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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 SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from_______ to
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
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1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
One Energy Plaza, Jackson, Michigan 49201
(517) 788-0550
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
One Energy Plaza, Jackson, Michigan 49201
(517) 788-0550
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: Yes [ ] No [X]
Number of shares outstanding of each of the issuer's classes of common stock at
November 1, 2003:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 161,130,925
CONSUMERS ENERGY COMPANY, $10 par value, privately held by CMS Energy Corporation 84,108,789
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CMS ENERGY CORPORATION
AND
CONSUMERS ENERGY COMPANY
QUARTERLY REPORTS ON FORM 10-Q TO THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
This combined Form 10-Q is separately filed by CMS Energy Corporation and
Consumers Energy Company. Information contained herein relating to each
individual registrant is filed by such registrant on its own behalf.
Accordingly, except for its subsidiaries, Consumers Energy Company makes no
representation as to information relating to any other companies affiliated with
CMS Energy Corporation.
TABLE OF CONTENTS
Page
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Glossary.................................................................................................. 4
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Forward-Looking Statements and Risk Factors..................................................... CMS - 1
Critical Accounting Policies.................................................................... CMS - 1
Results of Operations........................................................................... CMS - 14
Capital Resources and Liquidity................................................................. CMS - 20
Outlook......................................................................................... CMS - 26
Other Matters................................................................................... CMS - 40
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CMS - 44
Consolidated Statements of Cash Flows........................................................... CMS - 46
Consolidated Balance Sheets..................................................................... CMS - 48
Consolidated Statements of Common Stockholders' Equity.......................................... CMS - 50
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies......................... CMS - 51
2. Asset Sales and Restructuring.............................................................. CMS - 54
3. Discontinued Operations.................................................................... CMS - 57
4. Uncertainties.............................................................................. CMS - 61
5. Financings and Capitalization.............................................................. CMS - 82
6. Earnings Per Share......................................................................... CMS - 89
7. Risk Management Activities and Financial Instruments....................................... CMS - 91
8. Equity Method Investments.................................................................. CMS - 95
9. Reportable Segments........................................................................ CMS - 96
10. Implementation of New Accounting Standards................................................. CMS - 98
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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 - 11
Capital Resources and Liquidity................................................................. CE - 14
Outlook......................................................................................... CE - 19
Other Matters................................................................................... CE - 28
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CE - 32
Consolidated Statements of Cash Flows........................................................... CE - 33
Consolidated Balance Sheets..................................................................... CE - 34
Consolidated Statements of Common Stockholder's Equity.......................................... CE - 36
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies.......................... CE - 38
2. Uncertainties............................................................................... CE - 40
3. Financings and Capitalization............................................................... CE - 56
4. Financial and Derivative Instruments........................................................ CE - 61
5. Implementation of New Accounting Standards.................................................. CE - 64
Quantitative and Qualitative Disclosures about Market Risk................................................ CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ CO - 1
Item 2. Changes in Securities and Use of Proceeds.................................................... CO - 3
Item 5. Other Information............................................................................ CO - 3
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
ABATE........................................ Association of Businesses Advocating Tariff Equity
Accumulated Benefit Obligation............... The liabilities of a pension plan based on service and pay to
date. This differs from the Projected Benefit Obligation that
is typically disclosed in that it does not reflect expected
future salary increases.
AEP.......................................... American Electric Power, a non-affiliated company
ALJ.......................................... Administrative Law Judge
Alliance..................................... Alliance Regional Transmission Organization
AMT.......................................... Alternative minimum tax
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"
APT.......................................... Australian Pipeline Trust
ARO.......................................... Asset retirement obligation
Attorney General............................. Michigan Attorney General
bcf.......................................... Billion cubic feet
BG LNG Services.............................. BG LNG Services, Inc., a subsidiary of BG Group of the United
Kingdom
Big Rock..................................... Big Rock Point nuclear power plant, owned by Consumers
Board of Directors........................... Board of Directors of CMS Energy
Bookouts..................................... Unplanned netting of transactions from multiple contracts
Centennial................................... Centennial Pipeline, LLC, in which Panhandle, formerly a
wholly owned subsidiary of CMS Gas Transmission, owned a
one-third interest
CEO.......................................... Chief Executive Officer
CFO.......................................... Chief Financial Officer
Clean Air Act................................ Federal Clean Air Act, as amended
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 Field Services........................... CMS Field Services, formerly a wholly owned subsidiary of CMS
Gas Transmission. The sale of this subsidiary closed in July
2003.
CMS Gas Transmission......................... CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Generation............................... CMS Generation Co., a subsidiary of Enterprises
4
CMS Holdings................................. CMS Midland Holdings Company, a subsidiary of Consumers
CMS Land..................................... CMS Land Company, a subsidiary of Enterprises
CMS Midland.................................. CMS Midland Inc., a subsidiary of Consumers
CMS MST...................................... CMS Marketing, Services and Trading Company, a subsidiary of
Enterprises
CMS Oil and Gas.............................. CMS Oil and Gas Company, formerly a subsidiary of Enterprises
CMS Pipeline Assets.......................... CMS Enterprises pipeline assets in Michigan and Australia
CMS Viron.................................... CMS Viron Energy Services, formerly a wholly owned subsidiary
of CMS MST. The sale of this subsidiary closed in July 2003.
Common Stock................................. All classes of Common Stock of CMS Energy and each of its
subsidiaries, or any of them individually, at the time of an
award or grant under the Performance Incentive Stock Plan
Consumers.................................... Consumers Energy Company, a subsidiary of CMS Energy
Consumers Receivables Funding II............. Consumers Receivables Funding II LLC, a wholly-owned
subsidiary of Consumers
Court of Appeals............................. Michigan Court of Appeals
Customer Choice Act.......................... Customer Choice and Electricity Reliability Act, a Michigan
statute enacted in June 2000 that allows all retail customers
choice of alternative electric suppliers 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, LLC, a wholly owned
subsidiary of CMS Generation
DOE.......................................... U.S. Department of Energy
Dow.......................................... The Dow Chemical Company, a non-affiliated company
Duke Energy.................................. Duke Energy Corporation, a non-affiliated company
EITF......................................... Emerging Issues Task Force
EITF Issue No. 02-03......................... Issues Involved in Accounting for Derivative Contracts Held
for Trading Purposes and Contracts Involved in Energy Trading
and Risk Management Activities
El Chocon.................................... The 1,200 MW hydro power plant located in Argentina, which
CMS Generation holds a 17.23 percent ownership interest
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
Exchange Act................................. Securities Exchange Act of 1934, as amended
FASB......................................... Financial Accounting Standards Board
FERC......................................... Federal Energy Regulatory Commission
5
FIN 46....................................... FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities"
FMB.......................................... First Mortgage Bonds
FMLP......................................... First Midland Limited Partnership, a partnership that holds a
lessor interest in the MCV facility
FondElec..................................... FondElec Essential Services Growth Fund, an investment at
Enterprises, formed in 1997 to invest in companies whose
business is to invest in communications and utility sectors,
primarily in Latin America
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 CMS Gas Transmission
formerly owned a one-third interest
GWh.......................................... Gigawatt-hour
Health Care Plan............................. The medical, dental, and prescription drug programs offered
to eligible employees of Consumers and CMS Energy
HL Power..................................... H.L. Power Company, a California Limited Partnership, owner
of the Honey Lake generation project in Wendel, California
INGAA........................................ Interstate Natural Gas Association of America
Integrum..................................... Integrum Energy Ventures, LLC
IPP.......................................... Independent Power Production
IRA.......................................... Individual Retirement Account
ISO.......................................... Independent System Operator
ITC.......................................... Investment tax credit
JEC.......................................... Jubail Energy Company
JOATT........................................ Joint Open Access Transmission Tariff
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
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
6
Marysville................................... CMS Marysville Gas Liquids Company, a Michigan corporation
and a subsidiary of CMS Gas Transmission that holds a 100
percent interest in Marysville Fractionation Partnership and
a 51 percent interest in St. Clair Underground Storage
Partnership
mcf.......................................... Thousand cubic feet
MCV Expansion, LLC........................... An agreement entered into with General Electric Company to
expand the MCV Facility
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, formerly a subsidiary
of Consumers Energy and now an indirect subsidiary of
Trans-Elect
Michigan Gas Storage......................... Michigan Gas Storage Company, a former subsidiary of
Consumers that merged into Consumers in November 2002
Michigan Power............................... CMS Generation Michigan Power, LLC, owner of the Kalamazoo
River Generating Station and the Livingston Generating Station
MISO......................................... Midwest Independent System Operator
Moody's...................................... Moody's Investors Service, Inc.
MPSC......................................... Michigan Public Service Commission
MSBT......................................... Michigan Single Business Tax
MTH.......................................... Michigan Transco Holdings, Limited Partnership
MW........................................... Megawatts
NEIL......................................... Nuclear Electric Insurance Limited, an industry mutual
insurance company owned by member utility companies
NMC.......................................... Nuclear Management Company, LLC, formed in 1999 by Northern
States Power Company (now Xcel Energy Inc.), Alliant Energy,
Wisconsin Electric Power Company, and Wisconsin Public
Service Company to operate and manage nuclear generating
facilities owned by the four utilities
NOPR......................................... Notice of Proposed Rulemaking
NPS.......................................... National Power Supply Company, Ltd., owner of two generating
facilities in Thailand. CMS Generation sold its 66.2 percent
interest in NPS in 2002
NRC.......................................... Nuclear Regulatory Commission
NYMEX........................................ New York Mercantile Exchange
OATT......................................... Open Access Transmission Tariff
OPEB......................................... Postretirement benefit plans other than pensions for retired
employees
Palisades.................................... Palisades nuclear power plant, which is owned by Consumers
7
Panhandle.................................... Panhandle Eastern Pipe Line Company, including its
subsidiaries Trunkline, Pan Gas Storage, Panhandle Storage,
and Panhandle Holdings. Panhandle was a wholly owned
subsidiary of CMS Gas Transmission. The sale of this
subsidiary closed in June 2003.
Panhandle Eastern Pipe Line.................. PanhandleEastern Pipe Line Company, formerly a wholly owned
subsidiary of CMS Gas Transmission. The sale of this
subsidiary closed in June 2003.
PCB.......................................... Polychlorinated biphenyl
Pension Plan................................. The trusteed, non-contributory, defined benefit pension plan
of Panhandle, Consumers and CMS Energy
PJM.......................................... PJM Interconnection, a non-affiliated company
Powder River................................. CMS Oil & Gas previously owned a significant interest in
coalbed methane fields or projects developed within the
Powder River Basin which spans the border between Wyoming and
Montana. The Powder River properties have been sold.
PPA.......................................... The Power Purchase Agreement between Consumers and the MCV
Partnership with a 35-year term commencing in March 1990
Price Anderson Act........................... Price Anderson Act, enacted in 1957 as an amendment to the
Atomic Energy Act of 1954, as revised and extended over the
years. This act stipulates between nuclear licensees and the
U.S. government the insurance, financial responsibility, and
legal liability for nuclear accidents.
PSCR......................................... Power supply cost recovery
Public Act 141............................... Public Act 141, Customer Choice and Electricity Reliability
Act
Public Act 142............................... Public Act 142, Securitization Act
PURPA........................................ Public Utility Regulatory Policies Act of 1978
ROA.......................................... Retail Open Access
RTO.......................................... Regional Transmission Organization
SEC.......................................... U.S. Securities and Exchange Commission
Securitization............................... A financing method authorized by statute and approved by the
MPSC which allows a utility to set aside and pledge a portion
of the rate payments received by its customers for the
repayment of Securitization bonds issued by a special purpose
entity affiliated with such utility
SERP......................................... Supplemental Executive Retirement Plan
SFAS......................................... Statement of Financial Accounting Standards
SFAS No. 5................................... SFAS No. 5, "Accounting for Contingencies"
SFAS No. 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. 88.................................. SFAS No. 88, "Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for
Termination Benefits"
8
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, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical
Corrections"
SFAS No. 146................................. SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities"
SFAS No. 148................................. SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure"
SFAS No. 149................................. SFAS No. 149, "Amendment of Statement No. 133 on Derivative
Instruments and Hedging Activities"
SFAS No. 150................................. SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity"
SIPS......................................... State Implementation Plans
Southern Union............................... Southern Union Company, a non-affiliated 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
Taweelah..................................... Al Taweelah A2, a power and desalination plant of Emirates
CMS Power Company, a forty percent owned subsidiary of CMS
Generation
TEPPCO....................................... TE Products Pipeline Company, Limited Partnership
Toledo Power................................. Toledo Power Company, the 135 MW coal and fuel oil power
plant located on Cebu Island, Phillipines, in which CMS
Generation held a 47.5 percent interest. Toledo Power was
sold to Mirant Toledo Holdings Corporation on April 24, 2002.
Transition Costs............................. Stranded Costs, as defined, plus the costs incurred in the
transition to competition.
9
Trunkline.................................... Trunkline Gas Company, LLC, formerly a subsidiary of CMS
Panhandle Holdings, LLC
Trunkline LNG................................ Trunkline LNG Company, LLC, formerly 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
Union........................................ Utility Workers of America, AFL-CIO
VEBA Trusts.................................. VEBA (voluntary employees' beneficiary association) Trusts
are tax-exempt accounts established to specifically set aside
employer contributed assets to pay for future expenses of the
OPEB plan
10
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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, is engaged in domestic and
international diversified energy businesses including: natural gas transmission,
storage and processing; independent power production; and energy services.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
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/A, filed on July 1, 2003. This MD&A refers to 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 intention with the use of the words
"anticipates," "believes," "estimates," "expects," "intends," and "plans," and
variations of such words and similar expressions, is 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/A, filed on July 1,
2003, 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. All
note references within this MD&A refer to CMS Energy's Notes to the Consolidated
Financial Statements.
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
CMS-1
CMS Energy Corporation
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 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 under SFAS No. 144 through the use of
an undiscounted cash flow analysis of assets at the lowest level for which
identifiable cash flows exist and under APB Opinion No. 18 by analyzing the
ability to recover the carrying amount of the equity method investment and/or
the ability of the investee to sustain an earnings capacity that justifies the
carrying amount of the investment. 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 $12 billion at September 30, 2003, approximately 58 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 recorded write-downs of non-strategic or under-performing
long-lived assets as a result of implementing a new strategic direction. See
Outlook section of this MD&A. 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 payment will be made in the future as a result of a current
event, and when that amount can be reasonably estimated. CMS Energy 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.
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 September 30, 2003, Consumers has incurred $437
million
CMS-2
CMS Energy Corporation
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 substantially. As new environmental standards become
effective, Consumers will need additional capital expenditures to comply with
the standards. Capital expenditures will depend upon the composition of the
final regulations.
The EPA has proposed changes to the rules that govern generating plant cooling
water intake systems. The proposed rules will require significant abatement of
fish mortality. The proposed rules are scheduled to become final in the first
quarter of 2004 and some of Consumers' facilities would be required to comply by
2006. Consumers is studying the proposed rules to determine the most
cost-effective solutions for compliance. Until the method of compliance is
determined, Consumers is unable to estimate the cost of compliance with the
proposed rules.
The EPA has alleged that some utilities have incorrectly classified plant
modifications as "routine maintenance" rather than seek permits from the EPA.
Consumers has received and responded to information requests from the EPA on
this subject. Consumers believes that it has properly interpreted the
requirements of "routine maintenance". If Consumers' interpretation is
eventually found to be incorrect, it may be required to install additional
pollution controls at some or all of its coal-fired plants and could call into
question the viability of certain plants remaining in operation.
For further information on electric environmental matters see Note 4,
Uncertainties, "Consumers' Electric Utility 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 using the Gas Research
Institute-Manufactured Gas Plant Probabilistic Cost Model. A revised cost
estimate, completed in September 2003, estimated remaining costs to be between
$37 million and $90 million. The range reflects multiple alternatives with
various assumptions for resolving the environmental issues at each site. The
estimates are based on discounted 2003 costs using a discount rate of three
percent. The discount rate represents a ten-year average of U.S. Treasury bond
rates reduced for increases in the consumer price index. 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
CMS-3
CMS Energy Corporation
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. The remaining estimated future PPA liability associated with the
loss totaled $34 million at September 30, 2003 and $59 million at September 30,
2002. 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.
Under Michigan's electric restructuring law, Consumers will return to unfrozen
rates for large industrial customers beginning January 1, 2004, including the
resumption of the PSCR process. Under the PSCR process, 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. Recovery of capacity and fixed energy
charges will be subject to certain rate caps as discussed in Note 4,
Uncertainties, "Consumers' Electric Utility Rate Matters - Electric
Restructuring." 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, Consumers' cash
underrecoveries associated with the PPA could be as follows:
In Millions
- --------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- --------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5% (a) $57 $56 $56 $55 $39
Amount to be charged to operating expense $28 $27 $56 $55 $39
Amount to be charged to PPA liability $29 $29 $ - $ - $ -
===========================================================================================
(a) For the nine months ended September 30, 2003, Consumers' cash
underrecoveries associated with the PPA were $43 million.
As previously noted, until September 2007, the PPA and settlement require
Consumers to pay capacity costs based on the MCV Facility's actual availability
up to the 98.5 percent cap. After September 2007, Consumers expects to exercise
the "regulatory out" clause in the PPA, limiting its capacity payments to the
MCV Partnership to the amount collected from its customers. Depending on the
MPSC's future actions with respect to the capacity payments recoverable from its
customers subsequent to September 2007, the earnings of the MCV Partnership and
the value of Consumers' equity interest in the MCV Partnership, may be affected
negatively.
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Further, under the PPA, energy payments to the MCV Partnership are based on the
cost of coal burned in Consumers' coal plants and costs associated with fuel
inventory, operations and maintenance, and administrative and general expenses
associated with Consumers' coal plants. However, the MCV Partnership's costs of
producing electricity are tied, in large part, to the cost of natural gas.
Because natural gas prices have increased substantially in recent years, while
energy charge payments to the MCV Partnership have not, the MCV Partnership's
financial performance has been impacted negatively.
As of January 1, 2004, Consumers intends to return to forced (uneconomic)
dispatch of the MCV Facility in order to maximize recovery of its capacity
payments. As such, if the spread between MCV Facility's variable electricity
production costs and its energy payment revenues stays constant or widens, the
negative impacts on MCV Partnership's financial performance, and on the value of
Consumers' equity interest in the MCV Partnership, will be worse.
Consumers cannot estimate, at this time, the impact of these issues on its
future earnings or cash flow from its interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to Consumers' recovery of capacity payments are the two most
significant variables in the analysis of MCV Partnership's future financial
performance. Natural gas prices have historically been volatile and presently
there is no consensus in the marketplace on the price or range of prices of
natural gas beyond the next five years. Further, it is not presently possible
for Consumers to predict the actions of the MPSC in 2007 or later. For these
reasons, at this time Consumers cannot predict the impact of these issues on its
future earnings, cash flows, or on the value of its $404 million equity interest
in the MCV Partnership.
Consumers is exploring possible alternatives for utilizing the MCV Facility
without increasing costs to customers. Any changes regarding the recovery of MCV
capacity costs would require MPSC approval. Consumers cannot predict the outcome
of this matter.
For further information see Note 4, Uncertainties, "Consumers' Other 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 typically classifies as derivative instruments
are interest rate swaps, foreign currency exchange contracts, certain electric
call options, gas fuel options, fixed priced weather-based gas supply call
options, fixed price gas supply call and put options, gas futures, and gas and
power swaps and forward purchases and sales. CMS Energy does not account for
electric capacity and 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
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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 accumulated 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 valuation models. Valuation 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 certain contracts. At September 30, 2003, Consumers
assumed a market-based interest rate of one percent (six-month U.S. Treasury)
and an average volatility rate of 55 percent to calculate the fair value of its
gas 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 accumulated other comprehensive income and
are 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. Established
policies and procedures are used to manage the risks associated with market
fluctuations.
CMS Energy may use various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. CMS Energy 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. CMS
Energy minimizes such risk by performing financial
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credit reviews using, among other things, publicly available credit ratings of
such counterparties.
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 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, CMS Energy
and its subsidiaries rely on the experience and judgment of senior management to
revise strategies and adjust positions, as they deem necessary. Changes 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: CMS Energy is exposed to interest rate risk resulting from
the issuance of fixed-rate and variable-rate financing, 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 are designed to provide and maintain a balance
between risk and the lowest cost of capital.
As of September 30, 2003, CMS Energy had outstanding variable-rate financing of
$633 million, a $1.015 billion decrease (62 percent) from the December 31, 2002
balance of $1.648 billion. The decline in variable-rate financing is primarily
due to a shift toward fixed-rate financing. As of September 30, 2003, assuming a
hypothetical 10 percent adverse change in market interest rates, CMS Energy's
before tax annual earnings exposure on its variable-rate financing would be $1
million.
As of September 30, 2003, CMS Energy had outstanding fixed-rate financing,
including trust preferred securities, of $6.772 billion, a $768 million increase
(13 percent) over the December 31, 2002 balance of $6.004 billion. As of
September 30, 2003, the fair value of CMS Energy's fixed-rate financing was
$6.861 billion, a $1.364 billion increase (25 percent) over the December 31,
2002 fair value of $5.497 billion. The change in the fair value of the
fixed-rate financing is due to both an increase in outstanding fixed-rate debt
obligations as well as a decline in market interest rates. At September 30,
2003, assuming a hypothetical 10 percent adverse change in market interest
rates, the fair value of CMS Energy's fixed rate financing and trust preferred
securities would increase by $252 million.
At September 30, 2003 and December 31, 2002, the fair value of CMS Energy's
floating to fixed interest rate swaps with notional amounts of $14 million and
$294 million, were negative $1 million and negative $7 million, which represent
the amounts 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 energy commodities, including natural gas, oil, electricity, coal, natural
gas liquids and other commodities. CMS Energy employs established policies and
procedures to manage these risks and may use 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 may also hedge 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 three months would change by $0.8 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. The analysis does not quantify short-term exposure to hypothetically
adverse price fluctuations in inventories.
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For purposes other than trading, Consumers entered into electric call options,
fixed priced weather-based gas supply call options and fixed priced gas supply
call and 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 weather-based gas
supply call options, and the gas supply call and put options are used to
purchase reasonably priced gas supply. Call options allow Consumers the right
but not the obligation to purchase gas supply at predetermined fixed prices. Put
options allow third-party suppliers the right but not the obligation to sell
Consumers gas supply at predetermined fixed prices.
As of September 30, 2003 and December 31, 2002, the fair value of
electricity-related call option contracts, based on quoted market prices and
mathematical valuation models using current and historical pricing data, was $3
million and $9 million, respectively. As of September 30, 2003 assuming a
hypothetical 10 percent adverse change in market prices, the potential reduction
in fair value associated with these contracts would be $1 million. As of
September 30, 2003 and December 31, 2002, Consumers had an asset of $21 million
and $30 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 September 30, 2003, the
fair value of the fixed priced weather-based gas supply call options and fixed
priced gas supply call and put options, based on quoted market prices and
mathematical valuation models, was less than $1 million. As of September 30,
2003, assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $1
million.
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 accumulated
other comprehensive income as a component of foreign currency translation
adjustment. For the nine months ended September 30, 2003, there was no
mark-to-market adjustment included in the total net foreign currency translation
adjustment of $39 million. At September 30, 2003, there were no foreign exchange
hedges.
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 September 30, 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 further information on market risk and derivative activities, see Note 7,
Risk Management Activities and Financial Instruments.
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 loss
of $23 million, net of tax. See Note 10, Implementation 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.
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Changes in fair value of the energy trading contracts 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 trading 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. Where contractual 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.
The following tables provide a summary of the fair value of CMS Energy's energy
trading contracts as of September 30, 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 (9)
Other changes in fair value (c) 8
- -------------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of September 30, 2003 $ 14
=================================================================================================
(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.
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Fair Value of Contracts at September 30, 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 $ (39) $ (5) $ (17) $ (15) $ (2)
Prices based on models and
other valuation methods 53 11 27 13 2
- ---------------------------------------------------------------------------------------------------------------------
Total $ 14 $ 6 $ 10 $ (2) $ -
=====================================================================================================================
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 September 30, 2003, the cumulative Foreign Currency
Translation decreased stockholders' equity by $419 million. Included in this
amount is an unrealized loss of $118 million related to CMS Energy's investment
in Loy Yang. This loss, and the impact of certain deferred taxes associated with
the Loy Yang investment will be realized upon sale, full liquidation, or other
disposition of CMS Energy's investment in Loy Yang, for a total loss of
approximately $168 million. In July 2003, a conditional share sale agreement for
CMS Energy's investment in Loy Yang was executed. See Outlook, "Corporate
Outlook" section in this MD&A for further discussion.
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 previously had
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
reduce substantially 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
September 30, 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 Stockholders' Equity using an exchange rate of 2.975 pesos
per U.S. dollar was $259 million. This amount also reflects the effect of
recording U.S. income taxes with respect to
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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 may use 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 associated with adverse changes
in currency exchange rates that could affect materially cash flow. These
contracts would 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
not significant.
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 normally would 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 September 30, 2003, Consumers had $1.113 billion recorded as
regulatory assets and $461 million recorded as regulatory liabilities.
In 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. However,
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 allowed
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 10, Implementation of New Accounting Standards, "SFAS No. 143,
Accounting for Asset Retirement Obligations."
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For further information on industry regulation, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, "Utility Regulation".
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 CMS Energy and affiliates
which are not distinguishable from the Pension Plan's total assets. In June
2003, CMS Energy completed the sale of Panhandle to Southern Union Panhandle
Corp. No portion of the Pension Plan was transferred with the sale. Panhandle
employees are no longer eligible to accrue additional benefits. The Pension Plan
retained pension payment obligations for Panhandle employees that were vested
under the Pension Plan. Because of the significant change in the makeup of the
plan, SFAS No. 87 required a remeasurement of the obligation at the date of
sale. The estimated remeasurement resulted in an increase in pension expense of
approximately $4 million and OPEB expense of approximately $6 million for 2003,
as well as an additional charge to accumulated other comprehensive income of
approximately $30 million ($20 million after tax), as a result of the increase
in the additional minimum pension liability. Additionally, a significant number
of Panhandle employees elected to retire as of July 1, 2003 under the CMS Energy
Employee Pension Plan. As a result, CMS Energy has recorded a $13 million
after-tax settlement loss pursuant to the provisions of SFAS No. 88, which is
reflected in discontinued operations. The actuary is in the process of
finalizing the effects of the mid-year remeasurement. Although actual results
may differ from the estimates recorded, CMS Energy does not expect those
differences to be material.
CMS Energy estimates consolidated OPEB expense will approximate $58 million in
2003, $66 million in 2004, and $63 million in 2005. Additionally, CMS Energy
estimates consolidated pension expense will approximate $47 million in 2003, $51
million in 2004 and $53 million in 2005. 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 August 2003, CMS Energy made its planned contribution of $210 million
to the Pension Plan.
CMS Energy has announced amendments to the Pension Plan for salaried employees,
whereby, 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 addition, CMS Energy has implemented a cash balance plan for
employees hired on or after July 1, 2003. Under a cash balance plan, an
employee's retirement account is credited annually with a percentage of base
pay. Accounts will be valued at the end of each year, using an annual variable
interest rate to determine growth. Employees who leave the company and are
vested in the cash balance version of the pension plan can either start
receiving the benefit immediately, postpone receiving benefits until a future
date while receiving an earnings credit on the account (payment cannot be
deferred beyond age 70-1/2), or roll 100 percent of the cash balance account
into an IRA or another qualified plan. If a participant is not vested (less than
five years of service under the terms of the plan), the cash balance account is
forfeited.
CMS-12
CMS Energy Corporation
In 2003, a large majority of retiring employees elected the lump sum payment
option instead of receiving pension benefits as an annuity over time. As a
result, CMS Energy may be required to record a settlement loss in accordance
with SFAS No. 88, which requires a settlement loss to be recognized when the
cost of all settlements paid during the year exceeds the sum of the service and
interest costs for the same year. CMS Energy cannot yet determine if the amount
of lump sum payments for 2003 will exceed the threshold, but estimates that, if
the threshold is exceeded, between $60 million and $70 million could be
recognized as a loss in the fourth quarter of 2003.
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. The MPSC orders received in March and December of 1999 for Big Rock and
Palisades plants, respectively, provided for fully funding the decommissioning
trust funds for both sites. The December 1999 order set the annual
decommissioning surcharge for the Palisades decommissioning at $6 million.
Consumers estimates that at the time of the decommissioning of Palisades, its
decommissioning trust fund will be fully funded. This conclusion assumes 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 cost estimates use various inflation rates for labor,
non-labor, and contaminated equipment disposal costs.
In December 2000, funding of the Big Rock trust fund was stopped since it was
considered fully funded, subject to further review. A portion of future
decommissioning cost will result from the failure of the DOE to remove fuel from
the site. These costs, and similar costs incurred at Palisades, would not be
necessary if the DOE took possession of the spent fuel as required by the
Nuclear Waste Policy Act of 1982. A number of utilities, including Consumers,
which filed its complaint in December 2002, have commenced litigation in the
Court of Claims. 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. However, there is no assurance that the litigation against the
DOE will be successful.
The funds provided by the trusts and additional potential 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. For further information see Note 4, Uncertainties, "Other
Consumers' Electric Utility Uncertainties - Nuclear Matters."
In March 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 in April 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,
Detroit Edison, 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. In May 2003,
Consumers and the other named utilities each filed a motion to dismiss the
complaint. Consumers is unable to predict the outcome of this matter.
CMS-13
CMS Energy Corporation
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
In Millions (except for per share amounts)
- --------------------------------------------------------------------------------
Three months ended September 30 2003 2002
- --------------------------------------------------------------------------------
CMS Energy Net Income (Loss) $ (77) $ 37
CMS Energy Basic Earnings (Loss) per Share $ (0.51) $ 0.26
CMS Energy Diluted Earnings (Loss) Per Share $ (0.51) $ 0.26
- --------------------------------------------------------------------------------
CMS Energy's results of operations continue to reflect the implementation of a
back-to-basics strategy that focuses on a growing healthy utility and divesting
under performing or other non-strategic assets. The strategy is designed to
generate cash to pay down debt, to reduce business risk, and to provide for more
predictable future operating revenues and earnings. Through this strategy, CMS
Energy is continuing to rightsize and to restructure its business operations. In
2003, CMS Energy has experienced increased competition, cooler summer
temperatures, slow general economic recovery in Michigan, costs associated with
debt retirement and refinancing, and the loss of earnings from businesses and
assets sold.
In Millions (except for per share amounts)
- ----------------------------------------------------------------------------------------
Three months ended September 30 2003 2002 Change
- ----------------------------------------------------------------------------------------
Electric Utility $ 59 $ 88 $ (29)
Gas Utility (19) (18) (1)
Enterprises 13 58 (45)
Corporate Interest and Other (87) (117) 30
- ----------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (34) 11 (45)
- ----------------------------------------------------------------------------------------
Discontinued Operations (43) 25 (68)
Accounting Changes - 1 (1)
- ----------------------------------------------------------------------------------------
Net Income (Loss) $ (77) $ 37 $(114)
========================================================================================
For the three months ended September 30, 2003, CMS Energy's net loss totaled $77
million. The net loss reflects a $42 million after-tax asset impairment charge
at Enterprises, $28 million after-tax of debt retirement and refinancing costs,
and cooler summer weather.
COMPARISON TO COMPARABLE PERIOD IN 2002
Results from continuing operations ($34 million loss) were $45 million worse
than the $11 million of income earned in 2002. The decrease in results from
continuing operations reflects decreased Electric Utility deliveries due to a
cooler summer in 2003 and more industrial and commercial customers choosing
different electricity suppliers (see Electric Utility section in Results of
Operations). The decrease also reflects lower Enterprises' earnings due to the
absence of a $15 million after-tax gain on 2002 asset sales and the loss of
CMS-14
CMS Energy Corporation
earnings from businesses and assets sold (see Enterprises Outlook section in
MD&A). These reductions in earnings were partially offset by a $30 million
after-tax reduction in Corporate Interest and Other expenses. This expense
reduction reflects the absence of a $41 million after-tax income tax valuation
allowance recorded in 2002 attributable to a reduction in AMT carryforwards (see
Corporate Interest and Other section in Results of Operations).
Loss from discontinued operations was $43 million, a decrease of $68 million
from the comparable period in 2002, due to a $42 million after-tax asset
impairment at Enterprises and reduced earnings resulting from the sale of CMS
Oil and Gas in 2002, Panhandle in 2003, and other businesses as CMS Energy
continues to implement its back-to-basics strategy.
In Millions (except for per share amounts)
- -----------------------------------------------------------------------------------------------
Nine months ended September 30 2003 2002
- -----------------------------------------------------------------------------------------------
CMS Energy Net Income (Loss) $ (43) $ 5
CMS Energy Basic Earnings (Loss) per Share $ (0.29) $ 0.04
CMS Energy Diluted Earnings (Loss) Per Share $ (0.29) $ 0.04
In Millions (except for per share amounts)
- -------------------------------------------------------------------------------------------
Nine months ended September 30 2003 2002 Change
- -------------------------------------------------------------------------------------------
Electric Utility $ 145 $ 222 $ (77)
Gas Utility 40 13 27
Enterprises 48 126 (78)
Corporate Interest and Other (196) (221) 25
- -------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 37 140 (103)
- -------------------------------------------------------------------------------------------
Discontinued Operations (56) (153) 97
Accounting Changes (24) 18 (42)
- -------------------------------------------------------------------------------------------
Net Income (Loss) $ (43) $ 5 $ (48)
===========================================================================================
For the nine months ended September 30, 2003, CMS Energy's net loss totaled $43
million. The net loss reflects a $42 million after-tax asset impairment at
Enterprises, a $30 million after-tax loss on the Panhandle sale, $25 million
after-tax of debt retirement and refinancing costs, cooler summer weather, and
improved Gas Utility earnings.
COMPARISON TO COMPARABLE PERIOD IN 2002
Income from continuing operations was $103 million lower than the $140 million
of income earned in 2002. The decrease in income from continuing operations
primarily reflects a decline at the Electric Utility resulting from reduced
electric deliveries due to a cooler summer in 2003 and more industrial and
commercial customers choosing different electricity suppliers, the absence of
after-tax gains of $31 million primarily from the sale of transmission assets in
2002, and a scheduled refueling outage at Palisades (see Electric Utility
Results of Operations). The decrease is also due to a decline in Enterprises'
earnings reflecting the absence of an after-tax gain of $15 million associated
with asset sales in 2002 and the continuing implementation of the back-to-basics
strategy and the resulting loss of earnings from businesses and assets sold (see
Enterprises Results of Operations and Enterprises Outlook section in the MD&A).
The decrease was partially offset by improved Gas Utility earnings reflecting
increased gas deliveries and the impacts of a final gas rate order issued in
2002 that increased tariff rates; and Enterprises' foreign currency gains from
the stabilization of the Argentine Peso.
For the nine months ended September 30, 2003, Loss From Discontinued Operations
which totaled $56 million includes a $30 million after-tax loss resulting from
the sale of Panhandle and a $42 million after-tax asset
CMS-15
CMS Energy Corporation
impairment at CMS Electric and Gas, an improvement of $97 million from the
comparable period in 2002. Loss from Discontinued Operations for the nine months
ended September 30, 2002 reflects an after-tax gain on the sale of CMS Energy's
ownership interests in Equatorial Guinea properties of $310 million, and the
cumulative effect on a change in accounting for goodwill impairments, net of
tax, at both Panhandle of $(369) million and CMS Viron of $(10) million. The
change in results also reflects the loss of earnings of businesses and assets
sold and asset impairments and writedowns.
The nine months ended September 30, 2003 net income includes a $23 million
charge related to the cumulative effect of a change in accounting resulting from
the implementation of EITF Issue No. 02-03 and a $1 million charge associated
with the implementation of SFAS No. 143. The nine months ended September 30,
2002 net income reflects $18 million of after-tax earnings due to an accounting
change to adjust the fair value of certain long-term contracts held at the MCV
Partnership recorded in the second quarter of 2002.
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC UTILITY NET INCOME:
In Millions
- ------------------------------------------------------------------------------
September 30 2003 2002 Change
- ------------------------------------------------------------------------------
Three months ended $ 59 $ 88 $(29)
Nine months ended $145 $222 $(77)
==============================================================================
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------
Reasons for change September 30, 2003 vs. 2002 September 30, 2003 vs. 2002
- ------------------------------------------------------------------------------------------------------------------
Electric deliveries $ (34) $ (38)
Power supply costs and related revenue 2 14
Other operating expenses and non-commodity revenue (5) (43)
Asset sales - (38)
General taxes (3) 12
Fixed charges (5) (18)
Income taxes 16 34
-----------------------------------------------------------
Total change $ (29) $ (77)
==================================================================================================================
ELECTRIC DELIVERIES: For the three months ended September 30, 2003, electric
delivery revenues decreased by $34 million from the previous year. Electric
deliveries, including transactions with other wholesale market participants and
other electric utilities, were 10.3 billion kWh, a decrease of 0.6 billion kWh
or 4.9 percent from 2002. The decrease in revenue is primarily the result of
decreased deliveries to the higher margin residential sector due to milder
summer temperatures in 2003 compared to the same period in 2002, which included
record setting monthly sendout and monthly hourly peak demand volumes.
Commercial and industrial customers switching to alternative electric suppliers
as allowed by the Customer Choice Act further reduced electric delivery
revenues.
For the nine months ended September 30, 2003, electric delivery revenues
decreased by $38 million from the previous year. Electric deliveries, including
transactions with other wholesale market participants and other electric
utilities, were 29.3 billion kWh, a decrease of 0.2 billion kWh or 0.6 percent
from 2002.
CMS-16
CMS Energy Corporation
The decrease in delivery revenues can be attributed to the continuing switch by
commercial and industrial customers to alternative electric suppliers allowed by
the Customer Choice Act. Also contributing to decreased electric deliveries was
a reduction in residential consumption due to milder summer temperatures in 2003
compared to the same period in 2002, which included record setting monthly send
out and monthly hourly peak demand volumes.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended September 30,
2003, power supply costs and related revenues increased electric net income by
$2 million from 2002.
For the nine months ended September 30, 2003, power supply costs and related
revenues increased electric net income by $14 million from 2002. This increase
is primarily the result of increased intersystem revenues due to higher market
prices and sales made from additional surplus capacity.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three months ended
September 30, 2003, net operating expenses and non-commodity revenue decreased
operating income by $5 million compared to 2002. This decrease relates primarily
to increased amortization expense from securitized assets and reduced
miscellaneous electric service revenues.
For the nine months ended September 30, 2003, operating expenses increased
compared to 2002. This increase can be attributed to storm restoration expenses,
a scheduled refueling outage at Palisades, which began on March 16, 2003 and
ended on April 20, 2003, and higher transmission costs due to the loss of a
financial return on the Consumers' transmission system asset sold in May 2002.
Slightly offsetting these increased operating expenses were increased
non-commodity revenues associated with miscellaneous service revenues.
ASSET SALES: For the nine months ended September 30, 2003, pretax income from
asset sales decreased $38 million from the comparable period in 2002. This is
the result of the $31 million pretax gain associated with the May 2002 sale of
Consumers' electric transmission system and the $7 million pretax gain
associated with the June 2002 sale of nuclear equipment from the cancelled
Midland project.
GENERAL TAXES: For the three months ended September 30, 2003, general taxes
increased $3 million compared to 2002 primarily due to larger property tax
expense from increased investment.
For the nine months ended September 30, 2003, general taxes decreased $12
million from the comparable period in 2002. This decrease is due to reduced MSBT
expenses related to the years 2000 and 2001. This is the result of CMS Energy
receiving approval to file consolidated tax returns for the years 2000 and 2001.
These returns were filed during the second quarter of 2003.
FIXED CHARGES: For the three and nine months ended September 30, 2003, fixed
charges increased $5 million and $18 million, respectively, from the comparable
period in 2002. These increases can be attributed to increased financing
activities.
INCOME TAXES: For the three and nine months ended September 30, 2003, income tax
expense decreased $16 million and $34 million, primarily due to a decrease in
earnings by the electric utility compared to 2002.
CMS-17
CMS Energy Corporation
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
GAS UTILITY NET INCOME:
In Millions
- -----------------------------------------------------------------------
September 30 2003 2002 Change
- -----------------------------------------------------------------------
Three months ended $(19) $(18) $ (1)
Nine months ended $ 40 $ 13 $ 27
=======================================================================
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------
Reasons for change September 30, 2003 vs. 2002 September 30, 2003 vs. 2002
- ------------------------------------------------------------------------------------------------------------------
Gas deliveries $ (14) $ 14
Gas rate increase 5 35
Gas wholesales and retail services 1 4
Operation and maintenance 8 (6)
General taxes, depreciation, and other income (1) (2)
Fixed charges (1) (4)
Income taxes 1 (14)
---------------------------------------------------
Total change $ (1) $ 27
==================================================================================================================
GAS DELIVERIES: For the three months ended September 30, 2003, gas delivery
revenues decreased by $14 million from the previous year. The decrease primarily
reflects $7 million of increased expense associated with Consumers' annual
analysis of gas losses related to the gas transmission and distribution system.
The adjustment is recorded as a reduction to accrued gas revenues. System
deliveries, including miscellaneous transportation, totaled 38.2 bcf, a decrease
of 1.9 bcf or 4.8 percent compared with 2002.
For the nine months ended September 30, 2003, gas delivery revenues increased by
$14 million from the previous year. System deliveries, including miscellaneous
transportation, totaled 272.7 bcf, an increase of 18 bcf or 7.1 percent compared
with 2002. This increase is primarily due to colder weather during the first
quarter 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, for the three and nine months ended September 30, 2003,
Consumers recognized increased gas revenues of $5 million and $35 million,
respectively.
OPERATION AND MAINTENANCE: For the three months ended September 30, 2003,
operation and maintenance expenses decreased $8 million when compared to 2002.
This decrease reflects the absence of gas storage inventory losses recorded in
2002.
For the nine months ended September 30, 2003, operation and maintenance expenses
increased $6 million when compared to 2002. This increase reflects the
recognition of additional expenditures on safety, reliability and customer
service.
INCOME TAXES: For the three months ended September 30, 2003, income tax expense
decreased primarily
CMS-18
CMS Energy Corporation
due to decreased earnings of the gas utility compared to 2002.
For the nine months ended September 30, 2003, income tax expense increased
primarily due to improved earnings of the gas utility.
ENTERPRISES RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------
September 30 2003 2002 Change
- -------------------------------------------------------------------------------
Three months ended $ 13 $ 58 $ (45)
Nine months ended $ 48 $ 126 $ (78)
- -------------------------------------------------------------------------------
For the three months ended September 30, 2003, Enterprises' net income was $13
million, a decrease of $45 million from the comparable period in 2002. The
decrease in earnings reflects the absence of a $15 million after-tax benefit
associated with the sale of an ownership interest in NPS in 2002, foreign
currency losses in 2003, and the shift in business strategy and sale of
Enterprises assets and businesses (see the Enterprises Outlook section in the
MD&A).
For the nine months ended September 30, 2003, Enterprises' net income was $48
million, a decrease of $78 million from the comparable period in 2002. The
decrease in earnings reflects the absence of a $15 million after-tax benefit
associated with the sale of an ownership interest in NPS in 2002, and the shift
in business strategy and sale of Enterprises assets and businesses (see the
Enterprises Outlook section in the MD&A). The decrease was partially offset by
foreign currency gains related to the stabilization of the Argentine Peso and
increased earnings at CMS Generation due to lower depreciation expenses.
OTHER RESULTS OF OPERATIONS
CORPORATE INTEREST AND OTHER:
In Millions
- --------------------------------------------------------------------------------
September 30 2003 2002 Change
- --------------------------------------------------------------------------------
Three months ended $ (87) $ (117) $ 30
Nine months ended $ (196) $ (221) $ 25
- --------------------------------------------------------------------------------
For the three months ended September 30, 2003, corporate interest and other net
expenses were $87 million, a decrease of $30 million from the comparable period
in 2002. The decrease is primarily due to a $41 million reduction of income tax
expense due to the absence of a 2002 valuation allowance recorded on AMT credit
carryfowards, and a $26 million after-tax reduction in restructuring charges.
These decreases were offset by a $28 million after-tax increase in debt
retirement and refinancing costs, and an increase in other corporate interest
expenses.
For the nine months ended September 30, 2003, corporate interest and other net
expenses were $196 million, a decrease of $25 million from the comparable period
in 2002. The decrease is primarily due to a $41 million reduction of income tax
expense due to the absence of a 2002 valuation allowance recorded on AMT credit
carryfowards, a $28 million after-tax reduction of restructuring charges, and
$20 million of MSBT refunds received in 2003. These decreases were offset
partially by a $25 million after-tax increase in debt retirement and refinancing
costs, the establishment in June 2003 of a $24 million deferred tax asset
valuation allowance that may not be used in the future due to changes in CMS
Energy's tax planning strategy, and an increase in other corporate interest
expenses.
CMS-19
CMS Energy Corporation
DISCONTINUED OPERATIONS: For the nine months ended September 30, 2003,
discontinued operations included International Energy Distribution and
Marysville, as well as Panhandle, CMS Viron, and CMS Field Services through
their respective dates of sale. For the nine months ended September 30, 2002,
discontinued operations included Panhandle, CMS Viron, CMS Field Services,
International Energy Distribution, and Marysville, and CMS Oil and Gas through
its respective date of sale. 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. For the first nine
months of 2003, Consumers paid $162 million in common dividends and Enterprises
paid $179 million in common dividends and other distributions to CMS Energy.
Included in Enterprises' distributions to CMS Energy was a $16 million stock
dividend, discussed below. In October 2003, Consumers declared a $57 million
common dividend to CMS Energy, payable in November 2003. CMS Energy's
consolidated cash requirements are met by its operating, investing, and
financing activities. Consistent with CMS Energy's liquidity objectives, $869
million consolidated cash was on hand at September 30, 2003, which includes $205
million of restricted cash. Restricted cash includes cash collateral for letters
of credit to satisfy certain debt agreements and is classified as a current
asset as all restricted cash relates to letters of credit maturing within one
year.
The following discussion of operating, investing, and financing activities
summarizes CMS Energy's Consolidated Statements of Cash Flows found in CMS
Energy's consolidated financial statements.
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 nine
months, cash used in operations after interest charges totaled $14 million in
2003 and cash provided from operations after interest charges totaled $333
million in 2002. The $347 million decrease in cash from operations resulted
primarily from an increased pension contribution, an increase in inventories,
and a decrease in accounts payable and accrued expenses. 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 nine months, CMS Energy's net cash provided
by investing activities totaled $501 million in 2003 and $884 million in 2002.
The $383 million decrease in cash provided primarily reflects a decrease of $685
million in proceeds received from the sale of assets. CMS Energy's expenditures,
including investments and assets placed under capital lease, in the first nine
months of 2003 for its utility and diversified energy businesses were $326
million and $46 million, respectively, compared to $461 million and $187
million, respectively, for the first nine months of 2002.
FINANCING ACTIVITIES: For the first nine months, CMS Energy's net cash used in
financing activities totaled $184 million in 2003 and $1,008 million in 2002.
The $824 million change in financing cash flow resulted primarily from an
increase in proceeds received from notes, bonds and other long-term debt of
$1.576 billion, a decrease in the retirement of trust preferred securities of
$111 million, and a decrease in the payment of common stock dividends of $124
million. These improvements in financing activities were offset partially by a
decrease in the proceeds received from the issuance of common stock of $133
million, an increase in retirement of notes, bonds and other long-term debt of
$378 million, and a decrease in notes payable of $324 million.
CMS-20
CMS Energy Corporation
OTHER INVESTING AND FINANCING MATTERS: In January 2003, the Board of Directors
suspended the payment of CMS Energy's common stock dividend in order to improve
liquidity.
In June 2003, Enterprises transferred its 1,967,640 shares of CMS Energy Common
Stock, valued at $16 million, to CMS Energy in the form of a stock dividend.
There was no impact on shares outstanding or the consolidated income statement.
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. For further information see Note 4, Uncertainties and Note 5,
Financings and Capitalization.
The following table shows a summary of CMS Energy's contractual obligations,
including off-balance sheet commitments at September 30, 2003.
Contractual Obligations In Millions
- -------------------------------------------------------------------------------------------------------------------------
Payments Due
------------------------------------------------------------------------
September 30 Total 2003 2004 2005 2006 2007 Beyond
- -------------------------------------------------------------------------------------------------------------------------
On-balance sheet
Long-term debt $ 6,291 $ - $ 205 $ 602 $ 513 $ 537 $ 4,434
Current portion of debt 172 43 129 - - - -
Notes payable 4 1 3 - - - -
Capital Lease Obligations 128 4 15 14 13 12 70
- -------------------------------------------------------------------------------------------------------------------------
Total on-balance sheet $ 6,595 $ 48 $ 352 $ 616 $ 526 $ 549 $ 4,504
- -------------------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Non-recourse debt $ 2,647 $ 229 $ 152 $ 116 $ 409 $ 13 $ 1,728
Operating leases 92 7 14 12 12 10 37
Sale of accounts receivable 254 254 - - - - -
Unconditional purchase
Obligations 17,897 601 1,577 1,197 905 743 12,874
- -------------------------------------------------------------------------------------------------------------------------
Total off-balance sheet $20,890 $ 1,091 $ 1,743 $ 1,325 $ 1,326 $ 766 $14,639
=========================================================================================================================
LONG-TERM DEBT
CMS Energy Long-Term Financings: In July 2003, CMS Energy issued, in a private
placement to institutional investors, $150 million of 3.375 percent convertible
senior notes due July 15, 2023. The notes are putable to CMS Energy by the note
holders at par on July 15, 2008, July 15, 2013 and July 15, 2018. The notes are
convertible into CMS Energy common stock at the option of the holder under
certain circumstances. The initial conversion price is $10.671 per share, which
translates into 93.7137 shares of common stock for each $1,000 principal note
converted, and a total of 14,057,055 shares of CMS Energy common stock if all
notes are converted. CMS has agreed to file a shelf registration statement with
the SEC by October 14, 2004 relating to the resale of the notes and the common
stock issuable upon conversion thereof. Also in July 2003, CMS Energy issued
$300 million of 7.75 percent senior notes due 2010. CMS Energy has agreed to
file a registration statement with the SEC by March 14, 2004 to permit holders
of these notes to exchange the notes for new notes that will be registered under
the Securities Act of 1933. The approximately $433 million of
CMS-21
CMS Energy Corporation
proceeds from these issuances were used to retire a portion of debt outstanding
under CMS Energy's Second Amended and Restated Senior Credit Agreement and to
redeem a portion of CMS Energy's 6.75 percent Senior Notes due January 2004.
In July 2003, CMS Energy retired $150 million principal amount of CMS Energy's
8.375 percent Reset Put Securities due 2013. As a result, CMS Energy recorded a
charge in July 2003 of approximately $19 million after-tax related to the
accelerated amortization of debt issuance costs and the premium paid associated
with the discharge of these securities. In October 2003, $82 million of the 6.75
percent senior notes were called and redeemed. In October 2003, approximately
$15 million of Series E GTNs were called and redeemed.
Consumers Long-Term Financings: The following is a summary of Consumers'
Long-Term debt issuances during 2003:
- -------------------------------------------------------------------------------------------------------------
Facility Principal Use of
Type (millions) Issue Rate Issue Date Maturity Date Proceeds Collateral
- -------------------------------------------------------------------------------------------------------------
Term Loan $ 140 LIBOR + March 2003 March 2009 GCP FMB (f)
475 bps
Term Loan 150 LIBOR + March 2003 March 2006 (c) GCP FMB (f)
450 bps
FMB (a) 375 5.375% April 2003 April 2013 (c) -
FMB (a) 250 4.250% April 2003 April 2008 (c) -
FMB (a) 250 4.000% May 2003 May 2010 (d) -
FMB (b) 200 4.800% August 2003 February 2009 (e) -
FMB (b) 200 6.000% August 2003 February 2014 (e) -
-------
Total $ 1,565
=============================================================================================================
(GCP - General Corporate Purposes)
(FMB - First Mortgage Bonds)
(bps - basis points)
(a) Consumers has agreed to file a registration statement with the SEC by
December 26, 2003 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.
(b) Consumers has agreed to file a registration statement with the SEC by April
14, 2004 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.
(c) 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 included paying down additional
debt.
(d) Consumers used the net proceeds to prepay a portion of a term loan that was
due to mature in July 2004.
(e) Consumers used the net proceeds to pay off the $150 million term loan
negotiated in March 2003 that was due to mature in March 2006 as well as the
remaining $50 million balance on a term loan that was due to mature in March
2004, and for general corporate purposes.
(f) Refer to "Regulatory Authorization for Financings" below for information
about Consumers' remaining FERC debt authorization.
As part of Consumers' ongoing cost reduction measures in an attempt to reduce
its financing costs, Consumers will continue to monitor financial markets.
CMS-22
CMS Energy Corporation
Short-Term Financings: On March 30, 2003, CMS Energy entered into an amendment
and restatement of its then existing $300 million and $295.8 million revolving
credit facilities under which $409 million was outstanding. The Second Amended
and Restated Senior Credit Agreement included 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 included 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, were required to be used to prepay this facility. This facility
was collateralized primarily by the stock of Consumers, Enterprises and certain
Enterprises subsidiaries. In July 2003, the facility was paid down to $5 million
with a combination of a portion of the proceeds of the sale of CMS Field
Services and a portion of the proceeds of the issuance of the $300 million 7.75
percent Senior Notes due 2010. On September 12, 2003, this credit agreement was
amended and restated in the amount of $5 million. The amended and restated
credit facility does not include any restrictive financial covenants. As of
September 30, 2003, $5 million is outstanding on this facility.
In March 2003, Consumers obtained a replacement revolving credit facility in the
amount of $250 million secured by first mortgage bonds. In September 2003, this
facility was amended and restated as a $400 million revolving credit facility.
The interest rate of the facility was reduced from LIBOR plus 350 to LIBOR plus
175 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.
At September 30, 2003, all of the $400 million is available for general
corporate purposes.
In May 2003, CMS Energy entered into a revolving credit facility in an aggregate
amount of $185 million. The maturity date of this facility is May 21, 2004. This
facility is primarily used to provide letter of credit support for Enterprises'
subsidiary activities - principally credit support for project debt. Enterprises
provides funds to cash collateralize all letters of credit issued through this
facility. As of September 30, 2003, approximately $167 million of letters of
credit were issued under this facility and the cash that collateralizes the
letters of credit is included on the balance sheet as restricted cash.
Regulatory Authorization for Financings: At September 30, 2003, Consumers had
FERC authorization, through June 2004, to issue or guarantee up to $1.1 billion
of short-term securities outstanding at any one time. As of September 30, 2003,
Consumers had $400 million outstanding as collateral for the revolving credit
facility (discussed below) and had an additional $700 million available for
future issuances of short-term securities. At September 30, 2003, Consumers also
had remaining FERC authorization, through June 2004, to issue up to $800 million
of long-term securities for refinancing or refunding purposes, $560.3 million of
long-term securities for general corporate purposes, and $2.06 billion of
long-term first mortgage bonds to be issued solely as collateral for other
long-term securities. Also, FERC has granted waivers of its competitive
bid/negotiated placement requirements applicable to the long-term securities
authorization indicated above.
Required Ratios: CMS Energy's amended and restated $5 million credit facility
does not include any restrictive financial covenants. Consumers' credit
facilities have restrictive financial covenants that require Consumers to
maintain, as of the last day of each fiscal quarter, the following:
CMS-23
CMS Energy Corporation
Required Ratio Limitation Ratio at September 30, 2003
- ----------------------------------------------------------------------------------------------------------
CONSUMERS:
Debt to Capital Ratio(a)(b) not more than 0.65 to 1.00 0.58 to 1.00
Interest Coverage Ratio-Revolver(a) not less than 2.00 to 1.00 3.34 to 1.00
==========================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility that provides the lender, among other remedies, the right to
declare the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
In 1994, CMS Energy executed an indenture with JPMorgan Chase Bank, ultimate
successor to The Chase Manhattan 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 September 30, 2003, CMS Energy's
consolidated leverage ratio was 0.76 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 may refinance existing debt that was incurred while
CMS Energy was in compliance with the consolidated leverage ratio.
In 1992, CMS Energy executed an indenture with Bank One Trust Company, N.A.
(successor to NBD Bank, National Association) pursuant to which CMS Energy
issues its senior notes. The indenture, through supplements, contains certain
provisions that can trigger a limitation on consolidated indebtedness and the
ability of Consumers to incur indebtedness. The limitation can be activated when
CMS Energy's consolidated coverage ratio, as defined in the indenture, is below
1.70 to 1.0. At September 30, 2003, CMS Energy's consolidated coverage ratio was
2.02 to 1.0.
Consumers is subject to covenants in its financing agreements that could limit
its ability to incur additional indebtedness. Consumers has agreed in several of
its financing agreements to maintain specified levels of cash coverage of its
interest requirements and to not allow its indebtedness to exceed specified
levels of its consolidated capitalization (the "Debt Percentage Tests").
Consumers is in compliance with these requirements as of the most recent
measurement date, September 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. Consumers sought and received amendments to
certain of its financing agreements to modify the terms of the Debt Percentage
Tests in order to, among other things, remove the effect of the adoption of SFAS
No. 150, portions of which have now been deferred indefinitely, regarding Trust
Preferred Securities on the calculations.
Restricted Payments: Under the provisions of its articles of incorporation,
Consumers had $412 million of unrestricted retained earnings available to pay
common dividends at September 30, 2003. However, covenants in Consumers' debt
facilities cap common stock dividend payments at $300 million in a calendar
year. Through September 30, 2003, Consumers paid $162 million in common
dividends. In October 2003, Consumers declared a $57 million common dividend
payable in November 2003.
For information on the potential cap on common dividends payable included in the
MPSC Securitization order see Consumers' Electric Utility Business Outlook,
"Competition and Regulatory Restructuring - Securitization." Also, for
information on the potential cap on common dividends payable included in the
MPSC Staff's recommendation in Consumers' 2003 gas rate case see Consumers' Gas
Utility Business Outlook, "2003 Gas Rate Case."
CMS-24
CMS Energy Corporation
PREFERRED SECURITIES
In August 2003, 8,800,000 units of outstanding 7.25% Premium Equity
Participating Security Units (CMS Energy Trust III) were converted to 16,643,440
newly issued shares of CMS Energy Common Stock.
OTHER BALANCE SHEET OBLIGATIONS
CMS Energy has other contractual obligations including notes payable and capital
lease obligations. Notes payable include Consumers' $400 million revolving
credit agreement. Capital leases include leased service vehicles and the new
headquarters building.
On November 7, 2003, Consumers closed a three-year $60 million term loan at an
interest rate of LIBOR plus 135 basis points. The term loan is secured by First
Mortgage bonds. The proceeds of the loan were used to purchase Consumers'
headquarters building lease from the lessor, resulting in cost savings to
Consumers.
OFF-BALANCE SHEET ARRANGEMENTS
CMS Energy's use of long-term contracts for the purchase of commodities and
services, the sale of Consumers' accounts receivable, and operating leases are
considered to be off-balance sheet arrangements. CMS Energy's operating leases
are predominately railroad coal car leases, vehicles and miscellaneous office
equipment. The full lease obligation becomes due in case of lease payment
default. In addition, CMS Energy, through its subsidiary companies, has equity
investments in partnerships and joint ventures in which they have a minority
ownership interest. CMS Energy's proportionate share of unconsolidated debt
associated with these investments is non-recourse to CMS Energy.
In July 2003, CMS Energy and the National Power Company, through their joint
venture, Jubail Energy Company, closed a $170 million project financing for
construction of a co-generation plant designed to produce up to 250 MW of
electricity and 510 tons of industrial steam per hour. This financing did not
require any additional project investment by CMS Energy. The debt is
non-recourse to CMS Energy and its subsidiaries and is not included on CMS
Energy's balance sheet. At September 30, 2003, $14 million of this facility is
drawn and is included in non-recourse debt in the "Contractual Obligations"
table above.
Sale of Accounts Receivable: Under a revolving accounts receivable sales
program, Consumers currently sells certain accounts receivable to a wholly
owned, consolidated, bankruptcy remote special purpose entity, Consumers
Receivables Funding II. In turn, Consumers Receivables Funding II may sell an
undivided interest in up to $325 million of the receivables to a bank-sponsored
commercial paper conduit. The amount sold to the conduit was $254 million at
September 30, 2003 and $325 million at September 30, 2002. These amounts are
excluded from accounts receivable in Consumers' consolidated balance sheets.
Consumers continues to service the receivables sold; however, the purchaser of
the receivables has no recourse against Consumers' other assets for failure of a
debtor to pay when due and the purchaser has no right to any receivables not
sold. No gain or loss has been recorded on the receivables sold and Consumers
retains no interest in the receivables sold.
Unconditional Purchase Obligations: Unconditional purchase obligations include
natural gas, electricity, and coal purchase contracts and their associated cost
of transportation. These obligations represent normal business operating
contracts used to assure adequate supply and to minimize exposure to market
price fluctuations.
Included in unconditional purchase obligations are long-term power purchase
agreements with various generating plants including the MCV Facility. These
contracts require monthly capacity payments based on the plants' availability or
deliverability. These payments are approximately $47 million per month for the
remaining three 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 Consumers' Electric Utility Results of Operations above and Note 4,
Uncertainties, "Consumers' Electric Utility Rate Matters - Power Supply Costs"
and "Other Consumers' Electric Utility Uncertainties - The Midland Cogeneration
Venture" for further information concerning power supply costs.
CMS-25
CMS Energy Corporation
COMMERCIAL COMMITMENTS
As of September 30, 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 $477
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 September 30, 2003, the actual amount of
financial exposure covered by these guarantees and indemnities was $52 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 reduce the credit risk for the other party.
Commercial Commitments In Millions
- ----------------------------------------------------------------------------------------------------------------
Commitment Expiration
- ----------------------------------------------------------------------------------------------------------------
September 30 Total 2003 2004 2005 2006 2007 Beyond
- ----------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $ 208 $ - $ - $ - $ 4 $ - $ 204
Indemnities 65 - - 35 - - 30
Letters of Credit (a) 204 5 195 - - - 4
- ----------------------------------------------------------------------------------------------------------------
Total $ 477 $ 5 $195 $ 35 $ 4 $ - $ 238
================================================================================================================
(a) At September 30, 2003, CMS Energy had $176 million of cash collateralized
letters of credit and the cash used to collateralize the letters of credit
is included in Restricted Cash on the consolidated balance sheet.
For further information, see Note 5, Financings and Capitalization.
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.
CMS Energy has contractual obligations and planned capital expenditures that
would require substantial amounts of cash. As of January 2003, CMS Energy at the
parent level had approximately $598 million and Consumers and its subsidiaries
had approximately $727 million of publicly issued and credit facility debt
maturing in 2003. During 2003, CMS Energy and Consumers have taken steps to
address their 2003 maturities, as described below. As of September 30, 2003, CMS
Energy at the parent level had approximately $28 million, Consumers and its
subsidiaries had approximately $7 million, and Enterprises had approximately $8
million of publicly issued and credit facility debt maturing in 2003. In
addition, CMS Energy could become subject to liquidity demands pursuant to
commercial commitments under guarantees, indemnities and letters of credit.
CMS ENERGY PARENT LEVEL LIQUIDITY
CMS Energy has reduced debt through asset sales and securitization proceeds,
with a total of approximately $3.5 billion in cash proceeds from such events
over the two preceding calendar years. For the nine months
CMS-26
CMS Energy Corporation
ended September 30, 2003, CMS Energy has received gross cash proceeds of
approximately $848 million and stock valued at September 30, 2003 of
approximately $54 million as a result of additional asset sales as described
below. Refer to Capital Resources and Liquidity, "Long-Term Debt" above for
information about CMS Energy's 2003 debt financings.
In January 2003, CMS Energy closed on the sale of a substantial portion of CMS
MST's natural gas trading contracts for $17 million of gross cash proceeds. The
sale of Centennial, resulting in gross 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 to Constellation Power Source,
Inc. for gross cash proceeds of $34 million. 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.
In June 2003, CMS Energy completed the sale of its one-third membership interest
in the Guardian Pipeline, L.L.C., to a subsidiary of WPS Resources Corporation.
Gross proceeds from the sale were $26 million and were used to reduce debt. In
conjunction with the sale, approximately $63 million of cash that CMS Energy had
committed to collateralize a letter of credit was released. CMS Energy recorded
a loss on the sale of Guardian of $4 million ($3 million, net of tax) in the
second quarter of 2003.
In June 2003, CMS Energy completed the previously announced sale of all of the
outstanding capital stock of Panhandle to Southern Union Panhandle Corp., a
newly formed entity owned by Southern Union. CMS Energy received gross cash
proceeds of approximately $582 million and three million shares of Southern
Union common stock, worth approximately $49 million based on the June 11, 2003
closing price of $16.48 per share. The sale agreement allowed CMS Energy to sell
the stock 90 days after the closing date of June 11, 2003. The Southern Union
common stock was recorded as a current asset on CMS Energy's balance sheet. In
July 2003, Southern Union declared a five percent common stock dividend payable
July 31, 2003, to shareholders of record as of July 17, 2003. As a result of the
stock dividend, on September 30, 2003, CMS Energy held 3.15 million shares of
Southern Union common stock, worth approximately $54 million, based on the
closing price of $17.00 per share. The increase in CMS Energy's value of the
Southern Union common stock of approximately $2 million was recorded in dividend
income. In October 2003, CMS Energy sold its 3.15 million shares of Southern
Union common stock to a private investor for $17.77 per share. The proceeds from
the stock sale of approximately $56 million will be used to reduce debt.
Southern Union Panhandle Corp. also assumed approximately $1.166 billion of
Panhandle debt. CMS Energy used the initial cash proceeds from the sale of
Panhandle to pay off and terminate Enterprises' $441 million and $75 million
revolving credit facilities. The $30 million after-tax loss on the sale is
included in discontinued operations.
In June 2003, CMS MST's energy conservation unit, CMS Viron closed on the sale
of the majority of its assets associated with its non-federal business to
Chevron Energy Solutions Company, a division of Chevron U.S.A. and in April
2003, closed on the sale of its assets associated with its federal business to
Pepco Energy Services. The total loss on the sale of CMS Viron was $14 million
($9 million, net of tax).
In July 2003, CMS Energy completed the sale of CMS Field Services to Cantera
Resources Inc. for gross cash proceeds of approximately $113 million and a $50
million face value note of Cantera Resources Inc. 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 sale
resulted in a $5 million loss ($1 million, net of tax), which is included in
discontinued operations. The net sales proceeds of approximately $100 million
were used to reduce debt.
CMS-27
CMS Energy Corporation
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 its present level of cash, along with anticipated cash flows from
operating and investing activities will be sufficient to meet its liquidity
needs through 2003. CMS Energy believes, but can provide no assurance, that it
will have sufficient liquidity to meet its debt maturities through 2004.
CONSUMERS ENERGY LIQUIDITY
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. 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, including margin calls, in connection with
maintenance of ongoing deliveries of gas and electricity. This will also affect
Consumers' liquidity position.
Historically, Consumers has 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 borrowings, reduced capital expenditures, cash flow generated
from operations, and other measures. Refer to Capital Resources and Liquidity,
"Long Term Debt" above for information about Consumers' 2003 debt financings.
Consumers believes that its present level of cash and borrowing capacity
(assuming access to capital markets), along with anticipated cash flows from
operating and investing activities, will be sufficient to meet its liquidity
needs through 2004.
CORPORATE OUTLOOK
During 2003, CMS Energy continues to implement a back-to-basics strategy that
focuses on a growing healthy utility and divesting under-performing or other
non-strategic assets. The strategy is designed to generate cash to pay down
debt, to reduce business risk, and to provide for more predictable future
operating revenues and earnings.
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
$3.5 billion of cash from asset sales, securitization proceeds and proceeds from
LNG monetization since 2001. These assets are recorded at current fair value,
however, upon the sale of additional non-strategic and under-performing assets,
the proceeds realized may be different than the recorded value of those assets
if market conditions change. Even though these assets have been identified for
sale, management cannot predict when, nor make any assurance 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.
Earnings (loss) from equity method investments in Jorf Lasfar and the MCV
Partnership were $11 million and $(7) million, respectively for the three
months ended September 30, 2003 and $46 million and $19 million, respectively
for the nine months ended September 30, 2003. As CMS Energy continues to
implement its back-to-basics strategy and further reduces its ownership of
non-utility assets, the percentage of CMS Energy's future earnings relating to
Jorf Lasfar and the MCV Partnership may increase and CMS Energy's total future
earnings may depend more significantly upon the performance of Jorf Lasfar and
the MCV Partnership.
An affiliate of CMS Generation owns a 49.6 percent interest in the Loy Yang
Power Partnership ("LYPP"), which owns the 2,000 MW Loy Yang coal-fired power
project in Victoria, Australia. Due to unfavorable
CMS-28
CMS Energy Corporation
power prices in the Australian market, the LYPP is not generating cash flow
sufficient to meet its debt-service obligations. LYPP has A$500 million of term
bank debt that, pursuant to extensions from the lenders, is scheduled to mature
on February 12, 2004. The partners in LYPP (including affiliates of CMS
Generation, NRG Energy Inc. and Horizon Energy Australia Investments) have been
exploring the possible sale of the project (or control of the project) and a
restructuring of the finances of LYPP.
In July 2003, a conditional share sale agreement was executed by the LYPP
partners and partners of the Great Energy Alliance Corporation ("GEAC") to sell
the project to GEAC for A$3.5 billion (approximately $2.4 billion in U.S.
dollars), including A$165 million (approximately $111 million in U.S. dollars)
for the project equity. The Australian Gas Light Company, the Tokyo Electric
Power Company, Inc. and a group of financial investors led by the Commonwealth
Bank of Australia formed GEAC earlier this year to explore the possible
acquisition of Loy Yang. The conditions to completion of the sale to GEAC
include consents from LYPP's lenders to a restructuring of the project's debt,
satisfactory resolution of regulatory issues and approvals, rulings on tax and
stamp duty obligations, and approvals from the investors in Horizon Energy
Australia Investments and the creditors committee of NRG Energy Inc. It should
be noted in particular that the Australian federal antitrust regulator has
disapproved the transaction because of its perceived anticompetitive effects,
and GEAC has brought an action for declaratory relief against the regulator to
reverse that disapproval. Closing was targeted for early September 2003, but
given the regulatory uncertainties, the parties to the share sale agreement have
agreed to extend the date for resolution of the regulatory conditions to closing
to not later than December 19, 2003, assuming satisfactory interim resolution of
other closing conditions. The share sale agreement provides GEAC a period of
exclusivity while the conditions of the purchase are satisfied. The ultimate net
proceeds to CMS Energy for its equity share in LYPP may be subject to reduction
based on the ultimate resolution of many of the factors described above as
conditions to completion of the sale, as well as closing adjustments and
transaction costs, and could likely range between $20 million and a nominal
amount.
CMS Energy cannot predict whether this sale to GEAC will be consummated or, if
not, whether any of the other initiatives will be successful, and it is possible
that CMS Generation may lose all or a substantial part of its remaining equity
investment in the LYPP. CMS Energy previously has written off its equity
investment in the LYPP, and further write-offs would be limited to cumulative
net foreign currency translation losses. The amount of such cumulative net
foreign currency translation losses is approximately $168 million at
September 30, 2003. Any such write-off would flow through CMS Energy's income
statement but would not result in a reduction in shareholders' equity or cause
CMS Energy to be in noncompliance with its financing agreements.
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 experienced higher electric deliveries in 2002 as a result
of warmer than normal summer weather. For 2003, a slight decline in electric
deliveries from 2002 is anticipated. This short-term outlook for 2003 assumes
higher levels of manufacturing activity than in 2002 and normal weather
conditions in the last three months of the year.
CMS-29
CMS Energy Corporation
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 Consumers' 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 October
2003, alternative electric suppliers are providing 603 MW of generation supply
to retail open access 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 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. According to the MPSC, "net"
Stranded Costs are 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. Consumers in its hearing brief, filed
in August 2002, revised its request for Stranded Costs to $7 million for 2000
and $4 million for 2001. 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. As discussed below in
"Securitization", Consumers 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.
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to resolve numerous
issues regarding the "net" Stranded Cost methodology in a way 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 have also filed rehearing
petitions with the MPSC. Consumers has also initiated an appeal at the Michigan
Court of Appeals related to the MPSC's December 2001 "net" Stranded Cost order.
In March 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 Palisades expenditures
previously not securitized were approved as proposed in its securitization case
as discussed below in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 would be approximately $35 million. If the proposal to
securitize those costs is not approved, then Consumers indicated that the costs
would be
CMS-30
CMS Energy Corporation
properly included in the 2002 "net" Stranded Cost calculation, which would
increase Consumers' 2002 "net" Stranded Costs to approximately $103 million.
In June 2003, the MPSC issued a financing order in the securitization case,
authorizing the issuance of Securitization bonds in the amount of approximately
$554 million. Included in this amount were Clean Air Act expenditures. However,
the MPSC rejected Palisades expenditures previously not securitized as eligible
securitized costs. As a result, the Palisades expenditures previously not
securitized should be included as a component of "net" Stranded Costs and will
be included as a component of a future electric rate case proceeding with the
MPSC. With the inclusion of the Palisades expenditures previously not
securitized, Consumers' "net" Stranded Costs incurred in 2002 are estimated to
be approximately $50 million.
In July 2003, Consumers filed a petition for rehearing and clarification on a
number of features in the MPSC's financing order on securitization. Once a final
financing order by the MPSC on securitization is issued, the amount of
Consumers' request for "net" Stranded Cost recovery for 2002 will be known.
Consumers cannot predict how the MPSC will rule on its request for the
recoverability of Stranded Costs, and therefore Consumers 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 has participated in this collaborative process. In July 2003, the
staff suspended formal discussion while it considers possible conclusions and
recommendations.
Implementation Costs: Since 1997, Consumers has incurred significant electric
utility restructuring implementation costs. The following table outlines the
applications filed by Consumers with the MPSC and the status of recovery for
these costs.
In Millions
- --------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------
1999 1997 & 1998 $20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 - 8 -
2003 2002 2 2 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 order received for the year 2001, the MPSC also reserved the right to review
again the 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 September 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $16 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 is expected to begin after the rate freeze or rate cap
period has expired. As discussed below, Consumers has asked to include
implementation costs through December 31, 2000 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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Also, Consumers is 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. In May 2003, the FERC
issued an order denying MISO's request for authorization to reimburse Consumers.
In June 2003, Consumers and MISO filed a joint petition for rehearing with the
FERC. In September 2003, the FERC denied Consumers' and MISO's joint request.
Consumers plans to appeal the FERC ruling at the United States Court of Appeals
for the District of Columbia and pursue other potential means of recovery. In
November 2003, in conjunction with Consumers' appeal of the September Order
denying recovery, Consumers persuaded MISO to file a request with the FERC
seeking authority to reimburse METC, the legal successor in interest to the
Alliance RTO start-up costs. As part of the contract for sale of Consumers'
former transmission system, should the Commission approve the new MISO filing,
METC is contractually obligated to flow-through to Consumers the full amount of
any Alliance RTO start-up costs that it is authorized to recover through FERC.
Consumers cannot predict the outcome of the appeal process, the MISO request,
or the amount of implementation costs, if any; the FERC ultimately will allow
to be collected.
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. The application sought recovery of costs associated with Clean
Air Act expenditures, Palisades expenditures previously not securitized, retail
open access implementation costs through December 31, 2003, certain pension fund
costs, and expenses associated with the issuance of the bonds. In June 2003, the
MPSC issued a financing order authorizing the issuance of Securitization bonds
in the amount of approximately $554 million. This amount relates to Clean Air
Act expenditures and associated return on those expenditures through December
31, 2002, retail open access implementation costs and previously authorized
return on those expenditures through December 31, 2000, and the "up front" other
qualified costs related to issuance of the Securitization bonds. The MPSC
rejected Palisades expenditures previously not securitized as eligible
securitized costs. Therefore, Palisades expenditures previously not securitized
should be included as a component of "net" Stranded Costs and will be included
as a component of a future electric rate case proceeding with the MPSC.
In the June 2003 financing order, the MPSC also adopted a rate design that would
allow retail open access customers to pay a securitization charge (and related
tax charge) that are a small fraction of the amounts paid by full service
bundled sales customers and special contract customers of the utility. The
financing order provides that the securitization charges (and related tax
charges) for the full service and bundled sales customers are increased under
the rate design in the financing order in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the Securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers to its "earnings." In July 2003, Consumers
filed for rehearing and clarification on a number of features in the financing
order, including the rate design, accounting treatment of unsecuritized
qualified costs and dividend restriction. Also in July 2003, the Attorney
General filed a claim of appeal related to the financing order and the Attorney
General indicated it would challenge the lawfulness of the rate design. In
October 2003, the Court of Appeals dismissed the appeal and indicated that the
Attorney General could resubmit the appeal after the MPSC acted on Consumers'
rehearing request. Subsequently, the Attorney General filed a motion of
rehearing asking for reconsideration of the Court of Appeals' dismissal. The
financing order will become effective after rehearing, resolution of appeals and
upon acceptance by Consumers.
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. After December 31, 2003,
the statute would allow customers to petition the MPSC for rate reductions below
the cap. Consumers would have the opportunity to respond to such a petition
before rates could be reduced.
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As a result of Consumers meeting the transmission capability expansion
requirements and the market power test, as discussed in Note 4, Uncertainties,
"Consumers' Electric Utility Rate Matters - Electric Restructuring", Consumers
has met the requirements under Public Act 141 to return to the PSCR process. On
September 30, 2003, Consumers submitted a PSCR filing to the MPSC that would
reinstate the PSCR process for customers whose rates will no longer be frozen or
capped as of January 1, 2004. The proposed PSCR charge allows Consumers to
recover a portion of its increased power supply costs from large commercial and
industrial customers effective January 1, 2004. This is the first customer class
for which the rate freeze and cap expire. Consumers will, pursuant to its right
under applicable law, self-implement the proposed PSCR charge on January 1,
2004, unless the MPSC issues an order before that date establishing a different
charge. The charge is subject to subsequent change by the MPSC during the PSCR
period (calendar-year 2004). The revenues received pursuant to the PSCR charge
by statute are also subject to subsequent reconciliation when the year is
finished and actual costs have been reviewed for reasonableness and prudence.
Consumers cannot predict the outcome of this filing.
Included in Consumers' retail electric customers' frozen rates is a nuclear
decommissioning surcharge related to the decommissioning of Big Rock. The MPSC
authorized collection of the surcharge through December 2000. Consumers has
continued to collect the Big Rock nuclear decommissioning surcharge consistent
with the provisions of the Customer Choice Act rate freeze in effect through
December 31, 2003. Beginning in January 2004, the Big Rock decommissioning
surcharge will be eliminated, reducing Consumers' annual electric revenues by
approximately $35 million in 2004. A portion of this reduction is expected to be
offset by the collection of increased PSCR revenues.
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, totaling a maximum of approximately 685 MW of load, as part
of its phased introduction to competition. Unless terminated or restructured,
the majority of these contracts are in effect through 2005. As of September 30,
2003, contracts for 200 MW of load have terminated. Of the contracts that have
terminated, contracts for 64 MW have gone to an alternative electric supplier,
and contracts for 136 MW have returned to bundled tariff rates. Consumers cannot
predict the ultimate financial impact of changes related to these power supply
contracts, or whether additional special contracts will be necessary or
advisable.
Code of Conduct: In December 2000, as a result of the passage of the Customer
Choice Act, the MPSC issued a new code of conduct that applies to electric
utilities and alternative electric suppliers. The code of conduct seeks to
prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and 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. In November
2002, the Michigan
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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 down the guidelines 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. In July 2003,
legislation was introduced in the Michigan legislature that, if enacted, would
clarify the application of the code of conduct in a manner that would allow
Consumers to continue to offer the appliance service plan. In October 2003, the
Michigan Senate passed legislation to preserve the appliance service plan. The
House of Representatives of Michigan is scheduled to review the legislation in
early 2004; however, in the interim passed a bill to extend the MPSC's waiver
for the program to July 1, 2004.
Energy Policy: Uncertainty exists regarding the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills that have been introduced in the
United States Congress in recent years were designed to change existing federal
regulation of the industry. If the federal government enacts a comprehensive
energy policy, then that legislation could potentially affect company operations
and financial requirements.
Transmission: In May 2002, Consumers sold its electric transmission system for
approximately $290 million to MTH, a non-affiliated limited partnership whose
general partner is a subsidiary of Trans-Elect, Inc. The pretax gain was $31
million ($26 million, net of tax). Remaining open issues are not expected to
substantially impact the amount of the gain.
As a result of the sale, Consumers anticipates its after-tax earnings will
decrease 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 until May 1, 2007 under a
contract with MTH.
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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.
August 14, 2003 Blackout: On August 14, 2003, the electric transmission grid
serving parts of the Midwest and the Northeast experienced a significant
disturbance, which impacted electric service to millions of homes and businesses
throughout a vast region. In Michigan, more than 2 million electric customers
were without electricity. Consumers had five fossil-fueled generating unit
outages and, of Consumers' 1.7 million electric customers, approximately
100,000 were without power for approximately 24 hours as a result of the
disturbance. The impact was felt most heavily in the southeastern part of
Consumers' service territory.
As discussed above in "Transmission", Consumers sold its electric transmission
system in May 2002 to MTH, with Consumers providing transmission system
maintenance under a five-year contract with MTH. MTH now owns, controls, and
plans for the transmission system that serves Consumers. Consumers incurred
approximately $1 million of immediate financial impact as a result of the
blackout. Consumers continues to cooperate with investigations of the blackout
by several federal and state agencies. Consumers cannot predict the outcome of
these investigations.
In November 2003, the MPSC released its report on the August 14, 2003 blackout,
which found no evidence to suggest that the events in Michigan or actions taken
by the Michigan utilities or transmission operators were factors contributing to
the cause of the blackout. As a result of its investigation, the MPSC is
recommending that Congress pass legislation that would empower the FERC, where
necessary, to order membership into a RTO and that Congress should provide the
FERC with the authority to develop and enforce mandatory transmission
reliability standards with penalties for noncompliance.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards for Consumers and other Michigan electric distribution
utilities. The proposal would establish standards related to restoration after
an outage, safety, and customer relations. Failure to meet the standards would
result in customer bill credits. Consumers submitted comments to the MPSC. In
December 2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards. In November
2002, the MPSC issued an order initiating the formal rulemaking proceeding.
Consumers has filed comments on the proposed rules and will continue to
participate in this process. Consumers cannot predict the nature of the proposed
standards or the likely effect, if any, on Consumers.
For further information and material changes relating to the rate matters and
restructuring of the electric utility industry, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, and Note 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) pending litigation filed by
PURPA qualifying facilities; 5) uncertainties relating to the storage and
ultimate disposal of spent nuclear fuel; 6) electric industry restructuring
issues, including those described above; 7) 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; 8) the recovery of electric restructuring
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implementation costs; 9) Consumers' status as an electric transmission customer
and not as an electric transmission owner/operator; 10) sufficient reserves for
transmission rate refunds; 11) the effects of derivative accounting and
potential earnings volatility; 12) increased costs for safety and homeland
security initiatives that are not recoverable on a timely basis from customers;
13) potentially rising pension costs due to market losses and lump sum payments
(as discussed above in Accounting for Pension and OPEB); 14) Consumers' ability
to recover any of its "net" Stranded costs under the regulatory policies being
followed by the MPSC; 15) the effects of lost electric supply load from retail
open access and the recovery of associated margin loss; 16) the uncertain
effects, including exposure to liability, increased regulatory requirement and
new legislation, due to the future conclusions about the causes of the August
14, 2003 blackout. 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,
the level of natural gas consumption per customer, and the recent significant
increases in gas commodity prices.
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation case with the MPSC, Consumers expects to recover all of its gas
costs. In June 2003, Consumers filed a reconciliation of GCR costs and revenues
for the 12-months ended March 2003. Consumers proposes to recover from its
customers a net under-recovery of approximately $6 million using a roll-in
methodology. The roll-in methodology incorporates the under-recovery in the GCR
factor charged in the next GCR year. The roll-in tariff provision was approved
by the MPSC in a November 2002 order.
In July 2003, the MPSC approved a settlement agreement authorizing Consumers to
increase its gas cost recovery factor for the remainder of the current GCR plan
year (August 2003 through March 2004) and to implement a quarterly ceiling price
adjustment mechanism, based on a formula that tracks changes in NYMEX natural
gas prices. Consistent with the terms of the settlement, the ceiling price is
$6.11 per mcf. However, Consumers will utilize a GCR factor of $5.41 per mcf
commencing in November 2003 bills. All recoveries pursuant to such factors are
subject to final reconciliation by the MPSC.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. In November 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 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: In March 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 return on equity, based on a 2004 test year.
Contemporaneously with this filing, Consumers has requested interim rate relief
in the same amount. In August 2003, the MPSC Staff recommended interim rate
relief of $80 million be granted in this proceeding, subject to Consumers
voluntarily agreeing to limit its dividends to its parent, CMS Energy, to a
maximum of $190 million in any calendar year.
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In September 2003, Consumers filed an update to its gas rate case that lowered
the requested revenue increase from $156 million to $139 million and revised the
return on common equity from 13.5 percent to 12.75 percent. The majority of the
reduction is related to lower debt costs and changes in the projected capital
structure. The MPSC Staff and ABATE filed their cases in early October. The
Staff made no change to its interim position of $80 million and continued to
propose the same dividend limitation. ABATE did not make a specific
recommendation for a final rate increase, but did discuss the rate design used
to recover any rate increase granted. A proposal for decision is expected from
the administrative law judge in January 2004.
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) an inadequate regulatory response to applications for requested
rate increases; 5) market and regulatory responses to increases in gas costs,
including a reduced average consumption per residential customer; 6) increase in
costs for pipeline integrity, safety, and homeland security initiatives that are
not recoverable on a timely basis from customers; 7) potentially rising pension
costs due to market losses and lump sum payments (as discussed above in
Accounting for Pension and OPEB); and 8) potential adverse appliance service
plan ruling or related legislation. 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 September 30, 2003,
Consumers has incurred approximately $7 million in incremental security costs,
including operating, capital, and decommissioning and removal costs, mainly
relating to its nuclear facilities. Consumers estimates it may incur additional
incremental security costs for the last three months of 2003 of approximately $3
million, of which $2 million relates to nuclear security costs. 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. In February 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, over time, designated assets and investments that are
under-performing, non-
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region focused and non-synergistic with other CMS Energy business units. The IPP
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. CMS MST's future activities are
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.
For the nine months ended September 30, 2003, CMS Energy's operating revenue was
$4.059 billion, a decrease of $2.784 billion from the comparable period in 2002.
This decrease in operating revenue was due primarily to the sale of CMS MST's
gas and power books in the first quarter of 2003.
CMS Gas Transmission continues to narrow its scope of existing operations and
commitments. In doing so, CMS Energy is pursuing actively 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 increase substantially
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 by
CMS MST, CMS Energy's Board of Directors established a Special Committee 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. Previously, CMS Energy
terminated its speculative trading business and revised its risk management
policy. The Board of Directors adopted, and CMS Energy has implemented the
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 45 days that they have taken certain specified remedial measures with
respect to the reporting of natural gas trading data to publications that
compile and
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publish price indices. CMS MST made a written submission to the FERC on June 11,
2003 in compliance with the FERC's directives. On July 29, 2003, the FERC issued
an order stating that CMS MST met the requirements of the FERC's April 30, 2003
order. 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 by shareholders who allege that they purchased
CMS Energy's securities during a purported class period. The cases were
consolidated into a single lawsuit and an amended and consolidated class action
complaint was filed on May 1, 2003. The consolidated complaint contains a
purported class period beginning on May 1, 2000 and running through March 31,
2003. It generally 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, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. The companies intend to defend
vigorously against this action but cannot predict the outcome of this
litigation.
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 by 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 are serving 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 LAWSUITS: 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 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 CMS Energy Common Stock
held in the plan. Plaintiffs also seek other equitable relief and legal fees.
These cases will be defended vigorously. CMS Energy cannot predict the outcome
of this litigation.
GAS INDEX PRICE REPORTING INVESTIGATION: 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.
GAS INDEX PRICE REPORTING LITIGATION: In August 2003, Cornerstone Propane
Partners, L.P. ("Cornerstone") filed a putative class action complaint in the
United States District Court for the Southern District of New York against CMS
Energy and 40 other energy companies. The complaint alleges that false natural
gas price reporting by the defendants manipulated the prices of NYMEX natural
gas futures and options. The complaint contains two counts under the Commodity
Exchange Act, one for manipulation and one for aiding and abetting
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violations. Cornerstone has agreed to provide a blanket 60-day extension of time
for all defendants to answer or otherwise respond to the complaint. CMS Energy
intends to defend vigorously against this action but cannot predict the outcome
of this litigation.
INTEGRUM LAWSUIT: A complaint was filed in Wayne County, Michigan Circuit Court
on July 17, 2003 by Integrum against CMS Energy, Enterprises and APT. Integrum
alleges several causes of action against APT, CMS Energy and Enterprises in
connection with an offer by Integrum to purchase the CMS Pipeline Assets. In
addition to seeking unspecified money damages, Integrum is seeking an order
enjoining Enterprises and CMS Energy from selling and APT from purchasing the
CMS Pipeline Assets and an order of specific performance mandating that CMS
Energy, Enterprises and APT complete the sale of the CMS Pipeline Assets to APT
and Integrum. An officer and director of Integrum is a former officer and
director of CMS Energy, Consumers and certain of its subsidiaries. The
individual was not employed by CMS Energy, Consumers or its subsidiaries when
Integrum made the offer to purchase the CMS Pipeline Assets. CMS Energy and
Enterprises intend to vigorously defend against this action. CMS Energy and
Enterprises cannot predict the outcome of this litigation.
OTHER MATTERS
CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES: CMS Energy's management, with the
participation of its CEO and CFO, has evaluated the effectiveness of CMS
Energy's disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period
covered by this report. Based on such evaluation, CMS Energy's CEO and CFO have
concluded that, as of the end of such period, CMS Energy's disclosure controls
and procedures are effective.
INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes in
CMS Energy's internal control over financial reporting (as such term is defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal
quarter to which this report relates that have materially affected, or are
reasonably likely to materially affect, CMS Energy's internal control over
financial reporting.
CONTROL WEAKNESSES AT CMS MST
In late 2001 and during 2002, CMS Energy identified a number of deficiencies in
CMS 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 CMS Energy 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 CMS Energy 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 CMS Energy 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 CMS
Energy to prepare reliable restated financial statements for CMS MST for
December 31, 2000, 2001 and 2002, as well as for the quarterly periods of 2001
and 2002.
CMS-40
CMS Energy Corporation
Management believes that the improvements to its system of internal accounting
controls 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 also may 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. In October
2003, a final rule was issued by FERC. The rule will require Consumers, as a
FERC-regulated company, to file its cash management agreements with the FERC and
to notify the FERC within 45 days after the end of each calendar quarter when
their proprietary capital ratio drops below 30 percent, and when it subsequently
returns to or exceeds 30 percent. The rule also requires certain information
about cash management agreements and transactions to be maintained. The rule
becomes effective in late November 2003. Consumers operates its cash management
program independent of CMS Energy and, therefore, does not anticipate additional
reporting requirements as a result of this final rule.
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES: Issued by the FASB in April 2003, this statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement is effective for contracts
entered into or modified after June 30, 2003. Implementation of this statement
has not had an impact on CMS Energy's Consolidated Financial Statements.
SFAS NO. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS
OF BOTH LIABILITIES AND EQUITY: Issued by the FASB in May 2003, this statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. The
statement requires an issuer to classify financial instruments within its scope
as liabilities. Those instruments were previously classified as mezzanine
equity. SFAS No. 150 became effective July 1, 2003.
CMS Energy has one, and Consumers has four, trust preferred securities
outstanding as of September 30, 2003. The trust preferred securities are issued
by consolidated subsidiaries of CMS Energy and Consumers. Each trust holds a
subordinated debenture from the parent company. The terms of the debentures are
identical to those of the trust preferred securities, except that the debenture
has an explicit maturity date. The trust documents, in turn, require that the
trust be liquidated upon the repayment of the debenture. The preferred
securities are redeemable upon the liquidation of the subsidiary; and therefore,
are considered equity in the financial statements of the subsidiary.
At their October 29, 2003 Board meeting, the FASB deferred the implementation of
the portion of SFAS
CMS-41
CMS Energy Corporation
No. 150 relating to mandatorily redeemable noncontrolling interests in
subsidiaries when the noncontrolling interests are classified as equity in the
financial statements of the subsidiary. CMS Energy and Consumers trust preferred
securities are included in the deferral. As such, the CMS Energy and Consumers
trust preferred securities continue to be accounted for under existing
accounting guidance and are included in mezzanine equity. CMS Energy and
Consumers continue to study the FASB developments regarding the SFAS No. 150
deferral.
EITF ISSUE NO. 01-08, DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE: In
May 2003, the EITF reached consensus in EITF Issue No. 01-08 to clarify the
requirements of identifying whether an arrangement should be accounted for as a
lease at its inception. The guidance in the consensus is designed to mandate
reporting revenue as rental or leasing income that otherwise would be reported
as part of product sales or service revenue. EITF Issue No. 01-08 requires both
parties to an arrangement to determine whether a service contract or similar
arrangement is or includes a lease within the scope of SFAS No. 13, Accounting
for Leases.
Historically, CMS Energy has entered into power purchase and similar service
arrangements. Prospective accounting under EITF Issue No. 01-08, could affect
the timing and classification of revenue and expense recognition. Certain
product sales and service revenue and expenses may be required to be reported as
rental or leasing income and/or expenses. The consensus is to be applied
prospectively to arrangements agreed to, modified, or acquired in business
combinations in fiscal periods beginning July 1, 2003. The adoption of EITF
Issue No. 01-08 has not impacted CMS Energy's results of operations, cash flows,
or financial position. CMS Energy will evaluate new or modified contracts under
EITF Issue No. 01-08 prospectively.
ACCOUNTING STANDARDS NOT YET EFFECTIVE
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, FIN 46 requires the primary beneficiary of a
variable interest entity's activities to consolidate the variable interest
entity. The primary beneficiary is the party that absorbs a majority of the
expected losses and/or receives a majority of the expected residual returns of
the variable interest entity's activities. The consolidation requirements of the
interpretation apply immediately to variable interest entities created after
January 31, 2003. CMS Energy has not created any variable interest entities in
2003. Therefore, this portion of the interpretation has no impact on its
consolidated financial statements. Public companies, whose fiscal year is a
calendar year, were originally required to implement the guidance in this
interpretation by the third quarter of 2003. However, on October 9, 2003, the
FASB issued FASB Staff Position No. 46-6, Effective Date of FASB Interpretation
No. 46, and deferred implementation of FIN 46 until the fourth quarter of 2003
for variable interest entities and potential variable interest entities created
before February 1, 2003.
CMS Energy is evaluating all of its interests in entities, including
approximately 30 minority-held investments that are not currently consolidated,
to determine their treatment under FIN 46. The majority of these investments are
electric generation and gas transmission projects. CMS Energy's investment in
these entities totaled approximately $1,425 million as of September 30, 2003.
Jorf Lasfar and the MCV Partnership are the two largest entities impacting CMS
Energy's operations. For further information see Note 8, Equity Method
Investments.
If the completed analysis were to require CMS Energy to disclose information
about or consolidate in its financial statements, the assets, liabilities and
activities of the MCV Partnership and the First Midland Limited Partnership,
including the recognition of the debt of the MCV Partnership on CMS Energy's
financial statements, this could impact negatively CMS Energy's and Consumers'
various financial covenants under their financing agreements. As a result, CMS
Energy and Consumers may have to seek amendments to the relevant financing
agreements to modify the terms of certain of these covenants in order to remove
the effect of this potential consolidation or refinance the relevant debt. As of
September 30, 2003, Consumers' investments
CMS-42
CMS Energy Corporation
in the MCV Partnership and in the FMLP were $404 million and $222 million,
respectively. For a further description of the nature, purpose, size and
activities of the MCV Partnership see Note 4, Uncertainties, Other Consumers'
Electric Utility Uncertainties, "The Midland Cogeneration Venture" and Note 8,
Equity Method Investments. CMS Energy is continuing to study the implementation
of this interpretation and has yet to determine the effects, if any, on its
consolidated financial statements.
EITF ISSUE 03-04, ACCOUNTING FOR CASH BALANCE PENSION PLANS: In May 2003, the
EITF reached consensus in EITF Issue No. 03-04 to specifically address the
accounting for certain cash balance pension plans. EITF Issue No. 03-04
concluded that certain cash balance plans be accounted for as defined benefit
plans under SFAS No. 87, Employers' Accounting for Pensions. EITF No. 03-04
requires the use of the traditional unit credit method for the purposes of
measuring the benefit obligation and annual cost of benefits earned as opposed
to the projected unit credit method. The EITF concluded that the requirements of
this Issue be applied as of the next plan measurement date, which is December
31, 2003 for CMS Energy. CMS Energy commenced a cash balance pension plan that
covers employees hired after June 30, 2003. CMS Energy does account for this
plan as a defined benefit plan under SFAS No. 87. CMS Energy continues to
evaluate the impact, if any, this Issue will have upon adoption.
STATEMENT OF POSITION, ACCOUNTING FOR CERTAIN COSTS AND ACTIVITIES RELATED TO
PROPERTY, PLANT, AND EQUIPMENT: At its September 9, 2003 meeting, the Accounting
Standards Executive Committee voted to approve the Statement of Position,
Accounting for Certain Costs and Activities Related to Property, Plant, and
Equipment. The Statement of Position is expected to be presented for FASB
clearance late in the fourth quarter of 2003 and would be applicable for fiscal
years beginning after December 15, 2004. The Accounting Standards Executive
Committee concluded that at transition, a company would have the flexibility to
adopt a property, plant and equipment component accounting policy for
transition-date property, plant and equipment accounts. The property, plant and
equipment component accounting policy may differ from the componentization
policy, if any, previously used by the enterprise. Selecting a policy that
differs from the company's prior level of componentization at the date of
adoption of the Statement of Position would not result in any cumulative effect
difference for adopting such a policy. A company would not have to restate its
pre-adoption assets to conform with its post-adoption componentization policy.
The Accounting Standards Executive Committee concluded that companies would be
required to disclose meaningful ranges with respect to property, plant and
equipment depreciable lives. CMS Energy continues to evaluate the impact, if
any, this Statement of Position will have upon adoption.
CMS-43
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
OPERATING REVENUE $ 1,016 $ 2,534 $ 4,059 $ 6,843
EARNINGS FROM EQUITY METHOD INVESTEES 20 41 120 126
OPERATING EXPENSES
Operation
Fuel for electric generation 80 87 247 264
Purchased and interchange power 136 1,224 506 2,341
Purchased power - related parties 131 143 383 416
Cost of gas sold 168 500 1,304 2,088
Other 208 247 608 640
-----------------------------------------------
723 2,201 3,048 5,749
Maintenance 48 49 166 157
Depreciation, depletion and amortization 86 89 300 297
General taxes 50 46 115 150
-----------------------------------------------
907 2,385 3,629 6,353
- --------------------------------------------------------------------------------------------------------------------
OPERATING INCOME 129 190 550 616
OTHER INCOME (DEDUCTIONS)
Accretion expense (7) (8) (23) (23)
Gain (loss) on asset sales, net - 13 (8) 61
Other, net 7 (3) 28 (4)
-----------------------------------------------
- 2 (3) 34
- --------------------------------------------------------------------------------------------------------------------
FIXED CHARGES
Interest on long-term debt 134 109 357 305
Other interest 31 5 48 19
Capitalized interest (2) (5) (7) (12)
Preferred dividends - - 1 1
Preferred securities distributions 16 18 52 68
-----------------------------------------------
179 127 451 381
- --------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTERESTS (50) 65 96 269
INCOME TAX EXPENSE (BENEFIT) (16) 54 58 128
MINORITY INTERESTS - - 1 1
-----------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS (34) 11 37 140
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF $16 TAX
BENEFIT AND $2 TAX EXPENSE IN 2003 AND $6 AND $100 TAX
BENEFIT IN 2002 (43) 25 (56) (153)
-----------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (77) 36 (19) (13)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING, NET OF $13 TAX BENEFIT
IN 2003 AND $1 AND $10 TAX EXPENSE IN 2002
ENERGY TRADING CONTRACTS, EITF 02-03 (NOTE 10) - 1 (23) 18
ASSET RETIREMENT OBLIGATIONS, SFAS NO. 143 (NOTE 10) - - (1) -
-----------------------------------------------
- 1 (24) 18
-----------------------------------------------
NET INCOME (LOSS) $ (77) $ 37 $ (43) $ 5
====================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-44
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
CMS ENERGY
NET INCOME (LOSS)
Net Income (Loss) Attributable to Common Stock $ (77) $ 37 $ (43) $ 5
========================================
BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Income (Loss) from Continuing Operations $ (0.22) $ 0.08 $ 0.25 $ 1.02
Income (Loss) from Discontinued Operations (0.29) 0.17 (0.38) (1.11)
Income (Loss) from Cumulative Effect of Changes in Accounting - 0.01 (0.16) 0.13
----------------------------------------
$ (0.51) $ 0.26 $ (0.29) $ 0.04
========================================
DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Income (Loss) from Continuing Operations $ (0.22) $ 0.08 $ 0.25 $ 1.02
Income (Loss) from Discontinued Operations (0.29) 0.17 (0.38) (1.11)
Income (Loss) from Cumulative Effect of Changes in Accounting - 0.01 (0.16) 0.13
----------------------------------------
$ (0.51) $ 0.26 $ (0.29) $ 0.04
========================================
DIVIDENDS DECLARED PER COMMON SHARE $ - $ 0.18 $ - $ 0.91
- ----------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-45
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30 2003 2002
- ---------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (43) $ 5
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $4 and $5, respectively) 300 297
Loss on disposal of discontinued operations 93 127
Capital lease and debt discount amortization 16 14
Deferred income taxes and investment tax credit 56 (294)
Accretion expense 23 23
Bad debt expense 17 16
Undistributed earnings from related parties (38) (71)
(Gain) loss on asset sales, net 8 (61)
Cumulative effect of accounting changes 24 (18)
Pension contribution (210) (64)
Changes in other assets and liabilities:
Decrease in accounts receivable and accrued revenues 350 306
Increase in inventories (354) (47)
Decrease in accounts payable and accrued expenses (404) (130)
Changes in other assets and liabilities 148 230
---------------------
Net cash provided by (used in) operating activities (14) 333
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (352) (538)
Investments in partnerships and unconsolidated subsidiaries - (49)
Cost to retire property, net (52) (53)
Investment in Electric Restructuring Implementation Plan (5) (6)
Investments in nuclear decommissioning trust funds (4) (5)
Proceeds from nuclear decommissioning trust funds 26 19
Proceeds from sale of assets 848 1,533
Other investing 40 (17)
---------------------
Net cash provided by investing activities 501 884
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt 2,302 726
Issuance of common stock 229 362
Retirement of bonds and other long-term debt (1,831) (1,453)
Retirement of trust preferred securities (220) (331)
Restricted cash on hand (167) (14)
Payment of common stock dividends - (124)
Decrease in notes payable, net (487) (163)
Payment of capital lease obligations (10) (11)
---------------------
Net cash used in financing activities (184) (1,008)
- ---------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATES ON CASH 2 -
- ---------------------------------------------------------------------------------------------
NET INCREASE IN CASH AND TEMPORARY CASH INVESTMENTS 305 209
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 359 123
---------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 664 $ 332
=============================================================================================
CMS-46
NINE MONTHS ENDED
SEPTEMBER 30 2003 2002
- ----------------------------------------------------------------------------------------------------
In Millions
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 417 $ 326
Income taxes paid (net of refunds) (33) (42)
Pension and OPEB cash contribution 268 126
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 11 $ 50
====================================================================================================
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-47
CMS ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2003 2002 2002
(UNAUDITED) (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------
In Millions
PLANT AND PROPERTY (AT COST)
Electric utility $ 7,583 $ 7,523 $ 7,504
Gas utility 2,841 2,719 2,692
Enterprises 477 462 935
Other 31 45 51
-----------------------------------------
10,932 10,749 11,182
Less accumulated depreciation, depletion and amortization 5,550 6,068 6,018
-----------------------------------------
5,382 4,681 5,164
Construction work-in-progress 360 549 466
-----------------------------------------
5,742 5,230 5,630
- ----------------------------------------------------------------------------------------------------------------------
EQUITY METHOD INVESTMENTS
Enterprises Investments 797 748 945
Midland Cogeneration Venture Limited Partnership 404 388 370
First Midland Limited Partnership 222 255 250
Other 2 2 2
-----------------------------------------
1,425 1,393 1,567
- ----------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 664 359 332
Restricted cash 205 38 18
Accounts receivable, notes receivable and accrued revenue, less
allowances of $14, $8 and $5, respectively 178 319 99
Accounts receivable - Marketing, services and trading,
less allowances of $8, $8 and $9, respectively 74 248 276
Accounts receivable and notes receivable - related parties 164 186 103
Inventories at average cost:
Gas in underground storage 815 491 635
Materials and supplies 96 89 87
Generating plant fuel stock 44 37 49
Assets held for sale 84 648 342
Price risk management assets 80 115 211
Prepayments and other 271 218 138
-----------------------------------------
2,675 2,748 2,290
- ----------------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 659 689 699
Postretirement benefits 168 185 191
Abandoned Midland Project 10 11 11
Other 257 168 173
Assets held for sale 24 2,094 2,263
Price risk management assets 179 135 276
Nuclear decommissioning trust funds 553 536 530
Notes receivable - related parties 129 160 203
Notes receivable 125 126 126
Other 365 440 438
-----------------------------------------
2,469 4,544 4,910
-----------------------------------------
TOTAL ASSETS $ 12,311 $ 13,915 $ 14,397
======================================================================================================================
CMS-48
STOCKHOLDERS' EQUITY AND LIABILITIES
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2003 2002 2002
(UNAUDITED) (UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholders' equity
Common stock, authorized 250.0 shares; outstanding 161.1 shares,
144.1 shares and 144.1 shares, respectively $ 2 $ 1 $ 1
Other paid-in-capital 3,834 3,605 3,619
Accumulated other comprehensive loss (720) (753) (721)
Retained deficit (1,763) (1,720) (1,070)
------------------------------------------
1,353 1,133 1,829
Preferred stock of subsidiary 44 44 44
Company-obligated convertible Trust Preferred Securities
of subsidiaries (a) 173 393 393
Company-obligated mandatorily redeemable preferred securities
of Consumers' subsidiaries (a) 490 490 490
Long-term debt 6,291 5,356 5,648
Non-current portion of capital leases 116 116 110
------------------------------------------
8,467 7,532 8,514
- -------------------------------------------------------------------------------------------------------------------
MINORITY INTERESTS 23 21 12
- -------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 184 640 601
Notes payable 4 458 235
Accounts payable 328 363 308
Accounts payable - Marketing, services and trading 18 119 170
Accrued interest 112 131 114
Accrued taxes 151 291 259
Accounts payable - related parties 50 53 56
Liabilities held for sale 21 467 317
Price risk management liabilities 70 96 180
Current portion of purchase power contract 26 26 29
Current portion of gas supply contract obligations 28 25 24
Deferred income taxes 16 15 11
Other 189 214 243
------------------------------------------
1,197 2,898 2,547
- -------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Postretirement benefits 590 725 306
Deferred income taxes 417 414 570
Deferred investment tax credit 86 91 92
Regulatory liabilities for income taxes, net 309 297 282
Other regulatory liabilities 152 4 -
Asset retirement obligation 363 - -
Liabilities held for sale 36 1,243 1,321
Price risk management liabilities 175 135 178
Gas supply contract obligations 218 241 246
Power purchase agreement - MCV Partnership 8 27 30
Other 270 287 299
------------------------------------------
2,624 3,464 3,324
- -------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 4 and 5)
TOTAL STOCKHOLDERS' EQUITY AND LIABILITIES $ 12,311 $ 13,915 $ 14,397
===================================================================================================================
(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-49
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning of period $ 1 $ 1 $ 1 $ 1
Common stock issued 1 - 1 -
-----------------------------------------------
At end of period 2 1 2 1
- -----------------------------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 3,608 3,317 3,605 3,257
Common stock reacquired (4) (1) (5) (2)
Common stock reissued 1 - 1 -
Common stock issued 229 303 233 364
-----------------------------------------------
At end of period 3,834 3,619 3,834 3,619
- -----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (261) - (241) -
Minimum pension liability adjustment (1) - (21) -
-----------------------------------------------
At end of period (262) - (262) -
-----------------------------------------------
Investments
At beginning of period 5 (7) 2 (5)
Unrealized gain (loss) on investments (a) 1 1 4 (1)
-----------------------------------------------
At end of period 6 (6) 6 (6)
-----------------------------------------------
Derivative Instruments (b)
At beginning of period (56) (29) (56) (31)
Unrealized gain (loss) on derivative instruments (a) 17 (21) 15 (22)
Reclassification adjustments included in consolidated net income (loss) (a) (6) 2 (4) 5
-----------------------------------------------
At end of period (45) (48) (45) (48)
-----------------------------------------------
Foreign Currency Translation
At beginning of period (412) (650) (458) (233)
Change in foreign currency translation (a) (7) (17) 39 (434)
-----------------------------------------------
At end of period (419) (667) (419) (667)
-----------------------------------------------
At end of period (720) (721) (720) (721)
- -----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS (DEFICIT)
At beginning of period (1,686) (1,080) (1,720) (951)
Consolidated net income (loss) (a) (77) 37 (43) 5
Common stock dividends declared - (27) - (124)
-----------------------------------------------
At end of period (1,763) (1,070) (1,763) (1,070)
-----------------------------------------------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 1,353 $ 1,829 $ 1,353 $ 1,829
===================================================================================================================================
(a) Disclosure of Other Comprehensive Income (Loss):
Minimum Pension Liability
Minimum pension liability adjustments, net of tax of
$1, $-, $11 and $-, respectively $ (1) $ - $ (21) $ -
Investments
Unrealized gain (loss) on investments, net of tax of $(1),
$(1), $(2) and $-, respectively 1 1 4 (1)
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net of tax
of $-, $3, $(2) and $2, respectively 17 (21) 15 (22)
Reclassification adjustments included in net income (loss),
net of tax of $3, $(2), $2 and $(3), respectively (6) 2 (4) 5
Foreign currency translation, net (7) (17) 39 (434)
Net income (loss) (77) 37 (43) 5
-----------------------------------------------
Total Other Comprehensive Income (Loss) $ (73) $ 2 $ (10) $ (447)
===============================================
(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 beginning of period $ 13 $ 1 $ 8 $ (8)
Unrealized gain (loss) on derivative instruments (5) 1 8 7
Reclassification adjustments included in net income (2) 2 (10) 5
-----------------------------------------------
At end of period $ 6 $ 4 $ 6 $ 4
===============================================
Taweelah:
At beginning of period $ (37) $ - $ (32) $ -
Unrealized gain (loss) on derivative instruments 15 (24) 10 (24)
-----------------------------------------------
At end of period $ (22) $ (24) $ (22) $ (24)
===============================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-50
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 of a normal recurring nature 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 2002 Form 10-K/A, filed on July 1, 2003,
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
services.
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
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CMS Energy Corporation
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.
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.
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 subsequently ratified by the membership and
became effective April 1, 2003, and covers approximately 300 employees. The
agreement will continue in full force and effect until August 1, 2005.
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 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 accumulated other comprehensive income and
are 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. The change in the foreign currency translation
adjustment decreased equity by $7 million for the three months ended September
30, 2003 and increased equity by $39 million for the nine months ended September
30, 2003, net of after-tax hedging proceeds. The change in the foreign currency
translation adjustment decreased equity by $17 million for the three months
ended September 30, 2002 and decreased equity by $434 million for the nine
months ended September 30, 2002, 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
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CMS Energy Corporation
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, are 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 (net
of salvage credits), is charged to accumulated depreciation.
RESTRICTED CASH: At September 30, 2003, CMS Energy's restricted cash on hand
totaled $205 million. Restricted cash primarily includes cash collateral for
letters of credit to satisfy certain debt agreements and cash dedicated for
repayment of securitization bonds. It is classified as a current asset as the
related letters of credit mature within one year and the payments on the related
securitization bonds occur within one year.
STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS No. 148. 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 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 and
nine month periods ended September 30, 2002, consolidated net income as reported
and pro forma would have been as follows:
In Millions, Except Per Share Amounts
- -------------------------------------------------------------------------------------------------------
Three Months Ended September 30 2002 Basic Diluted
- -------------------------------------------------------------------------------------------------------
Net income, as reported $ 37 $0.26 $0.26
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 (1) - -
- -------------------------------------------------------------------------------------------------------
Pro forma net income $ 36 $0.26 $0.26
=======================================================================================================
In Millions, Except Per Share Amounts
- -------------------------------------------------------------------------------------------------------
Nine Months Ended September 30 2002 Basic Diluted
- -------------------------------------------------------------------------------------------------------
Net income, as reported $ 5 $0.04 $0.04
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 (3) (0.02) (0.02)
- -------------------------------------------------------------------------------------------------------
Pro forma net income $ 2 $0.02 $0.02
=======================================================================================================
In the third quarter of 2003, CMS Energy granted 1.6 million stock options to
employees. As a result, CMS Energy expensed approximately $5 million related to
the fair value of those stock options as of the grant date. Fair value is
estimated using the Black Scholes model, a mathematical formula used to value
options traded on the securities exchange.
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
the regulated utility
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CMS Energy Corporation
accounting standard SFAS No. 71. As a result, the actions of regulators affect
when Consumers recognizes revenues, expenses, assets and liabilities.
In 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. However,
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 allowed
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 10, Implementation of New Accounting Standards, "SFAS No. 143,
Accounting for Asset Retirement Obligations."
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.
2: ASSET SALES AND RESTRUCTURING
CMS Energy continues to implement its financial 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 July 2003, CMS Energy completed the sale of CMS Field Services to Cantera
Resources Inc. In June 2003, CMS Energy completed the sales of Panhandle and the
assets of CMS Viron. See Note 3, Discontinued Operations.
In June 2003, CMS Energy completed the sale of its one-third membership interest
in the Guardian Pipeline, L.L.C., to a subsidiary of WPS Resources Corporation.
Proceeds from the sale were $26 million and were used to reduce debt. In
conjunction with the sale, approximately $63 million of cash that CMS Energy had
committed to collateralize a letter of credit was released. CMS Energy recorded
a loss on the sale of Guardian of $4 million ($3 million after-tax) in the
second quarter of 2003.
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
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CMS Energy Corporation
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 August 2002, CMS Energy sold its equity ownership interest in The National
Power Supply Company electric generating facility in Thailand for $48 million.
The pretax gain of $15 million ($15 million, net of tax) is included in "Gain
(loss) on asset sales, net" on the Consolidated Statements of Income.
In May 2002, Consumers Energy closed on the sale of its electric transmission
system to a limited partnership whose general partner is Washington D.C.-based
Trans-Elect, Inc. Also, in May 2002, Consumers sold certain reactor top
equipment. The sales totaled approximately $295 million. The pretax gain on
these sales, which totaled $38 million ($31 million, net of tax), are included
in "Gain (loss) on asset sales, net" in the accompanying Consolidated Statements
of Income in 2002.
In April 2002, CMS Energy sold its equity ownership interest in Toledo Power for
$10 million. Proceeds from the sale were used to repay debt. The pretax loss, as
shown on the Consolidated Statements of Income, was $11 million ($8 million, net
of tax).
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
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 $19 million ($12 million, net
of tax) is included in "Gain (loss) on asset sales, net" in the accompanying
Consolidated Statements of Income. 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.
Nine Months ended September 30 In Millions
- -------------------------------------------------------------------------------------
Pre-tax After-tax Pre-tax After-tax
2003 2003 2002 2002
- -------------------------------------------------------------------------------------
Asset Sales - Gain (Loss)
Consumers $ - $ - $ 38 $ 31
Enterprises (9) (6) 23 19
Other 1 1 - -
- ------------------------------------------------------------------------------------
Total Gain (Loss) on Asset Sales $ (8) $ (5) $ 61 $ 50
====================================================================================
PENDING ASSET SALE
An affiliate of CMS Generation owns a 49.6 percent interest in the Loy Yang
Power Partnership ("LYPP"), which owns the 2,000 MW Loy Yang coal-fired power
project in Victoria, Australia. Due to unfavorable power prices in the
Australian market, the LYPP is not generating cash flow sufficient to meet its
debt-service obligations. LYPP has A$500 million of term bank debt that,
pursuant to extensions from the
CMS-55
CMS Energy Corporation
lenders, is scheduled to mature on February 12, 2004. The partners in LYPP
(including affiliates of CMS Generation, NRG Energy Inc. and Horizon Energy
Australia Investments) have been exploring the possible sale of the project (or
control of the project) and a restructuring of the finances of LYPP.
In July 2003, a conditional share sale agreement was executed by the LYPP
partners and partners of the Great Energy Alliance Corporation ("GEAC") to sell
the project to GEAC for A$3.5 billion (approximately $2.4 billion in U.S.
dollars), including A$165 million (approximately $111 million in U.S. dollars)
for the project equity. The Australian Gas Light Company, the Tokyo Electric
Power Company, Inc. and a group of financial investors led by the Commonwealth
Bank of Australia formed GEAC earlier this year to explore the possible
acquisition of Loy Yang. The conditions to completion of the sale to GEAC
include consents from LYPP's lenders to a restructuring of the project's debt,
satisfactory resolution of regulatory issues and approvals, rulings on tax and
stamp duty obligations, and approvals from the investors in Horizon Energy
Australia Investments and the creditors committee of NRG Energy Inc. It should
be noted in particular that the Australian federal antitrust regulator has
disapproved the transaction because of its perceived anticompetitive effects,
and GEAC has brought an action for declaratory relief against the regulator to
reverse that disapproval. Closing was targeted for early September 2003, but
given the regulatory uncertainties, the parties to the share sale agreement have
agreed to extend the date for resolution of the regulatory conditions to closing
to not later than December 19, 2003, assuming satisfactory interim resolution of
other closing conditions. The share sale agreement provides GEAC a period of
exclusivity while the conditions of the purchase are satisfied. The ultimate net
proceeds to CMS Energy for its equity share in LYPP may be subject to reduction
based on the ultimate resolution of many of the factors described above as
conditions to completion of the sale, as well as closing adjustments and
transaction costs, and could likely range between $20 million and a nominal
amount.
CMS Energy cannot predict whether this sale to GEAC will be consummated or, if
not, whether any of the other initiatives will be successful, and it is possible
that CMS Generation may lose all or a substantial part of its remaining equity
investment in the LYPP. CMS Energy previously has written off its equity
investment in the LYPP, and further write-offs would be limited to cumulative
net foreign currency translation losses. The amount of such cumulative net
foreign currency translation losses is approximately $168 million at
September 30, 2003. Any such write-off would flow through CMS Energy's
income statement but would not result in a reduction in shareholders' equity or
cause CMS Energy to be in noncompliance with its financing agreements.
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:
- 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 houses an estimated 1,450 CMS Energy and Consumers
Energy employees. The relocation will ultimately reduce
corporate operating expenses.
- Implementing changes to CMS Energy's 401(K) savings program
which provided additional savings for CMS Energy and enhanced
investment options for employee participants.
- Implementing changes to CMS Energy's health care plan in order
to keep benefits and costs
CMS-56
CMS Energy Corporation
competitive.
- Terminating 64 employees, including five officers. Prior to
December 31, 2002, 123 employees elected severance
arrangements. Of these 187 officers and employees, 65 had been
terminated as of December 31, 2002. All remaining terminations
were 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 September 30,
2003.
In Millions
- --------------------------------------------------------------------------------------
September 30, 2003
- --------------------------------------------------------------------------------------
Involuntary Lease
Termination Termination Total
- --------------------------------------------------------------------------------------
Beginning accrual balance, January 1, 2003 $ 12 $ 8 $ 20
Expense 4 - 4
Payments (11) (1) (12)
- --------------------------------------------------------------------------------------
Ending accrual balance $ 5 $ 7 $ 12
======================================================================================
Restructuring costs for the three and nine months ended September 30, 2003,
which are included in operating expenses, include $1 million and $4 million,
respectively, of involuntary employee termination benefits.
In addition, in 2003, restructuring costs related to relocating employees and
other headquarters expenses were approximately $2 million. The relocation was
completed July 2003 and such costs were expensed as incurred.
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 reclassified the operations of the International
Energy Distribution segment to discontinued operations. Subsequently to CMS
Energy's decision to sell the assets of CMS Electric and Gas, severe political
and economic events occurred in Venezuela outside CMS Energy's control that
prohibited the sale process. CMS Energy continues to actively pursue the sale of
CMS Electric and Gas in the current political and economic environment. Although
the timing is difficult to predict or ensure, management expects the sale to
occur within one year.
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 and 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 settlement
resulted in a gain of $6 million, net of tax, which is included in discontinued
operations in 2003.
In May 2002, CMS Energy closed on the sale of CMS Oil and Gas' coalbed methane
holdings in the
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CMS Energy Corporation
Powder River Basin to XTO Energy. The Powder River properties were included in
discontinued operations for the first four months of 2002, including a gain on
the sale of $17 million ($11 million net of tax).
In 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 $47 million loss ($31
million, net of tax) 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. In June 2003,
CMS Energy closed on the sale of the majority of the assets of CMS Viron and
recognized an additional loss of $3 million, net of tax, in discontinued
operations. The total loss on the sale of CMS Viron was $14 million ($9 million,
net of tax).
In December 2002, CMS Energy reclassified the operations of Panhandle to
discontinued operations. In June 2003, CMS Energy completed the previously
announced sale of all of the outstanding capital stock of Panhandle to Southern
Union Panhandle Corp., a newly formed entity owned by Southern Union. CMS Energy
received gross cash proceeds of approximately $582 million and three million
shares of Southern Union common stock, worth approximately $49 million based on
the June 11, 2003 closing price of $16.48 per share. The sale agreement allowed
CMS Energy to sell the stock 90 days after the closing date of June 11, 2003.
The Southern Union common stock was recorded as a current asset on CMS Energy's
balance sheet.
In July 2003, Southern Union declared a five percent common stock dividend
payable July 31, 2003, to shareholders of record as of July 17, 2003. As a
result of the stock dividend, on September 30, 2003, CMS Energy held 3.15
million shares of Southern Union common stock worth approximately $54 million
based on the closing price of $17.00 per share. The increase in value of the
Southern Union common stock of approximately $2 million was recorded in dividend
income. In October 2003, CMS Energy sold its 3.15 million shares of Southern
Union common stock to a private investor for $17.77 per share. The proceeds from
the stock sale of approximately $56 million will be used to reduce debt.
Southern Union Panhandle Corp. also assumed approximately $1.166 billion of
Panhandle debt. CMS Energy used the initial cash proceeds from the sale of
Panhandle to pay off and terminate Enterprises' $441 million and $75 million
revolving credit facilities. The $30 million after-tax loss on the sale is
included in discontinued operations. No portion of CMS Energy's Pension Plan was
transferred with the sale. Panhandle employees are no longer eligible to accrue
additional benefits. The Pension Plan retained pension payment obligations for
Panhandle employees that were vested under the Pension Plan. Because of the
significant change in the makeup of the plan, SFAS No. 87 required a
remeasurement of the obligation at the date of sale. The estimated
remeasurement, subject to receipt of the final actuarial report, resulted in a
$4 million increase in CMS Energy's 2003 pension expense and a $6 million
increase in CMS Energy's 2003 OPEB expense, as well as an additional charge to
accumulated other comprehensive income of approximately $30 million ($20 million
after-tax), as a result of the increase in the additional minimum pension
liability. Additionally, a significant number of Panhandle employees elected to
retire as of July 1,
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CMS Energy Corporation
2003 under the CMS Energy Employee Pension Plan. As a result, CMS Energy has
recorded a $13 million after-tax settlement loss pursuant to the provisions of
SFAS No. 88, which is reflected in discontinued operations.
In December 2002, CMS Energy reclassified the operations of CMS Field Services,
a subsidiary of CMS Gas Transmission to discontinued operations. In July 2003,
CMS Energy completed the sale of CMS Field Services to Cantera Resources Inc.
for gross cash proceeds of approximately $113 million, subject to post closing
adjustments, and a $50 million face value note of Cantera Resources Inc.. 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 sale resulted in a $5 million loss ($1 million, net of
tax) which is included in discontinued operations. The net sales proceeds of
approximately $100 million were used to reduce debt.
In June 2003, CMS Energy reclassified the operations of its gas transmission
plant in Marysville, Michigan to discontinued operations. In September 2003, CMS
Energy executed a definitive purchase and sale agreement for Marysville. It is
anticipated that the closing will occur in November 2003.
In September 2003, CMS Land, holding mainly real property assets, reclassified a
6,000 acre tract of undeveloped land along two miles of Lake Michigan's
shoreline near Arcadia, Michigan, having a net book value of $14 million, from
property, plant and equipment to "Assets held for sale". Neither CMS Land nor
the Arcadia assets are separate operating components of CMS Energy's business,
and therefore are not considered discontinued operations. CMS Land's Board of
Directors approved a resolution to offer a sales option agreement to the Grand
Traverse Regional Land Conservancy (GTRLC) for the purchase of Arcadia. On May
13, 2003, CMS Land granted GTRLC the option which, by its terms, expired on
September 15, 2003, but gave GTRLC the right to extend that expiration date to
December 11, 2003. In September 2003, GTRLC extended the option to purchase
Arcadia.
In September 2003, after performing an evaluation of fair value, CMS Energy
reduced the carrying amount of its investment in CMS Electric and Gas'
Venezuelan electric distribution utility and an associated equipment lease to
reflect the current assessment of fair value. The assessment was based on
estimates of the utility's future cash flows, incorporating certain assumptions
about Venezuela's regulatory, political, and economic environment. The
adjustment, which resulted in a $42 million after-tax charge, is reported in
discontinued operations.
As a result of the sale of CMS Oil and Gas, CMS Energy recorded liabilities for
certain sale indemnification obligations and other matters. In September 2003,
CMS Energy performed an evaluation of its likely exposure to the obligations and
reduced the carrying value of these liabilities by $8 million after-tax, to
reflect the current estimate of the obligations. This adjustment is reported in
discontinued operations.
The summary of balance sheet information below represents those entities that
are still in the disposal process. At September 30, 2003, "Assets held for sale"
includes International Energy Distribution, Marysville, and Arcadia. At
September 30, 2002, "Assets held for sale" includes Panhandle, CMS Viron, CMS
Field Services, International Energy Distribution, and Marysville. The assets
and liabilities of entities held for sale are shown as separate components in
the consolidated balance sheets of CMS Energy.
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CMS Energy Corporation
In Millions
- -----------------------------------------------------------------------
September 30 2003 2002
- -----------------------------------------------------------------------
Assets
Cash $ 11 $ 60
Accounts receivable, net 31 141
Materials and supplies 7 87
Other 35 54
- -----------------------------------------------------------------------
Total current assets held for sale $ 84 $ 342
Property, plant and equipment, net $ (30) $1,962
Unconsolidated investments 16 109
Goodwill 32 141
Other 6 51
- -----------------------------------------------------------------------
Total non-current assets held for sale $ 24 $2,263
- -----------------------------------------------------------------------
Liabilities
Accounts payable $ 10 $ 95
Current portion of long-term debt 2 3
Accrued taxes - 16
Other current liabilities 9 203
- -----------------------------------------------------------------------
Total current liabilities held for sale $ 21 $ 317
Long-term debt $ 5 $1,155
Minority interest 13 91
Other non-current liabilities 18 75
- -----------------------------------------------------------------------
Total non-current liabilities held for sale $ 36 $1,321
- -----------------------------------------------------------------------
Revenues from discontinued operations were $498 million and $662 million for the
nine months ended September 30, 2003 and 2002, respectively, including
Panhandle, CMS Field Services, and CMS Viron through their respective sale
dates. In accordance with SFAS No. 144, the net income (loss) of the operations
is included in the Consolidated Statements of Income under "Income (loss) from
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 $26 million
and $55 million for the nine months ended September 30, 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 September 30 2003 2002
- ---------------------------------------------------------------------
Discontinued operations:
Income from discontinued operations, net
of tax benefit of $10 and $8 $ 8 $ 20
Gain (loss) on disposal of discontinued operations,
net of tax benefit of $6 and tax of $2 (51) 5
- ---------------------------------------------------------------------
Income (loss) from discontinued operations $(43) $ 25
=====================================================================
In Millions
- ---------------------------------------------------------------------
Nine Months ended September 30 2003 2002
- ---------------------------------------------------------------------
Discontinued operations:
Income (loss) from discontinued operations, net
of tax of $8 and tax benefit of $33 $ 37 $ (26)
Loss on disposal of discontinued operations, net
of tax benefit of $6 and $67 (93) (127)
- ---------------------------------------------------------------------
Loss from discontinued operations $(56) $(153)
=====================================================================
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 by
CMS MST, CMS Energy's Board of Directors established a Special Committee 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. Previously, CMS Energy
terminated its speculative trading business and revised its risk management
policy. The Board of Directors adopted, and CMS Energy has implemented the
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 45 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 made a written submission to the FERC
on June 11, 2003 in compliance with the FERC's directives. On July 29, 2003, the
FERC issued an order stating that CMS MST met the requirements of the FERC's
April 30, 2003 order. Other than the FERC investigation,
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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 by shareholders who allege that they purchased
CMS Energy's securities during a purported class period. The cases were
consolidated into a single lawsuit and an amended and consolidated class action
complaint was filed on May 1, 2003. The consolidated complaint contains a
purported class period beginning on May 1, 2000 and running through March 31,
2003. It generally 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, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. The companies intend to defend
vigorously against this action but cannot predict the outcome of this
litigation.
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 by 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 are serving 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 LAWSUITS: 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 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 CMS Energy Common Stock
held in the plan. Plaintiffs also seek other equitable relief and legal fees.
These cases will be defended vigorously. CMS Energy cannot predict the outcome
of this litigation.
GAS INDEX PRICE REPORTING INVESTIGATION: 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.
GAS INDEX PRICE REPORTING LITIGATION: In August 2003, Cornerstone Propane
Partners, L.P. ("Cornerstone") filed a putative class action complaint in the
United States District Court for the Southern District of New York against CMS
Energy and 40 other energy companies. The complaint alleges that false natural
gas price reporting by the defendants manipulated the prices of NYMEX natural
gas futures
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and options. The complaint contains two counts under the Commodity Exchange Act,
one for manipulation and one for aiding and abetting violations. Cornerstone has
agreed to provide a blanket 60-day extension of time for all defendants to
answer or otherwise respond to the complaint. CMS Energy intends to defend
vigorously against this action but cannot predict the outcome of this
litigation.
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. The EPA has 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 September 30, 2003, Consumers has incurred $437 million in capital
expenditures to comply with the EPA regulations and anticipates that the
remaining capital expenditures will be incurred between 2003 and 2009. 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.
Consumers expects to supplement its environmental regulation 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 substantially.
The EPA has proposed changes to the rules which govern generating plant cooling
water intake systems. The proposed rules will require significant abatement of
fish mortality. The proposed rules are scheduled to become final in the first
quarter of 2004 and some of Consumers' facilities would be required to comply by
2006. Consumers is studying the proposed rules to determine the most
cost-effective solutions for compliance. Until the method of compliance is
determined, Consumers is unable to estimate the cost of compliance with the
proposed rules.
The EPA has alleged that some utilities have incorrectly classified plant
modifications as "routine maintenance" rather than seek permits from the EPA.
Consumers has received and responded to information requests from the EPA on
this subject. Consumers believes that it has properly interpreted the
requirements of "routine maintenance". If Consumers' interpretation is
eventually found to be incorrect, it may be required to install additional
pollution controls at some or all of its coal-fired plants and could call into
question the viability of certain plants remaining in operation.
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.
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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 September 30, 2003, Consumers
had accrued the minimum amount of the range for its estimated Superfund
liability.
In October 1998, during routine maintenance activities, Consumers identified PCB
as a component in certain paint, grout and sealant materials at the Ludington
Pumped Storage facility. Consumers removed and replaced part of the PCB
material. Consumers has proposed a plan to deal with the remaining materials and
is awaiting a response from the EPA.
LITIGATION: In October 2003, a group of eight PURPA qualifying facilities
selling power to Consumers filed a lawsuit in Ingham County Circuit Court
against Consumers. The lawsuit alleges that Consumers incorrectly calculated the
energy charge payments made pursuant to power purchase agreements between the
qualifying facilities and Consumers. More specifically, the lawsuit alleges that
Consumers should be basing the energy charge calculation on the cost of more
expensive eastern coal, rather than on the cost of the coal actually burned by
Consumers for use in its coal-fired generating plants. Consumers believes it has
been performing the calculation in the manner prescribed by the power purchase
agreements, and has filed a request with the MPSC (as a supplement to the PSCR
plan) that asks the MPSC to review this issue and to confirm that Consumers'
method of performing the calculation is correct. Also, Consumers has filed a
motion to dismiss the lawsuit in the Ingham County Circuit Court due to the
pending request at the MPSC in regard to the PSCR plan case. Although only eight
qualifying facilities have currently raised the issue, the same energy charge
methodology is used in the PPA with the MCV Partnership and in approximately 20
additional power purchase agreements with Consumers, representing approximately
1,670 MW of electric capacity. Consumers cannot predict the outcome of this
litigation.
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 Securitization bonds to refinance qualified costs, as
defined by the act; 5) establishes a market power supply test that if not met
may require transferring control of generation resources in excess of that
required to serve firm retail sales requirements (In September 2003, the MPSC
issued an order finding 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. (In
July 2002, the MPSC issued an order approving the plan to achieve the increased
transmission capacity. The MPSC found that once the planned projects were
completed and verification was submitted, a utility was in technical compliance.
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.); 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
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implementation costs incurred as a result of the passage of the act.
Under Public Act 141, Consumers currently offers standby generation services to
certain retail open access customers. The obligation to offer this service does
not extend beyond the later of December 31, 2001 or the date the MPSC finds that
Consumers complies with the market power test set forth in the Customer Choice
Act and has completed the projects necessary to meet Consumers', Detroit
Edison's and American Electric Power's obligation to jointly expand their
available transmission capability by at least 2,000 MW. As stated above, in
September 2003, the MPSC issued an order finding that Consumers is in compliance
with the market power test and in December 2002, Consumers filed verification
with the MPSC indicating that Consumers met the transmission capability
expansion requirements. As a result, Consumers filed a notice with the MPSC
indicating that it was terminating retail open access standby service on
December 31, 2003. Also, as a result of Consumers meeting the transmission
capability expansion requirements and the market power test, Consumers has met
the requirements under Public Act 141 to return to the PSCR process. For further
discussion on the PSCR process see, "Power Supply Costs" in this Note.
The rate-freeze imposed by Public Act 141 ends at December 31, 2003. After that
date, the statute would allow customers to petition the MPSC for rate reductions
below the cap. Consumers would have the opportunity to respond to such a
petition before rates could be reduced.
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 (as noted below in "Power Supply Costs"
in this Note 603 MW of load is currently being served by 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 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 late 2001. Securitization
resulted in lower interest costs and a longer amortization period for the
securitized assets, and offset the impact of the required residential rate
reduction. The Securitization orders
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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.
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 and cap period expire and an electric rate case is processed.
Securitization charge collections, $37 million for the nine months ended
September 30 2003, and $39 million for the nine months ended September 30, 2002,
are remitted to a trustee for the Securitization bonds. Securitization charge
collections are dedicated to 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. The
application sought recovery of costs associated with Clean Air Act expenditures,
Palisades expenditures previously not securitized, retail open access
implementation costs through December 31, 2003, certain pension fund costs, and
expenses associated with the issuance of the bonds. In June 2003, the MPSC
issued a financing order authorizing the issuance of Securitization bonds in the
amount of approximately $554 million. This amount relates to Clean Air Act
expenditures and associated return on those expenditures through December 31,
2002, retail open access implementation costs and previously authorized return
on those expenditures through December 31, 2000, and the "up front" other
qualified costs related to issuance of the Securitization bonds. The MPSC
rejected Palisades expenditures previously not securitized as eligible
securitized costs. Therefore, Palisades expenditures previously not securitized
should be included as a component of "net" Stranded Costs and will be included
as a component of a future electric rate case proceeding with the MPSC.
In the June 2003 financing order, the MPSC also adopted a rate design that would
allow retail open access customers to pay a securitization charge (and related
tax charge) that are a small fraction of the amounts paid by full service
bundled sales customers and special contract customers of the utility. The
financing order provides that the securitization charges (and related tax
charges) for the full service and bundled sales customers are increased under
the rate design in the financing order in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the Securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers to its "earnings." In July 2003, Consumers
filed for rehearing and clarification on a number of features in the financing
order, including the rate design, accounting treatment of unsecuritized
qualified costs and dividend restriction. Also in July 2003, the Attorney
General filed a claim of appeal related to the financing order and the Attorney
General indicated it would challenge the lawfulness of the rate design. In
October 2003, the Court of Appeals dismissed the appeal and indicated that the
Attorney General could resubmit the appeal after the MPSC acted on Consumers'
rehearing request. Subsequently, the Attorney General filed a motion of
rehearing asking for reconsideration of the Court of Appeals' dismissal. The
financing order will become effective after rehearing, resolution of appeals and
upon acceptance by Consumers.
ELECTRIC PROCEEDINGS: Stranded Costs - The Customer Choice Act allows electric
utilities to recover the
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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. According to the MPSC, "net"
Stranded Costs are 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. Consumers in its hearing brief, filed
in August 2002, revised its request for Stranded Costs to $7 million for 2000
and $4 million for 2001. 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. As discussed above in
"Securitization", Consumers 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.
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to resolve numerous
issues regarding the "net" Stranded Cost methodology in a way 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 have also filed rehearing
petitions with the MPSC. Consumers has also initiated an appeal at the Michigan
Court of Appeals related to the MPSC's December 2001 "net" Stranded Cost order.
In March 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 Palisades expenditures,
previously not securitized, were approved as proposed in its securitization case
as discussed above in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 would be 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.
In June 2003, the MPSC issued a financing order in the securitization case,
authorizing the issuance of Securitization bonds in the amount of approximately
$554 million. Included in this amount were Clean Air Act expenditures. However,
the MPSC rejected Palisades expenditures previously not securitized as eligible
securitized costs. As a result, the Palisades expenditures previously not
securitized should be included as a component of "net" Stranded Costs and will
be included as a component of a future electric rate case proceeding with the
MPSC. With the inclusion of the Palisades expenditures previously not
securitized, Consumers' "net" Stranded Costs incurred in 2002 are estimated to
be approximately $50 million.
In July 2003, Consumers filed a petition for rehearing and clarification on a
number of features in the MPSC's financing order on securitization. Once a final
financing order by the MPSC on securitization is issued, the amount of
Consumers' request for "net" Stranded Cost recovery for 2002 will be known.
Consumers cannot predict how the MPSC will rule on its request for the
recoverability of Stranded
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Costs, and therefore Consumers 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 has participated in this collaborative process. In July 2003, the
staff suspended formal discussion while it considers possible conclusions and
recommendations.
Implementation Costs - Since 1997, Consumers has incurred significant electric
utility restructuring implementation costs. The following table outlines the
applications filed by Consumers with the MPSC and the status of recovery for
these costs.
In Millions
- -------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- -------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 - 8 -
2003 2002 2 2 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 order received for the year 2001, the MPSC also reserved the right to review
again the 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 September 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $16 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 is expected to begin after the rate freeze or rate cap
period has expired. As discussed above, Consumers has asked to include
implementation costs through December 31, 2000 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.
Also, Consumers is 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. In May 2003, the FERC
issued an order denying MISO's request for authorization to reimburse Consumers.
In June 2003, Consumers and MISO filed a joint petition for rehearing with the
FERC. In September 2003, the FERC denied Consumers' and MISO's joint request.
Consumers plans to appeal the FERC ruling at the United States Court of Appeals
for the District of Columbia and pursue other potential means of recovery. In
November 2003, in conjunction with Consumers' appeal of the September Order
denying recovery, Consumers persuaded MISO to file a request with the FERC
seeking authority to reimburse METC, the legal successor in interest to the
Alliance RTO start-up costs. As part of the contract for sale of Consumers'
former transmission system, should the Commission approve the new MISO filing,
METC is contractually obligated to flow-through to Consumers the full amount of
any Alliance RTO start-up costs that it is authorized to recover through FERC.
Consumers cannot predict the outcome of the appeal process, the MISO request or
the amount of implementation costs, if any; the FERC ultimately will allow to be
collected.
Transmission Rates - In 1996, Consumers filed new OATT transmission rates with
the FERC for approval.
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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 final FERC 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 and Detroit Edison used the same
rates for JOATT transmission rates. Approval of the JOATT transmission rates
application is pending FERC approval. Consumers believes its reserve is
sufficient to satisfy its refund obligation under current rate applications. As
of October 2003, Consumers has paid $27 million in refunds. In October 2003,
Consumers filed with FERC its formal notice of cancellation of its transmission
tariffs since Consumers no longer has any transmission customers.
TRANSMISSION: In May 2002, Consumers sold its electric transmission system for
approximately $290 million to MTH, a non-affiliated limited partnership whose
general partner is a subsidiary of Trans-Elect, Inc. The pretax gain was $31
million ($26 million, net of tax). Remaining open issues are not expected to
materially impact the amount of the gain.
As a result of the sale, Consumers anticipates its after-tax earnings will
decrease 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 until May 1, 2007 under a
contract with MTH.
AUGUST 14, 2003 BLACKOUT: On August 14, 2003, the electric transmission grid
serving parts of the Midwest and the Northeast experienced a significant
disturbance, which impacted electric service to millions of homes and businesses
throughout a vast region. In Michigan, more than 2 million electric customers
were without electricity. Consumers had five fossil-fueled generating unit
outages and, of Consumers' 1.7 million electric customers, approximately
100,000 were without power for approximately 24 hours as a result of the
disturbance. The impact was felt most heavily in the southeastern part of
Consumers' service territory.
As discussed above in "Transmission", Consumers sold its transmission system in
May 2002 to MTH, with Consumers providing transmission system maintenance under
a five-year contract with MTH. MTH now owns, controls, and plans for the
transmission system that serves Consumers. Consumers incurred approximately $1
million of immediate financial impact as a result of the blackout. Consumers
continues to cooperate with investigations of the blackout by several federal
and state agencies. Consumers cannot predict the outcome of these
investigations.
In November 2003, the MPSC released its report on the August 14 blackout, which
found no evidence to suggest that the events in Michigan or actions taken by the
Michigan utilities or transmission operators were factors contributing to the
cause of the blackout. As a result of its investigation, the MPSC is
recommending that Congress pass legislation that would empower the FERC, where
necessary, to order
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membership into a RTO and that Congress should provide the FERC with the
authority to develop and enforce mandatory transmission reliability standards
with penalties for noncompliance.
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. As it did in 2003, Consumers is currently planning for a
reserve margin of approximately 11 percent for summer 2004 or supply resources
equal to 111 percent of projected summer peak load. Of the 111 percent,
approximately 100 percent is expected to be met from owned electric generating
plants and long-term power purchase contracts and 11 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 October 2003, alternative
electric suppliers are providing 603 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.
Currently, Consumers is required to provide backup service to ROA customers on a
"best efforts" basis. In October 2003, Consumers provided notice to the MPSC
that it would terminate the provision of backup service in accordance with
Public Act 141, effective January 1, 2004.
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 September 30, 2003, Consumers purchased capacity and energy
contracts partially covering the estimated reserve margin requirements for 2004
through 2007. As a result, Consumers has a recognized asset of $21 million for
unexpired capacity and energy contracts. The total premium cost of electricity
call option and capacity and energy contracts for 2003 is expected to be
approximately $10 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, effective 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.
On September 30, 2003, Consumers submitted a PSCR filing to the MPSC that would
reinstate the PSCR process for customers whose rates will no longer be frozen or
capped as of January 1, 2004. The proposed PSCR charge allows Consumers to
recover a portion of its increased power supply costs from large
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commercial and industrial customers effective January 1, 2004. This is the first
customer class for which the rate freeze and cap expire. Consumers will,
pursuant to its right under applicable law, self-implement the proposed PSCR
charge on January 1, 2004, unless the MPSC issues an order before that date
establishing a different charge. The charge is subject to subsequent change by
the MPSC during the PSCR period (calendar-year 2004). The revenues received
pursuant to the PSCR charge by statute are also subject to subsequent
reconciliation when the year is finished and actual costs have been reviewed for
reasonableness and prudence. Consumers cannot predict the outcome of this
filing.
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 include undistributed earnings from
the MCV Partnership, which at September 30, 2003 and 2002 are $238 million and
$217 million, respectively.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Earnings (loss) from equity method investees $ (3) $ 8 $ 31 $ 35
Operating taxes and other (1) 2 18 11
-------------------------------------------
Income (loss) before cumulative effect of accounting change (2) 6 13 24
Cumulative effect of change in method of accounting for
derivatives, net of $1 and $10 million tax expense in 2002 (a) - 1 - 18
-------------------------------------------
Net income (loss) $ (2) $ 7 $ 13 $ 42
===================================================================================================================
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Summarized Statements of Income for the MCV Partnership
In Millions
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------
Operating revenue $ 148 $ 156 $ 443 $ 451
Operating expenses 138 120 322 318
--------------------------------------------
Operating income 10 36 121 133
Other expense, net 25 27 82 86
--------------------------------------------
Income (loss) before cumulative effect of accounting change (15) 9 39 47
Cumulative effect of change in method of accounting for
derivative option contracts (a) - - - 58
--------------------------------------------
Net income (loss) $ (15) $ 9 $ 39 $ 105
====================================================================================================================
(a) On April 1, 2002, the MCV Partnership implemented Derivative Implementation
Group Issue C-16, an interpretation of SFAS No. 133. The MCV Partnership began
accounting for several natural gas contracts containing an option component at
fair value. As a result, a cumulative effect adjustment for the change in
accounting principle was recorded as an increase to earnings.
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. The remaining estimated future PPA liability associated with the
loss totaled $34 million at September 30, 2003 and $59 million at September 30,
2002. The PPA liability is expected to be depleted in late 2004. For further
discussion on the impact of the frozen PSCR, see "Consumers' Electric Utility
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.
Under Michigan's electric restructuring law, Consumers will return to unfrozen
rates for large industrial customers beginning January 1, 2004, including the
resumption of the PSCR process. Under the process, 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. Recovery of capacity and fixed energy charges will be
subject to certain rate caps as discussed in Note 4, Uncertainties, "Consumers'
Electric Utility Rate Matters - Electric Restructuring." 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, Consumers' cash underrecoveries associated with the PPA
could be as follows:
In Millions
- ------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5% (a) $ 57 $ 56 $ 56 $ 55 $ 39
Amount to be charged to operating expense $ 28 $ 27 $ 56 $ 55 $ 39
Amount to be charged to PPA liability $ 29 $ 29 $ - $ - $ -
======================================================================================================
(a) For the nine months ended September 30, 2003, Consumers' cash
underrecoveries associated with the PPA were $43 million.
As previously noted, until September 2007, the PPA and settlement require
Consumers to pay capacity costs based on the MCV Facility's actual availability
up to the 98.5 percent cap. After September 2007, Consumers expects to exercise
the "regulatory out" clause in the PPA, limiting its capacity payments to the
MCV Partnership to the amount collected from its customers. Depending on the
MPSC's future actions with respect to the capacity payments recoverable from its
customers subsequent to September 2007, the earnings of the MCV Partnership and
the value of Consumers' equity interest in the MCV Partnership, may be affected
negatively.
Further, under the PPA, energy payments to the MCV Partnership are based on the
cost of coal burned at Consumers' coal plants and costs associated with fuel
inventory, operations and maintenance, and administrative and general expenses
associated with Consumers' coal plants. However, the MCV Partnership's costs of
producing electricity are tied, in large part, to the cost of natural gas.
Because natural gas prices have increased substantially in recent years, while
energy charge payments to the MCV Partnership have not, the MCV Partnership's
financial performance has been impacted negatively.
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As of January 1, 2004, Consumers intends to return to forced (uneconomic)
dispatch of the MCV Facility in order to maximize recovery of its capacity
payments. As such, if the spread between MCV Facility's variable electricity
production costs and its energy payment revenues stays constant or widens, the
negative impacts on MCV Partnership's financial performance, and on the value of
Consumers' equity interest in the MCV Partnership, will be worse.
Consumers cannot estimate, at this time, the impact of these issues on its
future earnings or cash flow from its interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to Consumers' recovery of capacity payments are the two most
significant variables in the analysis of MCV Partnership's future financial
performance. Natural gas prices have historically been volatile and presently
there is no consensus in the marketplace on the price or range of prices of
natural gas beyond the next five years. Further, it is not presently possible
for Consumers to predict the actions of the MPSC in 2007 or later. For these
reasons, at this time Consumers cannot predict the impact of these issues on its
future earnings, cash flows, or on the value of its $404 million equity interest
in the MCV Partnership.
Consumers is exploring possible alternatives for utilizing the MCV Facility
without increasing costs to customers. Any changes regarding the recovery of MCV
capacity costs would require MPSC approval. Consumers cannot predict the outcome
of this matter.
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 PURPA. In July 1999, the district
court granted MCV Partnership's motion for summary judgment. The district 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: Significant progress continues to be made in the
decommissioning of Big Rock. Following the successful loading of spent fuel into
dry storage (see below under "Spent Nuclear Fuel Storage"), the spent fuel
storage racks were removed and disposed of and the spent fuel pool cleaned and
drained. The reactor vessel closure head was shipped for disposal in May 2003
and in August 2003, the reactor vessel was moved from the plant and sealed into
a specially designed shipping container. In October 2003, the shipping container
was transported to the licensed disposal facility in Barnwell, South Carolina.
The License Termination Plan was submitted to the NRC staff for review in April
2003. System dismantlement and building demolition continue on a schedule to
return the 560-acre site to a natural setting for unrestricted use in early
2006. The NRC and Michigan Department of Environmental Quality continue to find
that all decommissioning activities at Big Rock are being performed in
accordance with applicable regulatory and license requirements.
In July 2003, the NRC completed its mid-cycle plant performance assessment of
Palisades. The mid-cycle review for Palisades covered the period from January 1,
2003 through the end of July 2003. 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
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planned through September 2004.
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." Spent fuel was then loaded into the dry casks from the fuel pool and
transported to the temporary onsite storage pad. A total of seven dry casks have
been loaded with spent fuel. An additional eighth cask, containing high-level
radioactive waste material, was also loaded. This radioactive material was made
up of reactor vessel components that could not be shipped or stored with the
reactor vessel. These transportable dry casks will remain onsite until the DOE
moves the material to a national fuel repository.
At Palisades, the amount of spent nuclear fuel discharged from the reactor to
date exceeds Palisades' temporary onsite storage pool capacity. Consequently,
Consumers is using dry casks for temporary onsite storage. As of September 30,
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
onsite, 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.
As of September 30, 2003, Consumers has a recorded liability to the DOE of $139
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 the interest.
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,
including Consumers, which filed its complaint in December 2002, have commenced
litigation in the Court of Claims. 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. However, there is no assurance that
the litigation against the DOE will be successful.
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.
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In March 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 in April 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,
Detroit Edison, 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. In May 2003,
Consumers and the other named utilities each filed a motion to dismiss the
complaint. Consumers is unable to predict the outcome of this matter.
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 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 of the reactor head. Consumers will continue to comply with
the more aggressive reactor head inspection requirements in future planned
outages at Palisades.
Insurance: Consumers maintains primary and excess nuclear property insurance
from NEIL, totaling $2.750 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 $26 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 $10.862 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 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 $101 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 million. The Big Rock plant remains insured for nuclear
liability by a combination of insurance and United States government indemnity
totaling $544 million.
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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
resolution 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. A revised cost estimate, completed in September 2003, estimated remaining
costs to be between $37 million and $90 million. The range reflects multiple
alternatives with various assumptions for resolving the environmental issues at
each site. The estimates are based on discounted 2003 costs using a discount
rate of three percent. The discount rate represents a ten-year average of U.S.
Treasury bond rates reduced for increases in the consumer price index. Consumers
expects to fund a significant portion of these costs through insurance proceeds
and through MPSC approved rates charged to its customers. As of September 30,
2003, Consumers has an accrued liability of $47 million, net of $35 million of
expenditures incurred to date, and a regulatory asset of $68 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 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 case with the MPSC, Consumers expects to recover all of its gas
costs. In June 2003, Consumers filed a reconciliation of GCR costs and revenues
for the 12-months ended March 2003. Consumers proposes to recover from its
customers a net under-recovery of approximately $6 million using a roll-in
methodology. The roll-in methodology incorporates the under-recovery in the GCR
factor charged in the next GCR year. The roll-in tariff provision was approved
by the MPSC in a November 2002 order.
In July 2003, the MPSC approved a settlement agreement authorizing Consumers to
increase its gas cost recovery factor for the remainder of the current GCR plan
year (August 2003 through March 2004) and to implement a quarterly ceiling price
adjustment mechanism, based on a formula that tracks changes in NYMEX natural
gas prices. Consistent with the terms of the settlement, the ceiling price is
$6.11 per mcf. However, Consumers will utilize a GCR factor of $5.41 per mcf
commencing in November 2003 bills. All
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recoveries pursuant to such factors are subject to final reconciliation by the
MPSC.
2003 GAS RATE CASE: In March 2003, Consumers filed an application with the MPSC
seeking a $156 million increase in its gas delivery and transportation rates,
which included a 13.5 percent return on equity, based on a 2004 test year.
Contemporaneously with this filing, Consumers requested interim rate relief in
the same amount. In August 2003, the MPSC Staff recommended interim rate relief
of $80 million be granted in this proceeding, subject to Consumers voluntarily
agreeing to limit its dividends to its parent, CMS Energy, to a maximum of $190
million in any calendar year.
In September 2003, Consumers filed an update to its gas rate case that lowered
the requested revenue increase from $156 million to $139 million and revised the
return on common equity from 13.5 percent to 12.75 percent. The majority of the
reduction is related to lower debt costs and changes in the projected capital
structure. The MPSC Staff and ABATE filed their cases in early October. The
Staff made no change to its interim position of $80 million and continued to
propose the same dividend limitation. ABATE did not make a specific
recommendation for a final rate increase, but did discuss the rate design used
to recover any rate increase granted. A proposal for decision is expected from
the administrative law judge in January 2004.
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 ongoing
basis. Consumers may be required to comply with federal and state regulatory
security measures promulgated in the future. Through September 30, 2003,
Consumers has incurred approximately $7 million in incremental security costs,
including operating, capital, and decommissioning and removal costs, mainly
relating to its nuclear facilities. Consumers estimates it may incur additional
incremental security costs for the last three months of 2003 of approximately $3
million, of which $2 million relates to nuclear security costs. 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. In February 2003, the MPSC adopted filing requirements for
the recovery of enhanced security costs.
DERIVATIVE ACTIVITIES: Consumers may use 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
be adjusted to 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 7, Risk Management
Activities and Financial Instruments.
OTHER: 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.
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OTHER UNCERTAINTIES
INTEGRUM LAWSUIT: A complaint was filed in Wayne County, Michigan Circuit Court
on July 17, 2003 by Integrum against CMS Energy, Enterprises and APT. Integrum
alleges several causes of action against APT, CMS Energy and Enterprises in
connection with an offer by Integrum to purchase the CMS Pipeline Assets. In
addition to seeking unspecified money damages, Integrum is seeking an order
enjoining Enterprises and CMS Energy from selling and APT from purchasing the
CMS Pipeline Assets and an order of specific performance mandating that CMS
Energy, Enterprises and APT complete the sale of the CMS Pipeline Assets to APT
and Integrum. An officer and director of Integrum is a former officer and
director of CMS Energy, Consumers and certain of its subsidiaries. The
individual was not employed by CMS Energy, Consumers or its subsidiaries when
Integrum made the offer to purchase the CMS Pipeline Assets. CMS Energy and
Enterprises intend to vigorously defend against this action. CMS Energy and
Enterprises cannot predict the outcome of this litigation.
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. The tolling agreement stopped the running of any
statute of limitations during the period between September 13, 2002 and (through
several extensions of the original tolling period) December 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 with the plaintiffs in
the amount of $9 million. The primary insurance carrier paid $8 million of this
amount, and the Secondary insurer paid the remaining $1 million.
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.
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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 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 approximately $7 million for assorted damage claims
under several legal theories. As part of this arbitration, DIG has filed claims
against Rouge and Ford and Ford has filed claims against DIG for unspecified
amounts. DIG and CMS MST Michigan, LLC intend to vigorously defend themselves,
but cannot predict the outcome of this matter.
In October 2003, Rouge filed bankruptcy under Chapter 11 of the United States
Bankruptcy Code and as a result, the arbitration is subject to the automatic
stay imposed by the Bankruptcy Code. Rouge has indicated that it will continue
to honor its contractual obligations to pay for the steam and electricity DIG
provides. DIG is in the process of exploring its options relative to the
bankruptcy action but cannot predict the eventual outcome of the 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, that was filed in Wayne County Michigan Circuit Court. 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, MCV Expansion, LLC has a remaining contingent
obligation to GE in the amount of $2.2 million that may become payable in the
fourth quarter of 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, LLC
anticipates but cannot assure that purchase orders will be executed with GE
sufficient to eliminate contingent obligations of $2.2 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.
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
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CMS Energy Corporation
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
September 30, 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 Stockholders' Equity using an exchange rate of 2.975 pesos
per U.S. dollar was $259 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 $91 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 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.
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5: FINANCINGS AND CAPITALIZATION
The following is a summary of CMS Energy's Long-Term Debt as of September 30,
2003 and December 31, 2002:
LONG-TERM DEBT in Millions
- ---------------------------------------------------------------------------------------------------------------------------
September 30 December 31
Interest Rate (%) Maturity 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
CMS ENERGY
Senior Notes 7.625 2004 $ 176 $ 176
6.750 (a) 2004 82 287
9.875 2007 468 468
8.900 2008 260 260
7.500 2009 409 409
7.750 2010 300 -
8.500 2011 300 300
8.375 2013 - 150
3.375 (b) 2023 150 -
-------------------------------
2,145 2,050
-------------------------------
General Term Notes : Series D 6.938 (c) 2005 - 2008 65 94
Series E 7.718 (c)(a) 2003 - 2009 163 227
Series F 7.487 (c) 2003 - 2016 296 298
-------------------------------
524 619
-------------------------------
Extendible Tenor Rate Adjusted Securities 7.000 2005 180 180
Revolving Credit Facilities Floating 2003-2004 5 291
Other 8 29
-------------------------------
193 500
-------------------------------
CONSUMERS ENERGY
Senior Notes 6.000 2005 300 300
6.250 2006 332 332
6.375 2008 159 159
6.200 (d) 2008 - 250
6.875 2018 180 180
6.500 (e) 2018 141 141
6.500 (f) 2028 142 142
-------------------------------
1,254 1,504
-------------------------------
Securitization Bonds 5.075 (c) 2005-2015 434 453
First Mortgage Bonds 5.240 (c) 2008-2023 1,482 208
Long-Term Bank Debt Floating 2009 140 328
Nuclear Fuel Disposal Liability (g) 139 138
Pollution Control Revenue Bonds Various 2010-2018 126 126
Other 6 8
-------------------------------
2,327 1,261
OTHER SUBSIDIARIES 56 77
-------------------------------
Principal Amount Outstanding 6,499 6,011
Current Amounts (172) (627)
Net Unamortized Discount (36) (28)
- ---------------------------------------------------------------------------------------------------------------------------
Total Long-Term Debt $ 6,291 $ 5,356
===========================================================================================================================
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CMS Energy Corporation
(a) Senior notes of $82 million and Series E GTNs of $14.7 million were
called and redeemed as of October 15, 2003.
(b) These notes are convertible into shares of common stock at $10.671 per
share under certain circumstances.
(c) Represents the weighted average interest rate at September 30, 2003.
(d) These notes were subject to a Call Option by the Callholder or a
Mandatory Put on May 1, 2003.
(e) Senior Remarketed Notes subject to optional redemption by Consumers
after June 15, 2005.
(f) Callable at par on or after October 1, 2003.
(g) Maturity date uncertain.
CMS ENERGY
On March 30, 2003, CMS Energy entered into an amendment and restatement of its
then existing $300 million and $295.8 million revolving credit facilities under
which $409 million was outstanding. The Second Amended and Restated Senior
Credit Agreement included 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 included 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, were
required to be used to prepay this facility. This facility was collateralized
primarily by the stock of Consumers, Enterprises and certain Enterprises
subsidiaries. In July 2003, the facility was paid down to $5 million with a
combination of a portion of the proceeds of the sale of CMS Field Services and a
portion of the proceeds of the issuance of the $300 million 7.75 percent Senior
Notes due 2010. On September 12, 2003, this credit agreement was amended and
restated in the amount of $5 million. The amended and restated credit facility
does not include any restrictive financial covenants. As of September 30, 2003,
$5 million was outstanding on this facility.
LONG-TERM FINANCINGS: In July 2003, CMS Energy issued, in a private placement to
institutional investors, $150 million of 3.375 percent convertible senior notes
due July 15, 2023. The notes are putable to CMS Energy by the note holders at
par on July 15, 2008, July 15, 2013 and July 15, 2018. The notes are convertible
into CMS Energy common stock at the option of the holder under certain
circumstances. The initial conversion price is $10.671 per share, which
translates into 93.7137 shares of common stock for each $1,000 principal note
converted. CMS has agreed to file a shelf registration statement with the SEC by
October 14, 2004 relating to the resale of the notes and the common stock
issuable upon conversion thereof. Also in July 2003, CMS Energy issued $300
million of 7.75 percent senior notes due 2010. CMS has agreed to file a
registration statement with the SEC by March 14, 2004 to permit holders of these
notes to exchange the notes for new notes that will be registered under the
Securities Act of 1933. The approximately $433 million of proceeds from these
issuances were used to retire a portion of debt outstanding under CMS Energy's
Second Amended and Restated Senior Credit Agreement and to redeem a portion of
CMS Energy's 6.75 percent Senior Notes due January 2004.
In July 2003, CMS Energy retired $150 million principal amount of CMS Energy's
8.375 percent Reset Put Securities due 2013. As a result, CMS Energy recorded a
charge in July 2003 of approximately $19 million after-tax related to the
accelerated amortization of debt issuance costs and the premium paid associated
with the discharge of these securities. In October 2003, $82 million of the 6.75
percent senior notes were called and redeemed.
GENERAL TERM NOTES: At September 30, 2003, CMS Energy had issued and outstanding
$524 million GTNs, comprised of $65 million Series D GTNs, $163 million Series E
GTNs and $296 million of Series
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CMS Energy Corporation
F GTNs with weighted average interest rates of 6.94 percent, 7.72 percent and
7.49 percent, respectively. No Series G GTNs have been issued since their
registration in May 2002. In October 2003, approximately $15 million of Series E
GTNs were called and redeemed.
ENTERPRISES
In May 2003, CMS Energy entered into a revolving credit facility in an aggregate
amount of $185 million. The maturity date of this facility is May 21, 2004. This
facility is primarily used to provide letter of credit support for Enterprises'
subsidiary activities - principally credit support for project debt. Enterprises
provides funds to cash collateralize all letters of credit issued through this
facility. As of September 30, 2003, approximately $167 million of letters of
credit were issued under this facility and the cash that collateralizes the
letters of credit is included on the balance sheet as restricted cash.
CONSUMERS
REGULATORY AUTHORIZATION FOR FINANCINGS: At September 30, 2003, Consumers had
FERC authorization, through June 2004, to issue or guarantee up to $1.1 billion
of short-term securities outstanding at any one time. As of September 30, 2003,
Consumers had $400 million outstanding as collateral for the revolving credit
facility (discussed below) and had an additional $700 million available for
future issuances of short-term securities. At September 30, 2003, Consumers also
had remaining FERC authorization, through June 2004, to issue up to $800 million
of long-term securities for refinancing or refunding purposes, $560.3 million of
long-term securities for general corporate purposes, and $2.06 billion of
long-term first mortgage bonds to be issued solely as collateral for other
long-term securities. Also, FERC has granted waivers of its competitive
bid/negotiated placement requirements applicable to the 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.
In September 2003, this facility was amended and restated as a $400 million
revolving credit facility. The interest rate of the facility was reduced from
LIBOR plus 350 to LIBOR plus 175 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. At September 30, 2003, all of the $400
million is available for general corporate purposes. At September 30, 2003, a
total of $4 million was outstanding on all short-term financings at a weighted
average interest rate of 2.79 percent, compared with $235 million outstanding at
September 30, 2002 at a weighted average interest rate of 3.7 percent.
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 an interest rate of 4.25 percent, maturing in April
2008, and net proceeds were approximately $248 million; $375 million were issued
at an interest rate 5.375 percent, maturing in April 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 included
paying down additional debt. The $32 million option call payment was deferred
and is being amortized to interest expense over the term of the replacement debt
in accordance with SFAS No. 71. Consumers agreed to file a registration
statement with the SEC by December 26, 2003 to permit holders of the first
mortgage bonds to exchange the bonds for new bonds that will be registered under
the Securities Act of 1933.
In May 2003, Consumers sold $250 million principal amount of first mortgage
bonds in a private offering
CMS-84
CMS Energy Corporation
to institutional investors; the bonds were issued at an interest rate of 4.00
percent, maturing May 2010, and net proceeds were approximately $247 million.
Consumers used the net proceeds to pay down existing debt. Consumers agreed to
file a registration statement with the SEC by December 26, 2003 to permit
holders of the first mortgage bonds to exchange the bonds for new bonds that
will be registered under the Securities Act of 1933.
In August 2003, Consumers sold $400 million principal amount of first mortgage
bonds in a private offering to institutional investors; $200 million were issued
at an interest rate of 4.80 percent, maturing in February 2009, and net proceeds
were approximately $198 million and $200 million were issued at an interest rate
of 6.00 percent, maturing in February 2014, and net proceeds were approximately
$198 million. Consumers used the net proceeds to pay down existing debt and for
general corporate purposes. Consumers agreed to file a registration statement
with the SEC by April 14, 2004 to permit holders of the first mortgage bonds to
exchange the bonds for new bonds that will be registered under the Securities
Act of 1933.
SENIOR NOTES: 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 had a three-year maturity expiring in March 2006.
This term loan was paid in full with the proceeds of first mortgage bonds issued
in August 2003.
REQUIRED RATIOS
CMS Energy's amended and restated $5 million credit facility does not include
any restrictive financial covenants. Consumers' credit facilities have
restrictive financial covenants that require Consumers to maintain, as of the
last day of each fiscal quarter, the following:
Required Ratio Limitation Ratio at September 30, 2003
- ---------------------------------------------------------------------------------------------------
CONSUMERS:
Debt to Capital Ratio(a)(b) not more than 0.65 to 1.00 0.58 to 1.00
Interest Coverage Ratio-Revolver(a) not less than 2.00 to 1.00 3.34 to 1.00
===================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility that provides the lender, among other remedies, the right to
declare the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
In 1994, CMS Energy executed an indenture with JPMorgan Chase Bank, ultimate
successor to The Chase Manhattan 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 September 30, 2003, CMS Energy's
consolidated leverage ratio was 0.76 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 may refinance existing debt that
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CMS Energy Corporation
was incurred while CMS Energy was in compliance with the consolidated leverage
ratio.
In 1992, CMS Energy executed an indenture with Bank One Trust Company, N.A.
(successor to NBD Bank, National Association) pursuant to which CMS Energy
issues its senior notes. The indenture, through supplements, contains certain
provisions that can trigger a limitation on consolidated indebtedness. The
limitation can be activated when CMS Energy's consolidated coverage ratio, as
defined in the indenture, is below 1.70 to 1.0. At September 30, 2003, CMS
Energy's consolidated coverage ratio was 2.02 to 1.0.
Consumers is subject to covenants in its financing agreements that could limit
its ability to incur additional indebtedness. Consumers has agreed in several of
its financing agreements to maintain specified levels of cash coverage of its
interest requirements and to not allow its indebtedness to exceed specified
levels of its consolidated capitalization (the "Debt Percentage Tests").
Consumers is in compliance with these requirements as of the most recent
measurement date, September 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. Consumers sought and received amendments to
certain of its relevant financing agreements to modify the terms of the Debt
Percentage Tests in order to, among other things, remove the effect of the
adoption of SFAS No. 150, portions of which have now been deferred indefinitely,
regarding Trust Preferred Securities on the calculations.
RESTRICTED PAYMENTS: Under the provisions of its articles of incorporation,
Consumers had $412 million of unrestricted retained earnings available to pay
common dividends at September 30, 2003. However, covenants in Consumers' debt
facilities cap common stock dividend payments at $300 million in a calendar
year. Through September 30, 2003, Consumers paid $162 million in common
dividends. In October 2003, Consumers declared a $57 million common dividend
payable in November 2003.
For information on the potential cap on common dividends payable included in the
MPSC Securitization order see Note 4, Uncertainties, Consumers' Electric
Utility Rate Matters, "Securitization." Also, for information on the potential
cap on common dividends payable included in the MPSC Staff's recommendation in
Consumers' gas rate case see Note 4, Uncertainties, "Consumers' Gas Utility Rate
Matters - 2003 Gas Rate Case."
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 these 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. For further information, see Note 7, Risk Management
Activities and Financial Instruments, Financial Instruments, and Note 10,
Implementation of New Accounting Standards.
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CMS Energy Corporation
In Millions
- ----------------------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate Outstanding Maturity Redemption
- ----------------------------------------------------------------------------------------------------------------
September 30 2003 2002
- ----------------------------------------------------------------------------------------------------------------
CMS Energy Trust I (a) 7.75% $ 173 $ 173 2027 2001
CMS Energy Trust III (b) 7.25% - 220 2004 2003
Consumers Power Company Financing I,
Trust Originated Preferred Securities (c) 8.36% 70 70 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities (c) 8.20% 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities (d) 9.25% 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities (e) 9.00% 125 125 2031 2006
----------------
Total Amount Outstanding $ 663 $ 883
================================================================================================================
(a) Represents 3,450,000 shares of Quarterly Income Preferred Securities
that are convertible into 1.2255 shares of CMS Energy Common Stock
(equivalent to a conversion price of $40.80). Conversion is unlikely as
of September 30, 2003, based upon the market price of CMS Energy's
Common Stock of $7.37. If conversion were to occur in the future, the
securities would be converted into 4,227,975 shares of CMS Energy
Common Stock. Effective July 2001, CMS Energy can revoke the conversion
rights if certain conditions are met.
(b) In August 2003, 8,800,000 units of outstanding 7.25 percent Premium
Equity Participating Security Units (CMS Energy Trust III) were
converted to 16,643,440 newly issued shares of CMS Energy Common Stock.
(c) Consumers can currently redeem these securities at par value.
(d) Consumers cannot redeem these securities until 2004. If Consumers were
to redeem these securities as of September 30, 2003, they would be
required to pay market value, which is approximately $180 million.
(e) Consumers cannot redeem these securities until 2006. If Consumers were
to redeem these securities as of September 30, 2003, they would be
required to pay market value, which is approximately $128 million.
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CMS Energy Corporation
OTHER: Under a revolving accounts receivable sales program, Consumers currently
sells certain accounts receivable to a wholly owned, consolidated, bankruptcy
remote special purpose entity, Consumers Receivables Funding II. In turn,
Consumers Receivables Funding II may sell an undivided interest in up to $325
million of the receivables to a bank-sponsored commercial paper conduit. The
amount sold to the conduit was $254 million at September 30, 2003 and $325
million at September 30, 2002. These amounts are excluded from accounts
receivable in Consumers' consolidated balance sheets. Consumers continues to
service the receivables sold, however, the purchaser of the receivables has no
recourse against Consumers' other assets for failure of a debtor to pay when due
and the purchaser has no right to any receivables not sold. No gain or loss has
been recorded on the receivables sold and Consumers retains no interest in the
receivables sold.
Certain cash flows received from and paid to Consumers under its accounts
receivable sales program are shown below:
In Millions
- ----------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------
Proceeds from sales (remittance of collections)
under the program $ 204 $ 14 $ (71) $ (9)
Collections reinvested under the program 920 918 3,379 3,141
====================================================================================================
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS:
Effective January 1, 2003, CMS Energy adopted the provisions of this
interpretation that 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; no cumulative effect adjustments are required.
The following table is a summary of CMS Energy's guarantees as required by FASB
Interpretation No. 45:
September 30, 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 $ 1,971 $ 0.7 $ -
Letters of credit Various Various 204 - -
Surety bonds and other indemnifications Various Various 65 - -
Other guarantees Various Various 208 - -
Nuclear insurance retrospective premiums Various Various 133 - -
==========================================================================================================================
(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
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CMS Energy Corporation
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 September 30, 2003 are as follows:
Commercial Commitments In Millions
- ------------------------------------------------------------------------------------------------------------
Commitment Expiration
- ------------------------------------------------------------------------------------------------------------
September 30 Total 2003 2004 2005 2006 2007 Beyond
- ------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $ 208 $ - $ - $ - $ 4 $ - $ 204
Indemnities 65 - - 35 - - 30
Letters of Credit (a) 204 5 195 - - - 4
- ------------------------------------------------------------------------------------------------------------
Total $ 477 $ 5 $ 195 $ 35 $ 4 $ - $ 238
============================================================================================================
(a) At September 30, 2003, CMS Energy had $176 million of cash
collateralized letters of credit and the cash used to collateralize the
letters of credit is included in Restricted Cash on the consolidated
balance sheet.
CMS Energy and Enterprises, including subsidiaries, have guaranteed payment of
obligations, through letters of credit and surety bonds, of unconsolidated
affiliates and related parties approximating $477 million as of September 30,
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 September 30, 2003, the actual amount of
financial exposure covered by these guarantees was $52 million. This amount
excludes the guarantees associated with CMS MST's natural gas supply contract
obligations totaling $246 million, which are recorded as liabilities on the
Consolidated Balance Sheet at September 30, 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.
6: EARNINGS PER SHARE
The following table presents a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations.
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In Millions, Except Per Share Amounts
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK:
CMS Energy - Basic $ (77) $ 37
Add conversion of Trust Preferred
Securities (net of tax) - (a) - (a)
-------------------------------------
CMS Energy - Diluted $ (77) $ 37
=====================================
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 152.2 143.9
Add conversion of Trust Preferred Securities - (a) - (a)
Stock Options and Warrants - (b) -
-------------------------------------
Average Shares - Diluted 152.2 143.9
=====================================
EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Basic $ (0.51) $ 0.26
Diluted $ (0.51) $ 0.26
=====================================================================================================================
In Millions, Except Per Share Amounts
- ---------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK:
CMS Energy - Basic $ (43) $ 5
Add conversion of Trust Preferred
Securities (net of tax) - (a) - (a)
-------------------------------------
CMS Energy - Diluted $ (43) $ 5
=====================================
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 146.8 137.4
Add conversion of Trust Preferred Securities - (a) - (a)
Stock Options and Warrants - (b) -
-------------------------------------
Average Shares - Diluted 146.8 137.4
=====================================
EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Basic $ (0.29) $ 0.04
Diluted $ (0.29) $ 0.04
=====================================================================================================================
(a) The effects of converting the trust preferred securities were not
included in the computation of diluted earnings per share because to do
so would have been antidilutive.
(b) Shares of outstanding stock options and warrants of 0.3 million for
three months ended 2003 and 0.2 million for nine months ended 2003 were
not included in the computation of diluted earnings per share because
to do so would have been antidilutive.
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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.
CMS Energy and its regulated and non-regulated subsidiaries, may utilize a
variety of instruments to manage risk and may execute these transactions with
external parties either directly, or through CMS Enterprises or its marketing
subsidiary, CMS MST. These instruments may include futures contracts, swaps,
options and forward contracts to manage exposure to fluctuations in commodity
prices, interest rates and foreign exchange rates.
These instruments contain credit risk if the counterparties, including financial
institutions and energy marketers, fail to perform under the agreements. CMS
Energy minimizes such risk by performing financial credit mitigation programs
including, among other things, using publicly available credit ratings of such
counterparties, internally developed statistical models for credit scoring and
use of internal hedging programs to minimize exposure to external
counterparties. No material nonperformance is expected.
DERIVATIVE INSTRUMENTS: Contracts used to manage commodity price, interest rate,
and foreign exchange rate risk may be considered derivative instruments that are
subject to derivative and hedge accounting pursuant to SFAS No. 133. If a
contract is accounted for as a derivative instrument, it is recorded in the
consolidated 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 accumulated 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 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. CMS Energy uses a combination of quoted
market prices and mathematical valuation models to determine fair value of those
contracts requiring derivative accounting. The ineffective portion, if any, of
all hedges is recognized in earnings.
The majority of CMS Energy's 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 CMS Energy's exposures to electricity and gas commodity price risk and
interest rate and foreign currency exchange risk.
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 September 30, 2003, Consumers did not have any
unexpired purchased electric call option contracts subject to derivative
accounting. All remaining purchased electric
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call option contracts subject to derivative accounting as of June 2003, expired
in the third quarter of 2003. As of September 30, 2002, Consumers recorded on
the balance sheet all of its unexpired purchased electric call option contracts
subject to derivative accounting at a fair value of $1 million.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market 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.
Consumers' electric business also uses gas option and 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 contracts are financial contracts that
are used to offset increases in the price of potential gas purchases. These
contracts do not qualify for hedge accounting. Therefore, Consumers records any
change in the fair value of these contracts directly in earnings as part of
power supply costs. As of September 30, 2003, gas fuel for generation call
option contracts entered into in the second quarter of 2003 had expired. As of
September 30, 2002, gas fuel for generation swap contracts had a fair value of
less than $1 million. These contracts expired in December 2002.
For the three months ended September 30, 2003, Consumers recorded an unrealized
loss in accumulated other comprehensive income related to its proportionate
share of the effects of derivative accounting related to its equity investment
in the MCV Partnership of $5 million, net of tax. For the nine months ended
September 30, 2003, Consumers recorded an unrealized gain in accumulated other
comprehensive income related to its proportionate share of the effects of
derivative accounting related to its equity investment in the MCV Partnership of
$8 million, net of tax. As of September 30, 2003, the cumulative total of
unrealized gains recorded in other accumulated comprehensive income related to
Consumers' proportionate share of the effects of derivative accounting related
to its equity investment in the MCV Partnership is $6 million, net of tax.
Consumers expects to reclassify this gain, if this value remains, as an increase
to earnings from equity method investees 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
call and put options, and other types of contracts, to meet its regulatory
obligation to provide gas to its customers at a reasonable and prudent cost. As
of September 30, 2003, weather-based gas call options and gas call and put
options requiring derivative accounting had a net fair value that was less than
$1 million. The original cost of the options was a net $3 million. Consumers
recorded an unrealized loss of $3 million associated with these options directly
in earnings as part of other income, and then directly offset this loss and
recorded it on the balance sheet as a regulatory asset. Any subsequent changes
in fair value will be recorded in a similar manner.
As of September 30, 2002, Consumers gas supply contracts and weather-based gas
call options and gas put options requiring derivative accounting had a fair
value of $1 million, representing a fair value gain on the contracts since the
date of inception. Changes in fair value were recorded in a similar manner as
stated above for weather-based gas call options and gas call and put options.
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
records any change in the fair value of these contracts in accumulated other
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comprehensive income unless the swaps are sold. As of September 30, 2003,
Consumers did not have any interest rate swaps outstanding. As of September 30,
2002, Consumers had entered into a swap to fix the interest rate on $75 million
of variable-rate debt. This swap expired in June 2003. As of September 30, 2002,
this interest rate swap had a negative fair value of $2 million.
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: 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 loss of $23 million, net of tax. See Note 10,
Implementation 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. Where contractual 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 September 30, 2003 and 2002, CMS Energy has recorded a net price risk
management asset of $14 million and $129 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 have
entered into floating to
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CMS Energy Corporation
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 September 30, 2003, these swaps had a
negative fair value of $1 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. The weighted average interest rate associated with outstanding
swaps was approximately 7.4 percent at September 30, 2003 and 5.2 percent at
September 30, 2002.
In Millions
- ---------------------------------------------------------------------------------------------------------------------
Floating to Fixed Notional Maturity
Interest Rate Swaps Amount Date Fair Value
- ---------------------------------------------------------------------------------------------------------------------
September 30, 2003 $ 14 2005-2006 $ (1)
September 30, 2002 $ 294 2003-2006 $ (9)
=====================================================================================================================
FIXED TO FLOATING INTEREST RATE SWAPS: CMS Energy monitors its debt portfolio
mix of fixed and variable rate instruments and may enter into fixed to floating
rate swaps to maintain an appropriate 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 September 30, 2003 and 2002.
FOREIGN EXCHANGE DERIVATIVES: CMS Energy may use 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 associated
with adverse changes in currency exchange rates that could affect materially
cash flow. These contracts would 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.
There were no outstanding foreign exchange contracts at September 30, 2003. The
notional amount of the outstanding foreign exchange contracts at September 30,
2002 was $1 million Canadian contracts. The estimated fair value of the foreign
exchange and option contracts at September 30, 2002 was zero.
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 September 30, 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 financial instruments, except
for those as shown below, approximate fair value.
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CMS Energy Corporation
In Millions
- ----------------------------------------------------------------------------------------------------------------------
As of September 30 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Carrying Fair Unrealized Carrying Fair Unrealized
Cost Value Gain(Loss) Cost Value Gain
- ----------------------------------------------------------------------------------------------------------------------
Long-Term Debt (a) $ 6,291 $ 6,439 $ (148) $ 5,648 $ 5,206 $ 442
Trust Preferred Securities 663 603 60 883 676 207
Preferred Stock 44 33 11 44 23 21
Available-for-Sale Securities:
Nuclear Decommissioning (b) $ 450 $ 553 $ 103 $ 464 $ 530 $ 66
SERP 55 62 7 54 56 2
Southern Union Stock 54 54 - - - -
======================================================================================================================
(a) Settlement of long-term debt is generally not expected until maturity.
(b) On January 1, 2003, CMS Energy adopted SFAS No. 143 and began
classifying its unrealized gains and losses on nuclear decommissioning
investments as regulatory liabilities. CMS Energy previously classified
these investments in accumulated depreciation.
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. Net income from these investments included distributions in excess of
earnings of $33 million for the three months ended September 30, 2003 and
undistributed earnings of $14 million for the three months ended September 30,
2002. Net income from these investments included undistributed earnings of $38
million for the nine months ended September 30, 2003 and $71 million for the
nine months ended September 30, 2002. 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 September 30, 2003 Jorf Lasfar MCV Total
- -----------------------------------------------------------------------------------------
Operating revenue $ 89 $ 148 $ 237
Operating expenses 52 138 190
----------------------------------
Operating income 37 10 47
Other expense, net 17 25 42
----------------------------------
Net income (loss) $ 20 $ (15) $ 5
=========================================================================================
In Millions
- -----------------------------------------------------------------------------------------
Three Months Ended September 30, 2002 Jorf Lasfar MCV Total
- -----------------------------------------------------------------------------------------
Operating revenue $ 87 $ 156 $ 243
Operating expenses 47 120 167
----------------------------------
Operating income 40 36 76
Other expense, net 14 27 41
----------------------------------
Net income $ 26 $ 9 $ 35
=========================================================================================
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Income Statement Data
In Millions
- -----------------------------------------------------------------------------------------
Nine Months Ended September 30, 2003 Jorf Lasfar MCV Total
- -----------------------------------------------------------------------------------------
Operating revenue $ 270 $ 443 $ 713
Operating expenses 138 322 460
---------------------------------
Operating income 132 121 253
Other expense, net 41 82 123
---------------------------------
Net income $ 91 $ 39 $ 130
=========================================================================================
In Millions
- -----------------------------------------------------------------------------------------
Nine Months Ended September 30, 2002 Jorf Lasfar MCV Total
- -----------------------------------------------------------------------------------------
Operating revenue $ 274 $ 451 $ 725
Operating expenses 136 318 454
---------------------------------
Operating income 138 133 271
Other expense, net 36 86 122
Cumulative effect of change in method of
accounting for derivative options contracts (a) - 58 58
---------------------------------
Net income $ 102 $ 105 $ 207
=========================================================================================
(a) On April 1, 2002, the MCV Partnership implemented Derivative
Implementation Group Issue C-16, an interpretation of SFAS No. 133. The
MCV Partnership began accounting for several natural gas contracts
containing an option component at fair value. As a result, a cumulative
effect adjustment for the change in accounting principle was recorded
as an increase to earnings.
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 tables below show revenues, net income, and total assets by reportable
segment. The "Other" net income 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
- ----------------------------------------------------------
Three Months Ended September 30 2003 2002
- ----------------------------------------------------------
Revenues
Electric utility $ 714 $ 774
Gas utility 164 134
Enterprises 138 1,626
Other - -
--------------------
$ 1,016 $ 2,534
==========================================================
Reportable Segments In Millions
- ----------------------------------------------------------
Nine Months Ended September 30 2003 2002
- ----------------------------------------------------------
Revenues
Electric utility $ 1,966 $ 2,013
Gas utility 1,252 1,002
Enterprises 841 3,826
Other - 2
--------------------
$ 4,059 $ 6,843
==========================================================
Reportable Segments In Millions
- ----------------------------------------------------------
Three Months Ended September 30 2003 2002
- ----------------------------------------------------------
Net Income (Loss)
Electric utility $ 59 $ 88
Gas utility (19) (18)
Enterprises 13 58
Other (130) (91)
--------------------
$ (77) $ 37
==========================================================
Reportable Segments In Millions
- ----------------------------------------------------------
Nine Months Ended September 30 2003 2002
- ----------------------------------------------------------
Net Income (Loss)
Electric utility $ 145 $ 222
Gas utility 40 13
Enterprises 48 126
Other (276) (356)
--------------------
$ (43) $ 5
==========================================================
Reportable Segments In Millions
- ----------------------------------------------------------
September 30 2003 2002
- ----------------------------------------------------------
Total Assets
Electric utility $ 6,210 $ 5,483
Gas utility 2,331 2,024
Enterprises 3,610 6,728
Other 160 162
--------------------
$ 12,311 $ 14,397
==========================================================
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CMS Energy Corporation
10: 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. 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
$134 million regulatory liability; 3) a $42 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 were 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 insignificant 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, in 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 have been material for the nine months ended September 30,
2002.
The following table is a general description of the AROs and their associated
long-lived assets.
September 30, 2003 In Millions
- ------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- ------------------------------------------------------------------------------------------------------------
Palisades-decommission plant site 1972 Palisades nuclear plant $ 462
Big Rock-decommission plant site 1962 Big Rock nuclear plant 90
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line -
Closure of coal ash disposal areas Various Generating plants coal 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 -
============================================================================================================
CMS-98
CMS Energy Corporation
The following table is a reconciliation of the carrying amount of the AROs:
September 30, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
Pro Forma
ARO Liability ARO Liability Cashflow
ARO 1/1/02 1/1/03 Incurred Settled Accretion Revisions 9/30/03
- -------------------------------------------------------------------------------------------------------------------
Palisades-decommission $ 232 $ 249 $ - $ - $ 14 $ - $ 263
Big Rock-decommission 94 61 - (28) 10 - 43
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - (2) 4 - 53
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 $ - $ (38) $ 28 $ - $ 363
==================================================================================================================
a) ARO Liability was settled during 2003 as a result of the sales of Panhandle
and CMS Field Services.
SFAS NO. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES: Issued by the FASB in April 2003, this statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement is effective for contracts
entered into or modified after June 30, 2003. Implementation of this statement
has not had an impact on CMS Energy's Consolidated Financial Statements.
SFAS NO. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS
OF BOTH LIABILITIES AND EQUITY: Issued by the FASB in May 2003, this statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. The
statement requires an issuer to classify financial instruments within its scope
as liabilities. Those instruments were previously classified as mezzanine
equity. SFAS No. 150 became effective July 1, 2003.
CMS Energy has one, and Consumers has four, trust preferred securities
outstanding as of September 30, 2003. The trust preferred securities are issued
by consolidated subsidiaries of CMS Energy and Consumers. Each trust holds a
subordinated debenture from the parent company. The terms of the debentures are
identical to those of the trust preferred securities, except that the debenture
has an explicit maturity date. The trust documents, in turn, require that the
trust be liquidated upon the repayment of the debenture. The preferred
securities are redeemable upon the liquidation of the subsidiary; and therefore,
are considered equity in the financial statements of the subsidiary.
At their October 29, 2003 Board meeting, the FASB deferred the implementation of
the portion of SFAS No. 150 relating to mandatorily redeemable noncontrolling
interests in subsidiaries when the noncontrolling interests are classified as
equity in the financial statements of the subsidiary. CMS Energy and Consumers
trust preferred securities are included in the deferral. As such, the CMS Energy
and Consumers trust preferred securities continue to be accounted for under
existing accounting guidance and are included in mezzanine equity. CMS Energy
and Consumers continue to study the FASB developments regarding the SFAS No. 150
deferral.
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CMS Energy Corporation
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 nine months ended September 30, 2003.
EITF ISSUE NO. 01-08, DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE: In
May 2003, the EITF reached consensus in EITF Issue No. 01-08 to clarify the
requirements of identifying whether an arrangement should be accounted for as a
lease at its inception. The guidance in the consensus is designed to mandate
reporting revenue as rental or leasing income that otherwise would be reported
as part of product sales or service revenue. EITF Issue No. 01-08 requires both
parties to an arrangement to determine whether a service contract or similar
arrangement is or includes a lease within the scope of SFAS No. 13, Accounting
for Leases.
Historically, CMS Energy has entered into power purchase and similar service
arrangements. Prospective accounting under EITF Issue No. 01-08, could affect
the timing and classification of revenue and expense recognition. Certain
product sales and service revenue and expenses may be required to be reported as
rental or leasing income and/or expenses. The consensus is to be applied
prospectively to arrangements agreed to, modified, or acquired in business
combinations in fiscal periods beginning July 1, 2003. The adoption of EITF
Issue No. 01-08 has not impacted CMS Energy's results of operations, cash flows,
or financial position. CMS Energy will evaluate new or modified contracts under
EITF Issue No. 01-08 prospectively.
ACCOUNTING STANDARDS NOT YET EFFECTIVE
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, this interpretation requires the primary
beneficiary of a variable interest entity's activities to consolidate the
variable interest entity. The primary beneficiary is the party that absorbs a
majority of the expected losses and/or receives a majority of the expected
residual returns of the variable interest entity's activities. The consolidation
requirements of the interpretation apply immediately to variable interest
entities created after January 31, 2003. CMS Energy has not created any variable
interest entities in 2003. Therefore, this portion of the interpretation has no
impact on its consolidated financial statements. Public companies, whose fiscal
year is a calendar year, were originally required to implement the guidance in
this interpretation by the third quarter of 2003. However, on October 9, 2003,
the FASB issued FASB Staff Position No. 46-6, Effective Date of FASB
Interpretation No. 46, and deferred implementation of Interpretation No. 46
until the fourth quarter of 2003 for variable interest entities and potential
variable interest entities created before February 1, 2003.
CMS Energy is evaluating all of its interests in entities, including
approximately 30 minority-held investments that are not currently consolidated,
to determine their treatment under FIN 46. The majority of
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these investments are electric generation and gas transmission projects. CMS
Energy's investment in these entities totaled approximately $1,425 million as of
September 30, 2003. Jorf Lasfar and the MCV Partnership are the two largest
entities impacting CMS Energy's operations. For further information, see Note 8,
Equity Method Investments.
If the completed analysis were to require CMS Energy to disclose information
about or consolidate in its financial statements, the assets, liabilities and
activities of the MCV Partnership and the First Midland Limited Partnership,
including the recognition of the debt of the MCV Partnership on Consumers'
financial statements, this could impact negatively CMS Energy's and Consumers'
various financial covenants under their financing agreements. As a result, CMS
Energy and Consumers may have to seek amendments to the relevant financing
agreements to modify the terms of certain of these covenants in order to remove
the effect of this potential consolidation or refinance the relevant debt. As of
September 30, 2003, Consumers' investments in the MCV Partnership and in the
FMLP were $404 million and $222 million, respectively. For further description
of the nature, purpose, size and activities of the MCV Partnership see Note 4,
Uncertainties, Other Consumers' Electric Utility Uncertainties, "The Midland
Cogeneration Venture" and Note 8, Equity Method Investments. CMS Energy is
continuing to study the implementation of this interpretation and has yet to
determine the effects, if any, on its consolidated financial statements.
EITF ISSUE 03-04, ACCOUNTING FOR CASH BALANCE PENSION PLANS: In May 2003, the
EITF reached consensus in EITF Issue No. 03-04 to specifically address the
accounting for certain cash balance pension plans. EITF Issue No. 03-04
concluded that certain cash balance plans be accounted for as defined benefit
plans under SFAS No. 87, Employers' Accounting for Pensions. EITF No. 03-04
requires the use of the traditional unit credit method for the purposes of
measuring the benefit obligation and annual cost of benefits earned as opposed
to the projected unit credit method. The EITF concluded that the requirements of
this Issue be applied as of the next plan measurement date, which is December
31, 2003 for CMS Energy. CMS Energy commenced a cash balance pension plan that
covers employees hired after June 30, 2003. CMS Energy does account for this
plan as a defined benefit plan under SFAS No. 87. CMS Energy continues to
evaluate the impact, if any, this Issue will have upon adoption.
STATEMENT OF POSITION, ACCOUNTING FOR CERTAIN COSTS AND ACTIVITIES RELATED TO
PROPERTY, PLANT, AND EQUIPMENT: At its September 9, 2003 meeting, the Accounting
Standards Executive Committee voted to approve the Statement of Position,
Accounting for Certain Costs and Activities Related to Property, Plant, and
Equipment. The Statement of Position is expected to be presented for FASB
clearance late in the fourth quarter of 2003 and would be applicable for fiscal
years beginning after December 15, 2004. The Accounting Standards Executive
Committee concluded that at transition, a company would have the flexibility to
adopt a property, plant and equipment component accounting policy for
transition-date property, plant and equipment accounts. The property, plant and
equipment component accounting policy may differ from the componentization
policy, if any, previously used by the enterprise. Selecting a policy that
differs from the company's prior level of componentization at the date of
adoption of the Statement of Position would not result in any cumulative effect
difference for adopting such a policy. A company would not have to restate its
pre-adoption assets to conform with its post-adoption componentization policy.
The Accounting Standards Executive Committee concluded that companies would be
required to disclose meaningful ranges with respect to property, plant and
equipment depreciable lives. CMS Energy continues to evaluate the impact, if
any, this Statement of Position will have upon adoption.
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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 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' intention with the use of the words
"anticipates," "believes," "estimates," "expects," "intends," and "plans," and
variations of such words and similar expressions, is 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 Uncertainties" 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
Consumers' 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.
Consumers 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, 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, future commodity prices, mark-to-market valuations, investment
returns, impact of new accounting standards, future costs associated with
long-term contractual
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obligations, future compliance costs associated with environmental regulations
and continuing creditworthiness of counterparties. Actual results could differ
materially from those estimates.
The recording of estimated liabilities for contingencies within the financial
statements is guided by the principles in SFAS No. 5. SFAS No. 5 requires a
company to record estimated liabilities in the financial statements when it is
probable that a loss payment will be made in the future as a result of a current
event, and when that amount 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.
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 September 30, 2003, Consumers has incurred $437
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 substantially. As new environmental standards become
effective, Consumers will need additional capital expenditures to comply with
the standards. Capital expenditures will depend upon the composition of the
final regulations.
The EPA has proposed changes to the rules that govern generating plant cooling
water intake systems. The proposed rules will require significant abatement of
fish mortality. The proposed rules are scheduled to become final in the first
quarter of 2004 and some of Consumers' facilities would be required to comply by
2006. Consumers is studying the proposed rules to determine the most
cost-effective solutions for compliance. Until the method of compliance is
determined, Consumers is unable to estimate the cost of compliance with the
proposed rules.
The EPA has alleged that some utilities have incorrectly classified plant
modifications as "routine maintenance" rather than seek permits from the EPA.
Consumers has received and responded to information requests from the EPA on
this subject. Consumers believes that it has properly interpreted the
requirements of "routine maintenance". If Consumers' interpretation is
eventually found to be incorrect, it may be required to install additional
pollution controls at some or all of its coal-fired plants and could call into
question the viability of certain plants remaining in operation.
For further information on electric environmental matters 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 using the Gas Research
Institute-Manufactured Gas Plant Probabilistic Cost Model. A revised cost
estimate, completed in September 2003, estimated remaining costs to be between
$37 million and $90 million. The range reflects multiple alternatives with
various assumptions for resolving the environmental issues at each site. The
estimates are based on discounted 2003 costs using a discount rate of three
percent. The discount rate represents a ten-year average of U.S. Treasury bond
rates reduced for increases in the consumer price index. Any significant change
in assumptions, such as remediation techniques, nature and extent of
contamination, and legal and regulatory
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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. The remaining estimated future PPA liability associated with the
loss totaled $34 million at September 30, 2003 and $59 million at September 30,
2002. 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.
Under Michigan's electric restructuring law, Consumers will return to unfrozen
rates for large industrial customers beginning January 1, 2004, including the
resumption of the PSCR process. Under the PSCR process, 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. Recovery of capacity and fixed energy
charges will be subject to certain rate caps as discussed in Note 2,
Uncertainties, "Electric Rate Matters - Electric Restructuring." 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, Consumers' cash underrecoveries associated with the PPA
could be as follows:
In Millions
- -----------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- -----------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5% (a) $57 $56 $56 $55 $39
Amount to be charged to operating expense $28 $27 $56 $55 $39
Amount to be charged to PPA liability $29 $29 $ - $ - $ -
===============================================================================================
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(a) For the nine months ended September 30, 2003, Consumers' cash
underrecoveries associated with the PPA were $43 million.
As previously noted, until September 2007, the PPA and settlement require
Consumers to pay capacity costs based on the MCV Facility's actual availability
up to the 98.5 percent cap. After September 2007, Consumers expects to exercise
the "regulatory out" clause in the PPA, limiting its capacity payments to the
MCV Partnership to the amount collected from its customers. Depending on the
MPSC's future actions with respect to the capacity payments recoverable from its
customers subsequent to September 2007, the earnings of the MCV Partnership and
the value of Consumers' equity interest in the MCV Partnership, may be affected
negatively.
Further, under the PPA, energy payments to the MCV Partnership are based on the
cost of coal burned in Consumers' coal plants and costs associated with fuel
inventory, operations and maintenance, and administrative and general expenses
associated with Consumers' coal plants. However, the MCV Partnership's costs of
producing electricity are tied, in large part, to the cost of natural gas.
Because natural gas prices have increased substantially in recent years, while
energy charge payments to the MCV Partnership have not, the MCV Partnership's
financial performance has been impacted negatively.
As of January 1, 2004, Consumers intends to return to forced (uneconomic)
dispatch of the MCV Facility in order to maximize recovery of its capacity
payments. As such, if the spread between MCV Facility's variable electricity
production costs and its energy payment revenues stays constant or widens, the
negative impacts on MCV Partnership's financial performance, and on the value of
Consumers' equity interest in the MCV Partnership, will be worse.
Consumers cannot estimate, at this time, the impact of these issues on its
future earnings or cash flow from its interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to Consumers' recovery of capacity payments are the two most
significant variables in the analysis of MCV Partnership's future financial
performance. Natural gas prices have historically been volatile and presently
there is no consensus in the marketplace on the price or range of prices of
natural gas beyond the next five years. Further, it is not presently possible
for Consumers to predict the actions of the MPSC in 2007 or later. For these
reasons, at this time Consumers cannot predict the impact of these issues on its
future earnings, cash flows, or on the value of its $404 million equity interest
in the MCV Partnership.
Consumers is exploring possible alternatives for utilizing the MCV Facility
without increasing costs to customers. Any changes regarding the recovery of MCV
capacity costs would require MPSC approval. Consumers cannot predict the outcome
of this matter.
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.
The types of contracts Consumers typically classifies as derivative instruments
are interest rate swaps, certain
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electric call options, gas fuel options, fixed priced weather-based gas supply
call options and fixed price gas supply call and put options. Consumers does not
account for electric capacity and 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 accumulated 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 valuation models. Valuation 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 certain contracts. At September 30, 2003, Consumers
assumed a market-based interest rate of one percent (six-month U.S. Treasury)
and an average volatility rate of 55 percent to calculate the fair value of its
gas 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 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. 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 resulting from changes in fair value reported in
equity as part of accumulated other comprehensive income and are 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 September 30, 2003, Consumers held 2.4 million
shares of CMS Energy Common Stock with a fair value of $17 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. 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.
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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. Established policies and procedures are used to
manage the risks associated with market fluctuations.
Consumers may use various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. Consumers enters into all risk management
contracts for purposes other than trading.
These instruments contain credit risk if the counterparties, including financial
institutions and energy marketers, fail to perform under the agreements.
Consumers minimizes such risk by performing financial credit reviews using,
among other things, publicly available credit ratings of such counterparties.
In accordance with SEC disclosure requirements, Consumers performs sensitivity
analyses to assess the potential loss in fair value, cash flows and earnings
based upon a hypothetical 10 percent adverse change in market rates or prices.
Management does not believe that sensitivity analyses alone provide an accurate
or reliable method for monitoring and controlling risks. Therefore, Consumers
relies on the experience and judgment of its senior management to revise
strategies and adjust positions, as they deem necessary. Changes 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 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 deemed appropriate, based upon market
conditions. These strategies are designed to provide and maintain a balance
between risk and the lowest cost of capital.
As of September 30, 2003, Consumers had no outstanding interest rate swap
agreements. As of September 30, 2003, Consumers had outstanding variable-rate
financing of $628 million, a $640 million decrease (50 percent) from the
December 31, 2002 balance of $1.268 billion. The decline in variable-rate
financing is primarily due to a shift toward fixed-rate financing. As of
September 30, 2003, assuming a hypothetical 10 percent adverse change in market
interest rates, Consumers' before tax annual earnings exposure on its
variable-rate financing would be $1 million.
As of September 30, 2003, Consumers had outstanding fixed-rate financing of
$3.694 billion, a $934 million increase (34 percent) over the December 31, 2002
balance of $2.760 billion. As of September 30, 2003, the fair value of
Consumers' fixed-rate financing was $3.804 billion, a $1.127 billion increase
(42 percent) over the December 31, 2002 fair value of $2.677 billion. The change
in the fair value of the fixed-rate financing is due to both an increase in
outstanding fixed-rate debt obligations as well as a decline in market interest
rates. As of September 30, 2003, assuming a hypothetical 10 percent adverse
change in market interest rates, the fair value of Consumers' fixed-rate
financing would increase by $155 million.
As discussed below in Electric Business Outlook - Securitization, Consumers has
filed an application with the MPSC to securitize certain costs. Upon final
approval, Consumers intends to use the proceeds from the securitization to
retire higher cost 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
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adverse effect on either its consolidated financial position, results of
operation or cash flows.
Commodity Market Risk: For purposes other than trading, Consumers entered into
electric call options, fixed priced weather-based gas supply call options and
fixed priced gas supply call and 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 weather-based gas supply call options, and the gas supply call and put
options are used to purchase reasonably priced gas supply. Call options allow
Consumers the right but not the obligation to purchase gas supply at
predetermined fixed prices. Put options allow third-party suppliers the right
but not the obligation to sell Consumers gas supply at predetermined fixed
prices.
As of September 30, 2003 and December 31, 2002, the fair value of
electricity-related call option contracts, based on quoted market prices and
mathematical valuation models using current and historical pricing data, was $3
million and $9 million, respectively. As of September 30, 2003 assuming a
hypothetical 10 percent adverse change in market prices, the potential reduction
in fair value associated with these contracts would be $1 million. As of
September 30, 2003 and December 31, 2002, Consumers had an asset of $21 million
and $30 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 September 30, 2003, the
fair value of the fixed priced weather-based gas supply call options and fixed
priced gas supply call and put options, based on quoted market prices and
mathematical valuation models, was less than $1 million. As of September 30,
2003, assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $1
million.
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 normally would 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 September 30, 2003, Consumers had $1.113 billion recorded as
regulatory assets and $461 million recorded as regulatory liabilities.
In 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. However,
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
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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 allowed
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 5, Implementation of New Accounting Standards, "SFAS No. 143,
Accounting for Asset Retirement Obligations."
For further information on industry regulation, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, "Utility Regulation".
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 requires the
expertise of actuaries and is 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 are not distinguishable from the Pension
Plan's total assets. In June 2003, CMS Energy completed the sale of Panhandle to
Southern Union Panhandle Corp. No portion of the Pension Plan was transferred
with the sale. Panhandle employees are no longer eligible to accrue additional
benefits. The Pension Plan retained pension payment obligations for Panhandle
employees that were vested under the Pension Plan. Because of the significant
change in the makeup of the plan, SFAS No. 87 required a remeasurement of the
obligation at the date of sale. The estimated remeasurement resulted in an
increase in pension expense of approximately $3 million and OPEB expense of
approximately $5 million for 2003, as well as an additional charge to
accumulated other comprehensive income of approximately $27 million ($17 million
after tax) as a result of the increase in the additional minimum pension
liability. The actuary is in the process of finalizing the effects of the
mid-year remeasurement. Although actual results may differ from the estimates
recorded, Consumers does not expect those differences to be material.
Consumers estimates OPEB expense will approximate $54 million in 2003, $62
million in 2004, and $60 million in 2005. Consumers estimates pension expense
will approximate $38 million in 2003, $46 million in 2004, and $47 million in
2005. 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 August 2003, Consumers
made its planned contribution of $172 million to the Pension Plan.
Consumers has announced amendments to the Pension Plan for salaried employees,
whereby, 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 addition, Consumers has implemented a cash balance plan for
employees hired on or after July 1, 2003. Under a cash balance plan, an
employees' retirement account is credited annually with a percentage of their
base pay. Accounts will be valued at the end of each year, using an annual
variable interest rate to determine growth. Employees who leave the company and
are vested in the cash balance version of the pension plan can either start
receiving their benefit immediately, postpone receiving benefits until a future
date while receiving an
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earnings credit on their account (payment cannot be deferred beyond age 70-1/2),
or roll 100 percent of the cash balance account into an IRA or another qualified
plan. If a participant is not vested (less than five years of service under the
terms of the plan), the cash balance account is forfeited.
In 2003, a large majority of retiring employees elected the lump sum payment
option instead of receiving pension benefits as an annuity over time. As a
result, Consumers may be required to record a settlement loss in accordance with
SFAS No. 88, which requires a settlement loss to be recognized when the cost of
all settlements paid during the year exceeds the sum of the service and interest
costs for the same year. Consumers cannot yet determine if the amount of lump
sum payments for 2003 will exceed the threshold, but estimates that if the
threshold is exceeded, between $55 million and $65 million could be recognized
as a loss in the fourth quarter of 2003.
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. The MPSC orders received in March and December of 1999 for Big Rock and
Palisades plants, respectively, provided for fully funding the decommissioning
trust funds for both sites. The December 1999 order set the annual
decommissioning surcharge for the Palisades decommissioning at $6 million.
Consumers estimates that at the time of the decommissioning of Palisades, its
decommissioning trust fund will be fully funded. This conclusion assumes 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 cost estimates use various inflation rates for labor,
non-labor, and contaminated equipment disposal costs.
In December 2000, funding of the Big Rock trust fund was stopped since it was
considered fully funded, subject to further review. A portion of future
decommissioning cost will result from the failure of the DOE to remove fuel from
the site. These costs, and similar costs incurred at Palisades, would not be
necessary if the DOE took possession of the spent fuel as required by the
Nuclear Waste Policy Act of 1982. A number of utilities, including Consumers,
which filed its complaint in December 2002, have commenced litigation in the
Court of Claims. 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. However, there is no assurance that the litigation against the
DOE will be successful.
The funds provided by the trusts and additional potential 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. For further information see Note 2, Uncertainties, "Other Electric
Uncertainties - Nuclear Matters."
In March 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 in April 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,
Detroit Edison, Indiana & Michigan Electric Company, Wisconsin Electric Power
Company and Wisconsin Public Service Corporation, including
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Consumers Energy Company
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. In May 2003, Consumers and the other named utilities each filed a motion
to dismiss the complaint. Consumers is unable to predict the outcome of this
matter.
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 for generation from CMS MST, the sale of electricity to CMS MST, the
purchase of gas transportation from CMS Bay Area Pipeline, L.L.C., the payment
of parent company overhead costs to CMS Energy, the sale of 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 of 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 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. Consumers continues
to use the transmission facilities now owned by MTH, and a director of Consumers
is currently a stockholder of Trans-Elect, Inc.
For detailed information about related party transactions see Note 2,
Uncertainties, "Electric Rate Matters - Transmission", and "Other Electric
Uncertainties - The Midland Cogeneration Venture".
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Consumers Energy Company
RESULTS OF OPERATIONS
CONSUMERS' NET INCOME AVAILABLE TO COMMON STOCKHOLDER
In Millions
- ------------------------------------------------------------------------------
September 30 2003 2002 Change
- ------------------------------------------------------------------------------
Three months ended $ 33 $ 74 $ (41)
Nine months ended $172 $267 $ (95)
==============================================================================
2003 COMPARED TO 2002: For the three months ended September 30, 2003, Consumers'
net income available to common stockholder totaled $33 million, a decrease of
$41 million from the previous year.
A decrease in electric delivery revenues reduced earnings by $22 million
after-tax. This decrease was primarily due to reduced deliveries to the higher
margin residential sector resulting from milder summer weather compared to the
same period in 2002, which included record setting monthly sendout and monthly
hourly peak demand volumes. Commercial and industrial customers switching to
alternative electric suppliers as allowed by the Customer Choice Act further
reduced electric delivery revenues. Lower gas deliveries reduced after-tax
earnings by $9 million. Earnings were also reduced $10 million after-tax due to
a decrease in the fair value of certain long-term gas contracts held by the MCV
Partnership. The earnings decrease also reflects increased costs of borrowing
that reduced earnings by $4 million after-tax, and increased general tax expense
of $3 million after-tax. Offsetting the earnings decrease is an after-tax
benefit of $3 million due to the final gas rate order issued in 2002 authorizing
Consumers to increase its gas tariff rates.
For the nine months ended September 30, 2003, Consumers' net income available to
common stockholder totaled $172 million, a decrease of $95 million from the
previous year.
This decrease in earnings reflects the absence of the nonrecurring benefits from
2002, including the $31 million after-tax gain on asset sales, and the $18
million of after-tax earnings related to an adjustment to the fair value of
certain long-term gas contracts held by the MCV Partnership. Reduced earnings
also reflect a $12 million charge to non-utility expense in order to recognize a
decline in market value of CMS Energy Common Stock held by Consumers.
Decreased electric deliveries reduced after tax earnings by $25 million. This
decrease can be attributed to the continuing switch by commercial and industrial
customers to alternative electric suppliers allowed by the Customer Choice Act.
A reduction in residential consumption also contributed to the decrease in
electric deliveries. This decrease was due to milder summer temperatures in 2003
compared to the same period in 2002, which included record setting monthly send
out and monthly hourly peak demand volumes.
Increased electric and gas operating expenses reduced after-tax earnings by $32
million. Increased costs of borrowings reduced after-tax earnings by $16
million, and a $7 million after-tax charge at CMS Midland Holdings reflecting
the loss of certain tax credits also contributed to the earnings decrease.
Offsetting these decreases is an after-tax benefit of $9 million due to
increased gas deliveries reflecting colder winter weather in early 2003, a $23
million after-tax benefit due to the final gas rate order issued in 2002
authorizing Consumers to increase its gas tariff rates, and the $13 million
after-tax benefit relating to the reduction in MSBT expenses relating to years
2000 and 2001. The reduction in MSBT expense is a result of CMS Energy receiving
approval to file consolidated tax returns for years 2000 and 2001. These returns
were filed in the second quarter of 2003.
Finally, earnings for the three and nine month period ended September 30, 2003,
were reduced by $1 million
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after-tax as a result of the Northeast United States blackout that commenced
August 14, 2003.
For further information, see the Electric and Gas Utility Results of Operations
sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
- ------------------------------------------------------------------------------
September 30 2003 2002 Change
- ------------------------------------------------------------------------------
Three months ended $ 59 $ 88 $ (29)
Nine months ended $145 $222 $ (77)
==============================================================================
Three Months Ended Nine Months Ended
Reasons for change September 30, 2003 vs. 2002 September 30, 2003 vs. 2002
- --------------------------------------------------------------------------------------------------------------
Electric deliveries $ (34) $ (38)
Power supply costs and related revenue 2 14
Other operating expenses and non-commodity revenue (5) (43)
Asset sales - (38)
General taxes (3) 12
Fixed charges (5) (18)
Income taxes 16 34
------------------------------------------------
Total change $ (29) $ (77)
==============================================================================================================
ELECTRIC DELIVERIES: For the three months ended September 30, 2003, electric
delivery revenues decreased by $34 million from the previous year. Electric
deliveries, including transactions with other wholesale market participants and
other electric utilities, were 10.3 billion kWh, a decrease of 0.6 billion kWh
or 4.9 percent from 2002. The decrease in revenue is primarily the result of
decreased deliveries to the higher margin residential sector due to milder
summer temperatures in 2003 compared to the same period in 2002, which included
record setting monthly sendout and monthly hourly peak demand volumes.
Commercial and industrial customers switching to alternative electric suppliers
as allowed by the Customer Choice Act further reduced electric delivery
revenues.
For the nine months ended September 30, 2003, electric delivery revenues
decreased by $38 million from the previous year. Electric deliveries, including
transactions with other wholesale market participants and other electric
utilities, were 29.3 billion kWh, a decrease of 0.2 billion kWh or 0.6 percent
from 2002. The decrease in delivery revenues can be attributed to the continuing
switch by commercial and industrial customers to alternative electric suppliers
allowed by the Customer Choice Act. Also contributing to decreased electric
deliveries was a reduction in residential consumption due to milder summer
temperatures in 2003 compared to the same period in 2002, which included record
setting monthly send out and monthly hourly peak demand volumes.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended September 30,
2003, power supply costs and related revenues increased electric net income by
$2 million from 2002.
For the nine months ended September 30, 2003, power supply costs and related
revenues increased electric net income by $14 million from 2002. This increase
is primarily the result of increased intersystem revenues due to higher market
prices and sales made from additional surplus capacity.
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Consumers Energy Company
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three months ended
September 30, 2003, net operating expenses and non-commodity revenue decreased
operating income by $5 million compared to 2002. This decrease relates primarily
to increased amortization expense from securitized assets and reduced
miscellaneous electric service revenues.
For the nine months ended September 30, 2003, operating expenses increased
compared to 2002. This increase can be attributed to storm restoration expenses,
a scheduled refueling outage at Palisades, which began on March 16, 2003 and
ended on April 20, 2003, and higher transmission costs due to the loss of a
financial return on the Consumers' transmission system asset sold in May 2002.
Slightly offsetting these increased operating expenses were increased
non-commodity revenues associated with miscellaneous service revenues.
ASSET SALES: For the nine months ended September 30, 2003, pretax income from
asset sales decreased $38 million from the comparable period in 2002. This is
the result of the $31 million pretax gain associated with the May 2002 sale of
Consumers' electric transmission system and the $7 million pretax gain
associated with the June 2002 sale of nuclear equipment from the cancelled
Midland project.
GENERAL TAXES: For the three months ended September 30, 2003, general taxes
increased $3 million compared to 2002 primarily due to larger property tax
expense from increased investment.
For the nine months ended September 30, 2003, general taxes decreased $12
million from the comparable period in 2002. This decrease is due to reduced MSBT
expenses related to the years 2000 and 2001. This is the result of CMS Energy
receiving approval to file consolidated tax returns for the years 2000 and 2001.
These returns were filed during the second quarter of 2003.
FIXED CHARGES: For the three and nine months ended September 30, 2003, fixed
charges increased $5 million and $18 million, respectively, from the comparable
period in 2002. These increases can be attributed to increased financing
activities.
INCOME TAXES: For the three and nine months ended September 30, 2003, income tax
expense decreased $16 million and $34 million, primarily due to a decrease in
earnings by the electric utility compared to 2002.
GAS UTILITY RESULTS OF OPERATIONS
In Millions
- ----------------------------------------------------------------------
September 30 2003 2002 Change
- ----------------------------------------------------------------------
Three months ended $(19) $(18) $(1)
Nine months ended $ 40 $ 13 $27
======================================================================
Three Months Ended Nine Months Ended
Reasons for change September 30, 2003 vs. 2002 September 30, 2003 vs. 2002
- --------------------------------------------------------------------------------------------------------------
Gas deliveries $ (14) $ 14
Gas rate increase 5 35
Gas wholesales and retail services 1 4
Operation and maintenance 8 (6)
General taxes, depreciation, and other income (1) (2)
Fixed charges (1) (4)
Income taxes 1 (14)
--------------------------------------------------
Total change $ (1) $ 27
==============================================================================================================
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Consumers Energy Company
GAS DELIVERIES: For the three months ended September 30, 2003, gas delivery
revenues decreased by $14 million from the previous year. The decrease primarily
reflects $7 million of increased expense associated with Consumers' annual
analysis of gas losses related to the gas transmission and distribution system.
The adjustment is recorded as a reduction to accrued gas revenues. System
deliveries, including miscellaneous transportation, totaled 38.2 bcf, a decrease
of 1.9 bcf or 4.8 percent compared with 2002.
For the nine months ended September 30, 2003, gas delivery revenues increased by
$14 million from the previous year. System deliveries, including miscellaneous
transportation, totaled 272.7 bcf, an increase of 18 bcf or 7.1 percent compared
with 2002. This increase is primarily due to colder weather during the first
quarter 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, for the three and nine months ended September 30, 2003,
Consumers recognized increased gas revenues of $5 million and $35 million,
respectively.
OPERATION AND MAINTENANCE: For the three months ended September 30, 2003,
operation and maintenance expenses decreased $8 million when compared to 2002.
This decrease reflects the absence of gas storage inventory losses recorded in
2002.
For the nine months ended September 30, 2003, operation and maintenance expenses
increased $6 million when compared to 2002. This increase reflects the
recognition of additional expenditures on safety, reliability and customer
service.
INCOME TAXES: For the three months ended September 30, 2003, income tax expense
decreased primarily due to decreased earnings of the gas utility compared to
2002.
For the nine months ended September 30, 2003, income tax expense increased
primarily due to improved earnings of the gas utility.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING, AND FINANCING
The following discussion of operating, investing and financing activities
summarizes Consumers' consolidated statements of cash flows found in Consumers'
consolidated financial statements.
OPERATING ACTIVITIES: Consumers' principal source of liquidity is cash from the
sale and transportation of natural gas and the generation, delivery and sale of
electricity. For the nine months ended September 30, cash from operations
totaled $130 million in 2003 and $420 million in 2002. The $290 million decrease
in cash from operations resulted primarily from an increase in a depleted
natural gas inventory due to colder weather and higher gas prices, an increase
in the pension contribution for 2003, and an increase in accounts receivable and
accrued revenues. 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: For the nine months ended September 30, cash used for
investing activities totaled $326 million in 2003 and $144 million in 2002. The
change of $182 million is primarily due to the absence of
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Consumers Energy Company
$283 million of proceeds from the sale of METC and other asset sales, partially
offset by a $94 million decrease in capital expenditures.
FINANCING ACTIVITIES: For the nine months ended September 30, cash provided by
financing activities totaled $103 million in 2003 and cash used for financing
activities totaled $182 million in 2002. The change of $285 million is primarily
due to an increase of $941 million in proceeds from senior notes and bank loans,
offset partially by $371 million of payments for retirement of bonds and other
long-term debt and a $271 million additional payment of notes payable. Refer
below to discussion of Consumers' refinancing.
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
September 30 Total 2003 2004 2005 2006 2007 beyond
- ------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 3,531 $ - $ 8 $ 329 $ 361 $ 31 $ 2,802
Current portion of long-
term debt 28 8 20 - - - -
Notes payable 4 1 3 - - - -
Capital lease obligations 127 4 15 14 13 12 69
- ------------------------------------------------------------------------------------------------
Total on-balance sheet $ 3,690 $ 13 $ 46 $ 343 $ 374 $ 43 $ 2,871
- ------------------------------------------------------------------------------------------------
Off-balance sheet:
Operating leases $ 76 $ 6 $ 11 $ 9 $ 9 $ 8 $ 33
Non-recourse debt of FMLP 194 - 57 41 26 13 57
Sale of accounts receivable 254 254 - - - - -
Unconditional purchase
obligations 17,897 601 1,577 1,197 905 743 12,874
- ------------------------------------------------------------------------------------------------
Total off-balance sheet $18,421 $861 $1,645 $1,247 $ 940 $ 764 $ 12,964
================================================================================================
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Consumers Energy Company
LONG-TERM FINANCINGS:
The following is a summary of Consumers' Long-Term debt issuances during 2003:
Principal
Facility Type (millions) Issue Rate Issue Date Maturity Date Use of Proceeds Collateral
- ------------------------------------------------------------------------------------------------------------
Term Loan $ 140 LIBOR + 475 March 2003 March 2009 GCP FMB (f)
bps
Term Loan 150 LIBOR + 450 March 2003 March 2006 (c) GCP FMB (f)
bps
FMB (a) 375 5.375% April 2003 April 2013 (c) -
FMB (a) 250 4.250% April 2003 April 2008 (c) -
FMB (a) 250 4.000% May 2003 May 2010 (d) -
FMB (b) 200 4.800% August 2003 February 2009 (e) -
FMB (b) 200 6.000% August 2003 February 2014 (e) -
------
Total $1,565
============================================================================================================
(GCP - General Corporate Purposes) (bps - basis points)
(FMB - First Mortgage Bonds)
(a) Consumers has agreed to file a registration statement with the SEC by
December 26, 2003 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.
(b) Consumers has agreed to file a registration statement with the SEC by April
14, 2004 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.
(c) 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 included paying down additional
debt.
(d) Consumers used the net proceeds to prepay a portion of a term loan that was
due to mature in July 2004.
(e) Consumers used the net proceeds to pay off the $150 million term loan
negotiated in March 2003 that was due to mature in March 2006 as well as the
remaining $50 million balance on a term loan that was due to mature in March
2004, and for general corporate purposes.
(f) Refer to "Regulatory Authorization for Financings" below for information
about Consumers' remaining FERC debt authorization.
As part of Consumers' ongoing cost reduction measures in an attempt to reduce
its financing costs, Consumers will continue to monitor financial markets
REGULATORY AUTHORIZATION FOR FINANCINGS: At September 30, 2003, Consumers had
FERC authorization, through June 2004, to issue or guarantee up to $1.1 billion
of short-term securities outstanding at any one time. As of September 30, 2003,
Consumers had $400 million outstanding as collateral for the revolving credit
facility (discussed below) and had an additional $700 million available for
future issuances of short-term securities. At September 30, 2003, Consumers also
had remaining FERC authorization, through June 2004, to issue up to $800 million
of long-term securities for refinancing or refunding purposes, $560.3 million of
long-term securities for general corporate purposes, and $2.06 billion of
long-term first mortgage bonds to be issued solely as collateral for other
long-term securities. Also, FERC has granted waivers of its
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Consumers Energy Company
competitive bid/negotiated placement requirements applicable to the 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.
In September 2003, this facility was amended and restated as a $400 million
revolving credit facility. The interest rate of the facility was reduced from
LIBOR plus 350 to LIBOR plus 175 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. At September 30, 2003, all of the $400
million is available for general corporate purposes.
The revolving credit facility mentioned above has contractual restrictions that
require Consumers to maintain, as of the last day of each fiscal quarter, the
following:
Limitation Ratio at September 30, 2003
- --------------------------------------------------------------------------------------------------
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.58 to 1.00
Interest Coverage Ratio - Revolver (a) Not less than 2.00 to 1.00 3.34 to 1.00
==================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility that provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of securitization
bonds in the calculation of the debt to capital ratio.
Consumers is subject to covenants in its financing agreements that could limit
its ability to incur additional indebtedness. Consumers has agreed in several of
its financing agreements to maintain specified levels of cash coverage of its
interest requirements and to not allow its indebtedness to exceed specified
levels of its consolidated capitalization (the "Debt Percentage Tests").
Consumers is in compliance with these requirements as of the most recent
measurement date, September 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. Consumers sought and received amendments to
certain of its financing agreements to modify the terms of the Debt Percentage
Tests in order to, among other things, remove the effect of the adoption of SFAS
No. 150, portions of which have now been deferred indefinitely, regarding Trust
Preferred Securities on the calculations.
Under the provisions of its articles of incorporation, Consumers had $412
million of unrestricted retained earnings available to pay common dividends at
September 30, 2003. However, covenants in Consumers' debt facilities cap common
stock dividend payments at $300 million in a calendar year. Through September
30, 2003, Consumers paid $162 million in common dividends. In October 2003,
Consumers declared a $57 million common dividend payable in November 2003.
For information on the potential cap on common dividends payable included in the
MPSC Securitization order see Electric Business Outlook, "Competition and
Regulatory Restructuring - Securitization." Also, for information on the
potential cap on common dividends payable included in the MPSC Staff's
recommendation in Consumers' 2003 gas rate case see Gas Business Outlook, "2003
Gas Rate Case."
LEASES: Consumers' capital leases are predominately for leased service vehicles
and the new headquarters building. On November 7, 2003, Consumers closed a
three-year $60 million term loan at an interest rate of LIBOR plus 135 basis
points. The term loan is secured by first mortgage bonds. The proceeds of the
loan were used to purchase Consumers' headquarters building lease from the
lessor, resulting in cost savings to Consumers. 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
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Consumers Energy Company
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: Under a revolving accounts receivable sales
program, Consumers currently sells certain accounts receivable to a wholly
owned, consolidated, bankruptcy remote special purpose entity, Consumers
Receivables Funding II. In turn, Consumers Receivables Funding II may sell an
undivided interest in up to $325 million of the receivables to a bank-sponsored
commercial paper conduit. The amount sold to the conduit was $254 million at
September 30, 2003 and $325 million at September 30, 2002. These amounts are
excluded from accounts receivable in Consumers' consolidated balance sheets.
Consumers continues to service the receivables sold; however, the purchaser of
the receivables has no recourse against Consumers' other assets for failure of a
debtor to pay when due and the purchaser has no right to any receivables not
sold. No gain or loss has been recorded on the receivables sold and Consumers
retains no interest in the receivables sold.
UNCONDITIONAL PURCHASE OBLIGATIONS: Unconditional purchase obligations include
natural gas, electricity, and coal purchase contracts and their associated cost
of transportation. These obligations represent normal business operating
contracts used to assure adequate supply and to minimize exposure to market
price fluctuations.
Included in unconditional purchase obligations are long-term power purchase
agreements with various generating plants including the MCV Facility. These
contracts require monthly capacity payments based on the plants' availability or
deliverability. These payments are approximately $47 million per month for the
remaining three 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: 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.
Commercial Commitments In Millions
- --------------------------------------------------------------------------------
Commitment Expiration
------------------------------------------------
2008 and
September 30 Total 2003 2004 2005 2006 2007 beyond
- --------------------------------------------------------------------------------
Off-balance sheet:
Indemnities $8 $- $- $- $- $- $8
Letters of credit 7 - 7 - - - -
================================================================================
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Consumers Energy Company
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. 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, including margin calls, in connection with
maintenance of ongoing deliveries of gas and electricity. This will also affect
Consumers' liquidity position.
Historically, Consumers has 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 borrowings, reduced capital expenditures, cash flow generated
from operations, and other measures. Refer to Capital Resources and Liquidity,
"Long Term Debt" above for information about Consumers' 2003 debt financings.
Consumers believes that its present level of cash and borrowing capacity
(assuming access to capital markets), along with anticipated cash flows from
operating and investing activities, will be sufficient to meet its liquidity
needs through 2004.
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 experienced higher electric deliveries in 2002 as a result
of warmer than normal summer weather. For 2003, a slight decline in electric
deliveries from 2002 is anticipated. This short-term outlook for 2003 assumes
higher levels of manufacturing activity than in 2002 and normal weather
conditions in the last three months of the year.
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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 Consumers' 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 October
2003, alternative electric suppliers are providing 603 MW of generation supply
to retail open access 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 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. According to the MPSC, "net"
Stranded Costs are 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. Consumers in its hearing brief, filed
in August 2002, revised its request for Stranded Costs to $7 million for 2000
and $4 million for 2001. 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. As discussed below in
"Securitization", Consumers 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.
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to resolve numerous
issues regarding the "net" Stranded Cost methodology in a way 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 have also filed rehearing
petitions with the MPSC. Consumers has also initiated an appeal at the Michigan
Court of Appeals related to the MPSC's December 2001 "net" Stranded Cost order.
In March 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 Palisades expenditures
previously not securitized were approved as proposed in its securitization case
as discussed below in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 would be 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.
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Consumers Energy Company
In June 2003, the MPSC issued a financing order in the securitization case,
authorizing the issuance of Securitization bonds in the amount of approximately
$554 million. Included in this amount were Clean Air Act expenditures. However,
the MPSC rejected Palisades expenditures previously not securitized as eligible
securitized costs. As a result, the Palisades expenditures previously not
securitized should be included as a component of "net" Stranded Costs and will
be included as a component of a future electric rate case proceeding with the
MPSC. With the inclusion of the Palisades expenditures previously not
securitized, Consumers' "net" Stranded Costs incurred in 2002 are estimated to
be approximately $50 million.
In July 2003, Consumers filed a petition for rehearing and clarification on a
number of features in the MPSC's financing order on securitization. Once a final
financing order by the MPSC on securitization is issued, the amount of
Consumers' request for "net" Stranded Cost recovery for 2002 will be known.
Consumers cannot predict how the MPSC will rule on its request for the
recoverability of Stranded Costs, and therefore Consumers 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 has participated in this collaborative process. In July 2003, the
staff suspended formal discussion while it considers possible conclusions and
recommendations.
Implementation Costs: Since 1997, Consumers has incurred significant electric
utility restructuring implementation costs. The following table outlines the
applications filed by Consumers with the MPSC and the status of recovery for
these costs.
In Millions
- --------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $20 $ - $15 $5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 - 8 -
2003 2002 2 2 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 order received for the year 2001, the MPSC also reserved the right to review
again the 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 September 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $16 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 is expected to begin after the rate freeze or rate cap
period has expired. As discussed below, Consumers has asked to include
implementation costs through December 31, 2000 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.
Also, Consumers is 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. In May 2003, the FERC
issued an order denying MISO's request for authorization to reimburse Consumers.
In June 2003, Consumers and MISO filed a joint petition for rehearing with the
FERC. In September 2003, the FERC denied Consumers'
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and MISO's joint request. Consumers plans to appeal the FERC ruling at the
United States Court of Appeals for the District of Columbia and pursue other
potential means of recovery. In November 2003, in conjunction with Consumers'
appeal of the September Order denying recovery, Consumers persuaded MISO to
file a request with the FERC seeking authority to reimburse METC, the legal
successor in interest to the Alliance RTO start-up costs. As part of the
contract for sale of Consumers' former transmission system, should the
Commission approve the new MISO filing, METC is contractually obligated to
flow-through to Consumers the full amount of any Alliance RTO start-up costs
that it is authorized to recover through FERC. Consumers cannot predict the
outcome of the appeal process, the MISO request, or the amount of implementation
costs, if any; the FERC ultimately will allow to be collected.
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. The application sought recovery of costs associated with Clean
Air Act expenditures, Palisades expenditures previously not securitized, retail
open access implementation costs through December 31, 2003, certain pension fund
costs, and expenses associated with the issuance of the bonds. In June 2003, the
MPSC issued a financing order authorizing the issuance of Securitization bonds
in the amount of approximately $554 million. This amount relates to Clean Air
Act expenditures and associated return on those expenditures through December
31, 2002, retail open access implementation costs and previously authorized
return on those expenditures through December 31, 2000, and the "up front" other
qualified costs related to issuance of the Securitization bonds. The MPSC
rejected Palisades expenditures previously not securitized as eligible
securitized costs. Therefore, Palisades expenditures previously not securitized
should be included as a component of "net" Stranded Costs and will be included
as a component of a future electric rate case proceeding with the MPSC.
In the June 2003 financing order, the MPSC also adopted a rate design that would
allow retail open access customers to pay a securitization charge (and related
tax charge) that are a small fraction of the amounts paid by full service
bundled sales customers and special contract customers of the utility. The
financing order provides that the securitization charges (and related tax
charges) for the full service and bundled sales customers are increased under
the rate design in the financing order in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the Securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers to its "earnings." In July 2003, Consumers
filed for rehearing and clarification on a number of features in the financing
order, including the rate design, accounting treatment of unsecuritized
qualified costs and dividend restriction. Also in July 2003, the Attorney
General filed a claim of appeal related to the financing order and the Attorney
General indicated it would challenge the lawfulness of the rate design. In
October 2003, the Court of Appeals dismissed the appeal and indicated that the
Attorney General could resubmit the appeal after the MPSC acted on Consumers'
rehearing request. Subsequently, the Attorney General filed a motion of
rehearing asking for reconsideration of the Court of Appeals' dismissal. The
financing order will become effective after rehearing, resolution of appeals and
upon acceptance by Consumers.
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. After December 31, 2003,
the statute would allow customers to petition the MPSC for rate reductions below
the cap. Consumers would have the opportunity to respond to such a petition
before rates could be reduced.
As a result of Consumers meeting the transmission capability expansion
requirements and the market power test, as discussed in Note 2, Uncertainties,
"Electric Rate Matters - Electric Restructuring", Consumers has met the
requirements under Public Act 141 to return to the PSCR process. On September
30, 2003, Consumers submitted a PSCR filing to the MPSC that would reinstate the
PSCR process for customers whose rates will no longer be frozen or capped as of
January 1, 2004. The proposed PSCR charge allows Consumers
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Consumers Energy Company
to recover a portion of its increased power supply costs from large commercial
and industrial customers effective January 1, 2004. This is the first customer
class for which the rate freeze and cap expire. Consumers will, pursuant to its
right under applicable law, self-implement the proposed PSCR charge on January
1, 2004, unless the MPSC issues an order before that date establishing a
different charge. The charge is subject to subsequent change by the MPSC during
the PSCR period (calendar-year 2004). The revenues received pursuant to the PSCR
charge by statute are also subject to subsequent reconciliation when the year is
finished and actual costs have been reviewed for reasonableness and prudence.
Consumers cannot predict the outcome of this filing.
Included in Consumers' retail electric customers' frozen rates is a nuclear
decommissioning surcharge related to the decommissioning of Big Rock. The MPSC
authorized collection of the surcharge through December 2000. Consumers has
continued to collect the Big Rock nuclear decommissioning surcharge consistent
with the provisions of the Customer Choice Act rate freeze in effect through
December 31, 2003. Beginning in January 2004, the Big Rock decommissioning
surcharge will be eliminated, reducing Consumers' annual electric revenues by
approximately $35 million in 2004. A portion of this reduction is expected to be
offset by the collection of increased PSCR revenues.
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, totaling a maximum of approximately 685 MW of load, as part
of its phased introduction to competition. Unless terminated or restructured,
the majority of these contracts are in effect through 2005. As of September 30,
2003, contracts for 200 MW of load have terminated. Of the contracts that have
terminated, contracts for 64 MW have gone to an alternative electric supplier,
and contracts for 136 MW have returned to bundled tariff rates. Consumers cannot
predict the ultimate financial impact of changes related to these power supply
contracts, or whether additional special contracts will be necessary or
advisable.
Code of Conduct: In December 2000, as a result of the passage of the Customer
Choice Act, the MPSC issued a new code of conduct that applies to electric
utilities and alternative electric suppliers. The code of conduct seeks to
prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and 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. In November
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
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Consumers Energy Company
Michigan Court of Appeals struck down the guidelines 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. In July 2003, legislation was
introduced in the Michigan legislature that, if enacted, would clarify the
application of the code of conduct in a manner that would allow Consumers to
continue to offer the appliance service plan. In October 2003, the Michigan
Senate passed legislation to preserve the appliance service plan. The House of
Representatives of Michigan is scheduled to review the legislation in early
2004; however, in the interim they passed a bill to extend the MPSC's waiver for
the program to July 1, 2004.
Energy Policy: Uncertainty exists regarding the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills that have been introduced in the
United States Congress in recent years were designed to change existing federal
regulation of the industry. If the federal government enacts a comprehensive
energy policy, then that legislation could potentially affect company operations
and financial requirements.
Transmission: In May 2002, Consumers sold its electric transmission system for
approximately $290 million to MTH, a non-affiliated limited partnership whose
general partner is a subsidiary of Trans-Elect, Inc. The pretax gain was $31
million ($26 million, net of tax). Remaining open issues are not expected to
substantially impact the amount of the gain.
As a result of the sale, Consumers anticipates its after-tax earnings will
decrease 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 until May 1, 2007 under a
contract with MTH.
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Consumers Energy Company
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.
August 14, 2003 Blackout: On August 14, 2003, the electric transmission grid
serving parts of the Midwest and the Northeast experienced a significant
disturbance, which impacted electric service to millions of homes and businesses
throughout a vast region. In Michigan, more than 2 million electric customers
were without electricity. Consumers had five fossil-fueled generating unit
outages and, of Consumers' 1.7 million electric customers, approximately
100,000 were without power for approximately 24 hours as a result of the
disturbance. The impact was felt most heavily in the southeastern part of
Consumers' service territory.
As discussed above in "Transmission", Consumers sold its electric transmission
system in May 2002 to MTH, with Consumers providing transmission system
maintenance under a five-year contract with MTH. MTH now owns, controls, and
plans for the transmission system that serves Consumers. Consumers incurred
approximately $1 million of immediate financial impact as a result of the
blackout. Consumers continues to cooperate with investigations of the blackout
by several federal and state agencies. Consumers cannot predict the outcome of
these investigations.
In November 2003, the MPSC released its report on the August 14, 2003 blackout,
which found no evidence to suggest that the events in Michigan or actions taken
by the Michigan utilities or transmission operators were factors contributing to
the cause of the blackout. As a result of its investigation, the MPSC is
recommending that Congress pass legislation that would empower the FERC, where
necessary, to order membership into a RTO and that Congress should provide the
FERC with the authority to develop and enforce mandatory transmission
reliability standards with penalties for noncompliance.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards for Consumers and other Michigan electric distribution
utilities. The proposal would establish standards related to restoration after
an outage, safety, and customer relations. Failure to meet the standards would
result in customer bill credits. Consumers submitted comments to the MPSC. In
December 2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards. In November
2002, the MPSC issued an order initiating the formal rulemaking proceeding.
Consumers has filed comments on the proposed rules and will continue to
participate in this process. Consumers cannot predict the nature of the proposed
standards or the likely effect, if any, on Consumers.
For further information and material changes relating to the rate matters and
restructuring of the electric utility industry, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, and Note 2, Uncertainties,
"Electric Rate Matters - Electric Restructuring" and "Electric Rate Matters -
Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
the need to make additional capital expenditures and increase operating expenses
for Clean Air Act compliance; 3) environmental liabilities arising from various
federal, state and local environmental laws and regulations, including potential
liability or expenses relating to the Michigan Natural Resources and
Environmental Protection Acts and Superfund; 4) pending litigation filed by
PURPA qualifying facilities; 5) uncertainties relating to the storage and
ultimate disposal of spent nuclear fuel; 6) electric industry restructuring
issues, including those described above; 7) 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; 8) the recovery of electric restructuring implementation costs;
9) Consumers' status as an electric transmission customer and not as an electric
transmission owner/operator; 10) sufficient reserves for transmission rate
refunds; 11) the effects of derivative accounting and potential earnings
volatility; 12) increased costs for safety and homeland security initiatives
that are not recoverable on a timely basis from customers; 13) potentially
rising pension costs due to market losses and lump sum payments (as discussed
above in Accounting for Pension and OPEB); 14) Consumers' ability to recover any
of its "net" Stranded costs under the regulatory policies being followed by the
MPSC; 15) the effects of lost electric supply load from retail open access and
the recovery of associated margin loss; 16) the uncertain effects, including
exposure to liability, increased regulatory requirement and new legislation, due
to the future conclusions about the causes of the August 14, 2003 blackout. For
further information about these trends or uncertainties, see Note 2,
Uncertainties.
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Consumers Energy Company
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,
the level of natural gas consumption per customer, and the recent significant
increases in gas commodity prices.
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation case with the MPSC, Consumers expects to recover all of its gas
costs. In June 2003, Consumers filed a reconciliation of GCR costs and revenues
for the 12-months ended March 2003. Consumers proposes to recover from its
customers a net under-recovery of approximately $6 million using a roll-in
methodology. The roll-in methodology incorporates the under-recovery in the GCR
factor charged in the next GCR year. The roll-in tariff provision was approved
by the MPSC in a November 2002 order.
In July 2003, the MPSC approved a settlement agreement authorizing Consumers to
increase its gas cost recovery factor for the remainder of the current GCR plan
year (August 2003 through March 2004) and to implement a quarterly ceiling price
adjustment mechanism, based on a formula that tracks changes in NYMEX natural
gas prices. Consistent with the terms of the settlement, the ceiling price is
$6.11 per mcf. However, Consumers will utilize a GCR factor of $5.41 per mcf
commencing in November 2003 bills. All recoveries pursuant to such factors are
subject to final reconciliation by the MPSC.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. In November 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 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: In March 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 return on equity, based on a 2004 test year.
Contemporaneously with this filing, Consumers has requested interim rate relief
in the same amount. In August 2003, the MPSC Staff recommended interim rate
relief of $80 million be granted in this proceeding, subject to Consumers
voluntarily agreeing to limit its dividends to its parent, CMS Energy, to a
maximum of $190 million in any calendar year.
In September 2003, Consumers filed an update to its gas rate case that lowered
the requested revenue increase from $156 million to $139 million and revised the
return on common equity from 13.5 percent to 12.75 percent. The majority of the
reduction is related to lower debt costs and changes in the projected capital
structure. The MPSC Staff and ABATE filed their cases in early October. The
Staff made no change to its interim position of $80 million and continued to
propose the same dividend limitation. ABATE did not make a specific
recommendation for a final rate increase, but did discuss the rate design used
to recover any rate increase granted. A proposal for decision is expected from
the administrative law judge in January 2004.
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
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Consumers Energy Company
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) an inadequate regulatory response to applications for requested
rate increases; 5) market and regulatory responses to increases in gas costs,
including a reduced average consumption per residential customer; 6) increase in
costs for pipeline integrity, safety, and homeland security initiatives that are
not recoverable on a timely basis from customers; 7) potentially rising pension
costs due to market losses and lump sum payments (as discussed above in
Accounting for Pension and OPEB); and 8) potential adverse appliance service
plan ruling or related legislation. For further information about these
uncertainties, see Note 2, Uncertainties.
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 September 30, 2003,
Consumers has incurred approximately $7 million in incremental security costs,
including operating, capital, and decommissioning and removal costs, mainly
relating to its nuclear facilities. Consumers estimates it may incur additional
incremental security costs for the last three months of 2003 of approximately $3
million, of which $2 million relates to nuclear security costs. 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. In February 2003, the MPSC adopted filing requirements for
the recovery of enhanced security costs.
LITIGATION AND REGULATORY INVESTIGATIONS
SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading transactions by
CMS MST, CMS Energy's Board of Directors established a Special Committee 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. Previously, CMS Energy
terminated its speculative trading business and revised its risk management
policy. The Board of Directors adopted, and CMS Energy has implemented the
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 45 days that they have taken certain specified remedial measures with
respect to the reporting of natural gas trading data to publications that
compile and
CE-27
Consumers Energy Company
publish price indices. CMS MST made a written submission to the FERC on June 11,
2003 in compliance with the FERC's directives. On July 29, 2003, the FERC issued
an order stating that CMS MST met the requirements of the FERC's April 30, 2003
order. 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 by shareholders who allege that they purchased
CMS Energy's securities during a purported class period. The cases were
consolidated into a single lawsuit and an amended and a consolidated class
action complaint was filed on May 1, 2003. The consolidated complaint contains a
purported class period beginning on May 1, 2000 and running through March 31,
2003. It generally 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, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. The companies intend to defend
vigorously against this action but cannot predict the outcome of this
litigation.
ERISA LAWSUITS: Consumers is a named defendant, along with CMS Energy, CMS MST
and certain named and unnamed officers and directors, in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
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 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 CMS Energy Common Stock held in
the plan. Plaintiffs also seek other equitable relief and legal fees. These
cases will be defended vigorously. Consumers cannot predict the outcome of this
litigation.
OTHER MATTERS
CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES: Consumers' management, with the
participation of its CEO and CFO, has evaluated the effectiveness of Consumers'
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of the end of the period covered by
this report. Based on such evaluation, Consumers' CEO and CFO have concluded
that, as of the end of such period, Consumers' disclosure controls and
procedures are effective.
INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes in
Consumers' internal control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter
to which this report relates that have materially affected, or are reasonably
likely to materially affect, Consumers' internal control over financial
reporting.
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Consumers Energy Company
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 also may 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. In October
2003, a final rule was issued by FERC. The rule will require Consumers, as a
FERC-regulated company, to file its cash management agreements with the FERC and
to notify the FERC within 45 days after the end of each calendar quarter when
their proprietary capital ratio drops below 30 percent, and when it subsequently
returns to or exceeds 30 percent. The rule also requires certain information
about cash management agreements and transactions to be maintained. The rule
becomes effective in late November 2003. Consumers operates its cash management
program independent of CMS Energy and, therefore, does not anticipate additional
reporting requirements as a result of this final rule.
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES: Issued by the FASB in April 2003, this statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement is effective for contracts
entered into or modified after June 30, 2003. Implementation of this statement
has not had an impact on Consumers' consolidated financial statements.
SFAS NO. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS
OF BOTH LIABILITIES AND EQUITY: Issued by the FASB in May 2003, this statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. The
statement requires an issuer to classify financial instruments within its scope
as liabilities. Those instruments were previously classified as mezzanine
equity. SFAS No. 150 became effective July 1, 2003.
Consumers has four trust preferred securities outstanding as of September 30,
2003. The trust preferred securities are issued by consolidated subsidiaries of
Consumers. Each trust holds a subordinated debenture from Consumers. The terms
of the debentures are identical to those of the trust preferred securities,
except that the debenture has an explicit maturity date. The trust documents, in
turn, require that the trust be liquidated upon the repayment of the debenture.
The trust preferred securities are redeemable upon the liquidation of the
subsidiary; and therefore, are considered equity in the financial statements of
the subsidiary.
At their October 29, 2003 Board meeting, the FASB deferred the implementation of
the portion of SFAS No. 150 relating to mandatorily redeemable noncontrolling
interests in subsidiaries when the noncontrolling interests are classified as
equity in the financial statements of the subsidiary. Consumers' trust preferred
securities are included under the deferral. As such, the Consumers trust
preferred securities continue to be accounted for under existing accounting
guidance and are included in mezzanine equity. Consumers continues to study the
FASB developments regarding the SFAS No. 150 deferral.
CE-29
Consumers Energy Company
EITF ISSUE NO. 01-08, DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE: In
May 2003, the EITF reached consensus in EITF Issue No. 01-08 to clarify the
requirements of identifying whether an arrangement should be accounted for as a
lease at its inception. The guidance in the consensus is designed to mandate
reporting revenue as rental or leasing income that otherwise would be reported
as part of product sales or service revenue. EITF Issue No. 01-08 requires both
parties to an arrangement to determine whether a service contract or similar
arrangement is or includes a lease within the scope of SFAS No. 13, Accounting
for Leases.
Historically, Consumers has entered into power purchase and similar service
arrangements. Prospective accounting under EITF Issue No. 01-08, could affect
the timing and classification of revenue and expense recognition. Certain
product sales and service revenue and expenses may be required to be reported as
rental or leasing income and/or expenses. The consensus is to be applied
prospectively to arrangements agreed to, modified, or acquired in business
combinations in fiscal periods beginning July 1, 2003. The adoption of EITF
Issue No. 01-08 has not impacted Consumers' results of operations, cash flows,
or financial position. Consumers will evaluate new or modified contracts under
EITF Issue No. 01-08 prospectively.
ACCOUNTING STANDARDS NOT YET EFFECTIVE
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, this Interpretation requires the primary
beneficiary of a variable interest entity's activities to consolidate the
variable interest entity. The primary beneficiary is the party that absorbs a
majority of the expected losses and/or receives a majority of the expected
residual returns of the variable interest entity's activities. The consolidation
requirements of the interpretation apply immediately to variable interest
entities created after January 31, 2003. Consumers has not created any variable
interest entities in 2003. Therefore, this portion of the interpretation has no
impact on its consolidated financial statements. Public companies, whose fiscal
year is a calendar year, were originally required to implement the guidance in
this interpretation by the third quarter of 2003. However, on October 9, 2003,
the FASB issued FASB Staff Position No. 46-6, Effective Date of FASB
Interpretation No. 46, which defers implementation of FIN 46 until the fourth
quarter of 2003, for variable interest entities and potential variable interest
entities created before February 1, 2003.
If the completed analysis were to require Consumers to disclose information
about or consolidate in its financial statements, the assets, liabilities and
activities of the MCV Partnership and the First Midland Limited Partnership,
including the recognition of the debt of the MCV Partnership on Consumers'
financial statements, this could impact negatively Consumers' various financial
covenants under its financing agreements. As a result, Consumers may have to
seek amendments to the relevant financing agreements to modify the terms of
certain of these covenants in order to remove the effect of this potential
consolidation or refinance the relevant debt. As of September 30, 2003,
Consumers' investments in the MCV Partnership and in the FMLP were $404 million
and $222 million, respectively. For a further description of the nature,
purpose, size and activities of the MCV Partnership, see Note 2, Uncertainties,
Other Electric Uncertainties, "The Midland Cogeneration Venture." Consumers is
continuing to study the implementation of this interpretation and has yet to
determine the effects, if any, on its consolidated financial statements.
EITF ISSUE 03-04, ACCOUNTING FOR CASH BALANCE PENSION PLANS: In May 2003, the
EITF reached consensus in EITF Issue No. 03-04 to specifically address the
accounting for certain cash balance pension plans. EITF Issue No. 03-04
concluded that certain cash balance plans be accounted for as defined benefit
plans under SFAS No. 87, Employers' Accounting for Pensions. EITF No. 03-04
requires the use of the traditional unit credit method for the purposes of
measuring the benefit obligation and annual cost of benefits earned as opposed
to the projected unit credit method. The EITF concluded that the requirements of
this Issue be applied as of the next plan measurement date, which is December
31, 2003 for Consumers. Consumers commenced a cash balance pension plan that
covers employees hired after June 30, 2003. Consumers does account for this plan
as a defined benefit plan under SFAS No. 87. Consumers continues to evaluate the
CE-30
Consumers Energy Company
impact, if any, this Issue will have upon adoption.
STATEMENT OF POSITION, ACCOUNTING FOR CERTAIN COSTS AND ACTIVITIES RELATED TO
PROPERTY, PLANT, AND EQUIPMENT: At its September 9, 2003 meeting, the Accounting
Standards Executive Committee voted to approve the Statement of Position,
Accounting for Certain Costs and Activities Related to Property, Plant, and
Equipment. The Statement of Position is expected to be presented for FASB
clearance late in the fourth quarter of 2003 and would be applicable for fiscal
years beginning after December 15, 2004. The Accounting Standards Executive
Committee concluded that at transition, a company would have the flexibility to
adopt a property, plant and equipment component accounting policy for
transition-date property, plant and equipment accounts. The property, plant and
equipment component policy may differ from the componentization policy, if any,
previously used by the enterprise. Selecting a policy that differs from the
company's prior level of componentization at the date of adoption of the
Statement of Position would not result in any cumulative effect difference for
adopting such a policy. A company would not have to restate its pre-adoption
assets to conform with its post-adoption componentization policy. The Accounting
Standards Executive Committee concluded that companies would be required to
disclose meaningful ranges with respect to property, plant and equipment
depreciable lives. Consumers continues to evaluate the impact, if any, this
Issue will have upon adoption.
CE-31
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
In Millions
OPERATING REVENUE $ 879 $ 911 $ 3,223 $ 3,020
EARNINGS (LOSS) FROM EQUITY METHOD INVESTEES (3) 8 31 35
OPERATING EXPENSES
Operation
Fuel for electric generation 89 98 245 236
Purchased power - related parties 131 143 383 416
Purchased and interchange power 103 111 260 244
Cost of gas sold 90 20 793 528
Cost of gas sold - related parties 2 34 27 96
Other 178 182 505 487
-----------------------------------------------
593 588 2,213 2,007
-----------------------------------------------
Maintenance 41 43 149 141
Depreciation, depletion and amortization 80 77 275 256
General taxes 47 43 130 144
-----------------------------------------------
761 751 2,767 2,548
- -------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME 115 168 487 507
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates - - - 2
Accretion expense (1) (1) (5) (4)
Other, net 2 1 (3) 37
-----------------------------------------------
1 - (8) 35
- -------------------------------------------------------------------------------------------------------------------------------
INTEREST CHARGES
Interest on long-term debt 51 41 144 111
Other interest 2 5 10 16
Capitalized interest (2) (3) (7) (8)
-----------------------------------------------
51 43 147 119
- -------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 65 125 332 423
INCOME TAXES 21 41 126 140
-----------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE 44 84 206 283
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR DERIVATIVE
INSTRUMENTS, NET OF $1 AND $10 TAX EXPENSE IN 2002, RESPECTIVELY - 1 - 18
-----------------------------------------------
NET INCOME 44 85 206 301
PREFERRED STOCK DIVIDENDS - - 1 1
PREFERRED SECURITIES DISTRIBUTIONS 11 11 33 33
-----------------------------------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 33 $ 74 $ 172 $ 267
===============================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-32
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
September 30 2003 2002
- ----------------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 206 $ 301
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, depletion and amortization (includes nuclear decommissioning
of $4 and $5, respectively) 275 256
Gain on sale of METC and other assets - (38)
Deferred income taxes and investment tax credit 72 (18)
Loss on CMS Energy stock 12 -
Capital lease and other amortization 20 11
Distributions from related parties in excess of (less than) earnings 14 (20)
Cumulative effect of accounting changes - (18)
Pension contribution (172) (47)
Changes in other assets and liabilities:
Increase in inventories (335) (37)
Decrease in accounts receivable and accrued revenue 156 98
Decrease in accounts payable (39) (79)
Changes in other assets and liabilities (79) 11
------------------------
Net cash provided by operating activities 130 420
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (306) (400)
Cost to retire property, net (52) (50)
Investment in Electric Restructuring Implementation Plan (5) (6)
Investments in nuclear decommissioning trust funds (4) (5)
Proceeds from nuclear decommissioning trust funds 26 19
Proceeds from sale of METC and other assets 15 298
------------------------
Net cash used in investing activities (326) (144)
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from senior notes and bank loans, net 1,543 602
Retirement of bonds and other long-term debt (780) (409)
Decrease in notes payable, net (453) (182)
Payment of common stock dividends (162) (154)
Preferred securities distribution (33) (33)
Payment of capital lease obligations (10) (11)
Payment of preferred stock dividends (1) (1)
Restricted cash on hand (1) (14)
Redemption of preferred securities - (30)
Stockholder's contribution, net - 50
------------------------
Net cash provided by (used in) financing activities 103 (182)
- ----------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS (93) 94
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 253 13
------------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 160 $ 107
================================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 156 $ 116
Income taxes paid (net of refunds) 32 83
Pension and OPEB cash contribution 226 101
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 11 $ 50
================================================================================================================
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-33
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
ASSETS
SEPTEMBER 30 SEPTEMBER 30
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------
In Millions
PLANT (AT ORIGINAL COST)
Electric $ 7,583 $ 7,523 $ 7,504
Gas 2,841 2,719 2,692
Other 15 23 22
--------------------------------------------
10,439 10,265 10,218
Less accumulated depreciation, depletion and amortization 5,365 5,900 5,856
--------------------------------------------
5,074 4,365 4,362
Construction work-in-progress 359 548 463
--------------------------------------------
5,433 4,913 4,825
- ------------------------------------------------------------------------------------------------------------
INVESTMENTS
Stock of affiliates 17 22 19
First Midland Limited Partnership 222 255 250
Midland Cogeneration Venture Limited Partnership 404 388 370
Consumers Nuclear Services, LLC 2 2 2
--------------------------------------------
645 667 641
- ------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost,
which approximates market 160 253 107
Restricted cash 19 18 18
Accounts receivable, notes receivable and
accrued revenue, less allowances of $7, $4 and $4
respectively 81 236 36
Accounts receivable - related parties 7 13 18
Inventories at average cost
Gas in underground storage 813 486 601
Materials and supplies 72 71 71
Generating plant fuel stock 44 37 49
Deferred property taxes 88 142 82
Regulatory assets 19 19 19
Other 94 38 27
--------------------------------------------
1,397 1,313 1,028
- ------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 659 689 699
Postretirement benefits 168 185 191
Abandoned Midland Project 10 11 11
Other 257 168 173
Nuclear decommissioning trust funds 553 536 530
Other 147 218 108
--------------------------------------------
1,794 1,807 1,712
--------------------------------------------
TOTAL ASSETS $ 9,269 $ 8,700 $ 8,206
============================================================================================================
CE-34
STOCKHOLDER'S EQUITY AND LIABILITIES
SEPTEMBER 30 SEPTEMBER 30
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (Unaudited)
- ------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholder's equity
Common stock $ 841 $ 841 $ 841
Paid-in capital 682 682 682
Accumulated other comprehensive loss (191) (179) (8)
Retained earnings since December 31, 1992 555 545 525
--------------------------------------------
1,887 1,889 2,040
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred
securities of subsidiaries 490 490 490
Long-term debt 3,531 2,442 2,701
Non-current portion of capital leases 116 116 110
--------------------------------------------
6,068 4,981 5,385
- ------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 39 318 224
Notes payable 4 457 235
Accounts payable 241 261 212
Accrued taxes 84 214 152
Accounts payable - related parties 65 84 85
Deferred income taxes 23 25 18
Current portion of purchase power contract 26 26 29
Other 168 200 226
--------------------------------------------
650 1,585 1,181
- ------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Deferred income taxes 1,009 949 762
Postretirement benefits 431 563 244
Regulatory liabilities for income taxes, net 309 297 282
Asset retirement obligations 362 - -
Other regulatory liabilities 152 4 -
Deferred investment tax credit 86 91 92
Power purchase agreement - MCV Partnership 8 27 30
Other 194 203 230
--------------------------------------------
2,551 2,134 1,640
- ------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDER'S EQUITY AND LIABILITIES $ 9,269 $ 8,700 $ 8,206
============================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-35
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
September 30 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period (a) $ 841 $ 841 $ 841 $ 841
- -------------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 682 682 682 632
Stockholders' contribution - - - 150
Return of Stockholders' contribution - - - (100)
---------------------------------------------------
At end of period 682 682 682 682
- -------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (202) - (185) -
Minimum liability pension adjust (b) - - (17) -
---------------------------------------------------
At end of period (202) - (202) -
---------------------------------------------------
Investments
At beginning of period 8 (5) 1 16
Unrealized gain (loss) on investments (c) (2) (4) 5 (25)
---------------------------------------------------
At end of period 6 (9) 6 (9)
---------------------------------------------------
Derivative Instruments
At beginning of period (d) 11 (3) 5 (12)
Unrealized gain on derivative instruments (c) (4) 1 9 6
Reclassification adjustments included in
consolidated net income (loss) (c) (2) 3 (9) 7
---------------------------------------------------
At end of period 5 1 5 1
- -------------------------------------------------------------------------------------------------------------------
Total Accumulated Other Comprehensive Income (Loss) (191) (8) (191) (8)
- -------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
At beginning of period 522 480 545 441
Net income 44 85 206 301
Cash dividends declared - Common Stock - (29) (162) (183)
Cash dividends declared - Preferred Stock - - (1) (1)
Preferred securities distributions (11) (11) (33) (33)
---------------------------------------------------
At end of period 555 525 555 525
- -------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 1,887 $ 2,040 $ 1,887 $ 2,040
===================================================================================================================
CE-36
THREE MONTHS ENDED NINE MONTHS ENDED
September 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
(a) Number of shares of common stock outstanding was
84,108,789 for all periods presented.
(b) Because of the significant change in the makeup of the
pension plan due to the sale of Panhandle, SFAS No. 87 required
a remeasurement of the obligation at the date of sale. The
remeasurement resulted in an additional charge to Accumulated
Other Comprehensive Income (Loss) of approximately $27 million
($17 million after tax) as a result of the increase in the
additional minimum pension liability.
(c) Disclosue of Comprehensive Income:
Minimum pension liability adjustment (b) $ - $ - $ (17) $ -
Investments
Unrealized gain (loss) on investments, net of tax
of $-, $3, $(3) and $14, respectively (2) (4) 5 (25)
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net
of tax of $2, $(1), $(4) and $(4), respectively (4) 1 9 6
Reclassification adjustments included in net income,
net of tax of $1, $(2), $5 and $(4), respectively (2) 3 (9) 7
Net income 44 85 206 301
------------------------------------------------------------
Total Comprehensive Income $ 36 $ 85 $ 194 $ 289
============================================================
(d) Included in these amounts is Consumers' proportionate
share of the effects of derivative accounting related to its
equity investment in the MCV Partnership as follows:
At the beginning of the period $ 13 $ 1 $ 8 $ (8)
Unrealized gain (loss) on derivative instruments (5) 1 8 7
Reclassification adjustments included in net income (2) 2 (10) 5
------------------------------------------------------------
At the end of the period $ 6 $ 4 $ 6 $ 4
============================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-37
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 of a
normal recurring nature 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 subsequently ratified by the membership and became 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.
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. Consumers has used this accounting
principle to record estimated liabilities as discussed in Note 2, Uncertainties.
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. Intersegment sales and transfers are accounted for at
current market prices and are eliminated in consolidated net income available to
common stockholder by segment. The other business unit 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. The operating revenue and net income (loss) available to
common stockholder by
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reportable segment are as follows:
In Millions
- ------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------
Operating revenue
Electric $ 714 $ 775 $ 1,970 $ 2,015
Gas 164 135 1,252 1,002
Other 1 1 1 3
- ------------------------------------------------------------------------------------------------------
Total Operating Revenue $ 879 $ 911 $ 3,223 $ 3,020
======================================================================================================
Net income available to common stockholder
Electric $ 59 $ 88 $ 145 $ 222
Gas (19) (18) 40 13
Other (7) 4 (13) 32
- ------------------------------------------------------------------------------------------------------
Total Net Income $ 33 $ 74 $ 172 $ 267
======================================================================================================
FINANCIAL INSTRUMENTS: Consumers 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. 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 accumulated other comprehensive income and are 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. For further information regarding
financial instruments, see Note 4, Financial and Derivative Instruments -
Financial Instruments.
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 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. However,
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 allowed
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 5, Implementation of New Accounting Standards, "SFAS No. 143,
Accounting for Asset Retirement Obligations."
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Consumers Energy Company
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.
RESTRICTED CASH: At September 30, 2003, Consumers' restricted cash on hand
totaled $19 million. Restricted cash primarily consists of cash dedicated for
repayment of securitization bonds. It is classified as a current asset as the
payments on the related securitization bonds occur within one year.
STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS No. 148. 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 the fourth quarter of 2002, Consumers 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
option had been determined in accordance with SFAS No. 123 for the three and
nine month periods ended September 30, 2002, consolidated net income as reported
and pro forma would have been as follows:
In Millions
- ------------------------------------------------------------------------------------------------------
Three Months Ended September 30 2002
- ------------------------------------------------------------------------------------------------------
Net income, as reported $ 85
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 -
------------
Pro forma net income $ 85
======================================================================================================
In Millions
- ------------------------------------------------------------------------------------------------------
Nine Months Ended September 30 2002
- ------------------------------------------------------------------------------------------------------
Net income, as reported $ 301
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 (1)
------------
Pro forma net income $ 300
======================================================================================================
In the third quarter of 2003, Consumers granted 500,000 stock options to
employees. As a result, Consumers expensed approximately $3 million related to
the fair value of those stock options. Fair value is estimated using the Black
Scholes model, a mathematical formula used to value options traded on the
securities exchange.
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 and gas 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) pending
litigation regarding PURPA qualifying facilities; 5) electric industry
restructuring issues; 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'
status as an electric transmission customer and not as an electric transmission
owner/operator; 9) sufficient reserves for transmission rate refunds; 10)
uncertainties relating to the storage and ultimate disposal of spent nuclear
fuel; 11) the effects of derivative accounting and
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potential earnings volatility; 12) potential environmental costs at a number of
sites, including sites formerly housing manufactured gas plant facilities; 13)
future gas industry restructuring initiatives; 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; 16) increased costs for pipeline integrity and safety and
homeland security initiatives that are not recoverable on a timely basis from
customers; 17) Consumers' ability to recover any of its net stranded costs under
the regulatory policies being followed by the MPSC; 18) the effects of lost
electric supply load from retail open access and the recovery of associated
margin loss; and 19) the uncertain effects, including exposure to liability,
increased regulatory requirement and new legislation, due to the future
conclusions about the causes of the August 14, 2003 blackout.
SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading transactions by
CMS MST, CMS Energy's Board of Directors established a Special Committee 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. Previously, CMS Energy
terminated its speculative trading business and revised its risk management
policy. The Board of Directors adopted, and CMS Energy has implemented the
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 45 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 made a written submission to the FERC
on June 11, 2003 in compliance with the FERC's directives. On July 29, 2003, the
FERC issued an order stating that CMS MST met the requirements of the FERC's
April 30, 2003 order. 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 by shareholders who allege that they purchased
CMS Energy's securities during a purported class period. The cases were
consolidated into a single lawsuit and an amended and a consolidated class
action complaint was filed on May 1, 2003. The consolidated complaint contains a
purported class period beginning on May 1, 2000 and running through March 31,
2003. It generally 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, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. The companies intend to defend
vigorously against this action but cannot predict the outcome of this
litigation.
ERISA LAWSUITS: 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 was filed. Plaintiffs allege
breaches of fiduciary duties under ERISA and seek restitution on behalf of the
plan
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Consumers Energy Company
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 defended vigorously. 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. The EPA has 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 September 30, 2003, Consumers has incurred $437 million in capital
expenditures to comply with the EPA regulations and anticipates that the
remaining capital expenditures will be incurred between 2003 and 2009. 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.
Consumers expects to supplement its environmental regulation 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 substantially.
The EPA has proposed changes to the rules which govern generating plant cooling
water intake systems. The proposed rules will require significant abatement of
fish mortality. The proposed rules are scheduled to become final in the first
quarter of 2004 and some of Consumers' facilities would be required to comply by
2006. Consumers is studying the proposed rules to determine the most
cost-effective solutions for compliance. Until the method of compliance is
determined, Consumers is unable to estimate the cost of compliance with the
proposed rules.
The EPA has alleged that some utilities have incorrectly classified plant
modifications as "routine maintenance" rather than seek permits from the EPA.
Consumers has received and responded to information requests from the EPA on
this subject. Consumers believes that it has properly interpreted the
requirements of "routine maintenance". If Consumers' interpretation is
eventually found to be incorrect, it may be required to install additional
pollution controls at some or all of its coal-fired plants and could call into
question the viability of certain plants remaining in operation.
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
September 30, 2003, Consumers had accrued the minimum amount of the range for
its estimated Superfund liability.
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Consumers Energy Company
In October 1998, during routine maintenance activities, Consumers identified PCB
as a component in certain paint, grout and sealant materials at the Ludington
Pumped Storage facility. Consumers removed and replaced part of the PCB
material. Consumers has proposed a plan to deal with the remaining materials and
is awaiting a response from the EPA.
LITIGATION: In October 2003, a group of eight PURPA qualifying facilities
selling power to Consumers filed a lawsuit in Ingham County Circuit Court
against Consumers. The lawsuit alleges that Consumers incorrectly calculated the
energy charge payments made pursuant to power purchase agreements between the
qualifying facilities and Consumers. More specifically, the lawsuit alleges that
Consumers should be basing the energy charge calculation on the cost of more
expensive eastern coal, rather than on the cost of the coal actually burned by
Consumers for use in its coal-fired generating plants. Consumers believes it has
been performing the calculation in the manner prescribed by the power purchase
agreements, and has filed a request with the MPSC (as a supplement to the PSCR
plan) that asks the MPSC to review this issue and to confirm that Consumers'
method of performing the calculation is correct. Also, Consumers has filed a
motion to dismiss the lawsuit in the Ingham County Circuit Court due to the
pending request at the MPSC in regard to the PSCR plan case. Although only eight
qualifying facilities have currently raised the issue, the same energy charge
methodology is used in the PPA with the MCV Partnership and in approximately 20
additional power purchase agreements with Consumers, representing approximately
1,670 MW of electric capacity. Consumers cannot predict the outcome of this
litigation.
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 Securitization bonds to refinance qualified costs, as
defined by the act; 5) establishes a market power supply test that if not met
may require transferring control of generation resources in excess of that
required to serve firm retail sales requirements (In September 2003, the MPSC
issued an order finding 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. (In
July 2002, the MPSC issued an order approving the plan to achieve the increased
transmission capacity. The MPSC found that once the planned projects were
completed and verification was submitted, a utility was in technical compliance.
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.); 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.
Under Public Act 141, Consumers currently offers standby generation services to
certain retail open access customers. The obligation to offer this service does
not extend beyond the later of December 31, 2001 or the date the MPSC finds that
Consumers complies with the market power test set forth in the Customer Choice
Act and has completed the projects necessary to meet Consumers', Detroit
Edison's and American Electric Power's obligation to jointly expand their
available transmission capability by at least 2,000 MW. As stated above, in
September 2003, the MPSC issued an order finding that Consumers is in compliance
with the market power test and in December 2002, Consumers filed verification
with the MPSC indicating that Consumers met the
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Consumers Energy Company
transmission capability expansion requirements. As a result, Consumers filed a
notice with the MPSC indicating that it was terminating retail open access
standby service on December 31, 2003. Also, as a result of Consumers meeting the
transmission capability expansion requirements and the market power test,
Consumers has met the requirements under Public Act 141 to return to the PSCR
process. For further discussion on the PSCR process see, "Power Supply Costs" in
this Note.
The rate-freeze imposed by Public Act 141 ends at December 31, 2003. After that
date, the statute would allow customers to petition the MPSC for rate reductions
below the cap. Consumers would have the opportunity to respond to such a
petition before rates could be reduced.
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 (as noted below in "Power Supply Costs"
in this Note, 603 MW of load is currently being served by 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 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 late 2001. Securitization
resulted in lower interest costs and a longer amortization period for the
securitized assets, and offset 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.
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 and cap period expire and an electric rate case is processed.
Securitization charge collections, $37 million for the nine months ended
September 30 2003, and $39 million for the nine months ended September 30, 2002,
are remitted to a trustee for the Securitization bonds. Securitization charge
collections are dedicated to the repayment of the principal and interest on the
Securitization bonds and payment
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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. The
application sought recovery of costs associated with Clean Air Act expenditures,
Palisades expenditures previously not securitized, retail open access
implementation costs through December 31, 2003, certain pension fund costs, and
expenses associated with the issuance of the bonds. In June 2003, the MPSC
issued a financing order authorizing the issuance of Securitization bonds in the
amount of approximately $554 million. This amount relates to Clean Air Act
expenditures and associated return on those expenditures through December 31,
2002, retail open access implementation costs and previously authorized return
on those expenditures through December 31, 2000, and the "up front" other
qualified costs related to issuance of the Securitization bonds. The MPSC
rejected Palisades expenditures previously not securitized as eligible
securitized costs. Therefore, Palisades expenditures previously not securitized
should be included as a component of "net" Stranded Costs and will be included
as a component of a future electric rate case proceeding with the MPSC.
In the June 2003 financing order, the MPSC also adopted a rate design that would
allow retail open access customers to pay a securitization charge (and related
tax charge) that are a small fraction of the amounts paid by full service
bundled sales customers and special contract customers of the utility. The
financing order provides that the securitization charges (and related tax
charges) for the full service and bundled sales customers are increased under
the rate design in the financing order in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the Securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers to its "earnings." In July 2003, Consumers
filed for rehearing and clarification on a number of features in the financing
order, including the rate design, accounting treatment of unsecuritized
qualified costs and dividend restriction. Also in July 2003, the Attorney
General filed a claim of appeal related to the financing order and the Attorney
General indicated it would challenge the lawfulness of the rate design. In
October 2003, the Court of Appeals dismissed the appeal and indicated that the
Attorney General could resubmit the appeal after the MPSC acted on Consumers'
rehearing request. Subsequently, the Attorney General filed a motion of
rehearing asking for reconsideration of the Court of Appeals' dismissal. The
financing order will become effective after rehearing, resolution of appeals and
upon acceptance by Consumers.
ELECTRIC PROCEEDINGS: Stranded 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. According to
the MPSC, "net" Stranded Costs are 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. Consumers in its hearing brief, filed
in August 2002, revised its request for Stranded Costs to $7 million for 2000
and $4 million for 2001. 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. As discussed above in
"Securitization", Consumers 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.
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Consumers Energy Company
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to resolve numerous
issues regarding the "net" Stranded Cost methodology in a way 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 have also filed rehearing
petitions with the MPSC. Consumers has also initiated an appeal at the Michigan
Court of Appeals related to the MPSC's December 2001 "net" Stranded Cost order.
In March 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 Palisades expenditures,
previously not securitized, were approved as proposed in its securitization case
as discussed above in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 would be 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.
In June 2003, the MPSC issued a financing order in the securitization case,
authorizing the issuance of Securitization bonds in the amount of approximately
$554 million. Included in this amount were Clean Air Act expenditures. However,
the MPSC rejected Palisades expenditures previously not securitized as eligible
securitized costs. As a result, the Palisades expenditures previously not
securitized should be included as a component of "net" Stranded Costs and will
be included as a component of a future electric rate case proceeding with the
MPSC. With the inclusion of the Palisades expenditures previously not
securitized, Consumers' "net" Stranded Costs incurred in 2002 are estimated to
be approximately $50 million.
In July 2003, Consumers filed a petition for rehearing and clarification on a
number of features in the MPSC's financing order on securitization. Once a final
financing order by the MPSC on securitization is issued, the amount of
Consumers' request for "net" Stranded Cost recovery for 2002 will be known.
Consumers cannot predict how the MPSC will rule on its request for the
recoverability of Stranded Costs, and therefore Consumers 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 has participated in this collaborative process. In July 2003, the
staff suspended formal discussion while it considers possible conclusions and
recommendations.
Implementation Costs - Since 1997, Consumers has incurred significant electric
utility restructuring implementation costs. The following table outlines the
applications filed by Consumers with the MPSC and the status of recovery for
these costs.
In Millions
- ------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- ------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 - 8 -
2003 2002 2 2 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 order received for the year 2001, the MPSC also reserved the right to review
again the implementation costs depending upon the progress and success of the
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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 September 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $16 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 is expected to begin after the rate freeze or rate cap
period has expired. As discussed above, Consumers has asked to include
implementation costs through December 31, 2000 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.
Also, Consumers is 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. In May 2003, the FERC
issued an order denying MISO's request for authorization to reimburse Consumers.
In June 2003, Consumers and MISO filed a joint petition for rehearing with the
FERC. In September 2003, the FERC denied Consumers' and MISO's joint request.
Consumers plans to appeal the FERC ruling at the United States Court of Appeals
for the District of Columbia and pursue other potential means of recovery. In
November 2003, in conjunction with Consumers' appeal of the September Order
denying recovery, Consumers persuaded MISO to file a request with the FERC
seeking authority to reimburse METC, the legal successor in interest to the
Alliance RTO start-up costs. As part of the contract for sale of Consumers'
former transmission system, should the Commission approve the new MISO filing,
METC is contractually obligated to flow-through to Consumers the full amount of
any Alliance RTO start-up costs that it is authorized to recover through FERC.
Consumers cannot predict the outcome of the appeal process, the MISO request or
the amount of implementation costs, if any; the FERC ultimately will allow to be
collected.
Transmission Rates - 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 final FERC
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 and Detroit Edison used the same rates for JOATT transmission rates.
Approval of the JOATT transmission rates application is pending FERC approval.
Consumers believes its reserve is sufficient to satisfy its refund obligation
under current rate applications. As of October 2003, Consumers has paid $27
million in refunds. In October 2003, Consumers filed with FERC its formal notice
of cancellation of its transmission tariffs since Consumers no longer has any
transmission customers.
TRANSMISSION: In May 2002, Consumers sold its electric transmission system for
approximately $290 million to MTH, a non-affiliated limited partnership whose
general partner is a subsidiary of Trans-Elect, Inc. The pretax gain was $31
million ($26 million, net of tax). Remaining open issues are not expected to
materially impact the amount of the gain.
As a result of the sale, Consumers anticipates its after-tax earnings will
decrease 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 until May 1, 2007 under a
contract with MTH.
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AUGUST 14, 2003 BLACKOUT: On August 14, 2003, the electric transmission grid
serving parts of the Midwest and the Northeast experienced a significant
disturbance, which impacted electric service to millions of homes and businesses
throughout a vast region. In Michigan, more than 2 million electric customers
were without electricity. Consumers had five fossil-fueled generating unit
outages and, of Consumers' 1.7 million electric customers, approximately
100,000 were without power for approximately 24 hours as a result of the
disturbance. The impact was felt most heavily in the southeastern part of
Consumers' service territory.
As discussed above in "Transmission", Consumers sold its transmission system in
May 2002 to MTH, with Consumers providing transmission system maintenance under
a five-year contract with MTH. MTH now owns, controls, and plans for the
transmission system that serves Consumers. Consumers incurred approximately $1
million of immediate financial impact as a result of the blackout. Consumers
continues to cooperate with investigations of the blackout by several federal
and state agencies. Consumers cannot predict the outcome of these
investigations.
In November 2003, the MPSC released its report on the August 14 blackout, which
found no evidence to suggest that the events in Michigan or actions taken by the
Michigan utilities or transmission operators were factors contributing to the
cause of the blackout. As a result of its investigation, the MPSC is
recommending that Congress pass legislation that would empower the FERC, where
necessary, to order membership into a RTO and that Congress should provide the
FERC with the authority to develop and enforce mandatory transmission
reliability standards with penalties for noncompliance.
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. As it did in 2003, Consumers is currently planning for a
reserve margin of approximately 11 percent for summer 2004 or supply resources
equal to 111 percent of projected summer peak load. Of the 111 percent,
approximately 100 percent is expected to be met from owned electric generating
plants and long-term power purchase contracts and 11 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 October 2003, alternative
electric suppliers are providing 603 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.
Currently, Consumers is required to provide backup service to ROA customers on a
"best efforts" basis. In October 2003, Consumers provided notice to the MPSC
that it would terminate the provision of backup service in accordance with
Public Act 141, effective January 1, 2004.
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 September 30, 2003, Consumers purchased capacity and energy
contracts partially covering the estimated reserve margin requirements for 2004
through 2007. As a result, Consumers has a recognized asset of $21 million for
unexpired capacity and energy contracts. The total premium cost of electricity
call option and capacity and energy contracts for 2003 is expected to be
approximately $10 million.
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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, effective 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.
On September 30, 2003, Consumers submitted a PSCR filing to the MPSC that would
reinstate the PSCR process for customers whose rates will no longer be frozen or
capped as of January 1, 2004. The proposed PSCR charge allows Consumers to
recover a portion of its increased power supply costs from large commercial and
industrial customers effective January 1, 2004. This is the first customer class
for which the rate freeze and cap expire. Consumers will, pursuant to its right
under applicable law, self-implement the proposed PSCR charge on January 1,
2004, unless the MPSC issues an order before that date establishing a different
charge. The charge is subject to subsequent change by the MPSC during the PSCR
period (calendar-year 2004). The revenues received pursuant to the PSCR charge
by statute are also subject to subsequent reconciliation when the year is
finished and actual costs have been reviewed for reasonableness and prudence.
Consumers cannot predict the outcome of this filing.
OTHER ELECTRIC UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990 and to supply electricity and steam to Dow. Consumers,
through two wholly owned subsidiaries, holds the following assets related to the
MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general
partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through
FMLP, a 35 percent lessor interest in the MCV Facility.
Consumers' consolidated retained earnings include undistributed earnings from
the MCV Partnership, which at September 30, 2003 and 2002 are $238 million and
$217 million, respectively.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------
Earnings (loss) from equity method investees $ (3) $ 8 $ 31 $ 35
Operating taxes and other (1) 2 18 11
----------------------------------------
Income (loss) before cumulative effect of accounting change (2) 6 13 24
Cumulative effect of change in method of accounting for
derivatives, net of $1 and $10 million tax expense in 2002 (a) - 1 - 18
----------------------------------------
Net income (loss) $ (2) $ 7 $ 13 $ 42
================================================================================================================
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Summarized Statements of Income for the MCV Partnership
In Millions
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Operating revenue $148 $156 $443 $451
Operating expenses 138 120 322 318
-------------------------------------------
Operating income 10 36 121 133
Other expense, net 25 27 82 86
-------------------------------------------
Income (loss) before cumulative effect of accounting change (15) 9 39 47
Cumulative effect of change in method of accounting for
derivative option contracts (a) - - - 58
-------------------------------------------
Net income (loss) $(15) $ 9 $ 39 $ 105
===================================================================================================================
(a) On April 1, 2002, the MCV Partnership implemented Derivative Implementation
Group Issue C-16, an interpretation of SFAS No. 133. The MCV Partnership began
accounting for several natural gas contracts containing an option component at
fair value. As a result, a cumulative effect adjustment for the change in
accounting principle was recorded as an increase to earnings.
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. The remaining estimated future PPA liability associated with the
loss totaled $34 million at September 30, 2003 and $59 million at September 30,
2002. 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.
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Consumers Energy Company
Under Michigan's electric restructuring law, Consumers will return to unfrozen
rates for large industrial customers beginning January 1, 2004, including the
resumption of the PSCR process. Under the process, 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. Recovery of capacity and fixed energy charges will be
subject to certain rate caps as discussed in Note 2, Uncertainties, "Electric
Rate Matters - Electric Restructuring." 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, Consumers' cash underrecoveries associated with the PPA
could be as follows:
In Millions
- ----------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ----------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5% (a) $ 57 $ 56 $ 56 $ 55 $ 39
Amount to be charged to operating expense $ 28 $ 27 $ 56 $ 55 $ 39
Amount to be charged to PPA liability $ 29 $ 29 $ - $ - $ -
==============================================================================================
(a) For the nine months ended September 30, 2003, Consumers' cash
underrecoveries associated with the PPA were $43 million.
As previously noted, until September 2007, the PPA and settlement require
Consumers to pay capacity costs based on the MCV Facility's actual availability
up to the 98.5 percent cap. After September 2007, Consumers expects to exercise
the "regulatory out" clause in the PPA, limiting its capacity payments to the
MCV Partnership to the amount collected from its customers. Depending on the
MPSC's future actions with respect to the capacity payments recoverable from its
customers subsequent to September 2007, the earnings of the MCV Partnership and
the value of Consumers' equity interest in the MCV Partnership, may be affected
negatively.
Further, under the PPA, energy payments to the MCV Partnership are based on the
cost of coal burned at Consumers' coal plants and costs associated with fuel
inventory, operations and maintenance, and administrative and general expenses
associated with Consumers' coal plants. However, the MCV Partnership's costs of
producing electricity are tied, in large part, to the cost of natural gas.
Because natural gas prices have increased substantially in recent years, while
energy charge payments to the MCV Partnership have not, the MCV Partnership's
financial performance has been impacted negatively.
As of January 1, 2004, Consumers intends to return to forced (uneconomic)
dispatch of the MCV Facility in order to maximize recovery of its capacity
payments. As such, if the spread between MCV Facility's variable electricity
production costs and its energy payment revenues stays constant or widens, the
negative impacts on MCV Partnership's financial performance, and on the value of
Consumers' equity interest in the MCV Partnership, will be worse.
Consumers cannot estimate, at this time, the impact of these issues on its
future earnings or cash flow from its interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to Consumers' recovery of capacity payments are the two most
significant variables in
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Consumers Energy Company
the analysis of MCV Partnership's future financial performance. Natural gas
prices have historically been volatile and presently there is no consensus in
the marketplace on the price or range of prices of natural gas beyond the next
five years. Further, it is not presently possible for Consumers to predict the
actions of the MPSC in 2007 or later. For these reasons, at this time Consumers
cannot predict the impact of these issues on its future earnings, cash flows, or
on the value of its $404 million equity interest in the MCV Partnership.
Consumers is exploring possible alternatives for utilizing the MCV Facility
without increasing costs to customers. Any changes regarding the recovery of MCV
capacity costs would require MPSC approval. Consumers cannot predict the outcome
of this matter.
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 PURPA. In July 1999, the district
court granted MCV Partnership's motion for summary judgment. The district 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: Significant progress continues to be made in the
decommissioning of Big Rock. Following the successful loading of spent fuel into
dry storage (see below under "Spent Nuclear Fuel Storage"), the spent fuel
storage racks were removed and disposed of and the spent fuel pool cleaned and
drained. The reactor vessel closure head was shipped for disposal in May 2003
and in August 2003, the reactor vessel was moved from the plant and sealed into
a specially designed shipping container. In October 2003, the shipping container
was transported to the licensed disposal facility in Barnwell, South Carolina.
The License Termination Plan was submitted to the NRC staff for review in April
2003. System dismantlement and building demolition continue on a schedule to
return the 560-acre site to a natural setting for unrestricted use in early
2006. The NRC and Michigan Department of Environmental Quality continue to find
that all decommissioning activities at Big Rock are being performed in
accordance with applicable regulatory and license requirements.
In July 2003, the NRC completed its mid-cycle plant performance assessment of
Palisades. The mid-cycle review for Palisades covered the period from January 1,
2003 through the end of July 2003. 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 September 2004.
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." Spent fuel was then loaded into the dry casks from the fuel pool and
transported to the temporary onsite storage pad. A total of seven dry casks have
been loaded with spent fuel. An additional eighth cask, containing high-level
radioactive waste material, was also loaded. This radioactive material was made
up of reactor vessel components that could not be shipped or stored with the
reactor vessel. These transportable dry casks will remain onsite until the DOE
moves the material to a national fuel repository.
At Palisades, the amount of spent nuclear fuel discharged from the reactor to
date exceeds Palisades' temporary onsite storage pool capacity. Consequently,
Consumers is using dry casks for temporary onsite storage. As of September 30,
2003, Consumers had loaded 18 dry casks with spent nuclear fuel at Palisades.
Palisades will
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Consumers Energy Company
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 onsite,
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.
As of September 30, 2003, Consumers has a recorded liability to the DOE of $139
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 the interest.
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,
including Consumers, which filed its complaint in December 2002, have commenced
litigation in the Court of Claims. 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. However, there is no assurance that
the litigation against the DOE will be successful.
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.
In March 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 in April 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,
Detroit Edison, 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. In May 2003,
Consumers and the other named utilities each filed a motion to dismiss the
complaint. Consumers is unable to predict the outcome of this matter.
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 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 of the reactor head. Consumers will continue to comply with
the more aggressive reactor head inspection requirements in future
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Consumers Energy Company
planned outages at Palisades.
Insurance: Consumers maintains primary and excess nuclear property insurance
from NEIL, totaling $2.750 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 $26 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 $10.862 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 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 $101 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 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
resolution 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. A revised cost estimate, completed in September 2003, estimated remaining
costs to be between $37 million and $90 million. The range reflects multiple
alternatives with various assumptions for resolving the environmental issues at
each site. The estimates are based on discounted 2003 costs using a discount
rate of three percent. The discount rate represents a ten-year average of U.S.
Treasury bond rates reduced for increases in the consumer price index. Consumers
expects to fund a significant portion of these costs through insurance proceeds
and through MPSC approved rates charged to its customers. As of September 30,
2003, Consumers has an accrued liability of $47 million, net of $35 million of
expenditures incurred to date, and a regulatory asset of $68 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.
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Consumers Energy Company
The MPSC, in its November 2002, gas distribution rate order, authorized
Consumers to continue to recover approximately $1 million of manufactured gas
plant facilities environmental clean-up costs annually. Consumers defers and
amortizes, over a period of 10 years, manufactured gas plant facilities
environmental clean-up costs above the amount currently being recovered in
rates. Additional rate recognition of amortization expense cannot begin until
after a prudency review in a gas rate case. The annual amount that the MPSC
authorized Consumers to recover in rates will continue to be offset by $2
million to reflect amounts recovered from all other sources.
GAS RATE MATTERS
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation case with the MPSC, Consumers expects to recover all of its gas
costs. In June 2003, Consumers filed a reconciliation of GCR costs and revenues
for the 12-months ended March 2003. Consumers proposes to recover from its
customers a net under-recovery of approximately $6 million using a roll-in
methodology. The roll-in methodology incorporates the under-recovery in the GCR
factor charged in the next GCR year. The roll-in tariff provision was approved
by the MPSC in a November 2002 order.
In July 2003, the MPSC approved a settlement agreement authorizing Consumers to
increase its gas cost recovery factor for the remainder of the current GCR plan
year (August 2003 through March 2004) and to implement a quarterly ceiling price
adjustment mechanism, based on a formula that tracks changes in NYMEX natural
gas prices. Consistent with the terms of the settlement, the ceiling price is
$6.11 per mcf. However, Consumers will utilize a GCR factor of $5.41 per mcf
commencing in November 2003 bills. All recoveries pursuant to such factors are
subject to final reconciliation by the MPSC.
2003 GAS RATE CASE: In March 2003, Consumers filed an application with the MPSC
seeking a $156 million increase in its gas delivery and transportation rates,
which included a 13.5 percent return on equity, based on a 2004 test year.
Contemporaneously with this filing, Consumers requested interim rate relief in
the same amount. In August 2003, the MPSC Staff recommended interim rate relief
of $80 million be granted in this proceeding, subject to Consumers voluntarily
agreeing to limit its dividends to its parent, CMS Energy, to a maximum of $190
million in any calendar year.
In September 2003, Consumers filed an update to its gas rate case that lowered
the requested revenue increase from $156 million to $139 million and revised the
return on common equity from 13.5 percent to 12.75 percent. The majority of the
reduction is related to lower debt costs and changes in the projected capital
structure. The MPSC Staff and ABATE filed their cases in early October. The
Staff made no change to its interim position of $80 million and continued to
propose the same dividend limitation. ABATE did not make a specific
recommendation for a final rate increase, but did discuss the rate design used
to recover any rate increase granted. A proposal for decision is expected from
the administrative law judge in January 2004.
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 September 30, 2003,
Consumers has incurred approximately $7 million in incremental security costs,
including operating, capital, and decommissioning and removal costs, mainly
relating to its nuclear facilities. Consumers estimates it may incur additional
incremental security costs for the last three months of 2003 of approximately $3
million, of which $2 million relates to nuclear security costs. 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
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Consumers Energy Company
Choice Act. In February 2003, the MPSC adopted filing requirements for the
recovery of enhanced security costs.
DERIVATIVE ACTIVITIES: Consumers may use 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
be adjusted to 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.
OTHER: 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 September 30, 2003, Consumers had
FERC authorization, through June 2004, to issue or guarantee up to $1.1 billion
of short-term securities outstanding at any one time. As of September 30, 2003,
Consumers had $400 million outstanding as collateral for the revolving credit
facility (discussed below) and had an additional $700 million available for
future issuances of short-term securities. At September 30, 2003, Consumers also
had remaining FERC authorization, through June 2004, to issue up to $800 million
of long-term securities for refinancing or refunding purposes, $560.3 million of
long-term securities for general corporate purposes, and $2.06 billion of
long-term first mortgage bonds to be issued solely as collateral for other
long-term securities. Also, FERC has granted waivers of its competitive
bid/negotiated placement requirements applicable to the 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.
In September 2003, this facility was amended and restated as a $400 million
revolving credit facility. The interest rate of the facility was reduced from
LIBOR plus 350 to LIBOR plus 175 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. At September 30, 2003, all of the $400
million is available for general corporate purposes. At September 30, 2003, a
total of $4 million was outstanding on all short-term financings at a weighted
average interest rate of 2.79 percent, compared with $235 million outstanding at
September 30, 2002 at a weighted average interest rate of 3.7 percent.
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Consumers Energy Company
LONG-TERM DEBT:
The following is a summary of Consumers' Long-Term Debt as of September 30, 2003
and December 31, 2002:
In Millions
- -----------------------------------------------------------------------------------------------------------
September 30 December 31
Interest Rate (%) Maturity 2003 2002
- -----------------------------------------------------------------------------------------------------------
Senior Notes 6.000 2005 $ 300 $ 300
6.250 2006 332 332
6.375 2008 159 159
6.200(a) 2008 - 250
6.875 2018 180 180
6.500(b) 2018 141 141
6.500(c) 2028 142 142
---------------------------
1,254 1,504
---------------------------
Securitization Bonds 5.075(d) 2005-2015 434 453
First Mortgage Bonds 5.240(d) 2008-2023 1,482 208
Long-Term Bank Debt Floating 2009 140 328
Nuclear Fuel Disposal Liability (e) 139 138
Pollution Control Revenue Bonds Various 2010-2018 126 126
Other 6 8
---------------------------
2,327 1,261
---------------------------
Principal Amount Outstanding 3,581 2,765
Current Amounts (28) (305)
Net Unamortized Discount (22) (18)
---------------------------
Total Long-Term Debt $ 3,531 $2,442
===========================================================================================================
(a) These notes were subject to a call option by the callholder or a mandatory
put on May 1, 2003.
(b) Senior remarketed notes subject to optional redemption by Consumers after
June 15, 2005.
(c) Callable at par on or after October 1, 2003.
(d) Represents the weighted average interest rate at September 30, 2003.
(e) Maturity date uncertain.
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 an interest rate of 4.25 percent, maturing in April
2008, and net proceeds were approximately $248 million; $375 million were issued
at an interest rate 5.375 percent, maturing in April 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 included
paying down additional debt. The $32 million option call payment was deferred
and is being amortized to interest expense over the term of the replacement debt
in accordance with SFAS No. 71. Consumers agreed to file a registration
statement with the SEC by December 26, 2003 to permit holders of the first
mortgage bonds to exchange the bonds for new bonds that will be registered under
the Securities Act of 1933.
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Consumers Energy Company
In May 2003, Consumers sold $250 million principal amount of first mortgage
bonds in a private offering to institutional investors; the bonds were issued at
an interest rate of 4.00 percent, maturing May 2010, and net proceeds were
approximately $247 million. Consumers used the net proceeds to pay down existing
debt. Consumers agreed to file a registration statement with the SEC by December
26, 2003 to permit holders of the first mortgage bonds to exchange the bonds for
new bonds that will be registered under the Securities Act of 1933.
In August 2003, Consumers sold $400 million principal amount of first mortgage
bonds in a private offering to institutional investors; $200 million were issued
at an interest rate of 4.80 percent, maturing in February 2009, and net proceeds
were approximately $198 million and $200 million were issued at an interest rate
of 6.00 percent, maturing in February 2014, and net proceeds were approximately
$198 million. Consumers used the net proceeds to pay down existing debt and for
general corporate purposes. Consumers agreed to file a registration statement
with the SEC by April 14, 2004 to permit holders of the first mortgage bonds to
exchange the bonds for new bonds that will be registered under the Securities
Act of 1933.
SENIOR NOTES: 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 had a three-year maturity expiring in March 2006.
This term loan was paid in full with the proceeds of first mortgage bonds issued
in August 2003.
COMPANY-OBLIGATED 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.
In each case, the primary asset of the trust 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 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, 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. For further information, see Note 5,
Implementation of New Accounting Standards.
In Millions
- ------------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate Outstanding Maturity Redemption
- ------------------------------------------------------------------------------------------------------
September 30 2003 2002
- ------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities (a) 8.36% $ 70 $ 70 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities (a) 8.20% 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities (b) 9.25% 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities (c) 9.00% 125 125 2031 2006
------------
Total Amount Outstanding $ 490 $490
======================================================================================================
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Consumers Energy Company
(a) Consumers can currently redeem these securities at par value.
(b) Consumers cannot redeem these securities until 2004. If Consumers were
to redeem these securities as of September 30, 2003, they would be
required to pay market value, which is approximately $180 million.
(c) Consumers cannot redeem these securities until 2006. If Consumers were
to redeem these securities, as of September 30, 2003, they would be
required to pay market value, which is approximately $128 million.
REQUIRED RATIOS: The revolving credit facility has contractual restrictions that
require Consumers to maintain, as of the last day of each fiscal quarter, the
following:
Limitation Ratio at September 30, 2003
====================================================================================================================
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.58 to 1.00
Interest Coverage Ratio - Revolver (a) Not less than 2.00 to 1.00 3.34 to 1.00
====================================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility that provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of securitization
bonds in the calculation of the debt to capital ratio.
Consumers is subject to covenants in its financing agreements that could limit
its ability to incur additional indebtedness. Consumers has agreed in several of
its financing agreements to maintain specified levels of cash coverage of its
interest requirements and to not allow its indebtedness to exceed specified
levels of its consolidated capitalization (the "Debt Percentage Tests").
Consumers is in compliance with these requirements as of the most recent
measurement date, September 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. Consumers sought and received amendments to
certain of its relevant financing agreements to modify the terms of the Debt
Percentage Tests in order to, among other things, remove the effect of the
adoption of SFAS No. 150, portions of which have now been deferred indefinitely,
regarding Trust Preferred Securities on the calculations.
OTHER: Under a revolving accounts receivable sales program, Consumers currently
sells certain accounts receivable to a wholly owned, consolidated, bankruptcy
remote special purpose entity, Consumers Receivables Funding II. In turn,
Consumers Receivables Funding II may sell an undivided interest in up to $325
million of the receivables to a bank-sponsored commercial paper conduit. The
amount sold to the conduit was $254 million at September 30, 2003 and $325
million at September 30, 2002. These amounts are excluded from accounts
receivable in Consumers' consolidated balance sheets. Consumers continues to
service the receivables sold, however, the purchaser of the receivables has no
recourse against Consumers' other assets for failure of a debtor to pay when due
and the purchaser has no right to any receivables not sold. No gain or loss has
been recorded on the receivables sold and Consumers retains no interest in the
receivables sold.
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Consumers Energy Company
Certain cash flows received from and paid to Consumers under its accounts
receivable sales program are shown below:
In Millions
- --------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------
Proceeds from sales (remittance of collections)
under the program $ 204 $ 14 $ (71) $ (9)
Collections reinvested under the program 920 918 3,379 3,141
==================================================================================================
DIVIDEND RESTRICTIONS: Under the provisions of its articles of incorporation,
Consumers had $412 million of unrestricted retained earnings available to pay
common dividends at September 30, 2003. However, covenants in Consumers' debt
facilities cap common stock dividend payments at $300 million in a calendar
year. Through September 30, 2003, Consumers paid $162 million in common
dividends. In October 2003, Consumers declared a $57 million common dividend
payable in November 2003.
For information on the potential cap on common dividends payable included in the
MPSC Securitization order see Note 2, Uncertainties, Electric Rate Matters,
"Securitization." Also, for information on the potential cap on common dividends
payable included in the MPSC Staff's recommendation in Consumers' gas rate case
see Note 2, Uncertainties, "Gas Rate Matters - 2003 Gas Rate Case."
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS:
Effective January 2003, this interpretation elaborates on the disclosure to be
made by a guarantor about its obligations under certain guarantees that it has
issued. It also requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provision of this
interpretation does not apply to certain guarantee contracts, such as
warranties, derivatives, or guarantees between either parent and subsidiaries or
corporations under common control, although disclosure of such guarantees is
required. For contracts that are within the initial recognition and measurement
provision of this interpretation, the provisions are to be applied to guarantees
issued or modified after December 31, 2002; no cumulative effect adjustments are
required.
Following is a general description of Consumers' guarantees as required by this
Interpretation:
September 30, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------
Expiration Maximum Carrying Recourse
Guarantee Description Issue Date Date Obligation Amount Provision(a)
- -------------------------------------------------------------------------------------------------------------
Standby letters of credit Various Various $ 7 $ - $ -
Surety bonds Various Various 8 - -
Nuclear insurance retrospective premiums Various Various 133 - -
=============================================================================================================
(a) Recourse provision indicates the approximate recovery from third parties
including assets held as collateral.
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Consumers Energy Company
Following is additional information regarding Consumers' guarantees:
September 30, 2003
- ------------------------------------------------------------------------------------------------------------------
Events That Would Require
Guarantee Description How Guarantee Arose Performance
- ------------------------------------------------------------------------------------------------------------------
Standby letters of credit Normal operations of coal power plants Noncompliance with environmental
regulations
Self-insurance requirement Nonperformance
Surety bonds Normal operating activity, permits and Nonperformance
license
Nuclear insurance retrospective Normal operations of nuclear plants Call by NEIL and Price Anderson
premiums 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 financial instruments, except as shown below,
approximate fair value. For held-to-maturity securities and related-party
financial instruments, see Note 1.
In Millions
- --------------------------------------------------------------------------------------------------------------------------
September 30 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Cost Fair Unrealized Cost Fair Unrealized
Value Gain (Loss) Value Gain (Loss)
- --------------------------------------------------------------------------------------------------------------------------
Long-Term Debt (a) $3,531 $3,633 $ (102) $2,701 $2,694 $ 7
Trust Preferred Securities 490 497 (7) 490 439 51
Preferred Stock 44 33 11 44 23 21
Available for sale securities:
Common stock of CMS Energy (b) 10 17 7 35 19 (16)
SERP 17 20 3 18 19 1
Nuclear decommissioning investments (c) 450 553 103 464 530 66
==========================================================================================================================
(a) Settlement of long-term debt is generally not expected until maturity.
(b) 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 September 30, 2003, Consumers held 2.4 million
shares of CMS Energy Common Stock.
(c) 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.
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Consumers Energy Company
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. Established
policies and procedures are used to manage the risks associated with market
fluctuations.
Consumers may use 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. 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
accumulated 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 for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings. Consumers uses a combination of quoted
market prices and mathematical valuation models to determine fair value of those
contracts requiring derivative accounting. 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.
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Consumers Energy Company
The following table reflects the fair value of contracts requiring derivative
accounting:
In Millions
- -----------------------------------------------------------------------------------------
September 30 2003 2002
- -----------------------------------------------------------------------------------------
Fair Fair
Derivative Instruments Cost Value Cost Value
- -----------------------------------------------------------------------------------------
Electric - related contracts $ - $ - $ 8 $ 1
Gas contracts 3 - - 1
Interest rate risk contracts - - - (2)
Derivative contracts associated with Consumers'
equity investment in the MCV Partnership - 10 - 7
=========================================================================================
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. Effective April
1, 2002, the MCV Partnership changed its accounting for derivatives, see Note 2,
Uncertainties, Other Electric Uncertainties, The Midland Cogeneration Venture.
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 September 30, 2003, Consumers did not have any
unexpired purchased electric call option contracts subject to derivative
accounting. All remaining purchased electric call option contracts subject to
derivative accounting as of June 2003, expired in the third quarter of 2003. As
of September 30, 2002, Consumers recorded on the balance sheet all of its
unexpired purchased electric call option contracts subject to derivative
accounting at a fair value of $1 million.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market 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.
Consumers' electric business also uses gas option and 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 contracts are financial contracts that
are used to offset increases in the price of potential gas purchases. These
contracts do not qualify for hedge accounting. Therefore, Consumers records any
change in the fair value of these contracts directly in earnings as part of
power supply costs. As of September 30, 2003, gas fuel for generation call
option contracts entered into in the second quarter of 2003 had expired. As of
September 30, 2002, gas fuel for generation swap contracts had a fair value of
less than $1 million. These contracts expired in December 2002.
For the three months ended September 30, 2003, Consumers recorded an unrealized
loss in accumulated other comprehensive income related to its proportionate
share of the effects of derivative accounting related to its equity investment
in the MCV Partnership of $5 million, net of tax. For the nine months ended
September 30, 2003, Consumers recorded an unrealized gain in accumulated other
comprehensive income related to its proportionate share of the effects of
derivative accounting related to its equity investment in the MCV Partnership of
$8 million, net of tax. As of September 30, 2003, the cumulative total of
unrealized gains recorded in other accumulated comprehensive income related to
Consumers' proportionate share of the effects
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Consumers Energy Company
of derivative accounting related to its equity investment in the MCV Partnership
is $6 million, net of tax. Consumers expects to reclassify this gain, if this
value remains, as an increase to earnings from equity method investees 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
call and put options, and other types of contracts, to meet its regulatory
obligation to provide gas to its customers at a reasonable and prudent cost. As
of September 30, 2003, weather-based gas call options and gas call and put
options requiring derivative accounting had a net fair value that was less than
$1 million. The original cost of the options was a net $3 million. Consumers
recorded an unrealized loss of $3 million associated with these options directly
in earnings as part of other income, and then directly offset this loss and
recorded it on the balance sheet as a regulatory asset. Any subsequent changes
in fair value will be recorded in a similar manner.
As of September 30, 2002, Consumers' gas supply contracts and weather-based gas
call options and gas put options requiring derivative accounting had a fair
value of $1 million, representing a fair value gain on the contracts since the
date of inception. Changes in fair value were recorded in a similar manner as
stated above for weather-based gas call options and gas call and put options.
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
records any change in the fair value of these contracts in accumulated other
comprehensive income unless the swaps are sold. As of September 30, 2003,
Consumers did not have any interest rate swaps outstanding. As of September 30,
2002, Consumers had entered into a swap to fix the interest rate on $75 million
of variable-rate debt. This swap expired in June 2003. As of September 30, 2002,
this interest rate swap had a negative fair value of $2 million.
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
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
$134 million regulatory liability; 3) a $42 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 were assumed,
Consumers' ARO liability would be $381 million.
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Consumers Energy Company
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 insignificant 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.
September 30, 2003 In Millions
- --------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- --------------------------------------------------------------------------------------------------------------------
Palisades - decommission plant site 1972 Palisades nuclear plant $ 462
Big Rock - decommission plant site 1962 Big Rock nuclear plant 90
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.
September 30, 2003 In Millions
- --------------------------------------------------------------------------------------------------------------------
Pro forma ARO Liability ARO
ARO liability --------------------------- Cash flow liability
ARO 1/1/02 1/1/03 Incurred Settled Accretion Revisions 9/30/03
- ---------------------------------------------------------------------------------------------------------------------
Palisades - decommission $ 232 $ 249 $ - $ - $ 14 $ - $ 263
Big Rock - decommission 94 61 - (28) 10 - 43
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - (2) 4 - 53
Wells at gas storage fields 2 2 - - - - 2
Indoor gas services relocations 1 1 - - - - 1
---------------------------------------------------------------------------
Total $ 375 $ 364 $ - $ (30) $ 28 $ - $ 362
==================================================================================================================
SFAS NO. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES: Issued by the FASB in April 2003, this statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement is effective for contracts
entered into or modified after June 30, 2003. Implementation of this statement
has not had an impact on Consumers' Consolidated Financial Statements.
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Consumers Energy Company
SFAS NO. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS
OF BOTH LIABILITIES AND EQUITY: Issued by the FASB in May 2003, this statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. The
statement requires an issuer to classify financial instruments within its scope
as liabilities. Those instruments were previously classified as mezzanine
equity. SFAS No. 150 became effective July 1, 2003.
Consumers has four trust preferred securities outstanding as of September 30,
2003. The trust preferred securities are issued by consolidated subsidiaries of
Consumers. Each trust holds a subordinated debenture from Consumers. The terms
of the debentures are identical to those of the trust preferred securities,
except that the debenture has an explicit maturity date. The trust documents, in
turn, require that the trust be liquidated upon the repayment of the debenture.
The trust preferred securities are redeemable upon the liquidation of the
subsidiary; and therefore, are considered equity in the financial statements of
the subsidiary.
At their October 29, 2003 Board meeting, the FASB deferred the implementation of
the portion of SFAS No. 150 relating to mandatorily redeemable noncontrolling
interests in subsidiaries when the noncontrolling interests are classified as
equity in the financial statements of the subsidiary. Consumers' trust preferred
securities are included under the deferral. As such, the Consumers trust
preferred securities continue to be accounted for under existing accounting
guidance and are included in mezzanine equity. Consumers continues to study the
FASB developments regarding the SFAS No. 150 deferral.
EITF ISSUE NO. 01-08, DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE: In
May 2003, the EITF reached consensus in EITF Issue No. 01-08 to clarify the
requirements of identifying whether an arrangement should be accounted for as a
lease at its inception. The guidance in the consensus is designed to mandate
reporting revenue as rental or leasing income that otherwise would be reported
as part of product sales or service revenue. EITF Issue No. 01-08 requires both
parties to an arrangement to determine whether a service contract or similar
arrangement is or includes a lease within the scope of SFAS No. 13, Accounting
for Leases.
Historically, Consumers has entered into power purchase and similar service
arrangements. Prospective accounting under EITF Issue No. 01-08, could affect
the timing and classification of revenue and expense recognition. Certain
product sales and services revenue and expenses may be required to be reported
as rental or leasing income and/or expenses. The consensus is to be applied
prospectively to arrangements agreed to, modified, or acquired in business
combinations in fiscal periods beginning July 1, 2003. The adoption of EITF
Issue No. 01-08 has not impacted Consumers' results of operations, cash flows,
or financial position. Consumers will evaluate new or modified contracts under
EITF Issue No. 01-08 prospectively.
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, FIN 46 requires the primary beneficiary of a
variable interest entity's activities to consolidate the variable interest
entity. The primary beneficiary is the party that absorbs a majority of the
expected losses and/or receives a majority of the expected residual returns of
the variable interest entity's activities. The consolidation requirements of the
interpretation apply immediately to variable interest entities created after
January 31, 2003. Consumers has not created any variable interest entities in
2003. Therefore, this portion of the interpretation has no impact on its
consolidated financial statements. Public companies, whose fiscal year is a
calendar year, were originally required to implement the guidance in this
interpretation by the third quarter of 2003. However, on October 9, 2003, the
FASB issued FASB Staff Position No. 46-6, Effective Date of FASB Interpretation
No. 46, which defers implementation of FIN 46 until the fourth quarter of 2003
for variable interest entities and potential variable interest entities created
before February 1, 2003.
If the completed analysis were to require Consumers to disclose information
about or consolidate in its financial statements, the assets, liabilities and
activities of the MCV Partnership and the First Midland Limited
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Consumers Energy Company
Partnership, including the recognition of the debt of the MCV Partnership on its
financial statements, this could impact negatively Consumers' various financial
covenants under its financing agreements. As a result, Consumers may have to
seek amendments to the relevant financing agreements to modify the terms of
certain of these covenants in order to remove the effect of this potential
consolidation or refinance the relevant debt. As of September 30, 2003,
Consumers' investments in the MCV Partnership and in the FMLP were $404 million
and $222 million, respectively. For further description of the nature, purpose,
size and activities of the MCV Partnership, see Note 2, Uncertainties, Other
Electric Uncertainties, "The Midland Cogeneration Venture." Consumers is
continuing to study the implementation of this interpretation and has yet to
determine the effects, if any, on its consolidated financial statements.
EITF ISSUE 03-04, ACCOUNTING FOR CASH BALANCE PENSION PLANS: In May 2003, the
EITF reached consensus in EITF Issue No. 03-04 to specifically address the
accounting for certain cash balance pension plans. EITF Issue No. 03-04
concluded that certain cash balance plans be accounted for as defined benefit
plans under SFAS No. 87, Employers' Accounting for Pensions. EITF No. 03-04
requires the use of the traditional unit credit method for the purposes of
measuring the benefit obligation and annual cost of benefits earned as opposed
to the projected unit credit method. The EITF concluded that the requirements of
this Issue be applied as of the next plan measurement date, which is December
31, 2003 for Consumers. Consumers commenced a cash balance pension plan that
covers employees hired after June 30, 2003. Consumers does account for this plan
as a defined benefit plan under SFAS No. 87. Consumers continues to evaluate the
impact, if any, this Issue will have upon adoption.
STATEMENT OF POSITION, ACCOUNTING FOR CERTAIN COSTS AND ACTIVITIES RELATED TO
PROPERTY, PLANT, AND EQUIPMENT: At its September 9, 2003 meeting, the Accounting
Standards Executive Committee voted to approve the Statement of Position,
Accounting for Certain Costs and Activities Related to Property, Plant, and
Equipment. The Statement of Position is expected to be presented for FASB
clearance late in the fourth quarter of 2003 and would be applicable for fiscal
years beginning after December 15, 2004. The Accounting Standards Executive
Committee concluded that at transition, a company would have the flexibility to
adopt a property, plant and equipment component accounting policy for
transition-date property, plant and equipment accounts. The property, plant and
equipment component policy may differ from the componentization policy, if any,
previously used by the enterprise. Selecting a policy that differs from the
company's prior level of componentization at the date of adoption of the
Statement of Position would not result in any cumulative effect difference for
adopting such a policy. A company would not have to restate its pre-adoption
assets to conform with its post-adoption componentization policy. The Accounting
Standards Executive Committee concluded that companies would be required to
disclose meaningful ranges with respect to property, plant and equipment
depreciable lives. Consumers continues to evaluate the impact, if any, this
Issue will have upon adoption.
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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 Form 10-K/A filed on July 1, 2003 and Consumers' Form
10-K, 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 and Note 2, Uncertainties for Consumers, 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 are serving 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.
INTEGRUM LAWSUIT
A complaint was filed in Wayne County, Michigan Circuit Court on July 17, 2003
by Integrum Energy Ventures LLC ("Integrum") against CMS Energy, CMS Enterprises
and Australian Pipeline Trust ("APT"). Integrum alleges several causes of action
against APT, CMS Energy and CMS Enterprises in connection with an offer by
Integrum to purchase certain CMS Enterprises pipeline assets in Michigan and
Australia (the "CMS Pipeline Assets"). In addition to seeking unspecified money
damages, Integrum is seeking an order enjoining CMS Enterprises and CMS Energy
from selling, and APT from purchasing, the CMS Pipeline Assets and an order of
specific performance mandating that CMS Energy, CMS
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Enterprises and APT complete the sale of the CMS Pipeline Assets to APT and
Integrum. A certain officer and director of Integrum is a former officer and
director of CMS Energy, Consumers and its subsidiaries. The individual was not
employed by CMS Energy, Consumers or its subsidiaries when Integrum made the
offer to purchase the CMS Pipeline Assets. CMS Energy and CMS Enterprises intend
to defend vigorously against this action. CMS Energy and CMS Enterprises cannot
predict the outcome of this litigation.
GAS INDEX PRICE REPORTING LITIGATION
In August 2003, Cornerstone Propane Partners, L.P. ("Cornerstone") filed a
putative class action complaint in the United States District Court for the
Southern District of New York against CMS Energy and 40 other energy companies.
The complaint alleges that false natural gas price reporting by the defendants
manipulated the prices of NYMEX natural gas futures and options. The complaint
contains two counts under the Commodity Exchange Act, one for manipulation and
one for aiding and abetting violations. Cornerstone has agreed to provide a
blanket sixty-day extension of time for all defendants to answer or otherwise
respond to the complaint. CMS Energy intends to defend vigorously against this
action but cannot predict the outcome of this litigation.
CMS ENERGY AND CONSUMERS
ERISA CLASS ACTION LAWSUITS
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 CMS Employee's
Savings and Incentive Plan (the "Plan"). The two cases, filed in July 2002 in
the U.S. District Court for the Eastern District of Michigan, 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 defended vigorously. 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 by
individuals who allege that they purchased CMS Energy's securities during a
purported class period. The cases were consolidated into a single lawsuit and an
amended and consolidated class action complaint was filed on May 1, 2003. The
consolidated complaint contains a purported class period beginning on May 1,
2000 and running through March 31, 2003. It generally 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, particularly with respect to revenues
and expenses recorded in connection with round-trip trading by CMS MST. The
companies intend to defend vigorously against this action but cannot predict the
outcome of this litigation.
ENVIRONMENTAL MATTERS
CMS Energy, Consumers 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
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legal and factual developments, CMS Energy and Consumers 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 and Consumers'
MANAGEMENT'S DISCUSSION AND ANALYSIS; and CMS Energy's and Consumers' CONDENSED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 6, 2003, CMS Energy issued 136,109 CMS Energy Common Stock warrants to
Miller Buckfire Lewis & Co., LLC and 67,891 CMS Energy Common Stock warrants to
Dresdner Klienwort Wasserstein, Inc. (herein collectively referred to as the
"warrants"). The warrants were issued at a price of $8.25 per share and were
granted as partial compensation for general financial advisory and investment
banking services provided to CMS Energy. The warrants were issued pursuant to
Section 4(2) of the Securities Act of 1933, as amended, as a transaction by an
issuer not involving any public offering.
On July 16, 2003, CMS Energy issued, in a private placement to institutional
investors pursuant to Rule 144A of the Securities Act of 1933, as amended, $150
million of 3.375 percent convertible senior notes due July 15, 2023 (the
"notes"). The notes were initially sold to Citigroup Global Markets Inc.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, and Deutsche Bank Securities
Inc., as initial purchasers. CMS Energy received proceeds of $145,500,000 after
the initial purchasers' discounts and commissions and offering expenses. The
notes are convertible into CMS Energy Common Stock at the option of the holder
under certain circumstances. The initial conversion price is $10.671 per share,
which translates into 93.7137 shares of CMS Energy Common Stock for each $1,000
principal note converted. CMS Energy has agreed to file a shelf registration
statement with the SEC by October 14, 2004 relating to the resale of the notes
and the CMS Energy Common Stock issuable upon conversion thereof.
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 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
(4)(a) 91st Supplemental Indenture, dated as of May 23, 2003, between
Consumers Energy Company and JPMorgan Chase Bank as Trustee
(4)(b) 92nd Supplemental Indenture, dated as of August 26, 2003, between
Consumers Energy Company and JPMorgan Chase Bank as Trustee
(4)(c) 93rd Supplemental Indenture, dated as of September 19, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(d) Registration Rights Agreement dated as of April 30, 2003 between
Consumers Energy Company and the Initial Purchasers, as defined
therein
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(4)(e) Registration Rights Agreement dated as of May 23, 2003 between
Consumers Energy Company and the Initial Purchasers, as defined
therein
(4)(f) Registration Rights Agreement dated as of August 26, 2003 between
Consumers Energy Company and the Initial Purchasers, as defined
therein
(4)(g) Amended and Restated Credit Agreement dated September 19, 2003
among Consumers Energy Company, the Banks, the Agent, the
Syndication Agent and the Co-Documentation Agents, all as defined
therein
(10)(a) Purchase Agreement dated April 23, 2003 between Consumers Energy
Company and the Initial Purchasers, as defined therein
(10)(b) Purchase Agreement dated May 20, 2003 between Consumers Energy
Company and the Initial Purchasers, as defined therein
(10)(c) Purchase Agreement dated August 19, 2003 between Consumers Energy
Company and the Initial Purchasers, as defined therein
(31)(a) CMS Energy Corporation's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(b) CMS Energy Corporation's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(c) Consumers Energy Company's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(d) Consumers Energy Company's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(32)(a) CMS Energy Corporation's certifications pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(32)(b) Consumers Energy Company's certifications pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(b) REPORTS ON FORM 8-K
CMS ENERGY
During 3rd Quarter 2003, CMS Energy filed a report on Form 8-K on July 11, 2003
(covering matters pursuant to ITEM 5. OTHER EVENTS), and furnished a report on
Form 8-K on August 13, 2003 (covering matters pursuant to ITEM 12. RESULTS OF
OPERATIONS AND FINANCIAL CONDITION).
CONSUMERS
During 3rd Quarter 2003, Consumers furnished a report on Form 8-K on August 13,
2003 (covering matters pursuant to ITEM 12. RESULTS OF OPERATIONS AND FINANCIAL
CONDITION).
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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: November 12, 2003 By: /s/ Thomas J. Webb
-----------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CONSUMERS ENERGY COMPANY
(Registrant)
Dated: November 12, 2003 By: /s/ Thomas J. Webb
-----------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
(4)(a) 91st Supplemental Indenture, dated as of May 23, 2003, between
Consumers Energy Company and JPMorgan Chase Bank as Trustee
(4)(b) 92nd Supplemental Indenture, dated as of August 26, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(c) 93rd Supplemental Indenture, dated as of September 19, 2003,
between Consumers Energy Company and JPMorgan Chase Bank as
Trustee
(4)(d) Registration Rights Agreement dated as of April 30, 2003
between Consumers Energy Company and the Initial Purchasers, as
defined therein
(4)(e) Registration Rights Agreement dated as of May 23, 2003 between
Consumers Energy Company and the Initial Purchasers, as defined
therein
(4)(f) Registration Rights Agreement dated as of August 26, 2003
between Consumers Energy Company and the Initial Purchasers, as
defined therein
(4)(g) Amended and Restated Credit Agreement dated September 19, 2003
among Consumers Energy Company, the Banks, the Agent, the
Syndication Agent and the Co-Documentation Agents, all as
defined therein
(10)(a) Purchase Agreement dated April 23, 2003 between Consumers
Energy Company and the Initial Purchasers, as defined therein
(10)(b) Purchase Agreement dated May 20, 2003 between Consumers Energy
Company and the Initial Purchasers, as defined therein
(10)(c) Purchase Agreement dated August 19, 2003 between Consumers
Energy Company and the Initial Purchasers, as defined therein
(31)(a) CMS Energy Corporation's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(b) CMS Energy Corporation's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(c) Consumers Energy Company's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(d) Consumers Energy Company's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(32)(a) CMS Energy Corporation's certifications pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(32)(b) Consumers Energy Company's certifications pursuant to Section
906 of the Sarbanes-Oxley Act of 2002