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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
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1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
Fairlane Plaza South, Suite 1100
330 Town Center Drive, Dearborn, Michigan 48126
(313) 436-9200
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
One Energy Plaza, Jackson, Michigan 49201
(517) 788-0550
1-2921 PANHANDLE EASTERN PIPE LINE COMPANY 44-0382470
(A Delaware Corporation)
5444 Westheimer Road, P.O. Box 4967, Houston, Texas 77210-4967
(713) 989-7000
Indicate by check mark whether the Registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark whether the Registrants are accelerated filers (as
defined in Rule 12b-2 of the Exchange Act).
CMS ENERGY CORPORATION: Yes [X] No [ ]
CONSUMERS ENERGY COMPANY AND PANHANDLE EASTERN PIPE LINE COMPANY: Yes [ ] No [X]
Panhandle Eastern Pipe Line Company meets the conditions set forth in General
Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q
with the reduced disclosure format. In accordance with Instruction H, Part I,
Item 2 has been reduced and Part II, Items 2, 3 and 4 have been omitted.
Number of shares outstanding of each of the issuer's classes of common stock at
May 1, 2003:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 144,096,264
CONSUMERS ENERGY COMPANY, $10 par value, privately held by CMS Energy 84,108,789
PANHANDLE EASTERN PIPE LINE COMPANY, no par value, indirectly privately held by CMS Energy 1,000
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CMS ENERGY CORPORATION
AND
CONSUMERS ENERGY COMPANY
AND
PANHANDLE EASTERN PIPE LINE COMPANY
QUARTERLY REPORTS ON FORM 10-Q TO THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED MARCH 31, 2003
This combined Form 10-Q is separately filed by each of CMS Energy Corporation,
Consumers Energy Company and Panhandle Eastern Pipe Line Company. Information
contained herein relating to each individual registrant is filed by such
registrant on its own behalf. Accordingly, except for their respective
subsidiaries, Consumers Energy Company and Panhandle Eastern Pipe Line Company
make no representation as to information relating to any other companies
affiliated with CMS Energy Corporation.
TABLE OF CONTENTS
Page
----
Glossary.................................................................................................. 4
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Critical Accounting Policies.................................................................... CMS - 1
Results of Operations........................................................................... CMS - 12
Capital Resources and Liquidity................................................................. CMS - 14
Outlook......................................................................................... CMS - 19
Other Matters................................................................................... CMS - 30
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CMS - 32
Consolidated Statements of Cash Flows........................................................... CMS - 34
Consolidated Balance Sheets..................................................................... CMS - 36
Consolidated Statements of Common Stockholders' Equity.......................................... CMS - 38
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies......................... CMS - 39
2. Asset Sales and Restructuring.............................................................. CMS - 42
3. Discontinued Operations.................................................................... CMS - 44
4. Uncertainties.............................................................................. CMS - 46
5. Short-Term and Long-Term Financings and Capitalization..................................... CMS - 60
6. Earnings Per Share......................................................................... CMS - 66
7. Risk Management Activities and Financial Instruments....................................... CMS - 66
8. Equity Method Investments.................................................................. CMS - 70
9. Reportable Segments........................................................................ CMS - 71
10. Adoption of New Accounting Standards....................................................... CMS - 72
2
TABLE OF CONTENTS
(CONTINUED)
Page
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Consumers Energy Company
Management's Discussion and Analysis
Forward-Looking Statements and Risk Factors..................................................... CE - 1
Critical Accounting Policies.................................................................... CE - 1
Results of Operations........................................................................... CE - 9
Capital Resources and Liquidity................................................................. CE - 10
Outlook......................................................................................... CE - 13
Other Matters................................................................................... CE - 22
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CE - 24
Consolidated Statements of Cash Flows........................................................... CE - 25
Consolidated Balance Sheets..................................................................... CE - 26
Consolidated Statements of Common Stockholder's Equity.......................................... CE - 28
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies.......................... CE - 31
2. Uncertainties............................................................................... CE - 33
3. Financings and Capitalization............................................................... CE - 45
4. Financial and Derivative Instruments........................................................ CE - 47
5. Implementation of New Accounting Standards.................................................. CE - 50
Panhandle Eastern Pipe Line Company
Management's Discussion and Analysis
Sale of Panhandle............................................................................... PE - 1
Forward-Looking Statements...................................................................... PE - 1
Critical Accounting Policies.................................................................... PE - 2
Results of Operations........................................................................... PE - 4
Outlook........................................................................................ PE - 6
Liquidity....................................................................................... PE - 7
Other Matters................................................................................... PE - 11
Consolidated Financial Statements
Consolidated Statements of Operations........................................................... PE - 13
Consolidated Statements of Cash Flows........................................................... PE - 14
Consolidated Balance Sheets..................................................................... PE - 15
Consolidated Statements of Common Stockholder's Equity and Comprehensive Income................. PE - 17
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure......................................................................... PE - 18
2. Summary of Significant Accounting Policies and Other Matters................................ PE - 19
3. Regulatory Matters.......................................................................... PE - 22
4. Goodwill Impairment......................................................................... PE - 24
5. Related Party Transactions.................................................................. PE - 24
6. Debt Rating Downgrades ..................................................................... PE - 26
7. Commitments and Contingencies............................................................... PE - 26
Quantitative and Qualitative Disclosures about Market Risk................................................ CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ CO - 1
Item 5. Other Information............................................................................ CO - 2
Item 6. Exhibits and Reports on Form 8-K............................................................. CO - 3
Signatures........................................................................................... CO - 5
3
GLOSSARY
Certain terms used in the text and financial statements are defined below.
ALJ....................................... Administrative Law Judge
APB....................................... Accounting Principles Board
APB Opinion No. 18........................ APB Opinion No. 18, "The Equity Method of Accounting for Investments
in Common Stock"
APB Opinion No. 20........................ APB Opinion No. 20, "Accounting Changes"
APB Opinion No. 30........................ APB Opinion No. 30, "Reporting Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business"
Accumulated Benefit Obligation............ The liabilities of a pension plan based on service and pay to date.
This differs from the Projected Benefit Obligation that is typically
disclosed in that it does not reflect expected future salary increases
Alliance.................................. Alliance Regional Transmission Organization
ARO....................................... Asset Retirement Obligation
bcf....................................... Billion cubic feet
BG LNG Services........................... BG LNG Services, Inc., a subsidiary of BG Group of the United Kingdom
Big Rock.................................. Big Rock Point nuclear power plant, owned by Consumers
Board of Directors........................ Board of Directors of CMS Energy
Centennial................................ Centennial Pipeline, LLC, in which Panhandle owns a one-third interest
CEO....................................... Chief Executive Officer
CFO....................................... Chief Financial Officer
Clean Air Act............................. Federal Clean Air Act, as amended
CMS Capital............................... CMS Capital Corp., a subsidiary of Enterprises
CMS Electric and Gas...................... CMS Electric and Gas Company, a subsidiary of Enterprises
CMS Energy................................ CMS Energy Corporation, the parent of Consumers and Enterprises
CMS Energy Common Stock................... Common stock of CMS Energy, par value $.01 per share
CMS Gas Transmission...................... CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Generation............................ CMS Generation Co., a subsidiary of Enterprises
CMS Holdings.............................. CMS Midland Holdings Company, a subsidiary of Consumers
CMS Midland............................... CMS Midland Inc., a subsidiary of Consumers
CMS MST................................... CMS Marketing, Services and Trading Company, a subsidiary of
Enterprises
CMS Oil and Gas .......................... CMS Oil and Gas Company, a subsidiary of Enterprises
CMS Viron................................. CMS Viron Energy Services, a wholly owned subsidiary of CMS MST
Consumers................................. Consumers Energy Company, a subsidiary of CMS Energy
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 as of January 1, 2002, provides for full
recovery of net stranded costs and implementation costs, establishes a
five percent reduction in residential rates, establishes rate freeze and
rate cap, and allows for Securitization
Detroit Edison............................ The Detroit Edison Company, a non-affiliated company
DIG....................................... Dearborn Industrial Generation, L.L.C., a wholly owned subsidiary of
CMS Generation
DOE....................................... U.S. Department of Energy
4
Dow....................................... The Dow Chemical Company, a non-affiliated company
Duke Energy............................... Duke Energy Corporation, a non-affiliated company
EITF...................................... Emerging Issues Task Force
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
FMB....................................... First Mortgage Bonds
FMLP...................................... First Midland Limited Partnership, a partnership that holds a lessor
interest in the MCV facility
FTC....................................... Federal Trade Commission
GCR....................................... Gas cost recovery
GTNs...................................... CMS Energy General Term Notes(R), $200 million Series D, $400 million
Series E and $300 million Series F
Guardian ................................. Guardian Pipeline, LLC, in which Panhandle owns a one-third interest
Health Care Plan.......................... The medical, dental, and prescription drug programs offered to
eligible employees of Panhandle, Consumers and CMS Energy
INGAA..................................... Interstate Natural Gas Association of America
IPP....................................... Independent Power Producer
Jorf Lasfar............................... The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS
Generation and ABB Energy Venture, Inc.
kWh....................................... Kilowatt-hour
LIBOR..................................... London Inter-Bank Offered Rate
Loy Yang.................................. The 2,000 MW brown coal fueled Loy Yang A power plant and an
associated coal mine in Victoria, Australia, in which CMS Generation
holds a 50 percent ownership interest
LNG....................................... Liquefied natural gas
LNG Holdings.............................. CMS Trunkline LNG Holdings, LLC, jointly owned by CMS Panhandle
Holdings, LLC and Dekatherm Investor Trust
Ludington................................. Ludington pumped storage plant, jointly owned by Consumers and Detroit
Edison
MACT...................................... Maximum Achievable Control Technology
MAPL...................................... Marathon Ashland Petroleum, LLC, partner in Centennial
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, formally a subsidiary of
Consumers Energy and now an indirect subsidiary of Trans-Elect
Michigan Gas Storage...................... Michigan Gas Storage Company, a subsidiary of Consumers
MISO...................................... Midwest Independent System Operator
5
SFAS No. 5................................ SFAS No. 5, "Accounting for Contingencies"
SFAS No. 34............................... SFAS No. 34, "Capitalization of Interest Cost"
SFAS No. 52............................... SFAS No. 52, "Foreign Currency Translation"
SFAS No. 71............................... SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation"
SFAS No. 87............................... SFAS No. 87, "Employers' Accounting for Pensions"
SFAS No. 106.............................. SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions"
SFAS No. 115.............................. SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"
SFAS No. 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. 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, "Recission 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. 148.............................. SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure"
SIPS...................................... State Implementation Plans
Southern Union............................ Southern Union Company, a non-affliated company
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, 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
TEPPCO.................................... TE Products PipeLine Company, Limited Partnership, partner in Centennial
Trunkline ................................ Trunkline Gas Company, LLC, a subsidiary of CMS Panhandle Holdings, LLC
Trunkline LNG ............................ Trunkline LNG Company, LLC, a subsidiary of LNG Holdings, LLC
Trust Preferred Securities................ Securities representing an undivided beneficial interest in the assets
of statutory business trusts, the interests of which 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
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
7
CMS Energy Corporation
CMS ENERGY CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
CMS Energy is the parent holding company of Consumers and Enterprises. Consumers
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Enterprises, through subsidiaries, including Panhandle and its
subsidiaries, is engaged in several domestic and international diversified
energy businesses including: natural gas transmission, storage and processing;
independent power production; and energy marketing, services and trading.
The MD&A of this Form 10-Q should be read along with the MD&A and other parts of
CMS Energy's 2002 Form 10-K. This MD&A refers to, and in some sections
specifically incorporates by reference, CMS Energy's Condensed Notes to
Consolidated Financial Statements and should be read in conjunction with such
Consolidated Financial Statements and Notes. This Form 10-Q and other written
and oral statements that CMS Energy may make contain forward-looking statements
as defined by the Private Securities Litigation Reform Act of 1995. CMS Energy's
intentions with the use of the words "anticipates," "believes," "estimates,"
"expects," "intends," and "plans," and variations of such words and similar
expressions, are solely to identify forward-looking statements that involve risk
and uncertainty. These forward-looking statements are subject to various factors
that could cause CMS Energy's actual results to differ materially from the
results anticipated in such statements. CMS Energy has no obligation to update
or revise forward-looking statements regardless of whether new information,
future events or any other factors affect the information contained in such
statements. CMS Energy does, however, discuss certain risk factors,
uncertainties and assumptions in this MD&A and in Item 1 of the 2002 Form 10-K
in the section entitled "Forward-Looking Statements Cautionary Factors and
Uncertainties" and in various public filings it periodically makes with the SEC.
CMS Energy designed this discussion of potential risks and uncertainties, which
is by no means comprehensive, to highlight important factors that may impact CMS
Energy's business and financial outlook. This Form 10-Q also describes material
contingencies in CMS Energy's Condensed Notes to Consolidated Financial
Statements, and CMS Energy encourages its readers to review these Notes.
CRITICAL ACCOUNTING POLICIES
CMS Energy's consolidated financial statements are based on the application of
accounting principles generally accepted in the United States. The application
of these principles often requires management to make certain judgments,
assumptions and estimates that may result in different financial presentations.
CMS Energy believes that certain accounting principles are critical in terms of
understanding its consolidated financial statements. These principles include
the use of estimates in accounting for contingencies and long-lived assets,
accounting for derivatives and financial instruments, mark-to-market accounting,
international operations and foreign currency, regulatory accounting, and
pension and postretirement benefits.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make judgments,
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Certain accounting principles require subjective and
complex judgments used in the preparation of financial statements. Accordingly,
a different financial presentation could result depending on the judgment,
estimates or assumptions that are used. Such estimates and assumptions include,
but are not specifically limited to: depreciation, amortization, interest rates,
discount rates, currency exchange rates, future commodity prices, mark-to-market
valuations, investment returns, impact of new accounting standards,
international economic policy, future costs associated with long-term
contractual obligations, future compliance costs associated with
CMS-1
CMS Energy Corporation
environmental regulations and continuing creditworthiness of counterparties.
Actual results could differ materially from those estimates.
Periodically, in accordance with SFAS No. 144 and APB Opinion No. 18, long-lived
assets and equity method investments of CMS Energy and its subsidiaries are
evaluated to determine whether conditions, other than those of a temporary
nature, indicate that the carrying value of an asset may not be recoverable.
Management bases its evaluation on impairment indicators such as the nature of
the assets, future economic benefits, domestic and foreign state and federal
regulatory and political environments, historical or future profitability
measurements, as well as other external market conditions or factors that may be
present. If such indicators are present or other factors exist that indicate
that the carrying value of the asset may not be recoverable, CMS Energy
determines whether impairment has occurred through the use of an undiscounted
cash flow analysis of assets at the lowest level for which identifiable cash
flows exist. If impairment, other than of a temporary nature, has occurred, CMS
Energy recognizes a loss for the difference between the carrying value and the
estimated fair value of the asset. The fair value of the asset is measured using
discounted cash flow analysis or other valuation techniques. The analysis of
each long-lived asset is unique and requires management to use certain estimates
and assumptions that are deemed prudent and reasonable for a particular set of
circumstances. Of CMS Energy's total assets, valued at $14.3 billion at March
31, 2003, approximately 45 to 50 percent represent the carrying value of
long-lived assets and equity method investments that are subject to this type of
analysis. If future market, political or regulatory conditions warrant, CMS
Energy and its subsidiaries may be subject to write-downs in future periods.
Conversely, if market, political or regulatory conditions improve, accounting
standards prohibit the reversal of previous write-downs.
CMS Energy has recently recorded write-downs of non-strategic or
under-performing long-lived assets as a result of implementing a new strategic
direction. CMS Energy is pursuing the sale of all of these non-strategic and
under-performing assets, including some assets that were not determined to be
impaired. Upon the sale of these assets, the proceeds realized may be materially
different from the remaining carrying value of these assets. Even though these
assets have been identified for sale, management cannot predict when, nor make
any assurances that, these asset sales will occur, or the amount of cash or the
value of consideration to be received.
Similarly, the recording of estimated liabilities for contingent losses within
the financial statements is guided by the principles in SFAS No. 5 that require
a company to record estimated liabilities in the financial statements when it is
probable that a loss will be incurred in the future as a result of a current
event, and when the amount can be reasonably estimated.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects to incur
significant costs for future environmental compliance, especially compliance
with clean air laws.
The EPA has issued regulations regarding nitrogen oxide emissions from certain
generators, including some of Consumers' electric generating facilities. These
regulations require Consumers to make significant capital expenditures estimated
to be $770 million. As of March 31, 2003, Consumers has incurred $420 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 and
their cost can change significantly. At some point, if new environmental
standards become effective, Consumers may need additional capital expenditures
to comply with the standards. For further information, see Note 4,
Uncertainties, "Consumers' Electric Utility Contingencies - Electric
Environmental Matters."
CMS-2
CMS Energy Corporation
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 4, Uncertainties, "Consumers' Gas Utility
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 the term of the PPA ending 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 and a fixed energy charge, and also to pay 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 and fixed energy charges in rates. After September 2007, the PPA's
regulatory out 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 March 31, 2003 and 2002 the remaining after-tax present value of
the estimated future PPA liability associated with the loss totaled $30 million
and $46 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
payments made on the basis of availability that may be billed by the MCV
Partnership at a maximum 98.5 percent availability level.
When Consumers returns, as expected, to unfrozen rates beginning in 2004,
Consumers will recover from customers capacity and fixed energy charges on the
basis of availability, to the extent that availability does not exceed 88.7
percent availability established in previous MPSC orders. For capacity and
energy 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. The regulatory out provision relieves Consumers of the obligation to
pay more for capacity and energy payments than the MPSC allows Consumers to
collect from its customers. Consumers estimates 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. 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:
CMS-3
CMS Energy Corporation
In Millions
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2003 2004 2005 2006 2007
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Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $ - $ - $ -
=================================================================================================================
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.
For further information see Note 4, Uncertainties, "Other Consumers' Electric
Utility Uncertainties - The Midland Cogeneration Venture."
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS AND MARKET RISK INFORMATION
DERIVATIVE INSTRUMENTS: CMS Energy uses the criteria in SFAS No. 133, as amended
and interpreted, to determine if certain contracts must be accounted for as
derivative instruments. The rules for determining whether a contract meets the
criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
The types of contracts CMS Energy currently classifies as derivative instruments
are interest rate swaps, foreign currency exchange contracts, certain electric
call options, fixed priced weather-based gas supply call options, fixed price
gas supply put options, gas futures, and gas and power swaps and forward
purchases and sales. CMS Energy does not account for electric capacity and
certain energy contracts, gas supply contracts, coal and nuclear fuel supply
contracts, or purchase orders for numerous supply items as derivatives.
Certain of Consumers' 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.
CMS-4
CMS Energy Corporation
In order to determine the fair value of contracts that are accounted for as
derivative instruments, CMS Energy uses a combination of quoted market 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 option contracts. The models used by CMS Energy have been tested against
market quotes to ensure consistency between model outputs and market quotes. At
March 31, 2003, CMS Energy assumed a market-based interest rate of 4.5 percent
and a volatility rate of 107.5 percent in calculating the fair value of its
electric call options.
In order for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings.
FINANCIAL INSTRUMENTS: CMS Energy accounts for its investments in debt and
equity securities in accordance with SFAS No. 115. As such, debt and equity
securities can be classified into one of three categories: held-to-maturity,
trading, or available-for-sale securities. CMS Energy's investments in equity
securities are classified as available-for-sale securities. They are reported at
fair value with any unrealized gains or losses resulting 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. Unrealized
gains or losses resulting from changes in the fair value of Consumers' nuclear
decommissioning investments are reported as regulatory liabilities. The fair
value of these investments is determined from quoted market prices.
MARKET RISK INFORMATION: CMS Energy is exposed to market risks including, but
not limited to, changes in interest rates, commodity prices, currency exchange
rates, and equity security prices. CMS Energy's 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 risk
committee's role is to review the corporate commodity position and ensure that
net corporate exposures are within the economic risk tolerance levels
established by CMS Energy's Board of Directors. Established policies and
procedures are used to manage the risks associated with market fluctuations.
In accordance with SEC disclosure requirements, CMS Energy performs sensitivity
analyses to assess the potential loss in fair value, cash flows and earnings
based upon hypothetical 10 percent increases and decreases 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, CMS
Energy and its subsidiaries rely on the experience and judgment of senior
management and traders to revise strategies and adjust positions as they deem
necessary. Losses in excess of the amounts determined in the sensitivity
analyses could occur if market rates or prices exceed the 10 percent shift used
for the analyses.
INTEREST RATE RISK: CMS Energy is exposed to interest rate risk resulting from
the issuance of fixed-rate and variable-rate debt, including interest rate risk
associated with trust preferred securities, and from interest rate swap
agreements. CMS Energy uses a combination of these instruments to manage and
mitigate interest rate risk exposure when deemed appropriate, based upon market
conditions. These strategies attempt to provide and maintain a balance between
risk and the lowest cost of capital. At March 31, 2003, the carrying amounts of
long-term debt and trust preferred securities were $5.2 billion and $883
million, respectively, with
CMS-5
CMS Energy Corporation
corresponding fair values of $5.1 billion and $640 million, respectively. Based
on a sensitivity analysis at March 31, 2003, CMS Energy estimates that if market
interest rates average 10 percent higher or lower, earnings before income taxes
for the subsequent 12 months would decrease or increase by approximately $9
million. In addition, based on a 10 percent adverse shift in market interest
rates, CMS Energy would have an exposure of approximately $331 million to the
fair value of its long-term debt and trust preferred securities if it had to
refinance all of its long-term fixed-rate debt and trust preferred securities.
CMS Energy does not intend to refinance all of its long-term fixed-rate debt and
trust preferred securities and therefore, CMS Energy believes that any adverse
change in interest rates would not have a material effect on its consolidated
financial position as of March 31, 2003.
At March 31, 2003, the fair value of CMS Energy's floating to fixed interest
rate swaps with a notional amount of $294 million was negative $4 million, which
represents the amount CMS Energy would pay to settle. The swaps mature at
various times through 2006 and are designated as cash flow hedges for accounting
purposes.
COMMODITY PRICE RISK: CMS Energy is exposed to market fluctuations in the price
of natural gas, oil, electricity, coal, natural gas liquids and other
commodities. CMS Energy employs established policies and procedures to manage
these risks using various commodity derivatives, including futures contracts,
options and swaps (which require a net cash payment for the difference between a
fixed and variable price), for non-trading purposes. The prices of these energy
commodities can fluctuate because of, among other things, changes in the supply
of and demand for those commodities. To minimize adverse price changes, CMS
Energy also hedges certain inventory and purchases and sales contracts. Based on
a sensitivity analysis, CMS Energy estimates that if energy commodity prices
change by an average 10 percent, operating income for the subsequent nine
months would change by $2.2 million. These hypothetical 10 percent shifts in
quoted commodity prices would not have had a material impact on CMS Energy's
consolidated financial position or cash flows at March 31, 2003. The analysis
does not quantify short-term exposure to hypothetically adverse price
fluctuations in inventories or for commodity positions related to trading
activities.
Consumers enters into electric call options, 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 March 31, 2003 and 2002, the fair value based on quoted future market
prices of electricity-related call option and swap contracts was $10 million and
$19 million, respectively. At March 31, 2003 and 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 and $4 million
respectively. As of March 31, 2003 and 2002, Consumers had an asset of $28
million and $48 million, respectively, related to premiums incurred for electric
call option contracts. Consumers' maximum exposure associated with the call
option contracts is limited to the premiums incurred. As of March 31, 2003,
Consumers did not have any gas supply-related call or put option contracts. As
of March 31, 2002, the fair value based on quoted future market prices of gas
supply contracts containing embedded options was $4 million. At March 31, 2002,
a hypothetical 10 percent adverse change in market prices was immaterial.
CURRENCY EXCHANGE RISK: CMS Energy is exposed to currency exchange risk arising
from investments in foreign operations as well as various international projects
in which CMS Energy has an equity interest and which have debt denominated in
U.S. dollars. CMS Energy typically uses forward exchange contracts and other
risk mitigating instruments to hedge currency exchange rates. The impact of the
hedges on the investments in foreign operations is reflected in other
comprehensive income as a component of foreign currency translation adjustment.
For the three months ended March 31, 2003, there was no mark-to-market
CMS-6
CMS Energy Corporation
adjustment included in the total net foreign currency translation adjustment of
$13 million. At March 31, 2003, there were no foreign exchange hedges.
Therefore, a sensitivity analysis at March 31, 2003 would be immaterial.
EQUITY SECURITY PRICE RISK: CMS Energy and certain of its subsidiaries have
equity investments in companies in which they hold less than a 20 percent
interest. At March 31, 2003, a hypothetical 10 percent adverse shift in equity
securities prices would not have a material effect on CMS Energy's consolidated
financial position, results of operations or cash flows.
For a discussion of accounting policies related to derivative transactions, see
Note 7, Risk Management Activities and Financial Instruments, incorporated by
reference herein.
MARK-TO-MARKET ACCOUNTING
Through December 31, 2002, CMS MST's wholesale power and gas trading activities
were accounted for under the mark-to-market method of accounting. Effective,
January 1, 2003, EITF Issue No. 98-10 was rescinded by EITF Issue No. 02-03 and
as a result, only energy contracts that meet the definition of a derivative in
SFAS No. 133 can be carried at fair value. The impact of this change for CMS MST
was recognized as a cumulative effect of a change in accounting principle of
$(23) million, net of tax. See Note 10, Adoption of New Accounting Standards.
Under mark-to-market accounting, energy-trading contracts are reflected at fair
market value, net of reserves, with unrealized gains and losses recorded as an
asset or liability in the consolidated balance sheets. These assets and
liabilities are affected by the timing of settlements related to these
contracts, current-period changes from newly originated transactions and the
impact of price movements.
Changes in fair value are recognized as revenues in the consolidated statements
of income in the period in which the changes occur. Market prices used to value
outstanding financial instruments reflect management's consideration of, among
other things, closing exchange and over-the-counter quotations. In certain
contracts, long-term commitments may extend beyond the period in which market
quotations for such contracts are available and volumetric obligations may not
be defined. Mathematical models are developed to determine various inputs into
the fair value calculation including price, anticipated volumetric obligations
and other inputs that may be required to adequately address the determination of
fair value of the contracts. Realized cash returns on these commitments may
vary, either positively or negatively, from the results estimated through
application of the mathematical model. CMS Energy believes that its mathematical
models utilize state-of-the-art technology, pertinent industry data and prudent
discounting in order to forecast certain elongated pricing curves. Market prices
are adjusted to reflect the impact of liquidating the company's position in an
orderly manner over a reasonable period of time under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. The creditworthiness of these counterparties will impact overall
exposure to credit risk; however, CMS Energy maintains credit policies that
management believes minimize overall credit risk with regard to its
counterparties. Determination of its counterparties' credit quality is based
upon a number of factors, including credit ratings, financial condition, and
collateral requirements. When trading terms permit, CMS Energy employs standard
agreements that allow for netting of positive and negative exposures associated
with a single counterparty. Based on these policies, its current exposures and
its credit reserves, CMS Energy does not anticipate a material adverse effect on
its financial position or results of operations as a result of counterparty
nonperformance.
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CMS Energy Corporation
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of March 31, 2003.
In Millions
- -----------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of December 31, 2002 $ 81
Fair value of new contracts when entered into during the period -
Implementation of EITF Issue No. 02-03 (a) (36)
Fair value of derivative contracts sold and received from asset sales (b) (30)
Changes in fair value attributable to changes in valuation techniques and assumptions -
Contracts realized or otherwise settled during the period (12)
Other changes in fair value (c) 4
- ----------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of March 31, 2003 $ 7
==============================================================================================
(a) Reflects the removal of contracts that do not qualify as
derivatives under SFAS No. 133 as of January 1, 2003.
(b) Reflects $(60) million of price risk management assets sold and
$30 million of price risk management assets received related to
the sales of the gas and power books.
(c) Reflects changes in price and net increase/(decrease) in position
size of forward positions as well as changes to mark-to-market
and credit reserves.
Fair Value of Contracts at March 31, 2003 In Millions
- ------------------------------------------------------------------------------------------------------
Total Maturity(in years)
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- ------------------------------------------------------------------------------------------------------
Prices actively quoted $ (2) $ (2) $ - $ - $ -
Prices based on models and
other valuation methods 9 4 4 1 -
- ------------------------------------------------------------------------------------------------------
Total $ 7 $ 2 $ 4 $ 1 $ -
======================================================================================================
INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY
CMS Energy, through its subsidiaries and affiliates, has acquired investments in
energy-related projects throughout the world. As a result of a change in
business strategy, over the last two years, CMS Energy has been divesting its
non-strategic or under-performing foreign investments.
BALANCE SHEET: CMS Energy's subsidiaries and affiliates whose functional
currency is other than the U.S. dollar translate their assets and liabilities
into U.S. dollars at the exchange rates in effect at the end of the fiscal
period. The revenue and expense accounts of such subsidiaries and affiliates are
translated into U.S. dollars at the average exchange rate during the period. The
gains or losses that result from this process, and gains and losses on
intercompany foreign currency transactions that are long-term in nature that CMS
Energy does not intend to settle in the foreseeable future, are reflected as a
component of stockholders' equity in the consolidated balance sheets as "Foreign
Currency Translation" in accordance with the accounting guidance provided in
SFAS No. 52. As of March 31, 2003, the cumulative Foreign Currency Translation
decreased stockholders' equity by $445 million. Included in this amount is an
unrealized loss of $119 million, net of tax, related to CMS Energy's investment
in Loy Yang. The loss will be realized upon sale, full liquidation, or other
disposition of CMS Energy's investment in Loy Yang. CMS Energy is continuing to
review its business alternatives for its investment in Loy Yang, including
future financing and operating alternatives, the nature and extent of CMS
Energy's future involvement and the potential for an ultimate sale of its
interest in the future. CMS Energy has not established a deadline for any of
these alternatives.
CMS-8
CMS Energy Corporation
Argentina: In January 2002, the Republic of Argentina enacted the Public
Emergency and Foreign Exchange System Reform Act. This law repealed the fixed
exchange rate of one U.S. dollar to one Argentina peso, converted all
dollar-denominated utility tariffs and energy contract obligations into pesos at
the same one-to-one exchange rate, and directed the President of Argentina to
renegotiate such tariffs.
Effective April 30, 2002, CMS Energy adopted the Argentine peso as the
functional currency for most of its Argentine investments. CMS had previously
used the U.S. dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 pesos per U.S. dollar, and recorded an initial
charge to the Foreign Currency Translation component of Common Stockholders'
Equity of approximately $400 million.
While CMS Energy's management cannot predict the most likely future, or average
peso to U.S. dollar exchange rates, it does expect that these non-cash charges
substantially reduce the risk of further material balance sheet impacts when
combined with anticipated proceeds from international arbitration currently in
progress, political risk insurance, and the eventual sale of these assets. At
March 31, 2003, the net foreign currency loss due to the unfavorable exchange
rate of the Argentine peso recorded in the Foreign Currency Translation
component of Common Stockholder's Equity using an exchange rate of 2.973 pesos
per U.S. dollar was $258 million. This amount also reflects the effect of
recording U.S. income taxes with respect to temporary differences between the
book and tax basis of foreign investments, including the foreign currency
translation associated with CMS Energy's Argentine investments, that were
determined to no longer be essentially permanent in duration.
INCOME STATEMENT: For subsidiaries operating in highly inflationary economies or
that meet the U.S. functional currency criteria outlined in SFAS No. 52, the
U.S. dollar is deemed to be the functional currency. Gains and losses that arise
from exchange rate fluctuations on transactions denominated in a currency other
than the U.S. dollar, except those that are hedged, are included in determining
net income.
HEDGING STRATEGY: CMS Energy uses forward exchange and option contracts to hedge
certain receivables, payables, long-term debt and equity value relating to
foreign investments. The purpose of CMS Energy's foreign currency hedging
activities is to protect the company from risk that U.S. dollar net cash flows
resulting from sales to foreign customers and purchases from foreign suppliers
and the repayment of non-U.S. dollar borrowings, as well as the equity reported
on the company's balance sheet, may be adversely affected by changes in exchange
rates. These contracts do not subject CMS Energy to risk from exchange rate
movements because gains and losses on such contracts are inversely correlated
with the losses and gains, respectively, on the assets and liabilities being
hedged. Foreign currency adjustments for other CMS Energy international
investments were immaterial.
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 be refunded to customers. Judgment is required to
discern the recoverability of items recorded as regulatory assets and
liabilities. As of March 31, 2003, Consumers had $1.121 billion recorded as
regulatory assets and $463 million recorded as regulatory liabilities.
CMS-9
CMS Energy Corporation
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 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 beginning in the fourth quarter of 2002, including regulatory
accounting treatment of costs required to be recognized in accordance with SFAS
No. 143.
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. A number of
utilities have commenced litigation in the Court of Claims, including Consumers,
which filed its complaint in December 2002. The Chief Judge of the Court of
Claims identified six lead cases to be used as vehicles for resolving
dispositive motions. Consumers' case is not a lead case. It is unclear what
impact this decision by the Chief Judge will have on the outcome of Consumers'
litigation. 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 submitted a
complaint to the MPSC which was served on Consumers by the MPSC on April 18,
2003. The complaint asks the MPSC to commence a generic investigation and
contested case to review all facts and issues concerning costs associated with
spent nuclear fuel storage and disposal. The complaint seeks a variety of relief
with respect to Consumers Energy, The Detroit Edison Company, Indiana & Michigan
Electric Company, Wisconsin Electric Power Company and Wisconsin Public Service
Corporation including establishing 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 related to the storage and
disposal of spent nuclear fuel. Consumers is reviewing the complaint. Consumers
is unable to predict the outcome of this matter.
CMS-10
CMS Energy Corporation
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 and the adequacy of the decommissioning trust funds.
ACCOUNTING FOR PENSION AND OPEB
CMS Energy provides postretirement benefits under its Pension Plan, and
postretirement health and life insurance benefits under its OPEB plans to
substantially all its retired employees. CMS Energy 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 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, all employees of Panhandle will no longer 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. CMS Energy expects a curtailment gain of $2 million for the Pension Plan
and $2 million for the OPEB plan relating to the sale of Panhandle.
CMS Energy estimates pension expense will approximate $46 million, $51 million
and $58 million in 2003, 2004 and 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.
CMS Energy 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 not earn any
additional 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.
In order to keep health care benefits and costs competitive, CMS Energy has
announced several changes to the Health Care Plan. These changes are effective
January 1, 2003. The most significant change is that CMS Energy's future
increases in health care costs will be shared with salaried employees. The
salaried retirees Health Care Plan also has 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 the
Company. Mail-order prescription copays also have been increased for all
salaried retirees.
CMS-11
CMS Energy Corporation
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
In Millions (Except for EPS)
- --------------------------------------------------------------------------------
Three Months Ended March 31 2003 2002
- --------------------------------------------------------------------------------
CMS Energy Net Income $ 79 $ 42
CMS Energy Basic Earnings Per Share $ 0.55 $0.32
CMS Energy Diluted Earnings Per Share $ 0.51 $0.32
- --------------------------------------------------------------------------------
CMS Energy net income reflects the continued implementation of the financial
improvement plan and on-going asset sales program first announced in 2001. The
financial improvement plan focuses on strengthening CMS Energy's balance sheet
and improving financial liquidity through debt reduction and aggressive cost
management. The on-going asset sales program's objectives are to generate cash
to reduce debt, reduce business risk and provide for more predictable future
earnings. This program encompasses the sale of non-strategic and
under-performing assets, the proceeds of which are being used primarily to
reduce debt.
CMS Energy Net Income In Millions
- --------------------------------------------------------------------------------
Three Months Ended March 31 2003 2002 Change
- --------------------------------------------------------------------------------
$ 79 $ 42 $ 37
================================================================================
Electric Utility $ 51 $ 50 $ 1
Gas Utility 54 28 26
Enterprises 23 66 (43)
Corporate Interest and Other (52) (51) (1)
Discontinued Operations 27 (51) 78
Accounting Changes (24) - (24)
- --------------------------------------------------------------------------------
Net Income $ 79 $ 42 $ 37
================================================================================
For the three months ended March 31 2003, CMS Energy's net income was $79
million or $0.51 per diluted share, an increase of $37 million or $0.19 per
share from the three months ended March 31, 2002. The increase primarily
reflects increased electric and gas deliveries and the impact of Consumers'
final gas rate order issued in the fourth quarter of 2002 that increased gas
tariff rates. The three months ended March 31, 2003 also includes the cumulative
effect of a change in accounting resulting from the implementation of EITF Issue
No. 02-03 at CMS MST of $(23) million, net of tax and the implementation of SFAS
No. 143 of $(1) million, net of tax. The three months ended March 31, 2002
includes an after-tax gain on the sale of CMS Energy's ownership interests in
Equatorial Guinea properties of $324 million and the cumulative effect of a
change in accounting for goodwill at Panhandle of ($369) million, net of tax and
CMS Viron of $(10) million, net of tax, which are reflected in discontinued
operations.
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CMS Energy Corporation
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------
March 31 2003 2002 Change
- -------------------------------------------------------------------------------
Three months ended $51 $50 $1
===============================================================================
Reasons for the change:
Electric deliveries $13
Power supply costs and related revenue 13
Other operating expenses and non-commodity revenue (22)
Fixed charges (3)
- --------------------------------------------------------------------------------
Total change $ 1
===============================================================================
ELECTRIC DELIVERIES: For the three months ended March 31, 2003, electric
delivery revenues increased by $13 million from the previous year. Electric
deliveries, including transactions with other wholesale market participants and
other electric utilities, were 9.7 billion kWh, an increase of 0.5 billion kWh
or 5.6 percent from 2002. This increase is primarily the result of increased
deliveries to the higher margin residential and commercial sectors, along with
the growth in retail deliveries.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended March 31,
2003, power supply costs and related revenues increased electric net income by
$13 million from 2002. This increase is primarily the result of increased
intersystem revenues.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three months ended
March 31, 2003, operating expenses increased compared to 2002. This increase can
be attributed to a scheduled refueling outage at Palisades that began in March
and higher transmission costs due to the loss of a financial return on the sold
Consumers' transmission system asset in May 2002. Slightly offsetting these
increased operating expenses are increased non-commodity revenues associated
with miscellaneous service revenues.
INCOME TAXES: For the three months ended March 31, 2003, income tax expense
remained relatively flat compared to 2002.
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------
March 31 2003 2002 Change
- -------------------------------------------------------------------------------
Three months ended $54 $28 $26
===============================================================================
Reasons for the change:
Gas deliveries $33
Gas rate increase 19
Gas wholesales and retail services 3
Operation and maintenance (10)
General taxes, depreciation, and other income (5)
Fixed charges (1)
Income taxes (13)
- -------------------------------------------------------------------------------
Total change $ 26
===============================================================================
CMS-13
CMS Energy Corporation
GAS DELIVERIES: For the three months ended March 31, 2003, gas delivery revenues
increased by $33 million from the previous year. System deliveries, including
miscellaneous transportation, totaled 174 bcf, an increase of 25 bcf or 16.4
percent compared with 2002. This increase is primarily due to colder weather
that resulted in increased deliveries to the residential and commercial sectors
in 2003.
GAS RATE INCREASE: 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 this order, Consumers recognized increased gas revenues of $19
million.
OPERATION AND MAINTENANCE: For the three months ended March 31, 2003, operation
and maintenance expenses increased $10 million compared to 2002. This increase
reflects the recognition of additional expenditures on safety, reliability and
customer service due to the colder temperatures for the quarter, compared to the
same period in 2002.
INCOME TAXES: For the three months ended March 31, 2003, income tax expense
increased primarily due to improved earnings of the gas utility.
ENTERPRISES RESULTS OF OPERATIONS
For the three months ended March 31, 2003, Enterprises net income was $23
million, a decrease of $43 million from the comparable period in 2002. The
decrease reflects reduced CMS MST and CMS Gas Transmission earnings due
primarily to the shift in business strategy. See the Enterprises Outlook section
in this MD&A. The decrease was partially offset by improved independent power
production results due to improved earnings at the MCV Facility and
stabilization of the Argentine Peso which resulted in foreign currency gains at
the Argentine power plants.
OTHER RESULTS OF OPERATIONS
For the three months ended March 31, 2003, corporate interest and other net
expenses were $52 million compared to $51 million for the comparable period in
2002. Interest expense, net of tax, for the three months ended March 31, 2003
was $43 million, a decrease of $9 million from the comparable 2002 period,
reflecting lower interest costs at the Parent. Corporate overhead and other
expenses increased $11 million from the comparable 2002 period due primarily to
the timing of certain corporate expenses incurred.
OTHER: Discontinued Operations includes Panhandle, CMS Viron, CMS Field Services
and International Energy Distribution. For more information, see Note 3,
Discontinued Operations.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
CMS Energy's primary ongoing source of cash is dividends and other distributions
from subsidiaries, including proceeds from asset sales. During the first quarter
of 2003, Consumers paid $78 million in common dividends and other distributions
and Enterprises paid $18 million in common dividends and other distributions to
CMS Energy. In March 2003, Consumers declared a $31 million common dividend to
CMS Energy, payable in May 2003. CMS Energy's consolidated cash requirements are
met by its operating and financing activities. Consistent with CMS Energy's
liquidity objectives, $675 million consolidated cash was on hand at March 31,
2003.
CMS-14
CMS Energy Corporation
OPERATING ACTIVITIES: CMS Energy's net cash provided by operating activities is
derived mainly from the processing, storage, transportation and sale of natural
gas and the generation, distribution and sale of electricity. For the first
three months of 2003 and 2002, cash from operations after interest charges
totaled $400 million and $247 million, respectively. The $153 million increase
in cash from operations resulted primarily from an increase in cash earnings and
a decrease in inventories. These improvements in cash from operations were
partially offset by an increase in accounts receivable and accrued revenues and
other temporary changes in working capital items due to timing of cash receipts
and payments. CMS Energy uses cash derived from its operating activities
primarily to maintain and expand its businesses and to pay interest on and
retire portions of its long-term debt.
INVESTING ACTIVITIES: For the first three months of 2003 and 2002, CMS Energy's
net cash (used in) provided by investing activities totaled $(53) million and
$647 million, respectively. The $700 million decrease in cash provided primarily
reflects a decrease in proceeds received from the sale of assets. CMS Energy's
expenditures, including investments and assets placed under capital lease, in
the first three months of 2003 for its utility and diversified energy businesses
were $126 million and $42 million, respectively, compared to $164 million and
$30 million, respectively, for the first three months of 2002.
FINANCING ACTIVITIES: For the first three months of 2003 and 2002, CMS Energy's
net cash used in financing activities totaled $50 million and $891 million,
respectively. The $841 million decreased use of cash resulted primarily from an
increase in proceeds received from notes, bonds and other long-term debt of $15
million, a decrease in retirement of notes, bonds and other long-term debt of
$742 million, a decrease in the retirement of trust preferred securities of $30
million, a decrease in the payment of common stock dividends of $49 million and
a lesser decrease in notes payable of $48 million. These improvements in
financing activities were partially offset by a decrease in proceeds received
from the issuance of common stock of $42 million.
In January 2003, the Board of Directors suspended the payment of common stock
dividends. CMS Energy expects this dividend suspension will improve its
liquidity by more than $100 million in 2003.
OTHER INVESTING AND FINANCING MATTERS: At March 31, 2003, the book value per
share of CMS Energy Common Stock was $8.53.
CREDIT FACILITIES: On March 30, 2003, CMS Energy entered into an amendment and
restatement of its existing $300 million and $295.8 million revolving credit
facilities under which $409 million was then outstanding. The Second Amended and
Restated Senior Credit Agreement includes a $159 million tranche with a maturity
date of April 30, 2004 and a $250 million tranche with a maturity date of
September 30, 2004. The facility was underwritten by several banks at a total
annual cost to CMS Energy of approximately ten percent, which includes the
initial commitment fee. Any proceeds of debt or equity issuances by CMS Energy
and its subsidiaries or any asset sales by CMS Energy or its subsidiaries, other
than Consumers, are required to be used to prepay this facility. This facility
is collateralized primarily by the stock of Consumers, Enterprises and certain
Enterprises subsidiaries.
On March 30, 2003, Enterprises entered into a revolving credit facility in an
aggregate amount of $441 million. The maturity date of this facility is April
30, 2004. Subsequently, on April 21, 2003, Enterprises entered into a $75
million revolving credit facility with a maturity date of April 30, 2004. These
facilities were underwritten by several banks at a total annual cost to CMS
Energy of approximately ten percent, which includes the initial commitment fee.
Proceeds from these loans will be used for general corporate purposes, to retire
debt and to collateralize $160 million of letters of credit. Any proceeds of
debt or equity issuances by CMS Energy and its subsidiaries or any asset sales
by CMS Energy or its subsidiaries, other than Consumers,
CMS-15
CMS Energy Corporation
are required to be used to prepay these facilities. It is expected that proceeds
from the Panhandle sale will be used to pay off these facilities in full. These
facilities are guaranteed by CMS Energy, whose guaranty is primarily secured by
the stock of Consumers and Enterprises.
REQUIRED RATIOS: CMS Energy's credit facilities have contractual restrictions
that require CMS Energy to maintain certain ratios as of the last day of each
fiscal quarter. Violation of these ratios 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. At March 31,
2003, CMS Energy was in compliance with required ratios.
Required Ratio Limitation Ratio at March 31, 2003
- -------------------------------------------------------------------------------------------------------------------
Consolidated Leverage Ratio not more than 7.00 to 1.00 5.84 to 1.00
Cash Dividend Coverage Ratio not less than 1.20 to 1.00 1.73 to 1.00
- -------------------------------------------------------------------------------------------------------------------
In 1994, CMS Energy executed an indenture with J.P.Morgan Chase Bank pursuant to
CMS Energy's general term notes program. The indenture, through supplements,
contains certain provisions that can trigger a limitation on CMS Energy's
consolidated indebtedness. The limitation can be activated when CMS Energy's
consolidated leverage ratio, as defined in the indenture (essentially the ratio
of consolidated debt to consolidated capital), exceeds 0.75 to 1.0. At March 31,
2003, CMS Energy's consolidated leverage ratio was 0.79 to 1.0. As a result, CMS
Energy will not and will not permit certain material subsidiaries, excluding
Consumers and its subsidiaries, to become liable for new indebtedness. However,
CMS Energy and the material subsidiaries may incur revolving indebtedness to
banks of up to $1 billion in the aggregate and refinance existing debt
outstanding of CMS Energy and of its material subsidiaries. This leverage ratio
may be significantly reduced with the proceeds of CMS Energy's sale of
Panhandle, its sale of CMS Field Services, or other asset sales.
REGULATORY AUTHORIZATION FOR FINANCINGS: At March 31, 2003, 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, $381 million for general
corporate purposes, and $610 million of first mortgage bonds to be issued solely
as collateral for the long-term securities. On April 30, 2003, Consumers sold
$625 million principal amount of first mortgage bonds. Its remaining FERC
authorization after this issue is (1) $250 million of long-term securities for
refinancing or refunding purposes, (2) $6 million for general corporate
purposes, and (3) $610 million remaining first mortgage bonds available to be
issued solely as collateral for the long-term securities. Consumers anticipates
applying in the second quarter of 2003 for an increase in FERC authorization to
issue new long-term securities for refinancing or refunding and for general
corporate purposes. 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 FINANCINGS: 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. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity expiring in March 2006;
the loan has a cost of LIBOR plus 450 basis points. Proceeds from this loan were
used for general corporate purposes.
In April 2003, Consumers sold $625 million principal amount of first mortgage
bonds in a private offering to institutional investors; $250 million were issued
at 4.25 percent, maturing on April 15, 2008, and net proceeds
CMS-16
CMS Energy Corporation
were approximately $248 million, $375 million were issued at 5.38 percent,
maturing on April 15, 2013, and net proceeds were approximatley $371 million.
Consumers used the net proceeds to replace a $250 million senior reset put bond
that matured in May 2003, to pay an associated $32 million option call payment,
and for general corporate purposes that may include paying down additional debt.
Consumers has agreed to file a registration statement with the SEC to permit
holders of these first mortgage bonds to exchange the bonds for new bonds that
will be registered under the Securities Act of 1933. Consumers has agreed to
file this registration statement by December 31, 2003.
SHORT TERM FINANCINGS: 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.
RESTRICTED PAYMENTS: Pursuant to restrictive covenants in debt facilities,
Consumers is limited to common stock dividend payments that will not exceed $300
million in any calendar year. In January 2003, Consumers declared and paid a $78
million common dividend. In March 2003, Consumers declared a $31 million common
dividend payable in May 2003.
OBLIGATIONS AND COMMITMENTS
The following information on CMS Energy's contractual obligations, off-balance
sheet arrangements and commercial commitments is provided to collect information
in a single location so that a picture of liquidity and capital resources is
readily available.
CONTRACTUAL OBLIGATIONS: CMS Energy has contractual obligations including
long-term debt, notes payable, and capital lease obligations. Notes payable
include Consumers' $250 million revolving credit agreement. Capital leases
include leased service vehicles and the new headquarters building.
OFF-BALANCE SHEET ARRANGEMENTS: CMS Energy's use of long-term contracts for the
purchase of commodities and services, the sale of Consumers' accounts
receivables, and operating leases are considered to be off-balance sheet
arrangements.
CMS Energy's operating leases are predominately railroad coal car leases,
aircraft, vehicles and miscellaneous office equipment. The full lease obligation
becomes due in case of lease payment default.
At March 31, 2003, 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. At March 31, 2003
and 2002, the receivables sold totaled $325 million for each year; the average
annual discount rate was 1.57 percent and 2.15 percent, respectively. Accounts
receivable and accrued revenue in the Consolidated Balance Sheets have been
reduced to reflect receivables sold. On April 30, 2003, Consumers ended its
trade receivable sale program with its then existing purchaser and anticipates
that a new receivable program will be in place with a new purchaser in May 2003.
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. Consumers
has long-term power purchase agreements with various generating plants including
the MCV Facility. These contracts require monthly capacity payments based on the
plants' availability or deliverability. These payments are approximately $47
million per month for the remaining nine months of 2003, including $34 million
related to the MCV Facility. If a plant is not available to deliver electricity
to Consumers, then Consumers would not be obligated to make the capacity payment
while the plant is unable to deliver. CMS Energy uses these off-balance sheet
arrangements in its normal business operations.
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CMS Energy Corporation
In addition, CMS Energy, through its subsidiary companies, has equity
investments in partnerships and joint ventures in which they have a minority
ownership interest. As of March 31, 2003, CMS Energy's proportionate share of
unconsolidated debt associated with these investments was $2.6 billion. This
unconsolidated debt is non-recourse to CMS Energy and is not included in the
amount of long-term debt that appears on CMS Energy's Consolidated Balance
Sheets.
The following table shows a summary of CMS Energy's contractual obligations,
including off-balance sheet commitments at March 31, 2003.
Contractual Obligations In Millions
- --------------------------------------------------------------------------------------------------------------
Payments Due
------------------------------------------------------------
March 31 Total 2003 2004 2005 2006 2007 Beyond
- --------------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 6,127 $ 915 $ 461 $ 744 $ 663 $ 538 $ 2,806
Notes payable 253 253 - - - - -
Capital lease obligations(a) 153 12 19 18 17 16 71
- --------------------------------------------------------------------------------------------------------------
Total on-balance sheet $ 6,533 $1,180 $ 480 $ 762 $ 680 $ 554 $ 2,877
==============================================================================================================
Off-balance sheet:
Non-recourse debt $ 2,614 $ 270 $152 $ 128 $ 392 $ 32 $ 1,640
Operating leases 94 13 14 10 10 8 39
Sale of accounts receivable 325 325 - - - - -
Unconditional purchase
Obligations 18,888 1,843 1,386 1,119 874 742 12,924
- --------------------------------------------------------------------------------------------------------------
Total off-balance sheet $21,921 $2,451 $1,552 $1,257 $1,276 $ 782 $14,603
==============================================================================================================
(a) Capital lease obligations include $20 million of imputed interest.
COMMERCIAL COMMITMENTS: As of March 31, 2003, CMS Energy, Enterprises, and their
subsidiaries have guaranteed payment of obligations through guarantees,
indemnities and letters of credit, of unconsolidated affiliates and related
parties approximating $993 million. Included in this amount, Enterprises, in the
ordinary course of its business, has guaranteed contracts of CMS MST that
contain certain schedule and performance requirements. As of March 31, 2003, the
actual amount of financial exposure covered by these guarantees and indemnities
was $297 million. Management monitors and approves these obligations and
believes it is unlikely that CMS Energy would be required to perform or
otherwise incur any material losses associated with these guarantees.
Indemnities are three-party agreements used to assure performance of contracts
by CMS Energy. Letters of credit are issued by banks guaranteeing CMS Energy's
payments of its drafts. Drafts are for a stated amount and for a specified
period; they substitute the bank's credit for CMS Energy's and eliminate the
credit risk for the other party.
Commercial Commitments In Millions
- ----------------------------------------------------------------------------------------------------------------
Commitment Expiration
---------------------------------------------------------------
March 31 Total 2003 2004 2005 2006 2007 Beyond
- ----------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $ 469 $ 20 $ - $ - $ 4 $ - $445
Indemnities 241 5 - 36 - - 200
Letters of Credit 283 247 32 - - - 4
- ----------------------------------------------------------------------------------------------------------------
Total $993 $ 272 $ 32 $ 36 $ 4 $ - $649
================================================================================================================
For further information, see Note 5, Short-Term and Long-Term Financings and
Capitalization, incorporated by reference herein.
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CMS Energy Corporation
OUTLOOK
CAPITAL RESOURCES AND LIQUIDITY
CMS Energy's liquidity and capital requirements generally are a function of its
results of operations, capital expenditures, contractual obligations, working
capital needs and collateral requirements. CMS Energy has historically met its
consolidated cash needs through its operating and investing activities and, as
needed, through access to bank financing and the capital markets.
In 2003, CMS Energy has contractual obligations and planned capital expenditures
that would require substantial amounts of cash. CMS Energy at the parent level
had approximately $598 million, Consumers and its subsidiaries had approximately
$727 million, and Panhandle and its subsidiaries had approximately $52 million
of publicly issued and credit facility debt maturing in 2003.
CMS Energy and Consumers have taken significant steps to address their 2003
maturities, as described below. As of May 9, 2003, CMS Energy at the parent
level had approximately $220 million, Consumers and its subsidiaries had
approximately $20 million, and Panhandle and its subsidiaries had approximately
$39 million of remaining publicly issued and credit facility debt maturing in
2003. CMS Energy has amounts held in escrow to satisfy its 2003 maturities
including interest. In addition, CMS Energy could also become subject to
liquidity demands pursuant to commercial commitments under guarantees,
indemnities and letters of credit. Management is pursuing actively plans to
refinance debt and to sell assets, including the sale of Panhandle and Field
Services. See Corporate Outlook section below.
CMS ENERGY PARENT LEVEL LIQUIDITY
CMS Energy at the parent level is addressing its near-to-mid-term liquidity and
capital requirements through a financial improvement plan that involves the sale
of non-strategic and under-performing assets of approximately $900 million,
receipt of dividends from its subsidiaries of approximately $327 million, and
reduction of approximately $1.290 billion of outstanding debt along with reduced
capital expenditures, cost reductions and other measures.
CMS Energy has reduced debt through asset sales and securitization proceeds,
with a total of approximately $2.8 billion in cash proceeds from such events
over the past two years. Through March of 2003, CMS Energy has accomplished
approximately $97 million of additional asset sales as described below. In
January 2003, CMS MST closed on the sale of a substantial portion of its natural
gas trading contracts for $17 million of cash proceeds. The sale of Centennial,
resulting in proceeds to CMS Energy of $40 million, closed in February 2003. In
March 2003, CMS MST sold the majority of its wholesale power book and related
supply portfolio for cash proceeds of $34 million to Constellation Power Source,
Inc. The sale contains a potential to increase proceeds to $40 million dependent
upon future years' performance of the sold assets. Additionally, during the
first quarter of 2003, CMS MST sold its 50 percent joint venture ownership
interest in Texon, its 50 percent interest in Premstar and its Tulsa retail
contracts, resulting in net cash proceeds of approximately $6 million.
CMS Energy believes that further targeted asset sales, together with its planned
reductions in operating expenses, capital expenditures, and the suspension of
the common dividend also will contribute to improved liquidity. CMS Energy
believes that, assuming the successful implementation of its financial
improvement plan, its present 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. There can be no assurances
that the financial improvement plan will be successful and failure to achieve
its goals could have a material adverse effect on CMS Energy's liquidity and
operations. In such event, CMS Energy would be required to consider the full
range of strategic measures available to companies in similar circumstances. CMS
Energy continues to explore financing opportunities to supplement its financial
improvement plan.
CMS-19
CMS Energy Corporation
These potential opportunities include refinancing its bank credit facilities;
entering into leasing arrangements and/or vendor financing; refinancing and
issuing new capital markets debt, preferred and/or common equity; and
negotiating private placement debt, preferred and/or common equity.
CONSUMERS ENERGY LIQUIDITY
Consumers plans to meet its liquidity and capital requirements in 2003 through a
combination of approximately $290 million from operations, $1.290 billion from
borrowings including $563 million of new debt and $727 million refinancing of
existing debt, reduced capital expenditures, cost reductions and other measures.
The following table is a summary of Consumers' debt financing plan and actual
borrowings for 2003:
Debt Financing in 2003 In Millions
- ----------------------------------------------------------------------------------------------------------------
Financing Actual Retired or
Financing Plan Borrowing Type Issued Date Maturity Collateral
- ----------------------------------------------------------------------------------------------------------------
Anticipated Maturities:
Revolving credit $ 250 $ 250 Refinanced March 2003 March 2004 (a) FMB
facility
Senior note 250 250 Refunded (b) April 2003 April 2008 -
Gas Inventory
facility 227 - Retired (c) March 2003 - -
------ ------
Subtotal $ 727 $ 500
------ ------
New Financings:
Bank loan 140 140 New issue March 2003 March 2009 FMB(e)
Term loan 150 150 New issue March 2003 March 2006 FMB(e)
First mortgage bonds 250 375 New issue April 2003 April 2013 -
Additional gas
Inventory facility 23 - (d)- - - -
------ ------
Subtotal $ 563 $ 665
------ ------
Total $1,290 $1,165
================================================================================================================
(a) This facility has two annual extensions at Consumers' option, which would
extend the maturity to March 2006.
(b) Refunded and replaced with FMB.
(c) Includes a gas inventory facility of $207 million retired in March 2003 and
anticipated new gas inventory facility pay down of $20 million expected to occur
in December 2003. See footnote (d).
(d) Consumers will seek to arrange a $125 million gas inventory loan in the
third quarter 2003 and thus complete the $1.290 billion financing plan.
(e) Refer to Capital Resources and Liquidity, "Regulatory Authorization For
Financings" above for information about Consumers' remaining FERC debt
authorization.
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. In addition to executing the debt financing plan for 2003 as discussed
above, the following activities also have been initiated by Consumers to enhance
further its liquidity beyond 2003.
CMS-20
CMS Energy Corporation
o 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 it
will be in place by the fourth quarter of 2003.
o Consumers filed an application in March 2003, 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 rehearing
or court appeals and no other delays in the offering process,
Consumers anticipates that bonds could be issued by year-end
2003.
There is no assurance that the pending Securitization bond issuance transaction
noted above will be completed, nor is there assurance that the MPSC will grant
either interim or final gas utility rate relief.
CORPORATE OUTLOOK
During the first quarter of 2003, CMS Energy continued to implement its
financial improvement plan and on-going asset sales program first announced in
2001. The financial improvement plan focuses on strengthening CMS Energy's
balance sheet and improving financial liquidity through debt reduction and
aggressive cost management. The on-going asset sales program's objectives are to
generate cash to reduce debt, reduce business risk, and provide for more
predictable future earnings. This encompasses the sale of non-strategic and
under-performing assets, the proceeds of which are being used to reduce debt.
Consistent with its "back-to-basics" strategy, CMS Energy is pursuing actively
the sale of non-strategic and under-performing assets and has received
approximately $2.8 billion of cash from asset sales, securitization proceeds and
proceeds from LNG monetization. Upon the sale of additional non-strategic and
under-performing assets, the proceeds realized may be materially different than
the book value of those assets. Even though these assets have been identified
for sale, management cannot predict when, nor make any assurances that, these
asset sales will occur. CMS Energy anticipates, however, that the sales, if any,
will result in additional cash proceeds that will be used to retire existing
debt of CMS Energy or Consumers.
In December 2002, CMS Energy reached a definitive agreement to sell the
Panhandle companies to Southern Union Panhandle Corp. The agreement called for
Southern Union Panhandle Corp, a newly formed entity owned by Southern Union
Company and AIG Highstar Capital L.P. to pay $662 million in cash and assume
$1.166 billion in debt. On March 13, 2003, CMS Energy and Southern Union
Company received requests for additional information ("second requests") from
the FTC related to Southern Union's acquisition of Panhandle. CMS Energy and
Southern Union are in the process of responding to the second requests.
On May 12, 2003, the parties entered into an amendment to the original stock
purchase agreement that was executed in December 2002. Under the amendment, AIG
Highstar Capital, L.P. and AIG Highstar II Funding Corp. will no longer be
parties to the transaction. the Amended and Restated Stock Purchase Agreement
calls for Southern Union Panhandle Corp. to purchase all of Panhandle's
outstanding capital stock. Southern Union Panhandle Corp. agreed to pay
approximately $584 million in cash and 3 million shares of Southern Union
Company common stock, and to assume approximately $1.166 billion in debt. The
total value of the transaction to CMS Energy will depend on the price of
Southern Union Company common stock at the closing. At May 12, 2003, the closing
price of Southern Union common stock on the New York Stock Exchange was $12.79.
The boards of directors of all applicable companies have approved the amended
agreement. The sale of Panhandle is subject to customary closing conditions and
action by the Federal Trade Commission under the Hart-Scott-Rodino Act. All
necessary state regulatory approvals for the sale pursuant to the original stock
purchase agreement have been received. The parties expect the amendment will
expedite the regulatory approval of the transaction and anticipate that state
regulatory authorities will not object to the changed terms provided for in the
amended agreement. The closing is expected to occur by June 30, 2003. AIG
Highstar Capital's withdrawal from the transaction should help resolve
regulatory issues that arose as a result of AIG Highstar Capital's ownership of
Southern Star Central Gas Pipeline's Inc. CMS Gas Transmission and Southern
Union also entered into a shareholder agreement, relating to CMS Gas
Transmissions's ownership of the Southern Union shares of common stock. Pursuant
to this shareholder agreement, CMS Gas Transmission generally will be prohibited
from disposing of the Southern Union common stock for a period ending 90 - 105
days following the closing of the transaction.
Under the terms of the Panhandle sale agreement, CMS Energy was to retain
Panhandle's ownership interests in the Centennial and Guardian pipeline
projects, as well as certain of Panhandle's net deferred tax assets, all tax
liabilities, and pension assets and liabilities. Panhandle has since sold its
interest in Centennial and the Guardian interest has been transferred to
Panhandle's direct parent, CMS Gas Transmission, which has signed a definitive
agreement to sell its interest in Guardian. The sale is expected to close in
the second quarter of 2003.
In December 2002, CMS Energy discontinued the operations of Field Services, a
subsidiary of CMS Gas Transmission. In May 2003, CMS Energy signed a definitive
agreement to sell CMS Field Services to Cantera Resources Inc. for $115.5
million cash and $50 million face value note. The note is payable to CMS Energy
for up to $50 million subject to the financial performance of the Fort Union
and Bighorn natural gas gathering systems, from 2004 through 2008.
CMS-21
CMS Energy Corporation
CONSUMERS' ELECTRIC UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric deliveries
(including both full service sales and delivery service to customers who choose
to buy generation service from an alternative electric supplier, but 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 the remaining three quarters of 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
early May 2003, alternative electric suppliers are providing 571 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 for
2000 and $43 million for 2001. 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
CMS-22
CMS Energy Corporation
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 that were excluded from the Stranded Cost
calculation and post-2000 Palisades expenditures.
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
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 is participating 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 Pending Pending
2003 2002 2 2 Pending Pending
==============================================================================================================
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 March 31, 2003, Consumers incurred and deferred as a
regulatory asset, $2 million of additional implementation costs and has also
recorded as a regulatory asset $14 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. As discussed below, Consumers has asked
to include implementation costs through December 31, 2003 in the pending
securitization case. If approved, the sale of Securitization bonds will allow
for the recovery of these costs. 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: In March 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
CMS-23
CMS Energy Corporation
recovery of costs and reduce interest rates associated with financing 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 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 March 31, 2003, outstanding contracts involve approximately
513 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. However, of the original special contracts that have
terminated, contracts for 52 MW have gone to an alternative electric supplier
and contracts for 129 MW have returned to bundled tariff rates.
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 electric and gas revenues. In October 2002,
the MPSC denied waivers for three programs that provided approximately $32
million in gas 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 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 gas 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
CMS-24
CMS Energy Corporation
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 2002, Consumers sold its electric transmission system to MTH, a
non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc.
As a result of the sale, Consumers anticipates its after-tax earnings will be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a 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.
Under an 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.
Consumers is a customer of AEP, holding 300 MW of long-term transmission service
reservations through the AEP transmission system. 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, reserved through
the AEP transmission system. AEP has indicated its intent, and has received
preliminary FERC approval, to turn control of its transmission system over to
the PJM RTO. This will require current AEP wholesale transmission customers to
become members of, and resubmit reservation requests to, PJM. Due to legislation
recently enacted in Virginia, which precludes Virginia utilities (including AEP)
from joining an RTO until at least July 2004, as well as uncertainty associated
with state approvals AEP is seeking from various state regulatory bodies, the
timing of AEP's membership in PJM is currently in some doubt. Upon completion of
the steps necessary for the integration of AEP into PJM, Consumers will complete
the application process to join PJM as a transmission customer.
There are multiple proceedings and a proposed rulemaking pending before the FERC
regarding transmission pricing mechanisms and standard market design for
electric bulk power markets and transmission. The results of these proceedings
and proposed rulemaking could significantly affect the trend of transmission
costs and increase the delivered power costs to Consumers and the retail
electric customers it serves. The specific financial impact on Consumers of such
proceedings, rulemaking and trends are not currently quantifiable.
In addition, 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.
CMS-25
CMS Energy Corporation
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 4, Uncertainties,
"Consumers' Electric Utility Rate Matters - Electric Restructuring" and
"Consumers' Electric Utility 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; 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) potentially rising pension costs due to market losses (as discussed
above in Accounting for Pension and OPEB). For further information about these
trends or uncertainties, see Note 4, Uncertainties.
CONSUMERS' GAS UTILITY 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.
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 bill.
Contemporaneously with this filing, Consumers has requested interim rate relief
in the same amount.
CMS-26
CMS Energy Corporation
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.
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 $36 million in annual
gas revenues, may be restricted by the new code of conduct issued by the MPSC,
as discussed above in Consumers' Electric Utility Business Outlook, "Competition
and Regulatory Restructuring - Code of Conduct."
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; 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) potentially rising
pension costs due to market losses (as discussed above in Accounting for Pension
and OPEB). For further information about these uncertainties, see Note 4,
Uncertainties.
CONSUMERS' OTHER OUTLOOK
SECURITY COSTS: 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 nuclear electric division security costs incurred during the rate
freeze and cap periods imposed by the Customer Choice Act. Of the $4 million in
incremental security costs incurred through December 31, 2002, approximately $3
million related to nuclear security costs. Of the estimated $6 million for
incremental security costs expected to be incurred in 2003, $4 million relates
to nuclear security costs. On February 5, 2003, the MPSC adopted filing
requirements for the recovery of enhanced security costs.
ENTERPRISES OUTLOOK
CMS Energy's IPP subsidiary plans to complete the restructuring of its
operations by narrowing the scope of its existing operations and commitments to
two regions: North America and the Middle East/North Africa. In addition, its
plans include selling designated assets and investments that are
under-performing, non-region
CMS-27
CMS Energy Corporation
focused and non-synergistic with other CMS Energy business units. The
independent power production business unit will continue to optimize the
operations and management of its remaining portfolio of assets in order to
contribute to CMS Energy's earnings and to maintain its reputation for solid
performance in the construction and operation of power plants.
CMS MST has continued to streamline its portfolio in order to reduce its
business risk and outstanding credit guarantees. In January 2003, CMS MST closed
on the sale of a majority of the natural gas trading book inventory to Sempra
Energy Trading and in March 2003, CMS MST sold a majority of its wholesale power
trading portfolio to a unit of Constellation Energy Group, Inc. Also during the
first quarter of 2003, CMS MST sold its 50 percent joint venture ownership
interest in Texon, its 50 percent interest in Premstar and the Tulsa retail
contracts. The company expects the sale of its energy conservation unit, CMS
Viron, to be completed in the second quarter of 2003, however, management cannot
make any assurances as to when this asset sale will actually occur. Upon
completion of these sales, CMS Energy will exit from the energy services and
trading business and future activities will be centered around meeting
contractual obligations, as well as purchasing fuel for and marketing the
merchant power from DIG, Michigan Power, LLC and other IPPs as their current
power purchase agreements expire.
CMS Gas Transmission also plans to narrow its scope of existing operations and
commitments. In doing so, CMS Energy is actively pursuing the sale, liquidation,
or other disposition of certain of its assets and investments, but management
cannot predict when, nor make any assurances that, these asset and investment
sales will occur.
UNCERTAINTIES: The results of operations and financial position of CMS Energy's
diversified energy businesses may be affected by a number of trends or
uncertainties that have, or CMS Energy reasonably expects could have, a material
impact on income from continuing operations, cash flows and balance sheet and
credit improvement. Such trends and uncertainties include: 1) the ability to
sell or optimize assets or businesses in accordance with its financial plan; 2)
the international monetary fluctuations, particularly in Argentina, as well as
Brazil and Australia; 3) the changes in foreign laws, governmental and
regulatory policies that could significantly reduce the tariffs charged and
revenues recognized by certain foreign investments; 4) the imposition of stamp
taxes on certain South American contracts that could significantly increase
project expenses; 5) the impact of any future rate cases or FERC actions or
orders on regulated businesses and the effects of changing regulatory and
accounting related matters resulting from current events; and 6) the impact of
ratings downgrades on CMS Energy's liquidity, costs of operating, and cost of
capital.
OTHER OUTLOOK
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 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
CMS-28
CMS Energy Corporation
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. The FERC issued an order on April 30, 2003 directing eight companies,
including CMS MST, to submit written demonstrations within forty-five days that
they have taken certain specified remedial measures with respect to the
reporting of natural gas trading data to publications that compile and publish
price indices. CMS MST intends to make a written submission within the specified
time period demonstrating compliance with the FERC's directives. Other than the
FERC investigation, CMS Energy is unable to predict the outcome of these
matters, and 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 were filed against CMS Energy, Consumers, and
certain officers and directors of CMS Energy and its affiliates. The complaints
were filed as purported class actions in the United States District Court for
the Eastern District of Michigan. The cases were consolidated into a single
lawsuit and an amended and consolidated class action complaint was filed on May
1, 2003. The defendants named in the amended and consolidated class action
complaint consist of CMS Energy, Consumers, certain officers and directors of
CMS Energy and its affiliates, and certain underwriters of CMS Energy
securities. The purported class period is from May 1, 2000 through and including
March 31, 2003. The amended and consolidated class action complaint seeks
unspecified damages based on allegations that the defendants violated United
States securities laws and regulations by making allegedly false and misleading
statements about CMS Energy's business and financial condition. The companies
intend to vigorously defend against this action but cannot predict the outcome
of this litigation.
DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS: The Board of Directors
received a demand, on behalf of a shareholder of CMS Energy Common Stock, that
it commence civil actions (i) to remedy alleged breaches of fiduciary duties by
CMS Energy officers and directors in connection with round-trip trading at CMS
Energy, and (ii) to recover damages sustained by CMS Energy as a result of
alleged insider trades alleged to have been made by certain current and former
officers of CMS Energy and its subsidiaries. If the Board elects not to commence
such actions, the shareholder has stated that he will initiate a derivative
suit, bringing such claims on behalf of CMS Energy. CMS Energy has elected two
new members to its Board of Directors who will serve as an independent
litigation committee to determine whether it is in the best interest of CMS
Energy to bring the action demanded by the shareholder. Counsel for the
shareholder has agreed to extend the time for CMS Energy to respond to the
demand. CMS Energy cannot predict the outcome of this litigation.
ERISA CLAIMS: CMS Energy is a named defendant, along with Consumers, 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. CMS Energy cannot predict the outcome
of this litigation.
GAS INDEX PRICING REPORTING: CMS Energy has notified appropriate regulatory and
governmental agencies that some employees at CMS MST and CMS Field Services
appeared to have provided inaccurate information regarding natural gas trades to
various energy industry publications which compile and report index prices. CMS
Energy is cooperating with investigations by the Commodity Futures Trading
Commission, Department of Justice and FERC regarding this matter. CMS Energy is
unable to predict the outcome of these matters and what effect, if any, these
investigations will have on its business.
CMS-29
CMS Energy Corporation
OTHER MATTERS
DISCLOSURE AND INTERNAL CONTROLS
CMS Energy's CEO and CFO are responsible for establishing and maintaining CMS
Energy's disclosure controls and procedures. Management, under the direction of
CMS Energy's principal executive and financial officers, has evaluated the
effectiveness of CMS Energy's disclosure controls and procedures within the past
ninety days prior to this filing. Based on this evaluation, CMS Energy's CEO and
CFO have concluded that disclosure controls and procedures are effective to
ensure that material information was presented to them and properly disclosed.
There have been no significant changes in CMS Energy's internal controls or in
factors, other than as discussed below, that could significantly affect internal
controls subsequent to such evaluation.
CONTROL WEAKNESSES AT CMS MST
In late 2001 and during 2002, the Company identified a number of deficiencies in
MST's systems of internal accounting controls. The internal control deficiencies
related to, among other things, a lack of account reconciliations, unidentified
differences between subsidiary ledgers and the general ledger, and procedures
and processes surrounding the Company's accounting for energy trading contracts,
including mark-to-market accounting.
Senior management, the Audit Committee of the Board of Directors, the Board of
Directors, and the independent auditors were notified of these deficiencies as
they were discovered, and the Company commenced a plan of remediation that
included the replacement of certain key personnel and the deployment of
additional internal and external accounting personnel to CMS MST. Certain
aspects of the remediation plan, which includes the implementation of
improvements and changes to CMS MST's internal accounting controls, were
postponed to enable the Company to prepare restated financial statements for
2000 and 2001. While a number of these control improvements and changes were
implemented in late 2002, the most important ones occurred in the first quarter
of 2003.
The implementation of certain elements of its remediation plan enabled the
Company to prepare reliable restated financial statements for CMS MST for
December 31, 2000, 2001 and 2002, as well as for the quarterly periods of 2002.
Management is in the process of preparing restated quarterly financial
statements for 2001.
Management believes that the improvements to its system of internal accounting
controls implemented in late 2002 and the first quarter of 2003 are appropriate
and responsive to the internal control deficiencies that were identified.
Management will continue to monitor the operation of the improved internal
controls to assess their sustained effectiveness through 2003.
CASH MANAGEMENT
In August 2002, FERC issued a NOPR concerning the management of funds by certain
FERC-regulated companies. The proposed rule could establish limits on the amount
of funds that may be swept from a regulated subsidiary to a non-regulated parent
under cash management programs. The proposed rule would require written cash
management arrangements that would specify the duties and restrictions of the
participants, the methods of calculating interest and allocating interest income
and expenses, and the restrictions on deposits or borrowings by money pool
members. These cash management agreements may also require participants to
provide documentation of certain transactions. In the NOPR, FERC proposed that
to participate in a cash management or money pool arrangement, FERC-regulated
entities would be required
CMS-30
CMS Energy Corporation
to maintain a minimum proprietary capital balance (stockholder's equity) of 30
percent and both the FERC-regulated entity and its parent would be required to
maintain investment grade credit ratings. The FERC recently met, but no action
was taken on cash management issues related to the NOPR.
NEW ACCOUNTING STANDARDS
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 CMS Energy, the
consolidation requirements apply to pre-existing entities beginning July 1,
2003. CMS Energy will be required to consolidate any entities that meet the
requirements of the interpretation. CMS Energy is in the process of studying
this interpretation, and has yet to determine the effects, if any, on its
consolidated financial statements.
CMS-31
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2003 2002
- -------------------------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
OPERATING REVENUE
Electric utility $ 650 $ 608
Gas utility 789 616
Enterprises 553 1,038
Other - 1
-----------------------------------
1,992 2,263
- -------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Operation
Fuel for electric generation 94 86
Purchased and interchange power 249 466
Purchased power - related parties 132 140
Cost of gas sold 837 890
Other 194 172
-----------------------------------
1,506 1,754
Maintenance 57 55
Depreciation, depletion and amortization 126 122
General taxes 64 57
-----------------------------------
1,753 1,988
- -------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS)
Electric utility 116 115
Gas utility 103 64
Enterprises 23 85
Other (3) 11
-----------------------------------
239 275
OTHER INCOME (DEDUCTIONS)
Accretion expense (7) (8)
Gain (loss) on asset sales, net (5) 22
Other, net 10 -
-----------------------------------
(2) 14
- -------------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE INTEREST AND TAXES 237 289
- -------------------------------------------------------------------------------------------------------------------
FIXED CHARGES
Interest on long-term debt 97 95
Other interest 6 11
Capitalized interest (2) (3)
Preferred dividends - -
Preferred securities distributions 18 25
-----------------------------------
119 128
- -------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS 118 161
INCOME TAXES 41 68
MINORITY INTERESTS 1 -
-----------------------------------
INCOME FROM CONTINUING OPERATIONS 76 93
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF $15
TAX EXPENSE IN 2003 AND $33 TAX BENEFIT IN 2002 27 (51)
-----------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING 103 42
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING, NET OF $13
TAX BENEFIT IN 2003:
ENERGY TRADING CONTRACTS, EITF 02-03 (NOTE 10) (23) -
ASSET RETIREMENT OBLIGATIONS, SFAS NO. 143 (NOTE 10) (1) -
-----------------------------------
(24) -
NET INCOME $ 79 $ 42
===================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-32
THREE MONTHS ENDED
MARCH 31 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
CMS ENERGY
NET INCOME
Net Income Available to Common Stock $ 79 $ 42
==============================
BASIC EARNINGS PER AVERAGE COMMON SHARE
Income from Continuing Operations $ 0.53 $ 0.70
Income (Loss) from Discontinued Operations 0.18 (0.38)
Loss from Cumulative Effect of Change in Accounting (0.16) -
------------------------------
Net Income Attributable to Common Stock $ 0.55 $ 0.32
==============================
DILUTED EARNINGS PER AVERAGE COMMON SHARE
Income from Continuing Operations $ 0.49 $ 0.70
Income (Loss) from Discontinued Operations 0.16 (0.38)
Loss from Cumulative Effect of Change in Accounting (0.14) -
------------------------------
Net Income Attributable to Common Stock $ 0.51 $ 0.32
==============================
DIVIDENDS DECLARED PER COMMON SHARE $ - $ 0.365
- ---------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-33
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2003 2002
- -------------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 79 $ 42
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $2 and $2, respectively) 126 122
Gain on disposal of discontinued operations (1) -
Capital lease and debt discount amortization 2 4
Deferred income taxes and investment tax credit 27 (245)
Accretion expense 7 8
Undistributed earnings from related parties (31) (36)
(Gain) loss on the sale of assets 5 (22)
Cumulative effect of accounting changes 24 -
Changes in other assets and liabilities:
Decrease (increase) in accounts receivable and accrued revenues (122) 36
Decrease in inventories 241 185
Increase (decrease) in accounts payable and accrued expenses (54) 84
Changes in other assets and liabilities 97 69
-----------------------------
Net cash provided by operating activities 400 247
- -------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (156) (156)
Investments in partnerships and unconsolidated subsidiaries - (16)
Cost to retire property, net (17) (20)
Investment in Electric Restructuring Implementation Plan (2) (3)
Investments in nuclear decommissioning trust funds (2) (2)
Proceeds from nuclear decommissioning trust funds 6 8
Proceeds from sale of assets 97 878
Other investing 21 (42)
-----------------------------
Net cash provided by (used in) investing activities (53) 647
- -------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt 326 311
Issuance of common stock - 42
Retirement of bonds and other long-term debt (170) (912)
Retirement of trust preferred securities - (30)
Payment of common stock dividends - (49)
Decrease in notes payable, net (201) (249)
Payment of capital lease obligations (3) (3)
Other financing (2) (1)
-----------------------------
Net cash used in financing activities (50) (891)
- -------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATES ON CASH 1 (1)
- -------------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH AND TEMPORARY CASH INVESTMENTS 298 2
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 377 127
-----------------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 675 $ 129
=============================================================================================================
CMS-34
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 119 $ 94
Income taxes paid (net of refunds) - (42)
Pension and OPEB cash contribution 18 61
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 8 $ 17
=============================================================================================================
All highly liquid investments with an original maturity of three months or less
are considered cash equivalents.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-35
CMS ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
MARCH 31 MARCH 31
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------
In Millions
PLANT AND PROPERTY (AT COST)
Electric utility $ 7,356 $ 7,523 $ 7,733
Gas utility 2,787 2,719 2,625
Enterprises 527 508 1,172
Other 42 45 61
--------------------------------------------
10,712 10,795 11,591
Less accumulated depreciation, depletion and amortization 5,490 6,110 6,259
--------------------------------------------
5,222 4,685 5,332
Construction work-in-progress 488 549 580
--------------------------------------------
5,710 5,234 5,912
- ----------------------------------------------------------------------------------------------------------------------
INVESTMENTS
Enterprises 781 753 1,172
Midland Cogeneration Venture Limited Partnership 405 388 316
First Midland Limited Partnership 259 255 257
Other 2 2 (4)
--------------------------------------------
1,447 1,398 1,741
- ----------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 675 377 129
Accounts receivable, notes receivable and accrued revenue, less
allowances of $7, $8 and $5, respectively 365 322 275
Accounts receivable - Marketing, services and trading,
less allowances of $9, $8 and $10, respectively 305 248 276
Accounts receivable and notes receivable - related parties 180 187 115
Inventories at average cost
Gas in underground storage 258 491 407
Materials and supplies 93 89 92
Generating plant fuel stock 26 37 50
Assets held for sale 355 644 385
Price risk management assets 95 115 366
Prepayments and other 239 238 168
--------------------------------------------
2,591 2,748 2,263
- ----------------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 678 689 714
Postretirement benefits 180 185 203
Abandoned Midland Project 11 11 11
Other 233 168 171
Assets held for sale 2,042 2,081 2,697
Price risk management assets 172 135 434
Nuclear decommissioning trust funds 529 536 576
Notes receivable - related parties 148 160 213
Notes receivable 126 126 126
Other 428 444 543
--------------------------------------------
4,547 4,535 5,688
--------------------------------------------
TOTAL ASSETS $ 14,295 $ 13,915 $ 15,604
======================================================================================================================
CMS-36
STOCKHOLDERS' INVESTMENT AND LIABILITIES
MARCH 31 MARCH 31
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholders' equity
Common stock, authorized 250.0 shares; outstanding 144.1 shares,
144.1 shares and 134.2 shares, respectively $ 1 $ 1 $ 1
Other paid-in-capital 3,605 3,605 3,299
Other comprehensive loss (737) (753) (263)
Retained deficit (1,641) (1,720) (957)
----------------------------------------------
1,228 1,133 2,080
Preferred stock of subsidiary 44 44 44
Company-obligated convertible Trust Preferred Securities
of subsidiaries (a) 393 393 694
Company-obligated mandatorily redeemable preferred securities
of Consumer's subsidiaries (a) 490 490 490
Long-term debt 5,212 5,356 5,475
Non-current portion of capital leases 121 116 84
----------------------------------------------
7,488 7,532 8,867
- -------------------------------------------------------------------------------------------------------------------------
MINORITY INTERESTS 22 21 24
- -------------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 927 640 736
Notes payable 253 458 164
Accounts payable 350 363 296
Accounts payable - Marketing, services and trading 131 119 211
Accrued interest 108 131 142
Accrued taxes 283 291 111
Accounts payable - related parties 55 53 59
Liabilities held for sale 299 465 603
Price risk management liabilities 95 96 356
Current portion of purchase power contracts 26 26 24
Current portion of gas supply contract obligations 26 25 23
Deferred income taxes 23 15 15
Other 193 216 245
----------------------------------------------
2,769 2,898 2,985
- -------------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Postretirement benefits 732 725 298
Deferred income taxes 377 414 609
Deferred investment tax credit 89 91 100
Regulatory liabilities for income taxes, net 311 297 276
Other regulatory liabilities 152 4 -
Asset retirement obligation 365 - -
Liabilities held for sale 1,298 1,243 1,475
Price risk management liabilities 165 135 341
Gas supply contract obligations 226 241 254
Power purchase agreement - MCV Partnership 21 27 47
Other 280 287 328
----------------------------------------------
4,016 3,464 3,728
- -------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 4 and 5)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 14,295 $ 13,915 $ 15,604
=========================================================================================================================
(a) For further discussion, see Note 5 of the Condensed Notes to Consolidated
Financial Statements.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-37
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2003 2002
- ------------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period $ 1 $ 1
- ------------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 3,605 3,257
Common stock repurchased - -
Common stock reacquired - -
Common stock issued - 42
----------------------------
At end of period 3,605 3,299
- ------------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (241) -
Unrealized gain (loss) on investments (a) - -
----------------------------
At end of period (241) -
----------------------------
Investments
At beginning of period 2 (5)
Unrealized gain (loss) on investments (a) - -
----------------------------
At end of period 2 (5)
----------------------------
Derivative Instruments (b)
At beginning of period (56) (31)
Unrealized gain (loss) on derivative instruments (a) 8 12
Reclassification adjustments included in consolidated net income (a) (5) 2
----------------------------
At end of period (53) (17)
- ------------------------------------------------------------------------------------------------------------------
FOREIGN CURRENCY TRANSLATION
At beginning of period (458) (233)
Change in foreign currency translation (a) 13 (8)
----------------------------
At end of period (445) (241)
- ------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS (DEFICIT)
At beginning of period (1,720) (951)
Consolidated net income (a) 79 42
Common stock dividends declared - (48)
----------------------------
At end of period (1,641) (957)
----------------------------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 1,228 $ 2,080
==================================================================================================================
(a) Disclosure of Comprehensive Income (Loss):
Other Comprehensive Income
Minimum Pension Liability
Minimum pension liability adjustments, net of tax of
$- and $-, respectively $ - $ -
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $(5) and $(3), respectively 8 12
Reclassification adjustments included in net income,
net of tax of $3 and $(1), respectively (5) 2
Foreign currency translation, net 13 (8)
Net income 79 42
----------------------------
Total Comprehensive Income $ 95 $ 48
============================
(b) Included in these amounts is CMS Energy's proportionate share of the
effects of derivative accounting related to its equity investment in the
MCV Partnership and Taweelah as follows:
MCV Partnership:
At the beginning of the period $ 8 $ (8)
Unrealized gain (loss) on derivative instruments 7 5
Reclassification adjustments included in net income (4) 2
----------------------------
At the end of the period $ 11 $ (1)
============================
Taweelah:
At the beginning of the period $ (32) $ -
Unrealized gain (loss) on derivative instruments - -
----------------------------
At the end of the period $ (32) $ -
============================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-38
CMS Energy Corporation
CMS ENERGY CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by CMS Energy
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. As such, certain information and footnote
disclosures normally included in full year financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. Certain prior year amounts have been
reclassified to conform to the presentation in the current year. In management's
opinion, the unaudited information contained in this report reflects all
adjustments necessary to assure the fair presentation of financial position,
results of operations and cash flows for the periods presented. The Condensed
Notes to Consolidated Financial Statements and the related Consolidated
Financial Statements should be read in conjunction with the Consolidated
Financial Statements and Notes to Consolidated Financial Statements contained in
CMS Energy's Form 10-K for the year ended December 31, 2002, which includes the
Reports of Independent Auditors. Due to the seasonal nature of CMS Energy's
operations, the results as presented for this interim period are not necessarily
indicative of results to be achieved for the fiscal year.
1: CORPORATE STRUCTURE AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CORPORATE STRUCTURE: CMS Energy is the parent holding company of Consumers and
Enterprises. Consumers is a combination electric and gas utility company serving
Michigan's Lower Peninsula. Enterprises, through subsidiaries, is engaged in
domestic and international diversified energy businesses including: natural gas
transmission, storage and processing; independent power production; and energy
marketing, services and trading.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of CMS Energy, Consumers and Enterprises and their majority-owned
subsidiaries. Investments in affiliated companies where CMS Energy has the
ability to exercise significant influence, but not control are accounted for
using the equity method. Intercompany transactions and balances have been
eliminated.
USE OF ESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
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 it is probable
that a loss will be paid in the future as a result of a current event, and when
an amount can be reasonably estimated. CMS Energy has used this accounting
principle to record estimated liabilities as discussed in Note 4, Uncertainties.
REVENUE RECOGNITION POLICY: Revenues from deliveries of electricity and the
transportation and storage of natural gas are recognized as services are
provided. Revenues on sales of marketed electricity, natural gas, and other
energy products, as well as natural gas and LNGs, are recognized at delivery.
Revenues on sales of oil and natural gas produced are recognized when production
occurs, a sale is completed, and the risk of loss transfers to a third-party
purchaser. Mark-to-market changes in the fair value of energy trading contracts
that qualify as derivatives are recognized as revenues in the periods in which
the changes occur.
CMS-39
CMS Energy Corporation
CAPITALIZED INTEREST: SFAS No. 34 requires capitalization of interest on certain
qualifying assets that are undergoing activities to prepare them for their
intended use. SFAS No. 34 limits the capitalization of interest for the period
to the actual interest cost that is incurred and prohibits imputing interest
costs on any equity funds. The nonregulated portions of CMS Energy are subject
to these rules. The regulated businesses of CMS Energy are permitted to
capitalize an allowance for funds used during construction on regulated
construction projects and to include such amounts in plant in service.
EARNINGS PER SHARE: Basic and diluted earnings per share are based on the
weighted average number of shares of common stock and potential common stock
outstanding during the period. Potential common stock, for purposes of
determining diluted earnings per share, includes the effects of dilutive stock
options and convertible securities. The effect of such potential common stock is
computed using the treasury stock method or the if-converted method, as
applicable. For earnings per share computation, see Note 6.
FINANCIAL INSTRUMENTS: CMS Energy 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. CMS Energy's investments in equity securities are
classified as available-for-sale securities. They are reported at fair value,
with any unrealized gains or losses from changes in fair value usually reported
in equity as part of other comprehensive income and excluded from earnings
unless such changes in fair value are other than temporary. Unrealized gains or
losses from changes in the fair value of Consumers' nuclear decommissioning
investments are reported as regulatory liabilities. The fair value of these
investments is determined from quoted market prices.
FOREIGN CURRENCY TRANSLATION: CMS Energy's subsidiaries and affiliates whose
functional currency is other than the U.S. dollar translate their assets and
liabilities into U.S. dollars at the current exchange rates in effect at the end
of the fiscal period. The revenue and expense accounts of such subsidiaries and
affiliates are translated into U.S. dollars at the average exchange rates that
prevailed during the period. The gains or losses that result from this process,
and gains and losses on intercompany foreign currency transactions that are
long-term in nature, and which CMS Energy does not intend to settle in the
foreseeable future, are shown in the stockholders' equity section of the balance
sheet. For subsidiaries operating in highly inflationary economies, the U.S.
dollar is considered to be the functional currency, and transaction gains and
losses are included in determining net income. Gains and losses that arise from
exchange rate fluctuations on transactions denominated in a currency other than
the functional currency, except those that are hedged, are included in
determining net income. For the three months ended March 31, 2003 and 2002, the
change in the foreign currency translation adjustment increased equity by $13
million and decreased equity by $8 million, respectively, net of after-tax
hedging proceeds.
IMPAIRMENT OF INVESTMENTS AND LONG-LIVED ASSETS: In accordance with APB Opinion
No. 18 and SFAS No. 144, CMS Energy evaluates the potential impairment of its
investments in projects and other long-lived assets, other than goodwill, based
on various analyses, including the projection of undiscounted cash flows,
whenever events or changes in circumstances indicate that the carrying amount of
the assets may not be recoverable. If the carrying amount of the investment or
asset exceeds the amount of the expected future undiscounted cash flows, an
impairment loss is recognized and the investment or asset is written down to its
estimated fair value.
PLANT AND PROPERTY: Plant and Property, including improvements, is stated at
cost. Construction-related labor and material costs, as well as indirect
construction costs such as engineering and interest costs, are capitalized.
Property repairs, minor property replacements and maintenance are charged to
maintenance expense as incurred. When depreciable plant and property maintained
by CMS Energy's regulated operations are retired or sold, the original cost plus
cost of removal (net of salvage credits), is charged to accumulated
depreciation.
CMS-40
CMS Energy Corporation
STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure. 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 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. In the fourth quarter
of 2002, CMS Energy adopted the fair value method of accounting for stock-based
compensation under SFAS No. 123 as amended by SFAS No. 148, applying the
prospective method. If compensation cost for stock options had been determined
in accordance with SFAS No. 123 for the three months ended March 31, 2002,
consolidated net income as reported and pro forma would have been as follows:
In Millions, Except Per Share Amounts
- ----------------------------------------------------------------------------------------------------------
Three Months Ended March 31 2002 Basic Diluted
- ----------------------------------------------------------------------------------------------------------
Net income, as reported $ 42 $0.32 $0.32
Add: Stock-based employee compensation expense included
In reported net income, net of taxes - - -
Deduct: Total stock-based compensation expense determined
Under fair value based method for all awards, net of tax (2) (0.02) (0.01)
- ----------------------------------------------------------------------------------------------------------
Pro forma net income $ 40 $0.30 $0.31
==========================================================================================================
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.
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 March 31, 2003, Consumers had
a net investment in energy supply facilities of $1.554 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 beginning in the fourth quarter of
CMS-41
CMS Energy Corporation
2002, including regulatory accounting treatment of costs required to be
recognized in accordance with SFAS No. 143. See Note 4, Uncertainties,
"Consumers' Electric Utility 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.
NEW ACCOUNTING STANDARDS:
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 CMS Energy, 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. CMS Energy will be required to
consolidate any entities that meet the requirements of the interpretation. CMS
Energy is in the process of studying this interpretation, and has yet to
determine the effects, if any, on its consolidated financial statements.
2. ASSET SALES AND RESTRUCTURING
CMS Energy continues to implement its financial improvement plan and on-going
asset sales program that was initiated in late 2001. The asset sales program
encompasses the sale of all non-strategic and under-performing assets. The
impacts of these sales are included in "Gain (loss) on asset sales, net" in the
Consolidated Statements of Income.
ASSET SALES
In January 2003, CMS Energy closed on the sale of a substantial portion of CMS
MST's wholesale natural gas trading contracts and inventory to Sempra Energy
Trading, the wholesale commodity trading unit of Sempra Energy and received $17
million of cash proceeds. In February 2003, Panhandle sold its one-third
interest in Centennial Pipeline, LLC for $40 million to Centennial's two other
partners, Marathon Ashland Petroleum, LLC and TE Products Pipeline Company,
Limited Partner, through its general partner, Texas Eastern Products Pipeline
Company. In March 2003, CMS MST sold a majority of its wholesale power book and
related supply portfolio for $34 million cash proceeds to Constellation Power
Source, Inc. The sale contains a potential to increase proceeds to $40 million
in 2006 dependent upon future years' performance of the sold contracts. In
addition, during the first quarter of 2003, CMS MST sold its 50 percent joint
venture ownership interest in Texon, its 50 percent interest in Premstar and its
Tulsa retail contracts, resulting in net cash proceeds of approximately $6
million.
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
Proceeds from this transaction were used primarily to retire existing debt.
Included in the sale were all of CMS Oil and Gas' oil and gas reserves in
Equatorial Guinea and CMS Gas Transmission's ownership interest in the related
methanol plant. The gain on the methanol plant of $21 million ($14 million, net
of tax) is included in "Gain (loss) on asset sales, net" in the accompanying
Consolidated Statements of Income. The gain was subsequently adjusted during the
finalization of the sales agreement in June 2002 to $18 million ($12 million,
net of tax). The gain on the sale of CMS Oil & Gas' Equatorial Guinea properties
of $497 million ($310 million, net of tax) is included in discontinued
operations in 2002.
CMS-42
CMS Energy Corporation
In Millions
- ----------------------------------------------------------------------------------------
Pre-tax After-tax Pre-tax After-tax
2003 2003 2002 2002
- ----------------------------------------------------------------------------------------
Asset Sales - Gain (Loss):
Marketing, Services and Trading $(5) $(3) $ - $ -
Natural Gas Transmission - - 21 14
Other - - 1 -
-----------------------------------------------------------------------------------
Total Gain (Loss) on Asset Sales $(5) $(3) $ 22 $ 14
========================================================================================
RESTRUCTURING AND OTHER COSTS
CMS Energy announced in June 2002 a series of new initiatives intended to
sharpen its business focus and help restore its financial health by reducing
operating costs by an estimated $50 million annually. The initiatives announced
included the following:
o Relocating CMS Energy's corporate headquarters from Dearborn, Michigan
to a new combined CMS Energy and Consumers headquarters building then
under construction in Jackson, Michigan. The Jackson headquarters
building opened in March 2003 and will house an estimated 1,450 CMS
Energy and Consumers Energy employees. The relocation will ultimately
reduce corporate operating expenses.
o Implementing changes to CMS Energy's 401(K) savings program which
provided additional savings for CMS Energy and enhanced investment
options for employee participants.
o Implementing changes to CMS Energy's health care plan in order to keep
benefits and costs competitive.
o Terminating five officers, 18 CMS Field Services employees and 41 CMS
MST trading group employees. Prior to December 31, 2002, 31
Dearborn-based employees and 92 Houston employees elected severance
arrangements. Of these 187 officers and employees, 65 had been
terminated as of December 31, 2002. The remaining terminations will be
completed in 2003.
The following table shows the amount charged to expense for restructuring costs,
the payments made, and the unpaid balance of accrued costs at March 31, 2003 and
2002.
In Millions
- ------------------------------------------------------------------------------------------
March 31, 2003
- ------------------------------------------------------------------------------------------
Involuntary Lease
Termination Termination Total
- ------------------------------------------------------------------------------------------
Beginning accrual balance, January 1, 2003 $ 12 $ 8 $ 20
Expense 1 - 1
Payments (5) - (5)
- ------------------------------------------------------------------------------------------
Ending accrual balance $ 8 $ 8 $ 16
==========================================================================================
Restructuring costs for the three months ended March 31, 2003, which are
included in operating expenses, include $1 million of involuntary employee
termination benefits.
In addition, in the first half of 2003, restructuring costs related to
relocating employees and other headquarters expenses are expected to be $2
million. The relocation will occur between March and July 2003, and such costs
will be expensed as incurred.
CMS-43
CMS Energy Corporation
3: DISCONTINUED OPERATIONS
In accordance with SFAS No. 144, discontinued operations include components of
entities or entire entities that, through disposal transactions, will be
eliminated from the ongoing operations of CMS Energy. The assets and liabilities
of these entities were measured at the lower of the carrying value or the fair
value less cost to sell as required by SFAS No. 144. A description of the
entities included in discontinued operations is as follows:
In September 2001, CMS Energy discontinued the operations of the International
Energy Distribution segment. CMS Energy is actively seeking a buyer for the
assets of CMS Electric and Gas, and although the timing of this sale is
difficult to predict, nor can it be assured, management expects the sale to
occur in 2003.
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
Included in the sale were all of CMS Oil and Gas' oil and gas reserves in
Equatorial Guinea and CMS Gas Transmission's ownership interest in the related
methanol plant. The gain on the CMS Oil & Gas Equatorial Guinea properties of
$497 million ($310 million, net of tax) is included in discontinued operations.
In the first quarter of 2003, CMS Energy settled a liability with the purchaser
of Equatorial Guinea and reversed the remaining excess reserve. This transaction
resulted in a gain of $6 million, net of tax, which is included in discontinued
operations in 2003.
In May 2002, CMS closed on the sale of CMS Oil and Gas' coalbed methane holdings
in the Powder River Basin to XTO Energy. The Powder River properties were
included in discontinued operations for the first four months of 2002, including
a gain on the sale of $20 million ($11 million net of tax).
In June 2002, CMS Energy abandoned the Zirconium Recovery Project, which was
initiated in January 2000. The purpose of the project was to extract and sell
uranium and zirconium from a pile of caldesite ore held by the Defense Logistic
Agency of the U.S. Department of Defense. After evaluating future cost and risk,
CMS Energy decided to abandon this project and recorded a $31 million after-tax
loss in discontinued operations.
In June 2002, CMS Energy announced its plan to sell CMS MST's energy performance
contracting subsidiary, CMS Viron. CMS Viron enables building owners to improve
their facilities with equipment upgrades and retrofits and finance the work with
guaranteed energy and operational savings. At December 31, 2002, after
evaluating all of the relevant facts and circumstances including third-party bid
data and liquidation analysis, an impairment charge of $6 million, net of tax,
was reflected as an estimated loss on discontinued operations in accordance with
the provisions of SFAS No. 144. The provisions limited the impairment charge to
the book value of the noncurrent assets of CMS Viron at that time and there have
not been any additional impairment charges recorded during the first quarter of
2003. Although the timing of this sale is difficult to predict, nor can it be
assured, management expects the sale to occur in the second quarter of 2003.
In December 2002, CMS Energy reached a definitive agreement to sell the
Panhandle companies to Southern Union Panhandle Corp. The agreement called for
Southern Union Panhandle Corp, a newly formed entity owned by Southern Union
Company and AIG Highstar Capital L.P. to pay $662 million in cash and assume
$1.166 billion in debt. On March 13, 2003, CMS Energy and Southern Union Company
received requests for additional information ("second requests") from the FTC
related to Southern Union's acquisition of Panhandle. CMS Energy and Southern
Union are in the process of responding to the second requests.
On May 12, 2003, the parties entered into an amendment to the original stock
purchase agreement that was executed in December 2002. Under the amendment, AIG
Highstar Capital, L.P. and AIG Highstar II Funding Corp. will no longer be
parties to the transaction. The Amended and Restated Stock Purchase Agreement
calls for Southern Union Panhandle Corp. to purchase all of Panhandle's
outstanding capital stock. Southern Union Panhandle Corp. agreed to pay
approximately $584 million in cash and 3 million shares of Southern Union
Company common stock, and to assume approximately $1.166 billion in debt. The
total value of the transaction to CMS Energy will depend on the price of
Southern Union Company common stock at the closing. At May 12, 2003, the closing
price of Southern Union common stock on the New York Stock Exchange was $12.79.
The boards of directors of all applicable companies have approved the amended
agreement. The sale of Panhandle is subject to customary closing conditions and
action by the Federal Trade Commission under the Hart-Scott-Rodino Act. All
necessary state regulatory approvals for the sale pursuant to the original stock
purchase agreement have been received. The parties expect the amendment will
expedite the regulatory approval of the transaction and anticipate that state
regulatory authorities will not object to the changed terms provided for in the
amended agreement. The closing is expected to occur by June 30, 2003. AIG
Highstar Capital's withdrawal from the transaction should help resolve
regulatory issues that arose as a result of AIG Highstar Capital's ownership of
Southern Star Central Gas Pipeline's Inc. CMS Gas Transmission and Southern
Union also entered into a shareholder agreement, relating to CMS Gas
Transmission's ownership of the Southern Union shares of common stock. Pursuant
to this shareholder agreement, CMS Gas Transmission generally will be prohibited
from disposing of the Southern Union common stock for a period ending 90 - 105
days following the closing of the transaction.
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CMS Energy Corporation
In December 2002, CMS Energy discontinued the operations of Field Services, a
subsidiary of CMS Gas Transmission. In May 2003, CMS Energy signed a definitive
agreement to sell CMS Field Services to Cantera Resources Inc. for $115.5
million cash and a $50 million face value note. The note is payable to CMS
Energy for up to $50 million subject to the financial performance of the Fort
Union and Bighorn natural gas gathering systems, from 2004 through 2008.
The summary of balance sheet information below represents those entities that
are still in the disposal process, including Panhandle, CMS Viron, Field
Services, International Energy Distribution, and the Zirconium Recovery Project.
The assets and liabilities of the discontinued operations are shown as separate
components in the consolidated balance sheets of CMS Energy.
- --------------------------------------------------------------------------------
In Millions
March 31 2003 2002
- --------------------------------------------------------------------------------
Assets
Cash $ 65 $ 32
Accounts receivable, net 188 237
Materials and supplies 38 84
Other 64 32
--------------------------------------------------------------------------
Total current assets held for sale $ 355 $ 385
Property, plant and equipment, net $1,819 $2,378
Unconsolidated investments 20 90
Goodwill 140 152
Other 63 77
--------------------------------------------------------------------------
Total non current assets held for sale $2,042 $2,697
- -------------------------------------------------------------------------------
Liabilities
Accounts payable $ 112 $ 211
Current portion of long-term debt 2 5
Accrued taxes - 198
Other current liabilities 185 189
--------------------------------------------------------------------------
Total current liabilities held for sale $ 299 $ 603
Long-term debt $1,152 $1,286
Minority interest 64 93
Other non current liabilities 82 96
---------------------------------------------------------------------------
Total non current liabilities held for sale $1,298 $1,475
- --------------------------------------------------------------------------------
Revenues from such operations were $314 million and $276 million for the three
months ended March 31, 2003 and 2002, respectively. In accordance with SFAS No.
144, the net income (loss) of the operations is included in the consolidated
statements of income under "discontinued operations". The income (loss) related
to discontinued operations includes a reduction in asset values, a provision for
anticipated closing costs, and a portion of CMS Energy's interest expense.
Interest expense of $11 million and $20 million for three months ended March 31,
2003 and 2002, respectively, has been allocated to discontinued operations based
on the ratio of total capital of each discontinued operation to that of CMS
Energy. See the table below for income statement components of the discontinued
operations.
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In Millions
- --------------------------------------------------------------------------------
Three months ended March 31 2003 2002
- --------------------------------------------------------------------------------
Discontinued operations:
Income (loss) from discontinued operations, net of tax $ 25 $(51)
of $15 and tax benefit of $33
Gain on disposal of discontinued operations, net of tax
of $1 and tax of $0.4 2 -
- --------------------------------------------------------------------------------
Total $ 27 $(51)
================================================================================
4: UNCERTAINTIES
Several business trends or uncertainties may affect CMS Energy's financial
results. These trends or uncertainties have, or CMS Energy reasonably expects
could have, a material impact on net sales, revenues, or income from continuing
operations. Such trends and uncertainties are discussed in detail below.
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 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. The FERC issued an order on April 30, 2003
directing eight companies, including CMS MST, to submit written demonstrations
within forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST intends to make a written submission
within the specified time period demonstrating compliance with the FERC's
directives. Other than the FERC investigation, CMS Energy is unable to predict
the outcome of these matters, and 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 were filed against CMS Energy, Consumers, and
certain officers and directors of CMS Energy and its affiliates. The complaints
were filed as purported class actions in the United States District Court for
the Eastern District of Michigan. The cases were consolidated into a single
lawsuit and an amended and consolidated class action complaint was filed on May
1, 2003. The defendants named in the amended and consolidated class action
complaint consist of CMS Energy, Consumers, certain officers and directors of
CMS
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Energy and its affiliates, and certain underwriters of CMS Energy securities.
The purported class period is from May 1, 2000 through and including March 31,
2003. The amended and consolidated class action complaint seeks unspecified
damages based on allegations that the defendants violated United States
securities laws and regulations by making allegedly false and misleading
statements about CMS Energy's business and financial conditions. The companies
intend to vigorously defend against this action but cannot predict the outcome
of this litigation.
DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS: The Board of Directors
received a demand, on behalf of a shareholder of CMS Energy Common Stock, that
it commence civil actions (i) to remedy alleged breaches of fiduciary duties by
CMS Energy officers and directors in connection with round-trip trading at CMS
MST, and (ii) to recover damages sustained by CMS Energy as a result of alleged
insider trades alleged to have been made by certain current and former officers
of CMS Energy and its subsidiaries. If the Board elects not to commence such
actions, the shareholder has stated that he will initiate a derivative suit,
bringing such claims on behalf of CMS Energy. CMS Energy has elected two new
members to its Board of Directors who will serve as an independent litigation
committee to determine whether it is in the best interest of CMS Energy to bring
the action demanded by the shareholder. Counsel for the shareholder has agreed
to extend the time for CMS Energy to respond to the demand. CMS Energy cannot
predict the outcome of this litigation.
ERISA CLAIMS: CMS Energy is a named defendant, along with Consumers, 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. CMS Energy cannot predict the outcome
of this litigation.
GAS INDEX PRICING REPORTING: CMS Energy has notified appropriate regulatory and
governmental agencies that some employees at CMS MST and CMS Field Services
appeared to have provided inaccurate information regarding natural gas trades to
various energy industry publications which compile and report index prices. CMS
Energy is cooperating with investigations by the Commodity Futures Trading
Commission, Department of Justice and FERC regarding this matter. CMS Energy is
unable to predict the outcome of these matters and what effect, if any, these
investigations will have on its business.
FEES AND EXPENSES: CMS Energy has accrued $15 million for attorney's fees and
costs associated with responding to and/or defending against investigations and
lawsuits related to round-trip trading and the reporting of gas prices to trade
publications. These expenses could total as much as $37 million. CMS Energy
expects to recover a significant portion of these expenses from insurers.
CONSUMERS' ELECTRIC UTILITY CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental regulations. Consumers expects that the cost of future
environmental compliance, especially compliance with clean air laws, will be
significant.
Clean Air - In 1998, the EPA issued regulations requiring the state of Michigan
to further limit nitrogen oxide emissions. The Michigan Department of
Environmental Quality finalized rules to comply with the EPA 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 regulations
regarding nitrogen oxide emissions that require certain generators, including
some of Consumers' electric generating facilities, to achieve the same emissions
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CMS Energy Corporation
rate as that required by the 1998 regulations. The EPA and the state regulations
require Consumers to make significant capital expenditures estimated to be $770
million. As of March 31, 2003, Consumers has incurred $420 million in capital
expenditures to comply with the EPA 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 and
their price could change significantly. 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.
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 March
31, 2003, 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.
CONSUMERS' ELECTRIC UTILITY 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 (On March 31, 2003, Consumers filed an
application with the MPSC that seeks confirmation that Consumers is in
compliance with the market power test set forth in the Customer Choice Act); 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 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.
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CMS Energy Corporation
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: The Customer Choice Act allows for the use of low-cost
Securitization bonds to refinance certain qualified costs, as defined by the
act. Securitization typically involves issuing asset-backed bonds with a higher
credit rating than conventional utility corporate financing. In 2000 and 2001,
the MPSC issued orders authorizing Consumers to issue Securitization bonds.
Consumers issued its first Securitization bonds in 2001. 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. The Securitization 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.
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. 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, $13 million for the
three months ended March 31, 2003, and $12 million for the three months ended
March 31, 2002, are remitted to a trustee for the Securitization bonds.
Securitization charge collections are dedicated for the repayment of the
principal 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.
In March 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 and reduce interest rates
associated with financing 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.
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CMS Energy Corporation
TRANSMISSION: In 2002, Consumers sold its electric transmission system (METC) to
MTH, a non-affiliated limited partnership whose general partner is a subsidiary
of Trans-Elect Inc.
As a result of the sale, Consumers anticipates its after-tax earnings will be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a 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.
Under an 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.
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
did not include interest since the associated interconnection agreements did not
at that time provide for interest. MTH had asserted that Consumers might be
liable for interest on the IPP payments to be credited if interest provisions
were added to these agreements. However, in January 2003, the FERC changed and
clarified its approach to contracts that were entered into before the FERC
started allowing the crediting of interest, and as a result, Consumers believes
that there is no longer any such potential liability under the current FERC
policy.
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 supply
resources equal to 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 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 early May 2003, alternative electric
suppliers are providing 571 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 and energy contracts for the
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physical delivery of electricity primarily in the summer months and to a lesser
degree in the winter months. As of March 31, 2003, Consumers had purchased or
had commitments to purchase electric call option and capacity and energy
contracts partially covering the estimated reserve margin requirements for 2003
through 2007. As a result, Consumers has a recognized asset of $28 million for
unexpired call options and capacity and energy contracts. The total cost of
electricity call option and capacity and energy contracts for 2003 is expected
to be approximately $9 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 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 for
2000 and $43 million for 2001. 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 that were excluded
from the Stranded Cost calculation and post-2000 Palisades expenditures.
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
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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 is participating 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 Pending Pending
2003 2002 2 2 Pending Pending
================================================================================
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 March 31, 2003, Consumers incurred and deferred as a
regulatory asset, $2 million of additional implementation costs and has also
recorded as a regulatory asset $14 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. As discussed above, Consumers has asked
to include implementation costs through December 31, 2003 in the pending
securitization case. If approved, the sale of Securitization bonds will allow
for the recovery of these costs. 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 refund obligation. As of April 2003, Consumers had
paid $19 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
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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.
OTHER CONSUMERS' ELECTRIC UTILITY UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990 and to supply electricity and steam to Dow. Consumers,
through two wholly owned subsidiaries, holds the following assets related to the
MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general
partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through
FMLP, a 35 percent lessor interest in the MCV Facility.
Consumers' consolidated retained earnings includes undistributed earnings from
the MCV Partnership, which at March 31, 2003 and 2002 are $233 million and $187
million, respectively.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- -------------------------------------------------------------------------------
March 31 2003 2002
- -------------------------------------------------------------------------------
Operating income $16 $9
Income taxes and other 5 3
- -------------------------------------------------------------------------------
Net income $11 $6
===============================================================================
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the term of
the PPA ending 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 and a fixed energy charge, and also to pay 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 regulatory out 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 March 31, 2003 and 2002, the remaining after-tax present value
of the estimated future PPA liability associated with the loss totaled $30
million and $46 million, 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,
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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 payments made on the basis of
availability that may be billed by the MCV Partnership at a maximum 98.5 percent
availability level. When Consumers returns, as expected, to unfrozen rates
beginning in 2004, Consumers will recover from customers capacity and fixed
energy charges on the basis of availability, to the extent that availability
does not exceed 88.7 percent availability established in previous MPSC orders.
For capacity and energy 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. The regulatory out provision relieves Consumers of
the obligation to pay more for capacity and energy payments than the MPSC allows
Consumers to collect from its customers. Consumers estimates 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. 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:
In Millions
- ----------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ----------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 $36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $ - $ - $ -
==============================================================================================
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
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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 31, 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 March 31, 2003, Consumers had loaded 18 dry
casks with spent nuclear fuel at Palisades. Palisades will need to load
additional dry casks by the fall of 2004 in order to continue operation.
Palisades currently has three empty storage-only dry casks on-site, with storage
pad capacity for up to seven additional loaded dry casks. Consumers anticipates
that licensed transportable dry casks for additional storage, along with more
storage pad capacity, will be available prior to 2004.
In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to begin
accepting deliveries of spent nuclear fuel for disposal by January 31, 1998.
Subsequent U.S. Court of Appeals 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 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, including Consumers, which filed
its complaint in December 2002. The Chief Judge of the Court of Claims
identified six lead cases to be used as vehicles for resolving dispositive
motions. Consumers' case is not a lead case. It is unclear what impact this
decision by the Chief Judge will have on the outcome of Consumers' litigation.
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.
As of March 31, 2003, 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.
On March 26, 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumer Federation submitted a
complaint which was served on Consumers by the MPSC on April 18, 2003, that asks
the MPSC to commence a generic investigation and contested case to review all
facts and issues concerning costs associated with spent nuclear fuel storage and
disposal. The complaint seeks a variety of relief with respect to Consumers
Energy, The Detroit Edison Company, Indiana & Michigan Electric Company,
Wisconsin Electric Power Company and Wisconsin Public Service Corporation,
including establishing 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 related to the storage and disposal of spent
nuclear fuel. Consumers is reviewing the complaint and, at this time, is unable
to predict the outcome of this matter.
In July 2002, Congress approved and the President signed a bill designating the
site at Yucca Mountain,
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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 March 2002, corrosion problems were discovered in
the reactor head at an unaffiliated nuclear power plant in Ohio. As a result,
the NRC requested that all United States nuclear plants utilizing pressurized
water reactors to provide reports detailing their reactor head inspection
histories, design capabilities and future inspection plans. In response to the
issues identified at this and other nuclear plants worldwide, a bare metal
visual inspection was completed on the Palisades reactor vessel head during the
spring 2003 refueling outage. No indication of leakage was detected on any of
the 54 penetrations.
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.
CONSUMERS' GAS UTILITY CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at sites as studies are completed. Consumers has
estimated its costs related to 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
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discounted 2001 costs and follow EPA recommended use of discount rates between
three and seven percent for this type of activity. Consumers expects to fund a
significant portion of these costs through insurance proceeds and through MPSC
approved rates charged to its customers. As of March 31, 2003, Consumers has an
accrued liability of $49 million, net of $33 million of expenditures incurred to
date, and a regulatory asset of $69 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.
CONSUMERS' GAS UTILITY RATE MATTERS
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 increased its maximum GCR factor in May 2003, based on a formula that
tracks increases in NYMEX prices.
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 include 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 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 CONSUMERS' UNCERTAINTIES
SECURITY COSTS: 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
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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 nuclear electric division security costs incurred during the rate
freeze and cap periods imposed by the Customer Choice Act. Of the $4 million in
incremental security costs incurred through December 31, 2002, approximately $3
million related to nuclear security costs. Of the estimated $6 million for
incremental security costs expected to be incurred in 2003, $4 million relates
to nuclear security costs. On February 5, 2003, the MPSC adopted filing
requirements for the recovery of enhanced security costs.
OTHER UNCERTAINTIES
CMS GENERATION-OXFORD TIRE RECYCLING: In 1999, the California Regional Water
Control Board of the State of California named CMS Generation as a potentially
responsible party for the cleanup of the waste from a fire that occurred in
September 1999 at the Filbin tire pile. The tire pile was maintained as fuel for
an adjacent power plant owned by Modesto Energy Limited Partnership. Oxford Tire
Recycling of Northern California, Inc., a subsidiary of CMS Generation until
1995, owned the Filbin tire pile. CMS Generation has not owned an interest in
Oxford Tire Recycling of Northern California, Inc. or Modesto Energy Limited
Partnership since 1995. In 2000, the California Attorney General filed a
complaint against the potentially responsible parties for cleanup of the site
and assessed penalties for violation of the California Regional Water Control
Board order. The parties have reached a settlement with the state, which the
court approved, pursuant to which CMS Energy had to pay $6 million. At the
request of the U.S. Department of Justice in San Francisco (DOJ), CMS Energy and
other parties contacted by the DOJ entered into separate tolling agreements with
the DOJ in September 2002 that stopped the running of any statute of limitations
until March 14, 2003 (later extended to June 30, 2003) to facilitate the
settlement discussions between all the parties in connection with federal claims
arising from the fire at the Filbin tire pile. On September 23, 2002, CMS Energy
received a written demand from the U.S. Coast Guard for reimbursement of
approximately $3.5 million in costs incurred by the U.S. Coast Guard in fighting
the fire.
In connection with this fire, several class action lawsuits were filed claiming
that the fire resulted in damage to the class and that management of the site
caused the fire. CMS Generation has reached a settlement in principle with the
plaintiffs in the amount of $9 million. The primary insurance carrier will cover
100 percent of the settlement once the agreement is finalized.
DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel (DFD)
presented DIG with a change order to their construction contract and filed an
action in Michigan state court claiming damages in the amount of $110 million,
plus interest and costs, which DFD states represents the cumulative amount owed
by DIG for delays DFD believes DIG caused and for prior change orders that DIG
previously rejected. DFD also filed a construction lien for the $110 million.
DIG, in addition to drawing down on three letters of credit totaling $30 million
that it obtained from DFD, has filed an arbitration claim against DFD asserting
in excess of an additional $75 million in claims against DFD. The judge in the
Michigan State Court case entered an order staying DFD's prosecution of its
claims in the court case and permitting the arbitration to proceed. DFD has
appealed the decision by the judge in the Michigan state court case to stay the
arbitration. DIG will continue to vigorously defend itself and pursue its
claims. DIG cannot predict the outcome of this matter.
DIG CUSTOMER DISPUTES: As a result of the continued delays in the DIG project
becoming fully operational, DIG's customers, Ford Motor Company and Rouge
Industries, have asserted claims that the continued delays relieve them of
certain contractual obligations totaling $43 million. In addition, Ford and/or
Rouge have
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asserted several other commercial claims against DIG relating to
operation of the DIG plant. In February 2003, Rouge filed an Arbitration Demand
against DIG and CMS MST Michigan, LLC with the American Arbitration Association.
Rouge is seeking a total of $27 million plus additional accrued damages at the
time of any award, plus interest. More specifically, Rouge is seeking at least
$20 million under a Blast Furnace Gas Delivery Agreement in connection with
DIG's purported failure to declare a Blast Furnace Gas Delivery Date within a
reasonable time period, plus $7 million for assorted damage claims under several
legal theories. DIG and CMS MST Michigan, LLC intend to vigorously defend
themselves, and DIG has filed claims against Rouge and Ford as part of this
arbitration. DIG cannot predict the outcome of this matter.
DIG NOISE ABATEMENT LAWSUIT: In February 2003, DIG was served with a three-count
first amended complaint in the matter of Ahmed, et al. v. Dearborn Industrial
Generation, LLC, Wayne County Circuit Court Case No. 02-241296-CZ. The complaint
seeks damages "in excess of $25,000" and injunctive relief based upon
allegations of excessive noise and vibration created by operation of the power
plant. The first amended complaint was filed on behalf of six named plaintiffs,
all alleged to be adjacent or nearby residents or property owners. The damages
alleged are injury to persons and property of the landowners. Certification of a
class of "potentially thousands" who have been similarly affected is requested.
DIG intends to aggressively defend this action. DIG cannot predict the outcome
of this matter.
MCV EXPANSION, LLC: Under an agreement entered into with General Electric
Company ("GE") in October 2002, as of December 31, 2002 MCV Expansion, LLC has a
remaining contingent obligation to GE in the amount of $3.5 million that may
become payable on July 1, 2003. The agreement provides that this contingent
obligation is subject to a pro rata reduction under a formula based upon certain
purchase orders being entered into with GE by June 30, 2003. MCV Expansion
anticipates but cannot assure that purchase orders will be executed with GE by
June 30, 2003 sufficient to eliminate the contingent obligation of $3.5 million.
CMS OIL AND GAS: In 1999, a former subsidiary of CMS Oil and Gas, Terra Energy
Ltd., was sued by Star Energy, Inc. and White Pine Enterprises LLC in the 13th
Judicial Circuit Court in Antrim County, Michigan, on grounds, among others,
that Terra violated oil and gas lease and other agreements by failing to drill
wells. Among the defenses asserted by Terra were that the wells were not
required to be drilled and the claimant's sole remedy was termination of the oil
and gas lease. During the trial, the judge declared the lease terminated in
favor of White Pine. The jury then awarded Star Energy and White Pine $7.6
million in damages. Terra appealed this matter to the Michigan Court of Appeals.
The Court of Appeals reversed the trial court judgment with respect to the
appropriate measure of damages and remanded the case for a new trial on damages.
Terra has taken an appeal to the Michigan Supreme Court. A reserve has been
established for this matter.
ARGENTINA ECONOMIC SITUATION: In January 2002, the Republic of Argentina enacted
the Public Emergency and Foreign Exchange System Reform Act. This law repealed
the fixed exchange rate of one U.S. dollar to one Argentina peso, converted all
dollar-denominated utility tariffs and energy contract obligations into pesos at
the same one-to-one exchange rate, and directed the President of Argentina to
renegotiate such tariffs.
Effective April 30, 2002, CMS Energy adopted the Argentine peso as the
functional currency for most of its Argentine investments. CMS had previously
used the U.S. dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 pesos per U.S. dollar, and recorded an initial
charge to the Foreign Currency Translation component of Common Stockholders'
Equity of approximately $400 million.
While CMS Energy's management cannot predict the most likely future, or average
peso to U.S. dollar
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exchange rates, it does expect that these non-cash charges substantially reduce
the risk of further material balance sheet impacts when combined with
anticipated proceeds from international arbitration currently in progress,
political risk insurance, and the eventual sale of these assets. At March 31,
2003, the net foreign currency loss due to the unfavorable exchange rate of the
Argentine peso recorded in the Foreign Currency Translation component of Common
Stockholder's Equity using an exchange rate of 2.973 pesos per U.S. dollar was
$258 million. This amount also reflects the effect of recording U.S. income
taxes with respect to temporary differences between the book and tax basis of
foreign investments, including the foreign currency translation associated with
CMS Energy's Argentine investments, that were determined to no longer be
essentially permanent in duration.
OTHER: Certain CMS Gas Transmission and CMS Generation affiliates in Argentina
received notice from various Argentine provinces claiming stamp taxes and
associated penalties and interest arising from various gas transportation
transactions. Although these claims total approximately $75 million, the
affiliates and CMS Energy believe the claims are without merit and will continue
to vigorously contest them.
CMS Generation does not currently expect to incur significant capital costs at
its power facilities for compliance with current U.S. environmental regulatory
standards.
In addition to the matters disclosed in this Note, Consumers, Panhandle and
certain other subsidiaries of CMS Energy are parties to certain lawsuits and
administrative proceedings before various courts and governmental agencies
arising from the ordinary course of business. These lawsuits and proceedings may
involve personal injury, property damage, contractual matters, environmental
issues, federal and state taxes, rates, licensing and other matters.
CMS Energy has accrued estimated losses for certain contingencies discussed in
this Note. Resolution of these contingencies is not expected to have a material
adverse impact on CMS Energy's financial position, liquidity, or results of
operations.
5: SHORT-TERM AND LONG-TERM FINANCINGS AND CAPITALIZATION
LONG-TERM DEBT SUMMARY
In Millions
- ----------------------------------------------------------------------------------------------------------------------
March 31 Interest Rate (%) Maturity 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
CMS ENERGY
Senior Notes 8.125 2002 $ - $ 350
7.625 2004 176 178
6.750 2004 287 297
9.875 2007 468 497
8.900 2008 260 266
7.500 2009 409 464
8.500 2011 300 339
8.375 2013 150 150
---------------------------------
2,050 2,541
General Term Notes
Series D 6.932(a) 2003-2008 80 110
Series E 7.828(a) 2003-2009 216 318
Series F 7.580(a) 2003-2016 297 300
---------------------------------
593 728
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Extendible Tenor Rate Adjusted Securities 7.000 2005 180 180
Senior Credit Facilities 2003 248 -
Other 13 9
---------------------------------
441 189
CONSUMERS ENERGY
Senior Notes Floating 2002 - 100
6.000 2005 300 300
6.250 2006 332 332
6.375 2008 159 159
6.200(b) 2008 250 250
6.875 2018 180 180
6.500(c) 2018 141 141
6.500 2028 142 143
---------------------------------
1,504 1,605
Securitization Bonds 2003-2016 446 469
First Mortgage Bonds 7.375 2023 208 208
Long-Term Bank Debt 2004-2006 590 141
Nuclear Fuel Disposal (d) 138 136
Pollution Control Revenue Bonds 5.100 2010-2018 126 126
Other 7 6
---------------------------------
1,515 1,086
OTHER SUBSIDIARIES 53 81
Principal Amount Outstanding 6,156 6,230
Current Amounts (915) (723)
Net Unamortized Discount (29) (32)
---------------------------------
Total Long-Term Debt $ 5,212 $ 5,475
======================================================================================================================
a. Represents the weighted average interest rate at March 31, 2003.
b. These notes are subject to a Call Option by the Callholder or a Mandatory Put
on May 1, 2003.
c. Includes $141 million Senior Remarketed Notes subject to optional redemption
by Consumers after June 15, 2005.
d. Maturity date uncertain.
CMS ENERGY
On March 30, 2003, CMS Energy entered into an amendment and restatement of its
existing $300 million and $295.8 million revolving credit facilities. The Second
Amended and Restated Senior Credit Agreement includes a $159 million tranche
with a maturity date of April 30, 2004 and a $250 million tranche with a
maturity date of September 30, 2004. The facility was underwritten by several
banks at a total annual cost to CMS Energy of approximately ten percent, which
includes the initial commitment fee. Any proceeds of debt or equity issuances by
CMS Energy and its subsidiaries or any asset sales by CMS Energy or its
subsidiaries, other than Consumers, are required to be used to prepay this
facility. This facility primarily collateralized by the stock of Consumers,
Enterprises and certain Enterprises subsidiaries.
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GENERAL TERM NOTES: At March 31, 2003, CMS Energy had issued and outstanding
$593 million GTNs, comprised of $80 million Series D GTNs, $216 million Series E
GTNs and $297 million of Series F GTNs with weighted average interest rates of
6.9 percent, 7.8 percent and 7.6 percent, respectively. No Series G GTNs have
been issued since their registration in May 2002.
ENTERPRISES
On March 30, 2003, Enterprises entered into a revolving credit facility in an
aggregate amount of $441 million. The maturity date of this facility is April
30, 2004. Subsequently, on April 21, 2003, Enterprises entered into a $75
million revolving credit facility with a maturity date of April 30, 2004. These
facilities were underwritten by several banks at a total annual cost to CMS
Energy of approximately ten percent, which includes the initial commitment fee.
Proceeds from these loans will be used for general corporate purposes, to retire
debt and to collateralize $160 million of letters of credit. Any proceeds of
debt or equity issuances by CMS Energy and its subsidiaries or any asset sales
by CMS Energy or its subsidiaries, other than Consumers, are required to be used
to prepay these facilities. It is expected that proceeds from the Panhandle sale
will be used to pay off these facilities in full. These facilities are
guaranteed by CMS Energy, whose guaranty is primarily secured by the stock of
Consumers and Enterprises.
CONSUMERS
REGULATORY AUTHORIZATION FOR FINANCINGS: At March 31, 2003, 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, $381 million for general
corporate purposes, and $610 million of first mortgage bonds to be issued solely
as collateral for the long-term securities. On April 30, 2003, Consumers sold
$625 million principal amount of first mortgage bonds, described below. Its
remaining FERC authorization after this issue is (1) $250 million of long-term
securities for refinancing or refunding purposes, (2) $6 million for general
corporate purposes, and (3) $610 million remaining first mortgage bonds
available to be issued solely as collateral 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 FINANCINGS: 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. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity expiring in March 2006;
the loan has a cost of LIBOR plus 450 basis points. Proceeds from this loan were
used for general corporate purposes.
FIRST MORTGAGE BONDS: In April 2003, Consumers sold $625 million principal
amount of first mortgage bonds in a private offering to institutional investors;
$250 million were issued at 4.25 percent, maturing on April 15, 2008, and net
proceeds were approximately $248 million, $375 million were issued at 5.38
percent, maturing on April 15, 2013, and net proceeds were approximately $371
million. Consumers used the net proceeds to replace a $250 million senior reset
put bond that matured in May 2003, to pay an associated $32 million option call
payment, and for general corporate purposes that may include paying down
additional debt. Consumers has agreed to file a registration statement with the
SEC to permit holders of these first mortgage bonds to exchange the bonds for
new bonds that will be registered under the Securities Act of 1933. Consumers
has agreed to file this registration statement by December 31, 2003.
Consumers secures its first mortgage bonds by a mortgage and lien on
substantially all of its property.
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CMS Energy Corporation
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.
SHORT-TERM FINANCINGS: 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. At March 31, 2003, a total of $252 million was outstanding on all
short-term financing at a weighted average interest rate of 6.22 percent,
compared with $150 million outstanding at March 31, 2002 at a weighed average
interest rate of 2.6 percent.
RESTRICTED PAYMENTS: Under the provisions of its articles of incorporation,
Consumers had $423 million of unrestricted retained earnings available to pay
common dividends at March 31, 2003. However, pursuant to restrictive covenants
in its debt facilities, Consumers is limited to common stock dividend payments
that will not exceed $300 million in any calendar year. In January 2003,
Consumers declared and paid a $78 million common dividend. In March 2003,
Consumers declared a $31 million common dividend payable in May 2003.
OTHER: At March 31, 2003, 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. At March
31, 2003 and 2002, the receivables sold totaled $325 million for each year; the
average annual discount rate was 1.57 percent and 2.15 percent, respectively.
Accounts receivable and accrued revenue in the Consolidated Balance Sheets have
been reduced to reflect receivables sold. On April 30, 2003, Consumers ended its
trade receivable sale program with its then existing purchaser and anticipates
that a new trade receivable program will be in place with a new purchaser in May
2003.
Under the program discussed above, 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 been recorded on the sale of accounts receivable
and Consumers retains no interest in the receivables sold.
REQUIRED RATIOS
CMS Energy's credit facilities have contractual restrictions that require CMS
Energy to maintain certain ratios as of the last day of each fiscal quarter.
Violation of these ratios 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. At March 31, 2003, CMS
Energy is in compliance with required ratios.
Required Ratio Limitation Ratio at March 31, 2003
- -------------------------------------------------------------------------------------------------------
Consolidated Leverage Ratio not more than 7.00 to 1.00 5.84 to 1.00
Cash Dividend Coverage Ratio not less than 1.20 to 1.00 1.73 to 1.00
- -------------------------------------------------------------------------------------------------------
In 1994, CMS Energy executed an indenture with J.P. Morgan Chase Bank pursuant
to CMS Energy's general term notes program. The indenture, through supplements,
contains certain provisions that can trigger a limitation on CMS Energy's
consolidated indebtedness. The limitation can be activated when CMS Energy's
consolidated leverage ratio, as defined in the indenture (essentially the ratio
of consolidated debt to consolidated capital), exceeds 0.75 to 1.0. At March 31,
2003, CMS Energy's consolidated leverage ratio was 0.79 to 1.0. As a result, CMS
Energy will not and will not permit certain material subsidiaries, excluding
Consumers and its subsidiaries, to become liable for new indebtedness. However,
CMS Energy and the material subsidiaries may incur revolving indebtedness to
banks of up to $1 billion in the aggregate and refinance existing debt
outstanding of CMS Energy and of its material subsidiaries. This leverage ratio
may be significantly reduced with the proceeds of CMS Energy's sale of
Panhandle, its sale of CMS Field Services, or other asset sales.
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CMS Energy Corporation
Effective January 1, 2003, CMS Energy adopted the provisions of FASB
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. This
interpretation requires additional disclosures 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.
The following table is a summary of CMS Energy's guarantees as required by FASB
Interpretation No. 45:
March 31, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
Issue Expiration Maximum Carrying Recourse
Guarantee Description Date Date Obligation Amount(b) Provision(c)
- -------------------------------------------------------------------------------------------------------------------
Indemnifications from asset sales and
other agreements(a) Various Various $1,694 $0.1 $ -
Letters of credit Various Various 283 - -
Surety bonds and other indemnifications Various Various 241 - -
Other guarantees Various Various 469 - -
Nuclear insurance retrospective premiums Various Various 120 - -
- -------------------------------------------------------------------------------------------------------------------
(a) The majority of this amount arises from routine provisions in
stock and asset sales agreements under which the purchaser is
indemnified by CMS Energy or a subsidiary for losses resulting
from events such as failure of title to the assets or stock sold
by CMS Energy or a subsidiary to the purchaser. CMS Energy
believes the likelihood of a loss arising from such events to be
remote.
(b) The carrying amount represents the fair market value of
guarantees and indemnities on CMS Energy's balance sheet that are
entered into subsequent to January 1, 2003.
(c) Recourse provision indicates the approximate recovery from third
parties including assets held as collateral.
CMS Energy has entered into typical tax indemnity agreements in connection with
a variety of transactions including transactions for the sale of subsidiaries
and assets, equipment leasing and financing agreements. These indemnity
agreements generally are not limited in amount and, while a maximum amount of
exposure cannot be identified, the amount and probability of liability is
considered remote.
The off-balance sheet commitments at March 31, 2003 are as follows:
Commercial Commitments In Millions
- ---------------------------------------------------------------------------------------------------------------
Commitment Expiration
- ---------------------------------------------------------------------------------------------------------------
March 31 Total 2003 2004 2005 2006 2007 Beyond
- ---------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $ 469 $ 20 $ - $ - $ 4 $ - $445
Indemnities 241 5 - 36 - - 200
Letters of Credit 283 247 32 - - - 4
- ---------------------------------------------------------------------------------------------------------------
Total $ 993 $ 272 $ 32 $ 36 $ 4 $ - $649
===============================================================================================================
CMS Energy and Enterprises, including subsidiaries, have guaranteed payment of
obligations, through letters
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of credit and surety bonds, of unconsolidated affiliates and related parties
approximating $2.6 billion as of March 31, 2003. Included in this amount,
Enterprises, in the ordinary course of business, has guarantees in place for
contracts of CMS MST that contain certain schedule and performance requirements.
As of March 31, 2003, the actual amount of financial exposure covered by these
guarantees was $297 million. This amount excludes the guarantees associated with
CMS MST's natural gas supply contract obligations totaling $252 million, which
are recorded as liabilities on the Consolidated Balance Sheet at March 31, 2003.
Management monitors and approves these obligations and believes it is unlikely
that CMS Energy or Enterprises would be required to perform or otherwise incur
any material losses associated with the above obligations.
CAPITALIZATION: The authorized capital stock of CMS Energy consists of 250
million shares of CMS Energy Common Stock and 10 million shares of CMS Energy
Preferred Stock, $.01 par value.
COMPANY-OBLIGATED PREFERRED SECURITIES: CMS Energy and Consumers each have
wholly-owned statutory business trusts that are consolidated with the respective
parent company. CMS Energy and Consumers created their respective trusts for the
sole purpose of issuing trust preferred securities. In each case, the primary
asset of the trust is a note or debenture of the parent company. The terms of
the trust preferred security parallel the terms of the related parent company
note or debenture. The terms, rights and obligations of the trust preferred
security and related note or debenture are also defined in the related indenture
through which the note or debenture was issued, the parent guarantee of the
related trust preferred security and the declaration of trust for the particular
trust. All of these documents together with their related note or debenture and
trust preferred security constitute a full and unconditional guarantee by the
parent company of the trust's obligations under the trust preferred security. In
addition to the similar provisions previously discussed, specific terms of the
securities follow:
CMS Energy In Millions
- --------------------------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate (%) Outstanding Maturity Redemption
- --------------------------------------------------------------------------------------------------------------------
March 31 2003 2002
- --------------------------------------------------------------------------------------------------------------------
CMS Energy Trust I (a) 7.75 $173 $173 2027 2001
CMS Energy Trust II (b) 8.75 - 301 2004 -
CMS Energy Trust III (c) 7.25 220 220 2004 -
- --------------------------------------------------------------------------------------------------------------------
Total Amount Outstanding $393 $694
======================================================================================
(a) Represents Quarterly Income Preferred Securities that are
convertible into 1.2255 shares of CMS Energy Common Stock
(equivalent to a conversion price of $40.80). Effective July
2001, CMS Energy can revoke the conversion rights if certain
conditions are met.
(b) On July 1, 2002, the 7,250,000 units of Adjustable Convertible
Preferred Securities were converted to 8,787,725 newly issued
shares of CMS Energy Common Stock.
(c) Represents Premium Equity Participating Security Units in which
holders are obligated to purchase a variable number of shares of
CMS Energy Common Stock by the August 2003 conversion date.
Consumers Energy Company In Millions
- ---------------------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate (%) Outstanding Maturity Redemption
- ---------------------------------------------------------------------------------------------------------------
March 31 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36 $ 70 $ 70 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20 120 120 2027 2002
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CMS Energy Corporation
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00 125 125 2031 2006
- --------------------------------------------------------------------------------------------------------------
Total Amount Outstanding $490 $ 490
=====================================================================================
6: EARNINGS PER SHARE
The following table presents a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations.
In Millions, Except Per Share Amounts
- ------------------------------------------------------------------------
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------
Net Income Attributable to Common Stock:
CMS Energy - Basic $ 79 $ 42
Add conversion of Trust Preferred
Securities (net of tax) 5 2
------------------------
CMS Energy - Diluted $ 84 $ 44
========================
Average Common Shares Outstanding
Applicable to Basic and Diluted EPS
CMS Energy:
Average Shares - Basic 144.1 133.3
Add conversion of Trust Preferred
Securities 20.9 4.2
------------------------
Average Shares - Diluted 165.0 137.5
========================
Earnings Per Average Common Share
Basic $ 0.55 $ 0.32
Diluted $ 0.51 $ 0.32
========================================================================
7: RISK MANAGEMENT ACTIVITIES AND FINANCIAL INSTRUMENTS
The objective of the CMS Energy risk management policy is to analyze, manage and
coordinate the identified risk exposures of the individual business segments and
to exploit the presence of internal hedge opportunities that exist among its
diversified business segments. CMS Energy, on behalf of its regulated and
non-regulated subsidiaries, utilizes a variety of derivative instruments for
both trading and non-trading purposes and executes these transactions with
external parties through either CMS Enterprises or its marketing subsidiary, CMS
MST. These derivative instruments include futures contracts, swaps, options and
forward contracts to manage exposure to fluctuations in commodity prices,
interest rates and foreign exchange rates. In order for derivative instruments
to qualify for hedge accounting under SFAS No. 133, the hedging relationship
must be formally documented at inception and be highly effective in achieving
offsetting cash flows or offsetting changes in fair value attributable to the
risk being hedged.
Derivative instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. CMS Energy minimizes such risk by performing financial
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CMS Energy Corporation
credit mitigation programs including, among other things, using publicly
available credit ratings of such counterparties, internally developed
statistical models for credit scoring and use of internal hedging programs to
minimize exposure to external counterparties. No material nonperformance is
expected.
COMMODITY DERIVATIVES: Commodity contracts have been accounted for in accordance
with the requirements of SFAS No. 133, as amended and interpreted, and may or
may not qualify for hedge accounting treatment depending on the characteristics
of each contract.
DERIVATIVE INSTRUMENTS: CMS Energy adopted SFAS No. 133 on January 1, 2001. This
standard requires CMS Energy to recognize at fair value on the balance sheet, as
assets or liabilities, all contracts that meet the definition of a derivative
instrument. The standard also requires CMS Energy to record all changes in fair
value directly in earnings unless the derivative instrument meets certain
qualifying cash flow hedge criteria, in which case the changes in fair value
would be reflected in other comprehensive income. CMS Energy determines fair
value based upon quoted market prices and mathematical models using current and
historical pricing data. The ineffective portion, if any, of all hedges is
recognized in earnings.
CMS Energy believes that the majority of its contracts, power purchase
agreements and gas transportation contracts qualify for the normal purchases and
sales exception of SFAS No. 133 and are not subject to the accounting rules for
derivative instruments. CMS Energy uses derivative instruments that require
derivative accounting, to limit its exposures to electricity and gas commodity
price risk. The interest rate and foreign currency exchange contracts met the
requirements for hedge accounting under SFAS No. 133 and CMS Energy recorded the
changes in the fair value of these contracts in other comprehensive income.
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 electricity to
customers, to manage electric costs and to ensure a reliable source of capacity
during peak demand periods. As of March 31, 2003, 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. These contracts
will expire in the third quarter of 2003.
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 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. As of March 31, 2002, these contracts
had a fair value of $1 million. These contracts expired in December 2002.
As of March 31, 2003, Consumers recorded a total of $11 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-
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CMS Energy Corporation
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 and the weather-based gas call options and gas put options
required derivative accounting. The fixed price gas supply contracts expired in
October 2002, and the weather-based gas call options and gas put options expired
in February 2003. As of March 31, 2003, Consumers did not have any gas supply
related contracts that required derivative accounting.
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 March 31, 2003 and March 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 March 31, 2003,
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 March 31, 2002, this interest rate
swap had a negative fair value of $2 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. As of March 31, 2002, the swap had a negative fair value of less
than $1 million. 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.
Consumers was able to apply the shortcut method to all interest rate hedges,
therefore there was no ineffectiveness associated with these hedges.
ENERGY TRADING ACTIVITIES: CMS Energy, through its subsidiary CMS MST, engages
in trading activities. CMS MST manages any open positions within certain
guidelines that limit its exposure to market risk and requires timely reporting
to management of potential financial exposure. These guidelines include
statistical risk tolerance limits using historical price movements to calculate
daily value at risk measurements. Through December 31, 2002, CMS MST's wholesale
power and gas trading activities were accounted for under the mark-to-market
method of accounting. Effective, January 1, 2003, EITF Issue No. 98-10 was
rescinded by EITF Issue No. 02-03 and as a result, only energy contracts that
meet the definition of a derivative in SFAS No. 133 can be carried at fair
value. The impact of this change for CMS MST was recognized as a cumulative
effect of a change in accounting principle of $(23) million, net of tax. See
Note 10, Adoption of New Accounting Standards. Under mark-to-market accounting,
energy-trading contracts are reflected at fair market value, net of reserves,
with unrealized gains and losses recorded as an asset or liability in the
consolidated balance sheets. These assets and liabilities are affected by the
timing of settlements related to these contracts, current-period changes from
newly originated transactions and the impact of price movements. Changes in fair
value are recognized as revenues in the consolidated statements of income in the
period in which the changes occur. Market prices used to value outstanding
financial instruments reflect management's consideration of, among other things,
closing exchange and over-the-counter quotations. In certain contracts,
long-term commitments may extend beyond the period in which market quotations
for such contracts are available and volumetric obligations may not be defined.
Mathematical models are developed to determine various inputs into the fair
value calculation including price, anticipated volumetric obligations and other
inputs that may be required to adequately address the determination of fair
value of the contracts. Realized cash returns on these commitments may vary,
either positively or negatively, from the results estimated through application
of the mathematical model. CMS Energy believes that its mathematical models
utilize state-of-the-art technology, pertinent industry data and prudent
discounting in order to forecast certain elongated pricing curves. Market prices
are adjusted to reflect the impact of liquidating the company's position in an
orderly manner over a reasonable period of time under present market conditions.
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CMS Energy Corporation
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. The creditworthiness of these counterparties will impact overall
exposure to credit risk; however, CMS Energy maintains credit policies that
management believes minimize overall credit risk with regard to its
counterparties. Determination of its counterparties' credit quality is based
upon a number of factors, including credit ratings, financial condition, and
collateral requirements. When trading terms permit, CMS Energy employs standard
agreements that allow for netting of positive and negative exposures associated
with a single counterparty. Based on these policies, its current exposures and
its credit reserves, CMS Energy does not anticipate a material adverse effect on
its financial position or results of operations as a result of counterparty
nonperformance.
At March 31 2003 and 2002, CMS Energy has recorded a net price risk management
asset of $7 million and $103 million respectively, net of reserves, related to
the unrealized mark-to-market gains on existing wholesale power contracts, gas
contracts, and hedges for retail activities that are marked as derivatives.
FLOATING TO FIXED INTEREST RATE SWAPS: CMS Energy and its subsidiaries enter
into floating to fixed interest rate swap agreements to reduce the impact of
interest rate fluctuations. These swaps are designated as cash flow hedges and
the difference between the amounts paid and received under the swaps is accrued
and recorded as an adjustment to interest expense over the term of the
agreement. Changes in the fair value of these swaps are recorded in accumulated
other comprehensive income until the swaps are terminated. As of March 31, 2003,
these swaps had a negative fair value of $4 million that if sustained, will be
reclassified to earnings as the swaps are settled on a quarterly basis.
Notional amounts reflect the volume of transactions but do not represent the
amount exchanged by the parties to the financial instruments. Accordingly,
notional amounts do not necessarily reflect CMS Energy's exposure to credit or
market risks. As of March 31, 2003 and 2002, the weighted average interest rate
associated with outstanding swaps was approximately 5.2 percent.
In Millions
- --------------------------------------------------------------------------------------------------------------------------
Floating to Fixed Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- --------------------------------------------------------------------------------------------------------------------------
March 31, 2003 $ 294 2003-2006 $(4) $ 3
March 31, 2002 $ 295 2003-2006 $(7) $ 4
FIXED TO FLOATING INTEREST RATE SWAPS: CMS Energy monitors its debt portfolio
mix of fixed and variable rate instruments and from time to time enters into
fixed to floating rate swaps to maintain the optimum mix of fixed and floating
rate debt. These swaps are designated as fair value hedges and any realized
gains or losses in the fair value are amortized to earnings after the
termination of the hedge instrument over the remaining life of the hedged item.
There were no outstanding fixed to floating interest rate swaps as of March 31,
2003.
In Millions
- --------------------------------------------------------------------------------------------------------------------------
Fixed to Floating Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- --------------------------------------------------------------------------------------------------------------------------
March 31, 2003 $ - -- $ - $ -
March 31, 2002 $ 822 2004-2005 $(3) $ (2)
FOREIGN EXCHANGE DERIVATIVES: CMS Energy uses forward exchange and option
contracts to hedge certain receivables, payables, long-term debt and equity
value relating to foreign investments. The purpose of CMS Energy's foreign
currency hedging activities is to protect the company from the risk that U.S.
dollar net cash flows resulting from sales to foreign customers and purchases
from foreign suppliers and the repayment of
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CMS Energy Corporation
non-U.S. dollar borrowings as well as equity reported on the company's balance
sheet, may be adversely affected by changes in exchange rates. These contracts
do not subject CMS Energy to risk from exchange rate movements because gains and
losses on such contracts offset losses and gains, respectively, on assets and
liabilities being hedged. The estimated fair value of the foreign exchange and
option contracts at March 31, 2003 and 2002 2002 was zero 2003 and $(6) million,
respectively; representing the amount CMS Energy would receive or (pay) upon
settlement.
There were no outstanding foreign exchange contracts at March 31, 2003. Foreign
exchange contracts outstanding as of March 31, 2002 had a total notional amount
of $152 million. Of this amount, $100 million is related to CMS Energy's
investments in Brazil, $25 million is related to CMS Energy's investments in
Australia, and $27 million in Euro hedges.
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. The estimated fair values of long-term investments are based on quoted
market prices or, in the absence of specific market prices, on quoted market
prices of similar investments or other valuation techniques. Judgment may also
be required to interpret market data to develop certain estimates of fair value.
Accordingly, the estimates determined as of March 31, 2003 and 2002 are not
necessarily indicative of the amounts that may be realized in current market
exchanges. The carrying amounts of all long-term investments in financial
instruments, except for those as shown below, approximate fair value.
In Millions
- -------------------------------------------------------------------------------------------------------------------
As of March 31 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Carrying Fair Unrealized Carrying Fair Unrealized
Cost Value Gain(Loss) Cost Value Gain(Loss)
-----------------------------------------------------------------------------
Long-Term Debt (a) $5,212 $5,112 $(100) $5,475 $5,422 $(53)
Preferred Stock and
Trust Preferred Securities 927 664 (263) 1,228 1,125 (103)
- -------------------------------------------------------------------------------------------------------------------
(a) Settlement of long-term debt is generally not expected until maturity.
8: EQUITY METHOD INVESTMENTS
Certain of CMS Energy's investments in companies, partnerships and joint
ventures, where ownership is more than 20 percent but less than a majority, are
accounted for by the equity method of accounting in accordance with APB Opinion
No. 18. For the three months ended March 31, 2003 and 2002, net income included
undistributed earnings of $31 million and $34 million, respectively, from these
investments. The most significant of these investments is CMS Energy's 50
percent interest in Jorf Lasfar and its 49 percent interest in the MCV
Partnership. Summarized income statement information of CMS Energy's most
significant equity method investments follows.
Income Statement Data
In Millions
- ----------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2003 Jorf Lasfar MCV Total
- ----------------------------------------------------------------------------------------------------
Operating revenue $ 90 $153 $243
Operating expenses 43 100 143
-----------------------------
Operating income 47 53 100
Other expense, net 19 28 47
-----------------------------
Net income $ 28 $ 25 $ 53
====================================================================================================
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CMS Energy Corporation
In Millions
- ----------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2002 Jorf Lasfar MCV Total
- ----------------------------------------------------------------------------------------------------
Operating revenue $ 96 $149 $245
Operating expenses 48 109 157
-----------------------------
Operating income 48 40 88
Other expense, net 11 29 40
-----------------------------
Net income $ 37 $ 11 $ 48
====================================================================================================
9: REPORTABLE SEGMENTS
CMS Energy's reportable segments are strategic business units organized and
managed by the nature of the products and services each provides. Management
evaluates performance based upon the net income of each segment. Previously, CMS
Energy operated in five reportable segments: electric utility, gas utility,
natural gas transmission, independent power production and marketing, services
and trading. As a result of recent changes in its business strategy, including
the sale of non-strategic and under-performing assets, and management
reorganization, CMS Energy now operates principally in the following three
reportable segments: electric utility, gas utility, and enterprises.
The electric utility segment consists of regulated activities associated with
the generation, transmission and distribution of electricity in the state of
Michigan through its subsidiary, Consumers. The gas utility segment consists of
regulated activities associated with the transportation, storage and
distribution of natural gas in the state of Michigan through its subsidiary,
Consumers. The enterprises segment consists of investing in, acquiring,
developing, constructing, managing and operating non-utility power generation
plants and natural gas facilities in the United States and abroad; and providing
gas, oil, and electric marketing services to energy users.
The Consolidated Statements of Income reflect operating revenue and operating
income by reportable segment. Intersegment sales and transfers are accounted for
at current market prices and are eliminated in consolidated operating income by
segment. The table below shows net income by reportable segment. The "Other"
segment includes corporate interest and other, discontinued operations and the
cumulative effect of accounting changes. The 2002 information has been restated
to reflect the management reorganization and the change in CMS Energy's business
strategy from five to three operating segments.
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CMS Energy Corporation
Reportable Segments In Millions
- ------------------------------------------------------------------------------------------------------------------
Restated
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Net Income
Electric utility $ 51 $ 50
Gas utility 54 28
Enterprises 23 66
Other (49) (102)
--------------------------------------
$ 79 $ 42
==================================================================================================================
10. ADOPTION OF NEW ACCOUNTING STANDARDS
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Effective January 1,
2003, CMS Energy adopted SFAS No. 143. The new standard requires companies to
record the fair value of the legal obligation related to asset retirements in
the period in which the obligation is incurred. CMS Energy has determined that
it has legal asset retirement obligations, particularly in regard to Consumers'
nuclear plants.
Prior to adoption of SFAS No. 143, Consumers classified the removal cost
liability of assets included in the scope of SFAS No. 143 as part of the reserve
for accumulated depreciation. For these assets, the removal cost of $448 million
which was classified as part of the reserve at December 31, 2002, was
reclassified in January 2003, in part, as 1) a $364 million ARO liability, 2) a
$136 million regulatory liability, 3) A $45 million regulatory asset, and 4) a
$7 million net increase to property, plant, and equipment, as prescribed by SFAS
No. 143. As required by SFAS No. 71 for regulated entities, Consumers is
reflecting a regulatory asset and liability instead of a cumulative effect of a
change in accounting principle.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions, such as costs, inflation,
and profit margin that third parties would consider in order to take on the
settlement of the obligation. Fair value, to the extent possible, should include
a market risk premium for unforeseeable circumstances. No market risk premium
was included in Consumers' ARO fair value estimate since a reasonable estimate
could not be made. If a five percent market risk premium was assumed, Consumers'
ARO liability would be $381 million.
If a reasonable estimate of fair value cannot be made in the period the asset
retirement obligation is incurred, such as assets with an indeterminate life,
the liability will be recognized when a reasonable estimate of fair value can be
made. Generally, mass property such as transmission and distribution assets have
an indeterminate life, retirement cash flows cannot be determined and there is a
low probability of a retirement date, therefore no liability has been recorded
for these assets. No liability has been recorded for assets that have an
immaterial cumulative disposal cost, such as substation batteries. The initial
measurement of the ARO liability for Consumers' Palisades Nuclear Plant and Big
Rock Nuclear Plant is based on decommissioning studies, which are based largely
on third party cost estimates.
In addition, at March 31, 2003, CMS Energy recorded an ARO liability for certain
pipelines and non-utility generating plants and a $1 million, net of tax,
cumulative effect of change in accounting for accretion and depreciation expense
for ARO liabilities incurred prior to 2003. The pro forma effect on results of
operations would not be material for the three months ended March 31, 2002.
The following table is a general description of the AROs and their associated
long-lived assets.
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CMS Energy Corporation
March 31, 2003 In Millions
- ------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- ------------------------------------------------------------------------------------------------------------------
Palisades - decommission plant site 1972 Palisades nuclear plant $ 426
Big Rock - decommission plant site 1962 Big Rock nuclear plant 103
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line -
Closure of coal ash disposal areas Various Generating plants coal ash areas -
Closure of wells at gas storage fields Various Gas storage fields -
Indoor gas services equipment relocations Various Gas meters located inside structures -
Closure of gas pipelines Various Gas transmission pipelines -
Dismantle natural gas-fired power plant 1997 Gas fueled power plant -
- ------------------------------------------------------------------------------------------------------------------
The following table is a reconciliation of the carrying amount of the AROs:
March 31, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
Pro Forma
ARO liability ARO Liability Cash flow
ARO 1/1/02 1/1/03 Incurred Settled Accretion Revisions 3/31/03
- -------------------------------------------------------------------------------------------------------------------
Palisades - decommission $232 $249 $ - $ - $ 4 $ - $ 253
Big Rock - decommission 94 61 - (7) 3 - 57
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - - 1 - 52
Wells at gas storage fields 2 2 - - - - 2
Indoor gas services
relocations 1 1 - - - - 1
Closure of gas pipelines (a) 7 8 - - - - 8
Dismantle natural gas-fired
power plant 1 1 - - - - 1
- -------------------------------------------------------------------------------------------------------------------
Total $383 $373 $ - $ (7) $ 8 $ - $ 374
===================================================================================================================
(a) Amounts are included in discontinued operations.
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.
EITF ISSUE NO. 02-03, "RECOGNITION AND REPORTING OF GAINS AND LOSSES ON ENERGY
TRADING CONTRACTS UNDER EITF ISSUES NO. 98-10 AND 00-17": At the October 25,2002
meeting, the EITF reached a consensus to rescind EITF Issue No. 98-10,
Accounting for Contracts Involved in Energy Trading and Risk Management
Activities. As a result, only energy contracts that meet the definition of a
derivative in SFAS No. 133 will be carried at fair value. Energy trading
contracts that do not meet the definition of a derivative must be accounted for
as an executory contract (i.e., on an accrual basis). The consensus rescinding
EITF Issue No. 98-10 was required to be applied to all contracts that existed as
of October 25, 2002 and was required to be recognized as a cumulative effect of
a change in accounting principle in accordance with APB Opinion No. 20,
Accounting Changes, effective the first day of the first interim or annual
period beginning after December 15, 2002. The consensus also was required to be
applied immediately to all new contracts entered into after October 25, 2002.
The full adoption of EITF Issue No. 02-03 effective January 1, 2003, resulted in
CMS Energy recognizing a cumulative effect of change in accounting principle
loss of ($23) million, net of tax, for the three months ended March 31, 2003.
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Consumers Energy Company
CONSUMERS ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
Consumers, a subsidiary of CMS Energy, a holding company, is an electric and gas
utility company that provides service to customers in Michigan's Lower
Peninsula. Consumers' customer base includes a mix of residential, commercial
and diversified industrial customers, the largest segment of which is the
automotive industry.
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
Form 10-Q and other written and oral statements that Consumers may make contain
forward-looking statements as defined by the Private Securities Litigation
Reform Act of 1995. Consumers' intentions with the use of the words,
"anticipates," "believes," "estimates," "expects," "intends," and "plans," and
variations of such words and similar expressions, are solely to identify
forward-looking statements that involve risk and uncertainty. These
forward-looking statements are subject to various factors that could cause
Consumers' actual results to differ materially from the results anticipated in
such statements. Consumers has no obligation to update or revise forward-looking
statements regardless of whether new information, future events or any other
factors affect the information contained in such statements. Consumers does,
however, discuss certain risk factors, uncertainties and assumptions in this
MD&A and in Item 1 of the 2002 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 Form 10-Q also describes material contingencies in Consumers' Condensed
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 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.
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Consumers Energy Company
The EPA has issued regulations regarding nitrogen oxide emissions from certain
generators, including some of Consumers' electric generating facilities. These
regulations require Consumers to make significant capital expenditures estimated
to be $770 million. As of March 31, 2003, Consumers has incurred $420 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 and
their cost can change significantly. At some point, if new environmental
standards become effective, Consumers may need additional capital expenditures
to comply with the standards. 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 the term of the PPA ending 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 and a fixed energy charge, and also to pay 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 and fixed energy charges in rates. After September 2007, the PPA's
regulatory out 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 March 31, 2003 and 2002, the remaining after-tax present value
of the estimated future PPA liability associated with the loss totaled $30
million and $46 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
payments made on the basis of availability that may be billed by the MCV
Partnership at a maximum 98.5 percent availability level.
When Consumers returns, as expected, to unfrozen rates beginning in 2004,
Consumers will recover from customers capacity and fixed energy charges on the
basis of availability, to the extent that availability does
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Consumers Energy Company
not exceed 88.7 percent availability established in previous MPSC orders. For
capacity and energy 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. The regulatory out provision relieves Consumers of
the obligation to pay more for capacity and energy payments than the MPSC allows
Consumers to collect from its customers. Consumers estimates 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. 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:
In Millions
- ------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $-- $-- $--
============================================================================================================
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.
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 the criteria in SFAS No. 133, as amended
and interpreted, to determine if certain contracts must be accounted for as
derivative instruments. The rules for determining whether a contract meets the
criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
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
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Consumers Energy Company
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 determine the fair value of contracts that are accounted for as
derivative instruments, Consumers uses a combination of quoted market 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 March 31, 2003, Consumers assumed a market-based
interest rate of 4.5 percent and a volatility rate of 107.5 percent in
calculating the fair value of its electric call options.
In order for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value, attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings.
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, and an additional $12 million in the first quarter of 2003. As of March
31, 2003, Consumers held 2.4 million shares of CMS Energy Common Stock with a
fair value of $10 million. Unrealized gains or losses from changes in the fair
value of Consumers' nuclear decommissioning investments are reported as
regulatory liabilities. 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
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Consumers Energy Company
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 March 31, 2003 and 2002, Consumers had
outstanding $1.324 billion and $1.329 billion of variable-rate financing,
respectively, including variable-rate swaps and fixed-rate swaps. At March 31,
2003 and 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 and $3 million, respectively. As of March 31, 2003
and 2002, Consumers had entered into a floating-to-fixed interest rate swap
agreement for a notional amount of $75 million, and as of March 31, 2002 a
variable-to-fixed interest rate swap agreement for a notional of $300 million.
These swaps exchange variable-rate interest payment obligations for fixed-rate
interest payment obligations, or fixed-rate interest payment obligations for
variable-rate interest payment obligations in order to minimize the impact of
potential adverse interest rate changes. As of March 31, 2003 and 2002,
Consumers had outstanding fixed-rate financing, including fixed and
variable-rate swaps, of $2.756 billion and $2.477 billion, respectively, with a
fair value of $2.690 billion and $2.769 billion, respectively. As of March 31,
2003 and 2002, assuming a hypothetical 10 percent adverse change in market
rates, Consumers would have an exposure of $131 million and $144 million,
respectively, 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 debt. 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.
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Consumers Energy Company
As of March 31, 2003 and 2002, the fair value based on quoted future market
prices of electricity-related call option and swap contracts was $10 million and
$19 million, respectively. At March 31, 2003 and 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 and $4 million
respectively. As of March 31, 2003 and 2002, Consumers had an asset of $28
million and $48 million, respectively, related to premiums incurred for electric
call option contracts. Consumers' maximum exposure associated with the call
option contracts is limited to the premiums incurred. As of March 31, 2003,
Consumers did not have any gas supply-related call or put option contracts. As
of March 31, 2002, the fair value based on quoted future market prices of gas
supply contracts containing embedded put options was $4 million. At March 31,
2002, a hypothetical 10 percent adverse change in market prices was 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
and an additional $12 million loss in the first quarter of 2003, 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 March 31, 2003, Consumers held 2.4 million
shares of CMS Energy Common stock at a fair value of $10 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 4,
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 be refunded to customers. Judgment is required to
discern the recoverability of items recorded as regulatory assets and
liabilities. As of March 31, 2003, Consumers had $1.121 billion recorded as
regulatory assets and $463 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 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
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Consumers Energy Company
beginning in the fourth quarter of 2002, 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.
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 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 current
plan. Under the cash balance section, 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 not earn an additional
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.
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 claim costs for Consumers.
Mail-order prescription copays have also been increased for all salaried
retirees.
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,
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Consumers Energy Company
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. A number of
utilities have commenced litigation in the Court of Claims, including Consumers,
which filed its complaint in December 2002. The Chief Judge of the Court of
Claims identified six lead cases to be used as vehicles for resolving
dispositive motions. Consumers' case is not a lead case. It is unclear what
impact this decision by the Chief Judge will have on the outcome of Consumers'
litigation. 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 submitted a
complaint to the MPSC, which was served on Consumers by the MPSC on April 18,
2003. The complaint asks the MPSC to commence a generic investigation and
contested case to review all facts and issues concerning costs associated with
spent nuclear fuel storage and disposal. The complaint seeks a variety of relief
with respect to Consumers Energy, The Detroit Edison Company, Indiana & Michigan
Electric Company, Wisconsin Electric Power Company and Wisconsin Public Service
Corporation including establishing 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 related to the storage and
disposal of spent nuclear fuel. Consumers is reviewing the complaint. Consumers
is unable to predict the outcome of this matter.
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 and the adequacy of the decommissioning trust funds.
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
generally 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. Additionally, Consumers continues to use the transmission facilities
now owned by MTH, and a director of Consumers is currently a stockholder of
Trans-Elect, Inc.
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Consumers Energy Company
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
- -------------------------------------------------------------------------------------------------------------------
March 31 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $99 $81 $18
===================================================================================================================
2003 COMPARED TO 2002: For the three months ended March 31, 2003, Consumers' net
income available to the common stockholder totaled $99 million, an increase of
$18 million from the previous year. This increase in earnings reflects an
after-tax benefit of $30 million due to increased electric and gas deliveries.
Also contributing to the earnings increase is the after-tax benefit of $12
million due to the final gas rate order issued in 2002 authorizing Consumers to
increase its gas tariff rates. This increase in earnings also reflects an $8
million after-tax benefit primarily from increased intersystem revenues along
with a $5 million benefit from increased electric miscellaneous service
revenues. Offsetting these increases is a $12 million charge to non-utility
expense in order to recognize a decline in market value of CMS Energy Stock held
by Consumers and increased electric and gas operating expenses that reduced
earnings by $24 million after-tax.
For further information, see the Electric and Gas Utility Results of Operations
sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
March 31 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $51 $50 $1
===================================================================================================================
Reasons for the change:
Electric deliveries $13
Power supply costs and related revenue 13
Other operating expenses and non-commodity revenue (22)
Fixed charges (3)
-------
Total change $ 1
===================================================================================================================
ELECTRIC DELIVERIES: For the three months ended March 31, 2003, electric
delivery revenues increased by $13 million from the previous year. Electric
deliveries, including transactions with other wholesale market participants and
other electric utilities, were 9.7 billion kWh, an increase of 0.5 billion kWh
or 5.6 percent from 2002. This increase is primarily the result of increased
deliveries to the higher margin residential and commercial sectors, along with
the growth in retail deliveries.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended March 31,
2003, power supply costs and related revenues increased electric net income by
$13 million from 2002. This increase is primarily the result of increased
intersystem revenues.
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Consumers Energy Company
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three months ended
March 31, 2003, operating expenses increased compared to 2002. This increase can
be attributed to a scheduled refueling outage at Palisades that began in March
and higher transmission costs due to the loss of a financial return on the sold
Consumers transmission system asset in May 2002. Slightly offsetting these
increased operating expenses are increased non-commodity revenues associated
with miscellaneous service revenues.
INCOME TAXES: For the three months ended March 31, 2003, income tax expense
remained relatively flat compared to 2002.
GAS UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
March 31 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $54 $28 $26
===================================================================================================================
Reasons for the change:
Gas deliveries $33
Gas rate increase 19
Gas wholesales and retail services 3
Operation and maintenance (10)
General taxes, depreciation, and other income (5)
Fixed charges (1)
Income taxes (13)
----------
Total change $ 26
===================================================================================================================
GAS DELIVERIES: For the three months ended March 31, 2003, gas delivery revenues
increased by $33 million from the previous year. System deliveries, including
miscellaneous transportation, totaled 174 bcf, an increase of 25 bcf or 16.4
percent compared with 2002. This increase is primarily due to colder weather
that resulted in increased deliveries to the residential and commercial sectors
in 2003.
GAS RATE INCREASE: 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 this order, Consumers recognized increased gas revenues of $19
million.
OPERATION AND MAINTENANCE: For the three months ended March 31, 2003, operation
and maintenance expenses increased $10 million compared to 2002. This increase
reflects the recognition of additional expenditures on safety, reliability and
customer service due to the colder temperatures for the quarter, compared to the
same period in 2002
INCOME TAXES: For the three months ended March 31, 2003, 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. Cash
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Consumers Energy Company
from operations totaled $387 million and $270 million for the first three months
of 2003 and 2002, respectively. The $117 million increase resulted from an
increase in electric and gas deliveries, a gas rate increase and changes in
working capital items due to the timing of cash receipts and payments. Consumers
primarily uses cash derived from operating activities to operate, maintain,
expand and construct its electric and gas systems, to retire portions of
long-term debt, and to pay dividends. A decrease in cash from operations 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: Cash used for investing activities totaled $117 million
and $154 million for the first three months of 2003 and 2002, respectively. The
change of $37 million is primarily due to a $16 million decrease from the 2002
level of capital expenditures to comply with the Clean Air Act and a $12 million
decrease in gas supply system additions and improvements.
FINANCING ACTIVITIES: Cash used for financing activities totaled $51 million and
$105 million for the first three months of 2003 and 2002, respectively. The
change of $54 million is primarily due to a decrease of $309 million retirements
of bonds and other long-term debt, partially offset by $96 million additional
payments of notes payable and the absence of $150 million cash infusion from CMS
Energy.
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
March 31 Total 2003 2004 2005 2006 2007 beyond
- --------------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 2,724 $ - $228 $470 $512 $ 31 $ 1,483
Current portion of long-
term debt 277 277 - - - - -
Notes payable 252 252 - - - - -
Capital lease obligations 153 14 19 18 17 16 69
Off-balance sheet:
Operating leases 79 10 12 8 8 6 35
Non-recourse debt of FMLP 208 8 54 41 26 13 66
Sale of accounts receivable 325 325 - - - - -
Unconditional purchase
obligations 18,888 1,843 1,386 1,119 874 742 12,924
==============================================================================================================
REGULATORY AUTHORIZATION FOR FINANCINGS: At March 31, 2003, 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, $381 million for general
corporate purposes, and $610 million of first mortgage bonds to be issued solely
as collateral for the long-term securities. On April 30, 2003, Consumers sold
$625 million principal amount of first mortgage bonds, described below. Its
remaining FERC authorization after this issue is (1) $250 million of long-term
securities for refinancing or refunding purposes, (2) $6 million for general
corporate purposes, and (3) $610 million remaining first mortgage bonds
available to be issued solely as collateral for the long-term securities.
Consumers anticipates applying in the second quarter of 2003 for an increase in
FERC authorization to issue new long-term securities for
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Consumers Energy Company
refinancing or refunding and for general corporate purposes. 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: 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. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity expiring in March 2006;
the loan has a cost of LIBOR plus 450 basis points. Proceeds from this loan were
used for general corporate purposes.
In April 2003, Consumers sold $625 million principal amount of first mortgage
bonds in a private offering to institutional investors ; $250 million were
issued at 4.25 percent, maturing on April 15, 2008, and net proceeds were
approximately $248 million, $375 million were issued at 5.38 percent, maturing
on April 15, 2013, and net proceeds were approximately $371 million. Consumers
used the net proceeds to replace a $250 million senior reset put bond that
matured in May 2003, to pay an associated $32 million option call payment, and
for general corporate purposes that may include paying down additional debt.
Consumers has agreed to file a registration statement with the SEC to permit
holders of these first mortgage bonds to exchange the bonds for new bonds that
will be registered under the Securities Act of 1933. Consumers has agreed to
file this registration statement by December 31, 2003.
Consumers' current portion of long-term debt maturing in 2003 is $277 million.
Refer to Outlook, "Liquidity and Capital Resources" below for information about
Consumers strategic measures addressing its future liquidity and capital
requirements.
SHORT TERM FINANCINGS: 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.
Pursuant to restrictive covenants in debt facilities, Consumers is limited to
common stock dividend payments that will not exceed $300 million in any calendar
year. Consumers paid common stock dividends of $231 million in 2002 and $190
million in 2001 to CMS Energy. In January 2003, Consumers declared and paid a
$78 million common dividend. In March 2003, Consumers declared a $31 million
common dividend payable in May 2003.
LEASES: Consumers' capital leases are predominately for leased service vehicles
and the new headquarters building. Operating leases are predominately for
railroad coal cars.
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: At March 31, 2003, 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. At March 31, 2003 and 2002, the receivables sold totaled
$325 million for each year; the average annual discount rate was 1.57 percent
and 2.15 percent, respectively. Accounts receivable and accrued revenue in the
Consolidated Balance Sheets have been reduced to reflect receivables sold. On
April 30, 2003, Consumers ended its trade receivable sale program with its then
existing purchaser and anticipates that a new trade receivable program will be
in place with a new purchaser in May 2003.
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Consumers Energy Company
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 $47 million per month for the
remaining nine months of 2003, including $34 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
March 31 Total 2003 2004 2005 2006 2007 beyond
- --------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Indemnities $8 $- - - - - $8
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.
OUTLOOK
LIQUIDITY AND CAPITAL RESOURCES
Consumers' liquidity and capital requirements generally are a function of its
results of operations, capital expenditures, contractual obligations, debt
maturities, working capital needs and collateral requirements. 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 addition, 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.
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Consumers Energy Company
Consumers has historically met its consolidated cash needs through its operating
and financing activities and access to bank financing and the capital markets.
In 2003, Consumers has contractual obligations and planned capital expenditures
that would require substantial amounts of cash. Consumers may also become
subject to liquidity demands pursuant to commercial commitments under
guarantees, indemnities and letters of credit as indicated above. Consumers
plans to meet its liquidity and capital requirements in 2003 through a
combination of approximately $290 million from operations, $1.290 billion from
borrowings, including $563 million of new debt and $727 million from refinancing
of existing debt, reduced capital expenditures, cost reductions and other
measures. The following table is a summary of Consumers' debt financing plan and
actual borrowings for 2003:
Debt Financing in 2003 In Millions
- ----------------------------------------------------------------------------------------------------------------
Financing Actual Retired or
Financing Plan Borrowing Type Issued Date Maturity Collateral
- ----------------------------------------------------------------------------------------------------------------
Anticipated Maturities:
Revolving credit
facility $ 250 $ 250 Refinanced March 2003 March 2004 (a) FMB
Senior note 250 250 Refunded (b) April 2003 April 2008 -
Gas Inventory
facility 227 - Retired (c) March 2003 - -
------ ------
Subtotal $ 727 $ 500
------ ------
New Financings:
Bank loan 140 140 New issue March 2003 March 2009 FMB (e)
Term loan 150 150 New issue March 2003 March 2006 FMB (e)
First mortgage bonds 250 375 New issue April 2003 April 2013 -
Additional gas
Inventory facility 23 - (d)- - - -
------- ------
Subtotal $ 563 $ 665
------- ------
Total $1,290 $1,165
================================================================================================================
(a) This facility has two annual extensions at Consumers' option, which would
extend the maturity to March 2006.
(b) Refunded and replaced with FMB.
(c) Includes a gas inventory facility of $207 million retired in March 2003 and
anticipated new gas inventory facility pay down of $20 million expected to
occur in December 2003. See footnote (d).
(d) Consumers will seek to arrange a $125 million gas inventory loan in the
third quarter 2003 and thus complete the $1.290 billion financing plan.
(e) Refer to Capital Resources and Liquidity, "Regulatory Authorization for
Financings" above for information about Consumers' remaining FERC debt
authorization.
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. In addition to executing the debt financing plan for 2003 as discussed
above, the following activities also have been initiated by Consumers to enhance
further its liquidity beyond 2003:
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Consumers Energy Company
o 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 it will be in place by the fourth
quarter of 2003.
o Consumers filed an application in March 2003, 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 rehearing or court appeals and no
other delays in the offering process, Consumers anticipates that
bonds could be issued by year-end 2003.
There is no assurance that the pending Securitization bond issuance transaction
noted above will be completed, nor is there 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. The FERC issued an order on April 30, 2003
directing eight companies, including CMS MST, to submit written demonstrations
within forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST intends to make a written submission
within the specified time period demonstrating compliance with the FERC's
directives. Other than the FERC investigation, 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 were filed against CMS Energy, Consumers, and
certain officers and directors of CMS Energy and its affiliates. The complaints
were filed as purported class actions in the United States District Court for
the Eastern District of Michigan. The cases were consolidated into a single
lawsuit and an amended and consolidated class action complaint was filed on May
1, 2003. The defendants named in the amended and consolidated class action
complaint consist of CMS Energy, Consumers, and certain officers and directors
of CMS Energy and its affiliates, and certain underwriters of CMS Energy
securities. The purported class period is from May 1, 2000 through and including
March 31, 2003. The amended and consolidated class action complaint seeks
unspecified damages based on allegations that the defendants violated United
States securities laws and regulations by making allegedly false and misleading
statements about CMS Energy's business and financial condition. CMS Energy and
Consumers intend to vigorously defend against this action, but cannot predict
the outcome of this litigation.
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named
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Consumers Energy Company
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 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 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 the remaining three quarters of 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
early May 2003, alternative electric suppliers are providing 571 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 for
2000 and $43 million for 2001. 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
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Consumers Energy Company
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 that were excluded from
the Stranded Cost calculation and post-2000 Palisades expenditures.
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
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 is participating 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 Pending Pending
2003 2002 2 2 Pending Pending
==============================================================================================================
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 March 31, 2003, Consumers incurred and deferred as a
regulatory asset, $2 million of additional implementation costs and has also
recorded as a regulatory asset $14 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. As discussed below, Consumers has asked
to include implementation costs through December 31, 2003 in the pending
securitization case. If approved, the sale of Securitization bonds will allow
for the recovery of these costs. Consumers cannot predict the amounts the MPSC
will approve as allowable costs.
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Consumers Energy Company
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: In March 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 and reduce
interest rates associated with financing 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 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 March 31, 2003, outstanding contracts involve approximately
513 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. However, of the original special contracts that have
terminated, contracts for 52MW have gone to an alternative electric supplier
and contracts for 129MW have returned to bundled tariff rates.
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 electric and gas revenues. In October 2002,
the MPSC denied waivers for three programs that provided approximately $32
million in gas 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 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 gas 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
CE-18
Consumers Energy Company
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 2002, Consumers sold its electric transmission system to MTH, a
non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc.
As a result of the sale, Consumers anticipates its after-tax earnings will be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a 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.
Under an 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.
Consumers is a customer of AEP, holding 300 MW of long-term transmission service
reservations through the AEP transmission system. 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, reserved through
the AEP transmission system. AEP has indicated its intent, and has received
preliminary FERC approval, to turn control of its transmission system over to
the PJM RTO. This will require current AEP wholesale transmission customers to
become members of, and resubmit reservation requests to, PJM. Due to legislation
recently enacted in Virginia, which precludes Virginia utilities (including AEP)
from joining an RTO until at least July 2004, as well as uncertainty associated
with state approvals AEP is seeking from various state regulatory bodies, the
timing of AEP's membership in PJM is currently in some doubt. Upon completion of
the steps necessary for the integration of AEP into PJM, Consumers will complete
the application process to join PJM as a transmission customer.
There are multiple proceedings and a proposed rulemaking pending before the FERC
regarding transmission pricing mechanisms and standard market design for
electric bulk power markets and transmission. The results of these proceedings
and proposed rulemaking could significantly affect the trend of transmission
costs and increase the delivered power costs to Consumers and the retail
electric customers it serves. The specific financial impact on Consumers of such
proceedings, rulemaking and trends are not currently quantifiable.
In addition, 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.
CE-19
Consumers Energy Company
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; 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) potentially rising pension costs due to market losses (as discussed
above in Accounting for Pension and OPEB). 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.
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
CE-20
Consumers Energy Company
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 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.
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 $36 million in annual
gas 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."
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; 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) potentially rising
pension costs due to market losses (as discussed above in Accounting for Pension
and OPEB). 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.
SECURITY COSTS: 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 nuclear electric division security costs incurred during the rate
freeze and cap periods imposed by the Customer Choice Act. Of the $4 million in
incremental security costs incurred through December 31, 2002, approximately $3
million related to nuclear security costs. Of the estimated $6 million for
incremental
CE-21
Consumers Energy Company
security costs expected to be incurred in 2003, $4 million relates to nuclear
security costs. On February 5, 2003, the MPSC adopted filing requirements for
the recovery of enhanced security costs.
OTHER MATTERS
DISCLOSURE AND INTERNAL CONTROLS
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 prior to this filing. 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.
NEW ACCOUNTING STANDARDS
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. Upon
adoption of the standard on January 31, 2003, there was no impact on Consumers'
consolidated financial statements, and Consumers does not anticipate any
additional impact to its consolidated financial statements upon adoption of
additional standard requirements on July 1, 2003.
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Consumers Energy Company
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CE-23
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2003 2002
- ----------------------------------------------------------------------------------------------------------------
In Millions
OPERATING REVENUE
Electric $ 653 $ 609
Gas 789 616
Other 16 11
--------------------
1,458 1,236
- ----------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Operation
Fuel for electric generation 80 67
Purchased power - related parties 132 141
Purchased and interchange power 82 61
Cost of gas sold 519 396
Cost of gas sold - related parties 25 30
Other 160 139
-------------------
998 834
Maintenance 52 50
Depreciation, depletion and amortization 116 107
General taxes 59 57
--------------------
1,225 1,048
- ----------------------------------------------------------------------------------------------------------------
OPERATING INCOME
Electric 116 115
Gas 103 64
Other 14 9
--------------------
233 188
- ----------------------------------------------------------------------------------------------------------------
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates - 1
Accretion expense (2) (2)
Other, net (8) (1)
----------------------
(10) (2)
- -----------------------------------------------------------------------------------------------------------------
INTEREST CHARGES
Interest on long-term debt 42 33
Other interest 5 9
Capitalized interest (2) (2)
---------------------
45 40
- ----------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 178 146
INCOME TAXES 68 54
--------------------
NET INCOME 110 92
PREFERRED SECURITIES DISTRIBUTIONS 11 11
--------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 99 $ 81
================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-24
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2003 2002
- ----------------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $110 $ 92
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $2 and $2, respectively) 116 107
Deferred income taxes and investment tax credit 28 31
Loss on CMS Energy stock 12 -
Capital lease and other amortization 4 3
Undistributed earnings of related parties (16) (10)
Changes in assets and liabilities
Decrease in inventories 238 193
Decrease in accounts payable (5) (32)
Increase in accounts receivable and accrued revenue (50) (54)
Changes in other assets and liabilities (50) (60)
-----------------------------
Net cash provided by operating activities 387 270
- -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (114) (142)
Cost to retire property, net (18) (15)
Investment in Electric Restructuring Implementation Plan (2) (3)
Investments in nuclear decommissioning trust funds (2) (2)
Proceeds from nuclear decommissioning trust funds 6 8
Cash receipts from asset sales 13 -
--------------------------
Net cash used in investing activities (117) (154)
- -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in notes payable, net (205) (109)
Payment of common stock dividends (78) (55)
Retirement of bonds and other long-term debt (35) (344)
Preferred securities distributions (11) (11)
Payment of capital lease obligations (3) (3)
Redemption of preferred securities - (30)
Payment of preferred stock dividends - (1)
Stockholder's contribution - 150
Proceeds from senior notes and bank loans 281 298
------------------------
Net cash used in financing activities (51) (105)
- -----------------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH AND TEMPORARY CASH INVESTMENTS 219 11
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 271 17
--------------------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 490 $ 28
=================================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 61 $ 31
Income tax paid 5 -
Pension and OPEB cash contribution 18 61
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 8 $ 17
=================================================================================================================
All highly liquid investments with an original maturity of three months or less
are considered cash equivalents.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-25
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
ASSETS MARCH 31 MARCH 31
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------
In Millions
PLANT (AT ORIGINAL COST)
Electric $7,356 $7,523 $7,733
Gas 2,787 2,719 2,625
Other 21 23 21
----------------------------------------
10,164 10,265 10,379
Less accumulated depreciation, depletion and amortization 5,267 5,900 6,022
---------------------------------------
4,897 4,365 4,357
Construction work-in-progress 487 548 532
---------------------------------------
5,384 4,913 4,889
- ----------------------------------------------------------------------------------------------------------------
INVESTMENTS
Stock of affiliates 10 22 54
First Midland Limited Partnership 259 255 257
Midland Cogeneration Venture Limited Partnership 405 388 316
Consumers Nuclear Services, LLC 2 2 2
---------------------------------------
676 667 629
- ----------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 490 271 28
Accounts receivable and accrued revenue, less allowances
of $5, $4 and $3, respectively 279 236 183
Accounts receivable - related parties 15 13 15
Inventories at average cost
Gas in underground storage 256 486 378
Materials and supplies 74 71 69
Generating plant fuel stock 26 37 50
Deferred property taxes 117 142 120
Regulatory assets 19 19 19
Other 53 38 18
----------------------------------------
1,329 1,313 880
- ----------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory assets
Securitized costs 678 689 714
Postretirement benefits 180 185 203
Abandoned Midland Project 11 11 11
Other 233 168 171
Nuclear decommissioning trust funds 529 536 576
Other 199 218 154
---------------------------------------
1,830 1,807 1,829
- ----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $9,219 $8,700 $8,227
================================================================================================================
CE-26
STOCKHOLDERS' INVESTMENT AND LIABILITIES MARCH 31 MARCH 31
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholder's equity
Common stock $ 841 $ 841 $ 841
Paid-in capital 682 682 782
Other Comprehensive Income (175) (179) 9
Retained earnings since December 31, 1992 566 545 467
---------------------------------------
1,914 1,889 2,099
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred securities
of subsidiaries (a) 490 490 490
Long-term debt 2,724 2,442 2,433
Non-current portion of capital leases 121 116 85
----------------------------------------
5,293 4,981 5,151
- ----------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 290 318 253
Notes payable 252 457 150
Notes payable- CMS Energy - - 157
Accounts payable 252 261 249
Accrued taxes 161 214 161
Accounts payable - related parties 88 84 97
Deferred income taxes 29 25 23
Current portion of purchased power contracts 26 26 24
Other 167 200 234
---------------------------------------
1,265 1,585 1,348
- ----------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Deferred income taxes 961 949 808
Postretirement benefits 566 563 239
Regulatory liabilities for income taxes, net 311 297 276
Other Regulatory liabilities 152 4
Asset Retirement Obligation 364 - -
Power purchase agreement - MCV Partnership 21 27 47
Deferred investment tax credit 89 91 100
Other 197 203 258
---------------------------------------
2,661 2,134 1,728
- ----------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $9,219 $8,700 $8,227
================================================================================================================
(a) See Note 3, Financings and Capitalization
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE BALANCE SHEETS.
CE-27
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2003 2002
- ----------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period (a) $ 841 $ 841
- ----------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 682 632
Stockholder's contribution - 150
-----------------
At end of period 682 782
- ----------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME
Minimum Pension Liability
At beginning of period (185) -
Minimum liability pension adjustments - -
-----------------
At end of period (185) -
-----------------
Investments
At beginning of period 1 16
Unrealized loss on investments (b) - (3)
-----------------
At end of period 1 13
-----------------
Derivative Instruments (c)
At beginning of period 5 (12)
Unrealized gain on derivative instruments (b) 7 5
Reclassification adjustments included in net income (b) (3) 3
-----------------
At end of period 9 (4)
- ----------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
At beginning of period 545 441
Net income (b) 110 92
Cash dividends declared- Common Stock (78) (55)
Preferred securities distributions (11) (11)
-----------------
At end of period 566 467
- ----------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $1,914 $2,099
================================================================================================================
CE-28
(a) Number of shares of common stock outstanding was 84,108,789 for all periods
presented
(b) Disclosure of Comprehensive Income:
Other Comprehensive Income
Investments
Unrealized loss on investments, net of tax of
$- and $2, respectively $ - $ (3)
Derivative Instruments (d)
Unrealized gain on derivative instruments,
net of tax of $4 and $3, respectively 7 5
Reclassification adjustments included in net income,
net of tax of ($2) and $1, respectively (3) 3
Net income 110 92
-------------------
Total Comprehensive Income $ 114 $ 97
===================
(c) 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 $ (8)
Unrealized gain on derivative instruments 7 5
Reclassification adjustments included in net income (4) 2
-------------------
At the end of period $ 11 $ (1)
===================
The accompanying notes are an integral part of these statements
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CE-30
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by Consumers
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. As such, certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States have been
condensed or omitted. Certain prior year amounts have been reclassified to
conform to the presentation in the current year. In management's opinion, the
unaudited information contained in this report reflects all adjustments
necessary to assure the fair presentation of financial position, results of
operations and cash flows for the periods presented. The Condensed Notes to
Consolidated Financial Statements and the related Consolidated Financial
Statements should be read in conjunction with the Consolidated Financial
Statements and Notes to Consolidated Financial Statements contained in the
Consumers Form 10-K for the year ended December 31, 2002, which includes the
Reports of Independent Auditors. Due to the seasonal nature of Consumers
operations, the results as presented for this interim period are not necessarily
indicative of results to be achieved for the fiscal year.
1: CORPORATE STRUCTURE AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company,
is an electric and gas utility company that provides service to customers in
Michigan's Lower Peninsula. Consumers' customer base includes a mix of
residential, commercial and diversified industrial customers, the largest
segment of which is the automotive industry.
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. On March 26, 2003, Consumers reached a tentative agreement with
the Union for a collective bargaining agreement for its Call Center employees.
The agreement was effective April 1, 2003, and covers approximately 300
employees. The agreement will continue in full force and effect until August 1,
2005.
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.
REPORTABLE SEGMENTS: Consumers has two reportable segments: electric and gas.
The electric segment consists of activities associated with the generation and
distribution of electricity. The gas segment consists of activities associated
with the transportation, storage and distribution of natural gas. Consumers'
reportable segments are domestic business units organized and managed by the
nature of the product and service each provides. The accounting policies of the
segments are the same as those described in Consumers' 2002 Form 10-K.
Consumers' management has changed its evaluation of the performance of the
electric and gas segments from operating income to net income available to
common stockholder. The Consolidated Statements of Income show operating revenue
and operating income by reportable segment. Intersegment sales and transfers are
accounted for at current market prices and are eliminated in consolidated net
income available to common stockholder by segment. 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.
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The net income available to common stockholder by reportable segment is as
follows:
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended
March 31 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Net income available to common stockholder
Electric $51 $50
Gas 54 28
Other (6) 3
- ------------------------------------------------------------------------------------------------------------------
Total Consolidated $99 $81
==================================================================================================================
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 and an additional $12 million loss in the first quarter of 2003. As of
March 31, 2003, Consumers held 2.4 million shares of CMS Energy Common Stock
with a fair value of $10 million. Unrealized gains or losses from changes in the
fair value of Consumers' nuclear decommissioning investments are reported as
regulatory liabilities. The fair value of these investments is determined from
quoted market prices.
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.
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 March 31, 2003, Consumers had
a net investment in energy supply facilities of $1.554 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
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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 beginning in the fourth quarter of 2002, 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.
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 disclosures in financial statements about the
effects of stock-based compensation. The transition guidance and annual
disclosure provisions of the statement were 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. The following table
shows the amounts that would have been included in net income had the fair value
method been applied to all awards granted in the first quarter of 2002:
In Millions
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31 2002
- --------------------------------------------------------------------------------------------------------------------
Net income, as reported $92
Add: Stock-based employee compensation expense included in
reported net income, net of related taxes -
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of
related taxes (1)
----------
Pro forma net income $91
====================================================================================================================
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; 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
requested rate increases; 15) market and regulatory responses to increases in
gas costs, including a reduced average use per residential customer; and 16)
increased costs for pipeline integrity and safety and homeland security
initiatives that are not recoverable on a timely basis from customers.
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. The FERC issued an order on April 30, 2003
directing eight companies, including CMS MST, to submit written demonstrations
within forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST intends to make a written submission
within the specified time period demonstrating compliance with the FERC's
directives. Other than the FERC investigation, 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.
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SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints were filed against CMS Energy, Consumers, and
certain officers and directors of CMS Energy and its affiliates. The complaints
were filed as purported class actions in the United States District Court for
the Eastern District of Michigan. The cases were consolidated into a single
lawsuit and an amended and consolidated class action complaint was filed on May
1, 2003. The defendants named in the amended and consolidated class action
complaint consist of CMS Energy, Consumers, certain officers and directors of
CMS Energy and its affiliates, and certain underwriters of CMS Energy
securities. The purported class period is from May 1, 2000 through and including
March 31, 2003. The amended and consolidated class action complaint seeks
unspecified damages based on allegations that the defendants violated United
States securities laws and regulations by making allegedly false and misleading
statements about CMS Energy's business and financial condition. CMS Energy and
Consumers intend to vigorously defend against this action, but 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 regulations requiring the state of Michigan
to further limit nitrogen oxide emissions. The Michigan Department of
Environmental Quality finalized rules to comply with the EPA 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 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 regulations
require Consumers to make significant capital expenditures estimated to be $770
million. As of March 31, 2003, Consumers has incurred $420 million in capital
expenditures to comply with the EPA 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 and
their price could change significantly. 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.
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
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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 March 31,
2003, 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 (On March 31, 2003, Consumers filed an
application with the MPSC that seeks confirmation that Consumers is in
compliance with the market power test set forth in the Customer Choice Act); 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 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.
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.
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SECURITIZATION: The Customer Choice Act allows for the use of low-cost
Securitization bonds to refinance certain qualified costs, as defined by the
act. Securitization typically involves issuing asset-backed bonds with a higher
credit rating than conventional utility corporate financing. In 2000 and 2001,
the MPSC issued orders authorizing Consumers to issue Securitization bonds.
Consumers issued its first Securitization bonds in 2001. 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. The Securitization 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.
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. 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, $13 million for the
three months ended March 31, 2003, and $12 million for the three months ended
March 31, 2002, are remitted to a trustee for the Securitization bonds.
Securitization charge collections are dedicated for the repayment of the
principal 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.
In March 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 and reduce interest rates
associated with financing 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 2002, Consumers sold its electric transmission system (METC) to
MTH, a non-affiliated limited partnership whose general partner is a subsidiary
of Trans-Elect Inc.
As a result of the sale, Consumers anticipates its after-tax earnings will be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a 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.
Under an 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.
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
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payments that are to be credited. The $35 million liability for IPP credits did
not include interest since the associated interconnection agreements did not at
that time provide for interest. MTH had asserted that Consumers might be liable
for interest on the IPP payments to be credited if interest provisions were
added to these agreements. However, in January 2003, the FERC changed and
clarified its approach to contracts that were entered into before the FERC
started allowing the crediting of interest, and as a result, Consumers believes
that there is no longer any such potential liability under the current FERC
policy.
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 supply
resources equal to 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 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 early May 2003, alternative electric
suppliers are providing 571 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 and energy contracts for the physical delivery
of electricity primarily in the summer months and to a lesser degree in the
winter months. As of March 31, 2003, Consumers had purchased or had commitments
to purchase electric call option and capacity and energy contracts partially
covering the estimated reserve margin requirements for 2003 through 2007. As a
result, Consumers has a recognized asset of $28 million for unexpired call
options and capacity and energy contracts. The total cost of electricity call
option and capacity and energy contracts for 2003 is expected to be
approximately $9 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 required to cover the costs
associated with fixed generation assets, generation-related regulatory assets,
and
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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 for
2000 and $43 million for 2001. 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 that were excluded
from the Stranded Cost calculation and post-2000 Palisades expenditures.
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 is participating 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 Pending Pending
2003 2002 2 2 Pending Pending
==============================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs
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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 March 31, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded as a regulatory
asset $14 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. As discussed above, Consumers has asked to include
implementation costs through December 31, 2003 in the pending securitization
case. If approved, the sale of Securitization bonds will allow for the recovery
of these costs. 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 refund obligation. As of April 2003, Consumers had
paid $19 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.
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 includes undistributed earnings from
the MCV Partnership, which at March 31, 2003 and 2002 are $233 million and $187
million, respectively.
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Consumers Energy Company
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- -------------------------------------------------------------------------------------------------------------------
March 31 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Operating income $16 $9
Income taxes and other 5 3
- -------------------------------------------------------------------------------------------------------------------
Net income $11 $6
===================================================================================================================
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the term of
the PPA ending 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 and a fixed energy charge, and also to pay 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 regulatory out 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 March 31, 2003 and 2002, the remaining after-tax present value
of the estimated future PPA liability associated with the loss totaled $30
million and $46 million, 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
payments made on the basis of availability that may be billed by the MCV
Partnership at a maximum 98.5 percent availability level.
When Consumers returns, as expected, to unfrozen rates beginning in 2004,
Consumers will recover from customers capacity and fixed energy charges on the
basis of availability, to the extent that availability does not exceed 88.7
percent availability established in previous MPSC orders. For capacity and
energy 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. The regulatory out provision relieves Consumers of the obligation to
pay more for capacity and energy payments than the MPSC allows Consumers to
collect from its customers. Consumers estimates 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. If the MCV Facility's generating availability remains at the maximum
98.5 percent level during the next five years, Consumers' after-tax cash
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Consumers Energy Company
underrecoveries associated with the PPA could be as follows:
In Millions
- --------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- --------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 $36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $ - $ - $ -
====================================================================================================================
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 31, 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 March 31, 2003, Consumers had loaded 18 dry
casks with spent nuclear fuel at Palisades. Palisades will need to load
additional dry casks by the fall of 2004 in order to continue operation.
Palisades currently has three empty storage-only dry casks on-site, with storage
pad capacity for up to seven additional loaded dry casks. Consumers anticipates
that licensed transportable dry casks for additional storage, along with more
storage pad capacity, will be available prior to 2004.
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Consumers Energy Company
In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to begin
accepting deliveries of spent nuclear fuel for disposal by January 31, 1998.
Subsequent U.S. Court of Appeals 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 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, including Consumers, which filed
its complaint in December 2002. The Chief Judge of the Court of Claims
identified six lead cases to be used as vehicles for resolving dispositive
motions. Consumers' case is not a lead case. It is unclear what impact this
decision by the Chief Judge will have on the outcome of Consumers' litigation.
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.
As of March 31, 2003, 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.
On March 26, 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumer Federation submitted a
complaint to the MPSC, which was served on Consumers by the MPSC on April 18,
2003. The complaint asks the MPSC to commence a generic investigation and
contested case to review all facts and issues concerning costs associated with
spent nuclear fuel storage and disposal. The complaint seeks a variety of relief
with respect to Consumers Energy, The Detroit Edison Company, Indiana & Michigan
Electric Company, Wisconsin Electric Power Company and Wisconsin Public Service
Corporation, including establishing 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 related to the storage and
disposal of spent nuclear fuel. Consumers is reviewing the complaint and, at
this time, is unable to predict the outcome of this matter.
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 March 2002, corrosion problems were discovered in
the reactor head at an unaffiliated nuclear power plant in Ohio. As a result,
the NRC requested that all United States nuclear plants utilizing pressurized
water reactors to provide reports detailing their reactor head inspection
histories, design capabilities and future inspection plans. In response to the
issues identified at this and other nuclear plants worldwide, a bare metal
visual inspection was completed on the Palisades reactor vessel head during the
spring 2003 refueling outage. No indication of leakage was detected on any of
the 54 penetrations.
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.
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Consumers Energy Company
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.
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 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 fund a significant portion of these costs through insurance
proceeds and through MPSC approved rates charged to its customers. As of March
31, 2003, Consumers has an accrued liability of $49 million, net of $33 million
of expenditures incurred to date, and a regulatory asset of $69 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.
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Consumers Energy Company
GAS RATE MATTERS
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 increased its maximum GCR factor in May 2003, based on a formula that
tracks increases in NYMEX prices.
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 include 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 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 UNCERTAINTIES
SECURITY COSTS: 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 nuclear electric division security costs incurred during the rate
freeze and cap periods imposed by the Customer Choice Act. Of the $4 million in
incremental security costs incurred through December 31, 2002, approximately $3
million related to nuclear security costs. Of the estimated $6 million for
incremental security costs expected to be incurred in 2003, $4 million relates
to nuclear security costs. On February 5, 2003, the MPSC adopted filing
requirements for the recovery of enhanced security costs.
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 4, Financial and Derivative
Instruments.
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Consumers Energy Company
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 March 31, 2003, 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, $381 million for general
corporate purposes, and $610 million of first mortgage bonds to be issued solely
as collateral for the long-term securities. On April 30, 2003, Consumers sold
$625 million principal amount of first mortgage bonds, described below. Its
remaining FERC authorization after this issue is (1) $250 million of long-term
securities for refinancing or refunding purposes, (2) $6 million for general
corporate purposes, and (3) $610 million remaining first mortgage bonds
available to be issued solely as collateral 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: 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. At March 31, 2003, a total of $252 million was outstanding on all
short-term financing at a weighted average interest rate of 6.22 percent,
compared with $150 million outstanding at March 31, 2002 at a weighted average
interest rate of 2.6 percent.
LONG-TERM FINANCINGS: 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. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity expiring in March 2006;
the loan has a cost of LIBOR plus 450 basis points. Proceeds from this loan were
used for general corporate purposes.
FIRST MORTGAGE BONDS: In April 2003, Consumers sold $625 million principal
amount of first mortgage bonds in a private offering to institutional investors;
$250 million were issued at 4.25 percent, maturing on April 15, 2008, and net
proceeds were approximately $248 million, $375 million were issued at 5.38
percent, maturing on April 15, 2013, and net proceeds were approximately $371
million. Consumers used the net proceeds to replace a $250 million senior reset
put bond that matured in May 2003, to pay an associated $32 million option call
payment, and for general corporate purposes that may include paying down
additional debt. Consumers has agreed to file a registration statement with the
SEC to permit holders of these first mortgage bonds to exchange the bonds for
new bonds that will be registered under the Securities Act of 1933. Consumers
has agreed to file this registration statement by December 31, 2003.
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Consumers Energy Company
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.
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
- ------------------------------------------------------------------------------------------------------------------
March 31 2003 2002 2001 Year
- ------------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $ 70 $ 70 $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 $490 $395
==================================================================================================================
OTHER: At March 31, 2003, 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. At March
31, 2003 and 2002, the receivables sold under the program were $325 million for
each year; the average annual discount rate was 1.57 percent and 2.15 percent,
respectively. Accounts receivable and accrued revenue in the Consolidated
Balance Sheets have been reduced to reflect receivables sold. On April 30, 2003,
Consumers ended its trade receivable sale program with its then existing
purchaser and anticipates that a new trade receivable program will be in place
with a new purchaser in May 2003.
Under the program discussed above, 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 been recorded on the sale of accounts receivable
and Consumers retains no interest in the receivables sold.
DIVIDEND RESTRICTIONS: Under the provisions of its articles of incorporation,
Consumers had $423 million of unrestricted retained earnings available to pay
common dividends at March 31, 2003. However, pursuant to restrictive covenants
in its debt facilities, Consumers is limited to common stock dividend payments
that will not exceed $300 million in any calendar year. In January 2003,
Consumers declared and paid a $78 million common dividend. In March 2003,
Consumers declared a $31 million common dividend payable in May 2003.
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
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Consumers Energy Company
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:
March 31, 2003 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 8 - -
Nuclear insurance retrospective premiums Various Various 120 - -
==================================================================================================================
(a) Recourse provision indicates the approximate recovery from third
parties including assets held as collateral.
Following is additional information regarding Consumers' guarantees:
March 31, 2003
- ---------------------------------------------------------------------------------------------------------------------
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
=====================================================================================================================
4: 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.
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In Millions
- ---------------------------------------------------------------------------------------------------------------
March 31 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized
Available-for-sale securities Cost Value Gain Cost Value Gain
- ---------------------------------------------------------------------------------------------------------------
Common stock of CMS Energy (a) $ 10 $ 10 $ - $ 35 $ 54 $ 19
SERP 18 18 - 21 22 1
Nuclear decommissioning
investments (b) 458 529 71 465 576 111
===============================================================================================================
(a) Consumers recognized a $12 million loss on this investment in 2002 and an
additional $12 million loss in the first quarter of 2003 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 March 31, 2003, Consumers held 2.4 million shares
of CMS Energy Common Stock with a fair value of $10 million.
(b) On January 1, 2003, Consumers adopted SFAS No. 143 and began classifying its
unrealized gains and losses on nuclear decommissioning investments as regulatory
liabilities. Consumers previously classified these investments in accumulated
depreciation.
At March 31, 2003, the carrying amount of long-term debt was $2.7 billion and at
March 31, 2002, $2.4 billion, and the fair values were $2.7 billion and $2.4
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.
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.
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. SFAS No. 133 requires Consumers to
recognize at fair value all contracts that meet the definition of a derivative
instrument on the balance sheet as either assets or liabilities. The standard
also requires Consumers to record all changes in fair value directly in
earnings, or other comprehensive income if the derivative meets certain
qualifying cash flow hedge criteria. 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
CE-48
Consumers Energy Company
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 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 March 31, 2003,
Consumers assumed a market-based interest rate of 4.5 percent and a volatility
rate of 107.5 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.
The following table reflects the fair value of contracts requiring derivative
accounting:
In Millions
- ------------------------------------------------------------------------------------------------------------------
March 31 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Fair Fair
Derivative Instruments Cost Value Cost Value
- -------------------------------------------------------------------------------------------------------------------
Electric contracts $8 $ 1 $21 $ 5
Gas contracts - - - 4
Interest rate risk contracts - (1) - (2)
Derivative contracts associated with Consumers'
equity investment in the MCV Partnership - 17 - (1)
===================================================================================================================
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.
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 electricity to
customers, to manage electric costs and to ensure a reliable source of capacity
during peak demand periods. As of March 31, 2003, 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. These contracts
will expire in the third quarter of 2003.
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 in
earnings related to these contracts, particularly related to the PPA could be
material to the financial statements.
CE-49
Consumers Energy Company
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. As of March 31, 2002, these contracts
had a fair value of $1 million. These contracts expired in December 2002.
As of March 31, 2003, Consumers recorded a total of $11 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 and the weather-based gas call options
and gas put options required derivative accounting. The fixed price gas supply
contracts expired in October 2002, and the weather-based gas call options and
gas put options expired in February 2003. As of March 31, 2003, Consumers did
not have any gas supply related contracts that required derivative accounting.
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 March 31, 2003 and March 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 March 31, 2003,
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 March 31, 2002, this interest rate
swap had a negative fair value of $2 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. As of March 31, 2002, the swap had a negative fair value of less
than $1 million. 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.
Consumers was able to apply the shortcut method to all interest rate hedges,
therefore there was no ineffectiveness associated with these hedges.
5: IMPLEMENTATION OF 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.
Prior to adoption of SFAS No. 143, Consumers classified the removal cost
liability of assets included in the scope of SFAS No. 143 as part of the reserve
for accumulated depreciation. For these assets, the removal cost of $448 million
which was classified as part of the reserve at December 31, 2002, was
reclassified in January 2003, in part, as 1) a $364 million ARO liability, 2) a
$136 million regulatory liability, 3) a $45 million regulatory asset, and 4) a
$7 million net increase to property, plant, and equipment, as prescribed by SFAS
CE-50
Consumers Energy Company
No. 143. As required by SFAS No. 71 for regulated entities, Consumers is
reflecting a regulatory asset and liability instead of a cumulative effect of a
change in accounting principle.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions, such as costs, inflation,
and profit margin that third parties would consider in order to take on the
settlement of the obligation. Fair value, to the extent possible, should include
a market risk premium for unforeseeable circumstances. No market risk premium
was included in Consumers' ARO fair value estimate since a reasonable estimate
could not be made. If a five percent market risk premium was assumed, Consumers'
ARO liability would be $381 million.
If a reasonable estimate of fair value cannot be made in the period the asset
retirement obligation is incurred, such as assets with an indeterminate life,
the liability is to be recognized when a reasonable estimate of fair value can
be made. Generally, transmission and distribution assets have an indeterminate
life, retirement cash flows cannot be determined and there is a low probability
of a retirement date, therefore no liability has been recorded for these assets.
No liability has been recorded for assets that have an immaterial cumulative
disposal cost, such as substation batteries. The initial measurement of the ARO
liability for Consumers' Palisades Nuclear Plant and Big Rock Nuclear Plant is
based on decommissioning studies, which are based largely on third party cost
estimates.
The following table is a general description of the AROs and their associated
long-lived assets.
March 31, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- -------------------------------------------------------------------------------------------------------------------
Palisades - decommission plant site 1972 Palisades nuclear plant $ 426
Big Rock - decommission plant site 1962 Big Rock nuclear plant 103
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line -
Closure of coal ash disposal areas Various Generating plants coal ash areas -
Closure of wells at gas storage fields Various Gas storage fields -
Indoor gas services equipment relocations Various Gas meters located inside structures -
====================================================================================================================
The following table is a reconciliation of the carrying amount of the AROs.
March 31, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
Pro Forma ARO Liability ARO
ARO liability ---------------------------- Cash flow liability
ARO 1/1/02 1/1/03 Incurred Settled Accretion Revisions 3/31/03
- ------------------------------- --------- ----------------------------------------------------------------------
Palisades - decommission $232 $249 $ - $ - $4 $ - $253
Big Rock - decommission 94 61 - (7) 3 - 57
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - - 1 - 52
Wells at gas storage fields 2 2 - - - - 2
Indoor gas services relocations 1 1 - - - - 1
--------- ----------------------------------------------------------------------
Total $375 $364 $ - $(7) $8 $ - $365
===================================================================================================================
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.
Upon adoption of the standard, there was no impact on Consumers' consolidated
financial statements.
CE-51
Consumers Energy Company
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. Upon
adoption of the standard on January 31, 2003, there was no impact on Consumers'
consolidated financial statements, and Consumers does not anticipate any
additional impact to its consolidated financial statements upon adoption of
additional standard requirements on July 1, 2003.
CE-52
PANHANDLE EASTERN PIPE LINE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
SALE OF PANHANDLE
In December 2002, CMS Energy reached a definitive agreement to sell the
Panhandle companies to Southern Union Panhandle Corp. The agreement called for
Southern Union Panhandle Corp, a newly formed entity owned by Southern Union
Company and AIG Highstar Capital L.P. to pay $662 million in cash and assume
$1.166 billion in debt. On March 13, 2003, CMS Energy and Southern Union Company
received requests for additional information ("second requests") from the FTC
related to Southern Union's acquisition of Panhandle. CMS Energy and Southern
Union are in the process of responding to the second requests.
On May 12, 2003, the parties entered into an amendment to the original stock
purchase agreement that was executed in December 2002. Under the amendment, AIG
Highstar Capital, L.P. and AIG Highstar II Funding Corp. will no longer be
parties to the transaction. The Amended and Restated Stock Purchase Agreement
calls for Southern Union Panhandle Corp. to purchase all of Panhandle's
outstanding capital stock. Southern Union Panhandle Corp. agreed to pay
approximately $584 million in cash and 3 million shares of Southern Union
Company common stock, and to assume approximately $1.166 billion in debt. The
total value of the transaction to CMS Energy will depend on the price of
Southern Union Company common stock at the closing. At May 12, 2003, the closing
price of Southern Union common stock on the New York Stock Exchange was $12.79.
The boards of directors of all applicable companies have approved the amended
agreement. The sale of Panhandle is subject to customary closing conditions and
action by the Federal Trade Commission under the Hart-Scott-Rodino Act. All
necessary state regulatory approvals for the sale pursuant to the original stock
purchase agreement have been received. The parties expect the amendment will
expedite the regulatory approval of the transaction and anticipate that state
regulatory authorities will not object to the changed terms provided for in the
amended agreement. The closing is expected to occur by June 30, 2003. AIG
Highstar Capital's withdrawal from the transaction should help resolve
regulatory issues that arose as a result of AIG Highstar Capital's ownership of
Southern Star Central Gas Pipeline's Inc. CMS Gas Transmission and Southern
Union also entered into a shareholder agreement, relating to CMS Gas
Transmission's ownership of the Southern Union shares of common stock. Pursuant
to this shareholder agreement, CMS Gas Transmission generally will be prohibited
from disposing of the Southern Union common stock for a period ending 90 - 105
days following the closing of the transaction.
Under the terms of the Panhandle sale agreement, CMS Energy was to retain
Panhandle's ownership interests in the Centennial and Guardian pipeline
projects, as well as certain of Panhandle's net deferred tax assets, all tax
liabilities, and pension and other postretirement assets and liabilities.
Panhandle has since sold its interest in Centennial and the Guardian interest
and the related cash collateral has been transferred to Panhandle's direct
parent, CMS Gas Transmission. For further information, see Note 5, Related Party
Transactions. CMS Gas Transmission has signed a definitive agreement to sell its
interest in Guardian which is also expected to close in the second quarter of
2003.
FORWARD-LOOKING STATEMENTS
Panhandle, an indirect subsidiary of CMS Energy, is primarily engaged in the
interstate transportation and storage of natural gas and conducts operations
primarily in the central, gulf coast, midwest, and southwest regions of the
United States. Panhandle also owns a LNG importation terminal (See Note 1,
Corporate Structure). The rates and conditions of service of the interstate
natural gas transmission and storage operations of Panhandle, as well as the LNG
operations, are subject to the rules and regulations of the FERC.
This MD&A refers to, and in some sections specifically incorporates by
reference, Panhandle's Condensed Notes to Consolidated Financial Statements and
should be read in conjunction with such Consolidated Financial Statements and
Condensed Notes. This Form 10-Q and other written and oral statements that
Panhandle may make contain forward-looking statements, as defined by the Private
Securities Litigation Reform Act of 1995. Panhandle's intentions with the use of
the words "anticipates," "believes," "estimates," "expects," "intends," and
"plans" and variations of such words and similar expressions, are solely to
identify forward-looking statements that involve risk and uncertainty. These
forward-looking statements are subject to various factors that could cause
Panhandle's actual results to differ materially from those anticipated in such
statements. Panhandle has no obligation to update or revise forward-looking
statements regardless of whether new information, future events or any other
factors affect the information contained in such statements. Panhandle does,
however, discuss certain risk factors, uncertainties and assumptions in this
MD&A and in Item 1 of the 2002 Form 10-K in the section entitled
"Forward-Looking Statements, Cautionary Factors and Uncertainties" and in
various public filings it periodically makes with the SEC. Panhandle designed
this discussion of potential risks and uncertainties, which is by no means
comprehensive, to highlight important factors that may impact Panhandle's
business and financial outlook. This Form 10-Q also describes material
contingencies in Panhandle's Condensed Notes to Consolidated Financial
Statements and Panhandle encourages its readers
PE-1
to review these Notes. All note references within this MD&A refer to Panhandle's
Condensed Notes to Consolidated Financial Statements.
The following information is provided to facilitate increased understanding of
the Consolidated Financial Statements and accompanying Condensed Notes of
Panhandle and should be read in conjunction with these financial statements.
Because all of the outstanding common stock of Panhandle Eastern Pipe Line is
owned by a wholly-owned subsidiary of CMS Energy, the following discussion uses
the reduced disclosure format permitted for issuers that are wholly-owned direct
or indirect subsidiaries of reporting companies.
CRITICAL ACCOUNTING POLICIES
USE OF ESTIMATES: The preparation of financial statements, in conformity with
accounting principles generally accepted in the United States, requires
management to make judgments, estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. The principles of SFAS No. 5
guide the recording of contingent liabilities within the financial statements.
Certain accounting principles require subjective and complex judgments used in
the preparation of financial statements. Accordingly, a different financial
presentation could result depending on the judgment, estimates or assumptions
that are used. Such estimates and assumptions, include, but are not specifically
limited to: depreciation and amortization, interest rates, discount rates,
future commodity prices, mark-to-market valuations, investment returns,
volatility in the price of CMS Energy Common Stock, impact of new accounting
standards, future costs associated with long-term contractual obligations,
future compliance costs associated with environmental regulations and continuing
creditworthiness of counterparties. Although these estimates are based on
management's knowledge of current expected future events, actual results could
materially differ from those estimates.
SYSTEM GAS AND OPERATING SUPPLIES: System gas and operating supplies consists of
gas held for operations and materials and supplies, carried at the lower of
weighted average cost or market. The gas held for operations that is not
expected to be consumed in operations in the next twelve months has been
reflected in non-current assets. All system gas and materials and supplies
purchased are recorded at the lower of cost or market, while net gas received
from and owed back to customers is valued at market.
GAS IMBALANCES: Gas imbalances occur as a result of differences in volumes of
gas received and delivered. Gas imbalance in-kind receivables and payables are
valued at cost or market, based on whether net imbalances have reduced or
increased system gas balances, respectively.
FUEL TRACKER: Liability accounts are maintained for net volumes of fuel gas owed
to customers collectively. Trunkline records an asset whenever fuel is due from
customers from prior under recovery based on contractual and specific tariff
provisions which support the treatment as an asset. Panhandle's other companies
that are subject to fuel tracker provisions record an expense when fuel is under
recovered. The pipelines' fuel reimbursement is in-kind and non-discountable.
RELATED PARTY TRANSACTIONS: Panhandle enters into a number of significant
transactions with related parties. These transactions include revenues for the
transportation of natural gas for Consumers, CMS MST and the MCV Partnership
which are based on regulated prices, market prices or competitive bidding.
Related party expenses include payments for services provided by affiliates, as
well as allocated benefit plan costs. Other income is primarily interest income
from the Note receivable - CMS Capital (See Note 5, Related Party Transactions).
PE-2
GOODWILL: Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The Company adopted the provisions of SFAS No. 142 as of
January 1, 2002. Goodwill acquired in a purchase business combination and
determined to have an indefinite useful life is not amortized, but instead
tested for impairment at least annually in accordance with the provisions of
SFAS No. 142. Panhandle completed the goodwill impairment testing required upon
adoption of SFAS No. 142 in 2002 which resulted in a $601 million pre-tax
write-down ($369 million after-tax) under the new standard. The impact was
reflected retroactively to the first quarter of 2002 as a cumulative effect of a
change in accounting for goodwill, pursuant to the requirements of SFAS No. 142.
ACCOUNTING FOR RETIREMENT BENEFITS: Panhandle follows SFAS No. 87 to account for
pension costs and 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 is a CMS Energy plan for CMS Energy and affiliates, of which
Panhandle is a participating affiliate. The Pension Plan includes amounts for
employees of CMS Energy and 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. The Pension Plan assets and obligations associated with Panhandle
employees will be retained by CMS Energy. Upon the closing of the sale of
Panhandle to Southern Union Panhandle Corp., none of the Panhandle employees
will be eligible to accrue additional benefits under the Pension Plan. However,
the Pension Plan will retain pension payment obligations for Panhandle employees
who are vested under the Pension Plan.
CMS Energy estimates CMS Energy's pension expense will approximate $46 million,
$51 million and $58 million in 2003, 2004 and 2005, respectively, as compared to
an approximated $33 million in 2002 of which Panhandle's allocated share is
approximately 11 percent. 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.
In order to keep health care benefits and costs competitive, CMS Energy has
announced several changes to the Health Care Plan. These changes are effective
January 1, 2003. The most significant change is that CMS Energy's future
increases in health care costs will be shared with salaried employees. The
salaried retirees Health Care Plan also has been amended. Pre-Medicare retirees
now elect coverage from four different levels of coverage, with the two best
coverage options reacquiring premium contributions. These plans also coordinate
benefits under a maintenance of benefits provision to reduce claims costs.
Mail-order prescription copays also have been increased for all salaried
employees.
ACCOUNTING FOR DERIVATIVES: Panhandle utilizes interest-rate related derivative
instruments to manage its exposure on its debt instruments and does not enter
into derivative instruments for any purpose other than hedging purposes. That
is, Panhandle does not speculate using derivative instruments.
Interest rate swap agreements are used to reduce interest rate risks and to
manage interest expense. By entering into these agreements, Panhandle generally
converts floating-rate debt into fixed-rate debt. This reduces Panhandle's risk
of incurring higher interest costs in periods of rising interest rates. Interest
differentials to be paid or received because of swap agreements are reflected as
an adjustment to interest
PE-3
expense. The negative fair value of interest rate swap agreements was $24
million pre-tax, $14 million net of tax at March 31, 2003 which is reflected in
comprehensive loss. Current market pricing models were used to estimate fair
values of interest rate swap agreements. The negative fair value of interest
rate swap agreements was $22 million pre-tax, $13 million net of tax at December
31, 2002. Current market pricing models were used to estimate fair values of
interest rate swap agreements.
RESULTS OF OPERATIONS
NET INCOME (LOSS):
IN MILLIONS
- ------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $31 $(340) $371
==================================================================================================================
- ----------------------------------------------------------------------------
REASONS FOR THE CHANGE IN MILLIONS
2003 VS. 2002
- ----------------------------------------------------------------------------
Reservation revenue $ (1)
LNG terminalling revenue 1
Commodity revenue 3
Equity earnings and other revenue 1
Operation, maintenance, administrative and general (4)
Depreciation and amortization (1)
Other income, net 1
Interest charges (2)
Minority interest 1
Income taxes 1
Cumulative effect of change in accounting principle,
net of tax 371
- ----------------------------------------------------------------------------
Total Change $ 371
============================================================================
For the quarter ended March 31, 2003, Panhandle had net income of $31 million,
an increase of $371 million from the corresponding period in 2002 due primarily
to a goodwill impairment charge of $601 million ($369 million after-tax) in the
first quarter of 2002 which was recorded in conjunction with the adoption of
SFAS No. 142. SFAS No. 142 requires that goodwill no longer be amortized over an
estimated useful life, but rather goodwill amounts are subject to a fair-value
based impairment assessment.
RESERVATION REVENUE: For the three months ended March 31, 2003, reservation
revenue decreased $1 million compared to the same time period during 2002, due
to slightly lower average reservation rates on Panhandle.
LNG TERMINALLING REVENUE: For the three months ended March 31, 2003, LNG
terminalling revenue increased $1 million compared to the same time period
during 2002 due to higher LNG volumes
PE-4
on the BG LNG Services contract. Trunkline LNG's 22-year agreement with BG LNG
Services for the existing uncommitted long-term capacity at the company's
facility became effective in January 2002 (see Note 3, Regulatory Matters).
COMMODITY REVENUE: For the three months ended March 31, 2003, commodity revenue
increased $3 million compared to the same time period during 2002, primarily due
to an increase in commodity volumes. Volumes increased 16 percent in the three
months of 2003 versus 2002 due to a colder winter in the Midwest market area
during the first quarter of 2003 compared to the same time period during 2002.
EQUITY EARNINGS AND OTHER REVENUE: Equity earnings and other revenue for the
three months ended March 31, 2003 increased $1 million compared to the same time
period during 2002. The increase was primarily due to the sale of Panhandle's
one-third equity interest in Centennial in February 2003 for $40 million to
Centennial's two other partners, MAPL and TEPPCO, which resulted in no income
for the Centennial equity investment during the first quarter of 2003, while
start-up related losses of $1 million occurred during the first quarter of 2002.
In addition, imbalance cash-out gains in the first quarter of 2003, recouping
prior losses, were comparable to a non-recurring gain of $4 million for the
settlement of Order 637 matters related to capacity release and imbalance
penalties during the first quarter of 2002 (see Note 3, Regulatory Matters).
OPERATION, MAINTENANCE, GENERAL AND ADMINISTRATIVE: Operation, maintenance,
general and administrative expenses increased by $4 million for the three months
ended March 31, 2003, compared to the same time period during 2002. Expense
increases in the first three months of 2003 were primarily due to Panhandle's
fuel costs in excess of recoveries from customers of $6.4 million and a
non-recurring adjustment recorded in the first quarter of 2002 of $3 million for
lower final incentive plan payouts approved in 2002 for 2001 awards, partially
offset by decreased CMS corporate charges during the first quarter of 2003.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization increased by $1
million for the three months ended March 31, 2003, compared to the same time
period during 2002. Expense increases in the first three months of 2003 were
primarily due to increases in the property, plant and equipment asset balances.
OTHER INCOME, NET: Other income, net for the three months ended March 31, 2003
increased $1 million compared to 2002, primarily due to increased interest
income related to a higher Note Receivable - CMS Capital balance and a higher
interest rate related to the note receivable balance during the first quarter of
2003 compared to the first quarter of 2002.
INTEREST CHARGES: Interest Charges for the three months ended March 31, 2003,
compared to the same time period during 2002, increased by $2 million primarily
due to Panhandle securing short-term bank loans in the amounts of $30 million
and $10 million during December 2002 and January 2003, respectively, higher
charges for the LNG Holding's interest rate swaps of $150 million and a
non-recurring gain of $2 million in the first quarter of 2002 for reversal of
interest expense related to the Order 637 settlement. The increases were
partially offset by elimination of interest on $129 million of reductions of
long-term debt principal in April 2002 and May 2002. On March 31, 2003,
Panhandle retired approximately $7 million of the $40 million short-term bank
loans. For further discussion of Panhandle's long-term debt and guarantees, see
Note 7, Commitments and Contingencies - Other Commitments and Contingencies.
MINORITY INTEREST: Minority interest decreased $1 million for the three months
ended March 31, 2003 compared to the same time period during 2002 due to
Panhandle purchasing Dekatherm Investor
PE-5
Trust's interest in LNG Holdings during November 2002 for approximately $41
million. As a result, Panhandle owns 100 percent of LNG Holdings.
INCOME TAXES: Income taxes during the three months ended March 31, 2003,
compared to the same time period during 2002, decreased $1 million due to
corresponding changes in pretax income.
OUTLOOK
Panhandle is a leading United States interstate natural gas pipeline system and
also owns the nation's largest operating LNG regasification terminal and intends
to optimize results through expansion and better utilization of its existing
facilities and construction of new facilities. This involves providing
additional transportation, storage and other asset-based value-added services to
customers such as gas-fueled power plants, local distribution companies,
industrial and end-users, marketers and others. Panhandle conducts operations
primarily in the central, gulf coast, midwest, and southwest regions of the
United States.
In December 2002, CMS Energy reached a definitive agreement to sell the
Panhandle companies to Southern Union Panhandle Corp. The agreement called for
Southern Union Panhandle Corp, a newly formed entity owned by Southern Union
Company and AIG Highstar Capital L.P. to pay $662 million in cash and assume
$1.166 billion in debt. On March 13, 2003, CMS Energy and Southern Union Company
received requests for additional information ("second requests") from the FTC
related to Southern Union's acquisition of Panhandle. CMS Energy and Southern
Union are in the process of responding to the second requests.
On May 12, 2003, the parties entered into an amendment to the original stock
purchase agreement that was executed in December 2002. Under the amendment, AIG
Highstar Capital, L.P. and AIG Highstar II Funding Corp. will no longer be
parties to the transaction. The Amended and Restated Stock Purchase Agreement
calls for Southern Union Panhandle Corp. to purchase all of Panhandle's
outstanding capital stock. Southern Union Panhandle Corp. agreed to pay
approximately $584 million in cash and 3 million shares of Southern Union
Company common stock, and to assume approximately $1.166 billion in debt. The
total value of the transaction to CMS Energy will depend on the price of
Southern Union Company common stock at the closing. At May 12, 2003, the closing
price of Southern Union common stock on the New York Stock Exchange was $12.79.
The boards of directors of all applicable companies have approved the amended
agreement. The sale of Panhandle is subject to customary closing conditions and
action by the Federal Trade Commission under the Hart-Scott-Rodino Act. All
necessary state regulatory approvals for the sale pursuant to the original stock
purchase agreement have been received. The parties expect the amendment will
expedite the regulatory approval of the transaction and anticipate that state
regulatory authorities will not object to the changed terms provided for in the
amended agreement. The closing is expected to occur by June 30, 2003. AIG
Highstar Capital's withdrawal from the transaction should help resolve
regulatory issues that arose as a result of AIG Highstar Capital's ownership of
Southern Star Central Gas Pipeline's Inc. CMS Gas Transmission and Southern
Union also entered into a shareholder agreement, relating to CMS Gas
Transmission's ownership of the Southern Union shares of common stock. Pursuant
to this shareholder agreement, CMS Gas Transmission generally will be prohibited
from disposing of the Southern Union common stock for a period ending 90 - 105
days following the closing of the transaction.
Under the terms of the Panhandle sale agreement, CMS Energy was to retain
Panhandle's ownership interests in the Centennial and Guardian pipeline
projects, as well as certain of Panhandle's net deferred tax assets, all tax
liabilities, and pension and other postretirement assets and liabilities.
On February 10, 2003, Panhandle sold its one-third equity interest in Centennial
to Centennial's two other partners, MAPL and TEPPCO for $40 million with no
income impact resulting from the sale in 2003 (see Note 5, Related Party
Transactions).
On March 10, 2003, Panhandle's ownership interest in Guardian was transferred to
CMS Gas Transmission (see Note 5, Related Party Transactions). CMS Gas
Transmission has signed a definitive agreement to sell its interest in Guardian
which is also expected to close in the second quarter of 2003.
In October 2001, Trunkline LNG announced the planned expansion of the Lake
Charles facility to approximately 1.2 bcf per day of send out capacity, up from
its current send out capacity of 630 million cubic feet per day. In December
2002, FERC approved the expansion of the LNG regasification terminal. In March
2003, Trunkline LNG received FERC authorization to commence construction. On
April 17, 2003, Trunkline LNG filed to amend the authority granted for its LNG
expansion with certain facility modifications. The modifications will not affect
the authorized additional storage capacity and daily sendout capability and
confirms the revised in-service date of January 1, 2006. The expansion
expenditures are currently expected to be funded by Panhandle contributions to
LNG Holdings, sourced
PE-6
by operating cash flows, capital markets or other funding. For further
discussion of Trunkline LNG, see Note 3, Regulatory Matters.
UNCERTAINTIES: Panhandle's results of operations and financial position may be
affected by a number of trends or uncertainties that have, or Panhandle
reasonably expects could have, a material impact on income from continuing
operations and cash flows. Such trends and uncertainties include: 1) the
increased competition in the market for transmission of natural gas to the
midwest causing pressure on prices charged by Panhandle; 2) the current market
conditions causing more contracts to be of shorter duration, which may increase
revenue volatility; 3) the increased potential for declining financial condition
of certain customers within the industry due to recession and other factors; 4)
exposure to customer concentration with a significant portion of revenues
realized from a relatively small number of customers; 5) the possibility of
decreased demand for natural gas resulting from a downturn in the economy and
the scaling back of new power plants; 6) the impact of any future rate cases,
for any of Panhandle's regulated operations; 7) the impact of current
initiatives for additional federal rules and legislation regarding pipeline
safety; 8) capital spending requirements for safety, environmental or regulatory
requirements that could result in depreciation expense increases not covered by
additional revenues; 9) the impact of CMS Energy and its subsidiaries'
distressed financial condition and ratings downgrades on Panhandle's liquidity
and costs of operating, including Panhandle's reduced ability to draw on the CMS
Capital loan and current limited access to capital markets; 10) impact of the
trend of increasing costs for employee benefits including medical and retirement
related costs; 11) the effects of changing regulatory and accounting related
matters resulting from current events; and 12) the impact of the proposed
acquisition by Southern Union Panhandle Corp. For further information about
uncertainties, see Note 7, Commitments and Contingencies.
LIQUIDITY
CMS ENERGY FINANCIAL CONDITION
In July of 2002, the credit ratings of the publicly traded securities of CMS
Energy and Panhandle were downgraded by the major rating agencies. The ratings
downgrade for both companies' securities was largely a function of the
uncertainties associated with CMS Energy's financial condition and liquidity,
restatement and re-audit of 2000 and 2001 financial statements, and lawsuits
that directly affects and limits CMS Energy's access to the capital markets.
As a result of certain of these downgrades, contractual rights were triggered in
several contractual arrangements between Panhandle and third parties, as
described in the Panhandle Financial Condition section below.
In response to the July debt downgrades, CMS Energy and its subsidiaries
Consumers and Enterprises have replaced or restructured several of their
existing unsecured credit facilities with secured credits. The new facilities
have conditions requiring mandatory prepayment of borrowings from asset sales,
debt issuances and/or equity issuances, impose certain dividend restrictions and
grant the applicable bank groups either first or second liens on the capital
stock of Enterprises and its major direct and indirect domestic subsidiaries,
including Panhandle Eastern Pipe Line (but excluding subsidiaries of Panhandle
Eastern Pipe Line).
CMS Energy's liquidity and capital requirements are generally a function of its
results of operations, capital expenditures, contractual obligations, working
capital needs and collateral requirements. CMS Energy has historically met its
consolidated cash needs through its operating and investing activities and, as
needed, through access to bank financing and the capital markets.
PE-7
In 2003, CMS Energy has contractual obligations and planned capital expenditures
that would require substantial amounts of cash. CMS Energy at the parent level
had approximately $598 million and Panhandle had approximately $52 million of
publicly issued and credit facility debt maturing in 2003.
CMS Energy has taken significant steps to address its 2003 maturities, as
described below. As of May 9, 2003, CMS Energy at the parent level had
approximately $220 million and Panhandle had approximately $39 million of
remaining publicly issued and credit facility debt maturing in 2003. In
addition, CMS Energy could also become subject to liquidity
demands pursuant to commercial commitments under guarantees, indemnities and
letters of credit. Management is actively pursuing plans to refinance debt and
to sell assets, including the sale of Panhandle. See Outlook section of this
MD&A.
CMS Energy has reduced debt through asset sales, securitization proceeds, and
proceeds from LNG monetization, with a total of approximately $2.8 billion in
cash proceeds from such events over the past two years. Through March of 2003,
CMS Energy has accomplished approximately $97 million of additional asset sales.
In January 2003, CMS MST closed on the sale of a substantial portion of its
natural gas trading contracts for $17 million of cash proceeds. The sale of its
interest in the Centennial Pipeline, resulting in net proceeds to CMS Energy of
$40 million, closed in February 2003. Additionally, in March 2003, CMS MST sold
substantially all of its wholesale power book and related supply portfolio for
cash proceeds of $34 million to Constellation Power Source, Inc. The sale
contains a potential to increase proceeds to $40 million dependent upon future
years' performance of the sold assets. Additionally, during the first quarter of
2003, CMS MST sold its 50 percent joint venture ownership interest in Texon, its
50 percent interest in Premstar and its Tulsa retail contracts, resulting in net
cash proceeds of approximately $6 million.
CMS Energy believes that further targeted asset sales, together with its planned
reductions in operating expenses, capital expenditures, and the suspension of
the common dividend also will contribute to improved liquidity. CMS Energy
believes that, assuming the successful implementation of its financial
improvement plan, its present 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. There can be no assurances
that the financial improvement plan will be successful and failure to achieve
its goals could have a material adverse effect on CMS Energy's liquidity and
operations. In such event, CMS Energy would be required to consider the full
range of strategic measures available to companies in similar circumstances.
CMS Energy continues to explore financing opportunities to supplement its
financial improvement plan. These potential opportunities include refinancing
its bank credit facilities; entering into leasing arrangements and/or vendor
financing; refinancing and issuing new capital markets debt, preferred and/or
common equity; and negotiating private placement debt, preferred and/or common
equity. Specifically, as of March 31, 2003, CMS Energy has taken the following
action to supplement its financial improvement plan in 2003:
o On March 30, 2003 CMS Energy entered into an amendment and restatement
of its existing $300 million and $295.8 million revolving credit
facilities under which $409 was then outstanding. The Second Amended
and Restated Senior Credit Agreement includes a $159 million tranche
with a maturity date of April 30, 2004 and a $250 million tranche with
a maturity date of
PE-8
September 30, 2004. The facility was underwritten by several banks at a
total annual cost to CMS Energy of approximately ten percent, which
includes the initial commitment fee. Any proceeds of debt or equity
issuances by CMS Energy and its subsidiaries or any asset sales by CMS
Energy or its subsidiaries, other than Consumers, are required to be
used to prepay this facility. This facility is primarily collateralized
by the stock of Consumers, Enterprises and certain Enterprises
subsidiaries.
o On March 30, 2003 Enterprises entered into a revolving credit facility
in an aggregate amount of $441 million. The maturity date of this
facility is April 30, 2004. Subsequently, on April 21, 2003,
Enterprises entered into a $75 million revolving credit facility with a
maturity date of April 30, 2004. These facilities were being
underwritten by several banks at a total annual cost to CMS Energy of
approximately ten percent, which includes the initial commitment fee.
Proceeds from these loans will be used for general corporate purposes,
to retire debt and to collateralize $160 million of letters of credit.
Any proceeds of debt or equity issuances by CMS Energy and its
subsidiaries or any asset sales by CMS Energy or its subsidiaries,
other than Consumers, are required to be used to prepay these
facilities. It is expected that proceeds from the Panhandle sale will
be used to pay off these facilities in full. These facilities are
guaranteed by CMS Energy, whose guaranty is primarily secured by the
stock of Consumers and Enterprises.
In 1994, CMS Energy executed an indenture with J.P. Morgan Chase Bank pursuant
to CMS Energy's general term notes program. The indenture, through supplements,
contains certain provisions that can trigger a limitation on CMS Energy's
consolidated indebtedness. The limitation can be activated when CMS Energy's
consolidated leverage ratio, as defined in the indenture (essentially the ratio
of consolidated debt to consolidated capital), exceeds 0.75 to 1.0. At March 31,
2003, CMS Energy's consolidated leverage ratio was 0.79 to 1.0. As a result, CMS
Energy will not permit certain material subsidiaries, excluding Consumers and
its subsidiaries but including Panhandle and its subsidiaries, to become liable
for new indebtedness. However, CMS Energy and the material subsidiaries may
incur revolving indebtedness to banks of up to $1 billion in the aggregate and
refinance existing debt outstanding of CMS Energy and of its material
subsidiaries. This leverage ratio may be significantly reduced with the proceeds
of CMS Energy's sale of Panhandle, its sale of CMS Field Services, other asset
sales or other options.
PANHANDLE FINANCIAL CONDITION
On June 11, 2002, Moody's Investors Service, Inc. lowered its rating on
Panhandle's senior unsecured notes from Baa3 to Ba2 based on concerns
surrounding the liquidity and debt levels of CMS Energy (see discussion in the
CMS Energy Financial Condition section above). On July 15, 2002, Fitch Ratings,
Inc. lowered its rating on these notes from BBB to BB+ and again on September 4,
2002 to BB based on similar concerns. On July 16, 2002, S&P also lowered its
rating on these notes from BBB- to BB, in line with their rating on CMS Energy
based on their belief that CMS Energy and its subsidiaries are at equal risk of
default since the parent relies on its subsidiaries to meet its financial
commitments. Effective with these downgrades, Panhandle's debt is below
investment grade which, if not restored to investment grade, will increase
operating and financing costs. Panhandle's senior unsecured note provisions are
not directly impacted by debt rating reductions, but are subject to other
requirements such as the maintenance of a fixed charge coverage ratio and a
leverage ratio which restrict certain payments if not maintained and limitations
on liens. At March 31, 2003, Panhandle was subject to a $168 million limitation
on additional restricted payments, including dividends and loans to affiliates.
At March 31,
PE-9
2003, Panhandle was in compliance with all covenants, having received a waiver
for a certain matter as discussed below.
Due to liquidity issues related to CMS Energy and subsidiaries as discussed
above, Panhandle's ability to draw on the full amount of the Note Receivable
from CMS Capital, if needed, could be affected.
In conjunction with the Centennial and Guardian pipeline projects, Panhandle
provided guarantees related to the project financings during the construction
phases and initial operating periods. On July 17, 2002, following the Panhandle
debt ratings downgrades by Moody's and S&P, the lender sent notice to Panhandle,
pursuant to the terms of the guaranty agreements, requiring Panhandle to provide
acceptable credit support for its pro rata portion of those construction loans,
which aggregated $110 million including anticipated future draws. On September
27, 2002, Centennial's other partners provided credit support of $25 million
each in the form of guarantees to the lender to cover Panhandle's obligation of
$50 million of loan guarantees. The partners were paid credit fees by Panhandle
on the outstanding balance of the guarantees for the periods which they were in
effect. In December 2002, Panhandle recorded a $26 million pre-tax ($16 million
after-tax) write-down of its investment in Centennial to $40 million as a result
of indicated values upon announcement of the definitive agreement to sell
Panhandle and the associated efforts to sell Centennial. On February 10, 2003,
Panhandle sold its one-third equity interest in Centennial for $40 million to
Centennial's two other partners, MAPL and TEPPCO. Panhandle has been released by
MAPL, TEPPCO and the lenders for any liabilities related to Panhandle's $50
million parent guaranty of the project debt. In March 2003, $40 million of cash
capital from the sale of Centennial was returned to CMS Gas Transmission.
In October 2002, Panhandle provided a letter of credit to the Guardian lenders
which constitutes acceptable credit support under the Guardian financing
agreement. This letter of credit was cash collateralized by Panhandle with
approximately $63 million. Effective March 10, 2003, Panhandle's ownership
interest in Guardian was transferred to CMS Gas Transmission. Panhandle was
released from its guarantee obligations associated with the Guardian
non-recourse guaranty as of March 10, 2003 by Prudential and the other
noteholders. For further information, see Note 5, Related Party Transactions.
In December 2002 and January 2003, Panhandle secured short-term bank loans in
the amounts of $30 million and $10 million, respectively, with interest payable
at rates of LIBOR plus 4 percent. The loans are due the earlier of December 2003
or upon the sale of Panhandle. On March 31, 2003, Panhandle retired
approximately $7 million of the short-term bank loans. The stock of most of
Panhandle's subsidiaries were pledged as collateral for the loans, which were
utilized to improve overall liquidity which had been reduced by various cash
requirements.
On March 1, 2003, certain assets held by CMS Field Services were contributed to
Panhandle by its parent, CMS Gas Transmission, with a net book value of $15.2
million, to be included in the sale to Southern Union Panhandle Corp.
Panhandle had received a waiver until April 30, 2003 to provide certified
September 30, 2002 financial statements to the LNG Holdings lenders under that
credit facility. Panhandle has since satisfied that requirement. Panhandle also
has received a waiver until June 30, 2003 of a requirement to provide certain
documentation. Should it be unable to execute the required documents by the
timing indicated, LNG Holdings could be declared to be in default under its
credit facility and the debt thereunder could be accelerated and become
immediately due and payable.
PE-10
OTHER MATTERS
DISCLOSURE AND INTERNAL CONTROLS
Panhandle's CEO and CFO are responsible for establishing and maintaining
Panhandle's disclosure controls and procedures. Management, under the direction
of Panhandle's principal executive and financial officers, has evaluated the
effectiveness of Panhandle's disclosure controls and procedures within the past
ninety days of this filing. Based on this evaluation, Panhandle's CEO and CFO
have concluded that disclosure controls and procedures are effective to ensure
that material information was presented to them and properly disclosed. There
have been no significant changes in Panhandle's internal controls that could
significantly affect internal controls subsequent to such evaluation.
CUSTOMER CONCENTRATION
During the first quarter of 2003, sales to Proliance Energy, LLC, a
nonaffiliated local distribution company and gas marketer, accounted for 16
percent of Panhandle's consolidated revenues, sales to BG LNG Services, a
nonaffiliated gas marketer, accounted for 11 percent and sales to subsidiaries
of CMS Energy also accounted for 11 percent of Panhandle's consolidated
revenues. No other customer accounted for 10 percent or more of consolidated
revenues during the same period. Aggregate sales to Panhandle's top 10 customers
accounted for 67 percent of revenues during the first quarter of 2003.
ENVIRONMENTAL MATTERS
Panhandle is subject to federal, state, and local laws and regulations governing
environmental quality and pollution control. These laws and regulations under
certain circumstances require Panhandle to remove or remedy the effect on the
environment of specified substances at its operating sites.
PCB ASSESSMENT AND CLEAN-UP PROGRAMS: Panhandle previously identified
environmental contamination at certain sites on its systems and undertook
clean-up programs at these sites. The contamination resulted from the past use
of lubricants containing PCBs in compressed air systems and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle is
also taking actions regarding PCBs in paints at various locations. For further
information, see Note 7, Commitments and Contingencies - Environmental Matters.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. Based on EPA guidance to these states for development of
these SIPS, Panhandle expects future compliance costs to be approximately $16
million for capital improvements to be incurred from 2004 through 2007.
Panhandle expects final rules from the EPA in 2003 and 2004 regarding control of
hazardous air pollutants, and Panhandle expects that some of its engines and
turbines will be affected. In 2002, the Texas Commission on Environmental
Quality enacted the Houston/Galveston SIP regulations requiring reductions in
nitrogen oxide emissions in an eight-county area surrounding Houston.
Trunkline's Cypress compressor station is affected and may require the
installation of emission controls. In 2003, the new regulations will also
require all grandfathered facilities to enter into the new source permit program
which may require the installation of emission controls at five additional
facilities. The company expects to incur future capital costs of approximately
$21 million in order to comply with these programs.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm compressor station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a
PE-11
subsidiary of Duke Energy was obligated to indemnify Panhandle against this
environmental penalty. The state issued a permit in February 2002 requiring the
installation of certain capital improvements at the facility at a cost of
approximately $3 million. Controls were installed on two engines in 2002 and it
is planned to install controls on two additional engines in 2003 in accordance
with the 2002 permit. For further information on the above environmental
matters, see Note 7, Commitments and Contingencies - Environmental Matters.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS: The SEC
has adopted new rules that require the company to provide, in a separate
captioned subsection of the MD&A, a comprehensive explanation of its off-balance
sheet arrangements that have, or are reasonably likely to have, a current or
future effect on the company that is material to investors. As of December 31,
2002, Panhandle had guarantees related to the Centennial and Guardian pipeline
projects of $50 million and $60 million, respectively, and a letter of credit
for $63 million supporting the Guardian guarantee. Panhandle has since been
released from these guarantees and the letter of credit obligation has been
transferred to CMS Gas Transmission (see Panhandle Financial Condition section
of this MD&A). As of March 31, 2003, Panhandle has purchased $2 million of
surety bonds to indemnify third parties for unforeseen events which may occur in
the course of construction or repair projects.
CASH MANAGEMENT: In August 2002, FERC issued a NOPR concerning the management of
funds by certain FERC-regulated companies. The proposed rule could establish
limits on the amount of funds that may be swept from a regulated subsidiary to a
non-regulated parent under cash management programs. The proposed rule would
require written cash management arrangements that would specify the duties and
restrictions of the participants, the methods of calculating interest and
allocating interest income and expenses, and the restrictions on deposits or
borrowings by money pool members. These cash management agreements may also
require participants to provide documentation of certain transactions. In the
NOPR, FERC proposed that to participate in a cash management or money pool
arrangement, FERC-regulated entities would be required to maintain a minimum
proprietary capital balance (stockholder's equity) of 30 percent and both the
FERC-regulated entity and its parent would be required to maintain investment
grade credit ratings. The FERC recently met, but no action was taken on cash
management issues related to the NOPR.
NEW ACCOUNTING STANDARDS
In addition to the identified critical accounting policies discussed above,
future results will be affected by a number of new accounting standards that
recently have been issued.
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 Panhandle, 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. Panhandle will be required to
consolidate any entities that meet the requirements of the interpretation.
Panhandle has adopted the interpretation effective January 1, 2003 and the
implementation had no impact on the financial statements presented.
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PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN MILLIONS)
Three Months Ended March 31,
2003 2002
--------- ---------
OPERATING REVENUE
Transportation and storage of natural gas $ 116 $ 114
LNG terminalling revenue 14 13
Equity losses from unconsolidated subsidiaries - (1)
Other 7 7
--------- ---------
Total operating revenue 137 133
--------- ---------
OPERATING EXPENSES
Operation and maintenance 34 32
Administrative and general 19 17
Depreciation and amortization 14 13
General taxes 7 7
--------- ---------
Total operating expenses 74 69
--------- ---------
PRETAX OPERATING INCOME 63 64
OTHER INCOME, NET 4 3
INTEREST CHARGES
Interest on long-term debt 18 20
Other interest 2 (2)
--------- ---------
Total interest charges 20 18
MINORITY INTEREST - 1
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 47 48
INCOME TAXES 18 19
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 29 29
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE,
NET OF TAX:
Goodwill, FAS 142 - (369)
Asset Retirement Obligations, FAS 143 2 -
--------- ---------
CONSOLIDATED NET INCOME (LOSS) $ 31 $ (340)
========= =========
The accompanying condensed notes are an integral part of these statements.
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PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Three Months Ended March 31,
2003 2002
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 31 $ (340)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 14 13
Cumulative effect of change in accounting principle (2) 369
Deferred income taxes 18 22
Changes in current assets and liabilities (7) (35)
----------- ----------
Net cash provided by operating activities 54 29
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital and investment expenditures (13) (10)
Purchase of system gas (2) -
Sale of Centennial 40 -
Retirements and other 1 (5)
----------- ----------
Net cash provided by (used in) investing activities 26 (15)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (increase)/decrease in current Note receivable - CMS Capital (62) 7
Debt issuance 10 -
Debt retirements (10) -
Debt issuance costs - (2)
Return of capital (40) -
Dividend - (16)
Other - 1
----------- ----------
Net cash used in financing activities (102) (10)
----------- ----------
Net Increase in Cash and Temporary Cash Investments (22) 4
CASH AND TEMPORARY CASH INVESTMENTS,
BEGINNING OF PERIOD 81 3
----------- ----------
CASH AND TEMPORARY CASH INVESTMENTS,
END OF PERIOD $ 59 $ 7
=========== ==========
OTHER CASH FLOW ACTIVITIES WERE:
Interest paid (net of amounts capitalized) $ 32 $ 34
OTHER NONCASH ACTIVITIES WERE:
Return of capital - Guardian equity investment $ (28) $ -
Property contributions received 15 -
The accompanying condensed notes are an integral part of these statements.
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PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
March 31,
2003 December 31,
(Unaudited) 2002
------------ ------------
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Cost $ 1,794 $ 1,765
Less accumulated depreciation and amortization 202 188
------------ ------------
Sub-total 1,592 1,577
Construction work-in-progress 48 44
------------ ------------
Net property, plant and equipment 1,640 1,621
------------ ------------
INVESTMENTS IN AFFILIATES 5 68
------------ ------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 59 81
Restricted cash - 64
Accounts receivable, less allowances of $5 and $8 as of March 31, 2003
and December 31, 2002, respectively 50 50
Accounts receivable - related parties 6 9
Gas imbalances - receivable 31 18
System gas and operating supplies 27 41
Deferred income taxes 10 13
Note receivable - CMS Capital 185 60
Other 6 6
------------ ------------
Total current assets 374 342
------------ ------------
NON-CURRENT ASSETS
Goodwill, net 113 113
Debt issuance cost 17 17
Deferred income taxes 28 40
Non-current system gas 12 15
Other 16 16
------------ ------------
Total non-current assets 186 201
------------ ------------
TOTAL ASSETS $ 2,205 $ 2,232
============ ============
The accompanying condensed notes are an integral part of these statements.
PE-15
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
March 31,
2003 December 31,
(Unaudited) 2002
------------- -------------
COMMON STOCKHOLDER'S EQUITY AND LIABILITIES
CAPITALIZATION
Common stockholder's equity
Common stock, no par, 1,000 shares authorized, issued and outstanding $ 1 $ 1
Accumulated other comprehensive loss (40) (39)
Other paid-in capital 1,228 1,281
Accumulated deficit (310) (341)
Note receivable - CMS Capital (150) (150)
------------- -------------
Total common stockholder's equity 729 752
Long-term debt 1,147 1,150
------------- -------------
Total capitalization 1,876 1,902
------------- -------------
CURRENT LIABILITIES
Accounts payable 9 9
Accounts payable - related parties 6 8
Current portion of long-term debt 12 12
Note payable 33 30
Gas imbalances - payable 42 41
Accrued taxes 15 11
Accrued interest 11 25
Accrued liabilities 20 21
Other 43 38
------------- -------------
Total current liabilities 191 195
------------- -------------
NON-CURRENT LIABILITIES
Post-retirement benefits 55 53
Other 83 82
------------- -------------
Total non-current liabilities 138 135
------------- -------------
TOTAL COMMON STOCKHOLDER'S EQUITY AND LIABILITIES $ 2,205 $ 2,232
============= =============
The accompanying condensed notes are an integral part of these statements.
PE-16
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
AND COMPREHENSIVE INCOME
(UNAUDITED)
(IN MILLIONS)
Three Months Three Months
Ended Ended
March 31, March 31,
2003 2002
------------- -------------
COMMON STOCK
At beginning and end of period $ 1 $ 1
------------- -------------
OTHER PAID-IN CAPITAL
At beginning of period 1,281 1,286
Return of capital - Centennial (40) -
Return of capital - Guardian equity investment (28) -
Trunkline Field Services contribution from CMS Gas Transmission 15 -
------------- -------------
At end of period 1,228 1,286
------------- -------------
ACCUMULATED OTHER COMPREHENSIVE LOSS
Minimum Pension Liability
At beginning of period (26) -
------------- -------------
At end of period (26) -
------------- -------------
Interest Rate Swaps
At beginning of period (13) -
Unrealized loss related to interest rate swaps (1) -
------------- -------------
At end of period (14) -
------------- -------------
ACCUMULATED DEFICIT
At beginning of period (341) (13)
Net income 31 (340)
Common stock dividends - (16)
------------- -------------
At end of period (310) (369)
------------- -------------
NOTE RECEIVABLE - CMS CAPITAL
At beginning of period (150) (150)
------------- -------------
At end of period (150) (150)
------------- -------------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 729 $ 768
============= =============
Disclosure of Comprehensive Income:
Other comprehensive income
Interest Rate Swaps
Unrealized loss related to interest rate swaps, net of tax $ (1) $ -
Net income (loss) 31 (340)
------------- -------------
Total Comprehensive Income (Loss) $ 30 $ (340)
============= =============
The accompanying condensed notes are an integral part of these statements.
PE-17
PANHANDLE EASTERN PIPE LINE COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by Panhandle
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. As such, certain information and footnote
disclosures normally included in full year financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. Certain prior year amounts have been
reclassified to conform to the presentation in the current year. In management's
opinion, the unaudited information contained in this report reflects all
adjustments necessary to assure the fair presentation of financial position,
results of operations and cash flows for the periods presented. The Condensed
Notes to the Consolidated Financial Statements and the related Consolidated
Financial Statements should be read in conjunction with the Consolidated
Financial Statements and Notes to Consolidated Financial Statements contained in
the Panhandle Form 10-K for the year ended December 31, 2002 which includes the
Report of the Independent Auditors. Due to the seasonal nature of Panhandle's
operations, the results as presented for this interim period are not necessarily
indicative of results to be achieved for the fiscal year.
1. CORPORATE STRUCTURE
Panhandle is a wholly owned subsidiary of CMS Gas Transmission and ultimately
CMS Energy. Panhandle was incorporated in Delaware in 1929. Panhandle is
primarily engaged in interstate transportation and storage of natural gas, owns
a LNG regasification plant and related facilities, and is subject to the rules
and regulations of the FERC. It conducts operations in the central, gulf coast,
midwest, and southwest regions of the United States.
In December 2002, CMS Energy reached a definitive agreement to sell the
Panhandle companies to Southern Union Panhandle Corp. The agreement called for
Southern Union Panhandle Corp, a newly formed entity owned by Southern Union
Company and AIG Highstar Capital L.P. to pay $662 million in cash and assume
$1.166 billion in debt. On March 13, 2003, CMS Energy and Southern Union Company
received requests for additional information ("second requests") from the FTC
related to Southern Union's acquisition of Panhandle. CMS Energy and Southern
Union are in the process of responding to the second requests.
On May 12, 2003, the parties entered into an amendment to the original stock
purchase agreement that was executed in December 2002. Under the amendment, AIG
Highstar Capital, L.P. and AIG Highstar II Funding Corp. will no longer be
parties to the transaction. The Amended and Restated Stock Purchase Agreement
calls for Southern Union Panhandle Corp. to purchase all of Panhandle's
outstanding capital stock. Southern Union Panhandle Corp. agreed to pay
approximately $584 million in cash and 3 million shares of Southern Union
Company common stock, and to assume approximately $1.166 billion in debt. The
total value of the transaction to CMS Energy will depend on the price of
Southern Union Company common stock at the closing. At May 12, 2003, the closing
price of Southern Union common stock on the New York Stock Exchange was $12.79.
The boards of directors of all applicable companies have approved the amended
agreement. The sale of Panhandle is subject to customary closing conditions and
action by the Federal Trade Commission under the Hart-Scott-Rodino Act. All
necessary state regulatory approvals for the sale pursuant to the original stock
purchase agreement have been received. The parties expect the amendment will
expedite the regulatory approval of the transaction and anticipate that state
regulatory authorities will not object to the changed terms provided for in the
amended agreement. The closing is expected to occur by June 30, 2003. AIG
Highstar Capital's withdrawal from the transaction should help resolve
regulatory issues that arose as a result of AIG Highstar Capital's ownership of
Southern Star Central Gas Pipeline's Inc. CMS Gas Transmission and Southern
Union also entered into a shareholder agreement, relating to CMS Gas
Transmission's ownership of the Southern Union shares of common stock. Pursuant
to this shareholder agreement, CMS Gas Transmission generally will be prohibited
from disposing of the Southern Union common stock for a period ending 90 - 105
days following the closing of the transaction.
Under the terms of the Panhandle sale agreement, CMS Energy was to retain
Panhandle's ownership interests in the Centennial and Guardian pipeline
projects, as well as certain of Panhandle's net deferred tax assets, all tax
liabilities, and pension and other postretirement assets and liabilities.
Panhandle has since sold its interest in Centennial and the Guardian interest
and the related cash collateral has been transferred to Panhandle's direct
parent, CMS Gas Transmission. For further information, see Note 5, Related Party
Transactions. CMS Gas Transmission has signed a definitive agreement to sell its
interest in Guardian, which is also expected to close in the second quarter of
2003.
On March 1, 2003, certain assets held by CMS Field Services with net book value
of $15.2 million were contributed to Panhandle by its parent, CMS Gas
Transmission, to be included in the sale to Southern
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Union Panhandle Corp.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
PRINCIPLES OF CONSOLIDATIONS: The consolidated financial statements include the
accounts of Panhandle and all majority-owned subsidiaries, after eliminating
significant intercompany transactions and balances. Investments in businesses
not controlled by Panhandle, but over which it has significant influence, are
accounted for using the equity method.
USE OF ESTIMATES: The preparation of financial statements, in conformity with
accounting principles generally accepted in the United States, requires
management to make judgments, estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. The principles of SFAS No. 5
guide the recording of contingent liabilities within the financial statements.
Certain accounting principles require subjective and complex judgments used in
the preparation of financial statements. Accordingly, a different financial
presentation could result depending on the judgment, estimates or assumptions
that are used. Such estimates and assumptions, include, but are not specifically
limited to: depreciation and amortization, interest rates, discount rates,
future commodity prices, mark-to-market valuations, investment returns,
volatility in the price of CMS Energy Common Stock, impact of new accounting
standards, future costs associated with long-term contractual obligations,
future compliance costs associated with environmental regulations and continuing
creditworthiness of counterparties. Although these estimates are based on
management's knowledge of current expected future events, actual results could
materially differ from those estimates.
SYSTEM GAS AND OPERATING SUPPLIES: System gas and operating supplies consists of
gas held for operations and materials and supplies, carried at the lower of
weighted average cost or market. The gas held for operations that is not
expected to be consumed in operations in the next twelve months has been
reflected in non-current assets. All system gas and materials and supplies
purchased are recorded at the lower of cost or market, while net gas received
from and owed back to customers is valued at market.
GAS IMBALANCES: Gas imbalances occur as a result of differences in volumes of
gas received and delivered. Gas imbalance in-kind receivables and payables are
valued at cost or market, based on whether net imbalances have reduced or
increased system gas balances, respectively.
FUEL TRACKER: Liability accounts are maintained for net volumes of fuel gas owed
to customers collectively. Trunkline records an asset whenever fuel is due from
customers from prior under recovery based on contractual and specific tariff
provisions which support the treatment as an asset. Panhandle's other companies
that are subject to fuel tracker provisions record an expense when fuel is under
recovered. The pipelines' fuel reimbursement is in-kind and non-discountable.
RELATED PARTY TRANSACTIONS: Panhandle enters into a number of significant
transactions with related parties. These transactions include revenues for the
transportation of natural gas for Consumers,
PE-19
CMS MST and the MCV Partnership which are based on regulated prices, market
prices or competitive bidding. Related party expenses include payments for
services provided by affiliates and payment of overhead costs and management and
royalty fees to CMS Gas Transmission and CMS Energy, as well as allocated
benefit plan costs. Other income is primarily interest income from the Note
receivable - CMS Capital (See Note 5, Related Party Transactions).
GOODWILL: Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The Company adopted the provisions of SFAS No. 142 as of
January 1, 2002. Goodwill acquired in a purchase business combination and
determined to have an indefinite useful life is not amortized, but instead
tested for impairment at least annually in accordance with the provisions of
SFAS No. 142. Panhandle completed the goodwill impairment testing required upon
adoption of SFAS No. 142 in 2002 which resulted in a $601 million pre-tax
write-down ($369 million after-tax) under the new standard. The impact has been
reflected retroactively to the first quarter of 2002 as a cumulative effect of a
change in accounting for goodwill, pursuant to the requirements of SFAS No. 142.
ACCOUNTING FOR RETIREMENT BENEFITS: Panhandle follows SFAS No. 87 to account for
pension costs and 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 is a CMS Energy plan for CMS Energy and affiliates, of which
Panhandle is a participating affiliate. The Pension Plan includes amounts for
employees of CMS Energy and 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. The Pension Plan assets and obligations associated with Panhandle
employees will be retained by CMS Energy. Upon the closing of the sale of
Panhandle to Southern Union Panhandle Corp., none of the Panhandle employees
will be eligible to accrue additional benefits under the Pension Plan. However,
the Pension Plan will retain pension payment obligations for Panhandle employees
who are vested under the Pension Plan.
ACCOUNTING FOR DERIVATIVES: Panhandle utilizes interest-rate related derivative
instruments to manage its exposure on its debt instruments and does not enter
into derivative instruments for any purpose other than hedging purposes. That
is, Panhandle does not speculate using derivative instruments.
Interest rate swap agreements are used to reduce interest rate risks and to
manage interest expense. By entering into these agreements, Panhandle generally
converts floating-rate debt into fixed-rate debt. This reduces Panhandle's risk
of incurring higher interest costs in periods of rising interest rates. Interest
differentials to be paid or received because of swap agreements are reflected as
an adjustment to interest expense. The negative fair value of interest rate swap
agreements was $24 million pre-tax, $14 million net of tax at March 31, 2003.
Current market pricing models were used to estimate fair values of interest rate
swap agreements. In accordance with SFAS No. 133, an unrealized loss of $14
million after-tax was recorded to other comprehensive loss. The negative fair
value of interest rate swap agreements was $22 million pre-tax, $13 million net
of tax at December 31, 2002. Current market pricing models were used to estimate
fair values of interest rate swap agreements.
PE-20
NEW ACCOUNTING STANDARDS ADOPTED
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: In June 2001, the
FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations ("ARO"),
which is effective for fiscal years beginning after June 15, 2002. The Statement
requires legal obligations associated with the retirement of long-lived assets
to be recognized at their fair value at the time that the obligations are
incurred. Upon initial recognition of a liability, cost should be capitalized as
part of the related long-lived asset and allocated to expense over the useful
life of the asset. Panhandle adopted the new rules on asset retirement
obligations on January 1, 2003. Adoption of the new rule resulted in an increase
in net property, plant and equipment of $10 million, recognition of an asset
retirement obligation of $6 million, and a cumulative effect of adoption that
increased net income and stockholder's equity by $2 million, net of tax, and
there were no settlements during the first quarter of 2003. Accretion expense
for the first quarter of 2003 was approximately $0.1 million and the accretion
expense for the first quarter of 2002 would have been approximately $0.1 million
on a pro forma basis.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions, such as costs, inflation,
and profit margin that third parties would consider in order to take on the
settlement of the obligation. Fair value, to the extent possible, should include
a market risk premium for unforeseeable circumstances. No market risk premium
was included in Panhandle's ARO fair value estimate since a reasonable estimate
could not be made. If a reasonable estimate of fair value cannot be made in the
period the asset retirement obligation is incurred, such as assets with an
indeterminate life, the liability will be recognized when a reasonable estimate
of fair value can be made. Generally, mass property such as onshore transmission
assets have an indeterminate life, retirement cash flows cannot be determined
and there is a low probability of a retirement date, therefore no liability has
been recorded for these assets. The initial measurement of the ARO liability for
Panhandle's offshore lateral lines is based largely on cost estimates from third
parties.
The following table is a general description of the ARO and its associated
long-lived assets.
MARCH 31, 2003 IN MILLIONS
- -------------------------------------------------------------------------------------------------------
IN SERVICE
ARO DESCRIPTION DATE LONG LIVED ASSETS AMOUNT
- -------------------------------------------------------------------------------------------------------
Retire offshore lateral lines Various Panhandle offshore lateral lines $9.6
The following table is a reconciliation of the carrying amount of the ARO.
MARCH 31, 2003 IN MILLIONS
- ------------------------------------------------------------------------------------------------------
ARO LIABILITY
---------------------------------------------------------------------------------
PRO FORMA CASH FLOW
ARO DESCRIPTION 1/1/02 1/1/03 INCURRED SETTLED ACCRETION REVISIONS 3/31/03
- ------------------------------------------------------------------------------------------------------
Offshore laterals $5.6 $6.0 $0.5 - $0.1 - $6.6
---------------------------------------------------------------------------------
Total $5.6 $6.0 $0.5 - $0.1 - $6.6
=================================================================================
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44 AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB on April 30,
2002, this Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring and financial statements
issued after May 15, 2002. Panhandle has adopted SFAS No. 145 and the
implementation resulted in no amount being reclassified during the first quarter
of 2003.
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. SFAS No. 146
supersedes previous accounting guidance, EITF No. 94-3, "Liability recognition
for Certain Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred In a Restructuring)." This standard is effective for exit
or disposal activities initiated after December 31,
PE-21
2002. The scope of SFAS No. 146 includes, (1) costs related to termination
benefits of employees who are involuntarily terminated, (2) costs to terminate a
contract that is not a capital lease, and (3) costs to consolidate facilities or
relocate employees. Any future exit or disposal activities that Panhandle may
engage in will be subject to the provisions of this statement.
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 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. Panhandle has adopted the fair value based method of
accounting for stock-based employee compensation effective December 31, 2002,
the amounts of which were immaterial during the fourth quarter of 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. Panhandle has adopted SFAS No. 148
for new awards granted since January 1, 2002, and the application of SFAS No.
148 resulted in no amount recorded during the first quarter of 2003.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: Issued
by the FASB in November 2002, the interpretation expands on existing disclosure
requirements for most guarantees, and clarifies that at the time a company
issues a guarantee, the company must recognize an initial liability for the fair
value, or market value, of the obligations it assumes under that guarantee and
must disclose that information in its interim and annual financial statements.
The interpretation is effective for guarantees issued or modified on and after
January 1, 2003. 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. Implementation of the
standard resulted in no amount being recorded in the first quarter of 2003.
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 Panhandle, 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. Panhandle will be required to
consolidate any entities that meet the requirements of the interpretation.
Panhandle has adopted the interpretation effective January 1, 2003 and the
implementation had no impact on the financial statements presented.
3. REGULATORY MATTERS
In conjunction with a FERC order issued in September 1997, FERC required certain
natural gas producers to refund previously collected Kansas ad-valorem taxes to
interstate natural gas pipelines, including Panhandle Eastern Pipe Line. FERC
ordered these pipelines to refund these amounts to their customers. In June
2001, Panhandle Eastern Pipe Line filed with the FERC a proposed settlement,
which was supported by most of the customers and affected producers. In October
2001, the FERC approved that settlement. The settlement provided for a
resolution of the Kansas ad-valorem tax matter on the Panhandle Eastern Pipe
Line system for a majority of refund amounts. Certain producers and the state of
Missouri elected to not participate in the
PE-22
settlement. A FERC hearing to resolve all outstanding issues has been scheduled
for October 16, 2003. At March 31, 2003 and December 31, 2002, accounts
receivable included $8 million for tax collections due from natural gas
producers. At March 31, 2003 and December 31, 2002, other current liabilities
included $11 million for tax collections due to customers. On January 2, 2003,
the Commission issued an order indicating its intention to cease collection
efforts for approximately $5 million of the amounts due from affected producers.
Remaining amounts collected but not refunded are subject to refund pending
resolution of issues remaining in the FERC docket and Kansas intrastate
proceeding.
In March 2001, Trunkline received FERC approval to abandon 720 miles of its
26-inch diameter pipeline that extends from Longville, Louisiana to Bourbon,
Illinois. This filing was in conjunction with Centennial, a joint venture in
which Panhandle owned a one-third equity interest, converting the line from
natural gas transmission service to a refined products pipeline, which began
full commercial service in April 2002. Effective April 2001, the 26-inch
pipeline was conveyed to Centennial. On February 10, 2003, Panhandle sold its
one-third equity interest in Centennial for $40 million to Centennial's two
other partners, MAPL and TEPPCO.
In July 2001, Panhandle Eastern Pipe Line filed a settlement with customers on
FERC Order 637 matters to resolve issues including capacity release and
imbalance penalties, among others. On October 12, 2001 and December 19, 2001
FERC issued orders approving the settlement, with modifications. The settlement
changes became final effective February 1, 2002 and Panhandle recognized
approximately $3 million of income, after-tax, including interest. Management
believes that this matter will not have a material adverse effect on
consolidated results of operations or financial position.
In December 2001, Trunkline LNG filed with the FERC a certificate application to
expand the Lake Charles facility to approximately 1.2 billion cubic feet per day
of sendout capacity versus the current capacity of 630 million cubic feet per
day. The BG Group has contract rights for all of this additional capacity. In
December 2002, the FERC issued an order approving the LNG terminal expansion. In
March 2003, Trunkline LNG received FERC authorization to commence construction.
On April 17, 2003, Trunkline LNG filed to amend the authority granted for its
LNG expansion with certain facility modifications. The modifications will not
affect the authorized additional storage capacity and daily sendout capability
and confirms the revised in-service date of January 1, 2006.
Panhandle has sought refunds from the State of Kansas concerning certain
corporate income tax issues for the years 1981 through 1984. On January 25,
2002, the Kansas Supreme Court entered an order affirming a previous Board of
Tax Court finding that Panhandle was entitled to refunds which with interest
total approximately $26 million. Pursuant to the provisions of the purchase
agreement between CMS Energy and a subsidiary of Duke Energy, Duke retains the
benefits of any tax refunds or liabilities for periods prior to the date of the
sale of Panhandle to CMS Energy.
In February 2002, Trunkline Gas filed a settlement with customers on Order 637
matters to resolve issues including capacity release and imbalance penalties,
among others. On July 5, 2002, FERC issued an order approving the settlement,
with modifications. On October 18, 2002, Trunkline Gas filed tariff sheets with
the FERC to implement Order 637 changes effective November 1, 2002. On February
12, 2003, FERC issued an order approving the settlement to be effective November
1, 2002. Management
PE-23
believes that this matter will not have a material adverse effect on
consolidated results of operations or financial position.
4. GOODWILL IMPAIRMENT
Goodwill represents the excess of costs over fair value of assets of businesses
acquired. Panhandle adopted the provisions of SFAS No. 142 as of January 1,
2002. Goodwill acquired in a purchase business combination and determined to
have an indefinite useful life is not amortized, but instead tested for
impairment annually in accordance with the provisions of SFAS No. 142. SFAS No.
142's transitional goodwill impairment evaluation required Panhandle to perform
an assessment of whether there was an indication that goodwill was impaired as
of the date of adoption. Panhandle's goodwill, which resulted from CMS Energy's
acquisition in March 1999, was tested for impairment as of January 1, 2002,
based on valuations by independent appraisers. As defined in SFAS No. 142,
Panhandle was considered a single reporting unit. The fair value of the
reporting unit was determined using a combination of the income approach based
on discounted cash flows and a market approach using public guideline companies
and market transactions. The goodwill impairment amount was determined by
comparing the fair value of goodwill to book value. The goodwill impairment test
resulted in a $601 million pre-tax write-down ($369 million after-tax) and was
recorded retroactive to the first quarter of 2002 as the cumulative effect of a
change in accounting for goodwill, pursuant to the requirements of SFAS No. 142.
5. RELATED PARTY TRANSACTIONS
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
IN MILLIONS
Transportation of natural gas $ 15 $ 12
Other operating revenues - (1)
Operation and maintenance
Management & royalty fees - 4
Other Expenses (a) 6 8
Interest income 3 2
- -------------------------------------------------------------------------------------------------------------
(a) Includes allocated benefit plan costs
Panhandle has a number of significant transactions with related parties. Revenue
transactions, primarily for the transportation of natural gas for Consumers, CMS
MST and the MCV Partnership, all related parties, are based on regulated prices,
market prices or competitive bidding. Related party expenses include payments
for services provided by affiliates, as well as allocated benefit plan costs.
Effective January 1, 2003, in conjunction with the pending sale of Panhandle,
CMS Energy ceased charging Panhandle management and royalty fees.
PE-24
Other operating revenue for the three month period ended March 31, 2002 includes
equity losses related to Centennial of $1 million. There was no income related
to Centennial in the first quarter of 2003. On February 10, 2003, Panhandle sold
its one-third interest in Centennial for $40 million to Centennial's two other
partners, MAPL and TEPPCO. On March 28, 2003, $40 million of cash capital from
the sale of Centennial was returned to CMS Gas Transmission.
Interest income includes $3 million and $2 million for the period ended March
31, 2003 and 2002, respectively, for interest on the Note receivable from CMS
Capital.
In June 2001, Panhandle received a $150 million capital contribution from CMS
Gas Transmission. In June 2001, Panhandle also loaned CMS Capital $150 million.
At December 31, 2002, Note receivable - CMS Capital, totaled $210 million, of
which $150 million is reflected as a reduction to shareholder's equity and $60
million is reflected as current. At March 31, 2003, Note receivable - CMS
Capital, totaled $335 million, of which $150 million is reflected as a reduction
to shareholder's equity and $185 million is reflected as current. Net cash
generated by Panhandle, including funds from the Trunkline LNG monetization
transaction, in excess of operating, investing or financing needs, has been
loaned to CMS Capital and is reflected as Note receivable-CMS Capital on the
Consolidated Balance Sheet. Panhandle was credited with interest on the note at
the 30 day commercial paper rate plus 12.5 basis points through July 2002. In
August of 2002, the interest rate was increased to a one-month Libor plus 300
basis points.
Due to liquidity issues related to CMS Energy and subsidiaries, Panhandle's
ability to draw on the full amount of the Note Receivable from CMS Capital, if
needed, could be affected.
A summary of certain balances due to or due from related parties included in the
Consolidated Balance Sheets is as follows:
MARCH 31, DECEMBER 31,
2003 2002
(UNAUDITED) (AUDITED)
----------- ---------
IN MILLIONS
Note receivable - CMS Capital $185 $60
Accounts receivable 6 5
Accounts receivable - tax - 4
Current assets - other 2 1
Accounts payable 6 8
Stockholder's equity - note receivable (150) (150)
At December 31, 2002, Panhandle had an intercompany tax receivable of $4
million. The $4 million receivable at December 31, 2002 represented estimated
amounts to be received from CMS Energy over the next twelve months for federal
income taxes.
PE-25
At March 31, 2003 and December 31, 2002, Panhandle had an intercompany prepaid
insurance balances of $2 and $1 million, respectively, which represent insurance
prepayments by CMS Energy allocated to Panhandle and are included in Current
assets - other.
On March 10, 2003, Panhandle's ownership interest in Guardian was transferred to
CMS Gas Transmission as a return of capital and Panhandle was released from its
guarantee obligations associated with the Guardian non-recourse guaranty by
Prudential and the other noteholders (see Note 7, Commitments and
Contingencies). As a result, the $63 million in special deposits which
collateralized the guaranty and had been reflected as restricted cash in
Panhandle's financial statements were advanced to CMS Capital as part of the
demand Note Receivable from CMS Capital and were then made available to CMS Gas
Transmission.
On March 1, 2003, certain assets held by CMS Field Services with a net book
value of $15.2 million were contributed to Panhandle by its parent, CMS Gas
Transmission, to be included in the sale to Southern Union Panhandle Corp.
6. DEBT RATING DOWNGRADES
On June 11, 2002, Moody's Investors Service, Inc. lowered its rating on
Panhandle's senior unsecured notes from Baa3 to Ba2 based on concerns
surrounding the liquidity and debt levels of CMS Energy. On July 15, 2002, Fitch
Ratings, Inc. lowered its rating on these notes from BBB to BB+ and again on
September 4, 2002 to BB based on similar concerns. On July 16, 2002, S&P also
lowered its rating on these notes from BBB- to BB, in line with their rating on
CMS Energy based on their belief that CMS Energy and its subsidiaries are at
equal risk of default since the parent relies on its subsidiaries to meet its
financial commitments. Effective with this downgrade, Panhandle's debt is below
investment grade. Each of the three major ratings services currently have
negative outlooks for CMS Energy and its subsidiaries, due to uncertainties
associated with CMS Energy's financial condition and liquidity pending
resolution of the round trip trading investigations and lawsuits, financial
statement restatement and re-audit, and access to the capital markets.
Panhandle, as a result of the ratings downgrade by both Moody's and S&P to below
investment grade levels, can be required to pay the balance of the demand loan
owed LNG Holdings including the remaining principal and accrued interest at any
time such downgrades exist. In November 2002, Panhandle acquired Dekatherm
Investor Trust's interest, and owns 100% of LNG Holdings and will not demand
payment on the note payable to LNG Holdings.
7. COMMITMENTS AND CONTINGENCIES
LITIGATION: Panhandle is involved in legal, tax and regulatory proceedings
before various courts, regulatory commissions and governmental agencies
regarding matters arising in the ordinary course of business, some of which
involve substantial amounts. Where appropriate, Panhandle has made accruals in
accordance with SFAS No. 5 in order to provide for such matters. Management
believes the final disposition of these proceedings will not have a material
adverse effect on consolidated results of operations, liquidity, or financial
position.
ENVIRONMENTAL MATTERS: Panhandle is subject to federal, state and local
regulations regarding air and water quality, hazardous and solid waste disposal
and other environmental matters. Panhandle has identified environmental
contamination at certain sites on its systems and has undertaken cleanup
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programs at these sites. The contamination resulted from the past use of
lubricants containing PCBs in compressed air systems and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle
communicated with the EPA and appropriate state regulatory agencies on these
matters. Under the terms of the sale of Panhandle to CMS Energy, a subsidiary of
Duke Energy is obligated to complete the Panhandle cleanup programs at certain
agreed-upon sites and to indemnify against certain future environmental
litigation and claims. Duke Energy's cleanup activities have been completed on
all but one of the agreed-upon sites. Should additional information be requested
regarding sites where compliance information has been submitted, Panhandle would
be obligated to respond to these requests.
As part of the cleanup program resulting from contamination due to the use of
lubricants containing PCBs in compressed air systems, Panhandle Eastern Pipe
Line and Trunkline have identified PCB levels above acceptable levels inside the
auxiliary buildings that house the air compressor equipment at thirty-two
compressor station sites. Panhandle has developed and is implementing an
EPA-approved process to remediate this PCB contamination in accordance with
federal, state and local regulations.
At some locations, PCBs have been identified in paint that was applied many
years ago. In accordance with EPA regulations, Panhandle is implementing a
program to remediate sites where such issues have been identified during
painting activities. If PCBs are identified above acceptable levels, the paint
is removed and disposed of in an EPA-approved manner. Approximately 15 percent
of the paint projects in the last few years have required this special
procedure.
The Illinois EPA notified Panhandle Eastern Pipe Line and Trunkline, together
with other non-affiliated parties, of contamination at former waste oil disposal
sites in Illinois. Panhandle and 21 other non-affiliated parties conducted an
initial investigation of one of the sites. Based on the information found during
the initial investigation, Panhandle and the 21 other non-affiliated parties
have decided to further delineate the extent of contamination by authorizing a
Phase II investigation at this site. Once data from the Phase II investigation
is evaluated, Panhandle and the 21 other non-affiliated parties will determine
what additional actions will be taken. Panhandle Eastern Pipe Line's and
Trunkline's estimated share for the costs of assessment and remediation of the
sites, based on the volume of waste sent to the facilities, is approximately 17
percent.
Panhandle expects these cleanup programs to continue for several years and has
estimated its share of remaining cleanup costs not indemnified by Duke Energy to
range from $18 million to $25 million. Panhandle has accrued approximately $22
million of such costs, of which $8 million is included in Other Current
Liabilities for the estimated current amounts and $14 million is included in
Other Non-current Liabilities on the Consolidated Balance Sheet at March 31,
2003. At December 31, 2002, Panhandle had $4 million included in Other Current
Liabilities and $18 million included in Other Non-current Liabilities.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. This EPA ruling was challenged in court by various states,
industry and other interests, including INGAA, an industry group to which
Panhandle belongs. In March 2000, the court upheld most aspects of the EPA's
rule, but agreed with INGAA's position and remanded to the EPA the sections of
the rule that affected Panhandle. Based on EPA guidance to these states for
development of SIPs, Panhandle expects future compliance costs to be
approximately $16 million for capital improvements to be incurred from 2004
through 2007.
As a result of the 1990 Clean Air Act Amendments, the EPA must issue MACT rules
controlling hazardous air pollutants from internal combustion engines and
turbines. These rules are expected in late 2003 and mid 2004. Beginning in 2002,
the Texas Commission on Environmental Quality enacted the
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Houston/Galveston SIP regulations requiring reductions in nitrogen oxide
emissions in an eight county area surrounding Houston. Trunkline's Cypress
compressor station is affected and may require the installation of emission
controls. In 2003, the new regulations will also require all "grandfathered"
facilities to enter into the new source permit program which may require the
installation of emission controls at five additional facilities. The company
expects future capital costs for these programs to be approximately $21 million.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm compressor station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002,
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. Controls were installed on two engines in 2002
and Panhandle plans to install controls on two additional engines in 2003 in
accordance with the 2002 permit.
SEC INVESTIGATION: 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 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 market its services. The
committee found no apparent effort to manipulate the price of CMS Energy 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.
ACCOUNTING FOR RETIREMENT BENEFITS: Panhandle follows SFAS No. 87 to account for
pension costs and 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 is a CMS Energy plan for CMS Energy and affiliates, of which
Panhandle is a participating affiliate. The Pension Plan includes amounts for
employees of CMS Energy and 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. The Pension Plan assets and obligations associated with Panhandle
employees will be retained by CMS Energy. When the Southern Union Panhandle
Corp. transaction closes, none of the Panhandle employees will be eligible to
accrue additional benefits under the Pension Plan. However, the Pension Plan
will retain pension payment obligations under the Pension Plan for Panhandle
employees who are vested under the Pension Plan.
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The significant downturn in the equities markets has affected the value of the
Pension Plan's assets. The estimated fair value of the Pension Plan's assets at
December 31, 2002 was $607 million and the Accumulated Benefit Obligation was
estimated at $1.055 billion. The Pension Plan's Accumulated Benefit Obligation
thus exceeded the value of the assets at December 31, 2002, and as a result,
Panhandle and the other participants of the plan were required to recognize an
additional minimum liability for this excess in accordance with SFAS No. 87. As
of December 31, 2002, the additional minimum liability allocated to Panhandle
was $48 million, of which $6 million was recorded as an intangible asset, and
$42 million was charged to other comprehensive income ($26 million after-tax).
CMS Energy estimates CMS Energy's pension expense will approximate $46 million,
$51 million and $58 million in 2003, 2004 and 2005, respectively, as compared to
an approximated $33 million in 2002 of which Panhandle's allocated share was
approximately 11 percent. 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.
In order to keep health care benefits and costs competitive, CMS Energy has
announced several changes to the Health Care Plan. These changes are effective
January 1, 2003. The most significant change is that CMS Energy's future
increases in health care costs will be shared with salaried employees. The
salaried retirees Health Care Plan also has 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 costs.
Mail-order prescription copays also have been increased for all salaried
employees.
OTHER COMMITMENTS AND CONTINGENCIES: In 1993, the U.S. Department of the
Interior announced its intention to seek additional royalties from gas producers
as a result of payments received by such producers in connection with past
take-or-pay settlements, and buyouts and buydowns of gas sales contracts with
natural gas pipelines. Panhandle Eastern Pipe Line and Trunkline, with respect
to certain producer contract settlements, may be contractually required to
reimburse or, in some instances, to indemnify producers against such royalty
claims. The potential liability of the producers to the government and of the
pipelines to the producers involves complex issues of law and fact which are
likely to take substantial time to resolve. If required to reimburse or
indemnify the producers, Panhandle Eastern Pipe Line and Trunkline may file with
FERC to recover a portion of these costs from pipeline customers. Management
believes these commitments and contingencies will not have a material adverse
effect on consolidated results of operations, liquidity or financial position.
At March 31, 2003 and 2002, Panhandle has accrued approximately $14 million in
Non-current Liabilities on the Consolidated Balance Sheet related to this
matter.
In May 2001, Panhandle provided a guaranty related to project financing
associated with its investment in Centennial in an amount up to $50 million
during the initial operating period of the project. Due to rating agency
downgrades of Panhandle's debt, the Centennial lender required additional credit
support from Panhandle. On September 27, 2002 Panhandle's partners provided
credit support of $25 million each in the form of guarantees to the Centennial
lender to cover Panhandle's $50 million obligation. The partners were paid
credit fees by Panhandle on the outstanding balance of the guarantees for the
periods for which they were in effect. On February 10, 2003, Panhandle sold its
one-third equity interest in Centennial for $40 million to Centennial's two
other partners, MAPL and TEPPCO. Panhandle has been released by MAPL, TEPPCO and
the lenders for any liabilities related to Panhandle's $50 million parent
guaranty of the project debt.
In November 2001, in conjunction with the Guardian project, Panhandle provided a
$60 million guaranty related to project financing during the construction and
initial operating period of the project. The
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guaranty is released when Guardian reaches certain operational and financial
targets. Due to rating agency downgrades of Panhandle's debt, the Guardian
lender assessed credit fees and required additional credit support from
Panhandle. In October 2002, Panhandle provided a letter of credit to the lenders
which constitutes acceptable credit support under the Guardian financing
agreement. This letter of credit was cash collateralized by Panhandle with
approximately $63 million which, including accumulated interest, is reflected as
Restricted Cash on the Consolidated Balance Sheet at December 31, 2002. On March
10, 2003, Panhandle's ownership interest in Guardian was transferred back to CMS
Gas Transmission (see Note 5, Related Party Transactions). Panhandle was also
released from the guarantee obligations associated with the Guardian
non-recourse debt as of March 10, 2003, by the partners, Prudential and the
other noteholders.
In December 2002 and January 2003, Panhandle secured short-term bank loans in
the amounts of $30 million and $10 million, respectively, with interest payable
at rates of LIBOR plus 4 percent. The loans are due the earlier of December 2003
or upon sale of Panhandle. The stock of most of Panhandle's subsidiaries were
pledged as collateral for the loans, which were utilized to improve overall
liquidity which had been reduced by various cash requirements.
Panhandle had received a waiver until April 30, 2003 to provide certified
September 30, 2002 financial statements to the LNG Holdings lenders under that
credit facility. Panhandle has since satisfied that requirement. Panhandle also
received a waiver until June 30, 2003 of a requirement to provide certain
documentation. Should it be unable to execute the required documents by the
timing indicated, LNG Holdings could be declared to be in default under its
credit facility and the debt thereunder could be accelerated and become
immediately due and payable.
Occasionally, Panhandle will purchase surety bonds to indemnify third parties
for unforeseen events which may occur in the course of construction or repair
projects. As of March 31, 2003, Panhandle has purchased $2 million of these
surety bonds.
SALE OF PANHANDLE
On May 12, 2003, CMS Energy and Southern Union Company entered into an amendment
to the original stock purchase agreement executed in December 2002, related to
Southern Union's acquisition of Panhandle. For further information, see Note 1,
Corporate Structure.
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QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
CMS ENERGY
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CMS ENERGY CORPORATION'S MANAGEMENT'S DISCUSSION AND ANALYSIS, which is
incorporated by reference herein.
CONSUMERS
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CONSUMERS' ENERGY COMPANY'S MANAGEMENT'S DISCUSSION AND ANALYSIS, which is
incorporated by reference herein.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The discussion below is limited to an update of developments that have occurred
in various judicial and administrative proceedings, many of which are more fully
described in CMS Energy's, Consumers' and Panhandle's respective Form 10-Ks for
the year ended December 31, 2002. Reference is also made to the Condensed Notes
to the Consolidated Financial Statements, in particular Note 4 - Uncertainties
for CMS Energy, Note 2, Uncertainties for Consumers, and Note 7 - Commitments
and Contingencies for Panhandle, included herein for additional information
regarding various pending administrative and judicial proceedings involving
rate, operating, regulatory and environmental matters.
CMS ENERGY
DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS
The Board of Directors of CMS Energy received a demand, on behalf of a
shareholder of CMS Energy Common Stock, that it commence civil actions (i) to
remedy alleged breaches of fiduciary duties by CMS Energy officers and directors
in connection with round-trip trading at CMS MST, and (ii) to recover damages
sustained by CMS Energy as a result of alleged insider trades alleged to have
been made by certain current and former officers of CMS Energy and its
subsidiaries. If the Board elects not to commence such actions, the shareholder
has stated that he will initiate a derivative suit, bringing such claims on
behalf of CMS Energy. CMS Energy has elected two new members to its Board of
Directors who will serve as an independent litigation committee to determine
whether it is in the best interest of the company to bring the action demanded
by the shareholder. Counsel for the shareholder has agreed to extend the time
for CMS Energy to respond to the demand. CMS Energy cannot predict the outcome
of this litigation.
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CMS ENERGY AND CONSUMERS
EMPLOYMENT RETIREMENT INCOME SECURITY ACT ("ERISA") CLASS ACTION LAWSUITS
CMS Energy is a named defendant, along with Consumers, CMS MS&T 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 was 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 Common Stock held in the Plan. Plaintiffs also seek
other equitable relief and legal fees. These cases will be vigorously defended.
CMS Energy and Consumers cannot predict the outcome of this litigation.
SECURITIES CLASS ACTION LAWSUITS
Beginning on May 17, 2002, a number of securities class action complaints were
filed against CMS Energy, Consumers, and certain officers and directors of CMS
Energy and its affiliates. The complaints were filed as purported class actions
in the United States District Court for the Eastern District of Michigan. The
cases were consolidated into a single lawsuit and an amended and consolidated
class action complaint was filed on May 1, 2003. The defendants named in the
amended and consolidated class action complaint consist of CMS Energy,
Consumers, certain officers and directors of CMS Energy and its affiliates, and
certain underwriters of CMS Energy securities. The purported class period is
from May 1, 2000 through and including March 31, 2003. The amended and
consolidated class action complaint seeks unspecified damages based on
allegations that the defendants violated United States securities laws and
regulations by making allegedly false and misleading statements about CMS
Energy's business and financial condition. The companies intend to vigorously
defend against this action but cannot predict the outcome of this litigation.
CMS ENERGY, CONSUMERS AND PANHANDLE
ENVIRONMENTAL MATTERS: CMS Energy, Consumers, Panhandle and their subsidiaries
and affiliates are subject to various federal, state and local laws and
regulations relating to the environment. Several of these companies have been
named parties to various actions involving environmental issues. Based on their
present knowledge and subject to future legal and factual developments, CMS
Energy, Consumers and Panhandle believe that it is unlikely that these actions,
individually or in total, will have a material adverse effect on their financial
condition. See CMS Energy's, Consumers' and Panhandle's MANAGEMENT'S DISCUSSION
AND ANALYSIS; and CMS Energy's, Consumers' and Panhandle's CONDENSED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 5. OTHER INFORMATION
A shareholder who wishes to submit a proposal for consideration at the CMS
Energy 2004 Annual Meeting pursuant to the applicable rules of the SEC must send
the proposal to reach CMS' Corporate Secretary on or before December 24, 2003.
In any event if CMS has not
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received written notice of any matter to be proposed at that meeting by March 8,
2004, the holders of the proxies may use their discretionary voting authority on
any such matter. The proposals should be addressed to: Mr. Michael D. VanHemert,
Corporate Secretary, One Energy Plaza, Jackson, Michigan 49201.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) LIST OF EXHIBITS
(3) By-Laws of Consumers Energy Company
(4)(a) 87th Supplemental Indenture, dated as of March 26, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(b) 88th Supplemental Indenture, dated as of March 27, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(c) 89th Supplemental Indenture, dated as of March 28, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(d) 90th Supplemental Indenture, dated as of April 30, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(e) $140 million Term Loan Agreement dated March 26, 2003 between
Consumers Energy Company and the Bank/Agent, as defined
therein
(4)(f) $250 million Revolving Credit Facility dated March 27, 2003
among Consumers Energy Company, the Banks, the Agent, and the
Co-Documentation Agents, all as defined therein
(4)(g) $150 million Term Loan Agreement dated March 28, 2003 among
Consumers Energy Company, the Banks, and the Agent, all as
defined therein
(4)(h) $409 million Second Amended and Restated Credit Facility dated
March 30, 2003 among CMS Energy Corporation, the Banks, and
the Administrative Agent/Collateral Agent, all as defined
therein
(4)(i) $441 million Revolving Credit Facility dated March 30, 2003
among CMS Enterprises Company as Borrower, CMS Energy
Corporation as the Loan Party, the Banks, and the
Administrative Agent/Collateral Agent, all as defined therein
(4)(j) $75 million Revolving Credit Facility dated April 21, 2003
among CMS Enterprises Company as Borrower, CMS Energy
Corporation as the Loan Party, the Banks, and the
Administrative Agent/Collateral Agent, all as defined therein
(10)(a) Stock Purchase Agreement by and among CMS Gas Transmission
Company, AIG Highstar Capital, L.P., AIG Highstar II Funding
Corp., Southern Union Company and Southern Union Panhandle
Corp. dated as of December 21, 2002 (Filed as Exhibit 10.1 to
Form 8-K filed December 22, 2002)
(10)(b) Amended and Restated Stock Purchase Agreement by and among CMS
Gas Transmission Company, Southern Union Company and Southern
Union Panhandle Corp. dated as of May 12, 2003
(10)(c) Shareholder Agreement by and between CMS Gas Transmission
Company and Southern Union Company dated as of May 12, 2003
(10)(d) Amendment Agreement by and among CMS Gas Transmission Company,
AIG Highstar Capital, L.P., AIG Highstar II Funding Corp.,
Southern Union Company and Southern Union Panhandle Corp.
dated as of May 12, 2003
(12) CMS Energy: Statements regarding computation of Ratio of
Earnings to Fixed Charges
(99)(a) CMS Energy Corporation's certifications pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(99)(b) Consumers Energy Company's certifications pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
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(99)(c) Panhandle Eastern Pipe Line Corporation's certifications
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(B) REPORTS ON FORM 8-K
CMS ENERGY
During 1st Quarter 2003, CMS Energy filed reports of Form 8-K on January 24,
2003, February 21, 2003, March 5, 2003 and March 13, 2003 covering matters
pursuant to ITEM 5. OTHER EVENTS.
CONSUMERS
During 1st Quarter 2003, Consumers filed reports of Form 8-K on January 24,
2003, February 21, 2003, March 5, 2003 and March 13, 2003 covering matters
pursuant to ITEM 5. OTHER EVENTS.
PANHANDLE
During 1st Quarter 2003, Panhandle filed reports of Form 8-K on January 24,
2003, February 21, 2003 and March 13, 2003 covering matters pursuant to ITEM 5.
OTHER EVENTS.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiary.
CMS ENERGY CORPORATION
(Registrant)
Dated: May 13, 2003 By: /s/ Thomas J. Webb
-------------------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CONSUMERS ENERGY COMPANY
(Registrant)
Dated: May 13, 2003 By: /s/ Thomas J. Webb
-------------------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
PANHANDLE EASTERN PIPE LINE COMPANY
(Registrant)
Dated: May 13, 2003 By: /s/ Thomas J. Webb
-------------------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
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CERTIFICATION OF KENNETH WHIPPLE
I, Kenneth Whipple, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CMS Energy
Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this quarterly 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 quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying 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
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6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: May 13, 2003 By: /s/ Kenneth Whipple
---------------------------------------
Kenneth Whipple
Chairman of the Board and
Chief Executive Officer
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CERTIFICATION OF THOMAS J. WEBB
I, Thomas J. Webb, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CMS Energy
Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this quarterly 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 quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying 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
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6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: May 13, 2003 By: /s/ Thomas J. Webb
---------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
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CERTIFICATION OF KENNETH WHIPPLE
I, Kenneth Whipple, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Consumers
Energy Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this quarterly 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 quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying 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
CO-10
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: May 13, 2003 By: /s/ Kenneth Whipple
---------------------------------------
Kenneth Whipple
Chairman of the Board and
Chief Executive Officer
CO-11
CERTIFICATION OF THOMAS J. WEBB
I, Thomas J. Webb, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Consumers
Energy Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this quarterly 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 quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying 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
CO-12
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: May 13, 2003 By: /s/ Thomas J. Webb
---------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CO-13
CERTIFICATION OF CHRISTOPHER A. HELMS
I, Christopher A. Helms, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Panhandle
Eastern Pipe Line Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this quarterly 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 quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying 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
CO-14
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: May 13, 2003 By: /s/ Christopher A. Helms
---------------------------------------
Christopher A. Helms
President and
Chief Executive Officer
CO-15
CERTIFICATION OF THOMAS J. WEBB
I, Thomas J. Webb, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Panhandle
Eastern Pipe Line Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this quarterly 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 quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying 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
CO-16
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: May 13, 2003 By: /s/ Thomas J. Webb
---------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CO-17
CMS ENERGY, CONSUMERS AND PANHANDLE EXHIBITS
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
(3) By-Laws of Consumers Energy Company
(4)(a) 87th Supplemental Indenture, dated as of March 26, 2003
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(b) 88th Supplemental Indenture, dated as of March 27, 2003
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(c) 89th Supplemental Indenture, dated as of March 28, 2003
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(d) 90th Supplemental Indenture, dated as of April 30, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(e) $140 million Term Loan Agreement dated March 26, 2003 between
Consumers Energy Company and the Bank/Agent, as defined
therein
(4)(f) $250 million Revolving Credit Facility dated March 27, 2003
among Consumers Energy Company, the Banks, the Agent, and the
Co-Documentation Agents, all as defined therein
(4)(g) $150 million Term Loan Agreement dated March 28, 2003 among
Consumers Energy Company, the Banks, and the Agent, all as
defined therein
(4)(h) $409 million Second Amended and Restated Credit Facility dated
March 30, 2003 among CMS Energy Corporation, the Banks, and
the Administrative Agent/Collateral Agent, all as defined
therein
(4)(i) $441 million Revolving Credit Facility dated March 30, 2003
among CMS Enterprises Company as Borrower, CMS Energy
Corporation as the Loan Party, the Banks, and the
Administrative Agent/Collateral Agent, all as defined therein
(4)(j) $75 million Revolving Credit Facility dated April 21, 2003
among CMS Enterprises Company as Borrower, CMS Energy
Corporation as the Loan Party, the Banks, and the
Administrative Agent/Collateral Agent, all as defined therein
(10)(a) Stock Purchase Agreement by and among CMS Gas Transmission
Company, AIG Highstar Capital, L.P., AIG Highstar II Funding
Corp., Southern Union Company and Southern Union Panhandle
Corp. dated as of December 21, 2002 (Filed as Exhibit 10.1 to
Form 8-K filed December 22, 2002)
(10)(b) Amended and Restated Stock Purchase Agreement by and among CMS
Gas Transmission Company, Southern Union Company and Southern
Union Panhandle Corp. dated as of May 12, 2003
(10)(c) Shareholder Agreement by and between CMS Gas Transmission
Company and Southern Union Company dated as of May 12, 2003
(10)(d) Amendment Agreement by and among CMS Gas Transmission Company,
AIG Highstar Capital, L.P., AIG Highstar II Funding Corp.,
Southern Union Company and Southern Union Panhandle Corp.
dated as of May 12, 2003
(12) CMS Energy Statements regarding computation of Ratio of
Earnings to Fixed Charges
(99)(a) CMS Energy Corporation's certifications pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(99)(b) Consumers Energy Company's certifications pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(99)(c) Panhandle Eastern Pipe Line Corporation's certifications
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
CO-18