Annual Report — [x] Reg. S-K Item 405 — Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K405 Form 10-K for Year Ended 12/31/98 77 373K
2: EX-3 Exhibit 3.(Ii) - Bylaws 8 33K
3: EX-10 Exhibit 10.14 - Executive Security Agreement 11 48K
4: EX-10 Exhibit 10.15 - Split Dollar Agreement 10 43K
5: EX-10 Exhibit 10.16 - Deferred Comp and Stock Purch Agr 6 22K
6: EX-12 Exhibit 12 - Ratio of Earnings to Fixed Charges 1 10K
7: EX-21 Exhibit 21 - List of Subsidiaries 1 7K
8: EX-23 Exhibit 23 - Consent of Auditors 1 6K
9: EX-24 Exhibit 24 - Power of Attorney 2± 11K
10: EX-27 Exhibit 27 - Financial Data Schedule 1 8K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 0-8503
SEMCO Energy, Inc.
(Exact name of registrant as specified in its charter)
Michigan 38-2144267
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
405 Water Street, Port Huron, Michigan 48060
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 810-987-2200
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
None N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1 Par Value
--------------------------
(Title of Class)
$2.3125, Series A, Convertible
Cumulative Preferred Stock
------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock (Common Stock, $1 Par Value)
held by non-affiliates is computed at $261,439,000 based on 16,631,000 shares
held by non--affiliates as of February 26, 1999 at the average of the bid and
ask prices on the closest date on which trading occurred for such stock of
$15.69 and $15.75, respectively, as quoted on the National Association of
Securities Dealers Automated Quotation National Market System (NASDAQ/NMS)
(which prices may not represent actual transactions).
Number of shares outstanding of each of the Registrant's classes of Common
Stock, as of February 26, 1999: 17,462,000.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Registrant's definitive Proxy Statement (filed pursuant to
Regulation 14A) with respect to Registrant's April 20, 1999 Annual Meeting of
Shareholders are incorporated by reference herein in response to Part III.
T A B L E O F C O N T E N T S
PAGE
CONTENTS NUMBER
PART I
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . 1
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . 7
ITEM 3. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . 9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . 10
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS . . . . 10
ITEM 6. SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . 11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . 12
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA . . . . . 32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE . . . . . . . . . 63
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT . . 64
ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . 65
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . 65
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . 65
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K . . . . . . . . . . . . . . . . . . . . . 66
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
-i-
GLOSSARY
AMR . . . . . . . . . . (Automated Meter Reading) a meter reading system
that employs radio waves to collect consumption data
ATS . . . . . . . . . . (Aggregated Transportation Service) program that
allows commercial and industrial gas company
customers to purchase their gas from third-party gas
suppliers
Bcf . . . . . . . . . . A measure of natural gas volumes equivalent to one
billion cubic feet
Degree Day . . . . . . . A measure of coldness computed by the number of
degrees the average daily temperature falls below
65 degrees Fahrenheit
DRIP . . . . . . . . . . Direct Stock Purchase and Dividend Reinvestment Plan
FASB . . . . . . . . . . Financial Accounting Standards Board
FERC . . . . . . . . . . Federal Energy Regulatory Commission
Field Order System . . . A computerized dispatching system for field service
calls
GCR . . . . . . . . . . (Gas Cost Recovery) a process by which the gas
company, through annual gas cost proceedings before
the MPSC, can recover the prudent and reasonable
cost of gas sold
Mcf . . . . . . . . . . A measure of natural gas volumes equivalent to one
thousand cubic feet
MMcf . . . . . . . . . . A measure of natural gas volumes equivalent to one
million cubic feet
MPSC . . . . . . . . . . Michigan Public Service Commission
Normal Degree Days . . . An average of degree days over the last 10 years
Normal Weather . . . . . The average daily temperature during the last 10
years
NASDAQ . . . . . . . . . National Association of Securities Dealers Automated
Quotations System
NYMEX . . . . . . . . . New York Mercantile Exchange
SFAS . . . . . . . . . . Statement of Financial Accounting Standards
-ii-
FORWARD LOOKING STATEMENTS
This Annual Report contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 that are based on
current expectations, estimates and projections. Statements that are not
historical facts, including statements about the Company's belief and
expectations are forward-looking statements. These statements are subject to
potential risks and uncertainties and, therefore, actual results may differ
materially. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future
events or otherwise. 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) the economic climate and growth in the
geographical areas where the Company does business; (iii) the capital
intensive nature of the Company's business; (iv) increased competition within
the energy marketing industry as well as from alternative forms of energy;
(v) the timing and extent of changes in commodity prices for natural gas;
(vi) the effects of changes in governmental and regulatory policies,
including income taxes, environmental compliance and authorized rates; (vii)
the Company's ability to bid on and win business contracts; (viii) the impact
of energy prices on the amount of projects and business available to
Engineering Services; (ix) the nature, availability and projected
profitability of potential investments available to the Company and (x) the
conditions of capital markets and equity markets.
PART I
ITEM 1. BUSINESS
SEMCO ENERGY, INC.
SEMCO Energy, Inc. is a diversified energy services and infrastructure
holding company headquartered in southeastern Michigan. The Company was
incorporated in Michigan in 1977. SEMCO Energy, Inc. and its subsidiaries
(the "Company") operate five energy-related business segments. The business
segments are gas distribution, engineering services, construction services,
energy marketing and propane, pipelines and storage. The Company had
approximately 860 employees at December 31, 1998.
-1-
ITEM 1. BUSINESS (CONT.)
GAS DISTRIBUTION
The Company's gas distribution business segment ("Gas Company") serves nearly
250,000 customers in twenty-four of the counties in the state of Michigan.
It distributes and transports natural gas to residential, commercial and
industrial customers. The Company's gas distribution business is operated
through its SEMCO Energy Gas Company subsidiary and is its largest business
segment. Set forth in the table below is gas sales and transportation
information for the past three years:
[Enlarge/Download Table]
1998 1997 1996
-------------- -------------- --------------
Gas sales revenue (in thousands):
Residential......................................... $118,220 71% $139,538 64% $138,644 63%
Commercial.......................................... 42,041 25% 66,577 30% 65,509 30%
Industrial.......................................... 6,439 4% 12,065 6% 15,218 7%
-------- ---- -------- ---- -------- ----
Total gas sales revenue........................... $166,700 100% $218,180 100% $219,371 100%
======== ==== ======== ==== ======== ====
Gas transportation revenue (in thousands)............. $ 14,832 $ 13,243 $ 12,358
======== ======== ========
Volumes of gas sold (MMcf):
Residential......................................... 21,946 68% 25,968 62% 26,703 61%
Commercial.......................................... 8,840 27% 13,483 32% 13,670 31%
Industrial.......................................... 1,461 5% 2,534 6% 3,385 8%
------ ---- ------ ---- ------ ----
Total volumes sold................................ 32,247 100% 41,985 100% 43,758 100%
====== ==== ====== ==== ====== ====
Volumes of gas transported (MMcf)..................... 23,791 21,373 20,532
====== ====== ======
Refer to Note 12 of the Notes to the Consolidated Financial Statements
for the Gas Company's operating revenues, operating income, assets and other
financial information for the past three years.
Gas Sales. The Gas Company sells and delivers natural gas to residential,
commercial and industrial customers. Revenues are generated primarily
through sales to residential and commercial customers. These customers use
natural gas mainly for space heating purposes. Consequently, weather has a
significant impact on sales. Given the impact of weather on this business,
most gas sales revenue is earned in the first and fourth quarters of the
calendar year. Operating revenues from gas sales accounted for 26%, 28% and
40% of consolidated operating revenues in 1998, 1997 and 1996, respectively.
If operating revenues from the Company's marketing business, which the
Company entered into an agreement to sell in March 1999, are excluded, gas
sales by the Gas Company would have accounted for 68%, 88% and 92% of
consolidated operating revenues for those three years.
Competition in the gas sales market arises from the availability of
alternate energy sources such as electricity, propane and oil. However, this
competition is inhibited because of the time, inconvenience and investment
for residential and commercial customers to convert to an alternate energy
source when the price of natural gas fluctuates.
-2-
ITEM 1. BUSINESS (CONT.)
GAS DISTRIBUTION (CONT.)
The Gas Company continues to increase its customer base. Since 1988, it
has added 59,225 customers, or approximately 6,000 customers per year. These
additions have been primarily residential and are a result of expanded
service territories, conversion of existing homes and new home construction.
On April 1, 1998, an aggregation tariff became effective and provides
commercial and industrial customers the opportunity to aggregate multiple
service locations and purchase their gas from a third-party supplier, while
allowing the Gas Company to continue charging the existing distribution
charges and customer fees. Refer to Management's Discussion and Analysis for
further information regarding the impact of the aggregation tariff on gas
sales and transportation revenue.
Transportation. The Gas Company provides transportation services to its
large-volume commercial and industrial customers. This service offers those
customers the option of purchasing natural gas directly from producers or
marketing companies while utilizing the Gas Company's distribution network to
transport the gas to their facilities.
The market price of alternate energy sources such as coal, electricity,
oil and steam is the primary competitive factor affecting the demand for
transportation. Many large industrial customers have some limited ability to
convert to another form of energy when the price of natural gas increases
significantly. In addition, downward pressure on transportation rates has
resulted from the potential for industrial and power plants located on
various parts of the Gas Company's distribution system to connect directly to
interstate natural gas pipelines and bypass the Gas Company. Refer to
Management's Discussion and Analysis for additional information regarding
bypass potential. Partially offsetting the impact of price sensitivity has
been the use of natural gas as an industrial fuel because of clean air
legislation and the resultant pressures on industry and electric utilities to
reduce emissions from their plants.
Gas Supply. The Gas Company is served by four major interstate pipelines:
Panhandle Eastern Pipe Line Company, Northern Natural Gas Company, Great
Lakes Gas Transmission Company and ANR Pipeline Company.
Natural gas purchases are transported to the Gas Company's systems under
various firm and interruptible transportation arrangements with interstate
and intrastate transmission companies.
The Gas Company utilizes on-system and leased storage capacity of 35% to
40% of average annual gas sales volumes to reduce its reliance on the
interstate pipelines for peak day needs and allow for the purchase of natural
gas at lower prices.
The Gas Company owns underground storage facilities with a working
capacity of 5.0 billion cubic feet ("Bcf"). In addition, it leases 6.5 Bcf
of storage from Eaton Rapids Gas Storage System and 4.5 Bcf from
non-affiliates. SEMCO Gas Storage Company (an affiliated company) is a 50%
owner of Eaton Rapids Gas Storage System.
-3-
ITEM 1. BUSINESS (CONT.)
GAS DISTRIBUTION (CONT.)
The Company has entered into an agreement with TransCanada Gas Services,
Inc., under which the latter will provide the Gas Company's natural gas
requirements and manage the Gas Company's natural gas supply and the supply
aspects of transportation and storage operations for the three year period
beginning April 1, 1999. Refer to Note 2 of the Notes to the Consolidated
Financial Statements for additional information about the agreement.
Rates and Regulation. The Gas Company is subject to the jurisdiction of the
Michigan Public Service Commission ("MPSC") as to various phases of its
operations including rates, accounting and service standards. However, rates
charged to customers in the Battle Creek division are subject to the
jurisdiction of the City Commissioners of Battle Creek, Michigan.
Management periodically reviews the adequacy of the Gas Company's rates
and files requests for rate increases whenever it is deemed necessary and
appropriate. However, a recent rate case includes provisions limiting the
Gas Company's ability to request a rate increase during the next three years.
Refer to Note 2 of the Notes to the Consolidated Financial Statements for
further information on regulatory matters including the authorization by the
MPSC to suspend the Gas Company's gas cost recovery ("GCR") clause and freeze
for three years in its base rates a gas charge of $3.24 per Mcf.
Environmental Matters. The Gas Company currently owns seven sites which
formerly housed manufactured gas plants. In the earlier part of this
century, gas was manufactured from processes using coal, coke or oil.
By-products of this process have left some contamination at these sites. The
Company has submitted a plan to the State of Michigan for the proposed clean
up at one of these sites. Refer to Note 14 of the Notes to the Consolidated
Financial Statements for further discussion.
ENGINEERING SERVICES
The Company's engineering services business segment ("Engineering Services")
is comprised of two companies, Maverick Pipeline Services, Inc. ("Maverick")
and Oilfield Materials Consultants, Inc. ("OMC"). Maverick was acquired in
December 1997 and was accounted for as a purchase. OMC was acquired in
November 1998 and was accounted for as a pooling of interests (see Note 3 of
the Notes to the Consolidated Financial Statements for information regarding
acquisitions accounted for as a purchase or as a pooling of interests).
Engineering Services has offices in New Jersey, Michigan, Louisiana and Texas
and provides a variety of energy related engineering services in several
states. Refer to Note 12 of the Notes to the Consolidated Financial
Statements for Engineering Services' operating revenues, operating income,
assets and other financial information for the past three years.
-4-
ITEM 1. BUSINESS (CONT.)
ENGINEERING SERVICES (CONT.)
Engineering Services serves the natural gas distribution and
transmission, oil products, exploration/production and telecommunication
industries. The primary services provided include engineering design,
project management, field surveying, inspecting, testing, pipeline-mill
quality assurance and full turnkey service. Engineering Services competes
with regional, national and international firms as well as in-house
engineering and field service departments. Refer to Management's Discussion
and Analysis for further discussion concerning competitio-n in the engineering
services industry.
With the recent downturn in oil prices, there has been a reduction in
oil and gas production and related activities, as a result of which OMC has
experienced a reduction in the level of available construction inspection and
quality assurance projects. Management believes that the level of these
activities and available projects will increase as oil prices recover.
CONSTRUCTION SERVICES
The Company's construction services business segment ("Construction
Services") has offices in Michigan and Tennessee as of December 31, 1998.
Its primary service is underground pipeline installation and replacement for
the natural gas distribution industry. As of December, 31 1998, the
construction services segment was comprised of two companies, Sub-Surface
Construction Co. ("Sub-Surface") and King Energy & Construction Co. ("King").
Sub-Surface was acquired in August 1997 and King was acquired in May 1998.
Both acquisitions were accounted for as purchases. Refer to Note 12 of the
Notes to the Consolidated Financial Statements for Constructions Services'
operating revenues, operating income, assets and other financial information
for the past two years.
In January 1999, the Company acquired K&B Construction, Inc. ("K&B").
As of December 31, 1998 K&B employed 117 employees and had 1998 revenues of
approximately $9 million. K&B provides underground construction services in
Kansas and Missouri.
The natural gas construction services industry is comprised of a highly
fragmented group of companies focused primarily on regional or local markets.
The top six construction companies in the country have less than 6% of the
market. Approximately 30% of the market represents work done by utility
companies' in-house construction departments with the remainder of the market
being served by a large number of small- and medium-size companies. The
Company plans to expand Construction Services' market share significantly
over the next several years by acquiring small- to medium-size companies that
have a strong customer base.
Construction Services' business is seasonal in nature. Most of this
segment's annual profits are made during the summer and fall months.
Construction Services generally incurs losses during the winter months when
underground construction is inhibited.
-5-
ITEM 1. BUSINESS (CONT.)
PROPANE, PIPELINES AND STORAGE
The Company's pipelines and storage operations consist of several pipelines
and a gas storage facility. The Company has partial ownership interests or
equity interests in certain of these operations. The pipelines and storage
operations are all located in Michigan. Refer to Item 2 of this Form 10-K
for additional information on each pipeline and storage facility such as its
location and customers. In March 1998, the Company acquired its first
propane distribution business, Hotflame Gas, Inc. and Hot Flame Transport
Co., Inc. (together "Hotflame"). The acquisition of Hotflame was accounted
for as a purchase. Hotflame supplies propane to over 7,500 retail customers
in Michigan's upper peninsula and northeast Wisconsin. Refer to Note 12 of
the Notes to the Consolidated Financial Statements for operating revenues,
operating income, assets and other financial information for the past three
years for the propane, pipelines and storage business segment.
The retail propane industry is highly fragmented with the largest firm
in the industry serving less than 10% of the national market and the vast
majority of propane companies individually having less than one percent
market share. Propane is transported easily in pressurized containers and is
generally the fuel used in rural areas where natural gas pipelines and
distribution systems do not exist or are uneconomical to build. The Company
purchases the majority of its propane from BP Amoco PLC. The propane
operation competes with other regional propane providers. The basis of the
competition is generally price and service. Because propane is used
principally for heating, most of the operating income for the propane
business is generated in the first and fourth quarters of the calendar year.
ENERGY MARKETING
The Company's energy marketing business segment ("Energy Services") provides
natural gas marketing services to approximately 188 customers in several
states. Its customers include industrial, commercial and municipal natural
gas users, natural gas distribution companies and other marketers. Energy
marketing revenues accounted for 61%, 68% and 56% of the Company's
consolidated revenues for 1998, 1997 and 1996, respectively. Despite
accounting for a significant portion of the Company's total revenues, Energy
Services has incurred operating losses in two of the past three years. Refer
to Note 12 of the Notes to the Consolidated Financial Statements for Energy
Services' operating revenues, operating income, assets and other financial
information for the past three years.
Energy Services purchases and markets natural gas to customers on a
month-to-month basis and under long-term agreements. It also arranges for
transportation of gas supplies to the customers' premises and offers storage
capacity, contract administration and a variety of risk management services.
Competition in the energy marketing industry is strong. Firms compete
on the basis of price, the ability to arrange suitable transportation of the
product to the customer and the ability to provide related services such as
pipeline nominations and balancing. Refer to Management's Discussion and
Analysis for further discussion concerning the competitive pressures
associated with this industry.
-6-
ITEM 1. BUSINESS (CONT.)
ENERGY MARKETING (CONT.)
Energy Services obtains its gas supply from various production sources,
primarily located in Louisiana, Oklahoma and Michigan. It generally
contracts for gas supply on a monthly basis, however, it does enter into some
long-term gas purchasing arrangements. See Note 8 of the Notes to the
Consolidated Financial Statements for a description of Energy Services'
hedging activities as they relate to its gas supply strategy.
On March 15, 1999, the Company entered into a stock sale agreement,
subject to approval under the Hart-Scott-Rodino Anti-Trust Improvements Act
of 1987, to sell Energy Services to another energy marketer. The transaction
is anticipated to be effective as of March 31, 1999. Management has
concluded that the relatively low margins, generally poor industry returns
and high risks associated with natural gas marketing do not support remaining
in the business. The gas marketing business no longer fits the Company's
future strategic direction.
Pursuant to the stock sale agreement, the Company agreed that, for a
period of two years after the closing date, it would not compete in the
unregulated natural gas marketing business in the state of Michigan.
ITEM 2. PROPERTIES
SEMCO ENERGY, INC.
The properties of the SEMCO Energy, Inc. consist of the common stock of its
first-tier subsidiaries, leasehold improvements and office equipment.
GAS DISTRIBUTION
The Gas Company owns gas supply systems which, on December 31, 1998, included
approximately 151 miles of transmission pipelines and 5,170 miles of
distribution pipelines. The pipelines are located throughout the southern
half of Michigan's lower peninsula (centered around the cities of Port Huron,
Albion, Battle Creek and Holland) and also in the central and western areas
of Michigan's upper peninsula.
The Gas Company's distribution system and service lines are, for the
most part, located on or under public streets, alleys, highways and other
public places, or on private property not owned by the Gas Company with
permission or consent, except to an inconsequential extent, of the individual
owners. The distribution systems and service lines located on or under
public streets, alleys, highways and other public places were all installed
under valid rights and consents granted by appropriate local authorities.
The Gas Company owns and operates underground gas storage facilities in
eight depleted salt caverns and two depleted gas fields together with
measuring, compressor and transmission facilities. The aggregate working
capacity of the storage system is approximately 5.0 Bcf.
The Gas Company also owns meters and service lines, gas regulating and
metering stations, garages, warehouses and other buildings necessary and
useful in conducting its business. It leases its computer and transportation
equipment.
-7-
ITEM 2. PROPERTIES (CONT.)
ENGINEERING SERVICES
Engineering Services' properties include primarily computers, trucks, testing
equipment and related devices required to perform engineering and related
services. Much of the equipment is portable and is used by the Company's
employees at customer worksites throughout several states.
CONSTRUCTION SERVICES
The tangible properties of Construction Services include equipment required
for the installation, repair or replacement of underground pipelines or
similar items. This includes primarily equipment necessary for excavation
such as backhoes, trenchers, directional drills and dumptrucks. This
equipment can be driven or carried on trailers from one worksite to another.
Substantially all of Construction Services' equipment at December 31, 1998
was located in Michigan and Tennessee.
PROPANE, PIPELINES AND STORAGE
The principal properties of this business segment include interests and
operations in propane distribution, natural gas transmission and gathering
and an underground gas storage system.
[Download Table]
Set forth in the following table are the equity investments of the
propane, pipelines and storage business segment and its ownership percentage
and equity investment at December 31, 1998:
Percent Equity
Ownership Investment
--------- ----------
(in thousands of dollars)
Eaton Rapids Gas Storage System............. 50% $4,165
Nimrod Limited Partnership.................. 29% 257
Michigan Intrastate Pipeline System......... 50% 0
Michigan Intrastate Lateral System.......... 50% 100
------
$4,522
======
The Company owns a 50% equity interest in the Eaton Rapids Gas Storage
System. This system, located near Eaton Rapids, Michigan, became operational
in March 1990 and consists of approximately 12.8 Bcf of underground storage
capacity. Of the total, 6.5 Bcf is leased by the Gas Company.
The Company also owns 50% of the Michigan Intrastate Pipeline System and
the Michigan Intrastate Lateral System partnerships. The sole purpose of
these partnerships is to hold a 10% ownership of the Saginaw Bay Pipeline
Project, a 126-mile pipeline from Michigan's Saginaw Bay area to processing
plants in Kalkaska, Michigan.
The property of the propane distribution operation consists primarily of
pressurized propane storage tanks used by customers to store propane
purchased from the Company and trucks for transporting propane. The Company
also owns large propane storage tanks that allow the Company to store up to
258,000 gallons of propane inventory. The propane distribution property is
all located in Michigan's upper peninsula and northeast Wisconsin.
-8-
ITEM 2. PROPERTIES (CONT.)
PROPANE, PIPELINES AND STORAGE (CONT.)
[Enlarge/Download Table]
The following table sets forth the pipeline operations wholly or
partially owned by the Company, the total net property of the project, the
Company's ownership percentage and net property at December 31, 1998:
Total The Company's The Company's
Net Property Percent Ownership Net Property
------------ ----------------- -------------
(in thousands of dollars)
Litchfield Lateral............... $10,588 33% $ 3,494
Greenwood Pipeline............... 6,088 100% 6,088
Iosco-Reno System................ 2,439 40% 976
Eaton Rapids Pipeline............ 944 100% 944
------- -------
$20,059 $11,502
======= =======
The Litchfield Lateral is a 31-mile pipeline located in southwest
Michigan. The line, which is leased entirely to ANR Pipeline Company, links
the Eaton Rapids Gas Storage System with interstate pipeline supplies. The
Litchfield Lateral began operations in February 1993.
The Greenwood Pipeline, an 18-mile pipeline, was constructed in 1991, to
serve Detroit Edison's Greenwood power plant located in Michigan's thumb
area. The Company and Detroit Edison have entered into an agreement whereby
Detroit Edison has contracted for the entire capacity of the line which
amounts to 240 million cubic feet ("MMcf") per day.
The Iosco-Reno System includes the Iosco County Pipeline and Reno Gas
Processing Plant, which was placed in service in March 1992. The Iosco-Reno
System gathers and processes wet gas in the Au Gres and Santiago fields
located in mid-Michigan for delivery to the processing plant and ultimate
delivery to the gas markets.
The Eaton Rapids Pipeline is a 7.1 mile pipeline constructed in 1990.
It provides direct delivery of gas from the Eaton Rapids Gas Storage System
to the Gas Company's customers located in Battle Creek and Albion, Michigan.
ENERGY MARKETING
The properties of Energy Services include primarily computers and office
furniture and equipment. At December 31, 1998 all such property was located
in the state of Michigan.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
MARKET PRICE AND NASDAQ LISTING
NASDAQ Trading Symbol "SMGS"
The common stock of the Company is traded on The Nasdaq Stock Market under
the symbol "SMGS." The table below shows high and low closing bid prices of
the Company's common stock in the over-the-counter market as reported in the
Wall Street Journal adjusted to reflect the 5% stock dividends in May 1998
and 1997. These quotations reflect dealer prices, without brokerage
commission, and may not necessarily represent actual transactions.
[Enlarge/Download Table]
Price Range Price Range
------------------------------------------------ ------------------------------------------------
1998 High Low 1997 High Low
------------------------------------------------ ------------------------------------------------
First Quarter $17-7/8 $15-1/4 First Quarter $19-1/8 $16-1/4
Second Quarter $18-3/8 $15-1/4 Second Quarter $18-1/4 $15-2/3
Third Quarter $18 $13-1/8 Third Quarter $17-2/3 $15-2/3
Fourth Quarter $17-1/2 $14-1/2 Fourth Quarter $17-1/3 $15-2/3
See the cover page for a recent stock price and the number of shares
outstanding.
See Selected Financial Data for the number of shareholders at year end
for the past five years.
The Company issued unregistered shares of its common stock in connection
with certain acquisition transactions during 1998. See Note 3 of the Notes
to the Consolidated Financial Statements.
DIVIDENDS
See Notes 5 and 16 of the Notes to the Consolidated Financial Statements and
Selected Financial Data.
-10-
ITEM 6. SELECTED FINANCIAL DATA
[Enlarge/Download Table]
Years Ended December 31, 1998 1997<F11> 1996<F11> 1995 1994
-----------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA (000's)
Operating revenue.................. $637,485 $775,932 $547,910 $335,538 $372,430
-------- -------- -------- -------- --------
Operating expenses
Cost of gas sold.................. $109,388 $150,967 $151,135 $120,619 $135,669
Cost of gas marketed.............. 386,691 518,157 308,619 130,087 153,973
Operations and maintenance........ 92,696 55,209 43,211 36,217 35,558
Depreciation...................... 15,349 12,877 11,334 12,035 11,549
Property and other taxes.......... 9,166 9,555 8,777 7,966 8,186
-------- -------- -------- -------- --------
$613,290 $746,765 $523,076 $306,924 $344,935
-------- -------- -------- -------- --------
Operating income................... $ 24,195 $ 29,167 $ 24,834 $ 28,614 $ 27,495
Other income (deductions).......... (7,835)<F4><F10> (5,273)<F8> (44,702)<F6> (11,132) (12,944)<F4>
-------- -------- -------- -------- --------
Income (loss) before income taxes.. $ 16,360 $ 23,894 $(19,868) $ 17,482 $ 14,551
Income taxes....................... 6,320 8,469 (7,106) 6,151 4,559
-------- -------- -------- -------- --------
Net income (loss).................. $ 10,040 <F4><F10> $ 15,425 <F8> $(12,762)<F6> $ 11,331 $ 9,992 <F4>
Common dividends................... 11,836 10,225 9,814 9,230 8,656
-------- -------- -------- -------- --------
Earnings (deficit) reinvested
in the business................... $ (1,796) $ 5,200 $(22,576) $ 2,101 $ 1,336
======== ======== ======== ======== ========
COMMON STOCK DATA
Average shares
outstanding (000's) <F1>.......... 15,906 14,608 14,573 13,696 13,440
Earnings (loss) per share
- basic and diluted <F1>.......... $ 0.63 <F4><F10> $ 1.06 <F8> $ (0.88)<F6> $ 0.83 $ 0.74 <F4>
Dividends paid per share <F1>...... $ 0.74 $ 0.70 $ 0.67 $ 0.67 $ 0.64
Dividend payout ratio.............. 117.9% 66.0% N/A 81.5% 86.6%
Book value per share <F1><F2>...... $ 7.61 $ 6.44 $ 5.95 $ 7.99 $ 7.86
Market value
per share <F1><F2><F3>............ $ 16.25 $ 17.20 $ 16.78 $ 15.54 $ 14.80
Number of registered
common shareholders............... 9,336 8,755 8,509 8,334 8,149
BALANCE SHEET DATA <F2>
Total assets (000's)............... $489,662 $507,160 $479,037 $378,523 $368,498
======== ======== ======== ======== ========
Capitalization (000's)
Long-term debt <F5>............... $170,000 $163,548 $108,112 $107,325 $104,910
Preferred stock................... 3,255 3,269 3,269 3,272 3,288
Common equity..................... 132,228 95,131 86,678 109,511 107,379
-------- -------- -------- -------- --------
$305,483 $261,948 $198,059 $220,108 $215,577
======== ======== ======== ======== ========
FINANCIAL RATIOS
Capitalization
Long-term debt <F5>............... 55.6% 62.4% 54.6% 48.8% 48.7%
Preferred stock................... 1.1% 1.3% 1.6% 1.5% 1.5%
Common equity..................... 43.3% 36.3% 43.8% 49.7% 49.8%
-------- -------- -------- -------- --------
100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======== ========
Return on average common equity.... 8.8% 17.0%<F9> (13.0)%<F7> 10.4% 9.5%
======== ======== ======== ======== ========
<FN>
<F1>
Adjusted to give effect to 5 percent stock dividends in May each year, 1994 through 1998.
<F2>
Year end.
<F3>
Based on NASDAQ closing bid price.
<F4>
Includes $499 (net of tax) or $.03 per share and $1,286 (net of tax) or $.10 per share in 1998 and 1994,
respectively, attributable to an extraordinary item-loss on early extinguishment of debt.
<F5>
Includes current maturities of long-term debt.
<F6>
Includes the write-down of the NOARK investment - $21,000 (net of tax) or $1.44 per share.
<F7>
Excluding the write-down of the NOARK investment, return on average common equity was 7.6%.
<F8>
Includes adjustment to reserve for NOARK investment - $5,025 (net of tax) or $.34 per share.
<F9>
Excluding the adjustment to reserve for NOARK investment, return on average common equity was 11.8%.
<F10>
Includes income of $1,784 (net of tax) or $.11 per share attributable to a change in accounting method,
and a gain of $1,708 (net of tax) or $.11 per share from the sale of the NOARK investment.
<F11>
Restated to account for a 1998 acquisition as a pooling of interests. Years prior to 1996 were not
restated for the pooling of interests as the effects were deemed not material.
</FN>
-11-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
NET INCOME. The Company's net income was $10.0 million (or $0.63 per share)
in 1998. The unseasonably warm weather throughout 1998 had a significant
impact on earnings. On a weather-normalized basis, net income for 1998 would
have been $17.2 million (or $1.08 per share). The following table shows the
net income and earnings per share ("EPS") for the past three years, as well
as the impact of weather, the divestiture of the NOARK investment, a change
in accounting method and an extraordinary charge.
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
Net income (loss):
Reported $ 10,040 $ 15,425 $(12,762)
Weather-normalized $ 17,220 $ 15,425 $(13,997)
Earnings (loss) per share - basic and diluted (EPS):
Reported $ 0.63 $ 1.06 $ (0.88)
Weather-normalized $ 1.08 $ 1.06 $ (0.96)
Impact of divestiture of NOARK on:
Net income (loss): $ 1,708 $ 5,025 $(21,000)
EPS $ 0.11 $ 0.34 $ (1.44)
Impact of change in accounting method
and extraordinary charge on:
Net income (loss): $ 1,285 $ -- $ --
EPS $ 0.08 $ -- $ --
EPS, excluding special items above $ 0.89 $ 0.72 $ 0.48
The divestiture of NOARK, the change in accounting method and the
extraordinary charge are all discussed in greater detail after the following
discussions regarding the Company's business segments.
SUMMARY OF BUSINESS SEGMENTS
The Company has five business segments. They are gas distribution,
engineering services, construction services, energy marketing and propane,
pipelines and storage. Refer to Notes 1 and 12 of the Notes to the
Consolidated Financial Statements for additional information regarding each
business segment.
The following table shows the operating revenues and operating income of
each business segment as well as a reconciliation ("Corporate and other") of
the segment information to the applicable line in the consolidated financial
statements. Corporate and other includes corporate related expenses not
allocated to segments, intercompany eliminations and results of other smaller
operations.
-12-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
SUMMARY OF BUSINESS SEGMENTS (CONT.)
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
(in thousands)
Operating revenues
Gas Distribution $184,221 $232,511 $232,985
Engineering Services 41,366 5,660 2,961
Construction Services 25,904 13,207 --
Propane, Pipelines and Storage 4,852 3,027 3,070
Energy Marketing 397,888 555,367 344,379
Corporate and other (16,746) (33,840) (35,485)
-------- -------- --------
Consolidated $637,485 $775,932 $547,910
======== ======== ========
Operating income (loss)
Gas Distribution $ 22,363 $ 26,348 $ 27,438
Engineering Services 2,938 778 273
Construction Services (102) 762 --
Propane, Pipelines and Storage 1,585 1,458 1,471
Energy Marketing (696) 217 (3,857)
Corporate and other (1,893) (396) (491)
-------- -------- --------
Consolidated $ 24,195 $ 29,167 $ 24,834
======== ======== ========
Each business segment is discussed separately on the following pages. The
Company evaluates the performance of its business segments based on the
operating income generated. Operating income does not include non-operating
items such as income taxes, interest expense, extraordinary charges, changes
in accounting method and non-operating income and expense items. A review of
the non-operating items follows the business segment discussions.
GAS DISTRIBUTION
WARMER TEMPERATURES IMPACT EARNINGS. The Company's operating income from its
gas distribution business segment ("Gas Company") declined in 1998 due
primarily to the impact of the unseasonably warm temperatures throughout the
year. On a weather-normalized basis, the Gas Company's operating income
would have increased by $6.8 million in 1998 when compared to 1997 and by
$.8 million in 1997 compared to 1996.
-13-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
GAS DISTRIBUTION (CONT.)
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
(in thousands)
Gas Distribution
Gas sales revenue $166,700 $218,180 $219,371
Cost of gas sold 109,388 150,967 151,135
-------- -------- --------
Gas sales margin $ 57,312 $ 67,213 $ 68,236
Gas transportation revenue 14,832 13,243 12,358
Other operating revenue 2,689 1,088 1,256
-------- -------- --------
Gross margin $ 74,833 $ 81,544 $ 81,850
Operating expenses 52,470 55,196 54,412
-------- -------- --------
Operating income $ 22,363 $ 26,348 $ 27,438
======== ======== ========
Weather-normalized operating income $ 33,163 $ 26,348 $ 25,538
======== ======== ========
<FN>
The amounts in the table above include intercompany transactions
</FN>
GAS SALES MARGIN. In 1998, gas sales margin decreased by $9.9 million (or
15%) compared to 1997. This was due primarily to lower gas sales resulting
from the unseasonably warm weather during 1998 and the adoption of a new
aggregation tariff, offset partially by the addition of new gas sales
customers and a rate increase in October 1997. The weather during 1998 was
20% warmer than normal. $10.8 million of the decrease in operating income is
attributable to the warm temperatures.
The aggregation tariff, which was effective April 1, 1998, provides all
commercial and industrial customers the opportunity to purchase their gas
from a third-party supplier, while allowing the Gas Company to continue
charging the existing distribution charges and customer fees. The program is
referred to as the aggregated transportation service ("ATS") program.
Distribution charges and customer fees associated with customers who have
switched to third-party gas suppliers are recorded in gas transportation
revenue rather than gas sales revenue because the Gas Company is now acting
as a transporter for those customers. Therefore, the decrease in gas sales
margin due to customers switching to third-party suppliers ($2.5 million) is
offset by a corresponding increase in gas transportation revenue.
The addition of new customers increased gas sales margin by $1.8 million
in 1998. The Gas Company added an average of 7,359 new gas sales customers
in 1998. During the same period, an average of 2,900 gas sales customers
switched from gas sales service to the Company's new ATS program.
The October 1997 rate increase was granted primarily to allow for the
recovery of costs related to a change in accounting for retiree medical
benefits. The rate increase and aggregation tariff referenced above were
approved in the October 1997 Order of the Michigan Public Service Commission
("1997 rate case") (see Note 2 in the Notes to the Consolidated Financial
Statements).
-14-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
GAS DISTRIBUTION (CONT.)
In 1997, gas sales margin decreased by $1.0 million (or 2%), when
compared to 1996, due primarily to lower gas sales resulting from warmer
temperatures and several industrial gas sales customers converting to
transportation. Weather was essentially normal in 1997 but was approximately
4% warmer than 1996. The impact of these items was offset partially by the
addition of an average of 7,809 (or 3%) new gas sales customers in 1997.
GAS TRANSPORTATION REVENUE. Gas transportation revenue increased by
$1.6 million in 1998 when compared to 1997, due primarily to revenues from
the new ATS program discussed previously ($2.5 million), offset partially by
lower off-peak transportation rates approved in the 1997 rate case. The new
off-peak transportation rates are in effect from April through October and
are $0.15 per Mcf lower than the Gas Company's regular transportation rates.
Gas transportation revenue increased by $.9 million in 1997 when compared to
1996. This increase is primarily attributable to additional transportation
customers, most of which were previously gas sales customers.
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------------------------
Volumes:
Gas sold (MMcf) 32,247 41,985 43,758
Gas transported (MMcf) 23,791 21,373 20,532
------- ------- -------
Total (MMcf) 56,038 63,358 64,290
======= ======= =======
Average Number of Customers:
Gas sales customers 241,070 236,611 228,802
Transportation and ATS customers 3,105 183 151
------- ------- -------
Average number of total customers 244,175 236,794 228,953
======= ======= =======
Weather Statistics:
Heating degree days 5,566 6,838 7,099
Percent colder (warmer) than normal (19.7%) (0.6%) 4.5%
======= ======= =======
OTHER OPERATING REVENUE. In 1998, other operating revenue increased by
$1.6 million over 1997. The increase is due primarily to an increase in
balancing charges and various miscellaneous fees charged to customers
beginning in late 1997.
-15-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
GAS DISTRIBUTION (CONT.)
OPERATING EXPENSES. Operating expenses decreased by $2.7 million (or 5%) in
1998 when compared to 1997. Approximately $1.9 million of the decrease is
attributable to an overall reduction in general and administrative expenses
due to cost cutting measures initiated during 1998, lower incentive
compensation due to the decrease in Company earnings, and reductions in
compensation and pension expenses due primarily to lower employee levels as a
result of the Company's early retirement program and changes to the Company's
employee pension plans. See Note 9 in the Notes to the Consolidated
Financial Statements for more information on the early retirement program.
In addition, there were decreases in uncollectible gas accounts
($.4 million) due to increased collection efforts and warmer weather,
regulatory expenses ($.4 million) due to a reduced regulatory activity, and
insurance costs ($.5 million) due primarily to efforts to reduce premiums
while maintaining coverage levels. During 1998, the Gas Company also
recorded a one-time $.4 million reduction in employee benefit expenses as a
result of the early retirement program. These savings were offset partially
by increases in depreciation expense as a result of new property, plant and
equipment placed in service and increases in retiree medical expense. The
1997 rate case authorized a customer rate increase to offset the impact of
the additional retiree medical expense.
In 1997, operating expenses increased by $.8 million (or 1%) when
compared to 1996. The increase was attributable mainly to increases in
depreciation and property tax expenses ($1.2 million) due to additional
property, plant and equipment in service, an increase in uncollectible gas
accounts resulting from the previous year's colder weather and higher gas
prices, and a slight increase in retiree medical costs. Partially offsetting
these increases were decreases in pension and employee benefit expenses.
OUTLOOK. The strategy of the Gas Company is to maximize its earnings
potential. With the approval of incentive rates by the MPSC in late 1997 and
1998, the Gas Company is allowed to retain a portion of earnings in excess of
its authorized return and refund the remainder to customers. In 1998, the
MPSC also authorized the Gas Company to, among other things, suspend its GCR
clause and freeze for three years in its base rates a gas charge of $3.24 per
Mcf. The GCR freeze and new rates take effect in April 1999 and generally
extend through March 2002. The Gas Company was able to offer this GCR
suspension partly as a result of agreements reached with TransCanada Gas
Services, Inc., under which the latter will provide the Gas Company's natural
gas requirements and manage the Gas Company's natural gas supply and the
supply aspects of transportation and storage operations for the same three
year period. Management believes that the overall impact of the MPSC order
and the Gas Company's agreements with TransCanada will be lower rates for its
customers and an opportunity for the Company to increase profitability while
maintaining or improving service levels (see Note 2 of the Notes to the
Consolidated Financial Statements).
-16-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
GAS DISTRIBUTION (CONT.)
The Gas Company's 3% customer growth rate in 1998 was nearly double the
industry average and is anticipated to continue. Efforts to offer new
products and services will continue. Control of operating expenses will be
enhanced through the early retirement program offered during 1998, the
redesign of employee benefits during 1998 and increased use of technology to
achieve operating efficiencies. These technologies include automatic meter
reading and automated dispatch and scheduling. Through more effective
management of the construction budget and financing costs, growth in capital
costs are expected to be contained.
As is the case with many gas distribution utilities, there is a
potential for industrial and generating plants on the Gas Company's system to
bypass the Gas Company and connect directly to interstate natural gas
pipelines. Refer to the Industry Trends section in the following pages for
more information.
For information on environmental matters, regulatory matters and the
application of SFAS 71, "Accounting for the Effects of Certain Types of
Regulation", refer to Notes 2 and 14 of the Notes to the Consolidated
Financial Statements.
ENGINEERING SERVICES
SIGNIFICANT GROWTH IN ENGINEERING REVENUES AND EARNINGS. The Company's
engineering services business segment ("Engineering Services") contributed
$41.4 million in revenues and $2.9 million in operating income for 1998.
Engineering Services is comprised of two companies, Maverick Pipeline
Services, Inc. ("Maverick") and Oilfield Materials Consultants, Inc. ("OMC").
The acquisition of Maverick, in December 1997, was accounted for as a
purchase. Therefore, the consolidated financial statements and the table
below include the results of Maverick's operations since December 1997. The
acquisition of OMC, in November 1998, was accounted for as a pooling of
interests and, accordingly, the consolidated financial statements and the
table below have been restated to include the financial results of OMC as if
it were part of the Company for all of 1998, 1997 and 1996 (see Note 3 of the
Notes to the Consolidated Financial Statements).
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------------------------
(in thousands, except billed hours)
Engineering Services
Operating revenues $ 41,366 $ 5,660 $ 2,961
Operating expenses $ 38,428 $ 4,882 $ 2,688
-------- -------- --------
Operating income $ 2,938 $ 778 $ 273
======== ======== ========
Billed hours 586,000 180,000 72,000
======== ======== ========
<FN>
The amounts in the table above include intercompany transactions
</FN>
-17-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
ENGINEERING SERVICES (CONT.)
ENGINEERING REVENUES. Engineering Services' operating revenues in 1998
increased $35.7 million or nearly eight-fold from 1997. Approximately
$24.5 million of the increase represents the 1998 revenues of Maverick, which
was acquired in December 1997. Maverick's revenues reflect a $20 million
turnkey project it completed in Vineland, New Jersey. Maverick performed the
engineering and design-work and also managed construction of the project.
Maverick was able to win the turnkey project due, in part, to the financial
strength of SEMCO Energy, Inc. The remainder of the increase in 1998
engineering revenues ($11.2 million), when compared to 1997, is attributable
to OMC. OMC's 200% increase in revenues is due to growth in OMC's customer
base and growth in quality assurance and quality control projects worked on
in 1998.
In 1997, engineering revenues increased by $2.7 million (or 90%)
compared to 1996. The increase was due to growth in OMC's customer base,
which led to increased revenue from quality assurance projects in the natural
gas pipeline industry.
OPERATING EXPENSES. In 1998, operating expenses increased by $33.5 million,
when compared to 1997. $23.1 million of the increase is Maverick's 1998
operating expenses. $10.4 million of the increase is attributable to OMC and
represents increases in the level of business experienced in 1998.
Operating expenses increased by $2.2 million (or 82%) in 1997 compared
to 1996. The increase is due primarily to increases in compensation, payroll
taxes and project expenses to support the increase in revenues.
OUTLOOK. Management plans to expand Engineering Services by growing its
existing operations and through acquisitions. Management believes there is a
trend towards outsourcing in the utility industry and believes that
Engineering Services is positioned to take advantage of this trend. It is
also anticipated that the demand for turnkey services will increase. With
the financial strength of SEMCO Energy, Inc., Engineering Services is in a
position to win significant turnkey projects. Engineering Services
successfully completed its first turnkey project in 1998 and expects to
expand this type of business significantly in the future. With the recent
downturn in oil prices, there has been a reduction in oil and gas production
and related activities, as a result of which OMC has experienced a reduction
in the level of available construction inspection and quality assurance
projects. Management believes that the level of these activities and
available projects will increase as oil prices recover.
CONSTRUCTION SERVICES
CONSTRUCTION BUSINESS EXPANDS. The construction services business segment
("Construction Services") expanded into Tennessee with the acquisition of
King Energy & Construction Co. ("King") in May 1998. King provides
underground construction services similar to those provided by Sub-Surface
Construction Co. ("Sub-Surface"). Construction Services also started an
overhead-line construction company in Florida in January 1998. However, the
operations of this start-up business were halted in mid-1998 in resp-onse to
lower than expected business levels and earnings. The start-up business
generated an operating loss of $.9 million during the period it operated.
-18-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
CONSTRUCTION SERVICES (CONT.)
[Enlarge/Download Table]
Years Ended December 31, 1998 1997<F1>
------------------------------------------------------------------------------------------
(in thousands, except billed hours)
Construction Services
Operating revenues $ 25,904 $ 13,207
Operating expenses $ 26,006 $ 12,445
-------- --------
Operating income (loss) $ (102) $ 762
======== ========
Billed hours 564,000 291,000
======== ========
<FN>
The amounts in the table above include intercompany transactions
<F1>
Includes results from August 1, 1997 to December 31, 1997 only.
</FN>
OPERATING INCOME. Construction Services' operating income, excluding the
start-up business mentioned above, was $.8 million in both 1998 and 1997.
The 1997 results reflect the operations of Sub-Surface for the period
subsequent to its acquisition in August 1997, which excludes the seasonal
losses which are typical during the first half of the year.
OUTLOOK. Management believes there are significant opportunities for growth
in the pipeline construction industry. The industry is viewed as large but
highly fragmented. Management believes that customer preference is shifting
from smaller construction companies to much larger contractors. The Company
plans to expand Construction Services' market share significantly by
acquiring established companies that have a strong customer base.
PROPANE, PIPELINES AND STORAGE
PROPANE COMPANY ACQUIRED. The Company entered the propane distribution
business with the acquisition of Hotflame Gas, Inc. and Hot Flame Transport
Co., Inc. (together "Hotflame") on March 31, 1998. The acquisition of
Hotflame was accounted for as a purchase and, therefore, only the results of
operations since April 1998 are included in the consolidated financial
statements and the table below. Hotflame's 1998 operating results do not
include the very profitable winter heating months of January through March.
The operating results of the Company's pipelines and storage operations
have been fairly consistent over the past three years. The operations
consist of several pipelines and an ownership interest in a gas storage
facility (separate from the Gas Company), all of which are located in
Michigan.
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------------------------
(in thousands)
Propane, Pipelines and Storage
Operating revenues $ 4,852 $ 3,027 $ 3,070
Operating expenses $ 3,267 $ 1,569 $ 1,599
-------- -------- --------
Operating income $ 1,585 $ 1,458 $ 1,471
======== ======== ========
-19-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
PROPANE, PIPELINES AND STORAGE (CONT.)
OPERATING REVENUES. Operating revenues were $4.8 million in 1998 compared to
$3.0 million in 1997. The increase was due primarily to the propane
distribution revenue recorded in 1998 for Hotflame.
OPERATING INCOME. Operating income was generally unchanged with nearly all
income coming from the pipeline and storage operations. The propane
operation did not contribute any operating income due to the combination of
the warm weather (19% warmer than normal in the Company's propane market
area) and the fact that the operating results did not include operating
income from the profitable winter heating months of January through March.
On a weather-normalized basis, the propane operation would have contributed
$.2 million to operating income for the period of April through December of
1998.
OUTLOOK. Management's goal is to build a strong regional propane business.
Growth will be focused in the Midwest and regions contiguous to the Company's
existing propane or natural gas operations. Hotflame is currently the
largest provider of propane in the upper peninsula of Michigan. Through
prudent acquisitions, management will attempt to double or triple the size of
the Company's propane operation over the next five years.
Management believes that the gas pipelines and storage operations could
experience opportunities for growth with the increased deregulation of gas
markets. As gas markets continue to expand, management feels that the
quantity of gas moving through the Great Lakes Region will increase,
therefore, creating additional pipeline and storage opportunities.
ENERGY MARKETING
On March 15, 1999, the Company entered into an agreement, subject to
approval under the Hart-Scott-Rodino Anti-Trust Improvements Act of 1987, to
sell its energy marketing business ("Energy Services") to another energy
marketer. Management has concluded that the relatively low margins,
generally poor industry returns and high risks associated with natural gas
marketing do not support remaining in the business. The gas marketing
business no longer fits the Company's future strategic direction.
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
------------------------------------------------------------------------------------------------------
(in thousands, except gas marketing volumes)
Energy Marketing
Gas marketing revenues $397,888 $555,367 $344,379
Cost of gas marketed 393,762 546,562 344,295
-------- -------- --------
Gas marketing margin $ 4,126 $ 8,805 $ 84
Operating expenses $ 4,822 8,588 3,941
-------- -------- --------
Operating income (loss) $ (696) $ 217 $ (3,857)
======== ======== ========
Gas marketing volumes (MMcf) 166,197 199,689 129,429
======== ======== ========
<FN>
The amounts in the table above include intercompany transactions
</FN>
-20-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
ENERGY MARKETING (CONT.)
GAS MARKETING MARGIN. Gas marketing margin for 1998 decreased by
$4.7 million when compared to 1997 due primarily to the impact of warm
weather on market demand, increased competition, restructuring activities at
Energy Services and a decrease in gas marketing volumes. The warm weather
reduced prices which decreased gas marketing margins. Increased competition
also continued to put downward pressure on gas marketing margins. During
1998, Energy Services terminated agreements with all of its third-party gas
marketing companies in an effort to reduce risks, eliminate lower margin
transactions and improve profitability. The termination of these agreements
accounts for a portion of the decrease in gas marketing volumes when compared
to 1997.
In 1997, natural gas marketing revenues and volumes increased $211
million (or 61%) and 70,260 MMcf (or 54%), respectively, when compared to
1996. Revenues and volumes increased significantly due to the development of
additional marketing offices. The $8.7 million increase in gas marketing
margin in 1997, when compared to 1996, was due to the impact on 1996 results
of uneconomical trading contracts which Energy Services has since terminated.
OPERATING EXPENSES. Operating expenses decreased by $3.8 million (or 44%) in
1998, compared to 1997, due to lower incentive payments to the Company's
third-party gas marketers and the termination of gas marketing agreements
with these companies as discussed above.
In 1997, operating expenses increased $4.6 million (or 118%) when
compared to 1996. The increase was due to larger third-party marketer
incentive payments relating to higher margins ($2.2 million), additional
expenses to support increased gas marketing volumes ($1.1 million), increased
receivables write-offs ($.6 million) and other restructuring charges and
taxes ($.7 million).
OTHER INCOME AND DEDUCTIONS
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
(in thousands)
Consolidated Other Income (Deductions):
Divestiture of NOARK investment $ 5,048 $ 7,730 $(32,308)
Interest expense (14,811) (13,059) (11,083)
Dividends on preferred stock (193) (194) (194)
Other 836 250 (1,117)
-------- -------- --------
$ (9,120) $ (5,273) $(44,702)
======== ======== ========
DIVESTITURE OF NOARK INVESTMENT. On January 14, 1998, the Company sold its
entire interest in the NOARK Pipeline System Partnership ("NOARK") to ENOGEX
Arkansas Pipeline Corporation ("EAPC"). Refer to Note 15 of the Notes to the
Consolidated Financial Statements for additional information regarding NOARK.
-21-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
OTHER INCOME AND DEDUCTIONS (CONT.)
In December 1996, the Company recorded a $21.0 million after-tax
non-cash write-down of its general partnership interest in NOARK. In
December 1997, the Company reduced its reserve for NOARK by $5.0 million
after-tax based on the terms of the pending sale. The sale occurred in
January 1998 and, including subsequent adjustments, resulted in a final gain
on the sale of NOARK of $1.7 million after-tax. The adjustments to the gain
included income tax benefits related to tax losses generated by the
partnership and adjustments to discount rates used to compute the present
value of future cash flows pursuant to the terms of the sale. The discount
rates were adjusted to better reflect actual market rates at the time of the
sale.
INTEREST EXPENSE. Interest expense increased by $1.7 million (or 13%) in
1998 compared to 1997 due to the higher levels of debt outstanding during the
first half of 1998. The additional debt had been incurred to finance the
Company's ongoing capital expenditure program and for general corporate
purposes. During August 1998 the Company sold 1.82 million shares of its
common stock and used a significant portion of the net proceeds to repay
short-term debt. See Note 5 of the Notes to the Consolidated Financial
Statements for more information on debt issuances and refinancings. Interest
expense increased by $2.0 million (or 18%) in 1997 compared to 1996 due
primarily to increases in debt levels to finance the Company's capital
expenditure program and for general corporate purposes.
OTHER. In 1998, other income increased by $.6 million when compared to 1997.
The increase is due primarily to the impact of discontinuing the Company's
unprofitable appliance merchandising programs in 1997 and an increase in
equity income from partnership investments in gas pipeline and gas storage
facilities. Other income increased by $1.4 million from 1996 to 1997. The
increase is attributable mainly to the change in accounting treatment for
NOARK in 1996. With its write-down of NOARK in December 1996, the Company
discontinued accounting for NOARK under the equity method and stopped
accruing interest income on advances to the NOARK partnership.
ACCOUNTING METHOD CHANGE AND EXTRAORDINARY ITEM
The Company changed its method of accounting for property taxes during 1998.
The cumulative effect of the change in accounting method increased earnings
by $1.8 million. The Company also incurred an extraordinary charge of $.5
million after-tax during 1998 for the early redemption of all of its
outstanding 8.625% debentures due April 15, 2017. Refer to Note 1 of the
Notes to the Consolidated Financial Statements for more information on these
items.
-22-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS FROM INVESTING. The Company's single largest use of cash is
capital investments. The following table identifies investments for the past
three years:
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
(in thousands)
Capital Investments
Property additions - gas distribution $ 23,029 $ 28,201 $ 30,169
Property additions - diversified businesses 2,246 1,272 355
Business acquisitions <F1> 20,356 <F2> 15,567 --
-------- -------- --------
$ 45,631 $ 45,040 $ 30,524
======== ======== ========
<FN>
<F1>
Includes the value of Company stock issued for acquisitions.
<F2>
Includes $14,073 of Company stock issued for the acquisition of OMC. The acquisition of
OMC was accounted for as a pooling of interests.
</FN>
Capital expenditures for gas distribution represent primarily new
customer additions and, to a lesser extent, plant repair and replacement. In
addition, the Company invested approximately $4.5 million, $8 million and
$2 million in technology in 1998, 1997 and 1996, respectively. This
technology consists of automated meter reading, automated dispatch and
scheduling, in-truck computer terminals and other computer infrastructure
improvements which are expected to increase significantly customer service
and operational efficiency at the gas distribution operation.
In 1999, the Company plans to spend approximately $20 million on
property additions for the gas distribution and diversified businesses. In
addition, the Company is planning to incur additional expenditures for
business acquisitions in 1999.
CASH FLOWS FROM OPERATIONS. The Company's net cash provided from operating
activities totaled $24.7 million in 1998, $9.0 million in 1997, and
$11.4 million in 1996. The change in operating cash flows is significantly
influenced by changes in the level and cost of gas in underground storage,
changes in accounts receivable and accrued revenue and other working capital
changes. The changes in these accounts are largely the result of the timing
of receipts and payments.
The Company uses significant amounts of short-term borrowings to finance
natural gas purchases for storage during the non-heating season. The Company
owns and leases natural gas storage facilities with available capacity
approximating 35% to 40% of average annual gas sales. Generally, gas is
stored during the months of April through October and withdrawn for sale from
November through March. The carrying amount of natural gas stored
underground peaked at $58 million, $59 million, and $38 million in October
1998, 1997, and 1996, respectively.
-23-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
LIQUIDITY AND CAPITAL RESOURCES (CONT.)
CASH FLOWS FROM FINANCING. The Company raised $6.2 million by issuing new
common shares during 1998 to meet the dividend reinvestment and stock
purchase requirements of the DRIP.
In April 1998 the Company redeemed all of its outstanding 8.625%
debentures due April 15, 2017. The redemption was accomplished using
short-term debt.
The Company and SEMCO Capital Trust filed a registration statement on
Form S-3 ("registration statement") with the Securities and Exchange
Commission ("Commission") in July 1998 for the registration of debt
securities and common stock of the Company and trust preferred securities of
SEMCO Capital Trust in any combination up to $200 million.
During August 1998 the Company sold 1.82 million shares of its common
stock in a public offering. The proceeds of the offering were $26.2 million
after underwriting discounts but before expenses. The Company used the net
proceeds from the stock issuance to repay short-term debt and for general
corporate purposes.
In October 1998, the Company entered into a Distribution Agreement with
Merrill Lynch & Co., Morgan Stanley Dean Witter, A.G. Edwards & Sons, Inc.
and Edward D. Jones & Co., L.P. pursuant to which it may issue, from time to
time, an aggregate of $150 million of medium-term notes.
The Company issued, in November 1998, $5 million of 6.40% medium-term
notes due November 2008, $15 million of 6.50% medium-term notes due November
2005, and $10 million of 7.03% medium-term notes due November 2013.
During 1998, the Company made a $9.2 million payment on a note payable
to EAPC pursuant to the terms of the sale of NOARK (See Note 15 of the Notes
to the Consolidated Financial Statements).
The Company issued 1.3 million shares of its common stock to the
shareholders of businesses acquired during 1998. Of the shares issued,
.9 million were for the acquisition of OMC which was accounted for as a
pooling of interests. See Notes 1 and 3 of the Notes to the Consolidated
Financial Statements for more information.
Dividends paid to common shareholders increased from 1996 through 1998
due to the impact of 5% stock dividends in each of those three years. The
stated cash dividend of $.20 per share per quarter did not change. However,
the acquisition of OMC was accounted for as a pooling of interests and,
accordingly, the 1998, 1997 and 1996 dividends paid have been restated to
include the dividends paid by OMC.
FUTURE FINANCING. In general, the Company funds its capital expenditure
program and dividend payments with operating cash flows and the utilization
of short-term lines of credit. When appropriate, the Company will refinance
its short-term lines with long-term debt, common stock or other long-term
financing instruments. The Company expects to acquire additional businesses
in 1999 and will likely raise the required capital through a combination of
utilizing short-term lines of credit and issuing long-term debt or equity.
At December 31, 1998, the Company had $110 million of short-term credit
facilities, of which $50.2 million was unused.
-24-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
LIQUIDITY AND CAPITAL RESOURCES (CONT.)
During 1999, the Company will make a $3.1 million payment to EAPC
pursuant to the terms of the sale of NOARK. See Note 15 of the Notes to the
Consolidated Financial Statements for a discussion of the amounts to be paid
in conjunction with the sale of NOARK.
COMMODITY HEDGING. Energy Services has entered into various long-term sales
commitments which may extend up to 60 months into the future. Energy
Services maintains a hedging program with the objective of preserving the
anticipated margin on these sales commitments. The hedges are designed to
ensure that the impact of natural gas price fluctuations on the fair value of
long-term sales commitments will be offset by gains and losses on the hedging
instrument. The most frequently used hedging instruments are natural gas
futures and options, although Energy Services may also enter into natural gas
swap agreements, enter into contracts to purchase natural gas from producers
for future delivery or inject gas into storage for later withdrawal.
Critical to the success of the hedging program is the performance by
both the party to the hedge and the marketing customer buying gas under the
long-term sales commitment. Energy Services performs extensive credit
reviews on new and existing marketing customers and only enters into hedging
transactions with reputable dealers, primarily on the NYMEX, or directly with
reliable suppliers.
At December 31, 1998 and 1997, Energy Services had recorded net deferred
gains (losses) from its hedging program of approximately ($3.3 million) and
$.1 million, respectively. At the same time, Energy Services had offsetting
amounts of unrecorded gains or losses pursuant to the underlying long-term
sales commitments.
See Note 8 of the Notes to the Consolidated Financial Statements for
further information regarding the types, underlying notional volumes, and
fair values of Energy Services' hedges at December 31, 1998 and 1997.
MARKET RISK INFORMATION. The market risk inherent in the Company's market
risk sensitive instruments and positions is the potential loss arising from
adverse changes in natural gas prices. The prices of natural gas are subject
to fluctuations resulting from changes in supply and demand. To reduce price
risk caused by these market fluctuations, the Company's policy is to hedge
(through the use of derivatives) inventory and related purchase and sale
contracts. Because commodities covered by these derivatives are
substantially the same commodities that the Company buys and sells in the
physical market, no special correlation studies other than monitoring the
degree of convergence between the derivative and cash markets, are deemed
necessary. (The changes in market value of these financial instruments have
a high correlation to the price changes of natural gas.)
-25-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
LIQUIDITY AND CAPITAL RESOURCES (CONT.)
A sensitivity analysis has been prepared to estimate the price exposure
to the market risk of the Company's natural gas commodity position. The
Company's monthly net commodity position consists of natural gas inventories,
purchase and sale contracts, and derivative financial and commodity
instruments. The fair value of this position is a summation of the fair
value of each position calculated by valuing each net position at quoted
futures prices. Market risk is estimated as the potential loss in fair value
resulting from a hypothetical 25% adverse change in such prices over the next
12 months. The results of this analysis, which may differ from actual
results, showed that this type of change would reduce the market value of the
Company's net commodity position by less than $50,000.
IMPACT OF INFLATION
The cost of gas sold by the Gas Company is recovered from natural gas
distribution customers on a current basis through its GCR clause. However,
the MPSC has authorized the Company to suspend its GCR clause and freeze for
three years in its base rates a gas charge of $3.24 per Mcf. The GCR
suspension and rate freeze take effect in April 1999 and generally extend
through March 2002. See Note 2 of the Notes to the Consolidated Financial
Statements for more information regarding the rate freeze.
Increases in other utility operating costs are recovered through the
regulatory process of a rate case and, therefore, may adversely affect the
results of operations in inflationary periods due to the time lag involved in
this process. The Company attempts to minimize the impact of inflation by
controlling costs, increasing productivity and filing rate cases on a timely
basis.
INDUSTRY TRENDS
COMPETITION. The market prices of alternate sources of energy such as coal
and #6 fuel oil compete to a limited degree with the price the Gas Company
charges for industrial sales and transportation of natural gas. To lessen
the possibility of a fuel switch by industrial customers, the Company offers
additional services, such as gas storage and balancing, in addition to a more
environmentally friendly fuel.
-26-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
INDUSTRY TRENDS (CONT.)
The Gas Company serves a number of industrial and generating plants on
various parts of its system. Some of these plants are also located in the
vicinity of interstate natural gas pipelines. As is the case with many local
gas distribution utilities, the Gas Company is subject to being bypassed by
these pipelines. In response to this threat, the Gas Company, from time to
time, enters into agreements with companies under which the Gas Company may
reduce the rates it charges for transportation of natural gas to the
companies' plants, in return for which the plants will continue to use the
Gas Company system for all of their requirements for natural gas distribution
and transportation service, and not connect directly to the pipelines. The
Gas Company is currently negotiating agreements with two plants. There can
be no assurance that other plants located on the Gas Company's system and
accessible to interstate pipelines will not also seek to take advantage of
bypass opportunities in the future.
Engineering Services competes with regional, national and international
firms as well as in-house engineering and field service departments. Because
of the minimal initial capital requirements it is likely that new competition
will arise from other firms that possess the professional requirements and
qualifications.
Success in the engineering services market depends on factors such as
technical expertise, experience, price, financial stability and the
availability of skilled, technical personnel possessing required industry
qualifications. On the basis of these factors, the Company believes it will
compete favorably. With the recent downturn in oil prices, there has been a
reduction in oil and gas production and related activities, as a result of
which OMC has experienced a reduction in the level of available construction
inspection and quality assurance projects. Management believes that the
level of these activities and available projects will increase as oil prices
recover.
Construction Services competes with small- and medium-size regional
utility contractors who provide similar services and utilize comparable
equipment and installation techniques. There is also competition from
in-house construction crews of the existing or prospective customers. The
Company believes that its level of expertise, experience and resources will
allow it to compete favorably in the construction industry.
The Company's retail propane business competes with other energy sources
such as natural gas, fuel oil and electricity. There is also competition
from other regional propane providers. Expansion of natural gas service into
propane markets is inhibited due to the capital costs involved in the
pipeline infrastructure. Propane is less expensive to use than electricity
and conversion of appliances from one fuel to another is costly thereby
protecting existing propane markets.
The basis of competition with other regional propane providers is price
and service. Based on the Company's history of providing safe, reliable and
timely service to its customers, the Company believes it will compete
favorably with other propane providers.
Energy Services competes based on its ability to access competitively
priced natural gas and efficiently utilize the pipeline transmission system.
Price is the prominent competitive factor in sales to wholesale customers,
such as gas distribution companies and municipalities. In retail activities,
Energy Services competes based on its ability to offer a broad range of
competitively priced products and services that are tailored to meet the
needs of individual customers.
-27-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
INDUSTRY TRENDS (CONT.)
REGULATION. Since 1994 interstate pipelines have unbundled their services to
offer separate service for gas transportation, storage and gathering. As a
result, natural gas distribution companies have the ability to select and pay
for only those pipeline services they require. In addition, customers on
natural gas distribution systems may purchase the same level of unbundled
service directly from the interstate pipelines. Under such circumstances,
natural gas distribution companies generally provide transportation services
to those customers.
The availability of unbundled pipeline services has resulted in
continued pressure on gas distribution companies to offer similar unbundled
services in order to facilitate the customers' choice of possible suppliers.
This competition has resulted in some reduction in natural gas transportation
margins. Currently, the Gas Company is providing transportation services
principally to large industrial and commercial customers.
YEAR 2000
STATE OF READINESS. The Company uses computer systems, equipment, software
and related devices ("technology systems") that have date-sensitive embedded
technology that may not be able to distinguish between the year 1900 and the
year 2000 ("Y2K"). If not corrected, this could cause the Company to, among
other things, report inaccurate data, issue inaccurate bills or incur gas
delivery problems. The Company has initiated an enterprise-wide plan to
prepare for Y2K (the "Y2K Plan"). The Y2K Plan has four phases: (i)
identification; (ii) remediation; (iii) testing; and (iv) contingency
planning. The identification phase includes identification, inventory,
assessment, and prioritization plan development for all technology systems.
The remediation phase involves the upgrading, modification, or replacement of
technology systems. The testing phase includes testing the remediated
technology systems to ensure that they accurately handle the year 2000 date
and monitoring the remediated systems to ensure that Y2K problems are not
reintroduced. The contingency planning phase involves the development of
contingency plans to address certain risk scenarios.
The Y2K Plan is being used for traditional information technology ("IT")
which includes essential business systems such as payroll, billing,
accounting systems, wide area networks, local area networks, personal
computers, etc. The Company is also using the Y2K Plan for process control
computers and embedded systems contained in buildings, equipment and the gas
supply and delivery systems.
The Company has completed the identification phase for all significant
internal technology systems and is currently in the remediation and testing
phases on most of its Y2K projects. The Company currently plans to complete
the remediation phase for all significant internal technology systems by July
1999 and complete the testing phase by September 1999, with continuous
monitoring of tested systems through the end of 1999. The Company is in the
early stages of contingency planning for its Y2K projects and plans to be
completed with all contingency planning by November 1999.
-28-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
YEAR 2000 (CONT.)
The Company has inquired of third parties, i.e., vendors, suppliers and
customers, which have a material relationship with the Company, as to the
status of their Y2K readiness. To date, the Company has not received all of
the responses from these third parties and, therefore, is unable to state
with reasonable assurance the status of their readiness for Y2K. The Company
continues to work with critical vendors, suppliers and customers to gain
assurance of their Y2K readiness, and will develop contingency plans to
mitigate anticipated shortcomings in their readiness.
COST OF REMEDIATION. The Company is expensing the cost of modifications to
technology systems as incurred, while capitalizing and amortizing the cost of
new software over its useful life. The Company estimates that the total cost
of the Y2K Plan is approximately $2.0 to $2.5 million. Costs incurred
through December 31, 1998 related to the Y2K Plan were approximately
$1.3 million, with the majority of the work being performed by Company
employees. The Company has incurred an opportunity cost for implementing the
Y2K Plan, thus deferring potentially beneficial IT projects.
RISK ASSESSMENT. The Company has identified what it believes are the most
significant worst case Y2K scenarios. These scenarios are (i) interference
with the Company's ability to receive and deliver gas to customers and
perform services for customers; (ii) interference with the Company's ability
to monitor gas pressure and safety throughout the Company's gas distribution
system; (iii) interference with communications during safety related
emergencies and (iv) interference with the Company's ability to bill and
receive payments from customers. These scenarios could result in the Company
not being able to deliver gas or perform other services for a period of time,
which could have a material adverse effect on the Company's liquidity,
financial condition and results of operations. The Company's Y2K Plan is
being used to address these worse case scenarios. Contingency plans will be
revised and executed to further mitigate the risks associated with these
scenarios.
The Company expects that its Y2K Plan will be adequate to address its
Y2K issues and is developing contingency plans to further assure that vital
functions of the Company dependent on third parties will continue
uninterrupted. Contingency plans will include existence of short-term
in-house capabilities (i.e. back-up power generation) and diversification of
goods and services among multiple suppliers (i.e. pipeline companies).
However, there are functions, which cannot be duplicated, such as the local
telephone network, which remain a vulnerability to the Company. Of course,
there can be no assurance as to whether the contingency plans will
successfully address all contingencies that may arise. In the event that the
Company is unsuccessful in addressing its Y2K issues, there could be a
material adverse effect on the Company's liquidity, financial condition and
results of operations.
-29-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
NEW ACCOUNTING STANDARDS
In June of 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS 133 requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting.
SFAS 133 is effective for fiscal years beginning after June 15, 1999.
The Company has not yet quantified the impacts of adopting SFAS 133 on its
financial statements and has not determined the timing of or method of its
adoption of SFAS 133. However, SFAS 133 could increase volatility in
earnings and other comprehensive income.
In December 1998, the Emerging Issues Task Force reached consensus on
Issue No. 98-10, "Accounting for Contracts Involved in Energy Trading and
Risk Management Activities" ("EITF Issue 98-10"). EITF Issue 98-10 is
effective for fiscal years beginning after December 15, 1998. EITF Issue
98-10 requires energy trading contracts to be recorded at fair value on the
balance sheet, with the changes in fair value included in earnings. The
effects of initial application of EITF Issue 98-10 will be reported as a
cumulative effect of a change in accounting principle. Financial statements
for periods prior to initial adoption of EITF Issue 98-10 may not be
restated. The Company has not yet quantified the impacts of adopting EITF
Issue 98-10 on its financial statements but does not anticipate that the
accounting change will have a material effect going forward.
-30-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONT.)
FORWARD LOOKING STATEMENTS
This Annual Report contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 that are based on
current expectations, estimates and projections. Statements that are not
historical facts, including statements about the Company's belief and
expectations are forward-looking statements. These statements are subject to
potential risks and uncertainties and, therefore, actual results may differ
materially. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future
events or otherwise. 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) the economic climate and growth in the
geographical areas where the Company does business; (iii) the capital
intensive nature of the Company's business; (iv) increased competition within
the energy marketing industry as well as from alternative forms of energy;
(v) the timing and extent of changes in commodity prices for natural gas;
(vi) the effects of changes in governmental and regulatory policies,
including income taxes, environmental compliance and authorized rates; (vii)
the Company's ability to bid on and win business contracts; (viii) the impact
of energy prices on the amount of projects and business available to
Engineering Services; (ix) the nature, availability and projected
profitability of potential investments available to the Company and (x) the
conditions of capital markets and equity markets.
-31-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
[Enlarge/Download Table]
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------------------------
(in thousands of dollars, except per share amounts)
OPERATING REVENUES
Gas sales $166,700 $218,180 $219,371
Gas transportation 14,832 13,243 12,358
Engineering services 40,937 5,660 2,961
Construction services 16,621 7,484 --
Gas marketing 390,817 526,962 308,703
Other operations 7,578 4,403 4,517
-------- -------- --------
$637,485 $775,932 $547,910
-------- -------- --------
OPERATING EXPENSES
Cost of gas sold $109,388 $150,967 $151,135
Cost of gas marketed 386,691 518,157 308,619
Operations and maintenance 92,696 55,209 43,211
Depreciation 15,349 12,877 11,334
Property and other taxes 9,166 9,555 8,777
-------- -------- --------
$613,290 $746,765 $523,076
-------- -------- --------
OPERATING INCOME $ 24,195 $ 29,167 $ 24,834
-------- -------- --------
OTHER INCOME (DEDUCTIONS)
Divestiture of NOARK investment $ 5,048 $ 7,730 $(32,308)
Interest expense (14,811) (13,059) (11,083)
Dividends on preferred stock (193) (194) (194)
Other 836 250 (1,117)
-------- -------- --------
$ (9,120) $ (5,273) $(44,702)
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES $ 15,075 $ 23,894 $(19,868)
INCOME TAXES $ 6,320 $ 8,469 $ (7,106)
-------- -------- --------
NET INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF ACCOUNTING METHOD CHANGE AND
EXTRAORDINARY CHARGE $ 8,755 $ 15,425 $(12,762)
Cumulative effect of change in accounting
method for property taxes, net of income
taxes of $960 1,784 -- --
Extraordinary charge due to early retirement
of debt, net of income taxes of $269 (499) -- --
-------- -------- --------
NET INCOME (LOSS) $ 10,040 $ 15,425 $(12,762)
======== ======== ========
EARNINGS (LOSS) PER SHARE - BASIC AND DILUTED $ 0.63 $ 1.06 $ (0.88)
CASH DIVIDENDS PAID PER SHARE $ 0.74 $ 0.70 $ .67
AVERAGE COMMON SHARES OUTSTANDING 15,906 14,608 14,573
======== ======== ========
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-32-
[Enlarge/Download Table]
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998 1997 1996
--------------------------------------------------------------------------------------------------------------
(in thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 10,040 $ 15,425 $ (12,762)
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Depreciation 15,349 12,877 11,334
Extraordinary charge 499 -- --
Divestiture of NOARK investment (5,048) (7,730) 32,308
Deferred taxes and investment tax credit 1,832 6,388 (7,148)
Equity (income) loss, net of distributions 168 402 3,740
Changes in assets and liabilities, net of effects
of acquisitions and other changes as shown below: 1,848 (18,393) (16,099)
--------- --------- ---------
Net Cash From Operating Activities $ 24,688 $ 8,969 $ 11,373
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Property additions - gas distribution $ (23,029) $ (28,201) $ (30,169)
Property additions - diversified businesses (2,246) (1,272) (355)
Property sales proceeds, net of retirement costs 871 373 865
Acquisitions of businesses, net of cash acquired 26 (15,117) --
Advances to equity investees (4,284) (3,308) (844)
--------- --------- ---------
Net Cash From Investing Activities $ (28,662) $ (47,525) $ (30,503)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock, net of expenses $ 32,570 $ 5,874 $ 5,132
Repurchase of common stock and related expenses -- (3,071) (5,629)
Net cash change in notes payable (20,561) (19,976) 39,612
Issuance of long-term debt, net of expenses 29,390 60,000 --
Repayment of long-term debt and related expenses (24,503) (25) (15)
Payment of dividends (12,029) (10,419) (10,008)
--------- --------- ---------
Net Cash From Financing Activities $ 4,867 $ 32,383 $ 29,092
--------- --------- ---------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease) $ 893 $ (6,173) $ 9,962
Beginning of year 4,060 10,233 271
--------- --------- ---------
End Of Year $ 4,953 $ 4,060 $ 10,233
========= ========= =========
Changes in assets and liabilities, net of effects
of acquisitions and other changes:
Receivables, net $ 21,095 $ (3,836) $ (10,619)
Accrued revenue 6,083 9,551 (37,695)
Materials, supplies and gas in underground storage (1,710) (3,175) (12,380)
Gas charges, recoverable from customers 8,375 (6,140) (7,937)
Accounts payable (24,449) (20,439) 57,489
Customer advances and amounts payable to customers 1,594 (2,263) (1,539)
Other (9,140) 7,909 (3,418)
--------- --------- ---------
$ 1,848 $ (18,393) $ (16,099)
========= ========= =========
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-33-
[Download Table]
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
At December 31, 1998 1997
-----------------------------------------------------------------------------
(in thousands of dollars)
ASSETS
Current Assets
Cash and temporary cash investments, at cost $ 4,953 $ 4,060
Receivables, less allowances of $632 and $1,498 31,003 51,635
Accrued revenue 60,915 66,998
Materials and supplies, at average cost 2,191 2,924
Gas in underground storage 38,526 36,083
Gas charges, recoverable from customers 11,556 19,931
Other 13,906 11,702
-------- --------
$163,050 $193,333
-------- --------
Property, Plant and Equipment
Gas Distribution $364,513 $344,568
Diversified Businesses 43,857 37,267
-------- --------
$408,370 $381,835
Less - Accumulated depreciation 118,132 106,256
-------- --------
$290,238 $275,579
-------- --------
Deferred Charges and Other
Unamortized debt expense $ 5,619 $ 5,284
Advances to equity investees -- 8,370
Other 30,755 24,594
-------- --------
$ 36,374 $ 38,248
-------- --------
Total Assets $489,662 $507,160
======== ========
LIABILITIES AND CAPITALIZATION
Current Liabilities
Notes payable $ 63,576 $ 71,406
Accounts payable 57,498 80,043
Customer advance payments 10,417 8,035
Accumulated deferred income taxes 2,344 1,594
Accrued interest 1,935 1,997
Other 7,270 13,986
-------- --------
$143,040 $177,061
-------- --------
Deferred Credits and Other
Reserve for equity investment $ -- $ 25,212
Accumulated deferred income taxes 17,985 15,046
Unamortized investment tax credit 2,247 2,515
Customer advances for construction 3,147 3,935
Other 17,760 21,443
-------- --------
$ 41,139 $ 68,151
-------- --------
Capitalization
Long-term debt $170,000 $163,548
Cumulative preferred stock of subsidiary 3,100 3,100
Cumulative convertible preferred stock 155 169
Common shareholders' equity 132,228 95,131
-------- --------
$305,483 $261,948
-------- --------
Total Liabilities and Capitalization $489,662 $507,160
======== ========
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-34-
[Download Table]
CONSOLIDATED STATEMENTS OF CAPITALIZATION
At December 31, 1998 1997
-----------------------------------------------------------------------------
(in thousands of dollars)
LONG-TERM DEBT
6.83% notes due 2002 $ 30,000 $ 30,000
8.00% notes due 2004 55,000 55,000
7.20% notes due 2007 30,000 30,000
8.32% notes due 2024 25,000 25,000
6.50% medium-term notes due 2005 15,000 --
6.40% medium-term notes due 2008 5,000 --
7.03% medium-term notes due 2013 10,000 --
8.625% debentures due 2017 -- 23,548
-------- --------
$170,000 $163,548
-------- --------
CUMULATIVE PREFERRED STOCK OF SUBSIDIARY
$100 par value (callable at option of Subsidiary)
6.0% series A--15,000 shares authorized and
outstanding $ 1,500 $ 1,500
5.5% series B--10,000 shares authorized and
outstanding 1,000 1,000
5.5% series C--5,000 shares authorized;
4,000 shares outstanding 400 400
5.5% series D--2,000 shares authorized and
outstanding 200 200
-------- --------
$ 3,100 $ 3,100
-------- --------
CUMULATIVE CONVERTIBLE PREFERRED STOCK
Convertible preferred stock, par value $1 per
share--authorized 500,000 shares issuable in
series; 6,218 and 6,751 shares outstanding $ 6 $ 7
Capital surplus 149 162
-------- --------
$ 155 $ 169
-------- --------
COMMON SHAREHOLDERS' EQUITY
Common stock, par value $1 per share--authorized
20,000,000 shares; 17,382,229 and 14,066,244
shares outstanding $ 17,382 $ 14,066
Capital surplus 116,663 81,086
Retained earnings (deficit) (1,817) (21)
-------- --------
$132,228 $ 95,131
-------- --------
$305,483 $261,948
======== ========
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-35-
[Download Table]
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' INVESTMENT
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------
(in thousands of dollars)
CUMULATIVE CONVERTIBLE PREFERRED STOCK
Beginning of year $ 7 $ 7 $ 7
Conversion of preferred stock (1) -- --
-------- ------- -------
End of year $ 6 $ 7 $ 7
======== ======= =======
CUMULATIVE CONVERTIBLE PREFERRED STOCK
CAPITAL SURPLUS
Beginning of year $ 162 $ 162 $ 165
Conversion of preferred stock (13) -- (3)
-------- ------- -------
End of year $ 149 $ 162 $ 162
======== ======= =======
COMMON STOCK
Beginning of year $ 14,066 $13,221 $12,619
5% stock dividends May 1998, May 1997
and May 1996 726 661 629
Issuance of common stock for acquisitions,
the DRIP and other 770 346 293
Issuance of common stock through
public offering 1,820 -- --
Repurchase of common stock -- (162) (320)
-------- ------- -------
End of year $ 17,382 $14,066 $13,221
======== ======= =======
COMMON STOCK CAPITAL SURPLUS
Beginning of year $ 81,086 $78,678 $79,774
5% stock dividends May 1998, May 1997
and May 1996 (726) (661) (629)
Issuance of common stock for acquisitions,
the DRIP and other 12,243 5,978 4,842
Issuance of common stock through
public offering 24,060 -- --
Repurchase of common stock -- (2,909) (5,309)
-------- ------- -------
End of year $116,663 $81,086 $78,678
======== ======= =======
RETAINED EARNINGS (DEFICIT)
Beginning of year $ (21) $(5,221) $17,355
Net income (loss) 10,040 15,425 (12,762)
Cash dividends on common stock (11,836) (10,225) (9,814)
-------- ------- -------
End of year $ (1,817) $ (21) $(5,221)
======== ======= =======
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-36-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
SEMCO Energy, Inc., is an investor-owned holding company. SEMCO Energy, Inc.
and its subsidiaries (the "Company") operate five business segments. The
business segments are gas distribution, engineering services, construction
services, energy marketing and propane, pipelines and storage. The Company's
gas distribution business segment ("Gas Company") distributes and transports
natural gas to nearly 250,000 customers within the state of Michigan. The
engineering services segment ("Engineering Services") has offices in New
Jersey, Michigan, Louisiana and Texas and provides a variety of energy
related engineering services in several states. The construction services
business segment ("Construction Services") with offices throughout Michigan
and one in Tennessee provides primarily pipeline construction services in
Michigan, Tennessee and Florida. The propane, pipelines and storage segment
supplies propane to over 7,500 retail customers in Michigan's upper peninsula
and northeast Wisconsin and operates natural gas transmission, gathering and
storage facilities in Michigan. The energy marketing business segment
("Energy Services") engages in energy marketing to approximately 188
customers located in several states.
POOLING OF INTERESTS. During 1998, the Company acquired Oilfield Materials
Consultants, Inc. ("OMC"). The acquisition of OMC was accounted for as a
pooling of interests, and accordingly, the consolidated financial statements
and notes for the periods presented have been restated to include the
financial results of OMC. See Note 3 for further information.
FINANCIAL STATEMENT PRESENTATION. The financial statements of the Company
are presented in the conventional classification format rather than a
regulated utility format, which has been used in the past. Certain
reclassifications have been made to the prior years' financial statements to
conform with the 1998 presentation.
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of SEMCO Energy, Inc. and its wholly-owned subsidiaries.
Investments in unconsolidated companies at least 20% owned, but not greater
than 50% owned, are reported using the equity method of accounting.
-37-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
1. SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Certain of the Company's nonregulated businesses supply goods and
services at a profit to the Company's regulated gas distribution business.
In these situations, intercompany profits remaining in the assets of the
regulated business at a particular date are not eliminated since it is
probable that, through the ratemaking process, the cost will be recovered
through future revenue. As a result, $595,000 and $437,000 of profit on
sales earned from the Company's regulated business by the Company's
nonregulated businesses was not eliminated during consolidation in 1998 and
1997, respectively. All other significant intercompany transactions have
been eliminated.
RATE REGULATION. The rates of the Gas Company's customers located in the
Battle Creek division are subject to the jurisdiction of the City Commission
of Battle Creek, Michigan. The Michigan Public Service Commission ("MPSC")
authorizes the rates charged to all of the remaining Gas Company customers.
PROPERTY, PLANT, EQUIPMENT AND DEPRECIATION. The Company's property, plant
and equipment ("property") is recorded at cost. The Company provides for
depreciation on a straight-line basis over the estimated useful lives of the
related property. The ratio of depreciation to the average balance of
property approximated 3.9%, 3.6% and 3.6% for the years 1998, 1997 and 1996,
respectively. Certain investments in unconsolidated companies recorded using
the equity method are reported in the property of the diversified businesses.
See Note 13 for further discussion.
GAS IN UNDERGROUND STORAGE. Gas in underground storage for the Gas Company's
MPSC division is reported at average cost. The Battle Creek division's gas
inventory is stated at last-in, first-out ("LIFO") cost. At December 31,
1998 and 1997, the replacement cost of the Battle Creek division's gas
inventory did not exceed the LIFO cost. Energy Services reports gas in
storage at average cost.
In general, commodity costs and variable transportation costs are
capitalized as gas in underground storage. Fixed costs, primarily pipeline
demand charges and storage charges, are expensed as incurred through cost of
gas.
REVENUE RECOGNITION. The Gas Company bills monthly on a cycle basis and
follows the industry practice of recognizing accrued revenue for gas services
rendered to its customers but not billed at month end. Engineering Services
and Construction Services recognize revenues as services are rendered and
recognize accrued revenue for services rendered but not billed at month end.
The propane business recognizes propane sales in the same period that the
propane is delivered to customers. Energy Services recognizes marketing
revenues, and any related hedging gains or losses, in the same period natural
gas is delivered to customers. See Note 8 for further discussion about
Energy Services' hedging activities.
-38-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
1. SIGNIFICANT ACCOUNTING POLICIES (CONT.)
COST OF GAS. The Gas Company has regulator approved gas cost recovery
("GCR") mechanisms which allow for the adjustment of rates charged to
customers in response to increases and decreases in the cost of gas
purchased. In 1998, the MPSC authorized the Gas Company to suspend its GCR
clause and freeze for three years in its base rates a gas charge of $3.24 per
Mcf. The GCR freeze and new rates take effect in April 1999 and generally
extend through March 2002. As a result of the GCR suspension, customer rates
will not be adjusted during the three year period. See Note 2 for more
information.
INCOME TAXES. Investment tax credits ("ITC") utilized in prior years for
income tax purposes are deferred for financial accounting purposes and are
amortized through credits to the income tax provision over the lives of the
related property. The Company files a consolidated federal income tax return
and income taxes are allocated to each subsidiary based on its separate
taxable income.
EXTRAORDINARY CHARGE. During the second quarter of 1998, the Company
redeemed all of its outstanding 8.625% debentures due April 15, 2017 at a
redemption price of 104% of the principle amount of $23,548,000. The payment
of the call premium and the unamortized debt expense associated with the
non-regulated operations of the Company is reflected as an extraordinary
charge of $499,000 after-tax.
CHANGE IN METHOD OF ACCOUNTING. During the first quarter of 1998, the Gas
Company implemented a change in its method of accounting for property taxes
so that such taxes are expensed monthly during the fiscal period of the
taxing authority for which the taxes are levied. This change provides a
better matching of property tax expense with both the payment of services and
those services provided by the taxing authority. Prior to 1998, the Company
expensed property taxes monthly during the year following the assessment
date. The cumulative effect of this change in accounting for property taxes
increased 1998 earnings by $1,784,000 after-tax. The pro forma effect on
prior years' consolidated net income of retroactively recording property
taxes as if the new method of accounting had been in effect for all periods
presented is not material.
STATEMENTS OF CASH FLOWS. For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid investments purchased
with original maturities of three months or less to be cash and temporary
cash investments. The Company paid income taxes of $2,100,000, $3,153,000
and $3,275,000 during 1998, 1997 and 1996, respectively. The Company paid
$14,423,000, $11,949,000 and $10,566,000 for interest during 1998, 1997 and
1996, respectively.
-39-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
1. SIGNIFICANT ACCOUNTING POLICIES (CONT.)
[Enlarge/Download Table]
Supplemental cash flow information for the years ended December 31,
1998, 1997 and 1996, is summarized as follows (in thousands of dollars):
1998 1997 1996
-------- -------- --------
Non-Cash Investing and Financing Activities:
Capital stock issued for acquisitions $ 6,309 <F1> $ 450 $ --
Property purchased under capital leases $ -- $ 360 $ 3,252
Capital leases amortized and retired $ -- $ 4,899 $ 2,450
Details of Acquisitions:
Fair value of assets acquired $ 10,301 $ 22,464 $ --
Liabilities assumed (3,992) (6,330) --
Stock issued (6,309) (450) --
-------- -------- --------
Cash paid $ -- $ 15,684 $ --
Less cash acquired 26 567 --
-------- -------- --------
Net cash paid for (acquired via) acquisitions $ (26) $ 15,117 $ --
======== ======== ========
<FN>
<F1>
Does not include $14,073 of Company stock issued for the acquisition of OMC because the
acquisition was accounted for as a pooling of interests. Refer to Note 3 for more information.
</FN>
2. REGULATORY MATTERS
SUSPENSION OF GAS COST RECOVERY CLAUSE AND NEW INCOME SHARING MECHANISM. In
September 1998, the Gas Company's MPSC division received authority from the
MPSC to: (1) implement an experimental residential gas customer choice
program; (2) suspend its gas cost recovery ("GCR") clause; (3) roll into its
base rates and freeze for three years a gas charge of $3.24 per thousand
cubic feet ("Mcf"); (4) freeze distribution rate adjustments for the same
three year period, with exceptions; (5) suspend the income sharing mechanism
adopted in October 1997 and adopt a new income sharing mechanism for use
during the 1999, 2000 and 2001 calendar years; and (6) establish gas service
performance criteria. The new rates take effect in April 1999 and generally
extend through March 2002.
Under the experimental residential gas customer-choice program up to
21,000 residential customers, 10% of the Gas Company's residential customer
base, will be allowed to choose their own gas supplier by the third year of
the program. The Gas Company will deliver the customer-choice gas under a
tariff similar to its existing tariff used to provide such service to its
commercial and industrial customers. The Company anticipates that this
program will not significantly affect the Gas Company's income because the
Gas Company's approved rates for transportation service are designed to
recover all costs other than the cost of gas and provide a return in
approximately the same amounts as such costs are recovered from residential
customers for whom the Gas Company is the supplier.
-40-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
2. REGULATORY MATTERS (CONT.)
Several of the changes in the MPSC order are interrelated. The $3.24
GCR rate represents a reduction of approximately $.33 per Mcf from the Gas
Company's present rates. The suspension of the GCR clause means that the Gas
Company will not be able to recover any amounts by which its gas costs exceed
a weighted average cost of gas in excess of the $3.24 GCR for the three year
period. If the Gas Company is able to reduce its gas costs below the $3.24
level, a portion of the savings is retained. The Gas Company was able to
offer this GCR suspension mainly as a result of agreements reached with
TransCanada Gas Services Inc., under which the latter will provide the Gas
Company's natural gas requirements and manage the Gas Company's natural gas
supply and the supply aspects of transportation and storage operations for
the three year period.
There are two exceptions to the three year distribution rate freeze:
first, the incentive sharing mechanism described in the following paragraph,
and second, rate revisions arising in response to unanticipated legislative
or accounting actions. The MPSC order is applicable only in the geographic
areas subject to the regulatory jurisdiction of the MPSC, and, therefore,
does not govern rates regulated by the City of Battle Creek, Michigan.
However, the Gas Company is voluntarily reducing its Battle Creek GCR rate to
the $3.24 level to correspond with its GCR under the MPSC order.
The new income sharing mechanism substantially matches mechanisms
approved by the MPSC for two other major natural gas utilities in Michigan.
Under the mechanism, if the Gas Company's return on equity for its natural
gas utility business exceeds 12.75%, amounts equal to 50% of the excess
return between 12.76% and 16.75%, plus amounts equal to 75% of the excess
over 16.75% would be credited to customers, i.e., would be reflected
prospectively in reduced rates. Four safety and reliability performance
measures need to be met in order not to reduce the return on equity threshold
used in the income sharing mechanism.
Management believes that the overall impact of the MPSC order and the
Gas Company's agreements with TransCanada will be lower rates for its
customers and an opportunity for the Company to improve service to its
customers as well as improve profitability.
SOUTHEASTERN AND MICHIGAN GAS RATE CASE. In October 1997, the MPSC approved
the merger of Southeastern and Michigan Gas in a general rate case. This
allowed the Company to combine the rate structures, GCR clauses, tariffs, and
rules and regulations for those two divisions. It additionally granted a
rate increase to the combined divisions, which included the recovery of costs
related to a change in accounting for retiree medical benefits. There were
also adjustments to other fees and rates as a result of the rate case.
Overall, the adjustments offset one another and the rate case did not have a
material impact on the Company's results of operations. The MPSC also
approved incentive regulation, where profits generated in excess of the
authorized rate of return will be shared with the ratepayer. Finally, the
MPSC granted the Company the ability to offer its commercial and industrial
customers the option to aggregate their demand for gas into a pool and choose
a supplier.
-41-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
2. REGULATORY MATTERS (CONT.)
STATE PROPERTY TAX REDUCTIONS. In June 1994, the MPSC issued Orders U-10617
and U-10618 to Michigan Gas and Southeastern, respectively. These orders
required the companies to offset deferred retiree medical costs with certain
reductions in Michigan state property taxes until the MPSC issued a final
order in the companies' general rate case, which occurred in October 1997.
In accordance with orders U-10617 and U-10618, Michigan Gas and Southeastern
have reduced deferred retiree medical costs by a combined total of $553,000
in 1997 and $663,000 in 1996.
REGULATORY ASSETS AND LIABILITIES. The Gas Company is subject to the
provisions of SFAS 71, "Accounting for the Effects of Certain Types of
Regulation." As a result, the actions of regulators affect when revenues and
expenses are recognized. Regulatory assets represent incurred costs to be
recovered from customers through the ratemaking process. Regulatory
liabilities represent benefits to be refunded to customers. The following
regulatory assets and liabilities were recorded on the consolidated
statements of financial position as of December 31 (in thousands of dollars):
[Download Table]
1998 1997
------- -------
Regulatory Assets
Deferred retiree medical benefits $12,588 $13,487
Deferred pension benefits 2,287 2,287
Unamortized loss on retirement of debt 2,862 3,107
Other 1,827 1,763
------- -------
$19,564 $20,644
======= =======
Regulatory Liabilities
Unamortized investment tax credit $ 2,687 $ 3,052
Tax benefits amortizable to customers 4,179 4,329
------- -------
$ 6,866 $ 7,381
======= =======
In the event the Gas Company determines that it no longer meets the
criteria for following SFAS 71, the accounting impact would be an
extraordinary, non-cash charge to operations of an amount that could be
material. Criteria that give rise to the discontinuance of SFAS 71 include
(1) increasing competition that restricts the Gas Company'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. The Gas Company's periodic review of these
criteria currently supports the continuing application of SFAS 71.
-42-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
3. MERGERS AND ACQUISITIONS
On March 31, 1998, the Company acquired the assets, liabilities and business
of Hotflame Gas, Inc. and Hotflame Transport Company, Inc. (together
"Hotflame"). Hotflame supplies propane gas to over 7,500 retail customers in
Michigan's upper peninsula and northeast Wisconsin. The acquisition was a
form of merger whereby the Company exchanged 353,000 shares of its common
stock for 100% of the outstanding stock of Hotflame. The fair value of the
tangible assets acquired and liabilities assumed were $5,343,000 and
$3,074,000, respectively. Included in the assets acquired by the Company
were several non-compete agreements with the prior owners of Hotflame
totaling $200,000 ranging from two to ten years. The balance of the purchase
price, $3,731,000, was recorded as an excess of cost over net assets acquired
("goodwill") and is being amortized on the straight line method over forty
years.
On May 15, 1998, the Company acquired the assets, liabilities and
business of King Energy and Construction, Inc. ("King"). King, which is
located in Tennessee, is a multi-utility service provider furnishing water,
sewer and natural gas construction services to customers. The acquisition of
King was also a form of merger whereby the Company exchanged 18,000 shares of
its common stock for 100% of the outstanding stock of King. The fair value
of tangible assets acquired and liabilities assumed were $506,000 and
$773,000, respectively. The balance of the purchase price, $576,000, is
goodwill and is being amortized on the straight line method over forty years.
For financial statement purposes, the acquisition of both Hotflame and
King were accounted for as purchases and, accordingly, results of operations
are included in the consolidated financial statements since the date of each
acquisition. There were no adjustments necessary to the accounting practices
of Hotflame or King to conform with the practices of the Company.
On November 3, 1998, the Company acquired the assets, liabilities and
business of Oilfield Materials Consultants, Inc. ("OMC"). OMC is an
engineering and consulting firm located in Texas that specializes in quality
control and quality assurance services for the natural gas, oil products,
exploration/production and telecommunication industries. The acquisition of
OMC was also a form of merger whereby the Company exchanged 905,000 shares of
its common stock for 100% of the outstanding stock of OMC. The acquisition
of OMC was accounted for as a pooling of interests, and accordingly, the
consolidated financial statements for the periods presented have been
restated to include the financial results of OMC. Operating revenues,
extraordinary items, net income (loss) and common shareholders' equity for
the individual companies reported prior to the merger were as follows (in
thousands of dollars):
-43-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
3. MERGERS AND ACQUISITIONS (CONT.)
[Download Table]
Ten Months
Ended
Oct. 31, 1998 1997 1996
------------- -------- --------
(unaudited)
Operating Revenue
SEMCO, as previously reported $489,495 $770,272 $544,949
OMC 14,142 5,660 2,961
-------- -------- --------
Combined $503,637 $775,932 $547,910
======== ======== ========
Extraordinary Charge
SEMCO, as previously reported $ 499 $ -- $ --
OMC -- -- --
-------- -------- --------
Combined $ 499 $ -- $ --
======== ======== ========
Net Income (Loss)
SEMCO, as previously reported $ 3,296 $ 14,921 $(12,803)
OMC 542 504 41
-------- -------- --------
Combined $ 3,838 $ 15,425 $(12,762)
======== ======== ========
Common shareholders' equity at end of period
SEMCO, as previously reported $127,603 $ 94,502 $ 86,544
OMC 1,065 629 134
-------- -------- --------
Combined $128,668 $ 95,131 $ 86,678
======== ======== ========
For the periods preceding the merger of the Company and OMC, there were
no intercompany transactions which required elimination from the combined
results of operations and there were no adjustments necessary to conform the
accounting practices of the two companies.
The Company acquired Maverick Pipeline Services, Inc. ("Maverick") on
December 17, 1997. The acquisition was accounted for as a purchase and was
included in the Company's 1997 consolidated financial statements. Because
Maverick was acquired late in 1997, a complete review of the asset values and
liabilities was not complete until 1998. The determination of the final
values resulted in a $145,000 increase in goodwill and corresponding increase
in liabilities acquired.
4. INCOME TAXES
SFAS NO. 109. The Company accounts for income taxes in accordance with SFAS
109, "Accounting For Income Taxes." SFAS 109 requires an annual measurement
of deferred tax assets and deferred tax liabilities based upon the estimated
future tax effects of temporary differences and carry forwards.
-44-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
4. INCOME TAXES (CONT.)
[Enlarge/Download Table]
PROVISION FOR INCOME TAXES. The components of the provision for income taxes
are as follows (in thousands of dollars):
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
Federal
Currently payable $ 5,511 $ 2,259 $ 1,160
Deferred to future periods 1,767 6,477 (7,999)
Investment tax credits (ITC) (267) (267) (267)
-------- -------- --------
Total income taxes $ 7,011 $ 8,469 $ (7,106)
Less amounts included in:
Cumulative effect of change in accounting method 960 -- --
Extraordinary charge (269) -- --
-------- -------- --------
Income Taxes, excluding amounts shown separately $ 6,320 $ 8,469 $ (7,106)
======== ======== ========
[Enlarge/Download Table]
RECONCILIATION OF STATUTORY RATE TO EFFECTIVE RATE. A reconciliation of the
difference between the Company's provision for income taxes and income taxes
computed at the statutory rate follows (in thousands of dollars):
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
Net income (loss) $ 10,040 $ 15,425 $(12,762)
Add back:
Preferred dividends 193 194 194
Income taxes 7,011 8,469 (7,106)
-------- -------- --------
Pre-tax income (loss) $ 17,244 $ 24,088 $(19,674)
======== ======== ========
Computed federal income taxes $ 6,035 $ 8,431 $ (6,886)
Amortization of deferred ITC (267) (267) (267)
Amortization of non-deductible amounts
resulting from acquisitions 216 216 216
Other 1,027 89 (169)
-------- -------- --------
Total incomes taxes $ 7,011 $ 8,469 $ (7,106)
======== ======== ========
-45-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
4. INCOME TAXES (CONT.)
[Download Table]
DEFERRED INCOME TAXES. Deferred income taxes arise from temporary
differences between the tax basis of assets and liabilities and their
reported amounts in the financial statements. The principal components of
the Company's deferred tax assets (liabilities) were as follows (in thousands
of dollars):
At December 31, 1998 1997
--------------------------------------------------------------------------
Property $(19,430) $(22,801)
Reserve for equity investment -- 8,824
Retiree medical benefit obligation 4,480 4,795
Retiree medical benefit regulatory assets (4,406) (4,720)
Gas in underground storage 3,789 3,243
ITC 1,176 1,257
Unamortized debt expense (989) (1,111)
Gas cost underrecovery (3,707) (6,411)
Other (1,242) 284
-------- --------
Total deferred taxes $(20,329) $(16,640)
======== ========
Gross deferred tax liabilities $(42,129) $(46,369)
Gross deferred tax assets 21,800 29,729
-------- --------
Total deferred taxes $(20,329) $(16,640)
======== ========
At December 31, 1998 and December 31, 1997 there was no valuation allowance
recorded against deferred tax assets.
5. CAPITALIZATION
REGISTRATION STATEMENT AND DISTRIBUTION AGREEMENT. The Company and SEMCO
Capital Trust filed a registration statement on Form S-3 ("registration
statement") with the Securities and Exchange Commission ("Commission") in
July 1998 for the registration of debt securities and common stock of the
Company and trust preferred securities of SEMCO Capital Trust in any
combination up to $200 million. In October 1998, the Company entered into a
distribution agreement with Merrill Lynch & Co., Morgan Stanley Dean Witter,
A.G. Edwards & Sons, Inc. and Edward D. Jones & Co., L.P. pursuant to which
it may issue, from time to time, an aggregate of $150 million of medium-term
notes, which were included in the securities registered.
COMMON STOCK EQUITY. The Company issued five percent stock dividends in May
1998, May 1997 and May 1996. Earnings per share of common stock, cash
dividends per share of common stock and average number of common shares
outstanding have been restated to reflect the stock dividends.
-46-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
5. CAPITALIZATION (CONT.)
Pursuant to its DRIP, the Company issued 367,000 shares of common stock
in 1998 and 298,000 shares in 1997 and 292,000 shares in 1996. The Company
did not purchase shares on the open market in 1998 for the DRIP. The Company
purchased a total of 162,000 shares in 1997 and 320,000 shares in 1996 for
the DRIP. The Company contributed 30,000 shares of Company stock to the
Company's primary 401(k) plan in 1998, and 22,000 shares to the Company's
Employee Stock Ownership Trust in 1997.
During August 1998, the Company sold 1,820,000 shares of its common
stock in a public offering. Proceeds of the offering were $26,153,000 after
underwriting discounts but before expenses. The proceeds from the common
stock issuance were used to repay short-term debt and for general corporate
purposes.
The Company also issued 1,276,000 and 26,000 shares of its common stock
in 1998 and 1997, respectively, as part of certain business acquisitions. Of
the shares issued in 1998, 905,000 were for the acquisition of OMC which was
accounted for as a pooling of interests. See Notes 1 and 3 for more
information on the accounting for a pooling of interests.
CUMULATIVE CONVERTIBLE PREFERRED STOCK. At December 31, 1998 and 1997, only
6,218 and 6,751 shares of the Company's $2.3125 cumulative convertible
preferred shares were outstanding and each share was convertible at the
option of the holder to 4.11 shares of common stock. At December 31, 1998, a
total of 25,556 common shares are reserved for issuance upon conversion of
the convertible preferred stock.
CUMULATIVE PREFERRED STOCK OF SUBSIDIARY. The cumulative preferred stock of
the Gas Company is callable at the subsidiary's option at $105 per share.
Payment of dividends on this preferred stock is fully guaranteed by the
Company.
LONG-TERM DEBT. In April 1998, the Company redeemed all of its outstanding
8.625% debentures due April 15, 2017 at a redemption price of 104% of the
principle amount of $23,548,000. Later in 1998, the Company issued
$30,000,000 of medium-term notes with interest rates ranging from 6.40% to
7.03%.
In 1997, the Company issued $60,000,000 of private placement debt to
reduce short-term notes payable incurred to finance the Company's ongoing
capital expenditure program and for general corporate purposes.
The Company has long-term and short-term debt arrangements which contain
restrictive financial covenants including, among others, limits on the
payment of dividends beyond certain levels. The Company is currently in
compliance with all of the covenants in these agreements.
There are no annual maturities or sinking fund requirements for the
Company's existing debt over the next five years, except for the maturity of
$30,000,000 of 6.83% notes in 2002.
-47-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
6. SHORT-TERM BORROWINGS
The Company maintains unsecured lines of credit at two banks. Interest on
all such lines are at variable rates, which do not exceed the banks' prime
lending rates. These arrangements are set to expire during 1999 and the
Company expects they will be renegotiated at comparable terms. The Company
also has a note payable in connection with the sale of its investment in the
NOARK Pipeline System Partnership ("NOARK") (see Note 15).
[Enlarge/Download Table]
Information regarding these borrowings for each of the last three years
is as follows (in thousands of dollars):
1998 1997 1996
------- ------- -------
Notes payable balance at year end $63,576 $71,406 $91,382
Unused lines of credit at year end $50,200 $39,363 $ 8,968
Average interest rate at year end 5.6% 6.4% 7.0%
Maximum borrowings at any month-end $78,668 $99,037 $91,382
Average borrowings $49,418 $60,784 $41,388
Weighted average cost of borrowings 6.5% 6.2% 6.0%
7. FINANCIAL INSTRUMENTS
FINANCIAL INSTRUMENTS. The following methods and assumptions were used to
estimate the fair value of each significant class of financial instruments:
CASH, TEMPORARY CASH INVESTMENTS, ACCOUNTS RECEIVABLES, PAYABLES, AND NOTES
PAYABLE. The carrying amount approximates fair value because of the short
maturity of those instruments.
LONG-TERM DEBT. The fair values of the Company's long-term debt are
estimated based on quoted market prices for the same or similar issues or,
where no market quotes are available, based on discounted future cash flows
using current interest rates at which similar loans would be made to
borrowers with similar credit ratings and remaining maturities. Although the
current fair value of the long-term debt may differ from the current carrying
amount, settlement of the reported debt is generally not expected until
maturity.
[Download Table]
The estimated fair values of the Company's long-term debt as of
December 31, 1998 and 1997 are as follows (in thousands of dollars):
1998 1997
-------- --------
Long-term debt
Carrying amount $170,000 $163,548
Fair value 187,737 172,594
HEDGING ARRANGEMENTS. Refer to Note 8 for a description of Energy Services'
price hedging arrangements and their fair values.
-48-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
8. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
Energy Services enters into sales commitments which may extend up to 60
months into the future. Because of the volatility of natural gas prices,
there are significant market risks associated with these commitments. Energy
Services utilizes derivative financial and commodity instruments
("derivatives"), including futures contracts, options and swaps, to reduce
market risk associated with fluctuations in the price of natural gas. The
derivatives are utilized to ensure that the impact of natural gas price
fluctuations on the fair value of long-term sales commitments will be offset
by gains and losses on the hedging instrument. Energy Services' risk
management policy prohibits the utilization of derivatives for trading
purposes.
Gains or losses on derivatives associated with firm commitments are
recognized as adjustments to the cost of sales or revenues when the
associated transactions affect earnings. Gains and losses on derivatives
associated with forecasted transactions are recognized when such forecasted
transactions affect earnings. If a derivative instrument is terminated early
because it is probable that a transaction will not occur, any gain or loss as
of such date is immediately recognized in earnings. If a derivative is
terminated early for other economic reasons, any gain or loss as of the
termination date is deferred and recorded when the associated transaction or
forecasted transaction affects earnings. If a derivative is sold or matures,
any gain or loss is deferred and recognized as adjustments to the cost of
sales or revenues when the associated transaction affects earnings. In order
to meet the criteria for the gains and losses on derivatives to be deferred
and recognized in the same period as the physical transaction, the commodity
must expose the Company to price risk and the derivative used as a hedging
instrument must reduce that exposure. Because the commodities covered by the
derivatives are substantially the same commodities that the Company buys and
sells in the physical market, there is a high degree of correlation between
price changes in the derivative and cash markets. If those criteria were not
met, the derivative would be marked to market and any change in market value
would be recognized in earnings in the period of change.
Energy Services is also subject to credit risks due to the volume of
large transactions it enters into with third parties. Energy Services
maintains credit policies that management believes significantly minimizes
the overall credit exposure. These policies include an evaluation of the
potential parties' financial condition and the use of standardized agreements
which allow for netting of positive and negative exposures associated with a
single party. While notional amounts listed below are used to express the
volume of various derivatives, those amounts do not generally represent the
amounts exchanged by the parties and, thus, are not a measure of the exposure
to the Company. The amounts subject to credit risk are substantially
smaller. Energy Services does not anticipate any material impact to its
financial position or results of operations as a result of non-performance by
third parties.
-49-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
8. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS (CONT.)
[Download Table]
The following summarizes the types of derivatives used and the related
financial information on open contracts as of December 31, 1998 and 1997 (in
thousands of dollars):
1998 1997
------ -------
Futures Contracts
Notional amount (MMcf) 14,990 7,710
Unrealized gain (loss) $(4,798) $ (759)
Fair value $(4,798) $ (759)
Commodity Price Swaps
Notional amount (MMcf) 2,085 4,778
Unrealized gain (loss) $ (654) $ 114
Fair value $ (654) $ 114
Options
Notional amount (MMcf) -- 84
Unrealized gain (loss) $ -- $ (21)
Fair value $ -- $ 42
Energy Services estimates the fair value of the derivatives by using
available market data and valuation methodologies. Some judgment is required
in interpreting market data, and the use of market assumptions or estimation
methodologies may affect the estimated fair value amounts.
In addition to the unrealized gains and losses on open contracts shown
in the table above, Energy Services had approximately $2,202,000 and $782,000
in net deferred gains on contracts closed prior to December 31, 1998 and
December 31, 1997, respectively, related to sales commitments in the
following month. The deferred gains and losses on both the open and closed
contracts are included in other current assets.
Energy Services also had margin deposits of $3,923,000 and $4,890,000 as
of December 31, 1998 and 1997, respectively, which are also included in other
current assets. The cost of margin deposits approximates fair value.
Energy Services also hedges certain of its sales commitments with gas
held in storage. At December 31, 1998 and 1997, Energy Services held
approximately 3,829,000 Mcf and 4,027,000 Mcf in storage with a carrying
value of $8,879,000 and $10,364,000, respectively. At December 31, 1998 and
1997, Energy Services also had approximately 888,000 Mcf and 3,055,000 Mcf of
outstanding gas loans owed to third parties with a carrying value of
$2,286,000 and $6,614,000, respectively.
-50-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
9. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
[Enlarge/Download Table]
The Company has non-contributory, defined benefit pension plans and
postretirement benefit plans that cover the employees of certain companies in
the consolidated group. At December 31, 1998, plan assets consisted of 61.3%
equity investments, 12.5% guaranteed income insurance contracts, 25.9% fixed
income securities and 0.3% cash equivalents. The following table provides a
reconciliation of the benefit obligations, plan assets and funded status of
the plans (in thousands of dollars):
1998 1997 1998 1997
-------- -------- -------- --------
Other
Pension Benefits Postretirement Benefits
----------------------- -----------------------
Change in benefit obligation
Benefit obligation at January 1 $ 53,701 $ 52,869 $ 26,053 $ 26,525
Service cost 738 1,371 447 862
Interest cost 3,070 3,716 2,004 2,212
Actuarial (gain)/loss 2,537 2,002 1,034 3,837
Contributions by plan participants -- -- 64 --
Benefits paid from plan assets (2,558) (2,470) -- --
Benefits paid from corporate assets -- -- (1,547) (916)
Plan amendments 180 (3,787) 1,017 (6,467)
(Gain)/loss from reduction in workforce 1,840 -- 2,240 --
Lump sums paid for reduction in workforce (16,981) -- -- --
Special termination benefits 1,818 -- -- --
-------- -------- -------- --------
Benefit obligation at December 31 $ 44,345 $ 53,701 $ 31,312 $ 26,053
======== ======== ======== ========
Change in plan assets
Fair value of plan assets at January 1 $ 60,403 $ 49,788 $ 11,737 $ 7,702
Actual return on plan assets 9,875 10,586 1,740 1,505
Company contributions 1,082 2,499 2,463 2,530
Benefits paid from plan assets (2,558) (2,470) -- --
Lump sums paid for reduction in workforce (16,981) -- -- --
-------- -------- -------- --------
Fair value of plan assets at December 31 $ 51,821 $ 60,403 $ 15,940 $ 11,737
======== ======== ======== ========
Reconciliation of funded status of the plans
Funded (unfunded) status $ 7,476 $ 6,702 $(15,372) $(14,316)
Unrecognized net (gain) loss (8,603) (10,344) (14,943) (18,479)
Unrecognized prior service cost (benefit) 13 (153) -- --
Unrecognized net transition obligation 332 426 17,199 18,730
-------- -------- -------- --------
Prepaid (accrued) benefit cost $ (782) $ (3,369) $(13,116) $(14,065)
======== ======== ======== ========
Weighted average assumptions as of December 31
Discount rate 6.75% 7.00% 6.75% 7.00%
Expected long-term rate of return on plan assets 9.00% 9.00% 9.00% 9.00%
Rate of compensation increase 4.00% 4.00% 4.00% 4.00%
-51-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
9. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS (CONT.)
[Enlarge/Download Table]
Net periodic pension and other postretirement benefit costs include the
following components (in thousands of dollars):
Years ended December 31, 1998 1997 1996 1998 1997 1996
-----------------------------------------------------------------------------------------------------------
Pension Benefits Other Postretirement Benefits
------------------------------- -------------------------------
Service cost $ 738 $ 1,371 $ 1,796 $ 447 $ 862 $ 865
Interest cost 3,070 3,716 3,803 2,004 2,212 1,854
Expected return on plan assets (3,775) (4,119) (3,783) (1,055) (693) (535)
Amortization of transition obligation 77 79 79 1,250 1,680 1,680
Amortization of prior service costs 51 471 471 -- -- --
Amortization of net (gain) or loss (24) (436) 133 (946) (1,286) (1,310)
Net (gain) loss due to settlements,
curtailments and special
termination benefits (1,641) -- -- 1,298 -- --
------- ------- ------- ------- ------- -------
Net benefit cost (credit) $(1,504) $ 1,082 $ 2,499 $ 2,998 $ 2,775 $ 2,554
======= ======= ======= ======= ======= =======
PENSIONS. Pension plan benefits are generally based upon years of service
and compensation during the final years of employment. The Company's funding
policy is to contribute amounts annually to the plans based upon actuarial
and economic assumptions designed to achieve adequate funding of projected
benefit obligations.
On December 31, 1997, the pension plans were amended to provide a
special frozen benefit to all employees with at least two years of service on
December 31, 1997. This special frozen benefit added both three years of
service and three years of age to all eligible employees for purposes of
computing accrued pension benefits at December 31, 1997. In conjunction with
the amendment, the Company offered an early retirement program to all
eligible employees with at least two years of service on December 31, 1997.
The program was open from January 14, 1998 through February 27, 1998 and
offered employees the additional options of receiving either a lump-sum
pension benefit payment or an immediate annuity commencing April 1, 1998.
One hundred and one employees accepted the early retirement offer. As a
result of the early retirement program and in accordance with the provisions
of SFAS 88, "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits", the Company
incurred a one-time gain which reduced 1998 net periodic pension costs by
$1,641,000. This reduction was partially offset by a one-time charge in the
net retiree medical costs discussed below.
OTHER POSTRETIREMENT BENEFITS. The Company provides certain medical and
prescription drug benefits to qualified retired employees, their spouses and
covered dependents. Retirees with less than 30 years of service are required
to contribute from 5% to 50% of the Company's coverage cost, with the
percentage depending on the retiree's age and years of service. The Company
accounts for retiree medical benefits in accordance with SFAS 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions."
This standard requires the full accrual of such costs during the years that
the employee renders service to the Company until the date of full
eligibility.
-52-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
9. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS (CONT.)
In December 1992, the MPSC issued a generic order addressing the
adoption of SFAS 106 by utilities under its jurisdiction. The order allows
Michigan utilities to adopt SFAS 106 for accounting and ratemaking purposes,
subject to a final order in a general rate case and requires the external
funding for amounts recovered in rates. The general rate case approved by
the MPSC in October 1997 allowed for such recovery of retiree medical
benefits, as discussed in Note 2. The City Commission of Battle Creek
allowed the recovery of retiree medical benefits in Battle Creek's December
1995 rate increase. Prior to getting rate approval for the Gas Company's
portion of retiree medical costs, the Company deferred, as a regulatory
asset, those amounts not funded externally. After receiving rate approval
for recovery of such costs, the Company began amortizing, as retiree medical
expense, the amounts previously deferred.
In 1998, 1997 and 1996, the Company expensed retiree medical costs of
$3,897,000, $2,471,000 and $2,058,000, respectively. The 1998 retiree
medical expense includes a one-time charge of $1,298,000 related to the early
retirement program and $899,000 of amortization of previously deferred
retiree medical costs. In 1997 and 1996, the Company's retiree medical
expense included $553,000 and $663,000, respectively, of deductions pursuant
to certain MPSC orders regarding the reduction in Michigan state property
taxes. See Note 2 for further discussion of these MPSC orders. In 1997 and
1996, the Company also deferred, and recorded as a regulatory asset, $304,000
and $496,000, respectively of retiree medical costs.
The Company established a Voluntary Employee Benefit Association
("VEBA") trust in 1997 to fund its retiree medical benefits and contributed
$2,339,000 and $2,023,000 to the trust in 1998 and 1997, respectively.
Previously, and to a lesser extent in 1998, the Company had partially funded
retiree medical benefits on a discretionary basis through an Internal Revenue
Code Section 401(h) account. In 1998, 1997 and 1996, the Company made cash
contributions to the 401(h) account of $124,000, $508,000 and $744,000,
respectively.
The 1998 costs were developed based on the health care plan in effect at
January 1, 1998. As of December 31, 1998, the actuary assumed that retiree
medical cost increases would be 7.8% and prescription drug cost increases
would be 10.3% in 1999 and both would decrease uniformly to 5.0% in 2005 and
thereafter. At December 31, 1997, the actuary assumed that retiree medical
cost increases would be 8.2% and prescription drug cost increases would be
11.3% in 1998 and both would decrease uniformly to 5.0% in 2005 and
thereafter. The health care cost trend rate assumption significantly affects
the amounts reported. For example, a one percentage point increase in each
year would increase the accumulated retiree medical obligation as of
December 31, 1998 by $4,250,000 and the aggregate of the service and interest
cost components of net periodic retiree medical costs for 1998 by $361,000.
-53-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
9. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS (CONT.)
401(K) PLANS AND THE EMPLOYEE STOCK OWNERSHIP TRUST. The Company has a
defined contribution plan, commonly referred to as the primary 401(k) plan,
covering the employees of certain companies in the controlled group. The
Company also has an Employee Stock Ownership Trust ("ESOT") covering
approximately the same group of employees. During 1998, the Company merged
the assets of the ESOT into the primary 401(k) plan. Under the provisions
of the ESOT prior to the merger, Company contributions were discretionary.
The Company did not contribute to the ESOT in 1996. In 1997, the Company
contributed $400,000 in Company stock to the ESOT. During 1998, in
conjunction with the merger of the ESOT, the Company amended its primary
401(k) plan to allow for Company matching contributions made in Company
stock. The amount expensed for the Company match provision was $491,000 in
1998. The Company has other 401(k) plans which were acquired through business
acquisitions during 1998 and 1997. There were no Company matching
contributions to these plans in 1998 or 1997.
10. STOCK-BASED COMPENSATION
At the Company's 1997 annual meeting, the shareholders approved a long-term
incentive plan providing for the issuance of up to 500,000 shares of
non-qualified common stock options over the next ten years adjusted for any
subsequent stock dividends and stock splits. The options are reserved for
the executives and directors of the Company and are awarded based upon both
the Company's and individual's performance. The options vest at the rate of
33 1/3% per year beginning one year after the date of grant and expire ten
years after the grant date. Additionally, pursuant to an executive
employment agreement, the Company granted 30,000 and 15,000 common stock
options during 1997 and 1996, respectively. These options vest three years
after the grant date and expire ten years after the grant date.
[Enlarge/Download Table]
The exercise price of all the options granted is equal to the average of
the high and low market price on the options' grant date. Both the number of
options granted and the exercise price are adjusted accordingly for any stock
dividends and stock splits occurring during the options' life. Fair value of
the options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted average assumptions:
1998 1997 1996
----- ----- -----
Risk-free interest rate 5.55% 6.54% 6.47%
Dividend yield 6.11% 5.67% 6.50%
Volatility 22.97% 19.13% 19.13%
Average expected term (years) 5 5 6
Fair value of options granted $2.26 $2.61 $2.28
-54-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
10. STOCK-BASED COMPENSATION (CONT.)
[Enlarge/Download Table]
The status of the options granted under the long-term stock incentive
plan and the employment agreement are as follows:
Number Average Price
of Shares<F1> Per Share<F1>
---------- ----------
Outstanding at December 31, 1995 -- $ --
Granted 16,537 $14.97
Exercised -- --
Canceled -- --
Outstanding at December 31, 1996 16,537 $14.97
Granted 131,925 $17.07
Exercised -- --
Canceled (18,000) $18.00
Outstanding at December 31, 1997 130,462 $16.68
Granted 102,948 $16.01
Exercised -- --
Canceled (15,780) $16.11
Outstanding at December 31, 1998 217,630 $16.40
<FN>
<F1>
Adjusted to give retroactive effect to the 5% stock dividends of May 1997 and 1998.
</FN>
[Enlarge/Download Table]
Employee stock options available for grant were 357,000 and 444,000 at
December 31, 1998 and 1997, respectively, after adjusting for the 1998 stock
dividend. Employee stock options exercisable under these plans are as
follows:
Number Average Price
of Shares Per Share
--------- ---------
Options exercisable at December 31, 1996 -- $ --
Options exercisable at December 31, 1997 1,050 $17.14
Options exercisable at December 31, 1998 29,394 $16.97
[Enlarge/Download Table]
In October 1995, the FASB issued SFAS 123, "Accounting for Stock-Based
Compensation." In general, SFAS 123 recommends that all stock-based
compensation given to employees in exchange for their services be expensed
based on the fair value of the options granted. The Company has chosen to
continue accounting for these transactions under previously existing
accounting standards as allowed in SFAS 123. However, if expense had been
determined in a manner consistent with the provisions of SFAS 123, the
Company's net income and earnings per share would have been reduced to the
pro-forma amounts indicated below (in thousands of dollars, except for per
share amounts):
Years Ended December 31, 1998 1997 1996
---------------------------------------------------------------------------------------------------
Net income (loss)
As reported $ 10,040 $ 15,425 $(12,762)
Pro-forma $ 9,940 $ 15,374 $(12,767)
Earnings per share - basic and diluted
As reported $ 0.63 $ 1.06 $ (0.88)
Pro-forma $ 0.62 $ 1.05 $ (0.88)
-55-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
11. EARNINGS PER SHARE
The Company computes earnings per share ("EPS") in accordance with SFAS 128,
"Earnings per Share." SFAS 128 requires the computation and presentation of
two EPS amounts, basic and diluted. Basic EPS is computed by dividing income
available to common shareholders by the weighted average number of common
shares outstanding during the period. The computation of diluted EPS is
similar to that of basic EPS except that the weighted average number of
common shares outstanding is increased to include any shares that would be
available if outstanding stock options, warrants, or convertible securities
("dilutive securities") were exercised. Accordingly, income available to
common shareholders is also adjusted for any changes to income or loss that
would result from the assumed conversion of the dilutive securities. The
diluted EPS calculation excludes the effect of stock options when their
exercise prices exceed the average market price over the period.
[Enlarge/Download Table]
The computations of basic and diluted earnings (loss) per share for the
years ended December 31, 1998, 1997 and 1996 are as follows (in thousands of
dollars except per share amounts):
1998 1997 1996
------- ------- --------
Basic Earnings (Loss) Per Share Computation
Income (loss) before accounting change and extraordinary charge $ 8,755 $15,425 $(12,762)
Cumulative effect of change in accounting 1,784 -- --
Extraordinary charge (499) -- --
------- ------- --------
Net Income (Loss) $10,040 $15,425 $(12,762)
======= ======= ========
Weighted average common shares outstanding 15,906 14,608 14,573
------- ------- --------
Earnings (Loss) Per Share - Basic
Income (loss) before accounting change and extraordinary charge $ 0.55 $ 1.06 $ (0.88)
Cumulative effect of change in accounting 0.11 -- --
Extraordinary charge (0.03) -- --
------- ------- --------
Net Income (Loss) $ 0.63 $ 1.06 $ (0.88)
======= ======= ========
Diluted Earnings (Loss) Per Share Computation
Income (loss) before accounting change and extraordinary charge $ 8,755 $15,425 $(12,762)
Adjustment for effect of assumed conversions:
Preferred convertible stock dividends 15 16 --
------- ------- --------
Adjusted income (loss) before accounting change and extraordinary charge 8,770 15,441 (12,762)
Cumulative effect of change in accounting 1,784 -- --
Extraordinary charge (499) -- --
------- ------- --------
Net Income (Loss) $10,055 $15,441 $(12,762)
======= ======= ========
Weighted average common shares outstanding 15,906 14,608 14,573
Incremental shares from assumed conversions of:
Preferred convertible stock 26 28 --
Stock options 3 3 --
------- ------- --------
Diluted weighted average common shares outstanding 15,935 14,639 14,573
======= ======= ========
Earnings (Loss) Per Share - Diluted
Income (loss) before accounting change and extraordinary charge $ 0.55 $ 1.06 $ (0.88)
Cumulative effect of change in accounting 0.11 -- --
Extraordinary charge (0.03) -- --
------- ------- --------
Net Income (Loss) $ 0.63 $ 1.06 $ (0.88)
======= ======= ========
As a result of the loss in 1996, basic loss per share was not adjusted
because to do so would be antidilutive.
-56-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
12. BUSINESS SEGMENTS
The Company adopted SFAS 131, "Disclosure about Segments of an Enterprise and
Related Information," during 1998. SFAS 131 established standards for
reporting information about operating segments ("business segments") in
annual financial statements and requires selected information in interim
financial statements. Business segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, to make decisions on how to allocate resources and to assess
performance. The Company's chief operating decision making group is the
Chief Executive Officer ("CEO") and certain other executive officers that
report directly to the CEO. The operating segments are organized and managed
separately because each segment offers different products or services. The
Company evaluates the performance of its business segments based on the
operating income generated. Operating income does not include income taxes,
interest expense, extraordinary charges, changes in accounting method and
non-operating income and expense items.
Under SFAS 131, an operating segment that does not exceed certain
quantitative levels is not considered a reportable segment. Instead, the
results of all segments that do not exceed the quantitative thresholds are
combined and reported as one segment and referred to as "all other." The
Company's construction services business segment and propane, pipelines and
storage business segment did not meet these quantitative thresholds and could
have been grouped into the "all other" category. However, the Company has
decided to voluntarily disclose information on these two business segments
because they are an integral part of the Company's strategic plans to grow
and diversify the Company.
The Company has five business segments. They are gas distribution,
engineering services, construction services, energy marketing and propane,
pipelines and storage. Refer to Note 1 for a brief description of each
business segment.
The accounting policies of the operating segments are the same as those
described in Note 1 except that intercompany transactions have not been
eliminated in determining individual segment results. The following table
provides business segment information as well as a reconciliation ("Corporate
and other") of the segment information to the applicable line in the
consolidated financial statements. Corporate and other includes corporate
related expenses not allocated to segments, intercompany eliminations and
results of other smaller operations.
-57-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
12. BUSINESS SEGMENTS (CONT.)
[Enlarge/Download Table]
Years Ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------------------------------
(in thousands of dollars)
Operating Revenues
Gas Distribution $184,221 $232,511 $232,985
Engineering Services 41,366 5,660 2,961
Construction Services 25,904 13,207 --
Propane, Pipelines and Storage 4,852 3,027 3,070
Energy Marketing 397,888 555,367 344,379
Corporate and other <F1> (16,746) (33,840) (35,485)
-------- -------- --------
Total consolidated revenues $637,485 $775,932 $547,910
======== ======== ========
Depreciation
Gas Distribution $ 12,110 $ 11,112 $ 10,405
Engineering Services 182 14 17
Construction Services 1,903 743 --
Propane, Pipelines and Storage 793 622 629
Energy Marketing 44 60 41
Corporate and other 317 326 242
-------- -------- --------
Total consolidated depreciation $ 15,349 $ 12,877 $ 11,334
======== ======== ========
Operating Income (Loss)
Gas Distribution $ 22,363 $ 26,348 $ 27,438
Engineering Services 2,938 778 273
Construction Services (102) 762 --
Propane, Pipelines and Storage 1,585 1,458 1,471
Energy Marketing (696) 217 (3,857)
Corporate and other (1,893) (396) (491)
-------- -------- --------
Total consolidated operating income $ 24,195 $ 29,167 $ 24,834
======== ======== ========
Assets
Gas Distribution $359,592 $362,906 $352,314
Engineering Services 8,897 2,618 799
Construction Services 20,471 21,028 --
Propane, Pipelines and Storage 27,175 18,110 18,483
Energy Marketing 65,017 89,653 91,387
Corporate and other 8,510 12,845 16,054
-------- -------- --------
Total consolidated assets $489,662 $507,160 $479,037
======== ======== ========
Capital Investments <F2>
Gas Distribution $ 23,029 $ 28,201 $ 30,169
Engineering Services 14,586 459 15
Construction Services 1,076 15,990 --
Propane, Pipelines and Storage 6,285 -- --
Energy Marketing -- 156 1
Corporate and other 655 234 339
-------- -------- --------
Total consolidated capital investments <F3> $ 45,631 $ 45,040 $ 30,524
======== ======== ========
<FN>
<F1>
Includes the eliminations of intercompany energy marketing revenues of $7,071, $28,405 and $35,676
for 1998, 1997 and 1996, respectively. Includes the elimination of intercompany engineering services
revenue of $429 for 1998. Includes the elimination of intercompany construction services revenue of
$9,283 and $5,723 for 1998 and 1997, respectively.
<F2>
Capital investments include amounts paid for business acquisitions, including non-cash amounts
such as Company stock issued as part of the acquisitions.
<F3>
The 1998 capital investments, shown in the above table, include $14,073 of Company stock issued as
part of the acquisition of OMC. The acquisition of OMC was accounted for as a pooling of interests,
therefore, the supplemental cash flow information in Note 1 does not include the stock issued for the
OMC acquisition.
</FN>
-58-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
13. INVESTMENTS IN AFFILIATES
[Download Table]
The equity method of accounting is used for interests in affiliates 20% to
50% owned. These affiliate companies are generally involved in natural gas
transmission, storage or associated operations. The Company records income
taxes on its share of undistributed earnings of these affiliates at the time
the earnings are included in consolidated income. At December 31, 1998, the
Company held the following interests in these affiliates:
Percent Ownership
-----------------
Eaton Rapids Gas Storage System 50%
Michigan Intrastate Lateral System 50%
Michigan Intrastate Pipeline System 50%
Nimrod Limited Partnership 29%
[Enlarge/Download Table]
Summarized combined financial information for investments in affiliates
for the years ended December 31, 1998, 1997 and 1996 is as follows (in
thousands of dollars):
1998 1997 1996
------- -------- --------
Net sales $ 8,199 $ 13,368 $ 13,866
Operating income $ 2,100 $ 3,568 $ 4,029
Net income (loss) $ 285 $ (7,107) $ (4,230)
======= ======== ========
The Company's share of net income (loss) $ 160 $ (1,967) $ (1,196)
======= ======== ========
Current assets $ 2,796 $ 2,843 $ 2,744
Non-current assets 28,092 125,455 131,211
------- -------- --------
Total assets $30,888 $128,298 $133,955
======= ======== ========
Current liabilities $ 2,784 $ 42,745 $ 9,659
Non-current liabilities 15,942 88,348 114,997
Equity 12,162 (2,795) 9,299
------- -------- --------
Total liabilities and equity $30,888 $128,298 $133,955
======= ======== ========
The Company's equity investment $ 4,522 $ 4,710 $ 5,120
======= ======== ========
The Company's share of undistributed gains (losses) $ -- $ 475 $ (1,733)
======= ======== ========
14. COMMITMENTS AND CONTINGENCIES
CAPITAL INVESTMENTS. The Company's plans for expansion and improvement of
its natural gas delivery system and its other diversified business properties
are continually reviewed. Aggregate capital expenditures for property in
1999 are projected at $20,000,000. In addition, the Company is planning to
incur additional expenditures for business acquisitions in 1999.
GUARANTEES. On January 14, 1998, the Company sold its entire 32% interest in
NOARK. The sale released the Company from all its NOARK guarantees, which
related to 40% of NOARK's debt. See Note 15 for more information on NOARK.
-59-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
14. COMMITMENTS AND CONTINGENCIES (CONT.)
LEASE COMMITMENTS. The Company leases buildings, vehicles and equipment.
The resulting leases are classified as operating leases in accordance with
SFAS 13, "Accounting for Leases." Vehicle leases comprise a significant
portion of total lease expense. Leases on new vehicles are for a minimum of
twelve months. The Company has the right to extend each vehicle lease
annually and to cancel the extended lease at any time.
[Download Table]
The following is a schedule by year of future minimum lease payments
that have initial or remaining noncancelable lease terms in excess of one
year at December 31, 1998:
1999 $ 395,000 2002 $ 250,000
2000 328,000 2003 237,000
2001 278,000 Thereafter 1,078,000
Total lease expense approximated $2,164,000, $2,092,000 and $2,305,000
in 1998, 1997 and 1996, respectively. The annual future minimum lease
payments shown in the previous schedule are substantially less than the lease
expense incurred in 1996 through 1998 because most of the vehicle leases at
December 31, 1998 were on a month-to-month basis and were cancelable at any
time. However, management expects to renew or replace substantially all
leases.
ENVIRONMENTAL ISSUES. Prior to the construction of major natural gas
pipelines, gas for heating and other uses was manufactured from processes
involving coal, coke or oil. The Gas Company owns seven sites which
formerly housed such manufacturing facilities and expects that it will
ultimately incur investigation and remedial action costs at some of these
sites, and a number of other sites. The Gas Company has submitted a plan to
the appropriate environmental regulatory authority in the State of Michigan
for work to begin at one site. The extent of the Gas Company's liabilities
and potential costs in connection with these sites cannot be reasonably
estimated at this time. In accordance with an MPSC accounting order, any
environmental investigation and remedial action costs will be deferred and
amortized over ten years. Rate recognition of the related amortization
expense will not begin until after a prudence review in a general rate case.
15. DIVESTITURE OF NOARK INVESTMENT
On January 14, 1998, the Company sold its entire interest in NOARK to ENOGEX
Arkansas Pipeline Corporation ("EAPC"). NOARK is a 302-mile intrastate
natural gas pipeline which experienced significant cost overruns during
construction, resulting in higher than expected financing costs. In
addition, competition from two interstate pipelines required NOARK to
discount its transportation charges to attract volumes to the pipeline. Even
with discounted rates, NOARK had operated at less than 65% capacity since its
inception in 1992. As a result, NOARK continued to generate losses and its
operating cash flows were insufficient to meet principal and interest
payments on its debt.
-60-
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
15. DIVESTITURE OF NOARK INVESTMENT (CONT.)
In December 1996, the Company recorded a $21,000,000 after-tax non-cash
write-down of its general partnership interest in NOARK. In December 1997,
the Company reduced its reserve for NOARK by $5,025,000 after-tax based on
the terms of the pending sale. The sale occurred in January 1998 and,
including subsequent adjustments, resulted in a final gain on the sale of
NOARK of $1,708,000 after-tax. The adjustments to the gain included income
tax benefits related to tax losses generated by the partnership and
adjustments to discount rates used to compute the present value of future
cash flows pursuant to the terms of the sale. The discount rates were
adjusted to better reflect actual market rates at the time of the sale.
Pursuant to terms included in the sales agreement, the Company paid EAPC
$9,200,000 in April 1998 and will pay $3,100,000 and $800,000 in April 1999
and 2000, respectively. The sale released the Company from all debt
obligations and guarantees related to NOARK. The Company will receive annual
payments of $842,000 from EAPC for 17 years beginning in the year 2004.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
In the opinion of the Company, the following quarterly information includes
all adjustments necessary for a fair statement of the results of operations
for such periods. Earnings and dividends per share of common stock are
calculated based upon the weighted average number of shares outstanding
during each quarter adjusted for five percent stock dividends in May 1998 and
May 1997. The total earnings per share each year may not equal annual
earnings per share due to changes in shares outstanding throughout the year.
Due to the seasonal nature of the Company's gas distribution business, the
results of operations reported on a quarterly basis show substantial
variations.
[Enlarge/Download Table]
Quarters First Second Third Fourth
----------------------------------------------------------------------------------------------------
1998
Operating revenue $226,471 $111,280 $113,075 $186,659
Operating income (loss) 12,837 762 (496) 11,092
Net income (loss) 8,571 (2,639) (2,357) 6,465
Earnings (loss) per share 0.58 (0.17) (0.14) 0.37
Cash dividends per share 0.18 0.19 0.18 0.20
1997
Operating revenue $254,237 $122,987 $125,005 $273,703
Operating income (loss) 18,151 3,189 (1,613) 9,440
Net income (loss) 9,809 231 (3,013) 8,398
Earnings (loss) per share 0.67 0.02 (0.21) 0.57
Cash dividends per share 0.17 0.17 0.18 0.18
-61-
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO SEMCO ENERGY, INC.:
We have audited the accompanying consolidated statements of financial
position and capitalization of SEMCO Energy, Inc. (a Michigan corporation)
and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, changes in shareholders' investment and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements and schedule 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 consolidated financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated 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 SEMCO
Energy, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
As discussed in Note 1 of the consolidated financial statements,
effective January 1, 1998, the Company changed its method of accounting for
property taxes.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in item 14(a)2 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
schedule has been subjected to the auditing procedures applied in the audits
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Detroit, Michigan
February 4, 1999
-62-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-63-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information appearing under the captions "Information About Directors" in
Registrant's definitive Proxy Statement (filed pursuant to Regulation 14A)
with respect to Registrant's April 20, 1999 Annual Meeting of Shareholders is
incorporated by reference herein.
The executive officers of the Company are William L. Johnson, Sebastian
Coppola, Rudolfo D. Cifolelli, Carl W. Porter and Barrett Hatches.
Mr. Johnson (age 56) was elected Chairman of the Board of Directors in
December 1997. He has been President and Chief Executive Officer of the
Company since May 1996. From 1994 to May 1996 he was Chief Executive Officer
of Northern Pipeline Construction Company of Kansas City, Missouri, and from
1990 to 1994 he was President, Gas Service Division of Western Resources,
Inc. of Topeka, Kansas.
Mr. Coppola (age 47) has been Senior Vice President and Chief Financial
Officer of the Company since January 1999. He was Senior Vice President of
Finance, Treasurer and Investor Relations Officer of MCN Energy Group, Inc.,
Detroit, Michigan, from September 1994 to December 1998. While at MCN Energy
Group, Inc., he was Director of Accounting Services and Investor Relations
from October 1988 to August 1994.
Mr. Porter (age 49) has been Senior Vice President and Chief Operating
Officer of the Company since July 1996. He was Vice President-Gas Utilities
of Itron, Inc., Spokane, Washington, from August 1995 to July 1996. From
1992 to 1995 he was Senior Vice President of Operations of New Jersey Natural
Gas, Wall, New Jersey, and from 1990 to 1992 he was Vice President of
Operations of Western Resources, Inc., Topeka, Kansas.
Mr. Cifolelli (age 58) has been Senior Vice President and Chief
Information Officer of the Company since November 1998. He was President and
Owner of OACIS, Inc., Bloomfield, Michigan from June 1996 to October 1998.
While employed by the GENIX Group, a subsidiary of MCN Energy Group, Inc.,
Detroit, Michigan, he was President and Chief Executive Officer from 1994 to
1996 and President and Chief Operating Officer from 1990 to 1994.
Mr. Hatches (age 43) was elected Senior Vice President of Human
Resources and Public Affairs of the Company in February 1999. He has been
with the Company as Vice President of Human Resources and Public Affairs
since February 1997. He was Vice President of V. Robinson & Company, Inc.,
Kansas City, Missouri, from 1996 to February 1997. He was Director of
Logistics and Chief Operating Officer H & N Railroad of North American Salt
Company, Overland Park, Kansas, from 1995 to 1996. While employed by
Missouri Gas Energy, Kansas City, Missouri, he was Director Field Services
from May 1994 to January 1995 and Director Customer Information from July
1992 to May 1994.
-64-
ITEM 11. EXECUTIVE COMPENSATION
The information appearing under the captions "Compensation of Directors and
Executive Officers" and "Compensation Committee Interlocks and Insider
Participation" in Registrant's definitive Proxy Statement (filed pursuant to
Regulation 14A) with respect to Registrant's April 20, 1999 Annual Meeting of
Shareholders is incorporated by reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information appearing under the caption "Stock Outstanding, Voting Rights
and Votes Required" in the Registrant's definitive Proxy Statement (filed
pursuant to Regulation 14A) with respect to Registrant's April 20, 1999
Annual Meeting of Shareholders, is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing under the captions "Certain Business Relationships
of Directors" and "Employment and Related Agreements" in the Registrant's
definitive Proxy Statement (filed pursuant to Regulation 14A) with respect to
Registrant's April 20, 1999 Annual Meeting of Shareholders, is incorporated
by reference herein.
-65-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements. The following financial
statements are included in Part II, item 8 above.
Pages in 10-K
-------------
Consolidated Statements of Income for the years
ended December 31, 1998, 1997 and 1996 32
Consolidated Statements of Cash Flows for the
years ended December 31, 1998, 1997 and 1996 33
Consolidated Statements of Financial Position
as of December 31, 1998 and 1997 34
Consolidated Statements of Capitalization as
of December 31, 1998 and 1997 35
Consolidated Statements of Changes in
Shareholders' Investment for the years
ended December 31, 1998, 1997 and 1996 36
Notes to the Consolidated Financial Statements 37-61
Report of Independent Public Accountants 62
(a) 2. Financial Statement Schedules.
The following additional data should be read in conjunction with
the Consolidated Financial Statements in Part II, item 8 above.
Schedules not included herein have been omitted because they are
not applicable or the required information is shown in such
financial statements or notes thereto.
Schedule
Number Pages in 10-K
-------- -------------
I Consolidated Valuation and Qualifying
Accounts for the years ended
December 31, 1998, 1997 and 1996 71
-66-
(a) 3. Exhibits, including those incorporated by reference
Filed
--------------------
Exhibit By
No. Description Herewith Reference
------- ----------- -------- ---------
2 Plan of Acquisition, etc. NA NA
3.(i).1 Articles of Incorporation of SEMCO Energy,
Inc., as restated July 11, 1989.(a) x
3.(i).2 Certificate of Amendment to Article III
of the Articles of Incorporation dated
May 16, 1990.(b) x
3.(i).3 Certificate of Amendment to Articles I,
III and VI of the Articles of Incorporation
dated April 16, 1997.(j) x
3.(ii) Bylaws--last revised December 17, 1998. x
4.1 Trust Indenture dated April 1, 1992, with
NBD Bank, N.A. as Trustee.(c) x
4.2 Note Agreement dated as of June 1, 1994,
relating to issuance of $80,000,000 of
long-term debt.(e) x
4.3 Rights Agreement dated as of April 15, 1997
with Continental Stock Transfer & Trust
Company, as Rights Agent.(h) x
4.4 Note Agreement dated as of October 1, 1997,
relating to issuance of $60,000,000 of
long-term debt.(l) x
9 Voting Trust Agreement. NA NA
10 Material Contracts.
10.1 Short-Term Incentive Plan.(d) x
10.2 Deferred Compensation and Phantom Stock
Purchase Agreement (for outside
directors only).(f) x
10.3 Supplemental Retirement Plan for Certain
Officers.(g) x
10.4 1997 Long-Term Incentive Plan.(h) x
10.5 Stock Option Certificate and Agreement
dated October 10, 1996 with
William L. Johnson.(i) x
10.6 Stock Option Certificate and Agreement
dated February 26, 1997 with
William L. Johnson.(i) x
10.7 Employment Agreement dated October 10, 1996,
with William L. Johnson.(j) x
10.8 Change of Control Employment Agreement dated
October 10, 1996, with William L. Johnson.(j) x
10.9 Form of Change in Control Agreement
effective March 20, 1998, for all officers
except Mr. Johnson.(n) x
-67-
Filed
--------------------
Exhibit By
No. Description Herewith Reference
------- ----------- -------- ---------
10.10 Asset Purchase Agreement dated August 9, 1997
between Sub-Surface Construction Co., Stewart
Kniff and SEMCO Energy Construction Co.,
First Amendment to Asset Purchase Agreement,
Amendment to Leased Equipment Purchase
Agreements and Asset Purchase Agreement,
List of Schedules and Exhibits and Agreement
to Furnish Schedules and Exhibits.(k) x
10.11 Purchase Agreement between the Company and
Merrill Lynch & Co., etc., pertaining to an
offering of 1,600,000 Shares of Common Stock.(o) x
10.12 Distribution Agreement between the Company
and Merrill Lynch & Co., etc., pertaining to
an offering of $150,000,000 Medium-Term
Notes and Form of Medium Term Note.(p) x
10.13 Agreement and Plan of Merger dated as of
October 30, 1998, between the Company,
SEMCO Consultants, Inc. and Jimmy C. Foster
and the Press Release announcing the merger.(q) x
10.14 Executive Security Agreement. x
10.15 Split-Dollar Agreement. x
10.16 Deferred Compensation and Stock Purchase
Agreement for Outside Directors for 1999. x
11 Statement re computation of per share earnings. NA NA
12 Ratio of Earnings to Fixed Charges. x
13 Annual report to shareholders. NA NA
16 Letter re change in certifying accountant. NA NA
18 Letter re change in accounting principle.(m) x
21 Subsidiaries of the Registrant. x
22 Published report regarding matters submitted
to a vote of security holders. NA NA
23 Consent of Independent Public Accountants. x
24 Power of Attorney. x
27 Financial Data Schedule. x
99.1 Proxy Statement dated March 15, 1999.(r) x
99.2 Announcement of agreement to sell
SEMCO Energy Services, Inc.(s) x
Key to Exhibits Incorporated by Reference
(a) Filed with SEMCO Energy, Inc.'s Form 10-K for 1989, dated March 29,
1990, File No. 0-8503.
(b) Filed with SEMCO Energy, Inc.'s Form 10-K for 1990, dated March 28,
1991, File No. 0-8503.
(c) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1992, File No. 0-8503.
(d) Filed with SEMCO Energy, Inc.'s Form 10-K for 1992, dated March 30,
1993, File No. 0-8503.
(e) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
June 30, 1994, File No. 0-8503.
-68-
Key to Exhibits Incorporated by Reference (Continued)
(f) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1994, File No. 0-8503.
(g) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1996, File No. 0-8503.
(h) Filed March 6, 1997 as part of SEMCO Energy, Inc.'s 1997 Proxy
Statement, dated March 7, 1997, File No. 0-8503.
(i) Filed with SEMCO Energy, Inc.'s Form 10-K for 1996, dated March 27,
1997, File No. 0-8503.
(j) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1997, File No. 0-8503.
(k) Filed with SEMCO Energy, Inc.'s Form 8-K dated August 13, 1997,
File No. 0-8503.
(l) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1997, File No. 0-8503.
(m) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1998, File No. 0-8503.
(n) Filed with SEMCO Energy, Inc.'s Form 10-Q/A for the quarter ended
March 31, 1998, File No. 0-8503.
(o) Filed with SEMCO Energy, Inc.'s Form 8-K dated August 13, 1998,
File No. 0-8503.
(p) Filed with SEMCO Energy, Inc.'s Form 8-K dated October 21, 1998,
File No. 0-8503.
(q) Filed with SEMCO Energy, Inc.'s Form 8-K dated November 5, 1998,
File No. 0-8503.
(r) Filed March 11, 1999, pursuant to Rule 14a-6 of the Exchange Act,
File No. 0-8503.
(s) Filed with SEMCO Energy, Inc.'s Form 8-K dated March 23, 1999, File
No. 0-8503.
ITEM 14. (Continued)
(b) On October 23, 1998, the Company filed Form 8-K to file the Distribution
Agreement between the Company and the underwriters pertaining to an
offering of $150,000,000 Medium-Term Notes.
The Company filed Form 8-K on November 5, 1998, to file the Agreement
and Plan of Merger dated as of October 30, 1998, between the Company,
SEMCO Consultants, Inc. and Jimmy C. Foster.
(c) The Exhibits, if any, filed herewith are identified on the Exhibit
Index.
(d) The financial statement schedules filed are listed under Item 14.(a).2.
above.
-69-
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SEMCO ENERGY, INC.
Date: March 26, 1999 By /s/William L. Johnson
----------------------------------------
William L. Johnson
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/William L. Johnson Chairman, President and Chief March 26, 1999
------------------------
William L. Johnson Executive Officer (Director)
/s/Sebastian Coppola Senior Vice President and March 26, 1999
------------------------
Sebastian Coppola Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/Daniel A. Burkhardt* Director March 26, 1999
------------------------
Daniel A. Burkhardt
/s/Edward J. Curtis* Director March 26, 1999
------------------------
Edward J. Curtis
/s/John T. Ferris* Director March 26, 1999
------------------------
John T. Ferris
/s/Michael O. Frazer* Director March 26, 1999
------------------------
Michael O. Frazer
/s/Harvey I. Klein* Director March 26, 1999
------------------------
Harvey I. Klein
/s/Stewart J. Kniff* Director March 26, 1999
------------------------
Stewart J. Kniff
/s/Bruce G. Macleod* Director March 26, 1999
------------------------
Bruce G. Macleod
/s/Frederick S. Moore* Director March 26, 1999
------------------------
Frederick S. Moore
/s/Edith A. Stotler* Director March 26, 1999
------------------------
Edith A. Stotler
/s/Donald W. Thomason* Director March 26, 1999
------------------------
Donald W. Thomason
*By /s/William L. Johnson March 26, 1999
---------------------
William L. Johnson
Attorney-in-fact
-70-
SCHEDULE I
[Enlarge/Download Table]
SEMCO Energy, Inc.
SCHEDULE I - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(Thousands of Dollars)
Additions Deductions
--------- From Reserve
Balance Provision for Purpose of Balance
Beginning Charged Which the Reserve End
Description of Period to Income Was Provided of Period
------------------------------------------------------- --------- --------- ----------------- ---------
FOR THE YEAR ENDED DECEMBER 31, 1998
------------------------------------
RESERVE DEDUCTED FROM RECEIVABLES IN BALANCE SHEET -
UNCOLLECTIBLE ACCOUNTS $ 1,498 $ 742 $ 1,608 $ 632
======= ======= ======= =======
RESERVE DEDUCTED FROM OTHER PROPERTY IN BALANCE SHEET $ 2,401 $ 100 $ 1,100 $ 1,401
======= ======= ======= =======
RESERVE FOR EQUITY INVESTMENT $25,212 $ 0 $25,212 $ 0
======= ======= ======= =======
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------
RESERVE DEDUCTED FROM RECEIVABLES IN BALANCE SHEET -
UNCOLLECTIBLE ACCOUNTS $ 1,247 $ 2,199 $ 1,948 $ 1,498
======= ======= ======= =======
RESERVE DEDUCTED FROM OTHER PROPERTY IN BALANCE SHEET $ 2,401 $ 0 $ 0 $ 2,401
======= ======= ======= =======
RESERVE FOR EQUITY INVESTMENT $32,942 $ 0 $ 7,730 $25,212
======= ======= ======= =======
FOR THE YEAR ENDED DECEMBER 31, 1996
------------------------------------
RESERVE DEDUCTED FROM RECEIVABLES IN BALANCE SHEET -
UNCOLLECTIBLE ACCOUNTS $ 729 $ 1,209 $ 691 $ 1,247
======= ======= ======= =======
RESERVE DEDUCTED FROM OTHER PROPERTY IN BALANCE SHEET $ 2,401 $ 0 $ 0 $ 2,401
======= ======= ======= =======
RESERVE FOR EQUITY INVESTMENT $ 0 $32,942 $ 0 $32,942
======= ======= ======= =======
-71-
SEMCO ENERGY, INC.
Exhibit Index
Form 10-K
1998
Filed
--------------------
Exhibit By
No. Description Herewith Reference
------- ----------- -------- ---------
2 Plan of Acquisition, etc. NA NA
3.(i).1 Articles of Incorporation of SEMCO Energy,
Inc., as restated July 11, 1989.(a) x
3.(i).2 Certificate of Amendment to Article III
of the Articles of Incorporation dated
May 16, 1990.(b) x
3.(i).3 Certificate of Amendment to Articles I,
III and VI of the Articles of Incorporation
dated April 16, 1997.(j) x
3.(ii) Bylaws--last revised December 17, 1998. x
4.1 Trust Indenture dated April 1, 1992, with
NBD Bank, N.A. as Trustee.(c) x
4.2 Note Agreement dated as of June 1, 1994,
relating to issuance of $80,000,000 of
long-term debt.(e) x
4.3 Rights Agreement dated as of April 15, 1997
with Continental Stock Transfer & Trust
Company, as Rights Agent.(h) x
4.4 Note Agreement dated as of October 1, 1997,
relating to issuance of $60,000,000 of
long-term debt.(l) x
9 Voting Trust Agreement. NA NA
10 Material Contracts.
10.1 Short-Term Incentive Plan.(d) x
10.2 Deferred Compensation and Phantom Stock
Purchase Agreement (for outside
directors only).(f) x
10.3 Supplemental Retirement Plan for Certain
Officers.(g) x
10.4 1997 Long-Term Incentive Plan.(h) x
10.5 Stock Option Certificate and Agreement
dated October 10, 1996 with
William L. Johnson.(i) x
10.6 Stock Option Certificate and Agreement
dated February 26, 1997 with
William L. Johnson.(i) x
10.7 Employment Agreement dated October 10, 1996,
with William L. Johnson.(j) x
10.8 Change of Control Employment Agreement dated
October 10, 1996, with William L. Johnson.(j) x
10.9 Form of Change in Control Agreement
effective March 20, 1998, for all officers
except Mr. Johnson.(n) x
Filed
--------------------
Exhibit By
No. Description Herewith Reference
------- ----------- -------- ---------
10.10 Asset Purchase Agreement dated August 9, 1997
between Sub-Surface Construction Co., Stewart
Kniff and SEMCO Energy Construction Co.,
First Amendment to Asset Purchase Agreement,
Amendment to Leased Equipment Purchase
Agreements and Asset Purchase Agreement,
List of Schedules and Exhibits and Agreement
to Furnish Schedules and Exhibits.(k) x
10.11 Purchase Agreement between the Company and
Merrill Lynch & Co., etc., pertaining to an
offering of 1,600,000 Shares of Common Stock.(o) x
10.12 Distribution Agreement between the Company
and Merrill Lynch & Co., etc., pertaining to
an offering of $150,000,000 Medium-Term
Notes and Form of Medium Term Note.(p) x
10.13 Agreement and Plan of Merger dated as of
October 30, 1998, between the Company,
SEMCO Consultants, Inc. and Jimmy C. Foster
and the Press Release announcing the merger.(q) x
10.14 Executive Security Agreement. x
10.15 Split-Dollar Agreement. x
10.16 Deferred Compensation and Stock Purchase
Agreement for Outside Directors for 1999. x
11 Statement re computation of per share earnings. NA NA
12 Ratio of Earnings to Fixed Charges. x
13 Annual report to shareholders. NA NA
16 Letter re change in certifying accountant. NA NA
18 Letter re change in accounting principle.(m) x
21 Subsidiaries of the Registrant. x
22 Published report regarding matters submitted
to a vote of security holders. NA NA
23 Consent of Independent Public Accountants. x
24 Power of Attorney. x
27 Financial Data Schedule. x
99.1 Proxy Statement dated March 15, 1999.(r) x
99.2 Announcement of agreement to sell
SEMCO Energy Services, Inc.(s) x
Key to Exhibits Incorporated by Reference
(a) Filed with SEMCO Energy, Inc.'s Form 10-K for 1989, dated March 29,
1990, File No. 0-8503.
(b) Filed with SEMCO Energy, Inc.'s Form 10-K for 1990, dated March 28,
1991, File No. 0-8503.
(c) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1992, File No. 0-8503.
(d) Filed with SEMCO Energy, Inc.'s Form 10-K for 1992, dated March 30,
1993, File No. 0-8503.
(e) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
June 30, 1994, File No. 0-8503.
Key to Exhibits Incorporated by Reference (Continued)
(f) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1994, File No. 0-8503.
(g) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1996, File No. 0-8503.
(h) Filed March 6, 1997 as part of SEMCO Energy, Inc.'s 1997 Proxy
Statement, dated March 7, 1997, File No. 0-8503.
(i) Filed with SEMCO Energy, Inc.'s Form 10-K for 1996, dated March 27,
1997, File No. 0-8503.
(j) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1997, File No. 0-8503.
(k) Filed with SEMCO Energy, Inc.'s Form 8-K dated August 13, 1997,
File No. 0-8503.
(l) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1997, File No. 0-8503.
(m) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1998, File No. 0-8503.
(n) Filed with SEMCO Energy, Inc.'s Form 10-Q/A for the quarter ended
March 31, 1998, File No. 0-8503.
(o) Filed with SEMCO Energy, Inc.'s Form 8-K dated August 13, 1998,
File No. 0-8503.
(p) Filed with SEMCO Energy, Inc.'s Form 8-K dated October 21, 1998,
File No. 0-8503.
(q) Filed with SEMCO Energy, Inc.'s Form 8-K dated November 5, 1998,
File No. 0-8503.
(r) Filed March 11, 1999, pursuant to Rule 14a-6 of the Exchange Act,
File No. 0-8503.
(s) Filed with SEMCO Energy, Inc.'s Form 8-K dated March 23, 1999, File
No. 0-8503.
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘10-K405’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 4/15/17 | | 25 | | 50 |
| | 6/15/99 | | 33 |
| | 4/20/99 | | 1 | | 68 | | | DEF 14A, PRE 14A |
| | 4/1/99 | | 7 |
| | 3/31/99 | | 10 | | | | | 10-Q, 4, 4/A |
| Filed on: | | 3/26/99 | | 73 |
| | 3/23/99 | | 72 | | 77 | | | 8-K |
| | 3/15/99 | | 10 | | 76 |
| | 3/11/99 | | 72 | | 77 | | | DEF 14A |
| | 2/26/99 | | 1 |
| | 2/4/99 | | 65 |
| For Period End: | | 12/31/98 | | 1 | | 74 | | | 4, 5, U-3A-2 |
| | 12/17/98 | | 70 | | 75 |
| | 12/15/98 | | 33 |
| | 11/5/98 | | 72 | | 77 | | | 8-K |
| | 11/3/98 | | 46 |
| | 10/30/98 | | 71 | | 76 |
| | 10/23/98 | | 72 | | | | | 424B5, 8-K |
| | 10/21/98 | | 72 | | 77 | | | 8-K |
| | 8/13/98 | | 72 | | 77 | | | 10-Q, 424B5, 8-K |
| | 5/15/98 | | 46 | | | | | 10-Q |
| | 4/1/98 | | 6 | | 55 |
| | 3/31/98 | | 22 | | 77 | | | 10-K405, 10-Q, 10-Q/A, 4 |
| | 3/20/98 | | 70 | | 75 |
| | 2/27/98 | | 55 |
| | 1/14/98 | | 24 | | 63 |
| | 1/1/98 | | 56 | | 65 |
| | 12/31/97 | | 22 | | 74 | | | 10-K405, 4, 5, U-3A-2 |
| | 12/17/97 | | 47 |
| | 10/1/97 | | 70 | | 75 |
| | 9/30/97 | | 72 | | 77 | | | 10-Q, 4 |
| | 8/13/97 | | 72 | | 77 | | | 10-Q, 8-K |
| | 8/9/97 | | 71 | | 76 |
| | 8/1/97 | | 22 |
| | 4/16/97 | | 70 | | 75 |
| | 4/15/97 | | 70 | | 75 | | | DEF 14A |
| | 3/31/97 | | 72 | | 77 | | | 10-K405, 10-Q, 4 |
| | 3/27/97 | | 72 | | 77 |
| | 3/7/97 | | 72 | | 77 |
| | 3/6/97 | | 72 | | 77 | | | DEF 14A |
| | 2/26/97 | | 70 | | 75 |
| | 12/31/96 | | 43 | | 74 | | | 10-K405, 10-K405/A, U-3A-2 |
| | 10/10/96 | | 70 | | 75 |
| | 3/31/96 | | 72 | | 77 | | | 10-Q, 10-Q/A |
| | 12/31/95 | | 58 | | | | | 10-K405, U-3A-2 |
| | 9/30/94 | | 72 | | 77 | | | 10-Q |
| | 6/30/94 | | 71 | | 76 | | | 10-Q |
| | 6/1/94 | | 70 | | 75 |
| | 3/30/93 | | 71 | | 76 |
| | 4/1/92 | | 70 | | 75 |
| | 3/31/92 | | 71 | | 76 |
| List all Filings |
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