**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 MARCH 31,  2004**                                                                                                                                                                                   |
|                                                                                                                                                                                                                                 |
| **OR**                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                 |
| **o**                                                                                                                                                                                                                                | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                 |   |
| **FOR THE TRANSITION PERIOD FROM                    TO                 ** |
|                                                                                                                                                                                                                                 |   |
| **Commission file number 1-10389**                                                                                                                                                                                                   |

 

### **WESTERN GAS RESOURCES, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                                         |   | **84-1127613**                        |
|--------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                      |   | (I.R.S. Employer  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                              |
|                                                                                 |   |                                  |
| **No Changes**                                                                       |
| (Former name, former address and former fiscal year, if changed since  last report). |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.Yes  ý   No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes  ý   No  o

 

On May 1, 2004, there were36,819,669 shares of the registrant’s Common Stock outstanding.

 

 

----

 

**Western GasResources, Inc.**

**Form 10-Q**

**Table of Contents**

 
| PART I - Financial Information |                                                                                                |
|--------------------------------|-----------------------------------------------------------------------------------------------------|
|                           |                                                                                                |
| Item 1.                        | Financial Statements                                                                                |   |
|                           |                                                                                                |   |
|                           | Consolidated Balance Sheet - March 31, 2004 and December 31, 2003                                   |   |
|                           |                                                                                                |   |
|                           | Consolidated Statement of Cash Flows -  Three Months Ended March 31, 2004 and 2003                  |   |
|                           |                                                                                                |   |
|                           | Consolidated Statement of Operations -  Three Months Ended March 31, 2004 and 2003                  |   |
|                           |                                                                                                |   |
|                           | Consolidated Statement of Changes in  Stockholders’ Equity - Three Months Ended March 31, 2004 |   |
|                           |                                                                                                |   |
|                           | 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 2.                        | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities                   |   |
|                           |                                                                                                |   |
| Item 6.                        | Exhibits and Reports on Form 8-K                                                                    |   |
|                           |                                                                                                |   |
| Signatures                     |                                                                                                |

 

2

----

 

**PART I****- FINANCIAL INFORMATION**

 

**ITEM1**.      FINANCIALSTATEMENTS

 

WESTERN GAS RESOURCES, INC.

CONSOLIDATEDBALANCE SHEET

(Dollars in thousands, except share data)

 
|                                                                                                                                                                                                                         |   | **March 31,  2004** | ** ** | **December  31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                                                                                                                                                                                                         |   | **(unaudited)**     |       |                    |       |
| ASSETS                                                                                                                                                                                                                       |   |                |       |                    |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Current assets:                                                                                                                                                                                                              |   |                |       |                    |       |
| Cash and cash equivalents                                                                                                                                                                                                    |   | $                   | 31,767     |                    | $          | 26,116 |   |
| Trade accounts receivable, net                                                                                                                                                                                               |   | 252,645             |       | 262,509                 |       |
| Inventory                                                                                                                                                                                                                    |   | 30,432              |       | 70,304                  |       |
| Assets from price risk management  activities                                                                                                                                                                                |   | 10,941              |       | 17,149                  |       |
| Other                                                                                                                                                                                                                        |   | 3,767               |       | 11,225                  |       |
| Total current assets                                                                                                                                                                                                         |   | 329,552             |       | 387,303                 |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Property and equipment:                                                                                                                                                                                                      |   |                |       |                    |       |
| Gas gathering, processing and  transportation                                                                                                                                                                                |   | 1,045,972           |       | 1,028,176               |       |
| Oil and gas properties and equipment  (successful efforts method)                                                                                                                                                            |   | 349,499             |       | 329,555                 |       |
| Construction in progress                                                                                                                                                                                                     |   | 133,898             |       | 134,751                 |       |
|                                                                                                                                                                                                                         |   | 1,529,369           |       | 1,492,482               |       |
| Less:   Accumulated depreciation, depletion and amortization                                                                                                                                                            |   | (509,132            | )          | (495,721                | )          |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Total property and equipment, net                                                                                                                                                                                            |   | 1,020,237           |       | 996,761                 |       |
|                                                                                                                                                                                                                              |   |                |       |                    |       |
| Other assets:                                                                                                                                                                                                                |   |                |       |                    |       |
| Gas purchase contracts (net of accumulated  amortization of $39,365 and $38,937, respectively)                                                                                                                               |   | 28,790              |       | 29,219                  |       |
| Assets from price risk management  activities                                                                                                                                                                                |   | 1,343               |       | 1,466                   |       |
| Equity investments                                                                                                                                                                                                           |   | 39,766              |       | 39,289                  |       |
| Other                                                                                                                                                                                                                        |   | 5,705               |       | 6,486                   |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Total other assets                                                                                                                                                                                                           |   | 75,604              |       | 76,460                  |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| TOTAL ASSETS                                                                                                                                                                                                                 |   | $                   | 1,425,393  |                    | $          | 1,460,524 |   |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                    |   |                |       |                    |       |
| Current liabilities:                                                                                                                                                                                                         |   |                |       |                    |       |
| Accounts payable                                                                                                                                                                                                             |   | $                   | 321,093    |                    | $          | 303,186 |   |
| Accrued expenses                                                                                                                                                                                                             |   | 41,883              |       | 42,136                  |       |
| Liabilities from price risk management  activities                                                                                                                                                                           |   | 13,281              |       | 10,603                  |       |
| Dividends payable                                                                                                                                                                                                            |   | 2,554               |       | 3,056                   |       |
| Total current liabilities                                                                                                                                                                                                    |   | 378,811             |       | 358,981                 |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Long-term debt                                                                                                                                                                                                               |   | 245,000             |       | 339,000                 |       |
| Liabilities from price risk management  activities                                                                                                                                                                           |   | 1,112               |       | 1,304                   |       |
| Other long-term liabilities                                                                                                                                                                                                  |   | 22,600              |       | 22,057                  |       |
| Deferred income taxes payable, net                                                                                                                                                                                           |   | 189,506             |       | 176,673                 |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Total liabilities                                                                                                                                                                                                            |   | 837,029             |       | 898,015                 |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Stockholders’ equity:                                                                                                                                                                                                   |   |                |       |                    |       |
| Preferred Stock; 10,000,000 shares  authorized: $2.625 cumulative convertible preferred stock, par value $.10;  1,260,000 and 2,060,000 issued and outstanding, respectively ($62,285,200  aggregate liquidation preference) |   | 126                 |       | 206                     |       |
| Common stock, par value $.10; 100,000,000  shares authorized; 35,313,300 and 34,135,901 shares issued, respectively                                                                                                          |   | 3,549               |       | 3,438                   |       |
| Treasury stock, at cost; 25,016 common  shares in treasury                                                                                                                                                                   |   | (788                | )          | (788                    | )          |
| Additional paid-in capital                                                                                                                                                                                                   |   | 387,391             |       | 385,019                 |       |
| Retained earnings                                                                                                                                                                                                            |   | 199,637             |       | 173,076                 |       |
| Accumulated other comprehensive income                                                                                                                                                                                       |   | (1,551              | )          | 1,558                   |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| Total stockholders’ equity                                                                                                                                                                                              |   | 588,364             |       | 562,509                 |       |
|                                                                                                                                                                                                                         |   |                |       |                    |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                             |   | $                   | 1,425,393  |                    | $          | 1,460,524 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

3

----

 

WESTERN GAS RESOURCES, INC.

CONSOLIDATEDSTATEMENT OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

 
|                                                                                    |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                    |   | **2004**                           |   | **2003** |   |
| Reconciliation of net income to net cash  provided by operating activities:             |   |                               |   |   |   |
| Net income                                                                              |   | $                                  | 29,088 |   | $ | 23,375 |   |
| Add income items that do not affect cash:                                               |   |                               |   |   |   |
| Depreciation, depletion and amortization                                                |   | 22,626                             |   | 18,143 |   |
| Loss on the sale of property and equipment                                              |   | —                             |   | 281 |   |
| Deferred income taxes                                                                   |   | 10,465                             |   | 17,183 |   |
| Non-cash change in fair value of  derivatives                                           |   | 6,219                              |   | 4,163 |   |
| Cumulative effect of change in accounting  principle                                    |   | (4,714                             | )      | 6,724 |   |
| Compensation expense from re-priced options                                             |   | 181                                |   | 241 |   |
| Other non-cash items, net                                                               |   | (2,940                             | )      | 2,114 |   |
|                                                                                    |   |                               |   |   |   |
| Adjustments to working capital to arrive at  net cash provided by operating activities: |   |                               |   |   |   |
| (Increase) decrease in trade accounts  receivable                                       |   | 9,939                              |   | (173,095 | ) |
| Decrease in product inventory                                                           |   | 39,927                             |   | 20,308 |   |
| Decrease in other current assets                                                        |   | 642                                |   | 26,797 |   |
| (Increase) in other assets and liabilities,  net                                        |   | (171                               | )      | (343 | ) |
| Increase in accounts payable                                                            |   | 17,907                             |   | 178,528 |   |
| Increase (decrease) in accrued expenses                                                 |   | 7,932                              |   | (9,117 | ) |
|                                                                                    |   |                               |   |   |   |
| Net cash provided by operating activities                                               |   | 137,101                            |   | 115,302 |   |
|                                                                                    |   |                               |   |   |   |
| Cash flows from investing activities:                                                   |   |                               |   |   |   |
|                                                                                    |   |                               |   |   |   |
| Purchases of property and equipment                                                     |   | (36,955                            | )      | (57,076 | ) |
| Proceeds from the dispositions of property  and equipment                               |   | 315                                |   | 41 |   |
|                                                                                    |   |                               |   |   |   |
| Net cash used in investing activities                                                   |   | (36,640                            | )      | (57,035 | ) |
|                                                                                    |   |                               |   |   |   |
| Cash flows from financing activities:                                                   |   |                               |   |   |   |
|                                                                                    |   |                               |   |   |   |
| Proceeds from exercise of common stock  options                                         |   | 2,918                              |   | 1,268 |   |
| Payments on revolving credit facility                                                   |   | (354,850                           | )      | (391,800 | ) |
| Borrowings on long-term debt                                                            |   | —                             |   | 25,000 |   |
| Borrowings under revolving credit facility                                              |   | 260,850                            |   | 316,700 |   |
| Debt issue costs                                                                        |   | —                             |   | (95 | ) |
| Payments for redemption of preferred stock                                              |   | (672                               | )      | — |   |
| Dividends paid                                                                          |   | (3,056                             | )      | (3,464 | ) |
|                                                                                    |   |                               |   |   |   |
| Net cash used in financing activities                                                   |   | (94,810                            | )      | (52,391 | ) |
|                                                                                    |   |                               |   |   |   |
| Net increase in cash and cash equivalents                                               |   | 5,651                              |   | 5,876 |   |
|                                                                                    |   |                               |   |   |   |
| Cash and cash equivalents at beginning of  period                                       |   | 26,116                             |   | 7,312 |   |
|                                                                                    |   |                               |   |   |   |
| Cash and cash equivalents at end of period                                              |   | $                                  | 31,767 |   | $ | 13,188 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

4

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WESTERN GAS RESOURCES, INC.

CONSOLIDATEDSTATEMENT OF OPERATIONS

(Unaudited)

(Dollars in thousands, except share and per share amounts)

 
|                                                                                                                        |   | **Three  Months Ended  March 31,** |    |
|-----------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|
|                                                                                                                        |   | **2004**                           |    | **2003** |   |
|                                                                                                                        |   |                               |    |   |   |
| Revenues:                                                                                                                   |   |                               |    |   |   |
| Sale of gas                                                                                                                 |   | $                                  | 665,198 |   | $ | 793,270 |   |
| Sale of natural gas liquids                                                                                                 |   | 92,915                             |    | 92,049 |   |
| Gathering, processing and transportation  revenue                                                                           |   | 16,829                             |    | 19,777 |   |
| Price risk management activities                                                                                            |   | (5,368                             | )       | (17,694 | ) |
| Other                                                                                                                       |   | 1,642                              |    | 704 |   |
| Total revenues                                                                                                              |   | 771,216                            |    | 888,106 |   |
|                                                                                                                        |   |                               |    |   |   |
| Costs and expenses:                                                                                                         |   |                               |    |   |   |
| Product purchases                                                                                                           |   | 657,342                            |    | 771,602 |   |
| Plant and transportation operating expense                                                                                  |   | 21,934                             |    | 21,922 |   |
| Oil and gas exploration and production  expense                                                                             |   | 17,110                             |    | 12,511 |   |
| Depreciation, depletion and amortization                                                                                    |   | 22,626                             |    | 18,143 |   |
| Loss on sale of assets                                                                                                      |   | —                             |    | 281 |   |
| Selling and administrative expense                                                                                          |   | 9,946                              |    | 10,592 |   |
| (Earnings) from equity investments                                                                                          |   | (1,926                             | )       | (1,562 | ) |
| Interest expense                                                                                                            |   | 5,802                              |    | 6,814 |   |
| Total costs and expenses                                                                                                    |   | 732,834                            |    | 840,303 |   |
| Income before taxes                                                                                                         |   | 38,382                             |    | 47,803 |   |
| Provision for income taxes:                                                                                                 |   |                               |    |   |   |
| Current                                                                                                                     |   | 3,543                              |    | 521 |   |
| Deferred                                                                                                                    |   | 10,465                             |    | 17,183 |   |
| Total provision for income taxes                                                                                            |   | 14,008                             |    | 17,704 |   |
|                                                                                                                        |   |                               |    |   |   |
| Income before cumulative effect of changes  in accounting principles                                                        |   | 24,374                             |    | 30,099 |   |
|                                                                                                                        |   |                               |    |   |   |
| Cumulative effect of changes in accounting  principles net of tax of $2,710 and net of tax benefit of $3,967,  respectively |   | 4,714                              |    | (6,724 | ) |
|                                                                                                                        |   |                               |    |   |   |
| Net income                                                                                                                  |   | 29,088                             |    | 23,375 |   |
|                                                                                                                        |   |                               |    |   |   |
| Preferred stock requirements                                                                                                |   | (816                               | )       | (1,811 | ) |
|                                                                                                                        |   |                               |    |   |   |
| Income attributable to common stock                                                                                         |   | $                                  | 28,272  |   | $ | 21,564 |   |
|                                                                                                                        |   |                               |    |   |   |
| Net income per share of common stock before  cumulative effect of changes in accounting principles                          |   | $                                  | .69     |   | $ | .85 |   |
|                                                                                                                        |   |                               |    |   |   |
| Cumulative effect of changes in accounting  principles                                                                      |   | $                                  | .14     |   | $ | (.20 | ) |
|                                                                                                                        |   |                               |    |   |   |
| Earnings per share of common stock                                                                                          |   | $                                  | .83     |   | $ | .65 |   |
|                                                                                                                        |   |                               |    |   |   |
| Weighted average shares of common stock  outstanding                                                                        |   | 34,182,950                         |    | 33,087,680 |   |
|                                                                                                                        |   |                               |    |   |   |
| Income attributable to common stock -  assuming dilution                                                                    |   | $                                  | 29,088  |   | $ | 23,375 |   |
|                                                                                                                        |   |                               |    |   |   |
| Earnings per share of common stock -  assuming dilution                                                                     |   | $                                  | .79     |   | $ | .63 |   |
|                                                                                                                        |   |                               |    |   |   |
| Weighted average shares of common stock  outstanding - assuming dilution                                                    |   | 36,825,805                         |    | 37,163,098 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

5

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WESTERN GAS RESOURCES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(Dollars in thousands, except share amounts)

 
|                                                                |   | **$2.625  Cumulative  Convertible  Preferred  Stock** |   | **Shares  of Common  Stock** |   | **Shares  of Common  Stock  in Treasury** |   | **$2.625  Cumulative  Convertible  Preferred  Stock** |   | **Common  Stock** |   | **Treasury  Stock** |   | **Additional  Paid-In  Capital** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Income  Net of Tax** |   | **Total  Stock-  holders’  Equity** |    |
|---------------------------------------------------------------------|--------|-------------------------------------------------------|--------|------------------------------|--------|-------------------------------------------|--------|-------------------------------------------------------|--------|-------------------|--------|---------------------|--------|----------------------------------|--------|------------------------|--------|-----------------------------------------------------------|--------|------------------------------------------|---------|
| Balance at December 31, 2003                                        |   | 2,060,000                                             |   | 34,135,901                   |   | 25,016                                    |   | $                                                     | 206    |              | $      | 3,438               |   | $                                | (788   | )                      | $      | 385,019                                                   |   | $                                        | 173,076 |   | $ | 1,558 |   | $ | 562,509 |   |
| Comprehensive income:                                               |   |                                                  |   |                         |   |                                      |   |                                                  |   |              |   |                |   |                             |   |                   |   |                                                      |   |                                     |    |
| Net income, first quarter of 2004                                   |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | 29,088                 |   | —                                                    |   | 29,088                                   |    |
| Translation adjustments                                             |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | (1,528                                                    | )      | (1,528                                   | )       |
| Other comprehensive income                                          |   |                                                  |   |                         |   |                                      |   |                                                  |   |              |   |                |   |                             |   |                   |   |                                                      |   |                                     |    |
| From equity investees                                               |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | (983                                                      | )      | (983                                     | )       |
| Reclassification adjustment for settled contracts                   |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | 2,266                                                     |   | 2,266                                    |    |
| Changes in fair value of outstanding hedge positions                |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | (2,850                                                    | )      | (2,850                                   | )       |
| Reduction to estimated ineffectiveness                              |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | (14                                                       | )      | (14                                      | )       |
| Fair value of new hedge positions                                   |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | —                                                    |   | —                                   |    |
| Change in accumulated derivative comprehensive income               |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | (598                                                      | )      | (598                                     | )       |
| Total comprehensive income, net of tax                              |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | —                                                    |   | 25,979                                   |    |
| Stock options exercised                                             |   | —                                                |   | 117,195                      |   | —                                    |   | —                                                |   | 12                |   | —              |   | 2,906                            |   | —                 |   | —                                                    |   | 2,918                                    |    |
| Effect of re-priced options                                         |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | 181                              |   | —                 |   | —                                                    |   | 181                                      |    |
| Officer loans forgiven                                              |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | —                                                    |   | —                                   |    |
| Tax benefit related to stock options exercised                      |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | —                 |   | —                                                    |   | —                                   |    |
| Dividends declared on common stock                                  |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | (1,765                 | )      | —                                                    |   | (1,765                                   | )       |
| Dividends declared on $2.625 cumulative convertible preferred stock |   | —                                                |   | —                       |   | —                                    |   | —                                                |   | —            |   | —              |   | —                           |   | (789                   | )      | —                                                    |   | (789                                     | )       |
| Conversion of $2.625 cumulative convertible preferred stock         |   | (786,751                                              | )      | 1,060,204                    |   | —                                    |   | (79                                                   | )      | 99                |   | —              |   | (46                              | )      | —                 |   | —                                                    |   | (26                                      | )       |
| Redemption of $2.625 cumulative convertible preferred stock         |   | (13,249                                               | )      | —                       |   | —                                    |   | (1                                                    | )      | —            |   | —              |   | (669                             | )      | 27                     |   | —                                                    |   | (643                                     | )       |
|                                                                |   |                                                  |   |                         |   |                                      |   |                                                  |   |              |   |                |   |                             |   |                   |   |                                                      |   |                                     |    |
| Balance at March 31, 2004                                           |   | 1,260,000                                             |   | 35,313,300                   |   | 25,016                                    |   | $                                                     | 126    |              | $      | 3,549               |   | $                                | (788   | )                      | $      | 387,391                                                   |   | $                                        | 199,637 |   | $ | (1,551 | ) | $ | 588,364 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

6

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WESTERN GAS RESOURCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

***GENERAL***

 

We have prepared the accompanying unaudited interim consolidatedfinancial statements under the rules and regulations of the Securities andExchange 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 consolidated financial statements presented herein shouldbe read in conjunction with the Consolidated Financial Statements and Notesthereto included in our Annual Report on Form 10-K for the year ended December31, 2003.  The interim consolidatedfinancial statements as of March 31, 2004 and for the three-month periods endedMarch 31, 2004 and 2003 included herein are unaudited but reflect, in theopinion of management, all adjustments (which include only normal recurringadjustments) necessary to fairly present the results for such periods.  The results of operations for the threemonths ended March 31, 2004 are not necessarily indicative of the results ofoperations expected for the year ended December 31, 2004.

 

Prior period amounts in the interim consolidated financial statementsand notes have been reclassified as appropriate to conform to the presentationused in 2004, including items associated with Price risk management activities.

 

***EARNINGSPER SHARE OF COMMON STOCK***

 

Earnings per share of common stock are computed by dividing incomeattributable to common stock by the weighted average shares of common stockoutstanding.  In addition, earnings pershare of common stock - assuming dilution is computed by dividing incomeattributable to common stock by the weighted average shares of common stockoutstanding as adjusted for potential common shares.  Income attributable to common stock is net income less preferredstock dividends.  We declared preferredstock dividends of $789,000 and $1.8 million for the three months ended March31, 2004 and 2003, respectively.  Commonstock options and our $2.625 cumulative convertible preferred stock arepotential common shares.  In December2003, we issued a notice of redemption for a total of 800,000 shares of our$2.625 cumulative convertible preferred stock. The holders of these shares had the right to convert them into shares ofour common stock in lieu of receiving the redemption price in cash.   In January 2004, we issued an additional989,622 shares of common stock and paid $672,000 in cash proceeds to completethis redemption.  The following is a reconciliation of the weighted averageshares of common stock outstanding to the weighted average common sharesoutstanding – assuming dilution.  In thefirst quarter of 2004, we declared dividends on outstanding common stock of$0.05 per share and dividends on outstanding preferred stock of $0.65625 pershare.

 
|                                                                     |   | **Quarter  Ended  March 31,** |   |
|--------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                     |   | **2004**                      |   | **2003** |   |
| Weighted average shares of common stock  outstanding                     |   | 34,182,950                    |   | 33,087,680 |   |
| Potential common shares from:                                            |   |                          |   |   |   |
| Common stock options                                                     |   | 907,764                       |   | 603,719 |   |
| $2.625 Cumulative convertible preferred  stock                           |   | 1,735,091                     |   | 3,471,699 |   |
| Weighted average shares of common stock  outstanding - assuming dilution |   | 36,825,805                    |   | 37,163,098 |   |

 

The numerators and the denominators for these periods were adjusted toreflect these potential shares and any related preferred dividends incalculating fully diluted earnings per share.

 

***ACCUMULATED OTHER COMPREHENSIVE INCOME***

 

Included in Accumulated other comprehensive income at March 31, 2004were unrealized losses of $2.9 million from the fair value of derivativesdesignated as cash flow hedges and unrealized gains of $1.4 million ofcumulative foreign currency translation adjustments.  In the first quarter of 2004, we discontinued cash flow hedgeaccounting treatment on our hedges of equity butane production which utilizedcrude oil puts as a surrogate.  Thevalue of these hedging instruments will remain in Accumulated othercomprehensive income and will be reclassified to our results of operations asthe underlying transactions occur.  Aloss of $318,000 was included in Accumulated other comprehensive income atMarch 31, 2004 for these items.

 

7

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Included in Accumulated other comprehensive income at March 31, 2003were unrealized losses of $10.3 million from the fair value of derivativesdesignated as cash flow hedges and unrealized gains of $3.2 million ofcumulative foreign currency translation adjustments.

 

##### ***Revenue Recognition***

 

In the Gas Gathering, Processing and Treating segment, we recognizerevenue for our services at the time the service is performed. We recordrevenue from our gas and NGL marketing activities, including sales of ourequity production, upon transfer of title to the product.  These revenues are recorded on a gross salesversus sales net of purchases basis as we obtain title to all the gas and NGLsthat we buy including third-party purchases, and bear the risk of loss andcredit exposure on these transactions. Gas imbalances on our production are accounted for using the salesmethod.  For our marketing activities,we utilize mark-to-market accounting. Under mark-to-market accounting, the expected margin to be realized overthe term of the transaction is recorded in the month of origination.  To the extent that a transaction is notfully hedged or there is any hedge ineffectiveness, additional gains or lossesassociated with the transaction may be reported in future periods.  In the Transportation 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 fee is charged based upon volumes received intothe pipeline. 

 

***CUMULATIVE EFFECT OF CHANGES IN ACCOUNTINGPRINCIPLES***

 

##### ***Depreciation, Depletion and Amortization for Oiland Gas Properties***

##### *** ***

We follow the successful efforts method of accounting for oil and gasexploration and production activities. Producing properties and related equipment are depleted and depreciatedby the units-of-production method based on estimated proved reserves.  In the fourth quarter of 2003, we conducteda review of our oil and gas producing properties, which included an evaluationof the geologic formations and production history for these properties.  This review indicated that the cash flowsfrom individual wells in our operating areas were not largely independent ofthe cash flows of other wells producing in the same field or coal seam.  As a result of this review we redefined theasset groupings for the calculation of depreciation and depletion from awell-by-well basis to a field wide basis for each of the Jonah, Pinedale andSand Wash fields and to a grouping of all wells drilled into related coal seamsfor the Powder River Basin.

 

The change in the asset groupings for depreciation and depletionpurposes is treated as a change in accounting principle.  Accordingly, the Accumulated depreciation,depletion, and amortization for these assets has been recalculated under thenew asset groupings.  The cumulativeeffect of the change in depreciation and depletion method of $4.7 million, netof tax, or $0.13 per common share assuming dilution, is presented in theConsolidated Statement of Operations under the caption Cumulative effect ofchanges in accounting principles, net of tax. This change resulted in an increase in Depreciation expense of  $310,000, or $0.01 per share of commonstock, in the first quarter of 2004.

 

If we had adopted the change in asset groupings for depreciation anddepletion purposes on January 1, 2003, we estimate that Depreciation, depletionand amortization expense in the first quarter of 2003 would have been $527,000lower than reported on the Consolidated Statement of Operations.  The estimated pro forma effect of a January1, 2003 change in depreciation and depletion methodology would have been $5.5million in net income and $0.15 in earnings per share of common stock.  For 2003, earnings per share after thecumulative effect of change in accounting principle for asset retirementobligations was $.63 per share.  If wehad adopted the change in asset groupings for depreciation and depletionpurposes on January 1, 2003, earnings per share would have been $.78 per share.

 

***Accounting for AssetRetirement Obligations***

 

In June 2001, the FASB issued SFAS No. 143 “Accounting for AssetRetirement Obligations.”  SFAS No. 143was effective for fiscal years beginning after June 15, 2002.  SFAS No. 143 established accountingstandards for recognition and measurement of a liability for an assetretirement obligation and the associated asset retirement cost.  We adopted SFAS No. 143 on January 1, 2003and recorded an $11.5 million increase to Property and equipment, a $4.4million increase to Accumulated depreciation, depletion and amortization, a$17.8 million increase to Other long-term liabilities and a $6.7 millionnon-cash, net of tax, loss from the Cumulative effect of a change in accountingprinciple.  

 

***SUBSEQUENT EVENT***

 

***Conversion of Preferred Stock***

 

On March 16, 2004, we issued a notice of redemption for all ouroutstanding  $2.625 cumulativeconvertible preferred stock, or approximately 1,260,000 shares.  On April 20, 2004, a total of 1,556,791common shares were issued and $391,000 was paid in cash to complete theredemption of our $2.625 cumulative convertible preferred stock.  After the completion of the notice ofredemption, the $2.625 cumulative convertible preferred stock was delisted fromtrading on the New York Stock Exchange.

 

***DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES***

 

The net loss recognized in earnings through Sale of residue gas andSale of natural gas liquids during the first three months of 2004 from hedgingactivities was $743,000, and we recognized a loss from hedge ineffectiveness of$21,000. In the first quarter of 2004, we determined in our quarterlyeffectiveness testing that our hedges of equity butane production whichutilized crude oil puts as a surrogate are no longer effective hedges.  Therefore, in the first quarter of 2004, wediscontinued cash flow hedge accounting treatment on these instruments.  The value of these hedging instruments willremain in Accumulated other comprehensive income and will be reclassified toour results of operations as the underlying transactions occur.  A loss of $318,000 was included inAccumulated other 

 

8

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comprehensive income at March31, 2004 for these items.  Our remaininghedges for our other products are expected to continue to be “highly effective”under SFAS No. 133 in the future.

 

The gains and losses currently reflected in Accumulated othercomprehensive income will be reclassified to earnings based on the actual salesof the hedged gas or NGLs.  Based onprices as of March 31, 2004, approximately $2.9 million of losses inAccumulated other comprehensive income will be reclassified to earnings in2004.

 

***SUPPLEMENTARY CASH FLOWINFORMATION***

*** ***

Interest paid was $3.0 million and $3.1 million for the three monthsended March 31, 2004 and 2003, respectively.  No income taxes were paid in the threemonths ended March 31, 2004.  A total of$4.9 million was paid in income taxes in the three months ended March 31, 2003.

 

***STOCKCOMPENSATION***

 

As permitted under SFAS No. 123, “Accounting for Stock-BasedCompensation”, we have elected to continue to measure compensation costs forstock-based employee compensation plans as prescribed by Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees.”  We have complied with the pro formadisclosure requirements of SFAS No. 123 as required under thepronouncement.  We realize an income taxbenefit from the exercise of non-qualified stock options related to the amountby which the market price at the date of exercise exceeds the optionprice.  This tax benefit is credited toadditional paid-in capital.

 

We are required to record compensation expense (if not previouslyaccrued) equal to the number of unexercised re-priced options multiplied by theamount by which our stock price at the end of any quarter exceeds $21.00 pershare.  We had options covering 24,219and 59,500 common shares outstanding at March 31, 2004 and 2003, respectively,which were treated as repriced options. Based on our stock price at March 31, 2004 of $50.85 per share and ourstock price at March 31, 2003 of $32.55 per share, expense of $181,000 and$147,000, respectively, was recorded in the three months ended March 31, 2004and 2003.

 

SFAS No. 123 requires pro forma disclosures for each quarter that astatement of operations is presented. The following isa summary of the options to purchase our common stock granted during thequarters ended March 31, 2004 and 2003, respectively.

 
|      |   | **Quarter  Ended March 31,** |   |
|-----------|--------|------------------------------|--------|
|      |   | **2004**                     |   | **2003** |   |
| 2002 Plan |   | 17,500                       |   | 30,000 |   |

 

The following is a summary of the weighted average fair value per shareof the options granted during the quarters ended March 31, 2004 and 2003, respectively.

 
|      |   | **Quarter  Ended March 31,** |   |
|-----------|--------|------------------------------|--------|
|      |   | **2004**                     |   | **2003** |   |
| 2002 Plan |   | $                            | 22.53  |   | 18.28 |   |
|           |        |                              |        |  |  |  |

 

These values for the options granted during the quarter ended March 31, 2004 wereestimated using the Black-Scholes option-pricing model with the followingassumptions:

 
|                           |   | **2002 Plan** |   |
|--------------------------------|--------|---------------|--------|
| Risk-free interest rate        |   | 3.57          | %      |
| Expected life (in years)       |   | 7             |   |
| Expected volatility            |   | 44            | %      |
| Expected dividends (quarterly) |   | $             | 0.05   |   |
|                                |        |               |        |  |

 

Under SFAS No. 123, the fair market value of the options at the grantdate is amortized over the appropriate vesting period for purposes ofcalculating compensation expense.  If wehad recorded compensation expense for our grants under our stock-basedcompensation plans consistent with the fair value method under thispronouncement,

 

9

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our net income, incomeattributable to common stock, 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):

 
|                                                                                                                                           |   | **Quarter  Ended March 31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                                                                           |   | **2004  As Reported**        |   | **2004  Pro Forma** |   | **2003  As Reported** |   | **2003  Pro Forma** |   |
| Net income                                                                                                                                     |   | $                            | 29,088 |   | $ | 27,946 |   | $ | 23,375 |   | $ | 22,610 |   |
| Net income attributable to common stock                                                                                                        |   | 28,272                       |   | 27,130 |   | 21,564 |   | 20,799 |   |
| Earnings per share of common stock                                                                                                             |   | 0.83                         |   | 0.79 |   | 0.65 |   | 0.63 |   |
| Earnings per share of common stock -  assuming dilution                                                                                        |   | 0.79                         |   | 0.76 |   | 0.63 |   | 0.61 |   |
| Stock-based employee compensation cost, net  of related tax effects, included in net income                                                    |   | $                            | 115    |   | $ | — |   | $ | 92 |   | $ | — |   |
| Stock-based employee compensation cost, net  of related tax effects, includable in net income if the fair value based  method had been applied |   | $                            | — |   | $ | 1,257 |   | $ | — |   | $ | 857 |   |

 

***SEGMENT REPORTING***

 

We operate in four principal business segments, as follows:  Gas Gathering, Processing and Treating; Explorationand Production; Marketing; and Transportation. Management separately monitors these segments for performance againstour internal forecast, and these segments are consistent with our internalfinancial reporting package.  Thesesegments have been identified based upon the differing products and services,regulatory environment and the expertise required for these operations.

 

***Gas Gathering,Processing and Treating.***  In this segment, we connect producers’ wells (including those ofour Exploration and Production segment) to our gathering systems for deliveryto our processing or treating plants, process the natural gas to extract NGLsand treat the natural gas in order to meet pipeline specifications.  In some areas, where no processing isrequired, we gather and compress producers’ gas and deliver it to pipelines forfurther delivery to market.  Except forvolumes taken in kind by our producers, the Marketing segment sells the residuegas and NGLs extracted at most of our facilities.  In this segment, we recognize revenue for our services at thetime the service is performed.  Includedin this segment is our Powder River coal bed methane gathering operations,which gathers gas from producers, including our Exploration and Productionsegment.  In 2003, this service for theExploration and Production segment was performed under a percentage-of-proceedscontract and in 2004, this service is performed under a fee-basedcontract.  The change of contract typehas no effect on the Operating profit of either the Gas Gathering, Processingand Treating segment or the Exploration and Production segment.

 

Substantially all gas flowing through our gathering, processing andtreating facilities is supplied under three types of contracts providing forthe purchase, treating or processing of natural gas for periods ranging fromone month to twenty years or in some cases for the life of the oil and gaslease.  Approximately 65% of our plantfacilities’ gross margin, or revenues at the plant less product purchases, for themonth of March 2004 was under percentage-of-proceeds agreements in which we aretypically responsible for the marketing of the gas and NGLs.  Under these agreements, we pay producers aspecified percentage of the net proceeds received from the sale of the gas andthe NGLs.

 

Approximately 19% of our plant facilities’ gross margin for the monthof March 2004 was under contracts that are primarily fee-based from which wereceive a set fee for each Mcf of gas gathered and/or processed. This type ofcontract provides us with a steady revenue stream that is not dependent oncommodity prices, except to the extent that low prices may cause a producer todelay drilling.

 

Approximately 16% of our plant facilities’ gross margin for the monthof March 2004 was under contracts with "keepwhole" arrangements orwellhead purchase contracts.  Underthese contracts, we retain the NGLs recovered by the processing facility andkeep the producers whole by returning to the producers at the tailgate of theplant an amount of residue gas equal on a Btu basis to the natural gas receivedat the plant inlet.  The"keepwhole" component of the contracts permits us to benefit when thevalue of the NGLs is greater as a liquid than as a portion of the residue gasstream.  However, we are adverselyaffected when the value of the NGLs is lower as a liquid than as a portion ofthe residue gas stream.

 

***Exploration andProduction.*** The activities of the Exploration and Production segment include theexploration and development of gas properties in the Rocky Mountain area,including those where our gathering and/or processing facilities arelocated.  The Marketing segment sellsthe majority of the production from these properties.

 

10

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***Marketing.*** Our Marketing segment buys and sellsgas and NGLs in the United States and Canada from and to a variety ofcustomers.  In this segment, revenuesfor sales of product are recognized at the time the gas or NGLs are deliveredto the customer and are sensitive to changes in the market prices of theunderlying commodities.  The marketingof products purchased from third-parties typically results in low operatingmargins relative to the sales price.  Wesell our products under agreements with varying terms and conditions in orderto match seasonal and other changes in demand. This segment also markets gas and NGLs produced by our gathering,processing, treating and production assets. Also included in this segment are our Canadian marketing operations,which are conducted through our wholly-owned subsidiary WGR Canada, Inc. andare immaterial for separate presentation.

 

***Transportation.***  The Transportation segment reflects theoperations of Western’s MIGC, Inc. and MGTC, Inc.  pipelines.   The majorityof the revenue presented in this segment is derived from transportation ofresidue gas for our Marketing segment and other third parties.  In this segment, we realize revenue on amonthly basis from firm capacity contracts under which the shipper pays fortransport capacity whether or not the capacity is used and from interruptiblecontracts where a fee is charged based upon volumes received into thepipeline.  The Transportation segments’firm capacity contracts range in duration from seven months to fourteen years.

 

***Segment Information.***The following tables set forth our segment information as of and for the threemonths ended March 31, 2004 and 2003 (dollars in thousands).  Due to our integrated operations, the use ofallocations in the determination of business segment information isnecessary.  Inter-segment revenues arevalued at prices comparable to those of unaffiliated customers.  Prior period amounts in the interim segmentinformation have been reclassified to conform to the presentation used in 2004.

 
|                                             |   | **Gas Gathering,  Processing and  Treating** |    | **Exploration  and  Production** |   | **Marketing** |   | **Trans-  portation** |    | **Corporate** |   | **Elim-  inating  Entries** |   | **Total** |    |
|--------------------------------------------------|--------|----------------------------------------------|---------|----------------------------------|--------|---------------|--------|-----------------------|---------|---------------|--------|-----------------------------|--------|-----------|---------|
| **Quarter  Ended March 31, 2004**                |   |                                         |    |                             |   |          |   |                  |    |          |   |                        |   |      |    |
| Revenues from unaffiliated customers             |   |                                         |    |                             |   |          |   |                  |    |          |   |                        |   |      |    |
| Sale of gas                                      |   | $                                            | 924     |                             | $      | 2,239         |   | $                     | 659,824 |          | $      | 562                         |   | $         | —  |   | $ | — |   | $ | 663,549 |   |
| Sale of natural gas liquids                      |   | 1                                            |    | —                           |   | 95,298        |   | —                |    | 8             |   | —                      |   | 95,307    |    |
| Equity hedges:                                   |   |                                         |    |                             |   |          |   |                  |    |          |   |                        |   |      |    |
| Residue                                          |   | 149                                          |    | 1,500                            |   | —        |   | —                |    | —        |   | —                      |   | 1,649     |    |
| Liquids                                          |   | (2,392                                       | )       | —                           |   | —        |   | —                |    | —        |   | —                      |   | (2,392    | )       |
| Gathering, processing and transportation revenue |   | 14,926                                       |    | —                           |   | —        |   | 1,743                 |    | 160           |   | —                      |   | 16,829    |    |
| Total revenues from unaffiliated customers       |   | 13,608                                       |    | 3,739                            |   | 755,122       |   | 2,305                 |    | 168           |   | —                      |   | 774,942   |    |
| Inter-segment revenues                           |   | 257,637                                      |    | 55,931                           |   | 12,805        |   | 3,434                 |    | 15            |   | (329,822                    | )      | —    |    |
| Price risk management activities                 |   | (21                                          | )       | —                           |   | (5,347        | )      | —                |    | —        |   | —                      |   | (5,368    | )       |
| Interest income                                  |   | —                                       |    | —                           |   | —        |   | —                |    | 4,009         |   | (4,009                      | )      | —    |    |
| Other, net                                       |   | 341                                          |    | 1                                |   | (2            | )      | —                |    | 1,302         |   | —                      |   | 1,642     |    |
| Total revenues                                   |   | 271,565                                      |    | 59,671                           |   | 762,578       |   | 5,739                 |    | 5,494         |   | (333,831                    | )      | 771,216   |    |
| Product purchases                                |   | 215,578                                      |    | 628                              |   | 759,868       |   | 1,581                 |    | —        |   | (320,313                    | )      | 657,342   |    |
| Plant operating and transportation expense       |   | 20,164                                       |    | 248                              |   | (242          | )      | 1,760                 |    | 935           |   | (931                        | )      | 21,934    |    |
| Oil and gas exploration and production expense   |   | —                                       |    | 25,681                           |   | —        |   | —                |    | —        |   | (8,571                      | )      | 17,110    |    |
| Earnings from equity investments                 |   | (1,926                                       | )       | —                           |   | —        |   | —                |    | —        |   | —                      |   | (1,926    | )       |
| Operating profit                                 |   | 37,749                                       |    | 33,114                           |   | 2,952         |   | 2,398                 |    | 4,559         |   | (4,016                      | )      | 76,756    |    |
|                                             |   |                                         |    |                             |   |          |   |                  |    |          |   |                        |   |      |    |
| Depreciation, depletion and amortization         |   | 9,000                                        |    | 10,992                           |   | 17            |   | 416                   |    | 2,201         |   | —                      |   | 22,626    |    |
| Selling and administrative expense               |   | —                                       |    | —                           |   | —        |   | —                |    | 9,960         |   | (14                         | )      | 9,946     |    |
| (Gain) loss from sale of assets                  |   | —                                       |    | —                           |   | —        |   | —                |    | —        |   | —                      |   | —    |    |
| Interest expense                                 |   | —                                       |    | 35                               |   | 95            |   | (63                   | )       | 9,744         |   | (4,009                      | )      | 5,802     |    |
| Segment profit                                   |   | $                                            | 28,749  |                             | $      | 22,087        |   | $                     | 2,840   |          | $      | 2,045                       |   | $         | (17,346 | ) | $ | 7 |   | $ | 38,382 | ** ** |
|                                             |   |                                         |    |                             |   |          |   |                  |    |          |   |                        |   |      |    |
| Identifiable assets                              |   |                                         |    |                             |   |          |   |                  |    |          |   |                        |   |      |    |
| Other allocated assets                           |   | $                                            | 5,974   |                             | $      | 4,737         |   | $                     | 60,172  |          | $      | 27,152                      |   | $         | 319,475 |   | $ | (52,120 | ) | $ | 365,390 |   |
| Investment in others                             |   | —                                       |    | —                           |   | —        |   | —                |    | 483,720       |   | (443,954                    | )      | 39,766    |    |
| Capital assets                                   |   | 623,219                                      |    | 304,721                          |   | 17            |   | 38,503                |    | 54,346        |   | (569                        | )      | 1,020,237 |    |
| Total identifiable assets                        |   | $                                            | 629,193 |                             | $      | 309,458       |   | $                     | 60,189  |          | $      | 65,655                      |   | $         | 857,541 |   | $ | (496,643 | ) | $ | 1,425,393 |   |

 

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|                                             |   | **Gas  Gathering,  Processing and  Treating** |       | **Exploration  and  Production** |       | **Marketing** |       | **Trans-  portation** |       | **Corporate** |       | **Elim-  inating  Entries** |       | **Total** |       |
|--------------------------------------------------|--------|-----------------------------------------------|------------|----------------------------------|------------|---------------|------------|-----------------------|------------|---------------|------------|-----------------------------|------------|-----------|------------|
| **Quarter Ended March 31, 2003**                 |   |                                          | ** ** |                             | ** ** |          | ** ** |                  | ** ** |          | ** ** |                        | ** ** |      | ** ** |
| Revenues from unaffiliated customers             |   |                                          |       |                             |       |          |       |                  |       |          |       |                        |       |      |       |
| Sale of gas                                      |   | $                                             | 1,054      |                             | $          | 920           |       | $                     | 798,759    |          | $          | 296                         |       | $         | —     |   | $ | — |   | $ | 801,029 |   |
| Sale of natural gas liquids                      |   | 4                                             |       | —                           |       | 96,937        |       | —                |       |          |       |                        |       | 96,941    |       |
| Equity hedges:                                   |   |                                          |       |                             |       |          |       |                  |       |          |       |                        |       |      |       |
| Residue                                          |   | (968                                          | )          | (6,791                           | )          | —        |       | —                |       | —        |       | —                      |       | (7,759    | )          |
| Liquids                                          |   | (4,892                                        | )          | —                           |       | —        |       | —                |       | —        |       | —                      |       | (4,892    | )          |
| Gathering, processing and transportation revenue |   | 17,904                                        |       | —                           |       | —        |       | 1,838                 |       | 35            |       | —                      |       | 19,777    |       |
| Total revenues from unaffiliated customers       |   | 13,102                                        |       | (5,871                           | )          | 895,696       |       | 2,134                 |       | 35            |       | —                      |       | 905,096   |       |
| Inter-segment revenues                           |   | 302,037                                       |       | 63,342                           |       | 11,967        |       | 3,874                 |       | 33            |       | (381,253                    | )          | —    |       |
| Price risk management activities                 |   | (777                                          | )          | (2,045                           | )          | (14,872       | )          | —                |       | —        |       | —                      |       | (17,694   | )          |
| Interest income                                  |   | —                                        |       | 8                                |       | —        |       | 2                     |       | 2,339         |       | (2,349                      | )          | —    |       |
| Other, net                                       |   | 584                                           |       | 15                               |       | —        |       | —                |       | 105           |       | —                      |       | 704       |       |
| Total revenues                                   |   | 314,946                                       |       | 55,449                           |       | 892,791       |       | 6,010                 |       | 2,512         |       | (383,602                    | )          | 888,106   |       |
| Product purchases                                |   | 264,287                                       |       | 388                              |       | 877,927       |       | 201                   |       | —        |       | (371,201                    | )          | 771,602   |       |
| Plant operating and transportation expense       |   | 20,199                                        |       | 101                              |       | 80            |       | 1,747                 |       | 601           |       | (806                        | )          | 21,922    |       |
| Oil and gas exploration and production expense   |   | —                                        |       | 21,561                           |       | —        |       | —                |       | —        |       | (9,050                      | )          | 12,511    |       |
| Earnings from equity investments                 |   | (1,562                                        | )          | —                           |       | —        |       | —                |       | —        |       | —                      |       | (1,562    | )          |
| Operating profit                                 |   | 32,022                                        |       | 33,399                           |       | 14,784        |       | 4,062                 |       | 1,911         |       | (2,545                      | )          | 83,633    |       |
|                                             |   |                                          |       |                             |       |          |       |                  |       |          |       |                        |       |      |       |
| Depreciation, depletion and amortization         |   | 7,535                                         |       | 8,420                            |       | 35            |       | 433                   |       | 1,720         |       | —                      |       | 18,143    |       |
| Selling and administrative expense               |   | —                                        |       | —                           |       | —        |       | —                |       | 10,606        |       | (14                         | )          | 10,592    |       |
| (Gain) loss from sale of assets                  |   | (92                                           | )          | —                           |       | —        |       | —                |       | 373           |       | —                      |       | 281       |       |
| Interest expense                                 |   | 1                                             |       | —                           |       | 40            |       | (24                   | )          | 9,146         |       | (2,349                      | )          | 6,814     |       |
| Segment profit                                   |   | $                                             | 24,578     |                             | $          | 24,979        |       | $                     | 14,709     |          | $          | 3,653                       |       | $         | (19,934    | ) | $ | (182 | ) | $ | 47,803 |   |
|                                             |   |                                          |       |                             |       |          |       |                  |       |          |       |                        |       |      |       |
| Identifiable assets                              |   |                                          |       |                             |       |          |       |                  |       |          |       |                        |       |      |       |
| Other allocated assets                           |   | $                                             | (2,215     | )                                | $          | 3,424         |       | $                     | 107,202    |          | $          | 1,306                       |       | $         | 478,446    |   | $ | (51,330 | ) | $ | 536,833 |   |
| Investment in others                             |   | 2,914                                         |       | —                           |       | —        |       | 3,731                 |       | 53,714        |       | (36,174                     | )          | 24,185    |       |
| Capital assets                                   |   | 587,781                                       |       | 225,573                          |       | 1,637         |       | 42,142                |       | 54,432        |       | 7                           |       | 911,572   |       |
| Total identifiable assets                        |   | $                                             | 588,480    |                             | $          | 228,997       |       | $                     | 108,839    |          | $          | 47,179                      |       | $         | 586,592    |   | $ | (87,497 | ) | $ | 1,472,590 |   |

 

##### ***GUARANTOR AND NON-GUARANTOR SUBSIDIARIES***

 

Our paymentobligations under the revolving credit facility, the master shelf agreement andthe senior subordinated notes, or collectively the financing facilities, arefully and unconditionally guaranteed by our significant subsidiaries to theextent allowed by applicable law. These guarantees are joint and several and,in the case of the senior subordinated notes, are subordinated in right ofpayment to senior debt of the guarantors.

 

During the three months ended March 31, 2004and 2003, the guarantors of our payment obligations under the financingfacilities were Lance Oil & Gas Company, Inc., Western Gas Resources-Texas,Inc., Mountain Gas Resources, Inc., MIGC, Inc., MGTC, Inc. and Western GasWyoming, L.L.C., or collectively, the guarantor subsidiaries.

 

Our subsidiaries that did not guarantee ourpayment obligations under the financing facilities during the three monthsended March 31, 2004 and 2003 included Western Power Services, Inc., WesternGas Resources-Westana, Inc., WGR Canada, Inc., Western Gas Resources – SandWash, Inc., Mountain Gas Transportation, Inc., and Setting Sun PipelineCorporation, or collectively, the non-guarantor subsidiaries.

 

Presented below is condensed consolidatingfinancial information for Western Gas Resources, Inc., or the Parent Company,the guarantor subsidiaries and the non-guarantor subsidiaries.  Balance sheet data are presented as of

 

12

----

 

March31, 2004 and 2003.  The Statement ofOperations and Statement of Cash Flows data are presented for the three monthsended March 31, 2004 and 2003.

 

For purposes of the following tables, theParent Company’s investments in its subsidiaries are accounted for using theequity method of accounting.  Net incomeof guarantor and non-guarantor subsidiaries is, therefore, reflected in theParent Company column under Earnings from equity investments.  Selling and administrative expense andProvision for income taxes are primarily reflected in the Parent Companycolumn.  The Consolidating Entrieseliminate the investments in the subsidiaries and other inter-companytransactions for consolidated reporting purposes.

 

**SupplementalCondensed Consolidating Balance Sheet**

**As of March 31, 2004**

 
|                                               |   | **Parent  Company** |      | **Guarantor  Subsidiaries** |   | **Non-  Guarantor  Subsidiaries** |   | **Consolidating  Entries** |    | **Total** |   |
|----------------------------------------------------|--------|---------------------|-----------|-----------------------------|--------|-----------------------------------|--------|----------------------------|---------|-----------|--------|
| ASSETS                                             |   |                |      |                        |   |                              |   |                       |    |      |   |
| Current assets:                                    |   |                |      |                        |   |                              |   |                       |    |      |   |
| Cash and cash equivalents                          |   | $                   | 21,367    |                        | $      | 10,316                            |   | $                          | 84      |      | $      | — |   | $ | 31,767 |   |
| Trade accounts receivable, net                     |   | 136,813             |      | 107,276                     |   | 10,872                            |   | (2,316                     | )       | 252,645   |   |
| Inventory                                          |   | 13,740              |      | 1,741                       |   | 14,951                            |   | —                     |    | 30,432    |   |
| Assets from price risk  management activities      |   | 10,941              |      | —                      |   | —                            |   | —                     |    | 10,941    |   |
| Other                                              |   | 3,799               |      | (1,009                      | )      | 977                               |   | —                     |    | 3,767     |   |
| Total current assets                               |   | 186,660             |      | 118,324                     |   | 26,884                            |   | (2,316                     | )       | 329,552   |   |
| Total property and equipment,  net                 |   | 422,755             |      | 515,517                     |   | 82,641                            |   | (676                       | )       | 1,020,237 |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Other assets:                                      |   |                |      |                        |   |                              |   |                       |    |      |   |
| Gas purchase contracts, net                        |   | 7,302               |      | 21,488                      |   | —                            |   | —                     |    | 28,790    |   |
| Assets from price risk  management activities      |   | 1,343               |      | —                      |   | —                            |   | —                     |    | 1,343     |   |
| Other assets                                       |   | 55,480              |      | 20                          |   | 8                                 |   | (49,803                    | )       | 5,705     |   |
| Investments in subsidiaries                        |   | 614,362             |      | 37,397                      |   | 2,369                             |   | (614,362                   | )       | 39,766    |   |
| Total other assets                                 |   | 678,487             |      | 58,905                      |   | 2,377                             |   | (664,165                   | )       | 75,604    |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total assets                                       |   | $                   | 1,287,902 |                        | $      | 692,746                           |   | $                          | 111,902 |      | $      | (667,157 | ) | $ | 1,425,393 |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| LIABILITIES AND STOCKHOLDERS’  EQUITY         |   |                |      |                        |   |                              |   |                       |    |      |   |
| Current liabilities:                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Accounts payable                                   |   | $                   | 243,037   |                        | $      | 52,413                            |   | $                          | 28,883  |      | $      | (3,240 | ) | $ | 321,093 |   |
| Accrued expenses                                   |   | 23,912              |      | 15,577                      |   | 2,394                             |   | —                     |    | 41,883    |   |
| Liabilities from price risk  management activities |   | 13,281              |      | —                      |   | —                            |   | —                     |    | 13,281    |   |
| Dividends payable                                  |   | 2,554               |      | —                      |   | —                            |   | —                     |    | 2,554     |   |
| Total current liabilities                          |   | 282,784             |      | 67,990                      |   | 31,277                            |   | (3,240                     | )       | 378,811   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Long-term debt                                     |   | 245,000             |      | 44,967                      |   | 4,836                             |   | (49,803                    | )       | 245,000   |   |
| Other long-term liabilities                        |   | 11,736              |      | 10,026                      |   | 838                               |   | —                     |    | 22,600    |   |
| Liabilities from price risk  management activities |   | 1,112               |      | —                      |   | —                            |   | —                     |    | 1,112     |   |
| Deferred income taxes payable                      |   | 158,906             |      | 29,666                      |   | 5,989                             |   | (5,055                     | )       | 189,506   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total liabilities                                  |   | 699,538             |      | 152,649                     |   | 42,940                            |   | (58,098                    | )       | 837,029   |   |
| Total stockholders’ equity                    |   | 588,364             |      | 540,097                     |   | 68,962                            |   | (609,059                   | )       | 588,364   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total liabilities and stockholders’ equity    |   | $                   | 1,287,902 |                        | $      | 692,746                           |   | $                          | 111,902 |      | $      | (667,157 | ) | $ | 1,425,393 |   |

 

**Supplemental Condensed ConsolidatingStatement of Operations**

**For the Quarter Ended March 31, 2004**

 
|                                                     |   | **Parent  Company** |    | **Guarantor  Subsidiaries** |   | **Non-  Guarantor  Subsidiaries** |   | **Consolidating  Entries** |   | **Total** |   |
|----------------------------------------------------------|--------|---------------------|---------|-----------------------------|--------|-----------------------------------|--------|----------------------------|--------|-----------|--------|
| Total revenues                                           |   | $                   | 941,328 |                        | $      | 104,163                           |   | $                          | 59,557 |      | $      | (333,832 | ) | $ | 771,216 |   |
| Costs and expenses:                                      |   |                |    |                        |   |                              |   |                       |   |      |   |
| Product purchases                                        |   | 890,751             |    | 33,005                      |   | 52,371                            |   | (318,785                   | )      | 657,342   |   |
| Plant operating expense                                  |   | 15,729              |    | 7,907                       |   | 757                               |   | (2,459                     | )      | 21,934    |   |
| Oil and gas exploration and  production costs            |   | 288                 |    | 25,246                      |   | 147                               |   | (8,571                     | )      | 17,110    |   |
| Depreciation, depletion and  amortization                |   | 8,137               |    | 13,336                      |   | 1,153                             |   | —                     |   | 22,626    |   |
| Selling and administrative  expense                      |   | 9,351               |    | 536                         |   | 74                                |   | (15                        | )      | 9,946     |   |
| Earnings from equity  investments                        |   | (27,070             | )       | (1,384                      | )      | (542                              | )      | 27,070                     |   | (1,926    | )      |
| Interest expense                                         |   | 5,760               |    | 3,951                       |   | 93                                |   | (4,002                     | )      | 5,802     |   |
| Total costs and expenses                                 |   | 902,946             |    | 82,597                      |   | 54,053                            |   | (306,762                   | )      | 732,834   |   |
| Income before income taxes                               |   | 38,382              |    | 21,566                      |   | 5,504                             |   | (27,070                    | )      | 38,382    |   |
| Total provision for income  taxes                        |   | 14,008              |    | —                      |   | —                            |   | —                     |   | 14,008    |   |
| Income before cumulative change  in accounting principle |   | 24,374              |    | 21,566                      |   | 5,504                             |   | (27,070                    | )      | 24,374    |   |
| Cumulative effect of change in  accounting principle     |   | 4,714               |    | —                      |   | —                            |   | —                     |   | 4,714     |   |
|                                                     |   |                |    |                        |   |                              |   |                       |   |      |   |
| Net income                                               |   | $                   | 29,088  |                        | $      | 21,566                            |   | $                          | 5,504  |      | $      | (27,070 | ) | $ | 29,088 |   |

 

13

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**SupplementalCondensed Consolidating Statement of Cash Flows**

**For the Quarter EndedMarch 31, 2004**

 
|                                                         |   | **Parent  Company** |   | **Guarantor  Subsidiaries** |   | **Non-  Guarantor  Subsidiaries** |   | **Consolidating  Entries** |   | **Total** |   |
|--------------------------------------------------------------|--------|---------------------|--------|-----------------------------|--------|-----------------------------------|--------|----------------------------|--------|-----------|--------|
| Net cash provided by operating  activities                   |   | $                   | 93,866 |                        | $      | 28,302                            |   | $                          | 16,232 |      | $      | (1,299 | ) | $ | 137,101 |   |
| Cash flows from investing  activities:                       |   |                |   |                        |   |                              |   |                       |   |      |   |
| Purchases of property and equipment,  including acquisitions |   | (17,172             | )      | (18,111                     | )      | (2,972                            | )      | 1,300                      |   | (36,955   | )      |
| Proceeds from the disposition of property  and equipment     |   | 117                 |   | 3                           |   | 196                               |   | (1                         | )      | 315       |   |
| Other net cash from investing  activities                    |   | 14,995              |   | —                      |   | (14,995                           | )      | —                     |   | —    |   |
| Net cash used in investing  activities                       |   | (2,060              | )      | (18,108                     | )      | (17,771                           | )      | 1,299                      |   | (36,640   | )      |
| Cash flows from financing  activities:                       |   |                |   |                        |   |                              |   |                       |   |      |   |
| Payments on revolving credit  facility                       |   | (354,850            | )      | —                      |   | —                            |   | —                     |   | (354,850  | )      |
| Borrowings under revolving  credit facility                  |   | 260,850             |   | —                      |   | —                            |   | —                     |   | 260,850   |   |
| Dividends paid                                               |   | (3,056              | )      | —                      |   | —                            |   | —                     |   | (3,056    | )      |
| Other net cash from financing  activities                    |   | 2,246               |   | —                      |   | —                            |   | —                     |   | 2,246     |   |
| Net cash used in financing  activities                       |   | (94,810             | )      | —                      |   | —                            |   | —                     |   | (94,810   | )      |
| Net increase in cash and cash  equivalents                   |   | (3,004              | )      | 10,194                      |   | (1,539                            | )      | —                     |   | 5,651     |   |
| Cash and cash equivalents at  beginning of year              |   | 24,371              |   | 122                         |   | 1,623                             |   | —                     |   | 26,116    |   |
| Cash and cash equivalents at  end of year                    |   | $                   | 21,367 |                        | $      | 10,316                            |   | $                          | 84     |      | $      | — |   | $ | 31,767 |   |

 

**SupplementalCondensed Consolidating Balance Sheet**

**As of December 31,2003**

**(000s)**

 
|                                               |   | **Parent  Company** |      | **Guarantor  Subsidiaries** |   | **Non-  Guarantor  Subsidiaries** |   | **Consolidating  Entries** |    | **Total** |   |
|----------------------------------------------------|--------|---------------------|-----------|-----------------------------|--------|-----------------------------------|--------|----------------------------|---------|-----------|--------|
| ASSETS                                             |   |                |      |                        |   |                              |   |                       |    |      |   |
| Current assets:                                    |   |                |      |                        |   |                              |   |                       |    |      |   |
| Cash and cash equivalents                          |   | $                   | 24,371    |                        | $      | 122                               |   | $                          | 1,623   |      | $      | — |   | $ | 26,116 |   |
| Trade accounts receivable, net                     |   | 149,889             |      | 99,485                      |   | 14,786                            |   | (1,651                     | )       | 262,509   |   |
| Inventory                                          |   | 46,670              |      | 1,686                       |   | 21,948                            |   | —                     |    | 70,304    |   |
| Assets held for sale                               |   | —              |      | —                      |   | —                            |   | —                     |    | —    |   |
| Assets from price risk  management activities      |   | 17,149              |      | —                      |   | —                            |   | —                     |    | 17,149    |   |
| Other                                              |   | 9,782               |      | (149                        | )      | 1,592                             |   | —                     |    | 11,225    |   |
| Total current assets                               |   | 247,861             |      | 101,144                     |   | 39,949                            |   | (1,651                     | )       | 387,303   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total property and equipment,  net                 |   | 410,456             |      | 504,824                     |   | 80,858                            |   | 623                        |    | 996,761   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Other assets:                                      |   |                |      |                        |   |                              |   |                       |    |      |   |
| Gas purchase contracts, net                        |   | 7,386               |      | 21,833                      |   | —                            |   | —                     |    | 29,219    |   |
| Assets from price risk  management activities      |   | 1,466               |      | —                      |   | —                            |   | —                     |    | 1,466     |   |
| Other assets                                       |   | 78,123              |      | (15                         | )      | 8                                 |   | (71,630                    | )       | 6,486     |   |
| Investments in subsidiaries                        |   | 578,640             |      | 36,013                      |   | 3,276                             |   | (578,640                   | )       | 39,289    |   |
| Total other assets                                 |   | 665,615             |      | 57,831                      |   | 3,284                             |   | (650,270                   | )       | 76,460    |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total assets                                       |   | $                   | 1,323,932 |                        | $      | 663,799                           |   | $                          | 124,091 |      | $      | (651,298 | ) | $ | 1,460,524 |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| LIABILITIES AND STOCKHOLDERS’  EQUITY         |   |                |      |                        |   |                              |   |                       |    |      |   |
| Current liabilities:                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Accounts payable                                   |   | $                   | 233,708   |                        | $      | 43,447                            |   | $                          | 28,597  |      | $      | (2,566 | ) | $ | 303,186 |   |
| Accrued expenses                                   |   | 16,145              |      | 23,544                      |   | 2,447                             |   | —                     |    | 42,136    |   |
| Liabilities from price risk  management activities |   | 10,603              |      | —                      |   | —                            |   | —                     |    | 10,603    |   |
| Dividends payable                                  |   | 3,056               |      | —                      |   | —                            |   | —                     |    | 3,056     |   |
| Total current liabilities                          |   | 263,512             |      | 66,991                      |   | 31,044                            |   | (2,566                     | )       | 358,981   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Long-term debt                                     |   | 339,000             |      | 44,967                      |   | 19,931                            |   | (64,898                    | )       | 339,000   |   |
| Other long-term liabilities                        |   | 11,534              |      | 9,698                       |   | 825                               |   | —                     |    | 22,057    |   |
| Liabilities from price risk  management activities |   | 1,304               |      | —                      |   | —                            |   | —                     |    | 1,304     |   |
| Deferred income taxes payable                      |   | 146,073             |      | 29,805                      |   | 5,989                             |   | (5,194                     | )       | 176,673   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total liabilities                                  |   | 761,423             |      | 151,461                     |   | 57,789                            |   | (72,658                    | )       | 898,015   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total stockholders’ equity                    |   | 562,509             |      | 512,338                     |   | 66,302                            |   | (578,640                   | )       | 562,509   |   |
|                                               |   |                |      |                        |   |                              |   |                       |    |      |   |
| Total liabilities and stockholders’ equity    |   | $                   | 1,323,932 |                        | $      | 663,799                           |   | $                          | 124,091 |      | $      | (651,298 | ) | $ | 1,460,524 |   |

 

14

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**Supplemental Condensed ConsolidatingStatement of Operations**

**For the Quarter Ended March 31, 2003**

 
|                                                     |   | **Parent  Company** |      | **Guarantor  Subsidiaries** |   | **Non-  Guarantor  Subsidiaries** |   | **Consolidating  Entries** |   | **Total** |   |
|----------------------------------------------------------|--------|---------------------|-----------|-----------------------------|--------|-----------------------------------|--------|----------------------------|--------|-----------|--------|
| Total revenues                                           |   | $                   | 1,114,829 |                        | $      | 100,477                           |   | $                          | 60,225 |      | $      | (387,425 | ) | $ | 888,106 |   |
| Costs and expenses:                                      |   |                |      |                        |   |                              |   |                       |   |      |   |
| Product purchases                                        |   | 1,074,918           |      | 17,672                      |   | 53,912                            |   | (374,900                   | )      | 771,602   |   |
| Plant operating expense                                  |   | 14,911              |      | 7,424                       |   | 700                               |   | (1,113                     | )      | 21,922    |   |
| Oil and gas exploration and  production costs            |   | 279                 |      | 21,282                      |   | —                            |   | (9,050                     | )      | 12,511    |   |
| Depreciation, depletion and  amortization                |   | 7,240               |      | 10,367                      |   | 536                               |   | —                     |   | 18,143    |   |
| Selling and administrative  expense                      |   | 10,181              |      | 349                         |   | 76                                |   | (14                        | )      | 10,592    |   |
| (Gain) loss on sale of assets                            |   | 281                 |      | —                      |   | —                            |   | —                     |   | 281       |   |
| Earnings from equity  investments                        |   | (47,592             | )         | (993                        | )      | (569                              | )      | 47,592                     |   | (1,562    | )      |
| Interest expense                                         |   | 6,808               |      | 2,314                       |   | 40                                |   | (2,348                     | )      | 6,814     |   |
| Total costs and expenses                                 |   | 1,067,026           |      | 58,415                      |   | 54,695                            |   | (339,833                   | )      | 840,303   |   |
| Income before income taxes                               |   | 47,083              |      | 42,062                      |   | 5,530                             |   | (47,592                    | )      | 47,803    |   |
| Total provision for income  taxes                        |   | 17,704              |      | —                      |   | —                            |   | —                     |   | 17,704    |   |
| Income before cumulative change  in accounting principle |   | 30,099              |      | 42,062                      |   | 5,530                             |   | (47,592                    | )      | 30,099    |   |
| Cumulative effect of change in  accounting principle     |   | (6,724              | )         | —                      |   | —                            |   | —                     |   | (6,724    | )      |
| Net income                                               |   | $                   | 23,375    |                        | $      | 42,062                            |   | $                          | 5,530  |      | $      | (47,592 | ) | $ | 23,375 |   |

 

**Supplemental Condensed ConsolidatingStatement of Cash Flows**

**For the Quarter Ended March 31, 2003**

 
|                                                         |   | **Parent  Company** |    | **Guarantor  Subsidiaries** |   | **Non-  Guarantor  Subsidiaries** |   | **Consolidating  Entries** |   | **Total** |   |
|--------------------------------------------------------------|--------|---------------------|---------|-----------------------------|--------|-----------------------------------|--------|----------------------------|--------|-----------|--------|
| Net cash provided by operating  activities                   |   | $                   | 105,022 |                        | $      | 10,022                            |   | $                          | 4,081  |      | $      | (3,823 | ) | $ | 115,302 |   |
| Cash flows from investing  activities:                       |   |                |    |                        |   |                              |   |                       |   |      |   |
| Purchases of property and equipment,  including acquisitions |   | (46,042             | )       | (10,471                     | )      | (707                              | )      | 144                        |   | (57,076   | )      |
| Proceeds from the disposition of property  and equipment     |   | 137                 |    | 48                          |   | —                            |   | (144                       | )      | 41        |   |
| Other net cash from investing  activities                    |   | 4,680               |    | —                      |   | (4,680                            | )      | —                     |   | —    |   |
| Net cash from investing  activities                          |   | (41,225             | )       | (10,423                     | )      | (5,387                            | )      | —                     |   | (57,035   | )      |
| Cash flows from financing  activities:                       |   |                |    |                        |   |                              |   |                       |   |      |   |
| Payments on revolving credit  facility                       |   | (391,800            | )       | —                      |   | —                            |   | —                     |   | (391,800  | )      |
| Borrowings under revolving credit  facility                  |   | 316,700             |    | —                      |   | —                            |   | —                     |   | 316,700   |   |
| Dividends paid                                               |   | (3,464              | )       | —                      |   | —                            |   | —                     |   | (3,464    | )      |
| Other net cash from financing  activities                    |   | 26,173              |    | —                      |   | —                            |   | —                     |   | 26,173    |   |
| Net cash used in financing  activities                       |   | (52,391             | )       | —                      |   | —                            |   | —                     |   | (52,391   | )      |
| Net increase in cash and cash  equivalents                   |   | 11,406              |    | (401                        | )      | (1,306                            | )      | (3,823                     | )      | 5,876     |   |
| Cash and cash equivalents at  beginning of year              |   | 7,138               |    | 128                         |   | 46                                |   | —                     |   | 7,312     |   |
| Cash and cash equivalents at  end of year                    |   | $                   | 18,544  |                        | $      | (273                              | )      | $                          | (1,260 | )         | $      | (3,823 | ) | $ | 13,188 |   |

 

***LEGALPROCEEDINGS***

 

***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. ***Asreported in our Form 10-K for the year ended December 31, 2003, in October2002,TheCompany is a defendant in litigation filed on June 30, 1997, along withover 300 natural gas companies in 72 separate actions filed by Mr. Grynberg onbehalf 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 31 U. S. C. 3729 (a) (7) of theFalse Claims Act.  The cases have been consolidatedto the United States District Court 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.  On October 9, 2002, the courtdismissed Mr. Grynberg’s valuation claims, and his appeal against this decisionwas also unsuccessful.  The Companybelieves that Mr. Grynberg’s remaining claims are baseless and without meritand intends to vigorously contest the allegations in this case.

 

***Price,et al. v. Gas Pipelines, Western Gas Resources, Inc., et al., District Court,Stevens County, Kansas, Case No. 99-C-30. ***As reported in our Form 10-K for the yearended December 31, 2003, the Company is a defendant in litigation filed on September 23,1999, along with numerous other natural gas companies, in which Mr. Price isclaiming an under measurement of gas and Btu volumes throughout thecountry.  The Company along with othernatural gas companies filed a motion to dismiss for failure to state a claim.  The court denied these motions todismiss.   The court denied plaintiff’smotion for certification as a class and, in the second quarter of 2003, theplaintiff amended and refiled for certification as a class.  On May 12, 2003, Mr. Price filed a furtherclaim, *Will Price et al v. Western GasResources, Inc. et al., District Court, Stevens County, Kansas, Case No. 03C23*,relating to certain matters previously removed from the foregoing action.  The Company believes that Mr. Price’s claimsare without merit and intends to vigorously contest the allegations in thiscase.

 

***In the Matter of the Appeal of Lance Oil& Gas Company from a Decision by the Department of Revenue, Docket No.2003-44, Before the State Board of Equalization for the State of Wyoming.**** *Asreported in our Form 10-K for the year ended December 31, 2003, the WyomingDepartment of Revenue has conducted an audit of our wholly-owned subsidiaryLance Oil & Gas Company, Inc. for the period from January 1, 1998 throughDecember 31, 1999.  On March 24, 2003,the Department of Revenue notified us that it had assessed additional severancetaxes and increased taxable value for ad valorem tax purposes.  The additional severance and ad valoremtaxes claimed by the Department of Revenue amount to $196,000 and $351,000,respectively, together with statutory interest.  On April 23, 2003, we filed a Notice of Appeal with the WyomingState Board of Equalization.  On April21, 2004, we reached a settlement with the Wyoming Department of Revenue forthe periods 1998 through 2003.  We haveaccrued a total of $617,000 in the first quarter of 2004 for this settlement.

 

***Price Reporting to Gas Trade Publications. *** As reported in our Form 10-K for the yearended December 31, 2003, in the third quarter of 2003, we learned that severalemployees in our marketing department furnished inaccurate informationregarding natural gas transactions to energy publications, which compile andreport energy index prices.  Wediscovered the inaccuracies during a review of our marketing activities, whichwas being conducted in response to a subpoena issued by the Commodity FuturesTrading Commission, or CFTC.  Theseemployees have identified inaccuracies associated with reporting of natural gastransactions primarily related to points in Texas.  We have discontinued the practice of reporting pricinginformation to the industry publications. In conjunction with our investigation into this matter, we released onemanager in our marketing department. The outcome of this matter and the amount of any fines to be assessed isuncertain.  Given the uncertaintysurrounding the amounts of any fines to be assessed, we have not accrued anyamounts related to this matter as of March 31, 2004.

 

***Other Litigation.**** * We are involved invarious other litigation and administrative proceedings arising in the normalcourse of business.  In the opinion ofour management, any liabilities that may result from these claims will not,individually or in the aggregate, have a material adverse effect on ourfinancial position, results of operations or cash flow.

 

***Retirement Plan.***  As reported in our Form 10-K for the yearended December 31, 2003, we provide a Retirement Plan for our present and pastemployees, or participants.  The purposeof the Retirement Plan is to provide a method for the participants to save towardstheir retirement.  Beginning in January1989, the participants were given the option to invest their contributions inthe Western Gas Fund.  The Western GasFund is comprised of shares of our common stock, purchased in the open marketby the trustee, Fidelity Management Trust Company, and short-term investments.A participant’s ownership in the Western Gas Fund is measured in Units ratherthan in shares of common stock.  Toeffectuate participant investment elections and therefore purchases and sales ofUnits, the trustee purchases and sells the common stock in the open market atmarket prices.

 

We arerequired to register the shares of our common stock purchased by the trustee ofthe Retirement Plan under the Securities Act. Although all the purchases by the trustee were made in the open marketand in a manner consistent with the Retirement Plan and the investmentelections of the participants, we have determined that approximately 467,000shares of our common stock purchased by the trustee beginning August 14, 2001and ending August 14, 2002 (the “Rescission Period”) may not have been properlyregistered in accordance with the Securities Act.  These shares were purchased at an average price of $31.92 pershare for total value of $14.9 million. As a result of this determination, we filed a registration statement onForm S-3 with the SEC providing for a rescission offer to certain of the planparticipants as described below.  Thisregistration statement was filed in April 2004 and has not been declared effectiveby the SEC.

 

Anyparticipant who elected to allocate a percentage of such participant’s funds inthe Retirement Plan to the purchase of Units in the Western Gas Fund at anytime during the Rescission Period, and who still holds those Units during theperiod of the rescission offer, may direct a sale of those Units to us at theprice the participant paid for the Units, plus interest.  This election would be beneficial to anyparticipant who purchased Units at a price higher than our stock price at theend of the period of the rescission offer. At March 31, 2004, our common stock price was $50.85 per share and theWestern Gas Fund held approximately 136,400 shares of our common stock.  The trustee of the Western Gas Fund sold theremaining 333,600 shares of our common stock acquired during the RescissionPeriod.  If a participant has alreadydirected and caused the sale of those Units purchased during the RescissionPeriod at a loss, then the trustee or the participant may receive from us, theprice paid for those Units, plus interest, less the sale proceeds.  This election would be beneficial to anyparticipant who sold Units at a loss.

 

While we are unable to estimatethe cost or results of the rescission offer, we do not expect the costs to havea material adverse effect on our financial position, results of operations orcash flows.   We also believe that theamounts subject to the rescission offer are immaterial for separateclassification on the Consolidated Balance Sheet at March 31, 2004 and at December31, 2003.

 

***Recently Issued Accounting Pronouncements.***

 

**SFASNo. 141 and SFAS No. 142. **SFASNo. 141, “Business Combinations” and SFAS No. 142*, “*Goodwill and Intangible Assets*”* were issued in June 2001 and became effective for theCompany on July 1, 2001 and January 1, 2002, respectively.  SFAS No. 141 requires companies todisaggregate and report separately from goodwill certain intangibleassets.  SFAS No. 142 establishes newguidelines for accounting for goodwill and other intangible assets.  Under SFAS No. 142, goodwill and certainother intangible assets are not amortized, but rather are reviewed annually forimpairment.  One interpretation beingconsidered relative to these standards is that oil and gas mineral rights heldunder lease and other contractual arrangements representing the right toextract such reserves for both undeveloped and developed leaseholds should beclassified separately from oil and gas properties, as intangible assets on theConsolidated Balance Sheet.  Inaddition, the disclosures required by SFAS No. 141 and No. 142 relative tointangibles would be included in the Notes to Consolidated FinancialStatements.  Historically, we haveincluded these oil and gas mineral rights held under lease and othercontractual arrangements representing the right to extract such reserves aspart of the Oil and gas properties and equipment, even after SFAS No. 141 andNo. 142 became effective.

 

If we appliedthe interpretation of SFAS No. 141 and No. 142 described above, only theConsolidated Balance Sheet classification of oil and gas leaseholds would beaffected.  Our results of operations andcash flows would not be affected, since these oil and gas mineral rights heldunder lease and other contractual arrangements representing the right toextract such reserves would continue to be amortized in accordance withaccounting rules for oil and gas companies provided in SFAS No. 19, “FinancialAccounting and Reporting by Oil and Gas Producing Companies.”

 

At March 31,2004, we had undeveloped leaseholds of $55.3 million that would be classifiedon the Consolidated Balance Sheet as “intangible undeveloped leaseholds” anddeveloped leaseholds of $33.1 million that would be classified as “intangibledeveloped leaseholds” if the interpretation currently being considered wasapplied.  We will continue to classifyour oil and gas mineral rights held under lease and other contractual rightsrepresenting the right to extract such reserves as tangible oil and gas propertiesuntil further guidance is provided.

 

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**FIN 46.**  In January 2003, the FASB issuedInterpretation No. 46, or “FIN 46”, “Consolidation of Variable InterestEntities.”  FIN 46, as amended by FIN46r, provides guidance on how to identify a variable interest entity, or VIE,and determine when the assets, liabilities, and results of operations of a VIEneed to be included in a company’s consolidated financial statements.  FIN 46 also requires additional disclosuresby primary beneficiaries and other significant variable interest holders in aVIE.  The provisions of FIN 46 wereeffective immediately for all VIEs created after January 31, 2003.  For VIEs created before February 1, 2003,the provisions of FIN 46, as amended, were effective on January 1, 2004.   After evaluating this accountingpronouncement and our operations, we determined that we did not have anyinterests in any VIEs, hence the adoption of FIN 46 did not have any impact onour financial position, results of operations or cash flows.

 

**EITF 01-08. **In January 2004, the Emerging Issues Task Forceissued EITF 01-08, “Determining Whether an Arrangement Contains a Lease.”  The task force reached final consensus thatassets, which are built to provide services to one specific customer, should beevaluated for potential treatment as capital leases.  We have entered into a binding agreement to construct and operatea new refrigeration straddle plant that will provide services to the owner ofan interstate pipeline.  This newfacility is expected to be operational in the fourth quarter of 2004.  We are evaluating this contract and theprovisions of EITF 01-08 to determine the appropriate accounting treatment.

 

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

 

The following discussionand analysis relates to factors that have affected our consolidated financialcondition and results of operations for the three months ended March 31, 2004and 2003.  Certain prior year amountshave been reclassified to conform to the presentation used in 2004.  You should also refer to our interimconsolidated financial statements and notes thereto included elsewhere in thisdocument.  This section, as well asother sections in this Form 10-Q, contain “forward-looking statements” withinthe meaning of the Private Securities Litigation Reform Act of 1995, which canbe identified by the use of forward-looking terminology, such as “may,” “intend,”“will,” “expect,” “anticipate,” “estimate,” or “continue” or the negativethereof or other variations thereon or comparable terminology.  In addition to the important factorsreferred to herein, numerous factors affecting the gas processing industry generallyand in the specific markets for gas and NGLs in which we operate could causeactual results to differ materially from those in such forward-lookingstatements.

 

***CompanyOverview***

 

***Business Strategy***—Maximizing the value of our existing core assets is the focal point of ourbusiness strategy.   Our core assets areour fully integrated upstream and midstream assets in the Powder River andGreater Green River Basins in Wyoming and Colorado and our midstream operationsin west Texas, Oklahoma and New Mexico. Our long-term business plan is to increase stockholder value by: (i)doubling proven reserves and equity production of natural gas from the levelsachieved in 2001 over a five year period; (ii) meeting or exceeding throughputprojections in our midstream operations; and (iii) optimizing annual returns.

 

***Industry and CompanyOverview—***In North America, our industry hasexperienced several consecutive years of declining natural gas production.  Most of the major gas producing areas, suchas the Gulf of Mexico, are mature and are in production decline.  We are concentrating our efforts in theRocky Mountain gas producing basins where there are estimated to be largequantities 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 futureproduction growth with a large inventory of undeveloped drilling locations inthe Powder River and Greater Green River Basins to meet the growing demand forclean burning natural gas.  In addition,our experience and technical expertise position us to acquire new opportunitiesto develop natural gas in the Rocky Mountain region.  Our challenges will be to accomplish these goals with thedifficulties encountered by the industry in obtaining the necessary permitsfrom the BLM.  We believe that ourtechnical expertise in developing environmentally responsible solutions to theproblems encountered in the development of gas reserves will be a competitiveadvantage in overcoming these challenges.

 

Our operations are conducted through the following four businesssegments:

 

***Upstream***—Weexplore for, develop and produce natural gas reserves independently and toenhance and support our existing gathering and processing operations. Ourproducing properties are primarily located in the Powder River and GreaterGreen River Basins of Wyoming.  Theseplays are low-risk, long-lived development projects.  These provide us with the opportunity to steadily increase ourproduction volume at low operating and finding and development costs.  In the first quarter of 2004 our averageproduction was 145 MMcfe per day, or a decrease of 2 MMcfe per day as comparedto the same period in 2003.   Operatingincome in this segment remained relatively constant at approximately $33.1million in the first quarter of 2004 compared to the same period in 2003.

 

We are actively seeking to add additional upstream core projects thatare focused on Rocky Mountain natural gas.  We will utilize our expertise in exploration and low-risk development oftight-gas sands, coal bed methane and fractured shale plays to evaluateacquisitions of either additional leaseholds, proven and undeveloped reservesor companies with operations focused in the Rockies.  Toward this goal, through March 31, 2004, we have acquired thedrilling rights on approximately 370,000 net acres, in other Rocky Mountainbasins and continue to expand our leasehold positions.

 

***Gathering,Processing and Treating***—Our core operations are inwell-established areas such as the Permian, Anadarko, Powder River, GreaterGreen River, and San Juan Basins.  Weconnect natural gas from gas and oil wells to our gathering systems fordelivery to our processing or treating plants under long-term contracts. At ourplants we process natural gas to extract NGLs and treat natural gas in order tomeet pipeline specifications. We provide these services to major oil and gascompanies, to independent producers of various sizes and for our ownproduction.  We

 

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believe that our low cost of operations, our high on-line time, and oursafety records are key elements in our ability to compete effectively andprovide service to our customers.  Ourexpertise in gathering, processing and treating operations can enhance theeconomics of developing new upstream projects.

 

This segment of our operations has provided a stream of operatingprofit that is available for reinvestment into other projects or other segmentsof our business.  In the first quarterof 2004, we realized operating profit from this segment of $37.7 million, whichis an 18% increase from the same period in 2003.  This segment benefited from higher realized prices and improvedcontract terms on gas gathered in the Powder River Basin.  Overall throughput in our facilities duringthe first quarter of 2004 has remained relatively constant as compared to thefirst quarter of 2003 and averaged a total of 1.3 Bcf per day.

 

***Transportation***—In the Powder River Basin, we own one interstate pipeline, MIGC, Inc., and oneintrastate pipeline, MGTC, Inc., which transport natural gas for producers and energymarketers under fee schedules regulated by state or federal agencies.  In the first quarter of 2004, we realizedoperating profit from this segment of $2.4 million, which is a 41% decreasefrom the same period in 2003.  Thedecrease in profit in this segment is due to lower interruptible transportationvolume in 2004 as more gas was transported out of the basin through otherpipelines.

 

***Marketing***—Ourgas marketing segment is an outgrowth of our gas processing and upstreamactivities.  One of the primary goals ofour gas marketing operations is the preservation and enhancement of the valuereceived for our equity volumes of natural 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.  We also buy and sell naturalgas and NGLs in the wholesale market in the United States and in Canada.  These third-party sales, our firm transportationcapacity on interstate pipelines and our gas storage positions, combined withthe stable supply of gas from our facilities and production, enable us torespond quickly to changing market conditions and to take advantage of seasonalprice variations and peak demand periods.

 

In the first quarter of 2004, we realized operating profit from thissegment of $3.0 million, which is an 80% decrease from the first quarter of2003.  The decrease in operating profit is primarily due to lower profitability ontransactions associated with our firm transportation capacity from the RockyMountain region to the Mid-Continent. Our firm transportation allows us to purchase gas in the Rocky Mountainregion for resale in the higher priced Mid-Continent markets.  New transportation capacity added in thesecond quarter of 2003 out of the Rocky Mountain region has resulted in adecrease in the difference between the prices for natural gas received in thisregion compared to the prices received in the Mid-Continent marketing area.

 

***RESULTS OF OPERATIONS***

 

**Three months ended March 31, 2004 compared tothe three months ended March 31, 2003**

**(Dollars in thousands, except per shareamounts and operating data).**

 
|                                       |   | **Three  Months Ended  March 31,** |    | **Percent  Change** |   |
|--------------------------------------------|--------|------------------------------------|---------|---------------------|--------|
|                                       |   | **2004**                           |    | **2003**            |   |   |
|                                       |   |                               |    |                |   |   |   |
| **Financial results:**                     |   |                               |    |                |   |   |   |
| Revenues                                   |   | $                                  | 771,216 |                | $      | 888,106 |   | (13 | ) |
| Gross profit                               |   | 54,130                             |    | 65,490              |   | (17 | ) |
| Net income                                 |   | 29,088                             |    | 23,375              |   | 24 |   |
| Earnings per share of common stock         |   | 0.83                               |    | 0.65                |   | 28 |   |
| Earnings per share of common stock-diluted |   | 0.79                               |    | 0.63                |   | 25 |   |
| Net cash provided by operating activities  |   | 137,101                            |    | 115,302             |   | 19 |   |
| Net cash used in investing activities      |   | (36,640                            | )       | (57,035             | )      | (36 | ) |
| Net cash used in financing activities      |   | $                                  | (94,810 | )                   | $      | (52,391 | ) | 81 |   |
|                                       |   |                               |    |                |   |   |   |
| **Operating data:**                        |   |                               |    |                |   |   |   |
| Average gas sales (MMcf/D)                 |   | 1,367                              |    | 1,593               |   | (14 | ) |
| Average NGL sales (MGal/D)                 |   | 1,611                              |    | 1,655               |   | (3 | ) |
| Average gas prices ($/Mcf)                 |   | $                                  | 5.32    |                | $      | 5.53 |   | (4 | ) |
| Average NGL prices ($/Gal)                 |   | $                                  | 0.63    |                | $      | 0.62 |   | 2 |   |

 

Net income increased $5.7 million for the three months ended March 31,2004 compared to the same period in 2003. The increase in net income was primarily attributable to the offsettingeffects of a change in accounting

 

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principle in each of the quarters ended March 31, 2004 and 2003.  Effective as of January 1, 2004, we revisedour depreciation and depletion methodology for our oil and gas properties.  This change in accounting principle resultedin a cumulative reduction of depreciation for periods prior to 2004 of $4.7million, net of tax, in the quarter ended March 31, 2004.  Effective as of January 1, 2003, we adoptedSFAS No. 143, “Accounting for Asset Retirement Obligations. “  The adoption of this accounting principleresulted in a cumulative $6.7 million after-tax loss in the first quarter of2003.  Excluding the impact of the changes inaccounting principles, income in the quarter ended March 31, 2004 was $5.7million less than the same period in 2003. This decrease in net income in the first quarter of 2004 was primarily theresult of a pre-tax $11.8 million reduction in operating income from ourmarketing operations which was primarily due to a reduction in pricedifferentials between the Rocky Mountain and Mid Continent regions.

 

Revenues from the sale of gas decreased $128.1 million to $665.2million for the three months ended March 31, 2004 compared to the same periodin 2003.  This decrease was primarilydue to a decrease in product prices and a decrease in sales volume in the threemonths ended March 31, 2004.  Averagegas prices realized by us decreased $0.21 per Mcf to $5.32 per Mcf for thequarter ended March 31, 2004 compared to the same period in 2003.  Included in the realized gas price wereapproximately $1.6 million of gains recognized in the three months ended March31, 2004 related to futures positions on equity gas volumes.  We have entered into additional futurespositions for approximately half of our equity gas for the remainder of2004.  See further discussion in “Item3. Quantitative and Qualitative Disclosures About Market Risk”.  Average gas sales volumes decreased by 14%to 1,367 MMcf per day for the quarter ended March 31, 2004 compared to the sameperiod in 2003.  This decrease was dueto a reduction in third party sales volume resulting from the increase inproduct prices and related credit exposure.

 

Revenues from the sale of NGLs increased $866,000 to $92.9 million forthe three months ended March 31, 2004 compared to the same period in 2003.  This increase is primarily due to anincrease in product prices.  Average NGLprices realized by us increased $0.01 per gallon to $0.63 per gallon for thethree months ended March 31, 2004 compared to the same period in 2003.  Included in the realized NGL price wereapproximately $2.4 million of losses recognized in the three months ended March31, 2004 related to futures positions on equity NGL volumes.  We have entered into additional futurespositions for approximately 45% of our equity NGL production for the remainderof 2004.  See further discussion in“Item 3. Quantitative and Qualitative Disclosures About Market Risk”.  Average NGL sales volumes remainedrelatively constant at 1,611 MGal per day for the three months ended March 31,2004 compared to the same period in 2003.

 

Product purchases decreased by $114.3 million for the quarter endedMarch 31, 2004 compared to the same period in 2003 as a result of the reductionin third party sales volume.  Overall,combined product purchases as a percentage of sales of all products remainedconstant at 87% in the first quarter of 2004 as compared to the first quarterof 2003.

 

Oil and gas exploration and production expenses increased by $4.6million for the three months ended March 31, 2004 compared to the same periodin 2003.  This increase wassubstantially due to increased lease operating expenses, or LOE, in the PowderRiver Basin coal bed development. Overall, LOE averaged $0.64 per Mcf for the three months ended March 31,2004 and LOE in the Powder River Basin coal bed development averaged $0.79 perMcf for the three months ended March 31, 2004. These represent increases of $0.28 and $0.39 per Mcf from the sameperiods in 2003.  The increases in LOEare substantially due to higher water handling charges, contract labor, andfuel and operating costs of wellhead blowers.  We believe that LOE will decrease in the remaining quarters of 2004 andwill average approximately $0.62 per Mcf in 2004.

 

##### ***Depreciation,depletion and amortization increased by $4.5 million for the three months endedMarch 31, 2004 as compared to the same period in 2003.  This increase is the result of additionalcapital expenditures and depreciation and depletion on our oil and gasassets.  Effective January 1, 2004, weredefined the asset groupings for the calculation of depreciation and depletionon our oil and gas properties from a well-by-well basis to a field wide basisfor each of the Jonah, Pinedale and Sand Wash fields and to a grouping of allwells drilled into related coal seams for the Powder River Basin. This changeresulted in an increase in Depreciation, depletion and amortization expense of$310,000 in the first quarter of 2004.***

##### *** ***

##### ***Thechange in the depreciation and depletion methodology is treated as a change inaccounting principle.  Accordingly, theAccumulated depreciation depletion and amortization for these assets has beenrecalculated under the new methodology. The cumulative effect of the change in depreciation and depletionmethodology of $4.7 million, net of tax, is presented in the ConsolidatedStatement of Operations under the caption Cumulative effect of changes inaccounting principles, net of tax.***

##### *** ***

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***Cash FlowInformation***

 

Cash flows from operatingactivities increased by $21.8 million in the first quarter of 2004 compared tothe first quarter of 2003. This increase was primarily due to an increase innet income in the first quarter of 2004 compared to the prior year and thetiming of cash receipts and payables.

 

Cash flows used in investingactivities decreased by $20.4 million in the first quarter of 2004 compared tothe first quarter of 2003.  Thisincrease was primarily due to a lower level of capital expenditures.

 

Cash flows used in financingactivities increased by $42.4 million in the first quarter of 2004 compared tothe first quarter of 2003.  This increasewas due to increased cash flows from operating activities, which were used toreduce our long-term debt.

 

***Segment Information***

 

***Gas Gathering, Processing and Treating.***  The Gas Gathering, Processing and Treatingsegment realized segment-operating profit of $37.7 million for the three monthsended March 31, 2004 as compared to $32.0 million in the same period in2003.  The increase in operating profitin this segment in the 2004 period is primarily due to higher realized pricesand improved contractual terms on gas gathered in the Powder River Basin.

 

***Exploration and Production.***  The Exploration and Production segmentrealized segment-operating profit of $33.1 million for the three months endedMarch 31, 2004 compared to $33.4 million in the same period of 2003. The slightdecrease is primarily due to a minor decrease in production volume sold and anincrease in LOE, which were substantially offset by an improvement in realizedprices.

 

***Marketing.***  The Marketing segment realizedsegment-operating profit of $3.0 million for the three months ended March 31,2004 compared to $14.8 million in the same period of 2003.  Thedecrease in the marketing margin is primarily due to transactions associatedwith our firm transportation capacity from the Rocky Mountain region to theMid-Continent.  Our firm transportationallows us to purchase gas in the Rocky Mountain region for resale in the higherpriced Mid-Continent markets.  In thesecond quarter of 2003, additional transportation capacity out of the RockyMountain region became operational, which reduced the price difference betweenthe two regions.  We expect that thereduced margins will continue in future periods.

 

***Transportation.***  The Transportation segment realizedsegment-operating profit of $2.4 million for the three months ended March 31,2004 compared to $4.1 million in the same period of 2003.  The transportation segment includes theresults from the MIGC and MGTC pipelines in the Powder River Basin.  The decrease in profit in this segment isdue to lower interruptible transportation volume in 2003 as more gas wastransported out of the basin through other pipelines.

 

#### **Critical Accounting Estimates**

#### ** **

Theapplication of accounting policies is an important process that has developedas our business activities have evolved and as accounting rules havedeveloped.   Accounting rules generallydo not involve a selection among alternatives, but involve an interpretationand implementation of existing rules, and the use of judgment, to the specificset of circumstances existing in our business. We make every effort to properly comply with all applicable rules on orbefore their adoption, and we believe the proper implementation and consistentapplication of the accounting rules is critical.

 

***Use of Estimates. ***The preparation of consolidatedfinancial statements in conformity with generally accepted accountingprinciples requires us to make estimates and assumptions that affect theamounts reported for assets and liabilities, the disclosure of contingentassets and liabilities at the date of the financial statements, and the amountsreported for revenues and expenses during the reporting period.  These estimates are evaluated on an ongoingbasis, utilizing historical experience, consultation with experts and othermethods considered reasonable in the particular circumstances.  However, actual results may differsignificantly from the estimates used. Any effects on our business, financial position or results of operationsresulting from revisions to these estimates will be recorded in the

 

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period inwhich the facts that necessitate a revision become known.  Although there are a number of areas wherewe use estimates, what we believe to be the most significant ones are discussedbelow.

 

***Property and Equipment. *** Depreciation on our property and equipment isprovided using the straight-line method based on the estimated useful life ofeach facility, which ranges from three to 35 years.  Useful lives are determined based on the shorter of our estimateof the life of the equipment or our estimate of the reserves serviced by theequipment.  Among other factors, theestimates consider our experience with similar assets and technical analysis ofthe reserves.  The cost of acquired gaspurchase contracts is amortized using the straight-line method or units ofproduction.  If the actual lives of theequipment or the reserves serviced by the equipment were less than weoriginally estimated, we may be required to record a loss upon retirement of aspecific asset.

 

***Oil and Gas Reserves, Properties andEquipment. *** We follow the successful efforts method ofaccounting for oil and gas exploration and production activities.  Producing properties and related equipmentare depleted and depreciated by the units-of-production method based onestimated proved reserves.  The units ofproduction method is sensitive to the determination of proved reserves and tothe grouping of assets.  To the extentthe reserves or asset groupings are modified, the depletion determined underthe units of production method will be increased or decreased.

 

In the fourthquarter of 2003, we conducted a review of our oil and gas producing properties,which included an evaluation of the geologic formations and production historyfor these oil and gas properties.  Inthe Powder River Basin this review indicated that the cash flows fromindividual wells in our operating areas are interdependent with the cash flowsof other wells producing in the same coal seam.  As these wells continue to produce, it has become more apparentthat certain wells will produce a disproportionate amount of water, while otherwells in the same coal seam will produce a disproportionate amount of gas.  In addition in the Powder River Basin, weare utilizing shared infrastructure including water-handling methods, whichservice large groups of existing and future wells.  Our approaches to water handling meet the requirements of theBLM’s permitting process, which emphasizes a full field development minimizingsurface disturbances and the impact to the environment.

 

In our otheroperating areas, increased well density will cause an acceleration ofproduction and we are investing more capital in shared infrastructure,including but not limited to surface facilities, roads and gatheringlines.  In all of our operating areas,we continue to focus on a full field development plan to minimize surfacedisturbances and environmental impact, while maximizing capital efficiency.

 

Accordingly,effective January 1, 2004, we redefined the depreciation and depletionmethodology for the calculation of depreciation and depletion from awell-by-well basis to a grouping of all wells drilled into related coal seamsfor the Powder River Basin and a field wide basis for each of the Jonah,Pinedale and Sand Wash fields.

 

Our reserveestimates are subject to numerous uncertainties inherent in the estimation ofquantities of proved reserves, the projection of future rates of production andthe timing of development expenditures. The accuracy of these estimates is a function of the quality ofavailable data and of engineering and geological interpretation and judgment.Reserve estimates are imprecise and should be expected to change as additionalinformation becomes available.  Estimatesof economically recoverable reserves and of future net cash flows prepared bydifferent engineers or by the same engineers at different times may varysubstantially.  Results of subsequentdrilling, testing and production may cause either upward or downward revisionsof previous estimates.  In addition, theestimates of future net revenues from our proved reserves and the present valueof those reserves are based upon certain assumptions about production levels,prices and costs, which may not be correct. Further, the volumes considered to be commercially recoverable fluctuatewith changes in prices and operating costs. The meaningfulness of suchestimates is highly dependent upon the accuracy of the assumptions upon whichthey were based.  Actual results maydiffer materially from the results estimated.

 

***Asset Retirement Obligations.***  We use significant judgment in estimatingour future liability for asset retirement. We evaluate each asset and in some cases individual components of assetsto determine and estimate the future cost and timing of retiring thoseassets.  The estimate of the future costis then discounted back to the present and recorded as a liability.  This liability will vary based upon theprobability, timing and the extent of remediation necessary to reclaim thosefacilities, the discount factor used in those determinations and the projectedcosts of the remediation.  We evaluatethese estimates on an ongoing basis and modify our assumptions as appropriate.

 

***Impairment of Long-Lived Assets.*** If changes in the expected performance of anasset occur, or if overall economic conditions warrant, we will review ourassets to determine their economic viability. In accordance with

 

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SFAS No. 144 “Accountingfor the Impairment or Disposal of Long Lived Assets”, assets are to beevaluated at the lowest level for which identifiable cash flows are largelyindependent of the cash flows of other assets.   Accordingly, our review is completed at the plant facility, therelated group of plant facilities or the oil and gas producing field orproducing coal seam level.  In order todetermine whether an impairment exists, we compare the net book value of the assetto the estimated fair market value or the undiscounted expected future net cashflows, determined by applying future prices estimated by management over theshorter of the lives of the facilities or the associated reserves.  If an impairment exists, write-downs ofassets are based upon expected future net cash flows discounted using aninterest rate commensurate with the risk associated with the underlyingasset.  This analysis is sensitive to,among other things; management’s expectation of commodity prices, operatingcosts, drilling plans, production rates and the evaluation in determining assetgroupings for which cash flows are largely independent of the cash flows ofother assets.

 

***Identification of Derivatives and Mark toMarket Valuations****. *The determination of whichcontractual instruments meet the definition of a derivative under accountingrules is subject to differing interpretations as is the valuation of thosederivatives.  Management uses itsjudgment to analyze all contracts to determine whether or not they qualify asderivatives and to determine their value. A specific area in which management’s judgment is required includesidentifying contracts meeting the criteria for exclusions from derivativestreatment, market liquidity, and market valuation.   This analysis is sensitive to commodity prices, outside marketfactors and management’s intent upon entering into these contracts.

 

***Recently Issued Accounting Pronouncements.***  We continually monitor and revise ouraccounting policies as new rules are issued. Following are several new accounting pronouncements that have beenissued, which either have been adopted in the first quarter of 2004, or whichupon adoption may have an impact on our accounting. See Notes to ConsolidatedFinancial Statements (unaudited) in Item 1 of this Form 10-Q for a detaileddescription of recently issued accounting pronouncements.

 

 

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#### **Liquidityand Capital Resources**

#### ** **

Our sources ofliquidity and capital resources historically have been net cash provided by operatingactivities, funds available under our financing facilities and proceeds fromofferings of debt and equity securities. In the past, these sources have been sufficient to meet our needs andfinance the growth of our business.  Wecan give no assurance that the historical sources of liquidity and capitalresources will be available for future development and acquisition projects,and we may be required to seek additional or alternative financingsources.  Product prices, hedges ofequity production, sales of inventory, the volumes of natural gas processed byour facilities, the volume of natural gas produced from our producingproperties, the margin on third-party product purchased for resale, as well asthe timely collection of our receivables are all expected to have significantinfluences on our future net cash provided by operating activities.  Additionally, our future growth will bedependent upon obtaining additions to dedicated plant reserves, acquisitions,new project development, marketing results, efficient operation of ourfacilities and our ability to obtain financing at favorable terms.

 

During thepast several years, we have been successful in developing additional reservesof natural gas and increasing our equity natural gas production.  However, the overall level of drilling andproduction associated with our producing properties will depend upon, amongother factors, the price for gas, availability of transportation capacity tomarket centers, the energy and environmental policy and regulation bygovernmental agencies, and the issuance of drilling and water disposal permits,none of which is entirely within our control. Any reduction in the levels of exploration, development and productionby us or a significant reduction in natural gas prices could have a materialadverse effect on our financial condition, results of operations and cashflows.

 

Although someof our plants have experienced natural declines in dedicated reserves, overallwe have been successful in connecting additional reserves to more than offsetthese declines.  However, the overalllevel of drilling associated with our plant facilities will depend upon, amongother factors, the prices for oil and gas, the drilling budgets of third-partyproducers, availability of transportation capacity to market centers, theenergy and environmental policy and regulation by governmental agencies, thepace at which drilling permits are received, and the availability of foreignoil and gas, 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 reductionin prices for natural gas and NGLs may depress the levels of exploration, developmentand production by third-parties.  Lowerlevels of these activities could result in a corresponding decline in thedemand for our gathering, processing and treating services.  A reduction in any of these activities couldhave a material adverse effect on our financial condition, results ofoperations and cash flows.

 

We believethat the amounts available to be borrowed under the revolving credit facility,together with net cash provided by operating activities, will provide us withsufficient funds to connect new reserves, maintain our existing facilities andcomplete our current capital expenditure program.  Depending on the timing and the amount of our future projects, wemay be required to seek additional sources of capital.  Our ability to secure such capital isrestricted by our financing facilities, although we may request additionalborrowing capacity from our lenders, seek waivers from our lenders to permit usto borrow funds from third-parties, seek replacement financing facilities fromother lenders, use stock as a currency for acquisitions, sell existing assetsor use a combination of alternatives. While we believe that we would be able to secure additional financing,if required, we can provide no assurance that we will be able to do so or as tothe terms of any additional financing.

 

We believethat cash provided by operating activities and amounts available under therevolving credit facility will be sufficient to meet scheduled principalrepayments during 2004 of $35.0 million under the master shelf agreement.

 

We have effectiveshelf registration statements filed with the SEC for an aggregate of $200million of debt securities and preferred stock, along with the shares of commonstock, if any, into which those securities are

 

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convertible, and $62 million of debt securities, preferred stock orcommon stock.  These shelf registrationsallow us to access the debt and equity markets.

 

***Preferred StockRedemption.*** In December 2003, we issued a notice of redemption for a total of 800,000shares of our $2.625 cumulative convertible preferred stock.  The holders of these shares had the right toconvert them into shares of our common stock in lieu of receiving theredemption price in cash.   In January2004, we issued an additional 989,622 shares of common stock to holders whoelected to convert their shares and paid $672,000 in cash proceeds to completethis redemption.   In March 2004, weissued an additional notice of redemption for the remaining 1,260,000 shares ofour $2.625 cumulative convertible preferred stock.  In April 2004, we issued an additional 1,556,791 shares of commonstock to holders who elected to convert their shares and paid $391,000 in cashproceeds to complete this redemption. After the redemption, the $2.625 cumulative convertible preferred stockwas delisted from trading on the New York Stock Exchange and application wasmade to the SEC to deregister such stock.

 

***Sources and Uses of Funds*.**  Our sources and uses of funds for the threemonths ended March 31, 2004 are summarized as follows (dollars in thousands):

 

| **Sources of funds:**                                            |   |    |    |
|------------------------------------------------------------------|--------|---------|---------|
| Borrowings under the revolving credit  facility                  |   | $       | 260,850 |   |
| Proceeds from the dispositions of property  and equipment        |   | 315     |    |
| Net cash provided by operating activities                        |   | 137,101 |    |
| Proceeds from exercise of common stock  options                  |   | 2,918   |    |
| Total sources of funds                                           |   | $       | 401,184 |   |
| **Uses of funds:**                                               |   |    |    |
| Payments related to long-term debt  (including debt issue costs) |   | $       | 354,850 |   |
| Capital expenditures                                             |   | 36,955  |    |
| Redemption of $2.625 cumulative convertible  preferred stock     |   | 672     |    |
| Preferred dividends paid                                         |   | 1,349   |    |
| Common dividends paid                                            |   | 1,707   |    |
| Total uses of funds                                              |   | $       | 395,533 |   |

 

***Capital Investment Program.***  We currently anticipate capital expendituresin 2004 of approximately $246.2 million. Overall, capital expenditures in the Powder River Basin CBM developmentand in southwest Wyoming operations represent approximately 42% and 40%,respectively, of the total 2004 budget. Due to drilling and regulatory uncertainties that are beyond ourcontrol, we can make no assurance that our capital budget for 2004 will notchange.  This budget may be increased toprovide for acquisitions if approved by our board of directors.

 

The 2004capital budget and our capital expenditures during the three months ended March31, 2004 are presented in the following table (dollars in thousands). 

 
| **Type of Capital Expenditure**                              |   | **2004  Capital  Budget** |   | **Amount  Spent During  the Quarter Ended  March 31, 2004** |   |
|--------------------------------------------------------------|--------|---------------------------|--------|-------------------------------------------------------------|--------|
| Gathering, processing, treating and  pipeline assets         |   | $                         | 99.7   | *                                                           | $      | 16.6 | * |
| Exploration and production and lease  acquisition activities |   | 135.7                     |   | 18.4                                                        |   |
| Information technology and other items                       |   | 3.0                       |   | .7                                                          |   |
| Capitalized interest and overhead                            |   | 7.8                       |   | 1.3                                                         |   |
| Total Capital Expenditures                                   |   | $                         | 246.2  |                                                        | $      | 37.0 |   |

##### *** ***

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* Includes $13.6 million in 2004and $1.8 million in the first quarter of 2004 for maintaining existingfacilities.

 

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***ContractualCommitments and Obligations***

 

##### ***Contractual CashObligations. ***A summary of our contractual cash obligations as ofMarch 31, 2004 is as follows (dollars in thousands): 

 
|                                                   |   |                  |    | **Payments  by Period** |   |
|--------------------------------------------------------|--------|-----------------------|---------|-------------------------|--------|
| **Type of Obligation**                                 |   | **Total  Obligation** |    | **Due in  2004**        |   | **Due in  2005 – 2006** |   | **Due in  2007 – 2008** |   | **Due  Thereafter** |   |
| Guarantee of Fort Union Project Financing              |   | $                     | 5,351   |                    | $      | 608 |   | $ | 1,795 |   | $ | 2,081 |   | $ | 867 |   |
| Operating Leases                                       |   | 74,761                |    | 9,893                   |   | 27,050 |   | 23,342 |   | 14,476 |   |
| Firm  Transportation Capacity and Gathering Agreements |   | 201,618               |    | 21,665                  |   | 54,450 |   | 50,651 |   | 74,852 |   |
| Firm Storage Capacity Agreements                       |   | 21,753                |    | 6,067                   |   | 9,921 |   | 3,126 |   | 2,639 |   |
| Long-term Debt                                         |   | 245,000               |    | 35,000                  |   | 20,000 |   | 35,000 |   | 155,000 |   |
| Total Contractual Cash Obligations                     |   | $                     | 548,483 |                    | $      | 73,233 |   | $ | 113,216 |   | $ | 114,200 |   | $ | 247,834 |   |

 

***Guarantee of FortUnion Project Financing.***   We own a 13% equity interest in Fort Union Gas Gathering,L.L.C., or Fort Union, and are the construction manager and fieldoperator.  Fort Union gathers and treatsnatural gas in the Powder River Basin in northeast Wyoming.  Initial construction and any expansions ofthe gathering header and treating system have been project financed by FortUnion.  This debt is amortizing on anannual basis and is scheduled to be fully paid in 2009.  All participants in Fort Union haveguaranteed Fort Union’s payment of the project financing on a proportionalbasis, resulting in our guarantee of $5.4 million of the debt of Fort Union atMarch 31, 2004.  Our requirement to fundunder this guarantee would be reduced by the value of assets held by FortUnion.  This guarantee is not reflectedon our Consolidated Balance Sheet.

 

***OperatingLeases. ***Inthe ordinary course of our business operations, we enter into operating leasesfor office space, office equipment, communication equipment and transportationequipment.  In addition, we have enteredinto operating leases for compression equipment.   Payments made on these leases are a component of operatingexpenses and are reflected on the Consolidated Statement of Operations and, asoperating leases, are not reflected on our Consolidated Balance Sheet.  These leases have terms ranging from onemonth to ten years with return or fair market purchase options available atvarious times during the lease.   If wewere to exercise the purchase options on all the leased equipment, thesepurchase options would require the capital expenditure of approximately $37.4million between 2007 and 2012.

 

***Firm TransportationCapacity and Gathering Agreements.***  Access to firm transportation is alsoa significant element of our business strategy.  Firm transportation ensures that our equity production has accessto downstream markets and allows us to capture incremental profit in ourmarketing segment when pricing differentials between physical locationsoccur.  As of March 31, 2004, we hadcontracts for approximately 566 MMcf per day of firm transportation.  This amount represents our total contractedamount on many individual pipelines.  Inmany cases it is necessary to utilize sequential pipelines to deliver gas intoa specific sales market. In total, we have the capacity to transport 172 MMcfper day of gas from the Rocky Mountain area to the Mid-Continent.  This utilizes a total of approximately 376MMcf per day of firm capacity on three separate pipelines.   The total rate under these long-termcontracts to transport this gas to the Mid-Continent from the southern PowderRiver Basin approximates $0.35 per Mcf. Our remaining firm capacity consists of 110 MMcf per day to marketswithin the Rocky Mountains and 80 MMcf per day contracted in various othermarkets throughout the country.  Inaddition, we hold 83 MMcf per day of firm gathering capacity on the Fort Uniongathering line.  These agreements arenot reflected on our Consolidated Balance Sheet.

 

The fixed fees associated with our existing contracts for firmtransportation capacity during 2004 will average approximately $0.15 per Mcfper day.  The associated contractperiods range from seven months to thirteen years.  Under firm transportation contracts, we are required to pay thefees associated with these contracts whether or not the transportation is used.

 

***Firm StorageCapacity Agreements*.**  We customarily store gas inunderground storage facilities to ensure an adequate supply for long-term salescontracts and to capture seasonal price differentials.  As of March 31, 2004, we

 

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hadcontracts in place for approximately 16.1 Bcf of storage capacity at variousthird-party facilities.  Of the totalstorage capacity under contract, approximately 8.0 Bcf is under contract to ourCanadian subsidiary, WGR Canada, Inc., and Western guarantees the subsidiary’sperformance under these contracts.  Thissubsidiary is wholly owned by us and fully consolidated in our financialstatements.

 

The feesassociated with these contracts in 2004 will average $0.51 per Mcf of annualcapacity.  The associated contractperiods at March 31, 2004 have an average term of thirty months.  At March 31, 2004, we held gas in ourcontracted storage facilities and in pipeline imbalances of approximately 4.9Bcf at an average cost of $5.03 per Mcf compared to 4.4 Bcf at an average cost of $2.56per Mcf atMarch 31, 2003.  These positions are forstorage withdrawals within the next fourteen months.  At the time we place product into storage, we contract for thesale of that product, physically or financially, and do not speculate on thefuture value of the product.  Theseagreements for storage capacity are not reflected on our Consolidated BalanceSheet.

 

From time to time, we lease NGL storage space at major trading locationsto facilitate the distribution of products. At March 31, 2004, we held NGLs instorage at various third-party facilities of 2,863 MGal, consisting primarilyof propane and ethane, at an average cost of $0.30 per gallon compared to 2,772MGal at an average cost of $0.27 per gallon at March 31, 2003.  These agreements for storage capacity arenot reflected on our Consolidated Balance Sheet.

 

#### **Long-term Debt**

#### ** **

***Revolving CreditFacility. ***AtMarch 31, 2004, no amounts were outstanding under our existing four-year, $300million revolving credit facility.  Thisfacility matures in April 2007.  Loansmade under this facility are secured by a pledge of the capital stock of oursignificant subsidiaries.  Thesesubsidiaries also guarantee the borrowings under the facility.  The facility contains a provision thatrequires us to secure loans under the facility with 75% of our oil and gasreserves.  This provision would only betriggered in the event of a reduction to a debt rating on the revolving creditfacility of Ba3 or lower by Moody’s Investors Service, Inc., or Moody’s, or thereduction to a debt rating on the revolving credit facility of BB- or lower byStandard & Poor’s Rating Services, a division of The McGraw-Hill Companies,Inc., or S&P.  This facility hasbeen rated Ba1 by Moody’s and BB+ by S&P.

 

The borrowings under the credit facility bear interest at Eurodollarrates or a base rate, as requested by us, plus an applicable percentage basedon our debt to capitalization ratio. The base rate is the agent’s published prime rate.  We also pay a quarterly facility fee rangingbetween 0.30% and 0.50%, depending on our debt to capitalization ratio.  This fee is paid on the total commitment.  At March 31, 2004, the interest rate payableon borrowings under this facility was approximately 2.7%.

 

Under the credit facility, we are subject to a number of covenants,including: maintaining a total debt to capitalization ratio of not more than55%; maintaining a senior debt to capitalization ratio of not more than 40%; andmaintaining a ratio of EBITDA, as defined in the credit facility, to interestand dividends on preferred stock over the last four quarters in excess of 3.75to 1.0, increasing to 4.25 to 1.0 at March 31, 2005.

 

The credit facility ranks equally with borrowings under our mastershelf agreement with The Prudential Insurance Company.

 

***Master ShelfAgreement. ***Amountsoutstanding under the master shelf agreement with The Prudential InsuranceCompany of America at March 31, 2004 are as indicated in the following table(dollars in thousands):

 
| **Issue Date**   |   | **Amount** |         | **Interest  Rate** |   | **Final  Maturity** |              | **Principal  Payment Schedule**                 |                       |
|------------------|--------|------------|--------------|--------------------|--------|---------------------|-------------------|-------------------------------------------------|----------------------------|
| October 27, 1994 |   | $          |  25,000 |               | 9.24   | %                   | October 27,  2004 |                                            | single payment at maturity |   |
| July 28, 1995    |   | 40,000     |         | 7.61               | %      | July 28,  2007      |              | $ 10,000 on  each of July 28, 2004 through 2007 |                       |
|             |   |       |         |               |   |                |              |                                            |                       |
|             |   |       |         |               |   |                |              |                                            |                       |
| January 17, 2003 |   | 25,000     |         | 6.36               | %      | January 17,  2008   |              | single  payment at maturity                     |                       |
|             |   | $          | 90,000       |               |   |                |              |                                            |                       |   |

 

Our borrowings under the master shelf agreement are secured by a pledgeof the capital stock of our significant subsidiaries, some of which have alsoprovided a guaranty of payments we owe under the facility.   The master shelf requires us to secureloans under the facility with 75% of our oil and gas reserves.  This provision would only be

 

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triggered in the event of a reduction to the debt rating on therevolving credit facility of Ba3 or lower by Moody’s or the reduction to thedebt rating on the revolving credit facility of BB- or lower by S&P.

 

Under our master shelf agreement, we are subject to a number ofcovenants, including: maintaining a minimum tangible net worth equal to the sumof $300 million plus 50% of consolidated net earnings earned from January 1,1999 plus 75% of the net proceeds of any equity offerings after January 1,1999; maintaining a total debt to capitalization ratio of not more than 55% anda senior debt to capitalization ratio of not more than 40%; maintaining aquarterly test of EBITDA, as defined in the master shelf agreement, to interestfor the last four quarters in excess of 3.75 to 1.0, increasing to 4.25 to 1.0at March 31, 2005; and maintaining a ratio of senior debt to EBITDA of nogreater than 4.0 to 1.0.

 

In 2004, we will make scheduled payments totaling $35.0 million on thisfacility.  We intend to fund theserepayments with funds available under the revolving credit facility.

 

***Senior SubordinatedNotes. ***In1999, we sold $155.0 million of senior subordinated notes in a privateplacement with a final maturity of 2009 due in a single payment which weresubsequently exchanged for registered publicly tradable notes under the sameterms and conditions.  The subordinatednotes bear interest at 10% per annum and were priced at 99.225% to yield10.125%.  These notes contain covenants,which include limitations on debt incurrence, restricted payments, liens andsales of assets.  The subordinated notesare unsecured and are guaranteed on a subordinated basis by our materialsubsidiaries.  We incurred approximately$5.0 million in offering commissions and expenses, which were capitalized andare being amortized over the term of the notes.  The senior subordinated notes are callable at our option, inwhole or in part, at 105% of par value beginning in June 2004 and are callableat decreasing premiums thereafter.  Ourability to call these notes may be restricted by the covenants under our otherdebt facilities.

 

***CovenantCompliance. ***Wewere in compliance with all covenants in our debt agreements at March 31, 2004.

 

#### **Upstream Operations**

#### ** **

A vital aspect of our long-term business plan is to double provenreserves and equity production of natural gas from the level at December 31,2001 over a five year period.  In orderto achieve this goal, we will continue to focus on continued development of ourleasehold positions in the Powder River CBM development and the Greater GreenRiver Basin.  Each of our existingupstream projects is fully integrated with our midstream operations.  In other words, we provide the gathering,compression, processing, marketing or transportation services for both our ownproduction and for third-party operators. Additionally, we are actively pursuing new exploration, development andproducing property acquisition opportunities.

 

#### **Our principal upstream operationsare summarized in the following table:**

 
| **Production Area**    |   | **Gross  Acres  Under Lease At  March 31, 2004** |   | **Net Acres  Under Lease At  March 31, 2004** |   | **Average  Net  Production for the  Quarter Ended  March 31, 2004*** |   | **Gross  Productive Gas  Wells at  March 31, 2004** |   | **Net  Productive  Gas Wells at  March 31, 2004** |   |
|------------------------|--------|--------------------------------------------------|--------|-----------------------------------------------|--------|----------------------------------------------------------------------|--------|-----------------------------------------------------|--------|---------------------------------------------------|--------|
| Powder River Basin CBM |   | 1,042,000                                        |   | 528,000                                       |   | 111 Mmcfe/day                                                        |   | 3,534                                               |   | 1,674                                             |   |
| Pinedale/Jonah Basin   |   | 177,000                                          |   | 30,000                                        |   | 27 Mmcfe/day                                                         |   | 154                                                 |   | 17                                                |   |
| Sand Wash Basin        |   | 185,000                                          |   | 158,000                                       |   | 7 Mmcfe/day                                                          |   | 17                                                  |   | 17                                                |   |
| Northeast Colorado     |   | 395,000                                          |   | 342,000                                       |   | —                                                               |   | —                                              |   | —                                            |   |
| Other                  |   | 29,000                                           |   | 28,000                                        |   | —                                                               |   | 10                                                  |   | 2                                                 |   |

 

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* Represents net productionsold.

 

***PowderRiver Basin Coal Bed Methane.  ***Wecontinue to develop our Powder River Basin CBM reserves and expand the associatedgathering system in northeast Wyoming. The Powder River Basin CBM area is currently one of the largest on-shoreplays for the development of natural gas in the United States.  Within this area, together with ourco-developer, we continue to be the largest producer of natural gas.  Additionally, Western is the largestgatherer of natural gas and, through our MIGC pipeline, we transport asignificant volume of gas out of this basin.

 

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The drilling operations in the Powder River Basin have been primarilyfocused on developing reserves in the Wyodak and related coals, which arelocated on the east side of the coal bed development.  Our net production from the Wyodak coal averaged 89.5 MMcfd inMarch 2004.  Overall, we believe theWyodak coals have reached their peak production and will gradually decline overthe next several years.

 

The majority of future development will be concentrated on developingthe Big George and related coal seams. Our net production from the Big George coal continues to increase and inMarch 2004 was over 19.9 MMcfd from the All Night Creek Unit, Pleasantville andKingsbury Unit development areas.  As ofMarch 2004, we had 424 Big George wells that are dewatering and producinggas.  An additional 198 Big George wellsare dewatering and 287 Big George wells have been drilled and are in various stages of completion and hook-up inpreparation for production.

 

On April 30, 2003, the BLM issued the final Record of Decision, or ROD,for the Powder River Basin Oil & Gas Environmental Impact Statement, orEIS.  We have filed permit applicationsfor approval by the BLM under the terms of the new EIS, and although we havereceived federal permits for 178 wells since the issuance of the ROD andthrough April 15, 2004, we are unable to predict the rate at which permits willbe granted in the future.  Since theissuance of the final ROD, the BLM has been reviewing its permitting process inan effort to issue to industry a total of approximately 3,000 permits per yearunder the EIS.

 

Additionally, the Wyoming Department of Environmental Quality, or DEQ,has revised some standards for surface water discharge that have allowed theissuance of most of the permits that apply to the Cheyenne and Belle Fourchedrainage areas. The majority of our existing production is from wells draininginto these areas.  Most of ourundeveloped prospects from the Big George formation are located in the PowderRiver drainage area.  The Wyoming DEQwill require additional water management techniques, such as containment ortreating, in these areas pursuant to the conditions described in the EISreferred to above.  We believe theseadditional requirements will add to the cost of development of this area.  We are currently evaluating several optionsfor water treatment to determine which methodology is most cost efficient.

 

Our 2004 capital budget for the Powder River Basin coal bed project isestimated at $70.1 million, of which $10.6 million was spent in the first quarter.   We currently plan to participate in thedrilling of a total of 800 gross wells in 2004.   Of this total, we plan to drill 500 gross wells in the BigGeorge coals and 300 gross wells in the Wyodak coals.  As of April 30, 2004, we drilled a total of 118 gross wells inthe Big George coals and 43 wells in the Wyodak coals.  Of the remaining 639 wells we plan to drillin 2004, we have received permits from the BLM or no permits are required fromthe BLM on a total of 393 of those drill sites.  Due to regulatory uncertainties, which are beyond our control, wecan make no assurance that we will incur this level of capital expenditureduring 2004.

 

***Jonah/PinedaleFields.* **Ourupstream assets in the Green River Basin of southwest Wyoming are located inthe Jonah Field and Pinedale Anticline areas. Our capital budget for 2004 in the Jonah Field and Pinedale Anticlineareas provides for expenditures of approximately $43.1 million for drillingcosts and production equipment, of which $700,000 was spent in the firstquarter.  During 2004, we expect toparticipate in the drilling of 90 gross wells, or approximately nine net wells,on the Pinedale Anticline, of which 12 gross wells, or one net well, weredrilled in the first quarter.  Due todrilling and regulatory uncertainties, which are beyond our control, there canbe no assurance that we will incur this level of capital expenditure during2004.

 

***Sand Wash Basin.***   We continue to explore and develop ouracreage position in the Sand Wash Basin in northwest Colorado, located in theGreater Green River Basin.   Our 2004capital budget in this area provides for expenditures of approximately $11.3million for the drilling of eight gross and net development wells and oneexploratory well.   In the first quarterof 2004, we spent $5.5 million primarily for the drilling of three gross andnet development wells in this area.

 

***Exploration. *** Weare also actively seeking to add additional upstream core projects that arefocused on Rocky Mountain natural gas.  We will utilize our expertise in exploration and low-risk development oftight-gas sands, coal bed methane and fractured shale plays to evaluateacquisitions of either additional leaseholds, proven and undeveloped reservesor companies with operations focused in the Rockies.

 

Toward this goal, as of March 31, 2004, we have acquired the drillingrights on approximately 395,000 gross acres, or approximately 342,000 netacres, in the northeastern area of the Denver-Julesburg Basin in northeastColorado and southwest Nebraska.  In thefourth quarter of 2003, we drilled two test wells in this area to furtherevaluate its potential.  These wells arecompleted and have been flow tested. Overall the results of these test wells

 

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were encouraging and we will continue to evaluate the overallplay.  We plan to drill at least 15 testwells in this area in 2004.  We aretargeting the Niobrara formation at a depth of approximately 2,500 feet.  The drilling and completion costs per grosswell are expected to approximate $200,000 with possible gross reserves of300,000 to 500,000 Mcfe per well.

 

In the fourth quarter of 2003, we alsoparticipated in two gross exploratory wells, or one net well, in the easternGreen River Basin.  One of these wellsis currently testing at 400 Mcf per day, and the other well is waiting oncompletion.  If these wells aresuccessful, additional offset locations may be proposed.

 

Our capital expenditure budget for 2004 in the exploration area totals$11.2 million, primarily for our participation in drilling activities, seismicsurveys and leasehold acquisition.   Inthe first quarter of 2004, we spent a total of $1.6 million.

 

#### **Midstream Operations**

#### ** **

Our midstream operations consist of our gathering, processing, treating,marketing and transportation operations. An important element of our long-term business plan is to meet or exceedthroughput projections in these areas and to optimize their profitability.  To achieve this goal, we must continue ourefforts to add to natural gas throughput levels through new well connectionsand through the expansion or acquisition of gathering or processingsystems.  We also seek to increase theefficiency of our operations by modernization of equipment and theconsolidation of existing facilities.

 

***Gas Gathering,Processing and Treating***

 

At March 31, 2004, we operated a variety of gathering, processing andtreating facilities, or plant operations, as presented on the PrincipalGathering and Processing Facilities Table set forth below.  Our operations are located in some of the mostactively drilled oil and gas producing basins in the United States.  Five of our processing plants canfurther separate, or fractionate, the mixed NGL stream into ethane, propane,normal butane and natural gasoline to obtain a higher value for the NGLs, andthree of our plants are capable of processing and treating natural gascontaining hydrogen sulfide or other impurities that require removal prior todelivery to market pipelines.   In addition to our integrated upstreamand midstream operations in the Powder River and Green River Basins in Wyoming,our coreassets include our plant operations located in west Texas, Oklahoma and NewMexico.  We believe that our core assetshave stable production rates, provide a significant operating cash flow andcontinue to provide us with strategic growth opportunities.

 

***Midstream OperatingAreas***

 

#### **PowderRiver Basin. **Our midstream operationsin the Powder River Basin are fully integrated with our upstream operations aswe provide the gathering, compression and processing services for our ownproduction.  Additionally we provide thesame types of services for third-parties. Our assets in the Powder River Basin in northeast Wyoming were primarilycomprised of our coal bed methane gathering system, several gas processingfacilities and our 13% equity interest in Fort Union.

#### ** **

Our capitalbudget in the Powder River Basin for midstream activitiesprovides for expenditures of approximately $32.4 million during 2004, of which $1.5million was spent in the three months ended March 31, 2004.  Dueto drilling, regulatory, commodity pricing and other uncertainties, which arebeyond our control, there can be no assurance that we will incur this level ofcapital expenditure during 2004 or that we will not be required to makeadditional capital commitments to continue expansion in this basin

 

***GreenRiver Basin***.  Our midstream operations in the GreenRiver Basin of southwest Wyoming are also fully integrated with our upstreamoperations in this area.  Our midstreamassets in this basin are comprised of the Granger and Lincoln Road facilities,or collectively the Granger complex, our 50% equity interest in Rendezvous GasServices, L.L.C., or Rendezvous, our Red Desert facility and our Table Rock,Wamsutter and Desert Springs gathering systems.

 

Our 2004capital budget for midstream activities in this basin providesfor expenditures of approximately $40.2 million, of which $7.3 million wasspent in the first quarter of 2004. This capital budget includes approximately $36.5 million for gatheringlines and installation of compression to expand the capacity of our GrangerComplex, our Wamsutter gathering system and our Red Desert facility, and $1.3million for additional contributions to Rendezvous

 

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for the expansion of its systems.  Due to drilling, commodity pricing and regulatory uncertainties, whichare beyond our control, there can be no assurance that we will incur this levelof capital expenditure during 2004.

 

***West Texas******.*  **Ourprimary assets in west Texas are the Midkiff/Benedum complex and the Gomez andMitchell Puckett treating facilities. Our capital budget in this area provides for expenditures ofapproximately $5.6 million during 2004, of which $1.4 was spent in the firstthree months of 2004.  This budgetincludes approximately $2.5 million for additions to the gathering systems andplant facilities and approximately $3.1 million for replacing and upgradingfield and plant equipment.

 

***Oklahoma******.* **Ourprimary assets in Oklahoma are the Chaney Dell and Westana systems.  Our capital budget in this area provides forexpenditures of approximately $14.5 million during 2004, of which $3.9 millionwas spent in the first three months of 2004. This budget includes approximately $11.1 million for additions to thegathering systems and plant facilities and approximately $3.4 million forreplacing and upgrading field and plant equipment.

 

***San Juan. ***Our assets inthe San Juan Basin of New Mexico are the San Juan River processing facility andthe Four Corners Gathering system.  Ourcapital budget in this area provides for expenditures of approximately $1.1million during 2004, of which $126,000 was spent in the first three months of2004.  This budget includesapproximately $875,000 for additions to the gathering systems and plantfacilities and approximately $213,000 for replacing and upgrading field andplant equipment.

 

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***Principal Gathering andProcessing Facilities Table.***  The following table provides informationconcerning our principal gathering, processing and treating facilities at March31, 2004.

 
|                          |   |                         |   |                              |   |                                        |   | **Average  for the Quarter Ended  March 31, 2004** |   |
|-------------------------------|--------|------------------------------|--------|-----------------------------------|--------|---------------------------------------------|--------|----------------------------------------------------|--------|
|                          |   |                         |   | **Gas  Gathering  System  Miles** |   | **Gas  Throughput  Capacity  (MMcf/D) (2)** |   |                                               |
|                          |   |                         |   |                              |   | **Gas  Throughput  (MMcf/D) (3)**           |   | **Gas  Production  (MMcf/D) (4)**                  |   | **NGL  Production  (MGal/D) (4)** |   |
|                          |   | **Year  Placed  In Service** |   |                              |   |                                        |   |                                               |
| **Facilities (1)**            |   |                         |   |                              |   |                                        |   |
|                          |   |                         |   |                              |   |                                        |   |                                               |   |   |   |   |   |
| Texas                         |   |                         |   |                              |   |                                        |   |                                               |   |   |   |   |   |
| Gomez Treating (5)            |   | 1971                         |   | 389                               |   | 280                                         |   | 99                                                 |   | 89 |   | — |   |
| Midkiff/Benedum               |   | 1949                         |   | 2,257                             |   | 165                                         |   | 140                                                |   | 93 |   | 831 |   |
| Mitchell Puckett Treating (5) |   | 1972                         |   | 93                                |   | 120                                         |   | 53                                                 |   | 34 |   | 1 |   |
| Wyoming                       |   |                         |   |                              |   |                                        |   |                                               |   |   |   |   |   |
| Coal Bed Methane Gathering    |   | 1990                         |   | 1,323                             |   | 525                                         |   | 390                                                |   | 94 |   | — |   |
| Desert Springs Gathering      |   | 1979                         |   | 65                                |   | 10                                          |   | 6                                                  |   | 6 |   | 20 |   |
| Fort Union Gas Gathering      |   | 1999                         |   | 167                               |   | 635                                         |   | 387                                                |   | 387 |   | — |   |
| Granger (6)(7)(8)             |   | 1987                         |   | 555                               |   | 235                                         |   | 209                                                |   | 148 |   | 367 |   |
| Hilight Complex (6)           |   | 1969                         |   | 626                               |   | 124                                         |   | 17                                                 |   | 13 |   | 57 |   |
| Kitty/Amos Draw (6)           |   | 1969                         |   | 314                               |   | 17                                          |   | 6                                                  |   | 4 |   | 25 |   |
| Lincoln Road (8)              |   | 1988                         |   | 149                               |   | 50                                          |   | —                                             |   | — |   | — |   |
| Newcastle (6)                 |   | 1981                         |   | 146                               |   | 5                                           |   | 3                                                  |   | 2 |   | 20 |   |
| Red Desert (6)                |   | 1979                         |   | 119                               |   | 42                                          |   | 17                                                 |   | 14 |   | 44 |   |
| Rendezvous                    |   | 2001                         |   | 238                               |   | 275                                         |   | 236                                                |   | 236 |   | — |   |
| Reno Junction (7)             |   | 1991                         |   | —                            |   | —                                      |   | —                                             |   | — |   | 126 |   |
| Table Rock Gathering          |   | 1979                         |   | 101                               |   | 20                                          |   | 14                                                 |   | 14 |   | — |   |
| Wamsutter Gathering           |   | 1979                         |   | 238                               |   | 50                                          |   | 44                                                 |   | 44 |   | 18 |   |
| Wind River Gathering          |   | 1979                         |   | 109                               |   | 80                                          |   | 52                                                 |   | 52 |   | — |   |
| Oklahoma                      |   |                         |   |                              |   |                                        |   |                                               |   |   |   |   |   |
| Chaney Dell/Westana           |   | 1966                         |   | 3,209                             |   | 175                                         |   | 184                                                |   | 160 |   | 300 |   |
| New Mexico                    |   |                         |   |                              |   |                                        |   |                                               |   |   |   |   |   |
| San Juan River (5)            |   | 1955                         |   | 140                               |   | 60                                          |   | 26                                                 |   | 21 |   | 35 |   |
| Utah                          |   |                         |   |                              |   |                                        |   |                                               |   |   |   |   |   |
| Four Corners Gathering        |   | 1988                         |   | 104                               |   | 15                                          |   | 3                                                  |   | 2 |   | 19 |   |
| Total                         |   |                         |   | 10,342                            |   | 2,883                                       |   | 1,886                                              |   | 1,413 |   | 1,863 |   |

 

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(1)                      Ourinterest in all facilities is 100% except for Midkiff/Benedum (73%); Newcastle(50%); Fort Union (13%) and Rendezvous (50%). We operate all facilities, and all data include our interests and theinterests of other joint interest owners and producers of gas volumes dedicatedto the facility.  Unless otherwiseindicated, all facilities shown in the table are gathering, processing ortreating facilities.

(2)                      Gasthroughput capacity is as of March 31,2004 and represents capacity inaccordance with design specifications unless other constraints exist, includingpermitting or field compression limits.

(3)                      Aggregate wellhead natural gasvolumes collected by a gathering system.

(4)                      Volumes of gas and NGLs areallocated to a facility when a well is connected to that facility; volumesexclude NGLs fractionated for third-parties.

(5)                      Sour gas facility (capable ofprocessing or treating gas containing hydrogen sulfide and/or carbon dioxide).

(7)                      Processing facility that includesfractionation (capable of fractionating raw NGLs into end-use products).

(8)                      NGL production includesconversion of third-party feedstock to iso-butane.

(9)                      Lincoln Road is operated on anintermittent basis to process excess gas from the Granger system. As of January1, 2004, the volume information for this facility is reported with the volumeinformation reported for Granger.

 

***Transportation***

 

We own and operate MIGC, Inc., an interstate pipeline located in thePowder River Basin in Wyoming, and MGTC, Inc., an intrastate pipeline locatedin northeast Wyoming.  MIGC charges aFederal Energy Regulatory Commission, or FERC, approved tariff and is connectedto pipelines owned by Colorado Interstate Gas Company, Williston BasinInterstate Pipeline Company, Kinder Morgan Interstate Pipeline Co., WyomingInterstate Company, Ltd. and MGTC.  MIGCearns fees on a monthly basis from firm capacity contracts under which theshipper pays for

 

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transport capacity whether or not the capacity is used and frominterruptible contracts where a fee is charged based upon volumes received intothe pipeline.  Contracts with thirdparties for firm capacity on MIGC range in duration from one month to fiveyears and the fees charged averaged $0.33 per Mcf in 2003.  MGTC provides transportation and gas salesto various cities in Wyoming at rates that are subject to the approval of theWyoming Public Service Commission.

 

The FERC has implemented changes over the past several years torestrict transactions between regulated pipelines and affiliatedcompanies.  In addition, in November2003, the FERC issued a notice of rulemaking limiting the use of affiliates’employees in the operation of regulated entities.  We submitted a plan of compliance with the notice in February2004 and expect to be in compliance with the notice by September 1, 2004.  In accordance with this plan, we will addseveral employees to both MIGC and MGTC.

 

The following table provides information concerning our principaltransportation assets at March 31, 2004.

 
|                              |   |                         |   |                          |   | **Average  for the Quarter Ended  March 31, 2004** |   |
|-----------------------------------|--------|------------------------------|--------|-------------------------------|--------|----------------------------------------------------|--------|
| **Transportation Facilities (1)** |   | **Year  Placed  In Service** |   | **Transportation Miles** |   | **Pipeline  Capacity  (MMcf/D) (2)**               |   | **Gas  Throughput  (MMcf/D) (3)** |   |
| MIGC (4)                          |   | 1970                         |   | 263                           |   | 130                                                |   | 146 |   |
| MGTC (5)                          |   | 1963                         |   | 251                           |   | 18                                                 |   | 7 |   |
| Total                             |   |                         |   | 514                           |   | 148                                                |   | 153 |   |

 

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(1)                      Our interest in both facilitiesis 100%, and we operate both facilities.

(2)                      Pipeline capacity representscertificated capacity at the Powder River junction only and does not includeinterruptible capacity or capacity at other delivery points.

(3)                      Aggregate volumes transported bya pipeline.

(4)                      MIGC is an interstate pipelinelocated in Wyoming and is regulated by the FERC.

(5)                      MGTC is a public utility locatedin Wyoming and is regulated by the Wyoming Public Service Commission.

 

***Marketing***

 

***Gas*.*   ***Wemarket gas produced at our wells and our plants and purchased fromthird-parties to end-users, local distribution companies, or LDCs, pipelinesand other marketing companies throughout the United States and Canada.  In addition to our offices in Denver, wehave marketing offices in Houston, Texas and Calgary, Alberta.  Third-party sales, firm transportationcapacity on interstate pipelines and our gas storage positions, combined withthe stable supply of gas from our facilities and production, enable us torespond quickly to changing market conditions and to take advantage of seasonalprice variations and peak demand periods.

 

One of the primary goals of our gas marketing operations continues tobe the preservation and enhancement of the value received for our equityvolumes of natural gas.  This goal isachieved through the use of hedges on the production of our equity natural gasand through the use of firm transportation capacity.  Historically, the gas produced in the Rocky Mountain region hastraded at a substantial discount to the Mid-Continent and west coast areas as aresult of limited pipeline capacity from the region.  During the second quarter of 2003, additional pipeline capacityout of the Rocky Mountain region went into service.  This pipeline expansion contributed to a reduction in the pricedifference between the Rocky Mountain region and Mid-Continent marketcenter.  We expect this additional pipelinecapacity to continue to have an ongoing impact on the price differences betweenthe Rocky Mountain and Mid-Continent regions.

 

For the threemonths ended March 31, 2004, our total gas sales volumes averaged 1.4 Bcf perday, of which 493 MMcf per day was produced at our plants or from our producingproperties.  This volume of sales is anapproximate 14% decrease as compared to 2003. In general, we reduced our sales volume due to price volatility andcredit concerns with many counterparties in the energy industry.  The marketing of products purchased fromthird-parties typically results in low profit margins relative to the salesprice.  We sell gas under agreementswith varying terms and conditions in order to match seasonal and other changesin demand.

 

Revenues forsales of product are recognized at the time the gas is delivered to thecustomer and are sensitive to changes in the market prices of the underlyingcommodities.  Gains and losses on anyaccompanying financial transactions are recorded net.  Additionally, for our marketing activities, we utilizemark-to-market accounting.

 

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Under mark-to-market accounting, the expected margin to be realizedover the term of the transaction is recorded in the month of origination.  To the extent that a transaction is notfully hedged or there is any hedge ineffectiveness, additional gains or lossesassociated with the transaction may be reported in future periods.

 

***NGLs*.*  ***Wemarket NGLs, or ethane, propane, iso-butane, normal butane, natural gasolineand condensate, produced at our plants and purchased from third-parties, in theRocky Mountain, Mid-Continent and Southwestern regions of the UnitedStates.  A majority of our production ofNGLs moves to the Gulf Coast area, which is the largest NGL market in theUnited States.  Through the developmentof end-use markets and distribution capabilities, we seek to ensure thatproducts from our plants move on a reliable basis, avoiding curtailment ofproduction.  For the three months endedMarch 31, 2004, NGL sales averaged 1,611 MGal per day, of which 1,398 MGal perday was produced at our plants.

 

Consumers of NGLs are primarily the petrochemical industry, thepetroleum refining industry and the retail and industrial fuel markets.  As an example, the petrochemical industryuses ethane, propane, normal butane and natural gasoline as feedstocks in theproduction of ethylene, which is used in the production of various plasticsproducts.  Further, consumers usepropane for home heating, transportation and agricultural applications.  Price, seasonality and the economy primarilyaffect the demand for NGLs.

 

We sell NGLs underagreements with varying terms and conditions in order to match seasonal andother changes in demand.  The marketingof products purchased from third-parties typically results in low profitmargins relative to the sales price.  Asin the case of natural gas, we continually monitor and review the creditexposure to our NGL marketing counterparties.

 

Revenues for sales ofNGLs are recognized at the time the NGLs are delivered to the customer and aresensitive to changes in the market prices of the underlying commodities.  Gains and losses on any accompanyingfinancial transactions are recorded net. Additionally, for our marketing activities we utilize mark-to-marketaccounting.  As discussed above, undermark-to-market accounting, the expected margin to be realized over the term ofthe transaction is recorded in the month of origination.  To theextent that a transaction is not fully hedged or there is any hedgeineffectiveness, additional gains or losses associated with the transaction maybe reported in future periods.

 

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**ITEM 3.  QUANTITATIVE****AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our commodity price risk management program has two primaryobjectives.  The first goal is topreserve and enhance the value of our equity volumes of gas and NGLs withregard to the impact of commodity price movements on cash flow and net incomein relation to those anticipated by our operating budget.  The second goal is to manage price riskrelated to our marketing activities to protect profit margins.  This risk relates to fixed price purchaseand sale commitments, the value of storage inventories and exposure to physicalmarket price volatility.

 

We utilize a combination of fixed price forward contracts,exchange-traded futures and options, as well as fixed index swaps, basis swapsand options traded in the over-the-counter, or OTC, market to accomplish thesegoals.  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 financial instruments 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 anadverse change in the futures market will not be completely offset by an equaland opposite change in the cash price of the commodity being hedged.  Basis risk exists in natural gas primarilydue to the geographic price differentials between cash market locations andfutures contract delivery locations.

 

We enter into futures transactions on the New York Mercantile Exchange,or NYMEX, and through OTC swaps and options with various counterparties,consisting primarily of investment banks, financial institutions and othernatural gas companies.  We conductcredit reviews of all of our OTC counterparties and have agreements with manyof these parties that contain collateral requirements.  We generally use standardized swapagreements that allow for offset of positive and negative OTC exposures.  OTC exposure is marked-to-market daily forthe credit review process.  Our exposureto OTC credit risk is reduced by our ability to require a margin deposit fromour counterparties based upon the mark-to-market value of their netexposure.  We are also subject to margindeposit requirements under these same agreements and under margin deposit requirementsfor our NYMEX transactions.  At March31, 2004, we had $500,000 of margin deposits outstanding.

 

We continually monitor and review the credit exposure to our marketingcounterparties.  In order to minimizeour credit exposures, we have utilized existing netting agreements to reduceour net credit exposure, established new netting agreements with additionalcustomers, terminated several long-term marketing obligations, negotiatedaccelerated payment terms with several customers, and reduced the amount ofcredit which we make available to various customers.  Although netting agreements similar to those that we utilize havebeen upheld by bankruptcy courts in the past, if any of these customers withwhom we have netting agreements were to file for bankruptcy, we can provide noassurance that our agreements will not be challenged or as to the outcome ofany challenge.

 

The use of financial instruments may expose us to the risk of financialloss in some circumstances, including instances when (i) our equity volumes areless than expected, (ii) our customers fail to purchase or deliver thecontracted quantities of natural gas or NGLs, or (iii) our OTC counterpartiesfail to perform.  To the extent that weengage in hedging activities, we may be prevented from realizing the benefitsof favorable price changes in the physical market.  However, we are similarly insulated against decreases in theseprices.

 

***Risk Policy andControl.**** *We control the extent of riskmanagement and marketing activities through policies and procedures thatinvolve the senior level of management. On a daily basis, our marketing activities are audited and monitored byour independent risk oversight department, or IRO.  This department reports to the Chief Financial Officer, therebyproviding a separation of duties from the marketing department.  Additionally, the IRO reports monthly to theRisk Management Committee, or RMC.  Thiscommittee is comprised of corporate managers and officers and is responsiblefor developing the policies and guidelines that control the management andmeasurement of risk. The RMC is also responsible for setting risk limitsincluding value-at-risk and dollar stop loss limits.  Our board of directors approves the risk limit parameters andrisk management policy.

 

***HedgePositions.* **Asof March 31, 2004, we have hedged approximately 50% of our projected 2004equity natural gas volumes and approximately 45% of our estimated equityproduction of crude oil, condensate, and NGLs. All of these contracts are designated and accounted for as cash flowhedges.  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 gainsor losses on these cash flow hedges are recognized in the ConsolidatedStatement of Operations through Sale of gas or Sale of natural gas liquids whenthe hedged transactions occur.

 

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To qualify as cash flow hedges, the hedge instruments must bedesignated as cash flow hedges and changes in their fair value must be highlycorrelated with changes in the price of the forecasted transaction being hedgedso that our exposure to the risk of commodity price changes is reduced.  To meet this requirement, we hedge the priceof the commodity and, if applicable, the basis between that derivative’scontract delivery location and the cash market location used for the actual saleof the product.  This structure attainsa high level of effectiveness, insuring that a change in the price of theforecasted transaction will result in an equal and opposite change in the cashprice of the hedged commodity.  Weutilize crude oil as a surrogate hedge for natural gasoline, butane andcondensate.  Our hedges are tested foreffectiveness at inception and on a quarterly basis thereafter.  We use regression analysis based on afive-year period of time for this test.

 

In the first quarter of 2004, we determined in our quarterly effectivenesstesting that our hedges of equity butane production which utilized crude oilputs as a surrogate are no longer effective hedges.  Therefore, in the first quarter, we discontinued cash flow hedgeaccounting treatment on these instruments. The value of these financial instruments will remain in Accumulatedother comprehensive income and will be reclassified to our results ofoperations as the underlying transactions occur.  A loss of $318,000 was included in Accumulated othercomprehensive income at March 31, 2004 for these items.  Our remaining hedges for our other productsare expected to continue to be “highly effective” under SFAS No. 133 in thefuture.  Gains or losses from theineffective portions of changes in the fair value of cash flow hedges arerecognized currently in earnings through Price risk management activities.  During the quarter ended March 31, 2004, werecognized a loss of $21,000 from the ineffective portions of our hedges.

 

### **OutstandingEquity Hedge Positions and the Associated Basis for 2004**.  The following table details ourhedge positions as of March 31, 2004. In order to determine the hedged price to the particular operatingregion, deduct the basis differential from the NYMEX price.  The prices for NGLs do not include the costof the hedges of approximately $425,000. There is no associated cost forthe natural gas hedges.

### ** **

 
| **Product**                         |   | **Quantity and Settle Price**                                                                                                                |   | **Hedge of Basis Differential**                                                                                                                                                                                                                                                     |
|-------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Natural gas                         |   | 70,000 MMBtu per day  with a minimum price of $4.00 and a maximum price ranging from $6.50 to $9.45  per MMbtu (average of $7.81 per MMBtu.) |   | Mid-Continent –55,000  MMBtu per day with an average basis price of ($0.27) per MMbtu.  Permian –5,000 MMBtu per day with an  average basis price of ($0.34) per MMbtu. Rocky Mountain –10,000 MMBtu per  day with an average basis price of ($0.74) per MMbtu. |
|                                |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                |
| Crude, Condensate, Natural Gasoline |   | 50,000 Barrels per  month with a minimum price of $22.00 per barrel and a maximum price of $30.08  per barrel.                               |   | Not Applicable                                                                                                                                                                                                                                                                      |
|                                |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                |
| Propane                             |   | 90,000 Barrels per  month with minimum and maximum price of $0.42 per gallon and $0.56 per  gallon, respectively.                            |   | Not Applicable                                                                                                                                                                                                                                                                      |
|                                |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                |
| Ethane                              |   | 50,000 Barrels per  month.  Floor at $0.305 per gallon.                                                                                 |   | Not Applicable                                                                                                                                                                                                                                                                      |

 

Account balances related to equity and transportation hedgingtransactions at March 31, 2004 were $2.0 million in Current assets from pricerisk management activities, $6.6 million in Current Liabilities from price riskmanagement activities,  ($1.6) millionin Deferred income taxes payable, net, and a $2.9 million after-tax unrealizedloss in Accumulated other comprehensive income, a component of Stockholders’Equity.  Based on prices as of March 31,2004, approximately $2.9 million of losses in Accumulated other comprehensiveincome will be reclassified to earnings in the remainder of 2004.

 

***Summary ofDerivative Positions.***  A summary of the change in our derivative position from December31, 2003 to March 31, 2004 is as follows (dollars in thousands):

 

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| Fair value of contracts  outstanding at December 31, 2003              |   | $      | 6,707  |   |
|------------------------------------------------------------------------|--------|--------|--------|--------|
| Increase in value due to change in price                               |   | (2,016 | )      |
| Decrease in value due to new contracts  entered into during the period |   | 1,130  |   |
| Gains realized during the period from  existing and new contracts      |   | (7,931 | )      |
| Changes in fair value attributable to  changes in valuation techniques |   | — |   |
| Fair value of contracts outstanding at  March 31, 2004                 |   | $      | (2,110 | )      |

 

A summary of our outstanding derivative positions at March 31, 2004 isas follows (dollars in thousands):

 
|                             |   | **Fair Value  of Contracts at March 31, 2004** |   |
|----------------------------------|--------|------------------------------------------------|--------|
| **Source of Fair Value**         |   | **Total  Fair Value**                          |   | **Maturing  In 2004** |   | **Maturing  In  2005-2006** |   | **Maturing  In  2007-2008** |   | **Maturing  Thereafter** |   |
| Exchange published prices        |   | $                                              | 1,079  |   | $ | 629 |   | $ | 450 |   | — |   | — |   |
| Other actively quoted prices (1) |   | 2,557                                          |   | 1,703 |   | 854 |   | — |   | — |   |
| Other valuation methods (2)      |   | (5,746                                         | )      | (5,748 | ) | 2 |   | — |   | — |   |
| Total fair value                 |   | $                                              | (2,110 | ) | $ | (3,416 | ) | $ | 1,306 |   | — |   | — |   |

 

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(1)          Otheractively quoted prices are derived from broker quotations, trade publications,and industry indices.

(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 a normal part of our business, we enterinto physical gas transactions which are payable 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 protectmarketing margins from adverse changes in the U.S. and Canadian dollar exchangerate between the time the commitment for the payment obligation is made and theactual payment date of such obligation. As of March 31, 2004, the net notional value of such contracts wasapproximately $3.1 million in Canadian dollars.  The fair market value of these contracts is $2.3 million in U.S.dollars.

 

**ITEM 4.****                             CONTROLSAND PROCEDURES**

 

***Disclosure Controlsand Procedures.***

 

Underthe direction of the Chief Executive Officer and President and the ExecutiveVice President and Chief Financial Officer, we carried out an evaluation of theeffectiveness of our disclosure controls and procedures (as defined in Rules13a-15(d) and 15d-15(e) under the Securities Exchange Act of 1934) as of theend of the period covered by this report, and believe, based upon thisevaluation, that our disclosure controls and procedures are effective as ofMarch 31, 2004.

 

***Internal Controlover Financial Reporting.***

 

There has been no change in our internal control over financialreporting that occurred during the quarter ended March 31, 2004, that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

ITEM 1.                             LEGALPROCEEDINGS

 

Reference is made to “Notes toConsolidated Financial Statements (unaudited) - Legal Proceedings,” in Item 1of this Form 10-Q.

 

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**ITEM 2.****                       CHANGESIN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 
| **Period**    |   | **Total  Number of Shares  (or Units) Purchased (a)** |   | **Average  Price Paid per  Share (or Unit) (b)** |    | **Total  Number of Shares  (or Units) Purchased as  Part of Publicly  Announced Plans or  Programs** |    | **Maximum  Number (or  Approximate Dollar Value) of  Shares (or Units) that May Yet  Be Purchased Under the Plans or  Programs** |   |
|---------------|--------|-------------------------------------------------------|--------|--------------------------------------------------|---------|------------------------------------------------------------------------------------------------------|---------|----------------------------------------------------------------------------------------------------------------------------------|--------|
| January 1-31  |   | 800,000                                               |   | $                                                | 50.7438 |                                                                                                 | 800,000 |                                                                                                                             | 0      |   |
| February 1-29 |   | —                                                |   | —                                           |    | —                                                                                               |    | —                                                                                                                           |   |
| March 1-31    |   | —                                                |   | —                                           |    | —                                                                                               |    | 1,260,000                                                                                                                        | (c)    |
|               |        |                                                       |        |                                                  |         |                                                                                                      |         |                                                                                                                                  |        |  |

 

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(a)                      Amountrepresents the full 800,000 shares of our $2.625 Cumulative ConvertiblePreferred Stock, $0.10 par value, called for redemption pursuant to our Noticeof Redemption dated December 17, 2003, which expired on January 21, 2004.

(b)                     Includes theredemption price per share of $50.2625 plus accrued and unpaid dividends.

(c)                      Amountrepresents the full 1,260,000 shares of our $2.625 Cumulative ConvertiblePreferred Stock, $0.10 par value, called for redemption pursuant to our Noticeof Redemption dated March 16, 2004, with a redemption date of April 20, 2004.

 

38

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**ITEM6.****                             EXHIBITSAND REPORTS ON FORM 8-****K**

 

(a)                      Exhibits:

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                     |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                |
| 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                 |   | Certificate of Designation of the $2.625 Cumulative  Convertible Preferred Stock of Western Gas Resources, Inc. (previously filed  in our Current Report on Form 8-K filed on February 25, 1994 and incorporated  herein by reference).             |
|                |   |                                                                                                                                                                                                                                                |
| 3.5                 |   | Amended and Restated Bylaws of Western Gas Resources,  Inc. adopted by the Board of Directors on April 7, 2003 (previously filed as  Exhibit 3.5 to our Quarterly Report on Form 10-Q filed on May 14, 2003 and  incorporated herein by reference). |
|                |   |                                                                                                                                                                                                                                                |
| 18.1                |   | PricewaterhouseCoopers LLP letter re change in  accounting principle, dated May 6, 2004.                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                |
| 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.                                                                                                                                                         |

 

(b)              Reports on Form 8-K:

 

During the quarter ended March31, 2004, we filed or furnished the following Form 8-K reports:

 

•                  Current Reporton Form 8-K filed on January 23, 2004, announcing the completion of ourpreviously announced redemption of 800,000 shares of our $2.625 CumulativeConvertible Preferred Stock.

 

•                  Current Reporton Form 8-K furnished on February 13, 2004, announcing our 2003 reserveadditions and production.

 

•                  Current Reporton Form 8-K furnished on February 13, 2004, detailing our operationalprojections for the year ending December 31, 2004.

 

•                  Current Reporton Form 8-K furnished on February 19, 2004, announcing our financial resultsfor the year ended December 31, 2003.

 

•                  Current Reporton Form 8-K filed on March 17, 2004, announcing that we had called forredemption and delisting all remaining outstanding shares of our $2.625Cumulative Convertible Preferred Stock.

 

39

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SIGNATURES

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|               | WESTERN GAS  RESOURCES, INC. |                                                 |
|--------------------|------------------------------|------------------------------------------------------|
|               | (Registrant)                 |
|               |                         |                                                 |
|               |                         |                                                 |
| Date: May 7,  2004 | By:                          | /s/ PETER A.  DEA                                    |   |
|               |                         | Peter A. Dea                                         |
|               |                         | Chief  Executive Officer and President               |
|               |                         |                                                 |
|               |                         |                                                 |
| Date: May 7,  2004 | By:                          | /s/WILLIAM  J. KRYSIAK                               |   |
|               |                         | William J.  Krysiak                                  |
|               |                         | Executive  Vice President - Chief Financial  Officer |
|               |                         | (Principal  Financial and Accounting  Officer)       |

 

40

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INDEX TO EXHIBITS

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                     |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                |
| 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                 |   | Certificate of Designation of the $2.625 Cumulative  Convertible Preferred Stock of Western Gas Resources, Inc. (previously filed  in our Current Report on Form 8-K filed on February 25, 1994 and incorporated  herein by reference).             |
|                |   |                                                                                                                                                                                                                                                |
| 3.5                 |   | Amended and Restated Bylaws of Western Gas  Resources, Inc. adopted by the Board of Directors on April 7, 2003  (previously filed as Exhibit 3.5 to our Quarterly Report on Form 10-Q filed  on May 14, 2003 and incorporated herein by reference). |
|                |   |                                                                                                                                                                                                                                                |
| 18.1                |   | PricewaterhouseCoopers LLP letter re change in  accounting principle, dated May 6, 2004.                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                |
| 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.                                                                                                                                                         |

 

41

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