QEP-2012.9.30-10Q



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ________________________________________________
FORM 10-Q 
________________________________________________
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

For the quarter ended September 30, 2012

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to ______
 ________________________________________________
QEP RESOURCES, INC.
________________________________________________
 
(Exact name of registrant as specified in its charter)
STATE OF DELAWARE
001-34778
87-0287750
(State or other jurisdiction of
(Commission
(I.R.S. Employer
incorporation or organization
File Number)
Identification No.)
 
1050 17th Street, Suite 500, Denver, Colorado 80265
(Address of principal executive offices)
 
Registrant’s telephone number, including area code (303) 672-6900
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
ý
Accelerated filer
o
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  ý
 
At September 30, 2012, there were 178,116,761 shares of the registrant’s common stock, $0.01 par value, outstanding.

 



QEP Resources, Inc.
Form 10-Q for the Quarter Ended September 30, 2012

TABLE OF CONTENTS
 
 
 
 
Page
 
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
 
 
ITEM 3.
 
 
 
 
 
ITEM 4.
 
 
 
 
 
 
 
ITEM 1.
 
 
 
 
 
ITEM 1A.
 
 
 
 
 
ITEM 2.
 
 
 
 
 
ITEM 3.
 
 
 
 
 
ITEM 4.
 
 
 
 
 
ITEM 5.
 
 
 
 
 
ITEM 6.
 
 

1



PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
QEP RESOURCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in millions, except per share amounts)
REVENUES
 
 
 
 
 
 
 
Natural gas sales
$
170.3

 
$
309.8

 
$
470.4

 
$
921.1

Oil sales
117.7

 
76.9

 
335.7

 
220.6

NGL sales
67.5

 
79.3

 
247.0

 
191.0

Gathering, processing and other
46.3

 
57.1

 
141.9

 
162.6

Purchased gas, oil and NGL sales
140.6

 
356.8

 
449.9

 
810.6

Total Revenues
542.4

 
879.9

 
1,644.9

 
2,305.9

OPERATING EXPENSES
 

 
 

 
 

 
 

Purchased gas, oil and NGL expense
142.6

 
352.7

 
455.9

 
803.3

Lease operating expense
42.2

 
37.0

 
122.8

 
104.1

Natural gas, oil and NGL transportation and other handling costs
36.3

 
27.5

 
111.5

 
73.2

Gathering, processing and other
22.1

 
27.0

 
66.4

 
79.4

General and administrative
41.7

 
28.7

 
114.5

 
89.1

Production and property taxes
24.3

 
27.7

 
68.4

 
78.5

Depreciation, depletion and amortization
234.1

 
189.0

 
647.4

 
566.4

Exploration expenses
2.2

 
2.4

 
6.3

 
7.5

Abandonment and impairment
9.5

 
5.7

 
71.8

 
16.4

Total Operating Expenses
555.0

 
697.7

 
1,665.0

 
1,817.9

Net gain from asset sales

 
1.2

 
1.5

 
1.4

OPERATING (LOSS) INCOME
(12.6
)
 
183.4

 
(18.6
)
 
489.4

Realized and unrealized gains on derivative contracts (See Note 7)
36.1

 

 
334.7

 

Interest and other (loss) income
(0.2
)
 
(0.7
)
 
2.4

 
(0.5
)
Income from unconsolidated affiliates
2.3

 
2.3

 
5.6

 
4.5

Loss from early extinguishment of debt

 
(0.7
)
 
(0.6
)
 
(0.7
)
Interest expense
(30.0
)
 
(22.8
)
 
(82.9
)
 
(67.0
)
(LOSS) INCOME BEFORE INCOME TAXES
(4.4
)
 
161.5

 
240.6

 
425.7

Income tax benefit (provision)
2.3

 
(59.1
)
 
(86.5
)
 
(156.0
)
NET (LOSS) INCOME
(2.1
)
 
102.4

 
154.1

 
269.7

Net income attributable to noncontrolling interest
(1.0
)
 
(0.9
)
 
(2.7
)
 
(2.2
)
NET (LOSS) INCOME ATTRIBUTABLE TO QEP
$
(3.1
)
 
$
101.5

 
$
151.4

 
$
267.5

 
 
 
 
 
 
 
 
Earnings Per Common Share Attributable to QEP
 

 
 

 
 

 
 

Basic total
$
(0.02
)
 
$
0.58

 
$
0.85

 
$
1.52

Diluted total
$
(0.02
)
 
$
0.57

 
$
0.85

 
$
1.50

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
 

 
 

 
 

 
 

Used in basic calculation
177.9

 
176.6

 
177.6

 
176.5

Used in diluted calculation
177.9

 
178.5

 
178.6

 
178.5

Dividends per common share
$
0.02

 
$
0.02

 
$
0.06

 
$
0.06


See notes accompanying the condensed consolidated financial statements.

2



QEP RESOURCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in millions)
Net (loss) income
$
(2.1
)
 
$
102.4

 
$
154.1

 
$
269.7

Other comprehensive (loss) income, net of tax:
 

 
 

 
 

 
 

Reclassification of previously deferred derivative (gains) losses (1)
(42.1
)
 
37.3

 
(133.8
)
 
(13.0
)
Pension and other postretirement plans adjustments:
 

 
 

 
 

 
 

Amortization of net actuarial loss (2)
0.5

 

 
0.7

 

Amortization of prior service cost (3)
0.9

 
1.4

 
2.6

 
3.1

Total pension and other postretirement plans adjustments
1.4

 
1.4

 
3.3

 
3.1

Other comprehensive (loss) income
(40.7
)
 
38.7

 
(130.5
)
 
(9.9
)
Comprehensive (loss) income
(42.8
)
 
141.1

 
23.6

 
259.8

Comprehensive income attributable to noncontrolling interests
(1.0
)
 
(0.9
)
 
(2.7
)
 
(2.2
)
Comprehensive (loss) income attributable to QEP
$
(43.8
)
 
$
140.2

 
$
20.9

 
$
257.6

____________________________
(1) 
Presented net of income tax benefit of $24.9 million and $79.2 million during the three and nine months ended September 30, 2012, respectively, and net of income tax expense of $22.1 million during the three months ended September 30, 2011 and income tax benefit of $7.7 million during the nine months ended September 30, 2011, respectively.
(2) 
Presented net of income tax expense of $0.2 million and $0.4 million during the three and nine months ended September 30, 2012, respectively.
(3) 
Presented net of income tax expense of $0.5 million and $1.6 million during three and nine months ended September 30, 2012, respectively, and net of income tax expense of $0.8 million and $1.9 million during the three and nine months ended September 30, 2011, respectively.

See notes accompanying the condensed consolidated financial statements.


3



QEP RESOURCES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
2012
 
December 31,
2011
ASSETS
(in millions)
Current Assets
 
 
 
Cash and cash equivalents
$

 
$

Accounts receivable, net
274.3

 
397.4

Fair value of derivative contracts
187.2

 
273.7

Inventories, at lower of average cost or market
 

 
 

Gas, oil and NGL
14.0

 
16.2

Materials and supplies
94.9

 
87.6

Prepaid expenses and other
49.4

 
43.7

Total Current Assets
619.8

 
818.6

Property, Plant and Equipment (successful efforts method for gas and oil properties)
 

 
 

Proved properties
9,882.4

 
8,172.4

Unproved properties
983.4

 
326.8

Midstream field services
1,605.2

 
1,463.6

Marketing and other
56.3

 
49.8

Total Property, Plant and Equipment
12,527.3

 
10,012.6

Less Accumulated Depreciation, Depletion and Amortization
 

 
 

Exploration and production
3,977.6

 
3,339.2

Midstream field services
342.9

 
297.5

Marketing and other
16.9

 
14.6

Total Accumulated Depreciation, Depletion and Amortization
4,337.4

 
3,651.3

Net Property, Plant and Equipment
8,189.9

 
6,361.3

Investment in unconsolidated affiliates
41.7

 
42.2

Goodwill
59.5

 
59.5

Fair value of derivative contracts
35.2

 
123.5

Other noncurrent assets
50.0

 
37.6

TOTAL ASSETS
$
8,996.1

 
$
7,442.7

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Current Liabilities
 

 
 

Checks outstanding in excess of cash balances
$
27.5

 
$
29.4

Accounts payable and accrued expenses
464.6

 
457.3

Production and property taxes
56.3

 
40.0

Interest payable
23.7

 
24.4

Fair value of derivative contracts
2.7

 
1.3

Deferred income taxes
41.9

 
85.4

Total Current Liabilities
616.7

 
637.8

Long-term debt
3,180.7

 
1,679.4

Deferred income taxes
1,505.8

 
1,484.7

Asset retirement obligations
176.6

 
163.9

Fair value of derivative contracts
4.1

 

Other long-term liabilities
135.2

 
124.8

Commitments and contingencies


 


EQUITY
 

 
 

Common stock - par value $0.01 per share; 500.0 million shares authorized; 
178.5 million and 177.2 million shares issued, respectively
1.8

 
1.8

Treasury stock - 0.4 million and 0.4 million shares, respectively
(11.6
)
 
(13.1
)
Additional paid-in capital
455.8

 
431.4

Retained earnings
2,805.6

 
2,673.5

Accumulated other comprehensive income
77.4

 
207.9

Total Common Shareholders' Equity
3,329.0

 
3,301.5

Noncontrolling interest
48.0

 
50.6

Total Equity
3,377.0

 
3,352.1

TOTAL LIABILITIES AND EQUITY
$
8,996.1

 
$
7,442.7

 
See notes accompanying the condensed consolidated financial statements.

4



QEP RESOURCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2012
 
2011
 
(in millions)
OPERATING ACTIVITIES
 

 
 

Net income
$
154.1

 
$
269.7

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation, depletion and amortization
647.4

 
566.4

Deferred income taxes
54.7

 
155.9

Abandonment and impairment
71.8

 
16.4

Share-based compensation
19.5

 
16.5

Amortization of debt issuance costs and discounts
3.7

 
2.4

Dry exploratory well expense
0.1

 
0.5

Net gain from asset sales
(1.5
)
 
(1.4
)
Income from unconsolidated affiliates
(5.6
)
 
(4.5
)
Distributions from unconsolidated affiliates and other
6.1

 
7.6

Non-cash loss on early extinguishment of debt

 
0.7

Unrealized gain on derivative contracts
(32.8
)
 
(86.7
)
Changes in operating assets and liabilities
54.5

 
12.2

Net Cash Provided by Operating Activities
972.0

 
955.7

INVESTING ACTIVITIES
 

 
 

Property acquisitions
(1,400.3
)
 
(40.7
)
Property, plant and equipment, including dry exploratory well expense
(1,040.7
)
 
(957.7
)
Proceeds from disposition of assets
5.3

 
7.4

Net Cash Used in Investing Activities
(2,435.7
)
 
(991.0
)
FINANCING ACTIVITIES
 

 
 

Checks outstanding in excess of cash balances
(1.9
)
 
7.2

Long-term debt issued
1,450.0

 

Long-term debt issuance costs paid
(17.0
)
 
(10.5
)
Long-term debt repaid
(6.7
)
 
(58.5
)
Proceeds from credit facility
933.5

 
280.0

Repayments of credit facility
(876.0
)
 
(170.0
)
Other capital contributions
(4.2
)
 
0.1

Dividends paid
(10.7
)
 
(10.6
)
Excess tax benefit on share-based compensation
2.0

 
1.5

Distribution from Questar

 
0.2

Distribution to noncontrolling interest
(5.3
)
 
(4.1
)
Net Cash Provided by Financing Activities
1,463.7

 
35.3

Change in cash and cash equivalents

 

Beginning cash and cash equivalents

 

Ending cash and cash equivalents
$

 
$

 
 
 
 
Supplemental Disclosures:
 

 
 

Cash paid for interest
$
81.9

 
$
89.8

Cash paid (received) for income taxes
28.0

 
(7.2
)
Non-cash investing activities
 

 
 

Change in capital expenditure accrual balance
$
97.5

 
$
12.5

 
See notes accompanying the condensed consolidated financial statements.

5



QEP RESOURCES, INC.
NOTES ACCOMPANYING THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1 – Nature of Business
 
QEP Resources, Inc. (QEP or the Company) is a holding company with three major lines of business: natural gas and crude oil exploration and production; midstream field services; and energy marketing. These businesses are conducted through the Company’s three principal subsidiaries:
 
QEP Energy Company (QEP Energy) acquires, explores for, develops, and produces natural gas, oil, and natural gas liquids (NGL);

QEP Field Services Company (QEP Field Services) provides midstream field services, including natural gas gathering, processing, compression, and treating services, for affiliates and third parties;

QEP Marketing Company (QEP Marketing) markets affiliate and third-party natural gas and oil, and owns and operates an underground gas-storage reservoir.
 
Operations are focused in two major regions: the Northern Region (primarily in the Rockies) and the Southern Region (primarily Oklahoma, Louisiana, and the Texas Panhandle) of the United States. QEP’s corporate headquarters are located in Denver, Colorado.
 
Shares of QEP Resources’ common stock trade on the New York Stock Exchange under the ticker symbol “QEP”.
 
Note 2 – Basis of Presentation of Interim Consolidated Financial Statements
 
The interim condensed consolidated financial statements contain the accounts of QEP and its majority-owned or controlled subsidiaries. The condensed consolidated financial statements were prepared in accordance with United States Generally Accepted Accounting Principles (GAAP) and with the instructions for quarterly reports on Form 10-Q and Regulations S-X and S-K. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
The condensed consolidated financial statements reflect all normal recurring adjustments and accruals that are, in the opinion of management, necessary for a fair statement of financial position and results of operations for the interim periods presented. Interim condensed consolidated financial statements do not include all of the information and notes required by GAAP for audited annual consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
 
The preparation of the condensed consolidated financial statements and notes in conformity with GAAP requires that management make estimates and assumptions that affect revenues, expenses, assets and liabilities, and disclosure of contingent assets and liabilities. Actual results could differ from estimates. The results of operations for the three and nine months ended September 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.
 
De-designation of commodity derivative contracts
 
Effective January 1, 2012, QEP elected to discontinue hedge accounting prospectively for all of its derivative instruments. Accordingly, all realized and unrealized gains and losses will be recognized in earnings immediately each quarter as derivative contracts are settled and marked-to-market. For the three and nine months ended September 30, 2012, unrealized losses of $57.1 million and unrealized gains of $32.8 million were included in income that, prior to January 1, 2012, would have been deferred in Accumulated Other Comprehensive Income (AOCI) under hedge accounting. Refer to Note 7 – Derivative Contracts for additional information.
 
Transportation and other handling costs
 
In the fourth quarter of 2011, QEP revised its reporting of transportation and handling costs to reflect revenues in accordance with industry practice and GAAP. Transportation and handling costs, previously netted against revenues, were recast on the Condensed Consolidated Statement of Operations from “Revenues” to “Natural gas, oil and NGL transportation and other handling costs” for prior periods presented. The impact of this revision was immaterial to the accompanying financial

6



statements and had no effect on income from continuing operations, net income, or earnings per share. The following table details the impact for the three and nine months ended September 30, 2011, on the Condensed Consolidated Statement of Operations.
 
 
Three Months Ended September 30, 2011
 
Nine Months Ended September 30, 2011
 
As reported (1)
 
As revised
 
Change
 
As reported (1)
 
As revised
 
Change
 
(in millions)
 
(in millions)
REVENUES
 
 
 
 
 
 
 
 
 
 
 
Natural gas sales
$
266.7

 
$
309.8

 
$
43.1

 
$
795.8

 
$
921.1

 
$
125.3

Oil sales
76.1

 
76.9

 
0.8

 
218.4

 
220.6

 
2.2

NGL sales
75.7

 
79.3

 
3.6

 
183.1

 
191.0

 
7.9

Gathering, processing and other
77.1

 
57.1

 
(20.0
)
 
224.8

 
162.6

 
(62.2
)
OPERATING EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Natural gas, oil and NGL transportation and other handling costs

 
27.5

 
27.5

 

 
73.2

 
73.2

 ____________________________
(1) 
The “As reported” numbers reflect QEP Field Services NGL sales of $41.6 million and $115.3 million for the three and nine months ended September 30, 2011, which were reclassified from “Gathering, processing and other” into “NGL sales” for consistency with current period presentation. In its third quarter 2011 Form 10-Q, QEP reported “NGL sales” of $34.1 million and $67.8 million, and “Gathering, processing and other” of $118.7 million and $340.1 million for the three and nine months ended September 30, 2011, respectively. The QEP Field Services NGL reclassification is all within “Revenues” and has no effect on income from continuing operations, net income or earnings per share.

Impairment of oil and gas properties
 
Proved gas and oil properties are evaluated on a field-by-field basis for potential impairment. Impairment is indicated when a triggering event occurs and/or the sum of the estimated undiscounted future net cash flows of an evaluated asset is less than the asset’s carrying value. Triggering events could include, but are not limited to, an impairment of gas and oil reserves caused by mechanical problems, faster-than-expected decline of reserves, lease-ownership issues, other-than-temporary decline in natural gas, NGL and crude oil prices and changes in the utilization of midstream gathering and processing assets. If impairment is indicated, fair value is calculated using a discounted-cash flow approach. Cash flow estimates require forecasts and assumptions for many years into the future for a variety of factors, including commodity prices, operating costs, and estimates of probable and possible reserves. Cash flow estimates relating to future cash flows from probable and possible reserves are reduced by additional risk-weighting factors.

Unproved properties are evaluated on a specific-asset basis or in groups of similar assets, as applicable. The Company performs periodic assessments of individually significant unproved oil and gas properties for impairment and recognizes a loss at the time of impairment. In determining whether a significant unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration plans, favorable or unfavorable exploration activity on adjacent leaseholds, in-house geologists' evaluation of the lease, and the remaining lease term.

During the three and nine months ended September 30, 2012, QEP recorded impairment charges of $7.3 million and $68.7 million on its oil and gas properties, respectively. Of the $68.7 million impairment charge in the nine months ended September 30, 2012, $49.3 million related to the non-cash, price-related impairment charges on proved properties incurred in the first half of 2012. The impairment charges were related to the reduced value of certain fields resulting from lower natural gas, crude oil and NGL prices and impairments of unproven leasehold acquisition costs. Of the $68.7 million impairment charge during the nine months ended September 30, 2012, $60.0 million was related to oil and gas properties in the Southern Region and $8.7 million was related to oil and gas properties in the Northern Region.

Natural gas, NGL and crude oil prices
 
Historically, field-level prices received for QEP’s natural gas, NGL, and crude oil production have been volatile and unpredictable, and that volatility is expected to continue. In recent years, domestic natural gas supply has grown faster than natural gas demand, driven by advances in drilling and completion technologies, including horizontal drilling and multi-stage

7



hydraulic fracturing, which have allowed producers to extract increased quantities of natural gas from shale, tight sand formations, and other unconventional reservoirs. Increased natural gas and NGL supplies have resulted in downward pressure on natural gas and NGL prices, while growing U.S. supplies combined with concern about the global economy and other factors have created volatility in the price of crude oil. Changes in the market prices for natural gas, crude oil, and NGL directly impact many aspects of QEP’s business, including its financial condition, revenues, results of operations, planned drilling activity and related capital expenditures, liquidity, rate of growth, costs of goods and services required to drill and complete wells, and may impact the carrying value of its oil and natural gas properties.

New accounting pronouncements
 
In May of 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which develops common measurement and disclosure requirements regarding an entity’s fair value measurements and aligns GAAP and International Financial Reporting Standards. The amendments are required for interim and annual reporting periods beginning after December 15, 2011. The adoption of these requirements did not have a material impact on the financial statements of QEP.
 
In June of 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income, which revises the manner in which entities are able to present the components of comprehensive income in their financial statements. The new guidance requires entities to report the components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. However, this ASU does not change the items that are reported in other comprehensive income. The amendments are effective for reporting periods (including interim periods) beginning after December 15, 2011. The adoption of this ASU required minor disclosure changes to QEP’s financial statements and footnotes.
 
In December of 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, which enhances disclosure requirements regarding an entity’s financial instruments and derivative instruments that are offset or subject to a master netting arrangement. This information about offsetting and related netting arrangements will enable users of financial statements to understand the effect of those arrangements on the entity’s financial position, including the effect of rights of setoff. The amendments are required for annual reporting periods beginning after January 1, 2013, and interim periods within those annual periods. QEP is evaluating the impact of this ASU on its disclosure requirements.

In July of 2012, the FASB issued ASU 2012-02, Intangibles - Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment, which revises the way an entity can test indefinite-lived intangible assets for impairment by allowing an entity to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If there is no indication of impairment from the qualitative impairment test, the entity is not required to complete a quantitative impairment test of determining and comparing the fair value with the carrying amount of the indefinite-lived asset. Under the guidance in this ASU, an entity also has the option to bypass the qualitative assessment in any period and proceed directly in performing the quantitative impairment test and can resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this standard will allow the Company to more efficiently complete the annual goodwill impairment test but will not have a significant impact on the Company's consolidated financial statements.
 
Note 3 - Acquisition

On September 27, 2012, QEP Energy completed an acquisition of oil and gas properties in the Williston Basin for an aggregate purchase price of approximately $1.4 billion, subject to post-closing adjustments (the “Acquisition”). The properties are located in Williams and McKenzie counties of North Dakota, approximately 12 miles west of QEP's existing core acreage in the Williston Basin.

The Acquisition meets the definition of a business combination under ASC 805, Business Combinations, as it included proved properties. Pro-forma information has not been presented due to the immateriality of revenues and expenses related to the Acquisition during the periods presented. The results of operations from September 27 to September 30, 2012 from the assets purchased in the Acquisition are not included in the three and nine months ended September 30, 2012 Condensed Consolidated Statements of Operations. During the third quarter of 2012, QEP Energy recorded the acquisition on its Condensed Consolidated Balance Sheet; however, the final purchase price is subject to revision based on the final valuation work and settlement of post-closing adjustments. The following table presents a summary of the preliminary purchase accounting entries (in millions):


8



Consideration given:
 
Cash paid at closing
$
1,394.2

 
 
Amounts recognized for preliminary fair value of assets acquired and liabilities assumed:
 
Proved properties
$
707.6

Unproved properties
686.5

Asset retirement obligations
(0.6
)
Other assets
0.7

Total fair value
$
1,394.2


Note 4 – Earnings Per Share
 
Basic earnings per share (EPS) are computed by dividing net income attributable to QEP by the weighted-average number of common shares outstanding during the reporting period. Diluted EPS includes the potential increase in the number of outstanding shares that could result from the exercise of in-the-money stock options. QEP’s unvested restricted shares are included in weighted-average basic common shares outstanding because once the shares are granted, the restricted shares are considered issued and outstanding, the historical forfeiture rate is minimal and the restricted shares receive dividends.
 
Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are considered participating securities and are included in the computation of earnings per share pursuant to the two-class method. The Company’s unvested restricted stock awards contain non-forfeitable dividend rights and participate equally with common stock with respect to dividends issued or declared. However, the Company’s unvested restricted stock does not have a contractual obligation to share in losses of the Company. The Company’s unexercised stock options do not contain rights to dividends. Under the two-class method, the earnings used to determine basic earnings per common share are reduced by an amount allocated to participating securities. When the Company records a net loss, none of the loss is allocated to the participating securities since the securities are not obligated to share in Company losses. Use of the two-class method has an insignificant impact on the calculation of basic and diluted earnings per common share. During the three months ended September 30, 2012, 0.8 million shares were not included in diluted common shares outstanding as they were anti-dilutive due to QEP’s net loss position. There were no anti-dilutive shares during the nine months ended September 30, 2012, and during the three and nine months ended September 30, 2011.
 
A reconciliation of the components of basic and diluted shares used in the EPS calculation follows:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in millions)
Weighted-average basic common shares outstanding
177.9

 
176.6

 
177.6

 
176.5

Potential number of shares issuable upon excercise of in-the-
money stock options under the Long-term Stock Incentive Plan

 
1.9

 
1.0

 
2.0

Average diluted common shares outstanding
177.9

 
178.5

 
178.6

 
178.5


Note 5 – Asset Retirement Obligations
 
QEP records asset retirement obligations (ARO) when there are legal obligations associated with the retirement of tangible long-lived assets. The Company’s ARO liability applies primarily to abandonment costs associated with gas and oil wells, production facilities and certain other properties. The fair values of such costs are estimated by Company personnel based on abandonment costs of similar assets and depreciated over the life of the related assets. Revisions to ARO estimates result from changes in expected cash flows or material changes in estimated asset retirement costs. The ARO liability is adjusted to present value each period through an accretion calculation using a credit-adjusted risk-free interest rate.


9



The following is a reconciliation of the changes in the asset retirement obligation from January 1, 2012, to September 30, 2012, respectively:
 
 
Asset Retirement Obligations
 
2012
 
(in millions)
ARO liability at January 1,
$
163.9

Accretion
7.7

Liabilities incurred
5.2

Liabilities settled
(0.2
)
ARO liability at September 30,
$
176.6


Note 6 – Fair Value Measurements
 
QEP measures and discloses fair values in accordance with the provisions of ASC 820 “Fair Value Measurements and Disclosures”. This guidance defines fair value in applying GAAP, establishes a framework for measuring fair value and expands disclosures about fair-value measurements, but does not change existing guidance as to whether or not an instrument is carried at fair value. ASC 820 also establishes a fair-value hierarchy. Level 1 inputs are quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.
 
QEP has determined its commodity derivative instruments are Level 2. The Level 2 fair value of commodity derivative contracts (see Note 7 - Derivative Contracts) is based on market prices posted on the NYMEX on the last trading day of the reporting period and industry standard discounted cash flow models. QEP primarily applies the market approach for recurring fair value measurements and maximizes its use of observable inputs and minimizes its use of unobservable inputs. QEP considers bid and ask prices for valuing the majority of its assets and liabilities measured and reported at fair value. In addition to using market data, QEP makes assumptions in valuing its assets and liabilities, including assumptions about risk and the risks inherent in the inputs to the valuation technique. The Company’s policy is to recognize significant transfers between levels at the end of the reporting period.
 
However, certain of the Company's commodity derivative instruments are valued using industry standard models that consider various inputs, including quoted forward prices for commodities, time value, volatility, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these inputs are observable in the marketplace throughout the full term of the instrument and can be derived from observable data or are supported by observable prices at which transactions are executed in the marketplace. The determination of fair value for derivative assets and liabilities also incorporates nonperformance risk for counterparties and for QEP. Derivative contract fair values are reported on a net basis to the extent a legal right of offset with the counterparty exists.
 
In addition, QEP has interest rate swaps that it has determined are Level 2. The fair values of the interest rate swaps are determined using the market standard methodology of discounting the future expected cash flows that would occur under the contractual terms of the swap. The variable interest rates used in the calculation of projected cash flows are based on an expectation of future interest rates derived from observable market interest rate curves. QEP incorporates credit valuation adjustments to reflect both its nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. While the credit valuation adjustments are not observable inputs, they are not significant to the overall valuation and the other inputs used to value the interest rate swaps are observable Level 2 inputs.


10



The fair value of financial assets and liabilities at September 30, 2012, is shown in the table below:

 
Fair Value Measurements
 
September 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Netting
Adjustments
 
Total
 
 
 
(in millions)
Financial Assets
 
 
 
 
 
 
 
 
 
Commodity derivative instruments - short-term
$

 
$
199.4

 
$

 
$
(12.2
)
 
$
187.2

Commodity derivative instruments - long-term

 
38.2

 

 
(3.0
)
 
$
35.2

Total financial assets
$

 
$
237.6

 
$

 
$
(15.2
)
 
$
222.4

 
 
 
 
 
 
 
 
 
 
Financial Liabilities
 

 
 

 
 

 
 

 
 

Commodity derivative instruments - short-term
$

 
$
12.3

 
$

 
$
(12.2
)
 
$
0.1

Interest rate swaps - short-term

 
2.6

 

 

 
$
2.6

Commodity derivative instruments - long-term

 
3.0

 

 
(3.0
)
 
$

Interest rate swaps - long-term

 
4.1

 

 

 
$
4.1

Total financial liabilities
$

 
$
22.0

 
$

 
$
(15.2
)
 
$
6.8

 
Fair values related to the Company’s crude oil costless collars were transferred from Level 3 to Level 2 in the second quarter of 2012, due to the enhancements to the Company’s internal valuation process, including the use of observable inputs to assess the fair value. There were no other significant transfers in or out of Levels 1, 2 or 3 for the periods presented herein.

The change in the fair value of Level 3 commodity derivative instruments assets and liabilities for the nine months ended September 30, 2012, is shown below:
 
 
Change in Level 3 Fair
Value Measurements
 
2012
 
(in millions)
Balance at January 1,
$

Realized gains and losses
0.6

Unrealized gains and losses
3.8

Settlements
(0.6
)
Transfers out of Level 3
(3.8
)
Balance at September 30,
$



11



The fair value of financial assets and liabilities at December 31, 2011, is shown in the table below:

 
Fair Value Measurements
 
December 31, 2011
 
Level 1
 
Level 2
 
Level 3
 
Netting
Adjustments
 
Total
 
 
 
(in millions)
Financial Assets
 
 
 
 
 
 
 
 
 
Commodity derivative instruments - short-term
$

 
$
284.1

 
$

 
$
(10.4
)
 
$
273.7

Commodity derivative instruments - long-term

 
123.5

 

 

 
$
123.5

Total financial assets
$

 
$
407.6

 
$

 
$
(10.4
)
 
$
397.2

 
 
 
 
 
 
 
 
 
 
Financial Liabilities
 

 
 

 
 

 
 

 
 

Commodity derivative instruments - short-term
$

 
$
11.7

 
$

 
$
(10.4
)
 
$
1.3

Commodity derivative instruments - long-term

 

 

 

 
$

Total financial liabilities
$

 
$
11.7

 
$

 
$
(10.4
)
 
$
1.3


The following table discloses the fair value and related carrying amount of certain financial instruments not disclosed in other notes to the condensed consolidated financial statements in this quarterly report on Form 10-Q:
 
 
Carrying
Amount
 
Level 1
Fair Value
 
Carrying
Amount
 
Level 1
Fair Value
 
September 30, 2012
 
December 31, 2011
 
(in millions)
Financial liabilities
 

 
 

 
 

 
 

Checks outstanding in excess of cash balances
$
27.5

 
$
27.5

 
$
29.4

 
$
29.4

Long-term debt
$
3,180.7

 
$
3,330.4

 
$
1,679.4

 
$
1,754.9


The carrying amount of checks outstanding in excess of cash balances approximates fair value. The fair value of fixed-rate long-term debt is based on the trading levels and dollar prices for the Company’s debt at the end of the quarter. The carrying amount of variable-rate long-term debt approximates fair value because the floating interest rate paid on such debt was set for periods of one month.

The initial measurement of asset retirement obligations at fair value is calculated using discounted cash flow techniques and based on internal estimates of future retirement costs associated with property, plant and equipment. Significant Level 3 inputs used in the calculation of asset retirement obligations include plugging costs and reserve lives. A reconciliation of the Company’s asset retirement obligations is presented in Note 5 – Asset Retirement Obligations.

Nonrecurring Fair Value Measurements

The provisions of the fair value measurement standard are also applied to the Company’s nonrecurring, non-financial measurements.  The Company utilizes fair value on a non-recurring basis to review its proved oil and gas properties for potential impairment when events and circumstances indicate a possible decline in the recoverability of the carrying value of such property. During the nine months ended September 30, 2012 and the year ended December 31, 2011, the Company recorded impairments on certain oil and gas properties resulting in a write down of the associated carrying value to fair value. The fair value of the property was measured utilizing the income approach and utilizing inputs which are primarily based upon internally developed cash flow models. Given the unobservable nature of the inputs, proved oil and gas property impairments are considered Level 3 within the fair value hierarchy. During the nine months ended September 30, 2012, the Company recorded $49.3 million of impairments related to some of its proved properties. The proved properties were written down to their estimated fair values of $36.7 million, at the time of impairment.

Note 7 – Derivative Contracts
 

12



QEP has established policies and procedures for managing commodity price volatility through the use of derivative instruments. In the normal course of business, QEP uses commodity derivative instruments to reduce the impact of downward movements in commodity prices on cash flow, returns on capital, and other financial results. However, these instruments typically limit gains from favorable price movements. The volume of production subject to commodity derivative instruments and the mix of the instruments are frequently evaluated and adjusted by management in response to changing market conditions. QEP may enter into commodity derivative contracts for up to 100% of forecasted production from proved reserves. In addition, QEP may enter into commodity derivative contracts on a portion of its extracted NGL volumes in its midstream business and a portion of its natural gas sales and purchases for marketing transactions. QEP does not enter into commodity derivative instruments for speculative purposes.
 
QEP uses commodity derivative instruments known as fixed-price swaps and costless collars to realize a known price or range of prices for a specific volume of production delivered into a regional sales point. Costless collars are combinations of put and call options that have a floor price and a ceiling price and payments are made or received only if the settlement price is outside the range between the floor and ceiling prices. QEP’s commodity derivative instruments do not require the physical delivery of natural gas, crude oil, or NGL between the parties at settlement. Swap and costless collar transactions are settled in cash with one party paying the other for the net difference in prices, multiplied by the contract volume, for the settlement period. Natural gas price derivative instruments are typically structured as fixed-price swaps at regional price indices. Oil price derivative instruments are typically structured as NYMEX fixed-price swaps based at Cushing, Oklahoma. NGL price derivative instruments are typically structured as Mont Belvieu, Texas fixed-price swaps.

QEP enters into commodity derivative transactions that do not have margin requirements or collateral provisions that would require payments prior to the scheduled settlement dates. Commodity derivative contract counterparties are normally financial institutions and energy trading firms with investment-grade credit ratings. QEP routinely monitors and manages its exposure to counterparty risk by requiring specific minimum credit standards for all counterparties and avoids concentration of credit exposure by transacting with multiple counterparties.
 
Through December 31, 2011, QEP designated the majority of its natural gas, oil and NGL derivative contracts as cash flow hedges, whose unrealized fair value gains and losses were recorded to AOCI. Effective January 1, 2012, QEP elected to de-designate all of its natural gas, crude oil and NGL derivative contracts that were previously designated as cash flow hedges and discontinue hedge accounting prospectively. As a result of discontinuing hedge accounting, the mark-to-market values at December 31, 2011, were fixed in AOCI as of the de-designation date and are being reclassified into the Consolidated Statement of Operations as the transactions settle and affect earnings. At September 30, 2012, AOCI consisted of $182.9 million ($114.9 million after tax) of unrealized gains. QEP expects to reclassify into earnings from AOCI the fixed value related to de-designated natural gas, oil and NGL hedges over the remainder of 2012 and 2013. Currently, QEP recognizes all gains and losses from changes in the fair value of natural gas, oil and NGL derivative contracts immediately in earnings rather than deferring any such amounts in AOCI. All commodity derivative instruments are recorded on the Consolidated Balance Sheets as either assets or liabilities measured at their fair values and  all realized and unrealized gains and losses from derivative instruments incurred after January 1, 2012, are presented in the Consolidated Statement of Operations in “Realized and unrealized gains on derivative contracts” below operating income.
 
QEP also uses interest rate swaps to mitigate a portion of its exposure to interest rate volatility risk. During the second quarter of 2012, QEP entered into variable-to-fixed interest rate swap agreements having a combined notional principal amount of $300.0 million to minimize the interest rate volatility risk associated with its $300.0 million senior, unsecured term loan. QEP locked in a fixed interest rate in exchange for a variable interest rate indexed to the one-month LIBOR rate. The interest rate swaps settle monthly and will mature in March of 2017.
 



13



QEP Energy Derivative Contracts
 
The following table sets forth QEP Energy’s quantities and average prices for its commodity derivative contracts as of September 30, 2012:
 
 
 
 
 
 
 
 
 
Swaps
 
Collars
Year
 
Type of Contract
 
Index
 
Total
Volumes
 
Average price per
unit
 
Floor price
 
Ceiling
price
 
 
 
 
 
 
(in millions)
 
 
 
 
 
 
Natural gas sales
 
 
 
 
 
(MMBtu)

 
 
 
 
 
 
2012
 
Swap
 
NYMEX
 
19.3

 
$
4.72

 
 

 
 

2012
 
Swap
 
IFPEPL (1)
 
1.8

 
$
4.70

 
 
 
 
2012
 
Swap
 
IFNPCR (2)
 
22.1

 
$
4.67

 
 

 
 

2012
 
Swap
 
IFCNPTE (3)
 
2.8

 
$
2.66

 
 
 
 
2013
 
Swap
 
NYMEX
 
29.2

 
$
3.68

 
 

 
 

2013
 
Swap
 
IFNPCR (2)
 
65.7

 
$
5.66

 
 
 
 
Oil sales
 
 
 
 
 
(Bbls)

 
 

 
 

 
 

2012
 
Swap
 
NYMEX WTI
 
1.3

 
$
97.42

 
 
 
 
2012
 
Collar
 
NYMEX WTI
 
0.4

 
 

 
$
87.50

 
$
115.36

2013
 
Swap
 
NYMEX WTI
 
5.1

 
$
98.48

 
 

 
 

2014
 
Swap
 
NYMEX WTI
 
1.8

 
$
92.72

 
 
 
 
NGL sales
 
 
 
 
 
(Gals)

 
 

 
 

 
 

2012
 
Swap
 
Mt. Belvieu Ethane
 
3.9

 
$
0.64

 
 

 
 

2012
 
Swap
 
Mt. Belvieu Propane
 
5.8

 
$
1.28

 
 

 
 

____________________________
(1) 
Inside FERC monthly settlement index for the Panhandle Eastern Pipeline Company.
(2) 
Inside FERC monthly settlement index for the Northwest Pipeline Corp. Rocky Mountains.
(3) 
Inside FERC monthly settlement index for Centerpoint East.

QEP Field Services Derivative Contracts
 
QEP Field Services enters into commodity derivative transactions to manage price risk on extracted NGL volumes. The following table sets forth QEP Field Services’ volumes and swap prices for its commodity derivative contracts as of September 30, 2012:

Year
 
Type of Contract
 
Index
 
Total
Volumes
 
Average Swap price
per gallon
 
 
 
 
 
 
(in millions)
 
 
NGL sales
 
 
 
 
 
(Gals)

 
 
2012
 
Swap
 
Mt. Belvieu Ethane
 
3.9

 
$
0.64

2012
 
Swap
 
Mt. Belvieu Propane
 
1.9

 
$
1.28



14



QEP Marketing Derivative Contracts
 
QEP Marketing enters into commodity derivative transactions to lock in a margin on natural gas volumes placed into storage and for marketing transactions in which QEP Marketing is required to sell gas volumes at a fixed price. The following table sets forth QEP Marketing’s volumes and swap prices for its commodity derivative contracts as of September 30, 2012:
 
Year
 
Type of Contract
 
Index
 
Total
Volumes
 
Average Swap price
per MMBtu
 
 
 
 
 
 
(in millions)
 
 
Natural gas sales
 
 
 
 
 
(MMBtu)

 
 
2012
 
Swap
 
IFNPCR (1)
 
2.1

 
$
3.93

2013
 
Swap
 
IFNPCR (1)
 
3.1

 
$
3.77

Natural gas purchases
 
 
 
 
 
(MMBtu)

 
 

2012
 
Swap
 
IFNPCR (1)
 
1.5

 
$
2.76

2013
 
Swap
 
IFNPCR (1)
 
0.1

 
$
2.59

 ____________________________
(1) 
Inside FERC monthly settlement index for the Northwest Pipeline Corp. Rocky Mountains.

QEP Resources Derivative Contracts
 
In the second quarter of 2012, QEP Resources entered into interest rate swap agreements to effectively lock in a fixed interest rate on debt outstanding under its Term Loan.
 
The following table sets forth QEP Resources’ notional amounts and interest rates for its interest rate swaps outstanding as of September 30, 2012:
 
Notional amount
 
Type of Contract
 
Maturity
 
Fixed Rate Paid
 
Variable Rate Received
(in millions)
 
 
 
 
 
 
 
 
$300.0
 
Swap
 
March 2017
 
1.07%
 
One month LIBOR
 

15



QEP Derivative Financial Statement Presentation
 
The following table presents the balance sheet location of QEP’s outstanding derivative contracts on a gross contract basis as opposed to the net contract basis presentation in the Condensed Consolidated Balance Sheets and the related fair values at the balance sheet dates:
 
 
 
 
Gross asset derivative
instruments fair value
 
Gross liability derivative
instruments fair value
 
Balance Sheet
line item
 
September 30,
2012
 
December 31, 2011
 
September 30,
2012
 
December 31, 2011
 
 
 
(in millions)
 
(in millions)
Current:
 
 
 
 
 
 
 
 
 
Commodity
Fair value of derivative contracts
 
$
199.4

 
$
284.1

 
$
12.3

 
$
11.7

Interest rate swaps
Fair value of derivative contracts
 

 

 
2.6

 

Long-term:
 
 
 

 
 

 
 

 
 

Commodity
Fair value of derivative contracts
 
38.2

 
123.5

 
3.0

 

Interest rate swaps
Fair value of derivative contracts
 

 

 
4.1

 

Total derivative
   instruments
 
 
$
237.6

 
$
407.6

 
$
22.0

 
$
11.7



16



The effects and location of the change in fair value and settlement of QEP's derivative contracts on the Condensed Consolidated Statements of Operations are summarized in the following tables:
 
Derivative instruments not designated as cash flow hedges
 
Location of gain (loss) recognized in earnings
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
 
 
(in millions)
Realized gain (loss) on commodity derivative contracts
QEP Energy
 
 
 
 
 
 
 
 
 
 
Natural gas derivative contracts
 
 
 
$
86.2

 
$
(27.9
)
 
$
283.8

 
$
(86.7
)
Oil derivative contracts
 
 
 
2.7

 

 
2.2

 

NGL derivative contracts
 
 
 
3.4

 

 
6.5

 

QEP Field Services
 
 
 
 

 
 

 
 

 
 

NGL derivative contracts
 
 
 
1.9

 

 
6.3

 

QEP Marketing
 
 
 
 

 
 

 
 

 
 

Natural gas derivative contracts
 
 
 
(0.4
)
 

 
3.7

 

Total realized gain (loss) on commodity derivative contracts
 
 
 
93.8

 
(27.9
)
 
302.5

 
(86.7
)
Unrealized gain (loss) on commodity derivative contracts
QEP Energy
 
 
 
 

 
 

 
 

 
 

Natural gas derivative contracts
 
 
 
(50.6
)
 
27.9

 
3.3

 
86.7

Oil derivative contracts
 
 
 
4.1

 

 
31.2

 

NGL derivative contracts
 
 
 
(4.4
)
 

 
3.4

 

QEP Field Services
 
 
 
 

 
 

 
 

 
 

NGL derivative contracts
 
 
 
(2.5
)
 

 
2.0

 

QEP Marketing
 
 
 
 

 
 

 
 

 
 

Natural gas derivative contracts
 
 
 
(1.4
)
 

 
(0.5
)
 

Total unrealized (loss) gain on commodity derivative contracts
 
 
 
(54.8
)
 
27.9

 
39.4

 
86.7

Total realized and unrealized gain on commodity derivative contracts
 
 
 
$
39.0

 
$

 
$
341.9

 
$

Realized gain (loss) on interest rate swaps
Realized loss on interest rate swaps
 

 
$
(0.6
)
 
$

 
$
(0.6
)
 
$

Unrealized gain (loss) on interest rate swaps
Unrealized loss on interest rate swaps
 

 
(2.3
)
 

 
(6.6
)
 

Total realized and unrealized loss on interest rate swaps
 
 
 
$
(2.9
)
 
$

 
$
(7.2
)
 
$

 
 
 
 
 
 
 
 
 
 
 
Grand Total
 
Realized and unrealized gains on derivative contracts
 
$
36.1

 
$

 
$
334.7

 
$

 

17



Derivative instruments classified as cash flow hedges
 
Location of gain (loss) recognized in earnings
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Commodity derivatives
 
 
 
(in millions)
Gain on derivative instruments for the effective portion of hedge recognized in AOCI
 
Accumulated other comprehensive income
 
$

 
$
129.6

 
$

 
$
191.1

Gain reclassified from AOCI into income for effective portion of hedge
 
Natural gas sales
 

 
71.6

 

 
209.1

Gain reclassified from AOCI into income for effective portion of hedge
 
Oil sales
 

 
0.9

 

 
1.0

Gain reclassified from AOCI into income for effective portion of hedge
 
NGL sales
 

 
(0.3
)
 

 
(0.3
)
Gain reclassified from AOCI into income for effective portion of hedge
 
Marketing sales
 

 

 

 

Gain reclassified from AOCI into income for effective portion of hedge
 
Marketing purchases
 

 
0.4

 

 
4.3

Gain recognized in income for the ineffective portion of hedges
 
Interest and other income
 

 
(2.7
)
 

 
(2.6
)

The Company estimates that derivative contracts that were outstanding in AOCI at September 30, 2012, having a fixed fair value of $97.7 million, will be settled and reclassified from AOCI to the Condensed Consolidated Statements of Operations during the next twelve months.

Note 8 – Restructuring Costs
 
During the first quarter 2012, QEP began incurring costs related to the closure of its Oklahoma City office and the subsequent consolidation of its Southern Region operations into a single regional office located in Tulsa. The creation of one office for QEP’s Southern Region is intended to increase regional efficiency, team-based collaboration and organizational productivity over the long term. During the third quarter of 2012, QEP incurred additional restructuring and reorganization costs related to consolidating various corporate and accounting functions to the Denver corporate headquarters. As part of the reorganization, QEP will incur costs associated with the severance, retention and relocation of employees and other exit costs associated with the termination of operating leases arising from office space that will no longer be utilized by the Company. The majority of the restructuring costs will be incurred during the remainder of 2012 and in 2013.


18



The following table summarizes, by line of business, each major type of costs expected to be incurred and the total amounts recorded in "General and administrative" expense on the Condensed Consolidated Statement of Operations the respective periods indicated:

 
QEP
Energy
 
QEP
Field Services
 
QEP
Marketing
 
Total
Restructuring costs expected to be incurred
(in millions)
One-time termination benefits
$
3.4

 
$

 
$
0.3

 
$
3.7

Retention & relocation expense
5.5

 
0.2

 
0.2

 
5.9

Lease termination costs
0.6

 

 

 
0.6

Total restructuring costs expected to be incurred
$
9.5

 
$
0.2

 
$
0.5

 
$
10.2

 
 
 
 
 
 
 
 
Total restructuring costs recognized in income during the current period
 
 
 
 
During the three months ended September 30, 2012
 
 
 
 
 
 

One-time termination benefits
$
0.2

 
$

 
$

 
$
0.2

Retention & relocation expense

 

 

 

Lease termination costs

 

 

 

Total restructuring costs incurred for the three months ended September 30, 2012
$
0.2

 
$

 
$

 
$
0.2

 
 
 
 
 
 
 
 
During the nine months ended September 30, 2012
 
 
 
 
 
 

One-time termination benefits
$
2.1

 
$

 
$

 
$
2.1

Retention & relocation expense
3.2

 

 

 
3.2

Lease termination costs

 

 

 

Total restructuring costs incurred for the nine months ended September 30, 2012
$
5.3

 
$

 
$

 
$
5.3


The following is a reconciliation of the restructuring liability, by line of business, which is included within “Accounts payable and accrued expenses” on the Condensed Consolidated Balance Sheets:

 
QEP Energy
 
QEP Field Services
 
QEP Marketing
 
Total
 
(in millions)
Balance at December 31, 2011
$

 
$

 
$

 
$

Costs incurred and charged to expense
5.3

 

 

 
5.3

Costs paid or otherwise settled
(5.1
)
 

 

 
(5.1
)
Balance at September 30, 2012
$
0.2

 

 

 
$
0.2

 

19



Note 9 – Debt
 
As of the indicated dates, the principal amount of QEP’s debt, including amounts outstanding under its revolving credit facility, consisted of the following:
 
 
September 30,
2012
 
December 31,
2011
 
(in millions)
Revolving Credit Facility due 2016
$
664.0

 
$
606.5

Term Loan due 2017
300.0

 

6.05% Senior Notes due 2016
176.8

 
176.8

6.80% Senior Notes due 2018
134.0

 
138.6

6.80% Senior Notes due 2020
136.0

 
138.0

6.875% Senior Notes due 2021
625.0

 
625.0

5.375% Senior Notes due 2022
500.0

 

5.25% Senior Notes due 2023
650.0

 

Total principal amount of debt
3,185.8

 
1,684.9

Less unamortized discount
(5.1
)
 
(5.5
)
Total long-term debt outstanding
$
3,180.7

 
$
1,679.4

 
Of the total debt outstanding on September 30, 2012, the revolving credit facility due August 25, 2016, the Term Loan due April 18, 2017, and the 6.05% Senior Notes due September 1, 2016, will mature within the next five years.
 
Credit Facility
 
QEP’s revolving credit facility agreement, which matures in August 2016, provides for loan commitments of $1.5 billion from a group of financial institutions. The Credit Facility provides for borrowing at short-term interest rates and contains customary covenants and restrictions. The credit facility agreement also contains an accordion provision that would allow for the amount of the facility to be increased to $2.0 billion and for the maturity to be extended for up to two additional one-year periods, with the agreement of the lenders.

During the nine months ended September 30, 2012, QEP’s weighted-average interest rate on borrowings from its Credit Facility was 2.05%. At September 30, 2012 and December 31, 2011, QEP was in compliance with the covenants under the credit agreement. At September 30, 2012, there was $664.0 million outstanding and QEP had $4.1 million in letters of credit outstanding under the Credit Facility.

Term Loan
 
During the second quarter of 2012, QEP entered into a $300.0 million senior, unsecured term loan agreement (Term Loan) with a group of financial institutions. The Term Loan provides for borrowings at short-term interest rates and contains covenants, restrictions and interest rates that are substantially the same as the Company’s Credit Facility. The Term Loan matures in April 2017, and the maturity date may be extended one year with the agreement of the lenders. The proceeds from the Term Loan were used to pay down the Credit Facility and for general corporate purposes. During the nine months ended September 30, 2012, QEP’s weighted-average interest rate on borrowings from the Term Loan was 2.02%. At September 30, 2012, QEP was in compliance with the covenants under the Term Loan credit agreement.
 
Senior Notes

During the third quarter of 2012, QEP completed a public offering of $650.0 million in aggregate principal amount of 5.25% senior notes due in May 2023 (2023 Senior Notes). The 2023 Senior Notes were issued at face value. Interest on the 2023 Senior Notes will be paid semi-annually, in May and November of each year. The estimated net proceeds of $640.8 million were used to fund a portion of the Acquisition, as described in Note 3 - Acquisition. The estimated costs associated with the offering were $9.2 million and were deferred and are being amortized over the life of the notes. The amortization expense related to all of the Company's deferred finance costs is included in “Interest expense” on the Condensed Consolidated Statement of Operations.


20



During the second quarter of 2012, QEP repurchased $6.7 million of its senior notes outstanding. QEP recognized a loss on extinguishment of debt from those repurchases and associated write-offs of debt issuance costs, discounts and premiums paid of $0.6 million.

During the first quarter of 2012, QEP completed a public offering of $500.0 million in aggregate principal amount of 5.375% senior notes due in October 2022 (2022 Senior Notes). The 2022 Senior Notes were issued at face value. Interest on the 2022 Senior Notes will be paid semi-annually, in April and October of each year. The net proceeds of $493.1 million were used to repay indebtedness under QEP's Credit Facility. The finance costs associated with the offering were $6.9 million and were deferred and are being amortized over the life of the notes.

At September 30, 2012, the Company had $2,221.8 million principal amount of senior notes outstanding with maturities ranging from September 2016 to May 2023 and coupons ranging from 5.25% to 6.875%. The senior notes pay interest semi-annually, are unsecured senior obligations and rank equally with all of our other existing and future unsecured and senior obligations. QEP may redeem some or all of its senior notes at any time before their maturity at a redemption price based on a make-whole amount plus accrued and unpaid interest to the date of redemption. The indenture governing QEP’s senior notes contains customary events of default and covenants that may limit QEP’s ability to, among other things, place liens on its property or assets.


Note 10 – Contingencies
 
QEP is involved in various commercial and regulatory claims, litigation and other legal proceedings that arise in the ordinary course of its business. Management does not believe any of them will have a material effect on the Company's financial position, results of operations or cash flows, except with regard to cases discussed below where management cannot determine at this time whether they will have a material effect. In accordance with ASC 450, Contingencies, an accrual is recorded for a loss contingency when its occurrence is probable and damages can be reasonably estimated based on the anticipated most likely outcome or the minimum amount within a range of possible outcomes. QEP's estimates are based on information known about the claims, and experience in contesting, litigating and settling similar claims. Disclosures are also provided for reasonably possible losses that could have a material effect on the Company's financial position, results of operations or cash flows. The following discussion describes the nature of QEP's major loss contingencies.
 
Environmental Claims
 
United States of America v. QEP Field Services, Civil No. 208CV167, U.S. District Court for Utah. The U.S. Environmental Protection Agency (EPA) alleged that QEP Field Services (f/k/a Questar Gas Management) violated the Clean Air Act (CAA) and sought substantial penalties and a permanent injunction involving the manner of operation of five compressor stations located in the Uinta Basin of eastern Utah. On May 16, 2012, QEP Field Services settled this matter and the parties executed a consent decree which was subsequently approved by court order. The civil penalty paid to the government during the third quarter of 2012 was $3.7 million. A contribution of $0.4 million will be payable to a non-profit corporation or trust to be created by the Ute Indian Tribe of the Uintah and Ouray Reservation for the implementation of environmental programs for the benefit of Tribal members. The settlement also requires the Company to reduce its emissions by removing certain equipment, installing additional pollution controls and replacing the natural gas powered instrument control systems with compressed air control systems, all of which will require capital expenditures of approximately $2.4 million, of which $0.8 million had been spent as of September 30, 2012. QEP Field Services will have continuing operational compliance obligations under the consent decree at the affected facilities.

Litigation
 
Chieftain Royalty Company v. QEP Energy Company, Case No CJ2011-1, U. S. District Court for Oklahoma. This is a class action filed by two royalty owners on behalf of all QEP Energy royalty owners in the state of Oklahoma since 1988, asserting various claims for damages related to royalty valuation on all of QEP's Oklahoma wells. These claims include breach of contract, breach of fiduciary duty, fraud, unjust enrichment, tortious breach of contract, conspiracy, and conversion, based generally on asserted improper deduction of post-production costs. The court has certified the class as to the breach of contract, breach of fiduciary duty and unjust enrichment claims. Because this case involves complex legal issues and uncertainties, a large class of plaintiffs and a large number of producing properties and wells, and because the proceedings are in the early stages, with substantive discovery yet to be conducted, the Company is unable to estimate a reasonably possible loss or range of loss. Although the plaintiff class has not made a formal demand, based upon the class allegations, we believe the class may seek damages in excess of $200 million. QEP Energy is still evaluating the claims, but believes that it has properly valued and paid royalty under Oklahoma law and will vigorously defend this case.

21



 
Questar Gas Company v. QEP Field Services Company, Civil No. 120902969, Third Judicial District Court, State of Utah. QEP Field Services' former affiliate Questar Gas Company (QGC) filed this complaint in state court in Utah on May 1, 2012, asserting claims for breach of contract, breach of implied covenant of good faith and fair dealing, for an accounting and declaratory judgment related to a 1993 gathering agreement (1993 Agreement) entered when the parties were affiliates. Under the 1993 Agreement, QEP Field Services provides gathering services for producing properties developed by former affiliate Wexpro Company on behalf of QGC's utility ratepayers. The core dispute pertains to the annual calculation of the gathering rate, which is based on a cost of service concept expressed in the 1993 Agreement and in a 1998 amendment. The annual gathering rate has been calculated in the same manner under the contract since it was amended in 1998, without any prior objection or challenge by QGC. Specific monetary damages are not asserted. Also, on May 1, 2012, QEP Field Services Company filed a legal action against Questar Gas entitled QEP Field Services Company v. Questar Gas Company, in the Second District Court in Denver County, Colorado, seeking declaratory judgment relating to its gathering service and charges under the same agreement.
 
Note 11 – Share-Based Compensation
 
QEP issues stock options and restricted shares under its Long-Term Stock Incentive Plan (LTSIP) and awards performance-based share units under its Cash Incentive Plan (CIP) to certain officers, employees, and non-employee directors. QEP recognizes expense over time as the stock options, restricted shares, and performance-based share units vest. Deferred share-based compensation is included in additional paid-in capital in the Condensed Consolidated Balance Sheets. There were 13.1 million shares available for future grants under the LTSIP at September 30, 2012. Share-based compensation expense is recognized in “General and administrative” on the Condensed Consolidated Statements of Operations. During the three and nine months ended September 30, 2012, QEP recognized $7.2 million and $19.5 million, respectively, in total compensation expense related to share-based compensation compared to $5.7 million and $16.5 million during the three and nine months ended September 30, 2011. The increase in share-based compensation recognized in 2012 compared to 2011 was due to increased restricted shares and options granted in late 2011 and throughout 2012.
 
Stock Options
 
QEP uses the Black-Scholes-Merton mathematical model to estimate the fair value of stock options for accounting purposes. Fair-value calculations rely upon subjective assumptions used in the mathematical model and may not be representative of future results. The Black-Scholes-Merton model is intended for measuring the value of options traded on an exchange.
 
The calculated fair value of options granted and major assumptions used in the model at the date of grant are listed below:
 
 
Stock Option Variables
 
Nine Months Ended
 
September 30, 2012
Fair value of options at grant date
$
14.29

Risk-free interest rate
0.81
%
Expected price volatility
55.9
%
Expected dividend yield
0.26
%
Expected life in years
5.0



22



Stock option transactions under the terms of the LTSIP are summarized below:
 
 
Options
Outstanding
 
Weighted-
Average Price
 
Weighted-Average
Remaining
Contractual Term
 
Aggregate
Intrinsic Value
 
 
 
(per share)
 
(in years)
 
(in millions)
Outstanding at December 31, 2011
2,003,694

 
$
21.23

 
 
 
 
Granted
301,035

 
30.76

 
 
 
 
Exercised
(336,675
)
 
9.21

 
 

 
 

Forfeited

 

 

 
 
Outstanding at September 30, 2012
1,968,054

 
$
24.74

 
3.4

 
$
15.1

Options Exercisable at September 30, 2012
1,505,051

 
$
22.38

 
2.6

 
$
14.6

Unvested Options at September 30, 2012
463,003

 
$
32.43

 
5.9

 
$
0.2

 
The total intrinsic value (the difference between the market price at the exercise date and the exercise price) of options exercised was $7.1 million and $2.7 million during the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, $3.6 million of unrecognized compensation cost related to stock options granted under the LTSIP is expected to be recognized over a weighted-average period of 2.2 years.
 
Restricted Shares
 
Restricted share grants typically vest in equal installments over a three or four-year period from the grant date. The total fair value of restricted stock that vested during the nine months ended September 30, 2012 and 2011, was $16.6 million and $11.5 million, respectively. The weighted average grant-date fair value of restricted stock was $30.59 per share and $39.26 per share for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, $21.1 million of unrecognized compensation cost related to restricted shares granted under the LTSIP is expected to be recognized over a weighted-average vesting period of 2.2 years.
 
Transactions involving restricted shares under the terms of the LTSIP are summarized below:
 
 
Restricted Shares
Outstanding
 
Weighted-
Average Price
 
 
 
(per share)
Unvested balance at December 31, 2011
1,099,752

 
$
32.80

Granted
778,780

 
30.59

Vested
(538,668
)
 
31.88

Forfeited
(61,502
)
 
32.70

Unvested balance at September 30, 2012
1,278,362

 
$
31.85

 
Performance Share Units
 
Cash payouts are dependent upon the Company’s total shareholder return compared to a group of its peers over a three-year period. The awards are denominated in share units but delivered in cash at the end of the performance period. The weighted average grant-date fair value of the performance share units was $30.90 per share and $39.07 per share for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, $6.2 million of unrecognized compensation cost, or the fair market value, related to performance shares granted under the CIP is expected to be recognized over a weighted-average vesting period of 2.1 years.
 

23



Transactions involving performance share units under the terms of the CIP are summarized below:
 
 
Performance Share
Units Outstanding
 
Weighted-
Average Price
Unvested balance at December 31, 2011
115,274

 
$
39.07

Granted
179,304

 
30.90

Vested

 

Forfeited
(12,713
)
 
35.69

Unvested balance at September 30, 2012
281,865

 
$
34.03

 
Note 12 – Employee Benefits
 
The Company has a funded qualified defined benefit pension plan and an unfunded supplemental defined benefit pension plan. The Company also has unfunded postretirement benefit plans that provide certain health care and life insurance benefits for certain retired employees. During the nine months ended September 30, 2012, the Company made contributions of $4.9 million to its funded pension plan, and $1.0 million to its unfunded pension plan. Contributions to funded plans increase plan assets while contributions to unfunded plans are used to fund current benefit payments. During the remainder of 2012, the Company expects to contribute approximately $0.7 million to its funded pension plans, and approximately $0.3 million to its unfunded pension plans. In July 2012, Congress passed the Moving Ahead for Progress in the 21st Century Act, which included pension funding stabilization provisions. The measure, which is designed to stabilize the discount rate used to determine funding requirements from the effects of interest rate volatility, may reduce the Company’s United States Pension Plan contributions during the remainder of 2012 from the planned amounts.

The following table sets forth the Company’s pension and postretirement benefits net period benefit costs:
 
 
Pension
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in millions)
Service cost
$
1.1