MICHIGAN CONSOLIDATED GAS CO /MI/ - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended March 31, 2004

Commission file number 1-7310

The registrant meets the conditions set forth in General Instructions H (1) (a) and (b) of Form 10-Q and is, therefore, filing this Form with the reduced disclosure format.

MICHIGAN CONSOLIDATED GAS COMPANY

(Exact name of registrant as specified in its charter)


Michigan (State or other jurisdiction of incorporation or organization)		38-0478040 (I.R.S. Employer Identification No.)

2000 2^nd Avenue, Detroit, Michigan (Address of principal executive offices)		48226-1279 (Zip Code)

313-235-4000
Registrant’s telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (Exchange Act) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Exchange Act.

Yes o No x

DEFINITIONS


Customer Choice		The choice program is a statewide initiative giving customers in Michigan the option to choose alternative suppliers for gas.

DTE Energy		DTE Energy Company and subsidiary companies.

End User Transportation		A gas delivery service historically provided to large-volume commercial and industrial customers who purchase natural gas directly from producers or brokerage companies. Under MichCon’s Customer Choice program that began in 1999, this service is also provided to residential customers and small-volume commercial and industrial customers.

Enterprises		DTE Enterprises Inc. (successor to MCN Energy) and subsidiaries.

Gas Sales Program		A three-year program that ended in December 2001 under which MichCon’s gas sales rate included a gas commodity component that was fixed at $2.95 per Mcf.

GCR		A gas cost recovery mechanism authorized by the MPSC that was reinstated by MichCon in January 2002 permitting MichCon to pass on the cost of natural gas to its customers.

Intermediate Transportation		A gas delivery service provided to producers, brokers and other gas companies that own the natural gas, but are not the ultimate consumers.

MichCon		Michigan Consolidated Gas Company, an indirect, wholly-owned natural gas distribution and intrastate transmission subsidiary of Enterprises.

MPSC		Michigan Public Service Commission.

SFAS		Statement of Financial Accounting Standards.

Units of Measurement:
Bcf		Billion cubic feet of gas.

Mcf		Thousand cubic feet of gas.

MMcf		Million cubic feet of gas.

FORWARD-LOOKING STATEMENTS

Certain information presented herein includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve certain risks and uncertainties that may cause actual future results to differ materially from those contemplated, projected, estimated or budgeted in such forward-looking statements. There are many factors that may impact forward-looking statements including, but not limited to, the following:

• the effects of weather and other natural phenomena on operations and sales to, and purchases by, customers;

• economic climate and growth or decline in the geographic areas where we do business;

• environmental issues, laws and regulations, and the cost of remediation and compliance associated therewith;

• implementation of gas Customer Choice programs;

• impact of gas utility restructuring in Michigan, including legislative amendments;

• employee relations and the impact of collective bargaining agreements;

• access to capital markets and capital market conditions and the results of other financing efforts which can be affected by credit agency ratings;

• the timing and extent of changes in interest rates;

• the level of borrowings;

• changes in the cost and availability of natural gas;

• effects of competition;

• impacts of MPSC and other applicable governmental proceedings and regulations;

• changes in federal, state and local tax laws and their interpretations, including the code, regulations, rulings, court proceedings and audits;

• the ability to recover costs through rate increases;

• the availability, cost, coverage and terms of insurance;

• the cost of protecting assets against or damage due to terrorism;

• changes in accounting standards and financial reporting regulations;

• changes in federal or state laws and their interpretation with respect to regulation, energy policy and other business issues; and

• changes in the economic and financial viability of our suppliers and customers, and the continued ability of such parties to perform their obligations to the Company.

New factors emerge from time to time. We cannot predict what factors may arise or how such factors may cause our results to differ materially from those contained in any forward-looking statement. Any forward-looking statements speak only as of the date on which such statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

The Results of Operations discussion for MichCon is presented in accordance with General Instruction H(2)(a) of Form 10-Q.

MichCon reported earnings of $69 million for the first quarter of 2004 compared to earnings of $75 million for the 2003 first quarter. Results for the first quarter of 2004 were primarily impacted by increases in operation and maintenance expenses due to higher uncollectible accounts expense offset by a lower effective tax rate.


	Quarter
Increase (Decrease) in Income Compared to Prior Year
(in Millions)
Operating revenues	$	63
Cost of gas		(67	)

Gross margin		(4	)
Operation and maintenance		(18	)
Depreciation, depletion and amortization		(2	)
Taxes other than income		5
Other (income) and deductions		(2	)
Income tax provision		15

Net income	$	(6	)

Operating revenues increased $63 million in the first quarter of 2004, reflecting increased gas sales and reduced end user transportation revenues.


	Quarter
	2004		2003
Gas Markets (in Millions)
Gas sales	$	640	$	561
End user transportation		42		57

		682		618
Intermediate transportation		15		14
Other		18		20

	$	715	$	652

Gas Markets (in Bcf)
Gas sales		83		80
End user transportation		50		61

		133		141
Intermediate transportation		174		174

		307		315

Gas sales and end user transportation revenues in total increased $64 million in the first quarter of 2004. The increase is due primarily to an increase in Gas Cost Recovery (GCR) revenues of $73 million for the first quarter of 2004. This portion of revenues is offset by similar gas costs subject to collection through the GCR. End user transportation revenues for the three-month period reflect lower volumes for deliveries associated with a varying number of customers participating in the Customer Choice program. Customers participating in this program purchase gas from suppliers other than MichCon, while MichCon continues to deliver the gas to their premises. Accordingly, margins earned from selling gas and margins generated from providing end user transportation services to Customer Choice participants are the same. There were approximately 119,000 customers participating in the Customer Choice program at March 31, 2004, compared with approximately 129,000 customers at December 31, 2003.

Cost of gas is affected by variations in sales volumes, cost of purchased gas and related transportation costs. Cost of gas sold increased by $67 million in the first quarter of 2004. The average cost of gas sold increased $.71 per Mcf (14%) for the first quarter from the comparable 2003 period.

Operation and maintenance expenses increased $18 million for the 2004 first quarter from the comparable 2003 period primarily due to higher uncollectible accounts expense, reflecting higher past due amounts attributable to current economic conditions.

Income taxes decreased $15 million for the 2004 first quarter due to a lower effective tax rate in 2004 driven by lower estimated annual earnings.

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2004, which is the end of the period covered by this report, and have concluded that such controls and procedures are effectively designed to ensure that required information disclosed by the Company in reports that it files or submits under the Act is recorded, processed, summarized and timely reported in accordance with Commission’s rules and forms.

MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)


	Three Months Ended
	March 31
(in Millions)	2004			2003
Operating Revenues	$	715		$	652

Operating Expenses
Cost of gas		488			421
Operation and maintenance		96			78
Depreciation, depletion and amortization		27			25
Taxes other than income		12			17

		623			541

Operating Income		92			111

Other (Income) and Deductions
Interest expense		14			15
Interest income		(2	)		(3	)
Other		1			(1	)

		13			11

Income Before Income Taxes		79			100
Income Tax Provision		10			25

Net Income	$	69		$	75

See Notes to Consolidated Financial Statements (Unaudited)

MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF FINANCIAL POSITION


	March 31
	2004			December 31
(in Millions)	(Unaudited)			2003

ASSETS
Current Assets
Cash and cash equivalents	$	7		$	1
Accounts receivable
Customer (less allowance for doubtful accounts of $57 and $43, respectively)		290			178
Accrued unbilled revenues		74			117
Other		72			100
Accrued gas cost recovery revenue		57			19
Notes receivable from affiliate		12			—
Inventories
Gas		30			117
Material and supplies		15			14
Other		57			67

		614			613

Property, Plant and Equipment		3,128			3,124
Less accumulated depreciation, depletion and amortization		(1,361	)		(1,344	)

		1,767			1,780

Other Assets
Other investments		88			87
Notes receivable		82			83
Regulatory assets		60			61
Prepaid benefit costs and due from affiliate		342			333
Other		21			20

		593			584

	$	2,974		$	2,977

LIABILITIES AND SHAREHOLDER’S EQUITY
Current Liabilities
Accounts payable	$	128		$	131
Dividends payable		13			13
Short-term borrowings		3			235
Current portion of long-term debt, including capital leases		3			3
Federal income, property and other taxes payable		37			14
Regulatory liabilities		26			26
Gas inventory equalization		167			—
Other		54			73

		431			495

Other Liabilities
Deferred income taxes		130			134
Regulatory liabilities		564			563
Unamortized investment tax credit		20			20
Accrued postretirement benefit costs		100			96
Accrued environmental costs		15			16
Other		60			55

		889			884

Long-term debt, including capital lease obligations		774			775

Contingencies (Note 3)
Shareholder’s Equity
Common stock, $1 par value, 15,100,000 shares authorized, 10,300,000 shares issued and outstanding		10			10
Additional paid in capital		433			432
Retained earnings		437			381

		880			823

	$	2,974		$	2,977

See Notes to Consolidated Financial Statements (Unaudited)

MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)


	Three Months Ended
	March 31
	2004			2003
(in Millions)
Operating Activities
Net income	$	69		$	75
Adjustments to reconcile net income to net cash from operating activities:
Depreciation, depletion and amortization		27			25
Deferred income taxes and investment tax credit, net		(7	)		(2	)
Gain on sale of assets		(2	)
Changes in assets and liabilities:
Accounts receivable, net		(84	)		(132	)
Accrued unbilled revenues		43			43
Inventories		86			45
Property taxes assessed applicable to future periods		(9	)		(8	)
Prepaid benefit costs and due from affiliate		(9	)		(8	)
Accrued gas cost recovery		(38	)		(48	)
Accounts payable		(3	)		40
Gas inventory equalization		167			150
Federal income, property and other taxes payable		23			14
Other		9			21

Net cash from operating activities		272			215

Investing Activities
Capital expenditures		(14	)		(15	)
Proceeds from sale of assets		5			—
Notes receivable from affiliate		(12	)		(269	)
Other		—			(3	)

Net cash used for investing activities		(21	)		(287	)

Financing Activities
Issuance of long-term debt		—			199
Redemption of long-term debt		(1	)		(30	)
Short-term borrowings, net		(232	)		(90	)
Dividends paid		(12	)		(12	)

Net cash from (used for) financing activities		(245	)		67

Net Increase (Decrease) in Cash and Cash Equivalents		6			(5	)
Cash and Cash Equivalents at Beginning of Period		1			7

Cash and Cash Equivalents at End of Period	$	7		$	2

Supplementary Cash Flow Information
Interest paid (excluding interest capitalized)	$	19		$	14
Income taxes paid		—			14

See Notes to Consolidated Financial Statements (Unaudited)

MICHIGAN CONSOLIDATED GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 — GENERAL

These consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements included in our 2003 Annual Report on Form 10-K.

The accompanying consolidated financial statements are prepared using accounting principles generally accepted in the United States of America. These accounting principles require us to use estimates and assumptions that impact the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.

The consolidated financial statements are unaudited, but in our opinion, include all adjustments necessary for a fair statement of the results for the interim periods. Financial results for this interim period are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year.

We reclassified some prior year balances to match the current year’s presentation.

Retirement Benefits and Trusteed Assets

The MCN Energy Group Retirement Plan, that covered nonrepresented employees, merged into the DTE Energy Company Retirement Plan. Detroit Edison operates as the sponsor of the merged DTE Energy represented and nonrepresented plan, which is treated as a plan covering employees of various affiliates of DTE Energy from the affiliates’ perspective. We are allocated income or an expense each year as a result of our participation in the DTE Energy Retirement Plan. Income was approximately $7 million and $8 million for the three months ended March 31, 2004 and 2003, respectively and is not reflected in the table below.

The components of net periodic benefit costs for qualified and non-qualified pension benefits and other postretirement benefits follow:


							Other Postretirement
(in Millions)	Pension Benefits						Benefits
Three Months Ended March 31	2004			2003			2004			2003
Service Cost	$	2		$	1		$	2		$	2
Interest Cost		4			4			6			5
Expected Return on Plan Assets		(7	)		(7	)		(3	)		(4	)
Amortization of
Net loss		—			—			1			—
Prior service cost		—			—			—			—
Net transition liability		—			—			2			2

Net Periodic Benefit Cost (Credit)	$	(1	)	$	(2	)	$	8		$	5

NOTE 2 — REGULATORY MATTERS

Gas Rate Plan

Rate Request — In September 2003, MichCon filed an application with the MPSC for an increase in service and distribution charges (base rates) for its gas sales and transportation customers. The filing requests an overall increase in base rates of $194 million per year (approximately 7% increase, inclusive of gas costs), beginning January 1, 2005. MichCon has requested that the MPSC increase base rates by $154 million per year on an interim basis by April 1, 2004. The interim request is based on a projected revenue deficiency for the test year 2004.

MPSC Staff Report on Interim Rate Relief — The MPSC Staff report on MichCon’s interim rate request was filed on May 3, 2004. After adjusting for several items that it will address in its final rate relief recommendation, the MPSC Staff recommended a $25 million interim rate increase. This compares with MichCon’s requested total interim base rate relief of $154 million. In addition, the MPSC Staff proposed a 50% debt and 50% equity capital structure utilizing MichCon's current allowed rate of return of 11.5%. An interim order is expected in the third quarter of 2004 and a final order in the first quarter of 2005.

Gas Cost Recovery Proceedings

2002 Plan Year — In December 2001, the MPSC issued an order that permitted MichCon to implement GCR factors up to $3.62 per Mcf for January 2002 billings and up to $4.38 per Mcf for the remainder of 2002. The order also allowed MichCon to recognize a regulatory asset of approximately $14 million representing the difference between the $4.38 factor and the $3.62 factor for volumes that were unbilled at December 31, 2001. The regulatory asset is subject to the 2002 GCR reconciliation process. In March 2003, the MPSC issued an order in MichCon’s 2002 GCR plan case. The MPSC ordered MichCon to reduce its gas cost recovery expenses by $26.5 million for purposes of calculating the 2002 GCR factor due to MichCon’s decision to utilize storage gas during 2001 that resulted in a gas inventory decrement for the 2001 calendar year.

Although we recorded a $26.5 million reserve in 2002 to reflect the impact of this order, a final determination of actual 2002 revenue and expenses including any disallowances or adjustment will be decided in MichCon’s 2002 GCR reconciliation case that was filed with the MPSC in February 2003. The MPSC Staff and various intervening parties in this proceeding are seeking to have the MPSC disallow an additional $26 million, representing unbilled revenues at December 2001. One party has proposed that half of the $8 million related to the settlement of the Enron bankruptcy also be disallowed. The other parties to the case have recommended that the Enron bankruptcy settlement be addressed in the 2003 GCR reconciliation case. An MPSC administrative law judge has recommended disallowances of $26.5 million related to the use of storage gas in 2001 and $26 million related to the December 2001 unbilled issue, and recommended that the $8 million related to the Enron issue be addressed in the 2003 GCR reconciliation case. We have included this item in our testimony in the 20


	PAGE
	NUMBER
DEFINITIONS		3
FORWARD-LOOKING STATEMENTS		4
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statement of Operations		8
Consolidated Statement of Financial Position		9
Consolidated Statement of Cash Flows		10
Consolidated Statement of Retained Earnings		11
Notes to Consolidated Financial Statements		12
Independent Accountants’ Report		15
Item 2. Management’s Narrative Analysis of the Results of Operations		5
Item 4. Controls and Procedures		7
PART II — OTHER INFORMATION
Item 1. Legal Proceedings		16
Item 6. Exhibits and Reports on Form 8-K		16
SIGNATURE		17
Awareness Letter of Deloitte & Touche LLP
Section 302 Certification of CEO
Section 302 Certification of CFO
Section 906 Certification of CEO
Section 906 Certification of CFO

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•		the effects of weather and other natural phenomena on operations and sales to, and purchases by, customers;

•		economic climate and growth or decline in the geographic areas where we do business;

•		environmental issues, laws and regulations, and the cost of remediation and compliance associated therewith;

•		implementation of gas Customer Choice programs;

•		impact of gas utility restructuring in Michigan, including legislative amendments;

•		employee relations and the impact of collective bargaining agreements;

•		access to capital markets and capital market conditions and the results of other financing efforts which can be affected by credit agency ratings;

•		the timing and extent of changes in interest rates;

•		the level of borrowings;

•		changes in the cost and availability of natural gas;

•		effects of competition;

•		impacts of MPSC and other applicable governmental proceedings and regulations;

•		changes in federal, state and local tax laws and their interpretations, including the code, regulations, rulings, court proceedings and audits;

•		the ability to recover costs through rate increases;

•		the availability, cost, coverage and terms of insurance;

•		the cost of protecting assets against or damage due to terrorism;

•		changes in accounting standards and financial reporting regulations;

•		changes in federal or state laws and their interpretation with respect to regulation, energy policy and other business issues; and

•		changes in the economic and financial viability of our suppliers and customers, and the continued ability of such parties to perform their obligations to the Company.

(a)		Evaluation of disclosure controls and procedures

		The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2004, which is the end of the period covered by this report, and have concluded that such controls and procedures are effectively designed to ensure that required information disclosed by the Company in reports that it files or submits under the Act is recorded, processed, summarized and timely reported in accordance with Commission’s rules and forms.