Item 1. BUSINESS _________________
GENERAL _______
Upper Peninsula Energy Corporation (UPEN) is a holding company, incorporated in 1988 under the laws of the State of Michigan.
UPEN's principal subsidiary, Upper Peninsula Power Company (UPPCO) is the primary source of earnings. UPPCO, incorporated in 1947 under the laws of the State of Michigan, is an electric utility engaged in the generation, purchase, transmission, distribution and sale of electric energy in the Upper Peninsula of Michigan.
UPEN also has two other subsidiaries, Upper Peninsula Building Development Company (UPBDC), owns the corporate head-quarters building and leases it to UPPCO under a twenty-year renewable lease. The second subsidiary PENVEST, Incorporated was formed in 1995 to investigate opportunities in telecommunications, engineering services, and other non- regulated businesses.
SERVICE AREA AND CUSTOMERS __________________________
General _______
UPPCO supplies electric energy to approximately 48,000 customers in two-thirds of Michigan's Upper Peninsula. UPPCO's service area covers 4,460 square miles and has a population of about 130,000. Its service area is divided into the Integrated System and the Iron River System. "Integrated System" refers to UPPCO's "contiguous" service territory and does not include the isolated Iron River service territory. UPPCO's Integrated System serves 94 communities and adjacent rural areas at retail and furnishes electric energy at wholesale to four municipal- ities, two rural electrification associations and two investor owned utilities, namely Wisconsin Electric Power Company (WEPCO) and Edison Sault Electric Company. An interchange power agreement with WEPCO enables UPPCO to purchase and sell power during emergency conditions at various locations on its Integrated System. A separate purchase power contract with WEPCO allows UPPCO to purchase wholesale power from WEPCO to cover all of UPPCO's retail service requirements for its Iron River System which includes five communities and adjacent rural areas in the Iron River District.
Approximately 95% of UPPCO's sales are in its Integrated System with the balance being in the Iron River District.
Iron ore processing, wood products, tourism, equipment manufacturing, and institutions for higher education constitute the basic industries in UPPCO's service area.
Unemployment rates in the Upper Peninsula dropped to 7.6% in 1996 compared to 8.0% in 1995. These figures are high compared with the overall Michigan rate of 4.7% in December 1996 and 1995 as reported by the Michigan Employment Security Commission.
Sales and Customers ___________________
See "Consolidated Selected Financial Data" on pages 17 and 18 filed herewith for data on operating revenues and sales (by customer classification) and customer data.
During 1996 UPPCO derived 40% of its operating revenues from sales of electric energy to residential customers; 29% from small commercial and industrial customers; 14% from large commercial and industrial customers; 10% from sales to other electric utilities, municipalities and public authorities; and 7% from other sources.
In 1996, UPPCO's three largest commercial and industrial customers, which accounted in the aggregate for 13% of energy sales and 8% of operating revenues, were:
Stone Container Corporation operates a mill at Ontonagon, Michigan, producing corrugating medium. Sales to this customer in 1997 are anticipated to be 68,500 mWh.
Michigan Technological University in Houghton, is a nationally recognized university offering technical degrees and academic programs through the doctorate level. Michigan Tech has an enrollment of approximately 7,000. Sales to this customer in 1997 are anticipated to be 25,300 mWh.
Lakehead Pipe Line Company owns and operates a liquid petroleum transportation pipeline system that extends from Neche, North Dakota to Marysville, Michigan. UPPCO serves Lakehead's pumping station located at Rapid River, Michigan. Sales to this customer in 1997 are anticipated to be 21,400 mWh.
In 1996, UPPCO's five largest wholesale customers, which accounted in the aggregate for 14% of energy sales and 7% of operating revenues, were:
Sales to the above wholesale customers are projected to total 113,800 MWh in 1997.
Electric sales are influenced by, among other factors, weather conditions. Peak loads are usually experienced in December or January.
RATES AND REGULATIONS _____________________
UPPCO is subject to the jurisdiction of the Michigan Public Service Commission (MPSC) which has general power of supervision and regulation with reference to territory served, accounting, services, facilities, valuations, issuance of securities and all electric rates with the exception of wholesale for resale rates.
UPPCO is a licensee under Part I and a public utility under Part II of the Federal Power Act and, accordingly, various phases of its business, including wholesale for resale rates, are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC).
Retail Rates ____________
UPPCO derived approximately 83% of its operating revenues from retail electric sales in 1996.
Billings to customers under MPSC jurisdiction include base rate charges and a power supply cost recovery (PSCR) factor. Approximately 37% of UPPCO's operating expense is power supply costs. UPPCO is required under PA 304 to receive MPSC approval each year to recover projected power supply costs by establishment of PSCR factors. These factors are subject to annual reconciliation to actual costs and permit 100% recovery of allowed power supply costs. Any over or under recovery is deferred on UPPCO's balance sheet, and such deferrals are relieved as refunds or additional billings are made.
In Michigan, the implementation of customer choice has been studied for several years. Governor John Engler requested the MPSC to refine and act upon a "blueprint for competition" issued in January 1996. In December 1996, commission staff issued a report that recommends a restructuring approach that would allow customers to choose their electric power supplier over a phase-in period through 2003.
The MPSC staff report provides utilities the opportunity to recover stranded costs through a transition charge for customers who choose alternative energy suppliers. Concepts such as a performance-based cost- recovery system, rate-reduction bonds, and service-reliability standards are also addressed in the report.
The MPSC has not yet acted on the staff proposal, which is also subject to public comment. While we believe that the issues will be debated by interest groups with opposing needs, it appears that customer choice will be available to some degree in Michigan in the near future.
Wholesale Rates _______________
UPPCO derived 10% of its operating revenues from wholesale for resale rates in 1996.
UPPCO's wholesale rates include a base rate charge and are subject to a fuel clause (such clause includes certain purchased power costs), with a 30-day billing lag without reconciliation provisions. Most of UPPCO's wholesale customers are now taking service under special contracts.
Wholesale Wheeling __________________
"Wholesale Wheeling" refers to a transmission service provided by a transmission-owning electric utility (in this case WEPCO) to transmit energy purchased by UPPCO from a third party to the UPPCO Integrated System for resale at UPPCO filed rates.
Because of the availability of wholesale wheeling, we were able to take advantage of a lower-cost power supply for part of our off-peak energy requirements in 1996. These lower costs are expected to continue in 1997, and are passed directly to all customers through the power supply cost factors.
In its order 888, FERC required each utility with transmission lines that could potentially be used for buying or selling wholesale energy to file an Open-Access Tariff for transmission services. This tariff "unbundles" or isolates transmission services from the complete delivery packages that make up most utility rates. Order 888 also defines the terms, conditions, and rates for transmission services to be provided by transmission-system owners. We filed our tariff on January 31, 1997.
Another FERC order would have required us to separate our power marketing function from our transmission operations and planning function and to post our transmission capacity availability and tariff rates on an electronic bulletin board via the Internet. We requested and were granted a waiver from these requirements because of our small size and the additional expense involved with compliance.
Licensing of Hydroelectric Projects ___________________________________
Licenses have been issued to UPPCO pursuant to Part I of the Federal Power Act for the Bond Falls Project and the Prickett Hydro Project. Under the Federal Power Act and said licenses, the United States has the right to take over these projects at or after the expirations of the licenses in 1990 and 1993, respectively, on paying UPPCO's "net investment" as defined in the Act and by FERC. Current licenses are usually automatically extended on an annual basis until FERC issues a new license.
The power generated by UPPCO's hydro projects is delivered to the Integrated System for use by its' customers.
a) FERC 2402, Prickett - The installed nameplate rating at the Prickett Project is 2,200 kilowatts. The license offered by the FERC for this project requires run-of-river operation with a dependable capacity of 704 kW.
An order issuing a license for Prickett (FERC 2402) was issued on August 29, 1995. UPPCO entered a "Request for Rehearing of Order Issuing a New License" dated September 28, 1995. The Michigan Department of Natural Resources (MDNR) issued a "Request for Rehearing of License Order" dated September 26, 1995. The Michigan Hydro Relicensing Coalition filed a "Request for Rehearing" dated September 27, 1995. Motions for a rehearing have been granted. Further FERC action is pending.
b) FERC 1864, Bond Falls - The installed nameplate rating of the Victoria Project is 12,000 kilowatts. The license application before the FERC proposes a peaking operation, thus the nameplate capacity if the new license allows peaking, is 12,000 kilowatts.
A final application for license for the Bond Falls Project (FERC 1864) was submitted December 24, 1987. An Additional Information Request (AIR) was issued by the FERC on January 2, 1990 requesting additional studies and information within 18 months (by June 2, 1991) of the date of the request. Because of a FERC mandated dam replacement at Victoria, the deadline for gathering and submittal of certain information was extended to December 1995. The requested information was submitted to FERC in December 1995. FERC has indicated that it is proceeding with an Environmental Impact Statement (EIS) for the Project in conjunction with the license application. Completion date for the EIS is unknown. Final action by the FERC on the Application for a License will follow completion of the EIS. Meanwhile, the Project continues to operate under an annual license issued by the FERC in accordance with terms and conditions of the existing license issued for the Project in 1953 which expired on January 1, 1989.
In February 1988 UPPCO purchased from Cliffs Electric Service Company (CESCO), the McClure, Hoist, Cataract and AuTrain hydroelectric facilities with a total capacity of approximately 15.5 MW.
A license application for the Cataract Project was submitted to FERC in August 1993 and a license offered in February 1997 is being evaluated. A license application for the AuTrain Project was submitted in April 1993. FERC's response is pending. A license application for the Dead River Project (Silver Lake, Hoist and McClure Developments) was submitted to FERC in April 1994. FERC's response is pending.
Licensing expenditures through December 1996 were $6,473,000 with additional expenditures of approximately $185,000 estimated to be spent over the next two years to complete the licenses.
The estimated cost of licensing by projects are as follows: Bond Falls, $1,278,000; Prickett, $1,172,000; Dead River, $2,655,000; AuTrain, $938,000; and Cataract, $615,000. Typical allocation splits by function are 29% for engineering, 29% for environmental studies, 25% for preparation of the license application, and 17% for post-application requirements.
Although not in the existing rate structure, licensing cost(s) will be booked (upon acceptance of a license) as a capital asset, thus becoming eligible for inclusion in the rate base.
GENERATION AND PURCHASED POWER RESOURCES ________________________________________
Available generation and purchased power resources for UPPCO's Integrated System are described below, together with 1996 and projected 1997 net station generation:
During 1993 the Warden Station was upgraded to have natural gas burning capability and is now capable of burning gas and/or coal in any combination. Effective January 1, 1994, the station was taken out of service and placed in service lay-up status.
Generating equipment is in standby or inactive reserve ("service lay- up status") which is further defined as not normally used equipment that has been deactivated but would be available for service with short term reactivation procedures.
In the particular case of the John H. Warden Station, the boiler has been filled with water containing corrosion-inhibited chemicals which are periodically circulated throughout the entire system. The turbine generator is protected by circulating warm, dry air through the equipment to prevent corrosion resulting from moisture and oxidation. The ambient temperature of the plant is maintained above freezing during winter months.
In the Iron River District, all requirements are purchased from WEPCO and totalled 48,849 MWh in 1996 and are projected to be 45,145 MWh in 1997.
In 1996 virtually all energy generated by UPPCO owned facilities was produced by hydroelectric facilities. UPPCO purchased 61% of its total energy requirements from WEPCO. UPPCO supplies energy to an isolated WEPCO load (isolated from the remainder of WEPCO's service territory) in western Marquette County. WEPCO purchases the energy at wholesale for resale under their Michigan retail rate structure. This energy comes from any of UPPCO's resources, including generation and purchased power, and is included in UPPCO's load planning.
UPPCO has contracted with WEPCO for 65 MW of capacity through December 31, 1997.
We reported previously that we had entered into an agreement with Northern States Power Company (NSP) to be our major supplier beginning in 1998. Due to flexibility and pricing concerns, we came to a mutual agreement with NSP in 1996 to terminate that agreement. Early in 1997 we expect to solicit power supply proposals for our future energy needs.
UPPCO, for reasons of necessity or economy, may exchange energy with WEPCO, Wisconsin Public Service Corporation, NSP, Wisconsin Power & Light, the City of Marquette, the City of Escanaba and Edison Sault Electric Company when and if availability and need exists.
UPPCO's 1997 system net dependable capability, including its capacity entitlement from WEPCO is 167,740 kW. UPPCO is a winter-peaking utility. The maximum demand created on the Integrated System by UPPCO's customers was 137,000 kW experienced on December 26, 1996.
ARRANGEMENTS WITH OTHERS ________________________
Arrangements with WEPCO _______________________
Effective January 1, 1988 UPPCO and WEPCO entered into the following 5-year agreements: (a) Power Plant Operating Agreement whereby UPPCO will staff and operate WEPCO's Presque Isle Power Plant, (PI), (b) Dispatch Agreement whereby UPPCO performs electric power dispatch functions for PI and related transmission facilities, (c) Transmission Maintenance Agreement whereby UPPCO maintains certain of WEPCO's transmission lines and substations, and (d) Joint Use Transmission Agreement whereby UPPCO and WEPCO agree to the joint use of portions of transmission facilities owned by the other party. During 1990 all of the aforementioned agreements were extended. In December 1996, WEPCO gave notification that it intends to terminate the contract on December 31, 1997. The terms of the agreement call for all UPPCO employees at the plant to be offered employment by WEPCO. UPPCO and WEPCO representatives have begun efforts to ensure an orderly transition. UPPCO management believes that this action will not have a material adverse effect on its financial position or results of operations.
Arrangements with the City of Escanaba ______________________________________
UPPCO operates and manages the City of Escanaba's steam electric generating station. The City and UPPCO have the following agreements: (a) Plant Operating Agreement whereby UPPCO operates and manages the station and pays all costs of operation, and the City reimburses UPPCO for all expenses incurred in operating and maintaining the plant plus a management fee; (b) Interconnection Agreement whereby UPPCO and the City may transact energy exchanges according to published Service Schedules; and (c) Dispatch Services Agreement whereby UPPCO performs electric power and/or energy dispatching functions for the City's system. The Plant Operating and Interconnection Agreements can be terminated upon not less than 36 month's written notice to the other party. The Dispatch Agreement can be terminated upon 12 month's written notice to the other party.
Other Arrangements __________________
The Iron River area, which accounts for approximately 5% of UPPCO's kWh sales and is not integrated, is served by an interconnection with WEPCO.
UPPCO's 138-kV interconnections with WEPCO provide UPPCO with electrical interconnections to Wisconsin's electric utilities. These interconnections permit UPPCO to participate in coordinated planning, design and operating activities with Wisconsin's electric utilities as a member of the Wisconsin - Upper Michigan Systems organization. UPPCO also has a 69-kV interconnection with the City of Marquette, the City of Escanaba, and with Edison Sault Electric Company.
In 1990, an agreement was executed between UPPCO and WEPCO for the joint use and sharing of transmission facilities in connection with WEPCO's construction of an 80-mile, 345-kV transmission line from its Presque Isle Station in Marquette to Quinnesec, Michigan. The line was put into service in June 1992, after which UPPCO began maintaining a portion of the transmission line and terminal equipment under contract with WEPCO. The agreement allows the companies to share existing rights-of-way and utilize common structures in areas where transmission line routes coincide.
In October 1996 we transferred our after-hours trouble-call dispatching and selected system operation functions to Wisconsin Public Service (WPS) Corporation of Green Bay, Wisconsin. We expect WPS's high- tech energy management system to help us to reduce costs while maintaining high service and operating standards. As time goes on, the arrangement could save us more than originally anticipated by allowing us to avoid the additional costs of complying with FERC rules for unbundling generation and transmission activities.
CONSTRUCTION AND FINANCING __________________________
UPEN's construction expenditures for 1996 totaled $13,181,000 including an Allowance for Funds Used During Construction (AFUDC). Of this amount, $196,000 was expended on the licensing and relicensing of certain hydro-electric generating stations and $4,290,000 was spent on the construction of a new 138-kV transmission line to the Escanaba area and additions and improvements to several substations. Construction costs including AFUDC for 1997 and 1998 through 2001 are estimated as follows:
Net plant and property at December 31, 1996 amounted to $103,942,000 including AFUDC. The construction program for 1997 through 2001 contemplates aggregate gross additions to plant and property of $21,400,000. These estimates include capital expenditures of $185,000 that are required for certain hydro- electric generating stations to become licensed or relicensed to UPPCO and $300,000 to complete construction of a 138-kV transmission line to the Escanaba area. (See "Licensing of Hydroelectric Projects").
See "Liquidity and Capital Resources" under Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated herein.
ENVIRONMENTAL MATTERS _____________________
The Company's operations are subject to Federal, State and local regulations in regard to air and water quality, land use and other environmental matters.
The Company is in receipt of information which indicates that groundwater pollution is emanating from the ash disposal site at the Presque Isle Station in Marquette, Michigan, sold to WEPCO in December of 1987. Pursuant to certain agreements between WEPCO, UPPCO and The Cleveland Cliffs Iron Company, UPPCO may be required to reimburse WEPCO for a portion of the remediation costs. The first $2 million expended by WEPCO is not reimbursable and it is estimated that UPPCO's share of the remaining remediation costs will not be more than $200,000.
The closure of the ash disposal site at UPPCO's John H. Warden Station near L'Anse, Michigan was completed in 1994. A Closure Certification Report was submitted to the Michigan Department of Natural Resources (MDNR) and was approved in January, 1995.
The Closure Certification includes an agreement with the MDNR for the Company to monitor groundwater surrounding the ash disposal site for a 30- year period. In December, 1994, an estimated liability and regulatory asset of $841,000 was recorded for such future costs. The estimated liability and regulatory asset are being reduced as actual expenses are incurred. At December 31, 1996 the balance of the estimated liability and regulatory asset was $689,000.
The Michigan Department of Environmental Quality (MDEQ - Formally included in the MDNR) also advised UPPCO in early 1995 that recent water samples from the site indicated elevated levels of boron and lithium. The MDEQ determined that UPPCO's Feasibility Study submitted in 1993 did not address the recent issues and was rejected. A Supplemental Remedial Investigation was performed in 1995 and the results were submitted to the MDEQ in February 1996. UPPCO also requested and was granted an amendment to the Consent Order to allow for modification of the Feasibility Study and redefining a new timetable for submission of the Remedial Action Plan submitted to the MDEQ by July 31, 1997.
Closure reports for two of three remaining contaminated underground storage tank sites were submitted to the MDEQ in 1996. Audit responses from the MDEQ are still forthcoming. Additional site investigations may be required but are not expected to be extensive.
Title V of the 1990 Clean Air Act requires each State to develop a Renewable Operating Permit program based on State and Federal requirements. This Renewable Operating Permit will take the place of Michigan's Permit to Operate. A sources "Potential to Emit" air contaminants determines the applicable regulatory requirements. Sources that are not operated continuously can self impose enforceable limitations to restrict their emissions below major source threshold limits and not be subject to the Renewable Operating Permit program.
Because of the evolving changes in the electric utility industry, UPPCO has elected not to impose limitations on its generating capabilities at this time. Renewable Operating Permit applications were submitted for authorization of unrestricted operation for the Gladstone, Portage and John H. Warden Generating Stations. The applications were deemed "administratively complete" by the MDEQ in October, 1996.
No major expenditures are currently budgeted for the limitation or monitoring of hazardous substances or pollution control. The recurring operational and maintenance costs associated with these items are not expected to change significantly on an annual basis.
UPPCO cannot presently forecast the full costs and other effects that current and future regulations may have on the Company.
EMPLOYEE RELATIONS __________________
On December 31, 1996 UPPCO had 426 full-time employees, of whom 307 were represented by Local 510, International Brotherhood of Electrical Workers, AFL-CIO, under two separate agreements. UPPCO is in the second year of a three-year agreement with both the Physical and Clerical Unit employees, which is effective through April 30, 1998. Wage rate increases averaging 3.5% were granted to both Physical and Clerical Unit employees on April 1, 1996. Out of the 426 employees, 213 are assigned to PI, operated for WEPCO, and 26 are assigned to the Escanaba Generating Station, operated for the City of Escanaba.
UPPCO has not experienced a work stoppage since 1975. UPPCO has had an aggressive employee involvement program for the last 14 years and will continue their continuous improvement process in the future.
PATENTS AND FRANCHISES ______________________
In 1988 UPEN was incorporated as a holding company of which UPPCO is its principal subsidiary. Therefore, UPPCO retains all franchise agreements.
UPPCO has no patents.
UPPCO is the transferee of municipal franchises, or has obtained franchises itself, to conduct business in substantially all of the municipalities presently served by UPPCO in which operations were commenced subsequent to January 1, 1909. UPPCO has franchises in 54 townships and municipalities throughout its system, by virtue of 30-year grants. These franchises will expire at various times through 2022. All expired franchises have been renewed.
UPPCO operates in 20 other townships and municipalities by authority of Public Act 264 of 1905. Court decisions have held that electric companies who were operating under the 1905 statute before the Michigan Constitution of 1908 are not required to obtain franchises as stated in the constitutional provision. This right also applies to successor companies. UPPCO operates in the Village of Ontonagon by virtue of a 30-year revocable franchise granted in 1975 by the Village Council and in the Village of L'Anse by virtue of a 30-year nonrevocable franchise acquired in 1988.
Item 2.
Item 2. PROPERTIES ___________________
Transmission and Distribution _____________________________
UPPCO's transmission and distribution system is comprised of approximately 3,499 circuit miles. Transmission and sub-transmission networks are operated at 138, 69, 33 and 12 kV, consisting of approximately 355, 371, 48 and 13 circuit miles, respectively. The remaining 2,712 miles are operated at distribution voltages ranging between 120 and 15,000 volts.
As of December 31, 1996, there were 417 mVa of distribution transformers, 439 mVa of transmission bulk power step-down transformers, and 153 mVa of generation step-up transformers in service on the system.
Company-Owned Generation ________________________
Certain information as to UPPCO owned generation is set forth below:
See "Generation and Purchased Power Resources", part of Item I. Business, for information as to utilization of UPPCO-owned generation and other available generation. The Warden Station is a one-unit plant with an extraction steam turbine, which extraction unit is no longer in service.
Prickett, Cataract, and AuTrain hydroelectric generating stations are generally run-of-the river plants with limited capacity to store water while the Victoria, Hoist and McClure hydroelectric generating stations are operated as peaking facilities.
The Portage and Gladstone Stations are both one-unit oil- fired gas turbines.
Other Properties ________________
UPPCO owns numerous miscellaneous properties in various parts of its territory which are used for office, service and other purposes. The most important of these are Service Centers at Ishpeming, Houghton, Ontonagon, Iron River, Escanaba, and Munising, Michigan. UPPCO also leases small parcels of land for substations and miscellaneous temporary uses.
Property Additions and Retirements __________________________________
The gross additions to UPPCO's Utility Plant during the period January 1, 1992 to December 31, 1996 amounted to $43,117,815, approximately 24% of its Gross Utility Plant at December 31, 1996. During the same period, a total of $7,048,984 was retired.
Maintenance ___________
It is management's opinion that UPPCO's generating facilities are adequately maintained and equipped (subject to changing environmental requirements). UPPCO's maintenance practices at all generating facilities are designed to ensure safe and reliable operation.
UPPCO continues its systematic approach to maintaining and upgrading existing transmission and distribution plant to ensure reliable service to customers throughout the service territory. The Company does this through a program of inspections, rebuilds, replacements, and additions designed to improve the performance of facilities and enhance the quality of service to customers. The Company also conducts an aggressive program for maintenance of transmission and distribution line rights-of-way to improve continuity and quality of service to customers.
Titles ______
In the opinion of counsel, UPPCO has satisfactory title to its properties for use in its utility business. Electric transmission and distribution lines are constructed principally on rights-of-way which are maintained under franchise or held by easement only. All properties of UPPCO are subject to the lien of UPPCO's Indenture of Mortgage, dated May 1, 1947 as supplemented, other than "excepted property" as defined therein. In the opinion of counsel, UPBDC has satisfactory title to its properties which consist of an office building used by UPPCO for its general office and corporate headquarters.
Item 3.
Item 3. LEGAL PROCEEDINGS __________________________
UPEN is subject to various unresolved legal matters that arose in the normal course of business. Although it is not possible to predict the outcome of these legal actions, company management believes that these actions will not have a material adverse effect on its financial position or results of operations.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ____________________________________________________________
There were no security holder votes occurring in the fourth quarter of 1996.
Executive Officers of the Registrant ____________________________________
Clarence R. Fisher was first elected a UPEN director on April 8, 1992.
Burton C. Arola was elected a UPEN officer at the July 9, 1996 Board of Directors meeting. All officers serve until the first Board meeting following the April 22, 1997 Annual Shareholders' Meeting or until their respective successors are elected and qualified.
Executive Officers of Upper Peninsula Power Company ___________________________________________________
Clarence R. Fisher was first elected an UPPCO director on April 8, 1992.
Burton C. Arola and Neil D. Nelson were elected at the July 9, 1996 Board of Directors' meeting. All officers serve until the first Board meeting following the April 22, 1997 Annual Shareholders' Meeting or until their respective successors are elected and qualified.
There are no family relationships between officers and directors.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The corporation's stock is traded on The Nasdaq Stock Market under the symbol "UPEN." At December 31, 1996, UPEN had 3,924 registered common shareholders. To our knowledge, no individual shareholder holds more than 5% of the 2,969,215 total outstanding shares.
Dividends have been paid quarterly without interruption or reduction since May of 1949. Payments are made the first day of February, May, August, and November, and the current annual dividend is $1.28 per share. We intend to continue paying dividends, although future payments will be dependent upon earnings, liquidity, and indenture restrictions (See Notes to Financial Statements-Note 5). All dividends paid in 1996 were fully taxable for federal income tax purposes.
Shareholders of at least one (1) share of UPEN common stock may join this dividend reinvestment plan to purchase additional shares at market price without brokerage commissions. Part A of this plan allows for quarterly reinvestment of cash dividends, while part B allows for optional cash payments of $50 minimum or $5,000 maximum each quarter.
The Company does not sell its stock directly to the public, nor does it buy shares directly from its shareholders.
Item 6.
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA _____________________________________________ (In thousands, except per share data)
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA (Cont'd) ______________________________________________________
(In thousands, except per share data)
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS __________________________________________________________
RESULTS OF OPERATIONS
Upper Peninsula Energy Corporation (the Company) is the parent of Upper Peninsula Power Company (UPPCO), an electric utility, and two nonutility subsidiaries. The utility operations of UPPCO are the primary source of earnings.
Earnings
Earnings per share in 1996 were $1.73 compared with $1.78 in 1995 and $1.82 in 1994. The 2.8% decrease in earnings is attributable to a full-year impact of a 5.7% reduction in retail rates in April 1995 and a decline in large-industrial sales, offset by a reduction of maintenance expenditures. Earnings declined slightly in 1995 as a 7.7% reduction in operation and maintenance expense, exclusive of power supply costs, combined with a 1.0% increase in energy sales, offset the April rate decrease.
Sales and Revenues
The majority of operating revenues come from the sale of electricity based on rates authorized by the Michigan Public Service Commission (MPSC) and the Federal Energy Regulatory Commission (FERC). Over the past three years, approximately 90% of energy sales revenues were under the jurisdiction of the MPSC.
Fluctuations in revenues occur because of changes in rates, power supply costs, number of customers, weather, and energy-consumption trends. Power supply cost recovery matches fuel and purchased-power cost changes and does not affect earnings.
In 1996, operating revenues were 4.6% lower than in 1995 because of lower power supply costs, reduced sales, and the April 1995 retail rate reduction. Operating revenues in 1995 were 2.3% lower than in 1994. The April 1995 rate reduction and a slight decrease in power supply costs were the major reasons for the lower 1995 revenues.
Sales of electric energy accounted for 93.1% of operating revenues in 1996. Electric sales in 1996, 1995, and 1994 were 821,311 MWh, 846,951 MWh, and 838,518 MWh, which included 12,370 MWh, 39,816 MWh, and 31,793 MWh, respectively, sold at a non-firm emergency rate established in 1993 for certain large-industrial customers.
Excluding emergency sales, 1996 and 1995 energy sales were up 0.2% and 0.4%, respectively. In the past two years, there has been a general rise in sales, with the exception of large industrials due in large part to the closure of the K.I. Sawyer Air Force Base in September 1995. Small- commercial sales continue to lead the way, rising by 2.4% in 1996 following a 4.1% gain in 1995.
Sales to K.I. Sawyer Air Force Base accounted for $672,000, $1,406,000, and $2,783,000 of revenues in 1996, 1995, and 1994, respectively. New load continues to develop on the base site.
Customers with firm energy requirements exceeding 20,000 MWh in either of the past two years were:
Operating Expenses
Operating expenses decreased 4.5% in 1996 following a 2.6% decline in 1995.
Power supply costs (fuel and purchased power) accounted for 37.0%, 38.7%, and 38.1% of operating expenses in 1996, 1995, and 1994, respectively. Power supply costs change depending on overall system energy requirements, unit production costs for generation, and purchased-power rates. Purchased power represented 80.8%, 84.1%, and 84.8% of output to lines in 1996, 1995, and 1994, respectively. The decrease in the percentage of UPPCO's energy requirements purchased in 1996 was due to a 23.1% increase in hydro generation resulting from record snowfalls and a late spring.
Power supply costs decreased 8.7% and 1.0% in 1996 and 1995, respectively. These costs on a per-unit basis decreased 8.2% in 1996 because of a higher hydro generation and reduced purchased-power costs. In 1995, power supply costs decreased 1.6% on a per-unit basis, more than offsetting increased energy requirements.
Other operation expenses were 1.6% higher in 1996 as the reduced costs associated with fewer employees were offset by increased outside service needs associated with such areas as the changing regulatory climate and other strategic or operational changes. In 1995, other operation expenses were 9.0% lower as a result of reduced employment levels and associated benefit costs.
In 1996, maintenance expenses decreased 23.6% because of reduced tree- trimming and production-plant expenditures. Maintenance expenses were 2.7% lower in 1995 despite additional tree-trimming and production-plant expenditures because of ash-site closure costs in 1994.
Depreciation and amortization expense, which is normally a function of plant in service, decreased 2.3% in 1996 following a 3.7% increase in 1995. The decrease in the current year was due to an increase in the estimated service life of the Victoria hydro facility.
Ad Valorem taxes increased 6.8% and 4.5% in 1996 and 1995, respectively, due to additional plant in service.
Total interest charges increased slightly in 1996 due to additional short-term borrowing requirements. In 1995, interest charges remained relatively unchanged, as most cash needs were satisfied internally.
FUTURE OUTLOOK
In Michigan, the implementation of customer choice has been studied for several years. Governor John Engler requested the MPSC to refine and act upon a "blueprint for competition" issued in January 1996. In December 1996, commission staff issued a report that recommends a restructuring approach that would allow customers to choose their electric power supplier over a phase-in period through 2003.
The MPSC staff report provides utilities the opportunity to recover stranded costs through a transition charge for customers who choose alternative energy suppliers. Concepts such as a performance-based cost- recovery system, rate-reduction bonds, and service-reliability standards are also addressed in the report.
The MPSC has not yet acted on the staff proposal, which is also subject to public comment. While we believe that the issues will be debated by interest groups with opposing needs, it appears that customer choice will be available to some degree in Michigan in the near future.
In its order 888, FERC required each utility with transmission lines that could potentially be used for buying or selling wholesale energy to file an Open-Access Tariff for transmission services. This tariff "unbundles" or isolates transmission services from the complete delivery packages that make up most utility rates. Order 888 also defines the terms, conditions, and rates for transmission services to be provided by transmission-system owners. We filed our tariff on January 31, 1997.
Another FERC order would have required us to separate our power marketing function from our transmission operations and planning function and to post our transmission capacity availability and tariff rates on an electronic bulletin board via the Internet. We requested and were granted a waiver from these requirements because of our small size and the additional expense involved with compliance.
We cannot predict with any certainty the final outcome of deregulation efforts or their effect on UPPCO. However, because of UPPCO's relatively limited energy sales growth projections and the ever-increasing competitive nature of the electric business, we continue to concentrate on efforts to reduce costs and develop a more efficient organization to improve our competitive position.
Management believes that UPPCO meets the criteria of Statement of Financial Accounting Standards No. 71 (SFAS 71), "Accounting for the Effects of Certain Types of Regulation," and that all regulatory assets are probable of recovery. In the event UPPCO no longer meets the criteria of SFAS 71, such regulatory assets would be removed.
UPPCO's work force involved in regulated utility activities has decreased by 25.2% over the last three years, from 250 employees at the beginning of 1994 to 187 at December 31, 1996. In addition to normal retirements, these reductions were accomplished through voluntary retirements, severance programs, and layoffs. We are near the employee complement needed for the future, and further cost reductions will likely come through workplace efficiencies and operational changes.
The Company has entered into an agreement with the Michigan Department of Natural Resources to monitor groundwater surrounding the John H. Warden Station ash landfill, which was closed in 1994. Such monitoring is to be performed over a 30-year period. At December 31, 1996, the Company has recorded an estimated liability of $689,000 offset by a regulatory asset of $689,000 being amortized over the monitoring period.
Under contract with Wisconsin Electric Power Company (WEPCO), UPPCO has staffed and operated WEPCO's Presque Isle Power Plant located in Marquette, Michigan, since 1988. Under the terms of the agreement, UPPCO receives a management fee plus reimbursement for all costs associated with labor and other services provided. In December 1996, WEPCO gave notification that it intends to terminate the contract on December 31, 1997. The terms of the agreement call for all UPPCO employees at the plant to be offered employment by WEPCO. UPPCO and WEPCO representatives have begun efforts to ensure an orderly transition. UPPCO management believes that this action will not have a material adverse effect on its financial position or results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash needs are principally for construction expenditures and debt retirement. Cash is generated through internal operations and external financing.
To meet short-term cash needs, credit agreements are maintained with certain banks. These agreements are reviewed annually in the second quarter of the year. When short-term borrowings grow beyond normal seasonal requirements, they are replaced with long-term financing. The Company had $5,000,000 of short-term notes outstanding at December 31, 1996, and had $5,500,000 of unused lines of credit available at or below the prime rate.
Substantial cash flows are generated annually from operating activities. Net cash from this source was $11,475,000 in 1996, $13,101,000 in 1995, and $11,052,000 in 1994.
During the three-year period 1994 through 1996, there were no long- term financing activities. In 1994, the Company repurchased 25,000 common shares on the open market for $443,000.
Investment activities in 1996, 1995, and 1994 totalled $30,156,000 of capital expenditures, of which $7,298,000 was spent on a transmission line project (Chandler) to improve service to Delta County. This project is scheduled for completion in March 1997. Other utility expenditures were primarily for distribution and transmission improvements, new service requests, and equipment replacement.
Utility capital expenditures are expected to be $3,900,000 in 1997. Cash requirements will be met primarily with short-term borrowings and internally generated funds.
In 1998 through 2001, the Company is forecasting $22,000,000 of capital expenditures for system improvements and replacements. The Company estimates that almost all cash requirements will be internally generated.
Due to its capital-intensive nature, the utility industry is influenced by inflation. UPPCO's current utility regulation recognizes only original-cost rate base. However, assuming the continued ability to bill customers for increases in power supply costs and the receipt of adequate and timely rate relief, UPPCO will recover cost escalations caused by inflation.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ____________________________________________________
The following independent auditors' report and consolidated financial statements of the registrant for the year ended December 31, 1996, are included herein:
Independent Auditors' Report dated February 7, 1997.
Statements of Income--Years ended December 31, 1996, 1995 and 1994.
Statements of Cash Flows--Years ended December 31, 1996, 1995 and 1994.
Balance Sheets--December 31, 1996 and 1995.
Statements of Changes in Common Equity--Years ended December 31, 1996, 1995 and 1994.
Statements of Capitalization--December 31, 1996 and 1995.
Notes to Financial Statements--December 31, 1996.
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation and integrity of the financial statements and representations in this annual report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles as applied to regulated utilities and necessarily include some amounts that are based on informed judgements and best estimates of management.
To meet its responsibilities with respect to financial information, management maintains and enforces a system of internal accounting controls designed to provide assurance, on a cost-effective basis, that transactions are carried out in accordance with management's authorizations and assets are safeguarded against loss from unauthorized use or disposition. Management believes the Company's accounting policies and controls prevent material errors and irregularities and allow employees in the normal course of their duties to detect inaccuracies within a timely period.
Directors who are not officers or employees make up the Audit Committee of the Board of Directors. The committee meets with management, the internal auditor, and the Company's independent auditors to discuss auditing, internal accounting controls, and financial reporting matters. The independent auditors and internal auditor have free access to the committee, without management's presence, to discuss the results of their audits.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Upper Peninsula Energy Corporation
We have audited the consolidated balance sheets and statements of capitalization of Upper Peninsula Energy Corporation and its subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in common equity, and cash flows for each of the three years in the period ended December 31, 1996 listed in Item 8. Our audits also included the financial statement schedule listed in Item 14. These financial state- ments and financial statement schedule are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Upper Peninsula Energy Corporation and its subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP - ---------------------------------------- Deloitte & Touche LLP Chicago, Illinois February 7, 1997
CONSOLIDATED STATEMENTS OF INCOME
_________________________________________________________________________ The accompanying notes are an integral part of these financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
__________________________________________________________________________ The accompanying notes are an integral part of these financial statements.
CONSOLIDATED BALANCE SHEETS
__________________________________________________________________________ The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON EQUITY
__________________________________________________________________________ The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENTS OF CAPITALIZATION
__________________________________________________________________________ The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
General
The consolidated financial statements include the accounts of Upper Peninsula Energy Corporation (UPEN), a holding Company incorporated in 1988 under the laws of the State of Michigan, and its wholly owned subsidiaries (Company). All significant intercompany balances and transactions have been eliminated in consolidation.
UPEN's principal subsidiary, Upper Peninsula Power Company (UPPCO), is the primary source of earnings. UPPCO, incorporated in 1947 under the laws of the State of Michigan, is an electric utility engaged in the generation, purchase, transmission, distribution, and sale of electric energy in the Upper Peninsula of Michigan.
UPPCO supplies electric energy to approximately 48,000 customers in two-thirds of Michigan's Upper Peninsula. UPPCO's service territory covers 4,460 square miles and has a population of about 130,000. Its service area is contiguous except for a small area around the city of Iron River near the northeastern Wisconsin border.
UPEN has two other subsidiaries. Upper Peninsula Building Development Company owns the corporate headquarters building and leases it to UPPCO under a twenty-year renewable lease. PENVEST, Inc., was formed to investigate opportunities in tele- communications, engineering services, and other non-regulated businesses.
The accounting records of UPPCO are maintained in accordance with the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission (FERC) and the Michigan Public Service Commission (MPSC).
Utility Plant
Plant is stated at original cost. The cost of property additions, including replacements of units of property and betterments, is capitalized. Cost includes contract labor, Company labor, materials, allowance for funds used during construction, and overheads. Expenditures for maintenance and repairs of property and costs of replacing items determined to be less than units of property are charges to operating expenses. The original cost of property and the cost of removal, less salvage, are charged to accumulated provision for depreciation when the property is retired. Substantially all utility property is subject to lien and collateralized under first mortgage bonds.
Regulatory Assets and Liabilities
UPPCO is subject to the provisions of Statement of Financial Accounting Standard No. 71 (SFAS 71), "Accounting for the Effects of Certain Types of Regulation." Regulatory assets represent probable future revenue associated with certain costs that will be recovered from customers through the ratemaking process. Regulatory liabilities represent amounts previously collected from customers that are refundable in future rates.
The following regulatory assets and (liabilities) were reflected in the Consolidated Balance Sheets as of December 31:
Based on prior and current rate treatment of costs, management believes it is probable that UPPCO will continue to recover from ratepayers the deferred charges described above.
Allowance for Funds Used During Construction (AFUDC)
AFUDC is defined in the applicable regulatory system of accounts as the net cost, during the period of construction, of borrowed funds used for construction purposes and a reasonable rate on equity funds when so used. Allowance for borrowed funds used during construction also includes interest capitalized on qualifying assets of nonutility subsidiaries. The cost-of- borrowed-funds element of AFUDC is reported as a reduction of interest expense, and the noncash equity portion is reported as other income. AFUDC was capitalized on utility construction at a rate of 8.93% in 1996, 1995, and 1994, as ordered by the MPSC.
Depreciation and Amortization
For financial statement purposes, the original cost of utility property is depreciated by the straight-line method over its estimated service life. UPPCO's depreciation for book purposes, approved by the MPSC and calculated during each of the years ended December 31, 1996, 1995, and 1994, was equivalent to approximately 3.5% of depreciable plant in 1996 and 3.7% in 1995 and 1994. For income tax purposes, accelerated methods of depreciation are utilized.
Debt expense is amortized over the lives of the remaining debt issues.
Inventories
All inventories are valued at average cost.
Income Taxes
Deferred federal income taxes are provided for significant temporary differences between book and taxable income.
Investment tax credits used to offset federal income taxes are being amortized ratably over the estimated service lives of the related properties.
Revenue and Expense Recognition
UPPCO utilizes monthly cycle billing and records revenue based on bills rendered. Revenue is not accrued for energy delivered but unbilled at the end of the year. Cost of service rendered is recognized as incurred.
UPPCO is required under Public Act 304 to receive MPSC approval each year to recover projected fuel and purchased-power costs ("power supply costs") by establishment of power supply cost recovery (PSCR) factors. These factors are subject to annual reconciliation to actual costs and permit 100% recovery of power supply costs. Any over-or-under-recovery is deferred on the consolidated balance sheets, and such deferrals are relieved as refunds or additional billings are made.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Statements of Cash Flows
For purposes of the statements of cash flows, all highly liquid investments with original maturities of three months or less are considered to be cash equivalents.
Reclassification
Certain items previously reported have been reclassified to conform to current presentation in the financial statements.
2. Compensating Balances and Short-Term Borrowings
The Company's unused lines of credit available at December 31, 1996, totalled $5,500,000. During the past three years, portions of demand deposits maintained in lending banks were deemed to constitute compensating balances but were not legally restricted. Because such compensating amounts are based on average daily balances, cash is not restricted as of any one day.
3. Other Accounts Receivable
Under contract with Wisconsin Electric Power Company (WEPCO), UPPCO staffs and operates WEPCO's Presque Isle Power Plant located in Marquette, Michigan. Under the terms of the contract, UPPCO receives a management fee plus reimbursement for all costs associated with labor and other services provided. UPPCO had current receivables from WEPCO at year-end 1996 and 1995 of approximately $1,165,000 and $1,035,000, respectively, in connection with the above. UPPCO also has other contracts with WEPCO generally relating to wheeling, dispatching, and transmission maintenance. In December 1996, WEPCO gave notification of termination of the Presque Isle Power Plant Operating Agreement effective December 31, 1997. Company management believes that this action will not have a material adverse effect on its financial position or results of operations.
4. Common Stock
On December 31, 1996, there were approximately 425 employees eligible to participate in the employee stock purchase plan. On June 1, 1996, 172 employees purchased 7,424 shares at $17.55 per share, and on December 1, 1996, 159 employees purchased 6,640 shares at $17.10 per share.
A Dividend Reinvestment and Common Stock Purchase Plan (DRIP) provides for automatic reinvestment of common dividends and allows shareholders quarterly optional cash payments, within specific limits, for the purchase of additional shares under the plan. Shares of common stock for the above plans are purchased on the open market.
5. Dividend Restriction
UPPCO's indentures relating to first mortgage bonds contain certain limitations on the payment of cash dividends on common stock. Under the most restrictive of these provisions, approximately $15,659,000 of consolidated retained earnings was available at December 31, 1996, for the payment of common stock cash dividends by UPEN.
6. Preferred and Preference Stock
UPPCO is obligated under the terms of the Preferred Stock Purchase Agreements of the 5-1/4% and 4.70% of redeemable preferred stocks to annually offer to purchase, at prices not to exceed $100 per share plus accrued dividends, 3% of the maximum number of shares of each series issued, less any shares theretofore purchased as a purchase-fund credit for such year, and will offer to purchase, at $100 per share plus accrued dividends at May 1, 2002, all of the shares then outstanding under the above redeemable preferred stock issues. All shares so purchased and surrendered shall be cancelled and shall not be reissued. Maximum annual purchase-fund requirements as to outstanding shares of redeemable preferred stock are $75,000 for 1997 through 2001. At December 31, 1996, the optional redemption prices per share of the 5-1/4% and 4.70% shares were $105.00 and $101.00, respectively.
UPPCO has 1,000,000 shares of authorized but unissued $1 par value preference stock, which may be divided into and issued in one or more series from time to time as UPPCO's Board of Directors may direct. The preference stock shall be junior to the preferred stock but in preference to the common stock.
UPEN has 500,000 shares of authorized but unissued $.01 par value preferred stock, which may be divided into and issued in one or more series from time to time as UPEN's Board of Directors may direct.
7. Long-Term Debt
Amounts of long-term debt due in each of the five years subsequent to December 31, 1996, aggregate approximately $242,000 for 1997, $260,000 for 1998, $884,000 for 1999, $719,000 for 2000, and $683,000 for 2001.
As of December 31, 1996, the market value of UPEN's long-term debt was $47.4 million. This debt has a recorded value of $43.5 million.
8. Federal Income Taxes
Federal income taxes comprise the following:
Federal income tax expense applicable to current operations differs from the amount computed by applying the statutory rate on book income subject to tax for the following reasons:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant items included in the Company's net deferred tax liability as of December 31, 1996 and 1995, are as follows:
9. Retirement Benefits
UPPCO has a noncontributory, defined-benefit pension plan, as amended, covering full-time employees, subject to age and period-of-employment conditions, that provides benefits based on years of service and employee compensation. The current funding policy is to contribute to the plan amounts necessary to comply with the funding provision of the Employee Retirement Income Security Act of 1974 (ERISA). Contributions of $2,099,000, $1,385,000 and $3,500,000, were made in 1996, 1995, and 1994, respectively.
UPPCO has a noncontributory supplemental retirement plan for certain senior management employees that provides for benefit payments over a fifteen-year period to the participant upon retirement or to the participant's spouse upon death prior to retirement. This retirement plan is non funded, and benefits are paid by UPPCO from its general assets.
Net periodic pension cost for accounting purposes for 1996, 1995, and 1994 included the following components:
Net periodic pension expense includes amounts charged to WEPCO in connection with the operation of the Presque Isle Power Plant of $516,000, $673,000, and $849,000, and for 1996, 1995, and 1994, respectively.
A reconciliation of the funded status of the plans to the amounts recognized in the December 31 financial statements follows:
The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations were 7.5% and 4.0% for 1996 and 7.5% and 5.0% for 1995. The expected long-term rate of return on assets was 8.5%. Plan assets consist principally of common stock of public companies, corporate bonds, and U.S. government securities. Figures reported include benefits of UPPCO employees assigned to the Presque Isle Power Plant.
UPPCO had a sick leave payback provision in its contract with bargaining unit employees that provided for a lump-sum payment of accumulated sick days upon termination at the then-current wage rate up to a maximum of 100 days. This provision was changed in 1995 wherein the number of days and wage rate were capped at the May 1, 1995, level, and the payment is due only upon retirement. New hires will receive no such payments. Therefore, in 1995 a curtailment gain of $168,000 was realized.
10. Postretirement Benefits Other Than Pension
UPPCO provides certain health care and life insurance benefits for retired employees. Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employer's Accounting for Postretirement Benefits Other Than Pensions," requires the accrual of the cost of certain postretirement benefits other than pensions over the active service life of the employee. UPPCO previously recorded these costs on the pay-as-you-go (cash) basis. Effective January 1, 1993, UPPCO adopted SFAS 106. In 1993 UPPCO received MPSC approval in a general rate order to defer $574,000 in 1993 SFAS 106 postretirement health care costs as a regulatory asset to be amortized over 19 years to match rate recovery.
Net periodic postretirement benefits for accounting purposes in 1996 and 1995 included the following components:
Net periodic postretirement expense includes amounts charged to WEPCO in connection with the operation of the Presque Isle Power Plant of $564,000, $519,000, and $607,000 for 1996, 1995, and 1994, respectively.
A reconciliation of the funded status of the plan to the amounts recognized in the December 31 financial statements follows:
For measurement purposes, a 10.4% and 6.1% annual rate of increase in the per capita cost of covered health care benefits for participants under age 65 and over age 65, respectively, were assumed for 1996; both of the rates were assumed to decrease gradually to 5.5% for 2005 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rate by one (1) percentage point per year would increase the accumulated postretirement benefit obligation as of December 31, 1996, by $2,186,650 and the aggregate of the service cost and the interest cost components of the net periodic postretirement benefit cost for the year then ended by $187,744.
The obligations disclosed as of December 31, 1996 and 1995, used a discount rate of 7.5% to measure the accumulated postretirement benefit obligation.
11. Commitments and Contingencies
UPPCO has a service schedule to a purchase-power agreement with WEPCO that entitles UPPCO to purchase 65 MW of capacity through 1997. UPPCO pays $413,000 per month for this entitlement.
The Company is subject to various unresolved legal matters that arose in the normal course of business. Although it is not possible to predict the outcome of these legal actions, Company management believes that these actions will not have a material adverse effect on its financial position or results of operations.
Cost of the construction program for 1997 is estimated to be $3,900,000. In connection therewith, certain commitments have been made.
12. Quarterly Information (Unaudited)
The quarterly information has not been audited but in the opinion of the Company reflects all adjustments necessary for the fair statement of results of operations for each period.
The lower net income in the fourth quarter of 1995 reflects an increase in scheduled maintenance expenditures.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ______________________________________________________
There are no disagreements on accounting and financial disclosures between the Registrant and its accountants, Deloitte & Touche LLP.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ____________________________________________________________
The relevant information appearing under the captions, "Election of Directors", "Directors' Compensation", and "Directors' and Committee Meetings and Functions" in the Registrant's Proxy Statement (filed pursuant to Regulation 14A) with respect to the Registrant's April 22, 1997 Annual Meeting of Shareholders is incorporated herein by reference.
Item 11.
Item 11. EXECUTIVE COMPENSATION ________________________________
The relevant information appearing under the captions "Compensation Committee Report on Executive Compensation", "Summary Compensation Table", "Pension Plans", "Supplemental Retirement Plan", "Termination of Employment and Change of Control Statement Arrangements" and "Other Compensation Plans (filed pursuant to Regulation 14A) with respect to the Registrant's April 22, 1997 Annual Meeting of Shareholders is incorporated herein by reference.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT _____________________________________________________________
The information appearing in the first paragraph under the caption "Stock Outstanding, Voting Rights and Votes Required" and the material under the caption "Election of Directors" in the Registrant's Proxy Statement (filed pursuant to Regulation 14A) with respect to the Registrant's April 22, 1997 Annual Meeting of Shareholders is incorporated herein by reference.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ________________________________________________________
The information appearing under the caption "Transactions with Management" in the Registrant's Proxy Statement (filed pursuant to Regulation 14A) with respect to the Registrant's April 22, 1997 Annual Meeting of Shareholders is incorporated herein by reference.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K ______________________________________________________________
(a) 1. List of financial statements: Management's Responsibility for Financial Statements Independent Auditors' Report dated February 7, 1997. Consolidated Balance Sheets--December 31, 1996 and 1995. Consolidated Statements of Income--Years ended December 31, 1996, 1995 and 1994. Consolidated Statements of Cash Flows--Years ended December 31, 1996, 1995 and 1994. Consolidated Statements of Changes in Common Equity-- Years ended December 31, 1996, 1995 and 1994. Consolidated Statements of Capitalization-- December 31, 1996 and 1995. Notes to Financial Statements--December 31, 1996.
2. Schedule II Valuation and Qualifying Accounts and Provisions--Years ended December 31, 1996, 1995 and 1994.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, or are included in the information with the Annual Report to Shareholders and therefore have been omitted.
3. List of Exhibits
Exhibit No. Description of Exhibit __________ ______________________
( 3) Articles of Incorporation and Bylaws
3(a) --- Articles of Incorporation of Registrant (Exhibit 3(i) to Registration Statement No. 33-24066, filed on August 30, 1988) 3(b) --- Bylaws of the Registrant (Exhibit 3(ii) to Registration Statement No. 33-24066, filed on August 30, 1988)
[INSTRUMENTS TO WHICH UPPCO IS A PARTY]
3.1(a) --- 1980 Restated Articles of Incorporation of UPPCO, Incorporating Amendments No. 1, 2 and 3 (Exhibit 3.1(a) to Form 10-K, dated March 27, 1991) 3.1(b) --- Bylaws of UPPCO as amended and restated through June 8, 1988 (Exhibit 3.1(b) to Form 10-K, dated March 29, 1989)
[INSTRUMENTS TO WHICH UPBDC IS A PARTY]
3.2(a) --- Certificate of Articles of Incorporation of UPPCO dated January 18, 1989 (Exhibit 3.2(a) to Form 10-K, dated March 28, 1990) 3.2(b) --- Bylaws of UPBDC (Exhibit 3.2(b) to Form 10-K, dated March 28, 1990)
[INSTRUMENTS TO WHICH PENVEST, INC. IS A PARTY]
3.3(a) --- Certificate of Articles of Incorporation of PENVEST dated October 20, 1995 (Filed herewith) 3.3(b) --- Bylaws of PENVEST, INC. (Filed herewith)
( 4) Instruments defining the rights of security holders, including indentures
[INSTRUMENTS TO WHICH UPPCO IS A PARTY]
4.1(a)-1 --- Indenture of Mortgage dated May 1, 1947 relating to UPPCO's First Mortgage Bonds. (Exhibit 4(d)-1 to Form 8-K, dated December 13, 1988) 4.1(a)-2 --- Supplemental Indenture dated as of May 1, 1947. (Exhibit 4(d)-2 to Form 8-K, dated December 13, 1988) 4.1(a)-3 --- Second Supplemental Indenture dated as of December 1, 1948. (Exhibit 4(d)-3 to Form 8-K, dated December 13, 1988) 4.1(a)-4 --- Third Supplemental Indenture dated as of November 1, 1950. (Exhibit b(1)(d)4 to Registration No. 2-66759)* 4.1(a)-5 --- Fourth Supplemental Indenture dated as of October 1, 1953. (Exhibit b(1)(d)5 to Registration No. 2-66759)* 4.1(a)-6 --- Fifth Supplemental Indenture dated as of April 1, 1957. (Exhibit b(1)(d)6 to Registration No. 2-66759)* 4.1(a)-7 --- Sixth Supplemental Indenture dated as of September 1, 1958. (Exhibit b(1)(d)7 to Registration No. 2-66759)* 4.1(a)-8 --- Seventh Supplemental Indenture dated as of May 1, 1961. (Exhibit b(1)(d)8 to Registration No. 2-66759)* 4.1(a)-9 --- Eighth Supplemental Indenture dated as of May 1, 1963. (Exhibit b(1)(d)9 to Registration No. 2-66759)* 4.1(a)-10 --- Ninth Supplemental Indenture dated as of January 1, 1971. (Exhibit 4(d-10 to Form 8-K, dated December 13, 1988) 4.1(a)-11 --- Tenth Supplemental Indenture dated as of November 1, 1973. (Exhibit 4(d-11 to Form 8-K, dated December 13, 1988) 4.1(a)-12 --- Eleventh Supplemental Indenture dated as of May 1, 1976. (Exhibit 4(d-12 to Form 8-K, dated December 13, 1988) 4.1(a)-13 --- Twelfth Supplemental Indenture dated as of August 1, 1981 (Exhibit 4(a)-13 to Form 10-K, dated March 26, 1982)* 4.1(a)-14 --- Thirteenth Supplemental Indenture dated as of November 1, 1988 (Exhibit 4(d-14 to Form 8-K, dated December 13, 1988) 4.1(a)-15 --- Fourteenth Supplemental Indenture dated as of November 1, 1991 (Exhibit 4.1(a)-15 to Form 10-Q, dated November 11, 1991) 4.1(a)-16 --- Fifteenth Supplemental Indenture dated as of March 1, 1993 (Exhibit 4.1(a)-16 to Form 10-K, dated March 25, 1993) 4.1(b) --- Installment Sales Contract between the Village of L'Anse and UPPCO dated May 1, 1974. (Exhibit A-II to Form 8-K, dated July 10, 1974)* 4.1(c)-1 --- Lease and Security Agreement dated May 9, 1977 between UPPCO, as lessee and debtor, and PruLease, Inc., as lessor and secured party. (Exhibit 5 to Form 10-K dated March 28, 1978)* 4.1(c)-2 --- Amendment No. 1 to Lease and Security Agreement dated June 29, 1979 between UPPCO, as lessee and debtor, and PruLease, Inc. as lessor and secured party. (Exhibit b(1)(d)15 to Registration No. 2-66759)* 4.1(c)-3 --- Amendment No. 2 to Lease and Security Agreement dated May 1, 1982 between UPPCO, as lessee and debtor, and PruLease, Inc. as lessor and secured party. (Exhibit 4(c)-3 to Form 10-K dated March 28, 1983)* 4.1(c)-4 --- Loan Agreement dated as of June 30, 1988 between UPPCO and First of America Bank-Copper Country (Exhibit 4.1(c)-4 to Form 10-K dated March 29, 1989) 4.1(d) --- Lease Agreement dated as of November 13, 1991 between UPPCO and UPBDC (Exhibit 4.1(d) to Form 10-K dated March 25, 1992)
[INSTRUMENTS TO WHICH UPBDC IS A PARTY]
4.2(a) --- Trust Indenture, Mortgage and Security Agreement dated November 1, 1991, relating to UPBDCO's Senior Secured Note (Exhibit 4.2(a) to Form 10-K dated March 25, 1992) 4.2(c) --- Loan Agreement dated as of June 20, 1989 between UPBDC and National Bank of Detroit. (Exhibit 4.2(c) to Form 10-K, dated March 28, 1990) 4.2(d) --- Lease Agreement dated as of November 13, 1991 between UPBDC and UPPCO (Exhibit 4.2(d) to Form 10-K dated March 25, 1992
( 9) Voting Trust Agreement N/A
(10) Material Contracts
[INSTRUMENTS TO WHICH UPPCO IS A PARTY]
10.1(e)-8 --- Plant Operating Agreement, effective June 1, 1988 between UPPCO and the City of Escanaba (Exhibit 10.1(e)-8 to Form 10-K dated March 29, 1989) 10.1(e)-9 --- Interconnection Agreement, effective June 1, 1988 between UPPCO and the City of Escanaba (Exhibit 10.1(e)-9 to Form 10-K dated March 29, 1989) 10.1(e)-10 --- Dispatch Services Agreement, effective September 8, 1988 between UPPCO and the City of Escanaba (Exhibit 10.1(e)-10 to Form 10-K dated March 29, 1989) 10.1(f)-1 --- Contract among UPPCO and Board of Light and Power of the City of Marquette, Michigan, dated September 7, 1978 for 20 mW of capacity from City of Marquette plant. (Exhibit 10.1(f) to Form 10-K, dated March 28, 1990) 10.1(f)-2 --- Addendum to contract among UPPCO and Board of Light and Power of the City of Marquette, Michigan, dated February 16, 1982. (Exhibit 10(f)-1 to Form 10-K, dated March 26, 1982)* 10.1(g)-1 --- Power Plant Operating Agreement dated as of December 31, 1987 by and among UPPCO and WEPCO pertaining to operating the Presque Isle Power Plant and certain related facilities (Exhibit 10(g)-1 to Form 10-K, dated March 29, 1988)* 10.1(g)-1.1--- Power Plant Operating Agreement dated as of July 26, 1990 by and among UPPCO and WEPCO pertaining to operating the Presque Isle Power Plant and certain related facilities (Exhibit 1 to Form 10-Q, dated August 10, 1990) 10.1(g)-2 --- Dispatch Agreement dated as of December 8, 1987 between UPPCO and WEPCO pertaining to electric power dispatch functions for the Presque Isle Power Plant (Exhibit 10(g)-2 to Form 10-K, dated March 29, 1988)* 10.1(g)-2. --- Amendment No. 1 to Dispatch Agreement dated as of October 31, 1990 between UPPCO and WEPCO pertaining to electric power dispatch functions for the Presque Isle Power Plant (Exhibit 1 to Form 10-Q, dated November 12, 1990) 10.1(g)-3 --- Transmission Maintenance Agreement dated as of December 31, 1987 between UPPCO and WEPCO pertaining to the mainte- nance of certain WEPCO transmission and substation facilities (Exhibit 10(g)-3 to Form 10-K, dated March 29, 1988)* 10.1(g)-3.1--- Amendment No. 1 to Transmission Maintenance Agreement dated as of October 31, 1990 between UPPCO and WEPCO pertaining to the maintenance of certain WEPCO transmission and sub- station facilities (Exhibit 2 to Form 10-Q, dated November 12, 1990) 10.1(g)-4 --- Joint Use of Transmission Agreement dated as of December 8, 1987 between UPPCO and WEPCO (Exhibit 10(g)-4 to Form 10-K, dated March 29, 1988)* 10.1(g)-4.1--- Amendment No. 1 to Joint Use of Transmission Agreement dated as of October 31, 1990 between UPPCO and WEPCO (Exhibit 3 to Form 10-Q, dated November 12, 1990) 10.1(g)-5 --- Amendment dated December 8, 1987 to Interconnection Agreement dated April 9, 1974, as amended August 8, 1980 and February 2, 1982, between UPPCO and WEPCO (Exhibit 10(g)-5 to Form 10-K, dated March 29, 1988)* 10.1(g)-6 --- Joint Use and Facility Sharing Agreement dated as of October 9, 1990 between UPPCO and WEPCO (Exhibit 10.1(g)-6 to Form 10-K, dated March 27, 1991) 10.1(h)-1 --- Performance Incentive Plan for Officers of UPPCO, effective January 1, 1990 (Exhibit 10.1(h)-1 to Form 10-K, dated March 27, 1991) 10.1(i)-1 --- Power Supply Agreement dated September 17, 1993 between UPPCO and Northern States Power Company (Exhibit 1 to Form 10-K, dated March 24, 1994)
* Parenthetical references following descriptions of Upper Peninsula Power Company instruments are to filings made by that Company. 1934 ACT File No. is 0-1276
(11) Statement re computation of per share earnings N/A
(12) Statements re computation of ratios N/A
(18) Letter re change in accounting principles N/A
(21) Subsidiaries of the registrant:
21(a) --- UPPCO, incorporated in 1947 under the laws of the State of Michigan doing business under the same name. 21(b) --- UPBDC, incorporated in 1989 under the laws of the state of Michigan doing business under the same name. 21(c) --- PENVEST, incorporated in 1995 under the laws of the State of Michigan doing business under the same name.
(22) Published report regarding matters submitted to vote of security holders N/A
(23) Consents of experts and counsel
23(a) --- Consent of Independent Certified Public Accountants (Filed herewith)
(24) Power of attorney N/A
(27) Financial Data Schedule (Filed herewith)
(28) Information from reports furnished to state insurance regulatory authorities. N/A
(b) Reports on Form 8-K filed in the fourth quarter of 1996. No reports on Form 8-K have been filed during the last quarter of 1996.
(c) The exhibits filed herewith are identified above.
(d) See Item (a)2 above.
(99) Additional Exhibits
99(a) --- Notice of Annual Meeting and Proxy Statement with respect to Registrant's April 22, 1997 Annual Meeting of Shareholders (Filed March 19, 1997)
S I G N A T U R E S
Pursuant to the requirements of Section 13 or 15(d) 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.
UPPER PENINSULA ENERGY CORPORATION __________________________________ (Registrant)
Date: March 27, 1997 /s/ B. C. Arola __________________________________ B. C. Arola Vice President, Treasurer and Secretary (Principal Financial Officer and Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ L. Angeli 3/17/97 /s/ C. R. Fisher 3/17/97 _______________________________ ________________________________ L. Angeli, Director (Date) C. R. Fisher, Chairman (Date) of the Board and President (Principal Executive Officer)
/s/ S. S. Benedict 3/17/97 /s/ T. M. Strong 3/17/97 _______________________________ ________________________________ S. S. Benedict, Director (Date) T. M. Strong, Director (Date)
/s/ R. T. Ederer 3/17/97 /s/ R. A. Ubbelohde 3/17/97 _______________________________ ________________________________ R. T. Ederer, Director (Date) R. A. Ubbelohde, Director (Date)
SCHEDULE II
UPPER PENINSULA ENERGY CORPORATION AND SUBSIDIARIES ____________________________________________________ VALUATION AND QUALIFYING ACCOUNTS AND PROVISIONS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 and 1994