. Thesethird-party sales, our firm transportation capacity on interstate pipelines andour gas storage positions, combined with the stable supply of gas from ourfacilities and production, enable us to respond quickly to changing marketconditions and to take advantage of seasonal price variations and peak demandperiods.

 

***RESULTS OF OPERATIONS***

 

**Three and six months ended June30, 2006 compared to the three and six months ended June 30, 2005**

 

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**(Dollars in thousands, except pershare amounts and operating data).**

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Percent** | ** ** | **Six Months Ended  June 30,** | ** ** | **Percent** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|-------------|------------|--------------------------------|------------|-------------|------------|
| ** **                                   | ** ** | **2006**                         | ** ** | **2005**    | ** ** | **Change**                     | ** ** | **2006**    | ** ** | **2005** | ** ** | **Change** | ** ** |
|                                         |       |                             |       |        |       |                           |       |        |       |   |   |   |   |
| **Financial results:**                       |       |                             |       |        |       |                           |       |        |       |   |   |   |   |
| Revenues                                     |       | $                                | 787,174    |        | $          | 868,026                        |       | (9          | )          | $ | 1,776,255 |   | $ | 1,702,133 |   | 4 |   |
| Net income                                   |       | 42,369                           |       | 37,629      |       | 13                             |       | 104,231     |       | 57,335 |   | 82 |   |
| Earnings per share of common  stock          |       | 0.56                             |       | 0.51        |       | 10                             |       | 1.38        |       | 0.77 |   | 79 |   |
| Earnings per share of common stock - diluted |       | 0.55                             |       | 0.50        |       | 10                             |       | 1.36        |       | 0.76 |   | 79 |   |
| Net cash provided by operating activities    |       | 78,549                           |       | 42,706      |       | 84                             |       | 265,664     |       | 160,102 |   | 66 |   |
| Net cash used in investing activities        |       | (134,197                         | )          | (76,847     | )          | 75                             |       | (398,096    | )          | (191,088 | ) | 108 |   |
| Net cash provided by financing activities    |       | $                                | 51,960     |        | $          | 38,454                         |       | 35          |       | $ | 109,126 |   | $ | 36,634 |   | 198 |   |
|                                         |       |                             |       |        |       |                           |       |        |       |   |   |   |   |
| **Operating data:**                          |       |                             |       |        |       |                           |       |        |       |   |   |   |   |
| Average gas sales (MMcf/D)                   |       | 1,082                            |       | 1,162       |       | (7                             | )          | 1,094       |       | 1,231 |   | (11 | ) |
| Average NGL sales (MGal/D)                   |       | 1,790                            |       | 1,876       |       | (5                             | )          | 1,813       |       | 1,819 |   | — |   |
| Average gas prices ($/Mcf)                   |       | $                                | 5.99       |        | $          | 6.38                           |       | (6          | )          | $ | 6.86 |   | $ | 6.13 |   | 12 |   |
| Average NGL prices ($/Gal)                   |       | $                                | 1.14       |        | $          | 0.88                           |       | 30          |       | $ | 1.07 |   | $ | 0.86 |   | 24 |   |

 

Netincome increased $4.7 million for the three months ended June 30, 2006,compared to the same period in 2005. The increase in net income was primarilyattributable to higher production of equity gas volumes, and higher NGLcommodity prices in the second quarter of 2006.

 

Netincome increased $46.9 million for the six months ended June 30, 2006, comparedto the same period in 2005. This increase was primarily attributable to higherproduction of equity gas volumes, higher commodity prices, and gains from our price risk managementactivities related to our future sales ofgas utilizing our storage and transportation capacity.

 

Revenues from the sale of gas decreased $101.4 millionto $576.7 million for the three months ended June 30, 2006 compared to the sameperiod in 2005. This decrease was primarily due to a significant decrease ingas prices and a decrease in sales volume of third-party product in the threemonths ended June 30, 2006 compared to the same period in 2005 and theimplementation of EITF 04-13. EITF 04-13 requires that transactions withthe same counterparty that are entered into in contemplation of one anothershould be reported on a sales net of purchases basis. For the quarter endedJune 30, 2006, we reduced revenues and product purchases by $18.3 million fortransactions which were entered into concurrently and with the intent to buyand sell like quantities with the same counterparty. Average gas prices realized byus decreased $0.39 per Mcf to $5.99 per Mcf for the quarter ended June 30, 2006compared to the same period in 2005. Included in the realized gas price wereapproximately $13.0 million of gains recognized in the three months ended June30, 2006 related to futures positions on equity gas volumes. We have enteredinto additional futures positions for approximately 75% of our equity gas forthe remainder of 2006 and to a lesser extent in 2007. See further discussion in“Item 3. Quantitative and Qualitative Disclosures About Market Risk.”  Average gas sales volumes decreased by 80MMcf per day to 1,082 MMcf per day for the quarter ended June 30, 2006 comparedto the same period in 2005.

 

Revenues from the sale of gas decreased $25.9 million to$1,348.4 million for the six months ended June 30, 2006 compared to the sameperiod in 2005. This decrease was primarily due to the implementation of EITF04-13 in the six months ended June 30, 2006 as discussed above. For thesix months ended June 30, 2006, we reduced revenues and product purchases by$18.3 million for transactions which were entered into concurrently and withthe intent to buy and sell like quantities with the same counterparty. Average gasprices realized by us increased $0.73 per Mcf to $6.86 per Mcf for the sixmonths ended June 30, 2006 compared to the same period in 2005. Included in therealized gas price were approximately $21.5 million of gains recognized in thesix months ended June 30, 2006 related to futures positions on equity gasvolumes. We have entered into additional futures positions for approximately75% of our equity gas for the remainder of 2006 and to a lesser extent in 2007.Average gas sales volumes decreased 137 MMcf per day to 1,094 MMcf per day forthe six months ended June 30, 2006 compared to the same period in 2005.

 

Revenues from the sale ofNGLs increased $22.5 million to $172.0 million for the three months ended June30, 2006 compared to the same period in 2005. This is primarily due to asignificant increase in product prices, which more than offset a slightdecrease in sales volumes. Average NGL prices realized by us increased $0.26per gallon to $1.14 per gallon for the three months ended June 30, 2006 comparedto the same period in 2005. Included in the realized NGL price wereapproximately $700,000 of losses recognized in the three months ended June 30,2006 

 

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related to futures positions on equity NGL volumes. We have enteredinto additional futures positions for approximately 55% of our equity NGLproduction for the remainder of 2006. Average NGL sales volumes decreased 86MGal per day to 1,790 MGal per day for the three months ended June 30, 2006compared to the same period in 2005.

 

Revenues from the sale ofNGLs increased approximately $56.9 million to $339.4 million for the six monthsended June 30, 2006 compared to the same period in 2005. This is primarily dueto a significant increase in product prices. Average NGL prices realized by usincreased $0.21 per gallon to $1.07 per gallon for the six months ended June30, 2006 compared to the same period in 2005. Included in the realized NGLprice was approximately $700,000 of losses recognized in the six months endedJune 30, 2006 related to futures positions on equity NGL volumes. We haveentered into additional futures positions for approximately 55% of our equityNGL production for the remainder of 2006. Average NGL sales volumes decreasedslightly to 1,813 MGal per day for the six months ended June 30, 2006 comparedto the same period in 2005.

 

The effect of Price riskmanagement activities changed from $11.2 million for the quarter ended June 30,2005 to $9.2 million for the quarter ended June 30, 2006. This change was dueto the mark-to-market of our risk management activities. This account isprimarily impacted by changes in the forward price of natural gas in the secondquarter of 2006 as compared to the same period in 2005 and the impact of thoseprice changes on the fair value of the forward sale derivatives for our gas instorage.

 

The effect of Price riskmanagement activities changed from ($9.0) million for the six months ended June30, 2005 to $30.2 million for the six months ended June 30, 2006. This changewas due to the mark-to-market of our risk management activities. This accountis primarily impacted by changes in the forward price of natural gas in the2006 period as compared to 2005 period and the impact of those price changes onthe fair value of the forward sale derivatives for our gas in storage.

 

Product purchasesdecreased by $114.7 million and $45.9 million for the quarter and six monthsended June 30, 2006, respectively, compared to the same periods in 2005. Thesedecreases in product purchases were the result of lower third-party productsales volumes and lower product purchases on our keepwhole contracts. Keepwholecontracts are more beneficial when NGL prices are high relative to gas prices. Inaddition, the implementation of EITF 04-13, as discussed above, also reducedproduct purchases by $31.2 million. Overall, combined product purchases as apercentage of sales of all products were 79% in the quarter ended June 30, 2006compared to 85% in the quarter ended June 30, 2005. Combined product purchasesas a percentage of sales of all products decreased to 81% for the six monthsended June 30, 2006 from 85% in the 2005 period. The reductions in thesepercentages are primarily the result of a decrease in the sale of third partyproduct, an increase in the sale of equity production, and lower productpurchases on our keepwhole contracts.

 

Plant and transportationoperating expense increased by $3.1 million and $7.6 million, respectively, forthe three and six months ended June 30, 2006 compared to the same periods in2005. The increase for the quarter ended June 30, 2006 as compared to the sameperiod in 2005 was substantially due to increased labor and repair andmaintenance expenses. The increase for the six months ended June 30, 2006 ascompared to the same period in 2005 was substantially due to increased, labor,repair and maintenance expenses, and third-party gathering expenses.

 

Oil and gas explorationand production expense increased by $11.9 million and $15.5 million, respectively,for the three and six months ended June 30, 2006 compared to the same periodsin 2005. The increases for the quarter and six months ended June 30, 2006 ascompared to the same periods in 2005 were substantially due to increasedproduction taxes and increased operations throughout our operating areas. Overall,LOE averaged $0.93 per Mcf and $0.85 per Mcf for the quarter and six monthsended June 30, 2006, respectively, and LOE in the Powder River Basin coal beddevelopment averaged $1.05 per Mcf and $0.92 per Mcf in the quarter and sixmonths ended June 30, 2006, respectively. In the Powder River Basin, theserepresent increases of $0.13 and $0.03 per Mcf from the same periods in 2005. Theincrease in LOE per Mcf is substantially due to higher water handling chargeson dewatering wells in several new pilot areas that have no offsetting gasproduction as yet, contract labor, and fuel and operating costs of wellheadblowers in the Powder River Basin.

 

Depreciation,depletion and amortization increased by $5.1 million and $11.4 million,respectively, for the three and six months ended June 30, 2006 as compared tothe same periods in 2005. For the quarter ended June 30, 2006 as compared tothe same period in 2005, we had a $2.4 million increase in DD&A in our midstreamoperations primarily due to our expanding CBM gathering system in the PowderRiver Basin, and a $2.5 million increase in DD&A in our upstream operationsprimarily due to our continued development in the Powder River Basin. For thesix months ended June 30, 2006 as compared to the same period in 2005, we hadan $5.2 million increase in DD&A 

 

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in our midstream operations and a $5.6 millionincrease in our upstream operations primarily due to those items mentionedabove.

 

Selling andadministrative expenses increased by $3.8 million and $11.0 million for thethree and six months ended June 30, 2006 as compared to the same period in 2005.The increase in selling and administrative expenses for the three months endedJune 30, 2006 as compared to 2005 was primarily the result of increasedadministrative salaries, expenses related to our proposed merger, andcompensation expense related to our stock option and restricted stock plans. Additionally,a charge of $5.9 million was recorded in the second quarter of 2005 inconnection with a settlement of litigation. The increase in the six monthsended June 30, 2006 compared to 2005 is due to those items mentioned above.

 

The Total provision forincome taxes, as a percentage of Income before taxes was approximately 37.9%and 36.6%, respectively, during the quarter and six months ended June 30, 2006as compared to 36.8% and 36.7%, respectively, in same periods of 2005. Thisincrease is due to a change in the calculation of the franchise tax in Texas,which, effective January 1, 2007, will include an associated income tax.

 

***Cash FlowInformation***

 

Cash flows from operatingactivities increased by $105.6 million in the first six months of 2006 comparedto the same period in 2005. This increase was primarily due to the increase innet income and the timing of cash receipts and payables.

 

Cash flows used in investingactivities increased by $207.0 million in the first six months of 2006 comparedto the same period in 2005. This increase was primarily due to an increasedlevel of capital expenditures, including the March 2006 acquisition ofproperties in the Powder River Basin.

 

Cash flows provided byfinancing activities increased by $72.5 million in the first six months of 2006compared to the same period in 2005. This increase was due to the utilizationof our revolving credit facility to fund our capital investments in 2006,including the acquisition of properties in the Powder River Basin in the firstquarter.

 

***Adoption of FAS 123(R)***

 

OnJanuary 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment”, or SFAS 123(R), which requiresthe measurement and recognition of compensation expense for all share-basedpayment awards made to employees and directors including employee stock optionsbased on estimated fair values. SFAS 123(R) supersedes our previous accountingunder Accounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees”, or APB 25, for periods beginning in fiscal 2006. In March 2005,the SEC issued Staff Accounting Bulletin No. 107, or SAB 107, relating to SFAS123(R). We considered the guidance of SAB 107 in our adoption of SFAS 123(R).

 

We adopted SFAS 123(R)using the modified prospective transition method, which requires theapplication of the accounting standard as of January 1, 2006. In accordancewith the modified prospective transition method, our Consolidated FinancialStatements for prior periods are not restated to reflect, and do not include,any impact of SFAS 123(R). We did not modify any outstanding stock options inanticipation of the adoption of SFAS 123(R). The effect of the change inaccounting principle resulting from the adoption of SFAS 123(R) was recognizedin our financial statements through the elimination of previously recognizeddeferred compensation costs, with offsetting amounts recorded in the additionalpaid-in capital account within Stockholders’ equity.

 

Stock-based compensationexpense to be recognized under SFAS 123(R) for the three and six months endedJune 30, 2006 related to employee stock options, including compensation fromour 2006 grants is as presented in the following table. There was no additionalstock-based compensation expense related to employee stock options during thethree months ended March 31, 2005 resulting from the adoption of SFAS 123(R). 

 
| **(Amounts in thousands, except per share amounts)**                      | ** ** | **Quarter ended June 30, 2006** | ** ** | **Six Months   ended  June 30, 2006** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|
| Incremental stock-based compensation expense  recognized through earnings |       | $                               | 4,058      |                                  | $          | 6,900 |   |
| Related deferred income tax benefit                                       |       | (419                            | )          | (958                                  | )          |
| Decrease in net income                                                    |       | 3,639                           |       | 6,538                                 |       |
| Decrease in earnings per share of common stock                            |       | 0.05                            |       | 0.08                                  |       |
| Decrease in earnings per share of common stock –  assuming dilution  |       | 0.05                            |       | 0.08                                  |       |
| Stock-based compensation expense capitalized                              |       | $                               | 536        |                                  | $          | 953 |   |

 

23

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SFAS 123(R) requires usto estimate the fair value of share-based payment awards on the date of grantusing an option-pricing model. The value of the portion of the award that isultimately expected to vest is recognized as expense over the requisite serviceperiods in our Consolidated Statement of Operations. Prior to the adoption ofSFAS 123(R), we accounted for stock-based awards to employees and directorsusing the intrinsic value method in accordance with APB 25 as then allowedunder Statement of Financial Accounting Standards No. 123, “Accounting forStock-Based Compensation”, or SFAS 123. Under the intrinsic value method, withthe exception of the options granted under the Chief Executive Officer andPresident’s Plan and our restricted stock, no stock-based compensation expensehad been recognized in our Consolidated Statement of Operations, because theexercise price of our stock options granted to employees and directors equaledthe fair market value of the underlying stock at the date of grant.

 

Stock-based compensationexpense to be recognized is based on the fair value of the portion of share-basedpayment awards that is ultimately expected to vest during the period. Stock-basedcompensation expense recognized in our Consolidated Statement of Operations forthe first six months of 2006 includes compensation expense for share-basedpayment awards granted in 2006 and granted prior to, but not yet vested, as ofJanuary 1, 2006. Compensation expense for the awards granted prior to January1, 2006 was based on the grant date fair value estimated in accordance with thepro forma provisions of SFAS 123. Compensation expense for the share-basedpayment awards granted subsequent to December 31, 2005 was based on the grantdate fair value estimated in accordance with the provisions of SFAS 123(R). Inconjunction with the adoption of SFAS 123(R), we continued our method ofattributing the value of stock-based compensation using the straight-linesingle option method. As stock-based compensation expense recognized in theConsolidated Statement of Operations for the first six months of 2006 is basedon awards ultimately expected to vest, it was reduced for estimated forfeitures.SFAS 123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. At June 30, 2006, the compensation expense related tonon-vested awards to be recognized in future periods totals $23.0 million. Theweighted average period over which this expense is expected to be recognized is2.1 years; however, in connection with the proposed merger of Western withAnadarko, all outstanding options will fully vest and convert to the right toreceive a cash payment from the acquirer.

 

***Segment Information***

 

***Gas Gathering, Processing and Treating.***The GasGathering, Processing and Treating segment realized segment-operating profit of$126.9 million for the six months ended June 30, 2006 compared to $103.2million in the same period in 2005. The increase in operating profit in thissegment in the first six months of 2006 was primarily due to higher realizedprices and a 3% increase in throughput volume.

 

***Exploration and Production.***TheExploration and Production segment realized segment-operating profit of $119.9million in the first six months of 2006 compared to $86.5 million in 2005. Theincrease was due to increased equity production and higher product prices. Duringthe first six months of 2006, our production of natural gas as compared to thesame period in 2005 increased by 18% to 34.6 Bcfe. The following table setsforth the average sales price received for our oil and gas products along withcost information in the three and six months ended June 30, 2006 and 2005. 

 
| ** **                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                              | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Average sales price: (1)                                |       |                             |       |                           |       |   |   |   |   |
| Oil ($/Bbl)                                             |       | $                                | 62.62      |                           | $          | 47.88 |   | $ | 60.35 |   | $ | 45.58 |   |
| Gas ($/Mcf), excluding the effect of hedging positions  |       | 4.86                             |       | 5.34                           |       | 5.47 |   | 5.11 |   |
| Gas ($/Mcf), including the effect of hedging  positions |       | 5.50                             |       | 5.36                           |       | 6.02 |   | 5.17 |   |
|                                                    |       |                             |       |                           |       |   |   |   |   |
| Production and other costs:                             |       |                             |       |                           |       |   |   |   |   |
| Lease operating expense ($/Mcfe)                        |       | 0.93                             |       | 0.80                           |       | 0.85 |   | 0.83 |   |
| Production tax expense ($/Mcfe)                         |       | 0.78                             |       | 0.59                           |       | 0.72 |   | 0.53 |   |
| Gathering and transportation expense ($/Mcfe)           |       |                             |       |                           |       |   |   |   |   |
| Inter-segment  charges                                  |       | 0.67                             |       | 0.60                           |       | 0.65 |   | 0.61 |   |
| Third-party  charges                                    |       | 0.16                             |       | 0.16                           |       | 0.19 |   | 0.18 |   |
| Other expenses ($/Mcfe)                                 |       | 0.04                             |       | 0.04                           |       | 0.03 |   | 0.02 |   |
| Total costs  ($/Mcfe)                                   |       | $                                | 2.58       |                           | $          | 2.19 |   | $ | 2.44 |   | $ | 2.17 |   |

 

24

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(1)  Theprices received for NGLs are included in the price received for gas. 

#### ** **

#### **Our principal upstream operations are summarized inthe following table:**

 
| **Production Area**       | ** ** | **Gross Acres   Under Lease at   June 30, 2006** | ** ** | **Net Acres   Under Lease   at June 30,   2006** | ** ** | **Average Net   Production Sold   for the Six   Months Ended  June 30,  2006** | ** ** | **Gross Productive   Gas Wells at  June 30, 2006** | ** ** | **Net   Productive   Gas Wells at   June 30, 2006** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                | ** ** | ** **                                       | ** ** | ** **                                       | ** ** | **(MMcfe/day)**                                                                | ** ** | ** **                                         | ** ** | ** **                                          | ** ** |
| Powder River Basin CBM    |       | 1,060,000                                        |       | 559,000                                          |       | 131                                                                            |       | 5,514                                              |       | 2,633                                               |       |
| Pinedale Anticline/Jonah  |       | 130,000                                          |       | 23,000                                           |       | 43                                                                             |       | 402                                                |       | 45                                                  |       |
| San Juan/Delaware Basin   |       | 45,000                                           |       | 39,000                                           |       | 12                                                                             |       | 187                                                |       | 166                                                 |       |
| Sand Wash Basin           |       | 106,000                                          |       | 97,000                                           |       | 5                                                                              |       | 23                                                 |       | 23                                                  |       |
| Red Desert/Washakie/Uinta |       | 80,000                                           |       | 40,000                                           |       | 1                                                                              |       | 8                                                  |       | 3                                                   |       |
| Denver-Julesburg Basin    |       | 383,000                                          |       | 328,000                                          |       | —                                                                         |       | 9                                                  |       | 9                                                   |       |
| Canada                    |       | 46,000                                           |       | 44,000                                           |       | —                                                                         |       | 22                                                 |       | 21                                                  |       |
| Central Montana           |       | 666,000                                          |       | 588,000                                          |       | —                                                                         |       | 3                                                  |       | 3                                                   |       |
| Other                     |       | 27,000                                           |       | 26,000                                           |       | —                                                                         |       | 10                                                 |       | 2                                                   |       |
| Total                     |       | 2,543,000                                        |       | 1,744,000                                        |       | 192                                                                            |       | 6,178                                              |       | 2,905                                               |       |

 

***Drilling Results.***The following tablesets forth the number of wells we completed during the six month periods endedJune 30, 2006 and 2005 in each of our major producing areas. This informationshould not be considered to be indicative of future performance, nor should itbe assumed that there is necessarily any correlation between the number ofproductive wells drilled, quantities of reserves found or economic value. Productivewells are producing wells and wells capable of production. 

 
| ** **                              | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **2006**                      | ** ** | **2005** | ** ** |
| **Productive Area**                     | ** ** | **Gross**                     | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
| **Powder River Basin CBM**              |       |                          |       |   |   |   |   |   |   |
| Productive wells completed              |       | 362                           |       | 178 |   | 340 |   | 171 |   |
| Dry development wells drilled           |       | 42                            |       | 20 |   | 0 |   | 0 |   |
|                                    |       |                          |       |   |   |   |   |   |   |
| **Pinedale Anticline and Jonah Fields** |       |                          |       |   |   |   |   |   |   |
| Development productive wells completed  |       | 19                            |       | 2 |   | 30 |   | 3 |   |
| Exploratory productive wells completed  |       | 9                             |       | 1 |   | 5 |   | 0 |   |
| Dry exploratory wells drilled           |       | 0                             |       | 0 |   | 1 |   | 0 |   |
|                                    |       |                          |       |   |   |   |   |   |   |
| **San Juan Basin**                      |       |                          |       |   |   |   |   |   |   |
| Development productive wells completed  |       | 9                             |       | 9 |   | 20 |   | 18 |   |
| Exploratory productive wells completed  |       | 6                             |       | 6 |   | 7 |   | 7 |   |
|                                    |       |                          |       |   |   |   |   |   |   |
| **Sand Wash Basin**                     |       |                          |       |   |   |   |   |   |   |
| Dry exploratory wells completed         |       | 1                             |       | 0 |   | 1 |   | 1 |   |
|                                    |       |                          |       |   |   |   |   |   |   |
| **Canada (1)**                          |       |                          |       |   |   |   |   |   |   |
| Exploratory productive wells completed  |       | 4                             |       | 4 |   | 0 |   | 0 |   |
|                                    |       |                          |       |   |   |   |   |   |   |
| **Other (1)**                           |       |                          |       |   |   |   |   |   |   |
| Exploratory productive wells completed  |       | 6                             |       | 4 |   | 3 |   | 3 |   |

 

----

(1)   Someexploratory wells while classified as productive are still in the process of anextended production test.

 

***Marketing.***The Marketing segmentrealized a segment-operating profit of $29.5 million for the six months endedJune 30, 2006 compared to a segment-operating loss of ($8.2) million in thesame period of 2005. The increase in segment-operating profit was primarily dueto non-cash mark-to-market gains from economic hedges of future sales of gasutilizing our storage and transportation capacity for the six months ended June30, 2006 compared to a loss for the six months ended June 30, 2005.

 

25

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***Transportation.***The Transportationsegment realized segment-operating profit of $7.8 million for the six monthsended June 30, 2006 compared to $6.3 million in the same period of 2005. TheTransportation segment includes the results from the MIGC and MGTC pipelines inthe Powder River Basin.

 

#### **Liquidity and Capital Resources**

#### ** **

#### **Our sources of liquidity and capital resourceshistorically have been net cash provided by operating activities, fundsavailable under our financing facilities and proceeds from offerings of debtand equity securities. In the past, these sources have been sufficient to meetour needs and finance the growth of our business. We can give no assurance thatthe historical sources of liquidity and capital resources will be available forfuture development and acquisition projects, and we may be required to seekadditional or alternative financing sources. Product prices, hedges of equityproduction, sales of inventory, the volume of natural gas processed by ourfacilities, the volume of natural gas produced from our producing properties,the margin on third-party product purchased for resale, as well as the timelycollection of our receivables and the availability and cost of oil fieldservices and supplies such as concrete, steel pipe and compression equipmentare all expected to have significant influences on our future net cash providedby operating activities. Additionally, our future growth will be dependent uponthe success and timing of our exploration and production activities, obtainingadditions to dedicated plant reserves, acquisitions, new project development,marketing results, efficient operation of our facilities and our ability toobtain financing at favorable terms.**

#### ** **

During the past several years, we have beensuccessful in developing additional reserves of natural gas and increasing our equitynatural gas production. However, the overall level of drilling and productionassociated with our producing properties will depend upon, among other factors,the price for gas, availability of transportation capacity to market centers,the energy and environmental policy and regulation by governmental agencies,the drilling schedules of the operators of our non-operated properties, theissuance of drilling and water disposal permits, the availability of oil fieldservices, and the length of time for wells in the Powder River Basin to bedewatered, none of which is within our control. A significant reduction in thelevel of our production or a significant reduction in natural gas prices couldhave a material adverse effect on our financial condition, results ofoperations and cash flows.

 

Althoughsome of our plants have experienced natural declines in dedicated reserves,overall we have been successful in connecting additional reserves to more thanoffset these declines. However, the overall level of drilling associated withour plant facilities will depend upon, among other factors, the prices for oiland gas, the drilling budgets of third-party producers, availability oftransportation capacity to market centers, the energy and environmental policy andregulation by governmental agencies, and the pace at which drilling permits arereceived, none of which is within our control. There is no assurance that wewill continue to be successful in replacing the dedicated reserves processed atour facilities. Any prolonged reduction in prices for natural gas and NGLs maydepress the levels of exploration, development and production by third parties.Lower levels of these activities could result in a corresponding decline in thedemand for our gathering, processing and treating services. A significantreduction in any of these activities could have a material adverse effect onour financial condition, results of operations and cash flows.

 

Webelieve that the amounts available to be borrowed under our financing facilities,together with the net cash provided by operating activities, will provide uswith sufficient funds to connect new reserves, maintain our existing facilitiesand complete our current capital expenditure program. Depending on the timingand the amount of our future projects, we may be required to seek additionalsources of capital. Our ability to secure such capital is restricted by ourfinancing facilities, although we may request additional borrowing capacityfrom our lenders, seek waivers from our lenders to permit us to borrow fundsfrom third-parties, seek replacement financing facilities from other lenders,use stock as a currency for acquisitions, sell existing assets or use acombination of these alternatives. While we believe that we would be able tosecure additional financing, if required, we can provide no assurance that wewill be able to do so or as to the terms of any additional financing.

 

Ourdividends will total approximately $5.7 million in the third quarter of 2006. Thesedividends will be funded with amounts available under the revolving creditfacility.

 

***Sources and Uses of Funds*.**Our sourcesand uses of funds for the six months ended June 30, 2006 are summarized asfollows (dollars in thousands):

 

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| **Sources  of funds:**                                                     |   |    |      |
|----------------------------------------------------------------------------|--------|---------|-----------|
| Borrowings under our revolving credit facility                             |   | $       | 2,415,700 |   |
| Proceeds from the dispositions of property and  equipment                  |   | 1,255   |      |
| Net cash provided by operating activities                                  |   | 265,664 |      |
| Excess tax benefits from share-based payment awards                        |   | 2,379   |      |
| Proceeds from exercise of common stock options                             |   | 10,321  |      |
| Total sources of  funds                                                    |   | $       | 2,695,319 |   |
| **Uses of funds:**                                                         |   |    |      |
| Payments under our revolving credit facility  (including debt issue costs) |   | $       | 2,273,714 |   |
| Capital expenditures                                                       |   | 399,351 |      |
| Change in outstanding checks                                               |   | 34,207  |      |
| Common dividends paid                                                      |   | 11,353  |      |
| Total uses of  funds                                                       |   | $       | 2,718,625 |   |

 

***Capital Investment Program.***Subject tothe timing of the completion of the proposed merger, we currently anticipatecapital expenditures in 2006 of approximately $675.8 million. The 2006 capitalbudget is a 45% increase over the amount expended in 2005. This increase is theresult of our March 2006 acquisition of additional CBM properties and anexpected increase in drilling activity in each of our core upstream areas andadditional drilling activity by third party producers whose acreage isdedicated to our midstream facilities. Overall, capital expenditures in thePowder River Basin CBM development and in the Greater Green River Basinoperations represent 52% and 22%, respectively, of the total 2006 budget. Thisbudget is subject to limitations provided for in the merger agreement.

 

The 2006 capital budgetand our capital expenditures during the six months ended June 30, 2006 are presentedin the following table (dollars in thousands). 

 
| **Type of Capital Expenditure**                              | ** ** | **2006 Capital   Budget** | ** **  | **Capital Expenditures During the Six   Months Ended  June 30, 2006** | ** ** |
|--------------------------------------------------------------|------------|---------------------------|-------------|-----------------------------------------------------------------------|------------|
| Gathering, processing, treating and pipeline assets          |       | $                         |  185.0 | *                                                                     | $          |  122.3 | * |
| Exploration and production and lease acquisition  activities |       | 336.2                     |        | 132.1                                                                 |       |
| Acquisition of CBM properties                                |       | 136.7                     |        | 136.7                                                                 |       |
| Information technology and other items                       |       | 4.5                       |        | 1.6                                                                   |       |
| Capitalized interest and overhead                            |       | 13.4                      |        | 12.3                                                                  |       |
| Total Capital  Expenditures                                  |       | $                         | 675.8       |                                                                  | $          | 405.0 |   |

 

----

*  Includes $22.2 million budgeted in 2006 and$8.0 million expended in the first six months of 2006 for maintaining existingfacilities.

 

InMarch 2006, we acquired certain CBM properties and related gathering assets inthe Big George fairway of the Powder River Basin of Wyoming for an adjustedpurchase price of $138.6 million. This acquisition was funded with amountsavailable under our revolving credit facility. The purchase price includes the drilling rights onapproximately 40,000 gross and net acres and 110 drilled wells. Approximately70 of the drilled wells are currently dewatering, and the remaining 40 wellsare awaiting hookup.

 

#### **Long-termDebt**

#### ** **

*** Revolving Credit Facility.***At June 30, 2006, the commitment under therevolving credit facility was $700 million with a maturity date in November2010. At June 30, 2006, $427.0 million was outstanding under thisfacility. Loans made under this facility are secured by a pledge of the capitalstock of our significant subsidiaries, and these subsidiaries also guaranteethe borrowings under the facility.

 

The borrowings under ourcredit facility bear interest at Eurodollar rates or a base rate, as requestedby us, plus an applicable percentage based on our debt to capitalization ratio.The base rate is the agent’s published prime rate. We also pay a quarterlycommitment fee on undrawn amounts ranging between 0.10% and 0.30%, depending onour debt to capitalization ratio. This fee is paid on unused amounts of thecommitment. As of June 30, 2006, the interest rate payable on borrowings underthis facility was approximately 6.0% per year. Under the credit facility, weare subject to a number of covenants, including: maintaining a total debt tocapitalization ratio of not more than 55% and maintaining a ratio of EBITDA, asdefined in the credit facility, to interest over the last four quarters inexcess of 3.0 to 1.0. The credit facility ranks equally with borrowings underour master shelf agreement with The Prudential Insurance Company. This facilityhas been rated Ba1 by Moody’s and BB+ by Standard and Poor’s.

 

27

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***MasterShelf Agreement.***Amounts outstanding under our mastershelf agreement at July 31, 2006 are as indicated in the following table (dollarsin thousands): 

 
| **Issue Date**   | ** ** | **Amount** | ** ** | **Interest Rate** | ** ** | **Final Maturity** | ** **    | **Principal Repayment Schedule** | ** **               |
|------------------|------------|------------|------------|-------------------|------------|--------------------|---------------|----------------------------------|--------------------------|
| July 28, 1995    |       | $          | 10,000     |              | 7.61       | %                  | July 28, 2007 |                             | $10,000 on July 28, 2007 |   |
| June 30, 2004    |       | 100,000    |       | 5.92              | %          | June 30, 2011      |          | Single payment at maturity       |                     |
| January 18, 2005 |       | 25,000     |       | 5.57              | %          | January 18, 2015   |          | Single payment at maturity       |                     |
| Total            |       | $          | 135,000    |              |       |               |          |                             |                     |   |

 

Our borrowings under ourmaster shelf agreement are secured by a pledge of the capital stock of oursignificant subsidiaries. These subsidiaries also guarantee the borrowingsunder this facility. All of the borrowings under our master shelf agreement canbe prepaid prior to their final maturity by paying a yield-maintenance fee. Underour master shelf agreement, we are subject to a number of covenants, including:maintaining a total debt to capitalization ratio of not more than 55% andmaintaining a quarterly test of EBITDA, as defined in our master shelfagreement, to interest for the last four quarters in excess of 3.0 to 1.0.

 

The closing of ourproposed merger would be an event of default under our revolving creditfacility, which would entitle the lenders to terminate their commitments anddemand payment of all outstanding and unpaid amounts there under. Further, ourmaster shelf agreement contains cross default provisions, which would betriggered by the default under the revolving credit facility. Therefore, uponthe closing of the merger, the acquirer must renegotiate these agreements orrepay all amounts due under them. Also, the closing of our proposed merger isalso an event of default under some of our operating leases, which will entitleour counterparties to terminate their commitments and require a return of therelated equipment. Therefore, on or prior to the closing of the merger, theacquirer must renegotiate these agreements.

 

28

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**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Our commodity price riskmanagement program has two primary objectives. The first goal is to preserveand enhance the value of our equity volumes of gas and NGLs with regard to theimpact of commodity price movements on cash flow and net income in relation tothose anticipated by our operating budget. The second goal is to manage pricerisk related to our marketing activities to protect profit margins. This riskrelates to fixed price purchase and sale commitments, the value of storageinventories and exposure to physical market price volatility.

 

We utilize a combinationof fixed price forward contracts, exchange-traded futures and options, as wellas fixed index swaps, basis swaps and options traded in the over-the-counter,or OTC, market to accomplish these goals. These instruments allow us topreserve value and protect margins because corresponding losses or gains in thevalue of the financial instruments offset gains or losses in the physicalmarket.

 

We also use financialinstruments to reduce basis risk. Basis is the difference in price between thephysical commodity being hedged and the price of the futures contract used forhedging. Basis risk is the risk that an adverse change in the futures marketwill not be completely offset by an equal and opposite change in the cash priceof the commodity being hedged. Basis risk exists in natural gas primarily dueto the geographic price differentials between cash market locations and futurescontract delivery locations.

 

We enter into futurestransactions on the New York Mercantile Exchange, or NYMEX, and OTC swaps andoptions with various counterparties, consisting primarily of investment banks,financial institutions and other natural gas companies. We conduct creditreviews of all of our OTC counterparties and have agreements with many of theseparties that contain collateral requirements. We generally use standardizedswap agreements that allow for offset of positive and negative OTC exposureswith the same counterparty. OTC exposure is marked-to-market daily for thecredit review process. Our exposure to OTC credit risk is reduced by our abilityto require a margin deposit from our counterparties based upon themark-to-market value of their net exposure. We are also subject to margindeposit requirements under these same agreements and under margin depositrequirements for our NYMEX transactions. The closing of our proposed merger isan event of default under certain of our swap agreements, which will entitleour counterparties to terminate their commitments and require a settlement ofall outstanding transactions. Therefore, upon the closing of the merger, theacquirer must renegotiate these agreements or settle all amounts due thereunder.

 

We continually monitorand review the credit exposure to our marketing counterparties. In recentmonths the prices of natural gas and NGLs, and therefore our credit exposures,have increased significantly. Additionally, as a result of the damage in theGulf States caused by hurricanes Katrina and Rita, prices increased even moredramatically, and several of our counterparties experienced a significantamount of damage to their operating assets. In September 2005, one of ourcustomers, a utility serving the New Orleans area, filed for bankruptcyprotection under Chapter 11 of the Bankruptcy Code. At the time of thebankruptcy filing, we had an outstanding account receivable from this utilityof $4.1 million. In the third quarter of 2005, we reserved $800,000 againstthis amount, which represents our best estimate of the current market value ofthis receivable.

 

 In order to minimize our credit exposures, wehave utilized existing netting agreements to reduce our net credit exposure,established new netting agreements with additional customers, negotiatedaccelerated payment terms with several customers, curtailed sales to certaincounterparties, and increased the amount of credit which we make available tosubstantial companies which meet our credit requirements. Although nettingagreements similar to those that we utilize have been upheld by bankruptcycourts in the past, if any of the customers with whom we have nettingagreements were to file for bankruptcy, we can provide no assurance that ouragreements will not be challenged or as to the outcome of any challenge.

 

The use of financialinstruments may expose us to the risk of financial loss in some circumstances,including instances when (i) our equity volumes are less than expected, (ii)our customers fail to purchase or deliver the contracted quantities of naturalgas or NGLs, or (iii) our OTC counterparties fail to perform. To the extentthat we engage in hedging activities, we may be prevented from realizing thebenefits of favorable price changes in the physical market. However, we aresimilarly insulated against decreases in these prices.

 

***Risk Policy and Control.***We controlthe extent of risk management and marketing activities through policies andprocedures that involve the senior level of management. On a daily basis, ourmarketing activities are audited and monitored by our independent riskoversight department, or IRO. This department reports to the Chief FinancialOfficer, thereby providing a separation of duties from the marketingdepartment. Additionally, the IRO reports monthly to the Risk ManagementCommittee, or RMC. This committee is comprised of corporate managers and

 

29

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officers and isresponsible for developing the policies and guidelines that control themanagement and measurement of risk, subject to the approval of the board ofdirectors. The RMC is also responsible for setting risk limits includingvalue-at-risk and dollar stop loss limits, subject to the approval of our boardof directors.

 

***Hedge Positions.***Our hedge contractsare designated and accounted for as cash flow hedges. As such, gains and lossesrelated to the effective portions of the changes in the fair value of thederivatives are recorded in Accumulated other comprehensive income, a componentof Stockholders’ equity. Realized gains or losses on these cash flow hedges arerecognized in the Consolidated Statement of Operations through Sale of gas orSale of natural gas liquids when the hedged transactions occur.

 

Inthe second quarter of 2006, in order to properly align our hedged volumes ofnatural gas to our forecasted equity production, we discontinued hedgetreatment on financial instruments for 30 MMcf per day of natural gas as theanticipated transaction is no longer probable. As a result, a pre-tax gain of$2.8 million was reclassified into earnings from Accumulated othercomprehensive income.

 

Toqualify as cash flow hedges, the hedge instruments must be designated as cashflow hedges and changes in their fair value must be highly effective atoffsetting changes in the price of the forecasted transaction being hedged sothat our exposure to the risk of commodity price changes is reduced. To meetthis requirement, we hedge the price of the commodity and, if applicable, thebasis between that derivative’s contract delivery location and the cash marketlocation used for the actual sale of the product. This structure attains a highlevel of effectiveness, ensuring that a change in the price of the forecastedtransaction will result in an equal and opposite change in the price of thederivative instrument hedging the transaction. We utilize crude oil as asurrogate hedge for natural gasoline and condensate. Our hedges are tested foreffectiveness at inception and on a quarterly basis thereafter. We useregression analysis based on a five-year period of time for this test. Gains orlosses from the ineffective portions of changes in the fair value of cash flowhedges are recognized currently in earnings through Price risk managementactivities.

 

***Outstanding Equity Hedge Positions and the Associated Basisfor 2006 and 2007.***The following table details our hedgepositions as of June 30, 2006. In order to determine the hedged price to theparticular operating region, deduct the basis differential from the settleprice. There is no associated cost for the hedges.

 

30

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| **Product**      | ** ** | **Year** | ** ** | **Quantity and Settle Price**                                                                                                                                                                                                                      | ** ** | **Hedge of Basis Differential**                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|------------------|------------|----------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |     |       |                                                                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| Natural gas      |       | 2006     |       | 40,000 MMBtu per day  with an average minimum price of $6.00 per MMBtu and an average maximum price  of $10.13 per MMBtu.                                                                                                                          |       | Mid-Continent – 10,000  MMBtu per day with an average basis price of $0.55 per MMBtu.                                                                                                                                                                                                                                                                                                                                                                             |
|             |       |     |       |                                                                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|             |       |     |       | 45,000 MMBtu per day  with an average minimum price of $9.00 per MMBtu and an average maximum price  of $17.25 per MMBtu.  30,000 MMBtu per day with an average minimum price of $7.00 per MMBtu and an  average maximum price of $10.25 per MMBtu |       | Permian – 7,500 MMBtu  per day with an average basis price of $0.97 per MMBtu.  San Juan – 12,500 MMBtu per day with an average basis price of $1.51 per  MMBtu.  Rocky Mountain – 37,500 MMBtu per day with an average basis price of $1.48  per MMBtu.  NGPL Texas Oklahoma – 30,000 MMBtu per day with an average basis price of  $0.52 per MMBtu.  Nigas Chicago – 17,500 MMBtu per day with an average basis price of $0.37 per  MMBtu.  |
|             |       |     |       |                                                                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|             |       | 2007     |       | 115,000 MMBtu per day  with an average minimum price of $7.00 per MMBtu and an average maximum price  of $14.90 per MMBtu.                                                                                                                         |       | Mid-Continent – 20,000  MMBtu per day with an average basis price of $0.98 per MMBtu.  Permian – 10,000 MMBtu per day with an average basis price of $1.20 per  MMBtu.  San Juan – 10,000 MMBtu per day with an average basis price of $1.77 per  MMBtu.  Rocky Mountain – 45,000 MMBtu per day with an average basis price of $2.01  per MMBtu.  NGPL Texas Oklahoma – 30,000 MMBtu per day with an average basis price of  $0.55 per MMBtu. |
|             |       |     |       |                                                                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| Natural Gasoline |       | 2006     |       | 25,000 Barrels per  month with an average minimum price of $40.00 per barrel and an average  maximum price of $70.00 per barrel.                                                                                                                   |       | Not Applicable                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|             |       |     |       |                                                                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| Ethane           |       | 2006     |       | 200,000 Barrels per  month with an average minimum price of $0.51 per gallon and an average  maximum price of $0.67 per gallon.                                                                                                                    |       | Not Applicable                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|             |       |     |       |                                                                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| Propane          |       | 2006     |       | 140,000 Barrels per  month with an average minimum price of $0.83 per gallon and an average  maximum price of $1.04 per gallon.                                                                                                                    |       | Not Applicable                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

Account balances relatedto hedging transactions (designated as cash flow hedges under SFAS 133) at June30, 2006 were $26.9 million in Current assets from price risk managementactivities, $6.6 million in Long-term assets from price risk managementactivities, $22.0 million in Current liabilities from price risk managementactivities, $2.7 million in Liabilities from price risk management activities,$3.4 million in Deferred income tax payable, net, and a $5.9 million after-taxunrealized gain in Accumulated other comprehensive income, a component ofStockholders’

 

31

----

 

equity. Of theunrealized gain in Accumulated other comprehensive income at June 30, 2006,$1.4 million will be reclassified to earnings in 2006 and $4.5 million will bereclassified to earnings in 2007.

 

***Earnings Sensitivities.***At June 30,2006, we held gas in our contracted storage facilities and in imbalances ofapproximately 20.0 Bcf at an average cost of $6.07 per Mcf. This inventoried gas was soldforward. Based on a $1.00 increase in the forward price of gas in theanticipated month of withdrawal, the change in the non-cash mark-to-marketvalue of these derivatives would decrease pre-tax earnings by $20.0 million anda $1.00 decrease in the forward price of gas in the anticipated month ofwithdrawal would increase pre-tax earnings by $20.0 million. As the stored ortransported natural gas is sold and the future sale derivatives are settled, wewill realize the benefit of the storage and transportation transactions throughearnings and Net cash from operating activities.

 

As of June 30, 2006, wehad sold basis swaps for 115,000 MMBtu per day at various sales points for2008, at an average differential of $1.16. These positions will minimize ourprice risk as it relates to the change in the basis differential from NYMEX toour various sales points. Because we did not sell forward our equity naturalgas in conjunction with these basis transactions, these positions are noteligible for hedge accounting treatment. Accordingly, these transactions willbe marked-to-market through Price risk management activities. Based on a $0.10increase in the forward basis differential in the anticipated month of sale,the change in the non-cash mark-to-market value of these derivatives wouldincrease pre-tax earnings by $4.2 million and a $0.10 decrease in the forwardbasis differential in the anticipated month of sale would decrease pre-taxearnings by $4.2 million. As our equity gas is sold and the future basisderivatives are settled, we will realize the economic effect of thesetransactions through earnings and Net cash from operating activities.

 

***Summary of Derivative Positions.***Asummary of the net change in our derivative position from December 31, 2005 toJune 30, 2006 is as follows (dollars in thousands):

 
| Fair value of  contracts outstanding at December 31, 2005              |   | $       | 20,140 |   |
|------------------------------------------------------------------------|--------|---------|--------|--------|
| Increase in value due to change in price                               |   | 69,429  |   |
| Increase in value due to new contracts entered into  during the period |   | 14,003  |   |
| Contract settlements during the period                                 |   | (73,724 | )      |
| Changes in fair value attributable to changes in  valuation techniques |   | —  |   |
| Fair value of contracts outstanding at June 30, 2006                   |   | $       | 29,848 |   |

 

A summary of the sourcesof fair value of our net outstanding derivative positions at June 30, 2006 isas follows (dollars in thousands):

 
| **Source of Fair Value**         | ** ** | **Total  Fair Value** | ** ** | **Maturing In  2006** | ** ** | **Maturing In  2007-2008** | ** ** |
|----------------------------------|------------|-----------------------|------------|-----------------------|------------|----------------------------|------------|
| Exchange published prices        |       | $                     | (3,204     | )                     | $          | (6,985                     | )          | $ | 3,781 |   |
| Other actively quoted prices (1) |       | 14,570                |       | 15,106                |       | (536                       | )          |
| Other valuation methods (2)      |       | 18,482                |       | 9,828                 |       | 8,654                      |       |
| Total fair value                 |       | $                     | 29,848     |                  | $          | 17,949                     |       | $ | 11,899 |   |

 

----

(1) Other actively quotedprices are derived from broker quotations, trade publications, and industryindices.

(2) Othervaluation methods are the Black-Scholes option-pricing model utilizing pricesand volatility obtained from broker quotations, trade publications, andindustry indices.

 

***Foreign Currency Derivative Market Risk***. As anormal part of our business, we enter into physical gas transactions which arepayable in Canadian dollars. We enter into forward purchases and sales ofCanadian dollars from time to time to fix the cost of our future Canadiandollar denominated natural gas purchase, sale, storage, and transportationobligations. This is done to protect marketing margins from adverse changes inthe United States and Canadian dollar exchange rate between the time thecommitment for the payment obligation is made and the actual payment date ofsuch obligation. As of June 30, 2006, we had sold forward contracts for $63.6million in Canadian dollars in exchange for $56.0 million in United Statesdollars, and the fair market value of these contracts was a loss of $1.2million in United States dollars.

 

32

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**ITEM4.  CONTROLS AND PROCEDURES**

 

***Disclosure Controlsand Procedures.***

 

Our management evaluated,under the supervision of and with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, the effectiveness of our disclosurecontrols and procedures, as such term is defined under Rule 13a-15(e) under theSecurities Exchange Act of 1934, as of the end of the period covered by thisReport. Based on this evaluation, the Chief Executive Officer and ChiefFinancial Officer have concluded that our disclosure controls and procedureswere effective as of June 30, 2006, to ensure that information we are requiredto disclose in reports that we file or submit under the Securities Exchange Actof 1934 is recorded, processed, summarized and reported within the time periodsspecified in Securities and Exchange Commission rules and forms and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosures.

 

***Changes in InternalControls over Financial Reporting.***

 

There have not been anychanges in our internal control over financial reporting during the quarterended June 30, 2006, that have materially affected, or are reasonably likely tomaterially affect, our internal controls over financial reporting.

 

33

----

 

**PART II - OTHER INFORMATION**

 

**ITEM1.****          LEGALPROCEEDINGS**

 

Reference is made to“Notes to Consolidated Financial Statements (Unaudited)  – Legal Proceedings,” in Item 1 of this Form10-Q and incorporated by reference in this Item 1.

 

**ITEM4.****          SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

The following matterswere voted on at our Annual Meeting of Stockholders held on May 5, 2006:

 

John E. Brewster, Jr.,Thomas M. Hamilton, and Joseph E. Reid were elected as class two directors toserve until their terms expire in 2009 and until their successors have beenelected. The results of the election were as follows.

 
| ** **            | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|-----------------------|------------|---------------|------------|--------------------|------------|
| John E. Brewster, Jr. |       | 71,351,586    |       | 1,166,570          |       |
| Thomas M. Hamilton    |       | 71,533,772    |       | 984,383            |       |
| Joseph E. Reid        |       | 64,109,482    |       | 8,408,674          |       |

 

Our other directors whoseterms did not expire on the date of the Annual Meeting, James A. Senty, WalterL. Stonehocker, Bill M. Sanderson, Richard B. Robinson, Brion G. Wise, Peter A.Dea and Dean Phillips continued in office.

 

An amendment to ourCertificate of Incorporation to increase our authorized common stock to200,000,000 shares was approved as follows:

 
| ** **                                | ** ** | **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** |
|-------------------------------------------|------------|---------------|------------|-------------------|------------|-----------------|------------|
| Amendment to Certificate of Incorporation |       | 68,893,628    |       | 3,591,590         |       | 32,938          |       |

 

The first amendment toour 2005 Stock Incentive Plan to enable the grant shares of restricted stock tonon-employee members of the board of directors was approved as follows:

 
| ** **                             | ** ** | **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** | **Broker Non-votes** | ** ** |
|----------------------------------------|------------|---------------|------------|-------------------|------------|-----------------|------------|----------------------|------------|
| Amendment to 2005 Stock Incentive Plan |       | 47,338,067    |       | 16,703,390        |       | 588,933         |       | 8,417,806            |       |

 

**ITEM 6.****          EXHIBITS**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                 |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                            |
| ** **  | ** ** | ** **                                                                                                                                                                                                                                                                                                 |
| 2.1         |       | Agreement and Plan of  Merger, dated as of June 22, 2006, by and among Anadarko Petroleum  Corporation and APC Merger Sub, Inc. and Western Gas Resources, Inc.  (previously filed as Exhibit 2.1 to our Current Report on Form 8-K filed on  June 23, 2006 and incorporated herein by reference).         |
|        |       |                                                                                                                                                                                                                                                                                                       |
| 2.2         |       | Amendment No. 1 to  Agreement and Plan of Merger, dated July 7, 2006, by and among Anadarko  Petroleum Corporation, APC Merger Sub, Inc. and Western Gas Resources, Inc.  (previously filed as Exhibit 2.2 to our Current Report on Form 8-K filed on  July 7, 2006 and incorporated herein by reference). |
|        |       |                                                                                                                                                                                                                                                                                                       |
| 3.1         |       | Certificate of  Incorporation of Western Gas Resources, Inc. (previously filed as Exhibit 3.1  to our Registration Statement on Form S-1, Registration No. 33-31604 and  incorporated herein by reference).                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                       |
| 3.2         |       | Certificate of  Amendment to the Certificate of Incorporation of Western Gas Resources, Inc.  (previously filed as Exhibit 3.2 to our Registration Statement on Form S-1,  Registration No. 33-31604 and incorporated herein by reference).                                                                |
|        |       |                                                                                                                                                                                                                                                                                                       |
| 3.3         |       | Certificate of  Designation, Preferences and Rights of Series A Junior Participating  Preferred Stock (previously filed as part of Exhibit 1 to our Form 8-A filed  on March 30, 2001 and incorporated herein by reference).                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                       |
| 3.4         |       | Amended and Restated  Bylaws of Western Gas Resources, Inc. adopted by the Board of Directors on  January 13, 2006 (previously filed as Exhibit 3.01 to our Current Report on  Form 8-K filed on January 19, 2006 and incorporated herein by reference).                                                   |

 

34

----

 
| 4.6    |   | Amendment No. 1, dated  as of June 22, 2006, to the Rights Agreement, dated as of March 22, 2001,  between Western Gas Resources, Inc. and Computershare Trust Company, N.A. (successor-in-interest  to Fleet National Bank (f/k/a Bank Boston, N.A.)), as rights agent  (previously filed as Exhibit 4.6 to our Current Report on Form 8-K filed on  June 23, 2006 and incorporated herein by reference). |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1   |   | Amendment No. 1 to the  Western Gas Resources, Inc. Amended and Restated Directors’ Health Plan,  dated June 13, 2006 (previously filed as Exhibit 10.1 to our Current Report  on Form 8-K filed on June 15, 2006 and incorporated herein by reference).                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2   |   | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and John F.  Chandler (previously filed as Exhibit 10.1 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3   |   | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  John F. Chandler (previously filed as Exhibit 10.2 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference)                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4   |   | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and William J.  Krysiak (previously filed as Exhibit 10.3 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5   |   | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  William J. Krysiak (previously filed as Exhibit 10.4 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.6   |   | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and John C.  Walter (previously filed as Exhibit 10.5 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.7   |   | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  John C. Walter (previously filed as Exhibit 10.6 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.8   |   | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and Edward A.  Aabak (previously filed as Exhibit 10.7 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.9   |   | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  Edward A. Aabak (previously filed as Exhibit 10.8 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.10  |   | Description of First  Amendment to the 2005 Stock Incentive Plan from proxy statement for the 2006  annual meeting of stockholders (pages 4-8) (previously filed as Exhibit 10.1  to our Current Report on Form 8-K filed on May 10, 2006 and incorporated  herein by reference).                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1   |   | Section 302  Certification of the Chief Executive Officer.                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2   |   | Section 302  Certification of the Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1   |   | Section 906  Certification of the Chief Executive Officer and Chief Financial Officer.                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 99.1   |   | Form of Voting  Agreement, dated as of June 22, 2006, by and between Anadarko Petroleum  Corporation and the stockholder signatory thereto (previously filed as  Exhibit 99.1 to our Current Report on Form 8-K filed on June 23, 2006 and  incorporated herein by reference).                                                                                                                             |

 

35

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Date: August 8, 2006 | WESTERN GAS RESOURCES,  INC. |
|----------------------|------------------------------|
|                 | (Registrant)                 |
|                 |                         |
|                 |                         |
|                 | By:                          | /s/ PETER A. DEA |   |
|                 |                         | Peter A. Dea |
|                 |                         | Chief Executive Officer  and President |
|                 |                         |   |
|                 |                         |   |
| Date: August 8, 2006 | By:                          | /s/WILLIAM J. KRYSIAK |   |
|                 |                         | William J. Krysiak |
|                 |                         | Executive Vice  President - Chief Financial  Officer |
|                 |                         | (Principal Financial  and Accounting  Officer) |
|                      |                              |  |  |  |

 

36

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INDEX TO EXHIBITS

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                 |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.1         |       | Agreement and Plan of  Merger, dated as of June 22, 2006, by and among Anadarko Petroleum  Corporation and APC Merger Sub, Inc. and Western Gas Resources, Inc.  (previously filed as Exhibit 2.1 to our Current Report on Form 8-K filed on  June 23, 2006 and incorporated herein by reference).                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.2         |       | Amendment No. 1 to  Agreement and Plan of Merger, dated July 7, 2006, by and among Anadarko Petroleum  Corporation, APC Merger Sub, Inc. and Western Gas Resources, Inc. (previously  filed as Exhibit 2.2 to our Current Report on Form 8-K filed on July 7, 2006  and incorporated herein by reference).                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.1         |       | Certificate of  Incorporation of Western Gas Resources, Inc. (previously filed as Exhibit 3.1  to our Registration Statement on Form S-1, Registration No. 33-31604 and  incorporated herein by reference).                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2         |       | Certificate of  Amendment to the Certificate of Incorporation of Western Gas Resources, Inc.  (previously filed as Exhibit 3.2 to our Registration Statement on Form S-1,  Registration No. 33-31604 and incorporated herein by reference).                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.3         |       | Certificate of  Designation, Preferences and Rights of Series A Junior Participating  Preferred Stock (previously filed as part of Exhibit 1 to our Form 8-A filed  on March 30, 2001 and incorporated herein by reference).                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.4         |       | Amended and Restated  Bylaws of Western Gas Resources, Inc. adopted by the Board of Directors on  January 13, 2006 (previously filed as Exhibit 3.01 to our Current Report on  Form 8-K filed on January 19, 2006 and incorporated herein by reference).                                                                                                                                                   |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.6         |       | Amendment No. 1, dated  as of June 22, 2006, to the Rights Agreement, dated as of March 22, 2001,  between Western Gas Resources, Inc. and Computershare Trust Company, N.A.  (successor-in-interest to Fleet National Bank (f/k/a Bank Boston, N.A.)), as  rights agent (previously filed as Exhibit 4.6 to our Current Report on Form  8-K filed on June 23, 2006 and incorporated herein by reference). |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1        |       | Amendment No. 1 to the  Western Gas Resources, Inc. Amended and Restated Directors’ Health Plan,  dated June 13, 2006 (previously filed as Exhibit 10.1 to our Current Report  on Form 8-K filed on June 15, 2006 and incorporated herein by reference).                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2        |       | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and John F.  Chandler (previously filed as Exhibit 10.1 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3        |       | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  John F. Chandler (previously filed as Exhibit 10.2 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference)                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4        |       | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and William J.  Krysiak (previously filed as Exhibit 10.3 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5        |       | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  William J. Krysiak (previously filed as Exhibit 10.4 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.6        |       | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and John C.  Walter (previously filed as Exhibit 10.5 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.7        |       | Indemnification Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and John C.  Walter (previously filed as Exhibit 10.6 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                                                                                                                                          |

 

37

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| 10.8   |   | Employment Agreement,  dated July 6, 2006, by and between Western Gas Resources, Inc. and Edward A.  Aabak (previously filed as Exhibit 10.7 to our Current Report on Form 8-K  filed on July 11, 2006 and incorporated herein by reference).                                     |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                              |
| 10.9   |   | Indemnification  Agreement, dated July 6, 2006, by and between Western Gas Resources, Inc. and  Edward A. Aabak (previously filed as Exhibit 10.8 to our Current Report on  Form 8-K filed on July 11, 2006 and incorporated herein by reference).                                |
|   |   |                                                                                                                                                                                                                                                                              |
| 10.10  |   | Description of First  Amendment to the 2005 Stock Incentive Plan from proxy statement for the 2006  annual meeting of stockholders (pages 4-8) (previously filed as Exhibit 10.1  to our Current Report on Form 8-K filed on May 10, 2006 and incorporated  herein by reference). |
|   |   |                                                                                                                                                                                                                                                                              |
| 31.1   |   | Section 302  Certification of the Chief Executive Officer.                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                              |
| 31.2   |   | Section 302  Certification of the Chief Financial Officer.                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                              |
| 32.1   |   | Section 906  Certification of the Chief Executive Officer and Chief Financial Officer.                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                              |
| 99.1   |   | Form of Voting  Agreement, dated as of June 22, 2006, by and between Anadarko Petroleum  Corporation and the stockholder signatory thereto (previously filed as  Exhibit 99.1 to our Current Report on Form 8-K filed on June 23, 2006 and  incorporated herein by reference).    |

 

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