Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
INFORMATION ABOUT FORWARD-LOOKING STATEMENTS
This document 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 of SEMCO Energy, Inc. and its
subsidiaries (the "Company"). Statements that are not historical facts,
including statements about the Company's outlook, beliefs, plans, goals, 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 industry as well as from
alternative forms of energy; (v) the timing and extent of changes in commodity
prices for natural gas and propane; (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 construction
contracts; (viii) the impact of energy prices on the amount of projects and
business available to the Company's construction services business; (ix) the
nature, availability and projected profitability of potential investments
available to the Company; (x) the Company's ability to remain in compliance with
its debt covenants and accomplish its financing objectives in a timely and
cost-effective manner in light of changing conditions in the capital markets;
(xi) the Company's ability to operate and integrate acquired businesses in
accordance with its plans and (xii) the Company's ability to effectively execute
its strategic plan.
RESULTS OF OPERATIONS
The Company had net income of $8.9 million for 2002, a net loss of $6.4 million
for 2001 and net income of $16.7 million for 2000. The results for 2001 include
several unusual items, including losses associated with the Company's
discontinued engineering operations, restructuring charges and asset
impairments. These items are discussed in more detail below. The 2002 and 2000
results also include amounts associated with discontinued operations. Income
(loss) from continuing operations was $8.9 million, $(.2) million and $16.6
million for 2002, 2001, and 2000, respectively. Earnings (loss) per share from
continuing operations was $0.48, $(0.01) and $0.89 for 2002, 2001 and 2000,
respectively. All references to earnings or loss per share ("EPS") in
Management's Discussion and Analysis are on a diluted basis. For information
related to the calculation of diluted EPS, refer to Note 10 of the Notes to the
Consolidated Financial Statements.
As discussed above, operating results for 2001 include unusual items,
including losses associated with discontinued operations, restructuring charges
and asset impairments. During the fourth quarter of 2001, the Company began
plans to redirect its business strategy. The plans included the restructuring of
corporate, business unit and operational structures, including the integration
of the Company's Alaska and Michigan gas distribution divisions. The plans also
included the closure of the Company's Houston-based engineering and construction
headquarters and the related consolidation of administrative functions in
Michigan. The divestiture of the Company's engineering services business was
also part of the restructuring plan and has been accounted for as a discontinued
operation. Operating results, net of income taxes, from the discontinued
operations were $(1.1) million and $0.1 million for 2001 and 2000, respectively.
In the fourth quarter of 2001, the Company recorded a loss of $5.0 million, net
of income taxes, for the estimated loss the Company expected to incur on the
disposal of its engineering business segment, including estimated losses from
operations during the phase-out period. In November 2002, the Company sold its
engineering services business. There was a difference of $10 thousand between
the actual losses and the estimated losses, which is included in discontinued
operations for 2002.
In addition to the losses from discontinued operations, the Company's
results for 2001 include restructuring charges, asset impairments and certain
other unusual items that reduced net income by $5.1 million, or $0.28 per share.
The restructuring charges and asset impairments account for $4.0 million of the
charges, net of income taxes, and include severance expense, costs associated
with terminating leases, write-downs of certain construction operations and
other related expenses associated with the redirection of the Company's business
strategy. The other unusual items account for $1.1 million of the charges, net
of income taxes, and include the write-off of certain assets and an increase in
reserves for certain contingencies.
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16 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The 2001 restructuring charges and asset impairments ($6.1 million before
income taxes) are reflected in operating expenses in the Company's 2001
Consolidated Statement of Operations. The other unusual items are reflected in
both operating expenses ($.9 million before income taxes) and non-operating
expenses ($.6 million before income taxes). For 2001 business segment
reporting, the operating income of the gas distribution business includes $1.1
million of the charges; the operating loss of the construction services business
includes $3.3 million of the charges; and $2.6 million is reflected in the
operating loss of the corporate and other business segment.
The business segment analyses and other discussions on the next several
pages provide additional information regarding the differences in operating
results when comparing 2002, 2001 and 2000. The following table shows the
Company's consolidated operating results for the past three years.
Years Ended December 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(in thousands, except per share amounts)
Operating revenues . . . . . . . . . . . . . . . . . . . . . . $480,965 $445,823 $410,325
Restructuring and impairment charges . . . . . . . . . . . . - 6,103 -
Other operating expenses . . . . . . . . . . . . . . . . . . 424,256 395,329 345,092
--------- --------- ---------
Operating income . . . . . . . . . . . . . . . . . . . . . . . $ 56,709 $ 44,391 $ 65,233
Other income and (deductions). . . . . . . . . . . . . . . . (29,030) (29,449) (32,077)
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . (10,139) (6,578) (11,554)
--------- --------- ---------
Income before dividends on trust preferred securities and
discontinued operations. . . . . . . . . . . . . . . . . . . $ 17,540 $ 8,364 $ 21,602
Dividends on trust preferred securities, net of income tax . . (8,601) (8,603) (5,004)
--------- --------- ---------
Income (loss) from continuing operations . . . . . . . . . . . 8,939 (239) 16,598
Income (loss) from discontinued operations, net of income tax. 10 (6,122) 95
--------- --------- ---------
Net income (loss) available to common shareholders . . . . . . $ 8,949 $ (6,361) $ 16,693
--------- --------- ---------
Earnings per share - basic
Income (loss) from continuing operations . . . . . . . . . . $ 0.48 $ (0.01) $ 0.92
Net income (loss) available to common shareholders . . . . . $ 0.48 $ (0.35) $ 0.93
Earnings per share - diluted
Income (loss) from continuing operations . . . . . . . . . . $ 0.48 $ (0.01) $ 0.89
Net income (loss) available to common shareholders . . . . . $ 0.48 $ (0.35) $ 0.90
Cash dividends paid per share. . . . . . . . . . . . . . . . . $ 0.59 $ 0.84 $ 0.84
Average common shares outstanding - basic. . . . . . . . . . . 18,472 18,106 17,999
Average common shares outstanding - diluted. . . . . . . . . . 18,493 18,106 18,619
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17 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE IMPACT OF WEATHER
The Company's largest business segment is natural gas distribution and, as a
result, temperature fluctuations have a significant impact on operating results.
The Company believes that information about the estimated impact on operating
results of warmer or colder than normal temperatures is useful for fully
understanding the Company's gas distribution business. The Company's budgets,
forcasts and business plans are prepared by management using expected gas
consumption under normal weather conditions as a central assumption. The
regulatory bodies which have jurisdiction over the rates charged by the
Company's gas distribution business, use weather-normalized data to set customer
rates and to establish authorized rates of return. In addition, variations from
normal weather conditions can have a significant impact on the earnings of the
Company. Therefore, information about the estimated impact of warmer or colder
than normal weather is helpful in understanding the expected earnings of the
Company.
The Company estimates the impact of weather on its operating results by
comparing actual gas consumption per customer during a period to the average of
weather-normalized customer gas consumption during previous periods. The
difference is multiplied by the average number of customers during the period to
arrive at the total estimated increase or decrease in consumption associated
with weather. The total increase or decrease in consumption is multiplied by
the actual margin per unit of consumption during the period to arrive at the
estimated impact of weather on operating results for the period. The
weather-normalized customer consumption used in this calculation is determined
by multiplying actual customer gas consumption during a particular period by a
ratio, the numerator of which is an average of degree days during the same
periods in the prior fifteen years, and the denominator of which is the actual
degree days for that period.
The Company determines the percent (%) that weather is warmer or colder
than normal for a particular period by computing the deviation of actual degree
days for that period from the average of degree days during the same periods in
the prior fifteen years and dividing the deviation by such fifteen year average.
Degree days are a measure of coldness determined daily as the number of degrees
the average temperature during the day in question is below 65 degrees
fahrenheit. Degree days for a particular period are determined by adding the
degree days incurred during each day of that period.
The Company has estimated that warmer than normal weather reduced the gas
sales margin of its gas distribution business by approximately $5.9 million,
$8.4 million and $6.5 million in 2002, 2001 and 2000, respectively. Adjusted for
income taxes, the estimated impact would have been approximately $3.6 million,
$5.3 million and $3.9 million, respectively.
SUMMARY OF BUSINESS SEGMENTS
The Company operates four reportable business segments: (1) gas distribution;
(2) construction services; (3) information technology services; and (4) propane,
pipelines and storage. The latter three segments are sometimes referred to
together as the "diversified businesses." Refer to Note 11 of the Notes to the
Consolidated Financial Statements for further information regarding each
business segment and a summary of financial information by business segment.
Each business segment is discussed separately on the following pages. The
Company evaluates the performance of its business segments based on operating
income. Operating income does not include income taxes, interest expense,
discontinued operations, or other non-operating income and expense items. A
review of the non-operating items follows the business segment discussions.
GAS DISTRIBUTION
The Company's gas distribution business segment consists of operations in
Michigan and Alaska. The Michigan operation is sometimes referred to as "SEMCO
Gas" and the Alaska operation is sometimes referred to as "ENSTAR". These
operations are referred to together as the "Gas Distribution Business". Warm
weather during the past three years has had a significant impact on operating
income. Weather was approximately 3%, 9% and 6% warmer than normal during 2002,
2001 and 2000, respectively.
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18 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Years Ended December 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(in thousands)
Gas sales revenues . . . . . . . . . $ 335,655 $ 295,397 $ 273,312
Cost of gas sold . . . . . . . . . . 220,422 184,973 161,945
--------- --------- ---------
Gas sales margin . . . . . . . . . $ 115,233 $ 110,424 $ 111,367
Gas transportation revenue . . . . . 25,707 25,888 30,783
Other operating revenue. . . . . . . 3,349 3,080 3,756
--------- --------- ---------
Gross margin . . . . . . . . . . . $ 144,289 $ 139,392 $ 145,906
Restructuring charges. . . . . . . . - 1,051 -
Other operating expenses . . . . . . 85,213 88,004 83,030
--------- --------- ---------
Operating income . . . . . . . . . . $ 59,076 $ 50,337 $ 62,876
========= ========= =========
Volumes of gas sold (MMcf) . . . . . 65,057 63,127 61,054
Volumes of gas transported (MMcf). . 44,921 42,992 48,706
Number of customers at year end. . . 383,298 374,938 367,157
Average number of customers
Gas sales customers. . . . . . . . 375,996 364,442 353,168
Transportation and ATS customers . 2,392 5,453 8,253
--------- --------- ---------
378,388 369,895 361,421
Degree Days. . . . . . . . . . . . . 7,394 7,038 7,293
Percent colder (warmer) than normal. (3.3)% (8.6)% (5.9)%
<FN>
The amounts in the above table include intercompany transactions.
GAS SALES MARGIN. During 2002, gas sales margin increased by $4.8 million (or
4%) when compared to 2001. The increase was due primarily to the impact of
colder weather, increased gas cost savings, the addition of new customers and
customers switching from the Company's aggregated transportation service ("ATS")
program back to gas sales service. These items were offset partially by the
impact of a reduction in customer rates at ENSTAR, effective in September 2002.
During 2001, gas sales margin decreased by $.9 million (or 1%) when compared to
2000. The decrease was due primarily to the impact of warmer weather and a
decrease in gas cost savings, offset partially by the addition of new customers
and customers switching from the Company's ATS program back to general gas sales
service.
Under the terms of certain of the Company's third-party natural gas supply
and management agreements for its Michigan operations, certain gas cost savings
are retained by the Company. Gas cost savings were lower in Michigan during
2001, when compared to 2000, primarily as a result of purchasing gas with higher
thermal content during the first half of 2001. During the last half of 2001, the
thermal content of purchased gas returned to 2000 levels. The Company purchases
its gas on a thermal basis, but must sell it to most customers on a volumetric
basis (see Outlook for Gas Distribution section below regarding proposed change
to thermal rates). An increase in thermal content also causes a decrease in gas
sales because gas with a higher thermal content requires less volume to produce
the same amount of heat. When the thermal content increases, the Company has to
pay more for the gas but must still sell it based on volume. Other factors
contributing to the increase in gas costs in 2001 were the release of excess
pipeline capacity in 2000, which reduced the Company's 2000 gas costs, and an
increase in unaccounted-for gas.
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19 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The increase in gas cost savings during 2002, the majority of which
occurred in the first quarter of 2002, was due in part to the effective
management of the Company's gas supply under certain of the third-party supply
and management agreements. In addition, as discussed previously, gas cost
savings were lower during 2001, compared to 2000, as a result of purchasing gas
with a higher thermal content. Partially offsetting the increase in gas costs
savings that occurred during the first quarter of 2002, was a decrease in gas
cost savings after March 31, 2002 as a result of reinstating the gas cost
recovery ("GCR") pricing mechanism, effective April 1, 2002, for customers
subject to the jurisdiction of the Michigan Public Service Commission ("MPSC").
As a result of reinstating the GCR pricing mechanism, the Company no longer
retains the gas cost savings on sales to customers located in jurisdictions
regulated by the MPSC ("MPSC Customers"). A significant portion of the gas cost
savings realized during the first quarter of 2002 is non-recurring because it
relates to MPSC Customers. For further information regarding the Company's
natural gas supply and management agreements, gas cost savings and the GCR
pricing mechanism, refer to the Cost of Gas section of Note 1 of the Notes to
Consolidated Financial Statements.
The ATS program for residential customers was effective from April 1, 1999,
through March 31, 2002. The ATS program was further expanded and opened to
additional customers on October 1, 2002, as the customer choice program. These
programs provide all Michigan residential customers the opportunity to purchase
their gas from a third-party supplier, while allowing the Gas Distribution
Business to continue charging the existing distribution fees and customer fees.
Distribution and customer fees associated with customers who switched to
third-party gas suppliers were recorded in gas transportation revenue rather
than gas sales revenue, because the Company acted as a transporter for those
customers. During 2001 and 2002, certain ATS customers switched back to the
Company's gas sales service because the third-party suppliers they were
utilizing stopped participating in the ATS program, primarily due to significant
fluctuations in the market price of natural gas. In addition, when the ATS
program for residential customers ended on March 31, 2002, all remaining ATS
customers became gas sales customers because they were turned back to the
Company by their third-party gas suppliers. As customers switch back to general
gas sales service, gas sales revenue and gas sales margin increase but there is
a corresponding decrease in gas transportation revenue.
During 2002, the Company's average number of gas sales customers increased
by 11,554. Approximately 3,200 of the increase was caused by customers
switching from the ATS program back to general gas sales service. The remaining
increase of approximately 8,400 represents the average number of new gas sales
customers added to the Company's distribution system in 2002. During 2001, the
Company's average number of gas sales customers increased by 11,274.
Approximately 2,800 of the increase was caused by customers switching from the
ATS program back to general gas sales service. The remaining increase of
approximately 8,500 represents the average number of new gas sales customers
added to the Company's distribution system in 2001.
The reduction in customer rates at ENSTAR was required by an Order issued
by the Regulatory Commission of Alaska ("RCA") dated August 8, 2002. The RCA
Order was based on an RCA rate review. The rate reduction took effect in
September 2002 and generally reduces gas sales margins at ENSTAR by
approximately 3.6%. Refer to Note 2 of the Notes to the Consolidated Financial
Statements for additional information about the Order.
GAS TRANSPORTATION REVENUE. In 2002, gas transportation revenue decreased by
$.2 million when compared to 2001. The primary factors contributing to this
decrease were a decrease in transportation volumes for power companies in Alaska
and the impact of ATS customers switching from the ATS program back to gas sales
service in Michigan. As discussed above, under the ATS program, the Company
charged ATS customers the same distribution fees and customer fees that were
charged to gas sales service customers. These items were partially offset by an
increase in industrial and commercial transportation volume when compared to
2001.
In 2001, gas transportation revenue decreased by $4.9 million when compared
to 2000. The decrease was primarily the result of customers switching from the
ATS program back to the Company's general gas sales service and a decrease in
standard transportation revenue. The decrease in standard transportation revenue
was due to reduced consumption as a result of the softening economy and a few of
the Company's industrial and large commercial customers in Michigan switching
to alternative fuels earlier in 2001, due to high natural gas prices.
OTHER OPERATING REVENUE. During 2002, other operating revenue increased by $.3
million, when compared to 2001. The increase was due primarily to fees on new
transmission pipelines in service in Michigan, offset partially by a reduction
in ATS balancing fees as a result of ATS customers switching back to gas sales
service. During 2001, other operating revenue decreased by $.7 million. The
decrease was due primarily to a reduction in ATS balancing fees as a result of
ATS customers switching back to general gas sales service.
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20 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OPERATING EXPENSES. During 2002, operating expenses of the Gas Distribution
Business decreased by $3.8 million (or 4%) when compared to 2001. A
restructuring charge recorded in December 2001, most of which was made up of
employee severance expense associated with workforce reductions, accounted for
$1.1 million of the decrease for 2002. The remainder of the decrease was due to
a number of offsetting factors. Amortization expense decreased by $3.6 million
when compared to 2001. The decrease was due to the elimination of goodwill
amortization as a result of the adoption of SFAS 142. For further information on
SFAS 142 and its impact on goodwill, see Note 1 of the Notes to the Consolidated
Financial Statements. Operation and maintenance expense decreased by $1.2
million due primarily to general cost cutting measures and the impact of a
reduction in workforce and other cost reductions related to the Company's
redirected business strategy, offset partially by higher employee benefit costs,
including pension expense, health care costs and retiree medical costs and
increased maintenance costs. Property and other taxes increased by $.3 million,
due primarily to property taxes on additional property, plant and equipment
placed in service. Depreciation expense increased by $1.7 million, also due to
additional property, plant and equipment placed in service.
During 2001, operating expenses of the Gas Distribution Business increased
by $6.0 million (or 7%) when compared to 2000. The restructuring charge,
discussed above, accounted for $1.1 million of the increase. The 2001 increase
also included a $.9 million increase in depreciation and amortization expense
due primarily to additional property, plant and equipment placed in service and
a $2.8 million increase in operation and maintenance expenses. The increase in
operation and maintenance expenses was due primarily to increased
employee-related costs such as health care costs, retiree medical costs and
pension expense and increased maintenance costs.
In addition, there was a $1.2 million increase in 2001 general business tax
expense. The increase was due primarily to property tax reductions recorded in
2000 and higher property taxes in 2001, because of additional property in
service. The property tax reductions of $2.1 million in 2000 were based on
pending appeals of prior years' (1997 - 1999) personal property tax assessments
in Michigan ("prior year tax appeals") and new property valuation tables
approved by the State of Michigan in 1999 ("new property tax tables"). The
Company filed the appeals over the past several years, claiming that its
Michigan utility property was over-assessed. The new property tax tables
approved by the State of Michigan are consistent with the Company's claim
regarding its utility property assessments, and thus significantly increase the
likelihood of recovering the overpaid property taxes. See Note 13 of the Notes
to the Consolidated Financial Statements for further information regarding the
prior year tax appeals and recoverability of overpaid property taxes.
OUTLOOK FOR GAS DISTRIBUTION. The Company's strategy for the Gas Distribution
Business is to expand its distribution system in an economical manner through
attachment of on-main and near-main potential customers. The Company will also
seek ways to capitalize on other market opportunities, including new power
generation projects that may become available. The average number of customers
served by SEMCO Gas and ENSTAR, combined, increased by approximately 2.3% during
both 2002 and 2001. By comparison, recent surveys by the American Gas
Association indicate that the customer growth rate for the U.S. gas distribution
industry has averaged approximately 1.8% annually during the last ten years.
However, average annual gas usage per customer has been decreasing slightly
because new homes and appliances are more energy efficient.
The Company has offered early retirement programs during the past few years
to help reduce costs. The increased use of technology has also created operating
efficiencies. In addition, the Gas Distribution Business eliminated its
unprofitable Heating, Ventilation and Air Conditioning ("HVAC") department in
2001 and also eliminated other employee positions as part of the Company's
restructuring plan. The Gas Distribution Business will continue its efforts to
control operating expenses.
SEMCO Gas competes with suppliers of alternative energy sources such as
coal and #6 and #2 fuel oil to meet the energy requirements of its industrial
customers. Natural gas has typically been less expensive than these alternative
energy sources. However, during a short period of time in late 2000 and early
2001, natural gas prices increased significantly, making some of these
alternative energy sources more economical than natural gas. During this
period, a few of the Company's large Michigan industrial customers switched to
alternative energy sources. This competition did not have a material impact on
the financial results of the Company in 2001. Prior to 2000, the market price of
natural gas had been fairly stable. However, the Company cannot predict the
future stability of natural gas prices. To lessen the possibility of fuel
switching by industrial customers, the Company offers flexible contract terms
and additional services, such as gas storage and balancing, in addition to a
more environmentally friendly fuel. ENSTAR supplies natural gas in its service
territory at prices that currently preclude substitution of alternative energy
sources. At present, the residential energy cost of natural gas in Alaska is
less than half the cost of fuel oil, the next most economical energy choice.
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21 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General economic conditions also have an impact on the volume of gas sold
or transported to the Company's commercial and industrial customers. During
economic downturns, these customers may see a decrease in demand for their
product, which in turn may lead to a decrease in the amount of natural gas they
require for production. However, under normal weather conditions, the Gas
Distribution Business generates approximately 68 percent of its gas sales
revenues from residential customers who use natural gas for heating purposes,
which is generally not impacted materially by downturns in the economy.
Temperatures, however, do have an impact on the amount of gas sold for heating
purposes.
Consistent with other gas distribution utilities, there is a potential risk
that industrial and electric generating plants on the Company's gas distribution
system, and also located in close proximity to interstate natural gas pipelines,
will bypass the Company and connect directly to such pipelines. However,
management is currently unaware of any significant bypass efforts by the
Company's customers. The Company has addressed and would continue to address any
such efforts by offering special services and rate arrangements designed to
retain these customers on the Company's system.
On November 21, 2002 the Company filed an application for a general rate
increase of $10.9 million for the MPSC regulated division of SEMCO Gas. Among
the principal reasons for the requested increase were higher pension and
healthcare costs and investment of approximately $120 million in new plant since
the last rate increase was approved in 1997. In addition to specific rate
relief, the application sought an innovative rate design, which would mitigate
some of the effects of warmer than normal weather on the company's earnings.
This new rate design calls for greater recovery of fixed costs in the monthly
customer charge and declining block rates for gas sales customers. This would
provide more stability in customer bills by moving costs from the peak heating
season to summer and off-peak heating months. The filing also requests a change
to customer billing based on the heat content of natural gas, or therms, rather
than the current volumetric measure, cubic feet. Any changes resulting from this
rate case likely would be made in 2003. This rate case does not cover the
division of SEMCO Gas that is subject to the regulatory jurisdiction of the City
Commission of Battle Creek ("CCBC").
The Company received an Order dated August 8, 2002 from the RCA on its
review of rates for ENSTAR, based on normalized data for the year 2000. In its
Order the RCA established a revenue requirement of $107.6 million and a 12.55%
return on equity. In response to a petition by ENSTAR, the RCA issued an
additional Order dated September 16, 2002, which revised the indicated annual
revenue reduction from $2.1 million to $2.0 million, which was 1.84% of ENSTAR's
revenue in the normalized 2000 test year. The Order required ENSTAR to implement
the rate reduction by September 27, 2002 on an across-the-board basis. The RCA
also required ENSTAR to file an updated cost of service study by September 9,
2002 and a rate design in December 2002, with a hearing on the rate design
filing scheduled for May 2003. ENSTAR has implemented the rate reduction and
filed both the cost of service study and the rate design as required. The rate
design filed with the RCA by ENSTAR is similar to the rate design requested in
the MPSC rate case. It includes greater recovery of fixed costs in the monthly
customer charge and declining block rates for gas sales customers.
For further information regarding environmental matters, regulatory matters
and the application of SFAS 71, "Accounting for the Effects of Certain Types of
Regulation," refer to Notes 2 and 13 of the Notes to the Consolidated Financial
Statements and the Critical Accounting Policies section near the end of
Management's Discussion and Analysis.
CONSTRUCTION SERVICES
The Company's construction services segment ("Construction Services") does
business in the midwestern, southern and southeastern areas of the United
States. Construction Services generates the majority of its sales revenue from
the installation and upgrade of natural gas compressor stations and underground
natural gas mains and service lines. Underground construction businesses are
seasonal in nature. As a result, Construction Services generally incurs
operating losses during the winter and spring months when underground
construction is inhibited by weather, and generates the majority of its
operating revenue and operating income during the summer and fall months.
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22 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Years Ended December 31, 2002 2001 2000
- ------------------------ --------- --------- --------
(in thousands)
Operating revenues. . . . . . . . . . $119,254 $126,205 $105,231
Restructuring and impairment charges. - 3,098 -
Other operating expenses. . . . . . . 121,253 124,481 101,555
--------- --------- --------
Operating income (loss) . . . . . . . $ (1,999) $ (1,374) $ 3,676
========= ========= ========
Feet of pipe installed. . . . . . . . 5,198 7,320 7,969
========= ========= ========
<FN>
The amounts in the above table include intercompany transactions.
OPERATING REVENUES. Construction Services revenues decreased to $119.3 million
during 2002, a $7.0 million (or 6%) decrease from 2001. The decease during 2002
was due in part to customers in the northern regions of the country delaying
projects in 2002 in light of the generally depressed economy and their own
financial considerations. Operating revenues in the southern region of the
country were up significantly during the first half of 2002, due to large
projects in that region. However, during the second half of 2002, customers in
the southern region of the country also delayed a number of these projects for
the same reasons discussed above. Construction Services operating revenues were
$126.2 million for 2001, which was a $21.0 million (or 20%) increase over 2000.
The increase during 2001 was due primarily to large construction projects in the
southeastern region of the United States as well as increased construction
revenue in other regions of the country.
OPERATING INCOME. Construction Services had an operating loss of $2.0 million
for 2002, compared to an operating loss of $1.4 million for 2001 and operating
income of $3.7 million in 2000. Excluding restructuring charges, asset
impairments and other unusual charges of $3.3 million, Construction Services had
operating income of $1.9 million in 2001. The restructuring and impairment
charges and other unusual items include the write-down of goodwill and fixed
assets of certain construction operations, severance expense and other related
charges.
The operating loss of $2.0 million for 2002 represents a decline of $3.9
million from the $1.9 million of operating income, excluding unusual charges,
reported for 2001. The decrease is due primarily to reduced construction
activity during all of 2002 in the northern region of the country and during the
last half of 2002 in the southern region of the country. In addition, the
Company experienced lower than expected margins on some of the work performed
and higher than anticipated costs on some projects. The Company believes that
the softening economy has caused many customers to delay or cancel certain
construction projects, which changed the mix of work available to Construction
Services. The mix of work included more lower-margin work at certain business
units because of the competition for the limited supply of available work. The
reduced construction activity has also eroded margins because of the time lag
required to reduce the staffing levels and other fixed costs which were required
for the previously higher level of revenues. Certain fixed costs were not
eliminated for a number of reasons, including the expectation that work would
resume on many of the projects. In addition, the operating performance in
certain regions of Construction Services has been below the Company's
profitability expectations. These factors were offset partially by operating
income generated from the increase in construction projects in the southern
regions of the United States during the first half of 2002.
The $1.8 million decrease in 2001 operating income, excluding unusual
charges, when compared to 2000 operating income, was due primarily to the mix of
available work and the softening economy, as discussed above. In addition, the
softening economy reduced new housing starts during 2001 in the areas where
Construction Services does business, which caused a decrease in the number of
new gas service lines available for installation, when compared to 2000. The
factors causing the decrease in 2001 operating income were offset partially by
profits on the large projects, discussed above, in the southeastern region of
the country during the last half of 2001.
OUTLOOK FOR CONSTRUCTION SERVICES. Despite the decline in operating results
during the past two years, management believes there are opportunities for
growth in its segment of the pipeline and gas distribution construction
industry. Management believes that the current business downturn is short-term,
driven, in part, by the state of the U.S. economy, financial issues faced by the
Company's construction customers, and poor productivity in certain regions of
the construction services business. In late 2002, the Company ceased operations
in a number of under-performing regions, which will eliminate from future
results the operating losses Construction Services incurred in these regions
during 2002. In addition, plans are underway which the Company believes will
improve construction work crew productivity in 2003.
- ----------
23 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company believes that the increasing demand for natural gas will
sustain a continued, long-term increase in the need for natural gas
infrastructure expansion. Management continues to view the industry as large
but highly fragmented and believes that customer preference is shifting from
smaller construction companies to larger contractors. Management also believes
there is a trend in the utility industry towards outsourcing services such as
those provided by Construction Services. The Company's goal is to position
Construction Services to take advantage of these trends.
Construction Services competes with small, medium and large-size regional
underground facilities contractors who provide similar services and utilize
comparable equipment and installation techniques. There is also competition from
in-house construction operations of existing or prospective customers. New
federal regulations in the United States require a minimum level of operator
qualifications for individuals performing certain tasks on pipelines. The
Company believes that the costs and training required for compliance with these
new regulations may force some of Construction Services' smaller competitors to
abandon certain pipeline work.
General economic conditions also have an impact on the amount and type of
work available for Construction Services. During economic downturns, new
housing starts often decline, which leads to a decrease in new gas service line
installations. Customers may also reduce amounts typically spent for
non-essential construction projects, which also leads to a decrease in work
available to Construction Services.
As discussed previously, the Company has redirected its business strategy.
Under this redirected strategy, the Company's goal for Construction Services is
to expand its market share by focusing on profitable growth of its existing
construction businesses, with less emphasis on acquisitions. This change in
focus is intended to redirect resources to help maximize the profitability of
existing businesses. As part of its strategic redirection, the Company has
stopped doing business in certain regions that were not contributing profitably
to the organization. The Company has also consolidated certain regions of its
construction services operations and continues to look for opportunities to
become a more integrated business.
INFORMATION TECHNOLOGY SERVICES
The information technology business ("IT Services"), under the Aretech
Information Services name ("Aretech"), began operations in April of 2000 and
provides IT infrastructure outsourcing services, and other IT services with a
focus on mid-range computers, particularly the IBM I-Series (AS-400) platform.
Years Ended December 31, 2002 2001 2000
- ------------------------ ------ ------- ------
(in thousands)
Operating revenues. . . . $9,618 $10,275 $5,184
Restructuring charges . . - 20 -
Other operating expenses. 9,016 9,824 4,703
------ ------- ------
Operating income. . . . . $ 602 $ 431 $ 481
====== ======= ======
<FN>
This business began operations in April of 2000
The amounts in the above table include intercompany transactions.
OPERATING REVENUES. Operating revenues were $9.6 million, $10.3 million, and
$5.2 million in 2002, 2001 and 2000, respectively. Of these amounts $7.6
million, $9.3 million and $5.0 million for 2002, 2001 and 2000, respectively,
represent sales to affiliates. The decrease in revenues in 2002, when compared
to 2001, was due primarily to fewer special projects with affiliate customers,
offset partially by an increase in business with non-affiliates. The increase
in revenues in 2001, when compared to 2000, was due primarily to providing IT
services for all affiliates of the Company and the addition of non-affiliate
customers. During the first several months of its operation in 2000, the IT
services business was primarily providing services to the Michigan gas
distribution operation and the Company's corporate office. Non-affiliate
operating revenues were $2.0 million, $1.0 million and $.2 million in 2002, 2001
and 2000, respectively.
- ----------
24 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OPERATING INCOME. Operating income for the IT business was $.6 million, $.4
million and $.5 million for 2002, 2001 and 2000, respectively. The increase in
2002 when compared to 2001 is due primarily to an increase in business with
non-affiliate customers and a decrease in indirect operating expenses,
particularly advertising costs. The decrease in 2001, when compared to 2000, is
due primarily to more special project services performed during 2000, which
typically is higher margin work.
OUTLOOK FOR IT SERVICES. The Company believes there is a growing trend by small
to mid-sized companies to outsource certain information technology functions.
The Company believes the trend towards outsourcing large mainframe-computing
services is now moving to include mid-range computers. The Company's goal is to
capitalize on its internal expertise in this area and position this business to
take advantage of these trends. Aretech's business strategy is focused on IT
infrastructure outsourcing services.
Aretech competes with businesses that range from small local firms to large
international companies, as well as the in-house IT departments of potential
customers. Aretech is an early provider in the mid-range computer outsourcing
market and, as the market expands, it is likely that new competition will arise
from other firms that possess the necessary technical skills.
PROPANE, PIPELINES AND STORAGE
The Company's natural gas pipeline and storage operations consist of several
transmission pipelines and an ownership interest in a gas storage facility, all
of which are located in Michigan. The Company also owns a propane distribution
business ("Hotflame"), which sells more than 4 million gallons of propane to
retail customers in Michigan's upper peninsula and northeast Wisconsin.
Years Ended December 31, 2002 2001 2000
- ------------------------ ------ ------ ------
(in thousands)
Operating revenues. . . . $7,058 $7,443 $6,949
Operating expenses. . . . 5,112 5,572 5,419
------ ------ ------
Operating income. . . . . $1,946 $1,871 $1,530
====== ====== ======
<FN>
Amounts in the above table do not include the equity income from a 50%
investment in a gas storage partnership which amounted to $1,374,000, $1,190,000
and $1,186,000 in 2002, 2001 and 2000, respectively. The equity income is
reflected in other income and deductions.
OPERATING REVENUES. Operating revenues were $7.1 million in 2002, compared to
$7.4 million in 2001 and $6.9 million in 2000. The decrease in revenues in 2002,
when compared to 2001, was due primarily to lower propane distribution revenues
resulting from a reduction in the market price for propane. The increase in
revenues in 2001, when compared to 2000, was due primarily to higher propane
distribution revenues resulting from an increase in the market price of propane.
OPERATING INCOME. The operating income of the Company's Propane, Pipelines and
Storage segment for 2002 and 2001 was essentially unchanged at $1.9 million.
Operating income for 2000 was $1.5 million. The increase during 2001, when
compared to 2000 was due primarily to lower operating expenses and higher
propane margins.
Weather in Hotflame's market area was warmer than normal in 2002, 2001 and
2000. The impact of weather on the operating income of the propane, pipelines
and storage segment relates only to the propane business.
OUTLOOK FOR PROPANE, PIPELINES AND STORAGE. Management believes that the gas
pipeline and storage operations could experience opportunities for growth with
the increased deregulation of gas markets and the increasing demand for natural
gas. As gas markets expand or are deregulated, management believes that the
quantity of gas moving through the Great Lakes Region will increase, which could
create additional pipeline and storage opportunities.
The Company's propane business competes with other regional and national
propane providers and with other energy sources such as natural gas, fuel oil
and electricity.
- ----------
25 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OTHER INCOME AND DEDUCTIONS
Years Ended December 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(in thousands)
Interest expense. . . . . . . . . $(31,268) $(31,784) $(34,905)
Other income. . . . . . . . . . . 2,238 2,335 2,828
--------- --------- ---------
Total other income (deductions) $(29,030) $(29,449) $(32,077)
========= ========= =========
INTEREST EXPENSE. Interest expense decreased by $.5 million (or 2%) in 2002
when compared to 2001. The decrease is due primarily to lower short-term
interest rates and a reduction in interest expense as a result of an interest
rate swap agreement which was entered into in August 2001 and terminated in
August 2002. However, these items contributing to the decrease in interest
expense were offset partially by incremental interest on additional debt issued
in 2001. The interest rate swap referred to above was entered into in order to
hedge the Company's $55 million 8% Notes due in June of 2004. During the period
prior to terminating the swap, the floating interest rate under the terms of the
swap agreement steadily declined, which reduced the Company's interest expense.
The Company received $2.2 million in proceeds when the interest rate swap was
terminated in August 2002, which is being recognized pro-rata, as a reduction to
interest expense, over the remaining term of the 8% Notes due in June of 2004.
Interest expense decreased by $3.1 million (or 8.9%) in 2001, when compared
to 2000. The decrease is due primarily to lower debt levels as a result of
refinancing the $290 million short-term bridge loan, which was utilized to
finance the November 1, 1999 acquisition of ENSTAR, with various securities
offerings during the second and third quarters of 2000. The bridge loan was
outstanding during the first half of 2000. During the last half of 2000 and all
of 2001, the Company had an equivalent amount of long-term debt and trust
preferred securities outstanding. As a result, interest expense was less in 2001
primarily because the dividends on the trust preferred securities are reported
separately from interest expense. Lower short-term interest rates during 2001
also contributed to the overall decrease in interest expense. However, these
factors were partially offset by $2.1 million of non-recurring income from
terminated interest rate swaps, reflected in 2000 interest expense, and interest
on additional debt incurred in 2001 to finance the Company's capital expenditure
programs.
OTHER INCOME. In 2002, other income decreased by $.1 million when compared to
2001. A number of offsetting factors contributed to the change. A decrease in
allowance for funds used during construction ("AFUDC") and interest income
reduced other income during 2002. Partially offsetting these factors was the
write-off of certain assets in 2001, which did not recur in 2002, income earned
in 2002 on a special engineering project completed by SEMCO Gas for a
third-party, and an increase in equity income from an investment in a gas
storage facility.
During 2001, other income decreased by $.5 million when compared to 2000.
The decrease was due primarily to the write-off of certain assets in 2001 and
gains on property sales in 2000. These factors were partially offset by an
increase in AFUDC and an increase in interest income. The increase in interest
income was the result of interest received on a supplier refund in 2001.
INCOME TAXES
Income taxes for 2002, 2001 and 2000 were $10.1 million, $6.6 million and $11.6
million, respectively. The change in income taxes, when comparing one year to
another, is due primarily to changes in income before income taxes and dividends
on trust preferred securities, and any adjustments necessary for compliance with
tax laws and regulations. Refer to Note 3 of the Notes to the Consolidated
Financial Statements for information on current and deferred income tax expense,
deferred tax assets and liabilities, and recent net operating losses for tax
purposes.
- ----------
26 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
DIVIDENDS ON TRUST PREFERRED SECURITIES
The Company issued trust preferred securities and FELINE PRIDES during the
second quarter of 2000. These securities are described in Note 4 of the Notes to
the Consolidated Financial Statements. Dividends on these securities, net of
income tax, were $8.6 million during 2002 and 2001 and $5.0 million in 2000. The
$3.6 million increase in dividends in 2001, when compared to 2000, was the
result of a full year of dividends during 2001, in comparison to a half-year of
dividends during 2000.
DISCONTINUED OPERATIONS
In December 2001, the Company's Board of Directors approved a plan to redirect
the Company's business strategy, which, as discussed previously, included the
divestiture of its engineering services business. The planned divestiture has
been accounted for as a discontinued operation and, accordingly, the operating
results and the loss on the disposal of this business have been segregated and
reported as discontinued operations in the Consolidated Statements of
Operations. The Company completed the sale of its engineering services business
effective November 1, 2002. For additional information, including a component
breakdown of operating results reflected in discontinued operations and the
impact of the sale in comparison to the estimated loss, refer to Note 14 of the
Notes to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS USED FOR INVESTING. The Company's single largest use of cash is
capital investments. The following table identifies investments for the past
three years:
Years Ended December 31, 2002 2001 2000
- ------------------------ ------- ------- -------
(in thousands)
Capital investments
Property additions - gas distribution. . . . . . . . . $29,972 $34,074 $47,466
Property additions - diversified businesses and other. 5,005 21,370 19,170
Business acquisitions (a). . . . . . . . . . . . . . . - - 1,784
------- ------- -------
$34,977 $55,444 $68,420
======= ======= =======
<FN>
(a) Includes the net amounts paid for business acquisitions, including
non-cash amounts such as deferred payments and value, at the time of
issuance, of Company stock issued as part of the acquisitions.
Property additions for the Gas Distribution Business represent primarily
gas service lines for new customers and, to a lesser extent, gas main and
service line replacements. In addition, the Company invested approximately $.6
million, $5.9 million and $11.9 million in technology in 2002, 2001 and 2000,
respectively. This technology consists of automated meter reading, measurement
systems and other computer system and infrastructure improvements that have
increased customer service and administrative and operational efficiency. The
Company acquired a business for approximately $1.8 million in 2000. There were
no acquisitions in 2001 and 2002. In 2003, the Company plans to spend
approximately $33 million on property additions.
During 2002, the Company received $4.5 million in proceeds from property
sales, net of costs. This was a significant increase over prior years. The
primary reason for the increase was the sale of two buildings and vacant land.
The two buildings housed a large portion of the operations and administrative
personnel of SEMCO Gas. These two facilities are now being leased by the
Company.
- ----------
27 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CASH FLOWS PROVIDED BY OPERATIONS. The Company's net cash provided by operating
activities totaled $24.9 million in 2002, $36.7 million in 2001 and $49.0
million in 2000. The change in operating cash flows is influenced significantly
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 how the Company manages the
timing of cash 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 in Michigan, with available
capacity approximating 30% to 35% of the Company's average annual Michigan gas
sales. Generally, gas is injected into storage during the months of April
through October and withdrawn for sale from November through March.
CASH FLOWS PROVIDED BY FINANCING. The Company received net cash provided by
financing activities of $5.6 million, $19.3 million and $13.6 million in 2002,
2001 and 2000, respectively.
Years Ended December 31, 2002 2001 2000
- ------------------------ --------- --------- ----------
(in thousands)
Cash provided by (used for) financing activities
Issuance of common stock, net of repurchases. . $ 3,642 $ 2,436 $ 865
Issuance of trust preferred securities. . . . . - - 134,885
Issuance of long-term debt, net of redemptions. (1,135) 58,286 136,569
Net cash change in notes payable. . . . . . . . 13,878 (26,185) (243,708)
Payment of dividends. . . . . . . . . . . . . . (10,776) (15,193) (15,033)
--------- --------- ----------
$ 5,609 $ 19,344 $ 13,578
========= ========= ==========
The Company's net funds borrowed (paid) on notes payable were $13.9
million, ($26.2) million and ($243.7) million in 2002, 2001 and 2000,
respectively. During 2002 the Company issued $30 million of long-term debt and
used the proceeds to repay $30 million of debt which matured in October, 2002.
During 2001, the Company issued $60 million of long-term debt and used the
proceeds to repay a portion of its short-term lines of credit with banks. On
November 1, 1999, the Company financed the acquisition of ENSTAR with a $290
million unsecured bridge loan. In 2000, the Company utilized the proceeds of
several securities offerings and its short-term bank lines of credit to repay
the bridge loan. The net change in notes payable for 2000 includes the combined
cash borrowed or paid on the Company's short-term lines of credit with banks and
the ENSTAR bridge loan.
The Company redeemed certain of its securities and issued various debt and
equity securities during the past three years. Refer to Note 4 of the Notes to
the Consolidated Financial Statements for information regarding these
redemptions and issues.
Cash dividends paid per share for common shareholders were $0.59, $0.84 and
$0.84 in 2002, 2001 and
2000, respectively.
NON-CASH FINANCING ACTIVITIES. The Company issued .1 million shares of its
common stock to the shareholders of a business acquired during 2000.
OFF-BALANCE SHEET ARRANGEMENTS. The Company does not have any off-balance sheet
financing arrangements.
GUARANTEES. The Company does not have any material guarantees that are required
to be disclosed under the provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others."
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS. Summarized below are the
contractual obligations and other commercial commitments of the Company.
- ----------
28 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AS OF DECEMBER 31, 2002
- ---------------------------
(in millions)
Payments Due by Period
------------------------------------------------
2007
Contractual obligations Total 2003 2004 2005 2006 and beyond
- ----------------------- ------ ----- ----- ------ ----- -----------
Long-term debt (a). . . . . . . . . . . . . . . $365.0 $ - $55.0 $ 15.0 $ - $ 295.0
Trust preferred securities of subsidiaries (a). $141.0 - - 101.0 - 40.0
Unconditional gas purchase
and gas transportation obligations. . . . . . $209.8 76.6 42.4 38.2 29.4 23.2
Operating leases. . . . . . . . . . . . . . . . $ 13.1 1.8 1.7 1.3 1.1 7.2
Miscellaneous notes payable . . . . . . . . . . $ 0.6 0.4 0.2 - - -
------ ----- ----- ------ ----- -----------
Total contractual cash obligations. . . . . . . . $729.5 $78.8 $99.3 $155.5 $30.5 $ 365.4
------ ----- ----- ------ ----- -----------
Amount of Commitment Expiration Per Period
------------------------------------------------
2007
Commercial commitments Total 2003 2004 2005 2006 and beyond
- ---------------------- ------ ----- ----- ------ ----- -----------
Bank credit facility $145.0 $65.0 $ - $ 80.0 $ - $ -
------ ----- ----- ------ ----- -----------
<FN>
(a) Certain of these obligations are subject to remarketing and could become
due or could be cancelled before their maturity under specific
circumstances. Refer to Note 4 of the Notes to the Consolidated Financial
Statements for further information.
OTHER COMMITMENTS AND CONTINGENCIES. For information about other commitments
and contingencies, refer to Note 13 of the Notes to the Consolidated Financial
Statements.
FUTURE FINANCING. In general, the Company funds its capital expenditure program
and dividend payments with operating cash flows and the utilization of
short-term credit facilities. When appropriate, the Company will refinance its
short-term debt with long-term debt, common stock or other long-term financing
instruments. On June 25, 2002, the Company entered into a $145 million credit
agreement with a group of banks, replacing four lines of credit totaling $145
million, which were due to expire. The new agreement, all of which is
committed, consists of an $80 million three-year revolver and a $65 million
364-day facility, with a one-year term loan option. At December 31, 2002, the
unused portion of the Company's credit facility was $23.8 million.
In March 2000, a registration statement on Form S-3 ("registration
statement") filed by the Company and SEMCO Capital Trust I, SEMCO Capital Trust
II and SEMCO Capital Trust III ("Capital Trusts") with the Securities and
Exchange Commission became effective. The Company and Capital Trusts registered
up to $500 million of securities under the registration statement, of which $276
million, $60 million and $30 million were utilized to issue securities during
2000, 2001 and 2002, respectively. The remaining balance of $134 million under
the registration statement is available for any future issues of common stock,
preferred stock, trust preferred securities and long-term debt, as needed. Refer
to Note 4 of the Notes to the Consolidated Financial Statements for additional
information regarding the securities issued.
Two of the Company's securities, 10.1 million FELINE PRIDES securities and
$105 million of 8.95% Remarketable or Redeemable Securities ("ROARS") are
subject to remarketing and rate resets in 2003. In addition, the Company may
also redeem, or may be required to redeem, the ROARS during 2003. Refer to Note
4 of the Notes to the Consolidated Financial Statements for a description of
these securities and other information, including the terms related to
remarketing, rate resets or possible redemption of the securities in 2003.
The Company's long-term and short-term debt agreements contain restrictive
financial covenants including, among others, maintaining a Fixed Charges
Coverage Ratio (as defined in the agreements) of at least 1.50 and placing
limits on the payment of dividends beyond certain levels. Non-compliance with
these covenants could result in an acceleration of the due dates for the debt
obligations under the agreements. As of December 31, 2002, the Fixed Charges
Coverage Ratio was 1.89 and the Company was in compliance with all of the
covenants in these agreements. The Company has currently projected its financial
covenants for each of the four quarters during 2003, based on the Company's
forecasted operating results for the year, and these forecasted results show
that the Company would be able to remain in compliance with all of its covenants
during 2003. However, these forecasted results are dependent on several
internal assumptions and external factors. If these assumptions or factors
differ from management's current expectations, they could have an adverse impact
on the Company's ability to remain in compliance with its covenants during 2003.
- ----------
29 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The most significant assumptions and factors that could impact the ongoing
compliance with these covenants include the effects of weather on the Company's
operating results; the ability of the Company to improve the operating results
of the construction services business under the Company's current strategic
direction; the ability of the Company to refinance its long-term debt in
accordance with its financing plans; the ability of the Company to accomplish
its financing objectives in a timely and cost-effective manner in light of
changing conditions in the capital markets; and the Company's ability to
successfully pass its annual goodwill impairment tests in light of the these
factors.
In the event the Company is not able to remain in compliance with these
covenants, management plans to negotiate a modification of the covenants or a
waiver of certain covenant provisions. However, the Company cannot make any
assurances about whether modifications or waivers can be negotiated.
The Company's ratio of earnings to fixed charges, as defined under Item 502
of SEC regulations S-K, was 1.32, 1.04 and 1.60 for 2002, 2001 and 2000,
respectively. This ratio is more strictly defined than the Fixed Charges
Coverage Ratio used to determine compliance with the Company's previously
discussed debt covenants.
MARKET RISK INFORMATION
The Company's primary market risk arises from fluctuations in commodity prices
and interest rates. The Company's exposure to commodity price risk arises from
changes in natural gas and propane prices throughout the United States and in
eastern Canada, where the Company conducts sales and purchase transactions. The
Company does not currently use financial derivative instruments (such as swaps,
collars or futures) to manage its exposure to commodity price risk. A
significant portion of the natural gas requirements of the Company's Michigan
gas distribution operations are covered under third-party supply arrangements
and an MPSC-approved mechanism that passes commodity costs through to its
customers. ENSTAR's natural gas requirements are primarily covered by a number
of long-term supply arrangements and an RCA-approved mechanism that passes
commodity costs through to its customers. For further information on how these
agreements reduce the Company's exposure to commodity price risk, see the Cost
of Gas section in Note 1 of the Notes to the Consolidated Financial Statements.
The Company is also subject to interest rate risk in connection with the
issuance of variable and fixed-rate debt. In order to maintain its desired mix
of fixed-rate and variable-rate debt, the Company may use interest rate swap
agreements and exchange fixed and variable-rate interest payment obligations
over the life of the agreements, without exchange of the underlying principal
amounts. See Note 7 of the Notes to the Consolidated Financial Statements for
additional information on the fair value of interest rate swap agreements at
December 31, 2002, and how the Company accounts for its risk management
activities.
IMPACT OF INFLATION
The cost of gas sold in Alaska is recovered from natural gas distribution
customers on a current basis through its gas cost adjustment ("GCA") clause.
The cost of gas sold in the geographic areas of Michigan subject to the
jurisdiction of the MPSC is recovered from natural gas distribution customers on
a current basis through its gas cost recovery ("GCR") clause. The GCA and GCR
mechanisms allow for the adjustment of rates charged to customers in response to
increases and decreases in the cost of gas purchased. The Company applied for
and received approval from the CCBC to extend the fixed gas charge program until
March 31, 2005 for customers located in the City of Battle Creek, Michigan and
surrounding communities. See the Cost of Gas section in Note 1 of the Notes to
the Consolidated Financial Statements for more information.
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.
- ----------
30 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The Company has prepared its Consolidated Financial Statements in conformity
with accounting principles generally accepted in the United States. The
preparation of these financial statements 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. In the
event estimates or assumptions prove to be different from actual results,
adjustments are made in subsequent periods to reflect more current information.
The following is a summary of the Company's most critical accounting policies,
which are defined as those policies whereby judgments or uncertainties could
affect the application of those policies and materially different amounts could
be reported under different conditions or using different assumptions. For a
complete discussion of the Company's significant accounting policies, refer to
Note 1 of the Notes to the Consolidated Financial Statements.
RATE REGULATION. The Gas Distribution Business is subject to regulation. The
regulatory matters associated with gas distribution customers located in the
City of Battle Creek, Michigan, and surrounding communities are subject to the
jurisdiction of the City Commission of Battle Creek. The Michigan Public Service
Commission has jurisdiction over the regulatory matters related to the Company's
remaining Michigan customers. Regulatory matters for gas distribution customers
in Alaska are subject to the jurisdiction of the Regulatory Commission of
Alaska. These regulatory bodies have jurisdiction over, among other things,
rates, accounting procedures, and standards of service.
The Company's gas distribution business segment has accounting policies
which conform to SFAS 71, "Accounting for the Effect of Certain Types of
Regulation" and which are in accordance with the accounting requirements and
ratemaking practices of the regulatory authorities. The application of these
accounting policies allows the Company to defer expenses and income as
regulatory assets and liabilities in the Consolidated Statements of Financial
Position when it is probable that those expenses and income will be allowed in
the ratesetting process in a period different from the period in which they
would have been reflected in the Consolidated Statements of Operations by an
unregulated company. These deferred regulatory assets and liabilities are then
included in the Consolidated Statements of Operations in the periods in which
the same amounts are reflected in rates. Management's assessment of the
probability of recovery or pass through of regulatory assets and liabilities
requires judgment and interpretation of laws and regulatory commission orders.
If, for any reason, the Company ceases to meet the criteria for application of
regulatory accounting treatment for all or part of its operations, the
regulatory assets and liabilities related to those portions ceasing to meet such
criteria would be eliminated from the Consolidated Statements of Financial
Position and included in the Consolidated Statements of Operations for the
period in which the discontinuance of regulatory accounting treatment occurs.
Such amounts would be classified as an extraordinary item.
GOODWILL. The Company evaluates its goodwill for impairment in accordance with
SFAS 142, "Goodwill and Other Intangible Assets." SFAS 142 requires that the
Company perform impairment tests on its goodwill balance annually or at any time
when events occur which could impact the value of the Company's business
segments. The Company's determination of whether an impairment has occurred is
based on an estimate of discounted cash flows attributable to the Company's
reporting units that have goodwill, as compared to the carrying value of those
reporting units' net assets. The Company must make long-term forecasts of
future revenues, expenses and capital expenditures related to the reporting unit
in order to make the estimate of discounted cash flows. These forecasts require
assumptions about future demand, future market conditions, regulatory
developments and other factors. Significant and unanticipated changes to these
assumptions could require a provision for impairment in a future period. If an
impairment test of goodwill shows that the carrying amount of the goodwill is in
excess of the fair value, a corresponding impairment loss would be recorded in
the Consolidated Statements of Operations. The 2002 annual impairment tests were
performed for the Company's business segments and indicated that there was no
impairment of goodwill.
- ----------
31 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
PENSIONS AND OTHER POSTRETIREMENT BENEFITS. The Company accounts for pension
costs and other postretirement benefit costs in accordance with the SFAS 87,
"Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," respectively. These Statements
require liabilities to be recorded in the Consolidated Statements of Financial
Position at the present value of these future obligations to employees net of
any plan assets. The calculation of these liabilities and associated expenses
require the expertise of actuaries and are subject to many assumptions including
life expectancies, present value discount rates, expected long-term rate of
return on plan assets, rate of compensation increase and anticipated health care
costs. Any change in these assumptions can significantly change the liability
and associated expenses recognized in any given year. For example, a one
percentage point increase in anticipated health care costs each year would
increase the accumulated retiree medical obligation as of December 31, 2002 by
$4.4 million and the aggregate of the service and interest cost components of
net periodic retiree medical costs for 2002 by $.4 million.
NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") 143, "Accounting for Asset Retirement
Obligations," which is effective January 1, 2003. SFAS 143 requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which it is incurred.
When the liability is initially recorded, the entity capitalizes a cost by
increasing the carrying amount of the related long-lived asset. Over time, the
liability is accreted to its present value each period, and the capitalized cost
is depreciated over the useful life of the related asset. Upon settlement of
the liability, an entity either settles the obligation for its recorded amount
or incurs a gain or loss upon settlement. The Company does not believe that the
adoption of SFAS 143 will have a material impact on its financial condition and
results of operation.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
SFAS 145 eliminates SFAS 4, Reporting Gains and Losses from Extinguishment of
Debt" ("SFAS 4") and thus allows for only those gains or losses on the
extinguishment of debt that meet the criteria of extraordinary items to be
treated as such in the financial statements. SFAS 145 also amends SFAS 13,
Accounting for Leases" ("SFAS 13") to require sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The provisions of this Statement relating to the
rescission of SFAS 4 are effective for fiscal years beginning after May 15,
2002. The provisions of this Statement relating to the amendment of SFAS 13 are
effective for transactions occurring after May 15, 2002. All other provisions of
this Statement are effective for financial statements issued on or after
May 15, 2002.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS 146 requires that the liability for
costs associated with exit or disposal activities be recognized when incurred,
rather than at the date of a commitment to an exit or disposal plan. SFAS 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002.
The Company has evaluated the impact of SFAS 145 and SFAS 146 on its
financial statements and does not expect it to be material.
In November 2002, the FASB issued SFAS No. 148, "Accounting for stock-Based
Compensation - Transition and Disclosure- an amendment of FASB Statement No.
123." SFAS 148 amends SFAS No. 123 "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation. In addition,
SFAS 148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both the annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the method
used on reported results. The disclosure requirements apply to all companies for
fiscal years ending after December 15, 2002. The interim disclosure provisions
are effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. The adoption of SFAS 148 is not
expected to have a material impact on the Company's consolidated financial
statements.
- ----------
32 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan guarantees
and standby letters of credit. It also clarifies that at the time a company
issues a guarantee, the company must recognize an initial liability for the fair
value, or market value of the obligations it assumes under the guarantee and
must disclose that information in its interim and annual financial statements.
The provisions of FIN 45 related to recognizing a liability at inception of the
guarantee do not apply to product warranties or guarantees accounted for as
derivatives. The initial recognition and initial measurement provisions of FIN
45 apply on a prospective basis to guarantees issued or modified after December
31, 2002. The disclosure provisions are effective for financial statements for
periods ending after December 15, 2002. The Company believes that the adoption
of the recognition and measurement provisions of FIN 45 will not have a material
impact on its financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities an Interpretation of ARB No. 51" ("FIN 46"). FIN 46
is not expected to have an impact on the Company's financial statements because
the Company does not have any variable interest entities.
- ----------
33 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To SEMCO Energy, Inc.:
In our opinion, the accompanying consolidated statements of financial position
and capitalization as of December 31, 2002 and the related consolidated
statements of operations, changes in common shareholders' equity and cash flows
present fairly, in all material respects, the financial position of SEMCO
Energy, Inc. and it subsidiaries at December 31, 2002 and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion. The financial statements of the Company as of
December 31, 2001 and for each of the two years in the period ended December 31,
2001, prior to the inclusion of the goodwill transitional disclosures in Note 1,
were audited by other independent accountants who have ceased operations.
Those independent accountants expressed an unqualified opinion on those
financial statements in their report dated February 7, 2002.
As explained in Note 1 to the financial statements, effective January 1,
2002, SEMCO Energy, Inc. changed its method of accounting related to goodwill in
accordance with the adoption of Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets"
As discussed above, the financial statements of SEMCO Energy, Inc. as of
December 31, 2001, and for each of the two years in the period ended December
31, 2001 were audited by other independent accountants who have ceased
operations. As described in Note 1, these financial statements have been revised
to include the transitional disclosures required by Statement of Financial
Accounting Standards No. 142. We audited the adjustments in the transitional
disclosures in Note 1. In our opinion, all such adjustments are appropriate and
have been properly applied. However, we were not engaged to audit, review, or
apply any procedures to the 2001 and 2000 financial statements of the Company
other than with respect to such adjustments and, accordingly, we do not express
an opinion or any other form of assurance on the 2001 and 2000 financial
statements taken as a whole.
PricewaterhouseCoopers LLP
Detroit, Michigan
February 10, 2003
- ----------
34 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The following report is a copy of a report previously issued by Arthur Andersen
LLP (Andersen). This report has not been reissued by Andersen, and Andersen did
not consent to the incorporation by reference of this report (as included in the
form 10-K) into any of the company's registration statements.
As discussed in Note 1, the Company has revised its Financial Statements
for the years ended December 31, 2001 and 2000 to include the transitional
disclosures required by Statement of Financial Accounting Standards No. 142,
Goodwill and Intangible Assets. The Andersen report does not extend to these
changes. The revisions to the 2001 and 2000 Financial Statements related to
these transitional disclosures were reported on by PricewaterhouseCoopers LLP,
as stated in their report appearing herein.
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, 2001 and 2000, and the related consolidated
statements of income, changes in common shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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, 2001 and 2000, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Detroit, Michigan
February 7, 2002
- ----------
35 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(000's, except per share amounts)
OPERATING REVENUES
Gas sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335,655 $295,397 $273,312
Gas transportation . . . . . . . . . . . . . . . . . . . . . . . . . . 25,707 25,888 30,783
Construction services. . . . . . . . . . . . . . . . . . . . . . . . . 107,365 117,160 95,537
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,238 7,378 10,693
--------- --------- ---------
480,965 445,823 410,325
--------- --------- ---------
OPERATING EXPENSES
Cost of gas sold . . . . . . . . . . . . . . . . . . . . . . . . . . . 220,422 184,973 161,945
Operation and Maintenance. . . . . . . . . . . . . . . . . . . . . . . 156,653 162,289 140,236
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . 35,337 36,505 33,051
Property and other taxes . . . . . . . . . . . . . . . . . . . . . . . 11,844 11,562 9,860
Restructuring and impairment charges . . . . . . . . . . . . . . . . . - 6,103 -
--------- --------- ---------
424,256 401,432 345,092
--------- --------- ---------
OPERATING INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56,709 44,391 65,233
--------- --------- ---------
Other income (deductions)
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . (31,268) (31,784) (34,905)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,238 2,335 2,828
--------- --------- ---------
(29,030) (29,449) (32,077)
--------- --------- ---------
INCOME BEFORE INCOME TAXES AND DIVIDENDS ON
TRUST PREFERRED SECURITIES. . . . . . . . . . . . . . . . . . . . . . 27,679 14,942 33,156
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,139 6,578 11,554
--------- --------- ---------
INCOME BEFORE DIVIDENDS ON TRUST PREFERRED SECURITIES. . . . . . . . . . 17,540 8,364 21,602
Dividends on trust preferred securities, net of
income taxes of $4,631, $4,632 and $2,695 . . . . . . . . . . . . . . 8,601 8,603 5,004
--------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS . . . . . . . . . . . . . . . . 8,939 (239) 16,598
DISCONTINUED OPERATIONS:
Income (loss) from engineering services operations, net of income tax
benefit (expense) of $0, $694 and ($52). . . . . . . . . . . . . . . - (1,142) 95
Loss on divestiture of engineering services operations,
including losses during phase-out period, net of
income tax benefit (expense) of ($1,276), $2,429 and $0. . . . . . . 10 (4,980) -
--------- --------- ---------
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS . . . . . . . . . . . $ 8,949 $ (6,361) $ 16,693
========= ========= =========
EARNINGS PER SHARE - BASIC
Income (loss) from continuing operations . . . . . . . . . . . . . . . $ 0.48 $ (0.01) $ 0.92
Net income (loss) available to common shareholders . . . . . . . . . . $ 0.48 $ (0.35) $ 0.93
EARNINGS PER SHARE - DILUTED
Income (loss) from continuing operations . . . . . . . . . . . . . . . $ 0.48 $ (0.01) $ 0.89
Net income (loss) available to common shareholders . . . . . . . . . . $ 0.48 $ (0.35) $ 0.90
CASH DIVIDENDS PER SHARE . . . . . . . . . . . . . . . . . . . . . . . . $ 0.59 $ 0.84 $ 0.84
AVERAGE COMMON SHARES OUTSTANDING - BASIC. . . . . . . . . . . . . . . . 18,472 18,106 17,999
AVERAGE COMMON SHARES OUTSTANDING - DILUTED. . . . . . . . . . . . . . . 18,493 18,106 18,619
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these statements.
- ----------
36 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 2002 2001
- ------------ -------- --------
(000's)
CURRENT ASSETS
Cash and temporary cash investments, at cost. . . . . . . . . . . . . . $ 1,813 $ 1,728
Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,212 -
Receivables, less allowances of $1,909 and $1,849 . . . . . . . . . . . 49,841 64,219
Accrued revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,757 33,153
Gas in underground storage. . . . . . . . . . . . . . . . . . . . . . . 35,232 12,731
Prepaid expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,449 22,276
Materials and supplies, at average cost . . . . . . . . . . . . . . . . 4,254 5,258
Gas charges recoverable from customers. . . . . . . . . . . . . . . . . 2,200 1,994
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,537 3,608
-------- --------
160,295 144,967
-------- --------
PROPERTY PLANT AND EQUIPMENT
Gas distribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . 635,992 613,467
Diversified businesses and other. . . . . . . . . . . . . . . . . . . . 92,774 94,514
-------- --------
728,766 707,981
Less accumulated depreciation and impairments . . . . . . . . . . . . . 207,635 183,436
-------- --------
521,131 524,545
-------- --------
DEFERRED CHARGES AND OTHER ASSETS
Goodwill, less amortization and impairments of $17,764. . . . . . . . . 161,084 161,084
Deferred retiree medical benefits . . . . . . . . . . . . . . . . . . . 8,992 9,891
Unamortized debt expense. . . . . . . . . . . . . . . . . . . . . . . . 7,809 7,831
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,203 15,230
-------- --------
195,088 194,036
-------- --------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $876,514 $863,548
======== ========
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt. . . . . . . . . $121,835 $137,957
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,148 30,410
Customer advance payments . . . . . . . . . . . . . . . . . . . . . . . 11,408 13,530
Accrued interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,598 7,665
Accumulated deferred income taxes . . . . . . . . . . . . . . . . . . . 1,879 912
Amounts payable to customers. . . . . . . . . . . . . . . . . . . . . . 1,073 1,463
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,194 17,076
-------- --------
201,135 209,013
-------- --------
DEFERRED CREDITS AND OTHER LIABILITIES
Accumulated deferred income taxes . . . . . . . . . . . . . . . . . . . 33,043 33,149
Customer advances for construction. . . . . . . . . . . . . . . . . . . 15,841 15,548
Unamortized investment tax credit . . . . . . . . . . . . . . . . . . . 1,178 1,445
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,833 12,223
-------- --------
59,895 62,365
-------- --------
COMMITMENTS AND CONTINGENCIES (SEE NOTE 13)
CAPITALIZATION
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 366,026 338,966
Company-obligated mandatorily redeemable trust preferred securities
of subsidiaries holding solely debt securities of SEMCO Energy, Inc.. 139,436 139,394
Common shareholders' equity . . . . . . . . . . . . . . . . . . . . . . 110,022 113,810
-------- --------
615,484 592,170
-------- --------
TOTAL LIABILITIES AND CAPITALIZATION. . . . . . . . . . . . . . . . . . . $876,514 $863,548
======== ========
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these
statements.
- ----------
37 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ --------- --------- ----------
(000's)
CASH FLOW PROVIDED BY (USED FOR) OPERATING ACTIVITIES
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . $ 8,949 $ (6,361) $ 16,693
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . 35,337 36,505 33,051
Depreciation and amortization in discontinued operations . . 225 454 421
Accumulated deferred income taxes and investment tax credit. 3,516 4,402 6,877
Non-cash impairment charges and subsequent adjustment. . . . (1,732) 7,679 -
Changes in assets and liabilities, net of effects of
acquisitions, divestitures and other changes as
shown below . . . . . . . . . . . . . . . . . . . . . . . (21,350) (6,023) (8,080)
--------- --------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES. . . . . . . . . . . . . . 24,945 36,656 48,962
--------- --------- ----------
CASH FLOWS PROVIDED BY (USED FOR) INVESTING ACTIVITIES
Property additions - gas distribution. . . . . . . . . . . . . . . (29,972) (34,074) (47,466)
Property additions - diversified businesses and other. . . . . . . (5,005) (21,370) (19,170)
Proceeds from property sales, net of retirement costs. . . . . . . 4,508 (49) 15
Acquisitions of businesses, net of cash acquired . . . . . . . . . - - (784)
--------- --------- ----------
NET CASH USED FOR INVESTING ACTIVITIES . . . . . . . . . . . . . . . (30,469) (55,493) (67,405)
--------- --------- ----------
CASH FLOWS PROVIDED BY (USED FOR) FINANCING ACTIVITIES
Issuance of common stock, net of expenses. . . . . . . . . . . . . 3,642 2,436 865
Issuance of trust preferred securities, net of expenses. . . . . . - - 134,885
Net cash change in notes payable . . . . . . . . . . . . . . . . . 13,878 (26,185) (243,708)
Issuance of long-term debt, net of expenses. . . . . . . . . . . . 28,990 58,296 136,619
Repayment of long-term debt and related expenses . . . . . . . . . (30,125) (10) (50)
Payment of dividends . . . . . . . . . . . . . . . . . . . . . . . (10,776) (15,193) (15,033)
--------- --------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES. . . . . . . . . . . . . . 5,609 19,344 13,578
--------- --------- ----------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease). . . . . . . . . . . . . . . . . . . . . . 85 507 (4,865)
Beginning of period. . . . . . . . . . . . . . . . . . . . . . . . 1,728 1,221 6,086
--------- --------- ----------
END OF PERIOD. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,813 $ 1,728 $ 1,221
========= ========= ==========
CHANGES IN ASSETS AND LIABILITIES, NET OF EFFECTS OF
ACQUISITIONS, DIVESTITURES AND OTHER CHANGES:
Restricted cash. . . . . . . . . . . . . . . . . . . . . . . . $ (1,212) $ - $ -
Receivables, net . . . . . . . . . . . . . . . . . . . . . . . 14,378 8,920 7,161
Accrued revenue. . . . . . . . . . . . . . . . . . . . . . . . (7,604) (941) (6,832)
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . (1,173) (7,967) 12
Materials, supplies and gas in underground storage . . . . . . (21,497) (4,185) 4,065
Gas charges recoverable from customers . . . . . . . . . . . . (206) 704 311
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 7,738 (1,890) (3,780)
Customer advances and amounts payable to customers . . . . . . (2,219) (68) (4,036)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,555) (596) (4,981)
--------- --------- ----------
$(21,350) $ (6,023) $ (8,080)
--------- --------- ----------
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these
Statements.
- ----------
38 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITALIZATION
YEARS ENDED DECEMBER 31, 2002 2001
- ------------------------ --------- ---------
(000's)
CURRENT MATURITIES OF LONG-TERM DEBT
6.83% notes due 2002. . . . . . . . . . . . . . . . . . . . . $ - $ 30,000
--------- ---------
CAPITALIZATION
- ----------------------------------------------------------------
LONG-TERM DEBT
8.00% notes due 2004. . . . . . . . . . . . . . . . . . . . . $ 55,000 $ 56,900
7.20% notes due 2007. . . . . . . . . . . . . . . . . . . . . 30,000 30,000
8.95% notes due 2008, remarketable 2003 . . . . . . . . . . . 105,378 106,179
6.49% notes due 2009. . . . . . . . . . . . . . . . . . . . . 30,000 -
8.00% notes due 2010. . . . . . . . . . . . . . . . . . . . . 30,758 30,887
8.00% notes due 2016. . . . . . . . . . . . . . . . . . . . . 59,890 60,000
8.32% notes due 2024. . . . . . . . . . . . . . . . . . . . . 25,000 25,000
6.50% medium-term notes due 2005. . . . . . . . . . . . . . . 15,000 15,000
6.40% medium-term notes due 2008. . . . . . . . . . . . . . . 5,000 5,000
7.03% medium-term notes due 2013. . . . . . . . . . . . . . . 10,000 10,000
--------- ---------
$366,026 $338,966
--------- ---------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED
SECURITIES OF SUBSIDIARIES HOLDING SOLELY DEBT SECURITIES OF
SEMCO ENERGY, INC.
10.25% cumulative trust preferred securities - 1,600,000
shares issued and outstanding . . . . . . . . . . . . $ 38,436 $ 38,394
FELINE PRIDES -10,100,000 shares issued and outstanding . 101,000 101,000
--------- ---------
$139,436 $139,394
--------- ---------
COMMON SHAREHOLDERS' EQUITY
Common stock, par value $1 per share - 40,000,000 shares
authorized; 18,682,027 and 18,240,143 shares outstanding. $ 18,682 $ 18,240
Capital surplus . . . . . . . . . . . . . . . . . . . . . . . 120,089 117,091
Accumulated other comprehensive income (loss) . . . . . . . . (7,597) (2,196)
Retained earnings (deficit) . . . . . . . . . . . . . . . . . (21,152) (19,325)
--------- ---------
$110,022 $113,810
--------- ---------
TOTAL CAPITALIZATION . . . . . . . . . . . . . . . . . . . . . . $615,484 $592,170
========= =========
<FN>
The accompanying notes to the consolidated financial statements are an integral part
of these statements.
- ----------
39 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(000's)
COMMON STOCK
Beginning of year. . . . . . . . . . . . . . . . . . . . $ 18,240 $ 18,056 $ 17,909
Issuance of common stock for acquisitions,
the DRIP and other. . . . . . . . . . . . . . . . 442 184 147
--------- --------- ---------
End of year. . . . . . . . . . . . . . . . . . . . . . . $ 18,682 $ 18,240 $ 18,056
--------- --------- ---------
CAPITAL SURPLUS
Beginning of year. . . . . . . . . . . . . . . . . . . . $117,091 $115,186 $123,861
Issuance of common stock for acquisitions,
the DRIP and other. . . . . . . . . . . . . . . . 3,200 2,256 1,718
Costs related to FELINES PRIDES (See Note 4) . . . . (202) (351) (10,393)
--------- --------- ---------
End of year. . . . . . . . . . . . . . . . . . . . . . . $120,089 $117,091 $115,186
--------- --------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Beginning of year. . . . . . . . . . . . . . . . . . . . $ (2,196) $ - $ -
Minimum pension liability adjustment, net of income
tax benefit of $2,922, $781 and $0 (See Note 8). . (5,427) (1,452) -
Unrealized derivative gain (loss) on interest rate
hedge from an investment in an affiliate . . . . . 26 (744) -
--------- --------- ---------
End of year. . . . . . . . . . . . . . . . . . . . . . . $ (7,597) $ (2,196) $ -
--------- --------- ---------
RETAINED EARNINGS (DEFICIT)
Beginning of year. . . . . . . . . . . . . . . . . . . . $(19,325) $ 2,230 $ 570
Net income (loss). . . . . . . . . . . . . . . . . . 8,949 (6,361) 16,693
Cash dividends on common stock . . . . . . . . . . . (10,776) (15,194) (15,033)
--------- --------- ---------
End of year. . . . . . . . . . . . . . . . . . . . . . . $(21,152) $(19,325) $ 2,230
--------- --------- ---------
<FN>
The accompanying notes to the consolidated financial statements are an integral part of
these statements.
DISCLOSURE OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(000's)
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS. . . . . $ 8,949 $ (6,361) $ 16,693
Minimum pension liability adjustment, net of income
tax benefit of $2,922, $781 and $0 (See Note 8) . . . (5,427) (1,452) -
Unrealized derivative gain (loss) on interest rate
hedge from an investment in an affiliate . . . . . . . 26 (744) -
--------- --------- ---------
TOTAL COMPREHENSIVE INCOME (LOSS) . . . . . . . . . . . . . $ 3,548 $ (8,557) $ 16,693
--------- --------- ---------
<FN>
The accompanying notes to the consolidated financial statements are an integral part
of these statements.
- ----------
40 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Company Description. SEMCO Energy, Inc., is an investor-owned company. SEMCO
Energy, Inc. and its subsidiaries (the "Company") operate four reportable
business segments: (1) gas distribution; (2) construction services; (3)
information technology services; and (4) propane, pipelines and storage. The
latter three segments are sometimes referred to together as the "Diversified
Businesses." The Company's gas distribution business segment distributes and
transports natural gas to approximately 272,000 customers in the state of
Michigan and approximately 111,000 customers in the state of Alaska. The
Alaska-based operation and the Michigan-based operation are known together as
the "Gas Distribution Business" and operate as divisions of SEMCO Energy, Inc.
The construction services segment ("Construction Services") currently
conducts most of its business in the midwestern, southern and southeastern areas
of the United States. Its primary service is the installation and upgrade of
compressor stations and underground natural gas mains and service lines.
The information technology services segment ("IT Services") is
headquartered in Michigan and provides IT infrastructure outsourcing services
and other IT services with a focus on mid-range computers, particularly the IBM
I-Series (AS-400) platform. The Company's other business segments accounted for
approximately 79% of IT Services' revenues during 2002.
The propane, pipelines and storage segment sells more than 4 million
gallons of propane annually to retail customers in Michigan's upper peninsula
and northeast Wisconsin and operates natural gas transmission and storage
facilities in Michigan.
The Company began accounting for its engineering services segment as a
discontinued operation, effective with the fourth quarter of 2001. For
additional information, refer to the "Discontinued Operations" disclosure within
this Note.
BASIS OF PRESENTATION. The financial statements of the Company were prepared in
conformity with accounting principles generally accepted in the United States.
In connection with the preparation of the financial statements, management was
required 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 where the Company has significant influence, but does
not control the entity, are reported using the equity method of accounting.
Certain of the Company's diversified businesses, primarily Construction
Services and IT Services, supply services at a profit to the Company's regulated
gas distribution business. In accordance with Statement of Financial Accounting
Standard ("SFAS") 71, "Accounting for the Effects of Certain Types of
Regulation," 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, $.1 million, $.6 million and $.9 million of profit on
revenues earned from the Company's regulated business by the Company's
diversified businesses was not eliminated during consolidation in 2002, 2001,
and 2000 respectively. All other significant intercompany transactions have been
eliminated.
RATE REGULATION. The Gas Distribution Business is subject to regulation. The
regulatory matters associated with gas distribution customers located in the
City of Battle Creek, Michigan, and surrounding communities are subject to the
jurisdiction of the City Commission of Battle Creek ("CCBC"). The Michigan
Public Service Commission ("MPSC") has jurisdiction over the regulatory matters
related to the Company's remaining Michigan customers. Regulatory matters for
gas distribution customers in Alaska are subject to the jurisdiction of the
Regulatory Commission of Alaska ("RCA"). These regulatory bodies have
jurisdiction over, among other things, rates, accounting procedures, and
standards of service. The Gas Distribution Business is subject to the provisions
of SFAS 71. Refer to Note 2 for additional information regarding SFAS 71.
RESTRICTED CASH. At December 31, 2002, the Company had $1.2 million of
restricted cash. The Company expects this cash will be disbursed or that the
restricted status will be removed within one year.
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 4.9% for the year 2002 and 4.7% for the years 2001 and 2000.
- ----------
41 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
On January 1, 2002, the Company adopted SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" and Accounting Principles Board ("APB") Opinion 30, "Reporting
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions."
SFAS 144 requires long-lived assets to be measured at the lower of either
the carrying amount or the fair value less the cost to sell the assets, whether
reported in continuing operations or in discontinued operations. Therefore,
discontinued operations will no longer be measured at net realizable value or
include amounts for operating losses that have not yet occurred.
SFAS 144 also broadens the reporting of discontinued operations to include
all components of an entity with operations that can be distinguished from the
rest of the entity and that will be eliminated from the ongoing operations of
the entity in a disposal transaction. The adoption of SFAS 144 will result in
the Company accounting for any future impairment or disposal of long-lived
assets under the provisions of SFAS 144, but has not changed the accounting used
for previous asset impairments or disposals.
GAS IN UNDERGROUND STORAGE. The gas inventory of the Gas Distribution Business
at December 31, 2002 is reported at average cost. The gas inventory at December
31, 2001 was also stated at average cost with the exception of the inventory
held by the Battle Creek division of the Gas Distribution Business, which was
stated at last-in, first-out ("LIFO") cost. At December 31, 2001, the
replacement cost of the Battle Creek division's gas inventory exceeded the LIFO
cost by $0.2 million.
During 2002, the Battle Creek Division changed its method of accounting for
gas inventory from LIFO to average cost. This change in accounting principle was
made in order to provide a better matching of expenses with revenues and make
Battle Creek's accounting for gas inventory consistent with the Company's other
gas distribution divisions and other Michigan gas distribution companies. This
accounting change was not material to the financial statements, and,
accordingly, no retroactive restatement of prior years' financial statements was
made.
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.
GOODWILL. Goodwill represents the excess of purchase price and related costs
over the value assigned to the net tangible assets of businesses acquired. On
January 1, 2002, the Company adopted SFAS 141, "Business Combinations" and SFAS
142, "Goodwill and Other Intangible Assets." SFAS 141 addresses financial
accounting and reporting for all business combinations and requires that all
business combinations entered into subsequent to June 30, 2001 be recorded under
the purchase method. This Statement also addresses financial accounting and
reporting for goodwill and other intangible assets acquired in a business
combination at acquisition. SFAS 142 addresses financial accounting and
reporting for intangible assets acquired individually or with a group of other
assets at acquisition. This Statement also addresses financial accounting and
reporting for goodwill and other intangible assets subsequent to their
acquisition.
In compliance with SFAS 142, goodwill amortization ceased effective January
1, 2002. Prior to January 1, 2002, goodwill was being amortized on a
straight-line basis over periods of up to 40 years. Amortization expense was
approximately $4.6 in 2001 and $4.0 million in 2000. During 2001, the Company
recorded a charge of $4.0 million for the impairment of goodwill associated with
the Company's construction services segment and its discontinued engineering
services business. The Company's carrying amount for goodwill at December 31,
2002 was $161.1 million, of which $140.2 million related to the Gas Distribution
Business, $17.7 million related to Construction Services, $3.1 million related
to the Propane, Pipelines and Storage segment and $.1 million related to IT
Services.
The Company was required to complete a transition impairment test in the
year of adoption of SFAS 142 and perform subsequent impairment tests on the
remaining goodwill balance annually or at any time when events occur which could
impact the value of the Company's business segments. If an impairment test of
goodwill shows that the carrying amount of the goodwill is in excess of the fair
value, a corresponding impairment loss would be recorded in the Consolidated
Statements of Operations. The transition impairment tests were performed for the
Company's business units and the results of those tests indicate that no
impairment of the Company's goodwill balances existed as of January 1, 2002. The
2002 annual impairment tests were also performed for the Company's business
segments and indicated that there was no impairment of goodwill. As a result,
there was no change in the carrying amount of goodwill at December 31, 2002 when
compared to December 31, 2001.
The following table presents what would have been reported as net income
(loss) available to common shareholders and the related per share amounts on a
basic and diluted basis in 2002, 2001, and 2000, exclusive of amortization
expense (including any related tax effects) related to goodwill.
- ----------
42 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ ------ -------- -------
(000's)
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
Reported income (loss) from continuing operations. . . . . . $8,939 $ (239) $16,598
Discontinued operations. . . . . . . . . . . . . . . . . . . 10 (6,122) 95
Reported net income (loss) available to common shareholders. 8,949 (6,361) 16,693
Add back: Goodwill amortization, net of income taxes . . . . - 2,806 2,449
Adjusted net income (loss) available to common shareholders. $8,949 $(3,555) $19,142
ADJUSTED EARNINGS PER SHARE - BASIC
Reported income (loss) from continuing operations. . . . . . $ 0.48 $ (0.01) $ 0.92
Discontinued operations. . . . . . . . . . . . . . . . . . . 0.00 (0.34) 0.01
Reported net income (loss) available to common shareholders. 0.48 (0.35) 0.93
Add back: Goodwill amortization, net of income taxes . . . . - 0.15 0.13
Adjusted net income (loss) available to common shareholders. $ 0.48 $ (0.20) $ 1.06
ADJUSTED EARNINGS PER SHARE - DILUTED
Reported income (loss) from continuing operations. . . . . . $ 0.48 $ (0.01) $ 0.89
Discontinued operations. . . . . . . . . . . . . . . . . . . 0.00 (0.34) 0.01
Reported net income (loss) available to common shareholders. 0.48 (0.35) 0.90
Add back: Goodwill amortization, net of income taxes . . . . - 0.15 0.13
Adjusted net income (loss) available to common shareholders. $ 0.48 $ (0.20) $ 1.03
LONG-TERM NOTE RECEIVABLE. The Company sold its entire interest in an Arkansas
pipeline to ENOGEX Arkansas Pipeline Corporation ("ENOGEX") in 1998. Pursuant to
the terms included in the sales agreement, the Company will receive annual
payments of $.8 million from ENOGEX for 17 years beginning in the year 2004. At
December 31, 2002, the Company has a long-term discounted note receivable of
$7.7 million for this note, which is reported in deferred charges and other
assets in the Consolidated Statements of Financial Position.
REVENUE RECOGNITION. The Gas Distribution Business 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. Construction
Services recognizes revenues as services are rendered. In instances when
projects are long-term, Construction Services uses the percentage of completion
method. At December 31, 2002, Construction Services did not have any
significant long-term projects. The propane business recognizes propane sales in
the same period that the propane is delivered to customers.
COST OF GAS. The Alaska-based gas distribution operation ("ENSTAR") has a
regulator-approved gas cost adjustment ("GCA") pricing mechanism, which allows
for the adjustment of rates charged to customers in Alaska for increases and
decreases in the cost of gas purchased. Under the GCA pricing mechanism, the gas
charge portion of customers' gas rates is adjusted annually to reflect the
estimated cost of gas purchased for the upcoming 12-month period. Any difference
between actual cost of gas purchased and the estimate is deferred as a current
asset or current liability and included in the next annual adjustment to the gas
charge portion of rates. The GCA may be adjusted quarterly if it is determined
that there are significant variances from the estimates used in the annual
determination.
- ----------
43 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
ENSTAR has RCA approved gas purchase contracts with several entities. The
base price of gas purchased under these contracts can be adjusted annually based
on factors such as the price of certain traded oil futures, certain natural gas
futures and other inflationary measures. Under the GCA pricing mechanism,
customers in Alaska are charged amounts that allow the Company to recoup its
cost of purchased gas. As a result, the Company does not earn any income on the
gas charge portion of ENSTAR's rates.
Prior to April 1, 1999, the Company's Michigan-based gas distribution
operation had a regulator-approved gas cost recovery ("GCR") pricing mechanism
for the geographic areas subject to the regulatory jurisdiction of the MPSC and
CCBC. The GCR pricing mechanism works similarly to the GCA pricing mechanism.
During the three-year period from April 1, 1999 to March 31, 2002, the MPSC and
CCBC authorized the Company to suspend its GCR clause and freeze in its customer
base rate a fixed gas charge of $3.24 per thousand cubic feet ("Mcf"). The
Company was able to offer this Michigan GCR suspension and rate freeze mainly as
a result of agreements reached with TransCanada Gas Services, Inc.
("TransCanada"), which also covered the three-year period from April 1, 1999 to
March 31, 2002. During 2001, TransCanada sold its gas marketing business and
assigned the agreements to BP Canada Energy Marketing Corp. (formerly "BP Gas
and Power") , with the Company's consent. Under the agreements, TransCanada or
BP Canada Energy Marketing Corp ("BP") provided a significant portion of the
Company's natural gas requirements, and managed the Company's natural gas supply
and the supply aspects of transportation and storage operations in Michigan for
the three-year period, at a cost that was, in most instances, below the $3.24
price charged to customers. As a result, during the three-year period from April
1, 1999 through March 31, 2002, the Michigan gas distribution operation retained
any gas costs savings that resulted when the cost of purchased natural gas was
below the $3.24 fixed price charged to customers, subject to a customer profit
sharing mechanism described in Note 2.
When the suspension period for the GCR pricing mechanism expired on March
31, 2002, the Company reinstated its GCR pricing mechanism for customers subject
to the jurisdiction of the MPSC ("MPSC customers"). Consequently, effective
April 1, 2002, the Company could no longer earn any income on the gas charge
portion of MPSC customers' rates. The Company received approval from the CCBC to
extend the GCR suspension period and fixed gas charge program, with a new fixed
gas charge, until March 31, 2005 for customers subject to its jurisdiction
("CCBC customers").
The Company has entered into new agreements with BP for the natural gas
supply requirements of the CCBC customers, supply portfolio management for the
MPSC customers, and transportation and storage asset management for both the
CCBC and MPSC customers.
Under the new BP agreement covering MPSC customers, the Company no longer
purchases gas at a fixed cost over a number of years. In keeping with the
Company's switch back to the GCR pricing mechanism for MPSC customers, the
Company is required to solicit bids for all supplies with term lengths longer
than three days. Supplies with term lengths of three days or less are purchased
from BP. The new BP agreement covering CCBC customers will continue to have a
fixed cost for the purchase of natural gas and is effective for the three-year
period from April 1, 2002 through March 31, 2005.
In accordance with the GCR pricing mechanism, the Company had $2.2 million
recorded in current assets at December 31, 2002 for gas charges recoverable from
customers. Also at December 31, 2002, the Company had $1.1 million recorded in
current liabilities for amounts payable to customers in accordance with the GCA
pricing mechanism.
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 among the subsidiaries within each business segment based on
their separate taxable income.
- ----------
44 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DISCONTINUED OPERATIONS. In December 2001, the Company's board of directors
approved a plan to redirect the Company's business strategy, which included the
divestiture of its engineering services business. As a result, the operating
results and loss on disposal of this business have been segregated and reported
as discontinued operations in the Consolidated Statements of Operations. A loss
of approximately $5.0 million, representing the estimated loss during the
phase-out period and the estimated loss on disposal, was reported as
discontinued operations in the 2001 Consolidated Statement of Operations. The
Company sold its engineering services business effective November 1, 2002. There
was a difference of $10 thousand between the actual losses and estimated losses,
which is reported as discontinued operations in 2002. For additional
information, refer to Note 14 of the Notes to Consolidated Financial Statements.
STATEMENTS OF CASH FLOW. For purposes of the Consolidated Statements of Cash
Flow, the Company considers all highly liquid investments purchased with
original maturities of three months or less to be cash and temporary cash
investments. Supplemental cash flow information for the years ended December 31,
2002, 2001 and 2000, is summarized in the following table.
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ -------- ------- --------
(000's)
CASH PAID DURING THE YEAR FOR:
Interest . . . . . . . . . . . . . . . . . $30,304 $31,301 $29,153
Income taxes, net of (refunds) . . . . . . $(2,243) $ 4,258 $ 4,160
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital stock issued for acquisitions. . . $ - $ - $ 1,000
DETAILS OF ACQUISITIONS:
Fair value of assets acquired. . . . . . . $ - $ - $ 3,364
Fair value of liabilities assumed. . . . . - - (1,576)
Company stock issued . . . . . . . . . . . - - (1,000)
-------- ------- --------
Cash paid . . . . . . . . . . . . . . . . . . $ - $ - $ 788
Less cash acquired. . . . . . . . . . . . . . - - 4
-------- ------- --------
Net cash paid for acquisitions. . . . . . . . $ - $ - $ 784
======== ======= ========
NOTE 2. REGULATORY MATTERS
RCA. The Company's Alaska gas distribution division, ENSTAR Natural Gas Company
and its subsidiary, Alaska Pipeline Company (together known as "ENSTAR"), have
been undergoing a rate review with the RCA since 2000.
The Company received an Order dated August 8, 2002 from the RCA on its
review of rates for ENSTAR based on normalized data for the year 2000. In its
Order the RCA established a revenue requirement of $107.6 million and a 12.55%
return on equity. In response to a petition by ENSTAR, the RCA issued an
additional Order dated September 16, 2002 which revised the indicated annual
revenue reduction from $2.1 million to $2.0 million, which was 1.84% of ENSTAR's
revenue in the normalized 2000 test year. The Order required ENSTAR to implement
the rate reduction by September 27, 2002 on an across-the-board basis. The RCA
also required ENSTAR to file an updated cost of service study by September 9,
2002 and a rate design in December 2002, with a hearing on the rate design
filing scheduled for May 2003. ENSTAR has implemented the rate reduction and
filed both the cost of service study and the rate design as required. The rate
design filed with the RCA by ENSTAR requests greater recovery of fixed costs in
the monthly customer charge and declining block rates for gas sales customers.
MPSC AND CCBC. During the three-year period from April 1, 1999 to March 31,
2002, the division of the Gas Distribution Business, subject to the jurisdiction
of the MPSC, was under an MPSC order which, among other things, authorized the
Company to: (1) suspend its GCR clause; (2) freeze in its customer base rate, a
fixed gas charge of $3.24 per Mcf; (3) freeze distribution rate adjustments and
(4) adopt a new income sharing mechanism for use during the 1999, 2000 and 2001
calendar years.
The MPSC order was applicable only in the geographic areas subject to the
regulatory jurisdiction of the MPSC, and, therefore, did not govern rates
regulated by the CCBC. However, the Gas Distribution Business voluntarily
requested, and the CCBC approved, a similar freeze in the gas charge at $3.24
for customers subject to the jurisdiction of the CCBC. The CCBC also approved a
suspension of the GCR clause, a distribution rate freeze and an income sharing
mechanism similar to the MPSC approved program. The changes were effective for
the same time period as the changes approved by the MPSC.
- ----------
45 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Several of the items in the MPSC order were interrelated. The fixed gas
charge and the suspension of the GCR clause meant that customers paid $3.24 per
Mcf regardless of the Company's actual cost of gas. The Gas Distribution
Business was able to offer this Michigan GCR suspension and rate freeze mainly
as a result of agreements reached with TransCanada. Refer to the Cost of Gas
section of Note 1 for further information about the GCR clause, fixed gas charge
and TransCanada agreements.
The profit incentive and sharing mechanism was effective for the calendar
years 1999, 2000 and 2001. Under the mechanism, if the Company's return on
equity for its Michigan-based natural gas distribution business exceeded 12.75%,
certain portions of the excess return would be credited to customers, i.e.,
would be reflected prospectively in reduced rates. Four safety and reliability
performance measures were required to be met in order not to reduce the return
on equity threshold used in the income sharing mechanism.
The Company received approval from the CCBC to extend the GCR suspension
period and the fixed gas charge program, with a new fixed gas charge, until
March 31, 2005 for CCBC customers. The profit incentive and sharing mechanism
discussed previously will remain in effect through March 2005 for CCBC
customers. The Company also received approval during 2001 from the CCBC to start
charging CCBC customers on a thermal basis rather than a volumetric basis. The
Company buys all its natural gas by the dekatherm and now also sells it to these
customers by the dekatherm.
The Company filed an application with the MPSC in late 2001 to extend its
fixed charge program until March 31, 2005 and increase the current fixed charge
for MPSC customers. However, the Company was unable to reach an agreement with
the MPSC and other interested parties on a fixed customer charge for natural gas
for the three years of the proposed extended period. As a result, the Company
reinstated its GCR pricing mechanism when the fixed gas charge program expired
on March 31, 2002. Refer to the Cost of Gas section of Note 1 for information
regarding the GCR pricing mechanism.
Beginning in 2002, the profit incentive and sharing mechanism discussed
previously is no longer in effect for MPSC customers. Instead, the profit
incentive and sharing mechanism in effect for the calendar year 1998 was
reinstated for 2002. Under this mechanism, referred to as a reverse taper
incentive, if the return on equity for the division of Company's Michigan-based
natural gas distribution business that serves its MPSC customers exceeds 10.75%,
certain portions of the excess return between 10.75% and 16.0% would be credited
to customers. For purposes of this mechanism, if the return on equity exceeds
16.0%, the Company is required to file a general rate case with the MPSC. The
return on equity did not exceed 10.75% for 2002.
On November 21, 2002 the MPSC regulated division of SEMCO Energy Gas
Company filed an application for a general rate increase of $10.9 million.
Among the principal reasons for the requested increase were higher pension and
healthcare costs and investment of approximately $120 million in new plant since
the last rate case was approved in 1997. In addition to specific rate relief,
the application sought an innovative rate design, which would mitigate some of
the effects of warmer than normal weather on the Company's earnings. This new
rate design calls for greater recovery of fixed costs in the monthly customer
charge and declining block rates for gas sales customers. This would provide
more stability in customer bills by moving costs from the peak heating season to
summer and off-peak heating months. The filing also requests a change to
customer billing based on the heat content of natural gas, or therms, rather
than the current volumetric measure, cubic feet. An order is expected in 2003.
REGULATORY ASSETS AND LIABILITIES. The Gas Distribution Business 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.
In the event the Company determines that the Gas Distribution Business 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 ability of the Gas Distribution
Business 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 Company's periodic review of these
criteria currently supports the continuing application of SFAS 71.
- ----------
46 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the regulatory assets and liabilities
recorded in the Consolidated Statements of Financial Position.
DECEMBER 31, 2002 2001
- ------------ ------- -------
(000's)
REGULATORY ASSETS
Deferred retiree medical benefits. . . . . . . . . . $ 8,992 $ 9,891
Gas charges recoverable from customers . . . . . . . 2,200 1,994
Unamortized loss on retirement of debt . . . . . . . 1,881 2,126
Other. . . . . . . . . . . . . . . . . . . . . . . . 2,303 2,126
------- -------
$15,376 $16,137
------- -------
REGULATORY LIABILITIES
Tax benefits amortizable to customers. . . . . . . . $ 3,086 $ 3,448
Unamortized investment tax credit. . . . . . . . . . 1,228 1,593
Amounts payable to customers (gas cost overrecovery) 1,073 1,463
------- -------
$ 5,387 $ 6,504
------- -------
NOTE 3. 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 carryforwards.
PROVISION FOR INCOME TAXES. The table below summarizes the components of the
Company's provision for income taxes.
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ -------- -------- --------
(000's)
FEDERAL INCOME TAXES:
Currently payable (refundable). . . . . . $ 2,442 $(7,056) $ 3,065
Deferred to future periods. . . . . . . . 2,796 4,717 5,935
Investment tax credits ("ITC"). . . . . . (267) (267) (267)
STATE INCOME TAXES:
Currently payable (refundable). . . . . . 907 695 (473)
Deferred to future periods. . . . . . . . 906 734 651
-------- -------- --------
TOTAL INCOME TAX EXPENSE (BENEFIT). . . . . . . . $ 6,784 $(1,177) $ 8,911
LESS AMOUNTS INCLUDED IN:
Dividends on trust preferred securities . (4,631) (4,632) (2,695)
Discontinued operations . . . . . . . . . 1,276 (3,123) 52
-------- -------- --------
INCOME TAXES, EXCLUDING AMOUNTS SHOWN SEPARATELY. $10,139 $ 6,578 $11,554
======== ======== ========
- ----------
47 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
RECONCILIATION OF STATUTORY RATE TO EFFECTIVE RATE. The table below provides a
reconciliation of the difference between the Company's provision for income
taxes and income taxes computed at the statutory rate.
Years ended December 31, 2002 2001 2000
- ------------------------ -------- -------- --------
(000's)
NET INCOME (LOSS) . . . . . . . . . . . $ 8,949 $(6,361) $16,693
Add back: Income taxes . . . . . . . 6784 (1,177) 8,911
-------- -------- --------
PRE-TAX INCOME (LOSS) . . . . . . . . . $15,733 $(7,538) $25,604
-------- -------- --------
COMPUTED FEDERAL INCOME TAXES . . . . . $ 5,507 $(2,638) $ 8,961
AMORTIZATION OF DEFERRED ITC. . . . . . (267) (267) (267)
AMORTIZATION OF NON-DEDUCTIBLE AMOUNTS
RESULTING FROM ACQUISITIONS. . . . . 119 237 237
STATE INCOME TAX EXPENSE, NET OF
FEDERAL TAX BENEFIT. . . . . . . . . 1,178 928 79
OTHER . . . . . . . . . . . . . . . . . 247 563 (99)
-------- -------- --------
TOTAL INCOME TAX EXPENSE (BENEFIT). . . $ 6,784 $(1,177) $ 8,911
-------- -------- --------
DEFERRED INCOME TAXES. Deferred income taxes arise from temporary differences
between the tax bases of assets and liabilities and their reported amounts in
the financial statements. At December 31, 2002, there was a valuation allowance
of $.6 million recorded against deferred tax assets. The valuation allowance
relates to a capital loss incurred in 2002 that is likely to expire before being
realized for tax purposes. At December 31, 2001 there was no valuation allowance
recorded against deferred tax assets. The Company has an estimated net operating
loss ("NOL") carryforward for federal tax purposes of $35.6 million at December
31, 2002, of which $21.0 million expires in 2021 and $14.6 million expires in
2022. The table below shows the principal components of the Company's deferred
tax assets (liabilities).
DECEMBER 31, 2002 2001
- ------------ --------- ---------
(000's)
Property . . . . . . . . . . . . . . . . . . . . . $(46,413) $(35,235)
Retiree medical benefit obligation . . . . . . . . 986 1,249
Retiree medical benefit regulatory assets. . . . . (3,147) (3,462)
ITC. . . . . . . . . . . . . . . . . . . . . . . . 686 820
Unamortized debt expense . . . . . . . . . . . . . (864) (1,025)
Property taxes . . . . . . . . . . . . . . . . . . (2,460) (2,329)
Goodwill . . . . . . . . . . . . . . . . . . . . . (3,929) (1,430)
Other comprehensive income . . . . . . . . . . . . 3,704 781
Reserves associated with discontinued operations,
restructuring and impairments . . . . . . . . 2,304 4,108
Net operating losses . . . . . . . . . . . . . . . 12,465 -
Valuation allowance for deferred tax assets. . . . (580) -
Other. . . . . . . . . . . . . . . . . . . . . . . 2,326 2,462
--------- ---------
TOTAL DEFERRED TAXES . . . . . . . . . . . . . . . $(34,922) $(34,061)
--------- ---------
Gross deferred tax liabilities . . . . . . . . . . $(88,837) $(71,695)
Gross deferred tax assets. . . . . . . . . . . . . 54,495 37,634
Valuation allowance for deferred tax assets. . . . (580) -
--------- ---------
TOTAL DEFERRED TAXES . . . . . . . . . . . . . . . $(34,922) $(34,061)
--------- ---------
- ----------
48 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. CAPITALIZATION
COMMON STOCK EQUITY. During 2002 and the last half of 2001, the Company issued
approximately 372,000 shares and 166,000 shares, respectively of its common
stock to the Company's Direct Stock Purchase and Dividend Reinvestment Plan
("DRIP") to meet the dividend reinvestment and stock purchase requirements of
its participants. During 2000 and the first half of 2001, the DRIP purchased
Company common stock on the open market to meet these requirements.
The Company issued approximately 70,000, 19,000 and 52,000 shares of
Company common stock to certain of the Company's employee benefit plans in 2002,
2001 and 2000, respectively. Also during 2002 and 2001, the Company purchased
approximately 40,000 shares and 48,000 shares, respectively, of its common stock
on the open market to contribute to certain of its employee benefit plans. The
Company issued 83,000 shares of its common stock to the shareholders of a
business acquired during 2000.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES OF
SUBSIDIARIES. The Company's Capital Trusts were established for the sole
purpose of issuing trust preferred securities and lending the gross proceeds to
the Company. The sole assets of the Capital Trusts are debt securities of the
Company with terms similar to the terms of the related trust preferred
securities. The Capital Trusts are subsidiaries of the Company.
In April 2000, SEMCO Capital Trust I issued 1.6 million shares of 10.25%
cumulative trust preferred securities ("10.25% TPS") in a public offering at a
price of $25 per security. SEMCO Capital Trust I used the $40 million in
proceeds from the issuance of the 10.25% TPS to invest in subordinated
debentures of the Company bearing an interest rate of 10.25%. The 10.25% TPS are
subject to mandatory redemption upon repayment of the subordinated debentures at
maturity or their earlier redemption. The subordinated debentures mature in
2040, but may be redeemed at any time after April 19, 2005, or at any time
within 90 days following the occurrence of certain special events. The Company
used the entire net proceeds from the sale of the subordinated debentures to
repay a portion of the bridge loan utilized in the ENSTAR acquisition.
Also during 2000, the Company issued 10.1 million FELINE PRIDES in a
public offering at a price of $10 per security. Each FELINE PRIDES consists of a
stock purchase contract of the Company and a 9% trust preferred security of
SEMCO Capital Trust II due 2005 with a stated face value per security of $10
("9% TPS"). SEMCO Capital Trust II used the $101 million in proceeds to invest
in 9% senior deferrable notes of the Company due 2005. The Company used the net
proceeds from the sale of the senior deferrable notes to repay a portion of the
bridge loan utilized for the acquisition of ENSTAR and to repay a portion of its
short-term lines of credit.
Under the terms of each stock purchase contract (which is a component of a
FELINE PRIDES unit), the FELINE PRIDES holder is obligated to purchase, and the
Company is obligated to sell, between .7794 and .8651 shares of Company common
stock in August 2003. The actual number of shares of common stock to be sold
will depend on the average market value of a share of common stock in August
2003. In addition to payments on the 9% TPS, the Company is also obligated to
pay the FELINE PRIDES holders a quarterly contract adjustment payment on each
stock purchase contract at an annual rate of 2% of $10. The present value of the
contract adjustment payments, or $5.6 million, was recorded as a liability and
as a reduction to common stock capital surplus when the FELINE PRIDES were
issued. As the Company pays the contract adjustment payments, common stock
capital surplus is also reduced by the interest component of the payments. In
addition, common stock capital surplus was reduced by $4.6 million for the
issuance costs of the FELINE PRIDES.
The FELINE PRIDES holders can settle their obligation to purchase Company
common stock by paying cash or by having their 9% TPS remarketed in August 2003.
The distribution rate on the 9% TPS will also be reset in August 2003. The reset
rate will be equal to the sum of the reset spread and the rate on the two-year
benchmark treasury and will be determined by the reset agent as the rate the TPS
should bear in order to have an approximate market value of 100.5% of $10.
However, the Company may limit the reset rate to be no higher than the rate on
the two-year benchmark treasury plus 200 basis points (or 2%).
In the case of FELINE PRIDES holders who decide to have their 9% TPS
remarketed, $10 of the proceeds from remarketing each 9% TPS will automatically
be applied to satisfy in full the obligation to purchase Company common stock
under the related stock purchase contract. If the remarketing agent is unable
to remarket the 9% TPS at the reset rate, as described above, the Company may
exercise its right as a secured party to dispose of the 9% TPS in accordance
with the provisions of the FELINE PRIDES, in order to satisfy any unfulfilled
obligation to purchase common stock under the related stock purchase contract.
- ----------
49 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
LONG-TERM DEBT. In August 2002, the Company issued $30 million of 6.49% Senior
Notes due 2009 ("2009 Senior Notes"). Interest on the 2009 Senior Notes is
payable semiannually. The proceeds from the sale were used to redeem $30 million
of 6.83% Senior Notes, which matured on October 1, 2002.
In June 2001, the Company issued $60 million of 8% Senior Notes due 2016
("2016 Senior Notes"). Interest on the 2016 Senior Notes is payable quarterly.
On or after June 30, 2006, the Company may redeem some or all of the 2016 Senior
Notes at a redemption price of 100% of the principal amount plus any accrued and
unpaid interest. The 2016 Senior Notes contain provisions that give the estates
or heirs of deceased 2016 Senior Note holders the right to request that the
Company redeem their 2016 Senior Notes. During 2002, the Company redeemed $110
thousand of 2016 Senior Notes in accordance with these provisions. The proceeds
from the sale of the 2016 Senior Notes were used to repay short-term debt and
for general corporate purposes.
In August 2001, the Company entered into an interest rate swap agreement
with a financial institution in order to hedge its $55 million 8% Notes due June
1, 2004. The swap agreement, which covered the Notes through maturity,
effectively converted the fixed rate on the Notes to a floating rate of
interest. Under the terms of the swap agreement, the Company paid the
counterparty a floating rate of interest based on LIBOR plus a spread of 297
basis points and received payments based on a fixed rate of 8%. During 2002, the
Company terminated the interest rate swap and received $2.2 million. This amount
is being recognized pro-rata in the Company's Consolidated Statements of
Operations, as a reduction in interest expense, over the remaining term of the
$55 million 8% Notes.
In April 2000, the Company sold $30 million of 8% Senior Notes due 2010
("2010 Senior Notes") in a public offering. Interest on the 2010 Senior Notes is
paid semi-annually. The 2010 Senior Notes contain provisions that give the
estates or heirs of deceased 2010 Senior Note holders the right to request that
the Company redeem their 2010 Senior Notes. During 2002, 2001 and 2000, the
Company redeemed $15 thousand, 10 thousand and $50 thousand, respectively, of
2010 Senior Notes in accordance with these provisions.
The Company also sold $105 million of 8.95% Remarketable or Redeemable
Securities ("ROARS") in a public offering in June 2000. The ROARS were issued at
a discount of approximately $.3 million. Interest on the ROARS is payable
semi-annually. The ROARS mature in July 2008; however, the Company may purchase,
or be required to purchase, all of the ROARS in July 2003 if they are not
remarketed as discussed below. The Company used the entire net proceeds from the
sale of the 2010 Senior Notes and ROARS to repay a portion of the bridge loan
utilized for the acquisition of ENSTAR.
In conjunction with the sale of the ROARS, the Company entered into a
remarketing agreement with Banc of America Securities LLC ("BAS") under which
BAS has the option to purchase all the ROARS in July 2003, at 100% of the
aggregate principal amount of the ROARS. The Company received an option premium
of approximately $2.5 million for the remarketing option, which is included with
the ROARS in long-term debt in the Company's Consolidated Statements of
Financial Position. The option premium is being amortized to income over the
life of the ROARS.
If BAS elects to purchase the ROARS in July 2003, and the Company does not
exercise its right to elect a floating interest rate or its right to redeem the
ROARS, both of which are discussed below, BAS will remarket the ROARS at a new
interest rate. The new fixed interest rate would be equal to the sum of 6.5%
(the "Base Rate") and an applicable spread. Under the terms of the ROARS, the
applicable spread is defined as the lowest bid received by BAS from various
leading dealers of publicly traded debt securities, expressed as a spread above
the Base Rate and based on a purchase price equal to the Dollar Price of the
ROARS. The Dollar Price of the ROARS is defined as the present value, at the
remarketing date in July 2003, of the remaining scheduled payments of principal
and interest through maturity in July 2008 calculated at the Base Rate,
discounted to the remarketing date in July 2003 using the rate on U.S. treasury
securities with maturities comparable to the remaining term of the ROARS.
If BAS elects to purchase the ROARS in July 2003, the Company will have the
right to elect that BAS remarket the ROARS for a period of up to one year using
a floating interest rate ("Floating Rate Period") rather than the fixed interest
rate described above. At the end of the Floating Rate Period, BAS can elect to
purchase the ROARS to remarket at a new fixed interest rate as described above.
If BAS elects to purchase the ROARS for remarketing in July 2003 or at the
end of the Floating Rate Period, the Company will also have the right to redeem
the ROARS directly from BAS at either time at the Dollar Price as defined above.
If BAS does not elect to purchase the ROARS in July 2003, the Company is
required to redeem all of the ROARS at that time at 100% of the aggregate
principal amount of the ROARS. If BAS does not exercise its option to purchase
the ROARS at the end of the floating rate period, the Company is required to
redeem all of the ROARS at that time at the Dollar Price.
- ----------
50 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company's long-term and short-term debt agreements contain restrictive
financial covenants including, among others, maintaining a Fixed Charges
Coverage Ratio (as defined in the agreements) of at least 1.50 and placing
limits on the payment of dividends beyond certain levels. Non-compliance with
these covenants could result in an acceleration of the due dates for the debt
obligations under the agreements. As of December 31, 2002, the fixed charges
coverage ratio was 1.89 and the Company was in compliance with all of the
covenants in these agreements.
There are no annual sinking fund requirements for the Company's existing
debt over the next five years. Debt maturing over the next five years includes
the maturity of $55 million of 8.0% notes in 2004, $15 million of 6.5%
medium-term notes in 2005 and $30 million of 7.2% notes in 2007. The Company may
also purchase, or be required to purchase, the $105 million of ROARS in July
2003, or during the subsequent twelve months, if they are not remarketed, as
discussed previously. In addition, if the $101 million of 9% TPS are
successfully remarketed in 2003, they will mature in 2005.
NOTE 5. SHORT-TERM BORROWINGS
During 2002, the Company entered into a $145 million credit agreement with a
group of banks, replacing four lines of credit totaling $145 million, which were
due to expire. The new agreement, all of which is committed, consists of an $80
million three-year revolver and a $65 million 364-day facility, with a one-year
term loan option. The outstanding balances owed by the Company under these
credit facilities at December 31, 2002, 2001 and 2000 were $121.2 million,
$105.5 million, and $133.4 million, respectively. Interest on these credit
facilites is at variable rates, which do not exceed the banks' prime lending
rates.
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(000's)
Notes payable balance at year end. . $121,835 $107,957 $134,142
Unused lines of credit at year end . $ 23,800 $ 39,500 $ 26,650
Average interest rate at year end. . 2.8% 2.6% 7.3%
Maximum borrowings at any month-end. $123,244 $122,033 $371,621
Average borrowings . . . . . . . . . $ 99,584 $101,362 $214,813
Weighted average cost of borrowings. 2.9% 4.8% 7.2%
NOTE 6. 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, with the possible
exception of the ROARS which could be redeemed in July 2003 as discussed in Note
4.
- ----------
51 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The table below shows the estimated fair values of the Company's long-term
debt as of December 31, 2002 and 2001.
DECEMBER 31, 2002 2001
- ------------ -------- --------
(000's)
Long-term debt, including current maturities
Carrying amount. . . . . . . . . . . . . . $366,026 $368,966
Fair value . . . . . . . . . . . . . . . . 376,915 385,416
NOTE 7. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
The Company's business activities expose it to a variety of risks,
including commodity price risk and interest rate risk. The Company's management
identifies risks associated with the Company's business and determines which
risks it wants to manage and which type of instruments it should use to manage
those risks.
The Company records any derivative instruments it enters into under the
provisions of SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," and SFAS 137 and SFAS 138, which were amendments to SFAS 133
(hereinafter collectively referred to as "SFAS 133"). SFAS 133 requires that
every derivative instrument (including certain derivative instruments embedded
in other contracts) be recorded in the Consolidated Statement of Financial
Position as either an asset or liability measured at its fair value. SFAS 133
also 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.
The Company will, from time to time, enter into fixed to floating interest
rate swaps in order to maintain its desired mix of fixed-rate and floating-rate
debt. These swaps are designated as fair value hedges and the difference between
the amounts paid and received under these swaps is recorded as an adjustment to
interest expense over the term of the swap agreement. If the swaps are
terminated, any unrealized gains or losses are recognized pro-rata over the
remaining term of the hedged item as an increase or decrease in interest
expense. The Company entered into one such interest rate swap in August 2001 in
order to hedge the Company's $55 million of 8% Notes due in June 2004. The swap
was terminated in August 2002 and the Company received $2.2 million, which is
being recognized pro-rata, as a reduction in interest expense, over the
remaining term of the Notes. In accordance with SFAS 133, the Company's
Consolidated Statement of Financial Position, at December 31, 2001, included an
asset of $1.9 million and an increase in long-term debt of $1.9 million for this
interest rate swap.
An affiliate, in which the Company has a 50% investment, uses a floating to
fixed interest rate swap agreement to hedge the variable interest rate payments
on a portion of its long-term debt. This swap is designated as a cash flow hedge
and the difference between the amounts paid and received under the swap is
recorded as an adjustment to interest expense over the term of the agreement.
The Company's share of changes in the fair value of the swap are recorded in
accumulated other comprehensive income until the swap is terminated. As a result
of this interest rate swap agreement, the Company's Consolidated Statements of
Financial Position, at December 31, 2002 and December 31, 2001, reflected a $.7
million reduction in the Company's equity investment in the affiliate and in
accumulated other comprehensive income.
NOTE 8. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
PENSIONS. The Company has defined benefit pension plans that cover the
employees of certain companies in the consolidated group. Pension plan benefits
are generally based upon years of service or a combination of 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. The Company also has a supplemental executive retirement plan
("SERP"), which is an unfunded defined benefit pension plan.
- ----------
52 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
During 2000, certain pension plans covering employees at the Company's gas
distribution operations and corporate offices in Michigan and Alaska were
amended. The amendments to certain of the plans included a special frozen
benefit for certain eligible employees. In conjunction with the amendments, the
Company offered early retirement programs to certain eligible employees. The
programs gave the employees the options of receiving either a lump-sum pension
benefit payment or an immediate annuity. Sixty-three employees elected to take
the early retirement offer. As a result of the 2000 early retirement program,
the Company incurred a one-time gain, which reduced 2000 net periodic pension
costs by approximately $.4 million.
Because of unfavorable returns on pension plan assets in 2001 and 2002,
certain pension plans were underfunded at December 31, 2002 and 2001. As a
result, a minimum pension liability of $3.0 million was recorded during 2001 and
an additional minimum pension liability of $8.3 million was recorded in 2002.
The total minimum pension liability at December 31, 2002 was $11.3 million.
OTHER POSTRETIREMENT BENEFITS. The Company has postretirement benefit plans
that provide certain medical and prescription drug benefits to qualified retired
employees, their spouses and covered dependents. Determination of benefits is
based on a combination of the retiree's age and years of service at retirement.
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.
In 2002, 2001 and 2000, the Company expensed retiree medical costs of $2.0
million, $1.9 million and $1.5 million, respectively. The retiree medical
expense for each of those years includes $0.9 million of amortization of
previously deferred retiree medical costs. Prior to getting regulatory approval
for the recovery of retiree medical benefits in rates, the Michigan gas
distribution operation deferred, as a regulatory asset, any portion of retiree
medical expense that was not yet provided for in customer rates. After receiving
rate approval for recovery of such costs, the Company began amortizing, as
retiree medical expense, the amounts previously deferred.
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
---------------------------- -----------------------------
YEARS ENDED DECEMBER 31, 2002 2001 2000 2002 2001 2000
- ------------------------ -------- -------- -------- -------- -------- ---------
(000's)
COMPONENTS OF NET BENEFIT COST
Service cost . . . . . . . . . . . . . $ 2,089 $ 2,097 $ 1,988 $ 357 $ 348 $ 364
Interest cost. . . . . . . . . . . . . 4,222 4,054 4,076 2,377 2,527 2,235
Expected return on plan assets . . . . (5,611) (5,897) (6,600) (2,048) (2,150) (1,967)
Amortization of transition obligation. 40 53 53 922 921 920
Amortization of prior service costs. . 163 150 106 - - -
Amortization of net (gain) or loss . . 264 (301) (502) (553) (601) (950)
Amortization of regulatory asset . . . - - - 899 899 899
Net gain due to special
termination benefits . . . . . . . - - (354) - - -
-------- -------- -------- -------- -------- ---------
Net benefit cost (credit). . . . . . . $ 1,167 $ 156 $(1,233) $ 1,954 $ 1,944 $ 1,501
-------- -------- -------- -------- -------- ---------
The Company has certain Voluntary Employee Benefit Association ("VEBA")
trusts to fund its retiree medical benefits and contributed $0.5 million and
$3.0 million to the trusts in 2001 and 2000, respectively. There were no
contributions to the VEBA trusts during 2002. The Company can also partially
fund retiree medical benefits on a discretionary basis through an Internal
Revenue Code Section 401(h) account. No cash contributions were made to the
401(h) account in 2002, 2001 and 2000.
- ----------
53 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following table provides reconciliations of the plan benefit
obligations, plan assets, and funded status of the plans.
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
---------------------- -----------------------------
Year Ended December 31 2002 2001 2002 2001
- ---------------------- --------- ----------- --------- -----------
(000's)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at January 1 . . . . . . . . . $ 61,175 $ 57,184 $ 33,964 $ 34,323
Service cost. . . . . . . . . . . . . . . . . . . 2,089 2,097 357 348
Interest cost . . . . . . . . . . . . . . . . . . 4,222 4,054 2,377 2,527
Actuarial (gain) loss . . . . . . . . . . . . . . 2,869 3,461 2,370 (1,671)
Benefits paid from plan assets. . . . . . . . . . (3,287) (5,615) - -
Benefits paid from corporate assets,
net of participant contributions . . . . . - - (1,667) (1,563)
Plan amendments . . . . . . . . . . . . . . . . . - (6) (5,610) -
--------- ----------- --------- -----------
Benefit obligation at December 31 . . . . . . . . $ 67,068 $ 61,175 $ 31,791 $ 33,964
--------- ----------- --------- -----------
CHANGE IN PLAN ASSETS
Fair value of plan assets at January 1. . . . . . $ 53,930 $ 62,579 $ 21,964 $ 22,851
Actual return on plan assets. . . . . . . . . . . (5,458) (3,034) (2,589) (1,387)
Company contributions . . . . . . . . . . . . . . 4,225 - - 500
Benefits paid from plan assets. . . . . . . . . . (3,287) (5,615) - -
--------- ----------- --------- -----------
Fair value of plan assets at December 31. . . . . $ 49,410 $ 53,930 $ 19,375 $ 21,964
--------- ----------- --------- -----------
RECONCILIATION OF FUNDED STATUS OF THE PLANS
Funded (unfunded) status. . . . . . . . . . . . . $(17,658) $ (7,245) $(12,416) $ (12,000)
Unrecognized net (gain) loss. . . . . . . . . . . 22,643 8,968 1,456 (6,104)
Unrecognized prior service cost . . . . . . . . . 661 824 (528) -
Unrecognized net transition obligation. . . . . . 25 65 4,133 10,137
Additional minimum pension liability. . . . . . . (11,343) (2,983) - -
--------- ----------- --------- -----------
Prepaid (accrued) benefit cost . . . . . . . . . . $ (5,672) $ (371) $ (7,355) $ (7,967)
--------- ----------- --------- -----------
WEIGHTED AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate . . . . . . . . . . . . . . . . . . 6.75% 7.25% 6.75% 7.25%
Expected long-term rate of return on plan assets. 8.50% 9.75% 8.50% 9.75%
Rate of compensation increase . . . . . . . . . . 4.00% 4.00-5.00% 4.00% 4.00-5.00%
- ----------
54 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The 2002 postretirement medical costs were developed based on the health
care plan in effect at January 1, 2002. As of December 31, 2002, the actuary
assumed that retiree medical cost increases in 2003 would be 7% and prescription
drug cost increases in 2003 would be 12%. The actuary also assumed that the rate
of increase in retiree medical costs and prescription drug costs would decrease
uniformly to 5% in 2008 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, 2002 by $4.4 million and the aggregate of
the service and interest cost components of net periodic retiree medical costs
for 2002 by $.4 million.
401(K) PLANS AND PROFIT SHARING PLANS. The Company has defined contribution
plans, commonly referred to as 401(k) plans, covering the employees of certain
of its businesses or divisions. Certain of the 401(k) plans contain provisions
for Company matching contributions. The amount expensed for the Company match
provisions was $1.1 million for 2002, 2001 and 2000.
The Company has profit sharing plans covering the employees of certain of
its businesses or divisions. Annual contributions are generally discretionary or
determined by a formula, which contains minimum contribution requirements.
Profit sharing expense was $.4 million for 2002 and $.3 million for 2001 and
2000.
NOTE 9. STOCK-BASED COMPENSATION
The Company has a long-term incentive plan providing for the issuance of up to
500,000 shares of non-qualified common stock options, adjusted for any
subsequent stock dividends and stock splits. During 2000, the Company's Board of
Directors approved a second such plan that provides for the issuance of
non-qualified stock options up to an amount not to exceed five percent of the
total outstanding shares of the Company. 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.
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. The fair value of
the options was estimated at the date of grant using a Black-Scholes option
pricing model and the weighted average assumptions shown in the table below.
2002 2001 2000
------- ------- -------
Risk-free interest rate. . . . 4.45% 4.92% 6.55%
Dividend yield . . . . . . . . 6.63% 5.86% 6.98%
Volatility . . . . . . . . . . 34.39% 29.42% 24.96%
Average expected term (years). 5 5 5
Fair value of options granted. $ 1.41 $ 2.57 $ 1.80
The following table summarizes information concerning outstanding and
exercisable options at December 31, 2002.
Options Outstanding Options Exercisable
------------------------------------- ----------------------
Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercisable Prices Outstanding Life in Years Price ($) Exercisable Price ($)
- --------------------------- ----------- ------------- --------- ----------- ---------
$6.94 - $9.99 . . . . . 251,979 9.2 7.48 - -
$11.50 - $14.35 . . . . . 436,181 6.9 13.62 229,750 13.30
$14.37 - $15.95 . . . . . 349,958 6.6 14.91 213,292 15.24
$16.19 - $17.14 . . . . . 101,100 3.3 17.02 101,100 17.02
----------- ------------- --------- ----------- ---------
1,139,218 544,142
----------- ------------- --------- ----------- ---------
- ----------
55 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
There were 989,000 employee stock options available for grant at December
31, 2002. The following table shows the stock option activity during the past
three years and the number of stock options exercisable under the Company's
plans at the end of each such year.
Number Weighted Average
of Shares Exercise Price ($)
---------- ------------------
OUTSTANDING AT DECEMBER 31, 1999 . . . . 317,786 16.16
Granted . . . . . . . . . . . . . 192,701 12.07
Exercised . . . . . . . . . . . . - -
Canceled. . . . . . . . . . . . . (44,707) 14.18
OUTSTANDING AT DECEMBER 31, 2000 . . . . 465,780 14.65
Granted . . . . . . . . . . . . . 555,040 14.33
Exercised . . . . . . . . . . . . (667) 11.94
Canceled. . . . . . . . . . . . . (71,404) 14.25
OUTSTANDING AT DECEMBER 31, 2001 . . . . 948,749 14.49
Granted . . . . . . . . . . . . . 251,979 7.48
Exercised . . . . . . . . . . . . - -
Canceled. . . . . . . . . . . . . (61,510) 14.16
OUTSTANDING AT DECEMBER 31, 2002 . . . . 1,139,218 12.96
OPTIONS EXERCISABLE AT DECEMBER 31, 2000 200,924 16.38
OPTIONS EXERCISABLE AT DECEMBER 31, 2001 298,403 15.48
OPTIONS EXERCISABLE AT DECEMBER 31, 2002 544,142 14.75
The Company accounts for all stock options under the provisions and related
interpretations of Accounting Principles Board ("APB") Opinion 25, "Accounting
for Stock Issued to Employees." In accordance with SFAS 123, "Accounting for
Stock-Based Compensation," the Company has chosen to continue accounting for
these transactions under APB 25 for purposes of determining net income and to
present the pro forma disclosures required by SFAS 123. If compensation 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 in the table below.
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ ------ -------- -------
(000's)
NET INCOME (LOSS)
As reported. . . . . . $8,949 $(6,361) $16,693
Pro forma. . . . . . . $8,533 $(6,664) $16,517
EARNINGS PER SHARE - BASIC
As reported. . . . . . $ 0.48 $ (0.35) $ 0.93
Pro forma. . . . . . . $ 0.46 $ (0.37) $ 0.92
EARNINGS PER SHARE - DILUTED
As reported. . . . . . $ 0.48 $ (0.35) $ 0.90
Pro forma. . . . . . . $ 0.46 $ (0.37) $ 0.89
- ----------
56 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. 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 and stock purchase contracts ("dilutive securities")
were exercised. The diluted EPS calculation excludes the affect of stock
options when their exercise prices exceed the average market price of the
Company's common stock during the period and excludes the affect of stock
purchase contracts when their reference price exceeds the average market price
of common stock during the period.
The following table provides the computations of basic and diluted earnings
per share for the years ended December 31, 2002, 2001 and 2000.
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ ------- -------- -------
(000's, except per share amounts)
EARNINGS PER SHARE COMPUTATION
Income (loss) from continuing operations. . . . . . $ 8,939 $ (239) $16,598
Discontinued operations (a) . . . . . . . . . . . . 10 (6,122) 95
------- -------- -------
Net income (loss) available to common shareholders. $ 8,949 $(6,361) $16,693
------- -------- -------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC. . . . . 18,472 18,106 17,999
------- -------- -------
EARNINGS PER SHARE - BASIC
Income (loss) from continuing operations. . . . . . $ 0.48 $ (0.01) $ 0.92
Discontinued operations (a) . . . . . . . . . . . . 0.00 (0.34) 0.01
------- -------- -------
Net income (loss) available to common shareholders. $ 0.48 $ (0.35) $ 0.93
------- -------- -------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING. . . . . . . . . 18,472 18,106 17,999
Incremental shares from assumed conversions of:
FELINE PRIDES - stock purchase contracts (b). . . . - - 599
Stock options (b) . . . . . . . . . . . . . . . . . 21 - 21
------- -------- -------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - DILUTED (b). . 18,493 18,106 18,619
------- -------- -------
EARNINGS PER SHARE - DILUTED
Income (loss) from continuing operations. . . . . . $ 0.48 $ (0.01) $ 0.89
Discontinued operations (a) . . . . . . . . . . . . 0.00 (0.34) 0.01
------- -------- -------
Net income (loss) available to common shareholders. $ 0.48 $ (0.35) $ 0.90
------- -------- -------
<FN>
(a) Effective December 2001, the Company began accounting for the engineering services
business as a discontinued operation. Accordingly, its operating results are
segregated and reported as discontinued operations in the Consolidated Statements
of Operations.
(b) The FELINE PRIDES and stock options were not included in the computation of
diluted earnings per share for 2001 because their effect was antidilutive.
- ----------
57 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. BUSINESS SEGMENTS
The Company follows SFAS 131, "Disclosure about Segments of an Enterprise and
Related Information," which specifies 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 who 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, discontinued operations, 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 can be combined
and reported as one segment and referred to as "all other." The Company's
propane, pipelines and storage business segment and information technology
services 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 business segments.
The Company currently operates four reportable business segments. They are
gas distribution, construction services, information technology services, and
propane, pipelines and storage. Refer to Note 1 for a brief description of each
business segment.
In December 2001, the Company's board of directors approved a plan to
redirect the Company's business strategy, which included the divestiture of its
engineering services business. The operating results of the engineering services
business are segregated and reported as discontinued operations in the
Consolidated Statements of Operations. The Company sold its engineering services
business effective November 1, 2002. For further information refer to Note 14 of
the Notes to Consolidated Financial Statements.
The accounting policies of the Company's four 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.
- ----------
58 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002 2001 2000
- ------------------------ --------- --------- ---------
(000's)
OPERATING REVENUES (a)
Gas distribution. . . . . . . . . . . . . . . . $364,711 $324,365 $307,851
Construction services . . . . . . . . . . . . . 119,254 126,205 105,231
Information technology services (b) . . . . . . 9,618 10,275 5,184
Propane, pipelines and storage. . . . . . . . . 7,058 7,443 6,949
Corporate and other(c). . . . . . . . . . . . . (19,676) (22,465) (14,890)
--------- --------- ---------
Total consolidated revenues . . . . . . $480,965 $445,823 $410,325
--------- --------- ---------
DEPRECIATION AND AMORTIZATION (a)
Gas distribution. . . . . . . . . . . . . . . . $ 25,342 $ 27,180 $ 26,272
Construction services . . . . . . . . . . . . . 8,049 7,504 5,360
Information technology services (b) . . . . . . 586 397 60
Propane, pipelines and storage. . . . . . . . . 931 1,008 999
Corporate and other . . . . . . . . . . . . . . 429 416 360
--------- --------- ---------
Total consolidated depreciation . . . . $ 35,337 $ 36,505 $ 33,051
--------- --------- ---------
OPERATING INCOME (LOSS) (a)
Gas distribution. . . . . . . . . . . . . . . . $ 59,076 $ 50,337 $ 62,876
Construction services . . . . . . . . . . . . . (1,999) (1,374) 3,676
Information technology services (b) . . . . . . 602 431 481
Propane, pipelines and storage. . . . . . . . . 1,946 1,871 1,530
Corporate and other . . . . . . . . . . . . . . (2,916) (6,874) (3,330)
--------- --------- ---------
Total consolidated operating income . . $ 56,709 $ 44,391 $ 65,233
--------- --------- ---------
ASSETS AT YEAR END
Gas distribution. . . . . . . . . . . . . . . . $741,613 $734,115 $741,593
Construction services . . . . . . . . . . . . . 72,170 74,453 69,276
Engineering services(a) . . . . . . . . . . . . - 4,302 8,837
Information technology services (b) . . . . . . 4,569 4,384 1,808
Propane, pipelines and storage. . . . . . . . . 22,443 23,125 24,827
Corporate and other . . . . . . . . . . . . . . 35,719 23,169 4,882
--------- --------- ---------
Total consolidated assets . . . . . . . $876,514 $863,548 $851,223
--------- --------- ---------
CAPITAL INVESTMENTS (d)
Gas distribution. . . . . . . . . . . . . . . . $ 29,972 $ 34,074 $ 47,466
Construction services . . . . . . . . . . . . . 3,001 14,855 15,318
Engineering services (a). . . . . . . . . . . . - 275 209
Information technology services (b) . . . . . . 437 1,960 2,143
Propane, pipelines and storage. . . . . . . . . 267 335 251
Corporate and other . . . . . . . . . . . . . . 1,300 3,945 3,033
--------- --------- ---------
Total consolidated capital investments. $ 34,977 $ 55,444 $ 68,420
--------- --------- ---------
<FN>
(a) Effective December 2001, the Company began accounting for the engineering services
segment as a discontinued operation. Accordingly, its operating results are
segregated and reported as discontinued operations in the Consolidated Statements
of Operations.
(b) Operations began for the information technology services segment in April 2000.
(c) Includes the elimination of intercompany construction service revenue of
$11,889,000, $12,986,000 and $9,694,000 for 2002, 2001 and 2000, respectively.
Includes the elimination of intercompany information technology revenue of
$7,620,000, $9,349,000 and $5,032,000 for 2002, 2001 and 2000, respectively.
(d) Capital investments include purchase of property, plant and equipment and net
amounts paid for business acquisitions, including non-cash amounts such as
deferrred payments and the value, at the time of issuance, of Company stock issued
as part of the acquisitions.
- ----------
59 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. INVESTMENT IN AFFILIATE
The equity method of accounting is used for interests where the Company has
significant influence, but does not control the entity. At December 31, 2002,
the Company's only investment in affiliates was a 50% ownership interest in the
Eaton Rapids Gas Storage System ("ERGSS"). The investment in the unconsolidated
affiliate is reported in deferred charges and other assets in the Consolidated
Statements of Financial Position. ERGSS provides natural gas storage services
to the Company's Gas Distribution Business. ERGSS had annual operating revenues
associated with services provided to the Gas Distribution Business of $3.2
million in 2002 and $3.0 million in 2001 and 2000. The table below summarizes
the financial information for ERGSS.
2002 2001 2000
------- ------- -------
(000's)
Operating revenues . . . . . . . . $ 5,791 $ 5,714 $ 5,806
Operating income . . . . . . . . . $ 3,718 $ 3,489 $ 3,579
Net income . . . . . . . . . . . . $ 2,747 $ 2,379 $ 2,372
The Company's share of net income. $ 1,374 $ 1,190 $ 1,186
Current assets . . . . . . . . . . $ 2,647 $ 3,598 $ 1,435
Non-current assets . . . . . . . . 23,491 20,552 22,767
------- ------- -------
Total assets . . . . . . . . . . . $26,138 $24,150 $24,202
------- ------- -------
Current liabilities. . . . . . . . $ 5,679 $ 3,332 $ 2,024
Non-current liabilities. . . . . . 11,147 12,567 13,023
Equity . . . . . . . . . . . . . . 9,312 8,251 9,155
------- ------- -------
Total liabilities and equity . . . $26,138 $24,150 $24,202
------- ------- -------
The Company's equity investment. . $ 4,656 $ 4,126 $ 4,165
NOTE 13. COMMITMENTS AND CONTINGENCIES
CAPITAL INVESTMENTS. The Company's plans for expansion and improvement of its
business properties are continually reviewed. Aggregate capital expenditures for
property in 2003 are projected at approximately $33 million. The Company has no
plans to incur additional expenditures for business acquisitions in 2003.
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." A significant portion of the Company's vehicles are
leased. Leases on the majority of the Company's 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. During 2002, the Company
received $4.4 million in proceeds from the sale of two buildings and land. The
Company is leasing these facilities back over the period January 2003 through
September 2005 for normal operating purposes. The annual lease payments during
this period will amount to approximately $.5 million.
The Company's future minimum lease payments that have initial or remaining
noncancelable lease terms in excess of one year at December 31, 2002 totaled
$13.1 million consisting of (in millions): 2003 - $1.8; 2004 - $1.7; 2005 -
$1.3; 2006 - $1.1; 2007 - $1.1 and thereafter - $6.1. Total lease expense
approximated $2.2 million, $2.5 million and $2.3 million in 2002, 2001 and 2000,
respectively. The annual future minimum lease payments are less than the lease
expense incurred in 2000 through 2002 because most of the vehicle leases at
December 31, 2002 were on a month-to-month basis and were subject to
cancellation at any time. However, management expects to renew or replace
substantially all leases.
- ----------
60 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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 Company owns seven Michigan 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 one other site. The
Company has closed a related site with the approval of the appropriate
environmental regulatory authority in the State of Michigan, and has developed
plans and conducted preliminary field investigations at two other sites. The
Company is in the process of estimating its liabilities and potential costs in
connection with these sites, but the amounts of these estimates are not yet
available. 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.
PERSONAL PROPERTY TAXES. The Company and other Michigan utilities have asserted
that Michigan's valuation tables in effect prior to 2000 resulted in the
substantial overvaluation of utility personal property. Valuation tables
established by the Michigan State Tax Commission ("STC") are used to estimate
the reduction in value of personal property based on the property's age. In
1998, the Company began filing its personal property tax information with local
taxing jurisdictions, using a revised calculation of the value of personal
property subject to taxation. A number of local taxing jurisdictions accepted
the revised calculation, and the Company recorded lower property tax expense in
1998 and subsequent years associated with the accepting taxing jurisdiction. The
Company has also filed appeals to recover excess payments made in 1997 and
subsequent years based on the revised calculation and recorded lower property
tax expense as a result of the filings.
In November 1999, the STC approved new valuation tables that more
accurately recognize the value of a utility's personal property. The new tables
became effective in 2000 and are being used for current year assessments in most
jurisdictions. However, several local taxing jurisdictions have taken legal
action attempting to prevent the STC from implementing the new valuation tables
and have continued to prepare assessments based on the superceded tables.
The Company will seek to apply the new tables retroactively and to
ultimately settle the pending tax appeals related to prior periods. This is a
solution supported by the STC in the past. The legal action, along with possible
additional appeals by local taxing jurisdictions or negotiated settlements, may
delay the time period for recovery and ultimately impact the amount of recovery.
As of December 31, 2002, the Company had a receivable of approximately $4.0
million recorded for the Company's estimated recovery of these prior year excess
property tax payments.
On November 7, 2002, the MPSC issued an order requiring each natural gas
and electric utility company subject to its jurisdiction to show cause as to why
each such utility should not reduce its rates to reflect the new personal
property valuation tables that were placed in effect in 2000 by the STC and why
it should not refund to the ratepayers any recovery amounts it receives as
refunds from taxing jurisdictions as it implements the new valuation tables. The
Company filed a response to the Order in December 2002. In its response, the
Company stated that its rates should not be reduced and that refunds to
customers should not be required as a result of changes in personal property tax
multipliers. The reasons sighted by the Company were that (1) its existing rates
have been and currently are insufficient for it to earn its authorized rate of
return, (2) most of the potential for refunds relates to disputes arising out of
tax years prior to the change in the tax multipliers, (3) for that portion of
the receivable applicable to the change in the rate multipliers, customers have
already received the benefits of the resulting lower property tax expenses
through certain incentive regulation and income sharing rate mechanisms that
were implemented in conjunction with the Company's approved rates and (4) to
order any refund to customers of amounts received by the Company from taxing
authorities would constitute prohibited retroactive ratemaking.
OTHER CONTINGENCIES. Under the terms of the Company's acquisition agreement,
the former owners of K&B Construction were given the opportunity to receive
additional consideration if future results of operations exceed certain targeted
levels. The amounts potentially payable to the former owners of K&B are subject
to set-off for certain liabilities. There has been no additional consideration
paid in connection with the K&B acquisition. The amounts potentially payable
have been placed in escrow and are reflected in restricted cash in the Company's
Consolidated Statements of Financial Position pending the outcome of certain
claims and litigation.
In the normal course of business, the Company may be a party to certain
lawsuits and administrative proceedings before various courts and government
agencies. These lawsuits and proceedings may involve personal injury, property
damage, contractual issues and other matters. Management cannot predict the
ultimate outcome of any pending or threatening litigation or of actual or
possible claims; however, management believes resulting liabilities, if any,
will not have a material adverse impact upon the Company's financial position or
results of operations.
- ----------
61 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14. RESTRUCTURING AND DISCONTINUATION OF OPERATIONS
During the fourth quarter of 2001, the Company announced a redirection of its
business strategy and began restructuring its corporate, business unit and
operational structures. This involved the integration of the Company's Michigan
and Alaska gas distribution divisions and the closure of the Company's
Houston-based engineering and construction headquarters and related
consolidation of administrative functions in Michigan. The redirection also
involved the divestiture of the Company's engineering services business and the
ceasing of operations in certain regions of the construction business that were
not likely to contribute to shareholder value in the near term. The new strategy
concentrates more on profitable growth within each line of business and less on
acquisitions.
The Company recorded $6.1 million of restructuring and impairment charges
in the fourth quarter of 2001 for the planned restructuring activities and the
ceasing of operations in certain regions of its construction business. The
charges are included in operating expenses in the Consolidated Statements of
Operations and include severance expense, costs associated with terminating
leases, writedowns of certain construction operations and other related
expenses. There was no material adjustment to the restructuring and impairment
charges during 2002.
The activities of the Company's engineering services business have been
accounted for as a discontinued operation and, accordingly, the operating
results and the loss on the disposal of this business segment are segregated and
reported as discontinued operations in the Consolidated Statements of
Operations. Operating results, net of income taxes, from the discontinued
operations were $(1.1) million and $0.1 million for 2001 and 2000, respectively.
In the fourth quarter of 2001, the Company recorded a loss of $5.0 million, net
of income taxes, for the estimated loss the Company expected to incur on the
disposal of its engineering business segment, including estimated losses from
operations during the phase-out period. In November 2002, the Company sold its
engineering services business. The sale resulted in a loss, net of income taxes,
of $5.0 million, including actual operating losses during the phase-out period.
There was a difference of $10 thousand between the actual losses and the
estimated losses, which is included in discontinued operations for 2002.
Components of amounts reflected in the Consolidated Statements of Income
and Consolidated Statements of Financial Position for the engineering services
business are presented in the following table.
2002 2001 2000
----- -------- --------
(000's)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
Revenues. . . . . . . . . . . . . . . . . . . . . $ - $12,247 $20,655
Operating expenses. . . . . . . . . . . . . . . . - 14,340 20,630
Operating income (loss) . . . . . . . . . . . . . - (2,093) 25
Other income (deductions) . . . . . . . . . . . . - 257 122
Income tax benefit (expense). . . . . . . . . . . - 694 (52)
----- -------- --------
Income (loss) from discontinued operations. . . . $ - $(1,142) $ 95
----- -------- --------
Gain (loss) on divestiture of discontinued
operations, including losses during
phase-out period, net of income tax (expense)
benefit of ($1,276), $2,429 and $0. . . . . . . $ 10 (4,980) -
----- -------- --------
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION DATA
Current assets. . . . . . . . . . . . . . . . . . $ - $ 4,050 $ 5,136
Property, plant and equipment, net. . . . . . . . - 250 1,233
Deferred charges and other assets, net. . . . . . - 2 2,468
Current liabilities . . . . . . . . . . . . . . . - (4,880) (3,401)
Deferred credits and other liabilities. . . . . . - - (911)
----- -------- --------
Net assets (liabilities) of discontinued
operations held for sale . . . . . . . . . . . $ - $ (578) $ 4,525
----- -------- --------
- ----------
62 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15. 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 for each quarter are calculated based
upon the weighted average number of shares outstanding during each quarter. As a
result, adding the earnings or dividends per share for each quarter of a year
may not equal annual earnings or dividends 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.
Quarters First Second Third Fourth
- -------- -------- --------- -------- ---------
(000's, except per share amounts)
2002
Operating revenues. . . . . . . . . . . . $155,911 $106,100 $72,693 $146,261
Operating income. . . . . . . . . . . . . 28,619 10,341 (346) 18,095
Income (loss) from continuing operations. 11,330 45 (7,014) 4,578
Net income (loss) available to common
shareholders. . . . . . . . . . . . . . 11,330 45 (7,014) 4,588
Earnings per share from income (loss)
from continuing operations:
- basic. . . . . . . . . . . . . . . . 0.62 - (0.38) 0.25
- diluted. . . . . . . . . . . . . . . 0.62 - (0.38) 0.25
Earnings per share from net income (loss)
available to common shareholders:
- basic. . . . . . . . . . . . . . . . 0.62 - (0.38) 0.25
- diluted. . . . . . . . . . . . . . . 0.62 - (0.38) 0.25
Cash dividends per share. . . . . . . . . 0.21 0.13 0.13 0.13
-------- --------- -------- ---------
2001
Operating revenues. . . . . . . . . . . . $149,978 $ 86,512 $76,804 $132,529
Operating income. . . . . . . . . . . . . 25,666 5,344 939 12,442
Income (loss) from continuing operations. 9,478 (3,345) (6,503) 131
Net income (loss) available to common
shareholders. . . . . . . . . . . . . . 9,056 (3,339) (6,645) (5,433)
Earnings per share from income (loss)
from continuing operations:
- basic. . . . . . . . . . . . . . . . 0.52 (0.19) (0.36) 0.01
- diluted. . . . . . . . . . . . . . . 0.50 (0.19) (0.36) 0.01
Earnings per share from net income (loss)
available to common shareholders:
- basic. . . . . . . . . . . . . . . . 0.50 (0.18) (0.37) (0.30)
- diluted. . . . . . . . . . . . . . . 0.48 (0.18) (0.37) (0.30)
Cash dividends per share. . . . . . . . . 0.21 0.21 0.21 0.21
-------- --------- -------- ---------
- ----------
63 -- SEMCO ENERGY, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, 2002 2001 2000 1999
- ------------------------ ---------------- --------------- --------------- ------------
STATEMENT OF OPERATIONS DATA (000's)
Operating revenue . . . . . . . . . . . . . . . . . . . . . $480,965 $445,823 $410,325 $369,922
--------- --------- --------- ---------
Operating expenses
Cost of gas sold. . . . . . . . . . . . . . . . . . . . . $220,422 $184,973 $161,945 $117,789
Cost of gas marketed. . . . . . . . . . . . . . . . . . . - - - 95,632
Operations and maintenance. . . . . . . . . . . . . . . . 156,653 162,289 $140,236 85,696
Depreciation. . . . . . . . . . . . . . . . . . . . . . . 35,337 36,505 $ 33,051 19,742
Property and other taxes. . . . . . . . . . . . . . . . . 11,844 11,562 9,860 8,660
Restructuring and impairment charges. . . . . . . . . . . - 6,103 - -
--------- --------- --------- ---------
$424,256 $401,432 $345,092 $327,519
--------- --------- --------- ---------
Operating Income. . . . . . . . . . . . . . . . . . . . . . $ 56,709 $ 44,391 $ 65,233 $ 42,403
Other income (deductions) . . . . . . . . . . . . . . . . . (29,030) (29,449) (32,077) (16,750)
--------- --------- --------- ---------
Income (loss) before income taxes and
dividends on trust preferred securities . . . . . . . . . $ 27,679 $ 14,942 $ 33,156 $ 25,653
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . 10,139 6,578 11,554 7,631
Dividends on trust preferred securities, net of income tax. 8,601 8,603 5,004 -
--------- --------- --------- ---------
Income (loss) from continuing operations. . . . . . . . . . $ 8,939 $ (239) $ 16,598 $ 18,022
Discontinued operations, extraordinary charges
and changes in accounting methods . . . . . . . . . . . . 10 (f) (6,122)(f) 95 (f) (363)(f)
--------- --------- --------- ---------
Net income (loss) available to common shareholders. . . . . $ 8,949 (f) $ (6,361)(f) $ 16,693 (f) $ 17,659 (f)
Common dividends. . . . . . . . . . . . . . . . . . . . . . 10,776 15,193 15,033 15,272
--------- --------- --------- ---------
Earnings (deficit) reinvested in the business . . . . . . . $ (1,827) $(21,554) $ 1,660 $ 2,387
--------- --------- --------- ---------
COMMON STOCK DATA
Average shares outstanding (000's) (a)
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . 18,472 18,106 17,999 17,697
Diluted (b). . . . . . . . . . . . . . . . . . . . . . . 18,493 18,106 18,619 17,720
Earnings per share on net income (loss) available
to common shareholders (a)
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.48 (f) $ (0.35)(f) $ 0.93 (f) $ 1.00 (f)
Diluted (b). . . . . . . . . . . . . . . . . . . . . . . $ 0.48 (f) $ (0.35)(f) $ 0.90 (f) $ 1.00 (f)
Dividends paid per share (a). . . . . . . . . . . . . . . . $ 0.59 $ 0.84 $ 0.84 $ 0.87 (n)
Dividends payout ratio. . . . . . . . . . . . . . . . . . . 120.4% N/A 90.1% 86.5%
Book value per share (a) (c). . . . . . . . . . . . . . . . $ 5.89 $ 6.24 $ 7.50 $ 7.95
Market value per share (a) (c) (d). . . . . . . . . . . . . $ 6.10 $ 10.75 $ 15.56 $ 11.81
Number of registered common shareholders (c). . . . . . . . 9,087 9,327 9,517 9,217
BALANCE SHEET DATA (000's) (c)
Total assets. . . . . . . . . . . . . . . . . . . . . . . . $876,514 $863,548 $851,223 $815,183
--------- --------- --------- ---------
Capitalization
Long-term debt (e). . . . . . . . . . . . . . . . . . . . . $366,026 $368,966 $307,930 $170,000
Company-obligated mandatorily redeemable
trust preferred securities of subsidiaries . . . . . . . 139,436 139,394 139,374 --
Preferred stock . . . . . . . . . . . . . . . . . . . . . . -- -- -- --
Common equity . . . . . . . . . . . . . . . . . . . . . . . 110,022 113,810 135,472 142,340
--------- --------- --------- ---------
$615,484 $622,170 $582,776 $312,340
--------- --------- --------- ---------
FINANCIAL RATIOS
Capitalization
Long-term debt (e). . . . . . . . . . . . . . . . . . . . . 59.5% 59.3% 52.8% 54.4%
Company-obligated mandatorily redeemable
trust preferred securities of subsidiaries . . . . . . . 22.6% 22.4% 23.9% --
Preferred stock . . . . . . . . . . . . . . . . . . . . . . -- -- -- --
Common equity . . . . . . . . . . . . . . . . . . . . . . . 17.9% 18.3% 23.3% 45.6%
--------- --------- --------- ---------
100.0% 100.0% 100.0% 100.0%
--------- --------- --------- ---------
Return on average common equity . . . . . . . . . . . . . . 8.0% (5.1)% 12.0% 12.9%
--------- --------- --------- ---------
YEARS ENDED DECEMBER 31, 1998 1997 1996 1995
- ------------------------ ---------------- --------------- --------------- ------------
STATEMENT OF OPERATIONS DATA (000's)
Operating revenue . . . . . . . . . . . . . . . . . . . . . $596,548 $770,272 $544,949 $335,538
--------- --------- --------- ---------
Operating expenses
Cost of gas sold. . . . . . . . . . . . . . . . . . . . . $109,388 $150,967 $151,135 $120,619
Cost of gas marketed. . . . . . . . . . . . . . . . . . . 386,691 518,157 308,619 130,087
Operations and maintenance. . . . . . . . . . . . . . . . 55,064 50,562 40,669 36,217
Depreciation. . . . . . . . . . . . . . . . . . . . . . . 15,167 12,863 11,317 12,035
Property and other taxes. . . . . . . . . . . . . . . . . 8,981 9,334 8,648 7,966
Restructuring and impairment charges. . . . . . . . . . . - - - -
--------- --------- --------- ---------
$575,291 $741,883 $520,388 $306,924
--------- --------- --------- ---------
Operating Income. . . . . . . . . . . . . . . . . . . . . . $ 21,257 $ 28,389 $ 24,561 $ 28,614
Other income (deductions) . . . . . . . . . . . . . . . . . (8,986)(i) (5,240)(j) (44,672)(l) (11,132)
--------- --------- --------- ---------
Income (loss) before income taxes and
dividends on trust preferred securities . . . . . . . . . $ 12,271 $ 23,149 $(20,111) $ 17,482
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . 5,188 8,228 (7,308) 6,151
Dividends on trust preferred securities, net of income tax. - - - -
--------- --------- --------- ---------
Income (loss) from continuing operations. . . . . . . . . . $ 7,083 $ 14,921 $(12,803) $ 11,331
Discontinued operations, extraordinary charges
and changes in accounting methods . . . . . . . . . . . . 2,957 (f)-(h) 504 (f) 41 (f) -
--------- --------- --------- ---------
Net income (loss) available to common shareholders. . . . . $ 10,040 (f)-(i) $ 15,425 (f)(j) $(12,762)(f)(l) $ 11,331
Common dividends. . . . . . . . . . . . . . . . . . . . . . 11,836 10,225 9,814 9,230
--------- --------- --------- ---------
Earnings (deficit) reinvested in the business . . . . . . . $ (1,796) $ 5,200 $(22,576) $ 2,101
--------- --------- --------- ---------
COMMON STOCK DATA
Average shares outstanding (000's) (a)
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . 15,906 14,608 14,573 13,696
Diluted (b). . . . . . . . . . . . . . . . . . . . . . . (b) (b) (b) (b)
Earnings per share on net income (loss) available
to common shareholders (a)
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.63 (f)-(i) $ 1.06 (f)(j) $ (0.88)(f)(l) $ 0.83
Diluted (b). . . . . . . . . . . . . . . . . . . . . . . $ 0.63 $ 1.06 $ (0.88) $ 0.83
Dividends paid per share (a). . . . . . . . . . . . . . . . $ 0.744 $ 0.700 $ 0.673 $ 0.674
Dividends payout ratio. . . . . . . . . . . . . . . . . . . 117.9% 66.0% N/A 81.5%
Book value per share (a) (c). . . . . . . . . . . . . . . . $ 7.61 $ 6.44 $ 5.95 $ 7.99
Market value per share (a) (c) (d). . . . . . . . . . . . . $ 16.31 $ 17.26 $ 16.78 $ 15.54
Number of registered common shareholders (c). . . . . . . . 9,336 8,755 8,509 8,334
BALANCE SHEET DATA (000's) (c)
Total assets. . . . . . . . . . . . . . . . . . . . . . . . $489,662 $507,160 $479,037 $378,523
--------- --------- --------- ---------
Capitalization
Long-term debt (e). . . . . . . . . . . . . . . . . . . . . $170,000 $163,548 $108,112 $107,325
Company-obligated mandatorily redeemable
trust preferred securities of subsidiaries . . . . . . . -- -- -- --
Preferred stock . . . . . . . . . . . . . . . . . . . . . . 3,255 3,269 3,269 3,272
Common equity . . . . . . . . . . . . . . . . . . . . . . . 132,228 95,131 86,678 109,511
--------- --------- --------- ---------
$305,483 $261,948 $198,059 $220,108
--------- --------- --------- ---------
FINANCIAL RATIOS
Capitalization
Long-term debt (e). . . . . . . . . . . . . . . . . . . . . 55.6% 62.4% 54.6% 48.8%
Company-obligated mandatorily redeemable
trust preferred securities of subsidiaries . . . . . . . -- -- -- --
Preferred stock . . . . . . . . . . . . . . . . . . . . . . 1.1% 1.3% 1.6% 1.5%
Common equity . . . . . . . . . . . . . . . . . . . . . . . 43.3% 36.3% 43.8% 49.7%
--------- --------- --------- ---------
100.0% 100.0% 100.0% 100.0%
--------- --------- --------- ---------
Return on average common equity . . . . . . . . . . . . . . 8.8% 17.0%(k) (13.0)%(m) 10.4%
--------- --------- --------- ---------
YEARS ENDED DECEMBER 31, 1994 1993 1992
- ------------------------ ---------------- --------------- ---------------
STATEMENT OF OPERATIONS DATA (000's)
Operating revenue . . . . . . . . . . . . . . . . . . . . . $372,430 $288,963 $251,526
--------- --------- ---------
Operating expenses
Cost of gas sold. . . . . . . . . . . . . . . . . . . . . $135,669 $139,051 $121,643
Cost of gas marketed. . . . . . . . . . . . . . . . . . . 153,973 67,474 52,347
Operations and maintenance. . . . . . . . . . . . . . . . 35,558 34,496 33,590
Depreciation. . . . . . . . . . . . . . . . . . . . . . . 11,549 12,468 12,344
Property and other taxes. . . . . . . . . . . . . . . . . 8,186 8,446 7,729
Restructuring and impairment charges. . . . . . . . . . . - - -
--------- --------- ---------
$344,935 $261,935 $227,653
--------- --------- ---------
Operating Income. . . . . . . . . . . . . . . . . . . . . . $ 27,495 $ 27,028 $ 23,873
Other income (deductions) . . . . . . . . . . . . . . . . . (11,658) (11,612) (11,022)
--------- --------- ---------
Income (loss) before income taxes and
dividends on trust preferred securities . . . . . . . . . $ 15,837 $ 15,416 $ 12,851
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . 4,559 5,676 3,640
Dividends on trust preferred securities, net of income tax. - - -
--------- --------- ---------
Income (loss) from continuing operations. . . . . . . . . . $ 11,278 $ 9,740 $ 9,211
Discontinued operations, extraordinary charges
and changes in accounting methods . . . . . . . . . . . . (1,286)(g) (177)(g) (901)(g)
--------- --------- ---------
Net income (loss) available to common shareholders. . . . . $ 9,992 (g) $ 9,563 (g) $8,310 (g)
Common dividends. . . . . . . . . . . . . . . . . . . . . . 8,656 7,419 6,875
--------- --------- ---------
Earnings (deficit) reinvested in the business . . . . . . . $ 1,336 $ 2,144 $ 1,435
--------- --------- ---------
COMMON STOCK DATA
Average shares outstanding (000's) (a)
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . 13,440 12,155 11,835
Diluted (b). . . . . . . . . . . . . . . . . . . . . . . (b) (b) (b)
Earnings per share on net income (loss) available
to common shareholders (a)
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.74 (g) $ 0.79 (g) $ 0.70 (g)
Diluted (b). . . . . . . . . . . . . . . . . . . . . . . $ 0.74 $ 0.79 $ 0.70
Dividends paid per share (a). . . . . . . . . . . . . . . . $ 0.644 $ 0.610 $ 0.581
Dividends payout ratio. . . . . . . . . . . . . . . . . . . 86.6% 77.6% 82.7%
Book value per share (a) (c). . . . . . . . . . . . . . . . $ 7.86 $ 6.94 $ 6.45
Market value per share (a) (c) (d). . . . . . . . . . . . . $ 14.80 $ 17.24 $ 14.19
Number of registered common shareholders (c). . . . . . . . 8,149 7,261 6,892
BALANCE SHEET DATA (000's) (c)
Total assets. . . . . . . . . . . . . . . . . . . . . . . . $368,498 $348,813 $319,548
--------- --------- ---------
Capitalization
Long-term debt (e). . . . . . . . . . . . . . . . . . . . . $104,910 $117,022 $102,728
Company-obligated mandatorily redeemable
trust preferred securities of subsidiaries . . . . . . . -- -- --
Preferred stock . . . . . . . . . . . . . . . . . . . . . . 3,288 3,290 3,320
Common equity . . . . . . . . . . . . . . . . . . . . . . . 107,379 85,657 77,353
--------- --------- ---------
$215,577 $205,969 $183,401
--------- --------- ---------
FINANCIAL RATIOS
Capitalization
Long-term debt (e). . . . . . . . . . . . . . . . . . . . . 48.7% 56.8% 56.0%
Company-obligated mandatorily redeemable
trust preferred securities of subsidiaries . . . . . . . -- -- --
Preferred stock . . . . . . . . . . . . . . . . . . . . . . 1.5% 1.6% 1.8%
Common equity . . . . . . . . . . . . . . . . . . . . . . . 49.8% 41.6% 42.2%
--------- --------- ---------
100.0% 100.0% 100.0%
--------- --------- ---------
Return on average common equity . . . . . . . . . . . . . . 9.5% 11.6% 11.1%
--------- --------- ---------
<FN>
(a) Adjusted to give effect to 5 percent stock dividends in May each year, 1992 through 1998.
(b) Prior to 1999, diluted average common shares outstanding were not materially different than basic average common shares
outstanding. Therefore, there was no dilutive impact on earnings per share.
(c) At year end.
(d) Amounts prior to 1997 based on closing bid price. Amounts for 1997 and subsequent years, based on closing stock price.
(e) Includes current maturities of long-term debt.
(f) Includes, net of tax, $10 or $.00 per share, ($6,122) or ($.34) per share, $95 or $.01 per share, ($363) or ($.02) per
share, $1,672 or $.11 per share, $504 or $.03 per share and $41 or $.00 per share in 2002, 2001, 2000, 1999, 1998, 1997
and 1996, respectively, attributable to the reclassification of the operating results of the engineering services
business to discontinued operations.
(g) Includes $499 (net of tax) or $.03 per share, $1,286 (net of tax) or $.10 per share, $177 (net of tax) or $.01 per share,
and $901 (net of tax) or $.08 per share in 1998, 1994, 1993 and 1992, respectively, attributable to extraordinary losses
on the early extinguishment of debt.
(h) Includes income of $1,784 (net of tax) or $.11 per share attributable to a change in accounting method.
(i) Includes a gain of $1,708 (net of tax) or $.11 per share from the sale of the NOARK Investment.
(j) Includes income due to an adjustment to the reserve for the NOARK investment - $5,025 (net of tax) or $.34 per share.
(k) Excluding the adjustment to the reserve for the NOARK investment, return on average common equity was 11.8%.
(l) Includes the write-down of the NOARK investment - $21,000 (net of tax) or $1.44 per share.
(m) Excluding the write-down of the NOARK investment, return on average common equity was 7.6%.
(n) Includes a special one-time dividend of $0.05 per share.
- ----------
64/65 -- SEMCO ENERGY, INC. AND SUBSIDIARIES