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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
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1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
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
August 1, 2003:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 144,075,233
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 JUNE 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
Critical Accounting Policies.................................................................... CMS- 1
Results of Operations........................................................................... CMS-14
Capital Resources and Liquidity................................................................. CMS-19
Outlook......................................................................................... CMS-25
Other Matters................................................................................... CMS-39
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CMS-43
Consolidated Statements of Cash Flows........................................................... CMS-45
Consolidated Balance Sheets..................................................................... CMS-47
Consolidated Statements of Common Stockholders' Equity.......................................... CMS-49
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies......................... CMS-50
2. Asset Sales and Restructuring.............................................................. CMS-53
3. Discontinued Operations.................................................................... CMS-56
4. Uncertainties.............................................................................. CMS-59
5. Short-Term and Long-Term Financings and Capitalization..................................... CMS-78
6. Earnings Per Share......................................................................... CMS-85
7. Risk Management Activities and Financial Instruments....................................... CMS-86
8. Equity Method Investments.................................................................. CMS-90
9. Reportable Segments........................................................................ CMS-91
10. Adoption of New Accounting Standards....................................................... CMS-92
2
TABLE OF CONTENTS
(CONTINUED)
Page
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Consumers Energy Company
Management's Discussion and Analysis
Forward-Looking Statements and Risk Factors..................................................... CE - 1
Critical Accounting Policies.................................................................... CE - 1
Results of Operations........................................................................... CE - 10
Capital Resources and Liquidity................................................................. CE - 13
Outlook......................................................................................... CE - 17
Other Matters................................................................................... CE - 26
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CE - 28
Consolidated Statements of Cash Flows........................................................... CE - 29
Consolidated Balance Sheets..................................................................... CE - 30
Consolidated Statements of Common Stockholder's Equity.......................................... CE - 32
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies.......................... CE - 34
2. Uncertainties............................................................................... CE - 36
3. Financings and Capitalization............................................................... CE - 50
4. Financial and Derivative Instruments........................................................ CE - 53
5. Implementation of New Accounting Standards.................................................. CE - 56
Quantitative and Qualitative Disclosures about Market Risk................................................ CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ CO - 1
Item 5. Other Information............................................................................ CO - 2
Item 6. Exhibits and Reports on Form 8-K............................................................. CO - 3
Signatures........................................................................................... CO - 4
3
GLOSSARY
Certain terms used in the text and financial statements are defined below
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
CMS Holdings....................................... CMS Midland Holdings Company, a subsidiary of Consumers
CMS Midland........................................ CMS Midland Inc., a subsidiary of Consumers
4
CMS MST............................................ CMS Marketing, Services and Trading Company, a subsidiary of
Enterprises
CMS Oil and Gas.................................... CMS Oil and Gas Company, a subsidiary of Enterprises
CMS 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
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
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
5
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 owns 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
ISO................................................ Independent System Operator
ITC................................................ Investment tax credit
JEC................................................ Jubail Energy Company
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
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 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
6
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
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
7
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
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. 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"
8
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.
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
9
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.
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,
CMS-1
CMS Energy Corporation
estimates or assumptions that are used. Such estimates and assumptions include,
but are not specifically limited to: depreciation, amortization, interest rates,
discount rates, currency exchange rates, future commodity prices, mark-to-market
valuations, investment returns, impact of new accounting standards,
international economic policy, future costs associated with long-term
contractual obligations, future compliance costs associated with environmental
regulations and continuing creditworthiness of counterparties. Actual results
could differ materially from those estimates.
Periodically, in accordance with SFAS No. 144 and APB Opinion No. 18, long-lived
assets and equity method investments of CMS Energy and its subsidiaries are
evaluated to determine whether conditions, other than those of a temporary
nature, indicate that the carrying value of an asset may not be recoverable.
Management bases its evaluation on impairment indicators such as the nature of
the assets, future economic benefits, domestic and foreign state and federal
regulatory and political environments, historical or future profitability
measurements, as well as other external market conditions or factors that may be
present. If such indicators are present or other factors exist that indicate
that the carrying value of the asset may not be recoverable, CMS Energy
determines whether impairment has occurred through the use of an undiscounted
cash flow analysis of assets at the lowest level for which identifiable cash
flows exist. If impairment, other than of a temporary nature, has occurred, CMS
Energy recognizes a loss for the difference between the carrying value and the
estimated fair value of the asset. The fair value of the asset is measured using
discounted cash flow analysis or other valuation techniques. The analysis of
each long-lived asset is unique and requires management to use certain estimates
and assumptions that are deemed prudent and reasonable for a particular set of
circumstances. Of CMS Energy's total assets, valued at $13 billion at June 30,
2003, approximately 55 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. CMS
Energy is pursuing the sale of all of these non-strategic and under-performing
assets, including some assets that were not determined to be impaired. Upon the
sale of these assets, the proceeds realized may be materially different from the
remaining carrying value of these assets. Even though these assets have been
identified for sale, management cannot predict when, nor make any assurances
that, these asset sales will occur, or the amount of cash or the value of
consideration to be received.
Similarly, the recording of estimated liabilities for contingent losses within
the financial statements is guided by the principles in SFAS No. 5 that require
a company to record estimated liabilities in the financial statements when it is
probable that a loss will be incurred in the future as a result of a current
event, and when the amount can be reasonably estimated.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects to incur
significant costs for future environmental compliance, especially compliance
with clean air laws.
The EPA has issued regulations regarding nitrogen oxide emissions from certain
generators, including some of Consumers' electric generating facilities. These
regulations require Consumers to make significant capital expenditures estimated
to be $770 million. As of June 30, 2003, Consumers has incurred
CMS-2
CMS Energy Corporation
$430 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. At some point, when new
environmental standards become effective, Consumers will need additional capital
expenditures to comply with the standards. Capital expenditures will depend upon
final regulations.
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.
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 will be between $82 million and $113
million, using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. These estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between three and seven percent. Consumers
expects to recover a significant portion of these costs through MPSC-approved
rates charged to its customers. Any significant change in assumptions, such as
remediation techniques, nature and extent of contamination, and legal and
regulatory requirements, could change the remedial action costs for the sites.
For further information see Note 4, Uncertainties, "Consumers' Gas Utility
Contingencies - Gas Environmental Matters."
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV
Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990 and to supply electricity and steam to Dow. Consumers, through
two wholly owned subsidiaries, holds a 49 percent partnership interest in the
MCV Partnership, and a 35 percent lessor interest in the MCV Facility.
Consumers' annual obligation to purchase capacity from the MCV Partnership is
1,240 MW through the term of the PPA ending in 2025. The PPA requires Consumers
to pay, based on the MCV Facility's availability, a levelized average capacity
charge of 3.77 cents per kWh and a fixed energy charge, and also to pay a
variable energy charge based primarily on Consumers' average cost of coal
consumed for all kWh delivered. Consumers has not been allowed full recovery of
the capacity and fixed energy charges in rates. After September 2007, the PPA's
regulatory out terms obligate Consumers to pay the MCV Partnership only those
capacity and energy charges that the MPSC has authorized for recovery from
electric customers.
In 1992, Consumers recognized a loss and established a PPA liability for the
present value of the estimated future underrecoveries of power supply costs
under the PPA based on MPSC cost recovery orders. Primarily as a result of the
MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. The remaining after-tax present value of the estimated future PPA
liability associated with the loss totaled $26 million at June 30, 2003 and $42
million at June 30, 2002. The PPA liability is expected to be depleted in late
2004.
CMS-3
CMS Energy Corporation
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 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 during the next five
years, Consumers' after-tax cash underrecoveries associated with the PPA could
be as follows:
In Millions
- ------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 $36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $ - $ - $ -
======================================================================================================
As previously noted, the PPA requires Consumers to pay capacity costs based on
the MCV Facility's actual availability up to the 98.5 percent cap. Prior to
1998, Consumers was only allowed to recover MCV capacity costs that were
associated with actual energy deliveries (subject to certain caps established by
the MPSC). This recovery method essentially required Consumers to dispatch the
MCV Facility on a full-time basis, regardless of the overall cost compared to
other sources available to Consumers. Consistent with the initial PSCR freeze,
in the first quarter of 1998, Consumers began economically dispatching the MCV
Facility by scheduling deliveries on an economic basis. Consumers has continued
to economically dispatch the MCV Facility as a result of the overall rate freeze
implemented consistent with Public Acts 141 and 142. When Consumers returns to
the PSCR, beginning in January 2004, current MPSC orders will again only allow
Consumers to recover capacity charges from customers based on actual energy
deliveries up to the caps. Compared to periods under the rate freeze, the return
to full-time dispatch of the MCV Facility could have the effect of reducing the
earnings of CMS Midland via its ownership interest in the MCV Partnership. This
would be the result of MCV Partnership earnings being negatively impacted by the
relationship of higher fuel costs resulting from higher generation levels and
high natural gas prices, compared to the MCV Partnership's recovery of fuel
costs, which is, in large part, based on costs associated with Consumers' coal
plants.
Consumers is exploring possible alternatives that would allow Consumers to
continue dispatching the MCV
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Facility on an economic basis in 2004 and beyond, without increasing costs to
customers or impairing future earnings. Any changes regarding the recovery of
MCV capacity costs would require MPSC approval. Consumers cannot predict the
outcome of this issue.
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 court
overturned the lower court's order and dismissed the case against the MPSC. The
appellate court determined that the case was premature and concluded that the
qualifying facilities needed to wait until 2008 for an actual factual record to
develop before bringing claims against the MPSC in federal court.
For further information see Note 4, Uncertainties, "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 currently 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 put options, gas futures, and gas and power
swaps and forward purchases and sales. CMS Energy does not account for electric
capacity and certain energy contracts, gas supply contracts, coal and nuclear
fuel supply contracts, or purchase orders for numerous supply items as
derivatives.
Certain of Consumers' electric capacity and energy contracts are not derivatives
due to the lack of an active energy market in the state of Michigan, as defined
by SFAS No. 133, and the transportation cost to deliver the power under the
contracts to the closest active energy market at the Cinergy hub in Ohio. If a
market develops in the future, Consumers may be required to account for these
contracts as derivatives. The mark-to-market impact on earnings related to these
contracts, particularly related to the PPA, could be material to the financial
statements.
If a contract is accounted for as a derivative instrument, it is recorded in the
financial statements as an asset or a liability, at the fair value of the
contract. Any difference between the recorded book value and the fair value is
reported either in earnings or 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.
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In order to determine the fair value of contracts that are accounted for as
derivative instruments, CMS Energy uses a combination of quoted market prices
and mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the option contracts.
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
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.
In accordance with SEC disclosure requirements, CMS Energy performs sensitivity
analyses to assess the potential change in fair value, cash flows and earnings
based upon hypothetical 10 percent increases and decreases in market rates or
prices. Management does not believe that sensitivity analyses alone provide an
accurate or reliable method for monitoring and controlling risks. Therefore, CMS
Energy and its subsidiaries rely on the experience and judgment of senior
management to revise strategies and adjust positions as they deem necessary.
Changes in excess of the amounts determined in the sensitivity analyses could
occur if market rates or prices exceed the 10 percent shift used for the
analyses.
INTEREST RATE RISK: CMS Energy is exposed to interest rate risk resulting from
the issuance of fixed-rate and variable-rate debt, including interest rate risk
associated with trust preferred securities, and from interest rate swap
agreements. CMS Energy uses a combination of these instruments to manage and
mitigate interest rate risk exposure when deemed appropriate, based upon market
conditions. These strategies attempt to provide and maintain a balance between
risk and the lowest cost of capital. At June 30, 2003, the carrying amount of
long-term debt was $6.1 billion and trust preferred securities was $883 million,
with corresponding fair values of $6.3 billion and $769 million, respectively.
Based on a sensitivity
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analysis at June 30, 2003, CMS Energy estimates that if market interest rates
average 10 percent higher or lower, earnings before income taxes for the
subsequent 12 months would decrease or increase by approximately $4 million. In
addition, based on a 10 percent adverse shift in market interest rates, CMS
Energy would have an exposure of approximately $316 million to the fair value of
its long-term debt and trust preferred securities if it had to refinance all of
its long-term fixed-rate debt and trust preferred securities. CMS Energy does
not intend to refinance all of its long-term fixed-rate debt and trust preferred
securities; and therefore, CMS Energy believes that any adverse change in
interest rates would not have a material effect on its consolidated financial
position as of June 30, 2003.
At June 30, 2003, the fair value of CMS Energy's floating to fixed interest rate
swaps with a notional amount of $15 million was negative $2 million, which
represents the amount CMS Energy would pay to settle. The swaps mature at
various times through 2006 and are designated as cash flow hedges for accounting
purposes.
COMMODITY PRICE RISK: CMS Energy is exposed to market fluctuations in the price
of natural gas, oil, electricity, coal, natural gas liquids and other
commodities. CMS Energy employs established policies and procedures to manage
these risks using various commodity derivatives, including futures contracts,
options and swaps (which require a net cash payment for the difference between a
fixed and variable price), for non-trading purposes. The prices of these energy
commodities can fluctuate because of, among other things, changes in the supply
of and demand for those commodities. To minimize adverse price changes, CMS
Energy also hedges certain inventory and purchases and sales contracts. Based on
a sensitivity analysis, CMS Energy estimates that if energy commodity prices
change by an average 10 percent, operating income for the subsequent six months
would change by $0.3 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.
For purposes other than trading, Consumers enters into electric call options,
gas fuel for generation option and swap contracts, fixed price gas supply
contracts containing embedded put options, fixed priced weather-based gas supply
call options and fixed priced gas supply put options. The electric call options
are used to protect against risk due to fluctuations in the market price of
electricity and to ensure a reliable source of capacity to meet customers'
electric needs. The gas fuel for generation option and swap contracts are used
to protect generation activities against risk due to fluctuations in the market
price of natural gas. The gas supply contracts containing embedded put options,
the weather-based gas supply call options, and the gas supply put options are
used to purchase reasonably priced gas supply.
As of June 30, 2003 and 2002, the fair value of electricity-related call option
and swap contracts, based on quoted market prices and mathematical models using
current and historical pricing data, was $13 million and $13 million,
respectively. As of June 30, 2003 and 2002, assuming a hypothetical 10 percent
adverse change in market prices, the potential reduction in fair value
associated with these contracts would be $2 million and $3 million,
respectively. As of June 30, 2003 and 2002, Consumers had an asset of $26
million and $35 million, respectively, related to premiums incurred for electric
call option contracts. Consumers' maximum exposure associated with the call
option contracts is limited to the premiums incurred. As of June 30, 2003,
Consumers did not have any gas supply contracts containing embedded put options.
As of June 30, 2002, the fair value based on quoted market prices for gas supply
contracts containing embedded put options was $2 million. As of June 30, 2002,
assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $1
million. As of June 30, 2003, the fair value of the fixed priced weather-based
gas supply call options and fixed priced gas supply put options,
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based on quoted market prices, was $1 million. As of June 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 six months ended June 30, 2003, there was no mark-to-market
adjustment included in the total net foreign currency translation adjustment of
$46 million. At June 30, 2003, there were no foreign exchange hedges. Therefore,
a sensitivity analysis at June 30, 2003 would not be significant.
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 June 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 a discussion of accounting policies related to derivative transactions, see
Note 7, Risk Management Activities and Financial Instruments, incorporated by
reference herein.
MARK-TO-MARKET ACCOUNTING
Through December 31, 2002, CMS MST's wholesale power and gas trading activities
were accounted for under the mark-to-market method of accounting. Effective,
January 1, 2003, EITF Issue No. 98-10 was rescinded by EITF Issue No. 02-03 and
as a result, only energy contracts that meet the definition of a derivative in
SFAS No. 133 can be carried at fair value. The impact of this change for CMS MST
was recognized as a cumulative effect of a change in accounting principle loss
of $23 million, net of tax. See Note 10, Adoption of New Accounting Standards.
Under mark-to-market accounting, energy-trading contracts are reflected at fair
market value, net of reserves, with unrealized gains and losses recorded as an
asset or liability in the consolidated balance sheets. These assets and
liabilities are affected by the timing of settlements related to these
contracts, current-period changes from newly originated transactions and the
impact of price movements.
Changes in fair value are recognized as revenues in the consolidated statements
of income in the period in which the changes occur. Market prices used to value
outstanding financial instruments reflect management's consideration of, among
other things, closing exchange and over-the-counter quotations. In certain
contracts, long-term commitments may extend beyond the period in which market
quotations for such contracts are available and volumetric obligations may not
be defined. Mathematical models are developed to determine various inputs into
the fair value calculation including price, anticipated volumetric obligations
and other inputs that may be required to adequately address the determination of
fair value of the contracts. Realized cash returns on these commitments may
vary, either positively or negatively, from the results estimated through
application of the mathematical model. CMS Energy believes that its mathematical
models utilize state-of-the-art technology, pertinent industry data and prudent
discounting in order to forecast certain elongated pricing curves. Market prices
are adjusted to reflect the impact of
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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.
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of June 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 (12)
Other changes in fair value (c) 12
- ----------------------------------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of June 30, 2003 $ 15
=====================================================================================================================
(a) Reflects the removal of contracts that do not qualify as derivatives
under SFAS No. 133 as of January 1, 2003.
(b) Reflects $(60) million of price risk management assets sold and $30
million of price risk management assets received related to the sales
of the gas and power books.
(c) Reflects changes in price and net increase/(decrease) in position size
of forward positions as well as changes to mark-to-market and credit
reserves.
Fair Value of Contracts at June 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 $ (3) $ (1) $ (2) $ - $ -
Prices based on models and
other valuation methods 18 6 12 - -
- -------------------------------------------------------------------------------------------------------------------
Total $ 15 $ 5 $ 10 $ - $ -
===================================================================================================================
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.
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BALANCE SHEET: CMS Energy's subsidiaries and affiliates whose functional
currency is other than the U.S. dollar translate their assets and liabilities
into U.S. dollars at the exchange rates in effect at the end of the fiscal
period. The revenue and expense accounts of such subsidiaries and affiliates are
translated into U.S. dollars at the average exchange rate during the period. The
gains or losses that result from this process, and gains and losses on
intercompany foreign currency transactions that are long-term in nature that CMS
Energy does not intend to settle in the foreseeable future, are reflected as a
component of stockholders' equity in the consolidated balance sheets as "Foreign
Currency Translation" in accordance with the accounting guidance provided in
SFAS No. 52. As of June 30, 2003, the cumulative Foreign Currency Translation
decreased stockholders' equity by $412 million. Included in this amount is an
unrealized loss of $118 million, net of tax, related to CMS Energy's investment
in Loy Yang. The loss will be realized upon sale, full liquidation, or other
disposition of CMS Energy's investment in Loy Yang. In July 2003, a conditional
share sale agreement for CMS Energy's investment in Loy Yang was executed. See
Outlook, "Corporate Outlook" section below 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
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
June 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 Stockholder's Equity using an exchange rate of 2.975 pesos
per U.S. dollar was $253 million. This amount also reflects the effect of
recording U.S. income taxes with respect to temporary differences between the
book and tax basis of foreign investments, including the foreign currency
translation associated with CMS Energy's Argentine investments, that were
determined to no longer be essentially permanent in duration.
INCOME STATEMENT: For subsidiaries operating in highly inflationary economies or
that meet the U.S. functional currency criteria outlined in SFAS No. 52, the
U.S. dollar is deemed to be the functional currency. Gains and losses that arise
from exchange rate fluctuations on transactions denominated in a currency other
than the U.S. dollar, except those that are hedged, are included in determining
net income.
HEDGING STRATEGY: CMS Energy uses forward exchange and option contracts to hedge
certain receivables, payables, long-term debt and equity value relating to
foreign investments. The purpose of CMS Energy's foreign currency hedging
activities is to protect the company from risk that U.S. dollar net cash flows
resulting from sales to foreign customers and purchases from foreign suppliers
and the repayment of non-U.S. dollar borrowings, as well as the equity reported
on the company's balance sheet, may be adversely
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affected by changes in exchange rates. These contracts do not subject CMS Energy
to risk from exchange rate movements because gains and losses on such contracts
are inversely correlated with the losses and gains, respectively, on the assets
and liabilities being hedged. Foreign currency adjustments for other CMS Energy
international investments were 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 June 30, 2003, Consumers had $1.128 billion recorded as
regulatory assets and $468 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. 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, Adoption 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
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
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require the expertise of actuaries and are subject to many assumptions including
life expectancies, present value discount rates, expected long-term rate of
return on plan assets, rate of compensation increase and anticipated health care
costs. Any change in these assumptions can significantly change the liability
and associated expenses recognized in any given year.
The Pension Plan includes amounts for employees of CMS Energy and non-utility
affiliates which are not distinguishable from the Pension Plan's total assets.
On June 11, 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, subject to receipt of the final
actuarial report, resulted in an increase of CMS Energy's 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.
CMS Energy estimates 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 changes to the Pension Plan, 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. In addition, CMS Energy has announced its intent to
implement a cash balance plan for newly hired employees. Plan details have not
yet been completed.
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 a
year. Consumers estimates that at the time of the decommissioning of Palisades,
its decommissioning trust fund will be fully funded. Earnings assumptions are
that the trust funds are invested in equities and fixed income investments,
equities will be converted to fixed income investments during decommissioning
and fixed income investments are converted to cash as needed. Decommissioning
costs have been developed, in part, by independent contractors with expertise in
decommissioning. These costs estimates use various inflation rates for labor,
non-labor, and contaminated equipment disposal costs.
In December 2000, the Big Rock trust fund was considered fully funded. A portion
of its current decommissioning cost resulted from the failure of the DOE to
remove fuel from the site. These costs, and similar costs incurred at Palisades,
would not be necessary but for the failure of the DOE to take possession of the
spent fuel as required by the Nuclear Waste Policy Act of 1982. A number of
utilities, including Consumers, which filed its complaint in December 2002, have
commenced litigation in the Court of Claims.
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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 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.
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RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
In Millions (Except for per share amounts)
- -------------------------------------------------------------------------------------------------------------------
Three months ended June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
CMS Energy Net Loss $ (45) $ (74)
CMS Energy Basic Loss Per Share $ (0.31) $ (0.55)
CMS Energy Diluted Loss Per Share $ (0.31) $ (0.55)
- -------------------------------------------------------------------------------------------------------------------
CMS Energy results of operations continue to reflect the on-going asset sales
program and financial plan that began in 2001. The on-going asset sales program
encompasses the sale of non-strategic and under-performing assets in order to
generate cash to pay down debt, to reduce business risk, and to provide for more
predictable future earnings. The financial plan focuses on strengthening CMS
Energy's balance sheet and improving financial liquidity through debt reduction
and aggressive cost management.
In Millions
- -------------------------------------------------------------------------------------------------------------------
Three months ended June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Electric Utility $ 35 $ 84 $ (49)
Gas Utility 5 3 2
Enterprises 13 3 10
Corporate Interest and Other (58) (54) (4)
---------------------------------------
Income (Loss) from Continuing Operations (5) 36 (41)
--------------------------------------
Discontinued Operations (40) (127) 87
Accounting Changes - 17 (17)
----------------------------------------
Net Loss $ (45) $ (74) $ 29
===================================================================================================================
For the three months ended June 30, 2003, CMS Energy's net loss totaled $45
million, an improvement of $29 million from 2002. Loss from continuing
operations was $5 million, a decrease of $41 million from the comparable period
in 2002. The decrease in earnings from continuing operations primarily reflects
the absence of an after-tax gain of $31 million associated with asset sales at
the Electric Utility recorded in the second quarter of 2002 and decreased
Electric and Gas Utility deliveries in 2003. The reduction in earnings from
continuing operations was partially offset by improved IPP earnings and foreign
currency gains related to the stabilization of the Argentine Peso. Loss from
discontinued operations which includes a $30 million after-tax loss resulting
from the sale of Panhandle, was $40 million, an improvement of $87 million from
the comparable period in 2002. In the second quarter of 2002, net loss reflected
$17 million of after-tax earnings recorded due to an accounting change to adjust
the fair value of certain long-term contracts held by the MCV Partnership.
CMS-14
CMS Energy Corporation
In Millions (Except for per share amounts)
- -------------------------------------------------------------------------------------------------------------------
Six months ended June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
CMS Energy Net Income (Loss) $ 34 $ (32)
CMS Energy Basic Earnings (Loss) Per Share $ 0.24 $ (0.24)
CMS Energy Diluted Earnings (Loss) Per Share $ 0.24 $ (0.24)
- -------------------------------------------------------------------------------------------------------------------
In Millions
- -------------------------------------------------------------------------------------------------------------------
Six months ended June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Electric Utility $ 86 $ 134 $ (48)
Gas Utility 59 31 28
Enterprises 35 69 (34)
Corporate Interest and Other (109) (105) (4)
----------------------------------------
Net Income (Loss) from Continuing Operations 71 129 (58)
-----------------------------------------
Discontinued Operations (13) (178) 165
Accounting Changes (24) 17 (41)
- -------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 34 $(32) $ 66
===================================================================================================================
For the six months ended June 30, 2003, net income totaled $34 million, an
increase of $66 million from the comparable period in 2002. Income from
continuing operations totaled $71 million compared to $129 million for the
comparable period in 2002, a decrease of $58 million. The decrease in income
from continuing operations primarily reflects the absence of an after-tax gain
of $31 million associated with asset sales at the Electric Utility recorded in
2002 and reduced Enterprises earnings reflecting the shift in business strategy
at CMS MST and Gas Transmission (see the 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. The six months ended June 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
six months ended June 30, 2002 net income reflects $17 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. For the six months ended June 30, 2003, loss from discontinued
operations, which includes a $30 million after-tax loss resulting from the sale
of Panhandle, totaled $13 million, an improvement of $165 million from the
comparable period in 2002. The six months ended June 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 Panhandle of $(369) million
and at CMS Viron of $(10) million, which are reflected in discontinued
operations.
CMS-15
CMS Energy Corporation
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC UTILITY NET INCOME:
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $35 $84 $(49)
Six months ended $86 $134 $(48)
===================================================================================================================
Three Months Ended Six Months Ended
Reasons for change June 30, 2003 vs. 2002 June 30, 2003 vs. 2002
- -------------------------------------------------------------------------------------------------------------------
Electric deliveries $ (18) $ (5)
Power supply costs and related revenue (1) 12
Other operating expenses and non-commodity revenue (14) (36)
Asset sales (38) (38)
General taxes 15 15
Fixed charges (11) (14)
Income taxes 18 18
--------------------------------------
Total change $ (49) $ (48)
===================================================================================================================
ELECTRIC DELIVERIES: For the three months ended June 30, 2003, electric delivery
revenues decreased by $18 million from the previous year. Electric deliveries,
including transactions with other wholesale market participants and other
electric utilities, were 9.3 billion kWh, a decrease of 0.1 billion kWh or 1.6
percent from 2002. The decrease in revenue is primarily the result of cooler
temperatures in 2003 that resulted in decreased deliveries to the higher margin
residential sector along with the migration to the lower margin retail delivery
sector by commercial and industrial customers.
For the six months ended June 30, 2003, electric delivery revenues decreased by
$5 million from the previous year. Electric deliveries, including transactions
with other wholesale market participants and other electric utilities, were 19.0
billion kWh, an increase of 0.4 billion kWh or 2.0 percent from 2002. This
decrease in delivery revenues can be attributed to the continued migration by
commercial and industrial customers to the lower margin retail delivery sector.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended June 30,
2003, power supply costs and related revenues decreased electric net income by
$1 million from 2002.
For the six months ended June 30, 2003, power supply costs and related revenues
increased electric net income by $12 million from 2002. This increase is
primarily the result of increased intersystem revenues due to higher market
prices and additional surplus capacity.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three and six months
ended June 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 are increased non-commodity revenues associated
with miscellaneous service revenues.
CMS-16
CMS Energy Corporation
ASSET SALES: For the three and six months ended June 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 and six months ended June 30, 2003, general taxes
decreased $15 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 six months ended June 30, 2003, fixed charges
increased $11 million and $14 million, respectively, from the comparable period
in 2002. These increases can be attributed to the increased financing
activities.
INCOME TAXES: For the three months ended June 30, 2003, income tax expense
decreased primarily due to a decrease in earnings by the electric utility
compared to 2002.
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
GAS UTILITY NET INCOME:
In Millions
- ---------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- ---------------------------------------------------------------------------------------------------------------------
Three months ended $ 5 $ 3 $ 2
Six months ended $ 59 $31 $28
=====================================================================================================================
Three Months Ended Six Months Ended
Reasons for change June 30, 2003 vs. 2002 June 30, 2003 vs. 2002
- ---------------------------------------------------------------------------------------------------------------------
Gas deliveries $(3) $31
Gas rate increase 5 25
Gas wholesales and retail services 3 6
Operation and maintenance (4) (14)
General taxes, depreciation, and other income 5 (1)
Fixed charges (2) (4)
Income taxes (2) (15)
-----------------------------------------------
Total change $ 2 $28
=====================================================================================================================
GAS DELIVERIES: For the three months ended June 30, 2003, gas delivery revenues
decreased by $3 million from the previous year. System deliveries, including
miscellaneous transportation, totaled 60.8 bcf, a decrease of 4.5 bcf or 6.9
percent compared with 2002.
CMS-17
CMS Energy Corporation
For the six months ended June 30, 2003, gas delivery revenues increased by $31
million from the previous year. System deliveries, including miscellaneous
transportation, totaled 234.5 bcf, an increase of 20 bcf or 9.3 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 six months ended June 30, 2003,
Consumers recognized increased gas revenues of $5 million and $25 million,
respectively.
OPERATION AND MAINTENANCE: For the three and six months ended June 30, 2003,
operation and maintenance expenses increased $4 million and $14 million,
respectively, when compared to 2002. This increase reflects the recognition of
additional expenditures on safety, reliability and customer service.
INCOME TAXES: For the three and six months ended June 30, 2003, income tax
expense increased primarily due to improved earnings of the gas utility.
ENTERPRISES RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $ 13 $ 3 $ 10
Six months ended $ 35 $ 69 $ (34)
===================================================================================================================
For the three months ended June 30, 2003, Enterprises' net income was $13
million, an increase of $10 million from the comparable period in 2002. The
increase reflects primarily improved IPP earnings and foreign currency gains
related to the stabilization of the Argentine Peso, partially offset by an
increase in financing costs associated with 2003 bridge loans.
For the six months ended June 30, 2003, Enterprises' net income was $35 million,
a decrease of $34 million from the comparable period in 2002. The decrease
reflects reduced CMS MST and CMS Gas Transmission earnings due primarily to the
shift in business strategy. (See the Enterprises Outlook section in the MD&A.)
The decrease was offset partially by improved IPP earnings and foreign currency
gains related to the stabilization of the Argentine Peso.
OTHER RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $ (58) $ (54) $ (4)
Six months ended $ (109) $ (105) $ (4)
===================================================================================================================
For the three months ended June 30, 2003, corporate interest and other net
expenses were $58 million, an increase of $4 million from the comparable period
in 2002. The increase reflects primarily the establishment of a $24 million
income tax credit valuation reserve because CMS Energy has determined
CMS-18
CMS Energy Corporation
that the tax credits due to changes in its tax planning strategy may not be used
in the future. The increase was offset partially by the Michigan Single Business
Tax refunds of $20 million and reduced Parent interest expenses.
For the six months ended June 30, 2003, corporate interest and other net
expenses were $109 million, an increase of $4 million from the comparable period
in 2002. The increase reflects primarily the changes in the three months ended
June 30, 2003 as discussed above.
OTHER: During the second quarter of 2003, CMS Energy completed the sale of CMS
Panhandle Companies for total proceeds of $1.8 billion, including $1.166 billion
of assumed debt, 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, and $582 million cash. In addition, CMS Energy completed the sale of the
remainder of its energy management services business, CMS Viron and the sale of
its one-third membership interest in the Guardian Pipeline, L.L.C. For more
information, see Note 3 Discontinued Operations.
DISCONTINUED OPERATIONS: At June 30, 2003, discontinued operations included CMS
Field Services, International Energy Distribution, and Marysville, as well as
Panhandle and CMS Viron through their respective dates of sale. At June 30,
2002, discontinued operations included Panhandle, CMS Viron, CMS Field Services,
International Energy Distribution, and Marysville. 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 six months
of 2003, Consumers paid $109 million in common dividends and Enterprises paid
$35 million in common dividends to CMS Energy. In June 2003, Consumers declared
a $53 million common dividend to CMS Energy, payable in August 2003. CMS
Energy's consolidated cash requirements are met by its operating, investing, and
financing activities. Consistent with CMS Energy's liquidity objectives, $1.1
billion consolidated cash was on hand at June 30, 2003, which includes $187
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.
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 six
months, cash from operations after interest charges totaled $133 million in 2003
and $412 million in 2002. The $279 million decrease in cash from operations
resulted primarily from an increase in accounts receivable and accrued revenues,
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 six months, CMS Energy's net cash provided
by investing activities totaled $461 million in 2003 and $855 million in 2002.
The $394 million decrease in cash provided
CMS-19
CMS Energy Corporation
primarily reflects a decrease in proceeds received from the sale of assets of
$560 million. CMS Energy's expenditures, including investments and assets placed
under capital lease, in the first six months of 2003 for its utility and
diversified energy businesses were $232 million and $44 million, respectively,
compared to $316 million and $113 million, respectively, for the first six
months of 2002.
FINANCING ACTIVITIES: For the first six months, CMS Energy's net cash used in
financing activities totaled $42 million in 2003 and $1.172 billion in 2002. The
$1.13 billion change in cash resulted primarily from an increase in proceeds
received from notes, bonds and other long-term debt of $1,059 million, a
decrease in retirement of notes, bonds and other long-term debt of $512 million,
a decrease in the retirement of trust preferred securities of $30 million, and a
decrease in the payment of common stock dividends of $97 million. These
improvements in financing activities were offset partially by a decrease in the
proceeds received from the issuance of common stock of $57 million and a larger
decrease in notes payable of $344 million.
The above discussion of operating, investing, and financing activities
summarizes CMS Energy's consolidated statements of cash flows found in CMS
Energy's consolidated financial statements.
In January 2003, the Board of Directors suspended the payment of CMS Energy's
common stock dividend in order to improve liquidity.
OTHER INVESTING AND FINANCING MATTERS: 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.
In July 2003, CMS Energy retired $150 million principal amount of CMS Energy's
8.375% Reset Put Securities due 2013. As a result, CMS Energy will record 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.
CREDIT FACILITIES: On March 30, 2003, CMS Energy entered into an amendment and
restatement of its existing $300 million and $295.8 million revolving credit
facilities under which $409 million was then outstanding. The Second Amended and
Restated Senior Credit Agreement includes a $159 million tranche with a maturity
date of April 30, 2004 and a $250 million tranche with a maturity date of
September 30, 2004. The facility was underwritten by several banks at a total
annual cost to CMS Energy of approximately ten percent, which includes the
initial commitment fee. Any proceeds of debt or equity issuances by CMS Energy
and its subsidiaries or any asset sales by CMS Energy or its subsidiaries, other
than Consumers, are required to be used to prepay this facility. This facility
is collateralized primarily by the stock of Consumers, Enterprises and certain
Enterprises subsidiaries. At June 30, 2003, $390 million was outstanding under
this facility.
On March 30, 2003, Enterprises entered into a revolving credit facility in an
aggregate amount of $441 million. The maturity date of this facility is April
30, 2004. Subsequently, on April 21, 2003, Enterprises entered into a $75
million revolving credit facility with a maturity date of April 30, 2004. As a
result of the Panhandle sale, these credit facilities were paid in full and
terminated in June 2003.
In March 2003, Consumers obtained a replacement revolving credit facility in the
amount of $250 million secured by first mortgage bonds; this debt facility was
paid down and had a zero balance outstanding at
CMS-20
CMS Energy Corporation
June 30, 2003. The interest rate of the facility is LIBOR plus 350 basis points.
The new credit facility matures in March 2004 with two annual extensions at
Consumers' option, which would extend the maturity to March 2006. The prior
facility was due to expire in July 2003.
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 June 30, 2003, approximately $171 million of letters of credit
were issued under this facility and are included on the balance sheet as
restricted cash.
REGULATORY AUTHORIZATION FOR FINANCINGS: At June 30, 2003, Consumers had FERC
authorization to issue or guarantee through June 2004, up to $1.1 billion of
short-term securities outstanding at any one time. In June 2003, the FERC
granted Consumers' request to issue an additional $1.1 billion outstanding at
any one time of first mortgage bonds to act solely as collateral for short-term
securities. In June 2003, the FERC also granted Consumers' request for an
increase in its authorization for long-term debt. At June 30, 2003, Consumers
had remaining FERC authorization to issue through June 2004 up to $1 billion of
long-term securities for refinancing or refunding purposes, $760 million for
general corporate purposes, and $2.06 billion of first mortgage bonds to be
issued solely as collateral for the long-term securities. These amounts include
the June 2003 increase in FERC authorization. In October 2002, FERC granted a
waiver of its competitive bid/negotiated placement requirements applicable to
the remaining long-term securities authorization indicated above.
LONG TERM FINANCINGS: In July 2003, CMS Energy issued, in a private placement to
institutional investors, $150 million of 3.375% convertible senior notes due
2023 and $300 million of 7.75% senior notes due 2010. CMS Energy has granted the
initial purchasers an option to purchase up to an additional $50 million of the
convertible senior notes for a period of 45 days after the July 16, 2003
closing. The approximately $433 million of net proceeds from these offerings
were used to retire a portion of the debt outstanding under CMS Energy's Second
Amended and Restated Senior Credit Agreement and to redeem a portion of CMS
Energy's 6.75% Senior Notes due January 2004. If exercised, the proceeds from
the initial purchasers' option for the additional $50 million convertible senior
notes would be used to refinance existing indebtedness.
The following table is a summary of Consumers' debt issuances during 2003:
CMS-21
CMS Energy Corporation
Long-Term Debt Financings in 2003 In Millions
- ----------------------------------------------------------------------------------------------------------------
Facility Issue Use of
Type Principal Rate Date Maturity Proceeds Collateral
- ----------------------------------------------------------------------------------------------------------------
Term loan $ 140 LIBOR March 2003 March 2009 GCP FMB(c)
Plus 475
Basis points
Term loan 150 LIBOR March 2003 March 2006 GCP FMB(c)
Plus 450
Basis points
FMB (a) 375 5.375 April 2003 April 2013 (b) -
FMB (a) 250 4.25 April 2003 April 2008 (b) -
FMB (a) 250 4.00 May 2003 May 2010 Retire debt -
-----
Total $ 1,165
================================================================================
(GCP) General corporate purposes
(a) Consumers has agreed to file a registration statement with the SEC to permit
holders of these first mortgage bonds to exchange the bonds for new bonds that
will be registered under the Securities Act of 1933. Consumers has agreed to
file this registration statement by December 26, 2003.
(b) 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.
(c) Refer to Capital Resources and Liquidity, "Regulatory Authorization for
Financings" above for information about Consumers' remaining FERC debt
authorization.
As part of Consumers' ongoing cost reduction measures, Consumers will continue
to monitor financial markets in an attempt to reduce its financing costs.
Consumers' current portion of long-term debt maturing in 2003 and 2004 is $27
million. Refer to Outlook, "Consumers Energy Liquidity" below for information
about Consumers strategic measures addressing its future liquidity and capital
requirements.
REQUIRED RATIOS: CMS Energy's and Consumers' credit facilities have contractual
restrictions that require CMS Energy and Consumers to maintain, as of the last
day of each fiscal quarter, the following:
Required Ratio Limitation Ratio at June 30, 2003
- ----------------------------------------------------------------------------------------------------------
CMS ENERGY:
Consolidated Leverage Ratio(a)(b) not more than 7.00 to 1.00 5.70 to 1.00
Cash Dividend Coverage Ratio(a) not less than 1.20 to 1.00 1.49 to 1.00
CONSUMERS:
Debt to Capital Ratio(a)(b) not more than 0.65 to 1.00 0.57 to 1.00
Interest Coverage Ratio-Revolver(a)(b) not less than 2.00 to 1.00 3.83 to 1.00
Interest Coverage Ratio-Term Loan(a)(b) not less than 2.00 to 1.00 3.98 to 1.00
- ----------------------------------------------------------------------------------------------------------
CMS-22
CMS Energy Corporation
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to
declare the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of
securitization bonds in the calculation of this ratio.
In 1994, CMS Energy executed an indenture with J.P. Morgan Chase Bank pursuant
to CMS Energy's general term notes program. The indenture, through supplements,
contains certain provisions that can trigger a limitation on CMS Energy's
consolidated indebtedness. The limitation can be activated when CMS Energy's
consolidated leverage ratio, as defined in the indenture (essentially the ratio
of consolidated debt to consolidated capital), exceeds 0.75 to 1.0. At June 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 refinance existing debt
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 June 30, 2003, CMS Energy's
consolidated coverage ratio was 2.06 to 1.0. CMS Energy expects that due to
increased interest expenses to be incurred in the third quarter of 2003, CMS
Energy's consolidated coverage ratio may be below 1.70 to 1.0 at September 30,
2003. As a result, CMS Energy may be subject to indebtedness limitations
similar but less restrictive than those included in the general term note
indenture mentioned above.
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, June 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. After giving effect to the adoption of SFAS
No. 150 regarding the balance sheet classification of its Trust Preferred
Securities and to expected future use of its revolving credit facilities,
Consumers currently estimates that its ratio of indebtedness to total
capitalization at the end of the third and fourth quarters of 2003 will still
comply with the Debt Percentage Tests but will approach the limits specified in
some of the Debt Percentage Tests. Consumers plans to seek amendments to the
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 regarding Trust Preferred Securities on the calculations. Consumers believes
that it will receive the necessary consents of its lenders to these amendments.
However, it is possible that if Consumers does not receive the necessary
amendments and fails to be in compliance with some of the Debt Percentage Tests
such failure could constrain its ability to access its revolving credit or
accounts receivable sales facilities, or to incur additional indebtedness, and
could also result in defaults under one or more of these agreements.
RESTRICTED PAYMENTS: Covenants in Consumers' debt facilities cap common stock
dividend payments to $300 million in a calendar year. Consumers paid common
stock dividends of $208 million plus a capital distribution of $25 million in
2002 to CMS Energy. In January 2003, Consumers declared and paid a $78 million
common dividend. In March 2003, Consumers declared a $31 million common dividend
which was paid in May 2003. In June 2003, Consumers declared a $53 million
common dividend payable in August 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."
OBLIGATIONS AND COMMITMENTS
The following information on CMS Energy's contractual obligations, off-balance
sheet arrangements and commercial commitments is provided to collect information
in a single location so that a picture of liquidity and capital resources is
readily available.
CONTRACTUAL OBLIGATIONS: CMS Energy has contractual obligations including
long-term debt, notes payable, and capital lease obligations. Notes payable
include Consumers' $250 million revolving credit agreement. Capital leases
include leased service vehicles and the new headquarters building.
OFF-BALANCE SHEET ARRANGEMENTS: CMS Energy's use of long-term contracts for the
purchase of commodities and services, the sale of Consumers' accounts
receivables, and operating leases are considered to be off-balance sheet
arrangements.
CMS Energy's operating leases are predominately railroad coal car leases,
aircraft, vehicles and miscellaneous office equipment. The full lease obligation
becomes due in case of lease payment default.
SALE OF ACCOUNTS RECEIVABLE: In April 2003, Consumers ended its trade
receivables sales program with its existing purchaser. During May 2003, a new
trade receivables program was put in place with a different purchaser. As a
result of changing purchasers, Consumers established a new subsidiary, Consumers
Receivables Funding II. This consolidated subsidiary was established as a
special purpose entity in order to properly reflect the sale of receivables from
Consumers to Consumers Receivables Funding II, through to the purchaser, an
unrelated third party. The program's maximum receivable sale amount of $325
million remains unchanged. Consumers also will continue to retain servicing
responsibilities for the trade
CMS-23
CMS Energy Corporation
receivables sold, however, the purchaser of the trade 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 trade receivables sold and Consumers retains no interest in
the receivables sold. Accounts receivable and accrued revenue in the
Consolidated Balance Sheet have been reduced to reflect trade receivables sold.
At June 30 receivables sold under the program totaled $50 million in 2003 and
$311 million in 2002.
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. Consumers has long-term power purchase agreements with
various generating plants including the MCV Facility. These contracts require
monthly capacity payments based on the plants' availability or deliverability.
These payments are approximately $47 million per month for the remaining six
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.
In addition, CMS Energy, through its subsidiary companies, has equity
investments in partnerships and joint ventures in which they have a minority
ownership interest. As of June 30, 2003, CMS Energy's proportionate share of
unconsolidated debt associated with these investments was $2.7 billion. This
unconsolidated debt is non-recourse to CMS Energy and is not included in the
amount of long-term debt that appears on CMS Energy's Consolidated Balance
Sheets.
The following table shows a summary of CMS Energy's contractual obligations,
including off-balance sheet commitments at June 30, 2003.
Contractual Obligations In Millions
- -------------------------------------------------------------------------------------------------------------------
Payments Due
--------------------------------------------------------------
June 30 Total 2003 2004 2005 2006 2007 Beyond
- -------------------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $6,055 $ - $ 517 $ 740 $ 663 $ 538 $3,597
Current portion of debt 529 55 474 - - - -
Notes payable 1 1 - - - - -
Capital lease obligations(a) 147 9 17 18 17 16 70
- -------------------------------------------------------------------------------------------------------------------
Total on-balance sheet $6,732 $ 65 $ 1,008 $ 758 $ 680 $ 554 $3,667
- -------------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Non-recourse debt $2,676 $263 $152 $114 $406 $13 $1,728
Operating leases 92 10 13 11 11 10 37
Sale of accounts receivable 50 50 - - - - -
Unconditional purchase
Obligations 18,999 1,805 1,464 1,194 901 740 12,895
- -------------------------------------------------------------------------------------------------------------------
Total off-balance sheet $21,817 $2,128 $1,629 $1,319 $1,318 $763 $14,660
===================================================================================================================
(a) Capital lease obligations include $15 million of imputed interest.
COMMERCIAL COMMITMENTS: As of June 30, 2003, CMS Energy, Enterprises, and their
subsidiaries have guaranteed payment of obligations through guarantees,
indemnities and letters of credit, of unconsolidated
CMS-24
CMS Energy Corporation
affiliates and related parties approximating $633 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 June 30, 2003, the actual amount of financial exposure covered by these
guarantees and indemnities was $157 million. Management monitors and approves
these obligations and believes it is unlikely that CMS Energy would be required
to perform or otherwise incur any material losses associated with these
guarantees. Indemnities are three-party agreements used to assure performance of
contracts by CMS Energy. Letters of credit are issued by banks guaranteeing CMS
Energy's payments of its drafts. Drafts are for a stated amount and for a
specified period; they substitute the bank's credit for CMS Energy's and
eliminate the credit risk for the other party.
Commercial Commitments In Millions
- -------------------------------------------------------------------------------------------------------------------
Commitment Expiration
------------------------------------------------------------
June 30 Total 2003 2004 2005 2006 2007 Beyond
- -------------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $ 314 $ 20 $ - $ - $ 4 $ - $290
Indemnities 111 - - 36 - - 75
Letters of Credit 208 13 191 - - - 4
- -------------------------------------------------------------------------------------------------------------------
Total $ 633 $ 33 $ 191 $ 36 $ 4 $ - $369
===================================================================================================================
For further information, see Note 5, Short-Term and Long-Term Financings and
Capitalization, incorporated by reference herein.
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 June 30, 2003, CMS
Energy at the parent level had approximately $34 million, Consumers and its
subsidiaries had approximately $13 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 six months ended June 30, 2003,
CMS Energy has received cash proceeds of approximately $726 million and stock
valued at approximately $49 million as a result of additional asset sales as
described below.
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CMS Energy Corporation
In January 2003, CMS MST closed on the sale of a substantial portion of its
natural gas trading contracts for $17 million of cash proceeds. The sale of
Centennial, resulting in proceeds to CMS Energy of $40 million, closed in
February 2003. In March 2003, CMS MST sold the majority of its wholesale power
book and related supply portfolio to Constellation Power Source, Inc. for 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.
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 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 approximately
$582 million in cash, subject to post closing adjustments, 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 allows
CMS Energy to sell the stock 90 days after the closing date of June 11, 2003.
The Southern Union common stock has been 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, CMS Energy now holds 3.15 million shares of Southern
Union common stock, worth approximately $48.5 million, based on the July 31,
2003 closing price of $15.41 per share. Southern Union Panhandle Corp. also
assumed approximately $1.166 billion of Panhandle debt. CMS Energy used the 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, subject to post-closing adjustments, 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).
CMS Energy believes that further targeted asset sales, together with its planned
reductions in operating expenses, capital expenditures, and the suspension of
the common dividend also will contribute to improved liquidity. CMS Energy
believes that, assuming the successful implementation of its financial plan, its
present level of cash and borrowing capacity along with anticipated cash flows
from operating and investing activities will be sufficient to meet its liquidity
needs through 2003.
CMS Energy continues to explore financing opportunities to improve its financial
position. These potential opportunities include refinancing its bank credit
facilities; refinancing and issuing new capital markets debt, preferred and/or
common equity; and negotiating private placement debt, preferred and/or common
equity.
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CMS Energy Corporation
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.
Consumers has historically met its consolidated cash needs through its operating
and financing activities and access to bank financing and the capital markets.
In 2003, Consumers has contractual obligations and planned capital expenditures
that would require substantial amounts of cash. Consumers may also become
subject to liquidity demands pursuant to commercial commitments under
guarantees, indemnities and letters of credit as indicated above. Consumers
plans to meet its liquidity and capital requirements in 2003 through a
combination of borrowings, reduced capital expenditures, cash flow generated
from operations, and other measures. Refer to Capital Resources and Liquidity,
"Long Term Financings" above for information about Consumers' 2003 debt
financing.
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. In addition, the following activities also have been
initiated by Consumers to enhance further its liquidity:
o Consumers filed a general rate case for its gas utility business in
March, 2003. Consumers requested rate relief in the amount of
approximately $156 million. In its filing, Consumers requested
immediate interim relief. See Consumers' Gas Utility Business Outlook,
"2003 Gas Rate Case" below for MPSC Staff recommended interim rate
relief.
o Consumers filed an application in March 2003, with the MPSC seeking
authorization to issue $1.084 billion of Securitization bonds. These
bonds would provide liquidity to Consumers at interest rates reflective
of high quality credit. Consumers would utilize these proceeds to
retire higher cost debt and in turn would realize significant interest
expense savings over the life of the bonds.
In June 2003, the MPSC issued a financing order authorizing the issuance of the
Securitization bonds in the amount of approximately $554 million. 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. The financing order will
only become effective after rehearing and upon acceptance by Consumers.
Consumers anticipates that bonds could be issued by the first quarter 2004.
For further information on Securitization see, Consumers' Electric Utility
Business Outlook, "Competition and Regulatory Restructuring - Securitization."
There is no assurance that the pending Securitization bond issuance transaction
noted above will be completed, nor is there assurance that the MPSC will grant
either interim or final gas utility rate relief.
CMS-27
CMS Energy Corporation
CORPORATE OUTLOOK
During 2003, CMS Energy continued to implement its financial plan and its
on-going asset sales program first announced in 2001. The financial plan focuses
on strengthening CMS Energy's balance sheet and improving financial liquidity
through debt reduction and aggressive cost management. The on-going asset sales
program's objectives are to generate cash to reduce debt, reduce business risk,
and provide for more predictable future earnings. This encompasses the sale of
non-strategic and under-performing assets, the proceeds of which are being used
to reduce debt.
Consistent with its "back-to-basics" strategy, CMS Energy is pursuing actively
the sale of non-strategic and under-performing assets and has received
approximately $3.5 billion of cash from asset sales, securitization proceeds and
proceeds from LNG monetization. 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 assurances that, these asset
sales will occur. CMS Energy anticipates, however, that the sales, if any, will
result in additional cash proceeds that will be used to retire existing debt of
CMS Energy or Consumers.
In July 2003, CMS Energy completed the sale of CMS Field Services to Cantera
Resources Inc. for approximately $113 million in cash 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 net sales proceeds of
approximately $100 million were used to reduce debt.
An affiliate of CMS Generation owns a 49.6 percent interest in the Loy Yang
Power Partnership ("LYPP"), which owns the 2,000 megawatts 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
operating and debt-service obligations. LYPP has A$500 million of term bank debt
that, pursuant to prior extensions from the lenders, was scheduled to mature on
July 11, 2003. A further extension was received and as a result, this debt now
is scheduled to mature on November 11, 2003. 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) or 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
indicated its concern with the potential anticompetitive effects of this
transaction. Closing is targeted for early September 2003. Given the regulatory
uncertainties, however, 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 November 2, 2003, assuming satisfactory interim resolution of other
closing conditions. The share sale agreement provides GEAC a
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CMS Energy Corporation
period of exclusivity while the conditions of the purchase are satisfied. The
signing of the share sale agreement allows GEAC to begin discussions with LYPP's
lenders to pursue a debt restructuring. 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 $118 million at June 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.
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 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. The plant will
be located within the Saudi Petrochemical Company's (SADAF) complex at the
Jubail Industrial City in Saudi Arabia. CMS Energy owns 25 percent of Jubail
Energy Company, which has entered into a long-term contract with SADAF for the
entire output of the plant. CMS Energy's equity in the project is a
reimbursement of its prior development costs. CMS Energy does not plan to put
any additional funds into the project or be a long-term investor in Saudi
Arabia. The plant is expected to be in operation in 2005 and will be the first
independent power plant in Saudi Arabia.
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 much stronger growth in 2002 as a result of
warmer than normal summer weather. Assuming that, in the last half of 2003,
normal weather conditions will occur and manufacturing activity will average
about one percent less than last year, a slight decline from the strong 2002
electric deliveries is anticipated.
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.
CMS-29
CMS Energy Corporation
As a result, alternative electric suppliers for generation services have entered
Consumers' market. As of late July 2003, alternative electric suppliers are
providing 575 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 previously unsecuritized
Palisades expenditures were approved as proposed in its securitization case as
discussed below in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 are approximately $35 million. If the proposal to securitize
those costs is not approved, then Consumers indicated that the costs would be
properly included in the 2002 "net" Stranded Cost calculation, which would
increase Consumers' 2002 "net" Stranded Costs to approximately $103 million.
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
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CMS Energy Corporation
Act expenditures. However, the MPSC rejected previously unsecuritized Palisades
expenditures as eligible securitized costs. As a result, the previously
unsecuritized Palisades expenditures 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 previously
unsecuritized Palisades expenditures, 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 further 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 orders 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 June 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $15 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.
CMS-31
CMS Energy Corporation
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 filed a petition for rehearing with the FERC and in July
2003, the FERC granted Consumers' petition for rehearing. Consumers cannot
predict the amount of implementation costs the FERC will ultimately order to be
reimbursed by MISO.
Securitization: In March 2003, Consumers filed an application with the MPSC
seeking approval to issue Securitization bonds in the amount of approximately
$1.084 billion. The application sought recovery of costs associated with Clean
Air Act expenditures, previously unsecuritized Palisades expenditures, 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. Consumers
believes unsecuritized Palisades expenditures should be included as a component
of "net" Stranded Costs.
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 order by the MPSC 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. The financing order will become
effective after rehearing 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.
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 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 June 30, 2003, contracts for
200 MW of load have terminated and outstanding contracts involve approximately
485 MW of load. Of the contracts that have terminated, 52 MW have gone to an
alternative electric supplier and 148 MW have returned to bundled tariff rates.
Consumers cannot predict the ultimate financial impact of changes related
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CMS Energy Corporation
to these power supply contracts, or whether additional contracts will be
necessary or advisable.
Code of Conduct: In December 2000, as a result of the passage of the Customer
Choice Act, the MPSC issued a new code of conduct that applies to electric
utilities and alternative electric suppliers. The code of conduct seeks to
prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and 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 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.
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 be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a loss of revenue from wholesale and
retail open access customers who will buy services directly from MTH and the
loss of
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CMS Energy Corporation
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.
Consumers is a customer of AEP and holds 400 MW of long-term transmission
service reservations through the AEP transmission system. AEP has indicated its
intent, and has received preliminary FERC approval, to turn control of its
transmission system over to the PJM RTO. This change will require AEP wholesale
transmission customers to become members of, and resubmit reservation requests
to, PJM. Legislation recently enacted in Virginia, precludes Virginia utilities
(including AEP) from joining an RTO until July 2004. In addition, the Kentucky
Public Service Commission has denied AEP's request to transfer its assets to
PJM. These developments, as well as uncertainty associated with state approvals
AEP is seeking from various state regulatory bodies, raise some doubt regarding
the timing of AEP's membership in PJM. Upon completion of the steps necessary
for the integration of AEP into PJM, Consumers will complete the application
process to join PJM as a transmission customer.
There are multiple proceedings and a proposed rulemaking pending before the FERC
regarding transmission pricing mechanisms and standard market design for
electric bulk power markets and transmission. The results of these proceedings
and proposed rulemaking could significantly affect the trend of transmission
costs and increase the delivered power costs to Consumers and the retail
electric customers it serves. The specific financial impact on Consumers of such
proceedings, rulemaking and trends are not currently quantifiable.
In addition, Consumers is evaluating whether or not there may be impacts on
electric reliability associated with the outcomes of these various transmission
related proceedings. Consumers cannot assure that all risks to reliability can
be avoided.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards for Consumers and other Michigan electric distribution
utilities. The proposal would establish standards related to restoration after
an outage, safety, and customer relations. Failure to meet the standards would
result in customer bill credits. Consumers submitted comments to the MPSC. In
December 2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards. In November
2002, the MPSC issued an order initiating the formal rulemaking proceeding.
Consumers has filed comments on the proposed rules and will continue to
participate in this process. Consumers cannot predict the nature of the proposed
standards or the likely effect, if any, on Consumers.
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."
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CMS Energy Corporation
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
the need to make additional capital expenditures and increase operating expenses
for Clean Air Act compliance; 3) environmental liabilities arising from various
federal, state and local environmental laws and regulations, including potential
liability or expenses relating to the Michigan Natural Resources and
Environmental Protection Acts and Superfund; 4) uncertainties relating to the
storage and ultimate disposal of spent nuclear fuel; 5) electric industry
restructuring issues, including those described above; 6) Consumers' ability to
meet peak electric demand requirements at a reasonable cost, without market
disruption, and successfully implement initiatives to reduce exposure to
purchased power price increases; 7) the recovery of electric restructuring
implementation costs; 8) Consumers' status as an electric transmission customer
and not as an electric transmission owner/operator; 9) sufficient reserves for
OATT rate refunds; 10) the effects of derivative accounting and potential
earnings volatility; 11) increased costs for safety and homeland security
initiatives that are not recoverable on a timely basis from customers; and 12)
potentially rising pension costs due to market losses (as discussed above in
Accounting for Pension and OPEB). For further information about these trends or
uncertainties, see Note 4, Uncertainties.
CONSUMERS' GAS UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects gas deliveries, including
gas full service and customer choice deliveries (excluding transportation to the
MCV Facility and off-system deliveries), to grow at an average rate of less than
one percent per year based primarily on a steadily growing customer base. Actual
gas deliveries in future periods may be affected by abnormal weather, use of gas
by independent power producers, changes in competitive and economic conditions,
and the level of natural gas consumption per customer. Also, the recent
significant increases in gas commodity prices may reduce gas sales by amounts
which Consumers is not able to predict.
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation process with the MPSC, Consumers expects to collect all of its
incurred gas costs. In June 2003, Consumers filed a reconciliation of GCR costs
and revenues for the 12-month period April 2002 through March 2003. In the
filing, Consumers proposed to recover from customers a net under-recovery of
approximately $6 million according to a "roll-in" methodology, which
incorporates the under-recovery in rates charged in the succeeding GCR year. The
"roll-in" tariff provision was approved by the MPSC in a November, 2002 order.
Under an order issued by the MPSC 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 use
an August GCR factor of $5.56 per mcf to bill its customers.
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'
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CMS Energy Corporation
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 authorized 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.
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related services
to retail customers that focus on appliance maintenance, home safety, commodity
choice, and assistance to customers purchasing heating, ventilation and air
conditioning equipment. Consumers continues to look for additional growth
opportunities in providing energy-related services to its customers. The ability
to offer all or some of these services and other utility related
revenue-generating services, which provide approximately $36 million in annual
gas revenues, may be restricted by the new code of conduct issued by the MPSC,
as discussed above in Electric Business Outlook, "Competition and Regulatory
Restructuring -- Code of Conduct." 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.
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) increased
costs for pipeline integrity and safety and homeland security initiatives that
are not recoverable on a timely basis from customers; and 7) potentially rising
pension costs due to market losses (as discussed above in Accounting for Pension
and OPEB). For further information about these uncertainties, see Note 4,
Uncertainties.
CONSUMERS' OTHER OUTLOOK
SECURITY COSTS: Since the September 11, 2001 terrorist attacks in the United
States, Consumers has increased security at all critical facilities and over its
critical infrastructure, and will continue to evaluate security on an ongoing
basis. Consumers may be required to comply with federal and state regulatory
security measures promulgated in the future. Through June 30, 2003, Consumers
has incurred approximately $6 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 six 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.
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CMS Energy Corporation
ENTERPRISES OUTLOOK
CMS Energy's IPP subsidiary plans to complete the restructuring of its
operations by narrowing the scope of its existing operations and commitments to
two regions: North America and the Middle East/North Africa. In addition, its
plans include selling designated assets and investments that are
under-performing, non-region 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. 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. Inc. and in April 2003, closed on the sale of its
assets associated with its federal business to Pepco Energy Services. 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.
In June 2003, CMS Gas Transmission closed on the sale of Panhandle and Guardian
and in July 2003, completed the sale of CMS Field Services. 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 at
CMS MST, CMS Energy's Board of Directors established a Special Committee of
independent directors to investigate matters surrounding the transactions and
retained outside counsel to assist in the investigation. The Special Committee
completed its investigation and reported its findings to the Board of Directors
in October 2002. The Special Committee concluded, based on an extensive
investigation, that the round-trip trades were undertaken to raise CMS MST's
profile as an energy marketer with the goal of enhancing its ability to promote
its services to new customers. The Special Committee found no effort to
manipulate the price of CMS Energy Common Stock or affect energy prices. The
Special Committee also made recommendations
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CMS Energy Corporation
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 forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST 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 have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been 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 defend against this action but cannot predict the outcome of this
litigation.
DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS: The Board of Directors
received a demand, on behalf of a shareholder of CMS Energy Common Stock, that
it commence civil actions (i) to remedy alleged breaches of fiduciary duties by
CMS Energy officers and directors in connection with round-trip trading at CMS
MST, and (ii) to recover damages sustained by CMS Energy as a result of alleged
insider trades alleged to have been made by certain current and former officers
of CMS Energy and its subsidiaries. If the Board elects not to commence such
actions, the shareholder has stated that he will initiate a derivative suit,
bringing such claims on behalf of CMS Energy. CMS Energy has elected two new
members to its Board of Directors who will serve as an independent litigation
committee to determine whether it is in the best interest of CMS Energy to bring
the action demanded by the shareholder. Counsel for the shareholder has agreed
to extend the time for CMS Energy to respond to the demand. CMS Energy cannot
predict the outcome of this litigation.
ERISA CLAIMS: CMS Energy is a named defendant, along with Consumers, CMS MST and
certain named and unnamed officers and directors, in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
401(k) Plan. The two cases, filed in July 2002 in the United States District
Court, 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
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CMS Energy Corporation
seek other equitable relief and legal fees. These cases will be defended
vigorously. CMS Energy cannot predict the outcome of this litigation.
GAS INDEX PRICING REPORTING: CMS Energy has notified appropriate regulatory and
governmental agencies that some employees at CMS MST and CMS Field Services
appeared to have provided inaccurate information regarding natural gas trades to
various energy industry publications which compile and report index prices. CMS
Energy is cooperating with investigations by the Commodity Futures Trading
Commission, Department of Justice and FERC regarding this matter. CMS Energy is
unable to predict the outcome of these matters and what effect, if any, these
investigations will have on its business.
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
SEC COMPLIANCE
In July 2003, CMS Energy completed the filing of its 2002 Form 10-K/A and its
September 30, 2002 Form 10-Q/A. These filings restated the consolidated
financial statements for the quarters of 2002 and 2001 as a result of certain
audit and re-audit adjustments as well as adjustments identified through the
quarterly reconstruction and reconciliation project at CMS MST related to the
interim periods of 2001. The required management certifications were filed at
that time.
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
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CMS Energy Corporation
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.
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 may also require participants to
provide documentation of certain transactions. In the NOPR, FERC proposed that
to participate in a cash management or money pool arrangement, FERC-regulated
entities would be required to maintain a minimum proprietary capital balance
(stockholder's equity) of 30 percent and both the FERC-regulated entity and its
parent would be required to maintain investment grade credit ratings. The FERC
recently met, but no action was taken on cash management issues related to the
NOPR.
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. 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. This
interpretation's consolidation requirements also apply to pre-existing entities
beginning July 1, 2003. CMS Energy will be required to consolidate any entities
that meet the requirements of this portion of the interpretation. CMS Energy is
in the process of studying this interpretation, and has yet to determine the
effects, if any, on its consolidated financial statements.
Although CMS Energy has not determined the effect of this interpretation, it is
possible that CMS Energy and Consumers may be required to consolidate in its
financial statements, the assets, liabilities and activities of the MCV
Partnership. If that should occur, CMS Energy and Consumers would have to
recognize the MCV Partnership debt on their financial statements. This could
negatively impact 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.
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CMS Energy Corporation
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. CMS Energy is in the process of
studying this statement, and has yet to determine the effects, if any, the
statement will have on accounting for contracts entered into after June 30,
2003.
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 determined that all of its trust preferred securities fall under
the scope of SFAS No. 150. Consumers Financings I through IV and CMS Trust I
securities have fixed redemption dates and amounts and qualify as mandatorily
redeemable preferred securities under SFAS No. 150. CMS Trust III securities
have both a trust preferred security and a forward purchase contract. CMS Energy
determined that under SFAS No. 150, CMS Trust III securities were more similar
to debt than to equity at inception. Therefore, all of the above securities were
reclassified as liabilities on July 1, 2003.
At July 1, 2003, mandatorily redeemable preferred securities totaling $883
million, were reclassified from the mezzanine equity section to the liability
section of CMS Energy's consolidated balance sheet. In accordance with SFAS No.
150, prior periods will not be restated. No cumulative impact due to this
accounting change was incurred upon adoption.
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CMS Energy Corporation
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CMS-42
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
OPERATING REVENUE
Electric utility $ 602 $ 631 $ 1,252 $ 1,239
Gas utility 299 252 1,088 868
Enterprises 253 1,251 803 2,285
Other - 1 - 2
---------------------------------------------------
1,154 2,135 3,143 4,394
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Operation
Fuel for electric generation 73 91 167 177
Purchased and interchange power 121 651 370 1,117
Purchased power - related parties 120 133 252 273
Cost of gas sold 299 698 1,136 1,588
Other 208 224 400 393
---------------------------------------------------
821 1,797 2,325 3,548
Maintenance 61 53 118 108
Depreciation, depletion and amortization 88 86 214 208
General taxes 1 47 65 104
---------------------------------------------------
971 1,983 2,722 3,968
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME
Electric utility 97 116 213 231
Gas utility 24 18 127 82
Enterprises 32 18 54 102
Other 30 - 27 11
---------------------------------------------------
183 152 421 426
- ------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME (DEDUCTIONS)
Accretion expense (9) (7) (16) (15)
Gain (loss) on asset sales, net (3) 26 (8) 48
Other, net 11 (1) 21 (1)
---------------------------------------------------
(1) 18 (3) 32
- ------------------------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE INTEREST AND TAXES 182 170 418 458
- ------------------------------------------------------------------------------------------------------------------------------
FIXED CHARGES
Interest on long-term debt 126 102 223 196
Other interest 11 4 17 14
Capitalized interest (3) (4) (5) (7)
Preferred dividends 1 - 1 1
Preferred securities distributions 18 25 36 50
---------------------------------------------------
153 127 272 254
- ------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS 29 43 146 204
INCOME TAXES 34 6 74 74
MINORITY INTERESTS - 1 1 1
---------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS (5) 36 71 129
LOSS FROM DISCONTINUED OPERATIONS, NET OF $2 AND $18 TAX
EXPENSE IN 2003 AND $61 AND $94 TAX BENEFIT IN 2002 (40) (127) (13) (178)
---------------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING (45) (91) 58 (49)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING, NET OF $13
TAX BENEFIT IN 2003 AND $9 TAX EXPENSE IN 2002:
ENERGY TRADING CONTRACTS, EITF 02-03 (NOTE 10) - 17 (23) 17
ASSET RETIREMENT OBLIGATIONS, SFAS NO. 143 (NOTE 10) - - (1) -
---------------------------------------------------
- 17 (24) 17
NET INCOME (LOSS) $ (45) $ (74) $ 34 $ (32)
==============================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-43
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
CMS ENERGY
NET INCOME (LOSS)
Net Income (Loss) Available to Common Stock $ (45) $ (74) $ 34 $ (32)
===============================================
BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Income (Loss) from Continuing Operations $ (0.03) $ 0.27 $ 0.49 $ 0.96
Loss from Discontinued Operations (0.28) (0.94) (0.09) (1.32)
Income (Loss) from Cumulative Effect of Change in Accounting - 0.12 (0.16) 0.12
-----------------------------------------------
Net Income (Loss) Attributable to Common Stock $ (0.31) $ (0.55) $ 0.24 $ (0.24)
===============================================
DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Income (Loss) from Continuing Operations $ (0.03) $ 0.27 $ 0.49 $ 0.96
Loss from Discontinued Operations (0.28) (0.94) (0.09) (1.32)
Income (Loss) from Cumulative Effect of Change in Accounting - 0.12 (0.16) 0.12
-----------------------------------------------
Net Income (Loss) Attributable to Common Stock $ (0.31) $ (0.55) $ 0.24 $ (0.24)
===============================================
DIVIDENDS DECLARED PER COMMON SHARE $ - $ 0.365 $ - $ 0.73
- ---------------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-44
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30 2003 2002
- -----------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 34 $ (32)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $3 and $3, respectively) 214 208
Loss on disposal of discontinued operations 42 132
Capital lease and debt discount amortization 12 10
Deferred income taxes and investment tax credit 169 (325)
Accretion expense 16 15
Bad debt expense 8 11
Undistributed earnings from related parties (71) (57)
(Gain) loss on asset sales, net 8 (48)
Cumulative effect of accounting changes 24 (17)
Changes in other assets and liabilities:
Decrease (increase) in accounts receivable and accrued revenues (48) 139
Decrease (increase) in inventories (2) 99
Increase (decrease) in accounts payable and accrued expenses (317) 138
Changes in other assets and liabilities 44 139
--------------------------
Net cash provided by operating activities 133 412
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (259) (357)
Investments in partnerships and unconsolidated subsidiaries - (29)
Cost to retire property, net (35) (33)
Investment in Electric Restructuring Implementation Plan (4) (5)
Investments in nuclear decommissioning trust funds (3) (3)
Proceeds from nuclear decommissioning trust funds 18 12
Proceeds from sale of assets, net 726 1,286
Other investing 18 (16)
--------------------------
Net cash provided by investing activities 461 855
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt 1,449 390
Issuance of common stock 4 61
Retirement of bonds and other long-term debt (834) (1,346)
Retirement of trust preferred securities - (30)
Repurchase of common stock (1) (1)
Restricted cash on hand (167) -
Payment of common stock dividends - (97)
Decrease in notes payable, net (487) (143)
Payment of capital lease obligations (7) (7)
Other financing 1 1
--------------------------
Net cash used in financing activities (42) (1,172)
- -----------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATES ON CASH 2 -
- -----------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH AND TEMPORARY CASH INVESTMENTS 554 95
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 377 127
- -----------------------------------------------------------------------------------------------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $931 $ 222
===========================================================================================================
CMS-45
SIX MONTHS ENDED
JUNE 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) $ 230 $ 185
Income taxes paid (net of refunds) (33) (42)
Pension and OPEB cash contribution 40 108
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 10 $ 35
=====================================================================================================================
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-46
CMS ENERGY CORPORATION
Consolidated Balance Sheets
ASSETS
JUNE 30 JUNE 30
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- --------------------------------------------------------------------------------------------------------------------------------
In Millions
PLANT AND PROPERTY (AT COST)
Electric utility $ 7,465 $ 7,523 $ 7,396
Gas utility 2,805 2,719 2,651
Enterprises 497 462 902
Other 37 45 50
----------------------------------------------------
10,804 10,749 10,999
Less accumulated depreciation, depletion and amortization 5,493 6,068 5,974
----------------------------------------------------
5,311 4,681 5,025
Construction work-in-progress 429 549 481
----------------------------------------------------
5,740 5,230 5,506
- --------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS
Enterprises 769 748 975
Midland Cogeneration Venture Limited Partnership 422 388 359
First Midland Limited Partnership 263 255 261
Other 2 2 1
----------------------------------------------------
1,456 1,393 1,596
- --------------------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 931 377 222
Restricted cash 187 20 -
Accounts receivable, notes receivable and accrued revenue, less
allowances of $10, $8 and $4, respectively 439 319 132
Accounts receivable - Marketing, services and trading,
less allowances of $9, $8 and $11, respectively 145 248 340
Accounts receivable and notes receivable - related parties 182 186 111
Inventories at average cost:
Gas in underground storage 460 491 476
Materials and supplies 95 89 77
Generating plant fuel stock 42 37 57
Assets held for sale 142 648 414
Price risk management assets 101 115 226
Prepayments and other 311 218 142
----------------------------------------------------
3,035 2,748 2,197
- --------------------------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 669 689 709
Postretirement benefits 174 185 197
Abandoned Midland Project 11 11 11
Other 255 168 173
Assets held for sale 249 2,094 2,466
Price risk management assets 213 135 382
Nuclear decommissioning trust funds 553 536 555
Notes receivable - related parties 147 160 203
Notes receivable 126 126 126
Other 400 440 466
----------------------------------------------------
2,797 4,544 5,288
----------------------------------------------------
TOTAL ASSETS $ 13,028 $ 13,915 $ 14,587
================================================================================================================================
CMS-47
STOCKHOLDERS' INVESTMENT AND LIABILITIES
JUNE 30 JUNE 30
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholders' equity
Common stock, authorized 250.0 shares; outstanding 144.1 shares,
144.1 shares and 135.1 shares, respectively $ 1 $ 1 $ 1
Other paid-in-capital 3,608 3,605 3,317
Accumulated other comprehensive loss (724) (753) (686)
Retained deficit (1,686) (1,720) (1,080)
------------------------------------------------------
1,199 1,133 1,552
Preferred stock of subsidiary 44 44 44
Company-obligated convertible Trust Preferred Securities
of subsidiaries (a) 393 393 694
Company-obligated mandatorily redeemable preferred securities
of Consumer's subsidiaries (a) 490 490 490
Long-term debt 6,055 5,356 5,367
Non-current portion of capital leases 120 116 97
------------------------------------------------------
8,301 7,532 8,244
- ----------------------------------------------------------------------------------------------------------------------------------
MINORITY INTERESTS 23 21 13
- ----------------------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 541 640 639
Notes payable 1 458 269
Accounts payable 322 363 270
Accounts payable - Marketing, services and trading 52 119 233
Accrued interest 126 131 150
Accrued taxes 180 291 223
Accounts payable - related parties 47 53 57
Liabilities held for sale 86 467 579
Price risk management liabilities 93 96 178
Current portion of purchase power contract 26 26 24
Current portion of gas supply contract obligations 28 25 24
Deferred income taxes 32 15 13
Other 179 214 223
------------------------------------------------------
1,713 2,898 2,882
- ----------------------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Postretirement benefits 791 725 296
Deferred income taxes 463 414 529
Deferred investment tax credit 87 91 94
Regulatory liabilities for income taxes, net 313 297 276
Other regulatory liabilities 155 4 -
Asset retirement obligation 364 - -
Liabilities held for sale 91 1,243 1,350
Price risk management liabilities 206 135 321
Gas supply contract obligations 221 241 249
Power purchase agreement - MCV Partnership 14 27 41
Other 286 287 292
------------------------------------------------------
2,991 3,464 3,448
- ----------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 4 and 5)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 13,028 $ 13,915 $ 14,587
==================================================================================================================================
(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-48
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period $ 1 $ 1 $ 1 $ 1
- ----------------------------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 3,605 3,299 3,605 3,257
Common stock repurchased
Common stock reacquired (1) (1) (1) (1)
Common stock issued 4 19 4 61
-----------------------------------------------
At end of period 3,608 3,317 3,608 3,317
- ----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (241) - (241) -
Minimum pension liability adjustment (a) (20) - (20) -
-----------------------------------------------
At end of period (261) - (261) -
-----------------------------------------------
Investments
At beginning of period 2 (5) 2 (5)
Unrealized gain (loss) on investments (a) 3 (2) 3 (2)
-----------------------------------------------
At end of period 5 (7) 5 (7)
-----------------------------------------------
Derivative Instruments (b)
At beginning of period (53) (17) (56) (31)
Unrealized loss on derivative instruments (a) (10) (13) (2) (1)
Reclassification adjustments included in consolidated net income (loss) (a) 7 1 2 3
-----------------------------------------------
At end of period (56) (29) (56) (29)
-----------------------------------------------
Foreign Currency Translation
At beginning of period (445) (241) (458) (233)
Change in foreign currency translation (a) 33 (409) 46 (417)
-----------------------------------------------
At end of period (412) (650) (412) (650)
-----------------------------------------------
At end of period (724) (686) (724) (686)
- ----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS (DEFICIT)
At beginning of period (1,641) (957) (1,720) (951)
Consolidated net income (loss) (a) (45) (74) 34 (32)
Common stock dividends declared - (49) - (97)
-----------------------------------------------
At end of period (1,686) (1,080) (1,686) (1,080)
-----------------------------------------------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 1,199 $1,552 $1,199 $ 1,552
==================================================================================================================================
(a) Disclosure of Other Comprehensive Income (Loss):
Other Comprehensive Income
Minimum Pension Liability
Minimum pension liability adjustments, net of tax of
$10, $-, $10 and $-, respectively $ (20) $ - $ (20) $ -
Investments
Unrealized gain (loss) on investments, net of tax of $(1),
$1, $(1) and $1, respectively 3 (2) 3 (2)
Derivative Instruments
Unrealized loss on derivative instruments, net of tax
of $3, $2, $(2) and $(1), respectively (10) (13) (2) (1)
Reclassification adjustments included in net income (loss),
net of tax of $(4), $-, $(1) and $(1), respectively 7 1 2 3
Foreign currency translation, net 33 (409) 46 (417)
Net income (loss) (45) (74) 34 (32)
-----------------------------------------------
Total Other Comprehensive Income (Loss) $ (32) $ (497) $ 63 $ (449)
===============================================
(b) Included in these amounts is CMS Energy's proportionate share of the
effects of derivative accounting related to its equity investment in the
MCV Partnership and Taweelah as follows:
MCV Partnership:
At the beginning of the period $ 11 $ (1) $ 8 $ (8)
Unrealized gain on derivative instruments 6 1 13 6
Reclassification adjustments included in net income (4) 1 (8) 3
-----------------------------------------------
At the end of the period $ 13 $ 1 $ 13 $ 1
===============================================
Taweelah:
At the beginning of the period $ (32) $ - $ (32) $ -
Unrealized loss on derivative instruments (5) - (5) -
-----------------------------------------------
At the end of the period $ (37) $ - $ (37) $ -
===============================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-49
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 of oil and
CMS-50
CMS Energy Corporation
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.
EARNINGS PER SHARE: Basic and diluted earnings per share are based on the
weighted average number of shares of common stock and potential common stock
outstanding during the period. Potential common stock, for purposes of
determining diluted earnings per share, includes the effects of dilutive stock
options and convertible securities. The effect of such potential common stock is
computed using the treasury stock method or the if-converted method, as
applicable. For earnings per share computation, see Note 6.
FINANCIAL INSTRUMENTS: CMS Energy accounts for its debt and equity investment
securities in accordance with SFAS No. 115. As such, debt and equity securities
can be classified into one of three categories: held-to-maturity, trading, or
available-for-sale securities. CMS Energy's investments in equity securities are
classified as available-for-sale securities. They are reported at fair value,
with any unrealized gains or losses from changes in fair value usually reported
in equity as part of accumulated other comprehensive income and excluded from
earnings unless such changes in fair value are other than temporary. Unrealized
gains or losses from changes in the fair value of Consumers' nuclear
decommissioning investments are reported as regulatory liabilities. The fair
value of these investments is determined from quoted market prices.
FOREIGN CURRENCY TRANSLATION: CMS Energy's subsidiaries and affiliates whose
functional currency is other than the U.S. dollar translate their assets and
liabilities into U.S. dollars at the current exchange rates in effect at the end
of the fiscal period. The revenue and expense accounts of such subsidiaries and
affiliates are translated into U.S. dollars at the average exchange rates that
prevailed during the period. The gains or losses that result from this process,
and gains and losses on intercompany foreign currency transactions that are
long-term in nature, and which CMS Energy does not intend to settle in the
foreseeable future, are shown in the stockholders' equity section of the balance
sheet. For subsidiaries operating in highly inflationary economies, the U.S.
dollar is considered to be the functional currency, and transaction gains and
losses are included in determining net income. Gains and losses that arise from
exchange rate fluctuations on transactions denominated in a currency other than
the functional currency, except those that are hedged, are included in
determining net income. The change in the foreign currency translation
adjustment increased equity by $33 million for the three months ended June 30,
2003 and $46 million for the six months ended June 30, 2003, net of after-tax
hedging proceeds. The change in the foreign currency translation adjustment
decreased equity by $409 million for the three months ended June 30, 2002 and
$417 million for the six months ended June 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 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.
CMS-51
CMS Energy Corporation
Property repairs, minor property replacements and maintenance are charged to
maintenance expense as incurred. When depreciable plant and property maintained
by CMS Energy's regulated operations are retired or sold, the original cost plus
cost of removal (net of salvage credits), is charged to accumulated
depreciation.
RESTRICTED CASH: At June 30, 2003, CMS Energy's restricted cash on hand totaled
$187 million. 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.
STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation -- Transition and Disclosure. This
standard provides for alternative methods of transition for a voluntary change
to the fair value based method of accounting for stock-based employee
compensation. In addition, the statement amends the disclosure requirements of
SFAS No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. The
transition guidance and annual disclosure provisions of the statement are
effective as of December 31, 2002 and interim disclosure provisions are
effective for interim financial reports starting in 2003. In the fourth quarter
of 2002, CMS Energy adopted the fair value method of accounting for stock-based
compensation under SFAS No. 123 as amended by SFAS No. 148, applying the
prospective method. If compensation cost for stock options had been determined
in accordance with SFAS No. 123 for the three and six month periods ended June
30, 2002, consolidated net loss as reported and pro forma would have been as
follows:
In Millions, Except Per Share Amounts
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 2002 Basic Diluted
- -------------------------------------------------------------------------------------------------------------------
Net loss, as reported $ (74) $ (0.55) $ (0.55)
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 loss $ (74) $ (0.55) $ (0.55)
===================================================================================================================
In Millions, Except Per Share Amounts
- -------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30 2002 Basic Diluted
- -------------------------------------------------------------------------------------------------------------------
Net loss, as reported $ (32) $ (0.24) $ (0.24)
Add: Stock-based employee compensation expense included
In reported net income, net of taxes - - -
Deduct: Total stock-based compensation expense determined
Under fair value based method for all awards, net of tax (2) (0.01) (0.01)
- -------------------------------------------------------------------------------------------------------------------
Pro forma net loss $ (34) $ (0.25) $ (0.25)
===================================================================================================================
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
CMS-52
CMS Energy Corporation
No. 97-4, Consumers discontinued the application of SFAS No. 71 for the energy
supply portion of its business because Consumers expected to implement retail
open access at competitive market based rates for its electric customers.
Discontinuation of SFAS No. 71 for the energy supply portion of Consumers'
business resulted in Consumers reducing the carrying value of its Palisades
plant-related assets, in 1999, by approximately $535 million and establishing a
regulatory asset for a corresponding amount.
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, Adoption 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 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 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
CMS-53
CMS Energy Corporation
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 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.
Six months ended June 30 In Millions
- ------------------------------------------------------------------------------------------------------------------
Pre-tax After-tax Pre-tax After-tax
2003 2003 2002 2002
- -------------------------------------------------------------------------------------------------------------------
Asset Sales -- Gain (Loss):
Marketing, Services and Trading $(5) $(3) $ - $ -
Natural Gas Transmission (4) (3) 19 12
Independent Power Production - - (11) (8)
Consumers - - 38 31
Other 1 1 2 -
-------------------------------------------------------------------------------------------------------------
Total Gain (Loss) on Asset Sales $(8) $(5) $48 $35
==================================================================================================================
An affiliate of CMS Generation owns a 49.6 percent interest in the Loy Yang
Power Partnership ("LYPP"), which owns the 2,000 megawatts 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
operating and debt-service obligations. LYPP has A$500 million of term bank debt
that, pursuant to prior extensions from the lenders, was scheduled to mature on
July 11, 2003. A further extension was received and as a result, this debt now
is scheduled to mature on November 11, 2003. 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) or 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
CMS-54
CMS Energy Corporation
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 indicated its concern with the
potential anticompetitive effects of this transaction. Closing is targeted for
early September 2003. Given the regulatory uncertainties, however, 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 November 2, 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 signing of the share sale agreement allows GEAC to
begin discussions with LYPP's lenders to pursue a debt restructuring. 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 $118 million at June 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:
o Relocating CMS Energy's corporate headquarters from Dearborn, Michigan
to a new combined CMS Energy and Consumers headquarters building then
under construction in Jackson, Michigan. The Jackson headquarters
building opened in March 2003 and houses an estimated 1,450 CMS Energy
and Consumers Energy employees. The relocation will ultimately reduce
corporate operating expenses.
o Implementing changes to CMS Energy's 401(K) savings program which
provided additional savings for CMS Energy and enhanced investment
options for employee participants.
o Implementing changes to CMS Energy's health care plan in order to keep
benefits and costs competitive.
o Terminating five officers, 18 CMS Field Services employees and 41 CMS
MST trading group employees. Prior to December 31, 2002, 31
Dearborn-based employees and 92 Houston employees elected severance
arrangements. Of these 187 officers and employees, 65 had been
terminated as of December 31, 2002. All remaining terminations were
completed in 2003.
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The following table shows the amount charged to expense for restructuring costs,
the payments made, and the unpaid balance of accrued costs at June 30, 2003.
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30, 2003
- -------------------------------------------------------------------------------------------------------------------
Involuntary Lease
Termination Termination Total
- -------------------------------------------------------------------------------------------------------------------
Beginning accrual balance, January 1, 2003 $ 12 $ 8 $ 20
Expense 3 - 3
Payments (8) - (8)
- -------------------------------------------------------------------------------------------------------------------
Ending accrual balance $ 7 $ 8 $ 15
===================================================================================================================
Restructuring costs for the three and six months ended June 30, 2003, which are
included in operating expenses, include $1 million and $3 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. CMS Energy is actively
seeking a buyer for the assets of CMS Electric and Gas, and although the timing
of this sale is difficult to predict, nor can it be assured, management expects
the sale to occur.
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
Included in the sale were all of CMS Oil and Gas' oil and gas reserves in
Equatorial Guinea and CMS Gas Transmission's ownership interest in the related
methanol plant. The gain on the CMS Oil & Gas Equatorial Guinea properties of
$497 million ($310 million, net of tax) is included in discontinued operations.
In the first quarter of 2003, CMS Energy settled a liability with the purchaser
of Equatorial Guinea and reversed the remaining excess reserve. This 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 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
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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 approximately $582 million in cash, subject to post closing
adjustments, 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 allows CMS Energy to sell the stock 90 days after the
closing date of June 11, 2003. The Southern Union common stock has been 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, CMS Energy now holds 3.15 million shares of Southern Union common stock,
worth approximately $48.5 million, based on the July 31, 2003 closing price of
$15.41 per share. Southern Union Panhandle Corp. also assumed approximately
$1.166 billion of Panhandle debt. CMS Energy used the 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,
subject to post closing adjustments 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, 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 approximately $113 million in cash 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 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. CMS Energy is actively
seeking a buyer for the assets of Marysville, and although the timing of this
sale is difficult to predict, nor can it be assured, management expects the sale
to occur in 2003.
The summary of balance sheet information below represents those entities that
are still in the disposal process. At June 30, 2003, discontinued operations
included CMS Field Services, International Energy Distribution, and Marysville.
At June 30, 2002, discontinued operations included Panhandle, CMS Viron, CMS
Field Services, International Energy Distribution, and Marysville. The assets
and liabilities of the
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discontinued operations are shown as separate components in the consolidated
balance sheets of CMS Energy.
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Assets
Cash $ 6 $ 36
Accounts receivable, net 102 211
Materials and supplies 12 102
Other 22 65
--------------------------------------------------------------------------------------------------------------
Total current assets held for sale $ 142 $ 414
Property, plant and equipment, net $ 186 $ 2,152
Unconsolidated investments 21 99
Goodwill 33 149
Other 9 66
--------------------------------------------------------------------------------------------------------------
Total non current assets held for sale $ 249 $ 2,466
---------------------------------------------------------------------------------------------------------------
Liabilities
Accounts payable $ 72 $ 245
Current portion of long-term debt 3 4
Accrued taxes - 98
Other current liabilities 11 232
--------------------------------------------------------------------------------------------------------------
Total current liabilities held for sale $ 86 $ 579
Long-term debt $ 6 $ 1,158
Minority interest 64 93
Other non current liabilities 21 99
--------------------------------------------------------------------------------------------------------------
Total non current liabilities held for sale $ 91 $ 1,350
--------------------------------------------------------------------------------------------------------------
Revenues from such operations were $496 million and $426 million for the six
months ended June 30, 2003 and 2002, respectively, including Panhandle 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 "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 $23 million and $38 million for the six months ended June
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.
In Millions
- -------------------------------------------------------------------------------------------------------------------
Three months ended June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Discontinued operations:
Income from discontinued operations, net of tax $ 3 $ 5
of $2 and $8
Loss on disposal of discontinued operations, net of
tax benefit of $- and $69 (43) (132)
- -------------------------------------------------------------------------------------------------------------------
Total $(40) $(127)
===================================================================================================================
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In Millions
- -------------------------------------------------------------------------------------------------------------------
Six months ended June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Discontinued operations:
Income from discontinued operations, net of tax $ 29 $ (46)
of $18 and tax benefit of $25
Loss on disposal of discontinued operations, net of
tax benefit of $- and $69 (42) (132)
- -------------------------------------------------------------------------------------------------------------------
Total $(13) $(178)
===================================================================================================================
4: UNCERTAINTIES
Several business trends or uncertainties may affect CMS Energy's financial
results. These trends or uncertainties have, or CMS Energy reasonably expects
could have, a material impact on net sales, revenues, or income from continuing
operations. Such trends and uncertainties are discussed in detail below.
SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading transactions at
CMS MST, CMS Energy's Board of Directors established a Special Committee of
independent directors to investigate matters surrounding the transactions and
retained outside counsel to assist in the investigation. The Special Committee
completed its investigation and reported its findings to the Board of Directors
in October 2002. The Special Committee concluded, based on an extensive
investigation, that the round-trip trades were undertaken to raise CMS MST's
profile as an energy marketer with the goal of enhancing its ability to promote
its services to new customers. The Special Committee found no effort to
manipulate the price of CMS Energy Common Stock or affect energy prices. The
Special Committee also made recommendations designed to prevent any reoccurrence
of this practice. 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 forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST 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.
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CMS Energy Corporation
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been filed 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 at 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
received a demand, on behalf of a shareholder of CMS Energy Common Stock, that
it commence civil actions (i) to remedy alleged breaches of fiduciary duties by
CMS Energy officers and directors in connection with round-trip trading at CMS
MST, and (ii) to recover damages sustained by CMS Energy as a result of alleged
insider trades alleged to have been made by certain current and former officers
of CMS Energy and its subsidiaries. If the Board elects not to commence such
actions, the shareholder has stated that he will initiate a derivative suit,
bringing such claims on behalf of CMS Energy. CMS Energy has elected two new
members to its Board of Directors who will serve as an independent litigation
committee to determine whether it is in the best interest of CMS Energy to bring
the action demanded by the shareholder. Counsel for the shareholder has agreed
to extend the time for CMS Energy to respond to the demand. CMS Energy cannot
predict the outcome of this litigation.
ERISA CLAIMS: CMS Energy is a named defendant, along with Consumers, CMS MST and
certain named and unnamed officers and directors, in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
401(k) Plan. The two cases, filed in July 2002 in the United States District
Court, 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 PRICING REPORTING: CMS Energy has notified appropriate regulatory and
governmental agencies that some employees at CMS MST and CMS Field Services
appeared to have provided inaccurate information regarding natural gas trades to
various energy industry publications which compile and report index prices. CMS
Energy is cooperating with investigations by the Commodity Futures Trading
Commission, Department of Justice and FERC regarding this matter. CMS Energy is
unable to predict the outcome of these matters and what effect, if any, these
investigations will have on its business.
CONSUMERS' ELECTRIC UTILITY CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental
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CMS Energy Corporation
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 also issued additional regulations regarding
nitrogen oxide emissions that require certain generators, including some of
Consumers' electric generating facilities, to achieve the same emissions rate as
that required by the 1998 regulations. The EPA and the state regulations require
Consumers to make significant capital expenditures estimated to be $770 million.
As of June 30, 2003, Consumers has incurred $430 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 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.
Cleanup and Solid Waste - Under the Michigan Natural Resources and Environmental
Protection Act, Consumers expects that it will ultimately incur investigation
and remedial action costs at a number of sites. Consumers believes that these
costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $1 million and $9 million. As of June
30, 2003, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
During routine maintenance activities, Consumers identified PCB as a component
in certain paint, grout and sealant materials at the Ludington Pumped Storage
facility. Consumers removed and replaced part of the PCB material. Consumers has
proposed a plan to deal with the remaining materials and is awaiting a response
from the EPA.
CONSUMERS' ELECTRIC UTILITY RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan legislature passed electric
utility restructuring legislation known as the Customer Choice Act. This act: 1)
permits all customers to choose their electric generation
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CMS Energy Corporation
supplier beginning January 1, 2002; 2) cut residential electric rates by five
percent; 3) freezes all electric rates through December 31, 2003, and
establishes a rate cap for residential customers through at least December 31,
2005, and a rate cap for small commercial and industrial customers through at
least December 31, 2004; 4) allows for the use of low-cost Securitization bonds
to refinance qualified costs, as defined by the act; 5) establishes a market
power supply test that may require transferring control of generation resources
in excess of that required to serve firm retail sales requirements (In March
2003, Consumers filed an application with the MPSC that seeks confirmation that
Consumers is in compliance with the market power test set forth in the Customer
Choice Act. In June 2003, Consumers submitted a settlement of the parties to the
MPSC proceeding that, when approved by the MPSC, will provide the requested
confirmation); 6) requires Michigan utilities to join a FERC-approved RTO or
divest their interest in transmission facilities to an independent transmission
owner (Consumers has sold its interest in its transmission facilities to an
independent transmission owner, see "Transmission" below); 7) requires
Consumers, Detroit Edison and American Electric Power to jointly expand their
available transmission capability by at least 2,000 MW; 8) allows deferred
recovery of an annual return of and on capital expenditures in excess of
depreciation levels incurred during and before the rate freeze/cap period; and
9) allows recovery of "net" Stranded Costs and implementation costs incurred as
a result of the passage of the act. In July 2002, the MPSC issued an order
approving the plan to achieve the increased transmission capacity. Consumers has
completed the transmission capacity projects identified in the plan and has
submitted verification of this fact to the MPSC. Consumers believes it is in
full compliance with item 7 above.
In 1998, Consumers submitted a plan for electric retail open access to the MPSC.
In March 1999, the MPSC issued orders generally supporting the plan. The
Customer Choice Act states that the MPSC orders issued before June 2000 are in
compliance with this act and enforceable by the MPSC. Those MPSC orders: 1)
allow electric customers to choose their supplier; 2) authorize recovery of
"net" Stranded Costs and implementation costs; and 3) confirm any voluntary
commitments of electric utilities. In September 2000, as required by the MPSC,
Consumers once again filed tariffs governing its retail open access program and
made revisions to comply with the Customer Choice Act. In December 2001, the
MPSC approved revised retail open access tariffs. The revised tariffs establish
the rates, terms, and conditions under which retail customers will be permitted
to choose an alternative electric supplier. The tariffs, effective January 1,
2002, did not require significant modifications in the existing retail open
access program. The tariff terms allow retail open access customers, upon as
little as 30 days notice to Consumers, to return to Consumers' generation
service at current tariff rates. If any class of customers' (residential,
commercial, or industrial) retail open access load reaches 10 percent of
Consumers' total load for that class of customers, then returning retail open
access customers for that class must give 60 days notice to return to Consumers'
generation service at current tariff rates. However, Consumers may not have
sufficient, reasonably priced, capacity to meet the additional demand of
returning retail open access customers, and may be forced to purchase
electricity on the spot market at higher prices than it could recover from its
customers. Consumers cannot predict the total amount of electric supply load
that may be lost to competitor suppliers, nor whether the stranded cost recovery
method adopted by the MPSC will be applied in a manner that will fully offset
any associated margin loss.
SECURITIZATION: The Customer Choice Act allows for the use of low-cost
Securitization bonds to refinance certain qualified costs, as defined by the
act. Securitization typically involves issuing asset-backed bonds with a higher
credit rating than conventional utility corporate financing. In 2000 and 2001,
the MPSC issued orders authorizing Consumers to issue Securitization bonds.
Consumers issued its first Securitization bonds in 2001. Securitization resulted
in lower interest costs and a longer amortization period for the securitized
assets, and offset the impact of the required residential rate reduction. The
Securitization orders directed Consumers to
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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, $25 million for the six months ended June 30
2003, and $24 million for the six months ended June 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,
previously unsecuritized Palisades expenditures, 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. Consumers
believes unsecuritized Palisades expenditures should be included as a component
of "net" Stranded Costs.
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 order by the MPSC 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. The financing order will become
effective after rehearing 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
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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 previously unsecuritized
Palisades expenditures were approved as proposed in its securitization case as
discussed above in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 are approximately $35 million. If the proposal to securitize
those costs is not approved, then Consumers indicated that the costs would be
properly included in the 2002 "net" Stranded Cost calculation, which would
increase Consumers' 2002 "net" Stranded Costs to approximately $103 million.
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 previously unsecuritized Palisades expenditures as eligible
securitized costs. As a result, the previously unsecuritized Palisades
expenditures 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 previously unsecuritized Palisades expenditures,
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 further discussion while it considers possible conclusions and
recommendations.
Implementation Costs - Since 1997, Consumers has incurred significant electric
utility restructuring
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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 orders 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 June 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $15 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 filed a petition for rehearing with the FERC and in July
2003, the FERC granted Consumers' petition for rehearing. Consumers cannot
predict the amount of implementation costs the FERC will ultimately order to be
reimbursed by MISO.
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 FERC's
finally approved OATT rates. Since the initial decision, Consumers has been
reserving a portion of revenues billed to customers under the filed 1996 OATT
rates. Consumers submitted revised rates to comply with the FERC final order in
June 2002. Those revised rates were accepted by the FERC in August 2002 and
Consumers is in the process of computing refund amounts for individual
customers. Consumers believes its reserve is sufficient to satisfy its refund
obligation. As of July 2003, Consumers had paid $27 million in refunds.
Other Rate Proceedings - In November 2002, the MPSC, upon its own motion,
commenced a contested proceeding requiring each utility to give reason as to why
its rates should not be reduced to reflect new personal property tax multiplier
tables, and why it should not refund any amounts that it receives as refunds
from local governments as they implement the new multiplier tables. Consumers
responded to the MPSC that
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it believes that refunds would be inconsistent with the electric rate freeze
that is currently in effect, and may otherwise be unlawful. In May 2003, the
MPSC determined that it would not pursue changes in rates for all gas and
electric utilities as a result of reductions in personal property taxes since
these cost reductions will be address in rate case filings by individual
utilities.
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 be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a loss of revenue from wholesale and
retail open access customers who will buy services directly from MTH and the
loss of a return on the sold electric transmission system.
Under an agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers are fixed by contract at current levels
through December 31, 2005, and subject to FERC ratemaking thereafter. MTH has
completed the capital program to expand the transmission system's capability to
import electricity into Michigan, as required by the Customer Choice Act, and
Consumers will continue to maintain the system until May 1, 2007 under a
contract with MTH.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin. The reserve margin provides additional
power supply capability above Consumers' anticipated peak power supply demands.
It also allows Consumers to provide reliable service to its electric service
customers and to protect itself against unscheduled plant outages and
unanticipated demand. In recent years, Consumers has planned for a reserve
margin of approximately 15 percent from a combination of its owned electric
generating plants and electricity purchase contracts or options, as well as
other arrangements. However, in light of various factors, including the addition
of new generating capacity in Michigan and throughout the Midwest region and
additional transmission import capability, Consumers is continuing to evaluate
the appropriate reserve margin for 2003 and beyond. Currently, Consumers has an
estimated reserve margin of approximately 11 percent for summer 2003 or supply
resources equal to 111 percent of projected summer peak load. Of the 111
percent, approximately 101 percent is met from owned electric generating plants
and long-term power purchase contracts and 10 percent from short-term contracts
and options for physical deliveries and other agreements. The ultimate use of
the reserve margin will depend primarily on summer weather conditions, the level
of retail open access requirements being served by others during the summer, and
any unscheduled plant outages. As of July 2003, alternative electric suppliers
are providing 575 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.
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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 June 30, 2003, Consumers had purchased or had commitments
to purchase electric call option and capacity and energy contracts covering the
estimated reserve margin requirements for 2003, and partially covering the
estimated reserve margin requirements for 2004 through 2007. As a result,
Consumers has a recognized asset of $26 million for unexpired call options and
capacity and energy contracts. The total cost of electricity call option and
capacity and energy contracts for 2003 is expected to be approximately $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, and would not grant adjustment of customer rates through 2001. As a
result of the rate freeze imposed by the Customer Choice Act, the current rates
will remain in effect until at least December 31, 2003 and, therefore, the PSCR
process remains suspended. Therefore, changes in power supply costs as a result
of fluctuating electricity prices will not be reflected in rates charged to
Consumers' customers during the rate freeze period.
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 June 30, 2003 and 2002 are $243 million and $213
million, respectively.
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Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Operating revenue $18 $18 $34 $27
Operating taxes and other 14 6 19 9
-----------------------------------------
Income before cumulative effect of accounting change 4 12 15 18
Cumulative effect of change in method of accounting for
derivatives, net of $9 million tax expense (a) - 17 - 17
-----------------------------------------
Net income $ 4 $29 $15 $35
==================================================================================================================
Summarized Statements of Income for the MCV Partnership
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Operating revenue $142 $146 $295 $295
Operating expenses 84 89 184 198
------------------------------------------
Operating income 58 57 111 97
Other expense, net 29 30 57 59
------------------------------------------
Income before cumulative effect of accounting change 29 27 54 38
Cumulative effect of change in method of accounting for
derivative option contracts (a) - 58 - 58
------------------------------------------
Net income $ 29 $ 85 $ 54 $ 96
==================================================================================================================
(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.
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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 after-tax present value of the estimated future PPA
liability associated with the loss totaled $26 million at June 30, 2003 and $42
million at June 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.
Under Michigan's electric restructuring law, Consumers will return to unfrozen
rates 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 during the
next five years, Consumers' after-tax cash underrecoveries associated with the
PPA could be as follows:
In Millions
- ----------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ----------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 $36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $ - $ - $ -
================================================================================================================
As previously noted, the PPA requires Consumers to pay capacity costs based on
the MCV Facility's actual availability up to the 98.5 percent cap. Prior to
1998, Consumers was only allowed to recover MCV capacity costs that were
associated with actual energy deliveries (subject to certain caps established by
the MPSC). This recovery method essentially required Consumers to dispatch the
MCV Facility on a full-time basis, regardless of the overall cost compared to
other sources available to Consumers. Consistent with the initial PSCR freeze,
in the first quarter of 1998, Consumers began economically dispatching the MCV
Facility by scheduling deliveries on an economic basis. Consumers has continued
to economically dispatch the MCV Facility as a result of the overall rate freeze
implemented consistent with Public Acts 141 and 142. When Consumers returns to
the PSCR,
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beginning in January 2004, current MPSC orders will again only allow Consumers
to recover capacity charges from customers based on actual energy deliveries up
to the caps. Compared to periods under the rate freeze, the return to full-time
dispatch of the MCV Facility could have the effect of reducing the earnings of
CMS Midland via its ownership interest in the MCV Partnership. This would be the
result of MCV Partnership earnings being negatively impacted by the relationship
of higher fuel costs resulting from higher generation levels and changing
natural gas prices, compared to the MCV Partnership's recovery of fuel costs,
which is, in large part, based on costs associated with Consumers' coal plants.
Consumers is exploring possible alternatives that would allow Consumers to
continue dispatching the MCV Facility on an economic basis in 2004 and beyond,
without increasing costs to customers or impairing future earnings. Any changes
regarding the recovery of MCV capacity costs would require MPSC approval.
Consumers cannot predict the outcome of this issue.
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 court
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 load out 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 preparations are in the advanced stage for the removal and shipment of the
reactor vessel in the fall of 2003. 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 are
being performed in accordance with applicable regulatory and license
requirements.
In February 2003, the NRC completed its end-of-cycle plant performance
assessment of Palisades. The end-of-cycle review for Palisades covered the 2002
calendar year. The NRC determined that Palisades was operated in a manner that
preserved public health and safety and fully met all cornerstone objectives.
Based on the plant's performance, only regularly scheduled inspections are
planned through March 2004. The NRC noted that it is planning inspections of the
new independent spent fuel storage facility, as needed during construction
activities along with routine inspections for the new security requirements.
Spent Nuclear Fuel Storage: During the fourth quarter of 2002, equipment
fabrication, assembly and testing was completed at Big Rock on NRC-approved
transportable steel and concrete canisters or vaults, commonly known as
"dry-casks." 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. These transportable dry casks will remain
onsite until the DOE moves the material to a permanent national fuel repository.
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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 June 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.
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.
As of June 30, 2003, Consumers has a recorded liability to the DOE of $138
million, including interest, which is payable upon the first delivery of spent
nuclear fuel to the DOE. Consumers recovered through electric rates the amount
of this liability, excluding a portion of interest.
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.
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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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. 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 $2.7 billion in recoverable limits for the Palisades nuclear
plant. Consumers also procures coverage from NEIL that would partially cover the
cost of replacement power during certain prolonged accidental outages at
Palisades. NEIL's policies include coverage for acts of terrorism.
Consumers retains the risk of loss to the extent of the insurance deductibles
and to the extent that its loss exceeds its policy limits. Because NEIL is a
mutual insurance company, Consumers could be subject to assessments from NEIL up
to $25.8 million in any policy year if insured losses in excess of NEIL's
maximum policyholders surplus occur at its, or any other member's, nuclear
facility.
Consumers maintains nuclear liability insurance for injuries and off-site
property damage resulting from the nuclear hazard at Palisades for up to
approximately $9.5 billion (effective August 20, 2003, $11 billion), the maximum
insurance liability limits established by the Price-Anderson Act. Congress
enacted the Price-Anderson Act to provide financial protection for persons who
may be liable for a nuclear accident or incident and persons who may be injured
by a nuclear incident. The Price-Anderson Act was recently extended to December
31, 2003. Part of the Price-Anderson Act's financial protection consists of a
mandatory industry-wide program under which owners of nuclear generating
facilities could be assessed if a nuclear incident occurs at any of such
facilities. The maximum assessment against Consumers could be $88 million per
occurrence (effective August 20, 2003, $101 million), limited to maximum annual
installment payments of $10 million. Consumers also maintains insurance under a
master worker program that covers tort claims for bodily injury to workers
caused by nuclear hazards. The policy contains a $300 million nuclear industry
aggregate limit. Under a previous insurance program providing coverage for
claims brought by nuclear workers, Consumers remains responsible for a maximum
assessment of up to $6.3 million. The Big Rock plant remains insured for nuclear
liability by a combination of insurance and United States government indemnity
totaling $544 million.
Insurance policy terms, limits and conditions are subject to change during the
year as Consumers renews its policies.
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CONSUMERS' GAS UTILITY CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at sites as studies are completed. Consumers has
estimated its costs related to investigation and remedial action for all 23
sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic Cost
Model. The estimated total costs are between $82 million and $113 million; these
estimates are based on discounted 2001 costs and follow EPA recommended use of
discount rates between three and seven percent for this type of activity.
Consumers expects to fund a significant portion of these costs through insurance
proceeds and through MPSC approved rates charged to its customers. As of June
30, 2003, Consumers has an accrued liability of $48 million, net of $34 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 process with the MPSC, Consumers expects to collect all of its
incurred gas costs. On June 30, 2003, Consumers filed a reconciliation of GCR
costs and revenues for the 12-month period April 2002 through March 2003. In the
filing, Consumers proposed to recover from customers a net under-recovery of
approximately $6 million according to a roll-in methodology, which incorporates
the under-recovery in rates charged in the succeeding GCR year. The roll-in
tariff provision was approved by the MPSC in a November, 2002 order.
Under an order issued by the MPSC 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 current ceiling price is $6.11 per mcf. However, Consumers
will utilize an August GCR factor of $5.56 per mcf to bill its customers.
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 include a 13.5 percent authorized 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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PROPERTY TAX MULTIPLIER: In November 2002, the MPSC upon its own motion
commenced a contested proceeding requiring each utility to give reason as to why
its rates should not be reduced to reflect new personal property tax multiplier
tables, and why it should not refund any amounts that it receives as refunds
from local governments as they implement the new multiplier tables. Consumers
responded to the MPSC that it believes that refunds would be inconsistent with
the November 7, 2002 gas rate order in case U-13000, with the Customer Choice
Act, and may otherwise be unlawful. In May 2003, the MPSC determined that it
would not pursue changes in rates for all gas and electric utilities as a result
of reductions in personal property taxes since these cost reductions will be
addressed in rate case filings by individual utilities.
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 June 30, 2003, Consumers
has incurred approximately $6 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 six 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: CMS Energy uses a variety of contracts to protect against
commodity price and interest rate risk. Some of these contracts may be subject
to derivative accounting, which requires that the value of the contracts to be
adjusted fair value through earnings or equity depending upon certain criteria.
Such adjustments to fair value could cause earnings volatility. For further
information about derivative activities, see Note 7, Risk Management Activities
and Financial Instruments.
In addition to the matters disclosed in this note, CMS Energy 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.
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.
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. A certain officer and director of Integrum is a former officer and
director of
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CMS Energy Corporation
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 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 that stopped the running of any statute of limitations
until March 14, 2003 (first extended to June 30, 2003 and later to September 30,
2003) to facilitate the settlement discussions between all the parties in
connection with federal claims arising from the fire at the Filbin tire pile. On
September 23, 2002, CMS Energy received a written demand from the U.S. Coast
Guard for reimbursement of approximately $3.5 million in costs incurred by the
U.S. Coast Guard in fighting the fire.
In connection with this fire, several class action lawsuits were filed claiming
that the fire resulted in damage to the class and that management of the site
caused the fire. CMS Generation has reached a settlement in principle with the
plaintiffs in the amount of $9 million. The primary insurance carrier has agreed
to cover $8 million of the settlement. The remaining balance has been fully
accrued.
DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel (DFD)
presented DIG with a change order to their construction contract and filed an
action in Michigan state court claiming damages in the amount of $110 million,
plus interest and costs, which DFD states represents the cumulative amount owed
by DIG for delays DFD believes DIG caused and for prior change orders that DIG
previously rejected. DFD also filed a construction lien for the $110 million.
DIG, in addition to drawing down on three letters of credit totaling $30 million
that it obtained from DFD, has filed an arbitration claim against DFD asserting
in excess of an additional $75 million in claims against DFD. The judge in the
Michigan State Court case entered an order staying DFD's prosecution of its
claims in the court case and permitting the arbitration to proceed. DFD has
appealed the decision by the judge in the Michigan state court case to stay the
arbitration. DIG will continue to vigorously defend itself and pursue its
claims. DIG cannot predict the outcome of this matter.
DIG CUSTOMER DISPUTES: As a result of the continued delays in the DIG project
becoming fully operational, DIG's customers, Ford Motor Company and Rouge
Industries, have asserted claims that the continued delays relieve them of
certain contractual obligations totaling $43 million. In addition, Ford and/or
Rouge have asserted several other commercial claims against DIG relating to
operation of the DIG plant. In February 2003, Rouge filed an Arbitration Demand
against DIG and CMS MST Michigan, LLC with the American Arbitration Association.
Rouge is seeking a total of $27 million plus additional accrued damages at the
time of any award, plus interest. More specifically, Rouge is seeking at least
$20 million under a Blast Furnace Gas Delivery Agreement in connection with
DIG's purported failure to declare a Blast Furnace Gas Delivery Date within a
reasonable time period, plus $7 million for assorted damage claims under several
legal theories. As part of this arbitration, DIG has filed claims against Rouge
and Ford and Ford has filed claims against DIG for unspecified
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CMS Energy Corporation
amounts. DIG and CMS MST Michigan, LLC intend to vigorously defend themselves,
but cannot predict the outcome of this matter.
DIG NOISE ABATEMENT LAWSUIT: In February 2003, DIG was served with a three-count
first amended complaint in the matter of Ahmed, et al. v. Dearborn Industrial
Generation, LLC, Wayne County Circuit Court Case No. 02-241296-CZ. The complaint
seeks damages "in excess of $25,000" and injunctive relief based upon
allegations of excessive noise and vibration created by operation of the power
plant. The first amended complaint was filed on behalf of six named plaintiffs,
all alleged to be adjacent or nearby residents or property owners. The damages
alleged are injury to persons and property of the landowners. Certification of a
class of "potentially thousands" who have been similarly affected is requested.
DIG intends to aggressively defend this action. DIG cannot predict the outcome
of this matter.
MCV EXPANSION, LLC: Under an agreement entered into with General Electric
Company ("GE") in October 2002, as of December 31, 2002 MCV Expansion, LLC has a
remaining contingent obligation to GE in the amount of $3 million that may
become payable in the third 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 anticipates but cannot assure that purchase orders will be executed
with GE sufficient to eliminate contingent obligations of $3 million. MCV
Expansion, LLC has also the ability to substitute other orders from GE prior to
December 31, 2003 to satisfy these obligations.
CMS OIL AND GAS: In 1999, a former subsidiary of CMS Oil and Gas, Terra Energy
Ltd., was sued by Star Energy, Inc. and White Pine Enterprises LLC in the 13th
Judicial Circuit Court in Antrim County, Michigan, on grounds, among others,
that Terra violated oil and gas lease and other agreements by failing to drill
wells. Among the defenses asserted by Terra were that the wells were not
required to be drilled and the claimant's sole remedy was termination of the oil
and gas lease. During the trial, the judge declared the lease terminated in
favor of White Pine. The jury then awarded Star Energy and White Pine $7.6
million in damages. Terra appealed this matter to the Michigan Court of Appeals.
The Court of Appeals reversed the trial court judgment with respect to the
appropriate measure of damages and remanded the case for a new trial on damages.
Terra has taken an appeal to the Michigan Supreme Court. A reserve has been
established for this matter.
ARGENTINA ECONOMIC SITUATION: In January 2002, the Republic of Argentina enacted
the Public Emergency and Foreign Exchange System Reform Act. This law repealed
the fixed exchange rate of one U.S. dollar to one Argentina peso, converted all
dollar-denominated utility tariffs and energy contract obligations into pesos at
the same one-to-one exchange rate, and directed the President of Argentina to
renegotiate such tariffs.
Effective April 30, 2002, CMS Energy adopted the Argentine peso as the
functional currency for most of its Argentine investments. CMS had previously
used the U.S. dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 pesos per U.S. dollar, and recorded an initial
charge to the Foreign Currency Translation component of Common Stockholders'
Equity of approximately $400 million.
While CMS Energy's management cannot predict the most likely future, or average
peso to U.S. dollar 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
June 30, 2003, the net foreign currency loss due to the unfavorable exchange
rate of the Argentine peso recorded in the Foreign Currency
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CMS Energy Corporation
Translation component of Common Stockholder's Equity using an exchange rate of
2.975 pesos per U.S. dollar was $253 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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CMS Energy Corporation
5: SHORT-TERM AND LONG-TERM FINANCINGS AND CAPITALIZATION
LONG-TERM DEBT SUMMARY
In Millions
- ---------------------------------------------------------------------------------------------------------------------
June 30 December 31
Interest Rate (%) Maturity 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
CMS ENERGY
Senior Notes 7.625 2004 $ 176 $ 176
6.750 2004 287 287
9.875 2007 468 468
8.900 2008 260 260
7.500 2009 409 409
8.500 2011 300 300
8.375 2013 150 150
-------------------------------
2,050 2,050
General Term Notes
Series D 6.974(a) 2003--2008 66 94
Series E 7.859(a) 2003--2009 183 227
Series F 7.579(a) 2003--2016 297 298
-------------------------------
546 619
Extendible Tenor Rate Adjusted Securities 7.000 2005 180 180
Revolving Credit Facilities Floating 2003-2004 390 291
Other 11 29
-------------------------------
581 500
CONSUMERS ENERGY
Senior Notes Floating 2002 - -
6.000 2005 300 300
6.250 2006 332 332
6.375 2008 159 159
6.200(b) 2008 - 250
6.875 2018 180 180
6.500(c) 2018 141 141
6.500 2028 142 142
-------------------------------
1,254 1,504
Securitization Bonds 5.057(a) 2005-2015 440 453
First Mortgage Bonds 5.181(a) 2008-2023 1,082 208
Long-Term Bank Debt Floating 2004-2009 340 328
Nuclear Fuel Disposal Liability (d) 138 138
Pollution Control Revenue Bonds Various 2010-2018 126 126
Other 6 8
-------------------------------
2,132 1,261
OTHER SUBSIDIARIES 53 77
-------------------------------
Principal Amount Outstanding 6,616 6,011
Current Amounts (529) (627)
Net Unamortized Discount (32) (28)
-------------------------------
Total Long-Term Debt $ 6,055 $ 5,356
=====================================================================================================================
(a) Represents the weighted average interest rate at June 30, 2003.
(b) These notes are subject to a Call Option by the Callholder or a
Mandatory Put on May 1, 2003.
(c) Senior Remarketed Notes subject to optional redemption by Consumers
after June 15, 2005.
(d) Maturity date uncertain.
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CMS Energy Corporation
CMS ENERGY
On March 30, 2003, CMS Energy entered into an amendment and restatement of its
existing $300 million and $295.8 million revolving credit facilities. The Second
Amended and Restated Senior Credit Agreement includes a $159 million tranche
with a maturity date of April 30, 2004 and a $250 million tranche with a
maturity date of September 30, 2004. The facility was underwritten by several
banks at a total annual cost to CMS Energy of approximately ten percent, which
includes the initial commitment fee. Any proceeds of debt or equity issuances by
CMS Energy and its subsidiaries or any asset sales by CMS Energy or its
subsidiaries, other than Consumers, are required to be used to prepay this
facility. This facility is primarily collateralized by the stock of Consumers,
Enterprises and certain Enterprises subsidiaries. At June 30, 2003, $390 million
was outstanding under this facility.
GENERAL TERM NOTES: At June 30, 2003, CMS Energy had issued and outstanding $546
million GTNs, comprised of $66 million Series D GTNs, $183 million Series E GTNs
and $297 million of Series F GTNs with weighted average interest rates of 6.97
percent, 7.86 percent and 7.58 percent, respectively. No Series G GTNs have been
issued since their registration in May 2002.
ENTERPRISES
On March 30, 2003, Enterprises entered into a revolving credit facility in an
aggregate amount of $441 million. The maturity date of this facility is April
30, 2004. Subsequently, on April 21, 2003, Enterprises entered into a $75
million revolving credit facility with a maturity date of April 30, 2004. As a
result of the Panhandle sale, these credit facilities were paid in full and
terminated.
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 June 30, 2003, approximately $171 million of letters of credit
were issued under this facility and are included on the balance sheet as
restricted cash.
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CMS Energy Corporation
CONSUMERS
REGULATORY AUTHORIZATION FOR FINANCINGS: At June 30, 2003, Consumers had FERC
authorization to issue or guarantee through June 2004, up to $1.1 billion of
short-term securities outstanding at any one time. In June 2003, the FERC
granted Consumers' request to issue an additional $1.1 billion outstanding at
any one time of first mortgage bonds to act solely as collateral for short-term
securities. In June 2003, the FERC also granted Consumers' request for an
increase in its authorization for long-term debt. At June 30, 2003, Consumers
had remaining FERC authorization to issue through June 2004 up to $1 billion of
long-term securities for refinancing or refunding purposes, $760 million for
general corporate purposes, and $2.06 billion of first mortgage bonds to be
issued solely as collateral for the long-term securities. These amounts include
the June 2003 increase in FERC authorization. In October 2002, FERC granted
a waiver of its competitive bid/negotiated placement requirements applicable to
the remaining long-term securities authorization indicated above.
SHORT-TERM FINANCINGS: In March 2003, Consumers obtained a replacement revolving
credit facility in the amount of $250 million secured by first mortgage bonds,
this debt facility was paid down and had a zero balance outstanding at June 30,
2003. The cost of the facility is LIBOR plus 350 basis points. The new credit
facility matures in March 2004 with two annual extensions at Consumers' option,
which would extend the maturity to March 2006. The prior facility was due to
expire in July 2003. At June 30, 2003, a total of $1 million was outstanding on
all short-term financings at a weighted average interest rate of 3.17 percent,
compared with $255 million outstanding at June 30, 2002 at a weighted average
interest rate of 2.6 percent.
LONG-TERM FINANCINGS: In March 2003, Consumers entered into a $140 million term
loan secured by first mortgage bonds with a private investor bank. This loan has
a term of six years at a cost of LIBOR plus 475 basis points. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity expiring in March 2006;
the loan has a cost of LIBOR plus 450 basis points. Proceeds from this loan were
used for general corporate purposes.
FIRST MORTGAGE BONDS: In April 2003, Consumers sold $625 million principal
amount of first mortgage bonds in a private offering to institutional investors;
$250 million were issued at 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 of 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 has agreed to file a
registration statement with the SEC to permit holders of these first mortgage
bonds to exchange the bonds for new bonds that will be registered under the
Securities Act of 1933. Consumers has agreed to file this registration statement
by December 26, 2003.
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 in May 2010, and net proceeds were
approximately $247 million. Consumers used the net proceeds to pay down existing
debt. Consumers has agreed to file a registration statement with the SEC to
permit holders of these first mortgage bonds to exchange the bonds for new bonds
that will be registered under the Securities Act of 1933.
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CMS Energy Corporation
Consumers has agreed to file this registration statement by December 26, 2003.
Consumers secures its first mortgage bonds by a mortgage and lien on
substantially all of its property. Consumers' ability to issue and sell
securities is restricted by certain provisions in its first mortgage bond
Indenture, its articles of incorporation and the need for regulatory approvals
to meet appropriate federal law.
RESTRICTED PAYMENTS: Under the provisions of its articles of incorporation,
Consumers had $380 million of unrestricted retained earnings available to pay
common dividends at June 30, 2003. However, pursuant to restrictive covenants in
its debt facilities, Consumers is limited to common stock dividend payments that
will not exceed $300 million in any calendar year. In January 2003, Consumers
declared and paid a $78 million common dividend. In March 2003, Consumers
declared a $31 million common dividend which was paid in May 2003. In June 2003,
Consumers declared a $53 million common dividend payable in August 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 -- Electric Restructuring -- 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."
OTHER: In April 2003, Consumers ended its trade receivables sales program with
its existing purchaser. During May 2003, a new trade receivables program was put
in place with a different purchaser. As a result of changing purchasers,
Consumers established a new subsidiary, Consumers Receivables Funding II. This
consolidated subsidiary was established as a special purpose entity in order to
properly reflect the sale of receivables from Consumers to Consumers Receivables
Funding II, through to the purchaser, an unrelated third party. The program's
maximum receivable sale amount of $325 million remains unchanged. Consumers also
will continue to retain servicing responsibilities for the trade receivables
sold, however, the purchaser of the trade 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 sale of trade receivables and Consumers retains no interest in
the receivables sold. Accounts receivable and accrued revenue in the
Consolidated Balance Sheet have been reduced to reflect trade receivables sold.
At June 30 receivables sold under the program totaled $50 million in 2003 and
$311 million in 2002.
REQUIRED RATIOS
CMS Energy's and Consumers' credit facilities have contractual restrictions that
require CMS Energy and Consumers to maintain, as of the last day of each fiscal
quarter, the following:
Required Ratio Limitation Ratio at June 30, 2003
- -------------------------------------------------------------------------------------------------------------------
CMS ENERGY:
Consolidated Leverage Ratio(a)(b) not more than 7.00 to 1.00 5.70 to 1.00
Cash Dividend Coverage Ratio(a) not less than 1.20 to 1.00 1.49 to 1.00
CONSUMERS:
Debt to Capital Ratio(a)(b) not more than 0.65 to 1.00 0.57 to 1.00
Interest Coverage Ratio-Revolver(a)(b) not less than 2.00 to 1.00 3.83 to 1.00
Interest Coverage Ratio-Term Loan(a)(b) not less than 2.00 to 1.00 3.98 to 1.00
- -------------------------------------------------------------------------------------------------------------------
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to
declare the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of
securitization bonds in the calculation of this ratio.
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CMS Energy Corporation
In 1994, CMS Energy executed an indenture with J.P. Morgan Chase Bank pursuant
to CMS Energy's general term notes program. The indenture, through supplements,
contains certain provisions that can trigger a limitation on CMS Energy's
consolidated indebtedness. The limitation can be activated when CMS Energy's
consolidated leverage ratio, as defined in the indenture (essentially the ratio
of consolidated debt to consolidated capital), exceeds 0.75 to 1.0. At June 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 refinance existing debt 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 June 30, 2003, CMS Energy's
consolidated coverage ratio was 2.06 to 1.0. CMS Energy expects that due to
increased interest expenses to be incurred in the third quarter of 2003, CMS
Energy's consolidated coverage ratio may be below 1.70 to 1.0 at September 30,
2003. As a result, CMS Energy may be subject to indebtedness limitations similar
but less restrictive than those included in the general term note indenture
mentioned above.
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, June 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. After giving effect to the adoption of SFAS
No. 150 regarding the balance sheet classification of its Trust Preferred
Securities and to expected future use of its revolving credit facilities,
Consumers currently estimates that its ratio of indebtedness to total
capitalization at the end of the third and fourth quarters of 2003 will still
comply with the Debt Percentage Tests but will approach the limits specified in
some of the Debt Percentage Tests. Consumers plans to seek amendments to the
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 regarding Trust Preferred Securities on the calculations. Consumers believes
that it will receive the necessary consents of its lenders to these amendments.
However, it is possible that if Consumers does not receive the necessary
amendments and fails to be in compliance with some of the Debt Percentage Tests
such failure could constrain its ability to access its revolving credit or
accounts receivable sales facilities, or to incur additional indebtedness, and
could also result in defaults under one or more of these agreements.
Effective January 1, 2003, CMS Energy adopted the provisions of FASB
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. This
interpretation requires additional disclosures by a guarantor about its
obligations under certain guarantees that it has issued. It also requires that a
guarantor recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provision of this Interpretation does not apply to
certain guarantee contracts, such as warranties, derivatives, or guarantees
between either parent and subsidiaries or corporations under common control,
although disclosure of such guarantees is required. For contracts that are
within the initial recognition and measurement provision of this interpretation,
the provisions are to be applied to guarantees issued or modified after December
31, 2002; no cumulative effect adjustments are required.
The following table is a summary of CMS Energy's guarantees as required by FASB
Interpretation No. 45:
June 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 $1,981 $0.7 $ -
Letters of credit Various Various 208 - -
Surety bonds and other indemnifications Various Various 111 - -
Other guarantees Various Various 314 - -
Nuclear insurance retrospective premiums Various Various 120 - -
- -----------------------------------------------------------------------------------------------------------------
(a) The majority of this amount arises from routine provisions in stock and
asset sales agreements under which the purchaser is indemnified by CMS
Energy or a subsidiary for losses resulting from events such as failure
of title to the assets or stock sold by CMS Energy or a subsidiary to
the purchaser. CMS Energy believes the likelihood of a loss arising
from such events to be remote.
(b) The carrying amount represents the fair market value of guarantees and
indemnities on CMS Energy's balance sheet that are entered into
subsequent to January 1, 2003.
(c) Recourse provision indicates the approximate recovery from third
parties including assets held as collateral.
CMS Energy has entered into typical tax indemnity agreements in connection with
a variety of transactions including transactions for the sale of subsidiaries
and assets, equipment leasing and financing agreements. These indemnity
agreements generally are not limited in amount and, while a maximum amount of
exposure cannot be identified, the amount and probability of liability is
considered remote.
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CMS Energy Corporation
The off-balance sheet commitments at June 30, 2003 are as follows:
Commercial Commitments In Millions
- ---------------------------------------------------------------------------------------------------------------
Commitment Expiration
- ---------------------------------------------------------------------------------------------------------------
June 30 Total 2003 2004 2005 2006 2007 Beyond
- ---------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $ 314 $ 20 $ - $ - $ 4 $ - $ 290
Indemnities 111 - - 36 - - 75
Letters of Credit (a) 208 13 191 - - - 4
- ---------------------------------------------------------------------------------------------------------------
Total $ 633 $ 33 $ 191 $ 36 $ 4 $ - $ 369
===============================================================================================================
(a) At June 30, 2003, CMS Energy had $187 million of cash collateralized letters
of credit which are included 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 $633 million as of June 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 June 30, 2003, the actual amount of financial
exposure covered by these guarantees was $157 million. This amount excludes the
guarantees associated with CMS MST's natural gas supply contract obligations
totaling $249 million, which are recorded as liabilities on the Consolidated
Balance Sheet at June 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.
In July 2003, CMS Energy issued, in private placement to institutional
investors, $150 million of 3.375% convertible senior notes due 2023 and $300
million of 7.75% senior notes due 2010. CMS Energy has granted the initial
purchasers an option to purchase up to an additional $50 million of the
convertible senior notes for a period of 45 days after the July 16, 2003
closing. The approximately $433 million of net proceeds from these offerings
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% Senior Notes due January 2004. If exercised, the proceeds from
the initial purchasers' option for the additional $50 million convertible senior
notes would be used to refinance existing indebtedness.
In July 2003, CMS Energy required $150 million principal amount of CMS Energy's
8.375% Reset Put Securities due 2013. As a result, CMS Energy will record 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.
CAPITALIZATION: The authorized capital stock of CMS Energy consists of 250
million shares of CMS Energy Common Stock and 10 million shares of CMS Energy
Preferred Stock, $.01 par value.
COMPANY-OBLIGATED PREFERRED SECURITIES: CMS Energy and Consumers each have
wholly-owned statutory business trusts that are consolidated with the respective
parent company. CMS Energy and Consumers created their respective trusts for the
sole purpose of issuing trust preferred securities. In each case, the primary
asset of the trust is a note or debenture of the parent company. The terms of
the trust preferred security parallel the terms of the related parent company
note or debenture. The terms, rights and obligations of the trust preferred
security and related note or debenture are also defined in the related indenture
through which the note or debenture was issued, the parent guarantee of the
related trust preferred security and the declaration of trust for the particular
trust. All of these documents together with their related note or debenture and
trust preferred security constitute a full and unconditional guarantee by the
parent company of the trust's obligations under the trust preferred
CMS-83
CMS Energy Corporation
security. In addition to the similar provisions previously discussed, specific
terms of the securities follow. The classification of these securities will be
impacted by the new accounting standard SFAS No. 150. For further information,
see Note 10, Adoption of New Accounting Standards.
CMS Energy In Millions
- -------------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate (%) Outstanding Maturity Redemption
- -------------------------------------------------------------------------------------------------------
June 30 2003 2002
- -------------------------------------------------------------------------------------------------------
CMS Energy Trust I (a) 7.75 $173 $173 2027 2001
CMS Energy Trust II (b) 8.75 - 301 2004 -
CMS Energy Trust III (c) 7.25 220 220 2004 -
- ------------------------------------------------------------------------------------------------------
Total Amount Outstanding $393 $694
==========================================================================
(a) Represents Quarterly Income Preferred Securities that are convertible
into 1.2255 shares of CMS Energy Common Stock (equivalent to a
conversion price of $40.80). Effective July 2001, CMS Energy can revoke
the conversion rights if certain conditions are met.
(b) On July 1, 2002, the 7,250,000 units of Adjustable Convertible
Preferred Securities were converted to 8,787,725 newly issued shares of
CMS Energy Common Stock.
(c) Represents Premium Equity Participating Security Units in which holders
are obligated to purchase a varible number of shares of CMS Energy
Common Stock by the August 18, 2003 conversion date.
Consumers Energy Company In Millions
- ------------------------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate (%) Outstanding Maturity Redemption
- ------------------------------------------------------------------------------------------------------------------
June 30 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36 $ 70 $ 70 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00 125 125 2031 2006
----------------------------------------------------------------------------------------------------------------
Total Amount Outstanding $490 $490
====================================================================================
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CMS Energy Corporation
6: EARNINGS PER SHARE
The following table presents a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations.
In Millions, Except Per Share Amounts
- ------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 2003 2002
- ------------------------------------------------------------------------------------------------------------
NET LOSS ATTRIBUTABLE TO COMMON STOCK:
CMS Energy -- Basic $ (45) $ (74)
Add conversion of Trust Preferred
Securities (net of tax) - (a) - (a)
--------------------------
CMS Energy -- Diluted $ (45) $ (74)
==========================
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares -- Basic 144.1 134.7
Add conversion of Trust Preferred
Securities - (a) - (a)
--------------------------
Average Shares -- Diluted 144.1 134.7
==========================
LOSS PER AVERAGE COMMON SHARE
Basic $(0.31) $(0.55)
Diluted $(0.31) $(0.55)
============================================================================================================
In Millions, Except Per Share Amounts
- -----------------------------------------------------------------------------------------------------------
Six Months Ended June 30 2003 2002
- -----------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK:
CMS Energy -- Basic $ 34 $ (32)
Add conversion of Trust Preferred
Securities (net of tax) - (a) - (a)
-------------------
CMS Energy -- Diluted $ 34 $ (32)
===================
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares -- Basic 144.1 134.0
Add conversion of Trust Preferred
Securities - (a) - (a)
-------------------
Average Shares -- Diluted 144.1 134.0
===================
EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Basic $0.24 $(0.24)
Diluted $0.24 $(0.24)
===========================================================================================================
(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.
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CMS Energy Corporation
7: RISK MANAGEMENT ACTIVITIES AND FINANCIAL INSTRUMENTS
The objective of the CMS Energy risk management policy is to analyze, manage and
coordinate the identified risk exposures of the individual business segments and
to exploit the presence of internal hedge opportunities that exist among its
diversified business segments. CMS Energy, on behalf of its regulated and
non-regulated subsidiaries, utilizes a variety of derivative instruments and
executes these transactions with external parties through either CMS Enterprises
or its marketing subsidiary, CMS MST. These derivative instruments include
futures contracts, swaps, options and forward contracts to manage exposure to
fluctuations in commodity prices, interest rates and foreign exchange rates. In
order for derivative instruments to qualify for hedge accounting under SFAS No.
133, the hedging relationship must be formally documented at inception and be
highly effective in achieving offsetting cash flows or offsetting changes in
fair value attributable to the risk being hedged.
Derivative instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. CMS Energy minimizes such risk by performing financial credit
mitigation programs including, among other things, using publicly available
credit ratings of such counterparties, internally developed statistical models
for credit scoring and use of internal hedging programs to minimize exposure to
external counterparties. No material nonperformance is expected.
COMMODITY DERIVATIVES: Commodity contracts have been accounted for in accordance
with the requirements of SFAS No. 133, as amended and interpreted, and may or
may not qualify for hedge accounting treatment depending on the characteristics
of each contract.
DERIVATIVE INSTRUMENTS: CMS Energy adopted SFAS No. 133 on January 1, 2001. This
standard requires CMS Energy to recognize at fair value on the balance sheet, as
assets or liabilities, all contracts that meet the definition of a derivative
instrument. The standard also requires CMS Energy to record all changes in fair
value directly in earnings unless the derivative instrument meets certain
qualifying cash flow hedge criteria, in which case the changes in fair value
would be reflected in accumulated other comprehensive income. CMS Energy
determines fair value based upon quoted market prices and mathematical models
using current and historical pricing data. The ineffective portion, if any, of
all hedges is recognized in earnings.
CMS Energy believes that the majority of its contracts, power purchase
agreements and gas transportation contracts qualify for the normal purchases and
sales exception of SFAS No. 133 and are not subject to the accounting rules for
derivative instruments. CMS Energy uses derivative instruments that require
derivative accounting, to limit its exposures to electricity and gas commodity
price risk. The interest rate and foreign currency exchange contracts met the
requirements for hedge accounting under SFAS No. 133 and CMS Energy recorded the
changes in the fair value of these contracts in accumulated other comprehensive
income.
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CMS Energy Corporation
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 June 30, 2003, Consumers recorded on the
balance sheet those unexpired purchased electric call option contracts that are
subject to derivative accounting at a fair value of $413 thousand. These
contracts will expire in the third quarter of 2003.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market in the state of
Michigan, as defined by SFAS No. 133, and the transportation cost to deliver the
power under the contracts to the closest active energy market at the Cinergy hub
in Ohio. If a market develops in the future, Consumers may be required to
account for these contracts as derivatives. The mark-to-market impact in
earnings related to these contracts, particularly related to the PPA could be
material to the financial statements.
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 June 30, 2003, gas fuel for generation call option
contracts had a fair value that is not significant. As of June 30, 2002, gas
fuel for generation swap contracts had a fair value of $1 million. These
contracts expired in December 2002.
For the three and six months ended June 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 $2 million and $5 million, net of
tax, respectively. As of June 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 $13 million, net of tax. Consumers
expects to reclassify this gain, if this value remains, as an increase to other
operating revenue during the next 12 months.
GAS CONTRACTS: Consumers' gas business uses fixed price gas supply contracts,
and fixed price weather-based gas supply call options and fixed price gas supply
put options, and other types of contracts, to meet its regulatory obligation to
provide gas to its customers at a reasonable and prudent cost. During 2002, some
of the fixed price gas supply contracts and the weather-based gas call options
and gas put options required derivative accounting. The fixed price gas supply
contracts requiring derivative accounting expired in October 2002. As of June
30, 2003, weather-based gas call options and gas put options requiring
derivative accounting had a net fair value of $1 million. The original cost of
the options was a net $2 million. Consumers recorded an unrealized loss of $1
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.
INTEREST RATE RISK CONTRACTS: Consumers uses interest rate swaps to hedge the
risk associated with forecasted interest payments on variable-rate debt. These
interest rate swaps are designated as cash flow hedges. As such, Consumers will
record any change in the fair value of these contracts in accumulated other
comprehensive income unless the swaps are sold. As of June 30, 2002, Consumers
had entered into a swap to fix the interest rate on $75 million of variable-rate
debt. This swap expired in June 2003. As of June 30, 2002, this interest rate
swap had a negative fair value of $2 million.
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CMS Energy Corporation
Consumers also uses interest rate swaps to hedge the risk associated with the
fair value of its debt. These interest rate swaps are designated as fair value
hedges. In March 2002, Consumers entered into a fair value hedge to hedge the
risk associated with the fair value of $300 million of fixed-rate debt, issued
in March 2002. In June 2002, this swap was terminated and resulted in a $7
million gain that is deferred and recorded as part of the debt. It is
anticipated that this gain will be recognized over the remaining life of the
debt.
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,
Adoption of New Accounting Standards. Under mark-to-market accounting,
energy-trading contracts are reflected at fair market value, net of reserves,
with unrealized gains and losses recorded as an asset or liability in the
consolidated balance sheets. These assets and liabilities are affected by the
timing of settlements related to these contracts, current-period changes from
newly originated transactions and the impact of price movements. Changes in fair
value are recognized as revenues in the consolidated statements of income in the
period in which the changes occur. Market prices used to value outstanding
financial instruments reflect management's consideration of, among other things,
closing exchange and over-the-counter quotations. In certain contracts,
long-term commitments may extend beyond the period in which market quotations
for such contracts are available and volumetric obligations may not be defined.
Mathematical models are developed to determine various inputs into the fair
value calculation including price, anticipated volumetric obligations and other
inputs that may be required to adequately address the determination of fair
value of the contracts. Realized cash returns on these commitments may vary,
either positively or negatively, from the results estimated through application
of the mathematical model. CMS Energy believes that its mathematical models
utilize state-of-the-art technology, pertinent industry data and prudent
discounting in order to forecast certain elongated pricing curves. Market prices
are adjusted to reflect the impact of liquidating the company's position in an
orderly manner over a reasonable period of time under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. The creditworthiness of these counterparties will impact overall
exposure to credit risk; however, CMS Energy maintains credit policies that
management believes minimize overall credit risk with regard to its
counterparties. Determination of its counterparties' credit quality is based
upon a number of factors, including credit ratings, financial condition, and
collateral requirements. 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 June 30, 2003 and 2002, CMS Energy has recorded a net price risk management
asset of $15 million and $109 million respectively, net of reserves, related to
the unrealized mark-to-market gains on existing wholesale power contracts, gas
contracts, and hedges for retail activities that are marked as derivatives.
FLOATING TO FIXED INTEREST RATE SWAPS: CMS Energy and its subsidiaries enter
into floating to fixed interest
CMS-88
CMS Energy Corporation
rate swap agreements to reduce the impact of interest rate fluctuations. These
swaps are designated as cash flow hedges and the difference between the amounts
paid and received under the swaps is accrued and recorded as an adjustment to
interest expense over the term of the agreement. Changes in the fair value of
these swaps are recorded in accumulated other comprehensive income until the
swaps are terminated. As of June 30, 2003, these swaps had a negative fair value
of $2 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 at June 30, 2003 and 5.2 percent at June 30, 2002.
In Millions
- -----------------------------------------------------------------------------------------
Floating to Fixed Notional Maturity Fair
Interest Rate Swaps Amount Date Value
- -----------------------------------------------------------------------------------------
June 30, 2003 $ 15 2005-2006 $(2)
June 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 from time to time enters into
fixed to floating rate swaps to maintain the optimum mix of fixed and floating
rate debt. These swaps are designated as fair value hedges and any realized
gains or losses in the fair value are amortized to earnings after the
termination of the hedge instrument over the remaining life of the hedged item.
There were no outstanding fixed to floating interest rate swaps as of June 30,
2003 and 2002.
FOREIGN EXCHANGE DERIVATIVES: CMS Energy uses forward exchange and option
contracts to hedge certain receivables, payables, long-term debt and equity
value relating to foreign investments. The purpose of CMS Energy's foreign
currency hedging activities is to protect the company from the risk that U.S.
dollar net cash flows resulting from sales to foreign customers and purchases
from foreign suppliers and the repayment of non-U.S. dollar borrowings as well
as equity reported on the company's balance sheet, may be adversely affected by
changes in exchange rates. These contracts do not subject CMS Energy to risk
from exchange rate movements because gains and losses on such contracts offset
losses and gains, respectively, on assets and liabilities being hedged. The
estimated fair value of the foreign exchange and option contracts at June 30,
2003 and 2002 was zero.
There were no outstanding foreign exchange contracts at June 30, 2003. The
notional amount of the outstanding foreign exchange contracts at June 30, 2002
was $1 million Canadian contracts.
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. The estimated fair values of long-term investments are based on quoted
market prices or, in the absence of specific market prices, on quoted market
prices of similar investments or other valuation techniques. Judgment may also
be required to interpret market data to develop certain estimates of fair value.
Accordingly, the estimates determined as of June 30, 2003 and 2002 are not
necessarily indicative of the amounts that may be realized in current market
exchanges. The carrying amounts of all long-term investments in financial
instruments, except for those as shown below, approximate fair value.
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CMS Energy Corporation
In Millions
- -----------------------------------------------------------------------------------------------------------------
As of June 30 2003 2002
- -----------------------------------------------------------------------------------------------------------------
Carrying Fair Unrealized Carrying Fair Unrealized
Cost Value Gain(Loss) Cost Value Gain(Loss)
-------------------------------------------------------------------------
Long-Term Debt (a) $6,055 $6,261 $(206) $5,367 $5,107 $260
Trust Preferred Securities 883 769 114 1,184 790 394
Preferred Stock 44 32 12 44 24 20
Available-for-Sale Securities:
Nuclear Decommissioning (b) $453 $553 $100 $465 $555 $90
SERP 55 61 6 60 61 1
- -----------------------------------------------------------------------------------------------------------------
(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 undistributed earnings of
$40 million for the three months ended June 30, 2003 and $21 million for the
three months ended June 30, 2002 and $71 million for the six months ended June
30, 2003 and $57 million for the six months ended June 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 June 30, 2003 Jorf Lasfar MCV Total
- -------------------------------------------------------------------------------------------------------------------
Operating revenue $ 91 $142 $233
Operating expenses 43 84 127
-----------------------------------
Operating income 48 58 106
Other expense, net 5 29 34
----------------------------------
Net income $ 43 $ 29 $ 72
===================================================================================================================
In Millions
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2002 Jorf Lasfar MCV Total
- -------------------------------------------------------------------------------------------------------------------
Operating revenue $ 91 $146 $237
Operating expenses 41 89 130
-----------------------------------
Operating income 50 57 107
Other expense, net 11 30 41
Cumulative effect of change in method of
accounting for derivative options contracts (a) - 58 58
-----------------------------------
Net income $ 39 $ 85 $124
===================================================================================================================
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Income Statement Data
In Millions
- -------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2003 Jorf Lasfar MCV Total
- -------------------------------------------------------------------------------------------------------------------
Operating revenue $ 181 $295 $476
Operating expenses 86 184 270
-----------------------------------
Operating income 95 111 206
Other expense, net 24 57 81
-----------------------------------
Net income $ 71 $ 54 $125
===================================================================================================================
In Millions
- -------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2002 Jorf Lasfar MCV Total
- -------------------------------------------------------------------------------------------------------------------
Operating revenue $187 $295 $482
Operating expenses 89 198 287
-----------------------------------
Operating income 98 97 195
Other expense, net 22 59 81
Cumulative effect of change in method of
accounting for derivative options contracts (a) - 58 58
-----------------------------------
Net income $ 76 $ 96 $172
===================================================================================================================
(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 Consolidated Statements of Income reflect operating revenue and operating
income by reportable segment. Intersegment sales and transfers are accounted for
at current market prices and are eliminated in consolidated operating income by
segment. The table below shows net income by reportable segment. The "Other"
segment includes corporate interest and other, discontinued operations and the
cumulative effect of accounting changes. The 2002 information has been restated
to reflect the management reorganization and the change in CMS Energy's business
strategy from five to three operating segments.
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CMS Energy Corporation
Reportable Segments In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Net Loss
Electric utility $ 35 $ 84
Gas utility 5 3
Enterprises 13 3
Other (98) (164)
--------------------------
$ (45) $ (74)
==================================================================================================================
Reportable Segments In Millions
- ------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Net Income (Loss)
Electric utility $ 86 $ 134
Gas utility 59 31
Enterprises 35 69
Other (146) (266)
--------------------------
$ 34 $ (32)
==================================================================================================================
10. ADOPTION 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
CMS-92
CMS Energy Corporation
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 six months ended June 30, 2002.
The following table is a general description of the AROs and their associated
long-lived assets.
June 30, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- -------------------------------------------------------------------------------------------------------------------
Palisades - decommission plant site 1972 Palisades nuclear plant $ 455
Big Rock - decommission plant site 1962 Big Rock nuclear plant 97
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line -
Closure of coal ash disposal areas Various Generating plants coal ash areas -
Closure of wells at gas storage fields Various Gas storage fields -
Indoor gas services equipment relocations Various Gas meters located inside structures -
Closure of gas pipelines Various Gas transmission pipelines -
Dismantle natural gas-fired power plant 1997 Gas fueled power plant -
- -------------------------------------------------------------------------------------------------------------------
The following table is a reconciliation of the carrying amount of the AROs:
June 30, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
Pro Forma
ARO liability ARO Liability Cashflow
ARO 1/1/02 1/1/03 Incurred Settled Accretion Revisions 6/30/03
- -------------------------------------------------------------------------------------------------------------------
Palisades - decommission $232 $249 $ - $ - $ 9 $ - $258
Big Rock - decommission 94 61 - (18) 6 - 49
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - (1) 3 - 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 $ - $ (19) $ 18 $ - $372
===================================================================================================================
(a) Amounts are included in discontinued operations.
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
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CMS Energy Corporation
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 six months ended June 30, 2003.
ACCOUNTING STANDARDS NOT YET ADOPTED
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. 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. This
interpretation's consolidation requirements also apply to pre-existing entities
beginning July 1, 2003. CMS Energy will be required to consolidate any entities
that meet the requirements of this portion of the interpretation. CMS Energy is
in the process of studying this interpretation, and has yet to determine the
effects, if any, on its consolidated financial statements.
Although CMS Energy has not determined the effect of this interpretation, it is
possible that CMS Energy and Consumers may be required to consolidate in its
financial statements, the assets, liabilities and activities of the MCV
Partnership. If that should occur, CMS Energy and Consumers would have to
recognize the MCV Partnership debt on their financial statements. This could
negatively impact 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.
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. CMS Energy is in the process of
studying this statement, and has yet to determine the effects, if any, the
statement will have on accounting for contracts entered into after June 30,
2003.
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 determined that all of its trust preferred securities fall under
the scope of SFAS No. 150. Consumers Financings I through IV and CMS Trust I
securities have fixed redemption dates and amounts and qualify as mandatorily
redeemable preferred securities under SFAS No. 150. CMS Trust III securities
have both a trust preferred security and a forward purchase contract. CMS Energy
determined that under SFAS No. 150, CMS Trust III securities were more similar
to debt than to equity at inception. Therefore, all of the above securities were
reclassified as liabilities on July 1, 2003.
At July 1, 2003, mandatorily redeemable preferred securities totaling $883
million, were reclassified from the mezzanine equity section to the liability
section of CMS Energy's consolidated balance sheet. In accordance with SFAS No.
150, prior periods will not be restated. No cumulative impact due to this
accounting change was incurred upon adoption.
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Consumers Energy Company
CONSUMERS ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
Consumers, a subsidiary of CMS Energy, a holding company, is an electric and gas
utility company that provides service to customers in Michigan's Lower
Peninsula. Consumers' customer base includes a mix of residential, commercial
and diversified industrial customers, the largest segment of which is the
automotive industry.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This MD&A refers to 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
Presenting financial statements in accordance with accounting principles
generally accepted in the United States requires using estimates, assumptions,
and accounting methods that are often subject to judgment. Presented below are
the accounting policies and assumptions that Consumers believes are most
critical to both the presentation and understanding of its financial statements.
Applying these accounting policies to financial statements can involve very
complex judgments. Accordingly, applying different judgments, estimates or
assumptions could result in a different financial presentation.
USE OF ESTIMATES IN ACCOUNTING FOR CONTINGENCIES
The principles in SFAS No. 5 guide the recording of estimated liabilities for
contingencies within the financial statements. SFAS No. 5 requires a company to
record estimated liabilities in the financial statements when a current event
has caused a probable future loss payment of an amount that can be reasonably
estimated. Consumers has used this accounting principle to record estimated
liabilities for the following significant events.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects to incur
significant costs for future environmental compliance, especially compliance
with clean air laws.
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Consumers Energy Company
The EPA has issued regulations regarding nitrogen oxide emissions from certain
generators, including some of Consumers' electric generating facilities. These
regulations require Consumers to make significant capital expenditures estimated
to be $770 million. As of June 30, 2003, Consumers has incurred $430 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. At some point, when 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 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.
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 will be between $82 million and $113
million, using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. These estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between three and seven percent. Consumers
expects to recover a significant portion of these costs through MPSC-approved
rates charged to its customers. Any significant change in assumptions, such as
remediation techniques, nature and extent of contamination, and legal and
regulatory requirements, could change the remedial action costs for the sites.
For further information see Note 2, Uncertainties, "Gas Contingencies - Gas
Environmental Matters."
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV
Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990 and to supply electricity and steam to Dow. Consumers, through
two wholly owned subsidiaries, holds a 49 percent partnership interest in the
MCV Partnership, and a 35 percent lessor interest in the MCV Facility.
Consumers' annual obligation to purchase capacity from the MCV Partnership is
1,240 MW through the term of the PPA ending in 2025. The PPA requires Consumers
to pay, based on the MCV Facility's availability, a levelized average capacity
charge of 3.77 cents per kWh and a fixed energy charge, and also to pay a
variable energy charge based primarily on Consumers' average cost of coal
consumed for all kWh delivered. Consumers has not been allowed full recovery of
the capacity and fixed energy charges in rates. After September 2007, the PPA's
regulatory out terms obligate Consumers to pay the MCV Partnership only those
capacity and energy charges that the MPSC has authorized for recovery from
electric customers.
In 1992, Consumers recognized a loss and established a PPA liability for the
present value of the estimated future underrecoveries of power supply costs
under the PPA based on MPSC cost recovery orders. Primarily as a result of the
MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. The remaining after-tax present value of the estimated future PPA
liability associated with the loss totaled $26 million at June 30, 2003 and $42
million at June 30, 2002. The PPA liability is expected to be depleted in late
2004.
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Consumers Energy Company
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 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 during the next five
years, Consumers' after-tax cash underrecoveries associated with the PPA could
be as follows:
In Millions
- -------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- -------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 $36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $- $- $-
===================================================================================================================
As previously noted, the PPA requires Consumers to pay capacity costs based on
the MCV Facility's actual availability up to the 98.5 percent cap. Prior to
1998, Consumers was only allowed to recover MCV capacity costs that were
associated with actual energy deliveries (subject to certain caps established by
the MPSC). This recovery method essentially required Consumers to dispatch the
MCV Facility on a full-time basis, regardless of the overall cost compared to
other sources available to Consumers. Consistent with the initial PSCR freeze,
in the first quarter of 1998, Consumers began economically dispatching the MCV
Facility by scheduling deliveries on an economic basis. Consumers has continued
to economically dispatch the MCV Facility as a result of the overall rate freeze
implemented consistent with Public Acts 141 and 142. When Consumers returns to
the PSCR, beginning in January 2004, current MPSC orders will again only allow
Consumers to recover capacity charges from customers based on actual energy
deliveries up to the caps. Compared to periods under the rate freeze, the return
to full-time dispatch of the MCV Facility could have the effect of reducing the
earnings of CMS Midland via its ownership interest in the MCV Partnership. This
would be the result of MCV Partnership earnings being negatively impacted by the
relationship of higher fuel costs resulting from higher generation levels and
changing natural gas prices, compared to the MCV Partnership's recovery of fuel
costs, which is, in large part, based on costs associated with Consumers' coal
plants.
Consumers is exploring possible alternatives that would allow Consumers to
continue dispatching the MCV Facility on an economic basis in 2004 and beyond,
without increasing costs to customers or impairing future earnings. Any changes
regarding the recovery of MCV capacity costs would require MPSC approval.
Consumers cannot predict the outcome of this issue.
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Consumers Energy Company
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 court
overturned the lower court's order and dismissed the case against the MPSC. The
appellate court determined that the case was premature and concluded that the
qualifying facilities needed to wait until 2008 for an actual factual record to
develop before bringing claims against the MPSC in federal court.
For further information see Note 2, Uncertainties, "Other Electric Uncertainties
- - The Midland Cogeneration Venture."
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS AND MARKET RISK INFORMATION
DERIVATIVE INSTRUMENTS: Consumers uses the criteria in SFAS No. 133, as amended
and interpreted, to determine if certain contracts must be accounted for as
derivative instruments. The rules for determining whether a contract meets the
criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
Consumers currently accounts for the following contracts as derivative
instruments: certain electric call options, gas fuel options, fixed priced
weather-based gas supply call options and fixed price gas supply put options.
Consumers does not account for the following contracts as derivative
instruments: electric capacity and energy contracts, gas supply contracts
without embedded options, coal and nuclear fuel supply contracts, and purchase
orders for numerous supply items.
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.
Consumers uses quoted market prices to determine the fair value of contracts
that are accounted for as derivative instruments.
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
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Consumers Energy Company
early for other economic reasons, any gain or loss as of the termination date is
deferred and recorded when the forecasted transaction affects earnings.
FINANCIAL INSTRUMENTS: Consumers accounts for its 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 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. No further losses were required to be recognized in
the second quarter of 2003 on this investment. As of June 30, 2003, Consumers
held 2.4 million shares of CMS Energy Common Stock with a fair value of $19
million. 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: 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 uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. Consumers enters into all risk management
contracts for purposes other than trading.
These instruments contain credit risk if the counterparties, including financial
institutions and energy marketers, fail to perform under the agreements.
Consumers minimizes such risk by performing financial credit reviews using,
among other things, publicly available credit ratings of such counterparties.
In accordance with SEC disclosure requirements, Consumers performs sensitivity
analyses to assess the potential loss in fair value, cash flows and earnings
based upon a hypothetical 10 percent adverse change in market rates or prices.
Management does not believe that sensitivity analyses alone provide an accurate
or reliable method for monitoring and controlling risks. Therefore, Consumers
relies on the experience and judgment of its senior management to revise
strategies and adjust positions, as it deems necessary. Losses in excess of the
amounts determined in sensitivity analyses could occur if market rates or prices
exceed the 10 percent shift used for the analyses.
INTEREST RATE RISK: Consumers is exposed to interest rate risk resulting from
the issuance of fixed-rate financing and variable-rate financing, and from
interest rate swap agreements. Consumers uses a combination of these instruments
to manage and mitigate interest rate risk exposure when it deems it appropriate,
based upon market conditions. These strategies attempt to provide and maintain a
balance between risk and the lowest cost of capital. As of June 30, 2003 and
2002, Consumers had outstanding $624 million and $935 million of variable-rate
financing, respectively, including variable to fixed-rate swaps. As of June 30,
2003
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Consumers Energy Company
and 2002, assuming a hypothetical 10 percent adverse change in market interest
rates, Consumers' before tax earnings exposure on its variable-rate financing
would be $1 million and $2 million, respectively. As of June 30, 2002, Consumers
had entered into a floating-to-fixed interest rate swap agreement for a notional
amount of $75 million. The swap exchanged variable-rate interest payment
obligations for fixed-rate interest payment obligations in order to minimize the
impact of potential adverse interest rate changes. As of June 30, 2003 and 2002,
Consumers had outstanding fixed-rate financing, including variable to fixed-rate
swaps, of $3.297 billion and $2.777 billion, respectively, with a fair value of
$3.467 billion and $2.711 billion, respectively. As of June 30, 2003 and 2002,
assuming a hypothetical 10 percent adverse change in market rates, Consumers
would have an exposure of $143 million and $137 million, respectively, to the
fair value of these instruments if it had to refinance all of its fixed-rate
financing. As discussed below in Electric Business Outlook -- Securitization,
Consumers has filed an application with the MPSC to securitize certain costs.
Upon final approval, Consumers would use the proceeds from the securitization
for refinancing or retirement of debt, which could include a portion of its
current fixed-rate debt. Consumers does not believe that any adverse change in
debt price and interest rates would have a material adverse effect on either its
consolidated financial position, results of operation or cash flows.
COMMODITY MARKET RISK: For purposes other than trading, Consumers enters into
electric call options, gas fuel for generation option and swap contracts, fixed
price gas supply contracts containing embedded put options, fixed priced
weather-based gas supply call options and fixed priced gas supply put options.
The electric call options are used to protect against risk due to fluctuations
in the market price of electricity and to ensure a reliable source of capacity
to meet customers' electric needs. The gas fuel for generation option and swap
contracts are used to protect generation activities against risk due to
fluctuations in the market price of natural gas. The gas supply contracts
containing embedded put options, the weather-based gas supply call options, and
the gas supply put options are used to purchase reasonably priced gas supply.
As of June 30, 2003 and 2002, the fair value of electricity-related call option
and swap contracts, based on quoted market prices and mathematical models using
current and historical pricing data, was $13 million and $13 million,
respectively. As of June 30, 2003 and 2002, assuming a hypothetical 10 percent
adverse change in market prices, the potential reduction in fair value
associated with these contracts would be $2 million and $3 million,
respectively. As of June 30, 2003 and 2002, Consumers had an asset of $26
million and $35 million, respectively, related to premiums incurred for electric
call option contracts. Consumers' maximum exposure associated with the call
option contracts is limited to the premiums incurred. As of June 30, 2003,
Consumers did not have any gas supply contracts containing embedded put options.
As of June 30, 2002, the fair value based on quoted market prices for gas supply
contracts containing embedded put options was $2 million. As of June 30, 2002,
assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $1
million. As of June 30, 2003, the fair value of the fixed priced weather-based
gas supply call options and fixed priced gas supply put options, based on quoted
market prices, was $1 million. As of June 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.
EQUITY SECURITY PRICE RISK: Consumers owns less than 20 percent of the
outstanding shares of CMS Energy Common Stock. Consumers recognized a loss on
this investment through earnings of $12 million in the fourth quarter of 2002
and an additional $12 million loss in the first quarter of 2003, because the
loss was other than temporary as the fair value was below the cost basis for a
period greater than six months. No further losses were required to be recognized
in the second quarter of 2003 on this investment. As of June 30, 2003, Consumers
held 2.4 million shares of CMS Energy Common stock at a fair value of $19
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.
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Consumers Energy Company
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 June 30, 2003, Consumers had $1.128 billion recorded as
regulatory assets and $468 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. 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."
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.
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Consumers Energy Company
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. On June 11, 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, subject to receipt of the final actuarial report, resulted in an
increase of Consumers' 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.
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 changes to the Pension Plan, 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. In addition, Consumers has announced its intent to implement
a cash balance plan for newly hired employees. Plan details have not yet been
completed.
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 a
year. Consumers estimates that at the time of the decommissioning of Palisades,
its decommissioning trust fund will be fully funded. Earnings assumptions are
that the trust funds are invested in equities and fixed income investments,
equities will be converted to fixed income investments during decommissioning
and fixed income investments are converted to cash as needed. Decommissioning
costs have been developed, in part, by independent contractors with expertise in
decommissioning. These costs estimates use various inflation rates for labor,
non-labor, and contaminated equipment disposal costs.
In December 2000, the Big Rock trust fund was considered fully funded. A portion
of its current decommissioning cost resulted from the failure of the DOE to
remove fuel from the site. These costs, and similar costs incurred at Palisades,
would not be necessary but for the failure of the DOE to take possession of the
spent fuel as required by the Nuclear Waste Policy Act of 1982. A number of
utilities, 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.
CE-8
Consumers Energy Company
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 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 purchase
of gas transportation from Panhandle and Trunkline, 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
- ------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $ 40 $113 $(73)
Six months ended $139 $193 $(54)
===================================================================================================================
2003 COMPARED TO 2002: For the three months ended June 30, 2003, Consumers' net
income available to common stockholder totaled $40 million, a decrease of $73
million from the previous year.
This decrease in earnings reflects the absence of $31 million of after-tax
earnings associated with the asset sales in 2002, along with the absence of $17
million of after-tax earnings present in 2002 due to an increase in the fair
value of certain long-term gas contracts held by the MCV Partnership.
Earnings were also impacted by decreased electric delivery revenues which
reduced earnings by $12 million after-tax primarily due to cooler weather and
the migration to the lower margin retail delivery sector by industrial
customers. Increased electric and gas operating expenses reduced earnings by $11
million after-tax, which included storm restoration expenses incurred during the
second quarter of 2003 and higher electric transmission costs. The earnings
decrease reflects increased costs of borrowings that reduced earnings by $9
million after-tax and a $7 million charge at CMS Midland Holdings to reflect the
loss of certain deferred tax credits.
Offsetting these decreases is a $13 million after-tax benefit to earnings 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. Also
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 six months ended June 30, 2003, Consumers' net income available to
common stockholder totaled $139 million, a decrease of $54 million from the
previous year.
This decrease in earnings reflects the absence of the nonrecurring benefits from
2002, discussed above, including the $31 million after-tax gain on asset sales,
and the $17 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 Stock held by Consumers.
The decrease in earnings reflects increased electric and gas operating expenses
that reduced earnings by $32 million. Increased costs of borrowings reduced
earnings by $12 million after-tax, and a $7 million after-tax charge at CMS
Midland Holdings to reflect the loss of certain tax credits.
Offsetting these decreases is an after-tax benefit of $17 million due to
increased gas deliveries reflecting colder winter weather in early 2003, a $16
million after-tax benefit due to the final gas rate order issued in 2002
authorizing Consumers to increase its gas tariff rates, an $11 million after-tax
increase in electric intersystem revenues, and the $13 million benefit relating
to the reduction in MSBT expenses mentioned above.
For further information, see the Electric and Gas Utility Results of Operations
sections and Note 2, Uncertainties.
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Consumers Energy Company
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $35 $ 84 $(49)
Six months ended $86 $134 $(48)
===================================================================================================================
Three Months Ended Six Months Ended
Reasons for change June 30, 2003 vs. 2002 June 30, 2003 vs. 2002
- -------------------------------------------------------------------------------------------------------------------
Electric deliveries $ (18) $ (5)
Power supply costs and related revenue (1) 12
Other operating expenses and non-commodity revenue (14) (36)
Asset sales (38) (38)
General taxes 15 15
Fixed charges (11) (14)
Income taxes 18 18
-------------------------------------
Total change $ (49) $ (48)
==================================================================================================================
ELECTRIC DELIVERIES: For the three months ended June 30, 2003, electric delivery
revenues decreased by $18 million from the previous year. Electric deliveries,
including transactions with other wholesale market participants and other
electric utilities, were 9.3 billion kWh, a decrease of 0.1 billion kWh or 1.6
percent from 2002. The decrease in revenue is primarily the result of cooler
temperatures in 2003 that resulted in decreased deliveries to the higher margin
residential sector along with the migration to the lower margin retail delivery
sector by commercial and industrial customers.
For the six months ended June 30, 2003, electric delivery revenues decreased by
$5 million from the previous year. Electric deliveries, including transactions
with other wholesale market participants and other electric utilities, were 19.0
billion kWh, an increase of 0.4 billion kWh or 2.0 percent from 2002. This
decrease in delivery revenues can be attributed to the continued migration by
commercial and industrial customers to the lower margin retail delivery sector.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended June 30,
2003, power supply costs and related revenues decreased electric net income by
$1 million from 2002.
For the six months ended June 30, 2003, power supply costs and related revenues
increased electric net income by $12 million from 2002. This increase is
primarily the result of increased intersystem revenues due to higher market
prices and additional surplus capacity.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three and six months
ended June 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 are increased non-commodity revenues associated
with miscellaneous service revenues.
ASSET SALES: For the three and six months ended June 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
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Consumers Energy Company
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 and six months ended June 30, 2003, general taxes
decreased $15 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 six months ended June 30, 2003, fixed charges
increased $11 million and $14 million, respectively, from the comparable period
in 2002. These increases can be attributed to the increased financing
activities.
INCOME TAXES: For the three months ended June 30, 2003, income tax expense
decreased primarily due to a decrease in earnings by the electric utility
compared to 2002.
GAS UTILITY RESULTS OF OPERATIONS
In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Change
- -------------------------------------------------------------------------------------------------------------------
Three months ended $ 5 $ 3 $ 2
Six months ended $59 $31 $28
===================================================================================================================
Three Months Ended Six Months Ended
Reasons for change June 30, 2003 vs. 2002 June 30, 2003 vs. 2002
- ------------------------------------------------------------------------------------------------------------------
Gas deliveries $ (3) $ 31
Gas rate increase 5 25
Gas wholesales and retail services 3 6
Operation and maintenance (4) (14)
General taxes, depreciation, and other income 5 (1)
Fixed charges (2) (4)
Income taxes (2) (15)
---------------------------------------------
Total change $ 2 $ 28
==================================================================================================================
GAS DELIVERIES: For the three months ended June 30, 2003, gas delivery revenues
decreased by $3 million from the previous year. System deliveries, including
miscellaneous transportation, totaled 60.8 bcf, a decrease of 4.5 bcf or 6.9
percent compared with 2002.
For the six months ended June 30, 2003, gas delivery revenues increased by $31
million from the previous year. System deliveries, including miscellaneous
transportation, totaled 234.5 bcf, an increase of 20 bcf or 9.3 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 six months ended June 30, 2003,
Consumers recognized increased gas revenues of $5 million and $25 million,
respectively.
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Consumers Energy Company
OPERATION AND MAINTENANCE: For the three and six months ended June 30, 2003,
operation and maintenance expenses increased $4 million and $14 million,
respectively, when compared to 2002. This increase reflects the recognition of
additional expenditures on safety, reliability and customer service.
INCOME TAXES: For the three and six months ended June 30, 2003, income tax
expense increased primarily due to improved earnings of the gas utility.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING, AND FINANCING
OPERATING ACTIVITIES: Consumers' principal source of liquidity is cash from the
sale and transportation of natural gas and the generation, delivery and sale of
electricity. For the first six months, cash from operations totaled $179 million
in 2003 and $435 million in 2002. The $256 million decrease resulted from a $185
million decrease in cash collected from customers and related parties resulting
from lower accounts receivables sold, and a $108 million use of cash to increase
natural gas inventory due to colder weather and higher gas prices. 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 first six months, cash used for investing
activities totaled $225 million in 2003 and $7 million in 2002. The change of
$218 million is primarily due to a $278 million absence of proceeds from the
sale of METC and other asset sales, partially offset by a $58 million decrease
in capital expenditures.
FINANCING ACTIVITIES: For the first six months, cash used for financing
activities totaled $21 million in 2003 and $393 million in 2002. The change of
$372 million is primarily due to an increase of $844 million in proceeds from
senior notes and bank loans, offset partially by an increase of $202 million
from retirement of bonds and other long-term debt and a $295 million additional
payment of notes payable.
The above discussion of operating, investing and financing activities summarizes
Consumers' consolidated statement of cash flows found in Consumers' financial
statements.
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.
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Consumers Energy Company
Contractual Obligations In Millions
- ------------------------------------------------------------------------------------------------------------------
Payments Due
----------------------------------------------------------------
2008 and
June 30 Total 2003 2004 2005 2006 2007 beyond
- ------------------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 3,338 $ - $ 220 $ 470 $512 $ 31 $ 2,105
Current portion of long-
term debt 27 13 14 - - - -
Notes payable 1 1 - - - - -
Capital lease obligations 147 9 17 18 17 16 70
Off-balance sheet:
Operating leases 78 8 11 9 9 7 34
Non-recourse debt of FMLP 208 8 54 41 26 13 66
Sale of accounts receivable 50 50 - - - - -
Unconditional purchase
obligations 18,999 1,805 1,464 1,194 901 740 12,895
==================================================================================================================
REGULATORY AUTHORIZATION FOR FINANCINGS: At June 30, 2003, Consumers had FERC
authorization to issue or guarantee through June 2004, up to $1.1 billion of
short-term securities outstanding at any one time. In June 2003, the FERC
granted Consumers' request to issue an additional $1.1 billion outstanding at
any one time of first mortgage bonds to act solely as collateral for short-term
securities. In June 2003, the FERC also granted Consumers' request for an
increase in its authorization for long-term debt. At June 30, 2003, Consumers
had remaining FERC authorization to issue through June 2004 up to $1 billion of
long-term securities for refinancing or refunding purposes, $760 million for
general corporate purposes, and $2.06 billion of first mortgage bonds to be
issued solely as collateral for the long-term securities. These amounts include
the June 2003 increase in FERC authorization. In October 2002, FERC granted a
waiver of its competitive bid/negotiated placement requirements applicable to
the remaining long-term securities authorization indicated above.
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Consumers Energy Company
LONG-TERM FINANCINGS:
The following table is a summary of Consumers' debt issuances during 2003:
Long-Term Debt Financings in 2003 In Millions
- ----------------------------------------------------------------------------------------------------------------
Facility Issue Use of
Type Principal Rate Date Maturity Proceeds Collateral
- ----------------------------------------------------------------------------------------------------------------
Term loan $ 140 LIBOR March 2003 March 2009 GCP FMB(c)
Plus 475
Basis points
Term loan 150 LIBOR March 2003 March 2006 GCP FMB(c)
Plus 450
Basis points
FMB (a) 375 5.375 April 2003 April 2013 (b) -
FMB (a) 250 4.25 April 2003 April 2008 (b) -
FMB (a) 250 4.00 May 2003 May 2010 Retire debt -
-----
Total $ 1,165
==================================================================================================================
(GCP) General corporate purposes
(a) Consumers has agreed to file a registration statement with the SEC to permit
holders of these first mortgage bonds to exchange the bonds for new bonds that
will be registered under the Securities Act of 1933. Consumers has agreed to
file this registration statement by December 26, 2003.
(b) 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.
(c) Refer to Capital Resources and Liquidity, "Regulatory Authorization for
Financings" above for information about Consumers' remaining FERC debt
authorization.
As part of Consumers' ongoing cost reduction measures, Consumers will continue
to monitor financial markets in an attempt to reduce its financing costs.
Consumers' current portion of long-term debt maturing in 2003 and 2004 is $27
million. Refer to Outlook, "Liquidity and Capital Resources" below for
information about Consumers strategic measures addressing its future liquidity
and capital requirements.
SHORT-TERM FINANCINGS: In March 2003, Consumers obtained a replacement revolving
credit facility in the amount of $250 million secured by first mortgage bonds.
This debt facility was paid down and had a zero balance outstanding at June 30,
2003. The interest rate of the facility is LIBOR plus 350 basis points. The new
credit facility matures in March 2004 with two annual extensions at Consumers'
option, which would extend the maturity to March 2006. The prior facility was
due to expire in July 2003.
The revolving credit facility and the term loan mentioned above have contractual
restrictions that require Consumers to maintain, as of the last day of each
fiscal quarter, the following:
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Consumers Energy Company
Limitation Ratio at June 30, 2003
- ------------------------------------------------------------------------------------------------------------------
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.57 to 1.00
Interest Coverage Ratio - Revolver(a)(b) Not less than 2.00 to 1.00 3.83 to 1.00
Interest Coverage Ratio - Term Loan(a)(b) Not less than 2.00 to 1.00 3.98 to 1.00
==================================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facilities provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
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, June 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. After giving effect to the adoption of SFAS
No. 150 regarding the balance sheet classification of its Trust Preferred
Securities and to expected future use of its revolving credit facilities,
Consumers currently estimates that its ratio of indebtedness to total
capitalization at the end of the third and fourth quarters of 2003 will still
comply with the Debt Percentage Tests but will approach the limits specified in
some of the Debt Percentage Tests. Consumers plans to seek amendments to the
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, regarding Trust Preferred Securities on the calculations. Consumers
believes that it will receive the necessary consents of its lenders to these
amendments. However, it is possible that if Consumers does not receive the
necessary amendments and fails to be an compliance with some of the Debt
Percentage Tests such failure could constrain its ability to access its
revolving credit or accounts receivable sales facilities, or to incur additional
indebtedness, and could also result in defaults under one or more of these
agreements.
Also, covenants in Consumers' debt facilities cap common stock dividend payments
at $300 million in a calendar year. Consumers paid common stock dividends of
$208 million plus a capital distribution of $25 million in 2002 to CMS Energy.
In January 2003, Consumers declared and paid a $78 million common dividend. In
March 2003, Consumers declared a $31 million common dividend which was paid in
May 2003. In June 2003, Consumers declared a $53 million common dividend payable
in August 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. Operating leases are predominately for
railroad coal cars.
OFF-BALANCE SHEET ARRANGEMENTS: Consumers' use of long-term contracts for the
purchase of commodities and services, the sale of its accounts receivable, and
operating leases are considered to be off-balance sheet arrangements. Consumers
has responsibility for the collectability of the accounts receivable sold, and
the full obligation of its leases become due in case of lease payment default.
Consumers uses these off-balance sheet arrangements in its normal business
operations.
SALE OF ACCOUNTS RECEIVABLE: In April 2003, Consumers ended its trade
receivables sales program with its existing purchaser. During May 2003, a new
trade receivables program was put in place with a different purchaser. As a
result of changing purchasers, Consumers established a new subsidiary, Consumers
Receivables Funding II. This consolidated subsidiary was established as a
special purpose entity in order to properly reflect the sale of receivables from
Consumers to Consumers Receivables Funding II, through to the purchaser, an
unrelated third party. The program's maximum receivable sale amount of $325
million remains unchanged. Consumers also will continue to retain servicing
responsibilities for the trade receivables sold, however, the purchaser of the
trade 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 trade receivables sold and
Consumers retains no interest in the receivables sold. Accounts receivable and
accrued revenue in the Consolidated Balance Sheet have been reduced to reflect
trade receivables sold. At June 30 receivables sold under the program totaled
$50 million in 2003 and $311 million in 2002.
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 six months of 2003, including $34 million related to the MCV Facility.
For the period that a plant is
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Consumers Energy Company
not available to deliver electricity to Consumers, Consumers is not obligated to
make the capacity payments to the plant. See Electric Utility Results of
Operations above and Note 2, Uncertainties, "Electric Rate Matters - Power
Supply Costs" and "Other Electric Uncertainties - The Midland Cogeneration
Venture" for further information concerning power supply costs.
Commercial Commitments In Millions
- ------------------------------------------------------------------------------------------------------------------
Commitment Expiration
---------------------------------------------------------------
2008 and
June 30 Total 2003 2004 2005 2006 2007 beyond
- ------------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Indemnities $8 $- - - - - $8
Letters of credit 7 7 - - - - -
==================================================================================================================
Indemnities are agreements by Consumers to reimburse other companies, such as an
insurance company, if those companies have to complete Consumers' performance
involving a third party contract. Letters of credit are issued by a bank on
behalf of Consumers, guaranteeing payment to a third party. Letters of credit
substitute the bank's credit for Consumers' and reduce credit risk for the third
party beneficiary. The amount and time period for drawing on a letter of credit
is limited.
OUTLOOK
LIQUIDITY AND CAPITAL RESOURCES
Consumers' liquidity and capital requirements generally are a function of its
results of operations, capital expenditures, contractual obligations, debt
maturities, working capital needs and collateral requirements. During the summer
months, Consumers purchases natural gas and stores it for resale primarily
during the winter heating season. Recently, the market price for natural gas has
increased. 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.
Consumers has historically met its consolidated cash needs through its operating
and financing activities and access to bank financing and the capital markets.
In 2003, Consumers has contractual obligations and planned capital expenditures
that would require substantial amounts of cash. Consumers may also become
subject to liquidity demands pursuant to commercial commitments under
guarantees, indemnities and letters of credit as indicated above. Consumers
plans to meet its liquidity and capital requirements in 2003 through a
combination of 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 financing.
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Consumers Energy Company
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. In addition, the following activities also have been
initiated by Consumers to enhance further its liquidity:
o Consumers filed a general rate case for its gas utility business in
March, 2003. Consumers requested rate relief in the amount of
approximately $156 million. In its filing, Consumers requested
immediate interim relief. See Gas Business Outlook, "2003 Gas Rate
Case" below for MPSC Staff recommended interim rate relief.
o Consumers filed an application in March 2003, with the MPSC seeking
authorization to issue $1.084 billion of Securitization bonds. These
bonds would provide liquidity to Consumers at interest rates reflective
of high quality credit. Consumers would utilize these proceeds to
retire higher cost debt and in turn would realize significant interest
expense savings over the life of the bonds.
In June 2003, the MPSC issued a financing order authorizing the issuance of the
Securitization bonds in the amount of approximately $554 million. 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. The financing order will
only become effective after rehearing and upon acceptance by Consumers.
Consumers anticipates that bonds could be issued by the first quarter 2004.
For further information on Securitization see, Electric Business Outlook,
"Competition and Regulatory Restructuring - Securitization."
There is no assurance that the pending Securitization bond issuance transaction
noted above will be completed, nor is there assurance that the MPSC will grant
either interim or final gas utility rate relief.
LITIGATION AND REGULATORY INVESTIGATIONS
SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading transactions at
CMS MST, CMS Energy's Board of Directors established a special committee of
independent directors to investigate matters surrounding the transactions and
retained outside counsel to assist in the investigation. The Special Committee
completed its investigation and reported its findings to the Board of Directors
in October 2002. The Special Committee concluded, based on an extensive
investigation, that the round-trip trades were undertaken to raise CMS MST's
profile as an energy marketer with the goal of enhancing its ability to promote
its services to new customers. The Special Committee found no effort to
manipulate the price of CMS Energy Common Stock or affect energy prices. The
Special Committee also made recommendations designed to prevent any reoccurrence
of this practice. 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 forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST 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.
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Consumers Energy Company
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been filed 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.
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named and unnamed officers and directors, in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the CMS
Energy 401(k) plan. The two cases, filed in July 2002 in the United States
District Court for the Eastern District of Michigan, were consolidated by the
trial judge and an amended and consolidated complaint has been filed. Plaintiffs
allege breaches of fiduciary duties under ERISA and seek restitution on behalf
of the plan with respect to a decline in value of the shares of CMS Energy
Common Stock held in the plan. Plaintiffs also seek other equitable relief and
legal fees. These cases will be defended vigorously. Consumers cannot predict
the outcome of this litigation.
ELECTRIC BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric deliveries
(including both full service sales and delivery service to customers who choose
to buy generation service from an alternative electric supplier, but excluding
transactions with other wholesale market participants including other electric
utilities) to grow at an average rate of approximately two percent per year
based primarily on a steadily growing customer base. This growth rate reflects a
long-range expected trend of growth. Growth from year to year may vary from this
trend due to customer response to abnormal weather conditions and changes in
economic conditions including, utilization and expansion of manufacturing
facilities. Consumers experienced much stronger growth in 2002 as a result of
warmer than normal summer weather. Assuming that, in the last half of 2003,
normal weather conditions will occur and manufacturing activity will average
about one percent less than last year, a slight decline from the strong 2002
electric deliveries is anticipated.
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 late
July 2003, alternative electric suppliers are providing 575 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.
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Consumers Energy Company
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 previously unsecuritized
Palisades expenditures were approved as proposed in its securitization case as
discussed below in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 are approximately $35 million. If the proposal to securitize
those costs is not approved, then Consumers indicated that the costs would be
properly included in the 2002 "net" Stranded Cost calculation, which would
increase Consumers' 2002 "net" Stranded Costs to approximately $103 million.
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 previously unsecuritized Palisades expenditures as eligible
securitized costs. As a result, the previously unsecuritized Palisades
expenditures 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 previously unsecuritized Palisades expenditures,
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.
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Consumers Energy Company
In July 2003, the staff suspended further 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 orders 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 June 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $15 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 filed a petition for rehearing with the FERC and in July
2003, the FERC granted Consumers' petition for rehearing. Consumers cannot
predict the amount of implementation costs the FERC will ultimately order to be
reimbursed by MISO.
Securitization: In March 2003, Consumers filed an application with the MPSC
seeking approval to issue Securitization bonds in the amount of approximately
$1.084 billion. The application sought recovery of costs associated with Clean
Air Act expenditures, previously unsecuritized Palisades expenditures, 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. Consumers
believes unsecuritized Palisades expenditures should be included as a component
of "net" Stranded Costs.
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
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Consumers Energy Company
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 order by the MPSC 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. The financing order will
become effective after rehearing 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.
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 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 June 30, 2003, contracts for
200 MW of load have terminated and outstanding contracts involve approximately
485 MW of load. Of the contracts that have terminated, 52 MW have gone to an
alternative electric supplier and 148 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 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
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Consumers Energy Company
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.
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 be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a loss of revenue from wholesale and
retail open access customers who will buy services directly from MTH and the
loss of a return on the sold electric transmission system.
Under an agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers are fixed by contract at current levels
through December 31, 2005, and subject to FERC ratemaking thereafter. MTH has
completed the capital program to expand the transmission system's capability to
import electricity into Michigan, as required by the Customer Choice Act, and
Consumers will continue to maintain the system until May 1, 2007 under a
contract with MTH.
Consumers is a customer of AEP and holds 400 MW of long-term transmission
service reservations through the AEP transmission system. AEP has indicated its
intent, and has received preliminary FERC approval, to turn control of its
transmission system over to the PJM RTO. This change will require AEP wholesale
transmission customers to become members of, and resubmit reservation requests
to, PJM. Legislation recently enacted in Virginia, precludes Virginia utilities
(including AEP) from joining an RTO until July 2004. In addition, the Kentucky
Public Service Commission has denied AEP's request to transfer its assets to
PJM. These developments, as well as uncertainty associated with state approvals
AEP is seeking from various state regulatory bodies, raise some doubt regarding
the timing of AEP's membership in PJM. Upon completion of the steps necessary
for the integration of AEP into PJM, Consumers will complete the application
process to join PJM as a transmission customer.
There are multiple proceedings and a proposed rulemaking pending before the FERC
regarding transmission pricing mechanisms and standard market design for
electric bulk power markets and transmission. The results of these proceedings
and proposed rulemaking could significantly affect the trend of transmission
costs and increase the delivered power costs to Consumers and the retail
electric customers it serves. The specific financial impact on Consumers of such
proceedings, rulemaking and trends are not currently quantifiable.
In addition, Consumers is evaluating whether or not there may be impacts on
electric reliability associated with the outcomes of these various transmission
related proceedings. Consumers cannot assure that all risks to reliability can
be avoided.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
CE-23
Consumers Energy Company
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards for Consumers and other Michigan electric distribution
utilities. The proposal would establish standards related to restoration after
an outage, safety, and customer relations. Failure to meet the standards would
result in customer bill credits. Consumers submitted comments to the MPSC. In
December 2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards. In November
2002, the MPSC issued an order initiating the formal rulemaking proceeding.
Consumers has filed comments on the proposed rules and will continue to
participate in this process. Consumers cannot predict the nature of the proposed
standards or the likely effect, if any, on Consumers.
For further information and material changes relating to the rate matters and
restructuring of the electric utility industry, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, and Note 2, Uncertainties,
"Electric Rate Matters -- Electric Restructuring" and "Electric Rate Matters --
Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
the need to make additional capital expenditures and increase operating expenses
for Clean Air Act compliance; 3) environmental liabilities arising from various
federal, state and local environmental laws and regulations, including potential
liability or expenses relating to the Michigan Natural Resources and
Environmental Protection Acts and Superfund; 4) uncertainties relating to the
storage and ultimate disposal of spent nuclear fuel; 5) electric industry
restructuring issues, including those described above; 6) Consumers' ability to
meet peak electric demand requirements at a reasonable cost, without market
disruption, and successfully implement initiatives to reduce exposure to
purchased power price increases; 7) the recovery of electric restructuring
implementation costs; 8) Consumers' status as an electric transmission customer
and not as an electric transmission owner/operator; 9) sufficient reserves for
OATT rate refunds; 10) the effects of derivative accounting and potential
earnings volatility; 11) increased costs for safety and homeland security
initiatives that are not recoverable on a timely basis from customers; and 12)
potentially rising pension costs due to market losses (as discussed above in
Accounting for Pension and OPEB). For further information about these trends or
uncertainties, see Note 2, Uncertainties.
GAS BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects gas deliveries, including
gas full service and customer choice deliveries (excluding transportation to the
MCV Facility and off-system deliveries), to grow at an average rate of less than
one percent per year based primarily on a steadily growing customer base. Actual
gas deliveries in future periods may be affected by abnormal weather, use of gas
by independent power producers, changes in competitive and economic conditions,
and the level of natural gas consumption per customer. Also, the recent
significant increases in gas commodity prices may reduce gas sales by amounts
which Consumers is not able to predict.
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation process with the MPSC, Consumers expects to collect all of its
incurred gas costs. In June 2003, Consumers filed a reconciliation of GCR costs
and revenues for the 12-month period April 2002 through March 2003. In the
filing, Consumers proposed to recover from customers a net under-recovery of
approximately $6 million according to a "roll-in" methodology, which
incorporates the under-recovery in rates charged in the succeeding GCR year. The
"roll-in" tariff provision was approved by the MPSC in a November, 2002 order.
CE-24
Consumers Energy Company
Under an order issued by the MPSC 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 use
an August GCR factor of $5.56 per mcf to bill its customers.
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 authorized 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.
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related services
to retail customers that focus on appliance maintenance, home safety, commodity
choice, and assistance to customers purchasing heating, ventilation and air
conditioning equipment. Consumers continues to look for additional growth
opportunities in providing energy-related services to its customers. The ability
to offer all or some of these services and other utility related
revenue-generating services, which provide approximately $36 million in annual
gas revenues, may be restricted by the new code of conduct issued by the MPSC,
as discussed above in Electric Business Outlook, "Competition and Regulatory
Restructuring - Code of Conduct." 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.
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)
increased costs for pipeline integrity and safety and homeland security
initiatives that are not recoverable on a timely basis from customers; and 7)
potentially rising pension costs due to market losses (as discussed above in
Accounting for Pension and OPEB). For further information about these
uncertainties, see Note 2, Uncertainties.
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Consumers Energy Company
OTHER OUTLOOK
See Outlook, "Liquidity and Capital Resources" and "Litigations and Regulatory
Investigations" above.
SECURITY COSTS: Since the September 11, 2001 terrorist attacks in the United
States, Consumers has increased security at all critical facilities and over its
critical infrastructure, and will continue to evaluate security on an ongoing
basis. Consumers may be required to comply with federal and state regulatory
security measures promulgated in the future. Through June 30, 2003, Consumers
has incurred approximately $6 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 six 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.
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.
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. Consumers has not
created any variable interest entities in 2003. Therefore, this portion of the
interpretation has no impact on its consolidated financial statements. This
interpretation's consolidation requirements also apply to pre-existing entities
beginning July 1, 2003. Consumers will be required to consolidate any entities
that meet the requirements of this portion of the interpretation. Consumers is
in the process of studying this interpretation and has yet to determine the
effects, if any, on its consolidated financial statements.
Although Consumers has not determined the effect of this interpretation, it is
possible that Consumers may be required to consolidate in its financial
statements, the assets, liabilities and activities of the MCV Partnership. If
that should occur, Consumers would have to recognize the MCV Partnership debt on
its financial statements. This could negatively impact 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.
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. Consumers is in the process of
studying this statement, and has yet to determine the effects, if any, the
statement will have on accounting for contracts entered into after June 30,
2003.
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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 determined that all of its trust preferred securities fall under
the scope of SFAS No. 150. These securities have fixed redemption dates and
amounts and qualify as mandatorily redeemable preferred securities under SFAS
No. 150. On July 1, 2003, mandatorily redeemable preferred securities totaling
$490 million were reclassified from the mezzanine equity section to the
liability section of Consumers' consolidated balance sheet. Beginning July 1,
2003, periodic payments will be recorded as interest expense rather than
dividends. In accordance with SFAS No. 150, prior periods will not be restated.
Consumers did not incur any cumulative impact due to this accounting change.
CE-27
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------
In Millions
OPERATING REVENUE
Electric $ 603 $ 631 $ 1,256 $ 1,240
Gas 299 252 1,088 868
Other 18 18 34 29
--------------------------------------------------------
920 901 2,378 2,137
- -------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Operation
Fuel for electric generation 76 71 156 138
Purchased power - related parties 120 133 252 273
Purchased and interchange power 75 72 157 133
Cost of gas sold 184 113 703 508
Cost of gas sold - related parties - 31 25 62
Other 167 166 327 306
---------------------------------------------------------
622 586 1,620 1,420
- -------------------------------------------------------------------------------------------------------------
Maintenance 56 48 108 98
Depreciation, depletion and amortization 79 71 195 179
General taxes 24 44 83 101
---------------------------------------------------------
781 749 2,006 1,798
- -------------------------------------------------------------------------------------------------------------
OPERATING INCOME
Electric 97 116 213 231
Gas 24 18 127 82
Other 18 18 32 26
--------------------------------------------------------
139 152 372 339
- -------------------------------------------------------------------------------------------------------------
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates - 1 - 2
Accretion expense (2) (1) (4) (3)
Other, net 3 37 (5) 36
---------------------------------------------------------
1 37 (9) 35
- -------------------------------------------------------------------------------------------------------------
INTEREST CHARGES
Interest on long-term debt 51 37 93 70
Other interest 3 2 8 11
Capitalized interest (3) (3) (5) (5)
---------------------------------------------------------
51 36 96 76
- -------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 89 153 267 298
INCOME TAXES 37 46 105 99
---------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE 52 107 162 199
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING, FOR
DERIVATIVE INSTRUMENTS, NET OF $9 TAX EXPENSE
IN 2002 - 17 - 17
---------------------------------------------------------
NET INCOME 52 124 162 216
PREFERRED STOCK DIVIDENDS 1 - 1 1
PREFERRED SECURITIES DISTRIBUTIONS 11 11 22 22
---------------------------------------------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER
$ 40 $ 113 $ 139 $ 193
=============================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
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CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30 2003 2002
- ----------------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 162 $ 216
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $3 and $3, respectively) 195 179
Gain on sale of METC and other assets - (38)
Deferred income taxes and investment tax credit 74 (27)
Loss on CMS Energy stock 12 -
Capital lease and other amortization 13 8
Undistributed earnings of related parties (35) (28)
Cumulative effect of accounting change - (17)
Changes in assets and liabilities
Decrease in inventories 20 128
Decrease (increase) in accounts receivable and accrued revenue (124) 61
Decrease in accounts payable (51) (69)
Changes in other assets and liabilities (87) 22
-----------------------
Net cash provided by operating activities 179 435
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (215) (273)
Cost to retire property, net (36) (31)
Investment in Electric Restructuring Implementation Plan (4) (5)
Investments in nuclear decommissioning trust funds (3) (3)
Proceeds from nuclear decommissioning trust funds 18 12
Proceeds from sale of METC and other assets 15 293
-----------------------
Net cash used in investing activities (225) (7)
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from senior notes and bank loans, net 1,148 304
Retirement of bonds and other long-term debt (574) (372)
Increase (decrease) in notes payable, net (456) (161)
Payment of common stock dividends (109) (154)
Preferred securities distributions (22) (22)
Payment of capital lease obligations (7) (7)
Payment of preferred stock dividends (1) (1)
Redemption of preferred securities - (30)
Stockholder's contribution, net - 50
-----------------------
Net cash used in financing activities (21) (393)
- ----------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS (67) 35
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 271 17
-----------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 204 $ 52
================================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 93 $ 47
Income taxes paid (net of refunds) 29 52
Pension and OPEB cash contribution 36 83
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 10 $ 35
================================================================================================================
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-29
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
ASSETS JUNE 30 JUNE 30
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
- -----------------------------------------------------------------------------------------------------------------
In Millions
PLANT (AT ORIGINAL COST)
Electric $ 7,465 $ 7,523 $ 7,396
Gas 2,805 2,719 2,651
Other 21 23 21
------------------------------------------
10,291 10,265 10,068
Less accumulated depreciation, depletion and amortization 5,307 5,900 5,822
----------------------------------------
4,984 4,365 4,246
Construction work-in-progress 427 548 477
-----------------------------------------
5,411 4,913 4,723
- -----------------------------------------------------------------------------------------------------------------
INVESTMENTS
Stock of affiliates 19 22 26
First Midland Limited Partnership 263 255 261
Midland Cogeneration Venture Limited Partnership 422 388 359
Consumers Nuclear Services, LLC 2 2 2
-------------------------------------------
706 667 648
- -----------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 204 271 52
Accounts receivable and accrued revenue, less allowances
of $5, $4 and $4, respectively 346 236 76
Accounts receivable - related parties 22 13 15
Inventories at average cost
Gas in underground storage 458 486 431
Materials and supplies 74 71 67
Generating plant fuel stock 42 37 57
Deferred property taxes 103 142 99
Regulatory assets 19 19 19
Other 89 38 9
------------------------------------------
1,357 1,313 825
- -----------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory assets
Securitized costs 669 689 709
Postretirement benefits 174 185 197
Abandoned Midland Project 11 11 11
Other 255 168 173
Nuclear decommissioning trust funds 553 536 555
Other 178 218 137
-----------------------------------------
1,840 1,807 1,782
- -----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 9,314 $ 8,700 $ 7,978
=================================================================================================================
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STOCKHOLDER'S INVESTMENT AND LIABILITIES JUNE 30 JUNE 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 (183) (179) (8)
Retained earnings since December 31, 1992 522 545 480
-----------------------------------------
1,862 1,889 1,995
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred securities
of subsidiaries (a) 490 490 490
Long-term debt 3,338 2,442 2,441
Non-current portion of capital leases 119 116 97
-----------------------------------------
5,853 4,981 5,067
- -----------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 40 318 225
Notes payable 1 457 255
Accounts payable 232 261 219
Accrued taxes 129 214 213
Accounts payable - related parties 62 84 87
Deferred income taxes 39 25 19
Current portion of purchase power contract 26 26 24
Other 206 200 247
-----------------------------------------
735 1,585 1,289
- -----------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Deferred income taxes 993 949 755
Postretirement benefits 597 563 230
Regulatory liabilities for income taxes, net 313 297 276
Asset retirement obligations 363 - -
Other regulatory liabilities 155 4 -
Deferred investment tax credit 87 91 94
Power purchase agreement - MCV Partnership 14 27 41
Other 204 203 226
-----------------------------------------
2,726 2,134 1,622
- -----------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDER'S INVESTMENT AND LIABILITIES $ 9,314 $ 8,700 $ 7,978
=================================================================================================================
(a) See Note 3, Financings and Capitalization
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-31
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 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 682 782 682 632
Stockholder's contribution - - - 150
Return of Stockholder's contribution - (100) - (100)
-------------------------------------------------
At end of Period 682 682 682 682
- -----------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (185) - (185) -
Minimum liability pension adjustment (b) (17) - (17) -
-------------------------------------------------
At end of period (202) - (202) -
Investments
At beginning of period 1 13 1 16
Unrealized gain (loss) on investments (c) 7 (18) 7 (21)
-------------------------------------------------
At end of period 8 (5) 8 (5)
Derivative Instruments
At beginning of period (d) 9 (4) 5 (12)
Unrealized gain on derivative instruments (c) 6 - 13 5
Reclassification adjustments included in net income (c) (4) 1 (7) 4
-------------------------------------------------
At end of period 11 (3) 11 (3)
Total Accumulated Other Comprehensive Income (Loss) (183) (8) (183) (8)
- -----------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
At beginning of period 535 467 545 441
Net income 52 124 162 216
Cash dividends declared- Common Stock (53) (100) (162) (154)
Cash dividends declared- Preferred Stock (1) - (1) (1)
Preferred securities distributions (11) (11) (22) (22)
-------------------------------------------------
At end of period 522 480 522 480
- -----------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $1,862 $1,995 $1,862 $1,995
=================================================================================================================
CE-32
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 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) Disclosure of Comprehensive Income:
Minimum pension liability adjustment (b) $ (17) $ - $ (17) $ -
Investments
Unrealized gain (loss) on investments, net of tax of
$(4), $10, $(3) and $12, respectively 7 (18) 7 (21)
Derivative Instruments
Unrealized gain on derivative instruments,
net of tax of $(3), $- , $(7) and $(3), respectively 6 - 13 5
Reclassification adjustments included in net income,
net of tax of $2, $(1), $4 and $(2) , respectively (4) 1 (7) 4
Net income 52 124 162 216
-----------------------------------------------
Total Comprehensive Income $ 44 $ 107 $ 158 $ 204
===============================================
(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 $ 11 $ (1) $ 8 $ (8)
Unrealized gain on derivative instruments 6 1 13 6
Reclassification adjustments included in net income (4) 1 (8) 3
-----------------------------------------------
At the end of the period $ 13 $ 1 $ 13 $ 1
===============================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
CE-33
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.
REPORTABLE SEGMENTS: Consumers has two reportable segments: electric and gas.
The electric segment consists of activities associated with the generation and
distribution of electricity. The gas segment consists of activities associated
with the transportation, storage and distribution of natural gas. Consumers'
reportable segments are domestic business units organized and managed by the
nature of the product and service each provides. The accounting policies of the
segments are the same as those described in Consumers' 2002 Form 10-K.
Consumers' management has changed its evaluation of the performance of the
electric and gas segments from operating income to net income available to
common stockholder. The Consolidated Statements of Income show operating revenue
and operating income by reportable segment. Intersegment sales and transfers are
accounted for at current market prices and are eliminated in consolidated net
income available to common stockholder by segment. Consumers classifies its
equity investments as a part of the other business unit. The
CE-34
Consumers Energy Company
other business unit also includes Consumers' consolidated statutory business
trusts, which were created to issue preferred securities and Consumers'
consolidated special purpose entity for the sale of trade receivables. The net
income available to common stockholder by reportable segment is as follows:
In Millions
- ----------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Net income available to common stockholder
Electric $35 $ 84 $ 86 $134
Gas 5 3 59 31
Other - 26 (6) 28
- ----------------------------------------------------------------------------------------------------------------------
Total Consolidated $40 $113 $139 $193
======================================================================================================================
FINANCIAL INSTRUMENTS: Consumers accounts for its debt and equity investment
securities in accordance with SFAS No. 115. As such, debt and equity securities
can be classified into one of three categories: held-to-maturity, trading, or
available-for-sale securities. Consumers' investments in equity securities,
including its investment in CMS Energy Common Stock, are classified as
available-for-sale securities. They are reported at fair value, with any
unrealized gains or losses from changes in fair value reported in equity as part
of accumulated other comprehensive income and excluded from earnings, unless
such changes in fair value are other than temporary. In 2002, Consumers
determined that the decline in value related to its investment in CMS Energy
Common Stock was other than temporary as the fair value was below the cost basis
for a period greater than six months. As a result, Consumers recognized a loss
on its investment in CMS Energy Common Stock through earnings of $12 million in
the fourth quarter of 2002 and an additional $12 million loss in the first
quarter of 2003. As of June 30, 2003, Consumers held 2.4 million shares of CMS
Energy Common Stock with a fair value of $19 million. Unrealized gains or losses
from changes in the fair value of Consumers' nuclear decommissioning investments
are reported as regulatory liabilities. The fair value of these investments is
determined from quoted market prices.
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
the regulated utility accounting standard SFAS No. 71. As a result, the actions
of regulators affect when Consumers recognizes revenues, expenses, assets and
liabilities.
In 1999, Consumers received MPSC electric restructuring orders, which, among
other things, identified the terms and timing for implementing electric
restructuring in Michigan. Consistent with these orders and EITF No. 97-4,
Consumers discontinued the application of SFAS No. 71 for the energy supply
portion of its business because Consumers expected to implement retail open
access at competitive market based rates for its electric customers.
Discontinuation of SFAS No. 71 for the energy supply portion of Consumers'
business resulted in Consumers reducing the carrying value of its Palisades
plant-related assets, in 1999, by approximately $535 million and establishing a
regulatory asset for a corresponding amount.
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
CE-35
Consumers Energy Company
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."
SFAS No. 144 imposes strict criteria for retention of regulatory-created assets
by requiring that such assets be probable of future recovery at each balance
sheet date. Management believes these assets are probable of future recovery.
SFAS NO. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION -- TRANSITION AND
DISCLOSURE: Issued by the FASB in December 2002, this standard provides for
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, the
statement amends the disclosure requirements of SFAS No. 123 to require more
prominent and more frequent disclosures in financial statements about the
effects of stock-based compensation. The transition guidance and annual
disclosure provisions of the statement were effective as of December 31, 2002
and interim disclosure provisions are effective for interim financial reports
starting in 2003. Consumers decided to voluntarily adopt the fair value based
method of accounting for stock-based employee compensation effective December
31, 2002, applying the prospective method of adoption which requires recognition
of all employee awards granted, modified, or settled after the beginning of the
year in which the recognition provisions are first applied. The following table
shows the amounts that would have been included in net income had the fair value
method been applied to all awards granted in the three and six month periods
ended June 30, 2002:
In Millions
- ----------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 2002
- ----------------------------------------------------------------------------------------------------------------------
Net income, as reported $124
Add: Stock-based employee compensation expense included in reported net income, net of related taxes -
Deduct: Total stock-based employee compensation expense determined under fair value based method for all
awards, net of related taxes -
-----
Pro forma net income $124
======================================================================================================================
In Millions
- ----------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30 2002
- ----------------------------------------------------------------------------------------------------------------------
Net income, as reported $216
Add: Stock-based employee compensation expense included in reported net income, net of related taxes -
Deduct: Total stock-based employee compensation expense determined under fair value based method for all
awards, net of related taxes (1)
-----
Pro forma net income $215
======================================================================================================================
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
CE-36
Consumers Energy Company
expenses relating to the Michigan Natural Resources and Environmental Protection
Acts and Superfund; 4) electric industry restructuring issues; 5) Consumers'
ability to meet peak electric demand requirements at a reasonable cost, without
market disruption, and successfully implement initiatives to reduce exposure to
purchased power price increases; 6) the recovery of electric restructuring
implementation costs; 7) Consumers' status as an electric transmission customer
and not as an electric transmission owner/operator; 8) sufficient reserves for
OATT rate refunds; 9) uncertainties relating to the storage and ultimate
disposal of spent nuclear fuel; 10) the effects of derivative accounting and
potential earnings volatility; 11) potential environmental costs at a number of
sites, including sites formerly housing manufactured gas plant facilities; 12)
future gas industry restructuring initiatives; 13) an inadequate regulatory
response to applications for requested rate increases; 14) market and regulatory
responses to increases in gas costs, including a reduced average use per
residential customer; and 15) increased costs for pipeline integrity and safety
and homeland security initiatives that are not recoverable on a timely basis
from customers.
SEC AND OTHER INVESTIGATIONS: As a result of the round-trip trading transactions
at CMS MST, CMS Energy's Board of Directors established a Special Committee of
independent directors to investigate matters surrounding the transactions and
retained outside counsel to assist in the investigation. The Special Committee
completed its investigation and reported its findings to the Board of Directors
in October 2002. The Special Committee concluded, based on an extensive
investigation, that the round-trip trades were undertaken to raise CMS MST's
profile as an energy marketer with the goal of enhancing its ability to promote
its services to new customers. The Special Committee found no 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 forty-five days that they have taken certain specified remedial measures
with respect to the reporting of natural gas trading data to publications that
compile and publish price indices. CMS MST 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 have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been 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.
CE-37
Consumers Energy Company
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named and unnamed officers and directors in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
401(k) plan. The two cases, filed in July 2002 in the United States District
Court for the Eastern District of Michigan, were consolidated by the trial judge
and an amended and consolidated complaint has been filed. Plaintiffs allege
breaches of fiduciary duties under ERISA and seek restitution on behalf of the
plan with respect to a decline in value of the shares of CMS Energy Common Stock
held in the plan. Plaintiffs also seek other equitable relief and legal fees.
These cases will be 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 also issued additional regulations regarding
nitrogen oxide emissions that require certain generators, including some of
Consumers' electric generating facilities, to achieve the same emissions rate as
that required by the 1998 regulations. The EPA and the state regulations require
Consumers to make significant capital expenditures estimated to be $770 million.
As of June 30, 2003, Consumers has incurred $430 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 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.
Cleanup and Solid Waste -- Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. Consumers believes
that these costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $1 million and $9 million. As of June
30, 2003, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
During routine maintenance activities, Consumers identified PCB as a component
in certain paint, grout and sealant materials at the Ludington Pumped Storage
facility. Consumers removed and replaced part of the PCB
CE-38
Consumers Energy Company
material. Consumers has proposed a plan to deal with the remaining materials and
is awaiting a response from the EPA.
ELECTRIC RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan legislature passed electric
utility restructuring legislation known as the Customer Choice Act. This act: 1)
permits all customers to choose their electric generation supplier beginning
January 1, 2002; 2) cut residential electric rates by five percent; 3) freezes
all electric rates through December 31, 2003, and establishes a rate cap for
residential customers through at least December 31, 2005, and a rate cap for
small commercial and industrial customers through at least December 31, 2004; 4)
allows for the use of low-cost Securitization bonds to refinance qualified
costs, as defined by the act; 5) establishes a market power supply test that may
require transferring control of generation resources in excess of that required
to serve firm retail sales requirements (In March 2003, Consumers filed an
application with the MPSC that seeks confirmation that Consumers is in
compliance with the market power test set forth in the Customer Choice Act. In
June 2003, Consumers submitted a settlement of the parties to the MPSC
proceeding that, when approved by the MPSC, will provide the requested
confirmation); 6) requires Michigan utilities to join a FERC-approved RTO or
divest their interest in transmission facilities to an independent transmission
owner (Consumers has sold its interest in its transmission facilities to an
independent transmission owner, see "Transmission" below); 7) requires
Consumers, Detroit Edison and American Electric Power to jointly expand their
available transmission capability by at least 2,000 MW; 8) allows deferred
recovery of an annual return of and on capital expenditures in excess of
depreciation levels incurred during and before the rate freeze/cap period; and
9) allows recovery of "net" Stranded Costs and implementation costs incurred as
a result of the passage of the act. In July 2002, the MPSC issued an order
approving the plan to achieve the increased transmission capacity. Consumers has
completed the transmission capacity projects identified in the plan and has
submitted verification of this fact to the MPSC. Consumers believes it is in
full compliance with item 7 above.
In 1998, Consumers submitted a plan for electric retail open access to the MPSC.
In March 1999, the MPSC issued orders generally supporting the plan. The
Customer Choice Act states that the MPSC orders issued before June 2000 are in
compliance with this act and enforceable by the MPSC. Those MPSC orders: 1)
allow electric customers to choose their supplier; 2) authorize recovery of
"net" Stranded Costs and implementation costs; and 3) confirm any voluntary
commitments of electric utilities. In September 2000, as required by the MPSC,
Consumers once again filed tariffs governing its retail open access program and
made revisions to comply with the Customer Choice Act. In December 2001, the
MPSC approved revised retail open access tariffs. The revised tariffs establish
the rates, terms, and conditions under which retail customers will be permitted
to choose an alternative electric supplier. The tariffs, effective January 1,
2002, did not require significant modifications in the existing retail open
access program. The tariff terms allow retail open access customers, upon as
little as 30 days notice to Consumers, to return to Consumers' generation
service at current tariff rates. If any class of customers' (residential,
commercial, or industrial) retail open access load reaches 10 percent of
Consumers' total load for that class of customers, then returning retail open
access customers for that class must give 60 days notice to return to Consumers'
generation service at current tariff rates. However, Consumers may not have
sufficient, reasonably priced, capacity to meet the additional demand of
returning retail open access customers, and may be forced to purchase
electricity on the spot market at higher prices than it could recover from its
customers. Consumers cannot predict the total amount of electric supply load
that may be lost to competitor suppliers, nor whether the stranded cost recovery
method adopted by the MPSC will be applied in a manner that will fully offset
any associated margin loss.
SECURITIZATION: The Customer Choice Act allows for the use of low-cost
Securitization bonds to refinance certain qualified costs, as defined by the
act. Securitization typically involves issuing asset-backed bonds with a higher
credit rating than conventional utility corporate financing. In 2000 and 2001,
the MPSC issued orders authorizing Consumers to issue Securitization bonds.
Consumers issued its first Securitization bonds in 2001.
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Consumers Energy Company
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, $25 million for the six months ended June 30
2003, and $24 million for the six months ended June 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,
previously unsecuritized Palisades expenditures, 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. Consumers
believes unsecuritized Palisades expenditures should be included as a component
of "net" Stranded Costs.
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 order by the MPSC 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. The financing order will become
effective after rehearing 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
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Consumers Energy Company
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 previously unsecuritized
Palisades expenditures were approved as proposed in its securitization case as
discussed above in "Securitization", then Consumers' "net" Stranded Costs
incurred in 2002 are approximately $35 million. If the proposal to securitize
those costs is not approved, then Consumers indicated that the costs would be
properly included in the 2002 "net" Stranded Cost calculation, which would
increase Consumers' 2002 "net" Stranded Costs to approximately $103 million.
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 previously unsecuritized Palisades expenditures as eligible
securitized costs. As a result, the previously unsecuritized Palisades
expenditures 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 previously unsecuritized Palisades
expenditures, 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 further 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.
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In Millions
- --------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 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 orders 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 June 30, 2003, Consumers incurred and deferred as a regulatory asset, $2
million of additional implementation costs and has also recorded a regulatory
asset of $15 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 filed a petition for rehearing with the FERC and in July
2003, the FERC granted Consumers' petition for rehearing. Consumers cannot
predict the amount of implementation costs the FERC will ultimately order to be
reimbursed by MISO.
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 FERC's
finally approved OATT rates. Since the initial decision, Consumers has been
reserving a portion of revenues billed to customers under the filed 1996 OATT
rates. Consumers submitted revised rates to comply with the FERC final order in
June 2002. Those revised rates were accepted by the FERC in August 2002 and
Consumers is in the process of computing refund amounts for individual
customers. Consumers believes its reserve is sufficient to satisfy its refund
obligation. As of July 2003, Consumers had paid $27 million in refunds.
Other Rate Proceedings -- In November 2002, the MPSC, upon its own motion,
commenced a contested proceeding requiring each utility to give reason as to why
its rates should not be reduced to reflect new personal property tax multiplier
tables, and why it should not refund any amounts that it receives as refunds
from local governments as they implement the new multiplier tables. Consumers
responded to the MPSC that it believes that refunds would be inconsistent with
the electric rate freeze that is currently in effect, and may otherwise be
unlawful. In May 2003, the MPSC determined that it would not pursue changes in
rates for all gas and electric utilities as a result of reductions in personal
property taxes since these cost reductions will be address in rate case filings
by individual utilities.
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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 be
decreased by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a loss of revenue from wholesale and
retail open access customers who will buy services directly from MTH and the
loss of a return on the sold electric transmission system.
Under an agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers are fixed by contract at current levels
through December 31, 2005, and subject to FERC ratemaking thereafter. MTH has
completed the capital program to expand the transmission system's capability to
import electricity into Michigan, as required by the Customer Choice Act, and
Consumers will continue to maintain the system until May 1, 2007 under a
contract with MTH.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin. The reserve margin provides additional
power supply capability above Consumers' anticipated peak power supply demands.
It also allows Consumers to provide reliable service to its electric service
customers and to protect itself against unscheduled plant outages and
unanticipated demand. In recent years, Consumers has planned for a reserve
margin of approximately 15 percent from a combination of its owned electric
generating plants and electricity purchase contracts or options, as well as
other arrangements. However, in light of various factors, including the addition
of new generating capacity in Michigan and throughout the Midwest region and
additional transmission import capability, Consumers is continuing to evaluate
the appropriate reserve margin for 2003 and beyond. Currently, Consumers has an
estimated reserve margin of approximately 11 percent for summer 2003 or supply
resources equal to 111 percent of projected summer peak load. Of the 111
percent, approximately 101 percent is met from owned electric generating plants
and long-term power purchase contracts and 10 percent from short-term contracts
and options for physical deliveries and other agreements. The ultimate use of
the reserve margin will depend primarily on summer weather conditions, the level
of retail open access requirements being served by others during the summer, and
any unscheduled plant outages. As of July 2003, alternative electric suppliers
are providing 575 MW of generation supply to ROA customers. Consumers' reserve
margin does not include generation being supplied by other alternative electric
suppliers under the ROA program.
To reduce the risk of high electric prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electric call option and capacity and energy contracts for the physical delivery
of electricity primarily in the summer months and to a lesser degree in the
winter months. As of June 30, 2003, Consumers had purchased or had commitments
to purchase electric call option and capacity and energy contracts covering the
estimated reserve margin requirements for 2003, and partially covering the
estimated reserve margin requirements for 2004 through 2007. As a result,
Consumers has a recognized asset of $26 million for unexpired call options and
capacity and energy contracts. The total cost of electricity call option and
capacity and energy contracts for 2003 is expected to be approximately $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, and would not grant adjustment of customer rates through 2001. As a
result of the rate freeze imposed by the Customer Choice
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Consumers Energy Company
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.
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 June 30, 2003 and 2002 are $243 million and $213
million, respectively.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Operating revenue $18 $18 $34 $27
Operating taxes and other 14 6 19 9
-----------------------------------------
Income before cumulative effect of accounting change 4 12 15 18
Cumulative effect of change in method of accounting for
derivatives, net of $9 million tax expense (a) - 17 - 17
-----------------------------------------
Net income $ 4 $29 $15 $35
==================================================================================================================
Summarized Statements of Income for the MCV Partnership
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Operating revenue $142 $146 $295 $295
Operating expenses 84 89 184 198
------------------------------------------
Operating income 58 57 111 97
Other expense, net 29 30 57 59
------------------------------------------
Income before cumulative effect of accounting change 29 27 54 38
Cumulative effect of change in method of accounting for
derivative option contracts (a) - 58 - 58
------------------------------------------
Net income $ 29 $ 85 $ 54 $ 96
==================================================================================================================
(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
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Consumers Energy Company
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 after-tax present value of the estimated future PPA
liability associated with the loss totaled $26 million at June 30, 2003 and $42
million at June 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.
Under Michigan's electric restructuring law, Consumers will return to unfrozen
rates 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 during the next five
years, Consumers' after-tax cash underrecoveries associated with the PPA could
be as follows:
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In Millions
- --------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- --------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
Amount to be charged to operating expense, net of tax $18 $18 $36 $36 $25
Amount to be charged to PPA liability, net of tax $19 $18 $- $- $-
====================================================================================================================
As previously noted, the PPA requires Consumers to pay capacity costs based on
the MCV Facility's actual availability up to the 98.5 percent cap. Prior to
1998, Consumers was only allowed to recover MCV capacity costs that were
associated with actual energy deliveries (subject to certain caps established by
the MPSC). This recovery method essentially required Consumers to dispatch the
MCV Facility on a full-time basis, regardless of the overall cost compared to
other sources available to Consumers. Consistent with the initial PSCR freeze,
in the first quarter of 1998, Consumers began economically dispatching the MCV
Facility by scheduling deliveries on an economic basis. Consumers has continued
to economically dispatch the MCV Facility as a result of the overall rate freeze
implemented consistent with Public Acts 141 and 142. When Consumers returns to
the PSCR, beginning in January 2004, current MPSC orders will again only allow
Consumers to recover capacity charges from customers based on actual energy
deliveries up to the caps. Compared to periods under the rate freeze, the return
to full-time dispatch of the MCV Facility could have the effect of reducing the
earnings of CMS Midland via its ownership interest in the MCV Partnership. This
would be the result of MCV Partnership earnings being negatively impacted by the
relationship of higher fuel costs resulting from higher generation levels and
changing natural gas prices, compared to the MCV Partnership's recovery of fuel
costs, which is, in large part, based on costs associated with Consumers' coal
plants.
Consumers is exploring possible alternatives that would allow Consumers to
continue dispatching the MCV Facility on an economic basis in 2004 and beyond,
without increasing costs to customers or impairing future earnings. Any changes
regarding the recovery of MCV capacity costs would require MPSC approval.
Consumers cannot predict the outcome of this issue.
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 court
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 load out 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 preparations are in the advanced stage for the removal and shipment of the
reactor vessel in the fall of 2003. The License Termination Plan was submitted
to the NRC staff for review in April 2003. System dismantlement and building
demolition continue on a
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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 are being performed in accordance
with applicable regulatory and license requirements.
In February 2003, the NRC completed its end-of-cycle plant performance
assessment of Palisades. The end-of-cycle review for Palisades covered the 2002
calendar year. The NRC determined that Palisades was operated in a manner that
preserved public health and safety and fully met all cornerstone objectives.
Based on the plant's performance, only regularly scheduled inspections are
planned through March 2004. The NRC noted that it is planning inspections of the
new independent spent fuel storage facility, as needed during construction
activities along with routine inspections for the new security requirements.
Spent Nuclear Fuel Storage: During the fourth quarter of 2002, equipment
fabrication, assembly and testing was completed at Big Rock on NRC-approved
transportable steel and concrete canisters or vaults, commonly known as
"dry-casks." 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. These transportable dry casks will remain
onsite until the DOE moves the material to a permanent national fuel repository.
At Palisades, the amount of spent nuclear fuel discharged from the reactor to
date exceeds Palisades' temporary onsite storage pool capacity. Consequently,
Consumers is using dry casks for temporary onsite storage. As of June 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.
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.
As of June 30, 2003, Consumers has a recorded liability to the DOE of $138
million, including interest, which is payable upon the first delivery of spent
nuclear fuel to the DOE. Consumers recovered through electric rates the amount
of this liability, excluding a portion of interest.
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
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Consumers Energy Company
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.
In July 2002, Congress approved and the President signed a bill designating the
site at Yucca Mountain, Nevada, for the development of a repository for the
disposal of high-level radioactive waste and spent nuclear fuel. The next step
will be for the DOE to submit an application to the NRC for a license to begin
construction of the repository. The application and review process is estimated
to take several years.
Palisades Plant Operations: In March 2002, corrosion problems were discovered in
the reactor head at an unaffiliated nuclear power plant in Ohio. As a result,
the NRC requested that all United States nuclear plants utilizing pressurized
water reactors 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. 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 $2.7 billion in recoverable limits for the Palisades nuclear
plant. Consumers also procures coverage from NEIL that would partially cover the
cost of replacement power during certain prolonged accidental outages at
Palisades. NEIL's policies include coverage for acts of terrorism.
Consumers retains the risk of loss to the extent of the insurance deductibles
and to the extent that its loss exceeds its policy limits. Because NEIL is a
mutual insurance company, Consumers could be subject to assessments from NEIL up
to $25.8 million in any policy year if insured losses in excess of NEIL's
maximum policyholders surplus occur at its, or any other member's, nuclear
facility.
Consumers maintains nuclear liability insurance for injuries and off-site
property damage resulting from the nuclear hazard at Palisades for up to
approximately $9.5 billion (effective August 20, 2003, $11 billion), the maximum
insurance liability limits established by the Price-Anderson Act. Congress
enacted the Price-Anderson Act to provide financial protection for persons who
may be liable for a nuclear accident or incident and persons who may be injured
by a nuclear incident. The Price-Anderson Act was recently extended to December
31, 2003. Part of the Price-Anderson Act's financial protection consists of a
mandatory industry-wide program under which owners of nuclear generating
facilities could be assessed if a nuclear incident occurs at any of such
facilities. The maximum assessment against Consumers could be $88 million per
occurrence (effective August 20, 2003, $101 million), limited to maximum annual
installment payments of $10 million. Consumers also maintains insurance under a
master worker program that covers tort claims for bodily injury to workers
caused by nuclear hazards. The policy contains a $300 million nuclear industry
aggregate limit. Under a previous insurance program providing coverage for
claims brought by nuclear workers, Consumers remains responsible for a maximum
assessment of up to $6.3 million. The Big Rock plant remains insured for nuclear
liability by a combination of insurance and United States government indemnity
totaling $544 million.
Insurance policy terms, limits and conditions are subject to change during the
year as Consumers renews its policies.
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GAS CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at sites as studies are completed. Consumers has
estimated its costs related to investigation and remedial action for all 23
sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic Cost
Model. The estimated total costs are between $82 million and $113 million; these
estimates are based on discounted 2001 costs and follow EPA recommended use of
discount rates between three and seven percent for this type of activity.
Consumers expects to fund a significant portion of these costs through insurance
proceeds and through MPSC approved rates charged to its customers. As of June
30, 2003, Consumers has an accrued liability of $48 million, net of $34 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.
GAS RATE MATTERS
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation process with the MPSC, Consumers expects to collect all of its
incurred gas costs. On June 30, 2003, Consumers filed a reconciliation of GCR
costs and revenues for the 12-month period April 2002 through March 2003. In the
filing, Consumers proposed to recover from customers a net under-recovery of
approximately $6 million according to a roll-in methodology, which incorporates
the under-recovery in rates charged in the succeeding GCR year. The roll-in
tariff provision was approved by the MPSC in a November, 2002 order.
Under an order issued by the MPSC 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 current ceiling price is $6.11 per mcf. However, Consumers
will utilize an August GCR factor of $5.56 per mcf to bill its customers.
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 include a 13.5 percent authorized 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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PROPERTY TAX MULTIPLIER: In November 2002, the MPSC upon its own motion
commenced a contested proceeding requiring each utility to give reason as to why
its rates should not be reduced to reflect new personal property tax multiplier
tables, and why it should not refund any amounts that it receives as refunds
from local governments as they implement the new multiplier tables. Consumers
responded to the MPSC that it believes that refunds would be inconsistent with
the November 7, 2002 gas rate order in case U-13000, with the Customer Choice
Act, and may otherwise be unlawful. In May 2003, the MPSC determined that it
would not pursue changes in rates for all gas and electric utilities as a result
of reductions in personal property taxes since these cost reductions will be
addressed in rate case filings by individual utilities.
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 June 30, 2003, Consumers
has incurred approximately $6 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 six 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 uses a variety of contracts to protect against
commodity price and interest rate risk. Some of these contracts may be subject
to derivative accounting, which requires that the value of the contracts to be
adjusted fair value through earnings or equity depending upon certain criteria.
Such adjustments to fair value could cause earnings volatility. For further
information about derivative activities, see Note 4, Financial and Derivative
Instruments.
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 June 30, 2003, Consumers had FERC
authorization to issue or guarantee through June 2004, up to $1.1 billion of
short-term securities outstanding at any one time. In June 2003, the FERC
granted Consumers' request to issue an additional $1.1 billion outstanding at
any one time of first mortgage bonds to act solely as collateral for short-term
securities. In June 2003, the FERC also granted Consumers' request for an
increase in its authorization for long-term debt. At June 30, 2003, Consumers
had remaining FERC authorization to issue through June 2004 up to $1.0 billion
of long-term securities for refinancing or refunding purposes, $760 million for
general corporate purposes, and $2.06 billion of first mortgage bonds to be
issued solely as collateral for the long-term securities. These amounts include
the June 2003 increase in FERC authorization. In October 2002, FERC granted a
waiver of its competitive
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bid/negotiated placement requirements applicable to the remaining long-term
securities authorization indicated above.
SHORT-TERM FINANCINGS: In March 2003, Consumers obtained a replacement revolving
credit facility in the amount of $250 million secured by first mortgage bonds,
this debt facility was paid down and had a zero balance outstanding at June 30,
2003. The cost of the facility is LIBOR plus 350 basis points. The new credit
facility matures in March 2004 with two annual extensions at Consumers' option,
which would extend the maturity to March 2006. The prior facility was due to
expire in July 2003. At June 30, 2003, a total of $1 million was outstanding on
all short-term financings at a weighted average interest rate of 3.17 percent,
compared with $255 million outstanding at June 30, 2002 at a weighted average
interest rate of 2.6 percent.
LONG-TERM FINANCINGS: In March 2003, Consumers entered into a $140 million term
loan secured by first mortgage bonds with a private investor bank. This loan has
a term of six years at a cost of LIBOR plus 475 basis points. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured by first
mortgage bonds. This term loan has a three-year maturity expiring in March 2006;
the loan has a cost of LIBOR plus 450 basis points. Proceeds from this loan were
used for general corporate purposes.
The revolving credit facility and the term loan mentioned above have contractual
restrictions that require Consumers to maintain, as of the last day of each
fiscal quarter, the following:
Limitation Ratio at June 30, 2003
==================================================================================================================
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.57 to 1.00
Interest Coverage Ratio - Revolver(a)(b) Not less than 2.00 to 1.00 3.83 to 1.00
Interest Coverage Ratio - Term Loan(a)(b) Not less than 2.00 to 1.00 3.98 to 1.00
===================================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facilities provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
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, June 30, 2003. These covenants make use of both generally
accepted accounting principles and defined contractual terms in specifying how
the relevant calculations are made. After giving effect to the adoption of SFAS
No. 150 regarding the balance sheet classification of its Trust Preferred
Securities and to expected future use of its revolving credit facilities,
Consumers currently estimates that its ratio of indebtedness to total
capitalization at the end of the third and fourth quarters of 2003 will still
comply with the Debt Percentage Tests but will approach the limits specified in
some of the Debt Percentage Tests. Consumers plans to seek amendments to the
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, regarding Trust Preferred Securities on the calculations. Consumers
believes that it will receive the necessary consents of its lenders to these
amendments. However, it is possible that if Consumers does not receive the
necessary amendments and fails to be in compliance with some of the Debt
Percentage Tests such failure could constrain its ability to access its
revolving credit or accounts receivable sales facilities, or to incur additional
indebtedness, and could also result in defaults under one or more of these
agreements.
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 of 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 has agreed to file a
registration statement with the SEC to permit holders of these first mortgage
bonds to exchange the bonds for new bonds that will be registered under the
Securities Act of 1933. Consumers has agreed to file this registration statement
by December 26, 2003.
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 in May 2010, and net proceeds were
approximately $247 million. Consumers used the net proceeds to pay down existing
debt. Consumers has agreed to file a registration statement with the SEC to
permit holders of these first mortgage bonds to exchange the bonds for new bonds
that will be registered under the Securities Act of 1933.
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Consumers has agreed to file this registration statement by December 26, 2003.
Consumers secures its first mortgage bonds by a mortgage and lien on
substantially all of its property. Consumers' ability to issue and sell
securities is restricted by certain provisions in its first mortgage bond
Indenture, its articles of incorporation and the need for regulatory approvals
to meet appropriate federal law.
MANDATORILY REDEEMABLE PREFERRED SECURITIES: Consumers has wholly owned
statutory business trusts that are consolidated within its financial statements.
Consumers created these trusts for the sole purpose of issuing Trust Preferred
Securities. The primary asset of the trusts is a note or debenture of Consumers.
The terms of the Trust Preferred Security parallel the terms of the related
Consumers' note or debenture. The term, rights and obligations of the Trust
Preferred Security and related note or debenture are also defined in the related
indenture through which the note or debenture was issued, Consumers' guarantee
of the related Trust Preferred Security and the declaration of trust for the
particular trust. All of these documents together with their related note or
debenture and Trust Preferred Security constitute a full and unconditional
guarantee by Consumers of the trust's obligations under the Trust Preferred
Security. In addition to the similar provisions previously discussed, specific
terms of the securities follow. The classification of these securities will be
impacted by the new accounting standard SFAS No. 150. For further information
see Note 5, Implementation of New Accounting Standards.
In Millions
- ------------------------------------------------------------------------------------------------------------------
Earliest
Trust and Securities Rate Amount Outstanding Maturity Redemption
- ------------------------------------------------------------------------------------------------------------------
June 30 2003 2002 Year
- ------------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $70 $70 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20% 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25% 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00% 125 125 2031 2006
-----------------------
Total $490 $490
=====================================================================================================================
OTHER: In April 2003, Consumers ended its trade receivables sales program with
its existing purchaser. During May 2003, a new trade receivables program was put
in place with a different purchaser. As a result of changing purchasers,
Consumers established a new subsidiary, Consumers Receivables Funding II. This
consolidated subsidiary was established as a special purpose entity in order to
properly reflect the sale of receivables from Consumers to Consumers Receivables
Funding II, through to the purchaser, an unrelated third party. The program's
maximum receivable sale amount of $325 million remains unchanged. Consumers also
will continue to retain servicing responsibilities for the trade receivables
sold, however, the purchaser of the trade 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 sale of trade receivables and Consumers retains no interest in
the receivables sold. Accounts receivable and accrued revenue in the
Consolidated Balance Sheet have been reduced to reflect trade receivables sold.
At June 30 receivables sold under the program totaled $50 million in 2003 and
$311 million in 2002.
DIVIDEND RESTRICTIONS: Under the provisions of its articles of incorporation,
Consumers had $380 million of unrestricted retained earnings available to pay
common dividends at June 30, 2003. However, covenants in Consumers' debt
facilities cap common stock dividend payments at $300 million in a calendar
year. In January 2003, Consumers declared and paid a $78 million common
dividend. In March 2003, Consumers
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declared a $31 million common dividend which was paid in May 2003. In June 2003,
Consumers declared a $53 million common dividend payable in August 2003.
For information on the potential cap on common dividends payable included in the
MPSC Securitization order see, Electric Rate Matters, "Electric 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."
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:
June 30, 2003 In Millions
- -----------------------------------------------------------------------------------------------------------------------
Issue Expiration Maximum Carrying Recourse
Guarantee Description Date Date Obligation Amount Provision(a)
- -----------------------------------------------------------------------------------------------------------------------
Standby letters of credit Various Various $7 $- $-
Surety bonds Various Various 8 - -
Nuclear insurance retrospective premiums Various Various 120 - -
=======================================================================================================================
(a) Recourse provision indicates the approximate recovery from third parties
including assets held as collateral.
Following is additional information regarding Consumers' guarantees:
June 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 Act
premiums for nuclear incident
- ----------------------------------------------------------------------------------------------------------------------
4: FINANCIAL AND DERIVATIVE INSTRUMENTS
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. Consumers estimates the fair values of long-term investments based on
quoted market prices or, in the absence of specific market prices, on quoted
market prices of similar investments or other valuation techniques. The carrying
amounts of all long-term investments, except as shown below, approximate fair
value.
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In Millions
- -------------------------------------------------------------------------------------------------------------------
June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Cost Fair Unrealized Cost Fair Unrealized
Available for sale securities Value Gain Value Gain (Loss)
- -------------------------------------------------------------------------------------------------------------------
Common stock of CMS Energy(a) $10 $19 $9 $35 $26 $(9)
SERP 17 20 3 19 20 1
Nuclear decommissioning investments(b) 453 553 100 465 555 90
===================================================================================================================
(a) Consumers recognized a $12 million loss on this investment in 2002 and an
additional $12 million loss in the first quarter of 2003 because the loss was
other than temporary, as the fair value was below the cost basis for a period
greater than six months. As of June 30, 2003, Consumers held 2.4 million shares
of CMS Energy Common Stock with a fair value of $19 million.
(b) On January 1, 2003, Consumers adopted SFAS No. 143 and began classifying its
unrealized gains and losses on nuclear decommissioning investments as regulatory
liabilities. Consumers previously classified these investments in accumulated
depreciation.
At June 30, 2003, the carrying amount of long-term debt was $3.3 billion and at
June 30, 2002, $2.4 billion, and the fair values were $3.5 billion and $2.4
billion, respectively. For held-to-maturity securities and related-party
financial instruments, see Note 1.
RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS: Consumers is exposed to
market risks including, but not limited to, changes in interest rates, commodity
prices, and equity security prices. Consumers' market risk, and activities
designed to minimize this risk, are subject to the direction of an executive
oversight committee consisting of designated members of senior management and a
risk committee, consisting of certain business unit managers. Established
policies and procedures are used to manage the risks associated with market
fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Consumers enters into all risk management contracts for purposes other than
trading.
These instruments contain credit risk if the counterparties, including financial
institutions and energy marketers, fail to perform under the agreements.
Consumers minimizes such risk by performing financial credit reviews using,
among other things, publicly available credit ratings of such counterparties.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. SFAS No. 133 requires Consumers to
recognize at fair value all contracts that meet the definition of a derivative
instrument on the balance sheet as either assets or liabilities. The standard
also requires Consumers to record all changes in fair value directly in
earnings, or accumulated other comprehensive income if the derivative meets
certain qualifying cash flow hedge criteria. In order for derivative instruments
to qualify for hedge accounting under SFAS No. 133, the hedging relationship
must be formally documented at inception and be highly effective in achieving
offsetting cash flows or offsetting changes in fair value attributable to the
risk being hedged. If hedging a forecasted transaction, the forecasted
transaction must be probable. If a derivative instrument, used as a cash flow
hedge, is terminated early because it is probable that a forecasted transaction
will not occur, any gain or loss as of such date is immediately recognized in
earnings. If a derivative instrument, used as a cash flow hedge, is terminated
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early for other economic reasons, any gain or loss as of the termination date is
deferred and recorded when the forecasted transaction affects earnings.
Consumers determines fair value based upon quoted market prices. The ineffective
portion, if any, of all hedges is recognized in earnings.
The majority of Consumers' contracts are not subject to derivative accounting
because they qualify for the normal purchases and sales exception of SFAS No.
133. Derivative accounting is required, however, for certain contracts used to
limit Consumers' exposure to electricity and gas commodity price risk and
interest rate risk.
The following table reflects the fair value of contracts requiring derivative
accounting:
In Millions
- ------------------------------------------------------------------------------------------------------------------
June 30 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Fair Fair
Derivative Instruments Cost Value Cost Value
- -------------------------------------------------------------------------------------------------------------------
Electric - related contracts $8 $ - $19 $ 2
Gas contracts 2 1 - 2
Interest rate risk contracts - - - (2)
Derivative contracts associated with Consumers'
equity investment in the MCV Partnership - 20 - 2
===================================================================================================================
The fair value of all derivative contracts, except the fair value of derivative
contracts associated with Consumers' equity investment in the MCV Partnership,
is included in either Other Assets or Other Liabilities on the Balance Sheet.
The fair value of derivative contracts associated with Consumers' equity
investment in the MCV Partnership is included in Investments - Midland
Cogeneration Venture Limited Partnership on the Balance Sheet. April 1, 2002,
the MCV Partnership changed its accounting for derivatives, see Note 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 June 30, 2003, Consumers recorded on the
balance sheet those unexpired purchased electric call option contracts that are
subject to derivative accounting at a fair value of $413 thousand. These
contracts will expire in the third quarter of 2003.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market in the state of
Michigan, as defined by SFAS No. 133, and the transportation cost to deliver the
power under the contracts to the closest active energy market at the Cinergy hub
in Ohio. If a market develops in the future, Consumers may be required to
account for these contracts as derivatives. The mark-to-market impact in
earnings related to these contracts, particularly related to the PPA could be
material to the financial statements.
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 June 30, 2003, gas fuel for generation call option
contracts had a fair value that is not significant. As of June 30, 2002, gas
fuel for generation swap contracts had a fair value of $1 million. These
contracts expired in December 2002.
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For the three and six months ended June 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 $2 million and $5 million, net of
tax, respectively. As of June 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 $13 million, net of tax. Consumers
expects to reclassify this gain, if this value remains, as an increase to other
operating revenue during the next 12 months.
GAS CONTRACTS: Consumers' gas business uses fixed price gas supply contracts,
and fixed price weather-based gas supply call options and fixed price gas supply
put options, and other types of contracts, to meet its regulatory obligation to
provide gas to its customers at a reasonable and prudent cost. During 2002, some
of the fixed price gas supply contracts and the weather-based gas call options
and gas put options required derivative accounting. The fixed price gas supply
contracts requiring derivative accounting expired in October 2002. As of June
30, 2003, weather-based gas call options and gas put options requiring
derivative accounting had a net fair value of $1 million. The original cost of
the options was a net $2 million. Consumers recorded an unrealized loss of $1
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.
INTEREST RATE RISK CONTRACTS: Consumers uses interest rate swaps to hedge the
risk associated with forecasted interest payments on variable-rate debt. These
interest rate swaps are designated as cash flow hedges. As such, Consumers will
record any change in the fair value of these contracts in accumulated other
comprehensive income unless the swaps are sold. As of June 30, 2002, Consumers
had entered into a swap to fix the interest rate on $75 million of variable-rate
debt. This swap expired in June 2003. As of June 30, 2002, this interest rate
swap had a negative fair value of $2 million.
Consumers also uses interest rate swaps to hedge the risk associated with the
fair value of its debt. These interest rate swaps are designated as fair value
hedges. In March 2002, Consumers entered into a fair value hedge to hedge the
risk associated with the fair value of $300 million of fixed-rate debt, issued
in March 2002. In June 2002, this swap was terminated and resulted in a $7
million gain that is deferred and recorded as part of the debt. It is
anticipated that this gain will be recognized over the remaining life of the
debt.
Consumers was able to apply the shortcut method to all interest rate hedges,
therefore there was no ineffectiveness associated with these hedges.
5: IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning January
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.
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Consumers Energy Company
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.
The following table is a general description of the AROs and their associated
long-lived assets.
June 30, 2003 In Millions
- -------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- -------------------------------------------------------------------------------------------------------------------
Palisades - decommission plant site 1972 Palisades nuclear plant $ 455
Big Rock - decommission plant site 1962 Big Rock nuclear plant 97
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.
June 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 6/30/03
- ------------------------------- --------- ----------------------------------------------------------------------
Palisades - decommission $232 $249 $ - $ - $ 9 $ - $258
Big Rock - decommission 94 61 - (18) 6 - 49
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - (1) 3 - 53
Wells at gas storage fields 2 2 - - - - 2
Indoor gas services relocations 1 1 - - - - 1
----------------------------------------------------------------------------
Total $375 $364 $ - $(19) $18 $ - $363
===================================================================================================================
SFAS NO. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES:
Issued by the FASB in July 2002, this standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. This standard is
effective for exit or disposal activities initiated after December 31, 2002.
Upon adoption of the standard, there was no impact on Consumers' consolidated
financial statements.
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Consumers Energy Company
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. Consumers has not
created any variable interest entities in 2003. Therefore, this portion of the
interpretation has no impact on its consolidated financial statements. This
interpretation's consolidation requirements also apply to pre-existing entities
beginning July 1, 2003. Consumers will be required to consolidate any entities
that meet the requirements of this portion of the interpretation. Consumers is
in the process of studying this interpretation and has yet to determine the
effects, if any, on its consolidated financial statements.
Although Consumers has not determined the effect of this interpretation, it is
possible that Consumers may be required to consolidate in its financial
statements, the assets, liabilities and activities of the MCV Partnership. If
that should occur, Consumers would have to recognize the MCV Partnership debt on
its financial statements. This could negatively impact 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.
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. Consumers is in the process of
studying this statement, and has yet to determine the effects, if any, the
statement will have on accounting for contracts entered into after June 30,
2003.
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 determined that all of its trust preferred securities fall under
the scope of SFAS No. 150. These securities have fixed redemption dates and
amounts and qualify as mandatorily redeemable preferred securities under SFAS
No. 150. On July 1, 2003, mandatorily redeemable preferred securities totaling
$490 million were reclassified from the mezzanine equity section to the
liability section of Consumers' consolidated balance sheet. Beginning July
1, 2003, periodic payments will be recorded as interest expense rather than
dividends. In accordance with SFAS No. 150, prior periods will not be restated.
Consumers did not incur any cumulative impact due to this accounting change.
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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 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 will serve as an independent litigation committee to determine
whether it is in the best interest of the company to bring the action demanded
by the shareholder. Counsel for the shareholder has agreed to extend the time
for CMS Energy to respond to the demand. CMS Energy cannot predict the outcome
of this litigation.
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.
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, 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 have
been filed against CMS Energy, Consumers, and certain officers and directors of
CMS Energy and its affiliates. The complaints have been 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 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 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
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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
(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 2nd Quarter 2003, CMS Energy filed reports of Form 8-K on April 1 and May
8, 2003 (covering matters pursuant to ITEM 12. RESULTS OF OPERATIONS AND
FINANCIAL CONDITION), April l, 2003 (covering matters pursuant to ITEM 9.
REGULATION FD DISCLOSURE), May 1, 2003 (covering matters pursuant to ITEM 5.
OTHER EVENTS), and June 24, 2003 (covering matters pursuant to ITEM 2.
ACQUISITION OR DISPOSITION OF ASSETS, including unaudited pro forma condensed
consolidated financial statements).
CONSUMERS
During 2nd Quarter 2003, Consumers filed reports of Form 8-K on April 1 and May
8, 2003 (covering matters pursuant to ITEM 12. RESULTS OF OPERATIONS AND
FINANCIAL CONDITION), April 1, 2003 (covering matters pursuant to ITEM 9.
REGULATION FD DISCLOSURE), and May 1, 2003 (covering matters pursuant to ITEM 5.
OTHER EVENTS).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiary.
CMS ENERGY CORPORATION
(Registrant)
Dated: August 13, 2003 By: /s/ Thomas J. Webb
----------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CONSUMERS ENERGY COMPANY
(Registrant)
Dated: August 13, 2003 By: /s/ Thomas J. Webb
----------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
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CMS ENERGY AND CONSUMERS EXHIBITS
EXHIBIT NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
(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