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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended June 30, 2005
Commission file number 1-7310
The registrant meets the conditions set forth in General Instructions H (1) (a) and (b) of Form 10-Q and is, therefore, filing this Form with the reduced disclosure format.
MICHIGAN CONSOLIDATED GAS COMPANY
(Exact name of registrant as specified in its charter)
Michigan | 38-0478040 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
2000 2ndAvenue, Detroit, Michigan (Address of principal executive offices) | 48226-1279 (Zip Code) |
313-235-4000
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
Michigan Consolidated Gas Company
Quarterly Report on Form 10-Q
Quarter Ended June 30, 2005
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2 | ||||||||
PART I — FINANCIAL INFORMATION | ||||||||
Item 1. Financial Statements | ||||||||
7 | ||||||||
8 | ||||||||
10 | ||||||||
11 | ||||||||
12 | ||||||||
19 | ||||||||
Item 2. Management’s Narrative Analysis of the Results of Operations | 3 | |||||||
Item 4. Controls and Procedures | 6 | |||||||
20 | ||||||||
20 | ||||||||
21 | ||||||||
Awareness Letter of Deloitte & Touche LLP | ||||||||
Chief Executive Officer Section 302 Certification | ||||||||
Chief Financial Officer Section 302 Certification | ||||||||
Chief Executive Officer Section 906 Certification | ||||||||
Chief Financial Officer Section 906 Certification |
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Definitions
Customer Choice | The choice program is a statewide initiative giving customers in Michigan the option to choose alternative suppliers for gas. | |
DTE Energy | DTE Energy Company, directly or indirectly, the parent of Detroit Edison Company, and MichCon and numerous non-utility subsidiaries. | |
End User Transportation | A gas delivery service historically provided to large-volume commercial and industrial customers who purchase natural gas directly from producers or brokerage companies. Under MichCon’s Customer Choice program that began in 1999, this service is also provided to residential customers and small-volume commercial and industrial customers. | |
Enterprises | DTE Enterprises Inc., indirectly the parent of MichCon. | |
Gas storage | For MichCon, the process of injecting, storing, and withdrawing natural gas from a depleted underground natural gas field. | |
GCR | A gas cost recovery mechanism authorized by the MPSC, permitting MichCon to pass the cost of natural gas to its customers. | |
Intermediate Transportation | A gas delivery service provided to producers, brokers and other gas companies that own the natural gas, but are not the ultimate consumers. | |
MichCon | Michigan Consolidated Gas Company, an indirect, wholly-owned natural gas distribution and intrastate transmission subsidiary of Enterprises. | |
MPSC | Michigan Public Service Commission. | |
SFAS | Statement of Financial Accounting Standards. | |
Units of Measurement: | ||
Bcf | Billion cubic feet of gas. | |
Mcf | Thousand cubic feet of gas. |
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Forward-Looking Statements
Certain information presented herein 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. There are many factors that may impact forward-looking statements including, but not limited to, the following:
• | the effects of weather and other natural phenomena on operations and sales to customers, and purchases from suppliers; | |
• | economic climate and growth or decline in the geographic areas where we do business; | |
• | environmental issues, laws and regulations, and the cost of remediation and compliance associated therewith; | |
• | implementation of the gas Customer Choice program; | |
• | impact of gas utility restructuring in Michigan, including legislative amendments; | |
• | employee relations and the impact of collective bargaining agreements; | |
• | access to capital markets and capital market conditions and the results of other financing efforts which can be affected by credit agency ratings; | |
• | the timing and extent of changes in interest rates; | |
• | the level of borrowings; | |
• | changes in the cost and availability of natural gas; | |
• | effects of competition; | |
• | impact of regulation by the MPSC and other applicable governmental proceedings and regulations; | |
• | changes in federal, state and local tax laws and their interpretations, including the Internal Revenue Code, regulations, rulings, court proceedings and audits; | |
• | the ability to recover costs through rate increases; | |
• | the availability, cost, coverage and terms of insurance; | |
• | the cost of protecting assets against, or damage due to, terrorism; | |
• | changes in accounting standards and financial reporting regulations; | |
• | changes in federal or state laws and their interpretation with respect to regulation, energy policy and other business issues; | |
• | uncollectible accounts receivable; and | |
• | changes in the economic and financial viability of our suppliers and customers, and the continued ability of such parties to perform their obligations to the Company. |
New factors emerge from time to time. We cannot predict what factors may arise or how such factors may cause our results to differ materially from those contained in any forward-looking statement. Any forward-looking statements speak only as of the date on which such statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.
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Management’s Narrative Analysis of the Results of Operations
The Management’s Narrative Analysis of the Results of Operations discussion for MichCon is presented in accordance with General Instruction H(2)(a) of Form 10-Q.
OVERVIEW
MichCon reported losses of $50 million and $63 million for the second quarter and six-month period of 2005, respectively, compared with losses of $37 million and earnings of $33 million for comparable 2004 periods. Results for the second quarter and six-month period of 2005 were impacted by the April 2005 MPSC gas cost recovery and final rate orders and the impact of effective tax rate adjustments.
Gas cost recovery order- In December 2001, the MPSC issued an order that permitted MichCon to implement gas cost recovery (GCR) factors up to $3.62 per thousand cubic feet (Mcf) for January 2002 billings and up to $4.38 per Mcf for the remainder of 2002. The order allowed MichCon to recognize a regulatory asset representing the difference between the $4.38 factor and the $3.62 factor for volumes that were unbilled at December 31, 2001. MichCon’s 2002 GCR reconciliation case was filed with the MPSC in February 2003. On April 28, 2005, the MPSC issued an order in the 2002 GCR reconciliation case that disallowed $26 million plus accrued interest of $3 million. We recorded the impact of the disallowance in the first quarter of 2005.
Gas final rate order- On April 28, 2005, the MPSC issued an order for final rate relief. The MPSC granted a base rate increase to MichCon of $61 million annually, effective April 29, 2005. This amount is an increase of $26 million over the $35 million in interim rate relief approved in September 2004. The rate increase was based on a 50% debt and 50% equity capital structure and an 11% rate of return on common equity.
The MPSC adopted MichCon’s proposed tracking mechanism for uncollectible accounts receivable. Each year, MichCon will file an application comparing its actual uncollectible expense to its designated revenue recovery of approximately $37 million. Ninety percent of the difference will be refunded or surcharged after an annual reconciliation proceeding before the MPSC. The MPSC also approved the deferral of the non-capitalized portion of the negative pension expense. MichCon will record a regulatory liability in its financial statements for any negative pension costs as determined under generally accepted accounting principles. In addition, the order provided for $25 million in rates to recover safety and training costs. There is a one-way tracking mechanism that provides for refunding the portion of the $25 million not expended on an annual basis.
The MPSC order reduces MichCon’s depreciation rates and the related revenue requirement associated with depreciation expense by $14.5 million and is designed to have no impact on net income.
The MPSC did not allow the recovery of approximately $25 million of merger interest costs allocated to MichCon that were incurred by DTE Energy as a result of the acquisition of MCN Energy.
The MPSC order also resulted in the disallowance of computer system and equipment costs and adjustments to environmental regulatory assets and liabilities. The MPSC disallowed recovery of 90% of the costs of a computer billing system that was in place prior to DTE Energy’s acquisition of MCN Energy in 2001. As a result of the order, we recognized an impairment of this asset of approximately $42 million in the first quarter of 2005. The MPSC disallowed approximately $6 million of certain computer equipment and related depreciation and the recovery of certain internal labor and legal costs related to remediation of
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manufactured gas plants of approximately $6 million. The MPSC order resulted in an additional $5 million charge due to a change in the allocation of historical manufactured gas plant insurance proceeds.
RESULTS OF OPERATION
Quarter | Six Months | |||||||
Increase (Decrease) in Income Statement | ||||||||
Components Compared to Prior Year | ||||||||
(in Millions) | ||||||||
Operating revenues | $ | (10 | ) | $ | 109 | |||
Cost of gas | (30 | ) | 109 | |||||
Gross margin | 20 | — | ||||||
Operation and maintenance | (12 | ) | 10 | |||||
Depreciation, depletion and amortization | (2 | ) | (3 | ) | ||||
Taxes other than income | — | 1 | ||||||
Asset (gains) and losses, net | — | 50 | ||||||
Other (income) and deductions | — | — | ||||||
Income tax provision | 47 | 38 | ||||||
Net income | $ | (13 | ) | $ | (96 | ) | ||
Gross marginsincreased $20 million in the 2005 second quarter and were the same in the six-month periods.
Operating revenues decreased $10 million in the second quarter of 2005 reflecting decreased recorded GCR revenue, partially offset by the final rate order. The lower GCR revenue in the second quarter of 2005 results from adjustments to the GCR revenue associated with storage gas consumed in the first quarter; storage gas consumed was scheduled to be replaced before year-end based on forecasted gas purchases and therefore was recorded at forecasted replacement costs. In the second quarter of 2004 additional revenue was recognized due to an increase in the forecasted cost of gas and the related year-to-date adjustments for amounts estimated in the first quarter of 2004. The second quarter of 2005 had a reduction to revenue due to a decrease in the forecasted cost of gas and the related year-to-date adjustment for amounts estimated in the first quarter of 2005. Operating revenues increased $109 million in the six-month period of 2005, reflecting increased GCR revenue due to higher average gas purchase rates and by the final rate order, partially offset by the impact of the April 2005 MPSC GCR order disallowing $26 million representing unbilled revenues at December 2001. Changes to gas costs result in changes to GCR revenues since those costs are collectible through the GCR mechanism. Additionally, gas sales revenues and volumes in both periods reflect the impact of weather, which was 1% colder in the six-month period of 2005 from the comparable 2004 period.
Cost of gas is affected by variations in sales volumes, cost of purchased gas and related transportation costs, and the effects of any permanent liquidation of inventory gas. Cost of gas sold decreased $30 million in the second quarter and increased $109 million in the six-month period of 2005. The average cost of gas sold decreased $1.02 per Mcf (15%) in the second quarter and increased $1.10 per Mcf (18%) in the six-month period of 2005.
End user transportation revenues increased $3 million and $6 million in the second quarter and six-month period of 2005, respectively, due to contractually driven adjustments to end user transportation contracts, as well as additional throughput for gas-fueled electricity generation in June 2005.
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Quarter | Six Months | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Gas Markets (in Millions) | ||||||||||||||||
Gas sales | $ | 202 | $ | 216 | $ | 958 | $ | 856 | ||||||||
End user transportation | 28 | 25 | 73 | 67 | ||||||||||||
230 | 241 | 1,031 | 923 | |||||||||||||
Intermediate transportation | 11 | 12 | 26 | 27 | ||||||||||||
Other | 20 | 18 | 38 | 36 | ||||||||||||
$ | 261 | $ | 271 | $ | 1,095 | $ | 986 | |||||||||
Gas Markets (in Bcf) | ||||||||||||||||
Gas sales | 22 | 22 | 104 | 105 | ||||||||||||
End user transportation | 33 | 29 | 82 | 79 | ||||||||||||
55 | 51 | 186 | 184 | |||||||||||||
Intermediate transportation | 84 | 129 | 218 | 303 | ||||||||||||
139 | 180 | 404 | 487 | |||||||||||||
Operation and maintenanceexpense decreased $12 million in the second quarter and increased $10 million in the six-month period of 2005. The decrease in the second quarter was due to DTE Energy no longer allocating merger-related interest to MichCon effective in April 2005 as a result of the disallowance of those costs in the MPSC’s final rate order. The decrease for the second quarter was also due to a decline in injuries and damages accruals. For the six months ended, the increase is primarily due to the impact of the MPSC final rate order which disallowed certain environmental expenses that had been recorded as a regulatory asset and its requirement to defer negative pension expense as a regulatory liability. Uncollectible accounts receivables expense increased in the six-month period reflecting higher past due amounts attributable to an increase in gas prices, continued weak economic conditions and inadequate government-sponsored assistance for low-income customers.
Asset gains and losses, netdecreased $50 million for the six-month period due to the disallowances of approximately $42 million of costs related to a computer billing system and $6 million of certain computer equipment and related depreciation, as previously discussed. In March 2004, we recorded a $2 million gain from the sale of a gas storage facility.
Income taxesincreased $47 million and $38 million in the second quarter and six-month period of 2005, respectively. The increase in income taxes is attributed to increases in effective tax rate adjustments of $35 million in the 2005 second quarter and $59 million in the 2005 six-month period. The adjustments were required in 2005 to be consistent with the estimated annual effective tax rate. The 2005 effective income tax rate is unusually low due to the relationship of annual tax adjustments to the level of pre-tax income which has been impacted by rate order considerations.
Outlook– Operating results are expected to vary as a result of factors such as regulatory proceedings, weather and changes in economic conditions, and cost containment efforts and process improvements. Higher gas prices and economic conditions have resulted in an increase in past due receivables. We believe our allowance for doubtful accounts is based on reasonable estimates. In the April 2005 final gas rate order, the MPSC adopted our proposed tracking mechanism for uncollectible accounts receivable. Each year, we will file an application comparing our actual uncollectible expense to our designated revenue recovery of approximately $37 million. Ninety percent of the difference will be refunded or surcharged after an annual reconciliation proceeding before the MPSC.
See Note 3 – Regulatory Matters.
SHORT-TERM CREDIT ARRANGEMENTS AND BORROWINGS
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We currently have an $81.25 million, three-year unsecured credit agreement entered into in October 2003, and a $243.75 million, five-year unsecured revolving credit facility entered into in October 2004. These credit facilities are with a syndicate of banks and may be utilized for general corporate borrowings, but primarily are intended to provide liquidity support for our commercial paper program. These credit facilities make possible short-term borrowings primarily for seasonal needs to buy gas in the summer for use in the winter heating season. In the last twelve months, the peak borrowing for these facilities was $324.8 million. Borrowings under the facilities are available at prevailing short-term interest rates. Among other things, the agreements required us to maintain an “earnings before interest, taxes, depreciation and amortization” (EBITDA) to interest ratio of no less than 2 to 1 for each twelve-month period ending on the last day of March, June, September and December of each year.
As a result of the non-recurring accounting adjustments that were required due to the MPSC gas rate orders issued on April 28, 2005, we did not meet the EBITDA to interest ratio at March 31, 2005. The credit facilities were amended on May 9, 2005 to exclude the EBITDA to interest ratio for the first quarter of 2005, and subsequently amended on June 10, 2005 to exclude non-recurring items in the EBITDA calculation through the maturity of the agreement. If lenders had not amended the credit facilities, our access to the commercial paper markets would have been limited. At June 30, 2005, we do not have any indebtedness under the credit facilities or any commercial paper outstanding. If we experience diminished ability to access the short-term and/or long-term capital markets, we will have to seek additional sources of liquidity. This may have a material negative impact on our financial position and significantly harm the operation of our business. We believe that we will have sufficient internal and external capital resources to manage liquidity and to fund anticipated capital requirements.
CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
Management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30, 2005, which is the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that such controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Due to the inherent limitations in the effectiveness of any disclosure controls and procedures, management cannot provide absolute assurance that the objectives of its disclosure controls and procedures will be met.
(b) Changes in internal control over financial reporting
There has been no change in the Company’s internal control over financial reporting during the quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
Three Months Ended | Six Months Ended | |||||||||||||||
June 30 | June 30 | |||||||||||||||
(in Millions) | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Operating Revenues | $ | 261 | $ | 271 | $ | 1,095 | $ | 986 | ||||||||
Operating Expenses | ||||||||||||||||
Cost of gas | 131 | 161 | 758 | 649 | ||||||||||||
Operation and maintenance | 96 | 108 | 215 | 205 | ||||||||||||
Depreciation, depletion and amortization | 24 | 26 | 50 | 53 | ||||||||||||
Taxes other than income | 13 | 13 | 26 | 25 | ||||||||||||
Asset (gains) and losses, net (Note 3) | — | — | 48 | (2 | ) | |||||||||||
264 | 308 | 1,097 | 930 | |||||||||||||
Operating Income (Loss) | (3 | ) | (37 | ) | (2 | ) | 56 | |||||||||
Other (Income) and Deductions | ||||||||||||||||
Interest expense | 13 | 13 | 28 | 27 | ||||||||||||
Interest income | (3 | ) | (3 | ) | (5 | ) | (5 | ) | ||||||||
Other | — | — | — | 1 | ||||||||||||
10 | 10 | 23 | 23 | |||||||||||||
Income (Loss) Before Income Taxes | (13 | ) | (47 | ) | (25 | ) | 33 | |||||||||
Income Tax Provision (Benefit) | 37 | (10 | ) | 38 | — | |||||||||||
Net Income (Loss) | $ | (50 | ) | $ | (37 | ) | $ | (63 | ) | $ | 33 | |||||
See Notes to Consolidated Financial Statements (Unaudited)
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MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
June 30, 2005 | December 31, | |||||||
(in Millions) | (Unaudited) | 2004 | ||||||
ASSETS | ||||||||
Current Assets | ||||||||
Cash and cash equivalents | $ | 1 | $ | — | ||||
Accounts receivable | ||||||||
Customer (less allowance for doubtful accounts of $83 and $71, respectively) | 207 | 184 | ||||||
Accrued unbilled revenues | 30 | 167 | ||||||
Other | 52 | 82 | ||||||
Accrued gas cost recovery revenue | 10 | 55 | ||||||
Due from affiliate | 99 | — | ||||||
Inventories | ||||||||
Gas | 57 | 89 | ||||||
Material and supplies | 16 | 15 | ||||||
Other | 67 | 77 | ||||||
539 | 669 | |||||||
Property, Plant and Equipment | 3,180 | 3,195 | ||||||
Less accumulated depreciation, depletion and amortization | (1,433 | ) | (1,409 | ) | ||||
1,747 | 1,786 | |||||||
Other Assets | ||||||||
Other investments | 90 | 92 | ||||||
Notes receivable | 81 | 81 | ||||||
Regulatory assets | 56 | 64 | ||||||
Prepaid benefit costs and due from affiliate | 383 | 367 | ||||||
Other | 11 | 17 | ||||||
621 | 621 | |||||||
Total Assets | $ | 2,907 | $ | 3,076 | ||||
See Notes to Consolidated Financial Statements (Unaudited)
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MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
June 30, 2005 | December 31, | |||||||
(in Millions) | (Unaudited) | 2004 | ||||||
LIABILITIES AND SHAREHOLDER’S EQUITY | ||||||||
Current Liabilities | ||||||||
Accounts payable | $ | 157 | $ | 149 | ||||
Dividends payable | 13 | 13 | ||||||
Short-term borrowings | 5 | 242 | ||||||
Current portion of long-term debt, including capital leases | 40 | — | ||||||
Federal income, property and other taxes payable | 48 | 38 | ||||||
Regulatory liabilities | — | 28 | ||||||
Gas inventory equalization (Note 1) | 116 | — | ||||||
Other | 75 | 72 | ||||||
454 | 542 | |||||||
�� | ||||||||
Other Liabilities | ||||||||
Deferred income taxes | 214 | 184 | ||||||
Regulatory liabilities | 568 | 564 | ||||||
Unamortized investment tax credit | 18 | 18 | ||||||
Accrued postretirement benefit costs | 126 | 118 | ||||||
Accrued environmental costs | 20 | 17 | ||||||
Other | 59 | 57 | ||||||
1,005 | 958 | |||||||
Long-Term debt, including capital lease obligations | 745 | 785 | ||||||
Contingencies (Notes 3 and 5) | ||||||||
Shareholder’s Equity | ||||||||
Common stock, $1 par value, 15,100,000 shares authorized, 10,300,000 shares issued and outstanding | 10 | 10 | ||||||
Additional paid in capital | 432 | 432 | ||||||
Retained earnings | 262 | 350 | ||||||
Accumulated other comprehensive loss | (1 | ) | (1 | ) | ||||
703 | 791 | |||||||
Total Liabilities and Shareholder’s Equity | $ | 2,907 | $ | 3,076 | ||||
See Notes to Consolidated Financial Statements (Unaudited)
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MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Six Months Ended | ||||||||
June 30 | ||||||||
2005 | 2004 | |||||||
(in Millions) | ||||||||
Operating Activities | ||||||||
Net income (loss) | $ | (63 | ) | $ | 33 | |||
Adjustments to reconcile net income (loss) to net cash from operating activities: | ||||||||
Depreciation, depletion and amortization | 50 | 53 | ||||||
Deferred income taxes and investment tax credit, net | 23 | 2 | ||||||
Asset (gains) and losses, net | 48 | (2 | ) | |||||
Changes in assets and liabilities: | ||||||||
Accounts receivable, net | 7 | 47 | ||||||
Accrued unbilled revenues | 137 | 92 | ||||||
Inventories | 31 | 44 | ||||||
Property taxes assessed applicable to future periods | (2 | ) | (1 | ) | ||||
Postretirement obligation | 8 | 7 | ||||||
Prepaid benefit costs and due from affiliate | (16 | ) | (17 | ) | ||||
Accrued gas cost recovery | 17 | (70 | ) | |||||
Accounts payable | 8 | 24 | ||||||
Gas inventory equalization | 116 | 93 | ||||||
Federal income, property and other taxes payable | 10 | (3 | ) | |||||
Other | 38 | 22 | ||||||
Net cash from operating activities | 412 | 324 | ||||||
Investing Activities | ||||||||
Capital expenditures | (51 | ) | (41 | ) | ||||
Proceeds from sale of assets | — | 5 | ||||||
Notes receivable from affiliate | (99 | ) | (32 | ) | ||||
Other | 1 | 1 | ||||||
Net cash used for investing activities | (149 | ) | (67 | ) | ||||
Financing Activities | ||||||||
Redemption of long-term debt | — | (1 | ) | |||||
Short-term borrowings, net | (237 | ) | (232 | ) | ||||
Dividends paid | (25 | ) | (25 | ) | ||||
Net cash used for financing activities | (262 | ) | (258 | ) | ||||
Net Increase (Decrease) in Cash and Cash Equivalents | 1 | (1 | ) | |||||
Cash and Cash Equivalents at Beginning of Period | — | 1 | ||||||
Cash and Cash Equivalents at End of Period | $ | 1 | $ | — | ||||
Supplementary Cash Flow Information | ||||||||
Interest paid (excluding interest capitalized) | $ | 28 | $ | 27 | ||||
Income taxes paid | — | — |
See Notes to Consolidated Financial Statements (Unaudited)
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MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
AND COMPREHENSIVE INCOME (UNAUDITED)
Six Months Ended | ||||||||
June 30 | ||||||||
2005 | 2004 | |||||||
(in Millions) | ||||||||
Balance – beginning of period | $ | 350 | $ | 381 | ||||
Net income (loss) | (63 | ) | 33 | |||||
Common stock dividends declared | (25 | ) | (25 | ) | ||||
Balance – end of period | $ | 262 | $ | 389 | ||||
The following table displays other comprehensive income (loss) for the six-month periods ended June 30:
(in Millions) | 2005 | 2004 | ||||||
Net income (loss) | $ | (63 | ) | $ | 33 | |||
Comprehensive income (loss) | $ | (63 | ) | $ | 33 | |||
See Notes to Consolidated Financial Statements (Unaudited)
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Michigan Consolidated Gas Company
Notes to Consolidated Financial Statements (Unaudited)
NOTE 1 — GENERAL
These consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements included in our 2004 Annual Report on Form 10-K.
The accompanying consolidated financial statements are prepared using accounting principles generally accepted in the United States of America. These accounting principles require us to use estimates and assumptions that impact the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual results may differ from those estimates.
The consolidated financial statements are unaudited, but in our opinion, include all adjustments necessary for a fair statement of the results for the interim periods. Financial results for this interim period are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year.
We reclassified certain prior year balances to match the current year’s financial statement presentation.
Asset Retirement Obligations
SFAS No. 143, “Accounting for Asset Retirement Obligations,” requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred. We believe that adoption of SFAS No. 143 results primarily in timing differences in the recognition of legal asset retirement costs that we are currently recovering in rates and will be deferring such differences under SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation.”
A reconciliation of the asset retirement obligation for the 2005 six-month period follows:
(in Millions) | ||||
Asset retirement obligations at January 1, 2005 | $ | 5 | ||
Accretion | — | |||
Liabilities settled | — | |||
Asset retirement obligations at June 30, 2005 | $ | 5 | ||
Retirement Benefits and Trusteed Assets
MichCon sponsors a defined benefit retirement plan for eligible MichCon represented employees. MichCon also participates in a defined benefit retirement plan sponsored by Detroit Edison for its other nonrepresented employees, which is treated as a plan covering employees of various affiliates of DTE Energy from the affiliates’ perspective. We are allocated income or an expense each year as a result of our participation in the DTE Energy Company Retirement Plan. Income was approximately $6 million and $7 million for the three months ended June 30, 2005 and 2004, respectively, and was approximately $13 million and $14 million for the six months ended June 30, 2005 and 2004, respectively, and is not reflected in the following table.
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The components of net periodic benefit costs (credit) for pension benefits and other postretirement benefits follow:
Other Postretirement | ||||||||||||||||
(in Millions) | Pension Benefits | Benefits | ||||||||||||||
Three Months Ended June 30 | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Service Cost | $ | 1 | $ | 1 | $ | 3 | $ | 2 | ||||||||
Interest Cost | 3 | 3 | 6 | 6 | ||||||||||||
Expected Return on Plan Assets | (7 | ) | (7 | ) | (3 | ) | (3 | ) | ||||||||
Amortization of | ||||||||||||||||
Net loss | — | — | 1 | 1 | ||||||||||||
Prior service cost | 1 | 1 | 1 | — | ||||||||||||
Net transition liability | — | — | 1 | 2 | ||||||||||||
Net Periodic Benefit Cost (Credit) | $ | (2 | ) | $ | (2 | ) | $ | 9 | $ | 8 | ||||||
Other Postretirement | ||||||||||||||||
(in Millions) | Pension Benefits | Benefits | ||||||||||||||
Six Months Ended June 30 | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Service Cost | $ | 3 | $ | 3 | $ | 6 | $ | 4 | ||||||||
Interest Cost | 7 | 7 | 12 | 11 | ||||||||||||
Expected Return on Plan Assets | (14 | ) | (14 | ) | (6 | ) | (5 | ) | ||||||||
Amortization of | ||||||||||||||||
Net loss | — | — | 3 | 1 | ||||||||||||
Prior service cost | 1 | 1 | 1 | — | ||||||||||||
Net transition liability | — | — | 3 | 4 | ||||||||||||
Net Periodic Benefit Cost (Credit) | $ | (3 | ) | $ | (3 | ) | $ | 19 | $ | 15 | ||||||
Gas in Inventory
Gas inventory is priced on a last-in, first-out (LIFO) basis. In anticipation that interim inventory reductions will be replaced prior to year end, the cost of gas of net withdrawals from inventory is recorded at the estimated average purchase rate for the calendar year. The excess of these charges over the LIFO cost is credited to the gas inventory equalization account. During interim periods when there are net injections to inventory, the equalization account is reversed.
NOTE 2 – NEW ACCOUNTING PRONOUNCEMENTS
Accounting for Conditional Asset Retirement Obligations
In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143.”FIN 47 seeks to clarify the requirement to record liabilities stemming from a legal obligation to perform asset retirement activities on fixed assets when that retirement is conditioned on a future event. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company is currently assessing the effects of this interpretation, and has not yet determined the impact on the consolidated financial statements.
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NOTE 3 — REGULATORY MATTERS
Gas Rate Case
Rate Request —In September 2003, MichCon filed an application with the MPSC for an increase in service and distribution charges (base rates) for its gas sales and transportation customers. The filing requested an overall increase in base rates of $194 million per year beginning January 1, 2005. MichCon requested that the MPSC increase base rates by $154 million per year on an interim basis by April 1, 2004. The final rate request was subsequently revised to $159 million.
MPSC Final Rate Order– On April 28, 2005, the MPSC issued an order for final rate relief. The MPSC determined that the base rate increase granted to MichCon should be $61 million annually effective April 29, 2005. This amount is an increase of $26 million over the $35 million in interim rate relief approved in September 2004. The rate increase was based on a 50% debt and 50% equity capital structure and an 11% rate of return on common equity.
The MPSC adopted MichCon’s proposed tracking mechanism for uncollectible accounts receivable. Each year, MichCon will file an application comparing its actual uncollectible expense to its designated revenue recovery of approximately $37 million. Ninety percent of the difference will be refunded or surcharged after an annual reconciliation proceeding before the MPSC. The MPSC also approved the deferral of the non-capitalized portion of the negative pension expense. MichCon will record a regulatory liability in its financial statements for any negative pension costs as determined under generally accepted accounting principles. In addition, the order provided for $25 million in rates to recover safety and training costs. There is a one-way tracking mechanism that provides for refunding the portion of the $25 million not expended on an annual basis.
The MPSC order reduces MichCon’s depreciation rates, and the related revenue requirement associated with depreciation expense by $14.5 million and is designed to have no impact on net income.
The MPSC did not allow the recovery of approximately $25 million of merger interest costs allocated to MichCon that were incurred by DTE Energy as a result of the acquisition of MCN Energy.
The MPSC order also resulted in the disallowance of computer system and equipment costs and adjustments to environmental regulatory assets and liabilities. The MPSC disallowed recovery of 90% of the costs of a computer billing system that was in place prior to DTE Energy’s acquisition of MCN Energy in 2001. As a result of the order, MichCon recognized an impairment of this asset of approximately $42 million in the first quarter of 2005. The MPSC disallowed approximately $6 million of certain computer equipment and related depreciation and the recovery of certain internal labor and legal costs related to remediation of manufactured gas plants of approximately $6 million. The MPSC ordered an additional $5 million charge due to a change in the allocation of historical manufactured gas plant insurance proceeds.
Rehearing Request– In May 2005, MichCon filed for rehearing of various aspects of the MPSC final rate order. On July 19, 2005, the MPSC denied MichCon’s petition for rehearing.
Gas Cost Recovery Proceedings
2002 Plan Year- In December 2001, the MPSC issued an order that permitted MichCon to implement GCR factors up to $3.62 per thousand cubic feet (Mcf) for January 2002 billings and
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up to $4.38 per Mcf for the remainder of 2002. The order also allowed MichCon to recognize a regulatory asset representing the difference between the $4.38 factor and the $3.62 factor for volumes that were unbilled at December 31, 2001. The regulatory asset was subject to the 2002 GCR reconciliation process. In March 2003, the MPSC issued an order in MichCon’s 2002 GCR plan case. The MPSC ordered MichCon to reduce its gas cost recovery expenses by $26.5 million for purposes of calculating the 2002 GCR factor due to MichCon’s decision to utilize storage gas during 2001 that resulted in a gas inventory decrement for the 2001 calendar year. We recorded a $26.5 million reserve in 2002 to reflect the impact of this order.
MichCon’s 2002 GCR reconciliation case was filed with the MPSC in February 2003. The Staff and various intervening parties in this proceeding sought to have the MPSC disallow an additional $26 million, representing unbilled revenues at December 2001. One party also proposed the disallowance of half of an $8 million payment made to settle Enron bankruptcy issues. The other parties to the case recommended that the Enron bankruptcy settlement be addressed in the 2003 GCR reconciliation case. In April 2005, the MPSC issued an order in the 2002 GCR reconciliation case affirming the order in the 2002 GCR plan case disallowing $26.5 million related to the use of storage gas in 2001. The April 2005 order also disallowed the additional $26 million representing unbilled revenues at December 2001. We recorded the impact of the disallowance in the first quarter of 2005. The MPSC agreed that the $8 million related to the Enron issue be addressed in the 2003 GCR reconciliation case. MichCon included this item in testimony in the 2003 GCR reconciliation filed in February 2004 and the Staff has recommended that MichCon be allowed to recover the entire $8 million related to the Enron issue.
2003 Plan Year- MichCon’s 2003 GCR reconciliation case was filed with the MPSC in February 2004. In May 2005, the MPSC issued an order in the 2003 GCR reconciliation case approving recovery of the $8 million related to the Enron bankruptcy settlement.
2005-2006 Plan Year —In December 2004, MichCon filed its 2005-2006 GCR plan case proposing a maximum GCR factor of $7.99 per Mcf. The plan includes quarterly contingent GCR factors. These contingent factors allow MichCon to increase the maximum GCR factor to compensate for increases in market prices, thereby reducing the possibility of a GCR under-recovery. In April 2005, the MPSC issued an order recognizing that Michigan law allows MichCon to self-implement its quarterly contingent factors. Approval of the contingent factors will be determined in the MPSC’s final order in this case. In July 2005, MichCon self-implemented a quarterly contingent GCR factor of $8.54 per Mcf.
Other
We are unable to predict the outcome of the regulatory matters discussed herein. Resolution of these matters is dependent upon future MPSC orders, which may materially impact the financial position, results of operations and cash flows of the Company.
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NOTE 4 – SHORT-TERM CREDIT ARRANGEMENTS AND BORROWINGS
We currently have an $81.25 million, three-year unsecured credit agreement originally entered into in October 2003, and a $243.75 million, five-year unsecured revolving credit facility entered into in October 2004. These credit facilities are with a syndicate of banks and may be utilized for general corporate borrowings, but primarily are intended to provide liquidity support for our commercial paper program. Borrowings under the facilities are available at prevailing short-term interest rates. Among other things, the agreements required us to maintain an “earnings before interest, taxes, depreciation and amortization” (EBITDA) to interest ratio of no less than 2 to 1 for each twelve-month period ending on the last day of March, June, September and December of each year.
As a result of the non-recurring accounting adjustments that were required due to the MPSC gas rate orders issued on April 28, 2005, we did not meet the EBITDA to interest ratio at March 31, 2005. The credit facilities were amended on May 9, 2005 to exclude the EBITDA to interest ratio for the first quarter of 2005, and subsequently amended on June 10, 2005 to exclude non-recurring items in the EBITDA calculation through the maturity of the agreement. At June 30, 2005, we did not have any indebtedness under the credit facilities or any commercial paper outstanding.
NOTE 5 – CONTINGENCIES
Environmental Matters
Contaminated Sites– Prior to the construction of major interstate natural gas pipelines, gas for heating and other uses was manufactured locally from processes involving coal, coke or oil. We own, or previously owned, 17 such former manufactured gas plant (MGP) sites. During the mid-1980’s, we conducted preliminary environmental investigations at 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).
We are remediating eight of the former MGP sites and conducting more extensive investigations at four other former MGP sites. We received MDEQ closure of one site and a determination that we are not a responsible party for three other sites. We received closure from the EPA in 2002 for one site.
In 1984, we established a $12 million reserve for costs associated with environmental investigation and remediation activities. During 1993, we 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. We employed outside consultants to evaluate remediation alternatives for these sites, to assist in estimating its potential liabilities and to review its archived insurance policies. As a result of these studies, we accrued an additional liability and a corresponding regulatory asset of $32 million during 1995. In early December 2004, we retained multiple environmental consultants to estimate the projected cost to remediate each MGP facility. The results of the evaluation indicated that the MGP reserve should be set at $22 million.
During 2004, we spent $2.3 million, investigating and remediating these former MGP sites. At December 31, 2004, the reserve balance was $21.5 million, of which $4.5 million 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
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remedial action costs for the sites and, therefore, have an effect on our financial position and cash flows. However, we anticipate the cost deferral and rate recovery mechanism approved by the MPSC will prevent environmental costs from having a material adverse impact on our results of operations.
Personal Property Taxes
Prior to 1999, MichCon and other Michigan utilities asserted that Michigan’s valuation tables result in the substantial overvaluation of utility personal property. Valuation tables established by the Michigan State Tax Commission (STC) are used to determine the taxable value of personal property based on the property’s age. In November 1999, the STC approved new valuation tables that more accurately recognize the value of a utility’s personal property. The new tables became effective in 2000 and are currently used to calculate property tax expense. However, several local taxing jurisdictions have taken legal action attempting to prevent the STC from implementing the new valuation tables and have continued to prepare assessments based on the superseded tables. The legal actions regarding the appropriateness of the new tables were before the Michigan Tax Tribunal (MTT) which, in April 2002, issued its decision essentially affirming the validity of the STC’s new tables. In June 2002, petitioners in the case filed an appeal of the MTT’s decision with the Michigan Court of Appeals. In January 2004, the Michigan Court of Appeals upheld the validity of the new tables. With no further appeal by the petitioners available, the MTT began to schedule utility personal property valuation cases for Prehearing General Calls. MichCon has filed motions and the MTT agreed to place their cases in abeyance pending the conclusion of settlement negotiations being conducted by State of Michigan Treasury officials. On February 14, 2005, MTT issued a scheduling order that lifts the prior abeyances in a significant number of our appeals. The scheduling order sets litigation calendars for these cases extending into mid-2006.
We continue to record property tax expense based on the new tables. We will continue through settlement or litigation to seek to apply the new tables retroactively and to ultimately resolve the pending tax appeals related to 1997 through 1999. This is a solution supported by the STC in the past. To the extent that settlements cannot be achieved with the jurisdictions, litigation regarding the valuation of utility property will delay any recoveries by MichCon.
Other Commitments
At December 31, 2004, we have entered into numerous long-term purchase commitments relating to a variety of goods and services required for our business. These agreements primarily consist of long-term gas purchase and transportation agreements. We estimate that these commitments will be approximately $1.1 billion through 2011. We also estimate that our 2005 base level capital expenditures will be approximately $115 million. We have made certain commitments in connection with such expected capital expenditures.
Bankruptcies
We sell gas to numerous companies operating in the steel, automotive, energy and retail industries. A number of customers have filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. We have negotiated or are currently involved in negotiations with each of the companies, or their successor companies, that have filed for bankruptcy protection. We regularly review contingent matters relating to sale contracts and record provisions for amounts considered probable of loss. We believe our previously accrued amounts are adequate for probable losses. The final resolution of these matters is not expected to have a material effect on our financial statements in the period they are resolved.
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Other
We are involved in certain legal, regulatory, administrative and environmental proceedings before various courts, arbitration panels and governmental agencies concerning matters arising in the ordinary course of business. These proceedings include certain contract disputes, environmental reviews and investigations, audits, inquiries from various regulators, and pending judicial matters. We cannot predict the final disposition of such proceedings. We regularly review legal matters and record provisions for claims that are considered probable of loss. The resolution of pending proceedings is not expected to have a material effect on our operations or financial statements in the period they are resolved.
See Note 3 for a discussion of contingencies related to Regulatory Matters.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
Michigan Consolidated Gas Company
Michigan Consolidated Gas Company
We have reviewed the accompanying condensed consolidated statement of financial position of Michigan Consolidated Gas Company and subsidiaries as of June 30, 2005, and the related condensed consolidated statement of operations for the three-month and six-month periods ended June 30, 2005 and 2004, and the condensed consolidated statements of cash flows, retained earnings and comprehensive income for the six-month periods ended June 30, 2005 and 2004. These interim financial statements are the responsibility of Michigan Consolidated Gas Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial position of Michigan Consolidated Gas Company and subsidiaries as of December 31, 2004, and the related consolidated statements of operations, cash flows and retained earnings and comprehensive income for the year then ended (not presented herein); and in our report dated March 15, 2005 (which report includes an explanatory paragraph relating to the change in the method of accounting for asset retirement obligations in 2003), we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial position as of December 31, 2004 is fairly stated, in all material respects, in relation to the consolidated statement of financial position from which it has been derived.
/S/ DELOITTE & TOUCHE LLP
Detroit, Michigan
August 4, 2005
August 4, 2005
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OTHER INFORMATION
LEGAL PROCEEDINGS
We are involved in certain legal, regulatory, administrative and environmental proceedings before various courts, arbitration panels and governmental agencies concerning claims arising in the ordinary course of business. These proceedings include certain contract disputes, environmental reviews and investigations, audits, inquiries from various regulators, and pending judicial matters. We cannot predict the final disposition of such proceedings. We regularly review legal matters and record provisions for claims that are considered probable of loss. The resolution of pending proceedings is not expected to have a material effect on our financial statements in the period they are resolved.
See Note 3 for a discussion of contingencies related to Regulatory Matters and Note 5 for a discussion of specific non-regulatory matters.
EXHIBITS
Exhibit | ||
Number | Description | |
Filed: | ||
15-10 | Awareness Letter of Deloitte & Touche LLP | |
31-17 | Chief Executive Officer Section 302 Certification | |
31-18 | Chief Financial Officer Section 302 Certification | |
Incorporated by Reference: | ||
10-17 | Form of Amendment No. 2 dated as of June 10, 2005 to Amended and Restated Five-Year Credit Agreement dated as of October 15, 2004 among Michigan Consolidated Gas Company, JP Morgan Chase Bank, N.A. (successor to Bank One, N.A.), as a Lender and as administrative agent, and the Co-Syndication Agents named therein. (Exhibit 10.1 to Form 8-K dated June 10, 2005). | |
99-14 | Form of Amendment No. 2 dated as of June 10, 2005 to Three-Year Credit Agreement dated as of October 24, 2003 among Michigan Consolidated Gas Company, JP Morgan Chase Bank, N.A. (successor to Bank One, N.A.), as a Lender and as administrative agent, and the Co-Syndication Agents named therein. (Exhibit 99.1 to Form 8-K dated June 10, 2005). | |
Furnished: | ||
32-17 | Chief Executive Officer Section 906 Certification | |
32-18 | Chief Financial Officer Section 906 Certification |
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MICHIGAN CONSOLIDATED | ||
GAS COMPANY | ||
Date: August 4, 2005 | /s/ DANIEL G. BRUDZYNSKI | |
Daniel G. Brudzynski | ||
Chief Accounting Officer, | ||
Vice President and Controller |
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EXHIBIT INDEX
Exhibit | ||
Number | Description | |
15-10 | Awareness Letter of Deloitte & Touche LLP | |
31-17 | Chief Executive Officer Section 302 Certification | |
31-18 | Chief Financial Officer Section 302 Certification | |
32-17 | Chief Executive Officer Section 906 Certification | |
32-18 | Chief Financial Officer Section 906 Certification |