<PAGE> 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
================================================================================
<PAGE> 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
<PAGE> 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.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
EARNINGS COMPONENTS (IN MILLIONS)
--------------------------------
COMPARING 1998 TO 1997
---------------------
Quarter Nine Months Twelve Months
------- ----------- -------------
$ Change % Change $ Change % Change $ Change % Change
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
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
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
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
---------------------------------------------
<TABLE>
<CAPTION>
Quarter Nine Months Twelve Months
------- ----------- -------------
1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
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
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
1
<PAGE> 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 $144.8 million in
the 1998 nine- and twelve-month periods, respectively. The increase for the 1998
third quarter is due primarily to higher recognized revenues to recover gas
costs. As discussed in the "Cost of Gas" section that follows, MichCon's sales
rates are set to recover all reasonably and prudently incurred gas costs.
Substantially offsetting the increase in the current quarter is the impact of
reduced gas sales as a result of warmer weather. The decrease in revenues for
the 1998 nine- and twelve-month periods is due primarily to reduced gas sales
as a result of warmer weather. Additionally, the decrease for the 1998
nine-month period partially resulted from lower prices required to recover gas
costs. End user transportation deliveries increased slightly in the 1998 quarter
and declined in the 1998 nine- and twelve-month periods; however, revenues
increased slightly in the twelve-month period as a result of an increase
in the average transportation rate.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Quarter Nine Months Twelve Months
------- ----------- -------------
1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
GAS MARKETS ($ 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
------ ------ ------ ------ -------- --------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
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
<PAGE> 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
<PAGE> 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
<PAGE> 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
<PAGE> 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:
<TABLE>
<CAPTION>
Inventory Assessment Remediation Testing
------------ ------------- -------------- -----------
<S> <C> <C> <C> <C>
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%
</TABLE>
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
<PAGE> 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
<PAGE> 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
<PAGE> 11
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME (LOSS) (UNAUDITED)
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED TWELVE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------------ ----------------- -------------------
1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
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
=========== =========== =========== =========== =========== ===========
</TABLE>
CONSOLIDATED STATEMENT OF RETAINED EARNINGS (UNAUDITED)
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED TWELVE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------------ ----------------- -------------------
1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
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
========= ========= ========= ========= ========= =========
</TABLE>
The notes to the consolidated financial statements are an integral
part of these statements.
9
<PAGE> 12
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION (UNAUDITED)
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
SEPTEMBER 30, December 31,
----------------------------- ------------
1998 1997 1997
-------------- ------------- ------------
ASSETS
CURRENT ASSETS
<S> <C> <C> <C>
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
=========== ========== ==========
</TABLE>
The notes to the consolidated financial statements are an
integral part of this statement.
10
<PAGE> 13
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1998 1997
-------------- ------------
CASH FLOW FROM OPERATING ACTIVITIES
<S> <C> <C>
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
========= =========
</TABLE>
The notes to the consolidated financial statements are an integral part of
this statement.
11
<PAGE> 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
<PAGE> 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
<PAGE> 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
<PAGE> 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
<PAGE> 18
Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
12.1 Michigan Consolidated Gas Company and Subsidiaries
Computation of Ratio of Earnings to fixed charges.
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 12-1
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Twelve Months Ended Twelve Months Ended Twelve Months Ended
------------------- ------------------- -------------------
September 30, 1998 December 31, 1997 December 31, 1996
------------------- ------------------- -------------------
<S> <C> <C> <C>
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
======== ======== ========
</TABLE>
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.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
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.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 10,611
<SECURITIES> 0
<RECEIVABLES> 215,575
<ALLOWANCES> 8,912
<INVENTORY> 96,465
<CURRENT-ASSETS> 391,581
<PP&E> 2,845,717
<DEPRECIATION> 1,377,164
<TOTAL-ASSETS> 2,108,058
<CURRENT-LIABILITIES> 492,052
<BONDS> 621,745
0
0
<COMMON> 10,300
<OTHER-SE> 652,064
<TOTAL-LIABILITY-AND-EQUITY> 2,108,058
<SALES> 0
<TOTAL-REVENUES> 724,442
<CGS> 0
<TOTAL-COSTS> 624,808
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 7,703
<INTEREST-EXPENSE> 40,843
<INCOME-PRETAX> 70,967
<INCOME-TAX> 24,627
<INCOME-CONTINUING> 46,340
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 46,340
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
