UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
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 [X] No [ ]
The number of outstanding shares of the Registrant's common stock as of April
30, 2003: 18,939,912
INDEX TO FORM 10-Q
------------------
For Quarter Ended March 31, 2003
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 . . . . . . . . . . . . . . . . . . . . . . . . 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 2. Changes in Securities and Use of Proceeds . . . . . . . . . . . . . . . 28
Item 4. Submission of Matters to a Vote of Securityholders. . . . . . . . . . . 28
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . 28
SIGNATURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
CERTIFICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
EXHIBIT INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 that are based on current
expectations, estimates and projections of SEMCO Energy, Inc. and its
subsidiaries (the "Company"). Statements that are not historical facts,
including without limitation, statements about the Company's outlook, beliefs,
plans, goals and expectations, are forward-looking statements. In addition,
these forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may", "will", "expect", "intend",
"estimate", "anticipate", "believe", or "continue" or the negatives of these
terms or variations of them or similar terminology. 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 regions
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 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 Twelve Months Ended
March 31, March 31,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
OPERATING REVENUES
Gas sales. . . . . . . . . . . . . . . . . . . . . . . . . $181,516 $122,223 $394,948 $295,596
Gas transportation . . . . . . . . . . . . . . . . . . . . 8,184 8,315 25,576 26,145
Construction services. . . . . . . . . . . . . . . . . . . 12,902 21,874 98,393 118,891
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . 4,502 3,499 13,241 11,124
--------- --------- --------- ---------
207,104 155,911 532,158 451,756
--------- --------- --------- ---------
OPERATING EXPENSES
Cost of gas sold . . . . . . . . . . . . . . . . . . . . . 137,159 78,783 278,798 183,173
Operations and maintenance . . . . . . . . . . . . . . . . 30,484 36,619 150,518 167,077
Depreciation and amortization. . . . . . . . . . . . . . . 9,073 8,761 35,649 36,281
Property and other taxes . . . . . . . . . . . . . . . . . 2,909 3,129 11,624 11,779
Restructuring and impairment charges . . . . . . . . . . . - - - 6,103
--------- --------- --------- ---------
179,625 127,292 476,589 404,413
--------- --------- --------- ---------
OPERATING INCOME . . . . . . . . . . . . . . . . . . . . . . 27,479 28,619 55,569 47,343
OTHER INCOME (DEDUCTIONS)
Interest expense . . . . . . . . . . . . . . . . . . . . . (7,957) (7,674) (31,551) (31,457)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . 698 325 2,611 1,794
--------- --------- --------- ---------
(7,259) (7,349) (28,940) (29,663)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND
DIVIDENDS ON TRUST PREFERRED SECURITIES. . . . . . . . . . 20,220 21,270 26,629 17,680
INCOME TAX PROVISION . . . . . . . . . . . . . . . . . . . . 7,396 7,790 9,745 7,464
--------- --------- --------- ---------
INCOME BEFORE DIVIDENDS ON TRUST
PREFERRED SECURITIES . . . . . . . . . . . . . . . . . . . 12,824 13,480 16,884 10,216
Dividends on trust preferred securities, net of
income taxes of $1,158, $1,158, $4,631 and $4,632. . . . . 2,150 2,150 8,601 8,603
--------- --------- --------- ---------
INCOME FROM CONTINUING OPERATIONS. . . . . . . . . . . . . . 10,674 11,330 8,283 1,613
DISCONTINUED OPERATIONS
Loss from engineering services operations, net of
income tax benefit of $0, $0, $0 and $432. . . . . . . . - - - (720)
Loss on divestiture of engineering services operations
including losses during phase-out period, net of income
tax benefit (expense) of $0, $0, ($1,276) and $2,429 . . - - 10 (4,980)
--------- --------- --------- ---------
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . $ 10,674 $ 11,330 $ 8,293 $ (4,087)
========= ========= ========= =========
EARNINGS PER SHARE - BASIC
Net income from continuing operations. . . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Net income (loss) available to common shareholders . . . . $ 0.57 $ 0.62 $ 0.45 $ (0.22)
EARNINGS PER SHARE - DILUTED
Net income from continuing operations. . . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Net income (loss) available to common shareholders . . . . $ 0.57 $ 0.62 $ 0.45 $ (0.22)
CASH DIVIDENDS PAID PER SHARE. . . . . . . . . . . . . . . . $ 0.125 $ 0.21 $ 0.50 $ 0.84
AVERAGE COMMON SHARES OUTSTANDING - BASIC. . . . . . . . . . 18,779 18,315 18,587 18,169
AVERAGE COMMON SHARES OUTSTANDING - DILUTED. . . . . . . . . 18,779 18,327 18,587 18,180
The accompanying condensed notes to the unaudited consolidated financial statements are an integral part
of these statements.
- 3 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
ASSETS
(Unaudited)
(In thousands)
March 31, December 31,
2003 2002
---------- -------------
CURRENT ASSETS
Cash and temporary cash investments, at cost. . . . . . . . . . . . $ 7,201 $ 1,813
Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . 1,216 1,212
Receivables, less allowances of $2,119 and $1,909 . . . . . . . . . 57,858 49,841
Accrued revenue . . . . . . . . . . . . . . . . . . . . . . . . . . 29,477 40,757
Gas in underground storage, at average cost . . . . . . . . . . . . 11,080 35,232
Prepaid expenses. . . . . . . . . . . . . . . . . . . . . . . . . . 17,188 23,449
Materials and supplies, at average cost . . . . . . . . . . . . . . 4,702 4,254
Gas charges recoverable from customers. . . . . . . . . . . . . . . 12,097 2,200
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,945 1,537
---------- -------------
142,764 160,295
PROPERTY, PLANT AND EQUIPMENT
Gas distribution. . . . . . . . . . . . . . . . . . . . . . . . . . 640,520 635,992
Diversified businesses and other. . . . . . . . . . . . . . . . . . 92,259 92,774
---------- -------------
732,779 728,766
Less - accumulated depreciation and impairments . . . . . . . . . . 215,919 207,635
---------- -------------
516,860 521,131
DEFERRED CHARGES AND OTHER ASSETS
Goodwill, less accumulated amortization and impairments of $17,764. 161,084 161,084
Deferred retiree medical benefits . . . . . . . . . . . . . . . . . 8,767 8,992
Unamortized debt expense. . . . . . . . . . . . . . . . . . . . . . 7,584 7,809
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,784 17,203
---------- -------------
198,219 195,088
---------- -------------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 857,843 $ 876,514
========== =============
The accompanying condensed notes to the unaudited consolidated financial statements are an
integral part of these statements.
- 4 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
LIABILITIES AND CAPITALIZATION
(Unaudited)
(In thousands)
March 31, December 31,
2003 2002
----------- --------------
CURRENT LIABILITIES
Notes payable . . . . . . . . . . . . . . . . . . . . . . . $ 84,650 $ 121,835
Accounts payable. . . . . . . . . . . . . . . . . . . . . . 47,688 38,148
Customer advance payments . . . . . . . . . . . . . . . . . 7,596 11,408
Accrued interest. . . . . . . . . . . . . . . . . . . . . . 9,304 7,598
Accumulated deferred income taxes . . . . . . . . . . . . . 1,879 1,879
Amounts payable to customers. . . . . . . . . . . . . . . . 2,221 1,073
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,484 19,194
----------- --------------
172,822 201,135
DEFERRED CREDITS AND OTHER LIABILITIES
Accumulated deferred income taxes . . . . . . . . . . . . . 33,115 33,043
Customer advances for construction. . . . . . . . . . . . . 14,951 15,841
Unamortized investment tax credit . . . . . . . . . . . . . 1,111 1,178
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,350 9,833
----------- --------------
60,527 59,895
LONG-TERM DEBT. . . . . . . . . . . . . . . . . . . . . . . . 365,760 366,026
COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST
PREFERRED SECURITIES OF SUBSIDIARIES HOLDING
SOLELY DEBT SECURITIES OF SEMCO ENERGY, INC.. . . . . . . . 139,446 139,436
COMMON SHAREHOLDERS' EQUITY
Common stock - $1 par value; 40,000,000 shares authorized;
18,894,821 and 18,682,027 shares outstanding. . . . . . . 18,895 18,682
Capital surplus . . . . . . . . . . . . . . . . . . . . . . 120,797 120,089
Accumulated other comprehensive income (loss) . . . . . . . (7,587) (7,597)
Retained earnings (deficit) . . . . . . . . . . . . . . . . (12,817) (21,152)
----------- --------------
119,288 110,022
----------- --------------
TOTAL LIABILITIES AND CAPITALIZATION. . . . . . . . . . . . . $ 857,843 $ 876,514
=========== ==============
The accompanying condensed notes to the unaudited consolidated financial statements are an
integral part of these statements.
- 5 -
SEMCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
(in thousands)
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
CASH FLOWS PROVIDED BY (USED FOR) OPERATING ACTIVITIES
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . $ 10,674 $ 11,330 $ 8,293 $ (4,087)
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . . 9,073 8,761 35,649 36,281
Depreciation and amortization in discontinued operations . . . - 99 126 454
Accumulated deferred income taxes and investment tax credit. . 5 186 3,335 4,620
Non-cash impairment charges and subsequent adjustment. . . . . - - (1,732) 7,679
Changes in assets and liabilities, net of effects of
acquisitions, divestitures and other changes as shown below. 28,972 8,307 (685) (32,032)
--------- --------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES . . . . . . . . 48,724 28,683 44,986 12,915
--------- --------- --------- ---------
CASH FLOWS PROVIDED BY (USED FOR) INVESTING ACTIVITIES
Property additions - gas distribution. . . . . . . . . . . . . . . (4,675) (7,007) (27,640) (33,187)
Property additions - diversified businesses and other. . . . . . . (344) (815) (4,534) (17,751)
Proceeds from property sales, net of retirement costs. . . . . . . 292 559 4,241 748
--------- --------- --------- ---------
NET CASH USED FOR INVESTING ACTIVITIES. . . . . . . . . . (4,727) (7,263) (27,933) (50,190)
--------- --------- --------- ---------
CASH FLOWS PROVIDED BY (USED FOR) FINANCING ACTIVITIES
Issuance of common stock, net of expenses. . . . . . . . . . . . . 940 1,247 3,335 3,680
Net change in notes payable. . . . . . . . . . . . . . . . . . . . (37,185) (19,831) (3,476) (15,288)
Issuance of long-term debt, net of expenses. . . . . . . . . . . . - - 28,990 58,296
Repayment of long-term debt. . . . . . . . . . . . . . . . . . . . (25) - (30,150) (10)
Payment of dividends on common stock . . . . . . . . . . . . . . . (2,339) (3,835) (9,280) (15,236)
--------- --------- --------- ---------
NET CASH PROVIDED BY (USED FOR)
FINANCING ACTIVITIES. . . . . . . . . . . . . . . . . . . (38,609) (22,419) (10,581) 31,442
--------- --------- --------- ---------
CASH AND TEMPORARY CASH INVESTMENTS
Net increase (decrease). . . . . . . . . . . . . . . . . . . . . . 5,388 (999) 6,472 (5,833)
Beginning of period. . . . . . . . . . . . . . . . . . . . . . . . 1,813 1,728 729 6,562
--------- --------- --------- ---------
End of period. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,201 $ 729 $ 7,201 $ 729
========= ========= ========= =========
CHANGES IN ASSETS AND LIABILITIES, NET OF EFFECTS OF
ACQUISITIONS, DIVESTITURES AND OTHER CHANGES:
Restricted cash. . . . . . . . . . . . . . . . . . . . . . . $ (4) $ - $ (1,216) $ -
Receivables, net . . . . . . . . . . . . . . . . . . . . . . (8,017) 758 5,603 (15,426)
Accrued revenue. . . . . . . . . . . . . . . . . . . . . . . 11,280 5,265 (1,589) (4,302)
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . 6,260 7,531 (2,444) (355)
Materials, supplies and gas in underground storage . . . . . 23,704 7,357 (5,150) (3,193)
Gas charges recoverable from customers . . . . . . . . . . . (9,898) 216 (10,320) 694
Accounts payable . . . . . . . . . . . . . . . . . . . . . . 9,540 (6,767) 24,045 (4,008)
Customer advances and amounts payable to customers . . . . . (3,554) (4,848) (925) 2,748
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . (339) (1,205) (8,689) (8,190)
--------- --------- --------- ---------
$ 28,972 $ 8,307 $ (685) $(32,032)
========= ========= ========= =========
The accompanying condensed notes to the unaudited consolidated financial statements are an integral part of
these statements.
- 6 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 2002 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.
USE OF ESTIMATES - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
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.
GOODWILL - Goodwill represents the excess of purchase price and related
costs over the value assigned to the net tangible assets of businesses acquired.
The Company accounts for Goodwill under the provisions of Statement of Financial
Accounting Standard ("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. In
conjunction with the requirements of these Statements, the Company ceased
Goodwill amortization effective January 1, 2002.
The Company is also required to perform impairment tests annually on the
remaining goodwill balance 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 2002 annual impairment tests were performed for the Company's
business units and the results of those tests indicated that there was no
impairment of Goodwill. The 2003 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 March 31, 2003 when compared to December 31,
2002. The 2003 annual impairment tests for the remaining business units will be
conducted during the fourth quarter of 2003.
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.
- 7 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------ -------------------
2003 2002 2003 2002
------- ------- ------ --------
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
Reported net income from continuing operations. . . . . . . $10,674 $11,330 $8,293 $ 1,613
Discontinued operations . . . . . . . . . . . . . . . . . . - - 10 (5,700)
------- ------- ------ --------
Reported net income (loss) available to common shareholders 10,674 11,330 8,303 (4,087)
Add back: Goodwill amortization, net of income taxes. . . . - - - 2,106
------- ------- ------ --------
Adjusted net income (loss) available to common shareholders $10,674 $11,330 $8,303 $(1,981)
------- ------- ------ --------
ADJUSTED EARNINGS PER SHARE - BASIC
Reported net income from continuing operations. . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Discontinued operations . . . . . . . . . . . . . . . . . . - - - (0.31)
------- ------- ------ --------
Reported net income (loss) available to common shareholders 0.57 0.62 0.45 (0.22)
Add back: Goodwill amortization, net of income taxes. . . . - - - 0.12
------- ------- ------ --------
Adjusted net income (loss) available to common shareholders $ 0.57 $ 0.62 $ 0.45 $ (0.10)
------- ------- ------ --------
ADJUSTED EARNINGS PER SHARE - DILUTED
Reported net income from continuing operations. . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Discontinued operations . . . . . . . . . . . . . . . . . . - - - (0.31)
------- ------- ------ --------
Reported net income (loss) available to common shareholders 0.57 0.62 0.45 (0.22)
Add back: Goodwill amortization, net of income taxes. . . . - - - 0.12
Adjusted net income (loss) available to common shareholders $ 0.57 $ 0.62 $ 0.45 $ (0.10)
------- ------- ------ --------
COMPREHENSIVE INCOME - The Company's comprehensive income (loss) for the
three months and twelve months ended March 31, 2003 and March 31, 2002 is
summarized in the following table.
Three months ended Twelve months ended
March 31, March 31,
------------------ -------------------
2003 2002 2003 2002
------- ------- -------- --------
(in thousands)
Net income (loss) available to common
shareholders. . . . . . . . . . . . . . . . . . . . . . $10,674 $11,330 $ 8,293 $(4,087)
Minimum pension liability adjustment, net of
income tax benefits of $2,922 and $781. . . . . . . . . - - (5,427) (1,452)
Unrealized derivative gain (loss) on interest rate hedge
from an investment in an affiliate. . . . . . . . . . . 10 139 (103) (605)
------- ------- -------- --------
Total other comprehensive income (loss) . . . . . . . . . $10,684 $11,469 $ 2,763 $(6,144)
======= ======= ======== ========
STOCK BASED COMPENSATION - The Company accounts for all stock options under
the provisions and related interpretations of Accounting Principles Board
("APB") Opinion 25, "Accounting for Stock Issued to Employees." In accordance
with SFAS 123, "Accounting for Stock-Based Compensation," the Company has chosen
to continue accounting for these transactions under APB 25 for purposes of
determining net income and to present the pro forma disclosures required by SFAS
123 as amended by SFAS 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure." If compensation expense had been determined in a
manner consistent with the provisions of SFAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated in
the table below.
- 8 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------ -------------------
YEARS ENDED DECEMBER 31, 2003 2002 2003 2002
- ---------------------------------------- ------- ------- ------ --------
(000's)
NET INCOME (LOSS), AS REPORTED . . . . . $10,674 $11,330 $8,293 $(4,087)
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects . . 103 91 419 358
------- ------- ------ --------
PRO FORMA NET INCOME (LOSS). . . . . . . $10,571 $11,239 $7,874 $(4,445)
------- ------- ------ --------
EARNINGS PER SHARE - BASIC
As reported . . . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ (0.22)
Pro forma . . . . . . . . . . . . $ 0.56 $ 0.61 $ 0.43 $ (0.24)
EARNINGS PER SHARE - DILUTED
As reported . . . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ (0.22)
Pro forma . . . . . . . . . . . . $ 0.56 $ 0.61 $ 0.43 $ (0.24)
NEW ACCOUNTING STANDARDS - On January 1, 2003 the Company adopted FASB
issued SFAS 143, "Accounting for Asset Retirement Obligations." 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 adopted SFAS 143 on January 1, 2003 and has determined that it
does not have any asset retirement obligations (ARO) that are to be recorded in
accordance with SFAS 143. However, the Company does have non-ARO negative
salvage value that is recorded in the accumulated depreciation of its gas
distribution business. The non-ARO negative salvage value is recognized as a
component of depreciation expense when the Company receives amounts in its gas
distribution customer rates for estimated future removal costs related to its
regulated gas distribution infrastructure. The Company reflects these amounts
in its accumulated depreciation accounts in accordance with industry practice.
As of March 31, 2003, the non-ARO negative salvage included in accumulated
depreciation was approximately $49.4 million.
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.
- 9 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 adoption of SFAS 145 and SFAS 146 did not have a material impact on the
Company's financial statements. However, the provisions of SFAS 145 discussed
above will impact any debt extinguishments the Company may have in the future.
In November 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123." SFAS 148 amends SFAS No. 123 "Accounting for Stock-Based Compensation,"
to provide alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation. In addition,
SFAS 148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both the annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the method
used on reported results. The disclosure requirements apply to all companies
for fiscal years ending after December 15, 2002. The interim disclosure
provisions are effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002. The Company continues to
account for all stock options under the provisions and related interpretations
of APB 25 with reporting disclaimers provided by SFAS 148. The adoption of the
disclosure provisions of SFAS 148 did not to have a material impact on the
Company's consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan guarantees
and standby letters of credit. It also clarifies that at the time a company
issues a guarantee, the company must recognize an initial liability for the fair
value, or market value of the obligations it assumes under the guarantee and
must disclose that information in its interim and annual financial statements.
The provisions of FIN 45 related to recognizing a liability at inception of the
guarantee do not apply to product warranties or guarantees accounted for as
derivatives. The initial recognition and initial measurement provisions of FIN
45 apply on a prospective basis to guarantees issued or modified after December
31, 2002. The disclosure provisions were effective for financial statements for
periods ending after December 15, 2002. The adoption of the recognition and
measurement provisions of FIN 45 on January 1, 2003 did not have a material
impact on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities an Interpretation of ARB No. 51" ("FIN 46"). The
adoption of FIN 46 did not have an impact on the Company's financial statements
because the Company does not have any variable interest entities.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS 149 clarifies under what
circumstances a contract with an initial net investment meets the characteristic
of a derivative and when a derivative contains a financing component. This
Statement also amends the definition of an underlying to conform it to language
used in FIN 45 and certain other existing pronouncements. SFAS 149 is effective
for contracts entered into or modified after June 30, 2003. In addition, all
provisions of this Statement should be applied prospectively except that: a) the
provisions of this Statement that relate to SFAS 133 implementation issues that
have been effective for fiscal quarters that began prior to June 30, 2003,
should continue to be applied in accordance with their respective effective
dates and b) provisions related to forward purchases or sales of when-issued
securities or securities that do not yet exist, should be applied to both
existing contracts and new contracts entered into after June 30, 2003. The
Company does not believe that the adoption of SFAS 149 will have a material
impact on its financial condition and results of operation.
- 10 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 2 - SHORT-TERM BORROWINGS AND CAPITALIZATION
SHORT-TERM BORROWINGS - The Company has a $145 million credit agreement
with a group of banks, all of which is committed, consisting of an $80 million
three-year revolver and a $65 million 364-day facility, with a one-year term
loan option. On March 31, 2003, $60.7 million of these credit facilities was
unused. The Company is currently in the process of negotiating an increase in
and an amendment to its credit facilities to permit an offering of additional
debt securities as well as to provide an extension on its existing $65 million
364-day bank facility currently scheduled to mature on June 24, 2003.
COMMON STOCK EQUITY - On April 15, 2003, 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 May 15, 2003 to shareholders of record at the
close of business on May 1, 2003.
NOTE 3 - RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
In February 2003, 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"). During the first quarter of 2003, the Company issued
approximately 172,000 shares of Company common stock to meet the dividend
reinvestment and stock purchase requirements of its DRIP participants. Also
during the first quarter of 2003, the Company issued approximately 41,000 shares
of its common stock to certain of the Company's employee benefit plans.
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. For derivatives designated as cash flow hedges,
changes in fair value are recorded in other comprehensive income for the portion
of the change in value of the derivative that is effective.
An affiliate, in which the Company has a 50% ownership interest, uses a
floating to fixed interest rate swap agreement to hedge the variable interest
rate payments on a portion of its long-term debt. This swap is designated as a
cash flow hedge and the difference between the amounts paid and received under
the swap is recorded as an adjustment to interest expense over the term of the
agreement. The Company's share of changes in the fair value of the swap are
recorded in accumulated other comprehensive income until the swap is terminated.
As a result of this interest rate swap agreement, the Company's Consolidated
Statements of Financial Position, at March 31, 2003 and December 31, 2002,
reflected a $.7 million reduction in the Company's equity investment in the
affiliate and in accumulated other comprehensive income.
- 11 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 4 - EARNINGS PER SHARE
The computations of basic and diluted earnings per share for the three and
twelve months ended March 31, 2003 and 2002 are as follows (in thousands except
per share amounts):
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------ -------------------
2003 2002 2003 2002
------- ------- ------- --------
EARNINGS PER SHARE COMPUTATION
Income from continuing operations . . . . . . . . . $10,674 $11,330 $ 8,283 $ 1,613
Discontinued operations (a) . . . . . . . . . . . . - - 10 (5,700)
------- ------- ------- --------
Net income (loss) available to common shareholders. $10,674 $11,330 $ 8,293 $(4,087)
------- ------- ------- --------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING. . . . . . . . . 18,779 18,315 18,587 18,169
------- ------- ------- --------
EARNINGS PER SHARE - BASIC
Income from continuing operations . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Discontinued operations (a) . . . . . . . . . . . . - - - (0.31)
------- ------- ------- --------
Net income (loss) available to common shareholders. $ 0.57 $ 0.62 $ 0.45 $ (0.22)
------- ------- ------- --------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING. . . . . . . . . 18,779 18,315 18,587 18,169
Incremental shares from assumed conversions of:
FELINE PRIDES - stock purchase contracts (b). . . - - - -
Stock options . . . . . . . . . . . . . . . . . . - 12 - 11
------- ------- ------- --------
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (B). . . 18,779 18,327 18,587 18,180
------- ------- ------- --------
EARNINGS PER SHARE - DILUTED
Income from continuing operations . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Discontinued operations (a) . . . . . . . . . . . . - - - (0.31)
------- ------- ------- --------
Net income (loss) available to common shareholders. $ 0.57 $ 0.62 $ 0.45 $ (0.22)
------- ------- ------- --------
(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 Operations.
(b) The FELINE PRIDES were not included in the computation of diluted earnings per share for
the three months and twelve months period ending March 31, 2002 because their effect was
antidilutive.
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 segments, refer to Note 11 of the Notes
to the Consolidated Financial Statements in the Company's 2002 Annual Report on
Form 10-K.
- 12 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 5 - BUSINESS SEGMENTS (CONTINUED)
The Company's gas distribution segment distributes and transports natural
gas to approximately 273,000 customers in the state of Michigan and
approximately 112,000 customers in the state of Alaska. The construction
services segment ("Construction Services") currently conducts most of its
business in the mid-western, southern and southeastern areas of the United
States. Its primary service is the installation and upgrade of compressor
stations and underground natural gas mains and service lines. The information
technology 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 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 11 of the Notes to the Consolidated Financial
Statements in the Company's 2002 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 Twelve Months Ended
March 31, March 31,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(in thousands)
OPERATING REVENUES
Gas distribution . . . . . . . . $190,812 $131,452 $424,071 $324,848
Construction services. . . . . . 15,112 25,581 108,785 133,938
Information technology services. 2,154 2,261 9,511 10,326
Propane, pipelines and storage . 2,827 2,238 7,647 6,932
Corporate and other (a). . . . . (3,801) (5,621) (17,856) (24,288)
Total operating revenues . . . $207,104 $155,911 $532,158 $451,756
========= ========= ========= =========
OPERATING INCOME (LOSS)
Gas distribution . . . . . . . . $ 30,533 $ 30,192 $ 59,417 $ 52,570
Construction services. . . . . . (3,640) (1,310) (4,329) (611)
Information technology services. 220 176 646 455
Propane, pipelines and storage . 898 609 2,235 1,744
Corporate and other. . . . . . . (532) (1,048) (2,400) (6,815)
Total operating income . . . . $ 27,479 $ 28,619 $ 55,569 $ 47,343
========= ========= ========= =========
(a) Includes the elimination of intercompany construction services revenue
of $2,211,000 and $10,400,000 for the three and twelve months ended March 31,
2003, respectively, and $3,707,000 and $15,048,000 for the three and twelve
months ended March 31, 2002, respectively. Also includes the elimination of
intercompany information technology services revenue of $1,549,000 and
$7,299,000 for the three and twelve months ended March 31, 2003, respectively,
and $1,870,000 and $9,110,000 for the three and twelve months ended March 31,
2002, respectively.
- 13 -
SEMCO ENERGY, INC.
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(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
and one other site. The Company has closed a related site with the approval of
the appropriate environmental regulatory authority in the State of Michigan and
has developed plans and conducted preliminary field investigations at two other
sites. The Company is in the process of estimating its liabilities and
potential costs in connection with these sites, but the scope of the Company's
liabilities has not been finally determined. 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.
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. Notwithstanding the above
statement, in late March 2003 the Company was served a complaint in a putative
class-action lawsuit alleging that the approximately 30 defendants, including
SEMCO Energy and SEMCO Energy Ventures, Inc., engaged in practices that violated
the Sherman Anti-Trust Act and tortuously interfered with the business of the
plaintiffs. The Company is considering potential legal and factual defenses to
these claims and intends to vigorously defend itself in this action. Although
the Company cannot make assurances, management believes that this suit will not
have a material adverse effect on its business or results of operations. Refer
to Note 13 of the Notes to the Consolidated Financial Statements in the
Company's 2002 Annual Report on Form 10-K for further details regarding other
commitments and contingencies.
NOTE 7 - SUBSEQUENT EVENTS
REGULATORY MATTERS - On May 2, 2003, the Michigan Public Service Commission
("MPSC") approved a settlement agreement, authorizing the Company to implement
revised rates for the sale and transportation of natural gas and to revise its
depreciation rates and practices. The settlement establishes a revenue
requirement of $71.9 million based on a 2003 projected test year and an increase
in the return on its common equity from 10.75% to 11.40%. The settlement also
provides for a) the elimination of the reverse taper incentive mechanism so that
the Company is no longer required to refund revenues to customers above the
return on common equity, b) no potential refund to customers for property tax
expense based on lower state property tax tables and c) an increase in the
monthly service charge from $7.00 to $9.50 per month for residential customers.
The new authorized rates, which became effective May 3, 2003, are expected to
increase annual revenue by $3.4 million and decrease annual depreciation expense
by $1.4 million.
- 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 net income of
$10.7 million (or $0.57 per share) for the quarter ended March 31, 2003 compared
to net income of $11.3 million (or $0.62 per share) for the quarter ended March
31, 2002. 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 Condensed Notes to the
Unaudited Consolidated Financial Statements.
The Company had net income of $8.3 million (or $0.45 per share) for the
twelve months ended March 31, 2003 compared to a net loss of $4.1 million (or
$0.22 per share) for the twelve months ended March 31, 2002. The results for
the twelve months ended March 31, 2002 also include several unusual items, which
reduced net income by $10.8 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 2002 Annual
Report on Form 10-K for further information regarding these unusual items.
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
Condensed Notes to the Unaudited Consolidated Financial Statements for further
information regarding business segments and a summary of operating revenues and
operating income by business segment.
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 months ended March 31, 2003 and 2002 are not
necessarily indicative of results for a full year.
The business segment analyses and other discussions on the next several
pages provide additional information regarding variations in operating results
when comparing the three and twelve-month periods ended March 31, 2003 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.
- 15 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
RESULTS OF OPERATIONS (CONTINUED)
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(in thousands, except per share amounts)
Operating revenues. . . . . . . . . . . . . . . . . $207,104 $155,911 $532,158 $451,756
Restructuring & impairment charges. . . . . . . . - - - 6,103
Other operating expenses. . . . . . . . . . . . . 179,625 127,292 476,589 398,310
--------- --------- --------- ---------
Operating income. . . . . . . . . . . . . . . . . . $ 27,479 $ 28,619 $ 55,569 $ 47,343
Other income & (deductions) . . . . . . . . . . . (7,259) (7,349) (28,940) (29,663)
Income tax (provision) credit . . . . . . . . . . (7,396) (7,790) (9,745) (7,464)
--------- --------- --------- ---------
Income before dividends on trust preferred
securities & discontinued operations. . . . . . . $ 12,824 $ 13,480 $ 16,884 $ 10,216
Dividends on trust preferred
securities, net of income tax . . . . . . . . . (2,150) (2,150) (8,601) (8,603)
--------- --------- --------- ---------
Income from continuing operations . . . . . . . . . $ 10,674 $ 11,330 $ 8,283 $ 1,613
Income (loss) from discontined
operations, net of income taxes . . . . . . . . . - - 10 (5,700)
Net income (loss) available to common shareholders. $ 10,674 $ 11,330 $ 8,293 $ (4,087)
Earnings per share - basic
Income from continuing operations . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Net income (loss) available to
common shareholders . . . . . . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ (0.22)
Earnings per share - diluted
Income from continuing operations . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ 0.09
Net income (loss) available to
common shareholders . . . . . . . . . . . . . . $ 0.57 $ 0.62 $ 0.45 $ (0.22)
Cash dividends paid per share . . . . . . . . . . . $ 0.13 $ 0.21 $ 0.50 $ 0.84
Average common shares outstanding
Basic . . . . . . . . . . . . . . . . . . . . . . 18,779 18,315 18,587 18,169
Diluted . . . . . . . . . . . . . . . . . . . . . 18,779 18,327 18,587 18,180
THE IMPACT OF WEATHER
The Company's largest business segment is natural gas distribution and, as
a result, temperature fluctuations have a significant impact on operating
results. The Company believes that information about the estimated impact on
operating results of warmer or colder than normal temperatures is useful for
fully understanding the Company's gas distribution business. For further
information about the estimated impact of warmer or colder than normal weather
and how such information is calculated, refer to the Management's Discussion and
Analysis - Results of Operations section in the Company's 2002 Annual Report on
Form 10-K.
- 16 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
THE IMPACT OF WEATHER (CONTINUED)
Temperatures in Michigan for the three months ended March 31, 2003 were
colder than normal by 10.9%. By comparison, temperatures in Michigan for the
three months ended March 31, 2002 were warmer than normal by 8.0%. The Company
has estimated that the colder than normal weather in Michigan increased the gas
sales margin of its gas distribution business by approximately $2.4 million for
the three months ended March 31, 2003, while the warmer than normal weather for
the three months ended March 31, 2002 reduced gas sales margin by approximately
$2.7 million. Adjusted for income taxes, the estimated increase would have been
approximately $1.6 million for the three months ended March 31, 2003, compared
to an estimated decrease of $1.8 million for the three months ended March 31,
2002.
Temperatures in Alaska for the three months ended March 31, 2003 were
warmer than normal by 13.8%. By comparison, temperatures in Alaska were 4.7%
warmer than normal during the first quarter of 2002. The Company has estimated
that warmer than normal weather in Alaska reduced the gas sales margin of its
gas distribution business by approximately $2.4 million for the three months
ended March 31, 2003, compared to $1.0 million for the three months ended March
31, 2002. Adjusted for income taxes, the estimated impact would have been
approximately $1.4 million for the three months ended March 31, 2003, compared
to $.6 million for the three months ended March 31, 2002.
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."
- 17 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
GAS DISTRIBUTION (CONTINUED)
Operating income for the Gas Distribution Business was $30.5 million for
the quarter ended March 31, 2003, compared to operating income of $30.2 million
for the quarter ended March 31, 2002.
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(dollars in thousands)
Gas sales revenues. . . . . . . . . . $181,516 $ 122,223 $394,948 $295,596
Cost of gas sold. . . . . . . . . . . 137,159 78,783 278,798 183,173
--------- --------- --------- ---------
Gas sales margin. . . . . . . . . . $ 44,357 $ 43,440 $116,150 $112,423
Gas transportation revenue. . . . . . 8,184 8,315 25,576 26,145
Other operating revenue . . . . . . . 1,112 914 3,547 3,107
--------- --------- --------- ---------
Gross margin. . . . . . . . . . . . $ 53,653 $ 52,669 $145,273 $141,675
Restructuring charges . . . . . . . . - - - 1,051
Other operating expenses. . . . . . . 23,120 22,477 85,856 88,054
--------- --------- --------- ---------
Operating income. . . . . . . . . . . $ 30,533 $ 30,192 $ 59,417 $ 52,570
========= ========= ========= =========
Volumes of gas sold (MMcf). . . . . . 29,760 26,562 68,255 62,734
Volumes of gas transported (MMcf) . . 12,916 12,051 45,786 42,471
Number of customers at end of period. 385,508 377,550 385,508 377,550
Degree Days
Alaska. . . . . . . . . . . . . . . 3,431 3,809 9,014 10,413
Michigan. . . . . . . . . . . . . . 3,606 3,004 7,270 5,883
Percent colder (warmer) than normal
Alaska. . . . . . . . . . . . . . . (13.8)% (4.7)% (11.3)% .7%
Michigan. . . . . . . . . . . . . . 10.9% (8.0)% 8.3% (13.3)%
The amounts in the above table include intercompany transactions.
GAS SALES MARGIN - During the three months ended March 31, 2003, gas sales
margin increased by $.9 million when compared to the same period in 2002. The
increase was due primarily to the addition of new customers, the impact of
colder temperatures, and customers switching from the Company's aggregated
transportation service ("ATS") program back to gas sales service, offset
partially by the impact of a reduction in customer rates at ENSTAR effective in
September 2002, an increase in the amount of unaccounted-for gas and a decrease
in gas cost savings.
During the twelve months ended March 31, 2003, gas sales margin increased
by $3.7 million when compared to the same period in 2002. The increase was due
primarily to the same items that contributed to the variances in quarterly
results, as discussed above.
- 18 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
GAS DISTRIBUTION (CONTINUED)
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. One such contract expired on March 31, 2002
and was not renewed. As a result, a large portion of the gas cost savings
realized during the first quarter of 2002 was non-recurring.
The reduction in customer rates at ENSTAR was required by an Order issued
by the Regulatory Commission of Alaska ("RCA"). The RCA Order was based on an
RCA rate review. The rate reduction took effect in September 2002 and generally
reduces gas sales margins at ENSTAR by approximately 3.6%.
The ATS program for residential customers was effective from April 1, 1999
through March 31, 2002. A program similar to the ATS program, referred to as
the Gas Customer Choice program, was opened to customers on October 1, 2002.
These programs provide Michigan residential customers the opportunity to
purchase their gas from a third-party supplier, while allowing the Gas
Distribution Business to continue charging the existing distribution fees and
customer fees. Distribution and customer fees associated with customers who
switched to third-party gas suppliers were recorded in gas transportation
revenue rather than gas sales revenue because the Company acted as a transporter
for those customers. During 2001 and 2002, certain ATS customers switched back
to the Company's gas sales service because the third-party suppliers they were
utilizing stopped participating in the ATS program primarily due to significant
fluctuations in the market price of natural gas. When the ATS program for
residential customers ended on March 31, 2002, all remaining ATS customers
became gas sales customers because they were turned back to the Company by their
third-party gas suppliers. Currently, there are no third-party gas suppliers
providing service under this program in the Company's customer service
territories.
GAS TRANSPORTATION REVENUE - For the three-month period ended March 31,
2003, gas transportation revenue decreased by $.1 million when compared to the
three months ended March 31, 2002. Gas transportation revenue decreased by $.6
million for the twelve months ended March 31, 2003, when compared to the same
period ended March 31, 2002. The primary cause of the decreases was the impact
of ATS customers switching from the ATS program back to gas sales service in
Michigan 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. Also contributing to these
decreases, was a reduction in transportation volumes for power companies in
Alaska during 2002. These items were partially offset by the impact of an
increase in industrial and commercial transportation volumes when compared to
the same periods ended March 31, 2002.
OTHER OPERATING REVENUE - Other operating revenue for the three-month
period ended March 31, 2003, was $1.1 million compared to $.9 million for the
same period ended March 31, 2002. Other operating revenue for the twelve
months ended March 31, 2003 was $3.5 million, compared to $3.1 million for the
twelve months ended March 31, 2002. The $.2 million increase for the quarter
ended March 31, 2003 was due primarily to an increase in miscellaneous services
fees, offset partially by a reduction in ATS balancing fees as a result of ATS
customers switching back to gas sales service. The $.4 million increase for the
twelve months ended March 31, 2003 was due to the same items discussed above
plus an increase in fees on new transmission pipelines in service.
- 19 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
GAS DISTRIBUTION (CONTINUED)
OPERATING EXPENSES - Operating expenses of the Gas Distribution Business
remained largely flat for the three-month period ended March 31, 2003.
Operating expenses for the twelve months ended March 31, 2003 decreased by $3.2
million when compared to the twelve months ended March 31, 2002. Contributing
to this decrease is approximately $1.1 million of restructuring charges included
in the results for the twelve months ended March 31, 2002. The remainder of the
decrease was primarily the result of a decrease in amortization expense of $2.7
million and a decrease in operation and maintenance expenses of $1.1 million
offset partially by an increase in depreciation expense of $1.6 million and an
increase in general business tax expenses of $.1 million. The decrease in
goodwill amortization was due to its elimination effective January 1, 2002 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 Condensed Notes to the Unaudited
Consolidated Financial Statements. The decrease in operating expenses is due
primarily to general cost cutting measures and the impact of a reduction in
workforce and other cost reductions related to the Company's redirected business
strategy, offset partially by higher employee benefit costs, including pension
expense, health care costs and retiree medical costs, and increased maintenance
costs. The increase in depreciation expense is due primarily to additional
property, plant and equipment placed in service.
REGULATORY MATTERS - On May 2, 2003, the Michigan Public Service Commission
("MPSC") approved a settlement agreement, authorizing the Company to implement
revised rates for the sale and transportation of natural gas and to revise its
depreciation rates and practices. The settlement establishes a revenue
requirement of $71.9 million based on a 2003 projected test year and an increase
in the return on its common equity from 10.75% to 11.40%. The settlement also
provides for a) the elimination of the reverse taper incentive mechanism so that
the Company is no longer required to refund revenues to customers above the
return on common equity, b) no potential refund to customers for property tax
expense based on lower state property tax tables and c) an increase in the
monthly service charge from $7.00 to $9.50 per month for residential customers.
The new authorized rates, which became effective May 3, 2003, are expected to
increase annual revenue by $3.4 million and decrease annual depreciation expense
by $1.4 million.
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 Twelve Months Ended
March 31, March 31,
------------------ --------------------
2003 2002 2003 2002
-------- -------- --------- ---------
(in thousands)
Operating revenues. . . . . . . . . $15,112 $25,581 $108,785 $133,938
Restructuring & impairment charges. - - - 3,098
Other operating expenses. . . . . . 18,752 26,891 113,114 131,451
-------- -------- --------- ---------
Operating income (loss) . . . . . . $(3,640) $(1,310) $ (4,329) $ (611)
======== ======== ========= =========
Feet of pipe installed. . . . . . . 451 1,055 4,594 7,445
======== ======== ========= =========
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 (CONTINUED).
CONSTRUCTION SERVICES (CONTINUED)
OPERATING REVENUES - The operating revenues of Construction Services for
the first quarter of 2003 and 2002 were $15.1 million and $25.6 million,
respectively. The decrease of $10.5 million was due to the reduction of
projects in the southern division of Construction Services, the ceasing of
construction operations in certain unprofitable regions of the mid-western
division and lower work levels in the mid-western division due to cold weather.
During the first quarter of last year, the southern division of Construction
Services experienced an acceleration of work on projects that had been scheduled
for the second and third quarter, which caused a significant increase in
revenues during the first quarter of 2002. Colder than normal temperatures in
the mid-western regions of the United States kept frost levels deep during the
entire first quarter of 2003, which inhibited construction activity.
The operating revenues of Construction Services for the twelve-month period
ended March 31, 2003 and 2002 were $108.8 million and $133.9 million,
respectively. The decrease of $25.1 was due in part to customers in the
mid-western and southern regions of the country delaying projects in the latter
part of 2002 in light of the generally depressed economy and their own financial
considerations. Also contributing to the decrease were the reasons previously
discussed for the decrease in the first quarter of 2003.
OPERATING INCOME - Construction Services had a seasonal operating loss of
$3.6 million for the first quarter of 2003 compared to a loss of $1.3 million
for the first quarter of 2002. The decrease of $2.3 million was due primarily
to the impact of the reduction in project levels in the southern division and
cold weather and high frost conditions in the mid-western division, as
previously discussed.
Construction Services had an operating loss of $4.3 million for the twelve
months ended March 31, 2003, compared to an operating loss of $.6 million for
the twelve months ended March 31, 2002. The decrease of $3.7 million is due
primarily to reduced construction activity during 2002 in the mid-western region
of the country and during the last half of 2002 in the southern region of the
country. Also contributing to the decrease in operating income was lower
construction activity in the first quarter of 2003 in comparison to the same
period for 2002, as previously discussed. In addition, the Company experienced
lower than expected margins on some of the work performed and higher than
anticipated costs on some projects during the twelve months ended March 31,
2003. The Company believes that the softening economy caused many customers to
delay or cancel certain construction projects during 2002, which changed the mix
of work available to Construction Services. The mix of work during the twelve
months ended March 31, 2003 included more lower margin work at certain business
units because of the competition for the limited supply of available work. The
reduced construction activity also eroded margins because of the time lag
required to reduce the staffing levels and other fixed costs, which were
required for the previously higher level of revenues. In addition, the
operating performance in certain regions of Construction Services had been below
the Company's profitability expectations. The Company ceased operations in
several of these under performing regions in late 2002 and early 2003. These
factors were partially offset by the non-recurrence during the twelve months
ended March 31, 2002 of $3.3 million of restructuring charges, impairments and
other unusual charges incurred in the fourth quarter of 2001.
- 21 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
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 Twelve Months Ended
March 31, March 31,
------------------ -------------------
2003 2002 2003 2002
------ ------ ------ -------
(in thousands)
Operating revenues. . . . $2,154 $2,261 $9,511 $10,326
Restructuring charges . . - - - 20
Other operating expenses. 1,934 2,085 8,865 9,851
------ ------ ------ -------
Operating income. . . . . $ 220 $ 176 $ 646 $ 455
====== ====== ====== =======
The amounts in the above table include intercompany transactions.
OPERATING REVENUES - Operating revenues for IT Services for the three
months ended March 31, 2003 were $2.2 million compared to $2.3 million for the
three months ended March 31, 2002. Of these amounts, $1.5 million and $1.9
million for these same periods, respectively, represent sales to affiliates.
Operating revenues for the twelve months ended March 31, 2003 were $9.5 million,
compared to $10.3 million for the twelve months ended March 31, 2002. Of these
amounts, $7.3 million and $9.1 million for these same periods, respectively,
represent sales to affiliates. The decreases in operating revenues of $.1
million and $.8 million for the three-and twelve-month periods ended March 31,
2003, when compared to the same periods ended March 31, 2002, are due primarily
to fewer special projects with affiliate customers offset partially by an
increase in business with non-affiliate customers.
OPERATING INCOME - Operating income for the three months ended March 31,
2003, when compared to the same period ending March 31, 2002, increased by less
than $.1 million. Operating income for the twelve months ended March 31, 2003
increased by approximately $.2 million, compared to the same period ended March
31, 2002. These increases were due primarily to an increase in business with
non-affiliate customers as well as reductions in overhead and marketing costs.
PROPANE, PIPELINES AND STORAGE
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------ -------------------
2003 2002 2003 2002
------ ------ ------ ------
(in thousands)
Operating revenues. $2,827 $2,238 $7,647 $6,932
Operating expenses. 1,929 1,629 5,412 5,188
------ ------ ------ ------
Operating income. . $ 898 $ 609 $2,235 $1,744
====== ====== ====== ======
- 22 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
PROPANE, PIPELINES AND STORAGE (CONTINUED)
OPERATING REVENUES - The operating revenues of the Company's propane,
pipelines and storage business for the three and twelve-month periods ended
March 31, 2003 were $2.8 million and $7.6 million, respectively, compared to
$2.2 million and $6.9 million, respectively, for the same periods ended March
31, 2002. The increases for the three and twelve-month periods were due
primarily to higher propane distribution revenues resulting from colder weather
in the Company's propane distribution service area which increased propane sales
and an increase in the market price for propane.
OPERATING INCOME - Operating income from the propane, pipelines and storage
business for the first quarter of 2003 increased by $.3 million when compared to
the same period in 2002. Operating income for the twelve month period ended
March 31, 2003, when compared to the same period in 2002, increased by
approximately $.5 million. These increases were due primarily to colder weather
during the first quarter of 2003 and the second and fourth quarters of 2002,
which increased propane sales and margins.
OTHER INCOME AND DEDUCTIONS
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------ --------------------
2003 2002 2003 2002
-------- -------- --------- ---------
(in thousands)
Interest expense. . . . . . . . . $(7,957) $(7,674) $(31,551) $(31,457)
Other income. . . . . . . . . . . 698 325 2,611 1,794
-------- -------- --------- ---------
Total other income (deductions) $(7,259) $(7,349) $(28,940) $(29,663)
-------- -------- --------- ---------
INTEREST EXPENSE - Interest expense for the three and twelve-month periods
ended March 31, 2003 increased by $.3 million and $.1 million, respectively,
when compared to the same periods ended March 31, 2002. The increase in
interest expense for the three and twelve-month periods ended March 31, 2003 was
due primarily to higher average daily short-term debt balances in the first
quarter of 2003, an increase in bank fees relating to our short-term debt
facilities and an increase in amortization expenses for debt issuance costs.
OTHER INCOME - Other income for the three months and twelve months ended
March 31, 2003 increased by $.4 million and $.8 million, respectively, when
compared to the same periods ended March 31, 2002. The increase during the
first quarter of 2003 was due primarily to gains on the sale of equipment,
compared to losses during the first quarter of 2002. The increase during the
twelve months ended March 31, 2003 when compared to the same period of 2002, was
due primarily to an increase in gains on the sale of equipment and income from
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 (CONTINUED).
INCOME TAXES
Income taxes for the three and twelve-month periods ended March 31, 2003
decreased by $.4 million and increased by $2.3 million, respectively, when
compared to the same periods ended March 31, 2002. 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
and twelve-month periods ended March 31, 2003 were essentially unchanged at $2.1
million and $8.6 million when compared to the same periods ended March 31, 2002.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS USED FOR INVESTING - The following table identifies capital
investments for the three months ended March 31, 2003 and 2002:
Three Months Ended Twelve Months Ended
March 31, March 31,
------------------ -------------------
2003 2002 2003 2002
------ ------ ------- -------
Capital investments:
Property additions - gas distribution . . . . . . . . $4,675 $7,007 $27,640 $33,187
Property additions - diversified businesses and other 344 815 4,534 17,751
------ ------ ------- -------
$5,019 $7,822 $32,174 $50,938
====== ====== ======= =======
The Company's expenditures for property additions were approximately $5.0
million for the first quarter of 2003. Expenditures for property additions
during the remainder of 2003 are anticipated to be approximately $28 million.
CASH FLOWS PROVIDED BY OPERATIONS - Net cash provided by operating
activities for the three and twelve-month periods ended March 31, 2003, when
compared to the same periods of the prior year, increased by $20 million and
$32.1 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.
- 24 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
CASH FLOWS PROVIDED BY FINANCING - Net cash provided by financing
activities during the three and twelve-month periods ended March 31, 2003
decreased by $16.2 million and $42.0 million, respectively, when compared to the
same periods ended March 31, 2002.
Three Months Ended Twelve Months Ended
March 31, March 31,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Cash provided by (used in) financing activities:
Issuance of common stock . . . . . . . . . . . $ 940 $ 1,247 $ 3,335 $ 3,680
Net cash change in notes payable . . . . . . . (37,185) (19,831) (3,476) (15,288)
Isuance of long-term debt, net of expenses . . - - 28,990 58,296
Repayment of long-term debt. . . . . . . . . . (25) - (30,150) (10)
Payment of dividends on common stock . . . . . (2,339) (3,835) (9,280) (15,236)
--------- --------- --------- ---------
$(38,609) $(22,419) $(10,581) $ 31,442
========= ========= ========= =========
In April 2003, 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 May 15, 2003 to shareholders of record at the close of
business on May 1, 2003.
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. At March 31, 2003, the Company had $145 million of
short-term credit facilities, all of which are committed, consisting of an $80
million three-year revolver and a $65 million 364-day facility, with a one-year
term loan option. On March 31, 2003, $60.7 million of the Company's credit
facilities were unused. The 364-day facility is scheduled to mature on June 24,
2003. The Company is in the process of negotiating an increase in and an
amendment to its credit facilities to permit the issuance of additional debt
securities and to extend the 364-day facility. The Company expects this
amendment to provide covenant relief to permit the offering of senior unsecured
notes (as described below), including the incurrence of costs associated with
such offering and the other transactions contemplated to occur concurrently with
such offering.
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 March 31, 2003, 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 March 31, 2003, the Fixed Charges
Coverage Ratio was 1.84 and the Company was in compliance with all of the
covenants in these agreements.
- 25 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
The Company's ratio of earnings to fixed charges, as defined under Item 502
of SEC Regulation S-K, was 1.3 for the twelve months ended March 31, 2003. 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 and rate resets in 2003. These securities and their
terms for remarketing, rate resets and redemptions are described in Note 4 of
the Notes to the Consolidated Financial Statements in the Company's 2002 Annual
Report on Form 10-K.
The Company is planning an offering of an aggregate of $300 million of
senior unsecured notes. In connection with the issuance of these notes, the
Company intends to retire $105 million of its ROARS and repurchase $55 million
of its outstanding 8.00% Senior Notes due 2004, $30 million of its 7.2% Senior
Notes due 2007 and $25 million of its 8.32% Senior Notes due 2024. The
remainder of the notes, or proceeds therefrom, will be used to pay for costs,
estimated to be $49.0 million, related to the issuance of the senior unsecured
notes and the refinancing or repurchase of the notes described above, and for
working capital and general corporate purposes.
The $49 million of costs include fees and other costs associated with the
issuance of the new notes and make-whole premiums or similar amounts that will
be incurred in connection with the debt obligations being retired or
repurchased. The make-whole premiums or similar amounts will be incurred in
order to retire or repurchase these obligations prior to their maturity. The
Company expects to expense approximately $23.3 million ($15.1 million net of
taxes) of these costs at the time of the refinancing and the Company expects to
amortize the remainder over the life of the notes. These estimates are, in
part, based on our current plans with respect to the retirement of the ROARS.
If the Company retires the ROARS in a manner different than currently planned,
the amount the Company expects to expense at the time of the refinancing could
increase by up to $14.7 million ($9.7 million net of taxes) to $38.0 million
($24.7 million, net of taxes) and the amount the Company expects to amortize
over the terms of the notes could decrease by the same amounts to $11.0 million
($7.3 million net of taxes).
The Company currently plans to retire a portion of the ROARS in a manner
that will allow the Company to account for the retirement as a debt exchange.
If the ROARS are retired in a manner different than planned, it is possible that
the retirement will be accounted for as a debt extinguishment.
OTHER MATTERS - The Company is discussing the sale of Alaska Pipeline
Company (APC) with potential buyers. APC, a wholly owned subsidiary of SEMCO
ENERGY, delivers natural gas from several producing fields in south central
Alaska to ENSTAR Natural Gas Company's distribution system. APC has no
employees and ENSTAR is its only customer. Under the Company's proposed terms
of a sale, ENSTAR would continue to operate and manage APC's transmission
pipelines. A sales transaction acceptable to the Company would be expected to
close in the latter half of 2003, subject to various approvals, including
approval by the Regulatory Commission of Alaska. Proceeds of the potential sale
would be used to reduce SEMCO's outstanding debt obligations. It is anticipated
that rates to customers, the services offered, pipeline operations and staffing
would not change as a result of the sale. The book value of the APC assets the
Company expects to be part of a sale is $90.1 million. The Company has not
entered into any agreement with respect to the sale of APC and such sale may not
occur unless the Company is able to sell APC on terms acceptable to us.
- 26 -
PART I - FINANCIAL INFORMATION - (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED).
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.
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.
- 27 -
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In late March 2003 the Company was served a complaint in a putative
class-action lawsuit alleging that the approximately 30 defendants, including
SEMCO Energy and SEMCO Energy Ventures, Inc., engaged in practices that violated
the Sherman Anti-Trust Act and tortuously interfered with the business of the
plaintiffs. The Company is considering potential legal and factual defenses to
these claims and intends to vigorously defend itself in this action. Although
the Company cannot make assurances, its management currently believes that this
suit will not have a material adverse effect on its business or results of
operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
During the first quarter of 2003, the Company issued an aggregate of 1,365
shares of unregistered common stock to the members of its Board of Directors in
exchange for services rendered, valued at $6,096.
The preceding transaction was exempt from registration under Section 4(2)
of the Securities Act of 1933.
ITEM 3. DEFAULT 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 32 for the Exhibit Index.)
3.(ii) Bylaws--last revised April 15, 2003.
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 a Form 8-K Report on February 6, 2003, which discussed
earnings guidance, corporate strengths and business strategy.
- 28 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SEMCO ENERGY, INC.
(Registrant)
Dated: May 14, 2003
By:/s/John E. Schneider
-------------------------------------
Senior Vice President and Principal
Financial Officer
- 29 -
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: May 14, 2003 /s/Marcus Jackson
------------------------------------------
Marcus Jackson
Chairman of the Board, President and
Chief Executive Officer
SEMCO Energy, Inc.
- 30 -
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: May 14, 2003 /s/John E. Schneider
------------------------------------------
John E. Schneider
Senior Vice President and
Chief Financial Officer
SEMCO Energy, Inc.
- 31 -
EXHIBIT INDEX
Form 10-Q
First Quarter 2003
Exhibit
No. Description Filed Herewith
- -------- ----------- ---------------
3.(ii) Bylaws-last revised April 15, 2003. x
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
- 32 -