Back to GetFilings.com
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
================================================================================
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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.
- ----------- ----------------------------- ------------------
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
212 West Michigan Avenue, Jackson, Michigan 49201
(517)788-0550
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Registrant Title of Class on Which Registered
---------- -------------- -----------------------
CONSUMERS ENERGY COMPANY Preferred Stocks, $100 par value: $4.16 Series, $4.50 Series New York Stock Exchange
CONSUMERS POWER
COMPANY FINANCING I 8.36% Trust Originated Preferred Securities New York Stock Exchange
CONSUMERS ENERGY
COMPANY FINANCING II 8.20% Trust Originated Preferred Securities New York Stock Exchange
CONSUMERS ENERGY
COMPANY FINANCING III 9.25% Trust Originated Preferred Securities New York Stock Exchange
CONSUMERS ENERGY
COMPANY FINANCING IV 9.00% Trust Originated Preferred Securities New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether Registrant is an accelerated filer (as defined
in Exchange Act Rule 12b-2). Yes No X
--- ---
As of June 28, 2002 and March 15, 2003, CMS Energy held all voting and
non-voting common equity of Consumers.
Documents incorporated by reference: Consumers' information statement relating
to the 2003 annual meeting of shareholders to be held May 23, 2003, is
incorporated by reference in Part III, except for the organization and
compensation committee report and audit committee report contained therein.
================================================================================
CONSUMERS ENERGY COMPANY
Annual Report on Form 10-K to the Securities and Exchange Commission
for the Year Ended December 31, 2002
TABLE OF CONTENTS
Page
Glossary ............................................................................................. 3
PART I:
Item 1. Business..................................................................................... 7
Item 2. Properties................................................................................... 20
Item 3. Legal Proceedings............................................................................ 20
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 20
PART II:
Item 5. Market for Consumers' Common Equity and Related Stockholder Matters.......................... 21
Item 6. Selected Financial Data...................................................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................... 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................... 21
Item 8. Financial Statements and Supplementary Data.................................................. 22
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.................................................................... 104
PART III:
Item 10. Directors and Executive Officers of Consumers................................................ 105
Item 11. Executive Compensation....................................................................... 105
Item 12. Security Ownership of Certain Beneficial Owners and Management............................... 105
Item 13. Certain Relationships and Related Transactions............................................... 105
Item 14. Controls and Procedures...................................................................... 105
PART IV:
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................. 106
-2-
GLOSSARY
Certain terms used in the text and financial statements are defined below.
ABATE..................................... Association of Businesses Advocating Tariff Equity
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
AEP....................................... American Electric Power Co.
ALJ....................................... Administrative Law Judge
Alliance.................................. Alliance Regional Transmission Organization
AMT....................................... Alternative minimum tax
APB....................................... Accounting Principles Board
APB Opinion No. 25........................ APB Opinion No. 25, "Accounting for Stock Issued to Employees"
APB Opinion No. 30........................ APB Opinion No. 30, "Reporting Results of Operations -- Reporting the
Effects of Disposal of a Segment of a Business"
Arthur Andersen........................... Arthur Andersen, LLP
Articles.................................. Articles of Incorporation
Attorney General.......................... Michigan Attorney General
bcf....................................... Billion cubic feet
Big Rock.................................. Big Rock Point nuclear power plant, owned by Consumers
Board of Directors........................ Board of Directors of CMS
Bookouts.................................. Unplanned netting of transactions from multiple contracts
Btu....................................... British thermal unit
CEO....................................... Chief Executive Officer
CFO....................................... Chief Financial Officer
Clean Air Act............................. Federal Clean Air Act, as amended
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 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, formerly a subsidiary of Enterprises
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
Consumers Funding......................... Consumers Funding, L.L.C., a special consolidated subsidiary of
Consumers
Consumers Receivables Funding............. Consumers Receivables Funding, 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 alternative
electric suppliers no later than 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
-3-
Detroit Edison............................ The Detroit Edison Company, a non-affiliated company
DOE....................................... U.S. Department of Energy
Dow....................................... The Dow Chemical Company, a non-affiliated company
DSM....................................... Demand-side management
EISP...................................... Executive Incentive Separation Plan
EITF...................................... Emerging Issues Task Force
EITF No. 97-4............................. EITF 97-4, "Deregulation of the Pricing of Electricity"
Enterprises............................... CMS Enterprises Company, a subsidiary of CMS Energy
EPA....................................... U. S. Environmental Protection Agency
EPS....................................... Earnings per share
ERISA..................................... Employee Retirement Income Security Act
Ernst & Young............................. Ernst & Young LLP
FASB...................................... Financial Accounting Standards Board
FERC...................................... Federal Energy Regulatory Commission
FMLP...................................... First Midland Limited Partnership, a partnership which holds a lessor
interest in the MCV facility
GCR....................................... Gas cost recovery
Health Care Plan.......................... The medical, dental, and prescription drug programs offered to
eligible employees of Panhandle, Consumers and CMS Energy
IPP....................................... Independent Power Producer
ISO....................................... Independent System Operator
ITC....................................... Investment tax credit
kWh....................................... Kilowatt-hour
LIBOR..................................... London Inter-Bank Offered Rate
Ludington................................. Ludington pumped storage plant, jointly owned by Consumers and Detroit
Edison
MACT...................................... Maximum Achievable Control Technology
Massachusetts Formula..................... A widely used and FERC accepted method of allocating general and
administrative expenses, based on three factors: property, sales and payroll
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
METC...................................... Michigan Electric Transmission Company, a former subsidiary of
Consumers Energy, and now an indirect subsidiary of Trans-Elect, Inc.
Michigan Gas Storage...................... Michigan Gas Storage Company, a former subsidiary of Consumers that
merged into Consumers in November 2002
MISO...................................... Midwest Independent System Operator
Moody's................................... Moody's Investors Service, Inc.
MPSC...................................... Michigan Public Service Commission
MTH....................................... Michigan Transco Holdings, Limited Partnership
MW........................................ Megawatts
-4-
NEIL...................................... Nuclear Electric Insurance Limited, an industry mutual insurance
company owned by member utility companies
NMC....................................... Nuclear Management Company, a Wisconsin company, 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
NYMEX..................................... New York Mercantile Exchange
OATT...................................... Open Access Transmission Tariff
OPEB...................................... Postretirement benefit plans other than pensions for retired employees
Palisades................................. Palisades nuclear power plant, owned by Consumers
Panhandle................................. Panhandle Eastern Pipe Line Company, including its subsidiaries
Trunkline, Pan Gas Storage, Panhandle Storage, and Trunkline LNG.
Panhandle is a wholly owned subsidiary of CMS Gas Transmission
PCB....................................... Polychlorinated biphenyl
Pension Plan.............................. The trusteed, non-contributory, defined benefit pension plan of
Panhandle, Consumers and CMS Energy
PJM....................................... Pennsylvania-Jersey-Maryland
PPA....................................... The Power Purchase Agreement between Consumers and the MCV Partnership
with a 35-year term commencing in March 1990
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
PURPA..................................... Public Utility Regulatory Policies Act
RTO....................................... Regional Transmission Organization
SEC....................................... U.S. Securities and Exchange Commission
Securitization............................ A financing authorized by statute in which a MPSC approved flow of
revenues from a portion of the rates charged by a utility to its customers
is set aside and pledged as security 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. 109.............................. SFAS No. 109, "Accounting for Income Taxes"
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"
-5-
SFAS No. 123.............................. SFAS No. 123, "Accounting for Stock-Based Compensation"
SFAS No. 133.............................. SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities, as amended and interpreted"
SFAS No. 141.............................. SFAS No. 141, "Business Combinations"
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"
SFAS No. 147.............................. SFAS No. 147, "Acquisitions of Certain Financial Institutions"
SFAS No. 148.............................. SFAS No. 148 "Accounting for Stock-Based Compensation -- Transition
and Disclosure"
Special Committee......................... A special committee of independent directors, established by CMS
Energy's Board of Directors, to investigate matters surrounding
round-trip trading
Stranded Costs............................ Costs incurred by utilities in order to serve their customers in a
regulated monopoly environment, but 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
Trunkline................................. Trunkline Gas Company, a subsidiary of Panhandle Eastern Pipe Line
Company
Trust Preferred Securities................ Securities representing an undivided beneficial interest in the assets
of statutory business trusts, which interests have a preference 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 trusts
Union..................................... Utility Workers of America, AFL-CIO
VEBA Trusts............................... VEBA (voluntary employees' beneficiary association) Trusts are
tax-exempt accounts established to specifically set aside employer
contributed assets to pay for future expenses of the OPEB plan
-6-
PART I
ITEM 1. BUSINESS
GENERAL
CMS ENERGY
CMS Energy, formed in Michigan in 1987, is an energy holding company
operating, through subsidiaries, in the United States and in selected markets
around the world. Its two principal subsidiaries are Consumers and Enterprises.
Consumers is a public utility that provides natural gas and/or electricity to
almost 6 million of Michigan's 10 million residents and serves customers in all
68 of the state's Lower Peninsula counties. Enterprises, through subsidiaries,
is engaged in several energy businesses in the United States and in selected
international markets.
In 2002, CMS Energy's consolidated operating revenue was approximately $8.7
billion.
CONSUMERS
Consumers, formed in Michigan in 1968, is the successor to a corporation
organized in Maine in 1910 that conducted business in Michigan from 1915 to
1968. In 1997, Consumers, formerly named Consumers Power Company, changed its
name to Consumers Energy Company to better reflect its integrated electricity
and gas businesses.
Consumers' service areas include automotive, metal, chemical, food and wood
products and a diversified group of other industries. Consumers' consolidated
operations account for a majority of CMS Energy's total assets and income, as
well as a substantial portion of its operating revenue. At year-end 2002,
Consumers' customer base and operating revenues were as follows:
Customers Operating 2002 vs. 2001
Served Revenue Operating Revenue
(millions) (millions) % Increase/(Decrease)
---------- ---------- ---------------------
Electric Utility Business.................... 1.73 $2,648 0.57%
Gas Utility Business......................... 1.65 1,519 13.53
Other........................................ --- 55(a) 27.91
Total........................................ 3.38 $4,222 5.18%
- ----------
(a) Primarily represents earnings attributable to Consumers' interest in the MCV
Partnership and MCV Facility.
Consumers' rates and certain other aspects of its business are subject to
the jurisdiction of the MPSC and FERC, as described in CONSUMERS REGULATION
later in this Item 1.
CONSUMERS PROPERTIES -- GENERAL: The principal properties of Consumers and
its subsidiaries are owned in fee, except that most electric lines and gas mains
are located, pursuant to easements and other rights, in public roads or on land
owned by others. Substantially all of Consumers' properties are subject to the
lien of its First Mortgage Bond Indenture. For additional information on
Consumers' properties see BUSINESS SEGMENTS -- Consumers Electric Utility
Operations -- Electric Utility Properties, and -- Consumers Gas Utility
Operations -- Gas Utility Properties, below.
For information on capital expenditures, see ITEM 7. CONSUMERS' MANAGEMENT'S
DISCUSSION AND ANALYSIS -- OUTLOOK and ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA -- NOTE 10 OF CONSUMERS' NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS.
-7-
BUSINESS SEGMENTS
For information with respect to the operating revenue, net operating income,
identifiable assets and liabilities attributable to Consumers' business
segments, see ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -- SELECTED
FINANCIAL INFORMATION AND CONSUMERS' CONSOLIDATED FINANCIAL STATEMENTS AND NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS.
CONSUMERS' ELECTRIC UTILITY OPERATIONS
Based on the average number of customers, Consumers' electric utility
operations, if independent, would be the thirteenth largest electric utility
company in the United States. Consumers' electric utility operations include the
generation, purchase, distribution and sale of electricity. At year-end 2002, it
served customers in 61 of the 68 counties of Michigan's lower peninsula.
Principal cities served include Battle Creek, Flint, Grand Rapids, Jackson,
Kalamazoo, Midland, Muskegon and Saginaw. Consumers' electric utility customer
base includes a mix of residential, commercial and diversified industrial
customers, the largest segment of which is the automotive industry. Consumers'
electric utility operations are not dependent upon a single customer, or even a
few customers, and the loss of any one or even a few of such customers is not
reasonably likely to have a material adverse effect on its financial condition.
Consumers' electric utility operations are seasonal. The summer months
usually increase demand for electric energy, principally due to the use of air
conditioners and other cooling equipment, thereby affecting revenues. In 2002
and 2001, total electric deliveries were 39 billion kWh and 40 billion kWh,
respectively. In 2002, electric sales totaled 37 billion kWh and retail open
access deliveries totaled 2 billion kWh. In 2001, electric sales totaled 39
billion kWh and retail open access deliveries totaled 1 billion kWh.
Excluding retail open access loads, Consumers experienced a 2002 summer
peak demand of 7,697 MW. In 2002, the winter peak demand was 5,573 MW for the
winter 2001-02 period and 5,862 MW for the winter 2002-03 period. In 2002, based
on the actual summer peak, Consumers' power reserve, also called a reserve
margin, was 20.6 percent compared to 11.1 percent in 2001. Based on its summer
2002 forecast, Consumers carried a 15.0 percent reserve margin. In recent years,
Consumers has planned for a reserve margin of approximately 15 percent from a
combination of its owned electric generating plants and electricity purchase
contracts or options, as well as other arrangements. However, in light of
various factors, including the addition of new generating capacity in Michigan
and throughout the Midwest region and additional transmission import capability,
Consumers is continuing to evaluate the appropriate reserve margin for 2003 and
beyond. Currently, Consumers has an estimated reserve margin of approximately 11
percent for summer 2003 or 111 percent of projected summer peak load. Of the 111
percent, approximately 101 percent is met from owned electric generating plants
and long-term power purchase contracts and 10 percent from short-term contracts
and options for physical deliveries and other agreements. The ultimate use of
the 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.
Including retail open access loads, Consumers experienced a 2002 summer peak
demand of 7,984 MW. Winter peak demand for 2002, including retail open access
loads, was 5,694 MW for the winter 2001-02 period and 6,140 MW for the winter
2002-03 period.
-8-
ELECTRIC UTILITY PROPERTIES: At December 31, 2002, Consumers' electric
generating system consists of the following:
2002 Net
2002 Summer Net Generation
Size and Year Demonstrated (Thousands
Name and Location (Michigan) Entering Service Capability (KWs) of kWHs)
-------------------- -------------------- --------------
Coal Generation
J H Campbell 1 & 2 -- West Olive................ 2 Units, 1962-1967 615,000 4,406,940
J H Campbell 3 - West Olive..................... 1 Unit, 1980 765,140(a) 4,511,713
D E Karn -- Essexville.......................... 2 Units, 1959-1961 515,000 3,824,249
B C Cobb -- Muskegon ........................... 2 Units, 1956-1957 312,000 2,150,510
J R Whiting -- Erie............................. 3 Units, 1952-1953 326,000 2,262,509
J C Weadock -- Essexville....................... 2 Units, 1955-1958 310,000 2,205,575
-------------------- --------------
Total coal generation............................. 2,843,140 19,361,496
-------------------- --------------
Oil/Gas Generation
B C Cobb -- Muskegon............................ 3 Units, 1999-2000 183,000 38,035
D E Karn -- Essexville.......................... 2 Units, 1975-1977 1,276,000 650,008
-------------------- --------------
Total oil/gas generation.......................... 1,459,000 688,043
-------------------- --------------
Hydroelectric
Conventional Hydro Generation................... 13 Plants, 1906-1949 73,540 386,691
Ludington Pumped Storage........................ 6 Units, 1973 954,700(b) (486,322)(c)
-------------------- --------------
Total Hydroelectric............................... 1,028,240 (99,631)
-------------------- --------------
Nuclear Generation
Palisades -- South Haven........................ 1 Unit, 1971 767,000 6,357,962
-------------------- --------------
Gas/Oil Combustion Turbine
Generation...................................... 7 Plants, 1966-1971 346,800(d) 12,743
-------------------- --------------
Total owned generation............................ 6,444,180 26,320,613
-------------------- ==============
Purchased and Interchange Power
Capacity........................................ 1,766,180(e)
Total............................................. 8,210,360
====================
- ----------
(a) Represents Consumers' share of the capacity of the J H Campbell 3, net of
6.69 percent (ownership interests of the Michigan Public Power Agency and
Wolverine Power Supply Cooperative, Inc.).
(b) Represents Consumers' share of the capacity of Ludington. Consumers and
Detroit Edison have 51 percent and 49 percent undivided ownership,
respectively, in the plant.
(c) Represents Consumers' share of net pumped storage generation. This facility
electrically pumps water during off-peak hours for storage to later
generate electricity during peak-demand hours.
(d) Includes 1.8 MW of distributed diesel generation.
(e) Includes 1,240 MW of purchased contract capacity from the MCV Facility.
In 2002, Consumers purchased, through long-term purchase contracts, options,
spot market and other seasonal purchases, up to 2,683 MW of net capacity from
other power producers, which amounted to 34.9 percent of Consumers' total system
requirements, the largest of which was the MCV Partnership.
-9-
A high voltage transmission system interconnects Consumers' electric
generating plants at many locations with transmission facilities of unaffiliated
systems including those of other utilities in Michigan and Indiana. The
interconnections permit a sharing of the reserve capacity of the connected
systems. This allows mutual assistance during emergencies and substantially
reduces investment in utility plant facilities. Consumers owns: a) 338 miles of
high voltage distribution radial lines operating at 120 kilovolts and above; b)
4,159 miles of high voltage distribution overhead lines operating at 23
kilovolts and 46 kilovolts; c) 16 subsurface miles of high voltage distribution
underground lines operating at 23 kilovolts and 46 kilovolts; d) 54,681 miles of
electric distribution overhead lines; e) 8,201 subsurface miles of underground
distribution lines and f) substations having an aggregate transformer capacity
of 20,596,240 kilovoltamperes.
On April 1, 2001, Consumers transferred its investment in electric
transmission lines and substations to a wholly owned subsidiary, Michigan
Electric Transmission Company (METC). On May 1, 2002, Consumers transferred its
interest in METC to a third party, Michigan Transco Holdings, LLC (MTH), and
Consumers no longer owns or controls transmission facilities either directly or
indirectly. MTH owns the former Consumers transmission assets through a new
transmission company called Michigan Electric Transmission Company, LLC. For
additional information on the sale of the transmission assets, see ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS -- ELECTRIC RATE MATTERS -- TRANSMISSION.
FUEL SUPPLY: Consumers has four generating plant sites that use coal as a
fuel source and that constitute 73.6 percent of its baseload supply, the
capacity used to serve a constant level of customer demand. In 2002, these
plants produced a combined total of 19,361 million kWhs of electricity and
required 9.7 million tons of coal. On December 31, 2002, Consumers' coal
inventory amounted to approximately 30 days' supply. For additional information
on future sources of coal, see ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- OTHER
ELECTRIC UNCERTAINTIES -- COAL SUPPLY.
Consumers owns two nuclear power plants, Big Rock, located near Charlevoix,
Michigan and Palisades, located near South Haven, Michigan. In 1997, Consumers
ceased operating Big Rock. In May 2001, with the approval of the NRC, Consumers
transferred its authority to operate Palisades to the Nuclear Management Company
(NMC). The Palisades nuclear fuel supply responsibilities are under the control
of NMC acting as agent for Consumers. During 2002, Palisades' net generation was
6,358 million kWhs, constituting 24.2 percent of Consumers' baseload supply. New
fuel contracts are being written as NMC Agreements. Consumers/NMC currently have
sufficient contracts for uranium concentrates to provide up to 100 percent of
its fuel supply requirements for the 2003 and 2004 period. Consumers/NMC also
have contracts for conversion services and enrichment services with quantity
flexibility ranging up to 100 percent. If spot market prices are below the
contract price, NMC will purchase only the minimum amount of nuclear fuel
required by the contracts. Conversely, if spot market prices are above the
contract prices, Consumers will purchase the maximum amount of nuclear fuel
allowed by the contracts to meet its requirements.
For the spring 2003 refueling outage, Consumers has purchased all of its
fuel supply requirements. NMC also has contracts for nuclear fuel services and
for fabrication of nuclear fuel assemblies. The fabrication contract for
Palisades remains in effect for the next two reloads with options to extend the
contract for an additional two reloads. The fuel contracts are with major
private industrial suppliers of nuclear fuel and related services and with
uranium producers, converters and enrichers who participate in the world nuclear
fuel marketplace.
As shown below, Consumers generates electricity principally from coal and
nuclear fuel.
MILLIONS OF KWHS
-----------------------------------------------------
POWER GENERATED 2002 2001 2000 1999 1998
--------------- ---------- -------- -------- -------- --------
Coal 19,361 19,203 17,926 19,085 17,959
Nuclear 6,358 2,326(a) 5,724 5,105 5,364
Oil 347 331 645 809 520
Gas 354 670 400 441 302
Hydro 387 423 351 365 395
Net pumped storage (486) (553) (541) (476) (480)
------- -------- ------- -------- -------
Total net generation....................... 26,321 22,400 24,505 25,329 24,060
======= ======== ======= ======== =======
- ----------
(a) On June 20, 2001, the Palisades reactor was shut down so
technicians could inspect a small steam leak on a control rod drive assembly.
The defective components were replaced and the plant returned to service on
January 21, 2002.
-10-
The cost of all fuels consumed, shown below, fluctuates with the mix of
fuel burned.
COST PER MILLION BTU
-------------------------------------------------
FUEL CONSUMED 2002 2001 2000 1999 1998
------------- ------- ------- ------- ------- -------
Coal.......................................... $1.34 $ 1.38 $ 1.34 $ 1.38 $ 1.45
Oil........................................... 3.49 4.02 3.30 2.69 2.73
Gas........................................... 3.98 4.05 4.80 2.74 2.66
Nuclear ...................................... 0.35 0.39 0.45 0.52 0.50
All Fuels(a).................................. 1.19 1.44 1.27 1.28 1.28
- ----------
(a) Weighted average fuel costs.
Pursuant to the Nuclear Waste Policy Act of 1982, the federal government
became responsible for the permanent disposal of spent nuclear fuel and
high-level radioactive waste by 1998. To date, the DOE has been unable to
arrange for storage facilities to meet this obligation and it does not expect
that in 2003 it will be able to receive spent nuclear fuel for storage. For
additional information on disposal of nuclear fuel see ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS. The amount of spent nuclear fuel discharged from the
reactor to date exceeds Palisades' temporary on-site storage pool capacity, and
Consumers is currently storing spent nuclear fuel in NRC-approved steel and
concrete vaults, known as "dry casks". Currently, three dry casks are available
for future storage. For a discussion relating to the NRC approval of dry casks
and Consumers' use of the dry casks, see ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS -- UNCERTAINTIES -- OTHER ELECTRIC UNCERTAINTIES.
CONSUMERS' GAS UTILITY OPERATIONS
Based on the average number of customers, Consumers' gas utility operations,
if independent, would be the 6th largest gas utility company in the United
States. Consumers' gas utility operations purchase, transport, store, distribute
and sell natural gas. As of December 31, 2002, it was authorized to provide
service in 54 of the 68 counties in Michigan's lower peninsula. Principal cities
served include Bay City, Flint, Jackson, Kalamazoo, Lansing, Pontiac and
Saginaw, as well as the suburban Detroit area, where nearly 900,000 of the gas
customers are located. Consumers' gas utility operations are not dependent upon
a single customer, or even a few customers, and the loss of any one or even a
few of such customers is not reasonably likely to have a material adverse effect
on its financial condition.
Consumers' gas utility operations are seasonal. Consumers injects natural
gas into storage during the summer months of the year for use during the winter
months when the demand for natural gas is higher. Peak demand usually occurs in
the winter due to colder temperatures and the resulting increased demand for
heating fuels. In 2002, total deliveries of natural gas sold by Consumers and by
other sellers who deliver natural gas through Consumers' pipeline and
distribution network to ultimate customers, including the MCV Partnership,
totaled 376.4 bcf.
Due to prolonged colder than normal weather during the winter months of
2002-2003, Consumers' gas storage fields were drawn down to unexpected and
unusually low levels. This caused withdrawal of the entire amount of working
storage gas from some fields. As a result, some salt water has entered
Consumers' pipelines and distribution lines that may increase future maintenance
problems and costs resulting from pipe corrosion.
GAS UTILITY PROPERTIES: Consumers' gas distribution and transmission system
consists of 25,218 miles of distribution mains and 1,624 miles of transmission
lines throughout Michigan's lower peninsula. It owns and operates seven
compressor stations with a total of 162,000 installed horsepower. Consumers has
14 gas storage fields located across Michigan with an aggregate storage capacity
of 330.8 bcf.
In February 2002, the FERC approved Michigan Gas Storage's application for a
declaration of exemption from provisions of the National Gas Act. This allowed
Consumers to file with the MPSC for approval to merge with Michigan Gas Storage.
The merger was approved and completed in November 2002.
GAS SUPPLY: Total 2002 purchases included 58 percent from United States
producers outside Michigan, 22 percent from Canadian producers and 6 percent
from Michigan producers. Authorized suppliers in the permanent gas customer
choice pilot program, which started in April 2001, supplied the remaining 14
percent of gas delivered by Consumers.
-11-
Consumers' firm transportation agreements are with ANR Pipeline Company,
Great Lakes Gas Transmission, L.P., Trunkline and Panhandle Eastern Pipe Line.
Consumers uses these agreements to deliver gas to Michigan for ultimate
deliveries to market. In total, Consumers' firm transportation and city gate
arrangements are capable of delivering over 95 percent of Consumers' total gas
supply requirements. As of December 31, 2002, Consumers' portfolio of firm
transportation from pipelines to Michigan is as follows:
VOLUME
(DEKATHERMS/DAY) EXPIRATION
---------------- --------------------
ANR Pipeline Company.................................... 84,113 October 2003
Great Lakes Gas Transmission, L.P....................... 85,092 April 2004
Trunkline............................................... 336,375 October 2005
Panhandle Eastern Pipe Line (starting April 1, 2003).... 60,000 October 2003
ANR Pipeline Company.................................... 10,000 December 2002
Consumers purchases the balance of its required gas supply under firm city
gate contracts and as needed, interruptible contracts. The amount of
interruptible transportation service and its use varies primarily with the price
for such service and the availability and price of the spot supplies being
purchased and transported. Consumers' use of interruptible transportation is
generally in off-peak summer months and after Consumers has fully utilized the
services under the firm transportation agreements.
CONSUMERS REGULATION
Consumers and its subsidiaries are subject to regulation by various
federal, state and local governmental agencies, including those specifically
described below.
MICHIGAN PUBLIC SERVICE COMMISSION
Consumers is subject to the MPSC's jurisdiction, which regulates public
utilities in Michigan with respect to retail utility rates, accounting, utility
services, certain facilities and various other matters. The Attorney General,
ABATE, and the MPSC staff typically intervene in MPSC electric and gas related
proceedings concerning Consumers. For many years, almost every significant MPSC
order affecting Consumers has been appealed. Certain appeals from the MPSC
orders are pending in the Court of Appeals.
RATE PROCEEDINGS: In 1996, the MPSC issued an order that established the
electric authorized rate of return on common equity at 12.25 percent. In 2002,
the MPSC issued an order that established the gas authorized rate of return on
common equity at 11.4 percent.
MPSC REGULATORY AND MICHIGAN LEGISLATIVE CHANGES: State regulation of the
retail electric and gas utility businesses is in the process of undergoing
significant changes. In 2000, the Michigan Legislature enacted the Customer
Choice Act. Pursuant to the Customer Choice Act, as of January 2002, all
electric customers have their choice of buying generation service from an
alternative electric supplier. The Customer Choice Act also imposes rate
reductions, rate freezes and rate caps. For a description and additional
information regarding the Customer Choice Act, see ITEM 8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS.
As a result of regulatory changes in the natural gas industry, Consumers
transports the natural gas commodity that is sold to some customers by
competitors like gas producers, marketers and others. From April 1, 1998, to
March 31, 2001, Consumers' implemented a statewide experimental gas customer
choice pilot program that allowed up to 300,000 residential, commercial and
industrial retail gas sales customers to choose their gas supplier and froze the
rates Consumers was permitted to charge for the service of distributing gas to
its customers.
Beginning April 1, 2001, Consumers established a permanent gas customer
choice program that allows up to 600,000 of Consumers' gas customers to select
an alternative gas commodity supplier. By April 2003, all of Consumers' gas
customers will be eligible to select an alternative gas commodity supplier. As
of December 31, 2002, 178,000 of Consumers' gas customers had elected an
alternate gas commodity supplier. Also on April 1, 2001, pursuant to the
permanent gas customer choice program, Consumers returned to a GCR mechanism
that allows it to recover from its customers all prudently incurred costs to
purchase the natural gas commodity and transport it to Consumers' facilities.
For additional information on gas customer choice programs see ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS.
-12-
FEDERAL ENERGY REGULATORY COMMISSION
Some of Consumers' gas business is also subject to regulation by FERC,
including a blanket transportation tariff pursuant to which Consumers can
transport gas in interstate commerce. FERC also regulates certain aspects of
Consumers' electric operations including: compliance with FERC accounting rules;
wholesale rates; transfers of certain facilities; and corporate mergers and
issuance of securities. For a discussion of the effect of certain FERC orders on
Consumers, see ITEM 7. CONSUMERS' MANAGEMENT'S DISCUSSION AND ANALYSIS --
OUTLOOK -- ELECTRIC BUSINESS OUTLOOK.
NUCLEAR REGULATORY COMMISSION
Under the Atomic Energy Act of 1954, as amended, and the Energy
Reorganization Act of 1974, Consumers is subject to the jurisdiction of the NRC
with respect to the design, construction, operation and decommissioning of its
nuclear power plants. Consumers is also subject to NRC jurisdiction with respect
to certain other uses of nuclear material. These and other matters concerning
Consumers' nuclear plants are more fully discussed in ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA -- NOTES 1 AND 2 OF CONSUMERS' CONSOLIDATED
FINANCIAL STATEMENTS.
OTHER REGULATION
The Secretary of Energy regulates the importation and exportation of natural
gas and has delegated various aspects of this jurisdiction to FERC and the DOE's
Office of Fossil Fuels. Consumers is also subject to the Hazardous Liquid
Pipeline Safety Act of 1979, which regulates oil and petroleum pipelines.
CONSUMERS ENVIRONMENTAL COMPLIANCE
Consumers and its subsidiaries are subject to various federal, state and
local regulations for environmental quality, including air and water quality,
waste management, zoning and other matters. For additional information
concerning environmental matters, see ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS -- UNCERTAINTIES -- ELECTRIC CONTINGENCIES.
Consumers has installed and is currently installing modern emission controls
at its electric generating plants and has converted and is converting electric
generating units to burn cleaner fuels. Consumers expects that the cost of
future environmental compliance, especially compliance with clean air laws, will
be significant because of EPA regulations regarding nitrogen oxide and
particulate-related emissions. These regulations will require Consumers to make
significant capital expenditures. For the preliminary estimates of these capital
expenditures to reduce nitrogen oxide-related emissions see NOTE 2 OF CONSUMERS'
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- UNCERTAINTIES --ELECTRIC
CONTINGENCIES.
Consumers is in the process of closing older ash disposal areas at two
plants. Construction, operation, and closure of a modern solid waste disposal
area for ash can be expensive, because of strict federal and state requirements.
In order to significantly reduce ash field closure costs, Consumers has worked
with others to use bottom ash and fly ash as part of temporary and final cover
for ash disposal areas instead of native materials in cases where such use of
bottom ash and fly ash is compatible with environmental standards. To reduce
disposal volumes, Consumers sells coal ash for use as a filler for asphalt, for
incorporation into concrete products and for other environmentally compatible
uses. The EPA has announced its intention to develop new nationwide standards
for ash disposal areas. Consumers intends to work through industry groups to
help ensure that any such regulations require only the minimum cost necessary to
adhere to standards that are consistent with protection of the environment.
Consumers has PCB in some of its electrical equipment, as do most electric
utilities. 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.
Consumers has proposed a plan to the EPA to deal with the remaining materials
and is waiting on a response from the EPA.
Certain environmental regulations affecting Consumers include, but are not
limited to, the Clean Air Act Amendments of 1990 and Superfund. Superfund can
require any individual or entity that may have owned or operated a disposal
site, as well as transporters or generators of hazardous substances that were
sent to such site, to share in remediation costs for the site.
Consumers' current insurance coverage does not extend to certain
environmental clean-up costs, such as claims for air pollution, some past PCB
contamination and for some long-term storage or disposal of pollutants.
-13-
CONSUMERS COMPETITION
ELECTRIC COMPETITION
Consumers' electric utility business experiences competition, actual and
potential, from many sources, both in the wholesale and retail markets, and in
electric generation, electric delivery, and retail services.
In the wholesale electricity markets, Consumers competes with other
wholesale suppliers, marketers and brokers. Electric competition in the
wholesale markets increased significantly since 1996 due to FERC Order 888.
Whereas Consumers is still active in wholesale electricity markets, wholesale
for retail transactions by Consumers generated an immaterial amount of
Consumers' 2002 revenues from electric utility operations. Consumers does not
believe future loss of wholesale for retail sales to be significant.
A significant increase in retail electric competition is now possible with
the passage of the Customer Choice Act and the availability of retail open
access. The Customer Choice Act of June 2000 required Consumers to open
progressive tiers of its electric customer power supply requirement such that a
total of 750 MW was open to competition in 2001. As of January 1, 2002, the
Consumer Choice Act also gave all electric customers the right to buy generation
service from an alternative electric supplier. The Michigan Public Service
Commission has adopted a mechanism pursuant to the Customer Choice Act to
provide for recovery of stranded costs. The company cannot predict the total
amount of electric supply load that may be lost to competitor suppliers, nor
whether the stranded cost recovery method adopted by the MPSC will be applied in
a manner that will fully offset any associated margin loss.
In addition to retail electric customer choice, Consumers also has
competition or potential competition from: 1) the threat of customers relocating
outside Consumers' service territory; 2) the possibility of municipalities
owning or operating competing electric delivery systems; 3) customer
self-generation; and 4) adjacent municipal utilities that extend lines to
customers near service territory boundaries. Consumers addresses this
competition primarily through offering rate discounts, providing additional
services and insistence upon compliance with MPSC and FERC rules.
Consumers offers non-commodity retail services to electric customers in an
effort to offset costs. Consumers faces competition from many sources, including
energy management services companies, other utilities, contractors, and retail
merchandisers.
For additional information concerning electric competition, see ITEM 7.
CONSUMERS' MANAGEMENT'S DISCUSSION AND ANALYSIS -- OUTLOOK -- ELECTRIC BUSINESS
OUTLOOK.
GAS COMPETITION
Competition has existed for the past decade, and is likely to increase, in
various aspects of Consumers' gas utility business. Competition traditionally
comes from alternate fuels and energy sources, such as propane, oil, and
electricity. Competition has also been introduced through the gas customer
choice program which allows residential, commercial and industrial retail gas
sales customers to choose an alternative gas commodity supplier in direct
competition with Consumers. Consumers would continue to transport and distribute
gas to these customers.
For additional information concerning gas competition, see ITEM 7.
CONSUMERS' MANAGEMENT'S DISCUSSION AND ANALYSIS -- OUTLOOK -- GAS BUSINESS
OUTLOOK.
INSURANCE
Consumers maintains insurance coverage similar to other comparable companies
in the same lines of business. The insurance policies are subject to term,
conditions, limitations and exclusions that might not fully compensate Consumers
for all losses. Furthermore, as Consumers renews its policies it is possible
that full insurance coverage may not be obtainable on commercially reasonable
terms due to the recent increasingly restrictive insurance markets.
For additional information regarding Insurance, see ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS -- OTHER ELECTRIC UNCERTAINTIES -- INSURANCE.
-14-
EMPLOYEES
As of December 31, 2002, Consumers and its subsidiaries had 8,311 full-time
equivalent employees of whom 8,238 are full-time employees and 73 full-time
equivalent employees associated with the part-time work force. Included in the
total are 3,630 full-time operating, maintenance and construction employees of
Consumers who are represented by the Utility Workers Union of America. Consumers
and the Union negotiated a collective bargaining agreement that became effective
as of June 1, 2000 and will continue in full force and effect until June 1,
2005. Consumers is currently negotiating with the Union for a collective
bargaining agreement for its Call Center employees.
CONSUMERS FORWARD-LOOKING STATEMENTS CAUTIONARY FACTORS AND UNCERTAINTIES.
UNCERTAINTIES
Specific uncertainties are described in ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA -- NOTE 2 OF CONSUMERS' NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS. Certain risks are described in ITEM 7. CONSUMERS' MANAGEMENT'S
DISCUSSION AND ANALYSIS -- OUTLOOK -- LIQUIDITY AND CAPITAL RESOURCES.
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements to encourage such disclosures without the
threat of litigation, if those statements are identified as forward-looking and
are accompanied by meaningful, cautionary statements identifying important
factors that could cause the actual results to differ materially from those
projected in the statements. Forward-looking statements give our expectations or
forecasts of future events. You can identify these statements by the fact that
they do not relate strictly to historical or current facts. Forward-looking
statements have been and will be made in this Form 10-K and in our other written
documents (such as press releases, visual presentations, and securities
disclosure documents) and oral presentations (such as analyst conference calls).
Such statements are based on management's beliefs as well as assumptions made
by, and information currently available to, management. When used in our
documents or oral presentations, we intend the words "anticipate", "believe",
"estimate", "expect", "forecast", "intend", "objective", "plan", "possible",
"potential", "project", "projection" and variations of such words and similar
expressions to target forward-looking statements that involve risk and
uncertainty.
Any or all of our forward-looking statements in oral or written statements
or in other publications may turn out to be wrong. They can be affected by
inaccurate assumptions or by known or unknown risks and uncertainties. Many such
factors will be important in determining our actual future results.
Consequently, we cannot guarantee any forward-looking statement.
In addition to any assumptions and other factors referred to specifically in
connection with such forward-looking statements, there are numerous factors that
could cause our actual results to differ materially from those contemplated in
any forward-looking statements. Such factors include our inability to predict
and/or control:
- Achievement of capital expenditure reductions and cost savings;
- Capital and financial market conditions, including current price of CMS
Energy Common Stock and the effect on the Pension Plan, interest rates
and availability of financing to CMS Energy, Consumers, Panhandle or
any of their affiliates and the energy industry;
- Market perception of the energy industry, CMS Energy, Consumers,
Panhandle or any of their affiliates;
- CMS Energy's, Consumers', Panhandle's or any of their affiliates'
securities ratings;
- Ability to successfully access the capital markets;
- Factors affecting utility and diversified energy operations such as
unusual weather conditions, catastrophic weather-related damage,
unscheduled generation outages, maintenance or repairs, unanticipated
changes to fossil fuel, nuclear fuel or gas supply costs or
availability due to higher demand, shortages, transportation problems
or other developments, environmental incidents, or electric
transmission or gas pipeline system constraints;
- Electric transmission or gas pipeline system constraints;
-15-
- National, regional and local economic, competitive and regulatory
conditions and developments;
- Adverse regulatory or legal decisions, including environmental laws and
regulations;
- Federal regulation of electric sales and transmission of electricity
including re-examination by Federal regulators of the market-based
sales authorizations by which our affiliates participate in wholesale
power markets without price restrictions and proposals by FERC to
change the way it currently lets Consumers and other public utilities
and natural gas companies interact with each other;
- Energy markets, including the timing and extent of unanticipated
changes in commodity prices for oil, coal, natural gas, natural gas
liquids, electricity and certain related products due to lower or
higher demand, shortages, transportation problems or other
developments;
- Nuclear power plant performance, decommissioning, policies, procedures,
incidents, and regulation, including the availability of spent nuclear
fuel storage;
- Technological developments in energy production, delivery and usage;
- Changes in financial or regulatory accounting principles or policies;
- Outcome, cost, and other effects of legal and administrative
proceedings, settlements, investigations and claims;
- Disruptions in the normal commercial insurance and surety bond markets
that may increase costs or reduce traditional insurance coverage,
particularly terrorism and sabotage insurance and performance bonds;
- Other business or investment considerations that may be disclosed from
time to time in CMS Energy's, Consumers' or Panhandle's SEC filings or
in other publicly disseminated written documents; and
- Other uncertainties, which are difficult to predict and many of which
are beyond our control.
Consumers and its affiliates undertake no obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. The foregoing review of factors pursuant to the Private
Securities Litigation Reform Act should not be construed as exhaustive or as any
admission regarding the adequacy of our disclosures. Certain risk factors are
detailed from time to time in our various public filings. You are advised,
however to consult any further disclosures we make on related subjects in our
reports to the SEC. In particular, you should read the discussion in the section
entitled "Forward-Looking Statements and Risk Factors" in our most recent
reports to the SEC on Form 10-Q or Form 8-K filed subsequent to this Form 10-K.
-16-
EXECUTIVE OFFICERS
NAME AGE POSITION PERIOD
---- --- -------- ------
Kenneth Whipple................................. 68 Chairman of the Board, Chief Executive 2002-Present
Officer of CMS Energy
Chairman of the Board, Chief Executive 2002-Present
Officer of Consumers
Chairman of the Board of Enterprises 2002-Present
Director of CMS Energy 1993-Present
Director of Consumers 1993-Present
Chairman and Chief Executive Officer of
Ford Credit Company 1997-1999
Executive Vice President and President of 1989-1999
Ford Financial Services Group
S. Kinnie Smith, Jr. ........................... 72 Vice Chairman of the Board of CMS Enterprises 2003-Present
Vice Chairman of the Board and General 2002-Present
Counsel of CMS Energy
Vice Chairman of the Board of Consumers 2002-Present
Executive Vice President of Enterprises 2002-Present
Director of CMS Energy 2002-Present
Director of Consumers 2002-Present
Vice Chairman of Trans-Elect, Inc. 2002
Senior Counsel at Skadden, Arps, Slate, 1995-2002
Meagher & Flom LLP
David W. Joos................................... 49 Chairman of the Board and Chief Executive 2003-Present
Officer of CMS Enterprises
President and Chief Operating Officer of 2001-Present
CMS Energy
President and Chief Operating Officer 2001-Present
of Consumers
President and Chief Operating Officer of 2001-2003
CMS Enterprises
Director of CMS Energy 2001-Present
Director of Consumers 2001-Present
Executive Vice President and Chief Operating 2000-2001
Officer -- Electric of Enterprises
Executive Vice President and Chief Operating 2000-2001
Officer -- Electric of CMS Energy
Executive Vice President and President and 1997-2001
Chief Executive Officer -- Electric of
Consumers
Thomas J. Webb.................................. 50 Executive Vice President and Chief Financial 2002-Present
Officer of CMS Energy
Executive Vice President and Chief Financial 2002-Present
Officer of Consumers
Executive Vice President and Chief Financial 2002-Present
Officer of Enterprises
Executive Vice President and Chief Financial 2002-Present
Officer of Panhandle Eastern Pipe Line
Executive Vice President and Chief Financial 1999-2002
Officer of Kellogg Company
Vice President and Chief Financial Officer of 1996-1999
Visteon, a division of Ford Motor Company
Thomas W. Elward................................ 54 President and Chief Operating Officer of 2003-Present
CMS Enterprises
President and Chief Executive Officer of 2002-Present
CMS Generation Company
Senior Vice President of CMS Enterprises 2002
Senior Vice President of CMS Generation 1998
Company
-17-
NAME AGE POSITION PERIOD
---- --- -------- ------
Carl L. English................................. 56 Executive Vice President and President and 1999-Present
Chief Executive Officer -- Gas of Consumers
Vice President of Consumers 1990-1999
John G. Russell**............................... 45 Executive Vice President and President and 2001-Present
Chief Executive Officer - Electric of
Consumers
Senior Vice President of Consumers 2000-2001
Vice President of Consumers 1999-2000
John F. Drake.................................. 54 Senior Vice President of CMS Enterprises 2003-Present
Senior Vice President of CMS Energy 2002-Present
Senior Vice President of Consumers 2002-Present
Vice President of CMS Energy 1997-2002
Vice President of Consumers 1998-2002
David G. Mengebier*............................. 45 Senior Vice President of CMS Enterprises 2003-Present
Senior Vice President of CMS Energy 2001-Present
Senior Vice President of Consumers 2001-Present
Vice President of CMS Energy 1999-2001
Vice President of Consumers 1999-2001
Robert A. Fenech................................ 55 Senior Vice President of Consumers 1997-Present
Vice President of Consumers 1994-1997
Preston D. Hopper............................... 52 Senior Vice President of CMS Enterprises 2003-Present
Senior Vice President of CMS Energy 2003-Present
Senior Vice President of Consumers 2003-Present
Senior Vice President and Chief Accounting 1997-2003
Officer of Enterprises
Senior Vice President, Chief Accounting 1996-2003
Officer and Controller of CMS Energy
Senior Vice President and Controller of 1996-1997
Enterprises
Frank Johnson................................... 55 Senior Vice President of Consumers 2001-Present
President and Chief Executive Officer of CMS 2000-2002
Electric and Gas
Vice President and Chief Operating Officer of 2000
CMS Electric and Gas
Vice President of CMS Electric and Gas 1996-2000
David A. Mikelonis.............................. 54 Senior Vice President and General Counsel of 1988-Present
Consumers
Paul N. Preketes................................ 53 Senior Vice President of Consumers 1999-Present
Vice President of Consumers 1994-1999
Glenn P. Barba.................................. 37 Vice President and Chief Accounting
Officer of CMS Enterprises 2003-Present
Vice President, Controller and Chief 2003-Present
Accounting Officer of CMS Energy
Vice President, Controller and Chief 2003-Present
Accounting Officer of Consumers
Vice President and Controller of Consumers 2001-2003
Controller of CMS Generation 1997-2001
- ---------
* Mr. Mengebier has served as Senior Vice President of CMS Energy and
Consumers since 2001, after receiving a promotion from his position in both
companies as Vice President, which he had held since 1999. From 1997 to
1999, Mr. Mengebier served as Executive Director of Federal Governmental
Affairs for CMS Enterprises.
-18-
** Mr. Russell has served as Executive Vice President and President and Chief
Executive Officer - Electric of Consumers since October 2001. From December
2000 until October 2001, Mr. Russell served as Senior Vice President of
Consumers. From October 1999 until December 2000, Mr. Russell served as Vice
President of Consumers. From July 1997 until October 1999, Mr. Russell
served as Manager -- Electric Customer Operations of Consumers.
There are no family relationships among executive officers and directors of
Consumers.
The present term of office of each of the executive officers extends to the
first meeting of the Board of Directors after the next annual election of
Directors of Consumers (scheduled to be held on May 23, 2003).
-19-
ITEM 2. PROPERTIES.
A description of Consumers' properties is contained in ITEM 1. BUSINESS --
Consumers -- Consumers Properties -- General; BUSINESS -- BUSINESS SEGMENTS --
Consumers' Electric Utility Operations -- Electric Utility Properties;
Consumers' Gas Utility Operations -- Gas Utility Properties--all of which are
incorporated by reference herein.
ITEM 3. LEGAL PROCEEDINGS
Consumers and some of its subsidiaries and affiliates are parties to certain
routine lawsuits and administrative proceedings incidental to their businesses
involving, for example, claims for personal injury and property damage,
contractual matters, various taxes, and rates and licensing. Reference is made
to ITEM 1. BUSINESS -- CONSUMERS REGULATION, as well as ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS and Consumers' ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA -- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS included herein
for additional information regarding various pending administrative and judicial
proceedings involving regulatory, operating and environmental matters.
EMPLOYMENT RETIREMENT INCOME SECURITY ACT CLASS ACTION LAWSUITS
Consumers is a named defendant, along with CMS Energy, CMS MST and certain named
and unnamed officers and directors, in two lawsuits brought as purported class
actions on behalf of participants and beneficiaries of the CMS Employee's
Savings and Incentive Plan (the "Plan"). The two cases, filed in July 2002 in
the U.S. District Court, were consolidated by the trial judge and an amended
consolidated complaint has been filed. Plaintiffs allege breaches of fiduciary
duties under ERISA and seek restitution on behalf of the Plan with respect to a
decline in value of the shares of CMS Energy Common Stock held in the Plan.
Plaintiffs also seek other equitable relief and legal fees. These cases will be
vigorously defended. Consumers cannot predict the outcome of this litigation.
SECURITIES CLASS ACTION LAWSUITS
Beginning on May 17, 2002, a number of securities class action complaints have
been filed against CMS Energy, Consumers and certain officers and directors of
CMS Energy and its affiliates. The complaints have been filed in the United
States District Court for the Eastern District of Michigan as purported class
actions by individuals who allege that they purchased CMS Energy's securities
during a purported class period. At least two of the complaints contain
purported class periods beginning on August 3, 2000 and running through May 10,
2002 or May 14, 2002. 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 cases have been consolidated
into a single lawsuit and an amended and consolidated complaint is due to be
filed by May 1, 2003. CMS Energy and Consumers intend to vigorously defend
against this action. Consumers cannot predict the outcome of this litigation.
ENVIRONMENTAL MATTERS: Consumers and its 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, Consumers believes that it is
unlikely that these actions, individually or in total, will have a material
adverse effect on their financial condition. See ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS; and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -- NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the fourth quarter of 2002, Consumers did not submit any matters to
vote of security holders.
-20-
PART II
ITEM 5. MARKET FOR CONSUMERS' COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Consumers' common stock is privately held by its parent, CMS Energy, and does
not trade in the public market. In February, May, June, November and December
2002, Consumers paid $55 million, $43 million, $56 million, $52 million and $25
million in cash dividends, respectively, on its common stock. In February, May,
August, and November 2001, Consumers paid $66 million, $30 million, $39 million
and $55 million in cash dividends, respectively, on its common stock. Pursuant
to restrictive covenants in its debt facilities, Consumers is limited to
dividend payments that will not exceed $300 million in any calendar year.
ITEM 6. SELECTED FINANCIAL DATA.
Selected financial information is contained in ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA -- CONSUMERS' SELECTED FINANCIAL INFORMATION, which is
incorporated by reference herein.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management's discussion and analysis of financial condition and results of
operations is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -
CONSUMERS' MANAGEMENT'S DISCUSSION AND ANALYSIS, which is incorporated by
reference herein.
ITEM 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
Quantitative and Qualitative Disclosures About Market Risk is contained in ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CONSUMERS' MANAGEMENT'S
DISCUSSION AND ANALYSIS - CRITICAL ACCOUNTING POLICIES - ACCOUNTING FOR
DERIVATIVE AND FINANCIAL INSTRUMENTS AND MARKET RISK INFORMATION, which is
incorporated by reference herein.
-21-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Financial Statements: Page
----
CONSUMERS ENERGY
Selected Financial Information.......................................................... 24
Management's Discussion and Analysis.................................................... 25
Consolidated Statements of Income....................................................... 51
Consolidated Statements of Cash Flows................................................... 52
Consolidated Balance Sheets............................................................. 53
Consolidated Statements of Long-Term Debt............................................... 55
Consolidated Statements of Preferred Stock.............................................. 56
Consolidated Statements of Common Stockholder's Equity.................................. 57
Notes to Consolidated Financial Statements.............................................. 59
Reports of Independent Auditors......................................................... 100
Quarterly Financial Information......................................................... 103
-22-
[CONSUMERS ENERGY LOGO]
2002 FINANCIAL STATEMENTS
-23-
SELECTED FINANCIAL INFORMATION CONSUMERS ENERGY COMPANY
2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------
Operating revenue (in millions) ($) 4,222 4,014 3,935 3,874 3,709
Income before cumulative effect of change
in accounting principle (in millions) ($) 363 199 284 340 306
Net income (in millions) (b) ($) 381 188 284 340 349
Net income available to common
stockholder (in millions) ($) 335 145 248 313 312
Cash from operations (in millions) ($) 769 518 515 791 637
Capital expenditures, excluding capital
lease additions and DSM (in millions) ($) 559 745 498 444 369
Total assets (in millions) ($) 8,700 8,321 7,776 7,170 7,163
Long-term debt, excluding current
maturities (in millions) ($) 2,442 2,472 2,110 2,006 2,007
Non-current portion of capital
leases (in millions) ($) 116 72 49 85 100
Total preferred stock (in millions) ($) 44 44 44 44 238
Total preferred securities (in millions) ($) 490 520 395 395 220
Number of preferred shareholders at year-end 2,132 2,220 2,365 2,534 5,649
Book value per common share at year-end ($) 22.46 22.81 23.85 23.87 21.94
Return on average common equity (%) 17.6 7.4 12.4 16.2 17.5
Return on average assets (%) 5.9 3.9 5.4 6.4 6.6
Number of full-time equivalent
employees at year-end (d)
Consumers 8,547 8,477 8,748 8,736 8,456
Michigan Gas Storage (c) - 62 57 63 65
ELECTRIC STATISTICS
Sales (billions of kWh) 39.3 39.6 41.0 41.0 40.0
Customers (in thousands) 1,734 1,712 1,691 1,665 1,640
Average sales rate per kWh (cents) 6.88 6.65 6.56 6.54 6.50
GAS STATISTICS
Sales and transportation deliveries (bcf) 376 367 410 389 360
Customers (in thousands) (a) 1,652 1,630 1,611 1,584 1,558
Average sales rate per mcf ($) 5.67 5.34 4.39 4.52 4.56
- -----------------------------------------------------------------------------------------------------------------
(a) Excludes off-system transportation customers.
(b) See Notes 1 and 2 in the notes to the consolidated financial statements.
(c) Effective November 2002, Michigan Storage Company was merged into
Consumers.
(d) Includes employees on workers compensation and temporary employees at
December 31, 2002.
-24-
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.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This MD&A refers to, and in some sections specifically incorporates by
reference, Consumers' Notes to Consolidated Financial Statements and should be
read in conjunction with such Consolidated Financial Statements and Notes. This
Annual Report 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
MD&A and in Item 1 of this Form 10-K in the section entitled "Forward-Looking
Statements Cautionary Factors" 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' business and financial outlook. This Annual
Report also describes material contingencies in Consumers' Notes to Consolidated
Financial Statements, and Consumers encourages its readers to review these
Notes. All note references within this MD&A refer to Consumers' Notes to
Consolidated Financial Statements.
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 in the financial statements when a current event
has caused a probable future loss payment of an amount that can be reasonably
estimated. Consumers has used this accounting 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.
-25-
Consumers Energy Company
The EPA has issued final regulations regarding nitrogen oxide emissions from
certain generators, including some of Consumers' electric generating facilities.
These regulations will require Consumers to make significant capital
expenditures estimated to be $770 million. As of December 31, 2002, Consumers
has incurred $405 million in capital expenditures to comply with these
regulations and anticipates that the remaining capital expenditures will be
incurred between 2003 and 2009. Additionally, Consumers expects to supplement
its compliance plan with the purchase of nitrogen oxide emissions credits in the
years 2005 through 2008. The cost of these credits based on the current market
is estimated to average $6 million per year; however, the market for nitrogen
oxide emissions credits is volatile and the price could change significantly. At
some point, if new environmental standards become effective, Consumers may need
additional capital expenditures to comply with the standards. 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. For further information see Note 2, Uncertainties, "Electric
Contingencies - 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 three and seven 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 Contingencies - 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 49 percent partnership interest in the
MCV Partnership, and a 35 percent 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. After September
2007, the PPA's terms obligate Consumers to pay the MCV Partnership only those
capacity and energy charges that the MPSC has authorized for recovery from
electric customers.
In 1992, Consumers recognized a loss and established a PPA liability for the
present value of the estimated future underrecoveries of power supply costs
under the PPA based on MPSC cost recovery orders. Primarily as a result of the
MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. At December 31, 2002, 2001 and 2000, the remaining after-tax
present value of the estimated future PPA liability associated with the loss
totaled $34 million, $50 million and $64 million, respectively. The PPA
liability is expected to be depleted in late 2004.
In March 1999, Consumers and the MCV Partnership reached a settlement agreement
effective January 1, 1999, that addressed, among other things, the ability of
the MCV Partnership to count modifications increasing the capacity of the
existing MCV Facility for purposes of computing the availability of contract
capacity under the PPA for billing purposes. That settlement agreement capped
availability payments that may be billed by the MCV Partnership at a 98.5
percent level.
When Consumers returns, as expected, to unfrozen rates beginning in 2004,
Consumers will recover from customers, on-peak and off-peak capacity, so long as
availability does not exceed an average 88.7 percent established in previous
MPSC orders. For availability payments billed by the MCV Partnership after
September 15, 2007, and not recovered from customers, Consumers would expect to
claim a regulatory out under the PPA. If the MCV Facility's generating
availability remains 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:
-26-
Consumers Energy Company
In Millions
- -------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- -------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
===================================================================================================================
It is currently estimated that 51 percent of the actual cash underrecoveries for
the years 2003 and 2004 will be charged to the PPA liability, with the remaining
portion charged to operating expense as a result of Consumers' 49 percent
ownership in the MCV Partnership. All cash underrecoveries will be expensed
directly to income once the PPA liability is depleted.
For further information see Note 2, Uncertainties, "Other Electric Uncertainties
- - The Midland Cogeneration Venture."
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS AND MARKET RISK INFORMATION
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, certain electric call options, fixed priced
weather-based gas supply call options and fixed price gas supply put options.
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.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market in the state of
Michigan, as defined by SFAS No. 133, 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 on
earnings related to these contracts, particularly related to the PPA, could be
material to the financial statements.
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 December 31, 2002, Consumers assumed a
market-based interest rate of 4.5 percent and a volatility rate of 70 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
-27-
Consumers Energy Company
early for other economic reasons, any gain or loss as of the termination date is
deferred and recorded when the forecasted transaction affects earnings.
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' investments in equity securities,
including its investment in CMS Energy Common Stock, 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 unless such changes in
fair value are other than temporary. In 2002, Consumers determined that the
decline in value related to its investment in CMS Energy Common Stock was other
than temporary as the fair value was below the cost basis for a period greater
than six months. As a result, Consumers recognized a loss on its investment in
CMS Energy Common Stock through earnings of $12 million in the fourth quarter of
2002. As of December 31, 2002, Consumers held 2.4 million shares of CMS Energy
Common Stock with a fair value of $22 million; as of March 14, 2003 the fair
value was $8 million. 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 investments is determined from quoted
market prices.
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
certain business unit managers. 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 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.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Contracts used 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. Consumers enters into all risk management
contracts for purposes other than trading.
These 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.
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 10 percent shift used for the analyses.
INTEREST RATE RISK: Consumers is exposed to interest rate risk resulting from
the issuance of fixed-rate financing and variable-rate financing, and from
interest rate swap 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 December 31, 2002, Consumers had outstanding
$1.268 billion of variable-rate financing, including variable-rate swaps. At
December 31, 2002, assuming a hypothetical 10 percent adverse change in market
interest rates, Consumers' before tax earnings exposure on its variable-rate
financing would be $2 million. As of December 31, 2002,
-28-
Consumers Energy Company
Consumers had entered into floating-to-fixed interest rate swap agreements for a
notional amount of $75 million. 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 December
31, 2002, Consumers had outstanding fixed-rate financing, including fixed-rate
swaps, of $2.760 billion, with a fair value of $2.677 billion. As of December
31, 2002, assuming a hypothetical 10 percent adverse change in market rates,
Consumers would have an exposure of $137 million to the fair value of these
instruments if it had to refinance all of its fixed-rate financing. As discussed
below in Electric Business Outlook -- Securitization, Consumers has filed an
application with the MPSC to securitize certain costs. If approved, Consumers
will use the proceeds from the securitization for refinancing or retirement of
debt, which could include a portion of its current fixed-rate financing.
Consumers does not believe that any adverse change in debt price and interest
rates would have a material adverse effect on either its consolidated financial
position, results of operation or cash flows.
COMMODITY MARKET RISK: For purposes other than trading, Consumers enters into
electric call options, fixed price gas supply contracts containing embedded put
options, fixed priced weather-based gas supply call options and fixed priced gas
supply put options. 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 supply contracts
containing embedded put options, the weather-based gas supply call options, and
the gas supply put options are used to purchase reasonably priced gas supply.
As of December 31, 2002, the fair value based on quoted future market prices of
electricity-related call option contracts was $9 million. At December 31, 2002,
assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $2
million. As of December 31, 2002, Consumers had incurred $37 million, of
premiums for electric call option contracts. Consumers' maximum exposure
associated with the call option contracts is limited to the premiums incurred.
As of December 31, 2002, the fair value based on quoted future market prices of
gas supply-related call and put option contracts was $1 million. At December 31,
2002, a hypothetical 10 percent adverse change in market prices would be
immaterial.
EQUITY SECURITY PRICE RISK: Consumers owns less than 20 percent of the
outstanding shares of CMS Energy Common Stock. Consumers recognized a loss on
this investment through earnings of $12 million in the fourth quarter of 2002,
because the loss was other than temporary as the fair value was below the cost
basis for a period greater than six months. As of December 31, 2002, Consumers
held 2.4 million shares of CMS Energy Common stock at a fair value of $22
million, as of March 14, 2003 the fair value was $8 million. Consumers believes
that any further adverse change in the market price of this investment 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 5,
Financial and Derivative Instruments.
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
-29-
Consumers Energy Company
to customers. Judgment is required to discern the recoverability of items
recorded as regulatory assets and liabilities. As of December 31, 2002,
Consumers had $1.072 billion recorded as regulatory assets and $313 million
recorded as regulatory liabilities.
In March 1999, Consumers received MPSC electric restructuring orders which,
among other things, identified the terms and timing for implementing electric
restructuring in Michigan. Consistent with these orders and EITF No. 97-4,
Consumers discontinued the application of SFAS No. 71 for the energy supply
portion of its business because Consumers expected to implement retail open
access at competitive market-based rates for its electric customers. Since 1999,
there has been a significant legislative and regulatory change in Michigan that
has resulted in: 1) electric supply customers of utilities remaining on
cost-based rates and 2) utilities being given the ability to recover Stranded
Costs associated with electric restructuring, from customers who choose an
alternative electric supplier. During 2002, Consumers re-evaluated the criteria
used to determine if an entity or a segment of an entity meets the requirements
to apply regulated utility accounting, and determined that the energy supply
portion of its business could meet the criteria if certain regulatory events
occurred. In December 2002, Consumers received a MPSC Stranded Cost order that
allowed Consumers to re-apply regulatory accounting standard SFAS No. 71 to the
energy supply portion of its business. Re-application of SFAS No. 71 will have
no effect on the prior discontinuation accounting, but will allow Consumers to
apply regulatory accounting treatment to the energy supply portion of its
business on a prospective basis, including regulatory accounting treatment of
costs required to be recognized in accordance with SFAS No. 143.
ACCOUNTING FOR PENSION AND OPEB
Consumers provides postretirement benefits under its Pension Plan, and
postretirement health and life benefits under its OPEB plans to substantially
all its retired employees. 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. The Pension Plan includes
amounts for employees of CMS Energy and non-utility affiliates, including
Panhandle, which were not distinguishable from the Pension Plan's total assets.
On December 21, 2002, a definitive agreement was executed to sell Panhandle. The
sale is expected to close in 2003. No portion of the Pension Plan will be
transferred with the sale of Panhandle. At the closing of the sale, none of the
employees of Panhandle will be eligible to accrue additional benefits. The
Pension Plan will retain pension payment obligations for Panhandle employees
that are vested under the Pension Plan. Consumers does not expect the impact to
be material.
Pension and OPEB plan assets, net of contributions, have been reduced in value
from the previous year due to the downturn in the equities market, and a
decrease in the price of CMS Energy Common Stock. As a result, Consumers expects
to see an increase in pension and OPEB expense levels over the next several
years unless investment performance of plan assets improves. Consumers
anticipates its allocated share of pension expense to rise in 2003 by
approximately $11 million over 2002 expenses. OPEB expenses in 2003 are
anticipated to stay the same as 2002 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, and a decline in the
interest rate used to value the liability of the plan. Estimated 2003 OPEB
expenses, remained the same as 2002 due to additional required contributions
from retirees and increases in mail-order prescription copays. Under the OPEB
plans' assumptions, health care costs increase at a slower rate from current
levels through 2010; however, Consumers cannot predict the impact that future
health care costs and interest rates or market returns will have on pension and
OPEB expense in the future. As of January 2002, OPEB plan claims are paid from
the VEBA Trusts.
-30-
Consumers Energy Company
The recent significant downturn in the equities markets has affected the value
of the Pension Plan assets. The Pension Plan's Accumulated Benefit Obligation
exceeded the value of these assets at December 31, 2002, and as a result,
Consumers and the other participants were required to recognize an additional
minimum liability for this excess in accordance with SFAS No. 87. The fair value
of the Pension Plan assets at December 31, 2002 was $607 million, including CMS
Energy Common Stock which had a market value of $49 million based on a market
price of $9.44. As of March 14, 2003, the market value of CMS Energy Common
Stock in the Pension Plan was $18 million based on a share price of $3.52. As of
December 31, 2002, the Accumulated Benefit Obligation was estimated at $1.055
billion and the additional minimum liability was $426 million. Consumers was
allocated $325 million of the additional minimum liability, of which $40 million
was recorded as an intangible asset, and $285 million was charged to other
comprehensive income ($185 million after-tax).
At December 31, 2002, the balance of the OPEB plan's assets was $465 million.
This amount consists primarily of stocks and bonds, including CMS Energy Common
Stock of $1.3 million, based on a share price of $9.44. As of March 14, 2003,
the market value of CMS Energy Common Stock in the OPEB plan's assets was $0.5
million, based on a share price of $3.52.
During 2002, Consumers' portion of contributions made to the plans' trust
accounts was $120 million. This amount represents $47 million of pension related
benefits and $73 million of postretirement health care and life insurance
benefits. Consumers expects similar contributions for postretirement health care
and life insurance benefits will be made in 2003, 2004, and 2005. The investment
performance returns and declining discount rates have increased the underfunding
of the Pension Plan, net of benefit obligations, from $350 million at December
31, 2001 to $649 million at December 31, 2002. Because of the recent rise in the
underfunded status of the Pension Plan, based on actuarial assumptions,
Consumers expects to make cash contributions to the Pension Plan which
approximates $158 million, $209 million, and $24 million in 2003, 2004, and
2005, respectively. However, if necessary to increase liquidity, Consumers would
postpone the 2003 contribution.
Consumers' expense for the Pension Plan approximated $25 million and $17 million
for the years ended December 31, 2002 and December 31, 2001, respectively, and
is calculated based upon a number of actuarial assumptions, including an
expected long-term rate of return on the Pension Plan assets of 8.75 percent in
2002 and 9.75 percent in 2001.
Lowering the expected long-term rate of return on the Pension Plan assets by
0.25 percent (from 8.75 percent to 8.5 percent) would have increased pension
expense for fiscal 2002 by approximately $3 million. Lowering the discount rate
by 0.25 percent would have increased pension expense for fiscal 2002 by
approximately $2 million.
Consumers estimates pension expense will approximate $36 million, $42 million
and $48 million in fiscal 2003, fiscal 2004 and fiscal 2005, respectively.
Future actual pension expense will depend on future investment performance,
changes in future discount rates and various other factors related to the
populations participating in the Pension Plan.
Consumers bases the determination of pension expense on a market-related
valuation of assets, which reduces year-to-year volatility. This market-related
valuation recognizes investment gains or losses over a 5-year period from the
year in which they occur. Investment gains or losses for this purpose are the
difference between the expected return calculated using the market-related value
of assets and the actual return based on the market-related value of assets.
Since the market-related value of assets recognizes gains or losses over a
5-year period, the future value of assets will be impacted as previously
deferred gains or losses are recorded.
Due to the unfavorable performance of the equity markets, as of December 31,
2002, Consumers had
-31-
Consumers Energy Company
cumulative losses of approximately $205 million that remain to be recognized in
the calculation of the market-related value of assets. These unrecognized net
actuarial losses result in increases in future pension expense depending on
several factors, including whether such losses at each measurement date exceed
the corridor in accordance with SFAS No.87.
Consumers has announced changes to the Pension Plan. Employees hired on or after
July 1, 2003 will be covered by the cash balance plan section of the plan
currently being used. Under the cash balance plan, an employee's retirement
account is credited annually with a percentage of their salary and any amounts
that are vested are portable when an employee leaves the company. In addition,
the method used to convert an employee's benefit to a lump sum payment is being
changed. Employees who elect the lump sum payment option will no longer receive
an early retirement subsidy. As a result, employees who choose the lump sum
payment option, and retire before age 65, will receive lower lump sum payments.
Consumers also provides retirement benefits under a defined contribution 401(k)
plan. Consumers previously offered 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 exceeded targeted levels. Effective September 1, 2002, the
employer's match was suspended until January 1, 2005, and the incentive match
was permanently eliminated. The amount charged to expense for the employer's
match for 2002 was $8 million. Amounts charged to expense for the employer's
match and incentive match during 2001 were $12 million and $8 million,
respectively.
In order to keep health care benefits and costs competitive, Consumers has
announced several changes to the Health Care Plan. These changes were effective
January 1, 2003. The most significant change is that Consumers' future increases
in health care costs will be shared with salaried employees. The salaried
retirees health care plan has also been amended. Pre-Medicare retirees now elect
coverage from four different levels of coverage, with the two best coverage
options requiring premium contributions. These plans also coordinate benefits
under a maintenance of benefits provision to reduce claims cost for Consumers.
Mail-order prescription copays have also been increased for all salaried
retirees.
For detailed information on postretirement benefits see Note 7, Retirement
Benefits.
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 with all contaminated equipment and material removed and
disposed of in a licensed burial facility and the site released for unrestricted
use. A March 1999 MPSC order provided for fully funding the decommissioning
trust funds for both sites. The order set the annual decommissioning surcharge
for the Palisades decommissioning at $6 million a year. Consumers estimates that
at the time of the decommissioning of Palisades, its decommissioning trust fund
will be fully funded. Earnings assumptions are that the trust funds are invested
in equities and fixed income investments, equities will be converted to fixed
income investments during decommissioning and fixed income investments are
converted to cash as needed. Decommissioning costs have been developed, in part,
by independent contractors with expertise in decommissioning. These costs
estimates use various inflation rates for labor, non-labor, and contaminated
equipment disposal costs.
On December 31, 2000, the Big Rock trust fund was considered fully funded. A
portion of its current decommissioning cost is due to the failure of the DOE to
remove fuel from the site. These costs, and similar costs incurred at Palisades,
would not be necessary but for the failure of the DOE to take possession of the
spent fuel as required by the Nuclear Waste Policy Act of 1982. If the
litigation, that was commenced in the fourth quarter of 2002, against the DOE is
successful, Consumers anticipates future recoveries from the DOE to
-32-
Consumers Energy Company
defray the significant costs it will incur for the storage of spent fuel until
the DOE takes possession as required by law.
On March 26, 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumers Federation filed a
complaint with the MPSC that asks the MPSC to commence a generic investigation
and contested case to review all facts and issues concerning the recovery of
costs associated with spent nuclear fuel storage and disposal. The complaint
alleges that the rates of Consumers Energy, The Detroit Edison Company, Indiana
& Michigan Electric Company, Wisconsin Electric Power Company and Wisconsin
Public Service Corporation are unjust and unreasonable with respect to the
recovery of costs associated with spent nuclear fuel storage and disposal. The
complaint seeks a variety of relief, including the establishing of external
trusts to which amounts collected in electric rates for spent nuclear fuel
storage and disposal should be transferred, and the adoption of additional
measures to assure that adequate funds are available for the storage and
disposal of spent nuclear fuel. Consumers has not had an opportunity to review
the complaint in detail.
The funds provided by the trusts and additional funds from DOE litigation are
expected to fully fund the decommissioning costs. Variance from trust earnings,
a lesser recovery of costs from the DOE, changes in decommissioning technology,
regulations, estimates or assumptions could affect the cost of decommissioning
these sites.
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 sale of electricity to CMS MST, the purchase of gas
transportation from CMS Bay Area Pipeline, L.L.C., 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, 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. Transactions
involving the power supply purchases from the MCV Partnership, and certain
affiliates of Enterprises, are based upon avoided costs under PURPA and
competitive bidding; and the payment of parent company overhead costs to CMS
Energy are based upon use or accepted industry allocation methodologies.
In 2002, 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 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
- -------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 Change 2001 2000 Change
- -------------------------------------------------------------------------------------------------------------------
Net income available to common stockholder $335 $145 $190 $145 $248 $(103)
===================================================================================================================
2002 COMPARED TO 2001: For 2002, Consumers' net income available to the common
stockholder totaled $335 million, an increase of $190 million from the previous
year. The earnings increase reflects the after-tax benefit of decreased electric
power costs of $85 million from 2001. This reduction in power costs was
primarily due to the need to purchase higher replacement power resulting from a
refueling outage and an unscheduled forced outage at Palisades in 2001. This
reduction in power costs also can be attributed to the lower price of power
options and dispatchable capacity contracts purchased for 2002. The increase in
earnings also reflects the after-tax $26 million gain from the May 2002 sale of
Consumers' electric transmission system to MTH, an after-tax $5 million gain
from the sale of an unused nuclear plant reactor head, along with a $25 million
benefit, which includes an after-tax cumulative effect of accounting change of
$18 million, associated with 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 No. 133. Earnings
also increased as a result of an after-tax $11 million adjustment to its
electric call option and option like contracts that was booked in 2001, as a
result of the implementation of SFAS No. 133. For
-33-
Consumers Energy Company
further information on SFAS No. 133, see Note 5, Financial and Derivative
Instruments. Increased electric deliveries to the higher margin residential and
commercial sectors contributed an additional after-tax benefit of $27 million.
Also, contributing to the earnings increase is an after-tax benefit of $16
million due to the interim and final gas rate orders issued in 2001 and 2002.
Offsetting these increases is a $9 million decrease resulting from the
recognition of a historic, cumulative 4 bcf loss of natural gas from inventory.
2001 COMPARED TO 2000: For 2001, Consumers' net income available to the common
stockholder totaled $145 million, a decrease of $103 million from the previous
year. The earnings decrease reflects significantly increased operating expense
in 2001, primarily $59 million of after-tax costs for replacement power supply
costs due to a six month unscheduled outage at the Palisades Plant. Net income
in 2001 was also adversely impacted by $11 million to reflect a change in
accounting for certain electric call option contracts under SFAS No. 133. In
addition, 2001 earnings decreased due to the impact of reduced gas deliveries
resulting from milder temperatures during both the first quarter and fourth
quarter heating seasons. Gas delivery revenues were also adversely impacted as a
result of warmer temperatures compared to the 2000 heating season and a
reduction due to the year-long impact of an economic slowdown in 2001,
throughout Michigan. Also contributing to this earnings decrease is the fact
that 2001 reflects a full year impact of a five percent electric residential
rate decrease that was implemented to comply with the Customer Choice Act.
For further information, see the Electric and Gas Utility Results of Operations
sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 Change 2001 2000 Change
- -------------------------------------------------------------------------------------------------------------------
Net income available to common stockholder $264 $109 $155 $109 $199 $(90)
===================================================================================================================
Reasons for the change:
Electric deliveries $ 41 $ 19
Power supply costs and related revenue 120 (109)
Rate decrease - (35)
Other operating expenses and non-commodity revenue 5 17
Implementation of accounting standard (SFAS No. 133) 17 (17)
Gain on asset sales 38 -
Fixed charges 9 (6)
Income taxes (75) 41
---------------------------------------------------------
Total change $155 $ (90)
===================================================================================================================
ELECTRIC DELIVERIES: For the year 2002, electric delivery revenues increased by
$41 million from the previous year. Electric deliveries, including transactions
with other wholesale market participants and other electric utilities, were 39.3
billion kWh, a decrease of 0.3 billion kWh or 0.7 percent from 2001. This
reduction in electric deliveries is primarily due to reduced transactions with
other utilities and the expiration of wholesale power sales contracts with
certain Michigan municipal utilities. Although total deliveries were below the
2001 level, increased deliveries to the higher margin residential and commercial
sectors, along with the growth in retail deliveries, more than offset the impact
of reduced deliveries to lower margin customers. For the year, Consumers set an
all-time monthly sendout record during the month of July, and new monthly hourly
peak demand records were set on April 16, 2002, June 25, 2002, September 9,
2002, and October 1, 2002. For the year 2001, electric delivery revenues
increased by $19 million from the previous year. Electric deliveries,
-34-
Consumers Energy Company
including transactions with other wholesale market participants and other
electric utilities, were 39.6 billion kWh, a decrease of 1.4 billion kWh or 3.5
percent from 2000.
POWER SUPPLY COSTS AND RELATED REVENUE: For the year 2002, power supply costs
and related revenues provided a net increase of $120 million from 2001. This net
increase was primarily due to reduced purchased power costs resulting from the
Palisades plant being returned to service in 2002. In 2001, Consumers purchased
higher cost replacement power during the refueling outage that began in March
and ended in May and the unscheduled forced outage at Palisades that began in
June and ended in January 2002. Also contributing to this decrease in power
costs is lower priced power options and dispatchable capacity contracts that
were purchased for 2002. For the year 2001, power supply costs and related
revenues resulted in a net decrease of $109 million from 2000. This net decrease
was primarily due to the need to purchase greater quantities of higher-priced
electricity to offset the loss of generation resulting from the Palisades
outages mentioned above.
For the years 2002 and 2001 respectively, Consumers purchased and expensed $23
million and $65 million of electric call options to ensure a reliable source of
power supply during the summer months. As a result of periodic excess daily
capacity, certain call options were sold and the remaining call options were
either exercised or expired. Consumers accounted for the costs relating to the
expired call options and the income received from the sale of call options, as
purchased power supply costs.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the year 2002,
non-commodity revenues increased primarily resulting from increased
miscellaneous service revenues. Partially offsetting this increase in revenues,
are increased other operating expenses compared to 2001. This increase can be
attributed to higher depreciation expense resulting from higher plant in service
along with increased operating costs resulting from higher health care expenses,
storm restoration expenses, and increased contracted maintenance expenses. For
the year 2001, other operating expenses and non-commodity revenues provided a
net benefit when compared to 2000. This benefit is primarily due to reduced
amortization expense, as permitted by MPSC orders resulting from the Customer
Choice Act. Consumers temporarily suspended amortization of the securitized
assets pending the issuance of Securitization bonds in November 2001.
IMPLEMENTATION OF ACCOUNTING STANDARD (SFAS No. 133): In 2001, Consumers
implemented SFAS No. 133 which provides for derivative and hedge accounting for
certain utility industry contracts, particularly electric call option contracts
and option-like contracts. After receiving guidance from the FASB, Consumers
re-evaluated its electric call option and option-like contracts and determined
that these contracts require derivative accounting, and therefore recorded a $17
million pre-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.
GAIN ON ASSET SALES: For the year 2002, asset sales resulted in a $31 million
pretax gain associated with the sale of Consumers' electric transmission system
and a $7 million pretax gain on the sale of nuclear equipment from the cancelled
Midland project.
INCOME TAXES: For the year 2002, income tax expense increased primarily due to
an increase in earnings by the electric utility. Income taxes associated with
the transmission system sale reflect a $5 million benefit due to the recognition
of the remaining unutilized investment tax credit related to the assets sold.
-35-
Consumers Energy Company
GAS UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 Change 2001 2000 Change
- -------------------------------------------------------------------------------------------------------------------
Net income available to common stockholder $46 $21 $25 $21 $18 $3
===================================================================================================================
Reasons for the change:
Gas deliveries $ 21 $(21)
Gas commodity and related revenue - 44
Gas rate increase 25 -
Gas wholesales and retail services 1 8
Operation and maintenance (14) (30)
General taxes and depreciation (3) -
Fixed charges 3 1
Income taxes (8) 1
---------------------------------------------------------
Total change $ 25 $ 3
==================================================================================================================
GAS DELIVERIES: For the year 2002, gas delivery revenues increased by $21
million from the previous year. System deliveries, including miscellaneous
transportation, totaled 376.4 bcf, an increase of 9.4 bcf or 2.6 percent
compared with 2001. This increase is primarily due to colder weather that
resulted in increased deliveries to the residential and commercial sectors in
2002. For the year 2001, gas delivery revenues decreased by $21 million from the
previous year. System deliveries, including miscellaneous transportation,
totaled 367 bcf, a decrease of 43 bcf or 10 percent compared with 2000. This
decrease is primarily due to warmer temperatures compared to the 2000 heating
season and a reduction due to the economic slowdown in 2001.
GAS RATE INCREASE: In 2001, the MPSC issued an interim order in Consumers' gas
rate filing. In November 2002, the MPSC issued a final gas rate order
authorizing a $56 million annual increase in Consumers gas tariff rates. As a
result of these orders, Consumers recognized increased gas revenues of $25
million.
OPERATION AND MAINTENANCE: For the year 2002, operation and maintenance expenses
increased $14 million compared to 2001. This increase reflects the recognition
of gas storage inventory losses, and additional expenditures on customer
reliability and service.
INCOME TAXES: For the year 2002, income tax expense increased, primarily due to
improved earnings of the gas utility.
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. For 2002 and
2001, cash from operations totaled $769 million and $518 million, respectively.
The $251 million increase resulted primarily from an increase in cash due to
lower expenditures for natural gas and increased tax refunds provided by the Job
Creation and Worker Assistance Act of 2002, a gas rate increase and lower
electric power purchase costs as discussed in the results of operations also
contributed to the increase. Partially offsetting the cash increase was a
decrease in cash collected from customers and related parties. Consumers
-36-
Consumers Energy Company
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 could
reduce the availability of funds and result in additional short-term financings,
see Note 3, Financings and Capitalization for additional details about this
source of funds.
INVESTING ACTIVITIES: For 2002 and 2001, cash used for investing activities
totaled $311 million and $803 million, respectively. The change of $492 million
is primarily the result of $298 million cash proceeds from the sale of METC and
other assets, and lower capital expenditures to comply with the Clean Air Act.
FINANCING ACTIVITIES: Cash used for financing activities totaled $204 million
for 2002 compared to $281 million provided in 2001. The change of $485 million
is primarily due to $173 million additional retirement of bonds and other
long-term debt, and a net reduction in proceeds from new borrowings of $334
million for 2002 compared to 2001.
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, Financings and Capitalization.
Contractual Obligations In Millions
- --------------------------------------------------------------------------------------------------------------
Payments Due
------------------------------------------------------------
2008 and
December 31 Total 2003 2004 2005 2006 2007 beyond
- --------------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 2,442 $ - $328 $470 $362 $31 $1,251
Current portion of long-
term debt 305 305 - - - - -
Notes payable 457 457 - - - - -
Capital lease obligations (a) 157 21 20 18 17 16 65
Off-balance sheet:
Headquarters building lease (a) 6 - - - - - 6
Operating leases 78 13 10 8 8 6 33
Non-recourse debt of FMLP 208 8 54 41 26 13 66
Sale of accounts receivable 325 325 - - - - -
Unconditional purchase
obligations 17,344 1,368 975 877 727 727 12,670
==============================================================================================================
(a) The headquarters building capital lease is estimated to be $60 million of
which a $54 million construction obligation has been incurred and recorded on
Consumers' balance sheet as of December 31, 2002.
REGULATORY AUTHORIZATION FOR FINANCINGS: At December 31, 2002, Consumers had
FERC authorization to issue or guarantee through June 2004, up to $1.1 billion
of short-term securities outstanding at any one time. Consumers also had
remaining FERC authorization to issue through June 2004 up to $500 million of
long-term securities for refinancing or refunding purposes, $677 million for
general corporate purposes, and $900 million of first mortgage bonds to be
issued solely as security for the long-term securities. On October 10, 2002,
FERC granted a waiver of its competitive bid/negotiated placement requirements
applicable to the remaining long-term securities authorization indicated above.
LONG TERM DEBT: Consumers' current portion of long-term debt maturing in 2003 is
$305 million. Refer to Outlook, "Liquidity and Capital Resources" below for
information about Consumers strategic measures
-37-
Consumers Energy Company
addressing its future liquidity and capital requirements.
SHORT TERM FINANCINGS: On July 12, 2002, Consumers entered into two credit
facilities as follows: a $250 million revolving credit facility maturing July
11, 2003 and a $300 million term loan maturing July 11, 2003. In March 2003,
Consumers obtained a replacement revolving credit facility in the amount of $250
million. The new credit facility matures in March 2004 with two annual
extensions at Consumers' option, which would extend the maturity to March 2006.
In September 2002, the term loan maturity was extended by one year at Consumers'
option and now has a maturity date of July 11, 2004. These two facilities
aggregating $550 million replaced a $300 million revolving credit facility that
matured July 14, 2002, as well as various credit lines aggregating $200 million.
At December 31, 2002, a total of $550 million was outstanding under the revolver
and term loan, of which $250 million was included in notes payable and $300
million was included in long-term debt maturing in 2004. The prior credit
facilities and lines were unsecured. The two new credit facilities are secured
with Consumers' first mortgage bonds and are available to finance seasonal
working capital requirements and to pay for capital expenditures between
long-term financings.
Consumers' $250 million revolving credit facility had, as of December 31, 2002,
an effective interest rate of 5.9 percent, although the rate may fluctuate
depending on the rating of Consumers' first mortgage bonds or changes in the
base LIBOR rate. The effective interest rate on the $300 million term loan was
8.9 percent as of December 31, 2002. The rate may fluctuate depending on the
rating of Consumers' first mortgage bonds or changes in the base LIBOR rate.
Consumers' bank and legal fees associated with arranging the facilities in July
2002 were $6 million.
The two credit facilities have contractual restrictions that require Consumers
to maintain, as of the last day of each fiscal quarter, the following:
Limitation Ratio at December 31, 2002
- ------------------------------------------------------------------------------------------------------------------
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.55 to 1.00
Interest Coverage Ratio (a)(b) Not less than 2.0 to 1.0 4.00 to 1.0
===================================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facilities provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
Also, pursuant to restrictive covenants in the new facilities, Consumers is
limited to common stock dividend payments that will not exceed $300 million in
any calendar year. Consumers paid $231 million and $190 million in common stock
dividends to CMS Energy in 2002 and 2001, respectively. In January 2003,
Consumers declared and paid a $78 million common dividend.
In October 2002, Consumers simultaneously entered into a new term loan agreement
collateralized by first mortgage bonds and a new gas inventory term loan
agreement collateralized by Consumers' natural gas in storage. These agreements
contain complementary collateral packages that provide Consumers, as additional
first mortgage bonds become available, borrowing capacity of up to $225 million,
of which $207 million was outstanding at December 31, 2002 with an effective
interest rate of 6.3 percent. The bank and legal fees associated with the
agreements were $2 million. The first amortization payment under these
agreements occurred in December 2002 with monthly amortization payments
scheduled until full repayment is completed in mid-April of 2003. The loan
amortization also reduces the bank's loan commitment to the amount of loan
outstanding, which was $207 million as of December 31, 2002.
LEASES: Consumers' capital leases are predominately for leased service vehicles
and the new headquarters building. Operating leases are predominately railroad
coal car leases.
-38-
Consumers Energy Company
OFF-BALANCE SHEET ARRANGEMENTS: Consumers' use of long-term contracts for the
purchase of commodities and services, the sale of its accounts receivable, and
operating leases are considered to be off-balance sheet arrangements. Consumers
has responsibility for the collectability of the accounts receivable sold, and
the full obligation of its leases become due in case of lease payment default.
Consumers uses these off-balance sheet arrangements in its normal business
operations.
SALE OF ACCOUNTS RECEIVABLE: Consumers had, through its wholly owned subsidiary
Consumers Receivables Funding, a $325 million trade receivable sale program in
place as an anticipated source of funds for general corporate purposes and
currently expected capital expenditures at December 31, 2002. At December 31,
2001, prior to the establishment of its new subsidiary, Consumers Receivables
Funding, Consumers had a $450 million trade receivables sale program in place as
an anticipated source of funds for general corporate purposes and currently
expected capital expenditures. At December 31, 2002 and 2001, the receivable
sold totaled $325 million and $334 million, respectively. Accounts receivable
and accrued revenue in the Consolidated Balance Sheets have been reduced to
reflect receivables sold.
UNCONDITIONAL PURCHASE OBLIGATIONS: Unconditional purchase obligations include
natural gas, electricity, and coal purchase contracts and their associated cost
of transportation. These obligations represent normal business operating
contracts used to assure adequate supply and to minimize exposure to market
price fluctuations.
Included in unconditional purchase obligations are 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
2003, including $33 million related to the MCV Facility. For the period that a
plant is not available to deliver electricity to Consumers, Consumers is not
obligated to make the capacity payments to the plant. See Electric Utility
Results of Operations above and Note 2, Uncertainties, "Electric Rate Matters -
Power Supply Costs" and "Other Electric Uncertainties - The Midland Cogeneration
Venture" for further information concerning power supply costs.
Commercial Commitments In Millions
- --------------------------------------------------------------------------------------------------------------
Commitment Expiration
-----------------------------------------------------------
2008 and
December 31 Total 2003 2004 2005 2006 2007 beyond
- --------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Indemnities $11 $- - - - - $11
Letters of credit 7 7 - - - - -
==============================================================================================================
Indemnities are agreements by Consumers to reimburse other companies, such as an
insurance company, if those companies have to complete Consumers' performance
involving a third party contract. Letters of credit are issued by a bank on
behalf of Consumers, guaranteeing payment to a third party. Letters of credit
substitute the bank's credit for Consumers' and reduce credit risk for the third
party beneficiary. The amount and time period for drawing on a letter of credit
is limited.
-39-
Consumers Energy Company
OUTLOOK
LIQUIDITY AND CAPITAL RESOURCES
Consumers' liquidity and capital requirements are generally a function of its
results of operations, capital expenditures, contractual obligations, debt
maturities, working capital needs and collateral requirements. Consumers has
historically met its consolidated cash needs through its operating and financing
activities and access to bank financing and the capital markets. As discussed
above, during 2003, Consumers has contractual obligations and planned capital
expenditures that would require substantial amounts of cash. Consumers also has
approximately $727 million of publicly issued and credit facility debt maturing
in 2003, including the Consumers' credit facilities described above. However, in
March 2003, a $250 million revolving credit facility was replaced, as discussed
below. In addition, Consumers may also become subject to liquidity demands
pursuant to commercial commitments under guarantees, indemnities and letters of
credit as indicated above.
Consumers is partially addressing its near-to-mid-term liquidity and capital
requirements through reduced capital expenditures and cost reduction. Consumers
believes that its current level of cash and borrowing capacity, along with
anticipated cash flows from operating and investing activities, will be
sufficient to meet its liquidity needs through 2003, including debt maturities
in 2003. Consumers expects to borrow approximately $1.1 billion in total in
2003, which includes an amount to refinance the majority of the maturing debt
above.
During the summer months, Consumers purchases natural gas and stores it for
resale primarily during the winter heating season. Recently the market price for
natural gas has increased. If continued, this price increase could impose
liquidity needs beyond what is anticipated for 2003. Although Consumers' natural
gas purchases are recoverable from its customers, the amount paid for natural
gas stored as inventory could require additional liquidity due to the timing of
the cost recoveries.
In July 2002, the credit rating of the publicly traded securities of Consumers
was downgraded by the major rating agencies. As a result of certain of these
rating agency downgrades, certain 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
addressing these issues as required.
As a result of the ratings downgrades and related changes in its financial
situation, Consumers' access to bank financing and the capital markets and its
ability to incur additional indebtedness may be restricted. Consumers continues
to explore the full range of strategic measures to provide adequate liquidity.
These measures include refinancing its bank credit facilities, entering into
leasing arrangements, inventory financing, vendor financing, refinancing and
issuing new capital markets debt, and preferred equity, and negotiating private
placement debt, and preferred equity. Consumers believes that these measures
will also supplement its cash balances in 2003.
Consumers plans to meet its liquidity and capital requirements in 2003 through a
combination of approximately $229 million from operations and approximately $513
million of new debt along with reduced capital expenditures, cost reductions and
other measures. As of March 14, 2003, Consumers planned to refinance $727
million of debt in 2003. To that end, Consumers has initiated several
transactions with various financial institutions, regulators, banks, lenders,
and others that are designed to provide liquidity:
-40-
Consumers Energy Company
- Consumers has obtained a replacement revolving credit facility in the
amount of $250 million secured by first mortgage bonds. The cost of the
facility is LIBOR plus 350 basis points. The new credit facility
matures in March 2004 with two annual extensions at Consumers' option,
which would extend the maturity to March 2006. The prior facility was
due to expire in July 2003.
- Consumers has entered into a $140 million term loan secured by first
mortgage bonds with a private investor bank. This loan has a term of
six years at a cost of LIBOR plus 475 basis points. Proceeds from this
loan would be used to retire debt or for general corporate purposes.
- Consumers has entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity at a
cost of LIBOR plus 450 basis points. Proceeds from this
loan would be used to retire debt or for general corporate purposes.
- Consumers filed a general rate case for its gas utility business on
March 14, 2003. Consumers requested rate relief in the amount of
approximately $156 million. In its filing, Consumers requested
immediate interim relief. If interim relief of $156 million were
granted, Consumers expects that the rate relief will be in place by the
fourth quarter of 2003.
- Consumers has filed an application with the MPSC seeking authorization
to issue $1.084 billion of securitization bonds. These bonds would
provide liquidity to Consumers at interest rates reflective of high
quality credit. Consumers would utilize these proceeds to retire higher
cost debt and in turn would realize significant interest expense
savings over the life of the bonds. If the MPSC approves a financing in
the amount requested, and there are no delays in the offering process,
Consumers anticipates that bonds would be issued by year end, 2003.
If necessary for liquidity purposes, Consumers would also postpone the planned
$158 million pension contribution expected to be made in September 2003.
In the event Consumers is unable to access bank financing or the capital markets
to incur or refinance indebtedness, there could be a material adverse effect on
Consumers' liquidity and operations. There is no assurance that the pending
securitization bond issuance transaction noted above will be completed. Further,
there is no assurance that the MPSC will grant either interim or final gas
utility rate relief.
SEC AND OTHER INVESTIGATIONS
As a result of round-trip trading transactions at CMS MST, CMS Energy's Board of
Directors established a Special Committee of independent directors to
investigate matters surrounding the transactions and retained outside counsel to
assist in the investigation. The Special Committee completed its investigation
and reported its findings to the Board of Directors in October 2002. The Special
Committee concluded, based on an extensive investigation, that the round-trip
trades were undertaken to raise CMS MST's profile as an energy marketer with the
goal of enhancing its ability to promote its services to new customers. The
Special Committee found no apparent effort to manipulate the price of CMS Energy
Common Stock or affect energy prices. The Special Committee also made
recommendations designed to prevent any reoccurrence of this practice, most of
which have already been implemented. Previously, CMS Energy terminated its
speculative trading business and revised its risk management policy. The Board
of Directors adopted, and CMS Energy has begun implementing, the remaining
recommendations of the Special Committee.
CMS Energy is cooperating with other investigations concerning round-trip
trading, including an investigation by the SEC regarding round-trip trades and
CMS Energy's financial statements, accounting policies and controls, and
investigations by the United States Department of Justice, the Commodity Futures
Trading Commission and the FERC. CMS Energy has also received subpoenas from
U.S. Attorneys Offices regarding investigations of those trades. CMS Energy is
unable to predict the outcome of these matters, and Consumers is unable to
predict what effect, if any, these investigations will have on its business.
-41-
Consumers Energy Company
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been filed in the United States District Court for the
Eastern District of Michigan as purported class actions by individuals who
allege that they purchased CMS Energy's securities during a purported class
period. At least two of the complaints contain purported class periods beginning
on August 3, 2000 and running through May 10, 2002 or May 14, 2002. 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 cases have been consolidated into a single lawsuit and
an amended and consolidated complaint is due to be filed by May 1, 2003. CMS
Energy and Consumers intend to vigorously defend against this action. Consumers
cannot predict the outcome of this litigation.
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named and unnamed officers and directors, in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
401(k) plan. The two cases, filed in July 2002 in the United States District
Court for the Eastern District of Michigan, were consolidated by the trial judge
and an amended and consolidated complaint has been filed. Plaintiffs allege
breaches of fiduciary duties under ERISA and seek restitution on behalf of the
plan with respect to a decline in value of the shares of CMS Energy Common Stock
held in the plan. Plaintiffs also seek other equitable relief and legal fees.
These cases will be vigorously defended. Consumers cannot predict the outcome of
this litigation.
CAPITAL EXPENDITURES OUTLOOK
Consumers estimates the following capital expenditures, including new lease
commitments, by expenditure type and by business segments during 2003 through
2005. Consumers prepares these estimates for planning purposes and may revise
them.
In Millions
- ----------------------------------------------------------------------------------------------------------------
Years Ended December 31 2003 2004 2005
- ----------------------------------------------------------------------------------------------------------------
Construction $424 $520 $585
Nuclear fuel 33 32 0
Other capital leases 28 23 25
-------------------------------
$485 $575 $610
================================================================================================================
Electric utility operations (a)(b) $341 $408 $385
Gas utility operations (a) 144 167 225
-------------------------------
$485 $575 $610
================================================================================================================
(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.
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, but
-42-
Consumers Energy Company
excluding transactions with other wholesale market participants including other
electric utilities) 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. Consumers has experienced much stronger than expected
growth in 2002 as a result of warmer than normal summer weather. Assuming that
normal weather conditions will occur in 2003, electric deliveries are expected
to grow less than one percent over the strong 2002 electric deliveries.
COMPETITION AND REGULATORY RESTRUCTURING: The enactment in 2000 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. As a result, alternative
electric suppliers for generation services have entered Consumers' market. As of
mid-March 2003, alternative electric suppliers are providing 516 MW of
generation supply to customers. 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.
Consumers cannot predict the total amount of electric supply load that may be
lost to competitor suppliers, nor whether the stranded cost recovery method
adopted by the MPSC will be applied in a manner that will fully offset any
associated margin loss.
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 which calculated "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. The MPSC authorized Consumers to use deferred accounting to
recognize the future recovery of costs determined to be stranded. Consumers has
initiated an appeal at the Michigan Court of Appeals related to the MPSC's
December 2001 "net" Stranded Cost order.
According to the MPSC, "net" Stranded Costs were to be recovered from retail
open access customers through a Stranded Cost transition charge. 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.
Consumers, in its hearing brief, filed in August 2002, revised its request for
"net" Stranded Costs to $7 million and $4 million for 2000 and 2001,
respectively, and an estimated $73 million for 2002. The single largest reason
for the difference was the exclusion, as ordered by the MPSC, of all costs
associated with expenditures required by the Clean Air Act.
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to establish a defined
methodology that would allow a reliable prediction of the level of Stranded
Costs for 2002 and future years. In January 2003, Consumers filed a petition for
rehearing of the December 2002 Stranded Cost order in which it asked the MPSC to
grant rehearing and revise certain features of the order. Several other parties
also filed rehearing petitions with the MPSC. As discussed below, Consumers has
filed a request with the MPSC for authority to issue securitization bonds that
would allow recovery of the Clean Air Act expenditures and post-2000 Palisades
expenditures that were excluded from the Stranded Cost calculation.
On March 4, 2003, Consumers filed an application with the MPSC seeking approval
of "net" Stranded Costs
-43-
Consumers Energy Company
incurred in 2002, and for approval of a "net" Stranded Cost recovery charge. In
the application, Consumers indicated that if Consumers' proposal to securitize
Clean Air Act expenditures and post-2000 Palisades expenditures were approved as
proposed in its securitization case as discussed below, then Consumers' "net"
Stranded Costs incurred in 2002 are approximately $35 million. If the proposal
to securitize those costs is not approved, then Consumers indicated that the
costs would be properly included in the 2002 "net" Stranded Cost calculation,
which would increase Consumers' 2002 "net" Stranded Costs to approximately $103
million. Consumers cannot predict the recoverability of Stranded Costs, and
therefore has not recorded any regulatory assets to recognize the future
recovery of such costs.
The MPSC staff has scheduled a collaborative process to discuss Stranded Costs
and related issues and to identify and make recommendations to the MPSC.
Consumers intends to participate in this collaborative process.
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 - 20 5
2002 2001 8 8 - -
2003 2002 2 2 - -
==============================================================================================================
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 2000, 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. In addition to the
amounts shown above, as of December 2002, Consumers incurred and deferred as a
regulatory asset, $1 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. Consumers cannot predict the amounts the
MPSC will approve as allowable costs.
Consumers is also pursuing authorization at the FERC for MISO to reimburse
Consumers for approximately $8 million in certain electric utility restructuring
implementation costs related to its former participation in the development of
the Alliance RTO, a portion of which has been expensed. However, Consumers
cannot predict the amount the FERC will ultimately order to be reimbursed by the
MISO.
Securitization: On March 4, 2003, Consumers filed an application with the MPSC
seeking approval to issue Securitization bonds in the amount of approximately
$1.084 billion. If approved, this would allow the recovery of costs associated
with Clean Air Act expenditures, post-2000 Palisades expenditures and retail
open access implementation costs through December 31, 2003, and certain pension
fund expenses, and expenses associated with the issuance of the bonds.
Rate Caps: The Customer Choice Act imposes certain limitations on electric rates
that could result in Consumers being unable to collect from electric customers
its full cost of conducting business. Some of these
-44-
Consumers Energy Company
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 and associated transmission 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. The rate freeze is
in effect through December 31, 2003. The rate caps are in effect through at
least December 31, 2004 for small commercial and industrial customers, and at
least through December 31, 2005 for residential customers.
Industrial Contracts: In response to industry restructuring efforts, in 1995 and
1996, 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. Unless
terminated or restructured, the majority of these contracts are in effect
through 2005. As of December 2002, some contracts have expired, but outstanding
contracts involve approximately 500 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 by the MPSC
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 filed a
compliance plan in accordance with the code of conduct. It also sought waivers
to the code of conduct in order to continue utility activities that provide
approximately $50 million in annual revenues. In October 2002, the MPSC denied
waivers for three programs that provide approximately $32 million in revenues in
2001, of which $30 million relates to the appliance service plan. The waivers
denied included all waivers associated with the appliance service plan program
that has been offered by Consumers for many years. Consumers filed a renewed
motion for a stay of the effectiveness of the code of conduct and an appeal of
the waiver denials with the Michigan Court of Appeals. On November 8, 2002, the
Michigan Court of Appeals denied Consumers' request for a stay. Consumers has
filed an application for leave to appeal with the Michigan Supreme Court with
respect to the Michigan Court of Appeals' November ruling denying the stay. In
February 2003, the Michigan Supreme Court denied the application. In December
2002, Consumers filed a renewed request with the MPSC for a temporary waiver
until April 2004 for the appliance service plan, which generated $33 million in
revenues in 2002. In February 2003, the MPSC granted an extension of the
temporary waiver until December 31, 2003. The full impact of the new code of
conduct on Consumers' business will remain uncertain until the appellate courts
issue definitive rulings. Recently, in an appeal involving affiliate pricing
guidelines, the Michigan Court of Appeals struck the guidelines down because of
a procedurally defective manner of enactment by the MPSC. A similar procedure
was used by the MPSC in enacting the new code of conduct. Consumers is also
exploring seeking legislative clarification of the scope of the 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 the United States
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 company operations and financial requirements.
Transmission: In 1999, the FERC issued Order No. 2000, strongly encouraging
electric utilities to transfer operating control of their electric transmission
system to an RTO, or sell the facilities to an independent
-45-
Consumers Energy Company
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 system (METC) for sale rather
than own and invest in an asset it could not control. In May 2002, Consumers
sold its electric transmission system 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 of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by CMS
Energy, Consumers, or their affiliates when the transaction was discussed
internally and negotiated with purchasers. As a result of the sale, Consumers
experienced an after-tax earnings increase of approximately $17 million in 2002,
due to the recognition of a $26 million gain on the sale of the electric
transmission system. This gain from the sale is offset by a loss of revenue from
wholesale and retail open access customers who will buy services directly from
MTH, including the loss of a return on the sold electric transmission system.
Consumers anticipates that the future impact of the loss of revenue from
wholesale and retail open access customers who will buy services directly from
MTH and the loss of a return on the sold electric transmission system on its
after-tax earnings will be a decrease of $15 million in 2003, and a decrease of
approximately $14 million annually for the next three years.
Under the agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers are fixed by contract at current levels
through December 31, 2005, and subject to FERC ratemaking thereafter. MTH has
completed 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, and MTH (METC) has joined the MISO RTO. For further information, see Note
2, Uncertainties, "Electric Rate Matters -- Transmission."
Consumers is a customer of AEP, holding 500 MW of long-term transmission service
reservations through the AEP transmission system. AEP recently indicated its
intent to turn control of its transmission system over to the PJM RTO and become
part of the PJM market sometime after May 1, 2003, which requires approval by
FERC. This will require current AEP customers to become members of, and resubmit
reservation requests to, PJM. Consumers filed an intervention requesting
clarification in January 2003. Upon FERC's approval of this transfer, Consumers
will complete the application process to join PJM. Of the 500 MW of long-term
transmission service reservations held, 200 MW will expire on April 1, 2003.
Effective June 1, 2003, Consumers will have an additional 100 MW of long-term
transmission, resulting in a total of 400 MW of long-term transmission for
summer 2003.
In July 2002, the 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 proposed rulemaking is primarily designed to correct perceived
problems in the electric transmission industry. Consumers sold its electric
transmission system in 2002, but is a transmission customer. The financial
impact to Consumers is uncertain, but the final standard market design rules
could significantly increase delivered power costs to Consumers and the retail
electric customers it serves. Consumers has filed comments with the FERC in
general opposition to the proposal.
There are multiple proceedings pending before the FERC regarding transitional
transmission pricing mechanisms intended to mitigate the revenue impact on
transmission owners resulting from the elimination of "Rate Pancaking". "Rate
Pancaking" represents the application of the transmission rate of each
individual
-46-
Consumers Energy Company
transmission owner whose system is utilized on the scheduled path of an energy
delivery and its elimination has been alleged to result in "lost revenues" for
transmission owners. It is unknown what mechanism(s) may result from the
proceedings currently pending before the FERC, and as such, it is not possible
at this time to identify the specific effect on Consumers. It should be noted,
however, that Consumers believes the results of these proceedings could also
significantly increase the delivered power costs to Consumers and the retail
electric customers it serves.
Similarly, other proceedings before the FERC involving rates of transmission
providers of Consumers could increase Consumers' cost of transmitting power to
its customers in Michigan. As RTOs develop and mature in Consumers' area of
electrical operation, and those RTOs respond to FERC initiatives concerning the
services they must provide and the systems they maintain, Consumers believes
that there is likely to be an upward cost trend in transmission used by
Consumers, ultimately increasing the delivered cost of power to Consumers and
the retail electric customers it serves. The specific financial impact on
Consumers of such proceedings and trends are not currently quantifiable.
In addition to the potential cost impacts identified above, Consumers is
evaluating whether or not there may be impacts on electric reliability
associated with the outcomes of these various transmission related proceedings.
Consumers cannot assure that all risks to reliability can be avoided.
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 electric 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. In November
2002, the MPSC issued an order initiating the formal rulemaking proceeding.
Consumers has filed comments on the proposed rules and will continue to
participate in this process. Consumers cannot predict the nature 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) pending litigation and government investigations; 2)
the need to make additional capital expenditures and increase operating expenses
for Clean Air Act compliance; 3) 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; 4) uncertainties relating to the
storage and ultimate disposal of spent nuclear fuel and the successful operation
of Palisades by NMC; 5) electric industry restructuring issues, including those
described above; 6) 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; 7) the
recovery of electric restructuring implementation costs; 8) Consumers new status
as an electric transmission customer and not as an electric transmission
owner/operator; 9) sufficient reserves for OATT rate refunds; 10) the effects of
derivative accounting and potential earnings volatility; 11) increased costs for
safety and homeland security initiatives that are not recoverable on a timely
basis from customers, and 12) Consumers' continuing ability to raise funds at
reasonable rates in order to meet the cash
-47-
Consumers Energy Company
requirements of its electric business and to pay maturing debt in the
short-term; 13) potentially rising pension costs due to market losses. For
further information about these trends or uncertainties, see Note 2,
Uncertainties.
GAS BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects gas deliveries, including
gas full service and customer choice deliveries (excluding transportation to the
MCV Facility and off-system deliveries), to grow at an average rate of less than
one percent per year based primarily on a steadily growing customer base. Actual
gas deliveries in future periods may be affected by abnormal weather, use of gas
by independent power producers, changes in competitive and economic conditions,
and the level of natural gas consumption per customer.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. On November 7, 2002, the MPSC
issued a final order approving a $56 million annual distribution service rate
increase, which includes the $15 million interim increase, with an 11.4 percent
authorized return on equity, for service effective November 8, 2002. As part of
this order, the MPSC approved Consumers' proposal to absorb the assets and
liabilities of Michigan Gas Storage Company into Consumers' rate base and rates.
This has occurred through a statutory merger of Michigan Gas Storage Company
into Consumers and this is not expected to have an impact on Consumers'
consolidated financial statements. See Note 2, Uncertainties, "Gas Rate Matters
- -- 2001 Gas Rate Case" for further information.
2003 GAS RATE CASE: On March 14, 2003, Consumers filed an application with the
MPSC seeking a $156 million increase in its gas delivery and transportation
rates, which includes a 13.5 percent authorized return on equity, based on a
2004 test year. If approved, the request would add about $6.40 per month, or
about 9 percent, to the typical residential customer's average monthly
distribution bill. Contemporaneously with this filing, Consumers has requested
interim rate relief in the same amount.
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 MPSC addressed Consumers' study in the
November 2002 gas distribution rate case order and indicated that it makes
little sense to set rates for unbundled services before the details of those
services are known. Unbundled services may continue to be an issue in future
proceedings.
In September 2002, the FERC issued an order rejecting a filing by Consumers to
assess certain rates for non-physical gas title tracking services offered by
Consumers. Despite Consumers' arguments to the contrary, the FERC asserted
jurisdiction over such activities and allowed Consumers to refile and justify a
title transfer fee not based on volumes as Consumers proposed. Because the order
was issued six years after Consumers made its original filing initiating the
proceeding, over $3 million in non-title transfer tracking fees had been
collected. No refunds have been ordered, and Consumers sought rehearing of the
September order. If refunds were ordered they may include interest which would
increase the refund liability to more than the $3 million collected. In December
2002, Consumers established a $3.6 million reserve related to this matter.
Consumers is unable to say with certainty what the final outcome of this
proceeding might be.
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) pending litigation and government investigations; 2)
potential environmental costs at a number of sites, including sites formerly
housing manufactured gas plant facilities; 3) future gas industry restructuring
initiatives; 4) any initiatives undertaken to protect customers against gas
price increases; 5) an inadequate regulatory response to applications for
requested rate increases;
-48-
Consumers Energy Company
6) market and regulatory responses to increases in gas costs, including a
reduced average use per residential customer; 7) increased costs for pipeline
integrity and safety and homeland security initiatives that are not recoverable
on a timely basis from customers; and 8) Consumers' continuing ability to raise
funds at reasonable rates in order to meet the cash requirements of its gas
business; and 9) potentially rising pension costs due to market losses. For
further information about these uncertainties, see Note 2, Uncertainties.
OTHER OUTLOOK
See Outlook, "Liquidity and Capital Resources," "SEC and Other Investigations,"
"Securities Class Action Lawsuits," and "ERISA Cases" above.
TERRORIST ATTACKS: Since the September 11, 2001 terrorist attacks in the United
States, Consumers has increased security at all critical facilities and over its
critical 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. Through December 31, 2002,
Consumers has incurred approximately $4 million in incremental security costs,
including operating, capital, and decommissioning and removal costs. Consumers
estimates it may incur additional incremental security costs in 2003 of
approximately $6 million. Consumers will attempt to seek recovery of these costs
from its customers. In December 2002, the Michigan legislature passed, and the
governor signed, a bill that would allow Consumers to seek recovery of
additional electric division security costs incurred during the rate freeze and
cap periods imposed by the Customer Choice Act. On February 5, 2003, the MPSC
adopted filing requirements for the recovery of enhanced security costs.
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."
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. Consumers has determined that it has
legal asset retirement obligations, particularly in regard to its nuclear
plants, but has not yet finalized its assessment of the obligation. However,
upon initial adoption of the standard, Consumers expects to record a regulatory
liability, as well as an asset retirement obligation, as required by SFAS No.
71. The regulatory liability recognizes the difference between the cost of
removal included in the reserve for accumulated depreciation for assets within
the scope of SFAS No. 143 and the accretion expense of the asset retirement
obligation and the depreciation expense of the asset retirement obligation asset
from when the obligation was initially incurred through December 2002. When the
asset retirement obligation 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 initial liability would be accreted to its
present value each period and the capitalized cost would be depreciated over the
related asset's useful life.
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
-49-
Consumers Energy Company
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, but may be adopted early.
Consumers has adopted this provision early, with no material affect to its
income statement. SFAS No. 145 amends SFAS No. 13 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. Upon adoption of the standard, there was no impact on Consumers' 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 does not expect the adoption of SFAS No. 146 to have a material impact
on its financial position or results of operations.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: This
interpretation, effective January 1, 2003, elaborates on the disclosure to be
made by a guarantor about its obligations under certain guarantees that it has
issued. It requires that a guarantor recognize, at the inception of a guarantee,
a liability for the fair value of the obligation undertaken in issuing the
guarantee. For contracts that are within the initial recognition and measurement
provision of this interpretation, the provisions are to be applied to guarantees
issued or modified after December 31, 2002; no cumulative effect adjustments are
required. For further information see Note 1, Corporate Structure and Summary of
Significant Accounting Policies, "New Accounting Standards To Be Adopted".
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. For Consumers, the
consolidation requirements apply to pre-existing entities beginning July 1,
2003. Certain of the disclosure requirements apply to all financial statements
initially issued after January 31, 2003. Consumers will be required to
consolidate any entities that meet the requirements of the interpretation.
Consumers is in the process of studying the interpretation, and has yet to
determine the effects, if any, on its consolidated financial statements.
-50-
CONSOLIDATED STATEMENTS OF INCOME CONSUMERS ENERGY COMPANY
In Millions
Years Ended December 31 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE Electric $2,648 $2,633 $ 2,676
Gas 1,519 1,338 1,196
Other 55 43 63
---------------------------------
4,222 4,014 3,935
- -------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES Operation
Fuel for electric generation 320 330 324
Purchased power - related parties 546 543 534
Purchased and interchange power 314 476 402
Cost of gas sold 831 707 616
Cost of gas sold - related parties 131 123 103
Other 660 625 555
---------------------------------
2,802 2,804 2,534
Maintenance 190 203 172
Depreciation 300 309 322
Amortization 48 30 104
General taxes 193 187 197
---------------------------------
3,533 3,533 3,329
- -------------------------------------------------------------------------------------------------------------------
OPERATING Electric 512 349 454
INCOME Gas 127 97 96
Other 50 35 56
---------------------------------
689 481 606
- -------------------------------------------------------------------------------------------------------------------
OTHER INCOME Dividends and interest from affiliates 3 6 10
(DEDUCTIONS) Accretion income (Note 1) - - 2
Accretion expense (Note 1) (6) (11) (9)
Other, net 25 6 (5)
---------------------------------
22 1 (2)
- -------------------------------------------------------------------------------------------------------------------
INTEREST CHARGES Interest on long-term debt 153 151 141
Other interest 27 41 44
Capitalized interest (12) (6) (2)
---------------------------------
168 186 183
- -------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 543 296 421
INCOME TAXES 180 97 137
---------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 363 199 284
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR DERIVATIVE INSTRUMENTS,
NET OF $10 TAX EXPENSE IN 2002 (NOTE 11) AND $6 TAX BENEFIT IN 2001 (NOTE 5) 18 (11) -
---------------------------------
NET INCOME 381 188 284
PREFERRED STOCK DIVIDENDS 2 2 2
PREFERRED SECURITIES DISTRIBUTIONS 44 41 34
---------------------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 335 $ 145 $ 248
===================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
-51-
CONSOLIDATED STATEMENTS OF CASH FLOWS CONSUMERS ENERGY COMPANY
In Millions
Years Ended December 31 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM Net Income $ 381 $ 188 $ 284
OPERATING ACTIVITIES Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes
nuclear decommissioning of $6, $6 and $39,
respectively) 348 339 426
Deferred income taxes and investment tax credit 280 136 (21)
Capital lease and other amortization 15 20 32
Gain on sale of METC and other assets (38) - -
Loss on CMS Energy stock 12 - -
Cumulative effect of accounting change (18) 11 -
Undistributed earnings of related parties (net
of dividends, $15, $8 and $8, respectively) (38) (30) (49)
Changes in assets and liabilities
Decrease (increase) in accounts receivable
and accrued revenue (98) 149 (178)
Increase (decrease) in accounts payable (30) 53 19
Decrease (increase) in inventories 90 (307) (59)
Changes in other assets and liabilities (135) (41) 61
----------------------------------
Net cash provided by operating activities 769 518 515
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM Capital expenditures (excludes assets placed under
INVESTING ACTIVITIES capital lease) (559) (745) (498)
Cost to retire property, net (66) (118) (125)
Investment in Electric Restructuring Implementation Plan (8) (13) (29)
Investments in nuclear decommissioning trust funds (6) (6) (39)
Associated company preferred stock redemption - 50 50
Proceeds from nuclear decommissioning trust funds 30 29 37
Cash proceeds from sale of METC and other assets 298 - -
---------------------------
Net cash used in investing activities (311) (803) (604)
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM Retirement of bonds and other long-term debt (574) (401) (9)
FINANCING ACTIVITIES Payment of common stock dividends (231) (190) (245)
Preferred securities distributions (44) (41) (34)
Redemption of preferred securities (30) - -
Payment of capital lease obligations (15) (20) (32)
Contribution from (return of equity to) stockholder, net 50 (14) -
Payment of preferred stock dividends (2) (1) (2)
Increase (decrease) in notes payable, net 41 13 189
Proceeds from preferred securities, net - 121 -
Proceeds from senior notes and bank loans 601 355 225
Proceeds from securitization bonds, net - 459 -
-----------------------------------
Net cash provided by (used in) financing activities (204) 281 92
- ---------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENT 254 (4) 3
Cash and temporary cash investments - Beginning of year 17 21 18
---------------------------
End of year $ 271 $ 17 $ 21
=====================================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 147 $ 169 $ 165
Income taxes paid (net of refunds of $205, $53 and $15, respectively) (78) 3 133
Pension and OPEB cash contribution 120 96 -
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ - $ 13 $ 4
Other assets placed under capital lease 62 37 15
======================================================================================================================
ALL HIGHLY LIQUID INVESTMENTS WITH AN ORIGINAL MATURITY OF THREE MONTHS OR LESS
ARE CONSIDERED CASH EQUIVALENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
-52-
CONSOLIDATED BALANCE SHEETS CONSUMERS ENERGY COMPANY
ASSETS In Millions
December 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
PLANT (AT ORIGINAL COST) Electric $ 7,523 $ 7,661
Gas 2,719 2,593
Other 23 23
-----------------------------
$10,265 $10,277
Less accumulated depreciation, depletion
and amortization 5,900 5,934
-----------------------------
4,365 4,343
Construction work-in-progress 548 480
-----------------------------
4,913 4,823
- ------------------------------------------------------------------------------------------------------------------
INVESTMENTS Stock of affiliates 22 57
First Midland Limited Partnership 255 253
Midland Cogeneration Venture Limited Partnership 388 300
Consumers Nuclear Services, LLC 2 2
-----------------------------
667 612
- ------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS Cash and temporary cash investments at cost, which
approximates market 271 17
Accounts receivable and accrued revenue, less allowances
of $5 in 2002 and $4 in 2001 236 125
Accounts receivable - related parties 13 18
Inventories at average cost
Gas in underground storage 486 569
Materials and supplies 71 69
Generating plant fuel stock 37 52
Deferred property taxes 142 144
Regulatory assets 19 19
Other 38 14
-----------------------------
1,313 1,027
- ------------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS Regulatory Assets
Securitized costs 689 717
Postretirement benefits 185 209
Abandoned Midland project 11 12
Other 168 167
Nuclear decommissioning trust funds 536 581
Other 218 173
-----------------------------
1,807 1,859
- ------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $8,700 $ 8,321
==================================================================================================================
-53-
STOCKHOLDERS' INVESTMENT AND LIABILITIES CONSUMERS ENERGY COMPANY
In Millions
December 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
CAPITALIZATION (NOTE 3) Common stockholder's equity
Common stock, authorized --125.0 shares; $ 841 $ 841
outstanding 84.1 shares for all periods
Paid-in capital 682 632
Other comprehensive income (loss) (179) 4
Retained earnings since December 31, 1992 545 441
-----------------------------
1,889 1,918
Preferred stock 44 44
Company-obligated mandatorily redeemable
preferred securities of subsidiaries (a) 490 520
Long-term debt 2,442 2,472
Non-current portion of capital leases 116 72
-----------------------------
4,981 5,026
- ------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES Current portion of long-term debt and capital leases 318 257
Notes payable 457 416
Accounts payable 261 282
Accrued taxes 214 214
Accounts payable - related parties 84 96
Current portion of purchase power contracts 26 24
Deferred income taxes 25 12
Other 200 233
-----------------------------
1,585 1,534
- ------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES Deferred income taxes 949 784
Postretirement benefits 563 290
Regulatory liabilities for income taxes, net 297 276
Power purchase agreement-- MCV Partnership 27 52
Deferred investment tax credit 91 102
Other 207 257
-----------------------------
2,134 1,761
- ------------------------------------------------------------------------------------------------------------------
Commitments and Contingencies (Notes 1, 2, 8, and 11)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 8,700 $ 8,321
==================================================================================================================
(a) See Note 3, Short-Term Financings and Capitalization
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
-54-
CONSOLIDATED STATEMENTS OF LONG-TERM DEBT CONSUMERS ENERGY COMPANY
In Millions
December 31 Series (%) Due 2002 2001
- ----------------------------------------------------------------------------------------------------------------
FIRST MORTGAGE BONDS
6-3/8 2003 $ - $ 300
7-3/8 2023 208 208
-----------------------
208 508
SENIOR NOTES Floating 2002 - 100
6-3/8 2008 159 159
6-7/8 2018 180 180
6-1/5 2008 (a) 250 250
6-1/2 2018 (b) 141 141
6-1/2 2028 142 143
6-1/4 2006 332 332
6-0/0 2005 300 -
-----------------------
1,504 1,305
LONG-TERM BANK DEBT 328 184
POLLUTION CONTROL REVENUE BONDS 126 126
SECURITIZATION BONDS 453 469
OTHER 8 8
NUCLEAR FUEL DISPOSAL (c) 138 135
-----------------------
1,053 922
TOTAL PRINCIPAL AMOUNT OUTSTANDING 2,765 2,735
CURRENT AMOUNTS (305) (244)
NET UNAMORTIZED DISCOUNT (18) (19)
-------------------------
TOTAL LONG-TERM DEBT $2,442 $2,472
================================================================================================================
LONG-TERM DEBT MATURITIES In Millions
First Mortgage Senior Long-Term Securitization
Bonds Notes Bank Debt Bonds Other Total
- ----------------------------------------------------------------------------------------------------------------
2003 $ - $ 250 (a) $ 28 $ 27 $ - $ 305
2004 - - 300 28 - 328
2005 - 441 (b) - 29 - 470
2006 - 332 - 30 - 362
2007 - - - 31 - 31
Thereafter 208 481 - 308 272 1,269
------------------------------------------------------------------------------------------
Total $208 $1,504 $328 $453 $272 $2,765
================================================================================================================
(a) These Notes are subject to a Call Option by the Callholder or a Mandatory
Put on May 1, 2003
(b) Includes $141 Senior Remarketed Notes subject to optional redemption by
Consumers after June 15, 2005
(c) Due date uncertain (see Note 1)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
-55-
CONSOLIDATED STATEMENTS OF PREFERRED STOCK CONSUMERS ENERGY COMPANY
Optional
Redemption Number of Shares In Millions
December 31 Series Price 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK
Cumulative, $100 par value,
authorized 7,500,000 shares,
with no mandatory redemption $4.16 $103.25 68,451 68,451 $ 7 $ 7
4.50 110.00 373,148 373,148 37 37
----------------
TOTAL PREFERRED STOCK $44 $44
==================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
-56-
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY CONSUMERS ENERGY COMPANY
In Millions
Years Ended December 31 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
COMMON STOCK At beginning and end of period (a) $ 841 $ 841 $ 841
- ---------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL At beginning of period 632 646 645
Stockholder's contribution 150 150 -
Return of stockholder's contribution (100) (164) -
Miscellaneous - - 1
-----------------------------
At end of period 682 632 646
- ---------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period - - -
Minimum pension liability adjustments (b) (185) - -
------------------------------
At end of period (185) - -
Investments
At beginning of period 16 33 37
Unrealized gain (loss) on investments (b) (16) (16) (4)
Reclassification adjustments included in net
income (b) 1 (1) -
------------------------------
At end of period 1 16 33
Derivative Instruments (d)
At beginning of period (c) (12) 18 -
Unrealized gain (loss) on derivative
instruments (b) 10 (30) -
Reclassification adjustments included in
net income (b) 7 - -
------------------------------
At end of period 5 (12) -
- ---------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS At beginning of period 441 486 485
Net income (b) 381 188 284
Cash dividends declared - Common Stock (231) (190) (247)
Cash dividends declared - Preferred Stock (2) (2) (2)
Preferred securities distributions (44) (41) (34)
------------------------------
At end of period 545 441 486
- ---------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $1,889 $1,918 $2,006
===============================================================================================================
-57-
(a) Number of shares of common stock outstanding was 84,108,789 for all
periods presented
(b) Disclosure of Comprehensive Income:
Other comprehensive income
Minimum Pension Liability
Minimum pension liability adjustments, net of tax of
$100, $- and $-, respectively $(185) $ - $ -
Investments
Unrealized loss on investments, net of tax of
$9, $9 and $2, respectively (16) (16) (4)
Reclassification adjustments included in net income, net of tax of
$1, $1 and $-, respectively 1 (1) -
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net of tax of
$6, $15 and $-, respectively 10 (30) -
Reclassification adjustments included in net income, net of tax of
$4, $- and $-, respectively 7 - -
Net income 381 188 284
-----------------------
Total Comprehensive Income $ 198 $141 $280
======================
(c) Cumulative effect of change in accounting principle, as of 1/1/01 and
7/1/01, net of $(9) tax (Note 5)
(d) Included in these amounts is Consumers' proportionate share of the
effects of derivative accounting related to its equity investment in
the MCV Partnership as follows:
At the beginning of the period $(8) $ 5 $-
Unrealized gain (loss) on derivative instruments 12 (15) -
Reclassification adjustments included in net income 4 2 -
------------------------
At the end of period $ 8 $ (8) $-
========================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
-58-
Consumers Energy Company
CONSUMERS ENERGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 uses the equity method of
accounting for investments in 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. Consumers prepared the financial statements in
conformity with accounting principles generally accepted in the United States
that include the use of management's estimates.
USE OF ESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements. Estimates and
assumptions are also used in the disclosure of contingent assets and liabilities
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
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 in the financial statements when a current event
has caused a probable future payment of an amount that can be reasonably
estimated. Consumers has used this accounting principle to record estimated
liabilities discussed in Note 2, Uncertainties.
REVENUE RECOGNITION POLICY: Revenues from deliveries of electricity and natural
gas, and the storage of natural gas, are recognized as services are provided.
Therefore, revenues include the accrual of electricity or gas consumed and/or
delivered, but not billed at month-end.
ACCRETION INCOME AND EXPENSE: In 1991, the MPSC allowed Consumers to recover a
portion of its abandoned Midland investment over a 10-year period, but did not
allow Consumers to earn a return on that amount. Consumers reduced the
recoverable investment to the present value of the future recoveries. During the
recovery period, Consumers adjusts the unrecovered asset to its present value.
It reflects this adjustment as accretion income. In 1992, Consumers recorded a
loss for the present value of its estimated future underrecoveries of power
supply costs resulting from purchases from the MCV Partnership (see Note 2). It
now recognizes accretion expense annually to reflect the time value of money on
the recorded loss. Accretion expense is also recognized for some non-interest
bearing long-term electric option contracts for which Consumers has recorded a
liability at the present value of the contracts.
GAS INVENTORY: Consumers uses the weighted average cost method for valuing
working gas inventory. Beginning October 2000, gas inventory also includes
recoverable cushion gas. Consumers records non-recoverable cushion gas in the
appropriate gas utility plant account. Consumers stores gas inventory in its
underground storage facilities.
PROPERTY, PLANT AND EQUIPMENT: Additions to property, plant and equipment are
recorded at cost when first placed into service. When regulated assets are
retired, or otherwise disposed of in the ordinary course of the business, the
original cost and cost of removal, less salvage, is charged to accumulated
depreciation. With respect to the retirement or disposal of non-regulated
assets the resulting gains or losses are recognized as a component of income.
Consumers is permitted to capitalize an allowance for funds used during
construction on regulated construction projects and to include such amounts in
plant in service.
Property, plant and equipment at December 31, 2002 and 2001, was as follows:
In Millions
- -------------------------------------------------------------------------------------------------------------------
Estimated
Depreciable
Years Ended December 31 Life in Years 2002 2001
- -------------------------------------------------------------------------------------------------------------------
Electric:
Generation 13-75 $3,489 $3,368
Transmission 40-75 - 450
Distribution 12-85 3,619 3,448
Other 5-50 300 288
Capital Leases (b) 115 107
Gas:
Underground storage facilities (a) 25-55 217 210
Transmission 15-68 310 303
Distribution 35-70 1,899 1,807
Other 5-45 237 220
Capital Leases (b) 56 53
Other:
Non-utility property 7-71 23 23
Construction work-in-progress (c) 548 480
Less accumulated depreciation, depletion and amortization 5,900 5,934
- -------------------------------------------------------------------------------------------------------------------
Net property, plant and equipment $4,913 $4,823
===================================================================================================================
(a) Includes unrecoverable base natural gas in underground storage of $23
million and $14 million at December 31, 2002 and 2001, respectively, which
is not subject to depreciation.
(b) Capital leases presented in this chart are gross amounts. Amortization of
capital leases in 2002 and 2001 was $96 million and $91 million,
respectively. Capital leases are amortized over the lease term or the
service life of the assets in accordance with SFAS No. 13.
(c) Amount includes construction costs at December 31, 2002 and 2001 of $54
million and $16 million, respectively, relating to the capital lease of
Consumers main headquarters.
MAINTENANCE, DEPRECIATION, DEPLETION AND AMORTIZATION: Consumers charges
property repairs and minor property replacements to maintenance expense.
Depreciable property retired or sold, plus cost of removal (net of salvage
credits), is charged to accumulated depreciation. Consumers bases depreciation
provisions for utility
-59-
Consumers Energy Company
property on straight-line and units-of-production rates approved by the MPSC.
For 2002, 2001 and 2000, the composite depreciation rate for electric utility
property was 3.1 percent annually. For 2002, 2001 and 2000, the composite rate
for gas utility property was 4.5 percent, 4.4 percent and 4.4 percent,
respectively. For 2002, 2001 and 2000, the composite rate for other property was
7.2 percent, 11.2 percent and 10.7 percent, respectively.
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' investments in equity securities,
including its investment in CMS Energy Common Stock, 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, unless such changes in
fair value are other than temporary. In 2002, Consumers determined that the
decline in value related to its investment in CMS Energy Common Stock was other
than temporary as the fair value was below the cost basis for a period greater
than six months. As a result, Consumers recognized a loss on its investment in
CMS Energy Common Stock through earnings of $12 million in the fourth quarter of
2002. As of December 31, 2002, Consumers held 2.4 million shares of CMS Energy
Common Stock with a fair value of $22 million; as of March 14, 2003 the value
was $8 million. 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 investments is determined from quoted
market prices.
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 December 31,
2002, Consumers has a recorded liability to the DOE of $138 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.
NUCLEAR PLANT DECOMMISSIONING: In 2002, Consumers collected $6 million from its
electric customers for the decommissioning of its Palisades nuclear plant.
Amounts collected from electric retail customers and deposited in trusts
(including trust earnings) are credited to accumulated depreciation. In March
2001, Consumers filed updated decommissioning cost estimates for Big Rock and
Palisades that were $349 million and $739 million in 2000 dollars, respectively.
Using the inflation factors presented in the filing to the MPSC, the Palisades
estimated decommissioning cost in 2002 dollars is $809 million. The Big Rock
decommissioning cost in 2002 dollars is $327 million. Consumers' site-specific
decommissioning cost estimates for Big Rock and Palisades 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 the March
22, 1999 MPSC order and Consumers discontinued depositing funds in the trust. In
December 2000, the NRC extended the Palisades operating license to March 2011
and the impact of this extension was included as part of Consumers' March 2001
filing with the MPSC. Consumers is required to file the next "Report on the
Adequacy of the Existing Annual Provision for Nuclear Plant Decommissioning"
(Report) with the MPSC by March 31, 2004.
In 1997, Big Rock closed permanently and plant decommissioning began. Consumers
estimates that the Big Rock site will be returned to a natural state by the end
of 2012 if the DOE begins removing the spent nuclear fuel by 2010. In 2002,
Consumers incurred costs of $28 million that were charged to the accumulated
depreciation reserve for decommissioning and withdrew $30 million from the Big
Rock nuclear
-60-
Consumers Energy Company
decommissioning trust fund. In total, Consumers has incurred costs of $218
million that have been charged to the accumulated depreciation reserve for
decommissioning and withdrew $209 million from the Big Rock nuclear
decommissioning trust fund. These activities had no material impact on net
income. At December 31, 2002, Consumers is the beneficiary of the investment in
nuclear decommissioning trust funds of $110 million for Big Rock.
After retirement of Palisades, Consumers plans to maintain the facility in
protective storage if radioactive waste disposal facilities are not available.
Consumers will incur most of the Palisades decommissioning costs after the
plant's NRC operating license expires. Palisades' current NRC license will
expire in 2011 and the trust funds were estimated to have accumulated $921
million by that time, assuming currently approved MPSC surcharge levels.
Consumers estimates that at the time Palisades is fully decommissioned in the
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. At December 31, 2002, Consumers is the beneficiary of
the investment in the MPSC nuclear decommissioning trust funds of $416 million
for Palisades. In addition, at December 31, 2002, Consumers has a FERC
decommissioning trust fund with a balance of approximately $9 million.
UNAMORTIZED DEBT PREMIUM, DISCOUNT AND EXPENSE: Consumers amortizes premiums,
discounts and expenses incurred in connection with the issuance of presently
outstanding long-term debt over the terms of the respective issues. For the
regulated portions of our businesses, if debt is refinanced, Consumers amortizes
any unamortized premiums, discounts and expenses over the term of the new debt,
as allowed under regulated utility accounting.
RECLASSIFICATIONS: Consumers reclassified certain prior year amounts for
comparative purposes. These reclassifications did not affect consolidated net
income for the years presented.
RELATED-PARTY TRANSACTIONS: Consumers completed a five-year redemption of its
investment of $250 million in ten shares of Enterprises' preferred stock in
2001. The balances as of December 31, 2002, 2001 and 2000 were $0, $0 and $50
million, respectively. Consumers has an investment in 2.4 million shares of CMS
Energy Common Stock with a fair value totaling $22 million at December 31, 2002,
see Note 5. In 2002, 2001 and 2000, Consumers received dividends from these two
investments totaling $3 million, $6 million, and $10 million, respectively. In
2002, 2001, and 2000, Consumers paid parent company overhead costs to CMS Energy
of $18 million, $11 million and $1 million, respectively. Such overhead costs
were allocated to Consumers using the Massachusetts Formula.
In 2002, 2001 and 2000, Consumers paid $49 million, $55 million and $51 million,
respectively, for electric generating capacity and energy from affiliates of
Enterprises. From time to time, Consumers purchased a portion of its gas from
CMS Oil and Gas and CMS MST. In both 2002 and 2001, Consumers did not make a
purchase from CMS Oil and Gas. In 2000, Consumers purchased $3 million. In 2002,
2001 and 2000, Consumers' gas purchases from CMS MST were $127 million, $120
million and $95 million, respectively. Consumers pays a portion of its gas
transportation costs to Panhandle and its subsidiary Trunkline. In 2002, 2001
and 2000 transportation fees paid were $22 million, $21 million and $38 million,
respectively. In 2002, 2001 and 2000, Consumers paid $4 million, $4 million and
$1 million, respectively, for gas transportation from CMS Bay Area Pipeline,
L.L.C. In 2002, 2001 and 2000, Consumers and its subsidiaries sold, stored and
transported natural gas and provided other services to the MCV Partnership
totaling $27 million, $27 million and $26 million, respectively. For additional
discussion of related-party transactions with the MCV Partnership and the FMLP,
see Notes 2 and 11. Other related-party transactions are immaterial.
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
the regulated utility accounting standard SFAS No. 71. As a result, the actions
of regulators affect when Consumers recognizes revenues, expenses, assets and
liabilities.
-61-
Consumers Energy Company
In March 1999, Consumers received MPSC electric restructuring orders, which,
among other things, identified the terms and timing for implementing electric
restructuring in Michigan. Consistent with these orders and EITF No. 97-4,
Consumers discontinued the application of SFAS No. 71 for the energy supply
portion of its business because Consumers expected to implement retail open
access at competitive market based rates for its electric customers.
Discontinuation of SFAS No. 71 for the energy supply portion of Consumers'
business resulted in Consumers reducing the carrying value of its Palisades
plant-related assets, in 1999, by approximately $535 million and establishing a
regulatory asset for a corresponding amount. As of December 31, 2002, Consumers
had a net investment in energy supply facilities of $1.475 billion included in
electric plant and property.
Since 1999, there has been a significant legislative and regulatory change in
Michigan that has resulted in: 1) electric supply customers of utilities
remaining on cost-based rates and 2) utilities being given the ability to
recover Stranded Costs associated with electric restructuring, from customers
who choose an alternative electric supplier. During 2002, Consumers re-evaluated
the criteria used to determine if an entity or a segment of an entity meets the
requirements to apply regulated utility accounting, and determined that the
energy supply portion of its business could meet the criteria if certain
regulatory events occurred. In December 2002, Consumers received a MPSC Stranded
Cost order that allowed Consumers to re-apply regulatory accounting standard
SFAS No. 71 to the energy supply portion of its business. Re-application of SFAS
No. 71 had no effect on the prior discontinuation accounting, but will allow
Consumers to apply regulatory accounting treatment to the energy supply portion
of its business on a prospective basis, including regulatory accounting
treatment of costs required to be recognized in accordance with SFAS No. 143.
See Note 2, Uncertainties, "Electric Rate Matters -- Electric Restructuring.
SFAS No. 144 imposes strict criteria for retention of regulatory-created assets
by requiring that such assets be probable of future recovery at each balance
sheet date. Management believes these assets are probable of future recovery.
The following regulatory assets (liabilities), which include both current and
non-current amounts, are reflected in the Consolidated Balance Sheets. These
costs are expected to be recovered through rates over periods of up to 14 years.
Consumers recognized an OPEB transition obligation in accordance with SFAS No.
106 and established a regulatory asset for this amount, which it expects to
recover in rates over the next ten years.
In Millions
- ---------------------------------------------------------------------------------------------------------------
December 31 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Securitized costs (Note 2) $ 689 $ 717
Postretirement benefits (Note 7) 204 228
Electric Restructuring Implementation Plan (Note 2) 83 82
Manufactured gas plant sites (Note 2) 69 70
Abandoned Midland project 11 12
Income taxes (Note 4) - 6
Other 16 15
--------------------------
Total regulatory assets $1,072 $1,130
================================================================================================================
Income taxes (Note 4) $ (297) $ (282)
GCR over recovery (11) (9)
Other (5) -
-------------------------
Total regulatory liabilities $ (313) $ (291)
===============================================================================================================
In October 2000, Consumers received an MPSC order authorizing Consumers to
securitize certain regulatory assets up to $469 million, net of tax, see Note 2,
Uncertainties, "Electric Rate Matters -- Electric Restructuring". Accordingly,
in December 2000, Consumers established a regulatory asset for securitized costs
of $709 million, before tax, that had previously been recorded in other
regulatory asset accounts. In order to prepare for the financing of the
securitization assets and the subsequent retirement of debt with securitization
proceeds, issuance fees of $1 million, $10 million and $1 million were incurred
in 2002, 2001 and 2000, respectively, and capitalized as a part of
securitization costs. These issuance costs are amortized each month
-62-
Consumers Energy Company
for up to fourteen years. Amortization of the Securitized assets approximated
$29 million and $2 million in 2002 and 2001, respectively for accumulated
Securitized cost amortization of $31 million. The components of the unamortized
Securitized costs are illustrated below.
In Millions
- ----------------------------------------------------------------------------------------------------------------
December 31 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Unamortized nuclear costs $405 $405
Postretirement benefits 84 84
Income taxes 203 203
Uranium enrichment facility 16 16
Accumulated Securitization cost amortization (31) (2)
Other 12 11
-----------------------
Total unamortized securitized costs $689 $717
===============================================================================================================
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS:
SFAS NO. 142, GOODWILL AND OTHER INTANGIBLE ASSETS: This Standard issued in July
2001, requires that goodwill no longer be amortized to earnings, but instead be
reviewed for impairment. Effective January 1, 2002, the provisions of SFAS No.
142 had no impact on Consumers' consolidated results of operations or financial
position.
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, results in Consumers accounting for any
impairment or disposal of long-lived assets under the provisions of SFAS No. 144
subsequent to January 1, 2002, but will not change the accounting used for
previous asset impairments or disposals.
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, but may be adopted early. Consumers has adopted
this provision early, with no material affect to its income statement. SFAS No.
145 amends SFAS No. 13 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. Upon adoption of the
standard, there was no impact on Consumers' financial statements.
SFAS NO. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION -- TRANSITION AND
DISCLOSURE: Issued by the FASB in December 2002, this standard provides for
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, the
statement amends the disclosure requirements of SFAS No. 123 to require more
prominent and more frequent
-63-
Consumers Energy Company
disclosures in financial statements about the effects of stock-based
compensation. The transition guidance and annual disclosure provisions of the
statement are effective as of December 31, 2002 and interim disclosure
provisions are effective for interim financial reports starting in 2003.
Consumers decided to voluntarily adopt the fair value based method of accounting
for stock-based employee compensation effective December 31, 2002, applying the
prospective method of adoption which requires recognition of all employee awards
granted, modified, or settled after the beginning of the year in which the
recognition provisions are first applied. Therefore, Consumers recorded $1.7
million in expense for the fair value of stock options issued in 2002.
NEW ACCOUNTING STANDARDS TO BE ADOPTED
SFAS NO. 143, ACCOUNTING FOR ASSETS 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. Consumers has determined that it has
legal asset retirement obligations, particularly in regard to its nuclear
plants, but has not yet finalized its assessment of the obligation. However,
upon initial adoption of the standard, Consumers expects to record a regulatory
liability, as well as an asset retirement obligation, as required by SFAS No.
71. The regulatory liability recognizes the difference between the cost of
removal included in the reserve for accumulated depreciation for assets within
the scope of SFAS No. 143 and the accretion expense of the asset retirement
obligation and the depreciation expense of the asset retirement obligation asset
from when the obligation was initially incurred through December 2002. When the
asset retirement obligation 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 initial liability would be accreted to its
present value each period and the capitalized cost would be depreciated over the
related asset's useful life.
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 does not expect the adoption of SFAS No. 146 to have a material impact
on its financial position or results of operations.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS:
Effective January 2003, this interpretation elaborates on the disclosure to be
made by a guarantor about its obligations under certain guarantees that it has
issued. It also requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provision of this
interpretation does not apply to certain guarantee contracts, such as
warranties, derivatives, or guarantees between either parent and subsidiaries or
corporations under common control, although disclosure of such guarantees is
required. For contracts that are within the initial recognition and measurement
provision of this interpretation, the provisions are to be applied to guarantees
issued or modified after December 31, 2002; no cumulative effect adjustments are
required.
Following is a general description of Consumers' guarantees as required by this
Interpretation:
December 31, 2002 In Millions
- ------------------------------------------------------------------------------------------------------------------
Issue Expiration Maximum Carrying Recourse
Guarantee Description Date Date Obligation Amount Provision(a)
- ------------------------------------------------------------------------------------------------------------------
Standby letters of credit Various Various $ 7 $ - $ -
Surety bonds Various Various 9 - -
Nuclear insurance retrospective premiums Various Various 120 - -
==================================================================================================================
(a) Recourse provision indicates the approximate recovery from third parties
including assets held as collateral.
-64-
Consumers Energy Company
Following is additional information regarding Consumers' guarantees:
December 31, 2002
- ---------------------------------------------------------------------------------------------------------------------
Events That Would
Guarantee Description How Guarantee Arose Require Performance
- ---------------------------------------------------------------------------------------------------------------------
Standby letters of credit Normal operations of Non-compliance with
coal power plants environmental regulations
Self insurance requirement Non-performance
Surety bonds Normal operating activity, Non-performance
permits and license
Nuclear insurance retrospective premiums Normal operations of Call by NEIL and
nuclear plants Price-Anderson Act
for nuclear incident
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. For Consumers, the
consolidation requirements apply to pre-existing entities beginning July 1,
2003. Certain of the disclosure requirements apply to all financial statements
initially issued after January 31, 2003. Consumers will be required to
consolidate any entities that meet the requirements of the interpretation.
Consumers is in the process of studying the interpretation, and has yet to
determine the effects, if any, on its consolidated financial statements.
OTHER: For significant accounting policies regarding income taxes, see Note 4;
for derivatives, see Note 5; for executive incentive compensation, see Note 6;
for pensions and other postretirement benefits, see Note 7; and for leases, see
Note 8.
2: UNCERTAINTIES
Several 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 are discussed in
detail below and include: 1) pending litigation and government investigations;
2) the need to make additional capital expenditures and increase operating
expenses for Clean Air Act compliance; 3) 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; 4) electric industry restructuring
issues; 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; 9) uncertainties
relating to the storage and ultimate disposal of spent nuclear fuel and the
successful operation of Palisades by NMC; 10) the effects of derivative
accounting and potential earnings volatility; 11) potential environmental costs
at a number of sites, including sites formerly housing manufactured gas plant
facilities; 12) future gas industry restructuring initiatives; 13) any
initiatives undertaken to protect customers against gas price increases; 14) an
inadequate regulatory response to applications for
-65-
Consumers Energy Company
requested rate increases; 15) market and regulatory responses to increases in
gas costs, including a reduced average use per residential customer; 16)
Consumers' continuing ability to raise funds at reasonable rates in order to
meet the cash requirements of its electric and gas business.
SEC AND OTHER INVESTIGATIONS: As a result of the round-trip trading transactions
at CMS MST, CMS Energy's Board of Directors established a Special Committee of
independent directors to investigate matters surrounding the transactions and
retained outside counsel to assist in the investigation. The Special Committee
completed its investigation and reported its findings to the Board of Directors
in October 2002. The Special Committee concluded, based on an extensive
investigation, that the round-trip trades were undertaken to raise CMS MST's
profile as an energy marketer with the goal of enhancing its ability to promote
its services to new customers. The Special Committee found no apparent effort to
manipulate the price of CMS Energy Common Stock or affect energy prices. The
Special Committee also made recommendations designed to prevent any reoccurrence
of this practice, most of which have already been implemented. Previously, CMS
Energy terminated its speculative trading business and revised its risk
management policy. The Board of Directors adopted, and CMS Energy has begun
implementing, the remaining recommendations of the Special Committee.
CMS Energy is cooperating with other investigations concerning round-trip
trading, including an investigation by the SEC regarding round-trip trades and
CMS Energy's financial statements, accounting policies and controls, and
investigations by the United States Department of Justice, the Commodity Futures
Trading Commission and the FERC. CMS Energy has also received subpoenas from
U.S. Attorneys Offices regarding investigations of those trades. CMS Energy is
unable to predict the outcome of these matters, and Consumers is unable to
predict what effect, if any, these investigations will have on its business.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been filed in the United States District Court for the
Eastern District of Michigan as purported class actions by individuals who
allege that they purchased CMS Energy's securities during a purported class
period. At least two of the complaints contain purported class periods beginning
on August 3, 2000 and running through May 10, 2002 or May 14, 2002. 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 cases have been consolidated into a single lawsuit and
an amended and consolidated complaint is due to be filed by May 1, 2003. CMS
Energy and Consumers intend to vigorously defend against this action. Consumers
cannot predict the outcome of this litigation.
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named and unnamed officers and directors in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
401(k) plan. The two cases, filed in July 2002 in the United States District
Court for the Eastern District of Michigan, were consolidated by the trial judge
and an amended and consolidated complaint has been filed. Plaintiffs allege
breaches of fiduciary duties under ERISA and seek restitution on behalf of the
plan with respect to a decline in value of the shares of CMS Energy Common Stock
held in the plan. Plaintiffs also seek other equitable relief and legal fees.
These cases will be vigorously defended. Consumers cannot predict the outcome of
this litigation.
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 1998, the EPA issued final regulations requiring the state of
Michigan to further limit nitrogen
-66-
Consumers Energy Company
oxide emissions. The Michigan Department of Environmental Quality finalized
rules to comply with the EPA final regulations in December 2002 and submitted
these rules for approval to the EPA in the first quarter of 2003. In addition,
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 regulations. The EPA and the state final regulations will require
Consumers to make significant capital expenditures estimated to be $770 million.
As of December 31, 2002, Consumers has incurred $405 million in capital
expenditures to comply with the EPA final regulations and anticipates that the
remaining capital expenditures will be incurred between 2003 and 2009.
Additionally, Consumers currently expects to supplement its compliance plan with
the purchase of nitrogen oxide emissions credits for years 2005 through 2008.
The cost of these credits based on the current market is estimated to average $6
million per year, however, the market for nitrogen oxide emissions credits is
volatile and the price could change significantly. At some point, if new
environmental standards become effective, Consumers may need additional capital
expenditures to comply with the future standards. Based on the Customer Choice
Act, 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 from customers, subject to an MPSC prudency hearing.
These and other required environmental expenditures, if not recovered from
customers 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
December 31, 2002, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
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. Consumers has
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) cut 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; 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 (Consumers has sold its interest in its
transmission facilities to an independent transmission owner, see "Transmission"
below); 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
-67-
Consumers Energy Company
in excess of depreciation levels incurred during and before the rate freeze/cap
period; and 9) allows recovery of "net" Stranded Costs and implementation costs
incurred as a result of the passage of the act. In July 2002, the MPSC issued an
order approving the plan to achieve the increased transmission capacity.
Consumers has completed the transmission capacity projects identified in the
plan and has submitted verification of this fact to the MPSC. Consumers believes
it is in full compliance with item 7 above. Consumers is also highly confident
that it will meet the conditions contained in item 5 above, prior to the
earliest rate cap termination dates specified in the act. Failure to do so,
however, 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 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 as
little as 30 days notice to Consumers, to return to Consumers' generation
service at current tariff rates. If any class of customers' (residential,
commercial, or industrial) retail open access load reaches 10 percent of
Consumers' total load for that class of customers, then returning retail open
access customers for that class must give 60 days notice 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. Consumers cannot predict the total amount of electric supply load
that may be lost to competitor suppliers, nor whether the stranded cost recovery
method adopted by the MPSC will be applied in a manner that will fully offset
any associated margin loss.
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
resulted in lower interest costs and a longer amortization period for the
securitized assets, and offset the majority of the impact of the required
residential rate reduction (approximately $22 million in 2000 and $49 million
annually thereafter). The orders directed 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 approximately $12
million annually.
In November 2001, Consumers Funding 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 retire $164 million of its common equity from
its parent, CMS Energy. CMS Energy used the $164 million from Consumers to pay
down its own short-term debt. From December 2001 through March 2002, the
remainder of these proceeds were used to pay down Consumers' long-term debt and
Trust Preferred Securities. CMS Energy used the $164 million from Consumers to
pay down its own short-term debt.
Consumers and Consumers Funding 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.
-68-
Consumers Energy Company
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. The first
true-up occurred in November 2002, and prospectively modified the total
securitization and related tax charges from 1.677 mills per kWh to 1.746 mills
per kWh. 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 charge collections, $52 million in 2002, are
remitted to a trustee for the Securitization bonds. Securitization charge
collections are dedicated for the repayment of the principle and interest on the
Securitization bonds and payment of the ongoing expenses of Consumers Funding
and can only be used for those purposes. Consumers Funding is legally separate
from Consumers. The assets and income of Consumers Funding, including without
limitation, the securitized property, are not available to creditors of
Consumers or CMS Energy.
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 accumulated
amortization amount was approximately $31 million and the securitized assets
will be fully amortized by the end of 2015.
On March 4, 2003, Consumers filed an application with the MPSC seeking approval
to issue Securitization bonds in the amount of approximately $1.084 billion. If
approved, this would allow the recovery of costs associated with Clean Air Act
expenditures, post-2000 Palisades expenditures, and retail open access
implementation costs, through December 31, 2003 and certain pension fund
expenses, and expenses associated with the issuance of the bonds.
TRANSMISSION: In 1999, the FERC issued Order No. 2000, strongly encouraging
electric utilities to transfer operating control of their electric transmission
system 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 system for sale rather than own and invest in an asset
that it could not control. In May 2002, Consumers sold its electric transmission
system (METC) 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 of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by CMS
Energy, Consumers, or their affiliates when the transaction was discussed
internally and negotiated with purchasers. As a result of the sale, Consumers
experienced an after-tax earnings increase of approximately $17 million in 2002,
due to the recognition of a $26 million gain on the sale of the electric
transmission system. This gain from the sale is offset by a loss of revenue from
wholesale and retail open access customers who will buy services directly from
MTH, including the loss of a return on the sold electric transmission system.
Consumers anticipates that the future impact of the loss of revenue from
wholesale and retail open access customers who will buy services directly from
MTH and the loss of a return on the sold electric transmission system on its
after-tax earnings will be a decrease of $15 million in 2003, and a decrease of
approximately $14 million annually for the next three years.
Under the agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers are fixed by contract at current levels
through December 31, 2005, and subject to FERC ratemaking thereafter. MTH has
completed 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, and MTH (METC) has joined the MISO RTO.
-69-
Consumers Energy Company
When IPPs connect to transmission systems, they pay transmission companies the
capital costs incurred to connect the IPP to the transmission system and make
system upgrades needed for the interconnection. It is the FERC's policy that the
system upgrade portion of these IPP payments be credited against transmission
service charges over time as transmission service is taken. METC recorded a $35
million liability for IPP credits. Subsequently, MTH assumed this liability as
part of its purchase of the electric transmission system. Several months after
METC started operation, the FERC changed its policy to provide for interest on
IPP payments that are to be credited. The $35 million liability for IPP credits
does not include interest since the associated interconnection agreements do not
at this time provide for interest. MTH has asserted that Consumers may be liable
for interest on the IPP payments to be credited if interest provisions are added
to these agreements. Consumers believes that any potential liability would not
have a material adverse affect on its financial condition.
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. The reserve margin provides additional
power supply capability 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. In recent years, Consumers has planned for a reserve
margin of approximately 15 percent from a combination of its owned electric
generating plants and electricity purchase contracts or options, as well as
other arrangements. However, in light of various factors, including the addition
of new generating capacity in Michigan and throughout the Midwest region and
additional transmission import capability, Consumers is continuing to evaluate
the appropriate reserve margin for 2003 and beyond. Currently, Consumers has an
estimated reserve margin of approximately 11 percent for summer 2003, or 111
percent of projected summer peak load. Of the 111 percent, approximately 101
percent is met from owned electric generating plants and long-term power
purchase contracts and 10 percent from short-term contracts and options for
physical deliveries and other agreements. The ultimate use of the 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 mid-March 2003, alternative electric suppliers
are providing 516 MW of generation supply to ROA customers. Consumers' reserve
margin does not include generation being supplied by other alternative electric
suppliers under the ROA program.
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 and capacity contracts for the physical delivery of
electricity primarily in the summer months and to a lesser degree in the winter
months. As of December 31, 2002, Consumers had purchased or had commitments to
purchase electric call option and capacity contracts partially covering the
estimated reserve margin requirements for 2003 through 2007. As a result
Consumers has a recognized asset of $30 million for unexpired call options and
capacity contracts. The total cost of electricity call option and capacity
contracts for 2002 was $13 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 which calculated "net" Stranded
Costs as the shortfall between: (a) the revenue
-70-
Consumers Energy Company
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. The MPSC authorized
Consumers to use deferred accounting to recognize the future recovery of costs
determined to be stranded. Consumers has initiated an appeal at the Michigan
Court of Appeals related to the MPSC's December 2001 "net" Stranded Cost order.
According to the MPSC, "net" Stranded Costs were to be recovered from retail
open access customers through a Stranded Cost transition charge. 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.
Consumers in its hearing brief, filed in August 2002, revised its request for
Stranded Costs to $7 million and $4 million for 2000 and 2001, respectively, and
an estimated $73 million for 2002. The single largest reason for the difference
in the filing was the exclusion, as ordered by the MPSC, of all costs associated
with expenditures required by the Clean Air Act.
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to establish a defined
methodology that would allow a reliable prediction of the level of Stranded
Costs for 2002 and future years. In January 2003, Consumers filed a petition for
rehearing of the December 2002 Stranded Cost order in which it asked the MPSC to
grant a rehearing and revise certain features of the order. Several other
parties also filed rehearing petitions with the MPSC. As noted above, Consumers
has filed a request with the MPSC for authority to issue securitization bonds
that would allow recovery of the Clean Air Act expenditures and post-2000
Palisades expenditures that were excluded from the Stranded Cost calculation.
On March 4, 2003, Consumers filed an application with the MPSC seeking approval
of "net" Stranded Costs incurred in 2002, and for approval of a "net" Stranded
Cost recovery charge. In the application, Consumers indicated that if Consumers'
proposal to securitize Clean Air Act expenditures and post-2000 Palisades'
expenditures were approved as proposed in its securitization case as discussed
above, then Consumers' "net" Stranded Costs incurred in 2002 are approximately
$35 million. If the proposal to securitize those costs is not approved, then
Consumers indicated that the costs would be properly included in the 2002 "net"
Stranded Cost calculation, which would increase Consumers' 2002 "net" Stranded
Costs to approximately $103 million. Consumers cannot predict the recoverability
of Stranded Costs, and therefore has not recorded any regulatory assets to
recognize the future recovery of such costs.
The MPSC staff has scheduled a collaborative process to discuss Stranded Costs
and related issues and to identify and make recommendations to the MPSC.
Consumers intends to participate in this collaborative process.
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.
-71-
Consumers Energy Company
In Millions
- --------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 8 - -
2003 2002 2 2 - -
==============================================================================================================
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 2000, 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. In addition to the
amounts shown above, as of December 2002, Consumers incurred and deferred as a
regulatory asset, $1 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. Consumers cannot predict the amounts the
MPSC will approve as allowable costs.
Consumers is also pursuing authorization at the FERC for MISO to reimburse
Consumers for approximately $8 million in certain electric utility restructuring
implementation costs related to its former participation in the development of
the Alliance RTO, a portion of which has been expensed. However, Consumers
cannot predict the amount the FERC will ultimately order to be reimbursed by the
MISO.
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 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 the 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. Consumers submitted revised rates
to comply with the FERC final order in June 2002. Those revised rates were
accepted by the FERC in August 2002 and Consumers is in the process of computing
refund amounts for individual customers. Consumers believes its reserve is
sufficient to satisfy its estimated refund obligation. As of December 2002,
Consumers had paid $17 million in refunds.
In November 2002, the MPSC, upon its own motion, commenced a contested
proceeding requiring each utility to give reason as to why its rates should not
be reduced to reflect new personal property multiplier tables, and why it should
not refund any amounts that it receives as refunds from local governments as
they implement the new multiplier tables. Consumers responded to the MPSC that
it believes that refunds would be inconsistent with the electric rate freeze
that is currently in effect, and may otherwise be unlawful. Consumers is unable
to predict the outcome of this matter.
-72-
Consumers Energy Company
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.
Consumers' consolidated retained earnings include undistributed earnings from
the MCV Partnership for the years 2002, 2001 and 2000 of $226 million, $184
million, and $168 million, respectively.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
Years Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
Operating income $52 $36 $56
Income taxes and other 18 11 18
Cumulative effect of a change in accounting for derivatives,
net of $10 million tax expense (Note 11) 18 -- --
- ------------------------------------------------------------------------------------------------------------------
Net income $52 $25 $38
==================================================================================================================
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. Recovery of both the 915 MW and 325 MW portions of the PPA are subject to
certain limitations discussed below. After September 2007, the PPA's terms
obligate Consumers to pay the MCV Partnership only those capacity and energy
charges that the MPSC has authorized for recovery from electric customers.
In 1992, Consumers recognized a loss and established a PPA liability for the
present value of the estimated future underrecoveries of power supply costs
under the PPA based on MPSC cost recovery orders. Primarily as a result of the
MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. At December 31, 2002, 2001 and 2000, the remaining after-tax
present value of the estimated future PPA liability associated with the loss
totaled $34 million, $50 million and $64 respectively. The PPA liability is
expected to be depleted in late 2004. 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 a settlement agreement
effective January 1, 1999, that addressed, among other things, the ability of
the MCV Partnership to count modifications increasing the capacity of the
existing MCV Facility for purposes of computing the availability of contract
capacity under the PPA for billing purposes. That settlement agreement capped
availability payments that may be billed by the MCV Partnership at a 98.5
percent level.
When Consumers returns, as expected, to unfrozen rates beginning in 2004,
Consumers will recover from customers, on-peak and off-peak capacity, so long as
availability does not exceed an average 88.7% percent established in previous
MPSC orders. For availability payments billed by the MCV Partnership after
September 15, 2007, and not recovered from customers, Consumers would expect to
claim a regulatory out under the PPA. If the MCV Facility's generating
availability remains 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:
-73-
Consumers Energy Company
In Millions
- -----------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- -----------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
================================================================================================================
It is currently estimated that 51 percent of the actual cash underrecoveries for
the years 2003 and 2004 will be charged to the PPA liability, with the remaining
portion charged to operating expense as a result of Consumers' 49 percent
ownership in the MCV Partnership. All cash underrecoveries will be expensed
directly to income once the PPA liability is depleted.
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 MATTERS: Throughout 2002, Big Rock, currently in decommissioning,
progressed on plan with building and equipment dismantlement to return the site
to a natural setting free for any future use. Periodic NRC inspection reports
continued to reflect positively on Big Rock project performance. The NRC found
all decommissioning activities were performed in accordance with applicable
regulatory and license conditions.
In February 2003, the NRC completed its end-of-cycle plant performance
assessment of Palisades. The end-of-cycle review for Palisades covered the 2002
calendar year. The NRC determined that Palisades was operated in a manner that
preserved public health and safety and fully met all cornerstone objectives.
Based on the plant's performance, only regularly scheduled inspections are
planned through March 2004. The NRC noted that they are planning inspections of
the new independent spent fuel storage facility as needed during construction
activities along with routine inspections for the new security requirements.
Spent Nuclear Fuel Storage: During the fourth quarter of 2002, equipment
fabrication, assembly and testing was completed at Big Rock on NRC approved
transportable steel and concrete canisters or vaults, commonly known as
"dry-casks" for temporary onsite storage of spent fuel and movement of fuel from
the fuel pool to dry casks began. As of March 2003, all of the seven dry casks
had been loaded with spent fuel. These transportable dry casks will remain
onsite until the DOE moves the material to a permanent national fuel repository.
At Palisades, 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, "dry casks", for
temporary on-site storage. As of December 31, 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
-74-
Consumers Energy Company
casks for additional storage, along with more storage pad capacity, will be
available prior to 2004.
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 challenged the validity of the mechanism for
funding the settlement in an appeal, and recently the reviewing court sustained
their challenge. 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. If the litigation,
that was commenced in the fourth quarter of 2002, against the DOE is successful,
Consumers anticipates future recoveries from the DOE to defray the significant
costs it will incur for the storage of spent fuel until the DOE takes possession
as required by law.
On March 26, 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumer Federation filed a
complaint with the MPSC that asks the MPSC to commence a generic investigation
and contested case to review all facts and issues concerning the recovery of
costs associated with spent nuclear fuel storage and disposal. The complaint
alleges that the rates of Consumers Energy, The Detroit Edison Company, Indiana
& Michigan Electric Company, Wisconsin Electric Power Company and Wisconsin
Public Service Corporation are unjust and unreasonable with respect to the
recovery of costs associated with spent nuclear fuel storage and disposal. The
complaint seeks a variety of relief, including the establishing of external
trusts to which amounts collected in electric rates for spent nuclear fuel
storage and disposal should be transferred, and the adoption of additional
measures to assure that adequate funds are available for the storage and
disposal of spent nuclear fuel. Consumers has not had an opportunity to review
the complaint in detail.
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.
Palisades Plant Operations: 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.
Following a refueling outage in April 2001, the Palisades reactor was shut down
on June 20, 2001 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. The plant was
returned to service on January 21, 2002 and has been in continuous operation
with the exception of three days in December 2002 when there was a transmission
line related outage. 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,
-75-
Consumers Energy Company
the impact on 2002 net income was $5 million.
Insurance: Consumers maintains primary and excess nuclear property insurance
from NEIL, totaling $2.7 billion in recoverable limits for the Palisades nuclear
plant. Consumers also procures coverage from NEIL that would partially cover the
cost of replacement power during certain prolonged accidental outages at
Palisades. NEIL's policies include coverage for acts of terrorism.
Consumers retains the risk of loss to the extent of the insurance deductibles
and to the extent that its loss exceeds its policy limits. Because NEIL is a
mutual insurance company, Consumers could be subject to assessments from NEIL up
to $25.8 million in any policy year if insured losses in excess of NEIL's
maximum policyholders surplus occur at its, or any other member's nuclear
facility.
Consumers maintains nuclear liability insurance for injuries and off-site
property damage resulting from the nuclear hazard at Palisades for up to
approximately $9.5 billion, the maximum insurance liability limits established
by the Price-Anderson Act. Congress enacted the Price-Anderson Act to provide
financial protection for persons who may be liable for a nuclear accident or
incident and persons who may be injured by a nuclear incident. The
Price-Anderson Act was recently extended to December 31, 2003. Part of the
Price-Anderson Act's financial protection consists of a mandatory industry-wide
program under which owners of nuclear generating facilities could be assessed if
a nuclear incident occurs at any of such facilities. The maximum assessment
against Consumers could be $88 million per occurrence, limited to maximum annual
installment payments of $10 million. Consumers also maintains insurance under a
master worker program that covers tort claims for bodily injury to workers
caused by nuclear hazards. The policy contains a $300 million nuclear industry
aggregate limit. Under a previous insurance program providing coverage for
claims brought by nuclear workers, Consumers remains responsible for a maximum
assessment of up to $6.3 million. The Big Rock plant remains insured for nuclear
liability by a combination of insurance and United States government indemnity
totaling $544 million.
Insurance policy terms, limits and conditions are subject to change during the
year as Consumers renews its policies.
CAPITAL EXPENDITURES: In 2003, 2004, and 2005, Consumers estimates electric
capital expenditures, including new lease commitments and environmental costs
under the Clean Air Act, of $341 million, $408 million, and $385 million,
respectively.
COMMITMENTS FOR FUTURE PURCHASES: Consumers enters into a number of
unconditional purchase obligations that represent normal business operating
contracts. These contracts are used to assure an adequate supply of goods and
services necessary for the operation of its business and to minimize exposure to
market price fluctuations. Consumers believes that these future costs are
prudent and reasonably assured of recovery in future rates.
Coal Supply: Consumers has entered into coal supply contracts with various
suppliers for its coal-fired generating stations. Under the terms of these
agreements, Consumers is obligated to take physical delivery of the coal and
make payment based upon the contract terms. Consumers' current contracts have
expiration dates that range from 2003 to 2005, and total an estimated $276
million. Long-term coal supply contracts account for approximately 60 to 90
percent of Consumers annual coal requirements. In 2002, coal purchases totaled
$247 million of which $224 million (88 percent of the tonnage requirement) was
under long-term contract. Consumers supplements its long-term contracts with
spot-market purchases.
Power Supply, Capacity and Transmission: As of December 31, 2002, Consumers had
future unrecognized commitments to purchase power supply and transmission
services under fixed price forward contracts for the years 2003 and 2004
totaling $15 million. Consumers also had commitments to purchase capacity and
energy
-76-
Consumers Energy Company
under 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 for the
years 2003 through 2030 total an estimated $16 billion, undiscounted, which
includes $12 billion related to the MCV Facility. This amount may vary depending
upon plant availability and fuel costs. If a plant were not available to deliver
electricity to Consumers, then Consumers would not be obligated to make the
capacity payment until the plant could deliver. For further information, see
Note 2, Uncertainties, "The Midland Cogeneration Venture" for information
concerning power purchases from the MCV Facility.
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 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 three and seven 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 December 31, 2002, Consumers has an accrued liability of $51 million, net of
$31 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, in its November 7, 2002, gas distribution rate order, authorized
Consumers to continue to recover approximately $1 million of manufactured gas
plant facilities environmental clean-up costs annually. Consumers defers and
amortizes, over a period of 10 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. The annual amount that the MPSC
authorized Consumers to recover in rates will continue to be offset by $2
million to reflect amounts recovered from all other sources.
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 the on-going GCR process, which includes an annual
reconciliation process with the MPSC, Consumers expects to collect all of its
incurred gas costs. Under an order issued by the MPSC on March 12, 2003,
Consumers is allowed to increase its maximum GCR factor in May 2003, based on a
formula that tracks increases in NYMEX prices.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. On November 7, 2002, the MPSC
issued a final order approving a $56 million annual gas distribution service
rate increase, which includes the $15 million interim increase, with an 11.4
percent
-77-
Consumers Energy Company
authorized return on equity, effective for service November 8, 2002. As part of
this order, the MPSC approved Consumers' proposal to absorb the assets and
liabilities of Michigan Gas Storage Company into Consumers' rate base and rates.
This has occurred through a statutory merger of Michigan Gas Storage Company
into Consumers and this is not expected to have an impact on Consumers'
consolidated financial statements.
2003 GAS RATE CASE: On March 14, 2003, Consumers filed an application with the
MPSC seeking a $156 million increase in its gas delivery and transportation
rates, which includes a 13.5 percent authorized return on equity, based on a
2004 test year. If approved, the request would add about $6.40 per month, or
about 9 percent, to the typical residential customer's average monthly
distribution bill. Contemporaneously with this filing, Consumers has requested
interim rate relief in the same amount.
In September 2002, the FERC issued an order rejecting a filing by Consumers to
assess certain rates for non-physical gas title tracking services offered by
Consumers. Despite Consumers' arguments to the contrary, the FERC asserted
jurisdiction over such activities and allowed Consumers to refile and justify a
title transfer fee not based on volumes as Consumers proposed. Because the order
was issued six years after Consumers made its original filing initiating the
proceeding, over $3 million in non-title transfer tracking fees had been
collected. No refunds have been ordered, and Consumers sought rehearing of the
September order. If refunds were ordered they may include interest which would
increase the refund liability to more than the $3 million collected. In December
2002, Consumers established a $3.6 million reserve related to this matter.
Consumers is unable to say with certainty what the final outcome of this
proceeding might be.
In November 2002, the MPSC upon its own motion commenced a contested proceeding
requiring each utility to give reason as to why its rates should not be reduced
to reflect new personal property multiplier tables, and why it should not refund
any amounts that it receives as refunds from local governments as they implement
the new multiplier tables. Consumers responded to the MPSC that it believes that
refunds would be inconsistent with the November 7, 2002 gas rate order in case
U-13000, with the Customer Choice Act, and may otherwise be unlawful. Consumers
is unable to predict the outcome of this matter.
OTHER GAS UNCERTAINTIES
CAPITAL EXPENDITURES: In 2003, 2004, and 2005, Consumers estimates gas capital
expenditures, including new lease commitments, of $144 million, $167 million,
and $225 million, respectively.
COMMITMENTS FOR GAS SUPPLIES: Consumers contracts to purchase gas and
transportation from various suppliers for its natural gas business. These
contracts have expiration dates that range from 2003 to 2005. Consumers' 2002
gas requirements totaled 199 bcf at a cost of $727 million. As of the end of
2002, Consumers' expected gas requirements for 2003 are 231 bcf of which 38
percent is covered by existing contracts.
OTHER UNCERTAINTIES
COLLECTIVE BARGAINING AGREEMENT: As of December 31, 2002, 44 percent of
Consumers workforce was represented by the Utility Workers Union of America.
Consumers and the Union negotiated a collective bargaining agreement that became
effective as of June 1, 2000, and will continue in full force and effect until
June 1, 2005. Consumers is currently negotiating with the Union for a collective
bargaining agreement for its Call Center employees.
-78-
Consumers Energy Company
DERIVATIVE ACTIVITIES: Consumers uses a variety of contracts to protect against
commodity price and interest rate risk. Some of these contracts may be subject
to derivative accounting, which requires that the value of the contracts to be
adjusted fair value through earnings or equity depending upon certain criteria.
Such adjustments to fair value could cause earnings volatility. For further
information about derivative activities, see Note 5, Financial and Derivative
Instruments.
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: FINANCINGS AND CAPITALIZATION
REGULATORY AUTHORIZATION FOR FINANCINGS: At December 31, 2002, Consumers had
FERC authorization to issue or guarantee through June 2004, up to $1.1 billion
of short-term securities outstanding at any one time. Consumers also had
remaining FERC authorization to issue through June 2004 up to $500 million of
long-term securities for refinancing or refunding purposes, $677 million for
general corporate purposes, and $900 million of first mortgage bonds to be
issued solely as security for the long-term securities. On October 10, 2002,
FERC granted a waiver of its competitive bid/negotiated placement requirements
applicable to the remaining long-term securities authorization indicated above.
SHORT-TERM FINANCINGS: At December 31, 2002, a total of $457 million was
outstanding at a weighted average interest rate of 4.5 percent, compared with
$416 million outstanding on a revolving credit facility and unsecured lines of
credit at December 31, 2001, at a weighted average interest rate of 2.7 percent.
On July 12, 2002, Consumers entered into two credit facilities as follows: a
$250 million revolving credit facility maturing July 11, 2003 and a $300 million
term loan maturing July 11, 2003. In September 2002, the term loan maturity was
extended by one year at Consumers' option and now has a maturity date of July
11, 2004. 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. At December 31, 2002, a total of $550 million
was outstanding under the revolver and term loan, of which $250 million was
included in notes payable and $300 million was included in long-term debt
maturing in 2004. The prior credit facilities and lines were unsecured. The two
new credit facilities are secured with Consumers' first mortgage bonds and are
available to finance seasonal working capital requirements and to pay for
capital expenditures between long-term financings.
-79-
Consumers Energy Company
Consumers $250 million revolving credit facility had, as of December 31, 2002,
an effective interest rate of 5.9 percent, although the rate may fluctuate
depending on the rating of Consumers' first mortgage bonds or changes in the
base LIBOR rate. The effective interest rate on the $300 million term loan was
8.9 percent as of December 31, 2002. The rate may fluctuate depending on the
rating of Consumers' first mortgage bonds or changes in the base LIBOR rate.
Consumers bank and legal fees associated with arranging the facilities in July
2002 was $6 million.
The two credit facilities have contractual restrictions that require Consumers
to maintain, as of the last day of each fiscal quarter, the following:
Limitation Ratio at December 31, 2002
=================================================================================================================
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.55 to 1.00
Interest Coverage Ratio (a)(b) Not less than 2.0 to 1.0 4.00 to 1.0
=================================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facilities provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
In March 2003, Consumers obtained a replacement revolving credit facility in the
amount of $250 million, secured by first mortgage bonds. The cost of the
facility is LIBOR plus 350 basis points. The new credit facility matures in
March 2004 with two annual extensions at Consumers' option, which would extend
the maturity to March 2006. The prior facility was due to expire in July 2003.
Under the provisions of its articles of incorporation, Consumers had $394
million of unrestricted retained earnings available to pay common dividends at
December 31, 2002. However, 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. Consumers paid $231 million and $190 million in
common stock dividends to CMS Energy in 2002 and 2001, respectively. In January
2003, Consumers declared and paid a $78 million common dividend.
In July 2002, the credit rating of the publicly traded securities of Consumers
was downgraded by the major rating agencies. As a result of certain of these
downgrades, certain 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 addressing these issues as
required.
In October 2002, Consumers simultaneously entered into a new term loan agreement
collateralized by first mortgage bonds and a new gas inventory term loan
agreement collateralized by Consumers' natural gas in storage. These agreements
contain complementary collateral packages that provide Consumers, as additional
first mortgage bonds become available, borrowing capacity of up to $225 million,
of which $207 million was outstanding at December 31, 2002 with an effective
interest rate of 6.3 percent. The bank and legal fees associated with the
agreements were $2 million. The first amortization payment under these
agreements occurred in December 2002 with monthly amortization payments
scheduled until full repayment is completed in mid-April of 2003. The loan
amortization also reduces the bank's loan commitment to the amount of loan
outstanding which was $207 million as of December 31, 2002.
LONG-TERM FINANCINGS: In March 2002, Consumers sold $300 million principal
amount of 6 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.
In March 2003, Consumers entered into a $140 million term loan, secured by
first mortgage bonds, with a private investor bank. This loan has a term of six
years, at a cost of LIBOR plus 475 basis points. Also in March 2003, Consumers
entered into a $150 million term loan, secured by first mortgage bonds. This
term loan has a three year maturity, at a cost of LIBOR plus 450 basis points.
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 mortgage bond
Indenture, its articles of incorporation and the need for regulatory approvals
to meet appropriate federal law.
-80-
Consumers Energy Company
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.
In Millions
- -------------------------------------------------------------------------------------------------------------------
Earliest
Trust and Securities Rate Amount Outstanding Maturity Redemption
- -------------------------------------------------------------------------------------------------------------------
December 31 2002 2001 2000 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: Consumers has a total of $126 million of long-term pollution control
revenue bonds outstanding, secured by first mortgage bonds and insurance
policies. These bonds had a weighted average interest rate of 2.7 percent at
December 31, 2002.
On April 1, 2002, Consumers established a new subsidiary, Consumers Receivables
Funding. This consolidated subsidiary was established as a special purpose
entity to properly reflect the sale of trade receivables from Consumers to the
purchaser, an unrelated third party under a trade receivables sale agreement.
Prior to the establishment of Consumers Receivables Funding, Consumers sold its
accounts receivable directly to the purchaser. At December 31, 2002 and 2001,
the receivables sold under the program were $325 million and $334 million,
respectively. Accounts receivable and accrued revenue in the Consolidated
Balance Sheets have been reduced to reflect receivables sold.
Under the program discussed above, during 2002 and 2001, Consumers sold accounts
receivable but retained servicing responsibility. Consumers is responsible for
the collectability of the accounts receivable sold, however, the purchaser of
sale of accounts receivable have no recourse to Consumers' other assets for
failure of debtors to pay when due and there are no restrictions on accounts
receivables not sold. No gain or loss has
-81-
Consumers Energy Company
been recorded on the sale of accounts receivable and Consumers retains no
interest in the receivables sold. The average annual discount rate was 2.05
percent and 4.37 percent for 2002 and 2001, respectively.
4: INCOME TAXES
Consumers and its subsidiaries file a consolidated federal income
tax return with CMS Energy. Income taxes are generally allocated based on each
company's separate taxable income. As of December 31, 2002, 2001, 2000,
Consumers had tax related receivables (payables) from CMS Energy of $44
million, $27 million and ($12) million, respectively.
The Job Creation and Worker Assistance Act of 2002 provided to corporate
taxpayers a 5-year carryback of tax losses incurred in 2001 and 2002. As a
result of this legislation, CMS Energy was able to carry back consolidated 2001
and 2002 tax losses to tax years 1996 through 1999 to obtain refunds of prior
years tax payments totaling $250 million. The tax loss carryback, however,
resulted in a reduction in AMT credit carryforwards that previously had been
recorded by CMS Energy as deferred tax assets in the amount of $47 million. This
non-cash reduction in AMT credit carryforwards has been reflected in the tax
provisions of CMS Energy and allocated to each of its consolidated subsidiaries,
according to their contributions to the consolidated CMS Energy tax loss, under
the CMS Energy tax sharing agreement. Based on the final allocation, Consumers'
allocable share, $25 million, has been reflected as a dividend paid by Consumers
to CMS Energy.
Consumers practices deferred tax accounting for temporary differences in
accordance with SFAS No. 109. Consumers uses ITC to reduce current income taxes
payable, and defers and amortizes ITC over the life of the related property. AMT
paid generally becomes a tax credit that Consumers can carry forward
indefinitely to reduce regular tax liabilities in future periods when regular
taxes paid exceed the tax calculated for AMT. At December 31, 2002, Consumers
had tax loss carryforwards in the amount of $43 million that expire in 2021.
The significant components of income tax expense (benefit) consisted of:
In Millions
- ----------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
Current federal income taxes $(97) $(39) $149
Deferred income taxes 283 143 (4)
Deferred ITC, net (6) (7) (8)
-------------------------------------------
$180 $97 $137
=================================================================================================================
-82-
Consumers Energy Company
The principal components of Consumers' deferred tax assets (liabilities)
recognized in the balance sheet are as follows:
In Millions
- -----------------------------------------------------------------------------------------------------------------
December 31 2002 2001
- -----------------------------------------------------------------------------------------------------------------
Property $ (789) $ (557)
Unconsolidated investments (223) (211)
Securitization costs (Note 2) (192) (194)
Postretirement benefits (Note 7) (72) (76)
Gas inventories (74) (57)
Employee benefit obligations, includes (OPEB) of $94
and $103 and 2002 includes $100 for minimum pension
liability (Note 7) 208 123
FAS 109 regulatory liability 115 117
Power purchases (Note 2) 18 28
Tax loss carryforward 15 -
AMT credit carryforward 7 30
Other, net 13 1
--------------------------------
$ (974) $ (796)
=================================================================================================================
Deferred tax liabilities $(1,528) $ (1,270)
Deferred tax assets 554 474
--------------------------------
$ (974) $ (796)
=================================================================================================================
The actual income tax expense differs from the amount computed by applying the
statutory federal tax rate to income before income taxes as follows:
-83-
Consumers Energy Company
In Millions
- -----------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle $ 363 $ 199 $ 284
Income taxes 180 97 137
Preferred securities distributions (44) (41) (34)
-----------------------------------------------
Pretax income 499 255 387
Statutory federal income tax rate x 35% x 35% x 35%
-----------------------------------------------
Expected income tax expense 174 89 136
Increase (decrease) in taxes from:
Property differences not previously deferred 14 17 16
Loss on investment in CMS Energy Common Stock 4 - -
Gain on sale of METC (5) - -
ITC amortization/adjustments (6) (7) (9)
Affiliated companies' dividends (1) (2) (3)
Other, net - - (3)
---------------------------------------------
Actual income tax expense $ 180 $ 97 $ 137
================================================================================================================
Effective tax rate 36.0% 38.0% 35.4%
================================================================================================================
5: FINANCIAL AND DERIVATIVE INSTRUMENTS
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. Consumers estimates the fair values of long-term investments based on
quoted market prices or, in the absence of specific market prices, on quoted
market prices of similar investments or other valuation techniques. The carrying
amounts of all long-term investments, except as shown below, approximate fair
value.
-84-
Consumers Energy Company
In Millions
- ---------------------------------------------------------------------------------------------------------------
December 31 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized
Available-for-sale securities Cost Value Gain Cost Value Gain
- ---------------------------------------------------------------------------------------------------------------
Common stock of CMS Energy (a) $ 22 $ 22 $ - $ 35 $ 57 $ 22
SERP 18 19 1 22 24 2
Nuclear decommissioning
investments (b) 458 536 78 467 581 114
===============================================================================================================
(a) Consumers recognized a $12 million loss on this investment in 2002 because
the loss was other than temporary, as the fair value was below the cost basis
for a period greater than six months. As of December 31, 2002, Consumers held
2.4 million shares of CMS Energy Common Stock with a fair value of $22 million;
as of March 14, 2003 the value was $8 million.
(b) Consumers classifies its unrealized gains and losses on nuclear
decommissioning investments in accumulated depreciation.
At December 31, 2002, the carrying amount of long-term debt was $2.4 billion and
at December 31, 2001, $2.5 billion, and the fair values were $2.2 billion and
$2.5 billion, respectively. For held-to-maturity securities and related-party
financial instruments, see Note 1.
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 certain business unit managers. 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
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.
When management uses these instruments, it intends that an opposite movement in
the value of the at risk item would offset any losses incurred on the contracts.
Consumers enters into all risk management contracts for purposes other than
trading.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting in accordance with SFAS No. 133. 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 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
-85-
Consumers Energy Company
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. 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 December 31, 2002, Consumers assumed a market-based
interest rate of 4.5 percent and a volatility rate of 70 percent in calculating
the fair value of its electric call options. The ineffective portion, if any, of
all hedges is recognized in earnings.
The majority of Consumers' 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.
On January 1, 2001, upon initial adoption of the standard, Consumers recorded a
$21 million, net of tax, ($32 million, pretax) cumulative effect transition
adjustment as an unrealized gain increasing accumulated other comprehensive
income. Consumers then 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 remaining $9
million difference between the initial transition adjustment and the amounts
reclassified to earnings has been reduced to zero, decreasing other
comprehensive income, and represents an unrealized loss in the fair value of the
derivative instruments since January 1, 2001. As a result, 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 certain electric call option contracts.
In Millions
- ------------------------------------------------------------------------------------------------------------------
December 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Fair Fair
Derivative Instruments Cost Value Cost Value
- ------------------------------------------------------------------------------------------------------------------
Electric contracts $8 $ 1 $ 21 $ 2
Gas contracts - 1 - -
Interest rate risk contracts - (1) - (3)
Derivative contracts associated with Consumers'
equity investment in the MCV Partnership - 13 - (12)
==================================================================================================================
The fair value of all derivative contracts, except the fair value of derivative
contracts associated with Consumers' equity investment in the MCV Partnership,
is included in either Other Assets or Other Liabilities on the Balance Sheet.
The fair value of derivative contracts associated with Consumers' equity
investment in the MCV Partnership is included in Investments -- Midland
Cogeneration Venture Limited Partnership on the Balance Sheet. April 1, 2002,
the MCV Partnership changed its accounting for derivatives, see Note 11.
Consumers' ownership share of the cumulative effect adjustment to earnings is
reflected as a change in accounting principle on Consumers' Income Statement.
ELECTRIC CONTRACTS: Consumers' electric business uses purchased electric call
option contracts to meet, in part, its regulatory obligation to serve. This
obligation requires Consumers to provide a physical supply of
-86-
Consumers Energy Company
electricity to customers, to manage electric costs and to ensure a reliable
source of capacity during peak demand periods. 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 was reclassified to earnings as the
forecasted future transactions occurred or the call options expired. The
majority of these contracts expired in the third quarter 2001 and the remaining
contracts expired in the third quarter of 2002. As of December 31, 2001,
Consumers reclassified from other comprehensive income to earnings, $2 million,
net of tax, as part of the cost of power supply, and the remainder, $1 million,
net of tax, was reclassified from other comprehensive income 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
records any change in fair value subsequent to December 31, 2001, directly
in earnings, which could cause earnings volatility. During 2002, Consumers
recorded, as part of power costs, a $245 thousand unrecognized gain on its
unexpired electric call options contracts. As of December 31, 2002, Consumers
recorded on the balance sheet all of its unexpired purchased electric call
option contracts subject to derivative accounting at a fair value of $1 million.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market, as defined by
SFAS No. 133, 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 PPA could be
material to the financial statements.
During 2002, Consumers' electric business also used 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 were financial
contracts that were used to offset increases in the price of probable forecasted
gas purchases. These contracts did not qualify for hedge accounting. Therefore,
Consumers recorded any change in the fair value of these contracts directly in
earnings as part of power supply costs. These contracts expired in December
2002.
As of December 31, 2002, Consumers recorded a total of $8 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.
GAS CONTRACTS: Consumers' gas business uses fixed price gas supply contracts,
and fixed price weather-based gas supply call options and fixed price gas supply
put options, and other types of contracts, to meet its regulatory obligation to
provide gas to its customers at a reasonable and prudent cost. During 2002, some
of the fixed price gas supply contracts required derivative accounting because
they contained embedded put options that disqualified the contracts from the
normal purchase exception of SFAS No. 133. These contracts expired in October
2002.
-87-
Consumers Energy Company
As of December 31, 2002, weather-based gas call options and gas put options
requiring derivative accounting had a net fair value of $1 million, of which
$600,000, represents a fair value gain on the contracts 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 a similar
manner.
INTEREST RATE RISK CONTRACTS: 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 swaps are sold. As of December 31, 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 December 31, 2002, this interest rate swap
had a negative fair value of $1 million. This amount, if sustained, will be
reclassified to earnings, increasing interest expense when the swap is settled
on a monthly basis. As of December 31, 2001, this interest rate swap had a
negative fair value of $3 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 $7
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.
In 2001, Consumers had entered into interest rate swaps to hedge the risk
associated with the fair value of $400 million of fixed-rate debt, which expire
in May 2003 and December 2006. In November 2001, these swaps were terminated and
resulted in a $4 million gain that was deferred and recorded as part of the
debt. This gain is being recognized over the remaining life of the debt.
In 2001, Consumers entered into fair value hedges to hedge the risk associated
with the fair value of $250 million of debt. These swaps terminated in the third
quarter 2001, and resulted in a $4 million gain that has been deferred and
recorded as part of the debt. This gain is being recognized over the remaining
life of the debt.
In September 2001, Consumers entered into a cash flow hedge to fix the interest
rate on $100 million of debt to be issued. In September 2001, the swap
terminated and resulted in a $2 million loss that was recorded in other
comprehensive income and will be amortized to interest expense over the life of
the debt using the effective interest method.
Consumers was able to apply the shortcut method to all interest rate hedges,
therefore there was no ineffectiveness associated with these hedges.
-88-
Consumers Energy Company
6: EXECUTIVE INCENTIVE COMPENSATION
Consumers participates in CMS Energy's Performance Incentive Stock Plan. Under
the plan, restricted shares of Common Stock of CMS Energy, stock options and
stock appreciation rights related to Common Stock may be granted to key
Consumers' employees based on their contributions to the successful management
of Consumers. The plan reserves for award not more than five percent, as amended
January 1, 1999, of CMS Energy's Common Stock outstanding on January 1 each
year, less (1) the number of shares of restricted Common Stock awarded and (2)
Common Stock subject to options granted under the plan during the immediately
preceding four calendar years. The number of shares of restricted Common Stock
awarded under this plan cannot exceed 20 percent of the aggregate number of
shares reserved for award. Any forfeiture of shares previously awarded will
increase the number of shares available to be awarded under the plan. As of
December 31, 2002, under the plan, awards of up to 1,716,856 shares of CMS
Energy Common Stock may be issued.
Restricted shares of Common Stock are outstanding shares with full voting and
dividend rights. These awards vest over five years at the rate of 25 percent per
year after two years. Some restricted shares are subject to achievement of
specified levels of total shareholder return and are subject to forfeiture if
employment terminates before vesting. If performance objectives are exceeded,
the plan provides for additional awards. Restricted shares vest fully if control
of CMS Energy changes, as defined by the plan. At December 31, 2002, 113,960 of
the 320,720 shares of restricted CMS Energy Common Stock outstanding are subject
to performance objectives.
The plan grants stock options and stock appreciation rights relating to Common
Stock with an exercise price equal to the closing market price on each grant
date. All options may be exercised upon grant. All options expire up to ten
years and one month from date of grant. The status of the restricted stock and
options granted to Consumers' key employees under the Performance Incentive
Stock Plan follows.
Restricted
Stock Options
- ------------------------------------------------------------------------------------------------------------------
Number Number Weighted Average
CMS ENERGY COMMON STOCK of Shares of Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 2000 283,057 693,670 $34.37
Granted 81,030 221,900 $17.00
Exercised or Issued (48,979) (43,368) $17.48
Forfeited (55,731) -
Expired - (30,083) $31.87
-----------------------------------------------------------------
Outstanding at December 31, 2000 259,377 842,119 $30.75
Granted 71,930 294,150 $30.04
Exercised or Issued (34,704) (35,317) $19.34
Forfeited (56,938) -
Expired - -
-----------------------------------------------------------------
Outstanding at December 31, 2001 239,665 1,100,952 $30.93
Granted 163,890 490,600 $14.32
Exercised or Issued (26,663) (6,083) $17.13
Forfeited (56,172) -
Expired - (65,080) $32.03
-----------------------------------------------------------------
Outstanding at December 31, 2002 320,720 1,520,389 $25.58
=================================================================
-89-
Consumers Energy Company
The following table summarizes information about CMS Energy Common Stock options
outstanding at December 31, 2002:
Number Weighted Weighted
Range of of Shares Average Average
Exercise Prices Outstanding Remaining Life Exercise Price
- --------------------------------------------------------------------------------------------------------------------
CMS Energy Common Stock:
$8.12 - $17.00 445,532 8.73 years $11.53
$20.00 - $30.63 419,426 6.47 years $24.05
$31.04 - $39.06 552,949 6.93 years $34.75
$43.38 - $43.38 102,482 5.57 years $43.38
- --------------------------------------------------------------------------------------------------------------------
$8.12 - $43.38 1,520,389 7.24 years $25.58
====================================================================================================================
The weighted average fair value of options granted for CMS Energy Common Stock
in February 2002 was $3.79, and in July 2002, $1.40. In 2001 and 2000, the
weighted average fair value of options granted for CMS Energy Common Stock were
$6.37 and $1.91, respectively. Fair value is estimated using the Black-Scholes
model, a mathematical formula used to value options traded on securities
exchanges, with the following assumptions. For 2002 the assumptions listed are
for the February grant, followed by the July grant:
Years Ended December 31 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
CMS ENERGY COMMON STOCK OPTIONS
Risk-free interest rate 4.02%, 3.28% 4.80% 6.56%
Expected stock price volatility 31.64%, 39.67% 29.48% 26.53%
Expected dividend rate $ .365, $.1825 $ .365 $ .365
Expected option life (years) 4.5 4.6 4.4
====================================================================================================================
In December 2002, Consumers voluntarily adopted the fair value method of
accounting for stock-based employee compensation, in accordance with SFAS No.
123. To adopt this change, Consumers, in accordance with SFAS No. 148, is
applying the prospective method, which requires fair value treatment of all
awards granted, modified, or settled after the beginning of the fiscal year in
which the recognition provisions are first applied. As a result of these
changes, $1.7 million was recorded as stock-based employee compensation cost for
2002. Previously, Consumers accounted for stock-based compensation under APB
Opinion No. 25, and no stock-based employee compensation cost was reflected in
net income. In 2002, 2001, and 2000, the compensation cost charged against
income for restricted stock was less than $1 million, $3 million, and $1
million, respectively.
-90-
Consumers Energy Company
In Millions
- ---------------------------------------------------------------------------------------------------------------
Years ended December 31 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
Net income, as reported $381 $188 $284
Add: Stock-based employee 1 - -
compensation expense included in
reported net income, net of related taxes
Deduct: Total stock-based employee (1) (1) -
compensation expense determined under
fair value based method for all awards,
net of related taxes
Pro forma net income $381 $187 $284
===============================================================================================================
7: RETIREMENT BENEFITS
Consumers provides retirement benefits under a number of different plans,
including certain health care and life insurance benefits under OPEB, benefits
to certain management employees under SERP and EISP, and benefits to
substantially all its employees under a trusteed, non-contributory, defined
benefit Pension Plan, and a defined contribution 401(k) plan.
Weighted-Average Assumptions
- -------------------------------------------------------------------------------------------------------------------
Pension & SERP OPEB
Years Ended December 31 2002 2001 2000 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Discount rate 6.75% 7.25% 7.75% 6.75% 7.25% 7.75%
Expected long-term
rate of return on
plan assets 8.75% 9.75% 9.75% 7.60% 8.30% 7.00%
Rate of compensation increase:
Pension - to age 45 3.50% 5.25% 5.25%
- age 45 to
assumed retirement 3.50% 3.75% 3.75%
SERP 5.50% 5.50% 5.50%
===================================================================================================================
Retiree health care costs at December 31, 2002 are based on the assumption that
costs would increase at a slower rate from the 2002 trend rate of 8.5 percent to
5.5 percent in 2010 and thereafter.
-91-
Consumers Energy Company
Consumers Energy's Net Pension Plan, Consumers' SERP, Consumers' EISP, and OPEB
benefit costs are shown below:
Amounts presented below for the Pension Plan include amounts for employees of
CMS Energy and non-utility affiliates, which were not distinguishable from the
plan's total assets.
In Millions
- -------------------------------------------------------------------------------------------------------------------
Pension, SERP & EISP OPEB
Years Ended December 31 2002 2001 2000 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Service cost $ 40 $ 37 $ 31 $ 16 $ 13 $ 11
Interest expense 86 84 79 63 57 52
Expected return on plan assets (103) (99) (92) (40) (40) (34)
Amortization of unrecognized transition (asset) - (5) (5) - - -
Plan amendments 4 - - - - -
Amortization of:
Net (gain) or loss - - - 8 - (1)
Prior service cost 8 8 4 (1) (1) -
--------------------------------------------------------
Net periodic pension and
postretirement benefit cost (a) $ 35 $ 25 $ 17 $ 46 $ 29 $ 28
===================================================================================================================
The health care cost trend rate assumption significantly affects the amounts
reported. A one percentage point change in the assumed health care cost trend
assumption would have the following effects:
In Millions
- -------------------------------------------------------------------------------------------------------------------
One Percentage One Percentage
Point Increase Point Decrease
- -------------------------------------------------------------------------------------------------------------------
Effect on total service and interest cost component $ 13 $ (11)
Effect on postretirement benefit obligation $121 $(101)
====================================================================================================================
-92-
Consumers Energy Company
The funded status of the Consumers Energy Pension Plan, Consumers' SERP and OPEB
is reconciled with the liability recorded at December 31 as follows:
In Millions
- -------------------------------------------------------------------------------------------------------------------
Pension Plan SERP OPEB
2002 2001 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------
Benefit obligation January 1 $1,195 $ 1,081 $ 19 $ 18 $ 876 $ 754
Service cost 40 36 1 1 16 13
Interest cost 84 83 2 1 63 57
Plan amendment 3 - - - (57) (16)
Actuarial loss 72 96 - - 31 102
Benefits paid (138) (101) (1) (1) (39) (34)
--------------------------------------------------------------
Benefit obligation December 31 1,256 1,195 21 19 890 876
--------------------------------------------------------------
Plan assets at fair value at January 1 845 994 - - 475 450
Actual return on plan assets (164) (113) - - (44) (23)
Company contribution 64 65 - - 73 48
Actual benefits paid (138) (101) - - (39) -
--------------------------------------------------------------
Plan assets at fair
value at December 31(a) 607 845 - - 465 475
--------------------------------------------------------------
Benefit obligation less than
(in excess of) plan assets (649) (350) (21) (21) (425) (401)
Unrecognized net loss from
experience different than assumed 573 235 3 3 282 176
Unrecognized prior service cost 60 68 - 1 (70) (15)
Panhandle adjustment (7) (7) - - - -
--------------------------------------------------------------
Net Balance Sheet Liability $ (23) $ (54) $ (18) $(17) $(213) $(240)
Additional minimum liability adjustment (b) (426) - - - - -
--------------------------------------------------------------
Total Net Balance Sheet Liability $ (449) $ (54) $ (18) $(17) $(213) $(240)
===================================================================================================================
(a) Primarily stocks and bonds, including 5,241,656 and 141,000 shares of CMS
Energy Common Stock in the Pension Plan assets and OPEB plan assets,
respectively, with fair values of $49 million and $1.3 million at December 31,
2002. Fair values at December 31, 2001 were $126 million and $3 million in the
Pension Plan assets and OPEB plan assets, respectively.
(b) The Pension Plan's Accumulated Benefits Obligation of $1.055 billion
exceeded the value of the Pension Plan assets and Net balance sheet liability at
December 31, 2002. As a result, an additional minimum liability was recorded.
The adjustment includes $53 million of intangible asset, and $373 million of
accumulated other comprehensive income, of which $40 million and $285 million
($185 million after-tax) were allocated to Consumers.
SERP benefits are paid from a trust established in 1988. SERP is not a qualified
plan under the Internal Revenue Code, and as such, earnings of the trust are
taxable and trust assets are included in consolidated assets. At December 31,
2002 and 2001, trust assets were $19 million and $24 million, respectively, and
were classified as other non-current assets. In 2002 and 2001, the Accumulated
Benefit Obligation for SERP was $17 million and $16 million, respectively.
-93-
Consumers Energy Company
The Executive Incentive Separation Plan (EISP) was established to provide
flexibility in separation of employment by officers, a select group of
management, or other highly compensated employees. Terms of the plan may include
payment of a lump sum, payment of monthly benefits for life, payment of premium
for continuation of health care, or any other legally permissible term deemed to
be in the best interest of Consumers to offer. As of December 31, 2002, the
Accumulated Benefit Obligation of the EISP was $1.7 million. Consumers portion
of the EISP was approximately $250,000.
The Pension Plan includes amounts for employees of CMS Energy and non-utility
affiliates, including Panhandle, which were not distinguishable from the Pension
Plan's total assets. On December 21, 2002, a definitive agreement was executed
to sell Panhandle. The sale is expected to close in 2003. No portion of the
Pension Plan will be transferred with the sale of Panhandle. At the closing of
the sale, none of the employees of Panhandle will be eligible to accrue
additional benefits. The Pension Plan will retain pension payment obligations
under the Pension Plan for Panhandle employees that are vested under the Pension
Plan. Consumers does not expect the impact to be material.
Contributions to the 401(k) plan are invested in CMS Energy Common Stock.
Amounts charged to expense for this plan were $8 million in 2002, and $20
million in 2001. Effective September 1, 2002, the employer's match for the
401(k) plan was suspended until January 1, 2005.
In 1992, Consumers adopted the required accounting for postretirement benefits
and recorded a liability of $466 million for the accumulated transition
obligation and a corresponding regulatory asset for anticipated recovery in
utility rates (see Note 1, Corporate Structure and Summary of Significant
Accounting Policies, "Utility Regulation"). The MPSC authorized recovery of the
electric utility portion of these costs in 1994 over 18 years and the gas
utility portion in 1996 over 16 years.
8: LEASES
Consumers leases various assets, including vehicles, railcars, construction
equipment, computer equipment, and buildings. Consumers has both full-service
and net leases, the latter of which requires Consumers to pay for taxes,
maintenance, operating costs, and insurance.
-94-
Consumers Energy Company
Minimum rental commitments under Consumers' non-cancelable leases at December
31, 2002, were:
In Millions
- ----------------------------------------------------------------------------------------------------------------
Capital Leases Operating Leases
- ----------------------------------------------------------------------------------------------------------------
2003 $21 $13
2004 20 10
2005 18 8
2006 17 7
2007 16 6
2008 and thereafter 71 34
------------------------------------
Total minimum lease payments 163 $78
===
Less imputed interest 28
----
Present value of net minimum lease payments 135
Less current portion 13
Less non-current portion of off-balance sheet lease payments 6
---
Non-current portion $116
================================================================================================================
Consumers recovers lease charges from customers and accordingly charges payments
for its capital and operating leases to operating expense. For the years ended
December 31, 2002, 2001 and 2000, operating lease charges, including charges to
clearing and other accounts, were $13 million, $15 million, and $16 million,
respectively. In November 2001, Consumers' nuclear fuel capital leasing
arrangement expired upon mutual agreement by the lessor and Consumers. At
termination of the lease, Consumers paid the lessor $48 million, which was the
lessor's remaining investment at that time.
For the years ended December 31, 2002, 2001 and 2000, capital lease expenses
were $20 million, $26 million, and $41 million, respectively. Included in these
amounts, for the years ended 2002, 2001 and 2000, are nuclear fuel lease
expenses of $- million, $7 million and $22 million, respectively.
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. The new office-building lessor has committed to
fund up to $65 million for construction of the building and has appointed
Consumers the construction agent for the project. Consumers' balance sheet as of
December 31, 2002, reflects a capital lease asset and an offsetting non-current
liability equivalent to the cost of construction at that date of $54 million.
The agreement is a seven-year lease term with payments commencing upon
completion of construction, which occurred in March 2003. Total construction
costs amounted to $60 million. Consumers Campus Holdings has the right to
acquire the property at any time during the life of the agreement. At the end of
the lease term, Consumers Campus Holdings has the option to renew the lease,
purchase the property, or return the property and assist the lessor in the sale
of the building. The return option obligates Consumers Campus Holdings to pay
the lessor an amount equal to the outstanding debt associated with the building.
The estimated annual lease payments, based on the total construction cost of $60
million and LIBOR rates ranging upwards to four percent, would be $4 million
beginning on April 1, 2003 plus a termination payment of $54 million at the end
of the lease term. Actual lease payments will depend on the LIBOR rates in
effect for the period being paid.
-95-
Consumers Energy Company
9: JOINTLY OWNED UTILITY FACILITIES
Consumers is responsible for providing its share of financing for the jointly
owned utility facilities. Consumers includes in operating expenses the direct
expenses of the joint plants. The following table indicates the extent of
Consumers' investment in jointly owned utility facilities:
In Millions
- ------------------------------------------------------------------------------------------------------------------
Net Investment Accumulated Depreciation
December 31 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Campbell Unit 3 - 93.3 percent $299 $279 $312 $312
Ludington - 51 percent 75 76 94 88
Transmission facilities - various - 37 - 40
Distribution lines - various 13 10 1 -
==================================================================================================================
10: REPORTABLE SEGMENTS
Consumers has two reportable segments: electric and gas. The electric segment
consists of regulated activities associated with the generation and distribution
of electricity. The gas segment consists of regulated activities associated with
the transportation, storage and distribution of natural gas. Consumers'
reportable segments are domestic 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 Consumers describes in the summary of significant
accounting policies. Where appropriate, the financial statements reflect the
assets, liabilities, revenues and expenses directly related to the electric and
gas reportable segments. However, in instances where common accounts were not
readily attributable to a single business segment, Consumers allocated the
accounts between the electric and gas segment. The allocations are based on
certain measures of business activities, such as revenue, labor dollars,
customers, other operation and maintenance and construction expense, leased
property, taxes, or functional surveys. For example, customer receivables are
allocated based on revenue; pension provisions are allocated based on labor
dollars; and common property is allocated based on other operation and
maintenance and construction expense.
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. For 2002, 2001 and
2000, the amounts included in earnings from investments accounted for by the
equity method of $53 million, $38 million and $57 million, respectively. For
2002, 2001 and 2000, Consumers had investments accounted for by the equity
method of $645 million, $555 million and $535 million, respectively. Consumers
accounts for intersegment sales and transfers at current market prices and
eliminates them in consolidated net income available to common stockholder by
segment. Consumers classifies its equity investments as a part of the other
business unit. The other business unit also includes Consumers' consolidated
statutory business trusts, which were created to issue preferred securities and
Consumers' consolidated special purpose entity for the sale of trade
receivables. Additional segment information follows:
-96-
Consumers Energy Company
In Millions
- ------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
Depreciation, depletion and amortization
Electric $ 228 $ 219 $ 311
Gas 118 118 113
Other 2 2 2
---------------------------------------------------
Total Consolidated $ 348 $ 339 $ 426
==================================================================================================================
Interest Charges
Electric $ 144 $ 153 $ 145
Gas 47 50 48
Other 21 21 27
---------------------------------------------------
Subtotal 212 224 220
Eliminations (44) (38) (37)
---------------------------------------------------
Total Consolidated $ 168 $ 186 $ 183
==================================================================================================================
Income Taxes
Electric $ 138 $ 69 $ 123
Gas 33 25 24
Other 9 3 (10)
---------------------------------------------------
Total Consolidated (a) $ 180 $ 97 $ 137
==================================================================================================================
Net Income Available to Common Stockholder
Electric $ 264 $ 109 199
Gas 46 21 18
Other 25 15 31
---------------------------------------------------
Total Consolidated $ 335 $ 145 $ 248
==================================================================================================================
Total assets
Electric (b) $ 5,744 $ 5,454 $ 5,230
Gas (b) 2,002 2,194 1,776
Other 1,398 1,142 1,124
---------------------------------------------------
Subtotal 9,144 8,790 8,130
Eliminations (444) (469) (354)
---------------------------------------------------
Total Consolidated $ 8,700 $ 8,321 $ 7,776
==================================================================================================================
Capital expenditures (c)
Electric $ 437 $ 623 $ 430
Gas 181 145 120
---------------------------------------------------
Total $ 618 $ 768 $ 550
==================================================================================================================
(a) In 2002 and 2001, amounts exclude the $10 million tax expense and $6
million tax benefit, respectively, due to the change in accounting for
derivative instruments.
(b) Amounts include an attributed portion of Consumers' other common assets to
both the electric and gas utility businesses.
(c) Includes electric restructuring implementation plan, capital leases for
nuclear fuel, purchase of nuclear fuel and other assets and electric DSM costs.
Amounts also include an attributed portion of Consumers' capital expenditures
for plant and equipment common to both the electric and gas utility businesses.
-97-
Consumers Energy Company
11: SUMMARIZED FINANCIAL INFORMATION OF SIGNIFICANT RELATED ENERGY SUPPLIER
Under the PPA with the MCV Partnership discussed in Note 2, Consumers' 2002
obligation to purchase electric capacity from the MCV Partnership provided 15.1
percent of Consumers' owned and contracted electric generating capacity.
Summarized financial information of the MCV Partnership follows:
STATEMENTS OF INCOME
In Millions
- -------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Operating revenue (a) $597 $611 $604
Operating expenses 409 453 392
-------------------------------------
Operating income 188 158 212
Other expense, net 114 110 122
-------------------------------------
Net income before cumulative
effect of accounting change 74 48 90
Cumulative effect of change in method of
accounting for derivative options contracts (April 1, 2002) (b) 58 - -
-------------------------------------
Net income $132 $ 48 $ 90
===================================================================================================================
BALANCE SHEETS
In Millions
- -------------------------------------------------------------------------------------------------------------------
December 31 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------
ASSETS LIABILITIES AND EQUITY
Current assets (c) $ 356 $ 341 Current liabilities $ 209 $ 320
Plant, net 1,550 1,610 Non-current liabilities (d) 1,155 1,245
Other assets 192 166 Partners' equity (e) 734 552
-------------------- ----------------------
$2,098 $2,117 $2,098 $2,117
===================================================================================================================
(a) For 2002, 2001, and 2000, revenue from Consumers totaled $557 million, $550
million and $569 million, respectively.
(b) On April 1, 2002, the MCV Partnership implemented Derivative Implementation
Group Issue C-16, an interpretation of SFAS No. 133. The MCV Partnership began
accounting for several natural gas contracts containing an option component at
fair value. As a result, a $58 million cumulative effect adjustment for the
change in accounting principle was recorded as an increase to earnings. CMS
Midland's 49 percent ownership share was $28 million ($18 million after-tax),
which is reflected as a change in accounting principle on Consumers' Income
Statement.
(c) At December 31, 2002 and 2001, receivables from Consumers totaled $44 and
$49 million, respectively.
(d) FMLP is the sole beneficiary of an owner trust that is the lessor in a
long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings
holds a 46.4 percent ownership interest in FMLP. At December 31, 2002 and 2001,
the MCV Partnership owed lease obligations of $975 million and $1.11 billion,
respectively, to the owner trust. CMS Holdings' share of the interest and
principal portion for the 2002 lease payments was $34 million and $65 million,
respectively, and for the 2001 lease payments was $36 million and $54 million,
respectively. As of December 31, 2002 and 2001, the lease payments service $449
million and $597 million in non-recourse debt outstanding, respectively, of the
owner trust. The MCV Partnership's lease obligations,
-98-
Consumers Energy Company
assets, and operating revenues secures FMLP's debt. For 2002 and 2001, the
owner trust made debt payments (including interest) of $370 million and $217
million, respectively. FMLP's earnings for 2002, 2001, and 2000 were $38
million, $30 million, and $30 million, respectively.
(e) CMS Midland's recorded investment in the MCV Partnership includes
capitalized interest, which Consumers is amortizing to expense over the life of
its investment in the MCV Partnership. Covenants contained in financing
agreements prohibit the MCV Partnership from paying distributions until it meets
certain financial test requirements. Consumers does not anticipate receiving a
cash distribution in the near future.
-99-
Report of Independent Auditors
The Board of Directors and Stockholders
Consumers Energy Company
We have audited the accompanying consolidated balance sheets and consolidated
statements of long-term debt and preferred stock of Consumers Energy Company (a
Michigan corporation and wholly-owned subsidiary of CMS Energy Corporation) and
subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of income, common stockholders' equity and cash flows for each of
three years in the period ended December 31, 2002. Our audits also included the
financial statement schedule listed in the Index at Item 15(a)(2). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits. The financial statements of Midland
Cogeneration Venture Limited Partnership (a limited partnership in which
Consumers Energy Company and subsidiaries has a 49% interest), have been audited
by other auditors (the other auditors for 2001 and 2000 for Midland Cogeneration
Venture Limited Partnership have ceased operations) whose reports have been
furnished to us; insofar as our opinion on the consolidated financial statements
relates to the amounts included for Midland Cogeneration Venture Limited
Partnership, it is based solely on their report.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the reports of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the 2002
and 2001 financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Consumers Energy Company and
subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002 in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As discussed in Note 5 to the consolidated financial statements, in 2001
Consumers Energy Company, and in 2002, Midland Cogeneration Venture Limited
Partnership changed their method of accounting related to derivatives and
hedging activities. Also, in 2002 as discussed in Note 1 to the consolidated
financial statements, Consumers Energy Company changed its method of accounting
for stock-based compensation.
/s/ Ernst & Young LLP
Detroit, Michigan
March 14, 2003, except for Note 3
as to which the date is March 28, 2003
-100-
PRICEWATERHOUSECOOPERS LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners and the Management Committee of the
Midland Cogeneration Venture Limited Partnership:
In our opinion, the accompanying consolidated balance sheet as of December 31,
2002 and the related consolidated statements of operations, partners' equity and
cash flows present fairly, in all material respects, the financial position of
the Midland Cogeneration Venture Limited Partnership (a Michigan limited
partnership) and subsidiaries (MCV) at December 31, 2002 and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of MCV's Management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion. The financial statements of MCV as of December
31, 2001 and for each of the two years in the period ended December 31, 2001,
were audited by other independent accountants who have ceased operations. Those
independent accountants expressed an unqualified opinion on those financial
statements in their report dated January 18, 2002.
As explained in Note 2 to the financial statements, effective April 1, 2002,
Midland Cogeneration Venture Limited Partnership changed its method of
accounting for derivative and hedging activities in accordance with Derivative
Implementation Group ("DIG") Issue C-16.
/s/ PricewaterhouseCoopers LLP
Detroit, Michigan,
January 17, 2003
-101-
THIS REPORT IS A COPY OF THE PREVIOUSLY ISSUED ARTHUR
ANDERSEN REPORT AND THIS REPORT HAS NOT BEEN REISSUED
BY ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners and the Management Committee of the
Midland Cogeneration Venture Limited Partnership:
We have audited the accompanying consolidated balance sheets of the MIDLAND
COGENERATION VENTURE LIMITED PARTNERSHIP (a Michigan limited partnership) and
subsidiaries (MCV) as of December 31, 2001 and 2000, and the related
consolidated statements of operations, partners' equity and cash flows for each
of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of MCV's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Midland
Cogeneration Venture Limited Partnership and subsidiaries as of December 31,
2001 and 2000, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States.
As explained in Note 2 to the financial statements, effective January 1, 2001,
Midland Cogeneration Venture Limited Partnership changed its method of
accounting related to derivatives and hedging activities.
/s/Arthur Andersen LLP
Detroit, Michigan,
January 18, 2002
-102-
CONSUMERS ENERGY COMPANY
QUARTERLY FINANCIAL INFORMATION
2002 (UNAUDITED) 2001 (UNAUDITED)
-------------------------------------------------- ----------------------------------------------
QUARTERS ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ---------------------------------------------------------------------------------- ----------------------------------------------
Operating revenue(a) $1,236 $901 $919 $1,166 $1,219 $873 $900 $1,022
Operating income(a) $188 $152 $168 $181 $216 $112 $77 $76
Income before
cumulative effect of change
in accounting principle(a) $92 $107 $84 $80 $108 $45 $23 $23
Cumulative effect of change
in accounting for derivative
instruments, net of $10 tax
expense in 2002 and $6 tax
benefit in 2001(a) - $17 $1 - - - - ($11)
Net income $92 $124 $85 $80 $108 $45 $23 $12
Preferred stock dividends - - - $2 - $1 - $1
Preferred securities
distributions $11 $11 $11 $11 $9 $9 $12 $11
Net income available to
common stockholder $81 $113 $74 $67 $99 $35 $11 --
(a) Consumers reclassified $28 million ($18 million after tax) reducing June
and September 2002 operating amounts to reflect the MCV Partnership's change in
accounting for derivative instruments as a separate item. See Note 11 in the
Notes to the Consolidated Financial Statements.
-103-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
In April 2002, Consumers' Board of Directors, upon the
recommendation of the Audit Committee of the Board, voted to discontinue using
Arthur Andersen to audit Consumers' financial statements for the year ending
December 31, 2002. Consumers had previously retained Arthur Andersen to review
its financial statements for the quarter ended March 31, 2002. In May 2002,
Consumers' Board of Directors engaged Ernst & Young to audit its financial
statements for the year ending December 31, 2002. Ernst & Young audited 2000,
2001 and 2002. As a result, Consumers restated its 2000 and 2001 financial
statements. An amended Form 10-K/A and Form 10-Q/A were filed in February 2003
and March 2003, respectively.
-104-
PART III
ITEMS 10., 11., 12. and 13.
Consumers' definitive information statement, except for the Organization and
Compensation Committee Report and the Audit Committee Report contained therein,
is incorporated by reference herein. See also ITEM 1. BUSINESS for information
pursuant to ITEM 10.
ITEM 14. CONTROLS AND PROCEDURES
Consumers' CEO and CFO are responsible for establishing and maintaining
Consumers' disclosure controls and procedures. Management, under the direction
of Consumers' principal executive and financial officers, has evaluated the
effectiveness of Consumers' disclosure controls and procedures as of a date
within 90 days of the filing of this annual report on Form 10-K. Based on this
evaluation, Consumers' CEO and CFO have concluded that Consumers' disclosure
controls and procedures are effective to ensure that material information was
presented to them. There have been no significant changes in Consumers' internal
controls or in other factors that could significantly affect internal controls
subsequent to such evaluation.
-105-
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements and Reports of Independent Auditors for
Consumers are listed in ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA and are incorporated by reference herein.
(a)(2) Financial Statement Schedules and Reports of Independent Auditors for
Consumers are listed after the Exhibits in the Index to Financial
Statement Schedules, and are incorporated by reference herein.
(a)(3) Exhibits for Consumers are listed after Item (c) below and are
incorporated by reference herein.
(b) Reports on Form 8-K for Consumers
During the fourth quarter of 2002, Consumers filed no Current
Reports on Form 8-K.
(c) Exhibits, including those incorporated by reference (see also Exhibit
volume).
-106-
CONSUMERS EXHIBITS
PREVIOUSLY FILED
----------------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
- ---------- --------------- ----------------- -----------
(3)(a) 1-5611 (3)(c) -- Restated Articles of Incorporation dated May 26, 2000, of Consumers
(2000 Form 10-K)
(3)(b) 1-5611 (3)(d) -- By-Laws of Consumers. (1999 Form 10-K)
(4)(a) 2-65973 (b)(1)-4 -- Indenture dated as of September 1, 1945, between Consumers
and Chemical Bank (successor to Manufacturers Hanover Trust Company),
as Trustee, including therein indentures supplemental thereto through
the Forty-third Supplemental Indenture dated as of May 1, 1979.
-- Indentures Supplemental thereto:
33-41126 (4)(c) -- 68th dated as of 06/15/93
1-5611 (4) -- 69th dated as of 09/15/93 (Form 8-K dated Sep. 21, 1993)
1-5611 (4)(a) -- 70th dated as of 02/01/98 (1997 Form 10-K)
1-5611 (4)(a) -- 71st dated as of 03/06/98 (1997 Form 10-K)
1-5611 (4)(b) -- 72nd dated as of 05/01/98 (1st Qtr. 1998 Form 10-Q)
333-58943 (4)(d) -- 73rd dated as of 06/15/98 (Form S-4 dated July 13, 1998)
1-5611 (4)(b) -- 74th dated as of 10/29/98 (3rd Qtr. 1998 Form 10-Q)
1-5611 (4)(b) -- 75th dated as of 10/1/99 (1999 Form 10-K)
1-5611 (4)(d) -- 77th dated as of 10/1/99 (1999 Form 10-K)
1-5611 4(b) -- 79th dated as of 9/26/01 (3rd qtr 2001 10-Q)
1-5611 4(a)(i) -- 80th dated as of 3/22/02 (2001 Form 10-K)
1-5611 4.6 -- 81st dated as of 7/12/02 (Form 8-K dated July 30, 2002)
1-5611 4.7 -- 82nd dated as of 7/12/02 (Form 8-K dated July 30, 2002)
4(a)(i) -- 83rd dated as of 9/26/02
4(a)(ii) -- 84th dated as of 12/11/02
4(a)(iii) -- 85th dated as of 10/17/02
4(a)(iv) -- 86th dated as of 11/25/02
(4)(b) 1-5611 (4)(b) -- Indenture dated as of January 1, 1996 between Consumers and The Bank
of New York, as Trustee. (1995 Form 10-K)
-- Indentures Supplemental thereto:
1-5611 (4)(b) -- 1st dated as of 01/18/96 (1995 Form 10-K)
1-5611 (4)(a) -- 2nd dated as of 09/04/97 (3rd qtr 1997 Form 10-Q)
1-9513 (4)(a) -- 3rd 11/04/99 (3rd qtr 1999 Form 10-Q)
(4)(c) 1-5611 (4)(c) -- Indenture dated as of February 1, 1998 between Consumers and JPMorgan
Chase (formerly "The Chase Manhattan Bank"), as Trustee. (1997 Form
10-K)
1-5611 (4)(a) -- 1st dated as of 05/01/98 (1st Qtr. 1998 Form 10-Q)
333-58943 (4)(b) -- 2nd dated as of 06/15/98
1-5611 (4)(a) -- 3rd 10/29/98 (3rd Qtr. 1998 Form 10-Q)
(4)(d) 1-5611 4.4 -- $250 million Revolving Credit Facility dated July 12, 2002 among
Consumers, the Banks, and the Agent, all as defined therein (Form 8-K
filed July 30, 2002)
(4)(e) -- $155 million Term Loan Agreement dated October 17, 2002 among
Consumers Energy, the Banks, the Administrative Agent and the
Syndication Agent, all as defined therein.
(4)(f) -- $300 million Amended and Restated Term Loan Agreement dated September
26, 2002 among Consumers, the Banks and the Agent, all as defined
therein.
(10)(a) 1-9513 (10)(b) -- Form of Employment Agreement entered into by CMS Energy's
and Consumers' executive officers. (1999 Form 10-K)
(10)(b) 1-9513 (10)(a) -- Acknowledgement of Resignation between Tamela W. Pallas and CMS
Energy Corporation (3rd qtr 2002 Form 10-Q)
(10)(c) 1-5611 (10)(g) -- Consumers' Executive Stock Option and Stock Appreciation
Rights Plan effective December 1, 1989. (1990 Form 10-K)
(10)(d) 1-9513 (10)(b) -- Employment, Separation and General Release Agreement between William
T. McCormick and CMS Energy Corporation (3rd qtr 2002 Form 10-Q)
(10)(e) 1-9513 (10)(d) -- CMS Energy's Performance Incentive Stock Plan effective
February 3, 1988, as amended December 3, 1999. (1999 Form 10-K)
(10)(f) 1-9513 (10)(c) -- Employment, Separation and General Release Agreement between Alan M.
Wright and CMS Energy Corporation (3rd qtr 2002 Form 10-Q)
(10)(g) -- Employment Agreement dated as of June 1, 2002 between Kenneth Whipple
and CMS Energy Corporation
(10)(h) 1-9513 (10)(m) -- CMS Deferred Salary Savings Plan effective January 1, 1994.
(1993 Form 10-K)
-107-
PREVIOUSLY FILED
----------------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
- ---------- --------------- ----------------- -----------
(10)(i) 1-9513 (10)(n) -- CMS Energy and Consumers Annual Executive Incentive
Compensation Plan effective January 1, 1986, as amended January 1995.
(1995 Form 10-K)
(10)(j) 1-9513 (10)(h) -- Supplemental Executive Retirement Plan for Employees of CMS
Energy/Consumers Energy Company effective January 1, 1982, as amended
December 3, 1999. (1999 Form 10-K)
(10)(k) 33-37977 4.1 -- Senior Trust Indenture, Leasehold Mortgage and Security Agreement
dated as of June 1, 1990 between The Connecticut National Bank and
United States Trust Company of New York.
(MCV Partnership)
Indenture Supplemental thereto:
33-37977 4.2 -- Supplement No. 1 dated as of June 1, 1990. (MCV Partnership)
(10)(l) 1-9513 (28)(b) -- Collateral Trust Indenture dated as of June 1, 1990 among Midland
Funding Corporation I, MCV Partnership and United States Trust Company
of New York, Trustee. (3rd qtr 1990 Form 10-Q)
Indenture Supplemental thereto:
33-37977 4.4 -- Supplement No. 1 dated as of June 1, 1990. (MCV Partnership)
(10)(m) 1-9513 (10)(v) -- Amended and Restated Investor Partner Tax Indemnification Agreement
dated as of June 1, 1990 among Investor Partners, CMS Midland as
Indemnitor and CMS Energy as Guarantor. (1990 Form 10-K)
(10)(n) 1-9513 (19)(d)** -- Environmental Agreement dated as of June 1, 1990 made by CMS Energy to
The Connecticut National Bank and Others. (1990 Form 10-K)
(10)(o) 1-9513 (10)(z)** -- Indemnity Agreement dated as of June 1, 1990 made by CMS Energy to
Midland Cogeneration Venture Limited Partnership.
(1990 Form 10-K)
(10)(p) 1-9513 (10)(aa)** -- Environmental Agreement dated as of June 1, 1990 made by CMS Energy to
United States Trust Company of New York, Meridian Trust Company, each
Subordinated Collateral Trust Trustee and Holders from time to time of
Senior Bonds and Subordinated Bonds and Participants from time to time
in Senior Bonds and Subordinated Bonds. (1990 Form 10-K)
(10)(q) 33-37977 10.4 -- Amended and Restated Participation Agreement dated as of June 1, 1990
among MCV Partnership, Owner Participant, The Connecticut National
Bank, United States Trust Company, Meridian Trust Company, Midland
Funding Corporation I, Midland Funding Corporation II, MEC Development
Corporation and Institutional Senior Bond Purchasers.
(MCV Partnership)
(10)(r) 33-3797 10.4 -- Power Purchase Agreement dated as of July 17, 1986 between MCV
Partnership and Consumers. (MCV Partnership)
Amendments thereto:
33-37977 10.5 -- Amendment No. 1 dated September 10, 1987. (MCV Partnership)
33-37977 10.6 -- Amendment No. 2 dated March 18, 1988. (MCV Partnership)
33-37977 10.7 -- Amendment No. 3 dated August 28, 1989. (MCV Partnership)
33-37977 10.8 -- Amendment No. 4A dated May 25, 1989. (MCV Partnership)
(10)(s) 1-5611 (10)(y) -- Unwind Agreement dated as of December 10, 1991 by and among CMS
Energy, Midland Group, Ltd., Consumers, CMS Midland, Inc., MEC
Development Corp. and CMS Midland Holdings Company. (1991 Form 10-K)
(10)(t) 1-5611 (10)(z) -- Stipulated AGE Release Amount Payment Agreement dated as of June 1,
1990, among CMS Energy, Consumers and The Dow Chemical Company.
(1991 Form 10-K)
(10)(u) 1-5611 (10)(aa)** -- Parent Guaranty dated as of June 14, 1990 from CMS Energy to MCV, each
of the Owner Trustees, the Indenture Trustees, the Owner Participants
and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback
transaction, and MEC Development. (1991 Form 10-K)
(10)(v) 1-8157 10.41 -- Contract for Firm Transportation of Natural Gas between Consumers
Power Company and Trunkline Gas Company, dated November 1, 1989, and
Amendment, dated November 1, 1989.
-108-
PREVIOUSLY FILED
----------------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
- ---------- --------------- ----------------- -----------
(1989 Form 10-K of PanEnergy Corp.)
(10)(w) 1-8157 10.41 -- Contract for Firm Transportation of Natural Gas between Consumers
Power Company and Trunkline Gas Company, dated November 1, 1989.
(1991 Form 10-K of PanEnergy Corp.)
(10)(x) 1-2921 10.03 -- Contract for Firm Transportation of Natural Gas between Consumers
Power Company and Trunkline Gas Company, dated September 1, 1993.
(1993 Form 10-K)
(12) -- Statement regarding computation of Consumers Ration of Earnings to
Fixed Charges and Preferred Securities Dividends and Distributions
(16) 1-5611 16.1 -- Letter from Arthur Anderson LLP to the Securities and Exchange
Commission dated April 29, 2002 regarding change in certifying
accountant (Form 8-K filed April 29, 2002)
(21) -- Subsidiaries of Consumers. (Form U-3A-2 filed February 25, 2003).
(23)(a) -- Consent of Ernst & Young LLP
(23)(b) -- Consent of PricewaterhouseCoopers LLP
(24) -- Power of Attorney for Consumers
(99) -- Certifications pursuant to Section 906 of the Sarbanes--Oxley Act
of 2002
- ----------
** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries
of Consumers, and of CMS Energy but not of Consumers.
Exhibits listed above which have heretofore been filed with the Securities
and Exchange Commission pursuant to various acts administered by the Commission,
and which were designated as noted above, are hereby incorporated herein by
reference and made a part hereof with the same effect as if filed herewith.
-109-
INDEX TO FINANCIAL STATEMENT SCHEDULES
Page
Schedule II Valuation and Qualifying Accounts and Reserves
2002, 2001 and 2000.................................................................. 111
Report of Independent Public Auditors
Ernst & Young LLP for 2002, 2001 and 2000.............................................. 100
Schedules other than those listed above are omitted because they are either not
required, not applicable or the required information is shown in the financial
statements or notes thereto.
Columns omitted from schedules filed have been omitted because the information
is not applicable.
-110-
CONSUMERS ENERGY COMPANY
Schedule II - Valuation and Qualifying Accounts and Reserves
Years Ended December 31, 2002, 2001 and 2000
(In Millions)
Balance at Charged Charged to Balance
Beginning to other at End
Description of Period Expense Accounts Deductions of Period
- -----------------------------------------------------------------------------------------------------------------
Accumulated provision for
uncollectible accounts:
2002 $4 $17 - $16(a) $5
2001 $3 $13 - $12(a) $4
2000 $4 $10 - $11(a) $3
=================================================================================================================
(a) Accounts receivable written off including net uncollectible amounts of $14
in 2002, $10 in 2001 and $9 in 2000 charged directly to operating expense
and credited to accounts receivable.
-111-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Consumers Energy Company has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized, on the 28th
day of March 2003.
CONSUMERS ENERGY COMPANY
By /s/ Kenneth Whipple
----------------------------------
Kenneth Whipple
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report has been signed below by the following persons on behalf of Consumers
Energy Company and in the capacities and on the 28th day of March 2003.
SIGNATURE TITLE
--------- -----
(i) Principal executive officer:
/s/ KENNETH WHIPPLE Chairman of the Board and Chief Executive Officer
- -----------------------------------------------------
KENNETH WHIPPLE
(ii) Principal financial officer:
/s/ THOMAS J. WEBB Executive Vice President and Chief Financial Officer
- -----------------------------------------------------
THOMAS J. WEBB
(iii) Controller or principal accounting officer:
/s/ GLENN P. BARBA Vice President, Controller and Chief Accounting Officer
- -----------------------------------------------------
GLENN P. BARBA
(iv) A majority of the Directors including those named
above:
Director
- -----------------------------------------------------
JOHN M. DEUTCH
James. J Duderstadt* Director
- -----------------------------------------------------
JAMES J. DUDERSTADT
Kathleen R. Flaherty* Director
- -----------------------------------------------------
KATHLEEN R. FLAHERTY
Director
- -----------------------------------------------------
EARL D. HOLTON
David W. Joos* Director
- -----------------------------------------------------
DAVID W. JOOS
Michael T. Monahan* Director
- -----------------------------------------------------
MICHAEL T. MONAHAN
Joseph F. Paquette, Jr.* Director
- -----------------------------------------------------
JOSEPH F. PAQUETTE, JR.
Director
- -----------------------------------------------------
WILLIAM U. PARFET
Percy A. Pierre* Director
- -----------------------------------------------------
PERCY A. PIERRE
S. Kinnie Smith, Jr.* Director
- -----------------------------------------------------
S. KINNIE SMITH JR.
Kenneth L. Way* Director
- -----------------------------------------------------
KENNETH L. WAY
Kenneth Whipple* Director
- -----------------------------------------------------
KENNETH WHIPPLE
John B. Yasinsky* Director
- -----------------------------------------------------
JOHN B. YASINSKY
*By: Thomas J. Webb*
- -----------------------------------------------------
THOMAS J. WEBB, ATTORNEY-IN-FACT
-112-
CERTIFICATION OF KENNETH WHIPPLE
I, Kenneth Whipple, certify that:
1. I have reviewed this annual report on Form 10-K of Consumers Energy
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d--14) for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
-113-
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 28, 2003 By: /s/ Kenneth Whipple
------------------------------------
Kenneth Whipple
Chairman of the Board and
Chief Executive Officer
-114-
CERTIFICATION OF THOMAS J. WEBB
I, Thomas J. Webb, certify that:
1. I have reviewed this annual report on Form 10-K of Consumers Energy
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d--14) for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
-115-
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 28, 2003 By: /s/ Thomas J. Webb
------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
-116-