<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) October 15, 1999
MCN Energy Group Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
MICHIGAN 1-10070 38-2820658
State of Incorporation (Commission File (I.R.S. Employer
Number) Identification No.)
</TABLE>
<TABLE>
<S> <C>
500 GRISWOLD STREET, DETROIT, MICHIGAN 48226
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code:
(313) 256-5500
<PAGE> 2
Item 5. Other Events
The registrant is filing herewith the following in connection with management's
decision, in August 1999, to retain its natural gas producing properties in
Michigan. In the 1998 MCN Annual Report on Form 10-K/A, MCN accounted for its
Exploration & Production (E&P) segment, which included these properties, as a
discontinued operation. Accordingly, E&P's operating results for prior periods
have been reclassified from discontinued operations to continuing operations.
The decision to retain these properties was based on the interaction of two
factors. MCN significantly revised its strategic direction. Key aspects of the
new corporate strategy include a Midwest-to-Northeast regional focus rather than
a North American focus, and an emphasis on achieving operational efficiencies
and growth through the integration of existing businesses. Shortly thereafter,
the bid for the Michigan properties was lowered significantly. The lower price
was unacceptable, especially in light of MCN's new strategic direction.
<PAGE> 3
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 hereunto duly authorized.
MCN ENERGY GROUP INC.
Date: October 15, 1999 By: /s/ GERARD KABZINSKI
---------------------
Gerard Kabzinski
Vice President and Controller
<PAGE> 4
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
27-1 MCN 1998 Financial Data Schedule
27-2 MCN 1997 Financial Data Schedule
27-3 MCN 1996 Financial Data Schedule
99-1 MCN Energy Group Inc. 1998 Annual Report reflecting the
Exploration and Production segment reclassified as a
continuing operation.
99-2 March 31, 1999 and June 30, 1999
Quarterly Operating Results and Common Stock Prices
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS RESTATED 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>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 17,039
<SECURITIES> 0
<RECEIVABLES> 409,785
<ALLOWANCES> 9,665
<INVENTORY> 147,387
<CURRENT-ASSETS> 767,457
<PP&E> 4,041,417
<DEPRECIATION> 1,644,094
<TOTAL-ASSETS> 4,392,898
<CURRENT-LIABILITIES> 1,447,136
<BONDS> 1,307,168
502,203
0
<COMMON> 797
<OTHER-SE> 791,125
<TOTAL-LIABILITY-AND-EQUITY> 4,392,898
<SALES> 0
<TOTAL-REVENUES> 2,030,698
<CGS> 0
<TOTAL-COSTS> 2,436,550
<OTHER-EXPENSES> 19,561
<LOSS-PROVISION> 13,282
<INTEREST-EXPENSE> 111,750
<INCOME-PRETAX> (469,936)
<INCOME-TAX> (183,468)
<INCOME-CONTINUING> (286,468)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (286,468)
<EPS-BASIC> (3.63)
<EPS-DILUTED> (3.63)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS RESTATED 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>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 39,495
<SECURITIES> 0
<RECEIVABLES> 421,635
<ALLOWANCES> 15,711
<INVENTORY> 56,777
<CURRENT-ASSETS> 730,036
<PP&E> 4,186,774
<DEPRECIATION> 1,488,050
<TOTAL-ASSETS> 4,330,937
<CURRENT-LIABILITIES> 993,954
<BONDS> 1,212,564
505,104
0
<COMMON> 782
<OTHER-SE> 1,143,169
<TOTAL-LIABILITY-AND-EQUITY> 4,330,937
<SALES> 0
<TOTAL-REVENUES> 2,207,867
<CGS> 0
<TOTAL-COSTS> 1,985,477
<OTHER-EXPENSES> (10,759)
<LOSS-PROVISION> 21,934
<INTEREST-EXPENSE> 86,453
<INCOME-PRETAX> 180,467
<INCOME-TAX> 47,238
<INCOME-CONTINUING> 133,229
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 133,229
<EPS-BASIC> 1.82
<EPS-DILUTED> 1.79
</TABLE>
<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> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 30,462
<SECURITIES> 0
<RECEIVABLES> 381,083
<ALLOWANCES> 18,487
<INVENTORY> 79,161
<CURRENT-ASSETS> 724,228
<PP&E> 3,717,557
<DEPRECIATION> 1,335,201
<TOTAL-ASSETS> 3,633,404
<CURRENT-LIABILITIES> 947,195
<BONDS> 1,252,040
173,809
0
<COMMON> 673
<OTHER-SE> 783,895
<TOTAL-LIABILITY-AND-EQUITY> 3,633,404
<SALES> 0
<TOTAL-REVENUES> 1,997,268
<CGS> 0
<TOTAL-COSTS> 1,785,975
<OTHER-EXPENSES> 3,764
<LOSS-PROVISION> 29,425
<INTEREST-EXPENSE> 77,781
<INCOME-PRETAX> 148,944
<INCOME-TAX> 36,375
<INCOME-CONTINUING> 112,569
<DISCONTINUED> 37,771
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 150,340
<EPS-BASIC> 2.25
<EPS-DILUTED> 2.23
</TABLE>
<PAGE> 1
EXHIBIT 99.1
<PAGE> 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DECEMBER 31, 1998
RESULTS OF OPERATIONS
Special investigation results in restatement -- Subsequent to the issuance
of MCN's December 31, 1998 financial statements, certain matters came to
management's attention and resulted in a special investigation of prior years'
operations of CoEnergy Trading Company (CTC), MCN's non-utility energy marketing
subsidiary. As a result of the investigation, MCN identified that its internal
controls had been overridden and that certain transactions had not been properly
accounted for. Specifically, the investigation concluded that CTC had entered
into gas supply contracts and agreed to pay significantly less than market
prices in one period in return for above-market prices to be paid in subsequent
periods through March 2000. The effect of these transactions was to improperly
delay the accrual of cost of gas expenses, resulting in the overstatement of the
1998 net loss by $.5 million and the overstatement of 1997 net income by $8.6
million.
Additionally, the investigation identified that CTC had entered into
certain unauthorized gas purchase and sale contracts for trading purposes. The
unauthorized transactions violate MCN's risk-management policy that requires all
such activities to be reviewed and approved by a risk committee that reports
regularly to the MCN Board of Directors. The gas purchase and sale contracts
entered into in connection with trading activities, some of which remain in
effect through March 2000, were not accounted for properly using the required
mark-to-market method, under which unrealized gains and losses are recorded as
an adjustment to cost of gas. The effect of not properly marking to market these
transactions was the understatement of the 1998 net loss by $7.1 million and the
overstatement of 1997 net income by $.4 million. However, net income of $2.6
million and $1.8 million was realized and recorded in connection with these
trading activities in 1998 and 1997, respectively, resulting in a net loss of
$4.5 million in 1998 and net income of $1.4 million in 1997 from such
activities. From the inception of these trading activities in March 1997 through
March 1999, $5.7 million of net income was realized and recorded in connection
with these trading activities. However, marking these contracts to market, as
required, results in a previously unrecorded net unrealized loss of $8.4 million
through March 1999, indicating a net loss of $2.7 million from such activities.
Other items identified during the investigation resulted in the
understatement of the 1998 net loss by $.9 million and the overstatement of 1997
net income by $.1 million.
As described in Note 1b to the Consolidated Financial Statements, the
accompanying consolidated financial statements for 1998 and 1997 have been
restated from those originally reported to properly account for the transactions
identified, resulting in an increase in the 1998 net loss of $7.5 million or
$.09 per diluted share and a decrease in 1997 net income of $9.1 million or $.12
per diluted share. The corrections did not have an impact on the liquidity or
cash flows of MCN. The financial information contained in Management's
Discussion and Analysis herein has been revised to reflect the impact of such
restatement.
Discontinued operations subsequently retained -- In the 1998 MCN Annual
Report on Form 10-K/A, MCN accounted for its Exploration & Production (E&P)
segment as a discontinued operation as a result of its decision to sell all of
its gas and oil properties. In August 1999, management announced its intention
to retain its natural gas producing properties in Michigan. Accordingly, E&P's
operating results for all periods included herein have been reclassified from
discontinued operations to continuing operations. The decision to retain these
properties was based on the interaction of two factors. MCN significantly
revised its strategic direction. Key aspects of the new corporate strategy
include a Midwest-to-Northeast regional focus rather than a North American
focus, and an emphasis on achieving operational efficiencies and growth through
the integration of existing businesses. Shortly thereafter, the bid for the
Michigan properties was lowered significantly. The lower price was unacceptable,
especially in light of MCN's new strategic direction.
Results for 1998 reflect unusual charges -- MCN experienced a net loss of
$286.5 million or $3.63 per share in 1998. As subsequently discussed, 1998
results reflect several unusual charges that totaled $389.6 million or $4.94 per
share. Excluding these charges, MCN had 1998 earnings of $103.1 million or $1.31
per share compared to 1997 earnings of $133.2 million or $1.79 per diluted
share. The earnings
F-2
<PAGE> 3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
comparisons reflect the effects of low energy prices, abnormally warm weather
and higher financing costs, partially offset by reduced operating costs in the
Gas Distribution segment. MCN's earnings from continuing operations for 1997
increased $20.6 million or $.12 per diluted share from 1996, reflecting improved
contributions from the Diversified Energy group. Per share comparisons were
affected by an increase in the average number of shares outstanding due to the
June 1997 issuance of 9,775,000 shares of new common stock.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
NET INCOME (LOSS) (in Millions)
Continuing Operations:
Diversified Energy:
Before unusual charges................................. $ 14.7 $ 52.1 $ 31.2
Unusual charges (Notes 2a, 2b & 3)..................... (372.9) -- --
------- ------ ------
(358.2) 52.1 31.2
------- ------ ------
Gas Distribution:
Before unusual charges................................. 88.4 81.1 81.4
Unusual charges (Note 2c).............................. (16.7) -- --
------- ------ ------
71.7 81.1 81.4
------- ------ ------
Total from Continuing Operations:
Before unusual charges.................................... 103.1 133.2 112.6
Unusual charges (Notes 2 & 3)............................. (389.6) -- --
------- ------ ------
(286.5) 133.2 112.6
------- ------ ------
Discontinued Operations (Note 4):
Income from operations.................................... -- -- 1.6
Gain on sale.............................................. -- -- 36.2
------- ------ ------
-- -- 37.8
------- ------ ------
$(286.5) $133.2 $150.4
======= ====== ======
DILUTED EARNINGS (LOSS) PER SHARE
Continuing Operations:
Diversified Energy:
Before unusual charges................................. $ .19 $ .72 $ .47
Unusual charges (Notes 2a, 2b & 3)..................... (4.73) -- --
------- ------ ------
(4.54) .72 .47
------- ------ ------
Gas Distribution:
Before unusual charges................................. 1.12 1.07 1.20
Unusual charges (Note 2c).............................. (.21) -- --
------- ------ ------
.91 1.07 1.20
------- ------ ------
Total from Continuing Operations:
Before unusual charges.................................... 1.31 1.79 1.67
Unusual charges (Notes 2 & 3)............................. (4.94) -- --
------- ------ ------
(3.63) 1.79 1.67
------- ------ ------
Discontinued Operations (Note 4):
Income from operations.................................... -- -- .03
Gain on sale.............................................. -- -- .53
------- ------ ------
-- -- .56
------- ------ ------
$ (3.63) $ 1.79 $ 2.23
======= ====== ======
</TABLE>
F-3
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
STRATEGIC DIRECTION -- MCN's objective is to achieve competitive long-term
returns for its shareholders. MCN is pursuing a growth strategy by investing in
a diverse portfolio of energy-related projects. Inherent in this
portfolio-management strategy is the frequent review of internal and external
factors affecting the company's investments. Therefore, the pace of new
investments and the disposition of existing assets is subject to change.
Reflecting this strategy in 1998, MCN has: realigned the company in order to
improve operating efficiencies through a more streamlined organizational
structure; decided to sell a significant portion of its E&P oil and gas
properties; and reduced its planned capital investment levels to approximately
$600 million to $750 million annually, which will be invested primarily in North
America. MCN will continue to review the overall mix of its existing portfolio
and the level of new investments.
UNUSUAL CHARGES -- As previously discussed, MCN recorded several unusual
charges in 1998, consisting of property write-downs, investment losses and
restructuring charges, which reduced 1998 earnings by $389.6 million or $4.94
per share. A detailed discussion of each unusual charge by segment follows:
<TABLE>
<CAPTION>
1998
--------------------
NET DILUTED
INCOME EPS
------ -------
<S> <C> <C>
UNUSUAL CHARGES (in Millions, Except Per Share Amounts)
Diversified Energy:
Pipelines & Processing (Note 2a).......................... $ (89.5) $(1.13)
Electric Power (Note 3)................................... (1.6) (.02)
Exploration & Production (Note 2b)........................ (275.0) (3.49)
Corporate & Other (Note 3)................................ (6.8) (.09)
------- ------
(372.9) (4.73)
Gas Distribution (Note 2c).................................. (16.7) (.21)
------- ------
$(389.6) $(4.94)
======= ======
</TABLE>
Pipelines & Processing recorded a $133.8 million pre-tax ($87.0 million net
of taxes) write-off of its coal fines project. In June 1998, MCN placed into
operation six plants designed to recover particles of coal that are a waste
by-product of coal mining and then process the particles to create coal
briquettes for sale. The economic viability of the venture is dependent on the
briquettes qualifying for synthetic fuel tax credits and MCN's ability to
utilize or sell such credits. Although the plants were placed in service by June
30, 1998, the date specified to qualify for the tax credits, operating delays at
the plants have significantly increased the possibility that the Internal
Revenue Service will challenge the project's eligibility for tax credits. In
addition, there is uncertainty as to whether MCN can utilize or sell the
credits. Without the credits, the project generates negative cash flows. These
factors led to MCN's decision to record an impairment loss equal to the carrying
value of the plants, reflecting the likely inability to recover such costs. MCN
is currently negotiating the sale of its interest in the coal fines project.
Management does not expect proceeds from the sale to be in excess of selling
expenses and remediation obligations.
MCN also recorded an impairment loss of $3.9 million pre-tax ($2.5 million
net of taxes) relating to an acquired out-of-service pipeline in Michigan. This
pipeline was acquired for future development, along with related easements and
rights-of-way. In connection with certain lease renewal options, MCN reviewed
the business alternatives for these assets and determined that their development
is unlikely. Accordingly, MCN has recorded an impairment loss equal to the
carrying value of these assets.
Electric Power recorded a $2.5 million pre-tax ($1.6 million net of taxes)
restructuring charge related to certain international power projects. The charge
was incurred as a result of refocusing MCN's strategic plan, particularly to
exit certain international power projects and to limit future capital
investments in developing countries to projects where it has existing
commitments.
F-4
<PAGE> 5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
Exploration & Production recorded write-downs in the second and third
quarter of 1998 totaling $416.9 million pre-tax ($271.0 million net of taxes) to
reflect the impact of low oil and gas prices as well as the under-performance of
certain oil and gas properties. The E&P business recognized the write-downs
under the full cost method of accounting as prescribed by the Securities and
Exchange Commission (SEC). Under the full cost method of accounting, E&P's
capitalized exploration and development costs at September 30, 1998 and June 30,
1998 exceeded the full cost "ceiling," resulting in the excess being written off
to income. The ceiling is the sum of discounted future net cash flows from the
production of proved gas and oil reserves and the lower of cost or estimated
fair value of unproved properties, net of related income tax effects. Future net
cash flows are required to be estimated based on end-of-quarter prices and
costs, unless contractual arrangements exist, even if any price decline is
temporary. A significant portion of the write-down was due to
lower-than-expected exploratory drilling results.
In 1998, MCN also recognized a $6.1 million pre-tax loss ($4.0 million net
of taxes) from the write-down of an investment in the common stock of an E&P
company. The loss was due to a decline in the fair value of the securities that
is not considered temporary.
Subsequent to the issuance of the 1998 Annual Report on Form 10-K/A, the
E&P segment recorded several unusual charges in 1999 (Note 4a). Included in
these unusual charges for 1999 was the $68.8 million pre-tax ($44.7 million net
of taxes) loss on the sale of the Western and Midcontinent/Gulf Coast
properties. Proceeds from the sale of these properties totaled approximately
$265 million. At December 31, 1998, the Western and Midcontinent/Gulf Coast
properties had 360 billion cubic feet equivalent of proven reserves. MCN will
continue selling other non-Michigan E&P oil and gas properties. Additionally, in
the second quarter of 1999, MCN recognized a $52.0 million pre-tax ($33.8
million net of taxes) write-down of its gas and oil properties under the full
cost method of accounting, due primarily to an unfavorable revision in the
timing of production of proved gas and oil reserves as well as reduced
expectations of sales proceeds on unproved acreage. Also, MCN recognized an
additional 7.5 million pre-tax ($4.9 million net of taxes) write-down of its
investment in the common stock of an E&P company during the second quarter of
1999. MCN has no carrying value in this investment after this write-down.
Corporate & Other recorded a $10.4 million pre-tax ($6.8 million net of
taxes) restructuring charge related to the corporate realignment designed to
improve operating efficiencies through a more streamlined organizational
structure. The realignment includes cost saving initiatives expected to reduce
future operating expenses by approximately $15 million per year. The realignment
includes the reduction of 37 positions resulting in severance and termination
benefits of $4.7 million pre-tax. Also included in the charge was $5.7 million
pre-tax relating to net lease expenses and the write-down of fixed assets
consisting of leasehold improvements, office equipment and information systems,
which are no longer being used by MCN. As of December 31, 1998, payments of $.7
million have been charged against the restructuring accruals relating to
severance and termination benefits. These benefits will continue to be paid
through 2000. The remaining restructuring costs, primarily for net lease
expenses, are expected to be paid over the related lease terms that expire
through 2006.
Gas Distribution recorded a $24.8 million pre-tax ($11.2 million net of
taxes and minority interest) write-down of certain gas gathering properties. A
new gas reserve analysis was performed to determine the impact of the diversion
of certain untreated gas away from the gathering system. This analysis revealed
that projected cash flows from the gathering system were not sufficient to cover
the system's carrying value. Therefore, an impairment loss was recorded
representing the amount by which the carrying value of the system exceeded its
estimated fair value.
MCN also recorded an $8.5 million pre-tax ($5.5 million net of taxes) loss
from the write-down of an investment in a Missouri gas distribution company. As
a result of MCN's refocused strategic direction, MCN expects to sell this
investment in 1999. The write-down represents the amount by which the carrying
value exceeded the estimated fair value of the investment.
F-5
<PAGE> 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
DIVERSIFIED ENERGY
Results impacted by unusual charges, financing costs and low energy
prices -- The Diversified Energy group reported a loss in 1998 due to the
property write-downs and restructuring charges, as previously discussed.
Excluding these unusual items, Diversified Energy's earnings for 1998 declined
by $37.4 million from 1997. These results reflect higher financing costs,
reduced contributions from the Pipelines & Processing and E&P segments due to
low energy prices as well as increased losses from the Energy Marketing segment.
Partially offsetting the decreases for 1998 was increased operating and joint
venture income posted by the Electric Power segment.
Earnings for 1997 increased by $20.9 million from 1996, reflecting
increased operating and joint venture income from the Pipelines & Processing,
Electric Power and E&P segments. Reduced Energy Marketing contributions and
higher financing costs partially offset this growth.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
DIVERSIFIED ENERGY OPERATIONS (in Millions)
Operating Revenues*......................................... $ 992.8 $951.3 $734.4
-------- ------ ------
Operating Expenses*
Property write-downs (Notes 2a & 2b)...................... 554.6 -- --
Restructuring charges (Note 3)............................ 12.9 -- --
Other..................................................... 989.6 905.7 693.6
-------- ------ ------
1,557.1 905.7 693.6
-------- ------ ------
Operating Income (Loss)..................................... (564.3) 45.6 40.8
-------- ------ ------
Equity in Earnings of Joint Ventures........................ 61.2 53.1 16.6
-------- ------ ------
Other Income & (Deductions)*
Interest income........................................... 5.2 6.7 3.0
Interest expense.......................................... (54.3) (32.2) (28.7)
Dividends on preferred securities......................... (36.4) (31.1) (12.4)
Investment loss (Note 2b)................................. (6.1) -- --
Other..................................................... 20.2 10.1 5.5
-------- ------ ------
(71.4) (46.5) (32.6)
-------- ------ ------
Income (Loss) Before Income Taxes........................... (574.5) 52.2 24.8
Income Tax Provision (Benefit).............................. (216.3) .1 (6.4)
-------- ------ ------
Net Income (Loss)
Before unusual charges.................................... 14.7 52.1 31.2
Unusual charges (Notes 2a, 2b & 3)........................ (372.9) -- --
-------- ------ ------
$ (358.2) $ 52.1 $ 31.2
======== ====== ======
</TABLE>
- -------------------------
* Includes intercompany transactions
F-6
<PAGE> 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
OPERATING AND JOINT VENTURE INCOME
Operating and joint venture results, excluding the unusual charges,
declined $34.5 million in 1998 and increased $41.3 million in 1997. A discussion
of each business segment, its contributions and its outlook follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
OPERATING AND JOINT VENTURE INCOME (LOSS) (in Millions)
Before Unusual Charges:
Pipelines & Processing.................................... $ 21.4 $ 29.1 $ 10.7
Electric Power............................................ 26.0 18.1 4.6
Energy Marketing.......................................... (3.6) (2.3) 9.4
Exploration & Production.................................. 29.0 58.1 33.2
Corporate & Other......................................... (8.6) (4.3) (.5)
-------- ------ ------
64.2 98.7 57.4
Unusual Charges (Notes 2a, 2b & 3).......................... (567.3) -- --
-------- ------ ------
$ (503.1) $ 98.7 $ 57.4
======== ====== ======
</TABLE>
PIPELINES & PROCESSING owns and invests in pipeline, gathering, processing
and related facilities in major supply areas, including the Midwest/Appalachia,
Midcontinent/Gulf Coast and Rocky Mountain regions.
Pipelines & Processing operating and joint venture income, excluding the
write-offs, decreased $7.7 million in 1998. This decrease reflects lower
contributions from MCN's 25% interest in Lyondell Methanol Company, L.P.
(Lyondell), a limited partnership that owns a 248 million gallon-per-year
methanol production plant in Texas. Earnings from Lyondell reflect an
approximate 40% decrease in methanol prices during 1998 resulting in a $13
million unfavorable impact on joint venture income as compared to 1997. In
addition, the Pipelines & Processing segment incurred $9.1 million of operating
losses in 1998 related to the start up of the coal fines project. As discussed
earlier, the coal fines project was written-off during 1998 and is not expected
to have a significant impact on future earnings. Partially offsetting the effect
of lower methanol prices and coal fines losses were increased contributions from
gas pipeline and processing ventures.
Transportation volumes increased 59.5 Bcf or over 50% as a result of the
acquisition and expansion of pipeline facilities during 1997 and 1998. Gas
processed to remove carbon dioxide (CO(2)) increased 6.1 Bcf or 14% in 1998 and
decreased slightly in 1997. Gas processed to remove natural gas liquids (NGL)
more than doubled, increasing 23.3 Bcf and 14.4 Bcf in 1998 and 1997,
respectively, due to the acquisition of processing facilities since 1996.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
PIPELINES & PROCESSING STATISTICS*
Methanol Produced (million gallons)......................... 60.4 60.8 10.5
Transportation (Bcf)........................................ 175.5 116.0 86.4
Gas Processed (Bcf)
CO(2) treatment........................................... 48.9 42.8 44.2
NGL removal............................................... 45.1 21.8 7.4
</TABLE>
- -------------------------
* Includes MCN's share of joint ventures
Operating and joint venture income increased by $18.4 million in 1997,
primarily reflecting income from the late 1996 acquisition of MCN's interest in
Lyondell. Additionally, Lyondell benefited from strong methanol prices during
1997. Results for 1997 also reflect income from a 29.6 Bcf or 34% increase in
transportation volumes resulting from the acquisition and expansion of pipeline
facilities.
F-7
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
METHANOL PRICES*
per Gallon
[METHANOL PRICE CHART]
<TABLE>
<CAPTION>
YEAR METHANOL PRICES
- ---- ---------------
<S> <C>
96 0.44
97 0.58
98 0.36
</TABLE>
* Estimated U.S. Gulf average
Outlook -- Pipelines & Processing's expansion strategy will continue to
focus on investing in natural gas and gas liquid gathering, processing and
transmission facilities near areas of rapid reserve development or growing
consumer markets. This business segment acquired or advanced several pipeline
and processing ventures in 1998 that are expected to contribute to future
operating results. MCN has a 35% joint venture interest in Dauphin Island
Gathering Partners (DIGP), which is proceeding with the second phase of its
expansion. The expansion is expected to be completed during the first quarter of
1999 and will increase the throughput capacity of the system to 1.1 billion
cubic feet per day (Bcf/d). Also, the Mobile Bay Processing Partners joint
venture has constructed a 600 million cubic feet per day (MMcf/d) gas processing
plant at the Dauphin Island system's onshore terminus in Alabama. MCN owns 43%
of this venture, which is expected to be in service in the first quarter of
1999. In addition, MCN has partnership interests in three interstate pipeline
projects. Portland Natural Gas Transmission System (Portland), Millennium
Pipeline and Vector Pipeline will transport Canadian and U.S. natural gas
volumes into the Northeast and Southeast U.S. markets. MCN has a 21.4% interest
in the Portland system, a 292-mile pipeline that will transport up to 360 MMcf/d
and is expected to be in-service in early 1999. MCN has a 10.5% interest in the
442-mile Millennium Pipeline that will have the capacity to transport 700
MMcf/d. MCN also has a 25% interest in the 343-mile Vector Pipeline that is
expected to transport up to 1 Bcf/d. Both the Millennium and Vector Pipelines
are subject to regulatory approval and sufficient market development.
MCN's Pipelines & Processing segment also has a 75% interest in an asphalt
manufacturing partnership that has completed construction of a plant designed to
produce annually up to 100,000 tons of high-quality asphalt. Additional
manufacturing plants may be built if market conditions warrant. During 1998, MCN
acquired a 49.9% interest in an asphalt distribution operation.
Pipelines & Processing's future operating results are expected to be
favorably affected by an increase in gas volumes transported and processed as
well as an increase in asphalt manufactured and sold. Future results will also
be impacted by changes in gas processing margins, methanol and asphalt prices,
and transportation and gathering rates. Gas processing margins and methanol
prices were significantly lower in 1998 than in the past few years.
F-8
<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
ELECTRIC POWER holds joint venture interests in electric power generation
and distribution facilities in the United States, India and Nepal. Electric
Power also provides fuel management services and supplies gas to power
generation facilities under long-term sales contracts.
Electric Power operating and joint venture results, excluding restructuring
charges, increased $7.9 million in 1998 and $13.5 million in 1997. The increased
earnings for 1998 and 1997 reflect contributions from Midland Cogeneration
Venture L.P. (MCV), a limited partnership that owns a gas-fired cogeneration
facility capable of producing up to 1,370 megawatts (MW) of electricity and 1.35
million pounds per hour of process steam. MCN acquired an initial 18% interest
in MCV in the 1997 second quarter and an additional 5% interest in MCV in June
1998. In addition, earnings from MCV for 1997 include a favorable $2.8 million
pre-tax adjustment resulting from a change in accounting for property taxes.
ELECTRICITY SALES*
[ELECTRICITY SALES GRAPH]
<TABLE>
<CAPTION>
DOMESTIC AND INTERNATIONAL
--------------------------
<S> <C>
96 708.9
97 1843.3
98 3805
</TABLE>
* Includes MCN's share of joint ventures
Also contributing to the 1998 and 1997 results were higher earnings from
MCN's 50%-owned, 123 MW Michigan Power cogeneration facility and contributions
from the 1997 acquisition of a 40% interest in Torrent Power Limited (TPL), an
Indian joint venture. Improved earnings from the Michigan Power facility are due
to a higher electricity sales rate under its long-term sales contract. TPL holds
minority interests in two electric distribution companies and a power generation
project in the state of Gujarat, India. The power generation project was formed
to build, own and operate a 655 MW dual-fuel facility. This facility began
partial operations in December 1997, and became fully operational in late 1998.
Outlook -- MCN intends to expand its Electric Power business, primarily in
projects in North America. Under its refocused strategic plan, MCN has exited
certain international power projects and plans to limit future capital
investments in developing countries to projects where it has existing
commitments. In February 1999, MCN reached an agreement to sell its interest in
TPL for approximately $130 million (Note 5b). The sale is subject to certain
regulatory approvals and is expected to be completed by the third quarter of
1999. MCN will continue to pursue opportunities to acquire and sell properties
in order to optimize its portfolio.
The Michigan Public Service Commission (MPSC) has issued its final order
regarding electric restructuring, which is being appealed. MCN has investments
in three Michigan electric power generation facilities that could be impacted by
electric restructuring.
F-9
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
A number of projects were advanced or acquired in 1998 and are expected to
contribute to future results. In October 1998, MCN acquired a 48% interest in
the Carson cogeneration project, a 42 MW gas-fired cogeneration plant in
California. The plant sells electricity and steam under separate long-term
contracts. In addition, MCN has a 43% interest in the Mobile Bay cogeneration
project, a 40 MW natural gas-fired plant, which is expected to be placed into
service in the first quarter of 1999. In December 1997, MCN acquired a 65%
interest in a 36 MW hydroelectric power plant in Nepal. Construction on the $98
million project began in early 1997 and is scheduled to be completed in early
2000. MCN also has a 95% interest in the Cobisa-Person Power project, a joint
venture that will build, own and operate a 140 MW power plant in Albuquerque,
New Mexico. This gas-fired peaking plant is expected to be in service by
mid-2000.
Foreign currency translation adjustments relating to MCN's international
equity investments are included in Accumulated Other Comprehensive Loss, a
component of Common Shareholders' Equity. The foreign currency translation
adjustment through December 1998 primarily relates to the U.S. dollar and Indian
rupee exchange rate fluctuations from the TPL investment. MCN's financial
statements will continue to be affected by currency exchange rate fluctuations.
However, the expected sale of MCN's interest in TPL will significantly reduce
its foreign currency risk.
ENERGY MARKETING sells premium, reliable, primarily bundled energy services
to large-volume customers in the Midwest, Gulf Coast and Northeast United States
and eastern Canada. In addition, the segment holds market-area storage capacity
that adds value to its energy marketing activities.
Energy Marketing operating and joint venture loss increased $1.3 million in
1998. The increased loss in 1998 primarily reflects unrealized losses associated
with trading activities (Note 1b) and higher gas storage costs, partially offset
by higher earnings from a significant increase in gas sales volumes.
Additionally, the earnings comparison was affected as a result of 1997 including
$2.2 million of contributions from Energy Marketing's 25% interest in a gas
storage project that was sold in December 1997. Operating and joint venture
income for 1997 decreased $11.7 million due to lower gas sales margins as well
as higher costs for storage capacity, which enhances Energy Marketing's ability
to offer reliable gas supply during peak winter months.
GAS SALES & EXCHANGE GAS DELIVERIES*
in Bcf
[GAS SALES & EXCHANGE GAS DELIVERIES GRAPH]
<TABLE>
<CAPTION>
YEAR GAS SALES & EXCHANGE GAS DELIVERIES*
- ---- ------------------------------------
<S> <C>
96 241.5
97 358.8
98 465.7
</TABLE>
* Includes MCN's share of joint ventures
Energy Marketing's total gas sales and exchange deliveries increased 106.9
Bcf or 30% during 1998 and 117.3 Bcf or 49% for 1997. The increase in Energy
Marketing's gas sales volumes was driven by additional
F-10
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
sales in each of the company's market regions. Under exchange gas contracts,
Energy Marketing accepts gas from customers or delivers gas to customers, and
gas is returned during a subsequent period.
MCN has a 50% interest in a joint venture storage project that owns a 10
Bcf storage facility. This storage facility is utilized by MCN's Energy
Marketing unit, in conjunction with third-party storage and pipeline capacity,
to enhance its ability to provide reliable gas sales and exchange gas services.
Outlook -- MCN will focus on growing its Energy Marketing segment through
expansion of its coverage within existing markets as well as by entering new
markets through strategic alliances with other energy providers. Enhanced by its
ability to provide reliable and custom-tailored bundled services to large-volume
end users and utilities, MCN is positioned to capitalize on opportunities to
further expand its market base into the Northeast and Midwest United States and
eastern Canada.
MCN is in the process of converting a depleted natural gas reservoir into a
42 Bcf storage facility. The storage field is expected to be completed by
mid-1999 and, therefore to be available for the 1999-2000 winter heating season.
The storage field will support Energy Marketing's operations by enhancing its
ability to offer a reliable gas supply during peak winter months.
EXPLORATION & PRODUCTION is engaged in natural gas and oil exploration,
development and production.
E&P operating and joint venture income, excluding the write-downs,
decreased by $29.1 million in 1998 and increased $24.9 million in 1997. Earnings
for the 1998 period reflects a sharp decline in average oil sales prices,
partially offset by an increase in average gas sales prices, and a slight
decline in the level of gas and oil produced. The 1997 period reflects a
significant increase in gas and oil produced due to the development and
acquisition of properties, partially offset by a decline in oil sales prices.
Results for 1997 also include income from MCN's unconsolidated joint venture
which contributed $6.6 million of pre-tax gains from the sale of undeveloped
properties.
GAS & OIL PRODUCTION
(in Bcf equivalent)
[GAS & OIL PRODUCTION GRAPH]
GAS & OIL PRODUCTION
(in Bcf equivalent)
[GAS & OIL PRODUCTION GRAPH]
<TABLE>
<CAPTION>
YEAR GAS AND OIL
- ---- -----------
<S> <C>
96 63.7
97 98.3
98 97.9
</TABLE>
Gas and oil production declined .4 billion cubic feet equivalent (Bcfe) in
1998 and increased 34.6 Bcfe or 54% in 1997. E&P operating results reflect
average oil sales rates per barrel of $12.58 in 1998, $16.87 in 1997 and $20.18
in 1996. E&P experienced average gas sale rates per thousand cubic feet (Mcf) of
$2.04 in 1998, $1.95 in 1997 and $1.96 in 1996. The average gas and oil sales
rates include the effect of hedging with
F-11
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
commodity swap and futures agreements, which are used to manage Diversified
Energy's exposure to the risk of market price fluctuations as discussed in the
"Risk Management Strategy" section that follows.
E&P operating and joint venture income for 1998 also reflects higher
production-related expenses and depletion costs which increased per Mcf
equivalent by $.11 and $.07, respectively.
E&P operations have supplemented Diversified Energy's earnings through the
generation of gas production tax credits, primarily from production of coalbed
methane and Antrim shale gas properties. Tax credits decreased 41% to $10.5
million in 1998, compared to $17.8 million in 1997 and $15.9 million in 1996.
The decline in 1998 reflects the sale of Antrim tax credits in mid-1998, whereby
the income from such sale is recorded as other income as the credits are
generated.
Outlook -- In August 1999, MCN announced a significantly revised strategic
direction. Consistent with this revised strategy, as well as the result of the
lowering of the bid for the Michigan E&P properties, MCN will retain its natural
gas producing properties in Michigan and continue selling other E&P oil and gas
properties. The timing of any sales is dependent upon receiving bids that
reflect the long-term value of such properties.
RISK MANAGEMENT STRATEGY -- MCN primarily manages commodity price risk by
utilizing futures, options and swap contracts to more fully balance its
portfolio of gas and oil supply and sales agreements. MCN's Energy Marketing
business coordinates all of MCN's hedging activities to ensure compliance with
risk management policies that are periodically reviewed by MCN's Board of
Directors. Certain hedging gains or losses related to gas and oil production are
recorded by MCN's E&P operations. Gains and losses on gas and oil
production-related hedging transactions that are not recorded by MCN's E&P unit
are recorded by Energy Marketing. In late 1998, MCN began entering into
offsetting positions for existing hedges of gas and oil production from
properties that are expected to be sold in 1999. MCN's risk management strategy
is being revised to reflect the change in its business that will result from
selling a significant portion of its E&P properties.
CORPORATE & OTHER operating and joint venture losses, excluding
restructuring charges, increased $4.3 million in 1998 and $3.8 million in 1997.
The results reflect increased administrative expenses associated with corporate
management activities. The Diversified Energy group was charged a larger portion
of such expenses beginning in 1997, to reflect its larger percentage of MCN.
Operating and joint venture losses in 1998 were partially offset by adjustments
necessary to reduce or eliminate accruals for employee incentive awards that are
based on MCN's operating or stock-price performance. The 1996 results benefited
from a $1.7 million pre-tax gain from the sale of land by a 50%-owned real
estate joint venture.
OTHER INCOME AND DEDUCTIONS
Other income and deductions increased $24.9 million in 1998 and $13.9
million in 1997. The increases reflect higher dividends resulting from the
issuance of $332 million of preferred securities in 1997 and $80 million of
preferred securities in 1996. All periods also reflect higher interest costs on
increased borrowings required to finance capital investments in the Diversified
Energy group. In addition, 1998 reflects an unusual charge of $6.1 million
representing the write-down of an investment in the common stock of an E&P
company, as previously discussed.
Other income and deductions comparisons also were affected by several gains
from the sale of properties. In 1998, a $6.0 million pre-tax gain was recorded
from the sale of certain gas sales contracts and a $3.9 million pre-tax gain was
recorded from the sale of a 50% interest in the 30 MW Ada cogeneration facility.
Other income and deductions for 1997 included a $3.2 million pre-tax gain from
the December 1997 sale of Diversified Energy's 25% interest in a gas storage
project, a $2.5 million pre-tax gain from the sale of pipeline assets as well as
gains related to DIGP. In a series of transactions during 1996, MCN sold 64% of
its 99%
F-12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
interest in the DIGP partnership, resulting in pre-tax gains totaling $8.8
million, of which $2.4 million was deferred until 1997 when a related option
agreement expired unexercised.
Additionally, other income and deductions in 1998 include $7.4 million of
income from a tax credit sale transaction, whereby MCN records income from such
sale as the credits are generated by the purchaser.
INCOME TAXES
Income taxes decreased in 1998 and increased in 1997. Income taxes were
impacted by variations in pre-tax earnings. Income tax comparisons were also
affected by tax credits recorded in all periods and stock-related tax benefits
recorded in 1998, as well as the generation of foreign income in 1998 that was
not subject to U.S. or foreign tax provisions.
GAS DISTRIBUTION
Results reflect unusual charges, warmer weather and cost-saving
initiatives -- Gas Distribution's earnings for 1998 were affected by the
property write-down and investment loss, as previously discussed. Excluding
these unusual charges, the Gas Distribution group reported 1998 earnings of
$88.4 million, an improvement of $7.3 million over 1997. Earnings for 1997 were
$81.1 million, representing a slight decrease from 1996. Earnings comparisons
were impacted by variations in weather and cost-saving initiatives resulting in
F-13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
significantly lower operating costs. These cost-saving initiatives allowed the
Gas Distribution group to continue its record of solid financial performance,
producing returns on equity of 11.0% in 1998 and 13.2% in 1997.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
GAS DISTRIBUTION OPERATIONS (in Millions)
Operating Revenues*
Gas sales................................................. $ 838.9 $1,080.1 $1,102.9
End user transportation................................... 82.3 84.7 82.5
Intermediate transportation............................... 63.2 55.2 48.6
Other..................................................... 67.4 51.3 42.3
-------- -------- --------
1,051.8 1,271.3 1,276.3
Cost of Gas................................................. 462.1 642.0 646.3
-------- -------- --------
Gross Margin................................................ 589.7 629.3 630.0
-------- -------- --------
Other Operating Expenses*
Operation and maintenance................................. 256.6 286.7 298.4
Depreciation and depletion................................ 93.8 104.4 98.8
Property and other taxes.................................. 56.0 61.3 62.3
Property write-down (Note 2c)............................. 24.8 -- --
-------- -------- --------
431.2 452.4 459.5
-------- -------- --------
Operating Income............................................ 158.5 176.9 170.5
-------- -------- --------
Equity in Earnings of Joint Ventures........................ 1.0 2.5 1.3
-------- -------- --------
Other Income and (Deductions)*
Interest income........................................... 5.7 4.7 4.0
Interest expense.......................................... (57.5) (54.5) (48.9)
Investment loss (Note 2c)................................. (8.5) -- --
Minority interest......................................... 5.7 (1.9) (1.0)
Other..................................................... (.2) .5 (1.8)
-------- -------- --------
(54.8) (51.2) (47.7)
-------- -------- --------
Income Before Income Taxes.................................. 104.7 128.2 124.1
Income Tax Provision........................................ 33.0 47.1 42.7
-------- -------- --------
Net Income
Before unusual charges.................................... 88.4 81.1 81.4
Unusual charges (Note 2c)................................. (16.7) -- --
-------- -------- --------
$ 71.7 $ 81.1 $ 81.4
======== ======== ========
</TABLE>
- -------------------------
* Includes intercompany transactions
GROSS MARGIN
Gross margins reflect abnormally warm weather -- Gas Distribution gross
margin (operating revenues less cost of gas) decreased $39.6 million and $.7
million in 1998 and 1997, respectively, reflecting changes in gas sales and end
user transportation deliveries due primarily to abnormally warm weather in 1998
and significantly colder weather in 1996. Additionally, gross margins in 1998
and 1997 were favorably affected by
F-14
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
the continued growth in intermediate transportation services as well as
increased other operating revenues resulting from providing gas-related
services.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
EFFECT OF WEATHER ON GAS MARKETS AND EARNINGS
Percentage Colder (Warmer) Than Normal...................... (19.3)% .8% 5.4%
Increase (Decrease) From Normal in:
Gas markets (in Bcf)...................................... (40.3) .6 10.9
Net income (in Millions).................................. $(35.3) $ .5 $ 9.9
Diluted earnings per share................................ $ (.45) $.01 $ .15
</TABLE>
GAS SALES AND END USER TRANSPORTATION revenues in total decreased $243.6
million in 1998 and $20.6 million in 1997. Revenues were affected by
fluctuations in gas sales and end user transportation deliveries that decreased
by 41.7 Bcf to 312.5 Bcf in 1998 and decreased by 13.7 Bcf to 354.2 Bcf in 1997.
The decreases in gas sales and end user transportation deliveries for both
periods were due primarily to weather, which was 20.1% warmer in 1998 and 4.6%
warmer in 1997 compared to the previous years. The decrease in revenues in 1998
also reflects a reduction in gas sales rates resulting from lower gas costs. The
impact of reduced gas sales and transportation deliveries in 1997 was partially
offset by an increase in gas sales rates due to higher gas costs. As discussed
in the "Cost of Gas" section that follows, Gas Distribution's sales rates
through the end of 1998 were set to recover all of its reasonably and prudently
incurred gas costs. Therefore, the effect of any fluctuations in cost of gas
sold was substantially offset by a change in gas sales revenues.
End user transportation services are provided to large-volume commercial
and industrial customers who purchase gas directly from producers and brokers,
including MCN's Energy Marketing business, and contract with MichCon to
transport the gas to their facilities. Gas Distribution continues to enter into
multi-year, competitively priced transportation agreements with large-volume
users to maintain these gas markets over the long term.
GAS DISTRIBUTION VOLUMES/GROSS MARGIN COMPARISON
[GAS DISTRIBUTION VOLUMES/GROSS MARGIN COMPARISON GRAPH]
[BAR GRAPH]
<TABLE>
<CAPTION>
Volumes Gross Margins
Year In Bcf In Millions
- ---- ------- -------------
<S> <C> <C>
96 895.4 $ 630.0
$ 614.8*
97 940.7 $ 629.3
$ 628.6*
98 850.0 $ 589.7
$ 644.0*
</TABLE>
- - Gas Sales
- - End User Transportation
- - Intermediate Transportation
- - Other
- - Total Margins Weather Normalized
* Total Margins Weather Normalized
F-15
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
INTERMEDIATE TRANSPORTATION revenues increased by $8.0 million and $6.6
million in 1998 and 1997, 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 is a gas
delivery service provided to gas producers, gas brokers and other gas companies
that own the natural gas but are not the ultimate consumers.
Although intermediate transportation revenues increased in 1998, volumes
delivered decreased 49.0 Bcf to 537.5 Bcf. Intermediate transportation
deliveries increased in 1997 by 59.0 Bcf to 586.5 Bcf. The decrease in
intermediate transportation deliveries in 1998 reflects lower off-system demand
caused by the warmer weather and lower volumes transported for fixed-fee
customers. Although transported volumes for fixed-fee customers may fluctuate,
revenues from such customers are not affected. Intermediate transportation
revenues and volumes delivered for both 1998 and 1997 reflect additional Antrim
gas volumes transported for Michigan gas producers and brokers. There has been a
significant increase in Michigan Antrim gas production over the past several
years, resulting in a growing demand by gas producers and brokers for
intermediate transportation services. In order to meet the increased demand, Gas
Distribution expanded the transportation capacity of its northern Michigan
gathering system in 1996. In December 1997, MichCon purchased an existing
pipeline system and further expanded the capacity of this system. Although
intermediate transportation volumes are a significant part of Gas Distribution's
total markets, profit margins on this service are considerably less than margins
on gas sales or for end user transportation services.
OTHER OPERATING REVENUES increased $16.1 million in 1998 and $9.0 million
in 1997. The improvement in both periods is due in part to an increase in late
payment fees, appliance maintenance services and other gas-related services. The
comparisons are also impacted by unfavorable adjustments in 1997 and 1996
related to the discontinuance of MichCon's energy conservation programs.
COST OF GAS
Cost of gas is affected by variations in sales volumes and the costs of
purchased gas as well as related transportation costs. Under the Gas Cost
Recovery (GCR) mechanism in effect through 1998 (Note 7b), MichCon adjusted its
sales rates to recover all of its reasonably and prudently incurred gas costs.
Therefore, fluctuations in cost of gas sold had little effect on gross margins.
Cost of gas sold decreased by $179.9 million in 1998 and by $4.3 million in
1997 as a result of lower sales volumes, primarily due to warmer weather. The
decrease in 1998 also reflects lower prices paid for gas purchased of $.40 (13%)
per thousand cubic feet (Mcf). Additionally, the decrease in 1997 was impacted
by supplier refunds, partially offset by higher prices paid for gas purchased of
$.19 per Mcf (7%).
OTHER OPERATING EXPENSES
OPERATION AND MAINTENANCE expenses declined by $30.1 million or 10% in 1998
and $11.7 million or 4% in 1997. These reductions reflect management's
continuing efforts to control operating costs. More specifically, the reductions
for both 1998 and 1997 reflect lower benefit costs, primarily pension and
retiree healthcare costs, as well as lower uncollectible gas accounts expense.
Gas Distribution has streamlined its organizational structure over the past
several years while increasing its customer base and expanding energy services
to customers. MichCon implemented an early retirement program in early 1998 that
reduced its net workforce by approximately 175 employees or 6%. The cost of the
program and the related savings were largely offsetting in 1998 but will
contribute to lower operating costs in future years. Since 1995, the number of
Gas Distribution employees has declined by 410 or 13%, while the number of
customers has increased over 30,000 or 3%.
F-16
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
GAS DISTRIBUTION -- NUMBER OF CUSTOMERS SERVED PER EMPLOYEE
[GAS DISTRIBUTION/NUMBER OF CUSTOMERS SERVED PER EMPLOYEE GRAPH]
<TABLE>
<CAPTION>
GAS DISTRIBUTION - NUMBER OF CUSTOMERS SERVED
YEAR PER EMPLOYEE
- ---- ---------------------------------------------
<S> <C>
96 380
97 409
98 435
</TABLE>
Gas Distribution's uncollectible gas accounts expense declined by $8.7
million in 1998 and $5.7 million in 1997 reflecting the impact of warmer weather
on accounts receivable balances, the successful implementation of a more
aggressive collection program as well as increased home heating assistance
funding obtained by low-income customers.
Gas Distribution's uncollectible gas accounts expense is directly affected
by the level of government funded heating assistance its qualifying customers
receive. The State of Michigan provides this assistance in the form of Michigan
Home Heating Credits that are funded almost exclusively by the Federal
Low-Income Home Energy Assistance Program (LIHEAP). Congress approved funding
for the 1997 and 1998 fiscal years at $1 billion and $1.1 billion, respectively,
compared to funding of $.9 billion for the 1996 fiscal year. The State of
Michigan's share of LIHEAP funds was decreased from $64 million in fiscal year
1997 to $54 million in 1998. Gas Distribution received $13.4 million of these
funds in 1998, $.7 million more than in 1997. Home Heating Credits assisted
73,000 Gas Distribution customers in 1998, compared to 83,000 in 1997. During
1998, Congress approved a budget that maintains federal LIHEAP funding at $1.1
billion for fiscal year ending September 1999. Any future change in this funding
may impact Gas Distribution's uncollectible gas accounts expense.
DEPRECIATION AND DEPLETION decreased by $10.6 million in 1998 and increased
by $5.6 million in 1997. The decrease in 1998 resulted from lower depreciation
rates for MichCon's utility property, plant and equipment that became effective
in January 1998. Depreciation on higher plant balances partially offset the 1998
rate decrease and resulted in the increase in 1997. The higher plant balances
reflect capital expenditures of $158.0 million in 1998 and $157.7 million in
1997.
PROPERTY AND OTHER TAXES decreased by $5.3 million in 1998 and $1.0 million
in 1997. The decreases for both 1998 and 1997 are attributable to lower property
taxes based on pending appeals of personal property tax assessments. If Gas
Distribution is unsuccessful in its appeals, that outcome is not expected to
have a significant adverse effect on its results of operations. The decrease in
1998 is also due to lower Michigan Single Business taxes resulting from a
decrease in taxable income. Property and other taxes increased in 1996 as a
result of higher plant balances.
PROPERTY WRITE-DOWN of $24.8 million in 1998 reflects the impairment of a
Michigan gas gathering system (Note 2c).
F-17
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
EQUITY IN EARNINGS OF JOINT VENTURES
Earnings from joint ventures decreased $1.5 million in 1998 due to
increased losses from Gas Distribution's 47.5% interest in a Missouri gas
distribution company that is expected to be sold in 1999. Earnings from joint
ventures in 1997 increased $1.2 million reflecting increased contributions from
the Blue Lake gas storage project as a result of reduced operating and financing
costs.
OTHER INCOME AND DEDUCTIONS
Other income and deductions increased $3.6 million in 1998 and $3.5 million
in 1997. The increases reflect higher interest costs on increased borrowings
required to finance capital investments. MichCon issued $150 million of first
mortgage bonds in 1998 and $85 million of first mortgage bonds in 1997.
Additionally, non-utility subsidiaries of MichCon borrowed $40 million in 1997
under a nonrecourse credit agreement. Accordingly, interest expense increased
$3.0 million in 1998 and $5.6 million in 1997. Other income and deductions in
1998 were also impacted by an unusual charge to write-down the investment in a
small natural-gas distribution company located in Missouri. Partially offsetting
these increases in 1998 was a change in minority interest reflecting joint
venture partner's share of the write-down of certain gas gathering properties
(Note 2c). Other income and deductions in 1998 were also affected by a gain
recorded from the sale of land as well as by an increase in the capitalization
of the cost of equity funds used during construction resulting from higher
construction balances.
INCOME TAXES
Income taxes decreased in 1998 and increased in 1997. Income tax
comparisons were affected by variations in pre-tax earnings and by 1998 tax
credits and a provision for tax issues. Income taxes in 1997 and 1996 include
amounts for the favorable resolution of prior years' tax issues and tax credits.
ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for heating
and other uses was manufactured from processes involving coal, coke or oil. MCN
owns, or previously owned, 17 such former manufactured gas plant (MGP) sites.
During the mid-1980s, preliminary environmental investigations were
conducted at these former MGP sites, and some contamination related to the
by-products of gas manufacturing was discovered at each site. The existence of
these sites and the results of the environmental investigations have been
reported to the Michigan Department of Environmental Quality (MDEQ). None of
these former MGP sites is on the National Priorities List prepared by the U.S.
Environmental Protection Agency (EPA).
MCN is involved in an administrative proceeding before the EPA regarding
one of the former MGP sites. MCN has executed an order with the EPA, pursuant to
which MCN is legally obligated to investigate and remediate the MGP site. MCN is
remediating five of the former MGP sites and conducting more extensive
investigations at four other former MGP sites. In 1998, MichCon completed the
remediation of one of the former MGP sites, which was confirmed by the MDEQ.
Additionally, the MDEQ has determined with respect to one other former MGP site
that MichCon is not a responsible party for the purpose of assessing remediation
expenditures.
In 1984, MCN established an $11.7 million reserve for environmental
investigation and remediation. During 1993, MichCon received MPSC approval of a
cost deferral and rate recovery mechanism for investigation and remediation
costs incurred at former MGP sites in excess of this reserve.
MCN employed outside consultants to evaluate remediation alternatives for
these sites, to assist in estimating its potential liabilities and to review its
archived insurance policies. The findings of these investigations indicate that
the estimated total expenditures for investigation and remediation activities
for
F-18
<PAGE> 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
these sites could range from $30 million to $170 million based on undiscounted
1995 costs. As a result of these studies, MCN accrued an additional liability
and a corresponding regulatory asset of $35 million during 1995.
MCN notified more than 50 current and former insurance carriers of the
environmental conditions at these former MGP sites. MCN concluded settlement
negotiations with certain carriers in 1996 and 1997 and has received payments
from several carriers. In October 1997, MCN filed suit against major nonsettling
carriers seeking recovery of incurred costs and a declaratory judgment of the
carriers' liability for future costs of environmental investigation and
remediation costs at former MGP sites. Discovery is ongoing in the case, and a
preliminary trial date has been scheduled for August 1999.
During 1998, 1997, and 1996, MCN spent $1.6 million, $.8 million and $.9
million, respectively, investigating and remediating these former MGP sites. At
December 31, 1998, the reserve balance is $35.1 million, of which $.1 million is
classified as current. Any significant change in assumptions, such as
remediation techniques, nature and extent of contamination and regulatory
requirements, could impact the estimate of remedial action costs for the sites
and, therefore, have an effect on MCN's financial position and cash flows.
However, management believes that insurance coverage and the cost deferral and
rate recovery mechanism approved by the MPSC will prevent environmental costs
from having a material adverse impact on MCN's results of operations.
In 1998, MichCon received written notification from ANR Pipeline Company
(ANR) alleging that MichCon has responsibility for a portion of the costs
associated with responding to environmental conditions present at a natural gas
storage field in Michigan currently owned and operated by an affiliate of ANR.
At least some portion of the natural gas storage field was formerly owned by
MichCon. MichCon is evaluating ANR's allegations to determine whether and to
what extent, if any, it may have legal responsibility for these costs.
Management does not believe this matter will have a material impact on MCN's
financial statements.
OUTLOOK
Gas Distribution's strategy is to expand its role as the preferred provider
of natural gas and high-value energy services within Michigan. Accordingly, Gas
Distribution's objectives are to grow its revenues and control its costs in
order to deliver strong shareholder returns and provide customers high-quality
service at competitive prices. Revenue growth will be achieved through
initiatives to expand Gas Distribution's 900 Bcf of gas markets, its 1.2 million
residential, commercial and industrial customer base, as well as by providing
new energy-related services that capitalize on its expertise, capabilities and
efficient systems.
Gas Distribution expects to provide natural gas to approximately 13,000 new
customers in 1999. Gas Distribution's market share for residential heating
customers in the communities it serves is approximately 80%. While this
saturation rate is high, growth opportunities exist through conversion of
existing homes from other fuels as well as from new construction. Gas
Distribution continues to expand industrial and commercial markets by
aggressively facilitating the use of existing gas technologies and equipment.
Management is continually assessing ways to improve cost competitiveness.
Among other cost saving initiatives, MichCon implemented an early retirement
incentive program in 1998 that reduced its net workforce by approximately 6%.
Although this program did not have a material impact on 1998 net income, the
early retirement of employees is expected to contribute toward reducing
operating costs in future years.
The challenges and opportunities resulting from increased competition in
the natural gas industry have been a catalyst for MPSC action in the development
of major reforms in utility regulation aimed at giving all customers added
choices and more price certainty. The overall package of regulatory changes
connected with the gas industry restructuring is expected to generate additional
revenue and cost savings opportunities. Gas Distribution is positioning itself
to respond to changes in regulation and increased competition by reducing its
cost of operations while maintaining a safe and reliable system for customers.
F-19
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
Gas Distribution plans to capitalize on opportunities resulting from the
gas industry restructuring by implementing MichCon's Regulatory Reform Plan,
which was approved by the MPSC in April 1998. The plan includes a comprehensive
experimental three-year customer choice program that offers all sales customers
added choices and greater price certainty. Beginning April 1, 1999, a limited
number of 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 commodity component of MichCon's
sales rates at $2.95 per Mcf for the three-year period beginning on January 1,
1999. Prior to 1999, MichCon did not generate earnings on the gas commodity
portion of its operations. However, under this plan, changes in the cost of gas
will directly impact gross margins and earnings. As part of its gas acquisition
strategy, MichCon has entered into firm-price contracts for a substantial
portion of its expected gas supply requirements for the next three years. These
contracts, coupled with the use of MichCon's storage facilities, will
substantially mitigate risks from winter price and volume fluctuations.
Also beginning in 1999 under the plan, 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
program will have a favorable impact on future earnings. In October 1998, the
MPSC denied a request for rehearing and affirmed its approval of the plan.
Various parties have appealed the MPSC's decision to the Michigan Court of
Appeals.
Gas Distribution expects to continue growing revenues by offering a variety
of energy-related services, which includes appliance maintenance and home
safety. Additionally, Gas Distribution began participating in Michigan's $1.2
billion per year heating, ventilation and air conditioning market with the
October 1998 acquisition of three companies specializing in the sale,
installation and servicing of residential and commercial heating and cooling
systems. The acquired companies have total revenues of approximately $20 million
per year.
As described in Note 7a to the consolidated financial statements, MCN's Gas
Distribution segment complies with the provisions of Statement of Financial
Accounting Standards (SFAS), No. 71, "Accounting for the Effects of Certain
Types of Regulation." Future regulatory changes or changes in the competitive
environment could result in Gas Distribution discontinuing the application of
SFAS No. 71 for all or part of its business and require the write-off of the
portion of any regulatory asset or liability that was no longer probable of
recovery or refund. If Gas Distribution were to discontinue application of SFAS
No. 71 for all of its operations as of December 31, 1998, it would have an
extraordinary, noncash increase to net income of approximately $63.7 million.
Factors that could give rise to the discontinuance of SFAS No. 71 include (1)
increasing competition that restricts Gas Distribution's ability to establish
prices to recover specific costs, and (2) a significant change in the manner in
which rates are set by regulators from cost-based regulation to another form of
regulation. Based on a current evaluation of the various factors and conditions
that are expected to impact future regulation, management believes currently
available facts support the continued application of SFAS No. 71.
DISCONTINUED OPERATIONS
In June 1996, MCN completed the sale of its computer operations subsidiary
for an adjusted sales price of $132.9 million, resulting in an after-tax gain of
$36.2 million (Note 4b).
F-20
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
CAPITAL RESOURCES AND LIQUIDITY
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH AND CASH EQUIVALENTS (in Millions)
Cash Flow Provided From (Used For):
Operating activities...................................... $ 152.7 $ 343.4 $ 198.3
Financing activities...................................... 497.8 522.8 440.4
Investing activities...................................... (673.0) (857.2) (627.5)
------- ------- -------
Net Increase (Decrease) in Cash and Cash Equivalents........ $ (22.5) $ 9.0 $ 11.2
======= ======= =======
</TABLE>
OPERATING ACTIVITIES
MCN's cash flow from operating activities decreased $190.7 million during
1998 and increased $145.1 million during 1997. The decrease during 1998 was due
primarily to higher working capital requirements and a decline in earnings,
after adjusting for noncash items (depreciation, unusual charges and deferred
taxes). The increase in 1997 was primarily the result of lower working capital
requirements, as well as higher net income, after adjusting for noncash items
and nonoperating gains (Notes 2, 3 and 5e).
FINANCING ACTIVITIES
MCN's cash flow from financing activities decreased $25.1 million during
1998. The decrease reflects lower debt and equity issuances, net of debt
repayments, in 1998 compared to 1997 as a result of lower capital expenditures
and acquisitions. Cash flow from financing activities increased $82.5 million in
1997 as a result of higher issuances of common stock and preferred securities,
offset slightly by lower borrowings of long-term debt. The proceeds from the
issuances were used to finance higher capital investments during 1997.
MCN typically relies on commercial paper and bank borrowings to finance
capital expenditures on a temporary basis until paid down with the proceeds from
the issuance of more permanent capital, such as long-term debt, preferred
securities and common stock. However, MCN will rely more on short-term financing
and less on permanent capital issuances during 1999. Proceeds from the expected
sale of a significant portion of MCN's E&P properties in 1999 will be used to
repay commercial paper and bank borrowings. A summary of MCN's significant
financing activities for 1998 and financing plans for 1999 follows.
In late 1998, MCN issued $100 million of preferred securities and borrowed
$260 million under a one-year term loan (Note 9). Proceeds were used to reduce
commercial paper, to fund capital investments by Diversified Energy and for
general corporate purposes. MCN intends to repay the term loan with proceeds
from the sale of E&P properties.
In 1997, MCN sold 9,775,000 shares of common stock in a public offering,
generating net proceeds of $276.6 million (Note 11a). In 1997, MCN issued $100
million of Private Institutional Trust Securities (PRINTS) and $100 million of
Single Point Remarketed Reset Capital Securities (SPRRCS) (Note 10a). In 1997,
MCN also issued 2,645,000 FELINE PRIDES, generating proceeds of $132.3 million
(Note 10a). The proceeds from these issuances were invested by MCN in its
Diversified Energy group and were used to reduce short-term debt incurred to
fund capital investments.
During 1998, MCN retired the PRINTS early because it determined other forms
of financing provide greater flexibility.
In 1996, MCN issued $80 million of Trust Originated Preferred Securities
(TOPrS). Proceeds from the issuance were invested by MCN in its Diversified
Energy group and were used to reduce short-term debt incurred to fund capital
expenditures, for working capital requirements and for general corporate
purposes.
F-21
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
In April 1996, MCN issued 5,865,000 Preferred Redeemable Increased Dividend
Equity Securities (Enhanced PRIDES) (Note 10c). The Enhanced PRIDES are
convertible securities that consist of a forward contract under which MCN is
obligated to sell, and the Enhanced PRIDES holders are obligated to purchase,
$135 million of MCN common stock in April 1999. It is anticipated that proceeds
from the conversion of the Enhanced PRIDES will be used to repay Diversified
Energy's medium-term notes that mature in May 1999.
MCN traditionally has issued new shares of common stock pursuant to its
Direct Stock Purchase and Dividend Reinvestment Plan and various employee
benefit plans. During the 1996-1998 period, MCN issued 3,281,000 shares and
generated $55.3 million. Beginning in 1999, shares issued under these plans will
be acquired by MCN through open market purchases.
As of December 1998, MCN had an outstanding shelf registration with
approximately $835.9 million remaining to be issued in the form of debt or
equity securities.
The following table sets forth the ratings for securities issued by MCN and
its subsidiaries as of June 1999:
<TABLE>
<CAPTION>
STANDARD DUFF &
& POOR'S MOODY'S PHELPS FITCH
-------- ------- ------ -----
<S> <C> <C> <C> <C>
MCN:
FELINE PRIDES........................................... BBB- Ba1 BBB BBB
Enhanced PRIDES......................................... BBB- Baa3 BBB BBB
Preferred securities.................................... BBB- Ba1 BBB BBB
SPRRCS.................................................. BBB+ Baa3 BBB+ BBB+
MCNIC:
Commercial paper*....................................... A2 P3 D2 F2
Medium-term notes*...................................... BBB Baa3 BBB+ BBB
MichCon:
Commercial paper........................................ A2 P1 D1 F1
First mortgage bonds.................................... A- A2 A+ A
</TABLE>
- -------------------------
* Ratings based on MCN support agreement
DIVERSIFIED ENERGY
In 1998, Diversified Energy issued remarketable debt securities totaling
$300 million (Note 9). Proceeds from these issuances were used to reduce
short-term debt incurred by the Diversified Energy group to fund capital
investments and for general corporate purposes.
During 1998, a subsidiary of MCN Investment Corporation (MCNIC), currently
operating as MCN Energy Enterprises, retired early a $100 million five-year term
loan because it determined that other forms of debt financing provide greater
flexibility and lower costs.
In 1998, MCNIC renewed its credit lines, which now allow for borrowings of
up to $200 million under a 364-day revolving credit facility and up to $200
million under a three-year revolving credit facility. These facilities support
MCNIC's $400 million commercial paper program, which is used to finance capital
investments of the Diversified Energy group and working capital requirements of
its Energy Marketing operations. At December 31, 1998, commercial paper and bank
borrowings of $225.7 million were outstanding under this program.
In 1997, MCNIC repaid $30 million of senior debt on its stated maturity
date and issued $150 million of medium-term notes, using the proceeds to repay
short-term debt and for general corporate purposes.
F-22
<PAGE> 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
In 1996, MCNIC issued $330 million of medium-term notes, using the proceeds
to repay commercial paper balances and for general corporate purposes.
As of December 1998, MCNIC had an outstanding shelf registration with $620
million remaining to be issued in the form of debt securities.
GAS DISTRIBUTION
Gas Distribution 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 each
year, Gas Distribution'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, Gas Distribution 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.
At December 31, 1998, commercial paper of $218.4 million was outstanding under
this program.
During 1998, MichCon issued $150 million of remarketable debt securities
(Note 9). Proceeds from these issuances were used to retire first mortgage
bonds, fund capital expenditures and for general corporate purposes. Also during
1998, MichCon redeemed through a tender offer $89.7 million and repaid $20
million of first mortgage bonds.
During 1997, MichCon issued $85 million of first mortgage bonds. The funds
from this issuance were used to retire first mortgage bonds, fund capital
expenditures and for general corporate purposes. During 1997, nonutility
subsidiaries of MichCon borrowed $40 million under a nonrecourse credit
agreement that matures in 2005. Proceeds were used to finance the expansion of
the northern Michigan gathering system.
During 1997, MichCon redeemed $17 million of long-term debt and also repaid
$50 million of first mortgage bonds.
During 1996, MichCon issued first mortgage bonds totaling $70 million. The
proceeds were used to repay short-term obligations, finance capital expenditures
and for general corporate purposes. Also during 1996, MichCon repaid all amounts
owing under its Trust Demand Note program and did not renew this program which
allowed for borrowings of up to $25 million.
As of December 1998, MichCon had an outstanding shelf registration with
$250 million remaining to be issued in the form of debt securities.
INVESTING ACTIVITIES
MCN's cash used for investing activities decreased $184.2 million in 1998
and increased $229.7 million in 1997. The decrease in 1998 was due primarily to
lower capital expenditures and acquisitions, partially offset by the repayment
of an advance by a Philippine power producer. The 1997 increase reflects higher
acquisitions and joint venture investments compared to 1996.
Capital investments equaled $790.9 million in 1998 compared to $959.6
million in 1997. The 1998 decrease reflects lower acquisitions as well as lower
capital expenditures for the E&P properties. Partially offsetting this decrease
were significantly higher investments in Pipelines & Processing properties, as
well as increased investments in domestic and international power generation
projects.
F-23
<PAGE> 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CAPITAL INVESTMENTS (in Millions)
Consolidated Capital Expenditures:
Diversified Energy........................................ $324.8 $405.0 $395.3
Gas Distribution.......................................... 158.0 157.7 215.3
Discontinued Operations................................... -- -- 6.5
------ ------ ------
482.8 562.7 617.1
------ ------ ------
MCN's Share of Joint Venture Capital Expenditures:*
Pipelines & Processing.................................... 219.9 152.2 5.2
Electric Power............................................ 12.0 7.4 5.5
Energy Marketing.......................................... .8 3.2 .2
Gas Distribution.......................................... .8 2.6 4.8
Other..................................................... .1 .5 .3
------ ------ ------
233.6 165.9 16.0
------ ------ ------
Acquisitions:
Significant............................................... 66.8 231.0 133.2
Other..................................................... 7.7 -- 24.4
------ ------ ------
74.5 231.0 157.6
------ ------ ------
Total Capital Investments................................... $790.9 $959.6 $790.7
====== ====== ======
</TABLE>
- -------------------------
* A portion of joint venture capital expenditures is financed with joint venture
project debt.
Total capital investments in 1998 were partially funded from the sale of
property and joint venture interests that totaled $47 million.
OUTLOOK
1999 capital investments estimated at $750 million -- MCN's refocused
strategic direction will result in capital investments in future years of
approximately $600 million to $750 million annually, allocated approximately 35%
within Pipelines & Processing, 40% in Electric Power and 25% within Gas
Distribution. MCN intends to grow by investing in a diverse portfolio of
energy-related projects, primarily in North America.
The proposed level of investments for future years will increase capital
requirements materially in excess of internally generated funds and require the
issuance of additional debt and equity securities. MCN's actual capital
requirements will depend on proceeds received from the sale of assets. General
market conditions will dictate the timing and amount of future issuances. As it
expands its business, MCN's capitalization objective is to maintain its credit
ratings through a strong balance sheet. Its capitalization objective is a ratio
of 50% equity and 50% debt. It is management's opinion that MCN and its
subsidiaries will have sufficient capital resources, both internal and external,
to meet anticipated capital requirements.
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 MCN's operations
and business processes. The effects of the Year 2000 issue could be exacerbated
as a result of companies' dependence on partners, operators, suppliers and
government agencies.
F-24
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
Plan and State of Readiness -- 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. The Year 2000 project is overseen by a vice president of
the company who reports regularly to the MCN Chairman and Board of Directors.
MCN has also retained the services of expert consultants to evaluate its Year
2000 program, and to independently assess and validate its processes. MCN has
implemented a four-phase Year 2000 approach consisting of: i)
inventory -- identification of the components of MCN's systems, equipment and
facilities; ii) assessment -- assessing 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 remediated. MCN 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. MCN's
business systems primarily consist of general ledger, payroll, customer billing
and inventory control systems and their related hardware. MCN'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
and the projected status for the future follows:
<TABLE>
<CAPTION>
INVENTORY ASSESSMENT REMEDIATION TESTING
--------- ---------- ----------- -------
<S> <C> <C> <C> <C>
Business Systems
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
December 31, 1998............................... 98% 90% 70% 60%
March 31, 1999.................................. 100% 100% 95% 90%
June 30, 1999................................... 100% 100% 100% 100%
</TABLE>
MCN also has 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, MCN's operations may be
adversely affected. The majority of MCN's key partners, operators and suppliers
have represented to MCN that they have completed their Year 2000 inventory and
assessment phases. MCN is continuing to monitor the progress of these key
partners, operators and suppliers toward their completion of the remediation and
testing phases.
Cost of Remediation -- Costs associated with the Year 2000 issue are not
expected to have a material adverse effect on MCN's results of operation,
liquidity or financial condition. The total costs are estimated to be between $5
million and $6 million, of which approximately $3.7 million was incurred through
December 1998. This estimate does not include MCN'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, particularly MichCon's customer information
system. MCN has made a substantial investment in new systems that are in process
of being installed, as well as those installed over the past few years. The
replacement of these systems and the customer information system, in particular,
was necessary to maintain a high level of customer satisfaction and to respond
to changes in regulation and increased competition within the energy industry.
While the system replacements were not accelerated due to Year 2000 issues, MCN
expects the new systems to be Year 2000 ready.
Risk and Contingency Planning -- MCN anticipates a 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 as: i) delivery of gas to customers; ii) control and operation
of the distribution system by electronic devices; iii) communication with
customers for purposes of service calls or
F-25
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
inquiries; and iv) timely billing and collection. The risk and impact of such
failures is largely dependent on critical vendors and the external
infrastructure that includes telecommunications providers, gas suppliers and
project partners. The most reasonably likely worst case scenarios would be the
extended inability to deliver gas due to the failure of embedded systems in the
distribution process or the extended inability to communicate with and respond
to customers due to the loss of telecommunications. Such failures could have a
material adverse effect on MCN'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 government agencies, MCN cannot certify that it will be unaffected
by Year 2000 complications. MCN has addressed the Year 2000 risks of its
business by prioritizing such risks based on the worst case scenarios and their
impact on the business. Focusing first on the safety and welfare of MCN's
customers and employees, the following two mission-critical processes were
identified: gas supply and distribution, and leak management emergency response.
While MCN 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 government agencies. In order to reduce its
Year 2000 risk, MCN is developing contingency plans for mission-critical
processes in the event of a Year 2000 complication. Through failure scenario
identification, MCN's approach is to develop reasonable and practical
contingency plans to maintain operations in case of non-performance. Ten
contingency planning teams have been established to address specific scenarios
and mission critical functions identified in support of the safety and welfare
of customers and employees. External suppliers have been contacted for their
participation in the contingency planning efforts for gas supply and
transportation, and materials management. Contingency plans for several
essential gas transmission facilities were tested during December 1998 under a
"power outage" scenario and achieved excellent results. Contingency plans will
continue to be refined throughout 1999 as MCN works with partners, operators,
suppliers and governmental agencies.
MARKET RISK INFORMATION
MCN's primary market risk arises from fluctuations in commodity prices,
interest rates and foreign exchange rates. MCN manages commodity price and
interest rate risk through the use of various derivative instruments and limits
the use of such instruments to hedging activities. If MCN did not use derivative
instruments, its exposure to such risk would be higher. A further discussion of
MCN's risk management activities is included in Note 14 to the Consolidated
Financial Statements.
COMMODITY PRICE RISK
MCN's exposure to commodity price risk arises from changes in natural gas,
natural gas liquids, oil and methanol prices throughout the United States and in
eastern Canada where MCN conducts sales and purchase transactions. MCN closely
monitors and manages its exposure to commodity price risk through a variety of
risk management techniques. Natural gas and oil futures and swap agreements are
used to manage MCN's exposure to the risk of market price fluctuations on gas
sale and purchase contracts, natural gas and oil production and gas inventories.
A sensitivity analysis model was used to calculate the fair values of MCN's
natural gas and oil futures and swap agreements utilizing applicable forward
commodity rates in effect at December 31, 1998. The sensitivity analysis
involved increasing or decreasing the forward rates by a hypothetical 10% and
calculating the resulting unfavorable change in the fair values of the gas and
oil futures and swap agreements.
INTEREST RATE RISK
MCN is subject to interest rate risk in connection with the issuance of
variable- and fixed-rate debt and preferred securities. In order to manage
interest costs, MCN uses interest rate swap agreements to exchange
F-26
<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
fixed- and variable-rate interest payment obligations over the life of the
agreements without exchange of the underlying principal amounts. MCN's exposure
to interest rate risk arises primarily from changes in U.S. Treasury rates and
London Inter-Bank Offered Rates (LIBOR).
A sensitivity analysis model was used to calculate the fair values or cash
flows of MCN's debt and preferred securities, as well as its interest rate
swaps, utilizing applicable forward interest rates in effect at December 31,
1998. The sensitivity analysis involved increasing or decreasing the forward
rates by a hypothetical 10% and calculating the resulting unfavorable change in
the fair values or cash flows of the interest rate sensitive instruments.
The results of the sensitivity model calculations follow:
<TABLE>
<CAPTION>
UNFAVORABLE
AMOUNT CHANGE IN
------ -----------
<S> <C> <C>
MARKET RISK (in millions)
Commodity Price Sensitive:*
Swaps -- pay fixed/receive variable....................... $ 53.6 Fair Value
-- pay variable/receive fixed...................... $ 54.0 Fair Value
-- basis........................................... $ 5.2 Fair Value
Futures -- Longs.......................................... $ 1.9 Fair Value
-- Shorts......................................... $ .1 Fair Value
Interest Rate Sensitive:
Debt -- fixed rate........................................ $121.4 Fair Value
-- variable rate.................................... $ .6 Cash Flow
Swaps -- pay fixed/receive variable....................... $ .2 Fair Value
-- pay variable/receive fixed...................... $ 2.8 Fair Value
</TABLE>
- -------------------------
* Includes only the risk related to the derivative instruments that serve as
hedges and does not include the related underlying hedged item.
As discussed in Note 1b to the Consolidated Financial Statements, MCN's
non-utility energy marketing subsidiary entered into unauthorized gas purchase
and sale contracts for trading purposes. MCN is exposed to natural gas price
risk on such contracts that have not been effectively closed. At December 31,
1998, a 10% unfavorable change in basis would have reduced the fair value of
such open contracts that totaled 44 Bcf by $1.2 million. A 10% favorable change
in basis would have increased the fair value of such contracts by a
corresponding amount.
FOREIGN CURRENCY RISK
MCN is subject to foreign currency risk as a result of its investments in
foreign joint ventures, which are primarily located in India. MCN's foreign
currency risk arises from changes in the U.S. dollar and Indian rupee exchange
rates. MCN does not hedge its foreign currency risk and therefore will continue
to be affected by foreign currency exchange rate fluctuations. However, the
expected sale of MCN's interest in an Indian joint venture will significantly
reduce its foreign currency risk (Note 5b).
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
F-27
<PAGE> 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONCLUDED)
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 MCN's financial statements.
Start-Up Activities -- In April 1998, the AcSEC issued SOP 98-5, "Reporting
on the Costs of Start-up Activities." SOP 98-5 requires start-up and
organizational 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 MCN's financial statements.
Derivative and Hedging Activities -- In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," effective for fiscal years beginning after June 15, 1999.
SFAS No. 133 expands the definition of the types of contracts considered
derivatives, 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.
MCN manages commodity price risk and interest rate risk through the use of
various derivative instruments and predominantly limits the use of such
instruments to hedging activities. The effects of SFAS No. 133 on MCN's
financial statements are subject to fluctuations in the market value of hedging
contracts which are, in turn, affected by variations in gas and oil prices and
in interest rates. Management cannot quantify the effects of adopting SFAS No.
133 at this time.
Energy Trading Activities -- In November 1998, the Emerging Issues Task
Force reached consensus on Issue No. 98-10, "Accounting for Energy Trading and
Risk Management Activities" (EITF 98-10), effective for fiscal years beginning
after December 15, 1998. EITF 98-10 requires all energy trading contracts to be
recognized in the balance sheet as either assets or liabilities measured at
their fair value, with changes in fair value recognized currently in earnings.
Management does not expect EITF 98-10 to have a material impact on MCN's
financial statements.
FORWARD-LOOKING STATEMENTS
This Annual Report includes forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements involve certain risks and uncertainties that may cause actual future
results to differ materially from those contemplated, projected, estimated or
budgeted in such forward-looking statements. Factors that may impact
forward-looking statements include, but are not limited to, the following: (i)
the effects of weather and other natural phenomena; (ii) increased competition
from other energy suppliers as well as alternative forms of energy; (iii) the
capital intensive nature of MCN's business; (iv) economic climate and growth in
the geographic areas in which MCN does business; (v) the uncertainty of gas and
oil reserve estimates; (vi) the timing and extent of changes in commodity prices
for natural gas, natural gas liquids, methanol, electricity and crude oil; (vii)
the nature, availability and projected profitability of potential projects and
other investments available to MCN; (viii) conditions of capital markets and
equity markets; (ix) changes in the economic and political climate and
currencies of foreign countries where MCN has invested or may invest in the
future; (x) the timing and results of major transactions, such as the sale of
E&P properties; (xi) the timing, nature and impact of Year 2000 activities; and
(xii) the effects of changes in governmental policies and regulatory actions,
including income taxes, environmental compliance and authorized rates.
F-28
<PAGE> 29
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------------
1998 1997
(RESTATED) (RESTATED)
NOTE 1B NOTE 1B 1996
---------- ---------- ----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
OPERATING REVENUES
Gas and oil sales...................................... $1,813,343 $2,014,418 $1,827,198
Transportation......................................... 139,609 129,953 120,019
Other.................................................. 77,746 63,496 50,051
---------- ---------- ----------
2,030,698 2,207,867 1,997,268
---------- ---------- ----------
OPERATING EXPENSES
Cost of gas............................................ 1,205,774 1,335,033 1,193,578
Operation and maintenance.............................. 389,415 393,341 371,980
Depreciation, depletion and amortization............... 179,490 181,612 145,990
Property and other taxes............................... 69,553 75,491 74,427
Property write-downs and restructuring charges (Notes 2
and 3).............................................. 592,318 -- --
---------- ---------- ----------
2,436,550 1,985,477 1,785,975
---------- ---------- ----------
OPERATING INCOME (LOSS).................................. (405,852) 222,390 211,293
---------- ---------- ----------
EQUITY IN EARNINGS OF JOINT VENTURES (Note 6)............ 62,225 55,659 17,867
---------- ---------- ----------
OTHER INCOME AND (DEDUCTIONS)
Interest income........................................ 10,893 11,166 7,234
Interest on long-term debt............................. (87,346) (75,170) (66,517)
Other interest expense................................. (24,404) (11,283) (11,264)
Dividends on preferred securities of subsidiaries...... (36,370) (31,090) (12,374)
Investment losses (Notes 2b and 2c).................... (14,635) -- --
Minority interest...................................... 5,992 (1,964) (1,059)
Other (Note 5e)........................................ 19,561 10,759 3,764
---------- ---------- ----------
(126,309) (97,582) (80,216)
---------- ---------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES.................................................. (469,936) 180,467 148,944
INCOME TAX PROVISION (BENEFIT)........................... (183,468) 47,238 36,375
---------- ---------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS................. (286,468) 133,229 112,569
DISCONTINUED OPERATIONS, NET OF TAXES (Note 4)........... -- -- 37,771
---------- ---------- ----------
NET INCOME (LOSS)........................................ $ (286,468) $ 133,229 $ 150,340
========== ========== ==========
BASIC EARNINGS (LOSS) PER SHARE (Note 11d)
Continuing operations.................................. $ (3.63) $ 1.82 $ 1.68
Discontinued operations (Note 4)....................... -- -- .57
---------- ---------- ----------
$ (3.63) $ 1.82 $ 2.25
========== ========== ==========
DILUTED EARNINGS (LOSS) PER SHARE (Note 11d)
Continuing operations.................................. $ (3.63) $ 1.79 $ 1.67
Discontinued operations (Note 4)....................... -- -- .56
---------- ---------- ----------
$ (3.63) $ 1.79 $ 2.23
========== ========== ==========
AVERAGE COMMON SHARES OUTSTANDING
Basic.................................................. $ 78,823 $ 72,887 $ 66,944
---------- ---------- ----------
Diluted................................................ 78,823 75,435 67,521
---------- ---------- ----------
DIVIDENDS DECLARED PER SHARE............................. $ 1.0200 $ .9825 $ .9400
========== ========== ==========
</TABLE>
The notes to the consolidated financial statements are an integral part of this
statement.
F-29
<PAGE> 30
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1998 1997
(RESTATED) (RESTATED)
NOTE 1B NOTE 1B
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents, at cost (which approximates
market value).......................................... $ 17,039 $ 39,495
Accounts receivable, less allowance for doubtful accounts
of $9,665 and $15,711, respectively.................... 400,120 405,924
Accrued unbilled revenues................................. 87,888 93,010
Gas in inventory.......................................... 147,387 56,777
Property taxes assessed applicable to future periods...... 72,551 67,879
Accrued gas cost recovery revenues........................ -- 12,862
Other..................................................... 42,472 54,089
---------- ----------
767,457 730,036
---------- ----------
DEFERRED CHARGES AND OTHER ASSETS
Deferred income taxes (Note 17)........................... 50,547 --
Investments in debt and equity securities................. 69,705 97,521
Deferred swap losses and receivables (Note 14a)........... 63,147 51,023
Deferred environmental costs.............................. 30,773 30,234
Prepaid benefit costs (Note 16)........................... 111,775 80,242
Other..................................................... 98,940 86,181
---------- ----------
424,887 345,201
---------- ----------
INVESTMENTS IN AND ADVANCES TO JOINT VENTURES (NOTE 6)
Pipelines & Processing.................................... 521,711 323,597
Electric Power............................................ 231,668 180,127
Energy Marketing.......................................... 29,435 25,159
Gas Distribution (Note 2c)................................ 1,478 8,841
Other..................................................... 18,939 19,252
---------- ----------
803,231 556,976
---------- ----------
PROPERTY, PLANT AND EQUIPMENT
Pipelines & Processing (Note 2a).......................... 48,706 47,037
Gas Distribution (Note 2c)................................ 2,916,540 2,813,434
Exploration & Production (Note 2b)........................ 1,040,047 1,299,301
Other..................................................... 36,124 27,002
---------- ----------
4,041,417 4,186,774
Less -- Accumulated depreciation and depletion............ 1,644,094 1,488,050
---------- ----------
2,397,323 2,698,724
---------- ----------
$4,392,898 $4,330,937
========== ==========
</TABLE>
The notes to the consolidated financial statements are an integral part of this
statement.
F-30
<PAGE> 31
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1998 1997
(RESTATED) (RESTATED)
NOTE 1B NOTE 1B
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable.......................................... $ 304,349 $ 342,195
Notes payable............................................. 618,851 401,726
Current portion of long-term debt and capital lease
obligations............................................ 269,721 36,878
Federal income, property and other taxes payable.......... 69,465 86,826
Deferred gas cost recovery revenues....................... 14,980 --
Gas payable............................................... 42,669 8,317
Customer deposits......................................... 18,791 16,382
Other..................................................... 108,310 101,630
---------- ----------
1,447,136 993,954
---------- ----------
DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes (Note 17)........................... -- 153,159
Unamortized investment tax credit......................... 30,056 33,046
Tax benefits amortizable to customers..................... 130,120 123,365
Deferred swap gains and payables (Note 14a)............... 62,956 41,717
Accrued environmental costs............................... 35,000 35,000
Minority interest......................................... 10,898 19,188
Other..................................................... 75,439 69,889
---------- ----------
344,469 475,364
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTE 13)
CAPITALIZATION
Long-term debt, including capital lease obligations (Note
9)..................................................... 1,307,168 1,212,564
MCN-obligated mandatorily redeemable preferred securities
of subsidiaries holding solely debentures of MCN (Note
10a)................................................... 502,203 505,104
Common shareholders' equity (see accompanying
statement)............................................. 791,922 1,143,951
---------- ----------
2,601,293 2,861,619
---------- ----------
$4,392,898 $4,330,937
========== ==========
</TABLE>
The notes to the consolidated financial statements are an integral part of this
statement.
F-31
<PAGE> 32
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------------
1998 1997
(RESTATED) (RESTATED)
NOTE 1B NOTE 1B 1996
---------- ---------- ----
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss)......................................... $(286,468) $ 133,229 $ 150,340
Adjustments to reconcile net income (loss) to net cash
provided from operating activities
Depreciation, depletion and amortization
Per statement of operations........................... 179,490 181,612 145,990
Charged to other accounts............................. 8,000 7,728 11,026
Unusual charges (Notes 2 and 3)......................... 389,598 -- --
Deferred income taxes -- current........................ (2,587) (2,701) 8,061
Deferred income taxes and investment tax credit, net.... 14,565 11,660 23,892
Gain on sale of Genix, net of taxes (Note 4b)........... -- -- (36,176)
Equity in earnings of joint ventures, net of
distributions......................................... (40,360) (16,511) (2,506)
Other................................................... (11,550) (5,456) (7,541)
Changes in assets and liabilities, exclusive of changes
shown separately...................................... (97,966) 33,823 (94,754)
--------- --------- ---------
Net cash provided from operating activities........... 152,722 343,384 198,332
--------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net........................................ 307,482 68,000 87,491
Dividends paid............................................ (82,239) (72,851) (62,875)
Issuance of common stock (Note 11a)....................... 20,192 294,402 17,264
Issuance of preferred securities (Note 10a)............... 96,850 326,521 77,218
Issuance of long-term debt (Note 9)....................... 458,761 273,241 398,540
Long-term commercial paper and bank borrowings (Note 9)... 17,299 (261,822) (62,835)
Retirement of long-term debt and preferred securities
(Notes 9 and 10a)....................................... (328,810) (109,224) (8,139)
Other..................................................... 8,243 4,612 (6,249)
--------- --------- ---------
Net cash provided from financing activities............. 497,778 522,879 440,415
--------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures...................................... (482,775) (561,354) (610,323)
Acquisitions (Note 5)..................................... (42,429) (166,553) (133,201)
Investment in debt and equity securities, net............. 17,831 (63,123) (26,903)
Investment in joint ventures.............................. (189,309) (152,642) (36,217)
Sale of property and joint venture interests.............. 47,185 67,365 36,621
Sale of Genix (Note 4b)................................... -- -- 132,889
Other..................................................... (23,459) 19,077 9,590
--------- --------- ---------
Net cash used for investing activities.................. (672,956) (857,230) (627,544)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (22,456) 9,033 11,203
CASH AND CASH EQUIVALENTS, JANUARY 1........................ 39,495 30,462 19,259
--------- --------- ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31...................... $ 17,039 $ 39,495 $ 30,462
========= ========= =========
CHANGES IN ASSETS AND LIABILITIES, EXCLUSIVE OF CHANGES
SHOWN SEPARATELY
Accounts receivable, net.................................. $ (6,653) $ (49,017) $ (66,183)
Accrued unbilled revenues................................. 5,122 15,499 (16,099)
Gas in inventory.......................................... (90,610) 22,384 (7,398)
Accrued/deferred gas cost recovery revenues, net.......... 27,842 14,810 (28,250)
Prepaid/accrued benefit costs, net........................ (31,490) (16,086) (50,972)
Accounts payable.......................................... (35,597) 24,273 102,711
Federal income, property and other taxes payable.......... (17,333) (10,820) (19,587)
Gas payable............................................... 34,352 5,524 (9,339)
Other current assets and liabilities, net................. 8,152 5,998 (5,146)
Other deferred assets and liabilities, net................ 8,249 21,258 5,509
--------- --------- ---------
$ (97,966) $ 33,823 $ (94,754)
========= ========= =========
</TABLE>
The notes to the consolidated financial statements are an integral part of this
statement.
F-32
<PAGE> 33
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------
1998 1997
(RESTATED) (RESTATED)
NOTE 1B NOTE 1B 1996
---------- ---------- ----
(IN THOUSANDS)
<S> <C> <C> <C>
COMMON SHAREHOLDERS' EQUITY (Note 11)
COMMON STOCK,
par value $.01 per share -- 100,000,000 shares
authorized, 79,724,542, 78,231,889 and 67,303,908 shares
outstanding, respectively................................ $ 797 $ 782 $ 673
--------- ---------- --------
ADDITIONAL PAID-IN CAPITAL
Balance -- beginning of period........................... 806,997 493,078 445,828
Common stock and performance units....................... 25,969 313,485 47,326
Other.................................................... -- 434 (76)
--------- ---------- --------
Balance -- end of period................................. 832,966 806,997 493,078
--------- ---------- --------
ACCUMULATED OTHER COMPREHENSIVE LOSS
Foreign Currency Translation Adjustment:
Balance -- beginning of period........................ (6,335) (43) (141)
Net change in foreign currency translation adjustment
(a)................................................. (6,554) (6,292) 98
--------- ---------- --------
Balance -- end of period.............................. (12,889) (6,335) (43)
--------- ---------- --------
Unrealized Losses on Securities:
Balance -- beginning of period........................ (1,184) -- --
Net change in unrealized losses on securities(a)...... (2,503) (1,184) --
--------- ---------- --------
Balance -- end of period.............................. (3,687) (1,184) --
--------- ---------- --------
(16,576) (7,519) (43)
--------- ---------- --------
RETAINED EARNINGS
Balance -- beginning of period........................... 365,730 305,352 218,425
Net income (loss)(a)..................................... (286,468) 133,229 150,340
Cash dividends declared.................................. (82,239) (72,851) (62,875)
Other.................................................... -- -- (538)
--------- ---------- --------
Balance -- end of period................................. (2,977) 365,730 305,352
--------- ---------- --------
YIELD ENHANCEMENT, CONTRACT AND ISSUANCE COSTS............. (22,288) (22,039) (14,492)
--------- ---------- --------
$ 791,922 $1,143,951 $784,568
========= ========== ========
(A) DISCLOSURE OF COMPREHENSIVE INCOME (LOSS)(Note 1a):
Net income (loss)........................................ $(286,468) $ 133,229 $150,340
Other comprehensive income, net of taxes:
Foreign Currency Translation Adjustment:
Foreign currency translation gains (losses), net of
taxes of $3,529, $3,388 and $53..................... (6,554) (6,292) 98
Unrealized Losses on Securities:
Unrealized losses on securities, net of taxes of
$3,495, $637 and $--................................ (6,490) (1,184) --
Reclassification of losses recognized in net income,
net of taxes of $2,147, $-- and $--................. 3,987 -- --
--------- ---------- --------
$(295,525) $ 125,753 $150,438
========= ========== ========
</TABLE>
The notes to the consolidated financial statements are an integral part of this
statement.
F-33
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1a. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
COMPANY DESCRIPTION -- MCN Energy Group Inc. (MCN) is a diversified energy
company with markets and investments throughout North America and in India and
Nepal. MCN operates through two major business groups, Diversified Energy and
Gas Distribution.
- Diversified Energy, operating through MCN Investment Corporation (MCNIC),
currently operating as MCN Energy Enterprises, is involved in the
following segments: Pipelines & Processing with gathering, processing and
transmission facilities near areas of rapid reserve development and
growing consumer markets; Electric Power with investments in electric
generation facilities in operation and under construction with a combined
2,986 megawatts (MW) of gross capacity and investments in electric
distribution facilities; Energy Marketing with total gas sales and
exchange gas delivery markets of 465.7 billion cubic feet (Bcf) for 1998
and rights to 67 Bcf of storage capacity, of which 42 Bcf is currently
under development; Exploration & Production (E&P) properties with 1.2
trillion cubic feet equivalent of proved gas and oil reserves at December
31, 1998.
- Gas Distribution consists principally of Michigan Consolidated Gas
Company (MichCon), a natural gas distribution and transmission company
serving 1.2 million customers in more than 500 communities throughout
Michigan. MichCon is subject to the accounting requirements and rate
regulation of the Michigan Public Service Commission (MPSC) with respect
to the distribution and intrastate transportation of natural gas.
BASIS OF PRESENTATION -- The accompanying consolidated financial statements
were prepared in conformity with generally accepted accounting principles. In
connection with their preparation, management was required to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
expenses and the disclosure of contingent liabilities. Actual results could
differ from those estimates. Certain reclassifications have been made to prior
years' statements to conform to the 1998 presentation.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of MCN and certain consolidated subsidiaries and
partnerships. Investments in entities in which MCN has a controlling influence
that it intends to maintain are consolidated. Generally, investments in 50% or
less owned entities in which MCN has significant but not controlling influence,
and entities where control is temporary, have been accounted for under the
equity method.
REVENUES AND COST OF GAS -- Gas Distribution accrues revenues for gas
service provided but unbilled at month end. Through December 31, 1998, MichCon's
accrued revenues included a component for cost of gas sold that was recoverable
through the gas cost recovery (GCR) mechanism. Prior to 1999, GCR proceedings
before the MPSC permitted MichCon to recover the prudent and reasonable cost of
gas sold. The overcollection of gas costs totaling $14,980,000 at December 31,
1998, including interest, will be refunded to customers through reduced future
rates.
Beginning in 1999, MichCon implemented a Regulatory Reform Plan approved by
the MPSC. The plan suspends the GCR mechanism and fixes the gas commodity
component of MichCon's sales rates for the three-year period beginning January
1, 1999.
NATURAL GAS AND OIL EXPLORATION AND PRODUCTION -- The full-cost accounting
method prescribed by the Securities and Exchange Commission (SEC) is followed
for investments in gas and oil properties. Under the full cost method
substantially all acquisition, exploration and development costs are
capitalized. To the extent such capitalized costs exceed the "ceiling," the
excess is written off to income. The ceiling is the sum of discounted future net
cash flows from proved gas and oil reserves (using unescalated prices and costs
unless contractual arrangements exist), and the costs of unproved properties
after income tax effects. The ceiling test is applied at the end of each quarter
and requires a write-down of gas and oil properties if the ceiling is exceeded,
even if any price decline is temporary. Management's investment and operating
decisions are based upon prices, costs and production assumptions that are
different from those used to compute the ceiling. As a
F-34
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
result, it is possible that future fluctuations in key forecast assumptions
could result in impairments being recorded for accounting purposes, when the
long-term economics of such properties have not changed.
The unit of production method is used for calculating depreciation,
depletion and amortization (DD&A) on proved gas and oil properties. The average
DD&A expense per thousand cubic feet equivalent (Mcfe) was $.82, $.75, and $.70
in 1998, 1997 and 1996, respectively. Costs directly associated with the
acquisition and evaluation of unproved gas and oil properties are excluded from
the amortization base until the related properties are evaluated. Such unproved
properties are assessed periodically, and a provision for impairment is made to
the full-cost amortization base when appropriate.
SALES OF OWNERSHIP INTERESTS BY SUBSIDIARIES AND PARTNERSHIPS -- MCN
recognizes gains or losses on the sale of stock by subsidiaries or the sale of
partnership interests. Such gains or losses represent the difference between
MCN's share of the consideration received and the historical book value of its
investment.
COMPREHENSIVE INCOME -- Effective January 1, 1998, MCN adopted Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income,"
which establishes standards for the reporting and display of comprehensive
income. Comprehensive income is defined as the change in common shareholder's
equity during a period from transactions and events from nonowner sources,
including net income. Other items of comprehensive income include revenues,
expenses, gains and losses that are excluded from net income. Items of other
comprehensive income applicable to MCN and their accounting policies are as
follows:
- Foreign Currency Translation Adjustments -- MCN's foreign joint ventures
use the local currency as the functional currency. As a result, MCN's
investments in foreign entities are translated from foreign currencies
into U.S. dollars using end-of-period exchange rates. Equity in earnings
of foreign entities is translated at the average exchange rate prevailing
during the month the respective earnings occur. Translation adjustments,
net of deferred taxes, are excluded from net income and shown as a
separate component of other comprehensive income until realized in net
income upon sale or upon complete liquidation of the investment in the
foreign entity.
- Holding Gains and Losses on Available-for-Sale Securities -- Unrealized
holding gains and losses resulting from temporary changes in the fair
value of MCN's available-for-sale securities are excluded from net income
and reported as a separate component of other comprehensive income until
realized in net income upon sale. If a fair value decline is judged to be
other than temporary, the decline is recorded to net income.
PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment, excluding
E&P property, is stated at cost and includes amounts for labor, materials,
overhead and an allowance for funds used during construction. Unit of production
depreciation and depletion is used for certain Gas Distribution production and
transmission property. All other property, plant and equipment of MCN, excluding
E&P property, is depreciated over its useful life using the straight-line
method. Depreciation rates vary by class of property.
The ratio of the provision for depreciation and depletion to the average
cost of depreciable property is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Pipelines & Processing........................... 3.4% 3.5% 3.8%
Gas Distribution................................. 3.5% 4.1% 4.4%
Other............................................ 12.2% 12.3% 10.1%
</TABLE>
LONG-LIVED ASSETS -- In accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
MCN reviews its long-lived assets to be held and used for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be fully recoverable. MCN also reviews long-lived assets to be disposed
of to determine if the asset's carrying amount is in excess of its fair value
less the cost to sell.
F-35
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION -- Gas Distribution
capitalizes an allowance for both debt and equity funds used during construction
in the cost of major additions to plant. Diversified Energy also capitalizes
interest on debt funds used during construction. The total amount capitalized
was $19,938,000, $18,190,000 and $14,631,000 in 1998, 1997 and 1996,
respectively.
INCOME TAXES AND INVESTMENT TAX CREDITS -- Tax Benefits Amortizable to
Customers represents the net revenue equivalent of the difference in
property-related accumulated deferred income taxes computed in accordance with
SFAS No. 109, "Accounting for Income Taxes," as compared to the amounts
previously reflected in setting utility rates. This amount is primarily due to
current tax rates being lower than the rates in effect when the original
deferred taxes were recorded and because of temporary differences, including
accumulated investment tax credits, for which deferred income taxes were not
previously recorded in setting utility rates. These net tax benefits are being
amortized in accordance with the regulatory treatment over the life of the
related plant, as the related temporary differences reverse.
Investment tax credits relating to Gas Distribution property placed into
service were deferred and are being credited to income over the life of the
related property. Investment tax credits relating to Diversified Energy
operations were recorded to income in the year the related property was placed
into service.
DEFERRED DEBT COSTS -- In accordance with MPSC regulations, MichCon defers
reacquisition and unamortized issuance costs of reacquired long-term debt when
such debt is refinanced. These costs are amortized over the term of the
replacement debt.
CONSOLIDATED STATEMENT OF CASH FLOWS -- For purposes of this statement, MCN
considers all highly liquid investments, excluding restricted investments,
purchased with a maturity of three months or less to be cash equivalents. Other
cash and noncash investing and financing activities for the years ended December
31 follow:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Cash Paid During the Year for:
Interest, net of amounts capitalized.......... $117,162 $97,659 $74,775
Federal income taxes.......................... 12,175 30,300 19,934
Noncash Activities:
Common stock and performance units............ $ 288 $19,188 $ 6,210
Equity issued for acquisitions................ 5,409 -- --
Foreign currency adjustment................... 6,554 6,292 98
Unrealized losses on securities............... 6,490 1,184 --
Sale of joint ventures........................ -- 8,562 --
Yield enhancement and contract costs.......... -- 2,702 8,243
Property purchased under capital leases....... -- 1,303 6,765
</TABLE>
1b. RESTATEMENT
Subsequent to the issuance of MCN's December 31, 1998 financial statements,
certain matters came to management's attention and resulted in a special
investigation of prior years' operations of CoEnergy Trading Company (CTC),
MCN's non-utility energy marketing subsidiary. As a result of the investigation,
MCN identified that its internal controls had been overridden and that certain
transactions had not been properly accounted for. Specifically, the
investigation concluded that CTC had entered into gas supply contracts and
agreed to pay significantly less than market prices in one period in return for
above-market prices to be paid in subsequent periods through March 2000. The
effect of these transactions was to improperly delay the accrual of cost of gas
expenses, resulting in the overstatement of the 1998 net loss by $478,000 and
the overstatement of 1997 net income by $8,585,000.
F-36
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Additionally, the investigation identified that CTC had entered into
certain unauthorized gas purchase and sale contracts for trading purposes. The
unauthorized transactions violate MCN's risk-management policy that requires all
such activities to be reviewed and approved by a risk committee that reports
regularly to the MCN Board of Directors. The gas purchase and sale contracts
entered into in connection with trading activities, some of which remain in
effect through March 2000, were not accounted for properly using the required
mark-to-market method, under which unrealized gains and losses are recorded as
an adjustment to cost of gas. The effect of not properly accounting for these
transactions was the understatement of the 1998 net loss by $7,112,000 and the
overstatement of 1997 net income by $385,000. However, net income of $2,574,000
and $1,824,000 was realized and recorded in connection with these trading
activities in 1998 and 1997, respectively, resulting in a net loss of $4,538,000
in 1998 and net income of $1,439,000 in 1997 from such activities. From the
inception of these trading activities in March 1997 through March 1999,
$5,721,000 of net income was realized and recorded in connection with these
trading activities. However, marking these contracts to market, as required,
results in a previously unrecorded net unrealized loss of $8,435,000 through
March 1999, indicating a net loss of $2,714,000 from such activities.
Other items identified during the investigation resulted in the
understatement of the 1998 net loss by $879,000 and the overstatement of 1997
net income by $107,000.
The accompanying consolidated financial statements have been restated from
amounts originally reported to properly account for the transactions identified.
Additionally, amounts have been reclassified to reflect E&P as a continuing
operation. A summary of the significant effects of the restatement and
reclassification on MCN's 1998 and 1997 financial statements is as follows:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------- --------------------------------------
RECLASSIFIED RECLASSIFIED
AND AND
PREVIOUSLY RESTATED PREVIOUSLY RESTATED
REPORTED RESTATED (NOTE 4A) REPORTED RESTATED (NOTE 4A)
---------- -------- ------------ ---------- -------- ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
Cost of Gas....................... $1,250,815 $1,262,372 $1,205,774 $1,392,856 $1,406,819 $1,335,033
Income (Loss)From Continuing
Operations Before Income
Taxes........................... $ (21,620) $ (33,177) $ (469,936) $ 174,413 $ 160,450 $ 180,467
Income Tax Provision (Benefit).... $ (15,456) $ (19,500) $ (183,468) $ 62,266 $ 57,380 $ 47,238
Income (Loss) From Continuing
Operations...................... $ (6,164) $ (13,677) $ (286,468) $ 112,147 $ 103,070 $ 133,229
Net Income (Loss)................. $ (278,955) $ (286,468) $ (286,468) $ 142,306 $ 133,229 $ 133,229
Basic Earnings (Loss) Per Share
Continuing Operations........... $ (.08) $ (.17) $ (3.63) $ 1.54 $ 1.41 $ 1.82
Continuing and Discontinued
Operations.................... $ (3.54) $ (3.63) $ (3.63) $ 1.95 $ 1.82 $ 1.82
Diluted Earnings (Loss) Per Share
Continuing Operations........... $ (.08) $ (.17) $ (3.63) $ 1.51 $ 1.39 $ 1.79
Continuing and Discontinued
Operations.................... $ (3.54) $ (3.63) $ (3.63) $ 1.91 $ 1.79 $ 1.79
CONSOLIDATED STATEMENT OF FINANCIAL
POSITION
Accounts Receivable............... $ 397,298 $ 400,120 $ 400,120 $ 404,448 $ 405,924 $ 405,924
Gas in Inventory.................. $ 149,797 $ 147,387 $ 147,387 $ 56,777 $ 56,777 $ 56,777
Accounts Payable.................. $ 278,417 $ 304,349 $ 304,349 $ 326,756 $ 342,195 $ 342,195
Federal Income, Property and Other
Taxes Payable................... $ 78,395 $ 69,465 $ 69,465 $ 91,712 $ 86,826 $ 86,826
Common Shareholders' Equity....... $ 808,512 $ 791,922 $ 791,922 $1,153,028 $1,143,951 $1,143,951
</TABLE>
F-37
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
2. PROPERTY WRITE-DOWNS AND INVESTMENT LOSS
A. PIPELINES & PROCESSING
PROPERTY -- During 1998, MCN recorded an impairment loss relating to
its coal fines project totaling $133,782,000 pre-tax ($86,959,000 net of
taxes). In June 1998, MCN placed into operation six coal fines plants
designed to recover particles of coal that are a waste by-product of coal
mining and then process the particles to create coal briquettes for sale.
The economic viability of the venture is dependent on the briquettes
qualifying for synthetic fuel tax credits and MCN's ability to utilize or
sell such credits. Although the plants were in service by June 30, 1998,
the date specified to qualify for the tax credits, operating delays at the
plants in the third quarter have significantly increased the possibility
that the Internal Revenue Service will challenge the project's eligibility
for tax credits. In addition, there is uncertainty as to whether MCN can
utilize or sell the credits. Without the credits, the project generates
negative cash flows. These factors led to MCN's decision to record an
impairment loss equal to the carrying value of the plants, reflecting the
likely inability to recover such costs. MCN is currently negotiating the
sale of its interest in the coal fines project. Management does not expect
proceeds from the sale to be in excess of selling expenses and remediation
obligations.
In 1998, MCN also recorded an impairment loss of $3,899,000 pre-tax
($2,534,000 net of taxes) relating to an acquired out-of-service pipeline
in Michigan. This pipeline was acquired for future development, along with
easements and rights-of-way. In connection with certain lease renewal
options, MCN reviewed the business alternatives for these assets and
determined that their development is unlikely. Accordingly, MCN has
recorded an impairment loss equal to the carrying value of the assets.
B. EXPLORATION & PRODUCTION
PROPERTY --During 1998, MCN recognized write-downs of its gas and oil
properties held by its E&P business unit, MCNIC Oil & Gas Company (MOG),
totaling $416,977,000 pre-tax ($271,035,000 net of taxes). These properties
were accounted for under the full cost method. The write-downs were due
primarily to lower oil and gas prices and the under-performance of certain
exploration properties. Under the full cost method of accounting as
prescribed by the Securities and Exchange Commission, MCN's capitalized
exploration and development costs exceeded the full cost "ceiling,"
resulting in the excess being written off to income. The ceiling is the sum
of discounted future net cash flows from the production of proved gas and
oil reserves, and the lower of cost or estimated fair value of unproved
properties, net of related income tax effects. Future net cash flows are
required to be estimated based on end-of-quarter prices and costs, unless
contractual arrangements exist. A significant portion of the write-down was
due to lower-than-expected exploratory drilling results.
INVESTMENT --In 1998, MCN also recognized a $6,135,000 pre-tax
($3,987,000 net of taxes) loss from the write-down of an investment in the
common stock of an E&P company. The loss is due to a decline in the fair
value of the securities which is not considered temporary.
C. GAS DISTRIBUTION
PROPERTY -- During 1998, MichCon recognized a $24,800,000 pre-tax loss
($11,200,000 net of taxes and minority interest) from the write-down of a
gas gathering pipeline system. A new gas reserve analysis was performed in
1998 to determine the impact of the diversion of certain untreated gas away
from the gathering system. This analysis revealed that projected cash flows
from the gathering system were not sufficient to cover the system's
carrying value. Therefore, an impairment loss was recorded representing the
amount by which the carrying value of the system exceeded its estimated
fair value.
INVESTMENT -- During 1998, MCN recognized an $8,500,000 pre-tax
($5,525,000 net of taxes) write-down of a joint venture investment in a
small gas distribution company located in Missouri. As a result of MCN's
refocused strategic direction, MCN expects to sell this investment in 1999.
The write-down represents the amount by which the carrying value exceeded
the estimated fair value of the investment.
F-38
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
3. RESTRUCTURING CHARGES
During 1998, MCN initiated a two-part corporate restructuring and recorded
a combined restructuring charge totaling $12,860,000 pre-tax ($8,358,000 net of
taxes).
CORPORATE -- The first part, totaling $10,390,000 pre-tax, consists of a
corporate realignment designed to improve operating efficiencies through a more
streamlined organizational structure. The realignment includes the reduction of
37 positions resulting in severance and termination benefits of $4,714,000
pre-tax. Also included in the charge was $5,676,000 pre-tax relating to net
lease expenses and the write-down of fixed assets consisting of leasehold
improvements, office equipment and information systems, which are no longer used
by MCN. As of December 31, 1998, payments of $660,000 have been charged against
the restructuring accruals relating to severance and termination benefits. These
benefits will continue to be paid through 2000. The remaining restructuring
costs, primarily for net lease expenses, are expected to be paid over the
related lease terms, which expire through 2006.
ELECTRIC POWER -- The second part of the corporate restructuring relates to
a revised international investment strategy whereby MCN will primarily limit
future capital investments in developing countries to amounts required to
fulfill existing commitments. As a result of this revised strategy, MCN exited
certain international projects and recorded a charge of $2,470,000 pre-tax,
primarily related to capitalized costs that had been incurred on these exited
projects.
4. DISCONTINUED OPERATIONS
A. DISCONTINUED OPERATIONS SUBSEQUENTLY RETAINED
In the 1998 MCN Annual Report on Form 10-K/A, MCN accounted for its
E&P segment as a discontinued operation as a result of its decision to sell
all of its gas and oil properties. In August 1999, management announced its
intention to retain its natural gas producing properties in Michigan.
Accordingly, E&P's operating results for prior periods have been
reclassified from discontinued operations to continuing operations. The
decision to retain these properties was based on the interaction of two
factors. MCN significantly revised its strategic direction. Key aspects of
the new corporate strategy include a Midwest-to-Northeast regional focus
rather than a North American focus, and an emphasis on achieving
operational efficiencies and growth through the integration of existing
businesses. Shortly thereafter, the bid for the Michigan properties was
lowered significantly. The lower price was unacceptable, especially in
light of MCN's new strategic direction.
WRITE-DOWN OF E&P PROPERTIES: In the second quarter of 1999, MCN
recognized a $52,000,000 pre-tax ($33,800,000 net of taxes) write-down of
its gas and oil properties under the full cost method of accounting, due
primarily to an unfavorable revision in the timing of production of proved
gas and oil reserves as well as reduced expectations of sales proceeds on
unproved acreage. Under the full cost method of accounting as prescribed by
the Securities and Exchange Commission, MCN's capitalized exploration and
production costs at June 30, 1999 exceeded the full cost "ceiling,"
resulting in the excess being written off to income. The ceiling is the sum
of discounted future net cash flows from the production of proved gas and
oil reserves, and the lower of cost or estimated fair value of unproved
properties, net of related income tax effects.
LOSS ON INVESTMENT OF E&P COMPANY: MCN recognized an additional
$7,456,000 pre-tax loss ($4,846,000 net of taxes) from the write-down of an
investment in the common stock of an E&P company during the second quarter
of 1999. MCN has no carrying value in this investment after this
write-down.
LOSSES ON SALE OF PROPERTIES: In the second quarter of 1999, MCN
recognized losses from the sale of its Western and Midcontinent/Gulf Coast
E&P properties totaling $68,798,000 pre-tax ($44,719,000 net of taxes).
F-39
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
B. THE GENIX GROUP, INC.
In 1996, MCN completed the sale of its computer operations subsidiary,
The Genix Group, Inc. (Genix), to Affiliated Computer Services, Inc. for an
adjusted sales price of $132,900,000, resulting in an after-tax gain of
$36,176,000. Genix's 1996 income from operations totaled $1,595,000 and has
been accounted for as a discontinued operation.
5. ACQUISITIONS AND DISPOSITIONS
A. BHOTE KOSHI POWER COMPANY
In 1997, MCN acquired an approximate 65% interest in Bhote Koshi Power
Company, a partnership that is constructing a 36 MW hydroelectric power
plant in Nepal. Construction of the plant began in early 1997 and is
scheduled to be completed in early 2000. At December 31, 1998, MCN had paid
$7,200,000 of its total equity commitment of $20,100,000. The remaining
equity commitment balance will be paid in 1999 and 2000. The investment is
accounted for under the equity method.
B. TORRENT POWER LIMITED
In 1997, MCN acquired a 40% interest in the common equity of Torrent
Power Limited (TPL), a joint venture that holds minority interests in
electric distribution companies and power generation facilities located in
the state of Gujarat, India. In 1997 and 1998, MCN acquired preference
shares in TPL, bringing the total cost of the acquisitions to $121,200,000.
The joint venture holds a 36% interest in Ahmedabad Electricity Company
Limited (AEC), a 43% interest in Surat Electricity Company Limited (SECL)
and a 42% interest in Gujarat Torrent Energy Corporation (GTEC). AEC serves
the city of Ahmedabad and has 550 MW of electric generating capacity. SECL
provides electricity to the city of Surat. GTEC owns and operates a 655 MW
dual fuel generation facility that became fully operational in December
1998. MCN accounts for its interest in TPL under the equity method.
In February 1999, MCN reached an agreement to sell its interest in TPL
for approximately $130,000,000. The sale is subject to certain regulatory
approvals and is expected to be completed by the third quarter of 1999.
C. MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
MCN acquired an 18% general partnership interest in Midland
Cogeneration Venture Limited Partnership (MCV) during 1997 and acquired an
additional 5% general partnership interest in 1998. MCV is a partnership
that leases and operates a cogeneration facility in Midland, Michigan. The
facility can produce up to 1,370 MW of electricity, as well as 1.35 million
pounds per hour of process steam. MCN's total acquisition cost in MCV is
$73,000,000 and is accounted for under the equity method. During 1997, MCV
changed its method of accounting for property taxes. As a result, MCN's
pre-tax income from MCV was favorably impacted by $2,800,000.
D. LYONDELL METHANOL COMPANY, L.P.
In 1996, MCN acquired a 25% interest in Lyondell Methanol Company,
L.P., a limited partnership that owns a 248 million gallon-per-year
methanol production plant in Texas. MCNIC supplies a portion of the natural
gas to the methanol plant. The acquisition totaled $54,500,000 and is
accounted for under the equity method.
E. DAUPHIN ISLAND GATHERING PARTNERS
In early 1996, MCN acquired a 99% interest in Dauphin Island Gathering
Partners (DIGP) for $78,620,000. At the time of the acquisition, DIGP, the
general partnership, owned a 90-mile gas gathering system in the Mobile Bay
area of offshore Alabama. In mid-1996, MCN sold a 40% interest in the
partnership to PanEnergy Dauphin Island Company for $36,000,000. The sale
resulted in a pre-tax gain of $3,986,000.
F-40
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
In late 1996, a 41% interest in the partnership was sold to three
additional partners resulting in a pre-tax gain of $4,796,000, of which
$2,398,000 was deferred until 1997 when a related option agreement expired
unexercised. The three additional partners paid for their interests by
contributing to DIGP the Main Pass Gathering System, a 57-mile offshore gas
gathering system in the Gulf of Mexico. As a result of the sales, MCN's
ownership interest in DIGP was reduced to 35%. MCN accounts for its
interest in DIGP under the equity method.
6. INVESTMENTS IN AND ADVANCES TO JOINT VENTURES
MCN has equity interests in several joint ventures involved in the
following businesses: Pipelines & Processing -- 10 1/2% to 80% owned; Electric
Power -- 23% to 67 1/2% owned; Energy Marketing -- 10% to 50% owned; Gas
Distribution -- 47 1/2% owned; and Real Estate & Other -- 33% to 50% owned.
MCN's share of undistributed earnings in these joint ventures totaled
$54,753,000 at December 31, 1998.
F-41
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The following is the combined summarized financial information of the joint
ventures. No provision for income taxes has been included, since income taxes
are paid directly by the joint venture participants.
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Operating Revenues.......................................... $2,628,822 $1,598,208 $ 199,260
Operating Income............................................ 385,821 348,544 56,076
Income Before Taxes......................................... 205,961 197,453 30,194
---------- ---------- ----------
MCN's Share of Operating Revenues
Pipelines & Processing.................................... $ 276,613 $ 144,823 $ 36,927
Electric Power............................................ 315,516 168,051 40,731
Energy Marketing.......................................... 317,342 249,954 23,864
Real Estate & Other....................................... 12,436 7,740 8,684
---------- ---------- ----------
$ 921,907 $ 570,568 $ 110,206
========== ========== ==========
MCN's Share of Operating Income (Loss)
Pipelines & Processing.................................... $ 15,714 $ 27,485 $ 11,584
Electric Power............................................ 73,590 48,671 8,280
Energy Marketing.......................................... 6,214 9,933 9,253
Real Estate & Other....................................... (136) 645 1,387
---------- ---------- ----------
$ 95,382 $ 86,734 $ 30,504
========== ========== ==========
MCN's Share of Income (Loss) Before Taxes
Pipelines & Processing.................................... $ 29,987 $ 28,551 $ 10,590
Electric Power............................................ 28,546 12,655 (218)
Energy Marketing.......................................... 4,681 7,379 6,197
Real Estate & Other....................................... (989) 474 1,298
---------- ---------- ----------
$ 62,225 $ 49,059 $ 17,867
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Assets
Current assets............................................ $ 612,023 $ 717,346
Noncurrent assets......................................... 3,959,716 3,677,595
---------- ----------
$4,571,739 $4,394,941
========== ==========
Liabilities and Joint Ventures' Equity
Current liabilities....................................... $ 439,357 $ 590,234
Noncurrent liabilities.................................... 2,300,825 2,345,916
Joint ventures' equity.................................... 1,831,557 1,458,791
---------- ----------
$4,571,739 $4,394,941
========== ==========
MCN's Share of Total Assets
Pipelines & Processing.................................... $ 568,944 $ 296,670
Electric Power............................................ 722,038 691,202
Energy Marketing.......................................... 86,135 84,939
Gas Distribution.......................................... 23,149 22,626
Real Estate & Other....................................... 35,921 38,826
---------- ----------
$1,436,187 $1,134,263
========== ==========
MCN's Share of Joint Ventures' Equity
Pipelines & Processing.................................... $ 434,310 $ 259,116
Electric Power............................................ 191,627 164,361
Energy Marketing.......................................... 27,748 21,715
Gas Distribution.......................................... 7,832 8,363
Real Estate & Other....................................... 17,810 16,558
---------- ----------
679,327 470,113
Goodwill and Other(1)....................................... 123,904 86,863
---------- ----------
MCN's Investment In and Advances to Joint Ventures.......... $ 803,231 $ 556,976
========== ==========
</TABLE>
- -------------------------
(1) Primarily represents differences between MCN's carrying value and its share
of the joint ventures' underlying equity interest that is amortized over the
estimated useful lives of the related assets, which on a weighted average
basis equaled 28 years.
F-42
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
7. REGULATORY MATTERS
A. REGULATORY ASSETS AND LIABILITIES
MCN's Gas Distribution operations are subject to the provisions of
SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation."
As a result, several regulatory assets and liabilities are recorded in
MCN's financial statements. Regulatory assets represent costs that will be
recovered from customers through the ratemaking process. Regulatory
liabilities represent benefits that will be refunded to customers through
reduced rates.
The following regulatory assets and liabilities were reflected in the
Consolidated Statement of Financial Position as of December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Regulatory Assets
Accrued gas cost recovery revenues........................ $ -- $ 12,862
Deferred environmental costs (Note 13b)................... 30,773 30,234
Unamortized loss on retirement of debt.................... 15,548 10,181
Other..................................................... 804 1,637
-------- --------
$ 47,125 $ 54,914
======== ========
Regulatory Liabilities
Deferred gas cost recovery revenues....................... $ 14,980 $ --
Tax benefits amortizable to customers..................... 130,120 123,365
-------- --------
$145,100 $123,365
======== ========
</TABLE>
Gas Distribution currently has regulatory precedents and orders in
effect that provide for the probable recovery or refund of its regulatory
assets and liabilities. Future regulatory changes or changes in the
competitive environment could result in Gas Distribution discontinuing the
application of SFAS No. 71 for all or part of its business and require the
write-off of the portion of any regulatory asset or liability that was no
longer probable of recovery or refund. If MCN were to have discontinued the
application of SFAS No. 71 for all of its operations as of December 31,
1998, it would have had an extraordinary noncash increase to net income of
approximately $63,700,000. Management believes currently available facts
support the continued application of SFAS No. 71.
B. REGULATORY REFORM PLAN
In April 1998, the MPSC approved MichCon's Regulatory Reform Plan. The
plan includes a comprehensive experimental three-year customer choice
program, which is subject to annual caps on the level of participation. The
customer choice program begins April 1, 1999, when up to 75,000 customers
will have the option of purchasing natural gas from suppliers other than
MichCon. Up to 75,000 additional customers can be added April 1 of each of
the next two years, eventually allowing up to 225,000 customers the option
to choose a gas supplier other than MichCon. MCN's gas marketing affiliates
also participate as alternative suppliers under the program. In each of the
three plan years, there is also a volume limitation on commercial and
industrial participants. The volume limitation for these participants is 10
Bcf in 1999, 20 Bcf in 2000 and 30 Bcf in 2001. 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 commodity component of
MichCon's sales rates at $2.95 per Mcf for the three-year period beginning
on January 1, 1999. Prior to January 1999, MichCon did not generate
earnings on the gas commodity portion of its operations. However, under
this plan, changes in cost of gas will directly impact earnings. As part of
its gas acquisition strategy, MichCon has entered into firm-price
F-43
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
contracts for a substantial portion of its expected gas supply requirements
for the next three years. These contracts, coupled with the use of
MichCon's storage facilities, will substantially mitigate risks from winter
price and volume fluctuations.
Also beginning in 1999, the plan established an income sharing
mechanism that will allow customers to share in profits if actual utility
return on equity exceeds predetermined thresholds. In October 1998, the
MPSC denied a rehearing and affirmed its approval of the plan. Various
parties have appealed the MPSC's decision to the Michigan Court of Appeals.
While management believes that based upon applicable Michigan law the order
will be upheld on appeal, there can be no assurance as to the outcome.
8. GAS IN INVENTORY
Inventory gas is priced on a last-in, first-out (LIFO) basis. At December
31, 1998, the replacement cost exceeded the $147,387,000 LIFO cost by
$152,961,000. At December 31, 1997, the replacement cost exceeded the
$56,777,000 LIFO cost by $176,373,000.
F-44
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
9. CREDIT FACILITIES, SHORT-TERM BORROWINGS AND LONG-TERM DEBT
Detailed information on long-term debt, excluding current requirements, is
as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
First Mortgage Bonds, interest payable semi-annually
6.51% series due 1999..................................... $ -- $ 30,000
5 3/4 series due 2001..................................... 40,000 60,000
8% series due 2002........................................ 17,314 70,000
6.72% series due 2003..................................... 4,150 4,150
6.80% series due 2003..................................... 15,850 15,850
9 1/8% series due 2004.................................... 18,000 55,000
7.15% series due 2006..................................... 40,000 40,000
7.21% series due 2007..................................... 30,000 30,000
7.06% series due 2012..................................... 40,000 40,000
8 1/4% series due 2014.................................... 80,000 80,000
7.6% series due 2017...................................... 14,980 14,990
7 1/2% series due 2020.................................... 29,641 29,641
9 1/2% series due 2021.................................... 40,000 40,000
6 3/4% series due 2023.................................... 16,617 17,177
7% series due 2025........................................ 40,000 40,000
Unamortized discount...................................... (1,130) (1,235)
Remarketable Securities, interest payable semi-annually
6.375% series due 2008.................................... 100,000 --
6.3% series due 2011...................................... 100,000 --
6.35% series due 2012..................................... 100,000 --
6.45% series due 2038..................................... 75,000 --
6.2% series due 2038...................................... 75,000 --
Unamortized premium....................................... 10,551 --
Medium-Term Notes, interest payable semi-annually
5.84% series due 1999..................................... -- 80,000
6.82% series due 1999..................................... -- 130,000
6.03% series due 2001..................................... 60,000 60,000
6.89% series due 2002..................................... 90,000 90,000
6.32% series due 2003..................................... 60,000 60,000
7.12% series due 2004..................................... 60,000 60,000
Term Loan Due 2000, interest payable quarterly.............. -- 100,000
Commercial Paper and Bank Borrowings........................ 107,656 --
Project Loan Due 2006, interest payable quarterly........... 12,320 14,080
Long-Term Capital Lease Obligations......................... 5,345 7,702
Other Long-Term Debt........................................ 25,874 45,209
---------- ----------
$1,307,168 $1,212,564
========== ==========
</TABLE>
Substantially all of the net utility properties of MichCon, totaling
approximately $1,240,000,000, are pledged as security for the payment of
outstanding first mortgage bonds.
Maturities and sinking fund requirements during the next five years for
long-term debt outstanding at December 31, 1998 are $267,400,000 in 1999,
$27,000,000 in 2000, $86,600,000 in 2001, $113,700,000 in 2002 and $86,000,000
in 2003.
F-45
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
DIVERSIFIED ENERGY -- At December 31, 1998, MCNIC had credit lines
permitting borrowings of up to $200,000,000 under a 364-day revolving credit
facility and up to $200,000,000 under a three-year revolving credit facility,
both of which were renewed in July 1998. These facilities support MCNIC's
$400,000,000 commercial paper program. MCNIC usually issues commercial paper in
lieu of an equivalent amount of borrowings under these lines of credit.
Commercial paper and bank borrowings outstanding at December 31, 1998 and 1997
totaling $118,000,000 and $147,358,000, respectively, were classified as
short-term. The remaining 1998 commercial paper and bank borrowings of
$107,656,000 were classified as long-term. Commercial paper and bank borrowings
outstanding as of December 31, 1998 and 1997 were at weighted average interest
rates of 6.4% and 6.2%, respectively. Fees are paid to compensate banks for
lines of credit.
In 1998, MCN issued $260,000,000 of debt under a one-year term loan
facility, due December 1999. Principal payments are required based on certain
proceeds received from the sale of E&P assets. Under the terms of the agreement,
certain alternative variable interest rates are available at the borrower's
option. The weighted average interest rate at December 31, 1998 was 6.2%.
In 1998, MCNIC issued a total of $300,000,000 of remarketable debt
securities with various interest rates and maturity dates. These securities are
senior unsecured obligations of MCNIC and are subject to an MCN support
agreement. The securities are structured such that at a specified future
remarketing date the remarketing agents may elect to remarket the securities
whereby the annual interest rate will be reset. MCNIC received option premiums
in return for the remarketing option. If the remarketing agents elect not to
remarket the securities, MCNIC will be required to repurchase the securities at
their principal amounts. The option premiums received, net of financing costs
incurred, totaled $5,709,000 and are being amortized to income over the life of
the debt. The remarketing dates are in April 2001, 2002 and 2003.
During 1998, MOG retired early a five-year $100,000,000 term loan.
GAS DISTRIBUTION -- At December 31, 1998, MichCon had credit lines
permitting 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,
both of which were renewed in July 1998. MichCon issues commercial paper in lieu
of an equivalent amount of borrowings under these lines of credit. Commercial
paper outstanding at December 31, 1998 and 1997 totaled $218,447,000 and
$236,740,000 and was at weighted average interest rates of 5.6% and 5.8%,
respectively. This debt is classified as short-term. Fees are paid to compensate
banks for lines of credit.
In 1998, MichCon issued a total of $150,000,000 of remarketable debt
securities with various interest rates. 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 dates are in June 2003 and 2008. MichCon received option premiums in
return for granting options to underwriters to reset the interest rate for a
period of ten years at the initial remarketing dates. The option premiums
received, net of financing costs incurred, totaled $3,052,000 and 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.
In 1998, MichCon redeemed through a tender offer $37,000,000 of the
outstanding $55,000,000 balance of 9 1/8% first mortgage bonds due 2004, and
$52,686,000 of the outstanding $70,000,000 balance of 8% first mortgage bonds
due 2002.
During 1997, nonutility subsidiaries of MichCon borrowed $40,000,000 under
a nonrecourse credit agreement. Under terms of the agreement, certain
alternative variable interest rates are available at the borrowers' option
during the life of the agreement. Quarterly principal payments commenced in
1997, with a final installment due November 2005. The loan is secured by a
pledge of stock of the borrowers and a security interest in certain of their
assets. MichCon may be required to support the credit agreement through limited
F-46
<PAGE> 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
capital contributions to the subsidiaries if certain cash flow and operating
targets are not met. At December 31, 1998 and 1997, $29,200,000 and $36,400,000
were outstanding at weighted average interest rates of 5.8% and 6.4%,
respectively.
MichCon has variable interest rate swap agreements with notional principal
amounts aggregating $92,000,000 in connection with its first mortgage bonds.
Swap agreements of $40,000,000 through May 2002 have reduced the average cost of
the related debt from 7.3% to 6.3% for the year ended December 31, 1998. Swap
agreements of $40,000,000 through May 2005 have reduced the average cost of the
related debt from 7.1% to 5.9% for the year ended December 31, 1998. Swap
agreements of $12,000,000 through April 2000 have reduced the average cost of
the related debt from 8.3% to 4.4% for the year ended December 31, 1998. A
nonutility subsidiary of MichCon has an interest rate swap agreement on the
$14,080,000 outstanding balance of its project loan agreement at December 31,
1998 that effectively fixes the interest rate at 7.5% through February 2003.
10. PREFERRED AND HYBRID SECURITIES
A. MCN-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARIES
MCN has established various trusts and a partnership formed for the
sole purpose of issuing preferred securities and lending the gross proceeds
thereof to MCN. The sole assets of the trusts and partnership are
debentures of MCN with terms similar to those of the related preferred
securities.
F-47
<PAGE> 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Summarized information for MCN-obligated mandatorily redeemable
preferred securities of subsidiaries holding solely debentures of MCN is as
follows:
<TABLE>
<CAPTION>
LIQUIDATION MATURITY OF EARLIEST
VALUE UNDERLYING REDEMPTION
1998 1997 PER SHARE SECURITY DATE
---- ---- ----------- ----------- ----------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
MCN Financing I
8 5/8% Trust Originated Preferred
Securities........................ $ 77,068 $ 77,045 $ 25 2036 2001
(3,200,000 preferred securities)
Dividends payable quarterly
MCN Financing II
8 5/8% Trust Preferred
Securities..................... 96,669 -- 25 2038 2003
(4,000,000 preferred securities)
Dividends payable quarterly
MCN Financing V
6.305% Private Institutional Trust
Securities........................ -- 99,606 1,000 -- --
(100,000 preferred securities)
Dividends payable semi-annually
MCN Financing VI
6.85% Single Point Remarketed
Reset Capital Securities.......... 99,397 99,507 1,000 2037 1999
(100,000 preferred securities)
Dividends payable semi-annually
MCN Michigan Ltd. Partnership
9 3/8% Redeemable Cumulative
Preferred Securities, Series A.... 96,819 96,696 25 2024 1999
(4,000,000 preferred securities)
Dividends payable monthly
MCN Financing III
8% FELINE PRIDES.................. 132,250 132,250 50 2002 2002
(2,645,000 FELINE PRIDES)
Dividends payable quarterly
-------- --------
$502,203 $505,104
======== ========
</TABLE>
The preferred securities carry similar provisions as described below.
The preferred securities allow MCN the right to extend interest
payment periods on the debentures and, as a consequence, dividend payments
on the preferred securities can be deferred by the trusts and partnership
during any such interest payment period. In the event that MCN exercises
this right, MCN may not declare dividends on its common stock.
In the event of default, holders of the preferred securities will be
entitled to exercise and enforce the trusts' and partnership's creditor
rights against MCN, which may include acceleration of the principal amount
due on the debentures. MCN has issued guaranties with respect to payments
on the preferred securities. These guaranties, when taken together with
MCN's obligations under the debentures, the related indenture, and the
trust and partnership documents, provide full and unconditional guaranties
of the trusts' and partnership's obligations under the preferred securities
to the extent of the funds available therefor.
F-48
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Financing costs for these issuances were deferred and are reflected as
a reduction in the carrying value of the preferred securities. These costs
are being amortized using the straight-line method over the estimated lives
of the related securities.
In addition to the similar provisions previously discussed, specific
terms of the securities follow:
- 6.305% Private Institutional Trust Securities (PRINTS) -- MCN redeemed
the 6.305% PRINTS during 1998.
- 6.85% Single Point Remarketed Reset Capital Securities -- These
preferred securities are structured such that at a specified future
date, the rate reset date, the securities may be remarketed with a new
liquidation preference value of $25 per security and the number of
securities outstanding would adjust to 4,000,000. The annual dividend
payment rate will be reset to reflect the lowest rate, less than or
equal to a maximum rate, at which the securities can be remarketed at
a price equal to their liquidation preference value. On the rate reset
date, the terms of an equivalent amount of the MCN senior debentures
will change to reflect the new terms of the remarketed preferred
securities. The debentures will thereafter be subordinated and junior
in right of payment to all senior obligations of MCN. The rate reset
date for the securities is anticipated to be October 1999.
- 8% FELINE PRIDES -- Each security initially consists of a stock
purchase contract and a preferred security of MCN Financing III. Under
each stock purchase contract, MCN is obligated to sell, and the FELINE
PRIDES holder is obligated to purchase between 1.4132 and 1.7241
shares of MCN common stock in May 2000 for $50. The exact number of
MCN common shares to be sold is dependent on the market value of a
share in May 2000, but will not be less than 3,737,988 or more than
4,560,345 shares. MCN also is obligated to pay the FELINE PRIDES
holders a quarterly contract adjustment payment at an annual rate of
.75% of the stated amount. MCN has recorded the present value of the
contract adjustment as a liability and a reduction to Common
Shareholders' Equity on MCN's Consolidated Statement of Financial
Position. The liability is reduced as the contract adjustment payments
are made.
Holders of the preferred securities are entitled to receive cumulative
dividends at an annual rate of 7.25% of the liquidation preference
value. The preferred securities are pledged as collateral to secure
the FELINE PRIDES holders' obligation to purchase MCN common stock
under the stock purchase contracts. Each holder has the right after
issuance of the FELINE PRIDES to substitute for the preferred
securities, zero coupon U.S. Treasury securities maturing in May 2000.
Each FELINE PRIDES holder has the option to use the preferred
securities, treasury securities or cash to satisfy the May 2000
purchase contract commitment.
B. PREFERRED SECURITIES
MCN is authorized to issue 25,000,000 shares of no par value preferred
stock, and MichCon is authorized to issue 7,000,000 shares of preferred
stock with a par value of $1 per share and 4,000,000 shares of preference
stock with a par value of $1 per share. At December 31, 1998, no issuances
of preferred or preference stock were made under these authorizations.
C. ENHANCED PRIDES
MCN has issued 5,865,000 of Preferred Redeemable Increased Dividend
Equity Securities (Enhanced PRIDES) that yield 8 3/4% with a stated amount
of $23.00 per security. Each security represents a contract to purchase MCN
common stock in April 1999, or earlier under certain limited circumstances.
As subsequently discussed, proceeds from the issuance totaling
approximately $135,000,000 were used to acquire 6.5% U.S. Treasury notes
underlying the security. The interest from the Treasury notes passes
through to the Enhanced PRIDES holder. Accordingly, MCN received no cash
from issuing the Enhanced PRIDES.
F-49
<PAGE> 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Under each security, MCN is obligated to sell, and the Enhanced PRIDES
holder is obligated to purchase for $23.00, between .8333 of a share and
one share of MCN common stock. The exact number of MCN common shares to be
sold is dependent on the market value of a share in April 1999. However,
the total number to be sold will not be less than 4,887,500 shares or more
than 5,865,000 shares.
MCN also is obligated to pay the Enhanced PRIDES holders,
semi-annually, a yield enhancement payment at an annual rate of 2 1/4% of
the stated amount. MCN has recorded the present value of the yield
enhancement payments as a liability and a reduction to Common Shareholders'
Equity on MCN's Consolidated Statement of Financial Position. The liability
is reduced when the yield enhancement payments are paid. MCN has the right
to defer the yield enhancement payments, in which case MCN cannot declare
dividends on its common stock until the yield enhancement payments have
been made. In addition, MCN has incurred costs in conjunction with the
issuance of the Enhanced PRIDES and similarly has recorded the costs as a
reduction to Common Shareholders' Equity.
The Treasury notes underlying the securities are pledged as collateral
to secure the Enhanced PRIDES holders' obligation to purchase MCN common
stock under the stock purchase contract. At maturity in April 1999, the
principal received from the Treasury notes will be used to satisfy the
Enhanced PRIDES holders' obligation in full. Neither the Enhanced PRIDES
nor the Treasury notes are included on MCN's Consolidated Statement of
Financial Position. However, the issuance of common stock will be reflected
when cash proceeds totaling approximately $135,000,000 are received by MCN
in April 1999.
11. COMMON STOCK AND EARNINGS PER SHARE
A. COMMON STOCK
In 1998, MCN issued approximately 310,000 shares in conjunction with
the acquisition of heating, ventilating and air conditioning companies. In
1997, MCN sold 9,775,000 shares of new common stock in a public offering,
generating net proceeds of $276,600,000.
MCN has traditionally issued new shares of common stock pursuant to
its Direct Stock Purchase and Dividend Reinvestment Plan and various
employee benefit plans. The number of shares issued was approximately
1,190,000 in 1998, 1,165,000 in 1997, and 926,000 in 1996, generating net
proceeds of $20,200,000, $17,800,000 and $17,300,000, respectively.
Beginning in 1999, shares issued under these plans will be acquired by MCN
through open market purchases.
B. STOCK INCENTIVE PLAN
MCN's Stock Incentive Plan authorizes the use of performance units,
stock options, restricted stock or other stock-related awards to key
employees, primarily management. MCN's current policy is to issue
performance units, which encourages a strategic focus on long-term
performance and has a high employee retention value. The performance units
are denominated in shares of MCN common stock and issued to employees based
on total shareholder return over a six-year period, as compared to a group
of peer companies. The initial number of performance units granted is based
on total shareholder return relative to the peer group during the previous
three-year period. Participants receive dividend equivalents on the units
granted. The initial grants will be adjusted upward or downward based on
total shareholder return relative to the peer group for the subsequent
three-year period. The final awards are then payable in shares of common
stock or can be deferred. Participants must retain 50% of any common shares
paid until certain stock ownership guidelines are met. The deferred units
must be retained by the participants until their employment with MCN
ceases.
During 1998, 1997 and 1996, MCN granted 293,116, 245,340 and 301,616
performance units with a weighted average grant date fair value of $37.00,
$31.00 and $24.625 per unit, respectively. MCN accounts for stock-based
compensation awards under the fair value-based method as prescribed under
SFAS No. 123, "Accounting for Stock-Based Compensation," which was adopted
in 1996. Accordingly,
F-50
<PAGE> 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
the costs of performance units awarded, measured at their fair value on the
grant date, are being recorded as compensation expense and Additional
Paid-in Capital over their vesting period. MCN adjusts compensation expense
for changes in the number of performance units that are expected to vest. A
stock-based compensation benefit of $3,625,000 was recognized during 1998
for all awards outstanding as a result of a reduction in the number of
performance units expected to vest. Stock-based compensation costs
recognized during 1997 and 1996 for all awards outstanding totaled
$15,070,000 and $14,055,000, respectively. At December 31, 1998, there were
5,143,730 shares available to be issued under the Stock Incentive Plan.
In February 1999, MCN revised its policy whereby a portion of any
stock-related awards under the Stock Incentive Plan will be in the form of
stock options. The remaining portion of any awards will continue to be in
the form of performance units.
C. SHAREHOLDERS' RIGHTS PLAN
One preferred share purchase right is attached to each outstanding
share of MCN common stock. The rights are exercisable only upon certain
triggering events and expire in July 2007. The rights, which cannot be
traded separately from MCN's common stock, are intended to maximize
shareholders' value in the event that MCN is acquired.
D. EARNINGS PER SHARE
MCN reports both basic and diluted earnings per share. Basic earnings
per share is computed by dividing income available to common stockholders
by the weighted average number of common shares outstanding during the
period. Diluted earnings per share assumes the issuance of potential
dilutive common shares outstanding during the period and adjusts for
changes in income and the repurchase of common shares that would have
occurred with proceeds from the assumed issuance. A reconciliation of both
calculations for continuing operations is shown below.
<TABLE>
<CAPTION>
WTD. AVG. EARNINGS
COMMON (LOSS) PER
INCOME (LOSS) SHARES SHARE
------------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
1998
Basic Loss Per Share..................................... $(286,468) 78,823 $(3.63)
------
Effect of Dilutive Securities............................ -- --
--------- ------
Diluted Loss Per Share................................... $(286,468) 78,823 $(3.63)
========= ====== ======
1997
Basic Earnings Per Share................................. $ 133,229 72,887 $ 1.82
------
Effect of Dilutive Securities
FELINE PRIDES.......................................... 1,688 1,021
Enhanced PRIDES........................................ 222 623
Stock-based compensation plans......................... -- 904
--------- ------
Diluted Earnings Per Share............................... $ 135,139 75,435 $ 1.79
========= ====== ======
1996
Basic Earnings Per Share................................. $ 112,569 66,944 $ 1.68
------
Effect of Dilutive Securities
Enhanced PRIDES........................................ 73 41
Stock-based compensation plans......................... -- 536
--------- ------
Diluted Earnings Per Share............................... $ 112,642 67,521 $ 1.67
========= ====== ======
</TABLE>
F-51
<PAGE> 52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
12. LEASES
MCN leases certain property (principally a warehouse, office building and
parking structure) under lease arrangements expiring at various dates to 2006,
with renewal options extending beyond that date. Portions of the office
buildings and parking structure are subleased to various tenants.
In January 1998, MCN purchased one of its office buildings previously
leased, thereby eliminating the related long-term capital lease obligation. As a
result, the long-term capital lease obligation of $6,818,000 was reclassified as
a current capital lease obligation at December 31, 1997. Other long-term capital
lease obligations of MCN are not significant.
Minimum rental commitments related to noncancelable operating leases
outstanding at December 31, 1998 are $5,952,000 in 1999, $5,072,000 in 2000,
$4,887,000 in 2001, $4,632,000 in 2002, $3,111,000 in 2003 and $5,735,000
thereafter.
Total minimum lease payments for operating leases have not been reduced by
future minimum sublease rentals of $1,430,000 under noncancelable subleases.
Operating lease payments for the years ended December 31, 1998, 1997 and
1996 were $6,774,000, $5,007,000 and $5,243,000, respectively.
13. COMMITMENTS AND CONTINGENCIES
A. GUARANTIES
MCN issued a guaranty in conjunction with a Genix building lease
expiring no later than 2010. The lease agreement does not allow MCN to
transfer its obligation under the guaranty to ACS, who acquired Genix in
June 1996 (Note 4b). However, ACS is obligated to reimburse MCN for any
payments made as a result of this guaranty. Obligations under the guaranty
approximated $11,908,000 at December 31, 1998.
MCN has a 47.5% interest in a partnership that owns and operates a
natural gas transmission and distribution system located in southern
Missouri. MCN has issued a guaranty for the full amount of construction
financing obtained by the partnership and one of the parties to the
partnership is obligated to reimburse MCN for 50% of any payments made as a
result of this guaranty. Borrowings outstanding under the construction loan
totaled $29,000,000 at December 31, 1998.
A subsidiary of MichCon and an unaffiliated corporation have formed a
series of partnerships engaged in the construction and development of a
residential community on the Detroit riverfront (Harbortown). One of the
partnerships obtained $12,000,000 of tax-exempt financing due June 2004
through the Michigan State Housing Development Authority. Both partners and
their parent corporations have issued guaranties for the full amount of
this financing, and each parent corporation has agreed to reimburse the
other for 50% of any payments made as a result of these guaranties.
B. ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for
heating and other uses was manufactured from processes involving coal, coke
or oil. MCN owns, or previously owned, 17 such former manufactured gas
plant (MGP) sites.
During the mid-1980s, preliminary environmental investigations were
conducted at these former MGP sites, and some contamination related to the
by-products of gas manufacturing was discovered at each site. The existence
of these sites and the results of the environmental investigations have
been reported to the Michigan Department of Environmental Quality (MDEQ).
None of these former MGP sites is on the National Priorities List prepared
by the U.S. Environmental Protection Agency (EPA).
F-52
<PAGE> 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
MCN is involved in an administrative proceeding before the EPA
regarding one of the former MGP sites. MCN has executed an order with the
EPA, pursuant to which MCN is legally obligated to investigate and
remediate the MGP site. MCN is remediating five of the former MGP sites and
conducting more extensive investigations at four other former MGP sites. In
1998, MichCon completed the remediation of one of the former MGP sites,
which was confirmed by the MDEQ. Additionally, the MDEQ has determined with
respect to one other former MGP site that MichCon is not a responsible
party for the purpose of assessing remediation expenditures.
In 1984, MCN established an $11,700,000 reserve for environmental
investigation and remediation. During 1993, MichCon received MPSC approval
of a cost deferral and rate recovery mechanism for investigation and
remediation costs incurred at former MGP sites in excess of this reserve.
MCN employed outside consultants to evaluate remediation alternatives
for these sites, to assist in estimating its potential liabilities and to
review its archived insurance policies. The findings of these
investigations indicate that the estimated total expenditures for
investigation and remediation activities for these sites could range from
$30,000,000 to $170,000,000 based on undiscounted 1995 costs. As a result
of these studies, MCN accrued an additional liability and a corresponding
regulatory asset of $35,000,000 during 1995.
MCN notified more than 50 current and former insurance carriers of the
environmental conditions at these former MGP sites. MCN concluded
settlement negotiations with certain carriers in 1996 and 1997 and has
received payments from several carriers. In October 1997, MCN filed suit
against major nonsettling carriers seeking recovery of incurred costs and a
declaratory judgment of the carriers' liability for future costs of
environmental investigation and remediation costs at former MGP sites.
Discovery is ongoing in the case, and a preliminary trial date has been
scheduled for August 1999.
During 1998, 1997 and 1996, MCN spent $1,649,000, $835,000 and
$900,000, respectively, investigating and remediating these former MGP
sites. At December 31, 1998, the reserve balance was $35,092,000, of which
$92,000 was classified as current. Any significant change in assumptions,
such as remediation techniques, nature and extent of contamination and
regulatory requirements, could impact the estimate of remedial action costs
for the sites and, therefore, have an effect on MCN's financial position
and cash flows. However, management believes that insurance coverage and
the cost deferral and rate recovery mechanism approved by the MPSC will
prevent environmental costs from having a material adverse impact on MCN's
results of operations.
In 1998, MichCon received written notification from ANR Pipeline
Company (ANR), alleging that MichCon has responsibility for a portion of
the costs associated with responding to environmental conditions present at
a natural gas storage field in Michigan currently owned and operated by an
affiliate of ANR. At least some portion of the natural gas storage field
was formerly owned by MichCon. MichCon is evaluating ANR's allegations to
determine whether and to what extent, if any, that it may have legal
responsibility for these costs. Management does not believe that this
matter will have a material impact on MCN's financial statements.
c. COMMITMENTS
In 1997, MCN's 50%-owned partnership, Washington 10 Storage
Partnership (W-10), entered into a leveraged lease transaction to finance
the conversion of a depleted natural gas reservoir into a 42 Bcf storage
facility. The storage facility is expected to begin operations in mid-1999
and cost $160,000,000 to develop. MCN has entered into a contract with W-10
to market 100% of the capacity of the storage field through 2029. Under the
terms of the marketing contract, MCN is obligated to generate sufficient
revenues to cover W-10's lease payments and certain operating costs, which
average approximately $16,000,000 annually. As of December 31, 1998, MCN
had long-term contracts in place ranging from 1999-2016 for approximately
40% of the field's capacity effectively reducing its commitments under the
marketing contract. A significant portion of the remaining capacity is
expected to be contracted by
F-53
<PAGE> 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
MCN's Energy Marketing operations, thereby effectively enhancing its
ability to offer a reliable gas supply during peak winter months.
To ensure a reliable supply of natural gas at competitive prices, MCN
has entered into long-term purchase and transportation contracts with
various suppliers and producers. In general, purchase prices are under
fixed price and volume contracts or formulas based on market prices. MCN
has firm purchase commitments through 2001 for approximately 641 Bcf of
gas, approximately 487 Bcf of which are Gas Distribution purchase
commitments. MCN expects that sales will exceed its minimum purchase
commitments. MCN has long-term transportation and storage contracts with
various companies expiring on various dates through the year 2016. MCN is
also committed to pay demand charges of approximately $105,286,000 during
1999 related to firm purchase and transportation agreements. Of this total,
approximately $54,248,000 relates to Gas Distribution.
Capital investments for 1999 are expected to approximate $750,000,000.
Certain commitments have been made in connection with such capital
investments.
D. OTHER
MCN 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 MCN's financial
statements.
14. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE FINANCIAL INSTRUMENTS
MCN manages commodity price and interest rate risk through the use of
various derivative instruments and predominantly limits the use of such
instruments to hedging activities. If MCN did not use derivative instruments,
its exposure to such risks would be higher. Although this strategy reduces risk,
it also limits potential gains from favorable changes in commodity prices and
interest rates. Derivative instruments also give rise to credit risks due to
nonperformance by counterparties. MCN's control procedures are designed to
minimize overall exposure to credit risk. MCN closely monitors the financial
condition and credit ratings of counterparties, diversifies its risk by having a
significant number of counterparties, and limits its counterparties to
investment grade institutions. MCN generally requires cash collateral when
exposure to each counterparty exceeds certain limits, and its agreements with
each counterparty generally allow for the netting of positive and negative
positions.
Commodity price and interest rate risks are actively monitored by a risk
control group to ensure compliance with MCN's risk management policies at both
the corporate and subsidiary levels. These policies, including related risk
limits, are regularly assessed to ensure their appropriateness given MCN's
objectives, strategies and current market conditions. MCN closely monitors and
manages its exposure to commodity price risk through a variety of risk
management techniques. MCN's objective is to manage its exposure to commodity
price risk to increase the likelihood of achieving targeted rates of return.
Derivative instruments are reviewed periodically to ensure they continue to
effectively reduce exposure to commodity price and interest rate risks, and,
therefore, high correlation is maintained between changes in the fair value of
derivative instruments and the underlying items or transactions being hedged. In
the event that a derivative is no longer deemed effective or does not qualify
for hedge accounting, the instruments are recorded as an asset or liability at
fair value, with changes in fair value recorded to income.
A. COMMODITY PRICE HEDGING
Natural gas and oil futures, options and natural gas and oil swap
agreements are used to manage Diversified Energy's exposure to the risk of
market price fluctuations on gas sale and purchase contracts, gas and oil
production and gas inventories. Changes in the market value of contracts
that hedge gas
F-54
<PAGE> 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
supply transactions are deferred and included in inventory costs until the
hedged transaction is completed, at which time the realized gain or loss is
included in the cost of gas. Market value changes of contracts that hedge
gas and oil sales transactions are also deferred and recorded as a deferred
credit or deferred charge until the hedged transaction is completed, at
which time the realized gain or loss is included as an adjustment to
revenues. Unrealized gains and losses on derivative contracts that are
terminated or sold continue to be deferred until such time as the initial
hedged transactions are completed. In the instance when a hedged item no
longer exists or is no longer probable of occurring, unrealized gains and
losses would be included in income unless the derivative is redesignated to
a similar transaction and qualifies for hedge accounting.
The following assets and liabilities related to the use of gas and oil
swap agreements are reflected in the Consolidated Statement of Financial
Position at December 31.
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Deferred Swap Losses and Receivables
Unrealized losses......................................... $48,700 $34,736
Receivables............................................... 25,864 16,683
------- -------
74,564 51,419
Less -- Current portion................................... 11,417 396
------- -------
$63,147 $51,023
======= =======
Deferred Swap Gains and Payables
Unrealized gains.......................................... $24,126 $15,005
Payables.................................................. 54,525 41,164
------- -------
78,651 56,169
Less -- Current portion................................... 15,695 14,452
------- -------
$62,956 $41,717
======= =======
</TABLE>
The following table of natural gas and oil swap agreements outstanding
at December 31 is summarized by fixed or variable prices to be received.
Notional amounts represent the volume of transactions valued at the fixed
or variable price that MCN has contracted to obtain. Notional amounts do
not represent the amounts exchanged by the parties to the swaps, and
therefore do not reflect MCN's exposure to commodity price or credit risks.
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS OF DOLLARS)
<S> <C> <C>
Fixed Price Receiver
Volumes (Bcf equivalent).................................. 280.9 447.5
Notional value............................................ $675,671 $994,159
Latest maturity........................................... 2013 2013
-------- --------
Variable Price Receiver
Volumes (Bcf equivalent).................................. 364.0 39.5
Notional value............................................ $816,414 $ 94,082
Latest maturity........................................... 2006 2006
-------- --------
</TABLE>
In addition, at December 31, 1998, MCN had futures contracts that
permit settlement by delivery of the underlying commodity of 113.5 Bcf with
unrealized gains of $4,699,000. Futures contracts of 73.3 Bcf with
unrealized gains of $2,031,000 and 21.7 Bcf with unrealized losses of
$10,120,000 were outstanding at December 31, 1997.
Collateral in the form of cash totaling $13,990,000 was provided under
hedging contracts at December 31, 1998.
F-55
<PAGE> 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
B. TRADING ACTIVITIES
As discussed in Note 1b to the Consolidated Financial Statements, a
special investigation of MCN's non-utility energy marketing operations
identified certain unauthorized gas purchase and sale contracts that were
entered into for trading purposes. The unauthorized transactions violate
MCN's risk-management policy that requires all such activities to be
reviewed and approved by a risk committee that reports regularly to the MCN
Board of Directors. The purchase and sale contracts entered into in
connection with trading activities run through March 2000 and are accounted
for using the mark-to-market method, with unrealized gains and losses
recorded as an adjustment to cost of gas.
C. INTEREST RATE HEDGING
In order to manage interest costs, MCN uses interest rate swap
agreements to exchange fixed and variable rate interest payment obligations
over the life of the agreements without exchange of the underlying
principal amounts. Interest rate swaps are subject to market risk as
interest rates fluctuate. The difference to be received or paid on these
agreements is accrued and recorded as an adjustment to interest expense
over the life of the agreements. The fair value of the swap agreements and
changes in the fair value as a result of changes in market interest rates
are not recognized in the financial statements. In the event of an interest
rate swap termination, any associated gains and losses would be deferred
and amortized as an adjustment to interest expense related to the debt over
the remaining term of the original contract life of the terminated swap
agreement. In the event of an early extinguishment of a designated debt
obligation, derivative gains and losses would be included in income, unless
the swap agreement is redesignated as a hedge of another outstanding debt
obligation with similar characteristics and qualifies for hedge accounting.
At December 31, 1998, MCN had interest rate swap agreements with
notional principal amounts totaling $186,100,000 (Note 9) and a weighted
average remaining life of 3.6 years. At December 31, 1997, the notional
principal amount of outstanding interest rate swaps totaled $288,000,000.
The notional principal amounts are used solely to calculate amounts to be
paid or received under the interest rate swap agreements and approximate
the principal amount of the underlying debt being hedged.
15. FAIR VALUE OF FINANCIAL AND OTHER SIMILAR INSTRUMENTS
MCN has estimated the fair value of its financial instruments using
available market information and appropriate valuation methodologies.
Considerable judgment is required in developing the estimates of the fair value
of financial instruments and, therefore, the values are not necessarily
indicative of the amounts that MCN could realize in a current market exchange.
The carrying amounts of certain financial instruments, such as notes payable,
customer deposits and notes receivable, are assumed to approximate fair value
due to their short-term nature.
F-56
<PAGE> 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The carrying amount and fair value of other financial instruments consist
of the following:
<TABLE>
<CAPTION>
1998 1997
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS
Investment in debt and equity
securities.............................. $ 69,705 $ 69,705 $ 97,521 $ 97,521
LIABILITIES AND CAPITALIZATION
Long-term debt, excluding capital lease
obligations............................. 1,301,823 1,358,371 1,204,862 1,251,883
Redeemable preferred securities........... 502,203 476,443 505,104 550,197
DERIVATIVE FINANCIAL AND OTHER SIMILAR
INSTRUMENTS (NOTE 14)
Natural gas & oil swaps
with unrealized gains................... 24,126 24,126 15,005 15,005
with unrealized losses.................. 48,700 48,700 34,736 34,736
Natural gas & oil futures
with unrealized gains................... 4,699 4,699 2,031 2,031
with unrealized losses.................. -- -- 10,120 10,120
Interest rate swaps
with unrealized gains................... -- 9,033 -- 5,006
with unrealized losses.................. -- 696 -- 415
</TABLE>
The fair values are determined based on the following:
INVESTMENT IN DEBT AND EQUITY SECURITIES -- carrying amount approximates
fair value taking into consideration interest rates available to MCN for
investments with similar terms.
LONG-TERM DEBT -- interest rates available to MCN for issuance of debt with
similar terms and remaining maturities.
REDEEMABLE CUMULATIVE PREFERRED SECURITIES -- quoted market prices on the
New York Stock Exchange and interest rates available to MCN for issuance of
preferred securities with similar terms.
NATURAL GAS AND OIL SWAPS AND FUTURES, AND INTEREST RATE SWAPS -- estimated
amounts that MCN would receive or pay to terminate the swap agreements and
futures, taking into account current gas and oil prices, interest rates and the
creditworthiness of the counterparties.
GUARANTIES (NOTE 13A) -- Management is unable to practicably estimate the
fair value of the Southern Missouri, Genix and Harbortown guaranties due to the
nature of the transactions.
The fair value estimates presented herein are based on information
available to management as of December 31, 1998 and 1997. Management is not
aware of any subsequent factors that would significantly affect the estimated
fair value amounts.
16. RETIREMENT BENEFITS AND TRUSTEED ASSETS
In 1998, MCN adopted SFAS No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits," which standardizes the disclosure
requirements for pensions and other postretirement benefits.
A. PENSION PLAN BENEFITS
Separate defined benefit retirement plans are maintained for union and
nonunion employees. The plans are noncontributory, cover substantially all
employees and generally provide for normal retirement
F-57
<PAGE> 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
at age 65, but with the option to retire earlier or later under certain
conditions. The plans provide pension benefits that are based on each
employee's compensation and years of credited service. Currently these
plans meet the full funding limitations of the Internal Revenue Code.
Accordingly, no contributions for the 1998, 1997 or 1996 plan years were
made, and none is expected to be made for the 1999 plan year.
Net pension credit for the years ended December 31 includes the
following components:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Service Cost............................................ $ 10,993 $ 10,380 $ 11,194
Interest Cost........................................... 38,046 36,059 34,223
Expected Return on Plan Assets.......................... (74,383) (63,879) (56,923)
Amortization of:
Net gain.............................................. (6,572) (5,410) (1,682)
Prior service cost.................................... 1,044 (149) (156)
Net transition asset.................................. (5,023) (5,080) (5,040)
Special Termination Benefits............................ 5,054 -- --
Settlements............................................. (7,300) (3,266) --
-------- -------- --------
Net Pension Credit...................................... $(38,141) $(31,345) $(18,384)
======== ======== ========
</TABLE>
F-58
<PAGE> 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The following table sets forth a reconciliation of the obligations, assets
and funded status of the plans as well as the amounts recognized as prepaid
pension cost in the Consolidated Statement of Financial Position:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Measurement Date............................................ October 31 October 31
Accumulated Benefit Obligation at the End of the Period..... $ 462,347 $ 413,280
--------- ---------
Projected Benefit Obligation at the Beginning of the
Period.................................................... $ 489,779 $ 450,912
Service Cost................................................ 10,993 10,380
Interest Cost............................................... 38,046 36,059
Plan Amendments............................................. 22,564 --
Actuarial Loss.............................................. 45,879 26,357
Special Termination Benefits................................ 5,054 --
Settlements Due to Lump Sums................................ (21,033) (8,844)
Regular Benefits............................................ (28,782) (25,085)
--------- ---------
Projected Benefit Obligation at the End of the Period....... $ 562,500 $ 489,779
========= =========
Plan Assets at Fair Value at the Beginning of the Period.... $ 844,107 $ 730,820
Actual Return on Plan Assets................................ 106,300 143,859
Settlements Due to Lump Sums................................ (16,333) (5,487)
Regular Benefits............................................ (28,782) (25,085)
--------- ---------
Plan Assets at Fair Value at the End of the Period.......... $ 905,292 $ 844,107
========= =========
Funded Status of the Plans.................................. $ 342,792 $ 354,328
Unrecognized
Net gain.................................................. (221,245) (244,405)
Prior service cost........................................ 19,448 (1,275)
Net transition asset...................................... (29,220) (35,014)
--------- ---------
Prepaid Pension Cost........................................ $ 111,775 $ 73,634
========= =========
Prepaid Benefit Cost........................................ $ 114,275 $ 75,921
Accrued Benefit Liability................................... (2,500) (2,287)
--------- ---------
Total Recognized............................................ $ 111,775 $ 73,634
========= =========
</TABLE>
In determining the actuarial present value of the projected benefit
obligation, the weighted average discount rate was 6.5%, 7.5% and 8% for
1998, 1997 and 1996, respectively. The rate of increase in future
compensation levels used was 5% for 1998 and 1997. The expected long-term
rate of return on plan assets, which are invested primarily in equity and
fixed income securities, was 9.5% for 1998 and 9.25% for 1997 and 1996.
In 1998, MichCon implemented an early retirement program under which
approximately 6% of its workforce retired in 1998 with incentives. The
program increased the projected benefit obligation and 1998 pension costs
by $5,054,000.
MCN also sponsors defined contribution retirement savings plans.
Participation in one of these plans is available to substantially all union
and nonunion employees. MCN matches employee contributions up to certain
predefined limits based upon salary and years of credited service. The cost
of these plans for continuing operations was $5,600,000 in 1998, $6,200,000
in 1997 and $6,100,000 in 1996.
F-59
<PAGE> 60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
B. OTHER POSTRETIREMENT BENEFITS
MCN provides certain healthcare and life insurance benefits for
retired employees who may become eligible for these benefits if they reach
retirement age while working for MCN. These benefits are being accounted
for under SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions," which requires the use of accrual accounting. Upon
adoption of SFAS No. 106, MCN deferred its 1993 postretirement costs
related to Gas Distribution in excess of claims paid until 1994, when new
rates to recover such costs became effective.
MCN's policy is to fund certain trusts to the extent its
postretirement benefit costs are recognized in Gas Distribution rates.
Separate qualified Voluntary Employees' Beneficiary Association (VEBA)
trusts exist for union and nonunion employees. Funding to the VEBA trusts
totaled $2,200,000, $6,700,000 and $41,918,000 in 1998, 1997 and 1996,
respectively. The expected long-term rate of return on plan assets that are
invested in life insurance policies, equity securities and fixed income
securities, was 9.8% for 1998 and 9.1% for 1997 and 1996.
Net postretirement cost for the years ended December 31 includes the
following components:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Service Cost..................................... $ 4,044 $ 4,354 $ 4,541
Interest Cost.................................... 16,891 17,857 16,826
Expected Return on Plan Assets................... (13,570) (11,082) (9,872)
Amortization of:
Net gain....................................... (5,723) (4,933) (4,332)
Net transition obligation...................... 12,898 13,587 13,587
Special Termination Benefits..................... 1,186 -- --
-------- -------- -------
Total Postretirement Cost........................ 15,726 19,783 20,750
Regulatory Adjustment............................ 43 4,907 7,553
-------- -------- -------
Net Postretirement Cost.......................... $ 15,769 $ 24,690 $28,303
======== ======== =======
</TABLE>
F-60
<PAGE> 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The following table sets forth a reconciliation of the obligations,
assets and funded status of the plans as well as the amounts recorded as
accrued postretirement cost in the Consolidated Statement of Financial
Position:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
Measurement Date..................................... October 31 October 31
<S> <C> <C>
Accumulated Postretirement Benefit
Obligation at the Beginning of the Period.......... $ 229,337 $ 223,214
Service Cost......................................... 4,044 4,354
Interest Cost........................................ 16,891 17,857
Plan Amendments...................................... (8,269) --
Actuarial (Gain) Loss................................ 24,660 (4,561)
Special Termination Benefits......................... 1,186 --
Benefits Paid........................................ (11,702) (11,527)
--------- ---------
Accumulated Postretirement Benefit Obligation at the
End of the Period.................................. $ 256,147 $ 229,337
========= =========
Plan Assets at Fair Value at the Beginning of the
Period............................................. $ 152,405 $ 126,716
Actual Return on Plan Assets......................... 25,848 26,251
Company Contributions................................ 6,700 7,200
Regular Benefits..................................... (10,674) (7,762)
--------- ---------
Plan Assets at Fair Value at the End of the Period... $ 174,279 $ 152,405
========= =========
Funded Status of the Plan............................ $ (81,868) $ (76,932)
Unrecognized
Net gain........................................... (116,959) (125,827)
Net transition obligation.......................... 190,776 203,674
Contributions Made After Measurement Date............ 2,200 6,700
Regular Benefits Made After
Measurement Date................................... (11,720) (1,007)
--------- ---------
Accrued Postretirement Asset (Liability)............. $ (17,571) $ 6,608
========= =========
</TABLE>
The rate at which healthcare costs are assumed to increase is the most
significant factor in estimating MCN's postretirement benefit obligation.
MCN used a rate of 6% for 1999, and a rate that gradually declines each
year until it stabilizes at 5% in 2003. A one percentage point increase in
the assumed rates would increase the accumulated postretirement benefit
obligation at December 31, 1998 by $33,046,000 (13%) and increase the sum
of the service and interest rate cost by $3,057,000 (15%) for the year then
ended. A one percentage point decrease in the assumed rates would decrease
the accumulated postretirement benefit obligation at December 31, 1998 by
$28,926,000 (11%) and decrease the sum of the service and interest rate
cost by $2,626,000 (13%) for the year then ended.
The discount rate used in determining the accumulated postretirement
benefit obligation was 6.5%, 7.5% and 8% for 1998, 1997 and 1996,
respectively.
In 1998, MichCon implemented an early retirement program under which
approximately 6% of its workforce retired in 1998 with incentives. The
program increased the postretirement benefit obligation and 1998
postretirement costs by $1,186,000.
C. GRANTOR TRUST
MichCon has established a Grantor Trust and contributed $28,200,000 in
1998 and $31,300,000 in 1997 to the trust, which invested such proceeds in
life insurance contracts and income securities. By
F-61
<PAGE> 62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
funding the Grantor Trust and VEBA trusts (Note 16b), MichCon is complying
with MPSC directives that it fund various trusts to the extent its
postretirement benefit costs are recognized in Gas Distribution rates.
Employees and retirees have no right, title or interest in the assets of
the Grantor Trust and MichCon can revoke the trust subject to providing the
MPSC with prior notification.
17. SUMMARY OF INCOME TAXES
MCN files a consolidated federal income tax return. The income tax
provisions or benefits of MCN's subsidiaries are determined on an individual
company basis. The subsidiaries record income tax payable to or receivable from
MCN resulting from the inclusion of its taxable income or loss in MCN's
consolidated tax return.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Effective Federal Income Tax Rate........................... (38.8)% 25.1% 23.4%
========= ======== ========
Income Taxes Consist of:
Current................................................... $ 7,002 $ 18,280 603
Deferred, net............................................. (176,995) 48,728 53,528
Gas production tax credits................................ (10,485) (17,797) (15,878)
Other tax credits, net.................................... (2,990) (1,973) (1,878)
--------- -------- --------
$(183,468) $ 47,238 $ 36,375
========= ======== ========
Reconciliation Between Statutory and Actual Income Taxes
Statutory Federal Income Taxes at a Rate of 35%............. $(164,477) $ 63,165 $ 52,130
Adjustments to Federal Taxes
Book over tax depreciation................................ 1,071 5,301 6,367
Adjustments to taxes provided in prior periods............ (412) (162) (3,369)
Stock-related benefits.................................... (1,095) -- --
Gas production tax credits................................ (10,485) (17,797) (15,878)
Other tax credits......................................... (2,990) (1,973) (1,878)
Allowance for funds used during construction.............. (1,900) (1,105) (245)
Undistributed foreign earnings............................ (1,244) -- --
Other, net................................................ (1,936) (191) (752)
--------- -------- --------
$(183,468) $ 47,238 $ 36,375
========= ======== ========
</TABLE>
No provision has been made for federal, state or foreign income taxes in
1998 related to approximately $3,553,000 of undistributed earnings of foreign
subsidiaries that are intended to be permanently reinvested. There were no
undistributed earnings of foreign subsidiaries in 1997 and 1996.
Deferred tax assets and liabilities are recognized for the estimated future
tax effect of temporary differences between the tax basis of assets or
liabilities and the reported amounts in the financial statements. Deferred tax
assets and liabilities are classified as current or noncurrent according to the
classification of the related assets or liabilities. The alternative minimum tax
credits may be carried forward indefinitely.
F-62
<PAGE> 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The tax effect of temporary differences that gave rise to MCN's deferred
tax assets and liabilities consisted of the following:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Deferred Tax Assets
Alternative minimum tax credit carryforward............... $ 71,519 $ 60,121
Vacation and other benefits............................... 17,745 20,846
Postretirement benefits................................... 6,287 --
Uncollectibles............................................ 3,234 4,771
Restructuring charges..................................... 5,915 --
Other..................................................... 20,257 11,985
-------- ---------
$124,957 $ 97,723
======== =========
Deferred Tax Liabilities
Depreciation and other property-related basis differences,
net.................................................... $ 12,978 $ 200,216
Pensions.................................................. 36,751 24,027
Property taxes............................................ 13,072 12,931
Gas cost recovery undercollection......................... 57 4,502
Postretirement benefits................................... -- 2,768
Other..................................................... 20,959 18,432
-------- ---------
$ 83,817 $ 262,876
======== =========
Net Deferred Tax Asset (Liability).......................... $ 41,140 $(165,153)
Less: Net Deferred Tax Liability -- Current................. (9,407) (11,994)
-------- ---------
Net Deferred Tax Asset (Liability) -- Noncurrent............ $ 50,547 $(153,159)
======== =========
</TABLE>
18. SEGMENT INFORMATION
In 1998, MCN adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which requires the reporting of business
segments based on the organizational structure used by management to assess
performance and make resource allocation decisions.
MCN is a diversified energy holding company with natural gas markets and
investments primarily in North America. MCN is organized into two business
groups, Diversified Energy and Gas Distribution. The groups operate five major
business segments as described in the Summary of Significant Accounting
Policies -- Company Description (Note 1a).
Information as to MCN's segments is set forth in the following tables. The
segments were determined based on the nature of their products and services and
how management reviews operating results. MCN evaluates segment performance
based on several factors, of which the primary measure is net income or loss.
Inter-segment sales are based on long-term fixed-price or index-price contracts.
Under Emerging Issues Task Force Issue No. 87-24, "Allocation of Interest
to Discontinued Operations," Diversified Energy's interest and preferred
dividend expenses were allocated to the E&P segment previously presented as
discontinued operations based on its ratio of total capital to that of
Diversified Energy (Note 4a). As discussed in Note 4a, the E&P segment is no
longer a discontinued operation, and the allocation of the interest and
preferred dividend expenses to the E&P segment has been changed to be based on
an imputed debt structure reflective of its industry as is done with MCN's other
segments.
F-63
<PAGE> 64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
<TABLE>
<CAPTION>
DIVERSIFIED ENERGY
----------------------------------------------------------------
EXPLORATION &
PIPELINES & ELECTRIC ENERGY PRODUCTION CORPORATE & GAS
PROCESSING POWER MARKETING (NOTE 4A) OTHER(A) DISTRIBUTION
----------- -------- --------- ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1998
Revenues From Unaffiliated
Customers................... $ 20,856 $ 47,131 $767,068 $ 150,504 $ -- $1,045,139
Revenues From Affiliated
Customers................... 345 -- 105,543 56,598 -- 6,635
--------- -------- -------- --------- -------- ----------
Total operating
revenues................ 21,201 47,131 872,611 207,102 -- 1,051,774
========= ======== ======== ========= ======== ==========
Depreciation, Depletion and
Amortization................ 1,705 208 1,229 80,576 1,998 93,774
Operating Income (Loss)....... (146,264) (5,021) (5,987) (387,955) (19,162) 158,537
Equity in Earnings of Joint
Ventures.................... 29,987 28,546 2,401 -- 308 983
--------- -------- -------- --------- -------- ----------
Operating and joint
venture income (loss)... (116,277) 23,525 (3,586) (387,955) (18,854) 159,520
========= ======== ======== ========= ======== ==========
Interest Income............... 1,001 944 1,676 426 53,100 5,716
Interest Expense(b)........... (14,382) (2,021) (5,726) (21,154) (62,960) (57,477)
Income Taxes.................. (46,893) 8,212 (510) (160,900) (16,377) 33,000
Net Income (Loss)............. (82,240) 19,271 (1,037) (253,353) (40,843) 71,734
Total Assets.................. 575,969 300,529 386,917 988,201 72,388 2,116,173
Investments In and Advances to
Joint Ventures.............. 521,711 231,668 29,435 -- 18,939 1,478
Capital Expenditures.......... 113,229 1,602 2,596 200,430 6,966 157,952
Capital Investments........... 333,128 88,209 3,355 200,430 7,092 158,716
Significant Noncash Items:
Property write-downs and
restructuring charges
(Notes 2 & 3)............. (137,681) (2,470) -- (416,977) (10,390) (24,800)
Investment losses (Notes 2b
and 2c)................... -- -- -- (6,135) -- (8,500)
<CAPTION>
ELIMINATIONS CONSOLIDATED
& OTHER TOTAL
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
1998
Revenues From Unaffiliated
Customers................... $ -- $2,030,698
Revenues From Affiliated
Customers................... (169,121) --
--------- ----------
Total operating
revenues................ (169,121) 2,030,698
========= ==========
Depreciation, Depletion and
Amortization................ -- 179,490
Operating Income (Loss)....... -- (405,852)
Equity in Earnings of Joint
Ventures.................... -- 62,225
--------- ----------
Operating and joint
venture income (loss)... -- (343,627)
========= ==========
Interest Income............... (51,970) 10,893
Interest Expense(b)........... 51,970 (111,750)
Income Taxes.................. -- (183,468)
Net Income (Loss)............. -- (286,468)
Total Assets.................. (47,279) 4,392,898
Investments In and Advances to
Joint Ventures.............. -- 803,231
Capital Expenditures.......... -- 482,775
Capital Investments........... -- 790,930
Significant Noncash Items:
Property write-downs and
restructuring charges
(Notes 2 & 3)............. -- (592,318)
Investment losses (Notes 2b
and 2c)................... -- (14,635)
</TABLE>
<TABLE>
<CAPTION>
DIVERSIFIED ENERGY
----------------------------------------------------------------
EXPLORATION &
PIPELINES & ELECTRIC ENERGY PRODUCTION CORPORATE & GAS ELIMINATIONS
PROCESSING POWER MARKETING (NOTE 4A) OTHER(A) DISTRIBUTION & OTHER
----------- -------- --------- ------------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997
Revenues From Unaffiliated
Customers................... $ 6,971 $ 51,804 $743,793 $ 144,033 $ -- $1,261,266 $ --
Revenues From Affiliated
Customers................... 397 -- 92,921 71,795 -- 10,020 (175,133)
-------- -------- -------- ---------- -------- ---------- ---------
Total operating
revenues................ 7,368 51,804 836,714 215,828 -- 1,271,286 (175,133)
======== ======== ======== ========== ======== ========== =========
Depreciation, Depletion and
Amortization................ 1,153 (22) 915 73,909 1,220 104,437 --
Operating Income (Loss)....... 585 5,377 (7,414) 51,455 (4,433) 176,820 --
Equity in Earnings of Joint
Ventures.................... 28,551 12,653 5,182 6,600 139 2,534 --
-------- -------- -------- ---------- -------- ---------- ---------
Operating and joint
venture income (loss)... 29,136 18,030 (2,232) 58,055 (4,294) 179,354 --
======== ======== ======== ========== ======== ========== =========
Interest Income............... 109 278 2,332 160 37,202 4,735 (33,650)
Interest Expense(b)........... (8,436) (165) (4,920) (13,937) (38,120) (54,525) 33,650
Income Taxes.................. 8,721 6,341 (1,180) (1,675) (12,105) 47,136 --
Net Income (Loss)............. 17,070 12,409 (1,308) 45,884 (21,911) 81,085 --
Total Assets.................. 391,550 208,421 313,669 1,237,813 97,819 2,167,637 (85,972)
Investments In and Advances to
Joint Ventures.............. 323,597 180,127 25,159 -- 19,252 8,841 --
Capital Expenditures.......... 19,491 4,823 663 374,997 4,951 157,732 --
Capital Investments........... 171,735 243,231 3,893 374,997 5,425 160,329 --
<CAPTION>
CONSOLIDATED
TOTAL
------------
<S> <C>
1997
Revenues From Unaffiliated
Customers................... $2,207,867
Revenues From Affiliated
Customers................... --
----------
Total operating
revenues................ 2,207,867
==========
Depreciation, Depletion and
Amortization................ 181,612
Operating Income (Loss)....... 222,390
Equity in Earnings of Joint
Ventures.................... 55,659
----------
Operating and joint
venture income (loss)... 278,049
==========
Interest Income............... 11,166
Interest Expense(b)........... (86,453)
Income Taxes.................. 47,238
Net Income (Loss)............. 133,229
Total Assets.................. 4,330,937
Investments In and Advances to
Joint Ventures.............. 556,976
Capital Expenditures.......... 562,657
Capital Investments........... 959,610
</TABLE>
F-64
<PAGE> 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
<TABLE>
<CAPTION>
DIVERSIFIED ENERGY
-----------------------------------------------------------------
EXPLORATION &
PIPELINES & ELECTRIC ENERGY PRODUCTION CORPORATE & GAS
PROCESSING POWER MARKETING (NOTE 4A) OTHER(A) DISTRIBUTION
----------- -------- --------- ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1996
Revenues From Unaffiliated
Customers.................. $ 5,928 $ 42,142 $589,036 $ 93,790 $ -- $1,266,372
Revenues From Affiliated
Customers.................. 441 -- 84,126 44,151 -- 9,882
-------- -------- -------- -------- -------- ----------
Total operating
revenues............... 6,369 42,142 673,162 137,941 -- 1,276,254
======== ======== ======== ======== ======== ==========
Depreciation, Depletion and
Amortization............... 944 (90) 916 44,468 938 98,814
Operating Income (Loss)...... 134 4,823 5,142 33,235 (2,525) 170,484
Equity in Earnings (Loss) of
Joint Ventures............. 10,590 (211) 4,208 -- 2,026 1,254
-------- -------- -------- -------- -------- ----------
Operating and joint
venture income
(loss)................. 10,724 4,612 9,350 33,235 (499) 171,738
======== ======== ======== ======== ======== ==========
Interest Income.............. 189 82 946 207 20,043 3,967
Interest Expense(b).......... (6,089) -- (3,426) (8,376) (29,243) (48,847)
Income Taxes................. 4,055 1,687 2,375 (6,487) (7,992) 42,737
Net Income (Loss)............ 7,117 3,159 5,574 31,506 (16,183) 81,396
Total Assets................. 220,943 47,611 310,732 963,273 40,714 2,086,325
Investments In and Advances
to Joint Ventures.......... 177,026 27,233 34,408 -- 20,046 6,675
Capital Expenditures......... 6,865 2,086 1,114 388,719 2,987 215,317
Capital Investments.......... 157,663 19,641 1,364 388,690 2,997 220,393
<CAPTION>
ELIMINATIONS CONSOLIDATED
& OTHER(C) TOTAL
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
1996
Revenues From Unaffiliated
Customers.................. $ -- $1,997,268
Revenues From Affiliated
Customers.................. (138,600) --
--------- ----------
Total operating
revenues............... (138,600) 1,997,268
========= ==========
Depreciation, Depletion and
Amortization............... -- 145,990
Operating Income (Loss)...... -- 211,293
Equity in Earnings (Loss) of
Joint Ventures............. -- 17,867
--------- ----------
Operating and joint
venture income
(loss)................. -- 229,160
========= ==========
Interest Income.............. (18,200) 7,234
Interest Expense(b).......... 18,200 (77,781)
Income Taxes................. -- 36,375
Net Income (Loss)............ 37,771 150,340
Total Assets................. (36,194) 3,633,404
Investments In and Advances
to Joint Ventures.......... -- 265,388
Capital Expenditures......... -- 617,088
Capital Investments.......... -- 790,748
</TABLE>
- -------------------------
(a) Corporate & Other includes administrative and financing expenses associated
with corporate activities as well as development and management activities
of real estate partnerships.
(b) Interest expense is allocated from Corporate & Other to each Diversified
Energy segment based on an imputed debt structure reflective of the
segments' related industry.
(c) Eliminations and other includes MCN's discontinued computer operations (Note
4b).
19. QUARTERLY OPERATING RESULTS (UNAUDITED)
Due to the seasonal nature of MCN's Gas Distribution operations, revenues,
net income and earnings per share tend to be higher in the first and fourth
quarters of the calendar year. Quarterly earnings per share may not total for
the years, since quarterly computations are based on weighted average common
shares outstanding during each quarter. There were 21,858 and 22,160 holders of
record of MCN common shares at December 31, 1998 and 1997, respectively.
F-65
<PAGE> 66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Subsequent to the issuance of the December 31, 1998 financial statements,
MCN management determined that certain transactions were improperly recorded.
Certain amounts have been restated primarily to record cost of gas expense,
including trading losses, in the appropriate accounting periods as described in
Note 1b. The effects of this restatement on each of the quarterly periods in the
years ended December 31, 1998 and 1997 are presented below. The effect of
reclassifying E&P from a discontinued operation to a continuing operation is
also presented below (Note 4a).
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
AS RESTATED AND RECLASSIFIED, NOTES 1B AND 4A
(IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1998
Operating Revenues..................... $701,460 $ 406,214 $ 351,145 $571,879 $2,030,698
Operating Income (Loss):
Before unusual charges............... $116,626 $ 22,040 $ (346) $ 48,146 $ 186,466
Unusual charges...................... -- (333,022) (259,296) -- (592,318)
-------- --------- --------- -------- ----------
$116,626 $(310,982) $(259,642) $ 48,146 $ (405,852)
======== ========= ========= ======== ==========
Operating and Joint Venture Income
(Loss):
Before unusual charges............... $133,387 $ 33,877 $ 17,617 $ 63,810 $ 248,691
Unusual charges...................... -- (333,022) (259,296) -- (592,318)
-------- --------- --------- -------- ----------
$133,387 $(299,145) $(241,679) $ 63,810 $ (343,627)
======== ========= ========= ======== ==========
Net Income (Loss)
Before unusual charges............... $ 78,882 $ 7,829 $ (7,578) $ 23,997 $ 103,130
Unusual charges...................... -- (220,452) (169,146) -- (389,598)
-------- --------- --------- -------- ----------
$ 78,882 $(212,623) $(176,724) $ 23,997 $ (286,468)
======== ========= ========= ======== ==========
Basic Earnings (Loss) Per Share:
Before unusual charges............... $ 1.01 $ .10 $ (.10) $ .31 $ 1.31
Unusual charges...................... -- (2.80) (2.14) -- (4.94)
-------- --------- --------- -------- ----------
$ 1.01 $ (2.70) $ (2.24) $ .31 $ (3.63)
======== ========= ========= ======== ==========
Diluted Earnings (Loss) Per Share:
Before unusual charges............... $ .95 $ .10 $ (.10) $ .30 $ 1.31
Unusual charges...................... -- (2.80) (2.14) -- (4.94)
-------- --------- --------- -------- ----------
$ .95 $ (2.70) $ (2.24) $ .30 $ (3.63)
======== ========= ========= ======== ==========
Dividends Paid Per Share............... $ .2550 $ .2550 $ .2550 $ .2550 $ 1.0200
Average Daily Trading Volume........... 195,997 328,005 530,228 395,530 364,558
Price Per Share:
High................................. $39.8750 $ 39.8750 $ 26.8125 $20.8125 $ 39.8750
Low.................................. $36.2500 $ 24.7500 $ 16.4375 $16.8125 $ 16.4375
Close................................ $37.3750 $ 25.0000 $ 17.0625 $19.0625 $ 19.0625
</TABLE>
F-66
<PAGE> 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
AS RESTATED, NOTE 1B
(IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1998
Operating Revenues..................... $658,584 $ 367,740 $ 316,301 $537,569 $1,880,194
Operating Income (Loss):
Before unusual charges............... $107,893 $ 13,883 $ (6,883) $ 42,551 $ 157,444
Unusual charges...................... -- -- (175,341) -- (175,341)
-------- --------- --------- -------- ----------
$107,893 $ 13,883 $(182,224) $ 42,551 $ (17,897)
======== ========= ========= ======== ==========
Operating and Joint Venture Income
(Loss):
Before unusual charges............... $124,654 $ 25,720 $ 11,080 $ 58,215 $ 219,669
Unusual charges...................... -- -- (175,341) -- (175,341)
-------- --------- --------- -------- ----------
$124,654 $ 25,720 $(164,261) $ 58,215 $ 44,328
======== ========= ========= ======== ==========
Net Income (Loss)
Continuing operations, before unusual
charges........................... $ 76,940 $ 4,509 $ (5,508) $ 24,958 $ 100,899
Unusual charges...................... -- -- (114,576) -- (114,576)
Discontinued operations.............. 1,942 (217,132) (56,640) (961) (272,791)
-------- --------- --------- -------- ----------
$ 78,882 $(212,623) $(176,724) $ 23,997 $ (286,468)
======== ========= ========= ======== ==========
Basic Earnings (Loss) Per Share:
Continuing operations, before unusual
charges........................... $ .98 $ .06 $ (.07) $ .32 $ 1.28
Unusual charges...................... -- -- (1.45) -- (1.45)
Discontinued operations.............. .03 (2.76) (.72) (.01) (3.46)
-------- --------- --------- -------- ----------
$ 1.01 $ (2.70) $ (2.24) $ .31 $ (3.63)
======== ========= ========= ======== ==========
Diluted Earnings (Loss) Per Share:
Continuing operations, before unusual
charges........................... $ .93 $ .06 $ (.07) $ .31 $ 1.28
Unusual charges...................... -- -- (1.45) -- (1.45)
Discontinued operations.............. .02 (2.76) (.72) (.01) (3.46)
-------- --------- --------- -------- ----------
$ .95 $ (2.70) $ (2.24) $ .30 $ (3.63)
======== ========= ========= ======== ==========
Dividends Paid Per Share............... $ .2550 $ .2550 $ .2550 $ .2550 $ 1.0200
Average Daily Trading Volume........... 195,997 328,005 530,228 395,530 364,558
Price Per Share:
High................................. $39.8750 $ 39.8750 $ 26.8125 $20.8125 $ 39.8750
Low.................................. $36.2500 $ 24.7500 $ 16.4375 $16.8125 $ 16.4375
Close................................ $37.3750 $ 25.0000 $ 17.0625 $19.0625 $ 19.0625
</TABLE>
F-67
<PAGE> 68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
AS PREVIOUSLY REPORTED, NOTE 1B
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1998
Operating Revenues..................... $658,584 $ 367,740 $ 316,301 $537,569 $1,880,194
Operating Income (Loss):
Before unusual charges............... $110,397 $ 17,764 $ (7,540) $ 48,380 $ 169,001
Unusual charges...................... -- -- (175,341) -- (175,341)
-------- --------- --------- -------- ----------
$110,397 $ 17,764 $(182,881) $ 48,380 $ (6,340)
======== ========= ========= ======== ==========
Operating and Joint Venture Income
(Loss):
Before unusual charges............... $127,158 $ 29,601 $ 10,423 $ 64,044 $ 231,226
Unusual charges...................... -- -- (175,341) -- (175,341)
-------- --------- --------- -------- ----------
$127,158 $ 29,601 $(164,918) $ 64,044 $ 55,885
======== ========= ========= ======== ==========
Net Income (Loss)
Continuing operations, before unusual
charges........................... $ 78,568 $ 7,032 $ (5,935) $ 28,747 $ 108,412
Unusual charges...................... -- -- (114,576) -- (114,576)
Discontinued operations.............. 1,942 (217,132) (56,640) (961) (272,791)
-------- --------- --------- -------- ----------
$ 80,510 $(210,100) $(177,151) $ 27,786 $ (278,955)
======== ========= ========= ======== ==========
Basic Earnings (Loss) Per Share:
Continuing operations, before unusual
charges........................... $ 1.00 $ .09 $ (.07) $ .36 $ 1.38
Unusual charges...................... -- -- (1.45) -- (1.46)
Discontinued operations.............. .03 (2.76) (.72) (.01) (3.46)
-------- --------- --------- -------- ----------
$ 1.03 $ (2.67) $ (2.24) $ .35 $ (3.54)
======== ========= ========= ======== ==========
Diluted Earnings (Loss) Per Share:
Continuing operations, before unusual
charges........................... $ .95 $ .09 $ (.07) $ .36 $ 1.38
Unusual charges...................... -- -- (1.45) -- (1.46)
Discontinued operations.............. .02 (2.76) (.72) (.01) (3.46)
-------- --------- --------- -------- ----------
$ .97 $ (2.67) $ (2.24) $ .35 $ (3.54)
======== ========= ========= ======== ==========
Dividends Paid Per Share............... $ .2550 $ .2550 $ .2550 $ .2550 $ 1.0200
Average Daily Trading Volume........... 195,997 328,005 530,228 395,530 364,558
Price Per Share:
High................................. $39.8750 $ 39.8750 $ 26.8125 $20.8125 $ 39.8750
Low.................................. $36.2500 $ 24.7500 $ 16.4375 $16.8125 $ 16.4375
Close................................ $37.3750 $ 25.0000 $ 17.0625 $19.0625 $ 19.0625
</TABLE>
F-68
<PAGE> 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
AS RESTATED AND RECLASSIFIED, NOTES 1B AND 4A
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1997
Operating Revenues..................... $788,761 $ 387,925 $ 327,817 $703,364 $2,207,867
Operating Income....................... $123,020 $ 24,485 $ 889 $ 73,996 $ 222,390
Operating and Joint Venture Income..... $137,381 $ 34,955 $ 18,238 $ 87,475 $ 278,049
Income from Continuing Operations...... $ 79,919 $ 7,181 $ 1,242 $ 44,887 $ 133,229
Earnings Per Share from Continuing
Operations:
Basic................................ $ 1.18 $ .10 $ .02 $ .57 $ 1.82
Diluted.............................. $ 1.16 $ .10 $ .02 $ .55 $ 1.79
Dividends Paid Per Share............... $ .2425 $ .2425 $ .2425 $ .2550 $ .9825
Average Daily Trading Volume........... 102,659 153,859 159,057 149,650 141,765
Price Per Share:
High................................. $32.6250 $ 30.8125 $ 33.0000 $40.5000 $ 40.5000
Low.................................. $28.1250 $ 27.3750 $ 30.3750 $32.0000 $ 27.3750
Close................................ $28.1250 $ 30.6250 $ 32.0000 $40.3750 $ 40.3750
</TABLE>
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
AS RESTATED, NOTE 1B
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1997
Operating Revenues..................... $753,728 $ 350,807 $ 287,508 $671,791 $2,063,834
Operating Income (Loss)................ $109,639 $ 11,593 $ (13,449) $ 63,152 $ 170,935
Operating and Joint Venture Income..... $119,300 $ 22,063 $ 2,275 $ 76,356 $ 219,994
Net Income (Loss):
Continuing operations................ $ 69,885 $ 1,366 $ (7,895) $ 39,714 $ 103,070
Discontinued operations.............. 10,034 5,815 9,137 5,173 30,159
-------- --------- --------- -------- ----------
$ 79,919 $ 7,181 $ 1,242 $ 44,887 $ 133,229
======== ========= ========= ======== ==========
Basic Earnings (Loss) Per Share:
Continuing operations................ $ 1.03 $ .02 $ (.10) $ .51 $ 1.41
Discontinued operations.............. .15 .08 .12 .06 .41
-------- --------- --------- -------- ----------
$ 1.18 $ .10 $ .02 $ .57 $ 1.82
======== ========= ========= ======== ==========
Diluted Earnings (Loss) Per Share:
Continuing operations................ $ 1.01 $ .02 $ (.10) $ .49 $ 1.39
Discontinued operations.............. .15 .08 .12 .06 .40
-------- --------- --------- -------- ----------
$ 1.16 $ .10 $ .02 $ .55 $ 1.79
======== ========= ========= ======== ==========
Dividends Paid Per Share............... $ .2425 $ .2425 $ .2425 $ .2550 $ .9825
Average Daily Trading Volume........... 102,659 153,859 159,057 149,650 141,765
Price Per Share:
High................................. $32.6250 $ 30.8125 $ 33.0000 $40.5000 $ 40.5000
Low.................................. $28.1250 $ 27.3750 $ 30.3750 $32.0000 $ 27.3750
Close................................ $28.1250 $ 30.6250 $ 32.0000 $40.3750 $ 40.3750
</TABLE>
F-69
<PAGE> 70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
AS PREVIOUSLY REPORTED, NOTE 1B
<S> <C> <C> <C> <C> <C>
1997
Operating Revenues..................... $753,728 $ 350,807 $ 287,508 $671,791 $2,063,834
Operating Income (Loss)................ $112,485 $ 14,508 $ (13,485) $ 71,390 $ 184,898
Operating and Joint Venture Income..... $122,146 $ 24,978 $ 2,239 $ 84,594 $ 233,957
Net Income (Loss):
Continuing operations................ $ 71,735 $ 3,261 $ (7,918) $ 45,069 $ 112,147
Discontinued operations.............. 10,034 5,815 9,137 5,173 30,159
-------- --------- --------- -------- ----------
$ 81,769 $ 9,076 $ 1,219 $ 50,242 $ 142,306
======== ========= ========= ======== ==========
Basic Earnings (Loss) Per Share:
Continuing operations................ $ 1.06 $ .05 $ (.10) $ .58 $ 1.54
Discontinued operations.............. .15 .08 .12 .06 .41
-------- --------- --------- -------- ----------
$ 1.21 $ .13 $ .02 $ .64 $ 1.95
======== ========= ========= ======== ==========
Diluted Earnings (Loss) Per Share:
Continued operations................. $ 1.04 $ .05 $ (.10) $ .56 $ 1.51
Discontinued operations.............. $ .15 .08 $ .12 .06 .40
-------- --------- --------- -------- ----------
$ 1.19 $ .13 $ .02 $ .62 $ 1.91
======== ========= ========= ======== ==========
Dividends Paid Per Share............... $ .2425 $ .2425 .2425 .2550 .9825
Average Daily Trading Volume........... 102,659 153,859 159,057 149,650 141,765
Price Per Share:
High................................. $32.6250 $ 30.8125 $ 33.0000 $40.5000 $ 40.5000
Low.................................. $28.1250 $ 27.3750 $ 30.3750 $32.0000 $ 27.3750
Close................................ $28.1250 $ 30.6250 $ 32.0000 $40.3750 $ 40.3750
</TABLE>
20. SUPPLEMENTARY INFORMATION FOR GAS AND OIL PRODUCING ACTIVITIES (UNAUDITED)
The following information was prepared in accordance with SFAS No. 69,
"Disclosures About Oil and Gas Producing Activities" and related SEC accounting
rules.
CAPITALIZED COSTS
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Proved Properties........................................... $1,357,413 $1,033,492
Unproved Properties......................................... 99,611 265,809
---------- ----------
1,457,024 1,299,301
SEC Ceiling Test Write-downs (Note 2b)...................... 416,977 --
Accumulated Depreciation, Depletion and Amortization........ 224,795 150,015
---------- ----------
Net Capitalized Costs....................................... $ 815,252 $1,149,286
========== ==========
</TABLE>
F-70
<PAGE> 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CAPITALIZED COSTS EXCLUDED FROM AMORTIZATION
Unproved properties held by MCN are excluded from amortization until they
have been evaluated. A summary of costs excluded from amortization at December
31, 1998, and the year in which they were incurred, follows:
<TABLE>
<CAPTION>
YEAR COSTS INCURRED
---------------------------------------
1995 &
TOTAL 1998 1997 1996 PRIOR
----- ---- ---- ---- ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Acquisition..................................... $43,131 $14,254 $17,119 $ 9,321 $2,437
Exploration..................................... 56,480 13,757 32,655 9,935 133
======= ======= ======= ======= ======
$99,611 $28,011 $49,774 $19,256 $2,570
======= ======= ======= ======= ======
</TABLE>
The acquisition amount includes all costs incurred to purchase or lease
property with unproved reserves.
COST INCURRED
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Acquisition:
Proved properties......................................... $ 53,377 $ 35,695 $ 60,340
Unproved properties....................................... 7,498 66,721 136,142
-------- -------- --------
60,875 102,416 196,482
Exploration................................................. 52,948 143,580 65,160
Development................................................. 86,607 129,001 120,569
======== ======== ========
$200,430 $374,997 $382,211
======== ======== ========
</TABLE>
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Operating Revenues:
Unaffiliated customers.................................... $ 150,504 $144,041 $ 94,615
Affiliated customers...................................... 56,598 71,787 43,326
--------- -------- --------
207,102 215,828 137,941
--------- -------- --------
Production Costs............................................ 79,245 68,364 48,255
SEC Ceiling Test Write-downs................................ 416,977 -- --
Depreciation, Depletion and Amortization.................... 80,576 73,910 44,469
--------- -------- --------
576,798 142,274 92,724
--------- -------- --------
Income (Loss) Before Income Taxes........................... (369,696) 73,554 45,217
--------- -------- --------
Income Taxes:
Income tax provision (benefit)............................ (129,698) 26,997 16,438
Gas production tax credits................................ (10,485) (17,797) (15,878)
--------- -------- --------
(140,183) 9,200 560
--------- -------- --------
Results of Operations, Excluding Corporate and Interest
Costs..................................................... $(229,513) $ 64,354 $ 44,657
========= ======== ========
</TABLE>
F-71
<PAGE> 72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
RESERVE QUANTITY INFORMATION
MCN's proved reserves are located in the United States. The estimated
quantities of proved reserves disclosed below are based upon estimates by MCN's
independent petroleum engineers.
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
GAS OIL GAS OIL
(MMCF) (MBBL) (MMCF) (MBBL)
------ ------ ------ ------
<S> <C> <C> <C> <C>
Proved Developed and Undeveloped Reserves:
Beginning of year.................................... 1,166,174 25,843 1,137,729 17,214
Revisions of previous estimates................... (66,188) (2,865) (30,260) (430)
Extensions and discoveries........................ 59,729 534 165,283 4,435
Production........................................ (82,040) (2,635) (78,218) (3,346)
Sales of minerals in place........................ (37,661) (8,389) (51,465) (1,019)
Purchases of minerals in place.................... 52,959 499 23,105 8,989
--------- ------ --------- ------
End of year.......................................... 1,092,973 12,987 1,166,174 25,843
========= ====== ========= ======
Proved Developed Reserves:
Beginning of year.................................... 590,299 12,601 688,995 9,554
End of year.......................................... 630,130 6,367 590,299 12,601
</TABLE>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
The following presentation of the standardized measure of discounted future
net cash flows is intended to be neither a measure of the fair market value of
MCN's gas and oil properties, nor an estimate of the present value of actual
future cash flows to be obtained as a result of their development and
production. It is based upon subjective estimates of proved reserves only and
attributes no value to categories of reserves other than proved reserves, such
as probable or possible reserves, or to unproved acreage. Furthermore, as it is
based on year-end prices and costs adjusted only for existing contractual
arrangements and assumes an arbitrary annual discount rate of 10%, it does not
reflect the impact of future price and cost changes. Future income tax expenses
were computed by applying statutory tax rates, adjusted for permanent
differences and tax credits, to estimated future pre-tax net cash flows.
The standardized measure is intended to provide a better means for
comparing the value of MCN's proved reserves at a given time with those of other
gas and oil producing companies than is provided by a simple comparison of raw
proved reserve quantities.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Future Revenues.......................................... $2,795,786 $3,121,124 $3,867,785
Future Production Costs.................................. 984,042 1,155,734 1,322,108
Future Development Costs................................. 264,631 328,739 340,190
---------- ---------- ----------
Future Net Cash Flows Before Income Taxes................ 1,547,113 1,636,651 2,205,487
Discount to Present Value at 10%......................... 806,746 812,605 1,139,507
---------- ---------- ----------
Present Value of Future Net Cash Flows Before Income
Taxes.................................................. 740,367 824,046 1,065,980
Future Income Taxes Discounted at 10%.................... -- 105,371 226,913
Future Tax Credits Discounted at 10%..................... -- (50,889) (62,207)
---------- ---------- ----------
Standardized Measure of Discounted Future Net Cash
Flows.................................................. $ 740,367 $ 769,564 $ 901,274
========== ========== ==========
</TABLE>
Future income taxes and tax credits have been excluded from the 1998
calculation since MOG is in a net operating loss position, and it is more likely
than not that these tax benefits would not be realized by MOG on a stand-alone
basis. However, MCN files a consolidated federal income tax return, which
includes the taxable
F-72
<PAGE> 73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
income or loss of MOG as well as MOG's tax credits. Accordingly, it is
management's opinion that any tax benefits earned by MOG will be utilized by MCN
in its consolidated tax returns.
The principal sources of change in the standardized measure of discounted
future net cash flows were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Beginning of Year........................................... $ 769,564 $ 901,274 $521,907
Net changes in sales prices and production costs.......... (67,085) (261,154) 126,526
Net change due to revisions in quantity estimates......... (59,106) (26,015) 5,061
Extensions, discoveries, additions and improved recovery,
net of related costs................................... 46,739 153,291 200,026
Development costs incurred, previously estimated.......... 86,607 103,201 86,810
Changes in estimated future development costs............. (26,573) (120,219) (81,069)
Sales, net of production costs............................ (127,857) (147,464) (89,686)
Net change in future income taxes......................... 105,371 116,366 (85,616)
Net change in federal tax credits......................... (41,997) (17,797) (15,878)
Sales of reserves in place................................ (56,924) (83,985) --
Purchases of reserves in place............................ 41,525 48,685 193,550
Accretion of discount and other........................... 70,103 103,381 39,643
--------- --------- --------
End of Year................................................. $ 740,367 $ 769,564 $901,274
========= ========= ========
</TABLE>
21. CONSOLIDATING FINANCIAL STATEMENTS
Debt securities issued by MCNIC are subject to a support agreement between
MCN and MCNIC, under which MCN has committed to make payments of interest and
principal on MCNIC's securities in the event of failure to pay by MCNIC.
Restrictions in the support agreement prohibit recourse on the part of MCNIC's
investors against the stock and assets of MichCon. Under the terms of the
support agreement, the assets of MCN, other than MichCon, and the cash dividends
paid to MCN by any of its subsidiaries are available as recourse to holders of
MCNIC's securities. The carrying value of MCN's assets on an unconsolidated
basis, primarily investments in its subsidiaries other than MichCon, is
$970,072,000 at December 31, 1998.
The following MCN consolidating financial statements are presented and
include separately MCNIC, MichCon and MCN and other subsidiaries. MCN has
determined that separate financial statements and other disclosures concerning
MCNIC are not material to investors. The other MCN subsidiaries represent
Citizens Gas Fuel Company, MCN Michigan Limited Partnership, MCN Financing I,
MCN Financing III, MCN Financing V, MCN Financing VI, MichCon Enterprises, Inc.
and Blue Lake Holdings, Inc. until its sale on December 31, 1997.
F-73
<PAGE> 74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CONSOLIDATING STATEMENT OF FINANCIAL POSITION
<TABLE>
<CAPTION>
MCN ELIMINATIONS
AND OTHER AND CONSOLIDATED
SUBSIDIARIES MCNIC MICHCON RECLASSES TOTAL
------------ ----- ------- ------------ ------------
DECEMBER 31, 1998
------------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents, at cost............. $ 1,400 $ 9,036 $ 6,603 $ -- $ 17,039
Accounts receivable............................ 10,039 265,312 151,746 (17,312) 409,785
Less -- Allowance for doubtful accounts...... 84 653 8,928 -- 9,665
---------- ---------- ---------- ----------- ----------
Accounts receivable, net..................... 9,955 264,659 142,818 (17,312) 400,120
Accrued unbilled revenues...................... 1,121 -- 86,767 -- 87,888
Gas in inventory............................... -- 90,418 56,969 -- 147,387
Property taxes assessed applicable to future
periods...................................... 214 1,172 71,165 -- 72,551
Other.......................................... 5,143 11,872 30,169 (4,712) 42,472
---------- ---------- ---------- ----------- ----------
17,833 377,157 394,491 (22,024) 767,457
---------- ---------- ---------- ----------- ----------
DEFERRED CHARGES AND OTHER ASSETS
Deferred income taxes.......................... 3,305 128,807 -- (81,565) 50,547
Investments in debt and equity securities...... -- 3,548 65,556 601 69,705
Deferred swap losses and receivables........... -- 63,147 -- -- 63,147
Deferred environmental costs................... 2,604 -- 28,169 -- 30,773
Prepaid benefit costs.......................... -- -- 113,879 (2,104) 111,775
Other.......................................... 9,401 26,870 59,007 3,662 98,940
---------- ---------- ---------- ----------- ----------
15,310 222,372 266,611 (79,406) 424,887
---------- ---------- ---------- ----------- ----------
INVESTMENTS IN AND ADVANCES TO JOINT VENTURES AND
SUBSIDIARIES................................... 1,550,770 782,471 19,343 (1,549,353) 803,231
---------- ---------- ---------- ----------- ----------
PROPERTY, PLANT AND EQUIPMENT, AT COST........... 48,681 1,103,716 2,889,020 -- 4,041,417
Less -- Accumulated depreciation and
depletion.................................... 17,210 229,944 1,396,940 -- 1,644,094
---------- ---------- ---------- ----------- ----------
31,471 873,772 1,492,080 -- 2,397,323
---------- ---------- ---------- ----------- ----------
$1,615,384 $2,255,772 $2,172,525 $(1,650,783) $4,392,898
========== ========== ========== =========== ==========
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable............................... $ 4,123 $ 218,851 98,891 $ (17,516) $ 304,349
Notes payable.................................. 260,771 137,762 221,169 (851) 618,851
Current portion of long-term debt and capital
lease obligations............................ -- 211,433 58,288 -- 269,721
Federal income, property and other taxes
payable...................................... 1,441 6,965 61,059 -- 69,465
Deferred gas cost recovery revenues............ -- -- 14,980 -- 14,980
Gas payable.................................... -- 17,332 25,337 -- 42,669
Customer deposits.............................. 22 -- 18,769 -- 18,791
Other.......................................... 18,337 25,276 67,222 (2,525) 108,310
---------- ---------- ---------- ----------- ----------
284,694 617,619 565,715 (20,892) 1,447,136
---------- ---------- ---------- ----------- ----------
DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes.......................... (10,308) -- 88,567 (78,259) --
Unamortized investment tax credit.............. 272 -- 29,784 -- 30,056
Tax benefits amortizable to customers.......... -- -- 130,120 -- 130,120
Deferred swap gains and payables............... -- 62,956 -- -- 62,956
Accrued environmental costs.................... 3,000 -- 32,000 -- 35,000
Minority interest.............................. -- 2,697 8,201 -- 10,898
Other.......................................... 10,435 15,741 51,460 (2,197) 75,439
---------- ---------- ---------- ----------- ----------
3,399 81,394 340,132 (80,456) 344,469
---------- ---------- ---------- ----------- ----------
CAPITALIZATION
Long-term debt, including capital lease
obligations.................................. -- 687,333 619,835 -- 1,307,168
Redeemable preferred securities of
subsidiaries................................. 502,203 -- -- -- 502,203
Common shareholders' equity.................... 825,088 869,426 646,843 (1,549,435) 791,922
---------- ---------- ---------- ----------- ----------
1,327,291 1,556,759 1,266,678 (1,549,435) 2,601,293
---------- ---------- ---------- ----------- ----------
$1,615,384 $2,255,772 $2,172,525 $(1,650,783) $4,392,898
========== ========== ========== =========== ==========
</TABLE>
F-74
<PAGE> 75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CONSOLIDATING STATEMENT OF FINANCIAL POSITION
<TABLE>
<CAPTION>
MCN ELIMINATIONS
AND OTHER AND CONSOLIDATED
SUBSIDIARIES MCNIC MICHCON RECLASSES TOTAL
------------ ----- ------- ------------ ------------
DECEMBER 31, 1997
------------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents, at cost............. $ 23 $ 25,119 $ 14,353 $ -- $ 39,495
Accounts receivable............................ 15,525 242,343 210,677 (46,910) 421,635
Less -- Allowance for doubtful accounts...... 75 621 15,015 -- 15,711
---------- ---------- ---------- ----------- ----------
Accounts receivable, net....................... 15,450 241,722 195,662 (46,910) 405,924
Accrued unbilled revenue....................... 1,114 -- 91,896 -- 93,010
Gas in inventory............................... -- 16,576 40,201 -- 56,777
Property taxes assessed applicable to future
periods...................................... 217 2,835 64,827 -- 67,879
Accrued gas cost recovery revenues............. -- -- 12,862 -- 12,862
Other.......................................... 3,745 17,612 33,361 (629) 54,089
---------- ---------- ---------- ----------- ----------
20,549 303,864 453,162 (47,539) 730,036
---------- ---------- ---------- ----------- ----------
DEFERRED CHARGES AND OTHER ASSETS
Investments in debt and equity securities...... -- 62,060 35,110 351 97,521
Deferred swap losses and receivables........... -- 51,023 -- -- 51,023
Deferred environmental costs................... 2,535 -- 27,699 -- 30,234
Prepaid benefit costs.......................... (3,418) -- 85,790 (2,130) 80,242
Other.......................................... 8,261 34,287 46,972 (3,339) 86,181
---------- ---------- ---------- ----------- ----------
7,378 147,370 195,571 (5,118) 345,201
---------- ---------- ---------- ----------- ----------
INVESTMENTS IN AND ADVANCES TO JOINT VENTURES AND
SUBSIDIARIES................................... 1,641,421 528,492 19,643 (1,632,580) 556,976
---------- ---------- ---------- ----------- ----------
PROPERTY, PLANT AND EQUIPMENT, AT COST........... 37,918 1,358,504 2,790,352 -- 4,186,774
Less -- Accumulated depreciation and
depletion.................................... 12,951 152,707 1,322,392 -- 1,488,050
---------- ---------- ---------- ----------- ----------
24,967 1,205,797 1,467,960 -- 2,698,724
---------- ---------- ---------- ----------- ----------
$1,694,315 $2,185,523 $2,136,336 $(1,685,237) $4,330,937
========== ========== ========== =========== ==========
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable............................... $ 4,385 $ 254,391 $ 130,267 $ (46,848) $ 342,195
Notes payable.................................. -- 163,113 241,691 (3,078) 401,726
Current portion of long-term debt and capital
lease obligations............................ 365 1,557 34,956 -- 36,878
Federal income, property and other taxes
payable...................................... 401 7,795 78,630 -- 86,826
Gas payable.................................... -- 6,254 2,063 -- 8,317
Customer deposits.............................. 19 -- 16,363 -- 16,382
Other.......................................... 13,599 22,944 65,717 (630) 101,630
---------- ---------- ---------- ----------- ----------
18,769 456,054 569,687 (50,556) 993,954
---------- ---------- ---------- ----------- ----------
DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes.......................... (4,642) 73,874 83,905 22 153,159
Unamortized investment tax credit.............. 301 -- 32,745 -- 33,046
Tax benefits amortizable to customers.......... 443 -- 122,922 -- 123,365
Deferred swap gains and payables............... -- 41,717 -- -- 41,717
Accrued environmental costs.................... 3,000 -- 32,000 -- 35,000
Minority interest.............................. -- 1,905 17,283 -- 19,188
Other.......................................... 10,792 16,586 44,663 (2,152) 69,889
---------- ---------- ---------- ----------- ----------
9,894 134,082 333,518 (2,130) 475,364
---------- ---------- ---------- ----------- ----------
CAPITALIZATION
Long-term debt, including capital lease
obligations.................................. -- 595,457 617,107 -- 1,212,564
Redeemable preferred securities of
subsidiaries................................. 505,104 -- -- -- 505,104
Common shareholders' equity.................... 1,160,548 999,930 616,024 (1,632,551) 1,143,951
---------- ---------- ---------- ----------- ----------
1,665,652 1,595,387 1,233,131 (1,632,551) 2,861,619
---------- ---------- ---------- ----------- ----------
$1,694,315 $2,185,523 $2,136,336 $(1,685,237) $4,330,937
========== ========== ========== =========== ==========
</TABLE>
F-75
<PAGE> 76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
MCN ELIMINATIONS
AND OTHER AND CONSOLIDATED
SUBSIDIARIES MCNIC MICHCON RECLASSES TOTAL
------------ ---------- ---------- ------------ ------------
TWELVE MONTHS ENDED DECEMBER 31, 1998
--------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES............................... $ 18,262 $ 992,828 $1,033,658 $ (14,050) $2,030,698
--------- ---------- ---------- --------- ----------
OPERATING EXPENSES
Cost of gas.................................... 10,706 752,207 451,529 (8,668) 1,205,774
Operation and maintenance...................... (10,207) 152,607 252,397 (5,382) 389,415
Depreciation, depletion and amortization....... 3,206 83,401 92,883 -- 179,490
Property and other taxes....................... 1,719 12,396 55,438 -- 69,553
Property write-downs and restructuring
charges...................................... 8,669 558,849 24,800 -- 592,318
--------- ---------- ---------- --------- ----------
14,093 1,559,460 877,047 (14,050) 2,436,550
--------- ---------- ---------- --------- ----------
OPERATING INCOME (LOSS).......................... 4,169 (566,632) 156,611 -- (405,852)
--------- ---------- ---------- --------- ----------
EQUITY IN EARNINGS (LOSSES) OF JOINT VENTURES AND
SUBSIDIARIES................................... (282,284) 61,242 1,946 281,321 62,225
--------- ---------- ---------- --------- ----------
OTHER INCOME AND (DEDUCTIONS)
Interest income................................ 37,408 6,609 5,688 (38,812) 10,893
Interest on long-term debt..................... (641) (41,821) (44,884) -- (87,346)
Other interest expense......................... (2,474) (48,630) (12,113) 38,813 (24,404)
Dividends on preferred securities of
subsidiaries................................. -- -- -- (36,370) (36,370)
Investment losses.............................. (8,500) (6,135) -- -- (14,635)
Minority interest.............................. -- 265 5,727 -- 5,992
Other.......................................... (605) 20,348 (182) -- 19,561
--------- ---------- ---------- --------- ----------
25,188 (69,364) (45,764) (36,369) (126,309)
--------- ---------- ---------- --------- ----------
INCOME (LOSS) BEFORE INCOME TAXES................ (252,927) (574,754) 112,793 244,952 (469,936)
INCOME TAX PROVISION (BENEFIT)................... (2,829) (216,456) 35,817 -- (183,468)
--------- ---------- ---------- --------- ----------
NET INCOME (LOSS)................................ (250,098) (358,298) 76,976 244,952 (286,468)
DIVIDENDS ON PREFERRED SECURITIES................ 36,370 -- -- (36,370) --
--------- ---------- ---------- --------- ----------
NET INCOME (LOSS) AVAILABLE FOR COMMON STOCK..... $(286,468) $ (358,298) $ 76,976 $ 281,322 $ (286,468)
========= ========== ========== ========= ==========
<CAPTION>
TWELVE MONTHS ENDED DECEMBER 31, 1997
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES............................... $ 17,607 $ 951,269 $1,253,679 (14,688) $2,207,867
--------- ---------- ---------- --------- ----------
OPERATING EXPENSES
Cost of gas.................................... 9,749 703,145 632,229 (10,090) 1,335,033
Operation and maintenance...................... 2,281 113,018 282,640 (4,598) 393,341
Depreciation, depletion and amortization....... 2,279 75,630 103,703 -- 181,612
Property and other taxes....................... 1,679 13,068 60,744 -- 75,491
--------- ---------- ---------- --------- ----------
15,988 904,861 1,079,316 (14,688) 1,985,477
--------- ---------- ---------- --------- ----------
OPERATING INCOME................................. 1,619 46,408 174,363 -- 222,390
--------- ---------- ---------- --------- ----------
EQUITY IN EARNINGS OF JOINT VENTURES AND
SUBSIDIARIES................................... 135,757 52,356 1,199 (133,653) 55,659
--------- ---------- ---------- --------- ----------
OTHER INCOME AND (DEDUCTIONS)
Interest income................................ 32,857 6,378 4,659 (32,728) 11,166
Interest on long-term debt..................... 408 (30,052) (45,526) -- (75,170)
Other interest expense......................... (1,253) (34,382) (8,664) 33,016 (11,283)
Dividends on preferred securities of
subsidiaries................................. -- -- -- (31,090) (31,090)
Minority interest.............................. -- (82) (1,882) -- (1,964)
Other.......................................... 74 10,149 536 -- 10,759
--------- ---------- ---------- --------- ----------
32,086 (47,989) (50,877) (30,802) (97,582)
--------- ---------- ---------- --------- ----------
INCOME BEFORE INCOME TAXES....................... 169,462 50,775 124,685 (164,455) 180,467
INCOME TAX PROVISION............................. 2,573 (1,000) 45,665 -- 47,238
--------- ---------- ---------- --------- ----------
NET INCOME....................................... 166,889 51,775 79,020 (164,455) 133,229
DIVIDENDS ON PREFERRED SECURITIES................ 31,090 -- -- (31,090) --
--------- ---------- ---------- --------- ----------
NET INCOME AVAILABLE FOR COMMON STOCK............ $ 135,799 $ 51,775 $ 79,020 $(133,365) $ 133,229
========= ========== ========== ========= ==========
</TABLE>
F-76
<PAGE> 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
MCN ELIMINATIONS
AND OTHER AND CONSOLIDATED
SUBSIDIARIES MCNIC MICHCON RECLASSES TOTAL
------------ ----- ------- ------------ ------------
TWELVE MONTHS ENDED DECEMBER 31, 1996
--------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES.................................... $ 17,469 $ 734,441 $1,258,785 $ (13,427) $1,997,268
--------- ---------- ---------- --------- ----------
OPERATING EXPENSES
Cost of gas......................................... 9,655 557,340 636,594 (10,011) 1,193,578
Operation and maintenance........................... 785 80,330 294,281 (3,416) 371,980
Depreciation, depletion and amortization............ 1,940 45,903 98,147 -- 145,990
Property and other taxes............................ 2,134 10,531 61,762 -- 74,427
--------- ---------- ---------- --------- ----------
14,514 694,104 1,090,784 (13,427) 1,785,975
--------- ---------- ---------- --------- ----------
OPERATING INCOME...................................... 2,955 40,337 168,001 -- 211,293
--------- ---------- ---------- --------- ----------
EQUITY IN EARNINGS OF JOINT VENTURES AND
SUBSIDIARIES........................................ 152,368 15,915 886 (151,302) 17,867
--------- ---------- ---------- --------- ----------
OTHER INCOME AND (DEDUCTIONS)
Interest income..................................... 12,675 3,220 3,900 (12,561) 7,234
Interest on long-term debt.......................... 114 (25,928) (40,703) -- (66,517)
Other interest expense.............................. (1,218) (14,595) (8,012) 12,561 (11,264)
Dividends on preferred securities of subsidiaries... -- -- -- (12,374) (12,374)
Minority interest................................... -- (71) (988) -- (1,059)
Other............................................... 190 5,330 (1,756) -- 3,764
--------- ---------- ---------- --------- ----------
11,761 (32,044) (47,559) (12,374) (80,216)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES............................................... 167,084 24,208 121,328 (163,676) 148,944
INCOME TAX PROVISION.................................. 1,814 (6,925) 41,486 -- 36,375
--------- ---------- ---------- --------- ----------
INCOME FROM CONTINUING OPERATIONS..................... 165,270 31,133 79,842 (163,676) 112,569
DISCONTINUED OPERATIONS, NET OF TAXES................. -- 37,771 -- -- 37,771
--------- ---------- ---------- --------- ----------
NET INCOME............................................ 165,270 68,904 79,842 (163,676) 150,340
DIVIDENDS ON PREFERRED SECURITIES..................... 12,356 -- 18 (12,374) --
--------- ---------- ---------- --------- ----------
NET INCOME AVAILABLE FOR COMMON STOCK................. $ 152,914 $ 68,904 $ 79,824 $(151,302) $ 150,340
========= ========== ========== ========= ==========
</TABLE>
F-77
<PAGE> 78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
MCN ELIMINATIONS
AND OTHER AND CONSOLIDATED
SUBSIDIARIES MCNIC MICHCON RECLASSES TOTAL
------------ ----- ------- ------------ ------------
TWELVE MONTHS ENDED DECEMBER 31, 1998
----------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NET CASH FLOW FROM OPERATING ACTIVITIES............... $ 72,476 $ (68,749) $ 217,918 $ (68,923) $ 152,722
--------- --------- --------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net.................................. 260,771 65,006 (20,522) 2,227 307,482
Capital contributions received from affiliates,
net............................................... -- 236,851 -- (236,851) --
Dividends paid...................................... (82,239) -- (46,084) 46,084 (82,239)
Preferred securities dividends paid................. (17,613) -- -- 17,613 --
Issuance of common stock............................ 20,192 -- -- -- 20,192
Issuance of preferred securities.................... 96,850 -- -- -- 96,850
Issuance of long-term debt.......................... -- 305,709 153,052 -- 458,761
Long-term commercial paper and bank borrowings,
net............................................... -- 17,299 -- -- 17,299
Retirement of long-term debt and preferred
securities........................................ (100,365) (102,153) (126,292) -- (328,810)
Other............................................... -- 8,243 -- -- 8,243
--------- --------- --------- --------- ---------
Net cash provided from (used for) financing
activities...................................... 177,596 530,955 (39,846) (170,927) 497,778
--------- --------- --------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures................................ (11,024) (318,276) (153,475) -- (482,775)
Acquisitions........................................ -- (42,429) -- -- (42,429)
Investment in debt and equity securities, net....... -- 48,527 (30,446) (250) 17,831
Investment in joint ventures and subsidiaries....... (238,951) (187,423) 214 236,851 (189,309)
Sale of property and joint venture interests........ 1,143 49,463 -- (3,421) 47,185
Other............................................... 137 (28,151) (2,115) 6,670 (23,459)
--------- --------- --------- --------- ---------
Net cash used for investing activities............ (248,695) (478,289) (185,822) 239,850 (672,956)
--------- --------- --------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS......................................... 1,377 (16,083) (7,750) -- (22,456)
CASH AND CASH EQUIVALENTS, JANUARY 1.................. 23 25,119 14,353 -- 39,495
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31................ $ 1,400 $ 9,036 $ 6,603 $ -- $ 17,039
========= ========= ========= ========= =========
TWELVE MONTHS ENDED DECEMBER 31, 1997
----------------------------------------------------------------------
NET CASH FLOW FROM OPERATING ACTIVITIES............... $ 97,490 $ 148,242 $ 187,263 $ (89,611) $ 343,384
--------- --------- --------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net.................................. -- 94,513 (23,435) (3,078) 68,000
Capital contributions received from (distributions
paid to) affiliates, net.......................... (3,985) 603,150 -- (599,165) --
Dividends paid...................................... (72,851) -- (40,000) 40,000 (72,851)
Preferred securities dividends paid................. (31,090) -- -- 31,090 --
Issuance of common stock............................ 294,402 -- -- -- 294,402
Issuance of preferred securities.................... 326,521 -- -- -- 326,521
Issuance of long-term debt.......................... -- 149,190 124,051 -- 273,241
Long-term commercial paper and bank borrowings,
net............................................... -- (261,822) -- -- (261,822)
Retirement of long-term debt and preferred
securities........................................ (55) (32,315) (76,854) -- (109,224)
Other............................................... -- 4,612 -- -- 4,612
--------- --------- --------- --------- ---------
Net cash provided from (used for) financing
activities...................................... 512,942 557,328 (16,238) (531,153) 522,879
--------- --------- --------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures................................ (6,559) (399,586) (155,208) (1) (561,354)
Acquisitions........................................ -- (166,553) -- -- (166,553)
Investment in debt and equity securities............ -- (48,441) (31,375) 16,693 (63,123)
Investment in joint ventures and subsidiaries....... (604,750) (151,360) (304) 603,772 (152,642)
Sale of property and joint venture interests........ -- 67,365 -- -- 67,365
Other............................................... 56 (1,484) 20,205 300 19,077
--------- --------- --------- --------- ---------
Net cash used for investing activities............ (611,253) (700,059) (166,682) 620,764 (857,230)
--------- --------- --------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS......................................... (821) 5,511 4,343 -- 9,033
CASH AND CASH EQUIVALENTS, JANUARY 1.................. 844 19,608 10,010 -- 30,462
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31................ $ 23 $ 25,119 $ 14,353 $ -- $ 39,495
========= ========= ========= ========= =========
</TABLE>
F-78
<PAGE> 79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
MCN ELIMINATIONS
AND OTHER AND CONSOLIDATED
SUBSIDIARIES MCNIC MICHCON RECLASSES TOTAL
------------ ----- ------- ------------ ------------
TWELVE MONTHS ENDED DECEMBER 31, 1996
-----------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NET CASH FLOW FROM OPERATING ACTIVITIES............... $ 38,535 $ 84,678 $ 101,694 $ (26,575) $ 198,332
--------- --------- ---------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net.................................. -- 19,000 68,491 -- 87,491
Capital contributions received from (distributions
paid to) affiliates, net.......................... (3,069) 41,195 1,614 (39,740) --
Dividends paid...................................... (62,875) -- (11,263) 11,263 (62,875)
Preferred securities dividends paid................. (12,356) -- (54) 12,410 --
Issuance of common stock............................ 17,264 -- -- -- 17,264
Issuance of preferred securities.................... 77,218 -- -- -- 77,218
Issuance of long-term debt.......................... -- 328,895 69,645 -- 398,540
Long-term commercial paper and bank borrowings,
net............................................... -- (62,835) -- -- (62,835)
Retirement of long-term debt and preferred
securities........................................ (55) (1,701) (6,384) 1 (8,139)
Other............................................... (6,249) -- -- -- (6,249)
--------- --------- ---------- --------- ---------
Net cash provided from financing activities....... 9,878 324,554 122,049 (16,066) 440,415
--------- --------- ---------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures................................ (5,474) (392,181) (212,668) -- (610,323)
Acquisitions........................................ -- (133,201) -- -- (133,201)
Investment in debt and equity securities............ -- (11,313) (15,590) -- (26,903)
Investment in joint ventures and subsidiaries....... (42,809) (35,793) (278) 42,663 (36,217)
Sale of property and joint venture interest......... -- 36,621 -- -- 36,621
Sale of Genix....................................... -- 132,889 -- -- 132,889
Other............................................... 546 2,732 6,334 (22) 9,590
--------- --------- ---------- --------- ---------
Net cash used for investing activities............ (47,737) (400,246) (222,202) 42,641 (627,544)
--------- --------- ---------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS............. 676 8,986 1,541 -- 11,203
CASH AND CASH EQUIVALENTS, JANUARY 1.................. 168 10,622 8,469 -- 19,259
--------- --------- ---------- --------- ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31................ $ 844 $ 19,608 $ 10,010 $ -- $ 30,462
========= ========= ========== ========= =========
</TABLE>
F-79
<PAGE> 80
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of MCN Energy Group Inc.:
We have audited the accompanying consolidated statements of financial
position of MCN Energy Group Inc. and subsidiaries (the "Company"), as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, cash flows, and shareholders' equity for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
As discussed in Note 1b, the accompanying 1998 and 1997 financial
statements have been restated.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
February 25, 1999
(June 7, 1999 as to the effects of the matters described in Note 1b.)
(October 15, 1999 as to effects of the matters described in Note 4a.)
F-80
<PAGE> 81
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of MCN Energy Group Inc.:
We have audited the consolidated financial statements of MCN Energy Group Inc.
and subsidiaries (the "Company"), as of December 31, 1998 and 1997, and for each
of the three years in the period ended December 31, 1998, and have issued our
report thereon dated February 25, 1999, June 7, 1999 as to the effects of the
matters described in Note 1b, and October 15, 1999 as to the effects of the
matters described in Note 4a (which expresses an unqualified opinion and
includes an explanatory paragraph relating to the restatement described in Note
1b); such consolidated financial statements and report are included in the
Company's Current Report on Form 8-K. Our audits also included the consolidated
financial statement schedule, Schedule II Valuation and Qualifying Accounts of
the Company. This consolidated financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, such consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
February 25, 1999
(June 7, 1999 as to the effects of the matters described in Note 1b)
(October 15, 1999 as to the effects of the matters described in Note 4a)
<PAGE> 82
SCHEDULE II
MCN ENERGY GROUP INC. AND SUBSIDIARIES
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
ADDITIONS
----------------------
PROVISIONS DEDUCTIONS
CHARGED TO FOR PURPOSES
BALANCE AT ---------------------- FOR WHICH THE BALANCE
BEGINNING REGULATORY RESERVES WERE AT END
DESCRIPTION OF PERIOD INCOME ASSET PROVIDED OF PERIOD
- -------------------------------------------------------------- --------- ------ ---------- ------------- ---------
YEAR ENDED DECEMBER 31, 1998
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(in Thousands)
Reserves deducted from assets in Consolidated Statement of
Financial Position:
Allowance for doubtful accounts........................... $15,711 $13,302 $ -- $19,348 $ 9,665
======= ======= ====== ======= =======
Reserves included in Current Liabilities -- Other and Deferred
Credits and Other Liabilities -- Other in Consolidated
Statement of Financial Position:
Restructuring Charge (1).................................. $ -- $10,390 $ -- $ 660 $ 9,730
======= ======= ====== ======= =======
Reserves included in Current Liabilities -- Other and in
Accrued Environmental Costs in Consolidated Statement of
Financial Position:
Environmental testing (2)................................. $36,741 $ -- $ -- $ 1,649 $35,092
======= ======= ====== ======= =======
Reserves included in Deferred Credits and Other Liabilities --
Other in Consolidated Statement of Financial Position:
Injuries and damages...................................... $ 4,838 $ (328) $ 438 $ 2,433 $ 2,515
======= ======= ====== ======= =======
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Reserves deducted from assets in Consolidated Statement
of Financial Position:
Allowance for doubtful accounts........................... $18,487 $21,847 $ -- $24,623 $15,711
======= ======= ====== ======= =======
Reserves included in Current Liabilities -- Other and in
Accrued Environmental Costs in Consolidated
Statement of Financial Position:
Environmental testing (2)................................. $37,576 $ -- $ -- $ 835 $36,741
======= ======= ====== ======= =======
Reserves included in Deferred Credits and Other
Liabilities -- Other in Consolidated Statement of
Financial Position:
Injuries and damages...................................... $ 9,182 $ 1,400 $ 608 $ 6,352 $ 4,838
======= ======= ====== ======= =======
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Reserves deducted from assets in Consolidated Statement
of Financial Position:
Allowance for doubtful accounts........................... $13,765 $29,425 $ -- $24,703 $18,487
======= ======= ====== ======= =======
Reserves included in Current Liabilities -- Other and in
Accrued Environmental Costs in Consolidated
Statement of Financial Position:
Environmental testing (2)................................. $38,451 $ -- $ -- $ 875 $37,576
======= ======= ====== ======= =======
Reserves included in Deferred Credits and Other
Liabilities -- Other in Consolidated Statement of
Financial Position:
Injuries and damages...................................... $ 8,013 $ 3,052 $ 674 $ 2,557 $ 9,182
======= ======= ====== ======= =======
</TABLE>
NOTES:
(1) Reference is made to Note 3 to the Consolidated Financial Statements.
(2) Reference is made to Note 13b to the Consolidated Financial Statements.
<PAGE> 1
EXHIBIT 99-2
QUARTERLY OPERATING RESULTS AND COMMON STOCK PRICES (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND
QUARTER QUARTER
------- -------
(IN THOUSANDS OF
DOLLARS -- EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C>
1999
Operating revenues.......................................... $796,586 $488,784
Operating income (loss):
Before unusual charges.................................... $153,918 $ 16,927
Unusual charges........................................... -- (52,000)
-------- --------
$153,918 $(35,073)
======== ========
Operating and joint venture income (loss):
Before unusual charges.................................... $166,376 $ 29,093
Unusual charges........................................... -- (52,000)
-------- --------
$166,376 $(22,907)
======== ========
Income (loss) before cumulative effect of accounting change:
Before unusual charges.................................... $ 88,415 $ (2,875)
Unusual charges........................................... -- (83,365)
-------- --------
$ 88,415 $(86,240)
======== ========
Net income (loss):
Before unusual charges.................................... $ 85,543 $ (2,875)
Unusual charges........................................... -- (83,365)
-------- --------
$ 85,543 $(86,240)
======== ========
Basic earnings (loss) per share:
Before unusual charges and cumulative effect of accounting
change................................................. $ 1.11 $ (.03)
Unusual charges........................................... -- (1.00)
Cumulative effect of accounting change.................... (.04) --
-------- --------
$ 1.07 $ (1.03)
======== ========
Diluted earnings (loss) per share:
Before unusual charges and cumulative effect of accounting
change................................................. $ 1.06 $ (.03)
Unusual charges........................................... -- (1.00)
Cumulative effect of accounting change.................... (.04) --
-------- --------
$ 1.02 $ (1.03)
======== ========
Dividends paid per share.................................... $ .2550 $ .2550
Average daily trading volume................................ 265,050 306,259
Price per share:............................................
High...................................................... $19.5625 $22.6250
Low....................................................... $15.8125 $15.9375
Close..................................................... $16.0625 $20.7500
</TABLE>
