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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------- --------
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
- -----------------------------------------------------------------------------------------------
1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
Fairlane Plaza South, Suite 1100
330 Town Center Drive, Dearborn, Michigan 48126
(313)436-9200
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
212 West Michigan Avenue, Jackson, Michigan 49201
(517)788-0550
1-2921 PANHANDLE EASTERN PIPE LINE COMPANY 44-0382470
(A Delaware Corporation)
5444 Westheimer Road, P.O. Box 4967, Houston,
Texas 77210-4967
(713)989-7000
Indicate by check mark whether the Registrants (1) have 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
Registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Panhandle Eastern Pipe Line Company meets the conditions set forth in General
Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q
with the reduced disclosure format. In accordance with Instruction H, Part I,
Item 2 has been reduced and Part II, Items 2, 3 and 4 have been omitted.
Number of shares outstanding of each of the issuer's classes of common stock at
July 31, 2002:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 143,872,669
CONSUMERS ENERGY COMPANY, $10 par value, privately held by CMS Energy 84,108,789
PANHANDLE EASTERN PIPE LINE COMPANY, no par value,
indirectly privately held by CMS Energy 1,000
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CMS ENERGY CORPORATION
AND
CONSUMERS ENERGY COMPANY
AND
PANHANDLE EASTERN PIPE LINE COMPANY
QUARTERLY REPORTS ON FORM 10-Q TO THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED JUNE 30, 2002
This combined Form 10-Q is separately filed by each of CMS Energy Corporation,
Consumers Energy Company and Panhandle Eastern Pipe Line Company. Information
contained herein relating to each individual registrant is filed by such
registrant on its own behalf. Accordingly, except for their respective
subsidiaries, Consumers Energy Company and Panhandle Eastern Pipe Line Company
make no representation as to information relating to any other companies
affiliated with CMS Energy Corporation.
TABLE OF CONTENTS
Page
------
Glossary............................................................................... 4
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
"Round Trip" Trades and Pending Restatement................................... CMS - 1
Results of Operations........................................................ CMS - 2
Critical Accounting Policies.................................................. CMS - 7
Capital Resources and Liquidity............................................... CMS - 12
Market Risk Information....................................................... CMS - 17
Outlook....................................................................... CMS - 19
Other Matters................................................................. CMS - 28
Consolidated Financial Statements
Consolidated Statements of Income............................................. CMS - 29
Consolidated Statements of Cash Flows......................................... CMS - 30
Consolidated Balance Sheets................................................... CMS - 32
Consolidated Statements of Common Stockholders' Equity........................ CMS - 34
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation............................ CMS - 35
2. Discontinued Operations.................................................. CMS - 38
3. Asset Disposition........................................................ CMS - 40
4. Goodwill................................................................. CMS - 41
5. Uncertainties............................................................ CMS - 41
6. Short-Term and Long-Term Financings, and Capitalization.................. CMS - 58
7. Earnings Per Share and Dividends......................................... CMS - 61
8. Risk Management Activities and Financial Instruments..................... CMS - 62
9. Reportable Segments...................................................... CMS - 66
2
TABLE OF CONTENTS
(CONTINUED)
Page
------
Consumers Energy Company
Management's Discussion and Analysis
Critical Accounting Policies.................................................. CE - 1
Results of Operations......................................................... CE - 5
Capital Resources and Liquidity............................................... CE - 7
Outlook....................................................................... CE - 10
Other Matters................................................................. CE - 16
Consolidated Financial Statements
Consolidated Statements of Income............................................. CE - 20
Consolidated Statements of Cash Flows......................................... CE - 21
Consolidated Balance Sheets................................................... CE - 22
Consolidated Statements of Common Stockholder's Equity........................ CE - 24
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies....... CE - 25
2. Uncertainties............................................................ CE - 28
3. Short-Term Financings and Capitalization................................. CE - 39
Panhandle Eastern Pipe Line Company
Management's Discussion and Analysis
Results of Operations......................................................... PE - 2
Critical Accounting Policies.................................................. PE - 4
Liquidity..................................................................... PE - 6
Outlook...................................................................... PE - 7
Other Matters................................................................. PE - 9
Consolidated Financial Statements
Consolidated Statements of Income............................................. PE - 12
Consolidated Statements of Cash Flows......................................... PE - 13
Consolidated Balance Sheets................................................... PE - 14
Consolidated Statements of Common Stockholder's Equity........................ PE - 16
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation............................ PE - 17
2. Regulatory Matters....................................................... PE - 19
3. Goodwill Impairment...................................................... PE - 20
4. Related Party Transactions............................................... PE - 20
5. Commitments and Contingencies............................................ PE - 21
6. Debt Rating Downgrades .................................................. PE - 23
7. System Gas .............................................................. PE - 24
8. Subsequent Event ........................................................ PE - 24
Quantitative and Qualitative Disclosures about Market Risk............................. CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.......................................................... CO - 1
Item 4. Submission of Matters to a Vote of Security Holders........................ CO - 3
Item 5. Other Information.......................................................... CO - 3
Item 6. Exhibits and Reports on Form 8-K........................................... CO - 4
Signatures............................................................................. CO - 6
3
GLOSSARY
Certain terms used in the text and financial statements
are defined below.
ABATE..............................Association of Businesses Advocating Tariff Equity
ALJ................................Administrative Law Judge
APB................................Accounting Principles Board
APB Opinion No. 18................ APB Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock"
APB Opinion No. 30.................APB Opinion No. 30, "Reporting Results of Operations -
Reporting the Effects of Disposal of a Segment of a
Business"
Accumulated Benefit Obligation.....The liabilities of a pension plan based on service and
pay to date. This differs from the Projected Benefit
Obligation that is typically disclosed in that it does
not reflect expected future salary increases
Alliance...........................Alliance Regional Transmission Organization
Arthur Andersen....................Arthur Andersen LLP
Articles...........................Articles of Incorporation
Attorney General...................Michigan Attorney General
bcf................................Billion cubic feet
BG LNG Services....................BG LNG Services, Inc., a subsidiary of BG Group of the
United Kingdom
Big Rock...........................Big Rock Point nuclear power plant, owned by Consumers
Board of Directors.................Board of Directors of CMS Energy
Bookouts...........................Unplanned netting of transactions from multiple contracts
Centennial........................ Centennial Pipeline, LLC, in which Panhandle owns a
one-third interest
Clean Air Act......................Federal Clean Air Act, as amended
CMS Capital........................CMS Capital Corp., a subsidiary of Enterprises
CMS Electric and Gas...............CMS Electric and Gas Company, a subsidiary of Enterprises
CMS Energy.........................CMS Energy Corporation, the parent of Consumers and
Enterprises
CMS Energy Common Stock............Common stock of CMS Energy, par value $.01 per share
CMS Gas Transmission...............CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Generation.....................CMS Generation Co., a subsidiary of Enterprises
CMS Holdings.......................CMS Midland Holdings Company, a subsidiary of Consumers
CMS Midland........................CMS Midland Inc., a subsidiary of Consumers
CMS MST............................CMS Marketing, Services and Trading Company, a subsidiary
of Enterprises
CMS Oil and Gas ...................CMS Oil and Gas Company, a subsidiary of Enterprises
CMS Panhandle Holdings, LLC .......A subsidiary of Panhandle Eastern Pipe Line
CMS Trunkline .................... CMS Trunkline Gas Company, LLC, a subsidiary of CMS Panhandle
Holdings, LLC
CMS Trunkline LNG .................CMS Trunkline LNG Company, LLC, a subsidiary of LNG
Holdings, LLC
CMS Viron..........................CMS Viron Energy Services, a wholly owned subsidiary of
CMS MST
Common Stock.......................All classes of Common Stock of CMS Energy and each of its
subsidiaries, or any of them individually, at the time of
an award or grant under the Performance Incentive Stock
Plan
Consumers..........................Consumers Energy Company, a subsidiary of CMS Energy
Consumers Campus Holdings..........Consumers Campus Holdings, L.L.C., a wholly owned
subsidiary of Consumers
Court of Appeals...................Michigan Court of Appeals
Customer Choice Act................Customer Choice and
Electricity Reliability Act, a Michigan
statute enacted in June 2000 that allows all
retail customers choice of
4
alternative electric suppliers as of January 1, 2002,
provides for full recovery of net stranded
costs and implementation costs, establishes a
five percent reduction in residential rates,
establishes rate freeze and rate cap, and
allows for Securitization
Detroit Edison.....................The Detroit Edison Company, a non-affiliated company
DIG................................Dearborn Industrial Generation, L.L.C., a wholly owned
subsidiary of CMS Generation
DIG Statement No. C16..............Derivatives Implementation Group, Statement 133
Implementation Issue No. C16, "Scope Exceptions:
Applying the Normal Purchases and Normal Sales Exception
to Contracts That Combine a Forward Contract and a
Purchased Option Contract"
DOE................................U.S. Department of Energy
Dow................................The Dow Chemical Company, a non-affiliated company
Duke Energy........................Duke Energy Corporation, a non-affiliated company
Energy Michigan....................Energy Michigan is a trade association for the
cogeneration, independent power and waste to energy
industries in Michigan.
Enterprises........................CMS Enterprises Company, a subsidiary of CMS Energy
EPA................................U. S. Environmental Protection Agency
EPS................................Earnings per share
Ernst & Young......................Ernst & Young LLP
FASB...............................Financial Accounting Standards Board
FERC...............................Federal Energy Regulatory Commission
FMLP...............................First Midland Limited Partnership, a partnership that
holds a lessor interest in the MCV facility
GCR................................Gas cost recovery
GTNs...............................CMS Energy General Term Notes(R), $200 million Series D,
$400 million Series E and $300 million Series F
Guardian ..........................Guardian Pipeline, LLC, in which Panhandle owns a
one-third interest
GWh................................Gigawatt-hour
Health Care Plan...................The medical, dental, and prescription drug programs
offered to eligible employees of Panhandle, Consumers and
CMS Energy
INGAA..............................Interstate Natural Gas Association of America
IPP................................Independent Power Producer
ISO................................Independent System Operator
Jorf Lasfar........................The 1,356 MW coal-fueled power plant in Morocco, jointly
owned by CMS Generation and ABB Energy Venture, Inc.
kWh................................Kilowatt-hour
LIBOR..............................London Inter-Bank Offered Rate
Loy Yang...........................The 2,000 MW brown coal fueled Loy Yang A power plant and
an associated coal mine in Victoria, Australia, in which
CMS Generation holds a 50 percent ownership interest
LNG................................Liquefied natural gas
5
LNG Holdings...................... CMS Trunkline LNG Holdings, LLC, jointly owned by CMS
Panhandle Holdings, LLC and Dekatherm Investor Trust
Ludington..........................Ludington pumped storage plant, jointly owned by
Consumers and Detroit Edison
mcf................................Thousand cubic feet
MCV Facility.......................A natural gas-fueled, combined-cycle cogeneration
facility operated by the MCV Partnership
MCV Partnership....................Midland Cogeneration Venture Limited Partnership in which
Consumers has a 49 percent interest through CMS Midland
MD&A...............................Management's Discussion and Analysis
MEPCC..............................Michigan Electric Power Coordination Center
METC...............................Michigan Electric Transmission Company, formally a
subsidiary of Consumers Energy and now an indirect
subsidiary of Trans-Elect
Michigan Gas Storage...............Michigan Gas Storage Company, a subsidiary of Consumers
Moody's ...........................Moody's Investors Service, Inc.
MPSC...............................Michigan Public Service Commission
MTH................................Michigan Transco Holdings, Limited Partnership
MW.................................Megawatts
NEIL...............................Nuclear Electric Insurance Limited, an industry mutual
insurance company owned by member utility companies
NMC................................Nuclear Management Company, LLC, formed in 1999 by
Northern States Power Company (now Xcel Energy Inc.),
Alliant Energy, Wisconsin Electric Power Company, and
Wisconsin Public Service Company to operate and manage
nuclear generating facilities owned by the four utilities
NRC................................Nuclear Regulatory Commission
OATT...............................Open Access Transmission Tariff
OPEB...............................Postretirement benefit plans other than pensions for
retired employees
Palisades..........................Palisades nuclear power plant, which is owned by Consumers
Panhandle..........................Panhandle Eastern Pipe Line Company, including its
subsidiaries Trunkline, Pan Gas Storage, Panhandle
Storage, and Panhandle Holdings. Panhandle is a wholly
owned subsidiary of CMS Gas Transmission
Panhandle Eastern Pipe Line........Panhandle Eastern Pipe Line Company, a wholly owned
subsidiary of CMS Gas Transmission
Panhandle Storage..................CMS Panhandle Storage Company, a subsidiary of Panhandle
Eastern Pipe Line Company
PCB................................Polychlorinated biphenyl
Pension Plan.......................The trusteed, non-contributory, defined benefit pension
plan of Panhandle, Consumers and CMS Energy
Powder River.......................CMS Oil & Gas previously owned a significant interest in
coalbed methane fields or projects developed within the
Powder River Basin which spans the border between Wyoming
and Montana. The Powder River properties have been sold
and reported as a discontinued operation for the three
months ended March 31, 2002
PPA................................The Power Purchase Agreement between Consumers and the
MCV Partnership with a 35-year term commencing in March
1990
6
Price Anderson Act.................Price Anderson Act, enacted in 1957 as an amendment to
the Atomic Energy Act of 1954, as revised and extended
over the years. This act stipulates between nuclear
licensees and the U.S. government the insurance,
financial responsibility, and legal liability for nuclear
accidents.
PSCR...............................Power supply cost recovery
PUHCA..............................Public Utility Holding Company Act of 1935
PURPA..............................Public Utility Regulatory Policies Act of 1978
RTO................................Regional Transmission Organization
SEC................................U.S. Securities and Exchange Commission
Securitization.....................A financing method authorized by statute and approved by
the MPSC which allows a utility to set aside
and pledge a portion of the rate payments
received by its customers for the repayment
of Securitization bonds issued by a special
purpose entity affiliated with such utility
SERP...............................Supplemental Executive Retirement Plan
SFAS...............................Statement of Financial Accounting Standards
SFAS No. 5.........................SFAS No. 5, "Accounting for Contingencies"
SFAS No. 13........................SFAS No. 13 "Accounting for Leases"
SFAS No. 71........................SFAS No. 71, "Accounting for the Effects of Certain Types
of Regulation"
SFAS No. 87........................SFAS No. 87, "Employers' Accounting for Pensions"
SFAS No. 106.......................SFAS No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions"
SFAS No. 115.......................SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities"
SFAS No. 121.......................SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be
Disposed Of"
SFAS No. 133.......................SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities, as amended and interpreted"
SFAS No. 142.......................SFAS No. 142, "Goodwill and Other Intangible Assets"
SFAS No. 143.......................SFAS No. 143, "Accounting for Asset Retirement
Obligations"
SFAS No. 144.......................SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets"
SFAS No. 145.......................SFAS No. 145, "Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and
Technical Corrections"
SFAS No. 146.......................SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities"
SIPS...............................State Implementation Plans
Stranded Costs.....................Costs incurred by utilities in order to serve their
customers in a regulated monopoly environment, which may
not be recoverable in a competitive environment because
of customers leaving their systems and ceasing to pay for
their costs. These costs could include owned and
purchased generation and regulatory assets.
Superfund..........................Comprehensive Environmental Response, Compensation and
Liability Act
Transition Costs...................Stranded Costs, as defined, plus the costs incurred in
the transition to competition.
Trust Preferred Securities.........Securities representing an undivided beneficial interest
in the assets of statutory business trusts,
the interests of which have a preference
7
with respect to certain trust distributions
over the interests of either CMS Energy or
Consumers, as applicable, as owner of the
common beneficial interests of the trust
8
CMS Energy Corporation
CMS ENERGY CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
CMS Energy is the parent holding company of Consumers and Enterprises. Consumers
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Enterprises, through subsidiaries, including Panhandle and its
subsidiaries, is engaged in several domestic and international diversified
energy businesses including: natural gas transmission, storage and processing;
independent power production; and energy marketing, services and trading.
The MD&A of this Form 10-Q should be read along with the MD&A and other parts of
CMS Energy's 2001 Form 10-K. This MD&A refers to, and in some sections
specifically incorporates by reference, CMS Energy's Condensed Notes to
Consolidated Financial Statements and should be read in conjunction with such
Consolidated Financial Statements and Notes. This report and other written and
oral statements that CMS Energy may make contain forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. CMS Energy's
intentions with the use of the words "anticipates," "believes," "estimates,"
"expects," "intends," and "plans," and variations of such words and similar
expressions, are solely to identify forward-looking statements that involve risk
and uncertainty. These forward-looking statements are subject to various factors
that could cause CMS Energy's actual results to differ materially from the
results anticipated in such statements. CMS Energy has no obligation to update
or revise forward-looking statements regardless of whether new information,
future events or any other factors affect the information contained in such
statements. CMS Energy does, however, discuss certain risk factors,
uncertainties and assumptions in this MD&A and in Item 1 of the 2001 Form 10-K
in the section entitled "Forward-Looking Statements Cautionary Factors and
Uncertainties" and in various public filings it periodically makes with the SEC.
CMS Energy designed this discussion of potential risks and uncertainties, which
is by no means comprehensive, to highlight important factors that may impact CMS
Energy's business and financial outlook. This report also describes material
contingencies in CMS Energy's Condensed Notes to Consolidated Financial
Statements, and CMS Energy encourages its readers to review these Notes.
"ROUND TRIP" TRADES AND PENDING RESTATEMENT
CMS MST engaged in simultaneous, prearranged commodity trading transactions in
which energy commodities were sold and repurchased at the same price during the
period of May 2000 through January 2002. These transactions, which had no impact
on previously reported consolidated net income, earnings per share or cash
flows, had the effect of increasing operating revenues, operating expenses,
accounts receivable, accounts payable and reported trading volumes. After
internally concluding that cessation of these trades was in CMS Energy's best
interest, these so called "round trip" trades were halted in January 2002.
CMS Energy accounted for these trades in gross revenue and expense through the
third quarter of 2001, but subsequently concluded that these round trip trades
should have been reflected on a net basis. In the fourth quarter of 2001, CMS
Energy ceased recording these trades in either revenues or expenses. CMS
Energy's 2001 Annual Report on Form 10-K, issued in March 2002, restated revenue
and expense for the first three quarters of 2001 to eliminate $4.2 billion of
previously reported revenue and expense. The 2001 Form 10-K did however reflect
$5 million of revenue and expense for 2001 from such trades, which was
erroneously not restated. Revenue and expense for 2000 were not restated at that
time.
In May 2002, CMS Energy stated its intention to amend, as soon as practical, its
2001 Form 10-K. The Form 10-K/A will reflect the elimination of $5 million of
revenue and expense related to round trip trades in 2001, the elimination of
approximately $122 million of outstanding accounts receivable and accounts
payable related to these transactions, and the elimination of approximately $1
billion of revenue and expense from round trip trades in 2000. CMS Energy
believes no amounts were outstanding in the consolidated balance sheet as of
December 31, 2000.
CMS-1
CMS Energy Corporation
CMS Energy is cooperating with the SEC investigation regarding "round trip"
trades and the Company's financial statements, accounting practices and
controls. CMS Energy is also cooperating with inquiries by the Commodity
Futures Trading Commission and the FERC regarding these transactions. CMS
Energy has also received subpoenas from the U.S. Attorney's Office for the
Southern District of New York and from the U.S. Attorney's Office in Houston
regarding investigations of these trades and has received or is aware of a
number of shareholder class action lawsuits. In addition CMS Energy's Board of
Directors has established a special committee of independent directors to
investigate matters surrounding "round trip" trading and has retained outside
counsel to assist in the investigation. The committee expects to complete its
investigation and report its findings to the Board of Directors by the end of
third quarter 2002. CMS Energy is unable to predict the outcome of these
matters.
Following CMS Energy's announcement that it would restate its financial
statements for 2000 and 2001 to eliminate the effects of "round trip" energy
trades and form a special committee of its Board of Directors to investigate
these trades, CMS Energy received formal notification from Arthur Andersen that
it had terminated its relationship with CMS Energy and affiliates. Arthur
Andersen notified CMS Energy that due to the investigation, Arthur Andersen's
historical opinions on CMS Energy's financial statements for the periods being
restated cannot be relied upon. Arthur Andersen also notified CMS Energy that
due to Arthur Andersen's current situation and the work of the special
committee, it would be unable to give an opinion on CMS Energy's restated
financial statements when they are completed. CMS Energy had previously
announced that it would no longer use Arthur Andersen for its independent audit
work and in May 2002, CMS Energy appointed Ernst & Young to audit the financial
statements for the year ending December 31, 2002.
Arthur Andersen clarified in its notification to CMS Energy that its decision
does not apply to separate, audited financial statements of Consumers Energy
Company and Panhandle Eastern Pipe Line Company for the applicable years. There
are no disagreements between CMS Energy and Arthur Andersen on any matter of
accounting principle or practice, financial statement disclosure, or auditing
scope or procedure during the years 2000 and 2001. Ernst & Young is currently
auditing CMS Energy's restated consolidated financial statements for each of the
fiscal years ended December 31, 2001 and December 31, 2000, and is expected to
release its opinion upon the completion of its audit procedures and the special
committee's investigation.
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED EARNINGS
For the three and six months ended June 30, 2002, consolidated net income
included gains on asset sales, restructuring costs associated with implementing
CMS Energy's new strategic direction, extraordinary losses associated with early
debt retirement, and the discontinued operations of CMS Oil and Gas and other
non-strategic businesses. The six months ended June 30, 2002 also reflect the
adoption of SFAS No. 142 as of January 1, 2002, which required a write-down of
goodwill at CMS MST. The following tables depict CMS Energy's Results of
Operations before and after the effects of the items mentioned above.
In Millions,
Except Per Share Amounts
---------------------------
Three months ended June 30 2002 2001
------- -------
CONSOLIDATED NET INCOME (LOSS) OF CMS ENERGY $ (75) $ 53
Net Asset Loss (Gain) (21) 1
Discontinued Operations Loss (Gain) 141 (19)
Restructuring Costs 7 --
Extraordinary Item 7 --
------- -------
Earnings Before Reconciling Items $ 59 $ 35
======= =======
CMS-2
CMS Energy Corporation
BASIC EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS (LOSS) PER SHARE $ (0.56) $ 0.40
Net Asset Loss (Gain) (0.16) 0.01
Discontinued Operations Loss (Gain) 1.05 (0.14)
Restructuring Costs 0.06 --
Extraordinary Item 0.05 --
------- -------
Earnings Per Share Before Reconciling Items $ 0.44 $ 0.27
======= =======
DILUTED EARNINGS PER AVERAGE COMMON SHARE OF
CMS ENERGY EARNINGS (LOSS) PER SHARE $ (0.56) $ 0.40
Net Asset Loss (Gain) (0.16) 0.01
Discontinued Operations Loss (Gain) 1.05 0.14
Restructuring Costs 0.06 --
Extraordinary Item 0.05 --
------- -------
Earnings Per Share Before Reconciling Items $ 0.44 $ 0.27
======= =======
For the three months ended June 30, 2002, consolidated net income before
reconciling items increased by $24 million. The increase reflects reduced power
supply costs from the 2001 unscheduled Palisades outage, improved earnings from
the independent power production business, and the beneficial effects of weather
on our gas and electric businesses, partially offset by expropriation and
devaluation issues in Argentina.
In Millions,
Except Per Share Amounts
---------------------------
Six months ended June 30 2002 2001
------- -------
CONSOLIDATED NET INCOME OF CMS ENERGY $ 314 $ 162
Net Asset Loss (Gain) (35) 1
Discontinued Operations Loss (Gain) (169) (20)
Restructuring Costs 7 --
Goodwill Accounting Change 9 --
Extraordinary Item 8 --
------- -------
Earnings Before Reconciling Items $ 134 $ 143
======= =======
BASIC EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS PER SHARE $ 2.34 $ 1.27
Net Asset Loss (Gain) (0.26) 0.01
Discontinued Operations Loss (Gain) (1.26) (0.15)
Restructuring Costs 0.06 --
Goodwill Accounting Change 0.07 --
Extraordinary Item 0.06 --
------- -------
Earnings Per Share Before Reconciling Items $ 1.01 $ 1.13
======= =======
DILUTED EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS PER SHARE $ 2.30 $ 1.25
Net Asset Loss (Gain) (0.26) 0.01
Discontinued Operations Loss (Gain) (1.22) (0.14)
Restructuring Costs 0.05 --
Goodwill Accounting Change 0.07 --
Extraordinary Item 0.05 --
------- -------
Earnings Per Share Before Reconciling Items $ 0.99 $ 1.12
======= =======
CMS-3
CMS Energy Corporation
For the six months ended June 30, 2002, consolidated net income before
reconciling items decreased by $9 million as compared to the same period in
2001. The decrease primarily reflects lower earnings from our marketing services
and trading business reduced power supply costs from the 2001 unscheduled
Palisades outage and lower Truckline LNG earnings reflecting the monetization of
the facility and the resulting lower spot rates effective in January 2002.
For further information, see the individual results of operations for each CMS
Energy business segment in this MD&A.
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC UTILITY NET INCOME:
In Millions
---------------------------------------
June 30 2002 2001 Change
---- ---- -----------
Three months ended $ 84 $ 30 $ 54
Six months ended 133 91 42
==== ==== ====
Three Months Six Months
Ended June 30 Ended June 30
Reasons for change 2002 vs 2001 2002 vs 2001
------------- -------------
Electric deliveries $ 7 $ --
Power supply costs and related revenue 34 18
Other operating expenses and non-commodity revenue (7) (7)
Gain on asset sales 38 38
Fixed charges 5 8
Income taxes (23) (15)
---- ----
Total change $ 54 $ 42
ELECTRIC DELIVERIES: For the three months ended June 30, 2002, electric
deliveries, including transactions with other electric utilities, were 9.4
billion kWh, an increase of 0.1 billion kWh, or 1.4 percent from the comparable
period in 2001. The increase in total electric deliveries was primarily due to
higher residential usage resulting from warmer June 2002 temperatures.
For the six months ended June 30, 2002, electric deliveries, including
transactions with other electric utilities, were 18.6 billion kWh, a decrease of
0.7 billion kWh, or 3.4 percent from the comparable period in 2001. This
decrease is the result of reduced first quarter industrial usage due to the
economic downturn.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended June 30,
2002, power supply costs decreased by $34 million from the comparable period in
2001. The decreased power costs in 2002 was primarily due to the higher
availability of the lower priced Palisades Nuclear Plant. In the 2001 period,
Consumers was required to purchase greater quantities of higher-priced power to
offset the loss of internal generation resulting from outages at Palisades.
For the six months ended June 30, 2002, power supply costs and related revenues
decreased by a total of $18 million from the comparable period in 2001. This
decrease was also the result of the Palisades outage described for the current
quarter partially offset by a plant outage at Palisades in early 2002.
CMS-4
CMS Energy Corporation
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUES: For the three and six
months ended 2002, other operating expenses increased $7 million due to
increased depreciation expense resulting from higher plant in service along with
a decrease in miscellaneous revenues.
GAIN ON ASSET SALES: For the three and six months ended 2002, asset sales
increased as a result of the $31 million pre-tax gain associated with the May
2002 sale of Consumers' electric transmission system and a $7 million pre-tax
gain on the sale of unused nuclear equipment from the cancelled Midland project.
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
GAS UTILITY NET INCOME:
In Millions
--------------------------------------
June 30 2002 2001 Change
---- ---- -----------
Three months ended $ 4 $ 1 $ 3
Six months ended 32 30 2
Three Months Six Months
Ended June 30 Ended June 30
Reasons for change 2002 vs 2001 2002 vs 2001
------------- -------------
Gas deliveries $ 9 $--
Gas rate increase 2 9
Gas wholesale and retail services 1 --
Operation and maintenance (4) --
Other operating expenses (4) (5)
Income taxes (1) (2)
--- ---
Total change $ 3 $ 2
=== ===
For the three months ended June 30, 2002, gas revenues increased due to colder
temperatures compared to the second quarter 2001. Operation and maintenance
cost increases reflect additional expenditures on customer reliability and
service. System deliveries, including miscellaneous transportation volumes,
totaled 65.3 bcf, an increase of 8.3 bcf or 14.7 percent compared with 2001.
For the six months ended June 30, 2002, gas revenues increased due to an interim
gas rate increase granted in December of 2001. System deliveries, including
miscellaneous transportation volumes, totaled 214.5 bcf, a decrease of 2 bcf or
..9 percent compared with 2001.
NATURAL GAS TRANSMISSION RESULTS OF OPERATIONS
NET INCOME: For the three months ended June 30, 2002, net income was $12
million, a decrease of $3 million (22 percent) from the comparable period in
2001. The decrease was primarily due to lower earnings from Trunkline LNG
reflecting fixed contract rates compared to higher spot rates in the second
quarter of 2001, and the impacts of Argentina expropriation and devaluation
issues.
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CMS Energy Corporation
For the six months ended June 30, 2002, net income was $52 million, a decrease
of $8 million (14 percent) from the comparable period in 2001. The decrease was
primarily due to lower earnings from Trunkline LNG due to lower volumes and
rates reflecting and the monetization of the facility that occurred in 2001, the
impacts of the Argentina expropriation and devaluation on ongoing operations and
lower commodity revenues at Panhandle due to unseasonably warm weather. These
decreases were partially offset by the gain of $12 million on the sale of
Natural Gas Transmission's ownership interests in Equatorial Guinea, lower
operation and maintenance expenses, and $8 million primarily due to the
elimination of goodwill amortization in 2002. However, Panhandle has completed
the first step of the goodwill impairment testing required upon adoption of SFAS
No. 142, which indicates a potentially significant impairment of Panhandle's
goodwill exists as of January 1, 2002 under the new standard. Panhandle has $700
million of goodwill recorded as of January 1, 2002 which is subject to
impairment testing.
INDEPENDENT POWER PRODUCTION RESULTS OF OPERATIONS
NET INCOME: For the three months ended June 30, 2002, net income was $39
million, a $22 million increase (122 percent) from the comparable period in
2001. The increase was primarily due to improved earnings from the MCV Facility
reflecting improved plant performance and mark to market accounting for
long-term natural gas fuel supply contracts, lower steam costs at DIG, which had
experienced construction delays in 2001 that led to increased costs for steam
generation, earnings from the Al Taweelah A2 project in the United Arab Emirates
which became operational in late-2001, and improved earnings at the Jorf Lasfar
facility. These increases were partially offset by the impacts of the Argentina
expropriation and devaluation on ongoing operations.
For the six months ended June 30, 2002, net income was $62 million, a $17
million increase (38 percent) from the comparable period in 2001. The increase
was primarily due to improved earnings from the MCV Facility reflecting improved
plant performance and mark to market accounting for long-term natural gas fuel
supply contracts, lower steam costs at DIG resulting from construction delays in
2001 that led to increased costs for steam generation, earnings from the Al
Taweelah A2 project which became operational in late-2001, improved earnings
from the Jorf Lasfar facility, and reduced operating expenses. These increases
were partially offset by the effects of the Argentina expropriation and
devaluation and lower earnings from certain domestic operations.
OIL AND GAS EXPLORATION AND PRODUCTION RESULTS OF OPERATIONS
In May of 2002, CMS Energy discontinued the operations of CMS Oil and Gas
Exploration and Production. In July 2002, CMS Energy signed a definitive
agreement and a letter of intent for the sale of CMS Oil and Gas. A definitive
agreement was signed in August 2002 with another party for CMS Oil and Gas'
assets in Colombia, which were previously covered by the letter of intent. The
total sale price is approximately $232 million, and results in an after tax
loss of approximately $110 million. For more information, see Note 2,
Discontinued Operations, incorporated by reference herein.
MARKETING, SERVICES AND TRADING RESULTS OF OPERATIONS
During the second quarter, CMS MST announced its intention to sell its ownership
interest in CMS Viron resulting in a reclassification of CMS Viron's results to
discontinued operations in the consolidated statements of income. For more
information, see Note 2, Discontinued Operations, incorporated by reference
herein.
NET INCOME: For the three months ended June 30, 2002, CMS MST's net loss was $33
million, a decrease of $66 million (200 percent) from the comparable period in
2001. During the second quarter of 2002, credit constraints severely limited the
overall liquidity of the energy trading markets reducing CMS MST's ability to
actively manage and optimize its open positions as well as impacting the ability
to execute new deals. These constraints have placed downward pressure on trading
margins for both wholesale power and natural gas. Operating revenues increased
as a result of sales volumes on long-term power contracts that were executed
during the latter part of 2001.
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CMS Energy Corporation
For the six months ended June 30, 2002, CMS MST's net loss was $36 million, a
decrease of $73 million (195 percent) from the comparable period in 2001. The
decrease was primarily due to the items identified above and also reflects the
adoption of SFAS No. 142, which required the writedown of goodwill at CMS MST
related to its CMS Viron business, retroactive to January 1, 2002. For more
information, see Note 4, Goodwill.
During the second quarter of 2002, power sales volumes were 18,137 GWh, an
increase of 14,123 GWh (352 percent) and natural gas sales volumes were 175 bcf,
an decrease of 44 bcf (20 percent) compared to the second quarter of 2001. For
six months ended June 30, 2002, power sales volumes were 32,290 GWh, an increase
of 24,789 GWh (330 percent) and natural gas sales volumes were 360 bcf, an
decrease of 7 bcf (2 percent) compared to 2001.
Due to the extreme volatility in energy trading markets and the competitive
nature of the industry, results for this interim period are not necessarily an
indication of results to be achieved for the fiscal year.
OTHER RESULTS OF OPERATIONS
Other items affecting net income are the after-tax effects of parent company
interest expense and an $8 million loss in June 2002 related to a non-strategic
Latin American investment. Interest expense after-tax effects for the three
months ended June 30, 2002 and 2001 was $50 million and $56 million,
respectively. Interest expense after-tax effects for the six months ended
June 30, 2002 and 2001 was $110 million and $111 million, respectively. These
expenses were partially offset by the $21 million consolidating elimination
in June 2002 of intercompany losses recorded by CMS MST that result from
mark-to-market accounting for transactions with affiliates.
Discontinued Operations include, in addition to CMS Oil and Gas and CMS Viron
discussed above, a $31 million loss after-tax effects, as a result of
abandoning the Zirconium Recovery Project after evaluating it's future costs
and risk.
CRITICAL ACCOUNTING POLICIES
The results of operations, as presented above, are based on the application of
accounting principles generally accepted in the United States. The application
of these principles often requires management to make certain judgments,
assumptions and estimates that may result in different financial presentations.
CMS Energy believes that certain accounting principles are critical in terms of
understanding its financial statements. These principles include the use of
estimates for long-lived assets, equity method investments and long-term
obligations, accounting for derivatives and financial instruments,
mark-to-market accounting, and international operations and foreign currency.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make judgments,
estimates and assumptions that affect the reported amounts of assets and
liabilities, 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. Certain accounting principles require subjective and
complex judgments used in the preparation of financial statements. Accordingly,
a different financial presentation could result depending on the judgment,
estimates or assumptions that are used. Such estimates and assumptions, include,
but are not specifically limited to: depreciation, amortization, interest rates,
discount rates, currency exchange rates, future commodity prices, mark-to-market
valuations, investment returns, volatility in the price of CMS Energy Common
Stock, impact of new accounting standards, international economic policy, future
costs associated with long-term contractual obligations, future compliance costs
associated with environmental regulations and continuing creditworthiness of
counterparties. Actual results could materially differ from those estimates.
Periodically, in accordance with SFAS No. 144 and APB Opinion No. 18, long-lived
assets and equity method investments of CMS Energy and its subsidiaries are
evaluated to determine whether conditions, other than those of a temporary
nature, indicate that the carrying value of an asset may not be recoverable.
Management bases its evaluation on impairment indicators such as the nature of
the assets, future economic benefits, domestic and foreign state and federal
regulatory and political environments, historical or future profitability
measurements, as well as other external market conditions or factors that may be
present. If such indicators are present or other factors exist that indicate
that the carrying value of the asset may not be recoverable, CMS Energy
determines whether impairment has occurred through the use of an undiscounted
cash flows analysis of assets at the lowest level for which identifiable cash
flows exist. If impairment, other than a temporary nature, has occurred, CMS
Energy recognizes a loss for the difference between the carrying value and the
estimated fair value of the asset. The fair value of the asset is measured using
discounted cash flow analysis or other
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valuation techniques. The analysis of each long-lived asset is unique and
requires management to use certain estimates and assumptions that are deemed
prudent and reasonable for a particular set of circumstances. Of CMS Energy's
total assets, valued at $15 billion at June 30, 2002, approximately 60 to 65
percent represent the carrying value of long-lived assets and equity method
investments that are subject to this type of analysis. If future market,
political or regulatory conditions warrant, CMS Energy and its subsidiaries may
be subject to write-downs in future periods. Conversely, if market, political or
regulatory conditions improve, accounting standards prohibit the reversal of
previous write-downs.
CMS Energy has recently recorded write-downs of non-strategic or
under-performing long-lived assets as a result of implementing a new strategic
direction. CMS Energy is pursuing the sale of all of these non-strategic and
under-performing assets, including some assets that were not determined to be
impaired. Upon the sale of these assets, the proceeds realized may be materially
different from the remaining carrying value of these assets. Even though these
assets have been identified for sale, management cannot predict when, nor make
any assurances that, these asset sales will occur, or the amount of cash or the
value of consideration to be received.
Similarly, the recording of estimated liabilities for contingent losses,
including estimated losses on long-term obligations, within the financial
statements is guided by the principles in SFAS No. 5 that require a company to
record estimated liabilities in the financial statements when it is probable
that a loss will be incurred in the future as a result of a current event, and
the amount can be reasonably estimated. Management uses cash flow valuation
techniques similar to those described above to estimate contingent losses on
long-term contracts.
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS
DERIVATIVE INSTRUMENTS: CMS Energy uses the criteria in SFAS No. 133, as amended
and interpreted, to determine if certain contracts must be accounted for as
derivative instruments. The rules for determining whether a contract meets the
criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
The types of contracts CMS Energy currently accounts for as derivative
instruments are interest rate swaps, foreign currency exchange contracts,
certain electric call options, and gas fuel call options and swaps. CMS Energy
does not account for electric capacity and energy contracts, gas supply
contracts, coal supply contracts, or purchase orders for numerous supply items
as derivatives.
If a contract must be accounted for as a derivative instrument, the contract is
recorded as either an asset or a liability in the financial statements at the
fair value of the contract. Any difference between the recorded book value and
the fair value is reported either in earnings or other comprehensive income
depending on certain qualifying criteria. The recorded fair value of the
contract is then adjusted quarterly to reflect any change in the market value of
the contract.
In order to value the contracts that are accounted for as derivative
instruments, CMS Energy uses a combination of market quoted prices and
mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the call option contracts. The models used by CMS Energy have been tested
against market quotes to ensure consistency between model outputs and market
quotes. At June 30, 2002, CMS Energy assumed an interest rate of 4.5 percent in
calculating the fair value of its electric call options.
In order for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value attributable to the risk being hedged. If hedging a forecasted
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CMS Energy Corporation
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings. CMS Energy believes that Consumers
electric capacity and energy contracts do not qualify as derivatives due to the
lack of an active energy market in the state of Michigan and the transportation
cost to deliver the power under the contracts to the closest active energy
market at the Cinergy hub in Ohio. If a market develops in the future, Consumers
may be required to account for those contracts as derivatives. The mark to
market impact in earnings related to these contracts, particularly related to
the purchase power agreement with the MCV, could be material to the financial
statements.
CMS Energy believes that Consumers electric capacity and energy contracts do
not qualify as derivatives due to the lack of an active energy market in the
state of Michigan and the transportation cost to deliver the power under the
contracts to the closest active energy market at the Cinergy hub in Ohio. If a
market develops in the future, Consumers may be required to account for these
contracts as derivatives. The mark to market impact in earnings related to
these contracts, particularly related to the purchase power agreement with the
MCV, could be material to the financial statements.
FINANCIAL INSTRUMENTS: CMS Energy accounts for its investments in debt and
equity securities in accordance with SFAS No. 115. As such, debt and equity
securities can be classified into one of three categories: held-to-maturity,
trading, or available-for-sale securities. CMS Energy's investments in equity
securities are classified as available-for-sale securities and are reported at
fair value with any unrealized gains or losses resulting from changes in fair
value excluded from earnings and reported in equity as part of other
comprehensive income. Unrealized gains or losses resulting from changes in the
fair value of Consumers' nuclear decommissioning investments are reported in
accumulated depreciation. The fair value of these investments is determined from
quoted market prices.
MARK-TO-MARKET ACCOUNTING
CMS MST's trading activities are accounted for under the mark-to-market method
of accounting. Under mark-to-market accounting, energy-trading contracts are
reflected at fair market value, net of reserves, with unrealized gains and
losses recorded as an asset or liability in the consolidated balance sheets.
These assets and liabilities are affected by the timing of settlements related
to these contracts, current-period changes from newly originated transactions
and the impact of price movements. Changes in fair value are recognized as
revenues in the consolidated statements of income in the period in which the
changes occur. Market prices used to value outstanding financial instruments
reflect management's consideration of, among other things, closing exchange and
over-the-counter quotations. In certain of these markets, long-term contract
commitments may extend beyond the period in which market quotations for such
contracts are available. The lack of long-term pricing liquidity requires the
use of mathematical models to value these commitments under the accounting
method employed. These mathematical models utilize historical market data to
forecast future elongated pricing curves, which are used to value the
commitments that reside outside of the liquid market quotations. Realized cash
returns on these commitments may vary, either positively or negatively, from the
results estimated through application of forecasted pricing curves generated
through application of the mathematical model. CMS Energy believes that its
mathematical models utilize state-of-the-art technology, pertinent industry data
and prudent discounting in order to forecast certain elongated pricing curves.
These market prices are adjusted to reflect the potential impact of liquidating
the company's position in an orderly manner over a reasonable period of time
under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. Counterparties in its trading portfolio consist principally of
financial institutions and major energy trading companies. The creditworthiness
of these counterparties will impact overall exposure to credit risk; however,
CMS Energy maintains credit policies that management believes minimize overall
credit risk with regard to its counterparties. Determination of its
counterparties' credit quality is based upon a number of factors, including
credit ratings, financial condition, and collateral requirements. When trading
terms permit, CMS Energy employs standardized agreements that allow for netting
of positive and negative exposures associated with a single counterparty. Based
on these policies, its current exposures and its credit reserves, CMS Energy
does not anticipate a material adverse effect on its financial position or
results of operations as a result of counterparty nonperformance.
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of June 30, 2002.
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In Millions
-----------
Fair value of contracts outstanding as of March 31, 2002 $ 109
Contracts realized or otherwise settled during the period(a) (11)
Fair value of new contracts when entered into during the period 1
Changes in fair value attributable to changes in valuation techniques and assumptions (5)
Other changes in fair value(b) (5)
-----
Fair value of contracts outstanding as of June 30, 2002 $ 89
=====
Fair Value of Contracts at June 30, 2002 In Millions
Total Maturity (in years)
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- --------------------------------------- ---------- ----------- ------ ------ -------------------
Prices actively quoted $42 $ 8 $20 $11 $ 3
Prices provided by other external sources 19 1 4 10 4
Prices based on models and other valuation methods 28 4 9 11 4
--- --- --- --- ---
Total $89 $13 $33 $32 $11
=== === === === ===
(a) Reflects value of contracts, included in March 31, 2002 values,
that expired during the second quarter of 2002.
(b) Reflects changes in price and net increase/decrease in size of
forward positions, as well as changes to mark-to-market reserve
accounts.
INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY
CMS Energy, through its subsidiaries and affiliates, has acquired investments in
energy-related projects throughout the world. As a result of a change in
business strategy, CMS Energy has begun divesting its non-strategic or
under-performing foreign investments.
BALANCE SHEET: CMS Energy's subsidiaries and affiliates whose functional
currency is other than the U.S. Dollar translate their assets and liabilities
into U.S. Dollars at the exchange rates in effect at the end of the fiscal
period. The revenue and expense accounts of such subsidiaries and affiliates are
translated into U.S. Dollars at the average exchange rate during the period. The
gains or losses that result from this process, and gains and losses on
intercompany foreign currency transactions that are long-term in nature that CMS
Energy does not intend to settle in the foreseeable future, are reflected as a
component of stockholders' equity in the consolidated balance sheets as "Foreign
Currency Translation" in accordance with the accounting guidance provided in
SFAS No. 52. As of June 30, 2002, the cumulative Foreign Currency Translation
decreased stockholders' equity by $698 million.
INCOME STATEMENT: For subsidiaries operating in highly inflationary economies or
that meet the U.S. functional currency criteria outlined in SFAS No. 52, the
U.S. Dollar is deemed to be the functional currency. Gains and losses that arise
from exchange rate fluctuations on transactions denominated in a currency other
than the U.S. Dollar, except those that are hedged, are included in determining
net income.
Argentina: In January 2002, the Republic of Argentina enacted the Public
Emergency and Foreign Exchange System Reform Act. This law, among other things,
repealed the fixed exchange rate of one U.S. Dollar to one Argentina Peso,
converted all Dollar-denominated utility tariffs and energy contract obligations
into Pesos at the same one-to-one exchange rate, and directed the President of
Argentina to renegotiate such tariffs.
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CMS Energy Corporation
In February 2002, the Republic of Argentina enacted additional measures that
required all monetary obligations (including current debt and future contract
payment obligations) denominated in foreign currencies to be converted into
Pesos. These February measures also authorize the Argentine judiciary
essentially to rewrite private contracts denominated in Dollars or other foreign
currencies if the parties cannot agree on how to share equitably the impact of
the conversion of their contract payment obligations into Pesos. In April 2002,
based on a consideration of these environmental factors, CMS Energy evaluated
its Argentine investments for impairment as required under SFAS No. 144 and APB
Opinion No. 18. These impairment models contain assumptions regarding
anticipated future exchange rates and operating performance of the investments.
Exchange rates used in the models assume that the rate will decrease from
current levels to approximately 3.00 Pesos per US Dollar over the remaining
life of these investments. Based on the results of these models, CMS Energy
determined that these investments were not impaired.
Effective April 30, 2002, CMS Energy adopted the Argentine Peso as the
functional currency for all of its Argentine investments. CMS had previously
used the U.S. Dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. Dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 Pesos per U.S. Dollar, and recorded a charge to
the Foreign Currency Translation component of Common Stockholders' Equity of
approximately $400 million.
For the six months ended June 30, 2002, CMS Energy recorded losses of $34
million or $0.25 per share, reflecting the negative impact of the actions of the
Argentine government. These losses represent changes in the value of
Peso-denominated monetary assets (such as receivables) and liabilities of
Argentina-based subsidiaries and lower net project earnings resulting from the
conversion to Pesos of utility tariffs and energy contract obligations that were
previously calculated in Dollars.
While CMS Energy's management cannot predict the most likely future, average, or
end of period 2002 Peso to U.S. Dollar exchange rates, it does expect that this
non-cash charge substantially reduces the risk of further material balance sheet
impacts when combined with anticipated proceeds from international arbitration
currently in progress, political risk insurance, and the eventual sale of these
assets. As a result of the change in functional currency, and the ongoing
translation of revenue and expense accounts of these investments into U.S.
Dollars, 2002 earnings for CMS Energy may be adversely affected by an additional
$3.8 million to $11.8 million or $0.03 to $0.09 per share assuming exchange
rates ranging from 3.00 to 4.00 Pesos per U.S. Dollar. At June 30, 2002, the net
foreign currency loss due to the unfavorable exchange rate of the Argentine Peso
recorded in the Foreign Currency Translation component of Common Stockholder's
Equity using an exchange rate of 3.86 Pesos per US Dollar was $402 million.
Australia: In 2000, an impairment loss of $329 million ($268 million after-tax)
was realized on the carrying amount of the investment in Loy Yang. This loss
does not include $168 million cumulative net foreign currency translation losses
due to unfavorable changes in the exchange rates, which, in accordance with SFAS
No. 52, will not be realized until there has been a sale, full liquidation, or
other disposition of CMS Energy's investment in Loy Yang, all of which are
currently being pursued but may not occur in 2002.
HEDGING STRATEGY: CMS Energy uses forward exchange and option contracts to hedge
certain receivables, payables, long-term debt and equity value relating to
foreign investments. The purpose of CMS Energy's foreign currency hedging
activities is to protect the company from risk that U.S. Dollar net cash flows
resulting from sales to foreign customers and purchases from foreign suppliers
and the repayment of non-U.S. Dollar borrowings, as well as the equity reported
on the company's balance sheet, may be adversely affected by changes in exchange
rates. These contracts do not subject CMS Energy to risk from exchange rate
movements because gains and losses on such contracts are inversely correlated
with the losses and gains, respectively, on the assets and liabilities being
hedged.
Foreign currency adjustments for other CMS Energy international investments in
Thailand, Venezuela, Ghana, India and the Philippines were immaterial due to
relatively stable exchange rates, minimal investment amounts, or such
adjustments were not applicable due to U.S. functional currency classifications
of the foreign investments. These countries are excluded in the hedging
portfolio due to a lack of forward markets, relatively stable exchange rates and
minimal amounts of investment.
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CMS Energy Corporation
NEW ACCOUNTING STANDARDS
In addition to the identified critical accounting policies discussed above,
future results will be affected by new accounting standards that recently have
been issued.
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning January 1,
2003, companies must comply with SFAS No. 143, which requires companies to
record the fair value of a liability for an asset retirement obligation in the
period in which the obligation is incurred. When the liability is initially
recorded, the company 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
related asset's useful life. CMS Energy is currently studying the effects of the
new standard, but has yet to quantify the effects of adoption on its financial
statements.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB on April 30,
2002, this Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring after May 15, 2002. Finally,
SFAS No. 145 amends other existing authoritative pronouncements to make various
technical corrections and rescinds SFAS No. 44, Accounting for Intangible Assets
of Motor Carriers. These provisions are effective for financial statements
issued on or after May 15, 2002. CMS Energy is currently studying the effects of
the new standard, but has yet to quantify the effects of adoption on its
financial statements.
SFAS NO. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES:
Issued by the FASB in July 2002, this standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. This standard is
effective for exit or disposal activities initiated after December 31, 2002. CMS
Energy believes there will be no impact on its financial statements upon
adoption of the standard.
For a discussion of new accounting standards effective January 1, 2002, see Note
1, Corporate Structure and Basis of Presentation.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
CMS Energy's primary ongoing source of cash is dividends and other distributions
from subsidiaries. During the first six months of 2002, Consumers paid $255
million in common dividends and other distributions and Enterprises paid $718
million in common dividends and other distributions to CMS Energy. CMS Energy's
consolidated cash requirements are met by its operating and investing
activities.
OPERATING ACTIVITIES: CMS Energy's consolidated net cash provided by operating
activities is derived mainly from the processing, storage, transportation and
sale of natural gas and the generation, transmission, distribution and sale of
electricity. For the first six months of 2002 and 2001, consolidated cash from
operations after interest charges totaled $501 million and $328 million,
respectively. The $173 million increase in cash from operations resulted
primarily from a decrease in accounts receivable and accrued revenues, a
decrease in inventories, and an increase in accounts payable and accrued
expenses. These sources of cash were partially offset by a decrease in cash
earnings and a decrease in deferred income taxes and investment tax credit.
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CMS Energy Corporation
CMS Energy uses cash derived from its operating activities primarily to maintain
its diversified energy businesses, to maintain and expand electric and gas
systems of Consumers, to pay interest on and retire portions of its long-term
debt, and to pay dividends.
INVESTING ACTIVITIES: For the first six months of 2002, CMS Energy's
consolidated net cash provided by investing activities totaled $752 million,
while net cash used in investing activities totaled $659 million for the first
six months of 2001. The $1,411 million increase in cash reflects increased net
proceeds from the sale of assets ($1,089 million) and a reduction in capital
expenditures and investments in partnerships and unconsolidated subsidiaries
($310 million). CMS Energy's expenditures in the first six months of 2002 for
its utility and diversified energy businesses were $285 million and $117
million, respectively, compared to $364 million and $355 million, respectively,
during the comparable period in 2001.
FINANCING ACTIVITIES: For the first six months of 2002, CMS Energy's net cash
used in financing activities totaled $1,178 million, while net cash provided by
financing activities totaled $325 million for the first six months of 2001. The
decrease of $1,503 million resulted primarily from an increase in the retirement
of bonds and other long-term debt ($912 million), a decrease in proceeds from
the issuance of common stock ($279 million), a decrease in proceeds from Trust
Preferred Securities ($121 million), a decrease in proceeds from notes, bonds
and other long-term debt ($108 million) and an increase in the retirement of
Trust Preferred Securities ($30 million). The following table summarizes
securities issued during the first six months of 2002:
Distribution/ Amount
Month Issued Maturity Interest Rate (In Millions) Use of Proceeds
- -------------- ------------ -------- ------------------ ------------- --------------------------
CMS ENERGY
GTNs Series F January (1) 8.09% $ 12 General corporate purposes
Common Stock (2) n/a 2.1 million shares 49 Repay debt and general
----- corporate purposes
$ 61
-----
CONSUMERS
Senior Notes March 2005 6.00% $ 300 Repay debt
-----
Total $ 361
=====
(1) GTNs are issued with varying maturity dates. The interest rate shown
herein is a weighted average interest rate.
(2) 1.3 million shares were issued in conjunction with CMS Energy's
Continuous Stock Offering Program, activated in February 2002, for which
two million shares are registered. CMS Energy also issued Common Stock
from time to time in conjunction with the stock purchase plan and
various employee savings and stock incentive plans.
In May 2002, CMS Energy registered $300,000,000 Series G GTNs. The notes will be
issued from time to time with the proceeds being used for general corporate
purposes. As of August 1, 2002, no Series G GTNs had been issued.
In the first six months of 2002, CMS Energy declared and paid $97 million in
cash dividends to holders of CMS Energy Common Stock. In July 2002, the Board of
Directors declared a quarterly dividend of $0.18 per share on CMS Energy Common
Stock, payable in August 2002. The reduction of the quarterly dividend from
$0.365 per share is consistent with the requirements of the new credit
facilities described below.
OTHER INVESTING AND FINANCING MATTERS: At June 30, 2002, the book value per
share of CMS Energy Common Stock was $13.00.
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CMS Energy Corporation
At August 1, 2002, CMS Energy had an aggregate $1.3 billion in securities
registered for future issuance.
On July 1, 2002, the 7,250,000 units of 8.75% Adjustable Convertible Trust
Securities (CMS Energy Trust II) were converted to 8,787,725 newly issued shares
of CMS Energy Common Stock.
On July 12, 2002, CMS Energy and its subsidiaries reached agreement with its
lenders on five credit facilities (facilities) totaling approximately $1.3
billion of credit for CMS Energy, Enterprises and Consumers. The agreements were
executed by various combinations of up to 21 lenders and by the company and are
as follows: a $295.8 million revolving credit facility by CMS Energy, maturing
March 31, 2003; a $300 million revolving credit facility by CMS Energy, maturing
December 15, 2003; a $150 million short term loan by Enterprises, maturing
December 13, 2002; a $250 million revolving credit facility by Consumers,
maturing July 11, 2003; and a $300 million term loan by Consumers, maturing July
11, 2003 with a one-year extension at Consumers' option. CMS Energy expects to
amend the Consumers term loan by the end of August 2002 so that the maturity
date is July 11, 2004.
The facilities are secured credits with mandatory prepayment of borrowings under
certain of the facilities with proceeds from asset sales and capital market
issuances. The CMS Energy and Enterprises facilities grant the applicable bank
groups either first or second liens on the capital stock of Enterprises and its
major direct and indirect domestic subsidiaries, including Panhandle Eastern
Pipe Line Company (but excluding subsidiaries of Panhandle Eastern Pipe Line
Company). The Consumers facilities grant the applicable bank groups security
through first mortgage bonds. Bank and legal fees associated with restructuring
the Facilities are estimated to be $12 million, of which $2 million was expensed
in June 2002.
The facilities essentially replace or restructure previously existing credit
facilities or lines at CMS Energy or Consumers, without substantially changing
credit commitments. The three CMS Energy and Enterprises facilities aggregating
$745.8 million represent a restructuring of a prior CMS Energy $300 million
three-year revolving credit facility maturing in June 2004 and a prior CMS
Energy $450 million revolving credit facility originally maturing June 2002, but
previously extended through July 12, 2002. The two Consumers facilities
aggregating $550 million replace a $300 million revolving credit facility that
matured July 14, 2002, as well as various credit lines aggregating $200 million.
The prior credit facilities and lines were unsecured.
Pursuant to restrictive covenants in the CMS Energy $295.8 million facility and
the Enterprises $150 million facility, CMS Energy is limited to quarterly
dividend payments of $0.1825 per share and must receive $250 million in net cash
proceeds from the planned issuance of equity or equity-linked securities by
December 31, 2002 in order to continue to pay a dividend thereafter. The CMS
Energy $300 million facility does not have the foregoing restrictive covenant,
but does include a limitation on cash dividends if CMS Energy's level of Cash
Dividend Income (as defined by the agreement) to interest expense falls below
1.05 to 1.00. As a result of these dividend restrictions, CMS Energy's Board of
Directors announced its intent to cut the CMS Energy Common Stock dividend by
approximately 50 percent, to an annual rate of 72 cents per share. Also pursuant
to restrictive covenants in its facilities, Consumers is limited to common stock
dividend payments that will not exceed $300 million in any calendar year. In
2001, Consumers paid $189 million in common stock dividends to CMS Energy, and
has paid $154 million for the six months ended June 30, 2002.
The CMS Energy credit facilities, as well as the Enterprises loan have an
interest rate of LIBOR plus 300 basis points. The Consumers' credit facility and
term loan have interest rates of LIBOR plus 200 basis points (although the rate
may fluctuate depending on the rating of Consumers First Mortgage Bonds) and
LIBOR plus 300 basis points, respectively.
CMS-14
CMS Energy Corporation
The facilities also have contractual restrictions that require CMS Energy and
Consumers to maintain, as of the last day of each fiscal quarter, the following:
Required Ratio Limitation Ratio at June 30, 2002
- --------------------------- -------------------------- ----------------------
CMS ENERGY:
Consolidated Leverage Ratio not more than 5.75 to 1.00 4.95 to 1.00
Cash Dividend Coverage Ratio not less than 1.25 to 1.00 1.96 to 1.00
CONSUMERS:
Debt to Capital Ratio not more than 0.65 to 1.00 0.51 to 1.00
Interest Coverage Ratio not less than 2.0 to 1.0 2.6 to 1.0
In July 2002, the credit ratings of the publicly traded securities of each of
CMS Energy, Consumers and Panhandle (but not Consumers Funding LLC) were
downgraded by the major rating agencies. The ratings downgrade for all three
companies' securities is largely a function of the uncertainties associated with
CMS Energy's financial condition and liquidity, the special committee
investigation of the "round trip" trading, restatement and re-audit of 2000 and
2001 financial statements and lawsuits, and directly affects and limits CMS
Energy's access to the capital markets.
As a result of certain of these downgrades, rights were triggered in several
contractual arrangements between CMS Energy subsidiaries and third parties. More
specifically, a $69 million loan to Panhandle made in connection with the
December 2001 LNG off balance sheet monetization transaction is subject to
repayment demand by the unaffiliated equity partner in the LNG Holdings joint
venture, although no such demand has been made to date. In addition, the
construction lenders for each of the Guardian and Centennial pipeline projects,
each partially owned by Panhandle, have requested acceptable credit support for
Panhandle's guarantee of its pro rata portion of those construction loans, which
aggregate $110 million including anticipated future draws. Further, one of the
issuers of a joint and several surety bond in the approximate amount of $190
million supporting a CMS MST gas supply contract has demanded acceptable
collateral for up to the full amount of such bond. This issuer has commenced
litigation against Enterprises and CMS MST in Michigan federal district court
and is seeking to require Enterprises and CMS MST to provide acceptable
collateral and to prevent them from disposing of or transferring any corporate
assets outside the ordinary course of business before the Court has an
opportunity to fully adjudicate the issuer's claim. Enterprises and CMS MST
continue to work with the issuer to find mutually satisfactory arrangements. A
second issuer of surety bonds aggregating approximately $113 million in support
of two other CMS MST gas supply contracts also has a right to request collateral
for up to the full amounts of such bonds, and certain parties involved in those
gas supply contracts have the right to seek replacement surety bonds due to the
ratings downgrade of the current surety bond issuer. CMS Energy is working with
its contractual parties to find mutually satisfying arrangements, but there can
be no assurance of reaching such arrangements or that litigation will not
result.
For further information, see Note 6, Short-Term and Long-Term Financings and
Capitalization, incorporated by reference herein.
CMS Energy plans to continue to pursue the sale of targeted assets throughout
2002. Even though assets have been identified for sale, management cannot
predict when, nor make assurances regarding the value of the consideration to be
received or whether these sales will occur.
The following information on CMS Energy's contractual obligations, commercial
commitments, and off-balance sheet financings is provided to collect information
in a single location so that a picture of liquidity and capital resources is
readily available.
CONTRACTUAL OBLIGATIONS: Contractual obligations include CMS Energy's long-term
debt, notes payable, lease obligations, sales of accounts receivable and other
unconditional purchase obligations, that represent normal business operating
contracts used to assure adequate supply of and minimize exposure to market
price
CMS-15
CMS Energy Corporation
fluctuations. Consumers has long-term power purchase agreements with various
generating plants including the MCV Facility. These contracts require monthly
capacity payments based on the plants' availability or deliverability. These
payments are approximately $45 million per month for year 2002, which includes
$33 million related to the MCV Facility. If a plant is not available to deliver
electricity to Consumers, then Consumers would not be obligated to make the
capacity payment until the plant could deliver.
COMMERCIAL COMMITMENTS: As of June 30, 2002, CMS Energy, Enterprises, and their
subsidiaries have guaranteed payment of obligations through guarantees,
indemnities and letters of credit, of unconsolidated affiliates and related
parties approximating $1.8 billion. Included in this amount, Enterprises, in the
ordinary course of its business, has guaranteed contracts of CMS MST that
contain certain schedule and performance requirements. As of June 30, 2002, the
actual amount of financial exposure covered by these guarantees and indemnities
was $569 million. Management monitors and approves these obligations and
believes it is unlikely that CMS Energy would be required to perform or
otherwise incur any material losses associated with these guarantees.
As of June 2002, Consumers had $300 million in credit facilities, $45 million
aggregate lines of credit and a $325 million trade receivable sale program in
place as anticipated sources of funds to fulfill its currently expected capital
expenditures. For further information about this source of funds, see Note 6,
Short-Term and Long-Term Financings, and Capitalization, incorporated by
reference herein.
OFF-BALANCE SHEET ARRANGEMENTS: CMS Energy, through its subsidiary companies,
has equity investments in partnerships and joint ventures in which they have a
minority ownership interest. As of June 30, 2002, CMS Energy's proportionate
share of unconsolidated debt associated with these investments was $3.1 billion.
This unconsolidated debt is non-recourse to CMS Energy and is not included in
the amount of long-term debt that appears on CMS Energy's Consolidated Balance
Sheets.
CAPITAL EXPENDITURES
CMS Energy estimates that capital expenditures, including new lease commitments
and investments in new business developments through partnerships and
unconsolidated subsidiaries, will total $2.6 billion during 2002 through 2004.
These estimates are prepared for planning purposes and are subject to revision.
CMS Energy expects to satisfy a substantial portion of the capital expenditures
with cash from operations. CMS Energy will continue to evaluate capital markets
in 2002 as a potential source for financing its subsidiaries' investing
activities. CMS Energy estimates capital expenditures by business segment over
the next three years as follows:
In Millions
------------------------------------
Years Ending December 31 2002 2003 2004
---- ---- ----
Consumers electric operations(a)(b) $460 $430 $450
Consumers gas operations(a) 190 205 230
Natural gas transmission 160 100 120
Independent power production 45 5 75
Oil and gas exploration and production 40 -- --
Marketing, services and trading 10 5 5
Other 20 -- --
---- ---- ----
$925(c) $745(c) $880(c)
==== ==== ====
(a) These amounts include an attributed portion of Consumers' anticipated
capital expenditures for plant and equipment common to both the electric and gas
utility businesses.
(b) These amounts include estimates for capital expenditures that may be
required by recent revisions to the
CMS-16
CMS Energy Corporation
Clean Air Act's national air quality standards. For further information see Note
5, Uncertainties - Electric Environmental Matters.
(c) These amounts include expenditures associated with the Trunkline LNG
terminal expansion, for which an application was filed with the FERC in December
2001, estimated at $11 million in 2002, $5 million in 2003 and $30 million in
2004.
For further explanation of CMS Energy's planned investments for the years 2002
through 2004, see the Outlook section below.
MARKET RISK INFORMATION
CMS Energy is exposed to market risks including, but not limited to, changes in
interest rates, currency exchange rates, commodity prices and equity security
prices. CMS Energy's derivative activities are subject to the direction of the
Executive Oversight Committee, which is comprised of certain members of CMS
Energy's senior management, and its Risk Committee, which is comprised of CMS
Energy business unit managers and chaired by the CMS Chief Risk Officer. The
purpose of the risk management policy is to measure and limit CMS Energy's
overall energy commodity risk by implementing an enterprise-wide policy across
all CMS Energy business units. This allows CMS Energy to maximize the use of
hedges among its business units before utilizing derivatives with external
parties. The role of the Risk Committee is to review the corporate commodity
position and ensure that net corporate exposures are within the economic risk
tolerance levels established by the Board of Directors. Management employs
established policies and procedures to manage its risks associated with market
fluctuations, including the use of various derivative instruments such as
futures, swaps, options and forward contracts. When management uses these
derivative instruments, it intends that an opposite movement in the value of the
hedged item would offset any losses incurred on the derivative instruments.
CMS Energy has performed sensitivity analyses to assess the potential loss in
fair value, cash flows and earnings based upon hypothetical 10 percent increases
and decreases in market exposures. Management does not believe that sensitivity
analyses alone provide an accurate or reliable method for monitoring and
controlling risks; therefore, CMS Energy and its subsidiaries rely on the
experience and judgment of senior management and traders to revise strategies
and adjust positions as they deem necessary. Losses in excess of the amounts
determined in the sensitivity analyses could occur if market rates or prices
exceed the 10 percent shift used for the analyses.
COMMODITY PRICE RISK: CMS Energy is exposed to market fluctuations in the price
of natural gas, oil, electricity, coal, natural gas liquids and other
commodities. CMS Energy employs established policies and procedures to manage
these risks using various commodity derivatives, including futures contracts,
options and swaps (which require a net cash payment for the difference between a
fixed and variable price), for non-trading purposes. The prices of these energy
commodities can fluctuate because of, among other things, changes in the supply
of and demand for those commodities. To minimize adverse price changes, CMS
Energy also hedges certain inventory and purchases and sales contracts. Based on
a sensitivity analysis, CMS Energy estimates that if energy commodity prices
average 10 percent higher or lower, pretax operating income for the subsequent
six months would increase or decrease by $3.17 million and $3.22 million,
respectively. These hypothetical 10 percent shifts in quoted commodity prices
would not have had a material impact on CMS Energy's consolidated financial
position or cash flows as of June 30, 2002. The analysis does not quantify
short-term exposure to hypothetically adverse price fluctuations in inventories
or for commodity positions related to trading activities.
Consumers enters into electric call options, gas fuel for generation call
options and swap contracts, and gas supply contracts containing embedded put
options, for purposes other than trading. The electric call options are used to
protect against risk due to fluctuations in the market price of electricity
and to ensure a reliable source of
CMS-17
CMS Energy Corporation
capacity to meet its customers' electric needs. The gas fuel for generation call
options and swap contracts are used to protect generation activities against
risk due to fluctuations in the market price of natural gas. The gas supply
contracts containing embedded put options are used to purchase reasonably priced
gas supply.
As of June 30, 2002 and 2001, the fair value based on quoted future market
prices of electricity-related call option and swap contracts was $13 million and
$33 million, respectively. At June 30, 2002 and 2001, assuming a hypothetical 10
percent adverse change in market prices, the potential reduction in fair value
associated with these contracts would be $3 million and $6 million,
respectively. As of June 30, 2002 and 2001, Consumers had an asset of $35
million and $122 million, respectively, related to premiums incurred for
electric call option contracts. Consumers' maximum exposure associated with the
call option contracts is limited to the premiums incurred. As of June 30, 2002,
the fair value based on quoted future market prices of gas supply contracts
containing embedded put options was $2 million. At June 30, 2002, assuming a
hypothetical 10 percent adverse change in market prices, the potential reduction
in fair value associated with these contracts would be $1 million.
INTEREST RATE RISK: CMS Energy is exposed to interest rate risk resulting from
the issuance of fixed-rate and variable-rate debt, including interest rate risk
associated with Trust Preferred Securities, and from interest rate swaps. CMS
Energy uses a combination of fixed-rate and variable-rate debt, as well as
interest rate swaps to manage and mitigate interest rate risk exposure when
deemed appropriate, based upon market conditions. CMS Energy employs these
strategies to attempt to provide and maintain a balance between risk and the
lowest cost of capital. At June 30, 2002, the carrying amounts of long-term debt
and Trust Preferred Securities were $6.3 billion and $1.2 billion, respectively,
with corresponding fair values of $6.0 billion and $0.8 billion, respectively.
Based on a sensitivity analysis at June 30, 2002, CMS Energy estimates that if
market interest rates average 10 percent higher or lower, earnings before income
taxes for the subsequent twelve months would decrease or increase, respectively,
by approximately $3 million. In addition, based on a 10 percent adverse shift in
market interest rates, CMS Energy would have an exposure of approximately $361
million to the fair value of its long-term debt and Trust Preferred Securities
if it had to refinance all of its long-term fixed-rate debt and Trust Preferred
Securities. CMS Energy does not intend to refinance its entire fixed-rate debt
and Trust Preferred Securities in the near term and believes that any adverse
change in interest rates would not have a material effect on CMS Energy's
consolidated financial position as of June 30, 2002.
At June 30, 2002, the fair value of CMS Energy's floating to fixed interest rate
swaps with a notional amount of $294 million was $9 million, which represents
the amount CMS Energy would pay to settle. The swaps mature at various times
through 2006 and are designated as cash flow hedges for accounting purposes.
CURRENCY EXCHANGE RISK: CMS Energy is exposed to currency exchange risk arising
from investments in foreign operations as well as various international projects
in which CMS Energy has an equity interest and which have debt denominated in
U.S. Dollars. CMS Energy typically uses forward exchange contracts and other
risk mitigating instruments to hedge currency exchange rates. The impact of the
hedges on the investments in foreign operations is reflected in other
comprehensive income as a component of foreign currency translation adjustment.
For the first six months of 2002, the mark-to-market adjustment for hedging was
approximately zero of the total net foreign currency translation adjustment of
$403 million of which $402 million was related to the Argentine currency
translation adjustment. Based on a sensitivity analysis at June 30, 2002, a 10
percent adverse shift in currency exchange rates would not have a material
effect on CMS Energy's consolidated financial position or results of operations.
At June 30, 2002, the estimated fair value of the foreign exchange hedges was
immaterial.
EQUITY SECURITY PRICE RISK: CMS Energy and certain of its subsidiaries have
equity investments in companies in which they hold less than a 20 percent
interest. As of June 30, 2002, a hypothetical 10 percent adverse shift in equity
securities prices would not have a material effect on CMS Energy's consolidated
financial position, results of operations or cash flows.
CMS-18
CMS Energy Corporation
For a discussion of accounting policies related to derivative transactions, see
Note 8, Risk Management Activities and Financial Instruments, incorporated by
reference herein.
OUTLOOK
CMS Energy announced in October 2001 significant changes in its business
strategy in order to strengthen its balance sheet, provide more transparent and
predictable future earnings, and lower its business risk by focusing its future
business growth primarily in North America. Specifically, CMS Energy announced
its plans to sell or optimize non-strategic and under-performing international
assets and discontinue its international energy distribution business. CMS
Energy also announced its plans to discontinue all new development outside North
America, which includes closing all non-U.S. development offices, except for
certain prior international commitments.
CMS Energy will continue to focus geographically on key growth areas where it
already has significant investments and opportunities. CMS Energy's focus will
be in North America, particularly in the United States' central corridor, and
in certain existing international operations and prior commitments in the
Middle East.
Consistent with this "back-to-basics" strategy, CMS Energy is actively pursuing
the sale of non-strategic and under-performing assets in order to improve cash
flow and the balance sheet and has received approximately $2.4 billion of cash
from asset sales, securitization proceeds and proceeds from LNG monetization out
of its $2.9 billion asset sales and balance sheet improvement program. Upon the
sale of additional non-strategic and under-performing assets, the proceeds
realized may be materially different than the book value of those assets. Even
though these assets have been identified for sale, management cannot predict
when, nor make any assurances that, these asset sales will occur. CMS Energy
anticipates, however, that the sales, if any, will result in additional cash
proceeds that will be used to retire existing debt of CMS Energy, Consumers
and/or Panhandle.
In May 2002, CMS Energy announced its plans to discontinue the operations of CMS
Oil and Gas and exit the exploration and production business. In July 2002, CMS
Energy signed a definitive agreement and a letter of intent for the sale of CMS
Oil and Gas. A definitive agreement was signed in August 2002 with another party
for CMS Oil and Gas' assets in Colombia, which were previously covered by the
letter of intent. The total sale price is approximately $232 million and results
in an after-tax loss of approximately $110 million. In June 2002, CMS Energy
announced its plans to sell CMS MST's performance contracting subsidiary, CMS
Viron. CMS MST will also eliminate its speculative trading business and will
reduce its workforce by approximately 25 percent or 50 people.
In July 2002, CMS Energy began to undertake a series of initiatives to further
sharpen its business focus and reduce operating costs. These include relocating
the corporate headquarters from Dearborn, Michigan to Jackson, Michigan, which
will result in lower operating and information technology costs starting in
2003, changes to CMS Energy's employee benefit plans, and adjustments to the
CEO's compensation package, which will be based largely on the financial
performance of CMS Energy.
In August 2002, CMS Energy began exploring the sale of its domestic pipeline and
field services businesses as part of its ongoing effort to strengthen its
balance sheet, improve its credit ratings and enhance financial flexibility. The
businesses being considered for sale include the Panhandle and Trunkline
interstate natural gas pipelines and CMS Field Services gathering and processing
facilities, as well as CMS Energy's interests in the Lake Charles LNG terminal,
the Centennial and Guardian. CMS Energy has begun assessing the market's
interest in purchasing the pipeline and field services businesses. It is
reviewing financial, legal and regulatory issues associated with the sale.
CMS-19
CMS Energy Corporation
DIVERSIFIED ENERGY OUTLOOK
NATURAL GAS TRANSMISSION OUTLOOK: Panhandle has a one-third interest in Guardian
Pipeline, L.L.C., which is currently constructing a 141-mile, 36-inch pipeline
from Illinois to southeastern Wisconsin for the transportation of natural gas
beginning late 2002. Upon completion of the project, Trunkline will operate and
maintain the pipeline. Panhandle also has a one-third interest in the Centennial
Pipeline LLC which operates a 720-mile, 26 inch pipeline extending from the U.S.
Gulf Coast to Illinois for the transportation of interstate refined petroleum
products. The pipeline began commercial service in April 2002.
In April 2001, FERC approved Trunkline's rate settlement without modification.
The settlement resulted in Trunkline reducing its maximum rates in May 2001. The
reduction is expected to reduce revenues by approximately $2 million annually.
In October 2001, Trunkline LNG, in which Panhandle owns an interest through its
equity interest in LNG Holdings, announced the planned expansion of the Lake
Charles, Louisiana facility to approximately 1.2 bcf per day of send out
capacity, up from its current send out capacity of 630 million cubic feet per
day. The terminal's storage capacity will also be expanded to 9 bcf from its
current storage capacity of 6.3 bcf. On July 31, 2002, the FERC issued its
Environmental Assessment of the expansion project with comments due to be filed
in thirty days. The application for a certificate of public convenience and
necessity of the expansion is pending the FERC action. The expanded facility
could be in operation as early as 2005 although various factors may delay the
in-service date. The expansion expenditures are currently expected to be funded
by Panhandle loans or equity contributions to LNG Holdings, which would be
sourced by repayment by CMS Capital to Panhandle on its outstanding note
receivable.
In October 2001, CMS Energy and Sempra Energy announced an agreement to jointly
develop a major new LNG receiving terminal to bring much-needed natural gas
supplies into northwestern Mexico and southern California. The plant would be
located on the Pacific Coast, north of Ensenada, Baja California, Mexico. As
currently planned, it will have a send out capacity of approximately 1 bcf per
day of natural gas through a new 40-mile pipeline between the terminal and
existing pipelines in the region. Since the October 2001 announcement, CMS
Energy has adjusted its role in the development of the terminal since CMS
Energy's top priority is to reduce debt and improve the balance sheet which will
require restraint in capital spending. As a result, Panhandle will not be an
equity partner in the project, but is expected to participate as the LNG plant
operator and will also provide technical support during the development of the
project which is currently estimated to commence commercial operations in 2007.
However, Panhandle has retained an option to participate as an equity partner in
the project at a later date.
In August 2002, CMS Energy began exploring the sale of its domestic pipeline and
field services businesses.
CMS Energy has completed the first step of goodwill impairment testing at
Panhandle as required by SFAS No. 142. The initial testing indicated a
potentially significant impairment of Panhandle's goodwill as of January 1,
2002. At June 30, 2002, Panhandle's net goodwill balance was $700 million.
Pursuant to SFAS No. 142 requirements, the actual impairment will be determined
in a second step involving a detailed evaluation of all assets and liabilities,
the results of which will be reflected as a cumulative effect of an accounting
change, restated to the first quarter of 2002. CMS Energy is utilizing an
independent appraiser to complete the valuation work, which is expected to be
complete in the third quarter of 2002. For further information, see Note 4,
Goodwill.
CMS-20
CMS Energy Corporation
INDEPENDENT POWER PRODUCTION OUTLOOK: CMS Energy's independent power production
subsidiary plans to complete the restructuring of its operations during 2002 by
narrowing the scope of its existing operations and commitments from four regions
to two regions: the U.S. and the Middle East/North Africa. In addition, its
plans include selling designated assets and investments that are
under-performing, non-region focused and non-synergistic with other CMS Energy
business units. The independent power production business unit will continue to
optimize the operations and management of its remaining portfolio of assets in
order to contribute to CMS Energy's earnings and to maintain its reputation for
solid performance in the construction and operation of power plants. CMS Energy
is actively pursuing the sale, full liquidation, or other disposition of several
of its designated assets and investments, but management cannot predict when,
nor make any assurances that, these asset and investment sales will occur.
MARKETING, SERVICES AND TRADING OUTLOOK: CMS Energy intends to use its
marketing, services and trading business to focus on customers such as Local
Distribution Companies, municipal utilities, cooperative electric companies, and
industrial and commercial businesses in selected locations in North America. CMS
Energy's marketing and trading business also intends to contract for use of
significant gas transportation and storage assets as well as energy and
generating capacity in North America to provide a platform for wholesale
marketing, trading, and physical arbitrage. CMS Energy also seeks to continue
the development of importing and marketing opportunities for LNG.
Recent events in the energy trading market have raised concerns about liquidity.
Management cannot predict what effect these events may have on the liquidity of
the trading markets in the short term, but credit constraints are severely
limiting CMS MST's ability to actively manage and optimize its open positions.
The sale of CMS MST's equity interest in Premstar Energy Canada Ltd., a Canadian
corporation primarily engaged in the brokerage of natural gas, is expected to
close during the third quarter of 2002. Disposition of its interest in CMS Viron
is expected to be completed by the second quarter of 2003.
UNCERTAINTIES: The results of operations and financial position of CMS Energy's
diversified energy businesses may be affected by a number of trends or
uncertainties that have, or CMS Energy reasonably expects could have, a material
impact on income from continuing operations, cash flows as well as balance sheet
and credit improvement. Such trends and uncertainties include: 1) the ability to
sell or optimize assets or businesses in accordance with its financial plan; 2)
the international monetary fluctuations, particularly in Argentina, as well as
Brazil and Australia; 3) the changes in foreign laws, governmental and
regulatory policies that could significantly reduce the tariffs charged and
revenues recognized by certain foreign investments; 4) the imposition of stamp
taxes on certain South American contracts that could significantly increase
project expenses; 5) the impact of any future rate cases or FERC actions or
orders on regulated businesses and the effects of changing regulatory and
accounting related matters resulting from current events; 6) the increased
competition in the market for transmission of natural gas to the Midwest causing
pressure on prices charged by Panhandle; 7) the impact ratings downgrades on
CMS Energy's liquidity, costs of operating and current limited access to capital
markets; and 8) actual amount of goodwill impairment and related impact on
earnings and balance sheet which could negatively impact CMS Energy's borrowing
capacity.
OTHER OUTLOOK: Since the September 11, 2001 terrorist attack in the United
States, CMS Energy has increased security at substantially all facilities and
infrastructure, and will continue to evaluate security on an ongoing basis. CMS
Energy may be required to comply with federal and state regulatory security
measures promulgated in the future. As a result, CMS Energy anticipates that
increased operating costs related to security after September 11, 2001 could be
significant. It is not certain that any additional costs will be recovered in
Consumers' or Panhandle's rates.
Rouge Steel Company, with whom DIG has contracted to sell steam for industrial
use and purchase blast furnace gas as fuel at prices significantly less than the
cost of natural gas, is considering altering certain of its operational
processes as early as mid-2004. These alterations could have an adverse
operational and financial impact on DIG by significantly reducing Rouge Steel
Company's demands for steam from DIG and its ability
CMS-21
CMS Energy Corporation
to provide DIG with economical blast furnace gas. However, these alterations may
result in additional electric sales to Rouge Steel Company. CMS Energy is
currently assessing these potential operational and financial impacts and DIG is
evaluating alternatives to its current contractual arrangements with Rouge Steel
Company, but CMS Energy cannot predict the ultimate outcome of these matters at
this time.
CMS Energy provides post retirement benefits under its Pension Plan, and post
retirement health and life benefits under its OPEB plan to substantially all its
employees. Pension and OPEB plan assets, net of contributions, have reduced in
value from the previous year due to a downturn in the equities market. As a
result, CMS Energy expects to see an increase in pension and OPEB expense levels
over the next few years unless market performance improves. CMS Energy
anticipates pension expense and OPEB expense to rise in 2002 by approximately
$10 million and $21 million, respectively, over 2001 expenses. For pension
expense, this increase is due to a downturn in the value of pension assets
during the past two years, forecasted increases in pay and added service,
decline in the interest rate used to value the liability of the plan, and
expiration of the transition gain amortization. For OPEB expense, the increase
is due to the trend of rising health care costs, the market return on plan
assets being below expected levels and a lower discount rate, based on recent
economic conditions, used to compute the benefit obligation. Health care cost
decreases gradually under the assumptions used in the OPEB plan from current
levels through 2009; however, CMS Energy cannot predict the impact that interest
rates or market returns will have on pension and OPEB expense in the future.
The recent significant downturn in the equities markets has affected the value
of the Pension Plan assets. If the Plan's Accumulated Benefit Obligation exceeds
the value of these assets at December 31, 2002, CMS Energy will be required to
recognize an additional minimum liability for this excess in accordance with
SFAS No. 87. CMS Energy cannot predict the future fair value of the Plan's
assets, but it is possible, without significant recovery of the Plan's assets,
that CMS Energy will need to book an additional minimum liability through a
charge to other comprehensive income. The Accumulated Benefit Obligation is
determined by the Plan's Actuary in the fourth quarter of each year.
In January 2002, CMS Energy contributed $85 million to the Pension Plan. This
amount was comprised of $64 million of pension related benefits and $21 million
of post retirement health care and life insurance benefits. In June 2002, CMS
Energy made an additional contribution in the amount of $21 million for post
retirement health care and life insurance benefits.
In order to keep health care benefits and costs competitive, CMS Energy
announced several changes to the Health Care Plan. These changes are effective
January 1, 2003. The most significant change is that CMS Energy's future
increases in health care costs will be shared with employees.
CMS Energy also provides retirement benefits under a defined contribution 401(k)
plan. CMS Energy currently offers a contribution match of 50 percent of the
employee's contribution up to six percent (three percent maximum), as well as an
incentive match in years when performance exceeds expectations. Effective
September 1, 2002, CMS Energy will suspend the employer's match until January 1,
2005, and eliminate the incentive match permanently. Amounts charged to expense
for the employer's match and incentive match during 2001 were $26 million and
$11 million, respectively.
CONSUMERS' ELECTRIC UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric deliveries
(including both full service sales and delivery service to customers who choose
to buy generation service from an alternative electric supplier) to grow at an
average rate of approximately two percent per year based primarily on a steadily
growing customer base. This growth rate reflects a long-range expected trend of
growth. Growth from year to year may vary from this trend due to customer
response to abnormal weather conditions and changes in economic conditions
including, utilization and expansion of manufacturing facilities.
COMPETITION AND REGULATORY RESTRUCTURING: The enactment of Michigan's Customer
Choice Act and other developments will continue to result in increased
competition in the electric business. Generally, increased competition can
reduce profitability and threatens Consumers' market share for generation
services. The Customer Choice Act allowed all of the company's electric
customers to buy electric generation service from Consumers or from an
alternative electric supplier as of January 1, 2002. Therefore, alternative
electric suppliers for generation services have entered Consumers' market. As of
July 2002, 386 MW of generation services were being provided by such suppliers.
To the extent Consumers experiences "net" Stranded Costs as determined by the
MPSC, the Customer Choice Act allows for the company to recover such
CMS-22
CMS Energy Corporation
"net" Stranded Costs by collecting a transition surcharge from those customers
who switch to an alternative electric supplier.
Stranded and Implementation Costs: The Customer Choice Act allows electric
utilities to recover the act's implementation costs and "net" Stranded Costs
(without defining the term). The act directs the MPSC to establish a method of
calculating "net" Stranded Costs and of conducting related true-up adjustments.
In December 2001, the MPSC adopted a methodology for calculating "net" Stranded
Costs as the shortfall between: (a) the revenue required to cover the costs
associated with fixed generation assets, generation-related regulatory assets,
and capacity payments associated with purchase power agreements, and (b) the
revenues received from customers under existing rates available to cover the
revenue requirement. Consumers has initiated an appeal at the Michigan Court of
Appeals related to the MPSC's December 2001 "net" Stranded Cost order, as a
result of the uncertainty associated with the outcome of the proceeding
described in the following paragraph.
According to the MPSC, "net" Stranded Costs are to be recovered from retail open
access customers through a Stranded Cost transition charge. Even though the MPSC
set Consumers' Stranded Cost transition charge at zero for calendar year 2000,
those costs for 2000 will be subject to further review in the context of the
MPSC's subsequent determinations of "net" Stranded Costs for 2001 and later
years. The MPSC authorized Consumers to use deferred accounting to recognize the
future recovery of costs determined to be stranded. In April 2002, Consumers
made "net" Stranded Cost filings with the MPSC for $22 million and $43 million
for 2000 and 2001, respectively. In the same filing, Consumers estimated that it
would experience "net" Stranded Costs of $126 million for 2002. The MPSC staff
and Energy Michigan filed appeals with the MPSC regarding the inclusion of
certain Clean Air Act-related investment and other costs in Consumers' "net"
Stranded Cost filing. In July 2002, the MPSC granted the MPSC staff its appeal.
As a result, Consumers revised and supplemented its "net" Stranded Costs filing
by excluding all costs associated with the Clean Air Act and resubmitting the
filing to MPSC. After exclusion of the Clean Air Act costs, the revised Stranded
Cost amounts are $11 million and $8 million for 2000 and 2001, respectively, and
an estimated $76 million for 2002. On August 9, 2002 the MPSC Staff and other
intervenors filed their position regarding 2000 and 2001 Stranded Cost. The
Staff recommended that the Commission find that Consumers had Stranded Costs of
$5.1M and $2.8M for 2000 and 2001, respectively. Other parties contended that
Consumers had stranded benefits in 2000 and 2001 and made various suggestions
on how those benefits should be treated. In a separate filing, Consumers
requested regulatory asset accounting treatment for its Clean Air Act
expenditures through 2003. The outcome of these proceedings before the MPSC is
uncertain at this time.
Since 1997, Consumers has incurred significant electric utility restructuring
implementation costs. The following table outlines the applications filed by
Consumers with the MPSC and the status of recovery for these costs.
In Millions
----------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- ---------- ------------- --------- ------- ------- ----------
1999 1997 & 1998 $20 $-- $15 $ 5
2000 1999 30 -- 25 5
2001 2000 25 25 -- --
2002 2001 8 8 -- --
======== ==== ==== ==== ====
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in electric rates. In
the orders received for the years 1997 through 1999, the MPSC also reserved the
right to review again the total implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs. Consumers expects to
receive in 2002, a final order for the 2001 implementation costs. In addition to
the amounts shown, as of June 2002, Consumers incurred and deferred as a
regulatory asset, $5 million of additional implementation costs and has also
recorded as a regulatory asset $13 million for the cost of money associated with
total implementation costs. Consumers believes the implementation costs and the
associated
CMS-23
CMS Energy Corporation
cost of money are fully recoverable in accordance with the Customer Choice Act.
Cash recovery from customers will probably begin after the rate freeze or
rate cap period has expired and Consumers cannot predict the amounts the MPSC
will allow the company to recover.
Rate Caps: The Customer Choice Act imposes certain limitations on electric rates
such that could result in Consumers being unable to collect from customers its
full cost of conducting business. Some of these costs are beyond Consumers'
control. In particular, if Consumers needs to purchase power supply from
wholesale suppliers while retail rates are frozen or capped, the rate
restrictions may make it impossible for Consumers to fully recover purchased
power costs from its customers. As a result, Consumers may be unable to maintain
its profit margins in its electric utility business during the rate freeze or
rate cap periods.
Industrial Contracts: In response to industry restructuring efforts, Consumers
entered into multi-year electric supply contracts with certain large industrial
customers to provide electricity at specially negotiated prices, usually at a
discount from tariff prices. The MPSC approved these special contracts as part
of its phased introduction to competition. From 2001 through 2005, Consumers or
these industrial customers can terminate or restructure some of these contracts.
As of June 2002, neither Consumers nor any of its industrial customers have done
so. Some contracts have expired, but outstanding contracts involve approximately
510 MW. Consumers cannot predict the ultimate financial impact of changes
related to these power supply contracts, or whether additional contracts will be
necessary or advisable.
Code of Conduct: In December 2000, as a result of the passage of the Customer
Choice Act, the MPSC issued a new code of conduct that applies to electric
utilities and alternative electric suppliers. The code of conduct seeks to
prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and internal transfer pricing between Consumers' departments and
affiliates. In October 2001, the new code of conduct was reaffirmed without
substantial modification. Consumers appealed the MPSC orders related to the code
of conduct and sought a stay of the orders until the appeal was complete;
however, the request for a stay was denied. Consumers has filed a compliance
plan in accordance with the code of conduct. It has also sought waivers to the
code of conduct in order to continue utility activities that provide
approximately $50 million in annual revenues. The full impact of the new code of
conduct on Consumers' business will remain uncertain until the appellate courts
issue definitive rulings or the MPSC rules on the waivers. Recently in an appeal
involving affiliate pricing guidelines, the Michigan Court of Appeals struck
them down because of a procedurally defective manner of enactment by the MPSC.
The same procedure was used by the MPSC in enacting the new code of conduct.
Energy Policy: Uncertainty exists regarding the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills introduced in Congress in recent
years aimed to change existing federal regulation of the industry. If the
federal government enacts a comprehensive energy policy or electric
restructuring legislation, then that legislation could potentially affect or
even supercede state regulation.
Transmission: In 1999, the FERC issued Order No. 2000, strongly encouraging
utilities to transfer operating control of their electric transmission
facilities to an RTO, or sell the facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which also requires utilities to divest or transfer the operating
authority of transmission facilities to an independent company. Consumers chose
to offer its electric transmission facilities for sale rather than own and
invest in an asset it cannot control.
In May 2002, Consumers sold its electric transmission facilities for
approximately $290 million in cash to MTH, a non-affiliated limited partnership
whose general partner is a subsidiary of Trans-Elect, Inc.
CMS-24
CMS Energy Corporation
Trans-Elect, Inc. submitted the winning bid through a competitive bidding
process, and various federal agencies approved the transaction. Consumers did
not provide any financial or credit support to Trans-Elect, Inc. Certain
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by such
affiliates when the transaction was discussed internally and negotiated with
purchasers. Consumers anticipates that after selling its transmission
facilities, its after-tax earnings will increase by approximately $17 million
in 2002, due to the recognition of a $26 million one time gain on the sale of
transmission assets. In 2003, Consumers anticipates that after-tax earnings
will decrease by $15 million. This decrease results from the loss of revenue
from wholesale and retail open access customers who would buy services directly
from MTH, including the loss of a return on the sold transmission assets.
Under the agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers will be fixed at current levels until
December 2004, and subject to FERC ratemaking thereafter. MTH will complete the
capital program to expand the transmission system's capability to import
electricity into Michigan, as required by the Customer Choice Act, and Consumers
will continue to maintain the system under a five-year contract with MTH.
Effective April 30, 2002, Consumers and METC withdrew from the Alliance RTO. For
further information, see Note 5, Uncertainties, "Electric Rate Matters -
Transmission."
On July 31, 2002, FERC issued a 600-page notice of proposed rulemaking on
standard market design for electric bulk power markets and transmission. Its
stated purpose is to remedy undue discrimination in the use of the interstate
transmission system and give the nation the benefits of a competitive bulk power
system. The proposal is subject to public comment for 75 days from its date of
publication in the federal register on August 1, 2002. Consumers is currently
studying the effects of the proposed rulemaking.
Wholesale Market Competition: In 1996, Detroit Edison gave Consumers its
four-year notice to terminate their joint operating agreements for the MEPCC.
Detroit Edison and Consumers restructured and continued certain parts of the
MEPCC control area and joint transmission operations, but expressly excluded any
merchant operations (electricity purchasing, sales, and dispatch operations). On
April 1, 2001, Detroit Edison and Consumers began separate merchant operations.
This opened Detroit Edison and Consumers to wholesale market competition as
individual companies. Consumers cannot predict the long-term financial impact of
terminating these joint merchant operations.
Wholesale Market Pricing: FERC authorizes Consumers to sell electricity at
wholesale market prices. In authorizing sales at market prices, the FERC
considers the seller's level of "market power" due to the seller's dominance of
generation resources and surplus generation resources in adjacent wholesale
markets. To continue its authorization to sell at market prices, Consumers filed
a traditional market dominance analysis and indicated its compliance therewith.
In November 2001, the FERC issued an order modifying the traditional method of
determining market power, but later because of uncertainty about its impact on
electric reliability, issued a stay of the order. If the order's modified market
power test is not amended, Consumers cannot be certain it will receive
authorization to continue selling wholesale electricity at market-based prices.
The company may be limited to charging prices no greater than its cost-based
rates. A final decision is not expected for several months.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards for Consumers and other Michigan distribution utilities.
The proposal would establish standards related to restoration after an outage,
safety, and customer relations. Failure to meet the standards would result in
customer bill credits. Consumers submitted comments to the MPSC. In December
2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards.
CMS-25
CMS Energy Corporation
Consumers will continue to participate in this process. Consumers cannot predict
the outcome of the proposed standards or the likely effect, if any, on
Consumers.
For further information and material changes relating to the rate matters and
restructuring of the electric utility industry, see Note 5, Uncertainties,
"Electric Rate Matters - Electric Restructuring" and "Electric Rate Matters -
Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) the need to make additional capital expenditures and
increase operating expenses for Clean Air Act compliance; 2) environmental
liabilities arising from various federal, state and local environmental laws and
regulations, including potential liability or expenses relating to the Michigan
Natural Resources and Environmental Protection Acts and Superfund; 3)
uncertainties relating to the storage and ultimate disposal of spent nuclear
fuel and the successful operation of the Palisades plant by NMC; 4) electric
industry restructuring issues, including those described above; 5) Consumers'
ability to meet peak electric demand requirements at a reasonable cost, without
market disruption, and successfully implement initiatives to reduce exposure to
purchased power price increases; 6) the recovery of electric restructuring
implementation costs; 7) Consumers new status as an electric transmission
customer and not as an electric transmission owner/operator; 8) sufficient
reserves for OATT rate refunds; and 9) the effects of derivative accounting and
potential earnings volatility. For further information about these trends or
uncertainties, see Note 5, Uncertainties.
CONSUMERS' GAS UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers anticipates gas deliveries,
including gas customer choice deliveries (excluding transportation to the MCV
Facility and off-system deliveries), to grow at an average of about one percent
per year based primarily on a steadily growing customer base. Actual gas
deliveries in future periods may be affected by abnormal weather, alternative
electric costs, changes in competitive and economic conditions, and the level of
natural gas consumption per customer.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Contemporaneously with this
filing, Consumers requested partial and immediate relief in the annual amount of
$33 million. In October 2001, Consumers revised its filing to reflect lower
operating costs and requested a $133 million annual distribution service rate
increase. In December 2001, the MPSC authorized a $15 million annual interim
increase in distribution service revenues under bond and subject to refund. In
February 2002, Consumers revised its filing to reflect lower estimated gas
inventory prices and revised depreciation expense and is now requesting an
annual $105 million distribution service rate increase. The MPSC staff supported
an annual increase of $30 million, with an 11 percent return on equity. The ALJ
in the Proposal for Decision issued June 3, 2002, recommended an annual rate
increase of $32 million, with a return on equity of 11 percent. See Note 5,
Uncertainties "Gas Rate Matters - Gas Rate Case" for further information.
UNBUNDLING STUDY: In July 2001, the MPSC directed gas utilities under its
jurisdiction to prepare and file an unbundled cost of service study. The purpose
of the study is to allow parties to advocate or oppose the unbundling of the
following services: metering, billing information, transmission, balancing,
storage, backup and peaking, and customer turn-on and turn-off services.
Unbundled services could be separately priced in the future and made subject to
competition by other providers. The subject is likely to remain the topic of
further study by the utilities in 2002 and further consideration by the MPSC.
Consumers cannot predict the outcome of unbundling costs on its financial
results and conditions.
UNCERTAINTIES: Several gas business trends or uncertainties may affect
Consumers' financial results and conditions. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing gas operations. Such trends and
uncertainties include: 1) potential environmental costs at a number of sites,
including sites formerly housing manufactured gas plant
CMS-26
CMS Energy Corporation
facilities; 2) future gas industry restructuring initiatives; 3) any initiatives
undertaken to protect customers against gas price increases; 4) an inadequate
regulatory response to applications for requested rate increases; 5) market and
regulatory responses to increases in gas costs, including a reduced average use
per residential customer; and 6) increased costs for pipeline safety and
homeland security initiatives that are not recoverable on a timely basis from
customers. For further information about these uncertainties, see Note 5,
Uncertainties.
CONSUMERS' OTHER OUTLOOK
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related services
to retail customers that focus on appliance maintenance, home safety, commodity
choice, and assistance to customers purchasing heating, ventilation and air
conditioning equipment. Consumers continues to look for additional growth
opportunities in providing energy-related services to its customers. The ability
to offer all or some of these services and other utility related
revenue-generating services, which provide approximately $50 million in annual
revenues, may be restricted by the new code of conduct issued by the MPSC, as
discussed above in Electric Business Outlook, "Competition and Regulatory
Restructuring - Code of Conduct."
PENSION AND OPEB COSTS: Consumers provides post retirement benefits under its
Pension Plan, and post retirement health and life benefits under its OPEB plan
to substantially all its employees. Pension and OPEB plan assets, net of
contributions, have been reduced in value from the previous year due to a
downturn in the equities market. As a result, Consumers expects to see an
increase in pension and OPEB expense levels over the next few years unless
market performance improves. Consumers anticipates pension expense and OPEB
expense to rise in 2002 by approximately $8 million and $20 million,
respectively, over 2001 expenses. For pension expense, this increase is due to a
downturn in value of pension assets during the past two years, forecasted
increases in pay and added service, decline in the interest rate used to value
the liability of the plan, and expiration of the transition gain amortization.
For OPEB expense, the increase is due to the trend of rising health care costs,
the market return on plan assets being below expected levels, and a lower
discount rate, based on recent economic conditions, used to compute the benefit
obligation. Health care cost decreases gradually under the assumptions used in
the OPEB plan from current levels through 2009; however, Consumers cannot
predict the impact that interest rates or market returns will have on pension
and OPEB expense in the future.
The recent significant downturn in the equities markets has affected the value
of the Pension Plan assets. If the Plan's Accumulated Benefit Obligation
exceeds the value of these assets at December 31, 2002, Consumers will be
required to recognize an additional minimum liability for this excess in
accordance with SFAS No. 87. Consumers cannot predict the future fair value of
the Plan's assets but it is possible, without significant recovery of the
Plan's assets, that Consumers will have to book an additional minimum liability
through a charge to Other Comprehensive Income. The value of the Plan assets
and the Accumulated Benefit Obligation are determined by the Plan's Actuary in
the fourth quarter of each year.
In January 2002, Consumers contributed $62 million to the Pension Plan. This
amount was for $47 million of pension related benefits and $15 million of post
retirement health care and life insurance benefits. In June 2002, Consumers made
an additional contribution, in the amount of $21 million, for post retirement
health care and life insurance benefits.
In order to keep health care benefits and costs competitive, Consumers announced
several changes to the Health Care Plan. These changes are effective January 1,
2003. The most significant change is that Consumers' future increases in health
care costs will be shared with employees.
Consumers also provides retirement benefits under a defined contribution 401(k)
plan. Consumers currently offers an employer's contribution match of 50 percent
of the employee's contribution up to six percent (three percent maximum), as
well as an incentive match in years when Consumers financial performance exceeds
expectations. Effective September 1, 2002, the employer's match will be
suspended until January 1, 2005, and the incentive match will be eliminated
permanently. Amounts charged to expense for the employer's match and incentive
match during 2001 were $20 million and $8 million, respectively.
CMS-27
CMS Energy Corporation
OTHER MATTERS
CHANGE IN AUDITORS
On April 22, 2002, the Board of Directors of CMS Energy, upon the recommendation
of the Audit Committee of the Board, voted to discontinue using Arthur Andersen
to audit the CMS Energy financial statements for the year ending December 31,
2002. CMS Energy previously retained Arthur Andersen to review its financial
statements for the quarter ended March 31, 2002. On May 23, 2002, CMS Energy's
Board of Directors engaged Ernst & Young to audit its financial statements for
the year ending December 31, 2002. Ernst & Young has hired some of Arthur
Andersen's Detroit office employees, some of whom are former auditors from the
CMS Energy audit engagement team.
As a result of certain financial reporting issues surrounding "round trip"
trading transactions at CMS MST, Arthur Andersen notified CMS Energy that Arthur
Andersen's historical opinions on CMS Energy's financial statements for the
fiscal years ended December 31, 2001 and December 31, 2000 cannot be relied
upon. Arthur Andersen clarified in its notification to CMS Energy that its
decision does not apply to separate, audited financial statements of Consumers
or Panhandle for the applicable years. Arthur Andersen's reports on Consumers'
and Panhandle's consolidated financial statements for each of the fiscal years
ended December 31, 2001 and December 31, 2000 contained no adverse or disclaimer
of opinion. Nor were the reports qualified or modified regarding uncertainty,
audit scope or accounting principles.
During the fiscal years ended December 31, 2001 and December 31, 2000, and
through the date of their opinion for the quarter ended March 31, 2002, CMS
Energy and Arthur Andersen did not disagree on any matter of accounting
principle or practice, financial statement disclosure, or auditing scope or
procedure. If Arthur Andersen and CMS Energy had disagreed on these matters and
they were not resolved to Arthur Andersen's satisfaction, Arthur Andersen would
have noted this in its report on CMS Energy's consolidated financial statements.
During CMS Energy's two most recent fiscal years ended December 31, 2000 and
December 31, 2001 and the subsequent interim period through June 10, 2002, CMS
Energy did not consult with Ernst and Young regarding any matter or event
identified by SEC laws and regulations. However, as a result of the "round trip"
trading transactions, Ernst & Young is in the process of re-auditing CMS
Energy's, consolidated financial statements for each of the fiscal years ended
December 31, 2001 and December 31, 2000, which includes audit work at Consumers
and Panhandle for these years. None of CMS Energy's former auditors, now
employed by Ernst & Young are involved in the re-audit of CMS Energy's
consolidated financial statements.
CEO AND CFO CERTIFICATIONS
CMS Energy did not file with the SEC the certificates required by our CEO and
CFO related to the financial statements included in the CMS Energy Form 10-K
for 2001, which includes financial statements for 2000 as well, and in the Form
10-Q, which contains the 2001 and 2002 quarterly and semiannually financial
statements for the period ended June 30, 2002.
The 2000 and 2001 financial statements need to be restated primarily as a
result of the reported revenues and expenses for "round trip" trades and
related balance sheet adjustments. The restatements cannot be completed until
the Special Investigative Committee of CMS Energy's Board of Directors
completes its investigation of "round trip" trading and related issues and CMS
Energy's newly appointed independent public accountants, Ernst & Young have
completed a re-audit of the 2000 and 2001 financial statements and their
reviews of the current quarterly and semi-annual statements for these years.
For the same reasons, the CEO and CFO of CMS Energy, Consumers and Panhandle
did not make the statements required by the Sarbanes-Oxley Act of 2002 with
respect to the Form 10-Q for the period ended June 30, 2002.
CMS-28
CMS Energy Corporation
CMS ENERGY CORPORATION
Consolidated Statements of Income
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 30 2002 2001 2002 2001
------- ------- ------- -------
In Millions, Except Per Share Amounts
OPERATING REVENUE
Electric utility $ 629 $ 624 $ 1,237 $ 1,289
Gas utility 252 239 868 779
Natural gas transmission 196 263 397 649
Independent power production 128 108 217 217
Marketing, services and trading 1,167 923 2,115 2,027
Other (4) 8 -- 12
------- ------- ------- -------
2,368 2,165 4,834 4,973
------- ------- ------- -------
OPERATING EXPENSES
Operation
Fuel for electric generation 96 88 183 171
Purchased and interchange power - Marketing, services and trading 595 304 1,015 516
Purchased and interchange power 73 107 136 226
Purchased power - related parties 133 126 273 244
Cost of gas sold - Marketing, services and trading 535 464 996 1,246
Cost of gas sold 249 337 749 988
Other 245 298 495 553
------- ------- ------- -------
1,926 1,724 3,847 3,944
Maintenance 61 63 123 129
Depreciation, depletion and amortization 95 101 226 240
General taxes 53 52 118 119
------- ------- ------- -------
2,135 1,940 4,314 4,432
------- ------- ------- -------
PRETAX OPERATING INCOME (LOSS)
Electric utility 116 82 231 216
Gas utility 20 16 83 80
Natural gas transmission 38 44 99 136
Independent power production 73 28 111 52
Marketing, services and trading (33) 51 (26) 57
Other 19 4 22 --
------- ------- ------- -------
233 225 520 541
------- ------- ------- -------
OTHER INCOME (DEDUCTIONS)
Accretion expense (8) (8) (17) (17)
Gain (loss) on asset sales, net 26 (1) 48 (1)
Other, net (1) -- 9 14
------- ------- ------- -------
17 (9) 40 (4)
------- ------- ------- -------
EARNINGS BEFORE INTEREST AND TAXES 250 216 560 537
------- ------- ------- -------
FIXED CHARGES
Interest on long-term debt 119 133 243 270
Other interest 5 17 14 29
Capitalized interest (5) (13) (9) (27)
Preferred dividends -- -- 1 1
Preferred securities distributions 25 24 50 46
------- ------- ------- -------
144 161 299 319
------- ------- ------- -------
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS 106 55 261 218
INCOME TAXES 32 20 97 75
MINORITY INTERESTS 1 1 2 1
------- ------- ------- -------
INCOME FROM CONTINUING OPERATIONS 73 34 162 142
INCOME (LOSS) FROM DISCONTINUED OPERATIONS (141) 19 169 20
------- ------- ------- -------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE AND EXTRAORDINARY ITEM (68) 53 331 162
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR GOODWILL -- -- (9) --
------- ------- ------- -------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (68) 53 322 162
EXTRAORDINARY ITEM (7) -- (8) --
------- ------- ------- -------
CONSOLIDATED NET INCOME (LOSS) $ (75) $ 53 $ 314 $ 162
======= ======= ======= =======
AVERAGE COMMON SHARES OUTSTANDING 135 132 134 129
======= ======= ======= =======
BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE $ (.56) $ .40 $ 2.34 $ 1.27
======= ======= ======= =======
DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE $ (.56) $ .40 $ 2.30 $ 1.25
======= ======= ======= =======
DIVIDENDS DECLARED PER COMMON SHARE $ .365 $ .365 $ .73 $ .73
======= ======= ======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-29
CMS Energy Corporation
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
----------------------
JUNE 30 2002 2001
------- -------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Consolidated net income $ 314 $ 162
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $3 and $3, respectively) 226 240
Discontinued operations (Note 2) (169) (20)
Capital lease and debt discount amortization 11 16
Accretion expense 17 17
Distributions from related parties in excess of (less than) earnings (81) 26
Gain on the sale of assets (48) 1
Cumulative effect of an accounting change 9 --
Extraordinary item 8 --
Changes in other assets and liabilities:
Decrease in accounts receivable and accrued revenues 205 49
Decrease (increase) in inventories 90 (103)
Increase (decrease) in accounts payable and accrued expenses 116 (85)
Increase (decrease) in deferred income taxes and investment tax credit (126) 99
Regulatory obligation - gas choice (6) (16)
Changes in other assets and liabilities (65) (58)
------- -------
Net cash provided by operating activities 501 328
======= =======
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (361) (554)
Investments in partnerships and unconsolidated subsidiaries (29) (146)
Cost to retire property, net (31) (55)
Investments in nuclear decommissioning trust funds (3) (3)
Proceeds from nuclear decommissioning trust funds 12 14
Proceeds from sale of assets 1,188 99
Other (24) (14)
------- -------
Net cash provided by (used in) investing activities 752 (659)
======= =======
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt 349 457
Proceeds from trust preferred securities -- 121
Issuance of common stock 49 328
Retirement of bonds and other long-term debt (1,313) (401)
Retirement of trust preferred securities (30) --
Payment of common stock dividends (97) (94)
Decrease in notes payable, net (150) (74)
Payment of capital lease obligations (7) (13)
Other financing 21 1
------- -------
Net cash provided by (used in) financing activities (1,178) 325
------- -------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS 75 (6)
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 189 182
------- -------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 264 $ 176
======= =======
CMS-30
CMS Energy Corporation
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING
AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 232 $ 238
Income taxes paid (net of refunds) (42) (6)
Pension and OPEB cash contribution 106 89
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ -- $ 12
Other assets placed under capital leases 15 10
======= =======
All highly liquid investments with an original maturity of three months or less
are considered cash equivalents.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-31
CMS Energy Corporation
CMS ENERGY CORPORATION
Consolidated Balance Sheets
ASSETS JUNE 30 DECEMBER 31 JUNE 30
2002 2001 2001
(UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- -----------
In Millions
PLANT AND PROPERTY (AT COST)
Electric utility $ 7,396 $ 7,661 $ 7,482
Gas utility 2,651 2,593 2,539
Natural gas transmission 2,288 2,271 2,158
Oil and gas properties (successful efforts method) 594 849 708
Independent power production 689 916 395
International energy distribution 229 228 224
Other 136 113 97
------- ------- -------
13,983 14,631 13,603
Less accumulated depreciation, depletion and amortization 6,873 6,833 6,398
------- ------- -------
7,110 7,798 7,205
Construction work-in-progress 515 564 934
------- ------- -------
7,625 8,362 8,139
------- ------- -------
INVESTMENTS
Independent power production 733 718 943
Natural gas transmission 257 501 538
Midland Cogeneration Venture Limited Partnership 359 300 295
First Midland Limited Partnership 261 253 253
Other 91 135 66
------- ------- -------
1,701 1,907 2,095
------- ------- -------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 264 189 176
Accounts receivable, notes receivable and accrued revenue, less
allowances of $16, $17 and $16, respectively 408 681 710
Accounts receivable - Marketing, services and trading,
less allowances of $12, $14 and $4, respectively 547 561 638
Inventories at average cost
Gas in underground storage 473 587 389
Materials and supplies 186 174 133
Generating plant fuel stock 57 52 48
Price risk management assets 255 461 1,092
Prepayments and other 217 206 262
------- ------- -------
2,407 2,911 3,448
------- ------- -------
NON-CURRENT ASSETS
Regulatory Assets
Securitization costs 709 717 710
Postretirement benefits 197 209 220
Abandoned Midland Project 11 12 12
Other 173 167 91
Price risk management assets 510 424 350
Goodwill, net 747 811 849
Nuclear decommissioning trust funds 555 581 594
Notes receivable - related party 203 177 166
Notes receivable 129 134 143
Other 506 568 829
------- ------- -------
3,740 3,800 3,964
------- ------- -------
TOTAL ASSETS $15,473 $16,980 $17,646
======= ======= =======
CMS-32
CMS Energy Corporation
STOCKHOLDERS' INVESTMENT AND LIABILITIES JUNE 30 DECEMBER 31 JUNE 30
2002 2001 2001
(UNAUDITED) (UNAUDITED) (UNAUDITED)
----------- ----------- -----------
In Millions
CAPITALIZATION
Common stockholders' equity $ 1,757 $ 1,890 $ 2,684
Preferred stock of subsidiary 44 44 44
Company-obligated convertible Trust Preferred Securities
of subsidiaries(a) 694 694 694
Company-obligated mandatorily redeemable preferred securities
of Consumer's subsidiaries(a) 490 520 520
Long-term debt 6,307 6,923 7,193
Non-current portion of capital leases 96 60 55
------- ------- -------
9,388 10,131 11,190
------- ------- -------
MINORITY INTERESTS 77 86 89
------- ------- -------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 644 981 341
Notes payable 280 416 328
Accounts payable 526 547 632
Accounts payable - Marketing, services and trading 380 452 378
Accrued taxes 337 125 222
Accrued interest 173 163 177
Accounts payable - related parties 66 62 72
Price risk management liabilities 198 381 1,060
Deferred income taxes 12 51 21
Other 438 510 622
------- ------- -------
3,054 3,688 3,853
------- ------- -------
NON-CURRENT LIABILITIES
Deferred income taxes 694 773 772
Postretirement benefits 271 333 350
Deferred investment tax credit 94 102 107
Regulatory liabilities for income taxes, net 276 276 264
Price risk management liabilities 457 352 340
Power loss contract reserves 327 354 50
Gas supply contract obligations 272 287 292
Other 563 598 339
------- ------- -------
2,954 3,075 2,514
------- ------- -------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 5)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $15,473 $16,980 $17,646
======= ======= =======
(a) FOR FURTHER DISCUSSION, SEE NOTE 6 OF THE CONDENSED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-33
CMS Energy Corporation
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 30 2002 2001 2002 2001
------- ------- ------- -------
In Millions
COMMON STOCK
At beginning and end of period $ 1 $ 1 $ 1 $ 1
------- ------- ------- -------
OTHER PAID-IN CAPITAL
At beginning of period 3,298 3,252 3,269 2,936
Common stock reacquired (1) -- (1) --
Common stock issued 20 12 49 328
------- ------- ------- -------
At end of period 3,317 3,264 3,317 3,264
------- ------- ------- -------
REVALUATION CAPITAL
Investments
At beginning of period 1 (3) (4) (2)
Unrealized gain (loss) on investments(a) (1) (1) 4 (2)
------- ------- ------- -------
At end of period -- (4) -- (4)
------- ------- ------- -------
Derivative Instruments
At beginning of period(b) (17) (7) (26) 13
Unrealized gain (loss) on derivative instruments(a) (10) (15) (3) (29)
Reclassification adjustments included in
consolidated net income (loss)(a) 2 (2) 4 (8)
------- ------- ------- -------
At end of period (25) (24) (25) (24)
------- ------- ------- -------
FOREIGN CURRENCY TRANSLATION
At beginning of period (290) (284) (295) (254)
Change in foreign currency translation(a) (408) (17) (403) (47)
------- ------- ------- -------
At end of period (698) (301) (698) (301)
------- ------- ------- -------
RETAINED EARNINGS (DEFICIT)
At beginning of period (714) (256) (1,055) (320)
Consolidated net income (loss)(a) (75) 53 314 162
Common stock dividends declared (49) (49) (97) (94)
------- ------- ------- -------
At end of period (838) (252) (838) (252)
------- ------- ------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 1,757 $ 2,684 $ 1,757 $ 2,684
======= ======= ======= =======
(a) Disclosure of Comprehensive Income (Loss):
Revaluation capital
Investments
Unrealized gain (loss) on investments, net of tax of
$1, $-, $(3) and $-, respectively $ (1) $ (1) $ 4 $ (2)
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $-, $5, $(1) and $13, respectively (10) (15) (3) (29)
Reclassification adjustments included in
consolidated net income (loss), net of tax
of $(1), $-, $(2) and $4, respectively 2 (2) 4 (8)
Foreign currency translation, net (408) (17) (403) (47)
Consolidated net income (75) 53 314 162
------- ------- ------- -------
Total Consolidated Comprehensive Income (Loss) $ (492) $ 18 $ (84) $ 76
======= ======= ======= =======
(b) Six months ended June 30, 2001 is the cumulative effect of change in
accounting principle, net of $(8) tax (Note 1).
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-34
CMS Energy Corporation
CMS ENERGY CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Our independent public accountants have not completed their review of these
interim Consolidated Financial Statements as required under Rule 10-01(d) of
Regulation S-X. CMS Energy expects that this review will occur upon completion
of the re-audit of the restated Consolidated Financial Statements for each of
the fiscal years ended December 31, 2001 and December 31, 2000, and the
completion of the special committee's investigation currently in progress. See
Note 5, Uncertainties - Restatement.
These interim Consolidated Financial Statements have been prepared by CMS Energy
in accordance with SEC rules and regulations. As such, certain information and
footnote disclosures normally included in full year financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted. Certain prior year amounts have
been reclassified to conform to the presentation in the current year. In
management's opinion, the unaudited information contained in this report
reflects all adjustments necessary to assure the fair presentation of financial
position, results of operations and cash flows for the periods presented. The
Condensed Notes to Consolidated Financial Statements and the related
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
contained in CMS Energy's Form 10-K for the year ended December 31, 2001. Due to
the seasonal nature of CMS Energy's operations, the results as presented for
this interim period are not necessarily indicative of results to be achieved for
the fiscal year.
1: CORPORATE STRUCTURE AND BASIS OF PRESENTATION
CMS Energy is the parent holding company of Consumers and Enterprises. Consumers
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Enterprises, through subsidiaries, including Panhandle and its
subsidiaries, is engaged in several domestic and international diversified
energy businesses including: natural gas transmission, storage and processing;
independent power production; and energy marketing, services and trading.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of CMS Energy, Consumers and Enterprises and their majority-owned
subsidiaries. Investments in affiliated companies where CMS Energy has the
ability to exercise significant influence, but not control, are accounted for
using the equity method. For the three and six months ended June 30, 2002,
undistributed equity earnings were $50 million and $81 million, respectively
compared to distributions in excess of earnings of $58 million and $26 million
for the three and six months ended June 30, 2001. Intercompany transactions and
balances have been eliminated.
USE OF ESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make judgments, 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
materially differ from those estimates.
The recording of estimated liabilities for contingent losses within the
financial statements is guided by the principles in SFAS No. 5. SFAS No. 5
requires a company to record estimated liabilities in the financial statements
when it is probable that a loss will be paid in the future as a result of a
current event, and that
CMS-35
CMS Energy Corporation
amount can be reasonably estimated. CMS Energy has used this accounting
principle to record estimated liabilities discussed in Note 5, Uncertainties.
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
SFAS No. 71. As a result, the actions of regulators affect when Consumers
recognizes revenues, expenses, assets and liabilities.
In March 1999, Consumers received MPSC electric restructuring orders and, as a
result, discontinued application of SFAS No. 71 for the electric supply portion
of its business. Discontinuation of SFAS No. 71 for the electric supply portion
of Consumers' business resulted in Consumers reducing the carrying value of its
Palisades plant-related assets by approximately $535 million and establishing a
regulatory asset for a corresponding amount. According to current accounting
standards, Consumers can continue to carry its electric supply-related
regulatory assets if legislation or an MPSC rate order allows the collection of
cash flows to recover these regulatory assets from its regulated transmission
and distribution customers. As of June 30, 2002, Consumers had a net investment
in electric supply facilities of $1.413 billion included in electric plant and
property. See Note 2, Uncertainties, "Electric Rate Matters - Electric
Restructuring."
IMPLEMENTATION OF SFAS NO. 133: CMS Energy adopted SFAS No. 133 on January 1,
2001. This standard requires CMS Energy to recognize at fair value on the
balance sheet, as assets or liabilities, all contracts that meet the definition
of a derivative instrument. The standard also requires CMS Energy to record all
changes in fair value directly in earnings unless the derivative instrument
meets certain qualifying hedge criteria, in which case, the changes in fair
value would be reflected in other comprehensive income. CMS Energy determines
fair value based upon quoted market prices and mathematical models using current
and historical pricing data. The ineffective portion, if any, of all hedges are
recognized in earnings.
CMS Energy believes that the majority of its contracts, power purchase
agreements and gas transportation contracts qualify for the normal purchases and
sales exception of SFAS No. 133 and are not subject to the accounting rules for
derivative instruments. CMS Energy uses derivative instruments that require
derivative accounting, to limit its exposures to electricity and gas commodity
price risk. The interest rate and foreign currency exchange contracts met the
requirements for hedge accounting under SFAS No. 133 and CMS Energy recorded the
changes in the fair value of these contracts in other comprehensive income.
The financial statement impact of recording the SFAS No. 133 transition
adjustment on January 1, 2001 is as follows:
In Millions
-----------
Fair value of derivative assets $35
Fair value of derivative liabilities 14
Increase in accumulated other comprehensive income, net of tax 7
CMS Energy believes that Consumers electric capacity and energy contracts do
not qualify as derivitives due to the lack of an active energy market in the
state of Michigan and the transportation cost to deliver the power under the
contracts to the closest active energy market at the Cinergy hub in Ohio. If a
market develops in the future, Consumers may be required to account for these
contracts as derivitives. The mark to market impact in earnings related to
these contracts, particularly related to the purchase power agreement with
the MCV, could be material to the financial statements.
On January 1, 2001, upon initial adoption of the standard including adjustments
for subsequent guidance, CMS Energy recorded a $7 million, net of tax,
cumulative effect adjustment as an increase in accumulated other comprehensive
income. This adjustment relates to the difference between the fair value and
recorded book value of contracts related to gas call options, gas fuel for
generation swap contracts, and interest rate swap contracts that qualified for
hedge accounting prior to the initial adoption of SFAS No. 133 and Consumers'
proportionate share of the effects of adopting SFAS No. 133 related to its
equity investment in the MCV Partnership. Based on the pretax initial transition
adjustment of $20 million recorded in accumulated other comprehensive income at
January 1, 2001, Consumers reclassified to earnings $12 million as a reduction
to the cost of gas, $1 million as a reduction to the cost of power supply, $2
million as an increase in interest expense
CMS-36
CMS Energy Corporation
and $8 million as an increase in other revenues for the twelve months ended
December 31, 2001. CMS Energy recorded $12 million as an increase in interest
expense during 2001, which includes the $2 million of additional interest
expense at Consumers. The difference between the initial transition adjustment
and the amounts reclassified to earnings represents an unrealized loss in the
fair value of the derivative instruments since January 1, 2001, resulting in a
decrease of other comprehensive income.
At adoption of the standard on January 1, 2001, derivative and hedge accounting
for certain utility industry contracts, particularly electric call option
contracts and option-like contracts, and contracts subject to Bookouts was
uncertain. Consumers accounted for these types of contracts as derivatives that
qualified for the normal purchase exception of SFAS No. 133 and, therefore, did
not record these contracts on the balance sheet at fair value. In June and
December 2001, the FASB issued guidance that resolved the accounting for these
contracts. As a result, on July 1, 2001, Consumers recorded a $3 million, net of
tax, cumulative effect adjustment as an unrealized loss decreasing accumulated
other comprehensive income, and on December 31, 2001, recorded an $11 million,
net of tax, cumulative effect adjustment as a decrease to earnings. These
adjustments relate to the difference between the fair value and the recorded
book value of electric call option contracts.
As of June 30, 2002, Consumers recorded a total of $1 million, net of tax, as an
unrealized gain in other comprehensive income related to its proportionate share
of the effects of derivative accounting related to its equity investment in the
MCV Partnership. Consumers expects to reclassify this gain, if this value
remains, as an increase to other operating revenue during the next 12 months.
DERIVATIVE IMPLEMENTATION GROUP ISSUES: In December 2001, the FASB issued final
guidance for DIG Statement No. C16, which was effective April 1, 2002. Consumers
has completed its study of DIG Statement No. C16, and has determined that this
issue will not affect the accounting for its fuel supply contracts.
For further discussion of derivative activities, see Note 5, Uncertainties,
"Other Electric Uncertainties - Derivative Activities" and "Other Gas
Uncertainties - Derivative Activities".
FOREIGN CURRENCY TRANSLATION: CMS Energy's subsidiaries and affiliates whose
functional currency is other than the U.S. dollar translate their assets and
liabilities into U.S. dollars at the current exchange rates in effect at the end
of the fiscal period. The revenue and expense accounts of such subsidiaries and
affiliates are translated into U.S. dollars at the average exchange rates that
prevailed during the period. The gains or losses that result from this process,
and gains and losses on intercompany foreign currency transactions that are
long-term in nature, and which CMS Energy does not intend to settle in the
foreseeable future, are shown in the stockholders' equity section of the balance
sheet. For subsidiaries operating in highly inflationary economies, the U.S.
dollar is considered to be the functional currency, and transaction gains and
losses are included in determining net income. Gains and losses that arise from
exchange rate fluctuations on transactions denominated in a currency other than
the functional currency, except those that are hedged, are included in
determining net income.
RECLASSIFICATIONS: CMS Energy has reclassified certain prior year amounts for
comparative purposes. For the three and six months ended June 30, 2002 and 2001,
CMS Energy reclassified a portion of cost of gas sold in 2001 to other operating
expenses, reclassified various operations to discontinued operations, and
reclassified the gain on the sale of CMS Oil and Gas' Equatorial Guinea
properties to discontinued operations. These reclassifications did not affect
consolidated net income for the years presented.
CMS-37
CMS Energy Corporation
EXTRAORDINARY ITEM: Cash proceeds received from asset sales in 2002 have been
used to retire existing debt early. As a result, charges associated with the
early extinguishment of debt of $7 million and $8 million, net of tax, have been
reflected as an extraordinary loss in the Consolidated Statements of Income for
the three and six months ended June 30, 2002, respectively.
SFAS NO. 142, GOODWILL AND OTHER INTANGIBLE ASSETS: SFAS No. 142, issued in July
2001, requires that goodwill and other intangible assets no longer be amortized
to earnings, but instead be reviewed for impairment on an annual basis. Goodwill
represents the excess of the fair value of the net assets of acquired companies
and was amortized using the straight-line method, over a forty-year life,
through December 31, 2001. Effective January 1, 2002, CMS Energy adopted SFAS
No. 142 (see Note 4, Goodwill).
SFAS NO. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS:
This new standard was issued by the FASB in October 2001, and supersedes SFAS
No. 121 and APB Opinion No. 30. SFAS No. 144 requires that long-lived assets be
measured at the lower of either the carrying amount or the fair value less the
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS No. 144 also broadens the reporting of discontinued operations to
include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. The adoption of SFAS No.
144, effective January 1, 2002, has resulted in CMS Energy accounting for
impairments or disposal of long-lived assets under the provisions of SFAS No.
144, but has not changed the accounting used for previous asset impairments or
disposals.
ACCOUNTING FOR HEADQUARTERS BUILDING LEASE: In April 2001, Consumers Campus
Holdings entered into a lease agreement for the construction of an office
building to be used as the main headquarters for Consumers in Jackson, Michigan.
Consumers' current headquarters building lease expires in June 2003. The new
office building lessor has committed to fund up to $70 million for construction
of the building, which is due to be completed during March 2003. Consumers is
acting as the construction agent of the lessor for this project. During
construction, the lessor has a maximum recourse of 89.9 percent against
Consumers in the event of certain defaults which Consumers believes are
unlikely. For several events of default, primarily bankruptcy or intentional
misapplication of funds, there could be full recourse for the amounts expended
by the lessor at that time. The agreement also includes a common change in
control provision, which could trigger full payment of construction costs by
Consumers. As a result of this provision, Consumers elected to classify this
lease as a capital lease. This classification represents the total obligation of
Consumers under this agreement. As such, Consumers' balance sheet as of June 30,
2002 reflects a capital lease asset and an offsetting non-current liability
equivalent to the cost of construction at that date of $33 million.
2: DISCONTINUED OPERATIONS
In June 2002, CMS Energy announced its plan to sell CMS MST's energy performance
contracting subsidiary, CMS Viron. CMS Viron enabled building owners to improve
their facilities with equipment upgrades and retrofits and finance the work with
guaranteed energy and operational savings. CMS Viron's strongest markets are in
the mid-Atlantic, Midwest and California. CMS MST, upon announcing its intention
to put CMS Viron up for sale, was required to measure the assets and liabilities
of CMS Viron at the lower of the carrying value or the fair value less cost to
sell in accordance with SFAS No. 144. After evaluating all of the relevant facts
and circumstances including third party bid data and liquidation analysis, a
loss of $15 million has been reflected as a loss on discontinued operations in
order to appropriately reflect the fair
CMS-38
CMS Energy Corporation
value less selling costs of CMS Viron. CMS Energy is actively seeking a buyer
for the assets of CMS Viron and although the timing of this sale is difficult to
predict, nor can it be assured, management expects the sale to occur within one
year.
In June 2002, CMS Energy abandoned the Zirconium Recovery Project, which was
initiated in January 2000. The purpose of the project was to extract and sell
uranium and zirconium from a pile of caldesite ore held by the Defense Logistic
Agency of the U.S. Department of Defense. After evaluating future cost and risk,
CMS Energy decided to abandon this project and recorded a $31 million after-tax
loss in discontinued operations at June 30, 2002.
In May 2002, CMS Energy announced its plan to discontinue the operations of CMS
Oil and Gas and exit the exploration and production business. Formed in 1967,
CMS Oil and Gas was a developer of oil and gas supplies in the Permian Basin of
west Texas and internationally in Cameroon, the Republic of Congo, Colombia,
Eritrea, Tunisia and Venezuela. In July 2002, CMS Energy signed a definitive
agreement and letter of intent with Perenco S.A., a privately held exploration
and production company, and its affiliates for the sale of substantially all of
CMS Oil and Gas. In August 2002 a definitive agreement was signed with another
party for CMS Oil and Gas' assets in Colombia, which were previously covered by
the letter of intent. The total sale price is approximately $232 million and
results in an after tax loss of approximately $110 million. The sales are
expected to close in the third or fourth quarter of 2002.
On May 1, 2002, CMS closed on the sale of CMS Oil and Gas' coalbed methane
holdings in the Powder River Basin to XTO Energy. The Powder River properties
were included in discontinued operations for the first four months of 2002,
including a gain on the sale of $17 million ($11 million net of tax).
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
Included in the sale were all of CMS Oil and Gas' oil and gas reserves in
Equatorial Guinea and CMS Gas Transmission's ownership interest in the related
methanol plant. The gain on the Equatorial Guinea properties of $497 million
($310 million, net of tax) is included in "discontinued operations" on the
Consolidated Statements of Income at June 30, 2002.
In September 2001, CMS Energy discontinued the operations of the International
Energy Distribution segment. CMS Energy is actively seeking a buyer for the
assets of CMS Electric and Gas, and although the timing of this sale is
difficult to predict, nor can it be assured, management expects the sale to
occur within one year.
The following summarizes the balance sheet information of the discontinued
operations:
In Millions
---------------------
June 30 2002 2001
------ ------
Assets
Cash $ 17 $ 70
Accounts receivable, net 138 155
Notes receivable 214 35
Materials and supplies 15 21
Property, plant and equipment, net 252 746
Goodwill 31 41
Other 100 109
------ ------
$ 767 $1,177
====== ======
CMS-39
CMS Energy Corporation
Liabilities
Accounts payable $ 158 $ 139
Current and long-term debt 13 183
Accrued taxes 143 31
Minority interest 20 84
Other 22 80
------ ------
$ 356 $ 517
------ ------
In accordance with SFAS No. 144, the net income (losses) of the operations are
included in the consolidated statements of income under "discontinued
operations". The pretax loss recorded for the six months ended June 30, 2002 on
the anticipated sale of these operations was $213 million, which included a
reduction in asset values, a provision for anticipated closing costs and a
portion of CMS Energy's interest expense. Interest expense was allocated to the
operation based on its ratio of total capital to that of CMS Energy. See table
below for income statement components of the discontinued operations.
In Millions
--------------------
Six months ended June 30 2002 2001
----- -----
Discontinued operations:
Income (loss) from discontinued operations, net of taxes of $190 $ 309 $ 20
and $16
Loss on disposal of discontinued operations, net of tax benefit of $73 (140) --
----- -----
Total $ 169 $ 20
===== =====
3: ASSET DISPOSITIONS
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
Proceeds from this transaction were used primarily to retire existing debt.
Included in the sale were all of CMS Oil and Gas' oil and gas reserves in
Equatorial Guinea and CMS Gas Transmission's ownership interest in the related
methanol plant. The pretax gain on the sale was $516 million ($322 million, net
of tax, or $2.44 and $2.36 per basic and diluted share, respectively). The gain
on the Equatorial Guinea properties of $497 million ($310 million, net of tax)
is included in discontinued operations and the gain on the methanol plant of $19
million ($12 million, net of tax) is included in "Gain (loss) on asset sales,
net" on the Consolidated Statements of Income.
In April 2002, CMS Energy sold its equity ownership interest in Toledo Power
Company in the Philippines for $10 million. Proceeds from the sale were used to
repay debt and improve the balance sheet. The pretax loss, as shown on the
Consolidated Statements of Income, was $11 million ($8 million, net of tax).
On May 1, 2002, Consumers Energy closed on the sale of its electric transmission
system for approximately $290 million to a limited partnership whose general
partner is Washington D.C.-based Trans-Elect. The pretax gain, as shown on the
Consolidated Statements of Income, was $39 million ($30 million, net of tax, or
$0.22 per basic and diluted share).
Also on May 1, 2002, CMS Energy closed on the sale of CMS Oil and Gas' coalbed
methane holdings in the Powder River Basin for $101 million. Proceeds from the
sale were used to reduce debt and improve CMS
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Energy's balance sheet. The pretax gain included in "discontinued operations" on
the Consolidated Statements of Income was $17 million ($11 million, net of tax).
4: GOODWILL
CMS MST: Effective January 1, 2002, SFAS No. 142 disallowed the continued
amortization of goodwill and required the testing of goodwill for potential
impairment. During the third quarter of 1999 CMS MST purchased a 100 percent
interest in Viron Energy Services. CMS MST consolidated the activity of CMS
Viron and recorded goodwill as a result of the purchase price allocation. In
performing the analysis of CMS Viron's fair value as of January 1, 2002, CMS MST
has (a) evaluated bids, (b) measured the liquidation basis fair value and (c)
qualitatively evaluated any significant changes in the market value of CMS
Viron's business between January 1, 2002 and the date of the bids. In performing
the second step of the SFAS No. 142 analysis, CMS MST concluded that CMS Viron's
entire fair value should be properly allocated to its non-goodwill assets and
liabilities as of January 1, 2002. Based on the quantitative and qualitative
analysis, CMS MST recorded a change in accounting principle loss of $14 million
($9 million, net of tax) for goodwill impairment in accordance with the
transition provisions of SFAS No. 142.
The following table represents what net income would have been had the goodwill
impairment been recorded for the three months ended March 31, 2002.
In Millions, Except Per Share Amounts
- --------------------------------------------------------------------------------------------------------
Three months ended March 31 2002
- --------------------------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME OF CMS ENERGY AS REPORTED $ 399
Goodwill Impairment (9)
----------------------------------------------------------------------------------------------------
Consolidated Net Income As Adjusted $ 390
======================================================================================================
BASIC EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY AS REPORTED $2.99
Goodwill Impairment (0.07)
----------------------------------------------------------------------------------------------------
Earnings Per Share As Adjusted $2.92
====================================================================================================
DILUTED EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY AS REPORTED $2.92
Goodwill Impairment (0.07)
----------------------------------------------------------------------------------------------------
Earnings Per Share AS Adjusted $2.85
====================================================================================================
PANHANDLE: In accordance with SFAS No. 142, Panhandle completed the first step
of the goodwill impairment testing which indicates a potentially significant
impairment of Panhandle's goodwill exists as of January 1, 2002. Panhandle has
$700 million of goodwill recorded as of January 1, 2002 which is subject to this
impairment test. Pursuant to SFAS No. 142 requirements, the actual amount of
impairment is determined in a second step involving a detailed valuation of all
assets and liabilities utilizing an independent appraiser and when determined,
will be reflected as a cumulative effect of an accounting change, restated to
the first quarter of 2002. This valuation work is underway and expected to be
completed in the third quarter of 2002 and results will be announced after
completion and review by the company.
5: UNCERTAINTIES
CONSUMERS' ELECTRIC UTILITY CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental regulations. Consumers expects that the cost of future
environmental compliance, especially compliance with clean air laws, will be
significant.
Clean Air - In 1997, the EPA introduced new regulations regarding the standard
for ozone and particulate-related emissions that were the subject of litigation.
The United States Supreme Court determined that the EPA has the power to revise
the standards but that the EPA implementation plan was not lawful. In 1998, the
EPA Administrator issued final regulations requiring the state of Michigan to
further limit nitrogen oxide emissions. The EPA has also issued additional final
regulations regarding nitrogen oxide emissions that require certain generators,
including some of Consumers' electric generating facilities, to achieve the same
emissions rate as that required by the 1998 plan if the state does not comply
with the 1998 regulations. The Michigan Department of Environmental Quality is
in the process of finalizing rules to comply with this plan. Rules are expected
to be promulgated and submitted to EPA by late summer or early fall of 2002.
These regulations will require Consumers to make significant capital
expenditures estimated to be $680 million, calculated in year 2002 dollars. Cost
estimates have been developed, in part, by independent contractors with
expertise in
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this field. The estimates are dependent on regulatory outcome, market forces
associated with emission reduction, and with regional and national economic
conditions. As of June 2002, Consumers has incurred $344 million in capital
expenditures to comply with these regulations and anticipates that the remaining
capital expenditures will be incurred between 2002 and 2006. At some point after
2006, if new environmental standards for multi-pollutants become effective,
Consumers may need additional capital expenditures to comply with the standards.
Consumers is unable to estimate the additional capital expenditures required
until the proposed standards are further defined. Based on existing
legislation, beginning January 2004, an annual return of and on these types of
capital expenditures, to the extent they are above depreciation levels, is
expected to be recoverable, subject to an MPSC prudency hearing, in future
rates.
These and other required environmental expenditures, if not recovered in
Consumers rates, may have a material adverse effect upon Consumers' financial
condition and results of operations.
Cleanup and Solid Waste - Under the Michigan Natural Resources and Environmental
Protection Act, Consumers expects that it will ultimately incur investigation
and remedial action costs at a number of sites. Consumers believes that these
costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $1 million and $9 million. As of June
30, 2002, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
In October 1998, during routine maintenance activities, Consumers identified PCB
as a component in certain paint, grout and sealant materials at the Ludington
Pumped Storage facility. Consumers removed and replaced part of the PCB
material. In April 2000, Consumers proposed a plan to deal with the remaining
materials and is awaiting a response from the EPA.
CONSUMERS' ELECTRIC RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan Legislature passed electric
utility restructuring legislation known as the Customer Choice Act. This act: 1)
permits all customers to choose their electric generation supplier beginning
January 1, 2002; 2) cuts residential electric rates by five percent; 3) freezes
all electric rates through December 31, 2003, and establishes a rate cap for
residential customers through at least December 31, 2005, and a rate cap for
small commercial and industrial customers through at least December 31, 2004; 4)
allows for the use of low-cost Securitization bonds to refinance qualified
costs, as defined by the act, as a means of offsetting the earnings impact of
the five percent residential rate reduction; 5) establishes a market power
supply test that may require transferring control of generation resources in
excess of that required to serve firm retail sales requirements (a requirement
Consumers believes itself to be in compliance with at this time); 6) requires
Michigan utilities to join a FERC-approved RTO or divest their interest in
transmission facilities to an independent transmission owner; 7) requires
Consumers, Detroit Edison and American Electric Power to jointly expand their
available transmission capability by at least 2,000 MW; 8) allows deferred
recovery of an annual return of and on capital expenditures in excess of
depreciation levels incurred during and before the rate cap period; and 9)
allows recovery of "net" Stranded Costs and implementation costs incurred as a
result of the passage of the act. On July 23, 2002, Consumers received an order
approving the plan to achieve the increased transmission capacity from the MPSC.
Once the increased transmission capacity projects identified in the plan are
completed, verification of completion must be sent to the MPSC. At this point,
Consumers is deemed to be in compliance with the MPSC statute. Consumers is
highly confident that it will meet the conditions of items 5 and 7 above, prior
to the earliest rate cap termination dates specified in the act. Failure to do
so could result in an extension of the rate caps to as late as December 31,
2013.
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In 1998, Consumers submitted a plan for electric retail open access to the MPSC.
In March 1999, the MPSC issued orders generally supporting the plan. The
Customer Choice Act states that the MPSC orders issued before June 2002 are in
compliance with this act and enforceable by the MPSC. Those MPSC orders: 1)
allow electric customers to choose their supplier; 2) authorize recovery of
"net" Stranded Costs and implementation costs; and 3) confirm any voluntary
commitments of electric utilities. In September 2000, as required by the MPSC,
Consumers once again filed tariffs governing its retail open access program and
made revisions to comply with the Customer Choice Act. In December 2001, the
MPSC approved revised retail open access service tariffs. The revised tariffs
establish the rates, terms, and conditions under which retail customers will be
permitted to choose an alternative electric supplier. The tariffs, effective
January 1, 2002, did not require significant modifications in the existing
retail open access program. The tariff terms allow retail open access customers,
upon thirty days notice to Consumers, to return to Consumers' generation service
at current tariff rates. However, Consumers may not have sufficient, reasonably
priced, capacity to meet the additional demand of returning retail open access
customers, and may be forced to purchase electricity on the spot market at
higher prices than it could recover from its customers.
SECURITIZATION: In October 2000 and January 2001, the MPSC issued orders
authorizing Consumers to issue Securitization bonds. Securitization typically
involves issuing asset-backed bonds with a higher credit rating than
conventional utility corporate financing. The orders authorized Consumers to
securitize approximately $469 million in qualified costs, which were primarily
regulatory assets plus recovery of the Securitization expenses. Securitization
results in lower interest costs and a longer amortization period for the
securitized assets, which would offset the majority of the impact of the
required residential rate reduction (approximately $22 million in 2000 and $49
million annually thereafter). The orders direct Consumers to apply any cost
savings in excess of the five percent residential rate reduction to rate
reductions for non-residential customers and reductions in Stranded Costs for
retail open access customers after the bonds are sold. Excess savings are
currently estimated to be approximately $12 million annually.
In November 2001, Consumers Funding LLC, a special purpose consolidated
subsidiary of Consumers formed to issue the bonds, issued $469 million of
Securitization bonds, Series 2001-1. The Securitization bonds mature at
different times over a period of up to 14 years, with an average interest rate
of 5.3 percent. The last expected maturity date is October 20, 2015. Net
proceeds from the sale of the Securitization bonds, after issuance expenses,
were approximately $460 million. Consumers used the net proceeds to buy back
$164 million of its common stock from its parent, CMS Energy. From December 2001
through March 2002, the remainder of these proceeds were used to pay down
Consumers long-term debt. CMS Energy used the $164 million from Consumers to pay
down its own short-term debt.
Consumers and Consumers Funding LLC will recover the repayment of principal,
interest and other expenses relating to the bond issuance through a
securitization charge and a tax charge that began in December 2001. These
charges are subject to an annual true-up until one year prior to the last
expected bond maturity date, and no more than quarterly thereafter. Current
electric rate design covers these charges, and there will be no rate impact for
most Consumers electric customers until the Customer Choice Act rate freeze
expires. Securitization charges are remitted to a trustee for the Securitization
bonds and are not available to Consumers' creditors.
Regulatory assets are normally amortized over their period of regulated
recovery. Beginning January 1, 2001, the amortization was deferred for the
approved regulatory assets being securitized, which effectively offset the
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CMS Energy Corporation
loss in revenue in 2001 resulting from the five percent residential rate
reduction. In December 2001, after the Securitization bonds were sold, the
amortization was re-established, based on a schedule that is the same as the
recovery of the principal amounts of the securitized qualified costs. In 2002,
the amortization amount is expected to be approximately $31 million and the
securitized assets will be fully amortized by the end of 2015.
TRANSMISSION: In 1999, the FERC issued Order No. 2000, strongly encouraging
utilities to transfer operating control of their electric transmission
facilities to an RTO, or sell the facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which also requires utilities to divest or transfer the operating
authority of transmission facilities to an independent company. Consumers chose
to offer its electric transmission facilities for sale rather than own and
invest in an asset that it cannot control. In May 2002, Consumers sold its
electric transmission facilities for approximately $290 million in cash to MTH,
a non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect Inc.
Trans-Elect, Inc. submitted the winning bid through a competitive bidding
process, and various federal agencies approved the transaction. Consumers did
not provide any financial or credit support to Trans-Elect, Inc. Certain
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by such
affiliates when the transaction was discussed internally and negotiated with
purchasers. Consumers anticipates that after selling its transmission
facilities, its after-tax earnings will increase by approximately $17 million in
2002 due to the recognition of a $26 million one time gain on the sale of
transmission assets. In 2003, Consumers anticipates after-tax earnings will
decrease by $15 million. This decrease results from the loss of revenue from
wholesale and retail open access customers who would buy services directly from
MTH, including the loss of a return on the sold transmission assets.
Under the agreement with MTH, and subject to additional RTO surcharges,
transmission rates charged to Consumers will be fixed at current levels until
December 31, 2004, and subject to FERC ratemaking thereafter. MTH will complete
the capital program to expand the transmission system's capability to import
electricity into Michigan, as required by the Customer Choice Act, and Consumers
will continue to maintain the system under a five-year contract with MTH.
Effective April 30, 2002, Consumers and METC withdrew from the Alliance RTO.
In the past, when IPPs connected to transmission systems, they paid a fee that
transmission companies used to offset capital costs incurred to connect the IPP
to the transmission system and make system upgrades needed for the
interconnection. In order to promote electric generation competition, the FERC
recently ordered that the system upgrade portion of the fee be refunded to IPPs
over time as transmission service is taken. As a result, transmission companies
no longer have the benefit of lowering their capital costs for transmission
system upgrades. METC recorded a $30 million liability for IPP refunds.
Subsequently, MTH assumed this liability as part of its purchase of the
transmission facilities.
In June 2001, the Michigan South Central Power Agency and the Michigan Public
Power Agency filed suit against Consumers and METC in a Michigan circuit court.
The suit sought to prevent the transmission facilities sale or transfer without
first binding a successor to honor the municipal agencies' ownership interests,
contractual agreements and rights. In August 2001, the parties reached two
settlements. The Michigan circuit
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court approved the settlements and they were amended in February 2002 to assure
that closing could occur if all closing conditions were satisfied. The circuit
court retained jurisdiction over the matter and has since dismissed the lawsuit.
On July 31, 2002, FERC issued a 600-page notice of proposed rulemaking on
standard market design for electric bulk power transmission. Its stated purpose
is to remedy undue discrimination in the use of the interstate transmission
system and give the nation the benefits of a competitive bulk power markets and
transmission system. The proposal is subject to public comment for 75 days from
its date of publication in the federal register on August 1, 2002. Consumers is
currently studying the effects of the proposed rulemaking.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin, of approximately 15 percent. The reserve
margin provides additional power supply above Consumers' anticipated peak power
supply demands. It also allows Consumers to provide reliable service to its
electric service customers and to protect itself against unscheduled plant
outages and unanticipated demand. For the summers 2002 and 2003, as it has in
previous summers, Consumers is planning for a reserve margin of 15 percent. The
actual reserve margin needed will depend primarily on summer weather conditions,
the level of retail open access requirements being served by others during the
summer, and any unscheduled plant outages. As of July 2002, alternative electric
suppliers are providing 386 MW of generation supply to customers.
To reduce the risk of high electric prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electric call option contracts for the physical delivery of electricity during
the months of June through September. As of June 30, 2002, Consumers had
purchased or had commitments to purchase electric call option contracts covering
the estimated summer 2002 reserve margin requirement and partially covering the
estimated reserve margin requirements for summers 2003 through 2007. Consumers
has recorded an asset of $35 million for these call options, of which $5 million
pertains to 2002. The total estimated cost of these electricity call option
contracts for summer 2002 is approximately $12 million.
Prior to 1998, the PSCR process provided for the reconciliation of actual power
supply costs with power supply revenues. This process assured recovery of all
reasonable and prudent power supply costs actually incurred by Consumers,
including the actual cost for fuel, and purchased and interchange power. In
1998, as part of the electric restructuring efforts, the MPSC suspended the PSCR
process, and would not grant adjustment of customer rates through 2001. As a
result of the rate freeze imposed by the Customer Choice Act, the current rates
will remain in effect until at least December 31, 2003 and, therefore, the PSCR
process remains suspended. Therefore, changes in power supply costs as a result
of fluctuating electricity prices will not be reflected in rates charged to
Consumers' customers during the rate freeze period.
ELECTRIC PROCEEDINGS: The Customer Choice Act allows electric utilities to
recover the act's implementation costs and "net" Stranded Costs (without
defining the term). The act directs the MPSC to establish a method of
calculating "net" Stranded Costs and of conducting related true-up adjustments.
In December 2001, the MPSC adopted a methodology for calculating "net" Stranded
Costs as the shortfall between: (a) the revenue required to cover costs
associated with fixed generation assets, generation-related regulatory assets,
and capacity payments associated with purchase power agreements, and (b) the
revenues received from customers under existing rates available to cover the
revenue requirement. Consumers has initiated an appeal at the Michigan Court of
Appeals related to the MPSC's December 2001 "net" Stranded Cost order, as a
result of the uncertainty associated with the outcome of the proceeding
described in the following paragraph.
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According to the MPSC, "net" Stranded Costs are to be recovered from retail open
access customers through a Stranded Cost transition charge. Even though the MPSC
set Consumers' Stranded Cost transition charge at zero for calendar year 2000,
those costs for 2000 will be subject to further review in the context of the
MPSC's subsequent determinations of "net" Stranded Costs for 2001 and later
years. The MPSC authorized Consumers to use deferred accounting to recognize the
future recovery of costs determined to be stranded. In April 2002, Consumers
made "net" Stranded Cost filings with the MPSC for $22 million and $43 million
for 2000 and 2001, respectively. In the same filing, Consumers estimated that it
would experience "net" Stranded Costs of $126 million for 2002. The MPSC staff
and Energy Michigan filed appeals with the MPSC regarding the inclusion of
certain Clean Air Act-related investment and other costs in Consumers' "net"
Stranded Cost filing. In July 2002, the MPSC granted the MPSC staff its appeal.
As a result, Consumers revised and supplemented its "net" Stranded Costs filing
by excluding all costs associated with the Clean Air Act and resubmitting the
filing to the MPSC. After the exclusion of the Clean Air Act costs, the revised
Stranded Cost amounts are $11 million and $8 million for 2000 and 2001,
respectively, and an estimated $76 million for 2002. On August 9, 2002 the MPSC
Staff and other intervenors filed their position regarding 2000 and 2001
Stranded Cost. The Staff recommended that the Commission find that Consumers had
Stranded Costs of $5.1M and $2.8M for 2000 and 2001, respectively. Other parties
contended that Consumers had stranded benefits in 2000 and 2001 and made various
suggestions on how those benefits should be treated. In a separate filing,
Consumers requested regulatory asset accounting treatment for its Clean Air Act
expenditures through 2003. The outcome of these proceedings before the MPSC is
uncertain at this time.
Since 1997, Consumers has incurred significant electric utility restructuring
implementation costs. The following table outlines the applications filed by
Consumers with the MPSC and the status of recovery for these costs.
In Millions
---------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- ---------- ------------- --------- ------- ------- ----------
1999 1997 & 1998 $20 $-- $15 $ 5
2000 1999 30 -- 25 5
2001 2000 25 25 -- --
2002 2001 8 8 -- --
===== ===== ===== =====
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in electric rates. In
the orders received for the years 1997 through 1999, the MPSC also reserved the
right review again the total implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs. Consumers expects to
receive in 2002, a final order for 2001 implementation costs. In addition to the
amounts shown, as of June 2002, Consumers incurred and deferred as a regulatory
asset, $5 million of additional implementation costs and has also recorded as a
regulatory asset $13 million for the cost of money associated with total
implementation costs. Consumers believes the implementation costs and the
associated cost of money are fully recoverable in accordance with the Customer
Choice Act. Cash recovery from customers will probably begin after the rate
freeze or rate cap period has expired and Consumers cannot predict the
amounts the MPSC will approve as recoverable costs.
In 1996, Consumers filed new OATT transmission rates with the FERC for approval.
Interveners contested these rates, and hearings were held before an ALJ in 1998.
In 1999, the ALJ made an initial decision recommending lower OATT rates that was
largely upheld by the FERC in March 2002 which requires Consumers to refund,
with interest, over-collections for past services as measured by FERC's finally
approved OATT rates. Since the initial decision, Consumers has been reserving a
portion of revenues billed to customers under the filed 1996 OATT rates. In
April 2002, FERC issued a
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decision largely affirming the initial decision but increasing the recommended
rate of return. A compliance proceeding is being held at FERC to determine
Consumers' refund responsibility. Consumers believes its reserve is sufficient
to satisfy its estimated refund obligation.
OTHER CONSUMERS' ELECTRIC UTILITY UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990 and to supply electricity and steam to Dow. Consumers,
through two wholly owned subsidiaries, holds the following assets related to the
MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general
partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through
FMLP, a 35 percent lessor interest in the MCV Facility.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
Six Months Ended
----------------------
June 30 2002 2001
---- ----
Pretax operating income $53 $21
Income taxes and other 18 7
--- ---
Net income $35 $14
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the
termination of the PPA in 2025. The PPA requires Consumers to pay, based on the
MCV Facility's availability, a levelized average capacity charge of 3.77 cents
per kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Since January 1,
1993, the MPSC has permitted Consumers to recover capacity charges averaging
3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and
variable energy charges. Since January 1, 1996, the MPSC has also permitted
Consumers to recover capacity charges for the remaining 325 MW of contract
capacity with an initial average charge of 2.86 cents per kWh increasing
periodically to an eventual 3.62 cents per kWh by 2004 and thereafter. However,
due to the current freeze of Consumers' retail rates that the Customer Choice
Act requires, the capacity charge for the 325 MW is now frozen at 3.17 cents per
kWh. After September 2007, the PPA's terms only require Consumers to pay the MCV
Partnership capacity and energy charges that the MPSC has authorized for
recovery from electric customers.
In 1992, Consumers recognized a loss for the present value of the estimated
future underrecoveries of power supply costs under the PPA based on MPSC cost
recovery orders. Consumers continually evaluates the adequacy of the PPA
liability for future underrecoveries. These evaluations consider management's
assessment of operating levels at the MCV Facility through 2007 along with
certain other factors, including MCV related costs that are included in
Consumers' frozen retail rates. During the third quarter of 2001, in connection
with Consumers' long-term electric supply planning, management reviewed the PPA
liability assumptions related to increases in the expected long-term dispatch of
the MCV Facility and increased MCV related costs. As a result, in September
2001, Consumers increased the PPA liability by $126 million. Management believes
that, following the increase, the PPA liability adequately reflects the present
value of the PPA's future
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effect on Consumers. At June 30, 2002 and 2001, the remaining present value of
the estimated future PPA liability associated with the loss totaled $173 million
and $64 million, respectively. For further discussion on the impact of the
frozen PSCR, see "Electric Rate Matters" in this Note.
In March 1999, Consumers and the MCV Partnership reached an agreement effective
January 1, 1999, that capped availability payments to the MCV Partnership at
98.5 percent. If the MCV Facility generates electricity at the maximum 98.5
percent level during the next five years, Consumers' after-tax cash
underrecoveries associated with the PPA could be as follows:
In Millions
---------------------------------------------
2002 2003 2004 2005 2006
---- ---- ---- ---- ----
Estimated cash underrecoveries at 98.5%, net of tax $38 $37 $36 $36 $36
=== === === === ===
In February 1998, the MCV Partnership appealed the January 1998 and February
1998 MPSC orders related to electric utility restructuring. At the same time,
MCV Partnership filed suit in the United States District Court in Grand Rapids
seeking a declaration that the MPSC's failure to provide Consumers and MCV
Partnership a certain source of recovery of capacity payments after 2007
deprived MCV Partnership of its rights under the Public Utilities Regulatory
Policies Act of 1978. In July 1999, the District Court granted MCV Partnership's
motion for summary judgment. The Court permanently prohibited enforcement of the
restructuring orders in any manner that denies any utility the ability to
recover amounts paid to qualifying facilities such as the MCV Facility or that
precludes the MCV Partnership from recovering the avoided cost rate. The MPSC
appealed the Court's order to the 6th Circuit Court of Appeals in Cincinnati. In
June 2001, the 6th Circuit overturned the lower court's order and dismissed the
case against the MPSC. The appellate court determined that the case was
premature and concluded that the qualifying facilities needed to wait until 2008
for an actual factual record to develop before bringing claims against the MPSC
in federal court.
NUCLEAR FUEL COST: Consumers amortizes nuclear fuel cost to fuel expense based
on the quantity of heat produced for electric generation. Through November 2001,
Consumers expensed the interest on leased nuclear fuel as it was incurred.
Effective December 2001, Consumers no longer leases its nuclear fuel.
For nuclear fuel used after April 6, 1983, Consumers charges disposal costs to
nuclear fuel expense, recovers these costs through electric rates, and then
remits them to the DOE quarterly. Consumers elected to defer payment for
disposal of spent nuclear fuel burned before April 7, 1983. As of June 30, 2002,
Consumers has a recorded liability to the DOE of $137 million, including
interest, which is payable upon the first delivery of spent nuclear fuel to the
DOE. Consumers recovered through electric rates the amount of this liability,
excluding a portion of interest. In 1997, a federal court decision has confirmed
that the DOE was to begin accepting deliveries of spent nuclear fuel for
disposal by January 31, 1998. Subsequent litigation in which Consumers and
certain other utilities participated has not been successful in producing more
specific relief for the DOE's failure to comply.
In July 2000, the DOE reached a settlement agreement with one utility to address
the DOE's delay in accepting spent fuel. The DOE may use that settlement
agreement as a framework that it could apply to other nuclear power plants;
however, certain other utilities are challenging the validity of the settlement.
Additionally, there are two court decisions that support the right of utilities
to pursue damage claims in the United States Court of Claims against the DOE for
failure to take delivery of spent fuel. A number of utilities have commenced
litigation in the Court of Claims. Consumers is evaluating its options with
respect to its contract with the DOE.
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In July 2002, Congress approved and the President signed a bill designating the
site at Yucca Mountain, Nevada, for the development of a repository for the
disposal of high-level radioactive waste and spent nuclear fuel. The next step
will be for the DOE to submit an application to the NRC for a license to begin
construction of the repository. The application and review process is estimated
to take several years.
NUCLEAR MATTERS: In April 2002, Palisades received its annual performance review
in which the NRC stated that Palisades operated in a manner that preserved
public health and safety. With the exception of one fire protection smoke
detector location finding with low safety significance, the NRC classified all
inspection findings as having very low safety significance. Other than the
follow-up fire protection inspection associated with this one finding, the NRC
plans to conduct only baseline inspections at the facility through May 31, 2003.
The amount of spent nuclear fuel discharged from the reactor to date exceeds
Palisades' temporary on-site storage pool capacity. Consequently, Consumers is
using NRC-approved steel and concrete vaults, commonly known as "dry casks", for
temporary on-site storage. As of June 30, 2002, Consumers had loaded 18 dry
casks with spent nuclear fuel at Palisades. Palisades will need to load
additional dry casks by the fall of 2004 in order to continue operation.
Palisades currently has three empty storage-only dry casks on-site, with storage
pad capacity for up to seven additional loaded dry casks. Consumers anticipates
that licensed transportable dry casks for additional storage, along with more
storage pad capacity, will be available prior to 2004.
In December 2000, the NRC issued an amendment revising the operating license for
Palisades to extend its expiration date to March 2011, with no restrictions
related to reactor vessel embrittlement.
In 2000, Consumers made an equity investment and entered into an operating
agreement with NMC. NMC was formed in 1999 by four utilities to operate and
manage the nuclear generating plants owned by these utilities. Consumers
benefits by consolidating expertise, cost control and resources among all of the
nuclear plants being operated on behalf of the NMC member companies.
In November 2000, Consumers requested approval from the NRC to transfer
operating authority for Palisades to NMC and the request was granted in April
2001. The formal transfer of authority from Consumers to NMC took place in May
2001. Consumers retains ownership of Palisades, its 789 MW output, the current
and future spent fuel on site, and ultimate responsibility for the safe
operation, maintenance and decommissioning of the plant. Under the agreement
that transferred operating authority of the plant to NMC, salaried Palisades'
employees became NMC employees on July 1, 2001. Union employees work under the
supervision of NMC pursuant to their existing labor contract as Consumers'
employees. NMC currently has responsibility for operating eight units with 4,500
MW of generating capacity in Wisconsin, Minnesota, Iowa and Michigan.
On June 20, 2001, the Palisades reactor was shut down so technicians could
inspect a small steam leak on a control rod drive assembly. There was no risk to
the public or workers. In August 2001, Consumers completed an expanded
inspection that included all similar control rod drive assemblies and elected to
completely replace all the components. Installation of the new components was
completed in December 2001 and the plant returned to service and has been
operating since January 21, 2002. Consumers' capital expenditures for the
components and their installation was approximately $31 million.
From the start of the June 20th outage through the end of 2001, the impact on
net income of replacement power supply costs associated with the outage was
approximately $59 million. Subsequently, in January 2002, the impact on 2002 net
income was $5 million.
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Consumers maintains insurance against property damage, debris removal, personal
injury liability and other risks that are present at its nuclear facilities.
Consumers also maintains coverage for replacement power supply costs during
prolonged accidental outages at Palisades. Insurance would not cover such costs
during the first 12 weeks of any outage, but would cover most of such costs
during the next 52 weeks of the outage, followed by reduced coverage to 80
percent for 110 additional weeks. The June 2001 through January 2002 Palisades
outage, however, was not an insured event. If certain covered losses occur at
its own or other nuclear plants similarly insured, Consumers could be required
to pay maximum assessments of $26.9 million in any one year to NEIL; $88 million
per occurrence under the nuclear liability secondary financial protection
program, limited to $10 million per occurrence in any year; and $6 million if
nuclear workers claim bodily injury from radiation exposure. Consumers considers
the possibility of these assessments to be remote. NEIL limits its coverage from
multiple acts of terrorism during a twelve-month period to a maximum aggregate
of $3.24 billion, allocated among the claimants, plus recoverable reinsurance,
indemnity and other sources. The nuclear liability insurers for Palisades and
Big Rock also limit the amount of their coverage for liability from terrorist
acts to $200 million. This could affect the amount of loss coverage for
Consumers should multiple acts of terrorism occur. The Price Anderson Act is
currently in the process of reauthorization by the U. S. Congress. It is
possible that the Price Anderson Act will not be reauthorized or changes may be
made that significantly affect the insurance provisions for nuclear plants.
DERIVATIVE ACTIVITIES: Consumers' electric business uses purchased electric call
option contracts to meet its regulatory obligation to serve. This obligation
requires Consumers to provide a physical supply of electricity to customers, to
manage electric costs and to ensure a reliable source of capacity during peak
demand periods. These contracts are subject to SFAS No. 133 derivative
accounting, and are required to be recorded on the balance sheet at fair value,
with changes in fair value recorded directly in earnings or other comprehensive
income, if the contract meets qualifying hedge criteria. On July 1, 2001, upon
initial adoption of the standard for these contracts, Consumers recorded a $3
million, net of tax, cumulative effect adjustment as an unrealized loss,
decreasing accumulated other comprehensive income. This adjustment relates to
the difference between the fair value and the recorded book value of these
electric call option contracts. The adjustment to accumulated other
comprehensive income relates to electric call option contracts that qualified
for cash flow hedge accounting prior to the initial adoption of SFAS No. 133.
After July 1, 2001, these contracts did not qualify for hedge accounting under
SFAS No. 133 and, therefore, Consumers records any change in fair value
subsequent to July 1, 2001 directly in earnings, which can cause earnings
volatility. The initial amount recorded in other comprehensive income will be
reclassified to earnings as the forecasted future transactions occur or the call
options expire. The majority of these contracts expired in the third quarter
2001 and the remaining contracts will expire in 2002. As of December 31, 2001,
Consumers reclassified to earnings, $2 million, net of tax, as part of the cost
of power supply. Consumers expects to reclassify the remainder to earnings in
the third quarter of 2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria used to determine if derivative accounting
is required. In light of the amended criteria, Consumers re-evaluated its
electric call option and option-like contracts, and determined that additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
will record any change in fair value subsequent to December 31, 2001, directly
in earnings, which could cause earnings volatility. As of June 30, 2002,
Consumers recorded on the balance sheet all of its
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purchased electric call option contracts subject to derivative accounting, at a
fair value of $2 million.
CMS Energy believes that Consumers electric capacity and energy contracts do
not qualify as derivatives due to the lack of an active energy market in the
state of Michigan and the transportation cost to deliver the power under the
contracts to the closest active energy market at the Cinergy hub in Ohio. If a
market develops in the future, Consumers may be required to account for those
contracts as derivatives. The mark to market impact in earnings related to
these contracts, particularly related to the purchase power agreement with the
MCV, could be material to the financial statements.
Consumers' electric business also uses gas swap contracts to protect against
price risk due to the fluctuations in the market price of gas used as fuel for
generation of electricity. These gas swaps are financial contracts that will be
used to offset increases in the price of probable forecasted gas purchases.
These contracts do not qualify for hedge accounting. Therefore, Consumers
records any change in the fair value of these contracts directly in earnings as
part of power supply costs, which could cause earnings volatility. As of June
30, 2002, a gain of $1 million has been recorded for 2002, which represents the
fair value of these contracts at June 30, 2002. These contracts expire in
December 2002.
CONSUMERS' GAS UTILITY CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at the remaining sites as studies are completed.
Consumers has estimated its costs related to further investigation and remedial
action for all 23 sites using the Gas Research Institute-Manufactured Gas Plant
Probabilistic Cost Model. The estimated total costs are between $82 million and
$113 million; these estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between 3 and 7 percent for this type of
activity. Consumers expects to recover a significant portion of these costs
through insurance proceeds and through MPSC approved rates charged to its
customers. As of June 30, 2002, Consumers has an accrued liability of $53
million, (net of $29 million of expenditures incurred to date), and a regulatory
asset of $70 million. Any significant change in assumptions, such as an increase
in the number of sites, different remediation techniques, nature and extent of
contamination, and legal and regulatory requirements, could affect Consumers'
estimate of remedial action costs. The MPSC currently allows Consumers to
recover $1 million of manufactured gas plant facilities environmental clean-up
costs annually. Consumers defers and amortizes, over a period of ten years,
manufactured gas plant facilities environmental clean-up costs above the amount
currently being recovered in rates. Additional rate recognition of amortization
expense cannot begin until after a prudency review in a gas rate case.
Consumers' position in the current general gas rate case is that all
manufactured gas plant facilities environmental clean-up expenditures for years
1998 through 2002 are prudent.
CONSUMERS' GAS UTILITY RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers conducted an
experimental gas customer choice pilot program that froze gas distribution and
GCR rates through the period. On April 1, 2001, a permanent gas customer choice
program commenced under which Consumers returned to a GCR mechanism that allows
it to recover from its bundled sales customers all prudently incurred costs to
purchase the natural gas commodity and transport it to Consumers for ultimate
distribution to customers.
GAS COST RECOVERY: As part of a settlement agreement approved by the MPSC in
July 2001, Consumers agreed not to bill a price in excess of $4.69 per mcf of
natural gas under the GCR factor mechanism through March 2002. This agreement is
not expected to affect Consumers' earnings outlook because Consumers recovers
from customers the amount that it actually pays for natural gas in the
reconciliation process. The
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settlement does not affect Consumers' June 2001 request to the MPSC for a
distribution service rate increase. The MPSC also approved a methodology to
adjust bills for market price increases quarterly without returning to the MPSC
for approval. In December 2001, Consumers filed its GCR Plan for the period
April 2002 through March 2003. Consumers is requesting authority to bill a GCR
factor up to $3.50 per mcf for this period. The Company also requested the MPSC
approve the same methodology which adjusts bills for market price increases that
the MPSC approved, through settlement, in the previous plan year. A settlement
with all parties in the proceeding was signed and submitted to the Commission in
March 2002. The settlement stipulated to all requests of Consumers and the MPSC
approved the settlement, as filed, in July 2002.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Consumers is seeking a 12.25
percent authorized return on equity. Contemporaneously with this filing,
Consumers requested partial and immediate relief in the annual amount of $33
million. The relief is primarily for higher carrying costs on more expensive
natural gas inventory than is currently included in rates. In October 2001,
Consumers revised its filing to reflect lower operating costs and requested a
$133 million annual distribution service rate increase. In December 2001, the
MPSC authorized a $15 million annual interim increase in distribution service
rate revenues. The order authorizes Consumers to apply the interim increase on
its gas sales customers' bills for service effective December 21, 2001. The
increase is under bond and subject to refund if the final rate increase is less
than the interim rate increase. In February 2002, Consumers revised its filing
to reflect lower estimated gas inventory prices and revised depreciation expense
and is now requesting an annual $105 million distribution service rate increase.
The MPSC staff supported an annual increase of $30 million, with an 11 percent
return on equity. The ALJ, in the Proposal for Decision issued June 3, 2002,
recommended an annual rate increase of $32 million, with a return on equity of
11 percent. If the MPSC approves Consumers' total request, then Consumers could
bill an additional amount of approximately $4.78 per month, representing a 7.6
percent increase in the typical residential customer's average monthly bill.
OTHER CONSUMERS' GAS UTILITY UNCERTAINTIES
DERIVATIVE ACTIVITIES: Consumers' gas business uses fixed price gas supply
contracts to meet its regulatory obligation to provide gas to its customers as
the lowest possible prudent cost. Some of these contracts require derivative
accounting because they contain embedded put options that disqualify the
contracts from the normal purchase exception of SFAS No. 133. As of June 30,
2002, Consumers' gas supply contracts requiring derivative accounting had a fair
value of $2 million, representing a fair value gain on the contract since the
date of inception. This gain was recorded directly in earnings as part of other
income, and then directly offset and recorded on the balance sheet as a
regulatory liability. Any subsequent changes in fair value will be recorded in
the same manner. These contracts expire in October 2002.
PANHANDLE MATTERS
REGULATORY MATTERS: In conjunction with a FERC order issued in September 1997,
FERC required certain natural gas producers to refund previously collected
Kansas ad-valorem taxes to interstate natural gas pipelines, including Panhandle
Eastern Pipe Line. FERC ordered the pipelines to refund these amounts to their
customers. In June 2001, Panhandle Eastern Pipe Line filed a proposed settlement
with the FERC which was supported by most of the customers and affected
producers. In October 2001, the FERC approved that settlement. The settlement
provided for a resolution of the Kansas ad-valorem tax matter on the Panhandle
Eastern Pipe Line system for a majority of refund amounts. Certain producers and
the state of Missouri elected to not participate in the settlement. At June 30,
2002 and December 31, 2001, accounts receivable included $8 million due from
natural gas producers, and other current liabilities included $12 million and
$11 million, respectively, for related obligations. Remaining amounts collected
but not refunded are subject to refund pending resolution of issues remaining in
the FERC docket and Kansas intrastate proceeding.
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In July 2001, Panhandle Eastern Pipe Line filed a settlement with customers on
Order 637 matters to resolve issues including capacity release and imbalance
penalties, among others. On October 12, 2001 and December 19, 2001 FERC issued
orders approving the settlement, with modifications. The settlement changes
became final effective February 1, 2002, resulting in a non-recurring gain of $4
million in Other revenue and a $2 million reversal of interest expense for
previously collected penalties retained.
In August 2001, an offer of settlement of Trunkline LNG rates sponsored jointly
by Trunkline LNG, BG LNG Services and Duke LNG Sales was filed with the FERC and
was approved on October 11, 2001. The settlement was placed into effect on
January 1, 2002. As part of the settlement, Trunkline LNG, now owned by LNG
Holdings, reduced its maximum rates.
In December 2001, Trunkline LNG, now partially owned by Panhandle, filed with
the FERC a certificate application to expand the Lake Charles facility to
approximately 1.2 billion cubic feet per day of sendout capacity versus the
current capacity of 630 million cubic feet per day. The BG Group has contract
rights for all of this additional capacity. Storage capacity will also be
expanded to 9 billion cubic feet, from its current capacity of 6.3 billion cubic
feet. On July 31, 2002, the FERC issued its Environmental Assessment of the
expansion project, with comments due to be filed in thirty days. The application
for a certificate of public convenience and necessity of the expansion is still
pending the action. The expansion expenditures are currently expected to be
funded by Panhandle loans or equity contributions to LNG Holdings, which would
be sourced by repayment by CMS Capital to Panhandle on its outstanding note
receivable or by a capital market or other funding.
Panhandle has sought refunds from the State of Kansas concerning certain
corporate income tax issues for the years 1981 through 1984. On January 25, 2002
the Kansas Supreme Court entered an order affirming a previous Board of Tax
Court finding that Panhandle was entitled to refunds which with interest total
approximately $26 million. Pursuant to the provisions of the purchase agreement
between CMS Energy and a subsidiary of Duke Energy, Duke retains the benefits of
any tax refunds or liabilities for periods prior to the date of the sale of
Panhandle to CMS Energy.
In February 2002, Trunkline Gas filed a settlement with customers on Order 637
matters to resolve issues including capacity release and imbalance penalties,
among others. On July 5, 2002 FERC issued an order approving the settlement,
with modifications. Trunkline's compliance filing and any requests for rehearing
are expected to be filed in August 2002.
ENVIRONMENTAL MATTERS: Panhandle is subject to federal, state and local
regulations regarding air and water quality, hazardous and solid waste disposal
and other environmental matters. Panhandle has identified environmental
contamination at certain sites on its systems and has undertaken clean-up
programs at these sites. The contamination resulted from the past use of
lubricants in compressed air systems containing PCBs and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle
communicated with the EPA and appropriate state regulatory agencies on these
matters. Under the terms of the sale of Panhandle to CMS Energy, a subsidiary of
Duke Energy is obligated to complete the Panhandle clean-up programs at certain
agreed-upon sites and to indemnify against certain future environmental
litigation and claims. Panhandle expects these clean-up programs to continue for
many years and has estimated its share of remaining clean-up costs not
indemnified by Duke Energy to be approximately $18 million. Such costs have been
accrued for and are reflected in Panhandle's Consolidated Balance Sheet in Other
Non-current Liabilities.
The Illinois EPA included Panhandle Eastern Pipe Line and Trunkline, together
with other non-affiliated parties, in a cleanup of former waste oil disposal
sites in Illinois. Prior to a partial cleanup by the EPA, a preliminary study
estimated the cleanup costs at one of the sites to be between $5 million and $15
million. The
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State of Illinois contends that Panhandle Eastern Pipe Line's and Trunkline's
share for the costs of assessment and remediation of the sites, based on the
volume of waste sent to the facilities, is approximately 17 percent. Panhandle
expects this clean-up to continue for many years and has estimated its share of
remaining clean-up costs to be approximately $3 million. Such costs have been
accrued for and are reflected in Panhandle's Consolidated Balance Sheet in Other
Non-current Liabilities.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. This EPA ruling was challenged in court by various states,
industry and other interests, including the INGAA, an industry group to which
Panhandle belongs. In March 2000, the court upheld most aspects of the EPA's
rule, but agreed with INGAA's position and remanded to the EPA the sections of
the rule that affected Panhandle. Based on the court's decision, most of the
states subject to the rule submitted their SIP revisions in October 2000.
However, the EPA must revise the section of the rule that affected Panhandle's
facilities. Panhandle expects the EPA to make this section of the rule effective
in 2002 and expects the future costs to range from $13 million to $29 million
for capital improvements to comply.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm Compressor Station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. It is expected that the capital improvements
will occur in 2002 and 2003.
OTHER UNCERTAINTIES
SEC INVESTIGATION AND SPECIAL COMMITTEE: CMS Energy's Board of Directors has
established a special committee of independent directors to investigate matters
surrounding "round trip" trading and has retained outside counsel to assist in
the investigation. The committee expects to complete its investigation and
report its findings to the Board of Directors by the end of third quarter 2002.
In addition, CMS Energy is cooperating with the SEC investigation regarding
round trip trades and the Company's financial statements, accounting practices
and controls. CMS Energy is also cooperating with inquiries by the Commodity
Futures Trading Commission and the FERC regarding these transactions. CMS Energy
has also received subpoenas from the U.S. Attorney's Office for the Southern
District of New York and from the U.S. Attorney's Office in Houston regarding
investigations of these trades and has received 18 shareholder class action
lawsuits, a demand for action against officers and directors and two Employment
Retirement Income Security Act claims. CMS Energy is unable to predict the
outcome of these matters.
RESTATEMENT: Following CMS Energy's announcement that it would restate its
financial statements for 2000 and 2001 to eliminate the effects of "round trip"
energy trades and form a special committee of its Board of Directors to
investigate these trades, CMS Energy received formal notification from Arthur
Andersen that it had terminated its relationship with CMS Energy and affiliates.
Arthur Andersen notified CMS Energy that due to the investigation, Arthur
Andersen's historical opinions on CMS Energy's financial statements for the
periods being restated cannot be relied upon. Arthur Andersen also notified CMS
Energy that due to Arthur Andersen's current situation and the work of the
special committee, it would be unable to give an opinion on CMS Energy's
restated financial statements when they are completed. CMS Energy had previously
announced that it would no longer use Arthur Andersen for its independent audit
work and in May 2002, CMS Energy appointed Ernst & Young to audit the financial
statements for the year ending December 31, 2002.
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Ernst & Young is currently auditing CMS Energy's restated consolidated
financial statements for each of the fiscal years ended December 31, 2001 and
December 31, 2000, and is expected to release its opinion upon the completion
of its audit procedures and the special committee's investigation.
CREDIT RATING: In July 2002, the credit ratings of the publicly traded
securities of each of CMS Energy, Consumers and Panhandle (but not Consumers
Funding LLC) were downgraded by the major rating agencies. The ratings downgrade
for all three companies' securities is largely a function of the uncertainties
associated with CMS Energy's financial condition and liquidity pending
resolution of the "round trip" trading investigations and lawsuits, the special
board committee investigation, financial statement restatement and re-audit, and
directly affects and limits CMS Energy's access to the capital markets.
As a result of certain of these downgrades, contractual rights were triggered in
several contractual arrangements between CMS Energy subsidiaries and third
parties. More specifically, a $69 million loan to Panhandle made in connection
with the December 2001 LNG off balance sheet monetization transaction is subject
to repayment demand by the unaffiliated equity partner in the LNG Holdings joint
venture, although no such demand has been made to date. In addition, the
construction lenders for each of the Guardian and Centennial pipeline projects,
each partially owned by Panhandle, have requested acceptable credit support for
Panhandle's guarantee of its pro rata portion of those construction loans, which
aggregate $110 million including anticipated future draws. Further, one of the
issuers of a joint and several surety bond in the approximate amount of $190
million supporting a CMS MST gas supply contract has demanded collateral for up
to the full amount of such bond. This issuer has commenced litigation against
Enterprises and CMS MST in Michigan federal district court and is seeking to
require Enterprises and CMS MST to provide acceptable collateral and to prevent
them from disposing of or an opportunity to fully adjudicate the issuer's claim.
Enterprises and CMS MST continue to work with the issuer to fund mutually
satisfactory arrangements. A second issuer of surety bonds aggregating
approximately $113 million in support of two other CMS MST gas supply contracts
also has a right to request collateral for up to the full amounts of such bonds,
and certain parties involved in those gas supply contracts have the right to
seek replacement surety bonds due to the ratings downgrade of the current surety
bond issuer. CMS Energy is working with its contractual parties to find mutually
satisfying arrangements, but there can be no assurance of reaching such
arrangements.
CLASS ACTION LAWSUITS: Eighteen separate civil lawsuits have been filed in
federal court in Michigan in connection with round-trip trading, alleging (i)
violation of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934
("Exchange Act") and (ii) violation of Section 20(a) of the Exchange Act. (See
Exhibit 99(d) for a case names, dates instituted and principal parties) All
suits name Messrs. McCormick and Wright and CMS Energy as defendants. Mr. Joos
is named as defendant in all but two of the suits, and Consumers Energy and Ms.
Pallas are named as defendants on certain of the suits. Counsel to CMS has
obtained an extension of the time to respond to these claims until
mid-September. Prior to that date the cases will be consolidated into a single
lawsuit. These complaints generally seek unspecified damages based on
allegations that the defendants violated United States securities laws and
regulations by making allegedly false and misleading statements about the
Company's business and financial condition. The Company intends to vigorously
defend against these actions.
DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS: The Board of Directors of CMS
Energy received a demand, on behalf of a shareholder of CMS common stock, that
it commence civil actions (i) to remedy alleged breaches of fiduciary duties by
CMS officers and directors in connection with round-trip trading at CMS, and
(ii) to recover damages sustained by CMS as a result of alleged insider trades
alleged to have been made by certain current and former officers of CMS and its
subsidiaries. The Board has approximately 90 days to determine whether it will
pursue such claims. If the Board elects not to do so, the shareholder has stated
that he will initiate a derivative suit, bringing such claims on behalf of CMS.
EMPLOYMENT RETIREMENT INCOME SECURITY ACT CLAIMS: On July 11, 2002 and July 18,
2002, two Consumers employees filed separate alleged class action lawsuits on
behalf of the participants and beneficiaries of the CMS Employees' Savings and
Incentive Plan in the United States District Court for the Eastern District of
Michigan. CMS Energy, Consumers and CMS MS&T are defendants in one action, and
CMS Energy, Consumers, and other alleged fiduciaries are defendants in the
other. The complaints allege various counts arising under the Employee
Retirement Income Security Act.
CMS GENERATION-OXFORD TIRE RECYCLING: In 1999, the California Regional Water
Control Board of the State of California named CMS Generation as a potentially
responsible party for the cleanup of the waste from a fire that occurred in
September 1999 at the Filbin tire pile. The tire pile was maintained as fuel for
an adjacent
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power plant owned by Modesto Energy Limited Partnership. Oxford Tire Recycling
of Northern California, Inc., a subsidiary of CMS Generation until 1995, owned
the Filbin tire pile. CMS Generation has not owned an interest in Oxford Tire
Recycling of Northern California, Inc. or Modesto Energy Limited Partnership
since 1995. In 2000, the California Attorney General filed a complaint against
the potentially responsible parties for cleanup of the site and assessed
penalties for violation of the California Regional Water Control Board order.
The parties have reached a settlement with the state, which the court approved,
pursuant to which we must pay $6 million, $2 million of which CMS Energy had
already paid.
In connection with this fire, several class action lawsuits were filed claiming
that the fire resulted in damage to the class and that management of the site
caused the fire. CMS Generation has reached a settlement in principle with the
plaintiffs in the amount of $9 million. The primary insurance carrier will cover
one hundred percent of the settlement once the agreement is finalized.
DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel (DFD)
presented DIG with a change order to their construction contract and filed an
action in Michigan state court claiming damages in the amount of $110 million,
plus interest and costs, which DFD states represents the cumulative amount owed
by DIG for delays DFD believes DIG caused and for prior change orders that DIG
previously rejected. DFD also filed a construction lien for the $110 million.
DIG, in addition to drawing down on three letters of credit totaling $30 million
that it obtained from DFD has filed an arbitration claim against DFD asserting
in excess of an additional $75 million in claims against DFD. The judge in the
Michigan State Court case entered an order staying DFD's prosecution of its
claims in the court case and permitting the arbitration to proceed. CMS Energy
believes the claims are without merit and will continue to vigorously contest
them, but any change order costs ultimately paid would be capitalized as a
project construction cost.
Ford Motor Company and Rouge Steel Company, the customers of the DIG facility,
continue to be in discussion with DIG regarding several commercial issues that
have arisen between the parties.
CMS OIL AND GAS: In 1999, a former subsidiary of CMS Oil and Gas, Terra Energy
Ltd., was sued by Star Energy, Inc. and White Pine Enterprises LLC in the 13th
Judicial Circuit Court in Antrim County, Michigan, on grounds, among others,
that Terra violated oil and gas lease and other agreements by failing to drill
wells. Among the defenses asserted by Terra were that the wells were not
required to be drilled and the claimant's sole remedy was termination of the oil
and gas lease. During the trial, the judge declared the lease terminated in
favor of White Pine. The jury then awarded Star Energy and White Pine $8 million
in damages. Terra has filed an appeal. CMS Energy believes Terra has meritorious
grounds for either reversal of the judgment or reduction of damages. CMS Energy
has an indemnification obligation in favor of the purchaser of its Michigan
properties with respect to this litigation.
ARGENTINA ECONOMIC EMERGENCY: In January 2002, the Republic of Argentina enacted
the Public Emergency and Foreign Exchange System Reform Act. This law, among
other things, repealed the fixed exchange rate of one U.S. Dollar to one
Argentina Peso, converted all Dollar-denominated utility tariffs and energy
contract obligations into Pesos at the same one-to-one exchange rate, and
directed the President of Argentina to renegotiate such tariffs.
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In February 2002, the Republic of Argentina enacted additional measures that
required all monetary obligations (including current debt and future contract
payment obligations) denominated in foreign currencies to be converted into
Pesos. These February measures also authorize the Argentine judiciary
essentially to rewrite private contracts denominated in Dollars or other foreign
currencies if the parties cannot agree on how to share equitably the impact of
the conversion of their contract payment obligations into Pesos. In April 2002,
based on a consideration of these environmental factors, CMS Energy evaluated
its Argentine investments for impairment as required under SFAS No. 144 and APB
Opinion No. 18. These impairment models contain assumptions regarding
anticipated future exchange rates and operating performance of the investments.
Exchange rates used in the models assume that the rate will decrease from
current levels to approximately 3.00 Pesos per US Dollar over the remaining life
of these investments. Based on the results of these models, CMS Energy
determined that these investments were not impaired.
Effective April 30, 2002, CMS Energy adopted the Argentine Peso as the
functional currency for all of its Argentine investments. CMS had previously
used the U.S. Dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. Dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 Pesos per U.S. Dollar, and recorded a charge to
the Foreign Currency Translation component of Common Stockholders' Equity of
approximately $400 million.
For the six months ended June 30, 2002, CMS Energy recorded losses of $34
million or $0.25 per share, reflecting the negative impact of the actions of the
Argentine government. These losses represent changes in the value of
Peso-denominated monetary assets (such as receivables) and liabilities of
Argentina-based subsidiaries and lower net project earnings resulting from the
conversion to Pesos of utility tariffs and energy contract obligations that were
previously calculated in Dollars.
While CMS Energy's management cannot predict the most likely future, average, or
end of period 2002 Peso to U.S. Dollar exchange rates, it does expect that these
non-cash charges substantially reduces the risk of further material balance
sheet impacts when combined with anticipated proceeds from international
arbitration currently in progress, political risk insurance, and the eventual
sale of these assets. As a result of the change in functional currency, and the
ongoing translation of revenue and expense accounts of these investments into
U.S. Dollars, 2002 earnings for CMS Energy may be adversely affected by an
additional $3.8 million to $11.8 million or $0.03 to $0.09 per share assuming
exchange rates ranging from 3.00 to 4.00 Pesos per U.S. Dollar. At June 30,
2002, the net foreign currency loss due to the unfavorable exchange rate of the
Argentine Peso recorded in the Foreign Currency Translation component of Common
Stockholder's Equity using an exchange rate of 3.86 Pesos per US Dollar was $402
million.
CAPITAL EXPENDITURES: CMS Energy estimates capital expenditures, including
investments in unconsolidated subsidiaries and new lease commitments, of $925
million for 2002, $745 million for 2003 and $880 million for 2004. These amounts
include expenditures associated with the LNG terminal expansion for which an
application was filed with the FERC on December 26, 2001, estimated at $11
million in 2002, $5 million in 2003 and $30 million in 2004.
OTHER: The recent significant downturn in the equities markets has affected the
value of the Pension Plan assets. If the Plan's Accumulated Benefit Obligation
exceeds the value of these assets at December 31, 2002, CMS Energy will be
required to recognize an additional minimum liability for this excess in
accordance with SFAS No. 87. CMS Energy cannot predict the future fair value of
the Plan's assets, but it is possible, without significant recovery of the
Plan's assets, that CMS Energy will need to book an additional minimum liability
through a charge to other comprehensive income. The Accumulated Benefit
Obligation is determined by the Plan's Actuary in the fourth quarter of each
year.
CMS Energy and Enterprises, including subsidiaries, have guaranteed
payment of obligations, through letters of credit and surety bonds, of
unconsolidated affiliates and related parties approximating $1.8 billion as of
June 30, 2002. Included in this amount, Enterprises, in the ordinary course of
business, has guarantees in place for contracts of CMS MST that contain certain
schedule and performance requirements. As of June 30, 2002, the actual amount of
financial exposure covered by these guarantees was $569 million. This amount
excludes the guarantees associated with CMS MST's natural gas sales arrangements
totaling $272 million, which are recorded as liabilities on the Consolidated
Balance Sheet at June 30, 2002. Management monitors and approves these
obligations and believes it is unlikely that CMS Energy or Enterprises would be
required to perform or otherwise incur any material losses associated with the
above obligations.
Certain CMS Gas Transmission and CMS Generation affiliates in Argentina received
notice from various Argentine provinces claiming stamp taxes and associated
penalties and interest arising from various gas
CMS-57
CMS Energy Corporation
transportation transactions. Although these claims total approximately $75
million, the affiliates and CMS Energy believe the claims are without merit and
will continue to vigorously contest them.
CMS Generation does not currently expect to incur significant capital costs at
its power facilities for compliance with current U.S. environmental regulatory
standards.
In addition to the matters disclosed in this Note, Consumers, Panhandle and
certain other subsidiaries of CMS Energy are parties to certain lawsuits and
administrative proceedings before various courts and governmental agencies
arising from the ordinary course of business. These lawsuits and proceedings may
involve personal injury, property damage, contractual matters, environmental
issues, federal and state taxes, rates, licensing and other matters.
CMS Energy has accrued estimated losses for certain contingencies discussed in
this Note. Resolution of these contingencies is not expected to have a material
adverse impact on CMS Energy's financial position, liquidity, or results of
operations.
6: SHORT-TERM AND LONG-TERM FINANCINGS, AND CAPITALIZATION
CMS ENERGY: On July 12, 2002, CMS Energy and its subsidiaries reached agreement
with its lenders on five credit facilities (facilities) totaling approximately
$1.3 billion of credit for CMS Energy, Enterprises and Consumers. The agreements
were executed by various combinations of up to 21 lenders and by the company and
are as follows: a $295.8 million revolving credit facility by CMS Energy,
maturing March 31, 2003; a $300 million revolving credit facility by CMS Energy,
maturing December 15, 2003; a $150 million short term loan by Enterprises,
maturing December 13, 2002; a $250 million revolving credit facility by
Consumers, maturing July 11, 2003; and a $300 million term loan by Consumers,
maturing July 11, 2003 with a one-year extension at Consumers' option. CMS
Energy expects to amend the Consumers term loan by the end of August 2002 so
that the maturity date is July 11, 2004.
In the first six months of 2002, CMS Energy called $243 million of Series A
through E GTNs at interest rates ranging from 7.00 percent to 9.00 percent using
funds available from asset sales proceeds. At June 30, 2002, CMS Energy had
remaining $110 million Series D GTNs, $267 million Series E GTNs and $300
million of Series F GTNs issued and outstanding with weighted average interest
rates of 6.9 percent, 7.8 percent and 7.6 percent, respectively.
In May 2002, CMS Energy registered $300,000,000 Series G GTNs. The notes will be
issued from time to time with the proceeds being used for general corporate
purposes. As of August 1, 2002, no Series G GTNs had been issued.
Under its most restrictive debt covenant, CMS Energy could pay $655 million in
common dividends at June 30, 2002.
CONSUMERS: At June 30, 2002, Consumers had FERC authorization to issue or
guarantee through June 2002, up to $1.4 billion of short-term securities
outstanding at any one time. Consumers also had remaining FERC authorization to
issue through June 2002 up to $520 million of long-term securities for general
corporate purposes and $200 million of First Mortgage Bonds to be issued solely
as security for the long-term securities.
Consumers currently has in place a $325 million trade receivables sale program.
At June 30, 2002 and 2001, receivables sold under the program totaled $311
million and $299 million, respectively. Accounts receivable and accrued revenue
in the Consolidated Balance Sheets have been reduced to reflect receivables
sold.
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CMS Energy Corporation
In April 2002, Consumers established a new subsidiary, Consumers Receivable
Funding, LLC. This consolidated subsidiary was established to sell accounts
receivable to an unrelated third party.
In March 2002, Consumers sold $300 million principal amount of six percent
senior notes, maturing in March 2005. Net proceeds from the sale were $299
million. Consumers used the net proceeds to replace a first mortgage bond that
was to mature in 2003.
Consumers secures its First Mortgage Bonds by a mortgage and lien on
substantially all of its property. Consumers' ability to issue and sell
securities is restricted by certain provisions in its First Mortgage Bond
Indenture, its Articles of Incorporation and the need for regulatory approvals
to meet appropriate federal law.
Under the provisions of its Articles of Incorporation, Consumers had $272
million of unrestricted retained earnings available to pay common dividends at
June 30, 2002.
REQUIRED RATIOS:
The credit facilities also have contractual restrictions that require CMS Energy
and Consumers to maintain, as of the last day of each fiscal quarter, the
following:
Required Ratio Limitation Ratio at June 30, 2002
-------------------------- ----------------------
CMS ENERGY:
Consolidated Leverage Ratio not more than 5.75 to 1.00 4.93 to 1.00
Cash Dividend Coverage Ratio not less than 1.25 to 1.00 1.98 to 1.00
CONSUMERS:
Debt to Capital Ratio not more than 0.65 to 1.00 0.51 to 1.00
Interest Coverage Ratio not less than 2.0 to 1.0 2.6 to 1.0
COMPANY-OBLIGATED PREFERRED SECURITIES: CMS Energy and Consumers each have
wholly-owned statutory business trusts that are consolidated with the respective
parent company. CMS Energy and Consumers created their respective trusts for the
sole purpose of issuing Trust Preferred Securities. In each case, the primary
asset of the trust is a note or debenture of the parent company. The terms of
the Trust Preferred Security parallel the terms of the related parent company
note or debenture. The terms, rights and obligations of the Trust Preferred
Security and related note or debenture are also defined in the related indenture
through which the note or debenture was issued, the parent guarantee of the
related Trust Preferred Security and the declaration of trust for the particular
trust. All of these documents together with their related note or debenture and
Trust Preferred Security constitute a full and unconditional guarantee by the
parent company of the trust's obligations under the Trust Preferred Security. In
addition to the similar provisions previously discussed, specific terms of the
securities follow:
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CMS Energy Corporation
CMS Energy Trust and Securities In Millions
--------------------
Amount
Outstanding
-------------------- Earliest
June 30 Rate(%) 2002 2001 Maturity Redemption
------- ---- ---- -------- ----------
CMS Energy Trust I (a) 7.75 $173 $173 2027 2001
CMS Energy Trust II (b) 8.75 301 301 2004 --
CMS Energy Trust III (c) 7.25 220 220 2004 --
---- ----
Total Amount Outstanding $694 $694
==== ====
(a) Represents Quarterly Income Preferred Securities that are convertible into
1.2255 shares of CMS Energy Common Stock (equivalent to a conversion price of
$40.80). Effective July 2001, CMS Energy can revoke the conversion rights if
certain conditions are met.
(b) Represents 7,250,000 Adjustable Convertible Preferred Securities that were
converted to 8,787,725 newly issued shares of CMS common stock on July 1, 2002.
(c) Represents Premium Equity Participating Security Units in which holders are
obligated to purchase a variable number of shares of CMS Energy Common Stock by
the August 2003 conversion date.
Consumers Energy Trust and Securities In Millions
--------------------
Amount
Outstanding
-------------------- Earliest
June 30 Rate(%) 2002 2001 Maturity Redemption
------- ---- ---- -------- ----------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36 $ 70 $100 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00 125 125 2031 2006
---- ----
Total Amount Outstanding $490 $520
==== ====
In March 2002, Consumers reduced its outstanding debt to Consumers Power Company
Financing I, Trust Originated Preferred Securities by $30 million.
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7: EARNINGS PER SHARE AND DIVIDENDS
The following tables present a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations.
COMPUTATION OF EARNINGS PER SHARE:
In Millions,
Except Per Share Amounts
---------------------------
Three Months Ended June 30 2002 2001
------- -------
NET INCOME APPLICABLE TO BASIC AND DILUTED EPS
Consolidated Net Income (Loss) $ (75) $ 53
======= =======
Net Income Attributable to Common Stock:
CMS Energy - Basic $ (75)(a) $ 53(b)
Add conversion of 7.75% Trust
Preferred Securities (net of tax) 2 2
------- -------
CMS Energy - Diluted $ (73) $ 55
======= =======
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 134.7 132.1
Add conversion of 7.75% Trust
Preferred Securities 4.2 4.2
Stock Options -- .3
------- -------
Average Shares - Diluted 138.9 136.6
======= =======
EARNINGS PER AVERAGE COMMON SHARE
Basic $ (0.56)(a) $ 0.40(b)
Diluted $ (0.56)(a) $ 0.40(b)
======= =======
In Millions,
Except Per Share Amounts
---------------------------
Six Months Ended June 30 2002 2001
------- -------
NET INCOME APPLICABLE TO BASIC AND DILUTED EPS
Consolidated Net Income $ 314 $ 162
======= =======
Net Income Attributable to Common Stock:
CMS Energy - Basic $ 314(c) $ 162(d)
Add conversion of 7.75% Trust
Preferred Securities (net of tax) 5 4
------- -------
CMS Energy - Diluted $ 319 $ 166
======= =======
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CMS Energy Corporation
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 134.0 128.8
Add conversion of 7.75% Trust
Preferred Securities 4.2 4.2
Stock Options -- .3
------- -------
Average Shares - Diluted 138.2 133.3
======= =======
EARNINGS PER AVERAGE COMMON SHARE
Basic $ 2.34(c) $ 1.27(d)
Diluted $ 2.30(c) $ 1.25(d)
======= =======
(a) Includes the effects of net asset gains, loss on discontinued operations,
restructuring costs and extraordinary item, which decreased net income by
$134 million, or $1.00 per basic and diluted share.
(b) Includes the effects of gain or discontinued operations and net asset loss,
which increased net income by $18 million, or $0.13 per basic and diluted
share.
(c) Includes the effects of net asset gains, gain on discontinued operations,
restructuring costs and extraordinary item, which increased net income by
$180 million, or $1.33 per basic and diluted share, respectively.
(d) Includes the effects of gain on discontinued operations and net asset loss,
which increased net income by $19 million, or $0.14 and $0.13 per basic and
diluted share, respectively.
In February and April 2002, CMS Energy paid dividends of $.365 per share on CMS
Energy Common Stock. In July 2002, the Board of Directors declared a quarterly
dividend of $.18 per share on CMS Energy Common Stock, payable in August 2002.
8: RISK MANAGEMENT ACTIVITIES AND FINANCIAL INSTRUMENTS
The objective of the CMS Energy risk management policy is to analyze, manage and
coordinate the identified risk exposures of the individual business segments and
to exploit the presence of internal hedge opportunities that exist among its
diversified business segments. CMS Energy, on behalf of it regulated and
non-regulated subsidiaries, utilizes a variety of derivative instruments for
both trading and non-trading purposes and executes these transactions with
external parties through its marketing subsidiary, CMS MST. These derivative
instruments include futures contracts, swaps, options and forward contracts to
manage exposure to fluctuations in commodity prices, interest rates and foreign
exchange rates. In order for derivative instruments to qualify for hedge
accounting under SFAS No. 133, the hedging relationship must be formally
documented at inception and be highly effective in achieving offsetting cash
flows or offsetting changes in fair value attributable to the risk being hedged.
Derivative instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. CMS Energy minimizes such risk by performing financial credit
mitigation programs including, among other things, using publicly available
credit ratings of such counterparties, internally developed statistical models
for credit scoring and use of internal hedging programs to minimize exposure to
external counterparties. No material nonperformance is expected.
COMMODITY DERIVATIVES: Prior to January 1, 2001, CMS Energy accounted for its
non-trading commodity contracts as hedges and deferred any changes in the market
value and gains/losses resulting from settlements until the hedged transaction
was completed. As of January 1, 2001, commodity contracts are now accounted for
in accordance with the requirements of SFAS No. 133, as amended and interpreted,
and may or may not qualify for hedge accounting treatment depending on the
characteristics of each contract.
Consumers' electric business uses purchased electric call option contracts to
meet its regulatory obligation to serve, which requires providing a physical
supply of electricity to customers, and to manage electric cost and to ensure a
reliable source of capacity during periods of peak demand. These contracts are
subject to derivative accounting in accordance with SFAS No. 133, and as such
are required to be recorded at fair value on the
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CMS Energy Corporation
balance sheet, with changes in fair value recorded either directly in earnings
or other comprehensive income if the contract meets certain qualifying hedge
criteria. On July 1, 2001, upon initial adoption of the standard for these
contracts, Consumers recorded a $3 million, net of tax, cumulative effect
adjustment as an unrealized loss decreasing accumulated other comprehensive
income. This adjustment relates to the difference between the fair value and the
recorded book value of these electric call option contracts. The adjustment to
accumulated other comprehensive income relates to electric call option contracts
that qualified for cash flow hedge accounting prior to the initial adoption of
SFAS No. 133. After July 1, 2001, these contracts do not qualify for hedge
accounting under SFAS No. 133 and, therefore, Consumers will record any change
in fair value subsequent to July 1, 2001 directly in earnings, which could cause
earnings volatility. The initial amount recorded in other comprehensive income
will be reclassified to earnings as the forecasted future transactions occur or
the call options expire. The majority of these contracts expired in the third
quarter 2001 and the remaining contracts will expire in 2002. As of December 31,
2001, $2 million, net of tax, was reclassified to earnings as part of cost of
power supply. The remainder is expected to be reclassified to earnings in the
third quarter of 2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria to be used to determine if derivative
accounting is required. Consumers re-evaluated its electric call option and
option-like contracts and determined that under the revised guidance additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
will record any change in fair value subsequent to December 31, 2001 directly in
earnings, which could cause earnings volatility. As of June 30, 2002, all of
Consumers' purchased electric call option contracts subject to derivative
accounting were recorded on the balance sheet at a fair value of $2 million.
Consumers believes that its electric capacity and energy contracts do not
qualify as derivatives due to the lack of an active energy market in the state
of Michigan and the transportation cost to deliver the power under the contracts
to the closest active energy market at the Cinergy hub in Ohio. If a market
develops in the future, Consumers may be required to account for these contracts
as derivatives. The mark to market impact in earnings related to these
contracts, particularly related to the purchase power agreement with the MCV,
could be material to the financial statements.
Consumers' electric business also uses gas swap contracts to protect against
price risk due to the fluctuations in the market price of gas used as fuel for
generation of electricity. These gas swaps are financial contracts that will be
used to offset increases in the price of probable forecasted gas purchases.
These contracts do not qualify for hedge accounting. Therefore, Consumers
records any change in the fair value of these contracts directly in earnings as
part of power supply costs, which could cause earnings volatility. As of June
30, 2002, a gain of $1 million has been recorded for 2002, which represents the
fair value of these contracts at June 30, 2002. These contracts expire in
December 2002.
Consumers' gas business uses fixed price gas supply contracts to meet its
regulatory obligation to provide gas to its customers as the lowest possible
prudent cost. Some of these contracts contain embedded put options that
disqualify the contracts from the normal purchase exception of SFAS No. 133, and
therefore require derivative accounting. As of June 30, 2002, Consumers gas
supply contracts requiring derivative accounting had a fair value of $2 million,
representing a fair value gain on the contract since the date of inception, and
this gain was recorded directly in earnings as part of other income, and then
directly offset and recorded as a regulatory liability on the balance sheet. Any
subsequent changes in fair value will be recorded in the same manner. These
contracts expire in October of 2002.
CMS Energy, through its subsidiary CMS MST, engages in trading activities. CMS
MST manages any open positions within certain guidelines that limit its exposure
to market risk and requires timely reporting to management of potential
financial exposure. These guidelines include statistical risk tolerance limits
using historical price movements to calculate daily value at risk measurements.
CMS MST's trading activities are
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CMS Energy Corporation
accounted for under the mark-to-market method of accounting. Under
mark-to-market accounting, energy-trading contracts are reflected at fair market
value, net of reserves, with unrealized gains and losses recorded as an asset or
liability in the consolidated balance sheets. These assets and liabilities are
affected by the timing of settlements related to these contracts; current-period
changes from newly originated transactions and the impact of price movements.
Changes in fair values are recognized as revenues in the consolidated statements
of income in the period in which the changes occur. Market prices used to value
outstanding financial instruments reflect management's consideration of, among
other things, closing exchange and over-the-counter quotations. In certain of
these markets, long-term contract commitments may extend beyond the period in
which market quotations for such contracts are available. The lack of long-term
pricing liquidity requires the use of mathematical models to value these
commitments under the accounting method employed. These mathematical models
utilize historical market data to forecast future elongated pricing curves,
which are used to value the commitments that reside outside of the liquid market
quotations. Realized cash returns on these commitments may vary, either
positively or negatively, from the results estimated through application of
forecasted pricing curves generated through application of the mathematical
model. CMS Energy believes that its mathematical models utilize state-of-the-art
technology, pertinent industry data and prudent discounting in order to forecast
certain elongated pricing curves. These market prices are adjusted to reflect
the potential impact of liquidating the company's position in an orderly manner
over a reasonable period of time under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. Counterparties in its trading portfolio consist principally of
financial institutions and major energy trading companies. The creditworthiness
of these counterparties will impact overall exposure to credit risk; however,
with regard to its counterparties, CMS Energy maintains credit policies that
management believes minimize overall credit risk. Determination of the credit
quality of its counterparties is based upon a number of factors, including
credit ratings, financial condition, and collateral requirements. When trading
terms permit, CMS Energy employs standardized agreements that allow for netting
of positive and negative exposures associated with a single counterparty. Based
on these policies, its current exposures and its credit reserves, CMS Energy
does not anticipate a material adverse effect on its financial position or
results of operations as a result of counterparty nonperformance.
At June 30, 2002, CMS MST has recorded a net asset of $89 million, net of
reserves, related to the unrealized mark-to-market gains on existing
arrangements. For the six months ended June 30, 2002 and 2001, CMS MST reflected
$30 million loss and $44 million gain, respectively, of mark-to-market revenues,
net of reserves, primarily from newly originated long-term power sales contracts
and wholesale gas trading transactions.
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of June 30, 2002.
In Millions
-----------
Fair value of contracts outstanding as of March 31, 2002 $ 109
Contracts realized or otherwise settled during the period (a) (11)
Fair value of new contracts when entered into during the period 1
Changes in fair value attributable to changes in valuation techniques and assumptions (5)
Other changes in fair value (b) (5)
-----
Fair value of contracts outstanding as of June 30, 2002 $ 89
=====
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CMS Energy Corporation
Fair Value of Contracts at June 30, 2002 In Millions
--------------------------------------------------------------------------
Maturity (in years)
Total -----------------------------------------------------------
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- -------------------- ---------- ----------- ------ ------ --------------
Prices actively quoted $42 $ 8 $20 $11 $ 3
Prices provided by other external sources 19 1 4 10 4
Prices based on models and
other valuation methods 28 4 9 11 4
--- --- --- --- ---
Total $89 $13 $33 $32 $11
=== === === === ===
(a) Reflects value of contracts, included in March 31, 2002 values,
that expired during the 2002.
(b) Reflects changes in price and net increase/decrease in size of
forward positions, as well as changes to mark-to-market reserve
accounts.
FLOATING TO FIXED INTEREST RATE SWAPS: CMS Energy and its subsidiaries enter
into floating to fixed interest rate swap agreements to reduce the impact of
interest rate fluctuations. These swaps are designated as cash flow hedges and
the difference between the amounts paid and received under the swaps is accrued
and recorded as an adjustment to interest expense over the term of the
agreement. Changes in the fair value of these swaps are recorded in accumulated
other comprehensive income until the swaps are terminated. As of June 30, 2002,
these swaps had a negative fair value of $9 million that if sustained, will be
reclassified to earnings as the swaps are settled on a quarterly basis. No
ineffectiveness was recognized during the first quarter of 2002 under the
requirements of SFAS No. 133.
Notional amounts reflect the volume of transactions but do not represent the
amount exchanged by the parties to the financial instruments. Accordingly,
notional amounts do not necessarily reflect CMS Energy's exposure to credit or
market risks. As of June 30, 2002 and 2001, the weighted average interest rate
associated with outstanding swaps was approximately 5.2 percent and 6.4 percent,
respectively.
In Millions
-------------------------------------------------------------------------------
Floating to Fixed Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- ------------------- -------- --------- ----- -----------
June 30, 2002 $294 2003-2006 $ (9) $ 2
June 30, 2001 $819 2001-2006 $(16) $ (2)
FIXED TO FLOATING INTEREST RATE SWAPS: CMS Energy monitors its debt portfolio
mix of fixed and variable rate instruments and from time to time enters into
fixed to floating rate swaps to maintain the optimum mix of fixed and floating
rate debt. These swaps are designated as fair value hedges and any realized
gains or losses in the fair value are amortized to earnings after the
termination of the hedge instrument over the remaining life of the hedged item.
There were no outstanding fixed to floating interest rate swaps as of June 30,
2002.
FOREIGN EXCHANGE DERIVATIVES: CMS Energy uses forward exchange and option
contracts to hedge certain receivables, payables, long-term debt and equity
value relating to foreign investments. The purpose of CMS Energy's foreign
currency hedging activities is to protect the company from the risk that U.S.
Dollar net cash flows resulting from sales to foreign customers and purchases
from foreign suppliers and the repayment of non-U.S. Dollar borrowings as well
as equity reported on the company's balance sheet, may be adversely affected
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CMS Energy Corporation
by changes in exchange rates. These contracts do not subject CMS Energy to risk
from exchange rate movements because gains and losses on such contracts offset
losses and gains, respectively, on assets and liabilities being hedged. The
estimated fair value of the foreign exchange and option contracts at June 30,
2002 and 2001 was approximately zero and $13 million, respectively; representing
the amount CMS Energy would receive or (pay) upon settlement.
The notional amount of the outstanding foreign exchange contracts at June 30,
2002 was $1 million Canadian contracts. The notional amount of the outstanding
foreign exchange contracts at June 30, 2001, which have all currently expired,
was $470 million consisting of $22 million, $50 million, and $398 million for
Australian, Brazilian and Argentine, respectively.
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. The estimated fair values of long-term investments are based on quoted
market prices or, in the absence of specific market prices, on quoted market
prices of similar investments or other valuation techniques. Judgment may also
be required to interpret market data to develop certain estimates of fair value.
Accordingly, the estimates determined as of June 30, 2002 and 2001 are not
necessarily indicative of the amounts that may be realized in current market
exchanges. The carrying amounts of all long-term investments in financial
instruments, except for those as shown below, approximate fair value.
In Millions
-------------------------------------------------------------------------------------
As of June 30 2002 2001
--------------------------------------- ---------------------------------------
Carrying Fair Unrealized Carrying Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
------ ------ ------ ------ ------ ------
Long-Term Debt (a) $6,307 $5,982 $ (325) $7,193 $7,011 $ (182)
Preferred Stock and
Trust Preferred Securities 1,228 814 (414) 1,258 1,209 (49)
(a) Settlement of long-term debt is generally not expected until maturity.
9: REPORTABLE SEGMENTS
CMS Energy operates principally in the following five reportable segments:
electric utility; gas utility; independent power production; natural gas
transmission; and marketing, services and trading.
CMS Energy's reportable segments are strategic business units organized and
managed by the nature of the products and services each provides. Management
evaluates performance based on the net income of each segment. The electric
utility segment consists of regulated activities associated with the generation,
transmission and distribution of electricity in the state of Michigan through
its subsidiary, Consumers Energy. The gas utility segment consists of regulated
activities associated with the transportation, storage and distribution of
natural gas in the state of Michigan through its subsidiary, Consumers Energy.
Independent power production invests in, acquires, develops, constructs and
operates non-utility power generation plants in the United States and abroad.
Natural gas transmission owns, develops, and manages domestic and international
natural gas facilities. The marketing, services and trading segment provides
gas, oil, and electric marketing, risk management and energy management services
to industrial,
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CMS Energy Corporation
commercial, utility and municipal energy users throughout the United States and
abroad.
The Consolidated Statements of Income show operating revenue and pretax
operating income by reportable segment. Revenues from a land development
business fall below the quantitative thresholds for reporting, and has never met
any of the quantitative thresholds for determining reportable segments. The
table below shows net income - operating by reportable segment.
Reportable Segments
In Millions
--------------------------
Six Months Ended June 30 2002 2001
----- -----
Net Income Before Reconciling Items
Electric utility $ 103 $ 89
Gas utility 32 28
Independent power production 70 45
Natural gas transmission 40 60
Marketing, services and trading (14) 37
Corporate interest and other (97) (116)
----- -----
$ 134 $ 143
Asset gains / (losses) 35 (1)
Discontinued operations 169 20
Extraordinary item (8) --
Accounting Change (9) --
Restructuring Costs (7) --
----- -----
Consolidated Net Income $ 314 $ 162
===== =====
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Consumers Energy Company
CONSUMERS ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
Consumers, a subsidiary of CMS Energy, a holding company, is an electric and gas
utility company that provides service to customers in Michigan's Lower
Peninsula. Consumers' customer base includes a mix of residential, commercial
and diversified industrial customers, the largest segment of which is the
automotive industry.
This MD&A refers to, and in some sections specifically incorporates by
reference, Consumers' Condensed Notes to Consolidated Financial Statements and
should be read in conjunction with such Consolidated Financial Statements and
Notes. This Form 10-Q and other written and oral statements that Consumers may
make contain forward-looking statements as defined by the Private Securities
Litigation Reform Act of 1995. Consumers' intentions with the use of the words,
"anticipates," "believes," "estimates," "expects," "intends," and "plans," and
variations of such words and similar expressions, are solely to identify
forward-looking statements that involve risk and uncertainty. These
forward-looking statements are subject to various factors that could cause
Consumers' actual results to differ materially from the results anticipated in
such statements. Consumers has no obligation to update or revise forward-looking
statements regardless of whether new information, future events or any other
factors affect the information contained in such statements. Consumers does,
however, discuss certain risk factors, uncertainties and assumptions in this
Management's Discussion and Analysis in the section entitled "CMS Energy,
Consumers and Panhandle Forward-Looking Statements Cautionary Factors" in
Consumers' 2001 Form 10-K Item 1 and in various public filings it periodically
makes with the SEC. Consumers designed this discussion of potential risks and
uncertainties, which is by no means comprehensive, to highlight important
factors that may impact Consumers' outlook. This Form 10-Q also describes
material contingencies in Consumers Notes to Consolidated Financial Statements,
and Consumers encourages its readers to review these Notes.
CRITICAL ACCOUNTING POLICIES
Presenting financial statements in accordance with accounting principles
generally accepted in the United States requires using estimates, assumptions,
and accounting methods that are often subject to judgment. Presented below, are
the accounting policies and assumptions that Consumers believes are most
critical to both the presentation and understanding of its financial statements.
Applying these accounting policies to financial statements can involve very
complex judgments. Accordingly, applying different judgments, estimates or
assumptions could result in a different financial presentation.
USE OF ESTIMATES IN ACCOUNTING FOR CONTINGENCIES
The principles in SFAS No. 5 guide the recording of estimated liabilities for
contingencies within the financial statements. SFAS No. 5 requires a company to
record estimated liabilities when it is probable that a current event will cause
a future loss payment and that loss amount can be reasonably estimated.
Consumers used this principle to record or disclose estimated liabilities for
the following significant events.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects to incur
significant costs for future environmental compliance, especially compliance
with clean air laws.
The EPA issued regulations regarding ozone and particulate-related emissions
that require some Consumers' electric generating facilities to lower their
emissions rates. These regulations will require Consumers to make significant
capital expenditures estimated to be $680 million, calculated in year 2002
dollars. As of June 2002,
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Consumers Energy Company
Consumers incurred $344 million of capital expenditures to comply. Consumers
expects to make the remaining capital expenditures between 2002 and 2006.
At some point after 2006, Consumers may incur additional capital expenditures if
new environmental standards for multi-pollutants become effective. These and
other required environmental expenditures may have a material adverse impact
upon Consumers' financial condition and results of operations after 2006. For
further information see Note 2, Uncertainties, "Electric Environmental Matters."
GAS ENVIRONMENTAL ESTIMATES: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will incur investigation
and remedial action costs at a number of sites. Consumers estimates the costs
for 23 former Manufactured Gas Plant sites will be between $82 million and $113
million, using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. These estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between 3 and 7 percent. Consumers expects to
recover a significant portion of these costs through MPSC-approved rates charged
to its customers. Any significant change in assumptions, such as remediation
techniques, nature and extent of contamination, and legal and regulatory
requirements, could change the remedial action costs for the sites. For further
information see Note 2, Uncertainties, "Gas Environmental Matters."
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV
Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990 and to supply electricity and steam to Dow. Consumers, through
two wholly owned subsidiaries, holds a partnership interest in the MCV
Partnership, and a lessor interest in the MCV Facility.
Consumers' annual obligation to purchase capacity from the MCV Partnership is
1,240 MW through 2025. The PPA requires Consumers to pay, based on the MCV
Facility's availability, a levelized average capacity charge of 3.77 cents per
kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Consumers has
not been allowed full recovery of the capacity charges in rates and has recorded
the estimated contract losses on this through 2007.
Consumers' availability payments to the MCV Partnership are capped at 98.5
percent. If the MCV Facility generates electricity at the maximum 98.5 percent
level during the next five years, Consumers' after-tax cash underrecoveries
associated with the PPA could be as follows:
In Millions
----------------------------------------------------
2002 2003 2004 2005 2006
---- ---- ---- ---- ----
Estimated cash underrecoveries at 98.5%, net of tax $38 $37 $36 $36 $36
==== ==== ==== ==== ====
For further information see Note 2, Uncertainties "The Midland Cogeneration
Venture" for additional detail.
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS
DERIVATIVE INSTRUMENTS: Consumers uses SFAS No. 133 criteria to determine which
contracts must be accounted for as derivative instruments. These rules, however,
are numerous and complex. As a result, significant judgment is required, and
similar contracts can sometimes be accounted for differently.
Consumers currently accounts for the following contracts as derivative
instruments: interest rate swaps and locks, certain electric call options and
gas supply contracts with embedded put options, and gas fuel swaps. Consumers
does not account for the following contracts as derivative instruments: electric
capacity and energy contracts, gas supply contracts without embedded options,
coal and nuclear fuel supply contracts, and purchase orders for numerous supply
items.
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Consumers Energy Company
If a contract is accounted for as a derivative instrument, it is recorded in the
financial statements as an asset or a liability, at the fair value of the
contract. Any difference between the recorded book value and the fair value is
reported either in earnings or other comprehensive income, depending on certain
qualifying criteria. The recorded fair value of the contract is then adjusted
quarterly to reflect any change in the market value of the contract.
In order to fair value the contracts that are accounted for as derivative
instruments, Consumers uses a combination of market quoted prices and
mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the call option contracts. At June 30, 2002, Consumers assumed an interest rate
of 4.5 percent in calculating the fair value of its electric call options.
In order for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value, attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings. Consumers believes that its electric
capacity and energy contracts do not qualify as derivatives due to the lack of
an active energy market in the state of Michigan and the transportation cost to
deliver the power under the contracts to the closest active energy market at the
Cinergy hub in Ohio. If a market develops in the future, Consumers may be
required to account for those contracts as derivatives. The mark to market
impact in earnings related to these contracts, particularly related to the
purchase power agreement with the MCV, could be material to the financial
statements. For further information see Note 1, Corporate Structure and Summary
of Significant Accounting Policies, "Implementation of New Accounting
Standards," Note 2, Uncertainties, "Other Electric Uncertainties - Derivative
Activities," and Note 3, Short-Term Financings and Capitalization, "Derivative
Activities."
FINANCIAL INSTRUMENTS: Consumers accounts for its debt and equity investment
securities in accordance with SFAS No. 115. As such, debt and equity securities
can be classified into one of three categories: held-to-maturity, trading, or
available-for-sale securities. Consumers' equity securities investments are
classified as available-for-sale securities. They are reported at fair value,
with any unrealized gains or losses from changes in fair value reported in
equity as part of other comprehensive income and excluded from earnings.
Unrealized gains or losses from changes in the fair value of Consumers' nuclear
decommissioning investments are reported in accumulated depreciation. The fair
value of these instruments is determined from quoted market prices.
ACCOUNTING FOR LEASES
Consumers uses SFAS No. 13 to account for any leases to which it may be a party.
Depending upon satisfaction of certain criteria, they are classified as
operating leases or capital leases. Under an operating lease, payments are
expensed as incurred, and there is no recognition of an asset or liability on
the balance sheet. Capital leases, on the other hand, require that an asset and
liability be recorded on the balance sheet at the inception of the lease for the
present value of the minimum lease payments required during the term of the
lease.
To determine whether to classify a lease as operating or capital under SFAS No.
13 and related statements, Consumers must use judgment. A lease must be
evaluated for transfer of ownership, provision for bargain purchase option, the
lease term relative to the estimated economic life of the leased property, and
the present value of the minimum lease payments at the beginning of the lease
term. Judgment is required for leases involving special purpose entities such as
trusts, sales and leasebacks and when the lessee is involved in the construction
of the property it will lease. Different financial presentations of leases could
result if different judgment, estimates or assumptions are made.
Consumers is party to a number of leases, the most significant are the leases
associated with its new
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Consumers Energy Company
headquarters building and its railcar lease. For further information see
"Contractual Obligations and Commercial Commitments" in the Capital Resources
and Liquidity section and Note 1, Corporate Structure and Summary of Significant
Accounting Policies, "Accounting for Headquarters Building Lease".
ACCOUNTING FOR THE EFFECTS OF INDUSTRY REGULATION
Because Consumers is involved in a regulated industry, regulatory decisions
affect the timing and recognition of revenues and expenses. Consumers uses SFAS
No. 71 to account for the effects of these regulatory decisions. As a result,
Consumers may defer or recognize revenues and expenses differently than a
non-regulated entity.
For example, items that a non-regulated entity would normally expense, Consumers
may capitalize as regulatory assets if the actions of the regulator indicate
such expenses will be recovered in future rates. Conversely, items that
non-regulated entities may normally recognize as revenues, Consumers may record
as regulatory liabilities if the actions of the regulator indicate they will
require such revenues to later be refunded to customers. Judgment is required to
discern the recoverability of items recorded as regulatory assets and
liabilities. As of June 30, 2002, Consumers had $1.211 billion recorded as
regulatory assets and $295 million recorded as regulatory liabilities.
ACCOUNTING FOR PENSION AND OPEB
Consumers uses SFAS No. 87 to account for pension costs and uses SFAS No. 106 to
account for other postretirement benefit costs. These statements require
liabilities to be recorded on the balance sheet at the present value of these
future obligations to employees net of any plan assets. The calculation of these
liabilities and associated expenses require the expertise of actuaries and are
subject to many assumptions including life expectancies, present value discount
rates, expected long-term rate of return on plan assets, rate of compensation
increase and anticipated health care costs. Any change in these assumptions can
significantly change the liability and associated expenses recognized in any
given year. For further information see the Other Outlook section.
ACCOUNTING FOR NUCLEAR DECOMMISSIONING COSTS
Consumers' decommissioning cost estimates for the Big Rock and Palisades plants
assume that each plant site will eventually be restored to conform to the
adjacent landscape, and all contaminated equipment will be disassembled and
disposed of in a licensed burial facility. On December 31, 2000, Big Rock trusts
were fully funded per a March 1999 MPSC order. A December 1999 MPSC order set
the annual decommissioning surcharge for Palisades decommissioning at $6 million
a year. Consumers estimates that at the time Palisades is fully decommissioned
in year 2049, the trust funds will have provided $2.5 billion, including trust
earnings, to pay for the anticipated expenditures over the entire
decommissioning period. Consumers also anticipates future recoveries from the
DOE for the cost of storage of spent nuclear fuel that will be added in the
future to the decommissioning trust funds. Earning assumptions are that the
trust funds are invested in equities and fixed income investments, the equity
funds will be converted to fixed income investments prior to decommissioning,
and that fixed income investments are converted to cash one year before
expenditures are made. The Palisades and Big Rock trust funds are currently
estimated to earn 7.1 percent and 5.7 percent, respectively, annually over the
life of the trust funds.
The funds added to and provided by the trusts are expected to fully fund the
decommissioning costs. The decommissioning costs have been developed, in part,
by independent contractors with expertise in decommissioning. These costs have
been developed using various inflation rates for labor, non-labor, and for
contaminated equipment burial costs. Variance from trust earnings, changes in
decommissioning technology, regulations, estimates or assumptions could affect
the cost of decommissioning these sites.
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Consumers Energy Company
RELATED PARTY TRANSACTIONS
Consumers enters into a number of significant transactions with related parties.
These transactions include the purchase of capacity and energy from the MCV
Partnership and from affiliates of Enterprises, the purchase of electricity and
gas supply from CMS MST, the purchase of gas transportation from Trunkline, a
subsidiary of Panhandle, the payment of parent company overhead costs to CMS
Energy, the sale, storage and transportation of natural gas and other services
to the MCV Partnership, certain transactions involving derivative instruments
with CMS MST, and an investment in CMS Energy Common Stock.
Transactions involving CMS Energy and its affiliates and the sale, storage and
transportation of natural gas and other services to the MCV Partnership are
based on regulated prices, market prices or competitive bidding. Purchases are
based upon the lowest market price available or most competitive bid submitted.
Transactions involving the power supply purchases from the MCV Partnership are
based upon avoided costs under PURPA; and the payment of parent company overhead
costs to CMS Energy are based upon use or accepted industry allocation
methodologies.
Consumers also sold its transmission facilities to MTH, a non-affiliated limited
partnership whose general partner is a subsidiary of Trans-Elect, Inc., an
independent company, whose management includes former executive employees of
Consumers. The transaction was based on competitive bidding. For detailed
information regarding the sale see Note 2, "Transmission."
For detailed information about related party transactions see Note 2,
Uncertainties, "Electric Rate Matters - Transmission", and "Other Electric
Uncertainties - The Midland Cogeneration Venture".
RESULTS OF OPERATIONS
CONSUMERS CONSOLIDATED EARNINGS
In Millions
------------------------------------------
June 30 2002 2001 Change
---- ---- ----
Three months ended $113 $ 33 $ 80
Six months ended 193 131 62
==== ==== ====
2002 COMPARED TO 2001: For the three months ended June 30, 2002, Consumers' net
income available to the common stockholder totaled $113 million, an increase of
$80 million from the comparable period in 2001. The earnings increase reflects
the after-tax benefit of decreased electric power costs of $22 million from the
comparable period in 2001. This reduction in power costs was primarily due to
higher replacement power supply costs in 2001, resulting from outages at
Palisades in the second quarter of 2001. The increase in earnings also reflects
a $26 million gain from the May 2002, sale of Consumers' electric transmission
facilities, to MTH, a non-affiliated limited partnership whose general partner
is a subsidiary of Trans-Elect Inc. Also contributing to the earnings increase
is a $22 million increase in the fair value of certain long-term gas contracts
held by the MCV Partnership. The fair value of these contracts is adjusted,
through earnings, on a quarterly basis in accordance with SFAS 133. For further
information on SFAS 133, see Note 2, Uncertainties. Also contributing to this
increase in earnings are reduced fixed charges due to declining interest rates.
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Consumers Energy Company
For the six months ended June 30, 2002, Consumers' net income available to the
common stockholder totaled $193 million, an increase of $62 million from the
comparable period in 2001. This increase includes the same items identified for
the second quarter and also reflects the benefit of an increase in gas
distribution tariff rates because of an interim rate increase, partially offset
by increased operating costs and higher replacement power costs resulting from a
plant outage at Palisades in early 2002.
For further information, see the Electric and Gas Utility Results of Operations
sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
-------------------------------------
June 30 2002 2001 Change
- ------- ---- ---- ------
Three months ended $ 84 $ 30 $ 54
Six months ended 133 91 42
==== ==== =====
Three Months Six Months
Ended June 30 Ended June 30
Reasons for change 2002 vs 2001 2002 vs 2001
- ------------------ ------------ ----------
Electric deliveries $ 7 $ --
Power supply costs and related revenue 34 18
Other operating expenses and non-commodity revenue (7) (7)
Gain on asset sales 38 38
Fixed charges 5 8
Income taxes (23) (15)
Total change $ 54 $ 42
======= =======
ELECTRIC DELIVERIES: For the three months ended June 30, 2002, electric
deliveries, including transactions with other electric utilities, were 9.4
billion kWh, an increase of 0.1 billion kWh, or 1.4 percent from the comparable
period in 2001. The increase in total electric deliveries was primarily due to
higher residential usage resulting from warmer June 2002 temperatures.
For the six months ended June 30, 2002, electric deliveries, including
transactions with other electric utilities, were 18.6 billion kWh, a decrease of
0.7 billion kWh, or 3.4 percent from the comparable period in 2001. This
decrease is the result of reduced first quarter industrial usage due to the
economic downturn.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended June 30,
2002, power supply costs decreased by $34 million from the comparable period in
2001. The decreased power costs in 2002 was primarily due to the higher
availability of the lower priced Palisades Nuclear Plant. In the 2001 period,
Consumers was required to purchase greater quantities of higher-priced power to
offset the loss of internal generation resulting from outages at Palisades.
For the six months ended June 30, 2002, power supply costs and related revenues
decreased by a total of $18 million from the comparable period in 2001. This
decrease was also the result of the Palisades outage described for the current
quarter partially offset by a plant outage at Palisades in early 2002.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUES: For the three and six
months ended 2002,
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Consumers Energy Company
other operating expenses increased $7 million due to increased depreciation
expense resulting from higher plant in service along with a decrease in
miscellaneous revenues.
GAIN ON ASSET SALES: For the three and six months ended 2002, asset sales
increased as a result of the $31 million pre-tax gain associated with the May
2002 sale of Consumers' electric transmission system and a $7 million pre-tax
gain on the sale of unused nuclear equipment from the cancelled Midland project.
GAS UTILITY RESULTS OF OPERATIONS
In Millions
-------------------------------------
June 30 2002 2001 Change
- ------- ---- ---- ------
Three months ended $ 4 $ 1 $ 3
Six months ended 32 30 2
==== ==== ====
Three Months Six Months
Ended June 30 Ended June 30
Reasons for change 2002 vs 2001 2002 vs 2001
- ------------------ ------------- -------------
Gas deliveries $ 9 $--
Gas rate increase 2 9
Gas wholesale and retail services 1 --
Operation and maintenance (4) --
Other operating expenses (4) (5)
Income taxes (1) (2)
Total change $ 3 $ 2
=== ===
For the three months ended June 30, 2002, gas revenues increased due to colder
temperatures compared to the second quarter 2001. Operation and maintenance cost
increases reflect additional expenditures on customer reliability and service.
System deliveries, including miscellaneous transportation volumes, totaled 65.3
bcf, an increase of 8.3 bcf or 14.7 percent compared with 2001.
For the six months ended June 30, 2002, gas revenues increased due to an interim
gas rate increase granted in December of 2001. System deliveries, including
miscellaneous transportation volumes, totaled 214.5 bcf, a decrease of 2 bcf or
..9 percent compared with 2001.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
OPERATING ACTIVITIES: Consumers' principal source of liquidity is from cash
derived from operating activities involving the sale and transportation of
natural gas and the generation, delivery and sale of electricity. Cash from
operations totaled $436 million and $379 million for the first six months of
2002 and 2001, respectively. The $57 million increase resulted primarily from a
$223 million increase in cash due to fewer expenditures for natural gas
inventories, partially offset by $139 million decrease in cash collected from
customers and related parties. Consumers primarily uses cash derived from
operating activities to operate, maintain, expand and construct its electric and
gas systems, to retire portions of long-term debt, and to pay dividends. A
decrease in cash from operations
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Consumers Energy Company
could reduce the availability of funds and result in additional short-term
financings, see Note 3, Short-Term Financings and Capitalization for additional
details about this source of funds.
INVESTING ACTIVITIES: Cash used for investing activities totaled $7 million and
$395 million for the first six months of 2002 and 2001, respectively. The change
of $388 million is primarily the result of $293 million cash from the sale of
METC, the reactor head and fewer capital expenditures to comply with the Clean
Air Act than the first six months of 2001.
FINANCING ACTIVITIES: Cash used by financing activities totaled $393 million for
the first six months of 2002 compared to $9 million provided in the first six
months of 2001, respectively. The change of $402 million is primarily the result
of $371 million retirement of bonds and other long-term debt, $178 million net
decrease in notes payable, the absence of $121 million proceeds from preferred
securities and an acceleration of $58 million in the payment of common stock
dividends, offset by $304 million of net proceeds from issuance of senior notes.
OFF-BALANCE SHEET ARRANGEMENTS: Consumers' use of long-term contracts for the
purchase of commodities and services, the sale of its accounts receivables, and
operating leases are considered to be off-balance sheet arrangements. Consumers
has responsibility for the collectability of the accounts receivables sold, and
the full obligation of its leases becomes due in case of lease payment default.
Consumers uses these off-balance sheet arrangements in its normal business
operations.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS: The following schedule of
material contractual obligations and commercial commitments is provided to
aggregate information in a single location so that a picture of liquidity and
capital resources is readily available. For further information see Note 2,
Uncertainties, and Note 3, Short-Term Financings and Capitalization.
Contractual Obligations In Millions
- ----------------------- ----------------------------------------------------------------------------------
Payments Due
----------------------------------------------------------------------------------
June 30 Total 2002 2003 2004 2005 2006 and beyond
- ------- ------- ------- ------- ------- ------- ---------------
On-balance sheet:
Long-term debt $ 2,441 $ 173 $ 333 $ 28 $ 470 $ 1,437
Notes payable 245 245 -- -- -- --
Capital lease obligations 167 20 21 20 19 87
Off-balance sheet:
Operating leases 89 12 12 9 7 49
Non-recourse debt of FMLP 277 65 8 54 41 109
Sale of accounts receivable 311 311 -- -- -- --
Unconditional purchase
Obligations 17,961 1,191 1,052 837 771 14,110
======= ======= ======= ======= ======= ========
Unconditional purchase obligations are for natural gas and electricity and
represent normal business operating contracts used to assure adequate supply and
minimize exposure to market price fluctuations.
Consumers has long-term power purchase agreements with various generating plants
including the MCV Facility. These contracts require monthly capacity payments
based on the plants' availability or deliverability. These payments are
approximately $45 million per month for year 2002, which includes $33 million
related to the MCV Facility. If a plant is not available to deliver electricity
to Consumers, then Consumers would not be obligated to make the capacity payment
until the plant could deliver. See Electric Utility Results of Operations above
and Note 2, Uncertainties, "Electric Rate Matters - Power Supply Costs" and
"Other
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CMS Energy Corporation
Electric Uncertainties - The Midland Cogeneration Venture" for further
information concerning power supply costs.
Commercial Commitments In Millions
- ---------------------- -----------------------------------------------------------------------------------
Commitment Expiration
-----------------------------------------------------------------------------------
June 30 Total 2002 2003 2004 2005 2006 and beyond
- ------- ----- ---- ---- ---- ---- ---------------
Off-balance sheet:
Guarantees $35 $35 -- -- -- --
Indemnities 17 -- -- -- -- 17
Letters of Credit 7 7 -- -- -- --
=== === === === === ===
As of June 2002, Consumers had $300 million in credit facilities, $45 million
aggregate lines of credit and a $325 million trade receivable sale program in
place as anticipated sources of funds for general corporate purposes and
currently expected capital expenditures.
In July 2002, the credit rating of the publicly traded securities of Consumers
was downgraded by the major rating agencies. The rating downgrade is proported
to be largely a function of the uncertainties associated with CMS Energy's
financial condition and liquidity pending resolution of the round-trip trading
investigations and lawsuits, the special board committee investigation,
restatement and re-audit of 2000 and 2001 financial statements and uncertain
future access to the capital markets. Consumers actual ability to access the
capital markets in the future on a timely basis will depend on the successful
and timely resolution of the board committee investigation and the successful
and timely conclusion of the re-audit of 2000 and 2001 financial statements.
As a result of certain of these downgrades, several commodity suppliers to
Consumers have requested advance payments or other forms of assurances in
connection with maintenance of ongoing deliveries of gas and electricity.
Consumers is working cooperatively with those suppliers to find mutually
satisfactory arrangements but there can be no assurance that all such
arrangements will be completed.
On July 12, 2002, Consumers reached agreement with its lenders on two credit
facilities as follows: $250 million revolving credit facility maturing July 11,
2003 and a $300 million term loan maturing July 11, 2003, with a one-year
extension anticipated at Consumers' option. These two facilities aggregating
$550 million replace a $300 million revolving credit facility that matured July
14, 2002 as well as various credit lines aggregating $200 million. The prior
credit facilities and lines were unsecured. The two new credit facilities are
secured with Consumers first mortgage bonds.
Consumers $250 million revolving credit facility has an interest rate of LIBOR
plus 200 basis points (although the rate may fluctuate depending on the rating
of Consumers first mortgage bonds) and the interest rate on the $300 million
term loan is LIBOR plus 300 basis points. Consumers bank and legal fees
associated with the facilities were $5.6 million.
The credit facilities have contractual restrictions that require Consumers to
maintain, as of the last day of each fiscal quarter, the following:
Required Ratio Limitation Ratio at June 30, 2002
- -------------- -------------------------- ----------------------
Debt to Capital Ratio Not more than 0.65 to 1.00 0.51 to 1.00
Interest Coverage Ratio Not less than 2.0 to 1.0 2.6 to 1.0
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Consumers Energy Company
Also pursuant to restrictive covenants in the new facilities, Consumers is
limited to dividend payments that will not exceed $300 million in any calendar
year. In 2001, Consumers paid $189 million in common stock dividends to CMS
Energy. Consumers has declared and paid $154 million in common dividends through
June 2002.
Consumers anticipates issuing $300 million in new securities in late October or
November 2002 of which $100 million will be used for refinancing purposes and
$200 million will be used for general corporate purposes including capital
expenditures and gas inventory purchases.
For further information, see Note 3, Short-Term Financings and Capitalization.
OUTLOOK
CAPITAL EXPENDITURES OUTLOOK
Over the next three years, Consumers estimates the following capital
expenditures, including new lease commitments, by expenditure type and by
business segments. Consumers prepares these estimates for planning purposes and
may revise them.
In Millions
------------------------------------
Years Ended December 31 2002 2003 2004
- ----------------------- ---- ---- ----
Construction $586 $555 $618
Nuclear fuel lease 9 33 32
Capital leases other than nuclear fuel 55 47 30
---- ---- ----
$650 $635 $680
==== ==== ====
Electric utility operations (a)(b) $460 $430 $450
Gas utility operations (a) 190 205 230
---- ---- ----
$650 $635 $680
==== ==== ====
(a) These amounts include an attributed portion of Consumers' anticipated
capital expenditures for plant and equipment common to both the electric and gas
utility businesses.
(b) These amounts include estimates for capital expenditures that may be
required by recent revisions to the Clean Air Act's national air quality
standards. For further information see Note 2, Uncertainties.
ELECTRIC BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric deliveries
(including both full service sales and delivery service to customers who choose
to buy generation service from an alternative electric supplier) to grow at an
average rate of approximately two percent per year based primarily on a steadily
growing customer base. This growth rate reflects a long-range expected trend of
growth. Growth from year to year may vary from this trend due to customer
response to abnormal weather conditions and changes in economic conditions
including, utilization and expansion of manufacturing facilities.
COMPETITION AND REGULATORY RESTRUCTURING: The enactment of Michigan's Customer
Choice Act and other developments will continue to result in increased
competition in the electric business. Generally, increased competition can
reduce profitability and threatens Consumers' market share for generation
services. The Customer Choice Act allowed all of the company's electric
customers to buy electric generation service from
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Consumers Energy Company
Consumers or from an alternative electric supplier as of January 1, 2002.
Therefore, alternative electric suppliers for generation services have entered
Consumers' market. As of July 2002, 386 MW of generation services were being
provided by such suppliers. To the extent Consumers experiences "net" Stranded
Costs as determined by the MPSC, the Customer Choice Act allows for the company
to recover such "net" Stranded Costs by collecting a transition surcharge from
those customers who switch to an alternative electric supplier.
Stranded and Implementation Costs: The Customer Choice Act allows electric
utilities to recover the act's implementation costs and "net" Stranded Costs
(without defining the term). The act directs the MPSC to establish a method of
calculating "net" Stranded Costs and of conducting related true-up adjustments.
In December 2001, the MPSC adopted a methodology for calculating "net" Stranded
Costs as the shortfall between: (a) the revenue required to cover the costs
associated with fixed generation assets, generation-related regulatory assets,
and capacity payments associated with purchase power agreements, and (b) the
revenues received from customers under existing rates available to cover the
revenue requirement. Consumers has initiated an appeal at the Michigan Court of
Appeals related to the MPSC's December 2001 "net" Stranded Cost order, as a
result of to the uncertainty associated with the outcome of the proceeding
described in the following paragraph.
According to the MPSC, "net" Stranded Costs are to be recovered from retail open
access customers through a Stranded Cost transition charge. Even though the MPSC
set Consumers' Stranded Cost transition charge at zero for calendar year 2000,
those costs for 2000 will be subject to further review in the context of the
MPSC's subsequent determinations of "net" Stranded Costs for 2001 and later
years. The MPSC authorized Consumers to use deferred accounting to recognize the
future recovery of costs determined to be stranded. In April 2002, Consumers
made "net" Stranded Cost filings with the MPSC for $22 million and $43 million
for 2000 and 2001, respectively. In the same filing, Consumers estimated that it
would experience "net" Stranded Costs of $126 million for 2002. The MPSC staff
and Energy Michigan filed appeals with the MPSC regarding the inclusion of
certain Clean Air Act-related investment and other costs in Consumers' "net"
Stranded Cost filing. In July 2002, the MPSC granted the MPSC staff its appeal.
As a result, Consumers revised and supplemented its "net" Stranded Costs filing
by excluding all costs associated with the Clean Air Act and resubmitting the
filing to MPSC. After exclusion of the Clean Air Act costs, the revised Stranded
Cost amounts are $11 million and $8 million for 2000 and 2001, respectively, and
an estimated $76 million for 2002. On August 9, 2002 the MPSC Staff and other
intervenors filed their position regarding 2000 and 2001 Stranded Cost. The
Staff recommended that the Commission find that Consumers had Stranded Costs of
$5.1M and $2.8M for 2000 and 2001, respectively. Other parties contended that
Consumers had stranded benefits in 2000 and 2001 and made various suggestions
on how those benefits should be treated. In a separate filing, Consumers
requested regulatory asset accounting treatment for its Clean Air Act
expenditures through 2003. The outcome of these proceedings before the MPSC is
uncertain at this time.
Since 1997, Consumers has incurred significant electric utility restructuring
implementation costs. The following table outlines the applications filed by
Consumers with the MPSC and the status of recovery for these costs.
In Millions
----------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- ---------- ------------- --------- ------- ------- ----------
1999 1997 & 1998 $20 $-- $15 $ 5
2000 1999 30 -- 25 5
2001 2000 25 25 -- --
2002 2001 8 8 -- --
=========== ===== ==== ===== ====
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in electric rates. In
the orders received for the years 1997 through 1999, the MPSC also reserved the
right to review again the total implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs. Consumers expects to
receive in 2002, a final order for the 2001 implementation costs. In addition to
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the amounts shown, as of June 2002, Consumers incurred and deferred as a
regulatory asset, $5 million of additional implementation costs and has also
recorded as a regulatory asset $13 million for the cost of money associated with
total implementation costs. Consumers believes the implementation costs and the
associated cost of money are fully recoverable in accordance with the Customer
Choice Act. Cash recovery from customers will probably begin after the rate
freeze or rate cap period has expired. However, Consumers cannot predict the
amounts the MPSC will allow the company to recover.
Rate Caps: The Customer Choice Act imposes certain limitations on electric
rates such that could result in Consumers being unable to collect from
customers its full cost of conducting business. Some of these costs are beyond
Consumers' control. In particular, if Consumers needs to purchase power supply
from wholesale suppliers while retail rates are frozen or capped, the rate
restrictions may make it impossible for Consumers to fully recover purchased
power costs from its customers. As a result, Consumers may be unable to
maintain its profit margins in its electric utility business during the rate
freeze or rate cap periods.
Industrial Contracts: In response to industry restructuring efforts, Consumers
entered into multi-year electric supply contracts with certain large industrial
customers to provide electricity at specially negotiated prices, usually at a
discount from tariff prices. The MPSC approved these special contracts as part
of its phased introduction to competition. From 2001 through 2005, Consumers
or these industrial customers can terminate or restructure some of these
contracts. As of June 2002, neither Consumers nor any of its industrial
customers have done so. Some contracts have expired, but outstanding contracts
involve approximately 510 MW. Consumers cannot predict the ultimate financial
impact of changes related to these power supply contracts, or whether
additional contracts will be necessary or advisable.
Code of Conduct: In December 2000, as a result of the passage of the Customer
Choice Act, the MPSC issued a new code of conduct that applies to electric
utilities and alternative electric suppliers. The code of conduct seeks to
prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and internal transfer pricing between Consumers' departments and
affiliates. In October 2001, the new code of conduct was reaffirmed without
substantial modification. Consumers appealed the MPSC orders related to the code
of conduct and sought a stay of the orders until the appeal was complete;
however, the request for a stay was denied. Consumers has filed a compliance
plan in accordance with the code of conduct. It has also sought waivers to the
code of conduct in order to continue utility activities that provide
approximately $50 million in annual revenues. The full impact of the new code of
conduct on Consumers' business will remain uncertain until the appellate courts
issue definitive rulings or the MPSC rules on the waivers. Recently in an
appeal involving affiliate pricing guidelines, the Michigan Court of Appeals
struck them down because of a procedurally defective manner of enactment by
the MPSC. The same procedure was used by the MPSC in enacting the new code of
conduct.
Energy Policy: Uncertainty exists regarding the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills introduced in Congress in recent
years aimed to change existing federal regulation of the industry. If the
federal government enacts a comprehensive energy policy or electric
restructuring legislation, then that legislation could potentially affect or
even supercede state regulation.
Transmission: In 1999, the FERC issued Order No. 2000, strongly encouraging
utilities to transfer operating control of their electric transmission
facilities to an RTO, or sell the facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which also requires utilities to divest or transfer the operating
authority of transmission facilities to an independent company. Consumers
chose to offer its electric transmission facilities for sale rather than own
and invest in an asset it cannot control. In May 2002, Consumers sold its
electric transmission facilities for approximately $290 million in cash to MTH,
a non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc.
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Trans-Elect, Inc. submitted the winning bid through a competitive bidding
process, and various federal agencies approved the transaction. Consumers did
not provide any financial or credit support to Trans-Elect, Inc. Certain
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by such
affiliates when the transaction was discussed internally and negotiated with
purchasers. Consumers anticipates that after selling its transmission
facilities, its after-tax earnings will increase by approximately $17 million
in 2002, due to the recognition of a $26 million one time gain on the sale of
transmission assets. In 2003, Consumers anticipates that after-tax earnings
will decrease by $15 million. This decrease results from the loss of revenue
from wholesale and retail open access customers who would buy services directly
from MTH, including the loss of a return on the sold transmission assets.
Under the agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers will be fixed at current levels until
December 2004, and subject to FERC ratemaking thereafter. MTH will complete the
capital program to expand the transmission system's capability to import
electricity into Michigan, as required by the Customer Choice Act, and Consumers
will continue to maintain the system under a five-year contract with MTH.
Effective April 30, 2002, Consumers and METC withdrew from the Alliance RTO.
For further information, see Note 2, Uncertainties, "Electric Rate Matters -
Transmission."
On July 31, 2002, FERC issued a 600-page notice of proposed rulemaking on
standard market design for electric bulk power markets and transmission. Its
stated purpose is to remedy undue discrimination in the use of the interstate
transmission system and give the nation the benefits of a competitive bulk power
system. The proposal is subject to public comment for 75 days from its date of
publication in the federal register on August 1, 2002. Consumers is currently
studying the effects of the proposed rulemaking.
Wholesale Market Competition: In 1996, Detroit Edison gave Consumers its
four-year notice to terminate their joint operating agreements for the MEPCC.
Detroit Edison and Consumers restructured and continued certain parts of the
MEPCC control area and joint transmission operations, but expressly excluded any
merchant operations (electricity purchasing, sales, and dispatch operations). On
April 1, 2001, Detroit Edison and Consumers began separate merchant operations.
This opened Detroit Edison and Consumers to wholesale market competition as
individual companies. Consumers cannot predict the long-term financial impact of
terminating these joint merchant operations.
Wholesale Market Pricing: FERC authorizes Consumers to sell electricity at
wholesale market prices. In authorizing sales at market prices, the FERC
considers the seller's level of "market power" due to the seller's dominance of
generation resources and surplus generation resources in adjacent wholesale
markets. To continue its authorization to sell at market prices, Consumers filed
a traditional market dominance analysis and indicated its compliance there with.
In November 2001, the FERC issued an order modifying the traditional method of
determining market power, but later because of uncertainty about its impact on
electric reliability, issued a stay of the order. If the order's modified
market power test is not amended, Consumers cannot be certain it will receive
authorization to continue selling wholesale electricity at market-based prices.
The company may be limited to charging prices no greater than its cost-based
rates. A final decision is not expected for several months.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards for Consumers and other Michigan distribution utilities.
The proposal would establish standards related to restoration after an outage,
safety, and customer relations. Failure to meet the standards would result in
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Consumers Energy Company
customer bill credits. Consumers submitted comments to the MPSC. In December
2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards. Consumers will
continue to participate in this process. Consumers cannot predict the outcome of
the proposed standards or the likely effect, if any, on Consumers.
For further information and material changes relating to the rate matters and
restructuring of the electric utility industry, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, and Note 2, Uncertainties,
"Electric Rate Matters - Electric Restructuring" and "Electric Rate Matters -
Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) the need to make additional capital expenditures and
increase operating expenses for Clean Air Act compliance; 2) environmental
liabilities arising from various federal, state and local environmental laws and
regulations, including potential liability or expenses relating to the Michigan
Natural Resources and Environmental Protection Acts and Superfund; 3)
uncertainties relating to the storage and ultimate disposal of spent nuclear
fuel and the successful operation of the Palisades plant by NMC; 4) electric
industry restructuring issues, including those described above; 5) Consumers'
ability to meet peak electric demand requirements at a reasonable cost, without
market disruption, and successfully implement initiatives to reduce exposure
to purchased power price increases; 6) the recovery of electric restructuring
implementation costs; 7) Consumers new status as an electric transmission
customer and not as an electric transmission owner/operator; 8) sufficient
reserves for OATT rate refunds; and 9) the effects of derivative accounting
and potential earnings volatility. For further information about these trends
or uncertainties, see Note 2, Uncertainties.
GAS BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers anticipates gas deliveries,
including gas customer choice deliveries (excluding transportation to the MCV
Facility and off-system deliveries), to grow at an average of about one percent
per year based primarily on a steadily growing customer base. Actual gas
deliveries in future periods may be affected by abnormal weather, alternative
electric costs, changes in competitive and economic conditions, and the level of
natural gas consumption per customer.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Contemporaneously with this
filing, Consumers requested partial and immediate relief in the annual amount of
$33 million. In October 2001, Consumers revised its filing to reflect lower
operating costs and requested a $133 million annual distribution service rate
increase. In December 2001, the MPSC authorized a $15 million annual interim
increase in distribution service revenues under bond and subject to refund. In
February 2002, Consumers revised its filing to reflect lower estimated gas
inventory prices and revised depreciation expense and is now requesting an
annual $105 million distribution service rate increase. The MPSC staff supported
an annual increase of $30 million, with an 11 percent return on equity. The ALJ,
in the Proposal for Decision issued June 3 2002, recommended an annual rate
increase of $32 million, with a return on equity of 11 percent. See Note 2,
Uncertainties "Gas Rate Matters - Gas Rate Case" for further information.
UNBUNDLING STUDY: In July 2001, the MPSC directed gas utilities under its
jurisdiction to prepare and file an unbundled cost of service study. The purpose
of the study is to allow parties to advocate or oppose the unbundling of the
following services: metering, billing information, transmission, balancing,
storage, backup and peaking, and customer turn-on and turn-off services.
Unbundled services could be separately priced in the future and made subject to
competition by other providers. The subject is likely to remain the topic of
further study by the utilities in 2002 and further consideration by the MPSC.
Consumers cannot predict the outcome of unbundling costs on its financial
results and conditions.
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Consumers Energy Company
UNCERTAINTIES: Several gas business trends or uncertainties may affect
Consumers' financial results and conditions. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing gas operations. Such trends and
uncertainties include: 1) potential environmental costs at a number of sites,
including sites formerly housing manufactured gas plant facilities; 2) future
gas industry restructuring initiatives; 3) any initiatives undertaken to protect
customers against gas price increases; 4) an inadequate regulatory response to
applications for requested rate increases; 5) market and regulatory
responses to increases in gas costs, including a reduced average use per
residential customer; and 6) increased costs for pipeline safety and homeland
security initiatives that are not recoverable on a timely basis from customers.
For further information about these uncertainties, see Note 2, Uncertainties.
OTHER OUTLOOK
TERRORIST ATTACKS: Since the September 11, 2001 terrorists attack in the United
States, Consumers has increased security at all facilities and over its
infrastructure, and will continue to evaluate security on an ongoing basis.
Consumers may be required to comply with federal and state regulatory security
measures promulgated in the future. As a result, Consumers anticipates increased
operating costs for security that could be significant. Consumers would try to
recover these costs from customers.
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related services
to retail customers that focus on appliance maintenance, home safety, commodity
choice, and assistance to customers purchasing heating, ventilation and air
conditioning equipment. Consumers continues to look for additional growth
opportunities in providing energy-related services to its customers. The ability
to offer all or some of these services and other utility related
revenue-generating services, which provide approximately $50 million in annual
revenues, may be restricted by the new code of conduct issued by the MPSC, as
discussed above in Electric Business Outlook, "Competition and Regulatory
Restructuring - Code of Conduct."
PENSION AND OPEB COSTS: Consumers provides post retirement benefits under its
Pension Plan, and post retirement health and life benefits under its OPEB plan
to substantially all its employees. Pension and OPEB plan assets, net of
contributions, have been reduced in value from the previous year due to a
downturn in the equities market. As a result, Consumers expects to see an
increase in pension and OPEB expense levels over the next few years unless
market performance improves. Consumers anticipates pension expense and OPEB
expense to rise in 2002 by approximately $8 million and $20 million,
respectively, over 2001 expenses. For pension expense, this increase is due to
a downturn in value of pension assets during the past two years, forecasted
increases in pay and added service, decline in the interest rate used to value
the liability of the plan, and expiration of the transition gain amortization.
For OPEB expense, the increase is due to the trend of rising health care costs,
the market return on plan assets being below expected levels, and a lower
discount rate, based on recent economic conditions, used to compute the benefit
obligation. Health care cost decreases gradually under the assumptions used in
the OPEB plan from current levels through 2009; however, Consumers cannot
predict the impact that interest rates or market returns will have on pension
and OPEB expense in the future.
The recent significant downturn in the equities markets has affected the value
of the Pension Plan assets. If the Plan's Accumulated Benefit Obligation exceeds
the value of these assets at December 31, 2002, Consumers will be required to
recognize an additional minimum liability for this excess in accordance with
SFAS No. 87. Consumers cannot predict the future Fair value of the Plan's assets
but it is possible, without significant recovery of the Plan's assets, that
Consumers will need to book an additional minimum liability through a charge to
other comprehensive income. The Accumulated Benefit Obligation is determined
by the Plan's Actuary in the Fourth Quarter of each year.
In January 2002, Consumers contributed $62 million to the Pension Plan. This
amount was for $47 million of pension related benefits and $15 million of post
retirement health care and life insurance benefits. In June 2002, Consumers
made an additional contribution, in the amount of $21 million, for post
retirement health care and life insurance benefits.
In order to keep health care benefits and costs competitive, Consumers announced
several changes to the Health Care Plan. These changes are effective January 1,
2003. The most significant change is that Consumers' future increases in health
care costs will be shared with employees.
Consumers also provides retirement benefits under a defined contribution 401(k)
plan. Consumers currently offers an employer's contribution match of 50 percent
of the employee's contribution up to six percent (three percent
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Consumers Energy Company
maximum), as well as an incentive match in years when Consumers financial
performance exceeds expectations. Effective September 1, 2002, the employer's
match will be suspended until January 1, 2005, and the incentive match will be
eliminated permanently. Amounts charged to expense for the employer's match and
incentive match during 2001 were $20 million and $8 million, respectively.
OTHER MATTERS
NEW ACCOUNTING STANDARDS
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning January 1,
2003, companies must comply with SFAS No. 143. The standard requires companies
to record the fair value of the legal obligations related to an asset retirement
in the period in which it is incurred. When the liability is initially recorded,
the company would capitalize an offsetting amount 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
related asset's useful life. Consumers is currently studying the new standard
but has yet to quantify the effects of adoption on its financial statements.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB in April 2002,
this standard rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring after May 15, 2002. Finally,
SFAS No. 145 amends other existing authoritative pronouncements to make various
technical corrections and rescinds SFAS No. 44, Accounting for Intangible Assets
of Motor Carriers. These provisions are effective for financial statements
issued on or after May 15, 2002. Consumers is currently studying the effects of
the new standard, but has yet to quantify the effects of adoption on its
financial statements.
SFAS NO. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES:
Issued by the FASB in July 2002, this standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. This standard is
effective for exit or disposal activities initiated after December 31, 2002.
Consumers believes there will be no impact on its financial statements upon
adoption of the standard.
DERIVATIVES AND HEDGES
MARKET RISK INFORMATION: Consumers is exposed to market risks including, but not
limited to, changes in interest rates, commodity prices, and equity security
prices. Consumers' market risk, and activities designed to minimize this risk,
are subject to the direction of an executive oversight committee consisting of
designated members of senior management and a risk committee, consisting of
business unit managers. The risk committee's role is to review the corporate
commodity position and ensure that net corporate exposures are within the
economic risk tolerance levels established by Consumers' Board of Directors.
Established policies and procedures are used to manage the risks associated with
market fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
Consumers enters into all risk management contracts for purposes other than
trading.
Contracts entered into to manage interest rate and commodity price risk may be
considered derivative
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Consumers Energy Company
instruments that are subject to derivative and hedge accounting pursuant to SFAS
No. 133. For derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings.
Derivative instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. Consumers minimizes such risk by performing financial credit reviews
using, among other things, publicly available credit ratings of such
counterparties.
In accordance with SEC disclosure requirements, Consumers performs sensitivity
analyses to assess the potential loss in fair value, cash flows and earnings
based upon a hypothetical 10 percent adverse change in market rates or prices.
Consumers determines fair value based upon mathematical models using current and
historical pricing data. Management does not believe that sensitivity analyses
alone provide an accurate or reliable method for monitoring and controlling
risks. Therefore, Consumers relies on the experience and judgment of its senior
management to revise strategies and adjust positions, as it deems necessary.
Losses in excess of the amounts determined in sensitivity analyses could occur
if market rates or prices exceed the ten percent shift used for the analyses.
INTEREST RATE RISK: Consumers is exposed to interest rate risk resulting from
the issuance of fixed-rate debt and variable-rate debt, and from interest rate
swap and rate lock agreements. Consumers uses a combination of these instruments
to manage and mitigate interest rate risk exposure when it deems it appropriate,
based upon market conditions. These strategies attempt to provide and maintain
the lowest cost of capital. As of June 30, 2002 and 2001, Consumers had
outstanding $935 million and $995 million of variable-rate debt, respectively.
At June 30, 2002 and 2001, assuming a hypothetical 10 percent adverse change in
market interest rates, Consumers' before tax earnings exposure on its
variable rate debt would be $2 million and $4 million, respectively. As of June
30 2002 and 2001, Consumers had entered into floating-to-fixed interest rate
swap agreements for a notional amount of $75 million and $225 million,
respectively. These swaps exchange variable-rate interest payment obligations
for fixed-rate interest payment obligations in order to minimize the impact of
potential adverse interest rate changes. As of June 30, 2002 and 2001, Consumers
had outstanding long-term fixed-rate debt, including fixed-rate swaps, of $2.652
billion and $2.283 billion, respectively, with a fair value of $2.603 billion
and $2.456 billion, respectively. As of June 30, 2002 and 2001, assuming a
hypothetical 10 percent adverse change in market rates, Consumers would have an
exposure of $137 million and $124 million to the fair value of these
instruments, respectively, if it had to refinance all of its long-term
fixed-rate debt. Consumers does not intend to refinance its fixed-rate debt in
the near term and believes that any adverse change in debt price and interest
rates would not have a material effect on either its consolidated financial
position, results of operation or cash flows.
COMMODITY MARKET RISK: Consumers enters into electric call options, gas fuel for
generation call options and swap contracts, and gas supply contracts containing
embedded put options for purposes other than trading. The electric call options
are used to protect against risk due to fluctuations in the market price of
electricity and to ensure a reliable source of capacity to meet customers'
electric needs. The gas fuel for generation call options and swap contracts are
used to protect generation activities against risk due to fluctuations in the
market price of natural gas. The gas supply contracts containing embedded put
options are used to purchase reasonably priced gas supply.
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Consumers Energy Company
As of June 30, 2002 and 2001, the fair value based on quoted future market
prices of electricity-related call option and swap contracts was $13 million and
$33 million, respectively. At June 30, 2002 and 2001, assuming a hypothetical 10
percent adverse change in market prices, the potential reduction in fair value
associated with these contracts would be $3 million and $6 million,
respectively. As of June 30, 2002 and 2001, Consumers had an asset of $35
million and $122 million, respectively, related to premiums incurred for
electric call option contracts. Consumers' maximum exposure associated with the
call option contracts is limited to the premiums incurred. As of June 30, 2002,
the fair value based on quoted future market prices of gas supply contracts
containing embedded put options was $2 million. At June 30, 2002, assuming a
hypothetical 10 percent adverse change in market prices, the potential reduction
in fair value associated with these contracts would be $1 million.
EQUITY SECURITY PRICE RISK: Consumers has a less than 20 percent equity
investment in CMS Energy. At June 30, 2002 and 2001, a hypothetical 10 percent
adverse change in market price would have resulted in a $5 million and $10
million change in its equity investment, respectively. This instrument is
currently marked-to-market through equity. Consumers believes that such an
adverse change would not have a material effect on its consolidated financial
position, results of operation or cash flows.
For further information on market risk and derivative activities, see Note 1,
Corporate Structure and Summary of Significant Accounting Policies, "Risk
Management Activities and Derivative Transactions" and "Implementation of New
Accounting Standards", Note 2, Uncertainties, "Other Electric Uncertainties -
Derivative Activities", "Other Gas Uncertainties - Derivative Activities", and
Note 3, Short-Term Financings and Capitalization, "Derivative Activities."
CHANGE IN AUDITORS
On April 22, 2002, the Board of Directors of Consumers, upon the recommendation
of the Audit Committee of the Board, voted to discontinue using Arthur Andersen
to audit the Consumers' financial statements for the year ending December 31,
2002. Consumers previously retained Arthur Andersen to review its financial
statements for the quarter ended March 31, 2002. On May 23, 2002, Consumers'
Board of Directors engaged Ernst & Young to audit its financial statements for
the year ending December 31, 2002. Ernst & Young has hired some of Arthur
Andersen's Detroit office employees, including some of the former auditors from
the Consumers' audit engagement team.
As a result of certain financial reporting issues surrounding "round trip"
trading transactions at CMS MST, Arthur Andersen notified CMS Energy that Arthur
Andersen's historical opinions on CMS Energy's financial statements for the
fiscal years ended December 31, 2001 and December 31, 2000 cannot be relied
upon. Arthur Andersen clarified in its notification to CMS Energy that its
decision does not apply to separate, audited financial statements of Consumers
for the applicable years. Arthur Andersen's reports on Consumers' consolidated
financial statements for each of the fiscal years ended December 31, 2001 and
December 31, 2000 contained no adverse or disclaimer of opinion. Nor were the
reports qualified or modified regarding uncertainty, audit scope or accounting
principles.
During the fiscal years ended December 31, 2001 and December 31, 2000, and
through the date of their opinion for the quarter ended March 31, 2002,
Consumers and Arthur Andersen did not disagree on any matter of accounting
principle or practice, financial statement disclosure, or auditing scope or
procedure. If Arthur Andersen and Consumers had disagreed on these matters and
they were not resolved to Arthur Andersen's satisfaction, Arthur Andersen would
have noted this in its report on Consumers' consolidated financial statements.
During Consumers' two most recent fiscal years ended December 31, 2000 and
December 31, 2001 and the subsequent interim period through June 10, 2002,
Consumers did not consult with Ernst and Young regarding any matter or event
identified by SEC laws and regulations. However, as a result of the "round trip"
trading transactions, Ernst & Young is in the process of re-auditing CMS
Energy's consolidated financial statements for each of the fiscal years ended
December 31, 2001 and December 31, 2000, which includes audit work at Consumers
for these years. None of Consumers' former auditors now employed by Ernst &
Young are involved in the re-audit of CMS Energy's consolidated financial
statements.
CEO AND CFO CERTIFICATIONS
The Sarbanes-Oxley Act of 2002 requires CEOs and CFOs of public companies to
make certain certifications relating to the financial statements included in
public filings. Consumers has not filed the certification required by the
Sarbanes-Oxley Act of 2002 relating to the financial statements included in this
Form 10-Q for the period ended June 30, 2002 because the 2000 and 2001 financial
statements of CMS Energy, the parent of Consumers, need to be restated and
re-audited.
The restatement and re-audit are primarily the result of reported revenues and
expenses for "round trip" trades and related balance sheet adjustments. The
restatement cannot be completed until a special investigative committee of CMS
Energy's Board of Directors completes its investigation of "round trip" trading
and related issues and CMS Energy's newly appointed independent public
accountants, Ernst & Young LLP completes a re-audit of CMS Energy's 2000 and
2001 financial statements and their reviews of the current quarterly and
semi-annual statements for these years. Therefore, Consumers' CEO and CFO are
not be able to make the statements required by the Sarbanes-Oxley Act of 2002
with respect to this Form 10-Q for the period ended June 30, 2002.
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Consumers Energy Company
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Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 30 2002 2001 2002 2001
------- ------- ------- -------
In Millions
OPERATING REVENUE
Electric $ 631 $ 624 $ 1,240 $ 1,289
Gas 252 239 868 779
Other 44 10 55 24
------- ------- ------- -------
927 873 2,163 2,092
------- ------- ------- -------
OPERATING EXPENSES
Operation
Fuel for electric generation 71 77 138 148
Purchased power - related parties 133 126 273 244
Purchased and interchange power 72 102 133 214
Cost of gas sold 113 112 508 430
Cost of gas sold - related parties 31 29 62 60
Other 165 159 305 300
------- ------- ------- -------
585 605 1,419 1,396
Maintenance 48 50 98 106
Depreciation, depletion and amortization 71 67 179 171
General taxes 44 43 101 98
------- ------- ------- -------
748 765 1,797 1,771
------- ------- ------- -------
PRETAX OPERATING INCOME (LOSS)
Electric 116 83 231 218
Gas 20 17 83 82
Other 43 8 52 21
------- ------- ------- -------
179 108 366 321
------- ------- ------- -------
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates 1 2 2 4
Accretion expense (2) (2) (5) (4)
Other, net 37 1 37 2
------- ------- ------- -------
36 1 34 2
------- ------- ------- -------
INTEREST CHARGES
Interest on long-term debt 37 37 70 76
Other interest 2 12 11 20
Capitalized interest (3) (2) (5) (4)
------- ------- ------- -------
36 47 76 92
------- ------- ------- -------
NET INCOME BEFORE INCOME TAXES 179 62 324 231
INCOME TAXES 55 19 108 81
------- ------- ------- -------
NET INCOME 124 43 216 150
PREFERRED STOCK DIVIDENDS -- -- 1 1
PREFERRED SECURITIES DISTRIBUTIONS 11 10 22 18
------- ------- ------- -------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 113 $ 33 $ 193 $ 131
======= ======= ======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-20
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
------------------
JUNE 30 2002 2001
----- -----
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 216 $ 150
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $3 and $3, respectively) 179 171
Gain on sale of METC and reactor head (38) --
Deferred income taxes and investment tax credit 13 29
Capital lease and other amortization 8 14
Undistributed earnings of related parties (53) (23)
Changes in assets and liabilities
Decrease (increase) in inventories 128 (95)
Decrease (increase) in accounts receivable and accrued revenue 61 200
Increase (decrease) in accounts payable (64) 24
Regulatory obligation - gas customer choice (6) (16)
Changes in other assets and liabilities (8) (75)
----- -----
Net cash provided by operating activities 436 379
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (273) (345)
Cost to retire property, net (31) (55)
Investment in Electric Restructuring Implementation Plan (5) (6)
Investments in nuclear decommissioning trust funds (3) (3)
Proceeds from nuclear decommissioning trust funds 12 14
Proceeds from sale of METC and reactor head 293 --
----- -----
Net cash used in investing activities (7) (395)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Retirement of bonds and other long-term debt (372) (1)
Increase (decrease) in notes payable, net (161) 17
Payment of common stock dividends (154) (96)
Redemption of preferred securities (30) --
Preferred securities distributions (22) (18)
Payment of capital lease obligations (7) (13)
Payment of preferred stock dividends (1) (1)
Proceeds from preferred securities -- 121
Proceeds from CMS cash infusion 50 --
Proceeds from senior notes and bank loans 304 --
----- -----
Net cash used in financing activities (393) 9
----- -----
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS 36 (7)
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 16 21
----- -----
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 52 $ 14
===== =====
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 31 $ 76
Income taxes paid (net of refunds) 22 36
Pension and OPEB cash contribution 83 72
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ -- $ 12
Other assets placed under capital leases 48 10
===== =====
All highly liquid investments with an original maturity of three months or less
are considered cash equivalents.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-21
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
ASSETS JUNE 30 JUNE 30
2002 DECEMBER 31 2001
(UNAUDITED) 2001 (UNAUDITED)
----------- ----------- -----------
In Millions
PLANT (AT ORIGINAL COST)
Electric $ 7,396 $ 7,661 $ 7,482
Gas 2,651 2,593 2,539
Other 54 23 17
------- ------- -------
10,101 10,277 10,038
Less accumulated depreciation, depletion and amortization 5,822 5,934 5,847
------- ------- -------
4,279 4,343 4,191
Construction work-in-progress 443 464 344
------- ------- -------
4,722 4,807 4,535
------- ------- -------
INVESTMENTS
Stock of affiliates 28 59 76
First Midland Limited Partnership 261 253 253
Midland Cogeneration Venture Limited Partnership 359 300 295
------- ------- -------
648 612 624
------- ------- -------
CURRENT ASSETS
Cash and temporary cash investments at cost,
which approximates market 52 16 14
Accounts receivable and accrued revenue, less allowances
of $4, $4 and $3, respectively 76 125 74
Accounts receivable - related parties 14 17 63
Inventories at average cost
Gas in underground storage 431 569 359
Materials and supplies 67 69 71
Generating plant fuel stock 57 52 48
Prepaid property taxes 99 144 101
Regulatory assets 19 19 19
Other 9 14 5
------- ------- -------
824 1,025 754
------- ------- -------
NON-CURRENT ASSETS
Regulatory assets
Securitization costs 709 717 710
Postretirement benefits 197 209 220
Abandoned Midland Project 11 12 12
Other 173 167 91
Nuclear decommissioning trust funds 555 581 594
Other 149 176 315
------- ------- -------
1,794 1,862 1,942
------- ------- -------
TOTAL ASSETS $ 7,988 $ 8,306 $ 7,855
======= ======= =======
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Consumers Energy Company
STOCKHOLDERS' INVESTMENT AND LIABILITIES JUNE 30 JUNE 30
2002 DECEMBER 31 2001
(UNAUDITED) 2001 (UNAUDITED)
----------- ----------- -----------
In Millions
CAPITALIZATION
Common stockholder's equity
Common stock $ 841 $ 841 $ 841
Paid-in capital 682 632 646
Revaluation capital (5) 4 16
Retained earnings since December 31, 1992 412 373 541
------- ------- -------
1,930 1,850 2,044
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred securities
of subsidiaries(a) 490 520 520
Long-term debt 2,441 2,472 2,098
Non-current portion of capital leases 95 56 51
------- ------- -------
5,000 4,942 4,757
------- ------- -------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 225 257 251
Notes payable 255 416 328
Notes payable- CMS Energy -- -- 92
Accounts payable 218 291 274
Accrued taxes 214 219 179
Accounts payable - related parties 86 80 71
Deferred income taxes 18 12 20
Other 263 260 263
------- ------- -------
1,279 1,535 1,478
------- ------- -------
NON-CURRENT LIABILITIES
Deferred income taxes 719 747 704
Postretirement benefits 233 279 307
Regulatory liabilities for income taxes, net 276 276 264
Power purchase agreement - MCV Partnership 160 169 50
Deferred investment tax credit 94 102 106
Other 227 256 189
------- ------- -------
1,709 1,829 1,620
------- ------- -------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 7,988 $ 8,306 $ 7,855
======= ======= =======
(a) See Note 3, Short-Term Financings and Capitalization
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE BALANCE SHEETS.
CE-23
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 30 2002 2001 2002 2001
------- ------- ------- -------
In Millions
COMMON STOCK
At beginning and end of period(a) $ 841 $ 841 $ 841 $ 841
------- ------- ------- -------
OTHER PAID-IN CAPITAL
At beginning and end of period 782 646 632 646
Stockholder's contribution -- -- 150 --
Return of Stockholder's contribution (100) -- (100) --
------- ------- ------- -------
At end of Period 682 646 682 646
------- ------- ------- -------
REVALUATION CAPITAL
Investments
At beginning of period 16 28 16 33
Unrealized gain (loss) on investments(b) (18) (2) (18) (7)
------- ------- ------- -------
At end of period (2) 26 (2) 26
Derivative Instruments
At beginning of period(c) (4) 1 (12) 21
Unrealized gain (loss) on derivative instruments(b) -- (11) 5 (24)
Reclassification adjustments included in net income(b) 1 -- 4 (7)
------- ------- ------- -------
At end of period (3) (10) (3) (10)
------- ------- ------- -------
RETAINED EARNINGS
At beginning of period 399 538 373 506
Net income 124 43 216 150
Cash dividends declared - Common Stock (100) (30) (154) (96)
Cash dividends declared - Preferred Stock -- -- (1) (1)
Preferred securities distributions (11) (10) (22) (18)
------- ------- ------- -------
At end of period 412 541 412 541
------- ------- ------- -------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 1,930 $ 2,044 $ 1,930 $ 2,044
======= ======= ======= =======
(a) Number of shares of common stock outstanding
was 84,108,789 for all periods presented
(b) Disclosure of Comprehensive Income:
Revaluation capital
Investments
Unrealized gain (loss) on investments, net of tax of
$10, $1, $10 and $4, respectively $ (18) $ (2) $ (18) $ (7)
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $-, $6 , $3 and $13, respectively -- (11) 5 (24)
Reclassification adjustments included in net income,
net of tax of $1, $-, $2 and $4 , respectively 1 -- 4 (7)
Net income 124 43 216 150
------- ------- ------- -------
Total Comprehensive Income $ 107 $ 30 $ 207 $ 112
======= ======= ======= =======
(c) Six Months Ended 2001 is the cumulative effect of change in accounting
principle, net of $(11) tax (Note 1)
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-24
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have not been reviewed by our
independent public accountants as required under Rule 10-01(d) of Regulation
S-X. Consumers expects that this review will occur upon completion of the
re-audit of the restated CMS Energy Consolidated Financial Statements for each
of the fiscal years ended December 31, 2001 and December 31, 2000.
These interim Consolidated Financial Statements have been prepared by Consumers
in accordance with SEC rules and regulations. As such, certain information and
footnote disclosures normally included in full year financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted. Certain prior year amounts have
been reclassified to conform to the presentation in the current year. In
management's opinion, the unaudited information contained in this report
reflects all adjustments necessary to assure the fair presentation of financial
position, results of operations and cash flows for the periods presented. The
Condensed Notes to Consolidated Financial Statements and the related
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
contained in the Consumers Form 10-K for the year ended December 31, 2001. Due
to the seasonal nature of Consumers operations, the results as presented for
this interim period are not necessarily indicative of results to be achieved for
the fiscal year.
1: CORPORATE STRUCTURE AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company,
is an electric and gas utility company that provides service to customers in
Michigan's Lower Peninsula. Consumers' customer base includes a mix of
residential, commercial and diversified industrial customers, the largest
segment of which is the automotive industry.
BASIS OF PRESENTATION: The consolidated financial statements include Consumers
and its wholly owned subsidiaries. Consumers prepared the financial statements
in conformity with accounting principles generally accepted in the United States
that include the use of management's estimates. Consumers uses the equity method
of accounting for investments in its companies and partnerships where it has
more than a twenty percent but less than a majority ownership interest and
includes these results in operating income.
REPORTABLE SEGMENTS: Consumers has two reportable segments: electric and gas.
The electric segment consists of activities associated with the generation
and distribution of electricity. The gas segment consists of activities
associated with the transportation, storage and distribution of natural gas.
Consumers' reportable segments are domestic strategic business units organized
and managed by the nature of the product and service each provides. The
accounting policies of the segments are the same as those described in
Consumers' 2001 Form 10-K. Consumers' management has changed its evaluation
of the performance of the electric and gas segments from pretax operating income
to net income available to common stockholder. The Consolidated Statements of
Income show operating revenue and pretax operating income by reportable segment.
Intersegment sales and transfers are accounted for at current market prices and
are eliminated in consolidated net income available to common stockholder by
segment. The net income available to common stockholder by reportable segment
is as follows:
CE-25
Consumers Energy Company
In Millions
Six Months Ended
--------------------
June 30 2002 2001
- ------- ---- ----
Net income available to common stockholder
Electric $133 $ 93
Gas 32 29
Other 28 9
---- ----
Total Consolidated $193 $131
==== ====
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
SFAS No. 71. As a result, the actions of regulators affect when Consumers
recognizes revenues, expenses, assets and liabilities.
In March 1999, Consumers received MPSC electric restructuring orders and, as a
result, discontinued application of SFAS No. 71 for the electric supply portion
of its business. Discontinuation of SFAS No. 71 for the electric supply portion
of Consumers' business resulted in Consumers reducing the carrying value of its
Palisades plant-related assets by approximately $535 million and establishing a
regulatory asset for a corresponding amount. According to current accounting
standards, Consumers can continue to carry its electric supply-related
regulatory assets if legislation or an MPSC rate order allows the collection of
cash flows to recover these regulatory assets from its regulated transmission
and distribution customers. As of June 30, 2002, Consumers had a net investment
in electric supply facilities of $1.413 billion included in electric plant and
property. See Note 2, Uncertainties, "Electric Rate Matters - Electric
Restructuring."
RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS: Consumers is exposed to
market risks including, but not limited to, changes in interest rates, commodity
prices, and equity security prices. Consumers' market risk, and activities
designed to minimize this risk, are subject to the direction of an executive
oversight committee consisting of designated members of senior management and a
risk committee, consisting of business unit managers. The risk committee's role
is to review the corporate commodity position and ensure that net corporate
exposures are within the economic risk tolerance levels established by
Consumers' Board of Directors. Established policies and procedures are used to
manage the risks associated with market fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
Consumers enters into all risk management contracts for purposes other than
trading. Contracts to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133.
For further discussion see "Implementation of New Accounting Standards" below,
Note 2, Uncertainties, "Other Electric Uncertainties - Derivative Activities",
"Other Gas Uncertainties - Derivative Activities" and Note 3, Short-Term
Financings and Capitalization, "Derivative Activities."
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS: Consumers adopted SFAS No. 133 on
January 1, 2001. This standard requires Consumers to recognize at fair value
all contracts that meet the definition of a derivative instrument on the balance
sheet as either assets or liabilities. The standard also requires Consumers to
record all changes in fair value directly in earnings, or other comprehensive
income if the derivative meets certain qualifying hedge criteria. Consumers
determines fair value based upon quoted market prices and mathematical models
using current and historical pricing data. Any ineffective portion of all hedges
is recognized in earnings.
CE-26
Consumers Energy Company
Consumers believes that the majority of its contracts are not subject to
derivative accounting because they qualify for the normal purchases and sales
exception of SFAS No. 133. Derivative accounting is required, however, for
certain contracts used to limit Consumers' exposure to electricity and gas
commodity price risk and interest rate risk.
Consumers believes that its electric capacity and energy contracts do not
qualify as derivatives due to the lack of an active energy market in the state
of Michigan and the transportation cost to deliver the power under the contracts
to the closest active energy market at the Cinergy hub in Ohio. If a market
develops in the future, Consumers may be required to account for these
contracts as derivatives. The mark to market impact in earnings related to
these contracts, particularly related to the purchase power agreement with the
MCV, could be material to the financial statements.
On January 1, 2001, upon initial adoption of the standard, Consumers recorded a
$21 million, net of tax, ($32 million, pretax) cumulative effect adjustment as
an unrealized gain increasing accumulated other comprehensive income. Based on
the pretax initial transition adjustment of $32 million recorded in accumulated
other comprehensive income on January 1, 2001, Consumers reclassified to
earnings $12 million as a reduction to the cost of gas; $1 million as a
reduction to the cost of power supply; $2 million as an increase in interest
expense; and $8 million as an increase in other revenue for the twelve months
ended December 31, 2001. The difference between the initial transition
adjustment and the amounts reclassified to earnings represents an unrealized
loss in the fair value of the derivative instruments since January 1, 2001,
decreasing other comprehensive income. As of December 31, 2001, there were no
amounts remaining in accumulated other comprehensive income related to the
initial transition adjustment.
On January 1, 2001, upon initial adoption of SFAS No. 133, derivative and hedge
accounting for certain utility industry contracts, particularly electric call
option contracts and option-like contracts, and contracts subject to Bookouts
was uncertain. Consumers did not record these contracts on the balance sheet at
fair value, but instead accounted for these types of contracts as derivatives
that qualified for the normal purchase exception of SFAS No. 133. In June and
December 2001, the FASB issued guidance that resolved the accounting for these
contracts. As a result, on July 1, 2001, Consumers recorded a $3 million, net of
tax, cumulative effect adjustment as an unrealized loss, decreasing accumulated
other comprehensive income, and on December 31, 2001, recorded an $11 million,
net of tax, cumulative effect adjustment, as a decrease to earnings. These
adjustments relate to the difference between the fair value and the recorded
book value of electric call option contracts.
As of June 30, 2002, Consumers recorded a total of $1 million, net of tax, as an
unrealized gain in other comprehensive income related to its proportionate share
of the effects of derivative accounting related to its equity investment in the
MCV Partnership. Consumers expects to reclassify this gain, if this value
remains, as an increase to other operating revenue during the next 12 months.
DERIVATIVE IMPLEMENTATION GROUP ISSUES: In December 2001, the FASB issued final
guidance for DIG Statement No. C16, which was effective April 1, 2002. Consumers
has completed its study of DIG Statement No. C16, and has determined that this
issue will not affect the accounting for its fuel supply contracts.
For further discussion of derivative activities, see Note 2, Uncertainties,
"Other Electric Uncertainties - Derivative Activities" and "Other Gas
Uncertainties - Derivative Activities" and Note 3, Short-Term Financings and
Capitalization, "Derivative Activities."
SFAS NO. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS:
This new standard was issued by the FASB in October 2001, and supersedes SFAS
No. 121, and APB Opinion No. 30. SFAS No. 144 requires long-lived assets to be
measured at the lower of either the carrying amount or of the fair value less
the cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS No. 144 also broadens the reporting of discontinued operations to
include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. The adoption of SFAS No.
144, effective January 1, 2002, will result in Consumers accounting for any
future impairment or disposal
CE-27
Consumers Energy Company
of long-lived assets under the provisions of SFAS No. 144, but has not changed
the accounting used for previous asset impairments or disposals.
ACCOUNTING FOR HEADQUARTERS BUILDING LEASE: In April 2001, Consumers Campus
Holdings entered into a lease agreement for the construction of an office
building to be used as the main headquarters for Consumers in Jackson, Michigan.
Consumers' current headquarters building lease expires in June 2003. The new
office building lessor has committed to fund up to $70 million for construction
of the building, which is due to be completed during March 2003. Consumers is
acting as the construction agent of the lessor for this project. During
construction, the lessor has a maximum recourse of 89.9 percent against
Consumers in the event of certain defaults which consumers believes are
unlikely. For several events of default, primarily bankruptcy or intentional
misapplication of funds, there could be full recourse for the amounts expended
by the lessor at that time. The agreement also includes a common change in
control provision, which could trigger full payment of construction costs by
Consumers. As a result of this provision, Consumers elected to classify this
lease as a capital lease effective for the second quarter of 2002. This
classification represents the total obligation of Consumers under this
agreement. As such, Consumers' balance sheet reflects a capital lease asset and
an offsetting non-current liability equivalent to as of June 30, 2002, the
cost of construction at that date of $33 million.
2: UNCERTAINTIES
ELECTRIC CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental regulations. Consumers expects that the cost of future
environmental compliance, especially compliance with clean air laws, will be
significant.
Clean Air - In 1997, the EPA introduced new regulations regarding the standard
for ozone and particulate-related emissions that were the subject of litigation.
The United States Supreme Court determined that the EPA has the power to revise
the standards but that the EPA implementation plan was not lawful. In 1998, the
EPA Administrator issued final regulations requiring the state of Michigan to
further limit nitrogen oxide emissions. The EPA has also issued additional final
regulations regarding nitrogen oxide emissions that require certain generators,
including some of Consumers' electric generating facilities, to achieve the same
emissions rate as that required by the 1998 plan if the state does not comply
with the 1998 regulations. The Michigan Department of Environmental Quality is
in the process of finalizing rules to comply with this plan. Rules are expected
to be promulgated and submitted to EPA by late summer or early fall 2002. These
regulations will require Consumers to make significant capital expenditures
estimated to be $680 million, calculated in year 2002 dollars. Cost estimates
have been developed, in part, by independent contractors with expertise in this
field. The estimates are dependent on regulatory outcome, market forces
associated with emission reduction, and with regional and national economic
conditions. As of June 2002, Consumers has incurred $344 million in capital
expenditures to comply with these regulations and anticipates that the remaining
capital expenditures will be incurred between 2002 and 2006. At some point after
2006, if new environmental standards for multi-pollutants become effective,
Consumers may need additional capital expenditures to comply with the standards.
Consumers is unable to estimate the additional capital expenditures required
until the proposed standards are further defined. Based on existing legislation,
beginning January 2004, an annual return of and on these types of capital
expenditures, to the extent they are above depreciation levels, is expected to
be recoverable, subject to an MPSC prudency hearing, in future rates.
These and other required environmental expenditures, if not recovered in
Consumers rates, may have a material adverse effect upon Consumers' financial
condition and results of operations.
Cleanup and Solid Waste - Under the Michigan Natural Resources and Environmental
Protection Act,
CE-28
Consumers Energy Company
Consumers expects that it will ultimately incur investigation and remedial
action costs at a number of sites. Consumers believes that these costs will be
recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $1 million and $9 million. As of June
30, 2002, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
In October 1998, during routine maintenance activities, Consumers identified PCB
as a component in certain paint, grout and sealant materials at the Ludington
Pumped Storage facility. Consumers removed and replaced part of the PCB
material. In April 2000, Consumers proposed a plan to deal with the remaining
materials and is awaiting a response from the EPA.
ELECTRIC RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan Legislature passed electric
utility restructuring legislation known as the Customer Choice Act. This act: 1)
permits all customers to choose their electric generation supplier beginning
January 1, 2002; 2) cuts residential electric rates by five percent; 3) freezes
all electric rates through December 31, 2003, and establishes a rate cap for
residential customers through at least December 31, 2005, and a rate cap for
small commercial and industrial customers through at least December 31, 2004; 4)
allows for the use of low-cost Securitization bonds to refinance qualified
costs, as defined by the act, as a means of offsetting the earnings impact of
the five percent residential rate reduction; 5) establishes a market power
supply test that may require transferring control of generation resources in
excess of that required to serve firm retail sales requirements (a requirement
Consumers believes itself to be in compliance with at this time); 6) requires
Michigan utilities to join a FERC-approved RTO or divest their interest in
transmission facilities to an independent transmission owner; 7) requires
Consumers, Detroit Edison and American Electric Power to jointly expand their
available transmission capability by at least 2,000 MW; 8) allows deferred
recovery of an annual return of and on capital expenditures in excess of
depreciation levels incurred during and before the rate cap period; and 9)
allows recovery of "net" Stranded Costs and implementation costs incurred as a
result of the passage of the act. On July 23, 2002 Consumers received an order
approving the plan to achieve the increased transmission capacity from the MPSC.
Once the increased transmission capacity projects identified in the plan are
completed, verification of completion must be sent to the MPSC. At this point,
Consumers is deemed to be in compliance with the MPSC statute. Consumers is
highly confident that it will meet the conditions of items 5 and 7 above, prior
to the earliest rate cap termination dates specified in the act. Failure to do
so could result in an extension of the rate caps to as late as December 31,
2013.
In 1998, Consumers submitted a plan for electric retail open access to the MPSC.
In March 1999, the MPSC issued orders generally supporting the plan. The
Customer Choice Act states that the MPSC orders issued before June 2000 are in
compliance with this act and enforceable by the MPSC. Those MPSC orders: 1)
allow electric customers to choose their supplier; 2) authorize recovery of
"net" Stranded Costs and implementation costs; and 3) confirm any voluntary
commitments of electric utilities. In September 2000, as required by the MPSC,
Consumers once again filed tariffs governing its retail open access program and
made revisions to comply with the Customer Choice Act. In December 2001, the
MPSC approved revised retail open access service tariffs. The revised tariffs
establish the rates, terms, and conditions under which retail customers will be
permitted to choose an alternative electric supplier. The tariffs, effective
January 1, 2002, did not require significant modifications in the existing
retail open access program. The tariff terms allow retail open access customers,
upon thirty days notice to Consumers, to return to Consumers' generation service
at current tariff rates. However, Consumers may not have sufficient, reasonably
priced, capacity to meet the additional demand of returning retail open access
customers, and may be forced to purchase electricity on the spot market at
higher prices than it could recover from its customers.
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SECURITIZATION: In October 2000 and January 2001, the MPSC issued orders
authorizing Consumers to issue Securitization bonds. Securitization typically
involves issuing asset-backed bonds with a higher credit rating than
conventional utility corporate financing. The orders authorized Consumers to
securitize approximately $469 million in qualified costs, which were primarily
regulatory assets plus recovery of the Securitization expenses. Securitization
results in lower interest costs and a longer amortization period for the
securitized assets, which would offset the majority of the impact of the
required residential rate reduction (approximately $22 million in 2000 and $49
million annually thereafter). The orders direct Consumers to apply any cost
savings in excess of the five percent residential rate reduction to rate
reductions for non-residential customers and reductions in Stranded Costs for
retail open access customers after the bonds are sold. Excess savings are
currently estimated to be approximately $12 million annually.
In November 2001, Consumers Funding LLC, a special purpose consolidated
subsidiary of Consumers formed to issue the bonds, issued $469 million of
Securitization bonds, Series 2001-1. The Securitization bonds mature at
different times over a period of up to 14 years, with an average interest rate
of 5.3 percent. The last expected maturity date is October 20, 2015. Net
proceeds from the sale of the Securitization bonds, after issuance expenses,
were approximately $460 million. Consumers used the net proceeds to buy back
$164 million of its common stock from its parent, CMS Energy. From December 2001
through March 2002, the remainder of these proceeds were used to pay down
Consumers long-term debt. CMS Energy used the $164 million from Consumers to pay
down its own short-term debt.
Consumers and Consumers Funding LLC will recover the repayment of principal,
interest and other expenses relating to the bond issuance through a
securitization charge and a tax charge that began in December 2001. These
charges are subject to an annual true-up until one year prior to the last
expected bond maturity date, and no more than quarterly thereafter. Current
electric rate design covers these charges, and there will be no rate impact for
most Consumers electric customers until the Customer Choice Act rate freeze
expires. Securitization charges are remitted to a trustee for the Securitization
bonds and are not available to Consumers' creditors.
Regulatory assets are normally amortized over their period of regulated
recovery. Beginning January 1, 2001, the amortization was deferred for the
approved regulatory assets being securitized, which effectively offset the loss
in revenue in 2001 resulting from the five percent residential rate reduction.
In December 2001, after the Securitization bonds were sold, the amortization was
re-established, based on a schedule that is the same as the recovery of the
principal amounts of the securitized qualified costs. In 2002, the amortization
amount is expected to be approximately $31 million and the securitized assets
will be fully amortized by the end of 2015.
TRANSMISSION: In 1999, the FERC issued Order No. 2000, strongly encouraging
utilities to transfer operating control of their electric transmission
facilities to an RTO, or sell the facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which also requires utilities to divest or transfer the operating
authority of transmission facilities to an independent company. Consumers chose
to offer its electric transmission facilities for sale rather than own and
invest in an asset that it cannot control. In May 2002, Consumers sold its
electric transmission facilities for approximately $290 million in cash to MTH,
a non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect Inc.
Trans-Elect, Inc. submitted the winning bid through a competitive bidding
process, and various federal agencies approved the transaction. Consumers did
not provide any financial or credit support to Trans-Elect, Inc. Certain
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by such
affiliates when the transaction was
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discussed internally and negotiated with purchasers. Consumers anticipates that
after selling its transmission facilities, its after-tax earnings will increase
by approximately $17 million in 2002 due to the recognition of a $26 million one
time gain on the sale of transmission assets. In 2003, Consumers anticipates
after-tax earnings will decrease by $15 million. This decrease results from the
loss of revenue from wholesale and retail open access customers who would buy
services directly from MTH, including the loss of a return on the sold
transmission assets.
Under the agreement with MTH, and subject to additional RTO surcharges,
transmission rates charged to Consumers will be fixed at current levels until
December 31, 2004, and subject to FERC ratemaking thereafter. MTH will complete
the capital program to expand the transmission system's capability to import
electricity into Michigan, as required by the Customer Choice Act, and Consumers
will continue to maintain the system under a five-year contract with MTH.
Effective April 30, 2002, Consumers and METC withdrew from the Alliance RTO.
In the past, when IPPs connected to transmission systems, they paid a fee that
transmission companies used to offset capital costs incurred to connect the IPP
to the transmission system and make system upgrades needed for the
interconnection. In order to promote electric generation competition, the FERC
recently ordered that the system upgrade portion of the fee be refunded to IPPs
over time as transmission service is taken. As a result, transmission companies
no longer have the benefit of lowering their capital costs for transmission
system upgrades. METC recorded a $30 million liability for IPP refunds.
Subsequently, MTH assumed this liability as part of its purchase of the
transmission facilities.
In June 2001, the Michigan South Central Power Agency and the Michigan Public
Power Agency filed suit against Consumers and METC in a Michigan circuit court.
The suit sought to prevent the transmission facilities sale or transfer without
first binding a successor to honor the municipal agencies' ownership interests,
contractual agreements and rights. In August 2001, the parties reached two
settlements. The Michigan circuit court approved the settlements and they were
amended in February 2002 to assure that closing could occur if all closing
conditions were satisfied. The circuit court retained jurisdiction over the
matter and has since dismissed the lawsuit.
On July 31, 2002, FERC issued a 600-page notice of proposed rulemaking on
standard market design for electric bulk power markets and transmission. Its
stated purpose is to remedy undue discrimination in the use of the interstate
transmission system and give the nation the benefits of a competitive bulk power
system. The proposal is subject to public comment for 75 days from its date of
publication in the federal register on August 1, 2002. Consumers is currently
studying the effects of the proposed rulemaking.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin, of approximately 15 percent. The reserve
margin provides additional power supply above Consumers' anticipated peak power
supply demands. It also allows Consumers to provide reliable service to its
electric service customers and to protect itself against unscheduled plant
outages and unanticipated demand. For the summers 2002 and 2003, as it has in
previous summers, Consumers is planning for a reserve margin of 15 percent. The
actual reserve margin needed will depend primarily on summer weather conditions,
the level of retail open access requirements being served by others during the
summer, and any unscheduled plant outages. As of July 2002, alternative electric
suppliers are providing 386 MW of generation supply to customers.
To reduce the risk of high electric prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electric call option contracts for the physical delivery of electricity
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during the months of June through September. As of June 30, 2002, Consumers had
purchased or had commitments to purchase electric call option contracts covering
the estimated summer 2002 reserve margin requirement and partially covering the
estimated reserve margin requirements for summers 2003 through 2007. Consumers
has recorded an asset of $35 million for these call options, of which $5 million
pertains to 2002. The total estimated cost of these electricity call option
contracts for summer 2002 is approximately $12 million.
Prior to 1998, the PSCR process provided for the reconciliation of actual power
supply costs with power supply revenues. This process assured recovery of all
reasonable and prudent power supply costs actually incurred by Consumers,
including the actual cost for fuel, and purchased and interchange power. In
1998, as part of the electric restructuring efforts, the MPSC suspended the PSCR
process, and would not grant adjustment of customer rates through 2001. As a
result of the rate freeze imposed by the Customer Choice Act, the current rates
will remain in effect until at least December 31, 2003 and, therefore, the PSCR
process remains suspended. Therefore, changes in power supply costs as a result
of fluctuating electricity prices will not be reflected in rates charged to
Consumers' customers during the rate freeze period.
ELECTRIC PROCEEDINGS: The Customer Choice Act allows electric utilities to
recover the act's implementation costs and "net" Stranded Costs (without
defining the term). The act directs the MPSC to establish a method of
calculating "net" Stranded Costs and of conducting related true-up adjustments.
In December 2001, the MPSC adopted a methodology for calculating "net" Stranded
Costs as the shortfall between: (a) the revenue required to cover costs
associated with fixed generation assets, generation-related regulatory assets,
and capacity payments associated with purchase power agreements, and (b) the
revenues received from customers under existing rates available to cover the
revenue requirement. Consumers has initiated an appeal at the Michigan Court of
Appeals related to the MPSC's December 2001 "net" Stranded Cost order, as a
result of the uncertainty associated with the outcome of the proceeding
described in the following paragraph.
According to the MPSC, "net" Stranded Costs are to be recovered from retail open
access customers through a Stranded Cost transition charge. Even though the MPSC
set Consumers' Stranded Cost transition charge at zero for calendar year 2000,
those costs for 2000 will be subject to further review in the context of the
MPSC's subsequent determinations of "net" Stranded Costs for 2001 and later
years. The MPSC authorized Consumers to use deferred accounting to recognize the
future recovery of costs determined to be stranded. In April 2002, Consumers
made "net" Stranded Cost filings with the MPSC for $22 million and $43 million
for 2000 and 2001, respectively. In the same filing, Consumers estimated that it
would experience "net" Stranded Costs of $126 million for 2002. The MPSC staff
and Energy Michigan filed appeals with the MPSC regarding the inclusion of
certain Clean Air Act-related investment and other costs in Consumers' "net"
stranded cost filing. In July 2002, the MPSC granted the MPSC staff its appeal.
As a result, Consumers revised and supplemented its "net" Stranded Costs filing
by excluding all costs associated with the Clean Air Act and resubmitting the
filing to the MPSC. After the exclusion of the Clean Air Act costs, the revised
Stranded Cost amounts are $11 million and $8 million for 2000 and 2001,
respectively, and an estimated $76 million for 2002. On August 9, 2002 the MPSC
Staff and other intervenors filed their position regarding 2000 and 2001
Stranded Cost. The Staff recommended that the Commission find that Consumers had
Stranded Costs of $5.1M and $2.8M for 2000 and 2001, respectively. Other parties
contended that Consumers had stranded benefits in 2000 and 2001 and made various
suggestions on how those benefits should be treated. In a separate filing,
Consumers requested regulatory asset accounting treatment for its Clean Air Act
expenditures through 2003. The outcome of these proceedings before the MPSC is
uncertain at this time.
Since 1997, Consumers has incurred significant electric utility restructuring
implementation costs. The following table outlines the applications filed by
Consumers with the MPSC and the status of recovery for these costs.
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In Millions
----------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- ---------- ------------- --------- ------- ------- ----------
1999 1997 & 1998 $20 $-- $15 $ 5
2000 1999 30 -- 25 5
2001 2000 25 25 -- --
2002 2001 8 8 -- --
=========== ==== ==== ==== ====
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in electric rates. In
the orders received for the years 1997 through 1999, the MPSC also reserved the
right review again the total implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs. Consumers expects to
receive in 2002, a final order for 2001 implementation costs. In addition to the
amounts shown, as of June 2002, Consumers incurred and deferred as a regulatory
asset, $5 million of additional implementation costs and has also recorded as a
regulatory asset $13 million for the cost of money associated with total
implementation costs. Consumers believes the implementation costs and the
associated cost of money are fully recoverable in accordance with the Customer
Choice Act. Cash recovery from customers will probably begin after the rate
freeze or rate cap period has expired and Consumers cannot predict the amounts
the MPSC will approve as recoverable costs.
In 1996, Consumers filed new OATT transmission rates with the FERC for approval.
Interveners contested these rates, and hearings were held before an ALJ in 1998.
In 1999, the ALJ made an initial decision recommending lower OATT rates that was
largely upheld by the FERC in March 2002 which requires Consumers to refund,
with interest, over-collections for past services as measured by FERC's finally
approved OATT rates. Since the initial decision, Consumers has been reserving a
portion of revenues billed to customers under the filed 1996 OATT rates then
existing OATT rates. In April 2002, FERC issued a decision largely affirming the
initial decision but increasing the recommended rate of return. A compliance
proceeding is being held at FERC to determine Consumers' refund responsibility.
Consumers believes its reserve is sufficient to satisfy its estimated refund
obligation.
OTHER ELECTRIC UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990 and to supply electricity and steam to Dow. Consumers,
through two wholly owned subsidiaries, holds the following assets related to the
MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general
partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through
FMLP, a 35 percent lessor interest in the MCV Facility.
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Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
Six Months Ended
----------------------
June 30 2002 2001
- ------- ---- ----
Pretax operating income $53 $21
Income taxes and other 18 7
--- ---
Net income $35 $14
=== ===
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the
termination of the PPA in 2025. The PPA requires Consumers to pay, based on the
MCV Facility's availability, a levelized average capacity charge of 3.77 cents
per kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Since January 1,
1993, the MPSC has permitted Consumers to recover capacity charges averaging
3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and
variable energy charges. Since January 1, 1996, the MPSC has also permitted
Consumers to recover capacity charges for the remaining 325 MW of contract
capacity with an initial average charge of 2.86 cents per kWh increasing
periodically to an eventual 3.62 cents per kWh by 2004 and thereafter. However,
due to the current freeze of Consumers' retail rates that the Customer Choice
Act requires, the capacity charge for the 325 MW is now frozen at 3.17 cents per
kWh. After September 2007, the PPA's terms only require Consumers to pay the MCV
Partnership capacity and energy charges that the MPSC has authorized for
recovery from electric customers.
In 1992, Consumers recognized a loss for the present value of the estimated
future underrecoveries of power supply costs under the PPA based on MPSC cost
recovery orders. Consumers continually evaluates the adequacy of the PPA
liability for future underrecoveries. These evaluations consider management's
assessment of operating levels at the MCV Facility through 2007 along with
certain other factors, including MCV related costs that are included in
Consumers' frozen retail rates. During the third quarter of 2001, in connection
with Consumers' long-term electric supply planning, management reviewed the PPA
liability assumptions related to increases in the expected long-term dispatch of
the MCV Facility and increased MCV related costs. As a result, in September
2001, Consumers increased the PPA liability by $126 million. Management believes
that, following the increase, the PPA liability adequately reflects the present
value of the PPA's future effect on Consumers. At June 30, 2002 and 2001, the
remaining present value of the estimated future PPA liability associated with
the loss totaled $173 million and $64 million, respectively. For further
discussion on the impact of the frozen PSCR, see "Electric Rate Matters" in this
Note.
In March 1999, Consumers and the MCV Partnership reached an agreement effective
January 1, 1999, that capped availability payments to the MCV Partnership at
98.5 percent. If the MCV Facility generates electricity at the maximum 98.5
percent level during the next five years, Consumers' after-tax cash
underrecoveries associated with the PPA could be as follows:
In Millions
----------------------------------------------------
2002 2003 2004 2005 2006
---- ---- ---- ---- ----
Estimated cash underrecoveries at 98.5%, net of tax $38 $37 $36 $36 $36
=== === === === ===
In February 1998, the MCV Partnership appealed the January 1998 and February
1998 MPSC orders related to electric utility restructuring. At the same time,
MCV Partnership filed suit in the United States District Court
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in Grand Rapids seeking a declaration that the MPSC's failure to provide
Consumers and MCV Partnership a certain source of recovery of capacity payments
after 2007 deprived MCV Partnership of its rights under the Public Utilities
Regulatory Policies Act of 1978. In July 1999, the District Court granted MCV
Partnership's motion for summary judgment. The Court permanently prohibited
enforcement of the restructuring orders in any manner that denies any utility
the ability to recover amounts paid to qualifying facilities such as the MCV
Facility or that precludes the MCV Partnership from recovering the avoided cost
rate. The MPSC appealed the Court's order to the 6th Circuit Court of Appeals in
Cincinnati. In June 2001, the 6th Circuit overturned the lower court's order and
dismissed the case against the MPSC. The appellate court determined that the
case was premature and concluded that the qualifying facilities needed to wait
until 2008 for an actual factual record to develop before bringing claims
against the MPSC in federal court.
NUCLEAR FUEL COST: Consumers amortizes nuclear fuel cost to fuel expense based
on the quantity of heat produced for electric generation. Through November 2001,
Consumers expensed the interest on leased nuclear fuel as it was incurred.
Effective December 2001, Consumers no longer leases its nuclear fuel.
For nuclear fuel used after April 6, 1983, Consumers charges disposal costs to
nuclear fuel expense, recovers these costs through electric rates, and then
remits them to the DOE quarterly. Consumers elected to defer payment for
disposal of spent nuclear fuel burned before April 7, 1983. As of June 30, 2002,
Consumers has a recorded liability to the DOE of $137 million, including
interest, which is payable upon the first delivery of spent nuclear fuel to the
DOE. Consumers recovered through electric rates the amount of this liability,
excluding a portion of interest. In 1997, a federal court decision has confirmed
that the DOE was to begin accepting deliveries of spent nuclear fuel for
disposal by January 31, 1998. Subsequent litigation in which Consumers and
certain other utilities participated has not been successful in producing more
specific relief for the DOE's failure to comply.
In July 2000, the DOE reached a settlement agreement with one utility to address
the DOE's delay in accepting spent fuel. The DOE may use that settlement
agreement as a framework that it could apply to other nuclear power plants;
however, certain other utilities are challenging the validity of the settlement.
Additionally, there are two court decisions that support the right of utilities
to pursue damage claims in the United States Court of Claims against the DOE for
failure to take delivery of spent fuel. A number of utilities have commenced
litigation in the Court of Claims. Consumers is evaluating its options with
respect to its contract with the DOE.
In July 2002, Congress approved and the President signed a bill designating the
site at Yucca Mountain, Nevada, for the development of a repository for the
disposal of high-level radioactive waste and spent nuclear fuel. The next step
will be for the DOE to submit an application to the NRC for a license to begin
construction of the repository. The application and review process is estimated
to take several years.
NUCLEAR MATTERS: In April 2002, Palisades received its annual performance review
in which the NRC stated that Palisades operated in a manner that preserved
public health and safety. With the exception of one fire protection smoke
detector location finding with low safety significance, the NRC classified all
inspection findings as having very low safety significance. Other than the
follow-up fire protection inspection associated with this one finding, the NRC
plans to conduct only baseline inspections at the facility through May 31, 2003.
The amount of spent nuclear fuel discharged from the reactor to date exceeds
Palisades' temporary on-site storage pool capacity. Consequently, Consumers is
using NRC-approved steel and concrete vaults, commonly known as "dry casks", for
temporary on-site storage. As of June 30, 2002, Consumers had loaded 18 dry
casks with spent nuclear fuel at Palisades. Palisades will need to load
additional dry casks by the fall of 2004 in order to continue operation.
Palisades currently has three empty storage-only dry casks on-site, with storage
pad capacity for up to seven additional loaded dry casks. Consumers anticipates
that licensed transportable dry casks for additional storage, along with more
storage pad capacity, will be available prior to 2004.
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In December 2000, the NRC issued an amendment revising the operating license for
Palisades to extend its expiration date to March 2011, with no restrictions
related to reactor vessel embrittlement.
In 2000, Consumers made an equity investment and entered into an operating
agreement with NMC. NMC was formed in 1999 by four utilities to operate and
manage the nuclear generating plants owned by these utilities. Consumers
benefits by consolidating expertise, cost control and resources among all of the
nuclear plants being operated on behalf of the NMC member companies.
In November 2000, Consumers requested approval from the NRC to transfer
operating authority for Palisades to NMC and the request was granted in April
2001. The formal transfer of authority from Consumers to NMC took place in May
2001. Consumers retains ownership of Palisades, its 789 MW output, the current
and future spent fuel on site, and ultimate responsibility for the safe
operation, maintenance and decommissioning of the plant. Under the agreement
that transferred operating authority of the plant to NMC, salaried Palisades'
employees became NMC employees on July 1, 2001. Union employees work under the
supervision of NMC pursuant to their existing labor contract as Consumers'
employees. NMC currently has responsibility for operating eight units with 4,500
MW of generating capacity in Wisconsin, Minnesota, Iowa and Michigan.
On June 20, 2001, the Palisades reactor was shut down so technicians could
inspect a small steam leak on a control rod drive assembly. There was no risk to
the public or workers. In August 2001, Consumers completed an expanded
inspection that included all similar control rod drive assemblies and elected to
completely replace all the components. Installation of the new components was
completed in December 2001 and the plant returned to service and has been
operating since January 21, 2002. Consumers' capital expenditures for the
components and their installation was approximately $31 million.
From the start of the June 20th outage through the end of 2001, the impact on
net income of replacement power supply costs associated with the outage was
approximately $59 million. Subsequently, in January 2002, the impact on 2002 net
income was $5 million.
Consumers maintains insurance against property damage, debris removal, personal
injury liability and other risks that are present at its nuclear facilities.
Consumers also maintains coverage for replacement power supply costs during
prolonged accidental outages at Palisades. Insurance would not cover such costs
during the first 12 weeks of any outage, but would cover most of such costs
during the next 52 weeks of the outage, followed by reduced coverage to 80
percent for 110 additional weeks. The June 2001 through January 2002 Palisades
outage, however, was not an insured event. If certain covered losses occur at
its own or other nuclear plants similarly insured, Consumers could be required
to pay maximum assessments of $26.9 million in any one year to NEIL; $88 million
per occurrence under the nuclear liability secondary financial protection
program, limited to $10 million per occurrence in any year; and $6 million if
nuclear workers claim bodily injury from radiation exposure. Consumers considers
the possibility of these assessments to be remote. NEIL limits its coverage from
multiple acts of terrorism during a twelve-month period to a maximum aggregate
of $3.24 billion, allocated among the claimants, plus recoverable reinsurance,
indemnity and other sources. The nuclear liability insurers for Palisades and
Big Rock also limit the amount of their coverage for liability from terrorist
acts to $200 million. This could affect the amount of loss coverage for
Consumers should multiple acts of terrorism occur. The Price Anderson Act is
currently in the process of reauthorization by the U. S. Congress. It is
possible that the Price Anderson Act will not be reauthorized or changes may be
made that significantly affect the insurance provisions for nuclear plants.
CAPITAL EXPENDITURES: In 2002, 2003, and 2004, Consumers estimates electric
capital expenditures, including new lease commitments and environmental costs
under the Clean Air Act, of $460 million, $430 million, and $450 million. For
further information, see the Capital Expenditures Outlook section in the MD&A.
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DERIVATIVE ACTIVITIES: Consumers' electric business uses purchased electric call
option contracts to meet its regulatory obligation to serve. This obligation
requires Consumers to provide a physical supply of electricity to customers, to
manage electric costs and to ensure a reliable source of capacity during peak
demand periods. These contracts are subject to SFAS No. 133 derivative
accounting, and are required to be recorded on the balance sheet at fair value,
with changes in fair value recorded directly in earnings or other comprehensive
income, if the contract meets qualifying hedge criteria. On July 1, 2001, upon
initial adoption of the standard for these contracts, Consumers recorded a $3
million, net of tax, cumulative effect adjustment as an unrealized loss,
decreasing accumulated other comprehensive income. This adjustment relates to
the difference between the fair value and the recorded book value of these
electric call option contracts. The adjustment to accumulated other
comprehensive income relates to electric call option contracts that qualified
for cash flow hedge accounting prior to the initial adoption of SFAS No. 133.
After July 1, 2001, these contracts did not qualify for hedge accounting under
SFAS No. 133 and, therefore, Consumers records any change in fair value
subsequent to July 1, 2001 directly in earnings, which can cause earnings
volatility. The initial amount recorded in other comprehensive income will be
reclassified to earnings as the forecasted future transactions occur or the call
options expire. The majority of these contracts expired in the third quarter
2001 and the remaining contracts will expire in 2002. As of December 31, 2001,
Consumers reclassified to earnings, $2 million, net of tax, as part of the cost
of power supply. Consumers expects to reclassify the remainder to earnings in
the third quarter of 2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria used to determine if derivative accounting
is required. In light of the amended criteria, Consumers re-evaluated its
electric call option and option-like contracts, and determined that additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
will record any change in fair value subsequent to December 31, 2001, directly
in earnings, which could cause earnings volatility. As of June 30, 2002,
Consumers recorded on the balance sheet all of its purchased electric call
option contracts subject to derivative accounting, at a fair value of $2
million.
Consumers believes that its electric capacity and energy contracts do not
qualify as derivatives due to the lack of an active energy market in the state
of Michigan and the transportation cost to deliver the power under the
contracts to the closest active energy market at the Cinergy hub in Ohio. If a
market develops in the future, Consumers may be required to account for these
contracts as derivatives. The mark to market impact in earnings related to
these contracts, particularly related to the purchase power agreement with the
MCV, could be material to the financial statements.
Consumers' electric business also uses gas swap contracts to protect against
price risk due to the fluctuations in the market price of gas used as fuel for
generation of electricity. These gas swaps are financial contracts that will be
used to offset increases in the price of probable forecasted gas purchases.
These contracts do not qualify for hedge accounting. Therefore, Consumers
records any change in the fair value of these contracts directly in earnings as
part of power supply costs, which could cause earnings volatility. As of June
30, 2002, a gain of $1 million has been recorded for 2002, which represents the
fair value of these contracts at June 30, 2002. These contracts expire in
December 2002.
GAS CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at the remaining sites as studies are completed.
Consumers has estimated its costs related to further investigation and remedial
action for all 23 sites using the Gas Research Institute-Manufactured Gas Plant
Probabilistic Cost Model. The estimated total costs are between $82 million and
$113 million; these estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between 3 and 7 percent for this
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type of activity. Consumers expects to recover a significant portion of these
costs through insurance proceeds and through MPSC approved rates charged to its
customers. As of June 30, 2002, Consumers has an accrued liability of $53
million, (net of $29 million of expenditures incurred to date), and a regulatory
asset of $70 million. Any significant change in assumptions, such as an increase
in the number of sites, different remediation techniques, nature and extent of
contamination, and legal and regulatory requirements, could affect Consumers'
estimate of remedial action costs. The MPSC currently allows Consumers to
recover $1 million of manufactured gas plant facilities environmental clean-up
costs annually. Consumers defers and amortizes, over a period of ten years,
manufactured gas plant facilities environmental clean-up costs above the amount
currently being recovered in rates. Additional rate recognition of amortization
expense cannot begin until after a prudency review in a gas rate case.
Consumers' position in the current general gas rate case is that all
manufactured gas plant facilities environmental clean-up expenditures for years
1998 through 2002 are prudent.
GAS RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers conducted an
experimental gas customer choice pilot program that froze gas distribution and
GCR rates through the period. On April 1, 2001, a permanent gas customer choice
program commenced under which Consumers returned to a GCR mechanism that allows
it to recover from its bundled sales customers all prudently incurred costs to
purchase the natural gas commodity and transport it to Consumers for ultimate
distribution to customers.
GAS COST RECOVERY: As part of a settlement agreement approved by the MPSC in
July 2001, Consumers agreed not to bill a price in excess of $4.69 per mcf of
natural gas under the GCR factor mechanism through March 2002. This agreement is
not expected to affect Consumers' earnings outlook because Consumers recovers
from customers the amount that it actually pays for natural gas in the
reconciliation process. The settlement does not affect Consumers' June 2001
request to the MPSC for a distribution service rate increase. The MPSC also
approved a methodology to adjust bills for market price increases quarterly
without returning to the MPSC for approval. In December 2001, Consumers filed
its GCR Plan for the period April 2002 through March 2003. Consumers is
requesting authority to bill a GCR factor up to $3.50 per mcf for this period.
The Company also requested the MPSC approve the same methodology which adjusts
bills for market price increases that the MPSC approved, through settlement, in
the previous plan year. A settlement with all parties in the proceeding was
signed and submitted to the Commission in March 2002. The settlement stipulated
to all requests of Consumers and the MPSC approved the settlement, as filed, in
July 2002.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Consumers is seeking a 12.25
percent authorized return on equity. Contemporaneously with this filing,
Consumers requested partial and immediate relief in the annual amount of $33
million. The relief is primarily for higher carrying costs on more expensive
natural gas inventory than is currently included in rates. In October 2001,
Consumers revised its filing to reflect lower operating costs and requested a
$133 million annual distribution service rate increase. In December 2001, the
MPSC authorized a $15 million annual interim increase in distribution service
rate revenues. The order authorizes Consumers to apply the interim increase on
its gas sales customers' bills for service effective December 21, 2001. The
increase is under bond and subject to refund if the final rate increase is less
than the interim rate increase. In February 2002, Consumers revised its filing
to reflect lower estimated gas inventory prices and revised depreciation expense
and is now requesting an annual $105 million distribution service rate increase.
The MPSC staff supported an annual increase of $30 million, with an 11 percent
return on equity. The ALJ, in the Proposal for Decision issued June 3, 2002,
recommended an annual rate increase of $32 million, with a return on equity of
11 percent. If the MPSC approves Consumers' total request, then Consumers could
bill an additional amount of approximately $4.78 per month, representing a 7.6
percent increase in the typical residential customer's average monthly bill.
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Consumers Energy Company
OTHER GAS UNCERTAINTIES
CAPITAL EXPENDITURES: In 2002, 2003, and 2004, Consumers estimates gas capital
expenditures, including new lease commitments, of $190 million, $205 million,
and $230 million. For further information, see the Capital Expenditures Outlook
section in the MD&A.
DERIVATIVE ACTIVITIES: Consumers' gas business uses fixed price gas supply
contracts to meet its regulatory obligation to provide gas to its customers as
the lowest possible prudent cost. Some of these contracts require derivative
accounting because they contain embedded put options that disqualify the
contracts from the normal purchase exception of SFAS No. 133. As of June 30,
2002, Consumers' gas supply contracts requiring derivative accounting had a fair
value of $2 million, representing a fair value gain on the contract since the
date of inception. This gain was recorded directly in earnings as part of other
income, and then directly offset and recorded on the balance sheet as a
regulatory liability. Any subsequent changes in fair value will be recorded in
the same manner. These contracts expire in October 2002.
OTHER UNCERTAINTIES
SEC Investigation: CMS Energy's Board of Directors has established a special
committee of independent directors to investigate matters surrounding "round
trip" trading and has retained outside counsel to assist in the investigation.
The committee expects to complete its investigation and report its findings to
the Board of Directors by the end of third quarter 2002. In addition, CMS
Energy is cooperating with the SEC investigation regarding round trip trades
and the Company's financial statements, accounting policies and controls. CMS
Energy is also cooperating with inquiries by the Commodity Futures Trading
Commission and FERC regarding these transactions. CMS Energy has also received
subpoenas from the U.S. Attorney's Office for the Southern District of New
York and from the U.S. Attorney's Office in Houston regarding investigations
of these trades and has received a number of shareholder class action lawsuits.
CMS Energy is unable to predict the outcome of these matters.
Restatement: Following CMS Energy's announcement that it would restate its
financial statements for 2000 and 2001 to eliminate the effects of "round trip"
energy trades and form a special committee of its Board of Directors to
investigate these trades, CMS Energy received formal notification from Arthur
Andersen that it had terminated its relationship with CMS Energy and
affiliates. Arthur Andersen notified CMS Energy that due to the investigation,
Arthur Andersen's historical opinions on CMS Energy's financials for the
periods being restated cannot be relied upon. Arthur Andersen clarified in its
notification to CMS Energy that its decision does not apply to separate,
audited statements of Consumers for the applicable years. Arthur Andersen also
notified CMS Energy that due to Arthur Andersen's current situation and the
work of the special committee, they would be unable to give an opinion on CMS
Energy's restated financial statements when they are completed. CMS Energy had
previously announced that it would no longer use Arthur Andersen for its
independent audit work and in May 2002, CMS Energy appointed Ernst & Young to
audit the financial statements for the year ending December 31, 2002. Ernst &
Young is currently auditing CMS Energy's restated consolidated financial
statements, which includes audit work at Consumers for each of the fiscal years
ended December 31, 2001 and December 31, 2000, and is expected to release its
opinion upon the completion of its audit procedures and the special committee's
investigation.
CLASS ACTION LAWSUITS: Eighteen separate civil lawsuits have been filed in
federal court in Michigan in connection with round-trip trading, alleging (i)
violation of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934
("Exchange Act") and (ii) violation of Section 20(a) of the Exchange Act. (See
Exhibit 99(d) for a case names, dates instituted and principal parties) All
suits name Messrs. McCormick and Wright and CMS Energy as defendants. Mr. Joos
is named as defendant in all but two of the suits, and Consumers Energy and Ms.
Pallas are named as defendants on certain of the suits. Counsel to CMS has
obtained an extension of the time to respond to these claims until
mid-September. Prior to that date the cases will be consolidated into a single
lawsuit. These complaints generally seek unspecified damages based on
allegations that the defendants violated United States securities laws and
regulations by making allegedly false and misleading statements about the
Company's business and financial condition. The Company intends to vigorously
defend against these actions.
The recent significant downturn in the equities markets has affected the value
of the Pension Plan assets. If the Plan's Accumulated Benefit Obligation
exceeds the value of these assets at December 31, 2002, Consumers will be
required to recognize an additional minimum liability for this excess in
accordance with SFAS No. 87. Consumers cannot predict the future fair value of
the Plan's assets but it is possible, without significant recovery of the
Plan's assets, that Consumers will have to book an additional minimum liability
through a charge to other comprehensive income. The Accumulated Benefit
Obligation is determined by the Plan's Actuary in the fourth quarter of each
year.
In addition to the matters disclosed in this note, Consumers and certain of its
subsidiaries are parties to certain lawsuits and administrative proceedings
before various courts and governmental agencies arising from the ordinary course
of business. These lawsuits and proceedings may involve personal injury,
property damage, contractual matters, environmental issues, federal and state
taxes, rates, licensing and other matters.
Consumers has accrued estimated losses for certain contingencies discussed in
this note. Resolution of these contingencies is not expected to have a material
adverse impact on Consumers' financial position, liquidity, or results of
operations.
3: SHORT-TERM FINANCINGS AND CAPITALIZATION
AUTHORIZATION: At June 30, 2002, Consumers had FERC authorization to issue or
guarantee through June 2002, up to $1.4 billion of short-term securities
outstanding at any one time. Consumers also had remaining FERC authorization to
issue through June 2002 up to $520 million of long-term securities for general
corporate purposes and $200 million of First Mortgage Bonds to be issued solely
as security for the long-term securities.
SHORT-TERM FINANCINGS: At June 30, 2002 Consumers had an unsecured $300 million
credit facility that matured in July 2002 and unsecured lines of credit
aggregating $45 million. These facilities were available to finance seasonal
working capital requirements and to pay for capital expenditures between
long-term financings. At June 30, 2002, a total of $255 million was outstanding
at a weighted average interest rate of 2.6 percent, compared with $328 million
outstanding at June 30, 2001, at a weighted average interest rate of 4.6
percent.
CE-39
Consumers currently has in place a $325 million trade receivables sale program.
At June 30, 2002 and 2001, receivables sold under the program totaled $311
million and $299 million, respectively. Accounts receivable and accrued revenue
in the Consolidated Balance Sheets have been reduced to reflect receivables
sold.
On April 1, 2002, Consumers established a new subsidiary, Consumers Receivable
Funding, LLC. This consolidated subsidiary was established to sell accounts
receivable to an unrelated third party.
In July 2002, the credit rating of the publicly traded securities of Consumers
was downgraded by the major rating agencies. The rating downgrade is proported
to be largely a function of the uncertainties associated with CMS Energy's
financial condition and liquidity pending resolution of the round-trip trading
investigations and lawsuits, the special board committee investigation,
restatement and re-audit of 2000 and 2001 financial statements and uncertain
future access to the capital markets. Consumers actual ability to access the
capital markets in the future on a timely basis will depend on the successful
and timely resolution of the board committee investigation and the successful
and timely conclusion of the re-audit of 2000 and 2001 financial statements.
As a result of certain of these downgrades, several commodity suppliers to
Consumers have requested advance payments or other forms of assurances in
connection with maintenance of ongoing deliveries of gas and electricity.
Consumers is working cooperatively with those suppliers to find mutually
satisfactory arrangements but there can be no assurance that all such
arrangements will be completed.
On July 12, 2002, Consumers reached agreement with its lenders on two credit
facilities as follows: $250 million revolving credit facility maturing July 11,
2003 and a $300 million term loan maturing July 11, 2003, with a one-year
extension anticipated at Consumers' option. These two facilities aggregating
$550 million replace a $300 million revolving credit facility that matured July
14, 2002 as well as various credit lines aggregating $200 million. The prior
credit facilities and lines were unsecured. The two new credit facilities are
secured with Consumers first mortgage bonds.
Consumers $250 million revolving credit facility has an interest rate of LIBOR
plus 200 basis points (although the rate may fluctuate depending on the rating
of Consumers first mortgage bonds) and the interest rate on the $300 million
term loan is LIBOR plus 300 basis points. Consumers bank and legal fees
associated with the facilities were $5.6 million.
The credit facilities have contractual restrictions that require Consumers to
maintain, as of the last day of each fiscal quarter, the following:
Required Ratio Limitation Ratio at June 30, 2002
-------------------------- ----------------------
Debt to Capital Ratio Not more than 0.65 to 1.00 0.51 to 1.00
Interest Coverage Ratio Not less than 2.0 to 1.0 2.6 to 1.0
========================== ======================
Also pursuant to restrictive covenants in the new credit facilities, Consumers
is limited to dividend payments that will not exceed $300 million in any
calendar year. In 2001, Consumers paid $189 million in common stock dividends to
CMS Energy. Consumers has declared and paid $154 million in common dividend
through June 2002.
LONG-TERM FINANCINGS: In March 2002, Consumers sold $300 million principal
amount of six percent senior notes, maturing in March 2005. Net proceeds from
the sale were $299 million. Consumers used the net proceeds to replace a first
mortgage bond that was to mature in 2003.
FIRST MORTGAGE BONDS: Consumers secures its First Mortgage Bonds by a mortgage
and lien on substantially all of its property. Consumers' ability to issue and
sell securities is restricted by certain provisions in its First
CE-40
Mortgage Bond Indenture, its Articles of Incorporation and the need for
regulatory approvals to meet appropriate federal law.
MANDATORILY REDEEMABLE PREFERRED SECURITIES: Consumers has wholly owned
statutory business trusts that are consolidated within its financial statements.
Consumers created these trusts for the sole purpose of issuing Trust Preferred
Securities. The primary asset of the trusts is a note or debenture of Consumers.
The terms of the Trust Preferred Security parallel the terms of the related
Consumers' note or debenture. The term, rights and obligations of the Trust
Preferred Security and related note or debenture are also defined in the related
indenture through which the note or debenture was issued, Consumers' guarantee
of the related Trust Preferred Security and the declaration of trust for the
particular trust. All of these documents together with their related note or
debenture and Trust Preferred Security constitute a full and unconditional
guarantee by Consumers of the trust's obligations under the Trust Preferred
Security. In addition to the similar provisions previously discussed, specific
terms of the securities follow:
Trust and Securities Amount Outstanding
In Millions Earliest
June 30 -------------------------- Redemption
Rate 2002 2001 2000 Maturity Year
---- ---- ---- ---- -------- ------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $ 70 $100 $100 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20% 120 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25% 175 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00% 125 125 -- 2031 2006
---- ---- ----
Total $490 $520 $395
==== ==== ====
In March 2002, Consumers reduced its' outstanding debt to Consumers Power
Company Financing I, Trust Originated Preferred Securities by $30 million.
OTHER: Under the provisions of its Articles of Incorporation, Consumers had $272
million of unrestricted retained earnings available to pay common dividends at
June 30, 2002.
DERIVATIVE ACTIVITIES: Consumers uses interest rate swaps to hedge the risk
associated with forecasted interest payments on variable rate debt. These
interest rate swaps are designated as cash flow hedges. As such, Consumers will
record any change in the fair value of these contracts in other comprehensive
income unless the swap is sold. As of June 30, 2002, Consumers had entered into
a swap to fix the interest rate on $75 million of variable rate debt. This swap
will expire in June 2003. As of June 30, 2002, this interest rate swap had a
negative fair value of $2 million. This amount, if sustained, will be
reclassified to earnings, increasing interest expense when the swaps are settled
on a monthly basis. As of June 30, 2001, Consumers had entered into swaps to fix
the interest rate on $225 million of variable rate debt. The swaps expired at
varying times from June through December 2001. As of June 30, 2001, these
interest rate swaps had a negative fair value of $4 million.
Consumers also uses interest rate swaps to hedge the risk associated with the
fair value of its debt. These interest rate swaps are designated as fair value
hedges. In March 2002, Consumers entered into a fair value hedge to hedge the
risk associated with the fair value of $300 million of fixed rate debt, issued
in March 2002. In June 2002, this swap was terminated and resulted in a $9
million gain that is deferred and recorded as part of the debt. It is
anticipated that this gain will be recognized over the remaining life of the
debt.
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Consumers Energy Company
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PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
Panhandle, a subsidiary of CMS Energy, a holding company, is primarily engaged
in the interstate transportation and storage of natural gas. Panhandle also owns
an interest in an LNG regasification plant and related facilities. The rates and
conditions for service of interstate natural gas transmission and storage
operations of Panhandle as well as the LNG operations are subject to the rules
and regulations of the FERC.
The MD&A of this Form 10-Q should be read along with the MD&A and other parts of
Panhandle's 2001 Form 10-K. This MD&A also refers to, and in some sections
specifically incorporates by reference, Panhandle's Condensed Notes to
Consolidated Financial Statements and should be read in conjunction with such
Statements and Notes. This report and other written and oral statements that
Panhandle may make contain forward-looking statements, as defined by the Private
Securities Litigation Reform Act of 1995. Panhandle's intentions with the use of
the words "anticipates," "believes," "estimates," "expects," "intends," and
"plans" and variations of such words and similar expressions, are solely to
identify forward-looking statements that involve risk and uncertainty. These
forward-looking statements are subject to various factors that could cause
Panhandle's actual results to differ materially from those anticipated in such
statements. Panhandle has no obligation to update or revise forward-looking
statements regardless of whether new information, future events or any other
factors affect the information contained in such statements. Panhandle does,
however discuss certain risk factors, uncertainties and assumptions in this MD&A
and in Item 1 of the 2001 Form 10-K in the section entitled "Forward-Looking
Statements Cautionary Factors and Uncertainties" and in various public filings
it periodically makes with the SEC. Panhandle designed this discussion of
potential risks and uncertainties, which is by no means comprehensive, to
highlight important factors that may impact Panhandle's business and financial
outlook. This report also describes material contingencies in Panhandle's
Condensed Notes to Consolidated Financial Statements, and Panhandle encourages
its readers to review these Notes.
The following information is provided to facilitate increased understanding of
the Consolidated Financial Statements and accompanying Notes of Panhandle and
should be read in conjunction with these financial statements. Because all of
the outstanding common stock of Panhandle Eastern Pipe Line is owned by a
wholly-owned subsidiary of CMS Energy, the following discussion uses the reduced
disclosure format permitted by Form 10-Q for issuers that are wholly-owned
direct or indirect subsidiaries of reporting companies.
PE-1
PANHANDLE EASTERN PIPE LINE COMPANY
RESULTS OF OPERATIONS
PANHANDLE CONSOLIDATED EARNINGS:
In Millions
----------------------------------------
June 30 2002 2001 Change
---- ---- -----------
Three months ended $ 13 $ 11 $ 2
Six months ended $ 38 $ 48 $(10)
==== ==== ====
In Millions
----------------------------------
Three Months Six Months
Ended June 30 Ended June 30
Reasons for the change: 2002 Vs 2001 2002 Vs 2001
- ----------------------- ------------ -------------
Reservation revenue $ (3) $ (3)
LNG terminalling revenue (21) (49)
Commodity revenue 1 (5)
Other revenue 7 6
Operation and maintenance 8 13
Depreciation and amortization 4 8
General taxes -- 2
Other income, net 1 1
Interest charges 5 9
Income taxes (1) 7
Extraordinary item 1 1
---- ----
Total change $ 2 $(10)
==== ====
RESERVATION REVENUE: For the three and six month periods ended June 30, 2002,
reservation revenue decreased $3 million due to lower average rates on capacity
sold, continuing a trend.
LNG TERMINALLING REVENUE: In May 2001, Trunkline LNG signed an agreement with BG
LNG Services that provides for a 22-year contract for the existing uncommitted
long-term capacity at the company's facility. The 22-year contract, in
conjunction with new rates which became effective January 2002 (see Note 2,
Regulatory Matters), along with significantly lower natural gas prices in the
first half of 2002 compared to the first half of 2001, resulted in reduced
revenues for Trunkline LNG from 2001 levels. In December 2001, Panhandle
completed a $320 million monetization of the Trunkline LNG business which
involved a new joint venture, LNG Holdings (see Off Balance Sheet Arrangements).
The joint venture transaction results in a reduced share of Trunkline LNG's
income and distributions being received by Panhandle due to such amounts being
after interest expense on debt of the joint venture as well as a reduced equity
ownership in the project. Panhandle uses the Hypothetical Liquidation at Book
Value method of equity income measurement for its investment in LNG Holdings,
the unconsolidated
PE-2
PANHANDLE EASTERN PIPE LINE COMPANY
joint venture which owns 100 percent of Trunkline LNG. Using this approach,
equity income is generally recordable by Panhandle only to the extent cash
distributions are made by LNG Holdings. Such distributions began in April 2002
and the resulting equity income is reflected in the Consolidated Statements of
Income as Other revenue, whereas in 2001 LNG revenues were fully consolidated.
COMMODITY REVENUE: For the six months ended June 30, 2002, commodity revenue
decreased $5 million primarily due to decreased natural gas transportation
volumes delivered for the first half of 2002 compared to the first half of 2001.
Volumes decreased 8 percent from the first six months of 2001 primarily due to
an unseasonably warm winter in the Midwest market area in early 2002.
OTHER REVENUE: Other revenue for the three month and six month periods ended
June 30, 2002 increased $7 million and $6 million, respectively. The increase
was primarily due to equity earnings of $8 million in the second quarter of 2002
related to Panhandle's investment in LNG Holdings (see LNG Terminalling Revenue
section of this MD&A). Prior to the monetization of Trunkline LNG in December
2001, revenues from LNG activities were consolidated and reflected in LNG
terminalling revenue. The increases were partially offset by equity losses of $2
million and $3 million, respectively, in the three and six month periods of 2002
related to the Centennial Pipeline equity investment due to startup operating
issues. Other revenue for the six months ended June 30, 2002 also includes a
non-recurring gain of $4 million in the first quarter of 2002 for the
settlement of Order 637 matters related to capacity release and imbalance
penalties (see Note 2, Regulatory Matters), equaling a non-recurring gain
related to a gas purchase contract in the first quarter of 2001.
OPERATION AND MAINTENANCE: Operation and maintenance expenses were reduced by $8
million and $13 million in the second quarter and first half of 2002,
respectively, partially due to Trunkline LNG expenses which are zero in 2002
since Trunkline LNG is no longer consolidated with Panhandle (see Off Balance
Sheet Arrangements section of this MD&A). Trunkline LNG operations and
maintenance expenses for the three month and six month periods ended June 30,
2001 were $1 million and $4 million, respectively. Additionally, Panhandle
operating expenses were lower for the three and six months ended June 30, 2002
due to lower fuel costs and a $3 million lower of cost or market adjustment to
the company's current system gas inventory recorded in 2001. Panhandle expenses
for the first six months of 2002 were also reduced by a non-recurring adjustment
in the first quarter of 2002 of $3 million for lower final incentive plan
payouts approved in 2002 for 2001 awards.
DEPRECIATION AND AMORTIZATION: For the three month and six month periods ended
June 30, 2002 amortization expense was reduced by $4 million and $8 million,
respectively, primarily due to adoption of SFAS No. 142. However, Panhandle has
completed the first step of the goodwill impairment testing required upon
adoption of SFAS No.142, which indicates a potential significant impairment of
Panhandle's goodwill exists as of January 1, 2002 under the new standard.
Panhandle has $700 million of goodwill recorded as of January 1, 2002 which is
subject to this impairment test. Per SFAS No. 142 requirements, the actual
impairment is determined in a second step involving a detailed valuation of all
assets and liabilities, the results of which will be reflected as the cumulative
effect of an accounting change, restated to the first quarter of 2002. This
valuation work is being performed utilizing an independent appraiser and is
expected to be completed in the third quarter of 2002. The results will be
announced after completion and review by the company. For further information,
see Note 1, Corporate Structure and Basis of Presentation - Implementation of
New Accounting Standards and Note 3, Goodwill Impairment.
INTEREST CHARGES: Interest Charges were reduced by $5 million and $9 million in
the second quarter and first half of 2002, respectively, primarily due to $249
million of net reductions of long-term debt principal in December 2001, April
2002 and May 2002 and due to favorable swap interest rates. In March 2002,
Panhandle executed a fixed to floating interest rate swap with notional amounts
totaling $175 million related to existing notes. The swaps were entered into to
take advantage of lower short-term interest rates which reduces interest expense
on the Consolidated Income Statement. In June 2002, Panhandle unwound the swaps
to monetize an increase in the market value of the fixed to floating rate
position. The resulting cash gain of approximately $3 million will be amortized
to income over the remaining term
PE-3
PANHANDLE EASTERN PIPE LINE COMPANY
of the hedged debt instrument. For further discussion of Panhandle's long-term
debt and guarantees, see Note 6, Debt Rating Downgrades.
INCOME TAXES: Income taxes increased $1 million and decreased $7 million in the
second quarter and first half of 2002, as compared to the same periods of 2001,
due to corresponding changes in pre-tax income.
CRITICAL ACCOUNTING POLICIES
Presenting financial statements in accordance with generally accepted accounting
principles requires using estimates, assumptions, and accounting methods that
are often subject to judgment. Presented below are the accounting policies and
assumptions that Panhandle believes are most critical to both the presentation
and understanding of its financial statements. Applying these accounting
policies to financial statements can involve very complex judgments.
Accordingly, applying different judgments, estimates or assumptions could result
in a different financial presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make judgments,
estimates and assumptions that affect the reported amounts of assets and
liabilities, 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. Certain accounting principles require subjective and
complex judgments used in the preparation of financial statements. Accordingly,
a different financial presentation could result depending on the judgment,
estimates or assumptions that are used. Such estimates and assumptions, include,
but are not specifically limited to: depreciation and amortization, interest
rates, discount rates, future commodity prices, mark-to-market valuations,
investment returns, volatility in the price of CMS Energy Common Stock, impact
of new accounting standards, future costs associated with long-term contractual
obligations, future compliance costs associated with environmental regulations
and continuing creditworthiness of counterparties. Actual results could
materially differ from those estimates.
OFF BALANCE SHEET ARRANGEMENTS
In December 2001, Panhandle entered into a joint venture transaction involving
LNG Holdings, which now owns 100 percent of Trunkline LNG. LNG Holdings is
jointly owned by a subsidiary of Panhandle Eastern Pipe Line and Dekatherm
Investor Trust, an unaffiliated entity. Panhandle initially contributed its
interest in Trunkline LNG to the joint venture. The joint venture then raised
$30 million from the issuance of equity to Dekatherm Investor Trust and then
$290 million from bank loans. The net proceeds were distributed to Panhandle
Eastern Pipe Line, with $75 million of the proceeds coming in the form of a
loan. While earnings are divided pursuant to a sharing formula, LNG Holdings'
owners require unanimous consent over significant governance issues, including,
among others, issuance of additional debt or equity, budgets, asset acquisitions
or dispositions, and appointment of officers.
The LNG Holdings transaction monetized the value of Trunkline LNG and the value
created by a 22- year contract with BG LNG Services, which began in January
2002, for the existing uncommitted long-term capacity at the facility. Due to
the commitment by Panhandle to reinvest the proceeds in the joint venture to
finance the LNG expansion project, the $183 million of proceeds received by
Panhandle in excess of Panhandle's book basis in Trunkline LNG was not
recognized as a gain, but instead was recorded as a deferred credit on
Panhandle's balance sheet. Panhandle Eastern Pipe Line has provided indemnities
to certain parties involved in the transaction for pre-closing claims and
liabilities, and
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PANHANDLE EASTERN PIPE LINE COMPANY
subsidiaries of Panhandle have provided indemnities for certain post-closing
expenses and liabilities as the manager/operator of the joint venture. For
further discussion, see Note 5, Commitments and Contingencies and Note 6, Debt
Rating Downgrades.
ACCOUNTING FOR RETIREMENT BENEFITS
Panhandle uses SFAS No. 87 to account for pension costs and uses SFAS No. 106 to
account for other postretirement benefit costs. These statements require
liabilities to be recorded on the balance sheet at the present value of these
future obligations to employees net of any plan assets. The calculation of these
liabilities and associated expenses require the expertise of actuaries and are
subject to many assumptions; including life expectancies, present value discount
rates, expected long-term rate of return on plan assets, rate of compensation
increase and anticipated health care costs. Any change in these assumptions can
significantly change the liability and associated expenses recognized in any
given year. For further information, see Outlook - Retirement Benefit Costs
section of this MD&A.
RELATED PARTY TRANSACTIONS
Panhandle enters into a number of significant transactions with related parties.
These transactions include revenues for the transportation of natural gas for
Consumers, CMS MS&T and the MCV Partnership which are based on regulated prices,
market prices or competitive bidding. Related party expenses include payments
for services provided by affiliates and payment of overhead costs to CMS Gas
Transmission and CMS Energy, as well as allocated benefit plan costs. Other
income is primarily interest income from the Note receivable - CMS Capital.
NEW ACCOUNTING STANDARDS
In addition to the identified critical accounting policies discussed above,
future results will be affected by new accounting standards that recently have
been issued.
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning January 1,
2003, companies must comply with SFAS No. 143, which requires companies to
record the fair value of a liability for an asset retirement obligation in the
period in which the obligation is incurred. When the liability is initially
recorded, the company 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
related asset's useful life. Panhandle is currently studying the effects of the
new standard, but has yet to quantify the effects of adoption on its financial
statements.
PE-5
PANHANDLE EASTERN PIPE LINE COMPANY
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44 AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB on April 30,
2002, this Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring after May 15, 2002. These
provisions are effective for financial statements issued on or after May 15,
2002. Panhandle is currently studying the effects of the new standard, but has
yet to quantify the effects, if any, of adoption on its financial statements.
SFAS NO. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES:
Issued by the FASB in July 2002, this standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. This standard is
effective for exit or disposal activities initiated after December 31, 2002.
Panhandle believes there will be no impact on its financial statements upon
adoption of the standard.
For a discussion of new accounting standards effective January 1, 2002, see Note
1, Corporate Structure and Basis of Presentation.
LIQUIDITY
CMS ENERGY FINANCIAL CONDITION
In July of 2002, the credit ratings of the publicly traded securities of CMS
Energy, Consumers and Panhandle (but not Consumers Funding LLC) were downgraded
by the major rating agencies. The ratings downgrade for all three companies'
securities is largely a function of the uncertainties associated with CMS
Energy's financial condition and liquidity pending resolution of the "round
trip" trading related investigations and lawsuits, the special board committee
investigation, financial statement restatement and re-audit (see Change in
Auditors section of this MD&A), and access to the capital markets.
As a result of certain of these downgrades, contractual rights were triggered in
several contractual arrangements between Panhandle and third parties, as
described in the Panhandle Financial Condition section below. Additionally, one
of the issuers of a joint and several surety bond in the approximate amount of
$190 million supporting a CMS MS&T gas supply contract has demanded collateral
for up to the full amount of the bond. This issuer has commenced litigation
against Enterprises and CMS MST in Michigan federal district court and is
seeking to require Enterprises and CMS MST to provide acceptable collateral and
to prevent them from disposing of or transferring any corporate assets outside
the ordinary course of business before the Court has an opportunity to fully
adjudicate the issuer's claim. Enterprises and CMS MST continue to work with
the issuer to find mutually satisfactory arrangements. A second issuer of
surety bonds aggregating approximately $113 million in support of two other CMS
MS&T gas supply contracts also has a right to request collateral for up to the
full amounts of such bonds, and certain parties involved in those gas supply
contracts have the right to seek replacement surety bonds due to the ratings
downgrade of the current surety bond issuer.
CMS Energy is working with its contractual parties to find mutually
satisfactory arrangements, but there can be no assurance of reaching such
arrangements.
PANHANDLE FINANCIAL CONDITION
On June 11, 2002, Moody's Investors Service, Inc. lowered its rating on
Panhandle's senior unsecured notes from Baa3 to Ba2 based on concerns
surrounding the liquidity and debt levels of CMS Energy (see discussion in the
CMS Energy Financial Condition section above). On July 15, 2002, Fitch Ratings,
Inc. lowered its rating on these notes from BBB to BB+ based on similar
concerns. On July 16, 2002, S&P also lowered
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PANHANDLE EASTERN PIPE LINE COMPANY
its rating on these notes from BBB- to BB, in line with their rating on CMS
Energy based on their belief that CMS Energy and its subsidiaries are at equal
risk of default since the parent relies on its subsidiaries to meet its
financial commitments. Effective with these downgrades, Panhandle's debt is
below investment grade which will increase operating and financing costs going
forward. Panhandle's senior unsecured note provisions are not directly impacted
by debt rating reductions, but are subject to other requirements such as the
maintenance of a fixed charge coverage ratio and a leverage ratio which
restrict certain payments if not maintained and limitations on liens. At
June 30, 2002, Panhandle was in compliance with all covenants.
In December 2001, $75 million of the proceeds from the Trunkline LNG
monetization transaction came to Panhandle in the form of notes payable to LNG
Holdings. Panhandle, as a result of its debt ratings downgrade to below
investment grade, upon the request of the unaffiliated equity partner, can be
required to pay on demand the remaining principal and accrued interest at any
time while such downgrades exist. No such demand has been made to date. At June
30, 2002, Panhandle's remaining balance on the $75 million note payable to LNG
Holdings was $69 million.
In conjunction with the Centennial and Guardian pipeline projects, Panhandle has
provided guarantees related to the project financings during the construction
phases and initial operating periods. On July 17, 2002, following the Panhandle
debt downgrades by Moody's and S&P, the lender sent notice to Panhandle,
pursuant to the terms of the Guaranty Agreement, requiring Panhandle to provide
acceptable credit support for its pro rata portion of those construction loans,
which aggregate $110 million including anticipated future draws. Panhandle has
30 business days, until August 27, 2002, to provide such credit support. If
Panhandle does not provide such credit support, the other partners would have 30
business days to provide such credit support or the debt would become due and
payable with premiums due. Partners providing such credit support could charge
fees to Panhandle during any period for which such credit support is provided.
In the interim, credit fees have been assessed based on a rate specified by the
lender and applied to Panhandle's share of the outstanding debt balance of
Guardian and Centennial.
Panhandle is working with its contractual parties with respect to these ratings
downgrades to find mutually satisfactory arrangements, but there can be no
assurance of reaching such arrangements.
At June 30, 2002, the Note receivable - CMS Capital balance was $290 million.
Due to CMS Energy's financial condition as described above, the liquidity of
this note is adversely affected and proceeds may not be immediately available
upon demand by Panhandle.
OUTLOOK
Panhandle is a leading United States interstate natural gas pipeline system and
also has a significant ownership interest in the nation's largest operating LNG
receiving terminal and intends to optimize results through expansion and better
utilization of its existing facilities and construction of new facilities. This
involves providing additional transportation, storage and other asset-based
value-added services to customers such as gas-fueled power plants, local
distribution companies, industrial and end-users, marketers and others.
Panhandle also has a one-third interest in Guardian Pipeline, L.L.C., which
is currently constructing a 141-mile, 36-inch pipeline from Illinois to
southeastern Wisconsin for the transportation of natural gas beginning late
2002. Upon completion of the project, Trunkline will operate and maintain the
pipeline. Panhandle also has a one-third interest in the Centennial Pipeline LLC
which operates a 720-mile, 26 inch pipeline extending from the U.S. Gulf Coast
to Illinois for the transportation of interstate refined petroleum products. The
pipeline began commercial service in April 2002.
In April 2001, FERC approved Trunkline's rate settlement without modification.
The settlement resulted in Trunkline reducing its maximum rates in May 2001. The
reduction is expected to reduce revenues by approximately $2 million annually.
For further information, see Note 2, Regulatory Matters.
In October 2001, Trunkline LNG, in which Panhandle owns an interest through its
equity interest in LNG Holdings, announced the planned expansion of the Lake
Charles, Louisiana facility to approximately 1.2 bcf per day of send out
capacity, up from its current send out capacity of 630 million cubic feet per
day. The terminal's storage capacity will also be expanded to 9 bcf from its
current storage capacity of 6.3 bcf. On July 31, 2002, the FERC issued its
Environmental Assessment of the expansion project with comments due to be filed
in thirty days. The application for a certificate of public convenience and
necessity of the expansion is pending the FERC action. The expanded facility
could be in operation as early as 2005
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PANHANDLE EASTERN PIPE LINE COMPANY
although various factors may delay the in-service date. The expansion
expenditures are currently expected to be funded by Panhandle loans or equity
contributions to LNG Holdings, which would be sourced by repayment by CMS
Capital to Panhandle on its outstanding note receivable or by capital markets or
other funding.
In October 2001, CMS Energy and Sempra Energy announced an agreement to jointly
develop a major new LNG receiving terminal to bring much-needed natural gas
supplies into northwestern Mexico and southern California. The plant would be
located on the Pacific Coast, north of Ensenada, Baja California, Mexico. As
currently planned, it will have a send out capacity of approximately 1 bcf per
day of natural gas through a new 40-mile pipeline between the terminal and
existing pipelines in the region. Since the October 2001 announcement, CMS
Energy has adjusted its role in the development of the terminal since CMS
Energy's top priority is to reduce debt and improve the balance sheet which will
require restraint in capital spending. As a result, Panhandle will not be an
equity partner in the project, but is expected to participate as the LNG plant
operator and will also provide technical support during the development of the
project which is currently estimated to commence commercial operations in 2007.
However, Panhandle has retained an option to participate as an equity partner in
the project at a later date.
CMS Energy is exploring the sale of the Panhandle and CMS Field Services
business units as part of an ongoing effort to strengthen its balance sheet,
improve its credit ratings and enhance financial flexibility. The units to be
considered for sale include Panhandle Eastern Pipe Line Company, Trunkline Gas
Company, Sea Robin, Pan Gas Storage and Panhandle's interests in LNG Holdings,
Guardian and Centennial. CMS Energy had previously announced an intention to
sell Panhandle's separate interest in Centennial but these separate efforts are
being discontinued. CMS Energy has begun assessing the market's interest in
purchasing the pipeline and field services businesses, and it is reviewing the
financial, legal and regulatory issues associated with the possible sale.
UNCERTAINTIES: Panhandle's results of operations and financial position may be
affected by a number of trends or uncertainties that have, or Panhandle
reasonably expects could have, a material impact on income from continuing
operations and cash flows. Such trends and uncertainties include: 1) the
increased competition in the market for transmission of natural gas to the
Midwest causing pressure on prices charged by Panhandle; 2) the current market
conditions causing more contracts to be of shorter duration, which may increase
revenue volatility; 3) the increased potential for declining financial condition
of certain customers within the industry due to recession and other factors; 4)
exposure to customer concentration with a significant portion of revenues
realized from a relatively small number of customers; 5) the possibility of
decreased demand for natural gas resulting from a downturn in the economy and
scaling back of new power plants; 6) the impact of any future rate cases or FERC
actions or orders, for any of Panhandle's regulated operations; 7) current
initiatives for additional federal rules and legislation regarding pipeline
safety; 8) capital spending requirements for safety, environmental or regulatory
requirements that could consume capital resources and also result in
depreciation expense increases not covered by additional revenues; 9) market and
other risks associated with Panhandle's investment in the liquids pipeline
business with the Centennial Pipeline venture; 10) increased security and
insurance costs as a result of the September 11, 2001 terrorist attack in the
United States; it is not certain what these cost levels will be or to what
extent these additional costs will be recoverable through Panhandle's rates; 11)
the impact of CMS Energy and its subsidiaries' financial condition and ratings
downgrades on Panhandle's liquidity and costs of operating, including
Panhandle's reduced ability to draw on the CMS Capital loan and current limited
access to capital markets; 12) actual amount of goodwill impairment and related
impact on earnings and balance sheet which could negatively impact Panhandle's
borrowing capacity; and 13) the effects of changing regulatory and accounting
related matters resulting from current events. For further information about
uncertainties, see Note 5, Commitments and Contingencies.
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PANHANDLE EASTERN PIPE LINE COMPANY
OTHER MATTERS
CUSTOMER CONCENTRATION
During the first six months of 2002, sales to Proliance Energy, LLC, a
nonaffiliated gas marketer, accounted for 16 percent of Panhandle's consolidated
revenues and sales to subsidiaries of CMS Energy accounted for 13 percent of
Panhandle's consolidated revenues. No other customer accounted for 10 percent or
more of consolidated revenues during the same period. Aggregate sales to
Panhandle's top ten customers accounted for 62 percent of revenues during the
first six months of 2002.
RETIREMENT BENEFIT COSTS
Panhandle, through its parent CMS Energy, provides post retirement benefits
under its Pension Plan, and post retirement health and life insurance benefits
under its OPEB plan to substantially all its employees, and benefits to certain
management employees under its SERP. Pension, OPEB and SERP plan assets, net of
contributions, have reduced in value from the previous year due to a downturn in
the equities market which has affected the value of the pension assets. As a
result, Panhandle expects to see an increase in pension and postretirement
benefit expense levels over the next few years unless market performance
improves significantly. Panhandle anticipates pension and postretirement benefit
expense to rise in 2002 by approximately $500 thousand and $2 million,
respectively, over 2001 expenses based on actuarial studies, with pension
expense likely to increase further in 2003. For pension expense, this increase
is due to a downturn in value of pension assets during the past two years,
forecasted increases in pay and added service, decline in the interest rate used
to value the liability of the plan, and expiration of the transition gain
amortization. For postretirement benefit expense, the increase is due to the
trend of rising health care costs, the market return on plan assets being below
expected levels and a lower discount rate, based on recent economic conditions,
used to compute the benefit obligation. Health care cost decreases gradually
under the assumptions used in the OPEB plan from current levels through 2009;
however, Panhandle cannot predict the impact that interest rates or market
returns will have on pension and postretirement benefit expense in the future,
nor whether actual health care costs will actually be limited to the projected
levels.
Through June 2002, Panhandle contributed $7 million to the Pension Trust and a
total of $4 million to the 401 (h) segment of the Pension Trust and VEBA Trust
to cover postretirement health care and life insurance benefits.
In order to keep health care benefits and costs competitive, CMS Energy
announced several changes to the Health Care Plan in which Panhandle
participates. These changes are effective January 1, 2003. The most significant
change is that Panhandle's future increases in healthcare costs will be shared
with employees.
Panhandle also provides retirement benefits under a defined contribution 401(k)
plan. Panhandle currently offers a contribution match of 50 percent of the
employee's contribution up to six percent (three percent maximum), as well as an
incentive match in years when performance exceeds expectations. Effective
September 1, 2002, Panhandle will suspend the employer's match until January 1,
2005, and eliminate the incentive match permanently which were originally
projected to be approximately $2 million and $1 million, respectively for the
full plan year 2002.
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PANHANDLE EASTERN PIPE LINE COMPANY
ENVIRONMENTAL MATTERS
Panhandle is subject to federal, state, and local laws and regulations governing
environmental quality and pollution control. These laws and regulations under
certain circumstances require Panhandle to remove or remedy the effect on the
environment of the disposal or release of specified substances at its operating
sites.
PCB (POLYCHLORINATED BIPHENYL) ASSESSMENT AND CLEAN-UP PROGRAMS: Panhandle
previously identified environmental contamination at certain sites on its
systems and undertook clean-up programs at these sites. For further information,
see Note 5, Commitments and Contingencies - Environmental Matters.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised State Implementation Plans (SIPS) for 22 states,
including five states in which Panhandle operates. For further information, see
Note 5, Commitments and Contingencies - Environmental Matters. In 1997, the
Illinois Environmental Protection Agency initiated an enforcement proceeding
relating to alleged air quality permit violations at Panhandle's Glenarm
Compressor Station. On November 15, 2001 the Illinois Pollution Control Board
approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. It is expected that the capital improvements
will occur in 2002 and 2003.
CHANGE IN AUDITORS
On April 22, 2002, the Board of Directors of CMS Energy, upon the recommendation
of the Audit Committee of the Board, voted to discontinue using Arthur Andersen
to audit the Panhandle financial statements for the year ending December 31,
2002. Panhandle previously retained Arthur Andersen to review its financial
statements for the quarter ended March 31, 2002. On May 23, 2002, CMS Energy's
Board of Directors engaged Ernst & Young to audit its financial statements for
the year ending December 31, 2002. Ernst & Young has hired some of Arthur
Andersen's Detroit office employees, some of whom are former auditors from the
CMS Energy audit engagement team.
As a result of certain financial reporting issues surrounding "round trip"
trading transactions at CMS MST, Arthur Andersen notified CMS Energy that Arthur
Andersen's historical opinions on CMS Energy's financials for the fiscal years
ended December 31, 2001 and December 31, 2000 cannot be relied upon. Arthur
Andersen clarified in its notification to CMS Energy that its decision does
not apply to separate, audited statements of Panhandle for the applicable
years. Arthur Andersen's reports on Panhandle's consolidated financial
statements for each of the fiscal years ended December 31, 2001 and
December 31, 2000 contained no adverse or disclaimer of opinion. Nor were the
reports qualified or modified regarding uncertainty, audit scope or accounting
principles.
During the fiscal years ended December 31, 2001 and December 31, 2000, and
through the date of their opinion for the quarter ended March 31, 2002,
Panhandle and Arthur Andersen did not disagree on any matter of accounting
principle or practice, financial statement disclosure, or auditing scope or
procedure. If Arthur Andersen and Panhandle had disagreed on these matters and
they were not resolved to Arthur
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PANHANDLE EASTERN PIPE LINE COMPANY
Andersen's satisfaction, Arthur Andersen would have noted this in its report on
Panhandle's consolidated financial statements.
During Panhandle's two most recent fiscal years ended December 31, 2000 and
December 31, 2001 and the subsequent interim period through June 10, 2002,
Panhandle did not consult with Ernst & Young regarding any matter or event
identified by SEC laws and regulations. However, as a result of the "round trip"
trading transactions, Ernst & Young is in the process of re-auditing CMS
Energy's, consolidated financial statements for each of the fiscal years ended
December 31, 2001 and December 31, 2000, which includes audit work at Panhandle
for these years. None of CMS Energy's former auditors, now employed by Ernst &
Young are involved in the re-audit of CMS Energy's consolidated financial
statements.
CEO AND CFO CERTIFICATIONS
The CEO and Principal Financial Officer of Panhandle could not make the
statements required by the Sarbanes-Oxley Act of 2002 with respect to the Form
10-Q for the period ended June 30, 2002. Panhandle's auditor, Ernst & Young has
initiated review of the financial statements in the 10-Q, but cannot complete
that review until the re-audit work on CMS Energy for the years 2000 and 2001,
which includes audit work at Panhandle, has been completed.
PE-11
PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(IN MILLIONS)
Three Months Six Months
Ended June 30, Ended June 30,
-------------------- --------------------
2002 2001 2002 2001
----- ----- ----- -----
OPERATING REVENUE
Transportation and storage of natural gas $ 90 $ 92 $ 204 $ 212
LNG terminalling revenue -- 21 -- 49
Other 9 2 15 9
----- ----- ----- -----
Total operating revenue 99 115 219 270
----- ----- ----- -----
OPERATING EXPENSES
Operation and maintenance 47 55 92 105
Depreciation and amortization 12 16 25 33
General taxes 6 6 12 14
----- ----- ----- -----
Total operating expenses 65 77 129 152
----- ----- ----- -----
PRETAX OPERATING INCOME 34 38 90 118
OTHER INCOME, NET 3 2 5 4
INTEREST CHARGES
Interest on long-term debt 18 22 35 43
Other interest (2) (1) (2) (1)
----- ----- ----- -----
Total interest charges 16 21 33 42
NET INCOME BEFORE INCOME TAXES 21 19 62 80
INCOME TAXES 9 8 25 32
----- ----- ----- -----
NET INCOME BEFORE EXTRAORDINARY ITEM 12 11 37 48
EXTRAORDINARY GAIN, NET OF TAX 1 -- 1 --
CONSOLIDATED NET INCOME 13 11 38 48
===== ===== ===== =====
The accompanying condensed notes are an integral part of these statements.
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PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Six Months
Ended June 30,
--------------------
2002 2001
----- -----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 38 $ 48
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 25 33
Deferred income taxes 39 36
Changes in current assets and liabilities (16) (48)
Other, net (4) (2)
----- -----
Net cash provided by operating activities 82 67
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital and investment expenditures (39) (30)
Retirements and other (3) --
----- -----
Net cash used in investing activities (42) (30)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Contribution from parent -- 150
Net (increase)/decrease in current note receivable - CMS Capital 57 (148)
Net decrease in non-current note receivable - CMS Capital 76 --
Long-term debt retirements (131) --
Dividends paid (27) (39)
----- -----
Net cash used in financing activities (25) (37)
----- -----
Net Increase in Cash and Temporary Cash Investments 15 --
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD -- --
----- -----
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 15 $ --
===== =====
OTHER CASH FLOW ACTIVITIES WERE:
Interest paid (net of amounts capitalized) $ 38 $ 42
Income taxes paid (net of refunds) 2 7
The accompanying condensed notes are an integral part of these statements.
PE-13
PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
June 30,
2002 December 31,
(Unaudited) 2001
----------- ------------
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Cost $1,683 $1,675
Less accumulated depreciation and amortization 167 142
------ ------
Sub-total 1,516 1,533
Construction work-in-progress 40 24
------ ------
Net property, plant and equipment 1,556 1,557
------ ------
INVESTMENTS IN AFFILIATES 71 66
------ ------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 15 --
Accounts receivable, less allowances of $4 and $3 as of June 30, 2002
and December 31, 2001, respectively 63 114
Gas imbalances - receivable 22 26
System gas and operating supplies 88 55
Deferred income taxes 6 7
Note receivable - CMS Capital 29 86
Other 25 24
------ ------
Total current assets 248 312
------ ------
NON-CURRENT ASSETS
Goodwill, net 700 700
Note receivable - CMS Capital 261 337
Debt issuance cost 5 8
Other 28 30
------ ------
Total non-current assets 994 1,075
------ ------
TOTAL ASSETS $2,869 $3,010
====== ======
The accompanying condensed notes are an integral part of these statements.
PE-14
PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
June 30,
2002 December 31,
(Unaudited) 2001
----------- ------------
COMMON STOCKHOLDER'S EQUITY AND LIABILITIES
CAPITALIZATION
Common stockholder's equity
Common stock, no par, 1,000 shares authorized, issued and outstanding $ 1 $ 1
Paid-in capital 1,286 1,286
Retained earnings 6 (5)
------- -------
Total common stockholder's equity 1,293 1,282
Long-term debt 939 1,082
------- -------
Total capitalization 2,232 2,364
------- -------
CURRENT LIABILITIES
Accounts payable 15 22
Current portion of long-term debt 11 --
Gas imbalances - payable 87 64
Accrued taxes 12 8
Accrued interest 23 26
Accrued liabilities 17 35
Other 34 40
------- -------
Total current liabilities 199 195
------- -------
NON-CURRENT LIABILITIES
Deferred income taxes 177 185
Deferred commitments 178 183
Other 83 83
------- -------
Total non-current liabilities 438 451
------- -------
TOTAL COMMON STOCKHOLDER'S EQUITY AND LIABILITIES $ 2,869 $ 3,010
======= =======
The accompanying condensed notes are an integral part of these statements.
PE-15
PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(Unaudited)
(In millions)
Six Months Six Months
Ended June 30, Ended June 30,
2002 2001
-------------- --------------
COMMON STOCK
At beginning and end of period $ 1 $ 1
------- -------
OTHER PAID-IN CAPITAL
At beginning of period 1,286 1,127
Contribution from parent -- 150
------- -------
At end of period 1,286 1,277
------- -------
RETAINED EARNINGS
At beginning of period (5) (6)
Net income 38 48
Common stock dividends (27) (39)
------- -------
At end of period 6 3
------- -------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 1,293 $ 1,281
======= =======
The accompanying condensed notes are an integral part of these statements.
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PANHANDLE EASTERN PIPE LINE COMPANY
PANHANDLE EASTERN PIPE LINE COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The review of these interim Consolidated Financial Statements has not been
completed by our independent public accountants as required under Rule 10-01(d)
of Regulation S-X. Panhandle expects that this review will occur upon completion
of the re-audit of the restated CMS Energy Consolidated Financial Statements for
each of the fiscal years ended December 31, 2001 and December 31, 2000 and the
completion of the special committee's investigation currently in progress (see
Note 5, Commitments and Contingencies -- SEC investigation and Restatement).
These interim Consolidated Financial Statements have been prepared by Panhandle
in accordance with SEC rules and regulations. As such, certain information and
footnote disclosures normally included in full year financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted. Certain prior year amounts have
been reclassified to conform to the presentation in the current year. In
management's opinion, the unaudited information contained in this report
reflects all adjustments necessary to assure the fair presentation of financial
position, results of operations and cash flows for the periods presented. The
Condensed Notes to Consolidated Financial Statements and the related
Consolidated Financial Statements contained within should be read in conjunction
with the Consolidated Financial Statements and Notes to Consolidated Financial
Statements contained in Panhandle's Form 10-K for the year ended December 31,
2001. Due to the seasonal nature of Panhandle's operations, the results as
presented for this interim period are not necessarily indicative of results to
be achieved for the fiscal year.
1. CORPORATE STRUCTURE AND BASIS OF PRESENTATION
Panhandle Eastern Pipe Line is a wholly owned subsidiary of CMS Gas
Transmission. Panhandle Eastern Pipe Line was incorporated in Delaware in 1929.
Panhandle is engaged primarily in interstate transportation and storage of
natural gas, and through equity investments is also engaged in LNG terminalling
and interstate liquids transportation, and is subject to the rules and
regulations of the FERC.
In December 2001, Panhandle completed a $320 million off-balance sheet
monetization transaction of its Trunkline LNG business and the value created by
long-term contracts for capacity at the Trunkline LNG Lake Charles terminal. The
joint venture transaction resulted in LNG Holdings owning 100 percent of
Trunkline LNG. LNG Holdings is jointly owned by a subsidiary of Panhandle
Eastern Pipe Line and Dekatherm Investor Trust, an unaffiliated entity. The
joint venture (including its $287 million of long-term debt at June 30, 2002) is
not consolidated with Panhandle, reflecting Panhandle's lack of control of the
new entity.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Panhandle Eastern Pipe Line and its wholly owned subsidiaries.
Intercompany transactions and balances have been eliminated. Investments in
affiliated companies where Panhandle has the ability to exercise significant
influence, but not control, are accounted for using the equity method. When
special conditions warrant, for example when an affiliate is a highly leveraged
entity and its capital structure is such that Panhandle's share of net income
cannot be simply stated as a percentage of net income based on its equity
ownership percentage, accounting rules dictate that the preferred approach to
equity income measurement is determined by using the Hypothetical Liquidation at
Book Value (HLBV) method. Panhandle believes such conditions exist with its LNG
Holdings investment, therefore Panhandle uses the HLBV method to account for
earnings from this investment.
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PANHANDLE EASTERN PIPE LINE COMPANY
USE OF ESTIMATES: The preparation of financial statements, in conformity with
accounting principles generally accepted in the United States, requires
management to make judgments, estimates and assumptions that affect the reported
amounts of assets and liabilities, 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
materially differ from those estimates.
SFAS NO. 142, GOODWILL AND OTHER INTANGIBLE ASSETS: SFAS No. 142, issued in July
2001, requires that goodwill no longer be amortized to earnings, but instead be
reviewed for impairment on an annual basis. Goodwill represents the excess of
the fair value of the net assets of acquired companies and was amortized using
the straight-line method, over a forty-year life, through December 31, 2001. The
amortization of goodwill ceased upon adoption of the standard at January 1,
2002. In accordance with the new standard, the first step of testing for
potential goodwill impairment under the new standard was completed in the second
quarter of 2002 which indicates a potentially significant impairment of
Panhandle's goodwill exists as of January 1, 2002 (see Note 3, Goodwill
Impairment). Pursuant to SFAS No. 142 requirements, the actual impairment, when
determined upon completion of the second step of the test, will be reflected as
the cumulative effect of an accounting change, as a restatement of first quarter
2002 results. The required valuation work is being performed by an independent
appraiser and is expected to be completed in the third quarter of 2002.
For purposes of comparison, the following table presents what net income would
have been in the three month and six month periods ended June 30, 2002 and 2001
had there been no amortization of goodwill recorded in those periods.
IN MILLIONS
-------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
JUNE 30 2002 2001 2002 2001
---- ---- ---- ----
Reported Net Income $ 13 $ 11 $ 38 $ 48
Add back: Goodwill amortization -- 5 -- 10
Tax effect
-- (2) -- (4)
---- ---- ---- ----
Adjusted Net Income $ 13 $ 14 $ 38 $ 54
==== ==== ==== ====
SFAS NO. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS:
This new standard was issued by the FASB in October 2001, and supersedes SFAS
No. 121 and APB Opinion No. 30. SFAS No. 144 requires that those long-lived
assets be measured at the lower of either the carrying amount or the fair value
less the cost to sell, whether reported in continuing operations or in
discontinued operations. Therefore, discontinued operations will no longer be
measured at net realizable value or include amounts for operating losses that
have not yet occurred. SFAS No. 144 also broadens the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. The adoption of SFAS
No. 144, effective January 1, 2002, has resulted in Panhandle accounting for
impairments or disposal of long-lived assets under the provisions of SFAS No.
144, but has not changed the accounting used for previous asset impairments or
disposals. The new rule significantly changes the criteria for classifying an
asset as held-for-sale. Adoption of the new standard had no material effect on
Panhandle's consolidated results of operations or financial position.
PE-18
PANHANDLE EASTERN PIPE LINE COMPANY
2. REGULATORY MATTERS
In conjunction with a FERC order issued in September 1997, FERC required certain
natural gas producers to refund previously collected Kansas ad-valorem taxes to
interstate natural gas pipelines, including Panhandle Eastern Pipe Line. FERC
ordered the pipelines to refund these amounts to their customers. In June 2001,
Panhandle Eastern Pipe Line filed a proposed settlement with the FERC which was
supported by most of the customers and affected producers. In October 2001, the
FERC approved that settlement. The settlement provided for a resolution of the
Kansas ad-valorem tax matter on the Panhandle Eastern Pipe Line system for a
majority of refund amounts. Certain producers and the state of Missouri elected
to not participate in the settlement. At June 30, 2002 and December 31, 2001,
accounts receivable included $8 million due from natural gas producers, and
other current liabilities included $12 million and $11 million, respectively,
for related obligations. Remaining amounts collected but not refunded are
subject to refund pending resolution of issues remaining in the FERC docket and
Kansas intrastate proceeding.
In July 2001, Panhandle Eastern Pipe Line filed a settlement with customers on
Order 637 matters to resolve issues including capacity release and imbalance
penalties, among others. On October 12, 2001 and December 19, 2001 FERC issued
orders approving the settlement, with modifications. The settlement changes
became final effective February 1, 2002, resulting in a non-recurring gain of $4
million in Other revenue and a $2 million reversal of interest expense for
previously collected penalties retained.
In August 2001, an offer of settlement of Trunkline LNG rates sponsored jointly
by Trunkline LNG, BG LNG Services and Duke LNG Sales was filed with the FERC and
was approved on October 11, 2001. The settlement was placed into effect on
January 1, 2002. As part of the settlement, Trunkline LNG, now owned by LNG
Holdings, reduced its maximum rates.
In December 2001, Trunkline LNG, now partially owned by Panhandle, filed with
the FERC a certificate application to expand the Lake Charles facility to
approximately 1.2 billion cubic feet per day of sendout capacity versus the
current capacity of 630 million cubic feet per day. The BG Group has contract
rights for all of this additional capacity. Storage capacity will also be
expanded to 9 billion cubic feet, from its current capacity of 6.3 billion cubic
feet. On July 31, 2002, the FERC issued its Environmental Assessment of the
expansion project, with comments due to be filed in thirty days. The application
for a certificate of public convenience and necessity of the expansion is still
pending the action. The expansion expenditures are currently expected to be
funded by Panhandle loans or equity contributions to LNG Holdings, which would
be sourced by repayment by CMS Capital to Panhandle on its outstanding note
receivable or by a capital market or other funding.
Panhandle has sought refunds from the State of Kansas concerning certain
corporate income tax issues for the years 1981 through 1984. On January 25, 2002
the Kansas Supreme Court entered an order affirming a previous Board of Tax
Court finding that Panhandle was entitled to refunds which with interest total
approximately $26 million. Pursuant to the provisions of the purchase agreement
between CMS Energy and a subsidiary of Duke Energy, Duke retains the benefits of
any tax refunds or liabilities for periods prior to the date of the sale of
Panhandle to CMS Energy.
In February 2002, Trunkline Gas filed a settlement with customers on Order 637
matters to resolve issues including capacity release and imbalance penalties,
among others. On July 5, 2002 FERC issued an order approving the settlement,
with modifications. Trunkline's compliance filing and any requests for rehearing
are expected to be filed in August 2002.
PE-19
PANHANDLE EASTERN PIPE LINE COMPANY
3. GOODWILL IMPAIRMENT
Panhandle has completed the first step of the goodwill impairment testing
required upon adoption of SFAS No. 142, which indicates a potentially
significant impairment of Panhandle's goodwill exists as of January 1, 2002
under the new standard. Panhandle has $700 million of goodwill recorded as of
January 1, 2002 which is subject to this impairment test. Pursuant to SFAS No.
142 requirements, the actual amount of impairment is determined in a second step
involving a detailed valuation of all assets and liabilities utilizing an
independent appraiser and when determined, will be reflected as a cumulative
effect of an accounting change, restated to the first quarter of 2002. This
valuation work is underway and expected to be completed in the third quarter of
2002 and results will be announced after completion and review by the company.
4. RELATED PARTY TRANSACTIONS
IN MILLIONS
--------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- --------------------
JUNE 30 2002 2001 2002 2001
- ------- ---- ---- ---- ----
Transportation and storage of natural gas $16 $14 $29 $27
LNG terminalling revenue -- 11 -- 20
Other revenues 6 -- 5 4
Operation and maintenance
11 10 23 21
Other income 2 2 4 4
Panhandle has a number of significant transactions with related parties. Revenue
generating transactions, primarily for the transportation of natural gas for
Consumers, CMS MS&T and the MCV Partnership, are based on regulated prices,
market prices or competitive bidding. Related party expenses include payments
for services provided by affiliates and payment of overhead costs to CMS Gas
Transmission and CMS Energy, as well as allocated benefit plan costs. Other
income is primarily interest income from the Note receivable - CMS Capital.
Other revenue for the three month and six month periods ended June 30, 2002
includes equity earnings of $8 million in the second quarter of 2002 related to
Panhandle's investment in LNG Holdings. Prior to the monetization of Trunkline
LNG in December 2001, income from this business was reflected in LNG
terminalling revenue. The increases were partially offset by equity losses
related to the Centennial Pipeline of $2 million and $3 million, respectively,
in the three and six month periods of 2002.
In the three months and six months ended June 30, 2002 and 2001, Other income
includes $2 million and $4 million, respectively, of interest income on the note
receivable from CMS Capital.
PE-20
PANHANDLE EASTERN PIPE LINE COMPANY
A summary of certain balances due to or due from related parties included in the
Consolidated Balance Sheets is as follows:
IN MILLIONS
--------------------------
JUNE 30, DECEMBER 31,
2002 2001
-------- ------------
Note receivable - CMS Capital $290 $423
Accounts receivable 26 61
Accounts payable 4 7
Accrued liabilities 3 2
Current portion of long-term debt 11 --
Long-term debt 58 75
Deferred income taxes 45 --
Deferred commitments 178 183
At June 30, 2002, Note receivable - CMS Capital represented a $290 million note
that bore interest at the 30-day commercial paper interest rate, $29 million of
which is shown as current based on estimated draws during the next twelve
months. During April and May 2002, $124 million of the note receivable with CMS
Capital was utilized to pay a portion of Panhandle's long-term debt. Due to CMS
Energy's financial condition, the liquidity of this note is adversely affected
and proceeds may not be immediately available upon demand by Panhandle.
Accounts receivable includes $19 million of tax related receivables from CMS
Energy due in November 2002. Deferred taxes include $45 million of tax losses
generated by Panhandle which have not been utilized by CMS Energy and are not
expected to be utilized within the next twelve months. Due to CMS Energy's
financial condition, the liquidity of these receivables is adversely affected
and funds may not be available to Panhandle when amounts are due. Deferred
commitments represents proceeds received by Panhandle from the LNG monetization
transaction which are committed to be reinvested in the LNG Holdings expansion
project filed with FERC by Trunkline LNG in December 2001.
5. COMMITMENTS AND CONTINGENCIES
CAPITAL EXPENDITURES: Panhandle currently estimates capital expenditures and
investments, including interest costs capitalized, to be $124 million in 2002,
$78 million in 2003 and $102 million in 2004. These amounts include expenditures
associated with an LNG terminal expansion which was filed with FERC in December
2001 by Trunkline LNG. The expansion expenditures (excluding capitalized
interest), estimated at $11 million in 2002, $5 million in 2003 and $30 million
in 2004, are currently expected to be funded by Panhandle loans or equity
contributions to LNG Holdings, sourced by repayments from CMS Capital on the
outstanding note receivable (see Note 5, Related Party Transactions). Panhandle
prepared these estimates for planning purposes and they are therefore subject to
revision. Panhandle satisfies capital expenditures using cash from operations,
repayment of loans to CMS Capital and contributions from the parent.
LITIGATION: Panhandle is involved in legal, tax and regulatory proceedings
before various courts, regulatory commissions and governmental agencies
regarding matters arising in the ordinary course of business, some of which
involve substantial amounts. Where appropriate, Panhandle has made accruals in
accordance with SFAS No. 5 in order to provide for such matters. Management
believes the final disposition of these proceedings will not have a material
adverse effect on consolidated results of operations, liquidity, or financial
position.
PE-21
PANHANDLE EASTERN PIPE LINE COMPANY
ENVIRONMENTAL MATTERS: Panhandle is subject to federal, state and local
regulations regarding air and water quality, hazardous and solid waste disposal
and other environmental matters. Panhandle has identified environmental
contamination at certain sites on its systems and has undertaken clean-up
programs at these sites. The contamination resulted from the past use of
lubricants in compressed air systems containing PCBs and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle
communicated with the EPA and appropriate state regulatory agencies on these
matters. Under the terms of the sale of Panhandle to CMS Energy, a subsidiary of
Duke Energy is obligated to complete the Panhandle clean-up programs at certain
agreed-upon sites and to indemnify against certain future environmental
litigation and claims. Panhandle expects these clean-up programs to continue for
many years and has estimated its share of remaining clean-up costs not
indemnified by Duke Energy to be approximately $18 million. Such costs have been
accrued for and are reflected in Panhandle's Consolidated Balance Sheet in Other
Non-current Liabilities.
The Illinois EPA included Panhandle Eastern Pipe Line and Trunkline, together
with other non-affiliated parties, in a cleanup of former waste oil disposal
sites in Illinois. Prior to a partial cleanup by the EPA, a preliminary study
estimated the cleanup costs at one of the sites to be between $5 million and $15
million. The State of Illinois contends that Panhandle Eastern Pipe Line's and
Trunkline's share for the costs of assessment and remediation of the sites,
based on the volume of waste sent to the facilities, is approximately 17
percent. Panhandle expects this clean-up to continue for many years and has
estimated its share of remaining clean-up costs to be approximately $3 million.
Such costs have been accrued for and are reflected in Panhandle's Consolidated
Balance Sheet in Other Non-current Liabilities.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. This EPA ruling was challenged in court by various states,
industry and other interests, including the INGAA, an industry group to which
Panhandle belongs. In March 2000, the court upheld most aspects of the EPA's
rule, but agreed with INGAA's position and remanded to the EPA the sections of
the rule that affected Panhandle. Based on the court's decision, most of the
states subject to the rule submitted their SIP revisions in October 2000.
However, the EPA must revise the section of the rule that affected Panhandle's
facilities. Panhandle expects the EPA to make this section of the rule effective
in 2002 and expects the future costs to range from $13 million to $29 million
for capital improvements to comply.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm Compressor Station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. It is expected that the capital improvements
will occur in 2002 and 2003.
SEC Investigation: CMS Energy's Board of Directors has established a special
committee of independent directors to investigate matters surrounding "round
trip" trading and has retained outside counsel to assist in the investigation.
The committee expects to complete its investigation and report its findings to
the Board of Directors by the end of third quarter 2002. In addition, CMS Energy
is cooperating with the SEC investigation regarding the round trip trades and
the Company's financial statements, accounting practices and controls. CMS
Energy is also cooperating with inquiries by the Commodity Futures Trading
Commission and FERC regarding these transactions. CMS Energy has also received
subpoenas from the U.S. Attorney's Office for the Southern District of New York
and from the U.S. Attorney's Office in Houston regarding investigations of these
trades and has received a number of shareholder class action lawsuits. CMS
Energy is unable to predict the outcome of these matters.
Restatement: Following CMS Energy's announcement that it would restate its
financial statements for 2000 and 2001 to eliminate the effects of "round trip"
energy trades and form a special committee of its Board of Directors to
investigate these trades, CMS Energy received formal notification from Arthur
Andersen that it had terminated its relationship with CMS Energy and affiliates.
Arthur Andersen notified CMS Energy that due to the investigation, Arthur
Andersen's historical opinions on CMS Energy's financials for the periods being
restated cannot be relied upon. Arthur Andersen clarified in its notification to
CMS Energy that its decision does not apply to separate, audited statements of
Panhandle Eastern Pipe Line Company for the applicable years. Arthur Andersen
also notified CMS Energy that due to Arthur Andersen's current situation and the
work of the special committee, they would be unable to give an opinion on CMS
Energy's restated financial statements when they are completed. CMS Energy had
previously announced that it would no longer use Arthur Andersen for its
independent audit work and in May 2002, CMS Energy appointed Ernst & Young to
audit the financial statements for the year ending December 31, 2002. Ernst &
Young is currently auditing CMS Energy's restated consolidated financial
statements, which includes audit work at Panhandle for each of the fiscal years
ended December 31, 2001 and December 31, 2000, and is expected to release its
opinion upon the completion of its audit procedures and the special committee's
investigation. The unavailability of audit opinions, reviews and comfort letters
severely limits Panhandle's access to capital markets.
OTHER COMMITMENTS AND CONTINGENCIES: In 1993, the U.S. Department of the
Interior announced its intention to seek additional royalties from gas producers
as a result of payments received by such producers in connection with past
take-or-pay settlements, and buyouts and buydowns of gas sales contracts with
natural gas pipelines. Panhandle's pipelines, with respect to certain producer
contract settlements, may be contractually required to reimburse or, in some
instances, to indemnify producers against such royalty claims. The potential
liability of the producers to the government and of the pipelines to the
producers involves complex issues of law and fact which are likely to take
substantial time to resolve. If required to reimburse or indemnify the
producers, Panhandle's pipelines will file with FERC to recover a portion of
these costs from pipeline customers. Management believes these
PE-22
PANHANDLE EASTERN PIPE LINE COMPANY
commitments and contingencies will not have a material adverse effect on
consolidated results of operations, liquidity or financial position.
In December 2001, Panhandle contributed its interest in Trunkline LNG to LNG
Holdings which then raised $30 million from the issuance of equity to Dekatherm
Investor Trust and $290 million from non-recourse bank loans. Panhandle
guaranteed repayment of $90 million of these loans if the joint venture had not
obtained replacement lenders by March 2002. Replacement lenders were found by
LNG Holdings, and Panhandle was not required to perform under the guaranty,
which is now expired. Panhandle Eastern Pipe Line has provided indemnities to
certain parties involved in the transaction for pre-closing claims and
liabilities, and subsidiaries of Panhandle have provided indemnities for certain
post-closing expenses and liabilities as the manager/operator of the joint
venture.
Panhandle has a note payable to LNG Holdings, which now is callable due to the
lowering of Panhandle's debt ratings (See Note 6, Debt Rating Downgrades). At
June 30, 2002 Panhandle's remaining balance on the original $75 million note
payable was $69 million.
Panhandle owns a one-third interest in Centennial along with TEPPCO Partners
L.P. and Marathon Ashland Petroleum LLC. In May 2001, in conjunction with the
Centennial Pipeline project which began commercial service in April 2002,
Panhandle has provided a guaranty related to project financing in an amount up
to $50 million during the initial operating period of the project. The guaranty
will be released when Centennial reaches certain operational and financial
targets. Due to rating agency downgrades of Panhandle's debt, the Centennial
lender has assessed credit fees and is requiring additional credit support from
Panhandle by August 27, 2002. For further information, see Note 6, Debt Rating
Downgrades.
Panhandle owns a one-third interest in Guardian along with Viking Gas
Transmission and WICOR. Guardian is currently constructing a 141-mile, 36-inch
pipeline from Illinois to Wisconsin for the transportation of natural gas. In
November 2001, in conjunction with the Guardian Pipeline project, Panhandle
provided a guaranty related to project financing for a maximum of $60 million
during the construction and initial operating period of the project, which is
expected to be completed in November 2002. The guaranty will be released when
Guardian reaches certain operational and financial targets. Due to rating agency
downgrades of Panhandle's debt, the Guardian lender has assessed credit fees and
is requiring additional credit support from Panhandle by August 27, 2002. For
further information, see Note 6, Debt Rating Downgrades.
Panhandle has a deferred state tax asset attributable to temporary differences
reflecting state tax loss carryforwards of $11 million as of June 30, 2002.
These carryforwards expire after 15 years, and their application for reduction
of future taxes is dependent on Panhandle's taxable income in 2013 and beyond
when these assets begin to expire. The possibility exists that this deferred tax
asset may not being fully realized, and a valuation allowance may be required at
some point in the future.
6. DEBT RATING DOWNGRADES
On June 11, 2002 Moody's Investors Service, Inc. lowered its rating on
Panhandle's senior unsecured notes from Baa3 to Ba2 based on concerns
surrounding the liquidity and debt levels of CMS Energy. On July 15, 2002 Fitch
Ratings, Inc lowered its rating on these notes from BBB to BB+ based on similar
concerns. On July 16, 2002 S&P also lowered its rating on these notes from BBB-
to BB, in line with their rating on CMS Energy based on their belief that CMS
Energy and its subsidiaries are at equal risk of default since the parent relies
on its subsidiaries to meet its financial commitments. Effective with this
downgrade, Panhandle's debt is below investment grade. Each of the three major
ratings services currently have negative outlooks for CMS Energy and its
subsidiaries, due to uncertainties associated with CMS Energy's financial
condition and liquidity pending resolution of the round trip trading
PE-23
PANHANDLE EASTERN PIPE LINE COMPANY
investigations and lawsuits, the special board committee investigation,
financial statement restatement and re-audit, and access to the capital markets.
Panhandle, as a result of the ratings downgrade by both Moody's and S&P to below
investment grade levels, upon the request of the equity partner, can be required
to pay the balance of the demand loan owed LNG Holdings including the remaining
principal and accrued interest at any time such downgrades exist. No such demand
has been made to date. At June 30, 2002, Panhandle's remaining balance on the
note payable to LNG Holdings was $69 million.
In conjunction with the Centennial and Guardian pipeline projects, Panhandle has
provided guarantees related to the project financings during the construction
phases and initial operating periods. On July 17, following the debt downgrades
by Moody's and S&P, the lender sent notice to Panhandle, pursuant to the terms
of the Guaranty Agreement, requiring Panhandle to provide acceptable credit
support for its pro rata portion of these construction loans, which aggregate
$110 million including anticipated future draws. Panhandle has 30 business days,
until August 27, 2002, to provide such credit support. If Panhandle does not
provide such credit support, the other partners would have 30 business days to
provide such credit support or the debt would become due and payable with
premiums due. Partners providing such credit support can charge certain fees to
Panhandle during any period for which such credit support is provided. In the
interim, credit fees have been assessed based on a rate specified by the lender
and applied to Panhandle's share of the outstanding debt balance of Guardian and
Centennial.
Panhandle is working with its contracted parties with respect to these ratings
downgrades, to find mutually satisfying arrangements, but there can be no
assurance of reaching such arrangements.
Panhandle's senior unsecured notes are not impacted by the debt rating
downgrades, but are subject to other requirements such as the maintenance of
certain fixed charge coverage ratios and leverage ratios, limitations on liens,
and restrictions from certain payments. At June 30, 2002, Panhandle was in
compliance with all covenants.
7. SYSTEM GAS
Panhandle classifies its current system gas at lower of cost or market. Amounts
for system gas, reflected in System gas and operating supplies on the
consolidated balance sheet, are $77 million and $45 million at an average of
$3.52 and $2.50 per dekatherm at June 30, 2002 and December 31, 2001,
respectively. Panhandle classifies its non-current system gas in Other
non-current assets and it is recorded at cost of $8 million and $18 million at
June 30, 2002 and December 31, 2001, respectively.
8. SUBSEQUENT EVENT
CMS Energy is exploring the sale of the Panhandle and CMS Field Services
business units as part of an ongoing effort to strengthen its balance sheet,
improve its credit ratings and enhance financial flexibility. The units to be
considered for sale include Panhandle Eastern Pipe Line Company, Trunkline Gas
Company, Sea Robin, Pan Gas Storage and Panhandle's interests in LNG Holdings,
Guardian and Centennial. CMS Energy had previously announced an intention to
sell Panhandle's separate interest in Centennial but these efforts are being
discontinued. CMS Energy has begun assessing the market's interest in purchasing
the pipeline and field services businesses, and it is reviewing the financial,
legal and regulatory issues associated with the possible sale.
PE-24
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
CMS ENERGY
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CMS ENERGY CORPORATION'S MANAGEMENT'S DISCUSSION AND ANALYSIS, which is
incorporated by reference herein.
CONSUMERS
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CONSUMERS' ENERGY COMPANY'S MANAGEMENT'S DISCUSSION AND ANALYSIS, which is
incorporated by reference herein.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to the CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS, in particular Note 2 - Uncertainties for CMS Energy and Consumers,
and Note 4 - Commitments and Contingencies for Panhandle, included herein for
additional information regarding various pending administrative and judicial
proceedings involving rate, operating, regulatory and environmental matters.
SEC/COMMODITY FUTURE TRADING COMMISSION/DEPARTMENT OF JUSTICE/
FERC INVESTIGATION
CMS Energy has received both informal letters and subpoenas from the SEC,
Commodity Futures Trading Commission, and the U.S. Attorneys Offices in the
Southern District of New York and the Southern District of Texas and FERC
requesting information and documentation related to "round trip" trades at CMS
Energy. By order dated July 1, 2002, the SEC commenced a formal private
investigation of CMS's financial statements, accounting practices and controls.
The scope of the investigation has broadened to include all marketing and
trading by all CMS Energy companies. We have made several submissions of
requested information to SEC, Commodity Futures Trading Commission, Departments
of Justice and FERC and production of additional information is ongoing. It is
expected that these investigations will continue, and expand to include
testimony to be given to the agencies and/or grand juries, for several months
before any conclusion would be made, or a formal charge or action would be taken
against CMS Energy or any individual, by any of these agencies. Several current
and former officers and employees of CMS Energy companies have engaged their own
counsel to defend them in connection with the administrative and criminal
investigation, any related litigation and any shareholder litigation in which
they are or may be named as a defendant. We are working with our insurers to
obtain coverage for the expenses and possibly the final settlement or judgment
with respect to these investigations.
SHAREHOLDER CLASS ACTION LAWSUITS
Eighteen separate civil lawsuits have been filed in federal court in Michigan in
connection with round-trip trading, alleging (i) violation of Section 10(b) and
Rule 10b-5 of the Securities Exchange Act of 1934 ("Exchange Act") and (ii)
violation of Section 20(a) of the Exchange Act. (See Exhibit 99(d) for a case
names, dates instituted and principal parties) All suits name Messrs. McCormick
and Wright and CMS Energy as defendants. Mr. Joos is named as defendant in all
but two of the suits, and Consumers Energy and Ms. Pallas are named as
defendants on certain of the suits. Counsel to CMS has obtained an extension of
the time to respond to these claims until mid-September. Prior to that date the
cases will be consolidated into a single lawsuit. These complaints generally
seek unspecified damages based on allegations that the defendants violated
United States securities laws and regulations by making allegedly false and
misleading statements about the Company's business and financial condition. The
Company intends to vigorously defend against these actions.
DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS
The Board of Directors of CMS Energy received a demand, on behalf of a
shareholder of CMS
CO-1
common stock, that it commence civil actions (i) to remedy alleged breaches of
fiduciary duties by CMS officers and directors in connection with round-trip
trading at CMS, and (ii) to recover damages sustained by CMS as a result of
alleged insider trades alleged to have been made by certain current and former
officers of CMS and its subsidiaries. The Board has until November 18, 2002
to determine whether it will pursue such claims. If the Board elects not to do
so, the shareholder has stated that he will initiate a derivative suit, bringing
such claims on behalf of CMS.
EMPLOYMENT RETIREMENT INCOME SECURITY ACT CLAIMS
On July 11, 2002 and July 18, 2002, Rodger Schilling and Karen Potter, two
Consumers Energy employees, filed separate alleged class action lawsuits on
behalf of the participants and beneficiaries of the CMS Employees' Savings and
Incentive Plan in the United States District Court for the Eastern District of
Michigan. CMS Energy, Consumers Energy and CMS MS&T are defendants in one
action, and CMS Energy, Consumers Energy, and other alleged fiduciaries are
defendants in the other. In connection with round-trip trades, the complaints
allege retirement account losses resulting from breaches of the fiduciary
obligations by the fiduciaries of the Plan. The complaints allege various counts
arising under the Employee Retirement Income Security Act.
AMERICAN HOME ASSURANCE COMPANY
American Home Assurance Company ("AHA") is one of the issuers of a joint and
several surety bond with a remaining surety amount of approximately $190 million
supporting a CMS MST gas supply contract. AHA has demanded that CMS Enterprises
and CMS MST post acceptable collateral for the remaining surety amount, and on
August 9, 2002, AHA filed a lawsuit against CMS Enterprises and CMS MST in the
United States District Court for the Eastern District of Michigan. In its
lawsuit, AHA is seeking to require CMS Enterprises and CMS MST to post
acceptable collateral and to enjoin CMS Enterprises and CMS MST from disposing
of or transferring any corporate assets outside the ordinary course of business
until AHA's claim is fully adjudicated. CMS Enterprises and CMS MST intend to
vigorously contest AHA's request for injunctive relief but continue to work with
AHA to find mutually satisfying arrangements.
CO-2
CMS ENERGY, CONSUMERS AND PANHANDLE
ENVIRONMENTAL MATTERS: CMS Energy, Consumers, Panhandle and their subsidiaries
and affiliates are subject to various federal, state and local laws and
regulations relating to the environment. Several of these companies have been
named parties to various actions involving environmental issues. Based on their
present knowledge and subject to future legal and factual developments, CMS
Energy, Consumers and Panhandle believe that it is unlikely that these actions,
individually or in total, will have a material adverse effect on their financial
condition. See CMS Energy's, Consumers' and Panhandle's MANAGEMENT'S DISCUSSION
AND ANALYSIS; and CMS Energy's, Consumers' and Panhandle's CONDENSED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS CMS ENERGY
CORPORATION
At the CMS Energy Annual Meeting of Shareholders held on May 24, 2002, the
shareholders ratified the appointment of Ernst & Young LLP as independent
auditors of CMS Energy for the year ended December 31, 2002. The vote was
103,043,984 shares in favor and 3,520,760 against, with 7,443,971 abstaining.
The CMS Energy shareholders also elected all eleven nominees for the office of
director. The votes for individual nominees were as follows:
CMS ENERGY CORPORATION
Number of Votes: For Against Total
-----------------------------------------------------------------------
William T. McCormick, Jr. 108,082,379 5,926,336 114,008,715
John M. Deutch 110,202,328 3,806,387 114,008,715
James J. Duderstadt 110,345,903 3,662,812 114,008,715
Kathleen R. Flaherty 110,844,552 3,164,163 114,008,715
Earl D. Holton 100,776,119 3,232,596 114,008,715
David W. Joos 110,919,904 3,088,811 114,008,715
William U. Parfet 110,370,489 3,638,226 114,008,715
Percy A. Pierre 110,338,693 3,670,022 114,008,715
Kenneth L. Way 110,837,721 3,170,994 114,008,715
Kenneth Whipple 110,776,017 3,232,698 114,008,715
John B. Yasinsky 110,376,992 3,631,723 114,008,715
Consumers did not solicit proxies for the matters submitted to votes at the
contemporaneous May 24, 2002 Consumers' Annual Meeting of Shareholders. All
84,108,789 shares of Consumers Common Stock were voted in favor of re-electing
the above-named individuals as directors of Consumers and in favor of ratifying
the appointment of Ernst & Young LLP as independent auditors of Consumers for
the year ended December 31, 2002. None of the 441,599 shares of Consumers
Preferred Stock were voted at the Annual Meeting.
ITEM 5. OTHER INFORMATION
In order for a shareholder to submit a proposal for a vote at the CMS Energy
2003 Annual Meeting, the shareholder must assure that CMS Energy receives the
proposal on or before March 6, 2003. CMS Energy will not include shareholder's
proposals in the CMS Energy's proxy
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statement. The shareholder must address the proposal to: Mr. Michael VanHemert,
Corporate Secretary, Fairlane Plaza South, Suite 1100, 330 Town Center Drive,
Dearborn, Michigan 48126. If the shareholder fails to submit the proposal on or
before March 6, 2003, then management may use its discretionary voting authority
to decide if it will submit the proposal to vote when the shareholder raises the
proposal at the CMS Energy 2003 Annual Meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) LIST OF EXHIBITS
(10)(a) Acknowledgement of Resignation between Tamela W. Pallas and CMS Energy
Corporation
(10)(b) Employment, Separation and General Release Agreement between William T.
McCormick and CMS Energy Corporation
(10)(c) Resignation and General Release Agreement between Alan M. Wright and
CMS Energy Corporation
(12) CMS Energy: Statements regarding computation of Ratio of Earnings to
Fixed Charges
(99)(a) CMS Energy Corporation's Letter regarding Section 906 of the
Sarbanes-Oxley Act of 2002
(99)(b) Consumers Energy Company's Letter regarding Section 906 of the
Sarbanes-Oxley Act of 2002
(99)(c) Panhandle Eastern Pipe Line Corporation's Letter regarding Section 906
of the Sarbanes-Oxley Act of 2002
99(d) Shareholder Class Action Lawsuits Summary
99(e) Statement Under Oath of Chief Executive Officer of CMS Energy
Corporation Regarding Facts and Circumstances Relating to Exchange Act
Filings
99(f) Statement Under Oath of Chief Financial Officer of CMS Energy
Corporation Regarding Facts and Circumstances Relating to Exchange Act
Filings
(b) REPORTS ON FORM 8-K
CMS ENERGY
During 1st Quarter 2002, CMS Energy filed reports of Form 8-K on May 29, 2002
covering matters pursuant to ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING
ACCOUNTANT and pursuant to ITEM 5. OTHER EVENTS and on June 11, 2002 covering
matters pursuant to ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT and on
July 30, 2002 and August 8, 2002 covering matters pursuant to ITEM 5. OTHER
EVENTS.
CONSUMERS
During 1st Quarter 2002, Consumers filed reports of Form 8-K on May 29, 2002
covering matters pursuant to ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING
ACCOUNTANT and pursuant to ITEM 5. OTHER EVENTS and on June 11, 2002 covering
matters pursuant to
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ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT and on July 30, 2002 and
August 8, 2002 covering matters pursuant to ITEM 5. OTHER EVENTS.
PANHANDLE
During 1st Quarter 2002, Panhandle filed reports of Form 8-K on June 11, 2002
covering matters pursuant to ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING
ACCOUNTANT and on July 30, 2002 and August 8, 2002 covering matters pursuant to
ITEM 5. OTHER EVENTS.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiary.
CMS ENERGY CORPORATION
---------------------------------------
(Registrant)
Dated: August 14, 2002 By: /s/ A.M. Wright
-------------------------------------
Alan M. Wright
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
CONSUMERS ENERGY COMPANY
----------------------------------------
(Registrant)
Dated: August 14, 2002 By: /s/ A.M. Wright
-------------------------------------
Alan M. Wright
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
PANHANDLE EASTERN PIPE LINE COMPANY
----------------------------------------
(Registrant)
Dated: August 14, 2002 By: /s/ C.A. Helms
-------------------------------------
Christopher A. Helms
President and Chief Executive Officer
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================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
CMS ENERGY CORPORATION,
CONSUMERS ENERGY COMPANY
AND
PANHANDLE EASTERN PIPE LINE COMPANY
FORM 10-Q
EXHIBITS
FOR QUARTER ENDED JUNE 30, 2002
================================================================================
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
(10)(a) Acknowledgement of Resignation between Tamela W. Pallas and CMS Energy
Corporation
(10)(b) Employment, Separation and General Release Agreement between William T.
McCormick and CMS Energy Corporation
(10)(c) Resignation and General Release Agreement between Alan M. Wright and
CMS Energy Corporation
(12) CMS Energy: Statements regarding computation of Ratio of Earnings to
Fixed Charges
(99)(a) CMS Energy Corporation's Letter regarding Section 906 of the
Sarbanes-Oxley Act of 2002
(99)(b) Consumers Energy Company's Letter regarding Section 906 of the
Sarbanes-Oxley Act of 2002
(99)(c) Panhandle Eastern Pipe Line Corporation's Letter regarding Section 906
of the Sarbanes-Oxley Act of 2002
99(d) Shareholder Class Action Lawsuits Summary
99(e) Statement Under Oath of Chief Executive Officer of CMS Energy
Corporation Regarding Facts and Circumstances Relating to Exchange Act
Filings
99(f) Statement Under Oath of Chief Financial Officer of CMS Energy
Corporation Regarding Facts and Circumstances Relating to Exchange Act
Filings
(b) REPORTS ON FORM 8-K