UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal period from to
------------- ------------
Commission file number 0-8503
SEMCO Energy, Inc.
(Exact name of registrant as specified in its charter)
Michigan 38-2144267
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
405 Water Street, Port Huron, Michigan 48060
(Address of principal executive offices)
810-987-2200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such requirements for the past 90 days. Yes [X] No [ ]
The number of shares of common stock outstanding as of April 30, 1999, is
17,667,571.
INDEX TO FORM 10-Q
------------------
For Quarter Ended March 31, 1999
Page
Number
------
COVER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements . . . . . . . . . . . . . . . . . . 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . 29
Item 2. Changes in Securities . . . . . . . . . . . . . . . . . 29
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . 29
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
EXHIBIT INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
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. Statements that are not
historical facts, including statements about the Company's belief and
expectations are forward-looking statements. These statements are subject to
potential risks and uncertainties and, therefore, actual results may differ
materially. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future
events or otherwise. Factors that may impact forward-looking statements
include, but are not limited to, the following: (i) the effects of weather
and other natural phenomena; (ii) the economic climate and growth in the
geographical areas where the Company does business; (iii) the capital
intensive nature of the Company's business; (iv) increased competition within
the energy industry as well as from alternative forms of energy; (v) the
timing and extent of changes in commodity prices for natural gas; (vi) the
effects of changes in governmental and regulatory policies, including income
taxes, environmental compliance and authorized rates; (vii) the Company's
ability to bid on and win business contracts; (viii) the impact of energy
prices on the amount of projects and business available to Engineering
Services; (ix) the nature, availability and projected profitability of
potential investments available to the Company and (x) the conditions of
capital markets and equity markets.
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Twelve Months Ended
March 31, March 31,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
OPERATING REVENUES
Gas sales $ 68,978 $ 70,837 $164,841 $199,221
Gas transportation 6,629 4,029 17,432 13,320
Engineering services 4,546 3,148 42,335 7,306
Construction services 3,558 1,179 19,000 8,663
Gas marketing 96,855 145,674 341,998 514,881
Other operations 3,314 1,604 9,289 4,775
-------- -------- -------- --------
$183,880 $226,471 $594,895 $748,166
-------- -------- -------- --------
OPERATING EXPENSES
Cost of gas sold $ 45,999 $ 48,514 $106,873 $135,206
Cost of gas marketed 95,632 143,334 338,989 508,998
Operations and maintenance 18,309 15,528 95,477 56,945
Depreciation 4,236 3,741 15,844 13,503
Property and other taxes 2,357 2,517 9,006 9,660
-------- -------- -------- --------
$166,533 $213,634 $566,189 $724,312
-------- -------- -------- --------
OPERATING INCOME $ 17,347 $ 12,837 $ 28,706 $ 23,854
OTHER INCOME (DEDUCTIONS)
Divestiture of NOARK investment $ -- $ 1,480 $ 3,568 $ 9,210
Divestiture of energy marketing business 1,122 -- 1,122 --
Interest expense (3,894) (3,688) (15,018) (13,556)
Dividends on preferred stock (48) (48) (193) (193)
Other 26 (1,521) 2,383 (1,445)
-------- -------- -------- --------
$ (2,794) $ (3,777) $ (8,138) $ (5,984)
INCOME BEFORE INCOME TAXES $ 14,553 $ 9,060 $ 20,568 $ 17,870
INCOME TAXES $ 4,150 $ 2,272 $ 8,198 $ 5,467
NET INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING METHOD CHANGE AND EXTRAORDINARY CHARGE $ 10,403 $ 6,788 $ 12,370 $ 12,403
Cumulative effect of change in accounting for
property taxes, net of income taxes of $960 -- 1,784 -- 1,784
Extraordinary charge due to early retirement of
debt, net of income taxes of $269 -- -- (499) --
-------- -------- -------- --------
NET INCOME $ 10,403 $ 8,572 $ 11,871 $ 14,187
======== ======== ======== ========
EARNINGS PER SHARE - BASIC AND DILUTED $ 0.60 $ 0.58 $ 0.72 $ 0.97
======== ======== ======== ========
CASH DIVIDENDS PER SHARE $ 0.20 $ 0.18 $ 0.77 $ 0.71
======== ======== ======== ========
AVERAGE COMMON SHARES OUTSTANDING 17,438 14,814 16,553 14,666
======== ======== ======== ========
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these statements.
</FN>
-3-
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
A S S E T S
(in thousands)
March 31, December 31, March 31,
1999 1998 1998
-------- -------- --------
(Unaudited) (Unaudited)
CURRENT ASSETS
Cash and temporary cash investments, at cost $ 5,827 $ 4,953 $ 1,983
Receivables, less allowances of $727 at March 31, 1999,
$632 at December 31, 1998 and $1,660 at March 31, 1998 41,690 31,003 34,773
Accrued revenue 11,854 60,915 59,433
Materials and supplies, at average cost 2,311 2,191 2,530
Gas in underground storage 12,222 38,526 18,360
Gas charges, recoverable from customers 2,764 11,556 11,045
Other 5,566 13,906 6,599
-------- -------- --------
$ 82,234 $163,050 $134,723
-------- -------- --------
PROPERTY, PLANT AND EQUIPMENT
Gas Distribution $368,353 $364,513 $349,487
Diversified Businesses 47,516 43,857 42,770
-------- -------- --------
$415,869 $408,370 $392,257
Less - Accumulated depreciation 121,722 118,132 109,756
-------- -------- --------
$294,147 $290,238 $282,501
-------- -------- --------
DEFERRED CHARGES AND OTHER
Unamortized debt expense $ 5,528 $ 5,619 $ 5,179
Deferred retiree medical benefits 12,363 12,588 13,262
Other 20,487 18,167 17,598
-------- -------- --------
$ 38,378 $ 36,374 $ 36,039
-------- -------- --------
TOTAL ASSETS $414,759 $489,662 $453,263
======== ======== ========
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these statements.
</FN>
-4-
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
LIABILITIES AND CAPITALIZATION
(in thousands)
March 31, December 31, March 31,
1999 1998 1998
-------- -------- --------
(Unaudited) (Unaudited)
CURRENT LIABILITIES
Notes payable $ 22,077 $ 63,576 $ 32,032
Accounts payable 13,964 57,498 74,924
Customer advance payments 5,091 10,417 4,125
Accumulated deferred income taxes 1,522 2,344 1,151
Accrued interest 4,436 1,935 4,515
Amounts payable to customers 2,666 -- --
Other 9,166 7,270 14,570
-------- -------- --------
$ 58,922 $143,040 $131,317
-------- -------- --------
DEFERRED CREDITS AND OTHER
Accumulated deferred income taxes $ 19,110 $ 17,985 $ 22,704
Unamortized investment tax credit 2,180 2,247 2,448
Customer advances for construction 3,062 3,147 3,817
Other 17,051 17,760 17,401
-------- -------- --------
$ 41,403 $ 41,139 $ 46,370
-------- -------- --------
LONG-TERM DEBT INCLUDING CAPITAL LEASES $170,000 $170,000 $163,559
-------- -------- --------
CUMULATIVE PREFERRED STOCK OF SUBSIDIARY
$100 par value (redemption price of $105 per share); authorized
50,000 shares issuable in series; 31,000 shares outstanding $ 3,100 $ 3,100 $ 3,100
-------- -------- --------
CUMULATIVE CONVERTIBLE PREFERRED STOCK
Convertible preferred stock - $1 par value; authorized 500,000
shares issuable in series; each convertible to 4.11 common
shares; 6,218, 6,218 and 6,618 shares outstanding $ 6 $ 6 $ 7
Capital surplus 149 149 158
-------- -------- --------
$ 155 $ 155 $ 165
-------- -------- --------
COMMON SHAREHOLDERS' EQUITY
Common stock - $1 par value; 20,000,000 shares authorized;
17,510,356, 17,382,229 and 14,506,972 shares outstanding $ 17,510 $ 17,382 $ 14,507
Capital surplus 118,562 116,663 88,336
Retained earnings (deficit) 5,107 (1,817) 5,909
-------- -------- --------
$141,179 $132,228 $108,752
-------- -------- --------
TOTAL LIABILITIES AND CAPITALIZATION $414,759 $489,662 $453,263
======== ======== ========
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these statements.
</FN>
-5-
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Three Months Ended Twelve Months Ended
March 31, March 31,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 10,403 $ 8,572 $ 11,871 $ 14,187
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Depreciation 4,236 3,741 15,844 13,503
Extraordinary charge -- -- 499 --
Divestiture of energy marketing business (1,122) -- (1,122) --
Divestiture of NOARK investment -- (1,480) (3,568) (9,210)
Equity (income) loss, net of distributions (259) (274) 183 110
Changes in assets and liabilities, net of
effects of acquisitions, divestitures and
other changes as shown below: 37,430 50,248 (9,138) 15,728
-------- -------- -------- --------
NET CASH FROM OPERATING ACTIVITIES $ 50,688 $ 60,807 $ 14,569 $ 34,318
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Property additions - gas distribution $ (3,907) $ (5,031) $(21,905) $(28,937)
Property additions - diversified businesses (1,922) (410) (3,758) (1,580)
Proceeds from property sales, net of retirement costs (31) (50) 890 337
Acquisitions of businesses, net of cash acquired (925) -- (899) (15,117)
Advances to equity investees -- (4,284) -- (6,744)
-------- -------- -------- --------
NET CASH FROM INVESTING ACTIVITIES $ (6,785) $ (9,775) $(25,672) $(52,041)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock, net of expenses $ 1,996 $ 1,687 $ 32,880 $ 6,288
Repurchase of common stock and related expenses -- -- -- (1,598)
Net cash change in notes payable (41,498) (52,105) (9,954) (42,520)
Issuance of long-term debt, net of expenses -- -- 29,390 60,000
Repayment of long-term debt and related expenses -- -- (24,504) (25)
Payment of dividends (3,527) (2,691) (12,865) (10,625)
-------- -------- -------- --------
NET CASH FROM FINANCING ACTIVITIES $(43,029) $(53,109) $ 14,947 $ 11,520
-------- -------- -------- --------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease) $ 874 $ (2,077) $ 3,844 $ (6,203)
Beginning of period 4,953 4,060 1,983 8,186
-------- -------- -------- --------
End of period $ 5,827 $ 1,983 $ 5,827 $ 1,983
======== ======== ======== ========
Changes in assets and liabilities, net of effects
of acquisitions, divestitures and other changes:
Receivables, net $ (2,933) $ 16,862 $ 1,300 $ 17,707
Accrued revenue 22,934 7,565 21,452 (11,762)
Materials, supplies and gas in underground storage 23,582 18,116 3,756 (13,567)
Gas charges, recoverable from customers 8,792 8,886 8,281 (459)
Accounts payable (13,494) (5,120) (32,823) 15,993
Customer advances and amounts payable to customers (2,745) (4,029) 2,878 (2,435)
Deferred taxes and investment tax credit 235 (2,898) 4,965 3,202
Other 1,059 10,866 (18,947) 7,049
-------- -------- -------- --------
$ 37,430 $ 50,248 $ (9,138) $ 15,728
======== ======== ======== ========
<FN>
The accompanying notes to the consolidated financial statements are an integral part of these statements.
</FN>
-6-
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) SIGNIFICANT ACCOUNTING POLICIES
Under the rules and regulations of the Securities and Exchange
Commission for Form 10-Q Quarterly Reports, certain footnotes and other
financial statement information normally included in the year-end financial
statements of SEMCO Energy, Inc. and its subsidiaries (the "Company") have
been condensed or omitted in the accompanying unaudited financial statements.
These financial statements prepared by the Company should be read in
conjunction with the financial statements and notes thereto included in the
Company's 1998 Annual Report on Form 10-K filed with the Securities and
Exchange Commission. The information in the accompanying financial
statements reflects, in the opinion of the Company's management, all
adjustments (which include only normal recurring adjustments) necessary for a
fair statement of the information shown, subject to year-end and other
adjustments, as later information may require.
FINANCIAL STATEMENT PRESENTATION - The financial statements of the
Company are presented in the conventional classification format rather than a
regulated utility format, which has been used in the past. Certain
reclassifications have been made to the prior periods' financial statements
to conform with the 1999 presentation.
POOLING OF INTERESTS - During 1998, the Company acquired Oilfield
Materials Consultants, Inc. ("OMC"). The acquisition of OMC was accounted
for as a pooling of interests, and accordingly, the consolidated financial
statements and notes for the periods presented have been restated to include
the financial results of OMC. See Note 3 in the Company's 1998 Annual Report
on Form 10-K for further information.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
-7-
SUPPLEMENTAL CASH FLOW INFORMATION - Supplemental cash flow information
for the three and twelve months ended March 31, 1999 and 1998 is as follows
(in thousands of dollars):
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
Cash paid during the period for:
Interest $ 1,271 $ 1,065 $14,692 $11,280
Income taxes $ 5,500 $ -- $ 7,600 $ 3,100
Non-Cash Investing and Financing Activities:
Capital stock issued for acquisitions $ -- $ 6,000 $ 309 $ 6,450
Debt incurred for acquisitions $ 1,000 $ -- $ 1,000 $ --
Details of Acquisitions:
Fair value of assets acquired $ 5,152 $ 8,306 $ 7,147 $30,770
Liabilities assumed (3,152) (2,306) (4,838) (8,636)
Debt incurred (1,000) -- (1,000) --
Stock issued -- (6,000) (309) (6,450)
------- ------- ------- -------
Cash paid $ 1,000 $ -- $ 1,000 $15,684
Less cash acquired 75 -- 101 567
------- ------- ------- -------
Net cash paid for (acquired via) acquisitions $ 925 $ -- $ 899 $15,117
======= ======= ======= =======
(2) ACQUISITIONS AND DIVESTITURES
On February 3, 1999, the Company acquired K&B Construction, Inc.
("K&B"). K&B provides underground pipeline construction services in Kansas
and Missouri. The purchase price was $2,000,000 plus a potential incentive
payment based on operating results during 1999, 2000 and 2001. $1,000,000
was paid in cash at closing and the remainder is to be paid on or before
April 15, 2002. For financial statement purposes, the acquisition of K&B was
accounted for as a purchase and, accordingly, its results of operations are
included in the consolidated financial statements since the date of
acquisition. There were no adjustments necessary to the accounting practices
of K&B to conform with the practices of the Company.
The Company sold the subsidiary which comprised its energy marketing
business, SEMCO Energy Services, Inc., effective March 31, 1999. The Company
recorded a gain of $1,122,000 ($729,000 after tax) on the sale, which is
reflected in other income and deductions. Pursuant to the stock sale
agreement, the Company agreed that, for a period of two years after the
closing date, it would not compete in the unregulated natural gas marketing
business in the state of Michigan.
(3) CAPITALIZATION
COMMON STOCK EQUITY - On April 20, 1999 the Company's Board of Directors
declared a regular quarterly cash dividend on common stock of $.205 per share
(a 2.5% increase over the prior quarterly cash dividend) and a special cash
dividend of $.05 per share. Both dividends are payable on May 15, 1999 to
shareholders of record at the close of business on May 5, 1999. The Board of
Directors announced it has discontinued the practice of declaring a five
percent stock dividend.
-8-
In February 1999, the Company paid a quarterly cash dividend on common
stock of $.20 per share. The total cash dividend was $3,480,000, of which
$731,000 was reinvested by shareholders into common stock through
participation in the Direct Stock Purchase and Dividend Reinvestment Plan
("DRIP"). The reinvested portion of the quarterly dividend plus
shareholders' optional cash payments of $1,133,000, resulted in 118,000 new
shares issued to existing shareholders during the quarter pursuant to the
DRIP. The Company also issued 10,000 shares of its common stock to the
Company's primary 401(k) plan during the first quarter of 1999 in accordance
with the Company match provisions of the plan.
(4) EARNINGS PER SHARE
The computations of basic and diluted earnings per share for the three
months and twelve months ended March 31, 1999 and 1998 are as follows (in
thousands except per share amounts):
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
Basic Earnings Per Share Computation
Income before accounting change and extraordinary charge $10,403 $ 6,788 $12,370 $12,403
Cumulative effect of change in accounting -- 1,784 -- 1,784
Extraordinary charge -- -- (499) --
------- ------- ------- -------
Net Income $10,403 $ 8,572 $11,871 $14,187
======= ======= ======= =======
Weighted average common shares outstanding 17,438 14,814 16,553 14,666
------- ------- ------- -------
Earnings Per Share - Basic
Income before accounting change and extraordinary charge $ 0.60 $ 0.46 $ 0.75 $ 0.85
Cumulative effect of change in accounting -- 0.12 -- 0.12
Extraordinary charge -- -- (0.03) --
------- ------- ------- -------
Net Income $ 0.60 $ 0.58 $ 0.72 $ 0.97
======= ======= ======= =======
Diluted Earnings Per Share Computation
Income before accounting change and extraordinary charge $10,403 $ 6,788 $12,370 $12,403
Adjustment for effect of assumed conversions:
Preferred convertible stock dividends 4 4 15 16
------- ------- ------- -------
Adjusted income before accounting change
and extraordinary charge 10,407 6,792 12,385 12,419
Cumulative effect of change in accounting -- 1,784 -- 1,784
Extraordinary charge -- -- (499) --
------- ------- ------- -------
Net Income $10,407 $ 8,576 $11,886 $14,203
======= ======= ======= =======
Weighted average common shares outstanding 17,438 14,814 16,553 14,666
Incremental shares from assumed conversions of:
Preferred convertible stock 26 27 26 28
Stock options 1 2 1 9
------- ------- ------- -------
Diluted weighted average common shares outstanding 17,465 14,843 16,580 14,703
======= ======= ======= =======
Earnings Per Share - Diluted
Income before accounting change and extraordinary charge $ 0.60 $ 0.46 $ 0.75 $ 0.85
Cumulative effect of change in accounting -- 0.12 -- 0.12
Extraordinary charge -- -- (0.03) --
------- ------- ------- -------
Net Income $ 0.60 $ 0.58 $ 0.72 $ 0.97
======= ======= ======= =======
-9-
(5) BUSINESS SEGMENTS
The Company's adoption of SFAS 131 addressing disclosure about business
segments and policies applicable to the disclosure are discussed in Note 12
in the Company's 1998 Annual Report on Form 10-K.
The Company sold the subsidiary comprising its energy marketing business
effective March 31, 1999. The Company operates four business segments: gas
distribution, engineering services, pipeline construction services and
propane, pipelines and storage. The Company's gas distribution business
segment distributes and transports natural gas to approximately 250,000
customers within the state of Michigan. The engineering services segment has
offices in New Jersey, Michigan, Louisiana and Texas and provides a variety
of energy related engineering and quality assurance services in several
states. The pipeline construction services business segment provides
primarily pipeline construction services in Iowa, Kansas, Michigan, Missouri,
Nebraska and Tennessee. The propane, pipelines and storage segment supplies
propane to over 7,500 retail customers in Michigan's upper peninsula and
northeast Wisconsin and operates natural gas transmission, gathering and
storage facilities in Michigan.
The accounting policies of the operating segments are the same as those
described in Note 1 except that intercompany transactions have not been
eliminated in determining individual segment results. The following table
provides business segment information as well as a reconciliation ("Corporate
and other") of the segment information to the applicable line in the
consolidated financial statements. Corporate and other includes intercompany
eliminations, corporate related expenses not allocated to segments and
results of other smaller operations.
Three Months Ended Twelve Months Ended
March 31, March 31,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
Operating Revenues
Gas Distribution $ 76,980 $ 75,789 $185,413 $214,139
Engineering Services 5,719 3,148 43,938 7,306
Construction Services 4,685 2,720 27,869 15,927
Propane, Pipelines and Storage 1,944 690 6,106 2,957
Energy Marketing 96,904 148,273 346,519 537,271
Corporate and other <F1> (2,352) (4,149) (14,950) (29,434)
-------- -------- -------- --------
Consolidated Operating Revenues $183,880 $226,471 $594,895 $748,166
======== ======== ======== ========
Operating Income (Loss)
Gas Distribution $ 17,867 $ 13,013 $ 27,217 $ 23,661
Engineering Services 451 414 2,975 864
Construction Services (1,245) (1,160) (186) (398)
Propane, Pipelines and Storage 796 374 2,008 1,501
Energy Marketing (341) 206 (1,243) (1,429)
Corporate and other (181) (10) (2,065) (345)
-------- -------- -------- --------
Consolidated Operating Income $ 17,347 $ 12,837 $ 28,706 $ 23,854
======== ======== ======== ========
<FN>
<F1>
Includes the elimination of intercompany energy marketing revenues of $49 and $4,521 for the three and
twelve months ended March 31, 1999 and $2,599 and $22,390 for the three and twelve months ended
March 31, 1998, respectively. Includes the elimination of intercompany engineering services revenue of
$1,173 and $1,603 for the three and twelve months ended March 31, 1999, respectively. Includes the
elimination of intercompany construction services revenue of $1,127 and $8,869 for the three and twelve
months ended March 31, 1999 and $1,541 and $7,264 for the three and twelve months ended March 31, 1998,
respectively.
</FN>
-10-
(6) COMMITMENTS AND CONTINGENCIES
NOARK - In January 1998, the Company sold its entire interest in the
NOARK Pipeline System Partnership ("NOARK") to ENOGEX Arkansas Pipeline
Corporation ("EAPC"). NOARK is a 302-mile intrastate natural gas pipeline
located in Arkansas, which operated at less than 65% capacity since its
inception in 1992 as a result of significant cost overruns during
construction and competition from two other interstate pipelines. The sale
released the Company from all debt obligations and guarantees related to
NOARK. Pursuant to terms included in the sales agreement, the Company paid
EAPC $9,200,000 in April 1998 and will pay $3,100,000 and $800,000 in April
1999 and 2000, respectively. The Company will receive annual payments of
$842,000 from EAPC for 17 years beginning in the year 2004.
ENVIRONMENTAL MATTERS - Prior to the construction of major natural gas
pipelines, gas for heating and other uses was manufactured from processes
involving coal, coke or oil. The Gas Company owns seven sites which formerly
housed such manufacturing facilities and expects that it will ultimately
incur investigation and remedial action costs at some of these sites, and a
number of other sites. The Gas Company has submitted a plan to the
appropriate environmental regulatory authority in the State of Michigan for
work to begin at one site. The extent of the Gas Company's liabilities and
potential costs in connection with these sites cannot be reasonably estimated
at this time. In accordance with an MPSC accounting order, any environmental
investigation and remedial action costs will be deferred and amortized over
ten years. Rate recognition of the related amortization expense will not
begin until after a prudence review in a general rate case.
(7) SUBSEQUENT EVENT
In April 1999, the Company acquired Iowa Pipeline Associates, Inc.
("Iowa Pipeline"). Iowa Pipeline provides underground construction services
to customers in Iowa, Kansas, Missouri and Nebraska and has annual revenues
of approximately $10 million.
-11-
PART I - FINANCIAL INFORMATION - (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
RESULTS OF OPERATIONS
Net income of SEMCO Energy, Inc. and its subsidiaries (the "Company")
was $10,403,000 (or $0.60 per share) for the quarter ended March 31, 1999
compared to $8,572,000 (or $0.58 per share) for the quarter ended March 31,
1998. On a weather-normalized basis, net income for the quarter ended
March 31, 1999 would have been approximately $11,070,000 (or $0.63 per share)
compared to approximately $11,172,000 (or $0.75 per share) for the same
period of the prior year. The net income for the first quarter of 1999
includes income of $729,000 after tax (or $0.04 per share) from the
divestiture of the Company's energy marketing business. The net income for
the first quarter of 1998 includes income of $1,784,000 after tax (or $0.12
per share) from a change in accounting method for property taxes and income
of $1,708,000 after tax (or $0.12 per share) from the divestiture of the
Company's investment in the NOARK Pipeline System Partnership ("NOARK").
Net income for the twelve months ended March 31, 1999 was $11,871,000
(or $0.72 per share) compared to $14,187,000 (or $0.97 per share) for the
twelve months ended March 31, 1998. On a weather-normalized basis, net
income would have been approximately $17,118,000 (or $1.03 per share) for the
twelve months ended March 31, 1999 compared to approximately $16,862,000 (or
$1.15 per share) for the same period of the prior year. The net income for
the twelve months ended March 31, 1999 includes the income discussed above of
$729,000 after tax related to the divestiture of the energy marketing
business plus an extraordinary charge of $499,000 after tax (or $0.03 per
share) from the early retirement of long-term debt. The net income for the
twelve months ended March 31, 1998 includes the income of $1,784,000 after
tax from a change in accounting method and $1,708,000 after tax from the
divestiture of NOARK discussed above.
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
(dollars in thousands)
Net income as reported $10,403 $ 8,572 $11,871 $14,187
Impact on net income of the following:
Colder (warmer) than normal weather $ (667) $(2,600) $(5,247) $(2,675)
Divestiture of NOARK investment $ -- $ 1,708 $ -- $ 6,733
Divestiture of marketing business $ 729 $ -- $ 729 $ --
Change in accounting method $ -- $ 1,784 $ -- $ 1,784
Extraordinary charge $ -- $ -- $ (499) $ --
Net income excluding the foregoing items $10,341 $ 7,680 $16,888 $ 8,345
EPS excluding the foregoing items $ 0.59 $ 0.52 $ 1.02 $ 0.57
-12-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
RESULTS OF OPERATIONS (Continued)
The Company's largest business segment, natural gas distribution, is
seasonal in nature and depends on the winter months for the majority of its
operating revenue. As a result, a substantial portion of the Company's
annual results of operations is earned during the first quarter of the year.
Therefore, the Company's results of operations for the three months ended
March 31, 1999 and 1998 are not necessarily indicative of results for a full
year.
SUMMARY OF BUSINESS SEGMENTS
The Company sold the subsidiary comprising its energy marketing business
effective March 31, 1999. The Company operates four business segments: gas
distribution, engineering services, pipeline construction services and
propane, pipelines and storage. The Company's gas distribution business
segment distributes and transports natural gas to approximately 250,000
customers within the state of Michigan. The engineering services segment has
offices in New Jersey, Michigan, Louisiana and Texas and provides a variety
of energy related engineering and quality assurance services in several
states. The pipeline construction services business segment provides
primarily pipeline construction services in Iowa, Kansas, Michigan, Missouri,
Nebraska and Tennessee. The propane, pipelines and storage segment sells
approximately 5 million gallons of propane annually to retail customers in
Michigan's upper peninsula and northeast Wisconsin and operates natural gas
transmission, gathering and storage facilities in Michigan.
The following table shows the operating revenues and operating income of
each of the Company's business segments 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
intercompany eliminations, corporate related expenses not allocated to the
segments and the results of other smaller operations.
-13-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
SUMMARY OF BUSINESS SEGMENTS (Continued)
Three Months Ended Twelve Months Ended
March 31, March 31,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
(dollars in thousands)
Operating Revenues
Gas Distribution $ 76,980 $ 75,789 $185,413 $214,139
Engineering Services 5,719 3,148 43,938 7,306
Construction Services 4,685 2,720 27,869 15,927
Propane, Pipelines and Storage 1,944 690 6,106 2,957
Energy Marketing 96,904 148,273 346,519 537,271
Corporate and Other (2,352) (4,149) (14,950) (29,434)
-------- -------- -------- --------
Total Operating Revenues $183,880 $226,471 $594,895 $748,166
======== ======== ======== ========
Operating Income (Loss)
Gas Distribution $ 17,867 $ 13,013 $ 27,217 $ 23,661
Engineering Services 451 414 2,975 864
Construction Services (1,245) (1,160) (186) (398)
Propane, Pipelines and Storage 796 374 2,008 1,501
Energy Marketing (341) 206 (1,243) (1,429)
Corporate and Other (181) (10) (2,065) (345)
-------- -------- -------- --------
Total Operating Income $ 17,347 $ 12,837 $ 28,706 $ 23,854
======== ======== ======== ========
Each business segment is discussed on the following pages. The Company
evaluates the performance of its business segments based on the operating
income generated. Operating income does not include income taxes, interest
expense, extraordinary items, changes in accounting method and other
non-operating income and expense items. A review of the non-operating items
follows the business segment discussions.
GAS DISTRIBUTION
Operating income from the Company's gas distribution business ("Gas
Company") was $17,867,000 for the quarter ended March 31, 1999 compared to
$13,013,000 for the quarter ended March 31, 1998. On a weather-normalized
basis, the Gas Company's operating income would have been approximately
$18,817,000 for the first quarter of 1999 compared to approximately
$17,063,000 for the same period of the prior year.
-14-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
GAS DISTRIBUTION (Continued)
Three Months Ended Twelve Months Ended
March 31, March 31,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
(dollars in thousands)
Gas sales revenue $ 68,978 $ 70,837 $164,841 $199,221
Cost of gas sold 45,999 48,514 106,873 135,206
-------- -------- -------- --------
Gas sales margin $ 22,979 $ 22,323 $ 57,968 $ 64,015
Gas transportation revenue 6,629 4,029 17,432 13,320
Other operating revenue 1,373 923 3,140 1,598
-------- -------- -------- --------
Gross margin $ 30,981 $ 27,275 $ 78,540 $ 78,933
Operating expenses 13,114 14,262 51,323 55,272
-------- -------- -------- --------
Operating income $ 17,867 $ 13,013 $ 27,217 $ 23,661
======== ======== ======== ========
Weather-normalized operating income $ 18,817 $ 17,063 $ 34,917 $ 27,811
======== ======== ======== ========
Volumes sold (MMcf) 15,875 15,569 32,552 39,030
Volumes transported (MMcf) 9,045 6,433 26,403 21,536
Number of customers at end of period 250,065 243,723 250,065 243,723
Degree days 3,239 2,784 6,021 6,455
Percent colder (warmer) than normal (2.1%) (16.0%) (12.5%) (6.1%)
<FN>
The amounts in the table above include intercompany transactions.
</FN>
GAS SALES MARGIN - The Gas Company's gas sales margin for the first
quarter of 1999 increased by $656,000 when compared to the first quarter of
1998. The increase over the prior period was due to additional gas sales
resulting from the colder weather and the addition of new customers, offset
partially by a shift in customers to transportation as a result of a new
multi-location aggregation program offered to customers.
Weather during the first quarter of 1999 was 2.1% warmer than normal
while the weather during the first quarter of 1998 was 16.0% warmer than
normal. The Gas Company had 250,065 customers at March 31, 1999, an increase
of 6,342 since March 31, 1998. The colder weather and increase in the number
of customers during the first quarter of 1999 when compared to first quarter
of 1998 increased gas sales margin by approximately $3,100,000.
-15-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
GAS DISTRIBUTION (Continued)
The aggregation program, which was effective April 1, 1998, provides all
commercial and industrial customers the opportunity to aggregate multiple
service locations and purchase their gas from a third-party supplier, while
allowing the Gas Company to continue charging the existing distribution fees
and customer fees. The program is referred to as the Aggregated
Transportation Service ("ATS") program. Distribution and customer fees
associated with customers who have switched to third-party gas suppliers are
recorded in gas transportation revenue rather than gas sales revenue because
the Gas Company is now acting as a transporter for those customers. Gas
sales margin for the three months ended March 31, 1999 decreased by
approximately $2,500,000 when compared to the same period of the prior year
as a result of customers participating in the ATS program. The $2,500,000
decrease in gas sales margin is offset by a corresponding increase in gas
transportation revenue. The aggregation program was approved in the October
1997 Order of the Michigan Public Service Commission ("1997 rate case") (see
Note 2 in the Notes to the Consolidated Financial Statements in the Company's
1998 Annual Report on Form 10-K).
Gas sales margin for the twelve months ended March 31, 1999 decreased by
$6,047,000 when compared to the twelve months ended March 31, 1998.
Approximately $5,000,000 of the decrease is attributable to customers
participating in the new ATS program. Warmer weather during the twelve
months ended March 31, 1999 caused a decrease of approximately $3,700,000 in
gas sales margin when compared to the prior twelve month period. These
decreases were offset partially by increases in gas sales margin due to the
addition of new customers and a rate increase effective in October 1997. The
rate increase was granted in the 1997 rate case to allow for the recovery of
costs related to a change in accounting for retiree medical costs (see Note 2
in the Notes to the Consolidated Financial Statements in the Company's 1998
Annual Report on Form 10-K).
GAS TRANSPORTATION REVENUE - For the three months and twelve months
ended March 31, 1999, gas transportation revenue increased by $2,600,000 and
$4,112,000, respectively when compared to the same periods of 1998. The
increase during the first quarter of 1999 relates primarily to customers
participating in the new ATS program. As discussed above, the increase in
gas transportation revenue as a result of participation in the ATS program is
generally offset by a corresponding decrease in gas sales margin. The
increase for the twelve months ended March 31, 1999 is due to new ATS
revenues of approximately $5,000,000 offset partially by lower off-peak
transportation rates approved in the 1997 rate case. The new off-peak
transportation rates are in effect from April through October and are $0.15
per Mcf lower than the Gas Company's regular transportation rates.
OTHER OPERATING REVENUE - Other operating revenue of the Gas Company
increased by $450,000 during the first quarter of 1999. The increase is due
primarily to additional balancing charges related to the new ATS program and
an increase in various miscellaneous fees. These items also account for the
$1,542,000 increase in other operating revenue during the twelve months ended
March 31, 1999 compared to the same period of 1998.
-16-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
GAS DISTRIBUTION (Continued)
OPERATING EXPENSES - The Gas Company's operating expenses decreased by
$1,148,000 during the three months ended March 31, 1999 compared to the three
months ended March 31, 1998. The decrease is due primarily to decreases in
employee expenses, retiree medical expenses and uncollectible gas accounts
offset partially by an increase in depreciation expense and outside services.
Employee expenses such as wages, insurance and benefits decreased by
approximately $350,000 due primarily to lower employee levels as a result of
the early retirement program in 1998 and changes to the Company's employee
benefit programs (refer to Note 9 in the Notes to the Consolidated Financial
Statements in the Company's 1998 Annual Report on Form 10-K for information
on the early retirement program). Retiree medical expense decreased by
approximately $940,000 due to changes to the Company's retiree medical
programs ($425,000) and a one-time charge ($515,000) recorded in the first
quarter of 1998 related to the early retirement program. There was a
decrease of approximately $325,000 in uncollectible gas accounts due
generally to increased collection efforts. Depreciation expense increased by
approximately $200,000 as a result of new property, plant and equipment
placed in service.
During the twelve months ended March 31, 1999, operating expenses
decreased by $3,949,000 when compared to the twelve months ended March 31,
1998. Approximately $2,500,000 of the decrease is attributable to an overall
reduction in general and administrative expenses due to cost cutting measures
initiated during the past twelve months and reductions in compensation and
employee benefit expenses due primarily to lower employee levels as a result
of the Company's early retirement program and changes to the Company's
employee benefit plans. In addition, regulatory expenses decreased by
$450,000 due to reduced regulatory activity, uncollectible gas accounts
decreased by $900,000 due to increased collection efforts and lower accounts
receivable as a result of the warmer weather, and insurance costs decreased
by $650,000 due primarily to efforts to reduce premiums while maintaining
coverage levels. Retiree medical costs for the twelve months ended March 31,
1999 decreased by $480,000, inclusive of a one-time reduction in retiree
medical expense of $860,000 recorded in the third quarter of 1998. The
one-time reduction of $860,000 related to the early retirement program
offered in 1998. Excluding the one-time reduction, retiree medical expense
increased by $380,000 during the twelve months ended March 31, 1999 due to
increases approved in the 1997 rate case offset partially by decreases
resulting from changes to the Company's retiree medical programs. The 1997
rate case authorized a customer rate increase to offset the impact of the
additional retiree medical costs. These decreases in various expenses during
the twelve months ended March 31, 1999 were offset partially by an increase
of approximately $1,070,000 in depreciation expense as a result of new
property, plant and equipment place in service.
-17-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
ENGINEERING SERVICES
Operating income for the Company's engineering services business
("Engineering Services") was $451,000 for the first quarter of 1999 compared
to $414,000 for the first quarter of 1998. Engineering Services is comprised
of two companies, Maverick Pipeline Services, Inc. ("Maverick") and Oilfield
Materials Consultants, Inc. ("OMC"). The acquisition of Maverick, in
December 1997, was accounted for as a purchase. Therefore, the consolidated
financial statements and the table below include the results of Maverick's
operations since December 1997. The acquisition of OMC, in November 1998,
was accounted for as a pooling of interests and, accordingly, the
consolidated financial statements and the table below have been restated to
include the financial results of OMC as if it were part of the Company for
all of periods presented.
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- ---------------------
1999 1998 1999 1998
------- ------- -------- --------
(dollars in thousands)
Operating revenues $ 5,719 $ 3,148 $ 43,938 $ 7,306
Operating expenses 5,268 2,734 40,963 6,442
------- ------- -------- --------
Operating income $ 451 $ 414 $ 2,975 $ 864
======= ======= ======== ========
Billed hours 97,000 65,000 619,000 160,000
======= ======= ======== ========
<FN>
The amounts in the table above include intercompany transactions.
</FN>
OPERATING REVENUES - Engineering Services' operating revenues increased
by $2,571,000 during the three months ended March 31, 1999 compared to the
same period of the prior year. The increase in operating revenues is due
primarily to growth in field service revenues and a meter/regulator turnkey
project in 1999. Operating income increased during the first quarter of 1999
but not in the same proportion that operating revenues increased due to a
different mix of work performed in the first quarter of 1999 when compared to
the first quarter of 1998.
During the twelve months ended March 31, 1999, Engineering Services'
operating revenues increased $36,632,000 or approximately six-fold from the
twelve months ended March 31, 1998. Approximately $26,100,000 of the
increase represents the operating revenues of Maverick since it was acquired
in December 1997. The remainder of the increase in operating revenues when
comparing the twelve-month periods is attributable to OMC. The growth in
OMC's revenues, most of which occurred in mid to late 1998, is due to growth
in OMC's customer base and growth in quality assurance and quality control
projects worked on during that period.
-18-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
ENGINEERING SERVICES (Continued)
OPERATING EXPENSES - During the first quarter of 1999, Engineering
Services' operating expenses increased by $2,534,000, when compared to the
first quarter of 1998. The increase is due primarily to increases in
employee and project costs to support the increase in operating revenue
during the three months ended March 31, 1999.
Operating expenses increased by $34,521,000 during the twelve months
ended March 31, 1999 compared to the same period of the prior year.
Approximately $24,300,000 of the increase represents the operating expenses
of Maverick since it was acquired in December 1997, and the remainder
represents increases in employee and project costs to support the increase in
OMC's operating revenue during the twelve months ended March 31, 1999.
CONSTRUCTION SERVICES
The Company's construction services business ("Construction Services")
incurred a seasonal operating loss of $1,245,000 during the first quarter of
1999. The loss was in line with management's expectations and was similar in
size to the loss incurred during the same period of the prior year.
Underground construction businesses generally incur operating losses during
the winter months when underground construction is inhibited.
Construction Services' operating results for the three and twelve months
ended March 31, 1999 and 1998 include the results of the following businesses
for the periods subsequent to their acquisition dates:
Company Acquisition Date
--------------------------------------------- ----------------
Sub-Surface Construction Co. ("Sub-Surface") August 1997
King Energy & Construction Co. ("King") May 1998
K&B Construction, Inc. ("K&B") February 1999
Construction Services' results also include the operating losses of an
overhead-line construction company it started in Florida in January of 1998.
The operations of this business were halted in mid-1998 in response to lower
than expected business levels and earnings.
For the twelve months ended March 31, 1999 and 1998, Construction
Services incurred operating losses of $186,000 and $398,000, respectively.
Excluding the losses from the start-up overhead-line business, Construction
Services would have generated operating income of approximately $475,000 for
the twelve months ended March 31, 1999 and would have generated an operating
loss of approximately $180,000 for the twelve months ended March 31, 1998.
-19-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
CONSTRUCTION SERVICES (Continued)
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- ----------------------
1999 1998 1999 1998
------- ------- --------- ---------
(dollars in thousands)
Operating revenues $ 4,685 $ 2,720 $ 27,869 $ 15,927
Operating expenses 5,930 3,880 28,055 16,325
------- ------- --------- ---------
Operating income (loss) $(1,245) $(1,160) $ (186) $ (398)
======= ======= ========= =========
Feet of pipe installed 697,000 426,000 4,702,000 2,847,000
======= ======= ========= =========
<FN>
The amounts in the table above include intercompany transactions.
</FN>
OPERATING REVENUES - Construction Services' operating revenues increased
by $1,965,000 during the first quarter of 1999, compared to the first quarter
of 1998. The increase is due primarily to the revenues of King and K&B,
which were acquired after the first quarter of 1998. Operating revenues
during the twelve months ended March 31, 1999 increased by $11,942,000 when
compared to the same period of the prior year. The increase in revenues from
one period to the next occurred primarily because each twelve-month period
includes only the results of each company subsequent to its acquisition date.
OPERATING EXPENSES - The operating expenses of Construction Services for
the three months ended March 31, 1999 increased $2,050,0000 when compared to
the three months ended March 31, 1998. The increase is due to the
acquisitions of King and K&B as discussed above. The $11,730,000 increase in
operating expenses for the twelve months ended March 31, 1999 compared to the
same period of 1998 is due to the same issue discussed in the operating
revenues section above.
PROPANE, PIPELINES AND STORAGE
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- ----------------------
1999 1998 1999 1998
--------- ---- --------- ------
(dollars in thousands)
Operating revenues $ 1,944 $690 $ 6,106 $2,957
Operating expenses 1,148 316 4,098 1,456
--------- ---- --------- ------
Operating income $ 796 $374 $ 2,008 $1,501
========= ==== ========= ======
Propane volumes sold (gallons) 1,644,000 n/a 4,051,000 n/a
========= ==== ========= ======
-20-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
PROPANE, PIPELINES AND STORAGE (Continued)
OPERATING REVENUES - For the three months and twelve months ended
March 31, 1999, the operating revenues of the Company's propane, pipelines
and storage business increased by $1,254,000 and $3,149,000, respectively
when compared to the same periods of 1998. The increases in both the three
and twelve month periods are due primarily to the operating revenues of
Hotflame Gas, Inc. ("Hotflame") which was acquired on March 31, 1998. The
acquisition of Hotflame was accounted for as a purchase and therefore, only
the results of operations since April 1998 are included in the Company's
operating results.
OPERATING INCOME - The operating income from propane, pipelines and
storage increased during the three months and twelve months ended March 31,
1999 by $422,000 and $507,000 when compared to the same periods of the prior
year. These increases are due primarily to the operations of Hotflame. As
discussed above, the three months and twelve months ended March 31, 1998 do
not include the results of Hotflame because it was acquired on March 31,
1998. On a weather-normalized basis, operating income for the propane,
pipelines and storage business would have been approximately $896,000 for the
three months ended March 31, 1999 and $2,388,000 for the twelve months ended
March 31, 1999.
ENERGY MARKETING
The Company sold its gas marketing business ("Energy Services")
effective March 31, 1999. The business was sold because management concluded
that it did not fit the Company's new strategic direction due to the high
risks and generally poor returns associated with the business. The Company
recognized a gain on the sale. The gain is reported in other income
(discussed in the subsequent section) and thus, is not reflected in the
operating income shown in the table below.
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- ---------------------
1999 1998 1999 1998
------- -------- -------- --------
(dollars in thousands)
Gas marketing revenues $96,904 $148,273 $346,519 $537,271
Cost of gas marketed 95,681 145,933 343,510 531,387
------- -------- -------- --------
Gas marketing margin $ 1,223 $ 2,340 $ 3,009 $ 5,884
Operating expenses 1,564 2,134 4,252 7,313
------- -------- -------- --------
Operating income (loss) $ (341) $ 206 $ (1,243) $ (1,429)
======= ======== ======== ========
<FN>
The amounts in the table above include intercompany transactions.
</FN>
-21-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
ENERGY MARKETING (Continued)
GAS MARKETING MARGIN - Gas marketing margins decreased during the three
months and twelve months ended March 31, 1999 by $1,117,000 and $2,875,000,
respectively, when compared to the same periods in 1998. A significant
portion of the decreases in both periods corresponds with the decrease in gas
marketing volumes as a result of terminating agreements with all of Energy
Marketing's third-party gas marketing companies during 1998. The agreements
were terminated to eliminate lower margin transactions and reduce risks. In
addition to the decrease in volumes, the impact of warm weather on market
demand and increased competition also pushed gas marketing margins lower.
OPERATING EXPENSES - Compared to the same periods of the prior year,
Energy Marketing's operating expenses decreased during the three months and
twelve months ended March 31, 1999 by $570,000 and $3,061,000, respectively.
The decreases were due primarily to lower incentive payments to the Company's
third-party gas marketers and the termination of gas marketing agreements
with these companies as discussed above.
OTHER INCOME AND DEDUCTIONS
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- ---------------------
1999 1998 1999 1998
------- ------- -------- --------
(dollars in thousands)
Divestiture of NOARK investment $ -- $ 1,480 $ 3,568 $ 9,210
Divestiture of energy marketing business 1,122 -- 1,122 --
Interest expense (3,894) (3,688) (15,018) (13,556)
Dividends on preferred stock (48) (48) (193) (193)
Other income (deductions) 26 (1,521) 2,383 (1,445)
------- ------- -------- --------
Total other income (deductions) $(2,794) $(3,777) $ (8,138) $ (5,984)
======= ======= ======== ========
DIVESTITURE OF NOARK INVESTMENT - The Company sold its investment in
NOARK in January 1998 after a number of write-downs and reserve adjustments
related to the investment. Refer to Management's Discussion and Analysis and
Note 15 in the Notes to the Consolidated Financial Statements in the
Company's 1998 Annual Report on Form 10-K for additional information related
to the NOARK investment.
DIVESTITURE OF ENERGY MARKETING BUSINESS - The Company sold its energy
marketing business effective March 31, 1999. The divestiture generated a
gain of $1,122,000 ($729,000 after tax) which is reflected in the results for
the three months and twelve months ended March 31, 1999.
-22-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
OTHER INCOME AND DEDUCTIONS (Continued)
INTEREST EXPENSE - During the first quarter of 1999, interest expense
increased $206,000 compared to the first quarter of 1998. The increase is
due primarily to increases in debt levels to finance the Company's capital
expenditure program offset partially by the repayment of short-term debt with
the proceeds from the Company's sale of 1.82 million shares of its common
stock in August 1998. Interest expense for the twelve months ended March 31,
1999 increased by $1,462,000 when compared to the same period in 1998. The
increase between the twelve-month periods is due generally to the same items
that caused the increases between quarterly periods.
OTHER INCOME AND DEDUCTIONS - The change in other income between the
three months ended March 31, 1999 and the same three months of 1998 is due
primarily to an increase in equity income from partnership investments in gas
pipeline and storage facilities and other non-recurring charges in 1998. The
change in other income between the twelve months ended March 31, 1999 and the
same twelve months of 1998 is due primarily to an increase in equity income
from partnership investments in gas pipeline and storage facilities and other
non-recurring charges in the twelve months ended March 31, 1998.
INCOME TAXES
Income taxes were $4,150,000 and $2,272,000 for the three months ended
March 31, 1999 and 1998, respectively, and $8,198,000 and $5,467,000 for the
twelve months ended March 31, 1999 and 1998, respectively. The change in the
amount of income taxes, when comparing one period to another, is due
primarily to changes in pre-tax earnings and any adjustments necessary for
compliance with current tax laws and regulations.
ACCOUNTING METHOD CHANGE AND EXTRAORDINARY ITEM
The Company changed its method of accounting for property taxes during
the first quarter of 1998. The cumulative effect of the change in accounting
method increased earnings by $1,784,000. The Company also incurred an
extraordinary charge of $499,000 after-tax in April 1998 for the early
redemption of all of its outstanding 8.625% debentures due April 15, 2017.
Refer to Note 1 of the Notes to the Consolidated Financial Statements in the
Company's 1998 Annual Report on Form 10-K for more information on these
items.
-23-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS - Net cash from operating activities for the three and twelve
month periods ended March 31, 1999, as compared to the same periods of the
prior year, decreased by $10,119,000 and $19,749,000, respectively. The
change in operating cash flows is significantly influenced by changes in the
level and cost of gas in underground storage, changes in accounts receivable
and accrued revenue and other working capital changes. The changes in these
accounts are largely the result of the timing of receipts and payments.
The Company has spent approximately $5,829,000 on property additions
during the first three months of 1999 and anticipates spending approximately
$14,500,000 on property additions during the remainder of 1999. In addition,
the Company is planning to incur additional expenditures for business
acquisitions during the remainder of 1999.
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------- ---------------------
CAPITAL INVESTMENTS 1999 1998 1999 1998
------ ------- ------- -------
(dollars in thousands)
Property additions - gas distribution $3,907 $ 5,031 $21,905 $28,937
Property additions - diversified businesses 1,922 410 3,758 1,580
Business acquisitions <F1> 1,925 6,000 16,281 <F2> 21,567
------ ------- ------- -------
$7,754 $11,441 $41,944 $52,084
====== ======= ======= =======
<FN>
<F1>
Includes the value of Company stock issued and debt incurred for acquisitions.
<F2>
Includes $14,073 of company stock issued for the acquisition of OMC. The acquisition of OMC was accounted
for as a pooling of interests.
</FN>
Financing activities used $43,029,000 in funds during the first quarter
of 1999 primarily to repay notes payable.
In April 1999 the Company's Board of Directors declared a regular
quarterly cash dividend on common stock of $.205 per share (a 2.5% increase
over the prior quarterly cash dividend) and a special cash dividend of $.05
per share. Both dividends are payable on May 15, 1999 to shareholders of
record at the close of business on May 5, 1999. The Board of Directors
announced it has discontinued the practice of declaring a five percent stock
dividend.
FUTURE FINANCING - The Company's operating cash flow needs, as well as
dividend payments and capital expenditures for the balance of 1999, are
expected to be met primarily through operating activities and the utilization
of short-term lines of credit. At March 31, 1999, the Company had
$110,000,000 of short-term credit facilities, of which $91,700,000 was
unused.
At March 31, 1999, the Company also had $142,700,000 in remaining
authorization on the $200,000,000 universal shelf registration filed in July
1998. The universal shelf registration includes debt securities and common
stock of the Company and trust preferred securities of SEMCO Capital Trust.
-24-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
LIQUIDITY AND CAPITAL RESOURCES (Continued)
The Company expects to acquire additional businesses during the
remainder of 1999 and will likely raise the required capital through a
combination of utilizing short-term lines of credit and issuing long-term
debt or common stock.
The Company sells new shares of common stock through its Direct Stock
Purchase and Dividend Reinvestment Plan ("DRIP") on a monthly basis. The
Company has determined that it does not need the additional equity capital
being generated through DRIP sales. Therefore, starting in May 1999, the
Company will begin purchasing shares of its common stock on the open market
(and/or in private transactions) to offset the number of shares sold through
the DRIP.
See Note 6 of the Notes to the Consolidated Financial Statements for a
discussion of the amounts to be paid in conjunction with the sale of NOARK.
YEAR 2000
STATE OF READINESS - The Company uses computer systems, equipment,
software and related devices ("technology systems") that have date-sensitive
embedded technology that may not be able to distinguish between the year 1900
and the year 2000 ("Y2K"). If not corrected, this could cause the Company
to, among other things, report inaccurate data, issue inaccurate bills or
incur gas delivery problems. The Company has initiated an enterprise-wide
plan to prepare for Y2K (the "Y2K Plan"). The Y2K Plan has four phases: (i)
identification; (ii) remediation; (iii) testing; and (iv) contingency
planning. The identification phase includes identification, inventory,
assessment, and prioritization plan development for all technology systems.
The remediation phase involves the upgrading, modification, or replacement of
technology systems. The testing phase includes testing the remediated
technology systems to ensure that they accurately handle the year 2000 date
and monitoring the remediated systems to ensure that Y2K problems are not
reintroduced. The contingency planning phase involves the development of
contingency plans to address certain risk scenarios.
The Y2K Plan is being used for traditional information technology ("IT")
which includes essential business systems such as payroll, billing,
accounting systems, wide area networks, local area networks, personal
computers, etc. The Company is also using the Y2K Plan for process control
computers and embedded systems contained in buildings, equipment and the gas
supply and delivery systems.
-25-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
YEAR 2000 (Continued)
The Company has completed the identification phase for all significant
internal technology systems and is currently in the remediation and testing
phases on most of its Y2K projects. The Company currently plans to complete
the remediation phase for all significant internal technology systems by July
1999 and complete the testing phase by September 1999, with continuous
monitoring of tested systems through the end of 1999. The Company is in the
early stages of contingency planning for its Y2K projects and plans to be
completed with all contingency planning by November 1999.
The Company has inquired of third parties, i.e., vendors, suppliers and
customers, which have a material relationship with the Company, as to the
status of their Y2K readiness. To date, the Company has not received all of
the responses from these third parties and, therefore, is unable to state
with reasonable assurance the status of their readiness for Y2K. The Company
continues to work with critical vendors, suppliers and customers to gain
assurance of their Y2K readiness, and will develop contingency plans to
mitigate anticipated shortcomings in their readiness.
COST OF REMEDIATION - The Company is expensing the cost of modifications
to technology systems as incurred, while capitalizing and amortizing the cost
of new software over its useful life. The Company estimates that the total
expense of the Y2K Plan is approximately $2.0 to $2.5 million. Expenses
incurred through March 31, 1999 related to the Y2K Plan were approximately
$1.6 million. The Company has incurred an opportunity cost for implementing
the Y2K Plan, thus deferring potentially beneficial IT projects.
RISK ASSESSMENT - The Company has identified what it believes are the
most significant worst case Y2K scenarios. These scenarios are (i)
interference with the Company's ability to receive and deliver gas to
customers and perform services for customers; (ii) interference with the
Company's ability to monitor gas pressure and safety throughout the Company's
gas distribution system; (iii) interference with communications during safety
related emergencies and (iv) interference with the Company's ability to bill
and receive payments from customers. These scenarios could result in the
Company not being able to deliver gas or perform other services for a period
of time, which could have a material adverse effect on the Company's
liquidity, financial condition and results of operations. The Company's Y2K
Plan is being used to address these worse case scenarios. Contingency plans
will be revised and executed to further mitigate the risks associated with
these scenarios.
-26-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
YEAR 2000 (Continued)
The Company expects that its Y2K Plan will be adequate to address its
Y2K issues and is developing contingency plans to further assure that vital
functions of the Company dependent on third parties will continue
uninterrupted. Contingency plans will include existence of short-term
in-house capabilities (e.g. back-up power generation) and diversification of
goods and services among multiple suppliers (e.g. pipeline companies).
However, there are functions, which cannot be duplicated, such as the local
telephone network, which remain a vulnerability to the Company. Of course,
there can be no assurance as to whether the contingency plans will
successfully address all contingencies that may arise. In the event that the
Company is unsuccessful in addressing its Y2K issues, there could be a
material adverse effect on the Company's liquidity, financial condition and
results of operations.
SUBSEQUENT EVENTS
In April 1999, the Company acquired Iowa Pipeline Associates, Inc.
("Iowa Pipeline"). Iowa Pipeline employs approximately 185 people and has
annual revenues of approximately $10 million. Iowa Pipeline provides
underground construction services to customers in Iowa, Kansas, Missouri and
Nebraska.
NEW ACCOUNTING STANDARD
In June of 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133
establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the
hedged item in the income statement, and requires that a company must
formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting.
SFAS 133 is effective for fiscal years beginning after June 15, 1999.
The Company is studying the effects of SFAS 133 but does not expect it to
have a material impact on the Company's liquidity, financial condition and
results of operations.
-27-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued).
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. Statements that are not
historical facts, including statements about the Company's belief and
expectations are forward-looking statements. These statements are subject to
potential risks and uncertainties and, therefore, actual results may differ
materially. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future
events or otherwise. Factors that may impact forward-looking statements
include, but are not limited to, the following: (i) the effects of weather
and other natural phenomena; (ii) the economic climate and growth in the
geographical areas where the Company does business; (iii) the capital
intensive nature of the Company's business; (iv) increased competition within
the energy industry as well as from alternative forms of energy; (v) the
timing and extent of changes in commodity prices for natural gas; (vi) the
effects of changes in governmental and regulatory policies, including income
taxes, environmental compliance and authorized rates; (vii) the Company's
ability to bid on and win business contracts; (viii) the impact of energy
prices on the amount of projects and business available to Engineering
Services; (ix) the nature, availability and projected profitability of
potential investments available to the Company and (x) the conditions of
capital markets and equity markets.
-28-
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities.
None.
Item 3. Not applicable.
Item 4. Not applicable.
Item 5. Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) List of Exhibits - (See page 32 for the Exhibit Index.)
--Articles of Incorporation of SEMCO Energy, Inc., as restated
July 11, 1989.
--Certificate of Amendment to Article III of the Articles of
Incorporation dated May 16, 1990.
--Certificate of Amendment to Articles I, III and VI of the Articles
of Incorporation dated April 16, 1997.
--Certificate of Amendment to Article III of the Articles of
Incorporation dated April 21, 1999.
--Bylaws--last revised December 17, 1998.
--Note Agreement dated as of June 1, 1994, relating to issuance of
$80,000,000 of long-term debt.
--Rights Agreement dated as of April 15, 1997 with Continental Stock
Transfer & Trust Company, as Rights Agent.
--Note Agreement dated as of October 1, 1997, relating to issuance
of $60,000,000 of long-term debt.
--Short-Term Incentive Plan.
--1997 Long-Term Incentive Plan.
--Stock Option Certificate and Agreement dated October 10, 1996 with
William L. Johnson.
--Stock Option Certificate and Agreement dated February 26, 1997 with
William L. Johnson.
--Employment Agreement dated October 10, 1996, with William L.
Johnson.
--Change of Control Employment Agreement dated October 10, 1996, with
William L. Johnson.
--Form of Change in Control Agreement effective March 20, 1998, for
all officers except Mr. Johnson.
--Asset Purchase Agreement dated August 9, 1997 between Sub-Surface
Construction Co., Stewart Kniff and SEMCO Energy Construction
Co., First Amendment to Asset Purchase Agreement, Amendment to
Leased Equipment Purchase Agreements and Asset Purchase
Agreement, List of Schedules and Exhibits and Agreement to
Furnish Schedules and Exhibits.
-29-
PART II - OTHER INFORMATION - (Continued)
Item 6. Exhibits and Reports on Form 8-K - (Continued).
(a) List of Exhibits - (Continued)
--Purchase Agreement between the Company and Merrill Lynch & Co.,
etc., pertaining to an offering of 1,600,000 Shares of Common
Stock.
--Distribution Agreement between the Company and Merrill Lynch &
Co., etc., pertaining to an offering of $150,000,000
Medium-Term Notes and Form of Medium Term Note.
--Agreement and Plan of Merger dated as of October 30, 1998,
between the Company, SEMCO Consultants, Inc. and Jimmy C.
Foster and the Press Release announcing the merger.
--Executive Security Agreement.
--Split-Dollar Agreement.
--Deferred Compensation and Stock Purchase Agreement for Outside
Directors for 1999.
--Stock Purchase Agreement dated March 15, 1999 concerning the sale
of the stock in SEMCO Energy Services, Inc.
--Financial Data Schedule.
--Announcement of agreement to sell SEMCO Energy Services, Inc.
--Announcement of dividend policy change.
(b) Reports on Form 8-K.
On March 23, 1999, the Company filed Form 8-K to report the
agreement reached for the sale of its natural gas marketing subsidiary, SEMCO
Energy Services, Inc.
On April 22, 1999, the Company filed Form 8-K to report the
declaration of an increase in its regular quarterly cash dividend, the
declaration of a special cash dividend and the discontinuation of the
practice of declaring a 5% stock dividend.
-30-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SEMCO ENERGY, INC.
(Registrant)
Dated: May 10, 1999
By: /s/Sebastian Coppola
-------------------------------------
Sebastian Coppola
Senior Vice President and
Principal Accounting and Financial
Officer
-31-
EXHIBIT INDEX
Form 10-Q
First Quarter 1999
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- -------- ----------- -------- ---------
2 Plan of Acquisition, etc. NA NA
3.(i).1 Articles of Incorporation of SEMCO Energy,
Inc., as restated July 11, 1989.(a) x
3.(i).2 Certificate of Amendment to Article III
of the Articles of Incorporation dated
May 16, 1990.(b) x
3.(i).3 Certificate of Amendment to Articles I,
III and VI of the Articles of Incorporation
dated April 16, 1997.(g) x
3.(i).4 Certificate of Amendment to Article III
of the Articles of Incorporation dated
April 21, 1999. x
3.(ii) Bylaws--last revised December 17, 1998.(o) x
4.1 Note Agreement dated as of June 1, 1994,
relating to issuance of $80,000,000 of
long-term debt.(d) x
4.2 Rights Agreement dated as of April 15, 1997
with Continental Stock Transfer & Trust Company,
as Rights Agent.(e) x
4.3 Note Agreement dated as of October 1, 1997,
relating to issuance of $60,000,000 of
long-term debt.(i) x
10 Material Contracts.
10.1 Short-Term Incentive Plan.(c) x
10.2 1997 Long-Term Incentive Plan.(e) x
10.3 Stock Option Certificate and Agreement
dated October 10, 1996 with
William L. Johnson.(f) x
10.4 Stock Option Certificate and Agreement
dated February 26, 1997 with
William L. Johnson.(f) x
10.5 Employment Agreement dated October 10, 1996,
with William L. Johnson.(g) x
10.6 Change of Control Employment Agreement dated
October 10, 1996, with William L. Johnson.(g) x
10.7 Form of Change in Control Agreement
effective March 20, 1998, for all officers
except Mr. Johnson.(j) x
-32-
EXHIBIT INDEX
(Continued)
Form 10-Q
First Quarter 1999
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- -------- ----------- -------- ---------
10.8 Asset Purchase Agreement dated August 9, 1997
between Sub-Surface Construction Co., Stewart
Kniff and SEMCO Energy Construction Co.,
First Amendment to Asset Purchase Agreement,
Amendment to Leased Equipment Purchase
Agreements and Asset Purchase Agreement,
List of Schedules and Exhibits and Agreement
to Furnish Schedules and Exhibits.(h) x
10.9 Purchase Agreement between the Company and
Merrill Lynch & Co., etc., pertaining to an
offering of 1,600,000 Shares of Common Stock.(k) x
10.10 Distribution Agreement between the Company
and Merrill Lynch & Co., etc., pertaining to
an offering of $150,000,000 Medium-Term
Notes and Form of Medium Term Note.(l) x
10.11 Agreement and Plan of Merger dated as of
October 30, 1998, between the Company,
SEMCO Consultants, Inc. and Jimmy C. Foster
and the Press Release announcing the merger.(m) x
10.12 Executive Security Agreement.(o) x
10.13 Split-Dollar Agreement.(o) x
10.14 Deferred Compensation and Stock Purchase
Agreement for Outside Directors for 1999.(o) x
10.15 Stock Purchase Agreement dated March 15, 1999
concerning the sale of the stock in SEMCO
Energy Services, Inc. x
11 Statement re computation of per share earnings. NA NA
12 Ratio of Earnings to Fixed Charges. x
15 Letter re unaudited interim financial
information. NA NA
18 Letter re change in accounting principle. NA NA
19 Report furnished to security holders. NA NA
22 Published report regarding matters submitted
to a vote of security holders. NA NA
23 Consent of Independent Public Accountants. NA NA
24 Power of Attorney. NA NA
27 Financial Data Schedule. x
99.1 Announcement of agreement to sell
SEMCO Energy Services, Inc.(n) x
99.2 Announce of dividend policy change.(p) x
-33-
Key to Exhibits Incorporated by Reference
(a) Filed with SEMCO Energy, Inc.'s Form 10-K for 1989, dated March 29,
1990, File No. 0-8503.
(b) Filed with SEMCO Energy, Inc.'s Form 10-K for 1990, dated March 28,
1991, File No. 0-8503.
(c) Filed with SEMCO Energy, Inc.'s Form 10-K for 1992, dated March 30,
1993, File No. 0-8503.
(d) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
June 30, 1994, File No. 0-8503.
(e) Filed March 6, 1997 as part of SEMCO Energy, Inc.'s 1997 Proxy
Statement, dated March 7, 1997, File No. 0-8503.
(f) Filed with SEMCO Energy, Inc.'s Form 10-K for 1996, dated March 27,
1997, File No. 0-8503.
(g) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1997, File No. 0-8503.
(h) Filed with SEMCO Energy, Inc.'s Form 8-K dated August 13, 1997,
File No. 0-8503.
(i) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1997, File No. 0-8503.
(j) Filed with SEMCO Energy, Inc.'s Form 10-Q/A for the quarter ended
March 31, 1998, File No. 0-8503.
(k) Filed with SEMCO Energy, Inc.'s Form 8-K dated August 13, 1998,
File No. 0-8503.
(l) Filed with SEMCO Energy, Inc.'s Form 8-K dated October 21, 1998,
File No. 0-8503.
(m) Filed with SEMCO Energy, Inc.'s Form 8-K dated November 5, 1998,
File No. 0-8503.
(n) Filed with SEMCO Energy, Inc.'s Form 8-K dated March 23, 1999, File
No. 0-8503.
(o) Filed with SEMCO Energy, Inc.'s Form 10-K for 1998, dated March 26,
1999, File No. 0-8503.
(p) Filed with SEMCO Energy, Inc.'s Form 8-K dated April 22, 1999, File
No. 0-8503.
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