1
EXHIBIT 13.1
Management's Discusson and Analysis
RESULTS OF OPERATIONS
MCN posts fifth consecutive record-setting year -- MCN's earnings from
continuing operations increased 26%, or $29.7 million, to a record $142.3
million in 1997. Basic earnings per share reached an all-time high, increasing
16% to $1.95. This performance reflects the successful implementation of MCN's
diversified portfolio investment strategy discussed below. MCN's continuing
operations generated 1996 income of $112.6 million, or basic earnings per share
of $1.68, an increase of $19.4 million or $.24 per share from 1995.
MCN's earnings comparisons were also affected by income from discontinued
operations. As discussed in the "Discontinued Operations" section
that follows, MCN sold its computer operations subsidiary, The Genix Group,
Inc. (Genix), during the second quarter of 1996.
NET INCOME
(in Millions) 1997 1996 1995
----------------------------------
Continuing Operations:
Diversified Energy $ 61.2 $ 31.2 $ 17.6
Gas Distribution 81.1 81.4 75.6
----------------------------------
142.3 112.6 93.2
----------------------------------
Discontinued Operations:
Income from operations -- 1.6 3.6
Gain on sale -- 36.2 --
----------------------------------
-- 37.8 3.6
----------------------------------
$ 142.3 $ 150.4 $ 96.8
==================================
BASIC EARNINGS PER SHARE
Continuing Operations:
Diversified Energy $ .84 $ .47 $ .27
Gas Distribution 1.11 1.21 1.17
-----------------------------------
1.95 1.68 1.44
-----------------------------------
Discontinued Operations:
Income from operations -- .03 .05
Gain on sale -- .54 --
-----------------------------------
-- .57 .05
-----------------------------------
$ 1.95 $ 2.25 $ 1.49
===================================
Strategic direction -- MCN's objective is to achieve superior, long-term returns
for its shareholders. To accomplish this, MCN will aggressively invest in a
diverse portfolio of domestic and international energy-related projects. The
success of this strategy will be demonstrated by the continuing growth of MCN's
earnings and the total return to its shareholders over time. MCN has achieved a
three-year annual growth rate in basic earnings per share of 15.7%. Similarly,
MCN's total return to shareholders, which includes stock price appreciation and
reinvested dividends, has averaged 35.9% per year since 1995.
DIVERSIFIED ENERGY
Earnings generate a 17.2% return on equity -- The Diversified Energy group
continued its strong financial performance with its sixth consecutive year of
double- or triple-digit earnings increases. Earnings for 1997 increased to $61.2
million, nearly double the $31.2 million earned in 1996. The growth in earnings
was driven primarily by increased operating and joint venture income as all of
MCN's Diversified Energy business units turned in exceptional performances.
Partially offsetting the growth in earnings were increased financing costs
resulting from additional capital needed to fund investments. Diversified Energy
continues to provide an increasing portion of MCN's earnings, contributing 43%
in 1997 compared to 28% in 1996 and 19% in 1995. Diversified Energy's earnings
for 1996 increased $13.6 million or 77% over 1995.
DIVERSIFIED ENERGY OPERATONS
(in Millions)
1997 1996 1995
------------------------------
Operating Revenues* $ 951.3 $ 734.4 $ 400.0
Operating Expenses* 891.7 693.6 378.1
------------------------------
Operating Income 59.6 40.8 21.9
------------------------------
Equity in Earnings of
Joint Ventures 53.1 16.6 3.9
------------------------------
Other Income and (Deductions)*
Interest income 6.7 3.0 3.6
Interest expense (32.2) (28.7) (13.3)
Dividends on
preferred securities (31.1) (12.4) (9.4)
Other 10.1 5.5 2.3
------------------------------
(46.5) (32.6) (16.8)
------------------------------
Income Before Income Taxes 66.2 24.8 9.0
------------------------------
Income Taxes
Current and deferred provision 22.8 9.5 2.7
Federal tax credits (17.8) (15.9) (11.3)
------------------------------
5.0 (6.4) (8.6)
------------------------------
Net Income $ 61.2 $ 31.2 $ 17.6
------------------------------
*Includes intercompany transactions
OPERATING AND JOINT VENTURE INCOME
Operating and joint venture income nearly doubles -- Diversified Energy's
operating and joint venture income increased $55.3 million and $31.6 million in
1997 and 1996, respectively. This performance primarily reflects the growing
returns from all business units resulting from successfully investing almost $2
billion in a diverse portfolio of energy-related projects during the past three
years. A discussion of each business unit, its contributions and its outlook
follows.
OPERATING AND JOINT VENTURE INCOME
(in Millions)
1997 1996 1995
----------------------------------
Exploration & Production $ 58.1 $ 33.2 $ 18.5
Pipelines & Processing 29.1 10.7 1.0
Energy Marketing, Gas
Storage & Electric Power 29.8 14.0 9.1
Corporate & Other (4.3) (.5) (2.8)
----------------------------------
$ 112.7 $ 57.4 $ 25.8
----------------------------------
EXPLORATION & PRODUCTION (E&P) owns, invests in and manages a diverse portfolio
of gas and oil properties in the Midwest/Appalachia, Midcontinent/Gulf Coast
and Western regions of the United States. MCN's gas and oil projects utilize
various technologies in diverse geological structures, including shallow
31
2
Management's Discussion and Analysis
Antrim shale formations, coalbed methane properties and unconventional oil
recovery projects.
E&P operating and joint venture income increased $24.9
million in 1997 and $14.7 million for 1996. The results reflect a significant
increase in the level of gas and oil produced due to the development and
acquisition of properties during 1997 and 1996. Gas and oil production increased
34.6 billion cubic feet equivalent (Bcfe) or 54% in 1997 and 30 Bcfe or 89% in
1996. This growth in production is primarily attributable to ongoing
developmental drilling as well as the acquisition of properties. MCN continues
to add oil to its production mix to further diversify its portfolio. Oil
accounted for 20.1 Bcfe or 20% of production in 1997 compared to 6.5 Bcfe or 10%
in 1996 and 2.3 Bcfe or 7% in 1995. MCN's unconsolidated joint ventures
generated $6.6 million of pre-tax income in 1997 from the sale of undeveloped
properties.
GAS AND OIL PRODUCTION PROVED GAS AND OIL RESERVES
(in Bcf equivalent) (in Tcf equivalent)
98.3................................97 1.32..........................97
1.24...................96
.89.............95
63.7........................96
33.7................95
[ ] Gas Production [ ] Developed
[ ] Oil Production [ ] Undeveloped
Since the inception of its E&P program in late 1992, MCN has invested more than
$1.3 billion to develop and acquire gas and oil reserves. Proved gas reserves
increased slightly in 1997 to 1,166.2 billion cubic feet (Bcf), and proved oil
reserves rose 50% to 155.1 Bcfe. The increase in gas and oil reserves during
1997 was tempered by the sale of properties with 57.6 Bcfe of proved reserves
and net downward reserve revisions of 32.8 Bcfe. Proved gas reserves increased
33% in 1996 to 1,137.7 Bcf, and proved oil reserves more than tripled to 103.2
Bcfe. MCN invested $375 million in its E&P business during 1997 with
approximately 34% directed toward developing existing properties. Developed
producing reserves represent 665.9 Bcfe, or 50% of total gas and oil reserves at
year end 1997 compared to 746.3 Bcfe in 1996, and 583.5 Bcfe in 1995.
E&P operating results reflect average gas sales rates per thousand cubic feet
(Mcf) of $1.95 in 1997, $1.96 in 1996 and $2.02 in 1995. E&P operating results
also reflect an average oil sales rate per barrel of $16.87 in 1997, $20.18 in
1996 and $16.24 in 1995. The average gas and oil sales rates include the effect
of hedging with 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. As a result of
strong energy prices, hedging agreements had the effect of reducing the average
gas sales rates by $.40 and $.35 per Mcf in 1997 and 1996, respectively, as well
as reducing the average oil sales rates by $.21, $.75 and $.20 per barrel in
1997, 1996 and 1995, respectively. Conversely, in a less favorable gas market
hedging agreements increased 1995's average gas sales rate by $.51 per Mcf.
E&P's 1997 operating costs per Mcfe remained relatively flat compared to 1996 as
lower unit production costs offset a higher depreciation, depletion and
amortization rate. Operating costs per Mcfe increased in 1996 over 1995
reflecting a $.24 higher average production and depreciation cost rate.
E&P operations have supplemented Diversified Energy's earnings through the
generation of an increasing amount of gas production tax credits, primarily from
production of coalbed methane and Antrim shale gas properties in the
Midwest/Appalachia region. Tax credits increased 12% to $17.8 million in 1997,
compared to $15.9 million in 1996 and $11.3 million in 1995.
Outlook -- MCN's strategy is to continue the growth of its reserve base in known
producing areas, generating attractive returns and developing reliable,
long-term gas supplies. MCN anticipates an increase in E&P operating results as
it implements this growth strategy by acquiring additional properties,
developing existing acreage and realizing the full benefits of previous
acquisitions. E&P expects gas and oil production levels to increase
significantly in 1998 as a result of acquisitions and the continued development
of E&P's 1.25 million acres of undeveloped property and proved undeveloped
reserves.
MCN will continue to evaluate opportunities to strategically sell certain E&P
properties. MCN's strategy is to sell and purchase assets to optimize its E&P
portfolio.
MCN also anticipates that oil will become a larger percentage of total
reserves and production in order to achieve a more balanced portfolio. In
addition to producing increasing quantities of oil through traditional methods,
MCN expects increased production from its investments in unconventional oil
recovery projects.
Risks associated with E&P activities are managed by diversifying investments
along the lines of geography, geology, risk profile and technology. MCN is
currently evaluating international investment opportunities which would
further diversify its E&P portfolio.
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 increased $18.4
million in 1997 and $9.7 million during 1996. The increase in 1997 reflects
income from the December 1996 acquisition of a 25% interest in Lyondell Methanol
Company, L. P.
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(Lyondell), a limited partnership that owns and operates a 248 million
gallon-per-year methanol production plant in Texas (Note 2e). Earnings from
Lyondell have benefited from strong methanol prices during 1997. Pipelines &
Processing operating and joint venture income for 1997 also reflects income
from a 29.6 Bcf or 34% increase in transportation volumes resulting from
the acquisition and expansion of pipeline facilities during the year.
PIPELINES & PROCESSING STATISTICS*
1997 1996 1995
-------------------------------
Transportation (Bcf) 116.0 86.4 5.0
Methanol Produced
(Million Gallons) 60.8 10.5 --
Gas Processed (Bcf) 42.8 44.2 14.6
*Includes MCN's share of joint ventures
The increase in 1996 operating and joint venture income compared to 1995 is due
to the December 1995 acquisition of a 50% interest in a 40-mile gas gathering
line in Virginia (Note 2g) and the February 1996 acquisition of an interest in a
90-mile gas gathering system in the Mobile Bay area of offshore Alabama (Note
2f). Results for 1996 also reflect a higher level of volumes treated through
additional gas processing plants.
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. MCN has partnership interests in three interstate pipeline
projects that will transport Canadian natural gas volumes into the
Mid-Atlantic and Northeast United States markets. MCN has a 20% interest in
the Portland Natural Gas Transmission System, its initial interstate pipeline
investment. The $340 million, 292-mile Portland pipeline is expected to
begin transporting up to 210,000 Mcf per day in late 1998. The Millennium
Pipeline System and the Vector Pipeline project are the other two interstate
pipeline projects. Both projects are subject to Federal Energy Regulatory
Commission approval and are expected to be completed in late 1999. MCN has a
10.5% interest in the $680 million, 440-mile Millennium Pipeline which will have
the capacity to transport up to 700,000 Mcf per day. MCN also has a 25% interest
in the $450 million, 343-mile Vector Pipeline which is expected to transport up
to 1 Bcf per day.
MCN's Pipelines & Processing business also formed partnerships in 1997 to
construct plants which will process coal fines and manufacture asphalt.
The coal fines venture produces coal briquettes from particles of coal that are
by-products of coal mining. The coal fines venture is currently constructing six
plants which are expected to be completed by June 1998. Each plant will be
capable of processing up to one million tons annually. Actual production levels
may vary significantly depending upon actual site conditions, including coal
fines quality and quantity, equipment performance and other factors. The
economic viability of the coal fines venture is highly dependent upon an
Internal Revenue Service (IRS) ruling that production from the plants qualifies
for synthetic fuel tax credits estimated to range from $20 to $25 per ton. MCN
has filed for, and expects to receive, a favorable IRS ruling by mid-1998.
The asphalt partnership is constructing a $15 million manufacturing facility
designed to produce approximately 100,000 tons of high quality asphalt annually.
The first plant is expected to be completed by the third quarter of 1998, with
additional plants built in 1999 and 2000 if market conditions warrant.
MCN is also evaluating various international pipeline and processing
opportunities, including investments in natural gas-based fertilizer projects.
ENERGY MARKETING, GAS STORAGE & ELECTRIC POWER markets premium, reliable,
primarily bundled energy services to large-volume customers in the Midwest, Gulf
Coast and Northeast regions of the United States and Eastern Canada. In addition
to owning market-area storage that adds value to its energy marketing
activities, this business unit holds interests in electric power generation
facilities in the United States and Asia.
Energy Marketing, Gas Storage & Electric Power operating and joint venture
income increased $15.8 million in 1997 and $4.9 million in 1996. The increase in
1997 reflects contributions from all businesses, specifically from the April
1997 acquisition of an 18% interest in Midland Cogeneration Venture L. P. (MCV)
(Note 2d). MCV is 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. Earnings from MCV include a favorable
$2.8 million adjustment for a change in accounting for property taxes. Also
contributing to the favorable 1997 results were higher earnings from MCN's
investment in the 50%-owned, 123 MW Michigan Power cogeneration facility.
Improved earnings from the Michigan Power facility are due to an increase in
plant availability and a higher electricity sales rate under its long-term sales
contract. Electric Power earnings reflect a higher level of electricity sales
which more than doubled 1996 sales levels.
33
4
Management's Discussion and Analysis
[Line Graph]
GAS SALES AND
ELECTRIC POWER SALES* EXCHANGE GAS DELIVERIES*
(in Thousands of MW Hours) (in Bcf)
1,843.3...........................97 358.8...................97
241.5...............96
187.1.........95
708.9.....................96
271.8.................95
*Includes MCN's share of joint ventures
The improvement in Energy Marketing's earnings in 1997 is due to a 117.3 Bcf or
49% increase in gas sales and exchange gas deliveries, partially offset by a
slight decrease in margins. The increase in gas sales volumes was driven by
additional sales to the Midwest and Northeast markets. Under exchange gas
contracts, Energy Marketing accepts gas from customers or delivers gas to
customers, and the gas is returned during a subsequent period. MCN has a 50%
equity interest in a joint venture storage project that owns a 10 Bcf storage
facility. This entire storage facility is utilized by MCN's Energy Marketing
unit to enhance its ability to provide reliable gas sales and exchange gas
services.
Gas Storage operating and joint venture income improved slightly in
1997 compared to 1996, primarily resulting from increased contributions from
Diversified Energy's 25% interest in the Blue Lake gas storage project (Blue
Lake). Diversified Energy sold its interest in Blue Lake in December 1997.
Accordingly, the comparability of Gas Storage's future operating results will be
impacted by such sale. MCN's Gas Distribution segment also owns a 25% interest
in Blue Lake and will maintain its share of the venture.
The increase in Energy Marketing, Gas Storage & Electric Power operating and
joint venture income for 1996 reflects a 54.4 Bcf or 29% increase in gas sales
and exchange gas deliveries as well as slightly higher margins on gas sales. The
increase in gas sales volumes was driven primarily by additional sales to
customers in the northeastern United States, as well as sales to the Michigan
Power cogeneration facility which began operations in late 1995.
Outlook - In order to grow Energy Marketing operations, MCN's strategy is to
aggressively pursue marketing opportunities within its current target markets as
well as expanding its coverage outside of those areas. Enhanced by its ability
to provide reliable and custom-tailored storage 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 has entered into marketing alliances with other energy marketers and
suppliers in order to expand its markets in the Great Lakes and Gulf Coast
regions as well as to enter new markets throughout the southern United States.
During 1997, MCN began converting a depleted natural gas reservoir into a 42 Bcf
storage facility. MCN expects the storage field to be completed by mid-1999 and
therefore to be available for the 1999-2000 winter heating season. Upon
completion, the storage field will support Energy Marketing's operations by
enhancing its ability to offer a reliable gas supply during peak winter months.
A key component of MCN's strategy to grow its Energy Marketing business is its
ability to capitalize on opportunities presented by the restructuring of the
electric industry. The electric industry is undergoing transition as a result of
efforts to deregulate electricity sales, on both a federal and state level. MCN
has formed a joint venture with DTE Energy Company to sell electricity, natural
gas and energy-related services to industrial and commercial customers in
nonregulated markets in the Mid-Atlantic and Midwest regions of the United
States. 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 which could be impacted
by electric restructuring.
During 1997, MCN acquired equity securities of Torrent Power Limited, an India
joint venture that holds interests in two electric distribution companies and a
power generation project under construction in the state of Gujarat, India. In
December 1997, MCN acquired an approximate 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 late 1999. In October 1997, MCN
advanced funds to an independent power producer to fund power generation
projects currently under construction in the Philippines. MCN is negotiating the
possible conversion of its advance to an equity interest in the power producer.
MCN is continuing to pursue several other domestic and international power
generation projects. MCN expects a significant increase in Electric Power joint
venture income as it realizes the full benefits from existing investments as
well as from additional investments in international projects over the next
several years.
Foreign currency translation adjustments relating to MCN's international equity
investments are included in Common Shareholders' Equity. The foreign currency
translation adjustment through December 1997 primarily relates to the United
States dollar and India rupee exchange rate fluctuations from the Torrent Power
Limited investment. MCN's financial statements will continue to be impacted by
currency exchange rate fluctuations.
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 has hedged a
significant portion of its gas production not covered by long-term, fixed-price
sales obligations. MCN's Energy Marketing group coordinates all of MCN's hedging
activities
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to ensure compliance with risk management policies which 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 group are absorbed by Energy Marketing.
CORPORATE & OTHER operating and joint venture income includes administrative
expenses associated with corporate management activities. The Diversified Energy
group has been charged a larger portion of such expenses in 1997, reflecting its
growing percentage of MCN. Operating and joint venture losses in 1996 were
partially offset by 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 for 1997 and 1996 reflect higher interest costs on
increased borrowings required to finance capital investments in the Diversified
Energy group, as well as dividends on $200 million of preferred securities
issued in June 1997, $132 million of preferred securities issued in March 1997
and $80 million of preferred securities issued in July 1996 (Note 6).
Partially offsetting the higher interest costs and preferred dividends was
increased interest income resulting from a $46 million advance made to a
Philippine independent power producer (Note 2b).
The other income and deductions comparisons were affected by gains related to
Dauphin Island Gathering Partners (DIGP) as well as a $2.5 million pre-tax gain
from the sale of pipeline assets in 1997 and a $3.2 million pre-tax gain from
the December 1997 sale of Diversified Energy's interest in the Blue Lake storage
project. In a series of transactions during 1996, MCN sold 64% of its 99%
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 (Note 2f).
Included in other income and deductions in 1995 is a $1.4 million bonus received
for exceeding required performance criteria at the Michigan Power project and
the reversal of a $1.6 million uncollectible reserve on an advance made to a
joint venture. The uncollectible provision was reversed upon the receipt of
payments and credit support to ensure repayment of the remaining advance
balance.
INCOME TAXES
The current and deferred income tax provisions reflect increased federal
taxes on improved pre-tax earnings. This increase was partially offset
by increased gas production tax credits related to E&P projects.
GAS DISTRIBUTION
Earnings produce a 13.2% return on equity - The Gas Distribution group
continued its solid performance during 1997 with earnings of $81.1 million,
representing a slight decrease from 1996. Earnings for 1996 increased
$5.8 million or 8% over 1995. The 1996 improvement was due primarily to
increased gross margins resulting from higher gas sales and transportation
deliveries.
GAS DISTRIBUTION OPERATIONS
(in Millions) 1997 1996 1995
----------------------------------
Operating Revenues*
Gas sales $ 1,080.1 $ 1,102.9 $ 931.9
End user transportation 84.7 82.5 80.8
Intermediate transportation 55.2 48.6 42.0
Other 51.3 42.3 52.9
----------------------------------
1,271.3 1,276.3 1,107.6
Cost of Gas 642.0 646.3 491.4
----------------------------------
Gross Margin 629.3 630.0 616.2
----------------------------------
Other Operating Expenses*
Operation and maintenance 286.7 298.4 299.8
Depreciation and depletion 104.4 98.8 91.3
Property and other taxes 61.3 62.3 58.8
----------------------------------
452.4 459.5 449.9
----------------------------------
Operating Income 176.9 170.5 166.3
----------------------------------
Equity in Earnings
of Joint Ventures 2.5 1.3 1.3
----------------------------------
Other Income and (Deductions)*
Interest income 4.7 4.0 4.4
Interest expense (54.5) (48.9) (43.7)
Minority interest (1.9) (1.0) (2.4)
Other .5 (1.8) (6.4)
(51.2) (47.7) (48.1)
----------------------------------
Income Before Income Taxes 128.2 124.1 119.5
Income Taxes 47.1 42.7 43.9
----------------------------------
Net Income $ 81.1 $ 81.4 $ 75.6
----------------------------------
*Includes intercompany transactions
GROSS MARGIN
Gross margins preserved despite warmer weather - Gas Distribution gross margin
(operating revenues less cost of gas) decreased $.7 million in 1997 and
increased $13.8 million in 1996, reflecting changes in gas sales and end user
transportation deliveries due primarily to significantly colder weather in 1996.
Additionally, gross margins in 1997 and 1996 were favorably affected by the
continued growth in intermediate transportation services. Margins in 1997 also
reflect increased other operating revenues resulting from initiatives of the Gas
Distribution segment to grow revenues by providing gas-related services.
EFFECT OF WEATHER ON GAS MARKETS AND EARNINGS
1997 1996 1995
-----------------------
Percentage Colder than Normal .8% 5.4% .3%
Increase from Normal in:
Gas markets (in Bcf) .6 10.9 1.5
Net income (in Millions) $ .5 $ 9.9 $ 1.4
Basic earnings per share $ .01 $ .15 $ .02
35
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Management's Discussion and Analysis
GAS SALES AND END USER TRANSPORTATION revenues in total decreased $20.6 million
in 1997 and increased $172.7 million in 1996. Revenues were affected by
fluctuations in gas sales and end user transportation deliveries which decreased
by 13.7 Bcf to 354.2 Bcf in 1997 and increased by 12.3 Bcf to 367.9 Bcf in 1996.
The decrease in gas sales and end user transportation deliveries in 1997 was due
primarily to weather, which was 4.6% warmer than in 1996. The increase in sales
and transportation deliveries in 1996 was due to 5.1% colder weather over the
previous year as well as marketing initiatives that expanded gas markets. Gas
sales revenues in 1997 and 1996 were also affected by higher gas costs which are
recovered in gas sales rates as discussed in the "Cost of Gas" section. 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 sales and gross margins have
also been affected by variations in revenues associated with MichCon's lost gas
costs.
MichCon's gas sales rates are set to recover lost gas costs using an
averaging method based on historical lost gas experience. As discussed in the
"Cost of Gas" section that follows, gross margins have also been impacted by
variations in lost gas costs.
GAS DISTRIBUTION - VOLUMES/GROSS MARGIN COMPARISON
VOLUMES GROSS MARGINS
(in Bcf) (in Millions of Dollars)
630........................97
940.7...........................97 629.3................................96
895.4....................96 616.2...............95
730.0..............95
[ ] Gas sales [ ] Intermediate Transportation
[ ] End User Transportation [ ] Other
INTERMEDIATE TRANSPORTATION revenues increased by $6.6 million in both 1997 and
in 1996. Revenues reflect deliveries of 586.5 Bcf in 1997 and 527.5 Bcf in 1996,
increases of 59.0 Bcf and 153.1 Bcf, respectively. The increased deliveries are
due primarily to additional volumes of Antrim gas 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 capacity of its northern
Michigan gathering system. The expansion enabled Gas Distribution to transport
an additional 128.5 Bcf in 1997 and 75 Bcf in 1996.
In December 1997, MichCon purchased a $13 million pipeline to expand the
transportation capacity of its northern Michigan gathering system. The pipeline
is expected to transport 44 Bcf of Antrim gas annually.
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 volumes have increased
significantly, profit margins on this service are considerably less than margins
on gas sales or for end user transportation markets.
OTHER OPERATING REVENUES increased $9.0 million in 1997 and decreased $10.6
million in 1996. The improvement in 1997 is due primarily to increased
merchandise sales and other gas-related services. The 1996 decrease reflects the
loss of revenues resulting from the discontinuance of MichCon's energy
conservation programs.
COST OF GAS
Cost of gas is affected by variations in sales volumes and cost of gas rates.
Through the gas cost recovery mechanism, the MPSC allows MichCon to recover all
of its reasonably and prudently incurred cost of gas sold. Therefore,
fluctuations in cost of gas sold have little or no effect on gross margins.
Cost of gas sold decreased in 1997 as a result of lower sales volumes, primarily
due to warmer weather and supplier refunds. Substantially offsetting this
decrease were higher spot market prices paid for natural gas purchases resulting
in a 7% or $.19 increase in the cost of gas sold per Mcf. In 1996, cost of gas
sold increased as a result of significantly higher spot market prices paid for
natural gas purchased and higher sales volumes due to colder weather. Cost of
gas sold for 1996 increased 24% or $.56 per Mcf. To mitigate price volatility
related to spot market prices, MichCon has been authorized by the MPSC to change
its supply strategy to purchase up to one-third of its gas under fixed price
contracts.
As previously discussed, cost of gas is affected by variations in lost gas
amounts. Lost gas costs for 1997 decreased by $.5 million and increased in 1996
by $6.6 million.
OTHER OPERATING EXPENSES
OPERATION AND MAINTENANCE expenses declined by $11.7 million or 4% in 1997 and
decreased slightly in 1996. The reduction for 1997 is due to lower benefit
costs, primarily pension and retiree healthcare costs, as well as lower
uncollectible gas accounts expense. Partially offsetting the decrease in 1997
were higher expenses associated with increased merchandise sales.
Management's continuing efforts to control operating costs also contributed to
the reductions in operation and maintenance expenses. Gas Distribution has
streamlined its organizational
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structure over the past several years while increasing its customer base and
expanding energy services to customers. Since 1994, the number of Gas
Distribution employees has declined by 408 or 12%, while the number of
customers has increased by nearly 40,000 or 3%.
GAS DISTRIBUTION - NUMBER OF
CUSTOMERS SERVED PER EMPLOYEE
409..............................97
380........................96
369................95
Expenses in 1996 were affected by lower benefit costs and reduced expenses
resulting from the discontinuance of MichCon's energy conservation programs.
Significantly offsetting these lower costs in 1996 was an increase in
uncollectible gas accounts expense. Uncollectible gas accounts were driven
higher by 1996's colder temperatures and rising gas prices which significantly
increased customers' heating bills. The impact of higher heating bills was
worsened by a reduction and delay in the home heating assistance funding
obtained by low-income customers.
Gas Distribution receives a significant amount of its heating assistance
funding from the federal Low-Income Home Energy Assistance Program (LIHEAP).
Congress reduced a substantial portion of the program's funding for the 1996
fiscal year, but increased the program's funding for the 1997 fiscal year to
$1 billion. The State of Michigan's share of LIHEAP funds was increased from
$47.5 million in fiscal year 1996 to $64 million in 1997. A significant
portion of such funds was passed on to qualified residents in the form of
Michigan Home Heating Credits. Gas Distribution received $12.7 million of
these funds, $3.5 million more than in 1996. Home Heating Credits assisted
83,000 Gas Distribution customers in 1997, compared to 74,000 in 1996.
During 1997, Congress approved a budget, which provides for federal LIHEAP
funding at $1 billion and $1.1 billion for fiscal years 1998 and 1999,
respectively. A portion of any future increase or decrease in funding may impact
MichCon's uncollectible accounts. MichCon is currently working with federal and
state officials to identify other ways to obtain energy assistance for
low-income customers and is taking actions to minimize the impact a reduction in
LIHEAP funds would have on MCN's financial statements.
DEPRECIATION AND DEPLETION increased in both 1997 and 1996 due to higher plant
balances, reflecting capital expenditures of $614.5 million over the past
three years. The MPSC approved an order that lowers MichCon's depreciation
rates effective January 1, 1998. In 1998, these new depreciation rates will
largely offset the increase in depreciation expense resulting from additional
capital expenditures. While the Michigan Attorney General has appealed the
depreciation order, management believes the MPSC order approving the lower
depreciation rates will be upheld.
PROPERTY AND OTHER TAXES decreased in 1997 and increased in 1996. Gas
Distribution reduced its property taxes for 1997 based on pending appeals of
personal property tax assessments. Gas Distribution has been assessed additional
amounts which are being protested. Management does not believe payments of these
additional amounts is probable. Offsetting the reduction in 1997 property and
other taxes was an increase in Michigan single business taxes due to improved
pre-tax earnings. Property and other taxes increased in 1996 as a result of
higher plant balances.
EQUITY IN EARNINGS OF JOINT VENTURES
Earnings from joint ventures increased in 1997 and were unchanged in 1996 as
compared to 1995. Joint venture earnings in 1997 reflect increased contributions
from the Blue Lake gas storage project as a result of reduced operating and
financing costs.
OTHER INCOME AND DEDUCTIONS
Interest expense increased in 1997 and 1996 due to additional long-term debt
required to finance capital investments. During 1997, MichCon issued $85
million of first mortgage bonds and nonutility subsidiaries of MichCon borrowed
$40 million under a nonrecourse credit agreement. During 1996, MichCon issued
$70 million of first mortgage bonds. In 1996, other income and deductions were
affected by an increase in the capitalization of the cost of equity funds used
during construction resulting from higher construction balances.
INCOME TAXES
Income tax increased in 1997 and decreased in 1996. Income taxes were
impacted by variations in pre-tax earnings. Income tax comparisons were
also impacted by the amounts recorded in 1996 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. None of these former MGP sites is on the
National Priorities List prepared by the U.S. Environmental Protection Agency.
37
8
Management's Discussion and Analysis
MCN is not involved in any administrative proceedings regarding these former MGP
sites but is currently remediating four of these sites and conducting more
extensive investigations at five other sites.
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 remedial activities at
all 17 former MGP sites could range between $30 million and $170 million based
on undiscounted 1995 costs. As a result of these studies, MCN accrued an
additional liability and a corresponding regulatory asset of approximately $35
million during 1995.
MCN has 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.
During 1997, 1996 and 1995, MCN spent $.8 million, $.9 million and $2.1 million,
respectively, investigating and remediating these former MGP sites. At December
31, 1997, the reserve balance was $36.7 million, of which $1.7 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 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.
OUTLOOK
Gas Distribution's strategy is to become the provider of choice for natural gas
and high-value energy services within Michigan. Accordingly, Gas Distribution's
objectives are to grow its revenues and reduce its costs in order to maintain
strong returns and provide customers with high-quality service at competitive
prices. Revenue growth will be achieved through initiatives to expand Gas
Distribution's 940 Bcf of gas markets and its 1.2 million residential,
commercial and industrial customer base.
Gas Distribution expects to provide natural gas to approximately 20,000 new
customers in 1998. Gas Distribution's market share for residential heating
customers in the communities in which it serves is approximately 80%. While this
saturation rate is high, significant opportunities exist through conversion of
existing homes from other fuels as well as from new construction. Gas
Distribution continues to expand the industrial and commercial markets by
aggressively facilitating the use of existing gas technologies and equipment as
well as by developing new natural gas technologies.
Management is continually assessing ways to improve cost competitiveness. Among
other cost saving initiatives, Gas Distribution has signed contracts with the
Detroit Edison Company and other utilities to share the cost of payment
processing, meter reading and staking of underground facilities. Gas
Distribution is continuing to explore opportunities to share the cost of common,
duplicative operating functions.
In December 1997, MichCon announced an early retirement incentive program. This
program could affect approximately 10% of MichCon's work force. Management does
not believe that these costs will have a material impact on 1998 net income.
However, 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. MichCon and other Michigan gas utilities voluntarily
implemented pilot transportation service programs in 1997 for small commercial
and residential customers. The overall package of regulatory changes connected
with the gas industry restructuring is expected to generate additional revenue
and cost savings opportunities as the restructuring advances. 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.
As described in Note 9 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, 1997, it would have an
extraordinary, noncash increase to net income of approximately $44 million.
Criteria that 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, man-
38
9
agement 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,
Genix, to Affiliated Computer Services, Inc. for an initial sales price of
$137.5 million, resulting in an after-tax gain of $36.2 million. In October
1996, the initial sales price was decreased by $4.6 million to reflect the
reduction in Genix's working capital between the effective and closing dates
of the transaction. The selling price of Genix could be further adjusted
downward by as much as $26.2 million depending upon the occurrence of certain
contingencies that include, among other things, retention of certain customers
through mid-1998 and tax-related matters. Management believes that no further
adjustment to the selling price will occur.
CAPITAL RESOURCES AND LIQUIDITY
OPERATING ACTIVITIES
MCN's cash flow from operating activities increased $145.1 million during 1997
and decreased $69.7 million during 1996. The increase in 1997 was primarily the
result of lower working capital requirements. Higher net income, after adjusting
for noncash items (depreciation and deferred taxes) and nonoperating gains
(Notes 2f and 2h), also contributed to the increase in 1997. The 1996 decrease
was due primarily to an increase in working capital requirements, partially
offset by higher net income, after adjusting for noncash items and nonoperating
gains.
FINANCING ACTIVITIES
In June 1997, MCN sold 9,775,000 shares of common stock in a public offering,
generating net proceeds of $276.6 million (Note 7a). Proceeds from this issuance
were used to fund capital expenditures, to repay short-term obligations and for
general corporate purposes.
In June 1997, MCN issued, through wholly-owned trusts, 100,000 Private
Institutional Trust Securities (PRINTS) and 100,000 Single Point Remarketed
Reset Capital Securities (SPRRCS) (Note 6b). Net proceeds of $199.1 million 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.
In March 1997, MCN issued 2,645,000 FELINE PRIDES, generating net proceeds of
$127.4 million (Note 6a). Proceeds from the issuance were used to reduce
short-term debt incurred by the Diversified Energy group to fund capital
investments and for general corporate purposes.
In July 1996, MCN issued, through a wholly-owned trust, 3,200,000 shares of
Trust Originated Preferred Securities (TOPrS), generating net proceeds of $77.2
million (Note 6c). 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.
In April 1996, MCN issued 5,865,000 Preferred Redeemable Increased Dividend
Equity Securities (Enhanced PRIDES) (Note 6d). 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,
approximately $135 million of MCN common stock in April 1999.
In March 1995, MCN sold 5,750,000 shares of new common stock in a public
offering, generating approximately $99 million. Proceeds from this issuance were
used to fund capital expenditures, to repay short-term obligations and for
general corporate purposes.
MCN also issues new shares of common stock pursuant to its Dividend Reinvestment
and Stock Purchase Plan and various employee benefit plans. During the 1995-1997
period, MCN issued 2,949,000 shares, generating $51.6 million. During 1998, MCN
anticipates the issuance of new shares of common stock pursuant to these plans,
generating approximately $20 million.
As of December 1997, MCN had an outstanding shelf registration with
approximately $136 million remaining to be issued in the form of debt or equity
securities. MCN anticipates filing a new registration statement with the
Securities and Exchange Commission (SEC) in the first quarter of 1998 to allow
it to issue an additional $800 million of debt and equity securities. MCN's
capital requirements and general market conditions will affect the timing and
amount of future issuances.
The following table sets forth the ratings for securities issued by MCN and
its subsidiaries. These ratings are considered investment grade by each rating
agency.
Standard Duff &
& Poor's Moody's Phelps Fitch
--------------------------------------------
MCN:
FELINE PRIDES BBB+ baa2 BBB+ BBB+
Enhanced PRIDES BBB+ baa1 BBB+ BBB+
PRINTS/SPRRCS A- baa1 A- A-
TOPrS/preferred
securities BBB+ baa2 BBB+ BBB+
MCNIC:
Commercial paper* A2 P2 D1- F2
Medium-term notes* BBB+ Baa2 A- BBB+
MichCon:
Commercial paper A1 P1 D1 F1
First mortgage bonds A A2 A+ A
--------------------------------------------
*Ratings based on MCN support agreement
DIVERSIFIED ENERGY
MCNIC has established credit lines for borrowings of up to $100 million under
a 364-day revolving credit facility and up to $300 million under a three-year
revolving credit facility, both of which expire in July 1998. 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 gas marketing operations.
During 1997, MCNIC repaid $182.5 million of commercial paper. Commercial paper
of $147.4 million was outstanding at December 31, 1997.
39
10
Management's Discussion and Analysis
In June 1997, MCNIC repaid $30 million of senior debt on its stated maturity
date.
In January 1997, MCNIC issued $150 million of medium-term notes, using the
proceeds to repay short-term debt and for general corporate purposes.
In January and May 1996, MCNIC issued $200 million and $130 million,
respectively, of medium-term notes using the proceeds to repay commercial paper
balances and for general corporate purposes.
As of December 1997, MCNIC had an outstanding shelf registration with
approximately $220 million remaining to be issued in the form of debt
securities. MCNIC anticipates filing a new registration statement with the SEC
in the first quarter of 1998 to allow it to issue an additional $700 million of
debt securities. MCNIC's capital requirements and general market conditions will
affect the timing and amount of future issuances.
In order to finance investment activities, MCN's E&P business obtained $100
million under a five-year term loan during 1995.
GAS DISTRIBUTION
During the latter part of each year, Gas Distribution generally incurs
short-term debt to finance increases in gas inventories and customer accounts
receivable. The short-term debt is normally reduced in the first part of the
year as gas inventories are depleted and funds are received from winter heating
sales. To meet its seasonal short-term borrowing needs, MichCon normally issues
commercial paper that is backed by credit lines with several banks. MichCon has
established credit lines to allow for borrowings of up to $150 million under a
364-day revolving credit facility and up to $150 million under a three-year
revolving credit facility, both of which expire in July 1998. At December 31,
1997, commercial paper of $236.7 million was outstanding under this program.
During May 1997, MichCon issued $85 million of first mortgage bonds under its
existing shelf registrations. The funds from this issuance were used to retire
first mortgage bonds, fund capital expenditures and for general corporate
purposes.
During April 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 the second quarter of 1997, MichCon redeemed $17 million of long-term
debt. MichCon also repaid $50 million of first mortgage bonds on its stated
maturity date in May 1997.
MichCon issued first mortgage bonds totaling $70 million in both 1996 and 1995.
The proceeds were used to repay short-term obligations, finance capital
expenditures and for general corporate purposes.
MichCon repaid all amounts owing under its Trust Demand Note program and did not
renew this program which expired in March 1997 and allowed for borrowings of up
to $25 million.
As of December 1997, MichCon had an outstanding shelf registration with
approximately $215 million remaining to be issued in the form of debt
securities.
INVESTING ACTIVITIES
CAPITAL INVESTMENTS
(in Millions) 1997 1996 1995
-----------------------------------
Consolidated Capital Expenditures:
Diversified Energy $ 405.0 $ 395.3 $ 291.5
Gas Distribution 157.7 215.3 241.5
Discontinued Operations - 6.5 9.4
-----------------------------------
562.7 617.1 542.4
-----------------------------------
MCN's Share of Joint Venture
Capital Expenditures:
Pipelines & Processing 152.2 5.2 1.0
Energy Marketing, Gas Storage,
& Power Generation 10.6 5.7 40.0
Gas Distribution 2.6 4.8 10.3
Other .5 .3 1.5
-----------------------------------
165.9 16.0 52.8
-----------------------------------
Acquisitions:
Significant (Note 2)* 231.0 133.2 83.2
Other - 24.4 10.4
-----------------------------------
231.0 157.6 93.6
-----------------------------------
Total Capital Investments $ 959.6 $ 790.7 $ 688.8
-----------------------------------
*Includes MCN's share of GTEC debt existing at the date of acquisition (Note 2c)
Capital investments near $1 billion - Capital investments increased $168.9
million in 1997 due to acquisitions in electric power generation and
distribution projects (Notes 2a, 2c and 2d) and increased investments in
Pipelines & Processing joint ventures.
In December 1997, Gas Distribution invested $31.3 million in a grantor trust to
meet future obligations related to certain postretirement healthcare costs (Note
11c), and Diversified Energy advanced $46 million to an independent power
producer to fund power generation projects under development in the Philippines
(Note 2b).
During 1997, MCN's E&P business sold certain gas and oil properties generating
proceeds of $64.2 million. During 1996, MCN completed the sale of Genix (Note
2h) and interests in DIGP (Note 2f) resulting in total proceeds of $168.9
million. Proceeds from these sales were used to reduce debt incurred to fund
Diversified Energy's capital investments.
Outlook
MCN's strategic direction is to grow significantly by investing in a portfolio
of energy-related projects. MCN's capital investments could range between $6
billion and $9 billion over the next five years. During 1998, MCN expects
capital investments to range from $1.2 billion to $1.5 billion, with
approximately 80% to 85% in Diversified Energy and the remainder in Gas
Distribution.
Within the Diversified Energy group, MCN anticipates over $400 million will be
invested in E&P projects for drilling operations and to acquire reserves in the
Midwest/Appalachia, Midcontinent/Gulf Coast and Western regions. Approximately
$250 million is expected to be invested in electric power projects, primarily
through foreign joint ventures. The remaining $350 million of
40
11
expenditures are anticipated to be in pipeline, gathering, processing and
related projects.
Gas Distribution capital investments during 1998 will approximate $200 million
and will be made to add new customers, develop new gas transportation markets,
make improvements to existing storage and transmission systems and improve its
information system.
The proposed level of investments in 1998 and 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 capital requirements
and general market conditions will affect 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 55% equity and 45% 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.
NEW ACCOUNTING PRONOUNCEMENTS
YEAR 2000 - In 1996 the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board reached a consensus that the cost associated with
modifying internal use software for the year 2000 should be expensed as
incurred. The year 2000 issue is the 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 could cause computer systems to perform
inaccurate calculations.
MCN has established processes for evaluating and managing the risks and costs
associated with the year 2000 issue. MCN has conducted a review to identify
computer systems that could be affected by the inability of these systems to
properly recognize the digits for the year 2000. MCN has developed a corrective
plan and is currently implementing such plan. Based on the corrective plan,
costs associated with the year 2000 issue are estimated to total between $5
million and $6 million over the next two years. The anticipated costs are not
higher due in part to the ongoing replacement of significant old systems. New
systems in process of being installed as well as those installed over the past
few years are year 2000 compliant. These systems were necessary to maintain a
high level of customer satisfaction and to respond to changes in regulation and
increased competition within the energy industry.
MCN is working with its suppliers, operators and partners to mitigate any
adverse effects of their system failures on MCN. As a result, management cannot
quantify the impact to MCN of other companies' system failures, but does not
expect it to be material.
REENGINEERING ACTIVITIES - In 1997 the EITF reached a consensus that the cost of
business process reengineering activities, whether done internally or by third
parties, is to be expensed as incurred. This consensus also applies when the
business process reengineering activities are part of a project to acquire,
develop or implement internal use software. Management does not expect the
financial impact of such activities to be material to MCN's results of
operations.
FORWARD LOOKING STATEMENTS
The 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, 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, and (x) the effects of changes in
governmental policies and regulatory actions, including income taxes,
environmental compliance and authorized rates.
41
12
Consolidated Statement of Cash Flows
Year Ended December 31 (in Thousands) 1997 1996 1995
----------------------------------
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 142,306 $150,340 $ 96,756
Adjustments to reconcile net income to net cash
provided from operating activities
Depreciation, depletion and amortization
Per statement of income 181,612 145,990 114,585
Charged to other accounts 7,728 11,026 14,318
Deferred income taxes-current (2,701) 8,061 8,927
Deferred income taxes and investment tax
credit, net 11,660 23,892 30,284
Gains related to DIGP and Genix, net of taxes (Notes 2f and 2h) (1,560) (40,326) -
Equity in earnings of joint ventures, net of distributions (16,511) (2,506) 1,777
Other (3,896) (3,391) 1,376
Changes in assets and liabilities, exclusive of
changes shown separately 24,746 (94,754) (20)
----------------------------------
Net cash provided from operating activities 343,384 198,332 268,003
----------------------------------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net 68,000 87,491 16,828
Dividends paid (72,851) (62,875) (58,193)
Issuance of common stock (Note 7a) 294,402 17,264 115,725
Issuance of preferred securities (Note 6) 326,521 77,218 -
Issuance of long-term debt 273,241 398,540 168,864
Long-term commercial paper and credit facilities, net (261,822) (62,835) 142,657
Retirement of long-term debt and preferred securities (109,224) (8,139) (8,271)
Other 4,612 (6,249) (2,084)
----------------------------------
Net cash provided from financing activities 522,879 440,415 375,526
----------------------------------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures (561,354) (610,323) (537,156)
Acquisitions (Notes 2) (166,553) (133,201) (83,176)
Investment in debt and equity securities (Notes 2b and 11c) (63,123) (26,903) (243)
Investment in joint ventures (152,642) (36,217) (20,539)
Sale of E&P property and equipment 64,200 621 -
Sale of Genix (Note 2h) - 132,889 -
Sale of investment in joint ventures 3,165 36,000 10,803
Other 19,077 9,590 (5,506)
----------------------------------
Net cash used for investing activities (857,230) (627,544) (635,817)
----------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 9,033 11,203 7,712
CASH AND CASH EQUIVALENTS, JANUARY 1 30,462 19,259 11,547
----------------------------------
CASH AND CASH EQUIVALENTS, DECEMBER 31 $ 39,495 $ 30,462 $ 19,259
----------------------------------
CHANGES IN ASSETS AND LIABILITIES, EXCLUSIVE OF
CHANGES SHOWN SEPARATELY
Accounts receivable, net $ (47,541) $(66,183) $(103,951)
Accrued unbilled revenues 15,499 (16,099) (9,357)
Accrued/deferred gas cost recovery revenues 14,810 (28,250) (18,495)
Gas in inventory 22,384 (7,398) 59,886
Accounts payable 8,834 102,711 74,537
Federal income, property and other taxes payable (5,934) (19,587) (3,716)
Prepaid/accrued benefit costs (16,086) (50,972) (27,199)
Other current assets and liabilities 11,522 (14,485) (2,819)
Deferred assets and liabilities 21,258 5,509 31,094
----------------------------------
24,746 $(94,754) $ (20)
----------------------------------
SUPPLEMENTAL DISCLOSURES
Cash paid during the year for:
Interest, net of amounts capitalized $ 97,659 $ 74,775 $ 52,833
Federal income taxes 30,300 19,934 9,366
Noncash investing and financing activities:
Common stock and performance units $ 19,188 $ 6,210 $ -
Foreign currency translation adjustment 6,292 98 123
Sale of investment in joint ventures 8,562 - -
Yield enhancement and contract costs 2,702 8,243 -
Property purchased under capital leases 1,303 6,765 3,809
The notes to the consolidated financial statements are an integral part of this
statement.
44
13
CONSOLIDATED STATEMENT OF CAPITALIZATION
1997 1996 1995
Year Ended December 31 (in Thousands) ----------------------------------------
LONG-TERM DEBT, EXCLUDING CURRENT REQUIREMENTS (Note 5)
First mortgage bonds, interest payable semi-annually
6-1/4% series due 1997 $ - $ - $ 50,000
6.30% series due 1998 - 20,000 20,000
6.51% series due 1999 30,000 30,000 -
5-3/4% series due 2001 60,000 60,000 60,000
8% series due 2002 70,000 70,000 70,000
6.72% series due 2003 4,150 4,150 4,150
6.80% series due 2003 15,850 15,850 15,850
9-1/8% series due 2004 55,000 55,000 55,000
7.15% series due 2006 40,000 40,000 -
7.21% series due 2007 30,000 - -
7.06% series due 2012 40,000 - -
8-1/4% series due 2014 80,000 80,000 80,000
7.60% series due 2017 14,990 - -
9-1/2% series due 2019 - 5,000 5,000
7-1/2% series due 2020 29,641 29,812 30,000
9-1/2% series due 2021 40,000 40,000 40,000
6-3/4% series due 2023 17,177 17,782 18,416
7% series due 2025 40,000 40,000 40,000
Unamortized discount (1,235) (1,349) (1,390)
Medium-term notes, interest payable semi-annually
5.84% series due 1999 80,000 80,000 -
6.82% series due 1999 130,000 130,000 -
6.03% series due 2001 60,000 60,000 -
6.89% series due 2002 90,000 - -
6.32% series due 2003 60,000 60,000 -
7.12% series due 2004 60,000 - -
Senior notes-7.79% series due 1997, interest
payable semi-annually - - 30,000
Term loan due 2000, interest
payable quarterly 100,000 100,000 100,000
Unsecured notes-9-3/4% series due 2000,
interest payable semi-annually - 12,000 12,000
Commercial paper and credit facilities - 261,822 324,657
Project loan due 2006, interest payable
quarterly 14,080 15,840 17,600
Long-term capital lease obligations 7,702 16,625 18,532
Other long-term debt 45,209 9,508 3,592
-------------------------------------------
1,212,564 1,252,040 993,407
-------------------------------------------
REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES (Note 6)
MCN-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES
HOLDING SOLELY DEBENTURES OF MCN, net of unamortized deferred
issuance costs, $512,250,000 aggregate liquidation preference value,
10,045,000 shares authorized and outstanding, Series A 505,104 173,809 96,449
-------------------------------------------
COMMON SHAREHOLDERS' EQUITY (Note 7)
COMMON STOCK,
par value $.01 per share-100,000,000 shares authorized,
78,231,889, 67,303,908, and 66,370,230 shares outstanding,
respectively 782 673 664
-------------------------------------------
ADDITIONAL PAID-IN CAPITAL
Balance-beginning of period 493,469 446,055 331,571
Common stock and performance units 313,485 47,326 115,840
Other (1,141) (303) (1,583)
-------------------------------------------
Balance-end of period 805,813 493,078 445,828
-------------------------------------------
RETAINED EARNINGS
Balance-beginning of period 305,352 218,425 179,862
Net income 142,306 150,340 96,756
Cash dividends declared on common stock (72,851) (62,875) (58,193)
Other - (538) -
-------------------------------------------
Balance-end of period 374,807 305,352 218,425
-------------------------------------------
FOREIGN CURRENCY TRANSLATION ADJUSTMENT (Note 1) (6,335) (43) (141)
-------------------------------------------
YIELD ENHANCEMENT, CONTRACT AND ISSUANCE COSTS (Notes 6a and 6d) (22,039) (14,492) -
-------------------------------------------
1,153,028 784,568 664,776
-------------------------------------------
TOTAL CAPITALIZATION
$ 2,870,696 $2,210,417 $1,754,632
-------------------------------------------
The notes to the consolidated financial statements are an integral part of
this statement.
45
14
Notes to Consolidated Finanacial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MCN Energy Group Inc. (MCN) is a diversified energy company with markets and
investments throughout North America and in Asia. MCN operates through two major
business groups, Diversified Energy and Gas Distribution.
- - Diversified Energy, operating through MCN Investment Corporation (MCNIC),
is involved in the following businesses: Exploration & Production (E&P)
with 1.3 trillion cubic feet equivalent (Tcfe) of proved gas and oil
reserves at December 31, 1997 in the Midwest/Appalachia, Midcontinent/Gulf
Coast and Western regions of the United States; Pipelines & Processing with
gathering, processing and transmission facilities near areas of rapid
reserve development and growing consumer markets; Energy Marketing with
total gas sales and exchange gas delivery markets of 358.8 billion cubic
feet (Bcf) for 1997; Electric Power with investments in electric generation
facilities in operation and under development with a combined 2,804
megawatts (MW) of gross capacity and investments in electric distribution
facilities; and Gas Storage with investments in storage facilities that
have 52 Bcf of storage capacity, 42 Bcf of which is currently under
development.
- - 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. Less than half of MichCon's
labor force is covered by collective bargaining agreements. In June 1998,
bargaining agreements covering approximately 15% of the labor force are due
to expire.
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 1997 presentation.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the
accounts of MCN and certain consolidated subsidiaries and partnerships. E&P
investments are predominantly accounted for using the proportionate
consolidation method. Investments in other entities in which MCN has a
controlling influence 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. MichCon also accrues revenues equal to the
recoverable cost of gas sold. Annual gas cost recovery (GCR) proceedings before
the MPSC permit MichCon to recover the prudent and reasonable cost of gas sold.
Any overcollection or undercollection of costs, including interest, will be
reflected in future rates.
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 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 $.75, $.70, and $.67 in
1997, 1996 and 1995, 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.
PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment, excluding E&P
property, is stated at cost and includes appropriate amounts of labor,
materials, overhead and an allowance for funds used during construction. Unit of
production depreciation and depletion is used for certain Gas Distribution
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:
1997 1996 1995
------------------------------------
Pipelines & Processing 3.5% 3.8% 2.1%
Gas Distribution 4.1% 4.4% 4.4%
Other 12.3% 10.1% 13.3%
INCOME TAXES AND INVESTMENT TAX CREDITS -- Tax Benefits Amortizable to Customers
represents the net revenue equivalent
46
15
of the difference in property-related accumulated deferred income taxes computed
in accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes" as compared to the amounts previously reflected in
setting utility rates. This amount is 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.
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 $18,190,000,
$14,631,000, and $7,893,000 in 1997, 1996 and 1995, respectively.
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.
SALES OF OWNERSHIP INTEREST 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.
FOREIGN CURRENCY TRANSLATION -- 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 United States 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
shown as a separate component of Common Shareholders' Equity and have no effect
on net income.
2. ACQUISITIONS, INVESTMENTS AND DISPOSITION
a. BHOTE KOSHI POWER COMPANY
In December 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 the fourth quarter of 1999. At December 31, 1997, MCN had paid
$3,760,000 of its total equity commitment of $20,100,000. The equity commitment
balance will be paid over the next two years. The investment is accounted for
under the equity method.
b. PHILIPPINE INVESTMENT
In October 1997, MCN advanced approximately $46,000,000 to an independent power
producer to fund power generation projects already under construction in the
Philippines. This investment is structured as an interest bearing loan with the
possibility of being converted into an equity interest in the independent power
producer. MCN's negotiations toward converting its advance to an equity interest
have been complicated by the devaluation of the Philippine peso.
c. TORRENT POWER LIMITED
In March 1997, MCN acquired a 40% interest in the common equity of Torrent Power
Limited (TPL), an India joint venture that holds minority interests in electric
distribution companies and power generation facilities located in the state of
Gujarat, India. In August and October 1997, MCN acquired preference shares in
TPL, bringing the total cost of the acquisitions to $114,200,000, of which
$108,000,000 was paid through December 1997. The remainder is expected to be
paid in 1998. Specifically, 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 is currently constructing a
655 MW dual fuel generation facility, the first phase of which became
operational in October 1997, and the entire facility is expected to be fully
completed by the end of 1998. In addition to equity investments, the
construction of this facility is being funded through nonrecourse project
financing of which the portion attributable to MCN's existing interest will be
approximately $90,000,000. TPL is currently negotiating to acquire further
interests in AEC and GTEC.
d. MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
During the second quarter of 1997, MCN purchased an 18% general partnership
interest in Midland Cogeneration Venture Limited Partnership (MCV), 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. The investment totaled
$54,750,000 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.
47
16
Notes to Consolidated Financial Statements
e. LYONDELL METHANOL COMPANY, L.P.
In December 1996, MCN acquired a 25% interest in Lyondell Methanol Company,
L.P., a limited partnership that owns and operates a 248 million gallon-per-year
methanol processing 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.
f. DAUPHIN ISLAND GATHERING PARTNERS
In the first quarter of 1996, MCN acquired a 99% interest in Dauphin Island
Gathering Partners (DIGP), a general partnership that owns a 90-mile gas
gathering system in the Mobile Bay area of offshore Alabama. The acquisition
totaled $78,620,000 and was accounted for under the purchase method. In mid-1996
MCN sold a 40% interest in the partnership to Pan Energy Dauphin Island Company
for $36,000,000. The sale resulted in a pre-tax gain of $3,986,000.
In December 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 the third quarter of 1997 when the related option agreement
expired unexercised. The three additional partners paid for their interests by
contributing the Main Pass Gathering System (Main Pass) to DIGP. Main Pass is a
57-mile offshore gas gathering system in the Gulf of Mexico, which was appraised
at $72,200,000. As a result of the sales, MCN's ownership interest in DIGP was
reduced to 35%. MCN no longer had a controlling interest, and accordingly DIGP
was deconsolidated and is accounted for under the equity method. The financial
information included herein reflects DIGP as an unconsolidated partnership for
all periods presented.
g. CONSOL COAL GROUP PROPERTIES
During December 1995, MCN acquired certain gas producing and pipeline businesses
located in Virginia from CONSOL Coal Group. The acquisition included 193 Bcf of
proved reserves, as well as rights to undertake additional development drilling
on approximately 100,000 acres of coalbed methane properties. The acquisition
also included approximately 80 miles of gathering lines and a 50% interest in a
40-mile gathering line connected to a major interstate pipeline. The acquisition
totaled $83,176,000 and was accounted for under the purchase method.
h. THE GENIX GROUP, INC.
In June 1996, MCN completed the sale of its computer operations subsidiary, The
Genix Group, Inc. (Genix), to Affiliated Computer Services, Inc. (ACS) for an
initial sales price of $137,500,000, resulting in an after-tax gain of
$36,176,000. In October 1996, the initial sales price was decreased
approximately $4,600,000 to reflect the reduction in Genix's working capital
between the effective and closing dates of the transaction. The selling price of
Genix could be further adjusted downward by as much as $26,200,000 depending
upon the occurrence of certain contingencies which include, among other things,
retention of certain customers through mid-1998 and tax-related matters.
Management believes that no further adjustment to the selling price will occur.
The results of Genix's operations have been accounted for as a discontinued
operation.
3. INVESTMENTS IN AND ADVANCES TO JOINT VENTURES
MCN has equity interests in several ventures involved in the following
businesses: Pipelines & Processing - 20% to 85% owned; Energy Marketing, Gas
Storage & Electric Power - 18% to 100% owned (includes temporarily controlled
entities); Gas Distribution - 47-1/2% owned; and Real Estate & Other - 33% to
50% owned. 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.
(in Thousands) 1997 1996 1995
-------------------------------------------
Operating Revenues
Pipelines & Processing $ 306,636 $ 64,530 $ 3,700
Energy Marketing, Gas
Storage & Electric Power 1,269,125 114,793 59,634
Real Estate & Other 22,447 19,937 17,471
-------------------------------------------
$ 1,598,208 $ 199,260 $ 80,805
-------------------------------------------
MCN's Share of Operating Revenues
Pipelines & Processing $ 144,823 $ 36,927 $ 1,535
Energy Marketing, Gas
Storage & Electric Power 418,005 64,595 36,381
Real Estate & Other 7,740 8,684 5,914
-------------------------------------------
$ 570,568 $ 110,206 $ 43,830
-------------------------------------------
Operating Income
Pipelines & Processing $ 89,491 $ 21,426 $ 1,545
Energy Marketing, Gas
Storage & Electric Power 256,236 32,736 21,853
Real Estate & Other 2,817 1,914 1,984
-------------------------------------------
$ 348,544 $ 56,076 $ 25,382
-------------------------------------------
MCN's Share of Operating Income
Pipelines & Processing $ 27,485 $ 11,584 $ 718
Energy Marketing, Gas
Storage & Electric Power 58,604 17,533 11,790
Real Estate & Other 645 1,387 425
-------------------------------------------
$ 86,734 $ 30,504 $ 12,933
-------------------------------------------
Income (Loss) Before Taxes
Pipelines & Processing $ 90,047 $ 21,391 $ 1,546
Energy Marketing, Gas
Storage & Electric Power 99,718 12,135 10,558
Real Estate & Other 7,688 (3,332) (5,202)
-------------------------------------------
$ 197,453 $ 30,194 $ 6,902
-------------------------------------------
MCN's Share of Income (Loss)
Before Taxes
Pipelines & Processing $ 28,551 $ 10,590 $ 628
Energy Marketing, Gas
Storage & Electric Power 20,034 5,979 5,030
Real Estate & Other 7,074 1,298 (413)
-------------------------------------------
$ 55,659 $ 17,867 $ 5,245
-------------------------------------------
MCN's Share of Income
Before Taxes by Segment
Diversified Energy $ 53,125 $ 16,611 $ 3,903
Gas Distribution 2,534 1,256 1,342
-------------------------------------------
$ 55,659 $ 17,867 $ 5,245
-------------------------------------------
48
17
(in Thousands) 1997 1996
--------------------------
ASSETS
Current Assets
Pipelines & Processing $ 98,563 $ 33,065
Energy Marketing, Gas
Storage & Electric Power 601,313 28,793
Gas Distribution 2,183 1,834
Real Estate & Other 15,287 8,964
--------------------------
717,346 72,656
--------------------------
Noncurrent Assets
Pipelines & Processing 494,784 309,837
Energy Marketing, Gas
Storage & Electric Power 3,029,580 311,941
Gas Distribution 45,450 36,619
Real Estate & Other 107,781 119,203
--------------------------
3,677,595 777,600
--------------------------
$ 4,394,941 $ 850,256
--------------------------
MCN's Share of Total Assets
Pipelines & Processing $ 296,670 $ 162,145
Energy Marketing, Gas
Storage & Electric Power 776,141 191,846
Gas Distribution 22,626 18,265
Real Estate & Other 38,826 39,824
--------------------------
$ 1,134,263 $ 412,080
--------------------------
LIABILITIES AND JOINT VENTURES' EQUITY
Current Liabilities
Pipelines & Processing $ 48,262 $ 20,591
Energy Marketing, Gas
Storage & Electric Power 531,004 26,344
Gas Distribution 986 1,036
Real Estate & Other 9,982 5,253
--------------------------
590,234 53,224
--------------------------
Noncurrent Liabilities
Pipelines & Processing 5,466 8,455
Energy Marketing, Gas
Storage & Electric Power 2,223,088 226,874
Gas Distribution 29,042 23,600
Real Estate & Other 88,320 92,723
--------------------------
2,345,916 351,652
--------------------------
Joint Ventures' Equity
Pipelines & Processing 539,619 313,856
Energy Marketing, Gas
Storage & Electric Power 876,801 87,516
Gas Distribution 17,605 13,817
Real Estate & Other 24,766 30,191
--------------------------
1,458,791 445,380
--------------------------
$ 4,394,941 $ 850,256
--------------------------
MCN's Share of Joint Ventures' Equity
Pipelines & Processing $ 259,116 $ 146,356
Energy Marketing, Gas
Storage & Electric Power 186,076 48,959
Gas Distribution 8,363 6,675
Real Estate & Other 16,558 17,886
--------------------------
470,113 219,876
Goodwill and Other(1) 86,863 45,512
--------------------------
MCN's Investment In and
Advances to Joint Ventures $ 556,976 $ 265,388
--------------------------
(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 23 years.
4. GAS IN INVENTORY
Inventory gas is priced on a last-in, first-out (LIFO) basis. At December 31,
1997, the replacement cost exceeded the $56,777,000 LIFO cost for 73 Bcf by
$176,373,000. At December 31, 1996, the replacement cost exceeded the
$79,161,000 LIFO cost for 85 Bcf by $269,083,000. MichCon's current GCR tariff
provisions prevent MichCon from retaining any benefits from a lower cost of gas
sold resulting from liquidating its LIFO inventory. MichCon's LIFO inventory
balance was 65 Bcf and 74 Bcf at December 31, 1997 and 1996, respectively.
5. CREDIT FACILITIES, SHORT-TERM
BORROWINGS AND LONG-TERM DEBT
At December 31, 1997, MCNIC had credit lines permitting borrowings of up to
$100,000,000 under a 364-day revolving credit facility and up to $300,000,000
under a three-year revolving credit facility, both of which expire in July 1998.
These facilities support MCNIC's $400,000,000 commercial paper program. MCNIC
has issued commercial paper in lieu of an equivalent amount of borrowings under
these lines of credit. The commercial paper balance outstanding at December 31,
1997 totaling $147,358,000 is classified as short-term. The commercial paper
balance used to temporarily finance working capital requirements at December 31,
1996 totaling $68,000,000 was classified as short-term. The remaining 1996
commercial paper balance of $261,822,000 was classified as long-term. Commercial
paper borrowings outstanding as of December 31, 1997 and 1996 were at weighted
average interest rates of 6.2% and 5.8%, respectively. Fees are paid to
compensate banks for lines of credit.
MCNIC Oil & Gas Company, a subsidiary of MCNIC, established a five-year term
loan during 1995 at certain alternative variable rates at MCN's option. The loan
allows for borrowings of up to $100,000,000 and is based on MCNIC Oil & Gas
Company's proved gas reserves. The balances outstanding at December 31, 1997 and
1996 were $100,000,000 at weighted average interest rates of 6.3% and 5.9%,
respectively. The most restrictive provision of the agreement requires MCNIC Oil
& Gas Company to maintain a minimum interest coverage ratio.
At December 31, 1997, 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 expire in July 1998.
MichCon usually issues commercial paper in lieu of an equivalent amount of
borrowings under these lines of credit. Commercial paper outstanding at December
31, 1997 and 1996 totaled $236,740,000 and $238,251,000, respectively, at
weighted average interest rates of 5.8% and 5.5%, respectively. This debt is
classified as short-term. Fees are paid to compensate banks for lines of credit.
In 1997, MichCon did not renew its Trust Demand Note program which expired in
March 1997 and allowed for borrowings of up to
49
18
Notes to Consolidated Financial Statements
$25,000,000. At December 31, 1996, borrowings of $25,000,000 were outstanding
under this program at an interest rate of 5.9%.
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 June 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 make limited capital contributions to the subsidiaries if certain
cash flow and operating targets are not met. At December 31, 1997, $36,400,000
was outstanding at a weighted average interest rate of 6.4%.
During 1997, MichCon redeemed early $5,000,000 of 9.5% first mortgage bonds and
$12,000,000 of 9.8% unsecured notes. MichCon had a variable interest rate swap
agreement through April 2000 on the $12,000,000 unsecured notes. This swap has
been redesignated as a hedge of other outstanding first mortgage bonds.
MichCon entered into variable interest rate swap agreements with notional
principal amounts aggregating $80,000,000 in connection with the first mortgage
bonds issued May 1997. Swap agreements of $40,000,000 through May 2002 have
reduced the average cost of debt from 7.3% to 6.3% for the year ended December
31, 1997. Swap agreements of $40,000,000 through May 2005 have reduced the
average cost of debt from 7.1% to 5.9% for the year ended December 31, 1997. A
nonutility subsidiary of MichCon has an interest rate swap agreement on the
$15,840,000 outstanding balance of its project loan agreement at December 31,
1997, which effectively fixes the interest rate at 7.5% through February 2003.
Substantially all of the properties of MichCon, totaling approximately
$1,200,000,000, serve as collateral for its outstanding first mortgage bonds.
Maturities and sinking fund requirements during the next five years for
long-term debt outstanding at December 31, 1997 are $26,900,000 in 1998,
$267,400,000 in 1999, $127,000,000 in 2000, $86,600,000 in 2001 and $166,400,000
in 2002.
6. PREFERRED AND HYBRID SECURITIES
a. FELINE PRIDES
In 1997, MCN issued 2,645,000 FELINE PRIDES yielding 8% with a stated amount of
$50 per security. 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 in May 2000 for $50, between 1.4132 and
1.7241 shares of MCN common stock. 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 is also 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 payments, totaling $2,661,015, 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. MCN has the right to defer the contract adjustment payments, in which
case MCN cannot declare dividends on its common stock until the contract
adjustment payments have been made. In addition, MCN has incurred costs of
approximately $4,900,000 in conjunction with the issuance and similarly has
recorded these costs as a reduction to Common Shareholders' Equity.
MCN Financing III, a business trust wholly owned by MCN, was formed for the sole
purpose of issuing preferred securities and lending the gross proceeds thereof
to MCN. In March 1997, the trust issued 2,645,000 shares of 7.25% redeemable
preferred securities, at the liquidation preference value of $50 per share. The
trust invested the $132,250,000 of gross proceeds from the issuance of the
preferred securities, as well as $4,090,250 of proceeds from the issuance of
common securities to MCN, in an equivalent amount of 7.25% Junior Subordinated
Debentures of MCN. The $136,340,250 of Junior Subordinated Debentures are due
May 2002 and are the sole assets of the trust. Upon maturity of the debentures,
the trust is required to redeem the preferred securities.
Holders of the preferred securities are entitled to receive cumulative dividends
at an annual rate of 7.25% of the liquidation preference value. Dividends are
payable quarterly and in substance are tax deductible by MCN. MCN has the right
to extend interest payment periods on the debentures for successive periods
through the May 2002 maturity date. As a consequence, quarterly dividend
payments on the preferred securities can be deferred by the trust 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 trust's creditor rights against MCN, which may include
acceleration of the principal amount due on the debentures. MCN has issued a
guaranty with respect to payments on the preferred securities. This guaranty,
taken together with MCN's obligations under the debentures, the related
indenture, and the trust documents, provides a full and unconditional guaranty
of the trust's obligations under the preferred securities to the extent the
trust has funds available therefor.
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 United States Treasury
50
19
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. PRIVATE INSTITUTIONAL TRUST SECURITIES (PRINTS) AND SINGLE POINT REMARKETED
RESET CAPITAL SECURITIES (SPRRCS)
In 1997, MCN Financing V and MCN Financing VI, business trusts wholly owned by
MCN, were formed for the sole purpose of issuing preferred securities and
lending the gross proceeds thereof to MCN. In June 1997, MCN Financing V issued
100,000 PRINTS, and MCN Financing VI issued 100,000 SPRRCS, both at their
liquidation preference value of $1,000 per security. The trusts invested the
$200,000,000 of gross proceeds from the issuances of the preferred securities,
as well as $6,186,000 of proceeds from the issuances of common securities to
MCN, in an equivalent amount of senior debentures of MCN. The $206,186,000 of
senior debentures due 2037 are on terms substantially the same as the preferred
securities and are the sole assets of the trusts.
The 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. 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
dates for the PRINTS and SPRRCS are anticipated to be June 1, 1998 and October
28, 1999, respectively.
Prior to the rate reset date, holders of the PRINTS and SPRRCS are entitled to
receive cumulative dividends at annual rates of 6.3% and 6.9% of the
liquidation preference value, respectively. Dividends are in substance tax
deductible by MCN and are payable semi-annually until the rate reset date, after
which they will become payable quarterly. Financing costs were deferred and
reflected as a reduction in the carrying value of the preferred securities.
These costs are being amortized using the straight-line method over 40 years.
Subsequent to the rate reset date, MCN has the right to extend
interest payment periods on the debentures for up to 20 consecutive quarters
through the June 2037 maturity date. As a consequence, dividend payments on the
preferred securities can be deferred by the trusts during any such interest
payment period. In the event that MCN exercises this right, MCN may not declare
dividends on its common stock. With MCN's consent, the preferred securities are
redeemable at the option of the trusts, in whole or in part, on the rate reset
date or at any time after the fifth anniversary of the rate reset date. In
addition, upon maturity of the debentures, the trusts are required to redeem the
preferred securities.
In the event of default, holders of the preferred securities will be entitled to
exercise and enforce the trusts' 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 documents, provide full and unconditional
guaranties of the trusts' obligations under the preferred securities to the
extent the trust has funds available therefor.
In 1997, MCN entered into a one-year variable interest rate swap agreement
with a notional amount of $100,000,000. The swap agreement effectively reduced
the PRINTS fixed dividend rate from 6.3% to 6.0% through December 31, 1997.
c. TRUST ORIGINATED PREFERRED SECURITIES (TOPrS)
In 1996, MCN Financing I, a business trust wholly owned by MCN, was formed
for the sole purpose of issuing preferred securities and lending the gross
proceeds thereof to MCN. In July 1996, the trust issued 3,200,000 shares of
8-5/8% TOPrS, at the liquidation preference value of $25 per share. The trust
invested the $80,000,000 of gross proceeds from the issuance of the TOPrS, as
well as $2,474,250 of proceeds from the issuance of common securities to MCN in
an equivalent amount of 8-5/8% Junior Subordinated Debentures of MCN due 2036.
The $82,474,250 of Junior Subordinated Debentures are the sole assets of the
trust. Holders of the preferred securities are entitled to receive cumulative
dividends at an annual rate of 8-5/8% of the liquidation preference value.
Dividends are payable quarterly and in substance are tax deductible by MCN.
Financing costs were deferred and reflected as a reduction in the carrying value
of the preferred securities. These costs are being amortized using the
straight-line method over 40 years.
MCN has the right to extend interest payment periods on the debentures for up to
20 consecutive quarters. As a consequence, quarterly dividend payments on the
preferred securities can be deferred by the trust during any such interest
payment period. In the event that MCN exercises this right, MCN may not declare
dividends on its common stock. With MCN's consent, the preferred securities are
redeemable at the option of the trust, in whole or in part, during or after July
2001. In addition, upon final maturity of the debentures, the trust is required
to redeem the preferred securities.
In the event of default, holders of the preferred securities will be entitled to
exercise and enforce the trust's creditor rights against MCN, which may
include acceleration of the principal amount due on the debentures. MCN has
issued a guaranty with respect to the preferred securities that, when taken
together with MCN's obligations under the debentures, the related indenture, and
the trust documents, provides a full and unconditional guaranty of the trust's
obligations under the TOPrS to the extent the trust has funds available
therefor.
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20
Notes to Consolidated Financial Statements
In 1996, MCN entered into two five-year variable interest rate swap
agreements with a combined notional amount of $80,000,000. The swap agreements
effectively reduced the TOPrS fixed dividend rate from 8-5/8% to 8.2% for the
year ended December 31, 1997.
d. PREFERRED REDEEMABLE INCREASED DIVIDEND EQUITY SECURITIES (ENHANCED PRIDES)
In 1996, MCN issued 5,865,000 Enhanced PRIDES yielding 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.
Proceeds from the issuance totaling approximately $135,000,000 were used to
acquire 6.5% United States Treasury Notes underlying the security as
subsequently discussed. Accordingly, MCN received no cash from issuing the
Enhanced PRIDES.
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 is also obligated to pay the Enhanced PRIDES holders a semi-annual 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, totaling
$8,243,000, 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 of $6,249,000 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.
e. REDEEMABLE CUMULATIVE PREFERRED SECURITIES
MCN Michigan Limited Partnership (MCN Michigan), a limited partnership of which
MCN is a 1% general partner, has outstanding 4,000,000 shares of 9-3/8%
Redeemable Cumulative Preferred Securities, Series A, at the liquidation
preference value of $25 per share. Holders of the securities are entitled to
receive dividends at an annual rate of 9-3/8% of the liquidation preference
value. Dividends are payable monthly and in substance are tax deductible by MCN.
Gross proceeds of the issuance totaling $100,000,000 were loaned to MCN.
Financing costs were deferred and reflected as a reduction in the carrying value
of the preferred securities. These costs are being amortized using the
straight-line method through 2024. MCN has the right under the loan agreement to
extend interest payment periods for up to 60 months, and as a consequence,
monthly dividend payments on the preferred securities can be deferred by MCN
Michigan during any such interest payment period. In the event that MCN
exercises this right, MCN may not declare dividends on its common stock. With
MCN's consent, the preferred securities are redeemable at the option of MCN
Michigan, in whole or in part, for $25 per share on or after November 30, 1999.
In addition, upon final maturity of the loan in 2024, MCN Michigan is required
to redeem the preferred securities. In the event of default, holders of the
preferred securities will be entitled to exercise and enforce MCN Michigan's
creditor rights against MCN, which may include acceleration of the principal
amount of the loan.
MCN is authorized to issue 25,000,000 shares of no par value preferred stock,
and MichCon is authorized to issue 4,000,000 shares of preference stock with a
par value of $1 per share. At December 31, 1997, no issuances of preferred or
preference stock were made under these authorizations.
7. COMMON STOCK AND EARNINGS PER SHARE
a. COMMON STOCK
In 1997, MCN sold 9,775,000 shares of new common stock in a public offering,
generating net of $276,600,000. In 1995, MCN sold 5,750,000 shares of new
common stock in a public offering, generating net proceeds of approximately
$99,000,000.
MCN issues new shares of common stock pursuant to its Dividend Reinvestment and
rchase Plan and various employee benefit plans. The number of shares issued was
approximately 1,165,000 in 1997, 926,000 in 1996 and 858,000 in 1995, generating
net proceeds of $17,800,000, $17,300,000, and $16,500,000, respectively.
b. STOCK INCENTIVE PLAN
MCN's Stock Incentive Plan authorizes the use of performance units, restricted
stock or other stock-related awards to key employees, primarily management.
MCN's current policy is to issue performance units which encourage a strategic
focus on long-term performance and have 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
52
21
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 fifty percent 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 1996, MCN adopted SFAS No. 123, "Accounting for Stock-Based
Compensation" and the fair value-based method of accounting for its stock-based
compensation plans.
During 1997 and 1996, MCN granted 245,340 and 301,616 performance units with a
weighted average grant date fair value of $31.00 and $24.625 per unit,
respectively. During 1995, MCN granted 370,920 performance units with a weighted
average modification date fair value of $24.875 per unit. Upon adoption of SFAS
No. 123, the previously accrued liability of $23,852,000 relating to then
outstanding performance units was reclassified to Additional Paid-in Capital.
The unrecognized costs of all outstanding performance units are being recorded
as compensation expense and Additional Paid-in Capital over the remaining
vesting period. Stock-based compensation costs recognized during 1997, 1996 and
1995 for all awards outstanding totaled $15,070,000, $14,055,000 and
$15,076,000, respectively. At December 31, 1997, there were 5,578,381 shares
available to be issued under the Stock Incentive Plan.
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
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings Per Share", which is effective for MCN's year-end 1997 financial
statements. SFAS No. 128 simplifies the standards for computing earnings per
share (EPS), replaces simple and primary EPS with a newly defined basic EPS and
modifies the computation of diluted EPS. Basic EPS is computed by dividing
income available to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted EPS 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 from the assumed issuance. A reconciliation of both calculations is
shown below.
Income From Wtd. Avg. Earnings
Continuing Common Per
(in Thousands, Except Per Share Amounts) Operations Shares Share
-------------------------------------------
1997
Basic EPS $ 142,306 72,887 $ 1.95
---------
Effect of Dilutive Securities:
FELINE PRIDES 1,688 1,021
Enhanced PRIDES 222 623
Stock-based compensation plans - 904
-------------------------
Diluted EPS $ 144,216 75,435 $ 1.91
-----------------------------------------
1996
Basic EPS $ 112,569 66,944 $ 1.68
---------
Effect of Dilutive Securities:
Enhanced PRIDES 73 41
Stock-based compensation plans - 536
-------------------------
Diluted EPS $ 112,642 67,521 $ 1.67
-----------------------------------------
1995
Basic EPS $ 93,169 64,743 $ 1.44
---------
Effect of Dilutive Securities:
Stock-based compensation plans - 401
-------------------------
Diluted EPS $ 93,169 65,144 $ 1.43
-----------------------------------------
8. COMMITMENTS AND CONTINGENCIES
a. GUARANTIES
In 1990, 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
2h). However, ACS is obligated to reimburse MCN for any payments made as a
result of this guaranty. Obligations under the guaranty approximated $13,068,000
at December 31, 1997.
During 1996, MCN acquired a 47.5% interest in a partnership that owns and
operates a natural gas transmission and distribution system located in southern
Missouri. In 1997, construction financing was in place to allow for borrowings
of up to $29,000,000. MCN has issued a guaranty for the full amount of this
financing, 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. The guaranty will
remain in place until permanent financing is established which is anticipated to
be in late 1998. Borrowings under the construction loan totaled $29,000,000 at
December 31, 1997.
A MichCon subsidiary 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.
53
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Notes to Consolidated Financial Statements
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 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. None of these former MGP sites is on the
National Priorities List prepared by the U.S. Environmental Protection Agency.
MCN is not involved in any administrative proceedings regarding these former
MGP sites but is currently remediating four of them. More extensive
investigations are underway at five other sites.
In 1984, MichCon 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 reasonable and prudent
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. MCN has notified more than 50 current and former
insurance carriers of the environmental conditions at these former MGP sites. In
1996 and 1997, MichCon received payments from certain carriers and expects
additional insurance recoveries over the next several years. The findings of
these investigations indicate that the estimated total expenditures for
investigation and remediation at all 17 former MGP sites will be between
$30,000,000 and $170,000,000 based on undiscounted 1995 costs. As a result of
these studies, MCN accrued an additional liability and corresponding regulatory
asset of $35,000,000 during 1995.
During 1997, 1996 and 1995, MCN spent $835,000, $900,000, and $2,100,000
respectively, investigating and remediating these former MGP sites. At
December 31, 1997, the reserve balance was $36,741,000, of which $1,741,000 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 and therefore
have an effect on MCN's financial position and cash flows. However, management
believes 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.
c. COMMITMENTS
In July 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, 1997, MCN had long-term contracts in
place for approximately 40% of the field's capacity thereby reducing its
commitments under the marketing contract. A significant portion of the remaining
capacity is expected to be contracted by MCN's Energy Marketing operations,
thereby 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 under these contracts are
determined by formulas based on market prices. In 1998, MCN has firm purchase
commitments for approximately 254 Bcf of gas, approximately 124 Bcf of which are
MichCon purchase commitments. MCN expects sales to exceed its minimum purchase
commitments. MCN is also committed to pay demand charges of approximately
$93,400,000 during 1998 related to firm transportation agreements. Of this
total, approximately $53,000,000 relates to Gas Distribution and is recoverable
through the GCR mechanism.
Capital investments for 1998 are estimated to be in the range of $1,200,000,000
to $1,500,000,000. Certain commitments have been made in connection with such
capital investments.
d. OTHER
MichCon receives a significant amount of heating assistance funding from the
federal Low-Income Home Energy Assistance Program (LIHEAP). Congress
increased the program's funding for the 1997 fiscal year to $1,000,000,000. The
State of Michigan's share of LIHEAP funds was increased from $47,500,000 in
fiscal year 1996 to $64,000,000 in 1997. During 1997, Congress approved a
budget, which provides for federal LIHEAP funding at $1,000,000,000 and
$1,100,000,000 in fiscal years 1998 and 1999, respectively. A portion of any
future increase or decrease in funding may impact MichCon's uncollectible gas
accounts.
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.
54
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9. 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 flow through to customers as refunds or reduced rates. The
following regulatory assets and liabilities were reflected in the Consolidated
Statement of Financial Position as of December 31:
(in Thousands) 1997 1996
-------------------------
Regulatory Assets:
Accrued gas cost recovery revenues $ 12,862 $ 27,672
Deferred postretirement
benefit costs (Note 11b) 651 5,559
Deferred environmental costs (Note 8b) 30,234 31,233
Unamortized loss on retirement of debt 10,181 9,237
Conservation programs - 2,908
Other 986 1,681
-------------------------
$ 54,914 $ 78,290
-------------------------
Regulatory Liabilities:
Tax benefits amortizable to customers $ 123,365 $ 116,496
Other - 405
-------------------------
$ 123,365 $ 116,901
-------------------------
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 MCN 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 its operations as of
December 31, 1997, it would have had an extraordinary, noncash increase to net
income of approximately $44,000,000. Management believes currently available
facts support the continued application of SFAS No. 71.
10. LEASES
MCN leases certain property (principally office buildings, a warehouse and a
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 principal office buildings, 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, 1997 are $5,801,000 in 1998, $5,815,000 in 1999, $5,551,000
in 2000, $5,102,000 in 2001, $4,231,000 in 2002, and $10,686,000 in 2003 and
thereafter.
Total minimum lease payments for operating leases have not been reduced by
future minimum sublease rentals of $3,740,000 under noncancelable subleases.
Operating lease expense reflected in MCN's Consolidated Statement of Income
for the years ended December 31, 1997, 1996 and 1995 was $5,007,000, $5,243,000
and $4,860,000, respectively.
11. RETIREMENT BENEFITS AND TRUSTEED ASSETS
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 provide for normal retirement at age 65, but with the option to
retire earlier or later under certain conditions. The plans provide pension
benefits that are based on the employee's compensation and years of credited
service. MCN's funding policy is to fund each year's actuarially determined
funding requirements of the plans, subject to regulations issued by the Internal
Revenue Service. Currently these plans meet the full funding limitations of the
Internal Revenue Code. Accordingly, no contributions for the 1997, 1996 or 1995
plan years were made, and none is expected to be made for the 1998 plan year.
During 1997, a pro-rata portion of deferred pension gains was recognized in
earnings in the amount of $3,266,000 due to the settlement of the projected
benefit obligation through lump sum payments to employees.
Net pension cost for these plans included the following components:
(in Thousands) 1997 1996 1995
-----------------------------------------------
Service Cost - Benefits
Earned During the Period $ 10,380 $ 11,194 $ 9,318
Interest Cost on Projected
Benefit Obligation 36,059 34,223 32,061
Net Amortization and Deferral 69,341 16,111 65,883
Actual Return on Plan Assets (143,859) (79,912) (123,952)
-----------------------------------------------
Net Pension Credit $ (28,079) $ (18,384) $ (16,690)
-----------------------------------------------
The following table sets forth a reconciliation of the funded status of the
plans and the amounts recorded as prepaid pension cost in the Consolidated
Statement of Financial Position:
55
24
Notes to Consolidated Financial Statements
(in Thousands) 1997 1996
--------------------------
Measurement Date October 31 October 31
Actuarial Present Value of:
Accumulated vested benefit obligation $ 379,930 $ 358,952
Accumulated nonvested benefit obligation 33,350 29,235
--------------------------
Total accumulated benefit obligation $ 413,280 $ 388,187
--------------------------
Projected benefit obligation for
service rendered to date $ 489,779 $ 444,937
Plan Assets at Fair Value 844,107 723,493
--------------------------
Plan Assets in Excess of Projected
Benefit Obligation 354,328 278,556
Unrecognized Net Asset at Transition (35,014) (40,099)
Unrecognized Prior Service Cost (1,275) (1,506)
Unrecognized Net Gain (244,405) (194,648)
--------------------------
Prepaid Pension Cost $ 73,634 $ 42,303
--------------------------
In determining the actuarial present value of the projected benefit obligation,
the weighted average discount rate was 7.5% for 1997 and 8% for 1996. The rate
of increase in future compensation levels used was 5% for 1997 and 1996. The
expected long-term rate of return on plan assets which are invested primarily in
equity and fixed income securities was 9.25%, 9.25% and 9% for 1997, 1996 and
1995, respectively.
Following the conclusion of union negotiations in December 1997, MichCon amended
its pension plans to enhance certain benefits to participants effective January
1998. The amendment is estimated to increase the projected benefit obligation by
$19,300,000 and the annual pension costs by $1,700,000. The impact of the
amendment is not reflected in the retirement amounts as of December 31, 1997.
Additionally, MichCon announced an early retirement program in December 1997
under which 10% of its workforce could retire effective April 1, 1998 with
incentives. MCN cannot estimate at this time the impact of the early retirement
program on the projected benefit obligation and 1998 pension costs.
MCN and its subsidiaries also sponsor defined contribution retirement savings
plans. Participation in one of these plans is available to substantially all
union and nonunion employees. The company 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 $6,200,000 in 1997,
$6,100,000 in 1996 and $6,000,000 in 1995.
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 currently 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 postretirement costs related to Gas Distribution (in
excess of claims paid) until January 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 recoverable in Gas Distribution rates. Separate qualified Voluntary
Employees' Beneficiary Association (VEBA) trusts exist for union and nonunion
employees. Funding to the VEBA trusts totaled $6,700,000, $41,918,000 and
$27,504,000 in 1997, 1996 and 1995, respectively. The expected long-term rate of
return on plan assets which are invested in life insurance policies, equity
securities and fixed income securities was 9.1%, 9.1% and 8.9% for 1997, 1996
and 1995, respectively.
Net postretirement cost for the years ended December 31 includes the
following components:
(in Thousands) 1997 1996 1995
-----------------------------------------------
Service Cost - Benefits Earned
During the Period $ 4,354 $ 4,541 $ 5,345
Interest Cost on Accumulated
Benefit Obligation 17,857 16,826 18,815
Amortization of Transition
Obligation 13,587 13,587 13,810
Net Amortization and Deferral 10,236 (1,936) 7,396
Actual Return on Plan Assets (26,251) (12,268) (15,670)
-----------------------------------------------
Total Postretirement Cost 19,783 20,750 29,696
Regulatory Adjustment 4,907 7,553 7,558
-----------------------------------------------
Net Postretirement Cost $ 24,690 $ 28,303 $ 37,254
-----------------------------------------------
The following table sets forth a reconciliation of the funded status of the
plans and the amounts recorded as accrued postretirement cost in the
Consolidated Statement of Financial Position:
(in Thousands) 1997 1996
--------------------------
Measurement Date October 31 October 31
Accumulated Postretirement Benefit Obligation:
Retirees $ 133,219 $ 140,310
Fully eligible active participants 31,285 26,178
Participants with less than
30 years of service 64,833 56,726
--------------------------
229,337 223,214
Plan Assets at Fair Value 152,405 126,716
--------------------------
Accumulated Postretirement Benefit
Obligation in Excess of Plan Assets (76,932) (96,498)
Unrecognized Transition Obligation 203,674 217,261
Unrecognized Net Gain (126,834) (111,030)
Contributions Made After Measurement Date 6,700 7,212
--------------------------
Accrued Postretirement Asset $ 6,608 $ 16,945
--------------------------
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 6.25% for 1998 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, 1997 by 12% and increase the sum of the service cost and interest
cost by 15% for the year then ended. The discount rate used in determining the
accumulated postretirement benefit obligation was 7.50% and 8.00% for 1997 and
1996, respectively.
56
25
MichCon has amended its retiree healthcare plans to reduce medical benefits to
certain existing retirees and all future retirees effective January 1998.
The amendment is estimated to decrease the accumulated postretirement benefit
obligation by $3,800,000 and the annual postretirement costs by $1,100,000. The
impact of the amendment is not reflected in the postretirement amounts as of
December 31, 1997. Additionally, MichCon announced an early retirement program
in December 1997 under which 10% of its workforce could retire effective April
1, 1998 with incentives. MCN cannot estimate at this time the impact of the
early retirement program on the postretirement benefit obligation and 1998
postretirement costs.
c. GRANTOR TRUST
In 1997, MichCon established a Grantor Trust and contributed $31,300,000
to the trust, which invested such proceeds in fixed income securities. These
assets are classified as available for sale and are recorded at fair value with
the unrealized gains and losses excluded from earnings and reported as a
separate component of Common Shareholders' Equity. By funding the Grantor Trust
and the VEBA trusts (Note 11b), MichCon is complying with MPSC directives that
it fund various trusts to the extent its postretirement benefit costs are
recoverable in Gas Distribution rates. Subject to MPSC notification, MichCon can
revoke the Grantor Trust, and employees and retirees have no right, title or
interest in the assets of the trust.
12. 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 risk 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 rating 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 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.
MichCon has not used financial derivatives to hedge natural gas prices in 1997
or prior years. Changes in the market value of contracts that hedge gas 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 also are 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.
(in Thousands) 1997 1996
--------------------------
Deferred Swap Losses and Receivables:
Unrealized losses $ 34,736 $ 53,166
Receivables 16,683 11,885
--------------------------
51,419 65,051
Less - Current portion 396 -
--------------------------
$ 51,023 $ 65,051
--------------------------
Deferred Swap Gains and Payables:
Unrealized gains $ 15,005 $ 5,519
Payables 41,164 64,641
--------------------------
56,169 70,160
Less - Current portion 14,452 21,795
--------------------------
$ 41,717 $ 48,365
--------------------------
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
57
26
Notes to Consolidated Financial Statements
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.
(in Thousands) 1997 1996
--------------------------
Fixed Price Receiver:
Volumes (Bcf equivalent) 447.5 355.7
Notional value $ 994,159 $ 790,549
Latest maturity 2013 2008
Variable Price Receiver:
Volumes (Bcf equivalent) 39.5 58.8
Notional value $ 94,082 $ 140,080
Latest maturity 2006 2006
In addition, at December 31, 1997, MCN had futures contracts that permit
settlement by delivery of the underlying commodity of 73.3 Bcf with unrealized
gains of $2,031,000 and 21.7 Bcf with unrealized losses of $10,120,000. Futures
contracts of 46.7 Bcf with unrealized gains of $7,899,000 and 23.9 Bcf with
unrealized losses of $2,351,000 were outstanding at December 31, 1996.
Collateral in the form of cash totalling $1,920,000 was provided under hedging
contracts at December 31,1997.
b. 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 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 could be redesignated as a hedge of another outstanding debt
obligation with similar characteristics and qualifies for hedge accounting.
At December 31, 1997, MCN had interest rate swap agreements with notional
principal amounts totaling $288,000,000 (Notes 5, 6b and 6c) and a
weighted average remaining life of 3.2 years. At December 31, 1996, the notional
principal amount of outstanding interest rate swaps totaled $109,600,000. 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.
13. 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 and customer
deposits, are assumed to approximate fair value due to their short-term nature.
The carrying amount and fair value of other financial instruments consist of the
following:
1997 1996
--------------------------------------------------------
Carrying Estimated Carrying Estimated
(in Thousands) Amount Fair Value Amount Fair Value
--------------------------------------------------------
Assets:
Investment in debt and
equity securities $ 97,521 $ 97,521 $ 35,582 $ 35,582
Liabilities and
Capitalization:
Long-term debt,
excluding capital
lease obligations 1,204,862 1,251,883 1,235,415 1,264,836
Redeemable
preferred securities 505,104 550,197 173,809 184,109
Derivative Financial
and Other Similar
Instruments (Note 12):
Natural gas and oil swaps:
with unrealized gains 15,005 15,005 5,519 5,519
with unrealized losses 34,736 34,736 53,166 53,166
Natural gas and oil futures:
with unrealized gains 2,031 2,031 7,899 7,899
with unrealized losses 10,120 10,120 2,351 2,351
Interest rate swaps:
with unrealized gains 5,006 1,154
with unrealized losses 415 476
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 assumptions.
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 and interest rate swaps and futures - 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 8a) - estimated cost to terminate the southern Missouri
project guaranty is immaterial. Management is unable
58
27
to practicably estimate the fair value of the Harbortown and Genix 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, 1997 and 1996. Management is not aware of any
subsequent factors that would significantly affect the estimated fair value
amounts.
14. 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 or receivable from MCN
resulting from the inclusion of its taxable income or loss in MCN's
consolidated tax return.
(in Thousands) 1997 1996 1995
---------------------------------------------
Effective Federal
Income Tax Rate 25.8% 23.4% 27.6%
---------------------------------------------
Income Taxes Consist of:
Current provision $ 23,166 $ 603 $ (4,600)
Deferred provision, net 48,628 53,528 53,087
Gas production tax credits (17,797) (15,878) (11,271)
Investment tax credits (1,873) (1,878) (1,886)
---------------------------------------------
$ 52,124 $ 36,375 $ 35,330
---------------------------------------------
Reconciliation Between
Statutory and Actual
Income Taxes:
Statutory Federal Income
Taxes at a Rate of 35% $ 68,051 $ 52,130 $ 44,975
Adjustments to Federal
Tax Expense:
Book over tax depreciation 5,301 6,367 7,365
Adjustments to taxes provided
in prior periods (162) (3,369) (1,337)
Investment tax credits (1,873) (1,878) (1,886)
Gas production tax credits (17,797) (15,878) (11,271)
Other, net (1,396) (997) (2,516)
---------------------------------------------
Total Income Taxes $ 52,124 $ 36,375 $ 35,330
---------------------------------------------
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. The tax effect of temporary
differences that gave rise to MCN's deferred tax assets and liabilities
consisted of the following:
(in Thousands) 1997 1996
--------------------------
Deferred Tax Assets:
Alternative minimum tax credit carryforward $ 60,121 $ 34,711
Vacation and other benefits 20,846 21,716
Uncollectibles 4,771 6,359
Other 11,985 14,035
--------------------------
97,723 76,821
--------------------------
Deferred Tax Liabilities:
Depreciation and other property-
related basis differences, net 200,216 175,213
Pensions 24,027 13,192
Property taxes 12,931 11,178
Postretirement benefit 2,768 9,186
Gas cost recovery undercollection 4,502 8,455
Other 18,432 24,130
--------------------------
262,876 241,354
--------------------------
Net Deferred Tax Liability 165,153 164,533
Less: Net Deferred Tax Liability-Current 11,994 14,695
--------------------------
Net Deferred Tax Liability-Noncurrent $ 153,159 $ 149,838
--------------------------
15. 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
(in Thousands) 1997 1996
--------------------------
Proved Properties $1,033,492 $ 771,817
Unproved Properties 265,809 210,084
--------------------------
1,299,301 981,901
Accumulated Depreciation,
Depletion and Amortization 150,015 79,426
--------------------------
Net Capitalized Costs $1,149,286 $ 902,475
--------------------------
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,
1997, and the year in which they were incurred, follows:
Year Costs Incurred
------------------------------------
1995 &
(in Thousands) Total 1997 1996 Prior
------------------------------------------------
Acquisition $ 147,903 $ 48,077 $ 85,527 $ 14,299
Exploration 117,906 90,057 24,987 2,862
------------------------------------------------
$ 265,809 $ 138,134 $ 110,514 $ 17,161
------------------------------------------------
The acquisition amount includes all costs incurred to purchase or lease property
with unproved reserves.
59
28
Notes to Consolidated Financial Statements
COSTS INCURRED
Year Ended December 31 - (in Thousands) 1997 1996 1995
-------------------------------------------
Acquisition:
Proved properties $ 35,695 $ 60,340 $ 114,956
Unproved properties 66,721 136,142 46,984
-------------------------------------------
102,416 196,482 161,940
Exploration 143,580 65,160 39,106
Development 129,001 120,569 98,099
-------------------------------------------
$ 374,997 $ 382,211 $ 299,145
-------------------------------------------
RESULTS OF OPERATIONS
(in Thousands) 1997 1996 1995
-------------------------------------------
Operating Revenues:
Unaffiliated customers $ 144,041 $ 94,615 $ 32,089
Affiliated customers 71,787 43,326 37,091
-------------------------------------------
215,828 137,941 69,180
-------------------------------------------
Production Costs 68,364 48,255 18,447
Depreciation, Depletion
and Amortization 73,910 44,469 22,518
-------------------------------------------
142,274 92,724 40,965
-------------------------------------------
Income Before Income Taxes 73,554 45,217 28,215
-------------------------------------------
Income Taxes:
Income tax provision 26,997 16,438 9,805
Gas production tax credits (17,797) (15,878) (11,271)
-------------------------------------------
9,200 560 (1,466)
-------------------------------------------
Results of Operations,
Excluding Corporate
and Interest Costs $ 64,354 $ 44,657 $ 29,681
-------------------------------------------
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.
1997 1996
----------------------------------------------------
Gas Oil Gas Oil
(MMcf) (Mbbl) (MMcf) (Mbbl)
----------------------------------------------------
Proved Developed and
Undeveloped Reserves:
Beginning of year 1,137,729 17,214 858,381 4,685
Revisions of previous
estimates (30,260) (430) 3,274 304
Extensions and
discoveries 165,283 4,435 204,277 1,985
Production (78,218) (3,346) (57,203) (1,086)
Sales of minerals
in place (51,465) (1,019) - -
Purchases of minerals
in place 23,105 8,989 129,000 11,326
----------------------------------------------------
End of year 1,166,174 25,843 1,137,729 17,214
----------------------------------------------------
Proved Developed
Reserves:
Beginning of year 688,995 9,554 563,395 3,349
End of year 590,299 12,601 688,995 9,554
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 (Note
12) 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.
(in Thousands) 1997 1996 1995
-------------------------------------------
Future Revenues $3,121,124 $3,867,785 $2,143,506
Future Production Costs 1,155,734 1,322,108 860,134
Future Development Costs 328,739 340,190 199,284
-------------------------------------------
Future Net Cash Flows
Before Income Taxes 1,636,651 2,205,487 1,084,088
Discount to Present
Value at 10% 812,605 1,139,507 536,405
-------------------------------------------
Present Value of Future
Net Cash Flows
Before Income Taxes 824,046 1,065,980 547,683
Future Income Taxes
Discounted at 10% 105,371 226,913 88,954
Future Tax Credits
Discounted at 10% (50,889) (62,207) (63,178)
-------------------------------------------
Standardized Measure of Discounted
Future Net Cash Flows $ 769,564 $ 901,274 $ 521,907
-------------------------------------------
The principal sources of change in the standardized measure of discounted
future net cash flows were as follows:
(in Thousands) 1997 1996 1995
-------------------------------------------
Beginning of Year $ 901,274 $ 521,907 $ 311,065
Net changes in sales prices
and production costs (261,154) 126,526 (55,262)
Net change due to revisions
in quantity estimates (26,015) 5,061 (21,294)
Extensions, discoveries, additions
and improved recovery, net
of related costs 153,291 200,026 145,184
Development costs incurred,
previously estimated 103,201 86,810 75,537
Changes in estimated
future development costs (120,219) (81,069) (50,757)
Sales, net of production costs (147,464) (89,686) (50,733)
Net change in future
income taxes 116,366 (85,616) (6,381)
Federal tax credits generated (17,797) (15,878) (11,271)
Sales of reserves in place (83,985) - -
Purchases of reserves in place 48,685 193,550 160,497
Accretion of discount and other 103,381 39,643 25,322
-------------------------------------------
End of Year $ 769,564 $ 901,274 $ 521,907
-------------------------------------------
60
29
16. SEGMENT INFORMATION
The business segments of MCN are defined as follows:
a) Diversified Energy - E&P, Pipelines & Processing, Energy Marketing, Gas
Storage & Electric Power; b) Gas Distribution - natural gas distribution and
transmission operations; c) Corporate & Other - corporate and other services.
Diversified Energy
------------------------------------- Intercompany
Gas Corporate Gas Eliminations Consolidated
(in Thousands) Services & Other Distribution & Other(1) Total
-------------------------------------------------------------------------------------------------
1997
OPERATING REVENUES $ 951,269 $ - $ 1,271,286 $ (14,688) $ 2,207,867
OPERATING INCOME (LOSS) 63,966 (4,433) 176,820 - 236,353
OPERATING AND JOINT
VENTURE INCOME (LOSS) 116,952 (4,294) 179,354 - 292,012
DEPRECIATION, DEPLETION AND
AMORTIZATION 75,955 1,220 104,437 - 181,612
IDENTIFIABLE ASSETS 2,135,085 97,819 2,167,637 (71,080) 4,329,461
CAPITAL EXPENDITURES 399,974 4,951 157,732 - 562,657
CAPITAL INVESTMENTS 793,856 5,425 160,329 - 959,610
- --------------------------------------------------------------------------------------------------------------------------------
1996
Operating Revenues $ 734,441 $ - $ 1,276,254 $ (13,427) $ 1,997,268
Operating Income (Loss) 43,333 (2,524) 170,484 - 211,293
Operating and Joint
Venture Income (Loss) 57,921 (499) 171,738 - 229,160
Depreciation, Depletion and
Amortization 46,238 938 98,814 - 145,990
Identifiable Assets 1,528,338 40,714 2,086,325 (21,973) 3,633,404
Capital Expenditures 392,275 2,987 215,318 6,508 617,088
Capital Investments 560,850 2,997 220,393 6,508 790,748
- --------------------------------------------------------------------------------------------------------------------------------
1995
Operating Revenues $ 400,027 $ - $ 1,107,646 $ (12,441) $ 1,495,232
Operating Income (Loss) 24,619 (2,709) 166,319 - 188,229
Operating and Joint
Venture Income (Loss) 28,561 (2,747) 167,660 - 193,474
Depreciation, Depletion and
Amortization 22,502 769 91,314 - 114,585
Identifiable Assets 925,141 21,775 1,893,888 57,836 2,898,640
Capital Expenditures 284,703 6,795 241,567 9,380 542,445
Capital Investments 420,277 7,100 252,081 9,380 688,838
- --------------------------------------------------------------------------------------------------------------------------------
(1) Intercompany eliminations primarily reflect revenues and receivables
related to gas sales and transportation agreements between Gas
Distribution and Gas Services. Other represents MCN's discontinued
computer operations (Note 2h).
17. 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, are
$1,093,125,000 at December 31, 1997.
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 and Blue Lake Holdings,
Inc. until December 31, 1997.
61
30
Notes to Consolidated Financial Statements
CONSOLIDATING STATEMENT OF FINANCIAL POSITION
DECEMBER 31, 1997
-----------------------------------------
MCN
and Other
(in Thousands) Subsidiaries MCNIC MichCon
-----------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents, at cost $ 23 $ 25,119 $ 14,353
Accounts receivable 15,525 240,867 210,677
Less-Allowance for doubtful accounts 75 621 15,015
-----------------------------------------
Accounts receivable, net 15,450 240,246 195,662
Accrued unbilled revenue 1,114 -- 91,896
Gas in inventory -- 16,576 40,201
Property taxes assessed applicable to future periods 217 2,835 64,827
Accrued gas cost recovery revenues -- -- 12,862
Other 3,745 17,612 33,361
-----------------------------------------
20,549 302,388 453,162
-----------------------------------------
DEFERRED CHARGES AND OTHER ASSETS
Investments in debt and equity securities -- 62,060 35,110
Deferred swap losses and receivables -- 51,023 --
Deferred postretirement benefit costs 651 -- --
Deferred environmental costs 2,535 -- 27,699
Prepaid benefit costs (3,418) -- 85,790
Other 7,610 34,287 46,972
-----------------------------------------
7,378 147,370 195,571
-----------------------------------------
INVESTMENTS IN AND ADVANCES TO JOINT VENTURES AND SUBSIDIARIES 1,641,421 528,492 19,643
-----------------------------------------
PROPERTY, PLANT AND EQUIPMENT, at cost 37,918 1,358,504 2,790,352
Less-Accumulated depreciation and depletion 12,951 152,707 1,322,392
-----------------------------------------
24,967 1,205,797 1,467,960
-----------------------------------------
$ 1,694,315 $ 2,184,047 $ 2,136,336
-----------------------------------------
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable $ 4,385 $ 238,952 $ 130,267
Notes payable -- 163,113 241,691
Current portion of long-term debt and capital lease obligations 365 1,557 34,956
Federal income, property and other taxes payable 401 12,681 78,630
Customer deposits 19 -- 16,363
Other 13,599 29,198 67,780
-----------------------------------------
18,769 445,501 569,687
-----------------------------------------
DEFERRED CREDITS AND OTHER LIABILITIES
Accumulated deferred income taxes (4,642) 73,874 83,905
Unamortized investment tax credit 301 -- 32,745
Tax benefits amortizable to customers 443 -- 122,922
Deferred swap gains and payables -- 41,717 --
Accrued environmental costs 3,000 -- 32,000
Minority interest -- 1,905 17,283
Other 10,792 16,586 44,663
-----------------------------------------
9,894 134,082 333,518
-----------------------------------------
CAPITALIZATION
Long-term debt, including capital lease obligations -- 595,457 617,107
Redeemable preferred securities of subsidiaries 505,104 -- --
Common shareholders' equity 1,160,548 1,009,007 616,024
-----------------------------------------
1,665,652 1,604,464 1,233,131
-----------------------------------------
$ 1,694,315 $ 2,184,047 $ 2,136,336
-----------------------------------------
DECEMBER 31, 1997
---------------------------
Eliminations
and Consolidated
Reclasses Total
---------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents, at cost $ - $ 39,495
Accounts receivable (46,910) 420,159
Less-Allowance for doubtful accounts -- 15,711
---------------------------
Accounts receivable, net (46,910) 404,448
Accrued unbilled revenue -- 93,010
Gas in inventory -- 56,777
Property taxes assessed applicable to future periods -- 67,879
Accrued gas cost recovery revenues -- 12,862
Other (629) 54,089
---------------------------
(47,539) 728,560
---------------------------
DEFERRED CHARGES AND OTHER ASSETS
Investments in debt and equity securities 351 97,521
Deferred swap losses and receivables -- 51,023
Deferred postretirement benefit costs -- 651
Deferred environmental costs -- 30,234
Prepaid benefit costs (2,130) 80,242
Other (3,339) 85,530
---------------------------
(5,118) 345,201
---------------------------
INVESTMENTS IN AND ADVANCES TO JOINT VENTURES AND SUBSIDIARIES (1,632,580) 556,976
---------------------------
PROPERTY, PLANT AND EQUIPMENT, at cost - 4,186,774
Less-Accumulated depreciation and depletion - 1,488,050
---------------------------
- 2,698,724
---------------------------
$(1,685,237) $ 4,329,461
===========================
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable $ (46,848) $ 326,756
Notes payable (3,078) 401,726
Current portion of long-term debt and capital lease obligations -- 36,878
Federal income, property and other taxes payable -- 91,712
Customer deposits -- 16,382
Other (630) 109,947
---------------------------
(50,556) 983,401
---------------------------
DEFERRED CREDITS AND OTHER LIABILITIES
Accumulated deferred income taxes 22 153,159
Unamortized investment tax credit -- 33,046
Tax benefits amortizable to customers -- 123,365
Deferred swap gains and payables -- 41,717
Accrued environmental costs -- 35,000
Minority interest -- 19,188
Other (2,152) 69,889
---------------------------
(2,130) 475,364
---------------------------
CAPITALIZATION
Long-term debt, including capital lease obligations -- 1,212,564
Redeemable preferred securities of subsidiaries -- 505,104
Common shareholders' equity (1,632,551) 1,153,028
---------------------------
(1,632,551) 2,870,696
---------------------------
$(1,685,237) $ 4,329,461
===========================
62
31
CONSOLIDATING STATEMENT OF FINANCIAL POSITION DECEMBER 31, 1996
-----------------------------------------------------------------
MCN Eliminations
and Other and Consolidated
Subsidiaries MCNIC MichCon Reclasses Total
-----------------------------------------------------------------
(in Thousands)
ASSETS
CURRENT ASSETS
Cash and cash equivalents, at cost $ 844 $ 19,608 $ 10,010 $ - $ 30,462
Accounts receivable 19,824 198,777 187,143 (24,661) 381,083
Less -Allowance for doubtful accounts 70 710 17,707 - 18,487
-----------------------------------------------------------------
Accounts receivable, net 19,754 198,067 169,436 (24,661) 362,596
Accrued unbilled revenue 1,132 - 107,377 - 108,509
Gas in inventory - 11,251 67,910 - 79,161
Property taxes assessed applicable to future periods 195 2,179 60,592 - 62,966
Accrued gas cost recovery revenues - - 27,672 - 27,672
Other 1,973 28,315 23,025 (451) 52,862
-----------------------------------------------------------------
23,898 259,420 466,022 (25,112) 724,228
-----------------------------------------------------------------
DEFERRED CHARGES AND OTHER ASSETS
Investment in debt and equity securities - 14,803 20,780 (1) 35,582
Deferred swap losses and receivables - 65,051 - - 65,051
Deferred postretirement benefit costs 696 - 4,863 - 5,559
Deferred environmental costs 3,000 - 28,233 - 31,233
Prepaid benefit costs - - 64,307 (5,059) 59,248
Other 4,204 30,301 29,426 828 64,759
-----------------------------------------------------------------
7,900 110,155 147,609 (4,232) 261,432
-----------------------------------------------------------------
Investments in and Advances to Joint Ventures and Subsidiaries 954,479 236,057 19,479 (944,627) 265,388
-----------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT, at cost 31,967 1,017,296 2,668,294 - 3,717,557
Less-Accumulated depreciation and depletion 10,983 81,158 1,243,060 - 1,335,201
-----------------------------------------------------------------
20,984 936,138 1,425,234 - 2,382,356
-----------------------------------------------------------------
$ 1,007,261 $1,541,770 $2,058,344 $(973,971) $3,633,404
-----------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable $ 5,745 $ 205,073 $ 130,725 $ (23,621) $ 317,922
Notes payable - 71,000 265,126 - 336,126
Current portion of long-term debt and capital lease obligations 55 31,460 53,232 - 84,747
Federal income, property and other taxes payable 280 12,578 84,788 - 97,646
Customer deposits 21 - 12,860 - 12,881
Other 9,315 25,701 63,309 (452) 97,873
-----------------------------------------------------------------
15,416 345,812 610,040 (24,073) 947,195
-----------------------------------------------------------------
DEFERRED CREDITS AND OTHER LIABILITIES
Accumulated deferred income taxes (1,625) 74,940 76,523 - 149,838
Unamortized investment tax credit 331 - 34,588 - 34,919
Tax benefits amortizable to customers 183 - 116,313 - 116,496
Deferred swap gains and payables - 48,365 - - 48,365
Accrued environmental costs 3,000 - 32,000 - 35,000
Minority interest - 306 17,604 1 17,911
Other 15,902 18,466 43,954 (5,059) 73,263
-----------------------------------------------------------------
17,791 142,077 320,982 (5,058) 475,792
-----------------------------------------------------------------
CAPITALIZATION
Long-term debt, including capital lease obligations 365 701,357 550,318 - 1,252,040
Redeemable preferred securities of subsidiaries 173,809 - - - 173,809
Common shareholders' equity 799,880 352,524 577,004 (944,840) 784,568
-----------------------------------------------------------------
974,054 1,053,881 1,127,322 (944,840) 2,210,417
-----------------------------------------------------------------
$ 1,007,261 $1,541,770 $2,058,344 $(973,971) $3,633,404
-----------------------------------------------------------------
63
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
TWELVE MONTHS ENDED DECEMBER 31, 1997
CONSOLIDATING STATEMENTS OF INCOME ----------------------------------------------------------------------
MCN Eliminations
and Other and Consolidated
(in Thousands) Subsidiaries MCNIC MichCon Reclasses Total
----------------------------------------------------------------------
Operating Revenues $ 17,607 $ 951,269 $ 1,253,679 $ (14,688) $ 2,207,867
-----------------------------------------------------------------------
Operating Expenses
Cost of gas 9,749 689,182 632,229 (10,090) 1,321,070
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
-----------------------------------------------------------------------
15,988 890,898 1,079,316 (14,688) 1,971,514
-----------------------------------------------------------------------
Operating Income 1,619 60,371 174,363 - 236,353
-----------------------------------------------------------------------
Equity in Earnings of Joint Ventures and Subsidiaries 144,834 52,356 1,199 (142,730) 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)
Gains related to DIGP - 2,398 - - 2,398
Other 74 7,669 (1,346) - 6,397
-----------------------------------------------------------------------
32,086 (47,989) (50,877) (30,802) (97,582)
-----------------------------------------------------------------------
Income Before Income Taxes 178,539 64,738 124,685 (173,532) 194,430
Income Tax Provision 2,573 3,886 45,665 - 52,124
-----------------------------------------------------------------------
Net Income 175,966 60,852 79,020 (173,532) 142,306
Dividends on Preferred Securities 31,090 - - (31,090) -
-----------------------------------------------------------------------
Net Income Available for Common Stock $ 144,876 $ 60,852 $ 79,020 $ (142,442) $ 142,306
=======================================================================
(in Thousands) TWELVE MONTHS ENDED DECEMBER 31, 1996
-----------------------------------------------------------------------
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)
Gains related to DIGP - 6,384 - - 6,384
Other 190 (1,125) (2,744) - (3,679)
-----------------------------------------------------------------------
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 (Benefit) 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
Income from operations - 1,595 - - 1,595
Gain on sale - 36,176 - - 36,176
-----------------------------------------------------------------------
- 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
-----------------------------------------------------------------------
64
33
CONSOLIDATING STATEMENT OF INCOME TWELVE MONTHS ENDED DECEMBER 31, 1995
------------------------------------------------------------------------
MCN Eliminations
and Other and Consolidated
Subsidiaries MCNIC MichCon Reclasses Total
(in Thousands) ------------------------------------------------------------------------
Operating Revenues $ 15,162 $ 411,699 $ 1,080,813 $ (12,442) $ 1,495,232
------------------------------------------------------------------------
Operating Expenses
Cost of gas 7,451 302,273 483,962 (7,493) 786,193
Operation and maintenance 4,027 49,019 294,424 (4,949) 342,521
Depreciation, depletion and amortization 1,671 23,786 89,128 - 114,585
Property and other taxes 1,330 5,362 57,012 - 63,704
------------------------------------------------------------------------
14,479 380,440 924,526 (12,442) 1,307,003
------------------------------------------------------------------------
Operating Income 683 31,259 156,287 - 188,229
------------------------------------------------------------------------
Equity in Earnings of Joint Ventures and Subsidiaries 98,751 3,300 739 (97,545) 5,245
------------------------------------------------------------------------
Other Income and (Deductions)
Interest income 9,685 3,551 3,983 (9,478) 7,741
Interest on long-term debt (76) (9,730) (35,047) - (44,853)
Other interest expense (53) (14,421) (7,053) 9,478 (12,049)
Dividends on preferred securities of subsidiaries - - - (9,610) (9,610)
Gains related to DIGP - - - - -
Other 1,483 (1,505) (6,182) - (6,204)
------------------------------------------------------------------------
11,039 (22,105) (44,299) (9,610) (64,975)
------------------------------------------------------------------------
Income From Continuing Operations
Before Income Taxes 110,473 12,454 112,727 (107,155) 128,499
Income Tax Provision (Benefit) 2,118 (7,792) 41,004 - 35,330
------------------------------------------------------------------------
Income From Continuing Operations 108,355 20,246 71,723 (107,155) 93,169
Discontinued Operations, Net of Taxes - 3,587 - - 3,587
------------------------------------------------------------------------
Net Income 108,355 23,833 71,723 (107,155) 96,756
Dividends on Preferred Securities 9,375 - 235 (9,610) -
------------------------------------------------------------------------
Net Income Available for Common Stock $ 98,980 $ 23,833 $ 71,488 $ (97,545) $ 96,756
------------------------------------------------------------------------
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(in Thousands) 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 credit facilities, 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 E&P property and equipment - 64,200 - - 64,200
Sale of investment in joint ventures - 3,165 - - 3,165
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
========================================================================
65
34
Notes to Consolidated Financial Statements
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS TWELVE MONTHS ENDED DECEMBER 31, 1996
----------------------------------------------------------------
MCN Eliminations
and Other and Consolidated
(in Thousands) Subsidiaries MCNIC MichCon Reclasses Total
----------------------------------------------------------------
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 credit facilities, 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 E&P property - 621 - - 621
Sale of Genix - 132,889 - - 132,889
Sale of investment in joint ventures - 36,000 - - 36,000
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
---------------------------------------------------------------
(in Thousands) TWELVE MONTHS ENDED DECEMBER 31, 1995
---------------------------------------------------------------
NET CASH FLOW FROM OPERATING ACTIVITIES $ 29,451 $ 100,271 $ 158,227 $ (19,946) $ 268,003
---------------------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net - (11,349) 28,178 (1) 16,828
Capital contributions received from
(distributions paid to) affiliates, net (3,066) 54,598 7,000 (58,532) -
Dividends paid (58,193) - (6,500) 6,500 (58,193)
Preferred securities dividends paid (9,375) - (276) 9,651 -
Issuance of common stock 115,725 - - - 115,725
Issuance of long-term debt - 99,880 68,764 220 168,864
Long-term commercial paper and credit facilities, net - 142,657 - - 142,657
Retirement of long-term debt and preferred securities (485) (3,029) (4,757) - (8,271)
Other (678) (1,406) - - (2,084)
---------------------------------------------------------------
Net cash provided from financing activities 43,928 281,351 92,409 (42,162) 375,526
---------------------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures (5,098) (296,356) (235,767) 65 (537,156)
Acquisitions - (83,176) - - (83,176)
Investment in debt and equity securities - (243) - - (243)
Investment in joint ventures and subsidiaries (68,198) (13,810) - 61,469 (20,539)
Sale of investment in joint ventures - 10,803 - - 10,803
Other 56 1,569 (7,705) 574 (5,506)
---------------------------------------------------------------
Net cash used for investing activities (73,240) (381,213) (243,472) 62,108 (635,817)
---------------------------------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 139 409 7,164 - 7,712
CASH AND CASH EQUIVALENTS, JANUARY 1 29 10,213 1,305 - 11,547
---------------------------------------------------------------
CASH AND CASH EQUIVALENTS, DECEMBER 31 $ 168 $ 10,622 $ 8,469 $ - $ 19,259
---------------------------------------------------------------
66
35
Supplementary Financial Information
SELECTED FINANCIAL DATA (UNAUDITED)
(In Thousands of Dollars-Except Per Share Amounts) 1997 1996 1995 1994 1993
-----------------------------------------------------------------
NET INCOME
Continuing operations $ 142,306 $ 112,569 $ 93,169 $ 74,598 $ 70,173
Discontinued operations - 37,771 3,587 3,170 2,617
--------------------------------------------------------------------
$ 142,306 $ 150,340 $ 96,756 $ 77,768 72,790
--------------------------------------------------------------------
CASH DIVIDENDS DECLARED ON COMMON STOCK $ 72,851 $ 62,875 $ 58,193 $ 51,492 $ 49,527
--------------------------------------------------------------------
COMMON STOCK DATA
Basic earnings per share
Continuing operations $ 1.95 $ 1.68 $ 1.44 $ 1.26 $ 1.20
Discontinued operations - .57 .05 .05 .04
--------------------------------------------------------------------
$ 1.95 $ 2.25 $ 1.49 $ 1.31 $ 1.24
--------------------------------------------------------------------
Diluted earnings per share
Continuing operations $ 1.91 $ 1.67 $ 1.43 $ 1.25 $ 1.20
Discontinued operations - .56 .05 .05 .04
--------------------------------------------------------------------
$ 1.91 $ 2.23 $ 1.48 $ 1.30 $ 1.24
--------------------------------------------------------------------
Book value per share $ 14.74 $ 11.66 $ 10.02 $ 8.56 $ 7.97
Return on average common shareholders' equity,
excluding gain on sale of Genix 14.7% 15.8% 16.5% 15.8% 16.1%
Average common shares outstanding (000)
Basic 72,887 66,944 64,743 59,394 58,642
Diluted 75,435 67,521 65,144 59,481 58,642
Actual common shares outstanding (000) 78,232 67,304 66,370 59,788 58,993
PROPERTY, PLANT AND EQUIPMENT
Gas Distribution $ 2,813,434 $ 2,689,039 $ 2,496,711 $2,267,187 $2,154,499
Diversified Energy 1,373,340 1,028,518 663,843 337,638 130,030
--------------------------------------------------------------------
4,186,774 3,717,557 3,160,554 2,604,825 2,284,529
Less-Accumulated depreciation and depletion 1,488,050 1,335,201 1,223,808 1,112,387 1,047,941
--------------------------------------------------------------------
$ 2,698,724 $ 2,382,356 $ 1,936,746 $1,492,438 $1,236,588
--------------------------------------------------------------------
ASSETS $ 4,329,461 $ 3,633,404 $ 2,898,640 $2,240,973 $1,881,900
--------------------------------------------------------------------
CAPITAL INVESTMENTS $ 959,610 $ 790,748 $ 688,838 $ 401,969 $ 245,611
--------------------------------------------------------------------
CAPITALIZATION
Long-term debt, including capital lease obligations $ 1,212,564 $ 1,252,040 $ 993,407 $ 685,519 $ 494,821
Redeemable cumulative preferred securities 505,104 173,809 96,449 98,967 5,618
Common shareholders' equity 1,153,028 784,568 664,776 511,495 470,168
--------------------------------------------------------------------
$ 2,870,696 $ 2,210,417 $ 1,754,632 $1,295,981 $ 970,607
--------------------------------------------------------------------
OPERATING REVENUES
Diversified Energy $ 951,269 $ 734,441 $ 400,027 $ 346,500 $ 289,296
--------------------------------------------------------------------
Gas Distribution
Gas sales 1,080,104 1,102,957 931,940 968,998 979,918
End user transportation 84,749 82,467 80,808 76,483 71,718
Intermediate transportation 55,221 48,570 41,985 39,391 31,397
Other 51,212 42,260 52,913 52,098 58,431
--------------------------------------------------------------------
1,271,286 1,276,254 1,107,646 1,136,970 1,141,464
--------------------------------------------------------------------
Less intercompany transactions 14,668 13,427 12,441 9,837 10,006
--------------------------------------------------------------------
$ 2,207,887 $ 1,997,268 $ 1,495,232 $1,473,633 $ 1,420,754
--------------------------------------------------------------------
EFFECT OF WEATHER
Degree days 6,818 7,170 6,777 6,489 6,675
Percent colder (warmer) than normal .8% 5.4% .3% (4.2)% (2.2)%
Increase (decrease) from normal in:
Gas markets (MMcf) 589 10,909 1,488 (4,353) (4,328)
Net income (loss) $ 467 $ 9,886 $ 1,415 (3,984) (3,696)
Basic earnings (loss) per share $ .01 $ .15 $ .02 $ (.07) $ (.06)
-----------
EMPLOYEES
Diversified Energy 289 243 219 190 176
Gas Distribution 2,920 3,117 3,183 3,328 3,420
67
36
Supplementary Financial Information
SELECTED FINANCIAL DATA (UNAUDITED)
1997 1996 1995 1994 1993
---------------------------------------------------------------------
OPERATING STATISTICS
Diversified Energy:
Exploration & Production:
Gas production (MMcf) 78,218 57,202 31,420 16,513 2,307
Oil production (Mbbl) 3,346 1,086 388 85 --
Gas and oil production (MMcf Equivalent) 98,294 63,718 33,748 17,023 2,307
Pipelines & Processing(1):
Gas processed (MMcf) 42,761 44,223 14,588 1,942 --
Methanol produced (Thousand Gallons) 60,810 10,545 -- -- --
Transportation (MMcf) 115,975 86,391 4,994 1,194 294
Energy Marketing, Gas Storage and Electric Power(1):
Gas sales (MMcf) 343,719 218,952 170,668 142,352 122,782
Exchange gas deliveries (MMcf) 15,109 22,586 16,462 13,301 10,016
---------------------------------------------------------------------
358,828 241,538 187,130 155,653 132,798
---------------------------------------------------------------------
Electricity sales (Thousands of MW Hours) 1,843 709 272 194 191
---------------------------------------------------------------------
Gas Distribution (MMcf):
Gas sales 209,092 220,958 209,816 204,384 205,372
End user transportation 145,101 146,895 145,761 140,020 128,643
Intermediate transportation 586,496 527,510 374,428 322,969 302,662
---------------------------------------------------------------------
940,689 895,363 730,005 667,373 636,677
---------------------------------------------------------------------
GAS DISTRIBUTION CUSTOMERS
Residential 1,105,749 1,100,101 1,090,039 1,073,306 1,061,679
Total 1,193,122 1,183,443 1,172,613 1,154,545 1,141,986
- --------------------------------------------------------------------------------
QUARTERLY OPERATING RESULTS AND COMMON STOCK PRICES (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 weighed average common shares
outstanding during each quarter. There were 22,160 and 23,431 holders of record
of MCN common shares at December 31, 1997 and 1996, respectively.
1997 First Second Third Fourth
(In Thousands of Dollars-Except Per Share Amounts) Quarter Quarter Quarter Quarter Year
-----------------------------------------------------------------------
Operating revenues $ 788,761 $ 387,925 $ 327,817 $ 703,364 $ 2,207,867
Operating income $ 125,866 $ 27,400 $ 853 $ 82,234 $ 236,353
Operating and joint venture income $ 140,227 $ 37,870 $ 18,202 $ 95,713 $ 292,012
Income from continuing operations $ 81,769 $ 9,076 $ 1,219 $ 50,242 $ 142,306
Earnings per share from continuing operations:
Basic $ 1.21 $ .13 $ .02 $ .64 $ 1.95
Diluted $ 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 $ 32.63 $ 30.81 $ 33.00 $ 40.50 $ 40.50
Low $ 28.13 $ 27.38 $ 30.38 $ 32.00 $ 27.38
Close $ 28.13 $ 30.63 $ 32.00 $ 40.38 $ 40.38
- ----------------------------------------------------------------------------------------------------------------------------------
1996
Operating revenues $ 790,638 $ 354,464 $ 243,311 $ 608,855 $ 1,997,268
Operating income (loss) $ 135,707 $ 13,732 $ (10,966) $ 72,820 $ 211,293
Operating and joint venture income (loss) $ 139,750 $ 18,574 $ (8,063) $ 78,899 $ 229,160
Net Income (loss):
Continuing operations $ 79,054 $ 5,207 $ (13,403) $ 41,711 $ 112,569
Discontinued operations 1,013 36,758 -- -- 37,771
---------------------------------------------------------------------
$ 80,067 $ 41,965 $ (13,403) $ 41,711 $ 150,340
---------------------------------------------------------------------
Earnings (loss) per share from continuing operations:
Basic $ 1.19 $ .08 $ (.20) $ .62 $ 1.68
Diluted $ 1.17 $ .08 $ (.20) $ .61 $ 1.67
Dividends paid per share $ .2325 $ .2325 $ .2325 $ .2425 .9400
Average daily trading volume 96,592 84,515 99,434 89,070 92,417
Price per share:
High $ 25.50 $ 25.63 $ 27.63 $ 30.50 $ 30.50
Low $ 21.63 $ 22.75 $ 22.75 $ 26.63 $ 21.63
Close $ 23.13 $ 24.38 $ 26.88 $ 28.88 $ 28.88
(1)Includes MCN's share of joint ventures
68
37
Responsibilities for Financial Statements
The consolidated financial statements of MCN Energy Group Inc. were prepared by
management which is responsible for their integrity and objectivity. The
statements have been prepared in conformity with generally accepted accounting
principles and, as such, include amounts based on judgments of management.
Financial information elsewhere in this Annual Report is consistent with that in
the consolidated financial statements.
Management is further responsible for maintaining a system of internal
accounting controls, designed to provide reasonable assurance that the books and
records reflect the transactions of MCN and its subsidiaries and that
established policies and procedures are carefully followed. Perhaps the most
important feature in the system of internal control is that it is
continually reviewed for its effectiveness and is augmented by a strong internal
audit program.
Deloitte & Touche LLP, independent certified public accountants, is engaged to
audit the consolidated financial statements of MCN and issue reports thereon.
Their audit is conducted in accordance with generally accepted auditing
standards which comprehend a review of internal accounting controls and tests of
transactions.
MCN's Board of Directors, through its Audit Committee, is responsible for: (1)
assuring that management fulfills its responsibilities in the preparation of the
consolidated financial statements, and (2) engaging the independent public
accountants. The Committee reviews the scope of the audits and the accounting
principles being applied in financial reporting. The independent public
accountants, representatives of management and the internal auditors meet
regularly (separately and jointly) with the Committee to review the activities
of each and to ensure that each is properly discharging its responsibilities.
Alfred R. Glancy III
Alfred R. Glancy III
Chairman, President and Chief Executive Officer
William K. McCrackin
William K. McCrackin
Vice Chairman and Chief Financial Officer
Harold Gardner
Harold Gardner
Vice President, Controller and Chief Accounting Officer
To the Board of Directors:
We have audited the accompanying consolidated statements of financial position
of MCN Energy Group Inc. and subsidiaries (the "Corporation"), as of December
31, 1997 and 1996, and the related consolidated statements of income, cash
flows and capitalization for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Corporation'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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Corporation and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
As discussed in Note 7b to the consolidated financial statements, in 1996 the
Corporation adopted Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation."
DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Detroit, Michigan
February 12, 1998
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