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MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 1
MCN ENERGY GROUP, INC.
MAY 4, 2001
9:00 A.M. CDT
Coordinator Stewart Lawrence, sir, you may begin when ready.
S. Lawrence Thank you, Todd. Thanks for joining us this morning,
everybody. As Todd said, I'm Stewart Lawrence, director of
investor relations for MCN Energy Group. I'm here with
MCN's executive vice president and chief financial officer,
Lee Dow. We also have on the line with us DTE Energy's
senior vice president of finance and treasurer Dave Meador,
who will be available to help answer any questions at the
end if needed.
Before we get into the discussion I need to remind you that
statements included in this conference call that are not
historical in nature are forward-looking within the meaning of
the Private Securities Litigation Reform Act of 1995. These
statements involve certain risks and uncertainties that may
cause actual future results to differ materially from those
contemplated, projected, estimated, or budged in such
forward-looking statements. A discussion of these risks and
uncertainties is included in the company's periodic reports
filed with the Securities and Exchange Commission.
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 2
I hope by now you've had the opportunity to read through the
earnings release issued this morning. The purpose of this call
is to review the first quarter results after which we'll
entertain your questions.
Starting with the earnings review. For the quarter, we
reported adjusted income of $63.8 million or $0.71 per diluted
share, up slightly from the $0.70 per diluted share in the
first quarter of last year. Weather-adjusted, we would have
reported $0.76. There was the negative $0.05 per share impact
from warmer than normal weather.
Consolidated net income came to $43.3 million. That included
several cash and non-cash items. On the cash, side the
significant item was about $83 million of net gains from asset
sales, primarily our coal fines facilities as previously
announced. On the non-cash side, we had a cumulative
transition charge of about $100.6 million from the adoption of
FAS 133, which is the accounting for derivatives and hedges.
This charge came in right about where we estimated it would
last quarter.
Moving on to individual segment results, gas distribution had
operating and joint venture income of $164 million, up from
$118 million in the 2000 first quarter. These results exclude
modest merger costs in both periods. The increase is explained
primarily by a $32 million increase in operating profits from
the gas sales program as margins rose through the use of low
cost gas from storage to meet the program's requirements.
Weather also had an impact on the results. While the weather
was about 6% warmer than normal, that compares to more than
14% warmer than
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 3
normal in last year's first quarter. That's about a $15
million improvement in operating income quarter over quarter
based on the weather.
The pipeline and processing segment had operating and joint
venture income of $500,000, down from almost $6 million in
last year's first quarter due to the sale of income producing
properties as well as lower margins on gathering, processing
and methanol production. The lower margins were in line with
what we saw in the fourth quarter as we reported at our
year-end conference and in line with what we expected to see
in early 2001. Not included in this quarter's income number,
of course, is the $128 million pretax gain on the sale of our
six coal fines facilities. In the electric power segment,
asset sales required under the merger agreement brought this
segment to about break even on the quarter down from nearly $2
million of earnings in the first quarter of 2000. Again, this
was in line with the fourth quarter results and our
expectations for this year since not much remains within this
segment.
The E&P segment also suffered from prior year asset sales as a
7% drop in production contributed to a decline in operating
income, which declined to $3.2 million compared with $4.7
million in the 2000 first quarter. This segment has achieved
significant operating cost reductions and should report
favorably comparable results in future periods.
Energy marketing results are difficult to analyze for a number
of reasons. As you may recall, a change in accounting for
natural gas storage balances beginning in the second quarter
of last year makes first quarter
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 4
comparisons next to impossible for the segment. Further
complicating things is the first quarter adoption of FAS
133, the accounting for derivative instruments and hedging
activities.
In addition to the cumulative transition charge I talked about
earlier, energy marketing got hit with a current period mark
to market loss of about $11 million from FAS 133 in the first
quarter. This loss is tied to gas sales to power facilities.
While we own and produce the gas that supplies these
contracts, only the sales contracts themselves and not the
physical gas that backs them up gets marked to market. When
the futures strip price increases as it did during the first
quarter, we report a loss. If the strip decreases we could see
that loss get reversed.
Similarly, there was about a $5 million loss from marking to
market non-hedged natural gas that remained in storage at the
end of the quarter. This gas had been marked to more than $10
per MCF at year-end, then got marked down to less than $6 at
the end of the quarter. On an ongoing basis we shouldn't see
such large impacts from this kind of mark to market on hedged
gas in storage.
Also effecting the quarter was about a $12 million loss as our
marketing unit struggled to keep a flat book in a highly
volatile market. The problem began in December, which was the
coldest on record here in the Midwest, 23% colder than normal.
Because of the extreme cold some commercial and industrial
customers used significantly more gas than anticipated, which
left us in a short position going into January. We bought to
cover that short to protect our position in what looked to be
a very cold January,
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 5
but then we got hit again since January weather turned out to
10% warmer than normal rather than colder as predicted. We
were left selling unwanted high cost gas into a plunging
market. It's highly unlikely such extreme swings in weather
and prices will repeat. At any rate, we're working to reduce
our exposure to such phenomenon, so we don't see these losses
as an ongoing issue.
With that, let me go ahead and turn it over to Lee.
L. Dow Thank you, Stewart. First let me recap capital
expenditures for the quarter as well as the year's
outlook. For the quarter total expenditures was $35
million of which around $20 million of that was in the
traditional utility distribution business and about $5
million to E&P segment as well as $10 million primarily in
our wrapping the Vector construction.
For the year we continue to look at our total capital
expenditures of $160 million, which we previously discussed as
being around $110 million in the distribution and $30 million
in E&P and then the other once again primarily in the pipeline
segment of $20 million. On a cash basis let me point out again
that this is a capital expenditure. It does not include
proceeds on sales such as the coal fines in the first quarter
as well as to the extent that we are able to sell our out of
region assets that don't, long-term, fit into our strategy
depending upon prices and our ability to negotiate deals. We
of course will continue to pursue the process of selling those
assets although not at fire sale pace or price.
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 6
As to the earnings outlook for 2001, other than the nickel
impact of weather in the first quarter there was nothing that
we discussed for the quarter that would change the guidance we
provided on March 7, 2001 of $1.00 to $1.10 per share. Most of
the items that Stewart discussed, particularly in energy
marketing, relate to accounting issues that we believe we
don't know any more about what the price of gas is going to be
at year-end 2001 than I did three months ago. A lot of the
volatility that we've experienced, nothing about that I
believe is sustainable.
Now I'd like to close by providing an update on the ongoing
status of the long pending merger with DTE Energy. As you
know, on May 15th we will have a shareholder meeting to vote
on the revised merger agreement. In addition with the filing
of the revised U1A on April 27th, we now have a notice period
that expires on May 17th with the Securities and Exchange
Commission. These now represent the final steps for the merger
to close. Assuming prompt action by the SEC, we expect to be
able to close by or near the end of May. We at MCN look
forward to finally uniting with DTE Energy to form the
integrated energy company that has an exciting future here in
the Midwest.
With that, I will turn it over to Todd so that we can open it
up for any questions.
Coordinator Thank you. Our first question comes from David Frank of
Zimmer Lukas Partners.
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 7
D. Frank I just wanted to ask if you could go over the marketing
segment again, some of those costs that were involved. You
said there was a $12 million loss from volatility. You
were short gas early. You went out to buy gas. You then
sold it at a loss later.
S. Lawrence Right.
D. Frank Is this marketing for customers that had signed on a choice
program that will fall off at the end of this year?
S. Lawrence No. That has absolutely nothing to do with the choice
program within the gas distribution segment. This is the
non-regulated energy marketing business, which sells
bundled gas services to commercial and industrial
customers.
D. Frank Just out of curiosity if you decided tomorrow that you no
longer wanted to participate in gas marketing could you close
it down or do you have contracts that go out for some
specified time period?
L. Dow We have contracts that go out particularly with storage and
transportation contracts, so we would have those costs. We
wouldn't want to close it down because we think long-term
there's value associated with the marketing business, but
it is one that we have built assets around. I will
emphasize, however, that this is an example in which the
conservative policies of trying to maintain a flat book in
the trading business has in fact hurt us by creating shorts
and longs that I think a more actively managed and traded
portfolio would have been more successful. I think this is
one
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 8
area we believe that will have a revenue synergy in a post
merger environment.
D. Frank Could you just go over again the other charges? I think
you said you had $11 million mark to market losses and
that's based on the strips, not the actual gas price that
you had experienced. Then there's another charge. I
didn't get the amount for marking gas inventory to market.
S. Lawrence Yes. David, the $11 million associated with gas sales
contracts to power facilities. These are contracts we
entered into a long time ago that were backed up by our
production from our Michigan properties. We've got
production to serve these gas contracts. The problem with
FAS 133 is that the owned gas that we have that is
supplying the contracts doesn't get marked up or down based
on current prices. The sales contracts themselves do get
marked up or down. In this case because the period over
which these contracts are in effect saw increased overall
average prices then those sales contracts were considered
that much farther out of the money and we took that hit.
Again, that's strictly an accounting issue. The gas is
there to back it up.
L. Dow On that point we believe there is likely a way through
other derivatives to make it so going forward we don't have
this misleading disconnect of the impact of gas prices on
one side of the transaction not being able to be offset by
the other side. Our business strategy here was to have a
low risk gas sales program supported by reserves and
unfortunately the way the accounting treatment for these
contracts is that it is creating the illusion of risk that
doesn't exist.
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 9
S. Lawrence The other charge, the $5 million approximately, we maintain
some cushion gas that's not hedged for uses as needed. There's
about 1.1, 1.2 BCF involved here that got marked up to $10 and
something cents at the end of last year and then got marked
down to less than $6 at the end of this quarter. Again, this
is strictly an accounting issue, but it exists.
D. Frank Does your $1.00 to $1.10 guidance, what does that include
from an operating contribution from gas marketing?
L. Dow We would expect the gas marketing business to be when you wash
out a lot of the accounting to be able to continue to have or
to have a very good contribution in 2001 of close to break
even to $0.10.
D. Frank Thank you very much.
L. Dow You're welcome.
Coordinator Our next question comes from Zach Schriber of Silcap.
Z. Schriber We were just wondering if you can sort of tell us about the
status of the gas storage draw downs. I guess I understand
that you guys have some low cost gas in inventory, which
you've been $0.50 per MCF, which you've been sort of
sucking down and reselling that under the fixed price, the
$2.85 per MCF. We're just wondering if that's what you're
doing and that's what accounts for the majority of this
positive $32 million for the quarter at the gas LDC. I was
also wondering if you could talk to us about
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 10
the physical integrity of the storage. There's been some sort
of scuttlebutt that potentially what you were doing could
jeopardize the physical integrity of the storage. We're just
wondering if you could address that.
L. Dow I'd be happy to. The first point, we are doing exactly
what we have indicated since early in 2001 we were going to
do and for that matter it was one of the hedges that we
discussed as we went through the end of 2000. Much of the
increase in the first quarter is in fact the result of the
pulling out of storage gas at low cost.
Now from the physical standpoint we always cycle storage down
at the end of the winter period. So that it's not that,
physically, storage balances are any lower than they normally
are at March 31st, but the key is that our expectation is that
year-end 2001 we will not replace 25 BCF of the gas that we
have pulled from storage and that in fact we will have gas
contracts in the winter of 2002 where we're going to be buying
flowing gas from third party suppliers rather than pulling
from storage. There's nothing about the physical aspects up
here that's changing. We will sell storage services to third
parties in 2001, so storage balances owned by others will
likely be higher in MichCon storage fields at the end of the
year. But from integrity of the system and from reliability
there's nothing that we're doing that would change or have any
adverse impacts on that.
Z. Schriber Can you tell us where storage levels are physically versus
financially now versus where they were at the end of 1999, the
end of 1998, and how much gas is actually in storage and how
does that compare to what you've historically had in storage?
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 11
L. Dow I don't have the numbers in front of me, but as of March
31st our storage balances at MichCon are in line with what
they've been in prior years. They are a lot lower than
what they were in the December 31st period because clearly
we have higher storage balances traditionally going into
the winter period. We typically plan on cycling storage
down to about a ten to 15 BCF of gas in storage at the end
of the withdrawal cycle and I believe that's where we're at
today as well.
Z. Schriber Again, just to make sure I understand what you guys have
done is you've cycled physically the storage exactly the
same way that you have historically, but what you've done,
which is different, is you've re-categorized the inventory
such that the gas, which you are actually physically taking
out, you're charging yourself a lower cost of goods sold
for that physical gas based on the reshuffling of the
inventory.
L. Dow Yes. Reshuffling probably wouldn't be the word, but based
on our expectations as of year-end we will not replace that
gas.
Z. Schriber Historically you do replace that gas at year-end, right?
L. Dow Yes. That's correct.
Z. Schriber Why are you not going to replace that gas at year-end now?
L. Dow Because we are using this storage to take us through the
gas choice program. We made a commitment with MPSC and our
customers to have
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 12
a $2.95 price for the three years. This allows us to honor
that commitment. We will instead in the winter of 2002 rather
than relying upon the storage withdrawals as we would have in
the past, we will be buying gas from flowing supplies from
third parties.
Z. Schriber Then it becomes a pure pass through.
L. Dow Yes.
Z. Schriber Great. The final question is you mentioned this cushion
gas as 1.2 BCF where we took a hit when gas prices came
down from $10 to $6 per MCF. What was the gain, which we
experienced in the fourth quarter when gas prices shot up
to $10 per MCF and how was that gain treated if you could
just refresh us?
L. Dow For that gas it would have been in the quarter would have
been written up from whatever the gas price was as of
September of 2001, which was probably in the $4 range, $4
to $5 range. We probably marked up just one BCF or so from
$5 to $10. There was a $5 million probably positive impact
in the fourth quarter of 2000. This is just the reversal
of that positive impact.
Z. Schriber Got it. Again, on the merger can you just go over those
key dates, which you spoke about in your prepared remarks,
the key dates, which we should look out for again?
L. Dow The key date would be the shareholder meeting of MCN
shareholders is May 15th. The proxy materials are out and the
shareholders are voting.
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 13
We expect the comment period for the SEC approval under the
Public Utility Holding Company Act is scheduled to expire May
17th.
Z. Schriber Great. Thanks so much, guys.
L. Dow Thank you.
Coordinator Our next question comes from Margaret Doris of First
Capital Alliance.
H. Chu Actually this is Henry Chu at First Capital. I'd like to
clarify how the dividends will be from an MCN shareholder
standpoint will be handled for the closing of the merger.
Will we receive the May dividend as well as a DTE dividend
for the payment in July or is there going to be some kind
of prorated dividend for closure?
S. Lawrence The MCN dividend is certain. That one's been declared. The
shareholder meeting is not until May 15th, so MCN shareholders
are certain to hit the record date of May 11th without risk of
closing prior to that. That payment date is May 25th, which is
relatively meaningless. If we closed before May 25th it
doesn't make any difference, or after.
As far as qualifying for DTE's dividend, that one's not been
declared. Dave might want to speak to it a little bit. It's
normally this quarter's dividend, I believe the record date
would be June 20th. If that's going to be the case here then
if you're holding DTE shares as a result of converting or as a
result of buying on the open market or as a result of holding
for years and years, you would qualify for that dividend as
long as
MCN ENERGY GROUP, INC.
MODERATOR: STEWART LAWRENCE
MAY 4, 2001/9:00 A.M. CDT
PAGE 14
you're a DTE stockholder at the dividend record date, which
again has not been declared yet.
H. Chu As long as the transaction closes let's say hypothetically
by the end of May then we'll be eligible to receive the DTE
dividend.
S. Lawrence That's correct. This is the anticipated window period
where no coordination would be required, coordination of
dividends.
H. Chu Great. Thank you very much.
Coordinator At this time there are no further questions. I'll return the
meeting to you, sir.
S. Lawrence Thank you very much. I appreciate everybody joining us
this morning and look forward to closing this deal and not
having another call. Thank you very much.
L. Dow Thank you.