UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal period from _____________ to _____________
Commission file number 001-15565
SEMCO ENERGY, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2144267
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
28470 13 MILE ROAD, SUITE 300, FARMINGTON HILLS, MICHIGAN 48334
(Address of principal executive offices)
248-702-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of outstanding shares of the Registrant's common stock as of October
31, 2002: 18,577,930
INDEX TO FORM 10-Q
------------------
For Quarter Ended September 30, 2002
Page
Number
------
COVER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS. . . . . . . . . . . . . . . . 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . .. . . . . . . . . . . 15
Item 3. Qualitative and Quantitative Disclosures About Market Risk. . . . . . . 27
Item 4. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 2. Changes in Securities and Use of Proceeds . . . . . . . . . . . . . . . 29
Item 4. Submission of Matters to a Vote of Securityholders. . . . . . . . . . . 29
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . 29
SIGNATURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
CERTIFICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
EXHIBIT INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 that are based on current
expectations, estimates and projections of SEMCO Energy, Inc. and its
subsidiaries (the "Company"). Statements that are not historical facts,
including statements about the Company's outlook, beliefs, plans, goals, and
expectations, are forward-looking statements. These statements are subject to
potential risks and uncertainties and, therefore, actual results may differ
materially. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future events
or otherwise. Factors that may impact forward-looking statements include, but
are not limited to, the following: (i) the effects of weather and other natural
phenomena; (ii) the economic climate and growth in the geographical areas where
the Company does business; (iii) the capital intensive nature of the Company's
business; (iv) increased competition within the energy industry as well as from
alternative forms of energy; (v) the timing and extent of changes in commodity
prices for natural gas and propane; (vi) the effects of changes in governmental
and regulatory policies, including income taxes, environmental compliance and
authorized rates; (vii) the Company's ability to bid on and win construction
contracts; (viii) the impact of energy prices on the amount of projects and
business available to the Company's construction services business; (ix) the
nature, availability and projected profitability of potential investments
available to the Company; (x) the Company's ability to remain in compliance with
its debt covenants and accomplish its financing objectives in a timely and
cost-effective manner in light of changing conditions in the capital markets;
(xi) the Company's ability to operate and integrate acquired businesses in
accordance with its plans and (xii) the Company's ability to effectively execute
its strategic plan.
- 2 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ -------------------- --------------------
2002 2001 2002 2001 2002 2001
-------- -------- --------- --------- --------- ---------
OPERATING REVENUES
Gas sales . . . . . . . . . . . . . . . . . . . . . . . $34,616 $32,146 $220,708 $202,415 $313,689 $303,289
Gas transportation. . . . . . . . . . . . . . . . . . . 5,051 4,931 19,012 18,333 26,567 26,301
Construction services . . . . . . . . . . . . . . . . . 30,730 37,618 86,510 84,349 115,380 114,922
Other . . . . . . . . . . . . . . . . . . . . . . . . . 2,296 2,109 8,474 8,198 11,596 11,549
-------- -------- --------- --------- --------- ---------
72,693 76,804 334,704 313,295 467,232 456,061
-------- -------- --------- --------- --------- ---------
OPERATING EXPENSES
Cost of gas sold. . . . . . . . . . . . . . . . . . . . 20,075 17,118 139,367 125,745 198,595 189,640
Operations and maintenance. . . . . . . . . . . . . . . 41,157 46,460 121,131 119,640 163,779 157,221
Depreciation and amortization . . . . . . . . . . . . . 8,834 9,351 26,487 27,304 35,689 36,133
Property and other taxes. . . . . . . . . . . . . . . . 2,973 2,937 9,105 8,657 12,011 10,820
Restructuring and impairment charges. . . . . . . . . . - - - - 6,103 -
-------- -------- --------- --------- --------- ---------
73,039 75,866 296,090 281,346 416,177 393,814
-------- -------- --------- --------- --------- ---------
OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . . (346) 938 38,614 31,949 51,055 62,247
OTHER INCOME (DEDUCTIONS)
Interest expense. . . . . . . . . . . . . . . . . . . . (7,951) (8,092) (23,102) (23,810) (31,076) (32,315)
Other . . . . . . . . . . . . . . . . . . . . . . . . . 694 345 1,728 1,710 2,356 2,815
-------- -------- --------- --------- --------- ---------
(7,257) (7,747) (21,374) (22,100) (28,720) (29,500)
-------- -------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES AND
DIVIDENDS ON TRUST PREFERRED SECURITIES . . . . . . . . (7,603) (6,809) 17,240 9,849 22,335 32,747
INCOME TAX PROVISION. . . . . . . . . . . . . . . . . . . (2,739) (2,456) 6,428 3,768 9,239 12,115
-------- -------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE DIVIDENDS ON TRUST
PREFERRED SECURITIES. . . . . . . . . . . . . . . . . . (4,864) (4,353) 10,812 6,081 13,096 20,632
Dividends on trust preferred securities, net of
income taxes. . . . . . . . . . . . . . . . . . . . . . 2,150 2,150 6,451 6,451 8,603 8,594
-------- -------- --------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS. . . . . . . . . (7,014) (6,503) 4,361 (370) 4,493 12,038
DISCONTINUED OPERATIONS
Loss from engineering services operations, net of
income taxes . . . . . . . . . . . . . . . . . . . - (142) - (558) (584) (444)
Estimated loss on divestiture of engineering services
operations, including provision for losses during
phase-out period, net of income taxes. . . . . . . - - - - (4,980) -
-------- -------- --------- --------- --------- ---------
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS. . . . . . . . . . . . . . . . . . . . . . $(7,014) $(6,645) $ 4,361 $ (928) $ (1,071) $ 11,594
======== ======== ========= ========= ========= =========
EARNINGS PER SHARE - BASIC
Income (loss) from continuing operations. . . . . . . . $ (0.38) $ (0.36) $ 0.24 $ (0.02) $ 0.24 $ 0.67
Net income (loss) available to common shareholders. . . $ (0.38) $ (0.37) $ 0.24 $ (0.05) $ (0.06) $ 0.64
EARNINGS PER SHARE - DILUTED
Income (loss) from continuing operations. . . . . . . . $ (0.38) $ (0.36) $ 0.24 $ (0.02) $ 0.24 $ 0.63
Net income (loss) available to common shareholders. . . $ (0.38) $ (0.37) $ 0.24 $ (0.05) $ (0.06) $ 0.61
CASH DIVIDENDS PAID PER SHARE . . . . . . . . . . . . . . $ 0.125 0.210 0.460 0.630 0.670 0.840
AVERAGE COMMON SHARES OUTSTANDING . . . . . . . . . . . . 18,519 18,109 18,422 18,076 18,365 18,069
The accompanying notes to the consolidated financial statements are an integral part of these statements.
- 3 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
ASSETS
(In thousands)
September 30, December 31,
2002 2001
-------------- -------------
(Unaudited)
CURRENT ASSETS
Cash and temporary cash investments, at cost. . . . . . $ 4,853 $ 1,728
Receivables, less allowances of $1,997 and $1,849 . . . 38,453 64,219
Accrued revenue . . . . . . . . . . . . . . . . . . . . 13,586 33,153
Prepaid expenses. . . . . . . . . . . . . . . . . . . . 23,241 22,276
Gas in underground storage. . . . . . . . . . . . . . . 40,770 12,731
Materials and supplies, at average cost . . . . . . . . 5,361 5,258
Gas charges recoverable from customers. . . . . . . . . 5,440 1,994
Other . . . . . . . . . . . . . . . . . . . . . . . . . 1,980 3,608
-------------- -------------
133,684 144,967
PROPERTY, PLANT AND EQUIPMENT
Gas distribution. . . . . . . . . . . . . . . . . . . . 635,802 613,467
Diversified businesses and other. . . . . . . . . . . . 94,496 94,514
-------------- -------------
730,298 707,981
Less - accumulated depreciation and impairments . . . . 207,450 183,436
-------------- -------------
522,848 524,545
DEFERRED CHARGES AND OTHER ASSETS
Goodwill, less amortization and impairments of $17,764. 161,084 161,084
Deferred retiree medical benefits . . . . . . . . . . . 9,216 9,891
Unamortized debt expense. . . . . . . . . . . . . . . . 8,102 7,831
Other . . . . . . . . . . . . . . . . . . . . . . . . . 16,567 15,230
-------------- -------------
194,969 194,036
-------------- -------------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . . . . $ 851,501 $ 863,548
============== =============
The accompanying notes to the consolidated financial statements are an integral part of
these statements.
- 4 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
LIABILITIES AND CAPITALIZATION
(In thousands)
September 30, December 31,
2002 2001
--------------- --------------
(Unaudited)
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt. . . $ 114,415 $ 137,957
Accounts payable. . . . . . . . . . . . . . . . . . . . . . 23,470 30,410
Customer advance payments . . . . . . . . . . . . . . . . . 11,696 13,530
Accrued interest. . . . . . . . . . . . . . . . . . . . . . 6,900 7,665
Amounts payable to customers. . . . . . . . . . . . . . . . 1,394 1,463
Accumulated deferred income taxes . . . . . . . . . . . . . 1,813 912
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,215 17,076
--------------- --------------
172,903 209,013
DEFERRED CREDITS AND OTHER LIABILITIES
Accumulated deferred income taxes . . . . . . . . . . . . . 33,268 33,149
Customer advances for construction. . . . . . . . . . . . . 15,336 15,548
Unamortized investment tax credit . . . . . . . . . . . . . 1,245 1,445
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,524 12,223
--------------- --------------
60,373 62,365
LONG-TERM DEBT. . . . . . . . . . . . . . . . . . . . . . . . 366,323 338,966
COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST
PREFERRED SECURITIES OF SUBSIDIARIES HOLDING
SOLELY DEBT SECURITIES OF SEMCO ENERGY, INC.. . . . . . . . 139,426 139,394
COMMON SHAREHOLDERS' EQUITY
Common stock - $1 par value; 40,000,000 shares authorized;
18,563,332 and 18,240,143 shares outstanding. . . . . . . 18,563 18,240
Capital surplus and accumulated other comprehensive income. 117,323 114,895
Retained earnings (deficit) . . . . . . . . . . . . . . . . (23,410) (19,325)
--------------- --------------
112,476 113,810
--------------- --------------
TOTAL LIABILITIES AND CAPITALIZATION. . . . . . . . . . . . . $ 851,501 $ 863,548
=============== ==============
The accompanying notes to the consolidated financial statements are an integral part of these
statements.
- 5 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
-------------------- -------------------- --------------------
2002 2001 2002 2001 2002 2001
--------- --------- --------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $ (7,014) $ (6,645) $ 4,361 $ (928) $ (1,071) $ 11,594
Adjustments to reconcile net income (loss) to net
cash from operating activities:
Depreciation and amortization . . . . . . . . . . . . 8,834 9,351 26,487 27,304 35,689 36,133
Non-cash impairment charges . . . . . . . . . . . . . - - - - 7,679 -
Changes in assets and liabilities, net of effects of
acquisitions, divestitures and other changes as
shown below. . . . . . . . . . . . . . . . . . . . (12,749) (16,085) (2,553) 6,919 (10,640) (6,963)
--------- --------- --------- --------- --------- ---------
NET CASH FROM OPERATING ACTIVITIES. . . . . . . (10,929) (13,379) 28,295 33,295 31,657 40,764
--------- --------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Property additions - gas distribution . . . . . . . . . . . (8,135) (11,152) (21,766) (28,820) (27,020) (38,447)
Property additions - diversified businesses and other . . . (1,871) (4,585) (4,557) (15,228) (10,699) (22,351)
Proceeds from property sales, net of retirement costs . . . 480 (214) 1,363 (350) 1,664 (971)
--------- --------- --------- --------- --------- ---------
NET CASH FROM INVESTING ACTIVITIES. . . . . . . (9,526) (15,951) (24,960) (44,398) (36,055) (61,769)
--------- --------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock, net of expenses . . . . . . . . . 852 1,171 2,796 1,315 3,917 1,521
Issuance of trust preferred securities, net of expenses . . - - - - - (83)
Issuance of long-term debt, net of expenses . . . . . . . . 29,043 (152) 29,043 58,296 29,043 58,198
Repayment of long-term debt and related expenses. . . . . . (30,060) - (30,060) (10) (30,060) (60)
Net change in notes payable . . . . . . . . . . . . . . . . 27,759 25,100 6,458 (37,691) 17,964 (27,661)
Payment of dividends on common stock. . . . . . . . . . . . (2,311) (3,796) (8,447) (11,380) (12,260) (15,170)
--------- --------- --------- --------- --------- ---------
NET CASH FROM FINANCING ACTIVITIES. . . . . . . 25,283 22,323 (210) 10,530 8,604 16,745
--------- --------- --------- --------- --------- ---------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease) . . . . . . . . . . . . . . . . . . 4,828 (7,007) 3,125 (573) 4,206 (4,260)
Beginning of period . . . . . . . . . . . . . . . . . . . . 25 7,655 1,728 1,221 648 4,908
--------- --------- --------- --------- --------- ---------
End of period . . . . . . . . . . . . . . . . . . . . . . . $ 4,853 $ 648 $ 4,853 $ 648 $ 4,854 $ 648
========= ========= ========= ========= ========= =========
CHANGES IN ASSETS AND LIABILITIES, NET OF EFFECTS OF
ACQUISITIONS, DIVESTITURES AND OTHER CHANGES:
Receivables, net. . . . . . . . . . . . . . . . . . . $ 8,371 $(16,471) $ 25,766 $ 7,532 $ 27,154 $ (4,898)
Accrued revenue . . . . . . . . . . . . . . . . . . . (868) (1,335) 19,567 18,156 470 (4,740)
Materials, supplies and gas in
underground storage. . . . . . . . . . . . . . . . (19,097) (4,373) (28,141) (5,289) (27,037) 110
Gas charges recoverable from customers. . . . . . . . (2,092) 48 (3,446) 436 (3,178) 616
Accounts payable. . . . . . . . . . . . . . . . . . . 4,144 1,946 (6,939) (6,046) (2,783) 5,167
Customer advances and amounts payable
to customers . . . . . . . . . . . . . . . . . . . 4,591 5,856 (2,115) (2,264) 81 (1,105)
Other . . . . . . . . . . . . . . . . . . . . . . . . (7,798) (1,756) (7,245) (5,606) (5,347) (2,113)
--------- --------- --------- --------- --------- ---------
$(12,749) $(16,085) $ (2,553) $ 6,919 $(10,640) $ (6,963)
========= ========= ========= ========= ========= =========
The accompanying notes to the consolidated financial statements are an integral part of these statements.
- 6 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Under the rules and regulations of the Securities and Exchange Commission
for Form 10-Q Quarterly Reports, certain footnotes and other financial statement
information normally included in the year-end financial statements of SEMCO
Energy, Inc. and its subsidiaries (the "Company") have been condensed or omitted
in the accompanying unaudited financial statements. These financial statements
prepared by the Company should be read in conjunction with the financial
statements and notes thereto included in the Company's 2001 Annual Report on
Form 10-K filed with the Securities and Exchange Commission. The information in
the accompanying financial statements reflects, in the opinion of the Company's
management, all adjustments (which include only normal recurring adjustments)
necessary for a fair statement of the information shown, subject to year-end and
other adjustments, as later information may require. Certain reclassifications
have been made to the prior periods' financial statements to conform with the
2002 presentation.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
GAS IN UNDERGROUND STORAGE - Effective April 1, 2002, the Battle Creek
Division of the Company's Gas Distribution business changed its method of
accounting for gas inventory from last-in, first-out (LIFO) to average cost.
This change in accounting principles was made in order to provide a better
matching of expenses with revenues and make Battle Creek's accounting for gas
inventory consistent with the Company's other gas distribution divisions and
other Michigan gas distribution companies. This accounting change was not
material to the financial statements, and, accordingly, no retroactive
restatement of prior years' financial statements was made.
COMPREHENSIVE INCOME - The Company's comprehensive income (loss) for the
three, nine and twelve months ended September 30, 2002 and September 30, 2001 is
summarized in the following table.
Three months ended Nine months ended Twelve months ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
-------- -------- ------ ------ -------- -------
(in thousands)
Net income (loss) available to common
shareholders . . . . . . . . . . . . . . $(7,014) $(6,645) $4,361 $(928) $(1,071) $11,594
Minimum pension liability adjustment, net
of income tax benefits of $781 . . . . . - - - - (1,452) -
Unrealized derivative gain (loss) on
interest rate hedge from an
investment in an affiliate . . . . . . . (98) - 107 - (637) -
-------- -------- ------ ------ -------- -------
Total other comprehensive income (loss). . $(7,112) $(6,645) $4,468 $(928) $(3,160) $11,594
======== ======== ====== ====== ======== =======
- 7 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING STANDARDS - On January 1, 2002, the Company adopted
Statement of Financial Accounting Standards ("SFAS") 141, "Business
Combinations" and SFAS 142, "Goodwill and Other Intangible Assets." SFAS 141
addresses financial accounting and reporting for all business combinations and
requires that all business combinations entered into subsequent to June 2001 be
recorded under the purchase method. This Statement also addresses financial
accounting and reporting for goodwill and other intangible assets acquired in a
business combination at acquisition. SFAS 142 addresses financial accounting
and reporting for intangible assets acquired individually or with a group of
other assets at acquisition. This Statement also addresses financial accounting
and reporting for goodwill and other intangible assets subsequent to their
acquisition.
Effective with the date of adoption of these Statements the Company ceased
Goodwill amortization, which has reduced amortization expense for the nine
months ended September 30, 2002 by approximately $2.1 million after income taxes
(or $0.11 per share based on the current level of outstanding common stock).
The Company is also required to complete a transition impairment test in
the year of adoption, and perform subsequent impairment tests on the remaining
goodwill balance annually or at any time when events occur which could impact
the value of the Company's business segments. If an impairment test of goodwill
shows that the carrying amount of the goodwill is in excess of the fair value, a
corresponding impairment loss would be recorded in the consolidated statements
of income. The transition impairment tests were performed for the Company's
business units and the results of those tests indicate that no impairment of the
Company's goodwill balances existed as of January 1, 2002. The 2002 annual
impairment test has also been performed for the Company's construction services
business segment and indicates that there is no impairment of goodwill. As a
result, there was no change in the carrying amount of goodwill at September 30,
2002 when compared to December 31, 2001. The 2002 annual impairment tests for
the remaining business units will be conducted during the fourth quarter of
2002.
The following table presents what would have been reported as net income
(loss) available to common shareholders and the related per share amounts on a
basic and diluted basis in all periods presented, exclusive of amortization
expense (including any related tax effects) recognized in those periods related
to goodwill.
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
-------- -------- ------ ------- -------- --------
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
Reported income (loss) from continuing operations . . . . . $(7,014) $(6,503) $4,361 $ (370) $ 4,493 $12,038
Discontinued operations . . . . . . . . . . . . . . . . . . - (142) - (558) (5,564) (444)
-------- -------- ------ ------- -------- --------
Reported net income (loss) available to common shareholders (7,014) (6,645) 4,361 (928) (1,071) 11,594
Add back: Goodwill amortization, net of income taxes. . . . - 703 - 2,107 698 2,800
-------- -------- ------ ------- -------- --------
Adjusted net income (loss) available to common shareholders $(7,014) $(5,942) $4,361 $1,179 $ (373) $14,394
-------- -------- ------ ------- -------- --------
ADJUSTED EARNINGS PER SHARE - BASIC
Reported income (loss) from continuing operations . . . . . $ (0.38) $ (0.36) $ 0.24 $(0.02) $ 0.24 $ 0.67
Discontinued operations . . . . . . . . . . . . . . . . . . - (0.01) - (0.03) (0.30) (0.03)
-------- -------- ------ ------- -------- --------
Reported net income (loss) available to common shareholders (0.38) (0.37) 0.24 (0.05) (0.06) 0.64
Add back: Goodwill amortization, net of income taxes. . . . - 0.04 - 0.12 0.04 0.16
-------- -------- ------ ------- -------- --------
Adjusted net income (loss) available to common shareholders $ (0.38) $ (0.33) $ 0.24 $ 0.07 $ (0.02) $ 0.80
-------- -------- ------ ------- -------- --------
ADJUSTED EARNINGS PER SHARE - DILUTED
Reported income (loss) from continuing operations . . . . . $ (0.38) $ (0.36) $ 0.24 $(0.02) $ 0.24 $ 0.63
Discontinued operations . . . . . . . . . . . . . . . . . . - (0.01) - (0.03) (0.30) (0.02)
-------- -------- ------ ------- -------- --------
Reported net income (loss) available to common shareholders (0.38) (0.37) 0.24 (0.05) (0.06) 0.61
Add back: Goodwill amortization, net of income taxes. . . . - 0.04 - 0.12 0.04 0.14
-------- -------- ------ ------- -------- --------
Adjusted net income (loss) available to common shareholders $ (0.38) $ (0.33) $ 0.24 $ 0.07 $ (0.02) $ 0.75
-------- -------- ------ ------- -------- --------
- 8 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
On January 1, 2002, the Company also adopted SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" and Accounting Principles Board ("APB") Opinion 30, "Reporting
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions."
SFAS 144 requires long-lived assets to be measured at the lower of either
the carrying amount or the fair value less the cost to sell the assets, whether
reported in continuing operations or in discontinued operations. Therefore,
discontinued operations will no longer be measured at net realizable value or
include amounts for operating losses that have not yet occurred.
SFAS 144 also broadens the reporting of discontinued operations to include
all components of an entity with operations that can be distinguished from the
rest of the entity and that will be eliminated from the ongoing operations of
the entity in a disposal transaction. The adoption of SFAS 144 will result in
the Company accounting for any future impairment or disposal of long-lived
assets under the provisions of SFAS 144, but has not changed the accounting used
for previous asset impairments or disposals.
In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations," effective January 1, 2003. The Standard requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which it is incurred.
When the liability is initially recorded, the entity capitalizes a cost by
increasing the carrying amount of the related long-lived asset. Over time, the
liability is accreted to its present value each period, and the capitalized cost
is depreciated over the useful life of the related asset. Upon settlement of
the liability, an entity either settles the obligation for its recorded amount
or incurs a gain or loss upon settlement. The Company is currently studying
SFAS 143 but has not quantified the effects of adoption on its financial
statements.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
SFAS 145 eliminates SFAS 4, Reporting Gains and Losses from Extinguishment of
Debt" ("SFAS 4") and thus allows for only those gains or losses on the
extinguishment of debt that meet the criteria of extraordinary items to be
treated as such in the financial statements. SFAS 145 also amends SFAS 13,
Accounting for Leases" ("SFAS 13") to require sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The provisions of this Statement relating to the
rescission of SFAS 4 are effective for fiscal years beginning after May 15,
2002. The provisions of this Statement relating to the amendment of SFAS 13 are
effective for transactions occurring after May 15, 2002. All other provisions
of this Statement are effective for financial statements issued on or after May
15, 2002.
In June 2002, The FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS 146 requires that the liability for
costs associated with exit or disposal activities be recognized when incurred,
rather than at the date of a commitment to an exit or disposal plan. SFAS 146
is to be applied prospectively to exit or disposal activities initiated after
December 31, 2002.
The Company is in the process of evaluating the impact of SFAS 145 and SFAS
146 on its financial statements, and does not expect the impact to be material.
- 9 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 2 - SHORT-TERM BORROWINGS AND CAPITALIZATION
SHORT-TERM BORROWINGS - On June 25, 2002, the Company entered into a $145
million credit agreement with a group of banks, replacing four lines of credit
totaling $145 million, which were due to expire. The new agreement, all of
which is committed, consists of an $80 million three-year revolver and a $65
million 364-day facility, with a one-year term loan option. On September 30,
2002, $31.6 million of these credit facilities was unused.
LONG-TERM DEBT - During September 2002, the Company issued $30 million of
6.49% unsecured Senior Notes due 2009. Interest on the Senior Notes is payable
semiannually. The proceeds from the sale were used to redeem $30 million of
6.83% Senior Notes, which were due to mature on October 1, 2002.
COMMON STOCK EQUITY - On October 17, 2002, the Company's Board of Directors
declared a quarterly cash dividend of $0.125 per share on the Company's common
stock. The dividend is payable on November 15, 2002 to shareholders of record
at the close of business on November 1, 2002.
In August 2002, the Company paid a quarterly cash dividend of $0.125 per
share on its common stock. The total cash dividend was approximately $2.3
million of which $.4 million was reinvested by shareholders into common stock
through participation in the Direct Stock Purchase and Dividend Reinvestment
Plan ("DRIP"). The cash dividend for the nine months ended September 30 2002,
was $8.4 million, of which $1.4 million was reinvested by shareholders through
participation in the DRIP. During the three and nine months ended September 30,
2002, the Company issued approximately 70,300 and 285,700 shares of Company
common stock, respectively, to meet the dividend reinvestment and stock purchase
requirements of its DRIP participants. Also during the three and nine months
ended September 30, 2002, the Company issued approximately 25,000 and 37,400
shares of its common stock, respectively, to certain of the Company's employee
benefit plans. During the first and second quarter of 2002, the Company
purchased 19,400 and 40,200 shares of its common stock, respectively, on the
open market to contribute to certain of its employee benefit plans.
NOTE 3 - RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
The Company's business activities expose it to a variety of risks,
including commodity price risk and interest rate risk. The Company's management
identifies risks associated with the Company's business and determines which
risks it wants to manage and which types of instruments it should use to manage
those risks.
The Company records all derivative instruments it enters into under the
provisions of SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," and SFAS 137 and SFAS 138, which were amendments to SFAS 133
(hereinafter collectively referred to as "SFAS 133"). SFAS 133 requires that
every derivative instrument (including certain derivative instruments embedded
in other contracts) be recorded in the statement of financial position, as
either an asset or liability, measured at its fair value. SFAS 133 also
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting.
An affiliate, in which the Company has a 50% investment, uses an interest
rate swap agreement to hedge the variable interest rate payments on its
long-term debt. This agreement qualifies under the provisions of SFAS 133 as a
cash flow hedge. As a result of this interest rate swap agreement, the
Company's Consolidated Statements of Financial Position, at September 30, 2002
- 10 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 3 - RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
(CONTINUED)
and December 31, 2001, reflected a $.6 million and $.7 million reduction,
respectively, in the Company's equity investment in the affiliate and in
accumulated other comprehensive income.
NOTE 4 - EARNINGS PER SHARE
The computations of basic and diluted earnings per share for the three,
nine and twelve months ended September 30, 2002 and 2001 are as follows (in
thousands except per share amounts):
Three Months Ended Nine Months Ended Twelve Months Ended
September 30 September 30 September 30
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
-------- -------- ------- -------- -------- --------
(in thousands)
BASIC EARNINGS PER SHARE COMPUTATION
Income (loss) from continuing operations. . . . . . $(7,014) $(6,503) $ 4,361 $ (370) $ 4,493 $12,038
Discontinued operations (a) . . . . . . . . . . . . - (142) - (558) (5,564) (444)
-------- -------- ------- -------- -------- --------
Net income (loss) available to common shareholders. $(7,014) $(6,645) $ 4,361 $ (928) $(1,071) $11,594
-------- -------- ------- -------- -------- --------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING . . . . . . . 18,519 18,109 18,422 18,076 18,365 18,069
-------- -------- ------- -------- -------- --------
EARNINGS PER SHARE - BASIC
Income (loss) from continuing operations. . . . . . $ (0.38) $ (0.36) $ 0.24 $ (0.02) $ 0.24 $ 0.67
Discontinued operations (a) . . . . . . . . . . . . - (0.01) - (0.03) (0.30) (0.03)
-------- -------- ------- -------- -------- --------
Net income (loss) available to common shareholders. $ (0.38) $ (0.37) $ 0.24 $ (0.05) $ (0.06) $ 0.64
-------- -------- ------- -------- -------- --------
DILUTED EARNINGS PER SHARE COMPUTATION
Income (loss) from continuing operations. . . . . . $(7,014) $(6,503) $ 4,361 $ (370) $ 4,493 $12,038
Discontinued operations (a) . . . . . . . . . . . . - (142) - (558) (5,564) (444)
-------- -------- ------- -------- -------- --------
Net income (loss) available to common shareholders. $(7,014) $(6,645) $ 4,361 $ (928) $(1,071) $11,594
-------- -------- ------- -------- -------- --------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING . . . . . . . 18,519 18,109 18,422 18,076 18,365 18,069
Incremental shares from assumed conversions of:
FELINE PRIDES - stock purchase contracts (b). . . . - - - - - 987
Stock options (b) . . . . . . . . . . . . . . . . . - - 30 - - 33
-------- -------- ------- -------- -------- --------
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (B) . 18,519 18,109 18,452 18,076 18,365 19,089
-------- -------- ------- -------- -------- --------
EARNINGS PER SHARE - DILUTED
Income (loss) from continuing operations. . . . . . $ (0.38) $ (0.36) $ 0.24 $ (0.02) $ 0.24 $ 0.63
Discontinued operations (a) . . . . . . . . . . . . - (0.01) - (0.03) (0.30) (0.02)
-------- -------- ------- -------- -------- --------
Net income (loss) available to common shareholders. $ (0.38) $ (0.37) $ 0.24 $ (0.05) $ (0.06) $ 0.61
-------- -------- ------- -------- -------- --------
(a) Effective December 2001, the Company began accounting for the engineering services business as a discontinued
operation. Accordingly, its operating results are segregated and reported as discontinued operations in the
Consolidated Statement of Income, with prior years restated.
(b) The stock options and FELINE PRIDES were not included in the computation of diluted earnings per share for a)
the three months ended September 30, 2002 and September 30, 2001, b) the nine months ended September 30, 2001
and c) the twelve months ended September 30, 2002, because their effect was antidilutive.
- 11 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 5 - BUSINESS SEGMENTS
The Company operates four reportable business segments: (1) gas
distribution; (2) construction services; (3) information technology services;
and (4) propane, pipelines and storage. The latter three segments are sometimes
referred to together as the "diversified businesses". For information regarding
the determination of reportable business segment, refer to Note 10 of the Notes
to the Consolidated Financial Statements in the Company's 2001 Annual Report on
Form 10-K.
The Company's gas distribution segment distributes and transports natural
gas to approximately 268,000 customers in the state of Michigan and
approximately 110,000 customers in the state of Alaska. The construction
services segment ("Construction Services") currently conducts most of its
business in the midwestern, southern and southeastern areas of the United
States. Its primary service is the installation of underground natural gas
mains and service lines. Other services include the installation and
maintenance of compressor and pipeline stations. The information technology
service segment ("IT Services") is headquartered in Michigan and provides IT
infrastructure outsourcing services, and other IT services with a focus on
mid-range computers, particularly the IBM I-Series (AS-400) platform. The
Company's other business segments currently account for a large portion of IT
Services revenues. The propane, pipelines and storage segment sells more than
four million gallons of propane annually to retail customers in Michigan's upper
peninsula and northeast Wisconsin and operates natural gas transmission and
storage facilities in Michigan.
The accounting policies of the operating segments are the same as those
described in Notes 1 and 10 of the Notes to the Consolidated Financial
Statements in the Company's 2001 Annual Report on Form 10-K, except that
intercompany transactions have not been eliminated in determining individual
segment results. The following table provides business segment information as
well as a reconciliation ("Corporate and other") of the segment information to
the applicable line in the Consolidated Financial Statements. Corporate and
Other includes corporate related expenses not allocated to segments,
intercompany eliminations and results of other smaller operations.
Three Months Ended Nine Months Ended Twelve Months Ended
September 30 September 30 September 30
------------------ -------------------- --------------------
2002 2001 2002 2001 2002 2001
-------- -------- --------- --------- --------- ---------
(in thousands)
OPERATING REVENUES
Gas Distribution . . . . . . . . $40,474 $37,653 $242,281 $223,079 $343,567 $333,322
Construction Services. . . . . . 33,868 41,397 95,973 93,394 128,784 126,441
Information Technology Services. 2,510 2,461 7,088 7,608 9,753 9,574
Propane, Pipelines and Storage . 1,097 1,289 4,751 5,407 6,787 7,786
Corporate and Other (a). . . . . (5,256) (5,996) (15,389) (16,193) (21,659) (21,062)
-------- -------- --------- --------- --------- ---------
Total Operating Revenues . . . $72,693 $76,804 $334,704 $313,295 $467,232 $456,061
======== ======== ========= ========= ========= =========
OPERATING INCOME (LOSS)
Gas Distribution . . . . . . . . $ (690) $(2,153) $ 38,037 $ 30,692 $ 57,682 $ 58,451
Construction Services. . . . . . 578 3,553 1,207 2,557 (2,725) 5,400
Information Technology Services. 48 117 367 353 444 553
Propane, Pipelines and Storage . 227 271 1,217 1,353 1,735 1,886
Corporate and Other. . . . . . . (509) (850) (2,214) (3,006) (6,081) (4,043)
-------- -------- --------- --------- --------- ---------
Total Operating Income . . . . $ (346) $ 938 $ 38,614 $ 31,949 $ 51,055 $ 62,247
======== ======== ========= ========= ========= =========
(a) Includes the elimination of intercompany construction services revenue
of $3,138,000, $9,463,000 and $13,404,000 for the three, nine and twelve months
ended September 30, 2002, respectively, and $3,779,000, $9,045,000 and
$11,519,000 for the three, nine and twelve months ended September 30, 2001,
respectively. Also includes the elimination of intercompany information
technology services revenue of $2,073,000, $5,801,000 and $8,087,000 for the
three, nine and twelve months ended September 30, 2002, respectively, and
$2,173,000, $7,063,000 and $9,400,000 for the three, nine and twelve months
ended September 30, 2001, respectively.
- 12 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 6 - COMMITMENTS AND CONTINGENCIES
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 Company owns seven Michigan sites, which
formerly housed such manufacturing facilities, and expects that it will
ultimately incur investigation and remedial action costs at some of these sites.
The Company has closed a related site with the approval of the appropriate
environmental regulatory authority in the State of Michigan, and has developed
plans and conducted preliminary field investigations at two other sites. The
extent of the 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.
PERSONAL PROPERTY TAXES - On November 7, 2002, the MPSC issued an order
requiring each natural gas and electric utility company subject to its
jurisdiction to show cause as to why each such utility should not reduce its
rates to reflect the new personal property valuation tables that were placed in
effect in 2000 by the Michigan State Tax Commission and why it should not refund
to the ratepayers any recovery amounts it receives as refunds from taxing
jurisdictions as it implements the new valuation tables. Responses to the Order
must be filed with the MPSC by December 9, 2002.
As of September 30, 2002, the Company had a receivable of approximately $4
million recorded for the Company's estimated recovery of prior year excess
property tax payments resulting from the application of these new tables." The
Company is currently studying the Order and its potential impact on this
estimated receivable. For further information regarding the new valuation
tables, see Note 13 of the Notes to Consolidated Financial Statements in the
Company's 2001 Annual Report.
OTHER - In the normal course of business, the Company may be a party to
certain lawsuits and administrative proceedings before various courts and
government agencies. These lawsuits and proceedings may involve personal
injury, property damage, contractual issues and other matters. Management
cannot predict the ultimate outcome of any pending or threatened litigation or
of actual or possible claims; however, management believes resulting
liabilities, if any, will not have a material adverse impact upon the Company's
financial position or results of operations. Refer to Note 13 of the Notes
to the Consolidated Financial Statements in the Company's 2001 Annual Report on
Form 10-K for further details regarding other commitments and contingencies.
NOTE 7 - DISCONTINUED OPERATIONS
In December 2001, the Company's board of directors approved a plan to redirect
the Company's business strategy, which includes the divestiture of its
engineering services business. The planned divestiture of the Company's
engineering services business has been accounted for as a discontinued operation
and, accordingly, the operating results and the estimated loss on the disposal
of this business segment are segregated and reported as discontinued operations
in the Consolidated Statements of Income, with prior years restated. In the
fourth quarter of 2001, the Company recorded a loss of $5.0 million, net of
income taxes, for the estimated loss the Company expects to incur on the
disposal of its engineering business segment including estimated losses from
operations during the phase-out period. As of September 30, 2002, no
adjustments to this estimated loss were required. See Note 8 for further
information regarding the sale of this business.
- 13 -
SEMCO ENERGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
NOTE 7 - DISCONTINUED OPERATIONS (CONTINUED)
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
----- ------- ----- -------- -------- --------
(in thousands)
CONSOLIDATED STATEMENTS OF INCOME DATA
Revenues . . . . . . . . . . . . . . . . . . . $ - $4,401 $ - $ 9,449 $ 2,798 $13,665
Operating expenses . . . . . . . . . . . . . . - 4,581 - 10,619 3,722 14,840
Operating income (loss). . . . . . . . . . . . - (180) - (1,170) (924) (1,175)
Other income (deductions). . . . . . . . . . . - (43) - 271 (13) 438
Income taxes . . . . . . . . . . . . . . . . . - (81) - (341) (353) (293)
----- ------- ----- -------- -------- --------
Income (loss) from discontinued operations . . $ - $ (142) $ - $ (558) $ (584) $ (444)
----- ------- ----- -------- -------- --------
Estimated loss on divestiture of discontinued
operations, including provisions for losses
during phase-out period, net of income
tax benefits of $2,429.. . . . . . . . . . . - - - - $(4,980) -
----- ------- ----- -------- -------- --------
September 30, December 31,
2002 2001
--------------- --------------
(in thousands)
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION DATA
Current assets . . . . . . . . . . . . . . . . . . $ 2,770 $ 4,050
Property, plant and equipment, net . . . . . . . . 205 250
Deferred charges and other assets, net . . . . . . 2 2
Current liabilities. . . . . . . . . . . . . . . . (3,954) (4,880)
Deferred credits and other liabilities . . . . . . - -
--------------- --------------
Net capital deficiency of discontinued operations
held for sale . . . . . . . . . . . . . . . . . $ (977) $ (578)
--------------- --------------
NOTE 8 - SUBSEQUENT EVENTS
The Company sold its engineering business effective November 1, 2002. This
business has been accounted for as a discontinued operation since December 2001
(See Note 7). The Company is currently evaluating the tax and other financial
aspects of the sale. Any required adjustments to the estimated loss, recorded
in December 2001, for the sale of this business, including the provision for
losses during phase-out, will be reflected in discontinued operations during the
fourth quarter of 2002. The Company expects that any adjustment will not be
material but cannot provide assurance of this until it has completed its
evaluation.
- 14 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
SEMCO Energy, Inc. and its subsidiaries (the "Company") had a net loss of
$7.0 million (or $0.38 per share) for the quarter ended September 30, 2002
compared to a net loss of $6.6 million (or $0.37 per share) for the quarter
ended September 30, 2001. All references to earnings per share in this
Management's Discussion and Analysis are on a diluted basis. For information
related to the calculation of diluted earnings per share, refer to Note 4 of the
Notes to the Consolidated Financial Statements. On a weather-normalized basis,
the net loss for the three months ended September 30, 2002 would have been
approximately $6.3 million (or $0.34 per share) compared to a net loss of
approximately $6.3 million (or $0.35 per share) for the same period of the prior
year.
The Company had net income of $4.4 million (or $0.24 per share) for the
nine months ended September 30, 2002 compared to a net loss of $.9 million (or
$0.05 per share) for the nine months ended September 30, 2001. On a
weather-normalized basis, the net income for the nine months ended September 30,
2002 would have been approximately $6.6 million (or $0.36 per share) compared to
net income of approximately $2.8 million (or $0.16 per share) for the same
period of the prior year.
The Company had a net loss of $1.1 million (or $0.06 per share) for the
twelve months ended September 30, 2002 compared to net income of $11.6 million
(or $0.61 per share) for the twelve months ended September 30, 2001. On a
weather-normalized basis, net income would have been approximately $2.8 million
(or $0.15 per share) for the twelve months ended September 30, 2002, compared to
net income of approximately $15.9 million (or $0.84 per share) for the same
period ended September 30, 2001. The results for the twelve months ended
September 30, 2002 also include several unusual items which reduced net income
by $10.6 million. The unusual items include losses from discontinued
operations, restructuring charges, asset impairments and other unusual items.
Refer to Management's Discussion and Analysis and Note 14 of the Notes to the
Consolidated Financial Statements in the Company's 2001 Annual Report on Form
10-K for further information regarding these unusual items.
The Company's largest business segment, natural gas distribution, is
seasonal in nature and depends on the winter months for the majority of its
operating revenue. As a result, a substantial portion of the Company's annual
income is earned during the first and fourth quarters of the year. In addition,
the Company's construction services business segment is also seasonal in nature
and earns most of its income during the summer and fall months and incurs losses
during the winter and spring months. Therefore, the Company's results of
operations for the three and nine months ended September 30, 2002 and 2001 are
not necessarily indicative of results for a full year.
- 15 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS (CONTINUED)
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ -------------------- --------------------
2002 2001 2002 2001 2002 2001
-------- -------- --------- --------- --------- ---------
(in thousands, except per share amounts)
Operating revenues. . . . . . . . . . . . . $72,693 $76,804 $334,704 $313,295 $467,232 $456,061
Restructuring & impairment charges. . . . - - - - 6,103 -
Other operating expenses. . . . . . . . . 73,039 75,866 296,090 281,346 410,074 393,814
-------- -------- --------- --------- --------- ---------
Operating income. . . . . . . . . . . . . . $ (346) $ 938 $ 38,614 $ 31,949 $ 51,055 $ 62,247
Other income & (deductions) . . . . . . . (7,257) (7,747) (21,374) (22,100) (28,720) (29,500)
Income tax (provision) credit . . . . . . 2,739 2,456 (6,428) (3,768) (9,239) (12,115)
-------- -------- --------- --------- --------- ---------
Income before dividends on trust preferred
securities & discontinued operations. . . $(4,864) $(4,353) $ 10,812 $ 6,081 $ 13,096 $ 20,632
Dividends on trust preferred
securities, net of income tax . . . . . (2,150) (2,150) (6,451) (6,451) (8,603) (8,594)
-------- -------- --------- --------- --------- ---------
Income (loss) from continuing operations. . $(7,014) $(6,503) $ 4,361 $ (370) $ 4,493 $ 12,038
Income (loss) from discontinued
operations, net of income taxes . . . . . - (142) - (558) (5,564) (444)
Net income (loss) available to common
shareholders. . . . . . . . . . . . . . . $(7,014) $(6,645) $ 4,361 $ (928) $ (1,071) $ 11,594
Earnings per share ("EPS"):
Basic . . . . . . . . . . . . . . . . . . $ (0.38) $ (0.37) $ 0.24 $ (0.05) $ (0.06) $ 0.64
Diluted . . . . . . . . . . . . . . . . . $ (0.38) $ (0.37) $ 0.24 $ (0.05) $ (0.06) $ 0.61
Average common shares outstanding . . . . . 18,519 18,109 18,422 18,076 18,365 18,069
Impact on net income of the following:
Colder (Warmer) than normal weather . . . $ (665) $ (394) $ (2,238) $ (3,728) $ (3,860) $ (4,337)
Income (Loss) from Discontinued
operations. . . . . . . . . . . . . . . - (142) - (558) (5,564) (444)
Reorganization charges, impairments
and other unusual items . . . . . . . . - - - - (5,083) -
Net income excluding the foregoing items. . $(6,349) $(6,109) $ 6,599 $ 3,358 $ 13,436 $ 16,375
EPS excluding the foregoing items:
Basic . . . . . . . . . . . . . . . . . . $ (0.34) $ (0.34) $ 0.36 $ 0.19 $ 0.73 $ 0.91
Diluted . . . . . . . . . . . . . . . . . $ (0.34) $ (0.34) $ 0.36 $ 0.19 $ 0.73 $ 0.86
The Company operates four reportable business segments: (1) gas
distribution; (2) construction services; (3) information technology services;
and (4) propane, pipelines and storage. The latter three segments are sometimes
referred to together as the "diversified businesses". Refer to Note 5 of the
Notes to the Consolidated Financial Statements for further information regarding
business segments and a summary of operating revenues and operating income by
business segment.
The business segment analyses and other discussions on the next several
pages provide additional information regarding variations in operating results
when comparing the three, nine and twelve-month periods ended September 30, 2002
to the same periods of the prior year. The Company evaluates the performance of
its business segments based on the operating income generated. Operating income
does not include income taxes, interest expense, discontinued operations or
other non-operating income and expense items. A review of the non-operating
items follows the business segment discussions.
- 16 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THE IMPACT OF WEATHER
The Company determines the impact of weather on its operating results by
comparing actual gas consumption per customer during a period to the average of
weather-normalized customer gas consumption during previous periods. The
difference is multiplied by the average number of customers during the period to
arrive at the total increase or decrease in consumption associated with weather.
The total increase or decrease in consumption is multiplied by the actual margin
per unit of consumption during the period to arrive at the impact of weather for
the period. The weather-normalized customer consumption used in this
calculation is determined by adjusting actual customer gas consumption during a
particular period by a ratio, the numerator of which is an average of degree
days during the same periods in the prior fifteen years, and the denominator of
which is the actual degree days for that period.
The Company determines the percent (%) that weather is warmer or colder
than normal for a particular period by computing the deviation of actual degree
days for that period from the average of degree days during the same period in
the prior fifteen years and dividing the deviation by such fifteen year average.
GAS DISTRIBUTION
The Company's gas distribution business segment consists of operations in
Michigan and Alaska. The Michigan operation is sometimes referred to as "SEMCO
Gas" and the Alaska operation is sometimes referred to as "ENSTAR". These
operations are referred to together as the "Gas Distribution Business".
The Gas Distribution Business had an operating loss of $.7 million for the
quarter ended September 30, 2002, compared to an operating loss of $2.2 million
for the quarter ended September 30, 2001. On a weather-normalized basis, the
Gas Distribution Business would have had operating income of approximately $.4
million for the third quarter of 2002 compared to an operating loss of
approximately $1.5 million for the same period of the prior year.
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
-------------------- -------------------- --------------------
2002 2001 2002 2001 2002 2001
--------- --------- --------- --------- --------- ---------
(dollars in thousands)
Gas sales revenues. . . . . . . . . . $ 34,616 $ 32,146 $ 220,708 $ 202,415 $ 313,689 $ 303,289
Cost of gas sold. . . . . . . . . . . 20,075 17,118 139,367 125,745 198,595 189,640
--------- --------- --------- --------- --------- ---------
Gas sales margin. . . . . . . . . . $ 14,541 $ 15,028 $ 81,341 $ 76,670 $ 115,094 $ 113,649
Gas transportation revenue. . . . . . 5,051 4,931 19,012 18,333 26,567 26,301
Other operating revenue . . . . . . . 807 576 2,561 2,331 3,311 3,732
--------- --------- --------- --------- --------- ---------
Gross margin. . . . . . . . . . . . $ 20,399 $ 20,535 $ 102,914 $ 97,334 $ 144,972 $ 143,682
Restructuring charges . . . . . . . . - - - - 1,051 -
Other operating expenses. . . . . . . 21,089 22,688 64,877 66,642 86,239 85,231
--------- --------- --------- --------- --------- ---------
Operating income. . . . . . . . . . . $ (690) $ (2,153) $ 38,037 $ 30,692 $ 57,682 $ 58,451
========= ========= ========= ========= ========= =========
Weather-normalized operating income . $ 355 $ (1,503) $ 41,452 $ 36,767 $ 63,417 $ 65,731
========= ========= ========= ========= ========= =========
Volumes of gas sold (MMcf). . . . . . 5,367 5,901 43,574 42,662 64,038 65,123
Volumes of gas transported (MMcf) . . 10,213 9,549 33,203 31,399 44,796 44,334
Number of customers at end of period. 377,845 369,231 377,845 369,231 377,845 369,231
Degree Days . . . . . . . . . . . . . 168 320 4,747 4,515 7,283 7,236
Percent colder (warmer) than normal . (32.5)% 3.6% (3.8)% (9.0)% (5.1)% (6.0)%
The amounts in the above table include intercompany transactions.
- 17 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GAS DISTRIBUTION (CONTINUED)
GAS SALES MARGIN - During the three months ended September 30, 2002, gas
sales margin decreased by $.5 million when compared to the same period in 2001.
The decrease is due primarily to warmer weather and lower gas cost savings,
partially offset by the addition of new customers and customers switching from
the Company's aggregated transportation service ("ATS") program back to gas
sales service.
During the nine months ended September 30, 2002, gas sales margin increased
by $4.7 million when compared to the same period in 2001. The increase is due
primarily to the impact of colder weather, increased gas cost savings, the
addition of new customers, and customers switching from the Company's aggregated
transportation service ("ATS") program back to gas sales service.
Weather during the third quarter of 2002 was 33% warmer than normal in
Michigan and Alaska combined, while the weather during the third quarter of 2001
was 4% colder than normal. However, in Alaska, weather was 5% warmer than
normal during the third quarter of 2001. Under normal weather conditions, gas
sales margin for the quarter ended September 30, 2002 would have been higher by
approximately $1.0 million and for the quarter ended September 30, 2001 would
have been higher by approximately $.7 million.
Weather during the nine months ended September 30, 2002 was 4% warmer than
normal in Michigan and Alaska combined, while the weather during the nine months
ended September 30, 2001 was 9% warmer than normal. Under normal weather
conditions, gas sales margin for the nine months ended September 30, 2002 would
have been higher by approximately $3.4 million and for the nine months ended
September 30, 2001 would have been higher by approximately $6.1 million.
Under the terms of certain of the Company's third-party natural gas supply
and management agreements for its Michigan operations, certain gas cost savings
are passed through to the Company. The decrease in gas cost savings during the
third quarter of 2002 was due primarily to reinstating the gas cost recovery
("GCR") mechanism, effective April 1, 2002, for Michigan customers subject to
the jurisdiction of the MPSC ("MPSC Customers"). As a result of reinstating the
GCR mechanism, the Company no longer retains the gas cost savings on sales to
MPSC Customers. The Company continues to retain any gas cost savings on sales
to customers subject to the jurisdiction of the City Commission of Battle Creek.
The increase in gas cost savings during the nine months ended September 30,
2002, the majority of which occurred in the first quarter of 2002, was due in
part to the effective management of the Company's gas supply under certain of
these agreements. In addition gas cost savings were lower during the first half
of 2001, compared to previous periods, as a result of purchasing gas with a
higher thermal content. A significant portion of the gas cost savings realized
during the first quarter of 2002 is non-recurring because it relates to MPSC
Customers. For further information regarding the Company's natural gas supply
and management agreements and the GCR mechanism, refer to Note 2 of the Notes to
Consolidated Financial Statements in the Company's 2001 Annual Report on Form
10-K.
The ATS program for residential customers, which was effective from April
1, 1999, through March 31, 2002, provided all Michigan residential customers the
opportunity to purchase their gas from a third-party supplier, while allowing
the Gas Distribution Business to continue charging the existing distribution
fees and customer fees. Distribution and customer fees associated with
customers who switched to third-party gas suppliers were recorded in gas
transportation revenue rather than gas sales revenue, because the Company acted
as a transporter for those customers. During 2001 and 2002 certain ATS
customers switched back to the Company's gas sales service because the
third-party suppliers they were utilizing stopped participating in the ATS
program, primarily due to a significant increase in the market price of natural
gas. In addition, when the ATS program for residential customers ended on March
31, 2002, all remaining ATS customers became gas sales customers.
- 18 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GAS DISTRIBUTION (CONTINUED)
Gas sales margin for the twelve months ended September 30, 2002 increased
by $1.4 million, when compared to the twelve months ended September 30, 2001.
The increase is due primarily to the impact of colder weather, the addition of
new customers, and customers switching from the Company's ATS program back to
gas sales service.
Weather during the twelve months ended September 30, 2002 was 5% warmer
than normal in Michigan and Alaska combined, while the weather during the twelve
months ended September 30, 2001 was 6% warmer than normal. Under normal weather
conditions, gas sales margin for the twelve months ended September 30, 2002 and
2001 would have been higher by approximately $5.7 million and $7.3 million,
respectively.
GAS TRANSPORTATION REVENUE - For the three, nine and twelve-month periods
ended September 30, 2002, gas transportation revenue increased by $.1 million,
$.7 million and $.3 million, respectively, when compared to the same periods
ended September 30, 2001. The primary cause of these increases was an increase
in industrial and commercial transportation volumes, as a result of cooler
weather in Alaska for the first three quarters of 2002, in comparison to the
same periods in 2001. This was offset partially by a decrease in transportation
volumes for power companies and the impact of ATS customers switching from the
ATS program back to gas sales service during each of the periods. As discussed
above, under the ATS program, the Company charged ATS customers the same
distribution fees and customer fees that were charged to gas sales service
customers.
OTHER OPERATING REVENUE - Other operating revenue for the three and
nine-month periods ended September 30, 2002, was $.8 million and $2.6 million,
respectively, compared to $.6 million and $2.3 million, respectively, for the
same periods ended September 30, 2001. The increases for the three and
nine-month periods were due primarily to fees on new transmission pipelines in
service, offset partially by a reduction in ATS balancing fees as a result of
ATS customers switching back to gas sales service. Other operating revenue for
the twelve months ended September 30, 2002 was $3.3 million, compared to $3.7
million for the twelve months ended September 30, 2001. The $.4 million
decrease was due primarily to a reduction in ATS balancing fees as a result of
ATS customers switching back to gas sales service, offset partially by an
increase in fees on new transmission pipelines in service.
OPERATING EXPENSES - Operating expenses of the Gas Distribution Business
decreased by $1.6 million and $1.8 million, respectively, for the three and
nine-month periods ended September 30, 2002. The decreases were the result of a
number of offsetting factors. Amortization expense decreased by $1.0 million
and $3.0 million, respectively, during the three and nine-month periods ended
September 30, 2002, when compared to the same periods in 2001. The decreases
were due to the elimination of goodwill amortization as a result of the adoption
of SFAS 142. For further information on SFAS 142 and its impact on goodwill,
see Note 1 of the Notes to the Consolidated Financial Statements. During the
three and nine-month periods ended September 30, 2002, operation and maintenance
expense decreased by $1.1 million and $.5 million due primarily to general cost
cutting measures and the impact of a reduction in workforce related to the
Company's redirected business strategy, offset partially by higher employee
benefit costs, including pension expense, health care costs and retiree medical
costs. During the three and nine-month periods ended September 30, 2002,
property and other taxes increased by $.1 million and $.3 million, respectively,
due primarily to property taxes on additional property, plant and equipment
placed in service. Depreciation expense also increased due primarily to
additional property, plant and equipment placed in service.
- 19 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GAS DISTRIBUTION (CONTINUED)
Operating expenses for the twelve months ended September 30, 2002 increased
by $2.1 million when compared to the twelve months ended September 30, 2001.
Included in this increase is approximately $1.1 million of restructuring charges
recorded in the fourth quarter of 2001. The remainder of the increase was
primarily the result of an increase in operation and maintenance expenses of
$2.0 million, an increase in general business tax expenses of $1.0 million and
an increase in depreciation expense of $1.0 million. The increase in operating
expenses is due largely to higher employee related costs, including pension
expense, health care costs and retiree medical costs, offset partially by the
cost cutting measures and the reduction in workforce discussed above. The
increase in general business tax expenses is due primarily to higher property
taxes related to new property placed in service. Depreciation expense increased
due to additional property, plant and equipment placed in service. These
increases were offset by a decrease in amortization expense of $3.0 million due
to the reasons discussed above.
REGULATORY MATTERS - The Regulatory Commission of Alaska ("RCA") has been
conducting a review of ENSTAR's rates. The Company received an Order dated
August 8, 2002 from the RCA on its review of rates for ENSTAR based on
normalized data for the year 2000. In its Order the RCA established a revenue
requirement of $107.6 million and a 12.55% return on equity. In response to a
petition by ENSTAR, the RCA issued an additional Order dated September 16, 2002
which revised the indicated annual revenue reduction from $2.1 million to $2.0
million, which was 1.84% of ENSTAR's revenue in the normalized 2000 test year.
The Order required ENSTAR to implement the rate reduction by September 27, 2002
on an across-the-board basis. The RCA also required ENSTAR to file an updated
cost of service study by September 9, 2002 and a rate design in February 2003,
with a hearing on the rate design filing scheduled for late summer 2003. ENSTAR
has implemented the rate reduction and filed the cost of service study as
required.
CONSTRUCTION SERVICES
The Company's Construction Services business ("Construction Services") is
seasonal. As a result, it generally incurs operating losses during the winter
and spring months when underground construction and related services are
inhibited by weather, and generates the majority of its operating income during
the summer and fall months.
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
------- ------- ------- ------- --------- --------
(in thousands)
Operating revenues. . . . . . . . . $33,868 $41,397 $95,973 $93,394 $128,784 $126,441
Restructuring & impairment charges. - - - - 3,098 -
Other operating expenses. . . . . . 33,290 37,844 94,766 90,837 128,411 121,041
------- ------- ------- ------- --------- --------
Operating income. . . . . . . . . . $ 578 $ 3,553 $ 1,207 $ 2,557 $ (2,725) $ 5,400
======= ======= ======= ======= ========= ========
Feet of pipe installed. . . . . . . 1,385 2,543 3,629 5,125 5,824 7,646
======= ======= ======= ======= ========= ========
The amounts in the above table include intercompany transactions.
- 20 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CONSTRUCTION SERVICES (CONTINUED)
OPERATING REVENUES - The operating revenues of Construction Services for
the three month period ended September 30, 2002 were $33.9 million, which
represents a $7.5 million decrease in comparison to the same period ended
September 30, 2001. The decrease was due primarily to customers in the northern
regions of the country cutting back or delaying projects this year in light of
uncertainty surrounding the economy and other factors. During the third quarter
of 2002, customers in the southern region of the country also delayed certain
large projects. The Company expects this trend to continue through the end of
2002.
The operating revenues of Construction Services for the nine and twelve
month periods ended September 30, 2002 were $96.0 million and $128.8 million,
respectively, which represent a $2.6 million and $2.3 million increase,
respectively, over the same periods ended September 30, 2001. These increases
are due primarily to an increase in construction projects in the southern
regions of the United States during the last half of 2001 and the first half of
2002. This was offset partially by reduced construction activity in the
northern regions of the country during 2002 and in the southern region during
the third quarter of 2002, as discussed above.
OPERATING INCOME - Construction Services had operating income of $.6
million and $1.2 million and an operating loss of $2.7 million, respectively,
for the three, nine and twelve-month periods ended September 30, 2002, compared
to operating income of $3.6 million, $2.6 million and $5.4 million,
respectively, for the three, nine and twelve-month periods ended September 30,
2001. These decreases were due primarily to the reduced construction activity,
particularly during the third quarter of 2002, and lower than expected margins
on some of the work performed. The Company believes that the softening economy
has caused many customers to delay or cancel certain construction projects,
which has changed the mix of work available to Construction Services. The mix
of work has included more lower-margin work at certain business units because of
the competition for the limited supply of available work. The reduced
construction activity has also eroded margins because of the time lag required
to reduce the fixed costs associated with the prior level of revenues. Certain
fixed costs also cannot be eliminated for a number of reasons, including the
expectation that work will resume on many of the projects. In addition, the
overall operating performance for the northern region of Construction Services
has been below the Company's expectations.
During the nine and twelve-month periods ended September 30, 2002, the
factors causing the decreases were offset partially by income generated from the
increase in construction projects in the southern regions of the United States
during the last half of 2001 and the first half of 2002. The decrease during
the twelve months ended September 30, 2002 was also due in part to restructuring
and impairment charges of $3.1 million recorded in the fourth quarter of 2001,
in addition to the factors discussed above.
- 21 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
INFORMATION TECHNOLOGY SERVICES
The information technology services business ("IT Services"), under the
Aretech Information Services name, provides IT infrastructure outsourcing
services and other IT services with a focus on mid-range computers, particularly
the IBM I-Series (AS-400) platform.
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
------ ------ ------ ------ ------ ------
(in thousands)
Operating revenues. . . . $2,510 $2,461 $7,088 $7,608 $9,753 $9,574
Restructuring charges . . - - - - 20 -
Other operating expenses. 2,462 2,344 6,721 7,255 9,289 9,021
------ ------ ------ ------ ------ ------
Operating income. . . . . $ 48 $ 117 $ 367 $ 353 $ 444 $ 553
====== ====== ====== ====== ====== ======
The amounts in the above table include intercompany transactions.
OPERATING REVENUES - Operating revenues for IT Services were $2.5 million
for both the three months ended September 30, 2002 and the three months ended
September 30, 2001. Of these amounts, $2.1 million and $2.2 million for these
same periods, respectively, represent sales to affiliates. Operating revenues
for IT Services for the nine months ended September 30, 2002 were $7.1 million
compared to $7.6 million in 2001. Of these amounts, $5.8 million and $7.1
million for these same periods, respectively, represent sales to affiliates.
The decrease in operating revenues of $.5 million for the nine month-period
ended September 30, 2002, when compared to the same period ended September 30,
2001,is due primarily to fewer special projects with affiliate customers offset
partially by an increase in business with non-affiliate customers.
Operating revenues for the twelve months ended September 30, 2002 were $9.8
million, compared to $9.6 million for the twelve months ended September 30,
2001. Of these amounts, $8.1 million and $9.4 million for these same periods,
respectively, represent sales to affiliates. The increase in operating revenues
of $.2 million for the twelve-month period ended September 30, 2002 is due
primarily to the addition of affiliate and non-affiliate customers offset
partially by fewer special projects with affiliate customers.
OPERATING INCOME - Operating income for the three months ended September
30, 2002, when compared to the same period ending September 30, 2001, decreased
by less than $.1 million. Operating income for IT Services for the nine months
ended September 30, 2002 was $.4 million, which is essentially unchanged from
the same period ending September 30, 2001. Operating income for the twelve
months ended September 30, 2002 decreased by $.1 million, compared to same
period ended September 30, 2001. This decrease is due primarily to more special
project services performed during the twelve-month period ended September 30,
2001. Special project services typically provide higher margins.
- 22 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
PROPANE, PIPELINES AND STORAGE
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
------ ------ ------ ------ ------ ------
(in thousands)
Operating revenues. . . $1,097 $1,289 $4,751 $5,407 $6,787 $7,786
Operating expenses. . . 870 1,018 3,534 4,054 5,052 5,900
------ ------ ------ ------ ------ ------
Operating income. . . . $ 227 $ 271 $1,217 $1,353 $1,735 $1,886
====== ====== ====== ====== ====== ======
OPERATING REVENUES - The operating revenues of the Company's propane,
pipelines and storage business for the three, nine and twelve-month periods
ended September 30, 2002 were $1.1 million, $4.8 million and $6.8 million,
respectively, compared to $1.3 million, $5.4 million and $7.8 million,
respectively, for the same periods ended September 30, 2001. The decreases for
the three, nine and twelve-month periods were due primarily to lower propane
distribution revenues resulting from warmer weather in the Company's propane
distribution service area and a reduction in the market price for propane.
OPERATING INCOME - Operating income from the propane, pipelines and storage
business for the third quarter of 2002 decreased by less than $.1 million when
compared to the same period in 2001. Operating income for the nine and twelve
month periods ended September 30, 2002, when compared to the same periods in
2001, decreased by approximately $.1 million. These decreases were due
primarily to warmer weather during the first and third quarters of 2002 and the
fourth quarter of 2001, which reduced propane sales and margins. This was
offset partially by the impact of colder weather during the second quarter of
2002.
OTHER INCOME AND DEDUCTIONS
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ -------------------- --------------------
2002 2001 2002 2001 2002 2001
-------- -------- --------- --------- --------- ---------
(in thousands)
Interest expense. . . . . . . . . . . $(7,951) $(8,092) $(23,102) $(23,810) $(31,076) $(32,315)
Other income. . . . . . . . . . . . . 694 345 1,728 1,710 2,356 2,815
-------- -------- --------- --------- --------- ---------
Total other income (deductions) . . $(7,257) $(7,747) $(21,374) $(22,100) $(28,720) $(29,500)
======== ======== ========= ========= ========= =========
INTEREST EXPENSE - Interest expense for the three, nine and twelve-month
periods ended September 30, 2002 decreased by $.1 million, $.7 million, and $1.2
million, respectively, when compared to the same periods ended September 30,
2001. The decrease in interest expense during the third quarter was due
primarily to income from an interest rate swap agreement which terminated in
August 2002. The decrease in interest expense for the nine and twelve-month
periods ended September 30, 2002 was due primarily to lower short-term interest
rates and income from the interest rate swap.
OTHER INCOME - Other income for the three months ended September 30, 2002
increased by $.4 million when compared to the same period ended September 30,
2001. The increase was due primarily to an engineering project performed by the
Gas Distribution business for a third party.
- 23 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OTHER INCOME AND DEDUCTIONS (CONTINUED)
Other income for the nine months ended September 30, 2002 was essentially
unchanged when compared to the same period ended September 30, 2001. The income
from the engineering project discussed above was offset by losses on the sale of
equipment and lower interest income.
The decrease of $.5 million during the twelve months ended September 30,
2002, when compared to the same period of 2001, was due to the previously
discussed factors affecting the nine months ended September 30, 2002, along with
a write-off of certain assets in the fourth quarter of 2001.
INCOME TAXES
Income taxes for the three and twelve-month periods ended September 30,
2002 decreased by $.3 million and $2.9 million, respectively, when compared to
the same periods ended September 30, 2001. Income taxes for the nine months
ended September 30, 2002 increased by approximately $2.7 million, when compared
to the same period ended September 30, 2001. The change in income taxes, when
comparing one period to another, is due primarily to changes in earnings before
income taxes and dividends on trust preferred securities and any adjustments
necessary for compliance with tax laws and regulations.
DIVIDENDS ON TRUST PREFERRED SECURITIES, NET OF INCOME TAX
Dividends on Trust Preferred Securities, net of Income taxes, for the
three, nine and twelve-month periods ended September 30, 2002 were essentially
unchanged at $2.2 million, $6.5 million and $8.6 million when compared to the
same periods ended September 30, 2001.
DISCONTINUED OPERATIONS
In December 2001, the Company began accounting for its engineering business
as a discontinued operation. This business was sold effective November 1, 2002.
Refer to Notes 7 and 8 of the Notes to the Consolidated Financial Statements for
more information.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS FROM INVESTING - The following table identifies capital
investments for the three and nine-month periods ended September 30, 2002 and
2001:
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2002 2001 2002 2001 2002 2001
------- ------- ------- ------- ------- -------
(in thousands)
Capital investments:
Property additions - gas distribution. . . . . . . . . $ 8,135 $11,152 $21,766 $28,820 $27,020 $38,447
Property additions - diversified businesses and other. 1,871 4,585 4,557 15,228 10,699 22,351
------- ------- ------- ------- ------- -------
$10,006 $15,737 $26,323 $44,048 $37,719 $60,798
======= ======= ======= ======= ======= =======
- 24 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
The Company's expenditures for property additions were approximately $26.3
million for the first nine months of 2002. Expenditures for property additions
during the remainder of 2002 are anticipated to be approximately $7.7 million.
CASH FLOWS FROM OPERATIONS - Net cash from operating activities for the
three, nine and twelve-month periods ended September 30, 2002, when compared to
the same periods of the prior year, increased by $2.5 million, decreased by $5.0
million and decreased by $9.1 million, respectively. The change in operating
cash flows is influenced significantly by changes in the level and cost of gas
in underground storage, changes in accounts receivable and accrued revenue and
other working capital changes. The changes in these accounts are largely the
result of the timing of cash receipts and payments.
CASH FLOWS FROM FINANCING - Net cash from financing activities during the
three, nine and twelve-month periods ended September 30, 2002 increased by $3.0
million, decreased by $10.7 million, and decreased by $8.1 million,
respectively, when compared to the same periods ended September 30, 2001.
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------- -------------------- --------------------
2002 2001 2002 2001 2002 2001
--------- -------- --------- --------- --------- ---------
(in thousands)
Cash provided by (used in) financing activities:
Issuance of common stock, net of expenses. . . . . . . . $ 852 $ 1,171 $ 2,796 $ 1,315 $ 3,917 $ 1,521
Issuance of trust preferred securities, net of expenses. - - - - - (83)
Issuance of long-term debt, net of expenses. . . . . . . 29,043 (152) 29,043 58,296 29,043 58,198
Repayment of long-term debt and related expenses . . . . (30,060) - (30,060) (10) (30,060) (60)
Net change in notes payable. . . . . . . . . . . . . . . 27,759 25,100 6,458 (37,691) 17,964 (27,661)
Payment of dividends on common stock . . . . . . . . . . (2,311) (3,796) (8,447) (11,380) (12,260) (15,170)
--------- -------- --------- --------- --------- ---------
$ 25,283 $22,323 $ (210) $ 10,530 $ 8,604 $ 16,745
========= ======== ========= ========= ========= =========
During September 2002, the Company issued $30 million of 6.49% unsecured
Senior Notes due 2009. Interest on the Senior Notes is payable semiannually.
The proceeds from the sale were used to redeem $30 million of 6.83% Senior
Notes, which matured on October 1, 2002.
In October 2002, the Company's Board of Directors declared a regular
quarterly cash dividend of $0.125 per share on the Company's common stock. The
dividend is payable on November 15, 2002 to shareholders of record at the close
of business on November 1, 2002.
FUTURE FINANCING - In general, the Company funds its capital expenditure
program and dividend payments with operating cash flows and the utilization of
its short-term credit facilities. When appropriate, the Company will refinance
its short-term debt with long-term debt, common stock or other long-term
financing instruments. On June 25, 2002, the Company entered into a $145
million credit agreement with a group of banks, replacing four lines of credit
totaling $145 million, which were due to expire. The new agreement, all of
which is committed, consists of an $80 million three-year revolver and a $65
million 364-day facility, with a one-year term loan option. On September 30,
2002, $31.6 million of the Company's credit facilities were unused.
- 25 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
In March 2000, a registration statement on Form S-3 ("registration
statement") filed by the Company and SEMCO Capital Trust I, SEMCO Capital Trust
II and SEMCO Capital Trust III ("Capital Trusts") with the Securities and
Exchange Commission became effective. On September 30, 2002, there was $134
million available under the Company's registration statement for any future
issuances of common stock, preferred stock, trust preferred securities and long
term debt.
The Company's long-term and short-term debt agreements contain restrictive
financial covenants including, among others, maintaining a Fixed Charges
Coverage Ratio (as defined in the agreements) of at least 1.50 and placing
limits on the payment of dividends beyond certain levels. Non-compliance with
these covenants could result in an acceleration of the due dates for the debt
obligations under the agreements. As of September 30, 2002, the Fixed Charges
Coverage Ratio was 1.8 and the Company was in compliance with all of the
covenants in these agreements. The Company has currently projected its
financial covenants for the remaining quarter during 2002, based on the
Company's forecasted operating results for the year, and these forecasted
results indicate that the Company will be able to remain in compliance with all
of its covenants during 2002. However, these projected results are based on a
number of assumptions and factors. If actual results differ from management's
current expectations, they could have an adverse impact on the Company's ability
to remain in compliance with its covenants during 2002. In the event the
Company is not able to remain in compliance with these covenants, management
plans to request a modification of the covenants or a waiver of certain covenant
provisions. For additional information concerning the factors impacting
compliance with the Company's debt covenants refer to the Management Discussion
and Analysis - Liquidity and Capital Resources section in the Company's 2001
Annual Report on Form 10-K.
The Company's ratio of earnings to fixed charges, as defined under Item 502
of SEC Regulation S-K, was 1.21 for the twelve months ended September 30, 2002.
If common stock of the Company had been issued in place of the FELINE PRIDES,
the ratio of earnings to fixed charges would have been 1.52. This ratio is more
strictly defined than the Fixed Charges Coverage Ratio used to determine
compliance with the Company's previously discussed debt covenants.
Two of the Company's securities, 10.1 million FELINE PRIDES securities and
$105 million of 8.95% Remarketable or Redeemable Securities ("ROARS") are
subject to remarketing, rate resets or possible redemption in 2003. These
securities are described in Note 5 of the Notes to the Consolidated Financial
Statements in the Company's 2001 Annual Report on Form 10-K.
Each FELINE PRIDE consist of a stock purchase contract of the Company and a
9% trust preferred security of SEMCO Capital Trust II with a stated face value
per security of $10 ("9% TPS"). Under the terms of each stock purchase
contract, the FELINE PRIDES holder is obligated to purchase, and the Company is
obligated to sell, a certain number of shares of Company common stock in August
2003. FELINE PRIDES holders can settle their obligation to purchase Company
common stock by paying cash or by having their 9% TPS remarketed in August 2003.
The distribution rate on the 9% TPS will also be reset in August 2003. However,
the Company may limit the reset rate to be no higher than the rate on the
two-year benchmark treasury plus 200 basis points.
In the case of FELINE PRIDES holders who decide to have their 9% TPS
remarketed, $10 of the proceeds from remarketing each 9% TPS will automatically
be applied to satisfy in full the obligation to purchase Company common stock
under the related stock purchase contract. If the remarketing agent is unable
to remarket the 9% TPS at the reset rate, as described above, the Company may
exercise its right as a secured party to dispose of the 9% TPS in accordance
with the provisions of the FELINE PRIDES, in order to satisfy any unfulfilled
obligation to purchase common stock under the related stock purchase contract.
- 26 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
In conjunction with the sale of the ROARS in June 2000, the Company entered
into a remarketing agreement with Banc of America Securities, LLC ("BAS") under
which BAS has the option to purchase all of the ROARS in July 2003, at 100% of
the aggregate principal amount of the ROARS. If BAS elects to purchase the
ROARS in July 2003 and the Company does not exercise its right to elect a
floating interest rate or its right to redeem the ROARS, both of which are
discussed below, BAS will remarket the ROARS at a new fixed interest rate. The
new fixed interest rate would be equal to the sum of 6.5% (the "Base Rate") and
an applicable spread. Under the terms of the ROARS, the applicable spread is
defined as the lowest bid received by BAS from various leading dealers of
publicly traded debt securities, expressed as a spread above the Base Rate and
based on a purchase price equal to the Dollar Price of the ROARS. The Dollar
Price of the ROARS is defined as the present value, at the remarketing date in
July 2003, of the remaining scheduled payments of principle and interest through
maturity in July 2008 calculated at the Base Rate, discounted to the remarketing
date in July 2003 using the rate on U.S. treasury securities with maturities
comparable to the remaining term of the ROARS.
If BAS elects to purchase the ROARS in July 2003, the Company will have the
right to elect that BAS remarket the ROARS for a period of up to one year using
a floating interest rate ("Floating Rate Period") rather than the fixed interest
rate described above. At the end of the Floating Rate Period, BAS can elect to
purchase the ROARS to remarket at a new fixed interest rate as described above.
If BAS elects to purchase the ROARS for remarketing in July 2003 or at the
end of the Floating Rate Period, the Company will also have the right to redeem
the ROARS directly from BAS at either time at the Dollar Price as defined above.
If BAS does not elect to purchase the ROARS in July 2003, the Company is
required to redeem all of the ROARS at that time at 100% of the aggregate
principal amount of the ROARS. If BAS does not elect to purchase the ROARS at
the end of the Floating Rate Period, the Company is required to redeem all of
the ROARS at the Dollar Price.
NEW ACCOUNTING STANDARDS
See Note 1 of the Notes to the Financial Statements, which is incorporated
herein by reference.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
- 27 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 4. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures - Within the 90 days prior to the date
of this report, the Company carried out an evaluation, under the supervision and
with the participation of management, including the Chief Executive Officer and
the Chief Financial Officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures. Based on the review of the
disclosure controls and procedures, the Chief Executive Officer and the Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to the material information
relating to the Company that is required to be included in the periodic SEC
filings.
Internal Controls and Procedures - There were no significant changes in
internal controls or in other factors that could significantly affect these
controls subsequent to the date of the Company's evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
- 28 -
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
During the third quarter of 2002, the Company issued an aggregate of
1,983 shares of unregistered common stock to the members of its Board of
Directors in exchange for services rendered, valued at $17,800.
The preceding transaction was exempt from registration under Section
4(2) of the Securities Act of 1933.
On June 25, 2002, the Registrant entered into a Credit Agreement
("Credit Agreement") with various financial institutions and Standard Federal
Bank N.A. as Agent and Arranger under which a line of credit (with a term loan
option) and a revolving credit facility (which includes letters of credit) were
made available to the Registrant. The Credit Agreement contains various
financial covenants including a minimum fixed charge coverage ratio, a maximum
leverage ratio, a minimum consolidated total capital amount, and a limitation on
the payment of dividends.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) List of Exhibits - (See page 33 for the Exhibit Index.)
12 Ratio of Earnings to Fixed Charges.
99.1 CEO Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 CFO Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K.
The Company filed the following Form 8-K Reports during the third
quarter of 2002: (1) report filed on August 14, 2002, to announce that the
Company's Alaska natural gas distribution unit had received an Order from the
Regulatory Commission of Alaska, and (2) report filed on September 19, 2002, to
file exhibits -- an Underwriting Agreement dated September 16, 2002 and Fourth
Supplemental Indenture dated as of September 19, 2002, both relating to 6.49%
Senior Notes Due 2009.
- 29 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SEMCO ENERGY, INC.
(Registrant)
Dated: November 13, 2002
By: /s/John E. Schneider
-------------------------------------
Senior Vice President and Principal
Financial Officer
- 30 -
CERTIFICATIONS
I, Marcus Jackson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SEMCO Energy, Inc.
(the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/Marcus Jackson
----------------------------------------
Marcus Jackson
Chairman of the Board, President and
Chief Executive Officer
SEMCO Energy, Inc.
- 31 -
CERTIFICATIONS (CONTINUED)
I, John E. Schneider, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SEMCO Energy, Inc.
(the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/John E. Schneider
----------------------------------------
John E. Schneider
Senior Vice President and
Chief Financial Officer
SEMCO Energy, Inc.
- 32 -
EXHIBIT INDEX
Form 10-Q
Third Quarter 2002
Exhibit
No. Description Filed Herewith
- -------- ----------- ---------------
12 Ratio of Earnings to Fixed Charges. x
99.1 CEO Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. x
99.2 CFO Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. x
- 33-