U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended March 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 0-8898
Midcoast Energy Resources, Inc.
(Exact name of Registrant as Specified in Its Charter)
Nevada 76-0378638
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1100 Louisiana, Suite 2950
Houston, Texas 77002
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (713) 650-89
00
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
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
On March 31, 1998, there were outstanding 5,681,330 shares
of the Company's common stock, par value $.01 per share.
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
Quarterly Report on Form 10-Q for the
Quarter Ended March 31, 1998
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements Consolidated Balance
Sheets as of December 31, 1997 and March 31, 1998 3
Consolidated Statements of Operations for the three
months ended March 31, 1997 and March 31, 1998 4
Consolidated Statement of Shareholders' Equity for
the three months ended March 31, 1998 5
Consolidated Statements of Cash Flows for the three
months ended March 31, 1997 and March 31, 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . 8
PART II. OTHER INFORMATION 15
SIGNATURE 17
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, March 31,
1997 1998
ASSETS
Current Assets:
Cash and cash equivalents 308 117
Accounts receivable, no allowance for doubtful accounts 27524 25460
Materials and supplies, at average cost 1225 2058
Total current assets 29057 27635
PROPERTY, PLANT AND EQUIPMENT, at cost:
Natural gas transmission facilities 90859 92620
Investments in transmission facilities 1341 1341
Natural gas processing facilities 4626 4684
Oil and gas properties, using the full-cost method of 1344 1352
accounting
Other property and equipment 2411 2465
100581 102462
ACCUMULATED DEPRECIATION, DEPLETION, AND AMORTIZATION -3029 -3729
97552 98733
OTHER ASSETS, net of amortization 1429 2069
Total assets 128038 128437
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities 25779 21612
Other current liabilities 491 218
Short-term borrowing from bank 700 2213
Current portion of long-term debt payable to banks 199 190
Total current liabilities 27169 24233
LONG-TERM DEBT PAYABLE TO BANKS 28923 29879
OTHER LIABILITIES 190 239
DEFERRED INCOME TAXES 9613 9613
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES 692 674
COMMITMENTS AND CONTINGENCIES (Note 3)
SHAREHOLDERS'EQUITY:
Common stock, $.01 par value, 10 million shares authorized, 57 57
5,681,330 shares issued and outstanding at December 31, 1997
and March 31, 1998
Paid-in capital 80695 80695
Accumulated deficit -19283 -16935
Unearned compensati -18 -18
Total Shareholders' equity 61451 63799
Total liabilities and shareholders' equity 128038 128437
The accompanying notes are an integral part of these consolidated financial
statements.
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
For the Three Months Ended
March 31, March 31,
1997 1998
OPERATING REVENUES:
Sale of natural gas 10582 63176
Transportation fees 835 2976
Natural gas processing revenue 1470 1099
Oil and gas revenues 77 88
Total operating revenues 12964 67339
OPERATING EXPENSES:
Cost of natural gas and transportation 10298 60455
charges
Natural gas processing costs 726 444
Production of oil and gas 12 10
Depreciation, depletion, and 255 693
amortization
General and administrative 374 1603
Total operating expenses 11665 63205
OPERATING INCOME 1299 4134
NON-OPERATING ITEMS:
Interest expense -95 -599
Minority interest in consolidated -60 -2
subsidiaries
Other income (expense), net -12 31
Total non-operating items -167 -570
INCOME BEFORE INCOME TAXES 1132 3564
PROVISION FOR INCOME TAXES 0 -803
NET INCOME 1132 2761
NET INCOME PER COMMON SHARE
Basic .41 .49
Diluted .41 .47
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING
Basic 2749998 5681330
Diluted 2749998 5880110
The accompanying notes are an integral part of these consolidated
financial statements.
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
ACCUMULATED COMMON PAID-IN ACCUMULATED UNEARNED TOTAL
COMPREHENSIVE STOCK CAPITAL DEFICIT COMPENSATION SHAREHOLDERS'
INCOME EQUITY
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996 0 25 26942 -13284 -90 13593
Shares issued or vested 0 0 0 0 72 72
under various stock-based
compensation arrangements.
Sale of 2,315,000 shares of 0 23 34030 0 0 34053
common stock
Common stock and warrants 0 4 9167 0 0 9171
issued in conjunction with
the Midla Acquisition
10% stock dividend (516,330 0 5 10556 -10565 0 -4
shares). (Note 2)
Net income 0 0 0 5764 0 5764
Other comprehensive income, 0 0 0 0 0 0
net of tax.
Common stock dividends, $.29 0 0 0 -1198 0 -1198
per share
Balance, December 31, 1997 0 57 80695 -19283 -18 61451
Net income 0 0 0 2761 0 2761
Other comprehensive income, 0 0 0 0 0 0
net of ta.
Common Stock dividends, $.07 0 0 0 -413 0 -413
per share
Balance, March 31, 1998 (Unaudited) 0 57 80695 -16935 -18 63799
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Three Months Ended
March 31, 1997 March 31, 1998
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income 1132 2761
Adjustments to arrive at
net cash provided by
operating activities-
Depreciation, depletion, 255 693
and amortization
Recognition of deferred -21 -21
income
Minority interest in 60 2
consolidated subsidiaries
Other 18 13
Changes in working capital
accounts-
Decrease in accounts 3871 577
receivable
Decrease in other current 0 163
assets
Decrease in accounts -2367 -4645
payable and accrued
liabilities
Net cash provided by 2948 -457
operating activities
CASH FLOWS FROM INVESTING
ACTIVITIES:
Capital expenditures -425 -1622
Acquisition -2000 0
Other -198 -129
Net cash used by investing -2623 -1751
activities
CASH FLOWS FROM FINANCING
ACTIVITIES:
Bank debt borrowings 2110 12233
Bank dept repayments -362 -9773
Distribution to joint venture partners 0 -30
Dividends on common stock -200 -413
Net cash provided by 1548 2017
financing activities
NET INCREASE (DECREASE)IN 1873 -191
CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, 1168 308
beginning of period
CASH AND CASH EQUIVALENTS, 3041 117
end of period
CASH PAID FOR INTEREST 95 842
CASH PAID FOR INCOME TAXES 51 101
The accompanying notes are an integral part of these consolidated
financial statements.
MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited financial information has been
prepared by Midcoast Energy Resources, Inc. ("Midcoast" or "the
Company") in accordance with the instructions to Form 10-Q. The
unaudited information furnished reflects all adjustments, all of
which were of a normal recurring nature, which are, in the
opinion of the Company, necessary for a fair presentation of the
results for the interim periods presented. Although the Company
believes that the disclosures are adequate to make the
information presented not misleading, certain information and
footnote disclosures, including significant accounting policies,
normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed
or omitted pursuant to such rules and regulations. Certain
reclassification entries were made with regard to the
Consolidated Financial Statements for the periods presented in
1997 so that the presentation of the information is consistent
with reporting for the Consolidated Financial Statements in 1998.
It is suggested that the financial information be read in
conjunction with the financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
2. CAPITAL STOCK
On February 3, 1998, the Board of Directors (the "Board")
declared a 10 percent stock dividend on the Company's common
stock. On March 2, 1998, shareholders of record as of February
13, 1998, received one additional share for each ten shares held.
Net income per share, dividends per share and weighted average
shares outstanding have been retroactively restated to reflect
the 10 percent stock dividend.
3. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT CONTRACTS
Certain executive officers of the Company have entered into
employment contracts which, through amendments, provide for
employment terms of varying lengths the longest of which expires
in April 2001. These agreements may be terminated by mutual
consent or at the option of the Company for cause, death or
disability. In the event termination is due to death, disability
or defined changes in the ownership of the Company, the full
amount of compensation remaining to be paid during the term of
the agreement will be paid to the employee or their estate, after
discounting at 12% to reflect the current value of unpaid
amounts.
MIT CONTINGENCY
As part of the Company's May 1997 acquisition of a 288 mile
interstate transmission system pipeline ("the MIT System") and
two end-user pipelines in northern Alabama ("the TRIGAS
Systems"), collectively ("the MIT Acquisition") , the Company has
agreed to pay additional contingent annual payments, which will
be treated as deferred purchase price adjustments, not to exceed
$250,000 per year. The amount each year is dependent upon
revenues received by the Company from certain gas transportation
contracts. The contingency is due over an eight-year period
commencing April 1, 1998, and payable at the end of each
anniversary date. The Company is obligated to pay the lesser of
50% of the gross revenues received under these contracts or
$250,000 . The acquisition agreement for the MIT Acquisition also
limits the amount of damages recoverable by Midcoast if there is
a breach by the seller of the representations and warranties to
$10 million after damages have exceeded $500,000, and requires
Midcoast to assert any such claims within 18 months of the
closing.
MIDLA CONTINGENCY
As part the Company's October 1997 acquisition of a 386 mile
interstate transmission pipeline ("the MLGC System"), one
intrastate ("the MLGT System"), two end-user pipelines and two
offshore gathering pipelines, located in Louisiana, collectively
("the Midla Acquisition"), the Company agreed that if a specific
contract with a third party was executed prior to October 2,
1999, which included specific provisions regarding price and
throughputs, Midcoast would be obligated to issue 110,000
warrants to acquire Midcoast common stock at an exercise price of
$19.773 per share to Republic. In addition, concurrent with
initial expenditures on the project, the Company would incur a
$1.2 million cash obligation to Republic. At March 31, 1998,
none of the provisions of this contingency have been met.
4 SUBSEQUENT EVENTS
In April 1997, the Company announced its purchase of the Port
Hudson system in Louisiana and in a separate transaction that it
has acquired a 50 percent ownership in Texana Pipeline Company
("Texana"), a joint venture which owns the Texana pipeline in
south Texas. The total purchase price for both systems was
$725,000.
The Port Hudson system was purchased by Mid Louisiana Gas
Transmission Company ("MLGT") a wholly owned subsidiary, from
Amoco Production Company. The system consists of approximately
four miles of 12" pipeline near Port Hudson, Louisiana. MLGT
acquired the system as part of its development of a high pressure
pipeline to service new customers in and around the Port Hudson
and Baton Rouge areas.
The Texana gathering pipeline system consists of 46 miles of
primarily 6" to 8" pipeline which extends through Aransas, San
Patricio and Refugio counties in south Texas. The pipeline
presently gathers natural gas from 12 producers with a system
throughput of approximately 6 Mmcf/day. Midcoast Gas Pipeline
Inc., another wholly owned subsidiary of Midcoast, acquired the
50 percent in Texana from El Paso Energy Marketing Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Since its formation, the Company has grown significantly as a
result of the construction and acquisition of new pipeline
facilities. Since the first quarter of 1994, the Company
acquired or constructed 46 pipelines for an aggregate acquisition
cost of over $82 million. The Company believes the historical
results of operations do not fully reflect the operating
efficiencies and improvements that are expected to be achieved by
integrating the acquired and newly constructed pipeline systems.
As the Company pursues its growth strategy in the future, its
financial position and results of operations may fluctuate
significantly from period to period.
The Company's results of operations are determined primarily by
the volumes of gas transported, purchased and sold through its
pipeline systems or processed at its processing facility. Most of
the Company's operating costs do not vary directly with volume on
existing systems, thus, increases or decreases in transportation
volumes on existing systems generally have a direct effect on net
income. Also, the addition of new pipeline systems typically
results in a larger percentage of revenues being added to
operating income as fixed overhead components are allocated over
more systems. The Company derives its revenues from three primary
sources: (i) transportation fees from pipeline systems owned by
the Company, (ii) the processing and treating of natural gas and
(iii) the marketing of natural gas.
Transportation fees are received by the Company for transporting
gas owned by other parties through the Company's pipeline
systems. Typically, the Company incurs very little incremental
operating or administrative overhead cost to transport gas
through its pipeline systems, thereby recognizing a substantial
portion of incremental transportation revenues as operating
income.
The Company's natural gas processing revenues are realized from
the extraction and sale of natural gas liquids ("NGLs") as well
as the sale of the residual natural gas. Once extracted, the NGLs
are further fractionated in the Company's facilities into
products such as ethane, propane, butanes, natural gasoline and
condensate, then sold to various wholesalers along with raw
sulfur from the Company's sulfur recovery plant. Typically, the
Company enters into agreements with natural gas producers wherein
the Company and the producer share in the revenue generated from
the sale of NGLs extracted at the Company's facilities. The
Company's processing operations can be adversely affected by
declines in NGL and natural gas prices, declines in gas
throughput or increases in shrinkage or fuel costs.
The Company's gas marketing revenues are realized through the
purchase and resale of natural gas to the Company's customers.
Generally, gas marketing activities will generate higher revenues
and correspondingly higher expenses than revenues and expenses
associated with transportation activities, given the same volumes
of gas. This relationship exists because, unlike revenues derived
from transportation activities, gas marketing revenues and
associated expenses include the full commodity price of the
natural gas acquired. The operating income the Company recognizes
from its gas marketing efforts is the difference between the
price at which the gas was purchased and the price at which it
was resold to the Company's customers. The Company's strategy is
to focus its marketing activities on Company owned pipelines.
The Company's marketing activities have historically varied
greatly in response to market fluctuations.
The Company has had quarter-to-quarter fluctuations in its
financial results in the past due to the fact that the Company's
natural gas sales and pipeline throughputs can be affected by
changes in demand for natural gas primarily because of the
weather. Although, historically, quarter-to-quarter fluctuations
resulting from weather variations have not been significant, the
acquisitions of the Magnolia System, the MIT System and the MLGC
System have increased the impact that weather conditions have on
the Company's financial results. In particular, demand on the
Magnolia System, MIT System and MLGC System fluctuate due to
weather variations because of the large municipal and other
seasonal customers which are served by the respective systems. As
a result, historically the winter months have generated more
income than summer months on these systems. There can be no
assurances that the Company's efforts to minimize such effects
will have any impact on future quarter-to-quarter fluctuations
due to changes in demand resulting from variations in weather
conditions. Furthermore, future results could differ materially
from historical results due to a number of factors including but
not limited to interruption or cancellation of existing
contracts, the impact of competitive products and services,
pricing of and demand for such products and services and the
presence of competitors with greater financial resources.
The Company has also from time to time derived significant income
by capitalizing on opportunities in the industry to sell its
pipeline systems on favorable terms as the Company receives
offers for such systems which are suited to another company's
pipeline network. Although no substantial divestitures are
currently under consideration, the Company will from time to time
solicit bids for selected properties which are no longer suited
to its business strategy.
RESULTS OF OPERATIONS
The following tables present certain data for major operating
units of Midcoast for the three month periods ended March 31,
1997 and March 31, 1998. A discussion follows which explains
significant factors that have affected Midcoast's operating
results during these periods. Gross margin for each of the units
is defined as the revenues of the unit less related direct costs
and expenses of the unit. As previously discussed, the Company
provides natural gas marketing services to its customers. For
analysis purposes, the Company accounts for the marketing
services by recording the marketing activity on the operating
unit where it occurs. Therefore, the gross margin for each of
the major operating units include a transportation and marketing
component.
TRANSMISSION PIPELINES
For the Three Months Ended March 31,
1997 1998
(in thousands, except gross
margin per Mmbtu)
OPERATING REVENUES:
Transportation Fees 369 1997
Marketing 4999 39314
TOTAL OPERATING REVENUES 5368 41311
OPERATING EXPENSES:
Cost of Natural Gas and 4798 35875
Transportation Charges
Operating Expenses 112 1172
TOTAL OPERATING EXPENSES 4910 37047
GROSS MARGIN 458 4264
VOLUME (in Mmbtu)
Transportation 3848 15152
Marketing 1767 16348
TOTAL VOLUME 5615 31500
GROSS MARGIN per Mmbtu .08 .14
The Company's entrance into the regulated interstate pipeline
business with the acquisition of the MIT System (June 1997) and
the MLGC Systems (November 1997) significantly enhanced the
Company's transmission pipelines operations in 1998.
Significant increases in revenues, gross margin, sales volumes
and margin per Mmbtu are primarily attributable to the MIT and
MLGC System. In addition, other Midcoast transmission systems
margins increased when compared to the equivalent period in 1997
but were partially mitigated by weather related decreases in
throughput volume. Corresponding reductions in cost of sales as
well as favorable marketing operations were responsible
for the increased margin.
The Company has succeeded in increasing contracted transportation
volumes on both the MIT System and MLGC System since completing
the acquisitions. Through the completion of two successful open
seasons, contracted demand on the MIT System has increased by 28%
for the winter of 1998 which includes new long term
transportation agreements with the cities of Huntsville and
Decatur, Alabama. Construction of new pipeline facilities on
the MIT System is planned to accommodate the incremental volumes
generated by the new transportation contracts and is awaiting
FERC approval. Contracted demand on the MLGC System has increased
due to the execution of a new 20 Mmcf/day gas transportation
contract to service a new cogeneration facility near Baton Rouge.
Transportation services under the new contract will commence upon
the completion of related construction of new facilities expected
in the fourth quarter of 1998.
END-USER PIPELINES
For the Three Months Ended March 31,
1997 1998
(in thousands, except gross
margin per Mmbtu)
OPERATING REVENUES:
End-User Transportation Fees 278 764
Marketing 3974 22905
TOTAL OPERATING REVENUES 4252 23669
OPERATING EXPENSES:
Cost of Natural Gas and 3634 22196
Transportation Charges
Operating Expenses 39 45
TOTAL OPERATING EXPENSES 3673 22241
GROSS MARGIN 579 1428
VOLUME (in Mmbtu)
Transportation 1945 4883
Marketing 1375 10236
TOTAL VOLUME 3320 15119
GROSS MARGIN per Mmbtu .17 .09
The Company's gross margin for the end-user pipelines operating
unit increased 147% from $579,000 to $1,428,000 for the three
month periods ending March 31, 1997 and 1998, respectively. The
acquisition of the TRIGAS (June 1997) and the MLGT System
(November 1997) are responsible for the significant increases in
revenues, gross margin and sales volumes. Gross margin per Mmbtu
declined 50% from the prior year quarter primarily due to
marketing activities becoming a much larger component of the
revenue mix within the end-user pipeline operating unit.
Marketing transactions are typically characterized as high
dollar, large volume, low margin transactions.
Since Midcoast's ownership of the MLGT System, new marketing
services contracts have been executed to provide 25 Mmcf/day of
new marketing services beginning January 1, 1998 to an industrial
facility near Port Hudson, Louisiana, and an additional 40
Mmcf/day of natural gas marketing services to a new cogeneration
facility near Baton Rouge by the end of 1998. The Company is
currently constructing a new high pressure end-user pipeline
system to service the new contracts. The new pipeline will allow
the Company to compete for potential new customers along the
industrial corridor of the Mississippi River requiring natural
gas at pressures previously not available through the MLGT
System.
GATHERING PIPELINES AND NATURAL GAS PROCESSING
For the Three Months Ended March 31,
1997 1998
(in thousands, except gross
margin per Mmbtu)
OPERATING REVENUES:
Gathering Transportation 188 215
Fees
Processing Revenue 1470 1099
Marketing 1609 957
TOTAL OPERATING REVENUES 3267 2271
OPERATING EXPENSES:
Cost of Natural Gas and 1332 777
Transportation Charges
Processing Costs 726 444
Operating Expenses 383 390
TOTAL OPERATION EXPENSES 2441 1611
GROSS MARGIN 826 660
VOLUME (in Mmbtu)
Gathering 3313 5866
Processing 494 511
Marketing 595 461
TOTAL VOLUME 4402 6838
GROSS MARGIN per Mmbtu .19 .10
The gathering pipelines and natural gas processing operating unit
reflected mixed results for the three month period ended March
31, 1998 as compared to the equivalent period in 1997.
Although gathering volumes increased (primarily as a result of
the Midla Acquisition), the gross margin for the operating unit
as a whole decreased 20% or $166,000. Contributing factors to
the decline include a reduction in processing margins, normal
production declines on certain gathering pipelines mitigated by
increased volumes on newly acquired gathering pipelines in the
Midla Acquisition. Due to a market decline in NGL prices,
processing margins at the Harmony Gas Plant decreased by $89,000
despite a small increase in processing volume. Gathered volumes
reflect a 77% increase, however, significant volumes were
gathered by pipelines acquired in the Midla Acquisition which
charge a much lower rate than the average gross margin per Mmbtu
for the operating unit as a whole. As a result of these factors,
the gross margin on a per Mmbtu basis declined sharply.
The future profitability of the Harmony Plant will be affected by
changes in commodity pricing of NGL and natural gas, production
curtailments, shut-in wells and also the natural declines in the
deliverability of the reservoirs connected and dedicated to
Midcoast's processing plant.
OTHER INCOME, COSTS AND EXPENSES
In the three month period ended March 31, 1998, the Company
received revenues of $88,000 from its oil and gas properties as
compared to $77,000 over the same period in 1997. The increase
is primarily associated with a successful drilling program in the
Company's Sun Field properties. In addition, certain of
Midcoast's oil and gas properties have been approved for changes
in well spacing and tertiary recovery by depressurization. The
Company believes these factors may contribute to increased
volumes and revenues for its oil and gas properties.
In the three month period ended March 31, 1998, the Company's
depreciation, depletion and amortization increased to $693,000
from $255,000 when compared to 1997. The increase is primarily
due to increased depreciation on assets acquired in the MIT and
Midla Acquisitions. Collectively, these new acquisitions
accounted for 93% of the increase of $438,000.
In the three month period ended March 31, 1998, the Company's
general and administrative expenses increased to $1,603,000 from
$374,000 in 1997. The increase is primarily due to increased
costs associated with the management of the assets acquired in
the MIT and Midla Acquisitions. Collectively, these new
acquisitions accounted for 121% of the increase of $1,229,000.
In addition, the increase can be attributed to the Company's
expansion of its infrastructure to allow for continued growth.
Interest expense for the three months ended March 31, 1998 and
1997, was approximately $599,000 and $95,000, respectively. The
increased expense is a result of additional debt incurred for
the Midla Acquisition. The Company was servicing an average of
$31.0 million in debt through March 31, 1998 as compared to $4.5
million in debt for the three month period ended March 31, 1997.
The additional expense related to increased debt levels was
mitigated by a reduction in the Company's weighted average
interest rate. The Company's weighted average interest rate was
7.72% for the three months ended March 31, 1998 as compared to
8.44% for the comparable 1997 period.
The Company recognized operating income and net income for the
three month period ended March 31, 1998 of $4.1 million and $2.7
million, respectively, as compared to $1.3 million in operating
income and $1.1 million in net income for equivalent period in
1997. Basic earnings per share ("EPS") increased 20% from $0.41
in 1997 to $.49 in 1998. The Company achieved the increased EPS
despite the dilutive effects of issuing additional shares in the
July 1997 common stock offering. The significant improvement in
EPS is primarily attributable to the positive impact of accretive
acquisitions consummated during 1997.
INCOME TAXES
As of December 31, 1997, the Company had net operating loss
("NOL") carryforwards of approximately $17.0 million, subject to
revision based on Republics final tax returns, expiring in
various amounts from 1998 through 2012. These NOLs were
generated by the Company's predecessor and Republic. The ability
of the Company to utilize the carryforwards is dependent upon the
Company generating sufficient taxable income and will be affected
by annual limitations (currently estimated at approximately $4.9
million) on the use of such carryforwards due to a change in
shareholder control under the Internal Revenue Code triggered by
the Company's July 1997 common stock offering and the change of
ownership created by the acquisition of Republic. The Company
believes, however, that the limitation will not materially impact
the Company's ability to utilize the NOL carryforwards prior to
their expiration. Depending on profitability, the limitation
could result in the Company's income tax expense to increase as
compared to previous years where no such limitation existed.
CAPITAL RESOURCES AND LIQUIDITY
The Company had historically funded its capital requirements
through cash flow from operations and borrowings from affiliates
and various commercial lenders. However, the capital resources of
the Company were significantly improved with the equity infusion
derived from its initial and secondary common stock offerings in
August 1996 and July 1997, respectively.
The net proceeds of the Company's combined stock offerings
contributed approximately $42.1 million and significantly
improved the Company's financial flexibility. This increased
flexibility has allowed the Company to pursue acquisition and
expansion opportunities utilizing lower cost conventional bank
debt financing. Currently, the Company's long-term debt to total
capitalization ratio stands at 32%.
Based on a re-evaluation of the cash flows generated from recent
acquisitions, Bank One Texas, N.A. ("Bank One") increased the
borrowing availability under the Company's bank financing
agreements. On October 31, 1997, amendments to credit
agreements were entered into which increased the Company's
borrowing availability from $46.5 million to $80.0 million,
eliminated principal reduction requirements, lowered the interest
rate on borrowings, and extended the maturity of the facility one
year to August 22, 2000.
Bank One has committed to lending, in the aggregate, up to $60.0
million of the $80.0 million in borrowing availability. If
required, the additional $20.0 million may be accessed with the
inclusion of another bank lender in a bank syndication. The
amended credit agreements provide borrowing availability as
follows: (i) a $15.0 million LC Line of Credit Facility, of which
$3.0 million can be used for working capital needs and $12.0
million is available for issuance of letters of credit, (ii) a
$60.0 million Revolver which expires in August 2000 and (iii) a
$5.0 million MIT Revolver expiring August 2000 (collectively the
"Credit Agreements").
When borrowings under the amended Credit Agreements are less than
50% of the $80.0 million borrowing base, at the Company's option,
interest will accrue at LIBOR plus 1.5% or the Bank One base
rate. When borrowings are greater than 50% of available credit,
an additional .25% will be added to the above rates. These rates
reflect a 1% reduction in the LIBOR option and a .25% reduction
in the Bank One base rate option effective September 2, 1997.
In addition, the Company is subject to a non-recurring 1%
facility fee as funds are borrowed, as well as a .375% commitment
fee payable quarterly on the unused portion of borrowing
availability. The Credit Agreements are secured by all accounts
receivable, contracts, the pledge of the stock of MIT, MLGC and
the pledge of the stock of Magnolia Pipeline Corporation and a
first lien security interest in the Company's pipeline systems.
The borrowing availability under each line is subject to
revision, on a monthly basis for the LC Line of Credit Facility
and a semi-annual basis for the Revolver's, based on the
performance of the Company's existing assets and any asset
dispositions or additions from new construction or acquisitions.
The Credit Agreements contains a number of customary covenants
that require the Company to maintain certain financial ratios,
and limit the Company's ability to incur additional indebtedness,
transfer or sell assets, create liens, or enter into a merger or
consolidation. Midcoast was in compliance with such financial
covenants at March 31, 1998.
For the three months ended March 31, 1998, the Company generated
cash flow from operating activities of approximately $3,448,000
before changes in working capital accounts and had approximately
$48.3 million available to the Company under its Credit
Agreements. At March 31, 1998, the Company had committed to
making approximately $10.9 million in capital expenditures for the
remainder of 1998. The Company believes that its existing Credit
Agreement and funds provided by operations will be sufficient for
it to meet its operating cash needs for the foreseeable future,
and its projected capital expenditures of approximately $10.9
million. If funds under the Credit Agreements are not available
to fund acquisition and construction projects the Company would
seek to obtain such financing from the sale of equity securities
or other debt financing. There can be no assurances that any
such financing will be available on terms acceptable to the
Company. Should sufficient capital not be available, the Company
will not be able to implement its growth strategy.
RISK MANAGEMENT
According to guidelines provided by the Board, the Company enters
into exchange-traded commodity futures, options and swap
contracts to reduce the exposure to market fluctuations in price
and transportation costs of energy commodities and is not to
engage in speculative trading. Approvals are required from senior
management prior to the execution of any financial derivative.
The financial derivatives have pricing terms indexed to both the
New York Mercantile Exchange and Kansas City Board of Trade. The
Company's market exposures arise from inventory balances and
fixed price purchase and sale commitments. The Company uses the
exchange-traded commodities to manage and hedge price risk
related to these market exposures.
Gas futures involve the buying and selling of natural gas at a
fixed price. Over-the-counter swap agreements require the
Company to receive or make payments based on the difference
between a specified price and the actual price of natural gas.
The Company uses futures and swaps to manage margins on
offsetting fixed-price purchase or sales commitments for physical
quantities of natural gas. Options held to hedge risk provide
the right, but not the obligation, to buy or sell energy
commodities at a fixed price. The Company utilizes options to
manage margins and to limit overall price risk exposure.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
This report includes "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Exchange Act of 1934. All statements
other than statements of historical fact included in this report
are forward looking statements. Such forward looking statements
include, without limitation, statements under "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity" regarding
Midcoast's estimate of the sufficiency of existing capital
resources, whether funds provided by operations will be
sufficient to meet its operational needs in the foreseeable
future, and its ability to utilize NOL carryforwards prior to
their expiration. Although Midcoast believes that the
expectations reflected in such forward looking statements are
reasonable, it can give no assurance that such expectations
reflected in such forward looking statements will prove to be
correct. The ability to achieve Midcoast's expectations is
contingent upon a number of factors which include (i) timely
approval of Midcoast's acquisition candidates by appropriate
governmental and regulatory agencies, (ii) the effect of any
current or future competition, (iii) retention of key personnel
and (iv) obtaining and timing of sufficient financing to fund
operations and/or construction or acquisition opportunities.
Important factors that could cause actual results to differ
materially from the Company's expectations ("Cautionary
Statements") are disclosed in this report, including without
limitation those statements made in conjunction with the forward
looking statements included in this report. All subsequent
written and oral forward looking statements attributable to the
Company or persons acting on its behalf are expressly qualified
in their entirety by the Cautionary Statements.
PART II. OTHER INFORMATION
LEGAL PROCEEDINGS
On February 28, 1998, Pan Grande, of which Midcoast owns a 50%
interest, filed for an arbitration hearing with the American
Arbitration Association pursuant to the provisions of a certain
contract with regard to a contractual dispute with Lone Star Gas
Company ("Lone Star"). The dispute concerns the relative
obligation of the parties to purchase and sell natural gas.
Subsequent to the arbitration filing by Pan Grande, Lone Star
withheld $732,910 from payments it owes for gas delivered by Pan
Grande to Lone Star. These funds were purportedly withheld for
damages claimed by Lone Star as a result of the failure of Pan
Grande to deliver natural gas to Lone Star on a separate
occasion. It is Pan Grande's belief that Lone Star has no legal
basis to withhold the funds and therefore no allowance for bad
debt has been provided for in the financial statements.
ITEM 6. Exhibits and Reports on Form 8-K
a. Exhibits:
EXHIBITS DESCRIPTION OF EXHIBITS
*4.14 First Amendment to Voting/Proxy Agreement dated April 29, 1998 by
and between Midcoast Energy Resources, Inc. and Steven G. Herbst,
June Herbst, Kenneth Holmes, Jr., Dorothy C. Holmes and Rainbow
Investments Company and Chase Bank of Texas.
10.27 Third Amendment to Employment Agreement dated March 2, 1998 by and
between Midcoast Energy Resources, Inc. and Dan Tutcher.
(Incorporated by reference from Midcoast Form 10-K dated
December 31, 1997).
10.28 Third Amendment to Employment Agreement dated March 18, 1998 by
and between Midcoast Energy Resources, Inc. and I.J. Berthelot,
II. (Incorporated by reference from Midcoast Form 10-K dated
December 31, 1997).
10.29 Third Amendment to Employment Agreement dated March 18, 1998 by
and between Midcoast Energy Resources, Inc. and Richard Robert.
(Incorporated by reference from Midcoast Form 10-K dated
December 31, 1997).
______
* Filed herewith
b. Reports on Form 8-K:
None
Signature
In accordance with the requirements of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MIDCOAST ENERGY RESOURCES, INC.
(Registrant)
BY: /s/ Richard A. Robert
Richard A. Robert
Principal Financial Officer
Treasurer
Principal Accounting Officer
Date: May 14, 1998
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