UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 0-8503
SEMCO Energy, Inc.
(formerly Southeastern Michigan Gas Enterprises, Inc.)
(Exact name of registrant as specified in its charter)
Michigan 38-2144267
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
405 Water Street, Port Huron, Michigan 48060
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 810-987-2200
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
None N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1 Par Value
--------------------------
(Title of Class)
$2.3125, Series A, Convertible
Cumulative Preferred Stock
------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock (Common Stock, $1 Par Value)
held by non-affiliates is computed at $205,153,000 based on 12,340,000 shares
held by non--affiliates as of February 27, 1998 at the average of the bid and
ask prices on the closest trading date for such stock of $16.50 and $16.75,
respectively, as quoted on the National Association of Securities Dealers
Automated Quotation National Market System (NASDAQ/NMS) (which prices may not
represent actual transactions).
Number of shares outstanding of each of the Registrant's classes of Common
Stock, as of February 27, 1998: 13,268,000.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Registrant's definitive Proxy Statement (filed pursuant to
Regulation 14A) with respect to Registrant's April 21, 1998 Annual Meeting of
Shareholders are incorporated by reference herein in response to Part III.
<PAGE>
T A B L E O F C O N T E N T S
PAGE
CONTENTS NUMBER
PART I
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . 1
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . 4
ITEM 3. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . 7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . 7
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS . . . . 8
ITEM 6. SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . 9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . 10
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA . . . . . 21
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE . . . . . . . . . 43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT . . 44
ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . 44
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . 45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . 45
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K . . . . . . . . . . . . . . . . . . . . . 46
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
-i-
<PAGE>
GLOSSARY
Bcf . . . . . . . . . . A measure of natural gas volumes equivalent to one
billion cubic feet
Degree Day . . . . . . . A measure of coldness computed by the number of
degrees the average daily temperature falls below
65 degrees Fahrenheit
DRIP . . . . . . . . . . Dividend Reinvestment and Common Stock Purchase Plan
FASB . . . . . . . . . . Financial Accounting Standards Board
FERC . . . . . . . . . . Federal Energy Regulatory Commission
Mcf . . . . . . . . . . A measure of natural gas volumes equivalent to one
thousand cubic feet
MMcf . . . . . . . . . . A measure of natural gas volumes equivalent to one
million cubic feet
MPSC . . . . . . . . . . Michigan Public Service Commission
Normal Degree Days . . . An average of degree days over the last 10 years
NASDAQ . . . . . . . . . National Association of Securities Dealers Automated
Quotations system
NYMEX . . . . . . . . . New York Mercantile Exchange
SFAS . . . . . . . . . . Statement of Financial Accounting Standards
-ii-
<PAGE>
PART I
ITEM 1. BUSINESS
SEMCO Energy, Inc.
SEMCO Energy, Inc. (the Company), formerly Southeastern Michigan Gas
Enterprises, Inc., is an energy-focused holding company which was formed in
1977. It provides professional and technical services to the consolidated
group in the areas of finance, accounting, tax, risk management, legal, human
resources and information systems.
The Company operates through three main subsidiaries. SEMCO Energy Gas
Company (the Gas Company) purchases, distributes and transports natural gas
to approximately 242,000 customers in the state of Michigan. SEMCO Energy
Services, Inc. (Energy Services) markets energy to approximately 210
customers located in several states. SEMCO Energy Ventures, Inc. (Energy
Ventures) is a diversified holding company with operations and investments in
many segments of the energy industry. The Company and its subsidiaries
employed approximately 520 persons throughout the state of Michigan at
December 31, 1997.
SEMCO Energy Gas Company
<TABLE>
The Gas Company serves approximately 242,000 customers in twenty-four
counties in the lower and upper peninsulas of Michigan. It provides for the
sale, delivery and transportation of natural gas to residential, commercial
and industrial customers. Set forth in the table below is sales and
transportation information for the past three years:
<CAPTION>
1997 1996 1995
-------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Gas sales revenue (in thousands):
Residential.......................... $139,538 64% $138,644 63% $115,242 62%
Commercial........................... 66,577 30 65,509 30 54,763 30
Industrial........................... 12,065 6 15,218 7 14,019 8
-------- --- -------- --- -------- ---
Total gas sales revenue............ $218,180 100% $219,371 100% $184,024 100%
======== === ======== === ======== ===
Gas transportation revenue............. $ 13,243 $ 12,358 $ 12,448
======== ======== ========
Throughput volumes (MMcf):
Gas sales volumes:
Residential.......................... 25,968 62% 26,703 61% 24,676 61%
Commercial........................... 13,483 32 13,670 31 12,738 31
Industrial........................... 2,534 6 3,385 8 3,373 8
------ --- ------ --- ------ ---
Total gas sales volumes............ 41,985 100% 43,758 100% 40,787 100%
====== === ====== === ====== ===
Gas transportation volumes............. 21,373 20,532 23,849
====== ====== ======
</TABLE>
-1-
<PAGE>
Gas Sales. The Gas Company provides for both the sale and delivery of
natural gas to residential, commercial and industrial customers. Revenues
are generated primarily through sales to residential and commercial
customers. These customers use natural gas mainly for space heating
purposes. Consequently, weather has a significant impact on sales. Given
the impact of weather on this business, most gas sales revenue is earned in
the first and fourth quarters of the calendar year.
Competition in the gas sales market arises primarily from the
availability of alternate energy sources such as electricity, propane and
oil. However, this competition is minimal because of the inability of
residential and commercial customers to economically convert to an alternate
energy source when the price of natural gas fluctuates.
The Gas Company continues to increase its customer base. Since 1988, it
has added approximately 6,000 gas sales customers per year. These additions
have been primarily residential and are a result of expanded service
territories, conversion of existing homes and new home construction.
Transportation. The Gas Company provides transportation services to its
large-volume industrial customers. This service offers those customers the
option of purchasing natural gas directly from producers or brokerage
companies while utilizing the Gas Company's distribution network to transport
the gas to their facilities. In conjunction with the transportation
services, the Gas Company also offers natural gas storage, backup supply and
balancing services.
The market price of alternate fuel sources such as coal, electricity,
oil and steam is the primary competitive factor affecting the demand for
transportation. Many large industrial customers have the ability to easily
convert to another form of energy when the price of natural gas fluctuates.
Partially offsetting the impact of price sensitivity has been an increase of
interest in the use of natural gas as an industrial fuel because of recent
clean air legislation and the resultant pressures on industry and electric
utilities to reduce emissions from their plants.
Gas Supply. The Gas Company is served by four major interstate pipelines:
Panhandle Eastern Pipe Line Company, Northern Natural Gas Company, Great
Lakes Gas Transmission Company and ANR Pipeline Company.
During 1997, the Gas Company purchased 68% of its natural gas volumes
from term suppliers and 32% from the spot market. Nearly 6% of the firm
supply volumes were purchased under fixed-price contracts, while the other
94% were purchased under contracts indexed to the spot market. Less than 1%
of 1997 gas purchases were from intrastate suppliers.
Natural gas purchases are transported to the Gas Company's systems under
various firm and interruptible transportation arrangements with interstate
and intrastate transmission companies.
The Gas Company utilized on-system and leased storage capacity of
approximately 38% of annual gas sales volumes to reduce its reliance on the
interstate pipelines for peak day needs and allow for the purchase of natural
gas at lower prices.
The Gas Company owns underground storage facilities with a working
capacity of 5.0 Bcf. In addition, it leases 6.5 Bcf of storage from Eaton
Rapids Gas Storage System and 4.3 Bcf from non-affiliates. SEMCO Gas Storage
Company (an affiliated company) is a 50% owner of Eaton Rapids Gas Storage
System.
-2-
<PAGE>
Rates and Regulation. The Gas Company is subject to the jurisdiction of the
MPSC as to various phases of its operations including rates, accounting,
service standards and the issuance of securities. However, rates charged to
customers in the Battle Creek division are subject to the jurisdiction of the
City Commissioners of Battle Creek, Michigan.
Management continually reviews the adequacy of the Gas Company's rates
and files requests for rate increases whenever it is deemed necessary and
appropriate. Refer to Note 3 of the Notes to the Consolidated Financial
Statements concerning the recent cases filed and the related outcomes.
Environmental Matters. The Gas Company currently owns five sites which
formerly housed manufactured gas plants. In the earlier part of this
century, gas was manufactured from processes using coal, coke or oil.
By-products of this process have left some contamination at these sites. The
Company has submitted a plan to the State of Michigan for the proposed clean
up at one of these sites. Refer to Management's Discussion and Analysis and
Note 12 of the Notes to the Consolidated Financial Statements for further
discussion.
SEMCO Energy Services, Inc.
<TABLE>
Energy Services provides natural gas marketing services to approximately
210 customers in several states. Its customers include industrial,
commercial and municipal natural gas users, natural gas distribution
companies and other marketers. Set forth in the table below are the
marketing revenue, cost of gas marketed and volumes for the past three years:
<CAPTION>
1997 1996<F1> 1995
-------- -------- --------
<S> <C> <C> <C>
Natural gas marketing operations (in thousands):
Gas marketing revenues............................... $526,962 $308,703 $133,396
Cost of gas marketed................................. 518,157 308,619 130,087
-------- -------- --------
Gross margin....................................... $ 8,805 $ 84 $ 3,309
======== ======== ========
Gas volumes marketed (MMcf).......................... 199,689 129,429 82,504
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
Energy Services purchases and markets natural gas to customers on a
month-to-month basis and under long-term agreements. It also arranges for
transportation of gas supplies to the customers' premises and offers storage
capacity, contract administration and a variety of risk management services.
Competition in the energy marketing industry is strong. Firms compete
on the basis of price, the ability to arrange suitable transportation of the
product to the customer and the ability to provide related services such as
pipeline nominations and balancing. Refer to Management's Discussion and
Analysis for further discussion concerning the competitive pressures
associated with this industry.
Energy Services obtains its gas supply from various production sources,
primarily located in Louisiana, Oklahoma and Michigan. It generally
contracts for gas supply on a monthly basis, however, it does enter into some
long-term gas purchasing arrangements. See Note 7 of the Notes to the
Consolidated Financial Statements for a description of Energy Services'
hedging activities as they relate to its gas supply strategy.
-3-
<PAGE>
SEMCO Energy Ventures, Inc.
<TABLE>
Energy Ventures is a diversified holding company with operations and
investments in many segments of the energy industry. It was incorporated on
April 24, 1997. The energy and non-energy assets of Energy Services which
were not directly related to the energy marketing operations were transferred
to Energy Ventures in order to provide the initial basis of operations. Set
forth in the table below is the operating revenue, operating income and
earnings (loss) from equity investments relating to the assets transferred to
Energy Ventures for the past three years:
<CAPTION>
1997 1996 1995
------- ------- -------
(in thousands of dollars)
<S> <C> <C> <C>
Operating revenues................ $10,798 $ 3,259 $ 4,504
Operating expenses................ 9,137 2,063 3,077
------- ------- -------
Operating income................ $ 1,661 $ 1,196 $ 1,427
======= ======= =======
Loss from equity investments...... $(1,967) $(1,196) $ (258)
</TABLE>
Energy Ventures, through its subsidiaries, operates or maintains equity
interests in energy related natural gas production, gathering, processing,
transmission and underground natural gas storage facilities. Additionally,
it manages the leasing of data processing equipment to companies in the
consolidated group and oversees the real estate operations of the Company.
Energy Ventures has no plans to expand its real estate operations.
On August 13, 1997, SEMCO Energy Construction Co. (SEMCO Construction),
a wholly-owned subsidiary of Energy Ventures, purchased the assets and
business of Sub-Surface Construction Co. (Sub-Surface). Sub-Surface is
involved primarily in the construction of underground gas distribution
pipelines, services lines and associated facilities mainly in Michigan.
A wholly-owned subsidiary of Energy Ventures also purchased Maverick
Pipeline Services, Inc. (Maverick) on December 19, 1997. Maverick provides
pipeline engineering with full project management and field services for
domestic and international clients for all types of liquid and gas pipeline
projects, both onshore and offshore.
The engineering and construction of pipelines is viewed by Energy
Ventures as an area with opportunities and growth. It is a large but
fragmented business with opportunities for marketing and cost synergies.
Additionally, Energy Ventures is positioned to take advantage of the
outsourcing trend in the utility industry. It is also evaluating other
nonregulated asset-based businesses which contain many of the industry
segments described above, such as propane distribution.
ITEM 2. PROPERTIES
SEMCO Energy, Inc.
The properties of the Company consist of the Common Stock of the Gas
Company, Energy Services and Energy Ventures and leasehold improvements and
office equipment.
-4-
<PAGE>
SEMCO Energy Gas Company
The Gas Company owns gas supply systems which, on December 31, 1997,
included approximately 139 miles of transmission pipelines and 5,089 miles of
distribution pipelines. The pipelines are located throughout the southern
half of Michigan's lower peninsula (centered around the cities of Port Huron,
Albion, Battle Creek and Holland) and also in the central and western areas
of Michigan's upper peninsula.
The Gas Company's distribution system and service lines are, for the
most part, located on or under public streets, alleys, highways and other
public places, or on private property not owned by the Gas Company with
permission or consent, except to an inconsequential extent, of the individual
owners. The distribution systems and service lines located on or under
public streets, alleys, highways and other public places were all installed
under valid rights and consents granted by appropriate local authorities.
The Gas Company owns and operates underground gas storage facilities in
eight depleted salt caverns and two depleted gas fields together with
measuring, compressor and transmission facilities. The aggregate working
capacity of the storage system is approximately 5.0 Bcf.
The Gas Company also owns meters and service lines, gas regulating and
metering stations, garages, warehouses and other buildings necessary and
useful in conducting its business. It leases its computer and transportation
equipment.
SEMCO Energy Ventures, Inc.
The principal properties of Energy Ventures include interests and
operations in natural gas transmission and gathering systems and an
underground gas storage system.
<TABLE>
Set forth in the following table are the equity investments of Energy
Ventures and its ownership percentage and equity investment at December 31,
1997:
<CAPTION>
Energy Energy
Ventures' Ventures'
Percent Equity
Ownership Investment
--------- ----------
(in thousands of dollars)
<S> <C> <C>
NOARK Pipeline System, L.P.................. 32% $ --
Eaton Rapids Gas Storage System............. 50 4,165
Nimrod Limited Partnership.................. 29 257
Michigan Intrastate Pipeline System......... 50 100
Michigan Intrastate Lateral System.......... 50 188
------
$4,710
======
</TABLE>
-5-
<PAGE>
SEMCO Arkansas Pipeline Company (a wholly-owned subsidiary of Energy
Ventures) was, until January 1998, a 32% general partner in the NOARK
Pipeline System, L.P. The partnership operates a 302-mile pipeline crossing
northern Arkansas which completed its first year of service in 1993. The
pipeline provides area producers access to interstate and intrastate
pipelines. In December 1996, Energy Ventures recorded a $21,000,000
after-tax write-down on its investment in NOARK. Energy Ventures sold its
entire interest in NOARK in January 1998. Pending the close of the sale,
Energy Ventures reduced its NOARK investment reserve by $5,025,000,
after-tax, in December 1997. See Note 12 of the Notes to the Consolidated
Financial Statements for further discussion of the transactions surrounding
this investment.
SEMCO Gas Storage Company (a wholly-owned subsidiary of Energy Ventures)
owns a 50% equity interest in the Eaton Rapids Gas Storage System. This
system, located near Eaton Rapids, Michigan, became operational in March 1990
and consists of approximately 12.8 Bcf of underground storage capacity. Of
the total, 6.5 Bcf is leased by the Company's subsidiaries.
SEMCO Pipeline Company (a wholly-owned subsidiary of Energy Ventures)
owns 50% of the Michigan Intrastate Pipeline System and the Michigan
Intrastate Lateral System partnerships. The sole purpose of these
partnerships is to hold a 10% ownership of the Saginaw Bay Pipeline Project,
a 126-mile pipeline from Michigan's Saginaw Bay area to processing plants in
Kalkaska, Michigan.
<TABLE>
The following table sets forth the operations wholly or partially owned
by Energy Ventures, the total net property of the project, Energy Ventures'
ownership percentage and net property at December 31, 1997:
<CAPTION>
Energy Energy
Total Ventures' Ventures'
Net Percent Net
Property Ownership Property
-------- --------- --------
(in thousands of dollars)
<S> <C> <C> <C>
Litchfield Lateral.................... $10,900 33% $ 3,597
Greenwood Pipeline.................... 6,359 100 6,359
Iosco-Reno System..................... 2,875 40 1,150
Eaton Rapids Pipeline................. 1,035 100 1,035
------- -------
$21,169 $12,141
======= =======
</TABLE>
SEMCO Pipeline Company is a 33% owner in the Litchfield Lateral, a
31-mile pipeline located in southwest Michigan. The line, which is leased
entirely to ANR Pipeline Company, links the Eaton Rapids Gas Storage System
with interstate pipeline supplies. The Litchfield Lateral began operations
in February 1993.
In 1991, SEMCO Pipeline Company constructed an 18-mile pipeline to serve
Detroit Edison's Greenwood power plant located in Michigan's thumb area.
SEMCO Pipeline Company and Detroit Edison have entered into an agreement
whereby Detroit Edison has contracted for the entire capacity of the line of
240 MMcf per day.
-6-
<PAGE>
SEMCO Pipeline Company is a 40% owner of the Iosco County Pipeline and
Reno Gas Processing Plant (Iosco-Reno System), which was placed in service in
March 1992. The Iosco-Reno System gathers and processes wet gas in the
Au Gres and Santiago fields located in mid-Michigan for delivery to the
processing plant and ultimate delivery to the gas markets.
SEMCO Pipeline Company completed the 7.1-mile Eaton Rapids Pipeline in
1990, providing direct delivery of gas from the Eaton Rapids Gas Storage
System to the Gas Company's customers located in Battle Creek and Albion.
Other properties of Energy Ventures consist of construction equipment,
data processing equipment primarily leased to affiliates, real property and
related improvements held for resale, and office properties leased to
affiliates and third parties. These other properties total $11.9 million or
4.3% of consolidated utility plant and other property, net at December 31,
1997.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-7-
<PAGE>
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
MARKET PRICE AND NASDAQ LISTING
<TABLE>
NASDAQ Trading Symbol "SMGS"
The common stock of the Company is traded on The Nasdaq Stock Market under
the symbol "SMGS." The table below shows high and low closing bid prices of
the Company's common stock in the over-the-counter market as reported in the
Wall Street Journal adjusted to reflect the 5% stock dividends in May 1997
and 1996. These quotations reflect dealer prices, without brokerage
commission, and may not necessarily represent actual transactions.
<CAPTION>
Price Range Price Range
- ------------------------------------------------ ------------------------------------------------
1997 High Low 1996 High Low
- ------------------------------------------------ ------------------------------------------------
<S> <C> <C> <S> <C> <C>
First Quarter $20-1/4 $17-1/8 First Quarter $16-7/8 $14-1/2
Second Quarter $19-1/4 $16-1/2 Second Quarter $17-3/8 $14-1/8
Third Quarter $18-5/8 $16-1/2 Third Quarter $17-5/8 $15
Fourth Quarter $18-1/4 $16-1/2 Fourth Quarter $18-1/4 $16-7/8
- ------------------------------------------------ ------------------------------------------------
</TABLE>
See the cover page for a recent stock price and the number of shares
outstanding.
See Selected Financial Data for the number of shareholders at year end
for the past five years.
DIVIDENDS
See Notes 5 and 13 of the Notes to the Consolidated Financial Statements
and Selected Financial Data.
-8-
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996<F10> 1995 1994 1993
-------- -------- -------- -------- --------
(thousands of dollars, except per share amounts)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Operating revenue.................... $770,272 $544,949 $335,538 $372,430 $288,963
-------- -------- -------- -------- --------
Operating expenses
Cost of gas sold.................... $150,967 $151,135 $120,619 $135,669 $139,051
Cost of gas marketed................ 518,157 308,619 130,087 153,973 67,474
Operations and maintenance.......... 50,562 40,669 36,217 35,558 34,496
Depreciation........................ 12,863 11,317 12,035 11,549 12,468
Income taxes........................ 5,406 4,304 6,188 5,204 5,598
Taxes other than income taxes....... 9,334 8,648 7,966 8,186 8,446
-------- -------- -------- -------- --------
$747,289 $524,692 $313,112 $350,139 $267,533
-------- -------- -------- -------- --------
Operating income..................... $ 22,983 $ 20,257 $ 22,426 $ 22,291 $ 21,430
Other income (expense), net.......... 5,158 <F8> (21,813)<F6> (179) (1,328)<F4> (136)<F4>
-------- -------- -------- -------- --------
Income (loss) before interest........ $ 28,141 $ (1,556) $ 22,247 $ 20,963 $ 21,294
Interest............................. 13,026 11,053 10,721 10,775 11,534
Dividends on preferred stock
of subsidiary and
convertible preferred............... 194 194 195 196 197
-------- -------- -------- -------- --------
Net income (loss).................... $ 14,921 <F8> $(12,803)<F6> $ 11,331 $ 9,992 <F4> $ 9,563 <F4>
Common dividends..................... 10,216 9,670 9,230 8,656 7,419
-------- -------- -------- -------- --------
Earnings (deficit) reinvested
in the business..................... $ 4,705 $(22,473) $ 2,101 $ 1,336 $ 2,144
======== ======== ======== ======== ========
COMMON STOCK DATA
Average shares outstanding(000)<F1>.. 13,050 13,017 13,044 12,800 11,576
Earnings (loss) per share
- basic and diluted<F1>............. $ 1.14 $ (.98) $ .87 $ .78 $ .83
Dividends paid per share<F1>......... $ .78 $ .74 $ .70 $ .68 $ .64
Dividend payout ratio................ 68.5% N/A 81.5% 86.6% 77.6%
Book value per share<F1><F2>......... $ 7.16 $ 6.65 $ 8.39 $ 8.25 $ 7.29
Market value per share<F1><F2><F3>... $ 18.06 $ 17.62 $ 16.32 $ 15.54 $ 18.10
Number of common shareholders
of record........................... 8,755 8,509 8,334 8,149 7,261
BALANCE SHEET DATA<F2>
Total assets......................... $505,487 $478,238 $378,523 $368,498 $348,813
======== ======== ======== ======== ========
Capitalization
Long-term debt<F5>.................. $163,548 $108,112 $107,325 $104,910 $117,022
Preferred stock..................... 3,269 3,269 3,272 3,288 3,290
Common equity....................... 94,502 86,544 109,511 107,379 85,657
-------- -------- -------- -------- --------
$261,319 $197,925 $220,108 $215,577 $205,969
======== ======== ======== ======== ========
FINANCIAL RATIOS
Capitalization
Long-term debt<F5>.................. 62.6% 54.6% 48.8% 48.7% 56.8%
Preferred stock..................... 1.2% 1.7% 1.5% 1.5% 1.6%
Common equity....................... 36.2% 43.7% 49.7% 49.8% 41.6%
-------- -------- -------- -------- --------
100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======== ========
Return on average common equity....... 16.5% <F9> (11.8%)<F7> 10.4% 9.5% 11.6%
======== ======== ======== ======== ========
<FN>
<F1>
Adjusted to give effect to 5 percent stock dividends in May each year, 1993 through 1997.
<F2>
Year end.
<F3>
Based on NASDAQ closing bid price.
<F4>
Includes $1,286 (net of tax) or $.10 per share and $177 (net of tax) or $.02 per share in 1994 and 1993,
respectively, attributable to an extraordinary item-loss on early extinguishment of debt.
<F5>
Includes current maturities.
<F6>
Includes write-down of NOARK investment - $21,000 (net of tax) or $1.61 per share.
<F7>
Excluding the write-down of the NOARK investment, return on average common equity was 7.4%.
<F8>
Includes adjustment to reserve of NOARK investment - $5,025 (net of tax) or $.39 per share.
<F9>
Excluding the adjustment to reserve of NOARK investment, return on average common equity was 11.0%.
<F10>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
-9-
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
<TABLE>
Net Income. Net income grew to $14.9 million (1.14 per share) in 1997. This
compares to a loss of $12.8 million (.98 per share) in 1996 and net income of
$11.3 million (.87 per share) in 1995. A number of special items are
included in net income during these periods:
<CAPTION>
Years Ended December 31, 1997 1996<F1> 1995
-------- -------- --------
(in thousands of dollars,
except per share amounts)
<S> <C> <C> <C>
Impact of Special Items
Writedown of NOARK investment $ -- $(32,308) $ --
Adjustment of NOARK reserve 7,730 -- --
Energy marketing systems enhancements (400) -- --
Colder than normal temperatures -- 1,900 900
NOARK litigation settlement -- -- 1,925
Management reorganization/severance (1,300) (900) (530)
Other special items (550) -- --
-------- -------- --------
$ 5,480 $(31,308) $ 2,295
Income tax effect (1,918) 10,958 (803)
-------- -------- --------
Impact of special items on net income $ 3,562 $(20,350) $ 1,492
======== ======== ========
Impact of special items on earnings per share $ 0.27 $ (1.56) $ 0.12
======== ======== ========
Net income, excluding special items $ 11,359 $ 7,547 $ 9,839
======== ======== ========
Earnings per share, excluding special items $ 0.87 $ 0.58 $ 0.75
======== ======== ========
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
SPECIAL ITEMS
NOARK Writedown and Reserve Adjustment. In December 1996, SEMCO Energy, Inc.
(the Company) recorded a $21 million non-cash after-tax writedown of its 32%
general partnership interest in the NOARK Pipeline System (NOARK). NOARK is
a 302-mile intrastate natural gas pipeline which experienced significant cost
overruns during construction, resulting in higher than expected financing
costs. In addition, competition from two interstate pipelines required NOARK
to discount its transportation charges to attract volumes to the pipeline.
Even with discounted rates, NOARK has operated at less than 65% capacity
since its inception in 1992.
As a result, NOARK continued to generate losses and its operating cash
flows were insufficient to meet principal and interest payments on its debt.
Since October 1994, the Company has had to contribute additional financing of
$8.4 million in connection with its loan guarantee.
On January 14, 1998, the Company sold its entire interest in the NOARK
partnership to ENOGEX Arkansas Pipeline Corporation (EAPC). In December
1997, the Company reduced its reserve for NOARK, based on the pending sale,
resulting in an increase in 1997 after-tax earnings of $5.0 million.
-10-
<PAGE>
Pursuant to terms included in the sales agreement, the Company will pay
EAPC $9.2 million, $3.1 million and $.8 million in April 1998, 1999 and 2000,
respectively. The sale released the Company from all debt obligations and
guarantees related to NOARK.
Energy Marketing Systems Enhancements. In 1997, SEMCO Energy Services, Inc.
(Energy Services), the Company's energy marketing subsidiary, completed a
systems project which included procedural and computer system improvements to
more efficiently and effectively manage its growth in energy marketing.
Impact of Weather. The operations of SEMCO Energy Gas Company (the Gas
Company) benefited from colder than normal weather in 1996 and 1995, while
1997 was marginally warmer than normal. The Company measures the financial
impact of weather based on the difference between actual gas used per
customer compared to the 10-year average of gas used per customer.
NOARK Litigation Settlement. In 1995, the Company recorded a gain of $1.3
million, net of tax, for its share of a litigation settlement paid to NOARK.
This settlement was paid to NOARK, by Vesta Energy Company, in termination of
a firm transportation agreement with NOARK and release from all contracts and
obligations related to NOARK.
Management Reorganization/Severance. In 1997 and 1996, the Company incurred
severance, management search, and relocation costs associated with a change
in several management positions. In 1995, the Company recorded severance
costs associated with centralizing certain administrative and engineering
functions previously performed in several locations throughout Michigan. The
Company does not expect this level of management reorganization and severance
activity to continue.
Other Special Items. The Company also incurred expenses in 1997 for the
Company's name change, the resolution of the Gas Company's rate case, and the
closing of the Gas Company's merchandise sales operation.
SEMCO ENERGY GAS COMPANY
Warmer Temperatures Impact Earnings, Partially Offset by Record Customer
Growth. The Gas Company's earnings declined in 1997 primarily due to the
impact of warmer temperatures on its weather sensitive heating customers.
Partially offsetting this impact was record customer growth and effective
cost management.
-11-
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
-------- -------- --------
(in thousands of dollars)<F1>
<S> <C> <C> <C>
SEMCO ENERGY GAS COMPANY
Gas sales revenue $218,180 $219,371 $184,024
Cost of gas sold 150,967 151,135 120,619
-------- -------- --------
Gas sales margin $ 67,213 $ 68,236 $ 63,405
Transportation revenue 13,243 12,358 12,448
Other operating revenue 1,088 1,256 1,167
-------- -------- --------
Gross margin $ 81,544 $ 81,850 $ 77,020
Operations and maintenance 35,433 35,830 34,713
Depreciation 11,112 10,405 9,686
Income taxes 5,582 6,106 5,367
Taxes other than income taxes 8,651 8,177 7,535
-------- -------- --------
Other operating expenses $ 60,778 $ 60,518 $ 57,301
-------- -------- --------
Operating Income $ 20,766 $ 21,332 $ 19,719
Other income (loss), net (376) (113) (62)
Interest expense and preferred stock dividends 9,936 8,879 8,298
-------- -------- --------
Net Income $ 10,454 $ 12,340 $ 11,359
======== ======== ========
Net Income, excluding special items $ 11,527 $ 11,690 $ 11,118
======== ======== ========
<FN>
<F1>
Includes intercompany transactions.
</FN>
</TABLE>
Gas Sales Margin. In 1997, gross margin on gas sales decreased by $1.0
million (2%), while gas sales volume decreased 1,773 MMcf (4%). The decline
in margin and volume was due to 4% warmer temperatures and several industrial
gas sales customers converting to transportation. The impact of these items
was partially offset by the addition of an average of 7,809 (3%) new
customers.
In 1996, gross margin on gas sales increased by $4.8 million (8%) and
gas volumes sold increased by 2,971 MMcf (7%) due primarily to the addition
of an average of 6,499 (3%) new customers. In addition, approximately $1.3
million of the margin increase was a result of a rate increase in the Gas
Company's Battle Creek division beginning in December 1995. However, this
revenue increase was partially offset by Battle Creek's change in its method
of accounting for retiree medical costs. Overall, the rate increase
contributed approximately $500,000 to net income in 1996 compared to 1995.
<TABLE>
The following table highlights the impact of volume, weather and number
of customers on gross margin.
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Throughput Volumes (in MMcf):
Total gas sales volumes 41,985 43,758 40,787
Gas transportation volumes 21,373 20,532 23,849
------- ------- -------
Total throughput 63,358 64,290 64,636
======= ======= =======
Degree Days:
Actual 6,838 7,099 7,158
Percent of normal 99.4% 104.5% 105.3%
Average Number of Gas Sales Customers 236,611 228,802 222,303
</TABLE>
-12-
<PAGE>
Transportation Revenue. Transportation revenue increased by $.9 million (7%)
in 1997 when compared to 1996. This increase is primarily attributable to
additional transportation customers, most of which were previous gas sales
customers. The Gas Company transported 766 MMcf and earned $.6 million in
1997 from these new transportation customers.
Transportation volumes decreased by 3,317 MMcf (14%) in 1996, compared
to 1995, while transportation revenue declined by $.1 million (1%). The
decrease in volumes was attributable to less transportation from customers
who have alternative fuel sources, primarily coal. During 1996,
"coal-displacement" transportation volumes were significantly lower than the
prior year. Transportation revenues declined only slightly, despite the
larger volume declines, because coal-displacement volumes generally
contribute less revenue per unit.
Other Operating Revenue. Other operating revenue consists primarily of gas
storage revenue, pipeline service charges, and customer late payment charges.
During 1996, the Gas Company received $.1 million of coal displacement
minimum requirement payments which did not reoccur in 1997.
Operations and Maintenance. Operations and maintenance expense declined by
$.4 million (1%) in 1997 when compared to 1996. The decrease is attributable
mainly to reduced costs in areas such as pension and employee benefits.
However, partially offsetting these savings were a slight increase in retiree
medical costs and an increase in uncollectible gas accounts resulting from
the previous year's colder weather and higher gas prices.
The increase of operations and maintenance of $1.1 million (3%) in 1996
when compared to 1995 resulted primarily from increased pension costs and,
due to the Battle Creek rate case, increased retiree medical costs.
Depreciation. Depreciation increased in both 1997 and 1996 due to higher
plant balances, reflecting capital expenditures of $85 million over the past
three years.
Taxes. Income taxes declined during 1997 as a result of decreased earnings
and increased during 1996 because of greater earnings. Taxes other than
income taxes consist primarily of State of Michigan property taxes and
generally increase along with the growth in utility plant.
Other Income (Loss), Net. Other income (loss), net consists primarily of
income and expenses associated with merchandise sales, appliance repairs,
natural gas vehicle conversions, community donations and various other
nonoperating income and expense items, net of tax. During 1997, the Gas
Company discontinued the sale of merchandise, increasing the 1997 total loss
when compared to 1996. The increased loss during 1996, when compared to
1995, resulted from the donation of a compressed natural gas fueling facility
to a public transportation commission.
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 5 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
-13-
<PAGE>
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.
Outlook. The Gas Company's strategy is to maximize the earnings potential of
the regulated gas distribution business. With the approval of incentive
rates by the MPSC in late 1997, the Gas Company can now earn in excess of its
authorized return and retain a portion of those earnings. The Gas Company's
strong customer growth, nearly double the industry average over the past five
years, is anticipated to continue. Efforts to offer new products and
services such as the GE Sharp appliance repair program will continue.
Control of operating and maintenance costs will be enhanced through an early
retirement program, which was offered in January 1998, a redesign of employee
benefits during 1998 and increased use of technology to achieve operating
efficiencies. These technologies include automatic meter reading and
automated dispatch and scheduling. Additionally, through more effective
management of the construction budget and financing costs, growth in capital
costs are expected to be constrained. In addition, the Gas Company will
consider mergers or alliances with other utilities to achieve its strategic
goals.
SFAS 71. As described in Note 3 of the Notes to the Consolidated Financial
Statements, the Gas Company complies with the provisions of SFAS 71,
"Accounting for the Effects of Certain Types of Regulation." In the event
the Gas Company determines that it no longer meets the criteria for following
SFAS 71, the accounting impact would be an extraordinary, non-cash charge to
operations of an amount that could be material. Criteria that give rise to
the discontinuance of SFAS 71 include (1) increasing competition that
restricts the Gas Company's ability to establish prices to recover specific
costs, and (2) a significant change in the manner in which rates are set by
regulators from cost-based regulation to another form of regulation. The Gas
Company's periodic review of these criteria currently supports the continuing
application of SFAS 71.
SEMCO ENERGY SERVICES
Energy Services Positions Itself for Growth. Energy Services, the Company's
energy marketing subsidiary, expensed over $1.0 million in 1997 to transition
itself for the tremendous growth it is experiencing. These costs include
personnel changes, the write-off of uncollectible accounts and costs
associated with a systems project which improved procedural and computer
system processes.
-14-
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
-------- -------- --------
(in thousands of dollars)<F1>
<S> <C> <C> <C>
SEMCO ENERGY SERVICES
Gas marketing revenue $555,367 $344,379 $162,909
Cost of gas marketed 546,562 344,295 159,600
-------- -------- --------
Gas marketing margin $ 8,805 $ 84 $ 3,309
Operations and maintenance $ 8,410 $ 3,871 $ 1,508
Depreciation 60 41 44
Income taxes (338) (1,510) 367
Taxes other than income taxes 118 29 64
-------- -------- --------
Other operating expenses $ 8,250 $ 2,431 $ 1,983
-------- -------- --------
Operating Income (Loss) $ 555 $ (2,347) $ 1,326
Other income (loss), net 67 45 63
Interest expense 916 467 708
-------- -------- --------
Net Income (Loss) $ (294) $ (2,769) $ 681
======== ======== ========
Net Income (Loss), excluding special items $ 96 $ (2,769) $ 681
======== ======== ========
<FN>
<F1>
Includes intercompany transactions.
</FN>
</TABLE>
<TABLE>
Gas Marketing Margin. The following table summarizes gas marketing margin
and volumes for the past three years:
<CAPTION>
Years Ended December 31, 1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Gas marketing margin (in thousands) $ 8,805 $ 84 $ 3,309
Gas marketing volumes (MMcf) 199,689 129,429 82,504
</TABLE>
In 1997, natural gas marketing revenues and volumes increased $211
million (61%) and 70,260 MMcf (54%), respectively, from the prior year.
Revenues and volumes increased significantly due to the development of
additional marketing offices over the past several years. The $8.7 million
increase in marketing margin, before incentive compensation, was due to the
impact of uneconomical trading contracts which Energy Services entered into
in 1996. See Note 2 of the Notes to the Consolidated Financial Statements
for further discussion regarding 1996 results.
Energy Services has expanded by contracting with independent marketers
who act as marketing representatives for Energy Services. The Northeast
marketing unit was established in New York in October 1995 and covers a
number of northeastern states. The Midwest unit was expanded from offices in
Michigan by adding a Chicago office in November 1995 and later expanding its
Chicago presence in July 1996. Energy Services opened two additional
marketing offices late in 1996 in West Virginia and Kentucky. These offices
serve markets in Maryland, Virginia and Washington, D.C.
From 1995 to 1996, natural gas marketing revenues and volumes increased
$181 million (111%) and 46,925 MMcf (57%), due primarily to new business
generated by the Northeast and Midwest marketing units. As discussed above,
uneconomical trading transactions in 1996 caused margins to decline from
1995.
Overall gas marketing volumes and margins are subject to significant
competitive factors which generally place downward pressure on margins. The
per-unit margin on Energy Services' marketing contracts, however, also varies
depending on the price and availability of alternative fuels, seasonal
patterns and the type of customer.
-15-
<PAGE>
Operations and Maintenance. Operations and maintenance expense increased
$4.5 million (117%), from the prior year, due to increased independent
marketer incentive payments relating to higher margins ($2.2 million),
additional expenses to support increased gas marketing volumes ($1.1
million), increased receivables write-offs ($.6 million), management turnover
($.2 million), and process improvement expenditures ($.4 million).
Operations and maintenance expense from 1995 to 1996 increased $2.4 million
(157%) due primarily to increased independent marketer compensation and costs
associated with opening marketing offices.
Interest Expense. Interest expense increased $.4 million during 1997 when
compared to 1996 as a result of greater borrowings required to finance
additional amounts of gas in storage. Energy Services enters into storage
agreements with its marketing offices. Gas in storage increased during 1997
as a result of the addition of two offices late in 1996 and the corresponding
storage agreements entered into at that time which were utilized during 1997.
Outlook. The Company expects competition in the gas marketing industry to
continue generating pressure on per-unit margins. The marketing operations
primary focus is on growing revenues through the new marketing offices and by
expanding its product and service offerings to create value-adding
opportunities for its customers.
SEMCO ENERGY VENTURES
NOARK Resolved; Sub-Surface Contributes to Net Income. On January 14, 1998,
SEMCO Energy Ventures, Inc. (Energy Ventures) sold its entire interest in the
NOARK partnership to EAPC (See Special Items above for further discussion).
The sale of the NOARK partnership has been a major goal of management and
positions Energy Ventures for increased growth going forward.
On August 13, 1997, SEMCO Energy Construction Co., a subsidiary of
Energy Ventures, acquired Sub-Surface Construction Co. Sub-Surface is
involved primarily in the construction of underground gas distribution
pipelines, service lines and associated facilities throughout Michigan.
Since its acquisition, Sub-Surface generated revenues of $13.2 million and
net income of $.5 million.
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
------- -------- -------
(in thousands of dollars)<F1>
<S> <C> <C> <C>
SEMCO ENERGY VENTURES
Other operating revenue $17,019 $ 3,754 $ 6,489
------- -------- -------
Operations and maintenance $12,585 $ 1,288 $ 1,907
Depreciation 1,691 872 2,184
Income taxes 517 (45) 599
Taxes other than income taxes 565 443 372
------- -------- -------
Operating expenses $15,358 $ 2,558 $ 5,062
------- -------- -------
Operating Income $ 1,661 $ 1,196 $ 1,427
Writedown of NOARK, net -- (21,000) --
Adjustment of NOARK reserve, net 5,025 -- --
Other income (loss), net 460 (697) (113)
Interest expense 979 1,028 1,539
------- -------- -------
Net Income (Loss) $ 6,167 $(21,529) $ (225)
======= ======== =======
Net Income (Loss),
excluding special items $ 1,142 $ (529) $(1,476)
======= ======== =======
<FN>
<F1>
Includes intercompany transactions.
</FN>
</TABLE>
-16-
<PAGE>
Operating Income. The $.5 million (39%) increase of operating income from
1996 to 1997 is entirely attributed to the acquisition of Sub-Surface. The
decline in operating income from 1995 to 1996, of $.2 million (16%), was due
to Energy Ventures' declining involvement in equipment leasing. Most notable
was the sale of the Company's vehicle fleet in December 1995, which reduced
other operating revenues, operations and maintenance, depreciation and income
taxes.
<TABLE>
Other Income (Loss), Net. Other income (loss), net, primarily consists of
Energy Ventures' earnings in unconsolidated subsidiaries, including its
partnership interest in NOARK. The year to year changes are primarily
indicative of the changes in NOARK's earnings and accounting treatment:
<CAPTION>
Years Ended December 31, 1997 1996 1995
---- ------- -------
(in thousands of dollars, net of tax)
<S> <C> <C> <C>
Energy Ventures' Other Income (Loss), Net
Equity loss in NOARK $ -- $(1,702) $(1,836)
NOARK litigation settlement -- -- 1,251
Interest income on advances to NOARK -- 407 --
Other income 460 598 472
---- ------- -------
Total Income (Loss), Net $460 $ (697) $ (113)
==== ======= =======
</TABLE>
With its writedown of NOARK in December 1996, Energy Ventures
discontinued accounting for NOARK under the equity method. Also in
conjunction with the writedown, Energy Ventures stopped accruing interest
income on advances made to the NOARK partnership. See Special Items above
for further information regarding the NOARK writedown and the 1995 litigation
settlement.
See Note 10 of the Notes to the Consolidated Financial Statements for
further information regarding the Company's equity investments.
Interest Expense. The $.5 million decline in interest expense from 1995 to
1996 reflects the cash received from the sale of the Company's fleet and the
pay down of related debt and a decline in Energy Ventures' equity
investments. See Note 10 of the Notes to the Consolidated Financial
Statements for further details.
Outlook. The pipeline/engineering construction business is an industry in
which management sees significant opportunities for growth. It is a large
but fragmented business with opportunities for marketing and cost synergies.
It is also positioned to take advantage of the outsourcing trend in the
utility industry. Energy Ventures is also evaluating other nonregulated
asset-based businesses, such as propane distribution, which contain many of
the industry characteristics described above.
-17-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
Cash Flows From Investing. The Company's single largest use of cash is
capital investments. The following table identifies investments for the past
three years:
<CAPTION>
1997 1996 1995
------- ------- -------
(in thousands of dollars)
<S> <C> <C> <C>
Capital Investments
Natural gas distribution $28,201 $30,169 $26,259
Acquisitions 15,117 -- --
Other 1,180 340 713
------- -------- -------
$44,498 $30,509 $26,972
======= ======= =======
</TABLE>
Capital expenditures for natural gas distribution represent primarily
new customer additions and, to a lesser extent, plant repair and replacement.
In addition, the Company invested approximately $8 million and $2 million in
technology in 1997 and 1996, respectively. This technology consists of
automated meter reading and in-truck computer terminals and is expected to
significantly increase customer service and operational efficiency.
In 1998, the Company plans to spend approximately $21.9 million on
capital investments. The main focus will be on technology and new customer
additions.
Cash Flows From Operations. The Company's net cash provided from operating
activities totaled $9 million in 1997, $11 million in 1996, and $33 million
in 1995. The change in operating cash flows is significantly influenced by
changes in the level and cost of gas in underground storage, changes in
accounts receivable and accrued revenue and other working capital changes.
The changes in these accounts are largely the result of the timing of
receipts and payments.
The Company uses significant amounts of short-term borrowings to finance
natural gas purchases for storage during the non-heating season. The Company
owns and leases natural gas storage facilities with available capacity
approximating 35% of annual gas sales. Generally, gas is stored during the
months of April through October and withdrawn for sale from November through
March. The carrying amount of natural gas stored underground peaked at $59
million, $38 million and $34 million in October 1997, 1996 and 1995,
respectively.
Cash Flows From Financing. In 1997, the Company began issuing new common
shares to meet the dividend reinvestment and optional payment requirements of
the DRIP and raised $2.8 million for 1997. Previously, the Company
substantially met the requirements of the DRIP by repurchasing shares in the
open market.
In October 1997, the Company issued $30 million of 6.83% notes due
October 1, 2002 and $30 million of 7.20% notes due October 1, 2007. The
proceeds were primarily used to pay down short term debt which was primarily
incurred to fund capital investments.
Dividends paid to common shareholders increased from 1995 through 1997
due to the impact of 5% stock dividends in each of those three years. The
stated cash dividend of $.20 per share per quarter did not change.
-18-
<PAGE>
Future Financing. In general, the Company funds its capital expenditure
program and dividend payments with operating cash flows and the utilitization
of short-term lines of credit. When appropriate, the Company will refinance
its short-term lines with long-term debt, common stock or other long-term
financing instruments. In 1998, the Company expects to refinance a portion
of its outstanding short-term debt, refinance some long-term debt, and issue
common equity and/or common equity hybrids to strengthen the financial
position of the Company.
During 1998, the Company will make a $9.2 million payment to EAPC in
connection with the sale of NOARK. See Note 12 of the Notes to the
Consolidated Financial Statements for discussion of the NOARK sale.
Commodity Hedging. The Company's energy marketing subsidiary, Energy
Services, has entered into various long-term sales commitments which may
extend up to 60 months into the future. Energy Services maintains a hedging
program with the objective of preserving the anticipated margin on these
sales commitments. The hedges are designed to ensure that the impact of
natural gas price fluctuations on the fair value of long-term sales
commitments will be offset by gains and losses on the hedging instrument.
The most frequently used hedging instruments are natural gas futures and
options, although Energy Services may also enter into natural gas swap
agreements, contracts to purchase natural gas from producers for future
delivery or inject gas into storage for later withdrawal.
Critical to the success of the hedging program is the performance by
both the party to the hedge and the marketing customer buying gas under the
long-term sales commitment. Energy Services performs extensive credit
reviews on new and existing marketing customers and only enters into hedging
transactions with reputable dealers, primarily on the NYMEX, or directly with
reliable suppliers.
At December 31, 1997 and 1996, Energy Services had recorded net deferred
gains (losses) from its hedging program of approximately $.1 million and
($1.7) million, respectively. At the same time, Energy Services had
offsetting amounts of unrecorded gains or losses pursuant to the underlying
long-term sales commitments.
See Note 7 of the Notes to the Consolidated Financial Statements for
further information regarding the types, underlying notional volumes, and
fair values of Energy Services' hedges at December 31, 1997 and 1996.
IMPACT OF INFLATION
The cost of gas sold by the Gas Company is recovered from natural gas
distribution customers on a current basis. Increases in other utility
operating costs are recovered through the regulatory process of a rate case
and, therefore, may adversely affect the results of operations in
inflationary periods due to the time lag involved in this process. The
Company attempts to minimize the impact of inflation by controlling costs,
increasing productivity and filing rate cases on a timely basis.
-19-
<PAGE>
INDUSTRY TRENDS
Competition. The market prices of alternate sources of energy such as coal
and #6 fuel oil compete directly with the price the Gas Company charges for
industrial sales and transportation of natural gas. To lessen the impact of
prices on fuel choice by industrial customers, the Company offers additional
services, such as gas storage and balancing. However, the competition among
fuels is expected to continue to affect volumes sold and transported and
associated margins.
Energy Services competes based on its ability to access competitively
priced natural gas and efficiently utilize the pipeline transmission system.
Price is the prominent competitive factor in sales to wholesale customers,
such as gas distribution companies and municipalities. In retail activities,
Energy Services competes based on its ability to offer a broad range of
competitively priced products and services that are tailored to meet the
needs of individual customers.
Regulation. Since 1994 interstate pipelines have unbundled their services
to offer separate service for gas transportation, storage and gathering. As
a result, natural gas distribution companies have the ability to select and
pay for only those pipeline services they require. In addition, customers on
natural gas distribution systems may purchase the same level of unbundled
service directly from the interstate pipelines. Under such circumstances,
natural gas distribution companies generally provide transportation services
to those customers.
The availability of unbundled pipeline services has resulted in
continued pressure on gas distribution companies to offer similar unbundled
services in order to compete with the pipelines. This competition has
resulted in pressure to reduce natural gas transportation margins.
Currently, the Gas Company is providing transportation services principally
to large industrial customers.
In addition to pressure on the transportation margins, this unbundling
of services is impacting the natural gas marketing operations of Energy
Services. Access to unbundled pipeline services has attracted new
competitors to the marketing industry and presented opportunities for
marketers to offer expanded services to their customers.
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 $.5 million to $1.5 million spread over the next two
years. 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
utilitized by the Company and the steps necessary to ensure its continued
viability in the coming years. The Company plans to have all "Year-2000"
issues addressed by the first quarter of 1999.
-20-
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
Years Ended December 31, 1997 1996<F1> 1995
----------- ----------- -----------
(in thousands of dollars, except per share amounts)
<S> <C> <C> <C>
OPERATING REVENUES
Gas sales $ 218,180 $ 219,371 $ 184,024
Gas marketing 526,962 308,703 133,396
Transportation 13,243 12,358 12,448
Other operations 11,887 4,517 5,670
----------- ----------- -----------
$ 770,272 $ 544,949 $ 335,538
----------- ----------- -----------
OPERATING EXPENSES
Cost of gas sold $ 150,967 $ 151,135 $ 120,619
Cost of gas marketed 518,157 308,619 130,087
Operations and maintenance 50,562 40,669 36,217
Depreciation 12,863 11,317 12,035
Income taxes 5,406 4,304 6,188
Taxes other than income taxes 9,334 8,648 7,966
----------- ----------- -----------
$ 747,289 $ 524,692 $ 313,112
----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME DEDUCTIONS
Operating Income $ 22,983 $ 20,257 $ 22,426
Write-down of NOARK investment,
net of income taxes of $11,308 -- (21,000) --
Adjustment to reserve of NOARK investment,
net of income taxes of $2,705 5,025 -- --
Other income (loss), net 133 (813) (179)
----------- ----------- -----------
$ 28,141 $ (1,556) $ 22,247
----------- ----------- -----------
INCOME DEDUCTIONS
Interest on long-term debt $ 9,388 $ 8,514 $ 8,546
Other interest 3,246 2,166 1,727
Amortization of debt expense 392 373 448
Dividends on preferred stock of
subsidiary and convertible preferred 194 194 195
----------- ----------- -----------
$ 13,220 $ 11,247 $ 10,916
----------- ----------- -----------
NET INCOME (LOSS) $ 14,921 $ (12,803) $ 11,331
=========== =========== ===========
Earnings (loss) per share - basic and diluted $ 1.14 $ (.98) $ .87
=========== =========== ===========
Cash dividends paid per share $ .78 $ .74 $ .70
=========== =========== ===========
Average common shares outstanding 13,050,111 13,016,989 13,044,427
=========== =========== ===========
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-21-
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Years Ended December 31, 1997 1996<F1> 1995
--------- --------- ---------
(in thousands of dollars)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers $ 764,905 $ 486,717 $ 320,707
Cash paid for payrolls and to suppliers (732,277) (456,169) (264,440)
Interest paid (11,921) (10,543) (10,283)
Income taxes paid (3,153) (3,275) (5,570)
Taxes other than income taxes paid (9,594) (8,197) (7,995)
Other cash receipts and payments, net 939 2,899 174
--------- --------- ---------
Net Cash From Operating Activities $ 8,899 $ 11,432 $ 32,593
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Natural gas distribution property additions $ (28,201) $ (30,169) $ (26,259)
Other property additions (1,180) (340) (713)
Proceeds from property sales, net of retirement costs 373 865 640
Proceeds from sale and leaseback of capital assets -- -- 3,737
Acquisition of businesses, net of cash acquired (15,117) -- --
Advances to equity investees (3,308) (844) (3,312)
--------- --------- ---------
Net Cash From Investing Activities $ (47,433) $ (30,488) $ (25,907)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock $ 5,874 $ 5,132 $ 6,012
Repurchase of common stock (3,071) (5,629) (5,998)
Net change in notes payable to banks (20,081) 39,400 1,700
Issuance of long-term debt 60,000 -- --
Repayment of long-term debt (25) (15) (1,322)
Payment of dividends (10,410) (9,864) (9,425)
--------- --------- ---------
Net Cash From Financing Activities $ 32,287 $ 29,024 $ (9,033)
--------- --------- ---------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease) $ (6,247) $ 9,968 $ (2,347)
Beginning of year 10,232 264 2,611
--------- --------- ---------
End Of Year $ 3,985 $ 10,232 $ 264
========= ========= =========
RECONCILIATION OF NET INCOME (LOSS) TO
NET CASH FROM OPERATING ACTIVITIES
Net income (loss) $ 14,921 $ (12,803) $ 11,331
Adjustments to reconcile net income (loss) to
net cash from operating activities:
Depreciation 12,863 11,317 12,035
Write-down of NOARK investment, net -- 21,000 --
Adjustment to reserve for NOARK investment, net (5,025) -- --
Deferred taxes and investment tax credits 3,442 3,958 304
Equity loss, net of distributions 402 3,740 990
Receivables (3,114) (10,189) (9,513)
Accrued revenue 9,551 (37,695) (5,555)
Materials and supplies and gas in underground storage (3,175) (12,380) 12,820
Gas charges, recoverable from customers (6,140) (7,937) 2,349
Other current assets 2,530 (4,839) 6,189
Accounts payable (20,467) 57,382 4,973
Customer advances and amounts payable to customers (2,263) (1,539) (1,638)
Accrued taxes (976) (2,528) (22)
Other, net 6,350 3,945 (1,670)
--------- --------- ---------
Net Cash From Operating Activities $ 8,899 $ 11,432 $ 32,593
========= ========= =========
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-22-
<PAGE>
<TABLE>
CONSOLIDATED BALANCE SHEETS
<CAPTION>
At December 31, 1997 1996<F1>
-------- --------
(in thousands of dollars)
<S> <C> <C>
ASSETS
Utility Plant
Plant in service, at cost $359,393 $340,675
Less--Accumulated depreciation 102,790 96,391
-------- --------
$256,603 $244,284
Construction work in progress 629 2,103
-------- --------
$257,232 $246,387
-------- --------
Other Property, Net $ 18,230 $ 9,585
-------- --------
Current Assets
Cash and temporary cash investments, at cost $ 3,985 $ 10,232
Receivables, less allowances of $1,498 and $1,247 50,154 42,509
Accrued revenue 66,998 76,549
Materials and supplies, at average cost 2,924 3,025
Gas in underground storage 36,083 32,807
Gas charges, recoverable from customers 19,931 13,791
Accumulated deferred income taxes -- 364
Other 11,702 11,864
-------- --------
$191,777 $191,141
-------- --------
Deferred Charges and Other
Unamortized debt expense $ 5,284 $ 5,328
Deferred gas charges, recoverable from customers -- 290
Advances to equity investees 8,370 5,062
Other 24,594 20,445
-------- --------
$ 38,248 $ 31,125
-------- --------
$505,487 $478,238
======== ========
CAPITALIZATION AND LIABILITIES
Capitalization
Common stock equity $ 94,502 $ 86,544
Cumulative convertible preferred stock 169 169
Cumulative preferred stock of subsidiary 3,100 3,100
Long-term debt, including capital lease obligations 163,548 106,468
-------- --------
$261,319 $196,281
-------- --------
Current Liabilities
Notes payable to banks $ 71,019 $ 91,100
Current portion of capital lease obligations -- 1,644
Accounts payable 79,842 95,400
Customer advance payments 8,035 5,612
Accumulated deferred income taxes 1,150 --
Accrued interest 1,985 1,272
Other 13,986 6,998
-------- --------
$176,017 $202,026
-------- --------
Deferred Credits
Reserve for equity investment $ 25,212 $ 32,942
Accumulated deferred income taxes 15,046 10,113
Unamortized investment tax credit 2,515 2,782
Customer advances for construction 3,935 8,621
Other 21,443 25,473
-------- --------
$ 68,151 $ 79,931
-------- --------
$505,487 $478,238
======== ========
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-23-
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF CAPITALIZATION
<CAPTION>
At December 31, 1997 1996<F1>
-------- --------
(in thousands of dollars)
<S> <C> <C>
COMMON STOCK EQUITY
Common stock, par value $1 per share--authorized
20,000,000 shares; 13,204,147 and 12,400,331
shares outstanding $ 13,204 $ 12,400
Capital surplus 81,938 79,489
Retained earnings (deficit) (640) (5,345)
-------- --------
$ 94,502 $ 86,544
-------- --------
CUMULATIVE CONVERTIBLE PREFERRED STOCK
Convertible preferred stock, par value $1 per
share--authorized 500,000 shares issuable in
series; 6,751 shares outstanding $ 7 $ 7
Capital surplus 162 162
-------- --------
$ 169 $ 169
-------- --------
CUMULATIVE PREFERRED STOCK OF SUBSIDIARY
$100 par value (callable at option of Subsidiary)
6% series A--15,000 shares authorized and
outstanding $ 1,500 $ 1,500
5 1/2% series B--10,000 shares authorized and
outstanding 1,000 1,000
5 1/2% series C--5,000 shares authorized;
4,000 shares outstanding 400 400
5 1/2% series D--2,000 shares authorized and
outstanding 200 200
-------- --------
$ 3,100 $ 3,100
-------- --------
LONG-TERM DEBT
SEMCO Energy, Inc.
6.83% notes due 2002 $ 30,000 $ --
7.20% notes due 2007 30,000 --
8.00% notes due 2004 55,000 55,000
8.32% notes due 2024 25,000 25,000
8.625% debentures due 2017 23,548 23,573
Long term capital lease obligations -- 2,895
-------- --------
$163,548 $106,468
-------- --------
$261,319 $196,281
======== ========
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
</TABLE>
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-24-
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT
<CAPTION>
Years Ended December 31, 1997 1996<F1> 1995
------- ------- -------
(in thousands of dollars)
<S> <C> <C> <C>
COMMON STOCK
Beginning of year $12,400 $11,837 $11,261
5% stock dividends May 1997, May 1996
and May 1995 620 590 564
Issuance of common stock through DRIP
and other 346 293 326
Repurchase of common stock (162) (320) (314)
------- ------- -------
End of year $13,204 $12,400 $11,837
======= ======= =======
COMMON STOCK CAPITAL SURPLUS
Beginning of year $79,489 $80,546 $81,091
5% stock dividends May 1997, May 1996
and May 1995 (620) (590) (564)
Issuance of common stock through DRIP
and other 5,978 4,842 5,702
Repurchase of common stock (2,909) (5,309) (5,683)
------- ------- -------
End of year $81,938 $79,489 $80,546
======= ======= =======
RETAINED EARNINGS (DEFICIT)
Beginning of year $(5,345) $17,128 $15,027
Net income (loss) 14,921 (12,803) 11,331
Cash dividends on common stock (10,216) (9,670) (9,230)
------- ------- -------
End of year $ (640) $(5,345) $17,128
======= ======= =======
CUMULATIVE CONVERTIBLE PREFERRED STOCK
Beginning of year $ 7 $ 7 $ 8
Conversion of preferred stock -- -- (1)
------- ------- -------
End of year $ 7 $ 7 $ 7
======= ======= =======
CUMULATIVE CONVERTIBLE PREFERRED STOCK
CAPITAL SURPLUS
Beginning of year $ 162 $ 165 $ 180
Conversion of preferred stock -- (3) (15)
------- ------- -------
End of year $ 162 $ 162 $ 165
======= ======= =======
<FN>
<F1>
Restated - See Note 2 of the Notes to the Consolidated Financial Statements.
</FN>
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
-25-
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
SEMCO Energy, Inc. (the Company), formerly Southeastern Michigan Gas
Enterprises, Inc., is an investor-owned holding company. The Company
operates through three main subsidiaries. SEMCO Energy Gas Company (the Gas
Company, formerly Battle Creek, Southeastern and Michigan Gas Companies)
purchases, distributes, and transports natural gas to 242,000 customers
within the state of Michigan. SEMCO Energy Services, Inc. (Energy Services)
is engaged in energy marketing to approximately 210 customers located in
several states. SEMCO Energy Ventures, Inc. (Energy Ventures) is a
diversified holding company with operations and investments in many segments
of the natural gas industry including natural gas transmission and gathering
systems, underground storage systems and the engineering and construction of
underground gas distribution pipelines, service lines and associated
facilities.
Basis of Presentation. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Principles of Consolidation. The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiaries, SEMCO Energy
Gas Company, SEMCO Energy Services and SEMCO Energy Ventures. Investments in
unconsolidated companies at least 20% owned, but not greater than 50% owned,
are reported using the equity method of accounting. Certain
reclassifications have been made to prior years' statements to conform with
the 1997 presentation.
Certain nonregulated subsidiaries supply goods and services at a profit
to the regulated affiliates in the consolidated group. In these situations,
intercompany profits remaining in the assets of the regulated affiliates at a
particular date are not eliminated since it is probable that, through the
ratemaking process, the cost will be recovered through future revenue. As a
result, $437,000 of profit on sales earned from the Company's regulated
subsidiary by the Company's nonregulated subsidiary was not eliminated during
consolidation. All other significant intercompany transactions have been
eliminated.
Rate Regulation. The rates of the Gas Company's customers located in the
Battle Creek division are subject to the jurisdiction of the City Commission
of Battle Creek, Michigan. The MPSC authorizes the rates charged to all of
the remaining Gas Company customers.
Utility Plant, Other Property and Depreciation. Utility plant and other
property are recorded at cost. The Company and its subsidiaries provide for
depreciation on a straight-line basis over the estimated useful lives of the
related property.
-26-
<PAGE>
The ratio of depreciation to the average balance of property
approximated 3.6%, 3.6% and 4.0% for the years 1997, 1996 and 1995,
respectively. Certain investments in unconsolidated companies recorded using
the equity method are reported as other property. See Note 10 for further
discussion.
Receivables, Gas Sales, Transportation and Gas Marketing Revenues. Customer
receivables, gas sales and transportation revenues arise from the operations
of the Gas Company. Gas marketing revenues and receivables arise from
Energy Services' marketing operations.
Revenue Recognition. The Gas Company bills monthly on a cycle basis and
follows the industry practice of recognizing accrued revenue for gas services
rendered to its customers but not billed at month end. Energy Services
recognizes marketing revenues, and any related hedging gains or losses, in
the same period natural gas is delivered to customers. See Note 7 for
further discussion about Energy Services' hedging activities.
Gas in Underground Storage. Gas in underground storage for Southeastern and
Michigan Gas divisions of the Gas Company is reported at average cost. The
Battle Creek division's gas inventory is stated at last-in, first-out (LIFO)
cost. At December 31, 1997, the replacement cost did not exceed the LIFO
cost. At December 31, 1996, the replacement cost exceeded LIFO cost by
$1,440,000. Energy Services reports gas in storage at cost.
In general, commodity costs and variable transportation costs are
capitalized as gas in underground storage. Fixed costs, primarily pipeline
demand charges and storage charges, are expensed as incurred through cost of
gas.
Cost of Gas. The Gas Company has regulator approved gas cost recovery
mechanisms which allow for the adjustment of rates charged to customers in
response to increases and decreases in the cost of gas purchased.
Income Taxes. Investment tax credits (ITC) utilized in prior years for
income tax purposes are deferred for financial accounting purposes and are
amortized through credits to the income tax provision over the lives of the
related property. The Company and its subsidiaries file a consolidated
Federal income tax return. Income taxes are allocated to each subsidiary
based on its separate taxable income.
Statements of Cash Flows. For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid investments purchased
with original maturities of three months or less to be cash and temporary
cash investments.
-27-
<PAGE>
</TABLE>
<TABLE>
Supplemental cash flow information for the years ended December 31,
1997, 1996 and 1995, is summarized as follows (in thousands of dollars):
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Non-Cash Investing and Financing Activities:
Capital stock issued for acquisition $ 450 $ -- $ --
Property purchased under capital leases $ 360 $ 3,252 $ 3,737
Capital leases amortized and retired $ 4,899 $ 2,450 $ --
Details of Acquisitions:
Fair value of assets acquired $22,464 $ -- $ --
Liabilities assumed (6,330) -- --
Stock issued (450) -- --
------- ------- -------
Cash paid $15,684 $ -- $ --
Less cash acquired 567 -- --
------- ------- -------
Net Cash Paid for Acquisitions $15,117 $ -- $ --
======= ======= =======
</TABLE>
Earnings Per Share. In February 1997, the FASB issued SFAS 128, "Earnings
Per Share." This statement establishes standards for computing and
presenting earnings per share. It requires companies with publicly held
common stock or potential common stock, such as options, warrants, or
convertible securities, to present a basic earnings per share amount and a
diluted earnings per share amount. Basic earnings per share is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding. The computation of diluted earnings per
share is similar to that of the basic earnings per share except that the
weighted average number of common shares outstanding is increased to include
any potential common shares. Accordingly, income available to common
shareholders is also adjusted for any changes to income or loss that would
result from the assumed conversion of those potential common shares.
<TABLE>
The computations of basic and diluted earnings (loss) per share for the
years ended December 31, 1997, 1996 and 1995 are as follows (in thousands of
dollars except per share amounts):
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Income available to common shareholders $14,921 $(12,803) $11,331
Weighted average common shares outstanding 13,050 13,017 13,044
Earnings (loss) per share - basic $ 1.14 $ (0.98) $ 0.87
======= ======== =======
Income available to common shareholders $14,921 $(12,803) $11,331
Adjustment for effect of assumed conversions:
Preferred convertible stock dividends 16 -- 17
------- -------- -------
Adjusted income available to common shareholders $14,937 $(12,803) $11,348
------- -------- -------
Weighted average common shares outstanding 13,050 13,017 13,044
Incremental shares from assumed conversions:
Preferred convertible stock dividends 28 -- 28
Stock options converted 3 -- --
------- -------- -------
Diluted weighted average common shares outstanding 13,081 13,017 13,072
------- -------- -------
Earnings (loss) per share - diluted $ 1.14 $ (0.98) $ 0.87
======= ======== =======
</TABLE>
As a result of the loss in 1996, basic loss per share was not adjusted
because to do so would be antidilutive.
-28-
<PAGE>
2. RESTATEMENT OF FINANCIAL STATEMENTS
While closing the accounting records for 1997, the Company discovered that
certain transactions associated with its energy marketing subsidiary, Energy
Services, were incorrectly recorded. The related financial impact has been
quantified and resulted from incorrect margin recognition, incorrect
accounting of gas in storage, the recognition of previously unrecorded
borrowed gas and various other items. The corrections resulted in a $873,000
after-tax charge to fourth quarter 1997 earnings and a $3,838,000 after-tax
reduction of previously reported 1996 earnings. The results contained herein
reflect the 1996 restatement.
During 1997, the Company implemented new computer, procedural and
accounting systems along with employing new management and accounting
personnel at Energy Services, which the Company believes will help prevent
such items from recurring.
3. REGULATORY MATTERS
Southeastern and Michigan Gas Rate Case. In October 1997, the MPSC approved
the merger of Southeastern and Michigan Gas in a general rate case. This
allowed the Company to combine the rate structures, gas cost recovery
clauses, tariffs, and rules and regulations for those two divisions. It
additionally granted a rate increase to the combined divisions, which
included the recovery of costs related to a change in accounting for retiree
medical benefits. The Company expects that the rate case will have an
immaterial impact on net income. The MPSC also approved incentive
regulation, where profits generated in excess of the authorized rate of
return will be shared with the ratepayer. Finally, the MPSC granted the
Company the ability to offer its commercial and industrial customers the
option to aggregate their demand for gas into a pool and choose a supplier.
State Property Tax Reductions. In June 1994, the MPSC issued Orders U-10617
and U-10618 to Michigan Gas and Southeastern, respectively. These orders
required the companies to offset deferred retiree medical costs with certain
reductions in Michigan state property taxes until the MPSC issued a final
order in the companies' general rate case, which occurred in October 1997.
In accordance with orders U-10617 and U-10618, Michigan Gas and Southeastern
have reduced deferred retiree medical costs by a combined total of $553,000
in 1997, $663,000 in 1996 and $663,000 in 1995.
Battle Creek Rate Increase. In November 1995, the City Commission of Battle
Creek approved a Battle Creek rate increase, effective December 1995, of
approximately $1,800,000. Battle Creek requested the increase to recover the
cost of certain accelerated main replacement projects, the cost of its
retiree medical benefits and overall increases in operating expenses.
-29-
<PAGE>
<TABLE>
Regulatory Assets and Liabilities. The Gas Company is subject to the
provisions of SFAS 71, "Accounting for the Effects of Certain Types of
Regulation." As a result, the actions of regulators affect when revenues and
expenses are recognized. Regulatory assets represent incurred costs to be
recovered from customers through the ratemaking process. Regulatory
liabilities represent benefits to be refunded to customers. The following
regulatory assets and liabilities were recorded on the consolidated balance
sheets as of December 31 (in thousands of dollars):
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Regulatory Assets
Deferred retiree medical benefits $13,487 $13,260
Deferred pension benefits 2,287 2,287
Unamortized loss on retirement of debt 3,107 3,353
Other 1,763 1,971
------- -------
$20,644 $20,871
======= =======
Regulatory Liabilities
Unamortized investment tax credit $ 3,052 $ 3,417
Tax benefits amortizable to customers 4,329 4,460
Other -- 67
------- -------
$ 7,381 $ 7,944
======= =======
</TABLE>
In the event the Gas Company determines that it no longer meets the
criteria for following SFAS 71, the accounting impact would be an
extraordinary, non-cash charge to operations of an amount that could be
material. Criteria that give rise to the discontinuance of SFAS 71 include
(1) increasing competition that restricts the Gas Company's ability to
establish prices to recover specific costs, and (2) a significant change in
the manner in which rates are set by regulators from cost-based regulation to
another form of regulation. The Gas Company's periodic review of these
criteria currently supports the continuing application of SFAS 71.
4. INCOME TAXES
SFAS No. 109. The Company accounts for income taxes in accordance with SFAS
109, "Accounting For Income Taxes." SFAS 109 requires an annual measurement
of deferred tax assets and deferred tax liabilities based upon the estimated
future tax effects of temporary differences and carry forwards. In general,
the total deferred tax benefit or expense for the year equals the difference
between the beginning and end of year balances in deferred tax assets and
liabilities.
-30-
<PAGE>
<TABLE>
Provision for Income Taxes. The components of the provision for income taxes
are as follows (in thousands of dollars):
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Federal
Currently payable $ 2,259 $ 1,160 $ 5,606
Deferred to future periods 6,236 (8,201) 812
Investment tax credits (267) (267) (267)
------- ------- -------
Total income taxes $ 8,228 $(7,308) $ 6,151
Less amounts included in:
Write-down of NOARK investment, net -- (11,308) --
Adjustment to reserve for NOARK investment, net 2,705 -- --
Other income (loss), net 117 (304) (37)
------- ------- -------
Amount included in operating expenses $ 5,406 $ 4,304 $ 6,188
======= ======= =======
</TABLE>
<TABLE>
Reconciliation of Statutory Rate to Effective Rate. A reconciliation of the
difference between the Company's provision for income taxes and income taxes
computed at the statutory rate follows (in thousands of dollars):
<CAPTION>
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Net income (loss) $ 14,921 $(12,803) $11,331
Add back:
Preferred dividends 194 194 195
Income taxes 8,228 (7,308) 6,151
-------- -------- -------
Pre-tax income (loss) $ 23,343 $(19,917) $17,677
======== ======== =======
Computed federal income taxes $ 8,170 $ (6,971) $ 6,187
Depreciation -- -- (43)
Amortization of deferred ITC (267) (267) (267)
Amortization of non-deductible amounts resulting from acquisitions 216 216 217
Other 109 (286) 57
-------- -------- -------
Total income taxes $ 8,228 $ (7,308) $ 6,151
======== ======== =======
</TABLE>
<TABLE>
Deferred Income Taxes. Deferred income taxes arise from temporary
differences between the tax basis of assets and liabilities and their
reported amounts in the financial statements. The principal components of
the Company's deferred tax assets (liabilities) were as follows (in thousands
of dollars):
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Property $(22,801) $(20,687)
Reserve for equity investment 8,824 11,530
Retiree medical benefit obligation 4,795 4,741
Retiree medical benefit regulatory assets (4,720) (4,641)
Gas in underground storage 3,243 2,934
ITC 1,257 1,392
Unamortized debt expense (1,111) (1,197)
Gas cost underrecovery (6,411) (4,169)
Other 728 348
-------- --------
Total deferred taxes $(16,196) $ (9,749)
======== ========
Gross deferred tax liabilities $(45,925) $(41,043)
Gross deferred tax assets 29,729 31,294
-------- --------
Total deferred taxes $(16,196) $ (9,749)
======== ========
</TABLE>
At December 31, 1997 and December 31, 1996 there was no valuation
allowance recorded against deferred tax assets.
-31-
<PAGE>
5. CAPITALIZATION
Common Stock Equity. The Company issued five percent stock dividends in May
1997, May 1996 and May 1995. Earnings per share of common stock, cash
dividends per share of common stock and average number of common shares
outstanding have been restated to reflect the stock dividends.
Pursuant to its DRIP, the Company issued 324,000 shares of common stock
in 1997 and 292,000 shares in 1996 and 274,000 shares in 1995. In January
1995, the Company amended its DRIP to allow the Company to acquire common
shares on the open market to meet the dividend reinvestment and optional
payment requirements of the DRIP. The Company purchased a total of 162,000
shares in 1997 and 320,000 shares in 1996 and 314,000 shares in 1995 for the
DRIP.
Cumulative Convertible Preferred Stock. At December 31, 1997 and 1996, only
6,751 shares of the Company's $2.3125 cumulative convertible preferred shares
were outstanding and each share was convertible at the option of the holder
to 4.11 shares of common stock. At December 31, 1997, a total of 27,747
common shares are reserved for issuance upon conversion of the convertible
preferred stock.
Cumulative Preferred Stock of Subsidiary. The cumulative preferred stock of
SEMCO Energy Gas Company is callable at the subsidiary's option at $105 per
share. Payment of dividends on this preferred stock is fully guaranteed by
the Company.
Long-Term Debt. In 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.
The Company has long-term and short-term debt arrangements which contain
restrictive financial covenants including, among others, limits on the
payment of dividends beyond certain levels. The Company is currently in
compliance with all of the covenants in these agreements.
There are no annual maturities or sinking fund requirements for the
Company's existing debt over the next five years.
6. SHORT-TERM BORROWINGS
The Company maintains unsecured lines of credit at two banks. Interest on
all such lines are at variable rates, which do not exceed the banks' prime
lending rates. These arrangements are set to expire during 1998 and the
Company expects they will be renegotiated at comparable terms.
<TABLE>
Information regarding these borrowings for each of the last three years
is as follows (in thousands of dollars):
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Notes payable balance at year end $71,019 $91,100 $51,700
Unused lines of credit at year end 39,000 8,800 38,200
Average interest rate at year end 6.4% 7.0% 6.4%
Maximum borrowings at any month-end $98,900 $91,100 $52,400
Average borrowings 60,493 41,228 28,224
Weighted average cost of borrowing 6.2% 6.0% 6.5%
</TABLE>
7. FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
Financial Instruments. The following methods and assumptions were used to
estimate the fair value of each significant class of financial instruments:
-32-
<PAGE>
Cash, Temporary Cash Investments, Accounts Receivables, Payables, and Notes
Payable to Banks. The carrying amount approximates fair value because of the
short maturity of those instruments.
Long-term Debt. The fair values of the Company's long-term debt are
estimated based on quoted market prices for the same or similar issues or,
where no market quotes are available, based on discounted future cash flows
using current interest rates at which similar loans would be made to
borrowers with similar credit ratings and remaining maturities. Although the
current fair value of the long-term debt may differ from the current carrying
amount, settlement of the reported debt is generally not expected until
maturity.
<TABLE>
The estimated fair values of the Company's long-term debt as of
December 31, 1997 and 1996 are as follows (in thousands of dollars):
<CAPTION>
1997 1996
------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Long-term debt $163,548 $172,594 $103,573 $107,625
======== ======== ======== ========
</TABLE>
Hedging Activities. Energy Services enters into sales commitments which may
extend up to 60 months into the future. Because of the volatility of natural
gas prices, there are significant market risks associated with these
commitments. Energy Services utilizes derivative financial and commodity
instruments (derivatives), including futures contracts, options and swaps, to
reduce market risk associated with fluctuations in the price of natural gas
sold under firm commitments and with a portion of the anticipated supply
requirements. The primary objective of Energy Services' hedging program is
to attempt to eliminate the effect of price fluctuations in the natural gas
spot market. Energy Services' risk management policy prohibits the
utilization of derivatives for trading purposes.
Gains or losses on derivatives associated with firm commitments are
recognized as adjustments to the cost of sales or revenues when the
associated transactions affect earnings. Gains and losses on derivatives
associated with forecasted transactions are recognized when such forecasted
transactions affect earnings. If a derivative instrument is terminated early
because it is probable that a transaction will not occur, any gain or loss as
of such date is immediately recognized in earnings. If a derivative is
terminated early for other economic reasons, any gain or loss as of the
termination date is deferred and recorded when the associated transaction or
forecasted transaction affects earnings. If a derivative is sold or matures,
any gain or loss is deferred and recognized as adjustments to the cost of
sales or revenues when the associated transaction affects earnings. In order
to meet the criteria for the gains and losses on derivatives to be deferred
and recognized in the same period as the physical transaction, the commodity
must expose the Company to price risk and the derivative used as a hedging
instrument must reduce that exposure. Because the commodities covered by the
derivatives are substantially the same commodities that the Company buys and
sells in the physical market, there is a high degree of correlation between
price changes in the derivative and cash markets. If those criteria were not
met, the derivative would be marked to market and any change in market value
would be recognized in earnings in the period of change.
-33-
<PAGE>
Credit risk relates to the risk of Energy Services' loss if a party does
not perform its contractual obligations. Energy Services maintains credit
policies that management believes significantly minimizes the overall credit
exposure. These policies include an evaluation of the potential parties'
financial condition and the use of standardized agreements which allow for
netting of positive and negative exposures associated with a single party.
While notional amounts listed below are used to express the volume of various
derivatives, those amounts do not generally represent the amounts exchanged
by the parties and, thus, are not a measure of the exposure to the Company.
The amounts subject to credit risk are substantially smaller. Energy Services
does not anticipate any material impact to its financial position or results
of operations as a result of nonperformance by third parties.
<TABLE>
The following summarizes the types of hedges used and the related
financial information on open contracts as of December 31, 1997 and 1996 (in
thousands of dollars):
<CAPTION>
1997 1996
------ -------
<S> <C> <C>
Futures Contracts
Notional amount (MMcf) 7,710 8,080
Unrealized gain (loss) $ (39) $ (843)
Fair value $ (39) $ (843)
Commodity Price Swaps
Notional amount (MMcf) 4,778 7,476
Unrealized gain (loss) $ 114 $ 450
Fair value $ 114 $ 450
Options
Notional amount (MMcf) 84 148
Unrealized gain (loss) $ (21) $ 176
Fair value $ 42 $ 321
</TABLE>
Energy Services estimates the fair value of the derivatives by using
available market data and valuation methodologies. Some judgment is required
in interpreting market data, and the use of market assumptions or estimation
methodologies may affect the estimated fair value amounts.
In addition to the above balances, Energy Services recorded
approximately $782,000 in net deferred gains on contracts closed prior to
December 31, 1997 related to January 1998 sales commitments which is included
in other current assets.
The margin deposits of $4,890,000 and $7,465,000 as of December 31, 1997
and 1996, respectively, are included with the deferred gains and losses on
other derivatives in other current assets. The cost of margin deposits
approximates fair value.
Energy Services also hedges certain of its sales commitments with gas
held in storage. At December 31, 1997 and 1996, Energy Services held
approximately 4,027,000 Mcf and 1,868,000 Mcf in storage with a carrying
value of $10,364,000 and $7,985,000, respectively. At December 31, 1997 and
1996, Energy Services also had approximately 3,055,000 Mcf and 189,000 Mcf
with a carrying value of $6,614,000 and $789,000, respectively, of
outstanding gas loans owed to third parties.
-34-
<PAGE>
8. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
Pension Plans. The Company has non-contributory, defined benefit pension
plans. Pension plan benefits are generally based upon years of service and
compensation during the final years of employment. The Company's funding
policy is to contribute amounts annually to the plans based upon actuarial
and economic assumptions designed to achieve adequate funding of projected
benefit obligations.
At December 31, 1997, plan assets consisted of 60.2% equity investments,
10.9% guaranteed income insurance contracts, 28.7% fixed income securities
and 0.2% cash equivalents.
<TABLE>
Combined net periodic pension cost for the Company's defined benefit
plans consists of the following components (in thousands of dollars):
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Service cost $ 1,371 $ 1,796 $ 1,465
Interest cost on projected benefit obligation 3,716 3,803 3,495
Actual return on assets (10,586) (6,290) (8,497)
Amortization of prior service costs 471 471 471
Amortization of unrecognized net (gain) loss (436) 133 (329)
Amortization of transition obligation 79 79 79
Asset gain deferred 6,467 2,507 5,066
------- ------- -------
Net periodic pension cost $ 1,082 $ 2,499 $ 1,750
======= ======= =======
</TABLE>
<TABLE>
The following table sets forth the funded status of the plans and
amounts recognized in the Company's consolidated balance sheets as of
December 31, 1997 and 1996 (in thousands of dollars):
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Actuarial present value of benefit obligation:
Vested benefit obligation $47,681 $39,074
Non-vested benefit obligation 2,455 2,012
------- -------
Accumulated benefit obligation $50,136 $41,086
======= =======
Projected benefit obligation $53,701 $52,869
Plan assets at fair value 60,403 49,788
------- -------
(Funded) unfunded status of plan $(6,702) $ 3,081
Unrecognized net gain 10,344 6,316
Unrecognized prior service cost 153 (4,106)
Unrecognized net obligation at transition to SFAS 87 (426) (505)
------- -------
Recorded pension liability $ 3,369 $ 4,786
======= =======
</TABLE>
<TABLE>
Significant pension plan assumptions are as follows:
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Plan discount rates 7.00% 7.75% 7.25%
Expected long-term rate of return on assets 9.00% 9.00% 9.00%
Rates of increase in future compensation levels 4.00% 5.00% 5.00%
</TABLE>
-35-
<PAGE>
On December 31, 1997, the pension plans were amended to provide a
special frozen benefit to all employees with at least two years of service on
December 31, 1997. This special frozen benefit added both three years of
service and three years of age to all eligible employees for purposes of
computing accrued pension benefits at December 31, 1997. In conjunction with
the amendment, the Company is offering an early retirement program to all
eligible employees with at least two years of service on December 31, 1997.
This program is open from January 14, 1998 through February 27, 1998 and
offers employees the additional options of receiving either a lump-sum
pension benefit payment or an immediate annuity commencing April 1, 1998.
Other Postretirement Benefits. In addition to providing pension benefits,
the Company provides certain medical and prescription drug benefits to
qualified retired employees, their spouses and covered dependents. Retirees
with less than 30 years of service are required to contribute from 5% to 50%
of the Company's coverage cost, with the percentage depending on the
retiree's age and years of service.
The Company accounts for retiree medical benefits in accordance with
SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions." This standard requires the full accrual of such costs during the
years that the employee renders service to the Company until the date of full
eligibility. The Company adopted SFAS 106 effective January 1, 1993.
In December 1992, the MPSC issued a generic order addressing the
adoption of SFAS 106 by utilities under its jurisdiction. The order allows
Michigan utilities to adopt SFAS 106 for accounting and ratemaking purposes,
subject to a final order in a general rate case and requires the external
funding for amounts recovered in rates. The general rate case approved by
the MPSC in October 1997 allowed for such recovery of retiree medical
benefits, as discussed in Note 3.
The City Commission of Battle Creek allowed the recovery of retiree
medical benefits in Battle Creek's December 1995 rate increase, as discussed
in Note 3.
<TABLE>
The combined net periodic retiree medical costs consisted of the following
components (in thousands of dollars):
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Service cost $ 862 $ 865 $1,443
Interest cost 2,212 1,854 2,945
Actual return on assets (1,504) (1,009) (1,116)
Net amortization and deferral 1,205 844 2,106
------ ------ ------
Net periodic retiree medical cost $2,775 $2,554 $5,378
====== ====== ======
</TABLE>
In 1997, 1996 and 1995, the Company expensed net retiree medical costs
of $1,918,000, $1,395,000 and $905,000, respectively, consisting of total
costs incurred under the pay-as-you-go method plus additional retiree medical
costs recorded by the non-utility subsidiaries and Battle Creek. In 1997,
1996 and 1995, the Company also expensed $553,000, $663,000 and $663,000,
respectively, of retiree medical costs pursuant to certain MPSC orders
regarding the reduction in Michigan state property taxes. See Note 3 for
further discussion of these MPSC orders. The Company recorded regulatory
assets related to the Gas Company's retiree medical costs of $304,000,
$496,000 and $3,810,000 in 1997, 1996 and 1995, respectively.
-36-
<PAGE>
The Company established a Voluntary Employee Benefit Association (VEBA)
trust to fund its retiree medical benefits during 1997 and contributed
$2,023,000 to the trust. Previously, the Company had partially funded
retiree medical benefits on a discretionary basis through an Internal Revenue
Code Section 401(h) account. In 1997 and 1996, the Company made cash
contributions to the 401(h) account of $508,000 and $744,000, respectively.
The accumulated balance in the 401(h) account will be used to cover all
retiree medical benefits costs until it is depleted, at which time the funds
in the VEBA trust will be used.
<TABLE>
The funded status of the retiree medical benefit plans is reconciled
with the liability recorded at December 31, 1997 and 1996 as follows (in
thousands of dollars):
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Actuarial present value of estimated benefits:
Retirees $ 12,354 $ 9,796
Fully eligible active 8,361 5,252
Other active 5,338 11,477
-------- --------
Accumulated retiree medical obligation $ 26,053 $ 26,525
Plan assets at fair value 11,737 7,702
-------- --------
Unfunded status of plan $ 14,316 $ 18,823
Unrecognized net obligation at
transition to SFAS 106 (18,730) (26,878)
Unrecognized net gain 18,479 22,791
-------- --------
Recorded liability $ 14,065 $ 14,736
======== ========
</TABLE>
<TABLE>
Significant plan assumptions are as follows:
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Plan discount rate 7.00% 7.75% 7.25%
Expected long-term rate of return on assets 9.00% 9.00% 9.00%
</TABLE>
The 1997 costs were developed based on the health care plan in effect at
January 1, 1997. As of December 31, 1997, the actuary assumed that retiree
medical cost increases would be 8.6% in 1997, 8.2% in 1998, and decrease
uniformly to 5.0% in 2005 and thereafter and that prescription drug cost
increases would be 12.1% in 1997, 11.3% in 1998, and decrease uniformly to
5.0% in 2005 and thereafter. The health care cost trend rate assumption
significantly affects the amounts reported. For example, a one percentage
point increase in each year would increase the accumulated retiree medical
obligation as of December 31, 1997 by $3,872,000 and the aggregate of the
service and interest cost components of net periodic retiree medical costs
for 1997 by $600,000.
Employee Stock Ownership Trust. Under the provisions of the Company's
employee stock ownership trust (ESOT), it may contribute an annual amount at
its discretion. The contribution may be made in cash or in common shares of
the Company. For the years 1997 and 1995, the Company's contributions were
$400,000 in stock and $300,000 in cash, respectively. The Company did not
make a contribution to the ESOT in 1996.
-37-
<PAGE>
9. STOCK-BASED COMPENSATION
At the Company's 1997 annual meeting, the shareholders approved a long-term
incentive plan providing for the issuance of up to 500,000 shares of
non-qualified common stock options over the next ten years adjusted for any
subsequent stock dividends and stock splits. The options are reserved for
the executives and directors of the Company and are awarded based upon both
the Company's and individual's performance. The options vest at the rate of
33 1/3% per year beginning one year after the date of grant and expire ten
years after the grant date. Additionally, pursuant to an executive
employment agreement, the Company granted 30,000 and 15,000 common stock
options during 1997 and 1996, respectively. These options vest three years
after the grant date and expire ten years after the grant date.
<TABLE>
The exercise price of all the options granted is equal to the average of
the high and low market price on the options' grant date. Both the number of
options granted and the exercise price are adjusted accordingly for any stock
dividends and stock splits occurring during the options' life. The weighted
average fair value of the options granted during 1997 was $2.61 per share.
The fair value of the options was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions: divided
yield of 5.67%; expected volatility of 0.1913%; risk-free interest rate of
6.54%; and expected lives of 5 years. The status of the options granted
under the long-term stock incentive plan and the employment agreement are as
follows:
<CAPTION>
Weighted Exercise
Avg. Shares Price
----------- --------
<S> <C> <C>
Granted in 1996 15,750 $15.71
------- ------
Outstanding at December 31, 1996 15,750 15.71
======= ======
Granted in 1997 126,500 17.90
Forfeited in 1997 18,000 18.00
------- ------
Outstanding at December 31, 1997 124,250 $17.60
======= ======
Options available for grant under the long-term
incentive plan at December 31, 1997 423,000
=======
</TABLE>
<TABLE>
The following table summarizes information concerning the stock options
outstanding:
<CAPTION>
At December 31, 1997
----------------------------------
Exercise Expiration Number Number
Price Date Outstanding Exercisable
- -------- ---------- ----------- -----------
<S> <C> <C> <C>
$15.71 04/30/06 15,750 --
16.75 07/21/07 7,000 --
18.00 05/01/07 70,000 1,000
17.86 01/03/07 31,500 --
----------- -----------
124,250 1,000
=========== ===========
</TABLE>
-38-
<PAGE>
<TABLE>
In October 1995, the FASB issued SFAS 123, "Accounting for Stock-Based
Compensation." In general, SFAS 123 recommends that all stock-based
compensation given to employees in exchange for their services be expensed
based on the fair value of the options granted. The Company has chosen to
continue accounting for these transactions under previously existing
accounting standards as allowed in SFAS 123. However, if expense had been
determined in a manner consistent with the provisions of SFAS 123, the
Company's net income and earnings per share would have been reduced to the
pro-forma amounts indicated below:
<CAPTION>
1997 1996
------------------------ --------------------------
Pro-forma As Reported Pro-forma As Reported
<S> <C> <C> <C> <C>
Net income (loss) (in thousands) $14,866 $14,921 $(12,808) $(12,803)
Earnings (loss) per share - basic and diluted $ 1.14 $ 1.14 $ (.98) $ (.98)
======= ======= ======== ========
</TABLE>
10. INVESTMENTS IN AFFILIATES
The equity method of accounting is used for interests in affiliates 20% to
50% owned or in which the Company has significant influence over operations.
These affiliate companies are generally involved in natural gas transmission,
storage or associated operations. The Company records income taxes on its
share of undistributed earnings of these affiliates at the time the earnings
are included in consolidated income.
<TABLE>
At December 31, 1997, the Company held the following interests in these
affiliates:
<CAPTION>
Percent Ownership
-----------------
<S> <C>
Eaton Rapids Gas Storage System 50%
Michigan Intrastate Lateral System 50
Michigan Intrastate Pipeline System 50
Nimrod Limited Partnership 29
NOARK Pipeline System, L.P. 32
</TABLE>
<TABLE>
Summarized combined financial information for investments in affiliates
for the years ended December 31, 1997, 1996 and 1995 is as follows (in
thousands of dollars):
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net sales $ 13,368 $ 13,866 $ 39,179
Operating income $ 3,568 $ 4,029 $ 9,958
Net (loss) $ (7,107) $ (4,230) $ (225)
======== ======== ========
The Company's share of net (loss) $ (1,967) $ (1,196) $ (258)
======== ======== ========
Current assets $ 2,843 $ 2,744 $ 8,988
Non-current assets 125,455 131,211 138,741
-------- -------- --------
Total assets $128,298 $133,955 $147,729
======== ======== ========
Current liabilities $ 42,745 $ 9,659 $ 12,310
Non-current liabilities 88,348 114,997 118,322
Equity (2,795) 9,299 17,097
-------- -------- --------
Total liabilities and equity $128,298 $133,955 $147,729
======== ======== ========
The Company's equity investment $ 4,710 $ 5,120 $ 8,024
======== ======== ========
The Company's share of undistributed gains (losses) $ 475 $ (1,733) $ (1,193)
======== ======== ========
</TABLE>
-39-
<PAGE>
11. MERGERS AND ACQUISITIONS
On August 13, 1997, SEMCO Energy Construction Co. (SEMCO Construction), a
subsidiary of Energy Ventures, purchased the assets and business of
Sub-Surface Construction Co. (Sub-Surface) for $15,634,000 in cash plus the
assumption of certain liabilities. Sub-Surface is involved primarily in the
construction of underground gas distribution pipelines, services lines and
associated facilities, primarily in Michigan. The fair value of the tangible
assets acquired and liabilities assumed were $15,252,000 and $5,884,000,
respectively. Included in the assets acquired by SEMCO Construction were
several non-compete agreements with prior employees of Sub-Surface totaling
$1,000,000 ranging from two to five years. The balance of the purchase
price, $6,266,000, was recorded as an excess of cost over net assets acquired
(goodwill) and is being amortized on the straight line method over forty
years for book purposes.
On December 19, 1997, Energy Ventures purchased the assets and business
of Maverick Pipeline Services, Inc. (Maverick) for $50,000 in cash and
$450,000 in the Company's stock, resulting in the issuance of 25,512 shares
of stock. Maverick provides pipeline engineering with full project
management and field services to domestic and international clients for all
types of liquid and gas pipeline projects, both onshore and offshore. The
fair value of the tangible assets acquired and liabilities assumed were
$686,000 and $446,000, respectively. The balance of the purchase price,
$260,000, was recorded as an excess of cost over net assets acquired
(goodwill) and is being amortized on the straight line method over forty
years for book purposes.
For financial statement purposes, both of the acquisitions were
accounted for as purchases and accordingly, results of operations are
included in the consolidated financial statements since the date of
acquisition.
12. COMMITMENTS AND CONTINGENCIES
Construction Program. The Company's plans for expansion and improvement of
its natural gas delivery system, and other plant, are continually reviewed.
Aggregate capital expenditures for 1998 are projected at $21,900,000.
Guarantees. SEMCO Arkansas Pipeline Company, a wholly owned subsidiary of
Energy Ventures, has a 32% interest in a partnership which operates the NOARK
Pipeline System. NOARK is a 302-mile intrastate natural gas pipeline which
experienced significant cost overruns during construction resulting in higher
financing costs than expected. In addition, competition from two interstate
pipelines required NOARK to discount is transportation charges to attract
volumes to the pipeline. Even with discounted rates, NOARK has operated at
less than 65% capacity since its inception in 1992.
In December of 1996, the Company recorded a one-time non-cash after-tax
charge (the Reserve) of $21,000,000 relating to its NOARK investment. The
Reserve was recorded because of recurring losses experienced by NOARK.
In December 1997, the Company reduced the Reserve based on a pending
sales agreement. This reduction increased 1997 after-tax earnings by
approximately $5,025,000.
On January 14, 1998, the Company sold its entire 32% interest in NOARK
to ENOGEX Arkansas Pipeline Corporation (EAPC). The sale released the
Company from all its NOARK guarantees, which related to 40% of NOARK's debt.
Pursuant to the sale, the Company must pay approximately $9,200,000,
$3,100,000, and $800,000 to EAPC in April 1998, 1999 and 2000, respectively.
-40-
<PAGE>
Lease Commitments. The Company leases vehicles and related equipment. The
resulting leases are classified as operating leases in accordance with SFAS
13, "Accounting for Leases." Leases on new vehicles are for a minimum of
twelve months. The Company has the right to extend each lease annually and
to cancel the extended lease at any time. When these leased vehicles are
later sold by the lessor, any gain or loss on the sale accrues to the
Company.
The minimum lease payments for 1998 approximate $278,000. There are no
further non-cancelable lease commitments thereafter. However, management
expects to renew or replace all leases. Total lease expense approximated
$2,039,000 in 1997 and $2,264,000 in 1996. Before 1996, the Company owned
its vehicles and related equipment.
Environmental Issues. 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 at 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 cost incurred by the Gas Company will be amortized over ten
years starting the year after incurred.
13. QUARTERLY FINANCIAL INFORMATION (Unaudited)
In the opinion of the Company, the following quarterly information includes
all adjustments necessary for a fair statement of the results of operations
for such periods. Earnings and dividends per share of common stock are
calculated based upon the weighted average number of shares outstanding
during each quarter adjusted for five percent stock dividends in May 1997 and
May 1996. Due to the seasonal nature of the Company's gas distribution
business, the results of operations reported on a quarterly basis show
substantial variations.
<TABLE>
The following amounts are shown in thousands of dollars, except per
share amounts:
<CAPTION>
Quarters First Second Third Fourth
- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
1997
Operating revenue $252,735 $121,481 $123,848 $272,208
Operating income 12,741 2,998 95 7,149
Net income (loss) 9,589 122 (3,148) 8,358
Earnings (loss) per share<F1><F2> .74 .01 (.24) .64
Cash dividends per share<F1> .19 .19 .20 .20
1996<F3>
Operating revenue $175,047 $ 82,105 $ 90,669 $197,128
Operating income 10,669 2,428 (377) 7,537
Net income (loss) 7,552 (179) (3,264) (16,912)
Earnings (loss) per share<F1><F2> .58 (.01) (.25) (1.30)
Cash dividends per share<F1> .18 .18 .19 .19
<FN>
<F1>
Adjusted for five percent stock dividends in May 1997 and May 1996.
<F2>
Total for each year may not equal annual earnings per share due to
changes in shares outstanding.
<F3>
Restated - See Note 2.
</FN>
</TABLE>
-41-
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To SEMCO Energy, Inc.:
We have audited the accompanying consolidated balance sheets and statements
of capitalization of SEMCO Energy, Inc. (a Michigan corporation) and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, changes in stockholders' investment and cash flows
for each of the three years in the period ended December 31, 1997. These
financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of SEMCO
Energy, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in item 14(a)2
is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
schedule has been subjected to the auditing procedures applied in the audits
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Detroit, Michigan
March 10, 1998
-42-
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-43-
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information appearing under the captions "Information About
Directors" in Registrant's definitive Proxy Statement (filed pursuant to
Regulation 14A) with respect to Registrant's April 21, 1998 Annual Meeting of
Shareholders is incorporated by reference herein.
The executive officers of the Company are William L. Johnson, Robert J.
Digan, II, Carl W. Porter and Barrett Hatches.
Mr. Johnson (age 55) was elected Chairman of the Board of Directors in
December 1997. He has been President and Chief Executive Officer of the
Company since May 1996. From 1994 to May 1996 he was Chief Executive Officer
of Northern Pipeline Construction Company of Kansas City, Missouri, and from
1990 to 1994 he was President, Gas Service Division of Western Resources,
Inc. of Topeka, Kansas.
Mr. Digan (age 40) has been Senior Vice President, Treasurer and Chief
Financial Officer of the Company since July 1997. He was Chief Financial
Officer of SuperShuttle International, Phoenix, Arizona, from September 1996
to July 1997. From January 1995 to September 1996 he was Chief Financial
Officer of Northern Pipeline Construction Co., Phoenix, Arizona. From
February 1993 to December 1994 he was Chief Financial Officer of Kemper
Management Services, Inc., Glastonbury, Connecticut, and from November 1985
to February 1993 he was Vice President - Finance of The Balf Co. & Affiliates,
Newington, Connecticut.
Mr. Porter (age 48) has been Senior Vice President and Chief Operating
Officer of the Company since July 1996. He was Vice President-Gas Utilities
of Itron, Inc., Spokane, Washington, from August 1995 to July 1996. From
1992 to 1995 he was Senior Vice President of Operations of New Jersey Natural
Gas, Wall, New Jersey, and from 1990 to 1992 he was Vice President of
Operations of Western Resources, Inc., Topeka, Kansas.
Mr. Hatches (age 42) has been Vice President of Human Resources and
Public Affairs of the Company since February 1997. He was Vice President of
V. Robinson & Company, Inc., Kansas City, Missouri, from 1996 to February
1997. He was Director of Logistics and Chief Operating Officer H & N
Railroad of North American Salt Company, Overland Park, Kansas, from 1995 to
1996. While employed by Missouri Gas Energy, Kansas City, Missouri, he was
Director Field Services from May 1994 to January 1995 and Director Customer
Information from July 1992 to May 1994.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing under the captions "Compensation Committee
Interlocks and Insider Participation" and "Compensation of Directors and
Executive Officers" in Registrant's definitive Proxy Statement (filed
pursuant to Regulation 14A) with respect to Registrant's April 21, 1998
Annual Meeting of Shareholders is incorporated by reference herein.
-44-
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information appearing under the caption "Stock Outstanding, Voting
Rights and Votes Required" in the Registrant's definitive Proxy Statement
(filed pursuant to Regulation 14A) with respect to Registrant's April 21,
1998 Annual Meeting of Shareholders, is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing under the caption "Employment and Related
Agreements" in the Registrant's definitive Proxy Statement (filed pursuant to
Regulation 14A) with respect to Registrant's April 21, 1998 Annual Meeting of
Shareholders, is incorporated by reference herein.
-45-
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements. The following financial
statements are included in Part II, item 8 above.
Pages in 10-K
-------------
Consolidated Statements of Operations for the years
ended December 31, 1997, 1996 and 1995 21
Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995 22
Consolidated Balance Sheets as of
December 31, 1997 and 1996 23
Consolidated Statements of Capitalization as
of December 31, 1997 and 1996 24
Consolidated Statements of Changes in
Stockholders' Investment for the years
ended December 31, 1997, 1996 and 1995 25
Notes to the Consolidated Financial Statements 26-41
Report of Independent Public Accountants 42
(a) 2. Financial Statement Schedules.
The following additional data should be read in conjunction with
the Consolidated Financial Statements in Part II, item 8 above.
Schedules not included herein have been omitted because they are
not applicable or the required information is shown in such
financial statements or notes thereto.
Schedule
Number Pages in 10-K
-------- -------------
I Consolidated Valuation and Qualifying
Accounts for the years ended
December 31, 1997, 1996 and 1995 50
-46-
<PAGE>
(a) 3. Exhibits, including those incorporated by reference
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- ------- ----------- -------- ---------
2 Plan of Acquisition, etc. NA NA
3.(i).1 Articles of Incorporation of SEMCO Energy, Inc.
(formerly Southeastern Michigan Gas
Enterprises, 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.(k) x
3.(ii) Bylaws--last revised August 15, 1997.(l) x
4.1 Trust Indenture dated April 1, 1992, with
NBD Bank, N.A. as Trustee.(d) x
4.2 Note Agreement dated as of June 1, 1994,
relating to issuance of $80,000,000 of
long-term debt.(f) x
4.3 Rights Agreement dated as of April 15, 1997
with Continental Stock Transfer & Trust
Company, as Rights Agent.(i) x
4.4 Note Agreement dated as of October 1, 1997,
relating to issuance of $60,000,000 of
long-term debt.(l) x
9 Voting Trust Agreement. NA NA
10 Material Contracts.
10.1 Guaranty Agreement dated October 10, 1991,
relating to financing of NOARK.(c) x
10.2 Short-Term Incentive Plan.(e) x
10.3 Deferred Compensation and Phantom Stock
Purchase Agreement (for outside
directors only).(g) x
10.4 Supplemental Retirement Plan for Certain
Officers.(h) x
10.5 1997 Long-Term Incentive Plan.(i) x
10.6 Stock Option Certificate and Agreement
dated October 10, 1996 with
William L. Johnson.(j) x
10.7 Stock Option Certificate and Agreement
dated February 26, 1997 with
William L. Johnson.(j) x
10.8 Employment Agreement dated October 10, 1996,
with William L. Johnson.(k) x
10.9 Change of Control Employment Agreement dated
October 10, 1996, with William L. Johnson.(k) x
11 Statement re computation of per share earnings. NA NA
12 Statements re computation of ratios. NA NA
13 Annual report to shareholders. NA NA
-47-
<PAGE>
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- ------- ----------- -------- ---------
16 Letter re change in certifying accountant. NA NA
18 Letter re change in accounting principle. NA NA
21 Subsidiaries of the Registrant. x
22 Published report regarding matters submitted
to a vote of security holders. NA NA
23 Consent of Independent Public Accountants. x
24 Power of Attorney. x
27 Financial Data Schedule. x
99.1 Proxy Statement dated March 27, 1998.(m) x
Key to Exhibits Incorporated by Reference
(a) Filed with SEMCO Energy, Inc.'s (formerly Southeastern Michigan Gas
Enterprises, 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 Registration Statement, Form S-2,
No. 33-46413, filed March 16, 1992.
(d) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1992, File No. 0-8503.
(e) Filed with SEMCO Energy, Inc.'s Form 10-K for 1992, dated March 30,
1993, File No. 0-8503.
(f) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
June 30, 1994, File No. 0-8503.
(g) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1994, File No. 0-8503.
(h) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1996, File No. 0-8503.
(i) Filed March 6, 1997, as part of SEMCO Energy, Inc.'s 1997 Proxy
Statement, dated March 7, 1997, File No. 0-8503.
(j) Filed with SEMCO Energy, Inc.'s Form 10-K for 1996, dated March 27,
1997, File No. 0-8503.
(k) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1997, File No. 0-8503.
(l) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1997, File No. 0-8503.
(m) Filed March 25, 1998, pursuant to Rule 14a-6 of the Exchange Act,
File No. 0-8503.
ITEM 14. (Continued)
(b) No reports on Form 8-K have been filed during the quarter ended
December 31, 1997.
(c) The Exhibits, if any, filed herewith are identified on the Exhibit
Index.
(d) The financial statement schedules filed are listed under Item 14.(a).2.
above.
-48-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SEMCO ENERGY, INC.
Date: March 31, 1998 By /s/William L. Johnson
-------------------------------------
William L. Johnson
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/William L. Johnson Chairman, President and Chief March 31, 1998
- ------------------------
William L. Johnson Executive Officer (Director)
/s/Robert J. Digan, II Senior Vice President and March 31, 1998
- ------------------------
Robert J. Digan, II Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/Daniel A. Burkhardt* Director March 31, 1998
- ------------------------
Daniel A. Burkhardt
/s/Edward J. Curtis* Director March 31, 1998
- ------------------------
Edward J. Curtis
/s/John T. Ferris* Director March 31, 1998
- ------------------------
John T. Ferris
/s/Michael O. Frazer* Director March 31, 1998
- ------------------------
Michael O. Frazer
/s/Harvey I. Klein* Director March 31, 1998
- ------------------------
Harvey I. Klein
Director ______________
- ------------------------
Stewart J. Kniff
/s/Bruce G. Macleod* Director March 31, 1998
- ------------------------
Bruce G. Macleod
/s/Frederick S. Moore* Director March 31, 1998
- ------------------------
Frederick S. Moore
/s/Edith A. Stotler* Director March 31, 1998
- ------------------------
Edith A. Stotler
/s/Donald W. Thomason* Director March 31, 1998
- ------------------------
Donald W. Thomason
*By /s/William L. Johnson March 31, 1998
---------------------
William L. Johnson
Attorney-in-fact
-49-
<PAGE>
SCHEDULE I
<TABLE>
SEMCO Energy, Inc.
SCHEDULE I - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(Thousands of Dollars)
<CAPTION>
Additions Deductions
--------- From Reserve
Balance Provision for Purpose of Balance
Beginning Charged Which the Reserve End
Description of Period to Income Was Provided of Period
- ------------------------------------------------------- --------- --------- ----------------- ---------
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------
<S> <C> <C> <C> <C>
RESERVE DEDUCTED FROM RECEIVABLES IN BALANCE SHEET -
UNCOLLECTIBLE ACCOUNTS $ 1,247 $2,199 $1,948 $ 1,498
======= ====== ====== =======
RESERVE DEDUCTED FROM OTHER PROPERTY IN BALANCE SHEET $ 2,401 $ -0- $ -0- $ 2,401
======= ====== ====== =======
RESERVE FOR EQUITY INVESTMENT $32,942 $ -0- $7,730 $25,212
======= ====== ====== =======
FOR THE YEAR ENDED DECEMBER 31, 1996
------------------------------------
<CAPTION>
<S> <C> <C> <C> <C>
RESERVE DEDUCTED FROM RECEIVABLES IN BALANCE SHEET -
UNCOLLECTIBLE ACCOUNTS $ 729 $ 1,209 $ 691 $ 1,247
====== ======= ====== =======
RESERVE DEDUCTED FROM OTHER PROPERTY IN BALANCE SHEET $2,401 $ -0- $ -0- $ 2,401
====== ======= ====== =======
RESERVE FOR EQUITY INVESTMENT $ -0- $32,942 $ -0- $32,942
====== ======= ====== =======
FOR THE YEAR ENDED DECEMBER 31, 1995
------------------------------------
<CAPTION>
<S> <C> <C> <C> <C>
RESERVE DEDUCTED FROM RECEIVABLES IN BALANCE SHEET -
UNCOLLECTIBLE ACCOUNTS $ 889 $ 608 $ 768 $ 729
====== ====== ====== ======
RESERVE DEDUCTED FROM OTHER PROPERTY IN BALANCE SHEET $1,801 $ 600 $ -0- $2,401
====== ====== ====== ======
</TABLE>
-50-
<PAGE>
SEMCO ENERGY, INC.
Exhibit Index
Form 10-K
1997
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- ------- ----------- -------- ---------
2 Plan of Acquisition, etc. NA NA
3.(i).1 Articles of Incorporation of SEMCO Energy, Inc.
(formerly Southeastern Michigan Gas
Enterprises, 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.(k) x
3.(ii) Bylaws--last revised August 15, 1997.(l) x
4.1 Trust Indenture dated April 1, 1992, with
NBD Bank, N.A. as Trustee.(d) x
4.2 Note Agreement dated as of June 1, 1994,
relating to issuance of $80,000,000 of
long-term debt.(f) x
4.3 Rights Agreement dated as of April 15, 1997
with Continental Stock Transfer & Trust
Company, as Rights Agent.(i) x
4.4 Note Agreement dated as of October 1, 1997,
relating to issuance of $60,000,000 of
long-term debt.(l) x
9 Voting Trust Agreement. NA NA
10 Material Contracts.
10.1 Guaranty Agreement dated October 10, 1991,
relating to financing of NOARK.(c) x
10.2 Short-Term Incentive Plan.(e) x
10.3 Deferred Compensation and Phantom Stock
Purchase Agreement (for outside
directors only).(g) x
10.4 Supplemental Retirement Plan for Certain
Officers.(h) x
10.5 1997 Long-Term Incentive Plan.(i) x
10.6 Stock Option Certificate and Agreement
dated October 10, 1996 with
William L. Johnson.(j) x
10.7 Stock Option Certificate and Agreement
dated February 26, 1997 with
William L. Johnson.(j) x
10.8 Employment Agreement dated October 10, 1996,
with William L. Johnson.(k) x
10.9 Change of Control Employment Agreement dated
October 10, 1996, with William L. Johnson.(k) x
11 Statement re computation of per share earnings. NA NA
12 Statements re computation of ratios. NA NA
<PAGE>
Filed
--------------------
Exhibit By
No. Description Herewith Reference
- ------- ----------- -------- ---------
13 Annual report to shareholders. NA NA
16 Letter re change in certifying accountant. NA NA
18 Letter re change in accounting principle. NA NA
21 Subsidiaries of the Registrant. x
22 Published report regarding matters submitted
to a vote of security holders. NA NA
23 Consent of Independent Public Accountants. x
24 Power of Attorney. x
27 Financial Data Schedule. x
99.1 Proxy Statement dated March 27, 1998.(m) x
Key to Exhibits Incorporated by Reference
(a) Filed with SEMCO Energy, Inc.'s (formerly Southeastern Michigan Gas
Enterprises, 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 Registration Statement, Form S-2,
No. 33-46413, filed March 16, 1992.
(d) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1992, File No. 0-8503.
(e) Filed with SEMCO Energy, Inc.'s Form 10-K for 1992, dated March 30,
1993, File No. 0-8503.
(f) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
June 30, 1994, File No. 0-8503.
(g) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1994, File No. 0-8503.
(h) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1996, File No. 0-8503.
(i) Filed March 6, 1997, as part of SEMCO Energy, Inc.'s 1997 Proxy
Statement, dated March 7, 1997, File No. 0-8503.
(j) Filed with SEMCO Energy, Inc.'s Form 10-K for 1996, dated March 27,
1997, File No. 0-8503.
(k) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
March 31, 1997, File No. 0-8503.
(l) Filed with SEMCO Energy, Inc.'s Form 10-Q for the quarter ended
September 30, 1997, File No. 0-8503.
(m) Filed March 25, 1998, pursuant to Rule 14a-6 of the Exchange Act,
File No. 0-8503.
EXHIBIT 21
SEMCO ENERGY, INC.
List of Subsidiaries
Exhibit 21 to Form 10-K (1997)
The subsidiaries of SEMCO Energy, Inc. (the Registrant) are:
SEMCO Energy Gas Company (formerly Southeastern Michigan Gas Company)
MI-GAS PROPANE COMPANY (a subsidiary of SEMCO Energy Gas Company)
SEMCO Energy Services, Inc.
SEMCO Propane, Inc.
SEMCO Energy Ventures, Inc.
SEMCO Pipeline Company (a subsidiary of SEMCO Energy Ventures, Inc.)
SEMCO Gas Storage Company (a subsidiary of SEMCO Energy Ventures, Inc.)
SEMCO Arkansas Pipeline Company (a subsidiary of SEMCO Energy Ventures, Inc.)
SEMCO Gathering Company (a subsidiary of SEMCO Energy Ventures, Inc.)
Southeastern Financial Services, Inc. (a subsidiary of SEMCO Energy Ventures,
Inc.)
Southeastern Development Company (a subsidiary of SEMCO Energy Ventures,
Inc.)
SEMCO Energy Construction Co. (a subsidiary of SEMCO Energy Ventures, Inc.)
Maverick Pipeline Services, Inc. (a subsidiary of SEMCO Energy Ventures,
Inc.)
Each is incorporated in the State of Michigan and each does business only
under its respective corporate name indicated above, except for SEMCO Energy
Construction Co. which does business as Sub-Surface Construction Co.
EXHIBIT 23
Consent of Independent Public Accountants
As independent public accountants, we hereby consent to the incorporation of
our report dated March 10, 1998, included in this Form 10-K for the year
ended December 31, 1997, into the Company's previously filed Registration
Statements No. 33-46413 and 333-18927.
ARTHUR ANDERSEN LLP
Detroit, Michigan,
March 30, 1998.
EXHIBIT 24
SEMCO ENERGY, INC.
POWER OF ATTORNEY
Whereas, the Board of Directors of SEMCO Energy, Inc., a Michigan
corporation, at a meeting held on February 27, 1998, authorized and approved
the execution of Form 10-K Annual Report for 1997 pursuant to Section 13 of
the Securities Exchange Act of 1934 and the filing of said Form 10-K with the
Securities and Exchange Commission under the Securities Exchange Act of 1934.
NOW, THEREFORE, each of the undersigned in his capacity as a Director or
officer, or both, as the case may be, of said Corporation, does hereby
appoint William L. Johnson and Robert J. Digan, II, and each of them
severally, his true and lawful attorneys or attorney to execute in his name,
place and stead, in his capacity as a Director or officer or both, as the
case may be, of said Corporation, the Form 10-K for the year ended December
31, 1997, and any and all amendments thereto and all instruments necessary or
incidental in connection therewith, and to file the same with the Securities
and Exchange Commission. Each of said attorneys shall have full power of
substitution and resubstitution. Each of said attorneys shall have full
power and authority to do and perform in the name and on behalf of each of
the undersigned, in any and all capacities, each act whatsoever requisite or
necessary to be done in the premises, as fully and to all intents and
purposes as each of the undersigned might or could do in person, and each of
the undersigned hereby ratifies and approves the acts of said attorneys and
each of them.
IN WITNESS WHEREOF, we have hereunto set our hands as of the 27th day of
February, 1998.
/s/Daniel A. Burkhardt /s/Harvey I. Klein
- ------------------------------------- -------------------------------------
Daniel A. Burkhardt, Director Harvey I. Klein, Director
/s/Edward J. Curtis /s/Bruce G. Macleod
- ------------------------------------- -------------------------------------
Edward J. Curtis, Director Bruce G. Macleod, Director
/s/Robert J. Digan, II /s/Frederick S. Moore
- ------------------------------------- -------------------------------------
Robert J. Digan, II, Senior Vice Frederick S. Moore, Director
President and Principal Financial
and Accounting Officer
/s/John T. Ferris /s/Edith A. Stotler
- ------------------------------------- -------------------------------------
John T. Ferris, Director Edith A. Stotler, Director
/s/Michael O. Frazer /s/Donald W. Thomason
- ------------------------------------- -------------------------------------
Michael O. Frazer, Director Donald W. Thomason, Director
/s/William L. Johnson
- -------------------------------------
William L. Johnson, Chairman,
President and Chief Executive Officer
and Director
POA10K.SAM(sla)
<TABLE> <S> <C>
<ARTICLE> UT
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENTS OF OPERATIONS, THE CONSOLIDATED BALANCE SHEETS AND THE
CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 257,232
<OTHER-PROPERTY-AND-INVEST> 18,230
<TOTAL-CURRENT-ASSETS> 191,777
<TOTAL-DEFERRED-CHARGES> 38,248
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 505,487
<COMMON> 13,204
<CAPITAL-SURPLUS-PAID-IN> 81,938
<RETAINED-EARNINGS> (640)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 94,502
0
3,269
<LONG-TERM-DEBT-NET> 163,548
<SHORT-TERM-NOTES> 71,019
<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> 173,149
<TOT-CAPITALIZATION-AND-LIAB> 505,487
<GROSS-OPERATING-REVENUE> 770,272
<INCOME-TAX-EXPENSE> 5,406
<OTHER-OPERATING-EXPENSES> 741,883
<TOTAL-OPERATING-EXPENSES> 747,289
<OPERATING-INCOME-LOSS> 22,983
<OTHER-INCOME-NET> 5,158
<INCOME-BEFORE-INTEREST-EXPEN> 28,141
<TOTAL-INTEREST-EXPENSE> 13,204
<NET-INCOME> 14,937
16
<EARNINGS-AVAILABLE-FOR-COMM> 14,921
<COMMON-STOCK-DIVIDENDS> 10,216
<TOTAL-INTEREST-ON-BONDS> 9,388
<CASH-FLOW-OPERATIONS> 8,899
<EPS-PRIMARY> 1.14
<EPS-DILUTED> 1.14
</TABLE>
