-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TB6bphBrgBZXAewsj5yo5pXrXgeOPEgzfhAL7s0Z7zjE4oZ5F3w7OK7g0PSSSBN9 i9+HJkhz45f1lfDmIQPdvw== 0000950124-98-006442.txt : 19981116 0000950124-98-006442.hdr.sgml : 19981116 ACCESSION NUMBER: 0000950124-98-006442 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MICHIGAN CONSOLIDATED GAS CO /MI/ CENTRAL INDEX KEY: 0000065632 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS DISTRIBUTION [4924] IRS NUMBER: 380478040 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-07310 FILM NUMBER: 98745949 BUSINESS ADDRESS: STREET 1: 500 GRISWOLD ST CITY: DETROIT STATE: MI ZIP: 48226 BUSINESS PHONE: 3139652430 10-Q 1 FORM 10-Q 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998, or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ------------ ------------- COMMISSION FILE NUMBER 1-7310 MICHIGAN CONSOLIDATED GAS COMPANY (Exact name of registrant as specified in its charter) MICHIGAN 38-0478040 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 500 GRISWOLD STREET, DETROIT, MICHIGAN 48226 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 313-965-2430 NO CHANGES (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Number of shares outstanding of each of the registrant's classes of common stock, as of October 31, 1998: Common Stock, par value $.01 per share: 10,300,000 ================================================================================ 2 INDEX TO FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 1998 PAGE NUMBER ------ COVER ................................................................. i INDEX ................................................................. ii PART I - FINANCIAL INFORMATION Item 1. Financial Statements.......................................... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 1 PART II - OTHER INFORMATION Item 1. Legal Proceedings............................................. 14 Item 6. Exhibits and Reports on Form 8-K.............................. 14 SIGNATURE ............................................................. 15 ii 3 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Earnings decreased $2.3 million and $0.7 million in the 1998 quarter and nine-month periods, respectively, and increased $3.8 million for the 1998 twelve-month period. Earnings in all three 1998 periods were unfavorably affected by a net $11.2 million ($24.8 million gross) asset write-down in the 1998 quarter relating to certain gas gathering properties. Excluding the unusual write-down, MichCon's earnings increased by $8.9 million, $10.5 million and $15.0 million for the 1998 quarter, nine- and twelve-month periods. Earnings in all three 1998 periods reflect significantly lower operating costs as well as continued growth in intermediate transportation revenues. These improvements more than offset lower gross margins in the nine-and twelve-month periods resulting from reduced gas sales and end user transportation deliveries, which were primarily due to abnormally warm weather.
- ------------------------------------------------------------------------------------------------------------------- EARNINGS COMPONENTS (IN MILLIONS) -------------------------------- COMPARING 1998 TO 1997 --------------------- Quarter Nine Months Twelve Months ------- ----------- ------------- $ Change % Change $ Change % Change $ Change % Change -------- -------- -------- -------- -------- -------- Operating Revenue ............... $ 3.3 2.8 $(131.9) (15.4) $(122.4) (9.8) Cost of Gas ..................... 3.3 11.8 (107.9) (26.1) (98.9) (15.9) Gross Margin .................... 0.0 0.0 (24.0) (5.4) (23.5) (3.8) Operation and Maintenance ....... (6.4) (10.0) (25.8) (12.4) (36.0) (12.3) Depreciation and Depletion ...... (3.2) (12.2) (9.2) (11.8) (7.7) (7.6) Property and Other Taxes......... (0.6) (4.6) (3.3) (7.0) (4.1) (6.7) Write-down of Gathering Property......................... 24.8 N/A 24.8 N/A 24.8 N/A Other Income and Deductions ..... (7.8) (70.7) (7.4) (20.5) (7.2) (14.6) Income Tax Provision ............ (4.5) (69.7) (2.4) (9.0) 3.0 7.4 Net Income....................... (2.3) (14.4) (0.7) (1.6) 3.8 5.1 - -------------------------------------------------------------------------------------------------------------------
GROSS MARGIN Gross margin (operating revenues less cost of gas) remained flat in the 1998 quarter and decreased in the 1998 nine- and twelve-month periods reflecting lower gas deliveries resulting from abnormally warm weather partially offset by increases in intermediate transportation and gas-related service revenues. EFFECT OF WEATHER ON GAS MARKETS AND EARNINGS ---------------------------------------------
Quarter Nine Months Twelve Months ------- ----------- ------------- 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- Percentage Colder (Warmer) than Normal .................. N/M N/M (21.6)% 1.7% (14.5)% 2.5% Increase (Decrease) from Normal in: Gas Markets (Bcf) ........ (1.5) (0.3) (26.7) 1.2 (27.4) 3.7 Net Income (Millions) ... $(1.1) $(0.2) $(23.1) $1.1 $(23.7) $3.3 N/M - Not meaningful - -------------------------------------------------------------------------------------------------------------------
1 4 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Gas sales and end user transportation revenues in total increased $1.3 million for the 1998 quarter and decreased $150.4 million and $144.8 million in the 1998 nine- and twelve-month periods, respectively. The increase for the 1998 third quarter is due primarily to higher recognized revenues to recover gas costs. As discussed in the "Cost of Gas" section that follows, MichCon's sales rates are set to recover all reasonably and prudently incurred gas costs. Substantially offsetting the increase in the current quarter is the impact of reduced gas sales as a result of warmer weather. The decrease in revenues for the 1998 nine- and twelve-month periods is due primarily to reduced gas sales as a result of warmer weather. Additionally, the decrease for the 1998 nine-month period partially resulted from lower prices required to recover gas costs. End user transportation deliveries increased slightly in the 1998 quarter and declined in the 1998 nine- and twelve-month periods; however, revenues increased slightly in the twelve-month period as a result of an increase in the average transportation rate.
- ---------------------------------------------------------------------------------------------------------------- Quarter Nine Months Twelve Months ------- ----------- ------------- 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- GAS MARKETS ($ MILLIONS) Gas Sales...................... $ 78.6 $ 77.7 $569.0 $717.7 $ 914.1 $1,059.2 End User Transportation........ 16.6 16.2 59.8 61.5 82.9 82.6 Intermediate Transportation................. 14.5 12.9 48.4 41.0 62.6 54.4 Other.......................... 12.7 12.3 47.2 36.2 62.2 48.0 ------ ------ ------ ------ -------- ------- $122.4 $119.1 $724.4 $856.4 $1,121.8 $1,244.2 ------ ------ ------ ------ -------- -------- GAS MARKETS (IN BCF) Gas Sales...................... 12.4 13.8 115.1 141.7 179.2 209.0 End User Transportation........ 28.7 28.6 102.1 105.7 141.4 144.4 Intermediate Transportation................. 133.9 164.9 430.8 447.1 570.2 567.5 ------ ------ ------ ------ -------- -------- 175.0 207.3 648.0 694.5 890.8 920.9 ------ ------ ------ ------ -------- -------- - ----------------------------------------------------------------------------------------------------------------
Intermediate transportation revenues increased for the 1998 quarter, nine- and twelve-month periods by $1.6 million, $7.4 million and $8.2 million, respectively, due in part to increased fees generated from the transfer of gas title among and between intermediate transportation service users and various gas owners. Intermediate transportation deliveries decreased for the 1998 quarter and nine-month periods as a result of lower off system volumes transported for customers who pay a fixed fee for intermediate transportation capacity regardless of actual usage. Although volumes associated with these fixed-fee customers may vary, the related revenues are not affected. All three 1998 periods reflect additional Antrim gas volumes transported for Michigan gas producers and brokers. In December 1997, MichCon purchased a pipeline to expand the transportation capacity of its northern Michigan gathering system. This expansion made possible an increase of 24.0 Bcf in volumes transported through September 1998. Other operating revenues increased for all three 1998 periods due in part to an increase in gas-related services. Also affecting the nine- and twelve-month comparisons to the 1997 periods are unfavorable adjustments for energy conservation revenues in the 1997 periods resulting from the discontinuance of MichCon's energy conservation programs. COST OF GAS Cost of gas is affected by variations in sales volumes and cost of purchased gas as well as related transportation costs. Under the existing Gas Cost Recovery (GCR) mechanism, MichCon recovers all of its reasonably and prudently incurred cost of gas sold. As a result, fluctuations in cost of gas sold had little effect on gross margins. 2 5 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Cost of gas sold increased in the 1998 quarter and decreased in the 1998 nine- and twelve-month periods. The increase in the 1998 quarter was due primarily to decreased supplier refunds and higher prices paid of $.10 (5%) per thousand cubic feet, partially offset by lower sales volumes resulting from warmer weather. The decrease in the 1998 nine- and twelve-month periods is due primarily to lower sales volumes resulting from warmer weather. Additionally, the nine- and twelve-month periods had reductions in prices paid of $.27 (9%) and $.05 (2%) per thousand cubic feet, respectively. OPERATION AND MAINTENANCE Operation and maintenance expenses decreased in all 1998 periods, reflecting lower uncollectible gas accounts expense and labor and benefit costs, primarily resulting from pension and retiree healthcare costs. MichCon implemented an early retirement program that reduced MichCon's net workforce by approximately 175 employees (6%). The cost of the program and the related savings are offsetting in 1998 but will contribute to lower operating costs in future years. As discussed in MichCon's 1997 Annual Report on Form 10-K, MichCon receives a significant amount of its heating assistance funding through Michigan Home Heating Credits, which are funded almost exclusively by the federal Low Income Home Energy Assistance Program (LIHEAP). In October 1998, Congress approved a budget that provides for LIHEAP funding at $1.1 billion for the fiscal year ending September 30, 1999, representing an amount equal to the fiscal year 1998 funding. Any future changes in funding levels may impact MichCon's uncollectible gas accounts expense. DEPRECIATION AND DEPLETION The decrease in depreciation and depletion for all three 1998 periods reflects lower depreciation rates for MichCon's utility property, plant and equipment, which became effective January 1, 1998. Depreciation on higher plant balances partially offset the effect of the lower rates. PROPERTY AND OTHER TAXES Property and other taxes decreased for all three 1998 periods. The decrease in the 1998 quarter was primarily attributable to lower Michigan Single Business taxes resulting from lower Single Business taxable income. This decrease was partially offset by higher property taxes resulting from higher plant balances. The decreases in the nine- and twelve-month periods reflects lower property taxes based on the Company's pending appeals of its personal property tax assessments as discussed in MichCon's 1997 Annual Report on Form 10-K. WRITE-DOWN OF GATHERING PROPERTY All three 1998 periods reflect a $24.8 million asset write-down of certain non-utility gas gathering properties recorded in the 1998 quarter. As a result of a need to divert certain untreated gas away from the respective gas system, a new gas reserve analysis was performed in the 1998 third quarter. This analysis resulted in projected cash flows insufficient to cover the system's book value. Though this write-down reflects an impairment of certain gas gathering properties, MichCon believes the write-down will not have a material impact on future revenues due to the growth and strength of MichCon's other ventures. 3 6 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) OTHER INCOME AND DEDUCTIONS Other income and deductions decreased in the 1998 quarter, nine- and twelve-month periods due primarily to a decrease in minority interest in net income of subsidiaries. The decrease in minority interest resulted from an asset write-down of certain non-utility gas gathering properties as previously discussed. INCOME TAXES Income taxes decreased for the 1998 quarter, nine- and twelve-month periods as a result of lower pre-tax earnings and the flow through effect of certain book to tax temporary differences. Income tax comparisons for the nine- and twelve-month periods were also affected by a 1998 provision for tax issues and by amounts recorded in the 1997 periods for the favorable resolution of prior years' tax issues and tax credits. CAPITAL RESOURCES AND LIQUIDITY OPERATING ACTIVITIES MichCon's cash flow from operating activities totaled $218.0 million for the 1998 nine-month period, increasing $8.1 million from the comparable 1997 period. The increase was due primarily to higher net income after adjusting for depreciation, the write-down of gathering properties, and deferred taxes. This increase was partially offset by a net decrease from changes in other assets and liabilities. Operating cash flows were sufficient for the payment of all capital expenditures. FINANCING ACTIVITIES MichCon maintains a relatively consistent amount of cash and cash equivalents through the use of short-term borrowings. Short-term borrowings are normally reduced in the first part of each year as gas inventories are depleted and funds are received from winter heating sales. During the latter part of the year, MichCon's short-term borrowings normally increase as funds are used to finance increases in gas inventories and customer accounts receivable. To meet its seasonal short-term borrowing needs, MichCon normally issues commercial paper that is backed by credit lines with several banks. MichCon has established credit lines to allow for borrowings of up to $150 million under a 364-day revolving credit facility and up to $150 million under a three-year revolving credit facility, both of which were renewed in July 1998. During the first nine months of 1998, MichCon repaid $35.0 million of commercial paper. Commercial paper borrowings of $201.7 million were outstanding under this program at September 30, 1998. Of the outstanding commercial paper borrowings, a total of $107.4 million was loaned to an affiliate during the third quarter of 1998. MichCon expects repayment of the amount loaned to the affiliate in December 1998. In October 1998, MichCon established a 60-day unsecured credit line that allows for borrowings of up to an additional $50 million. In June 1998, MichCon issued long term debt generating net proceeds of $153.1 million. The proceeds were used to retire first mortgage bonds, fund future capital expenditures and for general corporate purposes. In the 1998 second quarter, MichCon redeemed through a tender offer $89.7 million of long-term debt and repaid $20 million of first mortgage bonds on their stated maturity date. 4 7 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In June 1998, MichCon filed a new shelf registration statement with the Securities and Exchange Commission allowing for the issuance of an additional $185 million in long term debt. As of September 30, 1998, MichCon's capacity under its shelf registration totaled $250 million. During the third quarter of 1998, Standard & Poor's lowered MichCon's commercial paper and long-term debt securities ratings from A1 to A2 and A to A-, respectively. MichCon's securities ratings by Moody's, Duff & Phelps, and Fitch have remained unchanged. MichCon's commercial paper and long-term debt securities are considered investment grade quality by all four rating agencies. INVESTING ACTIVITIES MichCon's capital expenditures totaled $105.2 million during the 1998 nine-month period and are anticipated to be approximately $175 million for the year. Capital expenditures primarily represent the construction of new distribution lines to attach new customers, new computer systems and improvements to existing storage, distribution, and transmission systems. It is management's opinion that MichCon will have sufficient capital resources, both internal and external, to meet anticipated capital requirements. OUTLOOK MichCon's strategy is to aggressively expand its role as the preferred provider of natural gas and high-value energy services within Michigan. Accordingly, MichCon's objectives are to increase revenues and reduce its costs in order to maintain strong returns and provide customers with high-quality services at competitive prices. MichCon plans to capitalize on the opportunities resulting from the gas industry restructuring by implementing its Regulatory Reform Plan (Plan), which was approved by the Michigan Public Service Commission (MPSC) in April 1998. The Plan includes a comprehensive experimental three-year customer choice program that is designed to offer expanded availability and transportation options to all sales customers, subject to annual caps on the level of participation. Beginning April 1, 1999, customers will have the option of purchasing natural gas from suppliers other than MichCon. However, MichCon will continue to transport and deliver the gas to the customers' premises at prices that maintain its existing sales margins. The Plan also suspends the GCR mechanism for customers who continue to purchase gas from MichCon and fixes the gas cost component of MichCon's sales rates for the three-year period beginning on January 1, 1999. Currently, MichCon does not generate earnings on the gas-supply portion of its operations; however under this Plan, changes in cost of gas will directly impact gross margins and earnings. As part of its gas acquisition strategy, MichCon has contracted for a substantial portion of its expected gas requirements and intends to use its storage facilities to mitigate risks from winter price and volume fluctuations. Also beginning in 1999, an income sharing mechanism will allow customers to share in profits when actual utility return on equity exceeds predetermined thresholds. Although the Plan increases MichCon's risk associated with generating margins that cover its gas costs, management believes this Plan will have a favorable impact on future earnings. In October 1998, the MPSC denied a rehearing and affirmed its approval of the Plan. Various interested parties have appealed the MPSC's decision to the Michigan Court of Appeals. While management believes that, based upon applicable Michigan law, the order should be upheld by the Michigan Court of Appeals, there can be no assurance as to the outcome. 5 8 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) YEAR 2000 Background - As a result of computer programs being written using two digits rather than four digits to define the year, any programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This Year 2000 issue, if not addressed, could cause computer systems to malfunction and have a material adverse impact on MichCon's operations and business processes. The effects of the Year 2000 issue are exacerbated as a result of companies' dependence on partners, operators, suppliers and governmental agencies. Plan and State of Readiness - MichCon's parent company, MCN Energy Group Inc. (MCN), aware of the Year 2000 potential impact, initiated a business systems replacement program in 1995. Additionally, MCN established a corporate-wide program in 1997 under the direction of a Year 2000 Project Office that reports regularly to the MCN Board of Directors. MCN's programs include all MichCon operations and business processes. MCN has implemented a four-phase Year 2000 approach consisting of: i) inventory - identification of the components of MichCon's systems, equipment and facilities; ii) assessment - assessing the Year 2000 readiness and prioritizing the risks of items identified in the inventory phase; iii) remediation - upgrading, repairing and replacing non-compliant systems, equipment and facilities; and iv) testing - verifying items are Year 2000 ready. MichCon is on schedule to have its mission critical business systems, and measurement and control systems (including embedded microprocessors) Year 2000 ready by mid-1999, as detailed below. MichCon's business systems primarily consist of general ledger, payroll, customer billing and inventory control systems and their related hardware. MichCon's measurement and control systems primarily consist of the "SCADA" system which measures and monitors the transportation and distribution of gas, as well as regulators, pressure controls and meters. The estimated completion status of these systems as of September 30, 1998 and the projected status for future periods follows:
Inventory Assessment Remediation Testing ------------ ------------- -------------- ----------- Business Systems: September 30, 1998.................. 95% 90% 10% 10% December 31, 1998................... 100% 95% 15% 15% March 31, 1999...................... 100% 100% 80% 70% June 30, 1999....................... 100% 100% 100% 100% Measurement and Control Systems: September 30, 1998.................. 95% 85% 30% 30% December 31, 1998................... 100% 90% 70% 60% March 31, 1999...................... 100% 100% 100% 90% June 30, 1999....................... 100% 100% 100% 100%
MichCon has also visited key partners, operators and suppliers to review their Year 2000 issues and share information. To the extent that any of these parties experience Year 2000 problems in their systems, the reliability of MichCon's services may be adversely affected. The majority of MichCon's key partners, operators and suppliers have completed their Year 2000 inventory and assessment phases. MichCon is continuing to monitor the progress of these key partners, operators and suppliers toward their completion of the remediation and testing phases. 6 9 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Cost of Remediation - Costs associated with the Year 2000 issue are not expected to have a material adverse affect on MichCon's results of operation, liquidity and financial condition. The total costs are estimated to be between $3.0 million and $4.0 million of which approximately $2.0 million was incurred through September 1998. This estimate does not include MichCon's Share of Year 2000 costs that may be incurred by partnerships and joint ventures. The anticipated costs are not higher due in part to the ongoing replacement of significant older systems. New systems in process of being installed, as well as those installed over the past few years, are Year 2000 ready. These systems were necessary to maintain a high level of customer satisfaction and to respond to changes in regulation and increased competition within the energy industry. Risk and Contingency Planning - MichCon anticipates a relatively smooth transition to the Year 2000. However, the failure to correct a material Year 2000 problem could result in an interruption in or a failure of certain business activities and operations. Such interruptions or failures could have a material adverse effect on MichCon's results of operations, liquidity and financial condition. Due to the uncertainty inherent in the Year 2000 issue, resulting in part from the uncertainty of the Year 2000 readiness of key partners, operators, suppliers and governmental agencies, MichCon cannot certify that it will be unaffected by Year 2000 complications. MichCon has addressed the Year 2000 risks of its business by prioritizing such risks based on the likely worst case scenarios and their impact on the business. Focusing first on the safety and welfare of MichCon's customers and employees, two mission-critical processes were identified: gas supply and distribution, and leak management emergency response. While MichCon believes it will be able to remediate and test all internal systems that support these processes, it fully recognizes its dependence on partners, operators, suppliers and governmental agencies. In order to reduce its Year 2000 risk, MichCon is developing contingency plans for mission-critical processes in the event of a Year 2000 complication. Through failure scenario identification, MichCon's approach is to develop reasonable and practical contingency plans to maintain operations in case of non-performance. Contingency plans are being developed for these processes, highlighting plan objectives, test approaches, required equipment and resources, necessary personnel, schedules and locations, test procedures and expected results. Contingency plans are already in place for many scenarios and include manual intervention, and arrangements with multiple suppliers and service providers. Initial testing of MichCon's contingency plans is scheduled to commence by December 1998. Contingency plans will continue to be refined throughout 1999 as MichCon continues to work with partners, operators, suppliers and governmental agencies. NEW ACCOUNTING PRONOUNCEMENTS COMPUTER SOFTWARE In March 1998, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 requires the capitalization of internal-use software and specifically identifies which costs should be capitalized and which costs should be expensed. The statement is effective for fiscal years beginning after December 15, 1998. Management does not expect the SOP to have a material impact on MichCon's financial statements. 7 10 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONCLUDED) START-UP ACTIVITIES In April 1998, the AcSEC issued SOP 98-5, "Reporting on the Costs of Start-up Activities." SOP 98-5 requires organizational and start-up costs to be expensed as incurred and is effective for fiscal years beginning after December 15, 1998. Management does not expect the SOP to have a material impact on MichCon's financial statements. DERIVATIVE AND HEDGING ACTIVITIES In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities" effective for fiscal years beginning after June 15, 1999. SFAS No. 133 requires all derivatives to be recognized in the balance sheet as either assets or liabilities measured at their fair value, and sets forth conditions in which a derivative instrument may be designated as a hedge. The Statement requires that changes in the fair value of derivatives be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to be recorded to other comprehensive income or to offset related results on the hedged item in earnings. MichCon manages gas price risk and interest rate risk through the use of various derivative instruments and limits the use of such instruments to hedging activities. The effects of SFAS No. 133 on MichCon's financial statements are subject to fluctuations in the market value of hedging contracts, which are, in turn, affected by variations in gas prices and in interest rates. Accordingly, management cannot quantify the effects of adopting SFAS No. 133. FORWARD LOOKING STATEMENTS The Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve certain risks and uncertainties as set forth in MichCon's 1997 Annual Report on Form 10-K. Additional factors that may impact forward-looking statements include MichCon's dependence on partners, operators, suppliers and governmental agencies, and their ability to upgrade their business systems and measurement and control systems in order to mitigate the potential adverse effects of the Year 2000 issue. 8 11 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (LOSS) (UNAUDITED) (THOUSANDS OF DOLLARS)
THREE MONTHS ENDED NINE MONTHS ENDED TWELVE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- ------------------- 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- OPERATING REVENUES...................... $ 122,428 $ 119,114 $ 724,442 $ 856,359 $ 1,121,762 $ 1,244,174 ----------- ----------- ----------- ----------- ----------- ----------- OPERATING EXPENSES Cost of gas........................... 31,143 27,848 306,244 414,152 524,321 623,186 Operation and maintenance............. 57,422 63,809 181,512 207,308 256,844 292,879 Depreciation and depletion............ 22,973 26,159 68,910 78,084 94,529 102,268 Property and other taxes.............. 12,087 12,667 43,342 46,602 57,484 61,591 Write-down of gathering properties (Note 4).............................. 24,800 -- 24,800 -- 24,800 -- ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses............ 148,425 130,483 624,808 746,146 957,978 1,079,924 ----------- ----------- ----------- ----------- ----------- ----------- OPERATING INCOME (LOSS)................. (25,997) (11,369) 99,634 110,213 163,784 164,250 ----------- ----------- ----------- ----------- ----------- ----------- OTHER INCOME AND (DEDUCTIONS) Interest income....................... 1,639 1,144 3,573 3,630 4,602 4,910 Interest on long-term debt............ (10,975) (11,659) (33,694) (33,973) (45,247) (44,438) Other interest expense................ (2,001) (1,033) (7,149) (5,782) (10,031) (8,802) Minority interest..................... 7,050 (523) 5,907 (1,456) 5,481 (1,410) Equity in earnings of joint ventures.. 511 212 1,461 853 1,807 1,041 Other................................. 529 766 1,235 663 1,108 (808) ----------- ----------- ----------- ----------- ----------- ----------- Total other income and (deductions)........................ (3,247) (11,093) (28,667) (36,065) (42,280) (49,507) ----------- ----------- ----------- ----------- ----------- ----------- INCOME (LOSS) BEFORE INCOME TAXES....... (29,244) (22,462) 70,967 74,148 121,504 114,743 INCOME TAX PROVISION (BENEFIT).......... (10,906) (6,426) 24,627 27,060 43,232 40,267 ----------- ----------- ----------- ----------- ----------- ----------- NET INCOME (LOSS) AVAILABLE FOR COMMON STOCK............................ $ (18,338) $ (16,036) $ 46,340 $ 47,088 $ 78,272 $ 74,476 =========== =========== =========== =========== =========== ===========
CONSOLIDATED STATEMENT OF RETAINED EARNINGS (UNAUDITED) (THOUSANDS OF DOLLARS)
THREE MONTHS ENDED NINE MONTHS ENDED TWELVE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- ------------------- 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- BALANCE - BEGINNING OF PERIOD............. $ 440,003 $ 359,429 $ 375,325 $ 336,305 $ 343,393 $ 313,180 Add - Net income (loss)................. (18,338) (16,036) 46,340 47,088 78,272 74,476 --------- --------- --------- --------- --------- --------- 421,665 343,393 421,665 383,393 421,665 387,656 Deduct - Cash dividends declared: Common Stock......................... -- -- -- 40,000 -- 44,263 --------- --------- --------- --------- --------- --------- BALANCE - END OF PERIOD................... $ 421,665 $ 343,393 $ 421,665 $ 343,393 $ 421,665 $ 343,393 ========= ========= ========= ========= ========= =========
The notes to the consolidated financial statements are an integral part of these statements. 9 12 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL POSITION (UNAUDITED) (THOUSANDS OF DOLLARS)
SEPTEMBER 30, December 31, ----------------------------- ------------ 1998 1997 1997 -------------- ------------- ------------ ASSETS CURRENT ASSETS Cash and cash equivalents.......................................... $ 10,611 $ 12,148 $ 14,353 Accounts receivable, less allowance for doubtful accounts of $8,912, $16,104 and $15,015, respectively......................... 99,223 104,218 195,662 Accrued unbilled revenues.......................................... 17,145 21,972 91,896 Gas in inventory................................................... 96,465 96,533 40,201 Property taxes assessed applicable to future periods............... 31,401 26,870 64,827 Accrued gas cost recovery revenues................................. -- -- 12,862 Notes receivable - affiliate (Note 5).............................. 107,440 -- -- Other.............................................................. 29,296 32,375 33,361 ----------- ---------- ---------- 391,581 294,116 453,162 ----------- ---------- ---------- DEFERRED CHARGES AND OTHER ASSETS Investment in and advances to joint ventures....................... 20,458 19,229 19,643 Long term investments.............................................. 37,171 3,810 35,110 Deferred environmental costs....................................... 28,052 27,600 27,699 Prepaid benefit costs.............................................. 103,814 71,345 85,790 Other.............................................................. 58,429 51,399 46,972 ----------- ---------- ---------- 247,924 173,383 215,214 ----------- ---------- ---------- PROPERTY, PLANT AND EQUIPMENT (NOTE 4)................................ 2,845,717 2,741,653 2,790,352 Less - Accumulated depreciation and depletion....................... 1,377,164 1,303,841 1,322,392 ----------- ---------- ---------- 1,468,553 1,437,812 1,467,960 ----------- ---------- ---------- $ 2,108,058 $1,905,311 $2,136,336 =========== ========== ========== LIABILITIES AND SHAREHOLDER'S EQUITY CURRENT LIABILITIES Accounts payable..................................................... $ 67,591 $ 92,051 $ 130,267 Notes payable........................................................ 204,313 140,022 241,691 Current portion of long-term debt and capital lease obligations...... 58,066 28,099 34,956 Federal income, property and other taxes payable..................... 41,223 40,602 78,630 Deferred gas cost recovery revenues.................................. 23,899 646 -- Exchange gas payable................................................. 28,520 739 2,063 Customer deposits.................................................... 16,803 14,026 16,363 Other................................................................ 51,637 55,536 65,717 ----------- ---------- ---------- 492,052 371,721 569,687 ----------- ---------- ---------- DEFERRED CREDITS AND OTHER LIABILITIES Deferred income taxes................................................ 84,652 79,273 83,905 Unamortized investment tax credit.................................... 31,362 33,206 32,745 Tax benefits amortizable to customers................................ 132,676 123,540 122,922 Accrued environmental costs.......................................... 32,000 32,000 32,000 Minority interest.................................................... 9,349 16,927 17,283 Other................................................................ 41,858 38,553 44,663 ----------- ---------- ---------- 331,897 323,499 333,518 ----------- ---------- ---------- LONG-TERM DEBT, INCLUDING CAPITAL LEASE OBLIGATIONS (NOTE 1)........... 621,745 625,999 617,107 ----------- ---------- ---------- CONTINGENCIES (NOTE 6) COMMON SHAREHOLDER'S EQUITY Common stock......................................................... 10,300 10,300 10,300 Additional paid-in capital........................................... 230,399 230,399 230,399 Retained earnings.................................................... 421,665 343,393 375,325 ----------- ---------- ---------- 662,364 584,092 616,024 ----------- ---------- ---------- $ 2,108,058 $1,905,311 $2,136,336 =========== ========== ==========
The notes to the consolidated financial statements are an integral part of this statement. 10 13 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (THOUSANDS OF DOLLARS)
NINE MONTHS ENDED SEPTEMBER 30, ---------------------------- 1998 1997 -------------- ------------ CASH FLOW FROM OPERATING ACTIVITIES Net income ........................................................... $ 46,340 $ 47,088 Adjustments to reconcile net income to net cash flow provided from operating activities: Depreciation and depletion Per statement of income ........................................ 68,910 78,084 Charged to other accounts ...................................... 5,948 5,660 Write-down of gathering properties, net (Note 4) ................ 11,200 -- Deferred income taxes - current .................................. (11,889) (25,229) Deferred income taxes and investment tax credit - net ............ 15,218 8,595 Other ............................................................ (3,509) (1,159) Changes in assets and liabilities, exclusive of changes shown separately ............................................... 85,817 96,908 --------- --------- Net cash provided from operating activities .................. 218,035 209,947 --------- --------- CASH FLOW FROM FINANCING ACTIVITIES Notes payable - net (Note 5) ......................................... (37,378) (125,104) Issuance of long-term debt ........................................... 153,052 124,051 Cash dividend paid applicable to common stock ........................ -- (40,000) Retirement of long-term debt ......................................... (124,637) (74,792) --------- --------- Net cash used for financing activities ....................... (8,963) (115,845) --------- --------- CASH FLOW FROM INVESTING ACTIVITIES Notes receivable - affiliate - net ................................... (107,440) -- Capital expenditures ................................................. (105,179) (97,042) Other - net .......................................................... (195) 5,078 --------- --------- Net cash used for investing activities ....................... (212,814) (91,964) --------- --------- Net Decrease in Cash and Cash Equivalents .............................. (3,742) 2,138 Cash and Cash Equivalents, January 1 ................................... 14,353 10,010 ========= ========= Cash and Cash Equivalents, September 30 ................................ $ 10,611 $ 12,148 ========= ========= CHANGES IN ASSETS AND LIABILITIES, EXCLUSIVE OF CHANGES SHOWN SEPARATELY Accounts receivable - net .......................................... $ 94,274 $ 61,679 Accrued/deferred gas cost recovery revenues ........................ 36,761 28,318 Accrued unbilled revenues .......................................... 74,751 85,405 Gas in inventory ................................................... (56,264) (28,623) Property taxes assessed applicable to future periods ............... 33,426 33,722 Accounts payable ................................................... (62,666) (38,674) Federal income, property and other taxes payable ................... (37,407) (44,186) Exchange gas ....................................................... 26,457 2,756 Other current assets and liabilities ............................... 2,314 6,197 Deferred and prepaid benefit costs ................................. (18,024) (2,175) Deferred assets and liabilities .................................... (7,805) (7,511) ========= ========= $ 85,817 $ 96,908 ========= ========= SUPPLEMENTAL DISCLOSURES Cash paid for: Interest, net of amounts capitalized ............................... $ 38,164 $ 36,143 ========= ========= Federal income taxes ............................................... $ 17,181 $ 39,530 ========= =========
The notes to the consolidated financial statements are an integral part of this statement. 11 14 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. CAPITALIZATION A. LONG-TERM DEBT ISSUANCE In June 1998, MichCon issued $75,000,000 of 6.2% and $75,000,000 of 6.45% remarketable debt securities, both of which have stated maturities of June 2038. These securities are "fall-away mortgage" debt and as such, are secured debt as long as MichCon's current first mortgage bonds are outstanding and become senior unsecured debt thereafter. The securities are structured such that the interest rates of the issues can be reset at various remarketing dates over the life of the debt. The initial remarketing date is June 30, 2003 for the 6.2% debt and June 30, 2008 for the 6.45% debt. MichCon received an option premium in return for granting options to the underwriters to reset the interest rate for a period of ten years at the initial remarketing date. The option premiums received for these securities, net of financing costs incurred, totaled $3,052,000. The option premium portions are being amortized to income over the initial interest and corresponding option periods. If the underwriters elect not to exercise their reset options, the securities become subject to the remarketing feature. If MichCon and the remarketing agent cannot agree on an interest rate or the remarketing agent is unable to remarket the securities, MichCon will be required to repurchase the securities at their principal amounts. B. LONG-TERM DEBT REDEMPTION In the second quarter of 1998, MichCon redeemed through a tender offer $37,000,000 of the outstanding $55,000,000 balance of 9.125% first mortgage bonds, due 2004 and $52,686,000 of the outstanding $70,000,000 balance of 8% first mortgage bonds, due 2002. 2. LINES OF CREDIT MichCon has established credit lines that allow for borrowings of up to $150,000,000 under a 364-day revolving credit facility and up to $150,000,000 under a three-year revolving credit facility. These credit lines totaling $300,000,000 support its commercial paper program. Both the 364-day revolving and three-year revolving credit facilities were renewed in July 1998. As of September 30, 1998, $201,734,000 in borrowings were outstanding under these lines. In October 1998, MichCon established a 60-day unsecured credit line that allows for borrowings of up to an additional $50,000,000. 3. GAS PURCHASE SWAP AGREEMENTS MichCon has entered into gas swap agreements that are intended to hedge MichCon's gas purchase commitments and effectively fixes the commodity rate portion of certain gas purchase agreements. The swap reduces MichCon's price risk; however, it limits potential gains from favorable changes in gas purchase prices. Changes in the market value of the swap contracts are deferred and included in inventory costs until the hedged transaction is completed, at which time the realized gain or loss in included in the cost of purchased gas. As of September 30, 1998 MichCon's deferred loss from such swap contracts is $1,682,000. 12 15 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED) 4. LOSS ON ASSETS During the third quarter of 1998, MichCon recognized a $24,800,000 pre-tax loss ($11,200,000 net of taxes and minority interest) from the write-down of assets in certain non-utility gas gathering properties. As a result of a need to divert certain untreated gas away from the respective gathering system, a new gas reserve analysis was performed in the third quarter of 1998. This analysis resulted in projected cash flows insufficient to cover the system's book value. The write-down was recognized in accordance with Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." 5. AFFILIATE TRANSACTION During the third quarter of 1998, MichCon loaned MCN Energy Group Inc. $107,440,000 by issuing notes under its existing commercial paper program. The money loaned represents a short-term note receivable at an average interest rate of 5.79% from MCN Energy Group Inc. as of September 30, 1998. 6. CONTINGENCIES MichCon is involved in certain legal and administrative proceedings before various courts and governmental agencies concerning claims arising in the ordinary course of business. Management cannot predict the final disposition of such proceedings, but believes that adequate provision has been made for probable losses. It is management's belief, after discussion with legal counsel, that the ultimate resolution of those proceedings still pending will not have a material adverse effect on MichCon's financial statements. 7. GENERAL The accompanying consolidated financial statements should be read in conjunction with MichCon's 1997 Annual Report on Form 10-K. Certain reclassifications have been made to the prior year's financial statements to conform with the 1998 presentation. In the opinion of management, the unaudited information furnished herein reflects all adjustments necessary for a fair presentation of the financial statements for the periods presented. Because of seasonal and other factors, revenues, expenses and net income for the interim periods should not be construed as representative of revenues, expenses and net income for all or any part of the balance of the current year or succeeding periods. 13 16 OTHER INFORMATION LEGAL PROCEEDINGS MichCon settled the two class action lawsuits relating to the installation of high-efficiency furnaces. The furnace installation program was handled by heating contractors under three separate MPSC approved, MichCon financed, programs between 1989 and 1995. There were 46,000 class members. The notice of settlement was sent in June 1998 to the class members. Terms of the settlement included capped co-payments for the repair of chimney damages or the installation of a chimney liner and a reduced price for a carbon monoxide detector purchase from MichCon. The request for reimbursement period ended on October 9, 1998. A total of 113 claim forms were sent out. Claims totaling $3,105 were received and will be paid out in November 1998. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number Description ------- ----------- 12-1 Computation of Ratio of Earnings to Fixed Charges 27-1 Financial Data Schedule (b) Reports on Form 8-K None 14 17 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MICHIGAN CONSOLIDATED GAS COMPANY Date: November 12, 1998 By: /s/ Harold Gardner -------------------------------- Harold Gardner Vice President and Chief Accounting Officer 15 18 Exhibit Index
Exhibit No. Description - ----------- ----------- 12.1 Michigan Consolidated Gas Company and Subsidiaries Computation of Ratio of Earnings to fixed charges. 27 Financial Data Schedule
EX-12.1 2 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12-1 MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (THOUSANDS OF DOLLARS)
Twelve Months Ended Twelve Months Ended Twelve Months Ended ------------------- ------------------- ------------------- September 30, 1998 December 31, 1997 December 31, 1996 ------------------- ------------------- ------------------- EARNINGS AS DEFINED (1) Income............................................... $119,019 $125,630 $122,239 Fixed charges........................................ 59,817 57,905 53,831 -------- -------- -------- Earnings as defined................................ $178,836 $183,535 $176,070 ======== ======== ======== FIXED CHARGES AS DEFINED (1) Interest on long-term debt........................... $ 47,205 $ 47,024 $ 43,163 Interest on other borrowed funds..................... 10,031 8,664 8,012 Amortization of debt discounts, premium and expense........................................ 980 1,032 1,081 Interest implicit in rentals (2)..................... 1,601 1,185 1,575 -------- -------- -------- Fixed charges as defined........................... $ 59,817 $ 57,905 $ 53,831 ======== ======== ======== Ratio of Earnings to Fixed Charges .................. 2.99 3.17 3.27 ======== ======== ========
Notes: (1) Earnings and fixed charges are defined and computed in accordance with Item 503 of Regulation S-K. (2) This amount is estimated to be a reasonable approximation of the interest portion of rentals. MichCon is a guarantor of certain other debt. Fixed charges related to such debt are deemed to be immaterial and therefore have been excluded from the above ratios. EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENT OF INCOME AND THE CONSOLIDATED STATEMENT OF FINANCIAL POSITION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 10,611 0 215,575 8,912 96,465 391,581 2,845,717 1,377,164 2,108,058 492,052 621,745 0 0 10,300 652,064 2,108,058 0 724,442 0 624,808 0 7,703 40,843 70,967 24,627 46,340 0 0 0 46,340 0 0
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