<PAGE> 1
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 JUNE 30, 1998
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 July 31, 1998, is
14,459,364.
<PAGE> 2
INDEX TO FORM 10-Q
For Quarter Ended June 30, 1998
<TABLE>
<CAPTION>
Page
Number
------
<S> <C>
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 . . . . . . . . . . . . . . . . . . . . 25
Item 2. Changes in Securities . . . . . . . . . . . . . . . . . . 25
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . 26
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
EXHIBIT INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
</TABLE>
-2-
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Thousands of Dollars Except Per Share Amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended Twelve Months Ended
June 30, June 30, June 30,
------------------ ------------------- -------------------
1998 1997 1998 1997 1998 1997*
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
OPERATING REVENUE
Gas sales $ 26,975 $ 36,389 $ 97,812 $126,184 $189,807 $218,968
Gas marketing 66,228 80,943 211,901 238,699 500,166 425,430
Transportation 2,522 3,037 6,551 6,989 12,805 13,007
Other operations 11,398 1,112 14,879 2,344 24,422 4,608
-------- -------- -------- -------- -------- --------
$107,123 $121,481 $331,143 $374,216 $727,200 $662,013
-------- -------- -------- -------- -------- --------
OPERATING EXPENSES
Cost of gas sold $ 15,873 $ 22,994 $ 64,387 $ 87,270 $128,084 $151,041
Cost of gas marketed 65,825 79,943 209,158 232,435 494,882 419,207
Operations and maintenance 18,849 10,159 32,547 22,840 60,269 42,828
Depreciation 3,798 3,110 7,536 6,222 14,176 11,879
Income taxes (1,134) 35 1,844 5,117 2,133 5,127
Taxes other than income taxes 2,312 2,242 4,741 4,593 9,481 8,872
-------- -------- -------- -------- -------- --------
$105,523 $118,483 $320,213 $358,477 $709,025 $638,954
-------- -------- -------- -------- -------- --------
OPERATING INCOME $ 1,600 $ 2,998 $ 10,930 $ 15,739 $ 18,175 $ 23,059
Write-down of NOARK investment, net of income
taxes of $11,308 -- -- -- -- -- (21,000)
Adjustment to NOARK reserve, net of income taxes
of $2,705 -- -- -- -- 5,025 --
Other income (loss), net (107) (33) 643 46 729 (610)
-------- -------- -------- -------- -------- --------
INCOME BEFORE INTEREST CHARGES $ 1,493 $ 2,965 $ 11,573 $ 15,785 $ 23,929 $ 1,449
-------- -------- -------- -------- -------- --------
INTEREST CHARGES
Interest on long-term debt $ 2,757 $ 2,127 $ 5,937 $ 4,256 $ 11,069 $ 8,513
Other interest 667 570 1,046 1,531 2,762 2,833
Amortization of debt expense 107 97 213 190 415 376
Dividends on preferred stock 48 49 97 97 193 193
-------- -------- -------- -------- -------- --------
$ 3,579 $ 2,843 $ 7,293 $ 6,074 $ 14,439 $ 11,915
-------- -------- -------- -------- -------- --------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE AND EXTRAORDINARY CHARGE $ (2,086) $ 122 $ 4,280 $ 9,711 $ 9,490 $(10,466)
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) -- (499) -- (499) --
-------- -------- -------- -------- -------- --------
NET INCOME (LOSS) $ (2,585) $ 122 $ 5,565 $ 9,711 $ 10,775 $(10,466)
======== ======== ======== ======== ======== ========
EARNINGS (LOSS) PER SHARE - BASIC AND DILUTED $ (.18) $ .01 $ .39 $ .71 $ .77 $ (.77)
======== ======== ======== ======== ======== ========
CASH DIVIDENDS PER SHARE $ .19 $ .19 $ .38 $ .36 $ .76 $ .73
======== ======== ======== ======== ======== ========
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
(IN THOUSANDS) 14,280 13,654 14,095 13,663 13,917 13,668
======== ======== ======== ======== ======== ========
</TABLE>
*Restated - See note 1 of the notes to the consolidated financial statements.
The notes to the consolidated financial statements are an integral part of
these statements.
-3-
<PAGE> 4
SEMCO ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
A S S E T S
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
June 30, December 31, June 30,
1998 1997 1997
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
UTILITY PLANT
Plant in service, at cost $368,658 $360,022 $354,322
Less - Accumulated depreciation 108,630 102,790 101,325
-------- -------- --------
$260,028 $257,232 $252,997
OTHER PROPERTY, net 24,120 18,230 9,373
-------- -------- --------
$284,148 $275,462 $262,370
-------- -------- --------
CURRENT ASSETS
Cash and temporary cash investments,
at cost $ 3,491 $ 3,985 $ 5,586
Receivables, less allowances of
$1,715 at June 30, 1998, $1,498
at December 31, 1997 and $1,103
at June 30, 1997 18,462 50,154 22,224
Accrued revenue 25,669 66,998 31,071
Materials and supplies, at average cost 2,630 2,924 3,021
Gas in underground storage 43,588 36,083 22,705
Gas charges, recoverable from customers 8,237 19,931 10,758
Accumulated deferred income taxes -- -- 361
Other 5,503 11,702 3,261
-------- -------- --------
$107,580 $191,777 $ 98,987
-------- -------- --------
DEFERRED CHARGES
Unamortized debt expense $ 5,344 $ 5,284 $ 5,270
Deferred gas charges, recoverable
from customers -- -- 116
Advances to equity investees -- 8,370 6,726
Other 30,992 24,594 19,881
-------- -------- --------
$ 36,336 $ 38,248 $ 31,993
-------- -------- --------
$428,064 $505,487 $393,350
======== ======== ========
</TABLE>
The notes to the consolidated financial statements are an integral part of these
statements.
-4-
<PAGE> 5
SEMCO ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
STOCKHOLDERS' INVESTMENT AND LIABILITIES
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
June 30, December 31, June 30,
1998 1997 1997
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
COMMON STOCK EQUITY
Common stock-par value $1 per share,
20,000,000 shares authorized;
14,441,275, 13,204,147 and
13,018,144 shares outstanding $ 14,441 $ 13,204 $ 13,018
Capital surplus 90,368 81,938 78,879
Retained earnings (deficit) (449) (640) 3,229
-------- -------- --------
$104,360 $ 94,502 $ 95,126
-------- -------- --------
CUMULATIVE CONVERTIBLE PREFERRED STOCK
Convertible preferred stock - par value
$1 per share; authorized 500,000
shares issuable in series; each
convertible to 4.11 common shares $ 6 $ 7 $ 7
Capital surplus 156 162 162
-------- -------- --------
$ 162 $ 169 $ 169
-------- -------- --------
CUMULATIVE PREFERRED STOCK OF SUBSIDIARY
$100 par value (redemption price
$105 per share); authorized
50,000 shares issuable in series;
31,000 shares outstanding $ 3,100 $ 3,100 $ 3,100
-------- -------- --------
LONG-TERM DEBT INCLUDING CAPITAL LEASES $140,012 $163,548 $105,689
-------- -------- --------
CURRENT LIABILITIES
Notes payable to banks $ 71,168 $ 71,019 $ 50,700
Current portion of long-term debt
and capital leases -- -- 1,438
Accounts payable 46,917 79,842 45,354
Customer advance payments 4,403 8,035 1,986
Accrued taxes -- -- 3,700
Accrued interest 1,636 1,985 1,030
Accumulated deferred income taxes 1,152 1,150 --
Other 9,155 13,986 6,331
-------- -------- --------
$134,431 $176,017 $110,539
-------- -------- --------
DEFERRED CREDITS
Reserve for equity investment $ -- $ 25,212 $ 32,942
Accumulated deferred income taxes 22,217 15,046 10,616
Unamortized investment tax credit 2,381 2,515 2,651
Customer advances for construction 3,450 3,935 7,708
Other 17,951 21,443 24,810
-------- -------- --------
$ 45,999 $ 68,151 $ 78,727
-------- -------- --------
$428,064 $505,487 $393,350
======== ======== ========
</TABLE>
The notes to the consolidated financial statements are an integral part of
these statements.
-5-
<PAGE> 6
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(Thousands of Dollars)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended Twelve Months Ended
June 30, June 30, June 30,
-------------------- ------------------- --------------------
1998 1997 1998 1997 1998 1997*
--------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers $159,878 $163,057 $412,945 $439,115 $738,735 $644,043
Cash paid for payrolls and to suppliers (158,218) (132,948) (348,575) (371,212) (709,640) (596,729)
Interest paid (6,302) (4,373) (7,332) (6,028) (13,225) (11,293)
Income taxes paid (600) (3,000) (600) (3,000) (753) (3,750)
Taxes other than income taxes paid (1,086) (1,120) (2,397) (2,100) (9,891) (9,543)
Other cash receipts and payments, net (222) (18) (51) 241 647 1,726
-------- -------- -------- -------- -------- --------
NET CASH FROM OPERATING ACTIVITIES $ (6,550) $ 21,598 $ 53,990 $ 57,016 $ 5,873 $ 24,454
-------- -------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Natural gas distribution property additions $ (4,452) $(10,270) $ (9,483) $(14,565) $(23,119) $(34,711)
Other property additions (866) (44) (1,257) (146) (2,291) (293)
Proceeds from property sales, net of retirement costs (144) 215 (194) 201 (22) 984
Acquisition of businesses, net of cash acquired 26 -- 26 -- (15,091) --
Advances to equity investees -- (816) (4,284) (1,664) (5,928) (2,508)
-------- -------- -------- -------- -------- --------
NET CASH FROM INVESTING ACTIVITIES $ (5,436) $(10,915) $(15,192) $(16,174) $(46,451) $(36,528)
-------- -------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock $ 1,664 $ 1,435 $ 3,351 $ 2,708 $ 6,517 $ 5,245
Repurchase of common stock -- (1,227) -- (2,700) (371) (4,907)
Net change in notes payable to banks 48,573 (10,700) (3,377) (40,400) 16,942 21,700
Net change in notes payable - other (9,205) -- (9,205) -- (9,205) --
Costs related to early extinguishment of debt (941) -- (941) -- 59,059 --
Costs related to issuance of debt (99) -- (99) -- (99) --
Repayment of long-term debt (23,550) (25) (23,550) (25) (23,550) (25)
Payment of dividends (2,780) (2,586) (5,471) (5,071) (10,810) (10,123)
-------- -------- -------- -------- -------- --------
NET CASH FROM FINANCING ACTIVITIES $ 13,662 $(13,103) $(39,292) $(45,488) $ 38,483 $ 11,890
-------- -------- -------- -------- -------- --------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease) $ 1,676 $ (2,420) $ (494) $ (4,646) $ (2,095) $ (184)
Beginning of Period 1,815 8,006 3,985 10,232 5,586 5,770
-------- -------- -------- -------- -------- --------
End of Period $ 3,491 $ 5,586 $ 3,491 $ 5,586 $ 3,491 $ 5,586
======== ======== ======== ======== ======== ========
RECONCILIATION OF NET INCOME TO
NET CASH FROM OPERATING ACTIVITIES
Net income (loss) $ (2,585) $ 122 $ 5,565 $ 9,711 $ 10,775 $(10,465)
Adjustments to reconcile net income (loss) to
net cash from operating activities:
Depreciation 3,798 3,110 7,536 6,222 14,177 11,879
Extraordinary charge 499 -- 499 -- 499 --
Write-down of NOARK investment, net -- -- -- -- -- 21,000
Adjustment to reserve for NOARK investment, net -- -- -- -- (5,025) --
Deferred taxes and investment tax credits (24) 186 (3,007) 375 60 4,223
Equity (income) loss, net of distributions (164) (86) (438) (68) 32 1,845
Receivables 14,442 25,705 31,692 21,361 7,217 (1,367)
Accrued revenue 33,765 16,600 41,330 45,478 5,403 (13,515)
Materials and supplies and gas in
underground storage (25,328) (17,613) (7,212) 10,895 (21,282) (4,939)
Gas charges, recoverable from customers 2,808 (172) 11,694 3,033 2,521 (1,358)
Other current assets 3,392 2,576 6,321 6,779 2,072 (1,346)
Accounts payable (28,305) (4,392) (33,582) (46,006) (8,043) 19,146
Customer advances and amounts payable to customers (88) (682) (4,117) (4,539) (1,841) (917)
Accrued taxes (1,927) (2,314) 1,052 3,457 (3,381) (2,810)
Other, net (6,833) (1,442) (3,343) 318 2,689 3,078
-------- -------- -------- -------- -------- --------
NET CASH FROM OPERATING ACTIVITIES $ (6,550) $ 21,598 $ 53,990 $ 57,016 $ 5,873 $ 24,454
======== ======== ======== ======== ======== ========
</TABLE>
*Restated - See note 1 of the notes to the consolidated financial statements.
The notes to the consolidated financial statements are an integral part of these
statements.
-6-
<PAGE> 7
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) SIGNIFICANT ACCOUNTING POLICIES AND CHANGE IN ACCOUNTING METHOD
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 SEMCO Energy, Inc.'s (the Company's)
year-end financial statements 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 1997 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.
The preparation of financial statements in conformity with generally
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.
SUPPLEMENTAL CASH FLOW INFORMATION. Supplemental cash flow information for
the three, six and twelve months ended June 30, 1998 and 1997 is as follows
(in thousands of dollars):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended Twelve Months Ended
June 30, June 30, June 30,
------------------ ------------------ -------------------
1998 1997 1998 1997 1998 1997
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Acquisitions of Businesses,
Net of Cash Acquired
Fair value of assets acquired $ 1,559 $ -- $ 9,865 $ -- $32,329 $ --
Liabilities assumed (1,250) -- (3,556) -- (9,886) --
Capital stock issued
for acquisitions (309) -- (6,309) -- (6,759) --
------- ----- ------- ----- ------- -----
Cash paid $ 0 $ -- $ 0 $ -- $15,684 $ --
Less cash acquired 26 -- 26 -- 593 --
------- ----- ------- ----- ------- -----
Net Cash Paid/(Received) for Acquisitions $ (26) $ -- $ (26) $ -- $15,091 $ --
======= ===== ======= ===== ======= =====
</TABLE>
EXTRAORDINARY CHARGE. During the second quarter of 1998, the Company
redeemed all of its outstanding 8 5/8% debentures due April 15, 2017 at a
redemption price of 104% of the principal amount of $23,548,000. The payment of
the call premium and the unamortized debt expense associated with the
non-regulated operations of the Company is reflected as an extraordinary charge
of approximately $499,000 after taxes.
-7-
<PAGE> 8
CHANGE IN METHOD OF ACCOUNTING FOR PROPERTY TAXES. During the first
quarter of 1998, the Company implemented a change in its method of accounting
for property taxes so that such taxes are expensed monthly during the fiscal
period of the taxing authority for which the taxes are levied. This change
provides a better matching of property tax expense with both the payment of
services and those services provided by the taxing authority. Prior to 1998, the
Company expensed property taxes monthly during the year following the assessment
date. The cumulative effect of this change in accounting for property taxes
increased earnings by $1,784,000. The pro forma effect on prior years'
consolidated net income of retroactively recording property taxes as if the new
method of accounting had been in effect for all periods presented is not
material.
RESTATEMENT OF FINANCIAL STATEMENTS. The consolidated statements of
income and cash flows for the twelve months ended June 30, 1997 have been
restated as more fully described in the Company's 1997 Annual Report on Form
10-K. The results contained herein reflect the restatement.
-8-
<PAGE> 9
(2) EARNINGS PER SHARE
The computations of basic and diluted earnings (loss) per share for the
three, six and twelve months ended June 30, 1998 and 1997 are as follows (in
thousands except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended Twelve Months Ended
June 30, June 30, June 30,
------------------ ----------------- ------------------
1998 1997 1998 1997 1998 1997
------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
BASIC EARNINGS (LOSS) PER SHARE COMPUTATION
Income (loss) before cumulative effect of
accounting change and extraordinary charge $(2,086) $ 122 $ 4,280 $ 9,711 $ 9,490 $(10,466)
Cumulative effect of change in accounting
for property taxes -- -- 1,784 -- 1,784 --
Extraordinary charge (499) -- (499) -- (499) --
------- ------- ------- ------- ------- --------
Net Income (Loss) $(2,585) $ 122 $ 5,565 $ 9,711 $10,775 $(10,466)
======= ======= ======= ======= ======= ========
Weighted average common shares outstanding 14,280 13,654 14,095 13,663 13,917 13,668
Earnings (Loss) Per Share - Basic
Income (loss) before cumulative effect of
accounting change and
extraordinary charge $ (.15) $ .01 $ .30 $ .71 $ .68 $ (.77)
Cumulative effect of change in accounting
for property taxes -- -- .13 -- .13 --
Extraordinary charge (.03) -- (.04) -- (.04) --
------- ------- ------- ------- ------- --------
Net Income (Loss) $ (.18) $ .01 $ .39 $ .71 $ .77 $ (.77)
======= ======= ======= ======= ======= ========
DILUTED EARNINGS (LOSS) PER SHARE COMPUTATION
Income (loss) before cumulative effect of
accounting change and extraordinary charge $(2,086) $ 122 $ 4,280 $ 9,711 $ 9,490 $(10,466)
Adjustment for effect of assumed conversions:
Preferred convertible stock dividends -- 4 8 8 15 --
------- ------- ------- ------- ------- --------
Adjusted income (loss) before cumulative
effect of accounting change and
extraordinary charge $(2,086) $ 126 $ 4,288 $ 9,719 $ 9,505 $(10,466)
Cumulative effect of change in accounting
for property taxes -- -- 1,784 -- 1,784 --
Extraordinary charge (499) -- (499) -- (499) --
------- ------- ------- ------- ------- --------
Net Income (Loss) $(2,585) $ 126 $ 5,573 $ 9,719 $10,790 $(10,466)
======= ======= ======= ======= ======= ========
Weighted average common shares outstanding 14,280 13,654 14,095 13,663 13,917 13,668
Incremental shares from assumed conversions:
Preferred convertible stock -- 28 27 28 27 --
Stock options converted -- 1 5 2 6 --
------- ------- ------- ------- ------- --------
Diluted weighted average common
shares outstanding 14,280 13,683 14,127 13,693 13,950 13,668
======= ======= ======= ======= ======= ========
Earnings (Loss) Per Share - Basic
Income (loss) before cumulative effect of
accounting change and
extraordinary charge $ (.15) $ .01 $ .30 $ .71 $ .68 $ (.77)
Cumulative effect of change in accounting
for property taxes -- -- .13 -- .13 --
Extraordinary charge (.03) -- (.04) -- (.04) --
------- ------- ------- ------- ------- --------
Net Income (Loss) $ (.18) $ .01 $ .39 $ .71 $ .77 $ (.77)
======= ======= ======= ======= ======= ========
</TABLE>
-9-
<PAGE> 10
As a result of the loss from continuing operations for the three months
ended June 30,1998, and the twelve months ended June 30, 1997, basic loss per
share was not adjusted because to do so would be antidilutive.
(3) CAPITALIZATION
Common Stock Equity
- -------------------
On June 11, 1998 the Company's Board of Directors declared a regular
quarterly cash dividend on common stock of $.20 per share payable on August 15
to shareholders of record at the close of business on August 5.
In May 1998, the Company paid a quarterly cash dividend on common stock
of $.20 per share and issued a 5% common stock dividend. Of the total cash
dividend of $2,732,000, $792,000 was reinvested by shareholders into common
stock through participation in the Direct Stock Purchase and Dividend
Reinvestment Plan (DRIP). This portion of the quarterly dividend and
shareholders' optional cash payments of $748,000, resulted in 87,421 new shares
issued to existing shareholders during the quarter pursuant to the DRIP.
The May 1998 5% stock dividend resulted in 683,068 shares issued to
existing shareholders. Earnings per common share, cash dividends per common
share and weighted average number of shares outstanding have been retroactively
adjusted for all periods presented to reflect the 5% stock dividends in May 1998
and 1997.
(4) COMMITMENTS AND CONTINGENCIES
On January 14, 1998, the Company sold its entire 32% partnership
interest in the NOARK Pipeline System 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 of NOARK releases the company from all its NOARK guarantees,
which related to 40% of NOARK's debt. Furthermore, the Company agreed to pay
approximately $9,200,000, $3,100,000 and $800,000 to EAPC in April 1998, 1999
and 2000, respectively. In return, the Company will receive annual payments for
seventeen years beginning July 1, 2004 in the amount of $842,000 from EAPC. The
reserve for the NOARK investment provided at year-end 1996 was adjusted at
year-end 1997 to record the sale.
The Company expects to incur costs to investigate and/or clean up
several properties, including former manufactured gas plant sites. The Company
has submitted a plan to the State of Michigan for clean up of one site. The
extent of the Company's liabilities and potential costs in connection with these
sites cannot be reasonably estimated at this time. Any environmental costs
incurred by the gas distribution company will be amortized over ten years
starting the year after incurred.
-10-
<PAGE> 11
(5) ACQUISITIONS
On May 15, 1998, a subsidiary of the Company purchased the assets and
business of King Energy & Construction, Inc. (King Energy) for 18,062 shares of
common stock. King Energy, which is located in Tennessee, is a multi-utility
service provider furnishing water, sewer and natural gas construction services
to customers.
On March 31, 1998, a subsidiary of the Company purchased the assets and
business of Hot Flame Gas, Inc. (Hot Flame) for 352,944 shares of common stock.
Hot Flame supplies propane gas to over 10,000 customers in northern Michigan
and northeast Wisconsin.
For financial statement purposes, the acquisition of both King Energy
and Hot Flame were accounted for as purchases and, accordingly, results of
operations are included in the consolidated financial statements since the date
of each acquisition.
(6) EARLY RETIREMENT PROGRAM
The Company offered an early retirement program to all eligible
employees during the first quarter of 1998. In addition, the Company also
offered all eligible employees the additional option of receiving a lump sum
pension benefit if they elected to retire during the period of January 14, 1998
through February 27, 1998. One hundred and one employees accepted the early
retirement offer. As a result of the sizable reduction in the number of
employees, a pre-tax charge of $516,000 was recognized during the first quarter
of 1998 in the Company's results of operations.
(7) SUBSEQUENT EVENT
On July 8, 1998, the Company filed a registration statement with the
Securities and Exchange Commission for the registration of medium-term notes,
common stock and/or trust preferred securities (commonly known as TOPrS) in any
combination up to $200,000,000 over the next two years. The registration
statement was declared effective on July 24, 1998.
-11-
<PAGE> 12
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
Net loss for the quarter ended June 30, 1998, after an extraordinary
charge, was $2,585,000 ($.18 per share) compared to net income of $122,000 ($.01
per share) for the quarter ended June 30, 1997. Net loss for the quarter ended
June 30, 1998, before the extraordinary charge, was $2,086,000 ($.15 per share).
Net Income for the six months ended June 30, 1998, after a change in
accounting method and an extraordinary charge, was $5,565,000 ($.39 per share)
compared to $9,711,000 ($.71 per share) for the six months ended June 30, 1997.
Net income for the six months ended June 30, 1998, before the change in
accounting method and the extraordinary charge, was $4,280,000 ($.30 per share).
Net income for the twelve months ended June 30, 1998, after a change in
accounting method and an extraordinary charge, was $10,775,000 ($.77 per share)
compared to a net loss of $10,466,000 ($.77 per share) for the twelve months
ended June 30, 1997. Net income for the twelve months ended June 30, 1998,
before the change in accounting method and the extraordinary charge, was
$9,490,000 ($.68 per share). The net income for the twelve months ended June
30, 1998 also includes $5,025,000 of after-tax income related to the December
1997 adjustment to the NOARK reserve based on the then pending sale. Net income
for the twelve months ended June 30, 1997 includes a $21,000,000 after-tax
write-down of the Company's NOARK investment.
The Company's primary business of natural gas distribution is seasonal
in nature and depends on the winter months for the majority of its operating
revenue. Therefore, the Company's results of operations for the three month and
six month periods ended June 30, 1998 and 1997 are not necessarily indicative of
results for a full year.
See Note 4 in the notes to the consolidated financial statements for a
discussion of commitments and contingencies.
A comparison of revenues, margins and operating expenses for the
quarter, six months and twelve months ended June 30, 1998 and 1997 follows on
the next page.
-12-
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. - (CONTINUED)
<TABLE>
<CAPTION>
GAS DISTRIBUTION OPERATION
- --------------------------
Three Months Ended Six Months Ended Twelve Months Ended
June 30, June 30, June 30,
------------------ ------------------- --------------------
1998 1997 1998 1997 1998 1997
------- ------- ------- ------- ------- -------
(in thousands of dollars)
<S> <C> <C> <C> <C> <C> <C>
Gas sales revenue $26,480 $36,389 $ 97,317 $126,184 $189,312 $218,968
Cost of gas sold 15,626 22,994 64,140 87,270 127,838 151,041
------- ------- -------- -------- -------- --------
Gas sales margin $10,854 $13,395 $ 33,177 $ 38,914 $ 61,474 $ 67,927
Transportation revenue $ 2,522 $ 3,036 $ 6,550 $ 6,989 $ 12,805 $ 13,007
Other operating revenue 1,069 319 1,992 733 2,348 1,498
------- ------- -------- -------- -------- --------
Gross margin $14,445 $16,750 $ 41,719 $ 46,636 $ 76,627 $ 82,432
Operations and maintenance $ 8,270 $ 8,806 $ 17,225 $ 17,921 $ 34,737 $ 35,047
Depreciation 3,001 2,857 6,001 5,716 11,397 10,923
Income taxes (425) 192 3,169 4,770 3,978 6,085
Taxes other than income taxes 2,152 2,105 4,459 4,316 8,794 8,351
------- ------- -------- -------- -------- --------
Other operating expenses $12,998 $13,960 $ 30,854 $ 32,723 $ 58,906 $ 60,406
------- ------- -------- -------- -------- --------
OPERATING INCOME $ 1,447 $ 2,790 $ 10,865 $ 13,913 $ 17,721 $ 22,026
======= ======= ======== ======== ======== ========
<CAPTION>
NON-REGULATED OPERATIONS
- ------------------------
Three Months Ended Six Months Ended Twelve Months Ended
June 30, June 30, June 30,
------------------ ------------------- --------------------
1998 1997 1998 1997 1998 1997
------- ------- ------- ------- ------- -------
(in thousands of dollars)
Gas marketing revenue $68,329 $86,153 $216,602 $252,523 $519,447 $456,267
Cost of gas marketed 67,926 85,151 213,859 246,257 514,163 450,044
------- ------- -------- -------- -------- --------
Gas marketing margin $ 403 $ 1,002 $ 2,743 $ 6,266 $ 5,284 $ 6,223
Gas sales revenue (Propane) $ 495 $ -- $ 495 $ -- $ 495 $ --
Cost of gas sold 247 -- 247 -- 247 --
------- ------- -------- -------- -------- --------
Gas sales margin (Propane) $ 248 $ -- $ 248 $ -- $ 248 $ --
Other operating revenue $12,504 $ 917 $ 16,729 $ 1,860 $ 31,888 $ 3,480
Operations and maintenance $12,737 $ 1,458 $ 19,069 $ 5,133 $ 34,931 $ 7,989
Depreciation 797 253 1,534 506 2,779 956
Income taxes (355) (67) (747) 536 (1,098) (632)
Taxes other than income taxes 160 137 282 278 686 527
------- ------- -------- -------- -------- --------
Other operating expenses $13,339 $ 1,781 $ 20,138 $ 6,453 $ 37,298 $ 8,840
------- ------- -------- -------- -------- --------
OPERATING INCOME (LOSS) $ (184) $ 138 $ (418) $ 1,673 $ 122 $ 863
======= ======= ======== ======== ======== ========
</TABLE>
The above information is on a segment basis only. Therefore, it does not
include intercompany eliminations that would be necessary if the above
information was reported on a consolidated basis.
-13-
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. - (CONTINUED)
QUARTER RESULTS - GAS DISTRIBUTION OPERATION
The Company's gas sales margin during the second quarter of 1998
decreased by $2,541,000 compared to the second quarter of 1997. This was
primarily due to lower gas sales caused by unseasonably warm weather during the
second quarter of 1998 and the adoption of a new aggregation tariff, offset
partially by continued customer growth and the impact of an October 1997 rate
increase. The weather for the quarter ended June 30, 1998, was 36% warmer than
the same period of the prior year and 28% warmer than normal. Gas volumes sold
were 4,652,000 Mcf compared to 7,367,000 Mcf for the second quarter of 1997. The
aggregation tariff, which was effective April 1, 1998, gives all commercial and
industrial customers the opportunity to purchase their gas from a third party
supplier while allowing the Company to retain the existing distribution and
customer charges that the customer was previously being billed. Distribution and
customer charges associated with customers that switched to third party gas
suppliers are recorded in other operating revenues (discussed below) rather than
gas sales revenue because the Company is now acting as a transporter for those
customers. In other words, the decrease in gas sales margin is offset by an
increase in other operating revenue. The October 1997 rate increase was
granted to allow for the recovery of costs related to a change in accounting
for retiree medical benefits. The rate increase is offset by a corresponding
increase in retiree medical expense. The rate increase and aggregation tariff
referenced above were granted in the October 1997 Order of the Michigan Public
Service Commission (1997 rate case) (see Note 3 in the Notes to the
Consolidated Financial Statements in the Company's 1997 Annual Report on Form
10-K).
Transportation revenue decreased by $514,000, primarily due to lower
volumes and a reduction in transportation rates due to new off-peak rates
approved in the 1997 rate case. The new off-peak transportation rates are in
effect from April through October and are $0.15 lower per mcf than the Company's
regular transportation rates. Other operating revenue increased by $750,000
compared to the quarter ended June 30, 1997. Approximately $600,000 of the
increase is attributed to the impact of the new aggregation tariff. As discussed
above, under the new aggregation tariff, certain revenues that were previously
classified as gas sales revenue are now classified as other operating revenue.
The remainder of the increase is primarily due to an increase in various
miscellaneous fees charged to customers as authorized in the 1997 rate case.
Operation and maintenance expense decreased by $536,000 during the three
months ended June 30, 1998 compared to the three months ended June 30, 1997. The
decrease is due primarily to reductions in incentive compensation, due to lower
company earnings, and reductions in compensation and pension expenses. The
reductions in compensation and pension expenses are due primarily to the impact
of the Company's early retirement program and changes to the Company's employee
pension plans. The decreases were offset partially by increased retiree medical
expense.
-14-
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
Depreciation increased by $144,000 compared to the second quarter ended
June 30, 1997 primarily due to utility plant additions. Income taxes decreased
by $617,000 due to lower pre-tax earnings.
QUARTER RESULTS - NON-REGULATED OPERATIONS
Gas marketing margin during the quarter ended June 30, 1998, decreased
by $599,000 compared to the same period last year primarily due to the impact of
warm weather on market conditions, increased competition and restructuring
activities in the Company's gas marketing operation. The unseasonably warm
weather impacted market conditions by reducing price volatility which decreased
gas marketing margins during the second quarter of 1998. Increased competition
continues to put downward pressure on gas marketing margins. During the first
six months of 1998, the Company terminated agreements with certain of its
independent gas marketing representatives in an effort to reduce risks and
improve long-term profitability.
Gas marketing volumes and margins are subject to significant competitive
factors. In addition to fluctuations caused by seasonal patterns, competition
within the natural gas marketing industry continues to increase.
Gas sales margin (propane), for the quarter ended June 30, 1998, was
$248,000 with no operations in this area during the same period of the prior
year. The gas sales margin for the non-regulated business is comprised entirely
of propane sales by Hotflame Gas, Inc., which was acquired on March 31, 1998.
Other operating revenue during the quarter ended June 30, 1998 increased
by $11,587,000 compared to the same period of the prior year. The increase is
due primarily to the operating revenues recorded by Sub-Surface Construction
Company, Maverick Pipeline Services, Inc., Utility Construction Services, Inc.
and King Energy & Construction Company (new businesses acquired since the prior
year period). There were no revenues from these businesses recorded in the
second quarter of 1997 because they were not part of the Company's operations
during that period.
Operation and maintenance expense increased by $11,279,000 during the
three months ended June 30, 1998 compared to the three months ended June 30,
1997. The increase is due primarily to the Company's new businesses.
Depreciation increased by $544,000 compared to the quarter ended June
30, 1997 primarily due to depreciation of equipment acquired as part of the
Company's new businesses. Income taxes decreased by $288,000 compared to the
quarter ended June 30, 1997 due to lower pre-tax earnings.
-15-
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
The Company's new businesses (Sub-Surface Construction Company,
Maverick Pipeline Services, Inc., Utility Construction Services, Inc., King
Energy & Construction Company and Hotflame Gas, Inc.) account for a
significant portion of the increased revenues and expenses of the Company's
non-regulated operations. The seasonal cycle of these new businesses
(excluding Hotflame Gas) is different than the seasonal cycle of the regulated
gas distribution business. Pipeline construction and engineering businesses
typically have losses in the first quarter (during winter months), break-even
in the second quarter and generate income in the third and fourth quarters due
to the seasonal nature of their business. During the first quarter of 1998, the
new businesses generated an operating loss of $838,000, which was a more
favorable performance than expected due to the mild weather. The new businesses
generated operating income of $145,000 during the second quarter of 1998. The
quarterly income from the new businesses is reflected in the results for the
second quarter of 1998 but not in the second quarter of 1997 because the new
businesses were not part of the Company's operations during that period.
Sub-Surface Construction Company was acquired on August 13, 1997, Maverick
Pipeline Services was acquired on December 31, 1997, Utility Construction
Services is a start-up company that began operations in January of 1998,
Hotflame Gas was acquired on March 31, 1998 and King Energy & Construction was
acquired on May 15, 1998. During the second quarter of 1998, the operations at
Utility Construction Services were put on hold and its employees were laid-off
or relocated due to lower than expected workload and earnings.
QUARTERLY RESULTS - NON-OPERATING INFORMATION
Interest on long-term debt, as shown in the Consolidated Statements of
Income, increased by $630,000 due to the increase in long-term debt compared to
the quarter ended June 30, 1997. During the fourth quarter of 1997, the Company
issued $60,000,000 of private placement debt to reduce notes payable to banks
incurred to finance the Company's ongoing capital expenditure program and for
general corporate purposes. During the second quarter of 1998, the Company
refinanced $23,548,000 of long-term debt using short-term debt (see Note 1 in
the Notes to the Consolidated Financial Statements and the Future Financing
Sources section).
Other interest, as shown in the Consolidated Statements of Income,
increased by $97,000 as a result of the additional short-term debt used in the
above described refinancing during the second quarter of 1998 plus the impact
of additional borrowings for utility plant additions and other general
corporate purposes offset by the impact of the refinancing during the fourth
quarter of 1997, also mentioned above.
During the second quarter of 1998, the Company incurred an extraordinary
charge of $499,000 after-tax, related to the early redemption of a portion of
the Company's long-term debt (see Note 1 in the Notes to the Consolidated
Financial Statements).
-16-
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
SIX-MONTH RESULTS - GAS DISTRIBUTION OPERATION
The Company's gas sales margin for the six months ended June 30, 1998
decreased by $5,737,000 compared to the six months ended June 30, 1997. The
decrease was due primarily to lower gas sales due to unseasonably warm weather
during the first six months of 1998 and the adoption of a new aggregation
tariff, offset partially by continued customer growth and the impact of the
October 1997 rate increase. The weather for the six months ended June 30, 1998,
was 18% warmer than the same period of the prior year and 19% warmer than
normal. Gas volumes sold were 20,222,000 Mcf compared to 25,891,000 Mcf for the
first six months of 1997. Under the aggregation tariff, which was discussed in
greater detail in the quarterly results, certain revenues that were previously
classified as gas sales revenue are now classified as other operating revenue
(discussed below). In other words, the decrease in gas sales margin is offset by
an increase in other operating revenue. The impact of the rate increase, which
was also discussed in the quarterly results, is offset by a corresponding
increase in retiree medical expense.
Transportation revenue decreased by $439,000, primarily due to lower
volumes and a reduction in transportation rates due to new off-peak rates
included in the 1997 rate case. Other operating revenue increased by $1,259,000
compared to the six months ended June 30, 1997. $600,000 of the increase is
attributable to the impact of the new aggregation tariff discussed above. The
remainder of the increase is primarily due to an increase in various
miscellaneous fees charged to customers as authorized in the 1997 rate case.
Operation and maintenance expense decreased by $696,000 during the six
months ended June 30, 1998 compared to the six months ended June 30, 1997.
However, a charge of $516,000 related to the early retirement program is
included in operation and maintenance expense for the six months ended June 30,
1998 (see Note 6 in the Notes to the Consolidated Financial Statements). The
Company expects that the early retirement program will lower operating costs
over the next several years. The Company actually experienced a decrease of
$1,212,000 in operation and maintenance expense after excluding the charge
related to the early retirement program. The decrease is due primarily to
reductions in incentive compensation, due to lower company earnings, and
reductions in compensation and pension expenses. The reductions in compensation
and pension expenses are due primarily to the impact of the Company's early
retirement program and changes to the Company's employee pension plans. The
decreases were offset partially by increased retiree medical expense.
Depreciation increased by $285,000 compared to the six months ended June
30, 1997 primarily due to utility plant additions. Income taxes decreased by
$1,601,000 due to lower pre-tax earnings. Taxes other than income increased
primarily due to property taxes on utility plant additions.
-17-
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
SIX-MONTH RESULTS - NON-REGULATED OPERATIONS
Gas marketing margin for the six months ended June 30, 1998 decreased by
$3,523,000 compared to the same period last year primarily due to the impact of
warm weather on market conditions, increased competition and restructuring
activities in the Company's gas marketing operation. The warm weather impacted
market conditions by reducing price volatility which decreased gas marketing
margins. Increased competition continues to put downward pressure on gas
marketing margins. During the first six months of 1998 the Company terminated
agreements with certain of its independent gas marketing representatives in an
effort to reduce risks and improve long-term profitability.
Gas marketing volumes and margins are subject to significant competitive
factors. In addition to fluctuations caused by seasonal patterns, competition
within the natural gas marketing industry continues to increase.
Other operating revenue during the six months ended June 30, 1998
increased by $14,869,000 compared to the same period of the prior year. The
increase is due primarily to the operating revenues recorded by Sub-Surface
Construction Company, Maverick Pipeline Services, Inc., Utility Construction
Services, Inc. and King Energy & Construction Company (new businesses). There
were no revenues from these businesses recorded in the first six months of 1997
because they were not part of the Company's operations during that period.
Operation and maintenance expense increased by $13,936,000 during the
six months ended June 30, 1998 compared to the six months ended June 30, 1997.
However, during the first six months of 1998, operation and maintenance expenses
attributed to the new businesses totaled $15,259,000. This was offset by a
$1,323,000 decrease due primarily to decreases in gas marketer incentive
compensation partially offset by increased professional fees for additional
services associated with closing the financial records at year-end.
Depreciation increased by $1,028,000 compared to the six months ended
June 30, 1997 primarily due to depreciation of equipment acquired as part of
the Company's new businesses. Income taxes decreased by $1,283,000 compared to
the six months ended June 30, 1997 due to lower pre-tax earnings. $413,000 of
the decrease in income taxes is attributed to the Company's new businesses.
-18-
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
The Company's new businesses (Sub-Surface Construction Company,
Maverick Pipeline Services, Inc., Utility Construction Services, Inc., Hotflame
Gas, Inc. and King Energy & Construction Company) account for a significant
portion of the increased revenues and expenses of the Company's non-regulated
operations. There are additional details regarding these new businesses and
their seasonal cycles in the quarterly results. The new businesses generated an
operating loss of $691,000 during the six months ended June 30, 1998. The loss
from the new businesses is reflected in the results for the first six months of
1998 but not in the first six months of 1997 because the new businesses were
not part of the Company's operations during that period.
SIX-MONTH RESULTS - NON-OPERATING INFORMATION
Other income (loss), net , as shown in the Consolidated Statements of
Income, increased by $597,000 compared to the six months ended June 30, 1997 due
primarily to a non-recurring income tax benefit recognized during the first
quarter of 1998. The income tax benefit relates to tax deductions available to
the Company due to the operating results of the NOARK Pipeline System
Partnership. The Company's interest in the NOARK Pipeline System Partnership was
sold on January 14, 1998 (see Note 4 in the Notes to the Consolidated Financial
Statements).
Interest on long-term debt, as shown in the Consolidated Statements of
Income, increased by $1,681,000 due to the increase in long-term debt compared
to the six months ended June 30, 1997. During the fourth quarter of 1997, the
Company issued $60,000,000 of private placement debt to reduce notes payable to
banks incurred to finance the Company's ongoing capital expenditure program and
for general corporate purposes. During the second quarter of 1998, the Company
refinanced $23,548,000 of long-term debt using short-term debt (see Note 1 in
the Notes to the Consolidated Financial Statements and the Future Financing
Sources section).
Other interest, as shown in the Consolidated Statements of Income,
decreased by $485,000 as a result of the above described refinancing during the
fourth quarter of 1997 offset partially by the impact of the refinancing during
the second quarter of 1998 and additional borrowings for utility plant additions
and other general corporate purposes.
The Consolidated Statements of Income for the six months ended June 30,
1998 include after-tax income of $1,784,000 from a change in the method of
accounting for property taxes by the Company's gas distribution business (see
Note 1 in the Notes to the Consolidated Financial Statements). The six month
results also include an extraordinary charge of $499,000 after-tax, related to
the early redemption of a portion of the Company's long-term debt ( see Note 1
in the Notes to the Consolidated Financial Statements).
-19-
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
TWELVE-MONTH RESULTS - GAS DISTRIBUTION OPERATION
Lower gas sales due to warmer weather during the twelve months ended
June 30, 1998, offset partially by continued customer growth and the impact of
the October 1997 rate increase, reduced gas sales margin by $6,453,000 compared
to the twelve months ended June 30, 1997. The weather was 11% warmer during the
twelve months ended June 30, 1998 compared to the same period of the prior year
and 12% warmer than normal. Gas volumes sold were 36,316,000 Mcf compared to
42,867,000 Mcf for the twelve months ended June 30, 1997.
Other operating revenue increased by $850,000 primarily due to the
additional fees for transportation customers discussed in the quarterly results.
Operation and maintenance expense decreased by $310,000 during the
twelve months ended June 30, 1998 compared to the twelve months ended June 30,
1997. However, a charge of $516,000 related to the early retirement program is
included in operation and maintenance expense for the twelve months ended June
30, 1998 (see Note 6 in the Notes to the Consolidated Financial Statements). The
offsetting $826,000 decrease is attributable mainly to reduced compensation,
pension and employee benefit expenses offset by increased retiree medical
expenses.
Depreciation increased by $474,000 compared to the twelve months ended
June 30, 1997 primarily due to utility plant additions. Income taxes decreased
by $2,107,000 due to lower pre-tax earnings. Taxes other than income taxes
increased by $443,000 primarily due to property taxes on additional utility
plant in service.
TWELVE-MONTH RESULTS - NON-REGULATED OPERATIONS
During the twelve months ended June 30, 1998, gas volumes marketed
increased by 15% compared to the twelve months ended June 30,1997. Gas marketing
margin during the same period decreased by $939,000 primarily due to decreases
in per unit margins, the effect of warm weather on market conditions during the
first six months of 1998 and the restructuring activities discussed in the
quarterly and six month results, offset partially by the impact of the increase
in volumes. Gas marketing volumes and margins are subject to significant
competitive factors. In addition to fluctuations caused by seasonal patterns,
competition within the natural gas marketing industry continues to increase.
Other operating revenue during the twelve months ended June 30, 1998
increased by $28,408,000 compared to the same period of the prior year. The
increase is due to the operating revenues recorded by Sub-Surface Construction
Company, Maverick Pipeline Services, Inc., Utility Construction Services, Inc.
and King Energy & Construction Company (new businesses). There were no revenues
from these businesses recorded in the twelve months ended June 30, 1997 because
they were not part of the Company's operations during that period.
-20-
<PAGE> 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
Operation and maintenance expense increased by $26,942,000 during the
twelve months ended June 30, 1998 compared to the twelve months ended June 30,
1997. $26,818,000 of the increase is attributable to the new businesses. The
remaining $124,000 is primarily due to increased professional fees for
additional services associated with closing the financial records at year-end
and services related to a 1997 computer systems enhancement project offset
partially by decreases in gas marketer incentive compensation.
Depreciation increased by $1,823,000 compared to the twelve months ended
June 30, 1997 primarily due to depreciation of equipment acquired as part of
the Company's new businesses. Income taxes decreased by $466,000 compared to
the twelve months ended June 30, 1997 due to lower pre-tax earnings.
$129,000 of the decrease in income taxes is attributed to the new businesses.
The increase in taxes other than income taxes is also attributed primarily to
the new businesses.
TWELVE-MONTH RESULTS - NON-OPERATING INFORMATION
Net loss, as shown in the Consolidated Statements of Income, for the
twelve months ended June 30, 1997 includes a $21,000,000 after-tax write-down
of the Company's NOARK investment. Net income for the twelve months ended June
30, 1998 includes $5,025,000 of after-tax income related to the December 1997
adjustment to the NOARK reserve based on the then pending sale. The increase in
other income during the twelve month period ended June 30, 1998 is primarily
due to the non-recurring income tax benefit discussed in the six month results
and NOARK losses. The twelve month period ended June 30, 1997 includes six
months of NOARK losses totaling $896,000. As a result of the December 1996
write-down of the NOARK investment, no losses were incurred subsequent to that
date.
The increase in interest on long-term debt, as shown in the Consolidated
Statements of Income, is due to the $60,000,000 private placement debt offset
partially by the refinancing in April of 1998 as discussed in the quarterly
results.
The Consolidated Statement of Income for the twelve months ended June
30, 1998 include after-tax income of $1,784,000 from a change in the method of
accounting for property taxes by the Company's gas distribution business (see
Note 1 in the Notes to the Consolidated Financial Statements). The twelve months
ended June 30, 1998 also include an extraordinary charge of $499,000 after-tax,
related to the early redemption of a portion of the Company's long-term debt
(see Note 1 in the Notes to the Consolidated Financial Statements).
-21-
<PAGE> 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
Net cash from operating activities for the three, six and twelve month
periods ended June 30, 1998, as compared to the same periods last year,
decreased $28,148,000, $3,026,000 and $18,581,000, respectively. The changes
in operating cash flows between periods is primarily due to changes in net
income and the timing of cash receipts and cash payments and its effect on
working capital.
The Company anticipates spending approximately $11,300,000 for capital
items during the remainder of 1998. These estimated amounts will primarily
relate to customer additions and system replacement in the gas distribution
operation. This amount does not include any sum for business acquisitions, if
any, the Company may effect during the remainder of 1998.
See Note 4 in the Notes to the Consolidated Financial Statements for a
discussion of the amounts to be paid in conjunction with the sale of the
Company's partnership interest in the NOARK Pipeline System.
Financing activities contributed $13,662,000 in funds during the second
quarter of 1998, primarily for notes payable to banks used to fund gas purchases
and normal gas distribution construction.
FUTURE FINANCING SOURCES
The Company's operating cash flow needs, as well as dividend payments
and capital expenditures for the balance of 1998, are expected to be met
primarily through operating activities and short-term borrowings. However, if
the Company makes any business acquisitions during the year, they may be
financed with stock or long-term debt. At June 30, 1998, the Company had
$44,800,000 in unused lines of credit.
On April 15, 1998, the Company redeemed all of its outstanding 8 5/8%
debentures due April 15, 2017 (see Note 1 in the Notes to the Consolidated
Financial Statements). The redemption was accomplished using short-term debt
but the Company intends to convert the short-term debt to long-term debt before
the end of 1998.
On July 24, 1998 a registration statement, filed by the Company with the
SEC under the Securities Act of 1933 became effective pursuant to which
medium-term notes, common stock and/or trust preferred securities in any
combination up to $200,000,000 were registered for sale. (see Note 7 in the
Notes to the Consolidated Financial Statements).
-22-
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
YEAR 2000
The Company has initiated an enterprise-wide program to prepare its
computer systems and applications for the year 2000. The Company expects to
incur internal staff costs as well as consulting and other expenses related to
infrastructure and facilities enhancements necessary to prepare the systems for
the year 2000. Testing and conversion of system applications is expected to cost
approximately $1,000,000 to $1,500,000 spread over the next year.
A significant portion of these costs is not likely to be incremental, but
rather will represent the redeployment of existing information technology
resources. The Company has developed, and already is implementing, a detailed
"Year-2000" strategy which identifies each software application utilized by the
Company and the steps necessary to ensure its continued viability in the coming
years. The Company believes it has identified all significant internal systems
and applications that require attention of some form in order to be year-2000
ready. The Company has begun taking steps to correct the systems identified.
The Company currently plans to have all year-2000 issues addressed by the first
quarter of 1999.
The Company has identified what it believes are its most significant
worst case year-2000 scenarios. These scenarios are (i) interference with the
Company's ability to receive and deliver gas to customers; (ii) interference
with the Company's ability to monitor gas pressure throughout the Company's gas
distribution system and (iii) interference with the Company's ability to bill
and receive payments from customers. As discussed above, the Company has begun
taking the steps necessary to ensure that these worse case scenarios are
addressed by the first quarter of 1999. This should allow enough time to
properly test the systems and applications to ensure that they are functional
for year-2000.
The Company is in the process of surveying its large suppliers and
customers regarding their year-2000 plans and issues. The Company does not
currently have enough data to make an accurate assessment of the impact of its
supplier's and customer's year-2000 readiness.
NEW ACCOUNTING PRONOUNCEMENTS
In June of 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities. The Statement 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. The
Statement 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.
Statement 133 is effective for fiscal years beginning after June 15,
1999. The Company has not yet quantified the impacts of adopting Statement 133
on its financial statements and has not determined the timing of or method of
our adoption of Statement 133.
-23-
<PAGE> 24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. - (CONTINUED)
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10Q includes forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 and
the Commission's Rule 3b-6 under the Exchange Act. Forward-looking statements
involve certain risks and uncertainties that may cause actual future results to
differ materially from those contemplated, projected, estimated or budgeted in
such forward-looking statements. Factors that may impact forward-looking
statements include, but are not limited to, the following: (i) the effects of
weather and other natural phenomena; (ii) the economic climate and growth in the
geographical areas where SEMCO does business; (iii) the capital intensive nature
of SEMCO's business; (iv) increased competition within the energy marketing
industry as well as from alternative forms of energy; (v) the timing and extent
of changes in commodity prices for natural gas; (vi) the effects of changes in
governmental and regulatory policies, including income taxes, environmental
compliance and authorized rates; (vii) SEMCO's ability to bid on and win
business contracts; (viii) the nature, availability and projected profitability
of potential investments available to SEMCO and (ix) the conditions of capital
markets and equity markets.
-24-
<PAGE> 25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
At the April 21, 1998 Annual Meeting of Common Shareholders the
following nominees were elected to hold office on the Board of Directors for a
term of three years:
<TABLE>
<CAPTION>
Name Votes For Votes Withheld
---- --------- --------------
<S> <C> <C>
William L. Johnson 9,351,338 440,908
Bruce G. Macleod 9,314,355 477,891
Donald W. Thomason 9,384,356 407,890
</TABLE>
ITEM 5. Not applicable.
-25-
<PAGE> 26
PART II - OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) List of Exhibits - (See page 28 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.
--Bylaws--last revised August 15, 1997.
--Trust Indenture dated April 1, 1992, with NBD Bank, N.A. as Trustee.
--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.
--Deferred Compensation and Phantom Stock Purchase Agreement (for
outside directors only).
--Supplemental Retirement Plan for Certain Officers.
--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 for all other officers.
--Letter from Arthur Andersen dated May 5, 1998 re: change in
accounting principle.
--Financial data schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the second quarter of
1998.
-26-
<PAGE> 27
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: August 13, 1998
By: /s/Robert J. Digan, II
------------------------------------
Robert J. Digan, II
Senior Vice President and
Principal Accounting and Financial
Officer
-27-
<PAGE> 28
EXHIBIT INDEX
Form 10-Q
Second Quarter 1998
<TABLE>
<CAPTION>
Filed
----------------------
Exhibit By
No. Description Herewith Reference
- -------- ----------- -------- ---------
<S> <C> <C> <C>
2 Plan of Acquisition, etc. NA NA
3.(i).1 Articles of Incorporation of SEMCO Energy,
Inc., as restated July 11, 1989.(a) x
3.(i).2 Certificate of Amendment to Article III
of the Articles of Incorporation dated
May 16, 1990.(b) x
3.(i).3 Certificate of Amendment to Articles I,
III and VI of the Articles of Incorporation
dated April 16, 1997.(j) x
3.(ii) Bylaws--last revised August 15, 1997.(k) x
4.1 Trust Indenture dated April 1, 1992, with
NBD Bank, N.A. as Trustee.(c) x
4.2 Note Agreement dated as of June 1, 1994,
relating to issuance of $80,000,000 of
long-term debt.(e) x
4.3 Rights Agreement dated as of April 15, 1997
with Continental Stock Transfer & Trust Company,
as Rights Agent.(h) x
4.4 Note Agreement dated as of October 1, 1997,
relating to issuance of $60,000,000 of
long-term debt.(k) x
10 Material Contracts.
10.1 Short-Term Incentive Plan.(d) x
10.2 Deferred Compensation and Phantom Stock
Purchase Agreement (for outside
directors only).(f) x
10.3 Supplemental Retirement Plan for Certain
Officers.(g) x
10.4 1997 Long-Term Incentive Plan.(h) x
10.5 Stock Option Certificate and Agreement
dated October 10, 1996 with
William L. Johnson.(i) x
10.6 Stock Option Certificate and Agreement
dated February 26, 1997 with
William L. Johnson.(i) x
10.7 Employment Agreement dated October 10, 1996,
with William L. Johnson.(j) x
10.8 Change of Control Employment Agreement dated
October 10, 1996, with William L. Johnson.(j) x
10.9 Form of Change in Control Agreement
effective March 20, 1998, for all
officers except Mr. Johnson.(m) x
11 Statement re[A computation of per share earnings. NA NA
</TABLE>
-28-
<PAGE> 29
EXHIBIT INDEX
(Continued)
Form 10-Q
Second Quarter 1998
<TABLE>
<CAPTION>
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- -------- ----------- -------- ---------
<S> <C> <C> <C>
15 Letter re unaudited interim financial
information. NA NA
18 Letter re change in accounting principle.(l) x
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
</TABLE>
Key to Exhibits Incorporated by Reference
(a) Filed with SEMCO Energy, Inc.'s Form 10-K for 1989, dated March 29,
1990, File No. 0-8503.
(b) Filed with SEMCO Energy, Inc.'s Form 10-K for 1990, dated March 28,
1991, File No. 0-8503.
(c) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1992, File No. 0-8503.
(d) Filed with SEMCO Energy, Inc.'s Form 10-K for 1992, dated March 30,
1993, File No. 0-8503.
(e) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
June 30, 1994, File No. 0-8503.
(f) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1994, File No. 0-8503.
(g) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1996, File No. 0-8503.
(h) Filed March 6, 1997 as part of SEMCO Energy, Inc.'s 1997 Proxy
Statement, dated March 7, 1997, File No. 0-8503.
(i) Filed with SEMCO Energy, Inc.'s Form 10-K for 1996, dated March 27,
1997, File No. 0-8503.
(j) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1997, File No. 0-8503.
(k) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1997, File No. 0-8503.
(l) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1998, File No. 0-8503.
(m) Filed with SEMCO Energy, Inc.'s Form 10-Q/A for the quarter ended
March 31, 1998, File No. 0-8503.
-29-
<TABLE> <S> <C>
<ARTICLE> UT
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated statements of income, the consolidated balance sheets and the
consolidated statement of cash flows and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 260,028
<OTHER-PROPERTY-AND-INVEST> 24,120
<TOTAL-CURRENT-ASSETS> 107,580
<TOTAL-DEFERRED-CHARGES> 36,336
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 428,064
<COMMON> 14,441
<CAPITAL-SURPLUS-PAID-IN> 90,368
<RETAINED-EARNINGS> (449)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 104,360
0
3,262
<LONG-TERM-DEBT-NET> 140,012
<SHORT-TERM-NOTES> 71,168
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 0
0
<CAPITAL-LEASE-OBLIGATIONS> 0
<LEASES-CURRENT> 0
<OTHER-ITEMS-CAPITAL-AND-LIAB> 109,262
<TOT-CAPITALIZATION-AND-LIAB> 428,064
<GROSS-OPERATING-REVENUE> 331,143
<INCOME-TAX-EXPENSE> 1,844
<OTHER-OPERATING-EXPENSES> 318,369
<TOTAL-OPERATING-EXPENSES> 320,213
<OPERATING-INCOME-LOSS> 10,930
<OTHER-INCOME-NET> 643
<INCOME-BEFORE-INTEREST-EXPEN> 11,573
<TOTAL-INTEREST-EXPENSE> 7,196
<NET-INCOME> 4,377
97
<EARNINGS-AVAILABLE-FOR-COMM> 5,565<F1>
<COMMON-STOCK-DIVIDENDS> 5,374
<TOTAL-INTEREST-ON-BONDS> 5,937
<CASH-FLOW-OPERATIONS> 53,990
<EPS-PRIMARY> .39<F2>
<EPS-DILUTED> .39<F2>
<FN>
<F1>Includes the cumulative effect of a change in accounting for property taxes of
$1,784 and extraordinary charge due to early retirement of debt of $499.
<F2>Adjusted to give retroactive effect to a 5% stock dividend payable in May 1998.
Prior Financial Data Schedules have not been restated for this dividend.
</FN>
</TABLE>
